dartmouth business journal: winter 2010

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DARTMOUTHBUSINESS JOURNAL

An Uncertain Business World:

erspectives on Economic Growth

March 1, 2010 |Winter Issue


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TABLEof


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TaiwansRecovery Fromthe EconomicCrisis: Interviewwith Christina LiuShan Shan He

Christina Liu, chief economic

adviser of the Taiwanese firm

Chinatrust Financial Holding

Company talks about the current

state of the Taiwanese economy.

During their talk, He questioned

her on several topics including the

effects of the large-scale drop in

mortgage rates on national real

estate prices. Their conversation is

transcribed below and has beentranslated by He from the original

Chinese to best preserve the

meaning of Lius words.

DBJ: Good Afternoon Ms. Liu.

Thank you so much for agreeing to

meet with me today.

Liu: No problem. It is always

exciting for me when young people

are interested in global issues.

DBJ: (laughs) Well I know that you

are the chief economic adviser of

Chinatrust and a major figure in the

economic scene. Like most

economies around the world,

Taiwan's economy has suffered

some setbacks. Were there any

economic stimulus measures by

Taiwan government in 2009?

Liu: In the last year, almost all

countries adopted expansionarymonetary policies and fiscal policies.

Taiwan did the same, but the details

of our policy differ slightly. For

example, last February around the

Chinese New Year Festival, the

Taiwanese government distributed

consumption coupons. Each person

holding a Taiwan I.D received US

$200.

This was a very heartwarming

gesture from the government,

particularly poignant because of the

importance of the holiday. Many

shops even provided 50% discount

for shoppers and even shoppers

using consumption coupons to takeadvantage of the discount. This

stimulus method was very effective

since the coupons were constrained

by a time limit.

DBJ: What was the total amount

subsidized?

Liu: It was about USD$35 billion.

But let me return to the monetary

policies implemented by the

government. These types of policies

generally aim to reduce the interest

rate, but their effectiveness is very

dependant on whether or not banks

are willing to give.

The most effective example of this

type of policy can be seen in the

mainland of China. In mainland of

China, many banks are state

controlled, and these banks have to

accommodate government policies.

In many other countries where

banks are privately controlled, they

may behave differently. In U.S., the

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discount rate is 0-0.25%, and the

mortgage rate has been kept around

5%. In Taiwan, the market share of

state-owned banks was more than

50%. When the government cut

down the base rate, these state-

owned banks would follow by

reducing the mortgage rate.

Thus, other banks would have to

follow too in order to keep their

customers. The mortgage rate in

Taiwan is a bit more than 1% until

now. This low rate has stimulated the

real estate industry, and consequently

the price of real estate has been

pushed up.

DBJ: What is the normal mortgage

rate?

Liu: Usually above 3%. During this

crisis, it was kept at a bit above 1%,

1.2% was the lowest point. Taiwan

has kept a very low NPL

(nonperforming loan) ratio. During

the crisis, it was about 1.8%, and

now it is about 1.3%-1.8%.

DBJ: What was the rate of increase

of real estate price in Taiwan? Is

there the danger of a real estate

bubble?

Liu: It only increased by 20% and

may not pose too big of a problem.

The real estate price increase is

mainly attributed to high-end

properties. This is partly due to

Taiwan's reducing bequest tax rate.

It was 50% before the crisis and has

now been reduced to 10%. This

policy attracted a huge amount of

capital back to Taiwan.

DBJ: Mainland implemented a US$

588 billion plan to stimulate

economic recovery; is there a similar

plan in Taiwan?

Liu: We have ten major plans,

accounting for about US$ 200billion. Some have already been

implemented, but many plans will be

implemented in 2010. Taiwan has a

conservative fiscal policy; hence the

stimulus plan in Taiwan is about 3%

of GDP.

DBJ: What are the major areas

Taiwan wants to stimulate?

Liu: The areas Taiwan is looking to

stimulate are those targeted by many

other countries. They are mainly

centered on green energy, but also

include high tech industries.

DBJ: What is the current status of

economic recovery in Taiwan?

Liu: Well the financial sector has

been doing relatively well. The stock

market was up 80% at the end of

last year. This was due to

international capital inflows and tax

reform. The improving economic

cooperation with the Chinese

mainland has also played an

important role. Also, real estate and

companies have been doing well due

to the mainland's stimulus plan, as

many Taiwanese companiescurrently operate in the mainland.

