SHILLER: Greed Isn't Good, But Capitalism Is

$('.icon-tooltip').tooltip();Robert J. Shiller has predicted two crises, but his belief in the financial sector has not been shaken. The leading U.S. economist recently sat down with Credit Suisse to discuss the risks of today’s financial system and why he still believes in capitalism’s good side.

Credit Suisse: You were one of the only economists in the world to predict the end to both the housing and the dotcom bubbles. Still, your new book is something of a love letter to the financial sector. How do you reconcile the two?

Robert J. Shiller: The word “finance” comes from the Latin “finis” – objective or goal. That’s what innovations in the financial sector are for. They motivate people to work together, efficiently and constructively, toward a common goal. A major part of the progress made throughout history has been due to the innovative capacity of the financial world.

CS: For example?

RS: The invention of the corporation allowed clever minds to establish a company together on the basis of an idea. And the company can continue to exist after the original owners have left. The “limited liability” concept, which came a little later, guarantees that personal risk is limited to the share invested in a company. That is fundamental. If a person were liable with all of his assets, every individual share could mean ruin. As a consequence, there would be virtually no capital in the markets. 

CS: Not all financial innovations have such a positive impact.

RS: When they’re first experimented with, many instruments are viewed with skepticism – including the above ideas of shared ownership in a corporation or limited liability. If the results were good, the instruments were quickly copied. That is the history of progress. Our financial instruments are now used around the world, which is one sign of their success.

CS: The Economist recently called you a Cassandra – someone who foresees disaster, but finds no one willing to listen – as well as a Pangloss, Voltaire’s radical optimist. There are many people today who are much more critical about the financial sector than you are.

RS: As Jesus said, “It is easier for a camel to go through the eye of a needle than for a rich man to enter the kingdom of God.” The history of criticizing finance is a long one. Most of the world’s religions value generosity as a human virtue. Finance, however, also recognizes the egotistical side of human nature. This presents potential for conflict.

CS: Is this the main cause of the current crisis?

RS: The crisis is the result of different factors. Worst of all was the widespread perception in the U.S. that housing prices could not fall. So there was no reason to worry about a speculative bubble, and the authorities and central banks did little. This is something that we can fix, and to some extent, have already done.

CS: In your opinion, have too many new regulations already been introduced?

RS: Regulation is difficult to quantify. The prevailing political climate could actually lead to the suppression of innovation in the financial system because of the fear of further crises – because we are no longer willing to take on risk. I think it’s important that governments not simply issue regulations on their own, but that businesses participate in the process, for example, in the development of regulations by professional associations. They tend to view the problems a great deal more concretely than the people in Congress do. 

CS: What are the risks that you currently recognize in this area?

RS: The crisis has been going on for a long time now – it began six years ago. Many economies are still struggling today. Similar to the current crisis, the Great Depression in the 30s began with a financial crisis and – as absurd as it sounds – things did not improve until World War II, which acted as an economic stimulus. Many countries are currently caught up in their austerity policies and almost overdoing the cost cutting. We may well be experiencing an extended period of low growth. I’m also concerned that inequality will grow even more over the next few years.

CS: What are the signs of this?

RS: Median household income in the U.S. is already falling. That is a dramatic sign.

CS: You consider the social balance to be in danger?

RS: It is imperative that we remain an inclusive society, where every one of us has opportunity and a sense of belonging. Differences in wealth are better tolerated under those circumstances. A dramatic example: Joseph Stalin believed that he could use the anger of the simple farmers against the kulaks, the wealthier farmers, to his advantage. But the simple farmers did not want to shoot the kulaks. Why? Some of them were their friends. Society has to remain mixed. Everyone has to be included.

CS: You want to use financial instruments to contribute to a “good society,” a better world. That sounds, diplomatically speaking, rather bold.

RS: Not at all. During the last two years, many innovations in the sector have served to support the “good society.” Social impact bonds in the U.K., for example. Let’s take the Peterborough Prison in northern London, which has extremely high rate of recidivism. The non-profit organization Social Finance reached an agreement with the government for a payment of £6 million if recidivism declines to a clearly defined level within a certain period of time. Social Finance then issued a bond. Using the capital raised, measures were taken with the goal of reducing recidivism. If the goal is met, the £6 million will be distributed to investors. That is a private solution to a public problem. There are numerous other examples.

CS: Traditional theories of economics assume a rational, utility-maximizing person. One who is not necessarily interested in “good society.”

RS: Decades ago, the economist Kenneth E. Boulding showed how far removed we are from homo oeconomicus. People are much more dependent upon each other than the pure utility function would indicate. Generosity also seems to be an inborn trait, as Ernst Fehr at the University of Zurich has shown. People are generous and kind to people who they perceive as such. We want a society that reflects the golden rule: “Do unto others as you would have them do unto you.” Of course, people aren’t always good, but when generosity is fostered, they become better. Financial instruments can help with this, too.

CS: What is your own contribution to the “good society”?

RS: I have educated at least 3,000 finance students. I hope that they are doing their jobs well and responsibly. I have never preached “greed is good” like some colleagues. That existed even before Gordon Gecko, the prototypical representative of “Wall Street” in the film of the same name. I tell my students: “Follow your passion but be aware of your responsibilities in society.”

CS: You have been teaching at Yale University since the 80s. How have the students changed?

RS: I have the feeling that they have become more capitalistic. When I started, the students were radically anti-business, and held demonstrations. That has to some extent reemerged lately. When banks come on campus to recruit students, there are sometimes protests again.

CS: What advice do you give students?

I can only respond with a banality. They should be true to themselves and realize their dreams. I wrote books as a child – I enjoyed doing that. Daniel Kahneman, who won a Nobel Prize, recently stopped by and talked about how difficult it was for him to write a book. It is a hobby for me. When I watch television, I am bored. When I write, I am happy. That is my niche in this world.

Interview has been edited and condensed.

The Financialist is a digital magazine presented by Credit Suisse that looks at the trends and ideas that drive markets, businesses and economies.

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