RISK MANAGEMENT FOR THE AGE OF INFORMATION-THE NEW FINANCIAL ORDER: RISK IN THE 21ST CENTURY

RISK MANAGEMENT FOR THE AGE OF INFORMATION-THE of recent origin FINANCIAL ORDER: RISK IN THE 21ST hundred ROBERT J. SHILLER, PRINCETON UNIVERSITY PRES 2003; pp xvi, 366

INTRODUCTION

Noted author and financial commentator Peter Bernstein began his work Against the Gods with a provocative question: "What is it that distinguishes the thousands of years of history from what we think of as recent times? The answer," Bernstein argues, "goe way beyond the progres of science, technology, capitalism, and democracy. The revolutionary idea that defines the boundary between novel times and the past is the mastery of risk . . . The ability to define what may happen in the subsequent time and to choose among alternatives lies at the heart of contemporary societies."1 In this spirit, Robert Shiller, in The fresh Financial Order ("NFO"), outlines a radical rethinking of the biggest risks facing society. NFO is an ambitious volume the product of many years of cogitation scholarship and even entrepreneurship dedicated to its ideas. The proposals in NFO range from incremental improvements to existing risk management a whole s to wholesale reworkings of a certain number of of society's largest institutions. Shiller's ideas warrant serious attention. His last work Irrational Exuberance, came out in March 2000 at the height of the Internet fluid vesicle There Shiller argued-quite against the spirit of the times-that the pair the level of the stock market and the importance tribe attached to it were greatly exaggerated.2 Investors ignored his warnings at their peril.3 one time again, Shiller is cautioning that society faces risks that are massive on the contrary for various reasons all on the contrary invisible. And once again, we would do well to heed his counsel4

The thrust of NFO is that the information technology revolution is creating the couple unprecedented threats to people's financial well-being, and, at the same time, unprecedent opportunities for risk management.5 The work is divided into five parts. In Part single Shiller argues that rapid and accelerating advances in technology are creating of recent origin and potentially devastating risks that are inadequately addressed by dint of existing risk management institutions.6 Technology threatens to exacerbate existing inequality among and within nations: whole categories of calling may vanish, home values may decline precipitously, and a nation's GDP may shrink pop relative to the GDPs of other nations.7 The enigma is, there's no way to know ex ante where losse will fall. Moreover, certain cognitive obstacles stop people from perceiving risks that accumulate gradually.8 Fortunately, as Shiller explains in Part sum of two units the dynamics giving rise to similar threats also are creating opportunities: of recent origin technology and novel insights into the psychology of risk can be harnessed to spread the los of major dislocations.9 In the operational sections of the work Parts Three and Four, Shiller at hands his core ideas for a of recent origin financial order. Certain of Shiller's ideas are intended for implementation by means of the private sector; others would be the what one is bound [i]or[/i] under obligation to do of governments.10 Though Shiller does not explicitly constitution NFO this way, I think the private-public distinction provides a useful framework in approaching the book

On the private side, Shiller argues that society-wide risk management could be vastly improved if private firms tendered livelihood insurance, home equity insurance and income-linked loans.11 However, private firms seeking to market similar products face problems of the pair supply and demand. With venerate to supply, there is no way to hedge the risks the harvests create-that is, no way for insurers or banks to spread or lay not on the risks they take upon by selling the products-and there is no database containing the information required to conformation and settle the products.12 With reverence to demand, the problems of moral hazard and adverse selection (both described and discussed below) make it difficult to market the produces profitably.13 Shiller has answers to these vexed questions To enable banks and insurers to hedge the risks created by dint of his products, he proposes macro markets-markets for trading the largest income sweep alongs (such as occupational incomes) and asset values (such as abiding-place prices).14 To solve the information riddle Shiller proposes global risk information databases, or GRIDs-huge, constantly updated compilations of all data relevant to the financial risks faced through individuals, corporations and governments.15 And to take care of moral hazard and adverse selection, Shiller introduces the powerful idea of settling certain classes of insurance contracts and setting income-linked loan repayment bourns based on indexes of incomes and housing prices.16

On the public side, Shiller presents three domestic policy proposals and individual foreign policy proposal. With reverence to domestic policy, Shiller first presents replacing the current income tax with what he calls "inequality insurance"-in event a means of locking in the generally received level of inequality via annual adjustments to the tax schedule.17 next to the first he suggests replacing the rife pay-as-you go social security a whole with a tax that varies with the percentage of retirees in the population.18 Finally, he argues for replacing the existing coin system with units of account indexed to the price of a representative basket of usefuls and services.19 With respect to foreign policy, Shiller recommends replacing (or at least augmenting) the typical foreign aid program with a combination of parts to form a whole whereby countries or blocks of counties would swap unexpect changes in GDP; he calls the swaps "international agreements for risk control"20 Like his private sector ideas, Shiller's public sector ideas also face obstacles to implementation. The greatest in quantity obvious would seem to be political or institutional: particularly in the areas of tax and social security, economic ideas are closely intertwined with the political process-a proces as fallible, imperfect and unpredictable as the humans who make up legislatures and constituencies. Shiller has little to say about politics or institutions, and the feasibility of his public sector ideas undergos accordingly.