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 December 28, 1997
Stock Market Rises Over 20% in 1997, Third Year Of 20% Plus Gains. The Interactive Wall Street Journal (January 2, 1998) reported that the Dow Jones Industrial Average ended 1997 at 7908.25, up 22.64%. This capped the third year of 20% plus gains, the first time it has ever happened. Large capitalization stocks dramatically outperformed small-cap stocks while the entire market was lifted by declining U.S. interest rates at year end.
Converting Mutual Into Stock Companies Becoming Popular in Outside the United States. The Economist (January 3, 1997, pp. 71-2) reports that demutualizations have been growing in number in Britain, Australia, South Africa, and Switzerland. Following the trend of mutual to stock conversions among savings and loans, savings banks, and insurance companies in the United States, other countries with a history of mutual financial institutions are jumping on the bandwagon. The biggest holdout is Germany where mutuals control about one-third of all banking and insurance company assets. That may be changing, however, as mutual holders of these firms demand to hold stock and managers consider the possibility of higher compensation that stock ownership promises.
Merrill Lynch Moves to Open Japan’s Financial System. The Economist (January 3, 1997, p. 72) reported that Merrill Lynch’s announcement to hire 2,000 employees and acquire 50 offices of the recently failed Yamaichi Securities provides fresh evidence that Japan, like the rest of Asia, is under relentless pressure to open its financial system to foreigners. The deregulation of Japan’s investment trusts, a form of mutual fund, is being looked at as a compelling factor behind Merrill Lynch’s move.
Week of December 21, 1997
Public Employee Pension Plan Considers Seeking Board Seats. The Wall Street Journal (December 26, 1997, p. A3) reports that the $126 billion California Public Employees Pension Plan (Calpers) is considering seeking board seats in public companies in which it has major investment stakes. Calpers must consider a number of issues including board liability, insider trading, and trading issues before making its decision.
ATM Users Irked by Fees. The American Banker Online (December 26, 1997) reported that a recent Gallup poll of depository customers indicated a dramatic drop in satisfaction with pricing on ATM transactions. The dissatisfaction was most pronounced for "prices charged" which received the lowest possible "poor" rating by 38% of those surveyed, compared with 24 % the year earlier. Experts believe that it is the surcharges applied to "foreign" ATM machines that are the biggest source of concern.
Korea’s Need for Emergency Aid Puts United States in a Dilemma. The Wall Street Journal (December 26, 1997, p. A2) reports that the decision by the U.S. Treasury to participate in the recent $10 billion emergency bailout of Korea raises the issue of whether U.S. aid is bailing out private companies. Only a week and a half earlier, Secretary of the Treasury Robert Rubin reported that South Korea didn’t require emergency aid. Now it is being offered over concern that without it, Korea’s problems could grow to adversely affect Brazil and Russia.
Week of December 14, 1997
Japanese Investors Profit from Investments in U.S. Treasuries. The Economist (December 20, 1997, p. 109) reported that while Japanese investors may be forced to sell some U.S. Treasury securities due to problems in their weak banking sector, the sales would be one of the few times Japanese investors profited from investments in the United States. The Japanese held $321 billion in U.S. Treasuries in the summer of 1997. Unlike huge Japanese investments in U.S. real estate during the 1980s, however, the Treasury securities are trading at the top of the market and the dollar has appreciated significantly against the yen while they have held them. Moreover, U.S. interest rates have been at a significant premium over Japanese rates. The Japanese investor looks good this time around.
AT&T Exits Credit Card Business. Business Week (December 22, 1997, pp.32-34) reported that AT&T is exiting the credit card business after its seven-year shakeup of the industry. In 1990, the firm’s Universal Card shook up the industry by offering a lifetime no-annual-fee card that was accepted by over 10 million cardholders in two years. The card’s early success was aided by the marketing to 90 million AT&T long distance customers and to its use as a phone credit card. Some experts feel that AT&T may have become victim of its own low-price strategy as competitors matched the no-fee offer and added teaser rates to get customers to switch credit balances. The Wall Street Journal (December 17, 1997, p. A3) reported that Citicorp offered to buy AT&T’s card portfolio for an estimated $3 to $4 billion.
