Can Wonks Save Finance From Itself?

Does finance benefit society? Academics need a better answer.

Two on one hardly seems fair.

Photographer: Justin Sullivan/Getty Images

Does finance benefit society? It's a question that has become all too relevant in recent years, and one that academic economists need to do a much better job of answering.

Most economists assume that finance is an unmitigated good -- the more opportunities people have to diversify and insure against risks, the better off they are. The 2008 financial crisis and the long string of fraud and market-rigging scandals that followed, though, have given the public a different view: The latest wave of the Chicago Booth-Kellogg School Financial Trust Index shows that 48 percent of Americans think finance hurts the U.S. economy, with only 34 percent saying that it helps.

Strange as the proposition may seem to them, academics should care about public opinion. Popular resentment inevitably undermines the stable legal environment that a healthy financial system requires. Consider, for example, the retroactive 90 percent tax that Congress almost imposed on bank bonuses in 2009, amid public anger over bailouts. Fear of such expropriation naturally prompts the financial sector to seek political protection -- a luxury that only the largest institutions, operating in the least competitive markets, can afford. The resulting cronyism undermines the rule of law and further angers the public, in a vicious cycle that has played out around the world and now threatens the U.S.

Unfortunately, the public's opinion of finance is not merely a problem of misperception. Although academics can offer plenty of evidence that some financial activities benefit society, we cannot assert that all or even most do. Consider payday loans, which extend unsecured credit to lower income people at annualized rates as high as 440 percent, often disguised in the form of fees that borrowers seem incapable of understanding. While the access to emergency funds they provide may be useful, payday lenders profit by trapping people in a spiral of debt. Similar problems arise in various markets where buyers are too unsophisticated or conflicted to appreciate the actual cost of the financial services provided.

Then there's outright fraud, which paid off handsomely for its perpetrators during the most recent financial boom. Over the past couple years, financial companies have paid more than $100 billion in fines for transgressions ranging from lying about the contents of mortgage securities to laundering money for Latin American drug cartels. While shareholders paid the tab, the executives who engaged in misbehavior largely escaped punishment.

It would be wrong to ignore the benefits of finance and portray the entire financial industry as a criminal enterprise. It would be equally wrong, though, to turn a blind eye to the extent of its problems. Financial academics have a responsibility to contribute to the well-being of the industry we study. So what can we do?

First, we should employ empirical research to expose problems in the industry. The literature contains some beautiful examples of “forensic” finance, pointing out behavior such as collusion among Nasdaq dealers and shenanigans with stock options. The greatest challenge here is getting access to data from companies and regulatory agencies, which prefer to cooperate only with those academics who allow them to censor the results. Researchers should not submit to such conditions, and regulators should view academics not as their enemies but as their allies.

Second, we should not allow the rigor of our theoretical work to fall prey to lobbying pressure. All too often, economists build models that ignore specifically those parts of reality that are inconvenient for the financial industry -- a practice that can lead to misguided policies. Good theory should force us to look at the world in a different way, not skew our view of the world in favor of special interests.

Finally, we have a responsibility in the classroom. A recent experiment showed that bank employees behave more dishonestly when made aware of their professional identity -- a result that speaks poorly of the prevailing business culture in banking. Could it be that business schools are inadvertently training students to be dishonest? Professors need to make social norms, or at least business reputation, a part of regular MBA classes. Markets rely on trust to function. If we produce students who do not recognize the importance of trust, we risk undermining the very institution we all support.

Finance academics can make a difference. Our future is at stake. If finance deteriorates into a business of political relationships, our teaching services will be devalued. We should be at the forefront of the battle to make finance more efficient, more transparent and more useful to society. If we are not compelled to do it because it is right, at the very least we should do it because it is in our interest.

(Luigi Zingales is a finance professor at the University of Chicago's Booth School of Business and outgoing president of the American Finance Association. This article is adapted from his 2015 presidential address to the AFA.)

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

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    Luigi Zingales at

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