Current Affairs


Too Big to Fail or Too Small to Save? Dodd-Frank and the Ripple Effect on Big and Small Banks

Over the past decade, the United States has legislated huge responses to national crises. Shortly after 9/11, the Patriot Act was passed by Congress. In the wake of Enron and other accounting scandals, Sarbanes-Oxley was introduced. Troubled Asset Relief Program (TARP) was released to address the mortgage crisis of 2008 and, as a result of the bailout and other issues prevalent throughout the financial industry, the Dodd-Frank Wall Street Reform and Consumer Protection Act was legislated in 2010.

Dodd-Frank aims to “promote the financial stability of the United States by improving accountability and transparency in the financial system, to end ‘too big to fail’, to protect the American taxpayer by ending bailouts, to protect consumers from abusive financial services practices, and for other purposes.”1 2

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Video: US Financial Sectors and Europe

Glenn Reynolds, CEO of credit research firm, CreditSights, Inc., presents his outlook on US economic and financial sectors. Despite the general discourse, US banks and  the corporate field are in relatively good shape compared to previous projections. Rather than lack of ability, uncertainty is the main barrier to progress. Continued growth is unfortunately heavily dependent on the unstable economic situation in Europe. Overall, Reynolds believes US markets should be able to survive any hurdles that lie ahead.


Setting the Standards for Investing in the Solutions to Climate Change

The news around climate change grows more ominous every day, with reports of rising sea levels, droughts, severe weather, and mounting scientific evidence that the Earth’s temperature could well rise between 2 and 7 degrees in the coming century due to rising levels of atmospheric carbon. The International Energy Agency estimates that US$1 trillion investment in climate change combating projects per year will be required over the next four decades to address these catastrophic risks to the planet and global economy.

It has become more and more obvious that the challenge of climate change must be met not merely through punitive, regulatory measures. Big tent solutions that focus on the opportunities in investing in a low carbon economy are expected to be far more effective. The Climate Bonds Initiative—a not-for-profit collaboration among investors, policymakers, academics, and environmental NGOs seeking to support the development of a transparent global market for bonds issued to raise funding for climate-change mitigation and adaptation—is one such ambitious, solutions-oriented project.

Last month we spoke to Nick Robins, Director of HSBC’s Climate Change Center for Excellence, about his participation as an advisor to the Initiative. This month Sean Kidney, Chair and Co-founder of the Initiative, talks about its standard setting activities and why they are critical for the development of the market.

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Implications of New Accounting Standards

Accounting standards are modified on a regular basis and several changes will affect your analysis of financial statements in the coming months.  To put them into perspective, you might first ask yourself some other questions:

  • How does your organization approach such changes in accounting standards?
  • What does that say about your investment process?

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Who's Got G.A.M.E.?


Finance professionals will have the rare opportunity to attend a Who’s Who of financial industry leaders next month. On March 29, 2012, a host of notable speakers will gather to discuss and debate key issues in investments at the second annual Global Asset Management Education (G.A.M.E.) II Forum. “This is the first academia-hosted event of this magnitude in New York City,” said Dr. David Sauer, managing director and program chair, citing top names in the field such as Guy Adami (of CNBC’s “Fast Money”) and Abby Cohen (president of the Global Markets Institute and senior investment strategist at Goldman Sachs)—to name a few.

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What's Wrong with the Debt Debate

This former banker, and now sustainability investor and humble blogger, will not offer grand predictions for 2012. Forecasting in a world of rising uncertainty suggests a lack of understanding about uncertainty. Instead, inspired by my holiday reading, Debt: The First 5,000 Years, by anthropologist David Graeber, I will take up the debate about the debt, and offer an uncomfortable third view: jubilee (in some form) is inevitable.

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How and Where Should You Invest in Emerging Markets?

As the new year failed to ring in a solution to the debt crisis that has transfixed the eurozone, investors are left wondering whether now is the time to place their bets on potentially risky growth opportunities or to keep their assets in safe havens. Beyond Europe’s sovereign credit issues, other factors such as massive debt overhang, the threat of double-dip recessions, and ongoing money printing by central banks in the developed world call into question the traditional definition of “safe.” In this environment, some money managers are asking whether investing in emerging economies may, in fact, be safer than committing assets to developed markets.

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Global Evaluation of a Company’s Nonfinancial Information: A Challenge for New XBRL Technology


eXtensible Business Reporting Language (XBRL), an XML-based language for describing financial reports, is a freely available, market-driven, open, and global standard for exchanging business information. In an XBRL file, all of the line-items of the financial statement are tagged, depending on their accounting definition. Analysts can use these tags to capture line-item data (e.g., total revenue, net income, etc.). In general, analysts still have to read all of the items and then select what they need for the evaluation. They will also have to input the selected data into their spreadsheets. To minimize their work loads, there are some information service providers who offer the normalized financial data as part of their service. However, companies are now able to provide original data as XBRL directly to select tags themselves.

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Majority of US Finance Professionals Expect the Global Economy to Stagnate or Deteriorate

EfinancialCareersIs it time to stop thinking globally, and to start focusing locally? That’s more or less the consensus among more than 3,700 professional accountants who believe not only has international trade continued to dry up, but that the global economy will continue to erode while those industries that focus domestically will inspire greater confidence.

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Nick Robins Provides Insight on the Climate Bonds Initiative

We spoke recently with HSBC’s Nick Robins to learn more about his participation as a member of the advisory panel to the Climate Bonds Initiative. In 2007 Robins launched HSBC’s Climate Change Center for Excellence, which analyzes the long-term commercial consequences of climate change for the HSBC Group and its clients.

The Climate Bonds Initiative is a not-for-profit collaboration among investors, policymakers, academics, and environmental NGOs seeking to support the development of a transparent global market for bonds issued to raise funding for climate-change mitigation and adaptation projects. This is the first in a series of articles about this rapidly evolving, critical initiative. Next month we will talk with Sean Kidney, Chair and co-founder of the Initiative, about standard setting and product development.