Nasdaq Security Dealers Consider $900 million Settlement for Price Rigging. The Wall Street Journal (December 19, 1997, p. C1, C16) reported that over two dozen Nasdaq dealers are contemplating a $900 settlement offer to resolve a class-action suit brought against them in July 1994 claiming the dealers collude in setting prices. The lawsuit claimed that bid-ask spreads for stocks brokered by the dealers were kept too wide, thus enriching the dealers.
Rating Agencies and Others Are Blamed for Not Recognizing Asian Problems. The Economist (December 13, 1997, pp. 68-71) reports that investors in Asian securities are questioning why rating agencies did not anticipate the problems. Lack of experienced staff, an unwillingness of rating firms to deviate in ratings from one another, and the centralization of rating activities in London and New York far from the action are considered reasons why the rating services reacted so slowly to deteriorating events. The Wall Street Journal (December 19, 1997, p. A18) noted that the rating firms are not the only organizations that misread Asia. The U.S. Treasury also missed the call. Only weeks before the crisis broke, the President referred to the Asian situation as a "few little glitches on the road."
IMF Blamed for Old-style Policy Remedies in Asia. The Economist (December 13, 1997, pp. 65-66) reported that the International Monetary Fund’s (IMF’s) rescue efforts in Asia are being criticized. The IMF’s demand that Asian countries liberalize banking laws and implement tight monetary and fiscal policies are not supported by many. While allowing foreigners to buy banks is thought to be a sound long-term strategy, the demand for immediate liberalization is considered unnecessary. The demands for tight monetary and fiscal policies have even less support. Unlike the bailouts of Russia and Mexico, the Asian countries did not face high inflation and fiscal imbalances. Forcing these countries to slow economic growth may only compound their problems.
Week of December 7, 1997
European Banks Join Consolidation Move. The Wall Street Journal (December 8, 1997, p A3) reported that Union Bank of Switzerland and Swiss Bank announced a $25 billion merger agreement to create the 2nd largest bank in the world. The combined $590 billion asset bank would become the largest in Europe and 2nd in the world to Bank of Tokyo – Mitsubishi. Facing slow growth in Switzerland, the new bank would compete internationally with strengths in private banking and asset management.
Asian Countries Continue to Face Up to Problems. The Wall Street Journal (December 9, 1997, p. A14) reported that the Japanese government is proposing a $77 billion bond issue to help bail out weak banks and other financial firms. Meanwhile, the Thailand government reported that 56 out of 58 finance firms suspended earlier in the year will not be allowed to reopen. South Korea’s government is also reportedly planning a bank bailout.
Free Trade in Financial Services May Move Forward. The Economist (December 6, 1997, pp. 70-71) reported that a deadline on a World Trade Organization pact to free up trade in banking, insurance, and financial services may open up trade significantly. The tension involves large U.S. banks versus several developing countries that U.S. banks believe are not moving to embrace free trade fast enough.
Week of November 30, 1997
NYSE Backs Away from Major Changes to Circuit Breakers at This Time. The Wall Street Journal (December 5, 1997, p. C1) reported that the New York Stock Exchange (NYSE) adopted minor changes to its circuit breakers. The NYSE decided to revise its 550-point circuit breaker so that it now will result in only a one-half hour pause in trading if it is activated after 2 p.m. The 350-point circuit breaker would be removed after 3 p.m. The exchange will take up more significant change proposals in January or February 1998.
Fraud a Serious Problem in Sale of Penny Stocks. Business Week (December 15, 1997, p9. 112-128) reports that overpriced sales of penny stocks to unsuspecting investors is netting millions in profits for a wide range of unscrupulous groups. Dealing mainly in micro-cap stocks, these groups use a variety of tactics to entice unknowing investors into these near-worthless investments. Promoting stocks to rise to unrealistic values and then selling them, using fraudulent financial statements to hype stocks, charging excessive commissions, and playing off of the high demand for initial public offerings by unloading worthless new issues are a few of the tactics used to profit. The report indicates that the problem is much more common than most government law enforcement officials believe and constitutes a serious problem for unsuspecting investors.
