captioning made poible by friends of nci the mostasic financial impulse ofll is to save for a rainy day because, as we' been painfully rended by the recent months of financialurmoil, the future is so unpredictable. the world rely can be a dangerous ple. not many of us get throu life withoua little bad luck. some of get a lot. it'all about being in the wng place at the wrong time, like new orleans when hricane katrina hit. the queson is, how should we deal with t risks

and uncertainties of theuture? shld the onus be on the indidual to eure against disaster? should we be able rely on the voluntary charity of our fellow human beings when calamy strikes? should we be able to cou on the state-- inther words, the compulso contributions of our fellow xpayers-- toail us out when the floodomes? [thunder rumbles] that'a long way of asking a sile question. are yoinsured? we brish certainly think we are today pay a larger proportion of our income on insurce than any oer people in the world. it's really rather od cause britain is one of e safest countries on earth. the struggle to ovcome risk has been a conant theme of the history omoney, from the iention of life insurance

by 2ard-drinking scots clergyn to the rise and fall of t welfare state to t explosive growt of hedge funds and tir multi-billionaire owne. at the core ofur struggle with risk is an insoluble conflict. we want to b financially secure, and so we yearn for a edictable world. but the future alwayseems to come up with ne and unpleasantays to take us by surpri. we want calculable rk. we' stuck with random uncertainty. man: 1minutes! [m yell] 15 minut. announcer: funding for "t ascent of money" s provided by... man, voicever: my idea will bring rewable energy to everyone

announcer: an entrepneur with an idea can chge the world. i have an ea. kafman: the foundation of erepreneurship. because understanding e connections of a complex global econom is impornt to us all. t. rowe price: invest wh confidence. and by.. [men yelng] n: 15 minutes. ferguson: when hricane katrina hit new orans in the last week of augt 2005,

it caused deh and destruction. yet, it's t a natural catastrophe that now threatens the survival of the city. the real lesson of the disasr is about money, w the risk management system we call insurance simply failed when fac with a calamity on this ale. the hurricane did't hit new orleans dictly. the main force of the stor passed tthe northeast of the cit but just as the residents breathed a sigh of relief, the real catastrophe ban. this industrial canal nks lake pontchartrain to the mississippi, d after the hurricane, the hu storm surge raed the water level in theanal so high that it broke the lee, pouring umpteen llons of the lake over he into the ninth wd of new orleans.

just to the east of the ninth ward ist. bernard, a blueollar community of homeoers, al-on paper, at least-- cored by private insurance. councilor joey difta resed advice to leave the cy, staying put dung the storm. entually he was forced toetreat to the roof of theown hall as the waters ke rising. ...complex, and asou can see, this is the water line.. that's the water li. that's where it camup to. thwater came in this buildi, and feet of water in 15 minus. wow. from theecond floor of this builng, i could see, comi down judge perez, a wall owater. that wall of water was bris-- cars, vehies, pieces of roofs--

and this wall of wer,-- you know, you guesimate-- had to be maybe 15 to 20 et tall. and moving fast. moving quickly. just coming wn this boulevard street and just taking erything with it as it wod come. e whole of st. bernard pish was inunted in just 15 minutes. only 5 houseout of 26,000 weren'flooded. more tha2,000 people were killedn hurricane katrina and the suequent flooding. here in st. bernard parish 148 ople lost their lives, mostly because they became trapped in their houses as the flood waters rose the painted signs on these abandoned houses say whether deadodies were found after the fld waters receded, little bit like medieval ndon in the time of plagu yet, 3 years later, 's not flooding or plag

that's killing new orans. a harsh financl reality has emerged. people can't live here anymore becausthey can't insure thr homes. one man made it his missn tohow the limits of privatensurance when it cos to a really big crisis he's foer navy pilot richard f.cruggs, one of those lawyers that on america seems to produce dickie scrgs took $50 million off the asbestos industr then $248 billion off tobacco companies for failinto warn smokers of the dger of lung cancer. this kind work has its rewards. scruggs' share in fees on the tobco case was $1.4 billion

ruggs' latest target haseen america's insurae companies. his clies, hundreds of homeowners whe houses were destroyed katrina, arguedhat the companies were rusing to pay up on genuine claims, a viewhe insurers disputed. there was a hoe there? there was a house re and a house next to it where you see the trailer. scruggs had a dog of hiswn in this fight. his own home on scagoula's beach boevard here on the mississii coast was soadly damaged by katrina that it had to be demolied. this is the... the front or? this is the ont door right here, the edgef the slab, if you will. yowere slabbed... we were slabbed. if you could fix the stem... but i have the mns-- i'm fortunate engh that i have the means ...