DBJ: Thank you for sharing your

knowledge with the Dartmouth

community. We appreciate your

insights.

Liu: My pleasure.

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Harnessing the IncentivesCreated by the Capital GainsTaxDavid Kellenberger

Obama plans to let elements of the Bush tax cuts of 2003

expire when they come back up for renewal in 2011. He

will renew the tax cuts on lower tax brackets and onlyallow the rates on the two highest income brackets and

capital gains tax to increase. This falls in line with his

plan of moving much more of the nations tax burden

onto the higher income brackets. The highest tax bracket

($250,000 for a family) which was taxed 35% on income

under the Bush administration will, come 2011, be taxed

39.6%. The second highest bracket will be raised from a

33% income tax to one of 36%, while the capital gains

tax (the tax on long term investment) will be raised from

15% to 20%.

While the goal of raising the capital gains tax is to levymore taxes on higher income citizens, as they invest more,

it also results in bad incentives for investors. If Obama

wants to take money from higher income households he

should directly raise the income tax for the higher

brackets. This would take the money directly out of

salaries and thus have a smaller distortion effect. By

increasing the tax on capital gains he will increase

government revenue, but at the steep cost of reducing

long term investment, the kind that we are trying to foster

by having a capital gains tax in the first place.

The capital gains tax was put in place so that long terminvestments could be taxed at a lower rate than income,

as this type of investment is crucial economically. The

lower the capital gains tax, the more money people place

in long term investments. By raising this rate, the amount

of money placed in these long term equity and loan

investments will decrease, having a net negative impact

on the economy.

Politically it may be easier for Obama just to let the tax

cuts Bush put in place expire as this means he will not

have to push for new forms of tax legislation. However,

the economic implications of a rising capital gains tax donot favor investment. Thus raising the capital gains tax is

something neither the Obama administration or any

other administration should do. While it will be more

challenging, and will take time, Obama should take the

time and effort to change the tax laws and keep the

capital gains tax as low as possible.

If he wants to tax the rich it should be done through

increasing income taxes, because they do not affect

incentives nearly as much as a capital gains tax. Taxing

job income has incentive problems too. Technically, an

increase in the income tax could mean people do a worse

job at work as they earn a lower percentage of their total

compensation. However, in practice, since compensation

is our most important income stream, people work hard

(or not) regardless of whether or not income taxes are

higher. However, while there are few alternatives to

working hard for a consistent salary, there are other

accessible options to saving and investing our money.

Raising the capital gains tax encourages people to spend

more money now, as it is an easy and attractive

alternative. In response to this the government should

work to make long term investment as attractive as

possible to citizens. Spending excess money will start to

look less and less desirable in comparison.

Sources:

http://money.cnn.com/2010/02/01/pf/taxes/obama_budget_tax_changes/

http://www.heritage.org/research/economy/wm2263.cfm

http://www.businessweek.com/investor/content/feb2010/pi20100224_591737_page_2.htmD

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ovember18,2009


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GoogleIts ventures in ChinaMegan Ji

From artsy customized logos on every

occasion, to a saccharine sweet Super

Bowl ad, Google has always tried to

sell itself on the cute, the simple, the

familiar. Yet when Americas favorite

search engine announced its pull out

from China this past January, there

was nothing innocuous about the

global controversy that erupted as a

result. This dispute, reignited by a

highly directed cyber attack on

Google and its peer corporations, has

actually been six years in the making.

At the root of it all is an unexpected

question: to what extent does a

corporation have an obligation to doright thing over what is most

profitable?

Googles controversial compliance

with the Great Firewall of China

stems back to 2004, when the

company

announced its

intentions to

launch a Google

News China

Edition, whichwould filter news

sources not

sanctioned by the

PRC. Two years

later, Google

developed

Google.cn, in

which Google

self-removed all

search hits the

Chinese

governmentdeemed too

sensitive. In both

instances, Google rationalized their

controversial changes by arguing that

they were made for the sake of the

user experience.

