1. The New Financial Order and the Current Financial Crisis Robert J. Shiller Professor of Economics, Yale University Co-Founder and Chief Economist, MacroMarkets LLC New Economic School, Moscow March 14, 2008

2. New Financial Order Advances in mathematical finance Advances in behavioral finance Advances in information technology Democratization of finance

3. Books Discussing the need and history of financial innovation in risk management Macro Markets, 1993 The New Financial Order, 2003

4. New Markets in Progress Home price markets Oil price markets Natural gas markets Components of consumer price index –Medical costs –Education costs Personal income risks GDP Longevity

5. Current Financial Crisis International Stock market boom 1990s, collapse 2000-2003 International housing market boom Late 1990s-2000s Collapse of housing boom in US since 2006, following in other countries US Subprime crisis leads to freeze up of financial markets, systemic effects

6. Spread of Crisis to Europe IKB Deutsche Industriebank AG, and SachsenLB Bank in Germany Funds sponsored by BNP Paribas in France Northern Rock Building Society in the United Kingdom

7. The Crisis as Opportunity Example of stock market crash of 1929 US Reaction in 1930s: financial progress: creation of Securities and Exchange Commission, Federal Deposit Insurance Corporation, Fannie Mae, Homeowners Loan Corporation, Federal Home Loan Bank System, Federal Housing Administration European reaction: not so congenial to markets The current crisis should be dealt with with financial progress again

8. Real S&P500 Price and Earnings January 1871 to February 2008

9. P/E10 and Nominal Long Rate As of Today

10. Real Home Prices, Building Costs, Population, Interest Rates As of 2007-IV

11. Comparing Real Home Prices in Greater London and Greater Boston 1983-2007

12. Moscow Apartment Prices 1999-2008 $/Square Meter

13. Fig. 4 Real Home Prices Netherlands, Norway, USA 1890 to 2004-5-7

14. Fig. 1 US Real Price, Rent and Building Costs Quarterly 1987-I to 2007-II

15. Home Prices a Massive World Speculative Bubble Gold rush mentality Stories of the rapidly growing BRICs (Brazil, Russia, India, China) have the whole world spooked Widespread anxieties about how to fit in to the new capitalist world A popular view that property investments are the best way to secure ones future, same phenomenon over much of world

16. The Behavioral Finance Revolution Terms Behavioral Finance & Efficient Markets in News Media from 1981 to 2006

17. Wishful Thinking Bias People exaggerate probability that their team will win. People exaggerate probability that the candidate they favor will win.

18. Attention Anomalies Attention is fundamental aspect of human intelligence and its limits Social basis for attention Inability to account for ones attention No arbitrage assumption of financial theory: No ten-dollar bills lying around. Does not require everyone is paying attention.

19. Culture and Social Contagion Social cognition, collective memory A global culture in todays world

20. On May 22, 2006, The Chicago Mercantile Exchange launched the first successful futures and options market for home prices. The contracts currently settle on 11 different S&P/Case-Shiller ® Home Price Indices. The combined cumulative notional value traded in the CME housing products (both futures and options) in the first year exceeded $500mm, a period over which these products were limited to a maximum one-year term. On September 17, 2007, the CME began listing longer-dated contracts (up to 5 years) to meet market demand for greater product utility. Financial Engineering comes to real estate at last, and the housing market will never be the same. -Barrons 5.15.06 CME Housing Futures and Options UPDATE THIS S&P/Case-Shiller ® Home Price MacroShares ®

21. Problems Getting Market Started Open Interest May 2006 to Nov 2007

22. Home Price Futures Percent Discount of CME Housing Futures from S&P/Case-Shiller HPI Levels – as of January 3 rd, 2008.

23. Futures Price and Latest Home Price Index Daily, May 2006 – February 2008

24. Efficient Portfolio Frontier

25. The M ACRO S HARES Structure

26. A Vision Becomes a Reality On November 30 th, 2006: MacroMarkets LLC launched MacroMarkets LLC launched M ACRO S HARES Oil Up and M ACRO S HARES Oil Down are listed on the American Stock Exchange. These securities track the performance (and inverse performance) of West Texas Intermediate Crude Oil. Ticker Symbols: AMEX: UCR M ACRO S HARES Oil Up AMEX: DCR M ACRO S HARES Oil Down

27. NYMEX Oil Futures Prices to 60 Months and UCR Price Daily Nov 30 2006- Oct 28 2007

28. Spread Between Front-Month and 60-Month Futures and Spread Between UCR and Front- Month Futures, Daily Nov 30 2006-Oct 28, 2007

29. Pensions and the Risk of Outliving Ones Wealth Life annuities are an excellent old idea, rarely embraced by the public Wishful thinking bias, mental framing Public pension funds Private annuities Problem: annuity providers have to manage aggregate longevity risk

30. U.S. Life Expectancy, 1900-2001

31. Problems Inhibiting Longevity Bonds EIB Bonds were nominal bonds, should be real UK Issuers of life annuities were not seriously enough interested in this small issue to take fast action Those who would take other side are not easily found, need to look at prices in an established market

32. Efforts to Create Markets for Longevity Risk Swiss Re longevity bond, 2003 European Investment Bank-BNP Paribas longevity bond 2004 Swiss Re, takes on £1.7 billion of longevity from Friends Provident in UK JP Morgan Launches International Longevity and Mortality Index – LifeMetrics Index, March 2007 Goldman Sachs Launches Tradeable Index for Longevity and Mortality Risks Dec. 2007 To date the longevity risk market is still struggling to gain a foothold

33. Personal Income Risk Markets Subprime crisis could have been averted with income-linked (and real estate price linked) mortgages Such retail products require the creation of markets

34. GDP Linked Securities Governments could sell shares in their GDP One trill is a trillionth of a nations GDP Precursors: Bulgaria GDP warrants, 1993, Argentina GDP warrants, 2005

35. Summary There is enormous potential for improvement in human welfare from radical financial innovation in the area of energy,, real estate, longevity and multiple risks we still cannot immunize ourselves from today. The subprime crisis is evidence of the need to improve our markets