to lose a house and ild it. ...to lo a house and build it bac most peoe here don't. if you had the power change the system so that people reallyere insured, how would yodo that? is there aay of making insurance wo again? the is, and it's discsure of what you're bing, so thayou know-- like a drug. the's a black box warng on there. "this is what it doe this iwhat you should watch outor." as opposed to this devic which is called the modern insurance policy, which no one can interpret or understand. it seemed as if e insurance companies had en well and truly scrugg. one of america's biggest insurers settled hundre of cases brought by scrgs on balf of clients whose clai had been turned down. but in this tter high-stakes battle,

the insurance mpanies had the last lau. after winning thcase, scruggs was convted d sentenced to 5 yrs for attempti to bribe a judge d influence the distribution of legal fees. and the big insurance coanies responded to the weight of post-katrina claims by in effect declari parts of the gulf coast a -home-insurance zone. today, as councilor jo difatta has found out, insuring a house this part of new orles is virtually impsible. they ca't get a mortgage, eier. that is coect. they have to make a oice. do i build aouse here, or do i reloca to anoer area ere insurance may be a lile bit cheaper and i can ford it? so that is hurting our mmunity. it's taking our ople away-- the nucleus of this pari-- and pulling them away. three years ter disaster struck,

stbernard parish has only 1 of its pre-krina population. [thuer rumbles] of course, life has alys been dangerous. the real lesson of katna or any big disaster is that even when think we're protect against risk, sometimes it turns out we're not. even making quite mode insurance claims can seem more trble than it's worth. it leaves you wonderg why we bother spendingo much on insurance polies every year. where did th strange habit come from? sang up for the proverbialainy day is the first principle ofnsurance, but the trick isnowing what to do with yr savings, so that, unke in new orleans after trina, they're there in thkitty when you really ne them. but too that, you need to be me than usually canny, and that gives u a valuable clue

to where the history ofodern insurance has its igins. where se but in bonny, canny scland? [bells ching] they s the scots are a pessimisc people. mae it's the weather, l those hundreds of rainyays. maybe it's the endless years of srting disappointnt. or may it was the calvinism weicked up at the te of the reformation. certainly, it's 2 church of scotland ministe who serve the credit for inventing the first true insurance fund back in 174 and fathing a multi-billion-pounindustry. the cotyard of greyfriars is best knn for the grave robbers, the resuection men who came here

in the late 18 century toupply the medical school edinburgh university with corpses for dsection. but greyfriars' lasting importance comes from the work of the ministe here, robert wallace, d his friend, alexander bster. it's somehow apprriate that it was scotti ministers who invented modern insurce. after all, we tend to thi of them as t embodiment of prudence d thrift weighed down with an ancipation of impending divine retribion for every tiny transession. but in ft, robert wallace was a rd drinker as well as a mathematal prodigy who liked nothing bett than knocking back maums of claret withis bibulous buddies. wallace and webster were unhappy at the way the widows and children their fellow clergymen we treated when the grim reer struck.

they often found themsves homeless and pennile. the planallace andebster came up with was ienious-- the rst true insurance fund history. ese are some of the volumous calculations that robert wallace d, now housed at the national archives of scotland, and you can see how he ran the numbers over a over again, making very careful assumptis about the maximum numb of widows and orphans th would have to be provid for. the key point, however was that from now on, ministers wodn't just pay moneyn that would be paid out wh one of their number died. rather, they would pay premiums that would bused to create a fund, d the fund would then be vested for profitable purses. the wiws and orphans henceforthould be paid t of the returns on that ney, leavg the premiums to accumule.

