27 July 2012Robert Shiller interviewed by Romesh Vaitilingam, Voxeu
Romesh Vaitilingam: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam and todayís interview is with Professor Robert Shiller from Yale University. He and I met in the city of Bristol in the UK in May 2012, where we spoke about his book Finance and the Good Society. The basic theme of the book is the need to democratise finance by making the financial markets work better for everybody.
I began by asking Bob to explain exactly what he means by that.
Robert Shiller: The Occupy Wall Street and Occupy London people say ďWe are the 99%Ē. Thereís an increasing concern with unequal distribution of wealth, and finance is perceived as the villain in all of this. But Iím thinking it canít be the villain; finance is a technology that can, if itís properly applied, help reduce inequality if itís applied to everyone. So I think that people who are in finance today have a moral obligation to help advance the trend toward democratisation of finance. That means using the principles to really help people.
RV: Could you explain a little bit more on what that means? In the book you use the phrase ďfinance is about human desires and human possibilitiesĒ which is a very powerful sense of being about our deepest wants and what weíre able to achieve. Could you explain how finance helps us to fulfil our desires?
RS: When you think of finance, you come to it thinking ďMake money! Get rich!Ē You should instead think about financing activities, things that people do together that are important to them. Achieving goals that are shared by groups of people. Financing activities is what itís all about. And the underlying problem is that just about anything that we think is important to do canít be done by one person. You need groups of people and you need resources, various things that are produced in other countries that would be inputs to your activities. And the organisation generally has to last for years and years to achieve the goal, so it has to have some kind of continuity of support from people and resources. And that support is called financing, so thatís what itís all about.
RV: Can you give us some specific examples of great innovations, great advances in the technology of finance that have helped society to develop?
RS: Thereís a lot of scepticism about financial innovation. Paul Volcker, the former Fed chair, said he couldnít think of a financial innovation other than the Automatic Teller Machine that gives him cash. He said that about two years ago and itís been quoted a million times. Even since he said it I can think of a number of innovations. One of them is the benefit corporation, which was created in the United States. The first one was about a year and a half ago.
The benefit corporation is a new kind of corporation thatís halfway between profit and non-profit. It fills a need. The benefit corporation makes profits and distributes them to shareholders just like a for-profit corporation. The only difference is, and this may seem like a small difference to some, the corporate charter specifies a purpose Ė a social, environmental or charitable purpose Ė in addition to the profit-making purpose. It doesnít really clarify how the effort will be divided between the two. Some traditional economists who look at this would say, ďThis doesnít make any sense! A company should make profits and be focused on that. If thereís any charity itíll come after the company distributes the profit to shareholders, and they can do what they want with it, including charity.Ē
But the problem is, and this is whatís bothering people these days, a strictly for-profit corporation just seems selfish. And it is selfish, because focusing directly on profit is just not humane. I think everyone will feel better about these benefit corporations. Theyíre just starting up now, only in the US at this point but I think the idea will spread. So thatís one innovation.
The social impact bond, which started also in the last couple of years in the United Kingdom. Itís a bond issued by the government which pays out only if some social goal for the society is met. So, for example, the UK government issued a bond that will pay out in six years if the re-incarceration rate of prisoners released from Peterborough prison falls by 7.5%. A very well-defined goal. They release someone after his term is up and six months later heís done it again, heís right back in jail, and they just canít figure out what to do about that problem. So the social impact bond opens it up to entrepreneurship. Theyíre finally saying, ďWe donít know what to do about this problem. Can somebody out there figure it out?Ē And anybody who wants to can come in and invest in these bonds and the money goes to, say, working with prisoners, finding them jobs, that sort of thing. But these people know that they will get nothing unless they actually reduce the rate. The idea is that this incentivisation will bring in some diverse new ideas and enthusiasm to fix the problem.
RV: Youíve described a couple of financial innovations that have a really pro-social motivation. But when a lot of people think of financial innovation they think of specific things like collaterised debt obligations and credit default swaps and the kinds of things that people think contributed to the crisis.
RS: Collateralised debt obligations are a source of problems because they were flawed and they did help worsen the crisis. But I think collateralised debt obligations are in the same category as the things I just mentioned. What they do is they make it easier for people to buy a house. What they do is they take mortgages and package them, and then they split them up into tranches, and they have a triple-A tranch which is thought to be safe. It wasnít, as it turned out, but next time theyíll get the problems ironed out and it will be. So theyíre able to get investors investing in the mortgages. The ultimate thing is, and itís kind of hard to see but itís real, it ought to bring down the mortgage rate. And that means bringing more people into housing than there could have been. We donít know who they are, but there are some families living in homes who otherwise couldnít afford that if there werenít collateralised debt obligations. I have nothing to do with these people who issue CDOs, and I donít mean to sound like they did it right, but I donít think itís in a different category. I think itís something that has a social benefit.
