Archive for the ‘Financial Markets/ Finance’ Category

How do Venture capitalists make decisions?

July 20, 2017

Nice piece by Antoine Buteau.

Even though only 0.25% of companies receive venture financing, venture capital is an important source of financing that result in an outsized impact on the economy. Some studies estimate that 50% of U.S. IPOs are VC-backed and that these companies account for 20% of the U.S. market capitalization and 44% of R&D spending.

Although VCs fill a gap in the market by connecting entrepreneurs with good ideas but no money with investors, they are sometimes seen as a black box with little information on how they make decisions about their investments and portfolios. The authors of this paper wanted to answer these questions and they did so by surveying almost 900 VCs on multiple areas: deal sourcing, investment selection, valuation tools, deal structure, post-investment value add, exits, internal organization of the firms and relationships with limited partners. This summary will be focused on worldwide VC firms across stage (early/late) and on the information technology/software sector blended with the healthcare sector.

 

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Who Would Be Affected by More Banking Deserts (branchless banking)?

July 18, 2017

Learnt about this new term from St Louis Fed blog: banking deserts:

Although technology has made it easy to bank from almost anywhere, personal and public benefits are still derived from bank branches. In areas without branches—commonly referred to as “banking deserts”—the costs and inconveniences of cashing checks, establishing deposit accounts, obtaining loans and maintaining banking relationships are exacerbated.

As expected, the deserts ill impact the poor:

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20th anniversary of Start of Asian Crisis: Is China making the same mistakes?

July 12, 2017

Prof Barry Eichengreen points to several things South East Asian Countries have done since the 1997 crisis.

For starters, the crisis countries have ratcheted down their investment rates and growth expectations to sustainable levels. Asian governments still emphasize growth, but not at any cost.

Second, Southeast Asian countries now have more flexible exchange rates. None is perfectly flexible, to be sure, but the region’s governments have at least abandoned the rigid dollar pegs that were the source of such vulnerability in 1997.

Third, countries like Thailand that were running large external deficits, heightening their dependence on foreign finance, are now running surpluses. Running surpluses has helped them accumulate foreign-exchange reserves, which serve as a form of insurance.

Fourth, Asian countries are now working together to ring-fence the region. In 2000, in the wake of the crisis, they created the Chiang Mai Initiative, a regional network of financial credits and swaps. And now they have the Asian Infrastructure Investment Bank to regionalize the provision of development finance as well.

Ironically, the more things change the more they remain the same. In 1997, China was not a risk. This time it is as it seems to be following the same model followed by SE Asian countries 20 years ago:

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How did usury stop being a sin and become respectable finance?

July 7, 2017

This is just a superb article  by Alex Mayyasi who is a freelance writer. He looks at one of the most fundamental questions of finance: How did usury stop being a sin and become respectable finance?

There is never one answer to such questions but several plausible ones. He brings the contribution of Scholastics to making finance respectable:

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Making sense of Argentina ‘s 100 year bond offer

July 5, 2017

This blog pointed earlier how Argentina managed to sell a 100 year bond recently despite such a poor fiscal history.

Carmen Reinhart points this is mainly due to search for yield:

At the end of the day, this is not about the character of the country, the maturity of the debt, or the size of the issue. It is about the coupon rate on the offering, 7.9%, which is considerably higher than most other plausible alternatives. Just as water finds its level in nature, capital finds its level in international finance: when interest rates are low in core markets, it flows to higher-yielding alternatives.

Without question (and without much precedent), interest rates are extraordinarily low in advanced economies, pulled down partly by the slowdown in longer-term output growth, but also as a consequence of official efforts. Two of the “big three” central banks, the European Central Bank and the Bank of Japan, have lowered their policy rates into negative territory and continue to add to their balance sheets. As for the third, the US Federal Reserve’s slow motion monetary tightening has just put the federal funds rate above 1%, and plans to pare the Fed’s asset holdings appear to be in the works. As the chart shows, almost one half of GDP in advanced economies is produced where policy rates are below 0.5%. Only a sliver of activity takes place where the policy rate is above 1.5%.

Official measures extend beyond the realm of central banks, too. In terms of the huge stock of foreign exchange reserves held worldwide, the public sector holds more US Treasury securities than the private sector.

These distortions encourage investors in money centers to scan the horizon for more attractive destinations. Argentina got their attention, but so, too, did Cyprus, another country that recently had a financial crisis. Likewise, capital has flowed into Iceland at such a rapid clip that the International Monetary Fund felt obliged to warn that, “overheating risks are a clear and present concern.”

She is after all the co-author of the book which has become very important four words in economics: This time is different..

