Q4 Fall 2008

What's the new capital up to?

Online Features

The nonprofit sector is developing tools for financing and managing the organization that come largely from the for-profit world. Clara Miller, president and CEO of the Nonprofit Finance Fund discusses both the need for more financial savvy in the nonprofit realm as well as the pitfalls of an overly commercial mindset.

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When interviews for the print edition of Q4 were conducted in April through August 2008, sovereign wealth funds seemed like a potential source of stability in the global financial system, due to their large pools of available capital. But when credit markets froze and stocks tumbled, SWFs seemed to stay on the sidelines. Rachel Ziemba is an analyst with RGE Monitor specializing in the strategies of SWFs. She provides her perspective on what these funds have been doing during the global economic turmoil.

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Read an excerpt from Robert Shiller’s new book, The Subprime Solution, in which he explores what the S&P/Case-Shiller Home Price Indices reveal about the housing price bubble and its role in the current financial turmoil.

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Responding to Q4's conversation "Did innovation cause the credit crisis?" Rick Antle, William S. Beinecke Professor of Accounting at Yale SOM, puts accounting changes and their role in the current financial turmoil in context.

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What's the cost of changing accounting models?

Shyam Sunder and Stella Fearnley
With notable prescience, Shyam Sunder, the James L. Frank Professor of Accounting, Economics, and Finance at Yale SOM co-authored an editorial in the Financial Times with Stella Fearnley of Bournemouth University on August 23, 2007, warning of dangers from converging accounting models.

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Dialogs

Larry Summers has analyzed macroeconomic policies as a top academic economist, and helped form those policies in positions such as secretary of the treasury. He provides his take on the new forms of capital that are likely to affect markets, economies, and lives in the years ahead.

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How does a sovereign wealth fund operate?

Ng Kok Song and Jeffrey E. Garten
Sovereign wealth funds have become a source of controversy. They have the size to swing or stabilize markets. Meanwhile, their sometimes secretive strategies have invited worries that they could be used as tools of government policy. An insider describes how one of the world’s largest SWFs is run.

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Should capital be socially responsible?

Anne Simpson, Timothy Smith, and Anne Kvam
Two decades ago, socially motivated investing accounted for a tiny percentage of worldwide capital. Today, investors representing $14 trillion have signed on to the UN’s Principles for Responsible Investing. What influence are they having?

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What's the view from Dubai?

Nasser Saidi, William Foster, Ismail Odeh, Yasar Gamali, Jonathan GS Koppell, and Ira M. Millstein
The Dubai International Financial Center was established in 2004 as a “gateway” to the capital of the oil-producing countries of the Gulf Cooperation Council. Yale SOM’s Ira Millstein and Jonathan Koppell spoke with a group of experienced investors in the region about the DIFC and the role of capital in the GCC.

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Did innovation cause the credit crisis?

Frank J. Fabozzi, William N. Goetzmann ’86, and Gary B. Gorton
By 2006, the subprime market had grown to 20% of the total U.S. mortgage market, and 75% of these loans were securitized and sold off to investors around the world, facilitating an influx of capital. With credit easily available, more people than ever before were able to buy homes — but then the market seized up.

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Catherine Labio, an associate professor of comparative literature and French at Yale, studies the relationship between economics, fiction, and art. She teaches a course called Fictions of Capital, which explores the depiction of money and the economy from the 17th century to the present.

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The wealth generated by the dot-com boom of the 1990s produced a new generation of philanthropists, determined to use their capital and their business savvy to solve social problems. A decade later, have they transformed the world of philanthropy?

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From 2005 through the middle of 2007, one public company after another was bought out and went private. The size of the deals escalated — Hertz for $15 billion, HCA for $33 billion, Equity Office Properties for $39 billion, TXU Energy for $44 billion. Then the megadeals stopped. Andrew Metrick explains what happened.

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Q(n) readers offer a variety of perspectives on the question.

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Vignettes

A South African government program aimed at addressing deep historical inequities enabled a union-owned investment fund to build up enough capital to reach around the globe. The mostly black workers in the union now own a piece of a hotel chain in the Middle East and a clean-energy company in Pittsburgh. How much can be learned from this success?

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The emergence of new capital is an old phenomenon. Scottish investors bought cattle ranches in the Wild West. Early skyscrapers were funded with bonds marketed to small investors. The first corporate raiders assaulted apparently unassailable institutions. Index funds cut out the middlemen. Wealthy Japanese companies bought up American real estate. Look at the responses to each of these innovations.

