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CFA Institute Research Foundation, Univ. of Cambridge, U.K., 2016, 278
pgs., notes, bibliography, graphs, paperback. This is essays by 22 financial
academics focused on what went wrong in 2008 and the modern history of
financial markets, role of central banks, understanding of risk, investment
methods and more.
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Reviewer comments:
The content is packed with data, detailed information and analysis. The subject
is history in both the material and imaginary realms. The material world is the
history of facts about interest rates, money supply, inflation, financial
policy, and the events and actions of real people. The imaginary realm is the
history of thinking about these subjects and expressing opinions about them.
Each essay includes its own extensive, focused bibliography. The prose is clear
and conclusions are well expressed. But 'reader beware' this is not for the
casual reader. To gain a full understanding of the interrelated subjects will
require study, attention, and perhaps recourse to other sources, such as from
the bibliographies.
A lead section contains enlightening bibliographies of the authors, fully
establishing their credentials. The authors are very kind, probably not on
purpose. The conference and the essays are an effort to increase attention on
and study of the actual historical record and the many theories that claim to
be based on factual history. While hoping to increase such efforts they
describe the many, various, difficulties, such as lack of actual records, and
biases in the reported data. They are kind, first of all, in not mentioning the
political and personal biases of the various creators of the predictive methods
that they evaluate. But, more broadly, they don't mention that a very large and
significant number of economists don't even look at real history, but base
their elaborate economic -especially econometric - theories on deductive
reasoning - it is theory first, facts afterwards to support theories or
reliance on the received economic gospel selected from long ago authors they
claim are famous.
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Preface:
This section describes the content and its organization into sections and
chapters. These essays are the result of a 'workshop' held at the University of
Cambridge in 2015. The genesis of the conference: "Since the 2008
financial crisis, there has been a resurgence of interest in economic and
financial history among investment professionals." The third section is
focused on 'bubbles' a subject that has generated many books and articles since
2008.
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Introduction:
By Stephen Brown: He mentions his career as an educator in the financial
management field. He elaborates in detail the content of each essay and its
author(s), summarizing their subjects and their views on them.
The first section studies the 'trade-off of risk for return from an extensive
analysis of historical returns on equities, bonds, and other assets."
The second section relates the "historical evolution of how financial
claims are traded." The process pits bankers and investment management
firms versus stock traders.
The third section discusses the common idea that "financial markets are
inherently prone to irrational exuberance and bubbles."
The fourth section narrates the history of financial innovation since the 18th
century.
A final monograph in which Barry Eichengreen "argues that the research
frontier in financial history will be driven by current concerns motivated by
the 2008-09 financial crisis." But, that: "looking to the past may
not of itself allow us to predict what might happen in the future...."
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Part 1: Risk and Return over the Long Run
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1 Elroy Dimson, et al., Long Term Asset Returns:
The three authors (Elroy Dimson, Paul Marsh, and Mike Staunton) describe their
research work from which they have created a DMS Dataset of the annual returns
(stocks, bonds, and bills, plus inflation and exchange rates) of 21 countries
from 1900 to 2016. They describe their methodology. They depict the results in
7 graphic figures.
Their conclusion: During the 20th century there was a very significant
transformation of the size of stock markets and their content of industries
included. They found that during that period the returns on investment in
stocks "outperformed" bills by 4.2% annually and of bonds by 3.2%
annually. During that century the relative values of national currencies
'fluctuated considerably'. The Swiss franc strengthened while most other
currencies weakened against the US dollar. The fluctuations were caused mostly
by rates of inflation. They include 7 appendices - tables of statistics on the
returns.
The prose is clear - but its analysis will require considerable study.
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2 Antti Ilmanen, A Historical Perspective on Time-Varying Expected
Returns:
The author describes the content: "This chapter discusses the evolving
thinking about time-varying expected returns. the reasons behind it, and its
practical relevance in today's environment of low expected returns." He
has organized the material into sections:
Introduction
The expanded research in market history has shown that expected returns on
investments are not constant but change over time. Dr. Ilmanen is concerned
that investors are overconfident that since market returns change they can
'tine' these changes.
Shifting Conventional Wisdom from Constant to Time-Varying Expected Returns
He finds that investors in bonds look first at current market yields. But
investors in equities rarely begin with that, rather, they look at long-term
future returns, considering the average return over time. In other words they
consider the 'average' return to be equivalent to the 'constant' return. He
notes that Bill Sharpe's standard asset pricing model theory (CAPM) presupposes
a constant return. He also describes the 'random walk' theory and 'efficient
market' theory. In the 1980's behavioral economics became popular and favored
by Robert Schiller and Larry Summers. The theory that long term market
predictability would be possible became popular. He mentions Eugene Fama and
Kenneth French. In the 1990's Robert Schiller created his CAPE ratio. Then the
tech boom and bust cycle again changed 'conventional wisdom'. He continues the
narration of the seemingly cyclical shifts in economic theory between pro and
anit- predictability views.