How Bank of England used its balance sheet in earlier crises? And should it issue shares to fight future crises?

July 5, 2017

Interesting post by BoE’s Bloggers James Barker, David Bholat and Ryland Thomas.

They point how BoE used its balance sheet in the earlier crises as well:

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Stock market participation in the aftermath of Satyam accounting scandal

July 4, 2017

Interesting paper by Renuka Sane.

The paper compares Satyam stock holding investors with non-Satyam stock holding investors during the breakout of the scam. The results show that though Satyam investors cash out of the stock intensively but the impact is not long-lasting:

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Thinking about speculation, markets, securities and laws…

June 29, 2017

Fascinating post by Elaine which talks about multiple things forcing one to think.

First she points how the Metro train in Boston decided to increase price of its ticket/token. The hike was effective next month. This led to hoarding of the older tickets to sell them for a cool profit later. Unfortunately, she was not the only ne thinking on those lines. This led to many buying the old tokens to sell later. However, as there was no market for the same the profit remained just a dream:

In 2003, I had the best business idea ever. The MBTA had recently announced an upcoming increase in the price of Boston transit tokens, from a dollar to $1.25. The change would not be effective until the following January, which meant that any T tokens acquired before then would be guaranteed a 25% return. I had just over a month to hoard as many tokens as possible.

I wasn’t the only one with this strategy; many of my classmates did the same. But after a month-long buying spree, it became clear that realizing those profits would be a pain in the ass.

We could never use all those tokens ourselves, and there was no secondary market because all our friends had made the same brilliant investment. If only T tokens were tradeable on the blockchain!

She then wonders why we don’t fund projects using similar tokens. The answer is the tokens could be used as security to finance something else. After all these tokenshave been issued against some value. This is how financial instruments like shares and bonds work as well. But then as law permits only few things as securities, these tokens remain unused:

Why don’t we finance all our infrastructure projects with token sales? Is Trump still looking for ways to pay for that wall? Issue a Wall Token and put it on the blockchain! Each Wall Token confers the right to one border crossing.

But it turns out such Tokens might constitute a security.

Here’s a 1977 paper about property developers who finance their facilities by selling usage licenses before construction. Two fun examples:

In the case of Holloway v. Thompson , a landowner raised money for a cemetery by selling certificates entitling the holder to a future burial spot. After the cemetery was constructed, an elderly couple sued the developer because they were unable to resell their unused spots. They had purchased 31 spaces, hoping to flip ‘em for a quick profit. The court determined that the burial rights were  unregistered securities , and buyers were refunded.

In Forman v. Community Services, Inc, a property developer sold “shares” of a low-income housing project, which could be exchanged for a three-year lease on a future apartment. After construction, the lease agreements were less valuable than expected, and the shareholders sued. The Supreme Court determined that the housing shares, despite being explicitly sold as “shares”, were not securities. The case was dismissed. It helped that the defendant was a non-profit housing co-op trying to do a civic good.

There are many more cases, and every shade of grey in between. In the 1970s, a spate of country clubs raised money through initial membership offerings, at which point the SEC directed its staff to stop issuing no-action letters in this area and advised that past letters should not be relied upon: “The Commission is concerned that inferences may be drawn from the issuance of no-action letters in this rapidly-evolving area.”

Simple post but worth many ideas.

The investment advice given by bank salespersons is like standup comedy

June 23, 2017

Dhirendra Kumar of Valueresearch does not mince words here:

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Argentina manages to sell a 100 year bond!

June 21, 2017

Despite all the noise about Argentine economy, the investors continue to buy their bonds. And that too 1oo year ones:

Hyman Minsky must be rolling in his grave at the sight of a country with as checkered a long-run economic history as Argentina successfully placing a 100-year bond in the market. It would have been for him yet another indication of how little markets seem to learn from past experience. It would also likely have been for him a red flag as to how complacent global financial markets have become about risk and how all too likely it is that those markets are now setting up the very conditions for another major global financial market meltdown.

Against the backdrop of the extraordinarily easy monetary policies that have been pursued by the world’s major central banks over the past several years, global investors have been forced to stretch for yield by moving up the risk curve. Taking advantage of these favorable market conditions for issuers, the Argentine government has now successfully placed a 100-year bond in the amount of US $2.75 billion at a rate of 7.9%. A further indication as to how desperate global financial markets have become for yield is the fact that Argentina received bids in the amount of US $9.75 billion for those bonds.

In rushing to buy these very long-dated bonds, global investors are choosing to ignore how poorly managed the Argentine economy has been over the past century. They are also choosing to overlook how divided the country remains today and the questions that all too many years of past mismanagement must raise as to the country’s ability to honor its very long-dated debt obligations.

