Finance and the Good Society

March 26, 2012


JOANNE MYERS: Good morning. I'm Joanne Myers, and on behalf of the Carnegie Council I'd like to thank you all for joining us.

It gives me great pleasure to welcome Robert Shiller to our Public Affairs Programs. For many years now, Professor Shiller has been teaching, thinking, and writing about economic issues, and it is through his skillfully written commentaries that he has become known as one of the most prescient political economists of our time.

Given the pervasive discontent with the financial system and the perception that those working in finance are largely irresponsible, it's not surprising that Professor Shiller would be motivated to write a book that eloquently articulates the economic issues that we should be thinking about, especially in the aftermath of one of the most devastating financial crises in recent times.

Although the economy has somewhat improved in the last few weeks, the 99 percent are still expressing grievances towards the 1 percent and blaming ineffectual government policies for many of our problems. Amidst this discontent, Professor Shiller argues that "instead of condemning finance, we need to reclaim it for the common good."

Accordingly, in Finance and the Good Society, our sagacious speaker makes a powerful case for recognizing that finance should be defined, not merely as a manipulation of money or the management of risk, but as the stewardship of society's assets. In other words, far from being a parasite on society, finance is one of the strongest tools we have for solving our common troubles.

Professor Shiller tells us that finance has historically contributed to the good of society and cites CEOs, investment managers, lawyers, and regulators, along with financial inventions, such as insurance, savings accounts, and pensions, to show that finance has not been the problem but a solution to many of society's needs. He believes that we can be creative once again, and devise new inventions that will positively shape the future.

In 2000, Professor Shiller said the dot-coms would go bust, and Internet entrepreneurs scoffed. A few years later, he said the housing boom would cause a recession, and mortgage lenders downplayed his remarks.

Looking back, one thing has been made quite clear: when it comes to market dynamics, perhaps we should never turn a deaf ear to anything Professor Shiller might say. Instead, we should be listening carefully to his penetrating insights about finance, especially when he talks about human factors that drive the economy, as this will help us to gain our confidence in the market once again.

Having made so many landmark contributions in the past, I know that with this morning's presentation Professor Shiller will inspire us to think about finance in a very constructive way.

To begin, please join me in giving a warm welcome to our guest today.

Professor Shiller, it's a privilege to have you with us.


ROBERT SHILLER: Thank you very much.

I'll talk for about a half hour and we'll have questions. I am speaking about a controversial topic, which is about finance in our society.

The title of my book, Finance and the Good Society sounds like an oxymoron. They are inconsistent it seems. But that was the intent of this title; I wanted to draw out the fact that maybe they aren't contradictory.

I've been teaching undergraduate finance at Yale for 25 years. I've gotten a little bit of discomfort about that. I said to one reporter that "I feel a little bit like an ROTC [Reserve Officers' Training Corps] instructor." Remember back during Vietnam, when ROTC students would take off their uniforms before walking across campus? So it's the same thing, "What are you doing training young people to go into finance?" That was part of the motivation.

My course, by the way, is free. You can take my course. It's online. Yale has recorded all of the lectures. We are coming up with a new version. It's on Open Yale []. The new version will come out in April, which is built around this book. It's sort of supplementary reading for a finance course.

I thought, since I'm at the Carnegie Council, I would mention that Andrew Carnegie figures well in my course and in my book. So maybe I'll start out talking about Andrew Carnegie.

Andrew Carnegie wrote an article in, I think it was, the North American Review, in 1889 called "Wealth." It was about attitudes toward wealth in our society. The final paragraph of the article said: "This is my gospel of wealth, that people who make money should use it for society. They should give it away while they're still alive." Later that year, the article was republished in London with the new title "The Gospel of Wealth." It has been reverberating ever since.

It created a lot of hostility—"The arrogance of this man!" But what he was saying—this view will never be really popular, but the view that he expressed was that some people are talented in what he called "affairs." What that used to mean in the 19th century was business or management. You know, some people just are always thinking, "How can I get things done? People aren't managing this right. I want to fix that. Let me take hold and I'll fix it."

He said that kind of mentality tends to acquire wealth, and people with that mentality should have a moral purpose. They recognize that they have a god-given talent; they have acquired all this money. The dumbest thing to do would be to leave it to your children because they may be above average, but they're not you.

So he then in his life at—what age did he retire? It was 55 or—relatively early—and he devoted the rest of his life to giving away his fortune. The Carnegie Council is one of the things that he supported.

