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  • GARY GENSLER: Thanking everybody to coming back.

  • I think there'll be a few people coming in late,

  • still hitting the send button on the papers.

  • I want to thank everybody that submitted papers

  • before the ninth class, because I actually

  • had a chance to read those 26.

  • Since there are actually officially 84 or 85 people

  • registered for this class, I'm intrigued

  • to see if 59 papers came in a minute ago.

  • Human nature being human nature, these are just

  • the statistics on this class.

  • And as far as those of you who may have seen,

  • I chose that part of the experience

  • here is actually eyes on--

  • meaning my eyes on your papers--

  • and giving comments.

  • If you don't want the comments, you just want a grade,

  • you can always give me a heads up and send me an email,

  • and I will take less time.

  • I want to compliment everybody.

  • They're good.

  • I mean, there is a good engagement, a good dialogue.

  • You will see occasionally that I don't give you

  • everything you want back.

  • But a couple observations.

  • It's really an opportunity, on any topic

  • you want to choose in the second half of the semester up

  • to maybe the 23rd class, please, if 70 of you

  • hand it in on the 23rd class, that is your right, that

  • is your option, it's just--

  • it's just going to be harder on Sabrina, Thalita,

  • and me to grade.

  • But it's to use critical reasoning

  • about that week's topic.

  • So let me just mention two or three things some of you did--

  • I'm not going to be harsh about it-- but some of you

  • did that's not what I'm looking for.

  • I'm not looking for just addressing the three study

  • questions.

  • The three study questions are about us together here.

  • And just to sort of talk.

  • Secondly, I'm not looking for you

  • to take a reading from six weeks earlier

  • and describe that reading, or three weeks earlier.

  • So if you choose, in the future, to take November 15th--

  • I know November 15th, because we're going to--

  • it's going to be our second time with outside speakers,

  • and it's a really important time,

  • if you look at that class, to write something on that class

  • when it's--

  • we're fortunate enough that Jeff Sprecher, who

  • is the Chief Executive Officer of the Intercontinental

  • Exchange, and Kelly Loeffler, who is the Chief Executive

  • Officer of Bakkt, are going to come and do a class with us

  • about payment systems and what ICE and the New York Stock

  • Exchange is trying to do in payment systems.

  • I'm just using that.

  • If you write about that, it's really about that, not

  • about everything earlier.

  • And when we get earlier, I'll probably

  • say more about that class.

  • And we were fortunate to have one

  • of America's true great entrepreneurs

  • join us in Jeff Sprecher that week.

  • Who has, from scratch, created a $50 billion

  • market cap company in 20 years.

  • So those were my comments.

  • The papers were generally good.

  • Really looking for critical reasoning, ground truths.

  • Where did you take something?

  • Some of you brought a great narrative voice, by the way.

  • I have to compliment.

  • There were a couple-- a handful that I really

  • found you're really good writers and in addition to

  • being good business students.

  • So those are my thoughts today.

  • I'm going to go through--

  • oh, and we have we have an interesting guest next Tuesday,

  • but I'm not going to say anything more than that.

  • You'll find it fun.

  • Tuesday the 16th.

  • STUDENT: Nakamoto?

  • GARY GENSLER: What's that?

  • STUDENT: Nakamoto?

  • GARY GENSLER: Nakamoto!

  • Satoshi Nakamoto.

  • No, no.

  • Any other guesses?

  • I'm not giving any clues, but I will tell you you

  • will have fun next Tuesday the 16th.

  • It will be a guest you will not see at any other class.

  • So today, I want to talk about--

  • Ah, Tom's thinking about it, right?

  • Intrigued.

  • We're going to talk a little bit about finance.

  • Now, just as a way of background,

  • I've spent 39 years in finance.

  • So this is just my chance to take 80 minutes to talk

  • about finance with all of you.

  • We did have readings that will tie into it.

  • So overview, we're going to talk a little bit

  • about the readings, of course, as we always do.

  • Three slices of finance for a moment-- finance

  • and financial institutions.

  • What is a financial institution?

  • What does that word mean, and how do we think about it?

  • Finance and regulation, finance and technology.

  • So three quick slices of finance.

  • What is credit?

  • What's capital markets?

  • Again, a broad sort of Gensler's view of it,

  • maybe, but still I think you could--

  • it's grounded in academic literature.

  • Then what are the risks?

  • I spent a bunch of time at Goldman Sachs.

  • One of the last things I did as kind of the cofinance officer

  • was also sit on the firm-wide risk committee.

  • And so sort of bringing insight into,

  • what is risk management in finance?

  • Or at least in the capital market side of finance.

  • And crises.

  • I'm going to spend a couple of minutes on the OA crisis.

  • Some perspective from a guy who lived through it.

  • And then some of the opportunities

  • in the blockchain world.

  • We'll try to wrap and be out of here at 3:55, as usual.

  • So this study questions--

  • which, now I know there's probably 58 papers on this

  • in the inbox, I think.

  • But does anybody want to lend a hand?

  • I mean, it's getting shorter.

  • It's only 20 people on this list now.

  • But that means that 25% of you are

  • thinking that class participation is not

  • that important.

  • We're going to have to find a way that if somebody's still

  • on this list in a while that I don't give somebody

  • a terrible grade.

  • Because 30% of the grade is class participation.

  • I just say that.

  • I'm humorous about it.

  • I'm willing to work with people that,

  • if your language skills aren't there and you're just shy,

  • or you have an issue.

  • But does Monica want to help me out at all?

  • STUDENT: Yeah.

  • So, I'm back here.

  • So one of the trade offs that I talked about in my paper

  • was that we saw from one of the articles

  • that, as bankers were making more money,

  • there is a greater income disparity that we

  • saw in the entire sector.

  • And then one of the other things I talked about,

  • as some of these institutions combined,

  • they created like these huge conglomerates and the act

  • kind of deregulated the space that

  • allowed for that to happen.

  • GARY GENSLER: So Monica's raising two things, probably

  • from the Harvard paper, but two things that about income

  • disparities and also the concentration.

  • Anything else that people took from that Harvard--

  • I know it was a little dense, but the paper?

  • Is that a hand up?

  • Is that-- no?

  • You sure?

  • Oh, come on.

  • What's your first name?

  • STUDENT: Cece [INAUDIBLE].

  • Sorry, I'm not in the class list.

  • [INAUDIBLE] visiting MIT and hoping I

  • can audit this class today.

  • GARY GENSLER: All right. [? Cece ?]

  • is here as a listener.

  • Thank you.

  • Do you want--

  • STUDENT: Dan.

  • GARY GENSLER: Dan.

  • STUDENT: Yeah, in the Harvard paper, I just thought

  • was interesting.

  • It was that that act in 1994 that essentially caused--

  • it was the catalyst for just massive consolidation

  • of the financial services industry.

  • And so that's what ultimately led to disproportionate wages,

  • or disproportionate economic rents,

  • when related to productivity.

  • GARY GENSLER: OK.

  • So can you remind me which act?

  • Because '94 isn't ringing a bell.

  • I mean, the Gramm-Leach-Bliley was 1999,

  • and I don't know if there was something in '94 that--

  • [INTERPOSING VOICES]

  • GARY GENSLER: What's that?

  • STUDENT: Riegle-Neal.

  • GARY GENSLER: Riegle-Neal.

  • OK.

  • So Dan's raising that it's also regulation and law

  • has a lot of effect on it.

  • Consolidation is happening in many industries.

  • Finance is not separate from those industries.

  • 50, 60 years ago, you had the local drugstores,

  • now we have the big chains like CVS and the like.

  • So I just mention that the consolidation happens a lot.

  • One thing that I would say on the other side of that,

  • having actually watched and observed some of it,

  • is there was the desire to merge a lot of banking.

  • But the US, in contrast to other countries,

  • didn't have interstate banking.

  • All the way into the 1970s, banks

  • had to be within their own--

  • one of the 50 states, literally.

  • That started to break down in the late '70s.

  • It started-- Riegle Neal in '94, pretty much then it was,

  • Katie bar the door, we could have national banking.

  • And then by 1999, we also could have

  • commercial banking and investment banking together,

  • which is Gramm-Leach-Bliley.

  • I'm sorry.

  • I want to come back here, but next to Dan.

  • STUDENT: I was going to say that basically, the paper basically

  • went through a process of elimination of what

  • could explain the higher economic rents,

  • and basically checked everything off the list.

  • It said it was basically a bit of manipulation,

  • because there was more power by the banks that

  • had consolidated.

  • GARY GENSLER: Right.

