Interview With Robert Shiller

L.G.: And their reaction was to listen politely?

R.S.: Yeah, that's what happens all the time. We'd talked to insurance companies 15 years earlier about home-equity insurance. And sometimes it's a little bit more than polite listening-they actually sounded enthusiastic at the meeting. So we told insurance companies, "You have homeowners' insurance, insurance against fire. So what if you expanded that to cover and insure against losses on the home? Wouldn't that expand your business a lot?" Actually what they typically said—I think it's mainly what Fannie and Freddie said—is, "Well, there isn't an established market for home-price risk. So we couldn't hedge the risk." And I suppose that's also what Fannie and Freddie thought, that they have a portfolio measured in billions, and we're just talking very hypothetically because we didn't have any market price, and we didn't have any obvious ability to make a risk-management contract of any size. So it came across to them as just a pipe dream. And I suppose that's just the general thing.

L.G.: Were you visiting them in your capacity as a company?

R.S.: Yes, our company, Case-Shiller Weiss, was publishing indexes, and we were advocating for risk management.

L.G.: And some of the people who met with you said that they've been doing their own due diligence. Tell me about that.

R.S.: I had a conference at Yale, and it was Frank Nothaft [the chief economist of Freddie Mac] who told about the risk management. And this is actually in my book that's coming out-I'm scooping my book here.

L.G.: Well, we'll flog your book and make sure people know it's coming out in two months.

R.S.: That would be good.

L.G.: Princeton University Press—what's the title of it?

R.S.: The Subprime Solution: How Today's Global Financial Crisis Happened, and What to Do About It.

L.G.: Consider it flogged.

R.S.: Flogged? What does that word mean?

L.G.: I guess flogged is what happens in Singapore if you spit on the sidewalk. So, okay, go ahead and scoop your book some more.

R.S.: I have a publicity manager, and he said I shouldn't talk too much about it.

L.G.: Okay, but why don't you tell me that story at least.

R.S.: Well, that story was that Frank Nothaft claimed that they had considered price declines as much as 13.5 percent. And I said, "What if it was worse than that?" And he said, "It's never been worse than that." And then he corrected himself. "Except for the Depression." I don't remember exactly what I said to that, but plausibly it was something like, "Well, that could happen again too." So again, I started to sound at that point too academic-something like this isn't real anymore.

L.G.: Why do you think people just have trouble listening to these things?

R.S.: Well, I can talk as a sociologist—which I'm not trained to do—but there's a social construction of reality that happens. This is a basic principle of sociology. We have a "collective consciousness," to quote sociologist Maurice Halbwachs. As far as I know, he coined the term. And the point is, we talk so much. The human species is incessantly talking, and this incessant talk reinforces certain memories and facts. And other facts are not reinforced because no one's talking about them. So they elude our consciousness, and then we can't remember them. We can't act on them anymore, and so a certain sort of reality-construct forms. It's also informed by some kind of intuitive thinking. In the case of real estate, people think that the growing population is inevitable, and that means home-price increases are inevitable. And these are not economists thinking clearly about what that means. An economist who thinks about that would say, "Yes, but that doesn't make them a good investment." If everything is priced at the present value of the cash flow with the same interest rate, then it doesn't matter whether the cash flow is growing or not, and then everything is equally good as an investment. That's not something that the general public understands.

L.G.: The people who were getting into subprime mortgage-backed securities presumably understood all this. They're very sophisticated people. So what was driving them?

R.S.: Some of them were very sophisticated people [laughs], and there was a failure to communicate and a failure to put all this information together and act on it in a systematic way. There's a famous book written by Irving Janis, who's a psychologist, about 30 years ago, called Groupthink. He's a social psychologist, and he points out how even expert groups can make very colossal errors. He did a number of case studies in the book, and what tends to happen—suppose you imagine yourself and a group of experts who seem to have converged on an enlightened opinion which has arguments to support it, and it has prominent influential people saying that. It can be difficult for someone to stand up in that room and air what seem to be half-baked or half-formed doubts about it. It can be kind of damaging to your reputation. And you imagine that they have a reason to dismiss these doubts. But you don't want to be responsible for bringing it up—especially when they're reaching a decision. Sometimes they're trying to make an important decision. And at that time, you would think that people who have doubts should stand up and thrust them to the fore. But, in fact, they often retreat at that point, because they may just have a sense that they're being annoying, that they will lose status in the group. If we're close to a decision on something, and I'd raise doubts, and they're going to go ahead anyway and do it, you might think that's good—because it could be a disaster, and they'll remember that you had doubts. But the likelihood is to focus on, instead, "Now I'm kind of the party pooper," you know. "When they're going to implement this plan, they're not going to turn to me because I was the guy who doubted." Things like that went through peoples' minds, and they don't air doubts. And when Janis interviewed people afterward and asked them their memories of the discussion, they would say things like, "I think we had a very open and fair discussion, and everyone raised their views." That was their memory of what happened, but they couldn't remember the other arguments. So it wasn't happening—there was somebody who was expressing doubts, but not effectively. And so I think that's the kind of thing that happens when there's just a general presumption which becomes repeated everywhere.

L.G.: And do you think that's the sort of dynamic that might've been operating, not only in quasi-government agencies like Fannie Mae and Freddie Mac, but also in the banks on Wall Street?

R.S.: Yeah, I mean, it became the idea that risk was just not there.