The New York Times
Money & Business

Economic View, Louis Uchitelle

He Didn't Say It. But He Knew It.

They last spoke four years ago, when Alan Greenspan, worried that stock prices might be getting too high, invited eight experts to Washington to year their views. That was when Robert J. Shiller, a Yale economics professor, warned unequivocally that American investors, caught up in their own fervor, were creating a dangerous bubble.

In his 10-minute presentation, Mr. Shiller said, he never uttered the words "irrational" or "exuberance." "I liked the word 'zeitgeist' in those days, and I probably used it," he recalled. But two days later, on December 5, 1996, Mr. Greenspan, the chairman of the Federal Reserve, wondered in a now-famous speech whether "irrational exuberance" might be infecting the stock market. And Mr. Shiller saw his influence at work.

"He may have had elements of my way of thinking already in his mind, and when he heard my presentation, he may have been persuaded to say a little more in that speech than he would have otherwise," Mr. Shiller said. "That could be how 'irrational exuberance' got from me to him."

Now, though, the phrase has migrated back to Mr. Shiller, who made it the title of a book on the emotional nature of the stock market, written for a popular audience and published must as technology stocks tumbled, launching the markets into their wild April swings. Suddenly, Mr. Shiller, 54, found himself elevated to the status of Wall Street guru. His view that investors are driven by impulse, herd behavior, dinner party chatter, intuition, media hype, fear of being left out — everything, in short, but informed, reasoned analysis — offered a timely explanation for the spreading uneasiness about stocks.

An irony is that Mr. Greenspan, despite having introduced the notion of overexuberance into the national dialogue, increasingly sees high stock prices — a lot higher than they were in 1996 — as a rational appraisal of corporate America's profitability and prospects.

Technology is transforming the American economy, he says in his speeches and Congressional testimony. Productivity is rising, along with profits. And so investors are logically investing with enthusiasm in companies that are likely to grow in value. What's more, Mr. Greenspan notes, computer technology has increased the amount of information available to investors, and has thus reduced their risk of overpaying for stocks. "Because knowledge once gained is irreversible, so too are the lowered risk premiums," he declared in one recent speech.

Bulls are always more popular than bears — and most people would rather be regarded as rational than irrational — but Mr. Shiller's book has nonetheless given voice to an anxiety that clouds today's zeitgeist. "Shiller has managed to pluck an emotional chord," said James Grant, publisher of Grant's Interest Rate Observer, himself a Wall Street pessimist whose fame has waned as stock prices have kept rising.

That might be Mr. Shiller's fate, too, if the market recovers from its springtime stumble. Even now, Mr. Shiller's fellow economists are in no rush to take his advice. Spiritually, at least, they seem more in the camp of Wall Street strategists like Abby Joseph Cohen of Goldman Sachs, who for years has encouraged investors to buy into a rising market and a prosperous economy.

"I can present my research and findings to a bunch of academics and they seem to agree," Mr. Shiller said. "But afterward at dinner, they tell me they are 100 percent in stock. They say: 'What you argue is interesting, but I bet stocks will go up. I have this feeling'."

If Mr. Shiller turns out to be right about the markets, tens of millions of American families will have invested their savings too thoughtlessly and emotionally in stocks. And over the next 10 to 20 years, their retirement incomes will turn out to be a lot smaller than they now anticipate — not to mention the value of their stock options, the pleasure they get from feeling wealthy and the amount of money they therefore spend.

If Mr. Greenspan — with his faith that markets, even exuberant markets, essentially reflect the logical and sensible behavior of investors — is right, then the nation has ahead of it years of strong economic growth and high stock prices. There will be the usual, periodic recessions, of course — and immense volatility in stocks as the markets sort out winners from losers in the new economy — but no serious setbacks.

Mr. Shiller is no Jeremiah, raging at the markets. Rather, he is a courteous, even-tempered Midwesterner, raised in Detroit, educated as an undergraduate at the University of Michigan, with a Ph.D. in economics from the Massachusetts Institute of Technology. He is reluctant to stray far from mainstream economics, with its emphasis on rational behavior. And the conviction in his cautious, almost diffident comments takes a moment to sink in.

"Over the last 100 years," he asserted in an interview last week, "aggregate stock prices have either gone up too much or down too much."

His argument is that stock market indexes — the Dow Jones industrial average, the Standard & Poor's 500, the Nasdaq composite — are almost always too high or too low. An individual stock price is often an accurate barometer of a company's earnings prospects. But only occasionally, on their way up or on their way down, have the indexes in this country accurately reflected true corporate value. They have more closely resembled a stopped clock that cannot help but be accurate twice a day.

