Share Podcast
Why Finance Needs More Humanity, and Why Humanity Needs Finance
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...
- Subscribe:
- Apple Podcasts
- Spotify
- RSS
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.
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.