In 2010, Goldman Sachs chief executive Lloyd Blankfein was summoned to testify before the Financial Crisis Inquiry Commission, which was charged with investigating the role of derivatives and other arcane investments in the 2008 economic meltdown. Still smarting from the flogging he was given by the press the previous year for boasting that the financial sector was doing “God’s work,” Blankfein adopted a more pragmatic approach in heading off calls for increased regulation and oversight. “Taking risk completely out of the system,” he warned, “will be at the cost of economic growth. We know from economic history that innovation—and the new industries and new jobs that result from it—require risk taking.”
On the surface, this seems like a reasonable statement, even if the esoteric instruments peddled by Goldman Sachs have done little to foster industrial innovation. But the “economic history” of risk taking—and risk management—is far more vexed, judging from Jonathan Levy’s brilliant Freaks of Fortune. Levy argues that in the early United States, risk was more than a means of fostering growth; it was central to “the emergence, in tandem, of a new individualism and a new corporate financial system in nineteenth-century America.” Assuming risks in the capitalist marketplace, Levy writes, was a distinctly American way of securing individual independence. “To assume a risk, to take it, make it your own, to master it, or even just enjoy the existential thrill of it, was a birthright of the democratic soul, a soul born in commerce.”
But therein lay a paradox or two. The brave new world of independence inevitably led individuals to seek to manage and mitigate risk. In doing so, they became dependent on an emergent corporate financial system that peddled insurance policies, derivatives and other instruments that promised to lessen one’s exposure to “radical uncertainty and ceaseless change.” Worse, this same financial system transmuted individual risks into systemic risk via increasingly intricate financial innovations to which Blankfein is the heir. These innovations, though ostensibly created to manage risk, compounded it. “Risk management,” Levy argues, “constantly manufactured new forms of uncertainty and insecurity.”
Levy’s history begins at sea, aboard trading vessels owned by European merchant capitalists. While vast fortunes could be made on these ocean voyages, plenty of dangers lie in wait, from storms to pirates. These “perils of the sea” did not consist of chance events that could be defined with any kind of probability. Rather, they were literally God’s work, “exercised from a realm beyond and outside of secular time, inscrutable to human agents.” Not surprisingly, as Levy wryly notes, “there was no greater advocate of the scope of human agency than a sued insurance company,” and “no greater advocate for the ‘acts of God’ than the insured owner of a destroyed cargo.”
Merchants did not leave everything to God and the insurance companies, however: they sought to minimize their risk in ways not so dissimilar from the now-infamous slicing and dicing of securities implicated in the recent financial crisis. Merchants rarely sank their capital into a single ship; rather, they divided their investments among many different vessels and cargoes. These individual risks could be insured by an underwriter. But the hedging did not stop there. The underwriters rarely assumed the full burden of any individual risk; instead, numerous underwriters (often other merchants) combined forces to assume the risk in return for a portion of the premium. In this way, one merchant’s interest in a trading vessel or its contents—typically one-sixty-fourth of the total—might be insured by dozens of individual or corporate underwriters. In turn, the underwriters might hand off some or all of their portion of the risk to others via reinsurance—a practice banned by the British in 1745 but revived in the United States after the American Revolution. When a ship sank, it could take years to unravel—let alone litigate—the tangled skein of risks taken and risks assumed in advance of the voyage. The dockets of early federal courts in the United States were swamped with such cases.
Marine insurance depended more than anything else on the rise of the slave trade. Ships carrying African captives, or sugar, rice and cotton grown by slaves: all helped foster increasingly sophisticated forms of risk management. An economic system dedicated to depriving other people of their liberty became the template for risk management in a comparatively free, liberal, capitalist society. And though slavery was central to the emergence of risk management in the eighteenth century, it became a bulwark of conservatism in the nineteenth. Levy claims that slaveholders in the antebellum South eschewed the latest modes of managing risk, especially life insurance, which became widely available in the 1840s and 1850s. They thought it a poor substitute for what one pro-slavery advocate called “slavery insurance”: the ownership of human beings as a way to hedge risk. “Domestic slavery,” the writer concluded, “is nature’s mutual insurance society.”
