The Princeton Financier: Fall 2012

From Lehman to Barclays An Interview with Barbara Byrne

Why We Need SPECULATIVE BUBBLES

By Professor William H. Janeway

The rise and fall Of Spanish Banks

By Julian He, Oladoyin Phillips, and Christopher Wu

Investing in Myanmar An Interview with Phil Lopez Weider

Fall 2012 Issue

The Princeton

Financier FALL 2012 Volume 2 | Issue 1

EDITOR-IN-CHIEF Luke Cheng ‘14

MANAGING EDITORS Hannah Rajeshwar ‘14 Seth Perlman ‘14

BUSINESS MANAGERS Eric Wang ‘15 Manraj Singh ‘16

CONTRIBUTORS Phway Aye ‘15 Julian He ‘14 Darwin Li ‘16 Jason Nong ‘15 Oladoyin Phillips ‘14 John Su ‘16 Ambika Vora ‘15 Christopher Wu ‘14

PCFC Board FALL 2012

PRESIDENT Zara Mannan ’13

CLUB MANAGEMENT Hannah Rajeshwar ’14

EDUCATION Anastasia Auber ’13 Brian Fishbein ‘13

MENTORSHIP Miguel Tejeda ‘13

MARKETING Luke Cheng ’14

MEDIA & TECH Cosmo Zheng ‘13

INDUSTRY INSIGHT Alex Seyferth ‘14 Julian He ‘14 Jingwen Du ‘13

FINANCE Ani Deshmukh ’13 ALL CORRESPONDENCE MAY BE DIRECTED TO: The Princeton Financier 2818 Frist Center Princeton, NJ 08544 pcfc@princeton.edu www.princetoncfc.com

Let te r from th e E ditor The global financial crisis of the late 2000s happened more than four years ago, but we are still unraveling some of the financial system’s major issues from that tumultuous period. As the U.S. and the UK tackle systemic problems such as LIBOR rate manipulation and perverse incentives for credit rating agencies, the world still struggles to recover from the economic aftershocks of the financial crisis. This issue of The Princeton Financier comes at a time of great uncertainty. On this side of the Atlantic, Republicans and Democrats seem to be in a deadlock over budget negotiations, even as we approach the edge of a fiscal cliff. Meanwhile, Spain’s banking system teeters on the brink of disaster, igniting fears that the ECB will have to step in. Other parts of the world, however, hint at prospects for accelerated growth. India and Myanmar have both legislated new foreign direct investment policies, fueling an already rapid pace of development in those areas. In the following articles and interviews, the staff of The Princeton Financier aims to capture both the tense anxiety of the developed world as well as the exciting promises of growth in other countries.

Much like the Spring issue, this issue of The Princeton Financier features content from the Princeton Corporate Finance Club’s Industry Insight Team, which works tirelessly during the year to keep members up to date on the status of the global markets as well as ongoing M&A and IPO activity. From Spanish banks to Singaporean beverage conglomerates, the Industry Insight Team covers the globe, with each officer on the team responsible for his or her own geographic region.

Though the global nature of The Princeton Financier’s content has not changed, this issue will be the first in the magazine’s history to benefit from articles contributed by dedicated staff writers. The expansion of the magazine team has allowed the magazine to explore topics such as financial reform and the ethics of the credit rating

system. This issue is also the first one in which The Princeton Financier has featured an interview with a Princeton student— one who has taken a year off to pursue private equity ventures in Myanmar.

The Princeton Financier has always been inseparable from its parent organization, The Princeton Corporate Finance Club (PCFC). The magazine’s success is tied to that of the club, and this semester has been a phenomenal one for PCFC. The club has continued its acclaimed Food + Finance dinnertime talks with professors and professionals—this issue of the magazine includes a transcript of Dr. William Janeway’s perspective-changing lecture on the importance of stock market bubbles tied to technological innovations.

PCFC also organized its first conference, which took place on December 1st. The Princeton Corporate Finance Conference featured 15 speakers from bulge bracket banks, investment banking boutiques, private equity shops, venture capital companies, and other important firms in the industry. The Princeton Financier was fortunate enough to have the opportunity to interview one of the conference’s most popular speakers, Barbara Byrne of Barclays PLC, who is considered to be one of the most powerful women in banking.

The growth and success of this organization would not be possible without the hard work and firm dedication of the incredible officer team within PCFC and The Princeton Financier. And of course our events would be unattended and our magazine unread if not for the enthusiastic participation of the Princeton community.

With the publication of The Princeton Financier’s third issue, we would like to take the opportunity to thank all our officers, members, and readers for making this organization one to be proud of.

-Luke Cheng ’14

The Princeton

Financier 4 6 8 9 12 14 16 19 22 ABOUT PCFC

INSIDE: Financial Reform and Regulation: Present and Future

by John Su Foreign Direct Investment in Myanmar

by Phway Aye Private Equity in Myanmar: An Interview with Phil Lopez Weider Interview by Phway Aye From a Bank IPO to a Sovereign Bailout

by Julian He, Oladoyin Phillips, and Christopher Wu The Banality and the Necessity of Bubbles

by Professor William H. Janeway The Singaporean Takeover Tussle

by Jason Nong Surviving the Crisis: An Interview with Barbara Byrne Interview by Seth Perlman and Luke Cheng Making the Grade: The Ethics of Credit Rating Agencies

by Darwin Li Boon or Bane: FDI Retail Reforms in India

By Ambika Vora

The mission of the Princeton Corporate Finance Club is to provide an educational and networking platform for Princeton students interested in investment banking, private equity, venture capital, and the field of corporate finance at large. Established in March 2011, the Princeton Corporate Finance Club has quickly become a prominent club on the Princeton campus with over 400 student members and 30 officers working in seven divisions: Education, Mentorship, Industry Insight, Finance, Marketing, Communication & Technology, and The Princeton Financier. Our core values are fraternity, entrepreneurship, leadership, responsibility, integrity, professionalism, and mutual respect.

Financial Reform and Regulation: Present and Future

By John Su

The United States’ financial sector is the largest in the world and has often attributed its economic success to its reliable capital markets. But the 2008 financial crisis revealed that the stability of the U.S. financial industry had been grossly overestimated. In a span of three years, the average net worth of American households fell from $126,400 to $77,300. Household wealth declined by $17 trillion, and approximately one million Americans lost their jobs. In 2010, Congress and the Obama Administration approved sweeping reforms to the financial industry in an attempt to prevent any repeat of the 2008 crisis. However, the passing of the Dodd-Frank Act is just one of many steps the U.S. must take to avoid a similar crisis from occurring again.

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In the two years since the passing of Dodd-Frank, there have been some notable successes. One of the most conspicuous results of the Dodd-Frank Act was the formation of the Consumer Financial Protection Bureau, which was created in order to prevent consumers from falling prey to deceptive and confusing financial products such as the ones that were largely blamed for the 2008 crisis. Thus consumer finance protection has increased between financial institutions and customers.

Dodd-Frank also catalyzed the establishment of the Financial Stability Oversight Council in order to increase the control of federal financial regulators and

the supervision of systematic risk. When Lehman Brothers filed for bankruptcy in 2008, it was massively overleveraged and had only $1 in equity for every $30 it had borrowed. In order to combat this type of overleveraging, the Dodd-Frank act increased capital requirements. In the future, firms that fall into this type of trouble will have shareholders, not taxpayers, dealing with the consequences.

In addition, the Federal Reserve now imposes stronger regulatory reigns and annual stress tests on both banking and non-banking institutions that hold over $50 billion in assets.

One provision of the Dodd-Frank Act that has yet to be fully implemented

is the Volcker Rule. The Volcker Rule not only bans banks from propriety trading and from investing in their own funds, but also limits the speculative activity of financial institutions that have federally insured deposits and access to the Federal Reserve’s funds. Essentially, the Volcker Rule is the contemporary version of the Glass-Steagall Act, which was implemented in 1933 but then later repealed by the Gramm-Leach-Bliley Act (GLBA) in 1999. Although the Volcker Rule doesn’t call for a direct split between commercial and investment banks, it aims to prevent high-risk activities that could potentially threaten bank deposits.

The presence of stringent financial regulation is increasing on a global scale, and many governments are cooperating with one another in an attempt to present uniform standards. For example, in June 2012, Barclays was hit by an interest rate scandal and was subsequently fined $450 million after derivative traders were caught trying to fix the London Interbank Offered Rate (LIBOR). In September, the United Kingdom’s Financial Services Authority (FSA) published a report concentrating on the reform of LIBOR’s rating-setting system. But investigations into Barclays did not stop there. The United States’ Securities and Exchange Commission (SEC) scrutinized the bank’s relationships with third parties in order to check for compliance with the U.S. Foreign Corrupt Practices Act, and in late October, the U.S. Federal Energy Regulatory Commission (FERC) began to examine whether or not Barclays manipulated power prices in the western United States from 2006 to 2008. The crisis has spurred increased vigilance across the board and around the globe.

