Walt Whitman, Artist of Finance

Bloomberg: One of the myths surrounding economic inequality in our society is that high incomes are often the result of selfishness and narrow-mindedness, rather than idealism and humanity. We tend to think that those in careers other than our own are fundamentally different kinds of people.

Personality and character differences are, indeed, somewhat associated with occupation. But we tend to attribute the behavior of others to personality differences far more often than is warranted.

We tend to think of philosophers, artists or poets as the polar opposite of chief executive officers, bankers or businesspeople. But the idea that those involved in business have personalities fundamentally different from those in other walks of life is belied by the fact that many often combine or switch careers. Consider a few examples.

Walt Whitman is one of our most revered poets, and his poetry is among the most transcendent. But he could not ignore more material concerns; he had to make a living. To do so, he turned to fiction -- more marketable than poetry -- and made his name with a commercial novel called “Franklin Evans, or The Inebriate: A Tale of the Times.”

 

Poets Need Money

The book was an embarrassment to him, but it made money, though apparently not enough to finance his future, more serious work. In 1855, when Whitman self-published the first edition of his masterpiece, “Leaves of Grass,” he offered to set his own type as part of his deal with the printer.

Although “Leaves of Grass” gradually gained acceptance, the publication of each subsequent edition was accompanied by further struggles. The third edition was long delayed: When the publisher declared bankruptcy, the printing plates of some poems were actually auctioned off. Whitman lost profits that could have helped finance his further writing. In his lifelong struggle to get his work to readers, Whitman was forced to take on the role of a businessman -- sometimes none too successfully.

Charles Ives, thought by some to be America’s greatest symphonic composer, was first a highly successful insurance executive. He graduated from Yale in 1898, and in 1909 he and a partner founded a life-insurance agency, Ives & Myrick. (Ives also wrote a finance book, “Life Insurance With Relation to Inheritance Tax.”) The company, which by 1929 had grown to be the biggest life-insurance agency in the U.S., made him a fortune of more than $20 million. His wealth gave him the ability to produce, and subsidize the performance of, his idiosyncratic and not immediately popular music.

In a scene in one biography, Ives is portrayed at a recording session, “probably with a sigh or curse,” taking out his own checkbook to compensate a conductor. Because of his wealth, Ives was better able to produce the kind of music in which he truly believed.

The contemporary artists Jeff Koons and Damien Hirst sometimes sell their works for more than $10 million. Koons holds the world’s record auction price for a sculpture by a living artist: $25,752,059 for “Balloon Flower (Magenta),” auctioned at Christie’s in 2008. Koons and Hirst are financial sophisticates, running businesses with numerous employees, and aggressive marketers of their own works. Koons started out as a commodities trader at Smith Barney and used the money he earned there to finance his art.

 

Managing Finances

People in the most spiritually minded professions -- those who work in the church, the arts or philanthropy, for example -- are routinely involved in managing financial resources and executing deals and contracts.

Even revolutionaries have to involve themselves in finance. In “Walden: Or Life in the Woods,” Henry David Thoreau described spending 1845-47 in the woods at Walden Pond, contemplating nature and spirituality. But he was not really an advocate of dropping out, and in fact in his own life he did not do so. Throughout most of his life he was actually involved in managing his family’s pencil company and even invented a new way of making pencil leads. He just thought that making money should never be his life’s overriding purpose. “To have done anything by which you earned money merely is to have been truly idle or worse.” The key word in this sentence is “merely.”

To the list of revolutionaries who did not abandon commercial realities, we can add Jerry Rubin, the anti- establishment radical who wrote “Do It! Scenarios of the Revolution” and who was sentenced to four years in prison for inciting protesters at the 1968 Democratic National Convention in Chicago. After the sentence was overturned, Rubin headed to Wall Street to become a market analyst for the brokerage firm John Muir & Co.

