All language subtitles for The Ascent of Money - 4of6 - Risky Business - Ch4 2009 DVDRip XviD AC3

THUNDER RUMBLES

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.

lt's all about being in the wrong place
at the wrong time,

like New Orleans
when Hurricane Katrina hit.

The question is, how shouId we deaI with
the risks and uncertainties of the future?

ShouId the onus be on the individuaI
to insure against disaster?

ShouId we be abIe to reIy on the voIuntary
charity of our feIIow human beings

when caIamity strikes?

Or shouId we be abIe
to count on the state -

in other words, the compuIsory
contributions of our feIIow taxpayers -

to baiI us out when the fIood comes?

THUNDER RUMBLES

That's a long way of asking
a simple question -

are you insured?

The British certainly think they are.

GULLS CRY

Today, we pay a larger proportion
of our income on insurance

than any other people in the world.

lt'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.

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 IndustriaI CanaI Iinks
Lake Pontchartrain to the Mississippi.

After the hurricane,
the huge storm surge

raised the water IeveI
in the canaI so high

that it broke the Ievee,

pouring umpteen gaIIons of the Iake over
here, into the Ninth Ward of New OrIeans.

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 Iine.
- That's the water Iine.

(Joey DiFatta) Where it came up to.

The water came in this buiIding in, er...

- 1 4 feet of water in 15 minutes.
- Wow.

From the second fIoor of this buiIding,

I couId see, coming down
Judge Perez, a waII of water.

In that waII of water was debris -
cars, vehicIes, pieces of roofs.

And this waII of water,
you know, you guestimate,

had to be maybe 15 to 20 feet taII.

- And moving fast.
- Moving quickIy.

Just coming down this bouIevard street,
and taking everything with it as it came.

The whole of St Bernard Parish
was inundated in just 1 5 minutes.

Only five houses out of 26,000
weren't flooded.

More than 2,000 peopIe
were kiIIed in Hurricane Katrina

and the subsequent fIooding.

Here in St Bernard Parish,
1 48 peopIe Iost their Iives,

mostIy because they became
trapped in their houses

as the fIood waters rose.

The painted signs
on these abandoned houses

say whether dead bodies were found
after the fIood waters receded.

A IittIe bit Iike medievaI London
in the time of pIague.

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 traiIer.

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 sIab, if you wiII.

- You were sIabbed.
- We were sIabbed.

If you couId fix the system...

But I'm fortunate enough
that I have the means to...

- To Iose a house and buiId it.
- Most peopIe here don't.

If you had the power to change the system
so that peopIe really were insured,

how wouId you do that?

Is there a way of making
insurance work again?

There is, and it's discIosure
of what...what you're buying.

Er, so that, you know...

Iike...Iike a drug.

There's a bIack box warning on there.

''This is what it does, this is what
you shouId watch out for.''

As opposed to this device, which
is caIIed a modern insurance poIicy,

which no-one can interpret or understand.

lt 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.

THUNDER RUMBLES

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?
- (Joey DiFatta) That is correct.

They have to make a choice.
Do I buiId a house here?

Or do I reIocate to an area where
insurance may be a IittIe cheaper

and I can afford it?

That is hurting our community,
it's taking our peopIe away,

the nucIeus of this parish,
and puIIing them away.

SHIP HORN

Three years after disaster struck,

St Bernard Parish has only a third
of its pre-Katrina population.

THUNDER RUMBLES

Of course, life has always been dangerous.

The real lesson of Katrina,
or any big disaster,

is that even when we think
we're protected against risk,

sometimes it turns out we're not.

Even making quite modest insurance claims

can seem more trouble than it's worth.

lt 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 proverbiaI rainy day
is the first principIe of insurance,

but the trick is knowing
what to do with your savings

so that, unIike in New OrIeans
after Katrina,

they're in the kitty
when you reaIIy need them.

But to do that, you need to be
more than usuaIIy canny,

and that gives us a vaIuabIe cIue

as to where the history
of modern insurance has its origins.

Where eIse but in bonny, canny ScotIand?

BELL TOLLS

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 1 7 44,

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 1 8th 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 aII, 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 WaIIace
was a hard drinker,

as weII as a mathematicaI prodigy,

who Iiked nothing better than
knocking back magnums of cIaret

with his bibuIous 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 voIuminous
caIcuIations that Robert WaIIace did,

now housed at
the NationaI Archives Of ScotIand.