Three key areas of focus in the post-2008 regulations are the implementation of the Volcker Rule, funding of the Commodity Futures Trading Commission, and provisions on derivatives. Many banks including Barclays, Goldman Sachs, and J.P. Morgan have proprietary trading as one of their most profitable ventures, and each of these banks, in turn, are speaking out against the implementation of the Volcker Rule. Those criticizing

the regulation argue that the corrupt mortgage loans, not proprietary trading, sparked the financial crisis. These critics furiously maintain that the Volcker Rule would not have prevented the crisis even if it had been in effect in 2008.

In contrast, supporters of the Volcker Rule refer to the various financial giants that have suffered large deficits from proprietary trading. In 2007, Morgan Stanley lost $9 billion from a risky bet on derivatives tied to mortgages. In 2008,

of the financial crisis was Wall Street’s use of extraordinarily complex derivatives— financial instruments that derive their value from other financial instruments.

These derivatives were largely shielded from scrutiny in an opaque marketplace”.

If the derivatives market implemented a method of increased transparency, then both local governments and Main Street businesses would be able to access the best prices in a more efficient and competitive marketplace.

The debate concerning increased regulation of Wall Street institutions did not end with the mere passage of reforms.

Merrill Lynch lost $16 billion from a complex bet on securities, and that same year, Deutsche Bank lost $2 billion from an unsafe bet made by its trading desk.

Therefore, although it is unclear what effects the Volcker Rule would have had on the 2008 crisis, it is clear that leverage and risk can lead to various types of loss.

The debate concerning increased regulation of Wall Street institutions did not end with the mere passage of reforms. Congressman Barney Frank stated that, “the refusal by Republicans to meet the Obama administration’s request for $308 million for the CFTC, when the agency has helped bring into the Treasury approximately that amount in one successful prosecution [of Barclays], demonstrates that the party is driven… by ideological rigidity”. Since the CFTC relies solely on the congressional appropriations process, it suffered a 12% dip in funding within the last year, which is 40% lower than the requested budget of $308 million. The debate over Wall Street reform is now focused on the implementation of the recent legislation.

There has also been increased discussion over the reform of certain complex derivatives, such as those primarily responsible for the 2008 crash. Senator Carl Levin noted that, “among the causes

Indeed, various ideas and concepts can be enacted to help push our financial industry further ahead. Derivatives reform, once finalized, would shield the markets from overspeculation.

The Commodity Futures Trading Commission, once sufficiently funded, would guarantee regulators the resources to prevent future bailouts. President Obama noted in an open letter at the G20 Summit in 2010, “we all have a mutual responsibility to deliver on all our commitments to address the weaknesses that led to the financial crisis. Now is the time for the Leaders of the G20 both to recommit themselves and deliver on the ambitious reform objectives and agenda we have already agreed to and to explore cooperative approaches to meeting our common goals”. It is crucial to realize that the financial crisis did not only affect the United States since interconnected financial markets assume financial risks that transcend national borders. As a result, to ensure global financial stability, as well as economic growth in the U.S., it is crucial for a minimum set of basic financial rules to be established within the international arena. A sound international economy relies on a cohesive and secure global financial system, and that debate does not end on the legislative floor.

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Foreign Direct Investment in

MYANMAR

ပြည်ထောင်စု သမ္မတ မြန်မာနိုင်ငံတော်

By Phway AYE

In the past year, Myanmar has undergone massive political and economic reform.

Due to the developments surrounding the country’s latest foreign investment law as well as the increased transparency of its previously stagnant economy, Myanmar is now closely watched by the rest of the world. Myanmar is strategically located between two of Asia’s economic powerhouses—China and India—and contains large reserves of gas, oil, gemstones, and timber. The country’s potential for growth has had foreign investors from multinational corporations lining up to take advantage of the country’s latest reforms. Indeed, the rise of the Myanma economy has been compared to the progression that the Chinese economy underwent in 1978 following the passage of the Reform and Opening up Policy.

While the post-junta government’s intents are well-defined, it remains unclear how well the country’s legal and financial systems can withstand a new flood of investments. Thus, because there exists a potential for major returns, every large investor looking to enter the country needs to focus on understanding Myanmar’s new legal framework.

Since 1962, 60 million Myanma have been subject to General Ne Win’s oppressive political regime. The combination of Ne Win’s “Burmese Way to Socialism”, extreme political oppression, and persistent human rights abuses left the country isolated from the rest of the world. However, in 2011, Thein Sein was elected as the new President and has since

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been leading a quasi-civilian government that is intent on modernizing an economy that suffered decades of dormancy due to military rule.

This governmental reform, combined with the release of democratic leader Aung San Suu Kyi from house arrest, indicates that Myanmar will no longer survive solely on the outskirts of the international community. Since the election, Sein and his government have already abolished the fixed exchange rate, eased media censorship, and released more than 500 political prisoners, and the international community has responded positively to these changes. Japan, Australia, and the EU have all proposed to forgive Myanmar’s debts. The World Bank plans to increase its development aid and economic sanctions are being lifted by various countries. Furthermore, the investment environment in Myanmar has undergone several improvements.

These improvements, combined with low labor costs, high literacy rates, abundant natural resources, and an advantageous geographical position indicate that Myanmar is on the path to becoming a powerful player in the world economy.

Ultimately, Sein’s new foreign investment law will be one of the major factors that will help determine whether or not entering the Myanmar market at this stage is ideal.

The new law underwent months of discussions and hundreds of amendments as local businesses, foreign investors, and proponents of the dying military regime struggled to maintain the presence of

their interests in the legislation. On November 9th, 2011, Sein’s parliament finally passed the new foreign investment law, and although it may be months before an official English translation is published, Myanmar newspapers have been quick to provide a close look into the potential consequences of the law. While limitations for foreign investors remain, it is clear that the government is intent on attracting investments—especially in sectors that would allow local businesses to continue to flourish.

One of the largest reforms found in the new legislation is the allowance for 100% foreign capital backed joint venture operations. Foreign investors originally could only hold a maximum share of 35% in joint ventures with local partners, but under the new law, any stake ratio with a company’s partner is acceptable except in certain restricted sectors. These types of restrictions are determined by the newly formed Myanmar Investment Commission (MIC). The MIC is based in the capital city of Naypyidaw and consists of approximately 20 – 30 employees, all of whom are appointed, not elected. Since this group is going to be responsible for handling a wide range of investment deals that will inevitably come to Myanmar in the oncoming year, investors and entrepreneurs are anxious about the commission’s discretionary power concerning foreign investments.

The MIC will be able to determine which sectors of the economy should be considered restricted. Restricted sectors include any type of the economy that harm people’s health, erode Myanmar

traditions or cultures, or adversely affect the environment. The MIC will also be in charge of licensing and regulating foreign businesses—even deciding which Myanma banks foreign companies are allowed to operate with. Bribery has always been endemic throughout all levels of the Myanmar government, but if the MIC can maintain transparency with regard to its decisions and membership selection, many of these concerns can be alleviated.

The tax break system has also undergone reformation. Now investors will be allowed a tax holiday for the first 5 years, and foreign manufacturing companies will be able to attain tax relief for up to 50% of their export profits. Tax relief is also applicable to businesses that choose to reinvest profits back into their own ventures if these investments are done under a span of one year.

Furthermore, land lease terms for foreigners have also been extended.

Foreign investors are now granted ownership for up to 50 years, with a maximum of two ten-year extensions.

This is a vast improvement from the original term of 30 years that held a maximum of two five-year extensions.

Enterprises are now guaranteed exemption from nationalization at any point during their contract term or extension periods, whereas previously, the government would have been allowed to nationalize these foreign companies. The previously imposed minimum investment of $5 million has also been lifted.

While the new law does appear to be a step in the right direction to help attract foreign investment, it still suffers from ambiguity.

For example, despite the exemption guarantee from nationalization, the law reads that an enterprise will not be nationalized “without sufficient reason”.

However, the law does not specify as to what “sufficient” entails. Many other details have also yet to be determined, such as the categorization of businesses within industry definitions and the rules regarding share requirement rates for joint ventures in restricted sectors. The

law is an immense improvement from its 1988 counterpart, but correctly assessing the riskiness of large ventures will still be difficult.

