Autumn/Winter 2009 by Wharton International Business Review

iBR

FALL 2009 No. 01

iNTERNATIONAL BUSINESS REVIEW | PUBLISHED BY STUDENTS OF THE WHARTON SCHOOL

History of Our Financial Crises Lessons from our Grandparents

A NEW RUSSIA The Development of Business Ethics CHINESE REAL ESTATE MARKET Crisis or Hiccup? GERMAN CAR INDUSTRY The Porsche VW Saga

iBRCONTENTS 02

EDITORS’ NOTE

Hedge Funds: Post Mortem?

Seattle over Wall St.: An Alternative Path to Success

Vaccine Research: Nimble is the Name of the Game

PROF. JEREMY SIEGEL, THE WHARTON SCHOOL Jeremy Siegel, Russell E. Palmer Professor of Finance at the Wharton School, sheds some light into the causes of the ﬁnancial crisis.

INTERNATIONAL EDITORIALS

C. ROB HENRIKSON, CEO METLIFE INSURANCE

AMERICAS 24

Brazil - Last in First Out of the Crisis

WESTERN EUROPE

Wharton alumnus and MetLife CEO reﬂects on his academic experience at Penn. He offers insight into the everyday life of the CEO of the largest life insurer in the U.S and Mexico.

The Porsche VW Saga

Hotspot: Barcelona

GERARD KLEISTERLEE, CEO PHILIPS ELECTRONICS

EASTERN EUROPE / RUSSIA

An interview about Philips’ current ﬁnancial position and expectations for East Asia’s consumer markets and the importance of maintaining a strong balance sheet in times of a ﬁnancial downturn.

Lithuania’s Road to the Euro

Hasty Climbers Have Sudden Falls

The Development of Business Ethics in Russia

THE HISTORY OF OUR FINANCIAL CRISES

MIDDLE EAST 33

The World’s Next Monetary Union

Um-al Dunya

AFRICA 44

Nigeria & The Crisis: Interview with Ngozi Dozie

THE FINANCIAL CRISIS & THE MIDDLE EAST

ASIA 38

Real Estate Hiccup

OCEANIA 36

Riding the Wave

A comprehensive overview of the financial crisis of 1929, drawing parallels to the current financial crisis, emphasizing fiscal and monetary actions both then and now.

An in-dept look into the rising opportunities for much-needed reforms to the region’s business models, corporate governance, and ﬁnancial risk management.

I N T E R N AT I O N A L B U S I N E S S R E V I E W

EDITORS’ NOTE

iBR

International Business Review

Founder, Editor-in-Chief Daniel P. Hellwig Co-Founder, Senior Manager Maxwell Black Art Director Jonathan Hodes Publishing Managers Diego Arroyo Matthew Levin Max Maeckler Senior Editors Jasmin Imran Al-Sous Julia Hansen Communications Florian Hagenbuch International Editors Erik Buischi Rafael Levy Nicholas Theuerkauf Janis Kreilis Hamad A. Almudhaf Tosin Osibodu Alexander Cherniyak Charles Hendren Penny Metchev Contributing Authors Michael Ashmore Sean Caverly Sarah Hanna Peter Heyer Mantas Nemanis Randall Roth Philipp Schroeder Kaloyan Vladimirov

Faculty Advisor Prof. Nicholas Gonedes

International Business Review 204 S. 41ST Street, Philadelphia, PA 19104, Telephone: 215-796-4975 www.ibr-magazine.com contact@ibr-magazine.com

FA L L 2 0 0 9

The International Business Review is a student-run publication,

featuring

business-related

editorials

as well as internationally oriented interviews and articles. We aim to provide a platform to exchange ideas, opinions, and perspectives on economic issues, as well as to enhance communication and spark debate amongst students, faculty, and alumni, alike. Why might this magazine be relevant to you? Perhaps Gerard Kleisterlee, Wharton alumnus and CEO of Royal Philips Electronics put it best: “The key issue is, of course, continuing to renew yourself.” This remark is timely; as we emerge from the ﬁnancial crisis, the ability to renew ourselves under these circumstances is of vital importance. The way we decide, the way we consume, even the way we interact – a global change is occurring. The community at the Wharton School is comprised of highly motivated individuals, who should contribute to this change. This magazine therefore serves as a public platform to foster this idea. At the University of Pennsylvania, talented students from all around the world meet, engage, and interact, thus continuing a long-lasting tradition of global exchange. Therefore, we aim to publish articles that go beyond the scope of the American economy alone. That is why we have named the journal the International Business Review. This magazine is your magazine, too! We invite all of you to contribute. Read, engage, and enjoy!

Daniel P. Hellwig,

Maxwell Black,

Editor-in-Chief

Senior Manager

danielpa@wharton.upenn.edu

amax@wharton.upenn.edu

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HEDGE FUNDS: STATUS UPDATE OR POST MORTEM? BY R A N DA L L R OT H + S E A N C AV E R LY

Though global assets under management

that it did not conduct audits).

Enter

up front”—hedge funds must now pony

in the hedge fund industry will likely end

mid 2009, in speaking with multiple

up cash to enter such a trade. That being

the year at well over 1 trillion dollars, it

high ranking ofﬁcials at hedge funds

said, historically, innovation outpaces

has been quite a roller coaster ride from a

third party administrators like Citco

regulation and as credit markets thaw

mere 500 funds in 1990 to a peak of nearly

Group LTD are now responsible for a

total return swaps and a variety of exotic

8000 shops in 2007. Even if post-mortems

range of daily activities, which were until

ﬁnancial derivatives are still available to

never revive the dead as with the many

recently in-house functions, from P/L

obtain desired levels of “gearing.”

ﬁrms boarded up since the onset of the

reconciliations to estimating daily NAVs.

recession, hedge funds outperformed both

Warren Buffett made a very intriguing bet

the S&P and the MSCI World Index in

with a group of hedge fund managers. He

2008 and appear to be on the mend. Yet,

wagered that in the long term and net of

the next generation or evolution of hedge

all fees, costs, and expenses, hedge funds

funds will look unequivocally different

will perform worse than a low-cost S&P

as a number of structural reforms are

index. Beyond possibly annoying a group

already “baked in the cake” and a few may

of proud, alpha driven managers, his point

still remain in the oven.

was clear; the exorbitant fee structure of “2 and 20” (or “2 in 40” in the case of one

evolutionary

equilibrium

theory,

engenders

well known fund)—that is 2% of assets

punctuated sudden

and

under management (AUM) and 20% of

The global credit

any gains—represents an undesirable

crunch and a subsequent deleveraging

arrangement for investors. Today, as the

have wrought similar changes on Wall

nexus of power has shifted from managers

Street, and more speciﬁcally, on hedge

to clients, most funds are forced to decrease

funds.

At Princeton University, JC de

their fees and to throw in a number of

Swaan details speciﬁc reforms in his

other sweeteners aligned with investors’

article “The Future of Hedge Funds”,

interests. These include hurdle rates, high-

which your correspondent can conﬁrm

water marks, and the waiving of so- called

(after a number of unsuccessful job

“side pocket” provisions that segregate the

spasmodic change.

most illiquid investments into separate

interviews at some well known ﬁrms), are now virtually mandated in most cases.

Beyond compliance changes a massive

accounts that prevent investors from

economic deleveraging and credit crunch

making full redemptions. Yet hedge fund

Since the Bernie Madoff debacle, the need

has made it difﬁcult for anyone, including

detractors will be disappointed to note that

for investor due diligence has moved to

hedge funds, to obtain funds to purchase

the large and established fund complexes

the forefront of public debate. The issue

assets. The traditional method of short

with a track record of generating absolute

with hedge funds is that they are private

term ﬁnancing “buying on margin” has

returns will continue more or less with the

companies and thus not obliged to follow

given way to greater haircuts and thus

status quo fee arrangements—perhaps

the stringent regulations of their public

the need for more sophisticated methods

with some risk adjusted haircuts thrown

cousins (in spite of loose regulations for

utilizing derivatives.

Even so, in one

in for good measure. Two other interesting

private companies, it turns out Madoff‘s

method of such a “funding cost arbitrage”,

trends to look out for according to Swaan

one-room

credit default swaps (CDS) are evolving

begin with the development of a secondary

accounting industry group for years prior

to become exchange traded with “points

market for hedge funds. A number of

shop

accountants

FA L L 2 0 0 9

told

high-water marks without fundraising.

that are more likely to stay the course

have been willing to sell them to other

In light of the above reforms it is perhaps

in contrast to the more unruly wealthy

investors at a steep discount - which, is

not too surprising that investors are once

individuals. Whatever the case, no autopsy

an appealing proposition given how far

again opening up their purse strings for

needs to be performed on the hedge fund

underwater a number of these funds are

this asset class. To date, however, they

industry, as it is alive, if not all together

in relation to their high-water marks;

are being more selective in allocating the

well as larger groups gain access to this

investors pocket all gains up to the high-

lion’s share of funds to Rolls Royce names.

once private club and clandestine “Black

water mark/ prior to the application of an

Hence, we are witnessing the formation

Box” trading falls under the regulatory

investors unable to redeem their stakes

“THE TRADITIONAL METHOD OF SHORT TERM FINANCING “BUYING ON MARGIN” HAS GIVEN WAY TO GREATER HAIRCUTS AND THUS THE NEED FOR MORE SOPHISTICATED METHODS UTILIZING DERIVATIVES.” incentive fee. Second, take notice of any

of a bifurcated market—names like SAC,

hammer. Time will tell whether reforms

talent pool issues in relation to distance

Citadel, and Blackstone will continue to

will bring back the good old days of cash

from the high-water mark. Underwater

charge richly. Moreover, an increasing

soaked Greenwich fare or whether the

funds will likely struggle to pay their

amount of these funds are comprised of

piper will be paid - in the form of Mr.

best and brightest so far away from

pension funds and endowments, folks

Buffett’s wager. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

SEATTLE OVER WALL STREET: ALTERNATIVE PATH TO SUCCESS BY M I C K E Y A S H M O R E ( ‘ 0 9)

If you had asked me as a freshman,

with an emphasis on working abroad, if

incubator companies within the larger

sophomore, junior or even a couple months

the opportunity presented itself. After

Microsoft scope. A structured program

into my senior year where I would end up

many dozens of presentations, rounds

that infused an entrepreneurial ﬂavor

after graduation, working for Microsoft

of interviews, and hours of scrolling

seemed perfect for me. Furthermore,

in Seattle would not have even made

PennLink, I stumbled upon the Microsoft

this program could satisfy my desire

the consideration set. Not that I had

Finance Rotation Program (FRP) booth

to live abroad. Many rotation analysts

anything against the Paciﬁc Northwest

at a career fair. Something drew me to

have worked abroad to gain a better

or Microsoft (except maybe Vista), but

it. I dropped a resume—what the heck.

understanding of the global ﬁeld. The

the idea of working there had never

As I learned more about the program,

range and diversity of experiences is

crossed my mind or even been presented

I became even more intrigued by the

unmatched to any other job I could ﬁnd on

to me. But now, here I am—just over

opportunity. The Microsoft FRP gives

PennLink Microsoft’s FRP became my ﬁrst

two months into my new life and role

analysts

rotate

choice for my ﬁrst job. I just had to get in.

in Seattle and I could not be happier.

through four roles over two years within

So here I am, ﬁve weeks deep into my

the

opportunity

“I CAME TO WHARTON WITH A CREATIVE ENTREPRENEURIAL FLAIR. BY THE END OF MY JUNIOR YEAR...THE STEREOTYPICAL WHARTON EXPERIENCE HAD CONSUMED ME.” A little background to begin: I came to

Microsoft’s ﬁnance world, which is vast

ﬁrst rotation. I am working in a group

Wharton with a creative entrepreneurial

and varied. The range of experiences

called World Wide Licensing and Pricing

ﬂair. By the end of my junior year, I had

that past and current FRP members

Finance. We analyze business results

decided to concentrate in ﬁnance and real

enjoyed was astounding: capital markets

to drive strategy for all of Microsoft’s

estate and had worked on Wall Street for

(investing

cash),

Volume Licensing business. My team,

Goldman Sachs. Yes, the stereotypical

foreign exchange (Microsoft has a full

comprised of a few young, fun, and

Wharton experience had consumed me. At

corporate

energetic individuals, is fantastic, and the

Goldman, I learned so much about ﬁnance,

strategy, internal audit, and so much

atmosphere is comfortably relaxed—jeans

managing expectations, and Excel, but

more. Sure, Microsoft is a big company,

and polo shirts are the norm in the ofﬁce.

ultimately realized that I-Banking was not

and that does have its downsides, but at

This work environment is something

a ﬁt for me. So, senior year, I begrudgingly

its core, Microsoft is a tech company with

in particular that I have come to value.

joined the ranks of fellow classmates as

an innate entrepreneurial and creative

On Campus Recruiting commenced. I was

spirit. Small products or groups within

Aside from work, Seattle is an amazing

focused on real estate and private equity

Microsoft often function like startups or

place to live in. Unlike many large

FA L L 2 0 0 9

Microsoft’s

trading

ﬂoor),

excess M&A,

BARBARA’S NO BRAINERS! As students branch out of our community to seek post-graduate positions, we hope that they may glean some wisdom from Career Services Senior Associate Director Barbara Hewitt. Barbara has worked with students and alumni seeking jobs through good times and bad for more than twenty years, and she is prepared to offer us a few nuggets of her wisdom as recruiting season starts this fall:

cities, one can enjoy the outdoors with unparalleled

ease.

Everything

from

hiking to kayaking and boating is within

There are more opportunities out there than just with Firms X, Y, and Z! Many Penn students tend to be brand conscious, seeking out opportunities largely with well-known organizations or those that are

perceived to be prestigious. However, there are many excellent opportunities

immediate reach. While moving across

with smaller or lesser-known organizations. These organizations might offer a

the country to a completely unfamiliar

broader experience in which you could potentially gain exposure to different

city was daunting, I have embraced and

functional areas – perhaps working on marketing projects while also gaining

ﬂourished in my new environment. Every

exposure to ﬁnancial management. Such an opportunity can provide a great view

day in Seattle is a new adventure enriched

of an organization from top to bottom and can be an excellent career choice for

with the diverse elements of the city and

entrepreneurially minded students. Students should also use a variety of tactics in

its eclectic mix of cultures, peoples, and

their job search and not rely solely on OCR, which is just one means to an offer.

traditions. Do I have time to enjoy all these opportunities? The answer is a resounding “Yes.” Microsoft does not just

Networking: trickier than the age-old refrain, “GIVE ME A JOB!” Networking doesn’t have to embody a very speciﬁc end goal, per se. It can be a great tool to simply gather information and build your

network in the industry you’re interested in. There is a resource on the Career Services website called the Penn Alumni Career Network—about 2,000 alums who have volunteered to speak with students about their careers. The point is not to ask them for a job, but to gather more information about their company or the industry. These relationships can often turn into something very positive if maintained, and when an opportunity does come up in the organization, they might think of you and send you an email. Likewise, I hear stories every year from students who receive internships with speakers who come to campus. Because they went to the event, were genuinely interested in hearing what the speaker had to say, and made some follow up contact, they were able to develop positive

espouse the work/life balance as a desired

relationships, which ultimately led to great opportunities.

ideal, but genuinely values and practices it. Sure, there are days when I work late because I have a big project or major deadline, yet on most days, I am free to go when my work has been completed.

Figure out what it is that you really, really want, and set realistic expectations. Is it that you really want to live in Chicago? Maybe location provides a good way for you to focus your search. However, you may

need to be ﬂexible regarding the industry and size of employer. Maybe you want to work for a ﬁrm that has an outstanding training program. You could focus on

All in all, I could not be happier with my

seeking out those speciﬁc organizations, but you may need to be more ﬂexible

choice to join Microsoft. The experience

about location. Keep in mind, that while it can be discouraging to be rejected for

has been rich and rewarding in so many

an opportunity you really want, it’s an inevitable part of the job search. You have

ways. The work is challenging, the people

to pick yourself up and move on. Figure out what’s most important to you, and

are smart, and life, both inside and outside

be willing to give on some of the things you value less. All that being said, keep

the ofﬁce, does not just exist: it thrives. iBR

in mind that Penn provides an outstanding education and launching pad for you career, so you are well positioned to begin your search. Good luck!

Jeremy Siegel is the Russell E. Palmer Professor of Finance at the Wharton School.

