the princeton financier: spring 2013
DESCRIPTION
In addition to student contributed pieces, the fourth issue of the Princeton Financier features an interview wtih Bloomberg correspondent Scarlet Fu, an excerpt from Professor and Dr. Alan Blinder's When the Music Stopped, and a professional piece by Stratus Prep's Shawn P. O'Connor.TRANSCRIPT
WHEN THEMUSIC STOPPED
EXCERPT BY ALAN BLINDER
EVOLTUION AND OUTLOOK OF
ENTREPRENEURSHIPBY SHAWN P. O’CONNOR
THE DEALOF THE CENTURY
BY JULIAN HE, CHRIS WU, AND RYAN AZARRAFIY
Spring 2013 issue
The Princeton
FinancierSPRING 2013
Volume 2 | Issue 2
EDITOR-IN-CHIEF
Darwin Li ‘16
MANAGING EDITORS
Hannah Rajeshwar ‘14
Seth Perlman ‘14
DESIGN & LAYOUT
Michelle Molner ‘16
You-You Ma ‘16
CONTRIBUTORS
Jonathan Ma ‘15
Hadley Chu ‘15
Julian He ‘14
Chris Wu ‘14
Ryan Azarrafiy ‘16
William Beacom ‘15
Christopher Huie ‘16
PCFC BoardSPRING 2013
PRESIDENT
Hannah Rajeshwar ‘14
CLUB MANAGEMENT
Ambika Vora ‘15
EDUCATION
Jonathan Hastings ‘15
MENTORSHIP
Dalia Katan ‘15
MARKETING
Michelle Molner ‘16
COMMUNICATION & TECHNOLOGY
John Su ‘16
INDUSTRY INSIGHT
Sunny Jeon ‘14
Julian He ‘14
Alex Seyferth ‘14
FINANCE
Jason Nong ‘15
ALL CORRESPONDENCEMAY BE DIRECTED TO:
The Princeton Financier
0666 Frist Center
Princeton, NJ 08544
www.princetoncfc.com
LETTER FROMTHE EDITORThe improved economic conditions and
financial metrics of the United States
point toward continued growth in 2013,
both in the financial industry and in
the broader U.S. economy. For the first
time in several years, the recovery of the
real estate and housing sectors is creating
optimism that is reflected in the equities
and commodities markets. Yet despite
these glimmers of hope and recovery,
there are still reasons to worry. The nearly
$17 trillion national debt and the large
income disparities across classes have
caused public concern and unrest. This
issue of The Princeton Financier focuses
on this theme—improvement tinged
with uncertainty—on both a domestic
and global level. This issue begins by
addressing an issue pertinent to many
current citizens and future generations
of citizens: the recent events concerning
our national debt and the legislation
that has revolved around it. As this issue
of The Princeton Financier progresses, we
hope to instill in the reader both a sense
of confidence as they learn about the
growth prospects in different regions of
the world and also a sense of caution as
they understand the uncertainty in other
areas. We hope to leave the reader not only
more knowledgeable about current global
affairs but also cautiously excited about the
future prospects of the global economy.
As has been the case for the past several
issues, The Princeton Financier features
work from the Princeton Corporate
Finance Club’s Industry Insight Team,
which publishes weekly newsletters
that keep members of the Princeton
community well-informed on prominent
market activities around the world. Even
a cursory perusal of the magazine clearly
demonstrates their well-researched work,
which has undoubtedly contributed
significantly to the broader theme of
global economics. Furthermore, for the
second consecutive semester, dedicated
staff writers have been instrumental in
the magazine’s publication. Through
their efforts, this issue is able to cover
the topic of Canadian energy investment
policy and feature an interview with
Scarlet Fu, a chief markets correspondent
for Bloomberg, which provides a look
into the journalism industry. Finally,
this issue was also fortunate enough to
include two professionally contributed
pieces from Stratus Prep President
Shawn O’Connor, a column writer for
Forbes Magazine, and from renowned
American economist Alan Blinder, author
of After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead
and a Gordon S. Rentschler Memorial
Professor of Economics & Public Affairs
at Princeton University. We are extremely
grateful for the continued support from
our undergraduate contributors and
from leading industry professionals.
In addition to the efforts of the magazine
contributors and editors, the successful
publication of the fourth issue of The Princeton Financier was made possible by
the tenacity of many officers of its parent
organization, the Princeton Corporate
Finance Club (PCFC). From diligent
design and layout planning to tireless
fundraising and marketing campaigns,
it took the hard work of many divisions
of PCFC to create this final product.
If you find this issue of The Princeton Financier to be fascinating, I recommend
exploring many of the other exciting
opportunities PCFC has to offer as well.
On a final note, similar to a theme expressed
in this issue, the young yet burgeoning
PCFC sees a bright future ahead. With
a growing student officer team and
increased reach on campus, PCFC hopes
to continue and improve upon its current
operations for future semesters. With
your support, the backing of committed
corporate sponsors, and a creative team
with big plans for the future, the continued
growth and success of the PCFC is
viewed with great optimism. Thank you.
- Darwin Li
The mission of the Princeton Corporate Finance Club is to provide an educational and networking platform for Princeton students interested in investment banking, private equity, venture capital, and the field of corporate finance at large. Established in March 2011, the Princeton Corporate Finance Club has quickly become a prominent club on the Princeton campus with over 400 student members and 30 officers working in seven divisions: Education, Mentorship, Industry Insight, Finance, Marketing, Communication & Technology, and The Princeton Financier. Our core values are fraternity, entrepreneurship, leadership, responsibility, integrity, professionalism, and mutual respect.
ABOUTPCFC
Kicking the Can Down the Road
by Jonathan Ma
An Inside Look at Financial Journalism: Interview with Bloomberg’s Scarlet Fu
Interview by Hadley Chu
BP & Rosneft: Deal of the Century
by Julian He, Chris Wu, and Ryan Azarrafiy
When the Music Stopped: An Excerpt From After the Music Stopped
by Alan Blinder
Entrepreneurship: Individual Accomplishments, National Impact
by Shawn P. O’Connor
The CNOOC-Nexen Deal and the Future of Foreign Direct Investment in Canada
by William Beacom
Southeast Asia: The End of the Ride?
by Christopher Huie
The Princeton
Financier
INSIDE:
46912161922
Erskine Bowles. This Bowles-Simpson
Committee was tasked with identifying
“policies to improve the fiscal situation
in the medium term and to achieve fiscal
sustainability over the long run.”
The Committee’s proposal would have cut
$4 trillion in debt by 2020, which would
reduce the ratio of national debt to GDP
from its current level of 73% to 60%
by 2023 and to 40% by 2035. Bowles-
Simpson took a balanced approach, by
raising revenue and cutting entitlement
against the wishes of Republicans and
Democrats alike.
The Committee proposed putting limits
on discretionary spending and also
proposed eliminating all tax expenditures,
decreasing the current tax rates and then
later deciding which deductions to add
back on and then raising the tax rates
accordingly. Furthermore, the committee
proposed raising the scheduled retirement
age in an effort to reform Social Security.
Although the proposal tackled the debt
as diplomatically as possible, it ultimately
failed in December 2010 as it received
only 11 out of the 14 required votes to be
considered by Congress.
United States Debt Ceiling Crisis of 2011
In the middle of 2011, the Treasury
needed Congress to raise the national
debt ceiling because the United
States’ debt obligations had increased
from the previous year. To address
the nation’s high level of debt,
Republicans and some Democrats
In order to understand the budget
sequester of March 2013, it is necessary
to understand the events that came before
it. In 2007, the U.S. national debt was
34% of GDP. By March 2011, this figure
had ballooned to 75%. This increase
was primarily due to not only lower
tax receipts produced by a recovering
economy, but also major stimuli from
the Federal Government. The national
debt was and is predicted to grow due to
the combination of an aging population
with a higher demand for healthcare and
social security and compounding interest
payments on the current debt.
According to Harvard Economics
Professor Martin Feldstein, the United
States cannot afford to continue this
trend. At some point, when a nation
has too large of a ratio of debt to GDP,
investors will suspect the nation’s ability
to repay the debt and will demand higher
interest rates to account for the added
risk. Higher interest rates will not only
add to the existing national debt but also
affect consumers who would have to pay
a higher interest rate for borrowing. There
are two primary methods of lowering
the debt: raising taxes and cutting
expenditure. Both of these methods,
however, slow economic growth.
Bowles-Simpson Committee
In 2010, President Barack Obama
created the National Commission on
Fiscal Responsibility and Reform which
was co-chaired by former Republican
Senator Alan Simpson and former
Democrat White House Chief of Staff
tried to create a sustainable budget
before raising the debt ceiling, but
the ideological gulf between the sides
proved too large to bridge.
In the days directly prior to the
Department of Treasury exhausting its
borrowing ability, Congress passed the
Budget Controls Act of 2011. The act
raised the debt ceiling by $900 billion
in exchange for $917 billion in cuts
over 10 years.
Furthermore, a Joint Select Committee
of six Democrats and six Republicans
was created to devise a plan that would
decrease the deficit by $1.5 trillion over
the next 10 years. The only caveat was
that if the super committee could not
reach a decision, then increasing the debt
ceiling by $1.2 trillion would result in
a $1.2 trillion sequester, or automatic
spending cuts, which would be split
between defense and nondefense. The
sequestration was designed to be so
painful that the super committee should
be forced to find a compromise to avoid
the horrid automatic cuts.
The Super Committee
Political commentator Fareed Zakaria
described the super committee as “one
more occasion where Congress...basically
punted, kicked the can down the road.”
Zakaria argues that the super committee
was doomed to fail, as “the Democrats
are saying no cuts to entitlements…
The Republicans are saying no taxes…
that’s great except we all know the only
solution to our long-term debt problem
THE PRINCETON FINANCIER | 4
taxes. The optimal compromise is then the
solution the United States had all along:
the proposal by the Bowles-Simpson
committee. In February 2013, Bowles
and Simpson released a proposal similar to
their 2010 version, except this time they
included a means-test for the Medicare
beneficiaries as well as the suggestion of
raising Medicare eligibility age, which
ultimately made the proposal highly
unattractive to left wing Democrats.
