One Economist's Mission to Redeem the Field of Finance

Michael Marsland, Yale U.

Robert Shiller is a professor of economics at Yale U. and author of a new book that defends the positive power of finance.
April 08, 2012

Among the members of the rogues' gallery blamed for the crash of the economy in 2008, none have worn the black hat of villainy quite as convincingly as greedy financiers.

Robert J. Shiller, however, sees them and their field in shades of gray.

"It's kind of a mythology that's developed around finance," says Mr. Shiller, a behavioral economist, professor at Yale University, and teacher of many future financiers. Rapacious Wall Street types, he says, may make handy bad guys in the movies. "The problem is, we can't live in a mythic world. We have to live in the real world."

And in the real world, Mr. Shiller argues in his new book, Finance and the Good Society (Princeton University Press), finance is a powerful and necessary tool to keep society running.

It is the architecture that allows people to reach their goals, such as paying for college or starting a business, and to protect their assets throughout their lives.

Finance's architects and stewards pervade the work force, as Shiller sees it. They include such obvious examples as investment bankers, mortgage lenders, and financial engineers, as well as those who do not work in finance on a daily basis, but still influence it: policy makers, philanthropists, and economists. To characterize such a broad cross-section of people and their professions as blighting the economy simply makes no sense, as Mr. Shiller sees it, even if some of them made very bad choices, particularly before the economic crash.

"I never felt, as did so many, that these problems were a damning indictment of our entire financial system," he writes. "Imperfect as our financial system is, I still find myself admiring it for what it does, and imagining how much more impressive it can be in the future."

And the best way to make finance more impressive, he argues, is not to restrain innovation or to discourage the invention of new financial instruments, but to encourage further experiments.

Such experimentation, he continues, should be tied to a larger goal of making finance more humane, democratic, and inclusive, in support of what he calls the Good Society.

For example, a nation could create an inequality index instead of legislating fixed income-tax rates. Under such an index, a government would devise a formula that tied tax rates to statistical measures of pre-tax inequality. If incomes were to grow more disparate, tax rates would automatically become more progressive. It would serve as a kind of insurance policy against inequality.

Mr. Shiller also cites other people's ideas, including social-policy bonds, a proposal by the New Zealand-based economist Ronnie Horesh. Intended as a means to provide incentives for socially desirable outcomes, these bonds would be issued by governments and be redeemed when certain social-policy objectives were achieved, such as lower rates of pollution or crime.

While Mr. Shiller's book offers a handful of similar ideas, he also takes pains to defend the actions and character of those who work in finance, a system that he argues rewards people of moral purpose. The notion that businesses are prone to act immorally and aggressively, Mr. Shiller says, is an illusion.

"This assumption, if left unchallenged, will create resentment toward business that will inhibit its proper functioning," he writes, "thus threatening to slow the advance of the world's prosperity in coming years."

'Two Shillers'

For those who know Mr. Shiller as the Cassandra who predicted the bursting of the dot-com bubble in his book Irrational Exuberance and the subprime crisis in that book's second edition, such defenses of finance may be disconcerting.

Indeed, he stunned some listeners when he delivered the plenary speech at the annual meeting of the American Economic Association in January. He argued that concerns about rising inequality, as expressed by protesters aligned with Occupy Wall Street who demonstrated outside the conference, could be resolved by approaches like those he outlines in his new book.

Mr. Shiller also appeared to defend the high salaries paid to financial executives. "Unequal pay of executives is part of our society," he said. "We should be careful about modifying it."

The audience was fairly shocked, says Martha A. Starr, an associate professor of economics at American University, who introduced him that evening. But his faith in the virtues of the financial system is not as big a departure as it may seem to those who have watched Shiller's career.

"There have always been two Shillers," Ms. Starr says.

The first Shiller, she says, is the behavioral economist who has cautioned that unpredictable human choices can muddy rational thinking and render economic models less predictable in the real world than they might appear on paper. It is that Shiller who sees the connection between human foibles and the existence of stock-market and housing bubbles.

The other Shiller, Ms. Starr says, is the visionary who sees financial markets as holding the potential to fix social problems, if only they could be fully developed and left alone to innovate. It is this other Shiller, the one also in evidence in his 1998 book Macro Markets: Creating Institutions for Managing Society's Largest Economic Risks, whose thinking guides his new book.

The problem, says Ms. Starr, is that in Finance and the Good Society, Mr. Shiller offers an "optimistic and utopian view of finance," which the events of the last few years have called into question.

"In some ways, there's a missed opportunity here to bring the two strands of his thinking together," she says. "People are hesitant to come out in front with an opinion of his book, in part because the things they might say are a critique of the second Shiller, which they have to factor in with their extraordinary admiration for the first Shiller."

Reviewers have also noted the way Mr. Shiller's new book reveals contradictions in his thinking. James Pressley, writing for Bloomberg News, lauded Mr. Shiller for being both a pragmatist and a visionary. But he also faulted him for veering close to naïveté in defending finance even as fresh outrages keep emerging. Mr. Pressley's review appeared last month, just days after a Goldman Sachs employee resigned on the op-ed page of The New York Times, chastising the firm for what he called its "toxic and destructive" environment and for the contempt its junior analysts showed for their clients, except for the profits that could be extracted from them.

"If he hasn't already done so, Lloyd Blankfein should dash off a thank-you note to Robert Shiller," Mr. Pressley wrote, referring to the chief executive of Goldman Sachs.

Similarly, Robin Harding of the Financial Times praised Mr. Shiller for being "wonderfully persuasive" in refusing to play down Wall Street's problems. But he too faulted the economist for dismissing concerns about finance with an "airy wave," and for assuming that financial innovations automatically help to improve society.