Right now, he says, the indexes are reaching a peak, for the fourth time since 1901. And if history is a guide, this latest peak — the highest of all — will be followed by a decline that might last for years before stocks turn up again into a new bull market.

Just when the next downturn will begin and how it will unfold, Mr. Shiller says he does not know. He is confident, though, that after the fact, the experts will offer all sorts of rational — and incorrect — explanations.

One will undoubtedly have to do with corporate earnings. Falling market indexes should reflect a fall in average corporate earnings, or at least the expectation that they will fall. But that has seldom happened, and right now corporate profits are doing quite nicely, Mr. Shiller notes. When the turn comes, the irrational reason will be that all the group reinforcement that now drives the market up will go in reverse, and people will convince one another that stocks are a bad deal.

"People are smart, but they tend to make big errors, and they do it in groups," Mr. Shiller said.

If most economists don't get this — beyond the small group of behavioral economists to which Mr. Shiller belongs — that is because they don't pay enough attention to psychology, sociology and history. These disciplines, he says, offer more accurate descriptions of human behavior than the models of rational, sensible human beings at the heart of mainstream economic theory.

Psychology is particularly important, and ignored. Walking toward his office in the Cowles Foundation for Economic Research on Hillhouse Avenue, in a neighborhood of old mansions now mostly owned by Yale, Mr. Shiller points to the brick Victorian headquarters of the economics department and, a block away, the psychology department's building.

"The economists never visit the psychologists and hardly know where they are located," Mr. Shiller said.

He attributes his iconoclastic economics at least in part to the influence of his late father, Benjamin, described by the son as a fiercely independent engineer, inventor and entrepreneur who never achieved much success. Outside academia, the son had not made much of an impression, either.

And then last summer, he decided to offer his research in a hurriedly written popular book. On Friday, April 14, when the Nasdaq index fell almost 6 percent, "Irrational Exuberance" (Princeton University Press) jumped to 13th place on Amazon.com's sales rankings, from 43rd place the day before. (It will rank 22nd on the expanded hardcover nonfiction best-seller list to be published next Sunday on The New York Times on the Web.)

Suddenly, Mr. Shiller had captured the success — or at least the public attention — that had escaped his father.

"Being a best-selling author is a different thing than being a professor," he said. "It seems my social status has climbed. Neighbors ask me to sign copies of the book, and students come by my office, wanting to give signed books to their fathers. My college roommate, whom I have not seen in 20 years, called me. And my wife is saying that it will all go to my head."

On sabbatical this semester (though he still tends to his graduate students), he is away so much that his wife Virginia, a psychologist herself, says that when she and their two teenage sons want to see him, they turn on the television.

At a book signing at a New Haven bookstore, Dr. Shiller recounted, the audience was invited to talk to her husband. "My son said, `Wow' and rushed up," she said. "Maybe it was a joke, but it was not funny."

Over the last week, Mr. Shiller has appeared on more than a half dozen radio and television programs. Midweek, he taped an interview for Time magazine with James K. Glassman and Kevin A. Hassett, co-authors of another big seller, "Dow 36,000" Times Business/Random House); its thesis is that as investors come to understand the true value of stocks, the Dow should more than triple.

"I have debated them before, on television," said Mr. Shiller, who is out of the market himself, without regrets. "They say people have learned that stocks are not risky. I don't think people have learned anything, or will learn anything."

But he is careful in public appearances. He is not comfortable being cast as a Wall Street wise man, a calling that in his view requires constant forecasts of what the market will do in the next few days or weeks. He does not know, he says. An overly upbeat mood can last for months — or years — before the exuberance inevitably reverses. So he generalized.

"If it is an up day in the markets," he said, "I talk about how exuberance forms and why we have it. And if it is a down day, I talk about how markets drop because of negative feedback."

Mr. Shiller stands very nearly alone in his relentless insistence that markets move on feelings and herd behavior, not corporate fundamentals. Many experts agree that stock indexes are now too high. "But if you wait long enough," said Albert Wojnilower, a Wall Street economist, "you will find some conformity between stock prices and true value."

Markets, in sum, do get it right, and the excesses in between are mostly noise; dangerous noise, to be sure, subjecting markets to sudden crashes when investors temporarily panic, but noise nonetheless.

That is a view that Mr. Greenspan seems to hold, too, and he offers the reassurance that the Fed can end a panic and restore confidence through timely cuts in interest rates and plenty of support for the indebted. Rational solutions thus restore rational behavior.

Mr. Shiller describes public moods that are more ingrained, harder to rout, resistant to reason. "I have never been satisfied that markets are rational," he said. "It is not my experience."