The press portrayed his transition “from yippie to yuppie” as a contradiction, but in 1980 Rubin disagreed: “Money has always been power,” he said. “But in the 1960s a picket line made a difference. The ’80s are much more hierarchical. Picket lines don’t get much attention. Accountants have more power. Money is more the pressing social issue of our day.” The point here is not that Rubin has a coherent moral philosophy, but that the very same person could succeed on both the picket line and Wall Street.

Self-promotion and the acquisition of wealth, whether by financial or other means, is no crime. In fact, some of humanity’s greatest achievements originate in just such behavior.

Many people assume there is something sleazy about the business of finance, or the people who practice it. This impression is probably behind the commonly voiced opinion that it is a shame so many young people today are going into finance-related occupations, when they could be doing something more high- minded in other fields.

It’s true that many people in business do seem to feel rewarded, for the short run at least, in putting salesmanship ahead of purpose and in cutting legal corners. They seem too focused on money to have moral purpose in their business affairs.

Yet if one lives in the real world, one has to work with, or even for, such people. They are a reality, and it makes sense to try to understand them -- to see if they are as simply sleazy as people think.

Positions in certain finance-related fields often offer more than the usual temptation to be less than honest -- because finance is a profession that offers, at least to the lucky few, astronomically high incomes. On occasion, we may even ask: Why would anyone with a sense of personal morality go into finance?

 

Deliberate Deception

Finance may seem corrupt also because the management of information is central to success in the field. And to make the best deal in a financial transaction, there is always the temptation to withhold information. Deliberate financial deception wounds the victim’s ego; people feel foolish to have been duped.

Casinos reveal how it’s possible to exploit people’s recurring errors in judgment. Consider how much people act to avoid losses, even small ones, as research by psychologists Daniel Kahneman and Amos Tversky has shown. If offered an asymmetrical bet on a coin toss -- to win $20 if it comes up heads, or lose $10 if it comes up tails -- most people will turn it down. How is it then that casinos are able to induce many people to make investments (in the form of bets) -- and do it so much that, by the law of averages, losses are a virtual certainty?

Part of the answer has to do with the casino, which is designed to encourage risk-taking. Alcohol is served. And the setting cultivates the notion that all the casino’s customers are rich and successful. This confuses some, causing them to lose sight of their repeated losses at the tables. When people are in a place where they can see others making large bets, their own potential losses seem less salient.

By replicating some of these features in their laboratory, the psychologists Joseph Simmons and Nathan Novemsky found that they do, in fact, encourage risk- taking.

Left to unregulated market forces, many brokerage services would closely resemble casinos. We know this from observing the nature of securities establishments before regulation was effective. The “bucket shops” of the late 19th and early 20th centuries, where customers bet on commodities and prices, allowed patrons to make many very small bets, in a social atmosphere and while watching others bet. One patron of a bucket shop in the financial district of New York in 1879 said it reminded him of “a horse-pool room,” a place where people engaged in an early form of pari-mutuel betting.

 

Cognitive Dissonance

When someone participates in a business that seems in any way sleazy, that person may experience the discomfort of what psychologists call “cognitive dissonance.” To maintain self-esteem in such circumstances, people may revise their beliefs. Hypocrisy is one manifestation of this; a person espouses opinions mainly out of convenience and to justify certain actions, while often at some level actually believing them. Social psychologists have shown how cognitive dissonance leads with some regularity to moral lapses -- or, at times, to what we might call “sleaziness.”

Recently, the neuroscientist Vincent van Veen and his colleagues used functional magnetic-resonance imaging to monitor brain activity in experimental subjects as they were encouraged to lie about their true beliefs. The researchers found that the lying stimulated certain regions of the brain, the dorsal anterior cingulate cortex and the anterior insula. Some subjects showed more stimulation in these regions than did others. Importantly, those with more activity in these brain regions showed a stronger tendency to change their actual beliefs to be consonant with the beliefs the researchers led them to espouse. We thus have some evidence that a physical structure in the brain is associated with cognitive dissonance, and that this appears to be part of a neural mechanism that produces the phenomenon.

