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Finance and the Good Society

Finance and the Good Society

Robert J. Shiller
Copyright Date: 2012
Edition: STU - Student edition
Pages: 304
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  • Book Info
    Finance and the Good Society
    Book Description:

    The reputation of the financial industry could hardly be worse than it is today in the painful aftermath of the 2008 financial crisis.New York Timesbest-selling economist Robert Shiller is no apologist for the sins of finance--he is probably the only person to have predicted both the stock market bubble of 2000 and the real estate bubble that led up to the subprime mortgage meltdown. But in this important and timely book, Shiller argues that, rather than condemning finance, we need to reclaim it for the common good. He makes a powerful case for recognizing that finance, far from being a parasite on society, is one of the most powerful tools we have for solving our common problems and increasing the general well-being. We need more financial innovation--not less--and finance should play a larger role in helping society achieve its goals.

    Challenging the public and its leaders to rethink finance and its role in society, Shiller argues that finance should be defined not merely as the manipulation of money or the management of risk but as the stewardship of society's assets. He explains how people in financial careers--from CEO, investment manager, and banker to insurer, lawyer, and regulator--can and do manage, protect, and increase these assets. He describes how finance has historically contributed to the good of society through inventions such as insurance, mortgages, savings accounts, and pensions, and argues that we need to envision new ways to rechannel financial creativity to benefit society as a whole.

    Ultimately, Shiller shows how society can once again harness the power of finance for the greater good.

    eISBN: 978-1-4008-4617-7
    Subjects: Finance, Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-vi)
  3. Preface to the Paperback Edition
    (pp. vii-xii)
  4. Preface
    (pp. xiii-xxii)
  5. Introduction: Finance, Stewardship, and Our Goals
    (pp. 1-16)

    What are we to make of a book calledFinance and the Good Society?To some readers, this may seem an incongruous coupling of concepts. The wordfinanceis commonly thought of as the science and practice of wealth management—of enlarging portfolios, managing their risks and tax liabilities, ensuring that the rich grow richer. We will revisit—and challenge—this definition of finance later in this chapter. The phrasegood societyis a term used by generations of philosophers, historians, and economists to describe the kind of society in which we should aspire to live; it is usually understood...

  6. Part One Roles and Responsibilities

    • [Part One Introduction]
      (pp. 17-18)

      An old saying holds that while the problem with socialism is socialism, the problem with capitalism is capitalists. Some of the headlines of the past decade—from the exploits of the executives of Enron and Satyam to those of the likes of Bernard Madoff—would seem to confirm that the problem with financial capitalism is indeed financial capitalists. But achievement of the good society is dependent on a healthy and robust financial sector—including the people who occupy the roles that enable the financial system to run, and thus help the economy to run. If finance is the science of...

    • Chapter 1 Chief Executive Officers
      (pp. 19-26)

      The CEO of a company is in a very special position, because he or she stands for an idea—the core idea behind the company’s activities, a way of thinking that defines the work of all the company’s employees, and a culture that includes its corporate values, connecting the company to the larger society.

      The CEO is responsible for the formulation of short-run goals that promote that very idea. The CEO embodies the purpose of the company. This responsibility has to be put, to a significant extent, into the hands of an individual and not a committee of equals, just...

    • Chapter 2 Investment Managers
      (pp. 27-36)

      Investment managers—those who manage portfolios of shares in companies, bonds, and other investments—are among the most important stewards of our wealth and thus vitally important players in the service of healthy and prosperous market democracies—in the service of the good society. They are employed by all kinds of organizations, from multinational corporations and union pension funds through city governments, universities, libraries, and churches. The funds they manage are of many different types and legal forms, with names like “mutual funds,” “unit investment trusts,” “exchange-traded funds,” “hedge funds,” or “private equity funds.” In this chapter we lump the...

