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WORK TITLE: The Wisdom of Finance
WORK NOTES:
PSEUDONYM(S):
BIRTHDATE:
WEBSITE: http://www.mihirdesai.org/
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NATIONALITY:
http://www.hbs.edu/faculty/Pages/profile.aspx?facId=6585 * http://hls.harvard.edu/faculty/directory/10211/Desai * https://www.linkedin.com/in/mihir-desai-8246a0119/
RESEARCHER NOTES:
LC control no.: no 97065932
LCCN Permalink: https://lccn.loc.gov/no97065932
HEADING: Desai, Mihir A. (Mihir Arvind), 1968-
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PERSONAL
Born 1968, in Mumbai, India.
EDUCATION:Brown University, B.A., 1989; Harvard Business School, M.B.A., Baker Scholar, 1993; Harvard University, Ph.D., 1998; Fulbright Scholar to India, 1994.
ADDRESS
CAREER
Professor, economist, and financial researcher. Worked at CS First Boston, 1989-91 and McKinsey & Co., 1992; Harvard Business School, Mizuho Financial Group professor of finance, 1998–; Harvard Law School, Cambridge, MA, professor, 2011–; National Bureau of Economic Research, Public Economics and Corporate Finance Programs, research associate, co-director of the NBER’s India program.
WRITINGS
Contributor of articles to periodicals, including the Washington Post, Wall Street Journal, Tax Notes, New York Times, and Harvard Business Review.
SIDELIGHTS
Professor, economist, and financial researcher Mihir Desai is Mizuho Financial Group professor of finance at Harvard Business School. He was born in Mumbai, India, moved to Hong Kong, and grew up in Madison, New Jersey. With expertise in tax policy, international finance, international capital markets of multinational firms, and corporate finance, he has published academic articles in leading economics, finance, and law journals. Desai is also research associate in the National Bureau of Economic Research’s Public Economics and Corporate Finance Programs, and served as the co-director of the NBER’s India program.
In 2017 Desai published The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, which takes a historical and philosophical look at the industry of finance. Finance has gained a reputation of being deceitful, questionable, infamous, and vulgar, especially in the wake of events like the Great Depression and 2008 financial crisis. But Desai asserts that finance can also be principled, life-affirming, and a worthy profession. To support his thesis, he draws on literature, film, history, and philosophy to explain how finance works. “He aims to improve financial practice by rediscovering the humanity of its core ideas. By linking to literature, history and philosophy, he tries to build deeper resonance. It is a daring, intriguing work, offbeat and fascinating, something both practitioners of finance and the general public can learn from,” according to Harvey Schachter on the Globe and Mail Website.
Through the tenets of the humanities, Desai explains how those unfamiliar with finance can learn the underlying ideas, while insiders can review what they know of finance and hopefully learn to let go of their unease with the reputation their profession has garnered over the years. Mixing the humanities with finance, he presents some unusual pairings: Jane Austen and Anthony Trollope to discuss risk management, Jeff Koons to espouse the concept of leverage, Dashiell Hammett’s novel The Maltese Falcon to explain randomness and chance, and Mel Brooks’ The Producers to teach about fiduciary responsibility.
In another example, Desai uses Saul Bellow’s novel Seize the Day to talk about marriage and options. In Harvard Business Review, Desai said to Sarah Green Carmichael: “Marriage is the death of optionality, which of course is one way to characterize marriage. But it’s not the most productive way, which is to say it is the beginning of a large significant investment. And so that to my mind captures how the obsession with optionality can tip over into just the desire to create more and more options without actually executing on any of them.”
Believing that this erudite treatise will enrich any perspective on finance, a writer in Publishers Weekly added that it “does valuable work toward demystifying finance for laypeople and deepening the art for practitioners.” Explaining Desai’s rational for describing finance with the artistic values of literature and film, Gillian Tett said on the Financial Times Website that Desai argues that “one of the great failings of our modern world is a ‘chasm’ between the arts and science, and between finance and humanities. This prevents financiers from understanding the social context in which they operate.” Desai himself commented: “Perhaps we can all find our way back to a more noble profession by enlivening the ideas of finance through stories that illuminate our lives and our work.”
Describing the book’s appeal, Gary Morson said in Time Higher Education: “Desai takes a real step towards creating a dialogue of disciplines. Most of the time he succeeds. If only more people—whether financiers or academics—could combine with such finesse economic knowledge and an appreciation of the human condition!” Online at the Boston Globe, a reviewer said: “Those familiar with the world of finance will have their perspective shifted, and for the rest of us, Desai provides a welcome entry.”
BIOCRIT
PERIODICALS
Publishers Weekly, February 27, 2017, review of The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, p. 86.
ONLINE
Boston Globe, https://www.bostonglobe.com/ (May 19, 2017), review of The Wisdom of Finance.
Financial Times, https://www.ft.com/ (July 16, 2017), Gillian Tett, review of The Wisdom of Finance.
Globe and Mail, https://beta.theglobeandmail.com/ (September 25, 2017), Harvey Schachter, review of The Wisdom of Finance.
Mihir Desai Website, http://www.mihirdesai.org/ (November 1, 2017), author profile.
Times Higher Education, https://www.timeshighereducation.com/ (August 31, 2017), Gary Morson, review of The Wisdom of Finance.
MIHIR A. DESAI
Professor of Law
Mizuho Financial Group Professor of Finance, Harvard Business School
About Publications Courses
Biography
Mihir A. Desai is the Mizuho Financial Group Professor of Finance, Senior Associate Dean for Planning and University Affairs, and the Chair of Doctoral Programs at Harvard Business School. He received his Ph.D. in political economy from Harvard University; his MBA as a Baker Scholar from Harvard Business School; and a bachelors degree in history and economics from Brown University. In 1994, he was a Fulbright Scholar to India. Professor Desai's areas of expertise include tax policy, international finance and corporate finance. His academic publications have appeared in leading economics, finance and public economics journals. His work has emphasized the appropriate design of tax policy in a globalized setting, the links between corporate governance and taxation, and the internal capital markets of multinational firms. His research has been cited in The Economist, BusinessWeek, The New York Times, and several other publications. He is also the author of International Finance: A Casebook (New York: John Wiley & Sons, 2006) which features his many case studies on international corporate finance. He is a Research Associate in the National Bureau of Economic Research's Public Economics and Corporate Finance Programs, and is the co-director of the NBER's India program. He is also on the Advisory Board of the International Tax Policy Forum. Professor Desai teaches a second-year elective on International Financial Management and he co-teaches Public Economics (EC 1410) at Harvard College. He received the Student Association Award for teaching excellence from the HBS Class of 2001. His professional experiences include working at CS First Boston, McKinsey & Co., and advising a number of firms and governmental organizations.
Areas of Interest
Law and Economics: Public Economics
Tax Law and Policy
mihdesai@law.harvard.edu
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Mihir Desai
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Experience
Harvard Business School
Mizuho Financial Group Professor of Finance
Harvard Business School
1998 – Present (19 years)Greater Boston Area
Harvard Law School
Professor
Harvard Law School
2011 – Present (6 years)Greater Boston Area
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TeachingFinanceAnalysisCorporate FinanceData AnalysisEconomicsCross-border M&AEconometric ModelingBusiness Strategy
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Education
Harvard University
Harvard University
Doctor of Philosophy (PhD), Political Economy
1994 – 1998
Harvard Business School
Harvard Business School
Master of Business Administration (MBA)
1991 – 1993
Brown University
Brown University
Bachelor's degree, History and Economics
1985 – 1989
Mihir A. Desai
Mizuho Financial Group Professor of Finance
Mihir A. Desai is the Mizuho Financial Group Professor of Finance at Harvard Business School and a Professor of Law at Harvard Law School. He received his Ph.D. in political economy from Harvard University; his MBA as a Baker Scholar from Harvard Business School; and a bachelor's degree in history and economics from Brown University. In 1994, he was a Fulbright Scholar to India.
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The Wisdom of Finance
Discovering Humanity in the World of Risk and Return
The finance industry is widely thought of as being morally suspect. Even those who work in finance tend to compartmentalize between their personal lives and how they get ahead professionally. Mihir Desai argues that not only is this preconception completely false but it’s detrimental to those who work in finance as well as the industry itself.
In this provocative work, Desai deftly sets out his unexpected thesis: there is actually a deep connection between finance and morality. At its root, these two worlds are both animated by the same question: How do we pursue and create value? Through the use of entertaining case studies, Desai shows how finance professionals can find a way to see their work as uplifting rather than dispiriting. Readers will rethink the way everyday business is done to reflect the core moral principles on which the financial field is truly based.
HBX: Leading with Finance
Leading with Finance is a flexible, 6-week, highly-interactive online course which is designed to provide participants with a thorough understanding of the principles of finance – a toolkit for making smart financial decisions and the confidence to clearly communicate those decisions to key internal and external stakeholders. Leading with Finance is offered via HBX, the digital learning initiative from Harvard Business School.
Capital Flows, Taxation, and Institutional Variation
by Mihir Desai, NBER Reporter: Research Summary 2008 Number 3
Recent research has advanced our understanding of the role of taxation and investor protections on capital flows and patterns of FPI. We also have considered the causes and consequences of tax avoidance activity; we have established how foreign and domestic activity interact in order to inform new welfare measures; and we have elaborated on how investment and financing decisions by multinational firms reflect the effects of taxes and varying institutional regimes.
International Finance: A Casebook
by Mihir A. Desai, 2007
These case studies offer a unique perspective on making financial decisions in a globalizing world. The cases build the basics of understanding international financial markets — including the economics of exchange rates and international asset allocation — and then consider how firm financing and investment decisions must adapt to international circumstances. The cases provide the opportunity to consider the most critical firm financial decisions — from foreign exchange hedging strategies, the financing of multinational firm subsidiaries, cross-border valuation, to how to measure and manage the risks of operating in emerging markets.
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Interview with Mihir Desai (July 25, 2012)
Outsourcing jobs is a hot topic in this election, but experts find it inevitable for globalization.
In the News
30 May 2013
New York Times
Tax Only the Income Earned in the U.S.
23 May 2013
HBR Blogs
Don't Blame Apple for America's Broken Tax Code
01 Sep 2012
Harvard Magazine
Compensation Practices and Incentives
17 Jul 2012
Financial Times
Rivals clash on US corporate tax reform
05 Oct 2011
On Corporate Taxes, Put the Public in Publicly Traded: View
Bio
Mihir A. Desai is the Mizuho Financial Group Professor of Finance at Harvard Business School and a Professor of Law at Harvard Law School. He received his Ph.D. in political economy from Harvard University; his MBA as a Baker Scholar from Harvard Business School; and a bachelor's degree in history and economics from Brown University. In 1994, he was a Fulbright Scholar to India.
Professor Desai's areas of expertise include tax policy, international finance, and corporate finance. His academic publications have appeared in leading economics, finance, and law journals. His work has emphasized the appropriate design of tax policy in a globalized setting, the links between corporate governance and taxation, and the internal capital markets of multinational firms. His research has been cited in The Economist, BusinessWeek, The New York Times, and several other publications. He is a Research Associate in the National Bureau of Economic Research's Public Economics and Corporate Finance Programs, and served as the co-director of the NBER's India program.
His general interest publications include opinion pieces on varied topics, including tax policy and the effects of globalization on domestic welfare, in The Washington Post, The Wall Street Journal, Tax Notes and The New York Times. He has also written for practitioners in the Harvard Business Review on the role of the Global CFO, on how to reform the U.S. tax system, and how changing incentive systems have contributed to the degradation of American competitiveness. He has testified several times to Congressional bodies, including most recently to the Senate Finance Committee on corporate tax reform and inversions.
Professor Desai has taught extensively as an award-winning teacher at HBS and at Harvard University. As a second-year professor teaching finance in the required curriculum, he received the Student Association Award for teaching excellence from the HBS Class of 2001. He subsequently built a second-year elective on International Financial Management, and his many cases on international finance are collected in a casebook published by John Wiley and are taught around the world. Since 1999, he has co-taught Public Economics (EC 1410) at Harvard College. He has also taught seminars and classes on tax policy at Harvard Law School, NYU Law School, and Columbia Law School. Most recently, Professor Desai has been active in delivering various executive education programs at HBS, including the General Managers Program (GMP), on campus and around the world. In 2011, Professor Desai launched, with Professor Joe Lassiter, the first offering at HBS for Harvard undergraduates, Innovation and Entrepreneurship, that is also included as part of the General Education curriculum at Harvard College. In the fall of 2014, Professor Desai began teaching Taxation at Harvard Law School.
From 2008 to 2011, Professor Desai led HBS's doctoral programs, which include the DBA and joint programs with the Graduate School of Arts and Sciences. In that role, he led the restructuring of various programs and initiated a terminal master's program. From 2010 to 2014, Professor Desai was the Senior Associate Dean for Planning and University Affairs, where he was part of the senior management team of the Business School focused on integration with the rest of the University. Specifically, he has launched a program for Harvard undergraduates to collaborate on research with HBS professors (PRIMO), led the course for undergraduates described above, helped launch the Harvard Innovation Lab, worked on campus planning efforts including the design of Tata Hall and served on the newly created Harvard Libraries Board.
His professional experiences include working at CS First Boston (1989-1991), McKinsey & Co. (1992), and advising a number of firms and governmental organizations. He is also on the Advisory Board of the International Tax Policy Forum and the Centre for Business Taxation at Oxford University.
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Mihir Desai, professor at Harvard Business School and Harvard Law School, argues for re-humanizing finance. He says the practice of finance, with increasing quantification, has lost touch with its foundations. But he says finance can be principled, ethical, even life-affirming. And demonizing it or ignoring it means that the rest of us — those not in finance — risk misunderstanding it, which has all kinds of implications for how we make decisions and plan for our futures. Desai is the author of the new book, The Wisdom of Finance: Discovering Humanity in the World of Risk and Return. He also writes about finance and the economy for hbr.org.
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SARAH GREEN CARMICHAEL: Welcome to the HBR IdeaCast from Harvard Business Review. I’m Sarah Green Carmichael.
At a time when it seems there’s so little we all agree on, the finance industry seems universally reviled. Need someone to blame for market volatility? Point to the hedge fund guys. Want to be mad at someone for the housing crisis? Criticize the, so-called, vampire squid of Goldman Sachs. Angry at the state of the world? Talk about how Wall Street has ripped off Main Street.
It’s not just populist and the 99%. CEOs to have a one to pick with finance, arguing that investors and shareholders force them into poor short term decisions. But our guest today has a different relationship with finance.
