Current Affairs


THE GREAT MISMATCH PART II: The Barriers to Efficient Capital Flows

Efficient cross-border capital flows—allowing investors to search for reliable returns, and in the process, meet legitimate capital needs wherever they are—would be a more effective way to finance the global economy than today’s system. In theory, few dispute this. In practice, many barriers have been erected that hamper efficient flows. The deliberate or inadvertent barriers to efficient global capital flows have been erected by a unique combination of regulators, governments, historical conventions and path-dependencies, investor mindsets and capital-seekers themselves (see below exhibit).


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Living in the Outlier

The past few years can only be described as one of the most unusually serene periods in history for the U.S. equity market. While over time it began to feel normal, we have been living in the outlier. Let’s take a quick trip down memory lane. 

The DiMaggio Streak of Markets

We’ll begin with the historic run from November 2012 through October 2014, what I have called the “DiMaggio streak of markets.” At 475 consecutive trading days above the 200-day moving average, we have never seen such a steady advance and lack of a meaningful pullback in the history of the S&P 500.

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The Club of Rome’s Next Act

The Club of Rome was founded in 1968 but really came into the public eye with the publication of Limits to Growth in 1972. The controversial book, which sold 12 million copies in 37 languages, first called attention to the systemic limitations of the exponential expansion of the human population and the related material inputs and waste outputs of its economic system on a planet that is fixed in scale.

The concept is not complicated. Sooner or later, the endless expansion of the metabolism of a system within a finite body will cease.

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John Lennon Said It Best: “Living is Easy with Eyes Closed"

I was floored by this* Saturday’s New York Times article, “Seeing a Supersize Yacht as a Job Engine, Not a Self-Indulgence.”  I was amazed not only by how the subject of the article, Mr. Jones, rationalized his extraordinary consumption habits, but also by the mere fact that the article was published.

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Forward Thinking on Collateral Management

Most financial firms in the present day would need an overhaul of their current collateral management practices. This comes in the midst of the burden being experienced by an already intensely regulated financial industry and the new measures of regulation on OTC derivatives in the post financial crisis world. The costs of regulation are near-crippling to some firms. Big dealers are planning to exit or divest certain lines of business that will face huge operational costs as a result of regulation, and are no longer deemed profitable.

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Book Review: Young Money


Young Money: Inside the Hidden World of Wall Street's Post-Crash Recruits tells the stories of eight young Wall Streeters who were hired after the Crash. Author Kevin Roose, New York magazine business writer, shadowed each subject for more than three years. They started their jobs in 2009- 2010, and most, but not all, are from elite ivy universities. Their identities are not revealed, and understandably so, since they could be fired for unauthorized media contacts. While Roose says some of the personal details and events have been changed; the stories are true, and read as candid and revealing.

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How Paranoid Should These Senior BNP Bankers in the U.S. Be Now?


There’s more bad news for BNP Paribas’ U.S. sales and trading business. Only months after laying off some of its U.S. bankers, including senior sales and trading professionals, it’s being widely reported that the French bank will have to pay a $5bn fine in the U.S. for breaking trade sanctions with Iran and Sudan. Worse, it’s being suggested that BNP might be subject to a temporary ban on transfers of money into and out of the U.S. something which could drive many of its corporate clients especially to take their services elsewhere.  Shares at the bank are down 4% this week and may fall more.

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Yellen’s 2.25% Target for 2016 May Be a Huge Mistake

Janet Yellen surprised almost everyone on March 19 by speaking off-script and providing forward policy guidance that can undermine the Fed’s credibility, at best, or cause another crisis, at worst. If the economic data comes in weak by the end of tapering and the markets swoon, the Fed will have no choice but to implicitly admit it was wrong and keep interest rates close to zero indefinitely. However, if the Fed continues with its plan to raise rates in the face of a weaker economy and declining market, the actions may cause another violent crash.

Zero short-term rates and the first round of QE were essential to avoid a complete financial meltdown. Subsequent rounds did little for the real economy yet unintentionally produced high leverage and asset bubbles in various places by providing cheap financing for companies, investors, and speculators alike. The policy also resulted in a massive transfer of wealth from labor to asset owners leading to the largest wealth and income inequality in recent history.

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Can We Escape Bank Regulation by Lawsuit?

When I worked at JPMorgan in the 80s and 90s, even in the context of deregulation, the concept of “self-regulation” in the financial industry was discussed with a straight face. 

