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Street Smart

Robert Shiller, a professor at Yale since 1982, has authored or co-authored six books, and this spring Princeton University Press will publish his seventh, Finance and the Good Society

Born in Detroit in 1946, Shiller attended the University of Michigan and earned his PhD from MIT in 1972. His early writings critiqued the prevailing dogma of efficient markets by showing that the prices of dividend stocks fluctuated far more than predictable changes in dividends could justify. His conviction that investment decisions were often irrational helped Shiller argue that the tech-driven stock market of the late 1990s was a bubble well before the rest of the world was forced to accept the same painful conclusion. His earlier study of housing-price booms had already led Shiller, along with economists Karl Case and Allan Weiss, to develop the Case-Shiller housing index, probably the nation’s most relied upon evaluator of housing prices. His expertise led him to argue, as early as 2003, that the housing market had also become a bubble, which Shiller suggested could lead to a global economic meltdown.

Shiller has authored or co-authored six books, and this spring Princeton University Press will publish his seventh, Finance and the Good Society . In a sense, its aim is to puncture another bubble: the widespread hostility towards American financial institutions, particularly those found on or near Wall Street. For Shiller, finance is too important—and ultimately too beneficial—to tear down. “Finance,” he writes, “truly has the potential to offer hope for a more fair and just world.”

Worth spoke with Shiller at his office in Yale’s economics department on Hillhouse Avenue in New Haven.

Q: Driving into New Haven, I saw tents of Occupy Wall Street protesters on the New Haven Green. Finance and the Good Society feels like the next phase of that debate in that rather than simply criticize the financial world, it offers some possible reforms.

Finance and the Good Society is mainly motivated by the fact that I’ve been teaching finance at Yale for 25 years, and I’ve produced thousands of financiers. I wanted to think through the big picture.

Which is what?

I view the financial technology that we have as the source of our wealth, and the amazing emergence of the less-developed countries that’s been going on is related to their embracing modern finance.

So finance is such an important thing, and yet it needs thinking through. It involves things that make people angry and envious.

Does it bother you to have produced thousands of financiers?

No. I don’t think of these people as evil, as most people do. Some of them are evil. But you have evil people in any walk of life.

And they might have been evil before walking into your classroom.

(Laughing) I don’t think I did it to them.

How do you define finance?

Very broadly, because in fact we’re all in finance. More and more of our activities are ultimately financial. If you want to do something good—and young people want to do good things—it usually involves other people. You can’t do it by yourself. You need an organization, and increasingly, that is a financial entity.

So finance has gotten a bum rap?

There are a few folks who hate it, yes. And who hate the people who succeed.

Recently there seem to be more and more people who fit that description.

The thing is, I think of finance as a technology—a technology about coordinating the activities of people, making them work productively. And to make sure that things aren’t squandered and wasted, that they’re allocated in the right way, so people can move ahead and do constructive things.

Now, that’s a technology that at times doesn’t seem nice, and it involves people who have hurt others’ feelings sometimes. But it produces this civilization that we have.

So what went wrong in the past decade—the technology or the people wielding it?

In some ways there was a decline in moral standards. But it’s not the kind of thing that I feel outraged about, because a lot of what people do is view themselves in their role in life. If you’re the head of Bank of America, you have taken on a commitment to the shareholders of Bank of America. You think logically that your role now is to live up to that, to defend their interests and understand that our society has people in alternative roles defending the interests of other people. And that’s not so morally wrong—it’s just like a lawyer whose job is to defend someone accused of a crime.

So people fall into these roles and they may go a little too far, but it doesn’t outrage me. It makes me think that we have to fix the system.

Many people would say it wasn’t that the head of Bank of America didn’t go too far defending the interests of his constituency, but rather that he redefined his constituency to eliminate the vast majority of his stakeholders.

We shouldn’t keep talking about Bank of America—let’s take mortgage lenders, for example. Some of them used techniques that didn’t seem to be high minded. They would incentivize their mortgage originators to steer the client to the better-paying mortgage, not tell them that they might qualify for something else. That doesn’t sound right—Dodd-Frank makes that illegal now. But it wasn’t illegal at the time.