Mihir Desai is a professor at Harvard Business School and Harvard Law School. Finance, he argues, can be principled, ethical, even life affirming, and demonizing it or ignoring it means that the rest of us, those not in finance, risk misunderstanding it, which has all kinds of implications for how we make decisions and plan for our futures. He talks about all of this in his new book, The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, and he’s with us today on the HBR IdeaCast. Mihir, thanks for joining us.
MIHIR DESAI: Thanks so much Sarah. It’s great to be here.
SARAH GREEN CARMICHAEL: So how would you describe your relationship with finance?
MIHIR DESAI: Well, originally it was just as a student, and then I actually practiced for a while. I was on Wall Street a long, long time ago, lifetimes ago, and then I became a student of it again, when I got my PhD, and then most recently, in the last 18 years, I’ve been teaching it. So I have come to love the ideas of finance and yet be disappointed with the nature of the practice of finance. I think we need people in finance to raise their sights a little bit, because currently the expectations are so low that they have almost every incentive to behave badly. We need to kind of get into a different equilibrium where people expect them to behave much better than they do.
SARAH GREEN CARMICHAEL: So where do you think that the, sort of, some of the criticisms that have been lobbed at finance are fair?
MIHIR DESAI: Well, I think there’s a lot of fairness in being upset about the financial crisis. I think there’s a lot of fairness in this characterization that there are chunks of finance that are fundamentally value extracting, as opposed to value creating. I think chunks of asset management look like that. Certain parts of Wall Street look like that. I think that is all good and true and I think compensation levels for people in finance is problematic. The ways we compensate people is problematic, but what is also true is that finance is fundamental.
It’s fundamental to the way we borrow, the way we live, the way we spend, the way we think about retirement, so we certainly can’t live without it. It is the lifeblood of the economy, so when people kind of revile it and they dismiss it, that’s problematic. What I argue in the book is if we get back to the ideas of finance, that would actually help things get a lot better, as opposed to the regulatory or outreach paths.
SARAH GREEN CARMICHAEL: Give me an example of how finance is a deeply necessary, totally important life affirming thing.
MIHIR DESAI: Well, you can just think about students who want to borrow for their education or young companies who want to finance their newest investments. That is finance. That is what we are preoccupied within finance, transferring capital across from savers, like you and me, to people like companies who actually want to use that capital. So that is fundamental, which is a way of saying these ideas of leverage and value creation and optionality, they actually have a lot of life in them and if think about them in that way as opposed to the anti-septic quantitative mathematical way that they’re usually portrayed, they take on a different life.
SARAH GREEN CARMICHAEL: So let’s drill down on optionality. How would you give that a sort of more humanistic life–that idea?
MIHIR DESAI: One of the great things about optionality is that it’s something that people in finance love to talk about. They love to talk about: I’ve got to maximize my optionality. That’s the way they think about their life.
So what I do in the book is place it in the context of risk management. I try to use Jane Austen and Anthony Trollope. So it turns out the women in those novels– Phineas Finn and Pride and Prejudice have a fundamental risk management problem. And that risk management problem is, you’re a young woman. You have suitors coming along. Think about Lizzie Bennett. The first time Mr. Collins comes knocking, he tries to play on her risk aversion and say, you’re not that pretty and you’re not that wealthy. So you better come along with me.
SARAH GREEN CARMICHAEL: Right. It’s highly unlikely you’ll ever get a better offer.
MIHIR DESAI: Exactly. The most unromantic proposal you’ve ever heard. And so that is a risk management problem. So what I thought was fascinating is that these young women in these novels actually divine some of these risk management tools. So for example, Violet Effingham in Phineas Finn by Anthony Trollope, she’s really worried about this problem. And the first thing she says is, well, if only I could marry 10 of them, I’d be fine. She’s the essence of diversification.
SARAH GREEN CARMICHAEL: Right. Because some would work out, and some wouldn’t.
MIHIR DESAI: Some would work out, and some wouldn’t. And that would just be fine. The problem with marriage is it’s a one-time bet.
And in optionality she basically says—she has a very unromantic view of the world—she says, well, I’ll just line up 10 options or five options. And then whenever I’m ready, I’ll just hit the bid, which is like a pool of options that you just exercised when you’re ready. How can I go wrong?
And in fact what I see with a lot of my students and with a lot of young people is just this quest for optionality. And that quest for optionality is supposed to engender great risk-taking. What it ends up engendering is lots more optionality.
People just buy insurance for the rest of their lives. Just more and more options. And I think that is a little bit worrisome.
SARAH GREEN CARMICHAEL: So in a personal setting, if you’re sort of too enamored with keeping your options liquid, say. I don’t know if I just mixed metaphors there. You might end up in a kind of stasis where you never foreclose any options, because you always want to have the maximum number.
MIHIR DESAI: Exactly right. And so for example, Seize the Day by Saul Bellow and “Bartleby, the Scrivener,” which is a famous story by Herman Melville.
SARAH GREEN CARMICHAEL: Mm. Classic.
MIHIR DESAI: But those are two characters in those two books that are basically– they just don’t know how to make choices anymore. All they know how to do is have choices. And they come to a point in their life where they realize, God. I’m just enamored of choices.
In fact, in people in finance, you’ll often hear them say things like– and this applies to their personal life, which is, marriage is the death of optionality, which of course is one way to characterize marriage. But it’s not the most productive way, which is to say it is the beginning of a large significant investment.
And so that to my mind captures how the obsession with optionality can tip over into just the desire to create more and more options without actually executing on any of them.
SARAH GREEN CARMICHAEL: One of the other things I thought was interesting was the way you kind of reframe debt and talk about debt in the book. Because that is one where I think a lot of us have personal experiences with it, whether it’s student loans or a mortgage or maybe more abstract thoughts about the national debt or other forms of debt. Tell me a little bit about what you wish people knew about debt.
MIHIR DESAI: Well, so I think the first thing is it’s so foundational to finance. This idea of leverage is so foundational. Debt is fantastic.
It allows you to do things that are beyond your means. So this of course goes to the leverage angle and to the Archimedes picture, which is on the cover of the book, which is give me a place to stand and a lever. And I can move the world.
Debt allows you to do things you have no right to do. And that’s pretty fantastic. So when you’re young, you can invest in your human capital. When you’re a little bit older, you can actually invest in a house that you can grow into.
So all of that is pretty fantastic. Of course, the excesses are highly problematic. And I talk about that in the chapter on bankruptcy.
But I think people don’t recognize first how powerful it is and how good it is. What I tried to do in the book is make you think about debt as a commitment, which is what debt is. It’s a very, very serious commitment that allows you to do things you couldn’t be able to do otherwise. That’s the nature of a debt contract.
The Merchant of Venice, which people think is a story about debt, which it not only is. Of course, it is really a story about commitments and obligations. Antonio is committed to Portia. Portia’s obligated to Bassanio. There’s like a cycle of commitments.
And debt is not just a financial instrument. But it’s about our obligations to each other. Commitments and obligations in different domains actually are really great ways to live your life.
Those commitments actually are good for you. They’re good for you for your health. They’re good for you for your personal life, which is exactly what finance tends to think about leverage as well, which is by constraining yourself and by committing.
Managers won’t do bad things. And so that’s the sense in which I guess the most important lessons of debt are. Actually, it’s a really powerful thing that will allow you to do things that you couldn’t do. And then second, it has this great parallel to the way you think about commitments, which turn out to be really important to life.
SARAH GREEN CARMICHAEL: Debt. It’s a good thing. OK.
MIHIR DESAI: Well, but you’re right. The skepticism is about bankruptcy. And it’s about people take on too much.
SARAH GREEN CARMICHAEL: Right.
MIHIR DESAI: And so the second part of debt is, well, wait a second. Here’s what happens with debt. You end up having so much that it forecloses opportunities in the future.
And that is in finance called debt overhang. So you actually have this debt hanging over you literally. In that case, debt becomes not an enabler, but actually something that’s kind of crushing you. So finance recommends protecting the people who get in over their heads. That is the essence of bankruptcy. And by the way, this is in contrast to the way we thought about this 300 years ago.
And I think it maps well to how we think about life and failure. So debt is—and this is why it’s hard to talk about this thing—it is both this incredible powerful tool, and, in excess, has these really complicated attributes.
SARAH GREEN CARMICHAEL: There are some debt collection agencies that are still like very aggressive. There are some—if you think of payday lenders and other sort of predatory lenders– it seems like that’s not their approach.
MIHIR DESAI: Well, that’s true. I think historically, prior to the 19th century, we thought people who went bankrupt were evil and sinful. And we put them in jail.
SARAH GREEN CARMICHAEL: Not the Dickensian debtors’ prison anymore.
MIHIR DESAI: Exactly. And in fact, people used to talk about bankruptcy as death. And then it became all about rebirth.
Fast forward to the future and to today, this is one of the big debates about student debt, about all kinds of debt. The really hard part about this, as you can tell, Sarah, is, well, how do you know who’s opportunistically gotten in trouble? And how do you know who’s genuinely got in trouble? Right.
And that again, is where finance is a lot about that middle ground. How do you figure out rules and procedures to allow one set of people to actually emerge from bankruptcy and make sure that we don’t have all this opportunistic behavior at the same time.
SARAH GREEN CARMICHAEL: It seems like a lot of this is just different people who respond differently to risk, and really struggling with trying to think about how someone who thinks differently than they do might think about risk.
MIHIR DESAI: Yeah. That’s exactly right. It’s a really hard idea to understand risk. It’s a really hard idea to understand that look, crazy things happen. There’s a massive amount of uncertainty.
But in fact, there are patterns. It is an idea that not just we struggle with. But over the millennia, people have really had a hard time thinking this through. How do you make sense of the fact that there’s crazy stuff that happens, but there’s all these regularities as well.
SARAH GREEN CARMICHAEL: Tell me about the dowry fund of Renaissance Florence.
MIHIR DESAI: Sure. So this is a crazy story that I had never heard of, and many—almost all the people I’ve talked to had never heard of it. The dowry fund of Florence is this remarkable mechanism that was set up in Renaissance Florence. Dowries are payments from the father of daughters to grooms.
And prices were going up a lot in the dowry market because men were scarce because of the plague. And fathers were really worried about that. So that’s problem number one.
Problem number two is grooms were getting stiffed. So they were being promised dowries. And then the father wouldn’t come through.
And then problem number three, Renaissance Florence needed to raise a lot of money. So enter the dowry fund. Fathers of daughters age around five or six end up giving money to the state. They lend money to the state, just like you invest in government bonds.
The bonds mature when your daughter turns 15 or 16. You actually get that payment. But the payment goes directly to the groom.
So now the groom is secure. You get a high interest rate on your savings because you’re protected from these escalating prices in dowries. And the Renaissance Florence got funded.
SARAH GREEN CARMICHAEL: My sort of history of Florence that I got in school and museums has always been there was this flourishing of art and science. And then you sometimes get like, oh, and yes, there was this rise of banking. And that sort of helped the arts like get funded.
But you don’t realize how innovative and how much of a breakthrough that financial history is.
MIHIR DESAI: Absolutely. People think of Italy as the center of love and romance. It’s also the center of banking and finance. And it has been. Like the oldest bank that we know of is in Siena. It is really the birthplace of both romance and finance, in many ways.
SARAH GREEN CARMICHAEL: So if we could do one other historical detour, I think one other thing that people may not be as aware of is the role that finance played in the French Revolution. And I thought I’d love to hear you talk more about that as well.
MIHIR DESAI: Their public finances were a major explanation for the French Revolution. They did some things that were really wrong. And they misunderstood insurance.
So the first thing they did that was really wrong was they ended up selling annuities. So the French state would give a annuities to citizens. And the citizens would invest.
Well, here’s what the French state did wrong. They gave everybody the same annuity. Guess who bought all these policies?
Turns out to be five, 10-year-old kids bought these policies. And the French government’s on the hook forever. And then the second part of it is, the French also pioneered the tontine. Tontines are, again, annuity-like. But you do it in a pool.
And as the people die off in the pool, the people who are left get bigger and bigger payments, until of course, you’re the last one alive. And then you get huge payments.
This, by the way, is the storyline in a really fantastic episode of The Simpsons, where there is a tontine bond that engenders an effort to kill somebody.
SARAH GREEN CARMICHAEL: I was going to say, it sounds like an Agatha Christie waiting to happen.
MIHIR DESAI: Exactly. But the beauty of it is, it kind of demonstrates what’s known as moral hazard, which is, once you’re in these settings, people are going to do things differently than they would otherwise.
So that’s a way of saying A, the French public finance system in the 18th century is a complete mess, because they misunderstand insurance. For example, today when you think about the health insurance debate, if we don’t understand these principles, it’s really hard to have that debate. That’s what the debate about preexisting conditions is about. That’s what the debate about a mandate is about.
SARAH GREEN CARMICHAEL: So who do you imagine as the person that you hope will come along and pick up this book and have their mind changed or expanded by this? Is it the finance people? Or is it the humanities people?
MIHIR DESAI: Well, I hate to be cheeky. But yes. I really do believe that it’s a book for both types. And that’s why I wrote it.
So there’s this great essay that was written about 50, 60 years ago called “Two Cultures,” which was about science and the humanities and how they don’t get along, and how we have to put them together. And I feel like that about finance and the humanities.
So people in the humanities look down on it. And they think it’s actually quite crass and quite now evil. And people in finance look at most of humanities and think about it as useless.
That doesn’t actually get us to a bigger GDP. So what are we talking about? And of course, the truth is they’re both valuable. And they’re both interesting.
And the way to make that clear to both sides is actually to blend them. So I’m really hopeful that the person who is deeply outraged by finance reads the book and understands the ideas. They may still stay angry. But they’ll understand them.
And there won’t be just kind of anger. It’ll be, well, God. This is really important. These are really interesting ideas. We have to make it better.
And then the people in finance– I have these two hopes. The most important hope I have is, I really do think the practice of finance is broken. And regulation might help. Outrage might help.
But fundamentally, we have to go back to the ideas, because the ideas are good and life-affirming. And if you’re guided by those ideas, I’m really hopeful that people end up behaving better.
This is not a quick fix. It’s a let’s get back to the ideas so that we guide better behavior. But that’s, I think, ultimately what’s going to end up working.
SARAH GREEN CARMICHAEL: How do you think we got to this point where the humanities and finance are seen as so separate spheres?
MIHIR DESAI: Well, it’s interesting. You’re right. Because they weren’t always.
