Paying for a cult of risk

The former derivatives trader who in 2006 predicted the global credit crisis, Satyajit Das, says the world economy will continue to deteriorate unless international policymakers co-operate. Either way, he says, we're heading for dramatic change and offers a few tips on how to weather the storm.

In his book Extreme Money: The Masters of the Universe and the Cult of Risk, Das has coined the term "extreme money" to refer to the "process of financialisation" that has underpinned the banking sector and global economics throughout the past 40 years.

"Money was always a medium of exchange, a store of value but, essentially, what happened in the last 40 years is that it changed ... and became the driver of economies," he says.

Das says this process made borrowing a key driver of growth. "You end up with this situation of pure speculation as a way of making money - we like to call it investment."

His book chronicles the recent history of banking and the way it has shifted from a simple era - in which banks existed to borrow and lend sensible amounts, offer convenient and safe payment mechanisms such as credit cards and help manage risk with products such as insurance - up to the current state of chaos.

"Extreme Money spans this period and tries to turn out every little piece, which on its own looks fine, but when you add them all up it's this horrific tale of how we deluded ourselves for over 30 or 40 years."

Das says governments are in denial about the huge co-operative effort required to avoid turmoil. "We've been trying to defy financial gravity the question is: do we come down in a gentle control glide or do we just crash?"

Proactive and aggressive policies taken by global leaders are required to cushion the landing, Das says, acknowledging the inherent challenge in garnering international agreement on policies that will bring pain.

"There's huge denial because if people want to confront this they'll have to unravel a lot of things they've put in place over the last 30 years, which would mean lower living standards, which, in my view, is inevitable anyway."

Regardless of the approach world leaders take, Das says, individuals can begin to take steps now to cushion their own financial circumstances.

TAKE CHARGE

Taking the time to understand your investments is crucial, Das says. "You're the only person who can make a decision about what you're comfortable with," he says. "We've just delegated that to other people - funds managers, advisers - and generally, on average, they've not done a great job. There's also a conflict of interest because that person will always think their product is the best, naturally, even if it's not best for you.

"People have just walked away from trying to understand this, which is crazy because it's a very important part of your life. You have to understand this because otherwise you'll pay for this and you'll pay for this with your hard-earned cash."

REDUCE DEBT

Das forecasts borrowing costs may increase and it will be more difficult to secure a loan as the debt problems in Europe spread to the US and Japan and make it more difficult for Australian banks to lend from overseas. In a time of higher risk, higher cost and less availability of funds, you should reduce your debt, Das says. "Essentially, reducing your debt means cutting your mortgage, or, if you have a business, reduce the debt as quickly as possible."

SAVE MORE

"We're entering a period of lower returns, which means we need to save more," Das says.

"Individuals are going to need a lot more savings than they imagined because what Australians have relied on are two things: the value of their houses, which is a complete illusion because your house is not an investment, it is where you live. And the other savings are superannuation but the problem is your retirement savings are not earning enough to give you a reasonable lifestyle at retirement. Retirement savings earnings are pretty abysmal and they're not going to go up - if anything they're going to be lower."

As the global economy changes to a more realistic situation, Das says the Australian government will be forced to pull back funding for services such as education, health and aged care.

"You are going to need more of your personal resources to pay for all these things than you imagined because governments can't afford to pay."

SEEK CAPITAL SECURITY

With a forecast of low growth and high risk, Das says investors should seek secure investments with a focus on income rather than capital gain.

"You really need to get investments which provide you with income you can live on," he says. "If you have money to invest, make sure the money you have is protected. That will be very important."

Satyajit Das's book Extreme Money: The Masters of the Universe and the Cult of Risk is published by Portfolio (Penguin, $32.95).

Satyajit Das recommends four ways to protect yourself:

- Take charge of your own finances.

- Reduce your debt.

- Save more.

- Be concerned with capital security and income rather than capital gain.