Healthy Finance and Healthy LivingChallenges and Solutions

Didier SORNETTE

ETH ZurichDepartment of Management, Technology and Economics, Switzerland

Member of the Swiss Finance Institute

co-founder of the Competence Center for Coping with Crises in Socio-Economic Systems, ETH Zurich (www.ccss.ethz.ch)

Professor of Physics associated with the Department of Physics (D-PHYS), ETH Zurich

Professor of Geophysics associated with the Department of Earth Sciences (D-ERWD), ETH Zurichwww.er.ethz.ch

IMMENSE PROGRESS and INNOVATIONFINANCIAL SYSTEM

Financial innovations have fosteredthe use of capital for •economic development, •welfare, •education...

FOOD AND HEALTHCARE•Decrease of newborn and infantmortality•Height as a proxy for health

Unicef data

1800 2000Baten (2006)

Height

IMMENSE PROGRESS and INNOVATIONFINANCIAL SYSTEM

Financial innovations have fosteredthe use of capital for economic development, welfare, education...

Vaupel (2010)

Malthusiangrowth

FOOD AND HEALTHCAREIncrease of longevity... and inequality

Height differences

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Loss of “Fiduciary Principle”ʻno man can serve two mastersʼ(J. Bogle, former CEO Vanguard group, JPM 2009)

“Legal relationship of confidence or trust between two parties”

The issue of “moral relativism”

Moral hazard

Incentives

Loss of “Hippocratic oath”ʻnil nocereʼ

Fundamental conflict of interest to keep us “marginally ill”

Maximizing share-holder value

Rational focus on short-term in the presence of large risks and uncertainties

CONFLICTS OF INTERESTS

FINANCIAL SYSTEM FOOD AND HEALTHCARE

Michael Mandel

http://www.businessweek.com/the_thread/economicsunbound/archives/2009/03/a_bad_decade_fo.html

Financial investments accounted for >1/3 of corporate profits

The uneasy link between industry and education.Jim GilesNature 450 (7169)457-584 (2007)

Drug firms accused of biasing doctors' training

Qualitative theorem:In the presence of competition and regulations in complex and uncertain environments, optimizing agents will almost always find the optimal on the (fuzzy) boundaries...

leading progressively to excesses, such as creative accounting, moral hazard, conflict of interests, etc...

Y. Malevergne and D. Sornette, How to be moral at the edge of legality, Financial Times, op-ed, Monday March 31, 2008, p. 6.

System justification theoryPeople tend to justify the existing social order. Members

of disadvantaged groups internalize inferiority and manifest an implicit ingroup favoritism.

to enhance self-esteemto obtain a sense of stability and certaintyfeeling of safetyfacilitate formation of relationships...

Jost, J. T., Banaji, M. R. and Nosek, B. A. (2004), A Decade of System Justification Theory: Accumulated Evidence of Conscious and Unconscious Bolstering of the Status Quo. Political Psychology, 25: 881-919

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HUMAN INTRINSIC WEAKNESSES

The ScientistVolume 20 | Issue 2 | Page 51

People simply fail to do what is best even for themselves, in the face of good, freely available information.

People overeat, overindulge in alcohol, and refuse to wear seat-belts or bicycle helmets. Informed by their doctors that antibiotics will do nothing for a viral infection, people demand them anyway, and knowing the larger dangers involved, physicians still prescribe them.

United States Share of wages and of private consumption in Gross Domestic Product (GDP)Source of data and graphics: http://hussonet.free.fr/toxicap.xls

Rate of profit and rate of accumulation: The United States + European Union + Japan

* Rate of accumulation = rate of growth rate of the net volume of capital * Rate of profit = profit/capital (base: 100 in 2000)

Sources and data of the graphs: http://hussonet.free.fr/toxicap.xls

Thee gap widens between the share of wages and the share of consumption (gray zones), so as to compensate for the d i f f e r e n c e b e t w e e n p r o f i t a n d accumulation. FINANCE allows increasing debt and virtual wealth growh... which can only be transitory (even if very long).

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rate of profit

savings

consumption

wages

The illusionary “PERPETUAL MONEY MACHINE”

transfer of wealth from populations(young debtors buying housesto financial assets (older sellers)(Spencer Dale, Chief economistBank of England

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Over the past decade and a half, (B - F) has been closely correlated with realized capital gains on the sale of homes. B-F=change in h o m e e q u i t y d e b t o u t s t a n d i n g l e s s unscheduled repayment on RMDO

Alan Greenspan and James Kennedy (Nov. 2005)

Mortgage Equity Withdrawalimpact on GDP

source: John Mauldin (April 09)

Wealth Extraction

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• An economy which grows at 2 or 3 per cent cannot provide a universal profit of 15 per cent, as some managers of equities claim and many investors dream of.

• Financial assets represent the right to a share of the surplus value that is produced. As long as this right is not exercised, it remains virtual. But as soon as anyone exercises it, they discover that it is subject to the law of value, which means, quite simply, that you cannot distribute more real wealth than is produced.

