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The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It

Author : Robert J. Shiller Number of Pages : 208 Publisher : Princeton University Press

Product Description

The subprime mortgage crisis has already wreaked havoc on the lives of millions of people and now it threatens to derail the U.S. economy and economies around the world. In this trenchant book, best-selling economist Robert Shiller reveals the origins of this crisis and puts forward bold measures to solve it. He calls for an aggressive response--a restructuring of the institutional foundations of the financial system that will not only allow people once again to buy and sell homes with confidence, but will create the conditions for greater prosperity in America and throughout the deeply interconnected world economy.

Shiller blames the subprime crisis on the irrational exuberance that drove the economy's two most recent bubbles--in stocks in the 1990s and in housing between 2000 and 2007. He shows how these bubbles led to the dangerous overextension of credit now resulting in foreclosures, bankruptcies, and write-offs, as well as a global credit crunch. To restore confidence in the markets, Shiller argues, bailouts are needed in the short run. But he insists that these bailouts must be targeted at low-income victims of subprime deals. In the longer term, the subprime solution will require leaders to revamp the financial framework by deploying an ambitious package of initiatives to inhibit the formation of bubbles and limit risks, including better financial information; simplified legal contracts and regulations; expanded markets for managing risks; home equity insurance policies; income-linked home loans; and new measures to protect consumers against hidden inflationary effects.

This powerful book is essential reading for anyone who wants to understand how we got into the subprime mess--and how we can get out.

Customer reviews

Disappointing, esp. from Shiller by .. Kenneth Umbach (California USA)
I got the impression that this book was thrown together, in part from earlier published work, to catch the wave of public interest in the subprime meltdown. Much of the content seemed just odd and unrealistic, and Shiller's etymology for "bailout" is ludicrous. (Has he never heard of bailing out a water-filled boat? Or used an American dictionary in preference to the OED? Bailout, in reference to a financial rescue, has been flagged as an Americanism for decades in Webster's New World Dictionary, College Ed.)




His solutions seem too academic, airy, and remote to be of much practical interest to anyone but another academic. I expected better from the author of the wonderful Irrational Exuberance.



Mercifully, it is short and for the most part well written, even if some sections (for example the treatment of the "basket" as an inflation adjusted currency) are befuddling (to this layman, at least).

Thoughtful, straightforward diagnosis and prescription by .. Rolf Dobelli (Luzern Switzerland)
Robert Shiller, the prescient author of the book Irrational Exuberance, offers an insightful examination of the causes of the subprime mortgage crisis, and suggests a list of potential measures for the future. He lays the blame for the subprime crisis on the same oblivious fiscal attitudes that led to the technology bubble of the 1990s and the real estate bubble of the 2000s. Both bubbles involved excessive lending and resulted in severe losses for capital providers. His prescription for dealing with the crisis involves a range of policy measures. In the short term, he calls for bailouts for low-income borrowers who got drawn into subprime scams that they did not understand. For the long term, he proposes a new framework for financial institutions, more transparent information, simpler contracts, improved risk-management markets, equity insurance and home loans linked to income, among other measures. Both his diagnosis and his prescription will be controversial, no doubt, but getAbstract thinks his book is a necessary text for anyone who wants to understand what's happened, and how to survive it and learn from it.

3 for Diagnosis 1 for Solutions. Read why. by .. Gaetan Lion ()
Robert Shiller's track record was impressive at first. He wrote Market volatility in 1992 outlining how stock price volatility was due to psychological speculation as it was disconnected from economic fundamentals. He was right as the stock gyrations in 1987 and 1989 demonstrated. In 2000, he wrote the excellent Irrational Exuberance stating stock prices bubbled up and were bound for a crash. Within three months the NASDAQ did exactly that loosing more than half its value taking the rest of the market on a three year brutal downturn (dot.com Bubble). At this stage, we thought Shiller was blessed with superior insight. Then, he lost his edge by envisioning retail financial insurance products to protect against risks often not worth covering as introduced in his strange The New Financial Order: Risk in the 21st Century. This book recycles many of those confused concepts.




