Are the Markets Broken? Can We Make Investing More Humane?

Interview with Mihir Desai

Professor Mihir Desai of Harvard University, discusses the goal behind his newest book, as well as the wisdom of understanding the financial world.

Douglas Goldstein: I am very excited to be talking today with Mihir Desai, who is a Professor of Finance at Harvard Business School, and a Professor of Law at Harvard Law School. He’s got a new book out called, The Wisdom of Finance: Discovering Humanity in the World of Risk and Return.

Mihir, I have to tell you this is not really an overlap that a lot of people talk about – humanity and Wall Street. Tell me what you’re thinking there.

The Correlation between Humanity and Wall Street

Mihir Desai: Most people think that this title is a little bit of an oxymoron, like a contradiction in terms. But that’s in fact the whole point, that there’s a lot more time to get that wisdom in finance than you would think about.

The goal of the book is to demystify finance and to hopefully rehabilitate it - demystify it in the sense that many people find finance intimidating and they find the ideas a little hard to access.

The idea in the book is that you get all the big ideas of finance, but only through stories. No equations and graphs, nothing intimidating as a way into the ideas.

Second, chunks of finance are broken, and so the way to hopefully fix it is to make the people who participate in it look at their work through a moral lens. That’s what humanities do. That’s what they’re good at: making us understand issues through a moral lens.

Douglas Goldstein: Basically, what does that mean? When you say “chunks of finance are broken,” what are we talking about there?

Mihir Desai: The finance industry, 10 years after the financial crisis, remains problematic. There’s a lot of value extraction going on, as opposed to value creation. That’s a problem, and we haven’t really fully come to terms with that.

Regulation has helped a little bit, and outrage has maybe helped people feel a little bit better. But the reality is the industry still has a long way to go. Instead of looking at spreadsheets and screens, I want people in finance to really think hard about what they’re doing in the human dimension of it. That’s what the humanities do.

Douglas Goldstein: Finance is a very big world. From my standpoint, I just want to tell you about my day job. In real life, I am a personal financial advisor; I only get to do the radio gig once or twice a week.

But a lot of what I do personally is working with people and I like your model of telling stories. I try to listen to what their story is, and help them figure out how they can come to a fine conclusion of their story eventually, and build a portfolio that makes sense.

When you’re talking about finance, are you not talking about this kind of world? Or are you talking about the too-big-to-fail banks?

Skepticism in the Financial World

Mihir Desai: I am talking about both worlds, right? So the intersect. There are these bad wolves of finance, which are the large financial institutions. Then there is microfinance, which is in our lives, in our retirement savings, and all the things you help your clients with. But they’re linked because people use those big financial institutions in all kinds of ways, and those are actually very tightly linked.

My goal is to make the big financial institutions and the big players in the finance world behave better. Not only that, but also to restore the credibility for people, like your clients, so they don’t view finance with quite the same skepticism that they might now.

I am not sure if you find that, but a lot of people - here in the U.S. at least – view a lot of people in finance, and a lot of financial institutions with a great deal of skepticism.

Douglas Goldstein: Yes, I hear that. But I wonder if the guy on the street really feels that he’s getting bad service, for example at that counter at the bank. So that’s how he feels. Or that they’re computerizing everything so he can’t even get a meeting with a branch manager if he needs a loan, or something like that.

This is opposed to saying something like, “Well, we know that the big banks try to push through regulations which would allow them to continue doing all sorts of complex trading strategies.”

Knowing that at the end of the day, if that didn’t work out and they needed a bailout, then the FDIC, or the government on its own would come along and make everything better.

What part of the world of finance are normal people really worried about?

What Part of the World of Finance Are Normal People Worried About?

Mihir Desai: I think it depends on what people’s exposure to the financial crisis was. In short, I think 10 years later, people are still licking their wounds about what happened.

Certainly in the U.S., there’s a sense of, “Did we learn anything really from that traumatic episode? We’re still living with the consequences of that traumatic episode.”

I take your point, which is obviously that most people are concerned with their day-to-day lives, and that’s really what they experience in terms of finance. But first, there are these macro issues that are still hurting people.

Second, even at the micro level, with things like overdraft fees, or the inability to maybe get loans, or the feeling that your loans are kind of very burdensome, certainly like the student loans, that gives rise to a lot of skepticism about finance, even at the micro level.

