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    The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It
    The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It
    The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It
    Ebook184 pages2 hours

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

    By Robert J. Shiller

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    An essential account of the historic subprime mortgage crisis, from the Nobel Prize–winning economist and bestselling author of Irrational Exuberance

    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.

    LanguageEnglish
    PublisherPrinceton University Press
    Release dateSep 24, 2012
    ISBN9781400844999
    The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It

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      The Subprime Solution - Robert J. Shiller

      marriage.

      Introduction

      1

      The subprime crisis is the name for what is a historic turning point in our economy and our culture. It is, at its core, the result of a speculative bubble in the housing market that began to burst in the United States in 2006 and has now caused ruptures across many other countries in the form of financial failures and a global credit crunch. The forces unleashed by the subprime crisis will probably run rampant for years, threatening more and more collateral damage. The disruption in our credit markets is already of historic proportions and will have important economic impacts. More importantly, this crisis has set in motion fundamental societal changes—changes that affect our consumer habits, our values, our relatedness to each other. From now on we will all be conducting our lives and doing business with each other a little bit differently.

      Allowing these destructive changes to proceed unimpeded could cause damage not only to the economy but to the social fabric—the trust and optimism people feel for each other and for their shared institutions and ways of life—for decades to come. The social fabric itself is so hard to measure that it is easily overlooked in favor of smaller, more discrete, elements and details. But the social fabric is indeed at risk and should be central to our attention as we respond to the subprime crisis.

      History proves the importance of economic policies for preserving the social fabric. Europe after World War I was seriously damaged by one peculiar economic arrangement: the Treaty of Versailles. The treaty, which ended the war, imposed on Germany punitive reparations far beyond its ability to pay. John Maynard Keynes resigned in protest from the British delegation at Versailles and, in 1919, wrote The Economic Consequences of the Peace, which predicted that the treaty would result in disaster. Keynes was largely ignored, the treaty remained in force, and indeed Germany never was able to pay the penalties imposed. The intense resentment caused by the treaty was one of the factors that led, a generation later, to World War II.

      A comparable disaster—albeit one not of quite the same magnitude—is brewing today, as similar concerns are hammering at our psyches. Once again, many people, unable to repay their debts, are being pursued aggressively by creditors. Once again, they often feel that the situation is not of their own making, but the product of forces beyond their control. Once again, they see once-trusted economic institutions collapsing around them. Once again, they feel that they were lied to—fed overly optimistic stories that encouraged them to take excessive risks.

      It is impossible to predict the nature and extent of the damage that the current economic and social dysphoria and disorder will create. But a good part of it will likely be measured in slower economic growth for years to come. We may well experience several years of a bad economy, as occurred, for example, after the profligate mortgage lending booms in both Sweden and Mexico in the early 1990s. There could even be another lost decade, like that suffered by Mexico in the 1980s after its spending spree during the oil price boom, or by Japan in the 1990s after the bursting of the 1980s bubble in its stock and housing markets.

      In this book I argue that the housing bubble that created the subprime crisis ultimately grew as big as it did because we as a society do not understand, or know how to deal with, speculative bubbles. Even intelligent, well-informed people—who certainly knew that there had been bubbles throughout history and could even recite examples—typically did not comprehend that an epidemic of irrational public enthusiasm for housing investments was the core of the problem. Business and government leaders did not know how to deal with this situation, nor did they establish the kinds of new financial institutions that could have managed it.

      The view that the ultimate cause of the global financial crisis is the psychology of the real estate bubble (with contributions from the stock market bubble before that) has certainly been expressed before. But it would appear that most people have not taken this view to heart, and at the very least that they do not appreciate all of its ramifications. Accounts of the crisis often seem instead to place the ultimate blame entirely on such factors as growing dishonesty among mortgage lenders; increasing greed among securitizers, hedge funds, and rating agencies; or the mistakes of former Federal Reserve chairman Alan

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