But equally unattractive is the removal
of $1.1 trillion tax deductions. The new
Bowles-Simpson proposal would reduce
debt by $2.4 trillion in the next 10 years.
Two other possible solutions are evident
in Senate and House budgets for fiscal
year 2014. The largely Republican-
driven House budget seeks to reduce the
national debt by $4.6 trillion in the next
decade, increasing reliance on spending
cuts, capping government spending
on Medicare, and lowering taxes, all of
which are ideas that Democrats disagree
with. The Senate budget that was largely
spearheaded by Democrats seeks to
reduce the debt by $1.85 trillion in the
next decade. Of the $1.85 trillion in
the Senate budget, $1 trillion will come
from tax revenue, a solution that remains
unpalatable to Republicans.
Neither budget looks slated to receive wide
support from both parties. The best hope
is then to have a compromise that includes
both increases in revenue and cuts to
entitlement. Hopefully in 2013, Congress
and the President will decide to take the
House’s stance of reducing entitlement,
the Senate’s plan for raising taxes, or reach
another conclusion similar to the Bowles-
Simpson plan, rather than simply kicking
the can further down the road.
is cuts in entitlements and new taxes.”
On November 21, 2011, the super
committee announced it could not
reach a solution. Without a plan from
the super committee, America had to
brace for the automatic budget cuts
that were about to go into effect in
January 2013 unless Congress and the
President were able to find a way to
put the nation on a sustainable path
and to avert the cuts.
United States Fiscal Cliff of 2012
Due to the budget sequestration, the
Budget Controls Act of 2011, and
the expiring Bush Tax cuts, Congress
and the President were tasked with
preventing a massive increase in
taxes and sudden spending cuts.
The Congressional Budget Office
predicted that if Congress did not
act, unemployment would rise from
7.9% to 9.1% and the U.S. economy
would have a mild recession with
-0.5% GDP growth in 2013. Once
again, both sides clashed and a
grand bargain did not materialize.
President Obama, who had just been
re-elected, pushed for and succeeded
in passing the American Taxpayer
Relief Act of 2012 (ATRA) which
permanently extended the Bush Tax
cuts for individuals earning less than
$400,000 and raised the top marginal
tax rate for those earning more than
$400,000 from 35% to 39.6%, and
raised capital gains tax from 15% to
20%. Furthermore, ATRA phased out
certain tax deductions, raised estate
taxes, allowed payroll tax cuts to expire,
and extended federal unemployment
benefits for a year. However, the act
delayed the budget sequestration for
two months to March 1, 2013 and
did not address the issue of raising the
debt ceiling. The American Taxpayer
Relief Act is estimated to bring in
$600 billion in revenue over 10
years. However, in the February 2013
Budget Outlook, the Congressional
Budget Office projected that in 2023,
the United States’ national debt would
be 77% of its GDP and on an upward
path, which suggests that futher work
would need to be done.
Budget Sequester 2013
The automatic cuts from the Budget
Control Act of 2011, which were delayed
by two months by the American Taxpayer
Relief Act of 2012 became a concern in
March 2013. The sequestration was
supposed to cut $85 billion for the Fiscal
Year 2013, half in defense and half in
non-defense. After weeks of discussion,
once again no middle ground was found
and on March 1, 2013, President Obama
reluctantly signed an order putting the
cuts into effect.
Moving Forward
The debt limit is set to be breached on
May 18, 2013, which both Congress and
the President will again attempt to come
together to find a compromise to reign in
the United States’ national debt. There
are a few possible solutions.
The most pessimistic one is identified
by Harvard History Professor Niall
Ferguson, who laments, “is there a single
member of Congress who is willing to
cut entitlements or increase taxes in order
to avert a crisis that will culminate only
when today’s babies are retirees?” The span
of time between when the crisis will come
to a head and the present day may make
compromise politically inexpedient. If
this aversion continues for too long, the
crisis will become unpreventable by the
time action is taken.
However, Princeton Economics Professor
Paul Krugman suggests that in last year’s
election, “American voters made it clear
that they wanted to preserve the social
safety net while raising taxes on the rich.”
In this case, the solution may be to raise
THE PRINCETON FINANCIER | 5
There are two primary methods of lowering the debt: raising taxes and cutting expenditure. Both of these methods, however, slow economic growth.
THE PRINCETON FINANCIER | 6
AN INSIDE LOOK AT FINANCIAL JOURNALISM:
INTERVIEW WITH BLOOMBERG’S SCARLET FU
[ ]How do you choose your stories?
We decide the day before which guests will
be joining us. The show lasts from 6:00 to
8:00 AM, and then after it ends, I return
to my desk and see what else is going on in
the news, and then we have a meeting at
8:30 AM. You basically have half an hour
to go from one day to the next and so we
have to know all the headlines and news
pegs. The segment producers will have
booked around these stories and we will
have suggestions, but sometimes there are
holes to fill. We usually have a pretty good
idea of what 80% of the show will be
about but we won’t necessarily know what
the top stories will actually be. Based on
what is happening today, we can usually
provide you with an idea but that idea will
obviously be updated the next morning.
After the meeting, I go back to my desk
and then later, I contribute to the 10:00
AM to 12:00 PM show.
What was your first job?
I was a history major in college and after
I graduated, I moved to Hong Kong
because at the time, the economy was not
doing very well which meant my options
were ‘go to law school’ or ‘be a temp.’
Since neither of those options was very
appealing, I went to Hong Kong to look
for a job and got one at General Electric.
They had a financial management training
program, which sounded really good, but
after about two weeks I realized that job
was not the right fit for me.
How did you get from there to Bloomberg?
I did not want to be a mid-level finance
manager, so I talked to the manager of
the GE training program. At the time,
GE owned NBC which owned CNBC,
and CNBC was just launching. I told
the manager that I wanted to switch to
CNBC, and he helped me move over to
the editorial and production side, where I
started off as an intern. After that switch, I
had to prove myself indispensable so that
they would hire me full-time.
Why the switch from Hong Kong to New York?
I stayed at CNBC Asia for slightly over
two years and then I moved to Bloomberg
after seeing a job advertisement in the
newspaper. Back then, in Hong Kong,
it was common to get jobs by reading
advertisements in the newspapers. Since I
was on the print/production side, and so
I was ordering graphics, booking guests,
writing scripts, and writing questions
for the anchors to ask the guests, but I
was never on camera. Television is one of
those funny places where it takes a village
to put together a show but there are only
one or two people who actually get the
credit. I moved to Bloomberg because I
realized that as a television reporter, you
are only re-writing wire copy instead
of actually going out and doing the
reporting yourself. I wondered ‘where
do wire-copy people get their stuff? Why
did they say Hong Kong stocks rose or
fell? Where do they get this information
from?’ Bloomberg was the place to do all
of it because they have the information
and wrote all those stories. I moved from
CNBC to Bloomberg, started writing
those stories, and after I returned home
to the U.S., I eventually moved back to
television.
What have been the most interesting stories you’ve ever covered?
In Hong Kong, I covered the handover
which was certainly eventful but in the end
turned out to be extremely orchestrated, so
not a lot of news was generated from that.
But the financial crisis afterwards really
took everyone for a spin. That was really
volatile—no one knew what was going
on initially. I got trained to stare at the
Bloomberg screen just to watch the index
move. I remember watching it plunge, and
then all of a sudden, it would go back up
again. The government was buying stock
because people were attacking the Hong
Kong dollar and trying to break the peg.
Basically, the Hong Kong government
came in and defended the currency and
bought up shares as a show of force which
made a really great story. Of course, the
financial crisis overall in 2008 and 2009
was also just stunning to watch unfold.
Tell me about covering the recession from the inside.
Unfortunately, bad news creates more
interesting days for a news reporter. The
boring days were those when the stock
market was doing great in the summer
of 2007. It was like ‘oh look it’s another
buyout, it’s another M&A, another
takeover, another quarter-record profits,
and another record for the Dow.’ It lost
its luster after a while, and even then,
you would always get this unsettling
feeling because you knew it couldn’t go
on forever, but you didn’t know what
was going to make the music stop.
The financial crisis was fascinating, but
thinking back, I feel like we missed a lot
of the stories at the time because there was
so much misinformation flying around.
We knew what was going on with AIG
and Lehman Brothers but we didn’t know
the depth of the problems. Uncovering
those problems took more investigative
reporting by everyone.
Do you think being at Bloomberg at this time gave you a different perspective on the recession?
It’s possible—although when you fixate so
much on the day-to-day, you often miss
the bigger picture. I think what you are
able to appreciate is how interconnected
everything is and that there are a lot of
warning signs here and there. There are
always people who will be contrarians;
when times are good you give them the
opportunity to say it, but not everyone
wants to believe it. The other thing about
markets and Wall Street is that people
might be convinced that the good times
can’t last but that doesn’t mean that you
THE PRINCETON FINANCIER | 7
Scarlet Fu is the chief markets correspondent for Bloomberg Television. She covers trading activity in Asia, Europe and the United States, contributes to “Bloomberg Surveillance”, and is featured on Bloomberg Television, Bloomberg Radio, and Bloomberg.com. Fu began her career at Bloomberg News covering Asian equities and worked as a U.S. stocks editor before switching to Bloomberg Television. Prior to working at Bloomberg, she worked at CNBC Asia in Hong Kong. She graduated from Cornell University with a bachelor’s degree in history and a concentration in Asian American Studies.
sit it out either. You still have to make
money and you don’t have to believe in
something to make money off of it.
Who are the most interesting people you’ve interviewed?
Outside the world of finance? I
interviewed Adrian Grenier from
Entourage once. But what is really the
most interesting is talking to people who
head up companies and finding out how
they navigate the waters in this extremely
uncertain economy. It is always more
interesting to hear people who have a lot
of responsibilities; who have to take care
of people in their company and who are
really accountable for everything they do.