  • Erin, do you see that as manipulation or just

  • an opportunity to get some oligopolistic or monopolistic

  • rents?

  • And I'm just discerning the word manipulation--

  • STUDENT: Yeah.

  • I guess what they were--

  • yeah, I mean I think it's--

  • I mean manipulation in the sense that, higher--

  • maybe taking advantage in a way that

  • wouldn't exist in a market that wasn't so consolidated

  • compared to other markets that were consolidated

  • and regulated, such as Canada.

  • Because he made a lot [INAUDIBLE]..

  • GARY GENSLER: I would note that every entrepreneur's desire,

  • in a business context, maybe not in a moral sense,

  • is to be able to collect economic rents.

  • Like you start out as a disruptor,

  • and along the journey, you would actually

  • wish to become somebody who collects excess profits

  • or becomes the monopolist.

  • I'm not speaking that you literally

  • want to take advantage of people,

  • but you do want to sort of collect excess rents.

  • And so it's a sort of natural transformation.

  • I'm sorry, there was a hand here.

  • STUDENT: Yeah, similar to what Eric said last, compare also--

  • concentration by regulation, or concentration

  • by deregulating the market, and by regulating it,

  • incumbents are able to take more risks.

  • And that is bad for financial systems.

  • GARY GENSLER: Right.

  • Brotish?

  • STUDENT: Not from the paper, more from personal experience.

  • So the way I see it is the financial institutions

  • are increasingly trying to be at the center

  • of a lot of different [INAUDIBLE]

  • of different business.

  • And with many innovative products,

  • they are kind of connected like people across the industry

  • chain.

  • So they kind of [INAUDIBLE] some sort of accountability

  • with [INAUDIBLE] valuations.

  • And when a financial institution is at risk,

  • it connects all the different players in the value chain.

  • GARY GENSLER: Right.

  • So Brotish is raising also that finance, partly because

  • of its centrality in the economy,

  • tries to add other products or add other things

  • and be at the center of the value proposition or chain.

  • I would contend there is also non-financial firms that

  • try to do the same thing into finance.

  • So big tech right now--

  • you think about Apple Pay, or think of Alibaba in China.

  • But then Ant Financial is one of the most significant.

  • So sometimes it comes the other way.

  • If you can leverage a network, leverage your centrality

  • to a market and add products.

  • But I agree with you, it goes both ways, though.

  • Other comments from the readings?

  • Isabella?

  • STUDENT: [INAUDIBLE] articles also

  • was sort of the idea of innovation ahead of regulation.

  • The nice thing about bringing in new technology

  • is that it does take time for the government

  • to actually regulate it.

  • And I know one of the articles, or the interview

  • talked about needing to further regulate and restructure

  • the banks.

  • That's not something that's going to happen, especially

  • with people trying to overturn-- is it the Dodd-Frank act?

  • Yes.

  • So it's not really going in that direction,

  • but it's something people talk about it a lot.

  • GARY GENSLER: Right.

  • So there is an ebb and flow of regulation,

  • and we'll chat in a couple minutes.

  • Regulation in finance has been around for thousands of years.

  • I mean, literally, back when the Hammurabi

  • code was being written, there were regulated interest rates.

  • We went through a long period in Europe

  • where actually it was illegal to charge an interest rate,

  • for hundreds of years in different societies.

  • So there is an ebb and flow.

  • Now it's much more complicated today.

  • In a sense.

  • And Isabel was just mentioning that Dodd-Frank,

  • passed in the US, was a post crisis reform.

  • That would be a time, a period you would think, well,

  • maybe the public, through its legislative body,

  • will lean into doing more regulation.

  • And then as you move away from a crisis moment,

  • you see some easing up.

  • And there is always sort of an oscillation over the decades.

  • Why don't we take one more?

  • STUDENT: So I think one of the other interesting things

  • that the article brought up was the case of Citigroup,

  • which basically highlights the tradeoff perfectly.

  • So on the positive side, if you look

  • at Citigroup, what it's trying to do

  • is it's trying to provide universal services.

  • So it's a one stop shop for all your financial services.

  • Whereas [INAUDIBLE] argued that one

  • of the things that should have been done

  • post crisis was to break it up.

  • Because the problem with having the universal one-stop shop

  • is that, if it fails, then it's an obligation on the fed

  • actually prevent it.

  • GARY GENSLER: So [INAUDIBLE] raising something

  • about Citigroup or Citicorp that became,

  • in a sense, a one stop shop, a shopping

  • center of financial products, so maybe it

  • should've been broken up.

  • But who wants to tell me what Sheila Bair, who

  • was the head of the Federal Deposit Insurance Corporation,

  • said?

  • Because in that interview with Sheila, she talked about Citi.

  • Alpha?

  • STUDENT: She said she almost, I guess,

  • regrets not letting them restructure

  • and letting them fail, because it created

  • this sort of a moral protection that people

  • thought that [INAUDIBLE] large [INAUDIBLE] shouldn't survive.

  • GARY GENSLER: Kelly, were you going to add something to that?

  • STUDENT: Yeah, I was.

  • I thought her interview was--

  • it's kind of hard to weed out what she's really saying,

  • because it's toned with little strings of bias.

  • Obviously, one, because she's been through that crisis

  • and pretty much brokered that deal, and two

  • because she throws in political maneuvers.

  • So it's hard to tell what she thinks

  • is necessarily best for the health of the financial system.

  • Like she says, bank profits are good, dividends are robust.

  • They've got big tax cuts, they should be

  • building their capital bunkers.

  • So--

  • GARY GENSLER: Right.

  • But you mean it's hard to tell where Sheila

  • is on Citicorp, for instance?

  • STUDENT: Well, and also the state of,

  • like, how a lot of what she says is the banks too big to fail.

  • GARY GENSLER: So Sheila Bair, who was to her core

  • as a Kansas Republican, who worked for Senator Bob

  • Dole, who was then, when she worked for him, majority

  • leader in the US Senate on the Republican side,

  • is kind of a bit of a prairie populist,

  • if those terms mean something to the class.

  • And she got into the role of running the FDIC

  • and saw early--

  • frankly a little earlier than most--

  • that there was a problem going on

  • in mortgage financing and credit lending and the ease of credit

  • in the US.

  • When the crisis really hit hard, she

  • was part ultimately of the team.

  • Not the head, usually the Chairman

  • of the Federal Reserve, and the Secretary of the Treasury.

  • Or in any country, it's usually the finance minister

  • and the head of the central bank who

  • is somewhere in a war room sort of setting,

  • literally, in crisis and rolling conference calls and meetings

  • trying to sort through things.

  • But Sheila was certainly at that next level

  • in our multifaceted regulatory system in the US.

  • And I read her reading, and also just knowing her personally--

  • I was with her last Friday at a conference,

  • which I guess she arranged in Washington about the crisis.

  • I think her reading was what Alpha's saying.

  • I think it's-- but you're correct,

  • she is a political actor and is proud of that.

  • I mean, that's her lifeblood and where she's been for 30 years.

  • But she's also deeply a policy person

  • and tied to a sort of populist vein in her--

  • she would have probably preferred

  • to see Citi restructured or taken over because of what

  • Alpha said, that there is a quote "moral hazard,"

  • that the markets might think, well

  • there's always going to be a bailout waiting

  • for the largest of the banks.

  • That would be the translation of what she said there.

  • Let me let me hit upon, so what is the role of finance?

  • What's the central role when we simplify all down

  • to its essence?

  • We have a dozen masters of finance in here.

  • So what are they teaching?

  • And what's Andy Lowe teaching?

  • I don't know.

  • Is anybody taking Andy's intro class or no?

  • Nobody wants to tell me the role of finance?

  • Here, here we go.

  • Are you a master of finance student?

  • STUDENT: No, MBA.

  • GARY GENSLER: You're an MBA.

  • Who's a master of finance?

  • Oh no!

  • All right.

  • What's the role of finance?

  • Very simple.

  • It's like elevator stuff.

  • STUDENT: I guess it's [INAUDIBLE]

  • like different functions of [INAUDIBLE]

  • GARY GENSLER: All right, so intermediary, helps society.

  • What's it intermediating?

  • The two things it intermediates? [? M ?] finance students?

  • STUDENT: They allocate resources and also risk.

  • GARY GENSLER: Resources and risk.

  • So they move, allocate and price.

  • Really importantly, price allocate and move

  • money and risk.

  • Just easy pictures.

  • Money is something of value and risk.

  • And you will see this hourglass on a whole bunch of slides

  • because I've thought about finance for the whole 40 years

  • I've been around it as an hourglass.

