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I have been doing a series of book reviews on the financial crisis. The latest book that I have read is The Subprime Solution by Robert Shiller. I was attracted to the book and Dr Shiller's writting, after reading Irrational exuberance by Dr Shiller, which is one of my favorite books. The Subprime solution is not a new book. It was released in 2008 well before the financial crisis reached its peak. When I asked Dr Shiller for the book, he told me “Subprime Solution seems to be slipping from public attention, but it is all the more relevant now I think.” I could not agree more.

The book can be divided into three parts:

In the first segment of the book, Shiller describes what lead to the subprime solution. While to most investors this may seem like a review it is useful to read Shiller’s account of what led to the subprime problem. In addition, this section is valuable to the layman who is unfamiliar with the course of events that lead us to the situation we are in now. What I love about Shiller’s writing style is despite being an academic he is able to communicate on a simple level that most Americans would understand.

The second half of the book deals with the short term to the subprime mess. Much of the short term fix entails essentially a bailout. Dr. Shiller argues that these bailouts are necessary. He foresaw what would unfold if the Government failed to act. Shiller writes “bailouts of some sort are a necessary part of the subprime solution. To avoid an economic crisis that would destroy public confidence and possibly lead to systemic failure”. I only wish the Government had heeded this warning before the collapse of Lehman Brothers. Had the Government acted earlier it would have cost far less, and the damage to the US and global economy would likely not have been as severe.

The third part of the book contain Dr. Shiller’s long term solutions to avoid problems that lead to reckless subprime lending in the future. Dr Shiller describes this as "democratization" of the financial market.

Some of these solutions include

  1. Providing lower income, and less educated people with financial information. Shiller believes that this would have prevented many subprime borrowers from taking out loans.
  2. Specifically Shiller calls for a new financial Watchdog which would provide people with financial information. This agency would be similar to the consumer protection agency which protects people from unsafe products.
  3. Creating new instruments to provide people insurance in case of their personal economic problems such as home price declines and unemployment

The ideas contained in third part of the book, are why I believe Shiller described the book as more relevant than ever. As the debate in Washington about financial reform continues many ideas have been proposed. While Shiller’s ideas might be controversial and would not solve all the problems that led to the current financial crisis they definitely deserve an examination. While Shiller was not the first person to propose a consumer protection agency, I believe his endorsement of the idea may be a reason why it has become a key platform of President Obama’s financial reform proposal.

The best part about Dr Shiller’s book is his understanding of human psychology and how it affects the economy and can produce bubbles. As a value investor/ contrarian, I believe human psychology plays an important role in figuring out what investments to buy or to avoid. Dr Shiller foresaw the subprime problems and the housing bubble long before the full brunt of it unraveled. This is not the first time Shiller has predicted a bubble. Robert Shiller called the stock market bubble several years before it burst.

Many people now are playing Monday morning quarterback and are claiming that the dot com bubble and housing bubbles were obvious in hindsight. Yet, most experts including the nation’s most prestigious financial institutions, Government agencies, academics, and investors did not foresee either bubble. I wonder where all those people were while the bubbles were building up- maybe buying AOL or Citigroup stock. Dr Shiller is one of the only individuals who predicted both bubbles before they burst. My advice is next time Dr shiller says we are in a bubble; to take note.

To purchase the book on Amazon.com click on here.

Disclosure: I have a material connection because I received a copy of this book for free to review.

Source: Book Review: The Subprime Solution by Robert Shiller