Finance and the Good

Charles W. Calomiris

Fall 2023

Finance is a formal tool kit, mainly used for measuring the value of an asset and the risk of possible change in its value, and for studying how to organize companies, banks, portfolios, and exchanges to optimally realize the creation of wealth and the mitigation of risk. This assemblage of tools can gauge the desirability of various alternative choices that an individual, a company, a bank, an asset manager, or an exchange might make. Combining finance skills with control over resources creates what one might call "financial power," which is wielded by individuals, companies, banks, asset managers, central banks, exchanges, or governments. In and of itself, finance (like all tools) is neither good nor bad. The propriety of the exercise of financial power depends on the purposes it serves, and also on the legitimacy of the process that controls how that power is wielded.

Financial power, like all authority in our society, is a function of politics and law. The power of financial actors and institutions reflects the rules of the game in which they operate, which is determined by the government through laws and regulations and by regulatory bodies that oversee the exercise of financial power. If there are things we don't like about how or why financial power is exercised, that is not a fault of finance per se, but rather of the political decisions that make that exercise of power possible.

For financial power to serve the good, it must deliver good outcomes (such as material wealth), but it also must be part of a defensible process of private and public decision-making. Financial power, like all power, must be accountable for employing good processes used by individuals, firms, intermediaries, and government agencies in making decisions. Processes are judged by society and by individuals and, if greeted with approval, are endowed with legitimacy. Using finance tools to improve efficiency by coercing or tricking people to use their savings in a particular way, for example, would not be a defensible use of financial power because coercion and deceit are immoral. (They're often illegal, too.)

Can we define a short, useful list of what constitutes good outcomes and processes? One overarching good outcome is efficiency — not wasting resources by creating less value than is possible or by taking more risk than is necessary. A key feature of a good process is the accountability of those who wield power. Indeed, in a democracy, perhaps nothing is more important than that: We rely on accountability to make sure processes and outcomes express the will of those with ultimate power, the people. In addition to accountability, another facet of good process is its fairness. Although process fairness is hard to measure, it certainly includes whether all people have the right to access the benefits of the financial system, also known as financial inclusion.

While there may be other criteria for outcomes and processes that one might add to this short list, these serve as a useful metric for evaluating whether financial power is wielded in pursuit of the good. Put simply, good financial power achieves efficient outcomes, and follows an accountable and inclusive process.

Americans today may question whether financial power can serve any good. Recent bank failures and the 2007-2008 financial crisis — the effects of which still reverberate across our society, economy, and politics — have eroded trust in corporations, banks, and other financial and political institutions. The criteria of efficiency, accountability, and inclusion demonstrate how financial power can serve the good, and are therefore worth considering in more depth.


How do we measure those three aims, and how do we decide as a society whether we are achieving them? Logic and empirical evidence are the tools for evaluating whether those three purposes are being achieved in the wielding of financial power. In debating whether financial power is used in a way consistent with efficiency, accountability, and inclusion, everyone is entitled to an opinion about these objectives. But useful opinions in a conversation should be grounded in logic and verifiable facts, and should be expressed within an agreed format for debate. Such a dialogue recognizes what constitutes legitimate evidence, and what norms we respect for civil discourse.

My emphasis on accountability and inclusion, which are both key aspects of legitimacy, is only a clarification of Milton Friedman's classic analysis from 53 years ago about how finance achieves the good. Friedman focused on the efficiency of maximizing profit and the fiduciary responsibilities of agents to work for the benefit of principals, so long as they respected the law and broadly held cultural norms. The arguments that CEOs should not use coercion to increase value, even if it is legal, and should not engage in legal actions with the intent of limiting accountability to shareholders, were already implicit in Friedman's view. Using coercion does not respect widely accepted cultural standards, and seeking to avoid accountability is not in the interest of principals.

To illustrate this framework, consider the failures of Silicon Valley Bank (SVB) and Signature Bank in March from the perspective of efficiency, accountability, and inclusivity. Many of the criticisms of these banks as instruments of financial power are encompassed by these three criteria.

