IFJ Fall 2014 Edition by The IFJ

FALL 2014 • www.theifj.com

TULPEMANIE: “They would offer up everything they owned to get their hands on tulip bulbs, trading furniture, valuables and even their homes.”

SCOTLAND’S REFERENDUM: “Scotland’s experience underscores an alarming frustration with neoliberalism, globalization, and the prevailing economic order.”

SOCIALLY RESPONSIBLE INDULGENCE: “Eat locally. Not only is it socially responsible, it inevitably results in eating great food. No rate of return can beat that.”

THE IFJ TEAM ALEX DRECHSLER PRESIDENT MATTHEW OSTROW GENERAL MANAGER MAX DEUTSCH GENERAL MANAGER SARAH PARK MANAGING EDITOR CHRISTIAN ACKMANN ASSOCIATE MANAGING EDITOR CHRISTOPHER DEDERICK ASSOCIATE MANAGING EDITOR CHIA CHIEN TENG HEAD OF WEB DAVID COHEN HEAD OF CODING LAUREN SUKIN HEAD OF BLOG MICHELLE WATT HEAD OF SOCIAL MEDIA STEPH HENNINGS HEAD OF DESIGN & LAYOUT CLAIRE SU HEAD OF INTERCOLLEGIATE EXPANSION YUTA INUMARU HEAD OF INTERCOLLEGIATE EXPANSION AMANDA BEAUDOIN HEAD OF MARKETING MICHELE NARBONNE HEAD OF EXTERNAL AFFAIRS EMMA CURRIER HEAD OF ADVERTISING YVETTE RODRIGUEZ HEAD OF OPERATIONS EDITORIAL BOARD SARAH PARK MANAGING EDITOR CHRISTIAN ACKMANN ASSOCIATE MANAGING EDITOR CHRISTOPHER DEDERICK ASSOCIATE MANAGING EDITOR ALON GALOR MARKETS EDITOR THOMAS PESCE POLITICAL ECONOMY EDITOR OMAR BEN HALIM POLITICAL ECONOMY EDITOR MATTHEW JANIGIAN PERSONAL FINANCE EDITOR ELIZABETH STUDLICK STARTUPS & TECHNOLOGY EDITOR FRANCESCA WHITEHEAD CAREERS EDITOR ALEXANDRA NUTTBROWN HEAD OF STYLE SENIOR STAFF WRITERS ADRIJA DARSHA, ALEXANDER BURGER, CARLY WEST, CHARLES HEMSLEY, JACK DU, LYALL STUART, MALLIKA SAHAYA, MARIA JOSE HERRERA, MARIANA CARVALHO, DESIGN & LAYOUT STEPH HENNINGS HEAD OF DESIGN & LAYOUT CHANDELLE HEFFNER HEAD OF GRAPHIC DESIGN BLAZE LEE, CADENCE LEE, CEDRIC PARK, CHAERI BONG, INYOUNG KWON, MADELEINE JOHNSON, LINDA NAVON CHETRIT, SANG EUN OH, RACHEL BINDER

MASAHIRO NAKANISHI, MICHAEL GOLZ, MIGUEL FERREIRA, NIKHIL KUMAR, NIKHIL PATEL, RACHEL BINDER, TIFFANY CHANG, TIFFANY CHEN, WESLEY MEYER, YASHIL SUKURDEEP STAFF WRITERS AGNES CHAN, CHRISTOPHER ROBOTHAM, EDUARDO MARTIN, EMMA CHOW,

INTERCOLLEGIATE EXPANSION CLAIRE SU HEAD OF INTERCOLLEGIATE EXPANSION YUTA INUMARU HEAD OF INTERCOLLEGIATE EXPANSION SUDEEP JANDYAM INTERCOLLEGIATE MANAGER ZACKARY ZAPOLSKY INTERCOLLEGIATE MANAGER FRANK CHIANG CAMPUS MANAGER RAGHAV BANSAL CAMPUS MANAGER

GILLIAN LEE, JEFFREY MOK, LINDSEY CURRIER, NICHOLAS HARTMANN, PRANAY BOSE, SHIYING LUO, THEE MEENSUK COPY EDITORS & FACT CHECKERS ALEXANDRA NUTTBROWN HEAD OF STYLE DUNCAN WEINSTEIN, ERIC HU, KERRY YAN, MARIA JOSE HERERRA, NATHAN JOHNSON, SAFIYA WALKER

DANIEL GREENBERG, MARCO LORENZO LUY, MATTHEW BONEY, MICHAEL JANIGIAN, MUHAMMAD NASIR, NATHAN LUI, SAFIYA WALKER, SHAHZEB KHALID

WEB CHIA CHIEN TENG HEAD OF WEB

MARKETING AMANDA BEAUDOIN HEAD OF OUTREACH MICHELE NARBONNE HEAD OF EXTERNAL AFFAIRS ALLIE SHAEFER, DANIELLE PETERSON, JASMINE BALA, LORI EBENSTEIN, MARINA CANO SOSTRE, SHIVAM AGARWAL

DAVID COHEN HEAD OF CODING RAYMOND HOLDEN ASSISTANT HEAD OF CODING LINDE CHEN HEAD OF WEB PUBLISHING AARON GOKASLAN, AFRA RAHMAN, JAMES COHAN, KIMBERLY NGUYEN, LLOYD KEVIN SY, PRANAVAN CHANTHRAKUMAR

ADVERTISING EMMA CURRIER HEAD OF ADVERTISING

BLOG LAUREN SUKIN HEAD OF BLOG

BRIAN LEE, JACOB JAFFE, KRISTINA PARK, LORI EBENSTEIN, LYN TRAN, MCKENNA

ERIC HAN EDITOR

WEBSTER, MUHAMMAD NASIR, PETER LEE, SHIQI WU, THOMAS WALKER

JULIE YUE EDITOR

EDWARD LI, ERIC HU, ERIN KILDUFF, GRACE SUN, GRAHAM GONZALES, JACOB OPERATIONS YVETTE RODRIGUEZ HEAD OF OPERATIONS KRISTINA PARK, LILY ZHAO, NIKHIL PATEL, TAYLOR CASEY

WILNER, KALI RIDLEY, KERRY YAN, KWANG CHOI, MARIA JOSE HERRERA, MICHAEL SIMIC, SAMANEE MAHBUB, SCOTT THEER, SHIYING LUO, SUNDEEP JANDYAM SOCIAL MEDIA

FOUNDERS BRICE GUMPEL, ALEX DRECHSLER, EMILY LAW

MICHELLE WATT HEAD OF SOCIAL MEDIA ARTON DOKIC, JONATHAN POWELL, JULIA WATSON, LORI EBENSTEIN

Intercollegiate Finance Journal

FALL 2014

Markets

Personal Finance

4 Tulpenmanie The Seeds of Discord in Economic History

26 Socially Responsible Indulgence The Spoils of Buying Locally Grown Food

Michael Golz

Matthew Janigian

6 Not Just a Game Redistribution Measures in Professional Sports

28 $0 To $2 Billion Real Quick How Peer-to-Peer Lending is Rapidly Revamping the Lending Industry

Christopher Robotham

9 Sit-Down Restaurants on the Chopping Block The Invasion of the Food Truck

Rachel Binder

30 Beating the Books Is the Reign of Textbook Publishers Finally Over?

Jack Du

10 The Unwritten Mandate Is Financial Stability Worth the Fed’s Time?

Tiffany Chen

Christian Ackmann

11 Which Came First: Consumers Got Confident or the Economy Got Better? Nicholas Hartmann

12 Goodbye Mr. Jones The End of the Dow as an American Index Charles Hemsley

Startups & Technology

Photo Essay 14 An Exposé on Danny Warshay

Francesca Whitehead & Mariana Carvalho

Political Economy

The IFJ Online www.theifj.com The Blog Con-struction Edward Li & Lauren Sukin Is the Ivy League Worth It? Erin Kilduff

16 Modi’s WMD Weapons of Mass Development Omar Ben Halim

17 Two Steps Forward, One Step Back Can China Escape the Middle-Income Trap? Alexander Burger

Investing in Bonds: What You Can Learn From Your Grandmother’s Portfolio Michael Simic

18 ISIS, Inc. The Economy of Terror

The Beautiful Game of Poker Sundeep Jandyam

20 Puerto Rico: America’s Firstborn or Lovechild? On the Debt Crisis in the Commonwealth

Recovering from Disaster: Settlements of the Financial Crisis Graham Gonzales Big Name or Big Impact: How to Go about Picking an Internship Samanee Mahbub

Facebook: facebook.com/theifj1 Twitter: @the_ifj

Carly West

Wesley Meyer

21 Saving Money & Saving Lives An Economic Case for Fighting Ebola Nikhil Kumar

22 Scotland’s Referendum, Europe’s Far Right, and the Islamic State In the Wake of a Great Recession Christopher Dederick

32 Israeli Innovation in Silicon Wadi Israel’s Vibrant Startup Culture Jeffrey Mok

34 Pizza in a Single Tap Making Your Lazy Pizza Nights Even Lazier Elizabeth Studlick

35 Disruptive Technologies Computing of the Future Jeffrey Mok

36 Mission Disputable Examining the Ups, the Downs, and the Cause of Gentrification in San Francisco Tiffany Chang

Careers 38 Microfinance, Macrogood Overcoming the Poverty Line A More Attainable Endeavor Adrija Darsha

40 Let’s Go Global The Internationalization of Financial Markets & What it Means for Your Career Nikhil Patel

41 Me, Inc. Building Your Personal Brand Mariana Carvalho

42 Ponytail Power? Students Reflect on Their Lack of a Y Chromosome during On-Campus Recruiting Francesca Whitehead

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Tulpenmanie:

THE SEEDS OF DISCORD IN ECONOMIC HISTORY by Michael Golz

ou graduated from Brown, class of ’06, and moved into your first apartment. It was a big step, sure, but even you know that you can’t build equity on a monthly rental. Housing prices are rising though, and all your friends are putting their money into homes as analysts forecast a continued swell in the housing index. Maybe it’s time to invest in a place of your own, and besides, banks are throwing out subprime rate mortgage loans like the homecoming queen tosses candy to kids at a parade. Now is the time to make a house the central asset of your portfolio. Now what if instead of a recent graduate, you were a merchant in what is today the Netherlands? What if you had your eye on a leafier prize? This is “Tulpenmanie” (tulip madness): the frenetic 1620s and 30s in the Dutch Republic, where it was not unheard of to witness merchants trading tulip bulbs for the cost equivalent of a year’s salary. A HISTORIA TULIPIA To get a sense of how an entire population could become enamored of a flower to the point of sacrificing years of savings, one must understand just how unique tulips were to the Dutch. Introduced to Europe at some point during the mid-16th century by one of the Holy Roman Empire’s ambassadors to Turkey, the tulip made its Flemish debut thanks to Carolus Clusius, a horticulturist at Leiden University who began major cultivation of the flower in the 1590s. To visitors of the university gardens, the tulip was a truly exotic specimen the likes of which had never been seen in Northern Europe. In addition to the surreal vibrancy of the petal color, a disease called Tulip Mosaic Virus hit the population, causing wild variegations. One such variety, the Semper Augustus, sported purple and white flame patterns that drove its meteoric rise as the most highly valued flower of the period. But the uniqueness of Clusius’s collection was not left intact for long. Eventually, through theft and further importation, a market for tulips began to sprout outside the university. Popular obses-

THE FLOWERING MARKET FOR TULIPS IN 16TH & 17TH CENTURY NETHERLANDS 4

1554 Tulips arrive in Vienna from the Ottoman Empire

1593 Tulips arrive at Leiden University in the Dutch Republic

1610 - 1630 Period of casual speculation, start of the tavern trade

1634 First recorded institutional speculation

MARKETS

sion with the flower quickly led to the appearance of numerous tulip cultivators. Given the flower’s astounding popularity, a substantial potential for speculative profits arose, and specialized tulip financiers appeared on the scene to take advantage of the new niche. BULLS IN THE GARDEN Initially, the rise in tulip prices was driven by casual traders. These traders came from all walks of life: farmers, artisans, and small-time merchants looking to get in on a demand-driven rise in prices caused by the infamy of special varieties of the flower. They would offer up everything they owned to get their hands on bulbs, trading furniture, valuables and even their homes. It is this quintessential display of animal spirit that led many to attribute the bubble to the pure irrational over-optimism of the population. However, new research suggests that the price figures cited to estimate the losses incurred by speculators and justify the mania are misaligned with what was really going on: a restructuring of the financial market. THE TAVERN TRADE Leading up to 1636, the tulip trade had become sophisticated enough to develop a significant futures market where investors would sign a contract obliging them to purchase a specific stock of bulbs from a grower or other investor after the tulips finished blooming in the spring and could be uprooted. However, in Feb. 1637, a significant change occurred: a Dutch decree allowed for the conversion of futures contracts written after Nov. 1636 into options, effectively allowing potential buyers to pay a 3.5 percent premium to back out of their futures contracts. This skewed the market hugely in favor of buyers and led to a skyrocketing of options prices. The key to understanding the issue is to realize that an option is a derivative: it deals with an underlying asset (tulips), but does not constitute the purchase of a tulip in its own right. A trader would buy an options contract, paying for the right to purchase a tulip

The Estimated Price of Tulips

Unexercised Strike

150

Spot / Futures

Nov Dec 1636

Jan

Feb Mar Apr May Jun 1637

Options conferred a future right to buy tulips at a set price. Their advent generated 100 irrational euphoria, even as the price of the options became increasingly detached 50 from reality and the value of the underlying asset. The disconnect highlights the risk 0 of financial innovations when their investment potential is poorly understood.

at a future date for a certain pre-determined amount if the spot price — the prevailing market price — rose above a so-called “strike price.” If the spot price of tulips had not reached a satisfying level, the trader could decide not to exercise the option, choosing to let it expire without actually buying the tulip bulbs. The trading of options for tulips then became a whole new game in the tulip finance market, where due to the novelty of the instrument, the strike prices became detached from the spot price of tulips, and traders began to bid up options prices without regard for how the market was valuing the physical asset. Needless to say, the modern mathematical analyses involved with options trading did not play a role in this market, where contracts were usually exchanged in local taverns. WEEDING THROUGH THE PRICE CONFUSION The bubble burst in the spring of 1637, according to most historians, who cite that prices had risen twenty-fold from the previous winter and then collapsed. But a look at tulip spot rates shows that prices had collapsed months earlier. The exact causes for spot price decline are unknown, but hypotheses include the deterioration of tulip reproduction due to the mosaic virus and the fallout of the Thirty Years’ Wars. According to Professor Earl Thompson at UCLA, what these figures really capture is the rapid decline of the options strike prices, not the market valuation of tulip bulbs, that occurred once the government realized the danger of the options trading and canceled the instruments. Thus, one of the most infamous cases of speculation in history may have been highly exaggerated. Most reports fail to separate the spot and options markets, or appropriately adjust prices, and thus are unable to generate legitimate estimates of the losses incurred. This is not to say that the event ought to be discounted. There was irrational speculation and the price of a tulip detached from its intrinsic value. While stories of the Semper Augustus famously trading for the cost of a luxury estate in Amsterdam give credence to the madness of the time, it is difficult to unhinge these tales from confounding price-adjustment failures. But what we can take away is a sense of the role that financial instruments play in major economic upheaval and, furthermore, in how we interpret those events. The behavior of financial institutions in the recent recession with regard to subprime mortgage loans is a telling example of how even centuries later, it is people’s response to the financial structure that often defines a crisis, and not necessarily a failure on their part to understand intrinsic asset value.

