Paul Solman’s Interview with Bob Shiller on Finance and Psychology: Weekend Reading

The Business Desk with Paul Solman: Nobel Laureate Bob Shiller on Why the Fed Can’t Say There’s a Housing Bubble:

Paul Solman: Can you say in a sentence or two what you got the Nobel Prize for?

Bob Shiller: Ha. I don’t know. … There’s a long scientific background paper on the Nobel website that talks about the three of us — Gene Fama, Lars Peter Hansen and me. As contributors to the same body of literature, which seems a little hard because Gene Fama, especially, takes a different summary view of it all.

Paul Solman: Exactly the opposite, in some sense, right? He says the market at any given time reveals what the underlying stocks are really worth.

Bob Shiller: The whole idea that the stock market reflects fundamentals is, I think, wrong. It really reflects psychology. The aggregate stock market reflects psychology more than fundamentals. This is where maybe I really do differ from Gene Fama. I don’t think he would say that.

Paul Solman: No. I don’t think he would believe it. Are we experiencing, to use your phrase from 1996, I think, irrational exuberance in the stock market again?

Bob Shiller: Well, some people are. I have my own confidence indexes, which I’ve been computing for years now. It has bubble elements to it because people see the market going up and they’re regretting the fact that they didn’t buy in several years ago, and they are tempted back into it. But it isn’t the really strong bubble that we saw before because there are so many clouds — there are so many issues on people’s minds that it doesn’t look like the chance of a lifetime now.

Paul Solman: But the index to which you refer, the cyclically adjusted price earnings ratio, that’s at about 25 at the moment. It peaked at 45 back in 2000. In 1929, it was about 35, but historically the average is somewhere like 15, 16? So 25 to 15 is overvalued by 60 percent.

Bob Shiller: It can keep going up. Even so, it’s not a clear signal yet. Well, 25… it could go up to 35, easily.

Paul Solman: And then you’d have left a lot of money on the table by not having bought at 25.

Bob Shiller: That’s the problem that… yeah, it’s time to be worried, but it’s not necessarily time to bail out. I have money in the stock market. I would say it’s about 50 percent, but I don’t have the exact number. And I don’t think it necessarily means that I’m a model for everyone. I’m someone who is older, and young people can take greater risks. I’m not advising them to, but it’s natural that they might.

What About Housing?

Paul Solman: I know you don’t like to make predictions and think they’re foolish in some sense, but I’m not doing my job if I don’t ask the Shiller of Case-Shiller, what about the housing market at the moment?

Bob Shiller: It’s a very interesting phenomenon to me that there are bubbles in so many different countries around the world. Like Brazil. I was just down there a few months ago, and they’re going through a huge boom in housing and it seems to be… well, they don’t have any data. They weren’t even paying attention. They didn’t have home price indices until a few years ago. Now, everyone’s talking about it and they’re excited about it.

Paul Solman: Even though in the world… in Ireland, in Spain, in the United States, there were these spectacular bursts of housing bubbles.

Bob Shiller: Right. You’d think that the Brazilians would learn that the Americans had this huge bubble and then it burst. But that doesn’t seem like what they learn. They’ve adopted kind of the mentality that we had eight years ago. It’s uncanny. When I was in Brazil talking to people, I felt like I was in the United States of 2005.

Paul Solman: Well, did you start to warn them, the way you warned us then?

Bob Shiller: I did, although the Brazilian home price boom is interpreted by most Brazilians as a sign of the country emerging. Brazil is joining the advanced countries of the world. Of course, if you want to buy a condo in Sao Paulo, you have to expect to pay New York prices. That’s where it’s going, right? And if I say: No, then it just feels bad to say that. And I can do it because I’m leaving Brazil in an hour. In a couple of hours I’m out of here.

Paul Solman: But you’re a Nobel laureate who won the prize based, in large measure, on your skepticism about irrational markets, right? I mean, so you would think the Brazilians would go: Oh my goodness; Bob Shiller’s calling it a housing bubble.

Bob Shiller: Some of them did. But I’m sure it stays as a fringe opinion. It’s just to the patriotic forces, that just doesn’t feel good, this alternative view. And, by the way, we have professional economists who could defend any viewpoint with statistics, and they do that.

Paul Solman: Everywhere in the world.

Bob Shiller: Everywhere in the world. Economics is not an exact science. I wanted to be a scientist when I was a child. And I’ve been lamenting ever since that I go into a field where I just can’t be exact, and I don’t think anybody can. What is the economy going to do next? We just went through the biggest housing bubble in U.S. history. It’s off the charts. And now it’s starting to go up again. What to make of that? I mean, are we going back into another bubble economy? I don’t know. I don’t see how anybody knows that.

Now, this reminds me: back in 2005, during our housing boom, I did a search on the Federal Reserve board website — research papers for “bubble” — “housing bubble.” And I found it was hard — this is our own Federal Reserve — hardly ever mentioned in their research papers. But I found one paper that mentioned that we might be in a housing bubble. So I called the economist up and I said, “You’re at the Federal Reserve board. You had worries about the housing bubble. Why didn’t you go for it and say strongly we might be in a housing bubble?” And he kind of hemmed and hawed and didn’t seem to want to answer me.

