Financial markets lecture 1 - lecture 11 transcript PDF

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Financial Markets Lecture 1 - Lecture 11 Transcript...

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ECON 252

Financial Markets (2011) Lecture 1 - Introduction and What this Course Will Do for You and Your Purposes [January 10, 2011] Chapter 1. Introduction to the Course [00:00:00] 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 G20, 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. Chapter 2. Broader Context of the Course [00:06:12] 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--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 can 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’ll 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. Chapter 3. Finance as an Occupation [00:22:41] 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 Gat...