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Dan Finn asks: When is Self-interest Moral?

There has been much discussion in the Catholic blog-sphere concerning the  recent “Note on Financial Reform from the Pontifical Council on Justice and Peace.” (It will not surprise any of my readers that I strongly support the document and its stellar economic analysis). Over at Commonweal, Dan Finn asks “When is Self-Interest Moral? A Gap in Catholic Social Teaching.”  As a professor of theology and economics, Finn is in a unique position to examine “the Note” as well as to explain the intricacies of the ongoing financial crisis. In particular, Finn artfully explains the financial fraud, scandal of credit default swaps and what remains a major gap in Catholic social teaching – if and when self-interest itself can be moral.

There’s plenty here for us and the Wall Street occupiers to be angry about, but we might come to a better understanding of our moral situation by considering the character of the investments involved and how they grew out of helpful but complex financial instruments susceptible to unethical use.

Derivatives are financial instruments created for sale in order to hedge risk, something like insurance. And what’s insurance? You’ve probably taken out fire insurance on your house. With a monthly payment, you provide the security of knowing that should your house burn down, the insurance company will give you the money to rebuild. People in business often have good reason for a similar insurance policy. Consider an inventor who’s just come up with a great new idea in computer technology. He’s quite confident that his idea will work and is willing to borrow the $10 million necessary to get it started, but he has one big worry. If the computer industry tanks while he’s working on this, he’ll lose this investment. So he wants to take out an insurance policy to cover that possible calamity.

The inventor goes to a firm like American International Group (AIG) and works out a deal, typically called a credit default swap. Put simply, he agrees to pay the firm, say, $100,000 per year and in return the firm will pay him $10 million if the computer industry tanks. Of course, they need a clearer definition of what it means to “tank” and they might agree that the trigger for the payment will be the day that a highly respected computer firm—say, Intel—sees it stock price drop to 50 percent of what it is on the day the inventor signs the insurance contract. So in a sense, he is here betting against Intel, but in doing so he is “hedging” his own $10 million bet on his new invention.

One big difference between your fire insurance and the inventor’s credit default swap is that insurance regulation forbids me from also buying fire insurance on your home. The reason our government does this is what economists artfully call “moral hazard.” If I had fire insurance on your home, I might then be tempted to visit your home with a match and some gasoline while you were away on vacation. No such restrictions exist on credit default swaps. Anyone can take out this bet against Intel, or any other firm or business deal, in effect hoping that it will fail. (Of course, the inability of firms like AIG to pay off these insurance policies is what deepened the financial crisis, but that’s another story.)

Once hedge funds got used to making such bets against firms and business deals they projected to fail, some of them learned it would be helpful to watch the finance houses that were creating those instruments in order to learn about the riskiest deals even before they were sold. The finance firms creating these bundles of mortgages gained their usual percentage commission from the sale and garnered more business with the hedge funds by offering them advance notice. Court records now show that the hedge funds planning to bet against a package were at times even part of the discussion as to how to structure the package itself, to increase the likelihood of failure or sweeten the payoff should failure occur. This is the most serious of the SEC charges against the big finance firms: they deliberately kept their own clients in the dark about the risks those clients were about to take on.

To translate this into our fire-insurance example: not only were people taking out fire insurance on others’ homes, they were also working with the builder to design a home likely to catch fire due to bad wiring. The builder then sold the home without mentioning the fire hazard to the buyers. Of course, we have building codes to prevent such dangers, but there were no such rules for financial derivatives. The investment houses typically say that all their clients are big investors that bear the usual risks of market uncertainty. Gone completely is the trust that clients once presumed they would have in their investment broker.

Beyond the problem of fraud, the systemic threat caused by the very size of the finance industry calls for the kind of oversight recommended in the Vatican’s Note. The Financial Times estimated that, prior to the crisis, there were between $30 trillion and $50 trillion of loans in the world with hard assets behind them (assets like land, buildings, etc., that would be lost if the lender defaulted). They estimated that the derivatives markets (where there’s nothing behind the instrument besides another firm’s pledge to pay as required) was more than ten times that large. Industry groups have since estimated that figure to be $75 trillion. (Recall the total GDP of the United States was about $14 trillion at the time; the world’s about $55 trillion.) The potential for instability was great and has not been much reduced since. Yet the finance industry continues to resist regulation.

When the pontifical council calls for stronger international oversight of the financial system, it speaks from common sense. Still, while the council can identify fraud as immoral, it hasn’t tried to say anything about where one should draw the line between immoral excess and moral profit-seeking in the finance industry. And it can’t. For it has no analysis of the moral exercise of self-interest in markets. Nor do the social encyclicals from Leo XIII’s Rerum novarum in 1891 to Benedict XVI’s Caritas in veritate in 2009.