1636

1637

NOV Month of obligatory honoring of futures contracts

EARLY FEB Decree is passed creating an options contract system

DEC Collapse of the tulip spot price

The price of tulip options continued to rise for months after 200 the price of the actual tulips had collapsed.

MID FEB Options prices for tulips skyrocket

LATE FEB EARLY MAR Government cancels options instrument; options market collapses to almost nothing

MAY Tulip prices fall to the level that they would remain at in the “normal” market

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Not Just a Game: REDISTRIBUTION MEASURES IN PROFESSIONAL SPORTS by Christopher Robotham

Professional athletes are overpaid. Wildly. After all, the Census Bureau reported that in 2012, the median household income in America was just over $51,000, and professional athletes’ yearly salaries, which are overwhelmingly upwards of $1 million, dwarf even the most skilled in other professions. Naturally, it therefore comes as a surprise to many that all major professional sports leagues in the United States have some form of “salary cap” intended to restrict players’ salaries.

ALEX RODRIGUEZ MADE $33 MILLION IN 2013, $15 MILLION MORE THAN THE HIGHEST PAID FOOTBALL PLAYER, TOM BRADY

KIND-OF-FOR-PROFIT The business model surrounding professional sports is a bizarre one and has few parallels in the broader American economy. For one thing, the National Football League (NFL), National Hockey League (NHL), Professional Golfers Association (PGA), and until 2007, Major League Baseball (MLB), are 501(c) (6) tax-exempt organizations with the goal of maximizing the bottom line of their constituent teams, which are themselves for-profit organizations. What this really means is that shell organizations like the NFL seek to maximize their teams’ profits, in some cases without paying any taxes. AN EXERCISE IN HEDGING The tricky part about managing a professional sports league trying to maximize the profitability and value of its constituent teams is that value comes from one thing: fans. Fans bring the money, and fans want wins, playoff appearances, and championships. But at the end of the day, any game has one winner and one loser. From the league’s standpoint, it’s trying to optimize its profits from revenue sources that are, to some extent, mutually exclusive. The two extremes of this situation are illustrative. Imagine an incredibly lopsided league, where one team wins every year and most others don’t stand a chance. This is probably a bad situation for the league — it will get significant revenue from that winning team’s fans, but very little from other teams’ fans. The other extreme is a league where victory can be treated as a random variable, and there is no carry over year-to-year or game-to-game in victories. In this case, it will be hard for any one team to generate a long enough winning streak to build up a fan base. Which extreme is better from a managerial standpoint, and which should the leagues go with? MAJOR LEAGUE BASEBALL: THE 99 PERCENT AND THE 1 PERCENT If professional sports leagues were historical countries, Major League Baseball would be pre-revolutionary France. MLB does have what it calls a “Competitive Balance Tax,” designed to constrain some of the more extreme payrolls,

MARKETS

such as those of the New York Yankees and Boston Red Sox. The tax, however, is merely assessed on the portion of a team’s payroll that is greater than the luxury tax threshold of $189 million. For the 2013 season, the New York Yankees — baseball’s universally recognized symbol of opulence and success — paid $28 million in luxury taxes. This puts the franchise at a total of $252.7 million of luxury taxes paid since the system was instituted in 2003. The Yankees’ share alone constitutes 88.6 percent of the total luxury taxes paid by all teams. However, only two of baseball’s 30 teams paid any luxury tax in 2013, meaning that the 28 of the 30 teams were in the exact same tax bracket. This means that the Philadelphia Phillies, with a $170.8 million payroll, paid the same amount in luxury taxes, $0.00, as the Houston Astros, which had a $21.6 million dollar payroll, a situation that sounds eerily similar to those which provoke the rage of the Elizabeth Warrens and Barney Franks of the world. The concentration of World Series wins illustrates the extent of inequality in success between teams. Of the 109 World Series that have been played, the New York Yankees have won a staggering 27 of them. If we assumed that championship wins followed a random walk, the probability of this happening is about as close to zero as it gets. Similarly, the five teams that have won the most World

WHAT THEY PAY TO PLAY 2013 MLB PAYROLLS $230,401,445 $214,830,909 $159,985,714 $157,594,786 $150,471,844

2013 NFL PAYROLLS $134,821,126 $133,542,880 $132,585,356 $129,603,859 $127,962,440

Major League Baseball teams are extremely unequal. The National Football League, on the other hand, has enforced much stricter caps on payrolls, fostering a more equitable distribution. Perhaps, this could be behind baseball’s falling popularity.

Series titles have captured 62 of these contests, and the top 10 teams account for 85 of them. Meanwhile, eight teams have never won a World Series. Without examining every factor, it is impossible to determine a line of causation between baseball’s much-noted financial struggles and decreasing fan base, but one factor that seems relevant is the massive disparity in team success. Currently, the New York Yankees, worth $2.5 billion, are the most valuable franchise in baseball, according to a Forbes report. The least valuable team, the Tampa Bay Rays, is worth a mere $485 million. The league is economically in trouble: 10 of its 30 teams had an operating revenue in the red in 2013, and 14 of the 30 teams had debt to value ratios higher than 20 percent. Mathematically, there is a strong correlation between winning and the variation in a team’s revenue. This is an important fact to consider, especially when half of a league’s teams will invariably have losing records. Baseball has other indications of faltering support: while the NFL had 205 million unique viewers during the 2013 regular season, the MLB had a mere 0.69 million. All signs point toward dangerous trends for the MLB, many of which appear to be tied to its extreme level of inequality. THE NFL: SOCIALIST UTOPIA? The National Football League presents an opposite model. The NFL employs what is known as a “hard cap,” meaning that teams must be below the salary cap of $133 million for a 53 man roster for the 2014 season, in order to play. Not only does the NFL have a stringent cap, it also employs a revenue sharing scheme where all television revenues are collectivized equally among teams. After all, if you look at the most valuable MLB teams, you’ll see larger-market teams like New York, Los Angeles, Boston, Chicago, San Francisco, and Philadelphia, and if you look at the bottom of the MLB’s list, you’ll see smaller markets like Cleveland, Oakland, Kansas City, and Tampa Bay. Meanwhile, the 16th most valuable NFL team out of the 32 is the Green Bay Packers. Green Bay, Wisconsin is not exactly a major city and yet they have a team worth $1.375 billion, which is higher than the values of teams in larger markets like Miami, Atlanta, and San Diego. If the NFL were a country in a time period, it would be a modern day Nordic country – somewhat socialized, but highly efficient and successful. The NFL outperforms all of its competition. The sum of individual team values is around $45.7 billion, with total

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

2013 MLB vs. NFL Player Salaries While Major League Baseball players make, on average, more than their football brethren, the difference between the highest and lowest paid baseball players is far greater than that in football.

Millions ($)

Alex Rodriguez

Tom Brady

Average

3.3 0.32

revenue exceeding $9.5 billion. This is exceptionally impressive especially given that the NFL only holds 256 regular season games every year, while the MLB holds 2,430 games per year. Additionally, the NFL’s average ticket price of $84.43 is considerably greater than baseball’s average ticket price of $29.73,yet the average football game in 2003 drew 68,397 fans while the average baseball game drew only 30,504. So do the NFL’s “socialist” measures work? The key to the NFL’s value lies in a black box, but one potential answer is that the correlation between current revenue and winning percentage over the last ten years lies at a mere 0.35, meaning a mere 12.3 percent of difference in revenue can be explained by differences in the team’s success over the last decade. And over about half as many years, the top five most decorated teams only accounted for 15 of the 48 Super Bowl wins, meaning, from a statistical standpoint, that while Super Bowl wins don’t follow a random walk, the championship is a lot more up in the air going into a given season than the World Series is in the MLB. This is a good model because after all, if you manage a sports league, the losing teams need to provide revenue too since every game has one winner and one loser. You need people to be willing to watch their teams lose and you also need people to think that the game isn’t over before it starts. The NFL, therefore, has quite clearly managed to accomplish both of these tasks in a way that the MLB simply has not. DON’T BORE PEOPLE At the end of the day, the issue with the MLB’s relative lack of success may simply lie in a greater interest in football compared to baseball. There’s only so much the MLB can do about this and while they are debuting new rules to try to speed up the game, they will need to change the fact that team revenues and winning are so closely connected. To those who say “Well, it makes sense because rich teams can just afford to pay better players, so of course they do better,” note that we are talking about revenue here; someone could spend all of King Midas’ gold on a payroll but if no one buys a ticket or watches a game, he or she won’t generate any revenue. It seems that there are myriad issues facing Major League Baseball and that the league could learn a lot from the National Football League, particularly about how to excite people. Although this alone will not solve the problem, one of the first things the MLB could do is to make championships more up for grabs. The playoffs this fall, which have featured teams like the Baltimore Orioles and Kansas City Royals, both of which have been unsuccessful for quite a while and are on the bottom half of team valuations, may provide a hope. But baseball still has a long way to go, and has much to learn from its boisterous younger brother in the NFL.

1.9 0.4

Highest Lowest

INEQUALITY IN TEAM WINNINGS

TOP 5 HAVE WON 31% FOOTBALL TEAMS

OF SUPERBOWLS

TOP 5 HAVE WON 57% BASEBALL TEAMS

OF WORLD SERIES

MARKETS

THE INVASIO by Jack Du

N OF THE FO

hili’s, Red Lobster, Olive Garden, Ruby Tuesday — you probably know all of these restaurants, but you can bet your children won’t. These restaurants are all prime examples of the classic sitdown restaurant that have been a staple of American cuisine for decades but are gradually being upended by new forms of diners. The reasons behind this shift can be explained with a touch of economic reasoning. In today’s American culture, the business model for sit-down restaurants is unsound due to cost inefficiencies and a shrinking target market. The flaws that are slowly clawing away at sitdown restaurants are otherwise absent from fast-casual diners and food trucks.

LINE FOR FOOD TRUCK quire larger spaces for customers to be seated and a larger kitchen, all of which lead to larger rent payments. A LIMITED TARGET MARKET Sit-down restaurants appeal to a small demographic that naturally excludes those who don’t have much time and those who are eating alone. In the day and age of 24/7 productivity, the frequency of eating alone is exploding. Since it often is not socially acceptable to sit at a restaurant alone, this takes out a huge chunk of potential diners. Time restraints also impact the market size. Going to a sit-down restaurant generally requires an hour at a minimum. You wait for your server to take your order, for your food to be made, for the check, and for your server to come back with the receipt. Many people are unwilling to allocate this kind of time for meals. A Canadian study has shown that since 1986, the average meal time has persistently dropped while the the number of people eating alone has continuously increased. OTHER BUSINESS MODEL PROBLEMS Sit-down restaurants’ business models have other unavoidable problems. They are dependent on how long customers sit at their table. In addition, the cleaning and preparation of a vacated table for new customers increases turnover time. While staff are wiping down tables

and cleaning up plates, people are waiting. Food trucks and fast casual diners easily bypass capped seating capacity and turnover times by providing disposable tableware and limited seating. With more complex menus, sit-down restaurants don’t cook your food until the order is placed, further increasing turnover times. This added wait time is often expected to be assuaged by complementary breadsticks, tea, coffee, or chips and salsa, the cost of which adds up over time and cuts into a restaurant’s bottom line. Sit-down restaurants won’t disappear; there is demand for them and there likely always will be, though it seems demand will never be as strong as in the past. Fast-casual restaurants and food trucks have leaner models, appeal to a larger customer base, and have greater flexibility. The rise of these types of restaurants is a testament to just how sensitive people are becoming about time-efficiency. In the end, all of this is simply a microcosm of the general trend of the fall of brick and mortar and the rise of e-commerce. Next time you’re munching on that bulgogi slider, think about why you didn’t opt for Andrea’s.

EMPTY SIT DOWN RESTAURANT

Photos by Cadence Lee

COST INEFFICIENCIES The cost problems largely arise from the fact that sit-downs have higher operating costs. They require a larger staff of waiters, waitresses, greeters, and busboys, which makes them more difficult to operate, compared to restaurants like Chipotle that have leaner business models. Efficiency impacts restaurants like Chipotle through several channels. It raises the bottom line by increasing the number of customers served per hour, decreasing production costs, and making a lasting impression on customers with prompt service. Sit-down restaurants are also more bogged down in fixed costs. They re-

OD TRUCK

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

The Unwritten Mandate: IS FINANCIAL by Christian Ackmann

ITY WORTH THE FED’S TIME? L I B STA

hen the Federal Reserve System was created in 1913, Congress declared only two objectives: maximum sustainable employment and stable prices. These two objectives are often called the Fed’s “dual mandate.” Given these simple goals, it may have been surprising when the Federal Reserve lent trillions of dollars to individual institutions during the recent recession. Over time, the responsibilities of the Federal Reserve have expanded beyond this dual mandate. Financial regulation is always changing, and the recently passed Dodd-Frank Act was one of the most massive regulation overhauls since the Fed’s inception. The ultimate goal of this constantly-expanding regulatory environment is to improve financial stability — that is,to mitigate economic shocks and avoid system-wide financial crises. While lending to targeted firms like AIG in 2008 was justified in the name of financial stability, economists disagree on whether financial stability should be included as the Fed’s explicit third mandate.

