"My Speech to the Finance Graduates" by Robert J. Shiller

Every Spring the educational system produces a new cohort of well-trained and well-educated students who must become the new generation of employees. The recent college graduates offer new ideas and a new source for creativity. Additionally, they will one day be the new stewards of the economic and political systems. What advice should these new graduates and future employees be told upon their graduation? What role does their formal training play in their new careers? How does their career choice affect the larger society around them? Robert J. Shiller, the Professor of Economics at Yale University and the co-creator of the Case-Shiller Index of US house prices, has an important message for college graduates who decide to pursue a career in finance.  

NEW HAVEN – At this time of year, at graduation ceremonies in America and elsewhere, those about to leave university often hear some final words of advice before receiving their diplomas. To those interested in pursuing careers in finance – or related careers in insurance, accounting, auditing, law, or corporate management – I submit the following address:

Best of luck to you as you leave the academy for your chosen professions in finance. Over the course of your careers, Wall Street and its kindred institutions will need you. Your training in financial theory, economics, mathematics, and statistics will serve you well. But your lessons in history, philosophy, and literature will be just as important, because it is vital not only that you have the right tools, but also that you never lose sight of the purposes and overriding social goals of finance.

Unless you have been studying at the bottom of the ocean, you know that the financial sector has come under severe criticism – much of it justified – for thrusting the world economy into its worst crisis since the Great Depression. And you need only check in with some of your classmates who have populated the Occupy movements around the world to sense the widespread resentment of financiers and the top 1% of income earners to whom they largely cater (and often belong).

While some of this criticism may be over-stated or misplaced, it nonetheless underscores the need to reform financial institutions and practices. Finance has long been central to thriving market democracies, which is why its current problems need to be addressed. With your improved sense of our interconnectedness and diverse needs, you can do that. Indeed, it is the real professional challenge ahead of you, and you should embrace it as an opportunity.

Young finance professionals need to familiarize themselves with the history of banking, and recognize that it is at its best when it serves ever-broadening spheres of society. Here, the savings-bank movement in the United Kingdom and Europe in the nineteenth century, and the microfinance movement pioneered by the Grameen Bank in Bangladesh in the twentieth century, comes to mind. Today, the best way forward is to update financial and communications technology to offer a full array of enlightened banking services to the lower middle class and the poor.

Graduates going into mortgage banking are faced with a different, but equally vital, challenge: to design new, more flexible loans that will better help homeowners to weather the kind of economic turbulence that has buried millions of people today in debt.

Young investment bankers, for their part, have a great opportunity to devise more participatory forms of venture capital – embodied in the new crowd-funding Web sites – to spur the growth of innovative new small businesses. Meanwhile, opportunities will abound for rookie insurance professionals to devise new ways to hedge risks that real people worry about, and that really matter – those involving their jobs, livelihoods, and home values.

Beyond investment banks and brokerage houses, modern finance has a public and governmental dimension, which clearly needs reinventing in the wake of the recent financial crisis. Setting the rules of the game for a robust, socially useful financial sector has never been more important. Recent graduates are needed in legislative and administrative agencies to analyze the legal infrastructure of finance, and regulate it so that it produces the greatest results for society.

A new generation of political leaders needs to understand the importance of financial literacy and find ways to supply citizens with the legal and financial advice that they need. Meanwhile, economic policymakers face the great challenge of designing new financial institutions, such as pension systems and public entitlements based on the solid grounding of intergenerational risk-sharing.

Those of you deciding to pursue careers as economists and finance scholars need to develop a better understanding of asset bubbles – and better ways to communicate this understanding to the finance profession and to the public. As much as Wall Street had a hand in the current crisis, it began as a broadly held belief that housing prices could not fall – a belief that fueled a full-blown social contagion. Learning how to spot such bubbles and deal with them before they infect entire economies will be a major challenge for the next generation of finance scholars.