One of the most important composers of the last 120 years was also the founder of the largest insurance agency, and was a guy who laid down the foundations for estate planning and the inheritance tax. That’s Charles Ives, who’s like this weird, crazy abstract composer from the early 1900s. But he also lived a life in financial.
And so I think it wasn’t always so disengaged. I think what’s happened to finance is it’s become very quantitative. It’s become more scientific in an effort to become more precise. It’s become more abstract and detached from reality. And it’s become much more specialized.
And what’s happened to the humanities is I think they feel like they’re under siege. And so they’ve disengaged a little bit. And they are I think trying to retain this posture of, we’re above the fray. And business is down in the fray. And finance is down at the bottom of business as the worst kind of business.
And so they’ve both kind of disengaged from the middle ground. And I think we’re all worse for that.
SARAH GREEN CARMICHAEL: I’ve always been sort of fascinated by these artists who produce great things while having a day job. TS Eliot I think is another example.
MIHIR DESAI: Yup. Exactly. He was a banker at Lloyd’s Bank. Exactly right. Franz Kafka produced most of his work while he was an insurance clerk. I mean, there’s some really striking examples. And they get made fun of, and they’re mocked.
Ezra Pound famously mocked TS Eliot and thought he was wasting his life. And the truth is, TS Eliot really enjoyed his job. And there are these correspondences.
Ezra Pound keeps trying to get like, quit that job. You’re wasting your time. You’re doing something terrible.
And TS Eliot enjoyed it. And it kept him attached to reality. Cause you may know, Wallace Stevens turned down the Charles Eliot Norton professorship of poetry at Harvard many times, because he wanted to be an insurance company executive. And that is like unfathomable to most humanists. But he found something in that world.
He has this great quote, which is poetry and surety claims, which is his version of insurance, basically poetry and insurance aren’t that different after all. For most people, that’s crazy. What does insurance have to do with poetry? It’s like the most prosaic thing you could imagine.
But in fact, they are connected, I think. One of the great essays I read in this process is by this poet Dana Gioia, who went through all the poets who used to have careers. And as a consequence, they were attached to the real world.
And so when you have these humanists who are very specialized and detached from the world, and work and business no longer play a role in their work, it’s hard for them to speak to people for whom work is really important and is there most of their life.
Gosh. It would be great if people actually used business and finance in creating great art, and had the great novels like we used to have set in these rich financial settings, as opposed to what we tend to have today.
SARAH GREEN CARMICHAEL: Today, how would you like to see these two worlds sort of come back together?
MIHIR DESAI: Well, I think most importantly, I want people in finance to behave better. And I want them to understand the ideas of finance better so that they move away from the value-extracting kinds of things they are doing towards value-creating kinds of things.
And then the second thing is I think humans have to engage finance. The central question of our time is how do we organize financial markets better for everybody. That is one version of the question of our time.
And humanists have something to add to that. They should be part of that debate, as they were for the last several centuries.
To my taste, they’re somewhat silent on those questions. And I think to speak, they have to actually learn what the ideas are, and talk in more subtle ways. It would be great to kind of convene a set of people who are on both sides of this divide. And to start with a conference or start with a dinner, and just try to get them talking to each other.
I think they meet usually when there’s a high financier who donates a lot of money to a museum. Or they bid on some art. But a real conversation about the way these two worlds inform each other– I think that would be a really, really important first step.
SARAH GREEN CARMICHAEL: It seems like one of the big stumbling blocks for people, and that leads to the kind of caricature you see of Wall Street like Wolf of Wall Street or Bonfire of the Vanities and American Psycho and those kinds of portrayals is the compensation structure and amount. If you are a sort of humanities professor making a good living, but not finance money, or if you are someone who builds homes for a living—
MIHIR DESAI: Sure.
SARAH GREEN CARMICHAEL: –you make a lot less money than someone in finance. And it’s easy to sort of brush aside the role of the financier and say, well, they don’t really make anything. They just extract rents. I build things.
MIHIR DESAI: Exactly.
SARAH GREEN CARMICHAEL: Do you think that we can move the debate forward without really grappling with the whole compensation thing?
MIHIR DESAI: I think the compensation thing is critical. We’ve bought into this idea that incentive compensation as measured by the market– look. Here’s some options. If the company does well, you do well. And it will just take care of itself.
That’s basically been the experiment in capitalism for the last 40 years to solve the principal aging problem. We just load people up with these high-powered incentives. And it hasn’t worked. And it hasn’t worked for a lot of reasons.
The second thing we have to kind of get away from—we have a lot of banks that are very large and that are quite bloated. And no bank licenses have been issued at a first approximation in the last 10 years. It’s crazy.
So there’s no entry. There’s very little exit. And our largest banks keep getting bigger. That’s a real problem.
And that’s a real problem for compensation, because effectively these big, large banks are in some ways employment compensation machines. And that is not about the high end incentive compensation. That’s just about, wait a second, there’s a lot of rents trapped in these banks. And we should think about reallocating them.
And technology is going to help. But I think regulation has got to help as well.
SARAH GREEN CARMICHAEL: Do you think that there are too many talented people going into finance and not enough into other industries? That’s one of the big sort of debates that seems to happen every graduation season.
MIHIR DESAI: I agree. I think one of the things I came to understand about finance is it is a field which is quite unique in the following sense. You have this setting where people are getting really tons of feedback. It’s really quantifiable. And it’s at a massive scale.
And I think what it kicks in is the attribution errors that kick in with everything. We all do this. When good things happen, we attribute it to ourselves. And when bad things happen, they go to the world.
But nowhere else does it happen at the frequency and at the scale and with the precision that it happens in finance. And that makes people into jerks. Because you get that much feedback. And you start to believe that you’re the one who’s responsible for the good outcomes. Right?
People in finance think about it as a super meritocratic system. We’re out there in the markets. It’s really tough out there. And only the good succeed.
And the answer is, maybe. But there’s no other field where you can kind of cover up and dress up luck as skill. There’s no field like that like finance, because it is unclear who’s winning and who’s losing.
So this whole idea that finance is like a very meritocratic thing I think is problematic. It is, in fact, an area where you can make luck look like skill.
The other view—is there any more important problem in capitalist society than who gets capital? And finance is the mechanism by which we decide that. It’s really important to get right.
I was born in a country where I was held back enormously because banks were nationalized. And financial markets were constrained. So these markets and these capital markets are profoundly important.
And by the way, the excesses of them are terrible, too. We saw it with housing. To some degree people see that today with education.
So it’s got to be understood to be central, incredibly powerful at times, and something that is prone to excesses. Which is not altogether not like a lot of other things in life. It just happens to be at the heart of the economy.
SARAH GREEN CARMICHAEL: If there is one work of fiction or poetry out there that you think people should read to think in more financial terms, what do you think that that would be?
MIHIR DESAI: Wow. That’s a tough one. I’ll suggest the following—which is Willa Cather’s O Pioneers! This is a woman—and it’s a female protagonist, Alexandra Bergson. And this is a woman who basically levers up her farm and does this incredible set of acquisitions for her family.
And all the themes of finance are in that story. There’s diversification. There’s options. There’s leverage. There are mergers. It’s crazy.
It’s got everything in there. But you have to read it to kind of see it. But the great thing about that story is, unlike most stories of finance, she’s fantastic. For example, she doesn’t confuse luck with skill.
When people say, how did you do this? She’s like, let’s not pretend like I did. Which is an incredibly humbling thing. She turns out to be a very successful woman in that business.
And so she really keeps her eye—despite the fact that she does all these financial things that are fantastic, and she builds a lot of wealth or her family—she never takes her eye off of what is interesting and important in life. And the reason I choose to end the book with that story is because there are so many stories that are the opposite.
You mentioned the Wolf of Wall Street or Gordon Gekko or whoever. At the end, she’s talking about her success. And she’s trying to figure out her legacy.
And she says, suppose I do will my land to their children. She doesn’t actually have children. So she’s talking about willing her land to other people’s children.
“What difference will that make? The land belongs to the future, Carl. That’s the way it seems to me. How many of the names on the county clerk’s plat will there be in 50 years? I might as well try to will the sunset over there to my brother’s children. We come and go. But the land is always here. And the people who love it and understand it are the people who own it for a little while.”
One of the reasons I really like that is it captures one of the notions in finance of stewardship, where we are all just stewards of capital. And then we hand it over to the next generation, which is one of the fundamental ideas in value creation. It’s in contrast to the way a lot of people think about finance.
But that is just one example of that story really capturing how finance can actually be quite powerful and quite life-affirming.
SARAH GREEN CARMICHAEL: Mihir, thank you for coming over to talk with us today.
MIHIR DESAI: My pleasure. It’s been really fun, Sarah.
SARAH GREEN CARMICHAEL: That’s Mihir Desai of Harvard Business and Harvard Law. His new book is called The Wisdom of Finance. He also writes about finance and the economy for Harvard Business Review. You can find his work at hbr.org.
Thanks for listening to the HBR IdeaCast. I’m Sarah Green Carmichael.
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NATIONAL & WORLD AFFAIRS > ECONOMICS
Finance meets humanities — really
Author Mihir Desai explains how the two are linked in deep and meaningful ways
July 14, 2017 | Editor's Pick 071317_Desai_038.jpg
By John Laidler, Harvard Correspondent
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As an economist, Mihir Desai has gained wide recognition for his expertise in tax policy and international and corporate finance. His writing and teaching have covered such topics as proposed reform of the U.S. tax system and the misuse of high-powered incentives and their impact on American competitiveness.
But Desai, Mizuho Financial Group Professor of Finance at Harvard Business School and a professor at Harvard Law School, has set aside his usual academic work in a new book, “The Wisdom of Finance: Discovering Humanity in the World of Risk and Return.” In it, Desai uses plain language and stories drawn from literature and art to explain the basic principles of finance and show how deeply they are rooted in the humanities.
The Gazette spoke to Desai about the book and the argument he advances in it that finance and the humanities have much to gain from reaffirming and strengthening the connections between them.
GAZETTE: Most people would not consider finance to have much to do with literature, philosophy, music, and movies. Yet your book argues that it has deep connections with our culture. What are some examples you like to cite to illustrate those links?
DESAI: Every chapter takes a big idea of finance and explains it by using the humanities. So “The Parable of the Talents” becomes a way to think about value creation, Jane Austen and Anthony Trollope become guides to understanding risk management, the Flitcraft parable in “The Maltese Falcon” is used to demonstrate the centrality of risk and insurance in our lives, the fall of Robert Morris is used to understand bankruptcy, and Mel Brooks’ “The Producers” becomes a way into corporate governance. The goal of doing that is twofold. First, we need to demystify finance so that it is not misunderstood and demonized. The easiest way into these ideas is through stories. The goal of the book is, in part, to teach a course in finance without an equation or graph, and only through stories.
Second, we need to rehabilitate finance. Chunks of finance are broken and now resemble value extraction rather than value creation. Clearly, regulation can help, but we know that regulation has unintended consequences and that many regulators and legislators have been captured by industry. The best way forward, in the long run, is to humanize finance by restoring a moral lens on the underlying ideas, and that’s what the humanities can do. If people in finance see these ideas and their work through a moral lens, then perhaps they’ll aspire to better behavior. So the book aims to correct the widespread misperception of finance as being evil but also encourage actors in the industry to reflect on their work and perform better.
GAZETTE: In fact, you see finance as rooted in our very humanity. So the earliest human beings were actually engaging in finance?
DESAI: Yes. One of my favorite quotes in the book comes from Nietzsche, who argued that being a buyer and seller and a debtor or creditor was so foundational to the human experience that these experiences shape the nature of human thought. Nietzsche frames it as foundational to the human condition, which is a very different way to think about finance. The logic of diversification shows up in Ecclesiastes and the Talmud, and the first options transaction was undertaken by Thales, the father of Greek philosophy. So finance is not just core to the modern economy; it’s core to our history, our lives, and our humanity.
GAZETTE: But you believe that finance has grown apart from its humanistic roots. What do you see as the cause of this estrangement?
DESAI: Over the last half century, finance has become more quantitative, more precise, more elegant, and more abstract, which is wonderful for the discipline. But in the process, it’s also become detached from the reality of daily life for most people. At the same time, frankly, I think the humanities have become more divorced from commerce and finance, and they tend to view the latter with more derision than ever before. So there’s just this widening gulf between the way people in finance and business view the world and the way people in the humanities think about finance. And both are worse off as a result. In finance, we’ve lost the ability to think through the questions that humanities force us to think through, and in a way humanists no longer speak to as broad an audience as they could be speaking to. The book closes with a call back to C.P. Snow’s “Two Cultures” because it is a similar problem. The gulf between finance and the humanities is a loss for all.
GAZETTE: What are some of the arguments you can offer business leaders about the importance of restoring humanity to finance?
DESAI: After the global financial crisis, many people have become alienated from finance and from business. The political and economic repercussions of that alienation will last through my lifetime. If leaders don’t learn to credibly promote what they do for the lives of people, we’ll never overcome that stigma. And, of course, it’s not just promotion. We need to re-examine practices within the asset management industry, the banking industry, the advisory industry to ensure that they are truly value-creating.
At a more personal level, no one wants to see their work maligned and misunderstood. In fact, it’s quite difficult for people to be enjoying something that is looked upon so negatively. So the goal is to remind them that even if the current reputation of their work is very negative, there are so many good ideas — and ideals — inside finance that they should feel quite proud of that, and they should aspire to live up to the humanity of those ideas and ideals.
GAZETTE: How can you convince finance students that being versed in literature and art can contribute to their professional success?
DESAI: Whenever I teach anything, I try to approach it from multiple angles because seeing the same phenomena through different lenses is powerful for developing intuition. This effort, in a way, is just an expansion of that idea. By approaching something as technical as finance through stories, we can create foundational intuitions. That’s powerful because it deepens your understanding of these ideas and allows you to communicate your ideas better. Often, people going into finance have a fragile understanding of the underlying ideas because they’ve just been taught it in a rote way. But if these ideas are attached to stories, then the underlying intuitions are likely to be much more compelling and long-lasting.
There’s also just a great deal to be said for framing your life’s work in a moral context, and that’s what these stories do. By allowing people to think about their life’s work in a more noble way, it avoids the need to separate their life’s work (which is viewed negatively) from their personal identity.
GAZETTE: You are also passionate about making finance more accessible to the general public. How can understanding concepts like value creation and asset pricing help people in their everyday lives?
