Zermatt Summit
Changing hearts and minds
Humanizing Globalisation
Now Paul Jorion will come up and speak.
Paul is by initial training a social anthropologist,
but he moved from social anthropology to finance.
and he tells me that there was no great transition,
because at the time he made the transition
he was working on artificial intelligence.
So perhaps we will have a bit of natural intelligence,
as well as artificial intelligence,
as we got through your presentation.
May I ask you please to welcome Paul Jorion
[applause]
I was blessed by the most inspirational introduction.
Preparing my little presentation,
I though Let's try to make something good.
But after having watched Malika, and listened to Elisabeth,
what crosses my mind is:
Let's try and make it even better.
I worked from 1999 to 2002 for a company called Indymac.
Indymac had a specialty of homeloans, as we call them,
and it's more usually called mortgages.
Indymac had 2 specialties:
Reverse Mortgages where the person who has the mortgage
is the owner of the house
and little by little, the house goes back to the bank.
The other one was called Alt A (Alternative A).
I won't be going into any details,
but Alt A is just one notch above Subprime.
Indymac was the third major bank run
in the history of American finance.
A bank run is when people start lining up in the streets
asking for their money to be returned to them.
That happened all in July 2008, on a Thursday.
Things got worse on the Friday.
On the Monday, the bank re-opened.
It was previously called Indymac bank,
and on the main entrance,
there was a banner now between the two words,
It was Indymac Federal Bank.
The FDIC had taken over the bank in the name of the American government,
and it was from now belonging to the American government.
From 2002 to 2004, I worked for Wells Fargo.
Wells Fargo is a well-known bank in San Francisco.
And it's doing well,
fortunately for its business, it's doing very well.
I was working in what was called "Consumer Credit".
And what was Consumer Credit was doing was essentially...
[A microphone issue needs to be fixed.]
- Just give me a second.
Try it on.
- Louder?
Alright ok.
In 2002, I moved working for Wells Fargo,
which as I said is still a major bank.
I was working in a division which is called 'Consumer Credit'.
and our specialty was called HELOC.
HELOC stands for Home Equity Line Of Credit.
And essentially, on home, if you're not familiar with that,
it's a second lean as we called it,
a second mortgage that you can get on a house.
The difficulty with the second mortgage is that
the first one comes first,
that's why it's called the first lean.
So when things turned sorer, in 2008,
what happened is that HELOC had no value whatever.
People hired up on HELOC as I was had lost rapidely their jobs.
From 2005 to 2007, I worked for CountryWide.
CountryWide as you know is the major corporate
in the disaster of the subprime industry.
A number of companies did worse and they fell earlier than did CountryWide,
but CountryWide is the main corporate.
In 2008 it was taken over by Bank of America.
So these 3 experiences made me think about finance.
I imagine that you think that justifies to have come to some thoughts.
It was not just on my own. We had conversations at lunchtime, between colleagues.
And we though: We are running into some major disaster
but what can we do?
M. Greenspan, who was, as you know,
Head of the Federal Reserve (the central bank of US)
for nearly 20 years from 1986 to 2006,
said at that time:
"The head of these companies did not think of their self interest, and did not work towards it."
assuming that if the head of these companies had worked for their self interest,
that would have produced "auto-regulation"
meaning that the system would go bad
and then would recover on its own.
And as you know from what you have seen in the news
there's been a lot of discussions lately in 2010 and 2011
about what some companies,
and particularly highlighed in that respect Goldman Sachs and Deutsche Bank,
that when it came to saving the whole mortgage industry
or try to save their own bank,
these companies chose to save their own bank
even at the detriment of the whole industry.
So what I started thinking at that time,
and as I said, in discussions with colleagues,
what can we do to prevent from within finance
that such a disaster happens again.
And I started thinking about different ideas.
In September 2008, which is just literally
one month before I got dismissed by CountryWide,
I was part of the first load, the first batch of people that were let go.
At that point I think about 30% of the people in the company were let go.
And maybe 4 or 5 months later, the company was simply taken over by Bank of America.
And I though at that time:
What should we do?