Despite its drawbacks, the new law is still a win for Myanmar’s political reformers. That said, a sizable chunk of the parliament remains intent on prioritizing their own interests and protecting their privileged positions

also not a part of the 1965 Convention on the Settlement of Investment Disputes between States and Nationals of Other States (ICSID Convention). Arbitration agreements are important in international business arrangements because they provide an alternative to domestic dispute resolution, especially when domestic frameworks, such as Myanmar’s, cannot be relied upon to fully ensure contracts and property rights are respected.

Although the new foreign investment law may seem like a green light for a flood of new investments, companies should still carefully factor legal risks into their decision-making processes. instead of working to improve the collective state of the economy. Still, the attraction of foreign investments is high on the parliamentary agenda, and it is more than likely that Myanmar’s new economic changes will continue to be tilted in favor of potential investors.

Due to the vague language in the new legislation, corruption remains a major concern, particularly with regards to the MIC and the role that this commission is to assume.

Although the new foreign investment law may seem like a green light for a flood of new investments, companies should still carefully factor legal risks into their decision-making processes.

While Myanmar is making political and economic progress, its regulatory framework and judicial system are still in need of work. Judicial independence and greater transparency within the legal system are two key changes that will need to be made before foreign investors can be assured adequate protection. Furthermore, since Myanmar has yet to sign on to various international arbitration agreements, many are concerned that resolving disputes in an international arena is currently impossible.

Myanmar was not a member of the 1958 Convention on the Recognition and Enforcement of International Arbitration Awards (New York Convention) and was

In one of her first speeches overseas after her release from house arrest, democratic leader Aung San Suu Kyi advised corporate leaders to refrain from “reckless optimism” and be aware of not only the improvements of economic conditions but also the continued pitfalls. Suu Kyi also emphasized that “the best investment laws would be of no use whatsoever if there are no courts that are clean enough and independent enough to be able to administer those laws justly”. Yet despite the unreliable judicial system, desirable returns on investment in Myanmar are not unattainable. Although entering a frontier economy entails enormous risks, the opportunity cost of not entering can be higher. Many foreign investors have already responded to the Myanmar government’s commitment to attracting FDI. Many Western firms, including General Electric, Coca Cola, and Microsoft, are all planning to enter the market. Furthermore, Global insurance giants such as AIA Group Ltd., Manulife Financial Corp., and Prudential PLC are all setting their sights on this emerging economy as well. These responses only demonstrate that even if portions of the new investment law are ambiguous, it is undeniable that foreign investment will continue to grow.

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PRIVATE EQUITY IN MYANMAR: AN INTERVIEW WITH PHIL LOPEZ WEIDER Phil Lopez Weider is an economics major at Princeton University. He is currently taking a year off to work on private equity investments in Myanmar.

What are you doing in Myanmar? What is your company involved in?

I work for Leopard Capital’s Myanmarfocused private equity fund. Leopard Capital is a firm that manages investment funds in several frontier markets—the largest is in Cambodia. The firm focuses on entering pre-emerging economies as a pioneer investor and guides on-site teams into uncommon opportunities. This earlymover strategy reflects the contrarian investor spirit of its chairman, Dr. Marc Faber, and its founder, Douglas Clayton.

Leopard’s Myanmar fund is separated into a property fund and a growth fund. At this time, Myanmar requires substantial amounts of investment in almost all sectors (Yangon’s property sector alone needs $40-60 billion), but there is only limited access to capital because of a severely underdeveloped financial system.

Myanmar lacks an interbank market, which means that its weak central bank focuses solely on monetizing the government’s large fiscal deficits, crowding out private sector investment. In this difficult investment environment, Leopard aims to supply financing and technical expertise for promising businesses.

Hiroshi Shin [another Princeton student] and I are the only members of the investment team currently located in Myanmar, even though our Managing Director usually flies in from Bangkok once a week. We analyze microeconomic, macroeconomic, and political conditions, as well as company information on the ground to make specific investment recommendations to our fund. Currently, our priority is the property fund, where we focus on developing high-end hotels, serviced apartments, and serviced offices.

What is the general attitude among foreign firms towards investment in Myanmar?

In light of the fast reform progress on the ground, investors are getting excited about Myanmar, but many remain cautious about making large financial The Princeton Financier | 8

commitments. The political and economic reform process is still fragile, with a myriad of challenges facing the current regime. There is a true historic chance to unleash the country’s economic potential, but the path to development will most likely be unorthodox and will not come without many ups and downs. However, it appears that for investors who can factor the increased risk profile into their return calculations, there is a wealth of lucrative investment opportunities in Myanmar.

Many U.S. companies still remain hesitant to invest, since lifting sanctions will take time, and there are onerous reporting requirements. There have also been many concerns about corruption within the country and political setbacks that could potentially complicate investments. In contrast to U.S. companies, many firms from Japan, Thailand, and Singapore, for example, have quickly moved in with package deals of investments backed by government money to develop infrastructure or forgive foreign debt. In Vietnam, it took 15 years before there was a large influx of U.S. companies, but I believe waiting that long would come at the expense of first-mover advantages in the most populated nation in continental South-East Asia.

Are you happy you took off a year to have this experience?

It’s a historic time for Myanmar, and it’s a unique opportunity to be here and to help set up a private equity fund. To experience first hand the cut and thrust of frontier market investing is intense, exhilarating, and formative, all at the same time. You can’t get this experience during a summer internship.

How would you compare American business practices to the way the Burmese people conduct their business?

I would say your reputation and trustworthiness matter even more than they do in the U.S., because business here

is still based considerably on personal relationships.

The military elite has almost full control over the economy’s flow of income. For example, they primarily lend capital amongst each other, and there is effectively no access to private credit through banks.

Government spending is not transparent and largely invested in the interest of the military junta. Foreign investments were limited to certain permits that only the military had. This is all slowly changing. Hopefully, stronger and more transparent institutions will provide more opportunities for private investments— and creative destruction—in a free and competitive market.

But for now, its impossible to ignore the protective “I scratch your back, you scratch my back” mentality of the economic elite. From my perspective, it is as much a cultural problem as it is a structural problem. You have to give people gifts in order to be accepted.

Several Burmese businessmen told me that this “give and take” mentality is part of Burmese culture and deeply engrained within the country’s elite.

How does political instability and the ambiguity in the legal structure affect your activities?

Forecasting economic developments is already difficult, and economists are frequently and dramatically wrong with their predictions. Forecasting political developments in fragile frontier markets is infinitely more complex, due to the idiosyncratic leaders, power struggles, the people’s passions, etc. In countries with strong political institutions, like the U.S., political change occurs slowly and is more predictable. In a country like Myanmar, however, political institutions are still weak and there are strong political forces that could threaten the current reform process. I read somewhere that economics has become the queen of social sciences by choosing solved political problems as its field of study—if Myanmar doesn’t get the politics right, there won’t be any economic progress. So we’re watching the political currents very carefully.

From a Bank IPO to a

Sovereign Bailout

By Julian He, Oladoyin Phillips, and Christopher Wu

On July 20th, 2011, Bankia, Spain’s fourth-largest lender, went public under “BKIA” on the Madrid stock exchange.

Within 10 months, the combination of over $9 billion in accrued losses and the exposure of nearly 350,000 retail investors to the worst of the Spanish housing crisis finally led to a hefty government bailout, thereby averting a possible meltdown of the nation’s entire financial sector. The aftershocks of this catastrophic IPO are still being felt today throughout Europe and have left many wondering about the cause of Bankia’s rapid demise. Although it could have been due to the questionable leadership of Chairman Rodrigo Rato, a former Managing Director of the International Monetary Fund (IMF) who seemingly ignored or covered up poor performance figures, it could also have been a result of the leniency in approval measures. However, it might

not be fair to place all the blame on Bankia when other Spanish banks also contributed to the untenable housing bubble. Even with a year’s hindsight, it is still difficult to pinpoint the catalyst of Bankia’s decline. Yet some facts are

The Ill-Fated IPO Bankia was formed in December of 2010 by the merger of seven regional savings banks managed by Banco Financiero y de Ahorros (BFA), a Spanish holding

Bankia is the first ‘too big to fail’ bank that has created systemic risk for the entire banking sector. clear: Bankia in the summer of 2011 had no shortage of opportunities or reasons to reconsider their decision to go public, and their reckless determination to forge ahead had disastrous effects not only on the Spanish banking sector, but on the European economy as a whole.

company which was mutually owned by the seven former “cajas” (Spanish regional banks). As a tier-one bank with $433 billion in loans and deposits, Bankia held a 10% market share and was a leader in domestic lending. At the time, Bankia Chairman Rodrigo Rato was an economic minister in the Spanish government, and

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under his tenure, Bankia became heavily involved in Spanish real estate and held over $40 billion in housing-related assets.