DESAI: It’s counterintuitive for people to think that finance might be able to teach us something about the human condition. When you step back and think about it, it’s not that surprising. The discipline of finance is centered on the question of where and how value is created. And that is a central question for many of us: When and how am I creating value for the world?
As one example, one of the big ideas in finance is about how borrowing allows you to do things that you wouldn’t be able to do otherwise. That is the essence of why people in finance love leverage. You end up being able to live in a house or to get an education that you may not be able to afford otherwise. The lessons from finance about leverage, though, are deeper. Part of the agency theory of borrowing is that managers need to be restrained, and leverage does that. That translates quite naturally into the power of commitments more generally. For personal health and for ethical behavior, we know that commitments are very powerful. So, there’s a nice analogy between the power of commitments in finance and in life more broadly.
The book tries to outline several of these counterintuitive parallels. There’s a parallel between the recipe for value creation in finance and the recipe for a good life embraced in many religious and philosophical texts. The folklore around mergers applies well to thinking about marriages. The principal-agent problem can be a frame for understanding conflicts in many parts of your life. And when wisdom comes from the logic of your life’s work, it’s more resonant than when wisdom is dispensed from upon high.
GAZETTE: You quote Wallace Stevens calling money “a form of poetry.” But with all the greed and corruption the business world has seen in recent decades, that sentiment may seem foreign to many people. How do you restore the reputation of the profession?
DESAI: The reason I chose that quote as an epigraph is that it’s jarring to think about something as crass as money being used in the same sentence with poetry. Even coupling the words “wisdom” and “finance” in the title seems oxymoronic. But these concepts need to be reintegrated. Stevens, who spent his career in insurance and consciously chose not to dedicate himself uniquely to poetry, also understood this when he said “poetry and surety claims aren’t as unlikely a combination as they might seem.” Reframing finance in moral and humanistic terms for practitioners and outsiders requires us to abandon the caricatures that are so prevalent — “business and finance are evil” or that “the humanities are divorced from the real world.” Abandoning those caricatures is the way forward for the profession and for our society.
MAY 25, 2017 @ 11:14 AM 2,300 The Little Black Book of Billionaire Secrets
Why Wall Street Went Astray: Eight Ways To Humanize Finance
Steve Denning , CONTRIBUTOR I write about radical management, leadership, innovation & narrative.
Opinions expressed by Forbes Contributors are their own.
Why did Wall Street go astray? For most of the last several centuries, bankers and financiers were the pillars of society, the bastions of morality, the people in society that everyone respected. Of course, there was the odd rotten apple in the barrel, but by and large, bankers were trusted and looked up to. Yet over the last few decades, Wall Street has become almost a synonym of evil. What went wrong? What can be done to restore the financial sector to the level of respect that it once enjoyed?
This week, I talked about these issues with Harvard Business School finance professor Mihir Desai, on the publication of his intriguing new book, The Wisdom of Finance: Discovering Humanity in the World of Risk and Return (Houghton Mifflin Harcourt, May 2017). I’m a big fan of Desai’s work and wrote about his pathbreaking Harvard Business Review article in 2012 (“The Incentive Bubble”) here.
Desai’s new book is unlike almost any business book you’ve ever read, with eight chapters packed with stories from English and American literature explaining the sometimes esoteric concepts of risk management in simple everyday language and showing how they apply to every aspect of our lives. Desai draws from literature in surprising ways. Who would have thought that Jane Austen could teach us risk management?
Jane Austen: risk manager? The Jane Austen Festival (Photo by Matt Cardy/Getty Images)
The book has eight chapters representing a kind of “everyman’s guide to finance:” (1) The wheel of Fortune; (2) Jane Austen’s Pride and Prejudice on risk management; (3) The cruel logic of value creation; (4) How the problem of ‘agency’ got a lot worse; (5) There’s no romance without finance; (6) Using leverage to live the dream; (7) Using bankruptcy to fail forward; and finally, (8) Why everyone hates finance.
I spoke with Desai about his new book.
The Purpose Of Desai’s Book
Steve Denning: I am a big fan of your work, particularly your 2012 HBR article, “The Incentive Bubble,” which I wrote about here. Your new book is very different from that article and from most business books. Why did you write it?
Mihir Desai: Writing this book was a bit of an accident. I had to give a talk to graduating Harvard MBA students two years ago and chose a title, “The Wisdom of Finance,” without knowing what it meant! As I struggled to meet the deadline, I found myself seeing striking parallels between the ideas of finance and how you think about your life. The talk was great fun and I gave it several more times. The talk really resonated with people because they were able to see the real world and their work as the source of wisdom – rather than have wisdom distilled from upon high.
The book has two audiences.
For people outside finance, I wanted to make the ideas accessible. Finance is deeply misunderstood, and we need to make it understandable to people so that they don’t demonize it. The way to do that is not through equations or graphs, but through stories. Finance is central to our lives and ignorance of it is very costly on an individual and societal level.
For people in finance, I wanted to give them an alternative to the demonization of their work that they encounter everywhere. The core ideas of finance are quite life affirming and very noble — we should make people in finance aspire to them rather than expect so little of them. If finance is going to rehabilitate itself, and I do think it’s broken in many ways, the way to rehabilitate is not through regulation, or outrage, but rather returning to its basic underlying ideas, which are actually quite wonderful. In the long run, that’s how we make finance better — by getting back to the core ideas.
What Did Finance Go Astray?
Denning: Let’s start then with the basic question: why did Wall Street go astray? What went wrong?
Desai: There are many reasons but clearly the most important one is that we’ve failed to think through the incentives of our financial actors – and the proliferation of high-powered incentives along with lax regulations have led to significant problems. The last chapter of my book discusses an alternative idea about why everyone hates financiers. Given my outlining of the nobility of the ideas of finance in the book, the question is: why does everyone hate financiers?
One answer is that finance can breed both arrogance and stupidity. This is the only field where you get quantifiable feedback at a high frequency and usually at a scale inflated by leverage. And, we know humans make attribution errors. This leads to the belief that any success is due to the financier’s brilliance while the mistakes are rationalized as part of the context. So, no other field can allow for the frequency and size of these attribution errors — and what we end up with is incredible amounts of arrogance. The people aren’t bad. It’s not that finance per se is bad. It’s that finance can breed this arrogance. The book is aimed at alerting people to that and helping think about ways that they can prevent that from happening.
Denning: Is rapid feedback really new? If you look over the last couple of centuries, that rapid feedback has always been in place. So why is the excessive arrogance happening now? There have been “bad patches” for finance before, with periods of financial frenzy and greed. Why are we having such a bad patch now?
Desai: If we think about the 2008 financial crisis, we can see that it was the product of both mistaken beliefs and terrible incentives. Over the last 30 years, we have seen the growth of the alternative asset industry and the proliferation of very high powered incentives (“2 & 20” and stock options), which make people very attuned to market outcomes. Those outcomes are the basis for market-based compensation and that, in turn, leads to the magnification of these attribution errors. That is new. Why did the growth of the alternative assets industry and high-powered incentives happen? A savings glut and demographic changes that led people to reach for yield. Declining interest rates that made hedge funds look brilliant and allowed private equity to boom. Those are recent phenomena.
Jane Austen: Risk Manager?
Denning: As a Jane Austen fan, I was particularly interested in chapter 2 and your presentation of Elizabeth Bennett, the central character in Pride and Prejudice, as a risk manager. As an outsider, one can interpret the story in that way. But I was wondering: what would Jane Austen have thought of that interpretation? Would she have applauded? Or would she have said, “That’s not what I’m talking about at all. I’m talking about duty, about manners, and about love, not about calculating how to land the best husband in a marriage market of gains and losses.” Is that a fair question?
Desai: Absolutely. I don’t know about gains and losses, but Jane Austen was certainly thinking about risk. The core of Liz Bennett’s problem when Mr Collins proposed marriage to her was one of managing risk. Mr Collins and her mother tried to play on Liz’s risk aversion, by suggesting that no better suitor would come along. Then Liz tells her father that she wants to go on gambling. She is managing the risk of a young woman in that period, who is in a marriage market. It’s a complex risk-management problem. They were not thinking about gains and losses. That’s not what finance is about. It’s about risk and how we manage it in our lives.
Denning: Looking at Jane Austen’s own life, we can see that she received only one marriage proposal, which she accepted for one day and then turned it down the next. The suitor — Harris Bigg-Wither — was wealthy, Oxford-educated, but personally disagreeable. The match would have solved all of the financial problems of Jane Austen and her family. But Jane Austen turned it down and, so far as we know, she never received another proposal. Does that mean that we should regard Jane Austen’s life as a failure, because she mismanaged her risk in the marriage market?
Desai: Not at all. She was obviously a remarkable person and one of the greatest authors — perhaps the greatest — of the last three centuries. I didn’t mean to equate getting married with success. What I do mean is that risk is ever present, and Austen understood that. The fact that she resisted the pressure to get married demonstrates her character and her willingness to go against societal norms. The fact that Jane Austen and her characters were struggling with issues of risk management helps explain and humanize finance and risk management to a wider audience. I also use Anthony Trollope’s Phineas Finn to show how another young character, Violet Effingham, intuited options and diversification as strategies for managing those risks.
Denning: One might say perhaps that, as an author, Jane Austen managed risk brilliantly. Her life goals were simply not those of the marriage market of her day.
How Efforts To Solve ‘The Agency Problem’ Made It A Lot Worse
Denning: Let’s turn to the “agency problem” that is discussed in chapter 4. You talked about this in your 2012 article, “The Financial Incentives Bubble,” and came down quite harshly on the role of incentives. At the heart of the disaster, you said, is market-based compensation — the idea that the C-Suite and financial managers should be compensated by the issuance of stock. Market-based compensation was intended to align managers' interests with those of shareholders, but the result has been the opposite. The idea of market-based compensation, you said, is “intellectually flawed” and “a foundational myth.” It seems that the “agency” theory which was meant to solve the supposed problem of agency has aggravated and turned it into a macro-economic problem.
In chapter 4 of your new book, you talk about the various chains of agency that are in place. The C-suite acts as agents for the board. The board acts as agents for the shareholders, and possibly other stakeholders like employees and customers. The institutional investors act as agents for investors, who are often in the end “us,” through our investments in mutual funds. In other words, we are complicit in supporting the whole system. I was hoping to learn what we should be doing about this tangled web of agency relationships, but on page 83, you say that this will have to wait for your next book. So, I was wondering whether you could give us a preview of that next book?
Desai: Sure. The next book would be an expansion on the 2012 HBR article. First, it would acknowledge that the principal agent problem is the fundamental frame on modern capitalism. Second, the rise and dominance of investors and the investor mentality have changed capitalism. It’s manifested in the way CEOs think about the world, the way investors make CEOs do things, and it’s highly problematic. There are many good things about it, but I am also concerned about the bad things. The book will go through those things and try to come up with guard rails. In the current book, I try to outline that problem so people become attuned to it (by reading about Mel Brooks!) but also describe why it’s a subtle, difficult problem not amenable to simple solutions. Recent shareholder activism at Apple and Tootsie Roll help explain how difficult a problem it is.
As one example, the share buyback craze is something I have been concerned about. There are a variety of guardrails that one could put up. We need to keep in mind that returning cash to shareholders is sometimes good, although the current craze is problematic. We should craft a solution that would recognize what that solution is trying to accomplish and then guard against the excesses. I don’t have an extreme view of the world. I don’t think that one class of people are good and another class are bad or that we need to stop doing x and start doing y. The system is prone to excesses and we need to think about guardrails.
Denning: Would you agree with Bill Lazonick when he wrote in HBR that almost $7 trillion in share buybacks in the U.S., Canada and Europe over 10 years is in effect stock price manipulation?
Desai: I think that what managers have done is excessive, and it’s problematic. But characterizations like that are not constructive. It makes people think that capitalism is all bad and that we should shut it down. I don’t think that’s right. We have to understand what people are trying to accomplish. Capital allocation is a hard problem. Figuring out how to distribute cash to shareholders is a hard problem. Distributions serve a purpose and they can be done very effectively. But the practice has come to the point where we do it without sufficient transparency.
Some of the proposals I would make are (a) to stop open market operations and only allow year-end tender offers, (b) to stop accelerated share re-purchase programs, and (c) to change the accounting of repurchases so the performance of managers when buying back shares is manifest in financial statements. I am not saying that something bad isn’t happening. Something bad is happening. But we should be careful how we characterize and guard against it.
Denning: You would agree that stock price manipulation is a bad thing?
Desai: Of course. It’s true that there have been a lot of ill-timed and poorly-executed share buybacks, that have been the source of value destruction. Some of those activities may have been stock price manipulation, but it is more likely to have been incentive-driven. They were not saying that they wanted the stock to be a certain price. They were saying: “I get compensated in a certain way and I need to feed investors in that way.”
Why Does Everyone Hate Finance?
Denning: Let’s turn to chapter 8, which is entitled, “Why Everyone Hates Finance.” Here you get to the question of whether “more” is ever enough and the fact that in the finance sector, it seems that there is no such thing as “enough.” It is always a quest for “more.”
The chapter cites as a positive example the story of Alexandra from Willa Cather’s novel, O Pioneers! She has a sense of herself and who she loves and is a steward of her involvement in the financial system and uses that in very astute ways. That’s an example of a financier who is acting as a steward.
My question is whether the problem isn’t deeper in the sense that the stewardship that we may need may be stewardship of the system, not just stewardship of personal finance and needs. Looking back on finance 40 years ago, it did seem like the partners at Goldman Sachs at that time were husbanding their own personal capital and were acting to some extent as stewards of the system overall. Now they are playing with other people’s money, where if they win, they win big, but if they lose, it’s not really their problem. In Singapore for instance there is more of a long-term perspective in the structure of financial markets. Do we need an equivalent of that kind of stewardship in the U.S. system — perhaps from institutional investors?
Desai: That’s a great and deep question. I tend to be skeptical about the possibility of stewards of the system. Part of the reason is that I don’t know who these stewards would be. I would be deeply skeptical of any financial institution that claimed to be acting as a steward of the system. The government might also act as a steward: they could be helpful but they can also be quite problematic.
I am interested in a more decentralized outcome. That means people understanding their responsibilities to their capital providers in a more serious way. It would also mean that we need more effective government agencies that are better at policing them. So, I just don’t buy the idea of stewards of the system as a simple solution to the problem.
Denning: That leaves us with the question: how do we get to a situation where the regulators are more alert to what is occurring, and where we have more “Alexandra’s” acting in a more prudent fashion with enlightened self-interest?