FOR

THE RISK OF PREVENTING RISKS Despite the compelling arguments for financial stability, some Fed leaders believe that a financial stability mandate would not reduce systemic financial risk. In an essay written for the Fed’s centennial, Jeffrey Lacker, President of the Federal Reserve Bank of Richmond, claimed that creating this third mandate “would seem to imply a central bank obligation to intervene to alleviate potential damage in cases of financial distress.” Lacker fears that bailouts like those in 2007 and 2008 create an expectation that the Fed will help financial institutions in future periods of economic stress. Critics of a financial stability mandate believe that this expectation will create moral hazard. That is, financial institutions could be encouraged to make unusually riskier investment decisions to earn a profit because they expect a government safety net in the event of a collapse. There is a potential for a self-perpetuating cycle of financial distress followed by Fed intervention. A financial stability mandate would imply that the Fed would continue to lend to large financial institutions to prevent financial instability. The expectation of crisis lending would encourage further risk-taking and perpetuate the cycle of moral hazard and govJEFFREY LACKER President of the Federal ernment intervention.

AGAINST

TIME FOR A CHANGE? In her testimony to Congress in July, Federal Reserve Chairwoman Janet Yellen referred to financial stability as an “unwritten third mandate” of the Federal Reserve. Not long after, a new Financial Stability Committee was created, led by Vice Chairman Stanley Fischer. The committee was charged with monitoring potential threats to the financial system and providing recomSTANLEY FISCHER mendations to the Fed on Vice Chairman of the U.S. Federal Reserve how it should respond. Fischer has previously used regulatory tools as the head of the Bank of Israel to fight a housing market bubble with limited success. Fischer attempted to protect the entire financial system’s stability through macroprudential tools, such as raising the minimum down payments for mortgages. In theory, macroprudential tools like this can replace interest-rate increases to pop asset-price bubbles. In a speech given at the National Bureau of Economic Research, Fischer said that every regulatory institution “should have the goal of financial stability added to its mandate.” Advocates for an explicit financial stability mandate argue that it would give regulators more authority to combat risks. Preventing asset bubbles is especially important in the low-interest rate environment that the United States has experienced since 2008, which has created incentives for investors to reach for yield.

Reserve of Richmond

IS THE FED FALLING BEHIND? Other countries have already tried to answer the financial stability question. The Bank of England created the Financial Policy Committee (FPC) in 2012, which is in charge of “taking action to remove or reduce systemic risks” in the U.K. financial system, according to the bank’s website. Explicitly stated goals like this allow the FPC to directly influence monetary policy decisions, whereas the Financial Stability Committee in the United States is more likely to advise than act. Does the Fed need an explicit financial stability mandate to empower regulators and the new committee? Or would a third mandate just perpetuate risk-taking? Only time will tell if the benefits of such a mandate will outweigh the risks.

MARKETS

Which Came First: CONSUMERS GOT CONFIDENT OR THE ECONOMY GOT BETTER? by Nicholas Hartmann

hat are your thoughts on the health of the economy? And how do you feel about your own personal financial prospects? Be careful how you answer—you just may prove yourself right. TESTING THE WATERS Consumer confidence is measured by a survey given to randomly selected American households, asking how they feel about current economic conditions. Businesses and citizens alike use it to assess consumers’ sentiment about the economy. Most Americans would probably agree that the health of our economy has greatly improved since the Great Recession of 2008. Statistics show that consumer confidence has risen a great deal over the past several years. But where did this confidence come from? Some may point to decreasing unemployment rates or the upward trends in the stock market. But perhaps one of the most significant factors in the rise of consumer confidence was, in fact, rising consumer confidence. THE INDEX EXPLAINED Americans’ confidence in the economy is measured by the Consumer Confidence Index. Since 1985, The Conference Board, a non-profit business membership and research group organization, has issued a survey every month to gauge consumers’ attitudes about the state of the economy and their future outlooks. The survey is given to 5,000 randomly selected American households, and asks their opinions about the topics such as employment and business conditions. Those surveyed give responses of “Positive,” “Negative,” or “Neutral” for each category. The Conference Board then compiles their data and publishes the index as a reflection of consumer sentiments. SELF-FULFILLING PROPHECY The index has significant effects on the behavior of firms. When consumer confidence is reported to be low, retail companies often cut back on their inventory, expecting to make fewer sales. These companies may also decrease employee hours or the number of people they hire. As a result, consumers are likely to grow even more pessimistic, which feeds into a cycle of pessimism. On the other hand, when consumer confidence levels are up, firms expect more buyer activity, and act accordingly. They may hire more workers, produce more products, or invest in new projects. This type of behavior will positively affect consumer confidence, and thus the economy will continue to thrive as a result. WHICH CAME FIRST? In thinking about how consumer sentiment and the economy affect each other, we find ourselves in a chicken or the egg type scenario. Where exactly does consumer

“

Perhaps one of the most significant factors in the rise of consumer confidence was, in fact, rising consumer confidence.

confidence come from? Does it result from the state of the economy? Or does the health of the economy fluctuate because of consumer sentiment? The answers depend on where consumer opinions come from. One theory posits that consumers respond to a lot of information, form their sentiments about the economy, and then change their purchasing behavior as a result. Another theory posits that consumer behavior is simply a reflection of current economic conditions. And a third view is that consumers’ confidence is a function of their uncertainty: more uncertainty entails less confidence. NEBULOUS CONSENSUS But does one theory trump the others? While there is some consensus that consumers spend more conservatively in the presence of uncertainty, the understanding of the mechanism by which consumers form their sentiments and behaviors is still in a nebulous state. Despite not knowing with certainty how consumers make their decisions, economists have been able to successfully gauge the impacts of these decisions. Although the impacts of consumer sentiments are difficult to accurately measure, it is interesting to consider that our recent economic fortunes might have to do with our optimism. The way we as consumers feel about our finances and our economy may indeed create a self-fulfilling prophecy.

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Goodbye Mr. Jones

THE END OF THE DOW AS AN AMERICAN INDEX by Charles Hemsley

fizer, America’s largest pharmaceutical company and a member of the Dow Jones Index, made a bid to acquire its British competitor AstraZeneca this past May. The acquisition would have allowed Pfizer to perform a tax inversion by moving its headquarters from the United States, which has the highest corporate tax rate of any rich nation, to Great Britain, which has one of the lowest. American and British lawmakers alike were up in arms over the deal, which AstraZeneca eventually rejected. American lawmakers denounced the potential loss of corporate tax revenue and of Pfizer as an American company - even though none of its assets held in America would invert. It would simply have been unpatriotic. The Dow has long been considered the showcase of American corporate power and the loss of one of its 30 members to the British would have been a huge blow to America’s corporate hegemony. The British similarly decried the potential loss of one of their most prestigious corporations to foreigners. The corporations themselves do not take patriotic pride into consideration, however, and see tax inversion simply as a sound business plan. CORPORATE MYTHOLOGY Decrying tax inversion as unpatriotic misses the point. The idea of an “American” corporation is increasingly becoming a myth. Pfizer’s CEO, for example, is British. According to The Economist, Pfizer’s domestic density index, which measures a company’s domestic business compared to its international side,

IS BURGER KING AN AMERICAN COMPANY? is 49 percent. AstraZeneca’s CEO is French and it has a domestic density rating of only 12 percent. Even Coca-Cola has less than half of its sales and staff in the United States, though, like Pfizer, a majority of its shareholders are American. America’s corporations are not really as “American” as we might like to think. This is the case for much of the Dow and corporate America in general. Medtronic, one of the world’s largest medical device makers, is currently in the process of inverting from Minnesota to Ireland; Burger King plans to send the King himself to Canada; and Chiquita – the only Banana company anyone has heard of – is moving to Ireland. This is all bad news for American corporate tax lawyers because, with their official headquarters overseas, companies will no longer be subject to American’s convoluted corporate tax code. Officially, the US corporate tax rate is 35 percent, but it is so fraught with loopDOW JONES INDEX (^DJI) Jan. 2014 - Oct. 2014

MARKETS

U.S. Inversions by Year

Congress imposes a Another wave of moratorium on inversions begins inversions, then as companies passes a law meant to exploit exceptions stop them to the new law

Completed inversion Pending inversion, may close in 2014 or 2015 McDermott Intl. changes its legal address to Panama

1982

1985

The technique becomes popular in the mid-1990s

1990

holes and tax breaks that companies rarely foot the whole bill. Corporations headquartered in the United States are supposed to pay taxes on revenue generated all over the world but are only required to pay taxes on the money that they actually bring home. Consequently, companies have stopped bringing foreign revenue home: U.S. corporations have around $2 trillion on foreign balance sheets. THE TRIALS OF TAX REFORM Tax inversion is not unpatriotic, but it is nonetheless a problem. The United States loses more than half of total corporate tax income to loopholes. Inversions will only compound this problem and siphon off more tax income. Congress is moving to change the laws governing inversion, which allows inversions as long as stockholders who were not holders of the U.S. company hold at least 20 percent of the merged company. The Stop Corporate Inversions Act of 2014 introduced by Senator Carl Levin (D-MI) aims to raise the level of ownership to 50 percent among other stipulations. Congressional Democrats claim that their legislation will keep $19.5 billion per year in the United States. The Treasury Department has also stepped up regulation in the face of the spate of recent inversions. New regulations proposed by Treasury Sec-

1995

2000

“

2005

2010

2014

The idea of an ‘American’ corporation is increasingly becoming a myth... Even Coca-Cola has less than half of its sales and staff in the United States.

retary Jack Lew would cut down on “spinversions,” which are a form of inversion where a company splits off one of its parts and turns it into a separate corporate entity backed by the original company and governed by the original company’s shareholders. Secretary Lew also aims to regulate “hopscotch,” which allows companies to access their foreign cash reserves without paying taxes. However, new regulations will not affect the Burger King deal or many others in their final stages of inversion. Tax inversions are a symptom of a larger problem: America’s bloated corporate tax code. Substantive tax reform is one of the most politically poisonous issues to grapple with in Washington D.C. and corporate tax debates arouse great rancor from politicians and interest groups. In light of these hurdles, these new measures are stopgap at

”

best. Tax inversions themselves do not need to be legislated away, if that is even possible in the face of an army of corporate tax lawyers. Instead, the corporate tax code needs to be streamlined and the rate lowered to be on par with that of other developed nations. Economics is the study of incentives, so a good economist knows that to change the corporate system, you have to change corporate incentives. Incremental regulation has failed in the past and will continue to fail as long as other nations have comparatively advantageous tax codes in the eyes of corporations. The idea of corporate patriotism is not enough to keep corporations in the United States. Politicians and regulators must accept this fact and work to alter the incentives so that corporate taxes for work done in the United States go to the United States.

28 28 U.S. COMPANIES HAVE BECOME EUROPEAN-BASED

An Exposé on Danny Warshay by Francesca Whitehead and Mariana Carvalho

anny Warshay teaches The Entrepreneurial Process: Innovation in Practice at Brown University. As the Entrepreneur-in-Residence at Brown he advises students as they start their own ventures. This is a fitting role for the guy who has spent his life innovating. As a Brown undergraduate, class of 1987, he was a History concentrator. Despite this unusual start, Danny began his entrepreneurial pursuits as co-founder of Clearview Software, the developer of the SmartForms suite of Macintosh applications software. Brown even provided an office space in the basement of Wayland, where Danny had been a Residential Counselor during his sophomore year. Danny is also the founder of DEW Ventures, in which he has helped develop a portfolio of new, quickly growing companies. Among those companies, he is co-founder of G-Form, which creates innovative athletic protection products. One of the reasons Danny chose Brown was for the university’s strong support of studying abroad. He found studying in Jerusalem during his junior year. When he returned, he wanted to increase his involvement with Hillel. He served on the board for ten years, and was president for four years during the $12 million capital campaign for the construction of its new 28,000 square foot facility. Danny also had some corporate experience at Procter & Gamble as a member of the Duncan Hines Brand Management team. This enabled him to learn key management skills that he later used in his own start-ups. Danny met his wife, Dr. Debra Herman, during their senior year, while they lived across the Young-O hall from each other. They have three children and now live a block from the Brown football stadium.

STARTUP IN WAYLAND “At the time we were developing Clearview, there were no entrepreneurship programs; in or out of the Brown curriculum. We did receive a lot of faculty support. In fact, Barrett Hazeltine was a crucial mentor for us.”

“Although P&G was not a good long-term fit for me, I gained a lot of valuable skills and insights from the large-scale business mindset and consumer marketing training they provided me.”

HILLEL

THE CLASSROOM

“I teach using the Socratic method, using Harvard case studies to stimulate critical thinking and discussion, which is a new mode of learning for many students I encounter across the globe.”

G-FORM

“The idea for G-Form was started at one of my friend’s houses, in a North Scituate barn. We initially would sit around a big table and take orders from there. Now we have factories in North Smithfield and Fall River, MA, 150 employees, and have distributors selling G-Form products in most countries around the world.”

INTERNATIONAL EXPERIENCE

CORPORATE EXPERIENCE

“I didn’t raise all that money myself. We had a few very generous donors in the beginning. When we stuck the spade in the ground and people realized that yes, this is real... this is happening. That’s when the capital campaign moved into high gear.”

“People have different ambitions, goals, and ways of seeing life. One of the most striking contrasts across countries is people’s level of comfort taking risk.”

