Final Say: Robert J. Shiller
Michael Marsland, Yale University
Robert J. Shiller, 65, is the Arthur M. Okun Professor of Economics at Yale University, a best-selling author, groundbreaking researcher and one of the 100 most influential economists in the world. He resides in New Haven.
Do you wish you had been wrong when you were trying to warn people about the dire consequences of what might happen when the housing bubble popped?
Well certainly because this is the biggest economic crisis since The Great Depression. It turned out to be a serious employment problem. Now long-term unemployment—that’s unemployment over 27 weeks—is at record highs, and it seems like people who take a hit now in terms of employment have a great deal of trouble bouncing back. It’s a time of national disappointment. It’d have been nice if the bubble hadn’t been a bubble, that the stock-market boom was justified by good information about a wonderful future, but it turns out that it wasn’t it true. The same thing with housing, that somehow people thought that the rising price of housing reflected a powerful economy, and that would continue. But it hasn’t.
Even though you saw it coming, do you think anything could have been done to prevent it?
Well, definitely things could’ve been done to prevent it. First of all, regulators could’ve done things to stop the growth of leverage borrowing to support speculative investments, and they could’ve spoken out against the bubble. It wouldn’t just have to be regulators—if we had national leaders from the private sector who made stated firmly that they were concerned about the bubble in the real estate and stock markets, that would’ve helped, too.
Why do you think it was ignored then?
Well, this is something that has happened repeatedly in history, that people become complacent. The most fundamental cause of this crisis is the complacency that set in after we’d gone three quarters of a century since The Great Depression. People thought, for example, that home prices could never fall. I remember asking people, “Why not? They fell in The Great Depression, didn’t they?” And then they would say, “But that was so long ago. What are you talking about? Are you saying we could have another Great Depression? Come on!” So that wasn’t a scientific answer, but an answer that reflected the general judgement that those kinds of things were past us. “After so many years, they can’t happen again, can they?” That’s what people felt. It is a sort of complacency that led people to think that prosperity was assured. So the saving rate dropped, people borrowed more—not just in the U.S., but in many places around the world.
What can we do to combat that complacency?
It’s a tough problem. People say that World War I came because the last big war—in the case of the U.S., it was the Civil War, but for the world, it was the Napoleonic Wars—was so long ago that people thought it couldn’t happen again. This is a fundamental problem. I don’t know how to solve it. We do have attempts by our government, legislative solutions, notably the Dodd-Frank Act in 2010 that created something called the Financial Stability Oversight Council [FSOC], which is supposed to warn us of these things, and to take steps to prevent them from happening. The Dodd-Frank Act also created the possibility that non-bank financial companies could receive the same kind of regulation that banks have received. This is the legislation, but it seems to be slow to happen.
The FSOC is just starting to think about what additional companies it might put under than legislation. And it’s a problem. How can an organization like that really create the political will and shock the public out of its complacency? We already had something that Ronald Reagan set up called the President’s Working Group on Financial Markets, and this was something like the FSOC. It was supposed to worry about things like the stock market crash of 1987 that motivated it. It’s been around, but it didn’t warn us. It didn’t do anything about the more recent crisis. It’s difficult. It’s like how do we prevent human error? If we knew how to do that, we could prevent wars, too.
It’s been said that the recession officially ended in 2009—what is sustaining this complacency?
I would say we can move from complacency to loss of confidence—they’re kind of opposites. Confidence indexes were quite high in 2006, maybe not as high as in 1999, which was the real peak, right when the dot.com bust came. But now we’re in a situation where confidence is just down, and people don’t have a bright outlook for the future. And because they don’t, consumers are not willing to spend at quite as high a level. You know, this isn’t the time to buy that really fancy car. I think it’s sort out of sympathy for your neighbor who’s unemployed—you don’t want to show off right now. It’s also a sense of uncertainty about your own job—you might lose your job. So everyone is pulling back. People who are in the position to hire people don’t want to do it for the same reason—they’re thinking about the business. “Well, if I hire somebody today, I might have to lay them off anyway because the situation looks bad.” So it’s these two things together—the lack of consumer spending and the lack of hiring by corporations. They’ve conspired to create a bad situation that can continue for a long time.
You’ve written about this concept of behavioral finance, that the biggest influence on investors are their emotions.
That’s right, it’s been a theme of my work since the late 1970s.
Knowing this, are there ways to shape investor emotions?
