A Great Fall

Getting rich selling the same assets over and over again. But the prices would go up forever. After all they are not making anymore land. There were some people looking out the housing sector and speaking out that it did not make sense and was not sustainable but no one wanted to listen to the bears. Perhaps if the investment banks looked at the big picture they would not be collapsing like dominoes.

Robert Shiller was one of the few lone voices speaking out about the nonsense that occurred during the bubble. Here are some excellent points from a Forbes article titled The Humpty Dumpty Economy. The article is a review of Shiller's new book titled The Subprime Solution: How Today's Global Financial Crisis Happened and What to Do About It. Lets take a look at the review -

Why did house prices get so out of whack? The litany of explanations and the associated cast of culprits are long and familiar. Aggressive and sometimes unscrupulous lenders pushed mortgage loans out to complacent, gullible and often uncreditworthy (subprime) borrowers, on terms that seemed enticingly low upfront. When the real estate-backed loans were repackaged and sold to investors as securities, rating agencies routinely and irresponsibly graded them as high quality. Regulators looked away.

This binge of borrowing and re-borrowing was facilitated by cheap money at home and plentiful money abroad. And Americans were in collective denial that wealth cannot be created by selling the same asset--homes--to each other in part because the whole business had the conscience-assuaging egalitarian veneer of promoting homeownership, especially for low-income blacks. Life, liberty and the pursuit of happiness in the new millennium required not just the SUV but also a home, preferably a McMansion.

Shiller's contribution here is to view all these elements as important but not the real deal. The ultimate cause, according to him, was simply bubble psychology, the collective belief that had taken hold that house prices could only head in one direction, a belief reinforced by the observable reality that house prices were indeed steadily accelerating for several years. Why is this diagnosis appealing? Because all the culpable actions--lazy home appraisals, regulatory neglect, dubious ratings and even the Greenspan "put"--were ultimately sustainable only because of the "social contagion," as Shiller aptly puts it, that house prices would not come down.

Shiller's focus on the fundamentals then naturally leads to his creative and original remedies. Caught up in the tangled web of proximate causes and multiple suspects, most mainstream analysts see the remedy largely in terms of better regulation. Leave aside how this is achieved in practice, history shows with depressing regularity that regulation alone is unable to prevent speculative bubbles in assets, whether they are tulips, art, stocks or land.

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To Shiller, the solution is not a choice between markets and regulation but more of both in order to harness the true potential of finance while minimizing its vulnerability. Trust should finally be reposed not just in regulators or markets but in financially literate and discerning consumers. Some of the more innovative ideas include providing subsidized financial advice to customers, creating default options for mortgages to prevent the average borrower from succumbing to enticing but bad choices involving teaser rates, ARMs, etc., and setting up a financial product safety commission like its consumer safety counterpart.

This summary is not just a great review of a book - it is also an excellent synopsis for the economic mess that is going on around us.