The Digital Financier The Digital Financier Update (DFIN.COM Update) provides a weekly commentary on important stories with significant financial, and or Internet implications. The purpose is to provide finance professionals and there staff with a timely brief synopses of recent and historic news events that best illustrates the changing digital economy. The stories will eventually impact all of us. Many of our stories may have received very little popular press coverage. The weekly summary is e-mailed at no cost to participating subscribers for distribution to staff and co-workers.
This publication is designed to be a quick read and the archive is a good resource for financial history.
The most common sources for the DFIN.COM Update include UP, AP, Fast Company, Business Week,The Economist, Forbes, Wired, Federal Reserve Bank Publications. The Wall Street Journal Interactive, MSNBC, L.A. Times, San Jose Mercury News.
Week of March 30, 1997
Commercial bank sales of mutual funds and annuities may be more hype than substance. Monetary Trends (Federal Reserve Bank of St. Louis, March 1997, p. 1) reports that only about 20% of all commercial banks sell mutual funds and annuities. Moreover, less than 3% of noninterest income involves commissions and other income from this business. Banks’ sales of mutual funds is primarily limited to money market mutual funds which represent 93% of total bank fund sales. 90% of total sales of mutual funds and annuities sold by banks are sold by banks with average assets in excess of $15 billion.
"Samurai bonds" a boom in Japan. The Economist (March 29, 1997, p. 81) reports that foreigners issued over ¥ 3.8 trillion in bonds in 1996 up from ¥ 1.3 trillion, or US$10 billion, in 1995. The buyers are mainly individuals and the secondary market is poorly developed. Experts feel the buyers are receiving "below" market yields while foreign borrowers are finding the bonds a cheap source of funds.
Pension Benefit Guarantee Corp (PBGC). reports first surplus. The Wall Street Journal (April 1, 1997, p. A4) reported that its first surplus of assets over liabilities of nearly $1 billion in 1996. The deficit reached nearly $3 billion by year-end 1993. The PBGC was created by Congress within the Department of Labor in 1974 to guarantee benefits for beneficiaries of underfunded pension programs. James H. Smalhout, in an op ed piece, was critical of the fund and its operations stating the Administration’s cheery report failed to tell that the unfunded pension liabilities of private pension funds rose to $64 billion at year-end 1995, up from $31 billion the year before. This is potential contingent liability of the PBGC if these pension funds fail in the future. When considering the unfunded problem the PBGC performance doesn't’t look so good. (James H. Smalhout, "The Pension-Guarantee Time Bomb", The Wall Street Journal, April 4, 1997, p. A6)
Selling financial securities exchanges may improve efficiency. The Economist (March 29, 1997, p. 85) reports a possible trend toward privatizing security markets. Amsterdam Exchanges, a Netherlands stock and futures exchange, recently sold shares to the public. Advocates say that privatization will create more responsive exchanges to the benefit of traders over dealers. Most exchanges are like the New York Stock Exchange which is owned by 480 member firms. Deregulation and global technology is putting pressure on organized market to be more responsive. Further privatization is likely.
"Synthetic leasing" taking off. The Wall Street Journal (April 2, 1997, p. CA1-4) reports that a specialized form of leasing has taken off since a favorable Financial Accounting Standards Board ruling. Under the synthetic lease, a firm can set up a special-purpose entity (SPE) to own land and buildings. The facility finances the assets, usually with a mortgage, and the firm leases it using an operating lease from the SPE. The firm can then keep the mortgage off their balance sheet. For accounting purposes, the transaction is simply an operating lease. For federal tax purposes, it is considered the owner of the property providing the depreciation tax shield.
Week of March 23, 1997
Regulators caution banks on credit standards. The Wall Street Journal (March 24, 1997, p. A6) reported that Federal Reserve Chairman Alan Greenspan and Currency Comptroller Eugene Ludwig both cautioned commercial bankers that declining profit margins are causing banks to adopt lax credit standards to improve profitability. Both warned of potential problems in the syndicated loan market and in portfolios of community banks.