From 1982 until 2007, the U.S. only experienced two shallow recessions that each lasted just 8 months. This stretch of 25 years may be the best 25 years in the US economic history. But much of this prosperity was bought with debt, as the ratio of debt to GDP rose from $1.60 to $3.50 for each $1.00 of GDP.

The illusionary “PERPETUAL MONEY MACHINE”

HUMAN INTRINSIC WEAKNESSES

The ScientistVolume 20 | Issue 2 | Page 51

FINANCIAL SYSTEM

The illusionary quest of society-at-large, pensions funds, mutual funds... to gain more than 2% return in real terms (above inflation)

The “gambling society” (stardom culture, emphasis on “luck”) vs work and risk management

FOOD AND HEALTHCARE

The illusionary syndrome for “blue pills and red pills”...

Principle of least effort (Zipf, 1949)

Principle of immediate or short-term gratification (large “discount rate”)

People simply fail to do what is best even for themselves, in the face of good, freely available information.

The root cause of the crisisis our illusion on financialsolution to growth (high returns, above GDP growth)

The root cause of the cominghealthcare crisis is our illusionin technical / medical solutions.

HUMAN INTRINSIC WEAKNESSES

The ScientistVolume 20 | Issue 2 | Page 51

FOOD AND HEALTHCARE•The food industry exploits our weakness (addictive and/or compensatory nature of some foods). •The pharmaceutical industry exploits our illusions for simple solutions to health problems.

Fundamental failure to grasp the SYSTEM nature of the problems:Instead, one problem => one proximate solution: THIS IS WRONG!

FINANCIAL SYSTEM•Bankers are sellers of dreams.•Bankers exploit our illusions and cognitive limitations... like casinos and lotteries...

Tversky, Amos and Craig R. Fox, “Weighing Risk and Uncertainty”, Psychological Review, CXLIX (1995), 269-83.

D-MTEC Chair of Entrepreneurial Risks

Prof. Dr. Didier Sornette www.er.ethz.ch

Most crises are ENDOGENOUSImmune system -external viral or bacterial attack - “ internal” (dis-)organization

Brain (learning) -external inputs -internal self-organization and reinforcements (role of sleep)

Aviation industry recession -September 11, 2001 -structural endogenous problems

Volatility bursts in financial time series -external shock -cumulative effect of “small” news

Parturition -mother/foetus triggered? -mother-foetus complex?

Commercial success and sales -Ads -epidemic network

Financial crashes -external shock -self-organized instability

Cancinogenesis -gene mutations (somatic mutation theory) -anomalous communications between cells and proliferation of cells is the normal state (tissue organization field theory) (Sonnenschein-Soto)

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Hong-Kong

Red line is 13.8% per year: but the market is never following the average growth; it is either super-exponentially accelerating or crashing

Patterns of price trajectory during 0.5-1 year before each peak: Log-periodic power law

Textbook example of a series of super-exponential acceleration followed by crashes

Arrows show peaks followed bycorrections of more than 15% in less than three weeks

Positive feedbacks

Our proposition: Faster than exponential transient unsustainable growth of price

What is a financial bubble?

Malthusiangrowth

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Mechanisms for positive feedbacks in the stock market

• Technical and rational mechanisms 1. Option hedging2. Insurance portfolio strategies3. Trend following investment strategies4. Asymmetric information on hedging strategies

• Behavioral mechanisms: 1. Trends are not stable (psychology of growth) 2. Imitation(many persons)

a) It is rational to imitateb) It is the highest cognitive task to imitatec) We mostly learn by imitationd) The concept of “CONVENTION” (Orléan)

• The ITC “new economy” bubble (1995-2000)

• Slaving of the Fed monetary policy to the stock market descent

(2000-2003)

• Real-estate bubbles (2003-2006)

• MBS, CDOs bubble (2004-2007) and stock market bubble

(2004-2007)

• Commodities and Oil bubbles (2006-2008)

Predictability of the 2007-XXXX crisis:15y History of bubbles and Dragons

Didier Sornette and Ryan WoodardFinancial Bubbles, Real Estate bubbles, Derivative Bubbles, and the Financial and Economic Crisis (2009)(http://arxiv.org/abs/0905.0220)

Merrill Lynch Corp. Non-Financial Bond Index

Gold spot price $/oz Cotton, CT1 Comdty, Generic1st ‘CT’ Future

D-MTEC Chair of Entrepreneurial Risks

Prof. Dr. Didier Sornette www.er.ethz.ch

Sornette et al., Journal of Biological Systems, Vol. 17, No. 2 (2009) 225–267

Health as an ENDO problem, not only exo (germ theory) or structural problem (genes)

DYNAMICALHOMEOSTASIS

<=>DYNAMICAL

OUT-OF-EQUILIBRIUM

MARKETS

Solutions for Financial Health?