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY M A X W E L L B L AC K ( ‘ 1 0) + DA N I E L H E L LW I G ( ‘ 1 1 )

PROF. JEREMY SIEGEL, THE WHARTON SCHOOL Jeremy Siegel, Russell E. Palmer Professor of Finance at the Wharton School, sheds some light into the causes of the financial turmoil. His confidence in the resilience of American finance is striking, and perhaps students of the field will find solace in his words of reassurance. Many of the factors that caused the economic crisis are

instruments are much riskier than they may seem by looking at

still up for debate. Some critics have, for a while now, been

historical data.” Of course, there was a lot of money to be made in

pointing the ﬁnger at academics and business programs

ﬂoating these subprime mortgages. I am not trying to claim that

like the Wharton School’s. As a professor of ﬁnance, do

these people knew that [subprime mortgages] were bad – but

you believe that business academia was a contributing

they certainly did not want to delve too much into that question

factor to the recession? Should we expect professors to

either. They had their set ways of examining the problem, and

change their outlook on the academics of business after

those ways seemed to imply that those securities were very safe.

this recession? It is my feeling that the crisis was not caused

If you want to talk about failure, it is the failure of these

by complex ﬁnancial instruments that were learned or invented

models to detect bubbles. Models use historical variances, and we

in academia. [Society has] developed sophisticated instruments

know that this methodology has limitations, especially when you

over time. The securitized mortgage market really started in

move outside relevant parameters, as we were doing at that time.

the 1980s, making the cost of home ownership to millions of

It’s comparable to the peak of the 1989 Japanese stock market

Americans lower than it would otherwise have been. Mortgages

bubble. Some Japanese analysts said: “Hey look, there is no risk.

are complex securities: the borrower can always pre-pay the

The Japanese market has not gone down for 25 years. How can

principal and that makes it rather complicated to price them.

you say there is any risk?” In fact, many stocks had PE ratios of

In my opinion, the crisis was caused by ignoring the real-

one hundred or more, and the market was just about to pop. The

estate bubble; using historical data over a period of 20-30 years

historical data was very misleading. One should look at deviations

that showed that nominal home prices almost never declined.

from the trend, but, unfortunately, those models did not do that.

I think the maximum one-year decline in nationwide nominal

A second problem was the concentration of these real-estate

home prices [in that 30-year sample] was 2.5%. Securities

securities in the hands of major ﬁnancial institutions, such as

that paid off the top 80% of the value appeared to be safe.

Lehman Brothers and Bear Stearns. They levered themselves in

Unfortunately, the rating agencies had neither the expertise nor

these ﬁnancial instruments, because they themselves misestimated

sufﬁcient data to detect that we were in a very unusual period

the risk. And that is a failure. It is a huge failure. But I would not

where home prices were very far above any historical norms.

call it a failure of the models that we teach. Certainly, there are a

A 20% decline in home prices would have been unthinkable if

lot of times we throw data in the computer and just use standard

you looked at the data from 1945 to 2002. However, when prices

models. What we need to do is to plot the data, look at the data,

double all of a sudden, as they almost did between 2000 and

stand back, and ask ourselves, “Is there any reason to believe that

2006, a 20% decline is something that can be very probable.

these data are acting differently than before?”

Someone should have said, “Hey listen, we cannot use historical data, it is misleading. We are in a bubble, and these mortgage

FA L L 2 0 0 9

Maybe we should have put more warnings when we actually analyzed statistical data: “Handle with Care!”.

So, as you say, it is a failure of modern models not to

You seem very conﬁdent in the liquidity of the U.S. dollar.

properly detect bubbles. Is it even feasible to forecast

Are overseas investors not losing faith in the currency?

bubbles in the ﬁrst place? It is very hard to predict bubbles.

Don’t forget, the dollar is pretty cheap. It is cheap because

Yet, some of the models today do not even do a good job in

people think that it is going to depreciate in the future, so it is

determining that you are in a bubble. You almost have to look

cheap today. If you ask me the one currency in the world that

at a long term trend, relative to other variables, and see whether

commands the highest purchasing power of the major convertible

you are moving outside established parameters. When you just

currencies, it is unquestionably the dollar. Everyone will accept

look at one-month changes, six-month changes, or twelve-month

the dollar. In my opinion, this will always be the case, unless the

changes, you are not able to detect a broad deviation from a

currency totally collapses, and I see no signs of that.

trend, as occurred in the real estate market. Is such a multi-trillion dollar relationship with China There has been a debate about whether there was a

sustainable? Japan ran trade surpluses with the U.S. for more

misallocation of capital by the concurrent ﬁnancial

than 40 years. Asia has always done that. Asia likes to export.

system-- the idea that there was far too much capital in

China wanted the dollars to buy whatever they needed in the

the housing industry, and not enough money for the “real”

international markets, such as raw materials for infrastructural

economy. Is that a reasonable explanation? That is debatable.

expansion. It is much easier to accumulate this in dollars. Oil,

The cost of capital was very low for everybody. Don’t forget: this

concrete, copper-- all raw materials are quoted in dollars. It was

housing boom did not really push up the cost of capital. Look at

best for China to keep on accumulating dollars as long as they

the interest rates, look at the risk premiums: all very low until

were building infrastructure, and they are still doing it today.

the crisis. Certainly, too much capital went into housing, but there was a lot of capital to go around. I did not see many ﬁrms saying

China

that they could not get capital during that period. It was cheap.

manufacturing. Is this leading to the end of the American

has

solidiﬁed

its

competitive

advantage

Trouble did not begin until lenders began to encourage borrowing

manufacturing sector? It has been ending for more than

from the subprime borrowers-- those that could not have in the

three decades. We have lost over 50% of our manufacturing

past received funding. I am not going to blame the government,

employment over the past 35 years. And during that time, while

though the government was partially there. The development of

we lost maybe 12-15 million factory jobs, we gained 50 million

prime tranches of securitized mortgages made it look like this

other jobs. It has been a long process of losing manufacturing

debt was much safer. And it was, if there was not a bubble.. What

jobs. It is a process that is really going on in most of the developed

happened was when the real estate values increased by 100%,

world, such as Japan and Europe. Germany is an exception. It

even the top 80% of mortgages rated and stamped as AAA were

does have a pretty good manufacturing sector, but even then,

not really AAA. That is what happened. Wall Street lost a lot of

employment is down compared to twenty or thirty years ago.

money-- in some cases more money than they were ever making.

Germany has been able to retain jobs because of their very

It was not like Wall Street put one over on the rest of the world;

specialized manufacturing. They have been able to keep niche

Wall Street was almost destroyed. It was not that I-banks created

markets, even though their cost of labor is certainly high.

those mortgages and said: “Oh boy, these are really bad pieces of

The loss of manufacturing jobs is happening all over the

paper, but we will sell them as something good, and we will get rid

world. But as I noted, the U.S. is still creating far more jobs

of all of them, and make our proﬁt.” If that were true, they would

than those we are losing in manufacturing. Two years ago,

not have held hundreds of billions of dollars of these mortgages

unemployment in the U.S. was 4%, even though we continued to

themselves. Wall Street was just as misled as everyone else.

lose manufacturing jobs.

Returning to the availability of capital, China came

You mentioned the role of the federal government. When

to mind for you. How do you foresee the economic

discussing the government bailout plan in early 2009, you

interdependence between the U.S. and China? I think

took a very Keynesian standpoint. Now, with an expected

China wants to have a trade surplus with the U.S., but that

deﬁcit enlargement of around 20%, are you apprehensive

means that they must accept dollars as a trade-off. Yes, China is

of more problems resulting from this plan? As I have said

a little bit nervous about the dollar, but they want those exports.

for a long time, I believe that the Federal Reserve was at fault

They can always take dollars and change them into something

for not alerting the investment banks and the commercial banks

else if they want. But of course, they have to accept them ﬁrst.

about the dangers in the real estate market. This was a major failure of Alan Greenspan [Chairman of the Federal Reserve

FA L L 2 0 0 9

from 1987 to 2006], in my opinion. Given that failure, I think

years ago that we are always going to bail out the depositors.

the Fed did extremely well with the measures that they took.

Long ago, the depositors were 80-90% of the funding of the bank.

What I do not think was done well at all was the Troubled Asset

Now banks also get funding from other sources. Citibank, for

Relief Program (TARP) by Hank Paulson [Secretary of the

example, had only 40% of funding from depositors.

U.S. Treasury from 2006 to 2009]. That plan never really got

My proposal is that if you are “too big to fail,” you are

implemented, however, and it still is not being implemented in

required to have more equity cushion. You must have more

the form it was originally intended to.

preferred stock and perhaps even subordinated bondholders. But

The Fed programs that have been implemented have been

all senior debt-holders, all agreements and guarantees on credit

excellent and have stemmed the crisis. We will be debating for

default swaps, we will guarantee if you hold enough equity.

years, however, whether Lehman Brothers should have been

There is a lot of controversy around what I proposed, but my

saved or not. Lehman’s bankruptcy set off a series of shocks that

feeling is that this is probably the best in terms of regulation.

badly hurt the credit and the ﬁnancial markets. They caused the severe recession that we are in. If the Fed had saved Lehman, how

Shifting to the job market, many students at Wharton faced

bad would it have become? We will never know. I believe that we

a tough time last year while searching for internships

would have had a recession anyway, though not as severe.

and jobs. What single piece of advice could you give those

If they had to do it again, they probably would have saved

students? I recognize how difﬁcult the job market is. Clearly,

Lehman. And when I say, “saved Lehman,” I mean bail out

those that just hit the market this year faced a very tough time.

the bondholders, because the stockholders would get nothing.

All I can say is that everything that I see is pointing to a much

Someone at the Treasury or at the Fed should have said, “Just a

better market in the next twelve months. Things are deﬁnitely

minute here, there are money funds that own Lehman papers,

going to improve, and they are already improving. There will be

“IT WAS NOT THAT I-BANKS CREATED THOSE MORTGAGES AND SAID: ‘OH BOY, THESE ARE REALLY BAD PIECES OF PAPER, BUT WE WILL SELL THEM AS SOMETHING GOOD, AND WE WILL GET RID OF ALL OF THEM, AND MAKE OUR PROFIT.’ ...WALL STREET WAS JUST AS MISLED AS EVERYONE ELSE..” and under the rules, they have to mark Lehman paper to zero.”

very good opportunities, and in fact, if you get a job you like, you

That means that several major money market funds may have

will be growing as the company is growing. Your opportunities

had to break the dollar. If that news were to have hit, compounded

will then expand, because a company that survives in this

with all that anxiety ﬂooding the markets, it would have been

stressful environment will be a survivor.

catastrophic. If they had thought this through, they probably would have saved Lehman. But even if they had prevented

In light of the crisis, what is the future of ﬁnance as a

Lehman’s downfall, there still would have been extreme stress

viable ﬁeld in which to specialize? Do ﬁnance majors

in the markets. The Fed still would have had to do what it did,

have anything to worry about?The crisis did not mean that

and we still would have had a recession—just not as severe.

finance was going out of business—not at all. In fact, the demand for financial services is as strong as ever. The only financial

What are some ﬁnancial regulations you would like to

service that will not be demanded is the subprime mortgage

see get implemented? I differ from many of my colleagues in

business. We are not going to have many of those. But, cross-

believing that we can have some ﬁnancial holding companies

border international ﬁnance is going to grow very dramatically.

that are “too big to fail.” Back in the 1930s, we ﬁgured out that

Financial ﬁrms experienced distress not because their core

we had banks that were too big to fail. Basically, we decided to

businesses were going down, but because they were over-

bail out the depositors. Remember: when the government says a

leveraged.. The rest of those companies remained both proﬁtable

bank is too big to fail, it means they are bailing out the depositors

and viable. In sum, the landscape is going to be rearranged, but

and some bondholders, but not the stockholders. We decided

the pieces are still there, and so is the demand. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

C. Rob Henrikson has been CEO of MetLife Insurance since 2006.

BY D I EG O A R R OYO ( ‘ 1 0) + DA N I E L H E L LW I G ( ‘ 1 1 ) + M A X M A EC K L E R ( ‘ 1 3 )

BY DA N I E L H E L LW I G ( ‘ 1 1 ) + M A X W E L L B L AC K ( ‘ 1 0)

C. ROB HENRIKSON, CEO, METLIFE INSURANCE Ever wonder what you will say about your education ten, twenty, or even thirty years down the road? C. Rob Henrikson, Wharton alumnus and CEO of the Metropolitan Life Insurance Company, reﬂects on his youth, education, and how his studies at Wharton propelled him into a successful career at the largest life insurer in the United States and Mexico.

FA L L 2 0 0 9

iBR: You have had a long journey to become the CEO of

to Wharton. More than half of the people at the program were

Metropolitan Life Insurance Company, a dominant force

from outside the U.S. It was a very meaningful experience for

in the insurance industry, and one of the most renowned

me, because by that time, MetLife had an international presence,

ﬁrms in ﬁnancial services. We’re curious how one starts

but we were not global by any stretch of the imagination. When

on a path like the one you took. Can you tell us about

I got to Wharton, I discovered that people were there from all

the time when you were a student at the University of

over the world. The primary question on the ﬁrst day of class was,

Pennsylvania? When I was a kid, if someone asked me what I

“Why did you select this program?” For people from outside the

wanted do, my answer was that I wanted to be a large animal

U.S., the answer was, “Because this school has the best ﬁnance

veterinarian. I’m from Alabama, and I had experience working

department in the world.” Those people were upset to some degree

with a veterinarian there as I was growing up, and I wanted

because when we started into the course, the “New Wharton

to take care of horses. So the primary reason I chose the

School,” as I would call it that time, said, “Well, we’re going to be

University of Pennsylvania was that, ﬁrst, it was a great school,

covering a lot of ﬁnance, and we’re going to be doing a lot of case

and second, if I decided to pursue that career, you couldn’t ﬁnd

work. But, we also want to visit the anthropology department

a better place to go. At that time, doctors were the hot item. If

and the University Museum, and you’re going to talk to people

you asked mothers and fathers, “What do you want your son to

about literature and history.” This upset some people. They would

be?” the answer was, “A physician.” I think about eighty percent

say, “I spent all this money because I want to focus on ﬁnance,”

of the freshman class of the University of Pennsylvania was pre-

however, what we all learned was that there’s more to life than

med. Even though I was probably in one of the highest quality

the numbers. We need to have an understanding about people,

pre-med classes in the United States, about half way towards

teamwork, and global points of view. For me, it was absolutely a

the end of my freshman year, it became clear that biology and

home run at that point in my career, and there’s not a day that

chemistry were not my best subjects. I was better suited to

goes by today when I don’t, in some way, leverage that experience.

English literature and history. So with some good guidance from my advisor, who basically said, “You are doing well in these

How was MetLife regarded publicly during those days?

areas. Why don’t you spend more time at what you seem to be so

MetLife was regarded as a solid, traditional insurance company,

directly suited for?” I became an English literature major.

not a global company. It was mainly known as a U.S.-based company that had a few small operations in foreign countries.

How did the Penn community view the Wharton School

It was known for its proud history of social responsibility,

in those days? I had roommates who were actually from the

strong leadership, sound investments, and innovative products.

Wharton School. At that time, those of us in the College kind

MetLife played a historic role in helping survivors of the Titanic,

of viewed Wharton students as simply people going to school to

aided farmers during the Great Depression by rehabilitating

learn how to make money.

more than 7,000 farms, and made the largest contribution of any private investor to the U.S. war effort in 1945.

After graduating, did you face any difficulties finding your first job? As I got closer to graduating in 1969, I happened

Before it went global, MetLife had to start somewhere.

to be having a conversation with my father. He was an engineer,

Why did you join, and what was the business model? At

who had attended the University of Pennsylvania, by the way.

Emory Law, about two years in, I was still not focused on a

So, my dad asked me about what I’m going to do, and I said,

particular career, so I started interviewing with all kinds of

“Well, I don’t know. I just don’t know.” (You can tell how focused I

companies as they came to the university. One of those companies

was on a career at the time.) And my dad said, “Why don’t you go

was MetLife. At the time, MetLife was looking for actuaries and

to law school?” So, being from the South and believing I would

people who could price products, within a sales driven culture.

return, I applied to law schools there. I got into all the ones I

People back then had marketing on their business cards. The

applied to, and ended up going to Emory University.

question was how to approach retail, and the solution was, “Why don’t we hire people that would be more naturally comfortable

How did you eventually end up in business school? That

going up-market?” The idea was to bring people in, give them

was much later. I was working at MetLife in sales, and my

sales experience, follow them, and commit to them. If they met

boss at the time, who was a forward thinker, decided to send

certain objectives within a ﬁve-year timeframe, they would be put

his management team to an executive training program so

into sales management and eventually run an agency. That is the

we would have a common language around business. I went

program that I entered, and that’s how I started at MetLife.

I N T E R N AT I O N A L B U S I N E S S R E V I E W

You started in sales. What were those initial years like

meet somebody at a cocktail party who may have retired ﬁve

with MetLife? I started in MetLife sales in Atlanta in 1972.

or ten years ago, and they say, “Rob, do you know that I get

Shortly thereafter, I became acquainted with a pension expert

my retirement check from MetLife every month?” With all the

at MetLife, who asked me to join that part of the company, and I

changes that have taken place in ﬁnancial services and with so

started my career on the pension side.

many companies no longer in business, MetLife is ﬁnancially

In a very short period of time, the Atlanta ofﬁce tripled its

strong and paying beneﬁts to people we sold policies to decades

production. Next, I led the Chicago ofﬁce for MetLife. I came

ago. So we create meaningful products to meet the “ifs” in life,

to New York, ran pension sales for the company, and was later

and personally, I ﬁnd that very rewarding. So, for young people

put in charge of the pensions department. In 1996 we created

today, I would certainly recommend that they consider working

Institutional Business, which I later headed, and in 2000,

in the insurance industry.