With respect to efficiency, it appears that SVB and Signature Bank did not create value or manage risk competently, which means they did not make efficient use of the resources entrusted to them. The use of financial power by government also deserves scrutiny. From an inclusion perspective, the apparent political influence wielded by SVB's and Signature Bank's customers and managers is especially troubling, and it provides the most plausible explanation for the bailout of uninsured depositors. Contrary to government pronouncements, avoiding losses to those banks' depositors could not conceivably have entailed any systemic consequence for the financial system or economy. And the actions undertaken had no clear effect in reducing systemic risk.

It's also important to note that no guarantees were offered to remaining banks' uninsured depositors. Indeed, when asked specifically about such guarantees, the secretary of the Treasury clarified that those uninsured deposits were not guaranteed by the action. Continuing withdrawals of uninsured deposits from other banks and the failure of First Republic occurred after those bailouts had been announced. Far better approaches exist for dealing with systemic risk, which remains a real problem given the weakness of many American banks.

Equal treatment under the law is a hallmark of a society governed by the rule of law. Our banking regulations undermine this principle by inviting abuses in the form of political favoritism. As I show below, SVB and Signature are not isolated examples: Favoritism is not a "bug" but rather a feature — albeit an unfortunate one — of American banking regulation, and one that undermines the legitimacy of our banking system.

From an accountability perspective, several questions arise from the SVB-Signature episode. Who will be held accountable for regulatory standards that are so poorly designed that they allow banks to hide large losses for many months? Will supervisors be fired for failing to intervene months earlier, given that the problems in the banks were predictable and observable to any examiner with rudimentary training? Their collapse exposes a broken regulatory and supervisory system grounded in a combination of bad thinking and politicized objectives, which in turn explains why banks like these two failed to create value or manage risk effectively. The socially costly abuse of financial power by value-destroying and risky banks, and the regulatory system that protects them from the discipline of the market (through deposit insurance and often additional bailouts) demand attention.

Unfortunately, attempts to end banks' abuse of their privileges have consistently failed. Powerful bankers, some even more powerful political constituencies allied with banks, and government officials favorable to both tend to regard demonstrated weaknesses in banks as inconvenient, routinely ignoring the social costs of avoiding needed reforms. Government officials in our democracy are able to avoid accountability for failing indefinitely to implement improvements. This partly reflects the fact that finance is a technical field, and most people are not skilled at assessing, or even following, discussions about value creation and risk. Thus, major challenges must be overcome to construct a regulatory system capable of ensuring that financial power is accountable.

Financial power now often fails to serve the good. And banks are not the only examples within our financial system of the problem. Other agents and intermediaries — corporate managers and asset managers, in particular — are also engaged in practices that abuse their power and subvert our democracy and its laws.

The problem has to do not only with violations of laws that are designed to protect property rights and ensure equal treatment. Beyond the question of legality, coercive processes cannot be legitimate in a society such as ours, governed economically by markets and politically by democracy. Coercion is employed in hidden ways to avoid accountability and to ensure unequal, disadvantaged treatment (which is the opposite of inclusion). Market or government outcomes are only legitimate if they occur in the context of the limited power we each exercise over one another as voluntary market participants, voters, or citizens. Compulsion is inimical to legitimacy.

I discuss below three important examples of financial power not serving the good, using the criteria of efficiency, accountability, and inclusion. This is largely a depressing tale. But several new trends raise the hope of reining in the worst of the abuses in corporate management and asset management, if not in banking.


Imagine you are operating a business and one morning you get a call from your banker explaining that he can no longer provide services to you. Your accounts at the bank must be closed immediately, despite the fact that your business is thriving and you have done nothing unlawful. When you call another banker to try to open a checking account, he turns you down. The bankers all tell you the same story: Bank regulators have told them that they should not serve you, and they must obey or face significant regulatory penalties. If this sounds like a fake-news story from a right-wing website, you would be mistaken. It was actually the Obama administration's "Operation Choke Point."

