PROFESSOR ROBERT SHILLER: OK.
Welcome to Economics 252.
This is Financial Markets,
and I'm Robert Shiller.
This is a course for
undergraduates.
It doesn't presume any
prerequisites except the basic
Intro Econ
[Introductory Economics]
prerequisite.
It's about --
well, the title of the course
is Financial Markets.
By putting "markets" in the
title of the course, I'm
trying to indicate that it's
down to earth, it's about the
real world, and, well, to me it
connotes that this is about
what we do with our lives.
It's about our society.
So, you might imagine it's a
course about trading since it
says "markets," but it's
more general than that.
Finance, I believe, is, as
it says in the course
description, a pillar of
civilized society.
It's the structure through which
we do things, at least
on a large scale of things.
It's about allocating resources
through space and
time, our limited resources
that we have in our world.
It's about incentivizing
people to
do productive things.
It's about sponsoring ventures
that bring together a lot of
people and making sure that
people are fairly treated,
that they contribute
constructively and that they
get a return for doing that.
And it's about managing risks,
that anything that we do in
life is uncertain.
Anything big or important
that we do is uncertain.
And to me that's what financial
markets is about.
To me, this is a course that
will have a philosophical
underpinning, but at the
same time will be
very focused on details.
I'm fascinated by the details
about how things work.
It can be boring, and I hope I'm
not boring in this course,
but it's in the details
that things happen.
So, I want to talk about
particular institutions, and
I'm interpreting finance
broadly in this course.
I want to talk about
banking, insurance.
Sometimes people don't include
insurance as part of finance,
but I don't see why not,
so we'll include it.
It's about securities, about
futures markets, about
derivatives markets, and
it's going to be
about financial crises.
And it's also about
the future.
I like to try to think about
the future, although
it's hard to do so.
Where are we going?
This course will have a U.S.
bias since we live in the
United States.
I know the U.S. better than any
other country, but at the
same time, I recognize that many
of you, or even most of
you, will work outside the U.S.,
and so it's important
that we have a world
perspective, which is
something I will try my utmost
to incorporate in this course.
The world perspective also
particularly matters since we
have other viewers for this
course besides those
people in this room.
This course is one of a couple
dozen courses that Yale
University is offering
free to the world as
part of Open Yale.
And that means there's
a cameraman back
there if you've noticed.
That's Dan Cody filming
the course.
And it will be eventually posted
on the internet and it
will be available through
Open Yale, and then by
proliferation, you'll
find it on many
other websites as well.
This is the second time
this course has been
filmed for Open Yale.
The first time was in 2008,
three years ago.
And I'm very pleased to report
that I have a lot of people in
every imaginable country who
have watched these lectures.
And I get emails from them, so I
know that they're out there.
But I thought that this course
needs updating, probably more
than any course on Open Yale.
You know, a course in physics
only has to be updated for the
last three years of research in
physics, and it's probably
not a big thing for an
undergraduate course.
But finance really has to be
updated, I think, because it's
going through such turmoil
and change right now.
We've had the worst financial
crisis since the Great
Depression, and it's been
a worldwide crisis.
And governments around the world
are working on changing
our financial institutions.
We have organizations of
governments, notably the G-20,
which is very involved
in finance.
It's one of the top items on
their agenda for international
cooperation, it's changing
our financial markets.
So, I think that that's another
reason why I want to
try to keep as international a
focus as I'm good at doing in
this course.
But I hope that those of you who
are in this room are not
disturbed by the camera and feel
you can ask questions.
You don't have to
be on camera.
I think I'm just being filmed.
So, that's where we are.
Now, I wanted to put this in a
little bit broader context.
The other major finance course
that we have here at Yale is
Economics 251 and it's taught by
Professor John Geanakoplos,
who is a mathematical
economist and also a
practitioner.
He's research director for
Ellington Capital.
So, he's somewhat like me in
that he's interested both in
theory and practice.
But his course is definitely
more theoretical and
mathematical than mine.
His is entitled "Financial
Theory." And I can read some
of the topics that --
and his course also will appear
on Open Yale shortly.
You can take the whole course.
But I don't know -- it's
not up at this moment.
It will be up in a
matter of months.
So, I encourage you, if
you want to, to take
Open Yale Econ 251.
But the things that he talks
about in that course, if you
read the topics in this course
you'll see that they're more
mathematical and technical
than mine.
He talks about ''Utilities,
Endowments and How It Leads to
Equilibrium,'' ''Assets and
Time,'' ''The Mathematical
Theory of Bond Pricing,''
''Dynamic Present Value,''
''Social Security and the
Overlapping Generations
Model,'' ''Uncertainty
and Hedging.''
I'm quoting his titles.
''State Pricing.'' That's kind
of an abstract theory.
We talk about the price
of a state of nature.
I won't explain that.
He talks in some length about
the ''Theory of Risk'' and the
''Capital Asset Pricing
Model,'' and about the
''Leverage Cycle,'' which is
relevant to our crises.
So, I recommend you take
Econ 251, but I don't
expect you to take it.
This course is self-contained.
And I'm going to keep
mathematics to the minimum in
these lectures.
But the idea here is that we
can't avoid it completely.
I personally am mathematically
inclined, too, but I'm
understanding that we have
divided our subject matter.
So, John Geanakoplos is doing
the math and the theory, and
I'm doing the real world.
It's not a complete division
like that, but it's
something like that.
So, I'm going to stay to that.
I'm going to talk more about
institutions and history than
about mathematics.
Since I know that most of you
or many of you will not take
Economics 251, what we are doing
is, I'll give a little
indication of the mathematical
principles, more intuitive,
and we have review sessions with
our teaching assistants.
We plan to have six of those.
And those will be on a
Friday in this room.
And they won't be
on Open Yale.
Those will cover the theory,
and it will be like a short
form of Geanakoplos' course.
And then we'll have
problem sets.
And there will be six problems
sets, one for
each of those sessions.
So, there will be some
math in this course.
I wanted to talk about the
purpose of this course, to
clarify it.
