The Wisdom of Finance — M. Desai

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Desai, an HBS professor, writes a fun reflection on finance in this book. Exploring basic financial concepts and connecting them to situations that historical figures, both real and fictional, have faced, The Wisdom of Finance is

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

The book, by combining wonderfully diverse cultural references to create coherent — and at times, thought-provoking — perspectives on financial concepts was interesting to read. Though it was a subtle undercurrent that could have been more explicitly stated, the ultimate narrative of the book felt like an attempt to offer advice on navigating the uncertainty and accordant struggles of life.

One of Desai’s examples that particularly stood out to me was his story of Gerard Arpey’s actions during the bankruptcy proceedings and eventual merger of American Airlines (with US Airways). Board members wanted Arpey to declare C11 so they could renegotiate labor agreements. Arpey declined to do so on moral grounds and ended up resigning, in the process losing his (massive) pension package, for which the NYT offered him praise in an op-ed “A CEO’s Moral Stand”. But Desai comments:

Returning to American Airlines, Arpey seems to have considered himself a jewel, perfectly resolute with unshakable confidence in how to navigate the future, and a Kantian, with categorical rules of duty. But Nussbaum suggests that, while such absolutism is appealing, in fact it is a cop-out to not acknowledge all the competing obligations and struggle with the hard choices they present. In that sense, Horton may well be the plant struggling with all these competing obligations, wrestling in the muck of a bankruptcy proceeding, to figure out a way through the morass for a struggling airline. Perhaps Horton (Arpey’s replacement) is the CEO who more fittingly deserved the New York Times op-ed on his “moral stand.”

In organization:

  1. insurance — and how it’s about binding people together and mutualizing risk,

    1. If our own experiences are inherently limited, understanding the world requires incorporating the experiences and welfare of others. Reacting against the idea of social Darwinism, Peirce instead thought that the logic of insurance and sampling inexorably led to “that famous trio of Charity, Faith and Hope, which, in the estimation of St. Paul, are the finest and greatest of spiritual gifts.” We must embrace others to understand the world—the imperative of experience gathering demands it. For Peirce, insurance teaches us that experience and empathy are the key methods for dealing with the chaos of the world.

  2. options/diversification — asymmetric payoff, optionality, and prioritizing the negative beta assets (as in life),

    1. on Pride & Prejudice: With risks investigated and returns well established, Lizzy gets a second bite at the apple as Darcy presents the option yet again, and now Lizzy doesn’t hesitate. Instead of thinking of how much the loss of optionality would cost her, she “hits the bid.” She seems to have understood that risk management is not a goal in and of itself—but rather a set of strategies to ensure that one can take the big bets one needs to take to truly create value.

  3. valuation/alpha/beta — from the Parable of Talents

    1. The finance recipe for value creation can also easily be mapped to the way we think about our lives. The first step, “surpass the expected returns of your capital providers,” can be understood as saying that you should give more than you take; that is, return much more to the world than the considerable talents you’ve been given. The second step, “surpass those expectations for as long as you can,” is simply another way of saying never stop giving more than you take. Finally, “grow, so you can keep generating returns that are higher than your cost of capital” is just another way of saying that you should never stop investing in yourself and continue to grow. Postpone harvesting as long as you can—because the returns to investing in your efforts can be enormous.

  4. the principal-agent problem — especially interesting is how this is connected to parenting,

    1. Most parents, myself included, like to think of ourselves as dutiful agents on behalf of our children. We want them to be “all that they can be” and the “best versions of themselves.” When we speak like that, we are thinking of our children as our principals whom we are merely helping toward their own self-realization. But in practice I find that version of parenting pretty superficial. Inevitably, children become agents of our agendas as well. Sometimes, that happens innocently—the children become accustomed to choices that reflect parental preferences and then internalize those preferences. They’re much more likely to follow our professions and enjoy the things that we like, relative to some random draw from the general population. In fact, for many of us, the chief responsibility of parenting is the act of imprinting a set of values on our children—if that’s the case, who’s the agent and who’s the principal in parenting? Sometimes the reversal of principal and agent roles happens not so innocently or consciously. Many of us parent with the best of intentions but are guilty of projecting our unrealized ambitions or hopes onto our children. In those situations, we pretend to be agents of our children’s dreams and potential, but we are actually the principals trying to force our agents/children into a mold.

  5. m&a — like marriage

    1. To frame this in a more personal setting, consider your daily transportation needs. Putting aside mass transit, how can you fulfill those needs? Today, one can wake up in the morning and decide to use Uber and contract with them on the spot. There is no membership fee to Uber, and I can transact at will and immediately, or not—that’s a spot market transaction. Alternatively, I could enter into a twelve-month lease with an automobile dealer. I don’t own the car but I have the ability to use it at will within certain parameters, such as mileage limits. Finally, I could buy a car and have complete control of that asset. That continuum—from a spot market transaction to a contractual arrangement all the way to ownership of the asset—is the continuum that we all live on for everything we need from another party. Very roughly speaking, this continuum of spot markets (Uber) vs. contracts (car leases) vs. mergers (car ownership) corresponds in the personal relationship setting to Tinder vs. living together vs. marriage.

  6. leverage — taking commitments in life, both high- and low-leverage lifestyles can work out

    1. The central question facing borrowers—how do I access opportunities beyond my current resources?—is analogous to a question that inspires many of us: How do I live the fullest life? Much of what life has to offer requires the help of others. Being married, starting a family, engaging in meaningful friendships, working in organizations, starting a business are all value-generating activities that one simply can’t do alone.

    2. In offering advice to young people, Thomas Watson, the founder of IBM, said, “Don’t make friends who are comfortable to be with. Make friends who will force you to lever yourself up.” Commitments to smart and demanding people keep us from doing stupid things—we gain from those commitments. Leverage is not a zero-sum game.

    3. Grant Study: Vaillant’s other main interest is the power of relationships. “It is social aptitude,” he writes, “not intellectual brilliance or parental social class, that leads to successful aging.” Warm connections are necessary—and if not found in a mother or father, they can come from siblings, uncles, friends, mentors. The men’s relationships at age 47, he found, predicted late-life adjustment better than any other variable, except defenses [mechanisms for reacting to adversity]. Good sibling relationships seem especially powerful: 93 percent of the men who were thriving at age 65 had been close to a brother or sister when younger. In an interview in the March 2008 newsletter to the Grant Study subjects, Vaillant was asked, “What have you learned from the Grant Study men?” Vaillant’s response: “That the only thing that really matters in life are your relationships to other people.”

  7. bankruptcy — responsibility/forgiveness

    1. The hardest moments in life are about competing duties and obligations and how to navigate them—just as the essence of the bankruptcy decision is how to navigate the competing, and seemingly unsustainable, set of commitments that a company or an individual has made.

    2. To be a good human being is to have a kind of openness to the world, an ability to trust uncertain things beyond your own control that can lead you to be shattered in very extreme circumstances, in circumstances for which you are not yourself to blame. And I think that says something very important about the condition of the ethical life. That it is based on a trust in the uncertain, a willingness to be exposed. It’s based on being more like a plant than like a jewel, something rather fragile, but whose very particular beauty is inseparable from that fragility.

  8. why finance has and always has had a bad reputation.

    1. But underneath all of finance is this underlying idea: the pursuit of more will yield less and less. And any expectation other than that is not consistent with the ideas of finance. The game of accumulation is one that will leave one less and less satisfied as one gains more and more. To search for ever-greater satisfaction through accumulation is folly. That is the bedrock idea in finance. And it runs completely counter to how individuals in finance often act and how they are perceived.