The Social Value of Finance

It’s been more than five years since the peak of the financial crisis, and it seems clear (to me, at least) that not much has changed when it comes to the structure of the financial sector, the existence of too-big-to-fail banks, and the types of activities that they engage in. It’s also clear that the Dodd-Frank Act and its ensuing rulemakings have embodied a technocratic perspective according to which important decisions should be left to experts and made on the grounds of economic efficiency. Even the Consumer Financial Protection Bureau, the Dodd-Frank achievement most beloved of reformers, is essentially dedicated to correcting market failures, which means attempting to achieve the outcomes that would be generated by a perfect market.

The big question is why we went down this route. The traditional explanation, and one that I’ve tended to assume in the past, is that it was a question of political power. Wall Street banks and their lawyers simply want less regulation of their industry, and they feel more comfortable granting actual rulemaking power to regulatory agencies that they feel confident they can dominate through the usual mix of congressional pressure, lobbying, and the revolving door. Given that the Obama administration also wanted to avoid structural reforms and preferred to rely on supposedly expert regulators, the outcome was foreordained.

In a recent (draft) paper, Sabeel Rahman puts forward a different, though not necessarily incompatible explanation. He draws a contrast between a managerial approach to financial regulation, which relies on supposedly depoliticized, expert regulators, and a structural approach, which imposes hard constraints on financial firms. Examples of the latter include the size caps that Simon and I argued for in 13 Bankers and the strict ban on proprietary trading that has been repeatedly watered down in what is now the Volcker Rule.

Rahman’s historical argument is that the managerial approach is actually a relatively recent creation. Among the Populists and Progressives (think of Louis Brandeis, for example), financial regulation was a political and even moral issue, and questions of the social utility of finance were paramount. In one sense, they finally won in the New Deal reforms of the 1930s. But the regulatory agencies created by those reforms became the new locus of technocratic expertise, and over time their objective became macroeconomic management rather than social progress. This trend only accelerated later in the twentieth century, bolstered by the general rise of economism and the fetishization of free markets, to the point where some (e.g., Greenspan) opposed any regulation and others defended regulation narrowly as a way of correcting for market failures.

What is missing, Rahman argues, is any actual consideration of the social value of finance in general and financial innovation in particular. In its absence, we are left with the judgment of the expert technocrats, which has predictably led us to where we are today. If we do open up the scope of financial regulation to take questions of social value into account, we might end up in a very different place.