By 2011, it faced the highest exposure to these assets of any Spanish bank, and problems arose when many of these properties turned toxic as Spain’s 10-year real estate boom drew to a close. The collapse of these assets greatly weakened Bankia’s balance sheet, and was probably a contributing factor to the firm’s narrow brush with bankruptcy (which was kept hidden from the public eye) in the autumn of 2010. However, even more incriminating than the unpublicized solvency woes were the allegations of fraud that were being circulated in the

audience, Bankia turned to its extensive retail network and aggressively advertised the IPO to individual investors as a “good investment opportunity” by channeling 50% of its net income into dividends. Ultimately, 60% of all shares (a total of approximately $4 billion) were sold to these retail investors, which was nearly twice the historic ratio for IPOs. Many of those individuals, who were less capable of assessing financial risk, were simply Bankia clients looking for higher yields in a low-interest rate environment. Therefore, when Bankia fell, the first to fall with it were not hedge funds or investment banks, but individual consumers.

The Spanish banking crisis, ignited

by Bankia’s bailout, threatens deeper recession throughout Europe. accounting back rooms. Due to lax financial oversight, Bankia’s $3 billion net loss in 2011 had been reported as a $300 million profit. Thus, in the months leading up to its July 2011 public offering, Bankia was in a weak financial position.

To the uninformed investor, however, the signs were very difficult to spot.

As the Eurozone crisis worsened in the summer of 2011, banking regulations tightened. One of the new measures that were introduced by the European Union demanded that the tier-one banks hold 10% of their assets in reserve, although this threshold was lowered to 8% for publicly-traded firms. This stringent demand was most likely a motivating factor in Bankia’s decision to go public, since at the time it was strapped for cash and had borrowed billions in highinterest loans that were nearing maturity.

In this respect, the IPO was a success for Bankia, because it gave it a core capital ratio of 9.6%. Yet not everything had gone smoothly. The firm had struggled to convince professional money managers and institutions, many of whom knew about the company’s anemic financials, to participate. Without their typical

Bankia’s woes truly began when the Spanish real estate crisis deepened and the toxic holdings began to eat away at the firm’s assets. By May 2012, Bankia had already experienced a $2 billion loss which expanded to $9 billion by October amidst fears that the bank’s collapse would cause extensive damage to the entire banking sector. Spain handed out the first of two bailouts on May 10th, which cost taxpayers $24 billion and converted the government’s €4.5 billion of preferred shares into a controlling 45% stake in the firm, partially nationalized the bank. On May 25th, the government stepped in yet again and suspended trading of Bankia’s shares. However, the damage to shareholders had been done. In addition to suffering a massive decline in value (which wiped out large portions of uninformed clients’ wealth), Bankia diluted shares and often failed to make dividend payments on time, if at all. Bankia’s executive leadership has also gone through the wringer. Former Chairman Rato and members of BFA have recently come under legal and regulatory scrutiny led by the UPyD (the leftist Union, Progress, and Democracy Party). These investigations are focused

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on allegations of fraud, falsification of returns, and misappropriation of funds.

The investigations have led to mass resignations within the firm. Rato, who retired shortly before the first bailout, is now under particular scrutiny for his decision to move forward with the IPO despite Deloitte’s refusal in 2011 to sign off on Bankia’s books.

Bankia’s problems pushed Spain itself to its very limits, and it was eventually forced to request a further €100 billion from the EU to clean up the troubled bank and the rest of the financial sector while enduring a downgrade in credit. Investor confidence in Spanish banks was crippled.

The Bank that Broke Spain Despite bank bailouts, real estate troubles and Spanish bond woes, Spain has yet to request a full sovereign bailout. Will Spain join Greece, Portugal and Ireland and request a full bailout? Not according to the Spanish government. However, as the Eurozone crisis escalates, it might just be a matter of time.

As the largest of the consolidated cajas formed from Spain’s attempted overhaul in 2010, Bankia’s woes highlight the doomed future of Spain’s banking reform.

Just 18 months after the creation of this ill-fated behemoth, Bankia had become the largest banking catastrophe in Spain’s history. Indeed, Bankia is only the first of a list of banks that are in need of a bailout.

An independent audit has calculated that Spain’s banks will need an injection of €59.3 billion in EU loans. The bailout of Bankia might very well be the tipping point for Spain’s financial sector. Since 2009, many of the cajas have failed, but Bankia is the first “too big to fail” bank that has created systemic risk for the entire banking sector.

After the Bankia bailout, Spanish yields surged to over 5% the German benchmark, fueled by escalating banking woes in Spain. This spread is often used as Spain’s risk premium. Richard McGuire, an interest rate strategist at Rabobank International, says that Spanish yields are likely to continue to rise, because the

government and banks are locked in a “feedback loop” and that “the process is self-fulfilling” since “the more yields rise, the more denuded banks’ balance sheets become [and] this in turn fuels concerns about the banking system which further inflames yields”. McGuire staunchly believes that ECB intervention in the bond markets is needed to calm surging Spanish yields.

Since the bailout, the Spanish government has been in full “crisis mode”. In August, the Spanish government approved the creation of a “bad bank” to absorb the toxic real estate assets of Spanish banks.

In September, Prime Minister Mariano Rajoy introduced new austerity measures for 2012, which emphasized spending cuts, savings, tax increases, and structural reforms. The Spanish government has been trying its best to convince other Eurozone countries that Spain does not need a bailout, because a bailout would ultimately force Madrid to cede some fiscal authority to lenders.

In order to avoid a sovereign bailout, the Spanish government has tried to convince the ECB to purchase Spanish bonds.

However, ECB President Mario Draghi reiterated that the ECB would only buy Spanish bonds if Spain formally requests an EU bailout. It is expected that if the Spanish risk premiums remain high, a Spanish sovereign bailout is inevitable. In the event of such a bailout, Bankia would truly be “the bank that broke Spain”.

The Tip of the Iceberg The collapse of the Spanish real estate bubble has exposed the Spanish banking sector to even greater losses than the United States and Ireland were exposed to when their real estate bubbles crashed.

The focus of the Eurozone is now on Spain and its teetering banking sector.

The Spanish banking crisis, ignited

by Bankia’s bailout, threatens deeper recession throughout Europe.

Research by the boutique investment house Variant Perception suggests that

housing prices in Spain will drop as far as 50% below their peak values. Because the typical Spaniard has 80% of his or her assets tied to real estate, a sharp decline in housing prices would lead to widespread impoverishment. Given the importance of construction in the Mediterranean, falling housing prices will only deepen the recession. GDP data for the last quarter of 2011 shows that the recession is rapidly accelerating in the region, led

by Greece (-7.5%), Portugal (-1.3%), Italy (-0.7%), and Spain (-0.3%).

Spain is the fifth largest economy in the Eurozone, with a GDP twice as large as that of Ireland, Greece, and Portugal combined. If the European Union eventually steps in, the Spanish bailout will need to be much bigger than any of the ones before it due to the sheer size of the Spanish economy. The Bankia bailout, caused by the collapse of Spanish real estate values, may have already sparked a Eurozone contagion that will spell the demise of the euro and endanger the entire global economy.

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THE BANALITY AND THE NECESSITY OF BUBBLES DR. WILLIAM H. JANEWAY

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William H. Janeway is currently Senior Advisor at Warburg Pincus and a visiting lecturer in Princeton’s Department of Economics. He joined Warburg Pincus in 1988 and was responsible for building the information technology investment practice. Previously, he was executive VP and director at Eberstadt Fleming. Currently, he is also a director of Magnet Systems, Nuance Communications, O’Reilly Media, and is a member of the Board of Managers of Roubini Global Economics. Dr. Janeway is Chairman of the Board of Trustees of Cambridge in America and Co-Chair of Cambridge’s 800th Anniversary Capital Campaign, as well as a Member of the Board of Managers of the Cambridge Endowment for Research in Finance (CERF). Dr. Janeway is a member of the board of directors of the Social Science Research Council and the board of governors of the Institute for New Economic Thinking and of the Advisory Boards of the Princeton Bendheim Center for Finance and the MIT-Sloan Finance Group. Dr. Janeway received his doctorate in economics from Cambridge University where he was a Marshall Scholar. He was valedictorian of the class of 1965 at Princeton University.

[The following is an abridged transcription of Professor William H. Janeway’s dinnertime talk with the Princeton Corporate Finance Club, given on March 29th, 2012.]

We find that bubbles are everywhere; you cannot find a liquid market in any asset that isn’t subject to bubbles and crashes.

The object of a bubble can be anything.

The focus can be on tulip bulbs, gold mines, or bonds of countries that no one knows the location of. Occasionally, the object of a bubble is a transformational technology that creates enormous new economic space—look to canal mania in Britain in the 1790s or the two railroad booms and bubbles in both Britain and the United States, first in the 1840s and 1850s and again in the 1870s and 1880s. In the 1920s, the hottest growth stocks were electric public utility stocks. All of these, including the most recent deployment of fiber for the internet in the 1990s, were funded by stock market bubbles.

