Monday, November 9, is the deadline for banks to apply for the Treasury’s Capital Assistance Program. Chances are, none will sign up.

The program — CAP for short — is the other shoe of last spring’s stress test. Announced on February 9 as a “core element of the Administration’s financial stability plan,” the program was designed to backstop banks that are unable to raise sufficient private capital. Secretary Geithner presented the plan to the Senate Banking Committee on February 10 and it was featured in Chairman Bernanke’s Senate testimony two weeks later.

Under the CAP, a bank receives government funds by issuing preferred securities to the Treasury. These CAP securities include complex embedded options for both the bank and the Treasury. In current work with Zhenyu Wang of the New York Fed, we have estimated prices at which these “structured products” would sell in a market transaction between private participants rather than as part of a government program. We have applied our method to the 18 publicly traded bank holding companies that participated in the stress test. (The 19th stress test bank, GMAC, is privately held and received funds through a special program for the auto industry.) Our estimates indicate that the CAP securities represent significant value — one might even say a huge potential subsidy — to eligible banks.

So why no takers? In many respects, the lack of participation is good news: the mere availability of CAP funds may have been enough to boost confidence in the financial system. The nine banks that were required to raise additional capital following the stress test all report being on track to meet their targets through the private sector, though some of the new capital, like the $2.1 billion in deferred tax assets claimed by Bank of America, falls short of a ringing endorsement from investors. But even if all the capital raised is solid, the question remains: Why pass up a good deal?

The circumstances suggest several possible explanations. A bank may avoid taking government funds if the strings attached require it to forgo other profitable opportunities. Citi’s sale of Phibro and troubles with Banamex illustrate this possibility, but such costs are unlikely to offset the value of the subsidy. In an odd twist, weak corporate governance may save taxpayers money. This explanation applies if bank executives pass up CAP funds to protect their own positions rather than the interests of shareholders. Senior management at any of the top banks would be unlikely to survive another injection of government capital.

These considerations apply to all the TARP programs, but one other explanation is specific to the CAP preferred securities. In our analysis, much of the value to a bank of the CAP securities lies in the option a bank gets to convert them to common equity. This feature comes at the cost of higher dividend payments than shares issued through earlier programs, which did not include a conversion option. But Citi negotiated conversion of some of its earlier shares, and remarks from Treasury officials and banks indicate that similar conversions have been discussed at other banks. Banks may be reluctant to pay for an option they think they can get for free.

Complex structured products designed in the private sector have drawn criticism for contributing to financial instability through a lack of transparency. The complexity of the Treasury’s design of the CAP shares — intended, no doubt, to avoid direct government purchase of bank stocks — may well have been a final factor in discouraging participation.

In September, Professor Bruce Kogut and Cheryl Rathbun, managing director and chief operating officer of Citi’s Institutional Client Group’s (ICG) Risk Management, participated in a question-and-answer fireside chat about the future of financial regulation.

While Rathbun made clear that “we’re not out of the woods yet”, she did say that some of “major contours” of the new financial landscape are appearing.

“I don’t think we’re going to see major money center banks growing and growing and we’ll just have three or four major institutions. I think we’ll see a paring down,” she said. “At the same time we’re going to have increased regulation and capital requirements, which will force the money center banks to have somewhat of a different model. It’s a little more retro and maybe going back to what we saw in the 1970s … we may see some reincarnation [of that era] and some bit separation between [securities and commercial banking].”

To learn more of Kogut and Rathbun’s exchange, watch the complete video coverage.

“Your Business School years have coincided with an extraordinary time and now you have a huge opportunity,” Paul Calello ’87 told students in a recent lecture. “The themes of this time are change and responsibility.”

The CEO of the investment bank and a member of the executive boards for Credit Suisse Group and Credit Suisse, shared his views on the financial crisis and gave mentor advice on September 17 as part of the Silfen Leadership Series. Calello serves on the School’s Board of Overseers.

In discussing the impact of the crisis on the financial industry, Calello talked about the ways banks have had to innovate new solutions. He pointed to Credit Suisse’s executive compensation strategy as an example. The bank made headlines last December when it announced it would use its illiquid assets to fund some of its executive compensation packages.

“At first it was internally unpopular … but it was the right and responsible thing to do,” Calello said. “It was a way to align with the interests of shareholders, continue to rid the firm of these risky assets and, at the same time, address employees’ needs.”

Looking into the near future for the finance industry, Calello said he expected “many more significant developments to come in the next two years,” particularly from regulators. In response to a question about job opportunities, he said flow trading areas and products that are exchange-traded and centrally cleared would be strong.

As for practical advice for MBA students, he said there was no alternative to hard work and urged students to learn all they can about the crisis they’ve been living through.

“You will be part of an era of reform,” he said. “We’re relying on you to not repeat mistakes that have been made, but to help restore trust and confidence in our industry.”

Photo courtesy of Columbia Business School

Dean Glenn Hubbard called the selection of James P. Gorman ’87 as the new chief executive of Morgan Stanley a “recipe for success.”

Morgan Stanley announced the news on September 10 that Gorman, currently in charge of the firm’s global wealth management division, would replace John J. Mack as CEO starting Jan. 1, 2010.

Gorman has been with Morgan Stanley for four years. In that time he has had key success, including turning around the bank’s retail brokerage operation. Prior to joining Morgan Stanley, he ran the global private client business at Merrill Lynch. Gorman has been a member of the School’s Board of Overseers since 2006.

Dean Hubbard, who has known Gorman since his days at Merrill Lynch, said Gorman was a “terrific pick” and a “strategic thinker”, underscoring industry reports that Gorman was favored as CEO for his ability to switch quickly between jobs and his long-term thinking for the firm.

Photo courtesy of Columbia Business School

A year ago this morning, we woke up to the news that Lehman Brothers had collapsed. The overnight demise of the investment bank is an important milestone, but it is only one failure in a series of calamitous events in the last year that shook the financial world and changed it forever.

Entire markets essential for world commerce effectively shut down and some markets continue to remain moribund today. Last year at this time, the whole banking system was on the verge of collapse and the world economy was tanking. Now that the economy is stabilizing — even perhaps tentatively recovering — and the financial sector is healthier, it is easy to forget just how bad things were.

It is true that investors today are now more cautious and banking will (hopefully) become more boring. But the financial and economic landscape has been permanently altered. The single biggest change pre- and post- Lehman Brothers’ failure is the role and the actions of the government and other financial authorities.

Before Lehman’s fall, the government played a relatively small direct role in financial markets. Now, the most important player, and still in some cases the only player, in financial markets is the government. The government essentially chose Lehman’s fate and allowed some of its peers to survive. Masses of money — tens of thousands of dollars per U.S. household — were injected by the United States Treasury to save the banking system from itself and bail out bankrupt industries. Unprecedented intervention by the Fed in markets, still continuing today, has slowly enticed investors back.

But now one year later, we can look back at how the government led us out, but the big question is: Where is it going to lead us next?

Photo credit: T. Shein

If the financial crisis taught business schools anything, it's that the curriculum can no longer turn a blind eye to pressing policy issues that impact business, says Professor Bruce Kogut. (See yesterday’s post about some of the ways the School is incorporating the financial crisis into course work.)

In a recent article in BusinessWeek magazine, Kogut elaborated on his view of the financial crisis and said that it might be best seen through a political perspective, rather than a technical or managerial one. Abundant liquidity and “unprecedented income inequality”, he wrote, paved the way for a flawed incentive system. Kogut argues that there should be more focus on “regulation of the financial markets and less deference paid to financial innovation.”