Desai: There are three paths forward. One is outrage. That can stir things up but it offers no real solution. A second is regulation. Clearly some things are under-regulated. But regulations are blunt instruments and regulators are susceptible to being “captured.” They have been captured in the past and they appear to be captured now in some ways. So, the real answer — the third path — is returning to the underlying ideas of finance.
The Shift From Value-Extraction to Value-Creation
Desai: Finance has lost its way because it got divorced from the underlying ideas. Finance is broken because it is no longer thinking about value-creation. It is thinking about value-extraction. That is the way forward. Maybe it will take decades? Maybe it will take more than our lifetimes? But that’s the way we get better.
Denning: Could you envisage a world in which academics and analysts were more systematically evaluating what is value-creation, and what is value-extraction.
Desai: Absolutely. That would be a huge step forward. And also having citizens and pension funds thinking about these issues in a clearer, more thoughtful way. That is exactly the right way to go.
The reason I tell the story of Alexandra is to contrast her with the more problematic characters in finance like Gordon Gekko in the movie, Wall Street. You need to pick the right story to live your life by. If you pick the wrong story, which is frankly what most people are doing today, and Gordon Gekko is the model of what they do, then not surprisingly they are going to behave badly. We need to pick our stories more carefully. I end with Alexandra Bergson and the quote from that book: “There are only two or three human stories in the world and they go on repeating themselves as fiercely as if they had never happened before.” We all pick stories to live our lives by and you should choose your stories carefully.
Denning: Is it more of a system problem than a problem of individuals acting badly? Individuals find themselves in systems that have certain incentives, and values, and corporate cultures. Is it surprising that they “fit in” to the system? They are almost trapped in the existing system. It’s difficult for people to do otherwise, unless they “get out of the system.” Do we need to change “the system”?
Desai: If you take that approach, I see two possible outcomes. One is revolution. That’s neither likely nor helpful. The second option is intervention by the state, which is a revolution of a different kind. The state and its politicians have demonstrated very limited capacity for resolving these problems. Often, they will make it worse. I don’t disagree that we have a system problem. I think that decentralized or individual action is likely to be the best way forward.
A Story-Based Outcome
Denning: I wonder whether there isn’t a third option, building on your idea of decentralized and individual action. Let’s use a metaphor. Let’s take the case of pesticides and DDT in 1962. The chemical industry was politically and financially dominant in the U.S. It was insistent that the pervasive use of poisonous DDT wasn’t a problem and that it was in any event necessary to assure America’s food supply. Otherwise the country would starve. The big firms had control of the media. Politicians and the general population also went along with the continuing the status quo. Objectively, the prospects of change in the use of poisonous pesticides in 1962 were hopeless. It was a massive system problem.
But then along came Rachel Carson and her book, The Silent Spring. She had no political power or financial resources. All she had were stories about the disaster that was unfolding and also stories about how the problems could be resolved. Lo and behold, people listened to her stories. A national, and eventually a global, movement emerged and so, the system changed, despite the overwhelming political, financial and media power of the chemical companies who were arrayed against change. Is something like that conceivable in the finance sector?
Desai: I think that’s a brilliant analogy and it’s basically right. I would love my work to contribute to that, both this book and the next book. People start believing in the underlying ideas. And the state starts to believe in the ideas and things snowball to the right outcome. It’s not a state-sponsored outcome. It would be a movement born of stories. I think that’s exactly right. If you think about the Progressive Era and Jacob Riis and Upton Sinclair, that’s the way that revolution happened. Their stories led to better behavior by both people and the state. I believe that’s what we need now in finance.
Some of the material in this article will appear in a different form in my forthcoming book, The Age of Agile (Amacom: February, 2018).
And read also:
The Pernicious Nonsense of Maximizing Shareholder Value
Mihir Desai: HBR Blows The Lid Off C-Suite Over-Compensation
How Modern Economics is Built on the World’s Dumbest Idea
How Big Firms Increasingly Resort To Corporate Cocaine
How Corporate America Is Cannibalizing Itself
________________________
Follow Steve Denning on Twitter @stevedenning
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May 27, 20175:52 PM ET
Heard on All Things Considered
Harvard Business School professor Mihir Desai says the unemployment rate is the lowest its been in a decade. He speaks with NPR's Michel Martin about the increasing options for recent graduates.
MICHEL MARTIN, HOST:
As the class of 2017 prepares to enter the job market, there is some good news waiting for them. The unemployment rate is the lowest it's been since 2007, but these students have also come of age during a recession followed by a sluggish recovery. So we were wondering how all this could be affecting these freshly minted graduates and job seekers.
To talk about this, we called Mihir Desai. He's a professor at the Harvard Business School. He has a new book out called "The Wisdom Of Finance." But we called him because he published a piece this week in The Crimson, Harvard's student newspaper. In the spirit of full disclosure, that was my first journalism gig. Professor Mihir Desai, thank you so much for joining us.
MIHIR DESAI: Thanks so much. It's a pleasure.
MARTIN: So the last time the unemployment numbers were this low, these students were in third grade. Do you see an impact on this generation of having grown up in this timeframe?
DESAI: Yeah. I think part of what's happened is they don't allocate as much importance to economic outcomes that, perhaps, previous generations did. So they grew up in an era of reduced expectations in some ways. And as a consequence, they look for different ways to fill their life up which is not purely professional.
In some ways, that's quite helpful. On the other hand, it is a time in their life when they really should be dedicating themselves to building the human capital that will last them through the rest of their lives.
MARTIN: And let me get to the piece that caught our eye which is the piece that you posted in The Crimson, "The Trouble With Optionality" which is a way of saying - can you break it down in layman's terms for us - what? - hedging your bets?
DESAI: Yeah, exactly.
MARTIN: Keeping your options open?
DESAI: Yeah. So the number of young people I see who talk about maximizing optionality which is just a fancy way of saying I want to make sure and have as many options as possible, so I think that sounds like a great strategy. But what I've observed over the last several years is these people become obsessed with optionality, you know, with having options. And instead of doing what we think that we do, which is enable risk-taking, you know, which is what options are supposed to be able to do. Right? You don't acquire options just for their own use. You do it, so you can actually take on big risks. What I observed these people doing is just habitually acquiring options. They just get so used to the process of acquiring options that they never really execute on this larger vision of what they want.
So part of what I wanted to do in the piece is say, look, that's not the right way to think about this. In fact, when you do these things that acquire options, for example, working at prestigious firms - these are, again, for the elite graduates going to grad school - you know, your social network, yes that's wonderful. It allows you to have a lot of optionality. But don't forget that the really great things in life come from big, risky investments. And I think that's a really important piece of what people are missing out on. And in particular, you can get stuck. You can get stuck in a place where you think you're maximizing your options, and then you wake up. And you're, you know - you're still there 20 years later.
MARTIN: That was going to be my last question. It's commencement season, and everybody from Hillary Clinton to Will Ferrell is - as we just heard - are offering advice to recent graduates. So any other advice that I didn't have the wit to squeeze out of you to this point?
DESAI: Well, yeah. It is - it's always remarkable how in some ways consistent graduation advices, and, in some ways, that makes it anodyne, but that doesn't make it any less true, which is the pursuit of things that we truly love is the secret to professional happiness and blocking out the noise.
I guess that's one thing I would add which is there is so much noise out there, noise about what, you know, the unemployment rate is or noise about what you should be doing with your life or noise about what your friends are doing or what your parents want you to do. Just block it all out. Look inside yourself. Find out who you are and pursue that. So block out all the noise I think is an important piece of it as well.
MARTIN: That was Mihir Desai, professor at the Harvard Business School. His latest book is "The Wisdom Of Finance: Discovering Humanity In The World Of Risk And Return." And as we said that we also called him for his piece posted in The Crimson, "The Trouble With Optionality." Professor Desai, thank you so much for speaking with us.
DESAI: Thanks so much Michel.
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TOPICS > ECONOMY > MAKING SEN$E
The world of finance has a dark side, but that’s only half the story
July 13, 2017 at 6:25 PM EDT
You could say that the field of finance has an image problem, with both fictional and real-life figures projecting greed and other less-than-likeable attributes. That’s why Mihir Desai has written a book, "The Wisdom of Finance," to balance the picture and appeal to those in the field to get back to the core ideas. Economics correspondent Paul Solman reports.
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JUDY WOODRUFF: When it comes to Wall Street, many people think of money and greed, but a professor at Harvard Business School argues there’s a lot more to the world of finance, and he uses books and movies to make his case.
Our economics correspondent Paul Solman has the story.
It’s part of our series Making Sense, which airs every Thursday.
ACTORS: One, two, three!
(CHEERING AND APPLAUSE)
PAUL SOLMAN: The field of finance, you might say it has an image problem. Consider “The Wolf of Wall Street,” based on a real-life character.
LEONARDO DICAPRIO, Actor: If anybody here thinks I’m superficial or materialistic, go get a job at McDonald’s, because that’s where you (EXPLETIVE DELETED) belong.
(CHEERING AND APPLAUSE)
PAUL SOLMAN: Investment banker Patrick Bateman in “American Psycho” is fictional, but not entirely implausible.
CHRISTIAN BALE, Actor: I have all the characteristics of a human being, flesh, blood, skin, hair, but not a single clear, identifiable emotion, except for greed and disgust.
MICHAEL DOUGLAS, Actor: I am not a destroyer of companies.
PAUL SOLMAN: Hey, finance has had an image problem since buyout bro Gordon Gekko graced the silver screen 30 years ago.
MICHAEL DOUGLAS: The point is, ladies and gentlemen that greed, for lack of a better word, is good.
ACTOR: Big bank, small bank, I like to make money. All right?
PAUL SOLMAN: And the real events of the 2008 financial crisis only made matters worse.
ACTOR: That’s America’s housing market.
PAUL SOLMAN: But Harvard Business School’s Mihir Desai says there are two faces to finance, though he readily acknowledges the dark one to his students.
MIHIR DESAI, Harvard Business School: Many people demonize what you do, and it’s hard to live that way.
PAUL SOLMAN: And he told me he gets why that perception is so pervasive.
MIHIR DESAI: When you have real-life figures like Martin Shkreli, who was both a hedge fund trader and then took over a pharmaceutical company, jacked up prices by 5000 percent, subsequently engaged in a variety of nefarious behavior, and very proudly so, so it almost makes you feel like real life is outpacing fiction.
PAUL SOLMAN: Desai has written a book to try to balance the picture, “The Wisdom of Finance.”
MIHIR DESAI: The goal in the book is to try to demystify finance so that the people who currently demonize it will come to understand it, as opposed to simply oppose it.
And then for the people who are in finance, we have to get back to the ideas. The ideas matter.
PAUL SOLMAN: To Professor Desai, the big idea of finance is illustrated by the Quincunx machine in Boston’s Museum of Science: the ability to find order in a seemingly random, and therefore risk-forsaken, world.
MIHIR DESAI: This was a real revolution in probability, which is random things happening results in predictable patterns.
PAUL SOLMAN: Balls drop, bounce randomly left or right as they encounter the pins, and eventually hit bottom to form a bell-shaped curve.
MIHIR DESAI: Things that seem random actually end up resulting in a very orderly pattern, in fact, this bell-shaped distribution or normal distribution. And that, of course, is the foundation of finance, because you observe a lot of random things, but it ends up behaving in predictable ways.
PAUL SOLMAN: Randomness and its risks are everywhere. Finance’s job, to try to manage them. Case in point? The income plight of women throughout most of history.
ACTOR: You should consider that it is by no means certain that another offer of marriage may ever be made to you.
MIHIR DESAI: Mr. Collins, who delivers the worst proposal ever to Lizzy Bennet in “Pride and Prejudice.”
ACTOR: I am well aware that 1,000 pounds is all you may ever be entitled to, but rest assured I shall never reproach on that score when we are married.
MIHIR DESAI: You’re not that wealthy, you’re not that pretty, you have an offer on the table today from me. You would better take it.
PAUL SOLMAN: It’s the great economic risk faced by all Jane Austen’s Bennet girls, but says Desai:
MIHIR DESAI: Lizzy turns down Mr. Collins, and the advice of her mother, because she wants to roll the dice again. Of course, that ends up very nicely, ultimately, with Mr. Darcy, but, at the time, she didn’t know.
PAUL SOLMAN: No, Lizzy was lucky in love and money. She accepted the risk. But most others didn’t.
MIHIR DESAI: The next day, he gives the same proposal to Charlotte, her friend, and she takes it.
ACTOR: Cousin Elizabeth, you can see before you the happiest of men.
PAUL SOLMAN: Charlotte Lucas’ lot wasn’t the happiest, but better than penury, one imagines.
MIHIR DESAI: She said, I’m just going to take the solution.
PAUL SOLMAN: In Anthony Trollope “Phineas Finn”:
ACTOR: How nice to find you and to find you alone.
PAUL SOLMAN: Violet Effingham had a very different problem: too many suitors.
ACTRESS: And you look very piratical tonight, Lord Chiltern.
ACTOR: That is because you see me by the side of all these smug, glossy parliament men.
MIHIR DESAI: She doesn’t know who to choose, and she says, you know, if only I could marry all 10. You know, she’s the essence of diversification.
PAUL SOLMAN: Because then you wouldn’t have all your eggs in one basket. You would have 10 different guys, 10 different fortunes.
MIHIR DESAI: Exactly. The intuition that you can lower risk by dividing resources is extremely old. That diversification idea goes back to shipping, when you split up your cargo across routes. It goes back to agriculture, when people would split up their land.
In Ecclesiastes, we see the advice to invest in seven ventures — no, eight ventures, because you never know what disaster will happen.
PAUL SOLMAN: So this is the benign face of finance. It allows you to protect against risk by, among other things, diversifying your investments. But then there’s the dark face again.
When you invest, you’re still stuck with the risk of giving your money to someone else.
MIHIR DESAI: I gave my money to Tim Cook, who runs Apple, and I own one share. Here’s the problem. I can’t watch Tim Cook. So the underlying problem becomes, well, wait a second, how do I monitor that guy? How do I watch that guy? How do I make sure he’s doing the right thing for me?
PAUL SOLMAN: This is the principal-agent problem. The principal is the shareholder, who has the wealth. The agent is the manager entrusted with it.
ACTOR: If you only know what I went through for you.
PAUL SOLMAN: And principals and agents can have conflicting interests, in the case of “The Producers,” extremely conflicting.
GENE WILDER, Actor: It’s absolutely amazing that, under the right circumstances, a producer could make more money with a flop than he could with a hit.
