1 00:00:02,720 --> 00:00:15,800 Speaker 1: Bloomberg Audio Studios, Podcasts, radio News. 2 00:00:18,520 --> 00:00:21,680 Speaker 2: Hello and welcome to another episode of the Odd Lots podcast. 3 00:00:21,840 --> 00:00:23,200 Speaker 2: I'm Tracy Alloway. 4 00:00:22,920 --> 00:00:25,640 Speaker 3: And I'm Joe Wisenthal. Joe Yes. 5 00:00:26,040 --> 00:00:30,560 Speaker 2: In the recent episode with Kaiser Quo, you dropped at 6 00:00:30,640 --> 00:00:32,720 Speaker 2: the very end because you said you were hoping that 7 00:00:32,760 --> 00:00:35,479 Speaker 2: no one was listening. You dropped that you are coming 8 00:00:35,640 --> 00:00:38,360 Speaker 2: round to complex financial products. 9 00:00:38,720 --> 00:00:41,240 Speaker 4: You know what, I did drop a little bomb there 10 00:00:41,280 --> 00:00:43,320 Speaker 4: at the very end of the episode because it's something 11 00:00:43,360 --> 00:00:45,559 Speaker 4: I've been thinking about more and more, and I'll just 12 00:00:45,640 --> 00:00:48,680 Speaker 4: lay it out very quickly what I think about, which 13 00:00:48,760 --> 00:00:50,959 Speaker 4: is the one of the most influential episodes we've done 14 00:00:51,000 --> 00:00:53,519 Speaker 4: in a long time in my mind, was episode we 15 00:00:53,560 --> 00:00:56,840 Speaker 4: did with Ricardo Houseman, who were either recently talked to 16 00:00:57,000 --> 00:00:59,080 Speaker 4: or about to talk to depending on when this episode 17 00:00:59,080 --> 00:01:02,560 Speaker 4: comes out, et cetera. About complexity is a good thing. 18 00:01:02,840 --> 00:01:05,640 Speaker 4: That's a sign of when wealthy economies are capable of 19 00:01:05,680 --> 00:01:10,080 Speaker 4: producing complex products. That's usually signed they get wealthier. That's 20 00:01:10,120 --> 00:01:12,880 Speaker 4: mostly discussed in the manufacturing sense. And then lately I've 21 00:01:12,920 --> 00:01:15,480 Speaker 4: been thinking, you know what, there are some wealthy countries 22 00:01:15,520 --> 00:01:18,960 Speaker 4: that produce really complex stuff that aren't manufacturing. The UK, 23 00:01:19,319 --> 00:01:22,200 Speaker 4: the US, et cetera. Mostly much of it is sort 24 00:01:22,240 --> 00:01:25,600 Speaker 4: of complex financial products. Maybe we need to rethink and 25 00:01:25,680 --> 00:01:28,240 Speaker 4: maybe we need to sort of take a fresh light 26 00:01:28,280 --> 00:01:31,400 Speaker 4: about why the market is willing to pay the creators 27 00:01:31,440 --> 00:01:35,480 Speaker 4: of complex financial products so much. And maybe they're not 28 00:01:35,560 --> 00:01:37,959 Speaker 4: as bad as sort of some of us thought, or 29 00:01:38,000 --> 00:01:39,960 Speaker 4: maybe we maybe we should be more proud of our 30 00:01:40,000 --> 00:01:43,440 Speaker 4: financial creations, lean into them a little bit more, lean 31 00:01:43,520 --> 00:01:44,240 Speaker 4: into you. 32 00:01:44,120 --> 00:01:47,240 Speaker 2: Know, complex financial products. 33 00:01:47,360 --> 00:01:48,120 Speaker 3: Because if there was this. 34 00:01:48,040 --> 00:01:50,960 Speaker 4: Other thing too, like in like early twenty tens, where 35 00:01:50,960 --> 00:01:53,640 Speaker 4: people are like all the great minds were working on, 36 00:01:53,880 --> 00:01:55,920 Speaker 4: you know, building derivatives when they should have been doing 37 00:01:55,920 --> 00:01:58,800 Speaker 4: something else, and then they went and built like social 38 00:01:58,840 --> 00:02:01,480 Speaker 4: media and like products to hack our attention to sell ed. 39 00:02:01,800 --> 00:02:02,800 Speaker 4: Was that so much better? 40 00:02:03,040 --> 00:02:03,480 Speaker 3: Anyway? 41 00:02:03,560 --> 00:02:06,200 Speaker 4: I don't know, Like maybe it's like time to rethink 42 00:02:06,640 --> 00:02:10,600 Speaker 4: the positives of finance in the world great financial crisis 43 00:02:10,600 --> 00:02:13,040 Speaker 4: that was history. Let's remember the good at parts. Anyway, 44 00:02:13,880 --> 00:02:15,480 Speaker 4: it's just been on my mind lately, all Right. I 45 00:02:15,480 --> 00:02:17,400 Speaker 4: didn't know you were gonna, like to her say, like, Okay, 46 00:02:17,400 --> 00:02:19,560 Speaker 4: now you have to do a whole episode defending this position. 47 00:02:19,639 --> 00:02:22,919 Speaker 2: Je, Well, I'm being nice. I brought this, I brought 48 00:02:22,960 --> 00:02:25,720 Speaker 2: you the perfect guest to discuss all of this, and 49 00:02:25,760 --> 00:02:27,959 Speaker 2: I mean, really the perfect guest. So this is actually 50 00:02:27,960 --> 00:02:30,360 Speaker 2: someone I've wanted to get on the podcast for a 51 00:02:30,440 --> 00:02:33,079 Speaker 2: very very long time. I used to work with her 52 00:02:33,200 --> 00:02:35,800 Speaker 2: at the Financial Times. I worked for her at the 53 00:02:35,840 --> 00:02:38,400 Speaker 2: Financial Times for a while. We're going to be speaking 54 00:02:38,440 --> 00:02:41,160 Speaker 2: with Gillian Tet. She is, of course a columnist for 55 00:02:41,200 --> 00:02:44,560 Speaker 2: the Ft and head of King's College at Cambridge. Jillian, 56 00:02:44,720 --> 00:02:45,560 Speaker 2: welcome to the show. 57 00:02:45,960 --> 00:02:47,600 Speaker 5: Well, it's great to be on the show. And I 58 00:02:47,680 --> 00:02:50,240 Speaker 5: think Tracy, I often felt like I was working for 59 00:02:50,360 --> 00:02:53,680 Speaker 5: you at the time. You were so much smarter than 60 00:02:53,680 --> 00:02:56,480 Speaker 5: the rest of us, and you really blaze into trail 61 00:02:56,560 --> 00:02:57,720 Speaker 5: in many of these discussions. 62 00:02:57,760 --> 00:02:59,560 Speaker 2: Well, thank you so much for saying that. I hope 63 00:02:59,560 --> 00:03:02,200 Speaker 2: my boss is a Bloomberg. Are listening, Yeah, I give 64 00:03:02,200 --> 00:03:06,200 Speaker 2: a bonus straight away. You, of course basically wrote the 65 00:03:06,360 --> 00:03:09,200 Speaker 2: book on derivatives, Fool's Gold, which came out at a 66 00:03:09,320 --> 00:03:12,200 Speaker 2: very fortuitous time two thousand and nine, So right after 67 00:03:12,280 --> 00:03:14,640 Speaker 2: the two thousand and eight financial crisis. Talk to us 68 00:03:14,680 --> 00:03:17,880 Speaker 2: about the genesis of that book, because I think a 69 00:03:17,919 --> 00:03:20,360 Speaker 2: couple years before when you started working on it, I 70 00:03:20,360 --> 00:03:23,040 Speaker 2: don't think a lot of people were thinking, oh, we 71 00:03:23,120 --> 00:03:26,040 Speaker 2: need to write an entire book on how we got 72 00:03:26,040 --> 00:03:28,359 Speaker 2: these things called credit default swaps. 73 00:03:28,800 --> 00:03:30,680 Speaker 5: No, well, most people aren't quite as weird as me. 74 00:03:30,840 --> 00:03:34,519 Speaker 5: But the reality is I'm trained as a cultural anthropologist, 75 00:03:34,880 --> 00:03:37,320 Speaker 5: which might sound like it's got nothing to do with 76 00:03:37,520 --> 00:03:40,720 Speaker 5: Wall Street, And in fact my PhD was based on 77 00:03:40,760 --> 00:03:45,120 Speaker 5: field work looking at marriage rituals in Tajikistan, so that's 78 00:03:45,160 --> 00:03:48,360 Speaker 5: not your obvious starting point. But one thing that cultural 79 00:03:48,360 --> 00:03:51,560 Speaker 5: anthropology teaches you is so as human beings, we all 80 00:03:51,600 --> 00:03:55,120 Speaker 5: wrap ourselves up in assumptions and ideas we inherit from 81 00:03:55,120 --> 00:03:59,160 Speaker 5: our cultural surroundings, and those often make us very blind 82 00:03:59,400 --> 00:04:03,119 Speaker 5: to things that we ignore in our world. Social silence 83 00:04:03,360 --> 00:04:06,160 Speaker 5: really matters. It's what we don't talk about that really matters. 84 00:04:07,000 --> 00:04:09,280 Speaker 5: And starting back in about two thousand and five, when 85 00:04:09,320 --> 00:04:12,440 Speaker 5: I was running the lex column at the Financial Times, 86 00:04:12,880 --> 00:04:17,960 Speaker 5: I noticed that newspapers and politicians talked obsessively about equity 87 00:04:18,000 --> 00:04:22,000 Speaker 5: markets and sometimes credit markets and bomb markets. But actually 88 00:04:22,040 --> 00:04:24,120 Speaker 5: when you looked at what was driving revenues in the 89 00:04:24,160 --> 00:04:26,800 Speaker 5: city of London, whereas based at the time, it was 90 00:04:26,920 --> 00:04:31,400 Speaker 5: actually things like derivatives and credit derivatives, which no one 91 00:04:31,440 --> 00:04:34,040 Speaker 5: talked about because they seemed to be geeky and technical 92 00:04:34,200 --> 00:04:39,120 Speaker 5: and incredibly dull. But the reality is that things that 93 00:04:39,160 --> 00:04:41,880 Speaker 5: look dull and boring to a point we don't discuss 94 00:04:41,920 --> 00:04:44,200 Speaker 5: them are often the most important things in the world. 95 00:04:44,920 --> 00:04:48,279 Speaker 5: So I became kind of fascinated by this underbelly of 96 00:04:48,360 --> 00:04:50,960 Speaker 5: the city of London and Wall Street. I used to 97 00:04:50,960 --> 00:04:53,760 Speaker 5: say that they looked like icebergs, in that you had 98 00:04:53,760 --> 00:04:56,119 Speaker 5: a bit poking above the surface that people talked about, 99 00:04:56,360 --> 00:04:59,599 Speaker 5: which was the equity markets, and a shadowy chunk than 100 00:04:59,680 --> 00:05:02,560 Speaker 5: everyone and ignored. So I dived in really, starting in 101 00:05:02,600 --> 00:05:05,080 Speaker 5: two thousand and five, into the world of credit derivatives, 102 00:05:05,520 --> 00:05:09,279 Speaker 5: initially to try and almost do a tourist guide to 103 00:05:09,560 --> 00:05:12,560 Speaker 5: what was happening there for the wider Financial Times readership. 104 00:05:13,040 --> 00:05:15,880 Speaker 5: This was a few years after the dot com boom, 105 00:05:16,320 --> 00:05:18,560 Speaker 5: and in the same way that my colleagues had gone 106 00:05:18,560 --> 00:05:21,920 Speaker 5: around explaining the Internet, I thought I could explain financial 107 00:05:21,920 --> 00:05:25,200 Speaker 5: innovation and see what was really going on. But of 108 00:05:25,240 --> 00:05:29,400 Speaker 5: course it turned out to be considerably more deceptive and 109 00:05:29,560 --> 00:05:33,160 Speaker 5: challenging and ultimately more dramatic than I ever imagined. 