What does this view mean for business education? Kogut says that politics must have place in the MBA education. He writes:

	Do you share this view? Please leave a comment.

Financial crises are the children of troubled politics, yet management education often eschews political questions. This is a fundamental flaw of most, if not all, business schools. If such questions are left unaddressed, we will produce business leaders with limited perspectives who may not be equipped to deal with the pressing issues of the day. In other words, we must make the case to our students that the political questions, while difficult, are critical to the practice of business — even if this kind of analysis may not appear to serve their immediate self-interest. …

The crisis has reshaped the financial landscape, shifting the value of management education toward pedagogies that strengthen students’ understanding of the fundamental relationships in society — how managerial, technical, ethical, and political elements work together.

Photo credit: Theo La Photo

“How do we make decisions under uncertainty?” Professor Wei Jiang posed the question to an audience of students last week during orientation. The question not only referred to the lecture’s topic — the financial crisis — but was offered as a framing device for students as they begin core classes in the MBA program this week.

“This will be the most important skill you can develop,” she said.

A new orientation module focused on the financial crisis was created this year to give new students an overview of the causes and issues of the crisis and provide key questions that connect it with upcoming courses in the core. In her lecture, Jiang considered different aspects of the crisis including international policy, behavioral bias, compensation structure, government regulation and risk models.

The module is part of a larger initiative by the School to use the financial crisis as a vehicle to foster integrative thinking in business training. Another element of that initiative is the creation of a new cross-discipline class, which will launch in Spring 2010, on the future of financial services. During the past summer term, former chief legal officer of Lehman Brothers, Thomas Russo, taught a half-term course looking at the crisis.

“Look ahead as well as look around you,” Jiang told students at the end of her lecture. “Think in terms of tradeoffs and equilibrium.”

Photo courtesy of Columbia Business School

A typical Wednesday morning finds millions of online banking customers checking their balances. Unless, that is, the stock market has tanked.

When the stock market goes down, sticking your head in the sand regarding your own money and investments is not uncommon. Early research findings from Professor Nachum Sicherman, working with George Loewenstein and Duane Seppi at Carnegie Mellon University and Steve Utkus at Vanguard, show that consumers undergo an ostrich effect — giving selective attention to investment information — with their bank account balances when they see bad financial news.

In their study of 3,000 consumers at a regional U.S. bank, Sicherman and his colleagues found that when the market goes down, so does online balance checking. On average, a one percent rise or fall in the stock market increases or decreases, respectively, the likelihood of a customer logging into his or her bank account by one percent. Additional preliminary results taken from the data of one million customers at Vanguard are consistent with this outcome, says Sicherman.

Initial results show that individuals with larger balances, especially those with higher percentage of stocks, check their balances more frequently. Women, for example, go online less than men, and the ostrich effect is stronger for men than for women. Their data also showed that Wednesday has the peak number of account logins and people tend to check their balance between 9 a.m. and noon.

Sicherman and his co-researchers are looking at the results to see if there is a link with patterns of trading.

“To what extent does the ostrich effect affect trading if people are reluctant to look at their account for psychological reasons when the markets go down?” says Sicherman. “The next logical thing to hypothesize is that if they are not looking, then they are trading less. But we don’t have an answer yet.”

Photo credit: Njitram lexe Nav

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Her words are now prescient. Sallie L. Krawcheck ’92, speaking on a panel to incoming students in early 2005, discussed the conflict of interest between analysts and investment bankers on Wall Street.

“There is one client and one client only,” she told the audience about how analysts should conduct themselves, warning that research should not be dressed up to please companies. “If the company gets upset with you, then so be it — that’s not your client.”

Her vision for a cleaner Wall Street — which has earned Krawcheck a reputation for honest numbers and ethical leadership over the past decade — may be getting closer to reality. On August 3, she was named president of Global Wealth and Investment Management for Bank of America. This places her as a potential successor to Kenneth Lewis as CEO, according to industry reports. From March 2007 to December 2008 she was the CEO and chairman for Citi Global Wealth Management. She is a member of the School’s Board of Overseers.

Krawcheck’s participation in the School’s Individual, Business and Society Curriculum, which is on focused corporate governance and ethical leadership, underscores the ethics framework she will likely bring to her latest role in the banking industry.

Later this month, incoming students will begin the MBA core, which encompasses corporate governance and lessons learned from the financial crisis of 2008. Paul Glasserman, the Jack R. Anderson Professor of Business, who is overseeing the curriculum’s response to the crisis, says that students will need to take a broader view of management, which includes the role of government in business and behavioral aspects of markets.

“The crisis is a reminder of the importance of integrative thinking — connecting ideas that cut across disciplines,” said Glasserman. “In the coming year, we’ll be involving our students in new cases and classes that stress integration. We’ll also be engaging them in a discussion of the future of finance in the wake of the crisis.”

Photo courtesy of Columbia Business School

The authors won the 2009 Pershing Square Value Investing and Philanthropy Challenge, which was made possible through a gift from Bill Ackman and Pershing Square Capital Management LP and awarded through the Heilbrunn Center for Graham and Dodd Investing.

Participating in the Pershing Square Challenge is the type of experience you go to business school for. Where else in the world do you have the opportunity to pitch a stock to a panel of value investing legends including Bill Ackman, John Griffin, Dan Loeb and Bruce Greenwald?

Our team came together quickly — Tim and Grant worked together over the summer at Blue Ridge Capital and John and Tim knew each other through the CIMA mentor program. Despite other recruiting, academic, and personal (like Grant’s son Griffin) commitments, we all agreed that our goal was to win the competition and that would be a priority for each of us.

We were keen to find a short to differentiate our work from the other 45 teams that were going to have very strong long ideas. After reviewing different sectors, for-profit education appeared to still be attracting rich valuations despite the severe downturn in the market and a questionable customer-value proposition.

We split the sector into three areas and each of us conducted initial diligence on a subset of companies. After reviewing all the major for-profit education stocks, we settled on the Apollo Group (parent company for the University of Phoenix) for three reasons. First, it had a rich valuation. Second, it has questionable business practices, and, lastly, the company cost U.S. taxpayers $250 million dollars through defaulted loans that the government guarantees. We believed highlighting the government subsidy of corporate profits dovetailed with the philanthropic goals of the competition.

We worked on the idea all semester, coming together weekly to discuss the team’s progress and ideas for different analyses. As we neared the submission deadline the measured pace became frantic and our weekly meetings turned into daily ones. In spite of our differing styles and opinions — Grant wanted to explain every detail, John wanted to explain nothing, and Tim wanted a balance — we shared a common goal and our discussions, though at times heated and lengthy, always ended with agreement.

After all the groups presented in the finals and we were waiting for the results, the three of us were remarkably calm. We all had a feeling of accomplishment, not from winning (we hadn’t heard the results yet!), but from putting together what we thought was a thorough and convincing stock pitch. Our feeling turned out to be spot on — we had won the competition and a prize of $25,000 to be used as a gift back to the School.

We took the responsibility of directing Mr. Ackman’s $25,000 gift very seriously. We agreed the money should be used to support both students interested in investing and students who will make a broader impact on society. We hope Mr. Ackman is pleased that the money will be going to scholarships for veterans returning from military service (as part of the Yellow Ribbon Program), a student with a focus on investing and community service, and to the Heilbrunn Center to support the value investing curriculum at Columbia Business School.

We would like to thank Bill Ackman for sponsoring the competition, the judges for taking the time to give us feedback, Erin Bellissimo and the Heilbrunn Center for supporting the competition and the class, professors Paul Sonkin ’95 and Caryn Zweig ’98 for their support in and outside the classroom, and all the mentors who took their personal time to help students and provide feedback throughout the semester.