One thing is, what do I imagine
you're going to do
with this course?
Well, first of all, I pride
myself that I think I teach --
if I might boast
for a minute --
I think I teach one
of the most useful
courses in Yale College.
At least that's the way
I think about it.
Because this course really
prepares you to do
things in the world.
By the way, I've been teaching
this course now for 25 years.
I first taught it in
the fall of 1985.
Now I don't know if that's
depressing or not.
To me, it's great.
I like to be able to
keep moving ahead.
I wonder what my 1985
course looked like?
Unfortunately, they didn't do
Open Yale and I can't go back
and look at it.
But I think I've gotten more
philosophical and maybe more
real world oriented as
time has gone by.
But the excitement I have
is when I go up --
I give a lot of public talks,
and it's often on Wall Street.
And when I do one on Wall
Street, I like to ask people
for a show of hands.
How many of you were in my
Economics 252 class?
And I typically get one or two
at least who raise their hand.
So, that's a source of pride to
me, that I was involved in
the beginning of
their careers.
And I hope I instilled some
kind of moral sense
to what they do.
But I should say I don't think
that most of you will go into
finance, because I think
that most of
you have other purposes.
What does it mean to
go into finance?
Well, it sounds like that means
you would be listed as
someone who is very focused
on finance.
But I think everyone should
know finance.
This should be a required
course, actually, at Yale
College, because finance is so
fundamental to what we do and
the structure of our lives that
I don't see how you can
avoid doing finance
if you want to do
something big and important.
Maybe you don't want to do that
either, so you might want
to become a hermit and then
you don't need finance.
But to me I like to think that
many of you have a sense of
purpose in life.
I should say --
that sounded funny, didn't it?
But what I'm saying is your
purpose is not to make money.
And this is one thing about
finance that bothers me, is
that people think that it's
a field for money-grubbing
people who just want to
go out and make money.
And I don't think so.
I think it's a technology for
doing things, and you don't
want to be mystified by it.
When someone talks some
financial jargon, you don't
want to say, I don't have a
clue what that's about,
because what that's about is
how we make things happen.
And so, I hope that you have
other purposes in life besides
finance, even those of you
who go into finance.
But the question is whether this
is a vocational course.
Here at Yale College there has
been a long tradition that we
are not a vocational school --
I suppose you know that --
that Yale is a liberal
arts [college]
--
we teach you the arts
and sciences.
I actually went to look at the
charter and the act of the
Connecticut government in 1701
that founded this university.
This university was initially
mostly a training ground for
the ministry.
But I actually read in the
Acts of the Governor and
Company of the Colony of
Connecticut: "Yale College is
founded for the educating and
instructing of youth in good
literature, arts, and sciences."
I think that is the
motive here for this
university.
And so, I think it is in some
level vocational, but it's not
vulgar vocational.
I want you to think about what
we're doing and how it fits
into what you do
for your life.
So, I think of finance as a kind
of engineering in a way.
But it's an engineering that
works not with what we call a
technical apparatus,
but with people.
And so, if we want to understand
how to do these
things, we have to get
some technical
apparatus under our belt.
And that's what I'm going to
try to do in this course.
The textbook that I chose for
this course is by Frank
Fabozzi, who is a professor
at the Yale School
of Management --
well, with two co-authors.
We have Franco Modigliani, for
whom I have some personal
affection, because he was my
dissertation adviser at MIT,
and who unfortunately died in
2003, and Frank Jones of
Guardian Life Insurance
Company.
I've also written joint
papers with, well, two
of the three authors.
I've written joint papers with
Fabozzi and with Modigliani --
research papers.
But they're similar to
me in many ways.
They're interested
in the details.
I hope you get interested
in the details.
I find this textbook
fascinating for me.
Well, I first read this
book when I first
started assigning it.
I was going on vacation with
my friend Jeremy Siegel and
our families, who's a professor
at the Wharton
School, and I brought this book
as my poolside reading.
And I was sitting there
with this book.
Other people were reading
novels and fun things.
I don't know what they thought
of me reading this textbook by
the pool, but I thought this is
great, because I thought I
knew most of what's in here,
but there's a lot of things
that I still didn't know
and it was answering
all kinds of questions.
Things you always wanted to
know about real estate
securities, OK, but you
never found out.
Well it's all answered here.
So, I hope you can
take that spirit
in reading the textbook.
That's the only book you have
to purchase for this course.
And it's the main work
that you have.
So, I'm going to ask you about
the details on exams. The
kinds of municipal securities
we have and how the rating
agencies rate them, that's
part of this course.
I believe the details matter.
And so, I'm not going to
just ask you broad
generalities on the exam.
I'm going to ask you
the details.
It's a little bit like teaching
a language, right?
Learning a language is really
important, and you've got to
learn all the words, right?
There's thousands of them.
It's like that.
You're going to be learning
the words of finance.
So, I have another book also,
which is actually not done
yet, but you can access it
through Classes*v2, and later
it will come out as
a published book.
But I'm working on
a book called --
well, I don't know what it
will be called finally.
When you're writing a book,
one thing you learn as an
author is, you can never be
sure what the title of the
book will be.
Because if somebody else uses
the same title and you're
done, somebody else gets to it
first, you've got to change
your title.
But at this moment the title of
my book is "Finance and the
Good Society." I'm not sure
when it will be out.
I was hoping next year, but now
I'm thinking it might take
longer than that.
So, you have something
that's imperfect.
I hope you excuse me when
you look at the
chapters of this book.
You don't have quite all
the chapters either.
But I just thought it was a
good thing to put it in
process for you to --
maybe if you have ideas you can
tell me and the book will
change with your input.
To me it's a good way to write
a book, is to be writing a
book and teaching a
class at the same
time on the same topic.
It's more social.
You know, you just sit in your
office and write and you end
up feeling sterile.
So, this makes it more
alive to me to do
that at the same time.
But I'll tell you what
my book is about.
