MANY finance students and members of the Occupy Wall Street movement have a great deal in common: a deep interest in democratizing Wall Street.
At Yale, where I have been teaching for 25 years, I’ve been hearing a great deal lately from my students about financial innovations linked to social media. One such innovation, called crowdfunding, is embedded in the jobs bill signed into law by President Obama on Thursday. The idea involves Web sites that help many investors contribute small amounts of capital to projects that they read about online, and that might otherwise be starved for money.
Though the concept is being tried, in different ways, on sites like Kickstarter.com and Kiva.org, it is still very much an experiment, and its real-world benefits for small investors are still uncertain.
The new law, called the Jump-start Our Business Start-ups, or JOBS, Act, tries to regulate crowdfunding constructively. This innovation might be as well received as Wikipedia, which is constantly being updated and improved by a vast army of users. There may well be disappointments at first, but the concept can be tinkered with, like other democratizing financial innovations that have eventually delivered much good to society. I discuss many such examples in my new book, “Finance and the Good Society.”
Consider Wall Street in 1811. It wasn’t obvious then, but worldwide economic growth received a major boost that year from a New York law that allowed anyone who satisfied some minimal requirements to set up a corporation, with limited liability. The law turned out to be one of the most socially productive pieces of modern financial history.
By clarifying that shareholders would never be personally liable for a corporation’s debts, the New York law would allow investors to hold a diversified portfolio consisting of many stocks. That wasn’t feasible without first establishing limited liability, because of the risk that a lawsuit involving any company in the portfolio could bring a major personal loss. The New York law, proven successful, was copied globally. This created a pool of investors for which investment bankers could place shares.
The framers of the New York law didn’t see themselves as inventors of a brand-new market. They were merely responding creatively to an economic crisis. Congress had imposed an embargo on trade with Britain starting in 1807, citing grievances related to Britain’s war with France. By 1811, the trade embargo was causing economic pain in the United States, because America had been an exporter of cotton and other fibers to British textile mills. There was a pressing need for more American textile mills, but few people in the United States wanted to start them, thinking it would be hard to compete with Britain after the embargo eventually ended.
The new provisions of the New York bill were regarded as expedients to deal with this crisis. The bill made it possible for anyone to start a joint stock company at any time and for any purpose, without special action by the government. But the effects were profound. It was the kind of socially productive financial innovation that the proponents of crowdfunding want today: a new means of financing exciting enterprises, products and services.
The crowdfunding concept also recalls another bit of historical financial innovation that promoted a more democratic economy: support for small businesses. In their 1961 book, “The New Capitalists,” Louis O. Kelso and Mortimer J. Adler proposed what they called a Capital Diffusion Insurance Corporation, which would guarantee small-business loans. The Small Business Administration had already been created, in 1953, to replace the Reconstruction Finance Corporation, and was then a maker of loans rather than just a guarantor of them.
Gradually, the S.B.A. was transformed from a lender to a partial guarantor of small-business loans, much in the Kelso-Adler spirit. The idea is that individuals should have an incentive to participate in the risk-taking, relieving general taxpayers of the full burden.
Crowdfunding is an altogether new twist on this idea. Financial innovation, of course, takes unanticipated forms, but wherever it turns next, we can expect some breathtaking transformations during the careers of today’s students. And despite the damage to its reputation from the subprime mortgage crisis and its aftermath, financial innovation could help solve many vexing problems — including many for those in the 99 percent.
Finance is substantially about controlling risk. If risk management is suitably democratized, and if its sophisticated tools are better dispersed throughout society, it could help reduce social inequality. Future financial innovation, for example, could deal with the problem of rigid entitlements — like Social Security or health benefits — that are making our national debt problems so difficult.
The essence of finance is that contracts should benefit all parties. We may be able to revise our entitlement programs, creating them in a more refined way, using data and analysis to account for the life situations of individuals while still retaining the simple concept of fairness.
Likewise, financial innovation can make our responses to catastrophes more intelligent. It can channel our gambling impulses into something more constructive. It can make speculative bubbles less of a problem, and help make prices in financial markets better reflect fundamental information.
As in the examples of crowdfunding, limited liability and small-business loans, financial professionals can better direct creative energies on longstanding problems that are lamentably neglected today. And they may be able to focus specifically on problems specific to the very poor.
In his 1936 book, “The Good Society,” Walter Lippmann saw the deepest human benefits flowing from private business: “How else, when we pause to ponder the matter, can the human race advance except by the emancipation of more and more individuals in ever-widening circles of activity?”
Contrary to popular opinion these days, the history of finance marks those “ever-widening circles of activity” with products ranging from venture capital to home mortgages to various forms of insurance, savings and pensions. The faults in institutions that contributed to the recent financial crisis can be corrected, but only by those who are willing to get inside the mechanism and get to know it.
The challenge ahead — both for my students bound for the world of finance and for those who would occupy it — is to truly democratize Wall Street.
Robert J. Shiller is professor of economics and finance at Yale and author of "Finance and the Good Society," to be published on Wednesday by Princeton University Press. A related, newly revised online course in financial markets is at oyc.yale.edu/economics/shiller. It is free and is part of the Open Yale project.
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