The finance profession gets maligned after every financial crisis. The anger is especially strong now, after the most recent financial crisis, which began in 2007, and the anger that is felt about it goes far beyond the Occupy Wall Street movement. The crisis is often viewed as more than an unfortunate accident, but as a revelation of an underlying moral fault.
Of course, some people in finance are evil, but that is true in every walk of life.
Maybe the wrongdoings of financiers loom especially large in our imagination, since some in finance make so much money doing it. We naturally want a more equal society where most people feel fulfilled and sense a basic respect from others. But, we have to think about how achieve that kind of equality without disrupting our goals or disturbing our standard of living.
Moving forward from here, we need to think about how we can make finance work toward a society that is both comfortable for all of us and stimulating and forward-moving as well. In my view, doing that means tinkering with some of the financial institutional structures so that they work better for everyone, and expanding the scope of finance to cover more of our risks and activities. That means enlisting the help of people with financial expertise. Throwing a lot of financial people in jail or shutting down financial institutions are not on my list.
In my new book Finance and the Good Society (Princeton) I advance some ideas how this can be done, in our new information-technology-rich society:
1. Advance the benefit corporation.
From the initiative of the nonprofit B Lab, the first law allowing benefit corporations was created in Maryland in 2010, and now eight states have them. A benefit corporation is a for-profit corporation that has some additional social or environmental purpose other than just making profits. Each benefit corporation can define its own purpose and will attract its own kind of idealists as investors. My guess is that this new idea will turn out to be a winner, that will yield some of our most profitable corporations because of the employee and community support they will inspire. The amazing example of Wikipedia, with its unpaid authors, shows how public purpose can motivate people.
2. Create what I am calling, in my new book, participation nonprofits, nonprofits that might run schools or hospitals or the like, but that raise money by selling shares to the public.
Such a firm pays dividends from its profits into a special account in the name of the shareholder. The shareholders get a charitable tax deduction for making the investment, but can use the dividends in the account only for further charitable contributions, including purchasing shares in participation nonprofits, or can spend them on themselves in some predefined emergency situations such as a medical crisis. With participation nonprofits, charitable giving will be more fun for the donors, for they could watch their money grow and feel their influence grow with it, if they invest wisely, fulfilling a natural human need for stimulation and appreciation. For example, the Wikipedia Foundation might have been even more successful if it had been set up as a participation nonprofit, and found some revenue opportunity associated with their mission. Instead of operating on a shoestring of the mere 75 employees it has today, I'll bet it would have received many billions in donations by now, which it probably could use for a much expanded social purpose.
3. Create what I am calling continuous-workout mortgages, mortgages whose contract specifies from the beginning that the loan balance will be reduced in contingencies like a decline in home prices or a severe economic recession.
In the current crisis, we are hampered by the fact that few troubled homeowners are getting workouts on their mortgages. This has been a significant factor in the severity of the crisis, since people who are underwater on their mortgages are not likely to spend, or to move to take a new job. Workouts could be not only preplanned but also made continuous, responding day by day to every change in the economic situation of the homeowner.
4. Get risk-management markets for real estate risks going on a high level.
In 2006, my colleagues and I worked with the Chicago Mercantile Exchange to launch the world's first futures exchange for single-family homes. The market is still going, though trade is very weak. But the CME Group has just launched new options on home prices, which may rekindle the market. If this initiative does not work well either, we need to come up with another initiative to make these markets work, which will enable private mortgage issuers to use them as risk management devices so that they can do such things as create continuous workout mortgages without taking on unacceptable risks by doing so. The financial crisis might largely have been prevented if we had such markets.
5. Empower lobbyists on behalf of the 99%, the people who make up all of the population except the very wealthy.
There is nothing wrong with lobbyists per se, for they give needed information to lawmakers. Every interest group should have lobbyists, including the working class and the poor. Financial lobbying is especially important since lawmakers cannot be expected to have expertise on difficult financial concepts. The problem has been that the financial lobbyists have grown dramatically in resources in recent decades, while other groups' lobbyists have not. Supporting a better balance of lobbying efforts needs to be emphasized.
6. Advance the cause of risk management for the very poor.
There are billions in the world today whose survival depends on subsistence farming. Farms ought to be able to insure their crops against failure due to bad weather. Traditional crop insurance has not worked because crops are difficult to verify and there is thus a moral hazard problem. Now that weather reporting is more detailed, and now that agronomists better understand the relation between crops and weather, we can base insurance on the weather changes that affect crops. The take-up by farmers of such insurance has been slow, despite demonstration programs sponsored by the World Bank and other donors. We need to experiment more with marketing forms until we get these right.
7. Create more sophisticated forms of public debt.
At the present time, national governments tend to rely exclusively on conventional debt to finance their deficits, in contrast to companies who use both debt and equity as well as a plethora of other financial devices. A simple first step would be for governments to sell shares analogous to the shares in corporations that are traded on stock markets. My Canadian colleague Mark Kamstra and I have proposed that governments with deficits, instead of borrowing more now, start selling what we call trills: each trill promises to pay a dividend equal to trillionth of GDP each year to the owner, in perpetuity. Investors who are optimistic about GDP might love these investments, and governments would then find that they are cushioned against financial crises like the present crisis since their required dividend payments decline then.
8. Create tradable social policy bonds.
The idea, first articulated by Ronnie Horesh in New Zealand, is for governments to create bonds that pay out if some specified social policy objective, such as an increase in public awareness of some important issue or a decline in some specified crime rate. By creating such bonds, an incentive is created for private sector initiatives to solve them. An entrepreneur can profit by buying the bonds and taking steps to solve the problem. The entrepreneur does not have to wait to profit until the day when the policy objective is finally met, for, if these bonds are traded on public markets, the price of the bonds will tend to increase in anticipation of the fulfillment as soon as the prospect is apparent.
9. Create an inequality indexation scheme in the tax code.
We would pass a law now that specifies that taxes will be indexed to inequality: tax rates on higher incomes will be automatically raised at any future date when inequality surpasses a specified threshold level worse than it is today. It should be politically much easier to create such a contingency plan now, to be triggered only at a future date if some specified level of higher inequality is reached, than to raise taxes later after such inequality is a reality and a political constituency for the newly rich is created. Just as, with fire insurance, one must insure a house before it burns down. So to, if we are to view increased inequality as a risk with a financial solution, we should take risk-managing actions while it is still just a risk.
10. Create livelihood insurance, insurance offered to individuals against declines in the average income paid to people in their professional specialty.
We already have disability insurance, insurance that protects individuals against loss of income due to illness. In the information age, we ought to be able to expand such insurance, without triggering moral hazard, to protect people against possibly catastrophic drops in lifetime earnings that sometimes occur when people's occupational income suffers a serious hit because of some technological innovation or change in the economy. If people are able to insure their livelihoods against such events, they will not only rest easier, they will be able to be more adventuresome in their career choices.
All of these ideas are expansion of basic financial technology toward the broader social benefits. The first step in making any such things happen is first to appreciate the kinds of financial institutions we already have, as well as their defects. We need then to improve and build up this financial infrastructure so that it works better in our lives.
Robert Shiller is professor of economics and finance at Yale University. This month Finance and the Good Society appeared and also a new revised version of his free video online Financial Markets course, part of Open Yale, was launched.
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