Photo courtesy of the Heilbrunn Center

The Credit Cardholder’s Bill of Rights, which was signed into law on May 22, is the first major overhaul of credit card regulation in 30 years. Is the bill a game-changer for the way consumers use credit or the way lenders dole it out? We spoke with assistant finance professor Enrichetta Ravina, who has done research on the credit card industry and consumer behavior, about the relationship between the lenders and borrowers, how it might change, and whether credit cards make us happier.

Now that credit card holders have a bill of rights, how might that affect consumer behavior?

1. Better debt management More transparency in the credit card terms could mean that consumers are more informed and better understand the terms of their credit card contract. They might avoid paying fees due to their inattention/misinformation and to switch to cheaper forms of credit if they need to borrow. The caveat is that more information doesn’t always lead to restraint. In the same way that knowing that fats are unhealthy doesn’t make everybody restrain from fast food, it is unlikely that being better informed on the terms of the credit card contract will make everybody manage their debt more carefully.

2. Prevent early onset debt New restrictions for issuing cards to people below 21 will make it harder for students and very young consumers to have easy access to credit. The legislation is aimed at protecting a category that might be less financially educated, has fewer incentives to be financially responsible and preventing that they become overwhelmed by debt even before starting their working life.

3. Harder to get easy credit The new legislation requires credit card companies to wait until the account is 60 days late before applying a penalty interest rate and to give 45-day advance notice before changing the interest rates or any other terms. Thus, the credit card companies’ pricing strategy will change. A better ex-ante assessment of the creditworthiness of the consumers will be necessary and credit card contracts will have lower credit limits, higher interest rates for certain categories of consumers and more upfront fees. Lower credit limits and higher interest rates will make it harder for overly optimistic, financially uneducated consumers to get into unmanageably high levels of debt.

What does a consumer’s spending say about his or her behavior?
Most consumers are very predictable in their credit card use. In my research I find that consumers exhibit a high degree of habit in their consumption choice and that they prefer a smooth, increasing consumption path. Demographics like gender, age and income bracket are important, but mostly people’s spending on catalog and online shopping and on other credit cards are the best predictors of their behavior and of whether he or she will carry a balance, pay late or always be on time.

Who are credit card companies making money from?
The most profitable consumers for a credit card company, and therefore the most sought after, are those that spend a lot, pay late and carry a balance (which 45% of Americans do). People’s attitudes to money and their finances tends to be remarkably consistent across financial instruments and therefore people that miss payments on other credit cards and auto loans, stretch themselves with high loan-to-value mortgages are more likely to do the same on this card. Among these very profitable consumers, however, are those that “hide” and who will generate charges only for a short period and will soon default.

Can credit card companies tell who might default from their spending behavior?
It is very difficult to predict this behavior early in advance. These consumers that are very risky are those with limited financial education. Such consumers do not understand the terms of the credit card contracts, are not good at budgeting, saving and spending within their means. At the beginning, they are very profitable for the credit card companies because they generate fees and interest charges. However, once an income shock hits them, or their spending habits get out of control, they rapidly become the worst type of accounts.

What is the upside to easy credit?
Credit cards constitute a tremendous opportunity for some consumers and are very important for economic growth. They allow entrepreneurs to finance the very first stages of their companies when it is hard or impossible to get a loan from a bank. They also allow households to finance durables, consumption goods and other projects. For these reasons, they promote economic activity and a more efficient allocation of economic resources. Compared to other countries where credit cards (and debt) are less diffused, U.S. consumers face more dangers, but also more opportunities and more means to fulfill their projects.

Does this greater opportunity and means to fulfill projects translate into more happiness?
In my research I find that happiness is a relative concept. Above a certain level of consumption that satisfies the necessities of a comfortable life, happiness doesn’t depend on the amount we consume, but rather on the amount we consume compared to the people around us. The reference group we belong to are work colleagues, neighbors, people with a similar socioeconomic status to which we tend to compare ourselves. Credit cards can be used to consume more than the reference group (even though the income is not enough to cover spending), in the hope that income will continue to grow or that no emergency comes to disrupt this fragile equilibrium. Such a use of the credit card is usually associated with short-term happiness and economic problems and anxiety down the road.

Photo credit: Andres Rueda Lopez

On Thursday the Treasury announced their choice of executive pay overseer, Kenneth R. Feinberg, who will have the task of setting compensation of the top 25 executives at seven financial firms. The new appointment challenges the view that it is not what you pay, but how you pay, that matters, says accounting professor Sudhakar V. Balachandran.

“What we have seen to date tells us that reforms in how boards set compensation are warranted, and that there needs to be a better relationship between pay and performance, particularly performance that is not immediately observable, ” he says.

“That said, it is a completely different matter to say that a centralized body in Washington D.C. can do this better, ” Balachandran continues. “Boards have substantially more information about the company and its circumstances and by centralizing the process we might be throwing away a lot of valuable information. There is a difference between providing reform to the compensation process and providing a centralized compensation policies that are determined by a political process. I believe only the former has a chance of success but I’m afraid we may be heading towards the latter. ”

Photo credit: Michael Aston

Thomas Russo, the former vice chairman and chief legal officer of Lehman Brothers, met last night with students in a Community Forum discussion about the financial crisis. Russo will be teaching the half-term summer course “Credit Crisis: As Seen Through Different Lenses.”

In a 45-minute presentation, followed by a Q&A, Russo gave his perspective on the origins and fallout of the crisis. One topic he focused on was the changing role of leverage for banks.

“Leverage now has a lot of bad things attached to it, but that’s the way we make money,” he said. “If you change leverage, you are limiting profitability.”

He predicted that it will be easier for smaller firms to make money in the future because they will not be encumbered by the enormous cost structures and lack of flexibility that larger institutions have.

“Since banks won’t have leverage down the road, it will be harder in the institutional sense to make money,” he said. “There will be more opportunity to make money outside the institution. Things in the future will be developed by smaller entities.”

Segueing into advice for future CEOs in the audience, Russo said the most important thing to remember was to have multiple points of view.

“You have to put yourself in other people’s shoes,” he advised. “Understand that every problem has many sides and if you’re in the decision-making role, you have to look at all of them.”

Photo credit: Antonio Morales Garcia

This post is part of a special series celebrating the School’s Alumni Forever Week (March 30 through April 2).

Profile
Karen Kalina ’94
Director, Strategy and Portfolio Analysis, Siemens Real Estate

Tell us about your career path since getting your MBA.
Before Columbia Business School, I worked at the United Nations. I worked on various budgets, and that inspired me to go to business school. I knew there was some method I needed to find out. I also speak five languages, including Czech and German, so my dream was always to get over to Eastern Europe. After I graduated, I worked at State Street Bank and Trust in the global custody division and later their credit and risk management group, focusing on Europe and Eastern Europe. After leaving State Street, I moved to Prague to work in financial services with KPMG Consulting on bank privatizations and then to Credit Suisse Financial Services in mergers and acquisitions in Weisbaden, Germany. After the Internet bubble popped, I had been in Europe for six years and I made a decision to come back to the U.S. I looked for jobs through the School’s job BANC network. Through a fellow alum I found a position with Siemens.

What has the transition from financial services to corporate business been like?
I am now celebrating five years at Siemens. In financial services I was a three-year person, so that tells you something! You can shift internally in corporate business and it is more flexible than financial services, which calls for a very defined set of skills. Working in finance as a woman with two kids, I had to make trade-offs. I am believer of staying in the work force as a working mother, but I knew being in mergers and acquisitions, where I was on the road all the time, would be too much. When I missed my second child’s first steps, that was an eye opener.