RV: Are there different categories? Could you divide financial innovations into productive and not so productive innovations?
RS: Absolutely. I am not saying in this book that everything that happens in the financial world is good. There are plenty of bad things that have happened, and they anger people, and they anger me too. If we stay on mortgages in the United States during the recent financial crisis, many people were lured into mortgages that werenít right for them. There was a common practice: employers would tell their mortgage counsellors to get the guy into the most expensive mortgage. If this guy qualifies for a lower rate, donít tell him. And they also said they would give these Ďteaserí lower rates. They would out-compete the competition by saying, ďfor two years you have a really low rateĒ. If they ask, ďwell what about after two years?Ē you just brush it aside. And, by the way, they donít care that when this higher rate comes they wonít be able to pay and will default, because then theyíre putting off the mortgage securities under some vulnerable investors and theyíre out of there. That was not good, and itís bordering on criminal. People are justifiably angry about that.
The way we respond to that is regulators, and our regulation of mortgages has tightened up. For example, mortgage brokers were never even licenced in the United States until after the crisis. So you could come right out of Peterborough prison and go in to mortgage broking, and you could lie and no oneís watching you. Weíve corrected that now.
RV: You talk in the book about a certain sense of sleaziness, a sort of inbuilt tendency to dishonesty, or certainly the pursuit of greed in finance.
RS: There is an incentive towards dishonesty. One of the fundamental things, especially when youíre trading, is not to let people know what you know. Keep it a secret. So, for example, Goldman Sachs was selling these Abacus Securities. And they knew that John Paulson, who was the other side of this, had stocked these securities with junk that would likely fail, and Goldman didnít tell the other side that this was happening. Ultimately Goldman had to pay a settlement of $550m. This was bad practice, and these things happen. Thatís why we need regulators and we need industry organisations, and we need people in the industry who voluntarily uphold standards. But of course it slips, and Iím not saying that everyone is nice.
RV: Obviously there have been regulatory efforts made by governments and other public agencies over many, many years, and there have been recent efforts in the wake of the crisis. But thereís always the danger with regulators that theyíre behind the curve, they know less, theyíre less well paid than the people doing the financial innovations. And thereís the possibility of regulatory capture as well, that theyíre taken over.
RS: Youíre talking about some genuine and important problems. Fortunately, people are not entirely selfish, and that ought to be obvious. And people will go into regulation out of public spirit. You said that theyíre not paid well, and thereís a common assumption that theyíre less smart, that the smart people go and become billionaires on Wall Street or in the City but they couldnít make it so they end up as regulators. I donít think thatís true. In fact, the same people will go in and out of those jobs. Theyíll be on Wall Street, and then theyíll become a regulator.
RV: Is that a good idea? Do you want to have someone from Goldman Sachs moving into a regulatory position? Do you want someone from Goldman Sachs being your Secretary of the Treasury?
RS: Unfortunately those things often make sense. Henry Paulson Ė not John Paulson Ė was head of Goldman Sachs and then President George Bush made him Treasury Secretary, and he handled the AIG bankruptcy in a way that benefited Goldman Sachs. You wonder: was that corrupt? Itís not obviously corrupt, and yet I donít know what happened. I think President Bush may well have done a good thing by putting Paulson in, because the guyís just financially savvy and heís doing a million things. I canít answer whether he was biased and funnelled money to Goldman, but it seems like we have a fundamental dilemma that the financial system represents a complicated technology, and you canít pick someone who knows nothing about it and put them in as Treasury Secretary. This is a fundamental dilemma in society. People who join professional groups start to identify with them and then start to promote the cause. People are cliquish, this is human nature, they form groups and then they feel loyalty to each other. It feels almost like a moral virtue to be loyal to your professional group. Itís part of the process that generates inequality. But we have other processes that limit it, so there is a sense of public spirit that is very common. People become regulators because they donít want bad things to happen.
RV: In the wake of the crisis thereís also been talk about finance just being too complicated. Some of these innovations have been too complicated even for the organisations that have made them. So the kind of people who were running organisations, dreaming up new kinds of derivatives, didnít really understand what was going on. That must be a real problem with financial innovation, that the people in charge donít really understand the technology that theyíre using.