Microsoft and Wells Fargo & Co. Promote On-line Banking. American Banker Online (December 5, 1997, p. 1) reported that Wells Fargo & Co. chairman Paul Hazen promoted the use of electronic presentment and automated payment of bills via personal computer. His speech followed on the heals of a similar pitch by Bill Gates of Microsoft.
Mr. Hazen made clear that the bank has made significant investments in Internet-based and other automated services in cooperation with Microsoft. Wells is one of the first to test Microsoft's Internet banking framework, code-named Marble, and it will pilot the MSFDC automated bill processing program. The stakes for how the U.S.’s payment system will be divided up in the years ahead are large and a major topic in the banking world.
Week of November 23, 1997
Central Bank’s Find Gold Too Costly to Hold. The Economist (November 22, 1997, p. 91) reports that gold has lost much of its luster as a central bank reserve asset. Gold prices have been falling, in part, because central banks in Belgium, the Netherlands, Canada and Australia have been selling from their gold stocks. The interest foregone by central banks holding gold instead of interest-earning assets is substantial. The Economist estimated that the United States foregoes $4.4 billion in annual income, while Germany, Switzerland and France lose nearly $1.5 billion a year.
New York Stock Exchange Recommends Wider Circuit Breakers. The Wall Street Journal (November 24, 1997, p. C1) reported that the New York Stock Exchange recommended replacing the 350 and 550 point circuit breakers with 10% and 20% moving levels. Based on the market close on November 21, the proposal would have the circuit breakers kick in at 788 and 1, 576 point drops in the Dow Jones Industrial Average, respectively.
National Association of Security Dealers Warns of IPO Allocation Violations. The Wall Street Journal (November 24, 1997, p. C1) reported that the National Association of Security Dealers (NASD) sent a warning to members suggesting that allocating initial public offerings of hot stocks to venture capitalists and others that might steer new issue business my violate regulatory rules. The NASD warning comes in the wake of reviews by the U.S. Security and Exchange Commission concerning industry practices.
Traders and Exchanges Duel over Cost of Price Quotes. Futures (November 1997, pp. 78-84) reported on the long-standing dispute between traders and organized exchanges over the industry practice of selling real-time price information. Traders need the information and argue that the fees are excessive. The exchanges generate considerable income from the fees. The Chicago Board of Trade generated $42.4 million in 1994, representing 28% of the total revenue. The New York Stock Exchange made $68.0 million, or 15% of their total revenue. The bottom line is whether the fees discourage trading volume. The major exception to the charging of fees has been from the Chicago Mercantile Exchange which provides a limited amount of free real-time price information over the Internet.
Week of November 16, 1997
First Union’s Purchase of CoreStates Raises Questions. The Wall Street Journal (November 20, 1997, p. A3) reported that First Union Corp.’s acquisition agreement to buy CoreStates Financial Corp. for $16.3 billion has forced First Union to defend the price paid. The price to book value of the deal is 5.39 versus 3.99 in the Barnett Bank purchase by NationsBank and 3.04 in Wells Fargo’s purchase of First Interstate. Business Week (December 1, 1997, p.152) reports that First Union expects to profit from the transaction using their strengths in technology, market share, and diversification.
Merrill Lynch Makes Big Foreign Asset Management Acquisition. The Wall Street Journal (November 20, 1997, p. C1) showed its faith in the prospects for international growth in asset management services by making a $5.8 billion offer to acquire Mercury Asset Management of London. The acquisition would make Merrill the third largest worldwide asset manager with nearly $500 billion under management.
Price Data Analyzed to Identify Market Anomalies. Business Week (December 1, 1997, p. 151-52) reports that financial analysts are using access to tick-by-tick price data to identify profitable trades in the foreign exchange and stock markets. Many reject the notion that past price behavior has no valuable information to predict future prices (academics call this weak-form market efficient). They analyze trade by trade data on the basis that different types of investors react differently to new information. Traders, long-term investors, central banks, and individuals may respond in different ways and over different time periods to new information about a financial asset’s value. Learning how to predict these reactions can yield systematic, but small, trading profits according to these analysts.
