The Finance Professionals' Post

Checks & Balances: Three Epochs of Federal Budget Management

Credit: Wikimedia Commons

“Today,” President Bill Clinton (1993–2001) said on January 6, 1999, “I am proud to announce that we can say the era of big deficits is over.”¹ Clinton’s pronouncement was profoundly premature, a fact underscored by the debt ceiling impasse and Treasury bond downgrade of 2011. Unless the US economy improves faster than even the most optimistic economist now forecasts, huge federal deficits will be in America’s future for many years to come. That means the national debt, already at almost $15 trillion and 100% of GDP, will continue to grow, putting more downward pressure on the government’s bond rating and additional upward pressure on interest rates. Many Americans believe that more dangerously destabilizing political squabbles over taxes and social programs are forthcoming, with results that no one with a decent respect for the intricacies of politics and economics dares to predict.

Wall Street in Widescreen: The Financial Crisis of '08 in Cinema

In the fall of 2008, as investment banks exploded and their debris cascaded upon the middle and lower classes, many Wall Street CEOs continued receiving bonuses worth millions. The Financial Crisis of 2008 fit Hollywood’s formula for profit—power, corruption, and lies equal ticket sales—so the recent spate of crisis-related films is not surprising. It is important to analyze the most noteworthy of the new films because they will, undoubtedly, become historical references in their own right in years to come as they help to define the Financial Crisis of 2008 for millions of moviegoers.

Harry Markowitz - Father of Modern Portfolio Theory - Still Diversified

Harry Markowitz’s Nobel Prize winning Modern Portfolio Theory was put to the supreme test in The Great Recession of 2008. The stock market plunged nearly 40%, stock and corporate bond markets crashed, the money markets froze up. Uncle Sam had to bail out major banks, while letting Bear Stearns and Lehman Brothers fail.

It raised the big question: Does Modern Portfolio Theory hold up during once-in-a-lifetime events?

“It is sometimes said that portfolio theory fails during a financial crisis because all asset classes go down and all correlations go up,” Markowitz said in a telephone interview from his office in San Diego, CA.

First Wall Street Collectors Bourse at the Museum of American Finance a Success

The first Wall Street Collectors Bourse, held at the Museum of American Finance, on October 21 and 22, 2011, was a success with approximately 400 visitors. Twenty-three dealers participated, showing and trading their stock and bond certificates and bank notes, including US and worldwide rarities in a wide variety of subjects. In addition, there were autographs, coins, and other ephemera related to finance.

The First Activist Congress

Observers who marvel at the far-reaching nature of the legislation passed by the 111th Congress that met from January 2009 to December 2010 may be even more amazed at the groundbreaking actions of the 37th Congress. 

That group of representatives met in four separate sessions from March 1861 to March 1863, and passed several acts that profoundly changed the federal government’s involvement in many aspects of the nation’s business.The 35th and 36th Congresses had passed 129 and 157 public acts and resolutions, respectively. The 37th Congress passed 428, while its successor extended or passed another 411. Many related not to contingencies of the ongoing Civil War, but to unfinished Republican Party business left over from prewar legislative sessions. Without representatives from 11 states that had seceded and formed the Confederate States of America (CSA), the 37th Congress passed landmark legislation such as the Revenue Act, Legal Tender Act, Homestead Act, Morrill Act, National Banking Act, and Pacific Railway Act, creating what historian Leonard Curry has labeled “a blueprint for modern America” that is still visible some 150 years later.

Nerds on Wall Street

Not long ago, trading on a stock market meant you would be in a crowd of people energetically shouting, running around, and making a mess with great quantities of paper.

No more.

Visiting a financial market now is more like visiting the “cloud,” a big data center. Computers and network gear hum in racks. Fans blow. Rows of tiny lights flicker. Occasionally someone shows up, but do not count on much water cooler conversation.

Technology did not suddenly transform our markets. It has been a gradual process, and understanding how we got here, and the simpler machines we used along the way, provides insight into today’s complex markets. It turns out that going back to the basics, from the buttonwood tree and hand signals, is a good way to explain technology that can seem hopelessly complex and buried in jargon.

Wall Street Bourse at Museum of American Finance

Wall Street Bourse, the first numismatic show to take place at the Museum of American Finance, will be held on October 21 and 22, 2011. Twenty-two dealers will bring stock and bond certificates and bank notes including US and worldwide rarities in a wide array of topics and subjects such as railroads, mining, autos, aviation, Internet and technology, telecommunications, and navigation.  In addition there will be autographs, coins, tokens and other ephemera related to finance and its history.  Admission to museum events, including the Bourse (which will be run by an independent numismatic group), will be free to the public from 10 am to 4 pm on both days.  Much to the delight of collectors and enthusiasts of numismatic objects, the Bourse will also feature an auction by Archives International Auctions on Friday evening at 8 pm, hosted at India House (One Hanover Square). John Herzog, founder and chairman emeritus of the Museum, says "This show should be of interest for the historical perspective it offers practitioners about companies they might be analyzing."   

The Real Road to Serfdom

        The past is never dead. It is not even the past.
                    —William Faulkner (1951), Requiem for a Nun

        History is more or less bunk.
                    —Henry Ford (1916), Interview in Chicago Tribune

In June of this year, I was a presenter, discussant, and session chair at the 18th Conference of the Multinational Finance Society, held in Rome. In his keynote address, Hersh Shefrin, professor of finance at Santa Clara University and a pioneer in behavioral finance, made a desperate plea to restore historical economics to the finance and international business curricula within graduate programs. There are several arguments in favor of educating future finance professors, economic diplomats, and investment bankers in the history of economic processes: 

    • First, many practices and relationships long abandoned by developed nations still flourish in developing markets. 

