The One Who Saw It Coming.(economist Robert Shiller's forecast on USA's economy)

Byline: Zachary Karabell; Karabell is president of River Twice Research.

Robert Shiller forecast the credit crisis for the right reasons, and has a novel idea for how to fix it.

Robert Shiller is one of a handful of economists who have been feted for foreseeing the credit crisis, but he is the only one who predicted it for the right reasons. New York University's Nouriel Roubini, now known as "Dr. Doom," warned as early as 2006 of an imminent housing crash that would stop America's consumer-spending spree and lead to severe recession. Another uber-bear, Morgan Stanley's Stephen Roach, had warned for years that the weakening dollar and the U.S. trade deficit with China were signs of a dangerously imbalanced global economy, doomed to fall. While both deserve credit for highlighting weaknesses that others ignored, neither had much to say about the real reasons for the current state of affairs, namely the vast amount of speculation that took place in the financial world linked to home mortgages.

Shiller did. Long before the extent of the subprime-mortgage crisis was evident, Shiller predicted that home prices would fall more rapidly than any models had predicted and that financial markets globally would be upended as a result. A specialist in the management of risk, he recognized that the real-estate bubble in the United States and parts of Europe represented, above all, a failure to manage risk. Now Shiller, a Yale professor who first made his name by accurately forecasting the stock-market collapse of 2001, is alone again, this time in his prescription for what needs to be done to stabilize credit markets in the future.

Most experts will tell you that Barack Obama needs to move quickly to contain the multitrillion-dollar market that turned low-quality mortgages into high-priced derivatives, the Wall Street innovation now widely blamed for the credit crisis. Shiller says the opposite. He argues that unless the central issue of risk is addressed, all the money that governments are pouring into financial rescues won't prevent another, potentially worse financial crisis down the line. In Shiller's view, derivatives "are a risk management tool much the same way insurance is. You pay a premium and if an event happens, you get a payment." His radical answer to our problems is that trying to leash financial innovation is hopeless, and that we should instead push forward into a brave new world where derivatives become as common as cash.

What separates Shiller from the majority of economists is his lack of faith in the "efficient-market hypothesis." That belief, which also guides the hand of most money managers, holds that the market will price assets according to their fundamental value and that those prices reflect all pertinent information. Shiller instead follows those, like John Kenneth Galbraith, who hold that market prices reflect "animal spirits" and popular passions, not perfect information.

That is why bubbles form, and that, for Shiller, is why financial innovation and government regulation are imperative. Pressure has been building in Washington to crack down on the complex derivatives that were structured on toxic mortgages, especially given the scale of global capital flows and trillions of transactions facilitated by computer models and electronic communications. Barney Frank, the powerful chairman of the House Financial Services Committee, has talked of finding ways to force financial companies to become more risk-averse. Similar measures are being considered in Europe and Asia.