WEBVTT 00:01.580 --> 00:06.240 Professor Robert Shiller: Next Wednesday we're having 00:06.240 --> 00:08.610 David Swensen lecture to us. 00:08.610 --> 00:12.530 He heads up the Yale endowment--or the investment of 00:12.527 --> 00:17.437 the Yale endowment--and I have a New York Times article on 00:17.444 --> 00:21.034 the syllabus, just sort of a biography of him 00:21.032 --> 00:26.112 you could read. On reserve, I have his recent 00:26.114 --> 00:32.984 books, so I hope that you will get a lot from him. 00:32.980 --> 00:37.090 I misspoke, he's not a Yale college graduate, 00:37.086 --> 00:41.736 he's a Yale Economics PhD; his undergraduate was from 00:41.736 --> 00:46.746 University of Wisconsin but he's been at Yale a very long time. 00:46.750 --> 00:51.260 He came to Yale from Wall Street in 1985 and at that time 00:51.264 --> 00:55.864 the Yale endowment was worth about one billion dollars. 00:55.860 --> 01:01.380 It is now, under his leadership, $22.5 billion and 01:01.376 --> 01:07.456 that explains a lot of the quality of your life because 01:07.455 --> 01:14.205 that means we have about $2 million dollars per student. 01:14.209 --> 01:19.589 The interest on $2 million dollars is--what is that? 01:19.590 --> 01:23.360 I can't even do division--$100,000 a year. 01:23.360 --> 01:28.660 So that's why Yale is much more generous with financial aid than 01:28.660 --> 01:33.540 other universities and why we have beautiful--of course, 01:33.540 --> 01:35.630 this room was built, I believe, in the 30s. 01:35.629 --> 01:40.679 Don't thank David Swensen for this room but for a lot of other 01:40.684 --> 01:44.204 things. So Yale had a 28% return on its 01:44.195 --> 01:48.385 portfolio last year, which was number one of all 01:48.387 --> 01:50.347 college endowments. 01:50.349 --> 01:56.129 Moreover, it's had a 17.8% average return for the last ten 01:56.129 --> 02:01.909 years, which is number one among university endowments. 02:01.909 --> 02:04.479 We beat Harvard, we beat Princeton, 02:04.481 --> 02:09.171 but actually Princeton was--the head of the Princeton endowment 02:13.329 --> 02:16.429 these people get together and talk. 02:16.430 --> 02:19.150 All of the major universities--Harvard has been 02:19.146 --> 02:21.446 doing very well too and so have Duke, 02:21.449 --> 02:24.529 MIT, Amherst, a lot of--it seems that 02:24.533 --> 02:28.133 universities manage to invest very well, 02:28.129 --> 02:30.689 at least they have in recent decades. 02:30.689 --> 02:33.549 I think that has--my theory--that has something to do 02:33.547 --> 02:36.347 with the intellectual atmosphere at universities. 02:36.349 --> 02:41.679 That is, investing well requires careful study and the 02:41.676 --> 02:47.606 intellectual tradition we have at universities helps promote 02:47.605 --> 02:51.355 that. I don't know if David Swensen 02:51.356 --> 02:53.806 can continue to do this. 02:53.810 --> 02:57.220 I think we're--he's had a spectacular return, 02:57.223 --> 03:00.563 but he's getting into a challenging year. 03:00.560 --> 03:05.100 This is a year of financial crises, so I'm warning you ahead 03:05.096 --> 03:09.706 that--don't expect a 28% return on the Yale portfolio for the 03:09.709 --> 03:13.869 coming year. You can ask him about that. 03:13.870 --> 03:18.250 If he can do it again in this situation, it will be amazing. 03:18.250 --> 03:23.940 That would be next Wednesday. 03:23.939 --> 03:29.749 Meanwhile, I want to talk today about regulation. 03:29.750 --> 03:38.980 Wow, I think we're alright--something needs more 03:38.978 --> 03:45.848 regulation here--all these wires. 03:45.850 --> 03:52.010 03:52.009 --> 03:55.759 I want to motivate regulation in terms of the last lecture. 03:55.759 --> 04:01.089 Our previous lecture was about behavioral finance and it was 04:01.091 --> 04:03.171 about human failings. 04:03.169 --> 04:06.969 I think that we to motivate a lot of our regulation of 04:06.973 --> 04:11.283 financial markets by the kinds of errors that people make. 04:11.280 --> 04:18.720 I wanted to list a few errors that are well-known and that are 04:18.719 --> 04:24.329 exploited by unscrupulous people in finance. 04:24.329 --> 04:28.699 I think they motivate a lot of what--I'm going to write a 04:28.695 --> 04:32.975 number of principles of behavioral finance down and just 04:32.982 --> 04:37.272 mention them briefly and then return to regulation. 04:37.269 --> 04:46.429 These are things from the field of psychology. 04:46.430 --> 04:51.490 Wishful thinking. 04:51.490 --> 04:54.370 This refers to the fact that people--this sounds like 04:54.373 --> 04:57.763 something you probably already know but it has been documented 04:57.755 --> 04:58.915 by psychologists. 04:58.920 --> 05:02.880 People tend to make the error of believing what they want to 05:02.878 --> 05:05.298 believe. For example, 05:05.300 --> 05:12.450 people tend to believe that their team will win; 05:12.449 --> 05:14.399 this has been documented by psychologists. 05:14.400 --> 05:15.920 They have a bias. 05:15.920 --> 05:18.660 If you ask them, what's the probability that 05:18.659 --> 05:21.079 Yale will win the Yale-Harvard game, 05:21.079 --> 05:24.499 don't expect Yale students or Harvard students to give an 05:24.503 --> 05:25.913 unbiased probability. 05:25.910 --> 05:27.600 You tend to, in your mind, 05:27.599 --> 05:29.829 think that you're going to win. 05:29.829 --> 05:35.809 This also applies to elections--we just had a primary 05:35.810 --> 05:39.280 yesterday. People tend to assume that the 05:39.277 --> 05:42.127 candidate that they believe in will win. 05:42.129 --> 05:47.279 So, it's well-known and this is something that can be exploited 05:47.281 --> 05:49.941 by people selling investments. 05:49.940 --> 05:54.540 Second thing: attention anomalies. 05:54.540 --> 06:04.210 06:04.209 --> 06:09.839 These are--human attention tends to be sporadic. 06:09.839 --> 06:14.519 That is that you--the errors that people naturally make are 06:14.519 --> 06:16.939 often errors of inattention. 06:16.939 --> 06:20.679 You look at certain things and you overly--you pay too much 06:20.683 --> 06:24.043 attention to some things and too little to others. 06:24.040 --> 06:29.510 This is something that psychologists have been talking 06:29.506 --> 06:32.906 about for over a hundred years. 06:32.910 --> 06:36.640 Human attention is part of human intelligence. 06:36.639 --> 06:40.139 We have to know what to pay attention to People who are not 06:40.140 --> 06:43.760 good in focusing their attention on the right things--I'm not 06:43.762 --> 06:46.782 just talking about attention deficit disorder, 06:46.779 --> 06:50.049 I'm talking about some more high-level question of how you 06:50.045 --> 06:52.675 know what you should be paying attention to. 06:52.680 --> 06:57.790 Under attention, there's a social basis for 06:57.786 --> 07:04.716 attention and that is that people tend to pay attention to 07:04.717 --> 07:10.307 what other people are paying attention to. 07:10.310 --> 07:16.740 It's easy to sweep things under the rug and get people to forget 07:16.744 --> 07:19.934 something. The kinds of things that are 07:19.934 --> 07:23.654 naturally talked about get excessive attention and the 07:23.654 --> 07:25.974 details tend to get forgotten. 07:25.970 --> 07:30.580 Three is anchoring. 07:30.580 --> 07:34.730 07:34.730 --> 07:39.750 This refers to a tendency for people in making quantitative 07:39.745 --> 07:45.275 judgments to subconsciously have their judgments anchored by some 07:45.280 --> 07:47.270 arbitrary stimulus. 07:47.269 --> 07:50.579 I mentioned overconfidence last period; 07:50.579 --> 07:54.199 we then tend to have overconfidence in our anchored 07:54.200 --> 07:57.980 judgments. The classic experiment that 07:57.980 --> 08:03.480 demonstrated anchoring was Kahneman and Tversky--I'm 08:03.477 --> 08:09.187 writing K&T--in a wheel of fortune experiment, 08:09.190 --> 08:13.920 which they did in 1974. 08:13.920 --> 08:18.530 What they did was they got subjects to participate in a 08:18.527 --> 08:23.817 psychological experiment and the experiment consisted of asking 08:23.816 --> 08:28.676 the subjects questions that had quantitative answers, 08:28.680 --> 08:31.260 which were always numbers from zero to one hundred. 08:31.259 --> 08:34.499 Then they said, I'm going to ask you a question 08:34.495 --> 08:38.215 but before you answer the question I'm going to spin a 08:38.222 --> 08:39.702 wheel of fortune. 08:39.700 --> 08:42.560 You know what a wheel of--it's like one of those things on quiz 08:42.560 --> 08:45.020 shows. You spin this big wheel and it 08:45.022 --> 08:48.722 rotates for a while and then it stops at one number, 08:48.720 --> 08:51.370 but obviously a random number, because this wheel of fortune 08:51.369 --> 08:53.479 had all the numbers from zero to one hundred. 08:53.480 --> 08:58.040 One of the questions they asked was, what percent of African 08:58.037 --> 09:01.047 nations belong to the United Nations? 09:01.049 --> 09:06.749 That apparently is a difficult question that most people didn't 09:06.750 --> 09:10.370 know in 1974. The way they did it--they said, 09:10.367 --> 09:13.757 we'll ask you the question and think about it, 09:13.759 --> 09:15.689 but while you're thinking about it--don't answer yet--we're 09:15.693 --> 09:16.963 going to spin this wheel of fortune. 