The Social Value of Finance

By James Kwak

It’s been more than five years since the peak of the financial crisis, and it seems clear (to me, at least) that not much has changed when it comes to the structure of the financial sector, the existence of too-big-to-fail banks, and the types of activities that they engage in. It’s also clear that the Dodd-Frank Act and its ensuing rulemakings have embodied a technocratic perspective according to which important decisions should be left to experts and made on the grounds of economic efficiency. Even the Consumer Financial Protection Bureau, the Dodd-Frank achievement most beloved of reformers, is essentially dedicated to correcting market failures, which means attempting to achieve the outcomes that would be generated by a perfect market.

The big question is why we went down this route. The traditional explanation, and one that I’ve tended to assume in the past, is that it was a question of political power. Wall Street banks and their lawyers simply want less regulation of their industry, and they feel more comfortable granting actual rulemaking power to regulatory agencies that they feel confident they can dominate through the usual mix of congressional pressure, lobbying, and the revolving door. Given that the Obama administration also wanted to avoid structural reforms and preferred to rely on supposedly expert regulators, the outcome was foreordained.

In a recent (draft) paper, Sabeel Rahman puts forward a different, though not necessarily incompatible explanation. He draws a contrast between a managerial approach to financial regulation, which relies on supposedly depoliticized, expert regulators, and a structural approach, which imposes hard constraints on financial firms. Examples of the latter include the size caps that Simon and I argued for in 13 Bankers and the strict ban on proprietary trading that has been repeatedly watered down in what is now the Volcker Rule.

Rahman’s historical argument is that the managerial approach is actually a relatively recent creation. Among the Populists and Progressives (think of Louis Brandeis, for example), financial regulation was a political and even moral issue, and questions of the social utility of finance were paramount. In one sense, they finally won in the New Deal reforms of the 1930s. But the regulatory agencies created by those reforms became the new locus of technocratic expertise, and over time their objective became macroeconomic management rather than social progress. This trend only accelerated later in the twentieth century, bolstered by the general rise of economism and the fetishization of free markets, to the point where some (e.g., Greenspan) opposed any regulation and others defended regulation narrowly as a way of correcting for market failures.

What is missing, Rahman argues, is any actual consideration of the social value of finance in general and financial innovation in particular. In its absence, we are left with the judgment of the expert technocrats, which has predictably led us to where we are today. If we do open up the scope of financial regulation to take questions of social value into account, we might end up in a very different place.


17 thoughts on “The Social Value of Finance

  1. ‘Wall Street banks and their lawyers simply want less regulation of their industry….’

    Which is not true. Regulation restricts entry, which restricts competition. That’s a good thing from the perspective of the existing players.

    ‘Among thethe Populists and Progressives (think of Louis Brandeis, for example), financial regulation was a political and even moral issue, and questions of the social utility of finance were paramount. In one sense, they finally won in the New Deal reforms of the 1930s.’

    Ha, ha, ha, ha…. Those ‘reforms’ created two cartels; commercial banking and investment banking, largely along the lines of the interests of the Rockefellers and the Morgans.

  2. Which wouldn’t have been so bad Pat had they kept those standards. Instead now we have such facts as proving their is no God, For had there been, he (OR SHE), would never have allowed usury rates to exceed 10%, for anyone, at any time. I smell consequences to be paid.

  3. ‘Following banking/security law reforms that took place in the 30′s and 40′s, commercial banks operated in the best interest of society and senior management of these banks took seriously that societal role.’

    Who told you that, a Rockefeller?

    ‘Starting in the late 1980′s Wall Street and securitization, moved into taking charge of commercial banking, that ended in the repeal of Glass Steagall. ‘

    Even Wikipedia knows that provisions 16 and 21 (that define separate investment and commercial banking)of Glass-Steagall are still the law.

  4. Btw, isn’t it a bit of bad form to write a post about The Social Value of Finance without mentioning that newly minted Nobelist Robert Shiller published a book titled, ‘Finance and the Good Society’?

  5. I frankly found ‘Finance and the Good Society’ rather utopian, nieve, and self-serving. Perhaps Schiller wasn’t quoted because Schiller didn’t write anything of use to the present discussion.

  6. So, Oregano, is it your belief that in places where there is little in the way of finance life is better for the masses? Or is that in such places people are likely living without indoor plumbing and electricity.

  7. So, Paddy, you are pretty much defending “creative” financial instruments that are dragging USA back to living without indoor plumbing and electricity – spare me the full-circle zen thingy

  8. Patrick, I simply found that Schiller was belaboring his points in his book. It could have been a pamphlet. I have no beef with financial services that promote general commerce cost-effectively. I think that Schiller’s book was somewhat misnamed; it was more about Economics and the application of Financial thinking to societal purposes. Of course, one must define the benefit criteria for this, and such criteria need to be far more broadly constituted for Schiller’s propositions to work. I question where the impetus to generate those broader metrics comes in the current financial environment, and that’s what I mean by utopian and self-serving. My comment was not meant as an attack on yourself, merely a statement of my disappointment in the light content of Schiller’s book.

  9. the social reason for money is to keep people honest. this is clearly a moral function.

    given that economists now say that economics (ie, “science” of livelihood) is not about livelihood, economists have gone rogue.