Prior to 2006, Google searches in

China brought up all results, but links

to censored pages led to errors

messages or dead pages. Google

argued that this posed a unique

problem for the news function:

reading headlines offers little value

when users cant view the articles

themselves and, perhaps more

significantly, showing controversial

headlines could prompt the Chinese

government to block Google News

altogether.

Later, in 2006, Google decided that

its overall user experience in China

was not on par with that of the rest of

the world. Google News, Images, and

even the general search engine were

available sporadically (if at all). By

self-filtering censured material,

Google.cn was designed to ensure

that Googles tools were always

accessible to the Chinese market.Critics flamed Google for complying

with Chinese censorship standards.

They argued that in self filtering,

Google was essentially assisting the

authoritarian Chinese government in

suppressing the Chinese peoples free

access to informationironic for a

company whose corporate motto is

Dont be Evil. Google, however,

defended its decision as necessary in

achieving its larger mission of

providing the greatest amount of

information to the greatest number of

people. 2

Specifically, Google posited its choice

as between compromising its mission

and failing to offer Google search at

all to a fifth of the worlds

population. 3 The comparison was

exaggeratedly dramatic, but from this

we can see that, at least for PR

purposes, Google maintains that it

acts on behalf of the people.

What Google did not mention is the

other key consideration within the

controversymoney. Discussion of

principles aside, the Chinese market

is a difficult one to give up. In 2009,

the number of Chinese internet users

rose to 384 million4, exceeding the

total population of the United States.

Eighty six million users were first year

web users5

, and there still existssignificant potential for the market to

continue expanding.

In fact, Chinas 384 million internet

users comprise less than thirty

percent of the countrys 1.3 billion

plus total population. Considering

this makes Googles humanitarian

argument seem farfetched, since,

Googles presence in China really

benefits itself more than it benefits

China. In fact, Chinese economic

and technological developments have

brought forth several worthy

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competitors in the search engine

industry.

These companies, along with other

foreign competitors, would all be too

glad to usurp Googles Chinas

market shares. Baidu, Chinas

number one search engine saw a

twenty percent surge in its stock value

after Google announced its possible

pullout6. Microsofts Bing, which had

been pushing for Chinese market

shares even before Googles

announcement also made a bid for

Googles position, announcing that it

intends to stay engaged, which

means [Microsoft] must respect the

laws of China. 7

Were it not for the enticing size and

potential of the Chinese market, it islikely that Google would have caved

to public pressure and pulled out of

China long ago. By taking the moral

high road, Google could adhere to

its Dont Do Evil corporate

mantra, appease its Western base,

and leave its image as a do-gooder

company unscathed.

But should Google be faulted for

choosing profitability over principle?

Senior Fellow at the USC AnnenbergCenter Thomas Lipscomb certainly

believes so. Lipscomb argues that

Googles affirmation of the greed is

good mindset is blasphemous,

considering the thousands of troops

fighting for our cherished freedoms

in Iraq and Afghanistan.8 This

accusation is absurd. Like any

corporation, Googles top priority is

profit and expansion into China has

proven profitable.

From a practical standpoint, Googlewould only refrain from pursuing

China if complying with Chinese law

resulted in public backlash that would

undermine its profit. Google has long

reaped the benefits of its positive

public image, but because it has so

heavily promoted and relied on its

image as a friendly and good

corporation, the effects of such a

backlash are likely inflated in

comparison to multinational

companies that are perceived as more

ruthless, such as Walmart.

The recent cyber attack directed at

the Gmail accounts of Chinese

human rights activists tipped the cost-

benefit balance for Google, though.

Although no such claim has been

made officially, there have been

suspicions connecting the attack to

the Chinese government.

Google saw its risk of being faulted

for or linked to the incident and

savvily took preemptive measures. In

issuing a statement against Chinese

censorship and announcing its

impending pullout, Google was able

to successfully distanced itself fromthe situation and reclaim its status as

a do-gooder company.

Former critics were thrilled by

Googles decision to finally take a

stand and the issue took a life of its

own in the political arena: Assistant

Senate Majority Leader Dick Durbin

released an official statement praising

Google for its choice,9 Secretary of

State Hilary Clinton made a heated

speech condemning the Chinesefirewall, and the Senate scheduled a

hearing on technology firms business

practices in Internet restricting

countries for March.

