The Finance Professionals' Post

Setting the Standards for Investing in the Solutions to Climate Change

2012-02-23T05:19:00-05:00

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.

[FPP:] How will the standards for certifying Climate Bonds encourage more institutional investors to participate in this emerging market?

[Kidney:] Most of the demand for climate change solution–related investment opportunities is coming from public sector funds, and that demand is considerable—19 of the top 20 pension funds are public sector funds. These investors recognize the macro risk of climate change but right now it is difficult for them to translate that into portfolio management practices.

For example, last year California State Teachers’ Retirement System (CalSTRS) issued an instruction to all its fund managers, both equity and fixed income, to look for climate change solutions in their portfolios. They got push back from the managers who said they did not have the expertise to do that. CalSTRS has joined the Climate Bonds Standards Board because it recognizes the need for a set of standards that can be used by its fixed income fund managers to carry out their mandate.

It is pretty obvious that any kind of thematic market like climate change, which depends on a view about the relative efficacy in non-credit terms of a particular investment, is going to be helped by a standard for that efficacy. [The Climate Bonds Initiative is not setting a credit standard—it will certify a bond based on its contribution to climate adaptation or mitigation, whether it is a junk bond or a triple A bond.] In the absence of a standard, the lowest common denominator of greenwashing corrupts the whole market and the result is reputation destruction for the market as a whole.

The standard becomes a useful screening tool for investors over time. We think that if we give those who care about the macro risk of climate change the opportunity to choose green over brown with the same risk/reward profile they will choose green. As the universe of certified Climate Bonds grows, the liquidity benefits will be obvious.

The standard should also be a tool for governments when they are looking to provide tax credits or other incentives to encourage climate change–related investments. The standard will be designed to give originators an easy means to decide whether they qualify for certification or not and to minimize the reporting they have to do to determine if they qualify.

[FPP:] What types of projects will you certify?

[Kidney:] We are unpacking what the low carbon economy will look like and planning over the next two years to release in an incremental way the criteria for a variety of low carbon economy investments.

Our first certifications will be bonds linked to wind energy but we are working on solar, grid infrastructure, and energy efficiency investments. We expect the latter to be about 40 percent of the US$1 trillion a year in investment we believe is needed for climate change adaptation and mitigation. We are also working on certifying bioenergy investments. It is a dynamic process and over time we may refine criteria and add others.

[FPP:] You note that some of the projects you certify may at present have a high level of “embedded” carbon. Can you explain what you mean and how they will qualify?

[Kidney:] Current levels of embedded carbon in a given project are not necessarily a big issue for us. We have to think long term and build everything in parallel. You can argue there is a lot of embedded carbon in solar, for example, but that is because the grid is still largely coal-fired. If we switch the grid to clean energy then the emitted carbon issue is dissipated. If you build a high-speed railway now it is only 15 percent less polluting than a plane if it is run on a coal-fired power-station-based grid. But we need to be building a high-speed railway line now, assuming the grid will eventually go green and that the railway line will therefore run on clean energy. So we plan to certify high-speed rail in the very near future because it is an essential infrastructure for a low carbon economy.

We are also considering certifying broadband infrastructure for the low carbon economy, because they will facilitate teleconferencing, smart grid applications, and load balancing across grids.

[FPP:] Are you looking at other ESG issues when you certify a Climate Bond?

[Kidney:] We are deliberately not tackling supply chain or ESG issues. As part of the application process we ask the originators to disclose how they are rated according to other types of standards but we do not mandate it. We cannot be all things to all people in disclosure. Our focus is clearly on the investments that need to be built to save the planet from climate change. That said, we would not support an investment that ends up having huge collateral damage like chopping down rainforests.

[FPP:] How do you see the Climate Bond Initiative aiding oil companies in their transition to becoming clean energy companies?

[Kidney:] Some institutional investors who want to mitigate their climate change risks are asking, “Is disengagement from oil companies going to make a difference and is it the right thing to do?” One can make the argument that the oil companies are in transition moving into cleaner forms of generation, and that helps climate change. So is disengagement the right thing?

One of our objectives is to get the petro fuel companies sideways into clean energy. It will only work if we can get conventional energy companies to retool. So one of our objectives is to make it easier for an Exxon to raise money for wind energy projects than it is for oil projects. It is a wild dream but it is one of the things we would like to change. Exxon is just a group of engineers and finance people and imagine if we could make it worth their while to build up clean energy rather than oil. If the money were cheaper to access for a clean energy project they would do it. That is what we hope the Climate Bonds Initiative will help accomplish.

Next month we will talk with Sean Kidney about the types of Climate Bonds that are likely to be issued into the market in the near future, and how they may be structured to attract investors.

–Susan Arterian Chang

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

Book Review: Startup Asia

2012-02-22T05:05:00-05:00

China is now the second largest venture market. India is third. Vietnam is quickly expanding. Now more than ever, rather than starting an entrepreneurship in the West, the newest generation of entrepreneurs are looking to the East. Many of the same venture investors that formed the original Silicon Valley are repeating these successful enterprises in Asia. Startup Asia: Top Strategies for Cashing in on Asia's Innovation Boom tells the dramatic story of how business start-ups have developed and boomed in Asia.

The author, Rebecca Fannin, a Forbes contributor, started covering this in its early days, got to know many of the key players, and has interviewed many of them. In addition to her interviews with and profiles of Asia entrepreneurs, she describes the key trends along the way in what is one of the most noteworthy parts of the globalization of entrepreneurship.

How did this change in entrepreneurial thinking begin? The first phase was the "returnees. " Those originally from China and India got top degrees in the West, worked for top-tier banking and technology firms, then returned home to use this experience and networks to create companies. Many of these new companies are termed "clones"—local copies of successful US Internet businesses. The next step was that the "locals" began to do start-ups. Then US venture capital companies moved in. Local networks, venture firms, and technology communities followed.

The biggest business startup country is China, although India is strong in research and development and mobile communications. Fannin notes that India has "the promise to close the gap with China but is no match yet.” Vietnam is on the rise and has a lot of startup activity, but is described as "just like China, only 25 years ago.”

The strength of this book is the author's "on-the-ground" knowledge, which comes from years of trips, conferences, and meetings. Fannin spent a year as a visiting professor at the University of Peking, which has a large group of continual visiting professors from around the world, to a far greater extent than any American university.

One thing missing from this book is description of start-up failure, a common and instructive part of entrepreneurship. The majority of the book describes success. The book does have "Strategies, " key points of how the startups achieved success. These “Strategies" are brief summaries, rather than in-depth case studies.

