How Insurance Works

24. Making It Work for Real People: The Democratization of Finance


Professor Robert
Shiller: This is, as I said, my last lecture for
this course and I’m entitling this lecture,
The Democratization of Finance. I wanted to save this to the
end because it’s really about looking at the broad purpose of
our financial markets and our financial institutions.
Ultimately, there’s only one purpose to all of this and
that’s human welfare. It’s people.
This should be obvious, but let’s not forget that
corporations exist only for the benefit of people.
Normally, we say for their owners, but we could also add
other stakeholders. But, it’s people–individual
people–that matter only, unless you want to add animals.
We have non-profits that are aimed at animal welfare as well,
so we’ll include them. I’ve made it a theme of my
recent books that finance is a powerful tool for improving
human welfare and in my latest two books I emphasize what I
call the democratization of finance.
Maybe I should write this down because it’s a term that I like
to use–democratization of finance–or you could say for
short, financial democracy,
but I mean something a little different.
In the 1930s, people talked about financial
democracy as the shareholders voting for the direction of a
corporation. I don’t mean it–by that–by
democratization of finance I mean bringing it to the people. There’s been a long trend
towards democratization of finance that goes back
centuries; that is, originally financial
techniques were a value only to the very rich or the very
sophisticated. In 1780, the President of
Harvard College had his paycheck–I think it was
President Lamont–indexed to inflation.
[Correction: It was President Samuel
Langdon.] I’ve been trying to figure out
if anyone else in the world had ever had a CPI indexed labor
contract and I’ve not been able to discover any other example.
That was 1780. So, there was one person in the
world who had an inflation index employment contract.
Funny, who was it? It was the President of
Harvard, so not a random person. As time goes by,
we have more and more spread of these concepts.
I make it as a mission in two of my books, New Financial
Order, which is on reserve, and my new book,
which I’ll write here, Subprime Solution,
which is not on reserve because I haven’t finished it yet,
but it will be out in–it will be sometime this summer.
It will be available in bookstores.
Apparently, well–so, the theme is that–in both
these books–is that a lot of our problems can be solved by
extending–continuing this trend toward democratization of
finance. We have problems with
inequality–economic inequality. This is, I think,
probably the most important issue facing advanced countries
today–that is that we are not sharing income equally.
There are a remarkable number of poor people and a small very
elite group who are making hundreds of millions of dollars.
In most countries of the world, inequality is getting worse.
This applies both to the advanced countries like the
United States and to the emerging countries like China
and India. It’s not altogether bad because
part of the reason inequality is getting worse is that they’re
suddenly getting rich people. If everyone’s getting better
off, you could say, what’s the problem?
In many ways that is the right answer, but I think that we
can’t tolerate excessive inequality.
The beauty of it is that the very same capitalism that has
been generating inequality has solutions for it.
Many of our venerable economic institutions that we already
have are working against inequality, so I’ll mention just
for example life insurance. That helps alleviate inequality
by eliminating one important cause of inequality.
A lot of poor people, traditionally,
are people who’ve lost–families that have lost
one of the two parents, either the mother or the
father. Of course, that puts the family
in stress because they have just lost half of their adults.
If you have life insurance, that solves that.
Another source of inequality is solved by health insurance. An important cause of
inequality is somebody gets sick, so they are unable to earn
an income and they end up in disastrous economic situations.
Another one is disability insurance. Disability insurance protects
you against something like an accident that causes you to
become unable to hold a job; that tends to be a lifetime
thing. Disability insurance is a
lifetime insurance contract; you pay for it while you’re
healthy. If you become disabled,
you get support for the rest of your life.
These are just some examples of how inequality is already being
dealt with through risk management institutions and why
finance–I always lump insurance in–these are all insurance,
but I lump that in with finance as risk management and why
they’re so important. We still see inequality getting
worse, so I think that is a challenge toward improving risk
management institutions. The subprime crisis that we’re
in now is really substantially due to failures of our risk
management institutions. Notably, we have had a failure
to provide institutions to help people to diversify their own
household portfolios. So, people who bought a house
would have been in a highly leveraged position and
vulnerable to risks of changes in home prices and to other
risks. We need to go a lot further.
Now, part of this theme of democratization of finance is
that we have to pay respect to behavioral finance. That’s because people
don’t–especially the less educated or less capable
people–don’t always make optimal use of financial
instruments like, for example, insurance.
If people don’t make use of risk management contracts,
then we have a problem. What we have to do going
forward in the future is design our risk management contracts to
work better for real people. That requires what they call in
the engineering department, human factors engineering,
but I’ll add financial. Financial engineering is a term
sometimes used in a disparaging term for people who invent
things that are just a bit too complicated.