But if you go to Open Yale and look at my reading list online, I have a recording, a podcast, of Andrew Carnegie. This is maybe the oldest podcast on the web. You can search for it. It's Andrew Carnegie describing what I just told you, the gospel of wealth.

The story of that is Thomas Edison wanted to record the voices of the great men and women—I assume women; maybe it was just men—of his time for posterity. Thomas Edison was at that point trying to invent the sound movie. So he got Andrew Carnegie in his studio and he said, "We're making a sound movie of you explaining your theory." It went on for like five minutes.

Thomas Edison was never successful in making a sound movie, or at least it's lost. All we have is the soundtrack. It's the only recording of Andrew Carnegie that survives.

So anyway, the motivation here is described by what Catherine Rampell wrote about in The New York Times a few months ago. She did a poll of some elite colleges and asked them to give statistics on where their graduates went.

Just before this crisis, about 25 percent of graduating seniors were going into financial services. The record was Princeton University in 2006 with 46 percent of the students. Some people think that's a moral issue—everyone's going after the money, right, and what about science or education or the arts and other things? Have we lost our purpose?

We live in a world of financial capitalism where things are done on a great scale by financial technology. This technology is so important that it warrants—I don't know if we need 25 percent; maybe that's too much—but it does warrant young people who are idealistic and want to serve the world to go into.

I don't know necessarily going into finance—what does that mean? That sounds like you're going to be a math finance type. I mean going into public service of the sort that understands the importance of financing activities, that activities that are important usually require the cooperation of many people, and that means we have to finance the activities.

I give a number of examples of people who we think of as idealists and reflect on how they financed what they did.

Henry David Thoreau—what do you think of him? Was he like a hippie who dropped out? Well, as a matter of fact he came from a wealthy family who had a pencil business, a manufacturing business. He went to Harvard. He met lots of people who inspired him in literature and philosophy. He took two years off to write a book, financed I suppose by his parents—I don't know all those details—and then he went back to the pencil business. I don't mean to diminish him in any way. But what I'm saying is he was not dropping out of society.

Now we have this Occupy Wall Street movement, which seems to suggest a sort of dropping out. That's not what I think we should be doing. Instead of Occupy Wall Street, I'm going to say we should democratize Wall Street in reaction to these people's thinking.

Now, the theme of the book is that there has been a process of democratization of finance that has been going on for hundreds of years actually. This process is continuing and will move forward.

This crisis that we saw that began in 2007 is upsetting, but it's like many other financial crises. It's a particularly bad one, but I don't think that it will be remembered that strongly in 20 years. We will be moving ahead, hopefully, if we do things right.

The financial crisis was not due to some fundamental problem with financial capitalism. It was due to certain flaws that we can fix. The whole history of capitalism is a sequence of fixes of problems and efforts to make the financial technology more pervasive.

What financial technology does is it clarifies ownership rights. It divides ownership into shares so that many people can participate in enterprise. It emphasizes employee incentives so that we put people on a task and we try to focus them on the right thing. It emphasizes risk management, that the future is inherently unknown and there's no way really to quantify it. It's intuitive. We have to make judgments that are ultimately intuitive about what we are going to do. It will be involved in our fortunes and things that matter deeply to us. So risk management is part of the technology.

But anytime you do risk management, you have potential problems. So we had a systemic problem that led to like a house of cards collapse, and now we are working on it.

We have the Dodd-Frank Act, which sets up a Financial Stability Oversight Council and a new resolution procedure. I don't know that this is it. It might not work. But we'll try something else if this doesn't work and we'll move ahead.

Another major source of the problem was the housing bubble that occurred and the failure of people to prepare themselves for that eventuality. So we got into a situation in which home prices were rising rapidly and we thought that they would only go up. People were burning their bridges behind them in terms of taking on real estate risk.

The conventional wisdom began to be that you recommended to everyone that they take a highly leveraged, undiversified, risky investment in a home in one city. Then, you've got to know that if home prices ever fell, they're wiped out. That's what leverage does. It makes you rich on the way up and it wipes you out on the way down.

It's amazing to me that it wasn't talked about more that home prices could fall. I was trying to talk about it. But even I felt kind of limited, like, "There must be something everybody else knows that I don't. I don't understand why they can't fall after they've been going up so much." But other people seemed to speak with such assurance that it can't happen, like,"Are you naive or something? Home prices never fall." I don't remember the economic theory that would justify that position.