As one reads Startup Asia, one gets the sense of the intense energy and vast scope of what is occurring. At times it is a combination of speculative bubble, and a major new phenomenon that will attract the attention of financial professionals far into the future.

–Bill Hayes

Are You a Candidate for Private Wealth Management?

2012-02-21T05:15:00-05:00

Interested in a career in the private wealth management space? It is an increasingly complex profession, and successful candidates will need to possess a wide range of skills - sale skills and a personable nature being of high importance on the list. Listen to our panel of experts from a NYSSA Career Chat™ on the state of private wealth management discuss the changes in private wealth management, and what makes an ideal candidate.

(Hint: Owing to the relationship between private wealth and investment banking, former investment bankers make good candidates for private wealth management.)

What's Really Going on with US-Listed Chinese Stocks?

2012-02-20T14:08:00-05:00

In this report, we analyze the technical position of every US-listed Chinese stock with a market cap above $5 billion. Of these, nine are based in mainland China, three in Taiwan and two in Hong Kong. By far the best looking chart is China Petroleum and Chemical while PetroChina shares are stuck at resistance. The worst stock, from a technical perspective is the telecom provider in Taiwan, Chunghwa Telecom.

From a value investing perspective, we believe that the best time to invest in a market sector is when sentiment is extremely biased against it. Presently, in our view, US-listed Chinese stocks appear to be one of the most reviled investment sectors, and not without some cause. A series of frauds uncovered by diligent short-sellers, and halfhearted support in reforming fraudulent practices by Chinese regulators have undermined confidence in Chinese stocks. The most widely cited index of US listed Chinese stocks, the USX China Index, is off 42% from its October 2007 high but has more than doubled from its November 2008 low.

We believe that Chinese stocks, having fallen out of favor, will gain newfound interest by investors. Later today, [Ed. Note: This paper is dated February 14, 2012.] Chinese Vice President Xi Jinping will be visiting the White House. Xi is expected to become the Premier or head of the government later this year and the media are expecting that this visit will lead to a “reset” of US-China relations. There are concerns about a slowdown in the Chinese economy as global commodities prices rise, real estate prices weaken and some manufacturing at the margin is returning to the US. But the Chinese economy is still largely tied to the financial health of its largest customer—the US consumer—who appears to regaining his health after a long illness. So despite the concerns, there is a bull case to be made for the Chinese economy as well.

We do not have a view as to whether Chinese stocks now represent a good fundamental value or how pervasive the fraud issues are. However, the key premise of technical analysis is that the charts represent “the wisdom of the crowds” or, in other words, the many market participants ranging from savvy short-sellers like Muddy Waters, large sell-side and buy-side firms globally, individual investors and corporate insiders collectively bring all their knowledge to bear in the setting of share prices, and those with the most conviction, and presumably best knowledge, have the most impact on price given the higher volumes they trade. So, stock prices tend to correctly reflect underlying fundamental value. So in this report we look at what the technicals are saying about US-listed Chinese stocks.

We begin with an overview of the major Chinese markets. Our focus is on mainland China, but it is impossible to analyze this market without considering the interrelated Hong Kong and Taiwan markets. The main stock exchange in China is the Shanghai Stock Exchange which trades two classes of stocks – A shares which are traded in Renimbi, and are limited to Chinese citizens and Qualified Foreign Institutional Investors, and B shares which are traded in dollars and available to global investors. The Shanghai Stock Exchange is 23% off its 52-week high and just 10% above its low having bottomed in January, so this may represent an interesting entry point for investors. In Hong Kong, the Hang Seng Index bottomed in September and has gained 29%. In Taiwan, the stock exchange is 19% off its high, having bottomed in December. The USX China Index of US-listed Chinese stocks also bottomed in October and is up 25% off its low. So investors are seeing something they like again in Chinese stocks. Overall, most stocks are at inflection points of breaking out to the upside. A positive catalyst such as a good visit by Xi or a Greek settlement could push these stocks significantly higher. But, in our view, it is definitely time to be looking east again.

–Barry M. Sine, CFA, CMT

This an exerpt from a white paper entitled, "What's Really Going on with US–Listed Chinese Stocks ?" by Barry Sine, CFA, CMT, Managing Director and Director of Research at Drexel-Hamilton. Click here to download the full report.

Checks & Balances: Three Epochs of Federal Budget Management

2012-02-20T05:03:00-05:00

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.

How and why did Clinton’s optimism turn so quickly to such despair? It is easy for Republicans to blame the policies of Barack Obama (2009–present) and for Democrats to blame those of George W. Bush (2001–2009) but the ultimate cause of the government’s current fiscal predicament was the Great Depression (1929–1933, strictly speaking). That massive downturn, and the policies and economic theories it spawned, shattered the government’s longstanding commitment to peacetime balanced budgets and thereby laid the foundations for its current budgetary woes.

John Maynard Keynes
Credit: Wikimedia Commons

The history of the US government’s management of its budget can be divided into three great epochs, each of which is depicted graphically in the accompanying figures [Ed. Note: The figures referred to here are in the original copy, contact us for the article]. During the first, the age of surpluses, which lasted from the administration of George Washington (1789–1797) through that of Calvin Coolidge (1923–1929), the federal government ran large deficits (>2% of GDP) only in wartime and paid down the resulting national debt by consistently running peacetime surpluses. During the second, the age of transition, which began during the administration of Herbert Hoover (1929–1933) and lasted through that of Richard Nixon (1969–1974), large deficits were tolerated during recessions or, under the influence of British economist John Maynard Keynes (1883–1946) and his followers, were encouraged in the name of macroeconomic stabilization. The ostensible goal of those administrations was to balance the budget across the business cycle rather than across the war-peace cycle. During the third epoch, the age of deficits, which began during the administration of Gerald Ford (1974–1977), deficit finance became a structural part of the US economy. To justify persistent, large deficits politicians began to point to the costs of fighting minor wars, establishing or maintaining social justice and stimulating economic growth.

The US government ran consistent peacetime surpluses during its first 140 years because everybody wanted it to. Even Alexander Hamilton, perhaps the most pro-debt policymaker of the first epoch, argued that a national debt was a blessing only if it was not “excessive.” Presidents virulently opposed to peacetime deficits, including Thomas Jefferson (1801–1809) and Andrew Jackson (1829–1837), did everything in their power to run surpluses and were generally successful at doing so. Thanks to a string of post–War of 1812 surpluses interrupted by only three years of small deficits, Jackson was able to retire the national debt entirely at the end of 1834.