09:16.960 --> 09:21.240 So it comes up with a random number then they asked for the 09:21.236 --> 09:23.456 answer. Well, it turns out that people 09:23.458 --> 09:26.518 tended to give an answer close to the number that came up on 09:26.523 --> 09:27.773 the wheel of fortune. 09:27.769 --> 09:31.489 Now, they perfectly well knew that the wheel of fortune was 09:31.492 --> 09:33.632 random. So, the experimenters, 09:33.625 --> 09:37.575 after they got the number, they'd say, hey your number is 09:37.584 --> 09:41.194 almost the same as the number that just came up. 09:41.190 --> 09:43.650 People would--and they would say, did you just give me the 09:43.650 --> 09:44.600 number that came up? 09:44.600 --> 09:46.480 And people would deny it. 09:46.480 --> 09:48.540 They would say, oh no I wasn't influenced by 09:48.539 --> 09:51.309 that number. The point of anchoring is that 09:51.312 --> 09:54.822 you are subconsciously influenced by numbers and it 09:54.817 --> 09:58.377 affects your judgment; you think you know. 09:58.379 --> 10:00.689 For example, in looking at a stock, 10:00.687 --> 10:04.897 if you ask people to predict a stock market price they think of 10:04.896 --> 10:09.096 some number that they saw before and they are overly influenced 10:09.104 --> 10:11.754 by that number. For example, 10:11.754 --> 10:15.634 in the late 1990s, if you were to ask a 10:15.630 --> 10:21.960 question--I'm hypothesizing--how likely is it that the Dow will 10:21.955 --> 10:25.725 be over 10,000 by the year 2008? 10:25.730 --> 10:29.150 People might give that a low probability because it had never 10:29.148 --> 10:31.198 been over 10,000, so they just had no 10:31.199 --> 10:33.649 psychological anchoring on that number. 10:33.649 --> 10:38.369 Once it passes 2000, then it seems completely 10:38.367 --> 10:41.047 natural; that's anchoring. 10:41.049 --> 10:45.579 Related to this is the representativeness 10:45.575 --> 10:47.255 heuristic. 10:47.260 --> 10:56.320 10:56.320 --> 11:02.280 It seems to me that if you type this you'll get a spell check 11:02.284 --> 11:05.944 error. And that's Kahneman and Tversky 11:05.938 --> 11:10.638 again and it's related to anchoring in some sense. 11:10.639 --> 11:16.289 What it means is that--it refers to a human tendency to 11:16.286 --> 11:22.456 judge events on the basis of similarity to other events that 11:22.456 --> 11:27.996 are prominent in our mind without regard to the actual 11:27.998 --> 11:31.238 probability of the event. 11:31.240 --> 11:36.170 I'll give you--in one of Kahneman and Tversky's examples, 11:36.165 --> 11:41.525 people were asked to judge the occupation of a young woman. 11:41.529 --> 11:46.149 They had a description of the young woman and the woman was 11:46.146 --> 11:49.326 described as sensitive, artistic, etc. 11:49.330 --> 11:55.250 The occupation choices that they were allowed were: 11:55.251 --> 12:00.581 bank teller, sculptress, or something else. 12:00.580 --> 12:03.750 Many people chose sculptress because they thought, 12:03.752 --> 12:07.252 well if she's a sensitive, artistic woman maybe she's a 12:07.248 --> 12:11.328 sculptress. But that is a terrible mistake 12:11.328 --> 12:17.128 because we should know that sculptresses are very rare; 12:17.129 --> 12:22.569 very few people have the job of a sculptress or sculptor, 12:22.567 --> 12:24.507 so it's a mistake. 12:24.509 --> 12:30.779 What it means is that people will--what it means is--[I have 12:30.781 --> 12:36.101 to stuff this wire in my pocket]--that we sometimes 12:36.095 --> 12:42.255 exaggerate in our imagination some rare event and it colors 12:42.260 --> 12:45.310 out thinking. For example, 12:45.312 --> 12:50.482 the stock market crash of 1929 is repeatedly re-expected even 12:50.476 --> 12:55.166 though it only happened once; it's just prominent in our 12:55.165 --> 12:57.625 thinking. People are looking at stock 12:57.632 --> 13:01.592 prices to see patterns that they remember that are prominent in 13:01.589 --> 13:04.779 their thinking and then those patterns are given an 13:04.779 --> 13:06.629 exaggerated probability. 13:06.629 --> 13:10.019 When we looked at the random walk series--I think the 13:10.023 --> 13:14.073 representativeness heuristic played a role in there as well. 13:14.070 --> 13:16.970 When you look at a random walk you have the intuitive 13:16.966 --> 13:19.966 impression that you can extrapolate it--that it doesn't 13:19.973 --> 13:22.873 look like--you can't believe it's really random, 13:22.870 --> 13:26.730 but the reason you can is because you overweigh the 13:26.727 --> 13:31.277 probability of certain things that caught your attention. 13:31.280 --> 13:35.740 13:35.740 --> 13:36.450 There are some more. 13:36.450 --> 13:53.180 13:53.179 --> 13:55.559 Five is gambling behavior. 13:55.560 --> 14:02.410 14:02.409 --> 14:07.989 Anthropologists have found that gambling is present in all human 14:07.986 --> 14:11.236 cultures. Not that everyone gambles but 14:11.240 --> 14:15.800 there will be--you go to any human society and ask about it 14:15.800 --> 14:20.050 and there will be some game of chance that they play at 14:20.046 --> 14:23.266 the--that influences their thinking. 14:23.269 --> 14:28.969 The problem with--there's a problem with gambling behavior 14:28.965 --> 14:34.355 because in a certain fraction of the population we have 14:34.361 --> 14:36.961 pathological gambling. 14:36.960 --> 14:40.770 One study estimated that 1.1% of men and .5% of women, 14:40.773 --> 14:44.233 for some reason more common among men than women, 14:44.226 --> 14:47.676 but in both sexes are pathological gamblers. 14:47.680 --> 14:52.390 That means it's like alcoholism; they cannot control themselves 14:52.386 --> 14:54.286 and it ruins their lives. 14:54.289 --> 14:59.429 They get divorces because the spouse complains that my husband 14:59.425 --> 15:03.795 or wife gambled away all of our money and that's bad, 15:03.803 --> 15:06.753 but they can't stop themselves. 15:06.750 --> 15:09.840 There's an organization called Gambler's Anonymous, 15:09.835 --> 15:12.175 which is like Alcoholic's Anonymous. 15:12.179 --> 15:16.539 It helps people who are really in trouble. 15:16.540 --> 15:17.390 This is a problem. 15:17.389 --> 15:21.809 I think the financial industry attracts people like that, 15:21.806 --> 15:25.666 so you're overrepresented--If people are not quite 15:25.670 --> 15:30.560 pathological--people who are stimulated somehow by chance; 15:30.560 --> 15:38.640 that is a problem. 15:38.640 --> 15:40.370 Magical thinking. 15:40.370 --> 15:46.680 This refers--this actually goes back to B.F. 15:46.677 --> 15:55.187 Skinner, a psychologist who flourished in the first half of 15:55.186 --> 15:58.656 this century. I actually had him as a 15:58.658 --> 15:59.508 next-door neighbor. 15:59.510 --> 16:00.730 It was a strange thing. 16:00.730 --> 16:06.770 I was visiting Harvard and MIT in Cambridge and I rented a 16:06.770 --> 16:10.480 house and this guy was next door. 16:10.480 --> 16:14.250 He and I both used to walk into work together--not together, 16:14.252 --> 16:17.582 I never really met him, but I always felt an affinity 16:17.576 --> 16:19.796 to him. He must have died twenty years 16:19.801 --> 16:23.021 ago by now. But anyway, he did a famous 16:23.015 --> 16:28.895 experiment with pigeons which, in the 1940s--1948--in which he 16:28.901 --> 16:33.731 induced strange behavior patterns in pigeons by the 16:33.725 --> 16:36.905 following simple experiment. 16:36.909 --> 16:41.369 The experiment was, he would put--the pigeon was in 16:41.370 --> 16:46.280 a cage and he'd let the pigeon get pretty hungry--hungry 16:46.276 --> 16:49.306 pigeons are not happy pigeons. 16:49.309 --> 16:53.689 Then he had a machine that granted each pigeon one piece of 16:53.690 --> 16:57.060 corn every fifteen seconds; that's very, 16:57.060 --> 17:02.960 frustratingly slow for a hungry pigeon to get one piece every 17:02.961 --> 17:06.051 fifteen seconds. Then he observed, 17:06.053 --> 17:08.933 through time, after subjecting pigeons to 17:08.933 --> 17:13.253 this torture for some time--it might be not approved by--it's 17:13.252 --> 17:16.502 not really torture, it's like dieting or something, 17:16.498 --> 17:18.358 you've all lived through that, right? 17:18.360 --> 17:21.530 Semi-torture for a pigeon. 17:21.529 --> 17:25.229 He noticed that the pigeons started behaving in strange ways 17:25.229 --> 17:28.799 and he kept them separate so they couldn't learn from each 17:28.803 --> 17:31.133 other. One pigeon was jumping up and 17:31.130 --> 17:33.710 down a lot, another one was bobbing its head, 17:33.710 --> 17:36.760 and another one was doing kind of a little dance. 17:36.759 --> 17:40.609 What he concluded was, these pigeons were trying to 17:40.612 --> 17:44.852 figure out what makes those pieces of corn come and they 17:44.849 --> 17:48.059 started to think--well, they had to get the interval 17:48.062 --> 17:49.642 between corns right to make this work. 17:49.640 --> 17:52.370 But he started--the pigeons started to think, 17:52.373 --> 17:54.923 effectively, what was it I did just before 17:54.920 --> 17:56.970 that last piece of corn came? 17:56.970 --> 17:59.920 I was bobbing my head, so maybe I better bob my head 17:59.916 --> 18:02.916 again and sure enough another piece of corn comes. 