Last week, Better Markets, a sophisticated civil society non-profit organization, run by former Skadden attorney Dennis Kelleher and committed to protecting the public interest in the government’s regulatory response to the financial crisis, filed a lawsuit against the Justice Department and Attorney General Eric Holder.  The suit seeks to block what Better Markets calls an “unlawful” $13 billion settlement with JPMorgan Chase & Co. over bad mortgage loans sold to investors leading up to the crisis.  We now have lawyers suing the United States Attorney General on the public’s behalf for failing to properly prosecute a record $13 billion settlement on the nation’s most powerful and flagrant abuser of the self-regulation ethic.

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Harvard and Brown Fail Moral Leadership Exam

At a time when institutions of business and government continue to fail society, two of our leading academic institutions missed the opportunity to provide essential moral leadership on the most pressing challenge ever faced in the history of human civilization.

Harvard President Drew Faust issued her October statement first: She and her colleagues on the Board do not believe “that university divestment from the fossil fuel industry is warranted or wise.”

Brown President Christina Paxson followed three weeks later with her own statement: “Our consideration of divestment [from coal] is over.”

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Will the Fed Need a Bailout? Nonsense!

“As stimulus tab rises for Fed, worries grow it may require a bailout” is the title of an article published in Los Angeles Times and blogged in CFA Institute's "Future of Finance."

I'll say it bluntly: This is nonsense. The logic goes that as interest rates rise, the value of the bonds on the Fed's balance sheet lose value and the central bank will be bankrupt—requiring the taxpayers to bail it out. This is wrong on many different levels.

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Book Review: The Federal Reserve and the Financial Crisis


Adapted from four lectures given by Ben Bernanke in March 2012, this book is a good primer on the workings of the central bank throughout its history, including its role in the recent financial crisis.

It is fitting that The Federal Reserve and the Financial Crisis should be published in the centennial year of the institution. Adapted from a series of four lectures given by Ben Bernanke at George Washington University in March 2012, the book is a good primer on the workings of the central bank throughout its history, including its role in the recent financial crisis. Concepts are introduced with clarity, and the prose is straightforward. The book is appropriate for students of central banking, and experienced readers will find it a worthwhile account of the historical record for what it both does and does not reveal.

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NYSSA's First Annual Global Infrastructure Conference

Infrastructure is very much on the mind of the American and global investment community at large.  The International Finance Corporation’s Asset Management Company recently completed $1.2 billion in financing (exceeding a $1 billion target) with commitments from 11 investors, including sovereign wealth funds from Singapore and sovereign and pension fund investors from across the globe.  In a recent editorial for Bloomberg law, Jay Tannon, a partner at Patton Boggs LLP, suggested a national infrastructure authority in the US to oversee much-needed improvements across the country.  A recent statement by Liberian President Ellen Johnson Sirleaf that the Dallas Cowboy’s new football stadium uses more electricity than the total capacity of her country prompted detailed responses from sources as diverse as The Wall Street Journal and the Brookings Institution. 

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Are We Not All Jasmines Now?

What is it about a Woody Allen film that leaves us always with a discomforting feeling of identification with its most abysmal character? This is certainly true with his latest film “Blue Jasmine,” which initially disappointed me, Kate Blanchett’s hauntingly brilliant performance notwithstanding. But given a little more time and reflection, its deeply disquieting meaning slowly seeped in.

I began to realize that it was more than an overdone cliché about a greedy Wall Street huckster who lavishes “everything one could want” on his attractive and well-kept wife “Jasmine,” who never asks or wants to know the true source of all that “success.” Easier to shop and party on Park Avenue and in the Hamptons as a socialite dripping platitudes about responsibility for “helping poor people.” Her husband “Hal” is a younger and flashier Bernie Madoff, higher up the Wall Street food chain perhaps, but nothing more than a sociopathic shyster, serially cheating on his complicit wife whom we cannot help but associate with Ruth Madoff.

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Book Review: After the Music Stopped


Throughout this long and multifaceted work on the recent financial crisis and its aftermath, Professor Blinder demonstrates that he is the rare academic economist who writes clearly about a complicated topic, clarifying complex issues for readers who remain confused about what happened. Some readers may find his proposed remedies problematic.

If writing the second draft of history is supposed to involve both fact telling and interpretation, Alan Blinder’s After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead certainly qualifies. But if books written several years after the worst financial crisis since the Great Depression are supposed to reflect a deeper understanding than those written in the throes of the emergency, this one falls short. Moreover, as the subtitle indicates, the author attempts to combine work of adescriptive nature and work of a prescriptive nature into a single, large, and far-reaching undertaking.

