When new digital technologies are applied to the world of finance in the near future, they will "change the way we live and work," predicts Robert Shiller, the Stanley B. Resor Professor of Economics.

Shiller made that forecast in his talk "Progress, Poverty and the Digital Age," presented as part of the Graduate School's "In the Company of Scholars" lecture series.

Increasingly, sophisticated computers and software will enable people to create new kinds of "financial engineering," Shiller said. An expert on behavioral economics, he argued that it is a basic principle of finance that "human beings like order and structure and managing risk." Financial inventions, he said, will make it possible to spread risks in novel ways.

Financial engineering is a relatively new concept. The International Association of Financial Engineers, established in the 1990s, now has some 2,000 members, and more than 20 schools offer degree programs in the subject. Most financial engineering involves designing such things as exotic options or other sophisticated derivatives, Shiller said. But Social Security and Medicare might also be considered in-stances of financial engineering -- innovations that were neither obvious nor inevitable until people thought them up and figured out how to implement them, he said, noting they have dramatically changed people's lives.

"Financial inventions, broadly construed, have a big impact on the quality of our lives," said the Yale economist. The future is full of promise, he added, because "Improved digital technology changes the possibilities."

These ideas will be explored in Shiller's next book. His most recent publication, "Irrational Exuberance," was on The New York Times best-seller list, won several prizes and earned Shiller considerable media attention for predicting the current slump in the stock market about a year before it happened.

One example of a novel kind of risk-sharing, Shiller said, is "weather insurance." Snow is an asset to ski resorts, but a drain to the budgets of governments responsible for clearing the roads. By pooling risks, Shiller said, both groups cancel out their vulnerability to the weather. If it snows a lot one winter, both parties benefit: resorts have the powder they need, and cities can make claims on their insurance to recover their costs. If there is little snow, city governments save on plowing, and the resorts file insurance claims against their losses. In the future, as our electronic technology allows more and more processing of information about risks, such risk sharing can be dramatically expanded, the economist told his audience.

Despite the controversy surrounding Enron, Shiller praised the bankrupt Houston-based energy-trading corporation for its pioneering financial innovations. Enron, he noted, was the first company to issue credit-sensitive notes, in 1989, and initiated financial contracts to manage weather risk in 1997. At the time of its bankruptcy, the company was working on trading index-based commercial real estate contracts, he said. Unfortunately, Enron pursued more projects than it could manage and "some projects were only hype," Shiller said. "In addition, they dishonestly concealed the truth about their failures for too long." Nonetheless, he reasoned, this "does not discredit the long-run importance of financial innovation."

Shiller stated in his talk that he would like to see increased financial equality among nations and individuals. Financial solutions need to be found to meet everyday problems for "employees of Wal-Mart as well as of Wall Street," he said. "New technology makes possible ideas that were once impractical." Progressive taxes and earned income tax credit have "dramatically reduced inequality" in the United States already, he said, adding that he has many ideas for building on that foundation, both here and abroad.

Some of the solutions depend on indexing, a concept Shiller has propounded for some time. Specifically, he has urged that the return on bonds be linked to the rate of inflation, making bonds more attractive investments for the long term. Using similar logic, he argued in his talk that if international loans were indexed to the Gross Domestic Product of the borrowing country, when the borrowing country's economy does well, it should be required to pay back more. If its economy slides, it should be expected to repay less. Along the same lines, Shiller recommended that mortgages be indexed to the market value of the property, instead of set at a fixed dollar amount, so that "the amount you borrow goes down if the value of your house goes down, and vice versa." Shiller noted that Professors William Goetzmann and Barry Nalebuff of the Yale School of Management are involved in a project to create such insurance, which Shiller calls "home equity insurance."

The economist also recommended the invention and implementation of "income insurance" and "insurance against the gradually evolving risks to our lives." Indexing and pooling risks would provide more stability for all members of the pool and reduce the number of debts defaulted on and bankruptcies filed.

The next talk in the Graduate School's "In the Company of Scholars" series will take place on Feb. 26 at 4 p.m. in Sterling Memorial Library Lecture Hall, when Marcia Johnson, professor of psychology, presents a talk titled "Memory and Reality."

-- By Gila Reinstein

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ENDOWED PROFESSORSHIPS

• Panel to probe questions surrounding Enron's collapse
  
  
• Conference pays tribute to judge who was committed to racial justice
  
  
• Trustee Barrington D. Parker sworn in to federal court
  

  
  

Aboard the Cultural Caravan

Exhibition honors memory of Dr. Donald Cohen

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MEDICAL SCHOOL NEWS

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Master architects inspire students to design for the future

Conference looks at the 'faces' of Japanese cinema

Library sponsoring program on Islamic civilization and identity

Campus Notes

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