18:02.920 --> 18:06.420 So, he started assuming that what they were doing is making 18:06.415 --> 18:10.195 the corn come. But each one does a different 18:10.199 --> 18:11.999 thing. If they're all in isolation 18:11.999 --> 18:13.739 they would all be doing different things. 18:13.740 --> 18:16.250 I think our financial markets are like that. 18:16.250 --> 18:19.630 That people--they develop some investment strategy and through 18:19.632 --> 18:21.132 pure chance it does well. 18:21.130 --> 18:24.810 But they--because of over confidence and magical thinking, 18:24.809 --> 18:26.809 it starts to go to their ego. 18:26.809 --> 18:29.539 They think, I'm really a smart investor, I figured it out,; 18:29.539 --> 18:36.469 it can reinforce the behavior until they get to maybe some 18:36.474 --> 18:40.144 terrible end. It doesn't necessarily work out 18:40.136 --> 18:40.926 as well. B.F. 18:40.929 --> 18:43.389 Skinner never let his pigeons starve; 18:43.390 --> 18:46.880 they all made it out alright. 18:46.880 --> 18:55.190 There's something else called quasi-magical thinking, 18:55.188 --> 19:03.498 which was a term coined many years later by Eldar Shafir and 19:03.496 --> 19:09.226 Amos Tversky. Shafir is a young psychologist 19:09.227 --> 19:16.237 at Princeton who teamed up with the old psychologist Tversky and 19:16.235 --> 19:18.455 wrote this paper. 19:18.460 --> 19:29.550 What it refers to is--people get the impression that they can 19:29.548 --> 19:33.428 control randomness. 19:33.430 --> 19:35.470 Maybe the pigeons were thinking that, maybe not, 19:35.466 --> 19:38.736 we don't know; Shafir and Tversky report 19:38.743 --> 19:42.673 experiments with people, not pigeons. 19:42.670 --> 19:48.930 Quasi-magical thinking is an illusion that they documented 19:48.927 --> 19:54.617 that occurs regularly in people, which they might deny if asked 19:54.616 --> 19:58.456 about, but there's an illusion that I can control randomness 19:58.464 --> 20:00.034 through my willpower. 20:00.029 --> 20:05.139 I won't talk about their experiments, but I just want to 20:05.142 --> 20:10.072 mention one by a Harvard psychologist Ellen Langer. 20:10.069 --> 20:14.859 I mentioned this before--I think I mentioned it before--if 20:14.855 --> 20:19.385 you say, I'm going to ask you to bet on a coin toss. 20:19.390 --> 20:22.080 There are two different ways of doing it. 20:22.079 --> 20:25.339 One is to say, how much will you bet and then 20:25.337 --> 20:27.697 I toss the coin. The other way is, 20:27.697 --> 20:31.377 I toss the coin first and I can conceal the outcome and then I 20:31.383 --> 20:33.743 ask, how much would you like to bet? 20:33.740 --> 20:38.170 Langer found that people want to bet more if the coin hasn't 20:38.168 --> 20:41.858 been tossed yet. Why would that be--why would 20:41.855 --> 20:44.735 you care? It's still the same experiment. 20:44.740 --> 20:47.770 It appears that people, at some level, 20:47.771 --> 20:52.201 think that they can exert willpower over it and control 20:52.196 --> 20:54.776 it. This gives rise again to 20:54.779 --> 20:57.459 overconfidence among investors. 20:57.460 --> 21:00.090 It's also--another example, which is relevant, 21:00.089 --> 21:02.719 I don't know if any of you voted yesterday. 21:02.720 --> 21:05.380 Why do people vote? 21:05.380 --> 21:09.350 Because an economic theory would say that nobody ever 21:09.349 --> 21:11.619 votes. If we're all--conventional 21:11.617 --> 21:14.867 economic theory says, we're all relentlessly selfish 21:14.868 --> 21:17.478 and calculating. Isn't that what you've learned 21:17.477 --> 21:19.997 in economics? Well, maybe you didn't 21:20.001 --> 21:23.661 necessarily but that is economical theory. 21:23.660 --> 21:28.390 If you're relentlessly selfish and calculating you would say, 21:28.388 --> 21:32.088 the chances that I decide the election are zero, 21:32.092 --> 21:34.932 so I'm just not going to bother. 21:34.930 --> 21:37.310 The question is--you must have thought that, 21:37.307 --> 21:39.537 right? You know that you're not going 21:39.538 --> 21:42.398 to decide the election, so what does it matter? 21:42.400 --> 21:45.850 If you can introspect and ask, why is it that I vote? 21:45.849 --> 21:49.429 I think that at least for many of us, there is a sort of 21:49.433 --> 21:52.433 logical conundrum we go through and that is, 21:52.430 --> 21:56.420 if good people don't vote then we'll be in a bad world; 21:56.420 --> 21:59.960 so I have to vote to prove that good people vote, 21:59.956 --> 22:02.016 then maybe it will happen. 22:02.019 --> 22:04.979 If I'm a good person, then other people will be good 22:04.979 --> 22:07.969 persons. This is magical thinking and it 22:07.970 --> 22:12.710 affects people because it gives them a sense of confidence and 22:12.714 --> 22:16.524 power over events that are thought to be random or 22:16.524 --> 22:23.594 uncontrollable. It can also be something that 22:23.593 --> 22:32.153 can be exploited by some not so nice people. 22:32.150 --> 22:37.260 I want to talk about regulation. 22:37.259 --> 22:43.149 The problem with finance is that it's a beautiful--financial 22:43.148 --> 22:48.838 institutions are beautiful structures but they only are as 22:48.837 --> 22:52.427 good as the people who use them. 22:52.430 --> 22:59.950 The problem is that the history of finance is the history of a 22:59.953 --> 23:06.123 lot of people being exploited and treated badly, 23:06.119 --> 23:11.589 so there are temptations from the market. 23:11.589 --> 23:17.059 People who know human psychology know that they can 23:17.057 --> 23:20.007 exploit human weaknesses. 23:20.009 --> 23:27.559 There's a temptation to oversell investments. 23:27.559 --> 23:31.639 That is, promise that they will do well--you see this all the 23:31.643 --> 23:33.703 time. I was just seeing yesterday's 23:33.702 --> 23:35.832 paper--someone was selling gold coins. 23:35.829 --> 23:40.279 Don't buy gold coins that you might see--and you know that, 23:40.276 --> 23:42.696 right? There were words in there--they 23:42.702 --> 23:45.922 said something--of course, we cannot guarantee that they 23:45.917 --> 23:49.017 won't go up in value but historically they have always 23:49.015 --> 23:51.115 done it or something like that. 23:51.120 --> 23:52.560 They're trying to oversell. 23:52.559 --> 23:56.059 You know that buying gold coins from some newspaper ad is not a 23:56.063 --> 23:58.663 smart investment, but they know that there will 23:58.663 --> 24:00.023 be people out there. 24:00.019 --> 24:02.959 A recent example of overselling: the National 24:02.960 --> 24:06.970 Association of Realtors has been running ads saying that home 24:06.969 --> 24:10.109 prices have always doubled every ten years. 24:10.109 --> 24:14.039 They didn't word it that--they put it in the present tense: 24:14.041 --> 24:16.551 home prices double every ten years. 24:16.549 --> 24:20.499 That's an organization of people who sell real estate and 24:20.497 --> 24:24.797 they have ad campaigns trying to convince you that home prices 24:24.798 --> 24:26.488 are going to double. 24:26.490 --> 24:30.800 That's overselling because we're in a real estate crisis 24:30.801 --> 24:35.511 and home prices are falling and that's the kind of thing that 24:35.505 --> 24:37.695 makes some people upset. 24:37.700 --> 24:40.880 There's a tendency to hide information. 24:40.880 --> 24:44.960 24:44.960 --> 24:48.220 You avoid telling people the things that would discourage 24:48.222 --> 24:50.162 them. People have attention 24:50.155 --> 24:54.655 anomalies, so they don't go out and see all the information and 24:54.660 --> 24:59.020 if you don't put it up front, then they'll never find it. 24:59.019 --> 25:04.939 There's a tendency for loyalty to friends--that's your own 25:04.940 --> 25:10.550 friends--and there's this word, other people. 25:10.549 --> 25:13.059 I think different languages have different words for 25:13.059 --> 25:15.859 this–-there are friends and then there are all those 25:15.864 --> 25:17.984 random people that we don't care about. 25:17.980 --> 25:22.390 So, investors will have a tendency to try to hide--or 25:22.389 --> 25:27.049 people who sell investments will try to channel the good 25:27.054 --> 25:32.064 investments to their friends and dump the bad stuff on other 25:32.057 --> 25:34.697 people. That's what has been happening 25:34.699 --> 25:37.879 a little bit--more than a little bit--in the subprime crises. 25:37.880 --> 25:41.690 We've managed to package subprime loans that we 25:41.685 --> 25:45.905 thought--some people thought--were terrible and sell 25:45.905 --> 25:50.285 them off to unwitting foreigners who didn't know. 25:50.289 --> 25:52.419 They thought that they were getting good stuff. 25:52.420 --> 26:00.050 There's also a tendency for churning for commission. 26:00.049 --> 26:03.989 This is a fault that real estate brokers can make. 26:03.990 --> 26:07.600 If they're paid by commission on each trade they just keep 26:07.603 --> 26:11.473 calling you up and coming up with new ideas for new trades. 