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Johns Hopkins UniversityArts and Sciences Magazine

A Sound Investment

Illustration © Timothy Cook

Ready for some good news (at last!) about our economic future? Look no further than the School of Arts and Sciences' innovative new Center for Financial Economics. Launched in 2007 and housed within the Department of Economics, the new center combines rigorous training in economics and finance and demonstrates how the two facets of the economy are integrated. In the lively discussion that follows, five faculty members who are key to the CFE tell why it was started and how it aims to equip tomorrow's leaders with the expertise they'll need to get us through—or ideally, avert—the world's next big financial crisis.

Is this a bad time to launch a Center for Financial Economics?

Greg Duffee: There's no wrong time to start the program. The faster it starts, the better. One of the issues that I face in the classroom is that students want to know what's going on right now. Turns out, no one actually knows. And students aren't terribly thrilled with that explanation. What you tell them is that they need to know fundamentals. They need to have a good grounding in economics. Most of the time, in non-crisis situations, they're patient. These days, they're a little more antsy. It definitely makes people show up and pay attention, and that's a good thing.

Jon Faust: It may simply be harder for a while to get the kind of career going that you'd like to have in finance. The important plus, from our standpoint, is that the current events strongly confirm the importance of teaching finance in the context of an economics department, where we intermingle financial tools with a broader understanding of how finance relates to the economy.


Can the program produce a new generation of leaders who can help us avoid the kind of mess we're in now?

Greg Duffee: What you need to have to avoid situations like we face now are people in the business world who understand that just because there hasn't been a crisis in the past five years, that doesn't mean there won't be one in the future. That there's no such thing as a free lunch. That if prices in financial markets look like they are great deals, maybe they're not.

In an economics department, that's taught from the day they walk in as freshmen. And the education in finance that we give them builds on that. Students who have a background in economics are not as likely to be fooled by current market conditions. More than anything else, I think, it'll give them a sense of caution when they're in the world of finance. As we see now, a sense of caution would have bought us a whole lot in the past few years.

Illustration © Timothy Cook

At a Glance:

The Center for Financial Economics

Launched: Fall 2007, within the Department of Economics
Dedicated Faculty: Three core faculty, including the Carl Christ and Louis J. Maccini professors, plus seven affiliated faculty
Director: Jon Faust
Coursework: macroeconomics, microeconomics, corporate finance,
and investments and portfolio management
Currently Offering: Undergraduate minor
Plans for the Future: To establish an undergraduate major and
PhD in financial economics

Jon Faust: This kind of training could help lead to a better, more stable financial world in the future. And that's exactly what happened after the Great Depression. There was an awful lot of study that led to a lot of thinking about how things should be done. We're hoping that we can be a part of that same sort of rethinking and retraining that followed the Great Depression.

Carl Christ: This centeris going to be based in a liberal arts program, and I think some understanding of history is important, as well as some understanding of the basic principles of economic theory. An understanding of some of the major mistakes that have been made in the history of the country is very useful.

Lou Maccini: The key principle in establishing the center was to give students the depth in both finance and economics that they would need to be well trained to think about problems in the financial world, but also give them breadth in history and in quantitative skills, and in writing and communication skills—which are extremely important in communicating these ideas to the public at large and to the people they work with.

The students who will come out of our financial economics minor and major (assuming we establish a major at some point), will be much better trained to deal with the kinds of problems that they face in this world.

Joe Harrington: There's also the other side of this—the government. One of the things we've learned here, obviously, is that markets don't work perfectly. There is a role for government regulation, and what economics delivers is an understanding of when it is that markets can be expected to function well and when they cannot. And then understanding, well, what exactly is the proper role for government in those instances?

Where do you see graduates of the CFE going?

Jon Faust: The first thing you might think of is a career in finance on Wall Street, or with a Wall Street kind of firm. Every business has to have people who understand finance. There's obviously a lot of work to be done rewriting financial regulations and the like, so people could go on perhaps to law school and contribute to the writing of regulations. And then we hope we get some folks who really catch the spark and become scholars of the area.

There are fascinating, important, and deep problems and issues here, and you can confront them in a very exciting career on Wall Street, in business, thinking about government policy, or even in academics.

Carl Christ: We don't need as many journalists as we need financial officers of companies, but we would certainly hope that from this program there would come a few eloquent people who can help to educate the public in general—educate people who read the news and read the analyses of the news that are put forth. People who are good at explaining what's going on.

The origins of the new center go back more than a decade, and there's been significant alumni support for starting it, hasn't there?

Lou Maccini: In the mid-1990s, the Career Center developed an idea for a day trip on Wall Street for undergraduates. It was clear that the students were ill-prepared for the presentations they were getting. So one of our alumni who has been extremely important and helpful to us, Chuck Clarvit, came up with the idea of starting this financial literacy program during Intersession.

