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Six Ideas for a New Financial Order
In this book I present six fundamental ideas for a new risk management
infrastructure. The first three are intended primarily for the private
sector: insurance, financial markets, and banking, respectively. The
risk management concepts in these three ideas are the same, but they
are applied to different risk management industries. Each industry—
insurance, financial markets, and banking—has evolved its own methods
of dealing with moral hazard, defining contracts, and selecting clients. At
a time of fundamental innovation in risk management, it is prudent to
build on these methods, respecting each industry’s unique body of
knowledge and extending and democratizing finance through them.
The next three ideas are designed primarily for development by the
government, both through taxation and social welfare and through
agreements with other countries. Government has a natural role in risk
management because long-term risk management requires the stability
of law, because most individuals have limited ability to construct appro-
priate long-term risk contracts, because fundamental institutions must
be managed in the public interest, and because major international
agreements require coordination with an array of government policies.
The first idea is to extend the purview of insurance to cover long-
term economic risks. Livelihood insurance would protect against long-
term risks to individuals’ paychecks. In contrast to life insurance, which
was invented at a time when deaths of young adults with dependents
were much more common than they are today, livelihood insurance
would protect against currently very significant risks—the uncertainties
in our livelihoods that unfold over many years. Home equity insurance
would protect the economic value of the home but would go far be-
yond today’s homeowners’ policies by protecting not just against spe-
cific risks to homes such as fires but also against all risks that impinge
on the economic value of homes. In the form offered here, first pro-
posed by my colleague Allan Weiss and me in 1994, the problem of
moral hazard is dealt with by tying the insurance contracts to indexes
of real estate prices.
1
The second idea for a new financial order is for macro markets, which
I first proposed in my 1992 Clarendon Lectures at Oxford University and
in my 1993 book, and that has been a campaign of mine ever since.
2
It en-
visions large international markets for long-term claims on national in-
comes and occupational incomes as well as for illiquid assets such as real
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estate. Some of these markets could be far larger in terms of the value of
the risks traded than anything the world has yet experienced, dwarfing
today’s stock markets. Even a market for the combined gross domestic
products (GDPs) of the entire world, a market for the sum total of every-
thing of economic value, should be established.
3
These markets would be
potentially more important in the risks they deal with than any financial
markets today, and they would remove pressures and volatility from our
overheated stock market. Individual and institutional investors could buy
and sell macro securities as they do stocks and bonds today.
The third idea is income-linked loans. Banks and other lending insti-
tutions would provide loans that are contingent on incomes to individ-
uals, corporations, and governments. The loan balance would automat-
ically be reduced if income falls short of expectations. Income-linked
loans would effectively allow borrowers to sell shares in their future in-
comes and in income indexes corresponding to their own incomes.
Such loans would provide protection against the hardship and bank-
ruptcy that afflicts so many borrowers today.
The fourth idea is inequality insurance, which is designed to address
definitively, within a nation, the serious risk that income in the future
will be distributed among people far less equally than it now is, that the
rich will get richer and the poor poorer. It reframes the progressive in-
come tax structure so that over time it fixes the amount of inequality
rather than fixing arbitrary tax brackets.
The fifth idea is intergenerational social security, which would re-
frame social security to be more truly a social insurance system, allow-
ing genuine and complete intergenerational risk sharing. Intergenera-
tional social security’s defining characteristic would be a plan to pool
the risks that different generations hold, risks that today are primarily
dealt with only informally and then only to a limited extent within the
extended family.
The sixth idea is international agreements to manage risks to national
economies. These unprecedented agreements among governments of
nations would resemble private financial deals, but they would surpass
such deals in scope and horizon.
Beyond these six ideas for risk management, this book proposes com-
ponents of a new economic information infrastructure: new global risk
information databases (GRIDs) to provide the information that would
allow effective risk management, and indexed units of account, new units
of measurement and electronic money for better negotiating risks.
the promise of economic security
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Some Scenes from the New Financial Order
Picture vast international markets that trade major macroeconomic ag-
gregates such as the total outputs of countries such as the United
States, Japan, Paraguay, and Singapore, or indexes of single-family
home prices both in cities—from New York to Paris to Sydney—and in
regions, such as shoreline properties on the Riviera or agricultural
property in the corn belt or the rubber plantations of Indonesia. Port-
folio investors will be able to take positions in a wide array of such mar-
kets with little cost. International markets for human capital will
emerge as well for occupations from medical and scientific professions
to the careers of actors and performers to common labor. These mar-
kets will facilitate the creation of livelihood insurance policies on every
major career and job category, and home equity insurance policies on
the value of everyone’s home. Massive electronic databases made ac-
cessible by user-friendly designs will enable people everywhere to en-
gage these markets to manage their real risks.
As these markets transform our appreciation of risks, our concepts
and patterns of thought will change accordingly. People will set prices
in light of the prices in these markets; countries will make international
agreements that parallel some of the risk management afforded in these
markets and will similarly revise their welfare and social security sys-
tems. Our economies will run more efficiently because these markets
provide the means to control our risks. The presence of these new mar-
kets will make it easier for firms to offer livelihood insurance, home eq-
uity insurance, and income-linked loans to individuals.
Our fundamental risks will thus be insured against, hedged, diversi-
fied, making for a safer world. By lightening the burden of risk, a new
democratic finance will encourage all of us to be more venturesome,
more inspired in our activities.
As a thought experiment, consider a young woman from India, liv-
ing in Chicago, who wants to be a violinist. She finds it worrisome to
borrow the money for her training given that her future income as a
musician is so uncertain. But new financial technology enables her to
borrow money online that need not be fully repaid if an index of future
income of violinists turns out to be disappointing. The loan makes it
easier for her to go into her favored career by limiting her risk because
if it turns out that musicians’ careers are not as lucrative as expected,
then she will not need to repay as much of the loan. Her risk over the
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