H. F. Ahmanson & Co. challenges accounting assumptions of Washington Mutual Inc. and Great Western Corp., keeping acquisition battle going.. The Wall Street Journal (March 24, 1997) reported that Ahmanson amended a lawsuit alleging that improper accounting methods were being used by Washington Mutual and Great Western to understate the true costs of the merger in shareholder disclosures. In 1995, the SEC ruled in a similar merger proposal that First Bank Systems,Inc. couldn’t use pooling-of-interest accounting in their offer to merge with First Interstate Bancorp.
Fed increases fed funds target rate, other rates rise and stock market falls. The Wall Street Journal (March 26, 1997, p.2; March 27, 1997, p.2; and March 28, 1997 p. C1 and A2) reported that this week’s rise in the fed funds target rate by 25 basis points by the Federal Reserve is having immediate adverse impacts on many sectors of the economy. Many international companies are being adversely affected by the strong dollar which is causing earnings to suffer due to weak international currency translations; adjustable-rate mortgage customers are facing higher mortgage payments; and stock market investors suffered a 140-point decline in the Dow Jones Industrial Average on March 27, 1997. Business Week (April 7, 1997, pp. 31-32; pp. 36-37) reported that a stronger than expected economy and labor market contributed to the decision. However, the Fed’s next move will be dependent on future economic conditions. Many analysts are not assuming this is the first of many upward moves.
Organization for Economic Cooperation and Development (OECD) adopting standards for Internet security. The Wall Street Journal (March 27, 1997) reported that the OECD is expected to remove restrictions on the use of encryption for Internet transmissions. The 29-country OECD action is likely to accelerate electronic commerce.
Index fund investors may be getting too much of a good thing. Forbes (April 7, 1997, pp. 90-92) reported that the index-fund craze may be fueled by unknowing investors. S&P 500 index funds are weighted by the market values of the 500 stocks in the index. Consequently, the top ten highest capitalized companies accounted for 20% of the index weight at year-end 1996. That means investors are really buying a high capitalization stock portfolio. Index fund investors should be aware that what they are buying is a portfolio heavily weighted in Microsoft, Intel, Coca-Cola, Merck and General Electric. That’s ok, if investors are willing to pay up for these firms, but many think the exceptional performance of the giants during the last three years won’t be replayed.
Week of March 16, 1997
Congress to review 1/8% pricing convention for stocks. Business Week, (March 31, 1997, p. 90), reported that two members of the U.S. Congress have introduced a bill to require decimal pricing for stocks. Steven M.H. Wallman, a member of the Securities and Exchange Commission, estimates that using 1/8s to price stocks now benefits market makers to the tune of $5 billion. In February 1996, the Toronto Stock Exchange moved to decimal pricing and the result is reported to have been a 21% decrease in the bid-ask spreads. Market makers are fighting the move, saying they would be unable to fill large orders due to reduced profits.
First Bank System Inc. merges with U.S. Bancorp. The Wall Street Journal (March 21, 1997, p. A3) reported that First Bank System of Minneapolis will merge with Portland, Ore.-based U.S. Bancorp. The resulting bank holding company will have assets of $70 billion with about 900 branches in 17 states.
H.F. Ahmanson & Co. raises bid and throws large bone to regulators. The Wall Street Journal, (March 21, 1997, p.B4), reported that Ahmanson proposed a $70 billion lending commitment to inner-city residents and businesses over a 10-year period as part of their bid to acquire Great Western Financial Corp.. This promise was made just days after Ahmanson increased its financial offer for Great Western. Great Western’s "white knight," Washington Mutual Inc., has stated that it will be offering its own lending commitment in a few weeks.
Week of March 9, 1997
Dow Jones Industrial Average revised. The Wall Street Journal (March 13, 1997, C1, C22) reported that four stocks have been replaced in the 30-stock index. Reflecting the increased role of services and data and communication technologies in the U.S. economy, Travelers Group replaced Westinghouse Electric, Hewlett-Packard Co. substituted for Texaco, Johnson and Johnson removed Bethlehem Steel Corp. and Wal-Mart Stores Inc. supplanted Woolworth Corp. The change was one of the most extensive in the index’s history.