    • Chapter 3 Bankers
      (pp. 37-44)

      Banks—and bankers—have survived centuries of financial evolution, and thus have found an important ecological niche in the economy. The form taken by banks evolves steadily; their function remains much the same. Their activities are fundamental to the economic environment; notably they provide transaction services and contribute to the money supply, which in turn facilitates commerce. They are so involved in our daily lives that they are known by everyone, and banking is a concept integral to modern world culture.

      And yet there is immense hostility today toward bankers. The wordbankster(rhymes withgangster) has come back into...

    • Chapter 4 Investment Bankers
      (pp. 45-49)

      Investment bankers are the people who help organizations sell new securities. In particular, they arrange for companies to issue shares to investors. If it is the first time the company has sold shares to the public, investment bankers help with what is called the initial public offering (IPO). If the company wants to raise yet more money by selling even more shares to the public, investment bankers help organize what is called a seasoned offering. Either way, the investment banker is facilitating the acquisition of capital by the company, dividing up the company into shares that appeal to investors, and...

    • Chapter 5 Mortgage Lenders and Securitizers
      (pp. 50-56)

      Housing is one of the most fundamental of economic needs. The need for housing tends to come at an early point in the life of a family, when it first has children or sees the immediate prospect of them, yet when resources may below. There is a strong motive for the financial industry to help with this fundamental problem. Society, as we have already noted, regards the subsidizing of homeownership as beneficial, and so sees a public good in promoting mortgage lending.

      And yet, particularly in the United States, public disgust has been directed toward mortgage lenders and securitizers today....

    • Chapter 6 Traders and Market Makers
      (pp. 57-63)

      The classic example of a trader is the specialist on a traditional stock exchange, who stands at a post where certain stocks are traded on the floor of the exchange, and who buys and sells from his personal inventory of these stocks in order to maintain an orderly market. But the specialist is only one of many people whose job involves trading minute by minute. In addition to market makers, there are also execution traders, who help others make transactions efficiently at good prices without disturbing the market to their own disadvantage, and proprietary traders, who trade on their own...

    • Chapter 7 Insurers
      (pp. 64-68)

      The insurance industry has been extremely important in reducing the impact of both major and minor tragedies on our lives. Most people simply do not appreciate what insurers offer, for the total value of the services they provide can be hard to grasp. In this respect the news media seem to see tragedy in the wrong places. Take for example the 2010 BP oil spill in the Gulf of Mexico, when theDeepwater Horizonoil rig exploded and spilled oil into the gulf for three months. The news media described this as a greater tragedy than it was, disregarding that...

    • Chapter 8 Market Designers and Financial Engineers
      (pp. 69-74)

      Market designers, sometimes called mechanism designers, start with a problem—the need for a market solution to some real human quandary—and then design a market and associated contracts to solve the problem. They are using financial and economic theory to create “trades” that leave people better off. In so doing they are humanizing finance and making it more relevant to human welfare. Sometimes these people are called financial engineers, since what they do seems analogous to what mechanical or electrical engineers do. At their best, market designers have the same practical common sense and drive to create, and the...

    • Chapter 9 Derivatives Providers
      (pp. 75-80)

      In recent years, the termderivativeshas become a dirty word, blamed by many for real evils, including the severe financial crisis that began in 2007. But a derivative is merely a financial product that derives from another market, and it is not inherently good or evil. Those specialists who drive the derivatives market may have gained a bad reputation, but in fact they are involved in some of the most creative and sophisticated aspects of finance.

      One example of a derivatives market is a forward market for a commodity, in which one can sign a contract to buy from...

    • Chapter 10 Lawyers and Financial Advisers
      (pp. 81-86)

      Lawyers and financial advisers are fundamental to financial capitalism because they provide information that is tailored to their clients’ complex needs. Richard J. Murnane and Frank Levy, whose theory of the role of labor in modern society was discussed in the introduction, chose law as a prime example of an occupation that will not be replaced by computers. They chose it because the practice of law essentially depends on both expert thinking and complex communication. The same is true of financial advisers.