In "The Subprime Solution" Shiller diagnoses the cause of the Subprime crisis and also develops a set of short-term and long-term solutions to fix and prevent this crisis.



His diagnosis is OK. He attributes the overarching cause of the Subprime crisis to bubble psychology. This diagnosis is a repeat of "Irrational Exuberance" focused on residential real estate instead of stock markets. He ties a lot of symptoms such as the increasingly lenient underwriting, lenient Moody's MBS ratings, and investors appetite for MBS to bubble psychology. He thinks bankers, MBS investors, Moody's, hedge funds, homeowners, and condo flippers all thought they could throw caution to the wind since the value of the underlying collateral (home) would shore up all boats.



When Shiller comes up with recommendations he is not convincing. In the short-term he simply suggests we bail out everybody by reviving the Home Owners' Loan Corporation (HOLC) first established in 1933 but no longer in existence. The former HOLC accepted mortgages as collateral for loans to mortgage lenders so long as the mortgages had more lenient terms than the market. This recommendation has several flaws to it. First, it runs into moral hazard. It would bail out with taxpayer's money homeowners who never had the financial resources to buy a house and condo flippers who speculated with other people's money. Second, a good deal of those mortgages has been securitized into complex collaterized bond structures with many tranches sold to international investors. Those mortgages administered by bond trusts are not pledgeable to an HOLC organization.



Shiller's long term recommendations are ineffective. Here he repeats many of the retail insurance products he envisioned in "The New Financial Order." His first recommendation is nationwide government subsidized retail financial advice. Yet, all the financial advice prospective homeowners need is to ask themselves if they can afford the mortgage. If the borrower is not numerate, the creditor should operate in a regulatory environment to be forced to make a prudent decision on his behalf. Shiller recommends the adoption of a new economic currency that would be adjusted for inflation. He feels this would improve price information of homes. In a country with very moderate historical inflation such an economic unit adds much confusion without merit. Shiller also thinks that his creation (with the Chicago Board of Trade) of home price index futures will eliminate bubbles because international investors will short (sell futures) on cities whose home prices appear to have bubbled. But, such futures markets have not eliminated bubbles in stock and commodity prices. Why would they eliminate bubbles in residential real estate? Additionally, those home price index future markets have been in existence for already two years. And, they don't seem to get off the ground. Trading volume is not sufficient to provide valuable price information. Other strange recommendations include his "continuous-workout mortgage" whose term would be adjusted downward to reflect the current income of the specific occupation of the borrower. This entails a huge transfer of risk to the creditors which would result in much higher mortgage rates. Another recommendation is home equity insurance for the borrower. But, it is not the borrower that bears the risk on the collateral value, it is the creditor. This insurance would be of little value to the borrower. Another recommendation is livelihood insurance insuring one's income from the risk of one's specific occupation. This product is not readily feasible. It also understates how transferable many professional skills are and how liquid are labor markets are. In summary, his long term recommendations do not address the Subprime crisis.



I recommend a far better book on the subject: Charles R. Morris The Trillion Dollar Meltdown: Easy Money, High Rollers, and the Great Credit Crash. Also, Shiller feels cities are commodities with urban amenities easily replicable. For an excellent book that explains why this is not so, I recommend Richard Florida's Who's Your City?: How the Creative Economy Is Making Where to Live the Most Important Decision of Your Life

The Troubles with Bubbles by .. Omer Belsky (Haifa, Israel)
Subprime. How often did you use the word three years ago? Today it is all over the news. But what, exactly, is "The Subprime Crisis"? How serious is it? Who is responsible? And what shall be done to solve it?



If you are looking for answers for any of these questions, than, alas, "The Subprime Solution", which comes hyped by some great economic writers (like Gregory Clark, of A Farewell to Alms: A Brief Economic History of the World (Princeton Economic History of the Western World) fame) is not a book for you. Shiller's analysis of the crisis is unsatisfactory, and his solution either mundane or speculative - with serious problems which Shiller overlooks.