New York Stock Exchange and SEC Review Circuit Breakers. The Wall Street Journal (November 19, 1997, p. C1) reported that officials of the New York Stock Exchange and U.S. Securities and Exchange Commission planned to review the performance of the exchange’s 350-point and 550-point circuit breakers which halted trading on Oct. 27, 1997. Critics claim the limit is too restrictive since the 550-point limit involves only a 7.2% drop in the market average. The closing of the market on Oct. 27 left some traders unable to trade and value stocks.
REITs Back in Favor. The Wall Street Journal (November 19, 1997, p. C1) reported that recent stock market volatility has put the focus on real estate investment trusts. The trusts invest in mortgages and real estate and generally provide dividend yields that are much higher than today’s average market level. REIT stocks are also included in a number of mutual funds. These funds have grown to an estimated $10 billion from only $1.5 billion three years ago. A recovering U.S. commercial real estate market, high dividend yields, and concern over market valuations in other stocks are the reasons for the interest in REITs.
Brokerage Firm Stops Practice of Using Hot IPO's to Gain Business. The Wall Street Journal (November 18, 1997, p. C1) reported that the brokerage firm BankAmerica Robertson Stephens is prohibiting the practice of allocating shares in hot IPO's to executives that might steer corporate-finance business to the firm. The practice has been under review by the U.S. Securities and Exchange Commission and National Association of Securities Dealers.
Week of November 9, 1997
On-line Brokerage Firms Start Price War. The Wall Street Journal (November 14, 1997, p. B11B ) reports that some on-line brokerage firms have drastically dropped commission rates to below $10 per transaction. No commission trading has even shown up as brokerage firms have developed efficient computerized trading systems while generating profits from lending on margin accounts and lending stock to short traders. Critics argue that if trading volume falls drastically these discount houses will face tough times.
Gold Prices Hit Twelve-year Low. Business Week (November 24, 1997, p. 158) reports that gold prices hit a 12-year low the week of November 9. Neither the Iraq conflict, stock market volatility, and financial crises in Asia and South America have helped the gold bugs. One major reason for the weak prices is gold selling by a number of countries. Since 1989, 64 million ounces of gold have been sold by governments around the world. Other countries, such as Germany, are increasing the supply by lending gold and earning interest on the loan.
Customized Internet Financial Advice Just Around the Corner. Business Week (November 24, 1997, p. 157) reports that new Internet-based personal financial services will soon provide customized financial services to individuals for a nominal fee. Using a person’s financial condition and financial algorithms programmed into computers accessible via the Internet makes possible customized asset allocation recommendations and other customized financial analyses. Currently the service is being sold to companies which offer employees 401(k) programs.
Deflation Concerns Overblown. The Economist (November 15, 1997, p. 77-78) disagrees with some economists who argue that excess capacity worldwide will combine with increased Asian competitiveness resulting from currency devaluation's to cause serious deflation in the United States and Europe. Not likely, says the magazine, given that only 25% of total GNP in developed nations is made up of manufactured goods. Services, not manufactured goods, is what drives these economies and deflation is not showing up in services. Health care, college tuition, airline tickets, and legal services are not falling in price. The magazine notes that these economists should know the difference between true "deflation," a systemic decline in general price levels, from a change in "relative prices" for some goods and services.
Week of November 2, 1997
Mutual Funds "Estimate" Net Asset Values. Business Week (November 17, 1997, p. 41) reports that a number of mutual funds "apparently" rode out the price volatility of recent weeks by using the rarely used valuation approach "fair-value pricing." The approach, approved by the U.S. Securities and Exchange Commission (SEC), allows mutual fund managers to use their estimate of a "fair" price if they feel a reliable market price is not available by 4 p.m. EST. Several mutual funds avoided substantial declines in net asset value during the sharp decline in Asian stocks by applying the methodology in recent weeks. The SEC will be reviewing the policy.