26:11.470 --> 26:19.080 That's unethical behavior because it--if you keep trading 26:19.083 --> 26:25.613 too much, then you cannot possibly make money. 26:25.609 --> 26:28.939 The trading commissions will eat up all of your profits and 26:28.942 --> 26:31.702 professionals know that, so it's bad behavior. 26:31.700 --> 26:42.540 We have historically developed regulations that deal with these 26:42.537 --> 26:46.097 problems. The only reason I believe that 26:46.097 --> 26:48.987 we have financial markets that work is because we have 26:48.991 --> 26:51.921 regulations. I'm going to talk primarily 26:51.920 --> 26:55.420 about U.S. regulations and give a little 26:55.415 --> 26:57.865 history of them. The U.S. 26:57.869 --> 27:01.369 is actually an important country for regulation because 27:01.368 --> 27:05.058 it has been a model for much of the regulations around the 27:05.062 --> 27:08.582 world. I'm going to give a kind of a 27:08.576 --> 27:14.796 history of financial regulations in the United States that makes 27:14.802 --> 27:17.572 it rather a simple story. 27:17.569 --> 27:22.339 The simple story is that regulation mostly came in with 27:22.339 --> 27:27.109 the Progressive Era at the beginning of the century and 27:27.109 --> 27:32.589 reached its culmination at the time of the Great Depression and 27:32.586 --> 27:38.236 set up a lot of institutions that are still with us today. 27:38.240 --> 27:42.210 Then there was deregulation, which started around the 1970s, 27:42.213 --> 27:46.463 and the events we've seen--that we're seeing today--are outcomes 27:46.457 --> 27:49.687 of both the regulation and the deregulation. 27:49.690 --> 27:55.580 I want to start out with the origins of securities 27:55.577 --> 28:00.367 regulation. A critical point was a book 28:00.372 --> 28:06.842 written by Louis Brandeis, that's the guy that Brandeis 28:06.837 --> 28:10.307 University is named after. 28:10.309 --> 28:16.559 He was an author, a lawyer, then Supreme Court 28:16.557 --> 28:24.887 Justice, but he wrote a book in 1914 called Other People's 28:24.888 --> 28:30.718 Money and it was very influential. 28:30.720 --> 28:33.010 I have it on reserve, but that's not required for the 28:33.006 --> 28:35.556 mid-term; it's just if you're interested 28:35.562 --> 28:39.772 in seeing it. He believed that the most 28:39.768 --> 28:46.508 important step for the government in promoting better 28:46.505 --> 28:53.105 financial markets is disclosure--to force businesses 28:53.112 --> 29:00.242 or financial businesses to disclose the truth equally to 29:00.237 --> 29:04.547 everybody. His famous quote is, 29:04.545 --> 29:08.435 "Sunshine is the best disinfectant." 29:08.440 --> 29:11.430 Sunshine, meaning the truth, and everyone in the financial 29:11.433 --> 29:14.273 industry has to just tell people what they're doing. 29:14.269 --> 29:19.609 He said it has to be really disclosed and he likened it to 29:19.609 --> 29:22.039 labeling. They were already, 29:22.036 --> 29:25.986 in 1914, starting to require that food packages show 29:25.992 --> 29:30.572 nutritional--or ingredients and nutritional information. 29:30.569 --> 29:34.219 It was on the package and he thought, that's the kind of 29:34.224 --> 29:36.554 model for the financial industry. 29:36.549 --> 29:39.799 The disclosure has to be made convenient so that--it's not 29:39.796 --> 29:43.326 like you can get the information by going downtown to City Hall 29:43.327 --> 29:44.577 and asking for it. 29:44.579 --> 29:49.469 The principle is that you have to require that the information 29:49.473 --> 29:51.643 be given to the investor. 29:51.640 --> 29:56.290 That was a very important--Around the time of 29:56.289 --> 30:01.149 this book, state regulators were developing, 30:01.150 --> 30:06.600 at the state government level in the United States, 30:06.595 --> 30:10.185 what they called Blue Sky Laws. 30:10.190 --> 30:18.350 These were laws regulating how securities are sold. 30:18.349 --> 30:22.619 There are different theories about why they call them Blue 30:22.616 --> 30:24.946 Sky Laws. I think it was because people 30:24.950 --> 30:28.280 were overselling investments and saying, there's no limit to this 30:28.283 --> 30:30.213 investment but the blue sky above. 30:30.210 --> 30:35.630 The problem with the Blue Sky Laws was that they were each 30:35.629 --> 30:41.809 done separately and it was hard for states to manage what were, 30:41.810 --> 30:45.870 basically, national businesses. 30:45.869 --> 30:49.539 So the Blue Sky Laws were basically coming in the teens. 30:49.539 --> 30:54.829 In the 1920s, things changed because the 30:54.829 --> 31:00.119 telephone first became widely spread. 31:00.119 --> 31:03.469 Until the teens, telephones were very expensive 31:03.465 --> 31:07.605 because they didn't have good amplification technology. 31:07.609 --> 31:10.329 But by the '20s, everybody got a telephone in 31:10.325 --> 31:13.775 their house and the average person made hundreds of phone 31:13.780 --> 31:17.680 calls a year, so it was a big change in our 31:17.679 --> 31:23.479 society, This led to the boiler rooms--these were businesses 31:23.475 --> 31:29.075 that called around on the telephone and sold stocks--often 31:29.076 --> 31:32.216 bogus stocks--in the 1920s. 31:32.220 --> 31:35.110 The reason they call them boiler rooms is, 31:35.110 --> 31:39.200 if you are selling stocks by telephone there's no reason to 31:39.198 --> 31:42.588 rent a nice office, so you get the cheapest--so you 31:42.585 --> 31:45.655 put a whole bank of telephones in the cheapest place. 31:45.660 --> 31:47.910 That would be the basement of some building where they have 31:47.914 --> 31:50.204 the boiler. So, you'd have a whole bunch of 31:50.196 --> 31:53.456 people selling securities down there and they could vacate 31:53.461 --> 31:56.041 quickly if the authorities challenged you. 31:56.039 --> 31:59.459 In the 1920s, a lot of bogus stuff was 31:59.456 --> 32:04.346 sold--a lot of people were cheated--so after the stock 32:04.351 --> 32:09.531 market crash of 1929, it led to a movement for 32:09.533 --> 32:17.333 regulation. The most important thing was 32:17.326 --> 32:28.446 the 1934 foundation of the Securities and Exchange 32:28.450 --> 32:36.850 Commission--or SEC--which I think, 32:36.849 --> 32:39.829 ultimately dates back to–it was really the 32:39.826 --> 32:42.546 embodiment of Louis Brandeis' principles. 32:42.549 --> 32:48.269 This Securities and Exchange Commission was an organization 32:48.272 --> 32:53.702 that--I guess you could say its principal structure--its 32:53.699 --> 32:59.819 principal thing was to make sure that disclosure was proper and 32:59.816 --> 33:05.046 that people found it easy to get the information about 33:05.045 --> 33:09.975 securities. The SEC was very controversial 33:09.982 --> 33:16.112 at first because it was seen as interfering with business and 33:16.107 --> 33:19.317 the U.S. has been built on principles of 33:19.320 --> 33:22.320 individual freedom; this seemed like unnecessary 33:22.316 --> 33:23.606 government intrusion. 33:23.609 --> 33:27.879 There was a hostile attitude between business and the 33:27.878 --> 33:32.378 original SEC. Franklin Delano Roosevelt was 33:32.378 --> 33:38.688 viewed as very left-wing by business and very contrary to 33:38.688 --> 33:42.238 American values. But in fact, 33:42.244 --> 33:48.734 the SEC promoted the very free-market concepts that were 33:48.725 --> 33:52.845 widely believed in this country. 33:52.849 --> 33:55.849 Basically, what it did was it made it feel that people 33:55.848 --> 34:00.568 wouldn't get cheated; the SEC was a strong regulator 34:00.573 --> 34:06.513 and it really did restore confidence in the financial 34:06.508 --> 34:09.588 markets in this country. 34:09.590 --> 34:12.820 Other countries--In Europe, after the 1929 crash, 34:12.816 --> 34:16.846 they had a different reaction to the scandals and problems of 34:16.850 --> 34:20.550 the '20s and it wasn't as favorable to markets as in the 34:20.547 --> 34:22.877 U.S. The Securities and Exchange 34:22.882 --> 34:26.582 Commission, from the beginning, had it as its mission to make 34:26.575 --> 34:33.145 financial markets work properly; that is a wonderful story. 34:33.150 --> 34:44.500 One of the first Chairmen of the SEC was a man named William 34:44.503 --> 34:50.083 O. Douglas, who was actually a 34:50.084 --> 34:54.514 Yale law professor. 34:54.510 --> 34:58.410 I guess he influences me because--I have on the reading 34:58.406 --> 35:01.216 list--again it's an optional reading, 35:01.219 --> 35:08.869 but he has a book called Democracy and Finance 35:08.874 --> 35:18.764 1940 and what he advocated again was that financial markets 35:18.762 --> 35:25.622 have to be made to work for the people. 35:25.619 --> 35:28.249 I guess this influenced me–actually, 35:28.247 --> 35:30.937 in my 2003 book, New Financial Order, 35:30.940 --> 35:34.080 I talked about the democratization of finance as a 35:34.076 --> 35:35.466 fundamental principle. 