The largest peacetime deficit in real or percent of GDP terms in the first epoch took place in 1837, the first year of Martin Van Buren’s presidency (1837–1841). It registered only .80% of GDP and was caused in large part by a 50% reduction in federal revenues following a financial panic and economic contraction. Nevertheless, it cost Van Buren considerable political clout. Two subsequent deficits, in 1838 and 1840, also hurt Van Buren, who found his fiscal policy difficulties excoriated in political cartoons and commentaries. Virginia politician William C. Rives (1793–1868), for example, asked a correspondent if there ever existed “a cooler piece of hypocrisy” than a Van Buren speech preaching “economy, in the face of the most lavish expenditure of the public Treasure by himself—to deprecate and denounce a public debt, when he is the only President who ever created one, in time of peace.”² Nicknamed the “Little Magician” and the “Red Fox of Kinderhook” (New York, his hometown) in recognition of his considerable political prowess, Van Buren was neither sly nor magical enough to overcome the political burden of having resurrected the national debt. Although he managed to receive almost 47% of the popular vote in 1840, Van Buren handily lost to William Henry Harrison (1841) in the electoral college, 234 to 60.

After Harrison died just a month into his term, his successor John Tyler (1841–1845) also ran three small deficits and also paid for it politically, though “His Accidency,” as Tyler was dubbed, probably would not have won re-election even if his administration had run surpluses. Another despised one-term President, James Buchanan (1857–1861), also ran deficits in three years, including, in 1858, the largest nominal peacetime deficit ($27.5 million) prior to 1894. The Panic of 1857 was mostly to blame for the large shortfall because federal revenues fell from $74 million in 1856 to just $46.7 million in 1858. More controversially, Buchanan increased expenditures from $69.6 to $74.2 million over the same span. Like Tyler, however, Buchanan’s relative fiscal profligacy played only a small role in his ouster.

After the Civil War, the federal government ran surpluses for almost three consecutive decades, even during economic downturns. By the early 1890s, however, the surpluses had shrunk from generally robust ones in the double and triple digits to just a few million dollars. When revenues collapsed in the wake of a financial panic, from $385.8 million in 1893 to $306.3 million in 1894, a fairly sizeable deficit of .43% of GDP occurred despite a simultaneous retrenchment in government expenditures of some $16 million. Deficits continued to dog the second administration of Grover Cleveland (1885–1889; 1893–1897) and the first three years of the presidency of his successor, William McKinley (1897–1901). Tellingly, however, McKinley ran a surplus heading into the 1900 election, which he won, only to be assassinated the following year.

With the national debt almost extinguished in real terms, dropping under 5% of GDP in 1902, Presidents Theodore Roosevelt (1901–1909), William Taft (1909–1913) and Woodrow Wilson (1913–1921) found it politically expedient to run a few, small peacetime deficits. The national debt grew slightly in nominal terms during their presidencies, but continued economic growth meant that by 1916, the last full year before US military involvement in World War I, it stood at a mere 2.47% of GDP, its lowest level since the Civil War. The government ran a large deficit in 1919 due to engagements entered into before the war ended in November 1918, but true to form it enjoyed surpluses averaging .85% of GDP throughout the 1920s. By 1929 the national debt stood at only 16.34% of GDP and about $17 billion, down from 32.53% and $25.5 billion a decade earlier. Had the Great Depression not occurred, the US government would have continued running surpluses and paying down the debt until World War II.

Franklin D. Roosevelt
Credit: Wikimedia Commons

The Depression did happen, however, and the nation has been paying for it ever since. The rhetoric of balanced budgets remained virulent for a long time. Both Herbert Hoover (1929–1933) and Franklin Roosevelt (1933–1945) repeatedly stated that in peacetime the government should at least balance the budget if not run surpluses. But the reality was different. After running surpluses in 1929 and 1930, the Hoover administration ran slightly into the red in 1931 at .6% of GDP, a common occurrence during recessions as described above. In 1932, however, Hoover busted all previous records with a peacetime deficit of $2.7 billion or 4.66% of a rapidly shrinking GDP. A precipitous drop in revenues from $3.1 to $1.9 billion was the primary culprit, but Hoover in his final year also increased government spending from $3.6 to almost $4.7 billion. Roosevelt ran deficits every year of his presidency, an average of 3.84% of GDP through 1941. By then, federal revenues had rebounded to $8.7 billion but expenditures grew even more quickly, to $13.6 billion, partly due to New Deal programs and partly due to military mobilization.

After the war, the US national debt stood at an unprecedented 122% of GDP. After demobilization was complete in 1946, Harry Truman (1945–1953) ran several surpluses, including an impressive $11.8 billion (4.38% of GDP) one in 1948. Thereafter, however, surpluses became smaller and less frequent. Wars in Korea and Vietnam, other foreign policy obligations, the space race, and the continued growth of New Deal and New Society entitlement programs stymied all attempts to balance the budget. Dwight Eisenhower (1953–1961) managed it only three years, and the last time only barely. The administrations of John F. Kennedy (1961–1963) and Lyndon Johnson (1963–1969) were in deficit every year, though only once, in 1968, at more than 2% of GDP. Richard Nixon (1969–1974) managed only one small surplus, in 1969, but two years later put the government in the red by over 2% of GDP.

But the track record of the Presidents during the second epoch was downright fiscally conservative compared to that of the Presidents since Nixon. In only one year during the administrations of Gerald Ford (1974–1977), Jimmy Carter (1977–1981), Ronald Reagan (1981–1989) and George H.W. Bush (1989–1993) was the deficit less than 2% of GDP. Reagan ran the two biggest in real terms, in 1983 and 1985. During his first term in office, Bill Clinton (1993–2001) and an increasingly buoyant economy sliced the deficit from 3.83% of GDP to just .26%. In his second term, the government ran the only surpluses of the third epoch. Deficits returned during both of George W. Bush’s terms, however, and half of them were over 2% of GDP. Under Obama, government deficits have topped 10% of GDP, twice those recorded under Reagan and completely unprecedented in peacetime.

Partisans naturally want to blame their political enemies for this stark disintegration of federal fiscal discipline, but clearly long-term forces were at play. During the third epoch government expenditures grew in nominal terms every year but revenue growth was much more sporadic and sometimes negative. Revenue growth exceeded expenditure growth in 20 out of the last 36 years, but total expenditure growth over the period outpaced total revenue growth by some 50%. The cause of chronic deficits was therefore two-fold: expenditures increased faster than revenues on average and revenues were much more volatile than expenditures.

