An Interview with Robert Shiller

Government As Tough Love

An Interview with Robert Shiller

Dec 16, 2011

Brandon Adams

When we observe people fall from grace, we tend to get a dopamine jolt that can be picked up in brain scans. This schadenfreude jolt is especially strong if the person who falls is similar to us but objectively superior in some key characteristics. It explains, among other things, the overwhelming popularity of tabloid news coverage. Shiller drops kernels of this type at an astounding rate, making our hour-and-a-half discussion at Yale both a fascinating and an intellectually taxing endeavor.

In conversation, one gets the impression that Shiller has fifty thoughts for every one he airs. His mind seems to move too fast for speech; you get the impression he’d rather be reading. He had graciously arranged to meet on a day when most of Yale had decamped for winter break. Extreme breadth of intellectual interest suggests, in my experience, a messy office, and on this count Shiller did not disappoint. Just before the interview, he offered me an espresso, which, as a caffeine addict, I eagerly accepted. He then surprised me by making himself a Nestlé hot chocolate. That pretty much summed up Shiller in a moment: a sixty-something millionaire academic, holed up in his office on a late Friday afternoon and drinking Nestlé hot chocolate. This was, I thought, the academic’s academic.

Shiller has always been ahead of the curve. In 1981, he wrote a cornerstone paper in behavioral finance at a time when the field was in its embryonic stages. In the early nineties, he noticed that insufficient attention was paid to real estate values, despite their overwhelming importance to personal wealth levels; this led him to create, along with Karl Case, the Case-Shiller index—now the Case-Shiller Home Prices Indices. In March 2000, Shiller published Irrational Exuberance, arguing that US stocks were substantially overvalued and due for a tumble. In 2008, he published The Subprime Solution, which detailed the origins of the housing crisis and suggested innovative policy responses for dealing with the fallout. These days, one of his primary interests is neuroeconomics, a field that relates economic decision making to brain function as measured by fMRIs.

Shiller is unique among academics in that he has a deep level of trust for both markets and government. It is fair to say that he is comfortable with the idea of a large and active government sector, but he’s long been an advocate of expanding the scope of financial markets, and some of his most important work (covered in Macro Markets and The New Financial Order) concerns the creation of tradable markets in entirely new areas. He believes, for example, that there should be indices of professional earnings, such that one could go short or long expected future salaries of doctors, lawyers, or computer engineers.  Much of the motivation for the creation of the Case-Shiller index stemmed from Shiller’s belief that there should be a reliable index of local real estate prices, such that individuals could potentially hedge the value of their homes. Shiller suggests of free markets that “the rare brilliance outweighs the nonsense.”

Today’s world is one in which financial markets are extremely loud, but they don’t do much. There is a lot of stir and fizzle, with personal trading accounts and twenty-four-hour news, but there is also a general sense that financial markets are not doing a great job with the fundamentals—allocating capital to businesses that can profitably deploy it, helping people save for retirement and hedge risk in intelligent ways. In Shiller’s ideal world, financial markets would be extremely quiet, but they would do quite a lot. He prefers markets that are boring and highly functional, and he thinks that such markets are possible.

Shiller believes that one of the dangers of our highly caffeinated markets is that, to some extent, the louder and more visible markets get, the more irrational they become.  “Most people don’t think about the real determinants of market prices,” he noted. “They tell themselves a story about market prices.” Shiller believes that today’s world of minute-by-minute market updates interacts with the dopamine reward system in the human brain. The stories we tell ourselves to support our financial decision making are “hijacked by our dopamine system,” which is “notably irrational.”

I asked Shiller about Twitter, and he said, “I think it might be fundamental, in that it connects our thoughts at a much higher frequency.” He suggested that the higher frequency creates an echo chamber effect during times of protest. People speed up their use of social media at such times. In a sense, more action is demanded at such times for consumption value via social media, and so more action happens.

Echoing Daniel Bell, Shiller believes that there is at all times in America a conflict between our Protestant ethic and our frenetic form of market capitalism. During boom times, this tension becomes especially severe. During bubbles, the growth in value of financial assets (which represent claims on real goods and services) far exceeds the growth rate in the economy’s ability to produce goods and services. The maintenance of a bubble requires that a strictly limited number of people attempt to convert their newfound financial wealth into real wealth. There is, in Shiller’s terminology, a “moral anchor” to extreme financial bubbles; bubbles cannot persist without a behavioral standard that one not cash in one’s gains from a bubble too quickly. The Protestant ethic encourages Americans to “behave like good capitalists” and not, in essence, cash out their financial holdings to go live on a beach somewhere. This societal tendency makes financial bubbles in the United States somewhat more common and more extreme.