Credit card delinquencies reached all-time high at year-end 1996. The Wall Street Journal (March 14, 1997, A6) reported that the American Bankers Association’s data on the percentage of credit-card accounts past due more than 30 days increased to 3.72% in the fourth quarter of 1996, the highest since tracking began in 1993. Overall composite consumer credit delinquencies, which include auto, home improvement, home-equity and other consumer loans, increased also, but remained well below the record level hit in the third quarter of 1989. Analysts were divided in their interpretation of the importance of the report.
FDIC will get new head. The Wall Street Journal (March 14, 1997, A6) reported that Ricki Helfer will step down as head of the Federal Deposit Insurance Corporation. During the last few years, the FDIC has undergone significant change as legislation mandated the shoring up of the FDIC-administrated Savings Association Insurance Fund through a special assessment of its members, the FDIC absorbed the Resolution Trust Corporation, and insurance premiums for the highest quality commercial banks were reduced to zero since the Bank Insurance Fund reserves reached 1.25% of total insured deposits, a target set by Congress.
Week of March 2, 1997
Great Western finds white knight. The Wall Street Journal (March 7, 1997, p. A3) reported that Great Western Financial Corp. agreed to be acquired by Washington Mutual Inc. The new entity would have assets of approximately $86 bil. and a transaction value of close to $7 bil. Great Western had been spurning a hostile offer by H.F. Ahmanson & Co. Ahmanson made what appeared to be a tactical mistake when it sent a memo to its employees saying that the expected layoffs would only include Great Western employees. Great Western countered with a beefed up severance program and a stall. Since the cost savings on a merger with Ahmanson would likely be greater than with Washington Mutual due to the high branch overlap with Ahmanson, many experts expected an Ahmanson counter offer.
Greenspan comments lift stock market and heighten controversy. The Wall Street Journal (March 6, A3 & C1 and March 7, C1, 1997) reported that Federal Reserve Board Chairman Alan Greenspan’s remarks about the stock market being "probably properly priced" helped fuel a market rise on March 5th. The paper then reported on March 7th that many small investors were getting upset with Greenspan’s frequent stock market comments. Still, a number of fed watchers defended the Chairman’s remarks. Greenspan defended himself by saying it was appropriate that the Fed indicate the indices it is watching.
Millennium create havoc for financial institutions. The Economist (March 8, 1997, p. 86-87) reports that commercial banks and other financial institutions are finding that correcting the now well known millennium computer programming problem is providing more expensive than first thought. Simply, most of the world’s computers for tracking such things as time deposits use only the last two digits for year, e.g., 09/09/02 for Sept. 9, 2002. Unfortunately, when programs were written years ago they ignored the 19 or 20 for centuries. When a certificate matures in the year 2002, the computer will incorrectly assume its the year 1902. No interest will be paid on that account! Rewriting the code is providing both difficult and expensive. Bank of Boston estimates a cost of nearly $50 million to correct the problem. That’s 7% of last year’s profit.
Week of February 23, 1997
Russia’s stock market was an outstanding performer last year. Business Week (March 10, 1997, pp. 100-101) reported that money managers are flocking to Russia to establish mutual funds to cash in on that country’s booming stock market. They report over 40 mutual funds are now offering equity and debt investments. The Economist (February 22, 1997, pp. 79-80) reported that Russia’s stock market outperformed all but Brazil’s market in the year ending February 18, 1997.
Information sharing now common among regulators and organized markets. Futures (March 1997, pp. 76-78) reports that information sharing agreements - Declarations, Memorandums of Understanding, and Cooperative Agreements - between organized futures exchanges and their regulators are now common around the world. These agreements, starting in the mid-1980s, are designed to detect market manipulation and ensure that when problems occur the regulator has data as fast as possible. Signing agreements and getting compliance are two different matters, however. The Commodity Futures Trading Commission of the United States has signed over ten agreements with organized exchanges around the world. Unfortunately, some of the exchanges that signed the agreements cannot supply the required data.
