Robert J. Shiller’s latest book comes at a time when many believe that the 2007 financial crisis is not over yet, and the worst is yet to come. Politicians and citizens all over the world are criticizing the excesses of financial capitalism. And finance, incidentally, was very much at the center of the recent French presidential campaign. Even the right wing, Nicolas Sarkozy said,

“Purely financial capitalism has perverted the logic of capitalism. Financial capitalism is a system of irresponsibility and is… amoral. It is a system where the logic of the market excuses everything”.

Originally written for his students in the finance class, he has been teaching at Yale University for the last 25 years, “Finance and the Good Society”, targets the general public to help them understand financial capitalism.

“In this book, I contend that the financial crisis was not due simply to the greed or dishonesty of players in the world of finance; it was ultimately due to fundamental structural shortcomings in our financial institutions,” writes Shiller who further acknowledges that these shortcomings are still not being addressed and the main focus has been on avoiding bailouts and reducing national debt by curtailing government spending.

In the first of two parts, Shiller reassesses the roles played by financial professionals and explains why they are perceived so negatively. One clear example is the CEO whose excessively high salaries have been prone to much criticism.

The author is a member of the Squam Lake Group (a nonpartisan, nonaffiliated group of fifteen academics who offer counsel on financial regulation) advised the government not to regulate the level of CEO compensation but thought that regulation of the structure of CEO compensation is necessary.

Investment managers play an essential role since they manage portfolios of shares in companies and bonds. They are basically paid to find the most profitable investments for their clients.

However, the biggest problem with investment managers is that they hide the risks they are taking and give the false impression they are doing very well. That is the reason, says Shiller, “one cannot merely allocate funds to the investment company that has the highest historic returns or Sharpe ratios or any other statistic… One must judge the integrity of the people who run the fund by the broad picture of their actions over time, and by other clues to their behavior. Character matters, and it is reflected in the reputation of certain firms, for better and worse”.

The constant evolution of banking has given birth to financial institutions that escape banking regulations. These so-called, “shadow banks” do not take deposits, yet they act like commercial banks. Shadow banks can obtain commercial securitized loans or mortgages which they re-sell to other investors, using securities as collateral. This financial system that included the now defunct Bear Stearns and Lehman Brothers, caused the severe financial crisis that began in 2007. Many experts want to put shadow banking activities under stronger regulation to prevent another similar crisis.

Mortgage lenders and securitizers were involved in the deals between the home buyer, the ultimate lender, and the government, that caused the collapse of the subprime mortgage securities market in the United States. People who wanted to buy a house were either given the wrong kind of mortgages or mortgages they could not afford to repay. Brokers, mortgage lenders or other deceitful financial representatives would persuade clients to buy large homes with adjustable-rate mortgages, without clearly informing them that the rates would go up and the houses would become unaffordable. But is Shiller right to call this merely “a failure to appreciate and manage risks”?

The trader who buys and sells on the stock exchange is often subject to harsh criticism. However markets and those who deal with them give us the opportunity to know the value of what is traded in the world.

Derivatives are also viewed with much hostility. Derivatives are in fact a financial product which stems from another market.

According to the author, the specialists who deal with the derivatives market are, in fact, involved in some of the most creative and sophisticated aspects of finance.

A derivatives market for example, is a forward market for a commodity in which a person can sign a contract to buy from another a commodity or a property for future delivery at a specified date at a specified price.

Derivatives were first mentioned by Aristotle (384-322 BCE), in his "Politics" text. Aristotle recounts how Thales gave earnest money, for the use of olive presses at an agreed rental rate for a later harvest. Thales committed himself to buy what we now call options on olives because he could later choose not to buy, and sacrifice his earnest money, if the value of olives fell instead of rising.

According to Aristotle’s story, the value of olives in fact went up as Thales had predicted and he made a lot of money when he rented out the olive presses at a more expensive price than the one he had originally paid. If disreputable sales practices for options still persist, such practices could be reduced if disinterested financial advice would be given the general public.

This expert advice should be given by financial advisers and lawyers. Shiller rightly points out that low-and middle-income people do not have adequate access to lawyers.

“This dearth affects them in numerous ways, including an inability to readily understand simple financial documents, like home mortgages or credit card contracts. The severe financial crisis that began in 2007 was made worse by the failure of most low- and middle-income people to get anything more than perfunctory legal and financial advice”.

Finance and the Good Society is an apology of financial capitalism and all the people involved in it. Despite rapid progress in information technology, we are still, more than ever, in need of financial experts.

“Finance” according to Shiller, “is a powerful tool because it has the ability to amass capital, pool information, and coordinate and incentivize people”. Finance plays a vital role in the lives of the rich people. The fortune they have amassed is not only due to their own efforts and talent but also to their uncanny ability to establish and manage huge organizations with many talented people.

In order to regulate and prevent the sleaziness inherent in finance, the author calls for the democratization of finance by improving the nature and extent of people’s participation in the financial system, increasing the awareness of fundamental information about the workings of the system.

Robert Shiller makes a bold but convincing plea to reform the present financial system and use its power for the benefit of society as a whole.