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

A Tale of Two BRICS:

CAPITALISM AND THE STATE IN INDIA AND CHINA Modi’s WMD WEAPONS OF MASS DEVELOPMENT by Omar Ben Halim

or a supposedly divisive leader, Narendra Modi inspires an unusual, renewed faith in government. The parallels with Barack Obama’s early days are clear – a charismatic, disruptive, bold politician who drives the imagination of those around him. Whether Modi will fulfill the wild hopes pinned on him or succumb to political realities of fragmented power and overwhelming expectations remains to be seen. That India has enormous potential is not a new assertion– the pros of the country are significant: location; a huge, youthful population of which 20 percent speak English; a stable and representative political system; and a long history of innovation. It is an unfortunate reality, however, that the drawbacks are also no pushover: government is ineffective and decentralized; education is lacking – the adult literacy rate of 62 percent pales in comparison to China’s 95 percent; and the paltry use of toilets – 65 percent – is becoming an international talking point. Given this unique backdrop, Modi has a significant task in front of him if he is to deliver on his campaign promise

“

Why, then, is corruption seen as a major barrier to growth in India, whereas in China it is not considered a crippling defect?

to recast India as a global manufacturing hub and economic center. His focus on improved decision-making and bureaucratic streamlining will ruffle feathers but improve the way in which policy is made and implemented. That Modi is willing to take action on the unglamorous plumbing of government and not purely headline policies is encouraging. The substance is important, however, and the job ahead of him will require addressing the existing bottlenecks in Indian growth – government effectiveness, infrastructure, and education. CUTTING DOWN Modi has sent encouraging signals by cutting his cabinet from 35 people to 23, but instituting a more competent government at all levels will not be easy. He is hampered by the power held at state level and in rural constituencies. He has been successful in maintaining public support for his policies through bold and inclusive initiatives, such as his order for government employees, including ministers, to clean up the offices where they work as part of the ‘Clean India’ campaign. Modi will need to clean up more than physical offices. He must focus on consistent, target-oriented, and accountable government, perhaps Modi’s biggest challenge: China is number 80 on Transparency International’s Corruption Index, and India is number 94 – trailing, but not too far off. Why, then, is corruption seen as a major barrier to growth in India, whereas in China it is not considered a crippling defect? While corruption is still a source of considerable public irritation in China, Chinese officials must hit their targets and quotas before they can safely skim off the top. In India, no such incentive structure exists. The challenges facing Modi of containing corruption, promoting consistency, and incentivising efficiency cannot be overcome in the span of a few years. A convincing start will be important nevertheless. BUILDING UP India’s infrastructure deficit is gaping – legal and procedural infrastructure systems such as courts and regulatory systems are lacking, as are transport, energy, and wireless facilities. There are two ways to approach such an issue –

privatization or reformed government management. Both strategies should be used where appropriate. Some duties must fall to the government. For instance, with a paltry 53.8 percent of roads paved, physical infrastructure is a clear place for the government to invest. Widely accepted as public goods the government should provide, roads, ports, and public transport systems aid the economy, job creation, and urbanization. In other cases, however, India should not be reluctant to privatize state-owned companies. Power, for instance, is suffering under the Coal India monopoly, which has resulted a deeply inefficient pricing mechanism. India has already broken state monopolies in several industries, including commercial banking, insurance, and telecommunications, and should not be afraid to go further. While these sectors have not been entirely privatized, competition from the entrance of private firms will be a healthy change. A “MOST POWERFUL WEAPON” Education is even more important in India than in many other developing countries. India’s renewed focus on manufacturing under Modi could succeed, as China’s did, with a population that has a even a low level of education. The capital formed by this industrialisation could then be ploughed back into areas such as infrastructure and education. India, however, is a democracy – the education of its people is far more urgent simply because an educated and fully literate electorate will elect far better leaders. Education will also be key for India to expand its competitive advantage in services like outsourcing and technology, and to look beyond these fields for higher margins and more innovative work. In building its education system, India can catapult itself forward on issues ranging from sanitation to manufacturing competitiveness. Most importantly, a more educated population is more likely to seek jobs in urban centers, allowing for more efficient land use and service provision in rural areas. While the future is full of opportunity for India, the obstacles are real and will present a significant challenge. A focus on the messy work of reform and disciplined prioritization of policy tar-

POLITICAL ECONOMY

“

Historically, governments have fallen in the face of economic turmoil and political infighting. But where the Soviet Union fell behind, China has surged ahead.

gets is required, and Modi will need all of his considerable energy and guile if he is to make any appreciable impact. Despite the widespread cries of ‘last chance saloon,’ however, it is worth remembering that whatever happens with Narendra Modi, 1.3 billion people aren’t going anywhere.

Two Steps Forward, One Step Back CAN CHINA ESCAPE THE MIDDLE-INCOME TRAP? by Alexander Burger

hina has already hosted the Olympics, joined the World Trade Organization (WTO), and lifted 400 million citizens out of poverty. Not bad for a country whose GDP was one fortieth that of the United States in 1980. But the future looks uncertain as wages rise and the sputter of the factories dies away.

SO FAR SO GOOD In the past, the Chinese leadership’s ability to assess the mistakes of other governments and adapt appropriately has allowed the Middle Kingdom to overcome major challenges, such as the

”

conflict over privatization and the 2008 financial crisis. Historically, governments have fallen in the face of economic turmoil and political infighting. But where the Soviet Union fell behind, China has surged ahead. Citizens have entrusted the party to maintain this trajectory. Central government intervention has been a key component of China’s economic success. But now China’s growth strategy - based on low wages and urbanization - is becoming less effective as the nation’s income increases. No longer will bureaucratic direction and massive government investment be sustainable policies. The administration has realized that it must turn to innovation and education, and has signaled its willingness to take the appropriate steps. BEWARE OF THE BRIDGE The middle-income trap describes a situation in which a nation’s growth stalls as incomes rise to the upper quartile of countries. As wages rise, a developing country can no longer compete against lower-wage countries in the context of low-skilled labor. At the same time, the country remains too poor to compete in high-skilled sectors against more technologically advanced countries. The

MOVING FORWARD With the same determination that enabled it to join the WTO, China has been proactive in pursuing better education for its citizens in hopes that improving its human capital will act as a catalyst for innovation. China is projected to have 200 million college graduates by the year 2030, and currently hosts eleven of the best 200 universities in the world. Xi Jinping understands that a strong financial sector is crucial for China’s success. Encouraging consumption will require liberalizing its financial industry, but doing so will entail giving up a degree of control. China currently maintains a cap on interest rates paid on consumer deposits, meant to prevent banks from competing for deposits by offering increasingly higher rates. However, low rates have forced Chinese consumers to dedicate a larger portion of their income to savings for retirement. Consumption has suffered as a result. The leadership’s plans to expand bank deposit insurance to private banks will help to mitigate the potentially disruptive effects of financial liberalization. The CCP is moving cautiously for now. The middle-income trap is just another obstacle that its leadership hopes to navigate. Though the Party may be restless, it seems that the “Chinese Dream” carries on.

Cartoon by Linda Navon Chetrit

COMMUNISTS IN NAME ONLY As a Communist Party presiding over an exceedingly capitalist economy, the legitimacy of President Xi Jinping’s government rests on delivering economic growth to his citizens. Tailoring its nominally communist system to the contemporary world, the Chinese Communist Party (CCP) has sought to shift from state capitalism towards a more market-based approach. This effort is underscored by the recent Third Plenum’s blueprint for the country, as well as the creation of the Shanghai Free Trade Zone. President Xi has a plan, and that plan is to jump the middle-income trap.

economy, stuck in the middle, cannot compete on either ground. The Communist Party leadership believes that by targeting greater education, increased productivity, and technological advances, China can avoid the middle-income trap and transition to a consumption-led economy driven by innovation and less government involvement.

POLITICAL ECONOMY

THE ECONOMY OF TERROR by Carly West

“

How did this group, deemed ‘too extreme’ for Al Qaeda, become wealthier than the terror network that spawned it?

”

n January 2014, President Obama was asked in an interview with the New Yorker about the threat of the Islamic State of Iraq and Syria (ISIS), which at the time was around 1,000 men strong. His response was: “If a JV team puts on Lakers uniforms, that doesn’t make them Kobe Bryant.” Over the course of seven months, however, ISIS has joined the big leagues. A $2 BILLION STARTUP The Sunni extremist group, whose brutal tactics have incited fear and outrage around the globe, has emerged as a powerful organization in Iraq and Syria. Though ISIS emerged out of complex historical and social conditions, it was most immediately spurred on in the wake of the U.S. retreat from Iraq, which left in power an exclusionary government under Iraqi Prime Minister Nouri al-Maliki. The ongoing Syrian civil war has also proven to be an essential asset for ISIS, serving as a recruitment center and staging ground. But what actually makes their ambitious operations viable? Funds, and lots of them. Analysts valued the group’s operations at $2 billion after Iraqi troops raided an ISIS compound and found flash drives detailing their financial accounting. But how did this group, deemed “too extreme” for Al Qaeda, become wealthier than the terror network that spawned it?

LIQUID GOLD However, the most critical element of their terror economy is oil. ISIS has gained control of around 11 oil fields in Iraq and Syria, and their profits from this liquid gold have exceeded $3 million a day. Their hold on oil has become so strong that their enemies in the Syrian government have been forced to buy electricity from them. They also have black market buyers in Turkey and Iraqi Kurdistan. This hold on oil is unprecedented, and could be the key to developing their terror operation into an empire. Recognition of this threat is clearly evident in Obama’s recent bombing campaign, which has included dozens of strikes on ISIS-owned oil refineries in eastern Syria. On a brighter note, some analysts have pointed out that ISIS’s hold on oil is making them vulnerable to strikes. Since the group has to protect its assets, maintain output, and then transport the product for sale, it is becoming increasingly easier to target. According to Michael Knights of the Washington Institute for Near East Policy, “If ISIS wants to run an oil industry, it is extraordinarily vulnerable to military attacks.” He describes how ISIS’s move to bigger trucks is a risky move. “They’re slow, they’re big, and they explode when you hit them. This is not a reliable way of making money,” he said. ISIS is a highly systematic and ruthless entity that has been capitalizing on the fractured loyalties and general disorder in the region. Profitable revenue sources have made ISIS highly effective on the battlefield, as the group pays better salaries than moderate Syrian rebels or the Syrian and Iraqi militaries, both of which have suffered mass desertions. If the West hopes to curb the spread of ISIS and its influence, examining these flows of capital will be critical to its success.

SHOW ME THE MONEY Wealthy donors in Kuwait, Qatar, Saudi Arabia, and other Gulf states have provided immense financial and operational support. They’ve been likened to angel investors, except they are interested in starting up “groups who want to stir up hatred,” according to James Stavridis, a former navy admiral, now Dean of the Fletcher School of Diplomacy at Tufts University. Stavridis and several U.S. officials suggest that the biggest share of the individual donations supporting ISIS and other radical terrorist groups comes from Kuwait and Qatar rather than Saudi Arabia, which is more closely aligned with U.S. policy. However, the administration has yet to put pressure on these states, despite clear evidence that they have either facilitated or turned a blind eye to these streams of funding. But donations are just a starting point - ISIS doesn’t depend on foreign aid to survive. ISIS has set up its own “mini state,” ISIS CONTROLS 30,000 BARRELS A DAY THAT IRAQ PRODUCES making its organization self-sustaining. Even prior to seizing Mosul, a region in Northern Iraq, the group began to impose “taxes” on nearly every economic exchange in the region, threatening death ISIS CONTROLS 50,000 BARRELS A for those unwilling to pay. An analysis by DAY THAT SYRIA PRODUCES the Council on Foreign Relations estimated the group was reaping $8 million a month from extortion in Mosul, plus $430 sells for $40 per barrel million from their main bank. In addition to on the black market extortion and theft, ISIS acquires funding from kidnapping ransoms, and, according COMPARED TO $93 PER BARREL IN THE FREE MARKET = 1,000 barrels of oil to a report in the Guardian newspaper, by illegally selling ancient artifacts.

HOW ISIS USES OIL TO FINANCE ITS TERROR OPERATIONS

IRAQ: $1.2 MILLION

A DAY

SYRIA: $2.0 MILLION

A DAY

$97 MILLION

A MONTH

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Puerto Rico: America’s Firstborn or Lovechild?

ON THE DEBT CRISIS IN THE COMMONWEALTH by Wesley Meyer

$72 BILLION Puerto Rico’s

DEBT

$19,518 PUERTO

RICAN

MEDIAN INCOME Puerto Rico’s

DEBT

88.9 PERCENT OF

PERSONAL

INCOME VS.

3.4

PERCENT U.S. STATE

AVERAGE 20

hey go to jail, they wreck cars, and they bring home stray dogs. Children place economic, physical, and emotional burdens on parents. Despite the damaging situations that kids concoct, parents support and bail out their struggling youth. Puerto Rico, a commonwealth of the United States since 1952, has found itself inundated with debt: the territory owes a whopping $72 billion — slightly over 70 percent of its GDP and more than any state in the union. Now cash-strapped, Puerto Rican companies running fundamental services like water, sewage, and power are pressed to meet their obligations to bondholders as well as maintain operational funding. The United States should support them, but also encourage tighter spending in the commonwealth. PARENTS JUST DON’T UNDERSTAND In many ways, the United States may share responsibility for Puerto Rico’s erratic economic behavior. As a commonwealth, the island is subject to the same federal minimum wage as the rest of the country, despite lower incomes. Puerto Rico’s relatively high wages and its lack of control over the value of the U.S. Dollar have damaged exports, but it still misses out on $10 billion of federal funding due to its territory status. Puerto Rico may have dug itself into a hole, but America keeps knocking down its escape ladder. There is no equivalent for bankruptcy protection in Puerto Rico and American lawmakers have thwarted the island’s attempts to establish a substitute framework. Helpful as always, the Federal Reserve has suggested they restructure their tax code. BULLIES OF THE BOND MARKET However, Puerto Rico is not without fault. $20 billion of its debt is owed by the power, water, and transportation agencies, as the island generates 65 percent of its power with expensive, imported oil. This costly practice drains government coffers. Puerto Rico should switch to cheaper and more efficient plants that run on natural gas. Investment, however, will be increasingly difficult to obtain if Puerto Rican bankruptcy laws remain uncertain. Bankruptcy exists to protect borrowers when they cannot meet their debt obligations. Bankruptcy does not absolve debts, but gives the borrower time and space to protect their assets and restructure their finances. Chapter 9 bank-

ruptcy protection, as opposed to default, benefits bondholders. This is the path Detroit took when it faced default in 2013, and precisely what Puerto Rico needs now. The commonwealth’s indebted companies require cash to operate and cannot afford to make their monthly payments. They have been left to fend for themselves against the bullies of the bond market while balancing their responsibilities at home. As a result, rates have soared and the costs have been passed on to the citizens of Puerto Rico. The territory already suffers from the worst poverty and highest unemployment in the United States. MARKET WOES Clarifying America’s role is crucial to restoring confidence in the bond market. The question of which party is liable for Puerto Rico’s debt caused a domino effect in markets and courtrooms. The United States government does not have to back municipal bonds, so it is unclear if it will back Puerto Rico’s. American mutual funds and individuals hold a majority of Puerto Rican debt and their investments have suffered greatly in the wake of this instability. The lack of clarity stirred the markets and will only disappear with legislative change; the future of investment in Puerto Rico depends on America’s response to their call for help. A HARSH REALITY Everyone is scrambling. U.S. mutual funds await their interest payments, bond insurers have summoned their troops of lawyers, and the Puerto Rican utility companies have hiked rates twice as high as the average in America. There will be no happy ending, although this process has forced the U.S. to reexamine its stance on commonwealths. By next year, it is likely that those involved will reach an agreement. America has embarrassed itself with the neglect of its territory. Instead of hiding Puerto Rico from the family, the United States should support the island by providing the same legal protection and fiscal support it gives to the states. Backing Puerto Rican bonds would result in greater efficiency and would encourage Puerto Rico’s economic growth. Puerto Rico’s cost of debt would fall, allowing for more spending on government projects and less on interest payments. The United States would no longer have to bear the weight of a needy child.

