Shiller Doesn’t Dare Say What He Believes Is the True Cause of the Economic Crisis


Valuation-Informed Indexing #201

by Rob Bennett

I detected an early sign of Spring in a recent column by Robert Samuelson titled Five Years On, the Financial Crisis Still Confounds. Samuelson wrote: “We still lack a true understanding of what caused the financial crisis and Great Recession.”??The column explained that: “Liberals blame a naive faith in free markets, deregulation and Wall Street greed. Conservatives slam government: lax monetary policy and ruinous home-lending by Fannie and Freddie. These selective narratives are self-serving, intended to advance political agendas and not to illuminate the messier reality.”

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Samuelson hints at the true cause of the crisis without quite becoming so bold as to identify it bluntly.

He tells us: “We were victims of success. The crisis originated from 25 years of prosperity, from roughly the end of 1982 to the end of 2007. This conditioned people — bankers, regulators, economists, almost everyone — to take stable growth for granted. The longer the prosperity continued, the more it inspired the risky behaviors that ultimately wrecked the economy. These included over-borrowing by consumers and financial institutions, housing speculation and loose regulation. The ‘causes’ cited by left and right were usually the consequences of a delusional mind-set: a belief that once-risky practices were prudent in a world of near-perpetual prosperity.”??It all began in 1982, huh? I wonder if there was anything relating to the stock market that began in 1982? I have a feeling that that might be the case. The words are on the tip of my tongue. I just cannot quite bring the thought to mind.

That phrase “delusional mind-set” might be a clue. It reminds me of a similar phrase. Irrational Something or Other. Again, I just don’t seem to be able to pin it down. Some sort of unease about saying the words out loud is holding me back.

More Samuelson.

“I’ve told this story before. It doesn’t take, because it blames faulty ideas more than crooks and scoundrels — the tempting target of most narratives. But the accumulating evidence suggests that false ideas, not evil people, were the main culprits.”??False ideas. Like Buy-and…Something. Buy-and-Fold? Buy-and-Cold perhaps? Buy-and-Bold? It’s all so foggy.

“Economists should be wrestling with these and other hard questions. They aren’t,” Samuelson concludes.

I agree. But I think we need to take it to the next step. We cannot just blame the economists any more than we can just blame evil Wall Street figures. To get things moving in the right direction again, we need to ask why there is this great reluctance on the part of economists to take up these hard questions.

There’s one economist who you wouldn’t think would be worried at all. That’s Nobel Prize Winner Robert Shiller. Shiller explained in a book published in March 2000 why we would be seeing the biggest economic crisis in U.S. history begin sometime late in the first decade of the 21st Century. We allowed the stock market to become overvalued to the tune of $12 trillion in the late 1990s and every time in the past in which we had permitted a bull market to get so out of control, we brought on an economic crisis as trillions of dollars of consumer spending power disappeared from the economy.

Shiller wrote: “If over some interval in the first decade or so of the 21st Century the U.S. stock market i going to follow an uneven course down, as well it might — back, let us say, to its levels in the mid-1990s or even lower — then individuals, foundations college endowments and other beneficiaries of the market are going to find themselves poorer in the aggregate by trillions of dollars. The real losses could be comparable to the total destruction of all the schools in the country, or all the farms in the country, or possibly even all the homes in the country.”

So he knows, right? ??He knows. At least on some level of consciousness.

But this is hard stuff and Shiller is one of those social-being humans just like all the rest of us. He reads the signs. He knows what people can stand to hear and what hurts too much by the signals that people send him when he suggests hard truths to them.

Shiller’s official position as of today is stated in an article he wrote titled The Financial Fire Next Time. He says: “The financial crisis, which is still ongoing, resulted largely from the boom and bust in home prices that preceded it for several years.”

It’s not quite the same thing, is it???Bad boom and bust in home prices! I wonder where the Pretend Gains came from that fueled that very, very bad boom in real estate prices.

Irrational Exuberance! That’s the phrase I was trying to bring to mind! It has something to do with stocks.

Bull market! That’s the thing that started in 1981. It’s all coming back to me now!??Buy-and-Hold! That’s the set of ideas that assures us that there is no need to exercise price discipline when buying stocks, that it all works out somehow in the end anyway. How did I forget Buy-and-Hold?

We making very slow progress.

But at least we are moving in the right direction.

One of these days we will all make it together to the other side of The Big Black Mountain.

I am sure.

I think.

Rob Bennett has recorded a podcast titled The Market Has a Brain: That’s Why Whatever You Decide to Do Turns Out to Be Wrong. His bio is here.

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Rob Bennett’s A Rich Life blog aims to put the “personal” back into “personal finance” - he focuses on the role played by emotion in saving and investing decisions. Rob developed the Passion Saving approach to money management; Passion Savers save not to finance their old-age retirements but to enjoy more freedom and opportunity in their 20s, 30s, 40s, and 50s - because they pursue saving goals over which they feel a more intense personal concern, they are more motivated to save effectively. He also developed the Valuation-Informed Indexing investing strategy, a strategy that combines the most powerful insights of Vanguard Founder John Bogle and Yale Professsor Robert Shiller in a simple approach offering higher returns at greatly diminished risk. Tom Gardner, co-founder of the Motley Fool web site, said of Rob’s work: “The elegant simplicty of his ideas warms the heart and startles the brain.”
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