  • Wall Street is sitting right at the neck of the hourglass.

  • Intermediaries.

  • I thank-- what's your name?

  • What's that?

  • Joey.

  • Intermediaries of financial assets and liabilities.

  • Because there's both sides of the balance sheet.

  • They can move around assets or they

  • can move around liabilities, again

  • at the neck of the hourglass.

  • So what are the key functions of finance?

  • I'm going to list four, but what are the functions of finance?

  • As opposed to a role?

  • Anybody else?

  • There were other hands up.

  • Sure.

  • STUDENT: Capital allocation.

  • GARY GENSLER: Capital allocation.

  • I'll take that.

  • It's not what I was looking for but it's good.

  • STUDENT: Market making.

  • GARY GENSLER: Market making.

  • Capital allocation, market making.

  • [INAUDIBLE]?

  • STUDENT: Payment.

  • GARY GENSLER: Payment.

  • STUDENT: Providing liquidity.

  • GARY GENSLER: Providing liquidity.

  • I'm agreeing with all of them.

  • You should have written my slides.

  • I should revise the slides.

  • So I say it's basically investments,

  • basically the store of value, and credit--

  • in essence, borrowing value.

  • Remember what money is.

  • I know Ross is looking at me like--

  • it's the two sides of--

  • we have this social concept of money

  • that goes back thousands of years.

  • And at some point in time, what if I want to store the value

  • or borrow the value?

  • It's the two sides of the--

  • it's, again, centered on a social construct.

  • And thus, financial intermediaries

  • sit right at the neck of the hourglass

  • and transform risk as well.

  • It could be a bank that's transforming risk,

  • short term deposits are then lent or loaned out long.

  • So right at the center of the banking system,

  • the commercial banking system.

  • Is what's called maturity transformation--

  • short term deposits versus long term lending.

  • And it's not something we're going to do away with.

  • In fact, we should say, that's a good thing.

  • But because there's maturity transformation,

  • you can also have what's known a run on the bank.

  • What are the key sectors?

  • I'm going to throw a bit up here, six or seven sectors.

  • But what are the sectors you think about as--

  • maybe some of you worked in?

  • This is easy.

  • STUDENT: Insurance.

  • GARY GENSLER: Insurance, one.

  • I don't remember your name.

  • STUDENT: Ross.

  • GARY GENSLER: Ross.

  • STUDENT: Asset management.

  • GARY GENSLER: Asset management.

  • Insurance, asset management.

  • Anton?

  • STUDENT: Banking broker.

  • GARY GENSLER: Oh, that's two sectors-- commercial banking

  • and brokers.

  • STUDENT: Private equity.

  • GARY GENSLER: Private equity.

  • I would call that asset management.

  • All right.

  • So I put commercial banks.

  • Sometimes in the US we have 7,000 or 8,000 credit unions

  • and 9,000 commercial banks.

  • Investment banks and brokerage firms.

  • In Europe and many countries, there are universal banks

  • and there are inside commercial banks.

  • But they perform a little bit different function.

  • Commercial banks think about taking depositors' money

  • and then lending.

  • The central thing about commercial banks

  • is a credit allocation, pricing of credit,

  • underwriting of credit.

  • The center thing about investment banks is about--

  • it still has underwriting, but it's usually

  • related to market based, rather than using their own balance

  • sheet, but market based securities and brokerage.

  • Insurance is a risk transformation.

  • I need to be covered if I get into an auto accident.

  • I need to be covered if my house burns down.

  • So thus I buy that insurance, classic forms of insurance.

  • And then all forms of asset management

  • and collective investment vehicles.

  • I make it as two different buckets,

  • because a collective investment vehicle is when you actually

  • put something into a shared balance sheet,

  • like a mutual fund.

  • Asset managers are really just getting paid a fee,

  • but the two overlap.

  • And of course all the infrastructure of exchanges

  • and clearinghouses.

  • It might end up employing a quarter of you in one day,

  • but I think about the different sectors.

  • When you're thinking about use cases for blockchain,

  • it could be an any one of these sectors,

  • in any one of these functions.

  • Financial markets or capital markets.

  • What's the difference between primary markets and secondary

  • markets?

  • STUDENT: Kyle.

  • GARY GENSLER: Kyle.

  • STUDENT: Primary markets was when

  • you issue a share that's new to the world,

  • like you bring a company public.

  • GARY GENSLER: All right.

  • I'm going to pause you there.

  • Good answer.

  • So Kyle says primary market is when an issuer--

  • if I can add a word--

  • an issuer is issuing a security for the first time

  • and receiving something of value which we call money.

  • That's primary.

  • Primary because it's the first issuance.

  • What's the secondary market?

  • Hugo?

  • STUDENT: [INAUDIBLE]

  • GARY GENSLER: Training of those later.

  • So primary markets, secondary markets.

  • It's relevant not only because they have different market

  • structures and different ecosystems,

  • but they tend to have a little bit different regulation

  • as well.

  • Which has the higher volume in the--

  • STUDENT: Secondary market.

  • GARY GENSLER: Secondary markets.

  • STUDENT: There are too many issues [INAUDIBLE] the market.

  • [INAUDIBLE] maybe some interval issue.

  • But [INAUDIBLE] it's [INAUDIBLE]

  • GARY GENSLER: Well, what's interesting

  • though, the secondary markets have much more volume

  • than the primary markets.

  • The ratio is not the same market to market.

  • Some markets, there's a lot of profitability.

  • If you're thinking about finance and where

  • you can make your own businesses and money,

  • there's a lot of juice in the primary market.

  • There's a lot of activity and various illiquid

  • or not tradable secondary markets.

  • Whereas like equity markets, highly liquid equity markets,

  • all the action is in the secondary market.

  • Apple I don't think has done any primary issuance

  • in well over a decade, maybe a couple of decades in the equity

  • markets.

  • But certainly the secondary market for Apple stock

  • is quite robust.

  • Whereas there's some things that it's only

  • about the primary market.

  • Alone, syndication is really a primary market,

  • and there's not a lot of trading of secondary loans.

  • So it's not all in one place.

  • And again, when you're thinking about use cases, that matters.

  • Because is it high volume or low volume?

  • Is there a lot of juice?

  • Juice is the margin of profits to earnings.

  • Non-technical term, sorry.

  • I include in capital markets the asset managers

  • that earn fees, the BlackRocks and Fidelitys

  • or the small asset managers, as well.

  • And then all the infrastructure-- the exchanges,

  • the clearinghouses and the like.

  • So again, finance, to sort of drill

  • back to where we were earlier, have ledgers and payment

  • systems.

  • Who's going to remind me what a ledger is?

  • It's easy stuff.

  • No.

  • Ledgers.

  • Wait, wait, no.

  • STUDENT: It can record transactions.

  • Priya.

  • GARY GENSLER: Priya.

  • STUDENT: Record transactions.

  • GARY GENSLER: A record of transactions.

  • I know you're tired and you're quiet,

  • but if I were to give you an exam,

  • one of the 20 questions I would give you on vocabulary

  • is ledgers.

  • Because ledgers matter to blockchain, and blockchain

  • matters to ledgers.

  • I'm not saying that there is no use for blockchain technology

  • absent ledgers, but I'm hard pressed

  • to think of a really good use case within finance,

  • at least, unless you have some ledger, some recordation

  • of things of value.

  • If you're keeping a record of things of value,

  • then the immutable nature of blockchain

  • becomes more relevant.

  • If it's not things of value, I'm just

  • saying I'm a little bit harder pressed to say,

  • well, you need the complexity of this database structure.

  • You could use other database structures to keep it,

  • even though Stuart Haber has that wonderful blockchain

  • that's published in The New York Times for notaries.

  • So ledgers are records of economic activity

  • and financial relationships.

  • They are embedded in every part of finance.

  • Insurance companies have ledgers,

  • investment banks have ledgers, central banks have ledgers.

  • They are embedded in every part and they have been around

  • for thousands of years, and they're

  • right at the center of blockchain

  • because the UTXO set in Bitcoin is a form of a ledger.

  • And there's an account based ledger in Etherium.

  • What is a payment and settlement system?

  • Anybody want to give it a shot?

  • Alpha I'm going to move money to you.

  • A payment system is moving money from Gary to Alpha.

  • You don't have to answer this question.

  • [? Kiera. ?] Payment system is moving money from me to Alpha.

  • What is it doing?

  • It's transferring?

  • Good.

  • Kelly?

  • STUDENT: I'm just going back to our second class, but a method

  • to amend and report the changes to letters?

