Rating: 
Summary: Unrealistic and often redundant
Review: Summary of opinion.
The risk management concepts developed by Shiller are far fetched. The likelihood of any being ever implemented is low. Thus, this book is not the best use of a reader's time. You are better off reading Shiller two earlier excellent books: Market Volatility, and Irrational Exuberance. Abstract.
Shiller develops economic concepts to reduce important risks within our society. These include: 1)Livelihood insurance against poor career choices.
2)Home value insurance.
3)Income-linked loans for reducing the risk of hardship and bankruptcy.
4)Inequality insurance. Protecting the distribution of income.
5)Intergenerational Social Security: Sharing risks between Young and Old.
6)International Agreements for Risk Control. Below I will briefly evaluate these concepts. Livelihood insurance.
Workers could get coverage against the decline in income that workers in the same field have experienced. The decline in income for the workers in this specific field would be measured whether the worker has remained in this given field or not. Take a cohort of 100 professional violinists. If 50 exit the field, and make their living as bartenders, this cohort of 100 violinists income would really reflect the income of 50 professional violinists and 50 bartenders. By the end, what would this income index really tell you? Shiller underestimates the liquidity of our labor markets. Today, you can find as many astrophysicists in consulting firms, and investment banking. The same is true for engineers. Many engineers end up as consultants in fields often not directly related to engineering, instead of working for engineering firms. Home value insurance.
Homeowners could buy insurance against the value of their homes. So, if the value of their homes went down, they would receive payments from the insurer. This product runs into two hurdles. First, if priced correctly, this product would be very expensive. Few homeowners would be willing to pay per year the several percentage points on the value of their homes to insure them against a decline in value of their homes for just a 12 month period. It is essentially the price of a Put option on the value of your home. Secondly, the brunt of this risk is not born by homeowners but by creditors. To conclude, this insurance product would be expensive to cover a risk that is mainly born by another party (creditors). Income linked loans. Borrowers would repay loans as a fixed percentage of their income. So, if their income goes down, the debt burden goes down, and vice versa. This product will never reach a critical mass because it is unworkable for banks. Banks try to match the cash flows from their assets with the ones from their liabilities. An income linked loan would have such an unpredictable cash flow that it could not be matched by any bank liabilities cash flow. You figure the deposits and bonds issued from banks are not income linked. As a bank depositor or a bondholder, you demand a very predictable cash flow stream, not one dependent on the income of the bank?s borrowers. Thus, I don't see income linked loans becoming part of "The New Financial Order." Inequality insurance, protecting the distribution of income.
Here the tax structure would be automatically adjusted to maintain a predicated distribution of income. This would have horrendous implications for financial planning. You would be uncertain as to your ultimate tax burden at the end of the year when the distribution of income would be recalculated. Intergenerational Social Security: Sharing risks between Young and Old.
This product would overhaul the structure of Social Security. Now, the Social Security system is structured as a pension system. Currently, social security contributions far exceed the payments. This is to build up the Social Security trust fund for when the large Baby Boomer generation retires, when payments will far exceed contributions. With Shiller, the income earned by active workers would be shared on a prorated basis with retirees. He states that currently retirees represent 11% of the population. So, the workers contribution would be 11% of their wages to support the retirees. But, this percentage will double in just a few decades. So, the 11% contribution will become 22%. This is unfair to the next generation. The current system of prefunding the social security trust to get set for higher social security payments in the future is better. It equalizes the burden of supporting retirees between current workers and their next generation. Shiller concept does the reverse.
International Agreements for Risk Control.
Countries would enter agreements that would hedge against their economies under performing in the future. So, let's say that India's GDP is expected to increase by 4% per year over the next 10 years. India would enter into a contract with a group of countries (U.S., UK, Germany, etc.). The group of countries would make a payment to India anytime India's GDP would grow by less than 4%. But, India would have to make very large payments to the group of countries whenever its GDP rose by more than 4% per year. It is unclear how India would come up with that extra money. Would it have to raise taxes on its citizen? The resulting counterparty risk associated with India making such payments would be unmanageable.
Rating: 
Summary: Controlling Risk - A New Matrix
Review: The NEW FINANCIAL ORDER outlines an ambitious plan for reworking the ways we control financial risk. Shiller "democratizes" the subject of risk by addressing, among other things, the vulnerability of "ordinary riches" like the value of our homes and our choice-of-career incomes. These risks are various, unpredictable, and unevenly distributed through time and geography. That unevenness (unfairness, Shiller might say) means the risks can be insured, securitized, and traded. The moral dimension to this is Shiller's intention to hedge inequality that is "gratuitous, random, and painful". Changes in a nation's economy and the unknowable effects of technological advances are two long-term, systemic risks we all face. By comparison, the risk to an investor's wealth of a company's stock missing its projected quarterly earnings is small in measure to the seismic shifts in the net worth of a much broader base of homeowner stakeholders. Now, if the stock market is not an adequate proxy for the overall wealth of the economy, then why not create "macro markets" for securities that swap out the risk of one nation's aggregrate output (GDP) for another's. Some will argue that the stock markets in the U.S. and other developed countries are already proxies for their economic prospects. But given the thin liquidity and relative immaturity of many other markets, securities tied to a more fundamental metric such as GDP or all real estate values are a clear positive. Shiller does a good job of suggesting the challenges government and the private sector will confront to implement a new risk infrastructure. There is an interesting anecdotal history in Part Five of how various financial and insurance plans came into being as with our social security system modeled after the German system in the 1880's. The development of sophisticated "global risk information databases (GRIDS)" will provide a resource for writing appropriate contracts in the future. Privacy advocates will shudder, but part of the point is that the ways we control risk have evolved over time and can be modified to work better. This is a provocative book because of the wealth of its vision. With this much innovative thinking it seems reasonable that additional studies will build on Shiller's work and pave the way for some of these ideas to be adopted.