    • Second, many extant laws and attitudes originated in the distant past. 

    • Finally, setting aside concepts such as quantum finance and “financial hydrogen bombs,” we find   that systemic dislocations in the financial markets have analogs in the past, for greed, fear, and gullibility have always been characteristic of our species. 

Pulp Finance

The tumultuous life of Wall Street has always fascinated American novelists, often (though not always) emerging from their pens in the form of potboilers, or pulp fiction—thrillers, murder mysteries, or hardboiled noir. And despite the fact that this literary subgenre has been alive and well for more than a century, the depiction of the hero (or antihero) has changed little in that time. In the popular imagination, the analyst or investment banker is rarely harried or cowed, drab or meek. Whether the protagonists of these novels are idealistic crusaders for free markets and fair play, or the scheming, sneering villains of insider deals and underhanded intrigue, they almost always embody American finance as a figure of daring—glamorous, breakneck, and dangerous!

Artifacts of Finance: Bull and Bear, Wall Street’s Good Luck Icon

There is debate as to the exact origins of the terms “bull” and “bear” markets. But, many agree that the term “bears” first originated in reference to London bearskin brokers who would speculate on the future purchase price of the skins they acquired from trappers. The bulls were likely designated the opponents of the bears due to the popular 19th century blood sport of pitting bears against bulls. It has also been suggested that the metaphor is derived from the manner in which the animals attack, with the bull thrusting its horns up, and the bear swiping its paw down.

From the Arcives: Benjamin Graham on Being Right in Security Analysis

Benjamin Graham, the man widely recognized as the father of security analysis, wrote the following article in 1946. Though the market has changed dramatically since then, his approach to judging the success of an analyst’s recommendations remain just as valid today.

ON BEING RIGHT IN SECURITY ANALYSIS

The most interesting and important work of the senior ana­lyst leads up to and includes the recommendation that one or more common stocks be purchased. How can we tell whether such a recommendation has been right or wrong?

The Bank Panic of October 1907—A Spectator's View

This is a story not an analysis: the “what happened” of this event is well-known. Several studies have focused on the economy, the money supply and systemic faults in the banking system, and the bank events have been well discussed. Behind them there was the stock market and the behavior of stock speculators in the month of October. This story explains more about the “why” of this event; it is the story of Charles W. Morse and his friend, Fritz Heinze.

To give some background on Morse and Heinze, we need to go back to 1900. A short man with penetrating blue eyes, Morse combined many ice companies to create the American Ice Company, which monopolized the natural ice business in New York (estimated to be two million pounds a year). Morse doubled the price of ice on May 1, during an early warm spell, and suddenly everyone in New York knew Charles W. Morse, including William Randolph Hearst and Governor Theodore Roosevelt. Under pressure in the press and through many law suits, the price was reduced, and in two years Morse was forced out of the company, taking at least $11 million with him.

Suggestions for Modern Security Analysts

Economics is the social science that most identifies itself with the natural sciences. There is much that can be written about this statement in light of the events that unfolded in the 2007–2008 credit crisis, but this article focuses on the consequences pertaining to the field of Security Analysis, which is an economics-based discipline.

Security Analysis seeks to value firms based on the goods and services sold to customers via the assets (tangible and intangible) and obligations (liabilities) generated to support those sales. Despite the simplicity of this exposition, and the related simplicity of cash flow-based valuation, assessing value can be extremely difficult. The difficulty stems from the well-known fact that value is subjective, and from the equally well-known fact that the future is uncertain. Subjectivity and uncertainty means that Security Analysis requires many working assumptions, which is important because modern economics is currently grounded in mathematics that accommodates only a limited number of assumptions. As a purely theoretical, science-like endeavor this may (or may not) work, but Security Analysis is a profession, and professions are concerned with decision-making in contrast to science, which is concerned with prediction.

Artifacts of Finance: Alexander Hamilton’s Society of the Cincinnati Badge

Alexander Hamilton is known for helping to create the US Mint and the first national bank—but he is also the founding father of our national debt, which, according to John Steele Gordon, eventually led to the creation of capital markets. Hamilton butted heads with Thomas Jefferson over the assumption of national debt—among many other issues—and revisiting these early debates seems apropos in light of recent politics.

The badge above, awarded to Hamilton by the Society of the Cincinnati and passed down through the generations to his descendants, is currently on display at the Museum of American Finance as part of the “Alexander Hamilton: Lineage and Legacy” exhibit (through July 12, 2011). According to guest curator Dr. Richard Sylla, “Hamilton’s principal goals—US independence, a stronger government and economic modernization—are also his legacy. The exhibit shows that Hamilton, the subject of many stiff portraits and cold statues, was really quite a passionate soldier, statesman and financier.” 

Artifacts of Finance: Puck Lampoons Jay Gould

This 1882 cover of Puck lampoons Jay Gould, a leading railroad developer of the times. Labeled the “Robber Baron” by the press, Gould considered himself the most hated man in late-19th-century America. He was often vilified as a reckless speculator and brutal strikebreaker. Although he sought to create intricate railroad and communication systems in New York City, his hand in bribery and stock manipulation overshadowed his contribution to the development of American industry.

Nothing Ventured, Nothing Gained: The Rise of Canada’s Unique Capital Market for Start-Ups

Many people know of the historic dinner where bitter foes Alexander Hamilton and Thomas Jefferson, moderated by James Madison, hashed out a compromise that put the United States on a sound economic footing over many bottles of claret: federal assumption of the states’ Revolutionary War debts in exchange for a new capital to be built in the South. Although it was not quite so momentous, a similar evening of earnest discussion and good wine enabled the various regional stock exchanges in Canada to combine to form what is today the Venture Exchange. While that institution is formally only 12 years old, its predecessor exchanges trace their heritage back more than a century.