While Googles decision has certainly

produced action, it is important to

recognize that Googles main purpose

in its announcement was likely

bolstering its image, not furthering

global good by opening access to

information. In fact, Google filters

remain in countries like Thailand andTurkey, which are less influential and

bring little controversy.10

Compounding to the evidence that

Googles announcement was strictly a

business decision is the fact that,

having reaped the PR benefits from a

pullout from China, it now seems to

be hedging. In mid-February, a

month after the pullout

announcement, all censors were still

in place.

When questioned by UKs The

Register, a Google spokesman directed

reporters to the official January 12th

statement,11 which said that Google

has decided [it is] no longer willing

to continue censoring our results on

Google.cn and that over the next

few weeks [Google] will be discussing

with the Chinese government the

basis on which [it] could operate an

unfiltered search engine within the

law, if at all.12 Evidently, we should

expect these discussions to continue

for a while.

Time will tell what Google ultimately

decide to do, but remember: in theend, its just business.

Sources:

1 http://googleblog.blogspot.com/2006/01/google-

in-china.html2 http://googleblog.blogspot.com/2006/01/google-

in-china.html3 http://www.asianews.it/news-en/Beijing-dampens

Google-controversy-and-censors-news-on-

line-17366.html4 http://www.asianews.it/news-en/Beijing-dampens

Google-controversy-and-censors-news-on-

line-17366.html5 http://www.tradingmarkets.com/news/press-

release/bidu_crwe_crwee_crweselect-com-

announces-a-stock-alert-watch-on-baidu-inc-

bidu--707310.html

6 http://arstechnica.com/microsoft/news/2010/02/

googles-china-problem-leaves-opening-for-bing-in

china.ars7 http://www.worldsecuritynetwork.com/

showArticle3.cfm?article_id=124878 http://durbin.senate.gov/showRelease.cfm?

releaseId=3220429 http://www.forbes.com/forbes/2010/0208/

outfront-technology-china-where-google-still-

censors.html

10 http://www.theregister.co.uk/2010/02/10/google_china11 http://googleblog.blogspot.com/2010/01/new-

approach-to-china.html

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A Union to FearOlga Korostelina

It seems like a new economic empire

looms in Eastern Europe. On January

1st 2010 Russia, Belarus and

Kazakhstan entered a new customs

union. This process took place swiftly,

without a notice to the general

population about the conditions of

the agreement. This union will

eliminate customs duties on trade

between the countries and will

implement a common external tariff

system on imports from the rest of

the world.

The level of the tariffs established by

these nations will most likely be

dictated by Russia, the mosteconomically powerful of the three

nations in the union. Stratfor, a

Texas-based think tank, estimates that

about 90 percent of the new customs

regulations implemented in Belarus

and Kazakhstan will be implemented

in order to equate them with Russias

customs duties.

This means that these nations, hard-

hit by the global economic crisis, will

now have to face higher prices forforeign import goods in exchange for

a guarantee of economic stability.

Because of this increase in price they

will have to turn to cheaper goods

from Russia, factually becoming

entirely dependent on the economic

giant.

Many see this move as Russias

attempt to formally exert its control

over the former USSR states. Once

again a system of economicdependency is emerging in these

nations, controlled by Russia. This

foreshadows an expansion of Russias

control over small Eastern European

and Central Asian states. For

example, Kyrgyzstan and Tajikistan,

members of the Eurasian Economic

Community, have already announced

their firm intentions to join the

customs union in the near future.

Armenia, another former USSR

nation, has also expressed interest in

joining the union. Ukraine, a nation

often seen as a battleground of Soviet

and Democratic ideals, may similarly

join this union, depending on the

outcome of its February Presidential

election. These nations, too, look for

Russia to provide them with cheap,

stable prices for imports.

What does this mean for the US?

The volume in products exported

from the US to Kazakhstan and

Belarus will decrease significantly.

While in Russia the strict import

standards have existed for years, this

new customs union will mean that

markets will be closed in Kazakhstan

and Belarus. Exports of drilling and

oilfield supplies, industrial engines,

agricultural machinery, civilian

aircraft supplies, and

telecommunications equipment to

Kazakhstan will dwindle.

