Financialization

Perhaps one of the most important developments in the US economy has been what analysts refer to as its “financialization” reflected in the growing weight and significance of financial markets. This process has destroyed much economic value and undermined many lives over the past 4 years. But might the increased salience of the financial markets have some developmental meaning as well?

It is said that we live in a “risk society.” This means I think that individuals feel more at risk and that institutions are no longer designed to buffer individuals from risk. This is reflected in many developments; the decline of careers, the loss of the stable employment relationship, the declining legitimacy of cultural institutions such as marriage, and political parties, the obsolescence of the linear life course. Ironically, in an age of affluence, individuals feel more and more like “proletarians.” As these many changes suggest, the risk society is not built on developments in finance alone. The risk society appears to be one expression of post-industrialism writ large. And we can also see some developmental responses to the challenges posed by risk, for example the cultural ideal of the “entrepreneurial self.”

But another developmental response might be the emergence of  financial markets that allocate risk taking across stakeholders, across time and between sectors. I am drawn to the fact that one of the most important technical innovation in finance has been the ability to price risk- (as represented by the Black-Scholes equation) Pricing risk would in this sense appear to be one of the tools we need to live within a risk society. The financial market would then be seen as a sociotechnical system for managing risk.

Here is where the link between psychology and economics may be most relevant. The risk society creates substantial anxiety and we know that under conditions of chronic anxiety people are more liable to behave thoughtlessly, to take undue risks, to overlook risks, to imperil others, to engage in magical thinking Perhaps, the magical thinking that underlay the belief in Madoff, or the conviction that housing prices could never fall, is one consequences of this anxiety. The system that was supposed to help us manage risk- the financial market, --gave expression to our dysfunctional responses to risk. This suggests that the financial market, like any sociotechnical system must be designed. The risk manager must be managed.