In 2011, the Federal Deposit Insurance Corporation (FDIC) warned banks of doing business with certain industries that engaged in "high-risk activities." Purveyors of "pornography" or "racist materials" may enjoy First Amendment rights, but not the right to a bank account. Gun and ammunition dealers were also targeted despite Americans' Second Amendment rights. Firms selling tobacco or lottery tickets were persona non grata, too. Payday lenders (those who offer short-term, high-interest loans that are generally due on the consumer's next payday) also were targeted based on the presumption that they prey on the poor. Thirty undesirable merchant categories were deemed to be high-risk activities. In 2012, the FDIC explained that having the wrong kinds of "risky" clients can produce "unsatisfactory Community Reinvestment Act ratings, compliance rating downgrades, restitution to consumers, and the pursuit of civil money penalties." Other regulatory guidelines pointed to difficulties banks with high "reputation risk" could have consummating acquisitions.

In 2014, a report by the House Committee on Oversight and Government Reform cited internal FDIC emails that voiced an intent to "take action against banks that facilitate payday lending" and "find a way to stop our banks from facilitating payday lending," which highlighted the FDIC's use of memoranda of understanding with banks and consent orders to implement its aims. The report found that "senior policymakers in FDIC headquarters oppose payday lending on personal grounds," and that the agency's campaign against payday lenders reflected "emotional intensity" and "personal moral judgments" rather than legitimate safety and soundness concerns. The agency's personal concerns and actions were "entirely outside of FDIC's mandate."

In September 2015, the inspector general of the FDIC issued a report substantiating the concerns raised by the House committee. Though the report largely denied any wrongdoing, it revealed that FDIC staff had been working closely with the Department of Justice to identify banks' relationships with payday lenders, which also (contrary to the FDIC's own financial interests and duties) served to heighten litigation risk for banks with payday-lending relationships.

Regulators who use invented risk measures to punish banks are engaging in a redundant practice. Banks are already in the business of gauging risk, and have the ability and incentive to avoid customer relationships that truly expose them to serious reputational danger. Regulators, by contrast, have shown themselves unskilled or unwilling to acknowledge risk — including the housing-finance risks leading up to the subprime crisis or the recent danger of collapse at SVB and Signature Bank. Studies indicate that this problem is pervasive. Operation Choke Point was not grounded in regulators' expertise, but rather their willingness to harass bank clients whose activities they disliked.

Note that there was never any legislation defining the 30 relevant industries as undesirable. Regulators also did not engage in formal rulemaking to set standards for what constituted undesirable behavior by a bank's client, or announce penalties for banks serving undesirables. Such legislation or formal rulemaking likely would have been defeated given the checks and balances inherent in congressional debate or formal regulation. Instead, regulators relied on "guidance" that requires no rulemaking, solicits no comments, entails no hearings, avoids defining violations, specifies no procedures for ascertaining violations, and defines no penalties for failing to heed the guidance.

Communications between regulators and banks are private; banks often aren't permitted to share them with outsiders. Regulators avoided public statements explicitly requiring banks to terminate undesirables but privately threatened banks with an array of punitive measures. They used secrecy to avoid accountability.

As Christopher DeMuth has documented, there has been a dramatic increase in reliance on regulatory guidance in recent years. Financial regulators find it particularly useful to rely on vaguely worded guidance and the veil of secrecy to maximize discretionary power, although doing so imposes unpredictable and discriminatory costs on banks and their customers.

The regulators' campaign against payday lenders produced a wave of bank-relationship terminations with dire consequences for the industry. These actions not only victimized firms but imposed significant costs on consumers by reducing competition. A large and one-sided academic literature finds that, at least as of 2017, payday lenders were serving customers' interests and performing competitively. Their presence reduced borrowing costs. If the prejudiced views of bureaucrats about payday lending had been subject to scrutiny during public debate, those perspectives would not have been able to withstand close examination.

From the standpoint of efficiency, payday lenders (and other industries victimized by Operation Choke Point) clearly were serving a constituency, creating value, and helping customers to manage risk. They were also a source of profit and presented no identifiable excessive risk to banks that allowed them to borrow or clear transactions through them. Even more obviously, the coercive abuse of regulatory and supervisory power that Operation Choke Point entailed is a stain on our democracy. And that intimidation was also associated with avoidance of accountability and the undermining of inclusion. From the standpoint of accountability, regulators and supervisors abused the secrecy of the examination process to avoid any responsibility for imposing their own preferences on banks. From the standpoint of inclusion, the rights of bankers, payday lenders, and their customers to have access to the financial system were all infringed.