And I know they did fall in the Great Depression. And people would say: "The Great Depression, what's does that matter—that was 70 years ago." But it happened.

It seems like we are subject to certain problems. But what to do about these problems?

In my book I give an analogy. I fear that I'll come across as an apologist for the rich. When we have Occupy Wall Street talking about the 99 percent, I don't want to do that. But it seems to me that Occupy Wall Street needs to think about what we actually do to correct the problems that they're aware of.

A lot of people think we should be throwing more people in jail who were involved in issuing mortgages or mortgage securities or ratings. Maybe there are some people who ought to go to jail but not very many, it seems to me.

The analogy that I describe in my book was this: What do we do about driving too fast on highways? Everyone goes 10 miles an hour over the speed limit. What do we do about that? We could send out traffic cops and just arrest everyone and send them to jail. But that seems a little excessive because—probably most of you have done this too—everybody else is doing it. You kind of want to keep up with the flow. It just seems maybe we are going too fast, but what do we do about that?

It seems to me that the solution isn't throwing people in jail; it's moving ahead with our regulations and our systems.

So I'm thinking of an analogy with automobiles. We have these elaborate cruise-control systems on new cars. We have feedback systems—have you see those signs that flash, "Your speed, 68 miles an hour," and then if it's too fast it says, "You're driving too fast"? It's systems like that in our modern technology system that we should be thinking about. And we're moving toward driver-less cars eventually.

That's what we want. We want to get people so that they have a system that encourages good behavior.

This is also related to what we call behavioral finance, something that I have been involved in for over 20 years, which is the application of psychology and other social sciences to finance.

Part of the reason we got into this crisis is we had this idea that people are rational and that markets are efficient. Well, people are often rational, but not always rational, and there are certain characteristic human errors that are coming up. But if we understand them better, we can devise a better system.

The second part of my talk: The theme of the book is that financial capitalism is a process, it is always changing, and it is improving, that we learn from our mistakes and new things are likely to happen. I wanted to talk about what new things are on the horizon, or that I imagine will come. Let me start with things that have already started to happen that you may not be fully aware of.

Let me start with the benefit corporation. The first benefit corporation was created in the state of Maryland in 2010. That's less than two years ago. So this is brand new. It is now adopted by eight U.S. states. New York was the most recent to adopt it.

What this is is a change in corporate law that allows a new kind of corporation. When you're setting up a company, you can set it up the old way, as always, that's an option. But there is a new option: you can decide that your for-profit company will be a benefit corporation.

What that means is that when you found the company you write into your charter some additional purpose for the company beyond making profits. So you are giving a dual mandate to your board and to the president of the company. The dual mandate is: (a) make profits for the shareholders; and (b) that's what you fill in when you set up the company.

So it's a little bit European. In fact, you might say that every German corporation is a benefit corporation with a state-imposed purpose, which is to be good to labor. The German law says that every company has to have representatives of essentially labor unions on their board.

But the U.S. law doesn't say that. It says: "We're not going to say what the purpose is. Any purpose—it's up to you."

What I like about this is that it changes the whole sense or mood of a company. That is, now the company has some idealistic purpose.

Also it changes the legal framework. Often lawyers report that boards are wary of doing something for the community or for labor or backing down to labor unions because they could get a shareholder revolt or a lawsuit. So let's make it clear with a dual mandate.

Now, economic theorists say,"That's fuzzy. Now you've given them two goals. How do they weigh them? So it's going to diminish the effectiveness of the corporation."

Well, I think it's an experiment, like Wikipedia was an experiment. When they set up Wikipedia and they had all these different authors contributing to one encyclopedia, it was going to produce crazy stuff, right? You might think so. But it worked out well. So this is another experiment.

I'm betting on this experiment. I think these will make more profits than the other. It depends on how they do it. It's a social experiment. We'll have to see.

Let me move to another thing that has just come up, which is the new jobs bill in Congress, which, among other things, is facilitating crowd funding.

There are a number of websites now that encourage little individuals to participate in capitalist enterprises. One of them is called That allows you to make small loans to poor people in developing countries.

Another one is called That allows you to participate in creative projects as an investor—movies or novels—and it gets millions of people each contributing a small amount of money.

So I think our Congress is not as dysfunctional as it seems. Both Republicans and Democrats are together on this, and Obama says he'll sign it. It has passed both houses. It has to be reconciled.

Let me move on, though. These are things that are already happening. Let me move on to some other ideas that I talk about in my book.