  • GARY GENSLER: Right.

  • I'm breaking it down.

  • It is a transfer.

  • But [? Keira ?] is absolutely right.

  • It's transferring value from Gary--

  • from me to Alpha.

  • But Kelly's right.

  • It's amending two ledgers.

  • It's going to amend the ledger on my side negative

  • and hopefully amend Alpha's positive.

  • So it's amending and recording ledgers.

  • It's also-- these systems, they have

  • to first authorize something.

  • They have to do something called clearing.

  • And we're going to get to all of these later in the semester.

  • You might think, oh, that's the boring stuff about finance.

  • It's the back office.

  • But authorizing, clearing, recording.

  • And the key word for blockchain is final transfer.

  • The reason blockchain might have application

  • is it is a way to finally move money.

  • I don't mean finally like over the centuries.

  • I mean, if I were to move money to Alpha through the US banking

  • system, it might not move for several days.

  • Blockchain is an application that could have more immediacy.

  • Final settlement.

  • Finance and regulation.

  • We talked a little bit about this

  • when we were talking about the readings,

  • but it's long been part of public policy debates.

  • This is not new.

  • It's not just a post financial crisis.

  • It's not part of like the post-industrial economies

  • of the globe.

  • It has been true for thousands of years.

  • Sometime to the point that people went to prison.

  • Does anybody know what debtor prison is?

  • Kyle or Priya?

  • STUDENT: You would basically have

  • to go to jail if you didn't pay your debts off

  • in a certain amount of time, to work off your debt [INAUDIBLE]

  • be there.

  • GARY GENSLER: So Kyle is mentioning

  • that debtor prison was that you literally

  • had to go to jail if you didn't pay off your debts.

  • Do you know when that went away in the US

  • or in Europe or in China, in any country?

  • STUDENT: Disturbingly recently.

  • GARY GENSLER: Disturbingly recently?

  • STUDENT: [INAUDIBLE]

  • GARY GENSLER: No, I thought it was 18th century.

  • But you're saying you think was 19th century.

  • I haven't researched when debtor prison finally went away.

  • But so regulation also is this horrible thought.

  • What did we do when people didn't pay their debts,

  • and how bankruptcy laws reflect--

  • because bankruptcy laws are a social

  • construct, in essence, that you don't go to jail,

  • but you have an opportunity to work through those debts.

  • I just highlight this that it's not a new thing.

  • Blockchain isn't the-- we don't have regulation because

  • of blockchain, and we don't necessarily

  • need a new set of regulations.

  • Because finance is so central to economies,

  • we've been grappling with regulation for a long time.

  • Now you saw this little framework before,

  • but I restacked it.

  • This is now the stack I think of in terms

  • of financial regulation.

  • Financial stability is first.

  • And while you can't see closely, this

  • is a bank run and a wonderful picture

  • by Dorothea Lange called "White Angel Bread Line."

  • But this is basically financial stability

  • is probably the first and foremost thing that regulation

  • around finance has been for a couple of centuries.

  • It's how do we make sure that the banks have backing when

  • they take the money in house?

  • And how do we make sure that we don't have a calamitous thing?

  • And even before Fiat currency, well before Fiat currencies,

  • we had economic cycles that had boom and bust.

  • Like in the 17th century, the tulip bulb craze--

  • the tulip bulbs in Holland, I guess.

  • But we also had incredible boom and bust periods

  • around the South Sea, the stock companies that

  • were being created over exploration and so forth.

  • Protecting the public, just as we've

  • talked about in blockchain, I would say that non-blockchain,

  • there's a lot more emphasis on consumer protection,

  • a tremendous amount of emphasis on consumer protection.

  • Of course, we've talked about investor protection

  • and so forth.

  • The illicit activity conversation

  • we've had all around blockchain is important around finance,

  • but it's not the leading--

  • it's not the tip of the spear.

  • It's not where this debate has been

  • over the decades or centuries.

  • It's frankly more something in the last 30 or 40 years.

  • As money has moved to digitized electronic means,

  • governments have stood up more emphasis

  • on any money laundering laws, Bank Secrecy Act

  • laws and the like.

  • But if you look at the history of like 19th century

  • or early 20th century financial regulation,

  • there was a little bit about guarding

  • against illicit activity.

  • But by and large, most of the regulatory regimes--

  • even in the 1930s, during the financial crisis of its time,

  • the Great Depression, most of it was about bank runs,

  • shoring up the banking system, standing up deposit insurance

  • and protecting the investors.

  • And it was this concept of money laundering and so forth was--

  • it's when we move from physical forms

  • of cash to electronic forms that you found more of that.

  • Yes, please.

  • STUDENT: In a public policy discussion,

  • how is financial stability defined?

  • Is it like more inflation?

  • GARY GENSLER: That's a very good question.

  • Remember your first name?

  • Jihee.

  • Jihee is asking, is financial stability

  • about inflation or otherwise?

  • It does include inflation, but financial stability is broader.

  • In essence, it's the thought of, does the financial system

  • lead to instability in the economy?

  • And what is true, again, for probably a couple

  • of thousand years, but the research that you can read--

  • Ken Rogoff's book.

  • I don't know if any of you have ever read Ken Rogoff's book.

  • It was a wonderful book about the history of crises

  • and economic cycles that came out 4 to 6 years ago,

  • and I could get you the name of it.

  • But finance adds to and leads to booms and busts.

  • Booms and busts existed well before Fiat currency

  • and banking, but there's booms and busts in the cycle.

  • And so financial stability, in essence,

  • is trying to smooth out the cycles you would say.

  • Central banks came along initially

  • in the late 17th century.

  • But then, by the early 20th century,

  • most nations had central banks as a check on the sovereign

  • in terms of currency.

  • And that's where, Jihee your question about inflation.

  • So if the sovereign can deflate--

  • if the currency could be devalued through inflation,

  • that can lead to instability.

  • But it's all forms of instability,

  • particularly because leverage is at the center of finance.

  • Leverage meaning that a financial institution's assets

  • are what?

  • What are financial intermediaries' assets?

  • If you look at a balance sheet--

  • Eilon?

  • STUDENT: Loans.

  • GARY GENSLER: Loans.

  • Brotish?

  • STUDENT: Deposits?

  • GARY GENSLER: Well, deposits are usually on the liability side.

  • But [INAUDIBLE]?

  • STUDENT: Capital?

  • GARY GENSLER: Capital.

  • You mean capital and somebody else?

  • STUDENT: Yeah.

  • GARY GENSLER: All right, one more.

  • I mean, loans-- these are all good answers.

  • Anton?

  • STUDENT: [INAUDIBLE]

  • GARY GENSLER: What's that?

  • STUDENT: The security they're investing in.

  • GARY GENSLER: The securities-- investments.

  • The difference between a commercial balance sheet,

  • or a non-financial balance sheet and a financial balance sheet,

  • easy to figure this out.

  • Commercial balance sheets have physical assets.

  • They own plants, equipment.

  • In the old days--

  • I mean, now it's intangible assets,

  • like movies and software development.

  • But and a financial balance sheet,

  • almost all financial balance sheets you look at,

  • all their assets are other financial assets.

  • A loan is a financial asset, a security is a financial asset,

  • a deposit is a security-- they're assets.

  • They have a little bricks and mortar, maybe a little bit

  • of goodwill or intellectual property,

  • and a lot of other financial assets.

  • And they're-- the right hand side of the balance sheet is

  • a bunch of liabilities and a little bit of capital.

  • And so they're levered.

  • And that leads to instability.

  • Finance and technology.

  • I contend finance has long been in a symbiotic relationship

  • with technology.

  • It just depends on the technology of its time.

  • Blockchain is just in that long history.

  • And we've talked about it.

  • Money started looking like this.

  • We've sort of gone down this path.

  • Then technology came along, and it could look like this.

  • But it's all technological evolution, or at times

  • revolution, that we went from that to paper money.

  • Now sometimes technology veers off

  • and we have private bank notes instead of Fiat notes

  • and so forth.

  • But it's just forms of technology.

  • And the modern money, Fiat currency,

  • is just another evolution in technology and regulation.

  • So that's why I'm saying it's sort of--

  • finance, regulation, and technology all

  • have this symbiotic bit together,

  • from debtor prison to where we are now.

  • And thankfully, we don't have debtor prison.

  • Yes?

  • STUDENT: Yes.

  • [INAUDIBLE] a consequence of reading

  • the readings for today's class.

  • I was kind of thinking that maybe it's

  • the very nature of the financial market and its configuration.