It’s not really my point to try to defend these people, because I know some of them weren’t very nice. But if they didn’t break the laws, because we didn’t have laws, we have to think about what kind of laws we should have in the future that would encourage good behavior.

You’re arguing for more financial innovation based on the idea that such innovation can lift all boats. But innovations of the past decade or two have been immensely risky and destructive. How do you reconcile the contradiction there?

We have had many financial crises going back hundreds of years, and the kind of complexity that you describe has been there for a long time. People didn’t understand the whole system and how a banking crisis would play out. It requires additional innovation and additional regulation to make things work well.

Most Americans wouldn’t say that they see great benefit from, for example, bundled mortgages or credit default swaps. Are they wrong?

I think that bundling mortgages into securities is an important innovation and it could be expanded so as to help prevent a repeat of this crisis. If it was done right.

Wasn’t mortgage bundling an innovation that proved far riskier than most of the people involved in it realized?

One problem was that when you securitize a mortgage, you shift the ownership to many different people, and then it becomes harder to do a workup for the homeowners. It might have been better if homeowners were given a principal reduction so that they didn’t default on the mortgage and could stay in their homes. Might have been better for the mortgage lender as well.

We talked about the fact that you defined finance broadly. How do you define a good society?

I searched the history of that term. It seems to have emerged in the 19th century and it seemed to refer to nice people people who are concerned about others and about education and hygiene and childcare. They’re good citizens. So it seems to me it connotes a caring society without unnecessary distinctions or prejudices.

The title of my book sounds like an oxymoron because people think of finance as a field that creates inequality, rather than levels it. But I think of risk management as a promoter of equality if it’s done right. And finance that brings opportunities for people is also a promoter of equality. Not complete equality—part of finance is incentivization. There has to be opportunity for people who want to work hard and want to make money to do so.

In the book you write that inequality is not a bad thing as long as it doesn’t lead to crushing poverty.

I listen to how people talk about the wealth of someone like Mark Zuckerberg or a professional athlete—I don’t hear a lot of antagonism for someone who’s done an amazing thing.

People can see what Mark Zuckerberg has done and the value that he has created for them. With many of the titans of Wall Street, that’s not so clear to the public.

It is and it isn’t. If you go to China, people in China generally think that their newfound prosperity has something to do with the market socialism and that these stock markets that they have in China today are a good thing. They are not angry and upset about this.

But don’t we have the inverse situation here, in which many Americans believe that our economic troubles were the result of Wall Street?

We didn’t think that people had stopped working productively or lived off the government compared to, say, the Greeks. The general public looked at Wall Street and thought, “You’re the one who screwed this up—it’s you who caused this recession.”
I don’t think that’s right.

That the sentiment exists or that the sentiment is correct?

The sentiment exists, yes, definitely. But we had a housing bubble, and that involved just about everybody, it seemed. One reason why the bailouts are unpopular is that people think you’re rewarding small-time speculators, someone who bought a house that was bigger than he or she should have bought with their income. There is anger at Wall Street. There’s anger at others who are not big-time as well.

In the book, you espouse the need for greater financial education. Certainly people need to know how markets work and how to invest and how not to invest, but at the same time, the financial world has grown so complex and sophisticated that it seems almost hopeless to expect people who are not specialists to be able to understand the economic forces that can throw their lives into turmoil.

There’s a whole array of IQs and certainly not everyone can grasp these issues. To some extent, the system works well if you have a substantial fraction of the population who understands what’s going on, and it seems to me that that’s possible to do. Another thing I emphasize in the book is personal financial advisors. People should have a relationship with someone who knows business and finance and law. Most people don’t, and so they’re easily victimized.

For someone who’s spent a lot of time predicting bubbles, you seem pretty optimistic by nature.

I’m a pretty optimistic person, but I’m also skeptical—I’m a cynical optimist.

Why did you become an economist?