Both of those problems can be traced to the Great Depression. Nominal government expenditures have increased every year since 1965 because entitlement programs like Social Security and Medicare grow ever larger due to demographic changes (e.g., an aging population), general inflation, and runaway medical costs. Social Security was of course a New Deal program. Its biggest fault was that it provided a permanent solution to a temporary problem, the growth in the number of the aged indigent. Before the Depression, the elderly were no more likely to live in poverty than members of any other age group were. As their wages declined as they aged, most Americans compensated by investing in financial (e.g., annuities), real (e.g., rental houses), and familial (e.g., working children) assets.

The Depression temporarily depressed all three income streams, leaving many retirees destitute. Instead of seeing them through the crisis and allowing the private security system to continue to evolve, the government instead enacted Social Security, in part to prevent the passage of even more radical plans like that of Francis Townsend (1867-1960). Forced to save through Social Security, many post-war Americans allowed the private security safety net to wither and thus became increasingly reliant on the government to provide for their retirement. Soon Social Security became the third rail of US politics, a program often expanded but only occasionally and marginally retrenched.

Medicare’s connection to the Depression was less direct but no less real. During the Depression, the government disassembled the nation’s first health insurance system, which was dominated by low cost mutuals and pre-paid medical care providers compensated for curing patients rather than just seeing them.

Lyndon Johnson Signing Medicare
Credit: Wikimedia Commons

In its place, the government encouraged the creation of a new system based on for-profit insurers, employer-provided insurance and a pay-for-service model. All three innovations encouraged continual cost increases to satiate stockholders and healthcare providers. By the 1960s, many older Americans found it increasingly difficult to obtain or pay for healthcare. Rather than try to reduce costs, the government provided retirees with a heavily subsidized healthcare program that actually accelerated healthcare cost pressures in myriad ways. Those costs, which continue to rise faster than inflation, combined with increases in longevity mean that Medicare, not Social Security, is currently considered the nation’s biggest budget buster.

The variability of government revenues is a by-product of Keynesian economics, another Depression-era innovation. According to Keynesians, governments should increase spending during recessions in order to stimulate the economy. (Output equals consumption plus business investment plus government spending plus net exports. Increases in government spending, Keynesians claim, can offset decreases in the other three, especially investment.) Of course government revenues drop during recessions, so the increased spending Keynesians call for must be financed by borrowing. Although few describe themselves as Keynesians, most post-war US Presidents have increased government spending during recessions. Revenues turned negative during 3 of the last 4 recessions, but expenditures continued to grow and even accelerated during the last 2. Roosevelt’s failed attempt to balance the budget in 1937, which according to Keynesians caused that year’s recession, was invoked as recently as the Great Contraction of 2008–9 to justify various economic stimulus plans and continued high levels of government expenditure. So while the effectiveness of Keynesian stimulus is hotly debated among academics, no President is likely to move significantly toward a balanced budget when the economy is on the skids. This de facto Keynesian policy consensus has precluded serious consideration of alternative tax regimes. Contingent or standby taxes that would kick in when large deficits loomed were briefly employed during the Reagan administration, but the 18th-century notion of directly tying taxes to expenditures in peacetime has largely been lost and is unlikely to be resuscitated as long as policymakers continue to think of deficit financing as a key macroeconomic stabilizer.

So the next time you want to bash your favorite political enemy over the head, think about blaming the Great Depression instead. Maybe then we can work together to actually end the age of deficits.

–Robert E. Wright

NOTES

¹ Website

²Emphasis in original as quoted in Wright, One Nation Under Debt, 274.

This article originally appeared in the Winter 2011 issue of Financial History, a publication of the Museum of American Finance.

Implications of New Accounting Standards

2012-02-16T04:45:00-05:00

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?

Before we consider those questions and some of the impending modifications, let’s look at a concrete example of the use of accounting information at your firm. When communicating estimated and reported earnings, do you adopt the treatments used by sell-side analysts and market data providers, whether they are GAAP or non-GAAP, or are there internal standards that are applied?

At many firms, there is an attitude of laissez-faire regarding questions like these, with the thinking that however alpha can be generated (and using whatever numbers), it is valuable. On the flip side, the lack of a common approach can prove to be sand in the gears of decision making, with the interpretation of information not as straightforward as it could be.

Whatever the practice might be for your organization, it illustrates one facet of a collective judgment about the relationship between accounting information and investment analysis. Similarly, your reaction to the promulgation of new accounting standards says much about your process.

Do you have in-house experts? Many firms, even sizable ones, do not have accounting specialists. As a result, there is a reliance on others to put new standards into perspective. The information might come from accounting organizations, consultants, or brokerage and rating agency analysts. Where do you get the expertise that you need?

Then—and this is the most important question—what do you do with the information? How do you judge the impact of the changes on asset prices and on issuer behavior going forward? How do you adjust your processes in light of them? What kind of training do you provide about them?

As you think about those larger issues, the immediate business is familiarizing yourself with the new standards and judging the implications for your work. A good place to start is the Financial Accounting Standards Board (FASB) website, specifically its most recent update for financial statement users. It provides a concise summary of the upcoming changes—as well as an update on the convergence of accounting standards globally—and there are links to documents that provide more detail.

Among the new standards is one requiring improved disclosure regarding multiemployer pension plans. Given the severely underfunded status of many plans and the ripple effect that has had on the financial performance of some firms, there is increased attention being paid to the burden of plan obligations. The new disclosures might cast the long-term financial health of some companies in a different light.

Other changes include a simplification of the testing for goodwill impairment and increased disclosure about items that are to be stated at fair value. A couple of standards could have meaningful effects on the reported results for specific industries: the recognition of net patient-service revenue will be altered for some health care companies and insurance firms will face new rules on the capitalization of costs related to the acquisition of contracts.

Still on the drawing board are changes in standards involving revenue recognition, the capitalization of leases, and the valuation of financial instruments that are impaired. Each has the potential for a notable impact on the work of analysts and the pricing of assets.

That is why every new standard should be evaluated in the context of your investment process. When the numbers change solely because of a change in standards, how do your methods change?

A simple illustration demonstrates the challenge. Let’s say that you invest based entirely upon the relationships of some financial ratios. A new standard dislodges those ratios from their historical context. There would be a great deal of effort involved in restating them and in many cases it wouldn’t be possible. Consequently, your frame of reference has changed and so has that of other market participants.

Of course, the impact depends on the asset class in which you are investing, your particular style, and the nature of the accounting modifications. There are risks and also opportunities.

A forthright consideration of new standards should be a routine aspect of your investment process, as should ongoing assessments of accounting risk and evaluations of the informational quality of reported numbers versus adjusted data. How your organization filters and uses accounting data has an impact on whether you are able to produce outstanding returns, and each new standard has the potential to change the dynamics of the analytical structure on which you rely.