But usually, the word financial engineering
is used approvingly to refer to people’s efforts to make finance
work even better than before–to make progress in our financial
institution. One of the themes of my–of
this book and this book–is that we have a lot of progress to be
made, but I think it has to be taking
account of our better financial institutions–knowledge of
financial theory and behavior. What I wanted to talk
about–actually, this lecture–I have several
parts. I wanted to talk first about
social insurance, which is not normally covered
in a finance course. It seems to be so relevant that
I want to talk about it. Social insurance refers to
government programs that insure people against risk.
I wanted to talk about the extremely important risk
management programs that the government has instituted.
I’m going to talk especially about bankruptcy and bailouts
because they’re relevant right now,
particularly relevant right now with the subprime crisis.
Then I wanted to conclude this lecture with some thoughts about
financial careers and about morality.
I wanted–I talked about that in the first lecture.
Maybe I should have talked more consistently about it.
Young people are thinking about careers and I think that,
ultimately, I give you credit for wondering about the moral
purpose of different careers. I think finance has a somewhat
tarnished reputation, but I think that’s really
undeserved. I guess people in finance get
into controversial positions more so than people who are in
other occupations that don’t put them in these moral dilemmas and
sometimes they can behave badly. I don’t actually claim to have
answers. You should take a philosophy
course. I won’t give you answers to all
these ethical questions, but what I want to do is at
least raise them and think a little bit about how they relate
to this course. The first principle of–I want
to come back now to what I said I would talk about–namely,
the role of the government in risk management. I think it would be a mistake
to ignore this because David Moss, who actually got his PhD
in history from Yale and I talked to him when he was still
here, wrote a book,
When All Else Fails. It was a history of risk
management in the U.S. This is about ten years ago
this book came–or eight years–I forget exactly,
sometime in the last decade. [David A.
Moss, When All Else Fails: Government as the Ultimate Risk
Manager, Cambridge: Harvard University Press,
2002.] He makes the argument that
really every government–he focuses on the U.S.,
but every government has a risk management role.
Much of what governments do is to do risk management,
especially modern governments. That wasn’t maybe true so much
before, before the end of the nineteenth century.
The governments have gotten in increasingly into risk
management. The first example I would give
is the progressive income tax or graduated income tax,
as it was called by Adam Smith in 1776, in his book,
The Wealth of Nations. He said that maybe we should
have a tax on incomes and the tax on incomes should be
graduated so that people with higher incomes pay a higher
fraction of their income and that would help reduce
inequality. Smith, although he raised it in
that famous book in 1776, he then quickly dismissed it as
unworkable. He said, if we had an income
tax it would be, quote, “a tax on conscience,”
meaning that only the honest people would pay it because it
was impossible to verify anyone’s income;
income is too complicated to measure.
Maybe he was right. The first income tax–it was
either the UK or Holland at the end of the eighteenth century. They had small income taxes and
they were progressive, but they were a beginning.
The U.S. experimented with an income tax
in the 1860s and abandoned it. The original experiments were
all only marginally successful, but the U.S.
finally got an income tax in 1913 and at a very low level,
but this is the U.S. It ultimately became very
important. After World War II,
the top marginal tax bracket rose above 90%,
so it became a very significant redistributor of income.
Ultimately, it’s gone way back down now;
we’ve reversed it, but ultimately it’s a risk
management device. What it means is that if you do
very poorly, you don’t pay any taxes and you get benefits. We also–I might add to it–we
have a progressive income tax that finances education for
everyone–universal education and other social services and
public goods. So, that is a risk management
device and it works despite limitations of human behavior
because it’s automatic; it’s imposed on you,
so nobody can forget about it. It becomes a universal risk
management device. In some sense,
it’s the most important risk management device of all because
it deals at the very low level. Starting in around the–well,
I guess you could go back to Milton Friedman,
who was a conservative economist who started advocating
a negative income tax in the 1940s.
He actually, in his 1963 book,
Capitalism and Freedom, he advocated it more strongly.
That’s the usual source–that we should have a negative tax on
low-income people to bring their income up to a good substantial
level; so, that was the negative
income tax. It sounded like a very negative
tax on low income; it sounded like a very
controversial crazy idea when he launched it, but crazy ideas
have a way of eventually becoming standard.
The United States adopted–and it is now fairly
significant–something called the Earned Income Tax Credit,
which is a negative income tax for low-income families. It emerged from
thinking–EITC–Earned Income Tax Credit.
If you are a family with children with income very low,
like under $10,000, you’ll get a substantial
negative tax–several thousand dollars–and that is risk
management. It means that anybody whose
income falls below very low is–it’s kind of like an income
insurance scheme run by the government.
The concern about all of these schemes, however,
is moral hazard. If you have an earned income
taxed credit–it’s kind of designed around moral hazard.
