Wolf, Shiller Predict the Future at Levin
On October 29, 2009 Martin Wolf, the Chief Financial Commentator of the Financial Times, and Robert Shiller, the Arthur M. Okun Professor of Economics at Yale University, had a spirited breakfast discussion on “The Future of Investing” at The Levin Institute, at an event co-hosted by Levin and the Financial Times and moderated by Levin’s President Garrick Utley. The discussion was prompted by the FT’s recent series on the same topic.
Both Messrs. Wolf and Shiller have a reputation as knowledgeable and iconoclastic thinkers about economics and finance, and their breakfast engagement exemplified this. Mr. Wolf began by noting that the last time he spoke at Levin, in February, the financial world was in crisis, and there were three possible outcomes: The end of the world, the end of the world as we know it, and muddling through. What’s the likely outcome now?
Prof. Shiller, who had predicted the bubbles in stocks (in 2000) and housing (2006), thought there was good news and bad news—as cause for optimism, governments had prevented a 1933-type disaster by stimulus packages and bailouts, but there is still no return to normalcy, which could take some time. Mr. Wolf referred to Prof. Shiller as a Keynesian, which used to be rare but “now everyone is;” Mr. Wolf thought the last forty years of economic thinking had been rendered irrelevant by the crisis. In response, Prof. Shiller noted that economic thinking tended to run herd-like in the same direction, and that an overly quantitative approach with reliance on mathematical models was wrong and didn’t take into account the human side of the equation—this, from the author of the recent book “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.” 
Several proposals to prevent future catastrophes were discussed, including the creation of a new Financial Services Oversight Council to address systemic vulnerability, the possible return of a Glass-Steagal separation of commercial and investment banking, higher capital requirements, and better control of securitization. But Prof. Shiller said that the fundamental problem was the failure to manage risk, and that would not be addressed by just splitting up banks; Mr. Wolf said that banks were retaining earnings instead of lending, and that much capital would be required to replace the securitization market.
Regarding the current situation, Mr. Wolf noted that there had been a quicker turnaround than he had expected last spring, but consumers were still in debt and had seen their net worth decline, Western governments were running big fiscal deficits, yet money was still cheap, and it would be difficult to withdraw fiscal stimulus. Prof. Shiller added that Keynes had noted that long-term expectations were important, and they are badly damaged in times like these; World War II was an example, no depression followed it although one preceded it because the war changed people’s mindset and expectations.
Mr. Wolf commented that solutions should focus on both the micro and macro: For individual institutions, make them better, “too good to fail,” and systemically, ensure the system is immune from individual institutional failure. Mr. Shiller said that in fact we have experience in addressing systemic failure but certain solutions like capital requirements aren’t necessarily the answer; for example, the Basle rules didn’t work. One possibility would be a new instrument, regulatory convertible debt, which would convert to equity when the regulators declared a systemic crisis. 
In response to a question from the audience, Mr. Wolf suggested there be capital requirements for non-bank companies too, like insurance companies, citing the example of AIG.
Regarding the topic question, the future of investing, both speakers said that the equity market is probably a bit above fair value, but not unduly so, and both touted diversification and investing in emerging markets where the future growth will be, not just from external investors, but internally as well; there is a shift of wealth to the East.
Regarding the future of capitalism, and the “choice” between the Anglo and European models, Mr. Shiller noted that the U.S.’s longstanding commitment to free enterprise would not be changed by the crisis, and Mr. Wolf noted that all countries had experienced crisis so no one model was clearly better than others. He predicted more regulation in the future, and noted that while free markets would continue, it is always the case that governments will rescue their financial sectors if they get in significant trouble.
So to answer the question he put in February: We will muddle through.