You can see how he ran the numbers
over and over again,

making very carefuI assumptions
about the maximum number

of widows and orphans
that wouId have to be provided for.

The key point was that, from now on,
ministers wouIdn't just pay money in

that wouId be paid out
when one of their number died.

Rather, they wouId pay premiums
that wouId be used to create a fund,

and the fund wouId then be invested
for profitabIe purposes.

The widows and orphans, henceforth, wouId
be paid out of the returns on that money,

Ieaving the premiums to accumuIate.

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 principIe of insurance
was sufficientIy widespread

to be adopted for the widows
of men who Iost their Iives

fighting against NapoIeon.

At the BattIe of WaterIoo, your chances
of getting kiIIed were up to one in four,

but at Ieast if you'd taken out insurance,

you had the consoIation of knowing
your wife and chiIdren

wouIdn't be thrown out onto the street.

Gives a whoIe 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 1 826,

to reassure his creditors they'd be paid
in the event of his death.

By the mid-1 9th century, being insured
was as much a badge of respectability

as going to church on Sunday.

BELL TOLLS

What no-one anticipated back in 1 7 44

was that the careful calculations
of two Scottish ministers

would grow into today's
huge insurance industry.

As Robert WaIIace
understood 250 years ago,

size matters in insurance,

because the more peopIe
are paying into a fund

the easier it becomes,
by the Iaw of averages,

to predict how much wiII have to be
paid out each year.

AIthough no individuaI's date of death
can be known in advance,

actuaries can caIcuIate the IikeIy Iife
expectancy of a Iarge group of individuaIs

with quite astonishing precision.

ln other words, insurance is all about

trying to cope
with the risks of the future.

lf, 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 Iot of the poor
was once a pretty harsh one -

either dependence on private charity,

or the harsh regime of the workhouse,

Iike this typicaIIy austere one
here in the heart of Edinburgh.

Yet by the 1880s,

peopIe began to feeI that Iife's Iosers
somehow deserved better.

The seed was pIanted of
an entireIy new approach to risk,

a seed that wouId uItimateIy sprout
into the modern weIfare state.

The state system of insurance was designed
to expIoit the uItimate economy of scaIe,

by covering IiteraIIy every citizen
from the cradIe 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.

ln 1 923, 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.

lt 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.

ENGINE REVS

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 1 945, 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.

1 945 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 Iesson was cIear -

the worId was just too dangerous a pIace

for private insurance markets
to cope with.

With the best wiII in the worId,

peopIe couIdn't be expected to insure
themseIves against the US Air Force.

The answer, practicaIIy
everywhere, was the same -

for government to step in.

In effect, to nationaIise 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 weIfare system

in October 1947,

their advisory committee
in sociaI 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 Iibrary of the Japanese
NationaI ParIiament, makes cIear.

It caIIed on the government to provide
against every cause of poverty.

Sickness and injury, disabiIity, death,

chiIdbirth, Iarge famiIies,
oId age and unempIoyment.

Whatever the reason, the needy wouId be
guaranteed the minimum standard of Iiving

by nationaI assistance.

MONKS PERFORM INCANTATIONS

The Japanese wouId no Ionger have to
reIy on the benevoIence of a feudaI Iord

or the Iuck of the gods -

the weIfare state wouId cover them

against aII the vagaries and
vicissitudes of the modern worId.

lf they couldn't afford education,

the state would pay.

lf they couldn't find work,

the state would pay.

lf 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.

ln public health and education,
Japan led the world.

By the late 1 97 0s,

the Japanese could boast
that their country had become

the welfare superpower.

Run Iike this, the weIfare state
seemed to make so much sense.

Japan had achieved security for aII,

the eIimination of risk,

whiIe at the same time
growing so rapidIy that by 1968

it had the second-Iargest
economy in the worId.

One US economist even predicted
that Japan's per-capita income

would overtake America's
by the year 2000.

WeIfare was working
where warfare had faiIed -

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 fataI fIaw in the design
of the post-war weIfare state.

Just what was it that caused those
predictions of Japan's uItimate triumph

to faiI to come true?

The welfare state looked to be working
smoothly enough in 1 97 0s Japan.

But elsewhere, there were signs
that all was not well.

ln 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.

ln 1 97 6, a diminutive professor
called Milton Friedman,

working here at the University of Chicago,

won the Nobel Prize in Economics.

