Conference Presentation, Panel
A Conversation With Financial Innovators
- Mission and Structure: The Milken Center for Financial Markets in Washington, D.C., focuses on four pillars: financial markets education for policymakers and the press; the structural strength of U.S. and emerging markets; access to capital (specifically via the Jobs Act); and applying financial architecture to solve non-financial problems like climate change and health.
- Core Problem Identification: Panelists identified the failure to model and price uncertainty, the decline of personal responsibility, and the misalignment of political incentives as the primary societal issues.
- Wealth Disparity Data: Panelist Mike Milken noted that over 30% of American adults have a net worth under $10,000, and the median net worth in the U.S. is a fraction of that in the UK, Japan, France, and even Greece.
- Human Capital Formula: Milken proposes a three-pronged approach to increasing human capital value: improving the K-12 education system, reforming immigration laws to attract talent, and controlling the cost of life extension/healthcare.
- Regulatory Critique: Lou Sabino argues that the Dodd-Frank Act and subsequent rule changes have made the housing market entirely government-dependent, as regulators refuse to deny consumer demands for low down payments and high leverage, effectively privatizing gains while socializing risks.
- Incentive Structure Proposal: Richard Thaler advocates for pricing externalities (e.g., pollution, carbon) rather than using command-and-control regulations, citing the Acid Rain program's success in reducing emissions by 15 million tons annually while saving $123 billion in medical costs.
- Acid Rain Case Study: The Acid Rain program utilized a cap-and-trade system managed by only 20 staff members, resulting in a 18 million ton reduction in emissions (down to 3 million) and preventing 30,000–40,000 deaths per year.
- Insurance Market Distortion: The panel highlighted that flood insurance is underpriced due to government guarantees; if Hurricane Sandy had hit New York directly, potential losses could have reached $1 trillion, threatening the $550 billion surplus of the direct insurance sector.
- Berkshire Hathaway Withdrawal: Warren Buffett's Berkshire Hathaway has completely exited the catastrophic insurance market due to the inability to price risk correctly in a government-subsidized environment.
- Housing Policy Failure: The U.S. currently faces a shortage of six million workplace affordable housing units, a result of shifting from mandated percentage requirements for medium-income units to "full" medium-income definitions that discourage supply.
- Liquidity Opportunity: Stacey Ward identified March 2014 as a unique convergence of unprecedented liquidity (with triple-C bonds yielding 5.5–6% and issuing at record volumes) and a new generation of wealthy philanthropists seeking to fund social solutions.
- Regulatory Inefficiency: A transmission line project by American Electric Power (AEP) took 17 years to permit and build an 85-mile line from West Virginia to Virginia, whereas China built 2,900 kilometers of gas distribution in 22 months during a similar crisis.
- Jobless Recovery Context: 65% of current U.S. jobs require specialized skills and 85% require semi-skills, creating a mismatch where the U.S. faces a deficit of 73 million jobs it cannot fill, despite technological advancements.
- Disincentive Structures: The current welfare system creates a "benefits cliff" where earning more income results in a net loss of value due to the abrupt removal of childcare and food stamp benefits, discouraging workforce participation.
- Outsourcing Dilemma: Panelists discussed the ethical and economic tension between outsourcing government-guaranteed mortgage servicing (potentially $7 trillion in volume) to reduce costs versus maintaining U.S. jobs for taxpayer-backed assets.
- Global Finance Shift: High-frequency trading is migrating to India and Singapore due to lower labor costs ($12,000–$20,000/year vs. $150,000+ in London), challenging the assumption that financial services are immune to globalization.
- Water Scarcity and Agriculture: Richard Thaler noted that agricultural water usage is often inefficient; vertical farming could use only 10% of the water, while current grain and meat exports represent hidden water exports (e.g., 1,800 gallons per pound of steak).
- Education Literacy Crisis: A financial literacy test administered to U.S. executives yielded an average score of 38%, with 70% unable to define free cash flow and a majority unable to distinguish between profit and cash flow.
- Foreclosure Delays: Foreclosure processes in New York and Florida take two to four years (vs. less than one year in California), correlating directly with slower market recoveries in those states.
- Public Default Perception: 55% of Americans believe it is acceptable to default on a mortgage if they can no longer afford payments, indicating a cultural shift in personal responsibility.
- Legislative Complexity: Richard Thaler criticized the Dodd-Frank Act as 2,300 pages long, noting it is longer than the Bible and the Quran combined, and argued that such complexity allows regulators to rewrite rules post-facto, creating uncertainty.
- Market Creation Persistence: Panelists emphasized that market innovation requires decades of persistence against skepticism; for example, the Black-Scholes model was rejected by journals for three years, and the mortgage securitization market took seven years to pass enabling legislation.
- Rule of Law Warning: Lou Sabino cautioned that modern legislation often lacks the precision of past laws, and without clear, unchangeable rules, future generations will face perpetual reinterpretation and regulatory drift.