Operation Choke Point was ended by the Trump administration's Justice Department and, as far as one can tell, has not been resurrected by the Biden administration. But as it was ending, it was replaced by a new version of the same policies. This time, lending restrictions were voluntarily enacted by banks that had decided to discriminate against clients in industries that they concluded were not serving the public interest. Activist organizations and bank employees, it turns out, no longer need the prodding or assistance of the Justice Department, the FDIC, or other regulators to discriminate against politically disfavored industries.

I first learned about all this as chief economist of the Office of the Comptroller of the Currency (OCC). The acting comptroller, Brian Brooks, asked his senior management team to consider the complaints voiced by the Alaskan congressional delegation against banks operating in their state. The lawmakers claimed banks were refusing to lend to firms involved in the fossil-fuels industry. The aggrieved parties included many small and medium-sized companies, some native tribe members interested in drilling for oil, and a wide range of constituents.

To investigate whether the phenomenon was pervasive and which banks were involved, the OCC circulated a survey asking national banks to explain whether they were discriminating against certain industries. While I am prevented by secrecy laws from disclosing the details of the survey responses here, I can say that I found them shocking. Some of the largest American banks not only admitted to discriminating against firms that they found politically unappealing, but revealed that they had instituted committees to review lending policies in light of their political preferences for borrowers. We found that the problem was systemic and encountered some evidence that the discrimination was being coordinated among the largest banks.

In the subsequent months, OCC senior leadership met frequently to discuss the laws that banks' discriminatory actions were violating, the economic costs and benefits that might come from disallowing such discrimination, the banks that any new regulations should be applied to, and how the rules should be crafted. The most obvious legal basis for disallowing the discrimination was Dodd-Frank's 2010 mandate that the banking system provide customers with "fair access." Banks that made politicized decisions to exclude some people from access to the financial system were clearly not permitting them to have fair access. This was particularly objectionable in light of the fact that, only a few years before, taxpayers had paid for a costly bailout of banks — including some of the largest banks, such as Citibank and Bank of America, which taxpayers had spent substantial funds supporting in 2008-2009. Some Americans who had helped to foot the bill for a bailout were now being told by those same banks that they were unworthy clients.

But don't businesses have the right to choose their customers? They do, but when government regulation creates a protected "utility" in the form of the current banking system (dominated by large banks that are sometimes the only game in town for borrowers), the large banks that dominate that system should be required to ensure fair access, just as electric companies shouldn't be able to decide which customers they provide electricity to. This is perhaps one of the reasons why the Dodd-Frank law, which codified bailout procedures for big banks in Title II, also makes it clear that banks have an obligation to provide fair access.

One wrinkle that shaped our thinking involved how to distinguish between economically justifiable discrimination in lending and politically motivated discrimination. At small banks, it is not feasible to serve all industries because they cannot afford to have more than a handful of loan officers, and the knowledge of these officers tends to be industry specific. The obvious solution — to avoid punishing legitimate sectoral specialization in lending — was to limit the application of the regulations to large banks. The economics-department staff at OCC engaged in research to determine what bank-size threshold was sufficiently high to ensure that affected banks would be able to lend to virtually all industries. This was not hard to ascertain. Data showed that sufficiently large banks historically have lent to all industries, and not just as passive participants in syndicated loans but rather as loan originators.

We also performed a county-by-county analysis of the locations of large banks to determine how limits on loan discrimination would affect competition in each county in the country. That research showed that preventing discrimination by the largest banks would have a significant positive effect in ensuring the competitiveness of lending in many counties throughout the country.

After studying the issue of lending discrimination, we settled on a proposed rule requiring only the largest banks to base lending decisions on economic criteria, and placing a burden on them to explain industrial "redlining" in which they depart from their historical practice of lending to all industries. This would have obvious social benefits (more competition and lower costs of borrowing in the loan market) at no social (or private) cost. Indeed, one could argue that the shareholders of the banks that the new regulation affected would be better off: By removing the politicized constraints imposed by bank managers that served their own political objectives at the expense of stockholders, the shareowners' banks would have more profitable and diversified loan portfolios. Our cost-benefit analysis could be accomplished quickly: There were no costs from adopting the rule, so long as it was restricted to sufficiently large banks.