Transformational infrastructure can also be funded by the state, when it has a politically compelling mission. The interstate highway system was built by the federal government under the National Interstate and Defense Highway Act, and each bridge on every interstate in the country was built to certain specifications.

The bridge had to be high enough above the ground so that a missile carrier with an Atlas first generation ICBM could go under the bridge. The key is that, as with the bubble-funded investments, the sources of capital are not concerned with the underlying long run economic return: it is national security or shortterm financial gain that matters.

When the bubble inevitably breaks, the infrastructure and technology created by the bubble is left behind. For example,

during the 1880s in the United States, 75,000 miles of railroad track were laid, the most ever to be installed. However, within three years after the crash of 1893, 40,000 miles of those railroad tracks were owned by companies that were bankrupt.

But no one actually pulled up the rails.

Similarly, when Global Crossing and WorldCom went bust, no one pulled up the fiber and sold it on eBay. Stock market speculation not only has funded the deployment of transformational networks. It has also financed the exploration of the new economic space thereby created. Note that if it hadn’t been for the Dotcom/ Telecom bubble, which financed all those ludicrous startups like Pets.com, Amazon could never have been funded. It took a huge amount of money to build Amazon’s dedicated set of warehouses required to support its unique retailing model.

Instead of distributed huge quantities of a limited number of different kinds of goods to a small number of places, Amazon ships a very large number of items in units of one and to millions of customers. It took something like three billion dollars before Amazon reached positive cash flow from operations. You only fund that type of success through a bubble—you discover eBay and Google through the waste of a bubble.

My main point is that contrary to what we are all taught in Economics 101 (that the virtue of economics is efficiency and that the optimal allocation of resources is what the whole game is about), the virtue of the innovation economy is actually the ability to tolerate waste. This kind of waste is what I call the Schumpeterian waste: it is associated with innovation and is often considered to be constructive and productive. But there is a second kind of waste that is simply dead loss:

unemployment and underemployed resources. The marginal productivity of a laid off worker whose skills atrophy or of unused machines that rust and become obsolete is negative. Back in the 1930s when there was a huge quantity of unused resources, Keynes suggested that anything that put those workers and those machines back to work was going to generate a greater return because once those people were employed they were going to start spending money again.

Keynes asserted that it would be better to invest in unproductive asset than to watch 20% of the labor force in Britain, 25% in the U.S., and 30% in Germany remain unemployed. He argued provocatively that it would be better for the treasury to take empty bottles of beer, stuff them full of banknotes, put them at the bottom of unused coal mines, and then fill the mines with municipal waste and tell people where they were and rely on the profit motive to get people to dig them out and to spend them.

But since then, and right through the political wars within the White House and with Congress over the stimulus act of 2009, it is still argued that it is only legitimate for the government to spend money on a project whose economic return can be evaluated, measured, and proved to be useful and productive.

Even when the conditions of general equilibrium—with all resources fully employed—are manifestly not applicable, these same arguments continue to be used. In this way, the argument for efficiency not only undermines the Schumpeterian process but also serves to increase toleration of the other kind of waste, the Keynesian waste, the waste of unemployed resources.

The Princeton Financier | 13

By JASON NONG It almost sounds like an extended soap opera with multiple love triangles that are all waiting to be resolved. The star of the show is Fraser and Neave (F&N), which is a food and beverage, brewing, and property conglomerate based in Singapore. F&N is currently torn between TCC Assets/Thai Beverage and Overseas Union Enterprise (OUE). Both TCC and ThaiBev are controlled by Thai billionaire Charoen Sirivadhanabhakdi, while OUE is a property affiliate of Indonesia’s Lippo Group, which is part of the Indonesian Riady family empire.

Charoen Sirivadhanabhakdi, who already had the largest stake in F&N through TCC and ThaiBev, first signaled his interest in fully acquiring F&N during a previous acquisition battle with Heineken International over Asia Pacific Breweries (APB). The fight over APB started out in 1931 as a joint venture between Heineken International and F&N. But this past summer, Heineken decided that it wanted full control of APB, whose brand includes the popular Singaporean Tiger Beer.

Sirivadhanabhakdi, as a self-made man who grew rich from his success in the beer business, naturally did not want to let Heineken, a competitor, gain control of APB. However, after a two-month standoff, he relented and consented to support the sale of F&N’s 39.7% stake in APB to Heineken.

While this complicated deal satisfied both parties, it surprised bankers at first. In return for Sirivadhanabhakdi not blocking Heineken’s bid for APB,

Heineken agreed to not make an offer for shares of F&N. Heineken also pledged to buy an 8.6% direct stake in APB owned by Kindest Place Group, which is owned by Sirivadhanabhakdi’s son-in-law. Heineken’s agreement not to make an offer for shares of F&N showed that Sirivadhanabhakdi was interested in acquiring all of F&N. His actions indicated that he would be free to make an offer for F&N without having to worry about one more competitor.

However, before this deal was announced on September 19th, Sirivadhanabhakdi made an offer of S$8.88 per share of F&N on September 13th after his companies ThaiBev and TCC Assets raised their combined stake in F&N to 31%. At the same time, his son-in-law also bought a stake in APB through Kindest Place Group. Since these moves were seen as an attempt to gain more control of F&N in order to block Heineken from buying APB, it’s not surprising that the September 19th announcement shocked many people.

The announcement confirmed the rumor that Sirivadhanabhakdi was now less interested in F&N’s beer assets and more interested in its property portfolio and the regional distribution network of its soft-drink business. It would appear that Sirivadhanabhakdi, who was already a leader in the beer industry, was looking to diversify rather than continue to focus solely on the brewing industry.

Once Sirivadhanabhakdi managed to reach an agreement with Heineken,

The Princeton Financier | 14

Heineken needed to convince the other shareholders of F&N to agree to the sale. One proposal was to have F&N’s board pay out S$4 billion ($3.3 billion) through a capital reduction.

However, this proposal ultimately failed to pass when the shareholders of F&N (including Sirivadhanabhakdi’s companies) voted to sell F&N’s stake in APB to Heineken in a S$7.9 billion ($6.4 billion) deal on September 28. While the proposal had required 75% support, it only received 54%, mostly because Sirivadhanabhakdi was actually against it. Excluding the Thai votes, 91% were in favor of the capital reduction. ThaiBev and TCC’s reasons not to support the proposal were simple: the capital could either be used to help F&N grow or to make it more expensive for a third party to launch a counterbid for F&N. However, the deal as a whole still made most happy. Heineken’s offer of S$53 per APB share was accepted by F&N’s board before it went to the shareholders and was considered generous since it was more than 18 times EBITDA. The deal included the condition that F&N would not distribute or sell brewery or brewery-related products in Singapore, Cambodia, Papua New Guinea, and Vietnam. It also stipulated that F&N would not poach senior employees from APB for one year and that Heineken would not make, distribute, or sell soft drinks in Singapore, Papua New Guinea, Cambodia, and Vietnam for two years.

These conditions essentially ensured that the two companies would no longer be direct competitors. Furthermore, the profitability of APB combined with

Heineken’s ability to get cheap credit benefits Heineken’s cash flows, which allowed their shares to rise which defies the natural pattern of an acquirer’s shares falling after executing this type of agreement. And while Heineken clearly benefited, Sirivadhanabhakdi also was able to continue his path to achieve his goals with regards to F&N and the expansion of his business.

TCC/ThaiBev’s S$8.88 per share offer, which had been announced in the middle of the APB takeover negotiation, was supposed to expire on October 29th.

However, on October 9th, OUE made an unsolicited offer of S$1.4 billion ($1.1 billion) for F&N’s hospitality and serviced residence business, which threatened to complicate TCC/ThaiBev’s offer. F&N rebuffed OUE’s offer and, on the subsequent day (October 10th), F&N decided that while TCC/ThaiBev’s offer was fair, it was not compelling. The justification for this decision stems from the evaluation done by F&N’s adviser, JPMorgan Chase, who indicated that the estimated value per share should fall between S$8.30 and S$11.22, and although the offer made the range, it also fell on the low side. F&N’s directors did not make a recommendation to the shareholders but noted that the four directors who owned shares in the company would not sell unless Sirivadhanabhakdi managed to obtain more than half of the company. The fact that F&N’s shares had been trading above S$8.88 indicated that investors expected him to raise his offer.

Despite being rebuffed, OUE was not finished bidding for F&N. It was rumored that OUE was looking for partners to make a counterbid offer for F&N, and this news caused F&N shares to spike up to S$9.29. One of OUE’s potential partners was Japanese brewer Kirin Holdings, which owns 14.8% (212.77 million shares) of F&N and had previously indicated interest in F&N’s food and non-alcoholic drinks business.