The title that I now have,
"Finance and the Good
Society," may sound to some
people like an oxymoron,
because they're kind
of incompatible.
People are angry about
finance these days.
We've had --
and this is going to be
an important part
of this course --
we've had the worst financial
crisis since the Great
Depression of the 1930s.
And it's been a worldwide
financial crisis and it isn't
over yet, or it's not clear
that it's over yet.
And people are angry.
People are angry about finance,
people who seem to be
getting rich often it seems
at the expense of others.
Or they seem to be lobbying
their governments to give them
breaks and bailouts,
and they walk home
with billions of dollars.
Something seems immoral
and wrong.
Well, I'm sure some immoral
things are happening, but I
don't think that finance
as a whole is wrong.
And I think of it as
a noble profession.
So, I wanted to try to put
it in perspective.
And it's especially important
when talking to young people
like yourselves, because you're
launching out on a
career, and I want that to be a
moral and purposeful career.
And I want to put finance
in the perspective.
So, the theme that I want
to develop in my book
is that part --
you know, we live in a
capitalist world now and this
world is increasingly
built on finance.
Some people call it we're living
in the era of financial
capitalism.
We have these big multinational
institutions
that are owned by huge numbers,
maybe millions, of
shareholders dispersed
all over the world.
And what makes the whole
thing work and click?
It's the financial
arrangements.
The world is discovering the
importance of finance.
When I go to a foreign country
and give a talk, I
find that people --
it doesn't matter what country
-- they're generally very
interested in finance, because
they think that our modern
financial techniques are part
of what's making so many
places in the world grow
at rapid rates now.
We're living in a time in
history when the developing
world is exploding with growth,
and these countries
that are doing that are
countries that are adopting
modern finance.
So, I want this to go right,
and I want this to be
developing a good society.
By good society, I mean a just
and fair society that allows
people to develop their
talents and expertise.
So, another thought I had was
that the field of finance--
let me give you another slide.
I said I view this course as
one of the most important
courses in Yale College, at
least from a standpoint of
your lives and careers.
I wanted to compare finance
jobs with jobs.
And I don't mean to put down
other departments, but at
least vocationally, let's
put this in perspective.
I wanted to compare jobs
in finance with
jobs in other fields.
So, this is a chart that I
constructed using data from
the Bureau of Labor
Statistics.
And what it has is the number
of people in various
occupations in 2008 and
their projections
for the same in 2018.
So, the red bar is for 2018,
and we'll emphasize that,
because you'll be just
getting into your
careers when that comes.
So, it says, if you look at
financial analysts in the
United States there's
almost 300,000.
Financial managers, it's
over half a million.
Personal financial advisers,
a quarter of a
million, all right?
These are people who specialize
entirely in one
form of finance or another.
But compare that with
economists.
Look at that.
What is that?
About 20,000?
I think they're excluding
professors.
But, you know, just economists
out there --
not very many.
How about astronomers?
OK.
I can't even read that.
I love astronomy by the way, but
I think I made the right
choice when I decided --
well, I shouldn't say that,
you never know.
We all have to do something
different.
And you could become an
astronomer, but there aren't
many jobs in astronomy.
Sociologists, political
scientists, just not many
compared to -- this is just
enormously bigger.
Or mathematicians.
I also put one oddball
field on here:
massage therapists, OK?
The number of massage therapist
jobs outnumbers any
of those other fields by,
what is it, 100:1.
So, this is the kind of
disappointment that people face.
You go to the college
or university --
this is very much on my mind
-- you go to the university
and you develop special skills,
and you leave and then
you end up driving a taxi.
That doesn't mean that I want
to become vocational.
I mean, I don't want to just
train you for a job, but I
want to be relevant.
And it seems to me that
I can be relevant in
talking about finance.
And so, that's the basic core
that I wanted to get.
I mentioned before that people
think that finance is the
field for people who want to get
rich, who want to make a
lot of money.
Well, I think that's
right, actually.
[LAUGHTER]
I don't advise you to
take that as your --
but I wanted to talk about
that a little bit.
So, one thing that you'll note,
Forbes Magazine has an
annual list of the 400 richest
people in America.
So, I looked at that list. Who
do you think they are?
Most of you probably have not
read this list. You might
think that, well, who makes
a lot of money?
Well, it's athletes.
Football players, right?
Baseball players.
And who else?
Oh, movie stars, right?
They make a lot of money.
So, how many do you think of
those are on the Forbes 400 of
the richest people in America?
Well, as I read the list I
didn't see a single movie star
or a single athlete.
There is -- it depends
on how you define it.
Oprah Winfrey is on
the list. OK?
You've heard of her.
She's in the entertainment
business.
But you know, she's also
a finance person.
She runs big businesses.
She's into making
things happen.
And I can assure you that she
knows finance, at least some
basic finance.
You see, finance gets you
to build organizations.
That's how it's done.
And it means raising capital
to make things
happen on a big scale.
You know, no athlete is as
powerful as one of these
random guys on the
Forbes 400 list.
It's interesting.
I looked down the list and I
didn't spot a single Nobel
Prize winner.
Maybe I missed one.
I looked for best
selling authors.
I found one: Bill Gates,
who wrote a book
called The Road Ahead.
But there are not many best
selling authors either.
What do they have in common?
Now about a third of them just
inherited it from their
parents, but most of them
did it themselves.
They just made huge
sums of money.
And what do they do?
Well, they're typically in some
boring line of business.
They make something,
but they're doing
it on a vast scale.
And so, that means they're
making deals, they're putting
things together, they're buying
companies, they're
absorbing other companies
into their's.
There's something powerful about
an ability to do that.
And I think that it's good
for you to understand and
appreciate that.
By the way, Forbes has another
list called the Forbes
Celebrity 100.
And to be on that list, you
have to be a celebrity.
It's a completely different
list. Oprah is on both lists,
but she's practically
the only one.
Steven Spielberg is on
both lists, I think.
He makes movies, but he has
a whole company called
DreamWorks, and he finances all
kinds of movies, so he's a
businessperson as well.
