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.