Douglas Goldstein: Mihir has been talking to us about the idea of trying to understand the financial world through stories. Not a lot of – as you said - equations and graphs. You’d like people to realize that the world of finance is approachable, if you understand a little bit more about it.

One of the concerns, Mihir, that I’ve discovered is that it seems that as people are feeling the government is more and more coming in and trying to regulate, they say, “Well, I don’t have to worry about it. The government will take care of that.” As a result, it seems to me that a lot of individuals maybe didn’t learn their lessons from the crash of 10 years ago.

They’re out there, taking on more debt. My guess is that more and more people are going to take on more mortgages than they can afford. Or they’ll take on adjustable rate mortgages, which, as soon as rates go up, are going to really devastate them.

They’re just not even learning on their own. Is there a way to educate normal people to be responsible for their own finances?

Teaching People How to Be Responsible with Their Finances

Mihir Desai: That’s a great point. This is in part why people are ignorant about it. Part of the story is we do such a terrible job with financial literacy at the primary and the K312 level. We should be doing a lot more than we currently do.

The second reason why is that people genuinely do find it intimidating. In part, the reason for that is people in finance like to intimidate you. They think that these ideas are really tough. A good example was debt; people make typically one of two big mistakes.

One mistake they often make is, “All debt is bad and I should never use it,” which is a mistake because debt can be wonderful. It can allow you to access opportunities that you wouldn’t be able to access otherwise - like education, or a home you couldn’t otherwise afford.

At the same time, the second mistake is if you take on debt, it’s a very serious commitment. People are making both those mistakes. Some people are ignoring the possibilities afforded by debt, and then others are actually not taking it seriously enough.

In the book, I use a variety of ways to think about that in a little more common-sensical way. For example, on debt, I talk about leverage, and why in finance it’s comparable to the way you think about commitments in your life. Commitments in your life actually allow you to experience things you wouldn’t be able to experience otherwise. This is the great part of debt.

Secondly, if you break those commitments, you renege on people, or companies or organizations, and it has really serious consequences. By mapping it to commitments, it is a way to think about what it is in your life that can be a proper way for people to understand, both why it is important to take on debt, but not to take on too much.

Douglas Goldstein: Is this a commitment like marriage? In other words, is that what you’re comparing it to?

Mihir Desai: Exactly. In part of the book, I use The Merchant of Venice. Part of what they do in that play is try to suggest that nominally it’s about debt. But it’s really about commitments. It’s about how people fashion their commitments to each other. About how that allows them to do things that they wouldn’t be able to otherwise - marriage, kids, being embedded in a large organization - all those things.

Having Debt Is a Commitment

Douglas Goldstein: It’s sort of interesting, because if you take a step back and look at – not to philosophize too much – where society’s coming from, how these institutions that we grew up on, seemed a little more holy at the time. But marriage and family are less and less important now.

Maybe this is going in parallel with the fact that people simply aren’t able to see that as a real parallel to something like debt. It’s actually an interesting comparison you’re making, that both of them give you a commitment.

Either you’re committed to your spouse, or you’re committed to paying off a loan. But if people are not ready, or not still interested in being committed to anyone or anything, then how are they going to be committed to paying back a loan?

Mihir Desai: That’s fair enough. One of the things we realize is that actually commitments are spectacular. The best example is kids; it’s like the biggest commitment in the world, but you get access to an experience you would never be able to have otherwise.

In a way, the book has all these parallels weighed out. There’s a chapter called “No Romance Without Finance,” which is all about marriage and the implications of mergers and finance for marriages.

There’s a chapter on commitments. The “Corporate Governance” chapter is about the principal agent problem, and uses Mel Brooks and The Producers.

It’s got like this big mishmash of things from the humanities and culture to explain all these big ideas in finance, so that people will think about it in a different way.

Douglas Goldstein: This is fascinating. A lot of people should spend a little time reading this book just to get a different view of finance. I know that the listeners to the show are probably people who are already interested.

But teaching yourself, your family, and your kids about finance, if it doesn’t work one way, you can always try another. In the last few seconds just tell us, how can people actually find you, your work, and your book?

Mihir Desai: I am on the web, and my homepage is mihirdesai.org, as well as on Twitter @desaimihira. Of course the book is available on Amazon and lots of other places.

Douglas Goldstein: Okay, we will put links to all of that at the show notes of today’s show. Mihir Desai, thanks so much for taking the time.

Mihir Desai: My pleasure, Doug. Thanks.