I like that. Sometimes we spend a lot of
time talking to economists and getting
their GDP forecasts. But after a while that
can sound the same, even though it’s not.
When the Federal Reserve is so involved
in the market, there is always a caveat
that everyone has to give when making
projections about the economy.
What’s the hardest part of your job?
The hardest part of my job is waking up at
3:00 AM! Being able to think clearly and
quickly when you are sleep deprived is a
huge challenge. But I think doing it day
after day is the only way you get better at
it because that’s the only way you build up
the muscle memory and the institutional
knowledge of everything since you can’t
predict what kind of news is going to break
at any given time.
Just to give you an example, the other
day there was breaking news on Fedex.
Earnings reports were coming out, and
they cut their forecasts for the full year,
which was a surprise. You have to know
the backstory to these delivery companies:
what is going on with the economy, how
leveraged they are to the economic cycle,
etc. You also have to know that Fedex in
particular is going through a big program
of restructuring. If you don’t know any of
that information, then the headline that
comes out does not make sense. You have
to know all of that information to be able
to add context to the headline and thus
make it a bigger story.
Quite simply, how much finance do you have to know to be a financial journalist?
You know a little bit about a lot of
different things, but you pick up a lot
of it on the job. Part of it just is reading
every day—constantly reading other
news stories, reading Bloomberg stories,
reading the Op Eds, reading the research
reports that people send us when they
come on as guests, and reading research
reports people send us because they were
guests. You have to read constantly.
Who are your competitors and how do you differentiate yourselves from them?
Anyone and everyone who covers business
and financial news are our competitors,
from the Wall Street Journal and the
Financial Times to various blogs. In
comparison to other TV networks, I feel
we’re less solely focused on the markets.
We also compete for the same guests,
but we try to ask smarter questions, and
I think we usually succeed.We try to
avoid the pattern of a CEO giving us the
standard patent answer, us letting it go,
and then moving on to the next topic. We
will really challenge them.
The way I see it, you’re both a mirror and a catalyst for Wall Street. What role does Bloomberg play in the industry today? Perhaps more generally, what do you think the role of financial journalism is today?
I think it’s interesting how a lot of
people in the financial world will use
media as a means to their own ends.
Take the battle between Bill Ackman
and Carl Icahn—they’re playing it
out in the media and we’re covering
it. We like the angle of ‘here’s Carl
Icahn—this big corporate raider guy
who’s inspired Gordon Gekko—he’s
got a personality larger than life, and
they’re battling each other.’ They
both have billions of dollars at stake,
and we contribute to that, so we
don’t help matters either. You have
to sift through a lot of information
to get to what it is they really believe
in. They use the media to push their
agendas and we allow it to happen
fairly often.
But on the other hand, the media has
done an incredible service to everyone
by explaining what happened with the
financial crisis. Were we responsible
for helping drive stock prices up the
way they were? Maybe, or maybe we
were a mirror of what was actually
going on too.
We try to be as hype-free as possible
but even as a financial news channel,
we are still part of the entertainment
business. We need to give people a
reason to watch. I’m sure you’ve heard
about the whole Lululemon story
right now about the see-through yoga
pants. People are joking ‘who’s going
to do the bend-over test?’ So even
though the problem resulted in a $20
million hit for the company, but it
was still entertaining.
What keeps you going every day?
The fact that I’m accumulating
knowledge and that I’m always
trying to learn something new. That
motivation is probably the best part
of the job. In two hours, I could be
interviewing someone on a topic I
know nothing about but I have an
hour beforehand to figure it out. You
probably won’t ask the best questions
in the world but all you can do is
make the best of what you have at the
moment and fly by the seat of your
pants knowing that you have built up
enough knowledge about the business
world and the economic world to be
able to ask an intelligent question.
Best advice you’ve ever been given?
While the tiger mom didn’t
personally give me this advice, there
is a certain truth to it: you don’t
enjoy something until you’re good
at it. The only way to get better at
something is to do it over and over
again and then it becomes fun. You
start to feel like you’re in control of
the material and so you can have a
higher-level discussion about it than
you were capable of having before.
THE PRINCETON FINANCIER | 8
Russian oil giant Rosneft has completed
a deal with British Petroleum (BP)
that has an expected worth of over $55
billion. The Daily Telegraph has dubbed
this deal the “deal of the century” as it will
make Rosneft the world’s third largest
oil producer after ExxonMobil and
Chevron and also secures BP a foothold
in one of the world’s largest and richest
oil regions. Rosneft reached agreements
with not only BP but also Alfa-Access
Renova (AAR) in order to secure their
ownership stakes in the Russian oil firm
TNK-BP—which is currently the third
largest oil firm in Russia and one of top
ten largest oil firms in the world. The
deal is expected to have wide-ranging
consequences for not only the Russian
oil sector, but for the Kremlin and future
foreign investment activity as well.
Background
The firm at the center of this deal
is TNK-BP, a vertically integrated
corporation that operates primarily
in Russia and the Ukraine. Formed
in 2003 as a “strategic partnership”
between BP and Russian business
consortium AAR, TNK-BP now
produces nearly 1.7 million barrels
of crude per day and currently has a
market value of $37 billion. In 2003
TNK-BP acquired natural gas firm
Rospan, and in 2004 began to pursue
international interests by purchasing
50% of Slavneft, a Russian-Belorussian
firm. Ownership of TNK-BP is
currently divided in an equal 50-50
split between BP and AAR.
Rosneft is an even larger firm. It is the
largest oil producer in Russia, both in
terms of extraction and refinement, and
is valued at nearly $85 billion. Similar to
TNK-BP, Rosneft is vertically integrated
and owns production facilities from
Chechnya to Siberia as well as shipping
and pipeline systems and refineries near
the Black Sea and the Pacific Ocean.
The firm’s first major expansion occurred
in 2003 via its acquisition of facilities
from the now-defunct Yukos Group, a
Russian firm whose former owner was
convicted of fraud and tax evasion. Much
of Rosneft’s complex organizational
structure is indebted to its origins as a
state-run enterprise from the early days
of post-Soviet Russia. At this time, policy
makers had appointed the executive
leadership of the firm and provided oil
fields originally run by the Soviet energy
department in an attempt to ultimately
push the fledgling corporation into the
private sector. Even after a 2006 IPO
that raised an impressive $10.7 billion,
over 75% of the firm is still owned by the
Russian government—and the Kremlin
regimes under both Putin and his
subsequent protégés have not been shy
about protecting their interests in both
Rosneft and other domestic firms.
As a “supermajor”, or one of the world’s
six largest public owned oil and gas
companies, BP is also accustomed to
governmental intervention. In 2008,
AAR leaders forced a power play by
spreading allegations that TNK-BP
British executives had violated Russian
visa laws. The threat of litigation led to
the removal of BP-backed CEO Bob
Dudley, an American national who
was subsequently replaced by Mikhail
Fridman, the president of AAR. Since
the Russian courts were favoring AAR’s
claims, and 25% of BP’s revenue
originates from its Russian venture, the
British chose to acquiesce to AAR to
avoid losing part of their investment.
BP was once again impeded by the
Russians in 2011 amidst the planning
of a joint venture with Rosneft for the
development of oil fields in the Arctic
shelf. In addition to expanding into
new sources, the two firms had hoped
to test cold-weather drilling technologies
Although BP is relinquishing its stake in TNK-BP, the British oil giant views the planned sale as an opportunity to secure a much stronger foothold in the rich Russian oil sector.
THE PRINCETON FINANCIER | 9
THE PRINCETON FINANCIER | 10
agreed to ship up to 67 million tons of oil
over five years. As the deal nears completion,
Rosneft has since borrowed another $6
billion from Gazprombank.
After the deal, Rosneft will become the
world’s largest energy company in terms
of liquid hydrocarbon extraction and
the third largest by estimated net profit
($21.46 billion). This deal will enable
Rosneft to extract half as much oil as
that of Saudi Arabia. The merger will
also initiate a powerful alliance between
Rosneft and BP and most notably, mark
the end of TNK-BP, Russia’s third largest
oil supplier that while profitable, was often
harmed by boardroom disagreements.
Rosneft’s acquisition of TNK-BP has
garnered widespread approval since
the deal was announced. Former
Russian President Vladimir Putin has
demonstrated strong support for the
merger, since it will make Rosneft’s Chief
Executive Officer, Igor Sechin, one of
Russia’s most powerful individuals, thus
increasing Rosneft’s and therefore, the
Russian government’s power. According
to Putin, “this is a good, large deal that is
necessary not only for the Russian energy
sector but also the entire economy.” In
early March, the European Union also
approved the merger, though according to
the EU anti-trust authority, “the merged
entity would continue to face constraints
from a number of strong competitors.”
Although BP is relinquishing its stake in
TNK-BP, the British oil giant views the
planned sale as an opportunity to secure
a much stronger foothold in the rich
developed exclusively for the Russian
Arctic. However, this undertaking was
blocked in Russian courts by AAR due
to claims that the partnership would
violate previous exclusivity contracts that
were signed during the creation of TNK-
BP. The case languished in court until
ExxonMobil offered Rosneft a cut in its
Texas and Gulf operations in exchange
for BP’s spot in the partnership. This
proposition was accepted because it
was favorable to both firms. The Exxon-
Rosneft deal was ultimately worth $3.2 billion
and is thus seen by many as a huge loss for BP.
The Deal
In 2012 Rosneft announced its plans to
acquire TNK-BP in a deal that could
quite possibly make Rosneft the largest
publicly traded energy company in the
world. The deal is worth $61 billion and
requires Rosneft to pay BP $17 billion in
cash and provide12.84% of its own shares
in return for the British’s 50% stake in
TNK-BP. As part of the deal, Rosneft
will assume control of AAR’s share as well
in what will become the largest global
M&A transaction in the past three years
and the largest oil deal in the past decade.
