Finance deserves its corrupt reputation

Harvard/Chicago economist Luigi Zingales published a sharply argued, searing paper about the finance industry's reputation for corruption and social uselessness, concluding that it's largely deserved and that academic economists have a role to play in reforming it.

It's not just that finance is corrupt, or that it captures its regulators, or that it routinely bilks its least-sophisticated customers, and is complicit in frauds perpetrated by politicians against the taxpayer. Lots of industries fit that bill — but finance is much better at it than those industries, and they do it more, and more egregiously.

Implicit in Zingales's paper is that it's not good for finance to be universally loathed and mistrusted. It's the same specter that haunts Piketty's Capital, the threat of the guillotines, or at least, Glass–Steagall.

Most refreshing is the prescription for academia, to be "watchdogs, not lapdogs" to finance, to be bold about policy prescriptions even if they are politically inconceivable. He cites research that puts the "Efficient Market Hypothesis" at the core of financial malfeasance. When you teach your students that it's "economically rational" to commit crimes where the fines for misconduct are lower than the expected return on the crime, you instill a professional ethic that has no room for morals.

As finance academics,
we should care deeply about the way
the financial
industry
is perceived by society. Not so much because this affects our own reputation, but
because there
might be some
truth in
all these criticisms,
truths
we cannot see because
we
are
too
embedded in our own
world. And even if we thought there
was
no truth, we should care about the
effects
that
this reputation has
in shaping regulation and government intervention
in the financial
industry.
Last but not least,
we should
care because
the
positive role
finance
can play in society
is very much
dependent upon the public
perception
of
our industry.

When the anti-finance sentiment becomes rage, it is difficult to maintain
a prompt and unbiased
enforcement of contracts
, the necessary condition for
competitive arm’s length financing. Without public
support, financiers need a
political protection
to operate, but only
those financiers who enjoy
rents
can
afford to pay for the heavy
lobbying. Thus, in the face of public res
entment only
the noncompetitive
and
clubbish finance can survive.
The more prevalent this
bad type of finance
is, the stronger
the anti-finance
sentiment
will be
come. Hence, a deterioration of the public perception of finance risks
triggering a
vicious circle, all too common
around the world (Zingales, 2012).
The United States experienced it after
the 1929 stock market crash and it faces this
risk again today.

What can we do as a profession?
First of all, acknowledge that our view of the benefits of finance
is inflated. While there is no doubt that a developed economy needs a sophisticated financial sector, at the
current state of knowledge there is no theoretical reason or empirical evidence to support the notion that
all the growth of the financial sector in the last forty years has been beneficial to society. In fact, we have
both theoretical reasons and empirical evidence to claim that a
component has been pure rent seeking. By
defending all forms of finance, by being unwilling to separate the wheat from the chaff, we have lost
credibility in defending the real contribution of finance.

Our second task is to
use
our research
and
our teaching
to curb the rent-seeking dimension of
finance. We should use
our research
to challenge the existing practices in f
inance and
blow the whistle
on
what does not work.
We should
be the watchdogs of the
financial industry, not its lapdogs.