If hypocrisy is thus built into the brain, then there is a potential for human error that can be of great economic significance. A whole economic system can take as given certain assumptions -- for example, the belief, held during the years before the current financial crisis, that home prices never fall. To doubt it would have caused cognitive dissonance for millions of people who either invested in real estate or were otherwise involved in a system that was overselling it.

Consider, too, the European bank regulators’ decision years ago to put zero capital requirements on euro- denominated government debt. At the time, an end to the euro was unthinkable; to recognize a risk of failure would have created dissonance. So European regulators adopted what in retrospect seems an irrational stance -- that euro- denominated debt was completely safe -- setting the scene for a potential disaster in the banking sector.

 

Truth Seekers

This kind of thinking is perennial and fundamental. But the finance professions also attract people who are relatively invulnerable to cognitive dissonance: traders or investment managers who delight in the truth that is ultimately revealed in the market. Troubled by hypocrisy, they seek vindication not by sounding right but by being proved right. Many financial theorists have tried to represent people as merely profit maximizers, perfectly selfish and perfectly rational. But people really do care about their own self-esteem, and profit maximization is at best only a part of that.

The practice of finance doesn’t universally incline its practitioners to sleazy behavior. It also rewards people with a certain kind of moral purpose -- one that may be visible to outsiders only intermittently. Day to day, it is hard to see the moral purpose inherent in helping one’s clients, and so it is easy to conclude that such moral purpose doesn’t even exist among people in finance. However, most people naturally project such purpose onto their daily routine. Most of us instinctively want to be helpful and good, within limits, to those around us.

The moral calculus of accumulating large sums of money over a lifetime can be extremely opaque. Most of us never have a true reckoning of our own moral purpose, let alone the moral purposes of others.

John D. Rockefeller Sr., himself the son of a small- time huckster and bigamist, was, in his business life, a ruthless, take-no-prisoners aggressor. Ida Tarbell made a scandal of his business practices in her 1904 book “The History of the Standard Oil Company.” But in his later life, Rockefeller became a philanthropist in the mold of Andrew Carnegie, establishing the Rockefeller Foundation, the University of Chicago and Rockefeller University. His son John D. Rockefeller Jr. continued the family philanthropy and, in turn, trained his six children in the ways of public service. One of them, Nelson Rockefeller, became vice president of the U.S., and the fourth generation includes John D. Rockefeller IV, who has been a U.S. senator from West Virginia for more than a quarter of a century.

 

Charitable Impulse

What ultimately motivated the Rockefellers? Was it mere ego gratification and the desire for a family dynasty? Or did their philanthropy serve some deeper moral purpose? Most likely, it is a little of both. Even if wealthy people plan to give away all their money and possessions eventually, no one else knows their ultimate intentions, and thus others are naturally suspicious of them. Such suspicion may express itself in a tendency to brand all of the rich as sleazy. Yet quantitative research suggests that negative stereotypes of top businesspeople aren’t universal.

In 1990, Maxim Boycko, a Russian economist; Vladimir Korobov, a Ukrainian economist; and I did conducted a survey on American (specifically New Yorkers’) and Russian (Muscovites’) attitudes toward business. We asked, “Do you think that those who try to make a lot of money will often turn out to be not very honest people?” In both countries many people answered yes. But more felt that way in Russia: 59 percent, compared with only 39 percent of the New Yorkers.

We then asked a more personal question: “Do you think that it is likely to be difficult to make friends with people who have their own business (individual or small corporation) and are trying to make a profit?” In Moscow, 51 percent of the respondents said yes, compared with only 20 percent in New York.

The further success of financial capitalism once again depends on people adopting a more nuanced view of human nature as it is expressed in a financial environment. In an economic system that is essentially good overall, we have to accept that there will be some less-than-high-minded behavior.

We have ample reason to believe that financial markets are quite useful. And yet our wonderful financial infrastructure has not yet brought us the harmonious society we might consider ideal. There remains the ugliness of extreme economic inequality, of some who endure hardship while others are pampered.