35:35.469 --> 35:38.409 We have to make finance work for real people, 35:38.405 --> 35:41.665 so for me that meant understanding human frailties 35:41.674 --> 35:45.614 and understanding human psychology to make things work. 35:45.610 --> 35:53.940 He was also a major figure in the Legal Realism school that 35:53.944 --> 36:01.274 recognized human failings and human behavior and the 36:01.273 --> 36:05.013 establishment of laws. 36:05.010 --> 36:09.310 We have to realize that people don't read all the fine print 36:09.314 --> 36:13.114 and don't understand--if you have a precisely written 36:13.108 --> 36:17.068 contract in legal language, maybe they don't get it. 36:17.070 --> 36:23.610 One of the things that came out and was firmly embodied into law 36:23.609 --> 36:26.619 with the advent of the SEC. 36:26.619 --> 36:32.119 There were precursors to this, but the SEC forces the 36:32.119 --> 36:38.569 difference between public and private securities and this is a 36:38.571 --> 36:41.851 very important distinction. 36:41.849 --> 36:47.039 Public securities are securities that the SEC will 36:47.039 --> 36:52.549 accept as suitable for the general public and private 36:52.547 --> 36:59.007 securities are securities that have not been vetted by the SEC 36:59.008 --> 37:02.078 for the general public. 37:02.079 --> 37:09.539 The SEC--you have to decide--you hear about public 37:09.542 --> 37:14.722 companies and private companies. 37:14.719 --> 37:17.839 If you're a public company it means that you've gone through 37:17.844 --> 37:21.184 the procedures at the SEC to be approved as a public company. 37:21.179 --> 37:25.179 If you are a public company, the important thing is you have 37:25.183 --> 37:29.733 to do all of the disclosure that Louis Brandeis would have liked; 37:29.730 --> 37:33.290 you have to file regular forms with the SEC, 37:33.290 --> 37:35.360 disclosing information. 37:35.360 --> 37:40.770 Public companies--these public companies--if you want to get on 37:40.769 --> 37:46.969 the SEC website, go to sec.gov and then there is 37:46.973 --> 37:53.253 a tab that you can click, which is Edgar. 37:53.250 --> 37:58.390 If you click on Edgar you can enter the name of any public 37:58.385 --> 38:03.695 company in the United States and then all of its filings are 38:03.701 --> 38:09.291 online and you can find out an incredible amount of information 38:09.287 --> 38:12.007 about companies. It's all there, 38:12.008 --> 38:13.828 as long as they're public companies. 38:13.829 --> 38:17.729 A public--a lot of companies don't want to be public because 38:17.734 --> 38:20.054 you can't keep secrets very well; 38:20.050 --> 38:22.870 you've got to regularly put those things up online and 38:22.869 --> 38:25.049 they're out there for everybody to see. 38:25.050 --> 38:30.780 Companies can choose whether to be public or private. 38:30.780 --> 38:32.930 Why do they choose to be public? 38:32.929 --> 38:35.259 Well they--it's a balancing--they have to 38:35.258 --> 38:38.628 balance--sometimes they don't like the choice they made but 38:38.634 --> 38:42.364 the advantage to being public is that people trust you more. 38:42.360 --> 38:48.170 Moreover, your market is bigger, so public companies have 38:48.165 --> 38:51.685 an advantage; so companies don't like to be 38:51.689 --> 38:52.979 public, generally. 38:52.980 --> 38:54.420 It's contrary to their instincts. 38:54.420 --> 38:56.800 We keep all sorts of secrets in our company; 38:56.800 --> 39:00.510 we don't want to be filing all of our information all the time 39:00.512 --> 39:04.232 and to have it go right up on the website on standard forms so 39:04.225 --> 39:06.655 that everyone can easily process it. 39:06.659 --> 39:11.449 They may swallow their doubts because they have a sense that 39:11.447 --> 39:15.177 it will improve the market for their shares. 39:15.179 --> 39:18.279 So we have a lot of public companies. 39:18.280 --> 39:27.760 Now, if you are a private company, you are limited to 39:27.755 --> 39:34.675 where you can sell your investments. 39:34.679 --> 39:38.649 Let's take an example of an important kind of private 39:38.652 --> 39:41.022 company, called a hedge fund. 39:41.020 --> 39:54.600 39:54.599 --> 40:00.179 If you are--this is a private investment company--let's think 40:00.180 --> 40:04.920 before we talk about hedge--think of--suppose you're 40:04.923 --> 40:09.763 a public investment company approved by the SEC. 40:09.760 --> 40:12.670 The problem with being a public investment company is you have 40:12.672 --> 40:15.592 to file quarterly reports about all the things you've invested 40:15.585 --> 40:17.575 in. So you say, how can I make 40:17.582 --> 40:21.102 money beating the market if every quarter I have to tell 40:21.099 --> 40:22.889 everybody what I'm doing? 40:22.889 --> 40:26.149 A lot of investment companies don't want to be public, 40:26.153 --> 40:29.113 they want to be private so they don't have to. 40:29.110 --> 40:32.710 Hedge funds do not post their investments on Edgar, 40:32.708 --> 40:34.218 so they're private. 40:34.219 --> 40:39.059 If you're a private company, you're subject to regulation 40:39.057 --> 40:42.597 that limits a lot of things you can do. 40:42.599 --> 40:45.889 Notably, you're not allowed to advertise. 40:45.889 --> 40:48.559 If you're a hedge fund, you're not for the 40:48.561 --> 40:52.341 public--you're not approved for investing by the public. 40:52.340 --> 40:55.410 So, what business do you have to buy ads in newspapers 40:55.414 --> 40:56.694 announcing yourself. 40:56.690 --> 41:00.930 As a result, hedge funds have a very low 41:00.932 --> 41:03.682 profile. It's not their choice--they 41:03.682 --> 41:07.382 might like to advertise--but they can't without running afoul 41:07.377 --> 41:08.777 of the SEC. They'll say, 41:08.780 --> 41:11.530 you're behaving like a public company and you're not public. 41:11.530 --> 41:16.880 So, hedge funds do not advertise, that's why people 41:16.884 --> 41:23.204 don't know about them and they have a mysterious--they sound 41:23.203 --> 41:27.953 mysterious. Moreover, very significantly, 41:27.953 --> 41:34.243 they are limited in what kind of investors they can take. 41:34.239 --> 41:39.519 Now, there are different kinds of hedge funds--there's a lot of 41:39.518 --> 41:44.288 legal complexity here--but a 3c1 hedge fund is limited to 41:44.286 --> 41:46.496 ninety-nine investors. 41:46.500 --> 41:51.100 41:51.099 --> 41:55.069 That's not very many people and they must be accredited 41:55.068 --> 41:55.948 investors. 41:55.950 --> 42:03.950 42:03.949 --> 42:06.679 You ask, what is an accredited investor? 42:06.679 --> 42:10.219 Well, if you want to find out you can get onto sec.gov and it 42:10.219 --> 42:12.519 will give you the current definition. 42:12.519 --> 42:15.789 I wonder how many of you are accredited investors? 42:15.790 --> 42:18.470 I would guess not many of you. 42:18.469 --> 42:21.259 Here's how you become an accredited investor: 42:21.257 --> 42:24.807 (a) you have $1 million dollars in investable--that's not 42:24.806 --> 42:28.376 including your house, it's in investable assets. 42:28.380 --> 42:32.660 I won't ask for a show of hands. 42:32.659 --> 42:36.519 (b) You're making at least $200,000 a year, 42:36.517 --> 42:41.567 or (c) if you're married, you have to be a couple making 42:41.569 --> 42:43.589 at least $300,000. 42:43.590 --> 42:49.990 So, it's supposed to be for rich people. 42:49.989 --> 42:51.789 Incidentally, they haven't raised the 42:51.789 --> 42:54.389 definition of accredited investors for many years. 42:54.389 --> 42:59.799 Last year, the SEC put out a proposal that--it's getting too 42:59.804 --> 43:04.484 easy to be an accredited investor--so they put out a 43:04.484 --> 43:09.994 proposal that we raise the wealth level to $2.5 million. 43:09.989 --> 43:13.929 I thought they were going to and that was to protect people 43:17.340 --> 43:20.640 million dollars or only have two million dollars and don't know 43:20.642 --> 43:22.722 what they're doing from hedge funds. 43:22.719 --> 43:26.789 But, it got shot down apparently because it never 43:26.787 --> 43:29.407 happened. I think it's very hard to raise 43:29.410 --> 43:32.680 the definition of accredited investors because the minute you 43:32.682 --> 43:35.952 do that you're closing large numbers of people out from their 43:35.954 --> 43:39.394 ability to invest in hedge funds and they don't like that; 43:39.389 --> 43:42.239 they feel insulted, so there was a lot of angry 43:42.238 --> 43:46.718 reaction. There's also another kind of 43:46.723 --> 43:52.563 hedge fund, 3c7, which can take five hundred 43:52.564 --> 43:56.564 investors. If they register as a 3c7, 43:56.558 --> 43:59.128 they can take more investors. 43:59.130 --> 44:05.510 But then, they're limited to qualified purchasers. 44:05.510 --> 44:07.810 This is just an example of their regulations. 44:07.809 --> 44:14.839 A qualified purchaser has to have at least $5 million dollars 44:14.839 --> 44:21.629 or, if it's an institution, at least $25 million--that is a 44:21.634 --> 44:27.304 natural person. A natural person refers to a 44:27.301 --> 44:34.431 human being, so it's $5 million for natural persons and $25 44:34.428 --> 44:37.868 million for institutions. 44:37.869 --> 44:41.369 So, if you're a small college with only $20 million in a 44:41.367 --> 44:45.117 portfolio you don't come across as a qualified purchaser. 44:45.119 --> 44:47.679 They're trying to protect innocent, small colleges who 44:47.676 --> 44:49.216 only have $20 million dollars. 