Another OUE bid would no longer be just for the hospitality and serviced residence unit, but for the entirety of F&N.

Despite these new developments and the fact that F&N’s shares were consistently trading over S$9, Sirivadhanabhakdi did not sweeten his offer. The original October 29th deadline was extended to November 8th, which in turn was extended to November 22nd after OUE promised to make its intentions clear by November 15th. Holding his offer where it was at the time was the best strategy for Sirivadhanabhakdi since if OUE did make an offer for F&N then he would have done the right thing by not raising the offer and thus working to potentially raise OUE’s offer. Conversely, if OUE did not make an offer, then investor enthusiasm for F&N’s prospects would fall and perhaps he could still achieve his goals.

shareholders”. This agreement implicitly signals that F&N prefers OUE. If Sirivadhanabhakdi had immediately accepted OUE’s offer, he could have made approximately S$500 million given that TCC acquired its shares of F&N when they were trading at below S$8 a share. But since he chose not to do so, he instead showed that he was up for the fight. On November 22nd, when his offer was supposed to expire, he extended it for a third time to December 11th. Although his offer was not immediately raised, he will most likely raise it in the near future because TCC/ThaiBev has up to 60 days to respond to OUE’s S$13.1 billion ($10.7 billion) offer after the bid document is sent to shareholders. This extension

It would appear that Sirivadhanabhakdi, who is already a leader in the beer industry, is looking to diversify rather than continue to focus solely on the brewing industry.

However, OUE did make an offer.

OUE’s consortium offered S$9.08 a share on November 15th. OUE’s offer was made through OUE Baytown, which is a unit of Cayman-incorporated Arbon Holdings and 50% owned by OUE with the remaining 50% comprised of certain investment funds and accounts managed

by Farallon Capital Management LLC, Noonday Global Management Ltd., and various other investors. Kirin, which had previously been rumored to be a potential partner for OUE, agreed to tender its shares and not accept any competing bids. Thus if the OUE-led bid succeeds, Kirin will offer S$2.7 billion for F&N’s food and beverage business.

F&N, on its part, agreed to pay OUE’s consortium a break-up fee of as much as S$50 million if a competing offer is successful. F&N also decided to not make a recommendation by the board but rather to “create a competitive bid situation, thereby maximizing value for

simply gives Sirivadhanabhakdi more time to shore up TCC/ThaiBev’s finances before coming up with another offer that hopefully (for him) holds off OUE. OUE, however, also appears to have been expecting this. Some analysts believe that OUE deliberately placed its bid low enough to give TCC/ThaiBev room to respond within J.P. Morgan Chase’s valuation of S$8.30 to S$11.22 so that OUE can choose how to best respond to TCC/ThaiBev’s response in turn.

F&N shareholders are also betting on an escalation of the bidding war, with its shares hitting a high of S$9.40 after OUE’s announcement of its offer.

Eventually, these bids will have to stop somewhere. Investors have already begun to wonder if both the Riady Family and Sirivadhanabhakdi are merely chasing after expensive goods that don’t generate returns. For now, it appears that at least one more round of bidding is in store for F&N. The Princeton Financier | 15

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Barbara Byrne is a Vice Chairman in the Investment Banking Division at Barclays PLC. Before working at Barclays, she was a 28year veteran at Lehman Brothers, where she was the first and only woman to be named a Vice Chairman in the firm’s history. Barbara Byrne is responsible for maintaining Barclays’ global relationships with some of the firm’s most important clients, including GE, IBM, Altria, EMC, HP, U.S. Steel, Microsoft, and Williams. She has held senior management positions in Energy and Technology investment banking groups throughout her career. In addition, Barbara Byrne has led diverse strategic advisory initiatives across the firm focused on enhancing clients’ global market positions. She participates in industry conferences as a forum leader on key issues and trends facing the financial services sector and global markets. She also frequently speaks on behalf of women in business and finance.

She has been invited to attend Fortune’s Most Powerful Women’s Summit for over 10 consecutive years and has been a company delegate at the Clinton Global Initiative for six years. In 2010, 2011 and 2012, Barbara Byrne was ranked by American Banker as one of the “25 Most Powerful Women in Finance”. She is currently a member of the Women’s Forum for the Economy & Society and 85 Broads Inner Circle. In addition, she has provided financial market commentary for news organizations including Fortune, Forbes, Bloomberg, and CNBC. She graduated from Mount Holyoke College magna cum laude in 1976 and serves on its board of trustees.

How did you initially become interested in investment banking? What motivated you to continue working at Lehman after your first few years there?

That was a long time ago. I graduated from college in ’76, and I was working for Mobil Corporation in sales and supply and was based in New York. My position involved trading of oil and gas, but I became very interested in the finance side of the business. I was studying for my MBA at NYU, and I knew some people who were involved with the investment banks. The banks were quite small at the time. I wanted to work with people who I thought were very smart, and I wanted to deal with the services side of the business. I moved over as a first year associate in 1980. I wanted to be in an environment with high energy and a high level of engagement. I was one of seven associates who joined Lehman Brothers that year. There was no such thing as an analyst program at the time, so I came in as a first year associate. I stayed at Lehman over the years because I loved the people that I worked with, and it is important to remember that the grass is not always greener on the other side.

What was it like to be the only woman to achieve a vice-chairman position at Lehman Brothers in the firm’s 158-year history?

I was obviously very pleased when I was promoted to Vice Chairman. I had asked for that position. There had been two gentlemen who had been named to

that position, and I felt I was equal to them or perhaps even better than them.

I talked to those in charge and I said, “I think I should have this as well”. And interestingly enough, they [the CEO and the other executives] hadn’t really thought about it. After I presented my case to them, however, they became champions of the idea. It is an important lesson that you need to speak up when you want something, rather than complaining.

Achieving the level of Vice Chairman gave me a voice. I already had a voice, but it gave me a validated voice to speak up. In an industry that is still dominated by white males, I believe that diversity enhances the strength of organizations. It allows you to bring more opinions to the table. I feel that being a woman allows me to speak up in a different way and to advocate for others who may feel they cannot speak up.

What was your immediate reaction when you heard Lehman was going to file for Chapter 11 bankruptcy? What was the rest of that week like for you?

I responded the way I would to a death.

My biggest fear was for my people.

Everyone just lost their healthcare, their pension, and their benefits. I was not worried for myself; I knew I could get another job doing something. But what about the assistant at the office with her two crying children? It was an awful situation. And it was made even worse by the response from society and the media. It was horrible that a firm which you were proud of and which you loved

became the name that was associated with everything that was wrong. Whether it was fair or not, they needed a villain. As a result of my experience over the course of that week, I focus hard on always giving someone a chance to explain him or herself.

All of the partners bleed Lehman green; it was a true partnership. The partners owned close to 40% of the company, so people lost not just their jobs but also a large part of their net worth and their ‘Lehman family’. That week still needs to be studied. I have often held that it will be at least a generation before we will have the emotional distance required to fully understood it.

Did your role change at all when you became a Barclay’s employee?

No. At the time, Barclays didn’t have a Vice Chairman position. When I introduced myself as a Vice Chairman, they replied that they didn’t have that. I let them know that they did now. What was important was that Barclays was very fair. We knew we would lose some of our employees, but at least the ones we lost were able to receive benefits.

What do you think about the value of leaving the industry after two years to get an MBA? From a young person’s perspective, I think it can be a good idea to pursue an MBA. It depends on whether or not you know what you want to do. It’s important for young people to be able to explore The Princeton Financier | 17

their interests. If you go into investment banking already knowing that you have a passion for valuation and modelling, an MBA is probably not for you. Barclays has a two year analyst program. Many of our analysts choose to stay on for a third year, after which they become associates.

Some of our competitors have gotten rid of their two year program, and recent college graduates are hired for longterm positions. I think Barclay’s model provides a lot more flexibility for young people to explore what they want to do.

Let’s say you enjoy doing finance, but also are interested in marketing—an MBA would be the perfect choice for you.

all future dealings. In the end, Barclays has been around 320 years, and it will be around for many more years to come.

What are your opinions of the fiscal cliff and the budget issues facing the U.S. at the moment?

The world is facing a lot of issues: the European debt crisis, China’s slowdown, Iran, and now Israel and the Gaza strip.

Apart from the those problems, the U.S. has taken on a self-made one, which is the fiscal cliff. I feel that President Obama should be governing now, rather than campaigning. He needs to be sitting with

My biggest fear was for my people.

Everyone just lost their healthcare, their pension, and their benefits.

