A review of the book "The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do About It" by Robert J. Shiller.

“The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do About It”

by Robert J. Shiller

Princeton University Press, 196 pp., $16.95


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When Robert J. Shiller looks at the subprime-mortgage maelstrom, he sees more than Lehman Brothers Holdings Inc. and Merrill Lynch & Co. sliding down the financial drain. He sees parallels to the Treaty of Versailles, the Great Depression and the Marshall Plan.

“The subprime crisis is the name for what is a historic turning point in our economy and our culture,” he writes in “The Subprime Solution,” a lucid primer on how we slipped into this money pit and what it might take to clamber out of it.

The Yale economist and author of “Irrational Exuberance” says the crisis has unleashed forces that are tearing at America’s social fabric and will probably slow economic growth for years. He likens the struggle to the punitive reparations imposed on Germany after World War I.

“Once again, many people, unable to repay their debts, are being pursued aggressively by creditors,” creating a sense of helplessness and betrayal, he says. We may be witnessing what he calls “the first act of a long and complex tragedy.”

Shiller is sometimes called a Cassandra, and his prophesies about the dot-com and housing bubbles did come true. Yet in these pages he sounds more like a visionary optimist who considers today’s emergency a grand opportunity.

The subprime crisis, he says, “can be transformed in its aftermath into a better environment for extending the financial franchise, for further democratizing finance.” He draws an analogy to what happened after the housing crisis of 1925-33.

Be bold

The Great Depression led to profound institutional changes, including the creation of the Federal Housing Administration, the Federal Deposit Insurance Corp. and the Securities and Exchange Commission. We should be “unafraid to think and act on the scale of the New Deal-era reformers,” he says.

The book opens with a concise summary of the subprime-mortgage chain of events — how unscrupulous lenders and naive borrowers fueled a boom, driving up prices and prompting builders to construct more homes. As the market became glutted, prices fell. Then mortgage rates started resetting at higher levels and borrowers began defaulting, triggering a “grim feedback loop.”

Instead of fingering individual culprits — such as bubble-blower Alan Greenspan — Shiller pins the blame on a broader phenomenon: “the contagion of market psychology.”

How else would an entire nation come to believe that home prices could go only up, up, up? Not long ago, after all, “people thought of their homes as depreciating manufactured goods, like cars and boats,” notes Shiller, the co-creator of the S&P/Case-Shiller home-price index.

Bitter, sweet

What can fix this mess? Shiller offers two answers — a sweet one for tomorrow and a bitter one for today.

For the future, Shiller proposes a package of innovations to make the housing market less bubble-prone and more open to people with low incomes. Imagine, for example, a more liquid market for real-estate futures such as those based on the S&P/Case-Shiller indexes: If an investor in Istanbul saw California home prices going through the plywood roof, he could sell the market short, pricking a bubble.

Or how about issuing “continuous-workout mortgages”? Instead of waiting for a low-income homeowner to default, this mortgage would be regularly adjusted to reflect trends in the housing markets and the ability of the homeowner to pay.

The government, meanwhile, could curb market contagion by educating its citizens about inflation. (If the “value” of your home doubles, check if prices for everything else have tripled.)

For today, though, Shiller says we must accept government bailouts, however unfair they are to taxpayers who never bought, sold, rated or invested in subprime mortgages. Why am I having trouble swallowing this?

As Shiller must know, humans are hard-wired to cooperate without hope of future gain. Yet studies show that we will punish those who don’t reciprocate. He appeals to our nobler instincts.

“Our sense of trust in each other is itself substantially the legacy of former humane actions that at times took the form of bailouts,” he says, citing the Marshall Plan.

Fair enough. Let’s just remember who foots the bill — the taxpayer — and that some punishment may be in order.