What has been your experience as a woman in finance?
I’ve always thought that being a woman in finance was fantastic. There are less of us so we tend to stand out more. I think that was an advantage because you automatically got more visibility; I stood out because I wasn’t wearing a necktie. Once you’re in, how do you handle it? There are not a lot of people to meet in the bathroom. You find other women in external organizations and keep in touch with them.

Looking back at your Columbia Business School experience, what was your aha! moment?
I was having tough time with Introduction to Finance, but I also didn’t have trouble visiting my professors’ office hours. The obvious one was in Bruce Greenwald’s class. I went to his office hours and he looked me in the eye and he said, “Not only can you do this, you can be great at it!” That was a turning point for me. His confidence that, yeah, I could do it, really empowered me, as did the knowledge that he and many others would support me. I knew at that moment that this was really possible if wanted to do it. Up until then, I would have done marketing or international business. Finance changed my life. The other person who was an “aha!” is Laura Resnikoff. I took Turnaround Management with Laura when she was still a new professor. That class was very small; it took place over the summer and I was the only female student. She’s an amazing teacher and a tough cookie. She really challenged us and especially challenged me. But again, she gave me a real “You can do it” impression. Her class taught me that I liked not only finance but also the whole business and strategy. Every job I’ve had since State Street has contained strategy elements, and Laura’s course opened my eyes to that possibility.

What advice do you have for MBA or prospective MBA students?
Let go of incredibly high expectations. When I graduated in 1994 it wasn’t that great of a job market. If you don’t start at most spectacular place on planet, you’re still going to be okay. I never thought of working at a major corporation, but each one has a finance group and excellent training programs. It is also important to pursue the things you are inherently interested in. Look inside yourself for career advice, because that is important, wherever it might lead you. In finance, people can get trapped into a certain narrow way of thinking. The world is a lot bigger than New York City.

When Jackie Endriss Oberoi ’04 arrived at Columbia Business School in the fall of 2002, she knew she wanted to move from human resource consulting into finance. She accomplished the career transition and is now an associate director and credit analyst with Standard & Poor’s. Public Offering spoke with her about the unexpected perks of working in industry finance.

What has been your path since graduation?
I took advantage of the School’s internship program and came to Standard & Poor’s in the summer of 2003. I came back to S&P after graduation. I have changed roles within the company — I am now in corporate ratings and rating retail companies. Even though I have stayed with the same company, changing positions has allowed my career to stay fresh.

How has your MBA experience shaped where you are today?
I came to CBS as a career-changer. I was in human resources consulting and had no financial background when I came to the School, but I knew I wanted to do something more quantitative. The finance classes were quite strong; I was impressed with the finance and capital markets courses in my second year, when I focused my studies. The excellent faculty and high quality of the students made the courses more discussion-oriented than lecture-oriented and contributed to the overall experience.

What helped you make the career change?
The key is parlaying your skills from your former industry into a new one. For me, I focused on how my presentation and communication skills were relevant to a career in finance. In this economy, people really have to push their strengths from their former career and explain how they can be applied.

Now that you are working in finance, have your expectations been met? What has been totally unexpected?
My expectations coming into S&P were met fully — this company is very transparent. I have found a challenging work environment with interesting people and a daily schedule that lacks monotony. There is a lot of flexibility in my career. With telecommuting and flexible hours, I was able to take a six-month maternity leave. Most nights, I can leave at 5:30 p.m. I can spend time with my family and excel at my job at the same time. That was unexpected. S&P is very family-friendly.

Where are the opportunities for people just starting their careers in finance?
My advice is to broaden your expectations — think about doing finance in industry or in-house and then you can move to an investment bank when the economy improves. This doesn’t just apply to students, but also to people who have lost their jobs.

What’s your advice to current MBA students?
Lean heavily on your network of other students. Build your network while you are at the School. You can learn so much from other students, so learn everything you can from the people you’re in contact with. The people you work with after you leave the School might not be as interesting and as diverse.

This column is part of our Next Steps series, which profiles alumni in their first five years after Columbia Business School. Do you know someone we should write about? Let us know about other candidates.

Photo courtesy of Jackie Endriss Oberoi

Mark-to-market currently requires banks to reprice their balance sheet assets each day based on the assets’ open-market value. Banks claim that the rule is forcing them to unfairly mark down the value of their assets, such as their mortgage-backed securities. Supporters of mark-to-market say that it creates more transparency.

While some investors are putting a bullish spin on the news of the possible rule adjustments, Floyd Norris ’83 has a much more skeptical view. In his Friday column in the New York Times, Norris writes, “Sadly, a victory for the bankers would not help them much. Even if it were true that banks would be held in higher regard now if they had not been forced to write down the value of their bad assets — and that is, at best, debatable — changing the rules now would be counterproductive. Would you trust banks more? Would other banks be more inclined to trust banks?”

In an interview earlier this week, Warren Buffett ’51 came out in favor of suspending the mark-to-market accounting for regulatory capital purposes.

Appearing on CNBC’s The Kudlow Report on Wednesday, Senior Vice Dean Chris Mayer offered his thoughts on the issue. “The problem is, ‘What are the write-downs that are still sitting in the system?’ The continued critique of mark-to-market is that the current values are just based on illiquidity and they’re low. But we have not seen the bottom of the economy, so I don’t know how anyone can say the values are too low.”

Over the last two weeks, international students and foreign nationals working in the United States under H-1B visas have been forced to grapple with a new reality: under a provision in President Obama’s recently passed stimulus package, they may not be able to continue working in the U.S. (View a list of H-1B employers in 2008.)

The provision, which calls for limits on hiring H-1B visa holders, affects firms that have accepted TARP funds. Major TARP recipients include Citigroup, Bank of America, AIG, JPMorgan Chase, American Express and Goldman Sachs among others. (View the compete list of TARP recipients.)

In response, Dean Glenn Hubbard has written letters to Treasury Secretary Timothy Geithner and National Economic Council head Larry Summers to express deep concern over the provision and how it will be implemented.

“This is absolutely terrible,” the dean told students in a town hall meeting last Thursday. “It gives an advantage to international institutions over American institutions,” he said. The dean did sound a note of optimism, saying, “I believe [the problem] will get fixed.”

It is still unclear how the provision will affect students looking to enter the workforce. Thomas Monaco, director of international advising and outreach, says that recruiters have not yet indicated any changes in their strategies. The School’s Career Management Center is in contact with all of its recruiters and peer schools to continue to monitor developments.

“Many of our recruiters are still translating the legislation,” Monaco says. “Right now it is very much a wait and see situation.”

International students comprise approximately one-third of the class of 2009. Some of those with student visas can stay in the United States for one year after graduation for optional practical training. However, workers who need or have H-1B visas still face some uncertainties.

“The School is doing everything possible to act as advocates where we can and stay abreast of developments as they occur,” says Monaco.

The provision has generated concern throughout financial and academic communities alike. Last month at a conference organized by the Council on Foreign Relations, Columbia professor and economist Jagdish Bhagwati commented on the loss in talent that will occur if the provision is upheld. “In terms of broader considerations like the people who are coming in on H-1B visas,” Bhagwati said, “they’re frequently highly trained and talented people … a lot of our progress and prosperity depend on having such people.”