State of the Art: How to Predict Asset Returns?
Dr. Ilmanen cites his own book, Expected Returns: An investor's Guide to
Harvesting market Rewards' in which he wrote that 'the assessment of
expected returns is as much art as science". He discusses the rational and
irrational explanations.
Focus on Value- or Yield- based Expected Returns
He notes that there are now many theoretical methods being proposed so
describes two. One is the expected real return based on the inverse of the
Shiller earnings yield. The other is based on the dividend discount model. He
depicts these in a graph.
Promising Forecasting Ability and Disappointing Reality
He analyzes the theories on which the two methods depicted in the previous
section graph. His evaluation: "However, let's get more realistic. First,
this evidence is 'in-sample', and second, it may not work as well over shorter
horizons. His subsequent comments are also adverse.
How Can Investors Better Take Advantage of Time-Varying Expected Returns?
"One constructive approach for tactical market timers is to combine both
contrarian and momentum signals; for example, when market valuations signal
cheapness, it may be worth waiting for a confirmatory signal from momentum that
the market has turned."
Conclusion:
Good advice for the amateur reader: So the returns one might expect from
investments are not constant but rather vary over time. Prediction, especially
of the future, ain't easy. His recommendation "Well-diversified strategic
exposures across many rewarded factors may be the most reliable way to earn
consistent long-term returns".
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3. Jan Annaert et al., Financial History Databases: Old Data, Old
Issues, New Insights?
The authors question the validity of the data in earlier historical constructs.
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Introduction:
The problem: "The recent financial crisis again highlighted the weak
empirical foundations of the economic and financial analytial models used to
study stakeholder expectations financial innovation, regulations, and
investment strategies."
General issues
One of the problems with collecting stock and bond indices is the 'easy data'
bias. That refers to the over use of that historical data that is easy to
obtain. "Another problem is selection bias". Wars and government
regimes may distort or simply not enable obtaining data. "Survivorship
bias is a special case of selection bias.".. "The indices that are
available are not necessarily representative of the investable universe."
There are other problems as well.
Stocks
The quality of data about stocks is highly variable and subject to variations
in the real time frame. The authors mention many more problems.
Bonds
The authors note that many of the same problems with stocks are shown for
bonds. Plus
bond markets show even more diversity that equity markets." The structure
of indices varies such as for issuers, maturity, coupon payment and liquidity.
They provide tables as illustrations of the use of approximations for data.
Conclusions:
They note that financial data indices can be "only partially compared
across time and space." They expand the details in tables in an appendix.
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4. Olivier Accominotti, Foreign Exchange Markets and Currency
Speculation: Historical Perspectives
The author first provides a brief history of the development of currency
markets in the Middle Ages. That was an era in which multiple governments
minted coins of various domination and quality - both of the metal and the
minting process. But the necessity of establishing the relative 'value' of
different coins began in ancient times, a service provided by the 'hated' money
changers mentioned in the Bible. But the role of money changers who provide a
service for a fee is not the subject of interest in this chapter. Rather, it is
the activity of speculation in the money market, not as a service to people
needing comparison values between different currencies. This is accomplished by
betting on expected changes in relative values and investing to profit from
being correct.
Dr. Accominotti organizes the information in the below topical headings.
I am not interested in speculation on the FEDEX so won't comment much here
Introduction
Interesting data point: "Between 2001 and 2016 the global turnover on
currency markets increased from 1.21 to 5.1 trillion US dollars per day. The
foreign exchange market is now considered the largest financial market in the
world."
Why is that? Is it due to expanded world trade? NO. "The once dominant
form of dealings, spot transactions, have now been surpassed by such
derivatives as foreign exchange swaps, outright forwards, and currency options.
Derivatives are now the most actively traded currency instruments. " In
other words the original purpose of a market in which businesses and countries
could exchange one currency for another to finance the exchange of real goods
and services. But now the exchange market is dominated by the speculation in
imaginary financial 'values' on ledgers in computers. The question that
intrigues economists is - are the traders making a profit? They are obviously
risky. The author's investigation suggests that, yes. it is possible for the
traders to make a profit. Unmentioned is the well known fact that the 'house'
always makes the real profit. The authors do not mention or consider WHO makes
the market? Who owns the casino? Judging from the published financial
statements of such outfits as JPMorgan my guess is that the consistent profit
accrues to the quickest fingers on the trading desks at the biggest banks. Read
Nassim Talib for some 'inside' comment. But Lombard Street has not been
excluded - don't forget the 'whale'. Also, the authors do not mention that in
the olden days when international currency transactions were balanced by
shifting accounts measured in gold there were some limits that do not exist
today when institutions are shifting imaginary accounts.
