I remember where I was when I read Matt Taibbi’s sermon in Rolling Stone, denouncing the finance industry as
“a great vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money."
This was just another confirmation of what we already knew, right? Shylock got his “pound of flesh”, Gordon Gecko told us “greed was good” and Patrick Bateman was as “into murders and executions” as much as his day job on Wall Street.
Yet I see great hope in this industry. After a career in human rights and public policy, I know it has the inherent potential to be a force for good in the world. But how to explain it in the face of such derision?
Mihir Desai’s 2017 book, The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, helps me out;
“There is great value — and there are great values — in finance”. After all, he says, finance is simply a way for us to try and find our own version of the Good Life. It is just “a set of tools for understanding how to address a risky, uncertain world”.
The tools of finance
The paragon of a value-producing financial system is one that enables efficient allocation of capital to support economic growth and manage risk. The core purpose of finance is to help people access the things they need (food, shelter, healthcare) and the things they want (education, self-expression, artistry).
Desai believes the finance industry can be guided back to this through the humanities - stories that illustrate its core purpose in literature, philosophy, and history.
“In finance,” (Desai says,) “we are trying to figure out how to invest our assets and manage toward the best risk-return tradeoff. In life, we are trying to figure out how to allocate our time and energies across many people.”
He describes how Lizzy Bennet of Jane Austen’s Pride and Prejudice is an exemplary risk manager as she navigates optionality in the 18th-century marriage market. Perturbed by Lizzy’s declining of Mr Collins’ proposal, her mother tried to play on Lizzy’s aversion to risk by warning her that no better marriage offer will come along. By holding her position, Lizzy realigned her investment strategy to maximise her own preferred suitor conditions.
Financial leverage is merely another way for us to access opportunities beyond our current resources. Do student loans not produce doctors? Do mortgages not provide secure shelter for families and venture capital not allow innovative technologies to enhance our lives?
Stories of the Bennet sisters do little, of course, to distract us from the general assholery of people in finance and their parasitic consumption of countries’ and communities’ economic health.
Using the tools of finance to find a husband is one thing, using them in a way that directly causes the global, catastrophic, economic shock of 2008 is another.
To return to the noble core of finance, we need a structural solution to the structural damage it has wrought.
The failures of finance
Where finance has gone wrong, Desai says, is the attribution error created by the “Incentive Bubble”. People working in finance have unusual exposure to immediate feedback for their decisions - so when a decision creates a favourable financial windfall, the person who made that decision wrongly attributes that outcome to skill, not luck.
An incentive bubble is formed when finance businesses hit a critical mass of financial gains untethered to measurable performance, vacuous governance practices, and under-enforcement of the rule of law by regulatory agencies.
“ It’s not finance that’s bad”, (Desai hopes,) “It’s not the people who finance attracts who are bad. It’s just that finance fuels ego and ambition in an unusually powerful way.”
Returning to the promise of finance
Surely the sepsis in the modern financial system cannot simply be pinned on, and fixed by, realigned compensation packages for finance professionals, right? Desai’s not leaving us with only the idea that “finding narratives that allow us to stay attached to what is meaningful in finance can insulate us from the feedback loops of attribution error” as a conclusion, right?
Desai is only hoping that the people using the tools of finance choose to do so in a better way.
While the promise of finance remains, I think he's missed that the current industry's roots are already rotted through.
Even if the industry could find the will to curtail their own remuneration packages, people's trust in its ability to do so, and therefore their willingness to continue allowing its powerful position, is irrevocably broken.
The advancements of decentralised finance - DeFi - are nascent but undeniably creating a new root system for a new finance industry. It retains the utility of financial tools, but removes the people who misuse them. It’s becoming possible for people to borrow, trade, invest, and save without the current finance industry as an intermediary.
DeFi might be on the way, it is not here yet. DeFi’s tools won’t be able to replicate the power of traditional finance tools until there is widespread adoption - you needed your Nanna to learn to text before she could get rid of her landline telephone, and you need your economic community to be using digital currency before you can start leveraging it.
That we can so specifically name DeFi’s barriers to adoption, however, tells me we’re well on the way to overcoming them.
Desai was right, it’s time to “return to the core ideas, and ideals, of finance”. It’s just not going to look anything like what he’s seen.