Week of February 16, 1997
Emerging stock markets lagging American and European markets since 1993. The February 22, 1997 Economist (pp. 79-80) reported that many emerging Asian and Eastern European stock market have lagged the markets in developed countries. The International Finance Corporation’s (IFC) investable index for emerging markets remained almost 10% below its year-end 1993 level, while the S&P 500 and MSCI developed market world index were up to over 170% and 140%, respectively, over their 1993 levels in February 1997. Experts claim these markets were over-hyped in the early 1990s. Most, however, still believe that the long-term outlook for emerging markets remains strong.
Good economic conditions, not mutual funds driving U.S. stock market. The March 3, 1997 Business Week (pp. 78-79) reported that it is low inflation and interest rates and strong corporate profits, not strong flows into mutual funds, that is driving the U.S. stock market to record high levels. Academics studying the relationship between fund flows into mutual funds and stock market prices find only a weak positive correlation. Other researches have shown that almost all the money being added to mutual funds by households is coming directly from sales of individuals stocks. That’s not net new money.
Collateralized Mortgage Obligations (CMOs) make a comeback. The February 24, 1997 Wall Street Journal reported that issuance's of hybrid forms of mortgage backed securities (MBS) are strengthening after a long dry spell following the demise of Orange County and several hedge funds in April 1994. CMOs (also known as Real Estate Investment Conduits, REMICs) are securities created by repackaging the cashflows from mortgage pass-through MBS of secondary market government sponsored enterprises. In 1993, over $300 billion was issued. This dropped to around $30 billion in 1995. Experts expect issuance to rise to over $100 billion in 1997. The reason is yield. The CMOs, with varying amounts of prepayment risk, provide a yield advantage over noncallable debt.
Week of February 9, 1997
Dow Jones Industrial Average rose to the 7,000 level on Feb. 13, 1997. The Wall Street Journal (C1) reported that the DJIA closed above the 7,000 level. This was less than four months since it hit the 6,000 level on Oct. 14, 1996. Declining interest rates prompted by low inflation numbers helped spur the market. Market analysts point toward a strong economy, rising productivity, low inflation and baby boom generation savers concerned about retirement.
Dollar continues strong advance. The Economist (February 8, 1997, p. 79) reported that the U.S. dollar hit a four-year high against the yen on February 5, 1997, up 50% since its April 1995 low. The strong dollar reflects a strong U.S. economy with possibly rising interest rates in relation to weaker economies in Europe and Japan where interest rates remain low. Other analysts point to the European monetary union as a concern. Their new currency is expected to be weaker than the German mark which now dominates Europe’s monetary system. According to Business Week (February 24, 1997, pp. 34-36), the dollar’s strength already has auto manufacturers and others concerned. Auto imports are expected to make strong gains in the U.S. market this year. According to The Wall Street Journal (February 10, 1997,. P A2), earlier in the week the Group of Seven (G-7) finance ministers and central bankers claimed victory in their two-year effort to strengthen the dollar. The G-7 collective statement read "We believe that major misalignments in exchange markets noted in our April 1995 communiqué have been corrected."
Calpers issues annual list of underperforming companies. Business Week (February 24, 1997) reported that on Feb. 11, 1997, the California Public Employees Retirement System (Calpers), the nation’s largest public-employee pension fund, issued its annual list of companies they feel are performing poorly. This list has made waves in corporate America in recent years since listed companies have often become the target of institutional pressure on directors and management. This year’s list included Apple Computer, Inc., Reebok International Ltd., Bassett Furniture Industries, Inc. Rollins Environmental Services, Stride Rite Corp., Sybase Inc. Fleming Cos., Summit Technology, and Sensormatic Electrics Corp. The Wall Street Journal (February 11, 1997, p. A4) reported that Calpers uses the list to decide whether to withhold votes for re-election of directors.
Week of February 2, 1997
Morgan Stanley Group and Dean Witter, Discover & Co. announce merger. February 5, 1997, The Wall Street Journal (A1) reported the proposed marriage of two major investment bankers. The deal, valued at over $10 billion, will marry a major wholesale and retail firm. Business Week (Feb. 17, 1997, pp. 78-79) reports that the biggest two issues are potential corporate culture clashes and distractions during the integration. Proponents expect the merger will give Merrill Lynch & Co. strong competition as an diversified firm. The merger is expected to kick off a round of mergers and acquisitions as commercial banks seek entry into investment banking. This is the result of recent Federal Reserve liberalization of holding company regulations. Another motivation will be for competitor investment banks to seek greater size and scope of operations.