110 00:05:33,600 --> 00:05:36,800 Speaker 4: It really is extraordinary vindication on your part, because the 111 00:05:36,839 --> 00:05:40,040 Speaker 4: book came out in May two thousand and nine, so 112 00:05:40,080 --> 00:05:42,680 Speaker 4: at that point, like people were just getting up to 113 00:05:42,760 --> 00:05:45,680 Speaker 4: speed and it was all anyone to talk about. And 114 00:05:45,680 --> 00:05:48,120 Speaker 4: here you were years ahead and you already are like, 115 00:05:48,200 --> 00:05:50,640 Speaker 4: here's the book then you all have to read now, 116 00:05:50,640 --> 00:05:53,880 Speaker 4: which is just, I mean, an extraordinary vindication of your 117 00:05:53,960 --> 00:05:57,960 Speaker 4: choice to like begin down this path of looking into them. 118 00:05:58,320 --> 00:06:00,839 Speaker 4: Tracy and I were both in London in a and 119 00:06:01,000 --> 00:06:03,240 Speaker 4: I loved it. It wasn't my first time there. 120 00:06:03,279 --> 00:06:03,800 Speaker 3: I loved it. 121 00:06:04,160 --> 00:06:08,400 Speaker 4: Extraordinary wealthy society. I know there's all this anxiety in 122 00:06:08,400 --> 00:06:10,919 Speaker 4: the UK is like, oh, you can't like build stealed 123 00:06:10,960 --> 00:06:13,599 Speaker 4: anymore economically all this, I get it. There are some issues, 124 00:06:13,680 --> 00:06:16,520 Speaker 4: et cetera. But people are willing to pay a lot 125 00:06:16,560 --> 00:06:19,720 Speaker 4: of money for the services that the city provides all 126 00:06:19,760 --> 00:06:21,520 Speaker 4: around the world and make it one of the richest 127 00:06:21,880 --> 00:06:23,919 Speaker 4: richest societies ever to exist on Earth. 128 00:06:24,360 --> 00:06:25,960 Speaker 5: Well, I have to be honest and say that I 129 00:06:26,000 --> 00:06:28,880 Speaker 5: did not originally expect to be writing a disaster book. 130 00:06:29,520 --> 00:06:32,560 Speaker 5: What actually happened was I spent the summer of two 131 00:06:32,600 --> 00:06:37,000 Speaker 5: thousand and seven writing the book and finished it in 132 00:06:37,040 --> 00:06:41,240 Speaker 5: September two thousand and seven, went back to work, thought 133 00:06:41,320 --> 00:06:43,320 Speaker 5: the whole thing was done and dusted, and at that 134 00:06:43,360 --> 00:06:45,760 Speaker 5: point It was simply an account of how this tribal 135 00:06:45,800 --> 00:06:48,480 Speaker 5: group at JP Morgan had dreamt up the idea of 136 00:06:48,560 --> 00:06:53,640 Speaker 5: credit derivatives and taken it to extremes. And literally the 137 00:06:53,720 --> 00:06:56,479 Speaker 5: day after I came back to work, Lihma Brothers collapsed 138 00:06:56,800 --> 00:06:59,320 Speaker 5: and the book had to be dramatically rewritten very fast, 139 00:07:00,000 --> 00:07:02,920 Speaker 5: because by then, of course, it was clear that credit 140 00:07:02,920 --> 00:07:07,000 Speaker 5: derivatives had the potential to destabilize very wide swaths of 141 00:07:07,120 --> 00:07:10,160 Speaker 5: the financial markets. And they weren't the source of the 142 00:07:10,200 --> 00:07:14,560 Speaker 5: crisis that was the subprime mortgage lending, but they amplified 143 00:07:14,600 --> 00:07:18,080 Speaker 5: the crisis dramatically. And of course, with the city of London, 144 00:07:18,560 --> 00:07:21,200 Speaker 5: a lot of its growth in the preceding years had 145 00:07:21,280 --> 00:07:25,200 Speaker 5: been due to its activities in the financial sector, and 146 00:07:25,240 --> 00:07:27,760 Speaker 5: particularly the fact that London was a home of much 147 00:07:27,760 --> 00:07:32,280 Speaker 5: of this creativity, and once the crisis hit, London not 148 00:07:32,320 --> 00:07:34,800 Speaker 5: only became an epicenter of the things that were going wrong, 149 00:07:35,200 --> 00:07:39,080 Speaker 5: but of course ultimately saw some of its own financial 150 00:07:39,120 --> 00:07:40,720 Speaker 5: fortunes suffer as a result. 151 00:07:41,320 --> 00:07:43,240 Speaker 4: First of all, the fact that you didn't go into 152 00:07:43,320 --> 00:07:46,240 Speaker 4: the book expecting to write a disaster book still in 153 00:07:46,360 --> 00:07:49,400 Speaker 4: my mind, vindicated the choice, because there was obviously. 154 00:07:50,760 --> 00:07:52,800 Speaker 5: I should say by the way, actually, you know, I 155 00:07:52,920 --> 00:07:55,120 Speaker 5: was predicting back in two thousand and five that credit 156 00:07:55,120 --> 00:07:58,440 Speaker 5: derivatives were a house of cards is going to come 157 00:07:58,480 --> 00:07:59,239 Speaker 5: at some point. 158 00:07:59,360 --> 00:08:01,840 Speaker 2: You wrote a lot about it in the Ft repeatedly, 159 00:08:02,320 --> 00:08:03,000 Speaker 2: but I want. 160 00:08:02,840 --> 00:08:06,080 Speaker 4: To press further on this point that people are clearly 161 00:08:06,160 --> 00:08:09,640 Speaker 4: willing to pay a lot of money for these financial 162 00:08:09,760 --> 00:08:13,440 Speaker 4: services for the service of creating these derivatives. There are 163 00:08:13,440 --> 00:08:16,400 Speaker 4: not many places they're not. You know, there's shen Zen 164 00:08:16,600 --> 00:08:21,200 Speaker 4: for manufacturing electronics, there's a few places I don't know 165 00:08:21,320 --> 00:08:24,360 Speaker 4: for manufacturing whatever else. And then there's like London in 166 00:08:24,400 --> 00:08:27,960 Speaker 4: New York for manufacturing complex derivatives. And they're worth a 167 00:08:28,000 --> 00:08:29,480 Speaker 4: lot of money, and people are willing to pay a 168 00:08:29,520 --> 00:08:32,160 Speaker 4: lot of money for them, like you mentioned that their 169 00:08:32,200 --> 00:08:35,080 Speaker 4: house at cards, et cetera. Yet around the world, clearly 170 00:08:35,600 --> 00:08:38,840 Speaker 4: don't customers think there's a value in all these services. 171 00:08:39,120 --> 00:08:42,959 Speaker 5: Well, credit derivatives and other derivatives and complex financial products 172 00:08:43,000 --> 00:08:46,200 Speaker 5: exist for a reason, which is that people want to 173 00:08:46,320 --> 00:08:48,840 Speaker 5: use them and buy them. And they want to use 174 00:08:48,840 --> 00:08:51,840 Speaker 5: them and buy them because essentially they offer a way 175 00:08:52,040 --> 00:08:58,000 Speaker 5: of expressing ideas in finance, taking bets, making investments that 176 00:08:58,080 --> 00:09:05,040 Speaker 5: are dramatically more flexible, more subtle, more multifaceted, and sometimes 177 00:09:05,200 --> 00:09:10,960 Speaker 5: cheaper than using other financial instruments. And the image I 178 00:09:11,040 --> 00:09:14,640 Speaker 5: sometimes use to explain what they do is a bit like, 179 00:09:14,920 --> 00:09:17,959 Speaker 5: you know, photoshopping a picture. You know, you can have 180 00:09:18,000 --> 00:09:20,240 Speaker 5: a picture of something, you can have the actual something, 181 00:09:20,840 --> 00:09:22,920 Speaker 5: or you can take a photograph and then photoshop it 182 00:09:22,960 --> 00:09:25,960 Speaker 5: according to your own desires, and that, in a sense 183 00:09:26,080 --> 00:09:30,120 Speaker 5: is a bit like what a derivative does. Or, to 184 00:09:30,200 --> 00:09:33,240 Speaker 5: use another analogy, if you want to invest in the 185 00:09:33,280 --> 00:09:36,599 Speaker 5: equity market, you can either go and buy an ETF 186 00:09:36,800 --> 00:09:39,200 Speaker 5: which is like a box of chocolates. It's pre selected. 187 00:09:40,080 --> 00:09:42,760 Speaker 5: Or you can go to an expensive equivalent of a 188 00:09:42,920 --> 00:09:46,280 Speaker 5: chocolette where you pick a mixed chocolates you want, but 189 00:09:46,320 --> 00:09:49,520 Speaker 5: that takes more money in time. Or you can just 190 00:09:49,559 --> 00:09:51,440 Speaker 5: take a photograph of all the chocolates you like in 191 00:09:51,480 --> 00:09:54,080 Speaker 5: the world and just a photoshop it to whichever ones 192 00:09:54,120 --> 00:09:56,800 Speaker 5: you want, and that essentially is a derivative. 193 00:09:57,200 --> 00:10:00,160 Speaker 2: I'm not sure how much I personally would value a 194 00:10:00,200 --> 00:10:03,400 Speaker 2: photo of a bunch of chocolates, but point taken, Okay, 195 00:10:03,440 --> 00:10:07,160 Speaker 2: So maybe, just as an example, let's use CDs and 196 00:10:07,400 --> 00:10:11,240 Speaker 2: the invention of credit default swaps, and then how I 197 00:10:11,240 --> 00:10:15,400 Speaker 2: guess they transformed during the financial crisis or running up 198 00:10:15,480 --> 00:10:18,880 Speaker 2: until the financial crisis, because as you pointed out, you 199 00:10:18,960 --> 00:10:22,600 Speaker 2: made the point that CDs is not necessarily the proximate 200 00:10:22,800 --> 00:10:26,760 Speaker 2: cause of the crisis, but definitely amplified it. So talk 201 00:10:26,800 --> 00:10:31,520 Speaker 2: us through what CDs were originally intended to do and 202 00:10:31,600 --> 00:10:32,760 Speaker 2: what they ended up doing. 