Photo credit: Columbia Business School

President Barack Obama announced a plan this week that would limit executive compensation at companies seeking large amounts of government aid. The plan includes placing a $500,000 cap on the annual salary of senior executives and restricting the cashing in of stock incentives until government assistance is repaid.

But will the limits create a leadership void at these firms? Professor Nahum Melumad said that some of the proposal’s terms could hinder recruitment and retention.

“You need the best talent money can buy and that may be difficult without the right award,” said Melumad. “Currently the administration is saying that a company may pay a large amount in the form of stock options, but that executives will be allowed to exercise those only after the government has sold its equity positions. That may be too long a period to retain any incentive impact and to attract top managers."

“A better way might be to have executive compensation consist of two key components: a ‘reasonable’ base pay and an additional component that is a function of improved company performance,” Melumad said. “The latter should have significant upside potential to attract top managerial talent.”

Professor Sudhakar Balachandran points out that even if firms aren’t too concerned about losing talent, they’re still faced with the challenge of motivation.

“There have been some arguments that there will be an exodus, but I am not too worried because the job market and prospects are tougher now,” he said. “In the past we’ve seen turnover when a firm’s retention mechanisms fail. But today, if someone wants to leave, where would they go?”

“If there’s no upside potential, you now have to worry that people will not work hard or smart, but instead that they will just show up and check off the boxes,” said Balachandran.

Photo credit: White House/Pete Souza

Models pose a paradox. They hold the key to extraordinary profits but can inflict destructive losses on a bank. Because a model entails a complex perspective on issues that are typically fuzzy and ambiguous, they can lock traders into a mistaken view of the world, leading to billionaire losses. Can banks reap the benefits of models while avoiding their accompanying dangers?

Our research suggests they do, and shows how. We conducted a sociological study of a derivatives trading room at a large bank on Wall Street. The bank, which remained anonymous in our study, reaped extraordinary profits from its models — but emerged from the credit crisis unscathed. For three years, we were the proverbial fly on the wall, observing the traders with the same ethnographic techniques that anthropologists used to understand tribesmen in the South Pacific. We identified a set of managerial procedures, which we call “reflexive modeling,” that lead to superior model development. (View the complete study)

The key to outstanding trades, we found, lies outside the models. It is a matter of culture, organizational design and leadership. The bank that we observed introduced reflexivity in every aspect of its organization. From the junior traders to the supervisors, everyone at the bank was ready to question their own assumptions, listen for dissonant cues and respect diverse opinions.

How? As many have already suggested, individuals certainly matter. The bank hired people with a healthy dose of humility and an appreciation for the limits of their smarts. This often meant opting for older traders rather than younger hotshots.

But the key to the bank’s reflexiveness did not just lie in individuals. By reflexiveness we don’t mean super-intelligent traders engaged in some heroic mental feat, splitting and twisting their minds back on themselves like some intellectual variant of a contortionist. Reflexivity is a property of organizations.

The architecture of the bank, for instance, was crucial. The open-plan trading room grouped different trading strategies in the same shared space. Each desk focused on a single model, developing a specialized expertise in certain aspect of the stocks.

To see why this was useful, think of a stock as a round pie. Investors on Main Street often eat the pie whole, with predictably dire consequences. The professionals that we saw, by contrast, sliced stocks into different properties. Each desk was in charge of a different property, and the different desks then shared their insights with each other. This could happen in a one-minute chat between senior traders across desks or in an overheard conversation from the desk nearby. This communication allowed traders to understand those aspects of the stock that lay outside their own models — the unexpected “black swans” that can derail a trade.

Sharing, of course, is easier said than done. The bank made it possible with a culture that prized collaboration. For instance, it used objective bonuses rather than subjective ones to ensure that envy did not poison teamwork. It moved teams around the room to build the automatic trust that physical proximity engenders. It promoted from within, avoiding sharp layoffs during downturns.

Most importantly, the leadership of the trading room had the courage to punish uncooperative behavior. Bill, the manger of the room, made it abundantly clear that he would not tolerate the view, prominent among some, that if you’re great at Excel, “it’s OK to be an asshole.” And he conveyed the message with decisive clarity by firing anti-social traders on the spot — including some top producers.

In other words, the culture at the bank was nothing like the consecration of greed that outsiders attribute to Wall Street. We refer to it as “organized dissonance.”

Our study suggests that a lack of reflexivity — that is, the lack of doubt on the part of banks — may be behind the current credit crisis. We are reminded of infantry officers who instructed their drummers to disrupt cadence while crossing bridges. The disruption prevents the uniformity of marching feet from producing resonance that might bring down the bridge. As we see it, the troubles of contemporary banks may well be a consequence of resonant structures that banished doubt, thereby engendering disaster.

This blog post was coauthored with Professor David Stark, chair of the Department of Sociology at Columbia University and author of The Sense of Dissonance (Princeton University Press, 2009). Please visit Professor Daniel Beunza’s blog Socializing Finance to learn more about his research on the social studies of finance.

Photo credit: Daniel Beunza

Transforming market uncertainty into opportunity is the theme of the 15th Annual Private Equity and Venture Capital Conference, which is taking place at Columbia Business School today. More than 700 people are expected to attend the conference’s six panels.

Dan Primack, editor of PEHub and moderator of the conference’s panel on venture capital, said that one of the questions the panel will address is how the weak IPO market affects the basic model of VC. Primack said that VC must consider these questions:

How they will honestly make money without an IPO market?
Can VC make money without an IPO market?
Do you make different types of investments without an IPO market?

“The average investor’s chances of making of money would have been better if he’d put his money under the mattress. That may be true of public markets, too, but you can’t liquidate in VC. All those median funds are a loser,” Primack said. “That shows you that the industry has some fundamental problems and there must be some considerations to radical proposals.” (He recently blogged about one such proposal.)

David Snow, the executive editor and director of PEI Media, who is moderating a panel on how LPs can think long-term in the volatile market, discussed some of the trends he sees.

“Negotiating power has moved squarely to the LPs. During the boom years, right up through 2007, there was a sense that GPs were holding a velvet rope in front of funds and raising billions in commitments while giving the impression that they were turning down extra demand. That demand from LPs allowed GPs to receive favorable terms,” Snow said.

“Now there’s far less capital available and many signs that partners are willing to concede on some terms in exchange for capital from LPs. But many LPs are heartbroken because first, they wish they had more money to commit, and what’s more, many experienced investors are aware that the best time to invest is during a recession. The inability of LPs to do more buying is causing grief and heartache. So you see huge activity in the secondaries market, as many LPs are trying to free up cash to double down in this environment.”

Snow said he would ask panelists about the role of the accounting rule FAS 157 in private equity, which requires the use of fair-value accounting.

“I’ll ask if, because of FAS 157, LPs would be perturbed if GPs assigned huge write-downs to existing portfolios,” he said. “Of course, the silver lining may be that write downs in private equity might allow LPs to invest more capital, because lower private equity valuations will equate to freed-up private equity allocations relative to the rest of the institutional portfolio. Are LPs with a long-term view on performance begging GPs to write down portfolio values?”

It’s Monday again, and in what has become a too-familiar weekend drill, major financial institutions — Lehman Brothers and Merrill Lynch — failed to emerge in their last-Friday form. And Lehman’s bankruptcy and Merrill’s takeover have important lessons for policymakers.

Lehman’s demise as one of Wall Street’s oldest and most well known independent firms comes on the heels of the forced sale of Bear Stearns to JPMorgan Chase, the government’s “conservatorship” of Fannie Mae and Freddie Mac, and now Bank of America’s acquisition of Merrill Lynch. Just two Wall Street titans remain.