Foreign Exchange Markets and Speculation in History Currency Markets from the
Middle Ages to the Early Modern Period
This topic is dexamined in the following sections.
Developments in the 19th and 20th Centuries
The Emergence of Foreign Exchange Derivatives
Fixed and Floating Exchange Rate Regimes
Long-Run Evidence on Currency Returns
Currency Speculation Strategies in the Post-Bretton Woods Period
Currency Returns over the Last 100 Years
Currency Investor Case Studies
Conclusion
This chapter provides a historical perspective on currency speculation and
currency returns. Speculation in currency values is an ancient activity. The
evidence from the last 100 years shows that it may be profitable but is very
risky.
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5. Christophe Spaenjers, The Long-Term Returns to Durable Assets
Introduction
This subject deals with an important subject because such assets comprise a
major part of the 'wealth' of many families. And institutions such as insurance
companies and endowments are also considering these assets as a means for
'diversifying their total wealth. Analysis of the 'value' of these assets is
difficult, for one reason, because it is difficult to evaluate the risk
involved. They may also be illiquid, especially in a crisis. The author has
focused on the capital gain (or loss) generated for the assets rather than the
dividend income they might create.
Housing and Land
He summarizes the long-term real (inflation-adjusted) prices for US and UK real
estate between 1900 and 2014 in a table. He uses the Shiller price index since
1953, and farmland values per acre starting in 1910. From the table he observes
that the long-term appreciation has been low. During the first few years land
actually lost relative value. His conclusion, no doubt, will disturb real
estate salesmen.
He does not venture an opinion on why this occurred. For one obvious reason he
uses farmland rather than urban real estate. And farmland lost value because
agriculture (food production) lost value after WWI when wartime demand declined
and then declined even more during the depression of 1930-50. It shows a
dramatic increase from about 1950 to 1980 when agriculture was generating huge
increases in food per acre. Housing prices are influenced by demographics.
Collectibles
For collectibles he considers art, stamps, wine, and violins. For art and
stamps the obvious reason for the declining years is World War I, when money
was not being spent on such things. For wine the decline in 1949 is likely due
to the greatly increased in supply when post WWII wine became available.
Gold, Silver and Diamonds
His graph and table are interesting. Probably the fluctuations can be
correlated with events. The one obvious example is the dramatic spiked rise in
gold and sliver in 1980-1 and then rapid crash. This was due to the Hunt
brothers attempt to corner the silver market generating the huge upward spike
followed by the rapid decline when the US government intervened. The
simultaneous spike and decline is gold was due to investors presuming that the
then popular idea that gold is valued at 15 times silver generated the
speculative reaction.
Diversification and Inflation Hedging
The author uses regression analysis (least square variations) and finds some
positive and some negative covariance with equity market, bond market and
inflation.
Conclusion
He considers that they " are unlikely to be good inflation hedges, but
they may still help diversify a portfolio because of their imperfect
correlations with financial assets." He shows that the returns on these
assets over the 20th century "had relative low capital gains and
substantial price fluctuations."
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Part 2: Stock Markets
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6. Larry Neal, The Role of Stock Exchanges in Financial Globalization:
A Historical Perspective
Dr. Neal provides the historical background of the increasing number of stock
exchanges since 1973. He cites the World Federation of Exchanges list showed
189 exchanges in 2015. Prior to WWI experts listed 89. Not only the number of
exchanges has increased but also the volume of shares and the volume of trade
in such shares has increased. He provides two tables, one showing the
capitalization on the London, Paris, Berlin and New York exchanges before WWI
and the other showing capitalization versus GDP on several exchanges in 2015.
Also, the structure and ownership of the leading exchanges changed, and so has
the functions from which they derive most of their income. They are now
corporations having shareholders and 'they all now seek ways to generate
overall profits for the exchange and their shareholders, whether by creating
new products or attracting new customers." "Their customers now
consist of institutional managers of huge portfolios held on behalf of pension
funds, insurance companies, state and local governments, sovereign wealth
funds, and hedge fund investors." ... "they seek profit from the
volume of trades."
