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8 September 2017 Financial Analysts Journal Book Review

Finance and the Good Society (a review)

  1. Murad J. Antia, CFA
Robert Shiller contends that the recent financial crisis was caused not by greed and dishonesty but by the structural shortcomings of financial institutions. He suggests that the financial industry can serve the common good through financial innovation that creates the kind of inclusive society in which all can benefit.

Robert Shiller is renowned for identifying the stock market bubble as early as 1996 and the real estate bubble in 2006.1 One might assume that he is not a fan of the financial industry, given its past excesses and ensuing wealth destruction, but one would be wrong. In Finance and the Good Society, Shiller suggests that the industry can serve the common good rather than be a parasite. He makes the case that financial innovation can create the kind of inclusive society in which all can benefit. Shiller contends that the recent financial crisis was caused not by greed and dishonesty but by the structural shortcomings of financial institutions.

The first half of the book is devoted to explaining the direct and indirect contributions of various participants in the financial industry, including CEOs, investment managers, bankers, lawyers, and regulators. Shiller mentions mostly positive and a few adverse impacts of these players.

Investment managers, to their sorrow, take it on the chin. Most of their claims of being able to outperform the market are deemed untrue because markets are too efficient. Shiller cites John Bogle, who maintains that some in the financial community are milking investors by providing false hope of superior returns and charging excessive fees for their services. By the same token, Shiller defends investment managers who provide value-added services and do beat the market, although very few do so consistently.

He concludes his discussion of investment management by writing, “In the future, better regulation and better financial advice for general investors can help improve the overall state of the investment management industry.” Such generalities do not help the informed reader who is looking for new or, dare we say, cutting-edge ideas from an author of Shiller’s stature.

A chapter on mortgage lenders and securitizers rehashes the notion that the real estate bubble resulted from a flawed assumption that home prices could never fall and false cover provided by the bond-rating agencies. According to Shiller, the problem was not stupidity but, rather, one of assigning responsibility and coordinating the efforts of diverse interests. He offers such creative reforms as mortgage contracts that give homeowners a more flexible repayment schedule and provide lending institutions the opportunity to co-own homes with homebuyers.

These ideas should have been explored further. A mortgage contract with flexible terms implies that the lender would receive an uncertain payment stream. The lender would logically demand a higher return to compensate for that uncertainty. Shiller’s proposal is essentially a risk transference from the buyer to the lender. How would such contracts change the mortgage market? Readers would like to know.

Errors by educators, Shiller believes, played a role in the financial crisis. He contends that the doctrine of perfect market efficiency, as propagated by many academics, created a false sense of security. According to the theorists’ view of the world, not even unethical practices could disturb this magnificent equilibrium.

Shiller also takes academics to task for focusing on research rather than preparing students for the real-world practice of finance. He does not address the impact (or lack thereof) of academic research on fostering the good society. Should the research conducted by finance (and economics) faculty have some measurable and virtuous social impact, especially given that taxpayers partially fund the research activities at state universities?

The second half of the book, titled “Finance and Its Discontents,” is devoted to the financial industry’s shortcomings and some proposed remedies. Shiller argues that the industry needs to think outside the box. For example, he recommends indexing rent to a basket of goods and services such that the real price would not fluctuate. In his view, government pensions should be indexed to taxpayers’ ability to pay as a means of promoting intergenerational risk sharing. He also advocates indexing the tax structure to inequality—that is, making tax rates more progressive when income inequality rises and less progressive when income inequality falls.

Again, these ideas merit a detailed discussion that could inform readers about their benefits and potential pitfalls. The devil is usually in the details of such innovations, which often lead to unintended consequences that render the cure worse than the disease.

Finance and the Good Society makes clear that Shiller is at heart an egalitarian who wants the financial industry to become more humane and inclusive in order to serve the common good. Some readers may regard the book as a public relations treatise for the industry or may object to his advocacy of an economy closer to the European model, with reduced income inequality. Few would deny, however, that Shiller floats novel ideas that deserve further scrutiny and debate.


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