MetLife converted from a mutual to a public company. I was fortunate enough to be part of the four person team that took

There are relatively few students who elect to concentrate

this great company public. Subsequent to that, I was made COO

in Insurance & Risk Management at Wharton. Why do

and then in 2006, CEO and Chairman of the Board of MetLife.

you think that is? If you asked somebody if they are interested in insurance, they might say no. But if you ask them if they are

Why do you think you became CEO? I can honestly tell

interested in joining a company that has a sophisticated and

you that I never had the thought, years and years ago when I

complex investment portfolio with over $350 billion in assets, I

began my career, that one day I would be CEO of MetLife. But

would bet they would then say, “Oh yeah!” MetLife also is one

when that time came, I felt – and still do – privileged to have the

of the largest real estate investors in the world. If you asked the

opportunity to be the one that can help take MetLife to the next

same person, “Did you read about the largest real estate sale ever

level and write another great chapter in what has been a long and proud history. How can someone crack into the insurance business? Should one be in ﬁnance? In actuarial science? In sales? And in any case, how could an insurance salesman ultimately climb to the top? You could come in through ﬁnance, through asset management, or even through actuarial science. And, of course, you could come in through sales, which, after all, is a large part of what I still do today. I would argue that in some respect, sales experience is probably right up there,

in the United States, in Manhattan – Peter Cooper Village &

in terms of what you need to be the CEO of a major company.

Stuyvesant Town – for $5.4 billion?” What if you also told them that MetLife provides insurance and employee beneﬁts to over

But the big question remains: How could somebody from sales end

90 of the Fortune 100 companies? That person and others at

up being CEO of a Fortune 50 ﬁnancial services company? My

Wharton would say: “I’d die to have that experience.” Well, one

response to that is that I, as a non-ﬁnancial person, had different

of the places where you can go to have that experience is MetLife.

abilities and experiences. I have worked with very talented people to make presentations to the most sophisticated ﬁnancial buyers

You are also chairman of an insurance education entity

in the world. We describe our businesses, products and services

at Wharton, called the Huebner Society…Yes, the Huebner

in a way that virtually anybody can understand it. It is a matter

Society is focused on providing aid and scholarship money to

of understanding your business, your customers, and selling your

very bright people who want to commit to teaching insurance.

company and the products and services it delivers.

It is very academically oriented. The Society helps these young people become teachers, so that other young bright people can

What makes the insurance business exciting and

learn about the world of insurance. I have always had a keen

attractive for young people today? This business is so

interest in academia throughout my career at MetLife, and I am

exciting because it’s not all about the numbers, but about

very proud to chair this important entity at Wharton.

what you can do for your customers. I get excited when I

FA L L 2 0 0 9

MetLife went public in the year 2000. What changed for

methodology, the Federal Reserve determined that MetLife

the company from a management point of view? I would say

has adequate capital to sustain a further deterioration in the

that the best thing that happened to our policyholders was the

economy. We are very pleased with this result, which we believe

day we went public. We make better decisions today as a public

reinforces what we have been saying – that MetLife is ﬁnancially

company: better business decisions, and better decisions about

strong and well positioned for both the current environment and

underlying system expenditures than we ever did as a mutual

a potential future economic downturn.

company. I think we add more value today to our policyholders because of the way we manage the company as a public company.

MetLife’s free standing derivatives created proﬁts in 2008. What are the risks MetLife hedges against? MetLife has a

Where would you like to position MetLife in the current

system in place and a dedicated team of people overseeing the

economic environment? MetLife is a company with a strong

company’s hedging program on a real-time basis. For example,

capital position, ample liquidity, and leading market positions

our asset/derivative values are updated continuously from real-

in our core group and individual insurance businesses, where

time feeds of market information. Feeds from our administrative

our revenues continue to be healthy. The company remains well

systems are fed to our hedging system daily, so our liabilities

positioned to continue meeting the needs of clients and has the

are valued daily. MetLife has invested heavily in the technology

capacity and ﬁnancial strength to further solidify its leading

platform supporting the hedging program for variable annuities

position in the industry. We continue to look for opportunities to

and its optional living beneﬁts and withdrawal beneﬁts.

grow organically and through acquisition, both internationally

Our risk management program, which includes hedging,

and here in the U.S. MetLife continues to have ﬁnancial strength

begins with product design. There are a number of levers we can

ratings that are among the highest in the insurance industry.

use to control risk – asset allocation, fund selection, and waiting

“THERE’S MORE TO LIFE THAN THE NUMBERS. WE NEED TO HAVE AN UNDERSTANDING ABOUT PEOPLE, TEAMWORK, AND GLOBAL POINTS OF VIEW.” mortgage-backed

periods. In fact, depending on the product design, MetLife may

securities? We’ve never been in the business of gathering

have a combination of direct hedging, reinsurance, and capital

assets, packaging them and then transferring them to others

markets reinsurance. At MetLife, we are pleased with the

and being paid for those transactions. It’s simply not the business

performance of our hedging program.

Was

MetLife

the

business

we’re in. As a life insurance company, our business is designing and selling products that may not be paid out for many decades

MetLife seems to be in good shape and was not severely

in the future, and making sure we have underlying assets to

affected by the economic crisis. What differentiates

match those long term liabilities.

MetLife? We like to say that what differentiates MetLife is that we are big, strong, and trusted. It sounds simple, but we

MetLife, as a ﬁnancial institution, also had to undergo

are very proud that MetLife continues to be recognized as a

the ﬁnancial stress test…The capital assessment exercise,

strong, stable leader in the ﬁnancial services industry during

commonly known as the stress test, reviewed federally chartered

a challenging environment. MetLife is well capitalized, with

bank institutions with more than $100 billion in total assets.

a strong balance sheet and ﬁnancial strength ratings that are

Owing to the fact that MetLife has been a federally chartered

among the highest in the industry. The long-term approach we

bank holding company since launching MetLife Bank, N.A.

take in managing our investment portfolio, combined with our

in 2001 and has more than $100 billion in total assets, it was

diverse mix of businesses, has served us well and will continue

included in the exercise. Based on its economic scenarios and

to do so in the years ahead. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

Gerard Kleisterlee was named 2006 Europe Businessman of the Year by Fortune Magazine.

FA L L 2 0 0 9

BY D I EG O A R R OYO ( ‘ 1 0) + DA N I E L H E L LW I G ( ‘ 1 1 ) + M A X M A EC K L E R ( ‘ 1 3 )

GERARD KLEISTERLEE, CEO, PHILIPS ELECTRONICS

Royal Philips Electronics is the world’s leading lighting company. For Q2 of 2009, Philips posted quarterly profits, disproving analysts’ widespread predictions of a quarterly loss. iBR’s editorial staff had the rare opportunity to meet with CEO Gerard Kleisterlee in Amsterdam and learn about Philips’ current financial position and expectations for East Asia’s burgeoning consumer markets, as well as the importance of maintaining a strong balance sheet in times of a financial downturn. iBR: Philips started out with light bulbs 120 years ago, has

Every company needs something of its true inner-self that acts

introduced numerous innovations over the last century,

like a compass and guides what people do. If you look at the

and is now still a leading company in the world: How was

history of Philips, you will ﬁnd that almost from the start of the

that possible? The key issue is, of course, continuing to renew

company, there was an ambition to help improve people’s lives.

yourself. It does not matter so much how old your company is;

There are a number of core values that you have as a company

what matters is, how new your company is. Staying in a position,

and that you need to retain, and having that, as a basic element

as we and several others have, is only possible if you are able

to guide you, you can do all kinds of different things while still

to renew yourself over those centuries and decades, and adapt

being true to your core inner self. That is what we have done over

yourself to new technologies, new markets, and new ways of

the past 10 years: Despite massive changes to the portfolio of the

doing business.

company, we stay true to our mission: We improve the quality of people’s lives and thereby remain Philips.

I N T E R N AT I O N A L B U S I N E S S R E V I E W

How is it possible to combine this approach with

product, you could also sell it, because the technologies were not

pressures to take advantage of cheaper labor and

there to provide all the products that people might have wanted.

outsourcing? Staying competitive is not just a matter of

Today, however, there is the technology to make almost anything

outsourcing and looking for cheaper labor; those are just

we can think of. So, our source of competitive advantage moved

elements of it. Staying competitive is very much about knowing

to branding and marketing. However, you need the combination

your competitive advantages, and sometimes that competitive

of innovation, marketing and branding.

advantage is in manufacturing. If I take our lighting position for example; here, our competitive advantage to a large extent lies

What is the danger of outsourcing your competitive

in manufacturing. We were the only company that could supply

advantage? Is it the cheap labor that is lacking in quality?

Mercury-free Xenon automotive headlights that were required

No. Your competitive advantage is, one could say, embedded in

by Toyota, and we could do that because we could not only design

the manufacturing process. If you outsource your competitive

the product, but also design the manufacturing process and the

advantage, you have to teach someone the manufacturing

assembly system that gave us the capability to do so. Some of

process, which subsequently then becomes available for others.

our manufacturing processes in Europe are highly sophisticated processes that require strong engineering capability - not only in

So it is protection of the intellectual property … Yes, and

order to design them, but also to run them. If you look at health

also of things that are not always protected via intellectual

care, there we supply complex systems. Here again we can only

property. Because a manufacturing process contains not

work with well educated and highly skilled labor, close to the end

always high key, it’s more know-how, and if I transfer the

markets. There are, of course, some areas where manufacturing

know-how, I lose it. I can license high key, but the know-how

has become an almost standardized process, particularly in

I can only transfer.

some parts of hardcore electronics, where the industry has changed with the rise of manufacturing service companies in the last two decades. The idea would be to ﬁnd the correct balance between the elements that put you at an advantage … and knowing where your competitive advantage lies! If I take a TV, for example: Assembling a TV is - in itself - a simple process, so there your competitive advantage is, if any, in the design. That’s where you can derive some differentiation, supported by our marketing, our product positioning and our branding. If I take some of our appliances, like our shaver head, it is elements like

You have been working in Asia for quite some time. How do

shape and functionality that make the difference. Here, our

you see Phillips’ future in China? We have a strong position.

source of competitive advantage is in how we make the shaver

In 2008, a little bit over 20 percent of our revenue came from

head and therefore, we do not outsource the manufacturing of

new markets. In four or ﬁve years, that will be 50 percent of our

the shaver head, because we would be outsourcing the source

revenue, for the simple reason that this shift towards China and

of competitive advantage. In general: We buy some elements,

India will be accelerated by this crisis, because the developed

but we keep the key elements. You always have to look precisely

markets will slow down much more than the emerging markets.

at how we compete in a particular ﬁeld; what is our source of

And Philips is not only well established, but the strength of our

competitive advantage? That must be retained and improved.

brand, the leadership positions of our products are some of the

This results in a differ went equation for each product.

best in those markets.

In which areas do you see Philips having a clear competitive

How did you experience the onset of the economic crisis,

advantage today? Let me answer that in a different way. We

and how has it affected Philips? Already, at the end of

always have a young, state-of-the art advanced product range,

2007, we started to notice in the US the ﬁrst hesitations in

but increasingly, branding and marketing have become sources

the consumer markets because then, of course, the subprime

of competitive advantage. Thirty years ago, when you made a

mortgage started to become noticeable in a little way and then

FA L L 2 0 0 9

gradually it deteriorated. Subsequently, you saw that residential

I’ve seen a lot of people who have built a company, have retired

housing slowed down in the US, commercial construction slowed

from the company, and have handed it over to their family. It

down, and of course now, health care is slowing down. From

is not strange to have a career in a company if that company

the US, with the export of the ﬁnancial products that are later

gives you the opportunity to develop yourself, do many different

due, the subprime mortgage crisis has evolved across the world.

things, and learn something new everyday. And vice versa, you

And as a result of that, our revenue is down 19 percent in the

are allowed to make a contribution to that company, to keep it

ﬁrst quarter of this year and 18 percent in the second quarter,

healthy and alive. That is what it means to have dedication.

predominantly in consumer lifestyle, then in lighting, and to a much lesser extent in our health care business. We are quite

One last question about the future of Philips: Where do

affected by the crisis. Markets are stabilizing here and there,

you see Philips in a decade? A decade in these days is what

but we do not see too many signs of a quick recovery.

an age was previously. Ten years ago, there was a very different Philips from the one we have today.

I think in the coming

How is it possible that you could announce a proﬁt for

years, Philips is comfortable with its portfolio. Our businesses

this quarter? We derive half of our revenue from leadership

are aligned with some major global trends. We build our health

positions, and we operate to a large extent in businesses that

care sector, because we live in a world with a growing and aging

have healthy margins. If you lose so much revenue your margins

population that will require more health care at affordable costs.

contract, of course, but they don’t go down to zero or negative. We

That is an area of opportunity for years and years to come. Our

still have quite a healthy proﬁtability in our healthcare business

oldest business in lighting almost goes through a revolution in

and a large part of our lighting business, as well as in our

a world that needs to be more energy efﬁcient. Here we work on

consumer lifestyle business. At the same time, some of the proﬁt

light with lower energy consumption. We have a world where the

“THIS SHIFT TOWARDS CHINA AND INDIA WILL BE ACCELERATED BY THIS CRISIS, BECAUSE THE DEVELOPED MARKETS WILL SLOW DOWN MUCH MORE THAN THE EMERGING MARKETS.” is offset by the charges we have to take for the restructuring

consumer is more empowered and has the desire to deﬁne his

attempt and through that the associative cost.

own life style, and so having a portfolio of consumer life style products that caters towards these consumer desires also gives

How does Philips’ ﬁnancial position today compare with

us ample opportunity. So from a portfolio perspective, we are

those of other companies? More companies have strong

very much aligned with what goes on in the world, and that

balance sheets. There are quite a few companies that went

doesn’t require a lot of changes in itself. The changes we will see

into the crisis with heavily leveraged balance sheets, and as a

are those that we discussed earlier. We will gradually shift from

result, they had to reﬁnance. This provides Philips with some

a transatlantic center of gravity, to an Asian center of gravity.

opportunities as we go forward, because people with strong

And that will change the offering to some extent, because the

balance sheets and good results will be able to teach some of the

Asian consumers, who do share a “worldly” taste of things, also

people with not so good balance sheets and good results!

have a particular Asian taste. Therefore, in Asia, we do many things differently from the consumer perspective than in the US

You have dedicated your entire career to Philips. Is such

or Europe. Those are the kind of changes that I see coming for

a career still possible today? It is possible. You will see people

Philips over the next years. iBR

like me who have a career in one company and make their way and stay there. I compare it with private entrepreneurship.

I N T E R N AT I O N A L B U S I N E S S R E V I E W

HISTORY OF OUR

CRISES 1929 - LESSONS FROM OUR GRANDPARENTS

FA ALL 2009

BY J U L I A H A N S E N ( ‘ 1 0) + D I E G O A R R OYO ( ‘ 1 0)

The world economy is going through one of the gravest crises in its history, and yet, neither a war, nor a natural catastrophe, is at its origin. The danger of a worldwide ﬁnancial collapse has never before been so clear, and only the mobilization of trillions by governments worldwide has prevented worldwide bankruptcy. The workings and causes of this crisis

industrialization to one of consumption—a

peaked in 1926. Automobile production

have become well known: easy money that

state that has since remained. Coupled

plants had reached overcapacity; virtually

was too readily available in a nation with

with technology, this allowed business

everyone who could afford a car already had

excessive internal demand, thus nurturing

to grow in ways that it could not before

one. Among the most serious systematic

the creation of real-estate and stock-market

World War I. The market for electricity,

defects of the 1920s, in particular, was

bubbles. An ever-increasing demand for

automobiles, and household goods such

the national banking system. There were

high returns, coupled with sophisticated

and

too many small banks in small towns with

and esoteric ﬁnancial instruments and

washing machines boomed in the 1920s.

inadequate capital that had poor state

techniques allowed the dissemination of

In that decade, industrial production

supervision and managerial skills and lax

risk throughout the planet.

refrigerators,

electric

irons,

increased by 90% and wages by 17%. The

selection of borrowers. When commercial

As these bubbles burst, conﬁdence

U.S. Federal Government was largely

loans gave way to loans collateralized by

evaporated, and worldwide panic ensued.

negligent of private sector-led growth, and

investment securities of suspect value,

In the United States, unemployment

sprouting companies remained virtually

these banks succumbed to the gradual loss

mounted as industrial production took

unregulated as they merged with one

of liquidity—a noticeable parallel to the

its greatest hit since World War II and

another, consolidating huge amounts of

ﬁscal quagmire of today.

credit, the crutch of many Americans,

capital. Low unemployment, standardized

Despite the foreboding undercurrent

disappeared. Higher levels of asset value

eight-hour workdays, increased leisure and

of imminent ﬁnancial collapse, the frenzy

destruction and indebtedness have not

consumption, widespread conﬁdence in the

been seen in modern economic times. In

market—these ingredients all encouraged

banks

fact, this crisis has been compared to

the archetypal lifestyles that gave such

captivated by the interest rates in the

another great crisis that happened not so

character to the “Roaring Twenties.”

call money market. In early 1928, rates

speculation and

escalated.

wealthy

Commercial

individuals

were

was

hovered around 5%, and by mid-1929, they

good lessons. The Crisis of 1929 and the

not so rosy. Beguiled by soaring stock

had swelled to 12%. Additionally, the Fed,

ensuing Great Depression, was a result of

prices,

ofﬁcials,

in an attempt to help Britain preserve the

many of the same factors that explain why

businessmen, and citizens could not sense

gold standard, lowered the discount rate

today we ﬁnd ourselves amid a worldwide

the weaknesses of the American economy.

from 4% to 3.5%, while simultaneously

ﬁnancial breakdown.

