Restoring Virtue to Finance
Finance is the engine of capitalism, according to Harvard economist Mihir Desai. Finance is what makes our whole economy tick, and its 600 year history is filled with success stories. Has finance reached a point, though, where its pervasiveness has become a weakness? John Dickerson, correspondent for CBS News’ “60 Minutes,” sits down with Desai to dig into what those working in finance should do to restore what Desai says the financial sector has lost.
Capitalism wouldn’t function the way it does without the mechanisms that finance creates, says author and Harvard economist Mihir Desai. Put simply, finance moves capital from those who have it to those who need it. Desai says that when finance works as it should, the results are unparalleled. But, he warns, finance done poorly can have major consequences. Desai explains how finance has drifted, and why it needs to be reined in:
Desai points fingers at what’s called value extraction — that, investors or businesses whose main focus is capturing value for themselves, not creating more for everyone (value creation). Desai compares value to a pie, and value extractors want to grab as much of the pie as possible, instead of helping to grow the pie for everyone.
Big IdeaA lot of the problems that people perceive in capitalism today…have to do with how finance has changed in the past 30 years.Mihir Desai
In order to understand the stakes of what’s at play when finance goes awry, Mihir Desai digs into the long history of capitalism and finance. Starting with prototype insurance companies and investment groups, Desai says finance has grown inextricably alongside our modern understanding of both society and humanity:
There’s a human face to finance that Desai claims capitalism would do well to remember. Spreadsheets, tables, and crunching numbers are great tools, but the abstractions they represent don’t capture the full picture of the humanity underlying it all.
So what happened over the past century that set finance on its current course? Mihir Desai traces it back to an unlikely culprit: the investment management industry that grew out of pension funds. Pension funds gave enormous amounts of money to investment managers — so much money, in fact, that their way of doing things became the default. Desai and John Dickerson explain further:
This exchange has been lightly edited for clarity
Mihir Desai: [The investment management industry’s] way of thinking about the world has come to dominate. That’s in everything. It’s in the way we think about share buybacks, it’s in the way we do social programs… How do we do nonprofits today? Everyone has to have an ROI. If you don’t have a return on investment model in your not-for-profit, you got a problem. That’s the dominance of an investor mentality, and when you come to think of it, it’s kind of absurd.
John Dickerson: But wouldn't people say we’re leveraging the investor mentality to do good things?
Mihir Desai: We are, but there is this sense in which we’ve contorted social policy and not-for-profits to have an investor mentality. So low income housing is a great example — that is the way we build low-income housing. If you think about a problem in the country that is really severe, it is housing shortages for low-income [communities]... And yet we really do it in this really weird, perverse way, which is that we sell tax credits to investors so that they can decide where to put low-income housing. It’s a complete Rube Goldberg machine, yet that’s the way it gets done.
Desai says investment managers dictate the rules because they hold so much sway over the economy, and that’s a problem. Desai explains that one way of solving one problem in society isn’t the solution to every problem.
Despite his critiques of the US financial system, Mihir Desai says that a handful of adjustments would go a long way to course-correcting the bedrock of capitalism. There’s a micro, he says, and there’s a macro:
On the more discrete level, Desai explains that investment managers need to make their decisions based off more than spreadsheets and statistics — they need to return humanity to finance. And on a larger scale, pension fund managers will have to take a more active role in deciding how and where their capital gets used. Otherwise, it’s too easily taken advantage of by the sort of value extractors that Desai says are leaching off true value creators.