all th was required for the scme to work was an accurate prection of how many widowsnd orphans there wod likely be in the futur a lculation which wallace d webster made with extraordina precision. the creaon of the scottish minists widows fund was a mistone in financial histo, for it provided a mode not just for scottish clgymen but for everyone who aired to provide for life's eventualitie by 1815,he principle of insurance was sufficiently widesprd to be adopd for the widows of men who lost their lives fighting against napoleon. at the battle of watloo, your chances of gettg killed werep to 1 in 4, but at least if you'd taken out insurance, you had the consolion of knowing that your wife and children wouldn't be thrown ou onto the street. give a whole new mning to the phrase, "takeover."

the scottish ministe fund grew into theorld-famous scottish wids. even novelists, not rewned for their financial udence, could join. walter stt took out a policy in 16 to reassure hicreditors that they'd beaid in the event of his ath. by t mid-19th century, being sured was as mh a badge of respectabily as going to chur on sunday. what no one antipated back in 1744 was at the careful calculatio of 2 scottish ministers woulgrow into today's hu insurance industry.

as robert wallace undersod 250 years ago, size matters in surance, because the more peopl are paying into a fund, the easier it become by the law of averages, to predict how much ll have to be paid out eh year. although nindividual's date odeath can be known in advce, actuies can calculate the lily life expectancy of a large group of iividuals with quite astonishing ecision. in other words surance is all about tryi to cope with the risks of t future, if, that is, you're insured in the firstlace. no matter how many priva funds like scottish widows wereet up, the were always going to bpeople beyond the reach insurance who were either too poor too feckless to savfor that rainy day.

the t of the poor was once aretty harsh one-- eier dependence on privateharity or the harsh regime the workhouse, like this typically auste one here the heart of edinburgh. yet, by the 80s, people began to feel that life's losers somehow deserved better. the se was planted of an entirely n approach to risk, a seed that would ultimately sprout into t modern welfare state. thistate system of insurance was designed to exploit the ultimate economy of sce by covering literall every citizen fr the cradle to the grave yet, whi we tend to think of theelfare state as british invention, fact, the world's firs welfare superpower was jan.

disaster just kept striki japan in the first hf of the 20th century. in 1923, a ge earthquake devastated tokyo. as in neorleans, many private insurance picies turned out to be wth little more than the pap they were printed on. a new ea began to emerge in jap-- that the state shouldake care of risk but this was to bstate protection allied with imperial ambitn. the japanese set up a welfare state... ...and they d it to promote warfare. it was the mid-20th ceury state's insatiab appetite

foable-bodied young soldie and workers, not some kind of beding heart altruism, that inspired the ri of welfare. state healcare would ensure a fitt populace and a steady supply of ae-bodied recruits the emperor's armed foes and deliver hian empire. the wartime slan "all people are soldiers" was adapted become "all people should havinsurance." thonly problem was that jap had gone to war with the world's economic colossus, the united states.

japan's warfare statproved to be a massive miake. quite apart from the neay 3 million lives lost in japan's doom bid for empire, by945, the value of japan's entire capital stock seemedo have been reduced to zo by american bombers. ties built largely out ofood were incinerated. near 1/3 of the urban populatn lost their hom. practically the only city to survive intact was kyoto, the formermperial capital. 19 may have seen the end ofhe japanese warfare state, but it wasn't the en of the japanese experime

with state-sponsored welfare in jap, as in most competent cotries, the lesson was cle. the world was just too dangerous a place for private insurance markets to cope with. but with the bt will in the world, people couldn't be expted to insure themselves agnst the u.s. air force. the answer praccally everywhere was the me-- for government to st in, in effect, to nationalizeisk. perhaps e most familiar system owelfare from theradle to the grave also born in t ruins of war was devised by t british economist william bevedge. when the japanese came up wi thr own comprehensive welfe system in october 1947, their adviry committee on social serity recommended what amounted to beveridgi no nihon-ban- beveridge r the japanese. and yet, they we even further than beverge had intended,

as this copy of their report here in theibrary of the japanese naonal parliament makes clear. it called on the government to provide against ery cause of poverty. sicknessnd injury, disability, deh, childbirth, large famies, old age and unemployment. whatever the rean, the needy would be guanteed the mimum standard of living byational assistance. [monks cnting] from now on, the panese would no longer ha to rely on the benevolence of aeudal lord or the lk of the gods. the welfare ste would cover them against all the vagaes and vicissitudes of the modern world. if they couldn't afrd education, the ste would pay. if they couldn'find work, the state woulpay. they were too ill to work, the state would pay.