In other words the exchanges are casinos that profit from the volume of traders
(gamblers), who are professionals whose custom requires the exchange owners to
cater to their needs - NOT those of the simple, individual investors. But these
'institutions' are themselves playing with other people's money - including
that of those individuals who are themselves attempting to profit from their
investments in the same assets. He refers to the best selling book, Flash
Boys as "a story of the centuries old conflict between bankers and
investment management firms, on the one hand, and stock traders on the other,
about the best way to serve their clients."
Meaning, who will retain the most profit from client fees. He describes some of
the hidden activities.
He mentions the competition between banking institutions whose interest rates
for customers (depositors) were set by government and mutual funds that paid
greater interest. One result was customers ( depositors) shifted funds to the
second resulting in bankruptcies of some of the first. (Savings and Loan
crisis)
How Did the Separation of Banks, Markets and Regulators Begin?
Dr. Neal begins by discussing the British national debt in the 18th century,
which expanded to fund the wars with France. The debt was denominated largely
in the BoE consols, which were traded by increasing numbers of brokers, as
Bagehot describes. He shows that 1801 was the year that these traders
(initially 260 in number) decided to establish an organization and location in
London to regularize the activity and exclude crooks, that is, traders, that
were jobbers or brokers, likely to go bankrupt. He names the place
"London's Exchange Alley" but Bagehot names it as "Lombard
Street". The organization became the London Stock Exchange. He notes the
result was the separation of ownership from operators. The operators wanted to
exclude anyone of doubtful risk. The owners wanted to increase the membership
as much as reasonable because membership cost a historically fixed entrance fee
and new members would generate more new customers. Thus, the London Stock
Exchange grew with world wide connections during the following century, until
1876. Members were prohibited from having anything to do with a bank. Memory of
the role of banks in the 18th century 'bubbles' did not die. Jobbers were
market makers who held an inventory from which they bought and sold, profiting
from the difference between bid and ask prices. Brokers represented their
clients seeking the best price for buyers or sellers.
Owners versus Operators
Dr. Neal describes the most dramatic test of the LSE structure in 1822 when
younger or newer members defaulted, having previously laid off their risks with
option contracts made with the older and better capitalized members, who then
suffered losses. This generated a battle between the two groups of members. The
issue then involved Parliament. He continues with the fascinating story of that
battle and subsequent developments including the establishment of a Foreign
Stock Market to deal in securities being created by the expansion of trading in
world wide trade and investment.
London and the Provincial Exchanges
In addition to the LSE there were regional or local stock markets which dealt
with each other. With the advent of the telegraph and rapid communication a new
type of trader was able to profit from buying in one market and selling at a
higher price in another. And banks were able to establish branches in many
locations.
Foreign Alternative Financial Systems
The different legal and political conditions in the other major countries
resulted in the stock markets there performing basically the same functions but
with different methods and organizational structures.
Conclusion
Dr. Neal discusses the situation since 1971. One change since the 19th century
is that owners of an exchange became the operators of that exchange.
Competition between exchanges increased.
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7. Caroline Fohlin, Frictions: Lessons from the History of Financial
Markets
Introduction
Dr. Fohlin decribes her essay. "The basic theory of microstructure pits
traders and market makers against one another in strategic games in which
players strive to maximize their profits."... "In this chapter, I
offer ideas on what lessons we might glean from the history of financial
markets, focusing on microstructure history....I lay out the major issues that
pervade market microstructure analysis, regardless of the era."
Financial Market Microstructure
"The key insight of microstructure theory is that asymmetric information
causes frictions that impede market quality." ... "the study of
microstructure is fundamentally the study of transaction costs -- how they
arise and why they vary -- across securities and over time."
A Brief History of Financial Market Development
"Most securities markets evolved out of markets that traded in either
commodities or commercial paper; as a result, the originators tended to be
merhants of some sort." And the security in largest supply and demand
initially was government debt - that is, government purchases exchanged for
paper credit. Dr. Folhin does not mention it, but most of that debt was to
finance war.
-- Call Auction versus Continuous Trading. This method was used with small
quantities of individual securities when the traders gathered to announce to
each other the bid and sell prices on offer until compromises led to clearing
the exchnge. Later, when the volume and variety of securities on offer at a
large exchange, such as the NYSE in 1872, a specialist in certain securities
was stationed at a specific post, where he could adjust the bid and sell
prices.
- Trading Technology and Speed. Dr. Fohlin makes the siginficant oint that all
activity requires the collection and availability of information. Hence, the
developing technology for collecting and disseminating information was key to
successful expansion of the trading markets. Naturally, he discusses the
telegraph from 1844 and telephone at the NSE in 1878. The first telephone call
between NY and San Francisco was in 1914. Today, of course, we have electronic
tranmission between computers.