There are so many things one could do with one’s life—I think finding a career is more significant than finding a spouse. When I was a child, I wanted to be a scientist or a mathematician. I could have gone into any intellectual discipline, but I kind of liked economics. Maybe I was influenced by the [1953] book The Worldly Philosophers by Robert Heilbroner. He said that economics is like philosophy, but it’s down to earth, it’s what people do every day.

Your father was in business—was he an influence on your career?

My father was an entrepreneur who set up his own business, got a patent and then failed. I got from my father an appreciation for people who take things into their own hands.

His company made industrial ovens.

Right. He had a patent for a different kind of oven—he sold a number of them, but it didn’t succeed. He had a heart attack and that ended the whole thing. But that technology is still used today; I looked it up on the Web.

What does an economist do all day?

Well, what is a week like? We only teach maybe three hours a week. Then you have your dissertation advisees, and you have to think about them, and student advisees—students come with problems. So that adds up to something like 20 hours a week. Then we’re supposed to think about economics and write papers.

In recent years it seems like economists have become so culturally ubiquitous, they’re practically celebrities.

Do you think that’s more than 30 years ago?

You tell me.

It seems to me that maybe they’re writing more books than 30 years ago. Business is more prominent, so there are business channels now. But if you look at how often they’re on CBS Evening News , I wonder if that’s changed.

If you look at Nouriel Roubini or Joe Stiglitz or Larry Summers…

But you had John Kenneth Galbraith, Paul Samuelson…

All right, how has the crisis changed the field of economics? Economists—yourself excluded—took a lot of criticism for not predicting it, and it felt like there was a crisis of confidence in the field.

I think there is more appreciation of the difficulties in formal modeling. We had the idea that econometric models were the way to understand the economy, and they’re still useful, but maybe there’s more respect now for the so-called intuitive economist. Keynes was an intuitive economist. His classic work The General Theory of Employment, Interest and Money [1936], has almost no equations in it. No math. And it was considered slippery by people who couldn’t quite get what he was trying to say—there was too much metaphor. So there might be more appreciation of that style.

Another change is that some economists, such as yourself, have adopted disclosure policies itemizing outside work giving speeches and consulting.

That came after this movie, Inside Job. Part of that 2010 documentary focused on economists and conflicts of interest that allegedly corrupted the profession. It seemed as if the director, Charles Ferguson, had put his finger on a dirty little secret of the profession.

The question is whether our research is really unbiased. There may be biases for subtle personal reasons, but it probably isn’t bribery. The film mentioned [Columbia Business School economist] Rick Mishkin taking $100,000 for a book that he wrote for the Icelandic chamber of commerce. I know Rick. Someone came to him and offered him $100,000 to co-write a pamphlet about the Iceland economy. His reaction was, why not? And they put a coauthor on with him who wrote all sorts of things that were overly optimistic, and Rick just didn’t pay attention. He just did it, because they were paying him $100,000. So I don’t think he’s evil like the film suggests.

It doesn’t suggest that he’s evil, just craven.
I think it’s more careless.

Isn’t there a danger, though, of academics being corrupted? Ruth Simmons, the president of Brown, recently found herself in a controversy over being paid millions for serving on the board of Goldman Sachs, even though she had no financial expertise whatsoever.

But maybe that’s not a bad thing, to have the president of Brown on Goldman Sachs’ board. Maybe she was a moral influence on them.

It’s also possible that she just wanted Goldman Sachs’ money for herself and for Brown.

People are selfish, often, and they are cliquish—these are human traits. They form alliances and exclude others. The history of this country is to try to create opportunity so that people can break into these cliques.

You said that the president of Brown serving on the Goldman Sachs board creates opportunities for her to behave selfishly, but it also creates opportunities for her to behave altruistically. Isn’t Goldman to be congratulated for putting the president of Brown on the board? What’s the cynical view?

The cynical view is that they wanted a black woman, of whom there aren’t a lot at Goldman Sachs…

So that’s even better—they put a black woman academic on their board.