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Regaining Investor Confidence for US-Listed Chinese Companies

A number of high profile scandals such as Longtop Financial Technologies and Sino-Forest have given Chinese companies a bad name among US investors. Portfolio managers who previously held extensive investments in US-listed Chinese equities now avoid the sector and some of the previously largest underwriters of US-listed Chinese equities have exited this market.

Between 2006 and 2010, a total of 339 Chinese companies listed on the major US stock markets, 106 on NYSE and 233 on NASDAQ. During this period of high interest in investing in Chinese companies, few anticipated the coming scandals and delistings.

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New Report Paints Optimistic Yet Challenging Picture for US Banks in 2012

EfinancialCareers CreditSights, an independent credit-focused research company, has issued a giant two-part report on what’s coming for US banks in 2012. Naturally, it’s credit-focused. Surprisingly, it’s also quite optimistic and suggests positive implications for jobs (in comparison to a more gloomy report also issued by JPMorgan Cazenove).

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The Hero or the Villain of the Euro

For more than two years, we have witnessed the demise of several European countries, starting with Greece’s shocking assertion in early 2009 that its deficit to GDP was more than double what had been presumed. Most investors and analysts were still not concerned since all major European countries enjoyed high investment grade ratings from the financial market’s watchdog—the major rating agencies. And, the traditional metrics for measuring sovereign debt performance, essentially all top-down macroeconomic indicators, were only just starting to signal a deteriorating scenario. The world’s financial community then began to systematically assess the health of several peripheral southern European countries (the so-called PIIGS [Portugal, Italy, Ireland, Greece and Spain]) leading to a spike in those nations’ required rates of returns on their Government’s debt. Finally, those lofty investment grade ratings began to tumble in 2010 and eventually the European Central Bank and its leading contributing countries were forced to set up rescue packages, first for Greece, then Ireland, now Portugal (still a work in progress).

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Video: The Changing Landscape of Wall Street

The economic downturn and increased financial regulations are changing the landscape of the Wall Street job market. Several of the largest corporations are hiring financial professionals to do work in-house, previously done on Wall Street for a fee. This is sending jobs out of Wall Street and into new sectors. As a result, new industries are being created as well. Banks must now change the way they operate to continue to sustain profitability.


With the Financial Markets Growing Riskier Why Aren’t Risk Managers More in Demand?



Risk management is a lot like anger management. It’s one of those disciplines you don’t really notice until it’s no longer there and things suddenly go awry. To put it simply, risk management is tasked with assessing, mitigating, and monitoring the potential for a bad outcome. When it’s working, everything runs smoothly. When it doesn’t … well, just turn on your television to any business channel.

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The Wisdom of Melville

"If your banker breaks, you snap." - Herman Melville, Moby Dick

One thousand miles into the journey, about a third of the way to England, we were struck by a humpback whale, destroying our rudder and leaving us floundering on the Atlantic.

Having read Synchronicity by Leon Jaworski, and seen this Jungian idea play out in my own life, I am a firm believer in the important hidden meaning of seemingly coincidental events, whch suggests there are no coincidences. Yet for 10 years now, I’ve been unable to connect the dots between my work on the imperative to transform economic and financial systems and the unlikely circumstance for me to decide to attempt an Atlantic crossing (I’m generally a small boat sailor), to pick up the daunting Moby Dick (I generally read non-fiction), and for us then to get slammed by a great whale.

I can now thank Carla Seaquist for showing me the meaning of this coincidence. In her insightful essay “Wall Street: Brush up your Melville”, she compares Jon Corzine (and implicitly all “Captains of Wall Street”) to Captain Ahab, although her treatment of them is far gentler than one might expect in the circumstances.

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How Psychological Pitfalls Generated the Global Financial Crisis


The root cause of the financial crisis that erupted in 2008 is psychological. In the events which led up to the crisis, heuristics, biases, and framing effects strongly influenced the judgments and decisions of financial firms, rating agencies, elected officials, government regulators, and institutional investors. Examples involving UBS, Merrill Lynch, Citigroup, Standard & Poor’s, the SEC, and end investors illustrate this point. Among the many lessons to be learned from the crisis is the importance of focusing on the behavioral aspects of organizational process.

Acknowledgments: I thank Mark Lawrence for his insightful comments about UBS; Marc Heerkens from UBS; participants at seminars I gave at the University of Lugano and at the University of California, Los Angeles; and participants in the Executive Master of Science in Risk Management program at the Amsterdam Institute of Finance, a program cosponsored with New York University. I also express my appreciation to Rodney Sullivan and Larry Siegel for their comments on previous drafts.

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How Bond Plays Work in a Market of Global Systemic Uncertainty

We recently spoke with Glenn Reynolds, CEO of CreditSights, who offered us some straight talk on how global credit market risk is impacting the broad capital markets. Reynolds will be a speaker at the upcoming NYSSA conference, Market Forecast: Turbulent Times, to be held on January 5.

Here he explains why he recommends a blended strategy of investing in high-yield corporate bonds as an equity surrogate and investment grade bonds as a defensive play to navigate what is likely to be continuing systemic market uncertainties.

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Recent Research: Highlights from December 2011

A Comment on “Better Beta Explained: Demystifying Alternative Equity Index Strategies”
The Journal of Index Investing (Winter 2011)
Noël Amenc

Cap-weighted indices have been subjected to increasing criticism. Empirical evidence suggests that cap-weighted indices deliver poor risk-adjusted performance. It has also been questioned whether market cap is a reliable proxy for the size and economic influence of a company. The fact that cap-weighted indices have been found to be neither representative nor efficient has led to the development of various alternative weighting schemes. However, how to best replace cap-weighted indices remains an open question. In an article from the Summer 2011 issue of The Journal of Index Investing, Robert Arnott discusses an empirical analysis of several alternative indexing methodologies that he broadly classifies as relying on heuristics or on portfolio optimization. Although an analysis of competing non-capweighted indices should, in principle, provide useful insights, the results reported by Arnott suffer from a flawed methodology and may confuse readers about the issues with different non-cap-weighted indices in practice.

