Think of risk, I was wondering how these large hedge funds and their ability to
take on large amounts of risk and leverage themselves, how that affects the market?
>> Well hedge funds are investment companies
that are not approved for the general retail market.
So they're not allowed to advertise.
They're not well-known, because they're not allowed to promote themselves,
except through private conversations, and to invest in them you
have to be an accredited investor, not a general investor.
So they are allowed to do sophisticated and dangerous things.
The idea is a hedge fund is regulated for
people who have professional advisors or family offices.
You know what a family office is?
If you are really rich you don't just hire an advisor.
You get a team of advisers,
who that's their whole job, is to work on your family investments.
That's what hedge funds are really for.
So they're dangerous because they're not,
it's like taking drugs.
[LAUGH] You need a physician to, between you and the drugs.
Then, so often in the past hedge funds have done really well.
In recent years, they haven't been doing well, on average, for the most of them.
So I don't know that I recommend them.
I can't recommend them as a group.
But if you're, do you have a family office?
[LAUGH] I assume you don't.
>> Unfortunately I do not. >> [LAUGH]
>> If your family office recommends it,
go for it, if you've selected them carefully.
But they just represent claiming to be the most sophisticated investors.
Another notable thing about hedge funds, is that traditionally they pay very
high rewards to their investments managers if they out perform.
But that comes out of your pocket.
And there are skeptics of hedge fund saying, I would never pay those
high management, those expenses, to the people who invest my money.
Because nobody can deserve that amount, and so hedge funds in a sense are,
at least many of them, have been a bubble in themselves.
They were doing well for awhile.
The impression was that they were doing well, lots of people piled into them,
and lately they haven't been doing so well.
>> I guess really that these big financial institutions, can take on a lot of risk,
and this risk that they take on has a potential to cause mass financial crises.
Should there be a way to regulate this risk or
how much of this risk should be regulated versus how much is it
important to the inherent way that these institutions are working?
>> Yeah, well, I think that we are in a situation where we had
heightened recognition of the importance of regulating for
dealing with big risks that, systemic risk.
So a systemic risk is a risk that the whole system will collapse,
like a house of cards, some people say.
Regulation before 2008-2009 crisis,
was mostly micro-credential.
That means they wanted to make sure that you as an investor weren't
being ripped off by this stockbroker who was squirreling away your money or
doing something like that.
They were thinking of you as an individual.
But we've now had new impetus for macro-credential regulation, and
it's now regulation about how interconnected are you with other,
or some big business connected, and
what will happen if that other business fails to this business?
So we want to, or
if there's a world financial crisis, how will this business fare?
So, since the 2008-2009 financial crisis,
we 've seen a lot more macro-credential regulation and
a lot more measures of risk that are being developed.
There are now what we call stress tests of financial
institutions that emphasize more on their interconnectedness, and
how they would act, how they would fair in various kinds of international crisis.
>> What are some measure of risk, I guess, post 2008 crisis now,
that are more appropriate to measuring?
>> How accurate are these measures?
>> Yeah, well there's a, that's a controversy.
Before the crisis, there was regulation, it's not new,
and there was some concern with macroprudential.
For example, before the crisis, there was a method
called value at risk, that was used to measure the risk of a company.
By looking at the assets and liabilities of the company and
considering what the probability of
big direction in the values would be and what it would mean for the company.
But after the financial crisis we now have more elaborate assessments of macro risk,
and the stress tests will consider, well the government regulator
will specify that the financial institution should estimate
how it would be affected by various kinds of financial crises.
So, it's getting more detailed, and more effort is being put into it.
That's because the 2008 crisis caught us all off guard,
and people just didn't know how interconnected banks,
and other financial institutions were, and they had to act in ignorance as a guess.
Because their, too much of their data collection was micro-credential.
>> I have one more question.
>> Yeah.
>> It's about going back to the ideal of measuring risks so in class you mentioned,
Nassim Taleb's idea of the Black Swans.
And he said that all these models to measure risk are, if you read his book,
are fundamentally flawed because they don't take into account this super run
like improbable events.
>> Right, right. >> Where you consider the financial crisis
into the [INAUDIBLE] was one of those events.