Instead of having welfare, welfare is a less–that’s just
a gift to someone who doesn’t have any job at all,
who has no income. Then, that moral welfare tends
to lead to a moral hazard problem.
If the government says, if you don’t have a job we’ll
support you, that encourages people to say,
okay I don’t have a job. But, the earned income tax
credit is different because it’s a negative tax rate on your
income. You have to have income in
order to get anything, so you have to get a job to get
EITC. The more you earn,
the more EITC, up to a limit for low levels of
income–the more negative tax you get.
The thing that we’re–what we’re doing as time goes by is
we’re getting a clearer picture of how to design risk management
contracts for the general public.
The EITC was invented in the ’70s in the U.S.;
it was sponsored by Senator Russell Long.
It is now being copied around the world;
although, I guess there were earlier antecedents,
but the U.S. was the first country to do
EITC. The other–I wanted just to
remind you of the different kinds of risk management that
the government offers. One important part of it is
Social Security. I want to go back to the
original Social Security system; it was in Germany under Otto
Von Bismarck that the first Social Security systems were
developed. It was considered a highly
radical idea in the 1880s when–I’ll put this down in
German, in case some of you can
understand this–1883 Krankenversicherung.
Health insurance was founded nationally in Germany,
so it was a government mandatory program;
everybody in Germany had to contribute to health insurance.
German words are very long; they run them together;
I ran out of room to write Krankenversicherung.
In 1884, Unfallversich erung–unfall means
accident, like a fall; Versicherung means
insurance. The government created an
accident referring to workplace accident insurance and it
was–the German government had it–it was an arrangement that
made it mandatory for employers to buy insurance against
injuries to people who worked there.
Then they had in 1889 Altersversicherung.
This isn’t supposed to be a German lesson,
but I like to put it this way because it suggests its origin.
This was old age insurance; alter means old. So, old age insurance was
generated for the whole country of Germany and,
at this point in 1889, Germany was the only country to
have a social insurance program. Shortly after the turn of the
century, Lloyd George, who was Prime Minister of the
UK, traveled to Germany and looked
at their system and was very much impressed and thought–he
said one thing he noticed about Germany,
there are no beggars. Normally, in London you
couldn’t walk down the street without seeing somebody who was
sitting there holding out a tin cup who had no legs or mothers
with children who were orphans. He said, it’s gone in Germany.
So, he became convinced that the UK should follow the lead.
This was copied over the whole word and it’s virtually
everywhere now. Some less developed countries
haven’t gotten there yet, but this is where they’re
going. I wanted to quote Gustav
Schmoller, who is a German economist in the 1880s. In the early twentieth century,
he wrote some memoirs about his life and the life of other
economists in Germany. He said “The triumph of
insurance in every imaginable area was one of the century’s,
[meaning the nineteenth century’s]
great advances in social progress.
It was an entirely logical development that insurance
should spread from the upper classes to the lower classes;
that it had to attempt as far as possible, to eliminate
poverty and that the older charitable relief funds for the
workers were more and more constructed on the sound
principle of insurance.” [Gustav Schmoller,
Charakterbilder, Leipzig, Verlag von Duncker,
1913, p. 57 (Shiller’s translation).
The problem with charity is that it tends to be whimsical
and capricious. If you’re relying on charity to
resolve problems of poverty, it’s going to be applied very
unevenly and it would be salient examples of poverty.
Like, if a child is suddenly stricken with some unusual
illness and it gets written up in the newspapers,
then generous contributions would come pouring into that
child, but other children who are not so blessed get nothing.
In the United States, we were about the last country
to jump onto the bandwagon, begun in Germany–partly I
guess because the U.S. is more free enterprise in its
orientation. Maybe it doesn’t like to adopt
ideas from Europe. It wasn’t until the Great
Depression that the U.S. adopted
Altersversicherung and we still haven’t adopted
Krankenversicherung; we still don’t have a national
health insurance. We have Medicare and Medicaid,
but they don’t apply to everyone.
We have about forty million uninsured Americans with no
health insurance, so we’re still not there yet;
maybe we’ll get there. I wanted to talk about some of
the important successes that–the Social Security System
in the U.S. is our copy of the German
system. Social Security started in
1935–that was about fifty years after the Germans invented it.
It’s remarkable how similar the idea that we have done is and it
stays–we really have something like the 1889 German system in
place today. What it did is it created a
system of contributions to–right now,
when you get a job, you have to pay 6.2%–that’s on
your pay stub. 6.2% is taken out as your
contribution to Social Security and then your employer pays
another 6.2%. So, 12.4% of your income goes
to Social Security and those are thought of as contributions to
an insurance scheme for your–it has three components.
It’s called OASDI; OA stands for old age,
S stands for survivors, and DI stands for disability
insurance. Well, they’re all insurance.
