In Defense of Finance

“The first thing we do, we kill all the lawyers bankers.”

— Shakespeare, Henry VI (Part 2) — if it were written in 2010

It’s not easy being a financier these days. Even the usually clear-thinking James Fallows jumps on the down-with-finance bandwagon by lamenting the increase in the percentage of Rhodes scholars that go into finance instead of other fields. But let’s think this through: We just had a near-collapse of the world’s financial system due to horrible decisions made by financiers. So that means we want fewer intelligent people in finance?

Hardly. The problem is not that we have too few or too many intelligent people in finance (though I suspect there are too many people overall in finance), the problem is that we have the wrong kinds of intelligent people in finance. There’s no shortage of smart people in finance; there’s a painful dearth of thoughtful people in finance.

To think about what kind of people we need in finance, it’s helpful to think through what exactly finance is for. People tend to think of finance as the (often rapid) movement of money. Yet money in and of itself isn’t what’s important; it’s only valuable because it’s a tool we can use to get stuff we want. Ignoring the tool of money, we see an economy is people exchanging their stuff to get other people’s stuff. You make me a sandwich, and I’ll do your laundry. As long as the goods are as simple as laundry and sandwiches, we don’t really need finance. But when we want to build something like, say, a 250-passenger jet airplane that can fly from San Francisco to Beijing, you can’t exactly use the barter system. Money is a tool that facilitates the exchange of stuff, and when we introduce money, we get two things: a common medium to exchange goods with and a way to shift the timing of when we consume things.

All money really is is future consumption. All finance really is is the exchanging of one person’s future consumption for another person’s current consumption. You make me 30 sandwiches now, and I’ll do your laundry for a month one year from now. Obviously, an airplane is a lot more complex, but it’s the same principle at work. You guys provide us with stuff now (steel, carbon, your time), and in five years, we’ll have planes that will fly people around, who in turn will give us some of their stuff. We’ll get you your stuff back and a lot more. This is an economy. This is finance.

If we want complex goods like airplanes, Google, buildings, electricity — i.e., things that take a long time to make — we need finance. An author who takes an advance in order to support herself until people buy her book is finance. Paying scientists a salary while they try to discover a life-saving drug is finance. If a guy wants to buy a new home, he generally has to pay for it upfront to the people who built it — they put a lot of their own money and time to get the house built after all — but he’s going to use (consume) it over 20 years. So there’s a mismatch between when something needs to get paid for and when it’s going to be used, and finance bridges this gap. People may call finance different things (e.g., an advance, payment deferrals), but it’s all the same thing: people exchanging with each other the timing of when they consume things. You can use my stuff now, as long as you give me more of your stuff later on. Without finance, we can’t make complex goods that take a long time to make.

And here’s our problem: Finance is inherently a long-term function of an economy, which requires people who can balance trade-offs today against benefits many years in the future, but the people in finance today are caricatures of frenetic, short-term, sloppy thinkers. Modern financial “innovations” have transformed long-term transactions into bite-sized, short-term packages. Today’s financiers seem to be the ultimate combination of high IQs and low levels of curiosity. And I say that as a financier.

Finance can continue to play its role in our society even if the people doing it don’t quite understand their role, just as cats in heat can create life even though they’re not aware that’s what they’re doing. But I submit that we end up with a better world if we have thoughtful bankers and investors who deeply understand their function and exhibit characteristics like intelligence, patience, a long-term orientation, and independent thinking. Today, we have hordes upon hordes of day-traders with herd mentalities whose behaviors put our economy at risk. Think of it as a massive feral cat problem.

2 responses to “In Defense of Finance

  1. Good post.

    “We just had a near-collapse of the world’s financial system due to horrible decisions made by financiers. So that means we want fewer intelligent people in finance?” — This is not defended / explained. Was the horrible decisions made by financiers to blame? Would “better people” not have made those decisions? Or were those decisions caused by fucked up incentives that even the best men would have pursued, etc.?

    “But I submit that we end up with a better world if we have thoughtful bankers and investors who deeply understand their function and exhibit characteristics like intelligence, patience, a long-term orientation, and independent thinking.”

    I don’t think this is a selection of people problem. It’s a system/rules/incentives problem.

  2. I think the case has been made by better men than me that this was a man-made problem. The Andrew Ross Sorkins, Nassim Talebs, and Roger Lowensteins tell that story better than I do. People massively leveraged companies to a ratio of up to 50:1, idiotic decisions that Jamie Dimon, Warren Buffett, or Taleb would never have done. This crisis arose due to horrible decisions by people who didn’t know what they were doing and took on excessive risks. If you replace the heads of Bear, Lehman, WaMu, etc., with Buffett or Dimon in 2002, those firms don’t go under. Those guys had the same systems/rules/incentives for their own firms, but exercised better judgment and restraint (not just better “trades”).

    The interesting question is then why aren’t there more thoughtful people making those decisions in the first place? And that’s where I think your point is spot on. That is a system/rules/incentives problem, and it’s just semantics of whether it’s people per se or the systems that determine what people get to the right places.

    Narrowing things down a bit, if we ask ourselves, “How do we fix this problem?”, we can’t just say “get better people.” My argument would be that we’d benefit from a system/rule structure that rewarded intelligent, long-term thinkers. As to how do that, that’s probably a much longer blog post.

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