      Efforts to create expert-thinking web sites to help people make financial decisions have not entirely succeeded. The mechanization...

    • Chapter 11 Lobbyists
      (pp. 87-93)

      One of the most troubling aspects of finance in modern society is that it often appears that the financial community now has the ability to take control of the government. They can hire lobbyists to present their case and persuade lawmakers to take their side. The “bailouts” and the favoritism apparently shown to some financial interests during the current financial crisis are widely seen as evidence of this.

      Arthur Levitt, the chairman of the SEC from 1993 to 2001, wrote about his experiences in a 2003 book,Take on the Street. He remarks as follows:

      During my seven and a...

    • Chapter 12 Regulators
      (pp. 94-99)

      Regulators as people with vision and purpose are typically omitted from discussions of financial markets. We hear a lot about energetic and effective entrepreneurs, but rarely about the people who work for regulatory agencies, whether they regulate government or industry. But in fact regulators and their intellect are fundamentally important to the financial system. It is they who make and interpret the all-important rules of the game.

      Just as in sports, people in business want referees who will enforce the rules. Everyone has an interest in the game being fair. The fact that players try to push the limits of...

    • Chapter 13 Accountants and Auditors
      (pp. 100-102)

      For an economic organization to function, it must have its own memories and its own way of storing, accessing, and communicating those memories. Accountants manage the repositories of financial memories, whether of an organization or of an individual client. Auditors evaluate and interpret their work. Accountants—particularly those who are chief financial officers of companies—are essential to finance because they preserve the integrity of essential financial structures.

      People who are actively involved in managing and running a business will typically have fine short-term memories, but, like most of us, they may not always be able to remember details over...

    • Chapter 14 Educators
      (pp. 103-106)

      At this point we have discussed the most central roles and responsibilities in the financial world, and we now move to some of those on its periphery. But peripheral does not mean less important, merely less involved in day-to-day operations. Educators are of central importance to the functioning of the financial system. Delicate as the proper functioning of the system is, it requires some understanding of the origins of its institutions, its practices, and their purpose, and a sense of how one’s own career can fit into that picture.

      Errors by educators in recent decades seem to have played an...

    • Chapter 15 Public Goods Financiers
      (pp. 107-110)

      Public finance, the financing of public goods and causes, is curiously considered a very different profession from “straight” finance. Courses in public finance at the university level are generally offered in the economics department, not the business school, and it appears that the professors in the two fields rarely talk to one another. Communications between the fields seem to be improving, and recognition is growing that they are, or at least ought to be, closely related. They deal with essentially similar problems, differentiated by the fact that public finance confronts a special “public goods” problem. Yet there still remains an...

    • Chapter 16 Policy Makers in Charge of Stabilizing the Economy
      (pp. 111-118)

      Financial capitalism is far from a perfect system, and one of its fundamental problems is that it is vulnerable to booms and busts, recessions and depressions. These events have happened so many times in the past that one can predict with certainty they will happen again. So it is widely appreciated that we need policy makers whose duty is to counteract such instabilities and reduce their impact.

      But preventing these episodes presents a difficult problem: the reasons for them have never been well understood. The causes of economic booms or busts are multifaceted, and understanding them requires human judgment—judgment...

    • Chapter 17 Trustees and Nonprofit Managers
      (pp. 119-123)

      Trustees manage portfolios to support others’ causes—causes that tend to outlive their clients, the people who defined them. Nonprofit organizations make grants or undertake activities in support of a cause. They enable people to see to it that their purposes are carried forward on a large scale and over a long time frame, though not always as perfectly as they might have wished. Defining such institutions is a difficult financial problem, but one with which we, at this point in history, have had some success.

      Most human goals have an implicit time frame, and many goals cannot be achieved...

