Special | 56m 4s | Video has closed captioning.
The roots of the insurance industry in Europe; disasters like Hurricane Katrina expose problems in risk management; the history of hedge funds.
Aired: 07/07/09
Problems Playing Video? | Closed Captioning
THE MOST BASIC FINANCIAL IMPULSE OF ALL
IS TO SAVE FOR A RAINY DAY,
BECAUSE, AS WE'VE BEEN PAINFULLY REMINDED
BY THE RECENT MONTHS OF FINANCIAL TURMOIL,
THE FUTURE IS SO UNPREDICTABLE.
THE WORLD REALLY CAN BE A DANGEROUS PLACE.
NOT MANY OF US GET THROUGH LIFE WITHOUT A LITTLE BAD LUCK.
SOME OF US GET A LOT.
IT'S ALL ABOUT BEING IN THE WRONG PLACE
AT THE WRONG TIME,
LIKE NEW ORLEANS WHEN HURRICANE KATRINA HIT.
THE QUESTION IS,
HOW SHOULD WE DEAL WITH THE RISKS
AND UNCERTAINTIES OF THE FUTURE?
SHOULD THE ONUS BE ON THE INDIVIDUAL
TO ENSURE AGAINST DISASTER?
SHOULD WE BE ABLE TO RELY
ON THE VOLUNTARY CHARITY OF OUR FELLOW HUMAN BEINGS
WHEN CALAMITY STRIKES?
OR SHOULD WE BE ABLE TO COUNT ON THE STATE--
IN OTHER WORDS, THE COMPULSORY CONTRIBUTIONS
OF OUR FELLOW TAXPAYERS--
TO BAIL US OUT WHEN THE FLOOD COMES?
[THUNDER RUMBLES]
THAT'S A LONG WAY OF ASKING A SIMPLE QUESTION.
ARE YOU INSURED?
WE BRITISH CERTAINLY THINK WE ARE.
TODAY WE PAY A LARGER PROPORTION
OF OUR INCOME ON INSURANCE
THAN ANY OTHER PEOPLE IN THE WORLD.
IT'S REALLY RATHER ODD,
BECAUSE BRITAIN IS ONE OF THE SAFEST COUNTRIES ON EARTH.
THE STRUGGLE TO OVERCOME RISK HAS BEEN A CONSTANT THEME
OF THE HISTORY OF MONEY,
FROM THE INVENTION OF LIFE INSURANCE
BY 2 HARD-DRINKING SCOTS CLERGYMEN
TO THE RISE AND FALL OF THE WELFARE STATE
TO THE EXPLOSIVE GROWTH
OF HEDGE FUNDS AND THEIR MULTI-BILLIONAIRE OWNERS.
AT THE CORE OF OUR STRUGGLE WITH RISK
IS AN INSOLUBLE CONFLICT.
WE WANT TO BE FINANCIALLY SECURE,
AND SO WE YEARN FOR A PREDICTABLE WORLD.
BUT THE FUTURE ALWAYS SEEMS TO COME UP WITH NEW
AND UNPLEASANT WAYS TO TAKE US BY SURPRISE.
WE WANT CALCULABLE RISK.
WE'RE STUCK WITH RANDOM UNCERTAINTY.
Man: 15 MINUTES!
[MEN YELL]
15 MINUTES.
Announcer: FUNDING FOR "THE ASCENT OF MONEY"
WAS PROVIDED BY...
MY IDEA CREATED JOBS Woman, voice-over: MY IDEA CREATED JOBS FOR 2,000 PEOPLE.
Man, voice-over: MY IDEA WILL BRING RENEWABLE ENERGY TO EVERYONE.
Announcer: AN ENTREPRENEUR WITH AN IDEA CAN CHANGE THE WORLD.
I HAVE AN IDEA.
KAUFFMAN: THE FOUNDATION OF ENTREPRENEURSHIP.
T. ROWE PRICE IS PROUD TO SPONSOR "THE ASCENT OF MONEY," BECAUSE UNDERSTANDING THE CONNECTIONS
OF A COMPLEX GLOBAL ECONOMY
IS IMPORTANT TO US ALL.
T. ROWE PRICE: INVEST WITH CONFIDENCE.
Announcer: AND BY...
AND BY...
[MEN YELLING]
Man: 15 MINUTES.
Ferguson: WHEN HURRICANE KATRINA HIT NEW ORLEANS
IN THE LAST WEEK OF AUGUST 2005,
IT CAUSED DEATH AND DESTRUCTION.
YET, IT'S NOT A NATURAL CATASTROPHE
THAT NOW THREATENS THE SURVIVAL OF THE CITY.
THE REAL LESSON OF THE DISASTER IS ABOUT MONEY,
HOW THE RISK MANAGEMENT SYSTEM WE CALL INSURANCE
SIMPLY FAILED WHEN FACED WITH A CALAMITY ON THIS SCALE.
THE HURRICANE DIDN'T HIT NEW ORLEANS DIRECTLY.
THE MAIN FORCE OF THE STORM
PASSED TO THE NORTHEAST OF THE CITY.
BUT JUST AS THE RESIDENTS BREATHED A SIGH OF RELIEF,
THE REAL CATASTROPHE BEGAN.
THIS INDUSTRIAL CANAL LINKS LAKE PONTCHARTRAIN
TO THE MISSISSIPPI, AND AFTER THE HURRICANE,
THE HUGE STORM SURGE
RAISED THE WATER LEVEL IN THE CANAL SO HIGH
THAT IT BROKE THE LEVEE,
POURING UMPTEEN GALLONS OF THE LAKE OVER HERE
INTO THE NINTH WARD OF NEW ORLEANS.
JUST TO THE EAST OF THE NINTH WARD
IS ST. BERNARD,
A BLUE-COLLAR COMMUNITY OF HOMEOWNERS,
ALL--ON PAPER, AT LEAST-- COVERED BY PRIVATE INSURANCE.
COUNCILOR JOEY DIFATTA
REFUSED ADVICE TO LEAVE THE CITY,
STAYING PUT DURING THE STORM.
EVENTUALLY HE WAS FORCED
TO RETREAT TO THE ROOF OF THE TOWN HALL
AS THE WATERS KEPT RISING.
...COMPLEX, AND AS YOU CAN SEE,
THIS IS THE WATER LINE...
THAT'S THE WATER LINE.
THAT'S WHERE IT CAME UP TO.
THE WATER CAME IN THIS BUILDING,
AND 14 FEET OF WATER IN 15 MINUTES.
WOW.
FROM THE SECOND FLOOR OF THIS BUILDING,
I COULD SEE, COMING DOWN JUDGE PEREZ,
A WALL OF WATER.
IN THAT WALL OF WATER WAS DEBRIS--
CARS, VEHICLES, PIECES OF ROOFS--
AND THIS WALL OF WATER,-- YOU KNOW, YOU GUESSTIMATE--
HAD TO BE MAYBE 15 TO 20 FEET TALL.
AND MOVING FAST.
MOVING QUICKLY.
JUST COMING DOWN THIS BOULEVARD STREET
AND JUST TAKING EVERYTHING WITH IT AS IT WOULD COME.
THE WHOLE OF ST. BERNARD PARISH
WAS INUNDATED IN JUST 15 MINUTES.
ONLY 5 HOUSES OUT OF 26,000 WEREN'T FLOODED.
MORE THAN 2,000 PEOPLE WERE KILLED IN HURRICANE KATRINA
AND THE SUBSEQUENT FLOODING.
HERE IN ST. BERNARD PARISH,
148 PEOPLE LOST THEIR LIVES,
MOSTLY BECAUSE THEY BECAME TRAPPED IN THEIR HOUSES
AS THE FLOOD WATERS ROSE.
THE PAINTED SIGNS ON THESE ABANDONED HOUSES
SAY WHETHER DEAD BODIES WERE FOUND
AFTER THE FLOOD WATERS RECEDED,
A LITTLE BIT LIKE MEDIEVAL LONDON
IN THE TIME OF PLAGUE.
YET, 3 YEARS LATER, IT'S NOT FLOODING OR PLAGUE
THAT'S KILLING NEW ORLEANS.
A HARSH FINANCIAL REALITY HAS EMERGED.
PEOPLE CAN'T LIVE HERE ANYMORE
BECAUSE THEY CAN'T INSURE THEIR HOMES.