In addition, BP will gain two seats on
Rosneft’s Board of Directors.
In order to finance the deal, Rosneft has been
massively borrowing from multiple lenders.
Since December 2012, Rosneft has borrowed
more than $30 billion from multiple banks
across countries including the U.S. and
China. Rosneft also secured $10 billion in
advance payments from commodity trading
companies Vitol and Glencore and in return,
Russian oil sector. The British stand to
gain a significant stake in Rosneft which
will become one of the largest oil firms in
the world at the conclusion of the merger.
The move also allows BP to protect
its financial interests in the area while
removing it from direct involvement,
which should lessen Russian political
interference. Yet the underlying question
is which firm got the better end of the
bargain: BP or Rosneft?
Winners and Losers
BP looks to gain the most from this deal,
since it will likely catalyze the end of
its difficult marriage to AAR. The four
oligarchs of AAR who collectively own
the other half of TNK-BP (Len Blavatnik,
Mikhail Fridman, German Khan, and
Viktor Vekselberg) have had historically
testy relations with BP. An argument
between AAR and the CEO Bob
Dudley concerning the relative merits
of dividend payments versus retention
of earnings led to Dudley’s removal in
2008. During this time, Dudley claimed
to be under “constant harassment”
from both his business partners and the
Russian government. Furthermore, AAR
was responsible for blocking the previous
$7.8 billion Arctic development deal
between BP and Rosneft which led to
BP’s rival ExxonMobil cashing in on the
opportunity and further souring relations
between BP and AAR.
This deal will dissolve the toxic
relationship between BP and AAR while
also smoothing relations with the Russian
government. Thus this deal seems to
secure BP’s future in the oil-rich nation.
In past years, Russian authorities have
raided BP’s offices in Moscow, and at
one point even sought to detain Dudley,
who was the CEO of BP at the time.
With BP’s 10% stake in Rosneft, the deal
provides an alliance with Russia’s state-
owned oil giant and opens a gateway to
Russia’s immense oil riches.
However, there are reasons to be skeptical
of BP’s future in Russia. Combined with
Rosneft’s continual underperformance,
the power struggle in the Kremlin only
adds increasing amounts of uncertainty to
Historically, state-run behemoths
not only are they prone to develop excessive internal bureaucracy, they are also susceptible to external political
THE PRINCETON FINANCIER | 11
the potential benefits of the deal. A 10%
stake is not insignificant in a venture filled
with uncertainties. Obviously, supporters
of the deal argue that BP will bring better
management and expertise to Rosneft
and revive the Russian oil giant. But that
logic is built upon an uncertainty. In
fact, many BP shareholders would rather
walk away from the TNK-BP venture
after many profitable years with a cash
settlement. However, a cash-only deal is
not being offered by Rosneft.
The lesson of the day is that there is no
free lunch. BP’s alliance with Rosneft,
though full of promises, is also full of
uncertainties and risks.
That being said, Rosneft’s gains are
accompanied by fewer downsides. After the
deal, Rosneft will become the world’s largest
listed oil producer, with 4.5 million barrels of
oil production per day, which is equivalent
to 45% of Russia’s oil output. Rosneft will
most likely not dominate the oil industry
to the degree that Gazprom dominates
the gas industry, but the deal will create a
comfortable margin between Rosneft and its
closest rivals, Lukoil and Surgutneftegaz.
On the other hand, the AAR oligarchs
seem to be in the sole losers of this deal.
They stand to lose their very profitable
alliance with TNK-BP, and even worse,
Rosneft has held the upper hand in
negotiations since the beginning, since
Rosneft already had a firm agreement
with BP to buy its half of the company.
Therefore, if the oligarchs had decided
to end the negotiation because they did
not approve of the terms, they would
find themselves in a 50-50 partnership
with Rosneft, and thus the Russian
government as well. The oligarchs will do
everything to avoid this situation as the
government would undoubtedly move to
remove whoever controls the other half.
Even though the deal helps Putin in
achieving his goal of state dominance
in key sectors, it does not necessarily
guarantee Russia’s success in the long run.
In the short term, the deal helps Russia
improve its image as a foreign investment
destination by ending BP’s troublesome
relationship with AAR, but in the long
term, inefficiency and capital flights could
present enormous difficulties for Russia.
Historically, state-run behemoths are
doomed to inefficiency because not only
are they prone to develop excessive internal
bureaucracy, they are also susceptible to
external political influence. Capital flight is
also another potential byproduct of state-
run behemoths. Net capital outflows from
Russia have been continually increasing
and reached $80 billion in 2011. The re-
emergence of state-run behemoths might
serve to further aggravate the problem.
Whether BP, with its newfound access to
the promised land of Arctic riches, and
Rosneft, with its fresh dominance in the
Russian oil industry, can be successful in
the future remains to be seen. Thus the
BP-Rosneft “deal of the century,” as one
of the biggest mergers in history and the
largest oil deal since the Exxon-Mobil
merger, might just prove to be more than
hype and could permanently change the
landscape of the oil industry.
THE PRINCETON FINANCIER | 12
By 2006 the United States had built an
intricate financial house of cards—a
concoction of great complexity,
but also of great fragility. Like
most houses of cards, this one was
constructed slowly and painstakingly.
The sheer ingenuity was impressive.
But when it fell, it tumbled suddenly
and chaotically. All that was necessary
to trigger the collapse was the removal
of one of its main supporting props.
The jig was up when house prices
ended their long ascent; after that,
the rest of the crumbling followed
logically. Unfortunately, not many
people had penetrated the tortured logic
beforehand; so few were prepared for
the devastation that ensued.
The end of the house-price bubble itself could
hardly have come as a surprise. By 2006 the
“is there a bubble” debate was just about
over, and seemingly everyone was wondering
how much longer the levitation act could
last. The disagreement—and it was a serious
one—was over how far house prices would
fall. Optimists thought prices would just
level off, ending their unsustainable climb,
Alan S. Blinder is the Gordon S. Rentschler memorial professor of economics and public affairs at Princeton University, vice chairman of the Promontory
Interfinancial Network, and a regular columnist for The Wall Street Journal. Dr. Blinder earned his A.B. from Princeton University, his M.Sc. from the London
School of Economics, and his Ph.D. from the Massachusetts Institute of Technology—all in economics. He has taught at Princeton since 1971, and was founder
of the university’s Center for Economic Policy Studies, where he served alternately as director and co-director from 1989 to 2011. He also served as vice chair-
man of the board of governors of the Federal Reserve System from June 1994 to January 1996. Before that, he served as a member of President Clinton's original
Council of Economic Advisers, from January 1993 to June 1994. He served as economic advisor to the Democratic presidential candidates in 2000 and 2004,
and he continues to advise numerous members of Congress and elected officials. He also served briefly as deputy assistant director of the Congressional Budget
Office when that agency was founded in 1975, and testifies frequently before Congress on a wide variety of public policy issues. Dr. Blinder is the author or co-
author of 20 books, including the textbook Economics: Principles and Policy (with William J. Baumol), now in its 12th edition, from which well over two and a
half million college students have learned introductory economics. His latest book, After the Music Stopped: The Financial Crisis, the Response, and the Work
Ahead, was published in January 2013 (Penguin Press). He is based in Princeton, NJ.
WHEN THE MUSIC STOPPED:
AFTER THE MUSIC STOPPED
By Alan Blinder
AN EXCERPT FROM
[ ](REPRINTED BY PERMISSION OF THE AUTHOR AND THE PENGUIN PRESS)
The real wake-up call didn’t come until
August 9, 2007, when BNP Paribas, a huge
French bank, halted withdrawals on three
of its subprime mortgage funds—citing as
its reason that “the complete evaporation
of liquidity in certain market segments of
the US securitization market has made it
impossible to value certain assets fairly.”
Loose translation: Dear Customer, you
can’t get access to the money you thought
was yours, and we have no idea how much
money that is. To people acquainted with
American history, Paribas’ announcement
brought to mind the periodic “suspensions
of specie payments” in the nineteenth
century—times when some prominent
bank precipitated bank runs by refusing to
exchange its notes for gold or silver. The big
French bank had just refused to exchange
its fund shares for cash. Whether you were
French or American, the signal was clear:
It was time to panic. And markets dutifully
did so, all over the world.
At some point, and in this case it didn’t
take long, the interplay of falling asset
values with high leverage starts calling
into question the solvency of heavily
exposed financial firms like Bear and
Paribas. Thus, market-price risk, which is
already acute and getting worse, conjures
up visions of counterparty risk: worries
that firms that owe you money might not
be able to pay up.
Once such seeds of doubt are sown,
the scramble for liquidity begins in
earnest, because, like it or not, markets
are fundamentally built on trust— in
particular, on trust that the other guy will
pay what he owes you in full and on time.
In worst cases, markets seize up. In less
severe cases, enormous “flights to quality”
are triggered, typically to U.S. Treasury
bills. In any case, the bond bubble, which
was predicated on blissfully ignoring risk,
ended with a bang on August 9, 2007.
Fear was taking over.
At the Fed’s Annual Watering Hole
In late August of each year, most members
of the Federal Open Market Committee
(FOMC) doff their gray suits, don their
cowboy boots (if they own any), and
head off to Jackson Hole, Wyoming.
There they meet with a select group of
anticipated this virtually unprecedented
collapse. (True confession: I was not one
of them.) For decades, Americans had
witnessed periodic housing bubbles, which
blew up and popped in particular parts of
the country. But when home prices fell in,
say, Boston, they kept rising in, say, Los
Angeles—and vice versa. The period after
2006 was different. House prices fell all
over the map, undermining the trumpeted
gains from geographical diversification.
That was a forgivable error. The proverbial
hundred-year flood actually happened.
But when the housing market began to
crater, we also learned that many of the
MBS were not nearly as well diversified
geographically as had been claimed. In
fact, it turned out that a distressingly
large share of the bad mortgages came
from a single state: California. Many
of the rest came from Florida, Arizona,
and Nevada—collectively known as
the “sand states.” For these and other
reasons, the MBS turned out to be much
riskier than advertised.