Shiller is strongly sympathetic to Occupy Wall Street. His policy views are infinitely nuanced; one could say they are situational. He’d be a terrible talk show guest, because one could never be sure of his policy opinions ex ante. If I had to pin him down, I’d say that his views in macroeconomics are New Keynesian, and his political views are strongly liberal. But it gets quite complicated from there. Shiller has great faith in free markets, but he is not afraid of suggesting heavy-handed government intervention and regulation, and he believes that government should at times step in to protect individuals from their own terrible decision making.  His view seems to be that government should act something like a benevolent grandfather.

David Moss’s 2004 When All Else Fails: Government as the Ultimate Risk Manager is a book that Shiller cites approvingly. Although Shiller is strongly pro-market, he believes that governments are essential for setting the rules of society and (to a lesser extent) for redistributing wealth and facilitating intelligent risk sharing. He eschews simple solutions; he believes that in a fast-moving and largely unpredictable world, the relationship between individuals, business, and government is likely to be highly complex.

He believes that much of the populace was duped during the long housing bubble that ended in 2006–7. Shiller suggests that maintaining a free market, with broad investor participation and reasonably accurate and stable prices, is no easy matter—that it involves a comprehensive system of investor education, along with a strong regulatory structure that deters fraud and misrepresentation.

People know less about finance than they think they do, in Shiller’s view, in part because “almost all financial advice people receive is biased,” as it tends to be paid for in one way or another by people trying to sell financial products.  Shiller thinks that it might be beneficial for the government to subsidize financial education. He gives the example of civil notaries in Germany, where government-trained legal professionals go over important financial contracts with citizens and ensure that they are fair and properly understood; he remains agnostic on whether such a system is beneficial, but he suggests that we should be open to such solutions because our own system is more flawed than generally realized.

Shiller believes that most Americans’ perception of the country as a level playing field has changed. He cites bailouts, which he believes have poisoned the atmosphere.  A common sentiment, Shiller said, is, “I don’t even have a lawyer. All the rich people have lawyers and lobbyists.” Indeed, he noted that much of the so-called 99 percent not only have no lawyers, no lobbyists, and no financial education—they also have no money. What is needed is not so much education about stocks and bonds but rather education about, as Shiller put it, “Suze Orman–type stuff.” Most people are ill-informed about simple matters of personal finance and personal spending behavior, and they are up against a business sector that carefully crafts products that cater to their every impulse. “The democratization of finance has a long way to go,” Shiller said.

Shiller is a student of what he terms “the morale of the American populace.” He believes that Americans’ patriotism and sense of purpose have contributed to the country’s economic strength. Morale has wavered lately, he said, but remains relatively strong. At times, positive morale can have a perverse impact. “During a bubble, there’s a sense that the confidence has to be maintained. Peope are reluctant to express skepticism.  They self-censor. An atmosphere of hypocrisy reigns.”

Shiller describes Ben Bernanke as “well-meaning” but says that Bernanke was a strong apologist for the boom who argued that it was driven by fundamentals. As late as May 2007, Bernanke said, “We believe the effect of the troubles in the subprime sector on the broader housing market will likely be limited, and we do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.” Shiller said that not only Bernanke but opinion makers generally feel strong pressure during bubbles to keep to “the general chorus of optimism.”

“Contracts are not inviolable,” he noted, pointing out that governments often step in to change them when they are no longer in the general interest. In the early phases of the subprime crisis, Shiller favored a bailout of both homeowners and banks. Both had made severe mistakes, in his view, and although he found a bailout of either offensive, he recognized early on that the scale of the crisis was such that a bailout was overwhelmingly in the general interest.

Shiller was disappointed but not surprised when governments bailed out banks in extreme fashion while leaving the contracts between banks and homeowners unchanged. He said, of Hank Paulson, “As Treasury Secretary, he presented himself in a very sober and collected way. . . . He did some bailouts that benefited Goldman Sachs, among others. And I can imagine that they were well-meaning, but I don’t know that they were totally well meaning, because the sense of self-interest is hard to clean out of your mind.”

—December 16, 2011

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[1] Robert Shiller, an economist at Yale University and a best-selling author, is ranked among the world’s top 100 economists. His most recent book is Finance and the Good Society (2012). Brandon Adams taught undergraduate economics courses at Harvard for eight years.  He was the primary research assistant for Michael Lewis’s The Big Short.