when they rered, the state would pay. and when they finally ed, the state uld pay their dependents so what happened after the war in japan was merely the extension of the warfare welfare sta. the slogan now became "all peopl should have pensions." the japanese welfaretate seemed to be miracle of effectiveness in public health a education, japan led thworld. by the lat1970s, the japanese couldoast that their country had bome the welfe superpower. n like this, the welfare state seemed to make so much sens japan had achied security for all, e elimination of risk,

while athe same time growing so ridly that by 1968, it had the second largest economy in the world. one u.s.conomist even predicted that japan'per capita income would overta america's by t year 2000. weare was working where waare had failed to make japan top naon. the key turnedut to be not a foreign emre bua domestic safety net. and yet, there was a cat, a fatal flaw in the design of the poswar welfare state. just wt was it that caused thospredictions of jan's ultimate triumph to fail to come true? the welfare statlooked to be working smooly enough in970s japan, but elsewhere there we signs that all was not wl. in britain a throughout the western world,

e welfare state, it seeme had removed the incentives without which a catalist economy simply cant function-- the carrotf serious money for thoswho strive, the stick hardship for those who e idle. the relt was stagflation-- low owth and high inflation. what was to be done? one man d his pupils thought theynew the answer. thanks in large measur to their influence, e of the great economic tnds the past 25 years has been for the wfare state to be dismantl, retroducing people with a srp shock to the unprectable monster they thought they h escaped from... risk.

in 1976, a diminutivprofessor called milton iedman woing here at the universitof chicago won the nobel prize in economics. milton friedman wohis place in the economihall of fame byestating this simple equaon... ...where "m" is t money supply, "v" is t velocity at which it ciulates, "p" is the pce level and "q" is the quanty of expenditures. friean's observation wasimple-- if the money supply we up, then so did the priclevel, hence the quantity tory of money. but you needed much more an a piece of chalk and blackboard to answer the second crucial question of milton friedman's career. at had gone wrong with t welfare state? in chile, he found thperfect laboratory

to test his eories. in september 197 tanks harolled through santiago to overthrow the government of chile'marxist president, salvadore allende, whose attempt tourn the country into a communi state had ded in total economic chaos d a call by the chilean rliament for a militaryoup. up there othe balcony of the carrera hot, oppones of the allende regime cebrated with champagne asir force jets flew oveead to bomb the moneda pace.

here in thpalace, allende prepar to make a desperate lasttand armed with an ak-47 presented to him by his cuban re model, fidel castro. looking out the palace wdow anseeing the tanks literallrolling in, allende reized that it was all over for hidream of a marxist chile cornered here in what waleft of the presidential arters, he took thdecision to shoot himself [march pying] 35 years lat, you n still see the bullet hes in se of the buildings around the sare. [man speaking ilean] what happened here ineptember 1973

in many ways epitozed a worldwide crisis ofhe welfare state and posed a stark choice between ternative economic syste. with output collapsi and inflation rampant, chile's syem of universal benefits was effectively bankrupt. for lende, the only solution was fulllown soviet-style takeov of the entire economy. well, thgenerals and their supporrs knew that they didn'want that, but what did they actual want given thathe status quo was unsustnable? enter milton friedman. in march 1975,riedman flew from chicagoo chile to answer that queion. [man speakg chilean] [march playing] in addition to givg lectures and seminars, friedman came here the moneda palace for a meeting with the nechilean president, generaaugusto pinochet.