What could be more important?

–Tom Brakke, CFA, provides consulting services to investment organizations on decision making and the communication of ideas. He also writes about investment processes on the research puzzle blog.

A Tale of Two Overhangs: The Nexus of Financial Sector and Sovereign Credit Risks

2012-02-15T05:15:00-05:00

ABSTRACT

There has emerged in the Western economies a strong nexus between the credit risks of financial sectors and their sovereigns. We argue that this phenomenon can be understood in the context of two debt overhang problems: one affecting the financial sector due to its under-capitalization following the crisis of 2007–08; the second, affecting the non-financial sector, whose incentives are crowded out by high sovereign debt and anticipated future taxes. While the desire to resolve the financial sector overhang may make bailouts tempting, they raise the risk of exacerbating the overhang related to sovereign debt. Conversely, reduction of growth prospects due to sovereign debt overhang can make the financial sector riskier as it is highly exposed to sovereign debt both through direct holdings and indirectly through implicit government guarantees. We provide evidence on this important nexus, based on our ongoing research that exploits data on European bank and sovereign credit risks.

From 2007 to 2010, the public debt to gross domestic product (GDP) ratio of the Irish government increased roughly at 20 percent per annum, from one of the most prudent in 2007, at 25 percent, to among the highest in 2010, at 96 percent. Irish banks had looked increasingly vulnerable in the Fall of 2008 with their credit default swap (CDS) spreads—the cost of buying protection against default on their unsecured bonds—having reached a peak (on average across the four largest banks) of over 400 basis points (bps) in September 2008. While Irish bank CDS stabilized to 150 basis points following the Irish government’s announcement of a blanket guarantee of all creditors of Irish banks on September 30, 2008, the post-bailout period saw Irish sovereign and bank CDS co-move strongly, with both increasing to over 600 (bps) by the start of 2011.

At the other end of Europe, the Italian government had maintained a debt-to-GDP ratio of close to 100 percent even before 2007. While the Italian banks were stable at CDS spreads of close to 100 bps in 2007, the Italian sovereign CDS widened steadily from 2007 to 2010, reaching nearly 600 bps in 2011. By this time, the Italian banks were also assessed in credit markets at a significantly higher risk of over 600 bps. The situation in Greece was similar, indeed worse, with Spain and Portugal sitting somewhere in between the case of Ireland and the cases of Greece and Italy. All of these countries experienced severe growth contractions during 2007–2011.

The pan-European patterns were similar: the average pre-bailout quality of the banking sector and the size of government debt predict future sovereign risk. We illustrate these relationships by examining empirical proxies for the quality of the banking sector and the size of the government debt before the bank bailouts and their association with the change in sovereign credit risk after the bailouts.

Figure 1 pertains to the quality of the banking sector. We measure the quality of the banking sector as the average bank CDS as of September 26, 2008. We choose this date because it is immediately prior to the first announcement of bank bailouts in Europe and the US. We thus interpret our measure as a proxy for the quality of the bank sector if investors do not necessarily expect bank bailouts. Consistent with this interpretation, we generally observe a large decline in average bank CDS after the announcement of a bailout. We use sovereign CDS to measure sovereign risk and we analyze the change in sovereign CDS over a short and a long horizon. The short horizon is September 26 until October 21, 2008, the period when a large group of Western governments announced their bank bailouts. For the long horizon, we extend this period until the 2010 European bank stress tests (September 26 to March 31, 2010). The 2010 European bank stress test is a natural cutoff for the long-term measure, but our results are robust to other cutoff dates.

As shown in Figure 1a, there is a positive relationship between the quality of the banking sector and the short-term change in the sovereign CDS. Countries with risky banking sectors, such as Spain and Ireland, had an increase in sovereign CDS of up to 50 basis points, whereas countries with safe banking sectors, such as Norway or Sweden, experienced an increase of less than 20 basis points. As shown in Figure 1b, the positive relationship survives if we examine the long-term change in sovereign CDS. The fit is quite remarkable given that the 2010 bank stress tests were conducted more than two years after the Lehman bankruptcy.

FIGURE 1a: Average Bank CDS before Bailouts Predicts Sovereign CDS after Bailouts (Short-Run)

This figure shows the relation between average bank CDS by country before the bank bailouts (as of September 26th, 2008) and the increase in sovereign CDS after the bank bailouts (from September 26th, 2008 to October 21, 2008). The bank and sovereign CDS data are from Datastream. We include all European countries with available data on sovereign CDS and bank CDS.

FIGURE 1b: Average Bank CDS before Bailouts Predicts Sovereign CDS after Bailouts (Long-Run)

This figure shows the relation between the debt-to-GDP ratio before the bank bailouts (as of July 1, 2008) and the increase in sovereign CDS after the bank bailouts (from September 26, 2008 to October 21, 2008). The debt-to-GDP ratio are from the OECD and the sovereign CDS data are from Datastream. We include all European countries with available data on sovereign CDS and debt-to-GDP ratio.

Figure 2 pertains to the size of government debt. We measure government debt as the debt-to-GDP ratio before the Lehman bankruptcy (as of June 2008). As shown in Figure 2a, there is a positive relationship between the pre-bailouts size of debt-to-GDP and the short-term change in the sovereign CDS. Countries with a high debt-to-GDP ratio, such as Italy and Greece, experienced an increase in bank CDS of up to 50 basis points, whereas countries with a low debt-to-GDP ratio, such as Finland and Germany, experienced an increase of less than 20 basis points. As shown in Figure 2b, the positive relationship survives if we examine the long-term change in sovereign CDS.

FIGURE 2a: Debt-to-GDP Ratio before Bailouts Predicts Sovereign CDS after Bailouts (Short-Run)

This figure shows the relation between the debt-to-GDP ratio before the bank bailouts (as of July 1, 2008) and the increase in sovereign CDS after the bank bailouts (from September 26, 2008 to October 21, 2008). The debt-to-GDP ratio are from the OECD and the sovereign CDS data are from Datastream. We include all European countries with available data on sovereign CDS and debt-to-GDP ratio.

FIGURE 2b: Debt‐to‐GDP Ratio before Bailouts Predicts Sovereign CDS after Bailouts (Long-Run)

This figure shows the relation between the debt-to-GDP ratio before the bank bailouts (as of July 1, 2008) and the increase in sovereign CDS after the bank bailouts (from September 26, 2008 to the European bank stress tests on March 31, 2010). The debt-to-GDP ratio are from the OECD and the sovereign CDS data are from Datastream. We include all European countries with available data on sovereign CDS and debt-to-GDP ratio.