POLITICAL ECONOMY

Saving Money and Saving Lives AN ECONOMIC CASE FOR FIGHTING EBOLA

t the end of September the United States was rocked by news that a man in Dallas had been diagnosed with Ebola. Despite the toll it had taken abroad, it wasn’t until then that the terrifying illness became a real threat for millions of Americans. The man’s death on October 8th led to a heightened sense of fear throughout the country, but the Centers for Disease Control and Prevention (CDC) has been firm in its stance that “the risk of an outbreak in the U.S. is very low.” The people of West Africa have more reason to worry. As of Oct. 19, the disease has claimed 4,500 lives — most of them in Guinea, Sierra Leone, and Liberia. These countries desperately need the help of the United States and others who have the expertise and resources to halt the spread of Ebola, but humanitarian arguments have until now yielded a lackluster response. However, there is a compelling economic case for aggressively fighting the outbreak, which could hopefully help persuade policymakers that a stronger international response to the crisis is beneficial for the entire world. JUST SAY YES According to the World Bank, health expenditure per capita in 2012 was $32 in Guinea, $65 in Liberia, and $96 in Sierra Leone, all of which are dwarfed by the United States’ per capita spending of $8,895. It’s no wonder that the two Americans who were whisked off to Emory University survived while the thousands of Africans checking into underfunded hospitals have faced far more uncertain fates. By subsidizing investment in hospitals and clinics, foreign governments can pave the way for medical supply companies to have a presence in the region long after the Ebola crisis has passed. In addition to investing in medical supplies and infrastructure, the developed world must do more to support research and production of experimental drugs, such as the ZMapp serum. The United States and Canada are providing funding to Mapp Biopharmaceutical, the creator of ZMapp, but they must do more. Not only would the development of a successful Ebola drug save lives now and in the future, but the research associated with it would likely improve understanding of other diseases as well, yielding a positive externality. The United States should subsidize such research.

IT’S THE ECONOMY, STUPID Outside of the medical industry, fiercely combating Ebola would have significant economic benefits. On Sept. 22, the World Health Organization said in a report that Ebola could become endemic in West Africa. The United States is already one of the largest aid donors to Sierra Leone and Liberia; if Ebola ultimately became endemic to those countries, it would place an even greater burden on U.S. aid. On the other hand, if the United States bears the cost of putting an end to the outbreak now, that investment will help prevent or reduce the impact of future crises. U.S. trade with the Economic Community of West African States totaled $23.3 billion in 2013; that number could grow in the future if physical and economic health in the region continues to improve. The prospect of an Ebola epidemic isn’t just a regional problem for West Africa, but a global one. The connectivity of air travel means that the entire world would have to be constantly on alert for Ebola. In such a future, the responsibility of screening and providing health care to passengers who arrive in the United States exhibiting symptoms of Ebola would be very costly. Furthermore, a long-lasting health crisis would weaken political stability in the region and could give rise to conflict that threatens U.S. interests. Analysts have warned that Ebola may cause the failure of states across West Africa. Decisive action by the United States would improve perceptions of the country in the region and the international community. One of the most powerful tools for rational decision-making is the cost-benefit analysis. In the case of a more aggressive American response to the West African Ebola outbreak, the short-term costs are far less than the long-term benefits: advances in medical infrastructure and understanding, the prevention of future crises, less aid, more trade, and a globalized world without the constant threat of Ebola. The message to Washington is clear. Doing everything in our power to eliminate Ebola isn’t just the right thing to do— it’s also smart economics.

BOLA VIRUS THE E

by Nikhil Kumar

Scotlandâ&#x20AC;&#x2122;s Referendum and the Islamic State: IN THE WAKE OF A GREAT RECESSION by Christopher Dederick

m, Europeâ&#x20AC;&#x2122;s Far Right, :

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

On Sept. 19, 2014, the clouds seemed to lift for Britain, Europe, and global financial markets. Scotland’s pro-independence “Yes” campaign had failed to channel discontent with the economic status quo into a vote for separation. Millions in Scotland awoke to disappointment, while millions more across Britain breathed a sigh of relief. However, the pressures that compelled 1.6 million Scots to vote for leaving the UK have by no means dissipated. These underlying forces are driving a broader backlash against the economic world order far beyond the shores of Britain. Fiscal policy has been at the heart of the debate over independence. In response to persistent government deficits since the financial crisis, Prime Minister David Cameron, a Conservative, has slashed budgets on programs ranging from unemployment benefits to health care. Scottish voters, traditionally more left-leaning than their English counterparts, have had frustratingly little say over policies made in Westminster. Only 16 percent of Scots actually voted for the Conservatives in the last election. Alex Salmond’s Scottish National Party (SNP) argued that independence would offer Scottish voters a more democratic choice over fiscal policy. According to Mark Blyth, Brown University’s eminent political economist: “The referendum was not on nationalism, but rather distribution and neoliberalism.” Blyth describes the fiscal and social policies of previous Labor Party governments as “neoliberalism with airbags.” As a result of Cameron’s budgetary cuts, “those airbags have since deflated.” CLEAR SKIES, OR THE EYE OF A STORM? Scottish voters rejected political independence by a 10 percent margin thanks to a promise to devolve more powers to Scotland’s national parliament. Cameron will now have to deliver if he hopes to avoid a repeat of this turbulent episode. Many Scots are understandably disappointed, but the political and economic repercussions of a “Yes” vote would have been worse still. Alex Salmond claimed that an independent Scotland could continue using the pound as its currency, but Mark Carney, Governor of the Bank of England (BoE), insisted that it would also have to make do without the support of Britain’s central bank. A shared currency that lacks the financial backing of a central bank is inherently unstable. Without a central bank, investors perceive assets such as sovereign bonds as much riskier, since repayment is guaranteed solely by the government’s ability to raise tax revenue. The Eurozone learned this the hard way. Though the bloc is still mired in a structural growth crisis, the financial crisis subsided in 2012 when Mario Draghi, the President of the European Central Bank (ECB), claimed he would do “whatever it takes” to save the Euro. In doing so, Draghi signaled his willingness to act as a lender of last resort and buy debt from investors. For Carney, an arrangement of this sort would entail subsidizing higher deficits in Scotland, clearly an “incompatible” solution to a contentious divorce. Without the BoE, investors would have charged higher rates on Scottish government bonds to compensate for risk. High interest rates obstruct growth and investment, leading to exactly the kind of economic stagnation the independence movement sought to escape. Alternatively, the Scottish government could have cut spending to reassure investors or reach an agreement with the BoE, in which case it would be back to square one for fiscal reform. Ultimately, Scotland would have to choose between the fiscal discipline demanded by the market and that imposed by the UK. On the other hand, creating a new currency would result in onerous foreign exchange costs for Scotland and the UK, its primary trade partner.

THUNDER IN THE DISTANCE Politically, the forecast looked even bleaker. Scottish voters strongly favor integration with the European Union, more so than the rest of the UK. With 10 percent of the pro-European vote missing from the upcoming British referendum on whether to stay in the EU, the possibility of one of its key members leaving looked all the more likely. Regrettably, this may still happen. Meanwhile, Scotland’s referendum has galvanized independence movements elsewhere in Europe. Despite the outcome, Catalonia, Spain’s wealthiest region, is now planning its own vote on independence. In the east, the EU’s newest members include various national enclaves where questions of irredentism have always simmered below the surface. The “Yes” campaign was ostensibly about improving democracy, but Mark Blyth contends that 90 percent of the stakeholders affected (the rest of Britain) had no say in the vote. Beyond the threat of disruptive separatism, Scotland’s experience underscores an alarming frustration with neoliberalism, globalization, and the prevailing economic order. Free trade and markets have mobilized resources and accelerated technological innovation. Efficiency and falling costs benefit consumers everywhere via more affordable goods and services. But even in wealthier economies, there is a growing sense that many have simply been left behind. In the United States, per capita GDP has risen dramatically in the last quarter century. However, median incomes have largely stagnated. For a while, credit, not income, fuelled higher consumption. This came to a grinding halt in 2008, spawning widespread social frustration manifested in the Occupy movement. Worse yet, the socio-economic fallout of austerity and a sluggish economy in Europe has elevated fringe political parties to new heights, most recently during elections for European Parliament in 2014. EUROPE’S NEWEST FAULT LINES The far-right Front National (FN) came first in France, despite its long history of racism and anti-semitism. Its populist leader, Marine Le Pen, has managed to tap French voters’ disillusionment with the economy, blaming globalization, neoliberalism and the EU. Le Pen beat French President Francois Hollande in a recent opinion poll, prompting Prime Minister Manuel Valls to warn that European fascists may be “at the gates of power.” It is no coincidence that Le Pen’s political “earthquake” has come in the

POLITICAL ECONOMY

ORKNEY ISLANDS

23%

SHETLAND ISLANDS

27%

OUTER HEBRIDES

20%

MORAY

19%

HIGHLAND

16%

ABERDEENSHIRE

ABERDEEN CITY

AUGUS

PERTH AND KINROSS

24%

ARGYLL AND BUTE

DUNDEE CITY

7% FIFE

STIRLING

14%

30%

EAST LOTHIAN

10% SOUTH LANKASHIRE

NORTH AYRSHIRE

29%

21% YES

% VOTE

SCOTTISH BORDERS

26%

SOUTH AYRSHIRE

50-55%

55.1%-60%

28%

DUMFRIES AND GALLOWAY

60.1-65%

65.1-70%

wake of the worst global recession since the Great Depression, when fascism first emerged. The FN were not the only ones to make big gains this year. UKIP, more moderate than its French counterpart, won first place in Britain off a tide of anti-immigrant and anti-European sentiment. In Denmark and Hungary, farright parties came in first and second place respectively. The far-left Syriza carried the day in Greece with an anti-capitalist and Eurosceptic message, while Golden Dawn, a far-right neo-Nazi party, took third. All the while, Islamic extremists have shocked the world with rapid territorial advances in Iraq and Syria. Their

success fundamentally has less to do with a religious awakening and more to do with festering resentment over unrepresentative economic and political policies. Many of the region’s governments have demonstrated little regard for the populations they purportedly serve. A more inclusive political-economic order could have destroyed the raison d’etre of groups such as the Islamic State. The Arab Spring began as an outcry against economic misery, but largely failed to fulfill expectations. Poverty and hopelessness have instead contributed to turning thousands of embittered young men into violent ideologues. In Syria, the ensuing disenchantment de-

volved into a summer of extremism. Dissatisfaction with the state of the economy has unleashed a deluge of instability, which now threatens the global economic system on multiple fronts. Preserving the system, which for all its faults has fostered unprecedented progress, will require addressing the stakeholders that it has disappointed. Without state investment to create opportunities, fight mass unemployment, smooth the business cycle, and confront economic stasis where it is most endemic, the forces perpetuating much of the world’s turbulence will continue to strengthen. In Scotland, the skies seem clear for now, but elsewhere a storm may still be gathering.

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Socially Responsible Indulgence

THE SPOILS OF BUYING LOCALLY GROWN FOOD by Matthew Janigian

“

Shifting purchases from large farms—typically not located in those regions— to local farms could parallel the increase of income spent in those

”

more local regions.

hifts in consumer behavior have led to the growth of socially responsible investing — investing in companies that care about environmental and social causes, and have ethical governance (ESG). By investing in ESG firms, investors have a tangible means of being proactive while also making money. So how can you get involved? Simple: by eating. A TASTY STRETCH That probably sounds too good to be true. If eating is analogous to investing, then eating locally grown food is analogous to socially responsible investing. While this might sound like a stretch, it’s a tasty stretch, so stick around for a minute. Typically, eating locally grown food is seen as expensive and indulgent. The price of produce marketed as organic or local is often hiked up. Grass-fed beef and free-range chicken sell at a premium. Products made with local ingredients are labeled as “artisanal” and given higher price tags. These products are still bought on background assumptions that allegedly add value in some form: they are healthier, taste better, and support the local economy—or their producers are more ethical than larger operations.

FREQUENT EVANESCENCE Scientific evidence does not substantiate the claim that locally grown foods are healthier. That said, the food tends to taste better. Better tasting food could very well lead to some degree of greater enjoyment. Food is frequent and evanescent: we consume food regularly to survive, but each meal only lasts so long. Food that tastes better just might make those fleeting moments feel a bit more nourishing. REGIONAL DISPARITY From an economic perspective, the results are mixed: on the national level, buying locally does not seem to make a difference. Economists explain this by suggesting that eating locally produced food is just shifting consumption from big farms to local ones, creating a net change in consumption of zero. However, on a regional level, eating locally can make a difference: a study found that consuming more from local farms benefited the economies of mid-Atlantic and Northeastern states. Shifting purchases from large farms—typically not located in those regions—to local farms could parallel the increase of income spent in those more local regions.

