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June 8, 2011

Pareto

TEACHING FINANCE IN MBA POST GLOBAL CRISIS

After the Crisis, one major question has been about the changes in teaching economics and finance. JR VARMA of IIM-A explores this issue in a new paper (Finance Teaching and Research after the Global Financial Crisis, 2011).

He says finance curriculum in a typical MBA programme has not kept pace with the developments in finance theories. There were clear gaps between theory and practice and finance needs to go to its theoretical roots. However, there is a need to re-examine finance theory itself. We need to add newer insights like market microstructure theories within finance.  There is a need to plant ideas from other fields like sociology and psychology. Beyond that, finance needs even more maths and models to go with these new additions.

Prof Varma says efficient markets hypothesis (EMH) has two perspectives: First, there are no free lunches and second, prices reflect the fundamentals and are always right. The crisis has strengthened the first claim and weakened the second. The EMH does not justify a light touch regulation of “too big to fail” banks. He also points how Repo market has blurred the lines between financial markets and institutions because  it turned investment banks into shadow banks.

WHAT IF FRANK-DODD ACT WAS ENACTED BEFORE THE CRISIS?

FDIC has released an interesting what-if paper (The Orderly Liquidation of Lehman Brothers Holdings Inc. under the Dodd-Frank Act, 2011) which wargames the scenario if Frank-Dodd Act (FDA) would have been enacted before the 2007 crisis.

Under the FDA, FDIC gets new powers to act for systemic financial firms like it does for banks.

The paper is divided in three parts: the first part plays the events of Lehman crisis; the second analyses the key aspects of FDA and FDIC’s new powers; and the third replays the Lehman crisis if FDA had been in place.

It suggests that the FDIC, with its new powers, could have promoted systemic stability while recovering substantially more for creditors than was done through the bankruptcy proceedings, and at no cost to taxpayers. It estimates that general unsecured creditors of Lehman could have recovered 97 percent of claims, compared to the estimated 21 percent on claims estimated in the most recent bankruptcy plan of reorganisation. While there remains no doubt that the orderly liquidation of Lehman would have been incredibly complex and difficult, the report concludes that it would have been vastly superior for creditors and systemic stability in all respects to the bankruptcy process as it was applied. Though the report points that there are limitations with such an exercise since it is based on many assumptions, but it still would have been a better outcome under the FDA.

WHEN IS SIZE OF FINANCIAL SECTOR DISRUPTIVE FOR GROWTH?

The recent crisis has however raised concerns that some countries may have ?nancial systems which are “too large” compared to the size of the domestic economy. JEAN LOUIS ARCAND, ENRICO BERKES AND UGO PANIZZA look at whether size of financial sector could be disruptive to growth (Too Much Finance?)

They say when private sector credit equals around 110 percent of GDP, financial sector starts to hinder growth prospects. Credit at 110 percent of GDP is like a threshold level. At lower than threshold finance leads to growth and higher than that it hinders growth. Importantly they include credit from both bank and non bank sources as we have seen latter becoming an important source of finance.

They look at a number of countries and show most advanced countries like US, UK, Iceland etc had credit higher than the threshold leading to crisis. They add bank capital requirements should be raised to lower the size of finance. The financial industry has argued that the Basel III capital requirements will have a negative effect on bank profits and lead to a contraction of lending with large negative consequences on future GDP growth. While it is far from certain that higher capital ratios will reduce profitability, their analysis suggests that there are several countries for which tighter credit standards would actually be desirable.

How much is India’s credit to GDP ratio? Bank credit to GDP ratio as on March 2011 is around 53.4 percent of GDP. But we do not have proper estimates on non-banking sources of credit.

DO WOMEN POLITICAL LEADERS HELP WOMEN?

Recent state elections saw two women emerge as leaders in their states. So what would one expect from a women leader? One of the first things should be improvement in women’s security. As a woman it is a shame to live freely with fear lurking in most corners of the country. LAKSHMI IYER of Harvard along with three economists explores these issues at a village level which has a female council head. (The Power of Political Voice: Women’s Political Representation and Crime in India).

The findings are surprising. First instead of declining, one sees reported crimes against women rising. The authors thought this would be because of backlash against women leaders with men committing more crime. The authors probed more and found the rise is not because of actual increase in crime against women. It is because women are now reporting crimes more as they are feeling confident that some action will be taken and further atrocities will not be done because of the woman leader. Hence they have become more empowered to act. The findings are interesting as basically village councils don’t have the power to influence police.

The new and existing women chief ministers should take lessons from their village counterparts and improve women’s security and empowerment in their respective states.


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