Finance in Society: A Preliminary Discussion

A few months before the Business + Society conference,  the participants in the panel entitled Finance in Society: Markets and Behavior gathered at the Yale School of Management to share their thoughts on financial institutions, markets, and innovations, and how all of these can contribute meaningfully to the human experience. One goal of the discussion was to help make financial education at SOM forward-looking, responsive to the world’s broader needs, and responsible to society as a whole. The transcript from this prior discussion is background reading for audience members and may help them orient them in advance of this important discussion.

William N. Goetzmann '86
Edwin J. Beinecke Professor of Finance and Management & Director of International Center for Finance, Yale School of Management

Professor Zhiwu Chen
Professor of Finance, Yale School of Management

Jane Mendillo '84
President & CEO, Harvard Management Company, Inc.

Professor Robert Shiller
Sterling Professor of Economics, Yale University, Professor of Finance, Yale School of Management

David Swensen
Chief Investment Officer, Yale University

Read biographies of the panelists on the  Finance in Society: Markets and Behavior page.

 

William Goetzmann William Goetzmann: Thanks, everybody, for coming. You know, SOM has a special role as a business school. It has a focus on business and society. Within that mission, we have a number of faculty, alumni and students interested in the role of finance in society—some of the most illustrious of whom are in this room today. I thought it would be a great opportunity to get you together to talk about what finance can do for society, what it has done, what it should be doing more broadly.

I’ll also ask you about what education can do to foster innovation in that direction. What can we do, particularly as a school, to train and encourage students to think about using finance as a way to make the world a better place. That’s the framework for this discussion.

I’ll start with Bob, since you’ve written a book about finance and society. Please give us your thoughts on the first question.

Robert Shiller: Well, what I think ought to be stressed at the beginning is that finance is about creating the wherewithal for human activities. I teach introductory finance. I like to ask my students what kinds of worthwhile human endeavors there are, and whether they can think of any endeavor that they can do alone as an individual, without an organization and without resources.

The students find it very difficult to think of anything they can do like that. We’re interconnected. Every valuable activity is interconnected. One student suggested I could be a poet, and I don’t need financing to be a poet. I don’t need anything. I can compose poems in my head and memorize them, like Homer did. But I replied, that’s not a productive activity. Poets need places where they can read their poetry. They need audiences, theaters, or venues for poetry reading. They need publishers. They need printers. They need bookstores in order to make it an event, to make it something worthwhile.

Robert Shiller The problem is that these activities involve the collaboration of large numbers of people, and consume resources, and finance is really the theory about making those things happen. That’s how I view it. So in my view the theory of finance is a central underpinning of our theory of society. We are a financial society. Just about anything important that happens is financed, and it involves people who are trained in finance.

So I guess the fundamental thing that I would stress is that finance is not about making money. Thinking of it in that way makes it a less than noble field. But I think that’s quite wrong, and that people should have a sense of real purpose in the pursuit of finance.

I’d like to hear if you have any objections to that. Maybe what I said wasn’t that controversial. One of our duties as educators is to reinforce people’s understandings of things that are almost obvious, but in fact are often forgotten. And when people view the financial community, it’s often with hostility. And I think that it’s part of our role as educators to bring back to their consciousness a sense of the legitimate and very important role that they play.

David Swensen: Let me pick up on Bob’s comment that there’s a tendency to think of finance as a less than noble profession. It shouldn’t be that way, but I’m afraid today that it is. The financial services industry has lost its way. If you look at what’s happened during my more-than-30-year professional career, finance moved from a profession where fiduciary responsibility mattered to one where only making money matters. In an ideal world, financiers provide services that benefit society and consequently allow people to live a better life. Today, all that matters is how much money bankers make, at the expense of the character and quality of what it is that they do.

Thirty years ago when I worked at Lehman Brothers, the SEC had just introduced shelf registration of securities. There was this big debate at the Lehman Brothers commitments committee about whether or not the firm would underwrite bonds that were issued by a Fortune 500 company, with which the firm had no prior relationship.