High risk car lender market is disarray . Feb. 7, 1997. The Wall Street Journal (A2) reported that a number of firms serving the fast-growing used and high risk car lending market are suffering from liquidity problems, filing bankruptcy, and experiencing debt downgrades. In the wake of used car lender Mercury Finance’s reported accounting irregularities, investors in the commercial paper of these fast growing lenders are having second thoughts. In recent years, a number of these lenders raised capital in the IPO market and their stocks have increased rapidly. Mercury’s problems are believed to have contributed to Jayhawk Acceptance Corp.’s bankruptcy filing and the downgrade of the ratings on securities of other auto finance companies.
Justice Department Considering Coming Down Hard on Visa and Mastercard. Feb. 17, 1997. Business Week (p. 80) reported that Justice is concerned about the exclusive distribution arrangement that Visa and Mastercard have with issuing commercial banks. American Express has been trying to break the exclusive arrangement for years. Experts say that a successful Justice challenge could reshape the credit card market.
Week of January 26, 1997
New inflation-indexed bonds to become target of Fed watchers. Feb. 3, 1997. The Wall Street Journal (C1) reported that the newly-issued inflation-adjusted 10-year notes are expected to become a major target of analysts forecasting Fed policy. The spread between the 10-year fixed-rate Treasury and 10-year inflation-indexed bond is considered to be a sound inflation forecast tool. If it rises, many analysts are expected to interpret the rise as increasing inflation expectation and a possible signal that the Fed might have to tighten monetary policy.
Regulators approve new wider "Circuit Breakers" on NYSE. Feb. 3, 1997. The Wall Street Journal. (C 6) reported that the SEC-approved wider bands for the circuit breakers dealing with trading on the New York Stock Exchange. The 30-minute halt in trading breaker moved from a 250 points to a 350-point move and the one-hour halt moved from 400 to 550 points. The rise in the Dow Jones Industrial Average caused the old lower circuit breakers to halt trading after only an 3.7% change in prices. The new level will halt trading after approximately a 5% move. New circuit breakers were also established for futures trading by the Commodity Futures Trading Commission
As reported on CNBC, the Federal Reserve Board released the Beige Book on the Internet two hours ahead of schedule. The beige book is a compilation of regional economic activity as presented by the Twelve Federal Reserve District Banks. The information swiftly spread through the financial markets making the traditional release a non event. This is an indication of the growing importance of the Internet in financial decision making. When asked, the spokesperson for the Fed stated that the traditional 2:PM EST release time will be adhered to in the future.
Japanese bank weaknesses contributing to Japan’s stock market woos. January 25, 1997. The Economist (p. 65) reported that Japanese bank stocks have fallen nearly 15% since the beginning of the year. One reason for a growing negative outlook for Japanese stocks is because Japanese banks, experiencing growing loan losses, are expected to be less able to set up large loss reserves. One reason is because Japanese banks no longer have large profits built up in their own equity holdings of Japanese stocks. Its a vicious cycle, more bankruptcies, higher loan losses, and lower equity prices of bank-owned stocks leading to increased difficulty in covering the new losses. Increasing investor concerns about the outlook for Japanese banks is the outlook that additional financial deregulation will cut into bank profit margins. Equally troubling is that declining bank stock prices is making it hard for banks to issue new stock to improve equity ratios.
Inflation-adjusted bonds led to investor speculation. Jan. 22, 1997. The Wall Street Journal reported that the "when issued" yield on the new inflation-indexed 10-year notes was 3.32%. The Treasury decided to offer $7 billion in bonds, the high end of a range estimated several days earlier at between $3 - $8 billion and reported in the Jan. 21, 1997 Wall Street Journal (C22). Investors expressed concern about illiquidity of the issue if it were too small in size.