Exports of other goods, such as used

cars, will also fall, leaving small

independent dealers of used cars

both in the US and in Kazakhstan to

find their businesses struggling as

Russian exports gain dominance in

the market. Car exporters to Belarus

will also have to face the same

problem. Industries that focused on

exporting engines, pharmaceutical

preparations, and agricultural

machinery to Belarus will also see a

decline.

Despite the fact that US exports to

these nations are both far below 1%

of total US exports, losing any trade

partners is unfavorable in the current

state of economy. The customs

union, therefore, will cause both large

and small dealers to lose business and

may even increase the number of US

citizens unemployed.

Clearly, the new customs union that

Russia, Belarus, and Kazakhstan

joined is very significant both

economically and politically. In

exchange for economic stability, two

former USSR states are now willingly

sacrificing some international trade

and giving up their economic

independence to Russia.

Their union indicates a possibility of

a new level of Russian geopolitical

ambition. This ambition is a

problem because it is highly possible

that Russia will now influence the

internal and international polices of

the other nations in the union.

Moreover, Russias power will only

grow if more satellite nations enter

the union. Russia has stepped out of

the shadows and is now openly

reestablishing its political and

economic empire. In fact, the

independence and equality that took

the European Union 50 years to

construct and foster may take Russia

just a few years to demolish.

Sources:

http://www.census.gov/foreign-trade/statistics/

product/enduse/exports/c4634.html

http://www.thetrumpet.com/index.php?q=6864.5373.0.0

http://www.census.gov/foreign-trade/statistics/product/enduse/exports/c4622.html

http://www.stratfor.com

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A New Round ofCash forClunkers?Kedar Mulpuri

On July 1, 2009, the Obama

administration initiated the Car

Allowance Rebate System (CARS), a

federal scrappage program intended

to provide rebates for car trade-ins.

Known to the general population as

Cash for Clunkers, the program

was considered a nationwide success

as hundreds of thousands of

Americans rushed in to exchange

their low fuel efficiency

junkmobiles for more fuel efficient

designs. Although Congress initially

approved $1 billion in funding forthe program, resources for CARS

were depleted by July 30, 2009well

before the expected end date of

November 1, 2009calling for

Congress to appropriate an

additional $2 billion for the program

(MSNBC). Even this was not enough

to satiate the overwhelming demand,

and CARS dissolved by August 24,

2009 (Reuters). Before the program

officially started, there was already

much controversy on the effectivenessof the program in benefitting the

environment. While car companies

and consumers continue to demand

more funding for CARS, many

environmentalists argue that Cash

for Clunkers weakly upheld its goals

of putting more eco-friendly cars on

the road. Also, many conservatives

feel that the program artificially

boosted demand for cars in the short

run, while draining taxpayers money

to fund the rebates. Months after theprogram ended, it appears that the

program was mostly successful but

could have used a few modifications.

Through the duration of the

program, new car purchasers could

get between $3,500 and $4,500 for

trading in eligible gas guzzlers

(MSNBC). Many critics, however, felt

the requirements for these trade-ins

were not set high enough. About the

mileage requirements, Representative

Earl Blumenauer (Oregon), one of

the 14 Democrats to oppose the

CARS bill in the House, had to say,

They werent set very high, so it

wasnt getting the worst of the worst

off the roads (The Washington

Independent).

While the top ten cars sold through

Cash for Clunkers had far betterfuel efficiency than many of the

trade-ins, the problem with CARS

was the large potential for abuse of

the system. The eligibility

requirements for the new cars were

abysmally low. Under the program,

new cars had to yield at least 22 mpg,

while new trucks and SUVs had to

yield 18 mpg if under 6000 pounds

and 15 mpg if over 6000 pounds

(AOL). Through these lax

requirements, many Americans

simply exchanged their old pickup

trucks for new pickup trucks,

defeating the purpose of the program

since these exchanges did not result in

new vehicles for owners with that

much better of fuel efficiency. In fact,

the programs excessive popularity

was the programs greatest failure,

since a substantial portion of the $3

billion was spent for cars that were

not substantially more fuel efficient

than their trade-ins. Overall, though

the program resulted in an average

increase of 60.8% in fuel efficiency

when comparing the trade-ins with

the new cars (the trade-ins had an

average mpg of 15.8, whereas the

new cars had an average mpg of

25.4) (Bloomberg). While this is a

notable improvement, the program

still had potential to make a more

significant and continual impact on

both the environment and the

economy with less of a burden on

taxpayers dollars.