Lehman was worried about its reputation, and whether involvement with this large, highly regarded, active participant in the financial markets would ultimately reflect well on the firm. I thought, this is a great debate. It’s a very healthy debate, because the firm is really concerned about its reputation.

Fast forward to the recent financial crisis. It is absolutely clear that the participants in the financial services industry didn’t care one whit about what it is that they did, as long as it was profitable. They engaged in all sorts of activities that were detrimental to society at large, knowingly participated in these activities, just so they could make money. Any tension between fiduciary responsibility and the profit motive just disappeared. The profit motive overwhelmed everything and as a consequence Wall Street’s actions put us in a pretty tough place in 2008 and 2009. It’s a tough place from which we’ve yet to recover.

Goetzmann: Do you think that’s a solvable problem?

David Swensen Swensen: Well, it’s solvable if you have the right people engaged in the activity, and it’s solvable if you’ve got the right regulatory environment. Excessive deregulation of the financial services industry led to the dysfunction that underpinned the financial crisis. A fundamentally different regulatory environment could make a big difference.

Goetzmann: I think just teaching people what it means to be a fiduciary is valuable. Fiduciary responsibility is a simple thing, but it creates a sound foundation for thinking and decision making. It cuts through a lot. It helps solve a lot of problems. You might find yourself on a slippery slope here and there, but if you have a set of principles that you’ve been taught and have thought hard about, it’s a good signpost for you.

Zhiwu, you’ve been working on educating China about the benefits of finance, and really thinking about the role of finance in society. Traditionally, it took a small role in China, and now people look to you to help them understand how finance can benefit them, and change their lives.

Zhiwu Chen: Just to echo Bob’s point about the somewhat demonizing sentiment, I guess, of the last few years, after the financial crisis, especially the Occupy Wall Street. Basically, many people in America—actually beyond America, think and talk so negatively about finance. It has always reminded me of what I have been trying to do over the last 10 some years in China.

Starting in 2001 when I began to write for a general audience and speak publicly in China, I was kind of forced to think, you know, what finance really does for society, when I know the audience and the readers of my writings are more or less ordinary Chinese people and officials who have not been so exposed to finance theory.

But then I was forced to look at finance from society’s perspective. So in some ways, for 12 years I’ve worked on the sociology of finance. What does finance really do for people?

I have focused on individual freedom as a topic. You know, in America, we take individual freedom as a given. But in the China context, while individual freedom has been on the rise, there is still a long way to go. Then, what roles does financial development play in facilitating the rise of individual freedom? Or, does finance have anything to do with individual liberty at all? I was then reminded of overlapping-generational economics models in which parents save and invest in children with the expectation that when their children grow up, they can live on the children’s payback; at the same time their children also save and invest in their own children, expecting the latter to pay back upon their own retirement; and so on.

Zhiwu Chen But in such economic modeling, we typically don’t think about what social norms and behavioral rules are required behind those implicit financial contracts or obligations between parents and children. For example, if the children would grow up totally free and were not indoctrinated about filial piety norms or absolute obedience to the elderly, that would challenge the performance of the implicit inter-generational financial contracts, which would in turn break down the social structure, leading to insecurity and unwillingness to take part in this implicit intra-family risk-sharing system. Thus, in traditional societies that lacked external financial markets, limits on individual freedom were intertwined with the extended family being the only or main intertemporal risk-sharing system. So as I was doing more research on financial history and even social history, I was made to realize that in traditional societies, individuals were not so free, not because they did not want freedom, but because in the absence of explicit financial markets, they had to rely on human beings or children as the embodied financial instruments. Children were the stocks, bonds, insurance, and all kinds of financial instruments of yesteryears.

As a result, in order to make those implicit financial contracts or financial obligations workable and less subject to default, the cultural rules had to be of the right form, of the right shape, and the right content, so that the social norms served to minimize the probability of default by children who have received so much investment from the parents.