Anti-slavery advocates thought of risk differently. Led by men like the abolitionist Elizur Wright, who would eventually become the nation’s first actuary, they urged white middle-class men to hedge risk by purchasing life insurance policies. This was a tough sell at first: the idea of commodifying a life struck many as profane. But abolitionists sincerely believed that “every man belongs to himself” and thought it made eminent sense to insure that self—one’s human capital—against misfortune. Unlike other methods of hedging risk—the ownership of land or slaves—life insurance policies mitigated risk via new, distinctly modern methods rooted in mortality statistics and probability theory.
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Life insurance was one way to hedge against the risk entailed by living in a capitalist economy; savings banks were another. These institutions, which proliferated in the urban North beginning in the early nineteenth century, took the modest savings of workers and directed them toward putatively risk-free investments. Though initially founded as charitable institutions to help the poor (and keep them off public assistance when hard times hit), these institutions acquired a life of their own, especially as growing numbers of working-class laborers turned to them to tame the uncertainty that increasingly characterized their economic lives.
When slavery died with the Civil War, Northern reformers welcomed the former slaves to modern risk management. Now that the freedmen owned themselves, in a manner of speaking, they owned their risk. As one Union general told a group of recently freed slaves, “In slavery, you did not think of the future…. In freedom, you must have an eye to the future, and have a plan and object in life.” Republicans went on to create an institution aimed at training former slaves in the art of saving for the future: the Freedmen’s Bank.
This story has been told before, but Levy offers a new twist. The freedmen did indeed learn lessons about risk management after they put millions of dollars of their hard-earned savings into its coffers—but not the lessons that the bank’s founders had in mind. Though initially quite stable and secure, the Freedmen’s Bank fell into the clutches of the speculators Jay and Henry Cooke, who funneled the freedmen’s savings into the high-risk bonds of the Northern Pacific Railroad. When the Panic of 1873 struck, it wiped out the Cooke brothers—and many of the bank’s depositors. In the process, the former slaves grasped what a growing number of participants in the nation’s unstable and unpredictable capitalist economy realized around the same time: that risk management and the freaks of fortune could be two sides of the same capitalist coin.
This became especially evident by the 1870s and ’80s, when Americans moved west in vast numbers, settling new lands in order to secure independence for themselves and their families. Conventional wisdom held that farming offered a sanctuary from the freaks of fortune: financial panics might come and go, but the land would endure, offering sustenance, stability and security.
But buying land required borrowing money. Banks and other financial firms were keen to lend because, after the Panic of 1873, investors burned by railroad bonds were looking for alternatives. A new generation of financial corporations arose to buy up farm mortgages, bundle them, and then slice and dice them in ways that apportioned them relative to an investor’s tolerance for risk. The risk of the mortgage, itself undertaken by a farmer seeking to eliminate risk by owning land, would become atomized in these acts of legerdemain as mortgages moved from their originators through multiple layers of financial intermediation. As with the collateralized debt obligations that nearly brought down the global economy in 2008, the owners of these securities could no longer accurately assess the underlying assets; as one broker happily declared in 1890, the Western farmer who borrowed the money “cannot treat directly with the eastern owner of the mortgage, for he cannot ascertain who that owner is.”
There was a cruel irony in all of this. If, as Levy argues, the condition of individual freedom in a liberal, capitalist society was the assumption of one’s own personal risk, this perversely led to a dependence on a corporate financial system that obliterated discrete individual “risks,” turning them into complex securities or anonymous probabilities. In this way, risk became systemic, detached from individual human beings; it lost its individuality. Instead, risk became a profitable new commodity among the countless commodities bought and sold in an increasingly impersonal, abstract, if not incomprehensible system of finance. When the system came crashing down, both the risk takers and the risk-averse found themselves playthings of forces far beyond their control, victims of perils they never imagined, and entangled with people they did not know. This was a most unexpected outcome. As Levy notes, “in the very act of underwriting liberal self-ownership the financial system also had the capacity to overwrite it.”
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In the Gilded Age, some Americans sought a method of managing risk that was neither anonymous nor prone to systemic breakdowns. They found common cause in fraternal organizations like the Ancient Order of United Workmen (founded in 1868), the Modern Woodmen of America, the Knights of the Maccabees and the Knights of Pythias, among others. These national organizations, made up of local chapters, promised their members a social outlet. And their members obtained benefits in the event of death, disability or even unemployment.
