Our Wullie manages to get rather confused again.
He was in London last week, promoting his new book The Subprime Solution and between events he met the Chancellor, the Governor of the Bank of England, the Secretary of State for Business and Regulatory Reform and even – for a few minutes – the Prime Minister. One reason for taking him seriously is that he’s the only prominent economist who can claim to have predicted today’s bust.
But his solutions are so non-standard and outside conventional thinking, and his manner so self-deprecating and academic, that it takes a while to get the radicalism of his message. Minds seemed to wander last week – and it took me a good few meetings before I understood.
If we are going to get banks to lend and borrowers to borrow, argues Shiller, we have got to reduce decisively the risks they confront. He starts with the mortgage market and the collapse in house prices because they are at the centre of this crisis.
Mortgages, he thinks, always unfairly contained too much risk for ordinary borrowers. Now they are a disaster. Who in their right mind would pledge hard-earned savings as a deposit for a house in a falling property market and, on top, take responsibility for repaying a big mortgage over 25 years when they may lose their job? It is far too much risk and reflects an unfair balance of power between borrower and lender. A left-of-centre government should insist that mortgages are redesigned so they contain far less risk for ordinary borrowers.
Shiller does indeed have some exceptionally interesting ideas about mortgages and the mortgage market. But not quite what Hutton goes on to say they are.
Here’s my review of the book.
Beyond that, though, he sees this not as a market failure but as the absence of a market. That is, a market that allows you to speculate or bet upon house prices falling. Thus, his long term solution is to build exactly such a market. Fortunately, he’s already built one of the essential building blocks, an index which we can use to measure house prices in the major US cities. Known as the Case-Shiller indices (modest man our Professor) these are already used as the basis for a modest futures market. Very modest, actually: business is such that it covers some $15 billion worth of houses, a small fraction of the trillions of total house value in the US. As with all futures markets you can speculate (translation: bet) that prices will rise or that they will fall. This is the extra layer of speculation that he wants to add to the current housing market. So what good might come of this? More besuited plutocrats gambling away the lives of the poor perhaps? Perhaps not actually, there are two obvious and highly desirable outcomes from having such a market.
I said up above that this solution would make some peoples’ heads explode, that the solution to an excess of speculation is to create a market in yet more speculation. Yet in this case it is indeed true, this is a valid solution. For what we’ve been suffering from is not a market failure, rather from the absence of a market. In which case, the solution is to design the market needed to solve our problem.
Shiller isn’t saying that the government should guarantee mortgages. He’s not saying that the State has to step in. He is saying, rather, that the response to the absence of a market is to create a market. In this case, a market of futures and options in house prices. In short, more speculation is needed.
Willie han’t spotted that. Odd really…..