Capital Markets - News and analysis

Find here a political FT article by Robert Reich, former US labour secretary and now professor of public policy at Berkeley.

FT: Why Obama must take on Wall Street, by Robert Reich, Jan 12, 2010

Leading bankers were invited to a Washington hearing. Without any doubt better regulation of banks is needed. However, currently the buck is passed back and forth between bankers, politicians and central bankers. Bankers divert blame away from their institutions and lay it on mortgage lending practices, the Fed Chairman claims that the low interest policy of the past did not create the real estate bubble and many politicians do not take into consideration that wrong regulations in the market for mortgages could also have contributed to the crisis. Here is a Guardian article about the latest Washington hearing:

Guardian: Wall Street's leading bankers admit: we made mistakes, Chief executives accept some activities were 'improper' in testimony to commission, but remain defiant over pay, Jan. 13, 2020

Leading Wall Street bankers said today they underestimated the severity of the financial crisis and apologised for making mistakes as a US government commission began its inquiry into the root causes of the banking meltdown.

In a dramatic hearing, the chief executives of four of the world's biggest banks, led by Lloyd Blankfein of Goldman Sachs and Jamie Dimon of JP Morgan, faced tough questioning over their role in the crisis, which ended with the US industry being bailed out with $360bn (£221bn) of taxpayer's money and saw ­unemployment rise to a 26-year high. read more

Regulating the financial industry in an appropriate manner is in fact a difficult task. Regulators have to keep in mind that government will never be a better banker than the now hated Wall Street managers. Regulatory measures should be market oriented and be defined around three major elements:

•Transparency, especially with regards to complex financial derivatives
•New rules limiting bank leverage
•Reform of compensation practices

White House Economic Adviser Christina Romer discusses "ridiculous" bank bonuses:

This are intriguing thoughts by R. Caballero!

The "Other" Imbalance and the Financial Crisis, Ricardo J. Caballero, MIT and NBER, December 14, 2009

Abstract:

"One of the main economic villains before the crisis was the presence of large global imbalances. The concern was that the U.S. would experience a sudden stop of capital flows, which would unavoidably drag the world economy into a deep recession. However, when the crisis finally did come, the mechanism did not at all resemble the feared sudden stop. Quite the opposite, during the crisis net capital inflows to the U.S. were a stabilizing rather than a destabilizing source. I argue instead that the root imbalance was of a different kind: The entire world had an insatiable demand for safe debt instruments that put an enormous pressure on the U.S. financial system and its incentives (and this was facilitated by regulatory mistakes). The crisis itself was the result of the negative feedback loop between the initial tremors in the financial industry created to bridge the safe assets gap and the panic associated with the chaotic unraveling of this complex industry. Essentially, the financial sector was able to create safe assets from the securitization of lower quality ones, but at the cost of exposing the economy to a systemic panic. The long run solution to this structural problem requires that governments around the world explicitly absorb a larger share of the systemic risk. The options range from surplus countries becoming willing to demand risky assets (rather than AAA bonds), to private public solutions where asset producer countries preserve the good parts of the securitization industry while removing the systemic risk from the banksf balance sheets. The fee structure for this service can incorporate all kind of too big or too interconnected to fail considerations."

Washington Post: Federal Reserve earned $45 billion in 2009, Jan. 10, 2010

"Wall Street firms aren't the only banks that had a banner year. The Federal Reserve made record profits in 2009, as its unconventional efforts to prop up the economy created a windfall for the government.

The Fed will return about $45 billion to the U.S. Treasury for 2009, according to calculations by The Washington Post based on public documents. That reflects the highest earnings in the 96-year history of the central bank. The Fed, unlike most government agencies, funds itself from its own operations and returns its profits to the Treasury."

Source: article linked to above

NYT: A Future That Doesn’t Guzzle, Jan. 11, 2010

About 98 percent of the vehicles sold in the United States last year were powered by conventional gasoline engines, and hybrids occupied just a tiny niche.

But at the opening Monday of the big Detroit auto show, the internal-combustion engine seemed almost passé.

The world’s automakers unveiled a number of hybrid gas-electric and battery-powered models, several of which might not be available for years to come.