  10. Sebastian Mallaby’s review in the NYT 6/12 Sunday Book Review of “Finance in the Good Society” captures my complaints about the work nicely:

    A similar complaint is echoed by The Economist’s review:

    Schiller himself boiled down his ideas into this short discussion paper presented at the Yale Cowles Foundation in 2013:

    Click to access d1894.pdf

    Finally, Schiller in a 2012 Milken Institute piece again distills his ideas more effectively:

    Click to access 65-78MR54.pdf

    I suspect that Schiller may have been compelled to expand upon his ideas overmuch to meet the needs of a book. In the process, his arguments lost focus and distractions to the reader crept in. This is a common problem: consider Nat Silver’s otherwise fascinating The Signal and the Noise.

    However, Schiller’s ideas for better financial instruments are interesting and worth pursuing. Implementing them well is another question, and requires institutional trust that is in short supply.

  11. How can anyone assert that “management” is a recent invention?

    All businesses have their limits to any one central or top authority’s ability to command and control what happens in that business from the top down. This is not to say that the state can’t have a few good laws and rules in place to govern how this or that business type behaves.

    Financial institutions are able today to cheat people largely because their top men don’t and can’t really know what is going on at their lower levels. Bank lobbyists claim that too many nitpicky rules and regs some of which don’t suit every situation, make them behave badly–and that is indeed often quite correct. It depends on what you are talking about. Neither “side” of this is ideologically, meaning, always by definition, right or wrong. Things are only right or wrong in particular cases. Overcomplexity suggests that banks today are just too large and ungovernable, and that none of their superiors are properly accountable. They have too much limited liability due to the corporate structure, and they benefit by too many corporate veils. At the same time, they actually don’t and can’t know what is “really” going on in detail (or if they do, it is very easy to lie about). They, and their boards, receive “glowing” reports from below with rosy conclusions. That immunizes their accountability.

    What is being missed is the antique principle of subsidiarity (Jesuit in origin as many things are). You have huge firms built on assumptions that size and scale self-insures, when it does not. It obfuscates and dumbs down and wrecks the natural sizes of enterprises if market (and legal) accountability were allowed to work (both are disrupted by the assumptions of crime “prevention” of regulation). And there is no legal accountability because the tracing of personal responsibility is too hard in large corporate situations. There, people do bad, self serving and stupid things, often not so much because they are malicious, but because they are ignorant. Those in charge of oversight at various levels have other incentives–such as their own short term gain, or, on the government regulatory end of it, simple, radical failure to see or understand the industry in enough detail to know what to do about it, or how to do that. Instead they just sit in meetings gabbling. All of this is a recipe for disaster because it just defrauds the American public that things are “under control” when they are not.

  12. What people do not understand about the Volcker Rule (really, just a comment, not a Rule) is that banks traditionally are fiduciaries. That means they cannot aggregate client information then to use it to self-serve (say, to front-run their clients on trades). They may not benefit themselves by stealing client information to benefit themselves. All of digital today including finance is ALL ABOUT getting an informational edge by aggregating “client” or “customer” information. The hard problems are not about economics at all, but about law, and about what we consider moral and immoral. In other words, what the “rules” are. After that it is about what is enforceable and what isn’t. Most of financial crime at the big bank level is just far beyond the ability of the government to prosecute within the limits of due process. Only the worst of the worst obvious crimes a la Madoff (or biggest media splash events) will get done.

  13. So at the end of this article and of this debate, what we have is a situation that is largely unchanged from 2007. The markets seem to find themselves a new disaster every 10 years or so, which means we are probably less than five years away from the next one. All so we can have an exclusive club issuing new shares of stock and trade around and around all the existing shares. Such professionals.

  14. @lynn – didn’t find the link to Jesuit philosophy for living in the wiki version of “subsidiarity”….where is that information revealed?

    WWJD at a Jesuit confab about the “economy”….? Jesuits and Mormons are not “christians” as an organization – tons of treaties on th esubject to back up that claim…

    SO one must also question THEIR definition – “survival of the fittest” – in HUMAN BEINGS…

    From that verboten, but LUCID, Urantia Book, a set-the-record straight version of the cleansing of the temple:

    Page 1891 – “…..This cleansing of the temple discloses the Master’s attitude toward commercializing the practices of religion as well as his detestation of all forms of unfairness and profiteering at the expense of the poor and the unlearned. This episode also demonstrates that Jesus did not look with approval upon the REFUSAL TO EMPLOY FORCE to protect the majority of any given human group against the unfair and enslaving practices of unjust minorities who may be able to entrench themselves behind political, financial, or ecclesiastical power. Shrewd, wicked, and designing men are NOT TO BE PERMITTED to organize themselves for the exploitation and oppression of those, who, because of their IDEALISM, are not disposed to resort to force for self-protection or for the FURTHERANCE OF THEIR LAUDABLE LIFE PROJECTS.”

    Once you get into someone’s “business”, as rule of law, there is nothing but violence at the end of that road.

    The wicked are still writing in the sky the message “Surrender Dorothy”…

    Good job taking out the Sands Casino websites – LOL

    “Returning computer to an earlier time” – they got no proof it’s theirs….

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