The Subprime Solution | Robert J. Shiller

Summary of: The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It
By: Robert J. Shiller

Introduction

The Subprime Solution: How Today’s Global Financial Crisis Happened, and What to Do about It by Robert J. Shiller delves into the United States’ subprime mortgage crisis and its profound global consequences. The book explores the factors that contributed to the crisis, addresses the loss of trust in social and economic systems, and attempts to identify common characteristics of speculative bubbles throughout history. Shifting the focus from just repairing financial institutions, the author provides solutions to regain trust and stability in the economic system. The introduction offers a glimpse into the origins, factors, and aftermath of the crisis, as well as potential remedies to prevent a similar event in the future.

The Harsh Reality of The Subprime Crisis.

The U.S. real-estate bubble that lasted for a decade culminated in the subprime mortgage crisis that sent shockwaves through the global economy. Its cause had far-reaching consequences that affected not only the financial system but the social fabric of society too. The aftermath of this crisis prompted a prolonged period of slow economic growth, akin to Mexico’s lost decade in the 1980s and Japan’s stagnation in the 1990s. The crisis also created distrust in the economic and social systems of the U.S. Many people lost trust in politicians, policymakers, pundits, and financiers in moments of assurances of continuous home and real-estate price increase. A lot of people lost their homes and savings, but more worrisome is that their trust and self-respect and trust in the system are gone too. Just like Germany after the Treaty of Versailles, events after this crisis continue to replicate themselves with people getting victimized by circumstances beyond their control. Threshold to this crisis is an understanding that speculative events are irrational responses to information, and trust in the system’s restoration is a much-needed premise for recovery.

The Subprime Bubble that No One Saw Coming

The U.S. subprime market’s real-estate bubble was one of the most crippling economic disasters of the modern era. Although financial analysts had studied speculative bubbles, no one was able to identify the 21-century real-estate bubble. Several factors contributed to the severity of the bubble, such as policies that encouraged home ownership for people who should not have owned homes, mortgage securitization that disconnected the mortgage originator and the recipient of payments, and financial engineering practices that led to extremely low-interest loans. The expansion of the real-estate bubble was due to the belief that real-estate prices would continue to rise. However, this faith overlooked historical market data, and the bubble continued to grow unchecked. Despite the economic fundamentals not supporting the bubble’s price rise, one factor was common to all bubbles – social contagion. The contagious ideas became “truth” because everyone accepted them as true. While investing in the expanding real-estate bubble made sense, the long-term effects of such a bubble were catastrophic.

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