It is a telling sign of how much emphasis that car companies are placing on the electrification of vehicles — even though consumers have yet to show widespread interest in alternatives to gas engines.

“Green technologies are the master key to the future of the automobile,” said Thomas Weber, the head of research and development at Mercedes-Benz, which plans to deliver the first 200 of its B-Class F-Cell electric cars to customers in the United States and Europe this year. read more

Related:

Find following a report about the investment performance of various asset categories in Q4 and selected expert opinions on the outlook. You will find a range from pessimistic to extremely optimistic.

NYT: A Great Run, but Where Will We Land?, Jan. 9, 2010

Matt Weinstein lost his life savings to Bernie Madoff's notorious scam. But his response to the disaster is unexpectedly hopeful.

Probably both have to take the blame!

FT: Bankers escape bonus blow, Jan. 8, 2010

City bankers will suffer little or no impact from the bonus supertax imposed by the government last month, according to a Financial Times poll of leading investment banks.

Most banks, polled in an anonymised survey, said they would absorb all or part of the cost of the one-off 50 per cent tax by inflating their bonus pools, even at the risk of irritating the government and their own shareholders.

The results chime with intelligence garnered by headhunters. “The tax is going to be 90 per cent absorbed by the banks,” said one senior recruitment consultant with clients in the City.

In many cases that will mean banks doubling bonus pools, with the cost of the tax borne by shareholders. Dividends, already under pressure as regulators force banks to retain earnings to boost capital, are likely to be hit, bankers concede. read more

Related:

Guardian: Bonus time as banks pay out £40bn, Jan. 8, 2010

Paul Krugman writes about the causes of this financial crisis and about what should be done:

NYT: Bubbles and the Banks, by Paul Krugman, Jan. 7, 2009

Whereas the implosion of the stock market bubble of the 1990s did not cause a financial crisis, the bursting of the real estate bubble in the US did. Paul Krugman sees following reasons for this:

"The short answer is that while the stock bubble created a lot of risk, that risk was fairly widely diffused across the economy. By contrast, the risks created by the housing bubble were strongly concentrated in the financial sector. As a result, the collapse of the housing bubble threatened to bring down the nation’s banks. And banks play a special role in the economy. If they can’t function, the wheels of commerce as a whole grind to a halt."

Reading this one might wonder why the banker's took on so much risk. Krugman says:

"Because it was in their self-interest to do so. By increasing leverage — that is, by making risky investments with borrowed money — banks could increase their short-term profits. And these short-term profits, in turn, were reflected in immense personal bonuses. If the concentration of risk in the banking sector increased the danger of a systemwide financial crisis, well, that wasn’t the bankers’ problem."

And the regulators with their lax attitude supported this short-term orientedness:

"... regulators failed to expand the rules to cover the growing “shadow” banking system, consisting of institutions like Lehman Brothers that performed banklike functions even though they didn’t offer conventional bank deposits."

And now, how should the financial system be reformed? Krugman:

"The test for reform, then, is whether it reduces bankers’ incentives and ability to concentrate risk going forward."

In a nutshell, Krugman mentions following elements:

• Transparency, especially with regards to complex financial derivatives
• New rules limiting bank leverage
• Reform of compensation practices

She shadow banking system explained by Paddy Hirsch from Marketplace:

When looking at analyst's buy and sell recommendations it might be worth to look at the agency costs in the investment industry:

Chen, Carl R., Steiner, Thomas L. and Carleton, Willard T., Optimism Biases Among Brokerage and Non-Brokerage Firms' Equity Recommendations: Agency Costs in the Investment Industry. Financial Management, Vol. 27, No. 1, pp. 17-30, Spring 1998. Available at SSRN: http://ssrn.com/abstract=648163

Abstract:

"This paper studies the investment recommendations made by brokerage and nonbrokerage firms in an effort to examine the differential agency costs across three unique recommendation production environments. Using the ACE database, recommendation production environments are categorized into national, regional, and non-brokerage firms. The results prove that differences exist between brokerage and nonbrokerage firms: 1) brokerage firms significantly inflate recommendations; 2) regional firms significantly inflate recommendations, compared to national firms; 3) brokerage firms' recommendations, compared to nonbrokerage firms' recommendations, are less credible and less predictive of future stock performance; 4) national firms have more reputational capital, and therefore, their recommendations are more predictive of investment performance than the regional brokerage firms' recommendations."