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European Safe Bonds (ESBies)

The euro-nomics groupi,*

Markus Brunnermeier, Luis Garicano, Philip R. Lane, Marco Pagano, Ricardo Reis, Tano Santos, Stijn Van Nieuwerburgh, and Dimitri Vayanos

26th of September 2011


The European Union today faces one of the greatest challenges in its existence. The euro-zone, which just at the start of this century was lauded as Europe's great unifying achievement, has given way to states on the verge of default, financial systems that seem as solid as a deck of cards, and a great deal of disappointment with the European institutions. There are many reasons for this state of affairs, most of which fall within the realm of economics. One factor, that is crucial but under-appreciated is that Europe's problems are a consequence of a much wider, world, problem: the lack of safe assets. As a long-term trend, the impressive growth in the developing world during the last two decades has increased the demand for safe assets, as those countries' economic development outpaces their financial development yet they already need to build up reserves to smooth future shocks. As a short-term phenomenon, but one that is here to stay, the financial crisis of 2007–08 showed that financial markets can go through periods of tremendous volatility that have investors plunging towards an asset that is deemed safe.ii.

Modern financial systems rely heavily on safe assets. At the foundation of even the most complex financial securities there is usually a requirement to post as collateral some asset that is deemed safe by the parties involved. Prudent bank regulation, following Basel in its many rounds, requires banks to manage the risk in their assets in proportion to their capital. As a result, a substantial part of any bank's balance sheet must be in safe assets, as defined by the financial regulators. Pension funds are another example of a large class of investors that must hold a significant amount of safe assets, and even the least risk-averse of investors needs, even if only temporarily, to park investments in a safe vehicle. Finally, in conducting conventional monetary policy, the central bank should exchange money for safe bonds.

A safe asset for all of these purposes is one tha is liquid, that has minimal risk of default, and that is denominated in a currency with a stable purchasing power. To meet the large demand we just described, there is very little supply of assets satisfying these three characteristics. As a result, the most used of them, the U.S. Treasury bills and bonds, earn a large "safe haven" premium of as much as 0.7% per year.iii Europe, in spite of the size of its economy and its developed financial markets, and in spite of being home to one of the worlds' reserve currencies, does not supply a safe asset that rivals U.S. Treasuries. This has been noted before. What is less appreciated is that this deficiency is at the heart of the current European crisis.

In the absence of a European safe asset, bank regulators, policymakers, and investors have treated the bonds of all of the sovereign states in the euro-area as safe for the last 12 years. Bank regulators following the Basel criteria give sovereign bonds held by national banks a riskless assessment in calculating capital requirements, even as insuring against the default of some sovereign bonds using credit default swaps costs more than 5% today. The stress tests of European banks rule out, by assumption, the likely default in some of the sovereign assets held by the banks, making it difficult for investors to trust them. European policymakers have treated Greek and Dutch bonds as identically safe, even though they have traded at widely different prices in the market. The ECB accepts sovereign bonds of all its member states in its discounting operations, and while it applies different haircuts to them, they have been generous towards the riskier sovereigns. In turn, national policymakers have persuaded national banks to hold larger amounts of local national debt than prudent diversification would suggest. Finally, investors have been fervently speculating on whether sovereign states will be bailed out or not by their European partners, alternating between seeing the bonds as all equally safe, or seeing some of them as hopelessly doomed.

This situation led to two severe problems. First it created a diabolic loop, illustrated in Figure 1. Encouraged by the absence of any regulatory discrimination among bonds, European banks hold too much of their national debts, which, far from being safe, instead feeds never-ending speculation on the solvency of the banks. Sovereigns, in turn, face a constant risk of having to rescue their banks, which, combined with the uncertainty on what fiscal support they will receive from their European partners, increases the riskiness of their bonds. Finally, European policymakers lack the institutions and own resources to intervene in all of the troubled sovereign debt markets. The ECB ends up holding the riskiest of the sovereign bonds as the ECB becomes the sole source of financing for the troubled banks.

Figure 1: Diabolic Loop between Sovereign Debt Risk and Banking Debt Risk.

 Stern fig 1

Breaking this loop, and giving the euro-zone a chance to survive in the long run, requires creating a European safe asset that banks can hold without being exposed to sovereign risk. However, contrary to what is widely believed, this does not require creating Eurobonds, backed in solidarity by all the European states and their taxing power. Many Europeans are not willing to accept the fiscal integration required by Eurobonds. Moreover, without essential control mechanisms on national public accounts, hastily introduced Eurobonds may lead to a much larger debt crisis in a few years, from which there is no way back. We offer an alternative that creates a safe asset, while eliminating these problems with Eurobonds.

The second severe problem is that, in the absence of a European safe bond, the bonds of some sovereigns at Europe’s center have satisfied the demand for safe assets. In times of crisis, capital flows from the periphery to the center; in boom phases, capital flows from the center to the periphery. These alternating capital flows between searching for “yield” and searching for “safe haven”, generate large capital account imbalances in the Euro area, with associated changes in relative prices and potential disruptions in asset markets.iv

Our proposal is to create European Safe Bonds (ESB), which we will refer to as ESBies for short.v They are European, issued by a European Debt Agency in accord with existing European Treaties, and do not require more fiscal integration than the one we already have. They are Safe, by virtue of being designed to minimize the risk of default, being issued in euros and benefitting from the ECB's anti-inflation commitment, and being liquid as they are issued in large volumes and serve as safe haven for investors seeking a negative correlation with other yields. They are Bonds, freely traded in markets, and held by banks, investors and central banks to satisfy the demand that we described.