ONE MAN MADE IT HIS MISSION
TO SHOW THE LIMITS OF PRIVATE INSURANCE
WHEN IT COMES TO A REALLY BIG CRISIS.
HE'S FORMER NAVY PILOT RICHARD F. SCRUGGS,
ONE OF THOSE LAWYERS THAT ONLY AMERICA SEEMS TO PRODUCE.
DICKIE SCRUGGS TOOK $50 MILLION
OFF THE ASBESTOS INDUSTRY,
THEN $248 BILLION OFF TOBACCO COMPANIES
FOR FAILING TO WARN SMOKERS OF THE DANGER OF LUNG CANCER.
THIS KIND OF WORK HAS ITS REWARDS.
SCRUGGS' SHARE IN FEES ON THE TOBACCO CASE
WAS $1.4 BILLION.
SCRUGGS' LATEST TARGET HAS BEEN AMERICA'S INSURANCE COMPANIES.
HIS CLIENTS, HUNDREDS OF HOMEOWNERS
WHOSE HOUSES WERE DESTROYED BY KATRINA,
ARGUED THAT THE COMPANIES WERE REFUSING TO PAY UP
ON GENUINE CLAIMS,
A VIEW THE INSURERS DISPUTED.
THERE WAS A HOUSE THERE?
THERE WAS A HOUSE HERE AND A HOUSE NEXT TO IT
WHERE YOU SEE THE TRAILER.
SCRUGGS HAD A DOG OF HIS OWN IN THIS FIGHT.
HIS OWN HOME ON PASCAGOULA'S BEACH BOULEVARD
HERE ON THE MISSISSIPPI COAST
WAS SO BADLY DAMAGED BY KATRINA
THAT IT HAD TO BE DEMOLISHED.
THIS IS THE...
THE FRONT DOOR?
THIS IS THE FRONT DOOR RIGHT HERE,
THE EDGE OF THE SLAB, IF YOU WILL.
YOU WERE SLABBED...
WE WERE SLABBED.
IF YOU COULD FIX THE SYSTEM...
BUT I HAVE THE MEANS--
I'M FORTUNATE ENOUGH THAT I HAVE THE MEANS TO...
TO LOSE A HOUSE AND BUILD IT.
...TO LOSE A HOUSE AND BUILD IT BACK.
MOST PEOPLE HERE DON'T.
IF YOU HAD THE POWER TO CHANGE THE SYSTEM
SO THAT PEOPLE REALLY WERE INSURED, HOW WOULD YOU DO THAT?
IS THERE A WAY OF MAKING INSURANCE WORK AGAIN?
THERE IS, AND IT'S DISCLOSURE OF WHAT YOU'RE BUYING,
SO THAT YOU KNOW-- LIKE A DRUG.
THERE'S A BLACK BOX WARNING ON THERE.
"THIS IS WHAT IT DOES.
THIS IS WHAT YOU SHOULD WATCH OUT FOR."
AS OPPOSED TO THIS DEVICE
WHICH IS CALLED THE MODERN INSURANCE POLICY,
WHICH NO ONE CAN INTERPRET OR UNDERSTAND.
IT SEEMED AS IF THE INSURANCE COMPANIES
HAD BEEN WELL AND TRULY SCRUGGED.
ONE OF AMERICA'S BIGGEST INSURERS
SETTLED HUNDREDS OF CASES BROUGHT BY SCRUGGS
ON BEHALF OF CLIENTS WHOSE CLAIMS HAD BEEN TURNED DOWN.
BUT IN THIS BITTER HIGH-STAKES BATTLE,
THE INSURANCE COMPANIES HAD THE LAST LAUGH.
AFTER WINNING THE CASE,
SCRUGGS WAS CONVICTED D SENTENCED TO 5 YEARS
FOR ATTEMPTING TO BRIBE A JUDGE
AND INFLUENCE THE DISTRIBUTION OF LEGAL FEES.
AND THE BIG INSURANCE COMPANIES
RESPONDED TO THE WEIGHT OF POST-KATRINA CLAIMS
BY IN EFFECT DECLARING PARTS OF THE GULF COAST
A NO-HOME-INSURANCE ZONE.
TODAY, AS COUNCILOR JOEY DIFATTA HAS FOUND OUT,
INSURING A HOUSE IN THIS PART OF NEW ORLEANS
IS VIRTUALLY IMPOSSIBLE.
THEY CAN'T GET A MORTGAGE, EITHER.
THAT IS CORRECT.
THEY HAVE TO MAKE A CHOICE.
DO I BUILD A HOUSE HERE, OR DO I RELOCATE TO ANOTHER AREA
WHERE INSURANCE MAY BE A LITTLE BIT CHEAPER AND I CAN AFFORD IT?
SO THAT IS HURTING OUR COMMUNITY.
IT'S TAKING OUR PEOPLE AWAY--
THE NUCLEUS OF THIS PARISH-- AND PULLING THEM AWAY.
THREE YEARS AFTER DISASTER STRUCK,
ST. BERNARD PARISH HAS ONLY 1/3
OF ITS PRE-KATRINA POPULATION.
[THUNDER RUMBLES]
OF COURSE, LIFE HAS ALWAYS BEEN DANGEROUS.
THE REAL LESSON OF KATRINA OR ANY BIG DISASTER
IS THAT EVEN WHEN WE THINK WE'RE PROTECTED AGAINST RISK,
SOMETIMES IT TURNS OUT WE'RE NOT.
EVEN MAKING QUITE MODEST INSURANCE CLAIMS
CAN SEEM MORE TROUBLE THAN IT'S WORTH.
IT LEAVES YOU WONDERING WHY WE BOTHER SPENDING SO MUCH
ON INSURANCE POLICIES EVERY YEAR.
WHERE DID THIS STRANGE HABIT COME FROM?
SAVING UP FOR THE PROVERBIAL RAINY DAY
IS THE FIRST PRINCIPLE OF INSURANCE,
BUT THE TRICK IS KNOWING WHAT TO DO WITH YOUR SAVINGS,
SO THAT, UNLIKE IN NEW ORLEANS AFTER KATRINA,
THEY'RE THERE IN THE KITTY WHEN YOU REALLY NEED THEM.
BUT TO DO THAT, YOU NEED TO BE MORE THAN USUALLY CANNY,
AND THAT GIVES US A VALUABLE CLUE
AS TO WHERE THE HISTORY OF MODERN INSURANCE HAS ITS ORIGINS.
WHERE ELSE BUT IN BONNY, CANNY SCOTLAND?
[BELLS CHIMING]
THEY SAY THE SCOTS ARE A PESSIMISTIC PEOPLE.
MAYBE IT'S THE WEATHER, ALL THOSE HUNDREDS OF RAINY DAYS.
MAYBE IT'S THE ENDLESS YEARS OF SPORTING DISAPPOINTMENT.
OR MAYBE IT WAS THE CALVINISM WE PICKED UP
AT THE TIME OF THE REFORMATION.
CERTAINLY, IT'S 2 CHURCH OF SCOTLAND MINISTERS
WHO DESERVE THE CREDIT
FOR INVENTING THE FIRST TRUE INSURANCE FUND BACK IN 1744
AND FATHERING A MULTI-BILLION-POUND INDUSTRY.
THE COURTYARD OF GREYFRIARS
IS BEST KNOWN FOR THE GRAVE ROBBERS,
THE RESURRECTION MEN WHO CAME HERE
IN THE LATE 18th CENTURY
TO SUPPLY THE MEDICAL SCHOOL AT EDINBURGH UNIVERSITY
WITH CORPSES FOR DISSECTION.
BUT GREYFRIARS' LASTING IMPORTANCE COMES
FROM THE WORK OF THE MINISTER HERE, ROBERT WALLACE,
AND HIS FRIEND, ALEXANDER WEBSTER.
IT'S SOMEHOW APPROPRIATE THAT IT WAS SCOTTISH MINISTERS
WHO INVENTED MODERN INSURANCE.
AFTER ALL, WE TEND TO THINK OF THEM
AS THE EMBODIMENT OF PRUDENCE AND THRIFT
WEIGHED DOWN WITH AN ANTICIPATION
OF IMPENDING DIVINE RETRIBUTION FOR EVERY TINY TRANSGRESSION.