The primary economic problem with

Cash for Clunkers is that it was a

short term program that artificially

drove up the demand for cars for only

a few months before the funds were

completely depleted, only resulting in

a delay in the deterioration of the car

market. During the second round of

funding for Cash for Clunkers,

Daniel Becker, director of the Safe

Climate Campaign, had to say,

[CARS] is turning into a

methadone program for addicted

automakers. They have no incentive

to turn it off (The Washington

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A typical gas guzzler trade-in


10/1410

Independent). Now that CARS has

ended, car makers are back at square

one, before Cash for Clunkers was

started; the speed of car sales

continues to not meet the speed of

car production. At the end of Cash

for Clunkers, government officials

reported that nearly 700,000 cars

were sold during the two monthperiod (Los Angeles Times). After

Cash for Clunkers ended, however,

Ford saw a 5.1% decrease in sales for

September 2009 compared to a year

ago, while Nissan saw a 7% decrease.

In fact, the month of September

marked the lowest sales rate in seven

months for the entire US car market

(Los Angeles Times).

The problem with Cash for

Clunkers was it was not a sustainablesystem that could have had a more

long term impact on both the

economy and the environment. To

reduce the cost of CARS, lawmakers

could have made the requirements

for both trade-ins and new cars

stricter. The selling point of Cash for

Clunkers was to benefit the

environment by taking gas guzzlers

off the roads and replacing them with

more eco-friendly cars. To this end,

Congress should have provided

rebates on the worst of the gas

guzzlers (say 16 mpg or less) and

should have required that they be

replaced with hybrid and gas saver

vehicles to receive the rebate. While

hybrid cars can typically get between48 and 60 mpg (providing massive

savings on the owners gas budget

while also contributing the least

possible level of emissions in the

environment), they are not appealing

to consumers since they cost

substantially more than regular cars.

If the government is going to involve

in the weaning car market with the

goal of also improving environmental

conditions, it should provide rebates

on only those car designs that have

proven to be the most eco-friendly.

Quite simply, the government should

reward those automakers that have

developed the most eco-friendly

models. In this way, funding for the

program would have lasted much

longer and would have made a

greater difference in terms of its

environmental impact.

While many continue to be strongly

in favor of another round of CARS,

Congress needs to rethink their

eligibility requirements even before

considering authorizing any

additional funding. Only then can

CARS provide the maximum benefit

to the car market and the

environment at a more affordablecost to the national budget.

Sources:

http://www.msnbc.msn.com/id/32228179/

http://articles.latimes.com/2009/oct/02/business/fiauto-sales2

www.bloomberg.com/apps/newspid=20601087&sid=a5xRebAM.Xa0

http://www.reuters.com/articleidUSTRE57J6AD20090820

http://washingtonindependent.com/53487/criticsblast-cash-for-clunkers-2-billion-lifeline

http://articles.latimes.com/2009/aug/27/business/ficlunkers27

autos.aol.com/article/cash-for-clunkers-101

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The Honda Fit was one of the top ten cars purchased through "Cash for Clunkers"


11/1411

Will ImpendingSanctions CauseCollateral

Damage?Ryan McClafferty

Harsh new trade rules seeking to

browbeat the willfully nuke-seeking

Iranian regime have recently passed

in the Senate.

The forthcoming laws would punish

non-Iranian firms with a presence in

Iran's energy sector by blocking

them from conducting transactionsin the US and limiting their access to

US banks, a significant departure

from previously employed practices.

Traditionally, American law

enforcement has punished trade

violatorsincluding companies

caught in Iranian deals with

connections to the US marketby

simply issuing fines and penalties.

Essentially, this new law will require

oil giants to choose between their

Iranian business and their ability to

pursue business opportunities anduse banks in the US. Nothing is final

yet, as the bill has to be reconciled

with a House version in committee.

But so far, both versions (S. 2799 and

HR. 2194) have received nearly

unanimous support.

This is bad news for several

international energy companies, and

could negatively affect many US

businesses as well. Petroleum

behemoths like Royal Dutch Shell,BP, and Total (which are ranked 1, 4,

and 6 on the Fortune Global 500,

respectively) do quite a bit of

business in Iran and will have hard

choices to make soon which could

have an adverse effect on their share

prices.

