Cultural implications of finance

Today I was thinking of the problems that can inhibit the evolution of social cooperation and why some societies could manage to remove the barriers to social collaboration while others are still struggling. In my view, openness in a society can open the door to more collaboration. One such social cooperation that can yield immense benefits to society manifest itself in people’s propensity to reveal and discuss their wealth. With an example, I want to explain how finance can contribute to the culture of openness and cooperation in a society.

If you need to get a loan form a bank, you will need to have collateral or securities to secure your loan. In a society with less developed financial system in which the availability of financial collateral is lower, it is more likely that borrowers would rely on the credit of another member of that society to get loans. For example, in Iran when you apply for a loan and you do not have collateral such as a house or a car, the bank requires you to find someone with relatively high credit rating (such as a government employee) to secure your loan. If the borrower defaults, the lender will have recourse to the guarantor’s (government employee’s) salary or assets (this is called surety or loan guarantee).

In this setting, lenders will depend on wealthy people to get loans and the well-to-do tend to hide their wealth for the fear that if they show off, a potential borrower will ask them to be the guarantor of his loan. On the contrary, in a country with higher availability of collateral, it is more likely for people to exhibit their wealth, because it is less likely that potential borrowers would ask them to be a guarantor by putting their credit (personal liability) as the security for those loans.

A financial system that allows for more monetization, securitizations, and then collateralization of economic values can address this problem. As we know, even in some countries the lender is allowed to put the collateral that he has acquired from the borrower as collateral for another loan that he wants to get from a third party; a practice called rehypothecation. It is telling how all these financial innovations and especially rehypothecation can contribute to the availability of credit in a society.

Hiding wealth can also be observed in societies in which the financial system is not sufficiently developed to offer investment vehicles to savers. An interesting example comes from Tyler Cowen who finds that in rural Guerrero State in Mexico there is a -%70 return on saving. Meaning that when people save and their family, friends or other relatives come to know about it, they come and borrow from the savers, because it is assumed that such savings are in the form of cash. In addition, the rate of default on such borrowings is very high. Therefore, there is no incentive to save in such a community. This is also a setting that will encourage members of the society to hide their wealth. And of course, hidden wealth, if not a road to perdition, is by no means the road to prosperity.