I am moderating a week-long forum on Skoll's SocialEdge on "What is Wealth." In that, I refer to the video of the interview Charlie Rose did of Robert Shiller. It was brought to my attention that as broadband is limited in areas where many Skoll participants are, that this would be useless to them.
So I sought to provide a link to the transcript, but unfortunately, Charlie Rose's site has a layout problem, and it's unreadable, at least to me. So I copied-and-pasted it here and cleaned up the tags until it laid out like it should.
CHARLIE
ROSE: The battered U.S. housing market has shown signs of improvement
after three years of steep losses. Some economists contend the bottom
is near as home prices have dropped one-third from their peak in 2006.
But while prices have halted their freefall in key areas, some warn
that markets could still decline for a year or more.
Joining me now is the man who knows this sector very well, Robert Shiller, an economics professor at Yale University. He helped develop they Case-Shiller index investors use to track home prices across the country. He`s also well known on Wall Street for giving early warnings about the technology and housing bubbles that later proved to be true. Earlier this year, he published his latest book titled "Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.” I am pleased to have him back on this program. Welcome.
ROBERT SHILLER: Glad to be here again.
CHARLIE ROSE: It`s a pleasure to have you here. Where is the housing market as you see it?
ROBERT SHILLER: Well, our latest data, as you said, correctly, are looking less dire. Our data, the S&P/Case-Shiller data was fine still in the latest month, but at a lower rate of decline. And if that were the stock market, you would say what does that mean? But the housing market shows a lot of momentum. And we`re seeing the downward momentum diminished. And so that is a good sign from the standpoint of home prices, but I don`t know that it means there`s going to be a sudden turnaround. The last cycle that peaked around 1990, home prices by `91, the rapid decline was over, but they didn`t increase until `97. And so, I think that people who are hoping for a rapid turnaround, they could be right, nobody knows these speculative markets. But I wouldn`t hold my breath. I mean, it`s -- given the situation that the whole economy is in, I am still concerned about the housing market.
CHARLIE ROSE: OK. Just put that aside just for a second. Where is the economic recovery?
ROBERT SHILLER: Well, we are now 18 months from the peak in December of 2007. Since then, we`ve lost 6.5 million jobs, making this the severest recession since the Great Depression. And it`s already 18 months old. We have not had an 18-month recession since the Depression. It`s the longest.
You might say it should come to an end soon, you know, when it`s this old, the turnaround seems natural. But we don`t really know. It really depends on the outcome of our policies. We have to make our future. You know, forecasting is one thing. We have to have the right policies to bring us to a more prosperous economy.
CHARLIE ROSE: Do we have the right policies?
ROBERT SHILLER: I think we`re making a beginning. I think that correcting the errors that led to this -- and I would say moving ahead to a better capital system will take five or 10 years.
If you look at what happened after the Great Depression, they were innovating, the government and private business were innovating for really a decade-long period. I think it`s really in a sense an opportunity when you have a crisis like this, it`s an opportunity for innovation. That`s the way we should view it.
CHARLIE ROSE: When you say, lessons -- I assume -- and I know that you think strongly about this -- we need significant more regulation.
ROBERT SHILLER: Well, I wouldn`t say more. I would say better.
CHARLIE ROSE: All right, tell me what better is.
ROBERT SHILLER: See, I don`t mean -- I don`t think -- and that doesn`t mean government even, necessarily. It means we have FINRA, which is a private self-regulatory organization. And we have others like that.
And regulation is about rules. We make rules. Businesses make internal rules. Families have rules. Children on the playground have rules. That is what has to be improved. This is not a time to move toward bigger government. It`s better regulations. And I think on top of that, also, we need innovation in the financial sector. And this is something that I`ve been involved for years in trying to bring up, so the risks are managed better.
This crisis was caused by a failure of risk management. And it`s a failure right up the alley that financial theorists ought to know about. And I think that they are figuring things out now, and some financial engineering coming not just from the government -- in fact, I think more from the private sector is what`s going to bring us to a better economy.
CHARLIE ROSE: Risk management, as I understand what you mean, is that financial -- a few major financial institutions had no idea what they had at risk. Therefore, risk management was not effective at all in terms of the mortgage-based securities that have been created.
ROBERT SHILLER: Well, I think that risk management tools have advanced a lot. But there were errors made. And the errors were trusting somebody`s quantitative analysis that wasn`t quite right. Not coming back to our first principles and thinking about what does this analysis -- so, for example, we had the impression that home prices always go up. And do you know how many financial errors were made because of that?
Why did we have that impression? It was primarily because people were not looking far enough back into history, and they mistook a bubble for historical reality. And that pervaded so many decisions and led to big errors.
And there was nobody managing real estate risk. Now, that`s one thing that I have been trying to correct. If I might talk, my company, Macro Markets, is just launching a New York Stock Exchange real estate product. Now, we`re a for-profit company, but this comes out of my sense also of what the economy needs. It needs to develop to a better capitalism. We don`t want to go to a bail-out economy, where the government is -- in the short run, OK, but we have to plan for a better economy. And the failure to manage real estate risk was central to what happened in this crisis. And so, that`s where we should go.
I have another book which I wrote in September to lay this out. This is an opportunity to develop an improved capitalism. And I don`t think we have any other way to go but improving capitalism.
CHARLIE ROSE: Let`s just stay with that. What`s the title of the new book?
ROBERT SHILLER: The other book…
CHARLIE ROSE: Or the other book.
ROBERT SHILLER: … that was in September was called "Subprime Solution." It was a proposal, what to do.
CHARLIE ROSE: All right. Let me understand what you are arguing with your company and what you believe is necessary. You believe that there ought to be a need to have a hedge…
ROBERT SHILLER: Right.
CHARLIE ROSE: … against real estate speculation, real estate what?
ROBERT SHILLER: Right. We need to allow people somehow to adjust their exposure to risks, so that they are bearing them in a proper amount. And also to express their opinion so that we have price discovery. I`m using some jargon here. Price discovery means we find the market price for real estate in five years. That`s what our security is doing, so we know what you can plan on.
So, we have a price now for real estate in five years, which shows it about 7 or 8 percent lower than now in five years. And you can lock that in for business decisions, because there`s a market that allows you to. So that`s -- of course it`s just beginning. But when it`s big enough, that`s where we are. And that will make for -- that`s the way capitalism is supposed to work. You look at prices, you make -- you think, can I make money on that -- can I make money as a builder if real estate prices are 8 percent lower than they are now? Maybe I can. If so, hedge it and do it.
CHARLIE ROSE: Right. All right, so but what you are saying is use derivatives at a time when derivatives are in -- are the subject of severe criticism.
ROBERT SHILLER: I think it`s a mistake to criticize derivatives, per se. Because derivatives -- you know, people talk about credit default swaps as a derivative. But it`s a kind of insurance. If I give it a different name, is anyone against insurance? What about health insurance? Is anyone against that? I mean…
CHARLIE ROSE: But the insurance…
ROBERT SHILLER: It`s like a health insurance for a company, that`s what credit default swaps are.
CHARLIE ROSE: Insurance is a management of risk, isn`t it?