If international petrochemical giants

pull back on using US banks and

markets to avoid the effects of the

sanctions, a substantial amount of

business could be lost; Royal Dutch

Shell, BP, and Total, for example

have combined revenue of $783.9billion and a combined net income

of $62.2 billion. To say the least,

their absence from US markets

would be significant.

French leviathan Total S.A. is a good

example of a company caught in this

dilemma. Although it slowed down

its expansion in Iran during 2008 by

quitting phases 11 and 13 of the

South Pars liquefied natural gas

project, Total has a 40% stake inphases 2 and 3 of the South Pars gas

project and the company is locked

into a $1 billion buyback contract for

the Dorood oil and gas field. (Under

a buyback contract, a developer sells

a property to an investor and then

buys it back under a long-term sales

contract.) Recently, Totals net

production in South Pars has been

around 9,000 barrels per day.

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Total is also one of

Irans main gasoline

suppliers, a role it

would have to

abandon once the

sanctions go into

effect. Due to limitedrefining aptitude, Iran

must import about

30%-40% of the

gasoline it consumes

domestically. Along

with 4 other non-

Iranian companies,

Total provides this

30%-40%.

By adding the

approximately $200million in annual net

profits available from

supplying Iran with

gas to the above-

mentioned investments

in oil field development, one begins

to see what the company must give

up, or else forfeit the myriad business

opportunities available in America

a loss which, while harder to

quantify, would be considerable

indeed.

A coalition of business organizations

including the US Chamber of

Commerce, the Business

Roundtable, and seven others urged

the Obama administration to oppose

the new legislation. Business leaders

rightly fear that the sanctions could

"prohibit any US company from

transacting routine business with

critical partners from around theglobe even if these transactions have

no bearing on business with Iran."

The letter also warns that the

provisions "could encompass a very

large portion of the global trade

community with consequences that

in our view have not been

adequately assessed." They are

referring to the destructive ripple

effect that would occur in the

American business community if

international oil companies choose

pullback from US transactions over

total divestment in Iran.

Indeed, California's insurancecommissioner and gubernatorial

candidate Steve Poizner has already

asked the 1,300 firms licensed in his

state to rid their portfolios of $6

billion of stock in companies that

operate in Iran.

If recent penalties against banks are

any indication, there is good reason

for oil giants to find a way to avoid

the coming sanctions, or else run

from Iran like a burning house.Credit Swisse got walloped with a

$536 million fine last December.

Earlier in 2009, Lloyds of London

was forced to shell out $350 million.

But fines are not the only thing

international petrochemical

companies have to fear should they

choose to continue pursuing

opportunities in Iran. They will also

have to carefully consider the long-

term implications of alienating the

American governmenta fearsome

adversary if ever there was one.

Sources:

"Competitive Landscape." UAE Oil & Gas Report(January 2010): 48-51.Business Source Complete ,EBSCOhost(accessed February 7, 2010).

van Groenendaal, Willem J.H., and MohammadMazraati. "A critical review of Iran's buybackcontracts."Energy Policy 34, no. 18 (December2006): 3709-3718.Business Source Complete ,EBSCOhost(accessed February 7, 2010).

Mark Dubowitz. Turn off Tehran's gas. TheFinancial Post(July 21, 2009)

Mark Dubowitz and Joshua D. Goodman. HitIran where it hurts. The Financial Post(April 16,2009)

Joanna Anderson. Senate Passes Iran SanctionsBill. Congressional Quarterly (January 28, 2010)


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Many factors contributed to the 2007-2008 financial

meltdown and the recession that followed. One of these

factors, a lack of regulatory oversight, has received agreat deal of attention from policy makers, members of

the banking industry, and the public.

Although laws intended to limit highly speculative trading

exist, the banks did not violate these laws. Therefore, no

one stopped the banks from taking risky positions that

ultimately threatened to bankrupt them. Then, the

government decided that it could not let the banks fail

because of their systematic importance and combated

insolvency with taxpayer dollars. This chain of events

revealed weaknesses in the regulatory system and

motivated efforts to create new rules that would restrictbanks ability to take on excessive risk.