While some inequality is actually in many ways a good thing, for the motivation and stimulation it provides, arbitrary and extreme inequality poses problems. It is an imperative that people feel society is basically fair to them.

We see this aversion most clearly today in the worldwide protests associated with Occupy Wall Street and its variants. Rising inequality is certainly a valid concern, and one that must be addressed. But financial capitalism does not necessarily produce unjust wealth distribution.

There is widespread skepticism that those who become extremely wealthy through financial dealings, or very high executive-compensation packages, are sufficiently deserving of their wealth.

 

World’s Richest People

If we define the field of finance broadly, then most of the world’s richest people may be classified as connected to it. Looking at the Forbes 400 list of the wealthiest Americans, you see that the great majority are in charge of large enterprises that participate frequently in markets and deal-making. The Forbes 400 billionaires have usually made use of some kind of specialized knowledge to achieve their wealth, but they rarely stand out for important contributions in any intellectual or creative field. There appear to be no distinguished scientists on the list, no Nobel Prize winners.

Their wealth comes not solely from their own efforts and talent, but often from their ability to form and lead huge and effective organizations composed of many other talented people. Still, it remains a puzzle that those connected to finance can become so fabulously rich to the seeming exclusion of everyone else. Wouldn’t you think that at least one scientist could come up with a patentable idea that would top all their successes?

Part of the reason for a sense of injustice at the unequal distribution of wealth is that some of the inequality seems to be the result of family dynasties, through which the children of successful businesspeople become rich. Some of these children (Donald Trump, for example) keep working in the family business. But, in fact, only about a third of family businesses are continued by the children of the founders, and only a tenth of them by the grandchildren. Still, the later generations remain rich.

The tendency for wealthy families to annoy others by “showing off” -- by spending extravagantly and wastefully on themselves -- is also often a cause for resentment. This tendency toward consumption for show has been dealt with for centuries, going back to ancient Greece and Rome, by means of sumptuary laws that forbid specified forms of wasteful consumption. In seventh-century B.C. Greece, for example, women were forbidden to wear extravagant clothing or jewelry unless they were prostitutes.

 

Progressive Consumption Tax

A modern version of sumptuary laws is the progressive consumption tax: one that’s based on the amount one consumes rather than the amount one earns, with higher rates on higher levels of consumption. Such a tax was proposed in the U.S. Senate in 1995 by Sam Nunn, a Democrat from Georgia; and Pete Domenici, a Republican from New Mexico.

Switching from a progressive income tax to a similarly progressive consumption tax might be a good idea, for it would not penalize one for earning a large income. And it might encourage saving, philanthropy or both. However, there are serious implementation problems that make progressive consumption taxes difficult. It would be hard, for example, not to effectively reduce taxes on the highest-income people. And it would be hard to manage withholding on income, since responsible withholding would have to depend on unknown future consumption. Neither a sumptuary tax nor a progressive consumption tax is an easy and obvious solution to the problem of wasteful and resentment-inducing consumption that announces wealth or social position.

Estate taxes are one of the most effective ways of restoring a sense of fairness in society. If they were pursued aggressively, they would do much to reduce economic inequality. But, to some, estate taxes can seem extremely onerous.

In late 2010, when a law suspending the federal estate tax in the U.S. was set to expire, so that the maximum estate tax rate would rise to 55 percent from 0 percent, stories were told of elderly people in poor health asking their doctors to cut off further treatment so they would die before the year ended.

Ideally, estate taxes should be set at some intermediate level, so that they neither confiscate people’s wealth at death nor allow it to pass entirely to the next generation. In fact, most people believe that society should give in somewhat to the natural desire to make one’s children rich, but limit it. A 1990 survey that Maxim Boycko, Vladimir Korobov and I conducted found that people in both the U.S. and the Soviet Union thought that the estate tax should take about a third of an estate.