  • Big companies with very high barriers of entry,

  • because of the regulation and the substantial capital

  • requirements, that their relationship with technology

  • innovation has been that fluid in the recent years up

  • until the recent showing of FinTech startups.

  • Because there's a certain sense of complacency,

  • in the sense that they've been approaching

  • technology innovation.

  • You see current incumbents--

  • and I was surprised by kind of noticing the same [INAUDIBLE]

  • here in the United States.

  • Big banks still use really old legacy systems.

  • And they can innovate, but incrementally.

  • They put the brand new mobile application--

  • GARY GENSLER: So Eric--

  • I think Eric's raising at least three points,

  • but maybe there's four or five and I missed some.

  • That concept that, yes, finance has always

  • been about technology, but do you

  • think something's accelerated in the last period of time?

  • That it's even more about technology?

  • That's Point 1.

  • Point 2 is, they seem to be slow at adaptation,

  • that the really kind of lumbering

  • of the bunch of legacy systems.

  • And they're slow.

  • Those were the two main points.

  • Maybe there's a third or fourth.

  • I would concur, though I wouldn't

  • overemphasize the first.

  • They had to grapple with what it meant when the telegraph wires

  • came and the telephones came.

  • I mean, maybe not in the same--

  • maybe it has accelerated, but there's still--

  • and it's said that--

  • they said that the people that did the best in the London

  • Stock Exchange about 200 years ago, the Battle of Waterloo

  • happened.

  • Does anybody know where the Battle of Waterloo--

  • I mean, it's before me too.

  • I wasn't around then.

  • Thank you.

  • Is that good?

  • What's that?

  • STUDENT: [INAUDIBLE] in Belgium.

  • GARY GENSLER: In Belgium.

  • But who was the great general?

  • STUDENT: Washington?

  • GARY GENSLER: Wellington.

  • So it's said that Lord Wellington sent carrier pigeons

  • back to London.

  • This is supposedly a real story.

  • Those carrier pigeons carried the information,

  • and the traders in London who got the carrier pigeons

  • traded before others knew the results.

  • The carrier pigeons, in a sense, were the technology

  • at the time.

  • So I'm just saying the intersection of technology

  • and finance, particularly for those who have the best carrier

  • pigeon, it works.

  • Now I used to use this story sometimes

  • at hearings, when high frequency traders would

  • be coming in front of the Commodity Futures Trading

  • Commission.

  • And they'd go, oh, the chairman is going to pull out

  • his carrier pigeon story again.

  • And they said, please don't call a high frequency trader

  • a carrier pigeon company.

  • But my point is is, I think you're right, Eric.

  • I think it's accelerated, but it's not that it wasn't-- and I

  • do think that the big incumbents are sometimes slow to adapt,

  • and that's part of the opportunity of blockchain.

  • Blockchain may not be better than what they're doing,

  • but blockchain might be the tool of a disruptor

  • to get someplace that the incumbents are too

  • invested in their current legacy system to get there.

  • So it might be that opportunity to get

  • underneath what they're doing.

  • Eilon.

  • STUDENT: Are you talking about building a bank that's

  • built on blockchain as an opportunity to disrupt

  • the banking industry?

  • Or using the blockchain within the activities [INAUDIBLE]..

  • GARY GENSLER: Well, see, that's not

  • a question I'm going to answer.

  • You all get to answer that in your final projects.

  • And I suspect you're going to be narrower--

  • if your project is, disrupt and build a whole bank,

  • I look forward to reading the project.

  • But I suspect you're going to be a little bit more targeted,

  • and that the most successful opportunities,

  • to the extent any will be successful--

  • and most will fail--

  • but to the extent any are successful,

  • my hunch will be more targeted than that.

  • But I leave it to the creative minds in this class.

  • Fiat currency we've talked about.

  • It's a liability of commercial banks.

  • It's central banks.

  • It's accepted for taxes and legal tender.

  • I do this in terms for repetition.

  • Because if this is a class today about finance,

  • I can't do it without talking about Fiat currency.

  • And yes, it relies on a system of ledgers.

  • Sorry.

  • Had to get that in there.

  • But ledgers at the central bank, that

  • has an entry that-- there's 9,000 commercial banks

  • in the US.

  • I don't mean to leave out any other country,

  • but the form and fashion is the same.

  • If there's 600 commercial banks in the UK,

  • and I don't know the number, or there's 1,000 in China,

  • it's always sort of that same thing.

  • One big ledger at the central bank and then every bank,

  • commercial bank, has a reserve account,

  • and that reserve account is on the master ledger

  • at the central bank in essence.

  • So this is just some of the technology of ledgers,

  • from the proto cuneiform.

  • The IBM 360 in 1961 revolutionized finance.

  • And IBM was not only the best disruptor company,

  • but it was revolutionizing finance.

  • That IBM 360 really started to get adopted in a lot of finance

  • in the 1970s.

  • In the 1960s, there was the paperwork problem.

  • The New York Stock Exchange had to shut down

  • for a couple of days in the late '60s, because they basically

  • had too much paper.

  • Physical limitations for finance.

  • Payment and settlement systems have come a long way.

  • That's Thomas Jefferson writing a check to himself.

  • But a check from Thomas Jefferson to himself in 1809

  • was a form to change two ledger accounts.

  • Telex, believe it or not, there was still

  • some telex machines when I started at Goldman Sachs

  • in 1979.

  • I was 6.

  • I was 21.

  • But telex machines were a very big innovation

  • in the 1950s that allowed for the communication

  • and sending around.

  • Now they're overcome by the important technologies later.

  • All of these technologies were before the big boom

  • and what I'll call encryptography,

  • and how to secure communications,

  • and the whole form of public key and private key cryptography

  • and other forms of cryptography, all of which

  • are used in banking today pre blockchain.

  • Almost everything that's done in blockchain

  • has some form of cryptography that's

  • being used for it and with it.

  • So blockchain, in a sense, is just possibly a new technology

  • using cryptography and using databases and doing it

  • in a different way.

  • And the question is, can we can we find use cases in finance

  • through that?

  • So what are some of the technologies today?

  • And this is not a fintech course.

  • If it was a fintech course, every one

  • of the things that are going to go on this slide

  • would be talked about.

  • But does anybody want to just have some fun and name what's

  • going on in fintech world?

  • Blockchain is one of the eight things I'm going to list.

  • Anybody want to do some guesses here?

  • STUDENT: AI.

  • GARY GENSLER: All right, AI.

  • Jihee.

  • STUDENT: Biometrics.

  • GARY GENSLER: Biometrics.

  • We've got two of the eight.

  • STUDENT: [INAUDIBLE] open banking.

  • GARY GENSLER: Oh good, banking.

  • Good.

  • We have three of the eight.

  • This is good.

  • I want to see how we're going.

  • Daniel, thank you.

  • STUDENT: Big data.

  • GARY GENSLER: Big data.

  • All right.

  • That's not-- yes, yes.

  • I'm agreeing with it.

  • I didn't put it up there.

  • What's that?

  • RPI?

  • STUDENT: RPA.

  • GARY GENSLER: RPA.

  • You want to tell the class what RPA is?

  • STUDENT: Robotic Processing Automation.

  • GARY GENSLER: Yes, Robotic Processing Automation.

  • Hugo?

  • No?

  • Oh, [INAUDIBLE] taken.

  • STUDENT: Machine learning.

  • GARY GENSLER: Machine learning, yes.

  • All right, so AI, machine learning, blockchain.

  • Nobody said cloud, because now you all sort of take cloud

  • for granted.

  • And so maybe cloud shouldn't even be on this page.

  • But it's still sort of changing some, open API.

  • I'm sorry?

  • STUDENT: [INAUDIBLE] we have a lot of revelations

  • about putting data on the cloud.

  • At least in Brazil, we cancel any data [INAUDIBLE]..

  • And we just can't put--

  • GARY GENSLER: So you're saying that--

  • STUDENT: [INAUDIBLE].

  • We do have a cloud, a private cloud

  • that we use, but it's not not the same as--

  • GARY GENSLER: So Leonardo is saying, in Brazil,

  • you can't put certain information on the cloud.

  • That's probably true of many countries.

  • It's certain information.

  • But a lot of bank information, a lot

  • of financial information in most countries

  • are now up in the cloud.

  • 10 years ago it wasn't.

  • So it's still sort of shifting, and probably but

  • country by country, jurisdiction by jurisdiction.

  • And I suspect, in a lot of countries,

  • the official sector doesn't even know what's in the cloud.

  • And then the other, biometrics are mentioned.