44:49.219 --> 44:51.829 The idea is that people who don't have much money can't 44:51.834 --> 44:54.554 afford expensive lawyers and they can't figure it out and 44:54.545 --> 44:57.155 they really shouldn't be investing in hedge funds. 44:57.160 --> 45:05.910 45:05.909 --> 45:09.719 These public-private distinctions are onerous--are 45:09.723 --> 45:13.613 offensive--to some people because it seems like the 45:13.614 --> 45:16.654 government is acting like a parent. 45:16.650 --> 45:19.780 Most of the people are--if you're not accredited as an 45:19.781 --> 45:23.091 investor it's like the government doesn't respect you; 45:23.090 --> 45:26.170 it's like they're treating you like children. 45:26.170 --> 45:29.710 Why would it be that somebody else is allowed to invest in a 45:29.710 --> 45:31.210 hedge fund and I'm not? 45:31.210 --> 45:37.940 It rankles, but on the other hand, these regulations survive 45:37.941 --> 45:44.331 because the reality is that people are victimized all the 45:44.330 --> 45:51.290 time and we can't just allow companies to act in secrecy. 45:51.289 --> 45:54.599 This is something that I believe in--not everyone 45:54.595 --> 45:58.105 believes in this--but the general principle has been 45:58.108 --> 46:01.968 now--ever since the 1930s--that the general public is not 46:01.965 --> 46:06.575 allowed to invest in things that are not properly documented. 46:06.579 --> 46:13.559 Another important distinction in securities regulation is the 46:13.558 --> 46:18.558 distinction between insider and outsider. 46:18.559 --> 46:26.589 An insider is someone who is privy to the secret information 46:26.591 --> 46:34.081 of a company and the secret information could be used to 46:34.078 --> 46:37.438 trade. If you know the secrets of a 46:37.444 --> 46:41.674 company, if you know some good news about the company before 46:41.669 --> 46:44.919 the public does, you could buy the shares of the 46:44.924 --> 46:48.474 company and experience the profit when the price goes up. 46:48.469 --> 46:52.109 You would be exploiting insider information and you would be 46:52.111 --> 46:53.841 victimizing the outsiders. 46:53.840 --> 47:00.180 The idea, from the beginning at the SEC, was that insiders 47:00.178 --> 47:06.408 should not be allowed to trade on information that is not 47:06.405 --> 47:10.515 properly disclosed to the public. 47:10.519 --> 47:18.599 There was an important change: Regulation F.D. 47:18.600 --> 47:22.220 came in 2000. F.D. 47:22.222 --> 47:26.642 stands for full disclosure--this is a SEC 47:26.642 --> 47:31.172 regulation. Regulation F.D. 47:31.170 --> 47:34.880 was, I think, passed in recognition of the 47:34.875 --> 47:39.155 internet. Under Louis Brandeis--Brandeis 47:39.155 --> 47:44.845 wanted companies to always present the information, 47:44.849 --> 47:47.369 but for him it always meant presenting a document, 47:47.373 --> 47:49.643 so they had something called a prospectus, 47:49.640 --> 47:52.470 for example. You could not sell a security 47:52.474 --> 47:56.924 without giving a prospectus to the potential buyers and the 47:56.924 --> 48:00.994 prospectus would be something approved by the SEC. 48:00.989 --> 48:04.729 I don't know if the word is approved but it's--you have to 48:04.728 --> 48:08.728 run it by the SEC and then you always have to give that up. 48:08.730 --> 48:10.450 But he was living in the paper age. 48:10.449 --> 48:16.189 We now live in the internet age and so Regulation F.D.--I don't 48:16.190 --> 48:21.190 know if it actually mentions the internet but it's--the 48:21.190 --> 48:25.700 Regulation F.D. basically says that whenever a 48:25.703 --> 48:31.033 company announces information it has to be available almost 48:31.028 --> 48:34.698 instantly to everybody in the market. 48:34.699 --> 48:38.559 So, the way it has worked out in practice is that companies, 48:38.562 --> 48:41.382 when they have a major announcement to make, 48:41.377 --> 48:43.797 they have some kind of web event. 48:43.800 --> 48:47.390 Anybody in the world--they would be notified and they could 48:47.393 --> 48:49.813 get on and hear it as it's happening. 48:49.809 --> 48:54.049 So we have meetings--big meetings--on the web for 48:54.051 --> 48:57.411 disclosure of important information. 48:57.409 --> 49:01.699 This has made it very clear that there has to be--if you 49:01.703 --> 49:06.153 announce anything you have to announce it all at once on a 49:06.153 --> 49:11.073 certain date and you can't have favored people that you give the 49:11.072 --> 49:16.802 announcement to. Market surveillance is a 49:16.804 --> 49:27.174 process that stock exchanges and other organizations do to make 49:27.173 --> 49:36.543 sure that inside information is not being mishandled. 49:36.539 --> 49:40.229 The self-regulatory organizations, 49:40.232 --> 49:45.722 SROs, are industry organizations that regulate the 49:45.715 --> 49:49.505 industry. That's the American way of 49:49.510 --> 49:52.650 doing things. Rather than have the government 49:52.654 --> 49:56.124 regulate, we have an industry organization that does it so 49:56.119 --> 49:58.489 that the government doesn't have to. 49:58.489 --> 50:04.409 The SROs have complex regulatory equipment, 50:04.409 --> 50:12.159 computers that can discover insider trading and the SROs 50:12.161 --> 50:19.491 will catch you or they may catch you if you try. 50:19.489 --> 50:24.519 I want to give you an example of SRO behavior and this is just 50:24.518 --> 50:27.938 one news story. It was in 1995, 50:27.942 --> 50:35.092 a secretary at IBM Corporation was asked to xerox some 50:35.087 --> 50:43.037 documents by her boss and the documents described a proposed 50:43.041 --> 50:47.761 takeover of Lotus Corporation. 50:47.760 --> 50:51.390 Remember Lotus? That was the corporation that 50:51.390 --> 50:54.840 produced the first spreadsheet program. 50:54.840 --> 50:58.600 It's now been replaced mostly by Microsoft Excel. 50:58.599 --> 51:01.699 But at the time it was big, so this was big news. 51:01.699 --> 51:06.899 IBM is going to take over Lotus or try to take over Lotus. 51:06.900 --> 51:12.320 We now know what happened because of the surveillance 51:12.321 --> 51:16.311 investigation. She told her husband that she 51:16.306 --> 51:20.536 had just Xeroxed this thing--she had read what she was 51:20.539 --> 51:24.529 Xeroxing--and she told her husband who was a beeper 51:24.533 --> 51:26.853 salesman about the news. 51:26.849 --> 51:31.349 He did nothing except tell two friends the story--he didn't buy 51:31.349 --> 51:35.269 shares, he just told two friends, my wife says that IBM 51:35.267 --> 51:37.587 is going to take over Lotus. 51:37.590 --> 51:47.100 The friends immediately bought Lotus shares and then--that was 51:47.101 --> 51:51.991 June 2--by June 5, twenty-five people had 51:51.990 --> 51:56.500 bought--had spent a half a million dollars to buy on this 51:56.496 --> 51:59.086 tip. They included a pizza chef, 51:59.092 --> 52:02.102 an electrical engineer, a bank executive, 52:02.103 --> 52:05.423 a dairy wholesaler, a school teacher and four 52:05.415 --> 52:08.765 stockbrokers; stockbrokers get the word 52:08.769 --> 52:11.649 faster. Guess what happened? 52:11.650 --> 52:16.160 Those people are all in trouble because it's illegal to trade on 52:16.157 --> 52:19.947 insider information and they tracked them all down. 52:19.949 --> 52:27.939 I'll give you another example and this is the example of 52:27.939 --> 52:30.989 Emulex Corporation. 52:30.989 --> 52:34.309 Maybe this isn't exactly insider trading, 52:34.312 --> 52:38.302 this is more fraud but in--what year was this? 52:38.300 --> 52:44.200 Around sometime in the late '90s, Mark Jacob--he's the 52:44.198 --> 52:49.428 criminal here, he's probably out of jail now. 52:49.429 --> 52:56.089 Mark Jacob was upset with--he had been an employee of Emulex 52:56.087 --> 53:02.177 and had access to inside information of the company. 53:02.179 --> 53:06.919 I guess he was involved in the dissemination of information for 53:06.920 --> 53:11.660 the company, so he kind of knew how they did press releases. 53:11.659 --> 53:15.599 So he sent out a fake--he bought--he shorted the company 53:15.599 --> 53:19.469 and he--the stock in the company--and he bought--he put 53:19.466 --> 53:23.906 out a fake press release saying that there was bad news for the 53:23.907 --> 53:27.187 company. He knew how to make it look one 53:27.190 --> 53:29.250 of Emulex's press releases. 53:29.250 --> 53:33.570 He also did it from the El Camino Community College Library 53:33.566 --> 53:36.016 because he thought, I'll be careful, 53:36.018 --> 53:39.068 I won't issue this fake press release on my own computer 53:39.073 --> 53:41.963 because they might be able to track me back to my own 53:41.962 --> 53:44.142 computer. So, he went to this community 53:44.144 --> 53:47.004 college and got one of their library computers and he issued 53:47.002 --> 53:48.312 the press release there. 