MIHIR DESAI: The essence of “The Producers” is that these two folks, Bialystock and Bloom, want to rip off a bunch of investors, and by creating a flop, the investors won’t want their money back. They raised 25000 percent of what they actually need. They create this — what they think is going to be a flop, “Springtime For Hitler,” and, of course, it becomes a hit, and they go to jail.
These investors trusted Bialystock and Bloom. They couldn’t actually monitor them. They turned out to be bad eggs. That is the problem with capital markets. That is the problem with me giving money to people and not knowing what they end up doing.
PAUL SOLMAN: But, of course, for every Bialystock, there’s a Buffett, for every Bernie Madoff, 1,000 honest brokers, because there have always been two faces of finance.
MIHIR DESAI: This is actually my favorite book about finance. It’s from 1688.
PAUL SOLMAN: Yes, a good year for finance.
MIHIR DESAI: And it was “Confusion de Confusiones.”
He basically describes finance as the most noble profession, as well as the most notorious profession. I think we have lost sense of the nobility part that he describes, and we tend to focus on the negative.
PAUL SOLMAN: Desai, wanting to accentuate the positive, uses an exemplar of finance from Willa Cather’s 19th century novel, “O Pioneers!”
MIHIR DESAI: Alexandra Bergson is this wonderful character who is a farmer, who starts by basically doing a leveraged buyout of farms near where she lives.
PAUL SOLMAN: She borrows money in order to buy.
MIHIR DESAI: She borrows a bunch of money to buy all of these farms.
ACTRESS: Now, I have figured it out. We sell most of the cattle e and the corn we have left over. We buy the Lindstrom place. Then we take out two loans on our half-section and buy Peter Crow’s place.
MIHIR DESAI: She ends up engaging in transactions that would be in any finance textbook. But she never loses sight of who she is. She never behaves in ways that would suggest that she thinks everything is due to her skill, as opposed to luck. She’s very conscious of and very humble of her outcome.
ACTOR: You have worked wonders with this land, Alexandra.
ACTRESS: Oh, we hadn’t any of us much to do with it, Carl. The land did it.
MIHIR DESAI: We really need good stories about finance, because good stories will guide good behavior.
PAUL SOLMAN: It’s a lesson Desai tries to teach his students.
MIHIR DESAI: Pick your stories carefully, because you will live your life by these stories. Some of you might pick Gordon Gekko. I don’t recommend it. Alexandra Bergson is a fantastic model.
PAUL SOLMAN: For the PBS NewsHour, this is economics correspondent Paul Solman reporting from Boston.
JUDY WOODRUFF: Who knew by watching all these films that you could get great economic advice?
So, while writing his book, Professor Desai says he was surprised to discover how many great writers, painters and musicians also held jobs in finance.
You can test your own knowledge of these entrepreneurial artists with our online quiz at PBS.org/NewsHour.
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A defence of finance drawing on the arts
The route to instilling more of an ethical compass in finance is by putting it through a prism of art and literature, argues new book by Harvard professor
Thu, Sep 28, 2017, 05:49
Fiona Reddan
Mihir Desai, a professor at Harvard Business and Harvard Law School, and author of ‘The Wisdom of Finance’
Mihir Desai, a professor at Harvard Business and Harvard Law School, and author of ‘The Wisdom of Finance’
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It’s not often – if ever – you’ll come across a book written by a Harvard finance professor who seems just as comfortable talking about the romantic choices of Pride and Prejudice’s Elizabeth Bennet or the business acumen of Stringer Bell in The Wire, as about economic theory.
But, in his new book The Wisdom of Finance, Mihir Desai, a professor at Harvard Business and Harvard Law School, has drawn on the arts to make his case. It could just as easily be called “in defence of finance”, with Desai attempting to calibrate the poor public perception of people working in his profession – and to offer a solution as to how this demonisation can end.
He had two motivations in writing the book.
“One, there is a great deal of misconceptions about finance and then finance gets demonised, and a lot of this happens because people don’t understand finance. And my second motivation is that people in finance . . . we have to rehabilitate finance, and look at what we do with a moral lens.”
For Desai, literature can offer this ethical insight.
“The humanities lets you look at things with a moral lens,” he says.
While Desi is not blind to the events that precipitated the most recent financial crisis – both in the US and Ireland – and he accepts that the stereotype of finance having some nefarious intent is “not undeserved”, he says it’s time we also realise the importance – and even the nobility of it.
“Finance is really central to our lives; historically we’ve understood the difficulties and also the nobility of it,” he says, drawing on a quote from the 17th century which asserts that finance “is at once the fairest and most deceitful in Europe, the noblest and the most infamous in the world, the finest and the most vulgar on earth”.
“We’ve lost the nobility,” he bemoans.
He accepts that finance has also used complexity to obfuscate and “intimidate other people”. But the “core idea is not rocket science, it’s quite intuitive”.
He also has some ideas on how we can expect better behaviour from financiers. And it’s not through regulation.
In the aftermath of the financial crisis, countries around the world – Ireland included – looked to shore up their regulatory regimes to prevent such bad behaviour taking place again.
For Desai however, regulation won’t fix the problems, as “people will game it”.
“The regulation we had was clearly insufficient, that’s clear, but we can’t expect that much of regulation ultimately,” he says, adding that his ambitions for regulation are actually quite low.
Instead, he says it’s about elevating financiers’ aspirations, “so that they will aspire to behave better”.
“It’s really difficult for the people being demonised as it leads to worse behaviour. We expect very little – and so they behave fairly poorly,” he says.
And the route to instilling more of an ethical compass is by putting it through a prism of art and literature.
“Finance is becoming divorced from the humanities, it’s really problematic . . . we need to bridge finance and the humanities,”he says, adding that the best way to get back to that, “is to understand risk management not through calculus and graphs, but through Jane Austen and Anthony Trollope.
An example used in the book that will be familiar to many is the romantic choices faced by Elizabeth Bennet in Pride and Prejudice. Her challenge in finding a husband, Desai writes, is like the tradeoffs faced in many other settings. Consider the risks Elizabeth faces when she turns down Mr Collins’ proposal; in doing so she risks being left with nothing. As her sister warns, when it comes to the marriage market, “one false step involves her in endless ruin”.
But this “trade-off” – which ultimately works for Elizabeth when she marries Mr Darcy – can be applied in a myriad of ways Desai writes. “Is continuing with further education ‘worth it’? Will the returns on that education compensate for the risks of specialisation and indebtedness? Is investing your human capital in that startup company worth the risk that it will go belly-up in the next 12 months? Should you keep looking for the perfect job or accept the offer on the table?”
While Desai concedes that a humanities-based approach to finance may be “idealistic”, he doesn’t see an alternative.
“I don’t think regulation is terribly constructive, we really have to expect more of these people.”
As a Harvard professor, Desai is also keenly aware of tax policies in the US – and how they might impact on Ireland.
On US president Trump’s proposed tax reforms, which could see the US corporate tax rate plummet from 35 per cent to as low as 15 per cent, Desai doesn’t expect much progress in the short term.
“The proposal is effectively one piece of paper, it doesn’t have details, and it doesn’t have any political realism for it,” he says, adding, “I’m deeply sceptical that it happens.”
However, he concedes that US corporate tax rates are nonetheless on a downward trajectory, noting that the major consequence of this will be that capital and cash immobilised offshore will be freed up. But noting how Ireland has developed “real capabilities, it’s an attractive place to be”, he doesn’t think the impact will be as bad as we fear.
“I actually think Ireland won’t get hurt by that; it’s strengths transcend the tax benefits,” he says.
On the Apple tax fine, Desai says “it’s a manifestation of how screwed up the US tax system is” adding that “it’s making firms do really crazy things”.
Noting the “great irony” in the European Commission demanding that Apple pay Ireland €13 billion, and the Irish Government says it doesn’t want it, Desai won’t however, draw a line from his work on morality in finance, and the issue of multinational structures established specifically to cut tax liabilities.
“I think we under-appreciate how hard this problem is,” he says, noting that the concept of everyone paying their fair share is “philosophically and conceptually, a hard thing to enact”.
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The Wisdom of Finance: Discovering Humanity
in the World of Risk and Return
Publishers Weekly.
264.9 (Feb. 27, 2017): p86.
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Full Text:
The Wisdom of Finance: Discovering Humanity in the World of Risk and Return
Mihir A. Desai. Houghton Mifflin Harcourt, $27
(240p) ISBN 978-0-544-91113-0
In this slender but erudite treatise, law and finance professor Desai (International Finance: A Casebook) proposes that
humanity, rather than the hot-button issue of income inequality, lies at the center of finance. To do this, he calls upon
none other than Jane Austen and John Milton, among others. Desai gives humanists explanations of basic financial
principles, such as value creation and leverage, with nary a numeral. For number crunchers, Desai provides a fresh way
of viewing basic ideas. A scene from Dashiell Hammett's novel The Maltese Falcon is used to explain randomness and
chance. The contemporary artist Jeff Koons is invoked to illustrate the power of financial leverage. Other analogies
work less well: the description of the Time Warner-AOL merger as a May-December romance seems both strained and
precious. Nonetheless, this book does valuable work toward demystifying finance for laypeople and deepening the art
for practitioners. Desai's approach will broaden and enrich any perspective. Agent: Jay Mandel, 'William Morris
Endeavor. (June)
Source Citation (MLA 8th
Edition)
"The Wisdom of Finance: Discovering Humanity in the World of Risk and Return." Publishers Weekly, 27 Feb. 2017,
p. 86. General OneFile, go.galegroup.com/ps/i.do?
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‘The Wisdom of Finance’, by Mihir Desai
Fiction helps bridge the divide between bankers and the rest of us
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Your Silence Will Not Protect You by Audre Lorde — before the word
Working Girl: Desai uses the arts and its narratives as a device to help shrink the chasm between finance and humanities
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JULY 16, 2017 by Review by Gillian Tett
When I first saw the title of Mihir Desai’s book — The Wisdom of Finance — I joked to myself that it was an oxymoron. There are many words non-bankers might employ to describe financiers: greedy, reckless, lawless, selfish or wealthy. But “wise” is not one; nobody would ask a banker for self-help advice. So why did Desai — who teaches at Harvard business and law schools — describe finance as “wise”? Was the title ironic? Or insufferably smug?
A few pages in, I stopped scoffing and became fascinated. The Wisdom of Finance offers a thoughtful explanation of how money works that recognises how perverted the industry can be, but which also argues that “there is great value — and there are great values — in finance”.
Desai does this by using a clever and unusual device: literature. Most notably, he explains how money works by citing stories ranging from Chaucer to Jane Austen to the 1988 film Working Girl. He knows that stories are a powerful narrative device. But the wider philosophical point is, Desai argues, that one of the great failings of our modern world is a “chasm” between the arts and science, and between finance and humanities. This prevents financiers from understanding the social context in which they operate. It also means that non-financiers do not understand how finance drives our world, or the fact that money encapsulates and crystallises social patterns and values. “Many distrust markets, particularly financial markets, because they are thought to be hostile to humanity — but perhaps that has things completely upside down.”
“Perhaps finance is deeply connected to our humanity,” Desai writes. “Perhaps we can all find our way back to a more noble profession by enlivening the ideas of finance through stories that illuminate our lives and our work.”
To illustrate the point. Desai teaches the reader about “risk” by citing the works of the philosopher Charles Sanders Peirce and the poet Wallace Stevens. He explains “asset value” through the biblical parable of servants and their “talents”, and “insurance” with reference to Jane Austen’s descriptions of marriage strategies. In one particularly powerful chapter, he explains “leverage” by writing about strategies that modern western professionals use to navigate their commitments to family, career and friends (the artist Jeff Koons is considered a highly leveraged social creature; George Orwell was under-leveraged.)
In the most important passage, Desai tries to explain why finance has created so much harm. He rejects the idea that finance itself is flawed or that financiers are inherently bad. Instead, he thinks the key problem is that finance, unlike most professions, gives its practitioners rapid feedback on their performance, and if they do well, they become arrogant and greedy. “Finance can breed insatiable desire in people who venture into it,” he observes. “Outsized successes fuelled by leverage create enormous wealth at all-too-early ages. The problem then becomes how to make sense of that success.”
He argues that the best cure for this is for financiers to relearn the art of humility and modesty, perhaps by contemplating the story of a financier who projects these values: Alexandra Bergson, the farmer heroine of O Pioneers!, a 1913 novel by Willa Cather. “Finding narratives that allow us to stay attached to what is meaningful in finance can insulate us from the feedback loops of attribution error — and perhaps help save us from becoming caricatures.” This is sensible. But one weakness in Desai’s argument is that it is modern markets in particular that offer these instant “feedback loops”; in earlier periods of history, greed emerged without such rapid accounting. Moreover, Desai does not give enough space to describing how the structure of modern finance creates deeply unhealthy incentives; not everything can be blamed on individual folly.
This is a charming, provocative and readable book. For non-financiers, it can be a great teaching tool; for financiers, it is a badly needed rap on the knuckles, and perhaps an inspiration. Let us just hope that we will see more copies of Austen — and Cather — on bank trading floors; better still, put them next to the algorithms and spread sheets.
The writer is the FT’s US managing editor
The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, by Mihir Desai, Profile £12.99/Houghton Mifflin $27
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The Wisdom of Finance: Discovering Humanity in the World of Risk and Return, by Mihir A. Desai
Book of the week: Great writing can enlighten and encourage dialogue between disciplines, says Gary Morson
August 31, 2017
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By Gary Morson
Biblical parable of the talents
Sow, to reap: in the biblical parable of the talents, a man rewards the servants who invest his wealth wisely and punishes one who, out of fear, makes no attempt
“I had always enjoyed stories,” writes Mihir Desai in his new book The Wisdom of Finance, “but becoming an economist made me distrust them.”
This is the economist’s professional ethos: stories are for the fuzzy-headed disciplines, while genuinely scientific fields use mathematical models. And yet some aspects of life, including economic behaviour, are best illuminated by stories, which is why we have literature. This is a theme I have myself developed in a recent book with economist Morton Schapiro, Cents and Sensibility: What Economics Can Learn from the Humanities, where we argue, like Desai, that economists need to supplement their toolkit with modes of thinking developed by reading great novels.
I began to understand economists’ distrust of stories some two decades ago, when I spent a year as a token humanist at Stanford University’s Center for Advanced Study in the Behavioral Sciences in Palo Alto, then dominated by rational choice theory. As soon as economic models could be applied to other social disciplines, everyone seemed to think, these disciplines too could achieve scientific status and do away with narrative.
