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The Subprime Solution. Robert J. Shiller. 196 pages. Princeton University Press, 2008.
For many years Robert Shiller has been warning us about market bubbles and advocating the creation of new markets that will enable individuals and firms to manage the risks that they face. The first edition of Irrational Exuberance (2000) warned of the bubble in the stock markets, and the book was published just prior to the crash in those markets. The second edition of Irrational Exuberance (2005) used data through 2004 and warned that the housing market in the United States had become a bubble. The crash in the housing market began in 2006. Shiller's latest book on the global financial crisis provides an explanation of the origins of the crisis in the U.S. housing market and makes short-term and long-term policy recommendations. Nowhere in the book does he say, "I told you so," but he did.
The Subprime Solution was published in mid 2008, so events have overtaken the book in some degree. Perhaps even Shiller was not fully aware of the degree of leverage in the shadow banking system and the fragility of the financial system. Nevertheless, the book contains a fair measure of the Shiller prescience.
The book begins with the bubble in the housing market. Shiller argues that market bubbles are caused by social contagions that are fueled by continuously increasing prices. He believes that social contagions act as epidemics. He recognizes that his interpretation may not be held widely,...