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The Global Access to Nutrition Index

The global Access to Nutrition Index (ATNI)—launched in March 2013—is a groundbreaking initiative designed to address two of the world’s most pressing public health challenges: obesity and undernutrition. As such, they pose a set of risks and opportunities to food and beverage manufacturers. The ATNI Global Index benchmarks 25 of the world’s largest food and beverage manufacturers’ performance on addressing obesity and undernutrition, highlighting how well positioned these companies are commercially to respond to these challenges. Recognizing the relevance of nutrition issues to this sector, 40 investment organizations from around the world, that collectively manage more than USD$2.6 trillion in assets, have signed up to ATNI’s Investor Statement.

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Recent Research: Highlights from February 2013

"Volatility, Correlation, and Diversification in a Multi-Factor World"
The Journal of Portfolio Management (Winter 2013)
Richard Roll

In a multi-factor world, diversification benefits do not generally depend on correlation. Investors can restructure portfolios to align factor sensitivities. This implies that diversification benefits depend only on the idiosyncratic volatility that remains after restructuring. Similarly, the risk reduction that follows adding an asset to an existing portfolio does not depend on the asset’s correlation with the portfolio. These implications evince the fundamental importance of measuring the underlying factors and estimating factor sensitivities for every asset. Other researchers have investigated several methods for measuring factors. An easy-to-implement general method involves specifying a group of heterogeneous indexes or traded portfolios. Exchange-traded funds (ETFs) could be well suited to this purpose.

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What JPMorgan's Recently Released Internal Reports Unintentionally Say

After apologizing at Davos—but only to his shareholders—according to William Cohan on the Bloomberg View, the JPMorgan Chairman and CEO hastened to add about 2012, “We did have record profits. Life goes on.”

It is true; JPMorgan reported a strong financial performance in 2012, “London Whale” trading fiasco notwithstanding. I must admit that despite my 18 years inside the firm (when it had a meager $300 billion balance sheet), I struggle to comprehend $100 billion of revenues, and a $2.3 trillion balance sheet, with an “off-balance sheet” managed by a few handfuls of mostly male, mostly 30-something traders that is many orders of magnitude larger. Maybe I’m a dinosaur. Life goes on.

Not so fast.

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Of Guns, Whales, Freedom, and Justice

After visiting an awe-inspiring women’s empowerment program at work in several rural villages north of Delhi, our host at the Ashram, scanning his Blackberry, related the news: a horrific shooting…assault rifle…children slaughtered…in a school…in Connecticut (my son’s school is in the state)…and then after what seemed like an endless pause as I grew more anxious…Newtown.

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Limericks Économiques: Punitive Measures

Limericks Économiques

A six-billion loss dealt a blow
To the name of a bank's CEO.
To atone for this trade,
He merely was paid
A paltry ten million or so.

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Three Questions with Joseph Longino

With the Securities and Exchange Commission’s (SEC) decision on the possible incorporation of International Financial Reporting Standards (IFRS) into the US system still outstanding, many are wondering about the implications for their work and organizations.

In anticipation of the potential upcoming changes, IASeminars and NYSSA will host the 18th Annual NYSSA International Financial Reporting Conference & Workshops January 8-10, 2013. In the following interview, we spoke with Joseph Longino, principal of Sandler O'Neill + Partners, L.P., and a primary resource to the firm’s clients on supervisory, regulatory, and accounting matters. Longino is also a member of the Financial Accounting Standards Advisory Council (FASAC), a diverse group of senior accounting experts who advise the Financial Accounting Standards Board (FASB) on a broad range of matters affecting financial accounting and reporting standards in the private sector, and co-chair of the US chapter of the Corporate Reporting Users’ Forum (CRUF), an international discussion forum committed to engaging the FASB and IASB as they set accounting standards.

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Four Questions with Pinto Suri

With the Securities and Exchange Commission’s (SEC) decision on the possible incorporation of International Financial Reporting Standards (IFRS) into the US system still outstanding, many are wondering about the implications for their work and organizations. In anticipation of the potential upcoming changes, IASeminars and NYSSA will host the 18th Annual NYSSA International Financial Reporting Conference & Workshops January 8-10, 2013.