  • Interestingly, nobody mentioned chat bots, one of my favorites.

  • But chat bots is a big piece of what's

  • going on in finance and so forth.

  • You don't like chat bots, Hugo?

  • How many people like chat bots?

  • Can I see a show of hands?

  • So what is it that you like about--

  • Tom, what do you like about chat bots?

  • STUDENT: If I'm going to go through a robotic system,

  • whether it's like an automated press button,

  • I would rather go through the automated system that

  • gives me the answer.

  • [INAUDIBLE] until I end up [INAUDIBLE]..

  • GARY GENSLER: Eric, you said you like chat bots?

  • STUDENT: Yeah, but not from the customer side,

  • but from the other side.

  • [LAUGHTER]

  • GARY GENSLER: All right.

  • From the customer side, how many people

  • really kind of don't like chat bots?

  • Right?

  • I mean, it's not a great customer experience.

  • But maybe that's where somebody is

  • going to spend a lot of technology and money

  • and ingenuity and some Sloan MIT group

  • will solve that, that it's a better customer experience.

  • Just an observation for anybody listening

  • if this film is ever seen.

  • Credit.

  • Let me just [INAUDIBLE] say.

  • What's credit?

  • I earlier already defined this.

  • But what is credit?

  • It's basically borrowing something of value,

  • but importantly, with an agreement

  • to give it back later.

  • As old as time can be.

  • It probably goes back 20,000, 30,000 years.

  • Some of the earliest writing is about what it is.

  • But here's a chart about US private and public debt

  • as a percentage of GDP.

  • It's based on the Federal Reserve numbers.

  • I got a chart--

  • I looked hard for this--

  • 140 year chart.

  • And if you can't see it, we are currently-- the debt in the US

  • is about 350% of our economy.

  • Our economy is $20 trillion, and debt totals

  • around $70 trillion.

  • Just easy, easy math for these days.

  • When did it peak?

  • The last time was in 1929 at 300%.

  • We zipped past 300%.

  • We had the 2008 crisis.

  • It's sort of been coming back down.

  • I'm not suggesting we're going come all the way back

  • down 140%.

  • But I raise this chart to say, debt in modern economies

  • is a big part of how economies work.

  • The US total credit market--

  • now those are the slices.

  • Government, commercial, financial, household.

  • Each about one fourth in the US.

  • It would break out a little bit different in other countries,

  • of course.

  • And then here's the US bond market.

  • Now, the US bond market is only about $40 trillion

  • and the debt market is $67.

  • What's the difference between those two?

  • What's that?

  • So this the bond market.

  • That's the credit market.

  • So all of that government debt is in the bond market,

  • but a lot of the commercial debt is bank loans.

  • And you're right.

  • A lot of the household paper is also then securitized.

  • So you've got to get rid of some of the double counting.

  • And there's all sorts of questions of double counting

  • and so forth.

  • $40 trillion bond market.

  • But the total is closer to $70 trillion

  • by Federal Reserve statistics.

  • I thought it'd be just interesting to say,

  • what's the bond and equity markets around the globe?

  • Our bond and equity markets combined are about 360%

  • of our economy.

  • The EU and China, you can see--

  • now, that might mean that we have an overvalued stock

  • market.

  • Our stock market right now is about 30--

  • well, today it might not be as good.

  • But it's hovering around $30 trillion.

  • I think it was up to $32 or $33 trillion.

  • Has is it done poorly today again?

  • Yeah.

  • But it gives you a sense.

  • It's not just the US that are about these numbers.

  • This is how financing of non-financial corporations

  • in the four big jurisdictions.

  • The US is far more securities-focused,

  • meaning we have very well-developed bond and equity

  • markets.

  • And loans, as you can see, only provide about 11% or 12%

  • of funding for commercial--

  • if you're a small company, you get your borrowings

  • from a bank.

  • If you're a big company, you go out in the securities market.

  • James?

  • STUDENT: Are these publicly traded companies

  • or just any company?

  • GARY GENSLER: I didn't do the research.

  • SIFMA, which is a securities industry association,

  • puts out a report annually and I grabbed

  • these from the SIFMA report that came out two weeks ago.

  • So I could look at the report, but I don't know.

  • I think it's more than public companies.

  • I think this is broadly the economy--

  • I'm not going to go through this.

  • But I have two slides here-- one is the equity market, one

  • the bond market-- to say, the holders of US bonds,

  • pretty diverse.

  • But it's a lot of other financial companies.

  • Who holds bonds?

  • It's a lot of other financial companies.

  • Whereas equities is households.

  • It's either household-- directly a household

  • through a mutual fund or a household

  • through their pension.

  • Now only 40% is direct.

  • About 1/3 is through mutual funds and about 12% or 15%

  • is through pension funds.

  • But it's kind of households own a lot of the equity and finance

  • firms own a bunch of the debt.

  • Rough, rough guidance.

  • Any of you masters of finance, you

  • can tell me if I'm going off the rails.

  • And also, a household debt-- and then I'll stop with the slides.

  • Household debt is primarily mortgage debt.

  • The orange on here is all the mortgage debt.

  • We're out about $9 trillion in mortgage debt.

  • But red-- red is what you all probably identify with.

  • You don't have to self tell me, but you're probably

  • all in the red.

  • That's the student debt.

  • Student debt in the US is now $1.5 trillion dollars.

  • And I'm just expressing my own public policy perspective,

  • but it's not--

  • I don't think it's good to mortgage everybody who's

  • just going through college and graduate school.

  • But that's a bigger public policy debate,

  • and I'm just expressing a point of view.

  • It did not used to be like this.

  • Here's an interesting chart to me is the number of accounts.

  • Again, US, we could have gotten broader countries.

  • There's 500 million credit cards in the US.

  • There's 328 million Americans, and about 1 and--

  • 1.6, 1.7 per population.

  • But auto loans and mortgages, which are the left access,

  • are 70 or 80 million.

  • So these are big markets.

  • These are just numbers of people who have an auto

  • loan or a number of auto loans.

  • These are numbers of mortgages.

  • And then HE is Home Equity, revolving.

  • These are the four big slip streams of household debt.

  • Mortgage is number one.

  • Student debt, number two, unfortunately.

  • Credit cards and then home equity.

  • And auto loans are--

  • I can't see on this chart, but auto loans are behind them.

  • Let's talk about risk.

  • This is a couple of ideas from my time in risk management.

  • Anybody want to give me the three big risks, if you were

  • managing Goldman Sachs, you'd be worried about on a daily basis?

  • Not whether the euro is going to crash, but broad topical risk.

  • What are the three or four big risks?

  • Addy?

  • STUDENT: Market risk.

  • GARY GENSLER: Market risk.

  • STUDENT: Credit risk and operating risk.

  • GARY GENSLER: All right.

  • Market risk, credit risk, operations.

  • Any others?

  • STUDENT: Counterparty risk.

  • GARY GENSLER: Counterparty risk.

  • STUDENT: Human capital.

  • GARY GENSLER: Human capital.

  • That's a good one.

  • I like it.

  • It's usually not taken up in a risk committee though.

  • It's an important risk though, but it's not usually taken up.

  • So what do I have?

  • Market risk.

  • All sorts of different market risk.

  • Credit and underwriting.

  • Credit is, will somebody pay me back?

  • Underwriting is usually, have I judged the risk well?

  • So it could be an insurance risk as well as

  • underwriting securities.

  • Three things I didn't hear from you all.

  • I'm not surprised I didn't hear, but these are

  • the three that lead to crises.

  • Market risk, credit risk and underwriting risk.

  • Even if firms blow it, they usually do it.

  • And usually the board of directors understands it.

  • My experience in looking at failed firms,

  • it's liquidity funding and settlement risk.

  • Liquidity means, can I sell something

  • when I want to sell it?

  • Or can I buy a hedge or cover when I want to cover?

  • Funding is, can I roll over my funding?

  • Because so much of finance is about short term funding

  • and long term assets.

  • And it's usually misunderstanding

  • liquidity in a crisis.

  • You can sell things all day long when things are good.

  • But when markets start to get frail and thin,

  • your liquidity dries up.

  • So it's a crazy thing to model.

  • It's a very tough thing.

  • I mean, great economists, great finance academics can model it.

  • But at the end of the day, it's a little tough

  • because it goes away fast.

  • And it's kind of a funny mathematical formula when

  • you see something just go away.

  • And the math doesn't matter.

  • When you can't sell something, and you think it was worth $98,

  • and you can't sell it for $88.

  • And the other big one is model risk or correlations.