• Glass-Steagall act (1933)

• Credit creation by banks (R. Werner)

The problem of institutional and academic memory loss

The key question: is there evidence that the new financial innovations and a much expanded bank system has brought any real gain for innovations, economic development, employment?

As Krugman suggested, is “boring banking” sufficient?

D-MTEC Chair of Entrepreneurial Risks

Prof. Dr. Didier Sornette www.er.ethz.ch

Hyp: +90%(?) of modern health problems come from forgetting simple low-tech grandmother-like recipes.-importance of deep breathing (also for brain which consumes 30%)-drink a lot of water (dilute and eliminate toxins) and outside meals (not to interfere with digestion)-digestion starts in the mouth (chew a lot)-exercise every morning 10 minutes (stretching, breathing) with non-routine “fractal” like runs, push-ups, HIIT... (A. de Vany)

-law of chemistry: effective food combining => do not mix alkaline (starchy) and acid (protein) food (mixing perturbs digestion and intestine flora and therefore our immune system which starts in the intestine)-eat a lot of raw vegetable and fruits (water-rich food)-less meat (uric acid and putrefaction gives its taste) and diary products-optimistic positive psychology, get a companion or a cat, socialize...

Solutions for healthy lifes?

One Way to Lower Health Costs: Pay People to Be Healthy When employers want their employees to live healthier lifestyles -- to lose weight, stop smoking and exercise regularly -- nothing works like cash, according to research led by Wharton faculty. While some may wince at the notion of paying people to do the right thing, the research found that the incentives cost less than the diseases they prevent.http://knowledge.wharton.upenn.edu/article/2266.cfm

The “Wharton” solution? Why Consumers -- Not Companies -- Should Make Health Care Decisions Mike McCallister, president and CEO of Humana, is precise when he chooses his words to describe the U.S. health care industry. "We don't actually have a health care system. We have a lot of different systems that are glued together," he told an audience at the recent 2009 Wharton Health Care Business Conference. And because of that, he noted, "the incentives are wrong for virtually everyone, including providers, payers and patients."http://knowledge.wharton.upenn.edu/article/2181.cfm

Old chinese way: pay physicians and Pharma only when healthy...STOP paying when ill... (issues of free market vs government innovations...)

Social capital includes reciprocal effects, fairness, altruism and other‐regarding behavior rule the world.

Self‐sustaining incentive to foster “social capital” of a culture / society / communities / group.

Field studies and lab experiments in close combination with complex system theory (ABM) can considerably contribute to improve the understanding of cooperation in order to promote and spread a sustainable behavior.

Promoting sustainable behavior by means of “social capital”

• Microfinance (Yunus): Losses and defaults of micro credits are almost negligible. The implementation of joint liabilities, social collateral and peer pressure mechanisms ensures a sustainable, effective and efficient way for self‐help without spending money. Lending micro credits is less risky and more profitable than standard investments.

•eBay uses a simple version of cross‐reporting schemes. Buyers and sellers can publicly rate each other to prevent abuse. This rating opportunity implements an additional feedback mechanism that takes the advantage of sustaining cooperation by punishing norm violators/defectors.

•Dimension Fund Advisors (Investment firm in Santa Monica, 1981): cultivating a culture of Trust (full disclosure, “penalty box”, full disclosure preventing asymmetric information)

•Switzerland... 26

Living examples of “social capital in action”

Summary

• Fundamental conflict of interests and mis-incentives• Principle of least effort (illusionary money machine

and pill solutions)• Endogenous versus exogenous origins• Solutions: mixture of “old” forgotten recipes + social

capital and innovation (bottom-up)

Four fundamental relational models

• Market pricing• Authority ranking• Equity matching• Communal sharing

(Alan Fiske; UCLA)

Laws and policies designed to harness self-regarding preferences to public ends may fail when they compromise the beneficial effects of pro-social preferences. Experimental evidence indicates that incentives that appeal to self interest may reduce the salience of intrinsic motivation, reciprocity, and other civic motives. Motivational crowding in also occurs. (Bowles, 2007)

Harnessing reciprocity, reputation, and trust to overcome the strong temptations of short-run self-interest (Olstrom, 1998)

HAPPINESS

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“History shows that where ethics and economics come in conflict, victoryis always with economics. Vested interests have never been known to havewillingly divested themselves unless there was sufficient force tocompel them.” B. R. Ambedkar (Indian Politician and founder Ofthe Indian Constitution.)

Hippocratics: "Life is short and art long; the occasion fleeting;experience fallacious, and judgement difficult."

• Extraordinary gains from finance and food-and-health industries• Fundamental conflict of interests• blue pill/red pill syndrome: the pb is the cognitive biases in all

of us• Health as an endo problem, not exo (germ theory) or structural

problem (genes)• need of a social bubble and meme on a new way of eating/

traiting/drinking• nutritional leadership for industry?• Health and economic challenges are more and more to the “rich”

=> not sustainable (intensive care units ex). • >100’000 chemical compounds (allergies...) emergent illnesses. • social-venture capital funds, social mutual funds, and a full-fledged social

stock market.

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