You are–it’s mandatory; you are paying a lot into this
system. You’re paying–the fact that
your employer pays half of it is perhaps misleading,
so it’s really like 12% of your income is forced to go into an
insurance scheme; that’s big.
Now, there’s a cut off though. After you reach I think it’s
around $95,000, [correction:
$102,000 for 2008] you don’t have to pay anymore,
but for most people it’s 12% of their income is going to Social
Security. What do they get for it?
They get a pension when they’re old and it’s guaranteed for the
rest of your life and these other things a lot of people
don’t even know about; you don’t even know that you’ve
got them. Survivor’s Insurance is a life
insurance program; this was actually added in 1939
with amendments. I guess maybe disability was
added at that time too. What it means is,
if you are under a certain age–I think it’s 18–if your
parents die, the government will–or one of
your parents dies–the government will pay money to the
family to support you. It’s life insurance offered by
the government. Why did the government get into
this? Well, the problem was–it’s
behavioral finance again–that while wealthy people tended to
get life insurance, the general mass of people were
not because of some behavioral problem.
They just didn’t see the value of it–didn’t understand it.
Disability insurance means that if you work and you have an
accident, then you can no longer work;
you start collecting Social Security.
Normally, you don’t get the–old age until the age 62 or
65, but disability you can get at any age if you become
disabled. It’s funny, I think a lot of
people don’t even know they have this.
These institutions operate so quietly, partly the
government–they called this Survivors’ Insurance when they
created it in 1939. I was wondering why don’t they
call it life insurance, that’s what it is.
Life insurance is something that pays the survivors of a
family member who dies. I think they didn’t want to
call it life insurance because they didn’t want to threaten the
industry. There’s a whole life insurance
industry. The government was going it in
a big way to create a product, which was mandatory,
but they didn’t want to upset the life–so they called it
something different. You can get a life insurance
salesman who will sell you life insurance and not even mention
that you’ve got a policy already whether you want it or not;
they would just be offering something to add to that. What also they did starting in
the 1930s–it was originally called Aid to Dependent
Children, but they changed it to Aid to
Families with Dependent Children and that was a separate program
beyond these. The parents didn’t have to be
disabled or old or anything like that to get this and that
started in 1935. That’s our welfare system;
it was for parents that couldn’t earn enough money–if
you have a mother, a single mother with no husband
and the husband–or the husband just can’t make any money,
she would get aid for herself and the children.
That, however, was abolished in 1996 because
of moral hazard. The aid to families with
dependent children was created in 1935 with little attention to
the amount of moral hazard it might eventually create.
There grew an increasing problem of welfare dependency.
You would have families that had lived on AFDC their whole
lives and their grandparent’s lives and their grandparent’s
lives. Public opinion turned against
that and it was in 1996 and we had a Welfare Reform Act that
abolished AFDC. It was a Republican bill,
but it was signed by the Democratic President Clinton.
That eliminated Federal–well, essentially they ended the
welfare program started in the Depression.
There still is some welfare, but there’s a lifetime
five-year limit on actual welfare;
after you’ve been collecting it for five years,
you are disqualified. It denied welfare to immigrants
who are not citizens and it limited food stamps to
unemployed, childless adults. I think that as we move ahead
we are becoming increasingly aware of how to design
institutions around human glitches.
So, the Welfare Reform Act–I don’t know if it was the right
policy, but it was trying to eliminate a moral hazard
problem. We have instead of–we’ve
replaced the aid to families with dependent children with a
more generous EITC. You see that it has very
different moral hazard implications.
To get Earned Income Tax Credit you’ve got to have a job and it
can’t just be a token job because you don’t–it says the
negative tax is a function of your income.
I take this as signs of past progress that will continue in
the future. I wanted to talk about
bankruptcy briefly here because that is something that I
mentioned is very important risk management device and it’s of
relevance right now in time of financial crises.
The United States did not have a bankruptcy law at the federal
level, generally, until 1898.
During the nineteenth century, there were repeated financial
crises that led to temporary bankruptcy laws.
What happened was, like what we’re seeing right
now, there was some financial crisis and it caused people to
lose their jobs for no fault of their own and they couldn’t pay
their debts. Laws back then were often very
harsh and they would send people to debtor’s prison.
I think the enlightened view gradually developed–this is
crazy; some person is trying hard;
there’s a big financial crisis; makes bad investments;
then, it can’t pay debts and we put this guy in jail.
That’s crazy. In fact, there should be some
other method that deals better with bankruptcy. There were numerous bankruptcy
laws but notable was the 1841 law, which for a temporary
period gave–this is after a financial crisis–gave a fresh
start. They said someone declaring
bankruptcy can wipe out all debts and not go to jail and as
long as they draw their wealth down to zero they could have a
fresh start and go back to life normally.