Many alumni came back to make presentations for that. Both through the Intersession program and the Wall Street trip, I connected with a lot of our alumni, many of whom I had actually taught when they were undergraduates, and they were repeatedly saying to me: 'Why can't Hopkins develop an undergraduate program that has the principles of a liberal arts education but focuses on finance and economics?'

What happened from there?

Lou Maccini: In the period around 1999, the department was seriously interested in expanding so that we could have a bigger influence on research development and on teaching programs. The idea that the department coalesced around was to develop a Center for Financial Economics. It would have two goals. One is to create educational programs that would train students in finance and economics in the context of a liberal arts education, the details of which we already talked about.

And secondly, what we had observed at the time was that in the two prior decades, research methodologies in theory and empirical methods and finance and economics were converging. The two fields were naturally coming together, and there were even then lots of open questions. So we developed this proposal for a Center for Financial Economics. There were other [university] fundraising priorities on the table then, so I basically volunteered to lead the fundraising effort.

We created an advisory committee consisting of alumni and parents in the finance industry, to both help us in developing the academic programs and help with the fundraising. And they have been extremely important, in both respects. This has not been just a nominal committee. This has been a committee that's had a real impact on the development of the center.

Jon Faust: Now that we have a CFE, the board has largely transformed itself into the CFE's advisory board [see p. 23], and these folks have continued to make major contributions to how the center operates on an ongoing basis. At a time like this, when strange things are happening, getting that kind of perspective to help us guide the program has been extremely useful.

I should add that a number of the people have supported this because they have a deep respect for what the Economics Department has done at Hopkins for many, many decades, long before I got here. That's really exemplified by the fact that our donors have endowed two chaired professorships in the CFE and have chosen to name those chairs after Carl Christ and Lou Maccini because of the important role they played in their formation and training at Hopkins. I've heard from many of these alums about how much they value the education they got from Carl and Lou.

How has the evolution of the center affected the Department of Economics as a whole?

Joe Harrington: One very fortunate development has been how the recruiting for the center has dovetailed with recruiting within the department more broadly. We did not start out with any particular direction within financial economics because we wanted to recruit the best people, but the fact is a direction has emerged. With Jon Faust and Greg Duffee and other hires in the department, particularly Jonathan Wright [a leading scholar at the intersection of macroeconomics and econometrics, who comes to Hopkins from the Federal Reserve Board], we have come to focus on the interaction between macroeconomics and financial markets. And I think that's going to be very important—in teaching, but particularly from the research dimension.

So, very much complementary to the development of CFE has been this very strong group in macroeconomics. It's really one of the strongest in the country—and has that financial edge to it that looks at the interface of the aggregate economy and financial markets.

Carl Christ: There's another sense in which finance and economics have been moving together. Finance has in recent years started to use much more in the way of quantitative techniques. Econometrics is an area that uses statistical methods and theoretical ideas in economics and data to try to understand the real functioning of markets and situations. And this is something that has been a very strong part of the growth of the center.

So I think that we're in a very good position to take advantage of the fact that econometric methods and statistical methods are very useful in understanding many of these new derivatives, these new forms of assets and liabilities that have been constructed by people in the financial industry, some of which have led to so much grief.

With the new minor launched, what's next for the CFE? How do you see it evolving?

Greg Duffee: We hope one of our seniors is about to invent some brilliant idea to get fabulously wealthy, and in two years give us a lot of money (laughter). So that's the plan we're banking on right now.

Jon Faust: Down the road we would very much like to start a major and a more heavy emphasis in the graduate program.

Without a couple of additional faculty, we couldn't start a major because we don't have the breadth of topics in financial economics that we need to have a first-rate, Hopkins-quality major. And to hire more faculty, we need to do some fundraising. So for now, we're getting the center off the ground. We're having a great response of the undergraduates to the minor. As we bring in more faculty doing research in this area, grad students naturally gravitate to those kinds of areas, so we're going to be producing graduate students who are doing research in financial topics.

So the level of student interest in the new minor has been high?

Jon Faust: We held an open house in the fall to tell people that the minor was started and we had about 50 students who came. They were very enthusiastic.

Greg Duffee: I'm teaching Corporate Finance, which is one of the required courses in the minor, and when I was asked in the fall how many people should I allot to the class, I thought, well, probably 40 people are going to show up, so give me a room that can hold 60. So 40 people signed up ahead of time. I'm now up to 65. The registrar's office didn't let me go any larger because apparently the fire department would shut me down. They said next time perhaps you'll want to request a larger room.

Jon Faust: Greg's course is a newly offered course, and it's also a very challenging course with very technical prerequisites, and the fact that there is this extraordinary demand we take as a really strong sign.