This perspective is what I have used over the last 10 years to participate in this large intellectual debate in China about Confucianism versus modern universal values. My basic point is that while Confucianism treats each individual merely as instruments and bricks in a pyramid and suppresses individual freedom, the lack of freedom for the individual had for more than 2,000 years served China well, as it had made the implicit financial contracts between parents and children, and also among relatives, more secure and workable. Thus, even though Confucianism is against individual freedom, it made the Chinese society feel more secure about future retirement and sickness.

In general, as long as financial markets are not there, individual freedom cannot be allowed to really expand, because, if every individual is free, then I as a parent would feel so insecure about my investment in my children: if they go do whatever they want to do and marry whoever they like, what about my investment in them? How can I get a payback when I retire and when I’m sick and so on? Unfortunately, for much of human history, human beings were merely used as economic instruments, not treated as individuals of rights.

It took the development of external financial markets such as insurance, retirement funds, annuity contracts, mutual funds and so on, to liberate the individual. Gradually developed in the past seven centuries, such financial markets serve to separate the risk-trading functions from human beings in general and from children in particular, so that human beings live as individuals of rights to choose and financial functions are left to financial markets to fulfill. Once risk-trading and intertemporal resource exchanges are done through explicit contracts and in the market place away from the family, all these old cultural norms constraining individual freedom are no longer needed and the individual is made free.

About once every two years, I’ve conducted large-scale surveys of people across different cities, towns and villages, each representing a different level of financial and economic development in China, in order to see whether those who have better access to modern financial instruments, like insurance, retirement funds, and other financial products, are equally demanding on their children being totally obedient to their wishes, their orders. Not surprisingly, I’ve found that those who have access to more modern financial products tend to treat their children much more equally and with more respect, and give their children more freedom. Typically their family’s power structure is more horizontal and flatter. On the other hand, those who have to rely on their children as future retirement and future insurance tend to tolerate much less freedom for their children and demand more obedience from the latter. My research shows a strong connection between the rise of modern finance and the rise of the individual. This connection is supported both theoretically and based on a lot of survey data. In this sense, Wall Street should feel good as they are partly responsible for the rise of individual freedom in the U.S. and beyond. They provide a key foundation for that.

Goetzmann: So it doesn’t have to be a complete market, but it has to be a market where you can insure against the future. In other words finance is a way of passing money through time—intergenerational support—and in former times, parents relied on their children for social security.

Chen: This is true not just in Chinese history, but also in Western history. I’ve always found this connection to be fascinating. For example, if you look at the Roman civil code as of 300 AD, there was a section on life annuity and other life insurance contracts. That means before the Middle Ages there was more individual freedom at a time when some modern financial contracts seemed to be actively transacted. But, as Western Europe entered the Middle Ages, the individual became more constrained and repressed just as life annuity and such financial products disappeared as well. Was that a random coincidence, or there was a deeper logic underlying it?

But prior to the Renaissance and the simultaneous re-emergence of the individual, financial products first resurfaced in Florence and other European city-states around the 13th and 14th centuries. So, it seems that financial re-emergence happened first before the individual rose again during and after the Renaissance.

So modern finance and individual rights seem to have developed together in human history. This cannot be just an accident. There is a connection between the rise of the individual and modernization on the one hand, and the reemergence and development of finance on the other hand.

Goetzmann: That’s a big historical theory, and it’s an exciting topic. Jane, do you have a different view?

Jane Mendillo: Well, I was just going to ask a question. Do you think that in another generation, that will change, since people today in China probably have more opportunities to amass their own wealth and their own assets, and might not see their children as so much of an investment from which they need to get something back?

Chen: The Chinese society has already changed a lot. In a generation’s time, it will definitely change even more. All the survey data that I’ve collected indicate that today, Beijing and Shanghai, as the biggest cities in China, are very much like the American society in terms of basic values and also even in terms of the family structure. The Chinese family used to be a pyramidal structure, with the father at the top with the most absolute authority, sons on the second grid level, and so on. Now it has become much flatter, meaning that the children and the parents are more equal in the way they relate to each other, each with almost the same rights, rather than the parent being the all-powerful individual of the family.