53:48.309 --> 53:51.259 He got picked up by all the major news services, 53:51.258 --> 53:54.458 the stock plummeted, he sold immediately and he made 53:54.458 --> 53:58.068 a lot of money. The problem is, it didn't work. 53:58.070 --> 54:02.230 They tracked back who sold--who shorted and who had sold just 54:02.229 --> 54:04.169 before--just at that time. 54:04.170 --> 54:09.240 They also went back to the El Camino Community College Library 54:09.236 --> 54:13.466 and they interviewed the librarians and tried to ask 54:13.472 --> 54:15.532 them, do you remember somebody coming 54:15.527 --> 54:17.127 here that didn't look like a student? 54:17.130 --> 54:21.080 They identified him and he was caught. 54:21.080 --> 54:24.240 That's what surveillance does. 54:24.239 --> 54:31.209 They make the markets work because if you didn't have this 54:31.210 --> 54:37.570 there would be all kinds of crooks and bad actors. 54:37.570 --> 54:41.750 The thing about these organizations is that they cost 54:41.754 --> 54:44.414 money and they cause nuisances. 54:44.409 --> 54:48.319 A lot of people in the financial community are annoyed 54:48.324 --> 54:52.244 by them because these regulations are costly to comply 54:52.238 --> 54:55.338 with and they take a lot of resources. 54:55.340 --> 55:00.850 I think the enlightened view is that these things are absolutely 55:00.849 --> 55:03.909 essential to trust in the market. 55:03.909 --> 55:13.519 Another form of regulation is accounting regulation. 55:13.519 --> 55:20.349 For example, we have in the United States 55:20.349 --> 55:29.909 the Financial Accounting Standards Board--it's right here 55:29.909 --> 55:34.689 in Connecticut--or FASB. 55:34.690 --> 55:37.200 This is not a government organization. 55:37.199 --> 55:43.749 It was organized by the SEC in 1973, but the SEC didn't want to 55:43.750 --> 55:48.220 do this job; they wanted it to be done 55:48.216 --> 55:52.656 privately. What FASB does for the United 55:52.663 --> 55:58.503 States is it creates what are called Generally Accepted 55:58.497 --> 56:01.087 Accounting Practices. 56:01.090 --> 56:08.480 They're rules for how a company should keep its books so that 56:08.480 --> 56:15.500 there's some regularity and standards in how accounting is 56:15.501 --> 56:19.611 done. When the Financial Accounting 56:19.614 --> 56:25.624 Standards Board listens to what corporations are saying and 56:25.622 --> 56:31.742 helps them--it adjusts these standards from time to time but 56:31.735 --> 56:37.635 it does have definitions that have to be maintained. 56:37.639 --> 56:45.889 A company has a profit and loss statement and there's something 56:45.885 --> 56:52.085 that is called net income, which is the measure of how 56:52.089 --> 56:57.599 much the company is making--the profits after expenses of the 56:57.599 --> 57:00.179 company, called the bottom line. 57:00.180 --> 57:06.830 The GAAP standards define this. 57:06.830 --> 57:10.090 There's also operating income. 57:10.090 --> 57:15.610 Now, companies can use other definitions of--other accounting 57:15.612 --> 57:21.322 standards besides these and some of these other definitions, 57:21.320 --> 57:26.490 which are not always GAAP--other standards--and are 57:26.490 --> 57:33.000 widely used in the industry are other kinds of--they have what's 57:33.004 --> 57:39.904 called core earnings, pro forma earnings, 57:39.898 --> 57:49.188 EBITDA, which is earnings before interest, 57:49.194 --> 57:56.114 taxes, depreciation, and amortization. 57:56.110 --> 58:00.020 Adjusted earnings. 58:00.019 --> 58:03.139 There are all kinds of different definitions and 58:03.139 --> 58:06.919 companies like to do it their own way because they want to 58:06.922 --> 58:10.442 present themselves in the best way to the public. 58:10.440 --> 58:13.490 But they're not allowed to just do it their own way; 58:13.489 --> 58:18.709 they have to do it according to standards, so the GAAP 58:18.712 --> 58:21.572 accounting is standardized. 58:21.570 --> 58:25.010 What a company can do is present things in two different 58:25.011 --> 58:28.061 ways. They can present GAAP and then 58:28.059 --> 58:33.279 that goes to Edgar and they can also present it any other way 58:33.279 --> 58:37.139 they like. But the law--the SEC requires 58:37.139 --> 58:42.689 that they at least present the standard earnings definitions 58:42.691 --> 58:44.951 for all these things. 58:44.949 --> 58:50.179 Now another--let me just mention off balance sheet 58:50.181 --> 58:53.841 accounting. The one thing that the SEC 58:53.836 --> 58:58.276 requires that companies file is their balance sheet, 58:58.281 --> 59:02.641 which you can look up for any company on Edgar. 59:02.639 --> 59:13.089 The balance sheet of a company has two columns; 59:13.090 --> 59:16.570 it has assets and it has liabilities. 59:16.570 --> 59:22.150 59:22.150 --> 59:25.220 So, on one side is everything the company owns and the other 59:25.215 --> 59:27.185 side is everything the company owes. 59:27.190 --> 59:32.520 The net worth of the company is their assets minus their 59:32.520 --> 59:38.430 liabilities and that represents the value that the company has 59:38.432 --> 59:42.602 if they paid off all their liabilities. 59:42.599 --> 59:48.649 What the SEC has to worry about is something called off balance 59:48.654 --> 59:50.514 sheet accounting, 59:50.510 --> 59:56.280 59:56.280 --> 1:00:01.740 which occurs when companies try to hide some of the things that 1:00:01.735 --> 1:00:07.005 they--the liabilities that they have by not recording them on 1:00:07.014 --> 1:00:08.954 the balance sheet. 1:00:08.949 --> 1:00:14.369 If you can get away with that then you can do--you can conceal 1:00:14.373 --> 1:00:19.353 maybe some risky investments you've made or some leverage 1:00:19.351 --> 1:00:22.901 that you've had. You might have brought in 1:00:22.898 --> 1:00:25.938 investments or something by borrowing money, 1:00:25.939 --> 1:00:30.319 so the investment--the combined investment and liability--could 1:00:30.324 --> 1:00:31.884 be very volatile. 1:00:31.880 --> 1:00:34.810 You don't want people to know that, so you don't put it on the 1:00:34.811 --> 1:00:38.341 balance sheet. The SEC and other regulators 1:00:38.342 --> 1:00:40.712 have to watch for this. 1:00:40.710 --> 1:00:44.840 The classic example of a company that did this--it's a 1:00:44.842 --> 1:00:47.652 classic now--is Enron Corporation. 1:00:47.650 --> 1:00:54.630 They had a number of partnerships that they put on as 1:00:54.626 --> 1:00:57.306 off balance sheet. 1:00:57.309 --> 1:01:02.449 They were making risky investments but they weren't 1:01:02.449 --> 1:01:08.819 reporting them properly on the SEC forms, so people didn't know 1:01:08.822 --> 1:01:11.292 how risky Enron was. 1:01:11.289 --> 1:01:17.579 More recently--this came out last year--the SIVs, 1:01:17.577 --> 1:01:23.207 so called structured investment vehicles, 1:01:23.210 --> 1:01:30.080 were used by banks to cover up investments they had, 1:01:30.079 --> 1:01:34.389 often in risky subprime loans. 1:01:34.389 --> 1:01:39.119 Well, they created special entities called SIVs and the 1:01:39.117 --> 1:01:44.547 SIVs would be borrowing money on the commercial paper market to 1:01:44.546 --> 1:01:46.556 buy subprime loans. 1:01:46.559 --> 1:01:52.329 They were in a very risky position because subprime loans 1:01:52.327 --> 1:01:56.547 were already recognized as being risky. 1:01:56.550 --> 1:02:00.640 They'd borrow to buy them, so if the value of the subprime 1:02:00.638 --> 1:02:05.228 loans went down just a little bit the SIV would be in trouble. 1:02:05.230 --> 1:02:08.580 In the SIV contract, there was some language that 1:02:08.582 --> 1:02:11.522 implied that if the SIV ever went bankrupt, 1:02:11.516 --> 1:02:14.656 the bank would come back and rescue them. 1:02:14.659 --> 1:02:19.419 The SIV really was a liability but it wasn't visible to 1:02:19.415 --> 1:02:22.405 investors investing in the bank. 1:02:22.409 --> 1:02:27.019 This is another example of off balance sheet accounting that 1:02:27.015 --> 1:02:30.055 was frustrating the rules of the SEC. 1:02:30.059 --> 1:02:39.199 I wanted to talk about another instance of regulation that is 1:02:39.199 --> 1:02:48.339 important in the United States but it's very poorly known. 1:02:48.340 --> 1:03:02.770 We have something called SIPC, that's the Securities Investor 1:03:02.766 --> 1:03:15.266 Protection Corporation, which was created in 1970. 1:03:15.269 --> 1:03:21.299 This is the securities' analog of the FDIC in banking. 1:03:21.300 --> 1:03:24.280 I don't know if I mentioned--I assume you know about the 1:03:24.281 --> 1:03:26.451 Federal Deposit Insurance Corporation? 1:03:26.450 --> 1:03:28.250 I thought that was better-known. 1:03:28.250 --> 1:03:30.780 Well, let me just mention it by analogy. 1:03:30.780 --> 1:03:39.370 In 1934, after the failure--it was actually created by Congress 1:03:39.374 --> 1:03:44.924 in 1933 and went into business in '34. 1:03:44.920 --> 1:03:53.250 The FDIC, Federal Deposit Insurance Corporation--I'll put 1:03:53.247 --> 1:04:02.017 it down as 1934--guaranteed for small depositors the savings 1:04:02.021 --> 1:04:06.781 deposits they had at a bank. 1:04:06.780 --> 1:04:11.600 That was to protect depositors in the case of bank failure and 1:04:11.602 --> 1:04:15.162 it was a very important innovation because, 1:04:15.159 --> 1:04:17.289 at that time, there were huge runs on banks. 