ROBERT SHILLER: Absolutely. And in fact, you know, over the centuries, people were very resistant to the idea of insurance. It`s only in modern times like the 20th century that it became like grandma and apple pie. We all know that insurance is a good thing.
Derivatives are still -- it`s a tainted word, but it`s the same thing. You know, it`s about getting a broader group of people to bear -- to spread out risks over more people, and to have them pay for the management of the risk, at a premium or price that compensates the other side for taking on the risk. That`s insurance and that`s derivative.
CHARLIE ROSE: And so your company, Macro Markets, is going to create the financial vehicles that will allow you to hedge these risks?
ROBERT SHILLER: We have got -- well, we have one for the U.S. as a whole.
CHARLIE ROSE: Right.
ROBERT SHILLER: We want to do medical costs…
CHARLIE ROSE: Before you do that, you experimented with this in Chile, didn`t you?
ROBERT SHILLER: Well, I did not. This is something related -- yes, I`ve been advocating -- that -- some kind of consumer price index management vehicle, like the Unidad de Fomento in Chile. That`s what -- yes. I have a lot of different proposals, but they`re all on the same theme of democratizing and developing financial markets, so that they work for the people.
CHARLIE ROSE: They are also on this theme. You worship at the holy grail of trying to figure out how to manage risk.
ROBERT SHILLER: Well, I think that quantitative finance is a really important technology, a little bit like nuclear physics. I know that sounds funny, but -- maybe not quite up to that. But something like -- in the sense that it`s a real technology, which can improve human welfare, and it has dangers if it`s not done right. But history has shown overall that something like that can be managed if we have the right regulation.
We regulate nuclear power, too. For the same reasons, to preserve public safety. And so, there is parallels there. And I think that ultimately, our society is not going to want to forgo the advantages of applying financial technology, just like they apply other technologies.
CHARLIE ROSE: Do the things that have happened to us over -- in this economic crisis, global economic crisis -- this may be simplistic -- simply suggest that markets are not efficient?
ROBERT SHILLER: Right. This is another theme of mine, which you`ll find in "Animal Spirits."
CHARLIE ROSE: I`m getting to that. Go ahead.
ROBERT SHILLER: I think the so-called efficient markets hypothesis, which came in around -- in the `60s, became very popular in the 1970s -- I think it was a half-truth. What does it mean to say markets are efficient? It means that the prices reflect information. They pool all the information, and they become a better price than any single person could. There`s some truth to that.
CHARLIE ROSE: Markets have perfect information, so to speak, some said.
ROBERT SHILLER: Yes. But we exaggerated the truth, and we went through an era from the `70s to the present of -- it`s almost like a new religion. We worshipped the markets. We went too far with that idea. And that`s part of our problem. It began when the Fed chairman would be reluctant to say any opinion about the markets because he didn`t think he could match the wisdom of the market. That was a big mistake.
CHARLIE ROSE: You used the word "irrational exuberance" before the Fed chairman used it, too.
ROBERT SHILLER: I`m not sure about that. Actually, I think it was his term.
CHARLIE ROSE: Oh, it was?
ROBERT SHILLER: I was talking to him on -- a couple days before -- it sounds like Alan Greenspan. But I do think it`s a good term. That`s why I used it as the title of my book.
CHARLIE ROSE: Of your book, right.
ROBERT SHILLER: Because it reflects -- you know, it`s kind of similar. I did “Irrational Exuberance,“ now I do "Animal Spirits," and -- this is with George Akerlof, I should say.
CHARLIE ROSE: Right, OK.
ROBERT SHILLER: But it`s kind of on a theme that the economics profession has gotten too hung up on rationality. And people have a rationale side, yes, that`s important to recognize, but they also have an animal spirit side, and it`s really important to understand that side if you want to understand economic fluctuations like the one we`re in now.
CHARLIE ROSE: Explain.
ROBERT SHILLER: The big problem that economists, theoretical economists have had in our opinion, in George Akerlof and my opinion, is they never figured out what drives the economy, what is the ultimate source of these fluctuations up and down?
Now, they got it partly right, but I think that they omitted -- we both strongly feel that they omitted a very important point. It`s the inconstancy of human behavior, that humans will become optimistic and over-optimistic, over-confident, and it will drive the economy into…
CHARLIE ROSE: Humans will believe that housing prices will never go down.
ROBERT SHILLER: Right. That`s exactly. You know, how in the world did they get that idea? One theme that George and I emphasize in the book is that it`s driven by stories. That narratives drive -- for example…
CHARLIE ROSE: The animal spirit is a human emotion driven by stories.
ROBERT SHILLER: Right. People have a story of their lives, a story of my country, a story of what epic am I -- what great historical things are happening now...
CHARLIE ROSE: What movie am I in, yes.
ROBERT SHILLER: Yes. That`s exactly right. People tend to view themselves as part of a movie…
CHARLIE ROSE: Or we`ve seen this movie before is an idea they sometimes will say. So can -- go ahead.
ROBERT SHILLER: So what was happening in the 1990s, there was this sense of possibility. We were entering the new millennium. The Internet had just been discovered. Young people were setting up dot-com companies. And these stories were very powerful, because they suggested what we should be doing. I felt -- we feel kind of like a loser if we`re not part of this.
CHARLIE ROSE: And it suggests the old rules didn`t apply.
ROBERT SHILLER: Yes, and so then you forgot history, and you made the same mistakes again.
CHARLIE ROSE: Can you measure this emotional fact that the animal spirits are there and that human emotions are not constant? Can you measure that? Can you factor that in to further understand markets?
ROBERT SHILLER: Well, back in 1947, George Katona set out -- he was at the University of Michigan, in -- set out to start measuring human confidence. And in 1951, he created the University of Michigan Consumer Sentiment Index, which was later followed up by the Conference Board, Consumer Confidence Index.
There are people who try to quantify this, with some success. And I find their research very interesting, but I wish there were more of it. It`s those two groups that are doing that, and academia, academic economists have generally dismissed that kind of measure. And I think that measuring the animal spirits is still an infant industry, even though Michigan has been doing this for about 60 years.
CHARLIE ROSE: There`s also this factor that`s at work in things like this. If the guy across the street, or the person across the street is taking a lot of risk and making a lot of money, then the pressure on you to do the same thing, and especially if your job or future is at stake, is huge.
ROBERT SHILLER: Right. You`re getting at some aspects of herd behavior. The word herd behavior is maybe not -- yes, it`s partly -- it is so complicated.
One thing that comes in is that if I don`t do it -- everyone else is doing something and they`re making money on it now. I don`t know that this is ever going to come to an end. It`s not clear. It`s a difference of opinion. Do I just not participate? Like people are writing subprime loans and I`m a mortgage originator. And you know, that`s where all the action is, they`re making a lot of money. And if I say I won`t do that, I kind of get left behind. I`m looking old. Your career -- your life -- you`re getting older and nothing is happening. So those kinds of thoughts enter, and it`s not the economists lately. In the established paradigm, they don`t generally represent those kinds of human emotions. I think that part of what we`re doing is influenced by psychology, by neuroeconomics, by sociology…
CHARLIE ROSE: What is neural economics?
