On Monday I wrote a post criticizing the sloppy way that Robert Shiller argued for financial innovation, which focused primarily on the use of metaphor and secondarily on the use of a valid example (people are overly cautious about some financial products) to make an invalid general point (people are overly cautious about all financial products. Then I threw in a sloppy paragraph, because I wanted to get to the end of a long post:
“From there, the article actually gets better, because Shiller gives us examples of areas where he thinks financial innovation would be good. And here I don’t really disagree with him that much. I agree with him that reliance on housing as an investment vehicle is bad. I don’t really agree that target-date mutual funds are such a good idea (since as far as I can tell the conventional wisdom about switching from stocks to bonds as you age is the equivalent of an old wives’ tale), but they are probably better than many of the things people are currently invested in. Retirement annuities, another thing he recommends, would definitely be useful if you could get them at a decent price. (I believe now they suffer from a significant adverse selection problem.)
“For the sake of argument, I am willing to concede that these are useful innovations that would make people better off.”
Felix Salmon rightly points out that I shouldn’t have conceded it for the sake of argument. Really, what I should have said was that I agreed with Shiller that people face real problems — relying on housing for investment is bad, and it “would definitely be useful” if you could get inflation-adjusted annuities for retirement. (I don’t like target-date funds, and I said so.) But since I had already made my main point (the one about metaphor), I didn’t look into the specific innovations that Shiller was proposing to solve these problems. Salmon points out accurately that the proposed solutions rely on embedded options that ordinary consumers are likely to get screwed by. I recommend reading his post.
By James Kwak