Fraternal orders self-consciously rejected the probabilistic determination of risk favored by insurance companies. Instead, when a member died, every other member was “assessed” a set sum that paid a benefit to the survivors. A similar structure delivered benefits in the aftermath of less calamitous events. This was a secular system of risk management: members trusted their brethren, not God, to help them out in their time of need. But it did not subject them to the coldhearted actuarial calculations perfected by the likes of the Travelers Insurance Company, which called fraternalism a “revolt against the multiplication tables.”
The major flaw in this system soon became apparent. The benefits delivered by fraternal orders did not have the status of a contract—not initially. Instead, the assessments were paid voluntarily—and when members failed to receive their promised benefits, they took the fraternal orders to court. Decision after decision affirmed the idea that a certificate of membership in a fraternal order was a legal contract; one’s fellow members were on the hook for the benefits. In response, the fraternal orders reluctantly adopted the same actuarial methods used by the insurance companies. “Corporate risk management,” Levy writes, “had co-opted the fraternal countermovement.”
By the late nineteenth century, the emergence of futures contracts had upended the concept of insurance, detaching it from a tangible asset. Unlike earlier advances in risk management, speculators in grain futures did not actually take possession of the grain; they merely “set off” the difference between the price on the futures contract and the price in the market the day it came due. Those betting on the price of the grain no longer needed to demonstrate that they had an “insurable interest” in the underlying commodity; they merely wagered on the movements of prices. Critics tried to secure congressional legislation banning futures trading. They came close to succeeding, but could not surmount a novel argument posed by the Chicago Board of Trade and its allies: futures trading was a form of insurance; it was a means, one trader argued, of hedging against “wide fluctuations” in prices. When Blankfein appeared before the Financial Crisis Inquiry Commission in 2010, he offered much the same defense: abandoning “market mechanisms created decades ago, such as derivatives,” he warned, would constrain “access to capital and the efficient hedging and distribution of risk.”
Defending derivatives nonetheless demands a more lofty line of argument, one that economists in the late 1890s happily provided. Allan Willett, who trained at Columbia, argued that “speculators serve society as insurers” by virtue of their frenzied trading, adding that “the benefit that society derives from this transaction is of the same kind as that which regular insurance companies confer.” Speculators, he argued, were “productive”; this was “God’s work,” indeed.
But only for the elect: ordinary small farmers lacked the cash or credit to speculate on margin, much less purchase a futures contract outright. Initially, they could use only so-called “bucket shops,” betting parlors that enabled ordinary men to hedge risk by wagering on the prices of commodities. But the large exchanges managed to secure a Supreme Court ruling that put the bucket shops out of business. With mortgages to maintain, small farmers had no choice but to sell their wheat to deep-pocketed speculators who could readily afford to store the grain, hedge the risk and maximize their profits.
The Populist movement of the 1890s tried to enlist the government on the farmers’ side, building warehouses where they could store their crops while awaiting more favorable prices. But the plan went nowhere, and for all the claptrap about how futures traders were the real “risk takers,” small-time farmers were the ones who truly took a risk by putting seeds in the ground. Burdened with debt, they had to sell at whatever the market would pay when the grain was harvested. Truly, this was “betting the farm.”
Levy closes with the story of George Walbridge Perkins, a financier who by the 1910s would become the most visible proponent of a new form of risk management designed to help quell labor unrest while ostensibly aiding employees. This was corporate profit sharing, though the shared profits came at a price: large industrial behemoths—so-called “trusts” like US Steel—rewarded only those employees who provided “satisfactory service” to the corporation by working twelve hours a day, seven days a week. Other corporations’ efforts at minimizing risks to employees (pensions, insurance benefits) reduced the requirements, but managers and owners inevitably set the terms under which risk might be reduced.
Perkins was a curious figure: toward the end of his life, he became an advocate for government-sponsored social insurance, an idea that died in the 1920s. Levy’s story largely stops here, though he briefly treats the New Deal and the social safety net it inaugurated. The consequences of that revolution in risk management were profound: “By the middle of the twentieth century something curious happened—the very expression ‘freaks of fortune’ all but dropped from the American vernacular…. The freaks did not survive the efflorescence of the New Deal order.”
It would seem that reports of their death have been greatly exaggerated. Since the 1970s, the great political project of the right has been to revive the freaks of fortune. Not that Reagan and his heirs would put it that way: they have invariably preached the virtue of individual responsibility and self-reliance. But the net effect is the same as that of owning one’s own risk. As Levy puts it, “Risk’s nineteenth-century liberal history appears to have a neoliberal doppelgänger.”