Finance has changed China in other ways as well. For example, across different countries, there is a high negative correlation between the level of financial development and the number of children per family. So the better financially developed societies tend to have lower fertility. Today in Shanghai, about every two years, another percent of newlywed couples will decide not to have children. Traditionally, not having children would be unthinkable in China. Of course, without financial markets to rely on, traditional Chinese would have to have children as that was the only way to provide for retirement and sickness.

But now with more and more financial instruments available for the young couples to use to manage their own future more actively, they don’t view children as their only financial solution for retirement. So now, if they want to have no children, they don’t have to have and they are more free than their parents and grandparents. When you look at finance this way, you then agree that financial markets should be treated and viewed more nobly than suggested by the Occupy Wall Street movement.

Of course, I agree with David that whenever there’s a crisis, then it raises a lot of questions about how to improve or change the regulatory framework. Personally, I always take the view that as long as—as soon as people start talking about this, then it’s already halfway to the solution.

Goetzmann: So I want to break in—Jane, when I think about your job, you took on one of the biggest tasks in finance, which is managing the endowment of the oldest corporation in the United States, and also one of our great educational institutions. By its very nature it is benefiting society directly. I’ve heard you talk pessimistically about the future of finance, of expected investment returns, and whether or not endowments really have the capability of supporting all the great things that their institutions want to do. I wonder whether you still feel that way, or whether you may be a little bit more optimistic about whether we can support all of our dreams on the kind of endowments that we have.

Jane Mendillo Mendillo: Sure. I don’t think of myself as being pessimistic, but perhaps this—just recognizing we are in an era where the markets might not deliver the kinds of returns that they have in the past 20, 30 years. And that recognition is based on where we are today, starting from the very ground up in the U.S., where the Treasury rate is very low, and risk premia and illiquidity premia look like they are being somewhat condensed by the growing population of investors searching for future returns.

But in respect to your question, about whether financial markets are a force for good or evil in society, I would be very firmly on the side of good versus evil. Financial markets are clearly needed, and serve an important purpose, ensuring that capital will flow to places it is needed and where the rewards for investors and the risk seems to be in sync.

From time to time, the financial markets lose that equilibrium—the housing bubble, the credit crisis—and the risk for the return that’s offered can get way out of sync and may not be well-understood. Individuals and organizations in finance have not always been constructive in these times, and sometimes they’ve even been unethical.

But in a normal functioning market, with money flowing freely through, information being fairly shared, with equity investors getting what they perceive to be adequate returns for equity-like risk, and debt investors getting what they perceive should be offered for debt-like risk, capital does flow to companies, projects, and investment opportunities, and fill gaps that need to be filled. Finance works.

So as that circle goes on and on, and whether it’s the 1980s, ‘90s, 2000s, or 2050s, we’ll continue to see opportunities and reward for investors of many different stripes. And that is why it is so important that Yale offers a good, fundamental education in finance—it is really key to the functioning of our society. So that’s a little more optimistic than pessimistic.

Having said that I do think that there are a number of specific investment areas, asset classes that were under-populated with investors 10 or 20 years ago that are much more crowded with investors today. So we as investors really have to stay on our toes and anticipate what that means for us as a large endowment, in terms of expected returns. We need to remain alert and innovative, and evolve as markets evolve. Because our institutions, a Harvard or a Yale, can be counted on to continue to want to increase their contributions to society, which inevitably means increasing their budgets, which in turn calls for even more endowment support.

Goetzmann: It means that there is always a difficult balance between budget cutting and hoping for higher returns. We certainly hear about this from time to time at the university.

Mendillo: I think, and David’s one of the few people that is a real exception here, there are a lot of universities and colleges where the whole financial picture isn’t really understood by any one individual. There are smart folks on the investment side, but they may not control the debt side, and or fully get the challenges on the budget side, and the individuals who tend to each of these pieces may not really know each other or work that efficiently together.

As I spend more and more time in this field, I see that a really significant challenge for a number of higher education institutions is trying to bring all those pieces of the picture together, which, by the way, a finance class at Yale might actually do. And I think that would be a fantastic class.