During

ﬁnally

retracting a large volume of government-

The intent of this article is to provide a

regained pre-war agricultural harvests,

issued bonds. This pronounced injection

brief overview of the Crash of 1929 and its

signiﬁcantly scaling back grain and cotton

of currency only served to exacerbate

consequences, to offer readers a historical—

imports from the States. In response,

the banks’ underlying liquidity problem;

and not hysterical— background to the

U.S. Congress subsidized the domestic

they had been incentivized to augment

current crisis, and to show how lessons

agriculture industry in order to keep

speculative lending.

gleaned from past events can supplement

proﬁts high and the appropriate political

the recovery of today’s ﬁnancial system.

constituents content. This transgression

phrased,

led to overproduction and accelerated the

market forced banks to sell securities

decline of agricultural prices.

at unrealistically low prices, and there

long ago, although long enough to forget

In the ﬁrst few decades of the 20th century, American society experienced

The

real

picture,

many

the

however,

government

twenties,

Europe

The 1929 Crash, or, more accurately Correction

the

stock

a change that would open it up to new

Other American industries likewise

were no efforts from the U.S. Fed to

dangers. It transformed from a society of

reached a plateau. Private construction

prevent otherwise sound banks from

I N T E R N AT I O N A L B U S I N E S S R E V I E W

failing. President Hoover’s government

based on colonial acquisitions, and the

AIG the US avoided the fast slide into the

expected

United States was the big loser.

situation where one bankruptcy leads to

the

speculative

bubble

burst eventually, yet it did not foresee

The New Deal did not solve the

ten others. And while they may not have

the momentous impact of the bubble’s

depression, but with massive injections

completely restored consumer conﬁdence,

effects. The standing policy was to let the

of liquidity into the economy, it started

these measures did prevent a massive

recession run its course and ultimately

the process of recovery. In order to avoid

escalation of fear and mistrust.

to purge the rottenness from the system.

subsequent over-speculation, regulators

On the other hand, the current

After a year, however, the economy had

rewrote the banking system and prohibited

administration is courting some of the

not corrected, and the conﬁdence that

any mergers between commercial banks

same misled ideas as Hoover, particularly

had built up the speculative bubble began

and investment banks. They erected fair

trade barriers. Early in September, tariffs

rapidly to dissipate. In fact, the crash

competition codes for industries, which

on certain products imported from China

was not so much the cause but a symptom

helped end destructive competition. Tariffs

were set at 35% and it is old news that

of the subsequent depression. A reduction

on international trade were reduced by 44%

the United States has been consistently

in consumer spending initiated a cycle of

on average. The New Deal, however, was

violating the provisions of NAFTA by not

destructive competition that accelerated

not responsible for the economic upturn

allowing Mexican trucks on American

bankruptcies

unemployment.

toward the end of the 1930s; World War II

roads.

Between 1929 and 1933, GDP fell a

was. It was preparing for the war caused

administration is reversing the US policies

third, the Consumer Price Index fell

ﬁrms produce at full capacity and to operate

that have in lesser or greater degree forged

a third, industrial production halved,

at full employment, meaning workers could

the way for global trade integration over

farm prices decreased by 60%, and

resume pre-crash consumption.

the past 80 years. While Obama surely

and

appears

that

the

current

private investment by 90%. The market

does not want to start a trade war with good

value of listed securities fell by 83%.

friends such as China and Mexico, Hoover

Unemployment reached 25%, and 9,000

did not foresee the predicament caused by

banks were bankrupt.

the Hawley Smoot tariffs of 1930, either. to

These measures suspiciously resemble

cushion the deﬂationary impact of the

degeneration into protectionism, which has

crash through public-private cooperation.

historically meant bad news for economies

He urged businesses not to lay off workers

on both sides of trade agreements.

Hoover

tried

unsuccessfully

and to continue normal production. Yet,

Independent of the government’s

his policies were largely obsolete; a rapidly

efforts to resolve the recession, some of the

industrializing United States of the late

problems lie at the heart of the American

1800s would have beneﬁtted more than the

mentality. In the years preceding the

1920s consumer culture. Hoover reduced

current

recession,

Americans

were

spending 15% of their disposable incomes

taxation on businesses and gave abundant credit to banks. He instituted minimal

Can the lessons learned from the last

on supporting debt, an excessiveness

tax-funded welfare programs and social

severe economic downturn serve to salvage

only matched in the months before the

services, and raised protective tariffs.

the present economy from another great

Great Depression.

He did little, however, to boost internal

depression?

Or, more importantly, are

will one hear expressions such as “shop

demand, the driving force in a consumer

leaders consciously avoiding the same

till you drop” or ﬁnd shopping malls as

culture. The tariffs, in particular, had

errors as were committed in the early

monolithic as in the United States. It

disastrous effects: between 1929 and 1932,

thirties?

A simple analysis reveals

remains problematic that the present

world trade declined by 60%, while the

conﬂicting results. On one hand, the US

policy is to get out of a crisis brought on

United States’ share of international trade

government was very quick in its response

by extreme borrowing and spending by

volume dwindled by three quarters. While

of injecting liquidity into the economy, a

borrowing and spending even more. If the

high import tariffs may have seemed a

severe shortcoming of Hoover’s policies, and

United States is to continue to lead the

good way to export deﬂation, the States’

in lowering the interest rate to encourage

global economy, it will have to show the

trading partners had the same idea, and

the velocity of money. The bailout of banks

world that it is responsible and moderate

the worldwide result was a breakdown of

has been of gargantuan proportions, and

not only in the ﬁnancial sector, but as an

international trade into regional blocks

by saving ﬁrms like Bear Stearns and

entire society. iBR

FA L L 2 0 0 9

In no other culture

NIMBLE IS THE NAME OF THE GAME BY P E T E R H E Y E R ( ‘ 1 1 )

young

costs associated with pursuing dead-

and decisively. Therefore, the scientists

vaccine research company that is changing

end hypotheses. This discovery process

are constantly trying to strike a balance

the way drug development is executed.

on average can take up to 10 years, and

between hedging risk and committing to a

Founded just three years ago around

Genocea is able to accelerate this to

potential triumph.

academic

months.

Genocea

Biosciences

research

Harvard

and

Berkeley, Genocea is well on its way to

Genocea

accomplishes

these

Clearly, the regulatory hurdles for any medical company are daunting to say

goals in two ways.

bringing revolutionary vaccines to market.

First and foremost is the creative

the least. Once again though, Genocea

Genocea was able to raise $23 million

method Genocea uses to pick promising

has anticipated future challenges in order

in venture funding in 2009, despite the

antigens. The team ﬁrst ﬁnds a diverse

to remain ahead of the game. As some of

ﬁnancial environment attracting top class

population of human carriers of a given

Genocea’s vaccines successfully complete

international investors, rare for accompany

disease. As a result of some natural

pre-clinical trials, management knows

at this stage of development, such as SR

phenomenon,

not

that the company will soon be performing

One, Polaris Ventures, Lux Capital, Auriga

actually afﬂicted with the disease. The

clinical tests in humans. In expectation

partners, and Cycad Group.

theory is that these people all have some

of this process, Genocea has added a

common, naturally occurring protein,

new team member, Jane Halpern, VP of

In addition, Genocea has brought

these

carriers

are

which protects them from the ailment.

Regulatory Affairs. “Some people may

categories to proof of concept (protection in

Genocea

proteins

think we’re crazy for starting this process

pre-clinical trials in the short period since

these people have in common. Through

18 months ahead of time and over-hiring

its incorporation. This summer I was lucky

this strategy, Genocea can narrow down

too early, but we need to be smarter than

enough to speak to Staph Leavenworth

millions of proteins to a small handful of

everyone else. We are making sure now,

Bakali, Genocea’s CEO. Mr. Leavenworth

likely candidates for vaccines.

that we have someone with a proven

vaccines

three

different

disease

investigates

which

Bakali gave me the inside scoop on what

The second, more straightforward

track record, who knows the regulatory

is driving Genocea’s success: the team’s

strategy for catching duds is to set very

environment, and can make sure now that

commitment to deﬁned goals and its

high standards early in the research cycle.

down the road, the FDA will approve the

ﬂexibility in pursuing these goals.

Vaccines must show huge potential early

actions we take and the processes we have.”

“WE NEED TO BE SMARTER THAN EVERYONE ELSE.” Clearly,

Genocea’s

management

The majority of vaccine research to

on. Otherwise, Genocea will not continue

date has been by and large trial and error.

spending time and money developing them.

knows that its major advantages are

Choose an antigen or a protein out of the

One key issue that I discussed

its size and ﬂexibility. Mr. Leavenworth

millions in existence, produce it in-vitro

with Mr. Leavenworth Bakali is risk

Bakali has demonstrated that Genocea

and test its ability to ﬁght or prevent a

management in determining which drugs

plans to use these characteristics at

given disease. The key to success in the

to pursue. Like any company, Genocea tries

every opportunity. So far, they have

drug industry is to direct this trial and

to diversify risk. In vaccine research, this

not missed a technical or ﬁnancial

error at the most promising antigens

means exploring drugs in various disease

milestone, thanks to the efforts of the

and to weed out failures early. This

groups afﬂicting a variety of markets.

science team led by Jessica Flechtner,

enables research companies to increase

On the other hand, a lack of focus will

Senior Director R&D, and Genocea’s

the probability of quickly discovering a

prevent Genocea from capitalizing on its

stakeholders remain optimistic about

winner. It also dramatically reduces the

key advantage, the ability to move swiftly

the future of the company. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY E R I K BU I S C H I ( ‘11)

BRAZIL AND THE CRISIS:

LAST IN, FIRST OUT? he past two years have been a rough one

This surprising sturdiness proves to be the result

for American investors. In the wake of

of an eight-year long systemic improvement of

the severe liquidity crisis foreboded by

the Brazilian economy. Merely ﬁve years ago

in no deleverage and no

the mortgage-related collapse of Bear Stearns

Brazil was bloated with over US$300 billion in

sudden change in individuals’

in March 2008, the Dow Jones has, after rising

foreign debt, or over 55% of its GDP at the time,

wealth, as experienced by

to an all-time closing high of 14,164 points

according to its central bank . The country also

Americans who relied on their

in October 9th 2007, shed 5,585.34 points,

had a below-investment grade credit rating,

inﬂated home-equities.

or 39%, in 2008. On September 29th 2008,

while real interest rates were around 17%.

the Dow suffered its largest loss in history,

Sixteen years ago, before the Plano Real, Brazil

declining 6.98% at a total of 777.68 points. As

suffered from hyperinﬂation, with prices rising

this article went to print, the Dow was still at

5000% between March 1989 and that same

8,500 points and volatility ruled the market:

month in 1990.

Brazilian households did not engage in the credit-spree that fueled house prices, resulting

hope-seeking investors fueled rallies simply to

FA L L 2 0 0 9

halt themselves later as their aspirations were

Today, however, Brazil is at a much better

shattered by news of the ongoing deterioration

economic position to endure the global crisis,

of the broad economy. As expected, the

and might even outperform America in the

distress pervading the American economy

coming recovery.

resulted in a shockwave that sent the global

is foretold by Brazil’s move to lend the IMF a

economy into a downward spiral as investors

total of US$10 billion, or 5% of its international

sought refuge in dollar-denominated Treasury

reserves, in June of 2009. Further ﬁscal

securitiesand global demand for goods and

strength was demonstrated after Brazil was

services contracted. However, Brazil proved

granted an investment-grade rating on May

to be peculiarly resilient to this crisis, despite

2008 from Fitch and Standard & Poor’s,

what many deem to be a more rudimentary,

two major rating ﬁrms. As measured by the

“third-world” economic structure.

consumer price index IPCA, inﬂation has

This potential outshining

been kept under control with 2006 pre-crisis

market in the year 2009. In the case of Brazil,

inﬂation at around 3%-- well below the Central

the benchmark index might in fact grossly

Banks’ target of 4.5%. What’s more, as of July

misrepresent the economy’s true strength.

2009, the central bank rate is at a historically

This is due to the IBOVESPA being 85%

low 8.75%. The labor market, however, shed

comprised of commodity ﬁrms, such as giants

jobs as the unemployment rate crept back

Vale do Rio Doce (VALE) and Petrobras (PBR),

to 9% in 2009 (which is up from 8% in 2008,

while commodities represent only 30% of the

according to the Brazilian Census Bureau).

Brazilian economy. Thus, investors should not see Brazil as a commodity play; in fact, they can

According to Ermínio Lucci, Head of Equity

proﬁt from opportunities in private placements

Sales at Fator Securities brokerage ﬁrm,

as more ﬁrms join the exchange.

Brazil’s fortune also stems from the fact that households did not get caught in the perfect

The ﬁfth largest country on earth, Brazil has

storm of job-loss, home-equity loss and credit

a larger middle class and a higher internal

seizure that devastated American markets.

demand per capita than both China and India.

As Mr. Lucci explains, Brazil is a country

Additionally,

where borrowing is not part of the culture;

property rights than Russia and greater political

Brazil

boasts

better-enforced

Brazil is a country where borrowing is not part of the culture; bank spreads have always been too high and, when possible, consumers pay as much as they can up-front. bank spreads have always been too high and,

stability than any other BRIC. Though Brazil

when possible, consumers pay as much as

may not be a consummate example of political

they can upfront. Thus, Brazilian households

repute, its governance is quite commendable

did not engage in the credit-spree that fueled

when compared to China’s authoritarianism,

house prices, resulting in no deleverage and

Russia’s puppet politicos, and India’s incessant

no sudden change in individuals’ wealth, as

pressure from the neighboring Pakistan.

experienced by Americans who relied on their

of these reasons place Brazil in a formidable

inﬂated home-equities. Brazil’s current credit-

position to consolidate its position in the global

to-GDP ratio is 32% while Latin American

economic landscape.

All

countries average between 40%-52%, proving the country’s low dependence on credit.

Despite this good news, Brazil is far from ideal: there is still a long way to go before Brazil

In comparison to other BRIC countries, Mr.

becomes a fully “developed” country. As we

Lucci also predicts that Brazil is likely to shine.

have seen, the economic reforms of the past

Unfortunately, Brazil’s main equity index has

might pave the way for a richer country, but

declined 27% from its all-time high of 73,000

there are still many educational and social

points in May 2008 to 53,000 points as of July

reforms that must happen before the country

2007. Nevertheless, the “IBOVESPA” is only

ﬁnally establishes itself as an international

bested by China as the best-performing equity

emblem of economic solidity. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY M A N TA S N E M A N I S ( ’ 13 )

LITHUANIA:

ROAD TO THE EURO T

The Euro:

his year, Lithuania is celebrating its

Enter the Maastricht criteria. All members of

1000th statehood anniversary. This

the EU are legally bound to adopt the Euro

is also a great time to re-evaluate

sooner or later, but, in order to do so; they

Lithuania‘s evolution from a country inhabited

must pass certain economic requirements,

by homo sovieticus, to a full-ﬂedged member

labeled the convergence criteria. Here is how

of the European Union. While Lithuania‘s

Lithuania fared throughout 2005 – 2007:

politicians are congratulating themselves on

Exchange rate stability? Check. Durability

steering the country in the right direction, they

of convergence? Check. Sustainable public

should not forget one of the most prominent

ﬁnances?

ﬂops in recent history: the failure to adopt the

Check. Price stability (inﬂation)?Houston, we

Euro. Let us take a heavyhearted drip down

have a problem. The Lithuanian consumer

the memory lane and see what went

price inﬂation rate of 2.66% exceeded the

wrong, what could have been averted

maximum allowed rate of 2.60%.Lithuania’s

and what can still be done.

inﬂation had been stable for the past 6 years,

Sound

public

ﬁnances?

and was expected to go down the following

Will it remain out of reach for Lithunia?

Check.

The early 2000s will probably go down in history as Lithuania‘s golden age. The

week, and the 0.06% might have been a statistical error, but rules are rules.

foundation of the economy was strong,

FA L L 2 0 0 9

the GDP and Human Development Index

The eventual negative ruling regarding Euro

were rapidly rising, while the unemployment

adoption came both as a shock and as an

rate – abating. In 2004, the country became

outrage.

a member of both NATO and the European

actions are still bafﬂing to some, and laughable

Union. The adoption of the Euro would have

to others, Lithuania must take a signiﬁcant

increased Lithuania‘s integrity among investor

portion of the blame. Throughout the course

and creditors, and resulted in cheaper loans,

of 2006, the European Commission issued

thus encouraging business development and

several warnings to the country’s Minister of

creating more jobs, not to mention the fact

Finance, Zigmantas BalÐytis, about inﬂation,

that Lithuania would have been the only Baltic

but it fell on deaf ears. Mr. NausÐda says that

country using Euro and having better access

the government had all the necessary tools to

to the international ﬁnancial markets; this

reduce the inﬂation index by at least 0.1 – 0.2%.

circumstance would have solidiﬁed Lithuania‘s

He also speculated that the EU might suffer

position as a region leader.

moral losses as a result of this development.

