The winner from last week’s drawing for Working Longer is Chris.  There were only 5 entries last week, so come on peopel!   I also want to remind readers that I am giving away 3 copies of Turbotax by subscribing to my blog.  You have to email me the secret word.  You get 3 chances to win, since I change the secret word every week.  The drawing will occur 1/25/09.  So good luck!

This week however, I’m reviewing the book “The Subprime Solution” by Professor Robert Shiller. His previous book was about the stock bubble of the 1990s “Irrational Exuberance”. This time however he’s decided to tackle the housing bubble of the 21st century. Again I’ll be giving away the book to one lucky reader, so leave a comment and I’ll draw a name Wednesday night 1-21-09 and announce it on next Thursday’s book review.

Chapter 1: Introduction

Shiller starts out by discussing how the Treaty of Versailles ended up hurting Europe and a factor in inciting World War II because of Germany’s inability to pay renumerations. This current economic crisis could be just as devastating.

He says that the problem with the housing crisis came about because of overly aggressive mortgage lenders, compliant appraisors, and complacent borrowers. Like me, Shiller believes that overly easy credit allowed many people, not just subprime borrowers to buy more house than they can afford. It was the speculation by the average homeowner, and belief that housing prices would only ever go up that drove the bubble.  Misplaced belief in the average consumer, combined with easier lending standards created the bubble.

He then looks back historically at previously housing bubbles, starting with the Great Depression. Home prices fell 30% and unemployement was at 25% during the Depression. However reforms under Herbert Hoover changed the way mortgages were given, 15 year fixed rates instead of ballon mortgages were to become the norm.

He ends by talking about the three financial goals necessary to end the subprime crisis.  First is improving the financial infrastructure so people can become more educated.  Second, expand the scope of financial products to cover more economic risks.  Finally creating new financial instruments to protect the borrower.

Chapter 2: Housing in History

This chapter talks about the history of housing in the US.  First shocker, is that no one had previously collected and tracked the performance of housing in the US long term.  No one had researched what the real returns of real estate was.  This chapter shows Shiller collecting the data and presenting it across cities and even price ranges in cities.  The conclusion was that even within cities the returns of real estate varies a lot.

Chapter 3: Bubble Trouble

Shiller spends chapter 3 talking about the idea of social contagion.   He begins to describe the real estate bubble much like the stock bubble he predicted.  As one where it is like a spread of a disease.  That it gains momentum because people spread the idea to others, and everyone “knew” real estate was a good deal.

He touches on the rate cuts done by the Federal Reserve as one reason for the subprime crisis. It allowed people to start using adjustable rate mortgages (ARMs) which in turn really ramped up the bubble.  Why?  Because people began to speculate and bet on real estate.  They used ARMs to buy homes they couldn’t afford and flip them for a profit.  This was not due to subprime borrowers.  No those people didn’t have the sophistification to use ARMs in highly leveraged deals.  Rather it was people who were normal investors “speculating” on real estate.

Remember Casin Serin with 30 homes?  He wasn’t a subprime borrower when he started out.  He was a guy with a good job who thought he found easy money buying and flipping homes instead of computer programming.

Shiller talks about how the stock market bubble made people believe they were investing geniuses.  They could retire wealthy.  The same thing happened with real estate.

Chapter 4: Real Estate Myth

Shiller talks about a few different real estate myths debunked in this chapter.  The first being that real estate is a great investment. He says over the past century it’s returned 3% annually.  It’s not a easy or fast money people believed it to be.  He also says that people always believe where they live is best.  Thus they believe others find it just as desirable.  He gives this as an example of why people in CA were investing in CA real estate beliving that others would flock to great weather.  He finally explain the myth that construction costs are exploding.  Truth is during the boom it was cheaper than ever.  Finally he makes the argument that we will eventually abandon poorly designed cities for newer, better planned walking/commuter cities in the future.  I wonder would we really leave Manhattan?

Chapter 5: A bailout by any other name

Shiller starts to talk about solving the problem and what role we as a society/government should play in it.  He suggests we need a bailout because it is like trying to halt a disease epidemic.  Treat the sickest, those near death first to prevent the spread.   Some would say let the sickest die and only the strong survive.  But Shiller suggest that severe economic crisis could have longer social effects than can be predicted, like the Great Depression.  We could cause a lack of trust in our economic system which could cripple us indefinitely.

He says that if we do a bailout  we have to do it full on.  There can be no half measure.  We have to fully admit there is a huge problem.  Then we might have to throw billions to solve the problem and be willing to watch it take a long time to work itself out.  Can it work itself out without our help?  Will it take longer?

Chapter 6: The promise of a financial democracy

Shiller says once we move past this crisis what are we going to do to prevent it from happening again?  He suggests applying sound financial principals to a larger demographic of the population.  What this means?  We need to educate people about finances, not just housing but everything.  He presented the study where people invested in their 401k when automatically enrolled.  They were able to live on less, and too lazy to change it.  But we still need to educate people about what they are investing in.  Much like buying a home.  If we don’t educate ourselves we’ll keep having speculative bubbles for the next “fast cash” investment.

Chapter 7: Epilogue

The last chapter just summarizes the book. That we need a bailout now to stop the bleeding. That we need to stabilize our economy before it becomes the Great Depression and we lose faith.  Then we need to implement new systems to prevent it from happening again.  A long term strategy.

This was another historical book about the real estate market and the US economy in general.  I think that it’s interesting read about the creation of HUD, Fannie Mae, and low income housing programs creations.  It’s interesting that we evolved to this bubble because we got caught up in the speculation that real estate is an investment instead of a place to live.

But anyway, leave a comment for a chance to win and hope you enjoyed it.