Barclays was the first of many banks to admit that they played a role in the LIBOR rate-manipulation scandal. Soon afterwards, the firm underwent a dramatic change in leadership. Can you give us your thoughts on how this affects the firm?

Barclays was the first of many companies involved in the scandal to settle and admit wrongdoing. A CEO of a company like Barclays is in charge of many thousands of employees, but maybe only a dozen report directly to the CEO. In this situation, the actions of a few people in a location far removed from the CEO caused the problem. The people at the top took responsibility for the people lower down. I really respect Bob Diamond. I feel he had a lot of vision and that he was good for the job and for the company. I miss him, but I think he did what he had to do. You don’t often see the Chairman and the Chief Executive Officer step down so quickly after a scandal. They did what they thought was best for Barclays, and Barclays did the correct thing by negotiating and settling on the issue. The LIBOR scandal was a breach of business ethics; Barclays took responsibility and was the first bank to settle. Barclays is committed to setting a very high bar in

Boehner and working out a compromise.

I am a lifelong Democrat, and I will tell you that tax increases on the wealthy will not be enough to fix the problem. Let me add that if you have two kids in New York and you make $250,000 a year, you are not rich. A small two bedroom apartment will set you back $6,000 a month. There have to be changes to entitlements. Social Security is not as much the issue as medical care. I will begin to collect social security at around 66. You [college students] may have to wait until maybe 68. That is somewhat ameliorated by that fact that you will live longer. However, that only exacerbates the problem in terms of medical care.

GDP loss will be around 4% if we go over the cliff, when you account for tax increases and the loss of spending. Out economy is currently only growing at around 2.5%, so we will almost certainly enter into a recession if we go over the cliff. The world will not stop if we are over for six weeks, but we cannot be over for any major length of time.

We know that you are involved with several non-profits, including the Clinton Global Initiative. Can you tell us a little more about that?

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I have a special fondness for the Clinton Global Initiative. Recently, CGI has been discussing what can be done in the aftermath of Hurricane Sandy and what can be done in response to rising sea levels as a whole. Obviously, we want to prevent it from happening as much as possible, and we should be taking steps to reduce carbon emissions. But it is key that we have a solution if we’re unable to stop it as well. There has been talk about not rebuilding homes on the Barrier Islands off the coast of New Jersey, but that may be untenable. What are you going to say to the fisherman that make their livelihoods there? What about Seaside heights? Are you going to tell the grandma that has lived there for 80 years that she will have to move out of her childhood home? This is what’s interesting to me: the intersection between business and NGOs, between how things actually work and how they theoretically should work. This is something that Clinton was very good at when he was president. He brings things to the middle. He did it when he was governing, and he does it now with the Clinton Global Initiative. We could definitely use more Bill Clinton at the moment with regards to the fiscal cliff.

All of your children have gone to Princeton or are currently attending Princeton, and your husband is an alumnus. Do you have any specific advice for the students on campus?

Three of my children are on campus, so I am well versed in giving advice to Princeton students. I remember that during Shirley Tilghman’s convocation address to this year’s freshmen, she told the class of 2016, “you are the 1%”. And this has nothing to do with money. You’re the 1% because of brains and effort.

But with your incredible talent and intelligence comes a great responsibility.

One thing that I tell my analysts is that it’s really not a competition, and that’s true at Princeton as well. You have a lot to learn from your peers, and in the end, whether it’s at Princeton, at Barclays, or anywhere else, it’s about cooperating to achieve a larger goal.

Making the Grade The Ethics of Credit Rating Agencies

By Darwin Li On August 5th, 2011, Standard and Poor’s (S&P) downgraded the United States’ sterling AAA rating for the first time in its history of delivering credit rating services. However, the downgrade ultimately turned out to be a greater humiliation for S&P than for the United States government when a $2 trillion miscalculation was unveiled following the close of the markets on the next trading day.

Ironically, the reason for such a cynical market reaction was in part due to the lack of downgrades implemented by the three big credit rating agencies (S&P, Moody’s, and Fitch) during the sub-prime mortgage crisis. In addition to evaluating countries, credit rating agencies also provide objective assessments of the creditworthiness of corporations, issuers of debt obligations, and debt instruments. As a result, these agencies play an important role in providing investors reliable information on the likelihood of financial obligation default. Thus it is surprising that during the peak of the housing bubble many top investment-grade (AAArated) innovations, such as Residential Mortgage Backed Securities (RMBS) and Collateralized Debt Obligations (CDOs),

ended in default. The overabundance of these time-bomb securities in the finance sector resulted in the bankruptcy of many asset management firms, bailouts of multiple large investment banks, and the global recession that still has a resounding negative impact in today’s economy.

The large-scale issuance of AAA ratings to RMBS and CDOs that relied on risky and subprime mortgages can be traced back to as early as 2004 (see Figure 1).

While this practice generated hundreds of millions of dollars in fee earnings for the rating agencies, it also instigated an investigation by the U.S. government after the effects were realized in late 2007.

Ultimately, the investigation determined that the failure of rating agencies to provide accurate evaluations was not merely a careless lapse of judgment, but rather was a by-product of multiple, equally egregious elements, one of which was the inherent conflict of interest that exists between the rating agencies, the companies they rate and are paid by, and the investors whom they commit to.

of favor and was subsequently replaced by the implementation of the “issuerpays” model by credit rating agencies.

In this system, agencies are paid by Wall Street firms that seek and profit from the high ratings of their financial products. Thus, this system leaves credit rating agencies dependent on the firms they rate and vulnerable to firms threatening to take their business to other agencies if the ratings these firms receive are undesirable, even if said ratings are warranted (see Figure 2).

Indeed, in a time when risky CDOs and RMBS dominated the financial industry, agencies began relaxing their standards in an effort to compete for and remain attractive to clients. Two other factors are responsible for the inaccurate ratings.

First, there are insufficient resources to adequately address the new and complex financial products and test the accuracy of preexisting ratings. Second, the current models used to analyze default risk are subpar and failed to account for the unsustainable rise in housing prices and rampant mortgage fraud.

Following the Great Depression, the “investor-pays” business model (in which investors pay credit rating agencies to evaluate financial instruments) fell out

While the issues surrounding the credit rating agencies ought to have set off alarm bells for the U.S. government, even today there has been little done to remedy the The Princeton Financier | 19

situation. Creditors continue to hide behind their First Amendment rights to free speech, and attempts to litigate the actions of rating agencies by disgruntled investors have proved fruitless ever since the 2001 Enron scandal resulted in a victory for the raters. Although the SEC published two reports concerning credit rating agencies, one mandated by Sarbanes-Oxley in 2003 and another in 2008, these were merely the first attempts to report on the agencies and did a poor job in actually addressing the fundamental issues. The 2003 report labeled the issuerpays business model a “potential conflict of interest”, which merely served to trivialize the already existing conflicts.

Though the 2008 report also recognized the possible conflict of interest, it took no move to correct it and only asked credit rating agency managers to provide further suggestions. As Anthony Catanach (Professor of Business at Villanova) and Edward Ketz (Professor of Accounting at Pennsylvania State University) stated, “we might as well let Madoff out of prison and ask him how to run a better Ponzi scheme”. Clearly, if credit rating agencies are to be improved from their

current state of disutility, something more substantive must be done, and the line dividing law and ethics must be more clearly defined.

Two leading solutions that will improve the credit rating agency market include increasing the transparency and objectivity of rating organizations and diminishing or even eliminating the explicit regulatory reliance on ratings.

The solution of transparency is simple: credit ratings agencies should be mandated to be more open about their internal affairs and provide detailed descriptions of their models. To avoid manipulation by investors, agencies ought to describe the weights of all of the factors affecting their rating decision on a case-by-case basis, which will also help them become more precise with their methodologies. Joshua Rosner of Graham Fisher argues, “following bonds once they trade in the secondary market is much less lucrative for the agencies … and they devote far fewer resources to it.

Although the agencies’ models make it clear what rating they will give a bond on issue, it is less clear what will cause them

to downgrade it later on”. This instance is only one of many which demonstrate just how beneficial transparency can be.

It would also be useful for rating firms to disclose historic performances on ratings and to prevent these firms from using due diligence reports by untrustworthy third parties, (which they did during the crisis).

Increased transparency in the credit rating agencies, beyond what has already been established via existing regulations, is undoubtedly necessary.

The elimination of explicit regulatory reliance on ratings also needs to be considered. Patricia Langhor, Professor at the French ESSEC Business School explains, “it gives ratings a force of law”.

Although detrimental to the business of credit rating agencies, there is a large social benefit to be gained if asset management funds and other low-risk schemes are not subject to laws concerning the purchases and sales of securities that have been deemed either worthy or unworthy by outside opinions.