ROBERT SHILLER: I think it`s an exciting new branch, which I am not a practitioner of. But they are trying to meld brain research with economics. And we have to understand how the brain functions. So they put people in a functional magnetic resonance imaging device, and watch what`s going on inside their brain when…
CHARLIE ROSE: When they`re doing what?
ROBERT SHILLER: When they`re making economic decisions.
CHARLIE ROSE: Decisions.
ROBERT SHILLER: And we find…
CHARLIE ROSE: Like what? You make an economic decision whether to buy this home or not, you`re making an economic decision whether I trade this security or not? Or what?
ROBERT SHILLER: Let me give you an example. And Ernst Fehr, in Zurich, Switzerland, did -- had people play games with each other, economic games, while they were -- I don`t remember the details exactly. There was a point in the game when some players showed vengeance to each other. In other words, they`re not making a good business decision; they`re doing something which actually cost them money, and it appears to be a retaliation.
CHARLIE ROSE: Because they want to retaliate.
ROBERT SHILLER: And some economists said, that, well, maybe there was some rational reason why they -- this was part of a grand strategy. But Ernst Fehr found that, that looking at their brain, that a region of the brain was activated at the time that they were being apparently vengeful. And it is the same pleasure center that -- it was -- that makes you happy when you`re sexually fulfilled or things like -- I`m making loosely from a study that…
CHARLIE ROSE: But this is interesting stuff, I`m telling you.
ROBERT SHILLER: What it means is that economists who say it`s all rational are wrong, because we can see with the neural imaging devices what the emotions that accompany these economic decisions are. And we now know that vengeance is part of what drives people.
You`ve heard people say it, I`m going to do this for the principle of it; I don`t care if it costs me money. And we now know that that`s not just talk, that is how people feel.
And that`s part of animal spirits, that Akerlof and I talk about, that people getting angry and they get resistant. And they don`t want to make a deal with someone that they don`t trust or they feel has wronged them. And unfortunately, that is part of an economic contraction, and that is part of what`s happening now.
CHARLIE ROSE: What is it about you, you, that makes you so fascinated by this?
ROBERT SHILLER: Well, it could be my wife, who is a psychologist.
CHARLIE ROSE: Yes, yes. Well, that`s interesting.
ROBERT SHILLER: Yes, it is interesting. I talk to her a lot. And…
CHARLIE ROSE: And how has she influenced you?
ROBERT SHILLER: She brings me back to reality.
CHARLIE ROSE: On these issues? Oh, she does?
ROBERT SHILLER: You know, I think George`s wife, too. He`s married to Janet Yellen, who was chairman of the Council of Economic Advisers and is now president of the San Francisco Fed. She is a smart woman. And I think both of our wives bring us back to reality more, that it`s very easy in academia to just go off on a tangent. And I think my work improved, I think George`s work improved when we married. So…
CHARLIE ROSE: Because you did what? Rather than going off on tangents, it was like a reality check?
ROBERT SHILLER: See, the thing that -- the academic incentive system is, you want to be on the frontier and you don`t want to be criticizable, right? So what do you do? You specialize really narrowly. And that I think is ultimately a mistake. You need someone with a broader judgment to bring you back and make you think, you know, writing that paper and getting into the top journal isn`t really what you want to do if the whole thing is meaningless. So even if you get the accolades, you want to feel good about what you`ve done.
CHARLIE ROSE: Here is what I don`t understand about you as well, beyond how you got to this, and now you`ve explained some of that, because of your wife, and you`ve paid tribute to her in lots of different ways too that I have read in reading about you.
I don`t understand this. When you, having the track record you did and the reputation you do, suggested that housing prices were going to fall, and that we were in for some rough sledding, and it could lead to exactly what`s happened, clearly people with a lot of money at stake should have been listening. Did they simply dismiss you? Did they say, thank you very much, Professor, now go back up to New Haven and write another book?
ROBERT SHILLER: That`s what they said.
(LAUGHTER)
ROBERT SHILLER: They didn`t put it quite like that…
CHARLIE ROSE: Essentially that was it.
ROBERT SHILLER: Well, it`s a question of how do we judge things. If I could have a mathematical proof that A, B and C implied D, and case closed, I think I would have prevailed. And others like me.
CHARLIE ROSE: Do you believe that what we went through, with all these mortgage-backed securities and the catastrophe that it led to, that it simply was a glitch in securitization?
ROBERT SHILLER: Yes, I think so.
CHARLIE ROSE: Explain.
ROBERT SHILLER: Well, companies were putting together in pools, mortgages, and then selling them off to investors. And they were dividing these up into tranches by risk categories, and selling the separate tranches off. And some of these separate tranches were then placed in other, CDOs and more -- CDO-squared. And it got very complicated.
And then when the whole system blew up, it was a mess cleaning through the wreckage. And people are naturally dismayed by what happened, but I take that as something like the sinking of the Titanic. You know, I mean, engineers when they built the Titanic, they were in a rush to get it done, they used the wrong rivets. The captain was going through iceberg-laden waters. You know, there were mistakes made, and they were mistakes by people in a hurry, who were -- we correct those and we fix them. And that`s how we improve.
I don`t think we have any other choice, really, any other sensible choice but to stick with capitalism, make it better.
CHARLIE ROSE: I just want to make sure about -- the kind of regulation you`re saying -- it`s not necessarily you believe that government should bring out all these new regulations, but we need to have better regulations. And some of them ought to be generated by the financial sector themselves.
ROBERT SHILLER: Right. I think actually most regulations are generated by people. Most financial regulations come in as suggestions by people in the financial sector, because government employees are not involved. You have to -- just like I`m saying the children at the playground, when they`re unsupervised, they realize we have to make a rule about this or that, you know, because they`re playing the game, and they kind of know.
But we also have to take in to all elements of the society, there is a problem that people in the financial sector may not show enough concern for people lower on the economic ladder. And I think actually one of the big problems that we are not confronting well right now is the rising economic inequality. And that`s part of the reason why I think anger is developing at this stage.
Inequality has been getting worse, and then we throw on this huge hit to unemployment. And people are losing their sense that America is for us together as the people. And that is so precious.
That`s why I support the efforts that Obama has made, and even -- you know, I wish they were stronger. The real mistake that has been made is that foreclosures are still at too high a rate. Too many -- and unemployment is at a high rate. I think we should have moved faster and more directly to protect all these people, because now we`ve got kind of a damaged animal spirits at this point. It`s still possible for us to, you know, we`ve done part of the job. We`ve done part of the job.
CHARLIE ROSE: So we come out of this, but it`s going to take, what, how long?
ROBERT SHILLER: Well, in terms of the National Bureau of Economic Research recession dating, it is quite possible that we will be out of the recession technically this year. But I`m not so optimistic from that, because we can have a double-dip recession. We can have a very slow recovery. That has been the pattern for recent recessions. So -- and given the amount of damage to the economy, damage to the animal spirits, which George Akerlof and I emphasize, not measured, that people are looking at this recession as just another in a string of recessions, and I think underestimating the longer term damage. What happened…
CHARLIE ROSE: What`s the longer-term damage?