The Treasury and the Fed have been aggressive. The “blank check” power given to the Treasury by Congress has provided taxpayer support of unknown size to mortgage giants Fannie Mae and Freddie Mac. The Fed’s rush of liquidity injections reflect Walter Bagehot’s classic Lombard Street advice “to lend freely.” And lend freely it has, with extraordinary liquidity provisions — through a more attractive regular primary credit program, the Term Auction Facility, the Term Securities Lending Facility, and the Primary Dealer Credit Facility. Borrowers include banks, investment houses, Fannie and Freddie and, now, AIG. The credit risk on the Fed’s balance sheet will be borne by — you guessed it — the taxpayer.

Now the Treasury and Fed should not ignore systemic risk just to limit moral hazard. But all of this firefighting has left us with problems remaining. Additional write-downs are coming. We cannot and should not try to protect every institution.

But, stepping back, there are steps we should take. To limit the further spread of real estate woes to the broader economy, expanded FHA authority for mortgage refinancing can make sense. In addition, putting in place a clean-up agency like the 1930s’ Homeowner’s Loan Corporation or the 1980s’ Resolution Trust Corporation would help. Taxpayer funds used to support such vehicles offer more stimulus and stabilization than temporary tax cuts or public spending.

The financial meltdown that engulfed Lehman and the uncomfortable responses of policymakers the past several months also highlight the need for regulatory reform. The problem is actually not too little regulation — both lightly and heavily regulated institutions are in trouble. And some regulations encouraged the growth of high-risk mortgage lending.

We do need smarter regulation: a key step is to broaden capital and liquidity requirements and increase them during financial booms to lean against excessive risk-taking.

The events of the past three years highlight that risk misperceptions in a boom can lead to a scramble for liquidity if collateral values decline. Ascertaining this problem in real time will always be tough for regulators (even for the increased number of regulators the Treasury recently proposed).

Bagehot picked up on this, too. His admonition goes on to say: “The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.” That is, regulation of capital adequacy could require more capital to support incremental risk-taking in a boom and lower such capital in a bust. With such requirements, financial institutions would find risk-taking marginally more costly in a credit boom, in which credit risk and liquidity risk are very low. In a downturn, a scramble for liquidity to meet capital requirements would be attenuated.

While strong supervision obviously remains important, this other advice from Bagehot would be an important addition to the policy tool kit. This could be implemented by raising banks’ capital requirements proportionately as risk-weighted bank assets grow. By varying capital cushions over credit cycles, consequences of risk distortions for actual lending and borrowing decisions will be reduced, along with the likelihood of asset fire sales and extraordinary central bank liquidity provisions.

I hope Secretary Paulson will be able to take Chairman Bernanke on one of his famous bird-watching expeditions next weekend.

This column also appeared on Forbes.com.

Photo credit: T. Shein

Understanding the financial underpinnings of mortgage-backed securities, the investments at the center of the financial crisis, is a difficult task. The complex structure of these investments may have even obscured their inherent risk to those parties directly involved with their purchase and sale.

A December 7 New York Times article by Gretchen Morgenson chronicles the predicament of Moody’s, the credit rating agency that has fallen under scrutiny for inaccurately giving high ratings to many mortgage-backed securities, including those with questionable financial fundamentals.

The rating agencies, however, were not alone in their misjudgment. According to a recent article by Professor Trevor Harris in Ideas at Work, all parties to the transactions — including the lenders, mortgage brokers and banks, securities firms and borrowers — failed to understand the fundamentals of these investments.

According to Harris, “[They] were making a bet on constantly rising home prices, while disregarding the real people and real homes on top of which these products were precariously built. Much like a Ponzi scheme, everyone lent to everyone else, creating a bubble and then compounding it. Returns could only continue while new money kept flowing into the system. When the money stopped, the whole system started unraveling.”

Harris suggests that by bringing transparency into the underlying fundamentals and risk characteristics of a business, regulators will be able to provide a more accurate and complete assessment of the related fundamentals and risks.

For a more detailed look at how the fundamentals of mortgage-related investments were neglected and what can be done to prevent this from happening again, see Harris’s article, “Back to Basics,” in Ideas at Work.

A crisis of trust is plaguing investors, says adjunct professor Seth Freeman in a recent column in the Christian Science Monitor. His column discusses the “promise problem” that we’re facing at the economic level — that is, how do investors know that borrowers will keep their word?

Freeman suggests that the solution is a building a “trust support,” and that doing so requires both parties to answer the following questions:

1. Who can serve as a credible bridge of trust? The government, for instance, can back borrowers’ promises.
2. How can we most effectively watch or test the promisemaker’s ability to perform? Helping lenders know what toxic assets borrowers hold might help them test for ability to perform.
3. What incentives and penalties can best encourage performance? My nephew is a case in point.
4. Are there ways to build in mild, moderate, and strong trust supports? A range can help lenders and backers intervene early and late with the least coercion necessary.
5. Does the solution satisfy all parties’ key interests?
6. What if the worst case scenario happens?

“The promise problem is as central to the current crisis as it has been to many others. It’s the issue lurking behind many of the world's biggest problems. Want to stop global warming? The spread of nuclear weapons? Human rights abuses?” Freeman writes. “Tackling the promise problem is the great and often solvable challenge behind the others.”

On Tuesday at lunchtime, students navigated pizza boxes and a packed auditorium for the semester’s first Town Hall meeting. Dean Glenn Hubbard addressed the school-wide audience about the near and long-term economic impact of the current Wall Street crisis. He also addressed the job market, a source of great concern for many students, saying:

A question that may be on your mind is “Does financial services need to shrink?” There will be job losses and exits, not only with the firms that have exited but probably more. But I have considerably more optimism for the medium term in financial services, and there are three simple reasons for that:

1. The global phenomenon of an aging society puts pressure on the demand for a whole variety of financial products and services. This isn’t as well developed as it should be in the U.S. or the U.K., let alone in many emerging economies, and the number of return income vehicles, insurance products and so on will increase.
2. Many of the big emerging economies are improving their domestic demand, which will generate a huge demand for financial services as they exit from the state provision of services to the market.
3. The overwhelming forces of globalization and the demands for international finance. Anyone who says that the financial sector is going to shrink out of business has not been through these cycles before.

Dean Hubbard urged students to remain flexible and keep perspective.

“We are behind you,” he said. “Ask yourself, ‘What are the right jobs for me on my career ladder?’”

Photo credit: Catherine New]]> Thu, 18 Sep 2008 09:56:53 EDT ]]> Corporate Finance Leadership Organizations

Financial markets worldwide were buoyed Monday after the U.S. Treasury took over mortgage giants Freddie Mac and Fannie Mae. The rescue, which involves placing the two organizations into a conservatorship, may lower mortgage rates, reduce investor uncertainty and stabilize the U.S. economy. “This is the beginning of the end of the financial difficulties,” Professor Charles Calomiris told the Boston Globe.

Even as the loan crisis could be eased for now, the historical significance — it is the largest government intervention into a private market in U.S. history — is still taking shape. Professor Lynne Sagalyn, director of the Paul Milstein Center for Real Estate, offered insight on the legacy of Fannie Mae:

The government takeover of Fannie and Freddie marks a stunning event in the historical legacy of these financial institutions. Fannie began life as an innovative policy experiment; its creation was designed to foster uniform availability of credit across the nation in an era of regional credit imbalances and develop a national secondary mortgage market when such trading of originated mortgages did not exist. These institutional innovations brought down the cost of mortgage credit, thereby expanding housing affordability and homeownership to millions of Americans. And Fannie benefited renters as well, through its provision of low-cost capital to the multi-family rental sector. Rather than see this policy innovation as a “failure,” we would do well to keep in mind its historical positive contribution to a housing finance system on the day of this sad and disappointing news.

