The Subprime Solution

I just picked up Robert Shiller's Subprime Solution. It is a quick read and I highly recommend it. Despite its title, I am not sure the book presents a perfect prescription for policymakers today. Shiller obviously wrote the book before the fatal issues with the GSE's, AIG and I-banks emerged. His main proposal is to re-establish the Home Owner's Loan Corporation to buy up distressed assets...an idea that has been tossed around for at least a year. But there is a lot to like about this book.

First, Shiller provides a nice background on the run up in house prices. In general research has been focused on asset bubbles for quite some time. He wrote Irrational Exuberance on the tech stock bubble (also a recommended read). Subprime Solution echoes many of the ideas of that book - that markets and economists tend to forget that psychology matters. People get caught up in a frenzy and start to believe prices can only go up (or if prices go down, it won't happen all at once or as much as what can and does happen). It is a compelling and easy to read description of the evidence. Too often we read the popular press blame the foreclosure crisis on the Fed keeping interest rates low, or, my personal favorite, Community Reinvestment Act lending (never mind almost all subprime lenders were not covered by CRA). He offers a simple explanation of a speculative bubble that fueled homeowners, bankers, Wall Street, ratings agencies and even policymakers. I think this is mostly right and not well understood.

Second, Shiller offers a wide ranging set of longer-term priorities. While this section reads as a bit of a grab bag, there are some great nuggets here. What I am most struck by is his emphasis on consumers. He discusses improvements to the 'information infrastructure' which will help prevent future problems. Number one is "comprehensive financial advice," especially for lower-income consumers. This might include subsidized fee-only financial planning (an idea EARN is working on in San Francisco, along with a handful of other nonprofits in other areas) or even new technologies. He also talks about using learnings from behavioral finance, such as relying more on default options in mortgage product promotion, and continuously adjustable mortgage contracts which in effect modify themselves as housing or economic conditions change over time. He also provides a critique of too low FDIC and SPIC deposit insurance coverage. All in all a nice collection of ideas.

Shiller concludes by plugging ideas he has worked on for a decade or more, including home equity insurance (he even notes his experiment in Syracuse NY run with Neighborhood Reinvestment Corporation) and options markets consumers can use to hedge drops in real estate prices.

Shiller's general theme in Subprime Solution is the Great Depression spurred the creation of bold social experiments - many of which still exist and play a vital role in the economy - like FHA and FDIC deposit insurance. He thinks today's crisis should result in a similar response. Time will tell if he is correct, but kudos for writing such a timely and accessible summary of policy options today, and for keeping consumer behavior at the center of the debate.