ROBERT SHILLER: The longer-term damage -- I`ll give you as an example. What was the real surprise in the Great Depression? There were two aspects of it. I`m making a Great Depression parallel advisedly. We`re not likely to have as bad an experience as that.
CHARLIE ROSE: 25 percent unemployment.
ROBERT SHILLER: Right. But I mean, there are a lot of ways in which the current experience resembles the Depression.
But let me just -- in the Great Depression, from 1929 to 1933, we had a 43-month contraction. That was almost the longest in history. But it did come up. And we had a recovery from `33 to `37. People forget that. But it was still the Depression, because the unemployment rate never got below 10 percent.
And then after `37, the economy started sinking again, and there still were no jobs. Well, not no jobs, but the unemployment rate averaged I think 17 percent from `31 to `41, for a whole decade. And the puzzlement then people said is, why isn`t the economy recovering?
I think that -- there`s a lot of -- there`s been so many books and ideas written about this. But the theme that Akerlof and I emphasized is that maybe the failure to recover reflected a failure for animal spirits to come back.
And what I mean by animal spirits is a willingness to spend, a willingness to hire people. A willingness to -- we emphasized that business really is built on a sense of -- entrepreneurial sense, a sense of possibility. A sense that we can do something new and different. It`s risky, but we`re going to do it.
But when you get into a bad economic atmosphere, everything seems too risky and people are pulling back. That I think is probably the most important reason why the Depression lasted for so long.
So I`m not predicting anything as bad as that, but thinking that it is plausible that we will have trouble climbing out of this malaise. We`ll have the NBER saying the resection is over. And then three, four, five years from now, home prices may be even lower. I don`t know. That`s a guess. I don`t know. And the whole thing is just disappointing. And the reason it`s disappointing is because we haven`t moved to a business environment that is conducive to starting important new -- I mean, some people will do it, but it won`t be at the normal level.
And that`s why I think that we want to have more -- and I talked about a lot of these in "Subprime Solutions." They sound a little radical and different, but ideas that expand on capitalism and make it work -- make it work as it should.
CHARLIE ROSE: That`s your next book?
ROBERT SHILLER: I don`t have a next book in mind right now.
CHARLIE ROSE: How capitalism can work.
ROBERT SHILLER: Well, but it`s in both of these books.
CHARLIE ROSE: I know. So you also worry about sort of the psychology of America, maybe the psychology of other peoples in other countries as well. But somehow, the belief in the work ethic has been eroded.
ROBERT SHILLER: That`s right, yes. This is why people sometimes are angry with people in finance. They have a sense that finance is all about picking money up fast…
CHARLIE ROSE: It`s financial engineering, and they didn`t do anything, didn`t build anything, didn`t make anything, and they somehow used inside information, and therefore it`s all unfair that they made billions of dollars.
ROBERT SHILLER: In fact, I think unfairness probably is another theme in "Animal Spirits." Unfair behavior tends to grow during a boom period. And so, business ethics do slip somewhat during a growth period.
And that`s -- the problem is, that people get angry about that. But in fact, there`s nothing wrong with -- I`ve met many fine people in finance. I`ve trained them. I am very proud. I have thousands of former students who…
CHARLIE ROSE: Now running hedge funds or something.
ROBERT SHILLER: Yes, and I guess there`s -- you know, but I come back to it. The biggest problem facing this country is not this crisis. It`s the growing inequality. And I think that we have to -- and it`s another theme in my books. I`ve written another book about it.
CHARLIE ROSE: What was the title of that one?
ROBERT SHILLER: I had a book called "New Financial Order" in 2003, but I thought in that book that we should manage inequality in a scientific way. We have to have a plan so that inequality doesn`t get worse.
I don`t think we have any reason to want it to get worse. So why don`t we spend now, time, thinking -- and no presidential candidate has ever mentioned this. Maybe it`s too -- we don`t want class warfare; we want to start thinking about the forces that we can be offset.
And you know, this is fundamental. Why is the health care issue so important right now? I think it`s fundamentally because medical technology is improving to the point where it`s developing a lot of expensive procedures that can save and prolong people`s lives, and give them useful more years. And now we`re realizing that income inequality is worse than we thought, because people who are poor will die younger. They didn`t used to be that way. But once we have expensive procedures that can prolong lives, how can we deny that to lower-income people? And so to me it`s even more fundamental than the health care debate now. It`s getting the income inequality managed, so that it doesn`t become a huge problem in the future.
And this is -- and to me, it`s a technical problem, how to do that, just as…
CHARLIE ROSE: It`s a technical problem?
ROBERT SHILLER: Yes, it`s a technical problem. I`d like to see -- OK. I`m talking about so many books here.
(LAUGHTER)
CHARLIE ROSE: We`re talking about ideas, and (inaudible) it`s OK with me, but I`m interested in the idea.
ROBERT SHILLER: I have another paper with Len Berman called -- maybe I shouldn`t bring things up like this which are so politically dynamite. I mean, let me just lay it out. We think the tax system…
CHARLIE ROSE: Don`t sensor yourself. Don`t edit yourself.
ROBERT SHILLER: I get angry e-mail every time I bring this up.
CHARLIE ROSE: Go ahead.
ROBERT SHILLER: But this is really risk management. We don`t know how bad the income inequality is going to get. It could get better, it could get worse. So it`s a risk. Let`s put in a system that manages the risk.
So the proposal we have is to index the tax system for inequality. So that, the plan is, in the future, if inequality gets worse, we automatically raise taxes on the wealthy. It`s not -- Obama wants -- Congress are talking about taxing the rich to pay for the…
CHARLIE ROSE: Health care.
ROBERT SHILLER: Health care. And that sounds so logical. But after the fact, you try to do that, and it creates political problems.
We have to plan for the next decade. Let`s write it into the law now that that`s going to happen.
My son is now a Ph.D. student in philosophy. It`s my son, my next generation will carry at a more ethereal level. For me, I think of myself as a humble engineer, who has -- financial…
CHARLIE ROSE: Engineer?
ROBERT SHILLER: … financial engineer. And I`m aware of a technology of risk management. I`m also aware of a technology of social sciences. Psychology, sociology. We mentioned neuroscience. And I am trying to think like an engineer to put these things together to make something that works. And I think it`s not just me, I think this is the new paradigm. We have…
CHARLIE ROSE: The new paradigm is?
ROBERT SHILLER: Is -- I mean, to quote Thaler and Sunstein -- you should talk to them, they have a book called "Nudge" -- and in that book, they talk about choice architecture.
But the idea is to design financial and economic contracts around people, knowing the way they behave, and nudging them in a direction that works, that manages the risks and manages their -- that becomes part of a functioning economy.
And I mention that Sunstein is now part of the Obama administration. I take it as very inspiring that I see people like this involved at the highest level of our government. I think that this is new. This is like the New Deal. We are thinking at a better level, a more enlightened level about how to change our economic policies. And I think it`s a process. We haven`t heard the end of this by any means, but I think that the application of financial technology in connection with application of our understanding of the human species and the human mind is a breakthrough frontier we`re breaking through right now. And I`m hopeful that we`ll have a better country in the U.S. and in other countries around the world.
