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Response Paper on Finance and the Good Society

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Response paper on Finance and the Good Society

                                                                

Two parts constitutes Finance and the good society. The first part discusses about the roles and responsibilities in finance, including CEOs, bankers, lawyers, regulators and educators, in total, 18 roles. The second part takes a critical look at the financial system’s strength and shortcomings, as well as how to improve in the future.

Why financial innovation is important?

According to human nature, we have a tendency for conventionality and familiarity, thus inhibiting the application of financial principles to the design of new financial institutions. Only a small fraction of population who have better understanding will try to do the innovation. Therefore, these innovations proceed at an excruciatingly slow pace.[1]

Many biases or crisis in financial history can be reduced if we introduce new words, and new units of measurement, to help shift patterns of thinking. “Such seemingly inconsequential matters as changes in wording must actually be part of how effective financial innovation proceeds”.[2]

What are the reasons for the most recent financial crises?

People’s impulse toward risk taking can cause people to disregard danger signals and run with crowds and bet on bubbles and neglect. While, their impulse toward conventionality and familiarity makes them take no steps to protect themselves from the risks. As a result, the calamity comes, they are in serious trouble.

Individuals, businesses and governments, often have difficulty in fully understanding that borrow means leverage and any small problem can be magnified by the debt. “Debt overhang” emerges if debt becomes too large relative to resources.

The 2007 global financial crisis is caused by “debt overhang”, including the household debt overhang and credit cards debt overhang.

   “During the boom in the United States just prior to the severe financial crisis, between 2001 and 2007, household debt, including mortgage debt and credit card debt, doubled from $7 trillion to $14 trillion. Household debt as a fraction of income rose to a level not seen since the onset of the Great Depression. The United States has in recent decades had a low savings rate just about zero. In the years leading up to the crisis, U.S. mortgage loan-to-value ratios soared. The boom in home prices that preceded the financial crisis was intimately tied up with increasing leverage. Mortgage lenders, caught up in the same psychology as the home buyers, were willing to accept lower and lower down payments as the boom progressed. The lower down payments made it possible for people to afford increasingly expensive housing. When the boom came to an abrupt end, mortgage lenders became worried and started demanding higher and higher down payments, making it impossible for home buyers to buy homes and thus contributing to a downward cycle. ”[3]

In addition, credit cards were widely heavily advertised In the United States before the crisis. “In 2008, on the eve of the crisis, there were five credit cards per person”, the aggressive credit card promotions led to people’s overburdening debt.[4]

All these factors led to the crisis and the drastic destroy in financial world.

The direct and indirect contributions of various participants in the financial industry

Roles

Direct contributions

Indirect contributions

 CEOs

Steer the company and coordinate the activities of large groups of people

Symbol the purpose and culture of the company

Investment managers

Provide many services to the investors such as managing portfolios

The intellectual community also constitutes an externality that benefits society, in directing resources and incorporating information into market prices

Bankers

Provide transaction services and contribute to the money supply, which in turn facilitates commerce

 Democratization of banks gives more help to poor people, including explicit incentives to banks to provide services to low-income people and the automatic opening of bank accounts for tax refunds and welfare payments.

Lawyers

Provide law information that is tailored to their clients’ complex needs and permit people to undertake much more complex actions

The further development of legal and financial advisers, will foster an expanded public discourse that might in turn help change the conventional wisdom, and better connect the knowledge base with the real problems people face, as well as make it more timely and relevant. The more people have access to those with useful knowledge, the more intelligent will be our approach, as a society, to financial capitalism.

Regulators

Make and interpret the all-important rules of the game, which is fundamentally important to the financial system.

Affect changes in a market and even to be part of history[5]

...

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