    • Chapter 18 Philanthropists
      (pp. 124-128)

      Philanthropists are essential to the market economy. Indeed there is only so much a purely selfish individual can do with the large amounts of wealth that our financial system can bestow on successful people. One can drive (or be driven in) only one car at a time. One can eat only so much food, or wear only one set of clothes at a time. Virtually all of the things one can buy are based on products that are made available to the great mass of people, and hence are not that dissimilar from the products everyone else consumes. One can...

  7. Part Two Finance and Its Discontents

    • Chapter 19 Finance, Mathematics, and Beauty
      (pp. 131-134)

      Financial theory, as well as economic theory more generally, can be beautiful. I was struck by remarks to this effect at a retirement dinner for my colleague Herbert Scarf, a distinguished mathematical economist. A number of speakers at the dinner noted that his lectures were “elegant.” They of course meant that the field itself had an inherent beauty, and that Herb was a master at expressing it.

      The fact that the real world of financial capitalism is so often messy and inhuman, and that it involves so much hypocrisy and manipulation, may detract from this sense of beauty. But the...

    • Chapter 20 Categorizing People: Financiers versus Artists and Other Idealists
      (pp. 135-138)

      One of our feelings about economic inequality is that high incomes in our society seem often to reward selfishness and narrow-mindedness rather than idealism and humanity. People naturally categorize other people, and we place them into groupings that take on exaggerated significance in our imaginations. We tend to think that those in careers other than our own are fundamentally different kinds of people. Personality and character differences are indeed somewhat associated with occupations. But this overly strong tendency to categorize people is related to what psychologists have dubbed “the fundamental attribution error.”¹ It is a known fact that we tend...

    • Chapter 21 An Impulse for Risk Taking
      (pp. 139-142)

      Economic theory presents people as substantially risk averse, rationally avoiding uncertainty. And yet there is a side to people that impels them to do just the opposite—to put themselves in risky situations. This natural impulse, which is connected with our sense of adventure as well as our self-esteem, is part of what drives entrepreneurship, what drives animal spirits in the real world. It is also part of what causes speculative bubbles and ultimately crashes.¹

      This side of human nature has not been adequately recognized in much of financial research—even in much of the work of behavioral finance researchers,...

    • Chapter 22 An Impulse for Conventionality and Familiarity
      (pp. 143-150)

      Standing in opposition to the impulse for risk taking described in the preceding chapter is a nearly opposite impulse for conventionality and familiarity. This impulse can take many forms, but for our broad purposes here it is important to consider how it can push people toward reliance on old-fashioned financial institutions and outdated economic structures.

      Financial concepts, as abstract as they are, are difficult for most people to comprehend. They fear being manipulated or cheated by others who are more facile with these concepts. And yet people readily understand that financial arrangements are terribly important to their lifetime well-being, as...

    • Chapter 23 Debt and Leverage
      (pp. 151-158)

      The impulses described in the preceding two chapters can interact to create a dangerous situation regarding debt and leverage. The impulse toward risk taking can cause people to disregard danger signals and run with crowds and bet on bubbles, taking on too much debt to do so. The impulse toward conventionality and familiarity can mean that they take no steps to protect themselves from the risks they assume. When the calamity comes, they are in serious trouble. It is no surprise that people have done such things repeatedly throughout history, given the primacy of these basic impulses.

      When one has...

    • Chapter 24 Some Unfortunate Incentives to Sleaziness Inherent in Finance
      (pp. 159-167)

      There is a widespread sense that there is something sleazy about the business of finance, or the people who populate it. This impression is probably behind the commonly voiced opinion that it is a shame so many young people today are going into finance-related occupations, when they could be doing something more high-minded in other fields.

      Many people in business do seem to feel rewarded, for the short run at least, in putting salesmanship ahead of purpose, in cutting corners on the law or the intent of the law; they seem to be focused on the money above all else...