I think we’ve done fairly well recently—and this is a judgement call, no one can prove it—but I think that the combined economic analysis involving all different brands of economic research has lead to an improved enlightenment, and we did better this time than we did in The Great Depression. After the 1929 stock market crash, the Federal Reserve was very remiss in not stimulation the economy more. Moreover, President Hoover was opposed to very much deficit spending, so he didn’t stimulate the economy, so it wasn’t until 1933 when President Roosevelt came in that there was any deficit spending. This time, we did it better. With Ben Bernanke, we immediately cut interest rate drastically, then launched a number of new programs and lending facilities through the Fed that tripled its balance sheet, and then they did this in coordination with central banks all over the world. As for fiscal policy, under Treasury Secretary Henry Paulsen, then continuing under Timothy Geitner, we’ve had a stimulus fiscal policy. These things together prevented us from falling into another depression. I think that we should be thankful. Now, the reasoning behind the policy advances may never be known entirely, but I think that the people who made these policy decisions read a number of different strands of economic literature, including behavioral economics. I imagine that it has influenced policy in a positive way. I think that the advisers that both President Bush and President Obama have had have been reasonable people, and who are knowledgeable about a lot of things, and who performed better than they had in The Great Depression.
You recently compared the recent wild fluctuations in markets to a beauty contest where people were challenged to pick whom they thought others would find prettiest—the idea being that investment decisions are not being based on actual financial data but on speculation as to what investments other investors might find attractive. What’s driving this and how can we get markets back on track?
This beauty contest analogy shows just how complicated human society really is. It’s not just own confidence that has to come back, but it’s our perception of others’ confidence that has to come back. What we do depends on what we think others are thinking, and so there has to be a common knowledge. That’s what confidence is—a common knowledge, not only that I feel more confident, but to go further, that I feel others feel that others feel more confident. And when all that comes back, then we feel more of a willingness to spend and invest and hire. It’s similar to when we talk about other human catastrophies. War occurs when people think that the other side might attack them. But why would the other side attack them, well, it’s because the other side doesn’t trust us. Even wars have the same origin in what people think other people are thinking. That’s why human history so bizarre—because big important things happen depends on a level of trust and confidence that’s a complicated social phenomena that no one can control, not really well. Maybe they can control it, but not perfectly.
Do you think that economic data is overanalyzed? Why?
One source of our complacency is our reliance on recent economic data. People would point out during the boom that preceded this crisis that home prices have never fallen, for example. But they relied on data sets that didn’t go back before say, the 1970s. If you rely on an analysis of data that doesn’t go very far back in time, then your data set won’t capture the really big events. It’s obvious, right? Maybe great depressions come around every 70 years, but you’re not going to figure that out if you use only 30 years of data. And yet, there’s a temptation to just go with the data.
There’s a scientism—that’s what Hans Morgenthau called it—that “We’re social scientists, so we only report things that are reported accurately with data.” The problem with this attitude is that you don’t learn the lessons of history, for which the data may not be so precise. You can’t just look at the most accurately recorded data and just ignore the other. But that’s what part of what happened in this crisis. That’s part of what lead to the complacency. We thought we had this scientific economists and portfolio managers and financial experts— they thought they had everything figured out, they had their computer models and everything was so modern. But in fact, it was an illusion, and the same kind of events that happened in The Great Depression could happen again, and they almost did.
What economic concept is most challenging to explain to students?
There is a lot of difficulty in trying to understand investment markets. There’s offsetting things that tend to confuse people. One of them is a tendency toward overconfidence. Everybody thinks that they’re a better driver than the average driver, and most everyone thinks that they’re a better investor than average. That’s one factor. Then people will go to the other extreme, and they will think that it’s been shown that there’s nothing possibly you can do to beat the market, that markets are efficient and nobody can beat the market, so you shouldn’t even try. And that view is often coupled with the view that you should be aggressive if you’re investing, like invest heavily in stocks because the smart money has done that. They’re not necessarily connected, it doesn’t even seem logically connected. But it became connected in people’s minds, and so the idea was that don’t worry about speculative bubbles, just invest aggressively and in the long run, you’ll be fine. It seems deeply ingrained in people’s minds. So I have to present a more nuanced view about this. Don’t be overconfident in your investing because you’re not as smart as you think you are. You have to temper your self-esteem when it comes to the possibility that you’re going to make reckless investment decisions. But don’t go too far, and don’t think that I suggest that you pull out of thinking about these things any more. You have to stay connected and watchful. It’s running to extremes that brought on the boom that lead to the ultimate bust. I find it difficult to present it to my students, to get them to put the right balance into their thinking.
What do you tell people who ask you for casual financial advice?
I’m not a licensed financial adviser, just a professor. I shouldn’t be giving advice except to say that you should get a financial adviser. [laughs] That’s the safe advice to give at all times!