This analysis led the OCC to finalize the rule fairly quickly after receiving and taking into account public comments. Unfortunately, the story does not have a happy ending. When Donald Trump lost the 2020 election, it was immediately clear that the acting comptroller would be replaced. Although the final rule was in hand, the new acting comptroller anticipated opposition from the incoming administration and decided not to "publish" it, which meant that it never took effect. To this day, large banks can act with impunity to discriminate against borrowers based on the perceived political incorrectness of their industry. Like with Operation Choke Point, the resulting inefficiency, lack of accountability, and exclusion continue to be unchallenged by regulators.

If bank employees, activist groups, and other citizens want to outlaw fossil fuels, pornography, gun sales, private prisons, payday lending, and other industries that they dislike, they should take those battles to their legislatures. But if they can't win those legislative fights, they turn instead to coercion and rely on the willingness of bank employees to violate their responsibilities as agents of stockholders to make loans based only on economic criteria. To the extent that these actors are successful in raising the costs of borrowing for some industries through backdoor tactics, they not only create economic costs for firms and banks. They also subvert accountability in our democracy by producing political outcomes that are not consistent with the popular will expressed through our government.


The broader phenomenon of employing Environmental, Social, and Governance (ESG) criteria in investing is closely related to the two examples above, in that it also concerns the abuse of power in the financial system. ESG standards now serve as a significant guide for investors' purchases of stock in firms or in portfolios of firms. Presumably, the point of ESG investing is to make investors' choices not depend entirely on expected return and risk (which, in finance theory, determine the value of a stock). In other words, ESG is intended to help investors find a way to give up value in their portfolio in order to achieve some other objective by empowering the corporations they finance and punishing those they do not.

Firms pursuing ESG objectives reduce shareholder value in response to outside pressure or employees' preferences; they are engaged in a tax-and-transfer scheme that taxes shareholders and subsidizes the pet ESG projects of employees or activists. If asset managers buy the shares of such companies, and are willing to pay more than the economic value of the shares in doing so, then they share the ESG tax cost, which is borne by the ultimate owners of the pension fund or mutual fund making that decision.

CEOs and asset managers never bear the cost of the ESG taxes they impose on others; shareholders of firms, pensioners, or mutual-fund shareowners are the ones who pay those costs. ESG preferences that choose to sacrifice value in pursuit of one of the three goals, therefore, violate the property rights of shareholders or fund participants. Managers of public companies or asset managers also fail to fulfill their fiduciary obligation to create value for shareholders. Although some law professors and others may give voice to so-called stakeholders' rights, CEOs of public companies and asset managers of pensions and mutual funds have only one fiduciary obligation under the law. Compromising that duty in favor of other objectives they personally favor is wrong.

If managers engage in ESG pursuits at the expense of value creation, what can we say about the outcomes such investments will produce? In sharp contrast to firms' cash flows and stocks' risks, which are routinely measured and forecast and which underlie traditional value maximization, ESG criteria do not exist as objective realities.

To illustrate that fact, consider a news story reporting that a firm has decided to forgo the use of coal in favor of natural gas. Is that a positive story about environmental consciousness? For some observers who focus on eliminating the use of carbon, it may be deserving of only a small positive grade. But for others who believe that fossil fuels will remain essential for the foreseeable future, and who recognize that natural gas has more favorable environmental consequences than coal, the story may receive high marks. Who is correct? Who can say? There is no correct score for this firm based on this story. One can come up with several additional examples for each of the ESG criteria. How much should staggered elections for directors on companies' boards harm firms' governance scores? Would adding another independent director to your board provide an offsetting positive score of equal magnitude?

The second most obvious thing to say about ESG criteria is that, even if each category could be quantified, investors have no objective way to aggregate across the three categories by attaching a weight to each. Thus, inferring any coherent investing aim against which to measure performance of a firm or an asset manager is not possible.

