MSRI Prize: Robert Shiller Keeps Innovating

Robert Shiller

The world’s most sought-after economist on housing issues has been an influential voice throughout the housing crisis and beyond. He is best known for the index that bears his name, but from digital media to new concepts for futures and securities, Robert Shiller isn’t running out of ideas anytime soon.

Shiller, a Yale University economics professor, has published books on a variety of topics related to finance and economics that run the gamut from financial markets and innovations, to macro and behavioral economics, to real estate and statistics.

But in an interview, Shiller was quick to mention his free online course on financial markets, Econ 252, recorded first in 2008 and more recently in 2011, as part of the Open Yale Sources series.

The lectures, in effect, help democratize the education of non-students by introducing them to key concepts in finance, and are available on the Open Yale website and iTunes, with some also on YouTube with foreign-language subtitles.

“I avoided the blackboard,” Shiller says, referring to the taping of the free lecture series. “They told me people like to listen to the lectures while jogging.”

As he says in the opening of the introductory lecture:  “Finance, I believe, is a pillar of civilized society.” Defining finance broadly to include insurance as well as banking and securities, Shiller says finance is about the allocation of resources and time, incentivizing people to do things, and “about managing risk in anything we do in life.”

But his foray into digital media is only the latest innovative milestone in a career full of them.


Creating Efficiency for Home Prices

Most of us know Shiller by the repeat-sales home price indexes he developed with Karl Case and produced in 1991-2002 by their firm Case Shiller Weiss. Designed to be a benchmark of U.S. housing prices, they are now published as the S&P/Case-Shiller Home Price Indices and measure the average change in home prices in 20 geographical areas.

Futures and options contracts for 11 of the indexes — 10 city indexes and a national index — are traded the Chicago Mercantile Exchange.  Case Shiller Weiss sold the rights to the indexes in 2002.

For these and other accomplishments in advancing global economics, Shiller will be awarded the CME Group-Mathematical Sciences Research Institute’s (MSRI) 2012 Prize in Innovative Quantitative Applications today.

Shiller addressed the topic of price fluctuations in his 1989 book, “Market Volatility,” a mathematical and behavioral analysis of speculative markets.

He discussed speculative bubbles, with a focus on stocks and real estate, in “Irrational Exuberance,” published in 2000 (with a nod to former Federal Reserve Chairman Alan Greenspan, who he says coined the phrase).  Shiller says an Excel file with the data set used and described in the book is updated monthly.

He says he began his examination of U.S. housing market prices after deciding that “research on speculative markets focused too much on financial markets (stocks), and that the 1980s housing market boom was different.”  People seemed to believe during the boom that housing prices always go up, he says.

“No one had ever done a careful job of testing whether housing markets are efficient, and amazingly, there wasn’t good data,” he says. Shiller and Case solved that problem by obtaining a computer tape with prices of millions of home sales from U.S. appraisers.

Once the appraisal data was processed and crunched, they were able to determine that the housing market was less efficient than the stock market, “because of the inability for professionals to trade it,” he says.

Shiller says until the 1980s, a housing bubble was possible, but rare.  A “land bubble” was more likely, he says, explaining that “land is fixed because you can’t make more of it,” but builders can always put more houses on land.

Shiller and Case initially devised indexes of 10 U.S. cities’ housing prices and eventually put together indexes of low- medium- and high-tier home and condo price indexes for 20 cities and a U.S. national index.


Solutions to the Housing Crisis

Though some economists have trumpeted the return of the housing market, Shiller is skeptical, noting that recent U.S. construction data remains weak. Of the 20 cities in the Shiller-Case Index, he says Phoenix and San Francisco are showing real signs of improvement, but nationwide it is too soon to tell if there is a real recovery.

The Federal Reserve is “our basic stabilizing institution,” he says, in support of the Fed policymakers’ latest decision to buy mortgage-backed securities in an effort to lower long-term interest rates.

“Sometimes we have to recognize we have a nation with responsibilities for each other,” he adds. “The real problem with this financial crisis is that the suffering is not equally shared.”

Shiller has proposed other solutions to the housing crisis, detailed in his book, “The Subprime Solution: How Today’s Global Financial Crisis Happened and What to Do About it.”

His ideas include the creation of a type of mortgage that contains a preplanned workout for homeowners – although this type of mortgage would need to be securitized, he adds. Another of his solutions calls for homeowners to take out home-equity insurance on their mortgages – an example of democratizing finance through institutions of risk management.

Shiller notes in the 19th and 20th Centuries, house fires were very common – candles were used for light and other flammables for heat. By the 1930s, mortgage lenders became more sophisticated and started demanding borrowers take out fire insurance.

Today house fires are less common – “now the biggest risk of (owning) a home is a decline in market value,” he says.

Research work was done on the value of home-equity insurance before the financial crisis in 2008, he says, including presentations to Fannie Mae and Freddie Mac. Ironically, the agencies “wouldn’t budge” on the issue.  For their part, insurers would have been more receptive if they had a vehicle, or market, to hedge risks, he adds.


“A failure of portfolio management”

“Since the 1870s, overall volatility hasn’t changed a lot,“ Shiller says. “There have been frequent bursts of volatility, but it’s roughly the same.”

Shiller points out that since Americans live in a stable country with an unchanged constitution since its inception, that helps insure a controlled rate of volatility over the long term. A stable government and respect for private contracts also helps, he adds.

While an event such as a war or a stock market crash has an impact, researchers have to go back to the Great Depression to find a situation with a similar magnitude to the financial crisis of 2008, he says.

Shiller calls the financial crisis, “a failure of portfolio management.”

For all his contributions as an economic innovator, teacher and author, Shiller is still coming up with new ideas on managing economic risk.

He recently looked at the concept of gross domestic product, or GDP, futures and securities. “The idea is that GDP is a very important risk, and should be traded,” he says, suggesting that they might be called “trills” and the dividend paid on one share might be set equal to one one trillionth of GDP, so that this years dividend would be about $15. The market would have to figure out how to price these—they might sell for over $1000 per trill.

A lot of Europe’s problems are refinancing problems,” he notes.  “If you could trade shares of GDP” that would offset these risks.

Debbie Carlson has focused on commodities for much of her writing career. She spent more than a decade at Dow Jones covering the Chicago-based futures exchanges. As a Dow Jones editor, she worked closely with The Wall Street Journal and Barron's in planning commodities coverage.

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