friedmanpent 3/4 of an hour with pinochet, urging him to duce the government defic that 'd identified as the mn cause chile's sky-high inflation, then running at an annual rate of 900%. a month aftefriedman's visit, the chilean junta annound that inflation would betopped any cost. the reme cut government spendinby 27%. this problem oinflation is not of rece origin. it arises from trend towards sociism that started 40 years ago and reached their local and terrible climax in the allende regime. for tendering this adve,

friedman found hself denounced for actings a consultant to a milary dictator responsible r the executions of more than,000 real and suspted communists and the torture nearly 30,000 more. chicago's role in chi's new regime consisted of more than st a visit by milton friedma since the 1950 there had been a steadytream of bright yog economists going from ts place, the tholic university in sanago, to study in chago, anthey'come back convinced of t need to balance the budg, tighten the money suly, and liberalize trade the were the chicago boys, iedman's foot soldiers, d yet the most radical ofheir ideas went beyond what fedman had remmended to pinochet.

it aunted to a full-scale rolng back of the welfare state. the coervative economic revolutn didn't begin in thaher's britain or rean's america, it began right here in cle. the mastmind behind this wholesaldismantling of the welfare state was a youneconomist called jose piñe. chile's economy wadestroyed. we have had 50 years of protectionism, state intervention, and me light socialism, if yowant, and thenhat was exacerbated duri the allende government. we had created a sort owelfare ste, and that, course, was going bankru in chile. between 1979nd 1981, piñera and his colleagues erected a radically new pension system for chile, givingvery worker the ance to opt out of the old pay-as-you-go state system

stead of a payroll tax, eachorker now could put 10% his wages aside into an individualersonal retirement accou toe managed by private comping companies. there s also a small premium for disability d life insurance. thidea was to give each worr a sense that the money being put asi was his own property, his own capital. [man singing native language] piñera gambled. he gave workers a choice. stick with the old system of pay-as-you-go or opt for the new persona retirement accounts. it paioff. convince by piñera's argument, 80% made thewitch to a priva pension plan. buwas it worth it? was it worth e huge moral compromise

that t chicago boys and the haard man made when they got in bed th a torturing, murderoudictatorship? well, the swer to that question very much dends on whether you think eir reforms helped pave a peaceful w back to a susinable democracy in chile and i think th did. in 1980, pinochet conced a new constitution th prescribed a 10-year trsition back to democracy. 10 years later, stepped down as preside. democracy was restored anby that time, the economic miracle was underway th helped to ensure its suival. for the nsion reform not only created a new class of property owners, each with his owretirement nest egg, it also gave t chilean economy a massivshot in the arm.

these brokers at the banco de chile are vesting chilean workers' pension contributions into the stock market, and they' been doing a pretty goojob of it. average returnon the personal retiremenaccounts has been over %, reflecting the ft that in the 20 years aer 1987, the ilean stock market has go up by a factor 18. of course, the chilean marts, like all stock marke, has taken a dive the last 2 years. and that's not the only down side to the system. since not everyone in the economy haa fulltime job, not everyone ends up participating in the system. which lees a substantial chunk ofhe population with no nsion coverage at all. i'm standing in ont of the communist partheadquarters

here in la victoria, suburb of santiago which was once of the hoeds of opposition to the pinochet reme. because most people re are either unemployed or work in the inforl sector, they don't can't pay into the nsion system, which means they do't get anything out oit. this is the kindf neighborhood where che evara is sll the local hero, not jo piñera. the poor of chile may nohave a private pension pl and may have to make do th a meager government handout in their old age, but even they have benefited fr chile's rapidly gring economy. growth makes a differee in the life of every cizen. the poverty rate in ile has gone down from aund 50% to 13% now, so this has been, rely, a huge success and the pension reformas been a critical eleme in this.

the improvement chile's econic performance since the chicago boys' reforms is very hard targue with. in the 15 yearbefore milton friedman's visit, the growth rate he was a measly .17% a year in the subsequen15 years, it increased ba factor of nearly 20. the poverty rate here down to 15% compar with 40% in the rest ofatin america. and en you look down at santio's shiny new financl district, you can see why thchilean pension reform habeen imitated right across the region and indeed around the worl for brita's margaret thatcher, the general fromhile and the professor fr chicago were heroes who'd monstrated that only by rolling back the welfare state could vernments revive economigrowth. yet one country where is recipe has not been trd is the coury that's come to ne it most.