Figures 1 and 2 suggest that is important to examine both the quality of the banking sector and the size of government debt. For example, Ireland is prominent in the banking sector figure but an outlier with regard to the debt-to-GDP ratio. In contrast, Italy is prominent in the debt-to-GDP figure but an outlier with regard to the banking sector. Taken together, our analysis shows that some countries, such as Ireland, entered distress due to significant debt overhang in the financial sector, whereas others, such as Italy, entered distress due to sovereign debt overhang.

We therefore argue in Acharya, Drechsler, and Schnabl (2010) that these relationships between financial and sovereign credit risks, and economic growth, are not accidents, but in fact represent a tale of two debt overhang problems. When financial sectors are under-capitalized, as after the losses suffered during the 2007–08 financial crisis, economic growth can collapse as financial intermediaries engage in de-leveraging and a credit crunch ensues. In other words, the resulting debt overhang in the financial sector reduces banks’ incentives to provide credit to the real economy. To avoid such a credit crunch and loss of real sector output, governments engage in large‐scale, often blanket, financial sector bailouts.

Such bailouts, however, are costly and run the risk of amounting to a “Pyrrhic victory” for the sovereigns. First, bailouts require immediate issuance of additional debt by the sovereign in order to backstop the creditors of distressed or insolvent financial firms. This leads to an immediate increase in the sovereign’s credit risk through the liability side of its balance-sheet. Second, and perhaps even more importantly, the sovereign runs the risk of becoming indebted to the point where another debt overhang can take hold in its economy. The private sector—households and corporations—anticipate that the sovereign’s additional debt will require higher taxes in the future. This dilutes long-run returns on real-sector and human-capital investments. The resulting under-investment in the economy can cause growth and productivity in the sovereign to slow down, affecting the sovereign’s credit risk through the asset-side of its balance‐sheet. There is therefore a tradeoff between the two overhangs and the sovereign many need to "sacrifice" its own creditworthiness in order to alleviate the financial sector’s overhang. The resulting rise in sovereign credit spreads induced by this "sacrifice" is consistent with the patterns in Figures 1 and 2, as are downwards revisions in expectations of growth in the Fall 2008.

Perversely, the deterioration in the sovereign’s creditworthiness introduces the risk that its credit problems will feed back adversely onto its financial sector. One channel through which this occurs is the significant direct holdings of government debt by the financial sector. The stress test data revealed by the European regulators in June 2010 (on positions as of March 31, 2010) show that for every six Euros of risk‐weighted assets, the 91 stress‐tested European banks held on average one Euro of sovereign bonds. Further, Figure 3 shows the extent of "home bias," the proportion of the sovereign debt that was held by banks in a given country in the form of the country’s own bonds. The home bias in government bond holdings is on average close to 60 percent, and is particularly strong for banks of troubled sovereigns (Greece, Ireland, Portugal, Spain, and Italy). This home bias creates one form of reverse feedback from sovereign to the financial sector. As Figure 4 shows, the credit quality of European banks as of the stress tests in March 2010—by when sovereign problems had begun to fester—was indeed related to the extent of their (respective) home bias.

FIGURE 3: Home bias in Government debt

This figure shows the average holdings of home sovereign debt as a share of total sovereign debt by country as of the European bank stress tests on March 31, 2010. The holdings are computed based on data released during the 2010 European bank stress test.

FIGURE 4: Home bias in Government Debt and Bank Credit Risk

This figure shows a positive association between home bias in government debt and bank credit risk (proxied for by the natural logarithm of a bank’s credit default swap) as of the European bank stress tests on March 31, 2010. Home bias in government debt is total home sovereign debt as a share of total sovereign debt. Home bias is computed from data released as part of the 2010 European bank stress tests. The bank CDS data are from Datastream. We include all banks that are included in the 2010 bank stress tests and that have bank CDS data.

The second form of reverse feedback arises due to the fact that the financial sector—with or without bailouts—is perceived to have creditor guarantees provided by the sovereign. As the sovereign’s creditworthiness declines, the value of these explicit and implicit government guarantees also declines, and this adversely impacts the financial sector’s credit quality.

The case of the Spanish Bank Santander provides an example of the increased borrowing costs paid by a bank as the value of its sovereign’s implicit guarantees deteriorates. Despite being the most profitable bank in the Euro region since 2007, Santander was in October 2010 paying more to borrow than some of its weaker counterparts in Germany. In particular, on June 1, 2010, Santander had a long‐term bond rating of 'AA' and was trading at a CDS fee of 207 bps. Its sovereign, Spain, had a sovereign CDS fee of 247 bps. On the same day, the German Bank WestLB had a long‐term rating of "BBB+" and traded at a CDS fee of 158 bps. Its sovereign, Germany, had a sovereign CDS fee of 43 bps. Hence, even though credit ratings suggested that the profitability of Santander was significantly higher than the profitability of WestLB, the credit risk of Santander was higher than that of WestLB. ¹

Figure 5 shows that that this pattern holds across Europe. We assign each bank the sovereign CDS of the country where the bank is headquartered and groups countries in five quintiles using sovereign CDS. Next, we compute average banks CDS by credit ratings and by country quintile. The figure shows that keeping credit ratings constant, bank CDS monotonically increase in country quintiles, weakly so in the left panel which is before the bank bailouts (second quarter of 2008), and strongly so after the 2010 European bank stress (second quarter of 2010). In particular, banks with credit ratings of 'AA' and 'A' in the highest country quintile (e.g., Spain in June 2010) had on average higher CDS prices than banks with credit ratings of "BBB" in the lowest four country quintiles. Alternatively, we can test the strength of the association between sovereign and bank CDS as a function of a bank’s credit rating. Specifically, we use daily bank‐level data to estimate
where log(Bank CDS_it) is the natural logarithm of the CDS of bank i at time t, Rating_ikt is an indicator variable for the S&P Rating k of bank i at time t, log(Sov CDS_it) is the natural logarithm of the CDS of the country in which bank i is based, and δ_t are time fixed effects. We focus our analysis on banks that are based in Europe and the US with more than $50 billion in assets (according to Bankscope) and that have traded bank CDS and sovereign CDS (according to Datastream). We restrict our sample to the period after the bank bailouts and we focus on banks with S&P investment grade ratings (according to S&P RatingsXpress).