CHARLIE ROSE: This book is called "Animal Spirits," how human psychology drives the economy and why it matters for global capitalism. George Akerlof and Robert J. Shiller. If you don`t want to read this now, there is nothing I can say that would make you want to read it after listening to this conversation. It is a fascinating inquiry that goes far beyond economics in terms of the way human nature works. My thanks to Bob Shiller. Thank you very much.
ROBERT SHILLER: My pleasure.
Joining me now is the man who knows this sector very well, Robert Shiller, an economics professor at Yale University. He helped develop they Case-Shiller index investors use to track home prices across the country. He`s also well known on Wall Street for giving early warnings about the technology and housing bubbles that later proved to be true. Earlier this year, he published his latest book titled "Animal Spirits: How Human Psychology Drives the Economy and Why It Matters for Global Capitalism.” I am pleased to have him back on this program. Welcome.
ROBERT SHILLER: Glad to be here again.
CHARLIE ROSE: It`s a pleasure to have you here. Where is the housing market as you see it?
ROBERT SHILLER: Well, our latest data, as you said, correctly, are looking less dire. Our data, the S&P/Case-Shiller data was fine still in the latest month, but at a lower rate of decline. And if that were the stock market, you would say what does that mean? But the housing market shows a lot of momentum. And we`re seeing the downward momentum diminished. And so that is a good sign from the standpoint of home prices, but I don`t know that it means there`s going to be a sudden turnaround. The last cycle that peaked around 1990, home prices by `91, the rapid decline was over, but they didn`t increase until `97. And so, I think that people who are hoping for a rapid turnaround, they could be right, nobody knows these speculative markets. But I wouldn`t hold my breath. I mean, it`s -- given the situation that the whole economy is in, I am still concerned about the housing market.
CHARLIE ROSE: OK. Just put that aside just for a second. Where is the economic recovery?
ROBERT SHILLER: Well, we are now 18 months from the peak in December of 2007. Since then, we`ve lost 6.5 million jobs, making this the severest recession since the Great Depression. And it`s already 18 months old. We have not had an 18-month recession since the Depression. It`s the longest.
You might say it should come to an end soon, you know, when it`s this old, the turnaround seems natural. But we don`t really know. It really depends on the outcome of our policies. We have to make our future. You know, forecasting is one thing. We have to have the right policies to bring us to a more prosperous economy.
CHARLIE ROSE: Do we have the right policies?
ROBERT SHILLER: I think we`re making a beginning. I think that correcting the errors that led to this -- and I would say moving ahead to a better capital system will take five or 10 years.
If you look at what happened after the Great Depression, they were innovating, the government and private business were innovating for really a decade-long period. I think it`s really in a sense an opportunity when you have a crisis like this, it`s an opportunity for innovation. That`s the way we should view it.
CHARLIE ROSE: When you say, lessons -- I assume -- and I know that you think strongly about this -- we need significant more regulation.
ROBERT SHILLER: Well, I wouldn`t say more. I would say better.
CHARLIE ROSE: All right, tell me what better is.
ROBERT SHILLER: See, I don`t mean -- I don`t think -- and that doesn`t mean government even, necessarily. It means we have FINRA, which is a private self-regulatory organization. And we have others like that.
And regulation is about rules. We make rules. Businesses make internal rules. Families have rules. Children on the playground have rules. That is what has to be improved. This is not a time to move toward bigger government. It`s better regulations. And I think on top of that, also, we need innovation in the financial sector. And this is something that I`ve been involved for years in trying to bring up, so the risks are managed better.
This crisis was caused by a failure of risk management. And it`s a failure right up the alley that financial theorists ought to know about. And I think that they are figuring things out now, and some financial engineering coming not just from the government -- in fact, I think more from the private sector is what`s going to bring us to a better economy.
CHARLIE ROSE: Risk management, as I understand what you mean, is that financial -- a few major financial institutions had no idea what they had at risk. Therefore, risk management was not effective at all in terms of the mortgage-based securities that have been created.
ROBERT SHILLER: Well, I think that risk management tools have advanced a lot. But there were errors made. And the errors were trusting somebody`s quantitative analysis that wasn`t quite right. Not coming back to our first principles and thinking about what does this analysis -- so, for example, we had the impression that home prices always go up. And do you know how many financial errors were made because of that?
Why did we have that impression? It was primarily because people were not looking far enough back into history, and they mistook a bubble for historical reality. And that pervaded so many decisions and led to big errors.
And there was nobody managing real estate risk. Now, that`s one thing that I have been trying to correct. If I might talk, my company, Macro Markets, is just launching a New York Stock Exchange real estate product. Now, we`re a for-profit company, but this comes out of my sense also of what the economy needs. It needs to develop to a better capitalism. We don`t want to go to a bail-out economy, where the government is -- in the short run, OK, but we have to plan for a better economy. And the failure to manage real estate risk was central to what happened in this crisis. And so, that`s where we should go.
I have another book which I wrote in September to lay this out. This is an opportunity to develop an improved capitalism. And I don`t think we have any other way to go but improving capitalism.
CHARLIE ROSE: Let`s just stay with that. What`s the title of the new book?
ROBERT SHILLER: The other book…
CHARLIE ROSE: Or the other book.
ROBERT SHILLER: … that was in September was called "Subprime Solution." It was a proposal, what to do.
CHARLIE ROSE: All right. Let me understand what you are arguing with your company and what you believe is necessary. You believe that there ought to be a need to have a hedge…
ROBERT SHILLER: Right.
CHARLIE ROSE: … against real estate speculation, real estate what?
ROBERT SHILLER: Right. We need to allow people somehow to adjust their exposure to risks, so that they are bearing them in a proper amount. And also to express their opinion so that we have price discovery. I`m using some jargon here. Price discovery means we find the market price for real estate in five years. That`s what our security is doing, so we know what you can plan on.
So, we have a price now for real estate in five years, which shows it about 7 or 8 percent lower than now in five years. And you can lock that in for business decisions, because there`s a market that allows you to. So that`s -- of course it`s just beginning. But when it`s big enough, that`s where we are. And that will make for -- that`s the way capitalism is supposed to work. You look at prices, you make -- you think, can I make money on that -- can I make money as a builder if real estate prices are 8 percent lower than they are now? Maybe I can. If so, hedge it and do it.
CHARLIE ROSE: Right. All right, so but what you are saying is use derivatives at a time when derivatives are in -- are the subject of severe criticism.
ROBERT SHILLER: I think it`s a mistake to criticize derivatives, per se. Because derivatives -- you know, people talk about credit default swaps as a derivative. But it`s a kind of insurance. If I give it a different name, is anyone against insurance? What about health insurance? Is anyone against that? I mean…
CHARLIE ROSE: But the insurance…
ROBERT SHILLER: It`s like a health insurance for a company, that`s what credit default swaps are.
CHARLIE ROSE: Insurance is a management of risk, isn`t it?
ROBERT SHILLER: Absolutely. And in fact, you know, over the centuries, people were very resistant to the idea of insurance. It`s only in modern times like the 20th century that it became like grandma and apple pie. We all know that insurance is a good thing.
Derivatives are still -- it`s a tainted word, but it`s the same thing. You know, it`s about getting a broader group of people to bear -- to spread out risks over more people, and to have them pay for the management of the risk, at a premium or price that compensates the other side for taking on the risk. That`s insurance and that`s derivative.