    • Chapter 25 The Significance of Financial Speculation
      (pp. 168-177)

      There has long been a negative feeling among the general public about speculation in markets. To them, the activity doesn’t seem to contribute to society. It seems to many to be a form of recreation for the rich or for those who really just want to be rich, an activity that is fundamentally selfish and egotistical—and, on top of that, often delusional. In a 1904 essay Charles Conant observed that

      One of the most persistent of the hallucinations which prevail among people otherwise apparently lucid and well informed is the conception that operations on the stock and produce exchanges...

    • Chapter 26 Speculative Bubbles and Their Costs to Society
      (pp. 178-186)

      Economic history is peppered with stories of speculative bubbles, their bursting, and the resultant economic dislocation. There are more such stories than any of us can remember. Even before we had stock markets, there were economically important fluctuations in speculative asset prices. There are vague stories of housing booms in ancient Rome, in the time of Julius Caesar and in the time of Hadrian. Large swings in land prices wrought great distress even before we had stock markets of any size. After the invention of the newspaper in the early 1600s, stories of bubbles began to take on their modern...

    • Chapter 27 Inequality and Injustice
      (pp. 187-196)

      We have ample reason to believe that financial markets are quite useful. And yet our wonderful financial infrastructure has not yet brought us the harmonious society that we might envision. There remains the ugliness of extreme economic inequality, of some who endure hardship while others are pampered. While some inequality is actually in many ways a good thing, for the motivation and stimulation it provides, arbitrary and extreme inequality poses problems.

      The public aversion to inequality is deep seated and ancient. It has been shown that even our distant relatives, nonhuman primates, share with us an aversion to inequity.¹ It...

    • Chapter 28 Problems with Philanthropy
      (pp. 197-208)

      Why is it that gifts to causes (charitable, religious, artistic, scientific, environmental, educational, and so forth) are not more common? In the United States in 2010 only 2.2% of national income was given away by individuals and organizations.¹ It would seem that people would give more. With just a little thought one naturally concludes that we suffer what economists would call diminishing marginal utility of consumption; that is, one cannot really consume a large amount of wealth. Certainly there are always others who are in greater need. So why don’t people see this and do something about it?

      Giving as...

    • Chapter 29 The Dispersal of Ownership of Capital
      (pp. 209-218)

      The history of financial capitalism is to a substantial extent a history of deliberate government policies to disperse financial interests, to disperse ownership across a wider segment of the population. Such policies have helped democratize finance.

      People seldom realize to what extent we live in a society that is structured by financial design to become better and better over time. The history that brought us to certain financial arrangements is often forgotten, and it is useful to remind ourselves of some of that history. Here I offer some examples of past progress that is unseen and unappreciated today.

      A modern...

    • Chapter 30 The Great Illusion, Then and Now
      (pp. 219-230)

      In 1910 Norman Angell, a British member of Parliament, documented a widespread and dangerous misconception through his best-selling bookThe Great Illusion: A Study of the Relation of Military Power to National Advantage. The great illusion was, in Angell’s words, an “optical illusion” that stood as “an all but universal idea”: the belief that

      a nation’s financial and industrial stability, its security in commercial activity—in short, its prosperity and well-being, depend upon its being able to defend itself against the aggression of other nations, who will, if they are able, be tempted to commit such aggression because in so...

  8. Epilogue: Finance, Power, and Human Values
    (pp. 231-240)

    There is one more aspect of financial capitalism, not fully dealt with in this book so far, that bothers many people deeply. And that is the economic power that some in the financial community attain. Their power in itself rankles. It offends our sense of participation in a society that aspires to respect, appreciate, and support everyone. The pursuit of power that so often seems to drive financial capitalism seems contrary to the concept, promoted in this book, that finance is all about the stewardship of society’s assets.

    If one searches the bookseller today for the phrase “wealth and...

  9. Notes
    (pp. 241-256)
  10. References
    (pp. 257-272)
  11. Index
    (pp. 273-288)