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Katharina Pistor
Says More…

This week in Say More, PS talks with Katharina Pistor, Professor of Comparative Law at Columbia Law School and the author of The Code of Capital: How the Law Creates Wealth and Inequality.

Project Syndicate: You have lamented the excessive financialization of the economy, noting that “finance is both dumb and dangerous,” not least because it relies almost entirely on the price mechanism. How should we go about changing what you call a “bloated, fragile financial system that is in constant need of stewardship by central banks”?

Katharina Pistor: The price mechanism assumes that everything that matters can be reliably expressed in prices, and when it comes to corporate shares, for example, that the price reflects all relevant information about the company. Yet investors are interested only in the price at which they will be able to resell the shares in the future. They pay little attention to costs – social, environmental, or otherwise – that firms can shift to others. In fact, thanks to “limited liability,” investors are protected from incurring these costs directly.

The price mechanism is also used for assessing debt, but rarely the risk that debt poses to the financial system. Credit-based financial systems are inherently fragile, because they under-estimate the probability that future events will interfere with debt repayment. And yet, we actively encourage the use of debt, both by making interest tax-deductible and by offering implicit guarantees for the financial system as a whole.