I have a new kind of nonprofit. A benefit corporation is a for-profit. I'd like to rethink nonprofits as well—say, a nonprofit that runs a school, a college, a hospital, something like that. They're an important part of our economy right now.

I would like to see a nonprofit that sells shares. Investors can invest in the nonprofit. But there's two stipulations: one is they get a tax deduction, as always, it's a charitable gift; but the other stipulation is you get dividends but you can only spend them on charity. Maybe there could be some special circumstances, like a medical emergency, where you could get it back. But do you understand what I'm saying?

What I don't like about philanthropy today is that it seems like it's just giving it away; you give away a sum of money and it's gone. I don't think it's that fulfilling. In fact, it seems like you get manipulated. The university takes your money and names a building after you. That doesn't seem that rewarding to me.

Part of what we learned with the experience of the stock market—when they created in New York State the 1811 Securities Law, they created an ability for anyone to set up a corporation and they created a situation in which all the investors have limited liability.

So it took away the fear that people used to have. They used to say, "Don't invest in stocks unless you know that company, because if they do something wrong, you will go to jail because you are an investor."

So New York said, "Not to worry. The most you can lose is the money you put up."

This created a whole array of maybe wild investments, but it produced excitement and it produced New York as we know it now.

I think the same thing would happen with a participation nonprofit. You would be involved as a donor.

And you know what else it would do? It would take the money out when the nonprofit is ineffective. If the nonprofit is paying dividends to you and you like what they are doing, you reinvest it in the company. If you don't like it, you take it somewhere else.

Anyway, I have a number of ideas like that. I'm running short on time. Let me mention a couple of other of the ideas.

One of them is what I call a continuous workout mortgage. This would be a mortgage with a preplanned workout, so that if home prices fall you automatically have relief on your mortgage—continuously too.

The system we have now, no one designed this for a crisis like this. The situation now is if home prices fall, you are under water, you can't move, you can't take another job because you can't pay off your mortgage. Then what do you do? You apply for a workout. You probably don't get it. They leave you in doubt. And then maybe they give you a workout, and then it turns out home prices fall even further and you need another workout. It's just not a responsive system. So let's just plan to have a workout built in.

Another idea is—actually this is an idea that we've made happen at a low level—hedging markets for real estate risk. We created at the Chicago Mercantile Exchange, Chip Case and my colleagues, a futures market for single-family homes. And on April 2, they are launching an options market. These things have not succeeded yet. But ideally we'd have risk markets for real estate that would provide price discovery, that would provide a hedging mechanism, that would allow people to issue things like continuous workout mortgages.

Another idea in the book is "Trill." That's a name that my colleague Mark Kamstra in Canada thought for a product that I had been sort of talking about even earlier.

The idea is the government should use more sophisticated financing for its operations. Right now the government relies exclusively on debt. In fact, every government in the world does this. That puts the government in a leveraged position. If you borrow a lot of money and then whatever source of income you have goes down, you're in trouble. That's the elementary problem with leverage.

So why do governments leverage themselves so much? It's an interesting question. I have a chapter in the book about how conventionality plays a role in our thinking. It's just conventional that governments issue only debt. But why don't they issue shares? This is the idea.

So you can buy one Trill, which would be one-trillionth of the U.S. economy. The government in its new borrowing would issue these.

Right now the GDP [gross domestic product] is about $14.5 trillion. So your dividend this year would be $14.50 on one share. What would that share be worth? That's the question. We have to find out in the market.

I'd bet a lot of people would like to buy a share in America. It would be a lively market. And if we did that—if Greece had done that—and by the way, I think maybe we should have leveraged versions. I can get into all sorts of things.

If Greece had issued 5:1 leveraged Trills, it wouldn't have had a crisis, because the decline in its GDP would have reduced its debt. It wouldn't be going now begging for bailouts. It would be all part of a market. There would be a plan.

Anyway, let me just give what is perhaps my most controversial proposal here. I call it inequality indexation of the tax system.

We should index the tax system to prevent massive future increases in inequality. The Occupy Wall Street people are complaining that the top 1 percent have seen their real incomes rise about 60 percent from 1990 while the other 99 percent have seen a decline. So it is getting more unequal.

Is this because the top 1 percent are getting smarter or they are getting more hard-working or anything like that? No, I don't think it has anything to do with that. It's some obscure economic forces. So why don't we make a plan now to prevent that from happening in the future; in other words, prevent it from getting a lot worse?