Efforts to reform the regulatory system, which revolve

around the Senate Banking Committee chaired by

Democrat Chris Dodd of Connecticut, have encountered

many political and logistical obstacles. As a result, several

months have passed without any substantial progress on

the issue. On February 2nd, however, Paul Volcker, former

Chairman of the Federal Reserve and current advisor to

President Obama, presented a proposal that would

significantly restrict the actions of banks.

Volckers proposal focuses on proprietary trading (actions

in which banks use their own money, rather than the

funds of depositors, to make potentially lucrative

investments) by government-insured institutions. Banks

proprietary trades can carry high risks; if they incur losses

and induce bankruptcy, taxpayers will foot the bill.

Accordingly, the Volcker Rule bans proprietary trading

on the grounds that it allows banks to take on large risks

at the publics expense. Volcker also says that proprietary

trading creates a conflict between the interests of the

bank and of the depositor.

Volcker cites several reasons to defend a ban on

proprietary trading. First, he says that the restriction will

not severely reduce banks profits. Although proprietary

trades can be very profitable for banks, the institutions

can thrive off income from their traditional activities such

as money management and credit provision. Second,

Volcker says that the ban will only affect four or five

banks. Although he has not listed these institutions, they

may include major financial players such as J.P. Morgan,

Goldman Sachs, Citigroup, Bank of America, and

Morgan Stanley. Finally, Volcker believes that the absence

of proprietary trading will create stability in the system

because banks will not be able to take risky positions

whose costs might be passed on to taxpayers in the case of

another bailout.2

Like other attempts at regulatory reform, Volckers

proposal contains many points of controversy and will

have to overcome a variety of obstacles before it passesthe senate. Politically, the proposal faces a mixed

reception. Senator Dodd favors it, while Senator Richard

Shelby of Alabama, the ranking Republican on the

Senate Banking Committee, does not. In addition, the

Republican Party, which in general opposes Volckers

ideas, has enough seats to filibuster in the Senate.3

Potential implementation of the Volcker Rule also

raises concerns about the U.S.s structural position in the

world economy. If American banks face restrictions on

proprietary trading, foreign banks might increase their

use of such trades to gain a competitive advantage. In thiscase, the overall system will suffer. Conversely, foreign

regulators could follow the United States lead in banning

proprietary trading and thus stabilize the international

system. Regardless, Volcker says that U.S. banks have

always been more heavily regulated than foreign ones and

have still been highly competitive.4

Some financial industry insiders suggest that regulation of

the kind that Volcker has proposed is ineffective because

regulators cannot fully understand banks actions or

motivations. Specifically, critics point out that it may be

difficult to pinpoint when proprietary trades have

occurred and that the proposal does not define that type

of trading narrowly enough for the rule to be effective.5

Every banker I speak with knows very well what

proprietary trading means and implies, counters Volcker

Volckers proposal may not pass in its current form. And

if it passes with revisions, it may be weak enough for

banks to maneuver around. Either way, some action on

the regulatory front must occur; Washington will face

serious political consequences if it does not take steps to

impose more order in the financial sector.

Sources:

1http://banking.senate.gov/public/index.cfm?FuseAction=Hearings.Testimony&Hearing_ID=54b42cc0-7ecd-4c0d-88c0-65f7d2002061&Witness_ID=091f5a89-dec4-4905-9fa1-678bfbec823a

2http://www.huffingtonpost.com/2010/02/01/volcker-rule-that-limits-_n_444876.html

3http://www.forbes.com/2010/01/27/obama-volcker-economy-business-banks-oxford.html

4http://www.reuters.com/article/idUSTRE60R6R820100128

Volcker ProposesRestrictions on ProprietaryTradingIan Martin-Katz

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President: Rubin Srimal

Treasurer: David Kellenberger

Head Editor: Kedar Mulpuri

Layout Editors: Ellena Kim & Anoosha Reddy

Copy Editors: Adam Harris & C. Ryan Zehner

Secretary: Alexandar Villar

Head of International Business: Giulia Siccardo

Head of Domestic Business: Kunal Arya

CONTRIBUTORS

OFFICERS

Shan Shan He

David Kellenberger

Olga Korostelina

Megan Ji

Ryan McClafferty

Ian Martin-Katz

Kedar Mulpuri

dartmouth business journal: winter 2010

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