Because we cannot measure what constitutes an ESG achievement, and because we cannot weigh them against one another, there is no such thing as "ESG performance" as an objective reality. And furthermore, there is no way to gauge the trade-offs of ESG objectives against value maximization of stockholdings.

One thing is clear: If society decides to move away from the single objective of value maximization for evaluating CEOs or portfolio managers, and substitutes multiple and amorphous alternative measures, it would reduce the accountability of CEOs and asset managers. Having several vague goals makes it harder to criticize CEOs or asset managers for failing to maximize value. "But look at my great environmental rating according to MSCI!" says the CEO with the imploding stock value. "Forget investment returns, don't you want to save the whales?" says the asset manager who substantially underperforms the S&P 500. If these examples seem implausible to you, then you are not paying attention. The highly inefficient and incompetent SVB, for example, didn't bother to retain a chief risk officer for most of its last year. Nevertheless, it had an active program in ESG investing.

Thus, ESG investing not only results in lower efficiency due to a noisier process for allocating capital, it also reduces accountability for asset managers and CEOs, which means we tolerate even greater inefficiency going forward. From an inclusion standpoint, note that small investors are the ones hurt the most by this inefficiency and unaccountability: Rich people control their own money or invest in private-equity funds or hedge funds that are much more responsive to their preferences; the poorer and middle classes, by contrast, rely on pensions and mutual funds where they do not have much ability to rein in asset managers, and have only an indirect influence (through those managers) on CEOs.

The reduced accountability doesn't stop there. By claiming to address society's problems through investment-policy pressures, ESG takes the focus (and the heat!) off of government officials, who are supposed to be the agents responsible for crafting laws to implement our collective will about ESG principles. Instead, we now have a substitute for laws in the form of ill-defined investor preferences pushing firms to nebulous outcomes. These pressures lack legitimacy because they do not reflect electoral outcomes, and they are ineffective because they substitute amorphous do-gooder intentions for laws passed by elected officials that prohibit or regulate activities.

If you had to think of an idea dreamed up by our financial and political elite (corporate managers, asset managers, and lawmakers) to avoid accountability and make their lives easier at the expense of the rest of us, it would probably look a lot like ESG. But for those of us who prize wealth creation, risk management, accountability, a reliance on democratically elected government to express and realize our collective will, and the inclusion of small investors in the market so that their wealth can be invested in a way that promises returns similar to those of the rich, ESG is a disaster.

If there is no such thing as an overall ESG measure in any objective sense, how do the ESG ratings agencies who charge for them arrive at their composite scores? My former Ph.D. student, Ruoke Yang — now an economist at the Securities and Exchange Commission (SEC) who is taking a leading role in the agency's ESG-related rulemaking — answered that question in his dissertation, part of which was published last year. He discovered that better environmental ratings did not predict less negative news, fewer lawsuits, or fewer regulatory penalties related to environmental issues over the next year. The same is true for social criteria. Yang built a model and performed various empirical tests that documented a link between ESG ratings and "greenwashing": purposeful behavior by firms to influence their ratings through public relations.

Not only do ESG ratings not provide a clear metric, they are also easily susceptible to manipulation from the corporations that are being rated. When firms know that their nefarious activities are about to be revealed, they invest more in public relations to promote themselves as lovers of the environment or people. Because ratings are poorly constructed and easily influenced by public-relations stunts, greenwashing works well in improving firms' environmental scores, thereby absolving them of the consequences of their environmental sins.

By just counting the number of hard data points about a company's past behavior, Yang found that he could construct simple measures of ESG that were generally predictive out-of-sample for negative news, lawsuits, and regulatory penalties related to the three criteria. In contrast to the commercial ratings, his measures are poorly correlated with greenwashing. Of course, he doesn't claim to know how to weight each of those events within or across the ESG categories, so this should not be confused with providing an objective ESG rating. Instead, his research is useful mainly for debunking existing ratings.

Like Operation Choke Point and voluntary lending discrimination against certain industries, ESG investing is a road to hell paved with good intentions. But unlike the failure of the fair-access rule at the OCC, the SEC appears to be cracking down on the ESG mirage in two ways.