And one month before I was let go, I wrote a piece,
an opinion piece for the French daily "Le Monde".
I called that piece "A Constitution for the Economy".
My idea was that we needed to find an exit out of the situation.
Let say at the highest possible level.
Let me here pause a little
to tell you exactly what I started thinking about.
A long time ago,
a person who is historical,
or maybe he's not... but anyway, the stories are beautiful,
a person called Moses came down from the Mount,
and he was holding the Tables of the Law.
And I'll just take one of the 10 commandments of these Tables of the Law:
“Thou shalt not kill"
To hook up what I'm saying
with some earlier discussions today,
there was an alternative here:
The first alternative was to wait patiently for people to reform themselves,
unless there was no danger anymore that anybody would ever be tempted
to murder his neighbour or part of his family or whatever...
Or, there was the alternative of maybe having a prohibition about it.
Personally I think that the idea of Moses,
or God if he was directly inspired by God,
I think it was a great idea.
I think we really saved a lot of time.
A little other historical anecdote,
during the French revolution in 1792,
a person called Saint-Just,
one historical figure in the French revolution,
came up with the idea at some point.
In 1792, it was the worse of the French revolution,
there was a civil war in France, nearly everywhere,
in Nantes, in Lyon.
There were external wars on all the borders of the country.
And Saint-Just had prepared a speech, where he said:
"What we need to do is to reform the individuals
(which was essentially the line that had been taken by the French revolution until then),
but at the same time, we have to do that in parallel with changing the institutions".
He started speaking.
He was booed.
It was the end of Robespierre, who was his friend,
it was finished: he never read this particular piece.
He was arrested on the following day,
and he was decapitated a couple of days later.
The idea was essential but it came pretty late.
So what I was thinking was the following:
Finance is extremely useful.
It provides the bloodstream of the economy.
It has 2 functions which are essential:
one that we call 'Price Discovery' which is essentially
finding people who need money in order to start a business, do something,
or even sometimes just to consume, and bring these people together
with other people who have some capital they can dispense of for a period of time,
make these people meet,
make it possible to work that way.
Another function which is essential for finance is the insurance principle.
A large institution like a bank can actually dump
the individual shocks of some little drama
happening here and there,
and paying a premium,
you can actually spread that risk over the whole system.
These are essential.
But there are other parts in finance that went really wrong.
So what I was thinking is not like some people say:
"Let's close all stock exchanges."
or "Let's eliminate all derivatives." (which are particularly useful financial instruments).
or "Let's tax every possible financial transaction".
I was thinking of something more specific.
Let's find a way to carve out very delicately,
Let's carve out exactly the part which is
useless and dangerous
and remove that part from the rest.
What makes this part in finance dangerous?
One is what we call systemic risk.
Systemic risk is the fragility of the whole system.
Making the contagion effects multiplied
and not enhanced by the whole way the system works.
The other danger is the following
and here I'll give you an example.
This example will explain exactly what I've got in mind.
In 2008 in the first half of the year,
at the very beginning of the period,
the price of a barrel of oil was $45.
On the 1st of July, it hit during one particular day, $147.
That was more than treble the price.
There was a major crisis.
Nobody much in American Government bothered except one party.
And that party asked for an investigation to be started.
That party, and it's a bit surprising if I tell you,
it was the Pentagone. Why was it the Pentagone?
Because the Pentagone had to make reserves of fuel
for the boats, for the planes, etc.
and the Pentagone wanted to find out what happened.
Investigation found out who were the corporates.
The corporates were not dark people in dark clothes...
They were pension funds.
They were deans from universities.
They were hospitals.
They were museums.
Why did they go into that business of going into the market
and making all these price being lifted?
Because they feared for the dollar.
They had some assets,
they feared that the value of these assets would depreciate.
So they moved in massively into the markets.
And the instruments which helped them doing that were of a special nature.
They are called baskets.
Baskets why?
Because it's not only oil you find
that you can buy in that particular perspective.
They make baskets, meaning that they add:
metals, like copper,
there's some food,
there are cereals like wheat,
there's coco,
there's coffee,
there's cotton,
whatever you want to think of.
