The Ascent of Money (2008) – Episode 4 – Risky Business [Transcript]

Life is a risky business – which is why people take out insurance. But faced with an unexpected disaster, the state has to step in.
The Ascent of Money (2008) - Episode 4 - Risky Business

Life is a risky business – which is why people take out insurance. But faced with an unexpected disaster, the state has to step in. Professor Ferguson travels to post-Katrina New Orleans to ask why the free market can’t provide some of the adequate protection against catastrophe. His quest for an answer takes him to the origins of modern insurance in the early 19th century and to the birth of the welfare state in post-war Japan.

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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 insure 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?

That’s a long way of asking a simple question – are you insured? The British certainly think they are. Today, we pay a larger proportion of our income on insurance than any other people in the world. It’s 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 two 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.

Risky Business

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 north-east 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. 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. Councillor 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.

And as you can see, this is the water line.

That’s the water line. Where it came up to. The water came in this building in, er….

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 guestimate, had to be maybe 15 to 20 feet tall.

And moving fast.

Moving quickly. Just coming down this boulevard street, and taking everything with it as it came.

The whole of St Bernard Parish was inundated in just 15 minutes. Only five 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 three years later, it’s not flooding or plague that’s killing New Orleans. A harsh financial reality has emerged. People can’t live here any more 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’s share in fees on the tobacco case was $1.4 billion. Scruggs’s 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, 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’m fortunate enough that I have the means to…

To lose a house and build it. 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… what you’re buying. Er, so that, you know… like… 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 a 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 and sentenced to five 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 Councillor 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 an area where insurance may be a little cheaper and I can afford it? 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 a third of its pre-Katrina population. 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 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?

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 two 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 Kirkyard 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. 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 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 one in four, but at least if you’d taken out insurance, you had the consolation of knowing your wife and children wouldn’t be thrown out onto the street. Gives 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 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 two 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. The 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, 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 three 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 a third 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. With the best will in the world, people couldn’t be expected to insure themselves against the US Air Force. The answer, practically everywhere, was the same – for government to step in. In effect, to nationalise risk.

Perhaps the most familiar sub-system of welfare from the cradle to the grave, also born in the ruins of war, was devised by the British economist, William Beverage.

When the Japanese came up with their own comprehensive welfare system in October 1947, their advisory committee in social security recommended what amounted to “Bebariji no Nihon-ban”, “Beverage for the Japanese”. And yet, they went even further than Beverage 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.

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 US 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. MV = PQ, 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, Salvador 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 realised 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.

35 years later, you can still see the bullet holes in some of the buildings around the square.

What happened here in September 1973 in many ways epitomised 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. The generals and their supporters knew 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. 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 three-quarters 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, however. Since the 1950s, there’d 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 liberalise 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 José Piñera.

[José Piñera] Chile’s economy was destroyed. We have had 50 years of protectionism, state intervention – like socialism, if you want – and 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, Pinera 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.

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. Convinced by Pinera’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? The answer to that question very much depends on whether you think their reform has 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 ten-year transition back to democracy. Ten years later, he stepped down as president. Democracy was restored, and by that time, the economic miracle was under way 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.

There is a downside to the system, to be sure. Since not everyone in the economy has a regular full-time 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 one 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 neighbourhood 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 meagre government handout in their old age… but even they’ve benefited from Chile’s rapidly growing economy.

[José Piñera] Growth makes a difference in the life of every citizen. The poverty rate in Chile has gone down from about 50% to 13%. 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 really very hard to argue with. In the 15 years before Milton Friedman’s visit, the growth rate here was a measly 0. 17% a year. In the subsequent 15 years, it increased by a factor of nearly 20. The poverty rate here’s down to 15%, compared to 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 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 programmes 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 were something like 11 active workers for every one retired person. But by 2025, that number could sink as low as two. In other words, there’ll be one old-age pensioner for every two 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 four.

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 expose 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 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.

[Ken Griffin, Citadel Investment Group] Nothing is constant. Nothing is the way it’s always been. So what I find is that people who are really good at this have great intuition, 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 can 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.

[Ken Griffin] 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 standardised 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 call option has 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 the 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.

In theory, derivatives offer a new way to hedge against an uncertain future. A much smarter way than boring old insurance. And much more profitable. In the past decade, derivatives have 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.

[Ken Griffin] There are tremendous economic benefits for people that work here. $20 billion in the hands of 1,000 people is really a 21st century phenomenon. This never happened 50 years ago.

Yet there are downsides to hedging too. When billionaire investor Warren Buffet described derivatives as “financial weapons of mass destruction”, he all but prophesised the downfall of American insurance giant AIG. Their 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-edged weapon too. 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.

As a pension or an insurance policy, this strategy has one very obvious flaw – it represents a one-way, totally unhedged bet on a single market, the property market.

But as we’ll see in the next episode of The Ascent Of Money, a bet on bricks and mortar, or good old Japanese wood, is anything but as safe as houses.

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