BUT IN FACT, ROBERT WALLACE WAS A HARD DRINKER
AS WELL AS A MATHEMATICAL PRODIGY
WHO LIKED NOTHING BETTER THAN KNOCKING BACK MAGNUMS OF CLARET
WITH HIS BIBULOUS BUDDIES.
WALLACE AND WEBSTER WERE UNHAPPY AT THE WAY
THE WIDOWS AND CHILDREN OF THEIR FELLOW CLERGYMEN
WERE TREATED WHEN THE GRIM REAPER STRUCK.
THEY OFTEN FOUND THEMSELVES HOMELESS AND PENNILESS.
THE PLAN WALLACE AND WEBSTER CAME UP WITH WAS INGENIOUS--
THE FIRST TRUE INSURANCE FUND IN HISTORY.
THESE ARE SOME OF THE VOLUMINOUS CALCULATIONS
THAT ROBERT WALLACE DID,
NOW HOUSED AT THE NATIONAL ARCHIVES OF SCOTLAND,
AND YOU CAN SEE HOW HE RAN THE NUMBERS OVER AND OVER AGAIN,
MAKING VERY CAREFUL ASSUMPTIONS ABOUT THE MAXIMUM NUMBER
OF WIDOWS AND ORPHANS THAT WOULD HAVE TO BE PROVIDED FOR.
THE KEY POINT, HOWEVER, WAS THAT FROM NOW ON,
MINISTERS WOULDN'T JUST PAY MONEY IN
THAT WOULD BE PAID OUT WHEN ONE OF THEIR NUMBER DIED.
RATHER, THEY WOULD PAY PREMIUMS
THAT WOULD BE USED TO CREATE A FUND,
AND THE FUND WOULD THEN BE INVESTED FOR PROFITABLE PURPOSES.
THE WIDOWS AND ORPHANS HENCEFORTH WOULD BE PAID
OUT OF THE RETURNS ON THAT MONEY,
LEAVING THE PREMIUMS TO ACCUMULATE.
ALL THAT WAS REQUIRED FOR THE SCHEME TO WORK
WAS AN ACCURATE PROJECTION OF HOW MANY WIDOWS AND ORPHANS
THERE WOULD LIKELY BE IN THE FUTURE,
A CALCULATION WHICH WALLACE AND WEBSTER MADE
WITH EXTRAORDINARY PRECISION.
THE CREATION OF THE SCOTTISH MINISTERS WIDOWS FUND
WAS A MILESTONE IN FINANCIAL HISTORY,
FOR IT PROVIDED A MODEL NOT JUST FOR SCOTTISH CLERGYMEN
BUT FOR EVERYONE WHO ASPIRED
TO PROVIDE FOR LIFE'S EVENTUALITIES.
BY 1815, THE PRINCIPLE OF INSURANCE
WAS SUFFICIENTLY WIDESPREAD
TO BE ADOPTED FOR THE WIDOWS OF MEN
WHO LOST THEIR LIVES FIGHTING AGAINST NAPOLEON.
AT THE BATTLE OF WATERLOO, YOUR CHANCES OF GETTING KILLED
WERE UP TO 1 IN 4,
BUT AT LEAST IF YOU'D TAKEN OUT INSURANCE,
YOU HAD THE CONSOLATION OF KNOWING
THAT YOUR WIFE AND CHILDREN WOULDN'T BE THROWN OUT ONTO THE STREET.
GIVE A WHOLE NEW MEANING TO THE PHRASE, "TAKE COVER."
THE SCOTTISH MINISTERS FUND GREW
INTO THE WORLD-FAMOUS SCOTTISH WIDOWS.
EVEN NOVELISTS, NOT RENOWNED FOR THEIR FINANCIAL PRUDENCE,
COULD JOIN.
WALTER SCOTT TOOK OUT A POLICY IN 1826
TO REASSURE HIS CREDITORS
THAT THEY'D BE PAID IN THE EVENT OF HIS DEATH.
BY THE MID-19th CENTURY, BEING INSURED
WAS AS MUCH A BADGE OF RESPECTABILITY
AS GOING TO CHURCH ON SUNDAY.
WHAT NO ONE ANTICIPATED BACK IN 1744
WAS THAT THE CAREFUL CALCULATIONS OF 2 SCOTTISH MINISTERS
WOULD GROW INTO TODAY'S HUGE INSURANCE INDUSTRY.
AS ROBERT WALLACE UNDERSTOOD 250 YEARS AGO,
SIZE MATTERS IN INSURANCE,
BECAUSE THE MORE PEOPLE ARE PAYING INTO A FUND,
THE EASIER IT BECOMES, BY THE LAW OF AVERAGES,
TO PREDICT HOW MUCH WILL HAVE TO BE PAID OUT EACH YEAR.
ALTHOUGH NO INDIVIDUAL'S DATE OF DEATH CAN BE KNOWN IN ADVANCE,
ACTUARIES CAN CALCULATE THE LIKELY LIFE EXPECTANCY
OF A LARGE GROUP OF INDIVIDUALS
WITH QUITE ASTONISHING PRECISION.
IN OTHER WORDS,
INSURANCE IS ALL ABOUT TRYING TO COPE
WITH THE RISKS OF THE FUTURE,
IF, THAT IS, YOU'RE INSURED IN THE FIRST PLACE.
NO MATTER HOW MANY PRIVATE FUNDS
LIKE SCOTTISH WIDOWS WERE SET UP,
THERE WERE ALWAYS GOING TO BE PEOPLE
BEYOND THE REACH OF INSURANCE
WHO WERE EITHER TOO POOR OR TOO FECKLESS
TO SAVE FOR THAT RAINY DAY.
THE LOT OF THE POOR WAS ONCE A PRETTY HARSH ONE--
EITHER DEPENDENCE ON PRIVATE CHARITY
OR THE HARSH REGIME OF THE WORKHOUSE,
LIKE THIS TYPICALLY AUSTERE ONE HERE
IN THE HEART OF EDINBURGH.
YET, BY THE 1880s, PEOPLE BEGAN TO FEEL
THAT LIFE'S LOSERS SOMEHOW DESERVED BETTER.
THE SEED WAS PLANTED
OF AN ENTIRELY NEW APPROACH TO RISK,
A SEED THAT WOULD ULTIMATELY SPROUT
INTO THE MODERN WELFARE STATE.
THIS STATE SYSTEM OF INSURANCE
WAS DESIGNED TO EXPLOIT THE ULTIMATE ECONOMY OF SCALE
BY COVERING LITERALLY EVERY CITIZEN
FROM THE CRADLE TO THE GRAVE.
YET, WHILE WE TEND TO THINK OF THE WELFARE STATE
AS A BRITISH INVENTION,
IN FACT, THE WORLD'S FIRST WELFARE SUPERPOWER WAS JAPAN.
DISASTER JUST KEPT STRIKING JAPAN
IN THE FIRST HALF OF THE 20th CENTURY.
IN 1923,
A HUGE EARTHQUAKE DEVASTATED TOKYO.
AS IN NEW ORLEANS,
MANY PRIVATE INSURANCE POLICIES TURNED OUT TO BE WORTH
LITTLE MORE THAN THE PAPER THEY WERE PRINTED ON.
A NEW IDEA BEGAN TO EMERGE IN JAPAN--
THAT THE STATE SHOULD TAKE CARE OF RISK.
BUT THIS WAS TO BE STATE PROTECTION
ALLIED WITH IMPERIAL AMBITION.
THE JAPANESE SET UP A WELFARE STATE...
...AND THEY DID IT TO PROMOTE WARFARE.
IT WAS THE MID-20th CENTURY STATE'S INSATIABLE APPETITE
FOR ABLE-BODIED YOUNG SOLDIERS AND WORKERS,
NOT SOME KIND OF BLEEDING HEART ALTRUISM,
THAT INSPIRED THE RISE OF WELFARE.
STATE HEALTHCARE WOULD ENSURE A FITTER POPULACE
AND A STEADY SUPPLY OF ABLE-BODIED RECRUITS
TO THE EMPEROR'S ARMED FORCES
AND DELIVER HIM AN EMPIRE.
THE WARTIME SLOGAN "ALL PEOPLE ARE SOLDIERS"
WAS ADAPTED TO BECOME
"ALL PEOPLE SHOULD HAVE INSURANCE."