Here, we spoke with Pinto Suri, a principal of Prudential Fixed Income’s Credit Research Group where he covers the insurance sector. Suri has been an active member of the Corporate Reporting Users Forum, a global organization formed to enable professional investors and analysts to engage in the debate on current and future corporate reporting issues. Prudential Fixed Income, a business of Prudential Financial, Inc., is one of the largest fixed income asset managers in the US with $348 billion in assets under management as of June 30, 2012.

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Wall Street Survives One Storm but Now Faces Another

Now that Wall Street’s huge bet on presidential candidate Mitt Romney has failed, banks face four more years of a less than sympathetic ear in the Oval Office.

The world’s major capital market banks are in bad shape. They are trading well below book value, were recently downgraded and the majority of them have failed for more than two years to earn a return on equity greater than its cost.

Seven of the top 10 banks have had chief executive changes since 2009, three of these being made “effective immediately.”

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Will Sandy Trigger Our Great Transformation?

We are now a couple of weeks into the aftermath of Super Storm Sandy, and no one has yet improved upon the analysis of Bloomberg Businessweek’s November 1 cover story: “It’s Global Warming, STUPID.”

In 1944, the famous political economist Karl Polanyi explained the root cause of WW II when he wrote in The Great Transformation, “The true nature of the international (economic) system under which we were living was not realized until it failed.” Similarly, mainstream economists and finance theorists still do not get the vital interconnection between the true nature of the (economic) system under which we are living, and healthy ecosystem function. What will it take?

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No Security in Book Value

Limericks Économiques

Said a banker: "The Crisis revealed,
In investments we carried for yield,
How extreme fluctuations Affect valuations,
So better to keep them concealed."

Said investors: "It's better to trust
In the price you could fetch if you must,
And the equity value
Which, hopefully, now you'll,
Accordingly, have to adjust."

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Book Review: Red Ink

Red-InkThe federal budget is one of the key focal points for the presidential election. The candidates have their proposals to reduce the budget deficit, however, political claims seem to make the subject more confusing than clear. In addition, there are increasing worries about the "fiscal cliff, " the tax increases and automatic spending cut coming in January if Congress fails to act. Moody's has just threatened to downgrade the US triple-A rating if Congress doesn't come up with a budget deal. The opposing political parties have indicated little, if any, inclination to compromise. For those seeking an objective picture of the federal budget, David Wessel's new book will be welcome.

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The Social Impact Bond: A Private Sector Funding Mechanism to Address Social Ills

Cash-strapped municipal and state governments across the country are increasingly looking for novel ways to access private capital to finance what were once taxpayer funded initiatives, including those that address intractable social ills. One such innovation, the social impact bond (SIB), is structured to transfer the risk of investing in a given preventative social program from taxpayers to private investors through its “pay for success” feature. SIBs will potentially provide funding for exemplary social services programs that might not otherwise be implemented. It is hoped that they will also create more rigor in the measurement of program outcomes. Yet some critics worry that SIBs may have other, more problematic unintended outcomes, if they result in the transfer of the responsibility for addressing social ills from the public and not-for-profit, to the for-profit sector.

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More than the Mainstream: Mish’s Global

More than the Mainstream

Last month, the Dow, S&P 500, and Russell 2000 were all up 4-6%. After that round of QE, everyone in the financial markets and mainstream media seemingly cheered.

“It’s clear that the global leaders are doing all they can to combat the slow economy…we look forward to a strong year-end rally,” Ryan Detrick, chief technical strategist at Schaeffer’s Investment Research said on CNBC.

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What's Going to Happen to the Euro?

The Eurozone has changed; it’s very apparent. In the last year or so, the playing field has been tipped with mountainous debt problems that Greece, and now Spain and Italy, are experiencing. Of course, all of Europe will experience a huge knock-on effect from the problems in Greece and Spain—but the question is, by how much? If the Euro fails, will all hell break loose? This article outlines some of the possible outcomes of the current Euro crisis.

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Limericks Économiques: Watch That Denominator

Limericks Économiques

A fall in the joblessness rate
Would normally seem to be great,
Excepting, of course,
When there's less labor force,
Deflating the weight of that rate.

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Video: Regulatory Insights from Eliot Spitzer

Former New York Governor Eliot Spitzer recently joined NYSSA for an interview with Bloomberg Television anchor, Pimm Fox. Spitzer gave his observations and opinions about the top regulators of the current economic recovery effort—Treasury Secretary Timothy Geithner and Federal Reserve Chairman Ben Bernanke.

On Ben Bernanke:

  • Bernanke is "the last man standing." He is the only one who has been willing to make the hard economic decisions as policymakers have remained in gridlock.
  • He has used monetary policy to the fullest extent, but now there is little more that he can do.