PERSONAL FINANCE

Photos by Cadence Lee

PEAK TOMATOES Obviously, if you are going to pursue a form of socially responsible investing through eating, it must be done properly. As with any investment, it is crucial to know what to invest in and when to invest in it. The best deals occur when buying produce that is not only in season, but at its peak. Tomatoes may be around in June, but by August they are at their peak ripeness and lowest prices. At farmers markets, checking multiple stands can help with price discovery. Most of the produce tastes better than any produce found in a supermarket, so it is best to focus on the prices rather than who the seller is. PRODUCE BACKED SECURITIES As with any conversation about investing, talking about diversification is crucial. After finding good value from a farm, that value ought to be preserved. If the investment is executed properly, you will have a large pile of cheap produce that seems to get closer to spoiling with every passing second. Instead of worrying, follow the example of banks when they had rotting mortgage bonds: turn them into something

better. Take that produce and create some exquisite Produce Backed Securities by making and freezing stock, or turning them into preserves with a longer shelf life. APPRECIATIVE NOURISHMENT In the end, eating local food probably will have no financial return, but then again, that is never the goal of eating. Buying locally grown food wonâ&#x20AC;&#x2122;t pay financial dividends, but it will generate positive effects. It supports regional farms and farmers who genuinely care for their crops, it benefits the environment by reducing food miles, and occasionally decreases the use of pesticides. More than just a statement, buying locally farmed produce shows respect for that which nourishes us and allows us to persist. What is lost in financial expenditures is made up for in a positive social benefitâ&#x20AC;&#x201D;and more flavorful food. It encourages deeper thinking about where the food comes from, and might even inspire greater appreciation of the ingredients. So let that inner locavore loose. Not only is it a socially responsible choice, it is a choice that inevitably results in eating great food. And no rate of return can beat that.

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

$0 To $2 Billion Real Quick HOW PEER-TO-PEER LENDING IS RAPIDLY REVAMPING THE LENDING INDUSTRY by Rachel Binder

“

What few people acknowledge is the striking resemblance between the current P2P lending marketplace and the housing market before the recession.

”

hen Chicago-based designer Lara Miller first started her eco-friendly clothing line, she needed cash to promote and sell her clothing. Without a strong credit history, she couldn’t get a loan or a line of credit from the bank. That’s when she turned to Prosper, one of the largest online platforms for peerto-peer lending. Soon after posting the loan, she had eight competitive bids for a $3,000 loan that was funded at an annual percentage rate of 10 percent. After additional loans, she was able to fully fund a website and launch her first collection. In an effort to increase transparency and accessibility in the lending process, Silicon Valley has developed a virtual marketplace known as peer-to-peer (P2P) lending. P2P lending directly connects investors to borrowers without the need for a bank. Without a middleman involved, there are no unnecessary costs or hidden fees, benefiting both sides of the transaction. A WIN-WIN FOR EVERYONE What most differentiates P2P lending as a lending platform is the access it creates. After the financial crisis in 2008, banks were reluctant to grant loans to the public and implemented tighter regulations. This made it almost impossible for anyone

with a low credit score to borrow money. P2P lending filled this void by providing access to easy, small-scale loans. As long as borrowers have a seemingly trustworthy credit history, they can log into one of the online platforms and fill out a request for a loan. Because no bank is involved, they pay a lower fee on their monthly payments and bypass many of the hidden fees associated with bank lending. Furthermore, investors also stand to gain. P2P lending provides the opportunity to diversify one’s portfolio. Investors can avoid the risk of a volatile stock market and at the same time earn higher returns than they would from bonds or savings accounts. The financial vacuum that resulted from the recession provided the perfect environment for P2P lending to thrive. The virtual marketplace has successfully captured the market for small, individual transactions and maintained steady growth. All of this begs the question: could this system potentially take the place of traditional banking? A CHANGING LANDSCAPE Much of the impressive growth of the P2P lending industry can be attributed to a transformation in the composition of the P2P marketplace. In 2013, insti-

HOW DOES PEER-TO-PEER LENDING WORK?

Consumer

A borrower applies for a loan, requesting money for anything from credit card consolidation to a new car to medical expenses.

Upon approval, the lending platform lists the loan criteria, and allows investors to research the loan to make a decision.

When investors find a loan criteria or purpose appealing, they can choose to fund a part of the loan. The loan originates when the funding amount is reached.

The borrower repays the agreed upon principal and interest to the lending platform through fixed payments each month.

Investors The lending platform divides the payments for distribution to the loan’s investors.

Investors receive their investment and return over time as the loan is repaid.

PERSONAL FINANCE

tutional investors increasingly turned to P2P lending to generate higher yields in a relatively short amount of time. With the participation of institutional investors, the two online platforms went from a combined total of $0.871 billion in issued loans in 2012 to $2.42 billion in 2013 – a growth of 177 percent. This achievement indicates a larger trend toward hedge funds and wealth managers serving as the main drivers of the P2P industry’s growth. For larger institutional investors, the failure of mortgage-backed securities during the recession made it more difficult to ensure the security of loans. More recently, many hedge funds and retirement funds have pooled together P2P loans and secured them in the form of bonds. They profit from the process by requiring a higher interest rate on the bonds than they pay on the loans. With this potential for profit, the presence of institutional investors in the P2P lending industry and the size of the industry itself will continue to grow. WHEN TOO MUCH IS TOO MUCH This new form of lending seems like a win-win scenario no matter who is involved. But what few people acknowledge is the striking resemblance between the P2P lending marketplace and the housing market before the recession. Once again, lending standards have eased, as borrowers with lower credit scores have increased access to cash. Despite an average default rate of 3 to 4 percent, it’s still crucial to recognize that banks refused to issue loans to most of the borrowers that use P2P lending. If the economy starts to lag, the dependence on less creditworthy borrowers could pose serious problems. With the introduction of institutional investors into the marketplace, it is important to note that, with more capital coming in, more money is available for loan. This puts downward pressure on rates, which entices more people to borrow. In the extreme case, too much available capital can be detrimental: money lent to a lot of people who cannot necessarily afford it can wreak havoc on the financial system. EVERYTHING IN MODERATION However, despite these similarities, there is one crucial difference between P2P lending and the housing bubble in 2008: the P2P market is a fraction of the size of the housing market. Residential investment and housing services have historically made up about 17 percent of the total GDP. In comparison, even at its largest size, P2P lending is only about $2.4 billion out of the current GDP of $16.8 trillion, which is far less than even

2.5

2.0

1.5

1.0

0.5

(in $ BN) 0

Since 2009, the two largest online platforms for P2P lending - Lending Club and Prosper - have experienced considerable growth in the total number of loans issued to borrowers. In 2009, the two platforms lent out $60.7 million in loans. By the end of 2013, this number reached $2.42 billion. 1 percent of total GDP. It is also important to note that investors may have learned their lesson from the recession and now enter the market with better perspective and understanding that with lower credit scores comes higher risk. As long as the market is well contained, P2P lending can continue to serve its niche market with success. The virtual marketplace allows the lending market – and the economy at large – to prosper by making the transaction process more accessible while also providing higher returns for individuals and institutions. When looking at P2P lending, the cliche “everything in moderation” seems relevant. Without it, many individuals would still be shut out from the lending market. But with it comes the challenge of maintaining the necessary accountability of small loan lending.

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Beating the Books: IS THE REIGN OF TEXTBOOK PUBLISHERS FINALLY OVER? by Tiffany Chen

“ Photo by Cadence Lee

The College Board notes that textbook prices have risen by over 82 percent in the past decade while inflation in the United States has only increased by one-third of that amount.

or the majority of college students, a four-year education has been the most expensive item purchased to date; the most unexpectedly expensive item purchased, however, perhaps wasn’t tuition – it was the first college textbook. It’s certainly not a secret that college isn’t cheap: financial officers preach it, parents know it, students discover it, and the textbook industry capitalizes on it. According to the College Board, textbooks have become one of the most increasingly visible “hidden costs” of college, with the average university student in America spending $1,253 annually on reading material alone. So why are heavily bound piles of papers so expensive? THE TEXTBOOK INDUSTRY: THE RISE OF A DICTATOR The major shift from durability to profitability in the textbook market occurred during the 1970s when high school and college classes began organizing their curricula around the order of content in a given textbook. While publishers of the past emphasized the longevity of their books, publishers in today’s society actively seek to release new editions of the same book every two or three years to maximize profit. The lucrative nature of the modern textbook industry stems from the fact that the money goes to a large amount of individuals: copyright fees must be paid to every author, cuts make their ways to publishers, campus bookstores receive their margins, and royalty fees go into the pockets of professors who authored or coauthored the textbook. According to the National Association of College Stores, the average bookstore’s markup of the textbook price accounts for 22.2 percent of its total price while the remaining 77.8 percent is attributed to its publishers. More alarmingly, the College Board notes that textbook prices have risen by over 82 percent in the past decade while inflation in the United States has only increased by one-third of that amount. Thus, students have walked out of their campus bookstores with lighter wallets and heavier backpacks.

”

$100,000,000? Just one of the more expensive textbooks in the Brown Bookstore

THE TEXTBOOK BLACK MARKET Students avoid purchasing books at their campus bookstores, instead flocking to the most popular online textbook store: Amazon. The Amazon Textbook Store touts a 90 percent discounts on used books and 80 percent discounts on rented books. Paired with the twoday shipping that comes with an Amazon Student account, the online corporation’s new textbook rental system has proven to be a budget-friendly option.

PERSONAL FINANCE

Inevitably, Amazon has caused a massive uproar in the textbook industry. Consumer Reports’ analysis of used textbook prices among online textbook sellers like Amazon, Chegg, and Barnes & Noble reveal that Amazon is most consistent in keeping its prices low. Publishers no longer hold a monopoly over academic material. In addition, students have the ability to not only purchase titles at significantly lower prices but also to decide between renting and buying their textbooks. A quick comparison of prices of several required textbooks for introductory courses at Brown University across multiple departments revealed that the majority of Amazon’s textbook prices were cheaper than those of Brown’s:

New

Used

($)

CLASS

TEXTBOOK NAME

Rental

($)

($ / semester)

BROWN

AMAZON

BROWN

AMAZON

BROWN

AMAZON

MATH 0090

Calculus Early Transcendentals, Single Variable

123

100

PHYS 0030

Halliday Fundamental Physics

124

227

109

NEUR 0010

Neuroscience: Exploring the Brain

125

SOC 0110

Statistical Methods for Social Sciences

185

142

139

114

CLPS 0030

Language Files

RENTING: A WIN-WIN WAR With the rise of Amazon’s online textbook store has also emerged a new student tendency to rent, rather than purchase textbooks. While some students buy textbooks with the intention of reselling them at the end of the semester to recover some of their expenses, there are drawbacks to relying on a book’s resale value:

NORMAL MARKET NORMAL MARKET

TEXTBOOK MARKET TEXTBOOK MARKET

Publisher $100

$175

$50

new editions make last year’s version of a textbook less valuable, and the resale value itself also decreases if the textbook comes with online supplements and special access codes that can only be used once. Thus, reselling does not always guarantee that an individual will recoup his or her costs. Renting can be considered the economically safer way to acquire textbooks. Although the availability of textbooks for rental has forced publishers to push down prices in the rest of the market, renting textbooks still benefits publishers and authors. Because authors and coauthors still receive royalties on second and third rentals, renting textbooks provides publishers a way to continue earning money from their books even after the first sale. That is not the case when reselling a used textbook to another student. While hardcopy renting has gained popularity, e-textbook renting has yet to gain the same attention. Chief executive of Chegg, Dan Rosensweig, reports that the average e-textbook rents for 25 percent more than the average hardcopy rental. Other students will forgo renting and buying textbooks altogether and opt for downloading illegal copies of textbooks on the web. Without a doubt, the textbook industry has been in dire need of disruption for a long time, and the only company with enough clout to do it was a company like Amazon. Renting may very well have dealt the textbook monopoly its final blow.

Publisher

vs.

Professor

Consumer

Student

In a normal market, suppliers compete with one another. Consumers can choose what they want to buy based on price and quality.

In the textbook market, publishers can charge higher price. Professors choose the textbooks, and students have no power of choice.

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Israeli Innovation in Silicon Wadi: ISRAEL’S VIBRANT STARTUP CULTURE by Jeffrey Mok

srael’s geopolitical conflicts have overshadowed its best kept economic secret: its booming tech industry. Israel’s coastal area has been dubbed Silicon Wadi — Arabic for “valley” — due to its large concentration of successful, high-tech startup companies. In fact, Israel has the highest density of startups per capita in the world. Israel is a 67 year old country the size of New Jersey with a population half that of New York City. It has faced seven wars and three military operations. So how did Israel come to be such a pioneer in the development of startup culture? Ironically, its relative youth and challenging geopolitical environment have been the very keys to its success. As Dan Senor and Saul Singer write in their book “Start-up Nation: The Story of Israel’s Economic Miracle,” Israel has grown into a unique startup powerhouse due to its institutions. THE KIBBUTZ: ISRAEL’S OLDEST STARTUP Kibbutzim, plural for kibbutz, are collective communities that were traditionally agriculturally based. Since the essence of the kibbutz is socialist and intensely collective, it provided a framework for resourceful inventions that have promoted the growth of Israel’s vibrant startup culture. This can be seen in one of Israel’s greatest innovations: the modern drip irrigation system. Traditional systems used small holes to slow the release of water, but these systems were easily blocked by dirt and other particles. The kibbutz Hatzerim, faced with a scarcity of water for agricultural production, first utilized a plastic emitter that could slow water through the water’s own velocity rather than the size of the irrigation system’s holes. This allowed longer and larger holes, and thus a decreased likelihood that water would be blocked — a huge step forward for modern irrigation. Hatzerim later started the multinational drip irrigation company Netafim. This innovation mirrors a prominent theme in Israel’s history: the tendency to deal with environmental hardship by producing dynamic solutions. In 2011, Netafim was valued at $1 billion, and the firm has given Israel a reputation for effectively fighting desertification. BALLISTICS & THE DIGESTIVE TRACT Driven by its security issues and active military, Israel has been a world leader in R&D spending, averaging about 4 percent of GDP in the last four years. In comparison,

“

How is it that Israel, a 67 year old country the size of New Jersey with a population half that of New York City, came to be such a pioneer in the development of startup culture?

the United States averaged roughly 2.8 percent over the last four years. Focus on research was spurred by mandatory military service for everyone — even women — and a reserve system that reinforced an ethos of critical analysis. With the potential for anyone to be commanding anyone, regardless of prior socio-economic context, comes a cultural paradigm that thrives on blunt, constructive criticism, chutzpah. This emphasis on research and development, coupled with Israel’s military meritocracy, has galvanized the success of the civilian high-tech sector. PillCams are one such example. Dr. Gavriel Iddan, an ex-employee of Israeli defense contractor Rafael Advanced Defense Systems, used his expertise in electro-optical devices for guided missiles to invent wireless capsule endoscopy. With gastrointestinal diseases a major world health concern, his patented PillCams have since been marketed in 60 countries. His company, Given Imaging, is now publicly traded on the NASDAQ with annual revenue of USD $178 million. This medical innovation is one of many examples of Israel’s R&D programs leading to entrepreneurship. THE COMING OF ANGELS (AND VENTURE CAPITALISTS) Of course, none of this would be possible without the presence of local venture capital to get these companies off the ground. A couple decades ago, Israel had little to no private equity financing. Most funding for startups came from government grants. The Yozma program, started in 1993 by the Israeli Ministry of Finance, created Israel’s premier domestic venture capital fund and laid the foundations for a private venture capital industry. Today, Israel has approximately 70 active venture capital funds. In 2008, Israel had more than twice the venture capital investments per capita than the United States. Israel’s government set the stage for its contemporary, independent startup culture.

