IRRATIONAL EXUBERANCE by Robert Shiller

Review by Wendy Bolger

Irrational Exuberance is a sobering read for anyone with investments in the stock market, or an interest in the “new economy.” Unlike most of the academics and experts whose work we are exposed to in business school curricula, Shiller does not subscribe to the efficient market theory, nor is he a “believer” in the internet. For a reader like me, only recently schooled in the elegant efficient market theory, Shiller’s perspective is a bit alarming. However, one cannot make it through an introductory finance course without questions arising as to the true efficiency of information flows in the market, so I was moderately prepared for his arguments against the “random walk.” What is even more disturbing to budding entrepreneurs, e-biz students, and other believers in the transformational power of the internet, is Shiller’s assertion that optimistic “new era” claims of unlimited growth and prosperity get dragged out every time the US economy experiences a bull market. The revolutionary internet economy is so compelling to our imaginations, he argues, because the internet is pervasive in nature, not because it will fundamentally change the way corporate America is run. Reading Irrational Exuberance as an MBA is a little like picking up A Christmas Story on Christmas Eve. “Bah Humbug” says Shiller. In fact, Shiller seems to have a reputation for being something of a Scrooge. He indicates in the text that his highly controversial positions on the overvaluation of the stock market have met with fierce criticism over the years. Like some of his critics, I had some problems with a few of Shiller’s survey methods, for example his practice of surveying only current investors, a biased audience, and drawing conclusions for his research from their rather small number of responses. But these objections do not change the fact that current opinions about today’s investment climate have vindicated Shiller’s perspective. The media and the general public have come around to the point of view that the stock market is a little crazed. Ouur concerns about the over-valuation of internet firms, at least, are now expressed in the drastically reduced prices of internet stocks. What saves this book from being an “I told you so” tract is Shiller’s apparent motivation in sharing his years of research. Before reading Irrational Exuberance, I was of the opinion that the stock market was probably overvalued, but I did not consider this to be a serious problem, or one with potential impact on our society. We may be floating on a speculative bubble, but the winners stand to reap huge profits from this speculation, and the losers can probably afford it, or are only losing on paper—otherwise they wouldn’t be in this game. On the contrary, Shiller theorizes that the dangers of the irrationally exuberant market run deeper. Irrational exuberance should be a policy concern, says Shiller, as it has the potential to threaten the quality of life for all Americans, whether or not they are playing the market. Because of the pervasiveness of stock market investment, our colleges, foundations, and other endowed institutions are at risk thanks to the bubble market. These organizations have wide-reaching social impact, and their collapse would be a true crisis to our society, the brunt of which would more likely be borne by the less-well-off. Similarly, up-and-coming baby boomer retirees, whose savings have accrued in 401K investment plans instead of less risky retirement benefit plans, could wind up with no financial support at all should the market collapse. Shiller’s concern for the social well-being of all of us, who he thinks have been duped into feeling secure within a risky bubble economy, makes a compelling argument for the creation of more opportunities for diversifying and hedging our investments, and is a powerful cautionary tale about irrational exuberance.

“To justify the notion that the stock market is at the appropriate level now, we would have to argue that it was not before. Such an argument would stand in sharp contradiction to the efficient markets theory.” p. 190 “If we are regularly spending time on the Internet, then these examples [of the Internet revolution] will come to mind very easily.” p. 21 “My work invited the attention of an army of critics. Most notable among them was Robert Merton, a brilliant theorist who was later to win the Nobel Prize in Economics (and also to suffer a major financial loss…).” p. 189 “How we value the stock market now and in the future influences major economic and policy decisions that affect not only investors but also society at large.” p. xii