Shiller informs us, at great length and repeatedly, that we are facing an extreme crisis. He calls it a "historic turning point in our economy and our culture"(p.1) and repeatedly compares it to the economic reparations inflicted on Germany after the Great War, and to the Great Depression. Watch out for the Hoovervilles! Seriously, such comparisons are unhelpful and unnecessary. The Subprime crisis is grave enough without comparing it to the Great Depression (is the Great Depression some sort of economic answer to Godwin's Law, which states that on every discussion, Hitler must at some point appear? Can't we ever talk about an economic crisis without channeling the nineteen thirties?).



But I digress. From approximately 1998 until 2006, the price of houses in the US rose much above their historical value, without any justification in terms of economic situation, the costs of construction, etc, (p. 36). Why did the prices rise? Well, because everyone thought that they would - and the expectations became self fulfilling prophecies. In short, there was a bubble.



But the bubble, as bubbles do, burst. Many lenders, who have offered mortgages to people based on the assumption that house prices would continue to rise, now have a lot of bad debt. Borrowers, who believed the same thing, now find it difficult to pay back their loans, and thus face the prospects of losing their homes. This problem is exacerbated by all sorts of "new" mortgages, especially ones with adjustable interest rates. As interest rates rise, people who used to be able to pay mortgages are no longer able to do so.



But why was there a real estates bubble, and not a bubble of, say, Tulips (as in the Dutch Tulip mania of the 17th century)? If Shiller knows, he's not sharing. Nor is he telling us how big a problem it is. At the time of writing US unemployment rate is approximately 6%, GDP growth is down and inflation up, but the US does not seem to face either a contraction or hyperinflation, but only a recession. Recessions are part of economic life, and probably altogether unavoidable (which is not to say that US economic policies were ideal or even adequate).





Following his non description of the crisis, Shiller offers one short term solution, six long term ones, and a general call for more sophisticated housing markets.



The short term solution is a bailout. How large a bailout, and of what kind? Shiller mentions several proposals for a bailout, but he does not critically evaluate them. Nor is it entirely clear who he plans to bail out. Most of the time it seems the bailout will target borrowers, but Shiller also says that "it is essential that the... cost of bailouts... not be dumped into the laps of a small set of investors" (p. 108). There's a lot of talk of "getting the bailout right", and a lot of historical analogies (to the Great Depression, of course), but very little description of right and wrong bailouts.



The six long term solutions - as I said earlier - vary from the mundane to the speculative. The mundane: Improving financial databases and financial disclosures (is there anyone who will disagree?) The speculative: Shiller suggests "default options financial planning", what is now commonly known as Libertarian Paternalism - the government will offer a basic option, which people can cope out of (Nudge: Improving Decisions About Health, Wealth, and Happiness). This is of course a useless measure in mortgages, as the mortgage lender drafts the contract, in which you'll sign away your "default options". Shiller therefore slides into good old fashioned paternalism, requiring a notary to approve of mortgages (p. 134). "Libertarian Paternalism" I like; Regular paternalism, not so much. Typically, Shiller does not discuss the costs of his proposal (a Notary would be open to negligence suits by every defaulting borrower, and thus would require a hefty fee, needlessly impeding the transaction). Two further speculative suggestions are (1) a "Financial Watchdog" -equivalent to a Consumer Product Safety Commission, and (2) tax deductions for financial advice. Both suggestions exaggerate the knowledge of financial experts, who are no better at divination than the rest of us. The "Financial Watchdog" (1) runs a great risk of becoming politicized (think about what the Bush administration has done with the EPA), and of being relied upon too greatly. Shiller offers no evidence that tax credits for financial advice (2) are likely to be taken up by the small consumers whom the scheme targets, and to his credit, he admits as much. That he nonetheless dreams of a post-tax-deduction Utopia, where "technology will carry us forward into new dimensions of democratized financial sophistication that we cannot now imagine", is odd (p. 129).



The most interesting long term suggestion is to stop pricing things in currency, and to start using "inflation adjusted currency" or baskets. The government would publish a daily rate of exchange between the basket and the dollars. All prices would be denominated in "baskets". On pay day, one would look at the daily exchange rate between the "basket" and the dollar, and pay dollars based upon that rate. Apparently, such a system works well in Chile.




