Robert Shiller knows us better than we know ourselves. In his bestseller, Irrational Exuberance, the Yale economics professor popularized the idea that Internet stocks represented a dangerous bubble that would end badly for investors. His timing was flawless: The book came out in March 2000, just as the great bull market of the 1990s was ending and many Internet stocks in particular were about to slide into a death spiral. A later edition of Irrational Exuberance, published in 2006, warned of the housing bubble that triggered our current misery.
Shiller says it's his knowledge of human behavior, not numbers and economic theory, that has allowed him to identify bubbles and warn of subsequent meltdowns. But he is also a heavyweight when it comes to analyzing the numbers. He helped develop the Standard & Poor's/Case-Shiller Home Price indexes, which are the standard in tracking home-price changes in the U.S.
In his latest book, Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism (Princeton University Press, $25), Shiller deftly picks apart the failings of traditional economics. He and his coauthor, Nobel Prize-winning economist George Akerlof, show how we ignore issues such as trust, overconfidence and fear at our peril, and they suggest ways to prevent us from being our own worst enemies.
To get Shiller's take on the current financial zeitgeist, and on the nation's economic woes and how to fix them, we recently visited him in New Haven, Conn., in his office at Yale.
KIPLINGER'S: This is a fine mess we've gotten ourselves into.
SHILLER: That's a quote from Oliver Hardy, of Laurel and Hardy fame. I wonder if he coined it during the Depression.
Do you think we could fall into a depression?
Unfortunately, we might. We don't have any examples of a government extricating a country from a crisis like this one -- especially when you consider that the crisis has spread around the world. Some of the recovery hinges on what other nations do. I'm hopeful there will be a worldwide stimulus, but that's not happening. We need to run up a big national debt to do a major stimulus. The reason we didn't stimulate more during the Great Depression -- when we needed to -- is that it just didn't work initially. That made it politically difficult to continue the stimulus.
When do you think the housing market will stabilize?
I don't actually forecast home prices, although I used to. And one thing I learned is that when prices move in one direction, they tend to continue in that direction for a while. So when officials in the Obama administration talk about a best-case scenario of a 17% decline in housing prices in 2009 and a 4% decline in 2010, they are, I believe, taking into account this momentum behavior. On the other hand, the economy could turn on good news, as it did after the Gulf War ended successfully in 1991.
What do you think of federal programs to help distressed homeowners?
Those are the kinds of things we need. I think we should reinstate the Home Owners' Loan Corp., a New Deal program that guaranteed new mortgages.
People need to have a sense of fairness and justice. That sense is damaged as each month of high foreclosure rates passes. People feel they've been treated unfairly because they followed the government's advice that they should buy a home, and now they're being evicted. This feeling of injustice is heightened when they hear stories of bonuses paid to Wall Street professionals. They are really angry, and you don't want to toy with that.
How does that anger hurt the economy?
Anger hurts confidence. Restoring confidence is not necessarily just about getting the stock market to go up; it's also about promoting a sense of trust in our economic institutions and in one another. When trust is damaged the way it is today, people won't do business in a million different ways, and that harms economic growth.