As one colleague explained to me, you can tell that a discipline has become scientific when it dispenses with stories. Think of Newtonian astronomy: no one would explain the orbit of Mars by narrating where it is moment by moment, since mathematical formulae exhaustively explain its positions. Modern economics was in fact modelled on Newtonian mechanics, and it seemed to follow that while stories can serve as illustrations for purposes of instruction they do not explain anything. If one calls the need for stories “narrativeness”, then some disciplines, like history, are high in narrativeness, while others, like economics, aspire to zero narrativeness.
Desai’s book presents itself at first as a short course in finance using literature, and so I prepared myself for one of those condescending books such as the anthology by Michael Watts, The Literary Book of Economics: Including Readings from Literature and Drama on Economic Concepts, Issues, and Themes (2003). Here we learn that Robert Frost’s poem The Road Not Taken is groping towards the concept of opportunity costs, while Mending Wall can help an instructor get across the concept of property rights. How about Hamlet as illustrating opportunity costs or King Lear as a first attempt at understanding “principal-agent issues”? The assumption is that economists have the answers, and writers, because they express themselves so well, provide nice pictures suitable for those with poor maths skills. The idea that great writers actually know something important does not seem to cross Watts’ mind, or the minds of many other social scientists who use literature.
But Desai is different. For him, issues in finance derive from some much larger aspect of human existence, like risk, which is also treated by great literature. Finance can attune us to these issues, but when we apply its concepts elsewhere they sometimes show their limitations. Given the human condition, issues are much more complex than first appears, and great literature can show us precisely how. And so literature can actually teach economists something, not just provide pretty illustrations of what they already know.
Desai’s chapter “On Value” begins with a discussion of the New Testament parable of the talents, which tells the story of a rich man going on a journey who entrusts his wealth to three servants. When he returns and asks for an accounting – as God will do at the Last Judgement – he finds that the one to whom he entrusted five talents and the one to whom he entrusted three talents have managed to double them, but the one to whom he entrusted one talent just buried it in the ground out of fear. He rewards the first two and banishes the third.
After drawing obvious (and not so obvious) conclusions about investments, Desai asks some more perplexing questions. We all have “talents” in the other sense – this parable may be the origin of the usual meaning of the word “talent” today – and perhaps we should we look at them not as handy things to use as we like but as gifts not of our own making that we are morally bound to develop. As Desai puts it, “we are stewards of those gifts and must make the most of them”. He then turns to Samuel Johnson, who was perpetually plagued by guilt for not making the most of his gift. His poem On the Death of Robert Levet considers a simple man, supported by Johnson, who through his constant care and affection brightened the lives of those around him and so demonstrated “the power of art without show”. Goodness is prosaic, and Johnson chose to illustrate the point by invoking the parable of the talents:
His virtues walk’d their narrow round,
Nor made a pause, nor left a void:
And soon th’ Eternal Master found
The single talent well employ’d.
John Milton also feared that, as he went blind, he would fail to make the most of his talents, and in the famous sonnet on his blindness, When I Consider How My Life is Spent, he laments that “one talent that is death to hide” is now lodged within him useless. Desai explains how Milton answers this parable with another, about the workers in the vineyard, who start to labour at different times but at the end of the day get paid the same. The readiness to serve also has value. “God does not need/Either man’s work or His own gifts…They also serve who only stand and wait.”
In Desai’s chapter on “Failing Forward”, the case of the American Airlines bankruptcy, and of the CEO who long refused to file for it because he believed in the moral obligation to honour one’s commitments, raises issues not only in finance but also in ethics more generally. “Bankruptcies are evocative”, suggests Desai, “because they are about our attitude toward our commitments and how conflicting obligations should be navigated.” As he glances at Aeschylus’ tragedy Agamemnon and the classic Indian epic, the Bhagavadgita, he shows why such questions have no easy solutions. One needs not a formula but good judgement, which is the product of experience – and great literature – sensitively reflected on. Desai concludes: “Bankruptcy is a process that can’t be approached with a simple moral frame or set of decision rules. Instead, it is a process of navigating deeply felt obligations – much as a good life is.”
In his afterword, Desai considers C. P. Snow’s classic essay on The Two Cultures, which deals with the radically different modes of thinking in the humanities and the hard sciences. “When these two senses [of the world] have grown apart, then no society is going to be able to think with wisdom,” Snow pleads. If we substitute economics and finance for the hard sciences, the same mutual incomprehension obtains today. Desai takes a real step towards creating a dialogue of disciplines. Most of the time he succeeds. If only more people – whether financiers or academics – could combine with such finesse economic knowledge and an appreciation of the human condition!
Gary Saul Morson is Lawrence B. Dumas professor of the arts and humanities at Northwestern University.
The Wisdom of Finance: Discovering Humanity in the World of Risk and Return
By Mihir A. Desai
Profile Books, 240pp, £12.99
ISBN 9781788160049
Published 31 August 2017
Mihir Desai
Source:
Phil Farnsworth
The author
Mihir Desai, Mizuho Financial Group professor of finance at Harvard Business School, was born in Mumbai, soon moved to Hong Kong but grew up, from the age of eight, in Madison, New Jersey. He believes that he “benefited enormously from these moves, as they provided for a great education, a solid American identity and a deep appreciation for what the rest of the world offers”.
For his first degree at Brown University, Desai majored in history, “a great discipline for learning how to write and for engendering a more subtle sense of causality”. He has always, he says, been “a voracious consumer of high and low culture. I grew up feasting on books, television and movies equally, and that pattern continued until I became a professor…As an economist, you are trained to distrust stories, but writing The Wisdom of Finance made me realise again how we create meaning out of narratives.”
With a PhD in political economy, Desai says he is “fully indoctrinated” in abstract mathematical models and produces work “built on neoclassical theory and various quantitative empirical methods. The book is not a reaction against that tradition but a complement to it. The rigour and formalised methods of economics and finance are not opposed to our humanity but actually related to it.”
Yet today, in Desai’s view, “much of finance has become about value extraction rather than value creation. The book attempts to use the humanities to demystify finance for outsiders and to humanise finance for practitioners. The discipline is reinventing itself, but I think in unfortunate ways. We have become far too enamoured of the latest behavioural bias that psychology purports to have found and randomised trials and all-too-subtle econometric methods. In the process, we’re losing the intellectual coherence of the discipline and the ability to address the really large and pressing problems of the world.”
Matthew Reisz
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Mihir Desai, The Wisdom Of Finance [Book Review]
June 2, 2017 2:07 am by Brenda Jubin Views: 2
Mihir Desai’s The Wisdom of Finance: Discovering Humanity in the World of Risk and Return (Houghton Mifflin Harcourt, 2017) takes “the unorthodox position that viewing finance through the prism of the humanities will help us restore humanity to finance.” This sentiment is actually becoming more mainstream. For instance, there’s the just published Cents and Sensibility: What Economics Can Learn from the Humanities by Gary Saul Morson and Morton Schapiro. But Desai, a professor at the Harvard Business School and Harvard Law School, outshines his competition in at least two respects: he distills finance down to a few key components, and not the usual suspects, and he brings to bear on them insights from a wide range of often unexpected sources. For instance, “the first chapter lays down the foundations of risk and insurance, with the help of Francis Galton’s quincunx, the author Dashiell Hammett, the philosopher Charles Sanders Peirce, and the poet Wallace Stevens.”
Mihir Desai, The Wisdom Of Finance
The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai
In subsequent chapters Desai deals with such topics as options and diversification, risk and return, asset pricing, the principal-agent problem, mergers, and debt and bankruptcy. Again, with exceedingly well chosen examples from the humanities.
Everyone hates finance, including novelists. From Leo Tolstoy’s “How Much Land Does a Man Need?” and Theodore Dreiser’s The Financier to the increasingly less sympathetic main characters of Wall Street, American Psycho, and Cosmopolis, the theme is “the untrammeled desire for more.” And real life provides more than its fair share of these financial archetypes—for instance, Martin Shkreli. So is insatiable desire fundamental to finance? Desai argues that it’s not, that finance is primarily the story of risk, though he admits that “the asshole theory of finance” is powerful: that is, “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.” To counter all the antiheroes in finance, real and fictional, he introduces the reader to Willa Cather’s O Pioneers!, a “story that truly belongs in every finance textbook.”
Desai’s book is an eye-opening, wonderful read. I highly recommend it.
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June 9, 2017
EDITOR'S CHOICE: The Wisdom of Finance: Discovering Humanity in the World of Risk and Return
By: Dylan Schleicher @ 10:28 AM – Filed under: Big Ideas & New Perspectives, Biography & Narrative, Current Events & Public Affairs, Innovation & Creativity, Leadership & Strategy, Personal Development & Human Behavior
Wisdomfinance
The Wisdom of Finance: Discovering Humanity in the World of Risk and Return by Mihir Desai, Houghton Mifflin Harcourt, 240 pages, Hardcover, May 2017, ISBN 9780544911130
This is the second week in a row I’m reviewing a book that references the 1988 movie Working Girl. Jennifer Romolini used it in Weird in a World That’s Not to point to the lack of good female role models and the shortcomings of how women bosses are portrayed in Hollywood. In this week’s book, The Wisdom of Finance, Mihir Desai brings it in to lend insight on the nature of mergers and marriage. If that sounds dry, it is a chapter that also touches on songs by Charlie Parker, Ray Charles, and Kanye West, dowries in fifteenth-century Florence, and the failed merger of AOL and Time Warner. And it’s all brought home with the story of the 1926 union of General Motors and Fisher Body, and the dissolution of a 100 year partnership between Ford and Firestone. Trust me when I say these are dramas of the highest order. “For economists,” Desai writes, the GM/Fisher story is “Anna Karenina, Middlemarch, and Jane Eyre all rolled into one.”
The great conceit of The Wisdom of Finance is that it is just as likely, or even more so, to turn to novels like that than to business history in articulating the finer points of finance. He does it all in the service of humanizing the subject, to make the point that “there is great value—and there are great values—in finance” and that they need to be reclaimed by those practicing it:
More than regulation and outrage, fixing finance requires practitioners to return to the core ideas, and ideals, of finance—which can help them ensure that they are creating value and not extracting it. By linking those core ideas to literature, history, and philosophy, we give them deeper resonance and make them more resistant to corruption.
So, if the idea of finance bores you, perhaps you’d like to know the role insurance may have played in sparking the French Revolution, or how it may have precipitated the decline in allegations of witchcraft. Maybe you would like to learn about the nature of risk from Pride and Prejudice, or about the underlying state of chaos we all live in, and how to manage it, from poet Wallace Stevens—who also happened to have been an insurance executive. It is here you begin to get the sense that the practical and philosophical, that literature and science, are being intricately intertwined.
For Stevens, “imagination is the power of the mind over the possibilities of things” and is the “power that enables us to perceive the normal in the abnormal, the opposite of chaos in the chaos.”
In probability theory, that is called normal distribution. In terms of insuring people, it means that, while you can never know when someone will die, you can determine an average lifespan and use it to pool risk.
What can you learn about options and the importance of diversification from Trollope’s Phineas Finn, from medieval agriculture, or The Wire? What can Shakespeare’s The Merchant of Venice and Kazuo Ishiguro’s Remains of the Day teach us about leverage and debt, about commitment and the bonds that bind us? The answer is, quite a bit.
In addition to showing what the humanities can teach us about finance, Desai draws lessons from finance to inform our humanity. Speaking to the benefits of forming relationships with people that are not like you, he writes:
In fact, the relationships that are most enriching are ones that broaden our perspective beyond our usual experience—those relationships are, in finance terms, “imperfectly correlated assets,” precisely the types of assets that most enhance the portfolios of our lives. … Homophily, or the desire to surround ourselves with like-minded people, is a common social instinct—and one that finance warns against. Yes, it’s easier to be around like-minded types, but finance recommends the hard work of exposing yourself to differences, not shielding yourself from them.
He’ll also reveal how the capital asset pricing model can teach you about the relationships you form in life, and how the principle-agent problem affects our relationships with our children, and even our own childhood. That principle-agent framework, “a powerful lens for understanding the muddle of modern capitalism and the role of finance,” is explored with stories from E.M. Forster’s A Room with a View, Mel Brooks’ The Producers, and a personal story of his mother’s living arrangements after his father passed away.
The Bible’s (rather harsh, in Desai’s view) parable of the talents is used to teach us how value is created and distributed, and what that might mean for how you approach life and use your natural abilities. He balances that harshness with the etymology of the very word “finance,” with a exhortation not to confuse outcomes with our efforts, and a reminder that finance means “living up to and settling one’s obligations.”
It is also a history of remarkable and intellectually romantic characters like Charles Sanders Peirce and Louis Bachelier, men whose ideas were ahead of their time and who died in poverty. It tells the story of Robert Morris, who financed the American Revolution and passed up the opportunity to become the first Secretary of the Treasury (suggesting Alexander Hamilton in his stead) to recoup the fortune he spent during the war, only to end up in debtors prison before the nation’s first bankruptcy law was enacted. In the discussion of bankruptcy, he references Aeschylus’s Agememnon and the story of Arjuna from the Bhagavad Gita, Martha Nussbaum’s The Fragility of Goodness and her take on Euripide’s Hecuba, and what it has to teach us about navigating uncertainty and competing obligations.
The depiction of finance in literature and film includes many more villains than heroes, and there is good reason for that depiction. Success in finance tends to lead to and oversized ego, an insatiable appetite and desire to accumulate ever more. Desai struggles with that, with the fundamental good service finance provides and the attribution error it seems to breed—our tendency to view our financial success is the result of our abilities rather than luck, while we attribute our failures to circumstances beyond our control. To guard against this, he suggests:
I think the best way to insure ourselves against that risk is through works—and the work—of imagination, just as Wallace Stevens suggested.
In searching for a hero, he finds Willa Cather’s portrait of Alexandra Bergson from O Pioneers! Reflecting on a line from that book, that “There are only two or three human stories, and they go on repeating themselves as fiercely as if they never happened before,” he writes:
For Cather, there are ultimately only a few stories that all of our lives end up resembling. Some of them, as we’ve seen, are tales of hollow accumulation and insatiable desire. Some are tales of heart and hard work. It is up to us to choose amongst them wisely. I recommend Alexandra Bergson’s story.
The stories Mihir Desai weaves together leave you feeling hope for our future. It bridges the barrier between art and science, between technical knowledge and human understanding. It reminds us that finance is at the heart of what we’ve come to know as the American Dream, and revives the argument that we must puts values back at the center of value creation to continue to finance that dream.