RS: That is a problem, and I would say that itís a problem with technology in general. When someone designs an airplane, if it gets too complicated then the engineers donít understand whatís happening. This is to do with systems, so if youíre designing an air traffic control system and itís too complicated, thereís going to be a catastrophe. But on the other hand Iím thinking that modern civilisation with modern computers can create some pretty complicated things. Iím thinking of, for example, the automobile. Itís got more and more complicated over the years and itís getting harder and harder for the backyard mechanic who wants to fix the car. So you take it out to a dealer who has a computerised diagnostic system and so on. Thatís the kind of society weíre living in. We always have to be mindful of some catastrophe that could result from our not understanding the complexity, definitely. But on the other hand I think weíre on a secure trend to more complexity, and computers are an important reason why we are. Life is going to get more and more complex and specialised, thatís pretty inevitable while civilisation advances.
RV: A number of people recently, including Mervyn King, the Governor of the Bank of England, have made a distinction between what they describe as essential financial services and the sort of exotic work that investment banks are up to. People make this distinction between the utility that finance is and the casino out back with all these people trading and speculating and trying to make money. Do you see any sense in making those distinctions, or do you see the financial world as one thing in which there might be some odd things going on that are not socially desirable?
RS: I donít really like gambling, personally. I donít go to casinos. We have a problem that thereís a gambling instinct. People are often bored with life, you go to a humdrum job and you just want some excitement, and thereís this casino and it seems to beckon. That attitude drives people to do all sorts of strange things. The question is: what do we do about that, and how much of a problem is it? It seems to me that we have to leave a little gambling in our lives. Trying to abolish that behaviour is like trying to abolish sex: youíre never going to do it, itís too hard-wired into our brains. We just have to make a good civilisation. Iím looking for constructive solutions, and I donít know what constructive solutions people who lament this are pointing to.
RV: I guess theyíre thinking that itís important to protect the savings of the regular person in the retail banks. You let the investment banks go off and do their stuff, but you want some kind of protective firewall.
RS: But you donít want to make life boring for them, either. Another example of an innovation, which I think is very controversial but which I support, is the crowd funding that was passed by the US Congress that allows websites to raise money for young startup companies. And getting it from a whole crowd, from thousands of people, small amounts from each person, so that people can become venture capitalists. The criticism of this was that someoneís going to get ripped off, someoneís going to blow their whole life savings on such an investment. But the US Congress then just closed that, they said that crowdfunding websites canít take more than 5% of anyoneís income in total, for all the websites, and they have to manage that. They have to report and prove that theyíre not, so it canít be a disaster. So gambling casinos are alright too, as long as they donít let you put your whole life savings on. Maybe they do let you do that, so regulation of casinos could be improved too! But you get down to a world where people donít have to gamble their lives in order to get a little excitement, and letís try to focus them on doing something constructive.
RV: Youíve alluded a little to the question of personal morality, perhaps we could talk about that in a bit more detail. You raise the issue of whether someone who has a strong personal morality can actually work in finance. You seem to suggest that they can, but what is that relationship between personal morality and the pursuit of financial gain?
RS: We need philosophers, because life puts you in funny situations. You could be a highly moral person and spend your entire life as a rapacious businessperson, and then give it all away to some grand cause. Bill Gates, I donít know if he was rapacious but some people think he was, was like that. Heís the biggest philanthropist in the world, and is he good or bad? A lot of people used to curse Microsoft because they seemed aggressive, but they never killed anybody and now theyíre helping the world in so many ways. So life is like that.
What I tell my students is that you canít always be doing things that make people like you. Youíve got to get tough sometimes. You have to do things that seem morally ambiguous, but you are the compass. Nobody else is judging. You are the compass of the ultimate story of your life.
RV: Another comment that people have made about the power of finance, certainly in the buildup to the crisis that started in 2007, has been that the industry attracted too many young people. Youíve seen many students go through your classroom, do you get a sense that the kind of rewards that were available in finance, and perhaps to some extent still are, divert too many people into finance?