The problem is clear: The founder of Christianity preached love of neighbor and told us that the greatest love was to lay down one’s life for another; self-interest wasn’t among the virtues Jesus encouraged. Thomas Aquinas was suspicious of the merchant, whose work so often led to greed (and of course he relied on both Aristotle and Jesus here).

Finn goes on to point out that Catholic social teaching needs to seriously consider this question of when self-interest can be moral – if it ever hopes to bridge the very wide gap between the left and the right on economic justice. There are, as he notes, some places within economics to find helpful sources (in Adam Smith and Thorstein Veblen for example).

Today, the church has publicly responded to the problem of the dangerous power of finance, and has done a creditable job of policy analysis. Three centuries after Mandeville, it’s high time that the church develop an ethical analysis that will integrate proposals for systemic change for financial markets with an ethical analysis of daily economic life. Conservative Catholic columnist and commentator George Weigel is certainly wrong in calling the pontifical council’s note “rubbish, rubbish, rubbish”—and in his confidence that Pope Benedict disagrees with its contents—but the rift between left and right in Catholic social thought on the economy won’t be closed without Rome’s careful attention to the criteria for a moral assertion of self-interest.

I highly recommend reading Finn’s article in its entirety  – he gives much food for thought on  the Vatican’s ”Note,” the scope and ongoing nature of the financial crisis, and the future of Catholic social teaching.

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5 Comments

  1. Meghan–

    Thanks for posting about Dan’s wonderful article – he is doing stellar work in advancing the conversation in Catholic economic ethics beyond merely the systemic issues that end up “mirroring” the Dem/Repub battles. This is an especially important issue for moral theology, because in the “traditional” sense, there HAVE to be some kinds of moral rules (even if not absolutes) that guide individual behavior. And Dan is right that the question hinges on self-interest. Otherwise, we are left with a split tradition – on the one hand, Francis of Assisi and Dorothy Day, on the other, the rest of us just trying to avoid stealing. This (arguably) has been being overcome (in various ways) in marital sexuality over the last 30 years, and now it is high time we do it on the topic of money.

    If we don’t do this, we essentially leave ourselves open to the Weigel/Novak problem – that is, economics is a kind of purely secular, scientific sphere, the mechanics of which the Church should stay out of. The market has explained self-interest is good. Leave that Jesus stuff where it belongs, at the soup kitchen and in the family. Instead, we need a Christian counteranalysis of self-interest.

    Or so Dan claims. The only response I have here (pace MacIntyre) is that the problem is in fact different: the problem is the lack of a common good, such that we cannot construct self-interest correctly. The common good is inclusive of my good, but not in a merely aggregate way, but because participation in the common good is an aspect of my own good. Families (at their best) model this. The problem of affirming “self-interest” in these circumstances is that in fact, one’s own interest in inseparable from the flourishing of the family, right?

    But this leads to the key issue of scale, which would be the response against MacIntyre. “Common good” simply cannot operate in the fashion it operates for a family or a small village as it has to with the scale of enterprise we presently have. The current scale depends on markets, and finance. Thus it does actually depend on structures that presume a motivation of self-interest, but as a kind of shorthand for common good, and therefore it needs defining and limiting, as Dan points out in his article. In his Moral Ecology of Markets, Dan suggests that what is needed is a proper “market ecology” – that is, sets of circumstances within which self-interested decisions have positive ramifications for the whole system.

    Of course, we are incredibly distant from EITHER of these models!!

  2. I agree with you that the common good is inclusive of my good…but i think that it is also a matter of how we define self-interest. Dan’s point, as i take it, is that we need to answer the quesiton what is legitimate self-interest…..the definition of neo-classical economics MUST be rejected. But, I don’t know that no nuance and definition can be achieved…think in terms of Catholic human rights tradition. Pacem in terris adopts human rights language while adapting it.

    Not only is the common good useful here but also Jim Keenan’s focus on the virtue of fidelity. That we have different sets of responsibilities defined by different relationships — ie. my responsibilities to my mother are different than to other people’s mothers….but that doesn’t mean i have no responsibilities with regard “others.” By the same token – self-interest, for many people, often are more broad…they include one’s spouse, children, grandchildren.

    My dad thinks that a lot of this is actually addressed in Smith’s Theory of the Moral Sentiments (as the pre-req for wealth of nations) however I have yet to set aside the time to read both in their entirety (only read excerpts of both).

  3. Great response here. Overall point – we must develop an alternative to the neo-classical definition – is certainly THE most important. And your suggestion about how human rights language (which can be dangerously individualistic) can be “adopted and adapted” is a very nice parallel from the political sphere. (Not coincidentally, MacIntyre thinks that this adoption of human rights language is also a mistake, or at least it cannot really be successfully “adapted” because it imports various assumptions that are incompatible with a proper notion of the inherently social self. But he’s got an uphill battle against the encyclical tradition here!)

