Tackling the challenges of governments as financial institutions

Inaugural MIT Center for Finance and Policy conference highlights need for financial research, education in public sector

September 23, 2014

MIT Sloan finance professor Deborah Lucas

Finance professor Deborah Lucas at the inaugural conference of the MIT Center for Finance and Policy

Governments not only regulate the private financial marketplace, they also own and operate some of the world’s largest financial institutions. Government agencies make trillions of dollars of loans, insure large and complex risks, and design new financial products. Yet their leaders often lack the analytical support and rigorous financial training of their peers in the private sector, and transparency is often lacking.

The MIT Center for Finance and Policy officially launched this month to address those gaps, along with other challenges facing financial policy makers.

“This is a big unmet need,” said Professor Deborah Lucas, director of the center. “To have an academic center devoted to the broad swath of government financial policies that have such an enormous effect on the allocation of capital and risk in the world economy.”

“What we want to do is to promote research that policymakers, practitioners, and informed citizens can turn to as an objective source of information when they’re thinking about these policy issues. That information often isn’t available now,” she said.

Research endeavors so far include, among others: the production of a world atlas of government financial institutions, an effort helmed by Lucas to catalog, compare, and evaluate governments’ financial involvement worldwide; a project led by Professor Andrew Lo to develop a dashboard that measures systemic financial risk; a study of the effects of algorithmic and high frequency trading, led by Professor Andrei Kirilenko; and a study of policies on retirement finance led by MIT Sloan professor and Nobel laureate Robert Merton.

Lo, Kirilenko, and Merton are all co-directors of the center.

Along with the research work, Lucas said there is also an educational mission for the center. In many cases, the center’s leaders say, financial problems could have been avoided, mitigated, or at least predicted had public sector workers had an education on par with that received by many private sector finance professionals.

“The idea is to provide the people who are working on finance within a government context with the same skillset as their peers in private industry,” Lucas said. “One reason you see a lack of finance education is because it’s tended to be a rather expensive education. And people going into the public sector may not even realize that finance is what they will need to know.”

At MIT Sloan, work at the center has already led to the creation of Kirilenko’s new course—Core Values, Regulation, and Compliance—as well as a student club on financial markets and policy.

The center began sponsoring events in October 2013, but officially launched Sept. 12-13 with the inaugural MIT Center for Finance and Policy Conference in Cambridge, Mass. More than 120 people attended the invite-only event, which featured discussions on the cost of government credit support, the costs of single-family mortgage insurance, and contagion in financial markets. Peter Fisher, senior director at BlackRock Investment Institute and a former undersecretary at the U.S. Department of the Treasury, gave a keynote talk.

The conference also included a panel discussion on improving government financial institutions, which addressed the need for government agencies to improve how they manage credit portfolios and monitor program risk levels over time. Panel members also discussed ways to raise red flags when there are problems in government credit programs.

The outlook was not entirely dire. “The move toward embracing risk management concepts across the federal government has been impressive in recent years,” said Doug Criscitello, a managing director at Chicago-based audit, tax, and advisory firm Grant Thornton and the former CFO of the U.S. Department of Housing and Urban Development. “We’ve seen the rise of independent risk management offices … that are housed outside the credit extension department.”

Lucas said she believes MIT’s depth in finance, economics, policy, and systems thinking make it the ideal place to study governments as the world’s largest and most complex financial institutions.

“I think an important reason that more academics haven’t taken on these issues—despite their importance—is that they are extremely complex,” she said. “Making progress takes a big investment in understanding institutions and laws and motivations. The problems are inherently interdisciplinary. And MIT is this great institution in terms of having the horsepower and energy to go after it and say ‘We can hit this question from a lot of different dimensions.’”