What We've Learned from Historical Analysis So Far
Dr. Fohlin notes the recent significant expansion of available data enabling
research and analysis. One benefit he highlights is "Market Competition is
Good for Investors" He explains why. Another conclsion is: "Market
Liquidity Reflects Information Flow" - Illiquidity increases when
surprises suddenly reveal risks. And that may increase the spread in prices. It
can also increase fixed transaction costs
- Opaqueness Damages Market quality, especially during crisis. Crisis means
'panic'. These come and develop from information problems.
- Uncertainty Shocks Destabilize Markets, and Interventions Can Restore Order -
He uses the sudden financial crisis that increased volatility and spreads athe
sudden advent of WWI, which caused stock markets to close until uncertainty was
reduced.
Conclusions
Despite the modern development of high speed techical market operations, there
are lessons than may be learned from financial history.
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8. Carsten Burhop, and David Chambers, Initial Public Offerings: A
Historical Overview
Introduction
The authors identify three fundamental questions that prospective investors
need answered when considering to buy and state the answers that 'empirical
evidence" indicates.
1 "How soon can the firm go public? answer: IPO's tend to exhibit
substantial flucuation in activity over time.
2. What price wll we get for our shares? IPO's are, on average, underpriced
andrise in price in initial trading;
3. How will the shares perform after the IPO? IPO's tend to perform poorly over
the long run."
They analyze the historical information under the following headers.
Historical IPO Data
IPO Cycle
IPO Underpricing
Long=Run IPO Performance
Concluding Comments
Financial historians have answered the questions based on the historical
evidence.They consider that investors will be 'disappointed' - although 'in the
case of the Unitesd States, these IPO's may well not have performeed any worse
than seasoned firms with similar characteristics.'
I believe what they are recommending is for investors who are not the insiders
who invested before the IPO, it is better to wait until the initial IPO
activity has passed and then consider the value time has shown.
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Part 3: Bubbles and Crises
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9. William N. Goetzmann, Bubble Investing: Learning from History
Now we come to what I consider the most important issues.
Introduction
The attention given to famous bubbles and crashes is well known and the subject
of media attention. But Dr Goetzmann argues: "that using past crashes in
this way is misleading to both investors and policymakers." He claims
that: "Particularly during periods of market booms, focusing attention on
a few salient crashes in financial history ignores the base rate for
bubbles". "not all booms resulted in crashes. He has reached his
conclusion based on "empirical evidence drawn from more than a century of
global stock market data." He presents much data in graphics.
Data Markets and Bubbles
History identifies market 'bubbles' starting with the 15th century in German
mining shares. His graph depicts the great fluctuations in share prices of the
San Giorgio bank in Genoa during the 16tb to 17th century.
Analysis
He ceners his analysis on the data created in the DMS and JG/ICF data bases.
The information is presented in a large table titled 'Sumary Statistics for
Global Markets', in which are presented markets in 35 counries for various time
periods between 1900 and 2014. He describes the sources for the data. For this
he defines 'a bubbls is defined as a boom followed by a crash, A boom is a
large, raid increase in stock prices. A crash is a large, raid decline inmrket
prices." In the next table he provides data on 'what happened when a stock
market doubled or halved in value.' And in the next table he shows what
happened in specific years for the markets in those countries.
Conclusion
His conclusion is somewhat reassuring. "The most imortant thing a
financial historian can tell investors about bubbles is that they are
rare". He continued by noting that actual recent evidence is lacking. The
DMS data presented in the first chapter provides 'some insignt into the rarity
of bubbles showing that the overwhelming proportion of price increases in
global markets were not followed by crashes."
But by his definition a price increase that was not followed by a crash was not
a 'bubble'.
He has noted previously that stock markets (like other variables) will revert
to their mean - so up is followed by down and down is followed by up. All
efforts at prediction involve uncertainty. He observes that regulators should
consider whether or not an intervention to 'deflate a bubble' is the right
course. But, again, the price increase wasn't a bubble until after it
'deflated'.
He recommends that historians study the many 'bubbles' that have not benefited
from this research.
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10. Eugene N. White, "The Fundamental things Apply": How to
Face Up to Asset Market Bubbles
Dr. White discusses the issues by answering the following questions. He
presumes that: "Bubbles in asset markets are propelled by investors'
belief that some industry or the economy in general has entered a new era of
unparalleled expansion - an era in which fundamentals that previously dictated
more limited growth do not apply". His purpose in writing is to help
investors (what about consumers?) see the 'opportunities and perils' involved.