On Timothy Geithner:

  • Geithner did not have an adequate understanding of the structural failures that existed in the financial services sector.
  • After the financial crisis of 2008, Geithner did not request enough from the banks in return for being bailed out. He simply did not comprehend how much reform was actually needed.



Podcast: Why Zombie Banks Remain Undead

Author Series Podcast

Zombie Banks author Yalman Onaran spoke with NYSSA about the aftermath of the 2008 financial crisis and the barriers blocking the road to recovery. Onaran's book asserts the inconvenient, but rational, view that recovery efforts are actually postponing the problem rather than addressing it—creating "zombie banks." Zombie banks are banks that should have died, but are being artificially preserved by government capital.

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Limericks Économiques: Swing States

Limericks Économiques

It's an axiom proven and tested
By candidates besting and bested:
If you're looking to win,
Mind the jobless rate in
All the states where the outcome's contested.

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Off-Grid Financing

The ramifications of the Libor scandal—what Warren Buffett glibly called a can of worms that affects the whole world—grow by the day. Criminal indictments of individuals, even if firms are too big to indict, appear to be in the making as the tsunami’s shock waves are about to spread to many of the usual suspects. One can only imagine the trial lawyers licking their chops. Has there ever been a class action lawsuit on behalf of the whole world?

Central bankers and regulators, understandably panicked at the height of the crisis, may have been complicit in some of the distortions in an effort to create the pretense of financial system stability. However, like the so-called “war on terror,” we find the war on financial system collapse is filled with ends-justifying-the-means moral and legal questions.

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Black Swan Events: No Longer a Rarity

Vinny Catalano, president and global investment strategist with Blue Marble Capital Management, is on a mission to heighten investment professionals’ awareness of the impact that black swan events and other hard-to-quantify and predict “big picture” phenomena are likely to have on market behavior in the 21st century. He reports investment analysts need to get comfortable navigating the uncharted waters where the black swan lurks. Catalano will be moderating NYSSA’s upcoming Market Forecast™: Are We There Yet? conference on August 9.

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Limericks Économiques: Day of LIBOR Reckoning

Limericks Économiques

Though collusion on rate executions
Was the norm in finance institutions,
When the tide quickly turned
Many bank traders learned
They would naturally face prosecutions.

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Is Jamie Dimon’s Business First Class?

JPMorgan CEO Jamie Dimon went before congress again a few weeks ago to make the case for why a $2 billion trading loss was a stupid mistake, not a willful breach of at least the intent of Dodd-Frank. And again our representatives who wrote the law didn't hold him to the standards set by JPMorgan’s own Code of Conduct: following the spirit and intent, not just the letter, of the law.

When Mr. Dimon’s predecessor J.P. Morgan Jr. was called before the Senate in 1933, he spoke humbly of a banker as a member of a long-standing profession for which there had grown a code of ethics and customs, “on the observance of which depend his reputation, his fortune, and his usefulness to the community in which he works.”

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Limericks Économiques: Unqualified Interest

Limericks Économiques

As a primary task of the Fed, it
Should cheapen the cost of our credit,
Which would help a lot more
If the mean credit score
Would qualify many to get it.

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Book Review: A Decade of Debt


In the wake of the global financial crisis, mainstream economists have begun to realize that financial markets need to be incorporated into their theoretical frameworks. The traditional view holds that asset prices ultimately reflect underlying economic activity. But it turns out that economic activity is, in turn, directly affected by asset prices, which is why the pathbreaking work of Carmen M. Reinhart and Kenneth S. Rogoff, economics professors at the University of Maryland and Harvard University, respectively, is so valuable. Their research offers a wealth of empirical data concerning the impact of debt on macroeconomic activity, as well as an analysis of the data. Because their analysis tends to be in the form of narration rather than econometric equations, it is highly accessible, even to nonspecialists.

A sequel of sorts to their acclaimed best-seller, This Time Is Different: Eight Centuries of Financial Folly (Princeton University Press, 2009), A Decade of Debt (Policy Analyses in International Economics) is shorter and summarizes some of the authors’ research that has appeared in academic journals since the publication of This Time Is Different.