Again Shiller does not discuss the costs of such changes, and thus it is difficult to know if it is worth the fuss. First, teaching people to use a new measurement system is hard. If you are reading this in your native tongue, you are unlikely to use the metric system, because two hundred odd years after the French Revolution, it is still not widespread in the English Speaking World.



Furthermore, Inflation is not all bad, and so eliminating it is not an unalloyed blessing. There are two advantages to inflation. First, it allows prices (especially wages) to adjust downwards. Most people vehemently oppose pay cuts, but they are more willing to forego raises in difficult times. Second, a point made by Milton Friedman of all people, is that because people buy many different things but sell only a few things, they notice more a rise in their income than moderate rise in prices. Seeing your income going up is emotionally and psychologically satisfying (see Money Mischief: Episodes in Monetary History).



At the end of the book, Shiller argues for the development of sophisticated financial instruments for the housing markets. If (like at least one of the Amazon reviewers) you think speculation was the root of the crisis, you are unlikely to approve. As a fan of free markets, I'm open to the idea. But financial markets for houses would necessarily be very different than the markets for other products. To give just one obvious example, the product in most speculative markets are standardized (gold, dollars, US treasury bonds) - But every house is unique; With a little imagination, one can foresee all kinds of complications that this little fact may cause. Maybe these complications can be resolved, but Shiller's superficial account makes them seem far too easy.



"The Subprime Solution" is not as bad as most books I give 2 stars to; it is not entirely devoid of value. Nevertheless, its superficial account, melodramatic style and general lack of usefulness stop me from rating it any higher.

Too Much Hindsight, Not Enough Foresight. I Expected Better by .. Claus Fosgen ()
As we all know by now, almost all economists are useless. They never forecast anything beyond the next month and their forecasts are consistently wrong, causing them to reforecast each month. They play this game of Monday morning quarterback because they rely only upon the government's "official" but manipulated data and they have neither the creativity nor backbone to think outside the box. Yet, the media gives them so much airtime, probably because they are tied very closely with the government.



Shiller is one of the few economists who is starting to get it. His emphasis of the importance of behavioral finance in the capital markets cannot be understated. But still, he is not much more than a broadcaster. And he offers no investment spin. Why didn't Shiller write a book a year or two ago warning of the problems? It is very easy to explain the sub-prime mess or predict doom and gloom now that the realities are apparent to the least informed consumer. All of the hacks are coming out only now talking on TV about problems. These are the same guys who kept denying there were major problems in 2007 and even 2008.




I suppose what was most disappointing to me was the fact that Shiller really did not lay down specific concrete solutions. Such solutions would be a part of fundamental change in Washington, the financial system and America's very broken free market economy. This book might be one to read down the road, but I do not feel it really adds much to what is going on, what to expect and how to resolve what appears to be the beginning of a depression. I am not so sure Shiller has a full handle on the complexities of America's real problems. But he is certainly not alone.



In my opinion, the real expert in this crisis is Mike Stathis, author of America's Financial Apocalypse. America's Financial Apocalypse: How to Profit from the Next Great Depression (Condensed Edition)



Stathis not only predicts the inevitable collapse of Fannie, Freddie and the banks, but goes far beyond the real estate and banking meltdown and discusses why America is headed for a depression by covering health care, Social Security, oil, free trade, debt, education, foreign acquisition of US assets, etc. His predictions have been 100% accurate and the investment guidance has proved very profitable for me. What is truly amazing is that this book was written in 2006.



I have not seen him being interviewed on TV but have heard him on the radio and he claims mainstream media has censored him because they are trying to hide the truth due to political reasons. I believe this. Just look at the how the media has continued to downplay things-just like they did during the dotcom collapse. Look at all of the shills on TV. The media is more interested in interviewing financial "celebrities" like Alan Greenspan, Jim Cramer and other guys who are always wrong rather than real experts who have been right. Before you read any other book related to housing or the economy, I suggest you read America's Financial Apocalypse. Stathis has proven to be the real expert and he is the only one I will listen to going forward. I am anxiously awaiting more books by him.