203 00:10:32,960 --> 00:10:36,040 Speaker 5: Well. At the most basic, credit fault swaps were a 204 00:10:36,120 --> 00:10:39,280 Speaker 5: way of taking out a bet on whether or not 205 00:10:39,320 --> 00:10:42,920 Speaker 5: you thought alone or a bond would go into default, 206 00:10:43,960 --> 00:10:49,160 Speaker 5: and they were originally created for corporate bonds, and essentially, 207 00:10:49,640 --> 00:10:53,400 Speaker 5: people who thought that a company looked a bit dodgy 208 00:10:53,960 --> 00:10:56,600 Speaker 5: could take out a credit a fault swap as a 209 00:10:56,640 --> 00:10:59,720 Speaker 5: form of insurance or as a way to bet the 210 00:10:59,720 --> 00:11:02,360 Speaker 5: company would actually default, depending on which side of the 211 00:11:02,400 --> 00:11:05,400 Speaker 5: trade they were on, And that was a much more 212 00:11:05,520 --> 00:11:09,920 Speaker 5: flexible way of trading that risk than actually buying the bond, 213 00:11:10,040 --> 00:11:14,120 Speaker 5: because of course corporate bonds are often pretty liquid, they 214 00:11:14,160 --> 00:11:17,000 Speaker 5: may not exist in the size you want, and if 215 00:11:17,000 --> 00:11:20,360 Speaker 5: you'd think a company's going to default, historically the only 216 00:11:20,440 --> 00:11:23,559 Speaker 5: way to express that belief in an investment trade was 217 00:11:23,600 --> 00:11:26,000 Speaker 5: simply not to buy the bond. But the credit defaults 218 00:11:26,040 --> 00:11:27,760 Speaker 5: what that you can actually be much more active in 219 00:11:27,840 --> 00:11:33,880 Speaker 5: betting that it will default. Now, these were initially single instruments, 220 00:11:34,120 --> 00:11:38,520 Speaker 5: usually attached to single companies, and they were created partly 221 00:11:38,559 --> 00:11:42,000 Speaker 5: as a way of running rules around regulations, and in 222 00:11:42,040 --> 00:11:45,560 Speaker 5: particular banking regulations, and it was also created as a 223 00:11:45,559 --> 00:11:47,920 Speaker 5: way for banks to lessen the risk on their own 224 00:11:47,960 --> 00:11:52,920 Speaker 5: books of having exposure to any particular corporate name. However, 225 00:11:53,600 --> 00:11:56,880 Speaker 5: the initial group that created these instruments, which in many 226 00:11:56,920 --> 00:12:00,720 Speaker 5: ways were very very clever and really clever innovation, saw 227 00:12:00,760 --> 00:12:04,000 Speaker 5: the business grow and they began to bundle different credit 228 00:12:04,040 --> 00:12:08,839 Speaker 5: default swats together, and then the idea got transplanted into 229 00:12:08,880 --> 00:12:13,920 Speaker 5: the mortgage market. And then what happened was that masses 230 00:12:14,040 --> 00:12:18,199 Speaker 5: of mortgages from different parts of America were bundled together, 231 00:12:18,880 --> 00:12:23,199 Speaker 5: and then credit defaults were written onto the actual bundles 232 00:12:23,200 --> 00:12:28,120 Speaker 5: of mortgages, and on top of that, the original credit 233 00:12:28,120 --> 00:12:32,360 Speaker 5: default swats linked those mortgages were sometimes pulled together, chopped 234 00:12:32,440 --> 00:12:36,040 Speaker 5: up into new pieces, and sometimes used to reissue entirely 235 00:12:36,080 --> 00:12:40,440 Speaker 5: brand new instruments all over again. And the problem that 236 00:12:40,520 --> 00:12:44,320 Speaker 5: happened at that point was that although when the original 237 00:12:44,360 --> 00:12:47,720 Speaker 5: idea popped up, people could look at a company like 238 00:12:47,840 --> 00:12:50,480 Speaker 5: IBM and say, yeah, you know what, I think it's 239 00:12:50,520 --> 00:12:52,319 Speaker 5: got quite a high default risk or not a high 240 00:12:52,320 --> 00:12:54,480 Speaker 5: default risk, and they kind of knew what they were 241 00:12:54,480 --> 00:12:57,640 Speaker 5: betting on. By the time you're dealing with mortgages from 242 00:12:57,840 --> 00:13:01,440 Speaker 5: gazillions of different homeowners all over the and by the 243 00:13:01,480 --> 00:13:04,959 Speaker 5: time they've been chopped up and then repackaged and then 244 00:13:05,000 --> 00:13:09,160 Speaker 5: repackaged again, it's very hard, indeed, to actually look through 245 00:13:09,240 --> 00:13:12,960 Speaker 5: to what the underlying risks are except by taking it 246 00:13:12,960 --> 00:13:16,319 Speaker 5: on trust, either from the issuer or from a credit 247 00:13:16,400 --> 00:13:20,360 Speaker 5: rating agency. And at the core of what happened in 248 00:13:20,360 --> 00:13:23,720 Speaker 5: two thousand and eight was that all of that complexity 249 00:13:24,000 --> 00:13:28,520 Speaker 5: and opacity meant that you had the equivalent of a 250 00:13:28,640 --> 00:13:32,320 Speaker 5: world where people were buying these instruments on trust, and 251 00:13:32,440 --> 00:13:35,240 Speaker 5: yet that trust wasn't justified because some of them were 252 00:13:35,240 --> 00:13:38,640 Speaker 5: turning bad. And when some of the underlying mortgages started 253 00:13:38,640 --> 00:13:41,720 Speaker 5: to turn bad, what happened was the equivalent of a 254 00:13:41,800 --> 00:13:44,400 Speaker 5: food poisoning scare. And I promise you, Tracy, I'm not 255 00:13:44,400 --> 00:13:46,680 Speaker 5: going to just talk about food, but the best number 256 00:13:46,880 --> 00:13:50,000 Speaker 5: I know is a food poisoning scare where essentially you 257 00:13:50,240 --> 00:13:54,760 Speaker 5: had some of the bits of underlying loans and debts 258 00:13:54,760 --> 00:13:58,880 Speaker 5: and the mortgage bundles went badly wrong. They dasically defaulted. 259 00:13:59,760 --> 00:14:04,040 Speaker 5: The problem was that, as with say sausages in a supermarket, 260 00:14:04,600 --> 00:14:06,600 Speaker 5: if you hear that one or two cows in the 261 00:14:06,600 --> 00:14:11,319 Speaker 5: food chain have got toxic problems and they're creating food 262 00:14:11,320 --> 00:14:14,839 Speaker 5: poisoning problems, if you don't know which sausages that meat 263 00:14:14,840 --> 00:14:17,480 Speaker 5: has gone into, you're probably going to refuse to buy 264 00:14:17,480 --> 00:14:20,960 Speaker 5: any sausages. And if your parents at a school where 265 00:14:21,040 --> 00:14:24,280 Speaker 5: kids are being fed sausage stew, you're probably going to 266 00:14:24,280 --> 00:14:27,160 Speaker 5: tell your kids to stop eating school lunches, period. And 267 00:14:27,320 --> 00:14:29,120 Speaker 5: what happened in two thousand and seven two thousand and 268 00:14:29,160 --> 00:14:32,040 Speaker 5: eight was the financial equivalent of that, because it became 269 00:14:32,160 --> 00:14:35,240 Speaker 5: clear that some of the mortgages had gone bad, nobody 270 00:14:35,280 --> 00:14:39,320 Speaker 5: knew which bundles of default swaps and the rivages had 271 00:14:39,360 --> 00:14:44,800 Speaker 5: gone into, and so essentially consumers aka investors fled the 272 00:14:44,840 --> 00:14:47,080 Speaker 5: market completely. And it throws up. 273 00:15:02,360 --> 00:15:06,880 Speaker 4: I love the analogy of food poisoning scare. I had 274 00:15:06,920 --> 00:15:10,200 Speaker 4: never really thought of it in that particular terms before, 275 00:15:10,240 --> 00:15:12,640 Speaker 4: but I think it sounds very apt. But it also 276 00:15:12,720 --> 00:15:17,080 Speaker 4: seems like when something like a food poisoning scare happens 277 00:15:17,240 --> 00:15:20,280 Speaker 4: in financial markets, you know we just call it a 278 00:15:20,280 --> 00:15:23,800 Speaker 4: bank run, right, And bank runs happen every you know, 279 00:15:24,040 --> 00:15:26,800 Speaker 4: several decades, or you know, big one, maybe happened once 280 00:15:26,840 --> 00:15:30,680 Speaker 4: a century, and they usually take a different form, et cetera. 281 00:15:31,240 --> 00:15:33,600 Speaker 4: But going back to the metaphor of the food poisoning 282 00:15:33,720 --> 00:15:37,120 Speaker 4: scare in retrospect, and I'm curious your take on this 283 00:15:37,200 --> 00:15:39,720 Speaker 4: now in twenty twenty five or maybe twenty fifteen or 284 00:15:39,720 --> 00:15:42,280 Speaker 4: two thousand and nine when the book came out, like 285 00:15:42,800 --> 00:15:46,760 Speaker 4: how much food was actually gone bad? And how much 286 00:15:46,920 --> 00:15:50,240 Speaker 4: was it that a little bit had gone bad? And 287 00:15:50,320 --> 00:15:52,160 Speaker 4: yet people were afraid that everything had gone bad. 288 00:15:52,520 --> 00:15:57,080 Speaker 5: Well, even to this day, the actual numbers are still contested. 289 00:15:57,600 --> 00:15:58,880 Speaker 3: Yeah, it's interesting, isn't it. 290 00:15:59,040 --> 00:16:02,640 Speaker 5: Yes, whether it was twenty five billion, whether it was 291 00:16:02,680 --> 00:16:05,160 Speaker 5: two hundred and fifty billion, we still don't know exactly 292 00:16:05,280 --> 00:16:07,560 Speaker 5: how the mortgagees defaulted. And of course, one of the 293 00:16:07,600 --> 00:16:12,080 Speaker 5: difficulties about trying to measure that in America, like any 294 00:16:12,120 --> 00:16:16,160 Speaker 5: other financial crisis, is that when you have an initial 295 00:16:16,200 --> 00:16:21,040 Speaker 5: property market bust, prices collapsed dramatically and for period of 296 00:16:21,080 --> 00:16:24,400 Speaker 5: time it looks like everything's gone bad, and then subsequently 297 00:16:24,520 --> 00:16:27,600 Speaker 5: some of those loans actually recover because property prices go 298 00:16:27,640 --> 00:16:31,200 Speaker 5: back up again. So it's very hard, indeed to measure 299 00:16:31,440 --> 00:16:34,440 Speaker 5: what the actual losses were. But what we do know 300 00:16:35,040 --> 00:16:36,800 Speaker 5: was that in the run up to two thousand and eight, 301 00:16:37,360 --> 00:16:41,040 Speaker 5: not only had vast amounts of derivities been written linked 302 00:16:41,120 --> 00:16:43,840 Speaker 5: to the mortgage market that was going bad, but a 303 00:16:43,880 --> 00:16:47,280 Speaker 5: lot of those products had been built with a huge 304 00:16:47,280 --> 00:16:50,440 Speaker 5: amount of leverage, which meant that even a small loss 305 00:16:50,440 --> 00:16:55,160 Speaker 5: made them extremely problematic. You had a problem of tranching, 306 00:16:55,440 --> 00:16:59,000 Speaker 5: which was very, very complicated in many of these products. 307 00:16:59,280 --> 00:17:02,040 Speaker 5: The credit rating agencies were for a long time, the 308 00:17:02,080 --> 00:17:04,959 Speaker 5: only way of actually judging whether or not a product 309 00:17:05,000 --> 00:17:06,960 Speaker 5: was good or bad, and it turned out their ratings 310 00:17:07,520 --> 00:17:10,720 Speaker 5: were completely wrong. And you also had a lot of 311 00:17:10,760 --> 00:17:14,040 Speaker 5: these products held by investors who had no tolerance for 312 00:17:14,080 --> 00:17:17,400 Speaker 5: these kind of risks. So you put that all together 313 00:17:17,680 --> 00:17:20,800 Speaker 5: and frankly, you had the makings of a perfect storm. 314 00:17:21,480 --> 00:17:25,719 Speaker 5: And you know, it was very, very painful indeed, And 315 00:17:25,720 --> 00:17:27,880 Speaker 5: what made it doubly painful was that, in the course 316 00:17:27,920 --> 00:17:30,800 Speaker 5: of slicing and dicing all of these different mortgages and 317 00:17:30,800 --> 00:17:34,200 Speaker 5: news and derivatives, many of the products had been labeled 318 00:17:34,320 --> 00:17:37,240 Speaker 5: triple A, and so people thought they were safe and 319 00:17:37,240 --> 00:17:40,040 Speaker 5: it paid them no attention they sat on their balance sheet. 