What are a few of the big, exciting questions in the field right now that the courses in this program seek to investigate?

Jon Faust: When do markets work well and when do markets not work well? That's perhaps the umbrella question that covers all aspects of the [current] crisis. When do financial institutions play their roles relatively flawlessly? When do they completely cease to play those roles? That family of questions will keep scholars busy for the next 20 or 30 years, sorting through the lessons of the current situation.Carl Christ: One of the most difficult questions is: How do you design policies that can be helpful to people who—through no fault of their own—have gotten into some kind of financial difficulty, without at the same time encouraging other people to let down their guard and become financially disabled? This is the "moral hazard" problem that you've heard so much about nowadays. That's a really tough problem: Designing incentives so that people who can support themselves and do constructive things and make big contributions to the growth of the economy will do so and yet not leave in the dust people who are less fortunate through no fault of their own.

Lou Maccini: A major question now facing the Obama Administration and Congress is what to do about oversight and regulation by the government. And it's clear (at least as I see it) that if the markets are not working properly, then there needs to be some government institution that provides oversight and regulation of the financial institutions. And that's a very difficult trade-off. On the one hand, you want the institution to take enough of a role in oversight and regulation so it prevents firms from taking risks that create the possibility that would bring down the entire industry. But on the other hand, you don't want too much regulation and oversight so that it stifles innovation. And that's a tricky balance.

Dare to dream for a little bit and think about the CFE 10 or 15 years out... What would you like to see?

Greg Duffee: That's something to dream about. Finance...(laughter).

Actually, I have two tracks to my dream. One is that in 10 to 15 years, I want to think my former students are now in investment banks, they're in commercial banks, they're in government agencies, and they're at a level where they're not just taking orders from bosses. They're starting to move up. And that makes me sleep better at night, knowing the people we've trained can react appropriately when the next crisis inevitably happens. Whenever there's a financial crisis, you need people who can think through the implications of that crisis logically. And we want to give our students the tools to do that.

But I'm also thinking about our students who will not go to Wall Street, not go to government agencies, and they'll just be in companies around the world. Finance is at the center of the economic system. Every company needs to raise money. How does that actually work? How are financial mechanisms designed to make that happen? Everybody needs to manage their investment portfolio. How does this actually happen? What risks do we need to think about? Every one of our students is going to have a rigorous way to think about these questions, and that's going to make typical companies in Baltimore and in Washington, D.C., and in the state of Pennsylvania better off.

Jon Faust: On the research side, I hope that when we look back after 20 years, people believe that the scholars here have seriously contributed to pushing back the frontier to advancing our understanding of the ways in which finance can be understood and brought to improve the world around us.

Joe Harrington: Hopkins has produced some of the leaders on Wall Street in spite of the fact that we haven't had the type of program to specifically generate those people. I would hope that 10, 15 years from now, maybe even sooner, that we're attracting students to Hopkins who are interested in that career path. That we've established the reputation broadly throughout the U.S. that if you have an interest in that and you want to develop a rigorous background, bringing together finance and economics, Hopkins is the place to come.

Lou Maccini: One might correlate that with the reputation we do have as a pre-medical institution. Perhaps we'll become the pre-financial economics institution. (laughter)

Jon Faust: You do dream, Lou, don't you? (laughter)









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The Panel

Lou MacciniLouis J. Maccini, who led efforts to establish the Center for Financial Economics, joined the Hopkins economics faculty in 1969 and served as department chair from 1992 to 2007. His research focuses on theoretical and empirical work in macroeconomics. The endowed Louis J. Maccini Professorship has been named in his honor.

Carl ChristCarl Christ, professor emeritus of economics, taught at Johns Hopkins for more than four decades before retiring in 2005. The author of three books and the editor of one, he has published more than 40 articles in journals and books. His major research interests are econometric methods, monetary and fiscal policy, and the history of econometrics. The endowed Carl Christ Professorship has been named in his honor.

Jon FaustJon Faust, director of the CFE and the Louis J. Maccini Professor of Economics, joined the department in 2006. He is an accomplished scholar and a leader in the field of finance who brings nearly 20 years of experience in the Federal Reserve System, most recently as assistant director of international finance at the Federal Reserve Board.

Joseph HarringtonJoseph Harrington, Economics Department chairman and a member of the faculty at Johns Hopkins since 1984, is the author of two books, including Games, Strategies and Decision Making (2009). His research focuses on industrial organization, organizations, and microeconomic theory.

Gregory DuffeeGregory Duffee is the inaugural holder of the Carl Christ Professorship, of the Center for Financial Economics. A leader in empirical asset pricing, Duffee came to Hopkins from the Haas School of Business at the University of California, Berkeley in 2008.