I question whether this is the actual cause. For one thing, the price level of
the entire available assets may rise when a government increases the nominal
supply of 'money' (which reduces the real value of money') while the supply of
goods and services available to exchange in the market does not increase
sufficiently to absorb that free money. Or the nominal 'value' of all or even
only a set of assets increases because a government is buying (confiscating) a
greater quantity of the asset in competition with the desire to buy by the
private sector. And David Fischer Hackett reveales in his famous book "The
Great Wave' that there were periods of dramatic price increases, while the
supply of currency available to consumers increased greatly absent a relative
increase ( sometimes actually a decrease) of the assets available for
consumption. Moreover, a dramatic increase in a price level may occur before
most consumers recognize it until after the fact.
Question 1: Do Bubbles Exist?
Dr. White prints a series of equations that depict what he terms 'fundamental
principles of finance' which 'require that the price of a stock at a point of
time, P, equals the present discounted value of all expected future
dividends." These boil down to the calculation of Price to dividend ratios
and price to earning ratios. He notes that there are problems with these
ratios. He notes the influence of human behavior. He also notes the academic
controversies such as the questioning of Robert Schiller's measure to identify
fundamental prices.
Question 2: Can A Bubble Be Measured?
He offers a truism: "The diversity of opinon within the economics
profession about the presence and magnitude of bubbles is striking. "
May I mention that the divrsity of opinion among academic or other economists
about nearly all of the subject matter they have brought within their demesne
is immense and frequently the venue for 'heated' (an understatement) personal
vituberation ? There is no consenses on how such measurement can be performed,
when the metric by which it might be measured, itself is questionable.
He cites someopinions, sch as fheld by Manard Lord Keynes,. Robert Schiller,
and John Cochrane. Dr. White posits seven comon features he believes can be
found in 'bubbles'. And he presents these as being meaningful in a table of 11
famous bubbles.
He identifies the reality: "Identification of the fundamentals driving a
rapidly rising market and then causing it to collapse has proven to be
notoriously difficult"... "The problem of constructing a model to
separate out the fundamental and non-fundamental factors driving asset prices
is that if fundamentals do not completely explain price movements, one cannot
claim there is a bubble element because the model may be mispecified or some
variable mismeasured or omitted." He continues by citing other problems.
Question 2: Should a Bubble Be Popped?
Naturally, since there is so much controversy and so little understanding, the
role of goveernment and central banks in "attempting to suppress or pop
asset bubbles lacks agrement". He discusses the events of the 1920's in
the US and the Federal Reserve's actions in 1929 and subsequently. He then
discusses government responses to the French Mississippi bubble and the British
South Sea bubble. He describes FED chariman Ben Bernanke's unprecedented
actions during the financial crisis of 2008.
Question 4: How Can An Investor Protect Herself/Himself?
With great dificulty. The author repeats that bubbles "present both a
danger and an opportunity for the investor."
Conclusion
His basic conclusion is be careful and learn from the experience. The
bibliography includes excellent references including several dated post 2008.
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11. Charles Goodhart, Financial Crises
This topic is different from 'bubbles' and their collapse but financial crises
may be created by that collapse.
The Facts
Dr. Goodhart considers that much can be learned by study of potential crises
that were averted. He begins with the potenetial default of Mexico Argentina,
and Brazil in 1981-82, which would have been a world disaster if not averted.
He notes that in some other situations it was government inaction or
inappropriate action that made the crisis "more severe and longer
lasting". He identifies the US in 1929-33 and Japan in 1991-95.
Causes of Crises
Macroeconomic Effects of Crises
Possible Cures for Crises?
Conclusions
Unfortunately, "Economic agents default on their promises to pay (IOU's)
on a regular basis. Then other people's IOU's may become questionable and then
not acceptable for payment." Banks are considered more trustworthy but
also are not riskless. And when a bank fails that might call into question by
other depositors or creditors and generate a general 'run'. No one can forcast
when a crisis will hit. "But we can discern when they may become more
likely- for example, when there is an asset boom largely financed by bank
credit expansion in a context of general macroexconomic over-optimism." We
may,'to some extent' be able to "alter the structure of the banking and
financial system to make such crises less frequent and less virulent." But
recent attempts have been "misguided".
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Part 4: Financial Institutions
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12. K. Geert Rouwenhorst, Structural Finance and the Origins of
Mutual Funds in 18th Century Netherlands
This is an interesting chapter about history.
Introduction "Predecessors of Mutual Funds
Mutual funds have become more popular for individual investors. The number of
such funds now exceeds the number of securities listed on the NYSE. These funds
have "advantages of liquidity and diversification at a relatively low
cost." The origins of mutual funds are not recent. The British Foreign and
Colonial Government Trust dates from 1868.