Bubble Trouble? Business Week (November 17, 1997, p. 56-57) reported on the continuing controversy between financial economists who believe in a strict interpretation of "efficient markets" and those that don’t. Recent high U.S. stock prices and those that occurred in Japan during the late 1980s are being used as evidence that stock prices can experience bubbles, overshoots, and panics. Today, the pure "efficient market" advocates are on the defensive.
Do Recent World-wide Market Tumbles Disprove Wisdom of Diversification. The Economist (November 8, 1997, p. 84) reviewed the early November market crashes in Asia, Europe, and the United States in terms of what they say about the wisdom of international equity diversification. Did the positive correlation of stock prices mean that diversification no longer works? Recent research indicates that global crashes are the exception. There is evidence, however, that the stock markets of several regions, Europe and Asia in particular, are more correlated today than in the past. However, global correlation's between the world’s stock markets remain low enough to show that diversification still has a firm foundation.
Week of October 26, 1997
New York Stock Exchange (NYSE) to Rethink Circuit Breakers. The Wall Street Journal (October 29, 1997, p. C23) reports that criticism by traders has persuaded the exchange to reconsider the use of circuit breakers. Circuit breakers were adopted by the NYSE in the wake of the 1987 crash as a means to break the fall in stock prices. The circuit breakers currently in use by the exchange call for a 30-minute break in trading whenever the Dow Jones Industrial Average falls by 350 points in a single day. Trading is stopped if the fall hits 550 points which occurred for the first time on October 24th. Some traders argued that the breakers actually fueled the decline by creating fear that stocks could not be sold.
Currency Boards Involve Costs and Benefits. The Economist (November 1, 1997, p. 80) discussed the pros and cons of currency boards used by Argentina, Bulgaria, Estonia, and Lithuania. A currency board is a mechanism that fixes an exchange rate by having the government support a predetermined rate of exchange between their country and another country with a desirable stable currency. The Hong Kong currency board has pegged its dollar to the U.S. dollar. A currency board, unlike a central bank, cannot set a domestic interest rate which is its major limitation. Consequently, the county must accept the rate of interest prevailing in the country its currency is tied too. The discipline of a currency board is generally considered to be the cause of lower inflation in countries with currency boards.
By Most Measures U.S. Stock Market Remains Overvalued. The Economist (November 1, 1997, p. 71-72) reviewed a host of valuation techniques used by investment houses and academics and concluded the U.S. stock market remains significantly overvalued even in the wake of the October 24 decline. High price/earnings ratios late in a business expansion is one sign of overvaluation. Another is the research by Campbell and Shiller which notes that each time the dividend yield on the market fell below its average of 4.72%, the market adjusted downward. Other research by Lee considered interest rates, dividends, and earnings forecasts and concluded that U.S. stock prices were higher than at any time in the last four decades. He valued the market at 6,200 on the Dow.
Week of October 19, 1997
Bankruptcy Commission Finds Many Critics of Its Recommendations. Business Week (November 3, 1997, p. 154) reports that the 1,300 page report of the National Bankruptcy Review Commission was criticized by both debtors and creditors. Creditors felt the commission did little to stem the growing number of bankruptcies by not recommending "means testing" bankruptcy. This would require more borrowers to repay debts. Debtors were upset that certain provisions in the current law allowing the rich to avoid debts were recommended to be eliminated. The number of bankruptcies is expected to climb to 1.3 million is 1997, up from less than 800,000 in 1994.
Citicorp Announces Major Staff Reduction. American Banker Online (Oct. 21, 1997, p.1) Citicorp announced a major restructuring that will result in the loss of 7,500 jobs and a pretax charge of $889 million. The announcement was interpreted as a sign that the bank was anticipating tighter margins in the years ahead. Other banks are expected to follow suit.
Even Smaller-Sized Banks Are Learning Customers Want Online Services. American Banker Online (Oct. 21, 1997, p.1) A recent Mentis Corp.,survey found that while only 1% of financial institutions with less than $1 billion of assets offered Internet access to customers, 42% said they planned to offer the service within three years. Many smaller banks have been waiting to see how customers respond to Internet banking services. Discussions with bankers indicate that bankers are finding the service is in demand.