STARTUPS & TECHNOLOGY

THE DOWNSIDE Tremendous technology exports are, in a sense, a detriment to Israel’s economy. This systematic farming of technology could result in a lack of large Israeli businesses that could become technological and economic powerhouses with their own unique brands. Israelis are growing worried about the downside of selling off too many companies and not allowing them the time to grow into global giants. This export mindset is also apparent in the human capital that Israel generates. Many are concerned with the “brain drain” that results from Israelis leaving for opportunities overseas. These two problems, along with a low labor-force participation rate and growing competition from countries such as China and India, pose a dilemma for the future of Israel’s economy. THE NOT-SO-DOWNSIDE However, not all of these problems are as dire as they seem. The disruptive nature of Israel’s technology sector hints at an opportunity for the development of novel economic sub-sectors. China and India’s economic success are by no means outright obstacles to Israel’s growth, but could instead represent opportunities for symbiotic trade relations. Israel’s economic and political history is intertwined with socio-cultural variables that have generated a steady stream of inventions. Israel’s focus on research, coupled with a military meritocracy and active government policy, has led to the creation of a slew of innovative companies. These startups have acted as catalysts for the Israeli economy and drawn the attention of nations that have since tried to replicate the country’s economic model. Welcome to the startup nation.

What began as a way of preserving water on the kibbutz Hatzerim has turned into a multi-national firm whose irrigation systems have been implemented worldwide. 33

Pizza in a Single Tap

MAKING YOUR LAZY PIZZA NIGHTS EVEN LAZIER by Elizabeth Studlick The eternal dilemma: “I want a pizza, but I don’t want to order a pizza,” Maximillian Hellerstein, cofounder of Push for Pizza, quips in the app’s snarky marketing video. The app’s premise is simple: a single button which, after putting in your credit card information and address once, can summon a pizza to your very location, saving the hassle of long web forms or, God forbid, picking up the phone. Launched in August, the app attracted attention from The Verge and Tech Crunch to the New York Times and the Huffington Post. We sat down with Brown student Graham Carling ’16, one of the co-founders and developers. HOW DID THIS GET STARTED? It started off kind of as a joke. My friend [Will Haack, another co-founder] at MIT and I started talking about Pizza Button during my freshman spring as a project for NYC BigApps [an app competition], and coded up something really simple as a way to learn developing for iPhone. We couldn’t really figure out a great way to do ordering until we found out about Ordr.in [the API for food delivery the app is built on]. And then it started getting a little more serious. We brought Max and Cyrus [Summerlin] on for marketing and strategy, and started working with another developer at MIT [Demitri Nava], but it wasn’t until this summer that we really finished it, and then we launched.

WORST MOMENT? We had gotten taken off the app store because Apple had asked us to fix something, and while that was happening, CBS had us on national TV. Like, four million people watched us on TV and no one could download it.

You couldn’t. It’s really sad, I know.

WHAT’S IT LIKE BALANCING A STARTUP WITH SCHOOL? It’s been good. Two of our founders aren’t currently in school, so they started off doing this full time. The two others at MIT are taking a semester off to work on this— they had wanted the chance to take time off to work. So I’m the exception. I’m taking three classes, TAing for credit, and doing this in my free time. There’s definitely a balance. It feels like I should try to match their enthusiasm and commitment, because they’re off doing this full time while this is more of a side project for me. Photo by Cadence Lee

DID YOU EXPECT THE COVERAGE THAT YOU GOT? Not at all. I know that they had emailed a few of the outlets, but I wasn’t expecting the amount that people picked up on this. It just exploded. I was at my internship and I didn’t get work done for two days because I was just watching the downloads go up and watching the news come in. It’s been an adventure. That was definitely the high point.

WHAT’S UP NEXT? Well, we had our peak when we launched, and now we’re in the valley. We used the peak to get press and talk to investors, and now we’re really focused on fine tuning our service. We’re redesigning, we already hired an Android developer at Brown, we’re hopefully redoing our back end. We’re working on hammering out the inconsistencies. We have to improve coverage. That’s the most pressing issue right now. We chose Ordr.in so we could roll out nationally. But if you’re not in New York City, your ARE YOU TELLING ME THAT I coverage drops immeCOULDN’T PUSH FOR PIZZA IN diately. PROVIDENCE?

IS PUSH FOR PIZZA CHANGING THE WORLD? What’s been really remarkable about it is that when we got on the app store, we had all of these five star and one star reviews. And all the one star reviews were like, “No coverage in my area, damn it.” All these people were so pissed that they couldn’t use our app, which is amazing. So we’ve proven the demand is there and that people who can use it use it at least once. And if you can get all of America to order a pizza at least once, that’s pretty cool.

STARTUPS & TECHNOLOGY

Disruptive Technologies COMPUTING OF THE FUTURE by Jeffrey Mok

2 The increase of global Internet traffic has been dramatic. In 1992, 100 GB of data was transmitted across the Internet a day; in 2013, global Internet traffic was 28,875 GB per second. We’ve entered the Zettabyte age: a byte is the amount of bits that is required to code a single character of text in a computer — a Zettabyte would be ten quintillion bytes (10007 bytes), or about 2.86 trillion times the length of your average song on iTunes. Imagine storing, organizing, and analyzing all this data so that it can be utilized. That’s big data, and that’s what companies like EMC are doing. Joe Tucci, Chairman and CEO of EMC, recently came to Brown and delivered the inaugural Leadership in Technology lecture, outlining the four interdependent drivers developing the next phase of computing.

Cloud Computing

The internet-based storing of data on a network of large groups of remote servers to allow for easy access to services and resources. Global data center traffic is projected to triple between 2012 and 2017, with data center traffic specifically in the cloud forecast to grow nearly fivefold during that period.

EXPECTED GROWTH IN CLOUD COMPUTING:

1.2 ZB 2012

A term that describes any amount of data that is too large to be processed using traditional techniques. Includes sharing, storage, analysis, sharing, visualization, security, and organizing.

EXPECTED ENTERPRISE DATA GROWTH THROUGH 2020:

40% 3

Mobile

Traffic on mobile devices is rapidly rising and soon to eclipse traffic from wired devices. One exabyte of traffic traversed the global Internet in 2000, and in 2013 mobile networks carried nearly 18 exabytes of traffic.

5.3 ZB

2017

15.9 EB

10.8 EB

7.0 EB 4.4 EB 1.5 EB 2013

2.4 ZB

1.4 ZB

Big Data

2.6 EB 2014

2015

2016

2017

EXABYTES PER MONTH

2018

Social Technologies

FACEBOOK’S MONTHLY ACTIVE USERS:

845 1.3

million (active users in 2011)

billion (active users in 2014) 35

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Mission Disputable: EXAMINING THE UPS, THE DOWNS, AND THE CAUSE OF GENTRIFICATION IN SAN FRANCISCO by Tiffany Chang

ake a walk through San Francisco’s Mission district on a weekday morning, and you might see a shiny white Google shuttle pulling up to a bus stop, ready to pick up a smiling bevy of back-pack wearing, coffee-bearing Google employees. You may stroll past rows of cheerful apartments, newly painted and adorned with “For Rent” signs advertising “Prices starting at $3,099 per month!” Look closer, and you may see the protestors at the bus stop bearing banners with messages like “Our Mission: No Eviction.” Look behind the door of the newly-painted building’s slightly run-down neighbor, and you may see families staring at eviction slips on their dining room tables. San Francisco is clearly undergoing gentrification. While the booming tech industry is used as a scapegoat, the root of the city’s problems are more complex. A MODERN CONCEPT The term gentrification was first identified in the 1960s, when middle-class families were moving en masse into the working-class neighborhoods of London. It is defined today by the Merriam-Webster Dictionary as “the process of renewal and rebuilding accompanying the influx of middle-class or affluent people into deteriorating areas that often displaces poorer residents.” However, the meaning of gentrification has come to encompass much more as the phenomenon has made its way through American cities over the past decades, triggered by a move from an industrial to service economy. It is typically accompanied by displacement of racial minorities and lower-income residents, a rise in the number of residents with higher incomes, and a reduction in household size as newly wed couples and recent graduates move in. The modern prevalence of gentrification has sparked debate between those who lament its impact on low income families and those who accept its inevitability while pointing out economic benefits. San Francisco’s boom has proved a hot topic for both sides, though the economics behind it are often overlooked. THE GOOD Perhaps the biggest boon of gentrification is the seeming economic growth it brings. San Francisco was ranked by Bloomberg Businessweek as “America’s Best City” due to its “prosperous economic base.” More than 13,000 jobs were created in the Bay Area by tech firms between 2010 and 2012, while median income in the area has increased by 20 percent.

As a result of gentrification, neighborhoods have become safer. Local businesses thrive. The investment in new buildings and the opening of new restaurants and retail options lead to an overall improvement in living conditions, along with a hike in economic activity. Despite the social controversy regarding the displacement of current residents, the Cleveland Federal Reserve Branch released a study last year suggesting gentrification is beneficial to the financial health of original residents, gleaned from a bevy of metrics such as credit scores. THE BAD Of course, the benefits engendered by gentrification are often disproportionately enjoyed by the newcomers. A study last year concluded that San Francisco has the second largest income gap between rich and poor in the United States. Moreover, it’s likely that this gap has been unevenly spread along racial lines; tech firms from LinkedIn to Yahoo made headlines this summer when they released reports on their internal diversity, revealing workforces that are still overwhelmingly white and Asian. Protesters blocking shuttles on their daily route to Googleplex have become a common scene, with Google

STARTUPS & TECHNOLOGY

kids being blamed for the evictions of artists and immigrants who make up the heart and unique character of San Francisco. Median home sale prices hit $1 million for the first time this July, and last year the city had the highest rent in the nation. Ellis evictions are one of the most protested manifestations of gentrification. The Ellis Act is a law which allows landlords to evict tenants on the premise of exiting the rental housing business. However, in many cases, real estate speculators are perpetrators of these evictions, buying up properties to resell or rent out for sky-high prices. The number of such evictions grew by 175 percent in 2013, causing protests. But percentages— and media coverage — can sometimes skew the magnitude of a problem. Though the number of Ellis evictions have grown by a large percentage, there were only 216 cases of Ellis evictions in San Francisco from

Spring 2013 to Spring 2014. This is a minor number in a city of over 800,000 people, suggesting Ellis evictions are only a small part of a larger problem. THE ECONOMICS Despite a focus on the tech boom, the problem is worsened by a simple economic concept: supply and demand. In particular, though demand for housing is increasing as new residents move in, construction has significantly lagged behind. San Francisco gained over 50,000 new residents from 2000 to 2012, around half of which arrived between 2010 and 2012. Chief Economist for the City of San Francisco Ted Egan estimated that 100,000 new homes would have to be built to meaningfully reduce prices. This far surpasses the mayor’s proposal to build 30,000 new homes by 2020, and the measly 269 new homes that were added in 2011. Additionally, San Francisco has

made it very difficult for landlords to match this increased demand. Landlords were allowed by the city to only increase rents by 1 percent the past year - despite high demand - as rent increases are capped at 60 percent of the inflation rate. As renting out apartments becomes decreasingly profitable, it is not surprising that landlords are exiting the rental market and are instead selling their properties to real estate speculators, who remake and bring the apartments back to market at higher - but more economically rational - prices. As prices increase, lower-income residents are forced out by a lack of affordability. Though tech kids are certainly a factor in the increase of gentrification, the pattern is indicative of larger economic trends. When demand picks up and supply is unable to meet the surge, prices skyrocket. It’s simple. You can Google it.

In San Francisco, the gap between the wealthy and the poor is growing faster than any other city in the nation. Between 2007 and 2012, the average income of San Francisco households at the 95th percentile rose by $27,815 while the average income at the 20th percentile dropped by $4,309. $30,000

3.9

Change in Household Income 2007–2012 95th percentile Change in Household Income 2007–2012 20th percentile Change in 95/20 ratio 2007–2012

3.1 $22,500

2.1

2.0

$15,000

1.7

1.6

1.5

$7,500

0.2

0.1

0.0

0.0 - 0.2

-$7,500

-1.3 -$15,000

EL Paso TX

Seattle WA

Denver CO

Okland CA

Oklahoma City OK

Memphis TN

Dallas TX

Louisville KY

Wichita KS

Austin TX

Tucson AZ

Charlotte NC

Baltimore MD

Indianapolis IN

Milwaukee WI

Jacksonville FL

Sacramento CA

Miami FL

Atlanta GA

-$30,000

San Francisco CA

-$22,500

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Microfinance, Macrogood OVERCOMING THE POVERTY LINE - A MORE ATTAINABLE ENDEAVOR by Adrija Darsha

“

How do we build the economy of developing nations, and lift people out of poverty, if no established banks are willing to invest in the hardworking, but low-income, entrepreneur?