CHARLIE ROSE: And so your company, Macro Markets, is going to create the financial vehicles that will allow you to hedge these risks?
ROBERT SHILLER: We have got -- well, we have one for the U.S. as a whole.
CHARLIE ROSE: Right.
ROBERT SHILLER: We want to do medical costs…
CHARLIE ROSE: Before you do that, you experimented with this in Chile, didn`t you?
ROBERT SHILLER: Well, I did not. This is something related -- yes, I`ve been advocating -- that -- some kind of consumer price index management vehicle, like the Unidad de Fomento in Chile. That`s what -- yes. I have a lot of different proposals, but they`re all on the same theme of democratizing and developing financial markets, so that they work for the people.
CHARLIE ROSE: They are also on this theme. You worship at the holy grail of trying to figure out how to manage risk.
ROBERT SHILLER: Well, I think that quantitative finance is a really important technology, a little bit like nuclear physics. I know that sounds funny, but -- maybe not quite up to that. But something like -- in the sense that it`s a real technology, which can improve human welfare, and it has dangers if it`s not done right. But history has shown overall that something like that can be managed if we have the right regulation.
We regulate nuclear power, too. For the same reasons, to preserve public safety. And so, there is parallels there. And I think that ultimately, our society is not going to want to forgo the advantages of applying financial technology, just like they apply other technologies.
CHARLIE ROSE: Do the things that have happened to us over -- in this economic crisis, global economic crisis -- this may be simplistic -- simply suggest that markets are not efficient?
ROBERT SHILLER: Right. This is another theme of mine, which you`ll find in "Animal Spirits."
CHARLIE ROSE: I`m getting to that. Go ahead.
ROBERT SHILLER: I think the so-called efficient markets hypothesis, which came in around -- in the `60s, became very popular in the 1970s -- I think it was a half-truth. What does it mean to say markets are efficient? It means that the prices reflect information. They pool all the information, and they become a better price than any single person could. There`s some truth to that.
CHARLIE ROSE: Markets have perfect information, so to speak, some said.
ROBERT SHILLER: Yes. But we exaggerated the truth, and we went through an era from the `70s to the present of -- it`s almost like a new religion. We worshipped the markets. We went too far with that idea. And that`s part of our problem. It began when the Fed chairman would be reluctant to say any opinion about the markets because he didn`t think he could match the wisdom of the market. That was a big mistake.
CHARLIE ROSE: You used the word "irrational exuberance" before the Fed chairman used it, too.
ROBERT SHILLER: I`m not sure about that. Actually, I think it was his term.
CHARLIE ROSE: Oh, it was?
ROBERT SHILLER: I was talking to him on -- a couple days before -- it sounds like Alan Greenspan. But I do think it`s a good term. That`s why I used it as the title of my book.
CHARLIE ROSE: Of your book, right.
ROBERT SHILLER: Because it reflects -- you know, it`s kind of similar. I did “Irrational Exuberance,“ now I do "Animal Spirits," and -- this is with George Akerlof, I should say.
CHARLIE ROSE: Right, OK.
ROBERT SHILLER: But it`s kind of on a theme that the economics profession has gotten too hung up on rationality. And people have a rationale side, yes, that`s important to recognize, but they also have an animal spirit side, and it`s really important to understand that side if you want to understand economic fluctuations like the one we`re in now.
CHARLIE ROSE: Explain.
ROBERT SHILLER: The big problem that economists, theoretical economists have had in our opinion, in George Akerlof and my opinion, is they never figured out what drives the economy, what is the ultimate source of these fluctuations up and down?
Now, they got it partly right, but I think that they omitted -- we both strongly feel that they omitted a very important point. It`s the inconstancy of human behavior, that humans will become optimistic and over-optimistic, over-confident, and it will drive the economy into…
CHARLIE ROSE: Humans will believe that housing prices will never go down.
ROBERT SHILLER: Right. That`s exactly. You know, how in the world did they get that idea? One theme that George and I emphasize in the book is that it`s driven by stories. That narratives drive -- for example…
CHARLIE ROSE: The animal spirit is a human emotion driven by stories.
ROBERT SHILLER: Right. People have a story of their lives, a story of my country, a story of what epic am I -- what great historical things are happening now...
CHARLIE ROSE: What movie am I in, yes.
ROBERT SHILLER: Yes. That`s exactly right. People tend to view themselves as part of a movie…
CHARLIE ROSE: Or we`ve seen this movie before is an idea they sometimes will say. So can -- go ahead.
ROBERT SHILLER: So what was happening in the 1990s, there was this sense of possibility. We were entering the new millennium. The Internet had just been discovered. Young people were setting up dot-com companies. And these stories were very powerful, because they suggested what we should be doing. I felt -- we feel kind of like a loser if we`re not part of this.
CHARLIE ROSE: And it suggests the old rules didn`t apply.
ROBERT SHILLER: Yes, and so then you forgot history, and you made the same mistakes again.
CHARLIE ROSE: Can you measure this emotional fact that the animal spirits are there and that human emotions are not constant? Can you measure that? Can you factor that in to further understand markets?
ROBERT SHILLER: Well, back in 1947, George Katona set out -- he was at the University of Michigan, in -- set out to start measuring human confidence. And in 1951, he created the University of Michigan Consumer Sentiment Index, which was later followed up by the Conference Board, Consumer Confidence Index.
There are people who try to quantify this, with some success. And I find their research very interesting, but I wish there were more of it. It`s those two groups that are doing that, and academia, academic economists have generally dismissed that kind of measure. And I think that measuring the animal spirits is still an infant industry, even though Michigan has been doing this for about 60 years.
CHARLIE ROSE: There`s also this factor that`s at work in things like this. If the guy across the street, or the person across the street is taking a lot of risk and making a lot of money, then the pressure on you to do the same thing, and especially if your job or future is at stake, is huge.
ROBERT SHILLER: Right. You`re getting at some aspects of herd behavior. The word herd behavior is maybe not -- yes, it`s partly -- it is so complicated.
One thing that comes in is that if I don`t do it -- everyone else is doing something and they`re making money on it now. I don`t know that this is ever going to come to an end. It`s not clear. It`s a difference of opinion. Do I just not participate? Like people are writing subprime loans and I`m a mortgage originator. And you know, that`s where all the action is, they`re making a lot of money. And if I say I won`t do that, I kind of get left behind. I`m looking old. Your career -- your life -- you`re getting older and nothing is happening. So those kinds of thoughts enter, and it`s not the economists lately. In the established paradigm, they don`t generally represent those kinds of human emotions. I think that part of what we`re doing is influenced by psychology, by neuroeconomics, by sociology…
CHARLIE ROSE: What is neural economics?
ROBERT SHILLER: I think it`s an exciting new branch, which I am not a practitioner of. But they are trying to meld brain research with economics. And we have to understand how the brain functions. So they put people in a functional magnetic resonance imaging device, and watch what`s going on inside their brain when…
CHARLIE ROSE: When they`re doing what?
ROBERT SHILLER: When they`re making economic decisions.