Second, the securities were not as widely
distributed as had been thought. Yes, there
were holders all over the world—from
hamlets in Norway to Italian pension
funds to billionaires in Singapore. But
when the crash came, we learned that
many leading financial institutions had
apparently found mortgage-related assets
so attractive that they still owned large
concentrations of them when the bottom
fell out. One reason was that there was so
much profit in selling the other tranches
of MBS, CDOs, and the like that
investment banks were willing to hold
the lowest-rated (“toxic waste”) tranches
themselves. The failures and near failures
of such venerable firms as Bear Stearns,
Lehman Brothers, Merrill Lynch,
Wachovia, Citigroup, Bank of America,
and others were all traceable, directly or
indirectly, to excessive concentrations of
mortgage-related risks.
The system began to crack in July 2007, when
Bear Stearns told investors in one of its mortgage-
related funds that there was “effectively no value
left.” The music was stopping. A variety of
financial markets started twitching nervously,
which should have been taken as an omen. But
wishful thinking dies hard.
or perhaps decline only a little. Pessimists
were talking about price declines of
20 percent, 30 percent, or even more.
What about the market? Futures traded
on the Chicago Mercantile Exchange
on September 16, 2006 indicated that
investors expected a 6.4 percent decline
in the Case-Shiller ten-city composite
index. That proved to be way too small.
In the end, the more pessimistic you
were, the more prescient you were.
The Cards Tumble
The bond bubble was far less visible to
most people, vastly more complicated,
and appreciated by few. It also burst
with devastating effect. But the
bursting came in stages.
Once house prices stopped rising,
subprime mortgages that had been
designed to default started doing
precisely that. At first, many of us wrongly
believed that subprime constituted too
small a corner of the financial market
to do much damage to the overall
economy. We soon learned better. To
pick two nonrandom examples, Treasury
Secretary Hank Paulson said in an April
2007 speech that the subprime mortgage
problems were “largely contained.” A
month later, Federal Reserve Chairman
Ben Bernanke told a Fed conference that
“we do not expect significant spillovers
from the subprime market to the rest of
the economy or to the financial system.”
Unfortunately, the huge amounts
of leverage multiplied the damages
many-fold, and the untoward degree
of complexity helped spread the ruin
far and wide. Financial industry
executives—allegedly the smartest guys
in the room—had every incentive to
keep the party going for as long as they
could, and they certainly tried. The
regulators, still asleep at their various
posts, allowed them to go on for far too
long. The day of reckoning was delayed
but not avoided. Why did the house of
cards tumble so hard and so fast?
First, when the national housing
bubble burst, home prices fell almost
everywhere—an “impossible” event
that had not occurred since the Great
Depression. In fairness, few observers
THE PRINCETON FINANCIER | 13
unlimited amounts—is the central bank.
Both the Federal Reserve and the European
Central Bank (ECB) did so massively,
starting on Paribas Day, August 9, 2007. In
so doing, they were performing a function
that central banks have performed for
centuries: serving as the “lender of last
resort” in order to get their financial systems
through liquidity crises. The volume of new
dollars and new euros spewing forth from
the world’s two largest central banks was
unprecedented. But the actions themselves
were time-tested and routine, part of every
central banker’s DNA.
Back in 1873, Walter Bagehot, the
sage of central banking, had instructed
central banks on what to do in a liquidity
crisis. His triad was lend freely, against
good collateral, but at a penalty rate.
Why? Because the acute shortage of
liquidity in a panic can push even solvent
institutions over the edge. Customers
come in demanding their money. If the
banks don’t have enough cash on hand,
word gets around, and bank runs start
sprouting up everywhere. The disease is
highly contagious.
By serving as the lender of last resort,
the central bank is supposed to stop all
that from happening. And every central
banker in the world knew Bagehot’s
catechism. So that’s basically what most
of them did in August 2007. In fact,
one can argue that the ECB stuck with
the Bagehot script until late 2011. The
ECB refused to cut its interest rates
until October 2008 (yes, that’s 2008,
not 2007), and even then it gave ground
grudgingly. The 4 percent European
overnight rate that prevailed in August
2007 did not fall to 3.25 percent until
November 2008 and did not get as low
as 2 percent until January 2009. By
contrast, the Fed had virtually hit zero by
December 2008.
Was this mess nothing more than
a big liquidity event, as the ECB’s
actions suggested? Perhaps not. An
alternative, and darker, view of the crisis
conceptualized what was happening as
a serious impairment of the economy’s
normal credit-granting mechanisms. On
this broader view, the scarcity of liquidity
that “the downside risks to growth have
increased.” That was a healthy step; they
demoted inflation from its singular status
as the predominant risk. But the FOMC
still refused to cut the funds rate. (It did
reduce the less-important discount rate.)
Looking back, it’s hard to see how this
could have been a close call on August
16, and many Fed critics said so at the
time. But thirteen days later, as FOMC
members from Washington and around
the country boarded planes to head to the
beautiful Grand Tetons, the funds rate
was still stuck at 5.25 percent.
We learned later that Bernanke took the
opportunity to cloister away several FOMC
members in a small upstairs conference
room to figure out what to do next—as their
initial efforts were clearly inadequate. There
must have been many other interesting
sidebar conversations. But still, rates weren’t
touched until the FOMC’s next regularly
scheduled meeting, which was on September
18—a full forty days after Paribas Day. Yes, a
lot of rain can fall in forty days and nights—
and it did. The Fed cut the funds rate by
50 basis points on September 18, observing
that “the tightening of credit conditions
has the potential to intensify the housing
correction and to restrain economic growth
more generally.”
That last thought was important. Before
the cataclysmic failure of Lehman Brothers
a year later, there were two competing
views of what the crisis was all about. In
the narrower, technical view, the financial
world was experiencing a liquidity crisis—
an acute one, to be sure, but still a liquidity
crisis. In plain English, that meant that
frightened investors and institutions wanted
to get their hands on more cash than was
available—partly because of the heightened
counterparty risk just mentioned, partly
because assets formerly deemed safe now
looked risky, and partly because banks and
investment funds feared that their customers
might show up at the electronic door one
day, seeking to make hefty withdrawals. The
Paribas approach—just say no—was not an
appealing way to cope with such a problem.
The dash for cash was on. The one
institution in any country that can provide
more cash in a hurry—in principle, in
academic economists and a highly select
group of bankers and Wall Streeters, for an
invitation to the Jackson Hole conference
is the hottest ticket in Lower Manhattan.
While plenty of time is set aside for hiking
and whitewater rafting, the dominant
activity at Jackson Hole is shoptalk. It was
in great abundance in August 2007.
The annual conclave, which is the Fed’s
premier event, is hosted by the Federal
Reserve Bank of Kansas City, and its
conference planners hit the jackpot
in selecting the topic for the 2007
edition: “Housing, Housing Finance,
and Monetary Policy.” When the group
convened on the evening of August 30,
housing was going to the dogs, housing
finance was cratering, and a monetary
policy response to all this was growing
increasingly urgent. Few people wanted
to talk about the weather—which, as
usual, was gorgeous.
Too bad the conference didn’t take place
four weeks earlier. At its August 7, 2007,
meeting, the FOMC had concluded
that “although the downside risks
to growth have increased somewhat,
the Committee’s predominant policy
concern remains the risk that inflation
will fail to moderate as expected.”
How’s that again?, many of us thought
when we read the statement. The
predominant concern is inflation?
Many Fed watchers blinked in disbelief.
What were those guys thinking?
Two days later in Paris, the financial
world started coming apart at the seams.
The next day, the FOMC held a hurriedly
arranged telephonic meeting. This time
their statement assured the financial world
that the Fed was “providing liquidity
to facilitate the orderly functioning of
financial markets.” (Translation: We are
pumping out cash like mad.) But the
federal funds rate was kept right where
it had been since June 2006, at 5.25
percent. Was the Fed still seeing inflation
as the “predominant policy concern”?
Okay, give them a break. Only three days
had passed since their August 7 meeting.
The Fed would fix things soon. Right?
Wrong. The committee met telephonically
again six days later, noting correctly
THE PRINCETON FINANCIER | 14
but the committee was not yet ready
to cut interest rates. Undaunted,
Bernanke got them all on the phone
again on January 21. The minutes
of that call observed that “incoming
information since the conference call
on January 9 had reinforced the view
that the outlook for economic activity
was weakening.” Only twelve days had
elapsed between the two calls. How
much could have changed?
What had changed was that the FOMC
was now ready to act—dramatically.
With just one dissenter, the members
agreed to announce an almost-
unprecedented 75-basis-point cut in
the federal funds rate early the next
morning. In the entire eighteen and a
half years of the Greenspan Fed, the
FOMC had moved the funds rate by
75 basis points only once—and that
was an increase. Furthermore, federal
funds rate announcements always come
at exactly 2:15 p.m. This one came at
8:30 a.m. The Fed clearly wanted to be
heard on January 22—and it was. Eight
days later, at its regularly scheduled
meeting, and again with one dissenter,
the FOMC dropped the funds rate
another 50 basis points, down to 3
percent, leaving federal funds trading
125 basis points lower than they were
only nine days previously. The Fed was
on DEFCON 1.
The FOMC majority now clearly saw
the task ahead of them as a two-front
war, and it was gearing up for battle on
both fronts. It needed to provide massive
amounts of liquidity, for well-known
reasons that Bagehot had articulated
135 years earlier. But it also needed to
cut interest rates to fight an imminent
recession, as Keynes had prescribed 72
years earlier. Chairman Bernanke did not
want to preside over another episode like
the 1930s. In Europe, however, overnight
rates were going nowhere. The ECB was
fighting the shortage of liquidity hard,
maybe even harder than the Fed. But it
was far from convinced that recession was
in its future. At the ECB’s headquarters
in Frankfurt, there was lots of Bagehot
but not much Keynes.
step that it repeated at its next regular
meeting on December 11. A number
of FOMC members were less than
convinced of the need for easier money.