320 00:17:40,680 --> 00:17:44,480 Speaker 5: And the other problem was that people ironically had bought 321 00:17:44,480 --> 00:17:48,000 Speaker 5: these products because they said they wanted to diversify and 322 00:17:48,160 --> 00:17:51,119 Speaker 5: hedge their risks. And the theory was that in the 323 00:17:51,240 --> 00:17:53,119 Speaker 5: old days, a bank had a bunch of loans to 324 00:17:53,560 --> 00:17:57,359 Speaker 5: say a mortgage company, or a bunch of properties, and 325 00:17:57,400 --> 00:18:00,439 Speaker 5: that was very concentrated on their books. If they then 326 00:18:00,520 --> 00:18:03,000 Speaker 5: repackaged them as derivatives and sold them to everyone else, 327 00:18:03,640 --> 00:18:06,880 Speaker 5: then you basically had a problem shared, and a problem 328 00:18:06,960 --> 00:18:09,760 Speaker 5: shared the problem halved. So people thought, well, right, this 329 00:18:09,760 --> 00:18:13,440 Speaker 5: stuff has been scattered across the markets. If something defaults, 330 00:18:13,600 --> 00:18:16,400 Speaker 5: it might hit a lot of people to a tiny amount, 331 00:18:16,760 --> 00:18:20,320 Speaker 5: but it won't wipe anybody out because it's diversified. The 332 00:18:20,520 --> 00:18:24,280 Speaker 5: critical misunderstanding people made was that because the system was 333 00:18:24,320 --> 00:18:28,040 Speaker 5: so opaque and complex, no one saw that all the 334 00:18:28,160 --> 00:18:33,600 Speaker 5: risks were actually reconcentrating themselves back on a couple of 335 00:18:33,640 --> 00:18:37,480 Speaker 5: big institutions books, because the same institution was writing credit 336 00:18:37,480 --> 00:18:41,120 Speaker 5: the false wats to everybody, and in particular, AIG Financial 337 00:18:41,160 --> 00:18:43,840 Speaker 5: Products was at the center of most of these trades. 338 00:18:44,440 --> 00:18:49,160 Speaker 5: So instead of diversifizing and spreading risk credit, the falsewats 339 00:18:49,160 --> 00:18:52,280 Speaker 5: were doing the very opposite and reconcentrating. 340 00:18:51,440 --> 00:18:55,480 Speaker 4: It tracy, the idea that it's really even still impossible 341 00:18:55,520 --> 00:18:58,440 Speaker 4: to know how much of these assets had properly gone bad. 342 00:18:58,720 --> 00:19:01,679 Speaker 4: This has always been my frustrat with badiod dictum of 343 00:19:02,000 --> 00:19:04,760 Speaker 4: lending against good collateral. Yeah, but I've never I've always 344 00:19:04,760 --> 00:19:07,000 Speaker 4: hated there because like, what's good collateral. It's like it's 345 00:19:07,040 --> 00:19:11,480 Speaker 4: good collateral contingent upon reflation of the economy anyway, But 346 00:19:11,600 --> 00:19:14,120 Speaker 4: that's always bothered me. It's a possibility of knowing what's 347 00:19:14,160 --> 00:19:16,320 Speaker 4: good or bad collateral even years after any keep going. 348 00:19:16,640 --> 00:19:19,879 Speaker 2: I enjoy your badget rants for sure. Okay, well, actually 349 00:19:19,920 --> 00:19:21,959 Speaker 2: this feeds into what I was going to ask. So 350 00:19:22,440 --> 00:19:27,280 Speaker 2: the solution to the crisis proposed eventually by regulators was 351 00:19:27,359 --> 00:19:32,520 Speaker 2: more transparency of derivatives and complex financial instruments, so people 352 00:19:32,560 --> 00:19:37,360 Speaker 2: would have to report their positions to the DTCC and 353 00:19:37,920 --> 00:19:42,679 Speaker 2: also central clearing for derivatives. Do you get any sense, Jillian, 354 00:19:42,760 --> 00:19:46,040 Speaker 2: of how big a difference that's made, because when I 355 00:19:46,040 --> 00:19:49,200 Speaker 2: look at the CDs market, parts of it still seem 356 00:19:49,359 --> 00:19:51,960 Speaker 2: very very opaque to me. I mean things like CDX 357 00:19:52,040 --> 00:19:56,560 Speaker 2: index options, swaptions. I don't think those get reported well. 358 00:19:56,600 --> 00:19:59,040 Speaker 5: I think it's basically, as often been, a case of 359 00:19:59,119 --> 00:20:03,280 Speaker 5: two steps forward, one back. So the progress is that 360 00:20:03,320 --> 00:20:05,280 Speaker 5: when I started covering this in two thousand and eight, 361 00:20:05,880 --> 00:20:08,800 Speaker 5: I couldn't get the price for a CDs on anything 362 00:20:09,320 --> 00:20:12,119 Speaker 5: without calling up the brokers individually, one by one and 363 00:20:12,119 --> 00:20:15,320 Speaker 5: getting a quote. I couldn't work out how the market was, 364 00:20:15,880 --> 00:20:19,240 Speaker 5: and it was so opaque that at one stage officials 365 00:20:19,240 --> 00:20:22,159 Speaker 5: at the BIS, a Bank for International Settlements that was 366 00:20:22,160 --> 00:20:24,240 Speaker 5: one of the few institutions that was trying to monitor 367 00:20:24,280 --> 00:20:27,440 Speaker 5: this and raise the alarm. They called me up and said, 368 00:20:27,480 --> 00:20:29,640 Speaker 5: do I have any data? And I went, well, hang, 369 00:20:30,000 --> 00:20:31,440 Speaker 5: you're supposed to have the data. This is the wrong 370 00:20:31,480 --> 00:20:34,080 Speaker 5: way around, and they said, yeah, The problem was we 371 00:20:34,160 --> 00:20:34,719 Speaker 5: just don't know. 372 00:20:35,520 --> 00:20:35,720 Speaker 3: Now. 373 00:20:35,760 --> 00:20:39,680 Speaker 5: The good news is today one you can get CDs 374 00:20:39,720 --> 00:20:44,080 Speaker 5: prices for most instruments that are traded, you know, even slightly. 375 00:20:44,280 --> 00:20:46,719 Speaker 5: You know, in the markets, you can get CDs prices 376 00:20:46,720 --> 00:20:50,680 Speaker 5: relatively easily. Two we do have macro figures about what's 377 00:20:50,720 --> 00:20:54,960 Speaker 5: going on. And three the very fact that you can 378 00:20:55,000 --> 00:20:58,119 Speaker 5: get those prices in the chart form changes how people 379 00:20:58,200 --> 00:21:00,720 Speaker 5: look at the financial sector. I mean, I remember very 380 00:21:00,720 --> 00:21:03,240 Speaker 5: clearly the first time that I actually pushed for the 381 00:21:03,320 --> 00:21:06,800 Speaker 5: ft to publish something called the ABX index, which was 382 00:21:06,840 --> 00:21:10,520 Speaker 5: showing mortgage defaults. It was transformational because suddenly people could 383 00:21:10,520 --> 00:21:13,560 Speaker 5: actually see it and imagine it, and that changed how 384 00:21:13,560 --> 00:21:17,320 Speaker 5: people imagined finance. The same thing happened when axel Weber, 385 00:21:17,800 --> 00:21:21,439 Speaker 5: not axel Weber, one of the other analysts, coined the 386 00:21:21,480 --> 00:21:24,800 Speaker 5: phrase shadow banking for the first time, and suddenly everyone 387 00:21:24,800 --> 00:21:27,800 Speaker 5: realized that what they thought was the financial system dominated 388 00:21:27,800 --> 00:21:30,639 Speaker 5: by banks was dead wrong. In fact, the shadow banking 389 00:21:30,680 --> 00:21:34,200 Speaker 5: world was huge and swelling. So then, in some ways 390 00:21:34,200 --> 00:21:37,200 Speaker 5: it's a lot more transparency than there was fifteen years ago, 391 00:21:37,280 --> 00:21:43,000 Speaker 5: and that's a very good thing. What is troubling is that, firstly, 392 00:21:43,040 --> 00:21:47,879 Speaker 5: the transparency doesn't extend to all instruments. Secondly, the level 393 00:21:47,880 --> 00:21:52,080 Speaker 5: of leverage and above all embedded leverage isn't apparent, and 394 00:21:52,119 --> 00:21:57,159 Speaker 5: that really matters, particularly right now. And thirdly, I'm a 395 00:21:57,200 --> 00:22:01,119 Speaker 5: strong believer that to have effective financial markets, you need 396 00:22:01,119 --> 00:22:03,480 Speaker 5: to have markets where assets can actually be traded properly 397 00:22:04,240 --> 00:22:07,960 Speaker 5: and people can have easy access to that quickly. That 398 00:22:08,000 --> 00:22:10,040 Speaker 5: wasn't the case before two thousand and eight, because people 399 00:22:10,040 --> 00:22:13,359 Speaker 5: who are creating CDOs were doing so ironically in the 400 00:22:13,400 --> 00:22:17,200 Speaker 5: name of creating perfectly liquid markets, and the great buzzword 401 00:22:17,240 --> 00:22:20,440 Speaker 5: back then was liquefication. We're going to use financial innovation 402 00:22:20,560 --> 00:22:24,160 Speaker 5: to liquefy everything, and then we'll have the perfect nirvana 403 00:22:24,480 --> 00:22:27,359 Speaker 5: where all risks surprised properly, and risks end up in 404 00:22:27,359 --> 00:22:29,280 Speaker 5: the hands of people who were best suited to hold them. 405 00:22:29,720 --> 00:22:32,960 Speaker 5: That was a justification for this innovation, And what people 406 00:22:33,000 --> 00:22:35,360 Speaker 5: fell to notice was that the complex instruments they were 407 00:22:35,359 --> 00:22:38,439 Speaker 5: creating were so darn complicated. In fact, they were barely 408 00:22:38,480 --> 00:22:41,240 Speaker 5: being traded at all. I mean, the bundles of so 409 00:22:41,359 --> 00:22:46,160 Speaker 5: called CDOs collateral defaultigations, which were essentially created often through 410 00:22:46,200 --> 00:22:51,000 Speaker 5: synthetic derivatives, were so difficult to trade that most institutions 411 00:22:51,080 --> 00:22:53,480 Speaker 5: just bought them and stuck them on the balance sheet 412 00:22:54,000 --> 00:22:56,920 Speaker 5: and ended up valuing them not with market prices because 413 00:22:56,920 --> 00:22:59,400 Speaker 5: they didn't really exist. There wasn't enough trading, but they 414 00:22:59,480 --> 00:23:01,400 Speaker 5: ended up value in them in the so called marked 415 00:23:01,400 --> 00:23:07,320 Speaker 5: and market system using implied prices from often rating agency models. 416 00:23:08,240 --> 00:23:11,920 Speaker 5: And if you have that situation, all the red lights 417 00:23:11,920 --> 00:23:14,959 Speaker 5: in the dashboard should be flashing, because that shows that 418 00:23:15,240 --> 00:23:17,000 Speaker 5: even if you have a so called marked and market 419 00:23:17,000 --> 00:23:20,120 Speaker 5: accounting system, you don't have enough markets to get proper 420 00:23:20,200 --> 00:23:22,960 Speaker 5: market prices, and you don't really know what the value 421 00:23:23,000 --> 00:23:23,480 Speaker 5: is of things. 422 00:23:24,280 --> 00:23:27,080 Speaker 4: You know, you mentioned that, suddenly you know, someone coins 423 00:23:27,160 --> 00:23:29,520 Speaker 4: the term shadow banking, and then you sort of rethink 424 00:23:29,840 --> 00:23:33,159 Speaker 4: all these different elements of how you see the financial system. 