1:04:17.289 --> 1:04:19.999 People were pulling money out of banks because they feared 1:04:20.003 --> 1:04:22.383 that if the bank failed, then they would lose their 1:04:22.383 --> 1:04:25.413 money; it created a huge crisis in 1:04:25.412 --> 1:04:29.452 1933. It's for small investors 1:04:29.450 --> 1:04:36.970 because currently the limit on the SEC is $100,000; 1:04:36.970 --> 1:04:40.840 that's not a lot of money. 1:04:40.840 --> 1:04:44.440 Maybe you think of it as a lot of money, but it's not. 1:04:44.440 --> 1:04:48.520 If someone's saving for their retirement you better have a lot 1:04:48.522 --> 1:04:51.942 more than that; $100,000 is only a few years of 1:04:51.942 --> 1:04:54.522 income even for low-income people. 1:04:54.519 --> 1:04:59.299 At least we want to protect the small investors' savings in 1:04:59.300 --> 1:05:02.040 banks. Actually, if you have more than 1:05:02.044 --> 1:05:06.154 $100,000 in a bank account you should probably pull it out and 1:05:06.147 --> 1:05:09.847 spread it around over several banks because each bank is 1:05:09.845 --> 1:05:13.105 separately insured, so there's effectively no limit 1:05:13.110 --> 1:05:16.040 if you're just a little bit smart and move your accounts 1:05:16.037 --> 1:05:18.677 around. We had deposit insurance 1:05:18.676 --> 1:05:24.376 starting in The Great Depression and that's been very important; 1:05:24.380 --> 1:05:26.530 it's now in every country. 1:05:26.530 --> 1:05:35.410 We had a run on a bank in the UK, it was called Northern Rock, 1:05:35.412 --> 1:05:39.392 last year. It turns out that there was a 1:05:39.389 --> 1:05:43.999 failure of the UK deposit--I would say it's a failure because 1:05:44.002 --> 1:05:48.622 UK deposit insurance insured Northern Rock only for the first 1:05:52.351 --> 1:05:57.051 many thousand pounds--you were 90% insured so that was not good 1:05:57.053 --> 1:06:01.073 enough because people were worried about losing 10% of 1:06:01.073 --> 1:06:04.553 their deposits. So there was a big bank run and 1:06:04.550 --> 1:06:08.350 Northern Rock would have failed if the Bank of England hadn't 1:06:08.345 --> 1:06:09.985 come by to rescue them. 1:06:09.989 --> 1:06:16.209 I think that deposit insurance is very important but we didn't 1:06:16.205 --> 1:06:22.415 have anything for corresponding accounts at brokerage services 1:06:22.420 --> 1:06:28.330 until 1970 This was motivated by a spectacular failure of a 1:06:28.329 --> 1:06:35.939 brokerage, Goodbody & Co., in 1970. 1:06:35.940 --> 1:06:41.040 1:06:41.040 --> 1:06:44.800 I hope you know what I mean; a brokerage service is a place 1:06:44.801 --> 1:06:48.531 where stockbrokers work and a stockbroker is somebody that 1:06:48.527 --> 1:06:51.467 manages your buying and selling of shares. 1:06:51.469 --> 1:06:55.239 So if you want to buy stock you can call the stockbroker. 1:06:55.239 --> 1:06:59.299 Merrill Lynch is a big retail broker--they're right down here 1:06:59.304 --> 1:07:01.784 on the Green. You can go there and say, 1:07:01.779 --> 1:07:04.699 I want to buy stocks, and the broker will say fine, 1:07:04.697 --> 1:07:06.737 we'll set up an account for you. 1:07:06.739 --> 1:07:09.599 You've deposited money in our account–now, 1:07:09.598 --> 1:07:12.338 he's not a bank, he's a broker--we'll set up a 1:07:12.335 --> 1:07:14.885 cash account and a securities account. 1:07:14.889 --> 1:07:18.169 Put some money in and then you think about it and then you call 1:07:18.170 --> 1:07:20.710 me up and say, do you want to buy some stocks. 1:07:20.710 --> 1:07:24.540 Then I'll take money out of your cash account and I'll put 1:07:24.543 --> 1:07:26.363 it into these securities. 1:07:26.360 --> 1:07:28.630 That's a broker. Goodbody & 1:07:28.628 --> 1:07:33.138 Company was a broker, but it failed in 1970--it went 1:07:33.140 --> 1:07:38.180 bankrupt--and then it looked like the people who had money 1:07:38.183 --> 1:07:41.283 and shares in them would lose. 1:07:41.280 --> 1:07:43.650 There are two things: you can have a cash account 1:07:43.645 --> 1:07:46.645 with them--you put money into the cash account and you haven't 1:07:46.651 --> 1:07:49.751 bought shares with it yet; it's just sitting--it's like in 1:07:49.751 --> 1:07:52.101 a bank. You could lose that because 1:07:52.103 --> 1:07:55.113 Goodbody & Company is going bankrupt; 1:07:55.110 --> 1:07:56.370 it doesn't have it anymore. 1:07:56.370 --> 1:07:57.850 Well, what about your shares? 1:07:57.849 --> 1:08:00.999 Well, Goodbody & Company is supposed to have 1:08:00.996 --> 1:08:04.746 your shares but they generally hold them in what's called 1:08:04.745 --> 1:08:07.715 "street name." That means Goodbody & 1:08:07.715 --> 1:08:11.525 Company owns the shares and you just have a contractual 1:08:11.528 --> 1:08:14.638 relationship with Goodbody that, in principle, 1:08:14.638 --> 1:08:16.208 some of those shares are yours. 1:08:16.210 --> 1:08:20.580 But the company that you're investing in ultimately doesn't 1:08:20.582 --> 1:08:23.402 have your money. It's Goodbody that they're 1:08:23.398 --> 1:08:25.868 dealing with, although they have ways of--for 1:08:25.867 --> 1:08:29.007 a proxy--and they have ways of finding out who's who. 1:08:29.010 --> 1:08:33.130 The problem is, if your brokerage firm fails 1:08:33.134 --> 1:08:36.744 you could lose a lot; you could lose your cash 1:08:36.739 --> 1:08:38.779 account and your security account. 1:08:38.779 --> 1:08:46.969 So, SIPC was set up in 1970 and SIPC insures cash accounts up to 1:08:46.970 --> 1:08:53.470 $100,000 and securities accounts up to $500,000. 1:08:53.470 --> 1:08:59.540 That's another example of government involvement. 1:08:59.539 --> 1:09:04.009 SIPC was set up by an act of Congress. 1:09:04.010 --> 1:09:11.650 So the–unfortunately, I don't know--have you ever 1:09:11.654 --> 1:09:15.234 heard of SIPC? Most people don't even know it 1:09:15.230 --> 1:09:17.800 exists. SIPC did a survey of the U.S. 1:09:17.800 --> 1:09:21.490 population and this is one of the--In 2001, 1:09:21.489 --> 1:09:25.179 this is one of the questions SIPC asked. 1:09:25.180 --> 1:09:28.740 The respondents were asked to identify the organization that 1:09:28.743 --> 1:09:32.433 insures you against losing money in the stock market or as the 1:09:32.427 --> 1:09:34.297 result of investment fraud. 1:09:34.300 --> 1:09:40.220 Only 16% of investors knew that there is no such company. 1:09:40.220 --> 1:09:44.690 Let me make this clear, SIPC does not--if you invest in 1:09:44.686 --> 1:09:49.646 some stock and it does badly you can't go to SIPC and say, 1:09:49.649 --> 1:09:53.799 hey my stocks went down please give me my money back. 1:09:53.800 --> 1:09:55.670 They won't do it. 1:09:55.670 --> 1:09:59.280 Moreover, if you say, this stockbroker he was lying 1:09:59.281 --> 1:10:03.621 to me, he told me that this was a good investment and he even 1:10:03.615 --> 1:10:07.005 lied and said something to get me roped in, 1:10:07.010 --> 1:10:08.230 they won't pay you back. 1:10:08.229 --> 1:10:12.059 The only thing that SIPC does is replace securities. 1:10:12.060 --> 1:10:14.490 In other words, if you had an account at a 1:10:14.492 --> 1:10:18.052 brokerage and you thought you had a hundred shares of IBM and 1:10:18.052 --> 1:10:20.962 now the broker is going bankrupt--the broker won't 1:10:20.960 --> 1:10:24.460 answer your email anymore and he's just gone--you go to SIPC 1:10:24.460 --> 1:10:27.820 and say, I had these hundred shares. 1:10:27.819 --> 1:10:31.979 SIPC than returns a hundred shares to you; 1:10:31.980 --> 1:10:32.920 they don't pay you cash. 1:10:32.920 --> 1:10:36.900 They give you the hundred shares and that's all they do. 1:10:36.899 --> 1:10:39.779 You might say that our regulation hasn't gone far 1:10:39.779 --> 1:10:42.959 enough and I think maybe it hasn't gone far enough. 1:10:42.960 --> 1:10:46.790 We protect certain kinds of things and people have to pay 1:10:46.789 --> 1:10:49.869 attention. It's a difficult problem that 1:10:49.866 --> 1:10:54.686 not everyone is smart--they vary in their ability--so we try to 1:10:54.691 --> 1:10:58.661 make a world in which it's pretty safe for the small 1:10:58.659 --> 1:11:01.849 investor who's not paying attention. 1:11:01.850 --> 1:11:06.380 It's never perfect and we can't figure out yet a way to make it 1:11:06.384 --> 1:11:10.704 perfect and we still have small investors who are defrauded, 1:11:10.698 --> 1:11:12.598 who are treated badly. 1:11:12.600 --> 1:11:15.790 The subprime crisis is an example: some people were 1:11:15.788 --> 1:11:18.848 treated badly in this recent financial crisis. 1:11:18.850 --> 1:11:21.870 So, we just have to keep improving our regulation and 1:11:21.872 --> 1:11:25.652 trying to make a deal with all of the problems as they come up. 1:11:25.649 --> 1:11:28.819 The problems are complex because we're trying to make a 1:11:28.820 --> 1:11:32.400 system in which people are able to make their own decisions as 1:11:32.401 --> 1:11:35.511 much as possible and to make them in a way that--in an 1:11:35.513 --> 1:11:37.513 environment that they trust. 1:11:37.510 --> 1:11:40.680 But it's just too complicated and too--it's impossible to make 1:11:40.680 --> 1:11:41.720 it work perfectly. 1:11:41.720 --> 1:11:44.370 So, that will conclude this lecture. 1:11:44.369 --> 1:11:50.329 So I'll--I won't be here Monday but my T.A.'s will handle the 1:11:50.326 --> 1:11:53.996 exam and I'll see you on Wednesday.