Separately, the January 1997 Monetary Trends(p.1), published by the Federal Reserve Bank of St. Louis reported that one of the major negatives of the new bonds is likely to be the unfavorable tax treatment, of the bonds. The new bonds will be taxed on both the current coupon and the inflation-compensating adjustments to the bond’s face value even if the bonds are not sold. This taxation of this unrealized capital gain may be a serious problem for many investors.
The Dow Jones Industrial Average ended Up 26% in 1996: Jan. 2, 1997. The Wall Street Journal (B15) reports that the DJIA closed at 6448.27, up 26% in 1996. The 1995-96 back-to-back gain was 68.2%, the 6th highest two-year, double-digit gain and the best in over 40 years.
Court of Appeals strikes down restrictive “Common Bond” definition:. December 27, 1996. The Wall Street Journal (A2) reported that a Washington DC court of appeals struck down a decision by a lower court that restricted the membership of credit unions to only a single employer. In recent years, credit unions have opened up membership to multiple employers in a effort to expand their markets. The case will go to the high court early in 1997.
Week of December 22, 1996
Federal Reserve expands security powers of bank holding companies: December 23, 1996. The Wall Street Journal (A2) reported that the Federal Reserve Board expanded the percentage of bank holding company revenue that can be earned from security sales and underwriting. The expansion is expected to bolster the security activities of the roughly 40 bank holding companies with subsidy broker/dealer activities.
Commercial bankers lose customer loyalties to nonbanks and thrifts. December 23, 1996. The American Banker ONLINE (p. 1) reported the results of a 1996 American Banker consumer survey showing that for the first time the number of consumers surveyed rated commercial banks as their number one financial relationship dropped below 50 percent. Nonbanks, especially broker/dealers, and thrifts have made significant inroads in the last few decades on commercial banks share of market in both the deposit and loan sides of the balance sheets.
Treasury uncertain how to deal with CPI bias in sale of price index-adjusted bonds. December 18, 1996: The Wall Street Journal (p.C1) reports that the uncertainty over how to deal with the known bias of the CPI may cause problems in the design of the U.S. Treasury’s price index-adjusted bonds planned for 1997. Investment professionals indicate that the uncertainty over how the Treasury will respond in the selection of an index will likely require the Treasury to pay a higher rate. These experts are sighting higher risk requires higher return as their theory behind the prediction.
Daiwa Bank ex-trader fined and sent to prison. December 17, 1996. The Wall Street Journal (p. B5) reported that a U.S. Federal judge decided that Toshihide Iguchi should serve 4 years in prison and pay fines and restitution of over $2.5 million for fraud and embezzlement in a conspiracy to cover-up losses of $1.1 billion in trading at the Diawa Bank Ltd. The losses were announced by the bank in September 1995. The action followed admission by the bank of 16 fraud charges and expulsion from the United States in Feb. 1996.
EMU leads to downturn in forex trading and more uniformity of macro economic policies. December 15, 1996. The Economist (pp. 17-25) reports that as Europe moves to a truly single currency market, decisions of the European Union, a body which sets the rules for the group. remain contentious. The rules for the countries involve targets for inflation, long-term interest rates, budget deficit to total GDP, public debt to total GDP, and exchange rate. While lonely Luxembourg will likely comply with all these goals during 1997, there has been an increase in macroeconomic policy uniformity among Europe’s major economic powers.
Greenspan’s “irrational exuberance” shakes market and spurs debate. Business Week (p. 35), December 23, 1996. Business Week (p. 35), December 23, 1996. Dec. 6, 1996 (p.1) Following an evening speech by Federal Reserve Chairman Alan Greenspan, where he mentioned the possibility of stock markets suffering from “irrational exuberance,” the world’s major stock market's shook.
Experts have been both supportive and critical of Greenspan’s apparent warning. Supporters claim the act was that of a responsible central banker who was letting the market know that the Fed was watching the situation and would take any necessary liquidity actions if called upon to do so. Critics, on the other hand, suggested that Greenspan is not a market sage and should refrain from such comments. He meet with market experts prior to the speech and learned that they were divided on the issue of appropriate market valuation.
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