japan. so successfuwas the japanese welfare perpower that by the 1970s, life expectancy was the longest in the world the problem was th japan's welfare stat was too successful. toy, the programs run here japan's ministry of weare rely on ever-smaller number of aive workers to support an everising population of reties. ba in 1960, there was someing like 11 active workers for every one retired rson. but by 2025, that number uld sink as low as 2. in other words, there wille one old-age pensioner foevery 2 bureaucrats workg here at the ministry. in just 30 years, e cost of social securityenefits

has risen in relation to japan's national ince by a factor of 4. toy, virtually all japan' health insurance societi arin deficit, and the pension nds are nearly out of money, too. jan's once-so-super weare state is threatening to barupt the nation. insurae--it seemed such a brillnt idea in the calculations those scottish ministers aneven more brilliant in jan's all-encompassing welfarstate. but as we've see the best laid schemes n be thrown into disarray by an unexpected turn of eves. so is there any better way of managing risk in an uncertain world? disasters like 9/1and katrina exposed the mits ofoth traditional insurance and the welfare state.

but insurance anwelfare aren't the ly ways to buy youelf protection against fure shocks. these da, the smart way of doingt is by ing hedged. now, everybody's heard of hedge funds, but what exactly ds hedging mean and where did it ce from? to most ofs, hedge funds are a mysty. but the one thing weo know is thathey can make you stupenusly rich. one hugelyuccessful hedge fund maner paid $60 million for is cezanne and hewns this degas, too. not to mention jasper johns he paid $8million for. h's also given hundreds of millions of dollars to chaty. ken iffin is the founder of e citadel investment group,

one of the wld's biggest hedge nds. last year, he navigated his way through the cred crunch so successfull that he was able to pay mself more than a billiodollars. to mt of us, risk is scary. but all of griff's vast wealth has me because he's found a wa of managing risk with a mixture of mathetical precision d brilliant intuition. it comes down having to make a judgme call. and good risk managers d good risk takers are individuals th have a history of ming good judgment calls pricing assets or contracts derivatives in the face uncertainty. and is that judgme, when you make it, somethg that is 99% mathematic algebra and 1% intuition? ors the intuition element, e unquantifiable element, bigger than that? so what i find is thateople who are really gooat this have great intuition, they have great instinct.

their gut acally tells them something the mathematics are importt because they demonstrate you understand the problem. but ultimately, the decisi about whether or not take a given risk i think is rlly a human judgment cal in every sense of e word. the origs of hedging, appropriaty enough, are agricultural. for a farmer, nothin is more important than the fure price of his crop after it's been harvest and brought to market. but that could be higher or much lower than he expes. a futures contract allows m to protect himself byommitting a merchant to b the crop en it's brought to marke at a price agreed en the seeds are being plted. the farmer gets a floobelow which the pre can't sink, the merchant gets a ceiling above which it can't se. by signing a futures ctract, both the farmer anthe merchant

have hedged their bets both parties are bter off, and because of tt, the world as a whole is mh better off. it encourages capitaformation, it encourages vestment, it encourages people to do what is needed to be done toake the world a better pce. with the developmentf a standardized futuresontract, agreed rulesand an effective clearingouse, the first true futures market was born. and its bihplace was here in the wdy city-- chicago. aftethe city's futures change was established in874, hedging coodities became standard practice. the next step wafor a conditional kind ofuture to evolve--the option.

some of thiseally is the financial eqvalent of rocket sciee, but the underlyingrinciple is simple. because they'reerived from underlying aets, all futures coracts are known as derivives. but an even smter kind of derivative ian option. the buyeof coal option as the rightsay, to buy a barrel of l for $120 in a year'time. now, if the price of oil rises to $150 a barrel, en the option is in the ney, and a smart guy kes a profit of $30. t if that doesn't happen if the price of oil stays the same or aually declines, h's under no obligation to carry through the deal. all he does is to write of the cost of the option ielf. we, it's by buying anselling complex, smart derivaves like options that ken griffin has beme a billionaire. [overlapping chaer]