Equipped with sophisticated financial ideas ranging from the capital asset pricing model to intricate options-pricing formulas, you are certainly and justifiably interested in building materially rewarding careers. There is no shame in this, and your financial success will reflect to a large degree your effectiveness in producing strong results for the firms that employ you. But, however imperceptibly, the rewards for success on Wall Street, and in finance more generally, are changing, just as the definition of finance must change if is to reclaim its stature in society and the trust of citizens and leaders.

Finance, at its best, does not merely manage risk, but also acts as the steward of society’s assets and an advocate of its deepest goals. Beyond compensation, the next generation of finance professionals will be paid its truest rewards in the satisfaction that comes with the gains made in democratizing finance – extending its benefits into corners of society where they are most needed. This is a new challenge for a new generation, and will require all of the imagination and skill that you can bring to bear.

Good luck in reinventing finance. The world needs you to succeed.

Money, Power, and Wall Street by FRONTLINE

Watch Money, Power and Wall Street: Part One on PBS. See more from FRONTLINE.

In 1994, a team of young, 20-something JPMorgan bankers on a retreat in Boca Raton, Fla. dreamed up the “credit default swap” — a complicated derivative they hoped would help manage risk and stabilize the financial system. Fourteen years later, they watched in horror as that global system — weighed down by the risk of credit default swaps tied to mortgage loans — collapsed.

The ensuing saga between that pivotal retreat and the start of the 2008 global financial crisis are “defined by daunting complexity,” writes Greg Evans in Bloomberg Businessweek today. But the first two hours of Money, Power and Wall Street, he adds, does an “exemplary job of walking viewers through [it].”

FRONTLINE’s four-hour epic on the global financial crisis goes inside the struggles to rescue and repair a shattered economy, exploring key decisions, missed opportunities and the unprecedented and uneasy partnership between government leaders and titans of finance.

“Money, Power and Wall Street is demanding — this isn’t Finance for Dummies,”  Evans writes in the review. “But it’s a compact and thorough lesson.”

In the first hour, FRONTLINE takes you inside the rapid rise of credit default swaps, including the voices of those who created them. With the real estate market booming, bankers successfully tweaked the credit default swap to bundle up and sell home mortgage loans to eager investors. But despite the money flowing into banks’ coffers, credit default swaps also loaded the financial system with lethal risk. And when the housing bubble burst, the credit default swaps — originally designed to stabilize the system — brought the global economy to its knees. Regulators, who had often stood on the sideline and allowed Wall Street to police itself, saw the ugly consequences rapidly unfold before them.

In the second hour, FRONTLINE investigates the largest government bailout in U.S. history, a series of decisions that rewrote the rules of government and fueled a debate that would alter the country’s political landscape. It offers play-by-play accounts of several secret meetings that permanently altered the financial system. (read more)

"How to End This Depression" by Paul Krugman

Is it possible to solve the depression and return the economy to full employment without severe austerity measures? Has the political response in Western Europe, wherein Germany argues for greater austerity measures in the struggling Southern economies, been successful? A strong consensus is building among prominent economists, historians, and politicians that the depression and high unemployment can be solved relatively easily and quickly. All that is needed is to understand the historical patterns of economic recovery after financial crisis and to muster up the necessary political will to create policies that are in accordance with the economic truth. Paul Krugman, the professor of economics and international affairs at Princeton University and Nobel Laureate in Economics, argues in his forthcoming book that the depression we are experiencing is not necessary and that the right policies can have a significant affect on the depressed labor markets and economic system. The following article gives a brief summary of Krugman's argument.      

PRINCETON-The depression we’re in is essentially gratuitous: we don’t need to be suffering so much pain and destroying so many lives. We could end it both more easily and more quickly than anyone imagines—anyone, that is, except those who have actually studied the economics of depressed economies and the historical evidence on how policies work in such economies.

The truth is that recovery would be almost ridiculously easy to achieve: all we need is to reverse the austerity policies of the past couple of years and temporarily boost spending. Never mind all the talk of how we have a long-run problem that can’t have a short-run solution—this may sound sophisticated, but it isn’t. With a boost in spending, we could be back to more or less full employment faster than anyone imagines.