So, I don't think of finance
as a mathematical --
I mean it is mathematical, it
has a core element of that.
But to me it's about making
things happen and about
putting together deals and
getting people incentivized to
do something, and getting
capital, getting resources in
a massive scale so that
something can happen.
And so, that's what this
course is about.
Oh, Jerry Seinfeld is listed by
Forbes as a possibility --
he's about the only one --
to make the list of
the Forbes 400.
But he isn't there yet.
I don't mean to diminish these
celebrity people, but there's
something else that goes on in
finance, and it's quiet.
It's behind the -- actually,
most of the Forbes 400 you've
never heard of.
They're kind of behind the
scenes doing things that are
big and important, but they
don't get on the news so much.
It's one of the ironies
of life.
You might aspire to do this,
to get on the Forbes 400.
You can do it and still nobody
knows who you are or cares.
So that's just as well, I
think, for many people.
So then, the question is:
Suppose you get on the Forbes
400, what are you going
to do with it?
In other words, to get on the
Forbes 400 you have to have
made at least a billion
dollars.
So that means, you have in your
own portfolio a thousand
million dollars.
That's the minimum to make the
list. So, what are you going
to do with a thousand million?
Any ideas what would
you do with it?
You could buy cars, right?
How many sports cars could
you buy for that?
What could you do?
You could buy 20 houses.
But that doesn't begin
-- you could buy 20
houses and so what?
You know, you still have
900 million leftover.
So, what are you going to
do with all that money?
And that's a question.
Now, some people who do that,
who make all this money, try
to see if they can maximize
their appearance of wealth.
They try to show to the world
how rich they are.
So, you just build the biggest
mansion and you do something
really spectacular.
But when you got a billion
dollars, there isn't a house
in the country you could buy
for a billion dollars.
You can only stay in one
at a time, right?
So, what are you going to do?
But there are people who do
that, and I think that there's
a history of disgust for those
people, a long history.
We don't like people
who do that.
It's almost like it's
a big mistake.
Why would you do that when
people don't like people who
show off their wealth?
There's evidence that people
feel that way in many
different countries and
cultures, because lots of
countries in history have what
are called sumptuary laws.
It goes back at least to 700 BC
in Ancient Greece with the
Locrian code.
These are laws prohibiting
people from conspicuous
consumption.
And they've been in so many
different countries that I
think it's evidence that
something is amiss with making
wealth as the objective
of your life.
So, one of the themes in
the beginning of our
reading list is --
I think there's a movement afoot
today around the world
of thinking about this problem,
that you can get so
big and powerful if you build
a business and you use the
financial techniques that are
successful for other people,
but it's meaningless unless
you give it away.
And so, what else can you do
with all this wealth but plan
to give it away.
So, one thing I have on the
reading list right at the
beginning is a chapter from a
book -- well, the title of the
book is The Gospel of Wealth
and Other Essays and it was
written by Andrew Carnegie.
Actually, he wrote a short
article in a magazine called
"Wealth" in 1889.
And in the final paragraph he
used the term "gospel of
wealth" and it was picked up
all over the world as just
outrageous.
And so, it became named
The Gospel of Wealth.
So, later in the early 20th
century he came out with a
book entitled The Gospel
of Wealth.
And that's what I
have assigned.
You can click on it on the
reading list. And Andrew
Carnegie was one of these --
they didn't have Forbes 400, but
he was one of the richest
men in America through his
Carnegie Steel Company, very
much steeped in finance.
But he decided when he wrote
his essay, The Gospel of
Wealth, in 1889 that once a
person reaches middle age,
like 50 or 55, and has made a
lot of money, they really have
to go into philanthropy.
There's a moral imperative.
So, the theme of The Gospel of
Wealth was some people are
just better at what he called
affairs than other people.
That means business.
Some people have a sense of
how to make things happen.
These people have a moral
obligation to make this work
for the benefit of humankind.
And that means, while they're
still young, they have to take
their fortune and give it all
away before they die.
Because if they don't give it
all away, it's nonsense.
If you make a billion dollars
and you leave it to your
children, chances are they're
not like you.
They're not going to be
interested in working hard and
making things happen.
They're just going
to squander it.
And so, that's what the
moral obligation is.
You have to stop at age,
let's say 55 --
OK, you still got time left --
and then use your
same talents.
So, it was almost a theory of
capitalism -- it is a theory
of capitalism.
It is a theory that some people
are just more practical
and hardworking and
business-oriented, and these
people can find things to do
that benefit mankind, and they
should do it.
So, there's a natural
selection.
This is Carnegie.
I'm not endorsing
this entirely.
I think there's an element of
truth to The Gospel of Wealth,
but it's not exactly true.
But the element of truth is
right, that people like
Carnegie who was a very
gifted person -- you
know what he did?
He set up the Carnegie Institute
of Technology, now
called Carnegie Mellon
University.
He set up the Carnegie Endowment
for World Peace,
Carnegie Hall in New York.
He probably gave something
to Yale, too.
Anyone know?
Is there a Carnegie?
He gave to like every imaginable
university.
I know at Princeton they
have a Lake Carnegie.
He was visiting Princeton and
someone pointed out this kind
of swampy land and said we'd
like to really create a lake.
So, he said, fine.
He gave them money to create
Lake Carnegie.
And he also gave the money for
the prize for the first true
competition on Lake Carnegie.
So, he just had all kinds
of gifts he gave away.
I also have -- it's
interesting, I
found this on the web.
Thomas Edison, the inventor,
was so impressed with
Carnegie's The Gospel of
Wealth that Edison was
developing the sound movie, I
think it was 1914, but he
didn't perfect it.
But he said the first sound
movie should involve geniuses
of our time.
So, he made a sound movie of
Carnegie reading from his The
Gospel of Wealth.
Unfortunately, the visual side
of it somehow got lost. Maybe
it didn't work.
We only have the soundtrack
from the movie.
So, you can listen to Carnegie
reading from this book in
1914, and it's the only
recording of Carnegie's voice
that survived.
