Books | Banking now on financial democracy

Books | Banking now on financial democracy

The US’ decade-long real estate bubble brought about the subprime mortgage crisis that began in 2006. The bubble’s severe consequences will go far beyond the intense financial wreckage it caused. Its ripple effects constricted credit globally and led to the failure of several major financial institutions. The impact is so drastic that a return to normalcy may take years, even decades. Expect a prolonged period of slow economic growth.

In his book, The Subprime Solution, Yale economist and best-selling author Robert Shiller warns that the damage this crisis has caused the social fabric is even more severe than the damage to the financial system. When people lose trust in their economic and social systems, the consequences can be terrible. That trust is now at risk in the US.

During the real estate bubble, many people took at face value the assurances of politicians, policymakers, pundits and financiers that the country had entered a new era in which home and real estate prices would rise continuously, an era in which anyone, regardless of income, could become a homeowner and live the American dream. Clearly, no such new era existed. The dream has turned into a nightmare. Many people have lost not only their homes but also their life savings and, more ominously, their self-respect and their trust in the system—the trust that is the foundation of a civil society. The solution to the subprime crisis must address this crisis of trust, and, to do so, must go farther than merely repairing damaged financial institutions and restoring credit flows.

While the subprime crisis may well be the worst financial catastrophe to hit the US since the Great Depression, it also provides an opportunity for reform that can leave the American economic system and society in a much better condition.

Also See: The Subprime Solution (Graphic)

Therefore, the response to the subprime crisis should not be to roll back the clock and punish the technologies and markets that hold future potential to reduce risk, improve economic equity and provide the foundation for a sounder, fairer financial system. The solution to the market failure, Shiller believes, lies in better and more liquid markets—not in market constriction.

Shiller offers an insightful examination of the crisis’ causes and suggests potential measures for the future. He lays the blame for the subprime crisis on the same “irrational exuberance" that led to the technology bubble of the 1990s and the real estate bubble of the 2000s. Both bubbles involved excessive lending and resulted in severe losses for capital providers. His prescription for dealing with the crisis involves a range of policy measures. In the short term, he calls for bailouts for low-income borrowers who got drawn into subprime scams that they did not understand.

For the long term, he calls for a “financial democracy", in which financial knowledge is no longer concentrated in the hands of a few. The only way to prevent a crisis such as this from happening again, he says, is greater financial awareness throughout society. Among other measures, he therefore proposes a new framework for financial institutions, more transparent information, simpler contracts, better advisers, improved risk management markets, equity insurance and home loans linked to income.

Both his diagnosis and his prescription are no doubt controversial but getAbstract thinks his book is a necessary text for anyone who wants to understand what’s happened and how to survive it and learn from it.

Rolf Dobelli is the chairman of getAbstract.