So much so for economy fundamentals and all that..

Did 2008 US financial crisis (which became global crisis later) happen due to lack of financial regulation?

June 16, 2017

This post by Thaya Brook Knight points to this 150-page report from US Treasury on US financial system.

It picks the section on US Financial Regulation Structure:

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Reflection on professionalism, Hippocratic oath and the banking industry

June 7, 2017

Mr Muhammad bin Ibrahim, chief of the Central Bank of Malaysia asks bankers to be more trustworthy and ethical in their approach:

When we reflect about professionalism, the medical profession often comes to mind for its dedication, devotion, care and interest for society. Over 2,000 years ago, the Hippocratic Oath was first introduced to the world. Today, most medical school students profess some form of the oath upon graduation.

While written in antiquity, its principles are held sacred by doctors to this day. Its words have evolved with history. But its message remains the same: treat the sick to the best of one’s ability, preserve patient privacy, teach the secrets of medicine to the next generation, and much more.

What is interesting is not the oath itself, but the principles it expounds and the deep philosophical values that have firmly grounded the medical profession over the years. With it has also come an unwavering sense of identity, ethics and purpose for medical practitioners.

The numbers are equally telling. Polls such as Gallup and Ipsos have consistently ranked doctors among the most competent and ethical professionals worldwide. In 2016, 65% of people surveyed believed that medical doctors had either a high or very high level of honesty and ethical standards. The corresponding number for bankers was a mere 24%. A sad reflection of the state of affairs in the banking industry.

We trust doctors with the most intimate details of our health problems, complications and issues. We adhere to their instructions and advice, often assuredly and willingly. Few professions enjoy such stature, respect and trust. This is the epitome of professionalism.

Professionalism matters. Like the medical field, professionalism ought to form the cornerstone of the banking sector. It can be fostered. It should be practiced. And above all, it must be earned. As intermediaries in the economy and guardians of public funds, banking sector cannot hope to perform its role effectively if the respect and trust of the people is not earned.

As we commemorate this graduation today, there’s no better time to ask ourselves what it means to be a professional banker. Drawing from the medical profession and the Hippocratic Oath, let us ponder on the traits to guide our pursuit of developing high calibre and trustworthy bankers, and professionalising the banking industry. Three traits come to mind; Competence, Character and Calling.

From a banker to bankster..what a turnaround for banking industry…most countries are worried about conduct of the profession..

Bank of England economists reading children books to simplify writing…

June 6, 2017

Paul Romer was recently sidelined for asking WB economists to wrote clearly. So much so for economists continued hubris.

However, some organisations are taking this criticism seriously. For instance Bank of England econs are reading children author books: (HT: MR Blog):

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Indian cricket’s Minsky moment…

June 2, 2017

Just so much happening in Indian cricket against all odds. They were winning so much with all kinds of amazing camaraderie stories/photos reported by media. Who would have imagined that there would be simmering tension between coach and captain? We all thought that Indian cricket was onto professional ways after a committee was appointed to look into affairs. And how all these have come crumbling down?

I can’t help but connect all this fallout with Minsky moment. Minsky said the chances of a financial crisis are highest when all things are going fine and the cycle is on an upswing. Thus both Great Depression and 2008 crisis came when all things were going fine just a while ago. Not many anticipated a crisis and those that did not anticipate the depth.

We have a near similar Minsky moment in cricket as well. Just unbelievable to see how the house of cards is just collapsing. Ram Guha’s outgoing letter has opened a can of worms with no holes barred. Here are 8 takeaways from the letter.

In case you think, India is the only one. Australia had its Minsky moment a while ago and has still not recovered.

Plenty happening.

Arizona’s government has adopted new pro-Gold reforms

June 2, 2017

This blog had pointed how some US States are planning to allow gold/silver as currencies.

Now Arizona has acted to removing taxes on Gold and Silver:

Last week in Arizona, Governor Ducey signed into law HB 2014, which removes state-level taxation of gold and silver coins, and moves the state further toward treating gold and silver as simply another form of legal tender. By removing taxation, the legislation facilitates the more widespread purchasing and selling of gold and silver both an a hedge against inflation and as a medium of exchange. 

In March, Ron Paul testified at the Arizona legislature in favor of the bill, and noted he considers the legislation as part of an effort to create more room for “competing currencies” against the dollar. 