THE ONLY PROBLEM WAS THAT JAPAN HAD GONE TO WAR
WITH THE WORLD'S ECONOMIC COLOSSUS,
THE UNITED STATES.
JAPAN'S WARFARE STATE PROVED TO BE A MASSIVE MISTAKE.
QUITE APART FROM THE NEARLY 3 MILLION LIVES LOST
IN JAPAN'S DOOMED BID FOR EMPIRE,
BY 1945, THE VALUE OF JAPAN'S ENTIRE CAPITAL STOCK
SEEMED TO HAVE BEEN REDUCED TO ZERO BY AMERICAN BOMBERS.
CITIES BUILT LARGELY OUT OF WOOD WERE INCINERATED.
NEARLY 1/3 OF THE URBAN POPULATION
LOST THEIR HOMES.
PRACTICALLY THE ONLY CITY TO SURVIVE INTACT WAS KYOTO,
THE FORMER IMPERIAL CAPITAL.
1945 MAY HAVE SEEN THE END OF THE JAPANESE WARFARE STATE,
BUT IT WASN'T THE END OF THE JAPANESE EXPERIMENT
WITH STATE-SPONSORED WELFARE.
IN JAPAN, AS IN MOST COMPETENT COUNTRIES, THE LESSON WAS CLEAR.
THE WORLD WAS JUST TOO DANGEROUS A PLACE
FOR PRIVATE INSURANCE MARKETS TO COPE WITH.
BUT WITH THE BEST WILL IN THE WORLD,
PEOPLE COULDN'T BE EXPECTED TO INSURE THEMSELVES
AGAINST THE U.S. AIR FORCE.
THE ANSWER PRACTICALLY EVERYWHERE WAS THE SAME--
FOR GOVERNMENT TO STEP IN,
IN EFFECT, TO NATIONALIZE RISK.
PERHAPS THE MOST FAMILIAR SYSTEM OF WELFARE
FROM THE CRADLE TO THE GRAVE
ALSO BORN IN THE RUINS OF WAR
WAS DEVISED BY THE BRITISH ECONOMIST
WILLIAM BEVERIDGE.
WHEN THE JAPANESE CAME UP WITH
THEIR OWN COMPREHENSIVE WELFARE SYSTEM IN OCTOBER 1947,
THEIR ADVISORY COMMITTEE ON SOCIAL SECURITY
RECOMMENDED WHAT AMOUNTED TO BEVERIDGI NO NIHON-BAN--
BEVERIDGE FOR THE JAPANESE.
AND YET, THEY WENT EVEN FURTHER THAN BEVERIDGE HAD INTENDED,
AS THIS COPY OF THEIR REPORT HERE
IN THE LIBRARY OF THE JAPANESE NATIONAL PARLIAMENT MAKES CLEAR.
IT CALLED ON THE GOVERNMENT
TO PROVIDE AGAINST EVERY CAUSE OF POVERTY.
SICKNESS AND INJURY, DISABILITY,
DEATH, CHILDBIRTH, LARGE FAMILIES,
OLD AGE AND UNEMPLOYMENT.
WHATEVER THE REASON, THE NEEDY WOULD BE GUARANTEED
THE MINIMUM STANDARD OF LIVING BY NATIONAL ASSISTANCE.
[MONKS CHANTING]
FROM NOW ON,
THE JAPANESE WOULD NO LONGER HAVE TO RELY ON THE BENEVOLENCE
OF A FEUDAL LORD OR THE LUCK OF THE GODS.
THE WELFARE STATE WOULD COVER THEM
AGAINST ALL THE VAGARIES AND VICISSITUDES
OF THE MODERN WORLD.
IF THEY COULDN'T AFFORD EDUCATION,
THE STATE WOULD PAY.
IF THEY COULDN'T FIND WORK, THE STATE WOULD PAY.
IF THEY WERE TOO ILL TO WORK, THE STATE WOULD PAY.
WHEN THEY RETIRED, THE STATE WOULD PAY.
AND WHEN THEY FINALLY DIED,
THE STATE WOULD PAY THEIR DEPENDENTS.
SO WHAT HAPPENED AFTER THE WAR IN JAPAN
WAS MERELY THE EXTENSION OF THE WARFARE WELFARE STATE.
THE SLOGAN NOW BECAME
"ALL PEOPLE SHOULD HAVE PENSIONS."
THE JAPANESE WELFARE STATE
SEEMED TO BE A MIRACLE OF EFFECTIVENESS.
IN PUBLIC HEALTH AND EDUCATION, JAPAN LED THE WORLD.
BY THE LATE 1970s, THE JAPANESE COULD BOAST
THAT THEIR COUNTRY HAD BECOME THE WELFARE SUPERPOWER.
RUN LIKE THIS, THE WELFARE STATE SEEMED TO MAKE SO MUCH SENSE.
JAPAN HAD ACHIEVED SECURITY FOR ALL,
THE ELIMINATION OF RISK,
WHILE AT THE SAME TIME GROWING SO RAPIDLY THAT BY 1968,
IT HAD THE SECOND LARGEST ECONOMY IN THE WORLD.
ONE U.S.
ECONOMIST EVEN PREDICTED
THAT JAPAN'S PER CAPITA INCOME WOULD OVERTAKE AMERICA'S
BY THE YEAR 2000.
WELFARE WAS WORKING WHERE WARFARE HAD FAILED
TO MAKE JAPAN TOP NATION.
THE KEY TURNED OUT TO BE NOT A FOREIGN EMPIRE
BUT A DOMESTIC SAFETY NET.
AND YET, THERE WAS A CATCH, A FATAL FLAW
IN THE DESIGN OF THE POST-WAR WELFARE STATE.
JUST WHAT WAS IT THAT CAUSED THOSE PREDICTIONS
OF JAPAN'S ULTIMATE TRIUMPH TO FAIL TO COME TRUE?
THE WELFARE STATE LOOKED TO BE WORKING SMOOTHLY ENOUGH
IN 1970s JAPAN,
BUT ELSEWHERE THERE WERE SIGNS THAT ALL WAS NOT WELL.
IN BRITAIN AND THROUGHOUT THE WESTERN WORLD,
THE WELFARE STATE, IT SEEMED,
HAD REMOVED THE INCENTIVES
WITHOUT WHICH A CAPITALIST ECONOMY SIMPLY CANNOT FUNCTION--
THE CARROT OF SERIOUS MONEY FOR THOSE WHO STRIVE,
THE STICK OF HARDSHIP FOR THOSE WHO ARE IDLE.
THE RESULT WAS STAGFLATION-- LOW GROWTH AND HIGH INFLATION.
WHAT WAS TO BE DONE?
ONE MAN AND HIS PUPILS THOUGHT THEY KNEW THE ANSWER.
THANKS IN LARGE MEASURE TO THEIR INFLUENCE,
ONE OF THE GREAT ECONOMIC TRENDS
OF THE PAST 25 YEARS
HAS BEEN FOR THE WELFARE STATE TO BE DISMANTLED,
REINTRODUCING PEOPLE WITH A SHARP SHOCK
TO THE UNPREDICTABLE MONSTER
THEY THOUGHT THEY HAD ESCAPED FROM...
RISK.
IN 1976, A DIMINUTIVE PROFESSOR CALLED MILTON FRIEDMAN
WORKING HERE AT THE UNIVERSITY OF CHICAGO
WON THE NOBEL PRIZE IN ECONOMICS.
MILTON FRIEDMAN WON HIS PLACE IN THE ECONOMIC HALL OF FAME
BY RESTATING THIS SIMPLE EQUATION...
...WHERE "M" IS THE MONEY SUPPLY,
"V" IS THE VELOCITY AT WHICH IT CIRCULATES,
"P" IS THE PRICE LEVEL
AND "Q" IS THE QUANTITY OF EXPENDITURES.
FRIEDMAN'S OBSERVATION WAS SIMPLE--
IF THE MONEY SUPPLY WENT UP, THEN SO DID THE PRICE LEVEL,
HENCE THE QUANTITY THEORY OF MONEY.
BUT YOU NEEDED MUCH MORE THAN A PIECE OF CHALK AND A BLACKBOARD
TO ANSWER THE SECOND CRUCIAL QUESTION
OF MILTON FRIEDMAN'S CAREER.
