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people undertake, the occupational specialties they choose, the ventures
they set out on, are all limited by the knowledge that economically we
are on our own and must bear virtually all of the losses we incur.
Imagining the social and economic achievement that could come
from a new financial order is difficult because we have not seen such an
alternate world. We have not yet seen what remarkable things can hap-
pen if we remove all unnecessary fear of loss and enable people to em-
bark on the pursuit of their greater potential.
Information Technology
In the past, complex financial arrangements such as insurance contracts
and corporate structures have been expensive to devise and have required
information that is costly to collect. With rapidly expanding new infor-
mation technology, these barriers are falling away. Computer programs,
using information supplied electronically in databases, can make complex
financial contracts and instruments. The presentation of these contracts
and instruments, and their context and framing, can be fashioned by this
technology to be user friendly. Financial creativity can now be supplied
cheaply and effectively. It is critical to pursue such a transformation.
The implementation of some of our most important existing per-
sonal risk management devices, including life insurance, health insur-
ance, and social security, was made possible for the broad public by im-
provements in information technology in the nineteenth century. The
information technology that was new then embodied simpler things:
cheap paper on which to keep records, printed forms, carbon paper,
typewriters, and filing systems, as well as an efficient postal service and
more effective business and government bureaucracy.
Consider the old age insurance of social security, which was first im-
plemented by Germany in 1889. That plan, like most modern social se-
curity plans today, made payouts to retirees that depended on lifetime
contributions, and hence required reliable records for millions of indi-
viduals for many decades. The German social security administrators
needed to add to the records regularly, retrieve records reliably with-
out losing them, and communicate with retirees around the country
while managing a large payment system. The information technology
available in the nineteenth century—the paper, the forms, the filing
systems, the government bureaucracy—made this possible without
prohibitive cost. It converted social dreamers into implementers. This
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particular risk management innovation has long since drastically re-
duced the problem of poverty among the elderly.
Today’s new information technology is orders of magnitude more
powerful than that of Germany in 1889. I have seen the kinds of
changes our newest technology can make. The new digital technology
has made vast amounts of data about people’s homes available elec-
tronically. Karl E. Case, Allan Weiss, and I founded our company, Case
Shiller Weiss, Inc., in 1991 to create new measures of price appreciation
by zip code and home-value tier in the United States to facilitate de-
vices to manage the risks to our homes.
6
Since then, we have witnessed
the proliferation of electronic databases about single family homes and
have been able to exploit these new measures in ways that we could not
have imagined when we began our company.
The emerging information technology in 1990 made it possible for
us to launch our campaign to create home equity insurance. We saw
then that it was important to base insurance claims in terms of indexes
of prices rather than on the selling price of the individuals’ homes; oth-
erwise, we would face a moral hazard. Our campaign probably would
not have been feasible before the 1990s because no electronic databases
on home prices existed to allow computation of neighborhood home
price indexes. Now the opportunities for such insurance, and many
other financial innovations, are even better: Our data resources are
growing at astounding rates.
Financial Theory and Practice
While finance has been progressing for centuries, it has made stunning
progress in the second half of the twentieth century, both in theory and
in practice. Theoretical finance was advanced to a high level of mathe-
matical sophistication by such scholars as Fischer Black, Eugene Fama,
Harry Markowitz, Merton Miller, Robert Merton, James Mirrlees,
Franco Modigliani, Stephen Ross, Paul Samuelson, Myron Scholes,
William Sharpe, and James Tobin, and by their successors.
An outcome of this research is a comprehensive theory showing
how rational individuals ought to decide on their lifetime investments
taking account of all the parameters of their uncertainty and the statis-
tical properties of all risk management tools.
7
No longer is the optimal
allocation of people’s assets to various investments just an intuitive
call or tradition-based rule of thumb. Specific outcomes of this re-
the promise of economic security
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search include computerized financial planning services—some partic-
ularly advanced examples being esplanner.com, financialengines.com,
morningstar.com, and riskgrades.com—that will improve in the future
as theoretical finance and econometrics continues to advance.
Academics have had their counterpart among numerous innovators
in real markets. Practical finance has seen many innovations created by
exchanges, such as the American Stock Exchange and the Chicago
Board of Trade, and electronic communications networks (ECNs),
such as Instinet and Island. Dramatic innovation has also come from
investment banking firms such as Bank of America, Barclays, Bear
Stearns, Citigroup, Deutsche Bank, Goldman Sachs, Hongkong and
Shanghai Banking Corporation, JP Morgan Chase, Merrill Lynch,
Morgan Stanley, Société Générale Group, and Wasserstein Perella.
8
More innovation has come from insurance and reinsurance companies
such as ACE Group, Aegon Insurance Group, AIG, Munich Re, Skan-
dia, Swiss Re, and XL; from mortgage and consumer finance firms such
as Fannie Mae, Freddie Mac, and GE Capital; from pension funds and
mutual funds such as CalPERS, Fidelity Investments, TIAA-CREF,
and the Vanguard Group; from settlement firms such as the Bank of
New York, Depository Trust, and State Street Bank; and from broker-
age firms such as Charles Schwab and E*Trade. Central banks, such as
the Federal Reserve and the European Central Bank, and development
organizations, such as the World Bank, the International Monetary
Fund and the Grameen Bank, have contributed as well.
Their strides have made the last few decades the most compelling
period in world financial history. We have seen the development of vast
varieties of new futures, options, swaps, and other risk management ve-
hicles, new forms of mortgages and consumer credit, new forms of
health insurance, and innovative ways of making development loans.
Finally, insurance has been extended to cover a wide variety of specific
risks, even including weather disasters and other such catastrophes.
9
Conferences sponsored by professional organizations such as the Asso-
ciation for Investment Management and Research (AIMR), the Global
Association of Risk Professionals (GARP), International Association of
Financial Engineers (IAFE), and the Risk Waters Group have become
major international events.
The 1980s saw the beginnings of a rapid rate of experimentation with
financial forms in countries formerly committed to Marxian commu-
nist ideologies, notably China and Russia, but also in numerous devel-
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