Shiller: Financial Infrastructure Must Improve

Congress has provided a Housing and Economic Recovery Act to bail out some homeowners, but many more are not going to be helped. This bitterness and loss of hope may adversely affect spending patterns.

The changes in popular assumptions about the future prices, about the outlook for the economy and sense of fair treatment, are fundamentally damaging to the economy, and to the outlook for various enterprises.

The response to this crisis should be, and hopefully will be, to develop our financial institutions better to prevent this kind of crisis from happening again.

There will continue to be angry recriminations against firms that offered smoke and mirrors, and who will be held responsible for our continuing ills. This will put pressure on those firms who can't offer a constructive response.

The crisis should result in major changes in our financial infrastructure. This will happen only over a period of years into the future. Many segments of the financial services industry will respond to criticism that they gave bad advice, or, in many cases, no advice. They will be responding to increasing regulatory pressure to clean up their act. But they will also be responding to public pressure towards a more rational economic system.

There should be pressures towards a democratization of finance, meaning developing the financial infrastructure to involve more people in high-level information acquisition. New financial institutions should be established. Some examples of these institutions would be continuous workout mortgages, home price derivatives and home equity insurance.

There will be opportunities for a different kind of firm if and when the kinds of responses that seem necessary to deal with this crisis are implemented. Firms that offer fundamental risk management services based on realistic assessments will eventually prevail.

Ultimately, we should move towards a better financial services sector that encourages faith in properly functioning risk management, rather than misplaced faith in speculative cycles.

TheStreet.com TV: Shiller: Homebuilders May Have Struck Bottom

Homebuilding stocks overshot to the upside before the housing bubble popped. Famed Yale economist Robert Shiller, author of The Subprime Solution, says the over-reaction to the downside may now be over.

To watch the video, click the player below:

For John Fout's take on this book, read "BOOK REVIEW: Shiller's Subprime Solutions."