Goetzmann: So Dave, back to you. You’ve essentially created a whole new investment style—sometimes called the Yale model—but also you’ve thought about other styles. I know you’ve said that one size doesn’t fit all in investing and you have a different idea about what individual investors should do. I think you probably also have a different idea of what sovereign wealth funds might do. So I’m just wondering what you think of the investing landscape extending into the future of this investment market. We’re all relying on for almost everything, from our education to our old age, and even for dealing with social problems.

Swensen: Well, you’re absolutely right that there are different approaches for different participants in the financial services arena. But there are some underlying principles that apply to all investors. During the financial crisis, there was a lot of criticism of the Yale model, starting with a November 2008, Barron’s article that criticized me for putting the entire group of colleges and universities into the soup.

Goetzmann: Well, there has been very much of a follow-the-leader process that’s taken place, as people have chased—tried to chase—your style and your success.

Swensen: The fact of the matter is, the underlying principles of what people refer to as the Yale model are diversification and equity orientation. Those are sensible fundamentals upon which to build a portfolio. If you look at the results of those institutions that have adopted the Yale approach, they’ve produced superior returns. The top-performing endowments over the past 10 years, a period that includes pre-crisis and post-crisis environments, are institutions that have followed this equity-oriented, diversified approach. They produced the best returns not only before the crisis, but also in periods that include the crisis.

Goetzmann: It sounds like it goes back to human ingenuity. I mean, when you say equity, people think, well, that is just investing in stocks, but going back to what Bob was talking about; underlying equity is an investment in the fundamental ingenuity of mankind. The question is, where does that equity premium come from? I guess is what I’m getting at is, will it still be there as the world matures?

Perhaps an aging global population with great need can’t afford to be allocated 50% to stocks and 50% to bonds. This portfolio might not have sufficient exposure to the equity premium. We may all have to reach for more equity return. I wonder what will happen in the long run as this tendency grows. Will ingenuity and invention grow as fast as we need it to?

Shiller: We have two buy-side investment managers here. I wanted to say that finance is broader than that. We have the sell side. We have consultants. We have lawyers. We have accountants. It’s a very broad field that goes beyond what you two are involved in day to day, as I understand it.

And it’s the study of all of these activities together that interacts with our big, national issues. I think that we have to keep all of these things in mind. So what are the big issues right now? One of them is inequality, which is rising today, and which Occupy Wall Street emphasized—you brought them up. Its slogan was 99%. The idea—the problem is that the top one percent in our society is rapidly growing richer, and so we have to give our students a sense of a broad purpose and a sense of mission in this environment.

Jacob Hacker, who’s in the political science department here, has written a book with Paul Pearson called Winner-Take-All Politics, and his claim—I don’t know what you were referring to when you referred to criticism of the financial services industry—but his criticism is focused on lobbying activities of these financial powers, which he and Pierson argue have increased a lot over the last few decades. So there may be some cultural changes that are working in a bad way against some of our deeply held values. This is something that I’m always struggling to understand.

But another concern right now is jobs, and President Obama is out there now talking about what to do about the problem that—this again relates to the inequality problem—that there are so many people who find there isn’t opportunity. So our president has proposed the creation of what he calls innovation institutes. He wants there to be 45 of them scattered over the country, financed by the federal government.

I say he’s getting at a core problem that animates voters and he comes around to setting up something that looks to me like an investment bank. I’m still trying to piece together why the government should be doing this, but maybe there is a role for government. But it gets back to the fundamental idea that—I think you were saying, David—that we have to integrate our whole concept of the structure of our financial institutions with our missions for all of society. In a sense that maybe they’re not tuned right now, and that maybe there can be retuning of these institutions, so that we can move ahead to something different.

Swensen: Or maybe we don’t need to move ahead to something different. Maybe we need to move back to where we were in the past. The basics of what we need in the financial system are pretty simple. I would like to see a return to the separation of commercial banking and investment banking.