Frank Partnoy of the University of San Diego proposes an interesting but

Figure 1. Graph from Graham Fisher & Co., Inc. providing evidence of the profits to be made in the RMBS and CDO market as well as the loosening of rating standards.

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Figure 2. Inherent conflict of interest in the issuer-pays business model. Fees are paid by issuers despite the fact that CRAs (Credit Rating Agencies) primary commitment is to the investors. Diagram from OECD. controversial solution in his research, advocating for the removal of NRSRO (Nationally Recognized Statistical Rating Organizations) designations and the replacement by a market-based measure of credit risk. This type of action would incorporate all available information into one rating, which could eliminate many of the drawbacks seen in the regulatory reliance on ratings during the financial crisis. It has also been suggested that a system to rate the rating quality of the agencies be introduced, and though it is logical why such a system could be beneficial to investors, further research needs to be done to determine the effectiveness and long-term viability.

Concerns regarding competition have been documented as early as the 2006 Credit Rating Reform Act. Due to basic capitalistic principles, it may make sense to introduce more rating firms in order to incentivize the existing ones (and those yet to exist) to produce higher quality, objective ratings. However, leading research suggests that an increase in competition in the rating agency market is unwise due to potential unsustainability. There is a relatively small pool of consumers for rating agency services, and historically, consumers tend to only form a relationship with one rating agency. Furthermore since ratings

are experience services, it stands to reason that a high-quality track record is crucial to maintain a competitive advantage. The credit rating agency market is oligarchic in nature and cannot sustain a large number of agencies. Research conducted

a misleading rating. However, such an approach may result in consequences on the other end of the spectrum; potential damage claims by clients could cause agencies to become risk-averse, which would result in rating deflation.

If credit rating agencies are to be improved from their current state of disutility, something more substantive must be done, and the line dividing law and ethics must be more clearly defined.

by Harvard Business School Professor Bo Becker and Finance Professor Todd Milbourn further corroborated this logic when they examined the expansion of Fitch between 2004 and 2006 and the expansion of other agencies postrecession that preceded the poor rating quality delivered by Moody’s and S&P. They determined that the increase in competition among credit rating agencies led to less accurate ratings.

Another suggested reform is to make agencies legally liable for their views, thereby preventing them from continuously hiding behind their First Amendment rights whenever they provide

It is undeniable that credit rating agencies were not the only culprits responsible for the disastrous economic storm of 2007.

One can just as easily point fingers at the government, the investment bankers, the commercial banks, and even at political sentiment. But while heavy reliance on ratings by the investors who manage the wealth of millions of working and retired Americans remains, it is unquestionable that further regulations and improvements to the system are necessary to restore the confidence in rating agencies and to prevent another large-scale failure.

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Boon or Bane F DI Re tail reform s in India b y A mbik a V OR A On September 14th, 2012, the Indian government under Prime Minister Manmohan Singh opened India to foreign direct investment (FDI).

Although multi-brand FDI is capped at 51%, foreign companies are allowed full ownership in single-brand retail. This policy marks one of the most radical, pro-liberalization decisions in India since 1991, when the Indian economy was first opened up to foreign investment.

Although the potential upside of the change is quite high, the choice to allow multi-brand FDI into India has been met with intense criticism.

The ruling coalition that permitted the liberalizing reforms, the center-left United Progressive Alliance (UPA), was opposed in the decision by the centerright National Democratic Alliance (NDA). Nitin Gadkari, a leader of the NDA, expressed concerns that the reforms would “hurt the livelihood of the small trader”. The chief ministers of two states, Tamil Nadu and Uttar

Pradesh, refused to allow foreign-owned retail supermarkets. Politician Uma Bharti went so far as to announce that she would burn down the first foreignowned supermarket she encountered.

The intensity of these sentiments is not unwarranted. The economic implications of multi-brand FDI are substantial for both India and the global marketplace.

One major concern is the potential effect on unemployment. The advent of foreign superstores could potentially destroy small businesses and privately owned retailers, eliminating millions of jobs. Foreign superstores might obtain monopolistic market share after fierce competition drives out domestic alternatives. Then, predatory pricing by the foreign monopolies would adversely impact consumers and generate a domino effect, wiping out the economy from its roots. The most dire projections place the number of newly-unemployed at over 10 million.

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There is good evidence, however, that these projections will not come to fruition. Foreign companies invest with the intention of reaping long-term profits. The informal sector (or “black market”) plays a startlingly large role in India. With that in mind, predatory pricing would be counter-productive.

India’s per capita GDP is around $1,500, compared to the United States’ estimated $49,000. Predatory pricing, rather than increased revenue, would instead drive consumers to informal stores instead.

Foreign companies looking to invest in India are aware of the limits of consumer purchasing power there and are unlikely to set prices that would repel their desired customers.

Foreign share in the retail market is expected to form 10 – 20% of the total market over the next few decades. That still leaves a large swath of the market to domestic retail. Moreover, the fine print in the policy indicates that foreign stores will only be permitted in cities with

populations of over one million people.

That restriction limits FDI to just 53 cities, accounting for less than 15% of India’s total population. Thus India’s economy would not be torn up by its roots because the majority of the population would never encounter a superstore at all.

Rather than increase unemployment, there is some evidence that foreign retail would create millions of jobs. Retail superstores would employ a large number of local workers in positions where a domestic applicant would be more effective and economical than a foreign worker. Though superstores will probably force some small businesses in large cities like Mumbai and Delhi to shut down, the rampant unemployment that the NDA fears is unlikely. The jobs will simply shift from small-scale businesses to the superstores themselves.

For example, Reliance Retail, a domestic superstore, recently took over various small cooperative stores in Mumbai. Reliance managed to refurbish the existing stores and train the current staff. The employees of the co-ops reported skyrocketing profits and customer satisfaction following this transformation, and Reliance was able to wrap the customers of the co-ops into their brand. Foreign retailers could very well follow Reliance’s example and assimilate local businesses into their infrastructure, a move that would be mutually beneficial to both foreign and local companies.

Beyond the solely economic considerations, there lies another facet to some Indians’ hesitancy toward FDI. In 1947, India finally gained its independence after a fierce struggle with the British Empire and to some, FDI is code for the re-colonization of India by the West. The start of British colonization came with the British East India Company, and FDI seems like it opens the door for the process to begin anew.

Despite its power as a talking point, the prospect of FDI truly reigniting colonialism does not seem likely given India’s current socioeconomic status.

Though FDI would certainly increase India’s dependence on foreign markets and investment, the foreign companies would still be constrained by Indian laws on investment limits and domestic sector involvement. Moreover, India is a much more united nation than it was four hundred years ago and is better prepared to fight off potential efforts to manipulate its political and economic spheres.

FDI would eliminate one of India’s economic strengths: its insularity, which effectively shielded the country from global shocks like the 2008 financial meltdown. India weathered the recession well due to its large domestic market and relative independence from international markets. FDI would integrate India into the global marketplace, making India more sensitive to economic

the small amount of foreign investment that already existed in India exacerbated the economy’s already negative current account balance. This prompted the steep devaluation of the Indian rupee.

Opening up retail to foreign companies has already attracted billions of dollars.

Swedish retailer IKEA announced plans to invest €1.5 billion in 25 stores, and American supermarket giant Wal-Mart has indicated willingness to invest in Indian retailing infrastructure. FDI is exactly what India’s economy needs at the moment, with a large influx of foreign capital coming as a lifeboat to the sinking rupee.

Ultimately, the retail reforms will help overcome the two most pressing issues afflicting the Indian economy in the short run: inflation and the

FDI is exactly what India’s economy needs at the moment, with a large influx of foreign capital coming as a lifeboat to the sinking rupee. changes worldwide. That said, the post1991 trends have shown that India’s economy has largely benefited from the minor liberalization policies that have been implemented. With the only other option being continued isolation, the potential for growth that comes with FDI seems to tip the balance in favor of a more open India.

There is reason to believe that one of the main things holding India’s economy back is its lack of foreign interaction. Following the release of the annual union budget in March of 2012, there was a steady stream of foreign disinvestment in India due to outrage and dissent regarding some of the propositions in the budget.

Tax proposals and other regulations dampened foreign investors’ spirits in India, and the subsequent outflow of

current account deficit. A closer relationship between foreign investors and India will most likely be mutually beneficial to both parties, as well as to the overall global economic health.

For an economy to flourish in an age of globalization, relaxing market restrictions is a necessity. Though the retail reforms mark a benchmark on India’s road to liberalization, their success and effectiveness depends on their implementation. With careful monitoring, foreign presence can be sustained at a level that is not detrimental to small businesses, local workers, and consumer welfare—in fact, just the opposite. FDI could very well provide the financial jump-start India needs to cement itself as one of the economic powerhouses of Asia.

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