Since then, Bill Gates and
Warren Buffett and others of
the Forbes 400 have done a
campaign to get billionaires
around the world to commit to
give most of their wealth
away, while they're
still alive.
And I'm trying to get one of
these people to speak to our
class, but I haven't
yet arranged that.
I also have on the website a
review from 1890 of Carnegie's
original essay from a California
newspaper, and they
were so negative about it.
They said, Carnegie thinks that
making wealth and giving
it away is a noble cause.
That cannot possibly be right.
These people who make money are
not the most enlightened
and smart people in our world.
I think that the truth lies
somewhere in between.
But we do have a society
now where people --
we have an increasing
concentration of wealth at the
top, and I don't know what we're
going to do about this.
This is a trend that
may continue.
And so, this is the thing
I want to think
about in this course.
I don't think finance
necessarily does this.
It may be a bubble, that there
is currently a bubble in
financial careers and that you
are going to be disappointed,
because 20 or 30 years from
now if you go into a
finance-related field, you'll
find that it's not as
lucrative as you hoped.
That kind of happens, right?
When a field becomes known for
having a lot of successful
people, then more young
people go into it and
they swamp the field.
On the other hand, I think that
it will always be true
that just because of the power
of the technology the top
wealthiest people in the world
will be finance-related.
And I think that they will have
a moral obligation to
give their wealth away
in a productive way.
So, I have several outside
speakers, and I tried to bring
in people that are connected
to the world
in a positive way.
I'm trying to bring in
inspirations for you as
outside speakers.
And they're people who
are in finance
but who are not selfish.
They may be rich but they
are good people.
So, the first person that I'm
going to bring in, as I've
done in previous years, is David
Swensen, who is Chief
Investment Officer for
Yale University.
Swensen also teaches a course,
Economics 450, with Dean
Takahashi, which you
might want to take.
But I have him here just
for one lecture.
And what Swensen has done is
turn the Yale endowment into a
huge number.
He came to Yale in 1985, and
at that time, Yale had less
than $1 billion in
its endowment.
Swensen is the most successful
university endowment manager
of the United States.
He turned less than $1 billion
into $22.9 in 2008.
The financial crisis hit and the
endowment fell, but as of
June of 2010, it was
still 16.7 billion.
So, he has done so much to
make Yale a success.
But it matters.
That's a lot of money.
And it's all for a good cause.
Now I say, I believe Swensen
is a good person.
I think he turned down
opportunities to make much
more on Wall Street, because
he is known -- and he's
continually turning
them down --
as an investment genius.
He can command huge salaries and
bonuses if he wanted to,
but he stays here with Yale.
I don't think that people in
finance are money-grubbers,
and this is an example
of someone who's not.
The second speaker I have is
Maurice "Hank" Greenberg, who
founded AIG.
It started out in 1962.
In 1962, he was put in charge
of North American operations
of the American International
Group, an insurance company,
which was then failing.
The head of the company, C.V.
Starr, put him in this to try
to turn the company around.
He turned it, over many years
as CEO of AIG, into the
biggest insurance company
in the world, and he
ran it until 2005.
The company -- have you
heard of this, AIG?
You must have heard of this.
In the recent financial crisis
it has encountered some
problems. And, in fact, it was
the biggest bailout of all.
It was bailed out by the
U.S. government.
And there's a scandal about
that because the
bailout was so huge.
It was in the hundreds
of billions.
Record-setting bailout.
And some people are angry
with Greenberg.
But I think that's completely
unfair, because it all
happened after he left AIG.
And the problems were in a
particular unit within AIG
that he was not really
responsible for.
But Greenberg is a person who
has, I think, a moral purpose
that I want to illustrate
for you.
He's been criticized.
Anyone who does business on
that scale is going to be
criticized for being too tough
or too aggressive at times.
But he's a very involved
person.
He's the Vice Chairman for the
Council on Foreign Relations,
which is a think tank that
thinks about the United States
and its place in the world.
It's a very important
think tank.
He's also a major philanthropist
and
he's given to Yale.
Notably, he gave the Greenberg
Center, which is right next to
the Center for Globalization.
A beautiful new building.
So, he has agreed to come.
I'm very pleased to have him.
The third outside speaker that
I have now is Laura Cha,
although she won't be
here in person.
We're going to have her image
up on the screen because she
is in Hong Kong.
And she is a non-official
member of the Executive
Council of Hong Kong.
She's a member of the government
of the People's
Republic of China at the
vice ministerial rank.
She's the first non-Chinese
delegate to the National
People's Congress representing
Hong Kong, and has been vice
chair of the China Securities
Regulatory Commission.
So, she is very involved
in finance.
She's also been affiliated with
Yale and helped some of
our initiatives.
She'll have to get up very late
at night, I think, to be
on for 9:00 in the morning
for us from Hong Kong.
I might get one or two other
speakers, but that's where it
stands right now.
So, I wanted also to tell you
about our teaching assistants.
We have four teaching
assistants now.
We might get another,
but at this point.
The first is Oliver Bunn who is
from Germany, University of
Bonn, and is a PhD student
in economics.
He's also our head TA who
coordinates the whole operation.
And then we have -- the second
one is Elan Fuld from the
United States.
And he's doing an interesting
study of the
pizza delivery industry.
It sounds funny, but it's an
interesting application of
economic theory to very
much the real world.
Bige Kahraman is from Bilkent
University in Turkey, and
she's interested in Behavioral
Finance.
That means --
I should have said this.
It's also an interest
of this course.
I've skipped by it
in my notes.
Behavioral Finance is the
application of psychology,
sociology, and other social
sciences to finance.
I don't know how I omitted
mentioning that.
It's about people in finance
-- well, I didn't really
completely omit mentioning it.
You've got the sense that I'm
interested in people.
But there's been a revolution
in finance
over the last 20 years.
Twenty years ago, finance was
thought of in academia as an
essentially mathematical
discipline,
that and nothing more.
Well, maybe I'm exaggerating
a little bit.