The HB 2014 easily passed through floor votes of both the House and Senate, although it remained unclear whether or not the bill would be signed into law. Governor Doug Ducey had previously vetoed similar legislation, likely motivated by tax revenue concerns. 

interesting set of developments in US despite all the noise…

Exorbitant privilege and the Triffin dilemma through forex swaps

May 31, 2017

The French said US has exorbitant privilege due to hegemony of US Dollar. Triffiin dilemma suggested that though US Dollar is a reserve currency, it implies that US will have to keep running trade deficits to keep supply of US dollar going to other countries. Thus the dilemma between looking at short term objectives and also playing a global role. Thus, both privilege and dilemma are connected in their own ways.

In this paper, Takeshi Kimura and Teppei Nagano say both these are present in forex swaps market as well:

Hmm.. never really thought about it..
The power of US Dollar extends much beyond the reserve currency role..

Economics and the human instinct for storytelling

May 29, 2017

Robert Shiller has a nice essay on the topic:

I’m starting now, with my more recent work, to think that we have to look at the humanities as well. There is something difficult to formalize about human beings, but something that we nonetheless have to understand, and I think one way to do that is with an approach that I’m calling “narrative economics”: taking economics and adding the study of the narratives that people transmit. 

The human species, everywhere you go, is engaged in conversation. We are wired for it: the human brain is built around narratives. We call ourselves Homo sapiens, but that may be something of a misnomer—sapiens means wise. The evolutionary biologist Stephen Jay Gould said we should be called Homo narrator. Your mind is really built for narratives, and especially narratives about other humans. That is why advertisers tend to focus not on a product itself, but rather on somebody doing some human action related to the product.

Narratives are contagious: they spread from one person to another. Some narratives disappear quickly; others can last a long time. I think of a narrative as a gem, something that you heard somewhere, and you think, I’ll remember that next time I’m in a conversation. I’ll use that. I’ll say it. I’ll try to present it right because I want it to have the effect that it had on me. That is a narrative. Narrative can, in the parlance of the internet, go viral. 

Hmm…

Church of England fund becomes top world performer

May 25, 2017

Always fascinating to see connections between religion and finance.

Came across this bit of news:

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What we can learn from tweets which predict movement of euro-dollar currency pair?

May 17, 2017

Interesting paper. As traders share their predictions across asset classes on social media, it leads to research opportunities.

Vahid Gholampour and Eric van Wincoop analyse tweets that predict Euro-Dollar rates. They find that Tweets get the direction right but not the magnitude:

We focus on opinions posted on Twitter, because Twitter is widely used to express opinions about asset prices. Several anecdotal stories suggest that this information can be important. For example, on 13 August 2013, Carl Icahn, an activist investor, tweeted about his large position in Apple. As a result, Apple shares increased in value by more than 4% in a few seconds. We investigate what can be learned from Twitter by considering two and a half years of tweets that expressed opinions about the euro-dollar exchange rate.

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We find that the direction of exchange rate changes is predicted by tweets in a way that is statistically significant. This suggests that there was information content in the tweets. But we also find that Twitter sentiment does not predict the magnitude of future exchange rate changes in a statistically significant way. Such predictability would be needed to develop trading strategies from this data. This absence of predictability based on a data-only approach is not surprising, because exchange rates are notoriously hard to predict. Twitter sentiment is only directional, and the data sample covers only two and a half years.

Also, Sharpe ratio for Tweet based trades is high indicating one could make money:

The large Sharpe ratios that we find suggest that there are significant gains from trading strategies based on Twitter sentiment. We can compare the Sharpe ratio from the TSI trading strategy to that of the popular currency carry-trade strategy based on interest differentials. Burnside et al. (2010) reported an average annualized Sharpe ratio of 0.44 for 20 currencies against the dollar based on a carry-trade strategy. A Sharpe ratio in the range [1.59, 1.78] is clearly very high by any reasonable standard. The methodology developed here could easily be applied to other currencies or portfolios of currencies, as well as other financial markets such as the stock market.

Hmm..

Should Walmart be allowed to get into banking?

May 17, 2017

Prof Lawrence White of Stern School has a piece on Walmart entry into banking. He says we should actually ask the following question: Why shouldn’t Walmart get into banking?

By the way I also learnt from the article that the retail giant entered banking in Canada and Mexico. In Mexico it sold off its banking business in 2014. The one in Canada continues. The issue is whether it should be allowed in America as well.

Prof White says:

One question to ask might be, “Why should Walmart be allowed to enter banking?” But a more relevant question would be, “Why shouldn’t Walmart be allowed to enter banking?” 

After all, the U.S. economy is generally market-oriented, and entry is generally recognized as potentially beneficial for consumers, as entrants can bring new ideas, innovations, and efficiencies to the market. Of course, incumbents usually don’t like the idea of entrants’ disrupting the status quo; and often those incumbents lobby for regulation and/or legislation that creates barriers to entry. But, for most markets, the presumption in broad U.S. economic policy is that entry should be encouraged—or at least, that policy should be neutral between incumbents and entrants—so that the benefits of entry can be enjoyed by consumers.