Combined with appropriate regulation that gives the correct risk weights to sovereign bonds, ESBies could solve the two problems that we just described. Banks would have an alternative to sovereign bonds, allowing them to become better diversified and less dependent on their country’ public finances. Moreover, the flight of capital to a “safe haven” would no longer be across borders, but across different financial instruments issued at the European level.

This document lays down the details of how ESBies work. The next section explains the proposal. Section 3 lists the main benefits that ESBies would bring. Section 4 to 6 go deeper into the nuts and bolts of ESBies explaining, in turn, how their composition is determined, how their safety is ensured, and how they would be issued. Section 7 compares our proposal with alternatives, the leading one being Eurobonds. Section 8 briefly concludes.


In one sentence, ESBies are securities issued by a European Debt Agency (EDA) composed of the senior tranche on a portfolio of sovereign bonds issued by European states, held by that agency and potentially further guaranteed through a credit enhancement.

In more detail, our proposal is for the EDA to buy the sovereign bonds of member nations according to some fixed weights. The weights would be set by a strict rule, to represent the relative size of the different member States. There would be no room to change the weights by discretion to respond to any crises, perceived or real. Therefore, the EDA cannot bail out a nation having difficulties placing its sovereign debt. It would typically run a boring business that does not make the headlines: It would simply passively hold sovereign bonds as assets in its balance sheet, and use them as collateral to issue two securities.

The first security, ESBies, would grant the right to a senior claim to the payments from the bonds held in the portfolio. If the tranching cut-off is X%, then the first X% lost in the pool of bonds because of potential European sovereign defaults would have no effect on the payment of the ESBies. The remaining 1-X% of revenues from holding the bonds would go to the holders of the ESBies. The number X% is relatively large, so that even in a worst-case scenario (e.g. a partial default by Greece, Portugal and Ireland and a haircut on Italian and Spanish debt), the payment on the ESBies would not be jeopardized. On top of it, the EDA, using some initial capital paid in by the member states, would offer a further guarantee on the payment of Y% of the ESBies, so that it would take losses of more than Y+X% before the ESBies did not offer a perfectly safe payment in euros to its holders. As long as this sum was picked adequately, the ESBies would be effectively safe. European banks, pension funds and the ECB would be a natural starting clientele for the ESBies, but as their reputation grows, they could be as widely used as US Treasuries are used today all over the world. They could also be used as reserve currency assets by countries such as China, Brazil, the OPEC, etc.

The second security, composed of the junior tranche on the portfolio of bonds, would be sold to willing investors in the market. In contrast with the ESBies, this is a risky security, akin to an equity claim on the EDA (but obviously without control rights). Any risk that a sovereign state may fail to honor in full its debts would be reflected in the expected return on this security. Any realized losses would be absorbed by the holders of this junior security, and not by the EDA nor the European Union nor its member States. Investors that want to hedge (or even speculate) on the ability of European member states to repay their debt would be willing to hold and trade this security.

Beyond being correctly designed and issued, the success of the ESBies depends on two regulatory changes. First, the ECB would grant strict preferential treatment to ESBies, accepting them as its main form of collateral in repo and discounting operations. In effect, the ECB would still be holding sovereign bonds as assets, but now indirectly via the ESBies; and, importantly, it would only hold the safest component of these sovereign bonds. Because of the fixed weights in the ESBies, this would be consistent with conventional monetary policy, where open market operations trade money for safe ESBies without creating credit risk for the ECB and ensuring it has a safe balance sheet. Second, banking regulators, including Basel, would give a zero risk weight to ESBies, but not automatically to other sovereign bonds. The new risk weights for European sovereign bonds will reflect their default risk just as risk weights reflect the risk on banks’ holdings of other assets such as corporate bonds or corporate loans.

Figure 2 summarizes the details in this description. There are three parts of the proposal that require further explanation: how to set the weights in the portfolio of sovereign bonds? How to choose the size of the ESBies relative to the junior tranche and the credit enhancement? And how would the EDA operate day-to-day? These are explained in more detail in sections 4 to 6. But, before discussing the details in more depth, we summarize the virtues of the proposal.

Figure 2: Graphical Representation of Tranching with Possible Credit Enhancement.


Stern fig 2

1 | 2 | 3 | 4 | APPENDIX |Next Page


*Euro-nomics is a group of concerned European economists, unaffiliated with any of their respective national governments. Their objective is to provide concrete, carefully considered, and politically feasible ideas to address the serious problems currently faced by the Eurozone. Their affiliations can be found at the end of the present document and on

i. This is an extract from a chapter of a book being produced as a larger project, Project Europe, by the euro-nomics group: That project proposes a new institutional framework for the European financial system to overcome the current crisis. European Safe Bonds are one of the legs of that proposal, and are explained in this document. We are not sponsored by any organization or institution and are independent from any country or policy institution.

ii. Farhi, Gourinchas and Rey (2011) go in detail over the many reasons why the demand for safe assets far outstrips supply today.

iii. Krishnamurthy and Vissing-Jorgensen (2010) estimate this premium.

iv.Some empirical evidence for the “flight to safety premium” for German bunds is that their yield sank to an almost record low in August and September, while at the same time the CDS spread for German bunds increased, indicating that even Germany’s default risk was increasing.

v.ESBies has the merit of capturing the sound of two possible initials for the securities, ESB for European Safe Bonds, and ESBBS for European Sovereign Bond-backed Securities.


Financial Collapse: It's Only Natural

What do the collapse of MF Global, the euro crisis, the subprime mortgage crisis, the collapse of Fannie Mae and Freddie Mac, and the 1998 collapse of Long-Term Capital Management (LTCM) all have in common?

Certainly these crises all shared the following characteristics: too much leverage, lack of transparency, inadequate regulatory oversight, agency problems of misaligned incentives, and failures of leadership at the very least. This is what we know, and we’re frustrated watching inadequate public and private sector responses to these problems.