WHAT HAD GONE WRONG WITH THE WELFARE STATE?
IN CHILE, HE FOUND THE PERFECT LABORATORY
TO TEST HIS THEORIES.
IN SEPTEMBER 1973,
TANKS HAD ROLLED THROUGH SANTIAGO
TO OVERTHROW THE GOVERNMENT OF CHILE'S MARXIST PRESIDENT,
SALVADORE ALLENDE,
WHOSE ATTEMPT TO TURN THE COUNTRY INTO A COMMUNIST STATE
HAD ENDED IN TOTAL ECONOMIC CHAOS
AND A CALL BY THE CHILEAN PARLIAMENT
FOR A MILITARY COUP.
UP THERE ON THE BALCONY OF THE CARRERA HOTEL,
OPPONENTS OF THE ALLENDE REGIME
CELEBRATED WITH CHAMPAGNE AS AIR FORCE JETS
FLEW OVERHEAD TO BOMB THE MONEDA PALACE.
HERE IN THE PALACE,
ALLENDE PREPARED TO MAKE A DESPERATE LAST STAND
ARMED WITH AN AK-47 PRESENTED TO HIM
BY HIS CUBAN ROLE MODEL, FIDEL CASTRO.
LOOKING OUT THE PALACE WINDOW
AND SEEING THE TANKS LITERALLY ROLLING IN,
ALLENDE REALIZED THAT IT WAS ALL OVER
FOR HIS DREAM OF A MARXIST CHILE.
CORNERED HERE IN WHAT WAS LEFT OF THE PRESIDENTIAL QUARTERS,
HE TOOK THE DECISION TO SHOOT HIMSELF.
[MARCH PLAYING]
35 YEARS LATER,
YOU CAN STILL SEE THE BULLET HOLES
IN SOME OF THE BUILDINGS AROUND THE SQUARE.
[MAN SPEAKING CHILEAN]
WHAT HAPPENED HERE IN SEPTEMBER 1973
IN MANY WAYS EPITOMIZED
A WORLDWIDE CRISIS OF THE WELFARE STATE
AND POSED A STARK CHOICE
BETWEEN ALTERNATIVE ECONOMIC SYSTEMS.
WITH OUTPUT COLLAPSING AND INFLATION RAMPANT,
CHILE'S SYSTEM OF UNIVERSAL BENEFITS
WAS EFFECTIVELY BANKRUPT.
FOR ALLENDE, THE ONLY SOLUTION
WAS FULL-BLOWN SOVIET-STYLE TAKEOVER OF THE ENTIRE ECONOMY.
WELL, THE GENERALS AND THEIR SUPPORTERS
KNEW THAT THEY DIDN'T WANT THAT,
BUT WHAT DID THEY ACTUALLY WANT
GIVEN THAT THE STATUS QUO WAS UNSUSTAINABLE?
ENTER MILTON FRIEDMAN.
IN MARCH 1975, FRIEDMAN FLEW FROM CHICAGO TO CHILE
TO ANSWER THAT QUESTION.
[MAN SPEAKING CHILEAN]
[MARCH PLAYING]
IN ADDITION TO GIVING LECTURES AND SEMINARS,
FRIEDMAN CAME HERE TO THE MONEDA PALACE
FOR A MEETING WITH THE NEW CHILEAN PRESIDENT,
GENERAL AUGUSTO PINOCHET.
FRIEDMAN SPENT 3/4 OF AN HOUR WITH PINOCHET,
URGING HIM TO REDUCE THE GOVERNMENT DEFICIT
THAT HE'D IDENTIFIED AS THE MAIN CAUSE
OF CHILE'S SKY-HIGH INFLATION,
THEN RUNNING AT AN ANNUAL RATE OF 900%.
A MONTH AFTER FRIEDMAN'S VISIT,
THE CHILEAN JUNTA ANNOUNCED THAT INFLATION WOULD BE STOPPED
AT ANY COST.
THE REGIME CUT GOVERNMENT SPENDING BY 27%.
THIS PROBLEM OF INFLATION IS NOT OF RECENT ORIGIN.
IT ARISES FROM TRENDS TOWARDS SOCIALISM
THAT STARTED 40 YEARS AGO
AND REACHED THEIR LOGICAL AND TERRIBLE CLIMAX
IN THE ALLENDE REGIME.
FOR TENDERING THIS ADVICE,
FRIEDMAN FOUND HIMSELF DENOUNCED FOR ACTING AS A CONSULTANT
TO A MILITARY DICTATOR RESPONSIBLE FOR THE EXECUTIONS
OF MORE THAN 2,000 REAL AND SUSPECTED COMMUNISTS
AND THE TORTURE OF NEARLY 30,000 MORE.
CHICAGO'S ROLE IN CHILE'S NEW REGIME
CONSISTED OF MORE THAN JUST A VISIT BY MILTON FRIEDMAN.
SINCE THE 1950s, THERE HAD BEEN A STEADY STREAM
OF BRIGHT YOUNG ECONOMISTS GOING FROM THIS PLACE,
THE CATHOLIC UNIVERSITY IN SANTIAGO,
TO STUDY IN CHICAGO,
AND THEY'D COME BACK CONVINCED OF THE NEED TO BALANCE THE BUDGET,
TIGHTEN THE MONEY SUPPLY, AND LIBERALIZE TRADE.
THESE WERE THE CHICAGO BOYS, FRIEDMAN'S FOOT SOLDIERS,
AND YET THE MOST RADICAL OF THEIR IDEAS
WENT BEYOND WHAT FRIEDMAN HAD RECOMMENDED TO PINOCHET.
IT AMOUNTED TO A FULL-SCALE ROLLING BACK
OF THE WELFARE STATE.
THE CONSERVATIVE ECONOMIC REVOLUTION
DIDN'T BEGIN IN THATCHER'S BRITAIN OR REAGAN'S AMERICA,
IT BEGAN RIGHT HERE IN CHILE.
THE MASTERMIND BEHIND THIS WHOLESALE DISMANTLING
OF THE WELFARE STATE WAS A YOUNG ECONOMIST
CALLED JOSE PIÑERA.
CHILE'S ECONOMY WAS DESTROYED.
WE HAVE HAD 50 YEARS OF PROTECTIONISM,
STATE INTERVENTION, AND SOME LIGHT SOCIALISM, IF YOU WANT,
AND THEN THAT WAS EXACERBATED DURING THE ALLENDE GOVERNMENT.
WE HAD CREATED A SORT OF WELFARE STATE,
AND THAT, OF COURSE, WAS GOING BANKRUPT IN CHILE.
BETWEEN 1979 AND 1981,
PIÑERA AND HIS COLLEAGUES
ERECTED A RADICALLY NEW PENSION SYSTEM FOR CHILE,
GIVING EVERY WORKER THE CHANCE
TO OPT OUT OF THE OLD PAY-AS-YOU-GO STATE SYSTEM.
INSTEAD OF A PAYROLL TAX,
EACH WORKER NOW COULD PUT 10% OF HIS WAGES ASIDE
INTO AN INDIVIDUAL PERSONAL RETIREMENT ACCOUNT
TO BE MANAGED BY PRIVATE COMPETING COMPANIES.
THERE WAS ALSO A SMALL PREMIUM
FOR DISABILITY AND LIFE INSURANCE.
THE IDEA WAS TO GIVE EACH WORKER A SENSE
THAT THE MONEY BEING PUT ASIDE WAS HIS OWN PROPERTY,
HIS OWN CAPITAL.
[MAN SINGING IN NATIVE LANGUAGE]
PIÑERA GAMBLED.
HE GAVE WORKERS A CHOICE.
STICK WITH THE OLD SYSTEM OF PAY-AS-YOU-GO
OR OPT FOR THE NEW PERSONAL RETIREMENT ACCOUNTS.
IT PAID OFF.
CONVINCE BY PIÑERA'S ARGUMENT, 80% MADE THE SWITCH
TO A PRIVATE PENSION PLAN.
BUT WAS IT WORTH IT?
WAS IT WORTH THE HUGE MORAL COMPROMISE
THAT THE CHICAGO BOYS AND THE HARVARD MAN MADE
WHEN THEY GOT INTO BED
WITH A TORTURING, MURDEROUS DICTATORSHIP?
