Dinosaur Derivatives and Other Trades. Josse Jeremy

things may, or may not, turn out in the way contemplated when undertaking a particular financial exercise, or calculation, or plan, or investment.

      A better word than “doubt” is “uncertainty.” And this is where finance and philosophy really converge. Volumes have been written, in the great pantheon of philosophy, on the question of how we can be certain of anything. (My “chair problem,” for instance: how can I really be certain my chair exists, even though I can feel it supporting my backside?) In finance we are plagued with uncertainty, and it's no abstraction. While philosophers and academicians may write at length on the topic of certainty without disrupting the general ebb and flow of goods and services, those actually involved in finance know all too well how uncertainty creates real-life events, including catastrophic economic collapses affecting whole societies worldwide.

      Of course, in finance most questions about uncertainty have to do with the future. We're concerned about managing the risk associated with uncertainty, or beating others by using our predictive capabilities. So the second chapter will analyze this concept through a very famous story about “prophecy” – namely, the story of Joseph from the book of Genesis. Here was a man (prophet) who apparently predicted firstly seven good years, then seven bad years in the Egyptian economy. But Joseph's predictions were quite unique for he was not “uncertain” about this economic future. According to the story, God had already informed Joseph what the outcomes would be.

      By looking at Joseph's ability to circumvent doubt over the future, and seeing the way he used his privileged economic knowledge, we glean some insights into the nature of “uncertainty” and “certainty” itself. As we all know, there are in practice, limits to human foresight.

      Next, the “contract” – perhaps the most basic building block in finance. What, really, are contracts? Why do business people so often argue and dispute their terms? In the third chapter, I will describe an old English legal case in the law of contract, just to give you a sense of what a contract may really be. This, in turn, opens a window on some very curious, logical puzzles concerning what it actually means to follow the terms – or “rules” – of a contract. Far from being set in stone, the rules in a contract can almost always be interpreted in such a way that any pattern of behavior (any pattern whatsoever) can be shown to be in conformity with those rules. No wonder then that hugely divergent interpretations of the terms of a contract can arise. When you mix that insight with good old human self-interest, it goes a long way toward explaining why the business world spends its time litigating, lying, and fighting over the terms of many business deals.

      “Financial instruments” are themselves a form of contract. So we look next at the concept of a financial instrument itself. In Chapter 4 I tell an antique tale about some of the earliest forms of financial contracts and the old prohibitions on usury. All financial instruments are merely peculiar interpretations of contracts, or reconfigurations of contracts, to achieve certain ends. They are invariably a form of “legal fiction.” And yet, though quite artificial in design, they can sometimes produce important economic benefits.

      Another peculiar philosophical question in finance concerns the very nature of “financial innovation,” the topic of Chapter 5. Why is financial innovation important and yet also potentially so dangerous and open to human distortion? Financial innovation is, in effect, the invention or discovery of new financial instruments and contracts. But when a new financial product is developed, or a new theory in finance is advanced, is that really the equivalent of a scientific discovery or a new invention? It certainly doesn't feel like that. Perhaps it is more like the development of a new theory in mathematics, though that doesn't seem quite right either. This is an issue that has manifested itself throughout economic history and even (as we shall see) in the growth of the American railway system in the 19^th century. Meanwhile, it has still more direct relevance to us today. I will argue it gives us a concrete insight into one of the often neglected causes of the 2007/8 credit crisis.

      Then, on to another core concept (Chapter 6): what really is an “ownership right?” This is a question that moral and political philosophers have brooded over for centuries. I'm going to approach it from a slightly skewed angle by considering the story of Faust and his pact with the Devil. Faust was a trader himself: he traded certain moral rights for material rights. So, what are these material rights? What, for example, does it mean to own a stock? And what would happen if we too could enter into a Faustian-style pact? Suppose we could trade, say, our political right to vote for rights to more money? Could it be that, in fact, we all do something like that in our everyday business activities? Do we trade away certain rights for cash?

      We must, of course, also ask “What is money?” While we know that money is just a means of exchange, today's electronic money has taken on a form that makes it uniquely incorporeal and replicable. In Chapter 7 I tell the strange story of a computer hacker who succeeds in breaking into the accounts of the major banks of a nation. What I want to imagine, however, is not a case of theft. Rather, what would happen if our hacker took nothing at all from anyone's accounts? Suppose that instead, he filled everyone's accounts with large quantities of electronic money. Should we consider him a great philanthropist? So it would seem. Instead, we will find that his largesse is more damaging than if he had stolen in the first place. Nor is this purely imaginary. What I wish to portray is a picture of our modern (IT-based) money supply and inflation. This story also gives some perspective on the latest financial buzzword, “quantitative easing.”

      Let's then touch on the whole issue of distributive justice. Huge profits can be made in lucky (or clever?) financial dealings – so how should these profits, and indeed all our finite resources, be shared among a nation? How do we manage wealth inequalities? This is a very hot issue today post the credit crisis and I want to analyze it via the question of “What is taxation?” However, my focus will not be taxation as it is today, but taxation as it might (perhaps) have been in the lost city of Atlantis. Tracking the political economics of that mythical land may give us some insights into today's polarized debate on taxation policy and wealth re-distribution.

      In Chapter 9 it's time to shift to the darker side and look at finance when it goes wrong. In order to address the question of “What is fraud?” I will tell a true tale of a brazen fraudster who destroyed multiple financial businesses. (The saga is from my own personal experience – though fortunately, I was a mere spectator, not a participant.) What is the nature of a fraudster? Often, we tend to imagine a “normal” individual who has gone astray or fallen on hard times. But there are those who are way beyond that. I'm going to pose the strong possibility that there really are white-collar “psychopaths.” These are people who do stuff that most of us would never do, and they do it consistently. For this select demographic, I question whether any sort of financial regulation will ever provide a foolproof barrier against wrongdoing. In fact too much regulation may make the fraudster's life easier, not harder.

      Which then brings us to the nature of “financial regulation” itself – addressed in Chapter 10. Truth to tell, much of the Western financial world is what I would call “regulated to death.” People might not agree whether this is a good or bad thing, but certainly in the U.S. we have one of the most complex bodies of financial regulation in history. With so many rules, how can we see which rules are effective and which unhelpful? The story I tell in this chapter focuses on one of the last remaining vestiges of a truly unregulated financial environment – the Fine Art market. This is the sole remaining Wild West frontier. In this truly bizarre landscape of financial freedom, I see the upside of an unregulated market but also the dubious practices and double dealing inherent in the business. This is a unique world where anything is possible: pigs fly, there are two moons, and nothing is kosher. We really do need effective market and financial regulation, but is modern financial regulation, with its micro-managing tendencies, undermining its own purpose and efficacy?

      Finally, there is the “end game” in finance, which is at heart another conundrum; “What is bankruptcy?” Here again I will dip into my own financial practice