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Not So Great Expectations

Oddly enough, the day after Steve Jobs died was the first time that I had been in Silicon Valley in decades.  Finding myself with a rental car and time on my hands, I drove to Apple headquarters. The scene was very much like that for other cultural icons that have passed on: a row of TV trucks, a large pile of notes, photos, flowers, and mementos, and the flags at half staff. There were spots available in the visitor parking area adjacent to the building, and people milling around—even going into the building—but I didn’t join them.

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Why the “Occupy Wall Street” Protesters Have Picked the Wrong Target


It’s easy to see why people who are angry with the current dismal economic state of the country so often mistakenly place the blame for this situation on Wall Street. After all, hasn’t it become the national symbol for greed, wealth, and corruption?

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Wall Street Week: It Scares the Public to Death

In Part 1 of "It Scares the Public to Death," Wall Street Week interviews Harry Clark, President and CEO of Clark Capital Investment.  After recent market lows, Clark gives his opinion on the state of the economy. "We could avoid [another recession], but I'm not going to bet on it," he says.



 Wall Street Week brings the latest thinking from nationally recognized financial advisors, analysts, and money managers.  


Commentary: The Big Choice

A $20 trillion “externality” appears to present civilization with its BIG CHOICE: economic destruction or ecological destruction, both with chilling global security implications. Here’s why, along with a practical and more hopeful alternative to “Sophie’s Choice.”

Carbon Tracker has released an illuminating report, “Unburnable Carbon—Are the world’s financial markets carrying a carbon bubble?

The report nicely describes the potential “stranded asset risk” to resource company investors, and calls for a regulatory response on disclosure. What the report does not make explicit is the BIG CHOICE: Barring a miracle technology advance in the next decade (keep working brilliant scientists and entrepreneurs), if we want to avoid civilization-transforming and global security threatening climate change, we must absorb a global security threatening a $20 trillion write off (that’s 40 percent of global GDP) into our already stressed global economy. Even if gradually spread over a decade or more, with partial offsetting value creation in sustainable energy industries, this is an unprecedented challenge.

First the essential facts as per the report:

  • The Potsdam Institute calculates that in order to reduce the risk of exceeding 2 degrees Celsius warming to a 20 percent chance (not all that comforting), the global carbon budget for 2000–2050 cannot exceed 886 GtC02. Minus emissions in the first decade of the century, this leaves a budget of 565 GtC02 over the next 40 years.
  • Total “proved” fossil fuel reserves listed on public company balance sheets and State reported reserves is estimated at 2795 GtC02, nearly 5 times the remaining budget, implying 80 percent of these reserves should be left in the ground.
  • Seventy four percent of these reserves are State owned (Russia, China, Saudi, Venezuela, Iran, Iraq, etc.) or owned by private companies, 26 percent are owned by the 200 largest public energy companies.

According to James Leaton at Carbon Tracker, the market value of the top 100 public oil and gas companies and the top 100 public coal companies listed in the report exceeds $7 trillion, approximately 12% of the global public equity market. Making a simple assumption1 that State-owned companies and reserves have an equivalent market value per unit of carbon would suggest the global market value of proved fossil fuel reserves equals $27 trillion.

A real cap on carbon emissions designed to limit warming to two degrees implies sovereign states and public corporations will need to strand 80 percent of their $27 trillion of proved reserves. Rounding down, this implies a potential $20 trillion write off.2

The risk of systemic collapse of an already fragile, interconnected global economy is high if we incur a write off of this magnitude. Fossil fuel intensive economies and investors would be severely damaged, no doubt triggering a deep and prolonged recession while the losses were absorbed. Some, like Saudi Arabia where energy represents 75% of government revenues, and Venezuela (50% of government revenues) would face economic devastation leading to widespread social unrest.

Not surprisingly, the markets are ignoring this risk today as the Carbon Tracker report makes clear. Why would they do otherwise when, as Bill McKibben pointed out, the US House of Representatives recently defeated a resolution stating simply that “climate change is occurring, is caused largely by human activities, and poses significant risks for public health and welfare”? Why listen to the broad scientific consensus when we can invent a more accommodating (and remarkably partisan) physics? No surprise that this week, American Electric Power announced that it is shelving plans for its $668-million, full-scale carbon capture plant at Mountaineer in West Virginia, the nation’s most prominent effort to capture carbon dioxide from a coal-burning power plant in the United States, “until economic and policy conditions create a viable path forward.”

Rising fossil fuel stock prices coupled with no game-changing promise of carbon sequestration technologies (the present reality) implies the markets assume we blow past the 2 degree warming limit into catastrophic climate change.

Is there an alternative to the BIG CHOICE between ecological destruction and economic destruction? I think the answer is “yes,” but not with the simple happy talk of “CSR” and “growing the green economy.” A viable plan will entail real costs, unprecedented commitment, and shared sacrifice.

Costs: The seminal “Stern Review” on the economics of climate change suggests that for a range of manageable costs centered around a 1% reduction of GDP growth, greenhouse gasses can be stabilized at 500 to 550 ppm by 2050. While this modeling exercise is highly complex, it contains at least two fundamental flaws. First, it presumes 500 ppm is consistent with the 2 degree goal, when the scientific consensus, propelled by increasingly disturbing new evidence of climate change, is calling for a limit of only 350 ppm, what Bill McKibben calls “the most important number in the world.” And second, it appears to ignore the $20 trillion stranded asset write down and associated economic spillovers by assuming carbon sequestration capabilities will allow us to continue burning fossil fuels largely unabated.