RS: I know that at Yale University, where I teach, there are a lot of students who are annoyed and angry about other students who go into finance. They think those people have sold out, theyíre just going to make money and move into a lifestyle that makes them insensitive to people and arts and culture and all that. I donít think thatís true, actually. There must be some element of truth to that, but people exaggerate these kinds of ideas. Some people go into finance and then later they become artists. Jeff Koons is the famous example of that, he was a trader and then became a famous artist. Itís a good example because finance is about financing activities, and a person with a mind focused on doing those sorts of things can help the arts, the humanities, the sciences in profound ways. Itís about getting some frustrated scientist or frustrated artist into a position where theyíre flourishing in what they do. Thatís financing, and so I donít think thereís any reason to think that people who do that are morally deficient.
RV: Letís go back to this word Ďdemocratisingí, linking to the process of education that youíre involved with, educating students at Yale. Do you feel in a sense that, to really achieve democratisation of finance, the whole of the public needs to have a better understanding of finance? Or a more general financial education, not just the smart guys who come to your classes at Yale?
RS: I tell my students, and by the way I have students all over the world with the free online lectures, I tell them all that you should have goals in life of your own and I canít tell you what they are. You should have higher goals, but you should also know about finance because finance is really about making things happen. So for example, youíre walking down the street in your city and you see something, some problem that the mayor ought to really get on to and correct. So you write a letter to the mayor.
On the other hand you could ask to speak to the appropriate manager in the city government and say, ďI think our city should issue revenue bonds, raise the cash, spend the money on such-and-such an improvement, and we would be better off.Ē If you can go in like that rather than just complaining, if you can go in with ideas of how to make it happen; that is, how to finance it, youíre just that much more effective. So what Iíve been saying is that I want people in all the majors at the university to take my course. I want engineers, I want scientists, I want theatre arts majors, I want artists, because youíre condemning yourself to a kind of childlike existence if you donít know how things get done in our society. Itís so much better if itís part of your toolbag, just some knowledge of these things.
RV: The case youíre making for the social value of finance is coming at a very difficult time with such a big backlash; you mentioned Occupy Wall Street and Occupy London. Itís a very hard message to get across, what kind of responses are you getting? Are people just laughing and saying, ďHow can you possibly say this? Look at the people who work in this industry. Look what theyíve done to our lives, look what theyíve done to our worldĒ?
RS: Yeah, I have to get a new spam filter for my email. There are a lot of people who think that I am defending bad behaviour. In no way am I defending corrupt behaviour and my book contains a plea for inclusiveness, that all people are created equal. The criticism that Karl Marx advanced of capitalism, in a nutshell, he said the capitalists dominate because they own the capital. And the other people, the working class, have no access to capital. But as modern society becomes more inclusive, everyone who becomes knowledgeable about finance can have access to capital. You donít have to be born rich; we have a mechanism that allocates capital, thatís the financial system at its best use. So what you have to know is: how do I get into that? You have to know how you can, for example, develop a business plan and present it to a venture capitalist, and in the modern economies I think they really donít care what social class you came from. You could be very working-class and, before you know it, you have millions of pounds to allocate, and that is the way that itís increasingly working. That is the fundamental flaw in Marxís thinking. He thought that these social classes were permanent and hopeless. Weíre learning that itís not. We should seek more progress, more democratisation of finance in the future.
RV: Final question, Bob. Youíre unusual among academic economists in being a prolific writer of books, and you make a remark along those lines at the start of this book, saying that you would like to encourage not just economists but all researchers, all intellectuals to focus more on writing books communicating to a general audience than to writing journal articles. Can you develop that idea of the value of books?
RS: I think that professional journals which publish highly specialised articles are very important, but on the other hand there is also something very important about books that are more general in their focus, and not just as popularisation. A scientist will publish articles about chemistry or something, which the public will never read. Only other chemists will read it. But then heíll publish a popularisation; chemistry for the masses. And many people think that those are the only two things that he can do: the scientific journals or a popularisation. But Iím thinking that thereís another kind of book that a chemist can write which is more broad-thinking and inductive or inspiring in its approach, but actually would be read both by other chemists and by a broader public. I know that there are many books like that, and I think that itís a really good thing to read them and to take them seriously.
Academics Ė especially in the sciences and the social sciences Ė have got away from book writing. I think itís turning back, I think publishers are telling me that theyíre going back more to writing long, thoughtful books and I really recommend that people take these seriously. The problem is that youíre tempted sometimes to pander to the public, so for example in writing about finance your temptation is to make a scandal sheet, to write about how crooked these guys are and how mad you ought to be. And you just know that that would sell better. Thatís not what Iím talking about. Iím talking about sincere authors who are thoughtful. I think they are recognised too. It tends to be at a lower level of sales, but those are the really important books to read.
RV: Bob Shiller, thanks very much.