in theory,erivatives offered a new y to hed against an uncertain fute. a much smarter way an boring old insurance and much me profitable. hedging also ushered i a new phase in the ascent of mon by speeding up the process of financial globalization and th the arrival of the hed fund came a new kin of economic hit man. the grandmaster ofhe new hedge fund industr was gege soros. [indistinct atter] sorobrought to global finance a brand-new theo of economic behavior that undlined the fallibility ofuman nature and the instability financial markets. yo actions, you have uninteed consequences,

so theutcome will not correspon to your expectations. and thats the way human affairs gerally work. according to soros' theory of reflivity, financial maets can't possibly beerfectly efficient, much ls rational, for the simple rean that prices are just threflection of the ignorance anthe biases, mostly completelirrational, of millions investors. in sos' eyes, markets arbound to go through cyclesf boom and bust as surelas the human temperament is prone to boutof euphoria and despondey. soros' quantum fd had made millions from srt selling, a type of dealing which boows stocks or currencies and sells them for futu delivery on the calcution that they'll gdown in value.

his biggest cos came from being right out losers, not winners, and the greatest of the was amg the most momentous specative hits all financial history on stember the 16th, 1992, wi the british pound in bigrouble, i watched as sos put out a contra on the bank of england. became convinced that spelators like soros re bound to win if it ca to a straight showdown withhe british government. it was a matter of sple arithmetic. a trillion dolla of currency traded everyay on foreign exchange rkets againsthe meager hard currency serves of the u.k. treasu. at that time, the itish pound was tightly nked to the german mark through the e.r.m., the europe exchange rate mechanism.

as german interest rates rose in the wake of that country's gely expensive reunification britain's ratead to rise, too, hurting homeowners and busisses. ros calculated that the itish chancellor norman lamo would be fced to withdraw from the.r.m. d devalue the pound. it was the biggestet of soros' life. so sure was that the pound would dro that he bet $10 billion. more than the entireapital of his fund. the risk-reward was sproportionate, and therefor it seems like a good spulation or investment, if y like, in shorting the pound. i was equally nvinced that srling would have to be dalued, though all i h to bet was credibility. that ening, headed to the opera to seeerdi's "the force odestiny."

it proved exceedgly appropriate. at the interval, they annound that chancellor norman lamont had appeared in there, in the treasury courtyard, to say that britain wawithdrawing from the e.r.m. howe all cheered. today has been extremely difficult and turbulent y. massive speculive flows have connued to disrupt the functioning the exchange rate mechanism soros made a blion dollars that day. and that was only 40% ofis fund's annual profits do you feel or did you fl a sense of triumph en your prophesy came true and the bet paid off hugely? of course. it s like when you're bting and you win, narally, you have that satfaction

analso the profit. in the past deca, the trade in derivativ by hed funds like soros' s seemed to take over the world of finance by the end of 2007 the notional value of allerivatives contracts reached a aggering $596 trillion. that's 43 tim the size of the americaeconomy. there artremendous economic benefs for people that work he. $20 billion the hands of a thousand ople really a 21st-century phenomena. this never happened50 years ago. yet as manhave discovered to theirreat cost recently, the are downsides to hedgi, too. whenillionaire investor warr buffet described derivatives as "financial weapons mass destruction," he all but pphesied the downfall

of american insurance giant aig, whose european headquarter are there behind me, brought low, not by sellg insurance policies, but by selling derivates that blew up in its fa. our basic human ge to protect ourselves against risk has proved frustrangly difficult to satisfy insurance companie let us down. welfare stes sink into insolvency. and derivaves turn out to a double-edge weapon, to [gunshot and for many families, proving for the future now takes one ry simple form-- an investmt in a house, the value which is supposed to keegoing up until the day the eadwinners need to retire

if the penon plan falls short, nev mind. there's alys home sweet home. encouraging home ownship may well create a potical constituency for catalism, but it alsdistorts the capital mark by persuading ople to bet the house on, well, the use. people need to borrow mone of course, to sta up businesses or to buy pensive assets, but it sms dangerous to lure themnto staking everything on the farrom-risk-free property mket. om buckinghamshire to bolivi to bonny scotland, the key is to strike the right balance between debtnd income. next time on "thescent of money," i'll be showing how the tire world economy manad to get that balance pelously wrong.

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