Predecessors of Mutual Funds
These include survival contracts "in which a borrower promises to pay a
group of individuals an annuity that will be divided among the surviving
members." and there were also plantation loans, which had some of the
characteristics of investment trusts..
The Wikipedia definition:  A tontine (/'t?nta?n, -i?n, ?t?n'ti?n/) is an investment linked
to a living person which provides an income for as long as that person is
alive. Such schemes originated as plans for governments to raise capital in the
17th century (often to fund war) and became relatively widespread in the 18th
and 19th centuries.
The First Mutual Fund: Eendragt Maakt Magt
This was created in 1774 by the Amsterdam broker, Abraham van Ketwich. The
members invested in foreign government or bank bonds, or plantation loans from
the West Indies. They were promised a 4% interest dividend. It has an
interesting history, which the author has found in a manuscript copy. He
includes facimialies with the essay.
Subsequent Funds
"The initial success of (this fund) soon invited followers." One was
founded in 1776.
The Demise of the Early Mutual Funds
They were largely investment in those plantation loans. With the outbreak of
the"Fourth English War" in 1780 colonial shipments were curtailed. He
means from the British viewpoint, the 4th Anglo-Dutch War. naturally with
British control of the seas Dutch investments in the West Indies took a
beating. But the major fighting in the West Indies was between the British and
the French. Amazingly, the final disposition of the successor took place in
1893 with a disribution of 430.55 guilders per par value 500 guilder
investment, a 87% payment.
Speculation on the Financial; Fortunes of the United States
dr. Rouwenhorst recounts the history of many successful investment trusts from
the 1780s which speculated on US government securities. The Dutch had financed,
along with the French and Spanish, much of the American Revolution. The story
of the depreciation of the US currency and loans is well known. He does not
give Alexander Hamilton credit for establishing the government promise to repay
those loans.
Depository Receipts
Dr. Rouwenhorst brings the idea up to date by noting that: "Closed end
mutual funds and plantation loans are examples of liquidity creation through
asset substitution and securitization." He gives some examples, such as
the Hope & Co which raised funds in Holland for the Russian Tsar.
Depository receipts created to facilitate foreign trade in govedrnmentdebt
became widespread.
Nineteenth-Century Mutual Funds
He writes that: "The first documented investment trust outside of the
Netherlands is the Foreign and Colonial Government Trust, founded in 1868 in
London." "By 1875 there were 18 trusts formed in London". They
were introduced into the United States in the 1890's.
Concluding Remarks
He considers that in the 18th century the Dutch created a "Remarkable set
of innovations that form the foundation of modern-day markets for
mortgage-backed securities, pension funds, mutual funds, and depository
receipts;" marking the origins of structured finance. He cnsiders it a
"puzzle" that the expansion of adoption of financial innovations was
slow. He recommends further historical study to find out what enables success
and contains failure in the process.
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13. Tom Nicholas, The Origins of High-Tech Venture Investing in America
Introduction
Here we get down to the amazing features of 21st century financial activity -
'high-tech investment and venture capital.
The Pathway to ARD: Formation and Structure
Initial Investments
Digital Equipment Corporation"
Venture Capital Supply and Entrepreneurial Demand
Regional advantage, Investment Cycles and Bubbles
Conclusion
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14. Janette Rutterford and Leslie Hannah, The Rise of Institutional
Investors
The chapter is an interesting historical summary of the expansion of
'instiutional' investment organizations as owners of stocks and bonds relative
to the ownership of these by individuals. The article is full of data, numbers
and years. Beingfrom England, as it the publisher as well, they give at least
equal attention to the British scene as to the US.
Introduction
The main institutional management institutions the authors describe are:
insurance companies, pension funds, investment trusts (closed end funds), and
unit trusts (open end trusts). They note that London was the center of global
investment in the early 20th century but now the leader is the US (such as the
NYSE and other exchanges). Not only has the number of institutions grown but
also the value of assets under management. For instance: "The
capitalization of the US equity market grew by a factor of more than 200
between 1950 and 2010." But in Germany and France banks and insurance
companies are larger than pension or mutual funds.
Origins
The authors present a full historical picture. In the early 20th century stock
exchanges were already very large in comparison with the size of their
economies. And most investors in both stocks and bonds were individuals. London
was "representative of the advanced industrial world" Railroad
securities were still a major component, but induistrial equities were more in
the LSE than in the NYSE. They conclude that: "The rise of institutional
investment in both countries was likely driven by the extension of shareholding
to less-wealthy people - those with limited exprience in managing investments
and thus in need of more assistance in the management of their assets."
