The Ascent of the Prudent Man: State Trust Rules and the Origins of Financialization

In the years after World War II, an alliance of lawyers and bankers quietly rewrote the state laws governing trust investments, a campaign that transformed American capital markets. The changes focused on state-level rules that determined how trustees—who oversaw estates, surplus corporate capital, and blossoming pension funds—could invest funds entrusted to their care. Before the war, most states followed New York’s “legal list” model. Legislatures and courts created strict criteria for permissible investments. These tended to be safe, low-yielding assets, like municipal, state, and US bonds. By contrast, Massachusetts and a few outliers followed the “prudent man” rule, which enabled trustees to invest “how men of prudence, discretion and intelligence manage their own affairs.” Here, trustees could invest not only in safe government bonds, but in corporate bonds, stocks, and more exotic securities. Guided by the American Law Institute, lawyers encouraged wider adoption of the prudent man rule beginning in the 1930s. They were joined in the early 1940s by the American Bankers Association (whose member banks managed trust investments). Writing in The Virginia Law Review in 1948, future Supreme Court Justice Lewis F. Powell, Jr., argued that the prudent man rule was “the manifest trend of the times.” Over the 1940s and 1950s, the rule supplanted the legal list model in most states, with several consequences. First, prudent man rules elevated prudent men—trust lawyers, bankers, investment advisers—granting them substantial authority over socially consequential capital allocation decisions that had, under the legal list model, resided in state legislatures. In practice, trustees seized the opportunity to prioritize corporate over public investment. More broadly, the ideology of the prudent man led public and private investors to pursue maximal individual returns, to downplay systemic risk, and to reject public-spirited tradeoffs. The ascent of the prudent man was, in the last analysis, a formative vector of financialization.