I am worried that this Occupy Wall Street movement is only the beginning, that the income inequality that we've seen is only the beginning of more serious inequality in the future.

With computers and high-tech Internet, I've even replaced myself. I have put my online course up, and now I could be out of a job because Yale doesn't need me anymore, except to update my course, because it's online and it's available for free.

I'm using myself as an example, but I don't know where this world is going with our information technology. My young people are wondering: What kind of career should I go into?

I could say, "Learn foreign languages really well and be a translator." But how do we know that in 10 or 20 years we won't have computers that do it better than you can? I'm not answering that question, but I'm saying this is what worries people.

The proposal that I have is let's decide now that we will increase taxes on the rich if they get a lot richer, to kind of target the amount, put a maximum on the level of inequality.

The psychologist [Yaacov] Trope talks about temporal construal theory. This is behavioral finance. People, when asked questions about morals, give more idealistic answers if the question is phrased as a question about the future 10 or 20 years from now, and people are real idealists. But if you ask about right now, they're not. So let's do it, let's make a plan for the future.

This was written up recently also independently by Aaron Edlin and Ian Ayres in a December New York Times op-ed piece. They called it "the Brandeis tax." It's the same idea. I don't know why they named it after Louis Brandeis. The idea they said is: Let's just decide on a limit to what percent of the national income can the top 1 percent earn. Let's decide. It could be well above what it is now, we can let things get worse for awhile, but let's then just decide that there's an automatic tax increase that kicks in then. So that's the idea.

I will conclude.

Let me just say that I don't want to be apologizing for the rich here. I think there are good people and bad people in all walks of life. But I don't want to be moralizing in the sense that I want to crack down. I think that we have to recognize that our society functions by creating the right incentives for getting people to do things in a moral and constructive way. That's a system design problem, and that's what we should be focusing on.

Questions and Answers

JOANNE MYERS: Thank you. I would like to say I don't think technology will ever replace creative thinking. So I thank you for your ideas.

QUESTION: Rob, two quick questions. One: all the Tea Party people have read or heard of Adam Smith's Wealth of Nations. What percentage of them have heard or read his The Theory of Moral Sentiments? Wouldn't his The Theory of Moral Sentiments be a welcome addition to all the reading lists you mentioned?

Second, my real question is: What can be done to restore the confidence of the public in a financial sector that can legally sell short the same defective financial instruments that they were peddling to their clients? How do you restore the confidence? I have a friend who refers to everybody in Wall Street as "unindicted coconspirators." That's a bit harsh. But how do you restore the confidence of the public in a firm that can go short exactly what they are selling someone else? Is that a fair question?

ROBERT SHILLER: That's a good question.

I'll take your second question first. This reminds me of Greg Smith's New York Times editorial. You seem to be referring to Goldman Sachs when you say that and what seems to be double-dealing behavior.

I'm not going to apologize for them, although I might just point out that some companies have Chinese walls between two different divisions, that they may not be communicating with each other and they may do opposite things. The company is comprised of many different people, some who have one opinion and some who have another opinion.

I don't know the situation about this abacus case that you're referring to closely enough. But that's not the point. The point is: What is Goldman Sachs as an institution and what can it be if there are problems that have surfaced?

Now, a lot of people have admired Goldman Sachs over the years. Charles Ellis, who is on the Yale Corporation, wrote a book called The Partnership about it recently.

Another book I recommend—it's kind of interesting—was written by John Whitehead, who was the chairman at Goldman Sachs during its transformation. He wrote a book called A Life in Leadership, which I think is pretty good, talking about his philosophy.

When I look at Whitehead—now, I don't know him personally, but reading his book—I don't get this double-dealing. I can't imagine that that's his story.

One thing that he emphasized is that he put forth a code of principles for Goldman employees. The first item on his thing was, "Your loyalty is to your client." He made it as strong as possible that you serve your client—"Don't worry about making money. If you serve your client, the money will come."

He had a nice story about the fact that over his life he has been repeatedly put in leadership positions that he never even asked for. Starting from D-Day on Normandy in 1944, when he was just a young soldier, they put him as a commander of one of those little landing boats. An awful moment. He said, "Why did they put me? Maybe it's because I have this take-charge, get-the-job-done mentality." So I think he conveyed that to the firm.

But there's another side to it. If you read The Partnership by Ellis, they are really focused on making money. He wasn't interested in fame or he wasn't going to write a book. That's why Goldman is so successful, because if you focus on making money, maybe you will make it happen.