Related:

Optimism Biases among Brokerage and Non-Brokerage Firm's Equity Recommendations

Mark Zandi, Chief Economist & Co-Founder, Moody's Economy.com

Nearly half of the American workforce are women today. This is a consequence of the economic downturn as there are much more men (75%) who lost their jobs than women (25%).

I wonder whether the share of women in investment jobs is also increasing. This might have a direct impact on investment behavior, as following paper suggests:

Testosterone and financial risk preferences, Coren L. Apicella, Anna Dreber, Benjamin Campbell, Peter B. Graye, Moshe Hoffman, Anthony C. Little, July 1, 2008

Abstract:

"Many human behaviors, from mating to food acquisition and aggressiveness, entail some degree of risk. Testosterone, a steroid hormone, has been implicated in a wide range of such behaviors in men. However, little is known about the specific relationship between testosterone and risk preferences. In this article, we explore the relationship between prenatal and pubertal testosterone exposure, current testosterone, and financial risk preferences in men. Using a sample of 98 men, we find that risk-taking in an investment game with potential for real monetary payoffs correlates positively with salivary testosterone levels and facial masculinity, with the latter being a proxy of pubertal hormone exposure. 2D:4D, which has been proposed as a proxy for prenatal hormone exposure, did not correlate significantly with risk preferences. Although this is a study of association, the results may shed light on biological determinants of risk preferences."

Nearly half of the American workforce are women today. This is a consequence of the economic downturn as there are much more men (75%) who lost their jobs than women (25%).

I wonder whether the share of women in investment jobs is also increasing. This might have a direct impact on investment behavior, as following paper suggests:

Testosterone and financial risk preferences, Coren L. Apicella, Anna Dreber, Benjamin Campbell, Peter B. Graye, Moshe Hoffman, Anthony C. Little, July 1, 2008

Abstract:

"Many human behaviors, from mating to food acquisition and aggressiveness, entail some degree of risk. Testosterone, a steroid hormone, has been implicated in a wide range of such behaviors in men. However, little is known about the specific relationship between testosterone and risk preferences. In this article, we explore the relationship between prenatal and pubertal testosterone exposure, current testosterone, and financial risk preferences in men. Using a sample of 98 men, we find that risk-taking in an investment game with potential for real monetary payoffs correlates positively with salivary testosterone levels and facial masculinity, with the latter being a proxy of pubertal hormone exposure. 2D:4D, which has been proposed as a proxy for prenatal hormone exposure, did not correlate significantly with risk preferences. Although this is a study of association, the results may shed light on biological determinants of risk preferences."

Nearly half of the American workforce are women today. This is a consequence of the economic downturn as there are much more men (75%) who lost their jobs than women (25%).

I wonder whether the share of women in investment jobs is also increasing. This might have a direct impact on investment behavior, as following paper suggests:

Testosterone and financial risk preferences, Coren L. Apicella, Anna Dreber, Benjamin Campbell, Peter B. Graye, Moshe Hoffman, Anthony C. Little, July 1, 2008

Abstract:

"Many human behaviors, from mating to food acquisition and aggressiveness, entail some degree of risk. Testosterone, a steroid hormone, has been implicated in a wide range of such behaviors in men. However, little is known about the specific relationship between testosterone and risk preferences. In this article, we explore the relationship between prenatal and pubertal testosterone exposure, current testosterone, and financial risk preferences in men. Using a sample of 98 men, we find that risk-taking in an investment game with potential for real monetary payoffs correlates positively with salivary testosterone levels and facial masculinity, with the latter being a proxy of pubertal hormone exposure. 2D:4D, which has been proposed as a proxy for prenatal hormone exposure, did not correlate significantly with risk preferences. Although this is a study of association, the results may shed light on biological determinants of risk preferences."

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