I can only speculate on what portion of the $20 trillion stranded cost potential will need to be incurred. It will depend on the success of carbon sequestration technologies (unknowable), and their cost (also unknowable). But it will not be cheap. Prudence suggests we should plan to incur at least half of these costs, still a profound multi-decade economic challenge. We must also determine what combination of caps, taxes, and regulation will best manage the difficult carbon-limiting prioritization decisions among coal, various qualities of oil, and gas, and among the resource bases of sovereign states (with armies) and multinational corporations that we decide to burn, all having profound financial, political, social, and security implications.

Unprecedented commitment: At the core, our challenge and our greatest chance to mitigate the most horrendous consequences of the BIG CHOICE boils down to a capital allocation decision. We must of course invest aggressively in the “green economy” of clean technologies including carbon sequestration, energy efficiency, and alternative energy. Indeed this process has begun as documented by Ethical Market’s Green Transition Scoreboard, which now documents over $2 trillion of private sector investments in, and commitments to, the “Green Transition.” We must accelerate low technology paths such as avoided deforestation and grassland restoration3 to sequester carbon. But we must also remove subsidies and divest from the destructive fossil-fuel- based energy, transportation, and industrial agriculture systems, and from the destabilizing and counterproductive speculation of the Wall Street financial system. Only if we marshal unprecedented private and public resources to the great energy system transition can we hope to manage the BIG CHOICE.

Shared sacrifice: It’s time for true leadership around shared sacrifice. This must start with the richest half billion people, less than 10% of the human race, whose consumption and investment decisions will determine the fate of civilization. It’s time we awaken to the burden we bear. Seeking justice, our children will ask—What did you do, once you knew?

–John Fullerton is the founder and president of the Capital Institute. He is also the principal of Level 3 Capital Advisors, LLC, an investment firm focused on high impact sustainable private investments. This article originally appeared on his blog, the Future of Finance.

1. This assumption is somewhat flawed because the market capitalization of a resource company should and usually does exceed the present value of its “proved reserves” because as a going concern, it is expected to create incremental value beyond its current reserves. However, my assumption remains conservative because it also ignores all “unproved” reserves whose values are only partially reflected in company valuations, and ignores reserves held by all private companies and public companies not in the top 100 lists. World recoverable reserves certainly exceed by a wide margin, some argue by multiples, the current quantity of “proved reserves” on the books, meaning the total potential for stranded reserves is far greater than indicated here.

2. Yes this analysis ignores the potential of carbon sequestration technologies, but they are probably at least a decade away and uncertain. It also probably overstates the sovereign value of reserves, given the widely held belief that some governments overstate their reserves for political reasons. But it also ignores the value of many refining assets, power plants, shipping, rail, and pipeline infrastructure that will be devalued if we decide to leave fossil fuels in the ground in order to limit carbon pollution. It ignores the value of all private and smaller energy companies. It ignores the value to dependent governments of all associated production and consumption tax receipts associated with fossil fuels which have tremendous economic value. And, it only achieves an 80 percent confidence that we don’t exceed the 2 degrees warming target. Overall, we believe the $20 trillion estimate of aggregate economic exposure is reasonable.

3. See


Commodities are Different (in a "Full World")

Foreign Policy’s recent “How Goldman Sachs Created the Food Crisis” reflects the dangerous, myopic thinking all too prone to “blame Wall Street” that is a natural consequence of Wall Street’s appalling, anti-social behavior in recent years.

I am no apologist for Wall Street’s modern business practices and ethics, and certainly not for Goldman Sachs, as reflected in this blog and in my 2009 Blankfein Letters. But to confuse the historic shift underway in the commodities markets that is a result of our “full world” economy with Goldman’s or any other Wall Street speculator’s bad behavior is missing the critical point.

Continue reading "Commodities are Different (in a "Full World")" »


Worldview: Summer Perspectives on the Arab Spring

It’s been scarcely six months since the start of what is now being called the “Arab Spring” : a series of revolts and, in some cases, the overthrow of authoritarian regimes in the Middle East. The conclusion of these events is yet uncertain even where revolts have thus far seemed “successful.” In this Wordlview special report, we offer some perspective on these events and suggestions on how to think about them as they evolve.

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“US Debt Default Would Be a Moral Disaster”

So declared JPMorgan CEO Jamie Dimon regarding the prospect of a US default on its debt, after which he received a standing ovation at the University of Colorado’s Denver School of Business.  Hmm… Let’s do a little press review—the following items quoted from recent news articles:

  • JPMorgan Chase recently lost a class-action lawsuit brought upon the bank for illegally foreclosing on military members’ homes while they were on active duty. 

Continue reading "“US Debt Default Would Be a Moral Disaster”" »


SEC Rules on Wall Street Pay—Major Intrusion or Minor Annoyance?

CFA InstituteWhen the U.S. Securities and Exchange Commission (SEC) took aim at incentive pay packages at financial institutions in a recent controversial proposal, it was the culmination of a three-year push to rein in executive pay at large banks, brokerages, and hedge funds. The move was not unexpected fol- lowing an era of lucrative incentives that were deemed to have fueled excessive risk taking and contributed to a global financial collapse. The crisis prompted a government rescue and, in turn, an angry reaction from Congress. The effects of the crisis will be long lasting, as reflected in our recent CFA Institute Financial Market Integrity Outlook Survey.

Continue reading "Operations in Financial Services—An Overview" »


The Threat of Losing the AAA is Self-Fulfilling

On Monday, April 18, Standard and Poor’s (S&P) put the US’s sovereign rating on negative outlook. The action was prompted by the continued deterioration of the US’s fiscal imbalances and the lack of urgency with which US political leaders have approached the country’s fiscal problems. By citing that Canada, the UK, France, and Germany all have better fiscal profiles including both better financial leverage ratios and stronger political discipline to manage their countries’ finances the rating agency has signaled that the US has lost its global financial pre-eminence. Such pre-eminence has allowed it to issue bonds at a premium to comparables and have a fiat money that has served as the world’s reserve currency. The US’s reign of global financial dominance has now officially ended.