…and if she lacked financial expertise, so much the better. Speaking more generally, corporate boards are a part of the financial world that Americans believe helped cause the recession, because many boards were stacked with yes-men and women who were not brought in to be strong voices of morality or dissent, but for the exact opposite reason.

We have to reinvent the corporation to deal with problems like this. We have to think more about how to change the corporate law to encourage better boards. One thing that I talk about is the flexible purpose corporation. [ Several states have legalized these hybrid organizations, whose purpose is to fulfill a social benefit while still earning a profit. ]

As a behavioral economist, I view that as changing the whole atmosphere. We have to have a system that rewards good behavior in a psychologically meaningful way, and the problem with charity now is that people give money and it’s gone—it’s like nothing happened. So I want to have a nonprofit that you would give money to and it would keep you involved as a sort of capitalist.

At one point in the book you ask the question, “Why would anyone with a sense of personal morality go into finance?” You meant it rhetorically, but could you answer that question?

There are many different careers in finance. I included among them regulators. In the book, I talk about my conversations with people in that job, asking them why they do it. Some of them say, “Oh, I’ll work as a regulator for some years and then I’ll go to Wall Street and make some money.”

But some of them say, “I worked formerly on Wall Street and I got tired of it. I found this more appealing. I like to regulate.”

People find lots of different things appealing. They have a sense of responsibility and purpose. Sometimes it seems to be fulfilled by being a regulator or being an accountant. As long as you’re earning an income, it really doesn’t matter that you’re not making a lot of money.

What if you’re making no money? In a New York Times op-ed last year, you wrote about high unemployment and quoted Thomas Jefferson warning of “a firebell in the night.” He was referring to slavery. What were you warning about?

I was worried about the animosity—this was before Occupy Wall Street [was widely known]. Occupy Wall Street is more of a meme, a thought virus, that put a name to the anger.

What were you worried about?

It didn’t seem healthy. It seemed like our society was fragmenting. Jefferson wrote that he was astonished by the rancor that was shown by the debate between the North and the South. Forty years later, we saw the South secede. So these things, once they have motion, can be very enduring. I’m imagining that Occupy Wall Street will be with us for many years.

Slave and free states were divided roughly 50-50. Occupy Wall Street frames the country’s division as 1 percent versus 99 percent. Do you think that’s accurate—that we’re experiencing a divide between a tiny minority of Americans and everyone else?

We’ve had that division in this country for a long time. In the 1890s we had the trusts. The Standard Oil trust was widely maligned.

But the heads of trusts were thought of more as individuals than as part of a permanent class.

Except the United States is kind of a classless society, right? Mark Zuckerberg, his family wasn’t rich. Bill Gates, his family wasn’t rich.

They were upper middle class, though, wealthy enough to send their sons to Harvard. Why does Mark Zuckerberg not bother us but Lloyd Blankfein and Jamie Dimon do?

Because it sounds like a conspiracy—that these people help each other, and then they buy congressmen.

Let’s talk about the economy. How are we doing?

We had the worst recession since the Great Depression, and we’ve been recovering for two and a half years, and this very slow recovery is what you expect. I worry about a double dip still, especially with the European crisis. It depends on our confidence, and that does seem to be slowly recovering.

You said repeatedly last year that the stock market was overvalued. It has risen significantly since then. Is that still your assessment?

It is overvalued, but not by an enormous amount. Stocks are still something people should have in their portfolios, it’s just not the greatest time for them.

What do you think of the level of economic discussion between our two political parties and their candidates for president?

I don’t find myself highly inspired by the discussion. I would like to see a longer-term solution where we actually have a plan to deal with the possibility of rising inequality. No political candidate has a serious proposal that would prevent it from getting a lot worse.

President Obama has proposed a “millionaire’s tax”—is that a good idea?

It’s a good idea, but I would make it part of a long-run plan that would raise the tax more if inequality gets worse. I’m not trying to redress the inequality that we have today—we just don’t want to see it get a lot worse.

So you’re actually pretty passionate about this idea of finance and the good society.

Yes. I think that the history of humanity is the gradual development of our ability to work together.

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