But people are reluctant to do that. One thing I like to tell my students is exactly that—to get a financial adviser. Most people accept the idea that they should get medical advice but they don’t think they need any financial advice. They’re all self-medicating when it comes to finance. I think that’s wrong. Again, public opinion about that is influenced by some rather simple ways of thinking. Many people think that financial advisers won’t help you because the market is so efficient and you could just pick stocks at random and do just as well. That is really wrong. So I think that the best advice is to learn a little humility, but not so much humility that you give up. The humility means that you keep up to date with what’s happening in financial markets, and you actually have an adviser. Literally, you have someone who you talk to who’s a professional.
You’ve been ranked among the most influential economists in the world—is there any special benefits to that? Easier restaurant reservations, better concert tickets?
I don’t know about that. [laughs] The only thing is that sometimes people will stop me in the train station or airport and say, “I saw you on TV.” That’s about it.
What’s more dangerous: Debt or the fear of debt?
That’s an interesting question. I don’t think a simple answer for all people.
Actual debt is dangerous. We have many personal bankruptcies. As a matter of fact, there are more personal bankruptcies than there are divorces in any given year. People are surprised to hear that, but I think that’s because they don’t hear about bankruptcies. People hush them up. But there is a real problem that many people get seriously into debt. The characteristic problem—this is something that Elizabeth Morin, who’s running for governor of Massachusetts wrote about in one of her books—is that people seem to forget that the debt that one has taken on might be okay and manageable today, but something will happen in your life—you’ll lose your job and have to take a lower-paying job, or there will be an illness in the family or even a divorce, and these things tend to push people into bankruptcy who are already highly in debt. So debt is dangerous. One can be addicted to spending and get out of control.
But on the other side of it, you were asking about the fear of debt that can create problems too, and that’s happening right now in this recession because people are so afraid that they’re not spending, so that’s creating the very crisis that people are afraid of.
Unemployment is a big issue right now, but 10 percent unemployment means 90 percent employment—why is that not a part of the discussion?
Did you read my book with George Akerlof, Animal Spirits? We used almost that same exact idea. We were pointing out that unemployment peaked at 25 percent in The Great Depression, but that meant that 75 percent of Americans were employed, even in The Great Depression. It’s an interesting perspective to take on things. Right now, yeah, it’s over 90 percent employed. So you could say we’re almost there to full employment! [laughs] But why is it that the system tends to equillibrate on employment that’s over 90 percent, but not quite there. Interesting question. The first thing to observe about our economic system is it’s quite successful in hiring people—even in bad times almost everyone is employed. But that ten, or five, percent unemployed matters because it stays there as a bugbear that worries people. The possibility of becoming unemployed is a big fear. And still, 10 percent of our workforce, some 14 million people are unemployed. That’s a lot of people. That’s like a small country who are unemployed, so it’s not a small problem.
What economic indicator should we be watching to see if an economic recovery is really occurring?
There are many different kinds of indicators, so I don’t have a single one. I mean there are some people who try to get an overall [view]—the index of leading indicators is widely talked about, but I really don’t follow that one. There are statistical analyses that try to figure out what leading indicator is the most productive. These analyses are sort of inconclusive I think because there are so many indicators.
I tend to think of confidence indicators as very important, even though they may not have been statistically confirmed as the best thing to look out for a professional forecaster. But to me, the confirm my understanding of the economy. So both the conference board and the University of Michigan publish the best-known consumer confidence indices.
One indicator that I like a lot—but this might be a bit esoteric—but the University of Michigan has a question, they number it X-4, which is a question about depression. I don’t have the exact words, but it’s something to the effect, “Do you think that economic conditions in this country over the next five years or so will be prosperous or will there be widespread unemployment?” So they can start the confidence index right out of that question, but it’s not one of their headline numbers. I look at it because it seems to me to get at, most perfectly, what the confidence situation is. Right now, it’s at record, or near-record lows, since the numbers have been first created in the 1950s. We are very lacking in confidence right now, and I think that I’d like to see that number come back up.
Speaking of numbers and indexes, you helped create the Case-Shiller Home Price Index—at any point did you suggest that maybe it should be the Shiller-Case Home Price Index?
No, it’s alphabetical. [laughs] I have to say that the initial impetus for that came from Charles Case, who had actually constructed an index before I even met him. Then we worked together on it, proving it. I think it’s okay to call it Case-Shiller.
What do you think it’s telling us right now?