In A Decade of Debt, Reinhart and Rogoff document that the public and private debts of industrialized nations have grown to unprecedented levels relative to their GDPs. Historically, high public debt levels have been reduced not through higher macroeconomic growth but, rather, through a combination of austerity measures and default. Default can occur through repudiation and restructuring, which is how debt incurred during World War I and the Great Depression was typically unwound. Default can also occur through what has been called financial repression, which refers to such government-imposed measures as ceilings on interest rates, regulatory requirements that effectively create captive audiences that extend credit to the government, and direct governmental influence on the ownership or management of financial institutions.

Financial repression is how governments of advanced nations dealt with the debt they ran up during World War II. It is likely also—Reinhart and Rogoff hypothesize—how they will deal with the debt incurred in the effort to support national banking sectors during the recent financial crisis. Because historical episodes of delevering have tended to last as long as seven years, the authors suggest that we are currently in the middle of “a decade of debt,” extending from 2008 to 2017.

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Will the JOBS Act Create Any Jobs in the Hedge Fund Industry?


The Jumpstart Our Business Startups Act, which is better known as the JOBS Act, is expected to create thousands of jobs and some of them, say industry insiders, are going to be created in the “startup” center of a financial services sector, the hedge fund industry.

The bulk of these jobs will be in marketing, investor relations, and client relations, and we can expect additional jobs to be created at vendor companies that either offer these services or will likely spring up as a result of the JOBS Act. Don’t expect an avalanche of new positions, but there should be an uptick.

That’s the opinion of several industry observers.

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Flawed, Ignorant, and Dangerous: A Bain Capital Partner’s Worldview

“At base, having a small elite with vast wealth is good for the poor and the middle class.”

This is how Adam Davidson’s piece in the New York Times Magazine summarized the frustrated former Bain Capital partner Edward Conard’s worldview, as expressed in his forthcoming book, Unintended Consequences: Why Everything You've Been Told About the Economy Is Wrong.

The article reveals the logic of what we might call the “extreme compete” elite investment class, as expressed by one of its highly “successful” participants—Conard ran the New York office for Bain Capital.

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Video: How the Economy Will Effect the P/C Insurance Industry in 2012

NYSSA's 16th Annual Insurance Conference featured presentations from a number of leaders in the insurance industry. Dr. Robert Hartwig, PhD, CPCU, President and Economist, Insurance Information Institute, gives an overview of how the current economic climate will affect the insurance industry. Hartwig's overall perspective is optimistic.

Predictions for 2012:

  • Although exposures are at their highest since 2004, they will not be restored until mid-decade.
  • No traditional hard market will emerge this year.
  • Increasing private sector hiring will drive payrolls/WC exposures.
  • Demand for commercial insurance will accelerate.
  • Auto insurers will see growth with a recovery in auto sales.
  • New home construction will continue to see very little growth.


Emerging Markets Warrant an Overweight Position in Investor Portfolios, Says David Hale

CFA Institute

Economist David Hale told delegates at the 65th CFA Institute Annual Conference that steady increases in exports and capital spending, combined with favorable demographics, will allow emerging market countries to continue to grow their economies at rates superior to those found in the more developed economies of “old industrial countries.” Given the comparatively strong growth outlook, he argued, emerging markets warrant an overweight position in investor portfolios.

In building his case, Hale noted that emerging markets have doubled their collective share of global GDP, exports, and capital spending over the past two decades, with China playing a key role in this growth. China displaced Germany two years ago as the world’s largest exporter of tradeable goods, amassing foreign exchange reserves of $3.3 trillion today (versus $3.4 trillion for all developed countries combined).

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The Covered Bond: A Vehicle for the Shift to a Low-Carbon Economy?

In our first two articles focused on the emerging climate bond market, we spoke with Nick Robins, Director of HSBC’s Climate Change Center for Excellence, and to Sean Kidney, Cofounder and Chairman of the Climate Bonds Initiative. Here, we look at how the covered bond might be adapted as an investment vehicle to catalyze the funding of the critical transition to a low-carbon economy.

The International Energy Authority now estimates that $1 trillion will be required in annual “low-carbon” project funding out to 2050 if the global economy is to avoid the most catastrophic impacts of climate change. Meanwhile, the fallout from the global financial crisis has left both governments and the capital markets severely constrained in their ability to support those funding needs.

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Time for Regulatory Change?

The shocking news out of JP Morgan this week about a $2 billion trading loss is a stark reminder that even Jamie Dimon, the CEO of such a major firm, can be completely in the dark about what's happening inside the very firm he runs. Dimon has said publicly that this surprised him.

Nonetheless, the timing is perfect for the politicians and regulators to pile on with their solutions to fix the banking industry. There are several regulations that will be referred to in the media and blogosphere during the next few weeks in relation to the JP Morgan trading losses.