425 00:23:33,680 --> 00:23:36,480 Speaker 4: We talk a lot on the podcast about these days 426 00:23:36,520 --> 00:23:40,359 Speaker 4: about non bank financial institutions in two forms. Primarily we 427 00:23:40,400 --> 00:23:43,080 Speaker 4: talk a lot about private credit. So the post DoD 428 00:23:43,160 --> 00:23:46,639 Speaker 4: Frank emergence of these non bank entities that do a 429 00:23:46,640 --> 00:23:50,960 Speaker 4: lot of lending, and the emergence of multi strategy hedge funds, 430 00:23:51,240 --> 00:23:53,639 Speaker 4: that the post DoD Frank emergence of a lot of 431 00:23:53,640 --> 00:23:55,560 Speaker 4: these funds that do a lot of what used to 432 00:23:55,560 --> 00:23:58,560 Speaker 4: be called prop trading. And of course banks still have 433 00:23:58,640 --> 00:24:01,160 Speaker 4: their role in the ecosystem. And so then the question 434 00:24:01,240 --> 00:24:03,800 Speaker 4: of all, do these risks ultimately redound back to the 435 00:24:03,840 --> 00:24:07,360 Speaker 4: banks who as these outside entities pursue leverage. But I'm curious, 436 00:24:07,640 --> 00:24:11,719 Speaker 4: putting back on the head of these sort of anthropologist perspective, 437 00:24:11,960 --> 00:24:15,120 Speaker 4: how would you go about, like, you know, try to 438 00:24:15,160 --> 00:24:17,400 Speaker 4: see if there are real risks here in the new model, 439 00:24:17,400 --> 00:24:19,720 Speaker 4: Because I don't know, like I've said on the podcast before, 440 00:24:20,200 --> 00:24:23,600 Speaker 4: some of the post dot Frank changes of separating this 441 00:24:23,720 --> 00:24:26,800 Speaker 4: risk taking from deposit taking seems like it maybe was 442 00:24:26,840 --> 00:24:29,440 Speaker 4: a good idea, But like, where might you explore in 443 00:24:29,560 --> 00:24:31,760 Speaker 4: terms of like trying to figure out where these new 444 00:24:31,840 --> 00:24:32,600 Speaker 4: risks emerge? 445 00:24:33,119 --> 00:24:35,640 Speaker 5: Well, I think one of the constant themes from financial 446 00:24:35,760 --> 00:24:39,640 Speaker 5: history is that new risks never emerge where the last 447 00:24:39,720 --> 00:24:42,280 Speaker 5: risks were. Yeah, so I think the parts of another 448 00:24:42,400 --> 00:24:47,000 Speaker 5: crisis with mortgage derivatives right now is about zero. How 449 00:24:47,040 --> 00:24:50,280 Speaker 5: does a crisis tend to emerge as a result of 450 00:24:50,840 --> 00:24:54,879 Speaker 5: three things? One is an overreaction last time round by 451 00:24:54,920 --> 00:24:59,000 Speaker 5: a bunch of regulators that end up introducing changes to 452 00:24:59,040 --> 00:25:01,600 Speaker 5: try and contain the last crisis. That does stort the 453 00:25:01,600 --> 00:25:04,000 Speaker 5: financial system so much that they create the next crisis. 454 00:25:05,000 --> 00:25:06,920 Speaker 5: Because one of the reasons why Crode Dedrivet is popped 455 00:25:07,000 --> 00:25:10,760 Speaker 5: up was partly because in reaction to what had happened 456 00:25:10,800 --> 00:25:13,320 Speaker 5: during the savings and loans crisis in America in the 457 00:25:13,359 --> 00:25:16,800 Speaker 5: nineteen eighties, when there was too much concentration of lending 458 00:25:16,840 --> 00:25:21,200 Speaker 5: exposures on banks books. So one justification for growth derivatives was, well, 459 00:25:21,280 --> 00:25:24,719 Speaker 5: let's create a tool that spreads that exposure around and 460 00:25:24,760 --> 00:25:26,959 Speaker 5: the problem will be solved, which it did, but then 461 00:25:27,000 --> 00:25:30,480 Speaker 5: it created new problems. So first point is look for 462 00:25:30,600 --> 00:25:35,920 Speaker 5: where excessively ham fitted regulation last time around has created 463 00:25:35,960 --> 00:25:40,280 Speaker 5: new distortions. The second key thing is look for what 464 00:25:40,320 --> 00:25:44,800 Speaker 5: people aren't talking about, so social silence is always critical 465 00:25:44,920 --> 00:25:49,880 Speaker 5: in any field. Third point is look for activity that's 466 00:25:49,920 --> 00:25:54,800 Speaker 5: occurring outside silos or between silos. And by that I 467 00:25:54,880 --> 00:25:58,000 Speaker 5: mean that one of the constant problems in finance is 468 00:25:58,040 --> 00:26:02,840 Speaker 5: that institutions and regulators create structures set up to monitor 469 00:26:03,080 --> 00:26:06,720 Speaker 5: and handle the world that existed a couple of years ago, 470 00:26:06,840 --> 00:26:11,000 Speaker 5: and then the outside world moves on and the institutions 471 00:26:11,000 --> 00:26:15,360 Speaker 5: are left with structures which have hardened into bureaucratic organizations. 472 00:26:16,200 --> 00:26:18,640 Speaker 5: So to give you an example of what I mean, UBS, 473 00:26:18,680 --> 00:26:21,000 Speaker 5: which I wrote about in my second to last book 474 00:26:21,000 --> 00:26:25,400 Speaker 5: called the Sido Effect, had a massive risk management department 475 00:26:26,200 --> 00:26:28,359 Speaker 5: and it spent a huge amount of time back in 476 00:26:28,400 --> 00:26:31,280 Speaker 5: two thousand and five sixty seven looking at the risks 477 00:26:31,280 --> 00:26:33,480 Speaker 5: that have blown up financed in the past, which were 478 00:26:33,520 --> 00:26:38,360 Speaker 5: basically hedge funds and leverage loans, and it's massive risk 479 00:26:38,400 --> 00:26:41,840 Speaker 5: management departments spent a huge amount of time examining every 480 00:26:41,840 --> 00:26:45,240 Speaker 5: single possible danger to UBS that might come from that. 481 00:26:46,200 --> 00:26:49,800 Speaker 5: What they did not do was look at this new 482 00:26:49,880 --> 00:26:55,200 Speaker 5: class of activity credit derivatives and mortgage backed securities because 483 00:26:55,320 --> 00:26:58,399 Speaker 5: they were label as triple A ultra safe inside the 484 00:26:58,440 --> 00:27:03,240 Speaker 5: bank's accounting system, so they were ignored, but also they 485 00:27:03,440 --> 00:27:07,000 Speaker 5: cut across different areas of activities inside the bank. So 486 00:27:07,520 --> 00:27:11,560 Speaker 5: a mortgage back default swap was basically both a tradable 487 00:27:11,560 --> 00:27:16,080 Speaker 5: security and something linked to credit and also something linked 488 00:27:16,119 --> 00:27:19,879 Speaker 5: to the operational risk inside the bank as well. And 489 00:27:20,200 --> 00:27:23,760 Speaker 5: UBS risk management department was split into three separate silos 490 00:27:24,560 --> 00:27:28,880 Speaker 5: credit trading and liquidity or logistical risk, and they didn't 491 00:27:28,880 --> 00:27:31,159 Speaker 5: talk to each other. And so on top of the 492 00:27:31,200 --> 00:27:33,639 Speaker 5: fat you had geographical splits in UBS, between the New 493 00:27:33,720 --> 00:27:36,359 Speaker 5: York desk and the zero desk and the London desk. 494 00:27:36,960 --> 00:27:40,080 Speaker 5: You had this completely fragmented system and the new products 495 00:27:40,080 --> 00:27:43,120 Speaker 5: felt in the cracks, and UBS ended up running enormous 496 00:27:43,240 --> 00:27:47,040 Speaker 5: risks that almost looked up even though it had a 497 00:27:47,080 --> 00:27:51,320 Speaker 5: massive risk management department. So I would say look for silos, 498 00:27:51,440 --> 00:27:54,639 Speaker 5: look for what's happening between the silos, and then also 499 00:27:54,880 --> 00:27:58,840 Speaker 5: look for new hidden concentrations of risk. And if I 500 00:27:59,200 --> 00:28:02,400 Speaker 5: extrapolate that to the current world today, you know one 501 00:28:02,480 --> 00:28:05,000 Speaker 5: area where you have a lot of activity falling between 502 00:28:05,160 --> 00:28:09,760 Speaker 5: regulatory silos and institutional silos is in fintech and in 503 00:28:09,760 --> 00:28:14,640 Speaker 5: additional finance, because the skills you need to understand cyberspace 504 00:28:14,720 --> 00:28:16,960 Speaker 5: are very different from the skills you've historically needed to 505 00:28:17,000 --> 00:28:19,919 Speaker 5: understand the world of money. And you've also got all 506 00:28:20,040 --> 00:28:23,240 Speaker 5: kinds of activity happening on the edge of regulatory perimeters 507 00:28:23,840 --> 00:28:27,360 Speaker 5: which are often not properly policed or understood at all. 508 00:28:27,600 --> 00:28:31,040 Speaker 5: So a classic example of this is the fact that 509 00:28:31,080 --> 00:28:35,040 Speaker 5: the big banks all use cloud computing a lot. They 510 00:28:35,280 --> 00:28:39,080 Speaker 5: all use the same two three four cloud computing providers. 511 00:28:39,720 --> 00:28:44,120 Speaker 5: There's a massive reconcentration of risks there, but groups like 512 00:28:44,160 --> 00:28:48,120 Speaker 5: the Bank for International Settlements and other banking regulators can't 513 00:28:48,280 --> 00:28:53,120 Speaker 5: really track that because it's outside their regulatory perimeter. The 514 00:28:53,520 --> 00:28:57,040 Speaker 5: tech regulators don't track it either, and so you have 515 00:28:57,080 --> 00:29:00,600 Speaker 5: a classic example of a potential risk of the future 516 00:29:00,720 --> 00:29:01,840 Speaker 5: falling between the crafts. 