Mortgage Daily

Published On: December 31, 2015

Robert Shiller is the ordinary citizen’s economist.

He may be a Nobel prize winner with an impeccable mathematics background, but it is human behavior and the real world which drives his thinking.

He is a great believer in free markets but warns that the economic system ‘is filled with trickery’ and thinks everyone should know that.

As a new year gets under way, Shiller fears that advanced economies could be on the cusp of another stock market and property bubble that could end in tears.

A tall, languid figure, with floppy, graying blond hair, Shiller talks in a drawl and freely uses anecdotes to illustrate his points.

Unlike many academic economists, he has tried his hand at business and believes that he inherited the entrepreneurial spirit from his Lithuanian father. He invented an industrial oven and obtained a patent, but it wasn’t a success.

“But I got some kind of culture from that,” Shiller says.

Among his own achievements was founding consulting firm Case Shiller Weiss, famous in the United States for collecting and analyzing house prices across America’s 50 states — the Case-Shiller Home Price Index.

If it had been tracked more carefully by the investment banks and credit rating agencies in the build-up to the financial crisis of 2007-2009, it would have flashed obvious warnings.

“We found in the boom cities the expectations for home prices was extraordinary. In Los Angeles we got an estimate of 22 percent for the next ten years,” he recalls.

Our conversation takes place at the Royal Society of Arts in London where the economist was on a book tour to promote Phishing for Phools co-written with another Nobel prize winner George Akerlof. His fellow author is an IMF economist who is married to the chairman of the Federal Reserve Board, Janet Yellen.

The theme of the book is that those who distort markets “phish” by getting people to do things that are in the interest of the “phisherman” but not in the interest of the target — who he calls the “phool.”

It is through this prism that Shiller, who won the Nobel prize for economics in 2013, views the great financial crisis.

Among the institutions at the core of that crisis were the credit ratings agencies Moody’s and Standard & Poor’s, which gave exemplary ‘AAA’ ratings to mortgage securities that contained subprime home loans that were never going to be paid back.

This was anathema to Shiller, who regards John Moody, the pioneer behind the credit ratings agency Moody’s Investors Services, as a hero.

Moody, Shiller notes, was a skillful financial analyst and wanted to be a millionaire. His cohorts recommended that he keep his data secret and use the information he gathered to make a market killing.

Instead, Moody published bond books which revealed his ratings.

It was a golden rule that Moody’s would not take money from people he rated. As a result the firm won a reputation for great integrity.

Shiller observes that in the 1970s that started to change and Moody’s began ‘accepting money for their ratings’ and became lax. The result in his view is that it became vulnerable to “reputation mining” where someone in the enterprise thinks they can make a fortune by cashing in on an established integrity. In his view free markets do not protect against such ethical lapses.

Shiller has impeccable economic credentials, having received his PhD from the Massachusetts Institute of Technology with the father of mathematical economics, Paul Samuelson, among his mentors.

But like another great economics writer, John Kenneth Galbraith, he wants his work to be accessible to the ordinary investor and reader.

In much the same way as he thinks Moody’s lost its way in the financial crisis, he is equally disparaging of the investment banks.

Goldman Sachs, he argues, took a wrong turn when it stopped being a partnership. Until then the founders and their successors were personally liable for the success or failure of the firm, and valued reputation. In 1987 Goldman underwrote an $87 million issue of bonds for the Penn Central railway which went bust leaving it with a lawsuit that almost brought it down.

Shiller says it was a remainder to every investment bank that they had to be “squeaky clean.”

As a corporation, Goldman took a different route, finding it could make huge profits by borrowing money and trading it on its own account. No longer did old rules apply and, like other investment banks, it was sucked into the subprime mortgage crisis.

Shiller is concerned that once again markets may be showing over-exuberance.

“I’ve tried to inquire why we are having these booms right now at a time of so-called secular stagnation with low interest rates, and arrived at the thought that low interest rates are promoting these bubbles.

“Central banks caused them but that’s only part of the truth. There are other things happening that may contribute to a high stock market and a high housing market.

“That is a sort of anxiety about inequality and about technology. I think we have much more angst now about where we will be in ten, 20 or 30 years.”

If Shiller were in charge of London, what would he do to resolve the house price bubble George Osborne seeks to burst by raising stamp duty?

He suggests I observe New York’s isolated tower 432 Park Avenue, the tallest building in the city.

“It looks like a toothpick sticking up.”

“You want a 100 of those in London. There’s room for them, you just tear down a relatively small amount of historic London. That would solve the problem,” he suggests, without irony and knowing that such suggestions will be greeted with scowls.

What is refreshing about Shiller is that although he thinks in maths — he muses over breakfast on the Roche limit (the gravitational pull of a satellite) — it is sociology, behavior and newspaper clippings that drive his thinking.

He is scornful of academics that exclude everyday matters such as “dishonesty” in their writings.

“You can write a popular book claiming crooks were behind the financial crisis, but you won’t see that in scholarly journals,” he notes.

Too right.

Phishing for Phools — George A Akerlof and Robert J Shiller, Princeton University Press.

Critic: The Yale economist disparages investment banks.

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