Original subtitles

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.