Professor Charles Calomiris presented his thoughts on the long-term ramifications of the subprime housing crisis as part of last week’s annual gathering of economists in Jackson Hole, Wyo. The following excerpt was originally posted on Vox. (download complete paper)

The financial system is working through a major shock. It started with problems in the subprime mortgage market but has spread to securitization products and credit markets more generally. Banks are being asked to absorb more risk — moving off-balance sheet assets back onto their balance sheets — when their ability to do so is reduced by massive losses. The result is a bank credit crunch as the scarcity of bank equity capital is forcing banks to limit exposure to new risk.

What long-term structural changes in financial intermediation will result from the subprime turmoil? One likely outcome is the conversion of some or all standalone investment banks to become commercial (depository) banks under Gramm-Leach-Bliley. The perceived advantages of remaining as a standalone investment bank — the avoidance of safety-net-regulation and access to a ready substitute for deposit funding in the form of repos — have diminished as the result of the turmoil.

The long-term consequences for securitization will likely be mixed. In some product areas with long histories of favorable experiences — like credit cards — securitization is likely to persist and may even thrive from the demise of subprime securitization, which is a competing consumer-finance mechanism. In less time-tested areas, particularly those related to real estate, simpler structures, including on-balance sheet funding through covered bonds, will substitute for discredited securitization in the near term and perhaps for many years to come.

Professor Frank Edwards is the faculty chairman of the Corporate Governance Committee and created the new corporate governance module that is part of the revised CBS core curriculum.

There is no more basic question in corporate governance than “who gets to decide.” We are moving away from a world where shareholders are small, passive investors to a world where investors hold sizeable positions in companies and want to be heard on vital corporate decisions.

There is a growing movement to give shareholders — especially institutional investors and substantial block-holders such as private equity firms — a larger role in corporate governance. In recent years, we have seen large individual activist shareholders, such as Carl Icahn and Warren Buffett, influence companies’ policies and strategies; activist hedge funds, private equity funds and union and public pension funds have successfully persuaded or forced changes upon recalcitrant managers.

But moving away from the traditional director-primary model raises the fundamental issue of what powers should shareholders have. Will more shareholder involvement disrupt the very mechanism that makes the public corporation practical, which is the centralizing power in the board of directors?

One controversial area is the adoption of majority voting standards. In the United States, the traditional way of electing directors has been by plurality voting in which directors typically are elected if they receive one or more shareholder votes in favor. Shareholders are now demanding that the plurality system be replaced by a majority vote rule, a system used in many other countries, including the United Kingdom. Some American firms have already voluntarily instituted some form of majority voting, while many others are resisting this change.

Another area of controversy is whether or not advisory or even binding shareholder “say-on-pay” resolutions should be permitted. The law in the U.S. specifies that even shareholder resolutions receiving a majority vote are nonbinding on the board. In the past, even shareholder advisory votes on executive compensation plans have not been permitted under SEC regulations. This has changed and evolved into a new, more profound issue: should a wider range of shareholder resolutions be permitted and should those receiving a majority vote be binding on the board?

Lastly, some shareholders want the right to propose resolutions pertaining to corporate social-issue policies. Resolutions on the emission of greenhouse gases, effects of climate change on less developed countries, research on renewable energy sources and national healthcare programs have all been proposed by shareholders.

In the future, managers will have to balance shareholder involvement with the practical considerations of running a company efficiently. Understanding what good corporate governance practices are and how these can contribute to the success of a company will help mangers find the optimal balance between these competing considerations. The goal of introducing corporate governance into the CBS core is to lay a strong foundation to help future MBA managers decide these issues and to manage successfully.

Photo credit: Daniel Martini

I’m interning this summer at BlackRock in San Francisco, and things are busy, to say the least. There was a lot of acquisition in the early to mid-2000s when the company bought tons of properties, and now it’s time to make them perform. Also, with so many banks selling distressed real estate debt, we see a lot of potential opportunity. I’m really learning the inner workings of valuation, ownership structure and the macroeconomic factors in specific markets.

I’m working on a complicated deal right now, and I’ve been talking to the experts at the Milstein Center: Professor Lynne Sagalyn and Senior Vice Dean Chris Mayer. Lynne put me in touch with a CBS grad who is the head of a fund. The alum gave me 20 minutes of her time on the phone and was incredibly helpful.

I’m the only real estate MBA intern at all of BlackRock, which means I’m getting a lot of exposure to a wide range of things, and I’m not ruffling with 15 other MBA interns for a full-time offer. It does mean I don’t have peers per se, but there is an alum here, Akbar Tajani ’07, who’s taken good care of me.

I’m on week 4 of my internship, and I’ve been hearing from a lot of my fellow students who are hitting the ground running at their internships too. We’ve all had the common experience of feeling pretty stupid during the first couple of days, but now that I’ve gotten into my work here, I see that I’m really well prepared for this, and I’m glad to be here.

If liquidity intervention is inevitable, the central bank must be able to supervise and regulate the beneficiaries of its liquidity insurance. Otherwise, such insurance fans moral hazard by failing to discourage taking on still more liquidity risk (read: the most recent crisis). And making that insurance more available simply raises this concern (read: where we are now).

The events of the past three years highlight that risk misperceptions in a boom can lead to a scramble for liquidity if collateral values decline.

Importantly, Bagehot’s admonition goes on to say: “The time for economy and for accumulation is before. A good banker will have accumulated in ordinary times the reserve he is to make use of in extraordinary times.”

While strong supervision obviously remains important, this other advice from Bagehot would be an important addition to the policy tool kit. This could be implemented by raising banks’ capital requirements proportionately as risk-weighted bank assets grow. By varying capital cushions over credit cycles, consequences of risk distortions for actual lending and borrowing decisions will be reduced, along with the likelihood of asset fire sales and extraordinary central bank liquidity provisions.

Remembering Bagehot’s advice would give the central bank a way to deal with bank-lending bubbles. While a central bank’s tools may be poorly suited to prick bubbles like that of the information technology boom of the late 1990s, a bank lending bubble can — and should — be addressed.

The current policy stance of holding the federal funds rate at two percent will keep monetary stimulus in place. With inflationary expectations not declining, this stimulus will almost surely raise inflationary expectations as the economy improves. This consequence can be seen already in surging commodity prices and the weakness in the foreign-exchange value of the dollar.

It is worrisome that the Fed’s own 2008 projections have risen over the year both for headline inflation and core inflation. Furthermore, the Fed’s projections of receding inflation in 2009 and 2010 coming true will almost surely require increases in the federal funds rate.

A continuation of a negative real federal funds rate and the increase in money growth accompanying it raises the risk of increasing inflationary expectations, a costly mistake to fix.

It is asking a lot for monetary policy alone to carry the burden of supporting aggregate demand.

Fiscal policy can play a role. Congress and President Bush did pass an economic stimulus package centered on tax rebates. But clarity about a positive future for the 2001 and 2003 tax cuts which bolster collateral values — along with a cut in corporate tax rates to promote investment — would offer a much more potent tonic.

Earlier this week, the SEC issued an emergency order prohibiting naked short selling in 19 financial stocks, including Fannie Mae, Freddie Mac, Lehman Brothers and other names in the news. Beginning on Monday (July 21), it won’t be enough to make a good-faith effort to locate shares to borrow. Short sellers will have to have a formal agreement to borrow the shares in these stocks before they actually initiate a short position.