But what's happened since then
is people think of finance as
involving psychology.
We have to bring people with
knowledge of human beings in.
And so, her dissertation topic,
a major theme of it, is
how mutual funds operate.
Mutual funds are companies that
offer investment vehicles
to the general public, and she
finds that the mutual fund
companies have complicated fee
schedules and they offer
different choices to people.
And what sense does this make?
Why are there all these
different choices?
You look at the fee schedules
and you think --
it's just like your cell
phone plan, right?
It's got different choices and
you don't know which one I
should take.
Why are they doing all this?
Well, she tries to analyze
what's going on and she finds
that sometimes it seems like
clients are steered toward a
fee schedule that's really not
in their interest and that the
mutual fund managers are doing
some things that maybe we
don't want them to do.
Maybe it's not ideal.
They're pushed by competitive
pressures into offering
products that are a little bit
manipulative of people.
And her dissertation also brings
up another theme, which
I thought I perhaps should have
emphasized, that all is
not well in the financial
world.
Lots of bad things happen.
Or not necessarily awful things,
but, you know, not
socially conscious things.
And that's why we
need regulators.
That's another reason
why I brought in
Laura Cha, by the way.
She's a regulator.
I wanted to have a voice from
that side, because I
personally admire regulators
and think that they have a
very important function
in our society.
So, her work fits
more into that
regulatory side of finance.
And then, finally, our fourth
teaching assistant is Bin Li
from Beijing, although he went
to college at University
College London.
And he has broad interests
including Leveraged Asset
Pricing and also Behavioral
Finance.
So, those are the teaching
assistants.
So, let me just give a brief
outline of the course.
There are 20 lectures that I'm
giving in this course.
This is the first. Let me just
go through what's the content
of these lectures.
So, Lecture 2, that would be on
Wednesday of this week, I
want to talk about the core
concept of risk and also about
financial crises.
The one reason why I wanted to
update this course with Open
Yale this year is, because I
wanted to talk about the
financial crisis that we've been
through, though I thought
this lecture would start with
something about the theory of
probability, but I'm not going
to get into that very much.
That will be more for
a TA section that
will come in later.
But even so, this is not
a probability course.
I just want to kind of remind
you of the concepts of
probability.
And there's a concept of
independent risks.
If risks are independent you can
diversify away them, and
you can put together
a portfolio that
minimizes the risks.
The law of large numbers says
if you have a lot of
independent risks, they'll
average out if you have a
large number of these different
risks in your
portfolio and there's
no risk left.
That's if they're independent.
But in fact, risks are not as
independent as you think, and
that's one reason why we
had a financial crisis.
And so, a lot of people were
making plans based on
portfolio theory in finance,
but the plans assumed that
there won't be a crisis, that
maybe one of our investments
will go bad, but they can't all
go bad or a large number
of them can't go bad.
So, that was a failure
of the independence
assumption in finance.
That failure created the
financial crisis that we've
been through.
It was a near miss onto another
Great Depression.
The financial crisis that
began in 1929 --
I'll talk about that briefly
in that lecture --
started with the stock market
crash of 1929 and the economy
spiraled down until 1933.
It just kept getting
worse and worse.
More and more bankruptcies,
more and more layoffs.
So, by 1933, 25% of the U.S.
population was unemployed.
And it wasn't just the U.S.,
it was all over the world.
It was a horrible crisis.
And we didn't get over that
crisis until World War II.
It's like we couldn't
get out of it.
The crisis got so bad that
nobody in the world could
figure out what to do.
And I think that part of the
reason we had World War II was
because of the anxieties and
animosities caused by this
massive unemployment.
But we got out of it because
World War II created a huge
stimulus program.
I mean, they drafted
all the unemployed
and made them fight.
What an awful outcome, but
that's what happened.
It's terrible.
And so, this time we
saw the beginnings
of a similar crisis.
We saw crashes in the stock
market and the real estate
market, we saw bankruptcies
appearing,
we saw runs on banks.
And this time the Government
decided on a controversial
bailout package.
And so, Ben Bernanke and Mervyn
King and other central
bankers and government
policymakers around the world
had the idea that we can't
let it happen the
same way this time.
So, there was massive bailouts,
controversial
bailouts, because they seemed
to be unfair to many people.
So, it's a huge and
interesting story.
I've written three books, by
the way, about this crisis.
Well, two of them
with co-authors.
So, it's something that
fascinates me.
But I don't want to dwell on
it too much in this course,
because I'm hopeful that it will
heal itself and we can
put it behind us.
And the financial crisis doesn't
call into question the
basic principles of finance.
Not in my mind.
The vulnerability to a crash
that we see in financial
markets is like the same thing
as the vulnerability to crash
of airplanes.
Airplanes crash from
time to time.
You must know that when
you get on one.
But that doesn't mean we
shouldn't have airplanes.
And I think the financial system
is advancing in the
world with such speed and such
impressiveness that this
crisis is just a blip on the
screen of that, and not
something I think we should
worry too much about.
The third lecture is about
technology and
invention in finance.
Finance is a technology just
like engineering or mechanical
engineering.
It has principles, it has
techniques, and it involves
inventing of details.
That is, financial institutions
are complicated.
They're complicated in the
same way automobiles or
airplanes or nuclear
power reactors are.
You can see this complexity,
if you read some of the
documents that are associated
with the modern corporation.
There's a lot there.
And the way the cash flows are
divided up among different
people, involving options and
derivatives and other
complicated financial
instruments, are part of the
technology.
And this technology is
advancing, and it will advance
a lot over the time
of your career.
I don't have an ability to
predict the future with any
accuracy, but I want to try to
think about what we can say
about the future.
I wrote a book in 2003 called
The New Financial Order, and
it was my take on the future.
But the problem is nobody
really knows
the future very well.
You kind of have to just invent
it or dream about what
it might be like.
That's what I did.
I kind of thought about
principles of financial theory
and where they might go with
the advance of information
technology and the globalization
of the world.