Continue reading "The Threat of Losing the AAA is Self-Fulfilling" »

The President's Counsel on Jobs and Competitiveness ... and Tax Avoidance

The NY Times report by David Kocieniewski on GE’s aggressive tax strategies under the leadership of John Samuels, a former Treasury Department tax lawyer, which enabled the company to pay no income taxes to Uncle Sam on their $5.1 billion of US-based income has many justifiably outraged.

Some, including GE on their website, are saying what GE is doing is legal so they are doing their job for shareholders. No one at GE made “the system.” They just compete in it.

Continue reading "The President's Counsel on Jobs and Competitiveness ... and Tax Avoidance" »


Poll: Investing in Nuclear Energy

With strong support from Congress and the Administration and 13 applications for 22 new reactors pending at the Nuclear Regulatory Commission, it is often repeated that the United States is poised for a “nuclear renaissance.” However, recent reports from Moody’s and Citigroup have raised serious concerns about the extent to which nuclear power can be revived in the US and other nations without either extensive support from ratepayers or taxpayers—or both. Even as others debate the pros and cons of nuclear power, investment professionals will need to start making their own financially driven decisions.


A Blueprint for Mortgage Finance Reform


The goal of reforming housing finance should be to ensure economic efficiency, both in the primary mortgage market (origination) as well as in the secondary mortgage market (securitization). By economic efficiency, we have in mind a housing finance system that

  • corrects any market failures if they exist; notably in this case is the externality from originators and securitizers undertaking too much credit and interest rate risk as this risk is inherently systemic in nature;
  • maintains a level-playing field between the different financial players in the mortgage market to limit a concentrated build-up of systemic risk; and
  • does not engender moral hazard issues in mortgage origination and securitization.

Motivated from economic theory, we argue that such a mortgage finance system should be primarily private in nature. It should involve origination and securitization of mortgages that are standardized and conform to reasonable credit quality. The credit risk underlying the mortgages should be borne by market investors, perhaps with some support from private guarantors. There should be few guarantees, if any, from the government.

Continue reading "A Blueprint for Mortgage Finance Reform" »


Financial Reforms, Future Risk Management, and Developing Investment Opportunities

CFA InstituteThe financial bubbles and crises that have affected the world’s markets and economies during the past five years have created many credit-related investment opportunities. Looking ahead, the dislocations that still exist will have to be resolved in some way. With good analysis, investors can benefit from the likely realignments associated with the imminent “global reset.”

Click here to read the full article. 


Teasing Out the Effects of QE2 on the Real Economy

James BullardWhile Fed officials are satisfied with the results from the second round of quantitative easing (QE2), critics are predicting hyperinflation, a loss to the Fed's credibility, and increasing economic instability. Both sides continue to argue whether recent upticks in the real economy are the result of quantitative easing. 

Speaking at NYSSA, James Bullard discussed the effects of QE2 and acknowledged the difficulty of teasing out the consequences of monetary policy on the real economy—even in the best of times. 


If you want to watch the webcast of this entire event or any other NYSSA program, visit NYSSA's On-Demand website.

Trains of Thought: Divergent Theories about Economic Crises

The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.

–John Maynard Keynes

Continue reading "Trains of Thought: Divergent Theories about Economic Crises" »

Goldman and Facebook: Who's Using Who?

I sure got that one wrong.

At the end of my 2009 year end letter to Lloyd Blankfein, Chairman and CEO of Goldman Sachs, the third in an exchange that took place during the depths of the financial crisis, I predicted that Goldman clients would begin to defect, either of their own volition, or because their own clients would force them to. I predicted “civil war (inside Goldman) could break out after Goldman loses the Facebook IPO for one reason alone: the Goldman Sachs brand.”


Continue reading "Goldman and Facebook: Who's Using Who? " »


Natural Gas: A Cleaner Energy Solution Grapples with Environmental Risks

The natural gas industry has recently been the beneficiary of the Obama administration’s efforts to strike a bipartisan pose in the wake of the Republican midterm-election ascendancy. At a news conference the day after the elections, when asked if there were ways he might find to collaborate with the new Congress, Obama responded that there was certainly broad agreement that the country has “terrific natural gas resources.” He went on to ask, “Are we doing everything we can to develop those?” His response was welcomed by the natural gas industry but viewed with mixed emotions by environmentalists. On the one hand, the latter acknowledge that natural gas is a significantly cleaner burning fuel than oil or coal and is a necessary complement to renewable sources of energy. According to the Environmental Protection Agency, the burning of natural gas produces a third of the quantity of nitrogen oxides, half the amount of carbon dioxide, and only one percent of the quantify of sulfur oxides as the burning of coal. Natural gas also emits negligible amounts of mercury compounds. But environmentalists are equally concerned about the environmental impacts of the boom in hydraulic fracturing—a technology used to extract natural gas from rock formations.

Continue reading "Natural Gas: A Cleaner Energy Solution Grapples with Environmental Risks" »


James Bullard's Five Easy Pieces of Quantitative Easing

James BullardThe Fed has drawn intense criticism for its decision to purchase $600 billion in long-term Treasuries over the next eight months. This approach, so-called quantitative easing, is aimed at keeping long-term interest rates suppressed. Speaking at NYSSA, James Bullard, the president and chief executive officer at the Federal Reserve Bank of St. Louis, explained the rationale behind the Fed's decision. 

  Five Easy Pieces of Quantitative Easing


Bullard Concerned about Japanese-Style Inflation

If you’re worried about a deflationary spiral taking hold in the US, you’re not alone. James Bullard, president of the St. Louis Federal Reserve Bank and a member of the Fed’s Open Market Committee, has been an outspoken proponent of aggressive Fed action to prevent such an outcome.

In a paper titled “Seven Faces of ‘The Peril’,” which was recently published by the St. Louis Fed, Bullard argues that the Fed must take immediate action to stimulate the US economy, otherwise the economy could stagnate for years, much like Japan’s “lost decade,” when prices fell during a more than 10-year period.