Table 1 presents the result. As shown in Column (1), bank CDS is larger for banks with lower ratings. This result is not surprising and suggests that credit ratings are informative about a bank’s financial distress. More importantly, Column (2) shows that the relationship between bank and sovereign CDS is positive for all banks and statistically significant for banks with lower ratings such as banks with A or BBB ratings. For banks with a credit rating of AA or higher, a 10 percent increase in sovereign CDS is associated with a 1.2 percent increase in bank CDS. For banks with a credit rating of A or BBB the effect increases to 3.1 percent and 2.6 percent respectively. Hence, the strength of the association is larger for banks with lower ratings. In short, these results suggest that an increase in sovereign CDS increases bank credit risk even after controlling for bank credit ratings and that the impact of sovereign CDS is larger for bank with lower credit ratings.

TABLE 1: Bank CDS and Sovereign CDS by Bank Rating

The table shows regressions of bank CDS on bank credit ratings and sovereign CDS for the period from November 2008 to December 2010 using daily data. The sample includes all banks that have more than $50 billion in assets in Bankscope, have an investment grade rating from S&P in RatingsXpress, and have traded CDS in Datastream. The omitted category is Rating AAA and AA. The standard errors are clustered at the bank-level
**1% significant, *5% significant, and + 10% significant

Both of these reverse feedbacks—the first due to direct holdings of government bonds by financial firms, and the second due to implicit guarantees of the financial sector by governments—would further result in withdrawal of intermediation by banks, exacerbating sovereign credit risks, and giving rise to severe downward spirals of growth.

The nexus of debt overhangs and credit risks between the sovereign and the financial sectors that we have highlighted has an important policy implication. Sovereign bonds are accorded minimal, often zero, risk-weights in capital requirements for banks as long as sovereigns are well-rated. However, through the nexus of debt overhangs, even small deteriorations in the credit quality of sovereigns can precipitate financial and economic crises. It may therefore be prudent in good times, even when sovereigns are well‐rated, to entertain the “stress test” possibility of future credit deterioration, e.g., though non‐zero risk weights on sovereign bonds, and to require banks to fund sovereign bond holdings with reasonable quantities of capital. Not doing so can result in excessive funding of sovereigns by banks in good times, but with sharp reversals in bad times, as is being witnessed currently in the eurozone.

–Viral V Acharya, Itamar Drechsler and Philipp Schnabl (NYU Stern)

NOTES

¹In another example, Santander sold in September 2010 1 billion euros ($1.4 billion) of 4.125 percent, seven-year senior bonds with a AA rating that yielded 156 basis points more than average market rates. In contrast, Germany’s Commerzbank AG, which required a government rescue in 2008, issued 1 billion euros of 4 percent, 10-year senior debt with an A rating that yielded 126 basis points more than the benchmark.

REFERENCES

Acharya, Viral V., Itamar Drechsler and Philipp Schnabl. 2010. “A Pyrrhic Victory? Bank Bailouts and Sovereign Credit Risk”, Working paper, NYU-Stern.

If the Bonus Season Made a Fashion Statement, Color it Gray

2012-02-14T05:10:00-05:00

Let’s face it. The forecast for this year’s bonus season is down right gloomy. And judging by eFinancialCareers most recent survey on the subject, most financial professionals were not surprised.

Like we do every year around this time, eFinancialCareers took a look at the year-end payouts that begin in December and last on through February by surveying Wall Street professionals who are bonus-eligible and know the amount of their annual bonus.

Nearly half (45%) of those more than 1,000 financial markets professionals surveyed said their bonus met their expectations while 1 in 10 (11%) said they did better with their bonus than they expected.

In fact, only just over a third (35%), said they were disappointed and indicated their payout had missed their expectations. And it is these unhappy souls about which Wall Street firms are most concerned.

Our research found that 1 in 3 (32%) of those who were disappointed had actually performed well, and saw their bonuses rise year over year. They just didn’t rise nearly enough as far as these star employees were concerned.

Part of this disappointment was obviously due to their company’s overall performance and a number of Wall Street firms saw revenues plummet, especially in their investment banking divisions.

Some firms, such as UBS, have slashed investment-banking bonuses by 60% this year. The head of UBS investment banking didn’t receive any bonus at all, but then why should he, if the unit lost money following a trading scandal last September that cost the bank $2.3 billion. Goldman Sachs has cut bonuses in half for its star performers, but then it saw earnings fall 58%.

“It’s hard to overcome firm performance with personal performance in the yin and yang of pay for performance culture,” said Constance Melrose, Managing Director, eFinancialCareers, North America. “Firms loathe losing top performers, and approach every bonus season concerned that murmurs of dissatisfaction escalate.”

This year we saw a shift upward in the earnings levels of this disappointed group to include financial markets professionals whose salaries top $200,000. Last year’s discouraged group registered lower salary levels.

“Every professional working on Wall Street has a number,” said Ms. Melrose. “Sometimes the number is long-term such as how much do I need to make before retirement, but there’s an annual number too—a useful marker of professional value to your current employer.”

The survey was conducted from January 2 to January 16 and drew responses from front-office and support staff at investment and commercial banks, hedge funds, and asset managers. The tally was limited to people who had already been informed of their awards.

Because of all the layoffs taking place, some firms may not be afraid of retaining their disappointed rainmakers. Morgan Stanley CEO James Gorman is famously quoted as chiding his bankers to stop whining about their slashed bonuses and that if they’re not happy they should just leave.

“It doesn’t pay to underestimate the moxie and ingenuity of financial markets professionals in finding the path to maximizing opportunity,” said Ms. Melrose. “No one wants to hear about the ten-bagger they let get away.”

Combine the euro-zone crisis, the skyrocketing US debt and an uncertain global economy, and the near term future for investment banking doesn’t look too promising.

A cover story on New York magazine went so far as to describe this year’s bonus season as “The End of Wall Street as They Knew It.” The accompanying article goes on to say “the masters of the universe have had their bonuses slashed due to the suffering economy and the provisions of the Dodd-Frank financial reform legislation. The industry also cut 200,000 jobs. Where’s a young, mathematically inclined valedictorian to turn?"

The story then quotes a hedge fund executive as saying “If you’re a smart PhD from MIT, you’d never go to Wall Street now. You’d go to Silicon Valley. There’s at least a prospect for a huge gain. You’d have the potential to be the next Mark Zuckerberg. It looks like he has a lot more fun.”

Fun is not a word being used to describe the atmosphere with employees in the financial markets who have seen their bonuses capped, slashed, and deferred. Investment bankers appear to be getting hit the hardest.

Among some of the banks cutting compensation for investment bankers are Barclays, Deutsche Bank, Morgan Stanley, Bank of America/Merrill Lynch, and Lazard with cuts ranging from 30% to 10%.