 

Taxes and Inequality

Another of society’s most important weapons against economic inequality is the progressive income tax. Higher tax rates are fixed on higher levels of income, and so revenue is raised disproportionately from high-income people, and much of the benefit of the proceeds is directed to, or at least shared by, the poor. Strangely, though, the income-tax system has never been designed with the express objective of managing inequality.

In the future, nations would be wise to index their tax systems to inequality. Under such a system, the government would not legislate fixed income-tax rates for each tax bracket, but would instead prescribe a formula that tied tax rates to statistical measures of pretax inequality. If income inequality were to increase, tax rates would automatically become more progressive. Inequality indexation could be considered a kind of insurance -- against worsening inequality.

Leonard Burman, a tax policy expert at Syracuse University, and I did a historical analysis of the possible effects of inequality indexation, had it been imposed many years ago. We found that if one had been legislated in 1979, freezing after- tax income inequality at the then-current level, the marginal tax rate on high-income individuals would have increased to an extraordinarily high level, more than 75 percent. This indicates how much economic inequality has worsened since 1979.

Progressive income taxes and estate taxes -- and possibly also progressive consumption taxes -- are important tools for dealing with excessive economic inequality. Real public concerns about inequality have already made some of these taxes common around the world.

But societies have great trouble dealing with the issue of inequality in a systematic manner. The principle has never been articulated that some degree of inequality is a good thing, that there should be some who are richly rewarded for their business success (or their parents’ success), but that society should put some limits on this inequality.

Because that principle has never been established, the effects of various tax laws are never considered systematically. Thus the wealthy instinctively oppose any increase in their taxes, fearing that acquiescing even to a limited extent might leave them open to a haphazard series of tax increases that, in combination, could amount to confiscatory taxation.

The inequality indexation scheme may not ultimately prove to be the right course, but it at least illustrates how more complex systems of tax rates grounded in risk-management theory and behavioral economics could work. We could introduce more responsiveness and nuance into the tax system to help achieve a better society -- one in which people feel that basic economic fairness is assured.

The economic power that some in the financial community attain bothers many people deeply. It offends our ideal of a society that aspires to respect, appreciate and support everyone. The pursuit of power that often drives financial capitalism seems contrary to the concept that finance should be about the stewardship of society’s assets.

Yet successful societies develop elites partly because they need leaders with the power to get things done. We have to make it possible for a relatively small number of people to use their personal judgment to direct our major activities. A system of financial capitalism will eventually imbue those in possession of such faculties with wealth and power.

Still, there is a reason that the level of resentment of the wealthy and powerful is so high: A free capitalist system can support an equilibrium in which some kinds of social conspiracy pay off. George Akerlof, in his 1976 article, “The Economics of Caste and of the Rat Race and Other Woeful Tales,” explains the tendency of certain social groups to form a sort of business conspiracy against outsiders. He uses the caste system, most notorious in traditional India, to examine the phenomenon of power elites in business and finance.

 

Castes in Finance

Those in the world of finance who belong to a higher caste -- because they are graduates of an elite college or are connected to a specific business culture -- realize an immense economic advantage. Fearful of compromising that advantage, they adhere to the caste’s social norms. They favor their own caste in business and reject those who don’t belong -- or who don’t respect the social norms. This promotes stability of the caste.

The financial tools themselves don’t create the caste structure, though their mechanisms are part of the equilibrium. The same financial tools can also, if suitably designed and democratized, become a means to break free from the grip of caste equilibrium. Truly democratic finance can enable citizens to escape outcast status.

Financial capitalism is a work in progress, not yet perfected but gradually improving. It is defined by a long list of practices and, within them, specific roles and responsibilities for people. Watching these people in operation day to day, one can easily observe that, in our society, caste- like behavior has been on the decline.

India’s caste system has never been accepted by the Buddhist, Christian and Muslim religions, and it was deplored by Mahatma Gandhi and other spiritual leaders. Vladimir Lenin in Russia, Kemal Ataturk in Turkey, Yukichi Fukuzawa in Japan, Sun Yat-sen and Mao Zedong in China, Eva Peron in Argentina and Nelson Mandela in South Africa had the same distaste for castes or their analogues. Just as their beliefs represent a worldwide 20th-century trend toward greater social enlightenment, a parallel trend exists in the business world.

