Mihir A. Desai - The Wisdom of Finance: Discovering Humanity in the World of Risk and Return

Copyright 2017 by Mihir A. Desai

All rights reserved

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Library of Congress Cataloging-in-Publication Data is available.

ISBN 978-0-544-91113-0

Illustration credits appear on .

Excerpt from Two Tramps in Mud Time from the book The Poetry of Robert Frost edited by Edward Connery Lathem. Copyright 1969 by Henry Holt and Company, copyright 1936 by Robert Frost, copyright 1964 by Lesley Frost Ballantine. Used by permission of Henry Holt and Company, LLC. All rights reserved.

Cover design by Brian Moore

Cover illustration: Archimedes Lever, courtesy of the Kislak Center for Special Collections, Rare Books and Manuscripts, University of Pennsylvania

e ISBN 978-0-544-91120-8
v1.0517

To

TEENA, MIA, ILA,

and

PARVATI

Money is a kind of poetry.

Wallace Stevens, Adagia in Opus Posthumous

This book is not about the latest study that will help you make money in the stock market or that will nudge you into saving more. And its not about the optimal allocation of your retirement assets.

This book is about humanizing finance by bridging the divide between finance and literature, history, philosophy, music, movies, and religion.

This book is about how the philosopher Charles Sanders Peirce and the poet Wallace Stevens are insightful guides to the ideas of risk and insurance, and how Lizzy Bennet of Pride and Prejudice and Violet Effingham of Phineas Finn are masterful risk managers. This book looks to the parable of the talents and John Milton for insight on value creation and valuation; to the financing of dowries in Renaissance Florence and the movie Working Girl for insight on mergers; to the epic downfall of the richest man in the American colonies and to the Greek tragedies for insight on bankruptcy and financial distress; and to Jeff Koonss career and Mr. Stevens of Remains of the Day for insight on the power and peril of leverage.

In short, this book is about how the humanities can illuminate the central ideas of finance. But this book is also about how the ideas of finance provide surprising insight on common aspects of our humanity.

So, this book is also about how understanding insurance can help us make sense of and confront the disorder of the world; how understanding the capital asset pricing model can allow us to realize the value of relationships and the nature of unconditional love; how understanding value creation can help us live a meaningful life; how understanding bankruptcy can help us react to failure; and how appreciating theories of leverage can teach us about the value of commitments.

For readers unfamiliar with, but curious about, finance, this book attempts to outline the main ideas of finance without a single equation or graphand only with stories. Im always struck by how intimidating finance is to many of my students. Theres a reason for thissome people in finance want to intimidate other people. By attaching stories to the ideas of finance, previously intimidating material will hopefully become accessible and fun. For concerned citizens or aspiring professionals, finance has never been more importantand ignorance of it has never been more costly. At a minimum, when someone you know starts going on about options, leverage, or alpha generation, youll know what theyre talking about.

For students or practitioners of finance, this book allows them to revisit the big ideas of finance in a fresh, different way. Many practitioners of finance I see in my classroom were taught finance in a mechanistic way that has led to a fragile understanding of the fundamental ideas. When I probe them for the underlying intuitions, their understanding of the formulae helps little, and they can struggle to relay the conceptual underpinnings of what they do. By seeing these same ideas in a completely different way than youre used to, you will deepen your understanding and, most importantly, your intuitions.

For those readers engaged in finance deeply, the book holds one final promise. Your endeavors are routinely maligned today, and it can be difficult to make sense of ones life when your work is characterized in such a negative way. But there is great valueand there are great valuesin finance. By reconnecting to that valueand those valuesperhaps you can understand your lifes work as a meaningful extension of the values you hold dear. At the end of his poem about a recreational woodchopper, Two Tramps in Mud Time, Robert Frost captures vividly how important it is for us to understand our work and our lives as an integrated whole.

My object in living is to unite

My avocation and my vocation

As my two eyes make one in sight.

Only where love and need are one,

And the work is play for mortal stakes,

Is the deed ever really done

For Heaven and the futures sakes.

Most ambitiously, this book endeavors to improve the practice of finance by rediscovering the humanity of the core ideas of finance. The demonization of finance is counterproductive, and regulation, while helpful, holds only limited promise for addressing the transformation of finance into an extractive, rather than a value-creating, industry. Perhaps we can all find our way back to a more noble profession by enlivening the ideas of finance through stories that illuminate our lives and our work.

The Wall Street vs. Main Street rhetoric that has become so pervasive reflects a common view of finance as an industry that extracts more value from the economy than it creates. At the same time, there is a growing awareness of how central finance is to our economy and our lives. We see finance everywhere, from our retirement assets to our investments in housing and education. The combination of deep suspicion and curiosity is further complicated by the complexity in which finance shrouds itselfmind-numbing acronyms, formulae, and spreadsheets serve as barriers to understanding the world of finance.

For practitioners of finance, this creates several problems. They need to explain and justify what they do more clearly to win back confidence. They need to ensure that their activities are truly value creating. More personally, working in an industry that is perceived negatively can take its toll. With expectations so low, finance professionals have little to aspire to, which creates a downward spiral of low expectations and poor behavior.

How do we open up the ideas of finance to everyone so they can access them in an affirmative way? How do we recover a sense of the virtues of finance so that the practice of finance can be improved?

This book takes the unorthodox position that viewing finance through the prism of the humanities will help us restore humanity to finance. The problems that finance addresses, and the beauty of the approach it adopts, are most easily understood by attaching finance to the stories of our lives. More than regulation or outrage, fixing finance requires practitioners to return to the core ideas, and ideals, of financewhich can help them ensure that they are creating value and not extracting it. By linking those core ideas to literature, history, and philosophy, we give them deeper resonance and make them more resistant to corruption.

I stumbled upon the idea of linking finance to stories. In the spring of 2015, I found myself in a position I often dostruggling at the last minute to make good on a commitment. I had agreed to give one of the last lectures to the graduating MBA class of Harvard Business School. The so-called last lecture is a tradition that allows professors to offer students, on the eve of their graduation, words of wisdom. At its best, it returns the university to a bygone era. Rather than the production and dissemination of specialized knowledge, for a moment we would all return to an antiquated notion of a university that acknowledged that, as John Henry Newman put it more than 150 years ago, the general principles of any study you may learn by books at home; but the detail, the color, the tone, the air, the life which makes it live in us, you must catch all these from those in whom it lives already.