While

European

Central

Bank’s

Most of the Eurozone’s members’ inﬂation and

manages to optimize the budget.

ﬁnancial indexes were considerably worse than

Recently, there have also been talks

Lithuania’s, setting the unwelcome precedent

of a one-sided adoption of the

of double standards. It also shed light on the

Euro, a speciﬁc monetary regime

stagnating EU bureaucratic machine, which

when a country institutes a foreign

still heeds the requirements from 1991, when

currency as the only legitimate

the Euro was a vision and not a reality, ignoring

means of settlement and gives

recent signiﬁcant economic permutations.

up sovereign monetary politics. Over ten countries have done this

Fast-forward to 2008. Lithuania‘s economy

already. There are also 3 European

is still strong, euro-skepticism is fading, but

countries that have single-handedly

the Euro is nowhere to be seen. Suddenly,

adopted the Euro: Montenegro, Kosovo

Lehman Brothers collapsed, and Bear Stearns

and Andora. Lower interest rates, regulated

and Merrill Lynch were taken over. In a

by the ECB, would normalize crediting and

ﬂash, recession ensues. The analysts of the

boost economic recovery for Lithuania. Using

Skandinaviska Enskilda Banken (SEB) suggest

a well-known international currency would

that the economic downturn in Lithuania started in Q4 of 2008. The quarterly GDP experienced a decrease of 2.0% (it would have been around 5% if not for the exceptional statistics of Lithuania‘s petroleum reﬁning company

„MažeikiÐnafta“).The

housing

If Lithuania and the Euro were in a Facebook relationship, it would still be “complicated”.

market shrunk by 10.3%, agriculture – 5.2%, and trade, transport, communications by 2.4%. Unfortunately, that is just the tip of the

increase Lithuania‘s export competitiveness

iceberg. In early 2009, Standard & Poor’s

and rumors about devaluating the national

downgraded the government’s credit rating

currency would cease. In the long term,

from A- to BBB. This took the possibility of a

GDP expansion would increase and inﬂation

stimulus package off the table, simply because

would decrease. However, such one-sided

it would cause the country to go bankrupt.

Euro adoption would severely damage the country‘s relations with the EU. Back in 2000,

Unpopular and immediate decisions had to

the European Commission stated that such

be made to cope with rising unemployment,

process would undermine the principles of

decreasing

the EU Treaty. Acting against the EC would

wages,

plummeting

household Andrius

severely affect ﬁnancial aid eligibility, which

Kubilius declared that in order for Lithuania‘s

is crucial for the development of countries

recovery plan to be effective, a goal must be set

like Lithuania and would probably cause more

to regulate the ﬁnancial chaos: the government

harm than good.

expenditure,

etc.

Prime

Minister

reintroduced the plans to adopt the Euro in 2011-2012. However, for that to happen, the

If Lithuania and the Euro were in a Facebook

country still needs to cope with inﬂation and

relationship, it would still be „complicated“.

budget deﬁcit. As of May 2009, the inﬂation

Hopefully, both parties will learn to respect

rate stood at 9.3%, whereas 3% is the limit,

each other, seek some form of reasonable

and the budget deﬁcit reached 2.9% of GDP,

middle-ground, and, hopefully sooner than

with a maximum of 3% allowed. Ironically, the

later, the Euro will take the baton from the

global economic crisis has become the driving

current Lithuanian currency, the Litas. iBR

force that could enable an early Euro adoption, as long as inﬂation is low and the government

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY JA N I S K R E I L I S ( ‘11)

HASTY CLIMBERS HAVE SUDDEN FALLS

astern

European

experienced

the

countries feeling

have

Despite constant warnings, it took around

the

two years for Aigars KalvÐtis’ government to

when

economy is not ticking, exactly the case

create a plan to ﬁght inﬂation, which included

during the communist rule. Centrally planned,

provisions of regulating the credit boom and

inefﬁcient, and technologically backward, the

creating a budget surplus by 2008. However,

Eastern European countries simply could not

some called the plan “toothless”, and the

provide the same quality of life for their citizens

government did not actually follow through

as those on the other side of the curtain could.

with the cuts. Enter the current crisis, and

However, those were the old days. Around

suddenly everything goes bust. The foreign

1990, central planning had exposed its failures,

banks in Latvia cut their lending, and much of

the communist system had collapsed, and

the speculative activities in the housing market

the newly reborn countries were rushing to

quickly came to an end, raising unemployment

embrace capitalism. Some—like the Czech

ﬁgures. With Latvia’s external debt reaching

Republic,

140% of the GDP, it became increasingly

more industrial approach to growth, whereas

harder for the Latvian government to sustain

others, like Poland, put a heavier emphasis on

the huge deﬁcit. First, the Lat, like a sinking

agriculture. In 2004, they all reached the point

ship, would most likely take the Latvian

of joining the European Union (EU). Three

economy with it, causing a sudden surge in

years later, Bulgaria and Romania followed suit.

defaults. The reason is simple: around 90%

Hungary

Slovakia—chose

of the loans taken out by Latvian businesses THOU HAST BEEN WARNED

and households are denominated in Euro,

Because of the policies run by the different

and their payload would rise hand in hand

governments of Eastern Europe, their fates in

with the exchange rate. Second, there is a

the current crisis have diverged, too. Latvia, once

high risk of contagion within the Baltic region.

showing one of the highest growth rates in the

Devaluation in Latvia would surely send ripples

world, is now facing one of the most catastrophic

of devaluation doubt to the neighboring

downfalls. Apart from the damage created by

Estonia and Lithuania, questioning their ability

the current downturn of the global economy, the

and necessity to sustain a ﬁxed exchanged

reasons for the Latvian crisis date back to 2004-

regime. Third, this would beckon an absolute

2005, when under-regulated mortgage and

catastrophe going on in Latvia to the rest of the

consumer credit with low interest rates started

world, making Latvia lose the last remainders of

pouring in due to the escalating competition for

investor conﬁdence and patience.

the market share by the foreign-owned banks in

FA L L 2 0 0 9

Latvia. Add to that several million dollars coming

IMF AND FRIENDS: TO THE RESCUE!

in mainly from the British Isles every week

Towards the end of 2008, when Latvia turned to the

as private money transfers from the Latvian

IMF and the European Commission for securing a

workers abroad to their families at home, and a

loan that could help ﬁnance the deﬁcit and avoid a

perfect mix for soaring inﬂation and a housing

national default, devaluation was crossed out from

bubble can be created.

the criteria list. Instead, the government agreed to

implement sharp budget cuts, a process

like Lithuania, have stated that they are

GET UP, STAY UP

that has become known in the country as

considering applying to the Fund’s new

The apparent difﬁculties of the Eastern

“internal devaluation”.

ﬂexible credit line program announced

European

for

in March. Poland has already applied for

integrated into the European community

European

$20.5 billion under the new program to

have not scared potential newcomers. The

Parliament, the government announced

boost its currency reserves as well as

communists’ hold on power in Moldova

another budget cut of ﬁve hundred

investor conﬁdence.

has

day

municipalities

after and

the

elections the

countries

weakened

which

considerably

are

after

the

parliamentary elections of July 2009. If

million lats (around $1 billion). This time, even the “untouchables” were not

THE ARK OF EURO

the communists refuse to cooperate with

spared: all state pensions were cut by

Previously seen as a threat to the national

the ex-opposition, another election might

10%, but working pensioners were to lose

identity of a country, the Euro has now

be called in January, exactly as in the

70% of their pension, starting July 2009.

acquired an aura of being a shelter in

scenario after the April 2009 election. Then,

Teachers’ wages were reduced close to

times when rumors about devaluation are

crowds of disappointed Moldovans took it

the minimum wage level, while the cuts

causing greater risks for the relatively small

to the streets of Chisinau, considerably

in healthcare forced hospitals to cancel

economies whose central banks’ reserves

damaging the Presidential quarters as

planned operations. Still, the IMF has

cannot ward off a massive speculative run

well as the Parliament, thereby channeling

delayed two payments of its part of the

on their currencies. However, the entrance

out

loan, declaring that the current ﬁscal cuts

gate has thus far remained closed for all

government’s inability to raise the living

do not equal the structural reforms of the

the new members of the EU save Slovenia

standards in the country, currently the

economy and government at which the

and Slovakia, which adopted the common

poorest in Europe. On 14 January 2009,

Fund is aiming. The Governor of the Bank

currency in 2007 and 2009, respectively.

a massive but initially peaceful protest in

of Latvia IlmÐrs RimšÐvics said that even

In the times of boom, the barrier used to

Latvia turned into the worst riots since the

with these cuts, the deﬁcit would stand

be the high inﬂation. Now, the greatest

collapse of the Soviet regime, with hundreds

frustration

about

the

communist

“...the Euro has now acquired an aura of being a shelter in times when rumors about devaluation are causing greater risks...” at 9-10% of the GDP, and the Fund wants

concern has been the budget deﬁcit, the

of rebellious youth looting the stores in Old

to know how the government is going to

ratio of which cannot surpass 3% of the

Riga, smashing windows of the the Latvian

GDP. The country closest to adopting euro

Parliament and overturning police cars.

achieve a 3% deﬁcit in the long-term. In November 2008, Belarus and

seems to be Estonia, whose government

Although aggression should rarely

Ukraine also made $2.5 billion and $16.4

accumulated reserves and implemented a

be justiﬁed, these recent cases sound

billion deals with the IMF, respectively.

policy of ﬁscal austerity before the crisis;

like they ought to. The aforementioned

Later, the IMF, the World Bank, and the EU

the Estonians are said to be ready for

countries have lately been suffering

collectively agreed to provide $25 billion

implementing euro by 2011.

from political arrangements of steadily

to Hungary after the forint had suffered

When the IMF kicked in to manage

rising alienation between the voters and

a steep fall which the Hungarian Central

the Eastern European crisis, it suggested

the ruling “elites”; the lack of strong

Bank could not avert, despite desperate

that perhaps the smaller economies like

and competent leaders has also been

attempts to raise interest rates up to 11.5%.

the Baltic States might adopt thr Euro

noticed abroad. For the ﬁrst time since

In March, Romania, shedding jobs in the

without gaining membership on the

the collapse of communism, the people

steel and car industry and experiencing a

board of the European Central Bank.

in these countries have shown that

real estate bubble gone bust, became the

However, the ECB has been extremely

there are certain limits to their patience,

third Eastern European country to receive

strict so far; when the Lithuanian inﬂation

especially in times of economic hardship.

an emergency package from the IMF, this

rate — the only criterion that stopped

Eastern Europeans have to be ready to

time $27 billion. So far, other countries,

them from joining — was only 0.06%

surf the wave, and that will require some

like Bulgaria, Croatia, or Macedonia, have

higher than determined by the Maastricht

restructuring of the economy and some

either denied any talks with the IMF, or,

treaty, their application was denied.

change of the political climate. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY H A M A D A . A L M U DH A F ( ‘11)

MIDDLE EAST:

WEATHERING THE FINANCIAL DUST STORM I

write to you from a small coffee shop on

and North Africa (MENA) differ greatly, the

the second ﬂoor of the recently opened

UAE is merely a pertinent example of the

Dubai Mall, the world’s largest shopping

internationally integrated MENA economies.

mall.

Dominating the landscape, behind my

And

while

the

MENA

economies

vary

laptop screen, and past a grand waterfront,

signiﬁcantly along a spectrum of economic

is by far the most magniﬁcent skyscraper I

development, the question worth asking is one

have ever seen: the world’s tallest building,

with an answer that is relevant to all of these

Burj Dubai. Despite these marvels and many

economies. How can the ﬁnancial woes and

more, Dubai, part of the seven territories of the

circumstances triggered by the global ﬁnancial

Burj Dubai, the world’s

United Arab Emirates (UAE), has been hit hard

crisis translate into advantages for the Middle

tallest man-made structure.

by the ﬁnancial storm. The mall is empty, with

East, especially for its ﬁnancial sector?

restaurant hostesses roaming the walkways with their endless lists of dining promotions. Burj

To address this issue, it is critical to brieﬂy

Dubai’s scheduled opening has been delayed till

highlight the typical and atypical aspects

December of this year. Estimates of the amount

of the crisis in the MENA region. When the

needed to cover Dubai banks’ toxic assets in

crisis ﬁrst hit the developed economies of the

their balance sheet are around 70 to 80 billions

world, multinational banks operating within

dollars. Multimillion-dollar projects have been

these nations cut off their lines of credit to

scrapped, and construction in the country that

ﬁnancial

hosts an estimated 30 percent of the world’s

companies in the Middle East region which

cranes has come to a complete standstill.

make up a huge segment of the private sector.

institutions,

including

investment

With the credit crunch strangling day-to-day While the economies of the Middle East

FA L L 2 0 0 9

business activities, these companies—which

have historically relied heavily on short-

which represent the largest components

in the Middle East, especially foreign

term borrowings—are facing a difﬁcult

of GDP for countries such as Kuwait,

investors,

task repaying their debts. Many of these

Saudi Arabia, UAE, and Qatar.

These

“irrational exuberance” that dominated

companies are either insolvent or are

effects also caused signiﬁcant damage

the region during the pre-crisis period.

spending most of their time negotiating

to the region’s sovereign wealth funds.

The burst of the bubble brought back

with debt holders and banks.

were

discouraged

this

These

Nevertheless, the massive surplus of oil

realistic valuations and appropriate levels

negotiations are an attempt to convince

revenues stored from previous years

of risk aversion, rather than valuations

them

companies’

helped keep these nations aﬂoat during

fueled by unwarranted optimism and

debt or reach some sort of ﬁnancial

the below $60/barrel dip. A focus study

unsubstantiated

restructuring.

Foreign investors have

on the Middle East by the German Institute

that pushed prices to high levels, while

also pulled out money invested in the

of Global and Area Studies showed that

squeezing spreads and risk premiums to

region to avoid defaulting on loans back

the largely populated energy-exporting

unsustainably low levels.

in their home countries, exacerbating

economies of Iran and Iraq, as well as

the ills of the region’s capital markets.

the Dubai emirate, have arguably been

A second advantage of the crisis is the

Local banks have called on borrowers to

hit the hardest due to deﬁcient ﬁnancial

change it is bringing to MENA business

boost their collateral as asset prices have

reserves to ﬁnance the deﬁcit between

structures,

depreciated signiﬁcantly, most notably

government

Middle

equity stocks and real estate. Similar to

from energy sales. The sharp decline in

estate companies are rethinking business

the rest of the world, the stock markets

tourism has also added to the ﬁnancial

models after a long period of relying on

of the region have also plummeted, with

woes of countries such as the UAE and

short-term borrowing to ﬁnance assets

investor and consumer conﬁdence falling

Oman. Additionally, the crisis caused the

that are long-term in nature. The crisis

to low levels.

shrinkage of regional and international

revealed the dysfunctional aspects of

trade which has weakened re-export and

this model that inevitably contributed

port economies such as that of the UAE

to the demise of the plethora of private

reschedule

the

MENA countries that historically have

spending

and

earnings

rosy

functions,

Eastern

expectations

and

investment

models. and

real

“Investment and real estate companies are rethinking business models after a long period of relying on short-term borrowing to ﬁnance assets that are long-term in nature. ” a lower correlation with international

and Egypt, the latter of which relies on

equity

markets

taxing passage through the Suez Canal, a

that dominated the private sector of

the crisis through lowered exports and

big portion of government revenues that

the region. The ﬁnancial crisis also

lowered remittances from their labor-

has declined over the last year.

showed us the fragility of investment

were

indirectly

affected

and

investment

companies

companies’ models in the Middle East.

export economies as unemployment rose globally with the shrinkage of economies.

As the ﬁnancial dust storm subsides, it

Many of the practices, although not

The IMF’s May 2009 survey predicts that

has in a way puriﬁed the region’s ﬁnancial

addressed by laws of their respective

such non-energy exporting economies,

system, revealing all its deﬁciencies and

countries, were unethical and irrational.

including Egypt and Lebanon, which

presenting the opportunity for much

A signiﬁcant number of the ﬁnancial

have been impacted to a lesser extent,

needed reforms to the MENA economies.

services companies placed an emphasis

will likely recover at a faster pace due to

One of the ﬁrst advantages is one that is

on deal origination rather than deal

this lowered exposure.