517 00:29:17,600 --> 00:29:20,560 Speaker 2: So I want to bring us up to speed even more, 518 00:29:20,680 --> 00:29:22,840 Speaker 2: I guess, and talk about current events. You've been writing 519 00:29:22,840 --> 00:29:26,800 Speaker 2: a lot about geonomics, which I guess is this idea 520 00:29:27,120 --> 00:29:31,280 Speaker 2: that I guess economic policy is becoming more intermingled with 521 00:29:31,400 --> 00:29:33,240 Speaker 2: state craft, and the idea that you're going to have 522 00:29:33,320 --> 00:29:37,200 Speaker 2: more activist measures from governments when it comes to solving 523 00:29:37,280 --> 00:29:40,480 Speaker 2: particular choke points in the economy. So obviously we have 524 00:29:41,040 --> 00:29:43,880 Speaker 2: Trump and the tariffs as one example, but we also 525 00:29:43,960 --> 00:29:46,800 Speaker 2: had industrial policy on the rise in the US under 526 00:29:46,840 --> 00:29:50,960 Speaker 2: the Biden administration even before that. And I guess I'm 527 00:29:51,040 --> 00:29:57,040 Speaker 2: curious what the rise of geonomics, or maybe the progress 528 00:29:57,080 --> 00:30:03,120 Speaker 2: of protectionism or the slow retreat from globalization. That's a 529 00:30:03,120 --> 00:30:06,400 Speaker 2: big assumption that it's all happening, but I'm curious what 530 00:30:06,480 --> 00:30:09,960 Speaker 2: it means for a financial industry, which, as we've discussed 531 00:30:10,000 --> 00:30:14,880 Speaker 2: on previous episodes, has very much grown in concert with 532 00:30:15,200 --> 00:30:19,320 Speaker 2: globalization and liberalized financial flows and things like that. 533 00:30:19,840 --> 00:30:22,520 Speaker 5: Well, in some ways, genomics is just a posh word 534 00:30:22,680 --> 00:30:27,120 Speaker 5: for political science or political economy, or if you like 535 00:30:27,440 --> 00:30:30,360 Speaker 5: life beyond the balance sheet. And by that I mean 536 00:30:30,680 --> 00:30:34,680 Speaker 5: that most of your listeners grew up in the late 537 00:30:34,720 --> 00:30:37,080 Speaker 5: twentieth century in the West in an era, or if 538 00:30:37,080 --> 00:30:38,320 Speaker 5: they didn't grow up in the West, they want to 539 00:30:38,320 --> 00:30:42,280 Speaker 5: grown up if they're listening to Bloomberg podcast in parts 540 00:30:42,280 --> 00:30:45,480 Speaker 5: of the world which were subject to the missionary zeal 541 00:30:45,680 --> 00:30:51,320 Speaker 5: of the CFA exams, and that essentially implied a certain 542 00:30:51,360 --> 00:30:56,000 Speaker 5: mindset and the mindset arose from a combination of three factors. 543 00:30:56,760 --> 00:31:02,120 Speaker 5: One was the growth of neoliberal free market ideas after 544 00:31:02,120 --> 00:31:06,440 Speaker 5: the nineteen seventies and eighties. The second was the explosion 545 00:31:06,440 --> 00:31:10,280 Speaker 5: in computing power, and the third was explosion in the 546 00:31:10,320 --> 00:31:14,880 Speaker 5: financial industry. And those three things came together to create 547 00:31:14,920 --> 00:31:18,640 Speaker 5: a voracious demand to use the new digital tools in 548 00:31:18,680 --> 00:31:23,920 Speaker 5: computing to model finance and free markets supposedly free markets 549 00:31:24,520 --> 00:31:27,280 Speaker 5: to create a set of instruments that the fast expanding 550 00:31:27,320 --> 00:31:31,880 Speaker 5: ranks of financial professionals could use to price securities, predict 551 00:31:31,920 --> 00:31:34,080 Speaker 5: the future, place trading bets, etc. 552 00:31:34,320 --> 00:31:34,480 Speaker 3: Etc. 553 00:31:34,880 --> 00:31:38,160 Speaker 5: Around the world, backed by groups like the CFA, which 554 00:31:38,200 --> 00:31:41,280 Speaker 5: were a bit like the American financial equivalent of the 555 00:31:41,280 --> 00:31:44,080 Speaker 5: Catholic Church in that they went around the world evangelizing 556 00:31:44,600 --> 00:31:49,120 Speaker 5: and spreading the creed right around the world. Now, that mindset, 557 00:31:49,200 --> 00:31:51,840 Speaker 5: which we all grew up with, and as an anthropologist 558 00:31:51,840 --> 00:31:55,080 Speaker 5: would say, we're all creatures of our own cultural environment, 559 00:31:55,640 --> 00:31:58,960 Speaker 5: seems to us to be normal, natural, and inevitable, and 560 00:31:59,160 --> 00:32:02,040 Speaker 5: it doesn't just useting pan to predict the future. It's 561 00:32:02,080 --> 00:32:04,920 Speaker 5: also marked by a certain amount of tunnel vision, because 562 00:32:05,480 --> 00:32:07,680 Speaker 5: it assumes that if you put the right inputs into 563 00:32:07,680 --> 00:32:10,840 Speaker 5: an economic model or put the information that matters onto 564 00:32:10,840 --> 00:32:13,840 Speaker 5: a balance sheet of a company, you've basically got the 565 00:32:13,920 --> 00:32:17,800 Speaker 5: key to model and forecast what's going to happen next. 566 00:32:18,800 --> 00:32:21,960 Speaker 5: And in some ways that worked really well. But the 567 00:32:22,000 --> 00:32:25,120 Speaker 5: problem is that there are always things that you leave 568 00:32:25,160 --> 00:32:27,720 Speaker 5: out of your economic model. There are always things that 569 00:32:27,760 --> 00:32:29,880 Speaker 5: you leave out of your balance sheet or just footnotes, 570 00:32:30,360 --> 00:32:35,200 Speaker 5: and those things tend to be things like politics, social conflict, 571 00:32:35,800 --> 00:32:41,080 Speaker 5: tech change, environmental risk, medical risk, or what groups like 572 00:32:41,080 --> 00:32:44,920 Speaker 5: the World Economic Forum coily call interstate conflict better known 573 00:32:44,960 --> 00:32:49,120 Speaker 5: as war. And the story of the last two decades 574 00:32:49,360 --> 00:32:51,640 Speaker 5: is that everything that wasn't on the balance sheet or 575 00:32:51,640 --> 00:32:55,240 Speaker 5: in the model is what's really blown up everyone's forecasts 576 00:32:55,800 --> 00:32:59,480 Speaker 5: and become increasingly important. So what we're seeing now, in 577 00:32:59,520 --> 00:33:03,760 Speaker 5: my view, is really the fifth big swing in the 578 00:33:03,800 --> 00:33:07,600 Speaker 5: intellectual zeitgeist since nineteen hundred, and by that I mean 579 00:33:07,640 --> 00:33:12,240 Speaker 5: that between up until nineteen fourteen, you really had imperialist 580 00:33:12,400 --> 00:33:16,360 Speaker 5: free market capitalism in the world. Then between the wars 581 00:33:16,560 --> 00:33:22,360 Speaker 5: you had protectionist, populist nationalist visions of the economy. Then 582 00:33:22,400 --> 00:33:25,840 Speaker 5: after World War II you essentially had Canesianism took root 583 00:33:26,240 --> 00:33:28,960 Speaker 5: the idea the state could jump in and direct things 584 00:33:29,000 --> 00:33:31,440 Speaker 5: for the good of all, and that was really sort 585 00:33:31,440 --> 00:33:35,280 Speaker 5: of international Knesianism. Then you had the neoliberal age really 586 00:33:35,320 --> 00:33:38,400 Speaker 5: start in the nineteen eighties, and now you've got a 587 00:33:38,440 --> 00:33:42,719 Speaker 5: swing of the pendulum back towards effectively geoeconomics, where there 588 00:33:42,880 --> 00:33:45,320 Speaker 5: was woken up and discovered what they always knew back 589 00:33:45,320 --> 00:33:47,840 Speaker 5: in the nineteen twenties, and they also sort of knew 590 00:33:47,840 --> 00:33:51,200 Speaker 5: back in the canes In period, which is that power matters, 591 00:33:51,640 --> 00:33:55,080 Speaker 5: politics matters. It's not all about free markets, and free 592 00:33:55,080 --> 00:33:58,120 Speaker 5: markets are often something of a canard or a falsehood, 593 00:33:58,680 --> 00:34:01,200 Speaker 5: and that actually, well, when you want to make sense 594 00:34:01,200 --> 00:34:05,480 Speaker 5: of the world, you have to combine economics and political analysis, 595 00:34:05,600 --> 00:34:09,120 Speaker 5: social analysis, tech analysis, look at a much wider range 596 00:34:09,120 --> 00:34:13,120 Speaker 5: of things. Get lateral vision, not tunnel vision. And I'm 597 00:34:13,160 --> 00:34:16,400 Speaker 5: not saying in any way, shape or form that that 598 00:34:16,480 --> 00:34:19,400 Speaker 5: means economic doesn't work anymore. But what I say is 599 00:34:19,440 --> 00:34:22,279 Speaker 5: you have to look at your economic models and all 600 00:34:22,320 --> 00:34:25,520 Speaker 5: the lovely tools that the financial industry has developed as 601 00:34:25,560 --> 00:34:28,560 Speaker 5: being a bit like a compass. And if you're stuck 602 00:34:28,600 --> 00:34:30,560 Speaker 5: in the dark wood at night, you don't want to 603 00:34:30,560 --> 00:34:34,040 Speaker 5: throw away your compass because it's incredibly useful. But if 604 00:34:34,080 --> 00:34:37,040 Speaker 5: you only stare down at the face of that compass 605 00:34:37,600 --> 00:34:40,400 Speaker 5: and walk through that wood at night, you're probably going 606 00:34:40,480 --> 00:34:42,200 Speaker 5: to walk into a tree or trip over a tree 607 00:34:42,239 --> 00:34:45,720 Speaker 5: root because you have to look up and around beyond 608 00:34:45,719 --> 00:34:50,040 Speaker 5: your compass to see what's actually happening. And that's really 609 00:34:50,080 --> 00:34:51,520 Speaker 5: what geo economics is trying to do. 610 00:34:51,800 --> 00:34:52,200 Speaker 3: I love that. 611 00:34:52,360 --> 00:34:55,320 Speaker 4: I love the compass forest analogy. You know, it's easy, 612 00:34:55,880 --> 00:34:58,719 Speaker 4: and I've engaged in it myself. But it's easy to 613 00:34:58,920 --> 00:35:01,239 Speaker 4: look back at the nine these and the sort of 614 00:35:01,480 --> 00:35:05,080 Speaker 4: the end of history optimism, you know, and some of 615 00:35:05,120 --> 00:35:07,600 Speaker 4: the predictions of you know, mid nineties, which is kind 616 00:35:07,600 --> 00:35:10,120 Speaker 4: of where the where their story much of it starts 617 00:35:10,120 --> 00:35:12,760 Speaker 4: in your book Fool's Gold with some of the early 618 00:35:12,840 --> 00:35:16,000 Speaker 4: iterations on this stuff, and it's easy to look back 619 00:35:16,080 --> 00:35:17,880 Speaker 4: and it's like talk about the naive take, but I 620 00:35:18,000 --> 00:35:20,239 Speaker 4: get it. I mean, like we the West had just 621 00:35:20,280 --> 00:35:23,239 Speaker 4: won the Cold War in like really decisive fashion, and 622 00:35:23,280 --> 00:35:24,719 Speaker 4: this is something you talk about in your book and 623 00:35:24,760 --> 00:35:26,759 Speaker 4: you just mentioned it. Now it's like we really did 624 00:35:26,800 --> 00:35:30,960 Speaker 4: suddenly also have this emergence of really powerful tools to 625 00:35:31,239 --> 00:35:32,879 Speaker 4: price risk and price. 626 00:35:32,719 --> 00:35:34,000 Speaker 3: Various events in the future. 627 00:35:34,040 --> 00:35:37,320 Speaker 4: So at the same time that like everyone sort of said, okay, 628 00:35:37,400 --> 00:35:41,560 Speaker 4: liberalism and capitalism, democracy are vindicated, and suddenly like we 629 00:35:41,640 --> 00:35:45,319 Speaker 4: have these incredible calculators or computers that can do a 630 00:35:45,360 --> 00:35:49,080 Speaker 4: reasonably good job pricing risk. Outside of the emergence of 631 00:35:49,160 --> 00:35:51,960 Speaker 4: some of these trees that you run into, like I 632 00:35:52,040 --> 00:35:55,759 Speaker 4: have a lot of sympathy for the characters of that time, 633 00:35:55,840 --> 00:35:57,600 Speaker 4: thinking like, oh this is things are going. 