That kind of idea has gradually been–and it’s now–now it’s
part of our general assumption about bankruptcies.
I mentioned that 1898 was the landmark bankruptcy law.
This is the first time that we had bankruptcy enshrined as an
institution that lasts all the time.
It’s not just during financial crisis;
you can at any time declare bankruptcy as a way to protect
yourself. There was another landmark.
This is a landmark bankruptcy law and there was another one in
1978–another landmark bankruptcy bill,
which made it even easier, much easier for people to
declare bankruptcy. As a result,
especially after 1978, bankruptcies became very
commonly used ways to manage extreme outcomes in one’s
finances. In fact, recently,
since 1978, there are typically over a million
bankruptcies–personal bankruptcies–a year.
It’s a little known fact that there are more bankruptcies than
divorces and you may wonder, well how can that be?
I don’t hear about bankruptcies; you hear about divorces all the
time. I think the reason you don’t
hear about bankruptcies is that nobody needs to tell you.
You don’t come across saying to–you ask someone,
what’s new? Oh, I just declared bankruptcy.
They don’t do that. They don’t do that about
divorces either, but the problem with divorces
is they can’t cover it up. Everybody knows you’ve gotten a
divorce, so we hear a lot more about them, but bankruptcies are
very important. The other bill that is very
important is 2005 and that reverses some of the 1978 bill.
We’ve been pulling back; maybe 1978 was too generous,
but I just wanted to give you some clue about what bankruptcy
is. If you–there are three
important kinds of bankruptcy and they refer to chapters of
the United States Code. There’s Chapter 7
Bankruptcy–you should know this because half of you are going to
declare bankruptcy some day–maybe not.
We hope that you get an education in finance and few of
you will declare bankruptcy, but some of you are going to be
going through this. Chapter 11 and Chapter 13.
Just so you’ll know in advance, before you actually do this,
Chapter 7 is the liquidation form and this is where you say,
this is it; this is the fresh start story.
You give up everything you have to your creditors.
The bankruptcy court will divide it up among the creditors
and then you have a fresh start. It used to be in 1978 you could
do this every six years. So remember,
2005 thought 1978 was too lenient, so they moved it to
every eight years; so, that’s what you can do.
If you are in big trouble–you’ve gotten in more
debt than you can handle–what you have to do is go to a lawyer
and file for bankruptcy. Chapter 7 is often the favorite
thing because it gives you a fresh start.
However, the 2005 law said that you can’t do–as an
individual–you can’t do Chapter 7 unless your income is below
the median for your state, so I guess you have to forget
Chapter 7. I’m assuming that most of you
will be making more than the median income for the state you
live in, so cross Chapter 7–unless
you’re really in a bad situation–cross Chapter 7 off.
Chapter 7 is for–Chapter 11–companies can also do
Chapter 7. Chapter 11 is for companies and
it’s a reorganization rather than liquidation.
For companies, it’s a system to help them get
back on their feet. When a company files for
Chapter 11 bankruptcy, what they’re saying is,
hey we can’t pay; we’re out of money;
and we have all these people coming to us that we owe money
to and we don’t know who to pay first.
We just don’t have enough money. It becomes a disorderly process
and so they go to the court for protection.
When a company runs out of money and it can’t pay its
bills, then that can destroy the company immediately because
people who were delivering things to the company that they
need will stop delivering them. They say, I hear you’re
bankrupt; you’re not going to pay us,
so we’re going to stop delivering.
That can destroy the company. The idea of Chapter 11 is to
keep the company going so the court would impose some order
and allow the company to continue in business and to hold
off the creditors for now. It’s ultimately in the
creditor’s interest if the Court does this because they’re better
off in getting their debts paid if the company is still making
money. Chapter 13 is something like
Chapter 11; it’s for individuals.
That’s the one you’re going to be filing–let me put it that
way. Some of you will be filing for
Chapter 13 bankruptcy. What it is is that the
court–the bankruptcy court–will make adjustments and
a plan for you to pay off the debts.
This is what we hope to see happen in increasing number of
cases during the current crisis. So, if somebody has taken out a
big mortgage, they’ve taken out car loans,
and they were kind of profligate and now there’s a
problem and they can’t pay on all these,
they declare Chapter 13. They get a lawyer to represent
them and the court can adjust their debts but not eliminate
them. It says right now in Federal
Bankruptcy Law that they cannot adjust the mortgage on your
house, but they can adjust other debts.
This is something that we’re talking about–the Congress is
talking about–changing because the mortgage on the house is a
big debt that bankruptcy ought to be able to adjust.
It hasn’t happened yet. I wanted to mention something
else just so you understand what bankruptcy is.
There’s something called informal bankruptcy.