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Can a double bottom line bring better returns?

Nancy Pfund ’82 and Seth Miller
Why is a venture capital firm encouraging the employees in a company it funds to give free music lessons? They’re trying to prove the thesis that companies that engage with their communities also reap a business advantage.

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A firm of financiers, technologists, and policy mavens is bringing capital to bear on projects around the world that reduce greenhouse gas emissions. They hope to help turn the tide against climate change — and make a healthy profit.

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Essays

Ernesto Zedillo, the former president of Mexico and a scholar at Yale, argues that overreacting to fears about sovereign wealth funds could hobble the global financial system. But he also points to the real risks inherent in the global imbalances that have fueled the recent growth of SWFs.

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Sensing a broad change in the capital markets in recent years, the Millstein Center for Corporate Governance and Performance set out to better understand what was happening. Jonathan Koppell describes what he and his colleagues learned from a series of discussions with investors, directors, managers, and regulators around the globe.

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Noteworthy

News on New Capital
Five billionaire hedge fund managers testified before Congress this week. They answered questions about leverage, transparency, and the importance of the $1.5 trillion industry to the broader economy. Philip Falcone of Harbinger Capital Partners Fund said he would favor greater public disclosure and transparency. Investors "have a right to know what assets companies have an interest in — whether on or off their balance sheets — and what those assets are really worth." For more see Bloomberg’s report on the proceedings or the New York Times offering including the full text of the prepared remarks of each manager.

The New York Times has a story about Dubai's reactions to a new economic reality. Read Q4’s dialog with key players in the Dubai International Finance Center for background on this "freest of free market enclaves."

Around the Web
Bill Ackman, the CEO of hedge fund Pershing Square Capital Management, appeared on the Charlie Rose show to discuss hedge funds, the ratings agencies, and the progress of bailout efforts.

That interview was among the many interesting links to be found on Paul Kedrosky’s economics blog Infectious Greed. Kedrosky also posted a snapshot of trends in globalization from the Progressive Policy Institute that includes the cost of an international long distance call, the world container shipping capacity, and exports as a share of world GDP.

 

Recent comments from the Q4 community

Comment from Should capital be socially responsible?

The Wall Street Journal has a story on socially responsible investment funds faring better than the market averages amid the downturn.

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Comment from Did innovation cause the credit crisis?

A story co-reported by NPR and the New York Times discusses how a school board in Wisconsin bought into CDOs trying to offset rising healthcare costs only to discover they didn’t understand what they had purchased. Hundreds of municipalities seem to have fallen into similar troubles. Listen to the radio pieces on NPR’s Planet Money website or read the New York Times story.



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Comment from Is something new happening with private equity?

More than a year into a slowdown in private equity activity some of the biggest players are facing a squeeze as debt obligations are coming due in a tight credit market. A New York Times story says that history shows the worst may be yet to come for private equity but is able to find some who see it as a time of opportunity.

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Comment from What's the new capital up to?

A bubble inside a bubble? The New York Times has a story about market bears standing contrary to investors like John Bogle and Warren Buffett who see a time to buy with the market down. Looking at historical price to earnings ratios, some bears say these are lows only relative to the last 20 years, a period which may represent a bubble itself and perhaps one that is ready to pop.

For an even longer view, read Q2’s interview with SOM economist Martin Shubik from last fall in which he discusses 50 years of market watching, including his views on how modern finance has created "a disconnect between the actual corporation and the piece of paper representing ownership of the corporation."

As the media seeks expertise for understanding the economic turmoil, increasingly they are turning to business and economic blogs. The PBS digital media blog highlights several top bloggers and how their work is proving valuable to both long-time and new readers.

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Comment from Where are the sovereign wealth funds?

Author and Middle East analyst Dilip Hiro has more on the ways sovereign wealth funds are investing in their own economies at Yale Global Online.

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Comment from What's the new capital up to?

What role is there for the new capital in the current financial crisis? French president Nicolas Sarkozy told the European Parliament that EU states should create sovereign wealth funds to buy ownership stakes in companies to prevent non-European SWFs from buying control of key industries during the deep fall in stock prices. Spiegel Online has the story.

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Comment from Did innovation cause the credit crisis?

In response to growing concerns on the spread of the financial crisis, the Yale School of Management, in partnership with the Wall Street Journal and CNBC, organized a roundtable discussion in New York on September 23. Stephen Schwarzman ’69 YC, the chairman, CEO, and cofounder of the Blackstone Group began the discussion with a summary of the factors leading up to the turmoil.