So, I have just a chapter
from that for that
section of the course.
Then, Lecture 4 is about
portfolio diversification, how
risks are spread.
And we'll talk briefly
about the Capital
Asset Pricing Model.
Now again, the Capital Asset
Pricing Model is a
mathematical theory of
diversification.
A very important theory, and
it's something that John
Geanakoplos will cover with more
rigor in Econ 251 that I
already mentioned.
But for me, I will talk briefly
about the capital
asset pricing model, and one
of our teaching assistants
will give a section on it.
But I want to also think about,
since this is a course
about the real world, I want
to think about financial
institutions, and so many of our
institutions are offering
diversification one
way or another.
And so, again, I wanted to
talk about the real world
component of this.
The fifth lecture is
about insurance.
And the insurance industry
developed over the centuries.
It goes, actually, all the
way back to Ancient
Rome, but only minimally.
People didn't have the concepts
until the 1600s when
probability theory
was invented.
There was an intuitive concept
that, sure, I could start an
insurance company, I could put
together a lot of insurance
policies and charge for them,
and probably I won't --
you just have intuitive sense
about law of large number or
independence of risks.
Probably, I'll be OK and
I can make good on the
policies that I wrote.
But it was never clear until
probability theory was developed.
Since then, it's been growing
and it's becoming a bigger and
bigger part of our lives.
And I think that insurance
is actually a lifesaver.
I'll give you one example.
You note that in the earthquake
in Haiti --
what was that, about
a year ago?
There was a tremendous loss of
life, but the earthquake in
San Francisco decades earlier
was of the same magnitude and
had very little loss of life.
Also, the loss suffered by
people in terms of destruction
of their homes and their office
buildings was vastly
higher in Haiti.
Well, it turns out that Haiti,
a less developed country,
didn't have much of the modern
insurance industry, so that
people were uninsured against
risk of collapse of their
structure and you didn't have
insurance industries going in
and policing building codes.
If the insurance company is
liable to the risk then they
go in and say, we won't insure
you unless you fix this.
Since it didn't happen,
so many people died.
I think that Haiti
will come along.
There is already a Caribbean
insurance
initiative that was starting.
We want to see the developing
world get these institutions.
I want to try to give a sense
of the reality of that, that
we tend to think of Haiti as
an opportunity for our
charity, and a lot of us gave
money to help these people.
But, you know, charity doesn't
work on a big enough scale.
Going around to people on the
street and asking them to give
money to help the Haitian
earthquake victims, it doesn't
amount to a lot.
What really becomes big and
important is the insurance
industry, which is doing
the same thing
as a business model.
And that's the real world and
it matters enormously.
The sixth lecture is about
efficient markets.
This is about a theory that
developed in the 1960s, that
financial markets are
wonderfully perfect.
I'm saying I'm a little bit
skeptical of this theory,
although I think it has
an element of truth.
Efficient Markets Theory is the
idea that you really can't
make money by trading in
financial markets, because the
markets are so competitive that
price is always pushed to
an optimal level that
incorporates all information
that anyone could ever have
about the security.
And the theory has been that
it's hopeless to try to invest
and beat the market.
Well, I think there's an element
of truth to that but
it's not quite true, and people
like David Swensen are
counterexamples, that it is
possible for professional
money managers to
beat the market.
And that's something I want to
think about and talk about in
that lecture.
Lecture 7 is about
debt markets.
We have a lot of money
that's lent.
The Federal Reserve manages
these markets.
They try to coordinate the
markets through open market
operations and through
what now is called
Quantitative Easing.
But the markets are huge
and international.
They involve errors
that people make.
A lot of people get overly
indebted and make mistakes
over their lives.
But they also offer
opportunities, that debt
markets are fundamental
to the things we want
to do in our lives.
For example, when you are a
little bit older, many of you
will want to buy
a house, right?
But you won't be in that point
in the life cycle when you
have the money to buy a
house, most of you,
so you'll be borrowing.
It's elementary.
You take out a mortgage.
That seems obvious.
But still today in many
countries of the world, the
mortgage market is not
very developed, and
you can't do that.
So, there's a good side
to borrowing as
well as a bad side.
I want to put it
in perspective.
We've got our review session.
We'll talk a little bit,
somewhat, with one of our
teaching assistants about
the mathematics of debt.
Lecture 8 will be about
the stock market.
Again, I think of the stock
market not as something that
we're going to beat.
I think it's something that is
an invention to motivate
people to get people
working together.
So, the basic idea of a stock
investment: You and your
friends want to set
up a company, OK?
How do you do that?
Well, the company needs
money to start.
So, somebody's got to
contribute capital.
Well, some of you have more
money to contribute than
others, so you should have a
bigger share in the company.
Some of you have no money at all
to contribute, but you're
going to contribute your
time and energy.
So, you want to give a share in
the company to these other
people as well in order
to incentivize them.
So, you devise a whole scheme
to set up a company that
involves the creation
of stock.
And then you start trading the
stock and then it gets all the
more interesting.
And then there are options on
these stock certificates.
But it's all for a purpose.
The purpose is to make some
enterprise happen.
And it really is important
that we have these
institutions, and if you don't
have them, your little group
trying to do something is
going to fall apart.
Someone's going to get angry
and leave. It's just
not going to work.
And so, I think of
the stock market
as doing these functions.
Now I know Karl Marx said he
thought it was a big casino,
but we're not communists here.
This is about modern finance.
Lecture 9 is about
real estate.
Another fascination for me.
I've been working for years
about real estate.
And, in fact, with my colleague
Karl Case, we have
our own home price indices
called the Standard and Poor
Case-Shiller Home
Price Indices.
We'll talk about those.
But it's really important for
this crisis that we've just
seen, because the financial
crisis was caused
substantially by a bubble in
home prices, I believe, a
psychologically induced
excitement or euphoria about
home prices in the United States
and in other countries
that collapsed around 2006.
These bubbles are restarting
in other parts of the world
more recently.
And the real estate market is
getting very speculative and
psychological, I believe.