WELL, THE ANSWER TO THAT QUESTION
VERY MUCH DEPENDS ON WHETHER YOU THINK THEIR REFORMS
HELPED PAVE A PEACEFUL WAY BACK
TO A SUSTAINABLE DEMOCRACY IN CHILE,
AND I THINK THEY DID.
IN 1980, PINOCHET CONCEDED A NEW CONSTITUTION
THAT PRESCRIBED A 10-YEAR TRANSITION
BACK TO DEMOCRACY.
10 YEARS LATER, HE STEPPED DOWN AS PRESIDENT.
DEMOCRACY WAS RESTORED.
AND BY THAT TIME, THE ECONOMIC MIRACLE WAS UNDERWAY
THAT HELPED TO ENSURE ITS SURVIVAL.
FOR THE PENSION REFORM NOT ONLY CREATED
A NEW CLASS OF PROPERTY OWNERS,
EACH WITH HIS OWN RETIREMENT NEST EGG,
IT ALSO GAVE THE CHILEAN ECONOMY A MASSIVE SHOT IN THE ARM.
THESE BROKERS AT THE BANCO DE CHILE
ARE INVESTING CHILEAN WORKERS' PENSION CONTRIBUTIONS
INTO THE STOCK MARKET,
AND THEY'VE BEEN DOING A PRETTY GOOD JOB OF IT.
AVERAGE RETURNS ON THE PERSONAL RETIREMENT ACCOUNTS
HAS BEEN OVER 10%,
REFLECTING THE FACT THAT IN THE 20 YEARS AFTER 1987,
THE CHILEAN STOCK MARKET HAS GONE UP
BY A FACTOR OF 18.
OF COURSE, THE CHILEAN MARKETS, LIKE ALL STOCK MARKETS,
HAS TAKEN A DIVE IN THE LAST 2 YEARS.
AND THAT'S NOT THE ONLY DOWN SIDE TO THE SYSTEM.
SINCE NOT EVERYONE IN THE ECONOMY HAS A FULLTIME JOB,
NOT EVERYONE ENDS UP PARTICIPATING IN THE SYSTEM.
WHICH LEAVES A SUBSTANTIAL CHUNK OF THE POPULATION
WITH NO PENSION COVERAGE AT ALL.
I'M STANDING IN FRONT OF THE COMMUNIST PARTY HEADQUARTERS
HERE IN LA VICTORIA, A SUBURB OF SANTIAGO
WHICH WAS ONCE OF THE HOTBEDS OF OPPOSITION
TO THE PINOCHET REGIME.
BECAUSE MOST PEOPLE HERE ARE EITHER UNEMPLOYED
OR WORK IN THE INFORMAL SECTOR,
THEY DON'T OR CAN'T PAY INTO THE PENSION SYSTEM,
WHICH MEANS THEY DON'T GET ANYTHING OUT OF IT.
THIS IS THE KIND OF NEIGHBORHOOD WHERE CHE GUEVARA
IS STILL THE LOCAL HERO, NOT JOSE PIÑERA.
THE POOR OF CHILE MAY NOT HAVE A PRIVATE PENSION PLAN
AND MAY HAVE TO MAKE DO WITH A MEAGER GOVERNMENT HANDOUT
IN THEIR OLD AGE,
BUT EVEN THEY HAVE BENEFITED
FROM CHILE'S RAPIDLY GROWING ECONOMY.
GROWTH MAKES A DIFFERENCE IN THE LIFE OF EVERY CITIZEN.
THE POVERTY RATE IN CHILE HAS GONE DOWN FROM AROUND 50%
TO 13% NOW,
SO THIS HAS BEEN, REALLY, A HUGE SUCCESS
AND THE PENSION REFORM HAS BEEN A CRITICAL ELEMENT IN THIS.
THE IMPROVEMENT IN CHILE'S ECONOMIC PERFORMANCE
SINCE THE CHICAGO BOYS' REFORMS IS VERY HARD TO ARGUE WITH.
IN THE 15 YEARS BEFORE MILTON FRIEDMAN'S VISIT,
THE GROWTH RATE HERE WAS A MEASLY .17% A YEAR.
IN THE SUBSEQUENT 15 YEARS, IT INCREASED BY A FACTOR OF NEARLY 20.
THE POVERTY RATE HERE IS DOWN TO 15%
COMPARED WITH 40% IN THE REST OF LATIN AMERICA.
AND WHEN YOU LOOK DOWN AT SANTIAGO'S SHINY NEW FINANCIAL DISTRICT,
YOU CAN SEE WHY THE CHILEAN PENSION REFORM HAS BEEN IMITATED
RIGHT ACROSS THE REGION AND INDEED AROUND THE WORLD.
FOR BRITAIN'S MARGARET THATCHER,
THE GENERAL FROM CHILE AND THE PROFESSOR FROM CHICAGO
WERE HEROES WHO'D DEMONSTRATED
THAT ONLY BY ROLLING BACK THE WELFARE STATE
COULD GOVERNMENTS REVIVE ECONOMIC GROWTH.
YET ONE COUNTRY WHERE THIS RECIPE HAS NOT BEEN TRIED
IS THE COUNTRY THAT'S COME TO NEED IT MOST.
JAPAN.
SO SUCCESSFUL WAS THE JAPANESE WELFARE SUPERPOWER
THAT BY THE 1970s,
LIFE EXPECTANCY WAS THE LONGEST IN THE WORLD.
THE PROBLEM WAS THAT JAPAN'S WELFARE STATE
WAS TOO SUCCESSFUL.
TODAY, THE PROGRAMS RUN HERE AT JAPAN'S MINISTRY OF WELFARE
RELY ON AN EVER-SMALLER NUMBER OF ACTIVE WORKERS
TO SUPPORT AN EVER-RISING POPULATION OF RETIREES.
BACK IN 1960, THERE WAS SOMETHING LIKE 11 ACTIVE WORKERS
FOR EVERY ONE RETIRED PERSON.
BUT BY 2025, THAT NUMBER COULD SINK AS LOW AS 2.
IN OTHER WORDS, THERE WILL BE ONE OLD-AGE PENSIONER
FOR EVERY 2 BUREAUCRATS WORKING HERE AT THE MINISTRY.
IN JUST 30 YEARS, THE COST OF SOCIAL SECURITY BENEFITS
HAS RISEN IN RELATION TO JAPAN'S NATIONAL INCOME
BY A FACTOR OF 4.
TODAY, VIRTUALLY ALL JAPAN'S HEALTH INSURANCE SOCIETIES
ARE IN DEFICIT,
AND THE PENSION FUNDS ARE NEARLY OUT OF MONEY, TOO.
JAPAN'S ONCE-SO-SUPER WELFARE STATE
IS THREATENING TO BANKRUPT THE NATION.
INSURANCE--IT SEEMED SUCH A BRILLIANT IDEA
IN THE CALCULATIONS OF THOSE SCOTTISH MINISTERS
AND EVEN MORE BRILLIANT IN JAPAN'S
ALL-ENCOMPASSING WELFARE STATE.
BUT AS WE'VE SEEN, THE BEST LAID SCHEMES
CAN BE THROWN INTO DISARRAY BY AN UNEXPECTED TURN OF EVENTS.
SO IS THERE ANY BETTER WAY OF MANAGING RISK
IN AN UNCERTAIN WORLD?
DISASTERS LIKE 9/11 AND KATRINA EXPOSED THE LIMITS
OF BOTH TRADITIONAL INSURANCE AND THE WELFARE STATE.
BUT INSURANCE AND WELFARE AREN'T THE ONLY WAYS
TO BUY YOURSELF PROTECTION AGAINST FUTURE SHOCKS.
THESE DAYS, THE SMART WAY OF DOING IT
IS BY BEING HEDGED.
NOW, EVERYBODY'S HEARD OF HEDGE FUNDS,
BUT WHAT EXACTLY DOES HEDGING MEAN
AND WHERE DID IT COME FROM?
TO MOST OF US, HEDGE FUNDS ARE A MYSTERY.
BUT THE ONE THING WE DO KNOW
IS THAT THEY CAN MAKE YOU STUPENDOUSLY RICH.
ONE HUGELY SUCCESSFUL HEDGE FUND MANAGER
PAID $60 MILLION FOR THIS CEZANNE
AND HE OWNS THIS DEGAS, TOO.