“Like all things like this, the factors are basically known. It's a perfect storm. It started with the Congress basically encouraging lending to lower income people and the system kicked in and started doing it, and we went from subprime loans being about 2% of total loans in 2002 to growing to be 30% of loans made in 2006. And that kind of enormous increase swept into that net a lot of people who shouldn't have ever been borrowing. Those loans were repackaged in CDOs and unfortunately rated Triple-A, which led the investment banking firms who distributed those to basically doing none to very light due diligence. And those securities were distributed throughout the world, at which point eventually they started defaulting. And as they started defaulting they started falling in value, and no one...

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Comment from Did innovation cause the credit crisis?

The accountants respond.

Read accounting professor Rick Antle's take on the role of accounting rules in the spread of the credit crisis.

Read a 2007 commentary by Shyam Sunder that presciently identified problems with fair value accounting.

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Comment from Did innovation cause the credit crisis?

The Yale SOM webpage with additional resources on the financial crisis includes video of a panel discussion in which Gary Gorton took part and a commentary by Will Goetzmann, among other items.

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Comment from How is the new philanthropy different?

Read more on this subject:

The Wall Street Journal reports on a recent study suggesting a generational shift in philanthropy.

Kash Rangan of Harvard Business School gives his own take on the state of philanthropy and the continuing evolution of social enterprises, both for-profit and nonprofit.

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Comment from Is emission reduction a new capital?

James Cameron, the cofounder and vice-chairman of Climate Change Capital, argued in a Times of London op-ed that, in the midst of the banking crisis, we mustn't lose sight of the steadily increasing risks of climate change.

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Comment from How do we write about capital?

Margaret Atwood, author of numerous volumes of fiction, nonfiction, and poetry, wrote an essay in the Wall Street Journal (subscription required) about another way that ideas of money and finance have weighed on the literary imagination: debt.

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Comment from Is emission reduction a new capital?

In a contrary view of carbon trading, Oliver Tickell argues that under the EU's emission trading system polluters are making a profit. Read his take.

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Comment from Should capital be socially responsible?

In the first agreement of its kind, Xcel Energy, a company that builds coal-fired power plants, agreed to disclose to investors the risks that global warming poses to its business. The move could give activist investors more leverage to push the company to improve its environmental performance. Will it be a model for others to follow?

Read a description in the New York Times.

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Comment from Is emission reduction a new capital?

Peter Sweatman, the managing director of client operations in Southern Europe and Latin America at Climate Change Capital, gave a speech to the Carbon Finance Speaker Series at Yale, outlining the fundamentals of carbon finance and explaining the essential question of why carbon credits have a value. His talk was turned into a chapter in Carbon Finance: Environmental Market Solutions to Climate Change, and is available online.

Read the chapter.

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Comment from Can a double bottom line bring better returns?

For more on the critical limits to the power grid read this New York Times story on the subject. Or see ways another venture capital firm is seeking to distinguish itself from the pack in this New York Times article.

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Comment from Should capital be socially responsible?

For more on corporate social responsibility read The Economist's special report.

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Comment from Can capital overcome the past?

For more on this topic read the Yale SOM case study on South Africa's Black Economic Empowerment efforts. An essay in Q1 by SOM's James Baron on creating markets for good corporate behavior also touched on the topic.

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Comment from Did innovation cause the credit crisis?

For more on the role of the subprime crisis in global financial system problems read Gary Gorton's paper prepared for the August 2008 Federal Reserve conference in Jackson Hole, Wyoming.

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Comment from How does a sovereign wealth fund operate?

What's Garten's take on SWFs?

In August 2007, Jeff Garten wrote an essay on sovereign wealth funds for the Financial Times, warning of the danger that state owners could use their investments for policy ends and calling for tougher regulations. It touched a nerve. He was cited in dozens of news articles, and his views were debated through the blogosphere.

Garten points to the recent emergence of SWFs as one reason why his suggestions drew such a vigorous response. "I think that I wrote about the subject just at the time when people were becoming aware of the issues," he says. "Also, I was very specific about policy recommendations and that provided an easy target for discussion."

Over the next year, as the credit crunch tightened, Bear Sterns imploded, and stocks tumbled, Garten's views of the situation evolved. "A year ago I was very casual about how much the funds of the SWFs were needed by the U.S. Unfortunately, we need the money more than I ever thought, and it may be that way for a long time. I am a pragmatist, and so I have concluded that we should work closely with the SWFs to...

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