First, it is pressuring asset managers who advertise an ESG-friendly approach to explain exactly what they are doing and why it is meaningful. Second, the SEC's actions show that it understands that stockholders in firms, and investors in funds overseen by asset managers, have a right to expect their agents to represent their interests.

In Congress, a bipartisan majority in both houses recently voted under the Congressional Review Act to disallow a Labor Department rule that permits pension managers to make value-destroying ESG investments with impunity. President Biden used his first veto to preserve the rule, but it must still survive court challenges and future regulatory repeal. While the rule's future is unclear, a consensus is emerging that it is wrong to let elite CEOs and asset managers use their positions to impose their preferences at the expense of stockholders. If the shareholder principals have not instructed their agents to take ESG into account, then doing so is a violation of their agency responsibility to maximize value.

Recognizing the responsibility of agents to act in the interest of principals would be a positive development from the standpoint of efficiency, inclusion, and accountability. The ESG movement should clarify the meaning of its objectives being pursued by CEOs and asset managers and hold them accountable for following the wishes of principals. Doing so would rein in the waste that ESG allows, empower small investors, and ensure that agents are accountable.

ESG 2.0

Those developments, however, would not mean the end of ESG, but rather its transformation into something much more interesting and desirable. Call it ESG 2.0: a new way to empower consumer sovereignty that would also be consistent with value maximization.

Consumers are increasingly conscious about environmental risks, and many of them claim to express those preferences in the marketplace. For example, tenants in apartment buildings may reward landlords with higher rent if they install electric-car charging stations in their garages, or provide better access to public transportation, or rely on solar power, or implement green-energy designs that reduce electricity use. Firms now exist that certify such actions by landlords, which are used by prospective tenants who are green conscious when they search for a home.

One new startup that I am advising (Mina Analytics) is pioneering the creation of new databases that will help firms and asset managers figure out how consumers reward products for their green attributes. Empowered with that information, CEOs and asset managers can identify good business strategies that also create value for firms' stockholders. Those sorts of investment strategies are entirely consistent with efficiency and legitimacy (and therefore accountability and inclusion). They empower consumers to use their pocketbooks to define what sorts of products and services create value in the marketplace. And they put the burden back on government to identify and enact regulations consistent with the public interest.

Social media has magnified substantially the potential impact of such consumer choices. Young people in, say, downtown Austin can now communicate information and perhaps even coordinate decisions to support the greening of their apartment buildings. Participation in chat groups or social-media postings presumably is voluntary, which implies that this sort of coordination is also voluntary. If not taken too far in a coercive direction, social-media communications could be a powerful mechanism for enabling tenants to coordinate their interests and pay more for items of value to the community, helping to resolve the problem of free riding.


Financial power best serves the pursuit of the good if it focuses on three key criteria: efficiency (which is advanced when agents are incentivized to maximize value), accountability (which is aided by endowing each of them with measurable objectives that can be used to evaluate their performance), and inclusion (which involves equality of access to the financial system).

The good news from the perspective of financial-system design is that these three objectives tend to be complementary. If one builds a society (or financial system) with greater accountability for agents and greater inclusion, it will also tend to promote efficiency. Research has shown that banking systems that operate with greater financial depth (which are more efficient by various measures) also tend to be the ones that most promote financial inclusion. My own work has found that breakthrough financial technologies in the United States today similarly promise both enormous efficiency and inclusion gains, but are currently constrained by political forces. (Incumbent large banks in alliance with the Federal Reserve and activist organizations have a vested interest in preserving the less productive and less inclusive status quo.)

Achieving an efficient, inclusive, and accountable financial order is not a difficult technical problem involving complex trade-offs. The reason we continue to fall short is simple: Governments suffer from political-agency problems that are central to the inability of finance to function efficiently and fairly. We produce laws and regulatory structures for reasons other than the desire to achieve efficiency, inclusion, and accountability. As noted at the outset, financial power, like all power, is a political outcome, and thus depends on the coalition of interests able to dictate those outcomes. To do better, Americans must demand better, which means they must first understand why the financial system does not serve them as well as it could.

Charles W. Calomiris is dean of the Center for Economics, Politics, and History at the University of Austin.


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