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Is finance beneficial to society and how?

By Shivang Singh

There are several theories that illustrate the crucial role played by finance in the world today: managing risk, providing important price signals, curbing agency problems, and eliminating informational irregularities, being the most essential ones. There is adequate evidence that demonstrates how finance fosters growth, promotes entrepreneurship, favors education, alleviates poverty, and reduces inequality (Beck et al., 2007). Yet, this impression is not consented by society at large. The global financial crisis that erupted in September 2008, propelled economies around the world towards recession. It destabilized several major financial institutions in the US and elsewhere, while severely damaging the global economy. This executive summary studies underlying motives, incentives, policies, laws, structures, and behaviors that led to the financial crisis, employing an analysis of critical elements highlighted in Inside Job (2010) and Enron: The Smartest Guys in the Room (2005).

Conclusively, this paper will determine the extent to which finance actually benefits society and will elucidate the methods that can ensure we get most out of our financial system. People around the world were left divested, denied, and exploited by the end of the financial crisis that prolonged till 2012, in the form of what economists term the Great Recession. Over 30 million employees lost their jobs worldwide (Murphy, 2008) and the US alone saw the foreclosures of 6 million homes (Ferguson, 2010) . The International Monetary Fund (IMF) estimated that large American and European banks lost over $1 trillion on flawed assets and bad loans between January 2007 and September 2009; this figure was expected to cross $2.8 trillion by the end of 2010 (Reuters, 2009) . A sample of American adults was surveyed in 2015, three years after the end of the Great Recession and seven since the financial crisis: “Overall, how much, if at all, do you think the US financial system benefits or hurts the US economy?” An aggregate of 48% responded that finance hurts the US economy; only 34% said that it benefits it, while the remaining could not comment (Zingales, 2015) . This sentiment is not just the result of the crisis.

Throughout history, finance has been perceived as a ‘rent-seeking’ activity. The aftermath of the 2007-08 financial crisishas only worsened this view. Prohibitions against finance date as far back as the Old Testament. From Libor fixing to exchange rate manipulation; from gold price rigging to outright financial fraud in subprime mortgages, not a day passes without news of a fresh financial scandal. But, why is this happening? Financial capitalism periodically undergoes a systemic crisis. Kotz (2008) validates that the crisis of 2008 exemplified a ‘neoliberal form of capitalism’. It intensively promoted economic liberalization policies such as privatization, deregulation, and free trade. This process disproportionately and perversely empowered financial institutions, hence helping the sector create a profiteering monopoly of its own. Intricately planned scandals duped customers of their savings, retirement funds, pensions, and homes while financial institutions continued to build their empire on the relics of their crime. The seeds of the 2008 catastrophe were sown in the credit explosion that peaked in 2007, characterized by the reckless dispensing of subprime mortgages, growth of the housing bubble, amplified predatory lending and overleveraging by investment banks (Ivashina & Scharfstein, 2008) . Financial institutions in the US had placed bets against Collateralized Debt Obligations (CDOs) they had deliberately sold to customers who couldn’tafford to pay back. The implication? Billions in profits from investors and insurance companies (Ferguson, 2010) .

The financial sector witnessed panic and turmoil following the bankruptcy of Lehman Brothers and Merrill Lynch, and government seizures of Fannie Mae, Freddie Mac, and AIG (Taylor, 2009) . Prices across commodities dropped, employment fell drastically, the cost of corporate and bank borrowing rose substantially, and financial market volatility rose to levels that have rarely been seen (Ivashina & Scharfstein, 2008) . The ‘neo-capitalistic era’ ended up sponsoring misery and deprivation. But, what aided this wreckage? Over the years, the financial sector has been able to apprehend the political system of countries across the globe (Murphy, 2008) . CEOs and other top executives of banks and other financial institutions end up holding important positions in government administration, thus endowing exclusive benefits to the financial sector. Ken Lay, the Chairman of Enron, was very close to the Bush family. He serves as a pertinent representation of the border where finance meets politics. George H. Bush had helped ‘Kennie Boy’ secure subsidies and other benefits for the company (Gibney, 2005) . Ken had also been proclaimed mascot of the new era of deregulation. To continue a favorable relationship with the government, Enron had made enormous financial contributions towards the Presidential candidature of Bush Jr.

Another accurate example of the finance-politics companionship was the merger of Citicorp and Travelers to form Citigroup, which had violated the Glass-Steagall Act. However, instead of criminally prosecuting Citigroup, Congress passed the Gramm-Leach-Bliley Act of 1999, legalizing the merger. Analogously, in May 1999, Brooksley Born of the Commodity Futures Trading Commission (CFTC) had proposed a legislation to regulate the derivatives market. In response to this, the then Secretary of the Treasury, Larry Summers, instructed her to withdraw her proposal immediately. Furthermore, Alan Greenspan, Robert Rubin, and U.S. Securities and Exchange Commission Chairman, Arthur Levitt, came up with a joint-statement condemning Born’s proposal. Finally, to ice the cake, The Commodity Futures Modernization Act of 2000 was passed by the Congress and it banned the regulation of derivatives. All this had been done to maintain the profit standards of the unregulated market. These examples point to the immoral and corrupt disposition of ‘Wall Street governments’. There seems to be a blatant disregard for the impact their actions have on the society. Not a single financial services firm had been prosecuted criminally for securities or accounting fraud till mid-2010. The agencies that blindly distributed ‘Triple A’ ratings to disastrous loans have also not been castigated appropriately. Kristin Davis’ account of the 10,000 frequent customers in her prostitution racket, 40-50% of which were from Wall Street, enlightens us on how the financial sector is indulging in societal tribulations, drugs being another feather to the cap.

Today, we readily tend to associate finance with the mortgage and debt hangover that plagued the world back in 2008. However, notwithstanding anything said previously in this paper, finance should not be condemned as a system of recklessness. Even though critics are right in some of their accusations, we cannot term finance a curse for the society. It might not be a boon either, but we can improve it through transformation and reform; these changes should focus on broadening the scope of financial innovation rather than confining it. We must work towards achieving a refined, more fundamental, expedient, and sustainable form of finance that serves the society before serving itself. Finance is meant to extend support to social goals – greater employment, economic welfare, wider education, skill development, and equality, among several others. It should be seen as a tool that can in fact ensure a more prosperous and unregimented society. In conclusion, I believe that while financial capitalism and financial innovation collectively shape the way forward, regulations, restrictions, corporate governance, and risk management should be pragmatically enforced in order to help financial institutions function in the interest of the society. It can be thought of as merely codifying rules of a game; rules that are best conceived by the players of the game themselves. Shiller (2013) expresses, “imperfect as our financial system is, I still find myself admiring it for what it does, and imagining how much more impressive it can be in the future.” Think about insurance: thriving in modern society would be impossible without it, or, for that matter, banking, mortgages or even pensions. It is an interesting yet unknown fact that the word ‘finance’ has actually been derived from a classical Latin word for ‘goal’ (Shiller, 2013). It reflects our interests in careers, hopes for our families, ambitions for our businesses, aspirations for our culture, and ideals for our society. Finance does not tell us what the goals are; finance itself does not embody a goal either. Finance is the goal…

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