    The two other points you raise here are interesting. On Jim’s fidelity: I’m not quite sure how the language of “self-interest” can include other people in a genuinely “other” sense. That is, I can understand how one can have interests in others insofar as they are beneficial to the self. But obviously you/Jim mean something else by this – you mean something like willing their flourishing in itself is of value to the self. But is this really “self-interest” any more? Isn’t this recognizing that, as family, you share a common good because you all participate in the whole? I’m realizing that the relation between self-interest language and common good language is a key place for work.

    On Smith: I too am an excerpt person (why couldn’t he have written 200 page books?). And I do think the two works rightly belong together. The only challenge here is that, if I understand Moral Sentiments correctly, Smith is fundamentally “Humean” in his moral psychology – that is, he appeals to feeling (most importantly, sympathy) as a kind of counterbalance to the mechanisms of market. The perennial difficulty here that reason and feeling end up appearing a separate (and sometimes conflicting) “sources” for action and choice, rather than being integrated through the virtues. A virtue involves properly-ordered passions, or passions ordered according to practical reason. But if feeling is an independent source of morality, and reason names objective mechanisms out in the world, then the agent seems constantly faced with dilemmas that cannot be solved except by arbitrary choice. So I agree that the two need to go together to grasp Smith properly, and that if you read Wealth of Nations independently, you do not get what Smith actually thought. But I’m not sure if “what Smith actually thought” is actually a workable model for moral reasoning!

  4. David
    I think you’re right – about what is “self-interest” I think the biggest starting critique of the neo-classical model is that its vision of the rational, economic man self-interested is simply empirically WRONG – UNTRUE. people do not think that way – even the greediest, self-involved people rarely fit this model.

    I think what is interesting is the reality that even when people think they are making decisions “for” self-interest – it often isn’t just about INDIVIDUAL INTEREST – thats what i think is maybe an analogous connection to jim’s fidelity concept — that we need to develop overlapping layers/spheres for appropriate “interests” b/c I think there are many levels between ME and the UNIVERSAL COMMON GOOD was really my point…..

    As to Smith…I’m the daughter of an economic historian – whose first book was Economic Theory and Natural Philosophy: The Search for Natural Laws of Economy – so I am hiding behind – one day I think you and he would have a great conversation! haha.

    I think the trick is that it isn’t just a workable model for moral reasoning we need but a workable model for economic moral reasoning…and thats gotta be interdisciplinary. So if Smith doesn’t have the sense of civic virtue and common good dad claims…then where do we go? Amartya Sen and capabilities theory as applied to economics? Marx’s critique of capitalism? (While Marx doesn’t provide the needed model…..I don’t think we can do witout his analysis of capitalism….but where do we go after that?)

  5. Meg–

    I agree with the first two points totally, ESPECIALLY the first one. It seems obvious to me that homo economicus is an embarrassment, even to many economists, and what is tragic is that as long as the model is retain, the world actually GETS SHAPED to privilege this kind of rationality… which is deeply harmful to all of us.

    And your last point is exactly right in posing this question – I guess I agree that the real limitation for MacIntyre’s model is that it’s intrinsically not scalable. I suppose I would argue from Polanyi’s Great Transformation that what is ultimately needed is a proper kind of “socialism” – that is, where the means of productions for a community is ultimately understood somehow as shared. Robert Owen is really the underlying hero in Polanyi’s tale, and Owenite societies rest on basically a cooperative model. No bureaucratic, top-down command economies.

    But even here, the scale issue is key. Now cooperatives CAN be scaled up some – there are the examples in Europe like Mondragon and the Emilia-Romagna region of Italy. It seems to me that Benedict in CV is asking us to be creative about how such “non-corporate, non-state” enterprises could be realized.

    One last thing: the impasse here at least in part hangs on the question of whether direct participation is necessary for the development of (civic, economic, whatever) virtue. I think I presume that it is, and that one of our problems currently is structures of absentee ownership, absentee government, etc. Theoreies like Sen’s are of course a massive improvement on some of our current dysfunctions, but I worry that they are abstract. I would compare this to education – I think we all believe that faculty should actually have an active, participatory role in the governance of the institution as a whole, and (ideally, though not actually) through this participation, one comes to develop the proper virtues.

    I think “participation” can be carried off in many different ways, though it is probably hard to imagine how it could happen on the scale of either a federal government or a very large joint-stock corporation. But of course we have these now, and they are not going to disappear overnight… so, as Benedict says, we still need models for these, and the obvious one is still public-minded legislators that properly regulate large industry to orient it toward the common good (or at least protect common goods from being abused by industry). Thus, one huge issue (which Dan has raised in his work frequently) is the problem of corporate lobbying, which undermines this model.

    Good conversation… sorry I have strayed so far from self-interest on this comment!

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