Shiller on a "financial democracy"

The "always ahead" Robert Shiller outlines four features of a financial democracy.

1. Handle moral hazard better. The present bailouts pose a major moral hazard problem with long term consequnces. We need to define a new generation of financial contracts, with a continuation of our evolving thinking about moral hazard, reflecting greater enlightenment, greater understanding of human psychology and the means to deal with financial failure. For example, I have proposed replacing the conventional mortgage with what I call the "continuous-workout mortgage" - one that would spell out in advance the conditions under which borrowers would see their debt reduced in a rocky economy. These conditions would be designed to minimize moral hazard: The borrowers would not be able to make the debt reduction happen deliberately.

2. To limit risks to the system, build better derivatives. Some kinds of derivatives, such as those maintained by futures exchanges using procedures that effectively eliminate the risk that the other party in the agreement will default, are more useful - and far safer - than others. It is high time to redesign derivatives to avoid what Buffett called "mega-catastrophic" risks.

3. Trust markets, not Wall Street titans. We need to learn to trust people and markets rather than institutions. This means developing better markets that will allow us to hedge against the kinds of risks that dragged us into this crisis, such as real estate gambles.

4. Ideas matter. People still seem to want to trust businessmen who have made bundles and have a huge investment bank behind them, rather than listen to experts who are thinking about the fundamentals of risk management. We would have been better off this month if we'd been ignoring the former and listening to the latter.

The first and second points are increasingly going to happen, while I am not sure about fourth, and the third is surely not going to happen!

Update 1

Shiller has been an advocate of a Rising Tide Tax System that seeks to usher in a taxation system that would address the widening inequality challenge. The system involves indexing inequality to partially insure against future increases in after-tax inequality. Tax rates would endogenously adjust to changes in inequality to dampen changes in the after-tax "Lorenz curve".