What’s the difference? With bankruptcy–bankruptcy is
for people who have enough foresight to hire a lawyer and
go out. If you are having trouble
paying your bills, you know enough to go and hire
a lawyer. The lawyer might demand a
little money up front; the lawyer has to be paid.
So, you should stop paying your bills and accumulate at least
$1,000 so you can go to a lawyer and start Chapter 13 bankruptcy
proceedings. A lot of people don’t have the
ability to save $1,000 or to figure this out and they won’t
call a lawyer. What is the common
thing–somebody is running up too much in credit card bills,
loses a job, creditors start calling–what
do you think happens? They don’t get a lawyer;
guess what they do? They stop answering the
phone–very simple. I’ve run up all these debts,
the phone keeps ringing, and these nasty people keep
annoying me, so I just stopped using the phone.
In fact, I left my whole phone bill lapse;
I don’t pay my phone bill. I don’t even have a phone
anymore, so no one can come and get–they knock on my door and I
don’t answer the door. What did courts do–what did
creditors do? In the various states,
they can go to a state court and appeal to the court to
garnish your salary and you don’t have to do anything;
you don’t have to show up. They go to–they find out who
your employer is and then the State gives an order for the
employer to take money out of your paycheck to help pay your
debts. You never even figure out what
happened. In fact, you might not even
know it because you don’t read your pay stub and now some of
your money is going through garnishment of your salary.
That happens, but see this is the reality of
bankruptcy. We are talking about another
revision of the Bankruptcy Bill because we’re in a serious
crisis and maybe 2005 pulled back too much.
We keep waffling about how tight we want these,
but ultimately bankruptcy law is very important in risk
management because this is big time risk management.
It has to be adjusted to deal with moral hazard and other
things. I just want to mention right
now, there’s a bill being proposed by our own Senator
Chris Dodd–here from Connecticut–and Barney Frank,
which is not a bankruptcy bill. It’s a bill–a bailout.
They don’t call it a bailout bill;
they say it’s not a bailout, but I call it a bailout bill to
help people who can’t pay their mortgages and they don’t have to
declare bankruptcy. What they want to do is empower
the Federal Housing Administration to guarantee
loans–to work out loans and guarantee them–and then an FHA
guarantee of loans. You don’t have to declare
bank–you just have to go to your mortgage lender and say,
I can’t pay; I’d like one of these FHA
workouts. Then, if–this hasn’t happened
yet. This is a bill,
but if this bill passes, then there would be they said
maybe several hundred billion dollars of mortgages would be
guaranteed. Here’s a typical story–might
be, you owe $300,000 on your house–maybe that’s too big.
You owe $100,000 on your house. They might lower that to
$90,000 and give a different payment schedule and then the
FHA will tell the bank that if you do this–to the bank–if you
make these adjustments, we will guarantee the mortgage.
So, this is another–that is that the federal government will
pay back the mortgage if the individual doesn’t,
so the government is getting into risk management;
they’re managing the risks to the mortgage lenders. In my–I’ll just mention one of
the ideas in my book, Subprime Solution.
I’m thinking that these things have happened in history so many
times–we’ve had bankruptcy bills;
we’ve had bailouts of one sort of another.
They’re very controversial because people say,
look there’s a moral hazard problem.
If we’re bailing out homeowners who didn’t pay their mortgage,
isn’t that a bad thing? Also, we’re doing it after the
fact. Nobody explained this to the
borrowers that they’d be getting this bailout,
so isn’t it unfair to maybe other people who didn’t buy a
house who are more sensible? What I am proposing in
Subprime Solution is that we just have–these bailouts are
important and we have to make them work better.
So, I have something, which I call a continuous
workout mortgage, which we should move to;
this is my idea. So, I just mention one of the
ideas in my book. The way Dodd-Frank is proposing
is that people who are in difficulty would have a single
workout. It’s just like a bankruptcy;
a bankruptcy is a single event and it occurs only once every
eight years. So, people who are in big
trouble get help from the government, but then it’s a
one-time only, big event and only every eight
years. Why don’t we do it continuously?
What we want to do is have a mortgage so the balance or the
payments adjust automatically for changes in home prices or
incomes. That would make it–you get a
workout every month. Now that sounds kind of radical
and strange, but I don’t see why we shouldn’t do that,
especially if we can get markets for home prices and
incomes so that the lenders can hedge the risk.
I’m talking about private institutions offering mortgages
that build in the kind of workouts that we’re doing on an
emergency basis from time to time.
Once you recognize that workouts are needed,
why don’t we make it part of the structure in institutions?
Anyway, that’s just a little story about what I’m doing in my
book. I said I would conclude this
lecture with some thoughts and I have fifteen minutes for
thoughts about finance. I wanted particularly to aim it
at people at your stage in the lifecycle, younger people,
because as I said at the beginning, there’s–I think
people at your age are rightly concerned about purpose in life.