Continue reading "Bullard Concerned about Japanese-Style Inflation" »


Market Upside Down: How to Invest Profitably in a Shrinking Economy

Market Upside Down In autumn 2008, the U.S. stock market crashed to the lows seen only at the depth of the tech stock bubble burst during 2000–2002, then it plunged even further a few months later.

The Dow Jones Industrial Average had just made historic highs the previous year. Euphoria still hung in the air. No one expected to see record lows again—not another bear market, not so soon. Yet, within 12 months, precipitated by house price declines and subprime mortgage defaults, the Dow Jones Industrial Average saw half of its value evaporate. Almost in a flash, investors saw their gains from U.S. stocks in the past decade disappear—all the fruits of their patient long-term investing.

Continue reading "Market Upside Down: How to Invest Profitably in a Shrinking Economy" »


Financial Reporting Issues Crowd Agenda

To say that vital financial reporting issues are clamoring for attention is a major understatement. Not only are huge accounting convergence projects underway with the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB), but controversies surrounding such issues as bank window dressing and underfunding of public pension are also hitting the business pages.

Continue reading "Financial Reporting Issues Crowd Agenda" »


Book Review: Overhaul

Overhaul by Steven RattnerWhen Steven Rattner led Team Auto—the taskforce charged with saving General Motors and Chrysler—he brought to the table his restructuring and private equity experience from his prior jobs as deputy chair at Lazard Freres and managing principal of Quadrangle Group. But, more importantly for the readers of his book, Overhaul: An Insider's Account of the Obama Administration's Emergency Rescue of the Auto IndustryRattner has also retained the writing skills from his early days as a New York Times journalist. The result is a graphic account, almost hour-by-hour record of the largest industrial restructuring ever. This book can serve as a lesson for financial professionals interested in this type of financing, and a cautionary tale about the ever-increasing role of government.

Continue reading "Book Review: Overhaul" »


EU Banks Sovereign Debt Mystery Deepens

EU Banks Sovereign Debt Mystery Deepens
Just when you thought it was safe to trust European banks again, the Wall Street Journal analyzed recent EU bank stress tests and found that a number of banks underreported their sovereign debt liabilities. Many investors, and EU regulators, were hoping to put the Greek debt crisis in firmly in the rear view mirror, but given the spotty nature of the bank’s disclosures, this may heighten concerns, rather than put them to rest.

Continue reading "EU Banks Sovereign Debt Mystery Deepens" »


One Big Happy Family: The Global Crisis Tests Postwar Alignments


If the global institutions and alignments created after World War II were looking a bit long in the tooth at the dawn of the 21st century, the economic crisis has pushed them one step closer toward irrelevance, if not extinction. Up-and-coming powers like China and India, no longer content with a subsidiary role on the global stage, are clamoring for more power, and the financial crisis is giving them the opportunity to explode the political and economic status quo.

Continue reading "One Big Happy Family: The Global Crisis Tests Postwar Alignments" »


James Bullard Discusses the Future of the Fed on Squawk Box

St. Louis Fed President James Bullard apppeared on CNBC's Squawk Box, speaking from the Kansas City Economic Symposium in Jackson Hole, Wyoming. He discussed the outlook for the US economy and potential Fed strategies.

Bullard will speak live at NYSSA on November 8, 2010, for the High Profile Speaker Series: Monetary Policy and Inflation Outcomes in the United States.


Construction Materials Outlook: Some Hope on the Far Horizon

The Finance Professionals' Post spoke with Jack Kasprzak, managing director of Equity Research at BB&T Capital, for his outlook on the three principal sectors of the construction materials sector—public works, housing, and commercial building—in the run-up to NYSSA’s Fifth Annual Construction & Materials Conference, to be held on September 29.

Continue reading "Construction Materials Outlook: Some Hope on the Far Horizon" »


In Defense of a Quant (Part I)

The public likes simple explanations, especially if they are argued with bombast. For instance, the financial crisis happened because “the young boys with PhDs in physics were conceiving a financial hydrogen bomb” (attributed to F. G. Rohatyn of Lazard Fréres). To me, it sounds like “the laws of fluid mechanics sunk the Titanic.” This is literally true, of course, but the substantive reason was much more mundane (and universal): hubris and the human propensity to throw all caution to the wind—literally and idiomatically—when big money is involved.

Continue reading "In Defense of a Quant (Part I)" »


Poll: The Bush Tax Cuts

With the Bush tax cuts set to expire at the end of the year a debate rages over whether they should be extended, modified, or simply allowed to expire. Some favor extending the cuts universally, while others—including President Obama—favor extending the cuts for the middle class and poor while letting them expire for those earning more than $250,000 a year. A recent national poll on the issue reveals a nation divided on the issue, what do you think?




Interview with Christine Richard, Author of "Confidence Game"

Confidence game
In Confidence Game: How a Hedge Fund Manager Called Wall Street's Bluff, Christine Richard unravels the story of Bill Ackman's six-year battle in warning the public of a catastrophic $2.5 trillion bond insurance business waiting to happen. As the hedge fund manager of the MBIA (Municipal Bond Insurance Association), Ackman placed a bet against the MBIA and brought in more than $1 billion for his investors from the collapse of the credit markets.  Despite his winnings, Ackman was called a fraud in the press and investigated by Eliot Spitzer and the Security and Equities Commission. A Bloomberg News reporter, Richard weaves a compelling narrative around Ackman, while revealing the financial fallacies on Wall Street. Bill Hayes, contributor to the Financial Professionals' Post, had the opportunity to speak with Richard about her book. (Richard will speak at NYSSA on Friday, September 24, 2010. Register now to reserve a spot.)

Continue reading "Interview with Christine Richard, Author of "Confidence Game"" »


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