Development Bank Research Bulletin

A billion-dollar academic paper in the Journal of Finance

What is the price of a paper in the Journal of Finance? For readers, it costs $57 to receive five issues a year. For contributors, they pay $70 to get the editors and referees to process their manuscripts. For professors who successfully publish a paper in this journal, it is estimated that your life-time income will increase by $100,000. For Nasdaq dealers, one of the Journal of Finance articles costed them one billion dollars!

In 1994, a paper by two assistant professors, William Christie and Paul Schultz, was published in The Journal of Finance. This is not an ordinary paper! They had found that Nasdaq dealers were commonly avoiding odd-eighth quotes (e.g., 60 5/8), and the authors suggested that dealers were "implicitly colluding" to keep spreads artificially wide. An investigation ensued of the Nasdaq market and Nasdaq dealers by the Department of Justice and the SEC, and a class action lawsuit was filed. Approval of the court was issued on November 9, 1998 of a settlement in the aggregate amount of $1,027 million.

Encouraged by this billion-dollar case,  nowadays numerous lawyers are scanning latest issues of Journal of Finance, and will file a law suit (based on templates that are  drafted in advance) immediately when they smell something unusual. In one case, they forgot to replace the name on the template.

Another paper that may have resulted in billion-dollar loss to the investment banking industry is Hsuan-Chi Chen and Jay Ritter’s Journal of Finance paper “ The Seven Percent Solution” , which finds that gross spreads received by underwriters on initial public offerings (IPOs) in the U.S. are much higher than in other countries. Furthermore, in recent years over 90 percent of deals raising between $20-80 million have spreads of exactly 7.0 percent, three times the proportion of a decade earlier. Investment bankers readily admit that the IPO business is very profitable, and that they avoid competing on fees because they “don’t want to turn it into a commodity business.” .

Any lawyers, however stupid they are, can smell the hint of “collusion” among investment bankers. As a matter of fact, Chen and Ritter did mention in their paper about the billion-dollar case of Christie and Schultz, in case anyone may forgot to file a lawsuit.

Why does Thaksin want to become Prime Minister?

Why does Thaksin want to become Prime Minister of Thailand? Two professors from Thailannd, Pramuan Bunkawanicha and Yupana Wiwattanakantang, study the stock market valuation change of politically-connected firms in Thailand and provide an answer: there is a lot of money in it! Connected firms' values jumped right after Taksin won the election, and stock prices continued drifting upward for the next two years.

Let me explain to you what this means. First, it means that all investors believed  that Taksin’s victory will benefit his connected firms, to some extent. Second, the continuing drift of price upward suggests that, at the beginning, investors underestimated Thaksin’s ability to create private benefits for his cronies, and over time they found out that he is very very good at it.
So, never underestimate the thickness of a politician’s face.

Tycoons Turned Leaders: Market Valuation of Political Connections   
Abstract: In this paper, we analyze the outcomes when a handful of business tycoons became the country leaders as premier and cabinet members. The first nomination of the Thai Premier in 2001 allow us to identify such an event. The event study shows that immediately after the tycoons won the general election, the stock market recognized the value of the firms owned by tycoons-cum-leaders. These firms experienced a significantly higher market valuation than other firms in the following two years. Interestingly, one year prior to having political power, the firms owned by tycoons-cum-leaders did not perform differently relative to other firms. Overall, the results indicate that political power is value enhancing to connected firms. Tycoons-cum-leaders have a political rent-seeking advantage to extend various economic favors to their firms.

Stock pickers have gone fishing

Utpal Bhattacharya and Neal Galpin at Indiana Univerity find a genius way to measure how many traders are still actively attempting to beat the market (although they rarely manage to). They find that two third of them have retreated to passive investing since 1960s. Their equilibrium model also suggests that, for the remaining who are still picking stocks, it is in the interest of our society to send half them to do some fishing in Tahiti. The paper also is featured in New York Times and the Economist

Is Stock Picking Declining Around the World? 
Abstract:      
We do three things in this paper. We first develop a metric to measure the maximum fraction of volume explained by stock picking in a market. We then use our metric to measure stock picking around the world. We find that though there is more stock picking in emerging markets than in developed countries, it is declining everywhere. In the United States, for example, stock picking has secularly declined from a high of 60% in the 1960s to a low of 24% in the 2000s. Finally, as markets cannot be efficient if everyone believes that they are efficient and, therefore, do no stock picking - the Grossman and Stiglitz (1980) paradox - we ask what is the long-run steady state fraction of stock pickers? We develop a simple theoretical model, and calibrate this model to the United States economy to conclude that stock picking will eventually settle at 11% of trading volume in the United States.

Should BB&T bank make loans to "eminent domain" projects?

BB&T won't offer eminent domain loans
JAN. 25: Regional bank BB&T Corp., one of the nation's largest financial institutions, will make no loans to developers who plan to build commercial projects on land taken from private citizens by the government through the power of eminent domain, the company said Wednesday.

Certainly it is wrong for the government to obtain private property through "eminent domain", but I think the management of BB&T Corp by taking this action violates its fiduciary duty to the shareholders. After all, whether BB&T should give up business opportunities (and profit) in such project (however immoral they are) is up to the judgment and decision of the BB&T shareholders. The management of BB&T should not put their ideological belief before the interest of shareholders, becasue they are employed to increase value for shareholders, not as political advocates.

Expecting the birth of the world’s largest bank: the Japanese Post Bank

Guess which financial institution in Japan controls the largest market share in deposit savings? It is not Mizuho; it is not Mitsubishi UFJ; it is not Sumitomo either.