NOT TO MENTION A JASPER JOHNS HE PAID $80 MILLION FOR.
HE'S ALSO GIVEN HUNDREDS OF MILLIONS OF DOLLARS TO CHARITY.
KEN GRIFFIN IS THE FOUNDER OF THE CITADEL INVESTMENT GROUP,
ONE OF THE WORLD'S BIGGEST HEDGE FUNDS.
LAST YEAR, HE NAVIGATED HIS WAY THROUGH THE CREDIT CRUNCH
SO SUCCESSFULLY
THAT HE WAS ABLE TO PAY HIMSELF MORE THAN A BILLION DOLLARS.
TO MOST OF US, RISK IS SCARY.
BUT ALL OF GRIFFIN'S VAST WEALTH HAS COME
BECAUSE HE'S FOUND A WAY OF MANAGING RISK
WITH A MIXTURE OF MATHEMATICAL PRECISION
AND BRILLIANT INTUITION.
IT COMES DOWN TO HAVING TO MAKE A JUDGMENT CALL.
AND GOOD RISK MANAGERS AND GOOD RISK TAKERS
ARE INDIVIDUALS THAT HAVE A HISTORY
OF MAKING GOOD JUDGMENT CALLS IN PRICING ASSETS OR CONTRACTS
OR DERIVATIVES IN THE FACE OF UNCERTAINTY.
AND IS THAT JUDGMENT, WHEN YOU MAKE IT,
SOMETHING THAT IS 99% MATHEMATICS, ALGEBRA
AND 1% INTUITION?
OR IS THE INTUITION ELEMENT, THE UNQUANTIFIABLE ELEMENT, BIGGER THAN THAT?
SO WHAT I FIND IS THAT PEOPLE WHO ARE REALLY GOOD AT THIS
HAVE GREAT INTUITION, THEY HAVE GREAT INSTINCT.
THEIR GUT ACTUALLY TELLS THEM SOMETHING.
THE MATHEMATICS ARE IMPORTANT
BECAUSE THEY DEMONSTRATE YOU UNDERSTAND THE PROBLEM.
BUT ULTIMATELY, THE DECISION ABOUT WHETHER OR NOT TO TAKE A GIVEN RISK
I THINK IS REALLY A HUMAN JUDGMENT CALL
IN EVERY SENSE OF THE WORD.
THE ORIGINS OF HEDGING, APPROPRIATELY ENOUGH,
ARE AGRICULTURAL.
FOR A FARMER, NOTHING IS MORE IMPORTANT
THAN THE FUTURE PRICE OF HIS CROP
AFTER IT'S BEEN HARVESTED AND BROUGHT TO MARKET.
BUT THAT COULD BE HIGHER OR MUCH LOWER THAN HE EXPECTS.
A FUTURES CONTRACT ALLOWS HIM TO PROTECT HIMSELF
BY COMMITTING A MERCHANT TO BUY THE CROP
WHEN IT'S BROUGHT TO MARKET AT A PRICE AGREED
WHEN THE SEEDS ARE BEING PLANTED.
THE FARMER GETS A FLOOR BELOW WHICH THE PRICE CAN'T SINK,
THE MERCHANT GETS A CEILING ABOVE WHICH IT CAN'T RISE.
BY SIGNING A FUTURES CONTRACT, BOTH THE FARMER AND THE MERCHANT
HAVE HEDGED THEIR BETS.
BOTH PARTIES ARE BETTER OFF, AND BECAUSE OF THAT,
THE WORLD AS A WHOLE IS MUCH BETTER OFF.
IT ENCOURAGES CAPITAL FORMATION, IT ENCOURAGES INVESTMENT,
IT ENCOURAGES PEOPLE TO DO WHAT IS NEEDED TO BE DONE
TO MAKE THE WORLD A BETTER PLACE.
WITH THE DEVELOPMENT OF A STANDARDIZED FUTURES CONTRACT,
AGREED RULES, AND AN EFFECTIVE CLEARING HOUSE,
THE FIRST TRUE FUTURES MARKET WAS BORN.
AND ITS BIRTHPLACE WAS HERE IN THE WINDY CITY--
CHICAGO.
AFTER THE CITY'S FUTURES EXCHANGE WAS ESTABLISHED IN 1874,
HEDGING COMMODITIES BECAME STANDARD PRACTICE.
THE NEXT STEP WAS FOR A CONDITIONAL KIND OF FUTURE
TO EVOLVE--THE OPTION.
SOME OF THIS REALLY IS THE FINANCIAL EQUIVALENT
OF ROCKET SCIENCE,
BUT THE UNDERLYING PRINCIPLE IS SIMPLE.
BECAUSE THEY'RE DERIVED FROM UNDERLYING ASSETS,
ALL FUTURES CONTRACTS ARE KNOWN AS DERIVATIVES.
BUT AN EVEN SMARTER KIND OF DERIVATIVE IS AN OPTION.
THE BUYER OF A COAL OPTION AS THE RIGHT, SAY, TO BUY
A BARREL OF OIL FOR $120 IN A YEAR'S TIME.
NOW, IF THE PRICE OF OIL RISES TO $150 A BARREL,
THEN THE OPTION IS IN THE MONEY,
AND A SMART GUY MAKES A PROFIT OF $30.
BUT IF THAT DOESN'T HAPPEN, IF THE PRICE OF OIL
STAYS THE SAME OR ACTUALLY DECLINES,
HE'S UNDER NO OBLIGATION TO CARRY THROUGH THE DEAL.
ALL HE DOES IS TO WRITE OFF THE COST OF THE OPTION ITSELF.
WELL, IT'S BY BUYING AND SELLING COMPLEX,
SMART DERIVATIVES LIKE OPTIONS
THAT KEN GRIFFIN HAS BECOME A BILLIONAIRE.
[OVERLAPPING CHATTER]
IN THEORY, DERIVATIVES OFFERED A NEW WAY
TO HEDGE AGAINST AN UNCERTAIN FUTURE.
A MUCH SMARTER WAY THAN BORING OLD INSURANCE
AND MUCH MORE PROFITABLE.
HEDGING ALSO USHERED IN A NEW PHASE
IN THE ASCENT OF MONEY
BY SPEEDING UP THE PROCESS OF FINANCIAL GLOBALIZATION.
AND WITH THE ARRIVAL OF THE HEDGE FUND
CAME A NEW KIND OF ECONOMIC HIT MAN.
THE GRANDMASTER OF THE NEW HEDGE FUND INDUSTRY
WAS GEORGE SOROS.
[INDISTINCT CHATTER]
SOROS BROUGHT TO GLOBAL FINANCE
A BRAND-NEW THEORY OF ECONOMIC BEHAVIOR
THAT UNDERLINED THE FALLIBILITY OF HUMAN NATURE
AND THE INSTABILITY OF FINANCIAL MARKETS.
YOUR ACTIONS, YOU HAVE UNINTENDED CONSEQUENCES,
SO THE OUTCOME WILL NOT CORRESPOND TO YOUR EXPECTATIONS.
AND THAT IS THE WAY
HUMAN AFFAIRS GENERALLY WORK.
ACCORDING TO SOROS' THEORY OF REFLEXIVITY,
FINANCIAL MARKETS CAN'T POSSIBLY BE PERFECTLY EFFICIENT,
MUCH LESS RATIONAL,
FOR THE SIMPLE REASON THAT PRICES ARE JUST THE REFLECTION
OF THE IGNORANCE AND THE BIASES,
MOSTLY COMPLETELY IRRATIONAL,
OF MILLIONS OF INVESTORS.
IN SOROS' EYES, MARKETS ARE BOUND TO GO THROUGH
CYCLES OF BOOM AND BUST
AS SURELY AS THE HUMAN TEMPERAMENT
IS PRONE TO BOUTS OF EUPHORIA AND DESPONDENCY.
SOROS' QUANTUM FUND HAD MADE MILLIONS
FROM SHORT SELLING,
A TYPE OF DEALING WHICH BORROWS STOCKS OR CURRENCIES
AND SELLS THEM FOR FUTURE DELIVERY
ON THE CALCULATION THAT THEY'LL GO DOWN IN VALUE.
HIS BIGGEST COUPS CAME FROM BEING RIGHT ABOUT LOSERS,
NOT WINNERS, AND THE GREATEST OF THESE
WAS AMONG THE MOST MOMENTOUS SPECULATIVE HITS
IN ALL FINANCIAL HISTORY.