634 00:35:57,520 --> 00:35:58,120 Speaker 3: To be really good. 635 00:35:58,440 --> 00:36:01,279 Speaker 5: Well, I completely ad sympathy. And the reality is that 636 00:36:01,520 --> 00:36:05,880 Speaker 5: humans basically move in pendulance wings and whenever it's a 637 00:36:05,920 --> 00:36:08,120 Speaker 5: new innovation, we're all dazzled by it until we see 638 00:36:08,160 --> 00:36:11,080 Speaker 5: the downside. And just as we learned about the upside 639 00:36:11,080 --> 00:36:14,640 Speaker 5: of derivatives and then learned about the downside, we've all 640 00:36:14,719 --> 00:36:16,920 Speaker 5: learned about the upside of economic models, and there are 641 00:36:17,080 --> 00:36:20,719 Speaker 5: huge economic advantages to using them, and now we see 642 00:36:20,719 --> 00:36:22,920 Speaker 5: the downsides. And I should say, the other thing that 643 00:36:22,960 --> 00:36:26,080 Speaker 5: makes it dangerous to use this kind of neoliberal mindset 644 00:36:26,280 --> 00:36:31,320 Speaker 5: is that you've got governments in the world moving away 645 00:36:31,560 --> 00:36:36,640 Speaker 5: from a liberal mindset themselves. And Donald Trump epitomizes that. 646 00:36:37,239 --> 00:36:39,600 Speaker 5: But he's as much a symptom as a cause of this, 647 00:36:40,320 --> 00:36:44,200 Speaker 5: in that for the Trump administration, economics doesn't sit in 648 00:36:44,239 --> 00:36:49,360 Speaker 5: a separate box, which is distinct from tech, trade policy, 649 00:36:49,640 --> 00:36:53,920 Speaker 5: military stuff anymore as far as the Donald Trump administration 650 00:36:53,960 --> 00:36:56,080 Speaker 5: is concerned. And you can see this in the way 651 00:36:56,120 --> 00:37:00,840 Speaker 5: they approach negotiations of other countries. Tech issues, tree issues, 652 00:37:00,960 --> 00:37:05,400 Speaker 5: cultural issues, finance issues, trade issues are all jumbled up 653 00:37:05,440 --> 00:37:09,799 Speaker 5: together as part of a whole, and it's horrifying to 654 00:37:09,960 --> 00:37:13,680 Speaker 5: most governments read in that near liberal mindset. But I 655 00:37:13,680 --> 00:37:15,560 Speaker 5: suspect it's probably going to be the trend for quite 656 00:37:15,560 --> 00:37:15,920 Speaker 5: a while. 657 00:37:16,360 --> 00:37:16,800 Speaker 3: Yeah. 658 00:37:16,920 --> 00:37:19,120 Speaker 4: I joked on Twitter the other day that in every 659 00:37:19,120 --> 00:37:21,359 Speaker 4: foreign election, I just like, just tell me which one 660 00:37:21,440 --> 00:37:23,200 Speaker 4: is the Trump and which one is the Liberal. Then 661 00:37:23,239 --> 00:37:26,080 Speaker 4: I figured there's I don't really see the world that flatly, 662 00:37:26,160 --> 00:37:29,320 Speaker 4: but kind of. But you know, going back to anthropology 663 00:37:29,440 --> 00:37:31,799 Speaker 4: and back to the nineties and back to these new 664 00:37:31,920 --> 00:37:35,440 Speaker 4: tools and the internet and computers, etc. You say in 665 00:37:35,480 --> 00:37:40,520 Speaker 4: your book that the incoming cohort of bankers who are 666 00:37:40,560 --> 00:37:44,000 Speaker 4: really like, you know, native to this new technology, did 667 00:37:44,000 --> 00:37:47,120 Speaker 4: they sneer? Did they look down to some extent at 668 00:37:47,120 --> 00:37:50,960 Speaker 4: the older generation that might have been more inclined towards 669 00:37:51,200 --> 00:37:54,880 Speaker 4: conservatism about banking because they didn't have the sort of 670 00:37:55,000 --> 00:37:58,319 Speaker 4: skills of the natural inclination to sort of use the 671 00:37:58,360 --> 00:37:59,560 Speaker 4: wonders of technology. 672 00:37:59,800 --> 00:38:03,520 Speaker 5: Well, almost every big innovation that we've seen in the 673 00:38:03,600 --> 00:38:05,719 Speaker 5: last one hundred and fifty years has been driven by 674 00:38:05,719 --> 00:38:08,319 Speaker 5: a bunch of kids. And since I'm sitting in king 675 00:38:08,360 --> 00:38:11,600 Speaker 5: smolishing Cambridge, anyone under the age of who know, thirty 676 00:38:11,640 --> 00:38:14,080 Speaker 5: looks like a kid to me. But a bunch of 677 00:38:14,239 --> 00:38:18,719 Speaker 5: you know, young kids coming in having the mastery of 678 00:38:18,920 --> 00:38:22,440 Speaker 5: knowledge of a new technology that often the older generation 679 00:38:22,520 --> 00:38:25,920 Speaker 5: doesn't understand, full of excitement about how they can innovate 680 00:38:25,960 --> 00:38:29,560 Speaker 5: and break all the rules. And they essentially usually get 681 00:38:29,600 --> 00:38:33,600 Speaker 5: together and do exactly that very rapidly, and you know, 682 00:38:33,680 --> 00:38:37,239 Speaker 5: bring about great benefits, but often end up bringing about 683 00:38:37,280 --> 00:38:40,680 Speaker 5: great harm too. And they often have a messianic zeal 684 00:38:40,800 --> 00:38:44,000 Speaker 5: and belief, although they tell themselves that they are somehow 685 00:38:44,040 --> 00:38:48,160 Speaker 5: saving the world or bringing good for humanity. We've seen 686 00:38:48,160 --> 00:38:51,080 Speaker 5: that happen in life science, We've seen that happening computing, 687 00:38:51,640 --> 00:38:54,840 Speaker 5: in AI, in social media when that was first created. 688 00:38:55,320 --> 00:38:58,719 Speaker 5: The same thing happened with finance and a generation of 689 00:38:58,960 --> 00:39:02,440 Speaker 5: kids who I profile in my book at JP Morgan, 690 00:39:02,520 --> 00:39:05,480 Speaker 5: but not just JP Morgan, who stumbled on the idea 691 00:39:05,520 --> 00:39:09,400 Speaker 5: of creating credit derivatives, did so very fast, did so 692 00:39:09,440 --> 00:39:12,640 Speaker 5: in a way that their bosses often didn't understand and 693 00:39:12,800 --> 00:39:15,279 Speaker 5: let rip. And that's the pattern we've seen over and 694 00:39:15,280 --> 00:39:19,640 Speaker 5: over again. And the reality is that every single innovation 695 00:39:19,719 --> 00:39:23,080 Speaker 5: in history has a good side and a bad side, 696 00:39:23,280 --> 00:39:26,760 Speaker 5: and the older generation can often see the bad side, 697 00:39:27,320 --> 00:39:30,160 Speaker 5: the younger generation can see the good side. Without the 698 00:39:30,400 --> 00:39:33,480 Speaker 5: enthusiasm of the younger generation, nothing will change, but they 699 00:39:33,520 --> 00:39:36,080 Speaker 5: still need the older generation. Oldie is like me now 700 00:39:36,600 --> 00:39:38,960 Speaker 5: to basically point out the previous risks. 701 00:39:39,719 --> 00:39:43,000 Speaker 2: So since we're on the topic of financial products and 702 00:39:43,440 --> 00:39:47,000 Speaker 2: very big changes in the financial system and the way 703 00:39:47,120 --> 00:39:50,000 Speaker 2: people are thinking of trade and things like that, there 704 00:39:50,120 --> 00:39:53,160 Speaker 2: was something that caught my eye and certainly caught your 705 00:39:53,200 --> 00:39:56,879 Speaker 2: eye recently, and that is something called Section eight nine 706 00:39:57,040 --> 00:40:00,600 Speaker 2: nine that basically opens the door to the US taxing 707 00:40:00,719 --> 00:40:04,640 Speaker 2: foreign holders of treasuries, which would be an enormous, enormous 708 00:40:04,719 --> 00:40:08,400 Speaker 2: change to how they've previously been treated. How big a 709 00:40:08,440 --> 00:40:09,080 Speaker 2: deal is that. 710 00:40:09,480 --> 00:40:09,719 Speaker 3: Well. 711 00:40:09,840 --> 00:40:14,400 Speaker 5: One of the other hallmarks of the neoliberal economic mindset 712 00:40:14,480 --> 00:40:16,600 Speaker 5: that we all grew up with and assumed was normal 713 00:40:16,719 --> 00:40:20,600 Speaker 5: and inevitable and unchanging is this idea that capital should 714 00:40:20,640 --> 00:40:25,600 Speaker 5: move freely, and that was seen in the prescriptions of 715 00:40:25,640 --> 00:40:27,960 Speaker 5: the IMF. It was seen in the way that Wall 716 00:40:28,000 --> 00:40:32,480 Speaker 5: Street worked and operated and in pronouncements of politicians, and 717 00:40:32,640 --> 00:40:35,640 Speaker 5: so Section eight ninety nine reverse to the idea that 718 00:40:35,760 --> 00:40:40,080 Speaker 5: there might be taxes, new taxes imposed on non American 719 00:40:40,239 --> 00:40:44,440 Speaker 5: holders of American assets. Now, some people might say, well, 720 00:40:44,480 --> 00:40:47,160 Speaker 5: that's kind of fair enough, because guess what Americans pay 721 00:40:47,239 --> 00:40:50,840 Speaker 5: taxes on capital gains, Why should non Americans be any different. 722 00:40:51,840 --> 00:40:53,839 Speaker 5: But the reality is there's been quite a few tax 723 00:40:53,840 --> 00:40:57,560 Speaker 5: breaks in the past for non Americans to encourage them 724 00:40:57,680 --> 00:41:01,000 Speaker 5: to bring their money to America, and there's been such 725 00:41:01,000 --> 00:41:04,240 Speaker 5: a desire to unleash that flood of money foreign capital 726 00:41:04,760 --> 00:41:08,000 Speaker 5: that back in nineteen eighty four, the American government actually 727 00:41:08,000 --> 00:41:12,680 Speaker 5: removed a pre existing tax on Chinese investors say that 728 00:41:12,800 --> 00:41:16,200 Speaker 5: bought treasuries securities, and so one of the reasons why 729 00:41:16,200 --> 00:41:19,320 Speaker 5: you've seen in China parlia in such big time into 730 00:41:19,440 --> 00:41:23,000 Speaker 5: the American treasures market is because of those kind of incentives. 