The concept of an aristocracy or “high society,” so strong in the 19th century, is fading around the world. No longer is a listing in the Social Register a coveted status symbol for prominent U.S. families. Burke’s Peerage has likewise fallen from importance in the U.K. In China, the national records of degree-holding literati and the local gazetteers died out before the end of the Qing dynasty in 1912. A more egalitarian spirit is abroad in the world, and it is supported by democratized finance.

 

Regarding the Rich

President Franklin D. Roosevelt once said, “I am delighted to show any courtesy to Pierpont Morgan or Andrew Carnegie or James Hill, but as for regarding any of them as, for instance, I regard … Peary, the Arctic explorer or Rhodes the historian -- why I could not force myself to do it even if I wanted it, which I don’t.”

Most of us might think Roosevelt himself was rich. After all, in the 1940s his family was the most prominent of all in the Social Register, with no less than a page and a half of entries. But he was not among the extremely rich, and he seems to have considered himself at the same distance from them that most of us do. This mindset must have been a factor in his New Deal policies, which helped democratize U.S. financial markets.

Further democratization of finance entails relying more on effective institutions of risk management that prevent random redistributions of power and wealth. We have to further develop the financial system’s inherent logic, its own ways of making deals among independent and free people -- deals that leave them all better off.

We also have to improve the nature and extent of participation in the financial system, including by distributing to everyone fundamental information about its workings. When people get reliable information, they come to feel less dominated by a power elite. At present, most people have little or no such information. Instead they are routinely confronted by salespeople for financial products who have inadequate incentive to tell them what they really need to know.

An enlightened system of financial capitalism requires some government interventions, including a progressive income tax. There also needs to be a social safety net, and it has to be continually improved and reworked.

 

Make Finance Humane

The democratization of finance works hand in hand with the humanization of finance. To that end, it is important that finance be humane, and that its models incorporate our increasingly sophisticated understanding of the human mind. The rise of behavioral economics and neuroeconomics in recent decades provides a foundation for such an approach, for understanding how people really think and act. People aren’t inherently and uniformly loving to their neighbors, but our institutions can be changed to reward the better side of human nature.

One of these better sides is the charitable impulse, and the tendency, at least in the right social environment, for wealthy people to give much of their wealth away constructively. Such a tendency ought to be considered central to financial capitalism.

One other singularly important human impulse was emphasized by Adam Smith in his 1759 book, “The Theory of Moral Sentiments.” This is the desire for praise. We see this plainly in the behavior of the youngest children and the oldest and weakest people, those with no hope of attaining power over others.

An enormous literature in modern psychology confirms the importance of self-esteem. But Smith put a different slant on the desire for praise. In mature people, he wrote, it is transformed into a desire for praiseworthiness. Further, he believed that our desire for praise can be truly satisfied only if we deserve it. No one is satisfied merely to look praiseworthy; one wants to be praiseworthy.

This aspect of human nature is essential to the success of our economic system. Economic development is, in substantial measure, the development of a social milieu in which few people find corrupt behavior worthy of praise.

Achieving such a system requires innovations to humanize finance. Regulations are like rules of war; they work to lessen the unnecessary damage of human aggression and encourage the expression of other, more charitable, impulses.

Many of our hopes for the future should be pinned on further development of the institutions representing financial capitalism. We are easily dazzled today by advances in information technology, and these advances can certainly interact positively with financial innovations. But advances in our economic institutions may ultimately be more important than those in our hardware and software. The financial system is itself an information-processing system -- one built with human, rather than electronic, units.

We need a system that allows people to make constructive deals to further their goals, and one that allows an outlet for our aggressions and lust for power. It must redirect inevitable human conflicts into a manageable arena, one that makes room for those who are happy to commit themselves to a life of stewardship and the protection of others.

By Robert Shiller