Rebuilding Confidence in the Markets

Dr. Robert Shiller, who co-invented the S&P/Case-Shiller home price index and also foresaw a housing bust several years ago, argues in a New York Times piece that the best way to re-ignite confidence in the markets is to determine what worked best in the past:

THE key to maintaining economic stability is well-placed confidence in the markets. Bubbles, by contrast, result from misplaced confidence...

While a temporary tax cut and interest rate cuts are good ideas, they don’t address the underlying crisis of confidence. If these measures succeed merely in making people consume more, running to the malls and making the already-negative personal saving rate even more negative, they won’t restore faith in the financial markets.

One main response to the Depression that helped prevent another from occurring was a set of tools that improved confidence by truly improving market security. One of these was the Federal Deposit Insurance Corporation, in 1933, but there were also a large number of others, especially the Securities and Exchange Commission the next year.

These were not obvious innovations and, in fact, were highly controversial at the time. Indeed, it is never obvious how the government should foster well-functioning markets. The fundamental role of governments in promoting markets is clear, but the design of their instruments must make creative use of a great deal of information about financial theory, human psychology and existing institutions and practices. The successful markets we have are a result of considerable inventive effort...

We need such inventive effort today. It won’t be easy, but the first step would be to set up a national study commission and to pay for serious creative research on how to adapt important ideas, like deposit insurance and securities regulation, to a modern financial world.