  • And you can build a correlation matrix

  • around all sorts of financial assets,

  • and it can work in most markets.

  • It can work in a market which I'll say out to two or three

  • standard deviations from the norm.

  • But will your correlation matrix still

  • work when you're in a market environment that's

  • four or five standard deviations out from the norm?

  • I'm sorry.

  • Think of a bell shaped curve, and just think of--

  • some people call it tail risk.

  • But I'm not talking about the price.

  • I'm talking about all your correlations in your model,

  • just throw them out the window.

  • And those four-- liquidity, funding, and settlement

  • and correlation, in my experience

  • is kind of where firms get into a bunch of trouble.

  • Or they're not.

  • Maybe it's not actually a bug but it's a feature.

  • It's sort of saying, I'm embedding all this risk.

  • This is why I'm earning excess returns when I'm in finance.

  • And 1 in 100 times, my firm's going to go bankrupt.

  • But that's just-- that's the risk I take.

  • Kelly?

  • STUDENT: I know we're going to talk about this

  • in the next unit, but can you talk a little bit

  • about how well stress testing within banks addresses these?

  • GARY GENSLER: OK.

  • So I've got operation and cyber risk.

  • It would have been operational in the past,

  • and now everybody's all focused on cyber.

  • And it's the right thing.

  • It's a big risk the banks and insurance companies are all

  • focused on.

  • Legal and compliance and reputational risk.

  • Literally, if you went back 30 years ago,

  • people would not be managing reputational, legal risk

  • at their risk committee.

  • But a well-run risk committee at a big bank

  • takes all these things-- every one of these categories

  • should go up to the risk committee

  • in some way or another.

  • Dan and then I'm going to try to do Kelly's question.

  • STUDENT: Of course this isn't something

  • that a company could control, but can you

  • talk about political risks in kind of context?

  • It might impact--

  • GARY GENSLER: Generally speaking--

  • Dan just asked about political risk--

  • classic sort of thinking is that you don't manage that

  • at a risk committee.

  • You might manage it in your Washington or Brussels

  • or London office dealing with--

  • and there's policy risk, that the policies can change,

  • the regulations can change.

  • You try to influence it and get ahead of changes

  • that lower your profit margins.

  • But you usually aren't going to be managing it in the same way

  • here.

  • So Dan, you're right.

  • There's political risk.

  • There's a second thing, which is expropriation risk.

  • In many countries, it's no longer a big challenge.

  • But it is.

  • And certainly, for big banks, there

  • is a lot of expropriation risk in earlier decades.

  • Crises.

  • You can see the hourglass is kind of broken,

  • and it's broken right at the neck where finance is.

  • Here's some just--

  • I hate to say it, but in my memory, I hope all of you

  • have such a rich career that in 30 or 40 years

  • you can be teaching somewhere like MIT

  • but you will have this.

  • No matter what country you live in,

  • you will have some list that you can--

  • I didn't go to Wikipedia.

  • I just said, oh, yeah, there was that Latin debt crisis.

  • I did go to the internet to remind myself what years.

  • And in the 1970s, I was in high school.

  • But I'm just saying that, I actually

  • remember all of these crises.

  • They happen.

  • They come, they go, they're part of it.

  • Let me just mention something about the subprime mortgage

  • crisis 2008.

  • So what's my quick take on it?

  • Like what happened?

  • You know, in 10 minutes or less.

  • But I'll take any questions.

  • One, I think at the core were weak underwriting practices,

  • mostly in the real estate sector for housing.

  • Underwriting is the word--

  • a bank is making a loan, or an insurance company

  • is taking a risk.

  • It's whenever somebody takes a risk,

  • you have to sort of make some probability weighting.

  • What's that risk like?

  • Let's take a bank.

  • Will I get repaid?

  • You're not going to get repaid 100% of the loans,

  • but underwriting is this concept of sort of sorting that out.

  • Or in insurance, the underwriting

  • risk of a house burning down and so forth.

  • There were weak underwriting standards.

  • And, on top of it, a lot of bad practices and predatory

  • lending.

  • Kyle?

  • STUDENT: Just a question.

  • Do you think that the predatory lending and accepting

  • loans when maybe you won't be able to pay it back,

  • as well as extending loans, is a symptom

  • of willingness to take on more risk

  • or being unaware of the risk that you're taking?

  • GARY GENSLER: So Kyle raises sort of a-- whatever

  • you want to call it-- the $64,000 question in the middle

  • of bad risk management.

  • I mean, because we could go back to this page.

  • Every one of these pieces of risk management

  • you can't do perfectly.

  • It's only so susceptible to higher math.

  • Every one of these, there's math around.

  • But poor risk management can be just not even

  • being aware that the risk is there.

  • I think that's what your question was like.

  • Was there just an unawareness that there were such bad things

  • going on in the street?

  • Or was it-- well, we're aware of it

  • but we're willing to take that risk?

  • I think it was a bit of both.

  • I think that the major investment banks--

  • the Lehman Brothers and some of the others,

  • they were underwriting a lot of the subprime mortgages--

  • were aware that there were no doc loans.

  • No document loans.

  • It was called no doc loans.

  • That the down payments were shrinking.

  • Because that was susceptible to math, that you could see

  • there was lower and lower down payments.

  • But I don't think that they knew everything

  • that was going on the street, the really bad action.

  • I testified in the US Congress in the spring of 2000,

  • as the Secretary, Undersecretary, about predatory

  • lending.

  • It wasn't that I was prescient.

  • I was asked to testify.

  • And we did a big study between the Department of Housing

  • and the Department of Treasury.

  • And we went out.

  • We had public hearings in a bunch of cities,

  • and we wrote a report and made recommendations.

  • And Ned Gramlich over at the Federal Reserve

  • was very helpful.

  • Andrew Cuomo at the Department of Housing,

  • who is now governor of New York, and I

  • was running point at Treasury.

  • So it was known, in a sense.

  • But I think a lot of the broad community, the policy community

  • and the banking community, tended to look the other way.

  • Partly because there were so much profits

  • and partly because, in the upside of a boom,

  • it feels like it's never going to turn,

  • and that that even a small report like

  • we did in the spring of 2000--

  • in fairness, we didn't bang the table enough maybe.

  • There I was testifying, and I left, and that was that.

  • You know?

  • Al Gore is running to succeed Bill Clinton.

  • The administration couldn't have gotten a law changed,

  • even if we tried at that time.

  • But nonetheless, that's-- so I think sometimes it's a bit

  • of both, from personal experience.

  • But back to the crisis.

  • So I think that weak underwriting and predatory

  • lending mixed in to have a subprime mortgage crisis

  • and then a big housing bubble.

  • But also beyond that--

  • beyond that, easy credit.

  • Easy credit partly because interest rates were so low.

  • We came out of the late part, the 1990s.

  • We went from an asset bubble in the stock market,

  • the internet bubble burst, and we kind of

  • moved that bubble valuation into the housing market.

  • The Federal Reserve lowered interest rates,

  • kept interest rates low for a very long time to kind of keep

  • the economy going.

  • And we even see now President Trump and Fed chair Powell

  • a little bit at odds about where should interest rates go.

  • And the Federal Reserve is moving interest rates

  • up in the US now.

  • But there's always that sort of dynamic, a little back pressure

  • in every country.

  • We like to think we have independent central banks.

  • But in some countries, it's a tug of war

  • and we're seeing that play out a little now.

  • So we have easy credit for a long time,

  • partly supplied by foreign governments.

  • Even China, in a sense.

  • I mean, people were willing to buy the US paper.

  • But also financial derivatives.

  • Credit default swaps in particular led to a lot

  • more leverage and also the interconnectedness.

  • The derivatives tied everybody together a lot more.

  • Part of the leverage was also accepting model

  • based capital rules at banks.

  • The other thing is I think we had

  • a lot of poor risk management, back to Kyle's point.

  • So poor risk management incentive structures.

  • The basic incentive structure at banks have a lot of bonuses.

  • And some of you worked at banks.

  • But on some level, it's sort of heads I win, tails you lose.

  • I mean, if you put a big position on and it pays off,

  • and you're a trader, and you're managing the mortgage

  • desk at Lehman and it pays off, you say, all right, where's

  • my $5 or $10 million bonus?

  • I'm saying if you're running the department.

  • I mean, hopefully some of you will do that.

  • But if you're on the other side, and the firm fails,

  • they don't say, please give me back that $5 or $10 million.

  • So there's asymmetric incentive structures.

  • And those have been written about widely, academically.

  • I mean, we do have a lot of asymmetric incentive

  • structures in banking.