ON SEPTEMBER THE 16TH, 1992,
WITH THE BRITISH POUND IN BIG TROUBLE,
I WATCHED AS SOROS
PUT OUT A CONTRACT ON THE BANK OF ENGLAND.
I BECAME CONVINCED THAT SPECULATORS LIKE SOROS
WERE BOUND TO WIN IF IT CAME TO A STRAIGHT SHOWDOWN
WITH THE BRITISH GOVERNMENT.
IT WAS A MATTER OF SIMPLE ARITHMETIC.
A TRILLION DOLLARS OF CURRENCY TRADED EVERY DAY
ON FOREIGN EXCHANGE MARKETS
AGAINST THE MEAGER HARD CURRENCY RESERVES OF THE U.K. TREASURY.
AT THAT TIME, THE BRITISH POUND WAS TIGHTLY LINKED
TO THE GERMAN MARK THROUGH THE E.R.M.,
THE EUROPEAN EXCHANGE RATE MECHANISM.
AS GERMAN INTEREST RATES ROSE IN THE WAKE OF THAT COUNTRY'S
HUGELY EXPENSIVE REUNIFICATION, BRITAIN'S RATE HAD TO RISE, TOO,
HURTING HOMEOWNERS AND BUSINESSES.
SOROS CALCULATED THAT THE BRITISH CHANCELLOR NORMAN LAMONT
WOULD BE FORCED TO WITHDRAW FROM THE E.R.M.
AND DEVALUE THE POUND.
IT WAS THE BIGGEST BET OF SOROS' LIFE.
SO SURE WAS HE THAT THE POUND WOULD DROP
THAT HE BET $10 BILLION.
MORE THAN THE ENTIRE CAPITAL OF HIS FUND.
THE RISK-REWARD WAS DISPROPORTIONATE,
AND THEREFORE, IT SEEMS LIKE A GOOD SPECULATION
OR INVESTMENT, IF YOU LIKE,
IN SHORTING THE POUND.
I WAS EQUALLY CONVINCED
THAT STERLING WOULD HAVE TO BE DEVALUED,
THOUGH ALL I HAD TO BET WAS MY CREDIBILITY.
THAT EVENING, I HEADED TO THE OPERA
TO SEE VERDI'S "THE FORCE OF DESTINY."
IT PROVED EXCEEDINGLY APPROPRIATE.
AT THE INTERVAL, THEY ANNOUNCED THAT CHANCELLOR NORMAN LAMONT
HAD APPEARED IN THERE, IN THE TREASURY COURTYARD,
TO SAY THAT BRITAIN WAS WITHDRAWING FROM THE E.R.M.
HOW WE ALL CHEERED.
TODAY HAS BEEN AN EXTREMELY DIFFICULT
AND TURBULENT DAY.
MASSIVE SPECULATIVE FLOWS HAVE CONTINUED TO DISRUPT
THE FUNCTIONING OF THE EXCHANGE RATE MECHANISM.
SOROS MADE A BILLION DOLLARS THAT DAY.
AND THAT WAS ONLY 40% OF HIS FUND'S ANNUAL PROFITS.
DO YOU FEEL OR DID YOU FEEL A SENSE OF TRIUMPH
WHEN YOUR PROPHESY CAME TRUE AND THE BET PAID OFF HUGELY?
OF COURSE.
IT WAS LIKE WHEN YOU'RE BETTING AND YOU WIN,
NATURALLY, YOU HAVE THAT SATISFACTION
AND ALSO THE PROFIT.
IN THE PAST DECADE, THE TRADE IN DERIVATIVES
BY HEDGE FUNDS LIKE SOROS'
HAS SEEMED TO TAKE OVER THE WORLD OF FINANCE.
BY THE END OF 2007,
THE NOTIONAL VALUE OF ALL DERIVATIVES CONTRACTS
REACHED A STAGGERING $596 TRILLION.
THAT'S 43 TIMES THE SIZE OF THE AMERICAN ECONOMY.
THERE ARE TREMENDOUS ECONOMIC BENEFITS
FOR PEOPLE THAT WORK HERE.
$20 BILLION IN THE HANDS OF A THOUSAND PEOPLE
IS REALLY A 21ST-CENTURY PHENOMENA.
THIS NEVER HAPPENED 50 YEARS AGO.
YET AS MANY HAVE DISCOVERED TO THEIR GREAT COST RECENTLY,
THERE ARE DOWNSIDES TO HEDGING, TOO.
WHEN BILLIONAIRE INVESTOR WARREN BUFFET
DESCRIBED DERIVATIVES
AS "FINANCIAL WEAPONS OF MASS DESTRUCTION,"
HE ALL BUT PROPHESIED THE DOWNFALL
OF AMERICAN INSURANCE GIANT AIG,
WHOSE EUROPEAN HEADQUARTERS ARE THERE BEHIND ME,
BROUGHT LOW, NOT BY SELLING INSURANCE POLICIES,
BUT BY SELLING DERIVATIVES THAT BLEW UP IN ITS FACE.
OUR BASIC HUMAN URGE TO PROTECT OURSELVES AGAINST RISK
HAS PROVED FRUSTRATINGLY DIFFICULT TO SATISFY.
INSURANCE COMPANIES LET US DOWN.
WELFARE STATES SINK INTO INSOLVENCY.
AND DERIVATIVES TURN OUT TO BE A DOUBLE-EDGE WEAPON, TOO.
[GUNSHOT]
AND SO FOR MANY FAMILIES, PROVIDING FOR THE FUTURE
NOW TAKES ONE VERY SIMPLE FORM--
AN INVESTMENT IN A HOUSE,
THE VALUE OF WHICH IS SUPPOSED TO KEEP GOING UP
UNTIL THE DAY THE BREADWINNERS NEED TO RETIRE.
IF THE PENSION PLAN FALLS SHORT, NEVER MIND.
THERE'S ALWAYS HOME SWEET HOME.
ENCOURAGING HOME OWNERSHIP MAY WELL CREATE
A POLITICAL CONSTITUENCY FOR CAPITALISM,
BUT IT ALSO DISTORTS THE CAPITAL MARKET
BY PERSUADING PEOPLE TO BET THE HOUSE
ON, WELL, THE HOUSE.
PEOPLE NEED TO BORROW MONEY, OF COURSE,
TO START UP BUSINESSES OR TO BUY EXPENSIVE ASSETS,
BUT IT SEEMS DANGEROUS TO LURE THEM INTO STAKING EVERYTHING
ON THE FAR-FROM-RISK-FREE PROPERTY MARKET.
FROM BUCKINGHAMSHIRE TO BOLIVIA TO BONNY SCOTLAND,
THE KEY IS TO STRIKE THE RIGHT BALANCE
BETWEEN DEBT AND INCOME.
NEXT TIME ON "THE ASCENT OF MONEY,"
I'LL BE SHOWING HOW THE ENTIRE WORLD ECONOMY
MANAGED TO GET THAT BALANCE PERILOUSLY WRONG.
NEXT TIME ON "THE ASCENT OF MONEY,"
AMERICANS KNOW THAT THERE'S NO PLACE LIKE HOME,
EVEN IF ALL THE HOMES ARE RATHER SIMILAR.
IS HOME OWNERSHIP THE PATH TO FINANCIAL SECURITY?
THE ROOSEVELT ADMINISTRATION PIONEERED THE IDEA
OF A PROPERTY-OWNING DEMOCRACY.
OR IS IT THE ROAD TO RUIN?
A SMALL TREMOR IN AMERICA'S VERY OWN REAL ESTATE MARKET
WOULD CAUSE A FINANCIAL EARTHQUAKE ALL AROUND THE WORLD.
"THE ASCENT OF MONEY,"
A FINANCIAL HISTORY OF THE WORLD.
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Woman, voice-over: MY IDEA CREATED JOBS FOR 2,000 PEOPLE.
Man, voice-over: MY IDEA WILL BRING RENEWABLE ENERGY TO EVERYONE.
Announcer: AN ENTREPRENEUR WITH AN IDEA CAN CHANGE THE WORLD.
I HAVE AN IDEA.
KAUFFMAN: THE FOUNDATION OF ENTREPRENEURSHIP.
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