It’s ambiguous right now. The latest numbers on a seasonally adjusted basis are flat, unchanged right now. So some people think we’re in a holding pattern, and that’s a reasonable scenario. My company, MacroMarkets, has been surveying professional forecasters, and with our latest survey, we found that the expectation of the average professional forecaster for home prices is about 1 percent a year, out to 2015. So they’re expecting increases of about 1 percent a year in home prices, but that well likely might be below the rate of inflation. So real home prices are expected to fall a little bit. It seems like the general outlook for home prices, as seen by a wide gamut of forecasters, is not very favorable for the foreseeable future, and there are many of them who think they might fall. I said earlier this year that falls of 10 to 25 percent in real terms for the nation is a scenario we ought to be concerned with. That wasn’t a forecast, but, I think there’s a risk of a further fall, but I don’t know. I don’t mean to say that one shouldn’t buy a house if it feels like the time to do it. Mortgage rates are very low now, so housing is actually quite affordable. Home prices have come back down to something their long-run level, and interest rates are very low. So I wouldn’t back off buying a house right now, even though, I think if one is in that stage of life where one wants it, there is a risk of further fall.
What do you think is on the economic horizon nationally?
Professional forecasters are still upbeat about it. Most don’t think we’re going to have another recession. That we’ll have modest growth but not enough to close the gap, which means the unemployment rate will stay around where it is now. Again, no one knows the future and that’s a reasonable scenario. I still worry about a double-dip recession; I know it’s not in the forecast models, so I’m going out on a limb a bit to say that this is a concern, but the situation is Europe is rattling people now. There could be a collapse in the financial situation in Europe, which could spread to the U.S. and bring on a worldwide recession. It’s looking like a real possibility now. I might even give it a probably of greater than a half that we’ll have another a recession, even though the models and the forecasters don’t think so.
Do you think the Occupy Wall Street movement or similar protests could actually impact markets?
I don’t know how to quantify that. I suppose the impact might be that people will think that their discontent bodes ill for the economy or might strengthen the government’s hand in regulating businesses. I’m worried about the Occupy Wall Street movement myself because I think it could push this country toward bad economic policy, which would limit our strength in the future. The United States has been a financial leader to the world. Our stock markets are the envy of the world, and our financial markets in general, and are the object of imitation all over the world. I think that Occupy Wall Street movement is discouraging further development of our special strength and expertise in this country. I’m glad that Dodd-Frank was as positive as it was—it wasn’t clamping down on businesses more than necessary.
My next book will be called Finance and the Good Society, which will be published in early 2012. And it’s really about what the Occupy Wall Street People are worried about. Why it is that so many people are angry with the financial sector and what we should do to strengthen our economy, strengthen the financial sector, and also give a better sense of fairness and equity in our country.
Do you feel that although you’ve been recognized as an influential economist, that sometimes you’re a voice crying in the woods?
I felt that strongly in 2005 when I was warning of the possible financial crisis. It was funny—I was going around giving talks saying that I thought we had a bubble in housing and stock markets, and it was interesting to see the reaction one gets when one tries to do this.
The reaction is kind of . . . disappointing in that nobody takes you seriously. So here I am warning of a crisis, and they must think, “Well, what does he know anyway, right?” And “Isn’t he being a little unpatriotic and rocking the boat that has brought us so much prosperity?” It was a little bit of hostility and basically no reaction. So I started thinking, “Well, who knows?” you know? Intuitively, I still feel optimistic. The thing is that when there’s an excessive boom going on and people are complacent, no evidence will ever really convince them. They all think it’s a matter of opinion, and they feel positive. A sense of confidence is substantially a psychological phenomenon—you can’t talk people out of it. It’s like people with a manic-depressive psychosis going to a psychologist and complaining, “I’m really feeling elated and exulted,” and the psychiatrist tries to explain to you, “No, it’s just your mental illness.” They’ll never listen to them.
I’m not saying a boom is a mental illness, I’m saying people have an intuitive thrust that’s based on their general impression and general idea of what consensus is. And when the consensus seems to be that the economy is very strong and we have nothing but good to look forward to, there’s nothing you can do to change that. People won’t listen.
I can sense your frustration while explaining this. What you really seem to be saying is that they’re dismissing you and saying "Well, what experience does he have?" After agreeing that you’re an influential economist, you’d think they’d want your opinion, yet after offering it to them, they don’t seem to want it.
Well, they listen politely. [laughs] And they usually don’t get angry. In 2005, I even spoke to regulatory agencies in Washington, and the kind of reaction I got was, “Uh yeah, we have someone here sort of saying the same thing, and we listen to him every day, but we don’t know.” And typically they’d say, “But we made some minor policy changes that recognize this possibility, and this is as far as we’re willing to go right now because we’re just not convinced.” They kind of have this skeptical attitude, but at the same time, they’re still moving forward on their basically optimistic outlook. So when everyone else is optimistic, it kind of seems intuitive that they’re probably right.