The financial evaluation of reputation

This contribution by Frank Pasquale, Visiting Professor of Law (Spring 2009) at the Yale Law School is a reponse to the earlier contribution by Adam Arvidsson, entitled Ethics, Finance and Crisis.

In this text Adam stated:

“the present crisis was preceded by a boom that built essentially on the securitization of life conduct, where the ethics of everyday life became a direct foundation of value. Like in the 1920s, however, the crisis resulted form a lack of rational measurements of the value of such forms of life conduct.”

Now that we have a crisis, because of a mismatch between the evaluation and the underlying value, Adam suggest that, instead of ‘punishing’ the financiers on the output side, we work on the input side, i.. we recognize that this, however faulty, financial evaluation of the immaterial surplus value, nevertheless has a sense and function.

He proposed:

“In this sense financial markets serve to distribute a global surplus, which is essentially produced in common. What we need is a democratization of the standards of value. We need established, generally accepted standards for how to value forms of life conduct to underpin a rational valuation of the securities that they support. How can this be done? A centralized authority build around the state, like in the Fordist compromise is simply not possible. Furthermore, standards of life conduct are multifaceted, so that a rational measurement requires a multitude of points of view. This seems like a task for the collective intelligence of the networked multitude! My suggestion would be to use social media platforms that combine the functions of networking and rating.”

The above is the background to Frank Pasquale’s reaction, which follows here.

The numbers refer to notes that are added below.

Frank Pasquale:

I have some constructive comments regarding these ideas and some critical views. Parenthesized numbers refer to footnotes (which are usually points I’ve elaborated on my blog).

A) Building reputation systems for financial securities is a good idea, but will run into some legal barriers–at least in the US, the system I am most familiar with. The extant credit rating system for securities failed because it was totally nonaccountable and was paid for by the entities seeking ratings. They could shop around for the easiest grader. Many scholars are working on this problem.(1) But they will face raters who will say their “free speech” rights give them a constitutional right to be free of substantive regulation or liability for bad or manipulated ratings.(2)

In the US, the lawyer rating site Avvo (which set itself up to evaluate the life-conduct of lawyers) has successfully used the First Amendment to fend off all legal efforts to make it more accountable.(3) Doctors have pressured insurer-backed doctor-rating sites to be more transparent, but may not be able to get real regulation of them from government.

B) Nevertheless, some scholars have proposed a “Financial Products Safety Commission” to evaluate the value and safety of proposed financial arrangements, and that may be a good base for your proposal.(4) But you will also find resistance in the finance community to transparency in the terms of the “products” they offer. They consider trade secrecy here to be a big part of the “value” they create.(5) I find it hard to believe that this is a real business model, but perhaps secrecy contributed to the finance sector’s ability to grab about 35% of corporate profits in the US and UK as of 2005. I also worry about “distributed contributions” here–aren’t crowds subject to just the kind of irrational exuberance that led to the current crisis?

C) That’s one reason why I favor a far more dirigiste approach to the current crisis. As someone who works on health law, I find the model of government funding and influence there a model. US governmental funds account for between 43 and 60% of health spending in the US (depending on the accounting). That federal contribution is used as leverage to assure several progressive characteristics of an admittedly bad system. For example, federal funding to many hospitals is conditioned on their having emergency rooms, taking some Medicaid patients, etc. I am presently proposing a plan to condition federal subsidies in medical education (which are between $500,000 to $1,000,000 per medical student) on students’ binding commitment to take a certain percentage of their patient load as Medicare and Medicaid (i.e., public program) patients. This is essential in our mixed public/private system because many specialists now can get all the money they want from privately insured patients, and simply refuse to see those in public programs.

What does this have to do with the bailout? To me, we have to tell the banks that they only get bailout money if at least half the money goes to broadly defined social purposes–say, 25% to green energy investment, 20% to infrastructure (our roads and bridges are a mess), etc. If the finance sector gets as much public support as the health care sector, it ought to be as universalistic and moral in its aims.

Consider the alternative. As financier-turned-academic Paul Woolley has observed, “There is no economic merit in a sector that makes exceptional profits and devours capital and labour, and then justifies it on the grounds that you can get some ‘cash back.'”(6) There is a cozy revolving door relationship between academics, regulators, and tycoons in high finance. All were complicit in a parasitic reallocation of money from the real economy to speculative games designed to enhance cream-skimming at the top. I see no reason why a distributed assessment of the value of the various schemes these people cook up won’t be dominated by the same self-serving get-rich-quick ethos that has poisoned the global economy.(6.5) As G.A. Cohen has written (in a critique of Rawls entitled “Where the Action Is”), attitudes and ethics matter just as much as institutional structures.

We also need to look critically at where the funds for investing are coming from. As James Fallows has reported, “China’s government imposes an unbelievably high savings rate on its people.”(7) I fear that the more deeply one contemplates these flows of money, the more worried one has to be about a) their stability, b) their unfairness, and c) the authoritarian foundations (in China) of a go-go, free market economy in the developed world.(7.5)

Real wages in the US have declined over the past 7 years (even as productivity has gone up), and that gap has largely been “made up for” in borrowing. That borrowing is in turn largely predicated on the forced savings of tens of millions of Chinese. A mania for massive, fuel-inefficient SUVs in the US is financed by a country where, “on winter nights, thousands of people mass along the curbsides of major thoroughfares, enduring long waits and fighting their way onto hopelessly overcrowded public buses that then spend hours stuck on jammed roads.”

In conclusion, I am deeply skeptical of the finance sector and the types of flows of resources it enables. In the end, a stock price is only a prediction of future income–and who knows how much of the “value” of a given nation’s stock prices is simply an estimate of how much that nation’s corporations will be able to get its government to impose their will by force on other nations.(8)

But I also realize that the finance sector’s domination of political discourse here will probably prevent any truly fundamental reform of it.(9) So I welcome your proposal as a way of bringing some accountability to it.”


(1) see, and my comment on it

(2) see

(3) see

(4) see

(5) see

(6) see

(6.5) For example, I think there were pump & dump schemes on Yahoo! Finance. The speed with which financial information is used makes it more susceptible to gaming and manipulation than, say, a Wikipedia page.

(7) see

(7.5) see, e.g.,

(8) see, e.g., (“The United Fruit Company was frequently accused of bribing government officials in exchange for preferential treatment, exploiting its workers, contributing little by way of taxes to the countries in which it operated, and working ruthlessly to consolidate monopolies.”)

(9) see

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