MiIton Friedman won his pIace
in the economic haII of fame

by restating this simpIe equation.

MV = PQ,

where M is the money suppIy,

V is the veIocity at which it circuIates,

P is the price IeveI

and Q is the quantity of expenditures.

Friedman's observation was simpIe -

if the money suppIy went up,
then so did the price IeveI.

Hence, the Quantity Theory of Money.

But you needed much more than
a piece of chaIk and a bIackboard

to answer the second cruciaI question
of MiIton Friedman's career -

what had gone wrong
with the weIfare state?

ln Chile, he found the perfect
laboratory to test his theories.

ln September 1 97 3, 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 baIcony
of the Carrera HoteI,

opponents of the AIIende regime
ceIebrated with champagne

as air force jets fIew overhead
to bomb the Moneda PaIace.

WHISTLING, EXPLOSION

Here in the paIace, AIIende prepared
to make a desperate Iast stand,

armed with an AK-47 presented to him
by his Cuban roIe modeI, FideI Castro.

Looking out the paIace window
and seeing the tanks IiteraIIy roIIing in,

AIIende reaIised that it was aII over
for his dream of a Marxist ChiIe.

Cornered here in what was Ieft
of the presidentiaI quarters,

he took the decision to shoot himseIf.

MILITARY BAND PLAYS

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 worIdwide crisis of the weIfare state,

and posed a stark choice between
aIternative economic systems.

With output coIIapsing
and infIation rampant,

ChiIe's system of universaI benefits
was effectiveIy bankrupt.

For AIIende, the onIy soIution

was fuII-bIown, Soviet-styIe
takeover of the entire economy.

The generaIs and their supporters
knew they didn't want that,

but what did they actuaIIy want,

given that the status quo
was unsustainabIe?

Enter MiIton Friedman.

ln March 1 97 5,

Friedman flew from Chicago
to Chile to answer that question.

SOLDIER SHOUTS ORDERS

ln 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.

''lt 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 roIe in ChiIe's new regime

consisted of more than just a visit
by MiIton Friedman, however.

Since the 1950s, there'd been a steady
stream of bright, young economists

going from this pIace,
the CathoIic University in Santiago,

to study in Chicago,

and they'd come back convinced
of the need to baIance the budget,

tighten the money suppIy,
and IiberaIise trade.

These were the Chicago Boys,
Friedman's foot soIdiers.

And yet the most radicaI of their ideas

went beyond what Friedman
had recommended to Pinochet.

It amounted to a fuII-scaIe
roIIing back of the weIfare state.

The conservative economic revoIution
didn't begin in Thatcher's Britain,

or Reagan's America.

It began right here in ChiIe.

The mastermind behind this wholesale
dismantling of the welfare state

was a young economist called Jose Pinera.

ChiIe's economy was destroyed.
We have had 50 years of protectionism,

state intervention -
Iike sociaIism, if you want -

and that was exacerbated
during the AIIende government.

We had created a sort of weIfare state,

and that, of course,
was going bankrupt in ChiIe.

Between 1979 and 1981 ,

Pinera and his coIIeagues erected
a radicaIIy new pension system for ChiIe,

giving every worker the chance to opt out
of the oId pay-as-you-go state system.

Instead of a payroII tax,

each worker now couId put
10% of his wages aside

into an individuaI
personaI retirement account,

to be managed by private
competing companies.

There was aIso a smaII premium
for disabiIity and Iife insurance.

The idea was to give each worker a sense

that the money being put aside
was his own property,

his own capitaI.

GUITAR PLAYING, MAN SINGING

Pinera gambled. He gave workers a choice -

stick with the old system
of pay as you go,

or opt for the new
personal retirement accounts.

lt 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 moraI 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 heIped pave a peacefuI way back
to a sustainabIe democracy in ChiIe.

And I think they did.

ln 1 980, 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 ChiIe

are investing ChiIean workers' pension
contributions into the stock market.

And they've been doing
a pretty good job of it.

Average returns on the personaI retirement
accounts has been over 10%,

refIecting the fact that
in the 20 years after 1987,

the ChiIean 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 peopIe here
are either unempIoyed

or work in the informaI 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 stiII the IocaI hero,

not Jose Pinera.

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.

(Jose Pinera) Growth makes
a difference in the Iife of every citizen.