You are launching out onto a whole lifetime career.
I don’t know how you feel; I’m just guessing that a lot of
the things that you might be doing seem possibly meaningless
or at least not having enough meaning or purpose.
I think that’s a good thing to worry about.
Most of the time you’re taking a job, you’re taking a job to do
some task that somebody wants done and it may be hard to see
how it figures into some global picture;
but, people want to do something that’s good.
I wanted to come back, first of all,
to a theme that I mentioned in the first lecture and that
was–I think it’s a remarkable book;
I’ll put it on reserve; I don’t think I actually got it
on reserve yet. Peter Unger is a philosopher
and his book is called Living High and Letting Die–that
was 1996. What it–this is a book about
what we do in our lives–namely, that we tend to be wrapped up
in ourselves. There’s–in advanced countries
like the U.S., we’re living pretty well,
but in other places people are starving or in desperate
situations. One of the moral dilemmas that
we seem to face is that you could save lives anytime you
want by just giving to one of the appropriate charities.
I’ll write this down; I said this on the first–I’m
repeating it. I said this in the first
lecture, but it’s worth repeating.
On the first page of his book, he has down an address to mail,
but you wouldn’t mail anymore. I’ll put it down
again–http://ww w.unicef.org–that’s the United
Nations Children’s Fund–support/in
dex.html–that’s their website. He is saying,
why don’t you put this book down right now and send a check
for $100 to UNICEF. He estimates that that will
save thirty-three lives of children in the world.
I actually got on UNICEF’s website this morning to check
this out. They claim that they have–9.7
million children die every year for preventable causes–for
things that are preventable through vaccinations and
improved water supply and things that they do,
but they don’t have enough money to do.
The reason I write this down–actually,
I don’t know what you would do, but when I was reading the book
I was wondering, it’s kind of shock to put this
down and think, I could save lives by just a
check for $100. I didn’t do it and so I
thought–that really made an impression on me because I just
continued to read the book. I never–so,
finally when I reread it the third time, I got on the website
and I contributed $100. Then, I have this moral dilemma;
why did I stop at $100? Because I could go way beyond
$100 and if all these people that are dying,
why am I not doing that? You start to think of
justifications and excuses that come to your mind.
Maybe you don’t want to read this book because he shoots them
all down–all these justifications.
One of the justifications is futility.
You say, well these poor people in these less developed
countries–you really can’t help them anyway because it’ll all
get lost or the population will increase and there will be more
dying people. Anyway, he dismisses that;
you have to read it. It’s a rationalization that we
don’t spend too much money–too much time on.
We don’t dwell on it but we assume that it’s futile and so
we ignore it. Another one is that it’s very
difficult to be a truly moral person.
I would have to give–if I really thought about what
was–the terrible things that were happening,
I would have to give 90% of my income.
That’s so–I’m not going to do that, so maybe I just won’t do
anything. So, people make–what he
illustrates in this book is, there’s a lot of casual
thinking that we use to justify–to create an illusion
of innocence that we feel that we’re innocent of any wrongdoing
for not supporting the poor. This is an appeal for charity.
So, maybe you will donate or you probably–some of you have
already done that. I wanted you to–because I
think you’re launching out on careers and there’s
something–there seems to be–moral dilemmas abound.
I was impressed just looking at the New York Times this
morning–the stories that suggested moral dilemmas for
young people who are launching out on careers.
One of them–they were reporting on the Pennsylvania
primary, which incidentally you heard Hillary Clinton won 55 to
45, but that’s not what I was
referring to. It was that they said the
voters thought the most important issue is the
economy–the U.S. economy–and I was thinking,
well what about Iraq? And what about all the people
that we are responsible–we’ve created the current situation
there and people are dying everyday there and we’re
concerned about the economy. Somehow, it seemed to be
something–next thing on the news this morning,
Rupert Murdoch will be buying Newsday,
the sixth largest regional paper in the United States for
$580 million. Somehow, there’s something
bothersome about that story. This guy is super rich;
he’s buying all the newspapers. He’s getting–I mean,
he’s a finance person and he’s gaining control over–people
read these newspapers as part of their recreation and relaxation
and Newsday is kind of a fun paper,
but it’s under control of this finance billionaire.
I don’t know if that’s a moral issue.
Next thing in today’s paper–the U.S.
has 5% of the world population and 25% of its prison inmates,
so something is maybe wrong here.
Another thing that was in today’s paper–South African
dockworkers refuse to unload a Chinese ship with weapons bound
for Robert Mugabe’s regime in Zimbabwe and that the Chinese
ship may return to China without delivering.