So maybe there was something a little bit limited about them, but I don't think that they're evil. I think it's a remarkable institution that has in the past contributed to our prosperity and can in the future.

Whitehead is not in charge. I think that corporations develop a culture and leadership matters a lot in the culture. Then the leadership changes and they have to somehow re-invigorate that culture. Maybe Goldman is in need of that.

JOANNE MYERS: Did you want to address The Theory of Moral Sentiments question?

ROBERT SHILLER: The other thing about Adam Smith, yes. Adam Smith wrote The Theory of Moral Sentiments in 1759, and then he came out with multiple editions of it. He only wrote one Wealth of Nations, one edition of that. I think Adam Smith thought The Theory of Moral Sentiments was his greater book.

I recently spoke to Paul Bloom, who is an eminent psychologist, and he said, "I just read The Theory of Moral Sentiments. As a psychologist I have to say it's really interesting."

It's really a book about psychology written before any of these psychologists you've ever heard of. How can it still be interesting? I find it amazing. But it says something about the talent that Adam Smith had, or the judgment that he had.

But the thing that I remember most from The Theory of Moral Sentiments is his discussion of what he calls desire for praiseworthiness. Now, he said that one of the things that is most striking about all people is they love praise. It doesn't matter—you may expect a different kind of praise. So you might be wanting to be praised as a good grandmother or something like that, but you would just crave the praise of other people.

But then, he said, mature people pass beyond that into a period in which they desire to be praiseworthy. He said: "Suppose you were praised for something you didn't do? Maybe it was a mistake. And imagine that you also know that nobody will ever find out that you didn't do it; they think you did it. Would you feel good about yourself?" He says a mature person wouldn't; you want to be praised for something genuine that you did.

He also reflects on his mathematician friends. He says: "Mathematicians are totally unknown by the public because what they do is so rarefied the public has no idea. But mathematicians develop a sense that: I'm going to do good mathematics, and my sense of praiseworthiness is heightened by my own personal knowledge."

And then Adam Smith said: "This human characteristic is what makes"—he didn't call it capitalism—"makes our economy work. It's this internal drive to do well that even motivates business people as much as mathematicians and others."

So I think it's a very important book.

QUESTION: Don Simmons.

I'm interested in your idea to make a security out of real estate prices. Where there are securities, there can be derivatives. I wonder if you think that individual homeowners might benefit from being able to hedge against the fall in the price of their houses, let's say with a derivative security?

ROBERT SHILLER: Well, we made that possible in 2006. But almost no one does it. I don't know why we failed.

We have these individual city—there's a New York City futures market right now but almost no trade.

But there's a problem with liquidity in any financial markets. I asked big-time money managers, "Did you think about trading in our futures market?"

They said, "Oh yes, we looked at it, but we saw there was no trade so we didn't. I'll look again next year." When there's no trade in a market you despair of being able to do anything. I mean you can trade one contract or five contracts, but you can't trade much. So that's a problem.

It's funny about how people think. The public has to come around to thinking.

In the UK, they have these spread-betting markets. They're considered a form of gambling. They bet mostly on sports, but they also bet on presidential elections and things like that. They have had betting on home prices. So there was a market. It was like a futures market for London home prices.

I wondered how many people are hedging their homes in London. So I called up the firm. It wasn't Intrade. Anyway, there's a number of these firms in London.

I said, "I'd like to speak to the guy who does the real estate spread betting." I said, "Do you know, do people hedge their home price risk?"

He said, "Oh, you know, we don't even talk about that. It's gambling."

I said, "Why?"

He said, "People love to gamble. Yes, they'll place a bet. But hedging, they don't think that way."

That's where we are. And nobody hedged, and they still don't hedge. So there's something about—we understand certain kinds of risks but not others.

That's why we need behavioral finance, because people are not just thorough-goingly rational. These economics models that have people doing all these calculations—I just don't believe them for a minute.

People are very smart when you get their attention on something. But most of the things that impinge on our lives we're just not paying attention to.

QUESTION: Ron Berenbeim.

Sitting here listening to you speak about the interchangeability of economic and political issues and the importance of finance in a transition, I was interested in knowing whether you thought someone with significant successful experience in the world of finance would be uniquely qualified to be president.

ROBERT SHILLER: To be president? Is there any example in any country? [Laughter]

QUESTIONER: I can't think of one offhand, but maybe you can. That's your field.