"If collateralized debt obligations and subprime mortgages have told us anything," Mr. Harding wrote, "it is surely the reverse: The natural tendency of financial innovation is toward complexity, exploitation, and crisis."

Mr. Shiller acknowledges his own uncertainties about whether he struck the proper tone, and he concedes that financiers who truly merit criticism may use his book for cover. "That is a concern of mine," he says. "I don't know if I did it right. Maybe I was too positive."

And he responds to criticism that he is inconsistent by saying his work acknowledges two realities: The financial sector drives much of the world economy, and bubbles exist. "Reconciling these two realities in one theory is difficult, and offends people who want to see simple answers," he says. "I want my students to know the truth, which is messy and does not allow any simple, all-embracing theory."

Mr. Shiller's tendency toward nuance and iconoclasm may explain the odd position in which his book may unintentionally put him. Views of finance have grown highly polarized, and they have changed quickly.

He began writing his book after the financial crisis set in, but before Occupy Wall Street helped to define the financial sector's high-flyers as members of the 1 percent versus the 99 percent.

In 2009, one year after the financial crisis hit, anger was concentrated on the "unreasonable" salaries of financial executives, an Ipsos poll found. Two years later, Gallup said that Americans were more than twice as likely to blame the government than Wall Street for the nation's economic woes.

This year, however, after inequality became a fixture in public discussions, the Pew Research Center saw evidence of increasing class tension. About two-thirds of respondents said that conflicts between the rich and poor had grown "very strong" or "strong," a 19-percentage-point increase since 2009.

Today Mr. Shiller speaks approvingly of some of the goals of Occupy Wall Street. He worries about rising inequality and describes financiers as existing in a separate caste, troublingly apart from the rest of society.

At the same time, he worries about public anger boiling over into destructiveness. In this sense, the voice of the first Shiller is the one prevailing—except that, when he cautions against the dangers of groupthink, he is aiming at public opinion instead of irrational exuberance.

"We may be at a time when the people reclaim their economy," he says. "That doesn't mean punishing finance or refusing to go into finance. It means expanding it and making it inclusive."

An Eye on the Future

When Mr. Shiller makes reference to those who refuse to go into finance, he has his primary audience in mind: his students at Yale, where he has taught for 30 years, including 25 teaching a class on financial markets. He intended his new book for those students, and he based much of his book on his lectures for that class.

Yale has been a prime feeder of young talent to Wall Street for decades. Since 1975, about one-quarter of each class of Yale graduates has consistently gone on to work in finance, according to the university's office of institutional research, though this number dropped to 14 percent in 2010.

But there and at other campuses, students have started debating whether they should work for financial firms after graduation. In November, 25 Yale students protested outside an information session offered near the campus by the financial-services firm Morgan Stanley. Students say that many consulting and financial firms recruit them by appealing to their idealism, telling students that working at these companies will prepare them for advancing the public good in the future.

The intent of the protests was to prompt students who enter finance to think hard about whether it is what they truly want for themselves or whether they are simply making an easy choice, says Marina E. Keegan, a senior majoring in English. In the campus newspaper, Ms. Keegan lamented how many of her classmates enter finance, and she helped organize the protests.

"I don't see it as a very productive use of the skills, passion, and creativity of the people that I know," Ms. Keegan says, describing classmates who work in the arts or advance social-justice causes while they are on campus, but then gravitate to finance, with its large starting salaries, after they leave. "I think it's a huge talent suck."

Duck Ju Kang, a senior majoring in economics and a research assistant for Mr. Shiller's book, says the debate on campus about finance has grown more heated this academic year.

"It affects you when there are 400 kids on the campus telling you you're just evil and you don't do anything for society," says Mr. Kang, who was an intern last summer for a hedge fund and plans to work as an investor after he graduates, "but then I don't believe that at all."

Some students in Mr. Shiller's financial-markets class, which is an upper-level elective, agree that many Yale graduates who enter finance do so because they are unsure about what else to do. "It's automatic brand recognition," says Rachel Wang, a senior majoring in economics who was also one of his research assistants.

And, while she sympathizes with the critiques leveled by Occupy Wall Street, Ms. Wang says those arguments tend to oversimplify. "You have to distinguish between finance as a field and specific people who make bad decisions."

Ms. Wang hopes to bring her analytical and financial skills to work for a firm specializing in clean energy, a position that would help her fulfill Mr. Shiller's vision of finance serving the good society. "You can absolutely go into finance and retain what you're passionate about," she says.

That perspective was echoed by Mark D. White, professor and chair of the department of political science, economics, and philosophy at the City University of New York's College of Staten Island, who studies ethics and economics.

He concedes, though, that recent graduates who enter finance are more likely to find themselves working at big firms where they may have little contact with their clients, and that those sorts of jobs can insulate people from the consequences of their decisions.

Students who are unhappy with the way finance operates should seek to enter the field and change it, he says. "Rather than protest them, join them."

But that line of argument is naïve, say some Yale protesters. Alexandra Z. Brodsky, a senior majoring in ethics, politics, and economics who helped organize the protests, says she is happy that Mr. Shiller's book discusses the need to democratize finance, but she worries how much such an effort can succeed when it seems to run counter to the purpose of finance, which is profit-making.

"I'd like to think that an idealistic twenty-something could go in and revolutionize the system," she says. "At the same time, I don't know how that would work. It's a huge system with the express goal of making a lot of money."

That, ultimately, may be where Mr. Shiller disagrees most with students at Yale. As he sees it, finance is simply a technology. Its goal is not to make money, but to serve societal goals.

Distinctions of this sort can easily get lost amid heated rhetoric about finance, says Mr. White, of Staten Island. "Discussion these days about anything tends to be polarized," he says. "I don't think someone trying to be nuanced and hit all the bases is likely to succeed. Someone of Shiller's stature may get listened to more."