In our daily lives, we often adhere to basic safety guidelines to mitigate avoidable risks. We avoid smoking, abstain from drunk driving, wear helmets while riding bikes, and secure seatbelts when we’re in vehicles. These guidelines, when religiously followed, can help us eschew preventable causes of death, thereby extending our lifespans. However, humans seldom calculate the odds of every action, evaluate the probability of mortality, and then consciously choose to act based on these calculated probabilities.

For instance, consider the bicycle rider who dismisses the idea of wearing a helmet, considering it ‘uncool.’ They might perceive the likelihood of getting into a fatal accident as less than 1%, a so-called ‘3-sigma event’ in statistical terms. They may feel safe gambling against these odds, but should that rare 3-sigma event occur, there are no second chances. He is just dead.

In stark contrast to this, financial institutions frequently gamble with what could be considered their ‘lives’ – they take risks based on the odds, knowing that a safety net is in place should things go awry. They can afford to be reckless because they trust that every 5 to 7 years, central banks and governments will step in to rescue them when they falter. This is made possible through the creation of new money, often at the expense of the public’s wealth.

In the finance sector, this is referred to as the ‘Sharpe World.’ This world, deeply loved by both governments and financial institutions, is governed by intricate rules designed by academic elites from prestigious universities. This rule-bound world ensures that when a catastrophe strikes, nobody can be accused of unseemly behavior, thereby reducing accountability. So, it’s deemed unfair for the public to show resentment when they are called upon to salvage yet another failing financial institution – think Credit Suisse.

The crux of this economic game, reinforced by speculative economic theories that are often presented as natural laws, is to keep investors committed to long-term government bonds. As a government, if you can persuade your citizens to postpone consumption and invest their savings with you on a long-term basis, it’s seen as a testament to your credibility as a state entity. However, if investors prefer short-term loans or avoid lending altogether, the state’s credibility could be at stake, forcing it to resort to unpopular measures like high taxes to generate funds.

Influential financiers are initiated into this Sharpe World early on in their careers. University finance curriculums typically extol the efficient frontier and glorify government bonds as magical assets that can both enhance returns and reduce overall portfolio volatility. Therefore, it’s often suggested that a portfolio manager merely needs to apply leverage to long-term government bonds to substantially boost their returns.

This entire setup might seem like an elaborate game of chance. Yet, as long as the wheels of the Sharpe World keep spinning, it remains an accepted norm in the realm of finance. It’s a game where the stakes are high and the rewards even higher – that is, until the music stops.