I had a sense that — and it’s obvious, right? You’re working as an economist at the Federal Reserve board, you can’t say that, I mean, because it would be attributed to your higher-ups; you’re part of an organization. And the Fed chairman is so careful about everything. The Fed chairman is not going to say “housing bubble.” So you down below, lower on the totem pole, are sure not going to say it. So this is what the psychologist Irving Janis called “groupthink,” and he called it “self-censorship.” I don’t think the Federal Reserve board censored this economist, but he knows that he’s part of an organization that’s part of our country’s animal spirits. It’s managing the level of our confidence. So he’s just going to keep these doubts to himself.

Paul Solman: But you didn’t keep the doubts to yourself.

Bob Shiller: I think it’s partly my personality; it’s partly my different sense of national duty, or my duty to the Brazilians, I don’t know. It’s partly that I’ve never accepted the conventional wisdom. It’s maybe an attitude that I got from my father — don’t believe all these important people. And when they tell you something’s right, well, there’s certain kinds of things you can trust in them, but when it comes to politically involved discussions, don’t believe anything they say. And so that gave me the fortitude to just stand up for what seems right to me.

The Uncomfortable Necessity of Speaking Up

Paul Solman: Were you uncomfortable? You, in the ’90s, were talking about irrational exuberance in the stock market. In the 2000s you were talking about a housing bubble. Were you uncomfortable when you were doing that?

Bob Shiller: Yes, yeah. Not only was I acting unpatriotic, but I was also working against a sense of self-esteem that we have that we’re the most capitalist country in the world, and we have a system that works better and better… an amazing system. To say that, well, there are others who did that, but to say that the system is flawed and that it’s open to psychological swings is just… it was a risky professional strategy. There were people who did it, like John Kenneth Galbraith in 1954 wrote a book called “1929, The Great Crash,” and that was a wonderful book, but it made the leaders of this country look a little foolish. I think he was very unpopular for that. But he had a sort of following. I think he was following his conscience.

Paul Solman: Well, he liked being contrarian.

Bob Shiller: I think I like being contrarian, too. But I like the truth and I’m not going to do it just to be contrarian. The word conventional wisdom, by the way, was coined by Galbraith and it refers to his frustration when so many high placed people were saying the same nonsense. They would say it because it’s the thing to say.

Paul Solman: The same “nonsense” meaning?

Bob Shiller: Well like, back in the ’50s [when] the stock market was booming, they would say patriotic things — “Own a share of America” — I think that was it, do I have that exactly right? It’s a New York Stock Exchange slogan. “Buy your share in America.” And so it was a triumph of our system that the stock market was going up.

How the Prize Will Change Him

Paul Solman: How surprised were you at getting the Nobel Prize?

Bob Shiller: Well, there were people telling me I would get it.

Paul Solman: Really?

Bob Shiller: But they’re my friends, right? But in fact I asked other professors, “Do you have friends telling you that you’re going to get the Nobel Prize?” And they said, “Yeah.” So I thought every professor has friends telling him that. My wife was asking me the night before, what’s the probability? And I thought, well, it could be as high as 2 percent. And I thought I was being really optimistic.

Paul Solman: Did you believe them when they called? There are all these stories about Nobel laureates who get the phone call and think it’s somebody joking.

Bob Shiller: That… Yeah. It crossed my mind they might be, but I listened carefully to their Swedish accents, and I thought, I can judge people. These are real Swedish intellectuals and it’s not some prankster. So I actually didn’t worry about that very long at all.

Paul Solman: How much of a difference does it make to you, to your life?

Bob Shiller: Well, it’s been a lot of fun. It’s been very hectic. It’s bringing back all of my old friends. It’s been bringing back all of my old friends from high school and all the like. They don’t realize I don’t have time for all of them at once. If you could wait a year or two, maybe we could get together and have coffee.

Paul Solman: And going forward, will it make a difference? If so, how?

Bob Shiller: Well, my wife is telling me I don’t have to work so hard any more. I’m thinking that maybe I will devote myself more to others and mentoring and helping students — maybe more moral purposes and less publication; I don’t have to publish so much.

I was more ambitious when I was young, and now I’m thinking that my students matter more to me than I realized and that I really was doing things for… for moral reasons more than I thought. I am reminded of Huckleberry Finn in the Mark Twain novel, who, at one point, decides that morally he has to turn in this runaway slave named Jim because what he is doing is stealing someone’s slave. But when the moment comes to turn Jim in, he doesn’t do it. He makes an alibi for Jim. And then he walks away, thinking, I’m just the most horrible person in the world. I just can’t be moral. I’m participating in the theft of a slave. So I think maybe I was more moral than I thought I was. I thought I was trying hard to get ahead.