I’ll bet that you’ve all seen the movie It’s a Wonderful Life. Well, that’s what our banking system should be like. It should be Bailey Brothers Savings and Loan, where George Bailey knew his borrowers and he knew his depositors. It was a simple gathering of deposits and making of loans that stayed on the balance sheet. These basic banking activities benefit society. Of course, deposit insurance was missing in the Bailey Brothers Savings and Loan era, which was why there was a run on the bank. But if you take the gathering of deposits and making of loans and add deposit insurance, you get a pretty basic system that adds to the functioning of society.

Today, there are all sorts of ancillary activities that the financial services industry has embraced. By and large, the activities provide little benefit to society. Often, the most profitable activities are those that are opaque and those that are complex. And then to that bankers add excessive amounts of leverage, which creates an incredibly volatile mix that ultimately led to the financial crisis.

The non-core activities, the opacity, the excessive leverage all stem from greed on Wall Street. An added consequence of this complex, opaque, highly leveraged financial system is the inequality in income and wealth that is tearing at the fabric of our society. The problem with inequality actually starts with financial services, because that’s where this increase in compensation relative to the rest of the economy has been most pronounced. If we can address the issue of compensation in financial services we’ll be well on our way to a solution to the problem.

Mendillo: There are a lot of very clever people in the financial services business, and clever people will sometimes try and find a way to beat the system or use the system for their own personal gain, especially those who lack a firm grip on the moral compass.

I think one of the great contributions that SOM could make to the field of finance would be to educate students to understand that they can be sophisticated users of and participants in the financial system, but that it isn’t appropriate to try and beat the system in order to use it for personal financial gain. And if Yale can produce leaders who can know the financial markets and system, understand market risks and opportunities, and use them to make their institutions and clients better off, versus looking to find a workaround that will lead to excess profit or an excess fee, which, you know, we definitely see all the time—that will be a valuable contribution to finance and to society.

Goetzmann: We struggle with this issue of whether or not we can train people to be ethical or whether we should be selecting people who have those characteristics. It’s a difficult issue when you’re an educational institution, because of course, you try and focus on teaching fiduciary responsibility. In our particular curriculum, we try to look at everything in a broader context, a social context, political context, and so forth. You hope that that resonates and creates a better practitioner.

But it’s very hard to know. As a teacher, you really can’t observe any immediate outcomes. It takes a long time to see careers develop, and see the great things that your students do. That’s something no business school has a good handle on. Harvard has students sign commitment letters about ethics. Maybe that’s the right way to jog people into thinking about that. But it’s also got to be an important part of the finance curriculum.

Shiller: And how about commitment letters about philanthropy? We haven’t mentioned philanthropy. People who make a lot of money should give much of it away. I tell my students this. I almost asked for a commitment from them, but I thought, well, I won’t do that. But they should give much of it away. The U.S. is a very philanthropic country, but even so, it’s not a high fraction that is given away. But Evans Hall, by the way, is a gift for which we can thank Mr. Evans for. This is the kind of thing that should be part of our educational mission, to recognize this kind of gift-giving.

Chen: That’s a good—very nice to hear Bob’s point about equality. Finance as an enabler of equality has been much less understood. Usually we don’t teach this in the courses. But over the years, especially when I looked at the history of consumer finance in America, I was really intrigued by the first adoption of installment payment loans used to promote sewing machine sales, because in the beginning, in the 1850s, just as the Industrial Revolution was finally starting to have an impact on the American home—what goes into the living room, the family room and so on—the sewing machine was one of the first to go in but it was too expensive for middle- and low-income families, because it was costing about $80 when the average annual household income was about $200 to $300. So there was a big inequality in terms of whether a family could benefit from the Industrial Revolution and buy a sewing machine.

Around 1854, Singer and Co. introduced this “Buy Now—Pay Later” installment loan. This financial innovation right away allowed lower income families to enjoy sewing machines.

This financial innovation quickly spread to promote piano sales, violin sales, vacuum sales, and many other things. Later, it was used to help low income families buy cars.

