Faculty members’ ideas make list of innovative concepts of 2008

What do the research topics of two Chicago finance professors and a Law School professor have in common? They are among the New York Times Magazine’s annual “Year in Ideas”—the 54 concepts that helped define 2008.

Anil Kashyap, the Edward Eagle Brown Professor in Economics and Finance at Chicago Booth, and Raghuram Rajan, the Eric J. Gleacher Distinguished Service Professor in Finance at Booth, were cited for their work on capital insurance for banks as a way to avoid the need for future taxpayer-financed bailouts.

Lior Strahilevitz, Professor and the Walter Mander Teaching Scholar in the Law School, was featured for his discussion of the relationship between privacy and antidiscrimination policies, an increasing concern in this age of instantaneous information.

One of only 10 economic and finance entries on this year’s list, Kashyap and Rajan proposed optional capital insurance for banks, provided by sovereign wealth funds, pension funds or market investors.

Their idea is appealing in the current economic climate.

“The fact that we are in the worst recession in a generation, and the financial crisis has played a big role, naturally generates a lot of interest,” said Kashyap. “Our paper tried to bring a new way of thinking about how regulation can be changed so that if another crisis occurs, we do not just bail out the banks without getting them to pay for some of the costs during good times.”

Kashyap and Rajan argue that new regulations that force banks to hold more capital are not the answer to the problems that the crisis unearthed. They illustrate their idea with a simple analogy: “In the case of a homeowner who faces a small probability of a storm that can cause $500,000 of damage, the most efficient solution is not for the homeowner to keep $500,000 in a cookie jar as an unconditional buffer stock—especially if the cookie jar is sometimes raided by the homeowner’s out-of-control children. Rather, a better approach is for the homeowner to buy an insurance policy that pays off only in the contingency—when it is needed, i.e. when the storm hits.”

The trick, of course, is to make sure the insurance really pays out when banks are hit, and much of their paper focuses on this issue.

Strahilevitz’s theory, nestled in the Magazine article between ideas on delaying kindergarten and investing locally, explores the intricate relationship between privacy and discrimination. In the Information Age, where people constantly worry about privacy issues, he suggests that too stringent privacy policies can actually lead to bias. When strangers have to make decisions with little or no information, they rely on observable characteristics like race, gender and age.

“The relationship between privacy and other important aspects of human flourishing is complex, and one of my research goals is to try to tease out the tradeoffs and interrelationships in a dispassionate way,” said Strahilevitz.

To ensure that decisions are not based on outward characteristics, individuals should welcome the publication of some personal reputation information. For example, disclosing information, such as criminal history, can reduce racial discrimination and could help in other areas where blanket discrimination occurs, such as the pricing of car insurance.

“Thanks to substantial recent innovation in the technology of reputation tracking, interactions between strangers are beginning to resemble the sorts of encounters more typical among residents of small towns or villages,” said Strahilevitz. “In a small town, there is little need to resort to statistical discrimination because residents typically have reasonably good information about the character of their peers.”