Oh dear Willie

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…..

3 comments on “Oh dear Willie

  1. This is a fundamentally brilliant idea. But, from the point of view of justice or fair play, it seems to unnecessarily limit the boon of the whole thing (an equity achieved without risk either of loss of value or loss through non-payment) to just those people who’d taken it in their heads to take advantage of the opportunity. Kids run around–for as many as 12 years, even more, in some circumstances–without ever it crossing their minds to buy a house. A patently unfair system demanding remedy lest society later be riven between the adult “did” and “didn’t” classes.

    An obvious solution to that particular problem will be to issue the property entitlement at birth, which will also serve, for each individual, to lengthen the period of time through which his property has been steadily increasing in value and rendering him rich. It can be left to subaltern functionaries to settle the questions surrounding whether immigrants are to be endowed upon arrival, at some point in the legal process of becoming resident aliens, or (as will become the focus of unremitting group pressure) from the moment of their birth “back home” (properly authenticated, of course). And the sticky matter of whether conjoined twins shall receive one or two properties (or of whether the second property shall be credited from birth or only at the instant of surgical separation) can, fairly safely, probably be left
    quite safely to later judicial ruling.

    It seems that the real problem, as always, is what conservatives have always insisted: the problem is one of insufficient supply. Where the immense majority of mainstream economists and the unwashed multitudes subject to their (subsidized) propaganda for the past 80 years will identify the critical core of the problem as “insufficient DEMAND for consumer goodies and stuff,” a clearer-sighted and farther-thinking group, until now relegated to the infequently-fashionable fringe only sometimes called “lunatic” has, for a very long time, insisted that the insufficiency has been, is now, and always will be, an insufficiency of SUPPLY.

    Go back and retrace the recommendations excerpted. The ill-bred have long described the entire process as an illustration of the “greater fool” phenomenon. And, if we trace common characteristics of every historical crisis with which we have any familiarity—as far as that afflicting the tulip market in long-ago Holland—we see no evidence whatever of shortage. In the Great Depression, despite people forming food lines, there was no shortage of farm products–the stuff was so abundant that farmers couldn’t make a living at the market prices. Presently, there’s no shortage of houses on the market and at ever-more-but-not-quite-yet-attractive prices and big auto manufacturers and dealers are clearly in overstock mode.

    So how, one might ask, is the situation I’ve described NOT an example of insufficient demand, as the regular guys insist?

    Because, all along, in every crisis, there’s an underlying reality: an ultimately limited SUPPLY of “greater fools.” Aye, there’s the rub.

  2. I think you’re off-target here.

    I saw Shiller speak last week and he is advocating the creation of new types of mortgages. It’s a separate proposal to the idea of creating a market in housing futures that you mention, and from memory not one that appears in the Subprime Solution.

    In addition at the meeting I was at Shiller was specifically asked whether the govt should step in and mandate new products if a market for the types of mortgages he envisages did not develop by itself. I’m pretty sure he said in response that yes the Govt should consider mandating the creation of new products along these lines. That’s all Hutton seems to be saying too, so I’m not sure what you think he has got wrong?

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