Why They grew
"Of the four types of investment institutions, insurance companies have
the longest history," They date from the early 18th century. Pension funds
became significant only after WWII, but then they expanded rapidly. The authors
point to government promotion via special tax rates and favorable regulations,
for instance on marketing and advertising.
In my opinion governments wanted to foist off to the individuals and
institutions the resposibility of the 'welfare state' in securing retirement
incomes. But later, when the fiscal burden on employers became onerous the
responsibility was delegated even more to the individuals themselves. And they
need even more 'expert' professional management. The authors describe how this
need has been 'met', if at all, by the creation of more and more mutual funds
despite the vagarities of the asset markets.
What They Invested In
The authors have dug deeply into records to calculate the quantity and
distribution of various types of investments the individual shareholders and
the institutions bought. A sample of their research: "A sample of 33,078
shareholders in 261company share registers relating to 47 UK-registered
companies, spread across all sectors for the period 1870 to 1935 reveals that
only 505 of the shareholders were institutional investors. They held 4.2% of
the value of these securities in the decade of the 1900's 7.7% in the 1910's,
60% in the 1920's, and 23.8$% by the 1930's." There is much more
information in the article, including their analysis of the data they found and
their conclusions. One conclusion is that the US and UK investment institutions
"were slow to invest in overseas equities." This 'domestic bias'
particularly in government and corporate bonds continues.
How They Managed Their Investments
They fond that only 1% to 2% of the population held most of the securities.
They conclude that these were wealthy investors who either knew how to invest
or used the assistance of banks and trust departments and stockborkers who
advised' their clients.
Performance Measurement
The authors identify two types of performance measurement of investment results
- one is to compare with peer groups and the other is to match against a
passive benchmark. They describe how both developed during the 20th century to
today.
The Changed Situation Today
They present more data about who owns what. Among their conclusions:
"London is the world's largest center for asset management in invests a
good deal beyond the United Kingdom". "Insurers now own more equities
than they did in the early 20th century, but they are now less dominant among
asset managers."
An interesting comment: "Some question whether there is now too much
financial intermediation by those who have lost sight of their investors'
objectives." Bravo - excactly my opinion. These financial intermeditors
are playing with other people's money and rake off sizable capital from what
they are managing in fees and bonuses. And, if there is not enough real capital
created from the returned earnings of production, they create imaginary capital
out of credit instruments that they create out of givernment debt via central
banks.
Corporate Governance, Agency Costs, and Institutional Investors
The author's opinion: "The rise of intermeditiaries in principle offered
several improvements." They cite three. But then they identify a negative
fact. "The extra layers between investors and multiple intermediaries have
introduced further problems of agency and added costs to the investment
chain." Indeed so. Just check the large sums that the CEO's of major banks
receive and the sallries and bonuses of their market traders. The authors point
to another result - short termism. They do not elaborate, but what they mean is
that the investment companies cater to their stockholders and other owners who
want immediate profits. And the employees seek to increase their commissions
and annual bonuses by year-end manipulative activity. One conclusion they
write: "It is difficult to conclude that investment institutions have
unequivocally improved governance and returns, althogh clearly they have
sometimes done so."
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Part 5: New Frontiers in Financial History
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15. Barry Eichengreen, Financial History in the Wake of the Global
Financial Crisis
Introduction
Dr Eichengreen points out that what observers see from research in financial
history depends on where they are sitting. He states: "My own persepectve
isthat the research in financial history will now be shaped by two sets of
considerations. First, the greater ease of digitizing archival data will allow
financial historians to pursue microeconomic analyses of a sort that were
prohibitively costly before." 'In addition to being data driven, the
research frontier in financial history will be driven by a second
consideration: concerns highlighted by the 2008-2009 global financial
crisis."
Effects of Technology and Research
He believes that: "The lower cost of assembling and analyzing large
datasets will incline research in financial history in directions that
capitalize on their availability." He describes some of the topics that
this research will address and identifies the names of some researchers who are
already active.
Effects of the Global Financial Crisis on Research
Conclusion
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Philip E Tetlock & Dan Gardner, Superforecasting The Art and
Science of Prediction
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Nassim Taleb., The Black Swan
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Nasim Taleb, Fooled by Randomness
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George Cooper, The Origin of Financial Crises
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Walter Bagehot - Lombard Street
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Wikipedia entry describing Bagehot's book - Lombard Street
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Lombard Street
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Perry Mehrling, The New Lombard Street
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Lombard Street
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Lombard Street
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Justin Fox, The Myth of the Rational Market: A History of Risk,
Reward, and Delusion on Wall Street
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Barry Eichengreen, Exorbitant Privilege
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