ROBERT SHILLER: That's actually a very stimulating question. I hadn't thought of that.

JOANNE MYERS: The prime minister of Italy is.

ROBERT SHILLER: The prime minister of Italy, Mario Monti, was a Yale Ph.D.

JOANNE MYERS: Well, there you go.

QUESTIONER: Excuse me. I said president. I didn't say parliamentary leader, I said president of the United States.

ROBERT SHILLER: Maybe Andrew Carnegie should have been president. [Laughter]

JOANNE MYERS: He was foreign-born.

ROBERT SHILLER: He was foreign-born. He wouldn't qualify. [Laughter]

But it's funny. There has only been one professor who ever became president too, Woodrow Wilson. So it seems like it's our conventionality. We think that there's a certain path to the presidency, which is usually governor. That's why Sarah Palin was picked, because she was a governor of a state. That looks more impressive to voters apparently than any of a number of other—someone like Bloomberg, for example, could he be president?

You know, Romney, that would be the one, that would be the first one. [Laughter] So maybe that's what we'll get.

I have lots of opinions about him. But one of his pluses is that he ran a successful venture capital firm. That's a major plus for him. So I think someone in that walk of life could be a good president.

I'm just wondering why it didn't happen yet. It's strange, isn't it?

Henry Ford was running for president, unsuccessfully. Maybe they can't talk the talk. In order to be president, you have to have a certain public speaking flair.

QUESTION: This has really been stimulating, to see somebody with so many off-the-wall ideas. [Laughter]

ROBERT SHILLER: I tell my students, "Don't be afraid to be off-the-wall, to try to do that."

QUESTIONER: Let's talk a little reality. Do you think any of these proposals that you've come up with in your book have a flying chance of being adopted in the Congress, given the dysfunctionality of the political system at this point? There's an endless debate about whether you can get any reform of any kind until you reform the political system.

ROBERT SHILLER: Well, first of all, I didn't say that this book was for Americans. I think that we live in a world that is becoming increasingly unified. I'm speaking at the Social Market Foundation in London in a month. I would hope that the UK government would adopt—

I don't care what country adopts any of these ideas. Once an idea is tried in one country, if it's a success, it acquires a legitimacy. The whole history of innovation within governments is a history of some government somewhere in the world trying something and then being ridiculed all over the world. But then it works and then it's copied. So I don't necessarily have to have it start in the United States.

I'm also thinking for the long term. We have a Congress which appears dysfunctional, but we'll just vote them out.

And anyway, I mentioned the jobs bill. That's a bipartisan thing. They are getting together. They are aware of the public anger and we are seeing a less dysfunctional Congress now.

QUESTION: John Richardson.

If you put aside the fantasy of Downton Abbey and look at the world before stocks and bonds were what they are now, it was about land, it was about owning land, and people who had had retainers and tenant farmers and the peasants, and the literature and the history usually is pretty uniformly critical of that, at least from the point of view of that sort of relationship because the poor end of the scale got squeezed. They didn't necessarily in Downton Abbey, but that's what the literature and the history says.

Now, isn't it worse today because we have a huge population, and an educational gap that is growing, it seems to me? It's probably very boring to be a biotech researcher for 25 years. It's much more fun to be an investment banker. Don't we have a strange world where in fact the inequalities are just built-in and cannot be—the educational inequalities to start with?

ROBERT SHILLER: Your question raises a lot of issues that I don't know that I can answer.

First of all, I have students who take my course and then go and do biotech. So I'm not telling them not to do that.

It seems, though, that—one thing I comment on in the book—if you look at the Forbes 400 list of the 400 richest Americans and you read them, there is no eminent scientist, there is no great writer, although someone wrote to me there is one eminent mathematician apparently, according to the email I got.

Scientists rarely get rich. I think it's kind of a puzzle. Wouldn't you think that some scientist would come up with some discovery and then patent it and then have huge wealth? I can't think of any example of that happening.

William Shockley invented the transistor in the 1950s in Bell Telephone Labs. It was Alexander Graham Bell, probably a friend of Carnegie, who set up a lab where scientists would have free rein to do their own research. Didn't pay them very much. So Shockley, who invented this amazing invention that makes all of this electronics that we're using possible, never got rich.

But on the other side of it, what's the problem with that? I encourage students to go into science and engineering. I think they are great fields.

What I'm saying in my finance class is merely that: "Finance is part of engineering, and I want you to understand it, and I want you to have the facility to develop ideas so that you're not naïve about them."