Rating:
Summary: Big Brother meet the Free Market
Review: This is a big, big book. Although it contains only 276 pages of commentary, its scope envisions a brave new world we can only imagine and argue about. No doubt the outcome of the argument will weigh heavily on our future for years to come. Professor Robert J. Shiller needs no introduction. Whether by intent or luck, his "Irrational Exuberance" warning about our overvalued stock market was published around the time NASDAQ topped out just above 5000 (March 2000). The rest is history. And while I, as a former member of two options exchanges, certainly welcome any suggestion to increase the trading opportunities available to us today, the six innovative financial instruments he proposes to reduce/share risk leave a lot to be explained, both mechanically and philosophically. The book, though, rates five stars for its thought-provoking ideas and for the stature that Shiller brings to them. There's a lot in this book and nothing in it should be discarded without extensive study and reflection. One of life's hardest lessons to accept is that none of us, either individually or collectively, can ignore the dynamic world we live in. Sitting still is not an option because of the relative motion of everyone else in the world. Our only choices are, in the immortal words of Lee Iacocca, "Lead, follow, or get out of the way." Today's informational databases were sure to evoke something like Shiller's ideas. It is useless to turn our heads because it will happen. Therefore the intent of this book should be exposed to the largest possible number of people because what we decide will determine how we spend the rest of our lives. On the surface, Dr. Shiller would be creating a Dr. Pangloss world, but the devil would be in the details.
The most obvious aspect of Shiller's proposals is that he would use classical capitalistic markets to achieve classical socialistic goals. A most creative feat in and of itself. Insuring against risk, of course, is nothing new. Lloyd's of London dates back to Edward Lloyd's coffeehouse in the late 1680s. But not only does Shiller want to mitigate the risk of error in individual decision making, he also wants to insure "society" against the collective mistakes of all. It will be interesting to see which power groups line up on which side of the argument. Maybe he isn't proposing cradle-to-grave socialism, but certainly something close to young-professional-through-retirement risk sharing as administered/regulated by a combination of governmental/financial superbodies.
He convincingly begins his presentation with a short history of how new innovations are always refuted at first, then eventually work their way into our lives. This is a good start to set the stage for his own ground-breaking ideas.
There is no point in going over the mechanics of the proposals because they will see many different permutations before they ever become tradable entities, but more important are the goals and philosophy that pushes them all.
His first proposal covers personal insurance: livelihood insurance to reduce the risk of people embarking on a dead-end profession. He is inspired here by the very legitimate concern that society losses out on tremendous talent when gifted individuals steer away from professions that might not pay off in the future. He feels that if we insure them against this failure, their contributions will pay off in the long run. Also included in personal insurance is his proposal for home equity insurance to guard against a decline in your home's value. He's already put his money where his mouth is by incubating such a company and then selling it to a financial conglomerate.
Next is MacroMarkets. Here he envisions GDP futures to enable trading in national economies based on how they perform. One of the benefits here would be when a country's GDP begins to weaken, it would be a signal to the affected economy's leaders that something must be done to remedy the situation or else things will get worse.
Third, he addresses banking and income-linked loans. Interest rates on loans would rise or fall with one's income, region, or profession, and could be used to modify or eliminate current bankruptcy laws. However, could a bank stay solvent by lending money on fluctuating terms unless it could also pay interest on fluctuating terms? We've just lived through the S & L crisis borne out of this same scenario.
Fourth, he tackles his most inflammatory subject, that of income inequality. His basic fear here, along with Dr. Ravi Batra and others, is that increasing disparity of income leads to riots, revolutions, and war. But who decides what is fair and equitable? And would an earlier leveling effect have robbed us of the builders Carnegie, Rockefeller, and Ford up through Walton and Gates?
Fifth - Intergenerational social security. This is the most pressing problem today and will cause the most heated debates going forward. What is fair can be debated until we all die of old age.
Last, he would like to set up swaps between rich and poor, strong and weak nations based on their GDPs. But what happens when politicians are accused of "exporting jobs" like companies are today? They won't be in office very long. The IMF doesn't have a great record getting the masses to toe the line either when it comes to living up to prior agreements.
The scariest ingredient of all Shiller's proposals is the collection, retrieval and analysis of masses of amounts of information (GRID) needed to administer such an interconnected trading arrangement. Yet, the Internet is making us one people, and Shiller's financial instruments would make us one world, interconnected, co-dependent, and risk-sharing. If Clausewitz was right that war is politics by other means, then perhaps politics is economics by other means. Maybe the time has come for economics to supercede politics and maybe Shiller is showing the way. He does have a vision. Do we want to be part of it or not?
Rating: 
Summary: Overall not very convincing
Review: Whether it is home value insurance or other improvements that Shiller offers to fix the market, the one question that Shiller never deals with is why those policies don't already exist. He simply assumes that he is smarter than the market and that others have made mistakes in not offering these options. Might there be moral hazard problems in home value insurance? No discussion is offered. This approach of simply asserting an "optimal" arrangement without really asking why it doesn't exist if it is so "optimal" is something that infects a lot of economics, but you would think that if a service is so valuable the first question would be "why doesn't the market already provide this?" Instead Shiller's presumption that he is so smart.
|
