Robert Shiller. The subprime solution : How today's global financial crisis happened, and what to do about it

After describing the history of all types of bubbles, Shiller proposed a number of solutions of three general types to alleviate future bubbles, information technology, market-based instruments, and risk-management institutions. Among the technology solutions, Shiller elucidated the capabilities of mathematical finance, which exposed the nuances of risk management. This capability demonstrated how both sides of a contractual relationship can win, a critical aspect of agency theory. Agency theory "explains how to motivate agents to behave as much as possible in the interest of all parties to a transaction" (p. 188). Shiller promoted information technology to achieve a number of goals: "comprehensive financial advice . . . financial product safety commission . . . standardized default-option financial plan . . . improve the disclosure of information . . . improve financial databases . . .new system of economic units of measurement" (pp. 121-148). The units of measurement that Shiller and other devised "would be defined for many common economic values including income, profits, and wages. But the greatest importance would be new units of measurement for inflation . . . an inflation-indexed unit of account" (p.141).

Of the market solutions, Shiller formulated new markets that would address risk. To minimize real estate risk, the source of the 2008 bubble, Shiller suggested a single-family home-price futures market, to short real estate without selling a home. Chicago Mercantile Exchange (CME) currently has such markets, which "have been predicting large declines in home prices in the United States almost since the markets' inception in May 2006" (p. 152). Other markets Shiller mentioned included "markets for long-term claims on incomes--individual incomes, incomes by occupation, incomes by region, and national incomes" (p. 154). These markets would reflect "livelihood risk" (p. 154). "Markets for occupational incomes--such as futures, forwards, swaps, and exchange-traded notes--will ultimately make it possible for people to hedge their life income risks" (p. 154). Shiller advanced another financial instrument, a "perpetual debt that pays a share of GDP as dividend" (p. 154). Dividends would fluctuate based on the economic growth or contraction of a country. Shiller argued that "in economic slowdown, the government would find that the burden of interest on the national debt would, in effect, fall below expectations. It would thus have more resources available to deal with the crisis" (p. 155-156).

Among the risk-management institutions, Shiller listed continuous-workout mortgages, home equity insurance, and livelihood insurance. With demographic data to establish criteria, issuers could minimize the possibility of individual abuse and manipulation.

Shiller, R. J. (2008). The Subprime solution: How today's global financial crisis happened, and what to do about it. Princeton, NJ: Princeton University Press.