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About Dylan Schleicher
Dylan Schleicher has been a part of the 800-CEO-READ claque since 2003. Even though he's stayed on at the company, he has not stayed put. After beginning in shipping & receiving, he joined customer service and accounting before moving into his current, highly elliptical orbit of duties overseeing the ChangeThis and In the Books websites, the company's annual review of books and in-house design. He lives with his wife and two children in the Washington Heights neighborhood on Milwaukee's West Side.
Finding humanity in finance
It’s a cold word, finance, one that conjures stereotypic images of buttoned-up, avaricious I-bankers spouting indecipherable lingo. In his new book “The Wisdom of Finance: Discovering Humanity in the World of Risk and Return’’ (Houghton Mifflin Harcourt), Harvard business professor Mihir Desai has tried to give finance a beating heart, to humanize it by viewing it through the lenses of literature, art, philosophy, music, movies, and TV.
Desai agrees that the field can be high technical. But examining it through examples drawn from the humanities makes concepts like risk and return, corporate governance, bankruptcy, and valuation easier to grasp. It also forces people to think about financial activity “through a moral lens.”
Take, for instance, Alexandra Bergson in Cather’s “O Pioneers!’’ and her strategy to save the family property during a crisis: “Her complex financing plan, which involves mortgaging the homestead, features debt service payments well into the future that will only work if she’s right about the future of land prices.” What makes her admirable, Desai argues, is that her scheme is not just to build wealth but stems from “her deepest relationships with close friends and family.’’ Those familiar with the world of finance will have their perspective shifted, and for the rest of us, Desai provides a welcome entry.
15 September 2017
How human is the world of risk and return?
By Oliver Wiseman @ollywiseman
How human is the world of risk and return?
Of markets and men: finance fuels ego and ambition in an unusually powerful way. Photo: Peter Macdiarmid / Getty Images
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Finance used to be a 'touchstone for the intelligent and a tombstone for the audacious'
There is no industry where it is easier to dress up luck as skill
Does the 'asshole theory of finance' explain why bankers are so hated?
When you think of human nature and the market, two opposing theories come to mind. The first concerns the perfectly rational homo economicus who sits at the heart of much economic theory. In a world of scarce resources, he navigates supply and demand in whatever way maximises his utility. The second features what Keynes dubbed animal spirits: the irrational forces of optimism, fear and greed that can drive decisions and move markets.
These two conceptions have helped economists understand why prices change in the way they do. But neither really offers anything close to an accurate account of how human nature works. And why should they? When market participants – and in particular those involved in today’s highly complex financial markets – consider humanity, they do so only to help their bottom line.
Humanity and finance would seem, therefore, to be worlds apart. Surely there is nothing more impersonal than the rows of graph-and-chart-filled screens that furnish 21st-century trading floors?
Not according to Mihir Desai, a professor of finance at Harvard Business School and the author of The Wisdom of Finance: Discovering Humanity in the World of Risk and Return. “Many distrust markets, particularly financial markets, because they are thought to be hostile to humanity,” writes Desai. “But perhaps that has things completely upside down. Perhaps finance is deeply connected to our humanity.”
To make that connection, Desai casts a wide net. The result is a lively book full of surprising references. The Wire’s Stringer Bell and Pride and Prejudice’s Lizzy Bennett are your guides to mitigating risk. The accidental success of Springtime for Hitler in The Producers explains the principle-agent problem. An episode of The Simpsons demonstrates how insurance can create moral hazard.
But it is when Desai uses finance as a window on life – rather than the inverse – that he writes with the most insight.
Insurance, he argues, is about so much more than the superficially dreary work of actuaries. Channelling the philosopher Charles Sanders Pierce, who said in 1869 that “each of us is an insurance company”, Desai writes: “Risk is everywhere, it is undeniable, and it shouldn’t be ignored or surrendered to – it should be managed. And insurance is the primary way we manage risk in our lives.”
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Bankruptcy law prompts a thoughtful consideration of the meaning of failure. By lowering the costs of failure and thereby encouraging people to take risk, US bankruptcy law has helped build a successful economy. Companies who stigmatise failure are less likely to learn from them. The logic, Desai argues, applies as much in our everyday lives as it does in business.
This might make The Wisdom of Finance sound like the sort of pseudo-spiritual guff Alain de Botton writes. “The last thing I wanted to do was write a self-help book,” Desai told me when we met recently in London. “I think they are kind of ridiculous in many ways … There is wisdom in there but it’s not three easy steps to nirvana.”
I asked Desai what he thinks the most common misconception people have about finance. His answer is blunt: “I think they think it is evil.” It’s a worrying thought for those who make their living in the square mile. As for the finance world’s view of itself, too many insiders subscribe to Goldman Sachs CEO Lloyd Blankfein’s view that they are doing “God’s work”, which Desai says is a “knee-jerk defensiveness”.
There is a grain of truth in both exaggerations. Some of finance’s bad reputation is justified; as Desai argues, “there are chunks of finance that are not creating value but extracting value”.
He thinks that Joseph de la Vega, the 17th century Jewish philosopher, captured the contradictions of the world of finance better than anyone else. It is a business, wrote de la Vega in Confusion de Confusiones, “which is at once the fairest and most deceitful in Europe, the noblest and the most infamous in the world, the finest and the most vulgar on earth. It is a quintessence of academic learning and a paragon of fraudulence; it is a touchstone for the intelligent and a tombstone for the audacious, a treasury of usefulness and a source of disaster.”
“That duality is what finance is,” says Desai. “We’ve lost a sense of that duality.” And, if anything, that duality proves the link between humanity and finance.
Re-establishing that connection, as The Wisdom of Finance does, allows the lay reader to understand finance, something they see as remote and abstract, in terms they understand. While for those in finance, that link is a reminder of the moral element of what they do.
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Paradoxically, after eight chapters about “how great finance is”, Desai ends The Wisdom of Finance with a chapter on what has gone wrong with it. “The biggest problem is that people confuse luck with skill,” he tells me, introducing his “asshole theory of finance”. Everyone, no matter what they do, is guilty of attribution error, crediting their own brilliance for successes and blaming failures on forces beyond their control. Finance, because of the precise and instant feedback people get on their performance, simply magnifies this particular human weakness.
Take an investor who outperforms the market eight years in a row. He is likely to put this down to his expertise and skill as a money manager. But the randomness of the market means it is impossible to know how much luck is involved.
“There is no industry where it is easier to dress up luck as skill,” Desai says. “You can’t do that in tennis. There is only a trivial amount of luck in Roger Federer’s game. I can say with absolute certainty that he is incredibly good at what he does. There are skillful people in finance, don’t get me wrong. But my ability to divine who they are is really limited.”
As he makes clear in the book: “It’s not finance that’s bad. 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.”
It is ironic that it has fallen into this trap, given that the very idea of an efficient market, which finance is rooted in, is a humbling one. Theory says that beating the market year after year is almost impossible. But finance isn’t theoretical. Even today it is, at root, the accumulation of billions of real-world human decisions. And the people making those decisions are no different from the rest of us.
Oliver Wiseman is Deputy Editor of CapX
FINANCE
When Finance Is a Character in a Novel
A new book on economic ideas in literature reminds us that they've always been some of humanity's best ones.
By Scott Duke Kominers
May 24, 2017, 6:54 AM PDT
Literature meets finance. Photographer: Chris Ratcliffe - Pool/Getty Images
Economic forces and incentives shape not only our lives, but also our fiction – and economists rarely miss a chance to point this out. “Economics spotting” isn’t just a parlor game, however. It can help us remember why we care about economics in the first place.
In an era when finance can look like alchemy or worse, its appearance in fiction can remind us that its most fundamental ideas are elegant and essential. There’s a bonus, too: approaching finance this way has the potential to enrich finance itself.
“The Wisdom of Finance,” a new book by my Harvard Business School colleague and mentor Mihir A. Desai, traces financial ideas as they turn up in literature (as well as in music, film and theater). Desai’s panorama underscores how finance serves basic human needs – and crops up in unusual places.
Desai starts with one of the fields of finance often considered to be the driest: insurance. He writes that he’s “delighted and surprised” when his students choose to go into insurance. Why? Because insurance addresses the fundamental uncertainty of our lives – the type personified in the life of Flitcraft, a fictional real estate executive described in “The Maltese Falcon.”
Flitcraft narrowly avoids death when a falling beam crashes into a sidewalk as he walks by. This random scare sends him in search of a random existence; he changes his name to Charles Pierce and lets his life take loops and unexpected turns. 1 By exposing himself to risk, Flitcraft becomes a human embodiment of the need for insurance. (This was intentional. Flitcraft is named after an early actuary; the mathematician and philosopher Charles Peirce 2 was an early champion of insurance.)
Desai also uncovers finance theory in Victorian romances. In Anthony Trollope's “Phineas Finn,” Violet Effingham thinks about option value as she maintains a diversified portfolio of suitors. Lizzy Bennett, Jane Austen's heroine of “Pride and Prejudice,” faces a classic “optimal stopping problem,” in which she risks ending up alone after turning down her first suitor. (Spoiler alert: Bennett’s bet pays off – she ends up with the delightful Mr. Darcy.)
While I’ve focused on literary examples, Desai’s exposition runs the cultural gamut. Jeff Koons manifests leverage in his art by financing and promising to create pieces before he knows how to construct them. Bialystock and Bloom’s antic scam in “The Producers” reminds us how important it is to have investor oversight.
At the end, Desai gives us a finance heroine to admire: Alexandra Bergson of Willa Cather's “O Pioneers!,” who takes calculated risks in land investment for the benefit of her loved ones – and even in success thinks of herself as only a steward of capital.
So where does this journey lead? First, it gives a vibrant rediscovery of finance a human face. That alone is valuable, especially for those disheartened by the financial crisis, rising inequality and finance bros. But Desai’s “Wisdom” does more; it reminds us what’s meaningful in finance, both in terms of theory and in terms of the people that theory supports.
If finance were better attuned to its human impact, we might see fewer Martin Shkrelis and more Alexandra Bergsons. At a more macro scale, we might see more research, business and policy that recognizes the consequences of modern finance’s faults. There’s a lesson for the rest of economics here, too: As we bring economics to bear on human problems like intergenerational mobility, immigration and housing, it might pay to be well-read.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
In what could almost be a textbook illustration of short-run stochasticity versus long-run reversion to fundamentals, Flitcraft eventually finds his way back to a situation much like his original life.
Note, as Desai does, the vowel swap.
To contact the author of this story:
Scott Duke Kominers at kominers@fas.harvard.edu
To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net
MANAGING BOOKS
Understanding finance in the context of art, history and humanity
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TITLE The Wisdom of Finance AUTHOR Mihir Desai GENRE Business PUBLISHER HMV PAGES 223 PRICE $38.50
To understand finance, a good place to start might be the writings of Jane Austen or Dashiell Hammett.
That's the seemingly odd path Harvard Business School professor Mihir Desai takes in The Wisdom of Finance, as he aims to improve financial practice by rediscovering the humanity of its core ideas.
By linking to literature, history and philosophy, he tries to build deeper resonance. It is a daring, intriguing work, offbeat and fascinating, something both practitioners of finance and the general public can learn from. Prof. Desai draws on diverse sources such as the film The Producers, Shakespeare, Samuel Johnson, George Orwell and Willa Cather.
For example, Pride and Prejudice, published in 1813, is a novel that in some ways becomes a treatise on handling risk. Author Jane Austen presents the dilemma faced by Elizabeth Bennet. In those days, young women had to rely on the marriage market for financial security. Accordingly, when Ms. Bennet rejects a proposal from William Collins, he warns: "You should take into further consideration that in spite of your manifold attractions, it is by no means certain that another offer of marriage may ever be made you."
In The Maltese Falcon, a 1929 detective novel, author Dashiell Hammett inserts the story of Flitcraft, a successful real estate executive in Tacoma, Wash. A steel beam falls eight storeys on a construction site and nearly wipes him out. Realizing life could be ended at random, he decides to flee his wife and family. Prof. Desai says the parable illustrates the dominance of chance in our life, as well as how we can't easily escape our own patterns of behaviour. After changing his name to Charles Pierce, Flitcraft winds up living an essentially identical life in a new locale.
The name of the character Flitcraft was borrowed from a legendary Pinkerton investigator who worked for insurance companies. And the real Charles Peirce (Hammett spelled the name differently in the novel) was a famed scientist/mathematician/philosopher who repeatedly turned his thoughts to insurance as a central frame for understanding life. "Each of us is an insurance company," he wrote in Grounds of Validity of the Laws of Logic, published in 1869.
Together, Hammett and Austen highlight risk and the ideas of probabilities – things we shy away from but need to understand.
Prof. Desai notes that chance is omnipresent but can be understood and analyzed rigorously. Since it's predictable in the aggregate, we can deal with it. He writes: "The tools needed to navigate a world filled with uncertainty is what finance endeavours to provide. Risk is everywhere, it is undeniable, and it shouldn't be ignored or surrendered to – it should be managed. And insurance is the primary way we manage the risks in our lives."
As for the risk management encountered by Ms. Bennet in selecting a husband, he says it symbolizes the tradeoffs we face in other aspects of our lives. Should you keep looking for the perfect job or accept the lesser offer on the table? Is continuing with further education worth the costs?
"These questions implicitly consider risk and return and require you to think about how to allocate your time, energy, and resources given a set of choices in the face of an uncertain future. This allocation problem is precisely the problem at the center of finance," he writes.
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The term "high finance" implies it's higher than us: Complicated, confusing, numbers-oriented – stuff for business-school graduates to pursue on Bay Street. Prof. Desai argues it's about our own lives – risk and insurance, debt, leverage and failure.
Just as importantly, he feels practitioners of finance need to explain and justify what they do more clearly to win back confidence. "More than regulation or outrage, fixing finance requires practitioners to return to the core ideas and ideals of finance – which can help them to ensure they are creating value and not extracting it," he says.
The Wisdom of Finance, by Mihir A. Desai (Houghton Mifflin Harcourt). This accessible book attempts to show that economic theories can illuminate other areas of our lives. Probabilistic thinking may help us to deal with life’s risks and randomness, and diversification can improve our relationship portfolios. Some analogies are labored, but Desai, a Harvard economist, is an omnivorous reader, referring to Trollope and Hammett amid explanations of such concepts as leverage and options theory. The book’s final question may be its most important: “If the ideas of finance are so life-affirming, why does everyone hate it?” But Desai, who avoids topics like the 2008 financial crash and rising income inequality, offers no convincing answer.