CHARLIE ROSE: Decisions.
ROBERT SHILLER: And we find…
CHARLIE ROSE: Like what? You make an economic decision whether to buy this home or not, you`re making an economic decision whether I trade this security or not? Or what?
ROBERT SHILLER: Let me give you an example. And Ernst Fehr, in Zurich, Switzerland, did -- had people play games with each other, economic games, while they were -- I don`t remember the details exactly. There was a point in the game when some players showed vengeance to each other. In other words, they`re not making a good business decision; they`re doing something which actually cost them money, and it appears to be a retaliation.
CHARLIE ROSE: Because they want to retaliate.
ROBERT SHILLER: And some economists said, that, well, maybe there was some rational reason why they -- this was part of a grand strategy. But Ernst Fehr found that, that looking at their brain, that a region of the brain was activated at the time that they were being apparently vengeful. And it is the same pleasure center that -- it was -- that makes you happy when you`re sexually fulfilled or things like -- I`m making loosely from a study that…
CHARLIE ROSE: But this is interesting stuff, I`m telling you.
ROBERT SHILLER: What it means is that economists who say it`s all rational are wrong, because we can see with the neural imaging devices what the emotions that accompany these economic decisions are. And we now know that vengeance is part of what drives people.
You`ve heard people say it, I`m going to do this for the principle of it; I don`t care if it costs me money. And we now know that that`s not just talk, that is how people feel.
And that`s part of animal spirits, that Akerlof and I talk about, that people getting angry and they get resistant. And they don`t want to make a deal with someone that they don`t trust or they feel has wronged them. And unfortunately, that is part of an economic contraction, and that is part of what`s happening now.
CHARLIE ROSE: What is it about you, you, that makes you so fascinated by this?
ROBERT SHILLER: Well, it could be my wife, who is a psychologist.
CHARLIE ROSE: Yes, yes. Well, that`s interesting.
ROBERT SHILLER: Yes, it is interesting. I talk to her a lot. And…
CHARLIE ROSE: And how has she influenced you?
ROBERT SHILLER: She brings me back to reality.
CHARLIE ROSE: On these issues? Oh, she does?
ROBERT SHILLER: You know, I think George`s wife, too. He`s married to Janet Yellen, who was chairman of the Council of Economic Advisers and is now president of the San Francisco Fed. She is a smart woman. And I think both of our wives bring us back to reality more, that it`s very easy in academia to just go off on a tangent. And I think my work improved, I think George`s work improved when we married. So…
CHARLIE ROSE: Because you did what? Rather than going off on tangents, it was like a reality check?
ROBERT SHILLER: See, the thing that -- the academic incentive system is, you want to be on the frontier and you don`t want to be criticizable, right? So what do you do? You specialize really narrowly. And that I think is ultimately a mistake. You need someone with a broader judgment to bring you back and make you think, you know, writing that paper and getting into the top journal isn`t really what you want to do if the whole thing is meaningless. So even if you get the accolades, you want to feel good about what you`ve done.
CHARLIE ROSE: Here is what I don`t understand about you as well, beyond how you got to this, and now you`ve explained some of that, because of your wife, and you`ve paid tribute to her in lots of different ways too that I have read in reading about you.
I don`t understand this. When you, having the track record you did and the reputation you do, suggested that housing prices were going to fall, and that we were in for some rough sledding, and it could lead to exactly what`s happened, clearly people with a lot of money at stake should have been listening. Did they simply dismiss you? Did they say, thank you very much, Professor, now go back up to New Haven and write another book?
ROBERT SHILLER: That`s what they said.
(LAUGHTER)
ROBERT SHILLER: They didn`t put it quite like that…
CHARLIE ROSE: Essentially that was it.
ROBERT SHILLER: Well, it`s a question of how do we judge things. If I could have a mathematical proof that A, B and C implied D, and case closed, I think I would have prevailed. And others like me.
CHARLIE ROSE: Do you believe that what we went through, with all these mortgage-backed securities and the catastrophe that it led to, that it simply was a glitch in securitization?
ROBERT SHILLER: Yes, I think so.
CHARLIE ROSE: Explain.
ROBERT SHILLER: Well, companies were putting together in pools, mortgages, and then selling them off to investors. And they were dividing these up into tranches by risk categories, and selling the separate tranches off. And some of these separate tranches were then placed in other, CDOs and more -- CDO-squared. And it got very complicated.
And then when the whole system blew up, it was a mess cleaning through the wreckage. And people are naturally dismayed by what happened, but I take that as something like the sinking of the Titanic. You know, I mean, engineers when they built the Titanic, they were in a rush to get it done, they used the wrong rivets. The captain was going through iceberg-laden waters. You know, there were mistakes made, and they were mistakes by people in a hurry, who were -- we correct those and we fix them. And that`s how we improve.
I don`t think we have any other choice, really, any other sensible choice but to stick with capitalism, make it better.
CHARLIE ROSE: I just want to make sure about -- the kind of regulation you`re saying -- it`s not necessarily you believe that government should bring out all these new regulations, but we need to have better regulations. And some of them ought to be generated by the financial sector themselves.
ROBERT SHILLER: Right. I think actually most regulations are generated by people. Most financial regulations come in as suggestions by people in the financial sector, because government employees are not involved. You have to -- just like I`m saying the children at the playground, when they`re unsupervised, they realize we have to make a rule about this or that, you know, because they`re playing the game, and they kind of know.
But we also have to take in to all elements of the society, there is a problem that people in the financial sector may not show enough concern for people lower on the economic ladder. And I think actually one of the big problems that we are not confronting well right now is the rising economic inequality. And that`s part of the reason why I think anger is developing at this stage.
Inequality has been getting worse, and then we throw on this huge hit to unemployment. And people are losing their sense that America is for us together as the people. And that is so precious.
That`s why I support the efforts that Obama has made, and even -- you know, I wish they were stronger. The real mistake that has been made is that foreclosures are still at too high a rate. Too many -- and unemployment is at a high rate. I think we should have moved faster and more directly to protect all these people, because now we`ve got kind of a damaged animal spirits at this point. It`s still possible for us to, you know, we`ve done part of the job. We`ve done part of the job.
CHARLIE ROSE: So we come out of this, but it`s going to take, what, how long?
ROBERT SHILLER: Well, in terms of the National Bureau of Economic Research recession dating, it is quite possible that we will be out of the recession technically this year. But I`m not so optimistic from that, because we can have a double-dip recession. We can have a very slow recovery. That has been the pattern for recent recessions. So -- and given the amount of damage to the economy, damage to the animal spirits, which George Akerlof and I emphasize, not measured, that people are looking at this recession as just another in a string of recessions, and I think underestimating the longer term damage. What happened…
CHARLIE ROSE: What`s the longer-term damage?
ROBERT SHILLER: The longer-term damage -- I`ll give you as an example. What was the real surprise in the Great Depression? There were two aspects of it. I`m making a Great Depression parallel advisedly. We`re not likely to have as bad an experience as that.
CHARLIE ROSE: 25 percent unemployment.
ROBERT SHILLER: Right. But I mean, there are a lot of ways in which the current experience resembles the Depression.