After that, however, the Fed seemed
to step it up a notch. The next day it
announced two new liquidity-providing
facilities. The first was a series of currency
swap lines with foreign central banks,
which were finding themselves seriously
short of dollars. In a currency swap,
the Fed, say, lends dollars to the ECB
in return for euros. When the dollar
liquidity crisis in Europe passes, the ECB
pays back the dollars and gets back the
euros. The initial announcement was for
just $24 billion, which was considered
sizable at the time. But the swap lines
eventually topped out at a whopping
$583 billion in December 2008.
The second facility was the Term Auction
Facility (TAF), designed to do Bagehot-
type lending to banks, though for periods
longer than normal—up to four weeks.
The Fed’s earlier attempts to lend to
banks had been stymied by bankers’
fears of being stigmatized by asking the
central bank for a loan. Didn’t that mean
you were on the ropes? The TAF sought
to overcome the stigma problem in two
ways: It was set up as an auction in which
any bank could show up to bid; the bank
didn’t need to be in bad shape. And since
the bank wouldn’t receive the cash for a
few days, a TAF loan would not save a
bank that was on the brink of disaster.
TAF was important—at its peak in
March 2009, it was lending $493 billion.
It was shut down in March 2010--no
longer needed.
But the Fed was just warming up.
Over the Christmas–New Year
holidays, Bernanke must have got to
thinking—or to having nightmares—
about the 1930s. On January 9, 2008,
he convened an FOMC conference
call—ostensibly to review recent
developments but perhaps actually to
shake the committee out of its lethargy.
The minutes of that meeting noted
that “the downside risks to growth had
increased significantly since the time
of the December FOMC meeting,”
was just the tip of the iceberg. The real
problems lurked down the road—in
gigantic losses of wealth; in massive
deleveraging and possible insolvencies of
major institutions; and, as just mentioned,
in severe damage to the banking system,
the shadow banking system, and other
credit-granting mechanisms. If all that
happened—and in August 2007, it hadn’t
happened yet—the whole economy
would be in big trouble. Economies that
are starved of credit fall into recessions,
or worse. Businesses decline and fail.
Workers lose their jobs.
The Fed Springs into Action
Well, maybe not exactly “springs.”
Bernanke, who was a noted scholar of the
Great Depression, was slowly bringing
his rather hawkish committee around to
the view that this was something big—
not just a major liquidity event, but
potentially the cause for a big recession.
But old habits die hard, and while the
Fed was way ahead of the ECB, it was
not quite there yet. At its September 18
meeting, the FOMC qualified its view
that “the tightening of credit conditions
has the potential to . . . restrain economic
growth” by adding that “some inflation
risks remain.” It was a finely balanced
assessment of risks—far too balanced,
given the emerging realities. Just five
days earlier, the Bank of England had
intervened massively to save Northern
Rock, a huge savings institution, from
the first bank run in Britain since 1866.
Things were coming unglued in England.
Our problems here were strikingly
similar. Could we be far behind?
While the Fed’s speed made the ECB
look like the proverbial tortoise
watching the hare, this particular hare
wasn’t actually running that fast. After
its 50-basis-point rate cut on September
18, 2007, the Fed waited another
six weeks—until its next regularly
scheduled meeting—to move again.
By that time, many mortgage-lending
companies had failed, and Citigroup
and others had announced major write-
downs on subprime mortgages. But the
Fed chipped in with only another 25
basis points on October 31—a baby
THE PRINCETON FINANCIER | 15
The concept of “the office,” aside from
conjuring up images of Steve Carell, of-
ten makes Americans think of cubicles,
sticky notes, 9-to-5 hours, a steady yet
modest salary, and most of all, safety
and security for their families. Today,
however, “the office” is changing—in-
deed, empirical evidence suggests that
for more and more Americans, home
and office are one and the same. Many
individuals today freelance, take on con-
tract positions, and/or work from home,
options which used to inspire a fear of
insecurity due to the lack of a consistent
paycheck and ancillary benefits. Work
is not only changing in physical space,
but also in expectations, responsibili-
ties, and the replacement of the concept
of an employee with that of what I will
call a “Value creator.” Given the state of
the macroeconomy and the political in-
transience in Washington, Americans are
beginning to solve this country’s finan-
cial crisis themselves through the often
lauded American ingenuity; through
innovation and with incredible determi-
nation, Americans are beginning to re-
inforce the nation’s future through small
business creation, intrapreneurship, and
community development efforts that are
not dependent on the government. In-
deed, the individual accomplishments
of intrepid entre- and intrapreneurs are
permitting us to envision a solution to
the funding crisis in Social Security and
Medicare: economic growth.
First, let’s take a historical look at tradi-
tional employment in the United States.
Beginning in the years after World War
II, after obtaining a college degree, many
new graduates secured their first job and
established a long-duration (often de-
cades) career within that firm. Loyalty
and commitment were the prerequisites
for advancement within a company even
for relatively inefficient workers who
might only create dubious value. We
see the costs of such a system in the 20+
year economic morass in Japan which
continues to preserve such an employ-
ment structure. Recently, the realities of
work in America have changed dramati-
cally. According to recent data from The
Bureau for Labor Statistics, the median
Shawn P. O’Connor is an honors graduate from Harvard Law School and Harvard Business School, where he was recognized as a Baker, Ford, and
Thayer Scholar for his academic accomplishments. Mr. O’Connor is a summa cum laude, Phi Beta Kappa graduate of Georgetown University’s School
of Foreign Service where he was valedictorian. Mr. O’Connor currently serves as the Founder and CEO of Stratus Prep (a global test preparation and
admissions counseling firm), Stratus Careers (a career counseling and corporate training organization), The Stratus Foundation (an educational
non-profit) and The Startup Stand (an entrepreneurship non-profit). He has published more than 50 articles in publications such as Fortune and The
Financial Times and is a weekly contributor to Forbes and US News and World Report. [ ]
THE PRINCETON FINANCIER | 16
number of years that workers have been
with their current employers is just 4.6
(“Employee Tenure Summary, 2012”).
Employees are always seeking new oppor-
tunities, facilitated by LinkedIn and on-
line job sites, like Monster and The Lad-
ders, which have significantly reduced the
investment required to seek out a new
position and enhanced the efficiency of
recruiters. However, in this more trans-
parent employment environment, work-
ers must differentiate themselves through
their demonstrated value creation.
According to Seth Godin’s “The Last
Days of Cubicle Life” in Time, “The job
of the future will have very little to do
with processing words or numbers (the
Internet can do that now). Nor will we
need many people to act as placeholders,
errand runners or receptionists. Instead,
there’s going to be a huge focus on find-
ing the essential people and outsourcing
the rest” (Godin, 2009). In other words,
especially for relatively low-skilled office
workers, it will no longer be enough to
show up at the office and meet expecta-
tions; the successful employees of tomor-
row will be creative problem solvers with
differentiated skill sets, innovative ideas,
and a commitment to “getting the job
done.” In other words, they will need
to be entrepreneurs (or at least intrapre-
neurs, the term given to those who per-
form as entrepreneurs within a broader
corporate context). The need for workers
to be entrepreneurial has been increasing
for at least the last decade and thereby
changing “the office” as we and our par-
ents and grandparents once knew it.
Entrepreneurs, rather than financiers, are
now revered by society. But the major-
ity of entrepreneurs look very little like
Mark Zuckerberg. Many are not twen-
ty-something technologists but middle-
aged Americans starting a small business
after losing their job at a large corpora-
tion and being unable to find similar
work as companies demand more from
current employees and contractors rather
than hiring new permanent employees,
as exemplified by the rising productiv-
ity levels but the still relatively anemic
economic picture. To support this the-
sis, Godin postulates that in the future,
“Work will mean managing a tribe, creat-
ing a movement and operating in teams to
change the world. Anything less is going
to be outsourced to someone a lot cheaper
and a lot less privileged than you or me”
(Godin, 2009). There will be a lot less
“busy work” in small and large companies
alike, requiring all workers to be entrepre-
neurial and innovative if they hope to sur-
vive in relatively well-paid positions in the
developed world.
Such entrepreneurship is critical to the
success of the United States and other
developed economies. The United States
has a long history of government support
for entrepreneurship, perhaps most evi-
dent in its bankruptcy laws, some of the
world’s most forgiving. Furthermore, in
1953 with the passage of the Small Busi-
ness Act, the Small Business Administra-
tion (SBA) was established to promote
the growth of small ventures, particularly
those founded by minorities and other
traditionally disadvantaged populations,
by helping such companies secure loans
and develop management skills. The gov-
ernment recognized the importance of
small business to economic growth, and
therefore set policies to incentivize entre-
preneurs to turn their ideas into lucra-
tive business. Later, during the last pro-
longed period of economic malaise, the
Small Business Economic Policy of 1979
was enacted, which required Congress to
“establish a national policy to implement
and coordinate the policies, programs,
and activities of all Federal departments,
agencies, and instrumentalities in order to
provide an economic climate conducive
to the development, growth, and expan-
sion of small and medium-sized business”
(Clark & Saade, 2010). While given to-
day’s fiscal realities, the next generation
of entrepreneurs cannot count on the
government for similar support, they are
again leading the nation’s recovery and
collectively, if unintentionally, suggesting
a growth path out of our economic woes.
Data from the SBA strongly supports
my hypothesis regarding the impact of
small businesses on the U.S. economy.
According to the SBA, “Small businesses
currently represent 98 percent of all busi-
nesses in the United States and they gen-
erate nearly 64 percent of all net new jobs
in this country” (Clark & Saade, 2010).
Because of the power of small businesses
and the continued economic stagnation
and political paralysis in Washington,
Americans do, can, and indeed must,
continue striking out on their own not
only to ensure their own economic future
but also that of the nation.