Week of October 12, 1997
Financial Economists Take Top Prizes. Business Week (October 27,1997, p. 48) reported that financial economists Robert C. Merton and Myron S. Scholes tool top honors in the Nobel Prize race. Their pioneer work in option valuation again put financial economists in the limelight. Traditional economics textbooks say little about the subjects studies by financial economists despite the stronger demand for them and their research.
A Look Back At the Crash of 1987. CNN Online (October 17, 1997) reported on why the 1987 stock market crash took place. Some academic studies concluded that many investors shifted from stocks to bonds as the yield on 30-year U.S. Treasury bonds approached 9.9 percent in the summer of 1987. Economists noted that inflation had been heating up in 1987, causing rates to rise. When the U.S. government released August trade-deficit figures in October, the data came out higher than expected which convinced currency traders that the dollar would have to fall causing them to dump dollars. Both were reasons for investors to dump stocks. Other economists looked at technical factors such as the use of something called "portfolio insurance" involving the sale of index futures contracts in "program trading" programs.
Week of October 5, 1997
Greenspan Shakes Up Markets Again. The Wall Street Journal (October 9, 1997, p. A2) reports that Greenspan characterized the U.S. economy as being "on an unsustainable track." Many investors took the comments to mean that an increase in the federal funds target rate is just around the corner. The stock and bond markets fell moderately in the wake of the testimony before the House Budget Committee.
Credit Unions Challenged Over Expanding Customer Base. The Wall Street Journal (Oct. 6, 1997, p. B1-B10) reported that the case over expanding customer bases at credit unions will be heard by the U.S. Supreme Court. At issue is the trend of credit unions to accept members from many different types of companies and places. Commercial banks have challenged this movement in court. Credit union regulators have gradually expanded the concept of "common bond," which has restricted membership in credit unions in the past. If credit unions lose this case, it could have far reaching implications on the future growth of the industry.
Service Versus Technology Defines Bank Retail Strategies. Forbes (October 20, 1997, pp. 102-105) reports that commercial banks are dividing into two camps, those using the high-tech, low-cost strategy and those the friendly customer-service approach. The article describes Wells Fargo & Co. as a leader in the high-tech strategy going against many smaller firms and thrifts who are sticking to the human touch approach. Although there are winners in each camp, so far Well Fargo & Co. is winning at the profitability window.
Week of September 28, 1997
FASB Derivative Ruling Still Moving Forward. The Wall Street Journal (Online Edition, September 29, 1997) reports lessening opposition to the Financial Accounting Standards Board's proposed rules on financial derivatives. This comes only days before congressional hearing are scheduled. FASB's proposal requires companies to mark derivative positions to market. Most companies argue that this is difficult to accomplish given the limited trading of many derivatives and there complicated structure. Others argue that earnings would be too volatile.
Mexico Leads World Stock Market So Far in 1997. The Wall Street Journal (October 1, 1997, p. C1) reports that the Mexican stock market rose nearly 59% measured in pesos and 61% in U.S. dollars through September 30, 1997. The U.S. came in sixth with a 28% gain. The biggest losers were in Asia with Thailand, Philippines, and Malaysia registering about 35% losses. Measured in U.S. dollars, the losses were over 50%.
Asian Currency Crises Not Scaring Away U.S. Investment Bankers. Business Week (October 13, 1997, pp. 90-94) reports that U.S. investment bankers continue to invest heavily in Asia even as the currency crisis in that region continues. They see great opportunities in this fast-growing region of the world. U.S. investment bankers have an advantage over the strongly entrenched Hong Kong firms in that they have stronger global activities.
Commercial Bank Profits Hit Another Record for 2nd Quarter. The FDIC Quarterly Banking Profile (Second Quarter 1997, p. 1) reports that commercial bank industry profits reached $14.6 billion in the 2nd quarter of 1997, up 6.2% from the year earlier. The return on average assets was the fifth highest on record at 1.24% and the return on equity a strong 14.72%.
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