But don’t we have to worry about long-run budget deficits? Keynes wrote that “the boom, not the slump, is the time for austerity.” Now, as I argue in my forthcoming book—and show later in the data discussed in this article—is the time for the government to spend more until the private sector is ready to carry the economy forward again. At that point, the US would be in a far better position to deal with deficits, entitlements, and the costs of financing them.

Meanwhile, the strong measures that would all go a long way toward lifting us out of this depression should include, among other policies, increased federal aid to state and local governments, which would restore the jobs of many public employees; a more aggressive approach by the Federal Reserve to quantitative easing (that is, purchasing bonds in an attempt to reduce long-term interest rates); and less timid efforts by the Obama administration to reduce homeowner debt.

But some readers will wonder, isn’t a recovery program along the lines I’ve described just out of the question as a political matter? And isn’t advocating such a program a waste of time? My answers to these two questions are: not necessarily, and definitely not. The chances of a real turn in policy, away from the austerity mania of the last few years and toward a renewed focus on job creation, are much better than conventional wisdom would have you believe. And recent experience also teaches us a crucial political lesson: it’s much better to stand up for what you believe, to make the case for what really should be done, than to try to seem moderate and reasonable by essentially accepting your opponents’ arguments. Compromise, if you must, on the policy—but never on the truth.

Let me start by talking about the possibility of a decisive change in policy direction.

Nothing Succeeds Like Success

Pundits are always making confident statements about what the American electorate wants and believes, and such presumed public views are often used to wave away any suggestion of major policy changes, at least from the left. America is a “center-right country,” we’re told, and that rules out any major initiatives involving new government spending.

And to be fair, there are lines, both to the left and to the right, that policy probably can’t cross without inviting electoral disaster. George W. Bush discovered that when he tried to privatize Social Security after the 2004 election: the public hated the idea, and his attempted juggernaut on the issue quickly stalled. A comparably liberal-leaning proposal—say, a plan to introduce true “socialized medicine,” making the whole health care system a government program like the Veterans Health Administration—would presumably meet the same fate. But when it comes to the kind of policy measures I have advocated—measures that would mainly try to boost the economy rather than try to transform it—public opinion is surely less coherent and less decisive than everyday commentary would have you believe.

Pundits and, I’m sorry to say, White House political operatives like to tell elaborate tales about what is supposedly going on in voters’ minds. Back in 2011 The Washington Post’s Greg Sargent summarized the arguments Obama aides were using to justify a focus on spending cuts rather than job creation:

A big deal would reassure independents who fear the country is out of control; position Obama as the adult who made Washington work again; allow the President to tell Dems he put entitlements on sounder financial footing; and clear the decks to enact other priorities later.

Any political scientist who has actually studied electoral behavior will scoff at the idea that voters engage in anything like this sort of complicated reasoning. And political scientists in general have scorn for what Slate’s Matthew Yglesias calls the pundit’s fallacy, the belief on the part of all too many political commentators that their pet issues are, miraculously, the very same issues that matter most to the electorate.

Most real voters are busy with their jobs, their children, and their lives in general. They have neither the time nor the inclination to study policy issues closely, let alone engage in opinion-page-style parsing of political nuances. What they notice, and vote on, is whether the economy is getting better or worse; statistical analyses say that the rate of economic growth in the three quarters or so before the election is by far the most important determinant of electoral outcomes. (read more)

The Austerity Debates: Old vs. New Ways of Economic Thinking

The 2008 financial crisis has evolved through many stages and now  centers around the role of the state to stabilize markets while minimizing deficits. As one would predict, this has led to highly contentious debates both in America and Western Europe regarding the role of the state versus private actors to stabilize the economic system, the importance of long-term financial stability versus short-term growth, and the role of old versus new ways of economic thinking. These debates center around the following questions: should the state implement pro-growth strategies even though it is struggling to deal with decreasing tax revenue and increasing sovereign debt? Should a pro-growth agenda be put on hold to allow strong austerity measures to take affect? Global leaders, economic organizations, and governments around the world have taken different positions regarding these questions. Below is an insightful interview with Joseph Stiglitz--the Nobel Prize winning economist, co-founder of the Institute for New Economic Thinking (INET), and professor at Columbia University--that helps us understand the underlying conflicts in the academy and among politicians, and the potential solutions that are possible.