A lot of people just think Wall Street and financial markets are just for the rich, but in fact, when you think about it from this perspective, certain financial products are particularly important for low to mid-income families, because these financial innovations help them smooth their lifetime income so that they don’t have to wait until they are old to buy a home, their children can enjoy more equal opportunities in piano lessons and in other educational experience.

Goetzmann: Implicit in your framework is the notion that individuals understand their best interests, that they’re independent, that they won’t eat a lot of candy and use up all their future income.

Chen: That’s a problem Bob has been trying to solve, the behavioral problems. But 99 percent of the people don’t have that problem.

Goetzmann: The other interesting contradiction that I hear is, Bob, you have been for a long time thinking about financial innovation as a way to solve problems, and Dave, I hear you saying we’ve had too much financial innovation, and complexity has not been helping us, it’s been hurting us. So that’s kind of an interesting contradiction in your viewpoints. I suspect that you’re on the same page on a lot of things, but I thought it might be interesting to explore.

Swensen: I’m not against financial innovation. When I was on Wall Street, I was involved in structuring the first swap transaction between IBM and the World Bank. That was a good thing. But, the regulatory environment needs to keep pace with innovation.

Consider the case of swaps. Let’s force swap activity onto exchanges, where it can be transparent and where it can be reasonably regulated. Exchange trading of swaps would have made a huge difference during the financial crisis. AIG had all these swap positions that were on one side of the market. Neither the market participants nor the regulators had any idea that these massive positions existed.

If there were an exchange where these positions were traded, then the market would be aware and regulators would be aware that AIG had this massive one-way exposure. Instead, we only find out about it after AIG proves to be a threat to the financial system. So why doesn’t Wall Street like transparency? Well, if you put the trading of swaps and derivatives onto exchanges, and you get rid of the opacity, all of a sudden the profitability of dealing in these markets declines dramatically.

The financial services industry wants to keep things opaque, so that they can make profits, even though it’s a threat to the underlying integrity of the financial system. I’m not against financial innovation, particularly when the products can help financial market participants hedge exposure or reduce risks. But I want those innovations to be appropriately regulated so they don’t end up proving a threat to our financial system or a threat to our economy, as was clearly the case during the financial crisis.

Shiller: I think of innovation as happening all the time, and we’re moving ahead in a good way. I’d like to give three examples of innovation in the last few years.

One of them is the invention in 2010 of the social impact bond in the United Kingdom. These are bonds that pay off to the investor only if some social goal is met. So the first social impact bond is a bond that would pay to investors after, I think, five years if the recidivism rate at the Peterborough Prison outside London were reduced by a certain amount. And so that creates an incentive to actually go in and reduce it.

Another example, starting in 2010, again, is the Benefit Corporation. The State of Delaware just last month created what they call Public Benefit Corporation, and this is a corporation that is halfway between a for-profit and nonprofit. The standard American corporation is about making money. The new corporate form is still allowed to make money but in its charter it will have a stated purpose for something beyond just making money.

Now this may seem like an odd hybrid, but it’s informed by behavioral economics, that people actually have both sides to them. They have generous, philanthropic sides, and they want to make money, too. And it might be best to put the two together in one corporation.

And my third and last example has been developing over years, but it was just given impetus by the Jobs Act that Congress passed in 2012, and it’s crowd funding. We see these websites now where small investors can put a small amount towards any of a number of projects. It’s like an investment bank, but of a different form. It’s web-based, internet-based, and it’s more—it’s social, because it involves not just a few venture capitalists. It involves the whole internet community. I find some inspiration in that. Let’s hope it works. I see a lot of innovation going on now that is more socially based. Maybe it’s the reaction to the financial crisis. But I hope we’ll see more of that.

Goetzmann: Yes it’s amazing. Peer-to-peer lending, or lending websites where people help each other out, that’s another example.