731 00:41:24,000 --> 00:41:26,319 Speaker 5: Now we've all got used to this idea, is that 732 00:41:26,360 --> 00:41:28,720 Speaker 5: there should be encouragements so foreigners to come and invest 733 00:41:28,760 --> 00:41:32,520 Speaker 5: in countries we give a granted as normal. The reality is, though, 734 00:41:32,560 --> 00:41:35,279 Speaker 5: that Trump administration has a very different perspective on this, 735 00:41:36,120 --> 00:41:39,400 Speaker 5: and so not only are they thinking reversing the nineteen 736 00:41:39,440 --> 00:41:42,759 Speaker 5: eighty four ruling, which means that in fact, Chinese and 737 00:41:42,800 --> 00:41:46,000 Speaker 5: others would face the taxes if they bought treasuries. But 738 00:41:46,080 --> 00:41:48,680 Speaker 5: they're also thinking of using this so called Section eight 739 00:41:48,760 --> 00:41:52,000 Speaker 5: ninet nine to impose taxes on non American holders of 740 00:41:52,000 --> 00:41:55,560 Speaker 5: American assets. And they're doing that partly because they want 741 00:41:55,560 --> 00:41:58,360 Speaker 5: to get lots of revenue. There's a think tank allied 742 00:41:58,400 --> 00:42:01,319 Speaker 5: with Jdvans that suggests you could get two trillion dollars 743 00:42:01,360 --> 00:42:04,920 Speaker 5: worth of revenue from this. But there's also a desire 744 00:42:04,960 --> 00:42:07,960 Speaker 5: to slow the amount of money flooding into America, to 745 00:42:08,080 --> 00:42:11,759 Speaker 5: weaken the dollar, and to ensure that American industry can 746 00:42:11,840 --> 00:42:15,760 Speaker 5: become more competitive. So it's quite a different mindset again 747 00:42:15,920 --> 00:42:17,640 Speaker 5: that I think most people are not prepared for. 748 00:42:18,120 --> 00:42:20,960 Speaker 2: Yeah, a very big change, Jillian. We're going to have 749 00:42:20,960 --> 00:42:22,839 Speaker 2: to leave it there. Honestly, we could talk to you 750 00:42:22,920 --> 00:42:26,400 Speaker 2: for hours about many, many different things. But that was 751 00:42:26,480 --> 00:42:29,640 Speaker 2: so much fun to catch up on derivatives and talk 752 00:42:29,680 --> 00:42:32,959 Speaker 2: about maybe where risks are lurking in the financial system. Now, 753 00:42:33,200 --> 00:42:35,879 Speaker 2: really appreciate you coming on our thoughts for the first time. 754 00:42:35,920 --> 00:42:36,919 Speaker 2: We have to have you back. 755 00:42:37,280 --> 00:42:39,120 Speaker 5: Well, thank you. I really enjoyed chatting to you. And 756 00:42:39,160 --> 00:42:41,360 Speaker 5: the last thought I'll leave you with is that the 757 00:42:41,400 --> 00:42:43,319 Speaker 5: period of time that we all grew up with when 758 00:42:43,360 --> 00:42:47,279 Speaker 5: free market ideals were taken for granted, is actually a 759 00:42:47,480 --> 00:42:51,080 Speaker 5: historical aberration, and if you look across the societies and 760 00:42:51,120 --> 00:42:53,840 Speaker 5: most points of history, it's not the case that the 761 00:42:53,880 --> 00:42:57,000 Speaker 5: world we're moving into now it's weird. We were the 762 00:42:57,040 --> 00:42:59,160 Speaker 5: weird ones for the last forty years. 763 00:42:59,600 --> 00:43:00,160 Speaker 3: I love that. 764 00:43:00,320 --> 00:43:02,480 Speaker 2: Okay, Jillian, thank you so much, thank you. 765 00:43:02,880 --> 00:43:03,520 Speaker 3: Thanks by. 766 00:43:16,440 --> 00:43:17,880 Speaker 2: Joe, we were the weird ones. 767 00:43:18,160 --> 00:43:21,120 Speaker 3: Yeah, I think about this all the time. Actually. 768 00:43:21,160 --> 00:43:24,360 Speaker 4: The thing so many, so many things in that conversation 769 00:43:24,480 --> 00:43:26,960 Speaker 4: I think about all the time actually, but one thing 770 00:43:27,000 --> 00:43:28,960 Speaker 4: I think about, like we are the weird ones, which 771 00:43:29,000 --> 00:43:31,400 Speaker 4: is probably true, but the idea that we would have 772 00:43:31,440 --> 00:43:35,200 Speaker 4: any conception of what normal is or like you know, 773 00:43:35,239 --> 00:43:37,439 Speaker 4: things are getting weird, Like it's so weird in its 774 00:43:37,440 --> 00:43:40,040 Speaker 4: premise because like in some sense, I think that the 775 00:43:40,080 --> 00:43:43,040 Speaker 4: modern economy or the modern world has roughly existed since 776 00:43:43,040 --> 00:43:45,600 Speaker 4: the end of World War two, and so basically eighty 777 00:43:45,680 --> 00:43:48,319 Speaker 4: years are a little more and so like literally like 778 00:43:48,360 --> 00:43:51,680 Speaker 4: the entire like one person's lifetime, Like that's nothing. Yeah, 779 00:43:51,680 --> 00:43:54,600 Speaker 4: that's literally nothing that we're barely getting. It's day one 780 00:43:54,640 --> 00:43:56,960 Speaker 4: around here in terms of what the modern So when 781 00:43:56,960 --> 00:43:59,520 Speaker 4: you think about all these changes AI et cetera, like, 782 00:43:59,800 --> 00:44:03,200 Speaker 4: we have no normal index against really because we're just 783 00:44:03,239 --> 00:44:03,920 Speaker 4: getting started. 784 00:44:04,040 --> 00:44:06,920 Speaker 2: Yeah, timelines are very very long. The other thing I 785 00:44:06,960 --> 00:44:10,440 Speaker 2: was thinking is just on the sort of geonomics revival 786 00:44:10,480 --> 00:44:13,640 Speaker 2: of industrial policy point. I wonder if we will get 787 00:44:13,719 --> 00:44:19,120 Speaker 2: financial products that are like tailored at targeting those particular risks. So, 788 00:44:19,400 --> 00:44:22,280 Speaker 2: for instance, could you come up with like a tariff 789 00:44:22,360 --> 00:44:25,759 Speaker 2: hedge of some sort just in case Trump is going 790 00:44:25,800 --> 00:44:28,759 Speaker 2: to announce something one day and then maybe take it 791 00:44:28,800 --> 00:44:30,879 Speaker 2: back the next day. I wonder if that's a risk 792 00:44:30,960 --> 00:44:32,919 Speaker 2: that companies could offload in some way. 793 00:44:33,239 --> 00:44:35,879 Speaker 4: It would be really interesting to think about like very 794 00:44:35,920 --> 00:44:39,360 Speaker 4: specific measurable risks. Yeah, you could build on them in 795 00:44:39,400 --> 00:44:41,800 Speaker 4: this new society. But I'm glad you asked that question. 796 00:44:41,880 --> 00:44:45,320 Speaker 4: Also about the sort of geonomics and what that means 797 00:44:45,360 --> 00:44:49,239 Speaker 4: for financial institutions, because you know, I really started thinking 798 00:44:49,280 --> 00:44:52,359 Speaker 4: about this after a recent episode with Scott Bock, and 799 00:44:52,600 --> 00:44:55,120 Speaker 4: I've thought about this in the derivative sense. So much 800 00:44:55,120 --> 00:44:59,200 Speaker 4: of the growth of finance is very specifically about solving, 801 00:44:59,480 --> 00:45:02,520 Speaker 4: not justres of problems of complexity, but problems of a 802 00:45:02,560 --> 00:45:06,719 Speaker 4: cross border complexity. And you know, even the fact that 803 00:45:07,320 --> 00:45:09,400 Speaker 4: Jillian talks about this in her book, the fact London 804 00:45:09,440 --> 00:45:12,400 Speaker 4: emerging as a source of this in part due to 805 00:45:13,040 --> 00:45:17,359 Speaker 4: US regulations and pre Glass Deegal repeal, stuff like that. 806 00:45:17,760 --> 00:45:20,799 Speaker 4: Lots of interesting themes right there, right, And. 807 00:45:20,800 --> 00:45:23,439 Speaker 2: If you have something like section eight nine to nine 808 00:45:23,520 --> 00:45:28,719 Speaker 2: that is calculated to just incentivize investors from holding US treasuries, 809 00:45:28,719 --> 00:45:31,160 Speaker 2: then that would decrease demand for a bunch of financial 810 00:45:31,200 --> 00:45:33,759 Speaker 2: products such as treasury futures and things like that. 811 00:45:33,920 --> 00:45:37,280 Speaker 4: I still want to push forward on my project to 812 00:45:37,480 --> 00:45:42,480 Speaker 4: vindicate the existence of high finance, and I suspect that 813 00:45:42,560 --> 00:45:45,480 Speaker 4: there's a reason that. And you know, like as Julian said, 814 00:45:45,520 --> 00:45:47,680 Speaker 4: like you know, there's still derivatives, but the next crisis 815 00:45:47,719 --> 00:45:50,160 Speaker 4: is probably not going to be in the derivatives that 816 00:45:50,200 --> 00:45:53,400 Speaker 4: were sort of vilified or people were anxious about fifteen 817 00:45:53,480 --> 00:45:53,839 Speaker 4: years ago. 818 00:45:53,920 --> 00:45:55,000 Speaker 3: Right, It's gonna be something. 819 00:45:55,040 --> 00:45:55,680 Speaker 2: It always changed. 820 00:45:55,719 --> 00:45:58,279 Speaker 4: But you know, people still get paid a lot of 821 00:45:58,320 --> 00:46:01,399 Speaker 4: money to create and trade these instruments. And I still 822 00:46:01,400 --> 00:46:04,240 Speaker 4: have this intuition is because they're providing a valuable service, 823 00:46:04,360 --> 00:46:06,440 Speaker 4: and so I want to you know, do more episodes 824 00:46:06,600 --> 00:46:10,000 Speaker 4: on vindicating the status of finance and society. 825 00:46:10,000 --> 00:46:11,960 Speaker 2: We got to get Dalio back on to do a 826 00:46:12,000 --> 00:46:15,000 Speaker 2: deep dive into hedging the chicken McNugget totally. 827 00:46:15,120 --> 00:46:17,280 Speaker 3: That's all kinds of these things that we will discover. 828 00:46:17,480 --> 00:46:19,239 Speaker 2: All right, shall we leave it there for now? 829 00:46:19,280 --> 00:46:20,000 Speaker 3: Let's leave it there. 830 00:46:20,040 --> 00:46:22,320 Speaker 2: This has been another episode of the aud Loots podcast. 831 00:46:22,440 --> 00:46:25,400 Speaker 2: I'm Tracy Aalloway. You can follow me at Tracy Alloway. 832 00:46:25,680 --> 00:46:28,400 Speaker 4: And I'm Joe Wysenthal. You can follow me at the Stalwart. 833 00:46:28,680 --> 00:46:32,640 Speaker 4: Follow Jillian Tet. She's at Jillian Tet. Follow our producers Carman, 834 00:46:32,719 --> 00:46:35,640 Speaker 4: Rodriguez at Kerman Erman dash Ol Bennett at Dashbot, and 835 00:46:35,760 --> 00:46:39,280 Speaker 4: Kilbrooks at Kelbrooks. More odd Lots content go to Bloomberg 836 00:46:39,320 --> 00:46:41,320 Speaker 4: dot com slash odd Lots, where we have a daily 837 00:46:41,360 --> 00:46:44,239 Speaker 4: newsletter and all of our episodes, and you can chout 838 00:46:44,239 --> 00:46:46,160 Speaker 4: about all of these topics twenty four to seven in 839 00:46:46,320 --> 00:46:49,800 Speaker 4: our discord Discord dot gg slash odd Lots. 840 00:46:49,920 --> 00:46:52,080 Speaker 2: And if you enjoy odd Lots, if you like it 841 00:46:52,120 --> 00:46:55,440 Speaker 2: when we talk about the value of complex financial products, 842 00:46:55,480 --> 00:46:58,000 Speaker 2: then please leave us a positive review on your favorite 843 00:46:58,040 --> 00:47:01,919 Speaker 2: podcast platform. And remember, if you are a Bloomberg subscriber, 844 00:47:02,000 --> 00:47:05,080 Speaker 2: you can listen to all of our episodes absolutely ad free. 845 00:47:05,400 --> 00:47:07,480 Speaker 2: All you need to do is find the Bloomberg channel 846 00:47:07,520 --> 00:47:11,120 Speaker 2: on Apple Podcasts and follow the instructions there. Thanks for listening.