”

ake a trip to a small village in Honduras and you will find that community life is centered around a market selling fresh fruits, vegetables, and handmade goods. Women in colorful dresses man the stands as people weave in and out of the market, exchanging iempira for a bag of carrots and peaches. If you were familiar with the highly industrialized type of economies, you might wonder where these marketplaces and the goods sold come from. Who built these wooden platforms? How are these markets funded? SOCIALLY GOOD, BUT ECONOMICALLY BAD? Established banks are often unwilling to invest in the hardworking, yet low-income, entrepreneur. Loaning money to those with low income is risky. The problem is this: How do we build the economy of developing nations and lift people out of poverty, if these banks are not willing to invest? Banks make far more money on large loans than small loans, and benefit more from savings accounts with significant funds than those with very little - more money to leverage. For this reason, banks tend to cater their financial services to people who already have money and a steady income. This leaves a group of hardworking, motivated people without any funds to get them on their feet. A NEW TYPE OF FINANCE A solution gaining popularity is microfinance. It all began with Dr. Mohammad

Yunus, an economics professor at Chittagong University who started providing small loans to poor women in Jobra in the 1970s. What initially began as a professor lending small amounts of money to poor women in Bangladesh has evolved into multiple international non-profit organizations providing financial services to thousands of people around the world. Global Brigades is the largest of these organizations, incorporating a holistic model that strives to improve all aspects of village life. Global Brigades is a student-led non-profit organization that seeks to set up basic financial systems in small, rural, and developing villages. They have been working in Panama, Ghana, Honduras,

CAREERS Photo by Ashley Wu Photos by Julia McGirr

STUDENTS PARTICIPATING IN GLOBAL BRIGADES EFFORTS and recently, Nicaragua. Their efforts have started with financial services. “The Brigades sets up new community banks where none existed before,” says Michael Golz, president of the Global Brigades chapter at Brown and a senior staff writer for the IFJ. “The startup capital comes from donations, student contribution fees, and to some extent, grants applied for by Brigades national headquarters administration. This money goes towards the funding of community — creating loan pools — and private public health projects, as well as business startups,” he said. These projects are supervised by the Brigades Business Branch. Banks affiliated with the Brigades also have the option of maintaining personal savings through the bank for villagers. “When Brown students travel to these villages they aid in es-

tablishing bank presence by educating households on the potential and responsible use of savings accounts and loans,” said Golz. DRAWBACKS Understandably, microfinance comes with a few tradeoffs. Like any other financial service, the cost of the money that it lends, the cost of loan defaults, and transaction costs all have to be covered. The smaller the loan size, the higher the transaction costs are. In effect, microfinance interest rates are very high—around 36 percent. In addition, some worry that the concern for profits will lead to the eventual end of microfinance. That the primary goal of those in microfinance is to lend a hand to low-income individuals, not acquire profit, must be preserved. That is not to say, however, that

microfinance is not profitable. Microfinance programs such as the Bangladesh Rural Advancement committee and the Association for Social Advancement (ASA) in Bangladesh have both gained profits of more than 4 percent of assets in 2000. LOOKING AHEAD Microfinance has been shown to improve the quality of life for low-income families. By providing people with access to savings, credit, insurance, and other financial services, the poor can take advantage of economic opportunities and live more comfortably with their families. In El Salvador, for example, the weekly income of clients of the Foundation for International Community Assistance (FINCA) increased, on average, by about 145 percent. In Lombok, Indonesia, borrowers of the Bank Rakyat Indonesia (BRI) had an increased average income of 112 percent, and 90 percent of households rose over the poverty line. The future of microfinance looks bright — with the involvement and innovation of hundreds of universities, millions of college students and individual contributors, the economies and quality of life in developing countries can be drastically improved.

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Let’s Go Global

THE INTERNATIONALIZATION OF FINANCIAL MARKETS & WHAT IT MEANS FOR YOUR CAREER by Nikhil Patel

“

magine having the ability to work anywhere in the world after graduation, from the mountains of South America to the cities of Europe and the emerging economies of Southeast Asia. The internalization of financial markets has made this possible. The decline of the United States as the global financial superpower has been driven by the rising status of financial institutions throughout the rest of the world. Finance careers are more concentrated in major financial centers, and thus globalization of finance has resulted in a change of the geographic locations of many finance-sector jobs.

A TRIP ABROAD Technology has leveled the playing field in finance, reducing the U.S. domination of financial markets. In the 1970s, stock prices could not be tracked on a near continuous basis. Today, the three major stock exchanges—New York, London and Tokyo—are together open for all but five hours of the day. This has allowed global market participants to make trades at nearly any time from any place. Between 2010 and 2013, the volume of trading on the NYSE fell 25 percent, from $12 trillion to $9 trillion traded annually. The yearly trading dollar volume increased in both London and Tokyo. This means that money is flowing out of United States exchanges in favor of international markets. In the past, New York was considered the financial capital of the world. Today, it is hard to say if this is still true. CHIA CHIEN TENG

When you work overseas, your learning extends far beyond the office because you are immersed in a foreign environment and culture everyday. In regards to finance, working in an overseas financial center such as London, Dubai, Singapore or Hong Kong gives you a better understanding of how the global financial system works.

”

Multi-national corporations are reincorporating outside the United States for tax reasons. The rise of financial instruments such as Eurobonds – bonds sold abroad that are denominated in a different currency – and new technologies have put London and Tokyo on equal footing with New York. In the past, the financial world ran on the U.S. clock. Now, the United States operates on the financial world’s clock. EXPLORING THE GLOBE Through a different lens, the relative decline of U.S. financial markets can be seen as a relative increase of international financial markets. Investment banks, asset managers, private equity firms, and consulting groups all recruit for international jobs as actively as they do for those in New York.

“

I really enjoyed working at Citibank in the bustling city of Kuala Lumpur over the summer, as I was able to witness how local values reconciled with that of a global corporation’s. I would definitely recommend working abroad as you will gain a priceless opportunity to experience a work culture very different from what you would encounter here.

BILL WEBER

The types of opportunity abroad can vary drastically from those offered domestically. In India and China, a new emerging middle-class has caused a boom in the asset management industry and tech-stock IPOs generally occur more often than they do in the United States. In the Middle East, Islamic finance – investing in accordance with Sharia law, which forbids the charging of interest – is promoting financial innovation, and the focus on oil and gas provides a great opportunity for financial analysts interested in the sector. Work-life balance also differs domestically and internationally. European financial analysts tend to work less on a weekly basis and are entitled to more vacation time — albeit, typically for a lower annual wage — compared to their American counterparts. While working abroad, the quality of life can also be different. For example, in Southeast Asia you may have a front-row seat in watching and aiding an emerging economy grow, but not have access to many Western amenities. FOR THE RIGHT PERSON Working abroad has its advantages and disadvantages, so it comes down to a personal decision. Working aboard requires acclimating to cultural changes and obtaining the right paperwork. It is not for everyone. Domestic opportunities are by no means non-existent but international opportunities are in high supply for those willing to confront the challenges of leaving home behind.

CAREERS

Me, Inc. BUILDING YOUR PERSONAL BRAND by Mariana Carvalho “So I heard you like P Reign?” one of my analysts asked me on a regular Monday morning. “Yeah!” I replied, taken entirely by surprise. “I like most rappers from Toronto, but this one is at the top of my list right now. He’s so versatile, he can sing softer than Drake...” “—and rap harder than Meek Mill” he interrupted. Earlier last year I decided to create a “professional” Twitter account and added it to the top of my résumé. Experts in career development consistently remind us to include an “interests” section at the bottom of our résumés. Recruiters claim that a quirky hobby that catches their eye can start developing curiosity to get to know you better. But I find that a Twitter account goes beyond that. YOU ARE A BRAND We often find ourselves overwhelmed by a wide array of interests and responsibilities. While some of these earn a position on our résumés, many never make it. In fact, on paper, I look similar to most college students applying to finance jobs. I am involved in a few business clubs and hold leadership positions in some of them. However, we are not defined only by our college degree or job title and we shouldn’t feel confined by our job description. If you left school today, what would your peers miss about you? Know who you are, as well as who you are not. When you allow yourself to be exposed on social media, you get the chance to be a free agent and vouch for yourself. YOU ARE IN CHARGE OF YOUR BRAND Try projecting as much of a brand as Coca-Cola, Louis Vuitton, or Adidas. Let’s become our own brand managers and ask ourselves: what is it that makes each of us different? What do you do that adds remarkable, distinctive value to a group? What have you done that you are most proud of? What’s your unique value proposition – your red sole? Think of the passions that keep you up into the early hours of the morning, the ones that get you out of bed and keep you up at night. While these passions alone may not be the reason you land the internship or job, they are the things that make you different, that make you, you. So why not express yourself and the nuances of your personality publicly? A new CareerBuilder survey found that 43 percent of employers use social networking sites to research job candidates. What’s more, 33 percent of employers who research candidates on social networking sites say they’ve found content that made them more likely to hire him or her. Allow employers to understand why you do what you do, what motivates you to make the choices you make. Allow them to see that you think differently than the other hundreds of people around you, and why that perspective adds value. YOUR BRAND MATTERS Careers are becoming less vertical and less linear. A career is now a checkerboard, full of moves that go sideways, diagonal, and even backwards — and this isn’t necessarily a bad thing either. One move backwards could lead to a double-jump “King Me” move down the road. A career is a portfolio of projects that bring you new skills, allow you to gain expertise, develop new capabilities, grow your colleague set, and constantly reinvent yourself as a person. Personal branding is about identifying and then communicating what makes you unique, relevant, and differentiated. If you understand your strengths, skills, and passions, you can use this knowledge to stand out. A strong, authentic personal brand helps you become known for what sets you apart from everyone else. Ultimately, you get the opportunity to establish your own personal equivalent of the Nike swoosh.

ACCORDING

TO RECRUITERS: Which social

networks do you use to screen candidates?

48% 53% 76% 41

INTERCOLLEGIATE FINANCE JOURNAL • FALL 2014

Ponytail Power?

STUDENTS REFLECT ON THEIR LACK OF A Y CHROMOSOME DURING ON-CAMPUS RECRUITING by Francesca Whitehead

hile sitting in the crammed Goldman Sachs information session at Brown University, I remember looking around and being amazed by the number of women. I was expecting it to be male-dominated, but there was an equal male to female ratio. In fact, it was roughly representative of Brown’s student body. Goldman Sachs asked seniors who had successfully obtained internships to speak, and there were more female than male interns present. However, this was not representative of the industry’s interns. There are clearly many women who are initially interested in finance, so what happens during the recruitment process that causes this number to drop to approximately 25:75 ratio? Is it just that men are more qualified to do the job? I WANT INFORMATION Over the years I have attended many information sessions, often with other women, but have repeatedly seen these women decide that they no longer want to pursue a career in investment banking. Many of them say this is in fact due to the info sessions. I remember clearly during a particular info session, a Sales and Trading Manager said he loved his office’s atmosphere because “there is always a very fun, easy-going atmosphere and often there will be guys throwing a football around as they are spit balling.” I was taken aback by this comment — what I took from it was a clear sign that the manager was only trying to appeal to the men in the room. Who knew I would need good hand-eye coordination to work in a bank? To me it just screamed frat life. I looked around the room and could see many of the women having a seemingly similar reaction. A friend, who chose to remain anonymous, spoke to me afterwards and said there was nothing that could persuade her to choose that type of environment. She wanted to be able to go to work and always feel comfortable in her own workspace. PLEASE LIKE ME Fast forward to the interview stage. Already the numbers are not 50:50 because many women who were initially interested are already discouraged and do not apply. I have never gone through the interview process myself so the information gathered is from fellow students’ experiences - who also chose to remain anonymous. From their own experiences, many women felt that it was inevitable that more men would receive job offers because the interview panels were often predominantly male. Interviews are about making first impressions — not just an evaluation of a candidate’s ability, but also a judgment of how well she or he will fit into the team. If you have a team of mainly men, is it not inevitable that there will be a bias towards men? Men with the same qualifications as women will have an easier time establishing a connection, because male interviewers are immediately more at ease with them. There is a sense of familiarity and potentially more shared interests with other men. One successful student noted that during the interview she was blown away by the overwhelming arrogance of the interviewers. She said she believes that the only women that continue are ones who like the challenge of having to overcome the stereotype, or feel comfortable in male-dominated environments. The characteristics that are desired for a good candidate include being competitive and aggressive, which to many women screams testosterone. Women who work in the finance world say that they are often called “bitchy”

CAREERS

for being assertive, while men acting identically would be called “tough.” Being assertive and competitive is needed in many industries and work environments, but the perception is that it is more extreme in finance. This adds an extra dimension that a woman must consider during the interview process, for she must come across as smart and confident without appearing to have incompatible qualities. An interview is already stressful enough — is it fair that a woman has the added worry of coming across as someone who could ruin the masculine fun? WHO TO LEARN FROM? The lack of female role models perpetuates the lack of women in investment banking. The limited number of role models mean that many women feel it would be a better use of their time to focus their attention on other equally challenging careers, such as law and accounting. Both of these careers have seen a huge influx of female applicants over the last decade, leaving investment banking behind. For example, according to the Chair of the American Bar Association’s Task Force on Gender Equity, in law there is now approximately equal numbers

“

Who knew I would need good hand-eye coordination to work in a bank?

of male and female graduates and 45 percent of associates are women. Admittedly these numbers decrease as you climb up the ladder, but there are still significant shifts in the right direction. There is a similar pattern within accounting, as 60.9 percent of accountants and auditors are women, although there is a smaller percentage of female partners. There are a greater number of female success stories in these sectors. There are visible goals to strive for, and things to aspire to. These numbers are in stark contrast to investment banks where even one of the leaders – Goldman Sachs – is undergoing a gender discrimination class action lawsuit for allegedly promoting 23 percent fewer women who are equally qualified. DON’T WORRY TOO MUCH Don’t get me wrong, I appreciate that many investment banks have taken great strides to improve the state of inequality, and the situation is undoubt-

”

edly better than it was even 20 years ago. But clearly, there is still a long way to go. Firm-wide diversity programs are helping to create a more welcoming environment for women and other minorities - an encouraging sign. Furthermore, the majority of women I spoke to who did receive internships said they had very positive experiences and all of them are returning upon graduation. However, there are enough examples to show that this is not always the case and more can and should be done to improve the imbalance. Hopefully, one day all women can feel they stand the same chance of getting a job as their male counterparts and will feel comfortable in an investment bank’s work environment. I hope one day women will stop feeling the need to change and to act in a certain way to be welcomed. Women can succeed just because they are qualified, not because they are experts at navigating the old boys’ club.

SALARY GAP

WOMEN TAKING THE GMAT

We’ve come a long way towards equitable earnings. In 1979, on average women earned 62 dollars for every 100 dollars men earned, whereas today they’re earning 80 dollars to every 100 dollars.

While the number of women taking the GMAT increased over the past decade, there are still fewer women than men taking it. This shows inequality among the educated elite as the GMAT is a required standardized exam for business school.

Women of Age 25-34 Women of Age 45-54 $100

40%

60%

(105,900)

$80

(158,079)

38%

$60

62%

(80,954)

(129,392)

$40 $20

2009-2010 total 263,979

2000-2001 total 210,346

Year

1979

2008