Question: Four years after the beginning of the financial crisis, are you encouraged by the ways in which economists have tried to make sense of it, and by the ways in which those insights have been taken up by policy makers? 

Stiglitz: Let me break this down in a slightly different way. Academic economists played a big role in causing the crisis. Their models were overly simplified, distorted, and left out the most important aspects. Those faulty models then encouraged policy-makers to believe that the markets would solve all the problems. Before the crisis, if I had been a narrow-minded economist, I would have been very pleased to see that academics had a big impact on policy. But unfortunately that was bad for the world. After the crisis, you would have hoped that the academic profession had changed and that policy-making had changed with it and would become more skeptical and cautious. You would have expected that after all the wrong predictions of the past, politics would have demanded from academics a rethinking of their theories. I am broadly disappointed on all accounts.

Question: Economists have seen the flaws of their models but have not worked to discard or improve them? 

Stiglitz: Within academia, those who believed in free markets before the crisis still do so today. A few people have shifted, and I want to give credit to them for saying: “We were wrong. We underestimated this or that aspect of our models.” But for the most part, the response was different. Believers in the free market have not revised their beliefs.

Question: So let’s take a longer view. Do you think that the crisis will have an effect on future generations of economists and policy-makers, for example by changing the way that economic basics are taught? 

Stiglitz: I think that change is really occurring with the young people. My young students overwhelmingly don’t understand how people could have believed in the old models. That is good. But on the other hand, many of them say that if you want to be an economist, you still have to deal with all the old guys who believe in their wrong theories, who teach those theories, and expect you to believe in them as well. So they choose not to go into those branches of economics. But where I have been even more disappointed is American policy-making. Ben Bernanke gives a speech and says something like, there was nothing wrong with economic theory, the problems were a few details in implementation. In fact, there was a lot wrong with economic theory and with the basic policy framework that was derived from theory. If your mindset is that nothing was wrong, you will not demand new models. That’s a big disappointment.

Question: There seemed to have been quite a bit of disagreement among Obama’s economic advisers about the right course of action. And in Europe, fundamental economic principles like the absolute focus on GDP growth have finally come under attack. 

Stiglitz: Some American policy-makers have recognized the danger of “too big to fail,” but they are a minority. In Europe, things are a bit better on the rhetorical side. Influential economists like Derek Turner and Mervyn King have recognized that something is wrong. The Vickers Commission has thoughtfully re-examined economic policy. We have nothing like that in the United States. In Germany and France, the financial transactions tax and limits to executive compensation are on the table. Sarkozy says that capitalism hasn’t worked, Merkel says that we were saved by the European social model – and they are both conservative politicians! The bankers still don’t understand this, which explains why we still see the head of the European Central Bank, Mario Draghi, arguing that we have to give up the welfare system at a time when Merkel says the exact opposite: That the social model kept us going when the central banks failed to do their regulatory job and used politics to change the nature of our societies.

Question: How have your own convictions been affected by the crisis? 

Stiglitz: I don’t think that there has been a fundamental change in my thinking. The crisis has reinforced certain things I said before and shown me how important they are. In 2003, I wrote about the risk of interdependence, where the collapse of one bank can bring about the collapse of other banks and increase the fragility of the banking system. I thought it was important, but the idea wasn’t picked up at the time. The same year we looked at agency problems in finance. Now we recognize just how important those issues are. I argued that the real issue in monetary economics is about credit, not money supply. Now everybody recognizes that the collapse of the credit system brought down the banks. So the crisis really validated and reinforced several strands of theory that I had explored before. One topic that I now consider much more important than I did previously is the question of adjustment and the role of exchange rate systems like the Euro in preventing economic adjustment. A related issues is the linkage between structural adjustment and macroeconomic activity. The events of the crisis have really induced me to think more about them.