Americans clearly have the power and
determination to address our vast fis-
cal challenges through the free mar-
ket. When I observe debates between
our two major political parties’ budget
proposals, I am distressed by the lack
of a long-term, sustainable method
to controlling our country’s national
debt and funding Social Security and
Medicare. But because of the fun-
damental shifts in the definition of
“work” outlined above and the dem-
onstrated power of entrepreneurship
as a driver of economic development, I
am confident that growing out of this
crisis through ingenuity is not only
possible, but likely.
THE PRINCETON FINANCIER | 17
Because of the power of small businesses and the continued economic stagnation and political paralysis in Washington, Americans do, can, and indeed must, continue striking out on their own not only to ensure their own economic future but also that of the nation.
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While publications as varied as The
Economist and GQ have called Fort
McMurray, Alberta (a small town
brimming with oil rents) a tough
epicenter with the potential to change the
global geopolitical map, it has yet to do
so. The Canadian federal government has
made numerous poor decisions, leaving
its energy policy in disarray. Observers
both in and out of Canada are watching
anxiously as energy markets take
shape with no clear signaling from the
Canadian government. The investment
climate in the Canadian natural resource
sector remains uncertain.
The generous endowment of natural
resources and relatively relaxed
controls on foreign investment have
historically made Canadian oil sands a
generally sound investment choice. A
diversified economy that weathered the
economic crisis relatively well allows
Canada to open its doors to foreign
investment without public outcries
of “neocolonialism” or fear of losing
national sovereignty. With Venezuela
and Saudi Arabia (the two countries
with the largest quantity of known
oil reserves) closely protecting their
national treasures through state-owned
enterprises, the oil reserves available
for private ownership in Canada are
the largest in the world. Remarkably,
they represent a massive 50% of global
market share. This opportunity has been
left available for foreign investment in
part because Canada recognizes that
its domestic capital is insufficient to
further catalyze development of its
export-led economy. The opportunity
that investment into Canada presents
to the world is clear: a stable political
economy with relatively free access
to foreign investors, but recent
developments have put this favorable
investment position into question.
Canada suffers severe price differentials
between its own crude and its global
counterparts. For Canadians, this practice
seems unjust, especially since Canada, in
contrast to the Middle East, represents
the United States’ most secure energy
supplier, so political stability in Canada
should represent a premium not a discount.
Although this idea lacks common economic
sense, the wedge between West Texas
Intermediate (WTI) and Western Canada
Select (WCS) prices of crude oil, which is
as large as $20 a barrel, is starting to spook
investors. Oil extraction from sand is costly,
and even slight price differentials are more
than enough to turn investments sour
and undermine Canada’s terms of trade.
As the Royal Bank of Canada pointed
out in a recent report, unfavorable terms
of trade “would ultimately first manifest
themselves in the form of reduced business
investment.” This loss affects the average
Canadian. Current losses in real domestic
income are valued at about $1,200 per
Canadian per year. Although the Canadian
economy is outwardly oriented, its
inaccessibility to the global market only
worsens price differentials. Rectifying
these price differentials is the first step
in improving market efficiency and the
investment climate.
The pipelines solution to market access
has also been the focus of intense
controversy. Although the price
differentials are in part due to difference
in quality, a surplus in supply is the
main culprit. Pipelines would bridge the
distance between high global demand
and high Canadian supply. Americans are
familiar with Keystone XL, which would
transport Canadian crude to American
buyers and export the remainder along
THE PRINCETON FINANCIER | 19
This development might at least be imagined to offer some certainty to the investment climate, but that view seems too charitable. The Canadian government is without a clear strategy.
the Texan coast. The proposal, while well
publicized, was rejected for the time being
on environmental grounds. However, oil
is fungible and its high demand tends
to overcome supply interventions. Tar
sand oil continues to travel south by
tanker and train. Unfortunately for
environmentalists, this is even more
carbon-costly than building Keystone.
Unfortunately for investors, the price
differential remains.
The rejection of Keystone sparked a
reactionary turn by Prime Minister
Harper towards Asia. Since the Enbridge
Northern Gateway pipeline set to export
oil to Asia through ports in Vancouver
already in the works, he established a
plan for diversification. Harper has
felt emboldened to softly push against
Canada’s given position as unequivocally
aligned with the U.S. As expected, this
option predicates entirely on China’s
eagerness to invest in Canada.
With the Trans-Pacific Partnership coming
into the foreground, Harper could be seen as a
chief strategist leveraging himself between the
United States and China. This development
might at least be imagined to offer some
certainty to the investment climate, but that
view seems too charitable. The Canadian
government is without a clear strategy.
Lobbying in China by the Canadian
government for closer economic ties after
the Keystone rejection was eventually
reciprocated by an equally aggressive
bid by CNOOC (China National
Offshore Oil Company) for Nexen, a
major Canadian oil and gas company.
Investment Canada, the governmental
body tasked with regulating large foreign
investment into Canada, has very flexible
criteria for making its decisions. It is
generally believed in Canada that politics
fill in the gaps and so the decision was
somewhat influenced by the federal
government. With CNOOC providing
the necessary capital, it was difficult for
Harper to reject a deal for which he had so
earnestly supported, but the acquisition of
Nexen would surrender Canada’s control
of some of its most important assets. To
much public surprise and dissent, the
government approved the deal and Nexen
was acquired for $15.1 billion. Canadian
commenters have argued that Investment
Canada should have rejected the deal
and opted for a joint venture agreement
instead. Canada did not outright reject
the CNOOC bid as a “national security
threat” like U.S. bureaucrats did when
CNOOC bid for Unocal for $18.5
billion, but Harper cautioned publically
that any forthcoming investment would
not enjoy such favorable treatment. A
bid by Petronas, Malaysia’s state energy
company, faced unexpected resistance
from Investment Canada. Nothing
undermines investor confidence like
unsystematic application of government
intervention, and Harper has given
no clear signals to potential investors
or concerned Canadians about how
Canada’s investment policy is shaping up.
Harper has faced even more drama over
the recent renegotiation of Canada’s
FIPA, or Foreign Investment Promotion
and Protection Agreement, with China.
Although FIPAs are common-place, few
are negotiated in private in Vladivostok,
ratified with minimal parliamentary
debate, and made legally binding for
decades to come. The rash turn, which
would grant Chinese companies the right
to sue the Canadian government in private
international courts for protectionism,
has provoked public outcry. To Canadian
observers, it appears that Harper turned
to China after being slighted by Obama
over Keystone, but he discovered that this
direction was unpalatable to the Canadian
public. In the long run, reacting, and
not leading, will not serve Canada, its
investors, or Harper well.
If Harper is simply responding to
events rather than driving them,
it is worth evaluating the different
currents in this moment of transition.
Under Canadian investment policy,
will Canada favor the American
investment, the Chinese investment,
or will both enjoy equal treatment?
The fact that the Canadian public
has taken great notice of this ongoing
debate, is undoubtedly a factor. Although
the Canadian press likes to pretend
emotionalist and alarmist fears about
foreign encroachment never factor into the
country’s decision-making, the control of
“national assets” by a state-owned enterprise
tied up with a Communist regime does not
sit well with the majority of Canadians.
Even the overwhelmingly centrist
Canadian public has been suspicious of
surrendering control of its “national” assets
to China. Does this translate into greater
access to American investors? American
investment in Canada has been a long-
standing tradition. The Canadian public
seems indifferent to American ownership
of most iconic Canadian conglomerates
from Molson Canadian, which runs by the
slogan “I am Canadian!” to Tim Hortons, a
fast food restaurant named after a Canadian
hockey player. Capital-rich Europe and the
United States have both enjoyed a favorable
investment position in Canada, and there
has been no outcry from the Canadian
public. There is a certain partiality in
Canada towards Canada’s traditional
partners, which suggests doors will remain
open to their investors.
There are, however, also more rational
reasons for the national politic to be wary
of this new China-based investment. From
a qualitative perspective, natural resources
are not just the fuel but the engine to
Canada’s economy. As Canada’s expertise is
resource extraction, its quaternary sector is
inextricably linked to the primary natural
resource sector. CNOOC’s strategy is
also more concerning. As argued in The
THE PRINCETON FINANCIER | 20
From a qualitative perspective, natural resources are not just the fuel but the engine to Canada’s economy.
ownership of its own resources. As a result,
PetroCanada was privatized and became a
retail subsidiary of Suncor Energy in 2009.
The rise of investment from abroad, which
threatens Canada’s foreign and domestic
capital positions, is enough to revive
protectionist sentiments.
Generally speaking, Harper is left with
two main options. The first is to continue
bandwagoning the United States and
accept the severe price differentials or wait
for Keystone approval. The second option
is to accept Chinese capital, but, in order
to placate the public, investment policy
will have to restrict large market share
ownership while welcoming in capital. The
first option does not necessarily signal an
unequivocally good investment climate for
American investors. Price differentials will
continue to disadvantage any company
that invests in Canada. The second option
would reflect a growing trend away from
American dependency. American investors
will have to compete with companies both
around the world and in Canada to secure
ownership. Preferably for Canada, Harper
could forge a path between the two. By
relying on the United States as a traditional
partner, but also taking advantage of Asian
investment for leverage and to resolve the
price differentials, Harper could forge
Canada’s new economic position in an
evolving global order.
Harper is in an unenviable position
of knowing that while Canada needs
capital, he also needs to satisfy the more
protectionist demands of some of his
constituents. A viable way forward is to
craft an energy policy that controls not
the level, but the kind of investment
into Canada so that Canada’s favorable
position is maintained while capitalizing
on a changing global market. We should
expect Investment Canada to restrict
its approval to only mergers and joint
ventures, not outright acquisitions, as they
pose less of a threat to Canadian control.