Mendillo: And we’ve seen that the internet has enabled the of elimination of a lot of intermediaries in the financial world, from buying houses to renting apartments to all kinds of other transactions, where individuals used to have to pay a significant brokerage fee, working through an intermediary, in order to close a transaction. Now you can go direct, even as a small investor. People are constantly coming up with new ideas about how to put the buyer and the seller together, or how to put the borrower and the lender together in more efficient ways, and ways that whittle down some of the excess transaction costs.

And if you look at what we do as an institution, 20 or 30 years ago we probably paid much more in brokerage and other transaction fees than we do today. And I agree with Bob that evolution is continuing all the time, and many of the experiments that are being tried today won’t last, but some of them are really going to be real value additions, and mean significant changes in how we do business and interact with each other, and how money flows through our society.

Goetzmann: Yes. I think of ETFs and the downward pressure on mutual fund fees in the United States compared to the rest of the world. I think it’s been tough, but it’s been a good step. This disintermediation process is a positive innovation.

Goetzmann: If we were going to revamp our way of teaching finance, any suggestions on how to do it? I know Dave, you’ve trained some fantastic asset managers, and so you’ve got a great track record. I think of your approach as picking really bright people and teaching them by doing.

Swensen: Well, there is a very strong connection between the School of Management and endowment management. Look at Jane Mendillo sitting here next to me, my colleague Dean Takahashi, Peter Ammon at Penn, Andy Golden at Princeton, Paula Volent at Bowdoin, Randy Kim at the Hilton Foundation. That’s a pretty substantial list, and it’s just the beginning.

Mendillo: I think teaching finance should also include teaching innovation. In fact, as a student of finance you should be exposed to three stages: the basics of finance, innovation in finance, and the responsibility that financial managers have to their clients and institutions. Because you absolutely can’t do a decent job of financial or investment management without knowing and having really solid basics. And then an understanding of innovation and the ongoing need for innovation in financial markets, and the good and bad that can come from innovation, as we’ve been discussing today, needs to be understood. And finally, there is to me this really overriding thing of responsibility, which goes to the moral compass and to Bob’s point about philanthropy. We need to address these high level issues as well if we’re going to train our students to be leaders in finance, and to take on roles where they’re dealing with a lot of money, especially other peoples’ or institutions’ money.

I have often thought about a quote that I read a while back attributed to Kingman Brewster: “Perpetuity is a long, long time.” And in the endowment management world, you know, we’re thinking about perpetuity all the time. These are pools of money that are going to be there long, long after we’re dead. What are we doing today as endowment managers that’s going to continue to both grow and protect that precious pool of money, which is going to continue to support the incredible contributions that can be made by a Yale or a Harvard and all of their students?

I think it really is world-changing, what we’re doing. And that feeling of possibility and responsibility is something that is so inspiring to me—finance really can change the world. And I think this could be inspiring to our students, and perhaps influence how they choose to use their educations coming out of here.

Goetzmann: That’s a nice way of thinking about it, because not all of our students are interested in finance, but an increasing number have interests in social themes such as respecting the environment, or other social causes, and for them to see that resonate with finance—and with the prospect of meaningful careers in finance as well—is a great way of portraying the field, and connecting students from different areas.

Bob, you’re experimenting all the time with new ways of teaching So any ideas about different approaches to MBA education, particularly finance?

Shiller: Well, the educational world is apparently changing rapidly, with the advent of internet-based education. And it’s more democratic in a way. I’ve been teaching financial markets online for some years. I get emails from all over the world now, from people who say they took my course. And so I think of finance as democratizing, that it’s becoming more accessible to the broader public. And so some effort to get the message out more broadly is appropriate.

Sometimes I feel uncomfortable when I’m talking to Yale students, some of whom may be privileged, and I find myself assuming that my students will be very successful in finance. But then I realize that somebody else might be listening to the course that doesn’t have a family background that gives them advantages. So I have to keep those people in mind. Yale—or any other university—is really an institution for all of society, not just the students who are here.

Goetzmann: Thank you Bob. And I want to thank all of you for sharing your thoughts today. I know participants in our session for the celebration of the opening of Evans Hall will be interested in what you have to say. I look forward to the discussion in January.