Of course, banking is special—as the regular readers of this blog are well aware. And how the specialness of banking and the presence of Walmart in banking can be reconciled must be addressed, and will be addressed below.

But first, consider what the entry of Walmart into banking might well achieve: Walmart is well known for providing reasonably priced goods to low- and moderate-income households. Its position as the largest company in the United States—as measured by sales and by employment—is a testament to that reputation.

But it is exactly this demographic group—low- and moderate-income households—that is most in need of reasonably priced financial services. The percentage of U.S. households that are unbanked (i.e., do not have a bank account) or underbanked (i.e., have an account but rely on non-bank providers for some financial services and products) has been a longstanding policy concern. The most recent data (from a FDIC report that covers 2015) in this regard—based on a survey of more than 36,000 households nationwide—show that 7% of all households were unbanked and an additional 20% of all households were underbanked. Unsurprisingly, the percentages are substantially larger for low- and moderate-income households (see table)

Hmmm.

The post also has a interesting discussion on the complex financial regulation setup in US:

So, how would the entry of Walmart—and, presumably, other non-financial companies that are interested in entering banking—fit into that system of prudential regulation?

The crucial concept is that the “Walmart Bank” that would provide banking services to the public would be organized as a separate subsidiary of the parent Walmart company. In essence, the parent Walmart company would be a bank holding company (BHC), which is a common ownership structure for U.S. banks. The Walmart Bank subsidiary would be expected to abide by all prudential regulations—including adequate net worth (capital) requirements—that apply to banks.

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However, because it is relatively easy for the owners (including BHCs) of a bank to drain the bank of its assets—for example, by paying excessive dividends to its owners, or by making loans to the owners that are not repaid, or even by paying excessive prices for any materials that it buys from the owners—it is essential that any transactions between the bank and its owners be on arm’s-length terms. U.S. bank regulators have long been aware of this danger of the draining of a bank by its owners and have rules in place (which are embodied in Sections 23A and 23B of the Federal Reserve Act) that insist on this arm’s-length standard.

Current U.S. banking policy has much of this story right.  But where policy has gone “off the rails” is the insistence that a BHC cannot be engaged in commerce—that is, in non-financial services activities. This restriction on scope was embodied in the Bank Holding Company Acts of 1956 and 1970 and remains established policy for banks and banking in 2017. Its persistence as policy is more a testament to the lobbying strength of the incumbent bankers (who clearly prefer less competition) rather than to a concern about the economic welfare of consumers. It also yields the economically absurd result that it is okay for a local car dealer to own a bank (so long as the dealer doesn’t form a BHC that involves the car dealership); but it is not okay for AutoNation (a publicly traded company that operates hundreds of car dealerships) to own a bank.

Until 1999 there was a potential way around this no-commerce restriction on the activities of a holding company: the holding company of a savings and loan (S&L or thrift) institution faced no such restriction, and at various times companies such as the Ford Motor Company, Fuqua Industries, Weyerhaeuser, ITT, Gulf & Western, Household International, and Sears, Roebuck have owned S&Ls via the formation of thrift holding companies.

In the middle of the 1990s, Walmart decided to try to enter banking by becoming a thrift holding company. However, before Walmart was able to become a thrift holding company, the Gramm-Leach-Bliley Act of 1999 (which was primarily focused on allowing commercial banks—via BHCs—to enter investment banking) forbade the creation of any new thrift holding companies that could engage in commerce. It also restricted the sale of an existing thrift holding company to a non-financial company, such as Walmart.

There was a second, more limited way around the “no commercial owner” restriction: a few states—most notably Utah—offered “industrial loan company” (ILC) charters that allowed a commercial firm to own a financial institution that could issue deposits and make loans and thus could function as a bank. But in order to operate, the ILC would need to obtain deposit insurance from the FDIC.

Walmart duly obtained a Utah ILC charter and in 2005 applied for FDIC deposit insurance. In 2007 Walmart withdrew its application after it was clear that the FDIC would not grant it deposit insurance. Further, the Dodd-Frank Act of 2010 placed a three-year moratorium on the granting of deposit insurance to any new (or newly acquired) ILC. Although the moratorium expired in 2013, bank regulators appear to have “gotten the message” that the commerce-finance barrier should remain intact.

Another example of how despite best intentions, regulations leave many gaps to be filled.

But overall a good discussion about many aspects of economics and finance..


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