Most importantly, such a policy must
be conveyed clearly and transparently to
Canadians and foreign investors. In the
meantime, investment into Canada will
be uncertain. CNOOC closed the door
behind it and there are uncertainties as to
how to reopen it.
manufacturing companies were able
to use Canadian capital to help them
develop at breakneck speeds. On this
framework, Canada vastly improved its
national real income and improved its
terms of trade by negotiating a series of
FIPAs. As countries like China transition
out of the manufacturing-dependent,
capital-poor phase, the reciprocity is
less clear. Canada could be the relatively
capital-poor, labor-poor partner in some
of its trade agreements. The graph above
depicts Canada’s net investment position
has deteriorated rapidly with respect to
the Asian tigers and Brazil. The capital
deficit with the U.S. may be greater in
absolute terms, but the relative imbalance
with China is much greater.
Despite Canada’s current affinity for
free trade, the country has a history
of protectionism. In the 1970s, the
nationalization of Fina to create
PetroCanada was largely a response to
public fears that Canada’s natural resources
would be exploited. However, as Canadian
expertise accumulated and its private
companies developed, Canada had no
reason to worry about competing for
Economist, CNOOC has discovered
that ownership of oil wells (upstream
investment) alone does not translate
into control of oil markets. CNOOC,
in the recent spate of acquisitions which
included Nexen, aims to seize managerial
talent. It attempts to buy out not only
Canadian resources but also Canadian
expertise—acquiring the whole Canadian
competitive package in one sitting.
Moreover, Canadians would become the
lower workforce under foreign managers
extracting their own resources.
The U.S.-China dichotomy has
consumed the Canadian press, but the
more troubling and long-term global
trend that could threaten Canada’s
investment position vis-à-vis many of its
partners has been ignored. As Asian tigers
rise, Canada becomes a net recipient of
foreign direct investment (FDI). Capital
dependency is often associated with a
mercantile or developing economy. In
the past, the mutual benefit of free trade
was more apparent. Canada enjoyed the
capital flows it needed to support its
export industries and develop its native
businesses, while labor-rich, capital-poor
THE PRINCETON FINANCIER | 21
that although the trading fundamentals
in these countries are healthy, the cost
to trade is extremely high, which is a
hindrance to the rapid growth of the
Southeast Asian markets. Also, despite
having extreme growth potential, there
exist inherent risks in the Southeast
Asian markets. Previous periods of strong
investment inflows and the resulting
currency appreciation have prompted
government actions in the form of
capital controls. As a result, interest rates
remain at historic lows, raising fears that
inflation problems may return and distort
investment relationships.
In particular, Vietnam’s growth has
been perpetually impeded. Prior to the
financial crisis, many foreign banks,
including those from North Asia,
Australia, and New Zealand, eagerly
bought into Vietnam’s banks. Today,
however, Vietnamese banks are less
inviting. According to HSBC, the
economy has slowed from an average of
7% annual growth since the early 1990s
to 5% last year. Moreover, decreasing
property prices and increasing bad loans
have made banks reluctant to lend,
thereby further obstructing economic
growth. Furthermore, other challenges
have led to rampant inflation, which
averaged approximately 8.9% annually
for the past few years, and annual credit
growth, which exceeded 20% from
2006 to 2010. The lack of transparency
and weak accounting practices have also
Southeast Asia’s enormous growth in
the past decade can be attributed to a
number of factors. As quantitative easing
and weak growth prospects in the West
pushed investors towards emerging
markets, the region experienced and
benefited from a substantial flow of
foreign investments. The combination
of its optimal central location, economic
relationships with other Asian countries,
and low costs spurred tremendous growth
rates in Southeast Asia. The region is the
center of Asia’s economic boom due to
the young population of over 600 million
people, abundant natural resources,
and growing trade connections between
both China and India. Additionally,
local governments have been able to
exploit record-low funding costs while
wages in China have been increasing
which is helping to bring export and
manufacturing businesses to the region.
The substantial growth and the markets’
strong performances, however, have left
equities trading at unstable valuations.
The Philippines index currently trades at
a price-to-book ratio of 2.6 and a price-
to-earnings ratio of 20.8. Similarly, the
Indonesian index is trading at a price-to-
book ratio of 2.7 and a price-to-earnings
ratio of 18. These statistics are highly
contrasted with the emerging markets
average price-to-book ratio of 1.6 and
price-to-earnings ratio of 12.3. These
noticeably higher ratios for the markets
in the Philippines and Indonesia indicate
Even throughout the recent financial
crisis, investors in Southeast Asia
have enjoyed a great ride over the
past decade with stocks in Indonesia,
Thailand, and the Philippines rising
over 220% since 2008. Moreover, in
the past year alone, Indonesia’s and the
Philippines’ GDP grew by 6.2% and
6.6% respectively. Over the same period
of time, the MSCI Emerging Markets
Index, an index designed by Morgan
Stanley Capital International to assess
the performance of global emerging
markets, has increased by 88%. This
growth can be viewed in contrast to the
MSCI ACWI Index, another Morgan
Stanley developed index that provides
a broad measure of equity-market
performance around the world, which
only increased by 52%. The disparity
represents the stark difference between
the rates at which these emerging
regions are growing relative to those of
the rest of the world. However, after this
exciting ride, investors are beginning to
wonder whether the growth in these
markets has plateaued, as countries in
the region have shown signs of both
mixed growth and instability. An
analysis of various economic factors
across the Philippines, Vietnam,
and Indonesia will help us better
comprehend the reasons for Southeast
Asia’s market performances, which will
ultimately help us understand how
investors are responding to these recent
developments.
THE PRINCETON FINANCIER | 22
to boost the infrastructure and the natural
resources sectors, both of which need
foreign investment. Thus, a prolonged
investment slowdown could generate severe
strains later on.
While certain countries of Southeast
Asia are falling out of favor for investors,
other parts of Asia have become more
attractive, particularly China and Japan.
Despite the general increase in wages
in China, since the end of the last
fiscal quarter of 2012, Chinese equities
have risen over 30% on average. This
substantial increase can be attributed to
the country’s efforts to improve economic
data reports, various financial reforms,
and a successful transition of political
power. The relative and recent stability
of China has renewed investors’ interest.
Likewise, reforms have also made
Japanese markets appealing. The Nikkei
225 has risen over 30% since the last
fiscal quarter of 2012 due to the change
in consumer and investor expectations
that the election of Prime Minister
Shinzo Abe will herald the start of a
far more aggressive monetary stimulus.
This change has consequently lead to
the weakening of the yen from 80 to 94
per United States dollar in December
2012, which has actually benefitted
the country with regards to exports. As
a result of these developments, many
investors are switching their focus away
from Southeast Asia towards the larger,
more liquid markets of China and Japan.
The journey for investors in Southeast Asia
has proven fruitful over the past decade.
However, various factors have caused this
ride to decelerate—a momentum that we
should continue to carefully follow and
analyze in the upcoming years.
stable statistics in the past decade.
Interestingly enough, Indonesia’s trade
and current account deficits are factors
that are contributing to its economic
stability. In the beginning of the first
fiscal quarter of 2013, Indonesia recorded
its second consecutive trade and current
account deficit, which is estimated to be
between $1.5 and $2 billion. Analysts
from The Wall Street Journal believe that
this figure is due to its strong growth
in recent years that has attracted many
imports even while global demand and
export prices slide. These imports are used
to upgrade the country’s factories and
infrastructure, which eventually lead to
more value-added exports.
However, though Indonesia may be
performing relatively well, there are still
certain aspects of its economy, much like
those of Vietnam and the Philippines,
that raise doubts for outside investors.
According to a Barclays report, investment
in the economy in the last fiscal quarter of
2012 was 7.3%, which was the lowest in
five quarters. One factor is that weak global
risk sentiment and unfavorable domestic
developments have been putting pressure
on Indonesian assets. The moderation
in investment is consistent with high
frequency indicators such as capital goods
imports and lending for investments. By
contrast, household consumption, the main
driver of the expansion of the Indonesian
economy, increased by 5.4%. With GDP
growth averaging 5.7% over the last decade,
Indonesian markets look to be a safer
investment and are clearly an exception
to the larger trend within Southeast Asia.
It is important to note, however, that
continued investment is required to keep
the momentum going, both in the private
and public sectors. Indonesia is still looking
generated great uncertainty concerning
the quality of loans in the system. The
State Bank of Vietnam (the country’s
central bank) reported in November
2012 that the ratio of bad debt to total
loans was 8.82%, but Moody’s Investors
Service estimated this ratio to be at least
10%. Thus, Vietnam is a prime example
of why foreign investors express caution
in investing in Southeast Asia. Foreign
investors are concerned with the region’s
unstable banking system and would
rather look towards other areas with less
risk and more growth.
The Philippines represents a slightly
different case, as its stable, long-term
growth has only recently been hampered
by a variety of factors. The primary
concern is the difficulty in sustaining
strong economic fundamentals, such as
stock prices and GDP values. Analysts
believe the market is trading at values
that leave little room for further upside.
According to Bill Maldonado, CIO
of Asia Pacific at HSBC Global Asset
Management, the Philippines has
become “relatively expensive compared
to its North Asian peers.” Stocks deliver
return on equity of about 15%, but
in turn, investors must pay more than
three times book value. In contrast,
according to a report by Duncan Mavin
of The Wall Street Journal, Chinese
shares offer a similar return on equity
for only about 1.5 times book value, and
South Korea offers a return on equity
of 12% for only 1 times book value.
Another aspect about the Philippines
that could hinder its growth is its weak
infrastructure. Although the government
has extensive plans for investment in
infrastructure, the Philippines has the
worst infrastructure quality among major
Southeast Asian countries according
to the 2012 World Economic Forum’s
Global Competitiveness report. This low
quality points to increasing instability of
the economy.
While both Vietnam and the Philippines
have demonstrated reasons for foreign
investors to be concerned, Indonesia
shows certain signs of promise. Its stocks
and GDP have both risen by enormous
proportions, and foreign investors are
still attracted because of its relatively
However, though Indonesia may be performing relatively well, there are still certain aspects of its economy, much like those of Vietnam and the Philippines, that raises doubts for outside investors.
THE PRINCETON FINANCIER | 23
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