And when the price of oil was lifted,
the price of all these commodities was going up simultaneously.
Why? Because people would buy these baskets.
What did it lead to in summer 2008?
That lead to some anger driven riots
in some countries in the world:
in Indonesia, in Haiti, in some parts of Africa, and so on.
When the Senate Commitee hold these people to explain what was going on,
they moved out of these markets. Why?
Because of the stigma.
They didn't want to be in the limelight.
They didn't want to be called there to testify about what was going on.
They all moved out. What happened?
All the prices dropped suddenly.
They dropped so low,
that in the process, the producers in Africa, of coco,
the producers of coffee all over the world, etc.
were hit by that. Why?
Because the prices at that point were going too low.
So what does that mean?
It means that prices going up were killing the consumers
because you and I at the filling station who were paying
for the price of the fuel going up.
When it comes down, it's the producers who are being hit
by the process of going down.
There was something even more I would say tragic
in terms of what we are concerned with today
in the process of coming down.
When the prices of oil comes up, it's interesting financially
to have startups on renewal energy.
The price of oil goes up, and it becomes more interesting
to go into research to see how to replace oil.
When the price of oil drops suddenly back to the level of $45 from $147,
a lot of these startups who were working on renewal energy were eliminated.
I hope you understand what I've got in mind when I'm talking about this.
What I though about what would be one of the essential, major, central principle
of the idea of a Constitution of Economy.
When I say Constitution of Economy,
I mean indeed something that applies to the world as a whole.
I think that's where we need to go.
You can call it Tables of the Law,
and you can think of adding an eleventh commandment
or maybe a twelfth and so on...
What I thought is one thing you need to do is to
prohibit these wagers on the evolution of price.
It is one part of finance,
it is a very essential part of finance nowadays.
In 2007, 47% of the GDP in the US was constituted of financial operations.
Out of these financial operations, on the commodities markets, the proportion varies:
it varies between 80% and 90% of the activity on these commodities markets
currently being done in the perspective of these wagers about fluctuations of prices,
which is one aspect of what we call speculation.
So what I was thinking is the part to carve out from finance
to go back to a financial market which serves the economy,
The part to carve is that part which is useless, dangerous,
which takes a lot of money out of the economy.
Just one remark:
some people criticize this idea I've been expressing,
saying "If you do what you say,
too much money will go back into the economy, maybe leading to inflation."
I think that it's a risk we can take.
The objection to what I propose as that
prohibition of bets, wagers on the evolution of prices,
the main objection is saying "it's impossible to implement,
it's too complicated, not everybody will agree to do it at the same time."
The main response is the following:
FASB 133 (Financial Accounting Standards Board of the United Nations, rule 133)
is doing that curving out that I'm telling you about right now.
It is there in that particular text.
What's the purpose there?
To make a difference between people that are useful to the economy
and people that are detrimental.
What is the purpose of the rule?
To make a difference in taxation.
People who are doing those parts
(that I suggest to be removed all together)
are taxed more.
When I'm being told it's impossible just to define what needs to be done,
it's already there, it's already in FASB133.
And something more:
A prohibition of wagers on the evolution of prices
was part of the law of the majority of countries in the world in the 19th century.
It was removed.
The article in Penal Law in France is article 421.
And it says exactly what I'm saying.
It's forbidden to make wagers on the evolution of prices.
It's been removed in 1885.
I've been going into the History of this evolution.
It's always the same explanation.
Under the pressure of the business community, these rules were removed.
And at some point when some countries started removing it,
business communities in the other countries said:
"we have a disadvantage now, we can't do this anymore."
I'll close on that.
I think it's not only possible,
it's already in the text in some way.
Some articles in the Law were there,
they have been removed, they can be reinstituted.
What I'm suggesting, what we need to do,
and that doesn't mean that we shouldn't reform individuals.
It needs to go together.
What I'm suggesting is only possible
if a large number of individuals reform themselves enough
in order to say we need to take a measure like that.
What I'm suggesting is:
"Thou shalt not wager on the evolution of prices."
Thank you.