Oil and natural

typical to any economy following a bubble

management.

gas exporting economies have had a

burst, but that is exceedingly relevant in

how to market bad investment products

harder time weathering the crisis. In the

the region. The crisis put an end to the

to ill-informed investors who were lured

advent of the ﬁnancial crisis, the adverse

domination of what Alan Greenspan once

by the lust to quickly become rich. Many

effects were multiplied by the sharp

coined the “irrational exuberance” of

across the region were going after

decrease in oil and natural gas prices,

asset prices. Those seeking investments

investments without realizing the high

They placed emphasis on

I N T E R N AT I O N A L B U S I N E S S R E V I E W

risks associated with them. The essential

institutions diversiﬁed their portfolios by

mismatch between assets and liabilities

relationship between risk and return were

investing in the ﬁnancial and real estate

maturities. Another positive of the crisis

completely distorted before the times of

markets, leaving out the sectors that

is that it revealed the need to develop

the crisis. The crisis has put an end to

generate income from operations such

MENA bankruptcy laws as a step forward

this distortion. If change doesn’t come

as healthcare, food, industrial, education,

towards efﬁcient markets.

from the ﬁnancial institutions, then it

and information technology. An upside

will be demanded from the more risk-

to the crisis is that no longer will these

In addition, the crisis should be a

averse investors.

sectors be neglected by institutional

call to the MENA region to not only

a result of the crisis is the realization of

investors,

increase corporate and governmental

the need to change the credit process of

advancements of these sectors, but also

transparency,

MENA banks.

to boosting the MENA standard of living.

efﬁciency and production output.

Another change as

Historically, many banks

leading

not

only

the

but

enhance

its It

needs to take advantage of the lower

either relied on name lending, balance sheet lending, or on collateral, failing to

The ﬁnancial crisis surfaced the need

valuation of different businesses and

place an emphasis ﬁrst on the cash ﬂow

to improve the effectiveness of the

increase its competitive advantage. The

generated by the borrower when it came

regulatory supervision of MENA ﬁnancial

main reason for these reforms is to lessen

to guaranteeing loans.

systems to mitigate the systemic risk

the region’s reliance on a minimal amount

that may occur following the failure

of export commodities.

These reforms

of the region’s ﬁnancial institutions.

will also help boost job creation to serve

also

The crisis provides the opportunity for

a rising working force.

increase the corporatization of family

regulators to develop their regulatory

businesses, a major segment of Middle

tools and supervision mechanisms, and

The ﬁnancial systems of the Middle East

Eastern industries. Private equity ﬁrms,

reforms.

and North Africa need to be upgraded.

learning from the mistakes of the pre-

Kuwait is a case in point. Throughout

The crisis has presented the opportunity

crisis models, would shift the focus and

the time leading up to the credit crunch,

for leaders to bring the much-needed

models of newly corporatized family

the Kuwaiti Central Bank had always

reforms.

businesses to rely on operational proﬁts.

been vigilant about the conduct of local

roots to grow a culture of transparent

I believe that most family businesses

banks, leaving them with little time to

and

The and

change

business

practices

models

would

execute

market-oriented

It has already planted the

disciplined

ﬁnancial

institutions.

“The financial crisis surfaced the need to improve the effectiveness of the regulatory supervision of MENA financial systems to mitigate the systemic risk that may occur following the failure of the region’s financial institutions.” such as that of the Saudi Al Gosaibi and

monitor Kuwaiti investment companies,

Restrictions on foreign investments are

Saad conglomerates went wrong when

with many malpractices slipping from

being stricken, and the low valuations

they shifted focus from their operating-

the radar. The passing of the Financial

have presented a myriad of opportunities.

nature business—which made them big in

Stability

Law,

entire

As investors move away from bailed-out

the ﬁrst place— to investments in stock

sections

investment

Wall Street, the MENA region is rising to

markets (speciﬁcally real estate and

companies, has been an important step

be a major investment hub.

ﬁnancial companies), derivatives, and

in reforming the ﬁnancial sector.

the

borrowing heavily to earn quick proﬁt.

can expect more attention to be paid

lags behind that of developed countries,

The emphasis on developing effective risk

the lessons learnt from the crisis will

management has also been heightened in

impositions on liquid asset reserves,

contribute

the wake of the crisis. In the years leading

minimum capital requirements, rules on

maturity of the Middle East’s ﬁnancial

up to the crisis, many MENA ﬁnancial

overleveraging, and regulations on the

and capital markets. iBR

FA L L 2 0 0 9

such

which banks

devotes and

corporations

with

potential

region’s

economic

the

And while

development

advancement

and

BY H A M A D A . A L M U DH A F ( ‘11)

GCC’S MONETARY UNION:

THEN THERE WERE FOUR... O

n New Year’s Eve of 2001, while

in this topic) states that, “If realised, the GCC

the sun set over the rocky Al Hajar

monetary union would be the second most

Mountains that lie west of and

important supranational monetary union in

overshadow Muscat, the capital city of the

the world in terms of GDP and population,

Sultanate of Oman, the royal rulers of six

after

Arabian Gulf nations reached a consensus

investment community, a uniform currency

on the future goals of their alliance. The

backed by strong GCC economies, would

agreement culminated the 21st annual summit

be another viable diversifying element or

of the Gulf Cooperation Council (GCC),

asset class denominated in the Gulf currency.

a trade bloc comprised of the nations of

As for energy investments and hedging, a

Bahrain, Kuwait, Oman, Qatar, Saudi Arabia,

positive correlation is likely to exist between

and the United Arab Emirates (UAE).

One

the Gulf currency and oil prices. Regional and

might wonder, what exactly was agreed upon

international trade would grow at a faster

that day, and why write about it now after so

pace, and both capital markets and direct

many years?

foreign investments would become more

the

euro

area.”

For

the

global

attractive. And the list goes on. The agreement incorporated a number of approved social and economic targets such

Prior to tackling the question of what has

as unifying a regional customs tariff at ﬁve

caused the delay, it is important to brieﬂy

percent, forming a GCC common market,

note the developments and the digressions

and establishing a single GCC currency by

in achieving this target. In 2003, the GCC

2010. With four months to go, the odds of

Customs Union was ofﬁcially established,

meeting the deadline of this last target —

and ﬁve years later, the GCC Common Market

which would be the second monetary union

was instigated. The outlook seemed positive,

in the world following the Euro— are slim. This

so what went wrong? At the end of 2006,

article focuses on the hidden truth behind the

Oman declared it cannot meet the Euro-style

inevitable question: Why this setback?

convergence criteria and left the monetary

Before answering this question, it is vital

union. Among other things, the criteria

to highlight the potential of this monetary

included speciﬁc levels for inﬂation, interest

union. The 31st issue of the European Central

rates, and budget deﬁcits. In May of 2009,

Bank’s Occasional Paper Series (which I

the UAE withdrew from the monetary union

highly recommend for individuals interested

after Riyadh, the capital of Saudi Arabia, was

I N T E R N AT I O N A L B U S I N E S S R E V I E W

declared the headquarters of the GCC

the past, the GCC nations in my opinion

countries would the world’s next monetary

Central Bank, a decision it opposed

have harmonized their markets enough

union form, without any abrupt delays and

vehemently. Saudi Arabia’s argument

that currency uniﬁcation is feasible. And

without any breakdowns. By studying the

was based on its status as the largest

unlike the Euro zone with its varying

Euro and its effects on the nations that

economy in the region, given the fact that

customs and economic structures, the

adopted the euro, it is easily observed that

it is the only GCC member to be part of

GCC shares a common language and

the countries with the largest economies

the G-20. The UAE argued its status as a

culture,

ought

have the most to gain, and hence Saudi

regional leader in ﬁnance, and as having

process.

Arabia’s determined effort in pushing

much more international exposure due to

Therefore the question remains: what is

uniﬁcation

lower governmental restrictions. Despite

the root cause of this delay? Is the quarrel

connect the remaining GCC nations?

these withdrawals, the remaining four

really about an inability to reach speciﬁc

Aligning Saudi Arabia’s interests to the

nations are still pushing for uniﬁcation

criteria or about where the central bank

interests of the remaining members is

among themselves, but all reports point

should be located? Could all this be a

the need for a strong currency (provided

to a delay in implementation.

pretext for something deeper?

a ﬂoating currency is implemented) for

Is some complex technical aspect of

It all goes back to the ruling nature

especially in combating imported inﬂation

integrating the currencies the cause

of the individuals sitting around the

when the dollar is on the decline.

of this delay? Probably not. Unlike the

table on New Year’s Eve of 2001 in

monetary union will no doubt achieve

mind-boggling technicalities of forming

that metropolitan patch of land along

this. On the other hand, the UAE and

the Euro, the technical aspects of linking

the Arabian Sea. It goes back to their

Oman have historically enjoyed a policy

the GCC currencies are considerably

conservative

sovereignty

of maintaining a weak Dirham and Omani

easier to handle since all the currencies

throughout history, where independence

Riyal (respectively) to support their ever-

are pegged to the US Dollar, with the

has been cherished, and where intrusion

growing tourism industries, the UAE’s re-

characteristic

simplify

the

that

uniﬁcation

forward.

What

interests

their massive oil and natural gas exports,

views

“It goes back to their conservative views of sovereignty throughout history, where independence has been cherished, and where intrusion has been met with resistance.” exception of the Kuwaiti Dinar (which

has been met with resistance. These

export industry, and overall trade. Joining

is tied to a basket of currencies with

individuals comprise of Kings, Emirs,

a stronger monetary union would go

the US Dollar representing a major

Sultans, and Sheikhs, all titles for leaders

against this policy and hinder their main

portion). So does each GCC market have

that value power and autonomy. Herein

revenue factor. The factors that bind

a disparate nature that might cause this

lies the hidden truth: that the rulers of

the remaining members into forming an

delay? An American business partner

these nations are not ready to relinquish

alliance

of mine once said to me that, from

control of their sovereign economic

belief.

his experience, there is a tendency in

policies, a power enjoyed and reminded

conﬂicting each other, and are unlikely to

the West to lump all GCC economies

of especially in the wake of the ﬁnancial

align. It is my belief that, only through the

together under the assumption that

crisis. While Oman’s inability to meet

existence of an over-dominating factor

they behave similarly, but the reality

the convergence criteria is a legitimate

that unites all members, would a currency

is far from it. The GCC countries do in

reason,

completely

union form, inclusive of all members. In

fact have considerably different market

from the union without laying down any

the end, the GCC along with its rulers will

structures and economies; however, by

preconditions for coming back. Similarly,

follow the policy that best beneﬁts their

achieving the GCC Common Market as

the UAE could have compromised for a

people, and if a currency union were in

the building block to a monetary union,

different location, or set some condition

all their interests, then the bumpy trail

they have harmonized their markets.

for return instead of opting out entirely.

to uniﬁcation would not have been so

Although this issue has been argued in

Only by aligning the interests of all GCC

bumpy. iBR

FA L L 2 0 0 9

Oman

withdrew

reveal These

this

interest-alignment

interests

are

currently

BY S A R A H H A N NA ( ‘11)

POST MUBARAK: EGYPT

UM-AL DUNYA M

asr um-al dunya (Arabic for Egypt

leaves many recent graduates from private

is mother of the world), was once a

and public Egyptian universities unqualiﬁed to

magniﬁcent truth, when the Egyptian

work. Yet through bribery and connections,

society was a leader amongst civilizations.

many of them are able to get jobs that

Today, however, the fact is that living standards

older,

in Egypt are extremely low by international

The Egyptian economy has turned into an

standards and have been declining since

atmosphere of chaos and dishonesty.

qualiﬁed

candidates

cannot.

1990. In an attempt to reconcile this irony, an open-door economic policy was established

The instability of the economic and political

in the early 1990s. It aimed towards achieving

situation in Egypt today is very troubling given

economic growth through trade in international

the current situation of the Middle East. Now

markets and consequently establishing higher

is a time when the Obama administration is

The Egyptian President:

standards of living in the Egyptian society.

relying heavily on the Egyptian government

Hosni Mubarak

for the establishment of U.S. policies with the The policy greatly beneﬁted the upper middle

Middle East. However, it is also a time when

class professionals involved with trade, but

most Egyptians believe that President Hosni

severely harmed the lower class citizens. As

Mubarak and his National Democratic Party

a result, the gap of wealth and income within

are on the verge of collapse.

the Egyptian economy became extremely

Egyptians have seen President Mubarak (now

wide. According to Aladdin Elassar’s The Last

in his eighties) turn the country into a major

Pharaoh, of the estimated 83 million Egyptian

police state, but the overwhelming corruption

citizens, 44% live on less than 2$ per day,

in Egypt has prevented him from boosting

while less than 20% control almost 80% of

the Egyptian economy to its full potential. It

the country’s wealth (GDP in 2008 was over

is unclear where the future of the Egyptian

$150 billion).

Since 1981,

This issue of uneven income

economy lies once the era of President Mubarak

distribution is not the only one troubling

is over. It is very certain, on the other hand, that

the Egyptian economy. Corruption within

there is a desperate need for ground-breaking

the government, ever-increasing prices and

economic reform that can only stem from more

underemployment are also main causes of

effective political and social systems. Once

frustration and anxiety amongst the Egyptian

these have been established, the Egyptian

population. As announced in the World News

economy will experience the advancement

Report, the overall inﬂation rate in 2009

and development that are natural for a country

reached 24%, and the actual unemployment

with such a large population of eager workers

rate was close to 20%, almost twice the ofﬁcial

and rich resources, both of which are not being

rate reported by the Egyptian government.

put to use. The future of Egypt might allow it

Furthermore, the poor quality of education

to once again become um-al dunya. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY P E N N Y M E T C H E V ( ‘1 2 )

RESOURCES BOOM IN AUSTRALIA:

RIDING THEWAVE F

or the last decade, much of Australia’s

This ensured that only 100 years after British

prosperity

colonization in 1788, Australia had become a

the

has

heated

been

mining

attributed and

resources

developed and wealthy nation.

boom. In the last year, as global demand and commodity prices sharply fell, Australians

The resource industry was however not always

began to wonder whether the overwhelming

proﬁtable. After World War II many European

success of the mining industry had ended. Had

economies recovered and ﬂourished rapidly.

the engine of our economy ﬁnally run out of

By the 1980s those countries had concluded

steam? Recent news suggests otherwise.

the modernization stage where they needed materials for construction and infrastructure.

Historically, mining booms have also encouraged immigration

On July 28, 2009 the Governor of the Australian

The prices of the raw materials needed were not

to Australia. Many different

Reserve Bank, Glenn Stevens, delivered the

rising. Furthermore, Australia was importing

ores and minerals are mined

speech, “Challenges of Economic Policy,”

increasingly more expensive manufactured

throughout the country.

where he discussed the issues policy makers

goods. Simply put, our exports were worth less

need to tackle as economies recover and

than our imports.

restructure. Interestingly he stressed that the “rise in demand for energy and resources has

The economic forecast looked grim, until

occurred, as a result of the cumulative growth

mineral prices began to quickly rise in the late

of the emerging world. This seems more likely

90s. What was the catalyst for the trend? One

to be a feature of the international economy

simple answer that would change the nature of

for some time than to go away.”

Australian foreign policy: China. Deng Xiaoping became China’s new leader in the late 70s

Although the mining boom started in the

and had begun the economic reforms which

late

would transform China’s socialist economy to

FA L L 2 0 0 9

historically

representative small

a mixed market. To secure foreign investment

population, our greatest asset has always been

in their factories, the Chinese needed vast

the abundance of arable land and precious

amounts of coal, oil and gas to power their

minerals. Early settlers capitalized on this with

factories and expand production. They turned

the Gold Rushes, wool and livestock trade.

to Australia and other resource-rich nations.

90s,

Australia’s

economy.

Despite

The increased production of manufactured

only ones to plummet; global trade did as well.

goods was not the only reason driving up the

The dollar value of trade globally is about a

demand of resources. China was experiencing

third lower than it was in mid-2008.

rapid urbanization and increased incomes. The need for new houses, roads, electricity and

Despite the bleak outlook, the proverbial

water connections had never been greater. In

wave Australians were riding has not lost all

the last 25 years China’s capacity to generate

its momentum. China is in fact recovering

electricity has increased ten times. Emerging

as the export and credit markets begin to

economies such as India’s were following the

mobilize. Their domestically driven investment

same path.

in urban infrastructure is making up for the lack of global demand in the past few months.

Global demand for natural resources continued

Moreover, emerging economies will need

higher,

natural resources for a long time in the future

especially in the period from 2004 to early

in order to complete the development process.

2008. Demand for raw materials was so high

As Glenn Stevens outlined, “the emergence

that oil peaked at $150 US a barrel in July of

of China (and other countries such as India)

2008. Between 2003 and 2008, proﬁts from

will continue, and will offer opportunities for

the mining industry increased by 160%. Over

Australia.” With booming populations, their

drive

the

commodity

prices

Between 2003 and 2008, proﬁts from the mining industry increased by 160%. Over the same period, the investment undertaken by mining increased by 212%. the same period, the investment undertaken

thirst for energy and construction materials

Drilling rig at a BHP

by mining increased by 212%.

will not vanish anytime soon.