Thankfully, you don't have to go to Washington, DC, or Wall Street for the debate. The New York Society of Security Analysts (NYSSA) is hosting a program called "Regulatory Changes as an Opportunity" this September. The speakers for the event will be Jim Allen, CFA, Head of the Capital Markets Policy Group for CFA Institute; and Kim Olson, a principal with Deloitte & Touche LLP.

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Recent Research: Highlights from May 2012

"The Death of Diversification Has Been Greatly Exaggerated"
The Journal of Portfolio Management (Spring 2012)
Antti Ilmanen and Jared Kizer

Diversification is famously referred to as the only “free lunch” in investing, but it has been under assault since the 2007–2009 global financial crisis, when virtually all longonly asset classes moved down together. Ilmanen and Kizer argue that the attacks are undeserved. Most investors were never as diversified as they thought they were, and there is ample room for improvement by shifting the focus from asset class diversification to factor diversification. They show that diversification into and across factors has been much more effective in reducing portfolio volatility and market directionality than asset class diversification. The benefits are greatest for long–short investing, which requires shorting and leverage but are also meaningful in a long-only context.

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Regulators Walk the Line on the Volcker Rule

Regulators are on the horns of a dilemma as they attempt to balance the conflicting concerns raised by their proposed rule for the implementation of the Volcker Rule, a provision of the Dodd-Frank Wall Street Reform and Consumer Protection Act banning FDIC-insured financial institutions from proprietary trading. Those concerns will be the topic of a discussion moderated by Martin Fridson, Global Credit Strategist for BNP Paribas Asset Management, at NYSSA’s upcoming 22nd Annual High Yield Bond Conference.

The Securities and Exchange Commission, the Federal Reserve, the Federal Deposit Insurance Corporation, and the Office of the Comptroller of the Currency released their joint implementation proposal in October 2011, and their request for comment resulted in over 14,000 letters. The Agencies’ proposal states the upfront challenge: that the delineation of what constitutes a prohibited or permitted activity under the Volcker Rule “often involves subtle distinctions that are difficult both to describe comprehensively within regulation and to evaluate in practice.” It goes on to say that the Agencies’ proposed rule was crafted to “not unduly constrain banking entities” in their business to provide “client-oriented financial services including underwriting, market making, and traditional asset management services,” but, at the same time, not to conflict with “clear, robust, and effective implementation of the statute’s prohibitions and restrictions.”

Not surprisingly, the Agencies’ best efforts to navigate these contentious waters appear to have satisfied few. On the one hand, industry lobbyists claim the Agencies’ rule places complex and onerous requirements on banks to prove that they are not engaged in propriety trading. They contend that the proposed rule will seriously compromise their market making function, raise the cost of capital, and result in knock-on effects for the economy, employment, and the banking industry’s global competitiveness.

Public interest advocacy groups, on the other hand, are clamoring just as energetically for a “bright line” interpretation of the Volcker rule that ensures banks have no room to circumvent its original intent. The latter claim it is the banking industry’s own success at lobbying to create exceptions to the Volcker Rule prohibitions on proprietary trading that led to the complexity of the Agencies’ current ruling. Many on both sides of the fence now argue that the proposed regulations will be unenforceable and should be simplified or scrapped and entirely rewritten.

A study by Oliver Wyman commissioned by the Securities Industry and Financial Markets Association illustrates the industry’s broad case against what it calls a “restrictive interpretation of the Volcker Rule. It warns of the huge liquidity impacts that would arise, including higher corporate funding costs, a reduction in household wealth due to compromised functioning of securities markets, reduced access to credit for small businesses, reduced ability for investors to exit investments, higher trading costs and lower returns for pension and mutual funds, and reduced ability for companies to transfer risks resulting in a “reduction in overall efficiency of the broad economy.”

Perhaps one of the most closely reasoned responses to industry’s criticisms of the Volcker Rule has been advanced by Wallace Turbeville, a former Goldman Sachs investment banker who testified in January 2012 before the House Committee on Financial Services on behalf of Americans for Financial Reform. In his testimony he pointed out that industry analyses of liquidity impacts have downplayed or largely ignored the reality that the Volcker Rule could not be interpreted in any way as a prohibition against proprietary trading. These activities, Turbeville, says, will instead migrate to non-taxpayer protected institutions. The Volcker Rule, he notes, merely “prohibits institutions that enjoy the benefits of a federal safety net from engaging in the risky businesses of proprietary trading and hedge fund sponsorship and ownership.” In his opinion, it will be a good thing if the rule does result in “the unavailability of cheap capital (subsidized by the public) that induces financially unsound trades.”

