Gordon's Reviews > The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do about It

The Subprime Solution by Robert J. Shiller
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's review
Jul 21, 2009

it was amazing
Read in August, 2009

This is one of the most creative books on finance I've ever read, not so much because of its diagnosis of the causes of the current economic crisis, but because of its proposed solutions for making sure a similar crisis doesn't happen again.

First, the causes. Shiller says much the same things as most other economists now say, with the advantage of more hindsight. The main cause was the housing bubble in the US, though similar bubbles arose in other places too, such as the UK. The bubble arose out of psychological factors first and foremost: a belief that housing prices would continue rising forever, and at a rate faster than inflation. This "social contagion", as he calls it, affected victims and victimizers alike. Sub-prime borrowers and central bankers both swilled the champagne, based on their recent experience. A longer term view would have led to a different conclusion: "We get the false impression that homes have been a spectacular investment when in fact their increase in value, measured in [real terms:], even over many decades, would generally have been -- at least until the recent housing boom -- nil."

Contributing factors include the financial instruments that allowed bad mortgages to be bundled up and resold to investors worldwide, lax regulation, low interest rates, compensation schemes that encouraged wild risk-taking by banking executives, and unscrupulous mortgage lenders. Needless to say, the Bush Administration was not exactly vigilant in reining in this housing boom, any more than the Clinton Administration reined in the tech boom of the 1990's. Too many people were making enormous amounts of money, and the skeptics were simply written off as party-poopers.

Second, the solutions. Shiller is a big believer that markets combined with better risk management tools are the best avenue to greater prosperity for all, including those on the lowest rungs of the economic ladder who were hit hardest by the collapse of the sub-prime mortgage market. The key problem with housing in particular, as he sees it, is that the typical homeowner is stuck with the worst kind of risky asset: it's financed with debt, it's an undiversified portfolio (a single house, in a single market, which can't be moved anywhere else) and it's not very liquid (you can't sell it quickly). What he suggests is a housing futures market, where homeowners could hedge their risk, so that they could buy an option to sell their house at a fixed price at some point in the future. In effect, it's insurance against the house losing value. This is a pretty clever idea. And he has lots more in a similar creative vein.

At 178 pages, this is a pretty quick yet fascinating read.


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message 1: by Masching (new)

Masching Hi Gord Do you ever read anything light? I'm reading Frommer's guide to Scotland and Ian Rankin's Doors Open, a crime novel set in Edinburgh. Janet

Gordon Masching wrote: "Hi Gord Do you ever read anything light? I'm reading Frommer's guide to Scotland and Ian Rankin's Doors Open, a crime novel set in Edinburgh. Janet"

Secretly, I'm a fan of bodice-rippers, but I'm afraid it would undermine my intellectual stature if I reviewed them on Goodreads.

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