Billiton minesite about 550 km outside of Newman,

What did this mean for Australians? Australia

Before Australians begin to rejoice, there are

began to experience record-high terms of trade

still domestic economic concerns. Western

levels. Our exports were incredibly expensive

Australia and Queensland’s economies will

whereas our imports were becoming cheaper;

continue to thrive as they reap the beneﬁts

China’s

manufactured

of the resource sector. On the other hand,

goods had made them more affordable. In

cities such as Sydney and Melbourne may

fact, it is estimated that the terms of trade

face stagnation as other industries contract.

effect caused an increase of 9% on national

Glenn Stevens also warned that an export

incomes between 2004 and 2008. Suddenly

base centered mainly on raw materials may be

under the economically conservative Howard

risky: “If we are more integrated into China’s

government, Australians were enjoying their

expansion, we will be similarly more exposed

greatest prosperity ever.

to the consequences of whatever might go

dominance

over

Western Australia.

wrong in that country.” The broad economic downturn and the ﬁnancial crisis at the end of 2008 stopped the wave of

Therefore, the resources sector will continue

good fortune. Not only did people have less

expand, albeit at a slower rate. The endless

disposable income for goods - and hence less

mining boom may have reached its peaks, but

demand- but governments were implementing

it has not experienced a bust. Australia is still

protectionist policies to deal with the growing

riding the resource wave. iBR

unemployment rates. Oil prices were not the

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY C H A R L E S H E N DR E N ( ‘10 )

CHINESE REAL ESTATE MARKET:

CRISIS OR HICCUP? he causes and effects of the U.S.

ten percent and export growth of more than

real estate crisis are well known: the

twice that much. It is therefore no surprise that

rapid expansion and securitization of

house prices in Shanghai, for example, increased

subprime and other nontraditional mortgage

by around 15 percent per year since 2002.

debt combined with expansionary monetary policy to fuel a massive house price bubble.

At the same time, rents in China were

This

rising

increasing alongside house prices. Andi Song

defaults and worsening credit conditions in

of NCR China commented that the rent on her

China’s real estate market

the larger economy. What are less well known

Beijing apartment had more than doubled in

sustained an impact from the

are the causes and effects of the concurrent

the two years leading up to the Olympics. This

ﬁnancial downturn of 2008, yet

real estate crisis in China. How did a nation

is in stark contrast to the U.S., where the ratio

commercial construction and

with virtually no nontraditional mortgage debt,

of house prices to rent increased dramatically

residential zoning in China’s

an almost unrivaled culture of saving, and tight

over the past decade.

metropolitan areas are as

government controls on capital seemingly

vibrant as ever. Just how hard

succumb—if only temporarily—to the same

Thus, while the rise and ultimate fall of real

hit was this market?

forces that crippled the U.S. real estate market?

estate prices in the U.S. can be characterized

Moreover, how did this unprecedented crisis in

Wachter cautions that what emerged in China

China turn around so quickly at the beginning

was a correction—and not an overvaluation

of 2009? The answer is, quite simply, that there

comparable to the United States.

bubble

ultimately

burst

amid

as the quintessential boom-and-bust cycle, Dr.

was no real crisis at all. As the graph on the rght shows, both Shanghai

FA L L 2 0 0 9

According to Susan Wachter, professor of real

and the U.S. saw remarkable increases in real

estate and ﬁnance at the Wharton School,

estate prices; however, the decline in real estate

China’s dip in real estate prices was “primarily

prices in Shanghai was less than one-eighth of

due to a the slowing of the economy and the

the decline in the U.S. What factors can explain

inability to maintain the high demand growth

this difference in outcomes? In other words,

of the past for real estate”. Since 2000, China

why did the U.S. experience a bubble, while

has consistently enjoyed GDP growth of over

China experienced a “correction?”

The answer is simple supply and demand. As

However,

Rong He, Chairman and President of Century

price growth was fundamentally sound, the

3 (Shanghai) Inc., explained, “residential real

nation nevertheless saw an unprecedented

estate always has buyers” in China. Many

decline in real estate prices toward the end

of these buyers paid for their homes with

of 2008. Mr. He attributes this decline to

cash, and those who took out mortgages

the fall in exports, foreign investment, and

were required to make down payments of at

stock market returns, as well as a slowing job

least 20 percent. Even with these stringent

market and decreased conﬁdence. Of these,

requirements and the limited ﬁnancing that

he believes that the decrease in conﬁdence

resulted, Chinese residents rushed into the

was

the

despite

single

the

most

fact

that

important

China’s

factor.

real estate market in droves, spending their rapidly increasing incomes on housing. At the

As declining fundamentals pushed conﬁdence

same time, foreign investment and speculation

further down, the rate of increase in house

added fuel to the ﬁre, though this was largely

prices

curtailed by government restrictions on capital

resulting in a drop of four percent. Demand

and the conservative practices of state-owned

remained strong; however, with the decline in

banks. House prices continued to climb with the

conﬁdence came the expectation of further

overall increase in organic demand resulting

declines in house prices. As a result, many

from

potential buyers stayed out of the real estate

China’s

steady

growth,

leading

Dr.

declined

precipitously,

ultimately

China’s dip in real estate prices was “primarily due to the slowing of the economy and the inability to maintain the high demand growth of the past for real estate.” Wachter to conclude that the increase in house

market, waiting for prices to bottom out.

REAL ESTATE PRICES IN CHINA AND U.S.

prices in China was “driven by fundamentals.” Unlike in the U.S., where real estate prices In the U.S., on the other hand, middle-

continued declining through April 2009, real

class incomes have remained stagnant for

estate prices in China stabilized within six

decades. Thus, similar increases in organic

months of the initial decline. GDP growth had

demand were not possible. Instead, mortgage

already begun to turn around by that point,

originators

and

thanks in large part to a $585 billion stimulus

products,

program, and these same buyers began to see

other

began

offering

nontraditional

subprime

mortgage

these

the proverbial light at the end of the tunnel.

mortgages in increasingly complex ways.

They entered the market anew in early 2009,

Loan-to-value ratios in some cases exceeded

and home prices have risen consistently over

100 percent—compared to a legal maximum

the past several months.

while

investment

banks

securitized

2500

225

2125

200

1750

175

1375

150

Aug 02

Nov 05

Feb 09

China: Shanghai Existing Homes Index (LHS) US: Case-Shiller Index (RHS)

of 80 percent in China—and underwriting standards deteriorated rapidly. In short, the

When historians look back at what was truly a

U.S. compensated for a lack of organic demand

global crisis of epic proportions, China—and

by essentially creating it in the form of riskier

especially its real estate market—will emerge

and riskier mortgages extended to people who

as a bright spot in an otherwise bleak picture.

were less and less able to afford them. The

Despite its momentary decline, real estate in

government restrictions on speculation and

China has proven to be quite robust, illustrating

ﬁnancing that kept China’s real estate market

clearly that a hiccup, even amid a climate of panic

largely under control were also completely

and hardship, need not turn into a crisis. iBR

absent in the U.S.

I N T E R N AT I O N A L B U S I N E S S R E V I E W

BY N IC HOL A S T H E U E R K AU F ( ‘11)

GERMAN CAR INDUSTRY:

THE PORSCHE VW SAGA A

chapter of the German car industry

Porsche.

has come to an end. A power struggle

Porsche. But perhaps the most important ﬁgure

between

in the feud was Wendelin Wiedeking, Porsche’s

the

Porsche

and

Piëch

Both

are

large

who

shareholders

was

families, who together own 50% of Porsche SE,

tenacious

CEO,

has resulted in the luxury sports carmaker’s

supported

loss of independence to Volkswagen AG.

Wiedeking, Wolfgang Porsche views VW as an

Wolfgang

wholeheartedly Porsche.

overly bureaucratic company that has recently The histories of Porsche and VW have always

strayed from its core business by engaging in

Wendelin Wiedeking was the

been closely connected by the Porsche clan.

“pet projects”, like the acquisition of Bentley

President and Chief Executive

Indeed, the ﬁrst Volkswagen Beetle was

and the development of Bugatti.

Ofﬁcer of Porsche AG from

designed

1993 to July 23, 2009.

Porsche in the 1930s and the two companies

Wiedeking became CEO of Porsche in 1993 and

have collaborated ever since. For instance,

is widely credited with turning the company

Porsche would never have been able to develop

from near bankruptcy to the most proﬁtable

Porsche

founder

Ferdinand

the Cayenne SUV by itself. So a future merger

carmaker in the world. Despite his huge

of the two companies, with the much larger

success, he has been a controversial ﬁgure.

VW at the helm, had long been considered a

When Porsche assembly workers showed

natural progression.

suspicion towards low inventory, Japanesestyle production, Wiedeking walked into the

FA L L 2 0 0 9

The central players in the family feud are

plant and destroyed iron shelves with an angle

Ferdinand Piëch, who started his career at

grinder. He accused the former Chancellor

Porsche and later left to become the CEO and

then the chairman of VW’s Supervisory Board,

incompetence and in a possible shot at VW he

and Wolfgang Porsche, Porsche’s chairman.

criticized the increasing number of mergers

Ferdinand Piëch and Wolfgang Porsche are

and acquisitions in the automobile industry,

cousins and the grandsons of Ferdinand

blistering “if size were the decisive criterion,

Germany,

Helmut

Kohl,

economic

In a May 2006 survey, Porsche was awarded the title of the most prestigious automobile brand by the Luxury Institute.

Courtesy of Stefan and Alexandra Maszynski.

“Volkswagen Law”, which gives the German

the dinosaurs would still be alive”.

state of Lower Saxony (a 20% shareholder in But Wiedeking knew that in the long run

VW) special veto rights for important decisions

an independent Porsche would face major

at VW, had to be overturned.

challenges.

Porsche

doesn’t

have

the

necessary economies of scale to develop new

Initially, both these conditions seemed feasible.

technologies by itself. He also reasoned that

VW would be acquired using Porsche’s Ð3

as a part of the larger VW group, which has

billion cash reserves, bank loans, and the

a range of fuel-efﬁcient cars, Porsche could

secret acquisition of secured options; the latter

avoid penalties from new European auto

triggered a huge squeeze on short-sellers and,

emission laws. So, in 2005 he proposed to

for a brief period, made VW the most valuable

the Porsche and Piëch families that Porsche

company in the world. Not only did their plan

use its Ð3 billion cash reserves to invest in

look like it would succeed, but they had also

VW. The families would most likely have been

outwitted many hedge funds and made huge

willing to merge Porsche into the VW Group

proﬁts. Due to VW’s stock appreciation,

for a stake in the giant combined Wolfsburg-

Porsche’s 2008 before tax proﬁts (Ð8.6 billion)

based company. But then Holger Härter,

exceeded its revenues from sales by Ð1.1 billion.

Porsche’s Kafka-reading CFO and close ally

In October 2008 Porsche had acquired 42.6%

of Wiedeking, stepped onto the scene. Härter

of VW’s voting shares and an additional 31.5%

along with investment bankers proposed a

through its purchasing of secured options—

complex plan for the hostile acquisition of VW,

very close to the 75% needed. Wiedeking and

a company with annual revenue about 15 times

Härter looked brilliant.

greater than that of Porsche. To Wiedeking and the Porsche clan, the prospect of a combined

But what Wiedeking had not counted on was

company with VW forced into a subordinate

the incredible shrewdness and determination of

position must have been extremely appealing.

his arch rival Ferdinand Piëch. Like Wiedeking,

It was at this point that the already strained

Piëch had enormous success as CEO of the VW

family relations spun out of control.

subsidiary Audi, which eventually propelled him to VW’s top position. Largely because of

The success of the plan only hinged on two

his leadership, Audi’s products and their image

conditions. First, Porsche needed to acquire

have improved dramatically in recent years.

75% of VW’s shares. This would give them

Wiedeking’s huge success (he was Germany’s

access to VW’s Ð11 billion capital reserves with

highest

which Porsche would be able to pay back its

management style, his outspoken criticism of

debt. In effect, Volkswagen would be paying for

VW’s expansion into the luxury segment and

its own acquisition. Second, the controversial

its excessively powerful workers councils, and

paid

manager),

his

aggressive

I N T E R N AT I O N A L B U S I N E S S R E V I E W

above all, his grandiose plan to acquire VW, got

turned to the Gulf state of Qatar. But they were

under the skin of Germany’s other automotive

weary of getting involved in the family power

titan, the 72 year old billionaire, Piëch. It is

struggle and only agreed to provide a capital

no secret that Piëch had long dreamed of a

injection once VW and Porsche had come to

combined VW-Porsche Group, but one on his

an agreement.

terms and not Wiedeking’s. On July 23, 2008, during a meeting to discuss Piëch’s ﬁrst move was to ally himself with

the options for rescuing Porsche, the Piëch

the powerful VW workers council and the

and Porsche families agreed to dismiss Mr.

Governor of Lower Saxony, Christian Wulff.

Wiedeking and allow Porsche to merge into

Piëch was able to convince both that a

VW. Mr. Wiedeking had lost, albeit with a huge

combined, Porsche-led company would not be

Ð50 million payoff (the biggest in German

in their interest. Porsche’s desire to restructure

corporate history). VW is planning on acquiring

VW into a leaner company with a strong focus

Porsche’s car business, which has been valued

on core products was no secret. To Wulff and

at Ð5 billion to Ð6 billion, as quickly as possible.

the workers council this translated into less

The company plans on raising Ð4.0 ($5.7)

generous working conditions and job cuts.

billion of capital. Although the details of the

During an important meeting with Chancellor

combined company’s structure have yet to be

Angela Merkel on April 15, 2008, Governor

hammer out, what’s certain is that the Porsche

Wulff secured her opposition to the potential

and Piëch families will end up with a large stake

overturning of the “VW Law” by the European

in the combined company (most likely between

Commission.

40 and 50%). To ensure this, the families intend to sell their Austrian auto distribution business

Piëch’s next move was to curb Porsche’s

to VW for over Ð3 billion. It’s also clear that

Ferdinand Karl Piëch is an

growing inﬂuence within Volkswagen. To put

the state of Lower Saxony will retain its special

Austrian automobile engineer

the breaks on further integration between the

voting rights and its status as second largest

and manager. He is a grandson

two companies, Piech abstained from voting

shareholder. Although a ﬁnal deal has not been

of Ferdinand Porsche and

on a VW supervisory board initiative to create a

reached, the third largest investor will most

supervisory board chairman of

committe that would have to approve all future

likely be the emirate of Qatar, which is meant

the Volkswagen AG.

transactions with Porsche. This effectively

to provide Porsche with capital and take over

ensured its adoption.

the majority of the VW options acquired by

Wiedeking, Wolfgang

Porsche, and even members of the Piëch

Porsche, which are valued at about Ð5 billion.

family were shocked. The action diminished the Porsche and indeed the Piëch families’ own

Already the world’s second largest automaker,

inﬂuence over VW, who after all owned a large

VW’s acquisition of Porsche will bring the

chunk of VW through Porsche.

company closer to the number one spot. Indeed, the gap between VW and Toyota has been

FA L L 2 0 0 9

In the process of amassing its stake in VW,

diminishing as VW has weathered the ﬁnancial

Porsche’s debt increased to Ð8.6 ($12.5)

crisis better than its competitors. However, the

billion.

Financing this debt shouldn’t have

soap-opera-like power struggle reveals the

been a problem for a company like Porsche—

dangers of family politics in the board room.

its VW stake alone was valued at Ð34.5 ($50)

Not everyone, least not Porsche employees, are

billion—but then the ﬁnancial crisis hit and even

rejoicing over the company’s lost sovereignty.

companies with strong balance sheets had

While family-owned businesses can focus on

difﬁculty ﬁnding money. In addition, the luxury

the long term, as opposed to the more short-

car maker faced a substantial slump in sales.

term orientation of public companies, they are

The crisis therefore provided Piëch with the

also bound to their owners’ whims, which may

opportunity to turn the tables and for VW to

not be in all stakeholders’ best interest. VW’s

acquire Porsche—an opportunity Piëch would

acquisition of Porsche might yet prove to be a

not let pass.

double edged sword. iBR

So, in a last effort Wiedeking

B Y P H I L I P P S C H R OE DE R , C O - F OU N DE R & M A NAGI NG PA R T E R , AC T I V E V E N T U R E PA R T N E R S

BARCELONA:

A HOTSPOT FOR ENTREPRENEURS he high living standards, coupled with

organizations, have been providing increased

a maturing venture capital and an

support and resources to stimulate economic

entrepreneurial ecosystem in Spain,

development, entrepreneurship, and private

particularly in Barcelona, are attracting more

equity investment in the region. A notable

and more international entrepreneurial teams to

example of this progress is the “22@Barcelona”

set up their new ventures. A few years ago there

project, which earmarked Ð7 billion to improve

were hardly any internationally recognized

the regional infrastructure and create a more

Spanish

conducive

technology

companies.