But I don't know what real problems you are pointing out that we can't fix in the future.

QUESTION: Susan Gitelson.

You cannot be replaced by a television film of yourself because of the need for Socratic dialogue, this interaction we're having here or that you have with your students.


QUESTIONER: On dealing with controlling the enormous inequalities, you mentioned the Europeans. European corporations do not pay the same kind of high salaries that are such a great multiple of workers' salaries. Why can't there be some way to bring down the salaries of the richest people and the bonuses which we see happening?

The other thing is, why not deal more with tax policy now, perhaps with a surtax on the very rich or whatever, and greater controls of how much they can put in offshore funds and all that?

ROBERT SHILLER: First of all, I'd support the idea of raising taxes on the top 1 percent now. That was in Obama's jobs plan. I didn't think it was possible. So I'm thinking that maybe something else is possible.

The other thing, about European salaries being lower than ours, there are many issues here. One of them is I think to some extent the high inequality that we see among executive salaries in the United States reflects—this might anger you—some kind of increasing enlightenment about differences in usefulness of people, that sometimes people have established themselves as managers, who are "skilled in affairs" as Carnegie said, and a company wants them.

So picture this. You are someone who managed a company very well. That means you have the people skills, you have the ability to judge the situation. Another company is big and it's failing, a multibillion-dollar company; it's big and something's wrong.

So the board comes to you and says: "We had a meeting. We would like you to take over the corporation."

Then you say, "I'm sorry, I've been working for so many years, my wife says it's time for me to retire and relax. I can't do it."

So then you come back with another offer. And hey, what's $100 million to a company like that? I can see that happening. I think that in more traditional economies that kind of thing would not happen, just because of some fairness or some idea that it's outrageous. So that's the good side of it.

The bad side of it, though, is—and this is something that Lucian Bebchuk at Harvard Law has written about—in the United States that kind of increased enlightenment has also opened the door for certain kinds of conspiracy.

So here's the conspiracy: now that we Americans know that some person is really wanted by a corporation because of his or her past managerial successes, now we as a board can rip off our shareholders.

The way we do that is we just vote a huge salary to the guy who's our friend and we say, "He's absolutely necessary, he's a genius, we pay him this huge salary." The shareholders kind of don't know what to make of it. They think, "Maybe they're right."

But it's really a ripoff because "We just give this guy $100 million, and we can't get anything back from him directly, but you know eventually we'll get paid back for being nice to him." It's a conspiracy. That's what we have to watch out about. It's a little bit hard to get things right.

So Sarbanes-Oxley tried to fix that by putting in a requirement that compensation boards have outside directors. That didn't fix it. We can think further. But changes in the structure might help deal with that.

QUESTION: George Paik.

I read the book and I've had a chance to reflect a little bit on the benefit corporation. You particularly did mention people are saying, "Well, you're giving two objectives." It occurs to me, though—and I'm wondering about this analogy—it occurs to me that we have for decades been analyzing risk against monetary returns for decades. I wonder how fair that is to say that we have been managing two objectives already in general.

I wonder if the analogy is too far, because if you look at various things that have started—from socially responsible investing, to philanthropy and whatnot—there are impulses to pursue other objectives with deployment of your capital. I wonder if there is the chance for a similar type of, if you will, industry surrounding that kind of configuration or what it would take or what hasn't happened?

ROBERT SHILLER: There's an interesting parallel which I had never thought of. But it seems like until Markowitz wrote in the early 1950s, nobody was clear on the idea that there is a tradeoff between risk and expected return. So investment companies would advertise their historical return, but they wouldn't bother to mention what risks they took.

That is so stupid. How could people not understand? To me it seems so stupid. You know that companies can just take big risks and that some of them will succeed and then the ones that will succeed will advertise they made big returns. But it's not going to happen going forward.

So what is the optimal thing to do in investing? What do you look at?

Markowitz wrote—it just seems so obvious in retrospect—in this famous article that there's a tradeoff: you could have a lot of return for a lot of risk or you can have safety and less return. So then he draws this curve, and then you have to pick a point on that curve.

So that's how you handle dual mandates. Maybe you could even specify the weights you give to the two mandates, or maybe you leave that to the judgment of—but with a benefit corporation, these things are not entirely quantifiable, so you can't specify the weights.

JOANNE MYERS: Having you speak today, little risk, big return. So thank you very much for being with us.

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