  • Brotish?

  • STUDENT: [INAUDIBLE]

  • GARY GENSLER: So Brotish asked, what about the rating agencies?

  • So I was absolutely say, their incentive

  • structures-- within those two words, a lot's packed.

  • Thank you.

  • Rating agencies got paid for issuing ratings,

  • but they're not-- you know, give some money back

  • if you got it wrong.

  • So it's perverse incentive structures,

  • both in terms of the bonus structure,

  • employment, payment structure, rating agencies, fees.

  • Inherently, finance has a lot of conflicts of interest.

  • We're not going to get rid of that, conflicts of interest.

  • There's always somebody in finance

  • who wants to separate their customer from their money.

  • It's the nature of things.

  • But in a sense, Starbucks wants to separate you

  • when they say, do you want the large cup--

  • or the grande instead of the large.

  • So that's the nature of commerce.

  • And it's just that, you want some market

  • base and regulatory things to [INAUDIBLE]..

  • So multiple failures started to happen.

  • In the US, Bear Stearns started to fail in 2007.

  • So well before the epicenter of all of this, you had--

  • in the UK--

  • James?

  • What was the first one that failed in your country?

  • What's that?

  • STUDENT: [INAUDIBLE]

  • GARY GENSLER: So where did--

  • where did-- but the timber was dry.

  • It was like the fire was going to go,

  • but the system could maybe withstand one failure, Northern

  • Rock or Bear Stearns.

  • But by the summer of '08, in this country when the large

  • financial mortgage companies, Fannie Mae and Freddie Mac,

  • had to go into receivership around Labor Day of 2008,

  • it was teetering.

  • And then, of course, if anybody remembers,

  • by September 15th or something, it was just--

  • the system would have collapsed.

  • Without government intervention, the system would have fully--

  • we were kind of--

  • And we would have been in one of those moments

  • from the 18th or 19th century where we--

  • or even the 1930s, where it's likely we

  • would have blown out the 20% or 30%

  • unemployment in this country.

  • And some of your countries, that is the case.

  • You saw it happen.

  • I don't know all the countries represented here.

  • So that's my little quick read of the financial crisis.

  • But this wasn't meant to be a lecture on it,

  • but I thought, well, why not throw it in?

  • It's finance.

  • Any questions on that?

  • Hugo?

  • STUDENT: Not exactly on the crisis.

  • But if you have to gauge the state of the financial--

  • like of US finances right now, what do you think?

  • Are we in a better place than we were 10 years ago?

  • GARY GENSLER: So Hugo is asking if we're in a better place

  • than we were 10 years ago.

  • Yes, in a number of ways.

  • But as Sheila Bair's writing said, in other ways,

  • it's not all that different.

  • So I think that we have high valuations in the stock market.

  • But it's not a levered asset class.

  • So real estate bubbles usually are very--

  • higher probability that a real estate bubble

  • will lead to calamitous outcomes,

  • because there's a lot of borrowing against the asset

  • bubble.

  • So when we had no aid, and you had--

  • in Iceland, when the banks failed.

  • In many countries, when you see huge failures,

  • it's when you have a real estate bubble with a lot of borrowings

  • against it.

  • When the revaluation comes, the debt on that asset class

  • is higher than the valuation on the asset class.

  • And that usually leads to some either calamitous outcome

  • or government bailouts, and it takes a while.

  • Debt bubbles.

  • A debt [INAUDIBLE] bubble is much harder.

  • So back to today, I think we have a bit of a bubble.

  • We've had low interest rates for a long time.

  • We've had pretty good economic growth,

  • even though it's not fully and equally shared.

  • But a lot of economic growth.

  • I think the banking sector is stronger.

  • It's more Capital.

  • One of the results of the reforms in Europe and the US,

  • there's a lot more capital in the system,

  • meaning less leverage.

  • But on the other hand, the banking sector

  • is a bit more concentrated.

  • And concentration leads to additional risk.

  • The other thing, and this is maybe

  • my feeling is, as we're not sharing the economic well-being

  • broadly in the economy, that middle income

  • America, middle income of Europe in particular

  • is not sharing as much, I think that hurts us in two ways.

  • One is, if we have the downturn, there's not as much--

  • all economies these days are led by consumption.

  • There's not as much ability to respond with consumption.

  • And two, I think it also tears at our social fabric.

  • And now I'm talking more about the political,

  • but it's sort of-- there's less of a social fabric

  • for consensus when things hit.

  • Sorry.

  • STUDENT: Going and touching on the consumption aspect,

  • I think Sheila mentioned that consumer spending was

  • a part of the financial crisis.

  • And she suggested that instead of providing relief

  • to the banks, what the government should have done

  • is provide relief to consumers instead.

  • I was wondering what your take on that is.

  • GARY GENSLER: So Sheila Bair's point was, we

  • did a bunch of things bailing out big institutions.

  • We didn't help home owners enough.

  • I think factually she's correct.

  • And then you have to say, are the adjectives correct?

  • Like we did provide trillions of dollars of support

  • for big institutions and not for individuals.

  • And there is where the debate is and all the challenge is.

  • I think it's correct--

  • Tim Geithner wrote a book.

  • If you ever get a chance to read it,

  • it's a very lively and easy read about the crisis.

  • And he said, sometimes, it's like, you

  • know, bailing out the arsonist.

  • I think those were Tim's exact words in his book,

  • but if I'm wrong, sorry Tim for misquoting you.

  • But it's a hard public policy challenge

  • that Ben Bernanke and Tim and others

  • were facing at that point.

  • But I think Sheila is right factually.

  • And then I leave for you the policy debate.

  • Let me just mention.

  • The financial sector--

  • I'm closing on this--

  • legacy customer interface.

  • When you're thinking about any blockchain solutions,

  • as Eric said, it's legacy.

  • Are they slow?

  • Are they moving slow?

  • It's got to be data intensive at some point.

  • I don't think blockchain has a lot of use

  • if it's not data intensive.

  • Are there economic rents?

  • If there aren't economic rents, it's

  • probably less likely you're going to be able to tuck in.

  • But if there's big economic rents,

  • like 2.7% on payments and the like, that might be a place

  • you can tuck in with a new disruptor strategy.

  • Sometimes there's concentrated risk.

  • We talked about that.

  • Or the infrastructure costs.

  • I know there was earlier talk about counterparty risk

  • and so forth.

  • The good news is there's a wide acceptance

  • of adoption of new tech.

  • I'm not going to say it's going to bail out a bad blockchain

  • idea, and I'm not looking for a bunch of ideas

  • about scams and frauds.

  • But there are wide acceptance.

  • And there's 7.5% of the US economy,

  • and similar numbers-- probably 5% to 7% of most economies

  • are in finance.

  • By the way, because the capital markets and the equity markets

  • are about 500% of the economy-- it's about $100 trillion when

  • you add up all those other slides--

  • finance earns 7.5%.

  • So that's about 1.5% vig.

  • That's an old term from a gambling house.

  • What's the vig?

  • What's the take?

  • Finance takes about 7.5% divided by over about 500%.

  • Or it's about 1 and 1/2%.

  • That's not true everywhere, but asset management

  • might take 50 or 80 basis points.

  • Banking might take wider.

  • But largely, that's the opportunity

  • that I keep mentioning.

  • Let me just mention one more thing.

  • I'm going to skip through this.

  • Next week's readings.

  • October 16th, you'll have a surprise guest.

  • You'll have some fun with the surprise guest.

  • I guarantee you.

  • I guarantee if you just want to have some fun,

  • you'll remember next Tuesday for a while.

  • But I added an additional reading that's from today.

  • Nouriel Roubini testified in front of the Senate Banking

  • Committee today.

  • I read it before I came to class.

  • I can't say it's required, it's just additional.

  • But it is lively.

  • And he just does a slap down on blockchain technology.

  • But for those of you who read it,

  • that will be part of our discussion next Tuesday

  • as well.

  • Because we're going to talk about the economics

  • of blockchain.

  • I'm going to focus more on Christian Catalini's paper.

  • But Paul Krugman, his is a two-page slap down.

  • These are kind of the Bitcoin and blockchain minimalists.

  • And next Thursday is a little bit towards the maximalists.

  • But I want to talk about the economics, what

  • I'll call Act 2.

  • So I thank you.

  • I'm supposed to let you go.

  • I've gone two minutes over.

  • So--

  • [APPLAUSE]

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10.金融システムの課題と機会 (10. Financial System Challenges & Opportunities)

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    林宜悉 に公開 2021 年 01 月 14 日
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