This

has

however signiﬁcantly changed; in 2008, Spain

environment

for

cutting

edge

research and technological development.

was represented by 17 ﬁnalists at the prestigious Spain’s rapidly maturing venture capital market

Red Herring Top 100 Europe Awards

is another factor to consider. The number of This drastic increase in Spain’s technological

venture capital investments in Spain has almost

innovation can be attributed to four main

doubled in the past ﬁve years, and in 2007 the

factors,

maturing

total value of early stage investments in Spain

technological ecosystem. Not too many years

was the fourth largest in Europe. The business

ago, Spain’s economy was primarily based on

environment in Spain is very friendly for both

real estate, tourism, industrial production and

venture capital funds and early stage companies.

textiles. This was reﬂected in the relatively small

For instance, there are high public sector

proportion of investments in the technology

incentives available to companies; in Spain, 50%

venture capital industry. Whereas in 2003

of all funded companies receive some form of

technological companies only represented

ﬁnancial support from public funds. Last but not

38% of overall Venture Capital investments, in

least, Spain also has relatively low labor costs;

2008 this number was up to 68%. This is mainly

labor costs are around 35% below the European

due to the growing ambitions of national

(EU15) average, which improves the capital

serial entrepreneurs to set up international

efﬁciency for venture ﬁnancing.

the

ﬁrst

being

Spain’s

technological companies and to start new technological ventures in Spain.

Overall, the effort to shift the traditional economy of Spain towards a more knowledge and research

The venture capital industry in Spain also beneﬁts

based economy shows great success. National

from the country’s recent efforts to move

entrepreneurs, as well as international serial

towards a more knowledge-based economy. In

entrepreneurs are starting to notice the lively

Barcelona, for example, governmental bodies,

entrepreneurial and venture capital ecosystem

alongside the educational and the non-proﬁt

that has recently developed. iBR

B Y P H I L I P P S C H R OE DE R

BY T O SI N O SI B ODU ( ‘11)

NIGERIA & THE CRISIS:

OPPORTUNITIES IN THE DOWNTURN Ngozi Dozie (WG’06) is a founding partner of Kaizen Venture Partners. a fund seeking longterm capital appreciation through the acquisition of control through privately negotiated equity investments. He was an investment banker at JPMorgan and a risk consultant for both Arthur Andersen UK and Deloitte & Touche. What does Kaizen Venture Partners do?

good fortune, we came across a new business

We’re a $50 million private equity fund that

model. A close family friend told us about a

is geared towards investment in distressed

distressed company she had consulted for.

assets in Nigeria and some other countries

This company owed 5 banks and, to cut the

in West Africa. We’re looking at resuscitating

long story short, she ended up buying the

distressed

the

company through restructuring the debt from

underlying assets of non-performing loans

all the ﬁve banks and injecting some capital

from banks.

in. The banks wrote down some of the loans,

companies

and

obtaining

What is the background of your company?

she raised some capital from other investors

How did it start? It started with my brother

in Nigeria and bought out the company. She

and me. I was working with JPMorgan up until

then began to turn it around. So we thought

January ‘08 but I’d always wanted to come

it was a good idea and decided to research

back to Nigeria. My brother was ﬁnishing up

that area. JPMorgan and Renaissance Capital

his MBA at Harvard Business School and he

research groups estimated that the value of

was looking to come back to Nigeria as well.

the non-performing loans in the Nigerian

We both didn’t want to do the corporate sector

banks was over $5bn. We thought that number

9-5. We wanted to do something on our own.

was underestimated. We began talking to

Initially, we were thinking about being an

banks, and talking to lawyers particularly in

incubator for ideas.

relation to bankruptcy proceedings. We did

Like a venture capital fund...Yes, like

FA L L 2 0 0 9

a lot of research on the current bankruptcy

a venture capital fund, but more active.

law in Nigeria and talked to people who had

We would actually manage the companies

experience with it. Currently, our funds screen

ourselves through the early stages and then

the assets but we don’t deal with the hands-

move on to the next thing. However, by some

on operations of the distressed company.

What’s your investment process?

be too deep in the ground. High risk

could even sell to the company in question

It depends on the channel we go

high reward though. Ideal structure is

if cash ﬂow is sufﬁciently adequate.

through. We either go through the

bad balance sheet, good management.

The actual owner buying the stake

bank to the distressed company or

It’s easier if the management team were

he sold? Yes. The idea being that if things

directly to the distressed company. It’s

competent but just too saddled in debt

get better he can raise funds to buy us

easier to go directly to the distressed

to perform. When it’s an operational

out. Our exit is something that we think

company. We then screen the company.

problem, it takes far more diagnosis and

about prior to making any investment.

There are certain criteria that we look

increases our due diligence cost.

Private equity investment is also a very

for in terms of potential revenue in the

How do you think Nigeria has

attractive option; we take a company

short-term, potential cash flow and the

been affected by the global ﬁnancial

from rundown to ok. The private equity

size of fixed assets.

crisis? The effect was secondary. We

investor can look to take the company

Fixed assets to leverage upon? Not

didn’t have any toxic assets in terms of

from ok to great. So we see those as the

to leverage but to limit our downside

derivatives and other credit instruments.

viable exits.

risk. We are attracted to companies

That’s a result of our underleveraged

What investment form would you

that have assets that are more valuable

ﬁnancial sector. With foreign investors

recommend a foreigner to use when

than our investment. If we have all

needing their capital, a lot of money was

approaching the Nigerian market as

these projections that don’t work out,

withdrawn from our stock market. You

alternative

investment

option?

“How to invest here is simply a question of your risk appetite.” at least, we have an asset base we can

had foreign banks that had lent dollars to

The safest way to do these things is to

use to recoup our investment. A nice big

Nigerian banks. They closed those credit

partner with a trusted party in Nigeria.

factory, for example, we can sell a few

lines and pulled out their money from the

For example, if a foreigner is looking

years down the line. So we look for that

economy.

if I had borrowed in dollars

at distressed investing in Nigeria, then

kind of asset coverage.

because I was in oil servicing, and my

Kaizen is your party. If you are not sure

What options are you looking at

costs and revenues were also earned in

of what level of investment you are ready

right now? Right now we have two deals

dollars, all of a sudden, my bank is telling

to put in, using Kaizen will minimize

in the pipeline. One concerns a household

me: “You owe us X amount in dollars that

your investment cost in terms of due

supplies

we have to convert into naira.” You have

diligence and business sourcing. We send

Nigeria. We’ve been looking at that for

the exchange rate risk, but you’re also

information to the foreign investor and if

the last months. The other deal concerns a

going from an interest rate where you

it’s what they like they can come in and

Ghanaian agribusiness company. Both are

were paying 11% on the dollar to 22% on

co-invest. The alternative is setting up

the same story: they have a bad capital

the naira.

shop here in Nigeria and doing all these

manufacturing

company

things themselves...

structure. So they’re interest payments

Who’s your competition right now?

are just too great and they haven’t been

Right now, to our knowledge, there is

able to invest in their business. Now,

no company doing what we do. They’re

idiosyncratic nature of doing business

they’re losing market share and creditors

case-by-case speculating individuals who

here? Yes. Having said that, how to invest

are banging at their door.

...and

without

knowing

the

are doing it on an opportunistic basis but

here it is simply a question of your risk

band

no one who is systematically looking to

appetite. You have investment banks who

in terms of size, management and

work with the banks to take their loans

do briefcase banking here; they’re still

development stage? Does a company

and turn them around.

based in London but every two months or

What’s

your

ideal

target

with bad management and a poor capital

What are your exit strategy options

so they come here to work deals. You also

structure have more potential for growth

on your investments? The options are a

have outﬁts that are fully based here and

after a management reshufﬂe? More

trade sale to a competitor in the same

taking the cost of doing business here

potential for growth but it’s inherently

industry, potentially an IPO, but that

independently so it really does depend

riskier. With bad management, they may

depends on the size of the company. We

on your risk appetite. iBR

I N T E R N AT I O N A L B U S I N E S S R E V I E W

Moscow is home to one of the largest numbers of billionaires; in 2008 Moscow was named the world’s most expensive city for foreign employees.

BY A L E X A N DE R C H E R N YA K ( ‘11)

RUSSIA

BUSINESS ETHICS M

FA L L 2 0 0 9

arket dynamics, rather than culture

In 2001, Goldman Sachs included Russia as one

differences are the primary driver for the

of the most prominent emerging markets in the

condition of business ethics in Russia.

world, coining the term BRIC. Moscow, once

Ironically, it is the relentless pursuit of proﬁts that

the symbolic capital city of the Soviet Bloc, has

caused Russian business to be unethical in the

been transformed to a cosmopolitan metropolis

ﬁrst place, that has compelled the adoption of a

and the world’s most expensive city in the world.

more ethical and transparent business system.

Amidst this progress, the average Russian

As market dynamics drive Russia to shift to a

citizen has prospered and the GDP has grown

long-term framework and diversify its economy

tremendously. The Russian government has

away from natural resources, business ethics will

acquired the third largest foreign reserves in the

continue to develop.

world and has maintained a positive balanced

budget since 2000. Public debt has been

as more acceptable than the current one.

and more proﬁtable to sell pure natural

lowered from 85% of GDP in 1999 to 8%

The

post-communist

resources. As a result, Russia developed

at the end of 2006. Real incomes have

transitions have been remarkably diverse.

a commodity economy with a rather

risen about 11% per year since 2000 and

Some countries are completely non-

undeveloped service and ﬁnal goods

unimaginable in Soviet Times, about 26

reformed (Belarus, Turkmenistan, and

sector. This created what AmartyaSen

million Russian tourists traveled abroad

Uzbekistan), while other countries have

coined as the “grabbing culture” in Russia;

in 2006. At the same time, Russia has

become full-ﬂedged market economies

Russia did not need to develop ethical

continually been ranked among most

(Romania, Slovakia and Estonia). In the

norms beyond delivery of the transaction.

corrupt and least ethical nations in the

Transparency International’s Worldwide

Entrepreneurs had signiﬁcant incentives

world. What is the underlying reason for

Corruption Index there is a high disparity

to obtain access to these commodities

the lack of business ethics and what are

in countries that used to constitute

at any ethical cost. In a New York Times

the prospects for ethics in Russia?

the former Soviet Union: Slovenia and

investigation of Russia’s aluminum sector,

Estonia rank 26 and 27 respectively, while

Andrew

Russia ranks 147.

was Siberia that one aluminum factory

One argument that has been made is

outcomes

Kramer

stated:

“so

lawless

changed hands literally with a keystroke,

that Russian culture and people are fundamentally different than Americans –

Interestingly enough, nearly one-third of

when one large shareholder was deleted

and this lends to a different perception of

Estonia is composed of ethnic Russians.

from a database of owners and had little

business ethics. In fact, numerous studies

The

and

recourse in the powerless courts.”Indeed,

conducted have shown with statistical

Estonia’s development paths lies in natural

Russia’s infamous aluminum wars claimed

signiﬁcance

differ

resources rather than people. Estonia

over one hundred lives. Russia was

between Russians and Americans. In one

developed transparency and ethics out of

subject to a Resource Cursealso known as

particular study, Raﬁk Beekun argues

necessity. Unlike Russia, Estonia is poor

The Paradox of the Plenty, which has led

that Americans seem to have stricter

when it comes to resources. However, it has

to an unfavorable development outcome

guidelines when assessing ethics.

something else to its advantage – location.

in which lawlessness prevailed.

that

ethical

views

difference

between

Russia

then leaps to conclude “national cultural

Situated on the Baltic Sea, Estonia has a

differences [between Russia and USA]

natural advantage in the transit industry

1999 – 2008: Emerging Market Economy

might be a major contributing factor in the

and upon collapse of the Soviet Union

After the period of chaos in incipient

assessment of ethical content”.

had the opportunity to develop a service

capitalism, the dust ﬁnally settled as

sector in its economy.

Reputation as a

the majority of stakes were claimed.

This, however, is a fundamental ﬂaw in

reliable and fair place of business is not

The Russian multinational corporation

logic, suggesting causation rather than

just a nicety but an imperative requirement

emerged. The rise in these entities

correlation. While it may be true that the

to gain trust from the West and survive.

stabilized

cultures view ethical situations differently,

Estonia had to diversify its economy and

brought Russian business to a global

this is a symptom rather than a cause of a

ﬁnd other ways to develop.

stage,

the

and

business increased

environment, the

typical

investment time frame.

system that breeds corruption Russia, on the other hand, is blessed with 1991 – 1998: Incipient Capitalism

natural resources. It has a wide commodity

When Russian conglomerates began to

The 1990’s in Russia was an era of massive

base including major deposits of oil (~20%

acquire companies they would typically

instability brought on by corruption,

of world supply), natural gas (~40% of

pay 2-3x earnings, which given Russia’s

inﬂation, and ruble devaluation. With a

world’s supply), aluminum, coal, timber,

lack of track record was perceived to be

lack of strong institutions to enforce laws

and many other strategic resources.

a lengthy time frame.

there was no ability to restore justice.

fact, as long as oil prices are above $70

environment stabilized, Russian managers

Entrepreneurs who played fair lost and

per barrel, the government runs a ﬁscal

looked abroad and saw similar companies

those who broke the rules survived. It

surplus. Russia could become wealthy

trading at valuations of 15-30x earnings

was natural selection and survival of the

solely from its natural resources and due

on the London Stock Exchange. It did not

ﬁttest. Those who were ﬁt weren’t ethical.

to fortunate market timing – it did. As

take much for Russian ﬁrms to see this

commodity prices started to appreciate,

arbitrage opportunity and realize that they

During this time, the Russian people

there was little incentive to develop other

would be able to exit at a 10x multiple. In

longed for a better system. In 1994, 65%

industries. Consumer goods remained

pursuit of proﬁt, managers desired for their

of the population regarded the old system

undeveloped, as it was easier, quicker,

companies to become publicly listed.

As the business

I N T E R N AT I O N A L B U S I N E S S R E V I E W

As Russian companies expanded beyond

2009: Maturing Market Economy

The consequences of this are grim to

their borders, they soon learned that

It took about a decade to achieve

society. Russia has inherited a history of

consequences of past behavior would

Russia’s remarkable stock market gains,

technological achievements that have

make business difﬁcult and expensive.

but just a few months to erase nearly all

impacted mankind, though lags behind

Suspicion of bribery and corruption

of it. As commodity prices plummeted,

when it comes to innovation. Today,

caused

lose

the Russian public equities collapsed.

Russia has over 478,000 researchers

international deals worth $50 billion in

Russia, which many considered an ‘island

and ranks 8th in number of publications

2006. Russian business learned the hard

of stability’, effectively sunk. The price/

in the world. Yet, intellectual property

way that to participate on the global

earnings ratio of public Russian companies

continues to be undeveloped in Russia.

stage, ethical business practices were a

fell to the lowest level in the world,

Despite the economic boom of the last

requirement. In Business Ethics in Modern

indicating a lack of faith by investors in

decade, it is still almost inconceivable to

Russian

companies

“Corruption and bribery have fundamentally shifted societal incentives. ” Russia and Sustainable EconomyAlexei

Russian companies. Because valuations

hear of a Russian manufacturer selling

Sidorov argues “investment in ethics and

reached historical lows, the incentives

beyond the CIS market. Russia’s revenues

reputation became no less effective than

system

fundamentally

from technology exports are $383 million

changed. Russian managers were now

compared to $52.6 billion for the United

compelled to optimize and re-engineer

States. Russia ranks among the lowest for

the companies they own and look beyond

innovation activity in Europe, with only

Indeed, Russian managers began to notice

natural resources to generate a proﬁt.

7% of industrial production composed of

that increased transparency won investor

The recent ﬁnancial crisis provided Russia

innovative products.

conﬁdence, which directly translated to

the opportunity to reform and diversify

a higher stock price. The share price of

the economy and to move away from its

By increasing transparency and fostering

Yukos, formerly Russia’s second largest

addiction to oil. While Russian companies

principled meritocracy, Russian managers

oil producer, tripled in value in 2001

ﬁgured out how to attract capital, one

can create an environment where ethics

following efforts to improve its appalling

managers

aretruly cherished.Through this fair work

record of corporate governance, while its

continue to face is the motivation of labor

environment, Russian companies that

rival LUKoil, who did not make reforms

and the ability to spark productivity and

will able to most effectively harness the

underperformed

innovation. Russia has an opportunity to

opportunity and innovation potential

gain an ethical advantage, but in order to

of its people and gain a competitive

do so, it will be imperative for ethics to

advantage in the marketplace.

new

equipment…nothing

personal,

only business.”

companies

the

began

market. to

Russian

compete

for

transparency and trust.

the

for

managers

greatest

obstacles

become an intrinsic value. In Russia, it is ultimately the invisible hand

Russian managers realized that in order to survive and compete on a global stage,

Corruption

have

of the market which drives demand for and

they would need to satisfy additional

fundamentally shifted societal incentives.

the implementation of business ethics.

stakeholders with new demands and

Students in Russian universities now

Perhaps Peter Vardinian said it best:

expectations. Business ethics became a

aspire to become customs agents and

“People realized that, if they were honest,

necessary investment to win international

government

bureaucrats.

they

business

adolescents

often

and

bribery

Parents

could

become

proﬁtable

admissions

because they would get more business.

companies, become listed in international

ofﬁcials close to 10,000 Euros to gain

And that changed people’s behavior. And

markets, and increase share price. Ethical

acceptance to police academies, The

this is why I realized it was not a question

business practices became a competitive

ofﬁcial yearly salary of police ofﬁcers is

of whether Russians were any better or

advantage over other Russian companies.

substantially less than that.

worse than other people” iBR

projects,

acquire

FA L L 2 0 0 9

foreign

bribe