Wonders Delgado
Finance used to be a means to an end, not an end in itself. From food and housing to family vacations, everything in our daily lives has to be paid for in one way or another. If we don’t have cash available, we contact a lender to get a line of credit.
Companies do the same thing. They routinely finance their operations by taking out loans or issuing stocks to various investors who place their trust and money in them with the expectation of future returns. By bringing these counterparties together, capital markets play a crucial role in the economy. So far, so good.
However, finance is no longer just an intermediary that transfers money from savers to borrowers. Their tasks are no longer limited to putting money into the hands of people who commit to repaying the principal plus interest in the future. Instead, the financial world is now in charge and setting the agenda for others, including governments.
There are two big problems with this: Finance is stupid and dangerous. They are stupid because they can only read numbers, they are incapable of understanding, let alone evaluating, difficult social problems or complex business or technical strategies. And they are dangerous because the people who run financial institutions believe they are smarter than they are, which leads them to believe that they should be steering the ship.
Just looking at the price tags, it seems easy to rule the world. Everything becomes comparable and you just have to buy low and sell high to make a profit. Unless you are one of the few ethical investors who want to be careful about how you spend your money, the type of thing you buy or sell doesn’t matter much. The pricing mechanism eliminates the need to understand the real characteristics, negative characteristics, or possible side effects of an asset.
In fact, the fewer investors who know or care about these issues, the more liquid the market will be. As a result, assets that have been around for a long time – such as stocks in oil and gas companies – are more attractive than newer ones. Asset prices without a proven track record are less reliable, regardless of the benefits they offer.
This eliminates the need for debate in the financial sector. When everyone can see what the price is, there is nothing left to discuss. If you believe an asset is overvalued, you can sell it at a cheaper price. Markets do not need political advice; They get things done here and now by allocating resources over and over to the highest bidder.
However, this tendency to replace problem solving with pricing is not limited to market participants. Many governments have taken the same approach, whether voluntarily or involuntarily, if only to meet the conditions demanded by their creditors. As a result, in the United States, the Congressional Budget Office must weigh the costs and benefits of legislation, and courts have sometimes rejected lawsuits from lobbying agencies that did not include such analysis. For example, the classification of the insurance company MetLife as a systemically important financial institution was successfully challenged on this basis.
However, reducing everything to one number also comes with costs. We have to pretend that only the price differences between goods and services matter, even though we all know that’s not the case. It leads us to group or equate factories and goods with nature, health, happiness, climate and life itself. And it simply pushes us to ignore issues that have no price, such as those related to justice.
We owe this reductionist worldview “solutions” such as the use of securitization to support home ownership, a private pension system to develop or deepen financial markets, and green assets to combat climate change. If you create an asset with a price, investors will flock to it, especially if they can rely on implicit government guarantees against potential losses (which is often the case).
But now look at the results. We had a mortgage market that supported a construction boom and rising house prices but failed to solve the housing crisis; a pension system that continually requires safe assets to meet future obligations, even if that means continuing to invest in oil and gas; and decades of delays in changing the way energy is sourced, produced and distributed because green plants simply cannot do these things. Because we rely on the “magic of the market,” we have a bloated and fragile financial system that constantly relies on central bank intervention to keep it from imploding and dragging down the economy.
None of this makes much sense. Finally, prices are not good guides to the future, which is inherently unknown and unknowable, even more so when there is convincing evidence that it will differ significantly from the past. In the 1930s, John Maynard Keynes argued that it was impossible to know if and when another world war would break out or what the inflation rate would be in the 1960s. In 2023, we do not know how quickly and where climate change will accelerate, the next wildfires will break out, or which parts of the world will experience devastating droughts or floods.
Because these scenarios are uncertain, there is no way for markets to accurately assess them. But if we don’t ignore the scientific evidence, we know one thing for sure: more climate-related devastation is coming, and we can’t imagine what additional social and political impacts it might bring.
Worse, with finances at the center, we have come to believe that the most obvious solution – cutting emissions immediately – is too “expensive”. For this reason, more and more companies and governments are failing to meet their emissions reduction commitments by watering down previously set targets or delaying policies to implement them.
The world of finance has taken such deep roots that it seems as if we have turned our backs on politics. By blindly relying on prices, we have deprived ourselves of the ability to build consensus and develop effective strategies that avoid imposing the highest costs on the people whose lives are not “priced in.” No one benefits more from this catastrophe than the financial world. But these returns cannot last indefinitely.
Katharina Pistor is a professor of comparative law at Columbia Law School and author of The Code of Capital: How the Law Creates Wealth and Inequality (Princeton University Press, 2019).
© Project Syndicate 1995-2023.
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