Risk & Compliance

Shiller to CFOs: Quick Action Needed to Avert “D-word”

The Yale economist tells CFO Rising conference that Obama stimulus is too slow and small so far. He contradicts Buffett, welcoming "geeks who can b...
Vincent RyanMarch 9, 2009

Restoring confidence — which means getting business leaders to take risks predicated on the assumption that good times lie ahead — is the fundamental problem of the U.S. economy, according to Yale economist Robert J. Shiller. And it doesn’t appear that we have struck on the solutions to achieve it.

Addressing attendees of the CFO Rising conference in Orlando Monday morning, Shiller set out some proposals for tackling the crisis. But he first stressed the severity of the current situation, saying the parallels between the current economy and the Great Depression, when business confidence totally collapsed, are apt.

“I used to feel bad using the ‘D’ word, but the word is out. It doesn’t mean it’s going to happen — history evolves and surprises us.”

Comparing data from the current markets with those from the Depression shows that the current market still has room to fall, Shiller noted. The S&P 500 has declined 63 percent in real terms since 2000, while in the 1929 crash the market fell 80 percent, peak to trough. But the current economy could also be history making: There’s a real possibility, for example, that earnings for S&P 500 companies will be negative for the entire year, something that has never happened, Shiller said.

Confidence among CFOs may well be at an all-time low. In a preconference survey conducted by CFO, a majority of conference attendees said that the recession would last another 14 to 16 months. Building back that confidence is key to reinvigorating the economy, he said, because much of what drives financial markets is human behavior, not the “efficient market” hypothesis. Indeed, economist have relied too much on [the efficient market] assumption. “Fundamental misconceptions have informed our thinking,” he said.

Unfortunately, U.S. regulators may not be acting quick enough to stop a depression from happening, according to Shiller. The Obama administration’s stimulus package, for example, is slow to arrive and may not be large enough, Shiller opined. “We have to be sure our stimulus is big and fast, but unfortunately we have already lost time.”

International coordination is vital, Shiller stressed, calling for G20 leaders meeting in London on April 2 to coordinate economic stimulus packages as well as any efforts to restore bank lending. In particular, G20 leaders need to be sensitive to the notion of fairness, which has been left out of the current economic analysis and the prescriptions to stem home foreclosures. “People feel unfairly treated, and that’s going to build,” he said.

However, the solution to the current crisis must involve innovative thinking about long-term solutions, which hasn’t happened yet, according to the economist.  “We shouldn’t react to the crisis by thinking that we want to punish people in finance — the big mission is not to send people to jail, but to fix the system. We have years of work ahead redeveloping our economy.”

Better disclosure of information to allow businesses to foresee systemic risks will be key to solving the economy’s long-term problems, Shiller said, as will improving risk markets, especially in real estate. Shiller has been working to launch a futures and options market based on the Case-Shiller home price index. The market, located on the Chicago Mercantile Exchange, has stalled due to lack of liquidity, he said. But he is also working to launch long and short securities tied to home prices on the NYSE. “We want to see price discovery in real estate pricing trends,” Shiller said, “as well as the ability to hedge real estate risk.”

A host of other potential solutions are available for the consumer mortgage market. Among them, Shiller proposed the subsidizing of financial advice for the general public. “What disastrous advice we have been giving people — to put all of their life savings into a house,” he said.

Shiller also proposed increasing consumer protection measures, providing home equity insurance to protect against declines in house values, and the adoption of “continuous workout mortgages,” loans that adjust automatically and continuously to home values. These measures would in part prevent future bubbles.

In the end, getting CFOs and other business leaders confident again will require improving the economic picture for consumers. But what regulators shouldn’t do is throw out financial innovation, which many have seen as the cause of the crisis. In the early days of air travel, many planes crashed. But then engineers invented better standards.

While investors like Warren Buffett have warned that CFOs need to be aware of “geeks bearing models,” Shiller believes that they are not to be shunned. “We need those geeks who can build and design things,” he said.