This may be–well, who are the dockworkers?
This is not Rupert Murdoch; this is humble people loading
the docks and they have a union and they said,
we’re not going to do this; we’re not going to support
Mugabe’s brutal efforts to suppress a free election.
You start to wonder, are finance people moral or are
they–I just give some–I think that–I don’t know how you
think, but when I was your age,
I somehow wanted a perfect career that was morally right
and important. So, who has as perfect career?
I don’t know. I don’t have an answer and I’m
not going to propose an answer, but let me just consider some
names that come to mind. Bill Gates–now,
he is a businessperson who runs a tight financial ship and you
may be aware of how tight it is when you try to pirate one of
his programs or something. So, he has a reputation for
being a tough guy. On the other hand,
he and Warren Buffett have set up the biggest transparently
operated charitable foundation in the world and it has $38.7
billion dollars. How should we view–I wonder
how Peter Unger would view Bill Gates.
He does have a–what did he spend on his house?
$35 million on his house. [News acconts now put current
assessed value at around $200 million.]
He does live a high style, but should he have started out
giving away 90% of his income when he was your age?
He wouldn’t be making any money if he did that,
so I’m just thinking about–I’m not saying what’s right or
wrong, but I wanted to give one other
example that comes to mind. Have you heard of this guy,
Muhammad Yunus? He went to Vanderbilt
University and got a PhD in Economics in 1969 and then he
became assistant professor of economics at Middle Tennessee
State University. It sounds like a very ordinary
career so far–actually, it’s good being a PhD,
but ordinary in a way; but then, he did something very
important in 1976. He went back to his home
country, which was Bangladesh–one of the poorest
countries in the world. He founded a bank called the
Grameen Bank. Does anyone speak Bengali here?
What does Grameen mean? There’s no Bengali here.
Well, I’m told it means “of the village.”
What he did was create a bank that made loans to poor people;
they’re called micro-finance. So, the typical loan was made
to a young woman who was in desperate poverty and the loan
would be enough to buy some small item that would start a
business–for example, a push cart that could serve
hot food so she could then go and stand on a street corner and
sell some kind of food. That can be huge difference,
having the money to buy a food cart, and can make her able to
support her family. No banks before the Grameen
Bank would do that sort of thing and they claimed that they
couldn’t make money doing it, but he apparently succeeded.
So, he won the Nobel–actually, the Nobel Peace Prize went both
to Yunus and the Grameen Bank a couple years ago.
Those are examples of people who had kind of financey
careers. If you looked at Muhammad Yunus
in earlier years it might not look like a very morally,
Peter Unger-type moral career. I don’t know what Peter Unger
would say about Muhammad Yunus now.
He never–we don’t ever have sense that he gave away 90% of
his income to poor people, but look what he did.
So, I don’t know the answer. I guess what I’m getting at is
that I don’t know the answer to these moral questions,
but I think that it’s kind of a mistake to think that a career
in finance is necessarily immoral.
If you read Peter Unger you get the impression that just about
everyone is evading the moral issues.
Maybe we’re incapable of really behaving the way logical
consideration of ethics would compel us to do.
So, hardly anyone is giving 90% of their income. I don’t know where that leaves
us exactly, but I guess what I want to do is leave open the
possibility that a career in something related to risk
management can be a very meaningful career path for life.
I guess it comes back to the feeling that we live in a very
risky world whose benefits are at this point shared very
unequally. I think that it’s not–the
simple idea that you should be writing checks to UNICEF is not
necessarily the final answer, but what you should be doing
with your life. Somehow, what we see in these
examples–I gave both of Bill Gates and Muhammad Yunus–and
I’m not setting them up as necessarily examples,
but it’s that a career that develops some idea that’s well
motivated can be a source of great meaning and purpose in
life. What these people do is,
it seems to me, is they develop a career with
some ultimate objective and somewhere along the career it
may seem that they’re doing something unimportant or
selfish, but you have to judge it in the
big context. At times, I felt annoyed with
Bill Gates when I had to pay for–when I bought my second
laptop and I had to buy Windows again,
but I think that what we really have to do is try to think of
how–I guess one’s moral imperative might be–one view is
it might be that you should develop some kind of human
capital and some kind of long run plan for how you are going
to apply your human capital. It doesn’t necessarily mean
satisfying the demands of UNICEF along with way.
We are a people and we have a certain psychology.
I think we can get above our psychology to some extent and
get above the drives of our psychology in moments of
inspiration and I think developing a career can be part
of that. Anyway, I’ve–that was my
inspirational conclusion to this.
So, I don’t know what careers you will go into,
but in the meantime, we do have two more lectures.
I doubt that Larry Summers will be giving you advice about your
careers, so I hope to see you again on Tuesday and Wednesday
of next week.


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