New Philanthropy & Financial Engineering
Michael Savage introduced on the New Philanthropy: Philanthropy has become a talking point. Vast fortunes have been made recently, and philanthropists like Bill Gates are giving on a huge scale. What is the new philanthropy and what could we say about it? The new philanthropy is amorphous. Debates about it are often vague and there is no agreed definition. But we can make sense of some overlapping ideas. Celebrity philanthropists are raising awareness, billionaires are demanding more bang for their philanthropic buck and social entrepreneurs like George Soros are engaged in political interventions.
There are several distinct features of the new philanthropy. Old-fashioned philanthropists often left fortunes in their wills, and gave money for others to spend. Today many philanthropists are giving earlier and maintaining involvement in how their money is spent. There was some discussion of the extent to which philanthropists are uncomfortable with being capitalists. Whilst there is celebration of capitalist giving, it was noted that entrepreneurship rather than capitalism is being celebrated.
We discussed political points to draw from the philanthropy discussion. Whilst it intersects with many issues, it is difficult to discuss directly because it is so amorphous. However, the undemocratic character of rejecting popular/political action in favour of rich people doing the right thing was noted.
Meanwhile, Stuart Simpson introduced on Financial Engineering, focusing on three key areas.
Risk: The trading of risk in financial markets must first be understood as a method of allocating capital. The term ‘risk’ has a specific meaning in the context of financial markets that is not directly transferable a wider social discussion of risk. Many functions performed by trading risk through the use of derivative products free up capital for other uses. The purchase of a commodity futures contract may reduce the requirement for a firm to hold large stocks of a commodity to protect against the volatility of commodities markets. Many of the largest derivative markets exist due to the withdrawal by the state from managing these risks directly, such as the ForEx markets. However, many states still significantly control the value of the domestic currency. The Chinese state, through controlling the value of RMB, removes the requirement for individual firms to manage their own foreign exchange risk through the financial markets or otherwise.
Financialisation: The use of financial products by non-financial firms is not sufficient evidence of a move towards increased financialisation. The purchase of financial products on the part of non-financial firms is often evidence of hedging activity, whereby non-financial firms limit their exposure to volatile financial markets in order to focus on the core business of the firm. Legal precedent makes it extremely unlikely that treasury departments of non-financial companies or public bodies such as councils are able to engage in speculative activity. Contracts that do not conform to strict definitions of a hedge – involving an underlying position that results in the net position that cancels out speculation – may be declared ultra vires, resulting in a lose-lose situation for any counterparty to the transaction. A specific point was raised regarding the profits made by car firms through financing the purchase of their own products. This type of activity is best understood as a pricing/sales policy on the part of car firms. Any profits made through financing are ultimately derived from the production of the product financed. It is not clear to what extent non-financial firms are involved in markets for more recent credit products.
Credit derivative products: Recent developments in credit derivative products are a significant departure from more traditional derivatives markets, although some important common features are shared. ‘Default is not a probabilistic event, a coin toss, it is a business decision.’ (Paul Wilmott). The use of mathematical models to construct default probabilities was identified as significantly different from the construction of more traditional models, such as Black-Scholes option pricing. The existence of an asset price bubble was regarded as a more significant feature leading to the acceptance of such models, than complex mathematics. The models allowed banks to make a profit. Credit derivative products can be understood as a method of increasing leverage and taking on more risk during an asset bubble. Credit derivative products allowed banks to lend increasing amounts supported by relatively decreasing capital reserve – they were a method of gaming capital adequacy regulations. In addition, US banks were able to use credit derivative products to circumvent the spirit of the depression era Glass-Steagal act, which was subsequently repealed after the fact. Hyman Minsky was recommended as a useful starting point in understanding the development of a asset bubble in the context of a complex financial system.