Question: The financial transaction tax seems to have died a political death in Europe. Now, economic policy in Europe seems largely dominated by the logic of austerity, and by forcing other European countries to become more like Germany.

Stiglitz: Austerity itself will almost surely be disastrous. It is leading to a double-dip recession that could be quite serious. It will probably make the Euro crisis worse. The short-term consequences are going to be very bad for Europe. But the broader issue is about the “German model.” There are many aspects to it – among them the social model – that allow Germany to weather a very big dip in GDP by offering high levels of social protection. The German model of vocational training is also very successful. But there are other characteristics that are not so good. Germany is an export economy, but that cannot be true for all countries. If some countries have export surpluses, they are forcing other countries to have export deficits. Germany has taken a policy that other countries cannot imitate and tried to apply it to Europe in a way that contributes to Europe’s problems. The fact that some aspects of the German model are good does not mean that all aspects can be applied across Europe.

Question: And it does not mean that economic growth satisfied the criteria of social fairness. 

Stiglitz: Yes, so there is one other thing we have to take into account: What is happening to most citizens in a country? When you look at America, you have to concede that we have failed. Most Americans today are worse off than they were fifteen years ago. A full-time worker in the US is worse off today than he or she was 44 years ago. That is astounding – half a century of stagnation. The economic system is not delivering. It does not matter whether a few people at the top benefitted tremendously – when the majority of citizens are not better off, the economic system is not working. We also have to ask of the German system whether it has been delivering. I haven’t studied all the data, but my impression is no.

Question: What do you say to someone who argues thus: Demographic change and the end of the industrial age have made the welfare state financially unsustainable. We cannot expect to cut down on our debt without fundamentally reducing welfare costs in the long run.

Stiglitz: That is absurd. The question of social protection does not have to do with the structure of production. It has to do with social cohesion or solidarity. That is why I am also very critical of Draghi’s argument at the European Central Bank that social protection has to be undone. There are no grounds upon which to base that argument. The countries that are doing very well in Europe are the Scandinavian countries. Denmark is different from Sweden, Sweden is different from Norway – but they all have strong social protection and they are all growing. The argument that the response to the current crisis has to be a lessening of social protection is really an argument by the 1% to say: “We have to grab a bigger share of the pie.” But if the majority of people don’t benefit from the economic pie, the system is a failure. I don’t want to talk about GDP anymore, I want to talk about what is happening to most citizens.

Question: Has the political Left been able to articulate that criticism? 

Stiglitz: Paul Krugman has been very strong on articulating criticism of the austerity arguments. The broader attack has been made, but I am not sure whether it has been fully heard. The critical question right now is how we grade economic systems. It hasn’t been fully articulated yet but I think we will win this one. Even the Right is beginning to agree that GDP is not a good measure of economic progress. The notion of the welfare of most citizens is almost a no-brainer.

Question: It seems to me that much of the discussion is still about statistical measurements – if we’re not measuring GDP, we’re measuring something else, like happiness or income differences. But is there an element to these discussions that cannot be put in numerical terms – something about the values we implicitly bake into our economic system? 

Stiglitz: In the long run, we ought to have those ethical discussions. But I am beginning from a much narrower base. We know that income doesn’t reflect many things we care about. But even with an imperfect indicator such as income, we should care about what happens to most citizens. It’s nice that Bill Gates is doing well. But if all the money went to Bill Gates, the system could not be graded as successful.

Question: If the political Left hasn’t been able to fully articulate that idea, has civil society been able to fill the gap? 

Stiglitz: Yes, the Occupy movement has been very successful in bringing those ideas to the forefront of political discussion. I wrote an article for Vanity Fair in 2011 – “Of the 1%, by the 1%, for the 1%” – that really resonated with a lot of people because it spoke to our worries. Protests like the ones at Occupy Wall Street are only successful when they pick up on these shared concerns. There was one newspaper article that described the rough police tactics in Oakland. They interviewed many people, including police officers, who said: “I agree with the protesters.” If you ask about the message, the overwhelming response has been supportive, and the big concern has been that the Occupy movement hasn’t been effective enough in getting that message across. (read more)