And the outlook right now for
the economy hinges on how
these markets behave. So, that
will be, I think, an important
lecture for this course.
Lecture 10 is about Behavioral
Finance.
It's about psychology
in finance.
I talked about that.
It's another long-standing
interest of mine to try to
incorporate psychology
into our theory.
So, lecture 12 is about banking,
multiple expansion of
credit, the money multiplier,
and bank regulation, which is
something that is a fascinating
topic, because we
almost lost our banking
system.
We had to bail them
out massively.
We have international
accords now.
Notably, a new one just came
out called Basel III from
Basel, which is the city in
Switzerland, and it was
endorsed by the G-20
countries at their
Korean meeting in Seoul.
So, we're seeing a change in
bank regulation that will, we
hope, prevent another
crisis like the one
we just went through.
Lecture 13 is about forwards
and futures markets.
Forward markets are markets for
contracts that deliver in
the future.
Over-the-counter contracts,
they're called, that are done
one on one between parties
with the help of
an investment bank.
Or futures contracts, which
are traded on organized
futures exchanges, like the
Chicago Mercantile Exchange.
I have some involvement with
this, because we worked with
the Chicago Mercantile Exchange
to create a futures
market for single-family
homes using the S&P
Case-Shiller Index.
So, I'm involved in this.
And we have that market
functioning at a rather low
level, but it is functioning
and it seems
to be growing lately.
I'm hopeful for that market.
Lecture 14 is about
options markets.
These are most typically stock
options, which are contracts
that allow you to purchase a
share of a stock or to sell a
share at a pre-specified
price.
These are traded on
options exchanges.
They have a price that
goes up and down.
This is an example of a
derivative contract that
injects a lot of complexity
into financial theory.
Lecture 15 is about
monetary policy.
It's about the central
banks of the world.
For example, our central bank,
called the Federal Reserve in
the United States.
And it's about what they do
and how they help prevent
crises like the one
we've just seen.
They did help prevent it.
I think they staved
off disaster.
Lecture 16 is about investment
banking.
I know this is of great
interest, because we place a
lot of students in good jobs
in investment banking.
Companies like Goldman Sachs,
the most talked about one.
Investment bankers help
companies raise capital, issue
securities, retire securities.
And we're going to talk about
how they're regulated.
And I didn't mention Dodd-Frank,
by the way, but we
have a new bill that just passed
in July in the United
States that changes the
regulatory structure for
investment banks and a whole
array of financial
institutions.
And I want to talk about that.
The European Parliament has
created a number of new laws
and organizations that somewhat
resemble Dodd-Frank.
And other countries have also
done financial regulation
reform that affects investment
banking and
other aspects of finance.
It's extremely complicated.
I don't want to give you too
many details but I want to
give you some sense of the
revolution that we're seeing.
Lecture 17 is about professional
money managers
like David Swensen, people
who manage portfolios.
You don't have to be a
billionaire to manage a
billion-dollar portfolio.
In fact, some of you may be
doing it sooner than you
realize if you get the
right kind of job.
Managing a portfolio means
managing the risks, putting
them in the right places.
You think of institutional
investors, big money managers,
as just trying to make money.
But when you get into that field
you realize that you
have power as an institutional
investor.
When you own a big share of some
company, you can go to
the board meeting and talk
to these people, or the
stockholders' meeting, and you
will get heard if you own 10%
of the shares of a company.
Then you suddenly realize that
you are a steward of the
public interest. And I think
institutional investors are
recognizing that
more and more.
Lecture 18 is about exchanges,
brokers, dealers,
clearinghouses, like the New
York Stock Exchange or the
London Stock Exchange.
They are proliferating
around the world.
Whereas there were just a few 30
years ago, now almost every
country has a stock
exchange and a
complicated list of exchanges.
They're increasingly electronic,
they have
interesting new features, like
microsecond trading that's
going on, computers trading
with other computers.
We'll talk about where
this is going.
Lecture 19 is about public
and nonprofit finance.
So, I think this is
very important.
Nonprofit finance would include
organizations like
Yale University, or churches
and charities and
other things like that.
But I'm also including in this
lecture public finance.
And that means governments
financing projects.
So, for example, you take it for
granted that our city here
of New Haven has roads,
it has schools, it has
sewers, it has water.
All this kind of comes without
you even asking.
But all of these things
had to be financed.
And the City of New Haven, like
other cities, is issuing
debt and it's a complicated
business.
I want to get you into some
of the details, because it
matters, because this is how
you make things happen.
You can go to your city
government and you can propose
that they issue revenue bonds
to start some new product.
You would know --
that's what I want you to do,
is to know how these things
are done, so that it's
not just imagination,
you can make it happen.
And also nonprofits.
I want you to understand that
you can set up your own
nonprofits, and there's a lot
of advantages to doing that.
That's an organization that has
a financial structure but
no shareholders.
Nobody takes home the money.
It all goes to some cause.
And, finally, my last lecture,
Lecture 20, I'm calling it
''Finding your Purpose in
Finance.'' I just want to come
back in the last lecture to the
idea that this is a course
not about making money.
I don't want you to give a
billion dollars to your
children and grandchildren,
which they will then squander
in conspicuous consumption.
The idea is a moral purpose.
And that's one thing I wanted to
try to convey, partly with
outside speakers, maybe with
other examples that I can
give, that I think that many
people who are wealthy and who
have succeeded in finance
really don't care about
spending the money
on themselves.
They really do have a purpose.
And even if that's not
true of many of them.
There's an interesting book by
Robert Frank, I don't have it
on the reading list, called
Richistan, who talks about
what wealthy people are
like these days.
And if you read his book
sometimes they are
disgustingly rich and spending
the money on silly things.
But there is an idea among many
of them that they are
going to do their good
things for the world.
Because I think many of you will
do these things, I want
to think about the purpose that
you'll find in finance.
So, that's just the
closing thought.
I'll see you again
on Wednesday.
But the closing thought is that
this is about making your
purposes happen.
OK.