Many of these banks also instituted caps and are deferring bonuses. Deutsche Bank will defer any part of an employee's bonus above $264,800 this year. Any staff with a bonus at or below that would receive half of their bonus in cash, and half of it restricted stock that they couldn’t sell until August, according to Bloomberg. Bank of America is also expected to give shares instead of cash as part of bonuses.

Morgan Stanley was one of the first of the big banks to initiate a deferred bonus program, which brought praise from Sanford C. Bernstein & Co. analyst Brad Hintz. Hintz, who, we should point out, was a former treasurer for Morgan Stanley said, “it makes economic sense to defer if management anticipates a rebound in revenue, which allows the expenses to catch up and deferred and current costs to be paid off without damaging earnings and thus the share price.”

If you were expecting to get your bonus in cash, you probably shouldn’t be working at a bulge-bracket bank, many of which paid out most of their bonuses in stock and stock options, which certain restrictions. Boutique firms and hedge funds on the other hand reportedly paid on average a higher portion of their bonuses in unrestricted cash.

“Managing compensation expectations is one of Wall Street’s premier arts,” said Ms. Melrose. The key is communications, to let employees know as early as possible what to expect in terms of bonuses so they aren’t disappointed when the firm’s numbers don’t reflect the hard work they’ve put in.

–Fred Yager, Editor, eFinancialCareers.com, North America

Recent Research: Highlights from February 2012

2012-02-13T05:20:00-05:00

"Measuring and Modeling Execution Cost and Risk"
The Journal of Portfolio Management (Winter 2012)
Robert Engle, Robert Ferstenberg, and Jeffrey Russell

Financial markets are considered to be liquid if a large quantity can be traded quickly and with minimal price impact. Although the idea of a liquid market involves both a cost as well as a time component, most measures of execution costs tend to focus on only a single number that reflects average costs and do not explicitly account for the temporal dimension of liquidity. In practice, trading takes time because larger orders are often broken up into smaller transactions or because of price limits. Recent work shows that the time taken to transact introduces a risk component in execution costs. In this setting, the decision can be viewed as a risk–reward trade-off faced by the investor who can solve for a mean-variance utility-maximizing trading strategy. Engle, Ferstenberg, and Russell introduce an econometric method to jointly model the expected cost and risk of the trade, thereby characterizing the mean-variance tradeoffs associated with different trading approaches, given market and order characteristics. They apply their methodology to a novel dataset and show that the risk component is a nontrivial part of the transaction decision.

"Are We Out of the Woods Yet? Economic and Real Estate Markets in 2011"
The Journal of Structured Finance (Winter 2012)
Mark Fleming

We seem to be basically moving sideways. The risk of a double-dip recession is fading from summer highs, but growth is still elusive. The housing market itself is beset by headwinds. Specifically the persistence of negative equity and the shadow inventory are likely to drag down any gains in housing for a number of years. When housing will rise again will depend on the economy.

"Is the ‘Euro Bond’ the Answer to the Euro Sovereign Debt Crisis? What Outcome Can Investors Expect from Europe?"
The Journal of Wealth Management (Spring 2012)
Kenneth Matziorinis

This article analyzes the causes of the sovereign debt crisis in the euro zone and examines the policy alternatives confronting euro area governments. The author suggests that pooling fiscal risks, creating an EU Treasury, and issuing jointly backed euro bonds would be an optimal solution and the inevitable conclusion of the economic integration project in Europe. The author examines the advantages and disadvantages of euro bonds and concludes that issuing euro bonds would transform a market that is fragmented along national lines into a single unified European government bond (EGB) market with the same depth, breadth, and liquidity as the US Treasury market. By enhancing the size and liquidity of the EGB market, global investors and wealth managers would be able to use euro bond instruments as a tool for payment or transaction needs as well as short-term precautionary and investment balances, which would increase the demand for them and lower their yields. This development would allow the euro area to extract “seigniorage” benefits similar to those that the US has enjoyed in the post–World War II period, which would lower funding costs even for fiscally strong euro area countries. It would also consolidate the euro as one of the world’s two principal reserve currencies. The risk that fiscally weak area countries might take advantage of low borrowing costs to increase debt could easily and effectively be mitigated by agreeing on a formula that would establish an escalating rate in the sharing of interest costs that would be proportional to their debt–GDP ratios. Thus, moral hazard would be mitigated, and incentives would be created to reduce debt and increase income.

Inside a Great Financial Services Cover Letter

2012-02-09T05:06:00-05:00

You have a great resume, but if you ever want it read, you need an introduction that has impact, and that means a great cover letter that separates you from the rest of the pack.

With the financial services sector having experienced such a drastic reduction in force in recent years, the competition for jobs today is tougher than ever. There are literally thousands of qualified, experienced, motivated professionals applying for a relative handful of opportunities.

So what is it that will get the hiring manager to look at your resume? Many career experts suggest that you focus your attention and energy on creating a dynamic cover letter. A cover letter is a sales letter. It’s selling you.

Before the digital age, resumes were always accompanied by a cover letter, swaddled in a blanket of bravado. But today, more often than not, resumes sail through as e-mail attachments or are up-and-downloaded completely naked. The cover letter has become the most neglected part of the job hunting process. Ironically, it can still be the difference between you getting your foot in the door, or being left still standing outside, clutching your grand resume.

And while a good cover letter may help you a bit, a poor one will almost certainly kill your chances entirely. Here’s what many professionals have found to be the key factors in creating a cover letter that works:

Capture Attention. You need to speak to the employer’s needs, not yours. What can you do for them better than anyone else? What skills (tangible and intangible) can you provide that it is costly or difficult to train others to do?
Summarize your competencies. Define your core, providing your level of experience in the financial world with comparable positions or with similar firms.
Visualize your value. Provide quantifiable examples of your accomplishments when possible. Exemplify your impact on past financial firms. Make this potential employer able to easily see your success translating to them.
Light on the lingo. Include some industry jargon; it shows you can talk the talk. While buzzwords and jargon used to be viewed as ignoble and uncreative, today’s database filters seek relevant words. These can raise your readability score especially if you use the same keywords that appear in the job description. Caution: a little goes a long way.

Call to Action. Create a sense of immediacy about meeting. Mention a date or two that you are available to share some of your ideas for the company. Close the deal.
Brevity. Keep it short and sweet. One page, no more. Any longer and it will not be read.

If you haven’t spent a painful evening or two on your cover letter, you haven’t done enough to get that next position. Today’s firms are keenly interested in the right “fit,” and cover letters give them a first insight into your personality. But once resumes have been culled, and you are among those still standing, your cover letter can and will set you apart from the other candidates. Make sure it represents you well.

–Fred Yager