The No.1 position belongs to the Postal Service!  The Postal Savings System (PSS) has 230 trillion yen of deposits in their control, which makes it the largest “bank” not only in Japan, but in the world.

In order to push forward his plan to privatize the Postal Service, Japanese Prime Minister Koizumi called early election and won with land-slide margin. Now the privatizing plan is only a matter of implementation. According to the plan, the savings system will be spinned off from the mail service, and sold to the private sector.

What are the consequences of the privatization?

(1)   Well, we will have the largest bank in the world. I have to inform you though, that the privatization will take place in 2017, not now. Be patient, Koizumi has been pushing for this since 1979 when he served as a junior finance minister.

(2)   Japanese government bond yield will rise, because the profit-maximization oriented PostBank (I guess it will be called PostBank) will not put up with the low return in government bond, and they are going to dump them. Man, more than 20% of outstanding bonds are now in their hands, what will be the market impact, I don’t know.

(3)  U.S.treasury bond yield will go down, because the PostBank will certainly purchase t-bonds to rebalance their portfolio

(4)   I don’t think the PostBank will inject credit into the private sector of Japanese economy, unless they find a really ambitious foreign buyer.

(5)   What will you get if you buy and control the PostBank? Certainly you will obtain a nationwide 100% coverage network and a customer base of 85% of Japan's population. Accepting deposit is not a profitable business, but you can profit from selling other financial services. Eh, I think this is pretty close to Citigroup’s philosophy! Could Citigroup be a potential bidder for the Postal Savings System? It is too early to say, but there is always the possibility.

And who's next? China's Postal Savings System?

What's Deutsche Bank's philosophy in Growth?

The text at the end of this post is taken from Norbert Walter's speech at the American Chamber of Commerce, Cairo, when discussing prospect of Egypt. Egyptian economy is certainly not interesting (well, I don't deny that Egypt already has all the elements needed for economic growth. Why does't Egypt grow? I really dont' know) , but I guess Mr Walter was simply using it to illustrate DB's philosophy in what determin prosperity of a nation.

Combined with what I read from DB's other recent reports in relation to their Global Growth Centres 2020 project (which is similar to Goldman Sachs's BRIC), it is very clear that DB believes in two things (because investment is endogenous, and he mentioned enviroment for political correctness reasons):
(1) Demography: younger nations grow faster
(2) Trade: open economies grow faster

These seem not very surprsing arguments. It doesn't take a large team of DB economists to show this. I read the message differently though: I think what DB wants to say is NOT that these two factors are very important, but that the other factors (that he didn't mention) are NOT important. That is to say, don't care about other risks (political or financial),  go forward and invest in China and India.

What makes a country grow?  (by Norbert Walter, Deutsche Bank)

In DB Research's Global Growth Centres project, we have analysed the factors that determine a country's growth prospects.
First, in the medium to long term the dynamism of a society is decisively influenced by its demography: by the development, size and age structure of its population. In this respect, it seems that today the world is split in two parts: one part ageing, with population growth declining or even becoming negative, and another part still young, dynamic, vital. However, countries with dynamic population and labour force growth, but meagre savings and little or ill-allocated investment will not excel either.
Therefore, the second most important factor in explaining growth is investment. And it is not just the volume of investment which is important, but also how intelligently the money is invested, for which a mature financial system is crucial.
A third element that we identified as determining growth is openness. This means the willingness of a society to be open-minded, to be a learning society, to be open to the outside world. If a country does not allow outside challenges to influence local businesses, the educational system, even the cultural system, it will forego enormous opportunities as well. Competition is good for everyone, and openness is about welcoming competition.
A fourth factor is important not only to propel growth but to make it sustainable: Is the environment taken care of properly? Medium-term growth does not depend on whether you make the economy grow 5% or 7% next year. The question is whether - in the process of growth - you ruin the very basis of your future. And if your soil is damaged, if there is no fresh water left, if the air is polluted, at the end of the day your economy cannot flourish. So good governance to preserve the environment is a very important long-term growth factor.

Macquarie Bank's interesting acquisitions

last week, they bought Global Baggage, world's largest airport baggage cart operator.See reports in Yahoo

This week, they are on the news bidding for London Stock Exchange (LSE) plc. The LSE board dismissed the bid as 'a blatant attempt to acquire the exchange on the cheap. see reports in Forbes

I wonder what kind of synergy benefit Macquarie Bank can create with a airport baggage cart operator, and with London Stock Exchange. Austrlian firms impress me as very imaginative when it comes to diversification. Last year a giant paperboard marker from Australia ambitiously entered U.S. community banking business.

I know HSBC and RBS always bid fierecly for sponsorship advertisment slots of Heathrow Airport, but they never go as far as purchasing an aiport baggage cart operator.

by the way, I saw an academic paper recently on the (negative) value of financial conglomerates:

Is There a Diversification Discount in Financial Conglomerates?
Author: Laeven, Luc and Levine, Ross

Abstract: This paper investigates whether the diversity of activities conducted by financial institutions influences their market valuations. We find that there is a diversification discount: The market values financial conglomerates that engage in multiple activities, e.g., lending and non-lending financial services, lower than if those financial conglomerates were broken into financial intermediaries that specialize in the individual activities. While difficult to identify a single causal factor, the results are consistent with theories that stress intensified agency problems in financial conglomerates that engage in multiple activities and indicate that economies of scope are not sufficiently large to produce a diversification premium.

My World Map

The world looks very different once we take into account not only headcounts but productivity of people. Guess what the numbers in the map mean?