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Turbeville also describes another positive outcome of the Volcker Rule if properly enforced—a reduction in covered banks’ capital bases. “The massive growth of [covered bank’s] assets and the capital to hold them dates from about 1980 when they started a race to compete with each other in the increasingly de-regulated trading markets,” he reports. “Every day until the Volcker Rule is implemented, the American people bear the risk associated with de facto guaranteeing these bloated capital bases.”

Turbeville acknowledges that the rule will have impacts on block trading but he maintains that is also all to the good. “Large market participants, such as mutual funds, can direct massive flows of trading activity to banks and commonly take advantage of this market power,” he notes. “In the post-Volcker Rule environment a given block trade may have to be transacted in smaller units. This is because the non-bank institution will be more sensitive to risk, and because the capital charge will reflect reality, not public subsidy.”

Turbevile reports that as the current July deadline for conformance to the rule approaches, the conversation around what it means to make a market has gotten more detailed and more focused. “There has been an informal sharing of thoughts that has been highly constructive,” he notes. What has emerged, says Turbeville, is a line in the sand. On the one side of that line are those who contend that covered banks must not under any circumstances enter into a transaction unless it has information from a market source about what the outcome of that transaction will be. On the other side are those who would say there should be exceptions to that rule. Whether the Agencies’ final ruling will reflect one or the other interpretation, or will remain in something like its present problematic state remains to be seen.

“We are analyzing the comments and determining a prudent way forward in close consultation with the banking agencies and the CFTC,” says David Blass, Chief Counsel and Associate Director for the SEC’s Division of Trading and Markets. “It is a challenge given the quality and quantify of comments—there are 14,000–15,000 responses in form letters alone.”

The bulk of comments have come from industry groups—not just from covered banks but from an array of institutions on both the buy side and sell side, including mutual and pension funds, hedge funds, and sovereign debt and municipal securities issuers. “I can say we are taking to heart the volume and the diversity of the messages from the comments that have come in,” says Blass. “But we know at the end of the day it is our responsibility to look to what the Volcker Rule was intended to do and not just to listen to interest groups.”

“We have to work through the comments and this goes with every rule, the Volcker Rule is not unique,” Blass reports. “But an added complexity here is that other agencies are involved in the process and we need to coordinate with them. I cannot predict at this time what will happen between now and July 21, though commenters have called for the Fed to extend the conformance period for the statutory provision past July 21, the date the statutory provision otherwise takes effect.”

–Susan Arterian Chang

Susan Arterian Chang is a contributing writer to The Finance Professionals’ Post and Director of Capital Institute’s Field Guide to Investing in a Resilient Economy


Update on Brazil: March 2012

When Worldview last addressed Brazil in the autumn of 2010, the country was on the eve of presidential elections and had been enjoying a year and a half of outstanding post-crisis investment returns and celebrations in the press. The world had rediscovered Brazil and concluded it was a haven from the economic carnage that had ripped through developed world economies. Even among emerging markets, Brazil’s economic and financial performance looked spectacular.

Our piece suggested that while the long-term dynamic in Brazil still looked good, asset prices had likely gotten ahead of themselves and were no longer as attractive as before. The risks we identified had to do with the then presidential candidates lacking charisma, the temptation to over-rely on Petrobras “pre-salt” rents, euphoric animal spirits that could lead to imprudent fixed investments, and a rush of financial capital back to the developed world once signs of a recovery began to look stronger. Some of these risks have diminished, others have taken place, and still others remain.

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A Look at Why So Many Merrill Financial Advisors Are Running from the Bull

EfinancialCareersMerrill Lynch seems to be hemorrhaging top financial advisors.

The announcement this week that a Merrill private banking team managing more than $1.4 billion for dozens of families, foundations, endowments, unions, and pension plans had joined advisor-owned HighTower was just the latest in a series of recent breakaways.

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Recent Research: Highlights from March 2012

"Topics in Applied Investment Management: From a Bayesian Viewpoint"
The Journal of Investing (Spring 2012)
Harry M. Markowitz

When John Guerard, the special editor for this issue, was assembling the articles to be published, he asked Harry Markowitz to write the introduction. By the author’s own words, once he had completed that task he could see that his remarks were more like discussant comments than an introduction and could equally well be read after reading the articles.

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