The poverty rate in ChiIe
has gone down from about 50%

to 13%.

So this has been reaIIy a huge success

and the pension reform
has been a criticaI eIement in this.

The improvement in ChiIe's
economic performance

since the Chicago Boys' reforms
is reaIIy very hard to argue with.

In the 15 years before
MiIton Friedman's visit,

the growth rate here
was a measIy 0. 1 7% a year.

In the subsequent 15 years,

it increased by a factor of nearIy 20.

The poverty rate here's down to 15%,

compared to 40%
in the rest of Latin America.

And when you Iook down at Santiago's
shiny new financiaI district,

you can see why the ChiIean pension reform

has been imitated right across the region
and, indeed, around the worId.

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 1 97 0s, 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 WeIfare

reIy on an ever-smaIIer number
of active workers

to support an ever-rising
popuIation of retirees.

Back in 1960, there were
something Iike 1 1 active workers

for every one retired person.

But by 2025,

that number couId sink as Iow as two.

In other words,
there'II be one oId-age pensioner

for every two bureaucrats
working here at the Ministry.

In just 30 years, the cost
of sociaI security benefits

has risen in reIation
to Japan's nationaI 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.

lnsurance. lt 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 Iike 9/1 1 and Katrina

expose the Iimits of both
traditionaI insurance

and the weIfare state.

But insurance and weIfare
aren't the onIy ways

to buy yourseIf 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 exactIy 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 lnvestment 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) Nothing is constant.
Nothing is the way it's aIways been.

So what I find is that peopIe
who are reaIIy good at this

have great intuition, great instinct.

Their gut actuaIIy teIIs them something.

The mathematics are important

because they demonstrate
you understand the probIem.

But uItimateIy, the decision about
whether or not to take a given risk

I think is reaIIy a human judgement caII
in every sense of the word.

The origins of hedging,
appropriateIy enough, are agricuIturaI.

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 Iower, than he expects.

A futures contract aIIows him
to protect himseIf

by committing a merchant to buy
the crop when it's brought to market

at a price agreed when the seeds
are being pIanted.

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 worId
as a whoIe is much better off.

It encourages capitaI formation,

it encourages investment,

it encourages peopIe to do
what is needed to be done

to make the worId a better pIace.

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 1 87 4,

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 underIying assets,

aII futures contracts
are known as ''derivatives''.

But an even smarter kind
of derivative is an ''option''.

The buyer of a caII option

has the right, say,
to buy a barreI of oiI for $120

in a year's time.

Now, if the price of oiI rises
to $150 a barreI,

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 oiI stays the same,

or actuaIIy decIines,

he's under no obIigation
to carry through the deaI.

AII he does is to write off
the cost of the option itseIf.

WeII, it's by buying and seIIing compIex
smart derivatives Iike options

that Ken Griffin has become a biIIionaire.

TRADERS SHOUTING

ln theory, derivatives offer a new way
to hedge against an uncertain future.

A much smarter way
than boring old insurance.

And much more profitable.

ln 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.

There are tremendous economic
benefits for peopIe that work here.

$20 biIIion in the hands of 1 ,000 peopIe

is reaIIy a 21st century phenomenon.

This never happened 50 years ago.

Yet there are downsides to hedging too.

When biIIionaire investor Warren Buffet

described derivatives as
''financiaI weapons of mass destruction'',

he aII but prophesised the downfaII
of American insurance giant AIG.

Their European headquarters
are there behind me.

Brought Iow not by seIIing
insurance poIicies,

but by seIIing derivatives
that bIew up in its face.

Our basic human urge
to protect ourselves against risk

has proved frustratingly
difficult to satisfy.

lnsurance companies let us down.

Welfare states sink into insolvency.

And derivatives turn out to be
a double-edged weapon too.

GUNSHOT

And so for many families,

providing for the future
now takes one very simple form -

an investment in a house,

the value of which
is supposed to keep going up

until the day the breadwinners
need to retire.

lf the pension plan
falls short, never mind.

There's always home, sweet home.

As a pension or an insurance poIicy,

this strategy has one very obvious fIaw -

it represents a one-way,
totaIIy unhedged bet

on a singIe market,
the property market.

But as we'II see in the next episode
of The Ascent Of Money,

a bet on bricks and mortar,

or good oId Japanese wood,

is anything but as safe as houses.