So do you think there's ways to improve this model to take into account more
unlikely events that this platforms,- >> Yeah.
>> The method is fundamentally flawed to take into account.
>> Right. So you're referring to Nassim Taleb,
who had a book called the Black Swan, that talked about rare,
low-probably events as being sometimes really big.
>> Yeah.
>> So you can work a lifetime creating a,
creating wealth under certain assumptions that something can't happen and then bang.
Everything, you've lost everything for
your whole lifetime, because you thought it couldn't happen.
That's kind of what happened in the recent crisis,
people thought that home prices can never fall, because they never have or
they never have since the Great Depression [LAUGH] and so-
>> [INAUDIBLE]
>> I know that's a perfect example, but
this it's how to deal with academically.
If you're talking about rare, big events,
well you don't have enough data on them because they're rare.
So, it's a problem.
So, things that happen in the market, this is what efficient market people sometimes
say, that the markets have to deal with the probability of these rare big events.
But they are so intangible and they are just something that i can't quantify.
But when the market goes down, Eugene Farmer might say [LAUGH],
when the market goes down, don't just assume it's crazy.
Maybe it is some subtle evidence about some big event that could happen.
So I gotta give it, that is a possible interpretation.
We just never know.
I wish there weren't these big black swan events,
finance would be so much better a [LAUGH] profession to be in.
Unfortunately, we live in a real world.
[LAUGH] I shouldn't put it like that.
>> [LAUGH] >> We live in a world with the risk of
huge events.
>> So we have so many risks in our life, like as we said,
if you go into a labor market during a recession.
Or basically, if something bad happens, like you need to find a way to hedge it,
we have stuff for, like hedging against oil risk or agricultural risk.
Are there any innovative financial products for
hedging against the labor market risks?
>> I'm glad you asked that question [LAUGH] because this has been a theme of
mine for a long time, that we should have labor market risk.
Now we do have something.
Unemployment insurance was started in the United Kingdom, I think it was 1911.
The idea is temporary assistance for finding a good job.
Now they realized, they're in the UK,
that people often are desperate when they lose their job.
They have a family, and often people no savings.
So what the person does is takes, has to, take the first job offer,
and it's often not a very good career track for them, and so
it's hard for them to move to another job.
So, let's give them time, let's give them may be six months of support so that
they can find the right job, and also give them some kind of help in finding a job.
They will have a career service for them.
That's an old idea.
The question is whether we can do more.
The unemployment insurance is really focused on finding a job in the short run.
But now there's a problem that we're seeing inequality grow in many
places around the world, and we see a lot of people who are complaining differently,
that often it occurs when they're middle age,
say they're 50 years old and they lose their job.
They suddenly find themselves, I mean they can get some job,
but they can only get those bad jobs.
Somehow people want to hire young people and they'd have to be retrained, and
someone doesn't want to retrain them, because right now it stays long, and so
they have a problem.
So one idea, I call it livelihood insurance,
this is kind of a futuristic idea, but this is not just,
there is Larry and Robert another couple
of the economists wrote a paper about 15 years ago.
For this similar idea, they called it wage insurance.
So their idea is when somebody loses their job and has to take
a job at a lower wage, they should be able to collect on an insurance policy.
Interestingly, President Obama brought this idea up
during his State of the Union address for 2016.
So the President of the United States appears behind this idea.
Unfortunately, a lot of ideas that President Obama has been
behind don't happen.
>> [LAUGH] >> But the other thought of it,
he was proposing to be some government insurance.
I don't see why it has to be exclusively government.
There could be private insurers or
private markets that would help protect people against loss of income.
But I think it's actually very important now, more so than in the past,
because of the rapid increase in information technology on robotics,
and the rapid globalization.
So things can happen really fast that make one's
investment in human capital obsolete.
And absolutely, there should be risk management devices for that.
And the important thing, as I've argued in my books,
[LAUGH] is if you help people manage risks, they will take more risks.
That's what we want.
We want people, in their decisions about their education, to do some risk-taking.
Develop some specialty that is at risk of being obsolete,
but who knows, nobody knows.
You're taking a chance.
Let's encourage people to take chances.