But let me just -- in the Great Depression, from 1929 to 1933, we had a 43-month contraction. That was almost the longest in history. But it did come up. And we had a recovery from `33 to `37. People forget that. But it was still the Depression, because the unemployment rate never got below 10 percent.
And then after `37, the economy started sinking again, and there still were no jobs. Well, not no jobs, but the unemployment rate averaged I think 17 percent from `31 to `41, for a whole decade. And the puzzlement then people said is, why isn`t the economy recovering?
I think that -- there`s a lot of -- there`s been so many books and ideas written about this. But the theme that Akerlof and I emphasized is that maybe the failure to recover reflected a failure for animal spirits to come back.
And what I mean by animal spirits is a willingness to spend, a willingness to hire people. A willingness to -- we emphasized that business really is built on a sense of -- entrepreneurial sense, a sense of possibility. A sense that we can do something new and different. It`s risky, but we`re going to do it.
But when you get into a bad economic atmosphere, everything seems too risky and people are pulling back. That I think is probably the most important reason why the Depression lasted for so long.
So I`m not predicting anything as bad as that, but thinking that it is plausible that we will have trouble climbing out of this malaise. We`ll have the NBER saying the resection is over. And then three, four, five years from now, home prices may be even lower. I don`t know. That`s a guess. I don`t know. And the whole thing is just disappointing. And the reason it`s disappointing is because we haven`t moved to a business environment that is conducive to starting important new -- I mean, some people will do it, but it won`t be at the normal level.
And that`s why I think that we want to have more -- and I talked about a lot of these in "Subprime Solutions." They sound a little radical and different, but ideas that expand on capitalism and make it work -- make it work as it should.
CHARLIE ROSE: That`s your next book?
ROBERT SHILLER: I don`t have a next book in mind right now.
CHARLIE ROSE: How capitalism can work.
ROBERT SHILLER: Well, but it`s in both of these books.
CHARLIE ROSE: I know. So you also worry about sort of the psychology of America, maybe the psychology of other peoples in other countries as well. But somehow, the belief in the work ethic has been eroded.
ROBERT SHILLER: That`s right, yes. This is why people sometimes are angry with people in finance. They have a sense that finance is all about picking money up fast…
CHARLIE ROSE: It`s financial engineering, and they didn`t do anything, didn`t build anything, didn`t make anything, and they somehow used inside information, and therefore it`s all unfair that they made billions of dollars.
ROBERT SHILLER: In fact, I think unfairness probably is another theme in "Animal Spirits." Unfair behavior tends to grow during a boom period. And so, business ethics do slip somewhat during a growth period.
And that`s -- the problem is, that people get angry about that. But in fact, there`s nothing wrong with -- I`ve met many fine people in finance. I`ve trained them. I am very proud. I have thousands of former students who…
CHARLIE ROSE: Now running hedge funds or something.
ROBERT SHILLER: Yes, and I guess there`s -- you know, but I come back to it. The biggest problem facing this country is not this crisis. It`s the growing inequality. And I think that we have to -- and it`s another theme in my books. I`ve written another book about it.
CHARLIE ROSE: What was the title of that one?
ROBERT SHILLER: I had a book called "New Financial Order" in 2003, but I thought in that book that we should manage inequality in a scientific way. We have to have a plan so that inequality doesn`t get worse.
I don`t think we have any reason to want it to get worse. So why don`t we spend now, time, thinking -- and no presidential candidate has ever mentioned this. Maybe it`s too -- we don`t want class warfare; we want to start thinking about the forces that we can be offset.
And you know, this is fundamental. Why is the health care issue so important right now? I think it`s fundamentally because medical technology is improving to the point where it`s developing a lot of expensive procedures that can save and prolong people`s lives, and give them useful more years. And now we`re realizing that income inequality is worse than we thought, because people who are poor will die younger. They didn`t used to be that way. But once we have expensive procedures that can prolong lives, how can we deny that to lower-income people? And so to me it`s even more fundamental than the health care debate now. It`s getting the income inequality managed, so that it doesn`t become a huge problem in the future.
And this is -- and to me, it`s a technical problem, how to do that, just as…
CHARLIE ROSE: It`s a technical problem?
ROBERT SHILLER: Yes, it`s a technical problem. I`d like to see -- OK. I`m talking about so many books here.
(LAUGHTER)
CHARLIE ROSE: We`re talking about ideas, and (inaudible) it`s OK with me, but I`m interested in the idea.
ROBERT SHILLER: I have another paper with Len Berman called -- maybe I shouldn`t bring things up like this which are so politically dynamite. I mean, let me just lay it out. We think the tax system…
CHARLIE ROSE: Don`t sensor yourself. Don`t edit yourself.
ROBERT SHILLER: I get angry e-mail every time I bring this up.
CHARLIE ROSE: Go ahead.
ROBERT SHILLER: But this is really risk management. We don`t know how bad the income inequality is going to get. It could get better, it could get worse. So it`s a risk. Let`s put in a system that manages the risk.
So the proposal we have is to index the tax system for inequality. So that, the plan is, in the future, if inequality gets worse, we automatically raise taxes on the wealthy. It`s not -- Obama wants -- Congress are talking about taxing the rich to pay for the…
CHARLIE ROSE: Health care.
ROBERT SHILLER: Health care. And that sounds so logical. But after the fact, you try to do that, and it creates political problems.
We have to plan for the next decade. Let`s write it into the law now that that`s going to happen.
My son is now a Ph.D. student in philosophy. It`s my son, my next generation will carry at a more ethereal level. For me, I think of myself as a humble engineer, who has -- financial…
CHARLIE ROSE: Engineer?
ROBERT SHILLER: … financial engineer. And I`m aware of a technology of risk management. I`m also aware of a technology of social sciences. Psychology, sociology. We mentioned neuroscience. And I am trying to think like an engineer to put these things together to make something that works. And I think it`s not just me, I think this is the new paradigm. We have…
CHARLIE ROSE: The new paradigm is?
ROBERT SHILLER: Is -- I mean, to quote Thaler and Sunstein -- you should talk to them, they have a book called "Nudge" -- and in that book, they talk about choice architecture.
But the idea is to design financial and economic contracts around people, knowing the way they behave, and nudging them in a direction that works, that manages the risks and manages their -- that becomes part of a functioning economy.
And I mention that Sunstein is now part of the Obama administration. I take it as very inspiring that I see people like this involved at the highest level of our government. I think that this is new. This is like the New Deal. We are thinking at a better level, a more enlightened level about how to change our economic policies. And I think it`s a process. We haven`t heard the end of this by any means, but I think that the application of financial technology in connection with application of our understanding of the human species and the human mind is a breakthrough frontier we`re breaking through right now. And I`m hopeful that we`ll have a better country in the U.S. and in other countries around the world.
CHARLIE ROSE: This book is called "Animal Spirits," how human psychology drives the economy and why it matters for global capitalism. George Akerlof and Robert J. Shiller. If you don`t want to read this now, there is nothing I can say that would make you want to read it after listening to this conversation. It is a fascinating inquiry that goes far beyond economics in terms of the way human nature works. My thanks to Bob Shiller. Thank you very much.
ROBERT SHILLER: My pleasure.
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