Emergency orders don’t happen every day, so you might think we are in uncharted waters. But when stocks go down sharply, it’s actually a fairly common response by regulators to try to throw sand in the gears and slow down the shorts. Perhaps the SEC was looking to the 1930s for guidance.

Back in September 1931, the world economy was spiraling downward into the depths of the Great Depression. U.S. stocks had fallen about 70 percent (!) from their 1929 peak, and short sellers were blamed. A number of commentators called for an outright ban on shorting. When Great Britain abandoned the gold standard on Sunday, September 21, 1931, the NYSE capitulated and issued an emergency order prohibiting all short selling. The gold standard news should’ve led to a sharp decline, but stocks advanced, mostly because specialists and other market-makers had no ability to provide liquidity on one side of the market. It was clear that the rise in prices was completely artificial, and after two days the NYSE repealed the ban.

An even closer analogy happened in early 1932. By then stocks had fallen even further. Opponents of short selling were encouraging stockholders to throttle short sellers by not lending shares to them. But like today, most brokerage customers held their shares in “street name,” and back then brokers could lend these shares without permission from the investor. On February 18, 1932, the NYSE announced that, effective April 1, brokers would need written authorization before lending an investor’s shares.

There was ample time for brokerage firms to secure the needed signatures, but they were apparently unable to do so in sufficient quantity. This wreaked havoc on the securities lending market. Share lenders were able to extract substantial concessions from borrowers. But the effect was completely temporary. Within two weeks, conditions in the share lending market had returned to normal. Stock prices rose on the announcement, but actually fell on April 1, because the market was expecting things to be worse. Ultimately there was only a short-term, temporary reduction in short interest.

I expect something similar here. None of the 19 stocks on the list are particularly hard to borrow. The vast majority have never been on the so-called threshold list, which identifies stocks with a significant amount of naked short selling. For these stocks, the SEC’s order really just adds more hoops for brokers. There could be a temporary effect if back offices can’t figure out right away how to jump through these hoops, but it will be very short-lived. Plus there are plenty of other ways for investors to take a bearish view. If a hedge fund can’t short, it can still buy puts. The options market-maker who sells the put will hedge by shorting the stock, and it looks like that options market-maker will be exempt from the naked shorting ban. At most, all we’ve done is add a middleman. So I suspect we won’t see much effect on Monday.

The pre-borrow requirement is actually a good idea. You can’t buy stocks unless you have the money or borrow it. You shouldn’t be able to sell stocks unless you have the shares or borrow them. I just think it won’t make much difference for these 19 stocks.

This post is part of a series following the “Pre-MBA World Tour,” organized by Shoaf and members of the class of 2010 with professional, cultural and social objectives. Over the course of nine weeks, the Tour will be visiting 24 major cities throughout Europe, the Middle East, Asia and South America, meeting with prominent alumni and business leaders.

Traveling through Thailand, Malaysia and Singapore this week, we had the opportunity to visit with the senior-most executives of several different types of institutions and discuss the challenges of competing in a global industry — and within the emerging markets.

After meeting with the executives of some major financial institutions, we started to reflect on the contrasting strategies of regional and global entities. For example, how must the perspectives differ between OCBC (a regional bank in Singapore) and Citi (the ubiquitous giant in global banking)?

Any successful organization requires growth in order to stay competitive, but how does a comparatively small company like OCBC continue to grow if it has a limited domestic market? The obvious answer seems to be that it must look outside its own country and consider entering new markets, and particularly emerging markets.

It may sound simple, but the problem is that entering a new market can require the company to stomach years of losses and investment — anywhere from 3 to 15 years.

This means that only companies able to subsidize these unprofitable years will be able to sustain themselves. These are typically either large companies with large domestic markets (such as Citi) or companies backed by another large institution (such as a sovereign wealth fund). A firm with a small domestic market of, say, four million people is not able to sustain such losses, and the investment may not provide value to shareholders in the short run.

But the real problem is this: if the target market is not large enough to give ample returns on this investment (in countries such as Vietnam or Cambodia, for example), there may not be sufficient returns in the long run, either. The payback period is simply too long.

So how can a regional player compete in a globalizing industry? Perhaps the best way is to specialize, catering to the local market and focusing on profitability and efficiency rather than top-line growth. This would make the company an attractive acquisition target for a global player with a larger domestic market (such as Citi) that can grow through acquisitions, rather than organic growth. This in effect shortens the learning curve and increases the company’s ROI.

This leaves two questions: First, does it make sense for a regional bank apply a similar strategy to compete in emerging markets? And second, with local expertise, can a regional bank be more effective in servicing its customers than a global bank?

The challenges of global expansion are complex and the appropriate solution will differ with each unique institution. Our trip to Singapore gave us a valuable lesson, pushing us to consider the variations in strategy among firms with different sets of resources and at times, different goals.

Taking organizational service to the next level is not just about executing key strategic goals. According to Professor Awi Federgruen, companies need to focus more on considering the relationship between strategic options and operating cost.

“It is challenging but relatively easy to come up with planning approaches that will take out the organizational fat to reduce operational costs for given strategic goals,” Federgruen told the FT in a BearingPoint podcast. “But what is much more challenging and ultimately much more important for most organizations is to understand how the required operating costs interact with the strategic goals of the company.”

Within a corporate landscape that’s becoming more and more competitive in terms of the quality, accuracy and timeliness of services provided, organizations need to take a step back and weigh the implications of certain initiatives to the bottom line.

“Those tradeoffs between operating costs and strategic goals are not easy to figure out . . . and yet [they’re] something that organizations should indeed stay awake about, because without having a good understanding about what indeed the revenue implications are of strategic choices . . . one may be missing the big picture,” Federgruen said.

What challenges does your organization face in thinking about strategy choices in terms of operating cost — and do you agree that the task deserves greater attention?

If you are planning to pursue a career in venture capital after business school, a word of advice: get experience doing market sizing (OK, market estimating is probably more like it) and practice, practice, practice.

By market sizing, I mean taking a given market (e.g., the market for HD televisions or widgets or oatmeal cookies) and slicing and dicing it based on a series of assumptions.

I have had some opportunities to practice this through my internships (looking at market sizes to inform business plans or VC investments) and to a small degree in classes, but you can always improve — and the only way to improve is to practice.

If I could rewind to last summer, I might have spent some time practicing management-consulting case interviews (even though I didn’t want to go into consulting) for that very reason.

Why?

Well, case interviews require you to quantitatively walk through a business problem and figure out the magnitude of profit, revenue, etc., which guides your decision making. More important, they force you to develop your own analytic process.

Doing this repeatedly is bound to make you improve.

Bonus VC job tip: Pick an industry you know little or nothing about and spend about 10 hours (give or take) during a one-week period looking at the industry trends, value chain, competitive landscape, market sizes and value proposition for key players, and think about what you would like to invest in (if anything). After doing this, you’ll be familiar with yet another space and have another set of insights to share during your informational and formal interviews.

There has been a lot of emotionally charged rhetoric surrounding sovereign wealth funds, especially with politicians and the media magnifying the “straw man” of suspicious foreign motives to conjure up advantages and ratings.

I just don’t buy it. Calls from politicians and the media for sovereign wealth fund regulation miss the larger point. Singling out sovereign wealth funds as bad guys suggests that they have the potential to be more hazardous to U.S. interests than other funds — and allows the rest of the investment field to roam freely, going largely unchallenged.

We should ask whether a fund’s national origin even matters. After all, hedge funds have an enormously extended reach and diverse investor bases. What if 49 percent of a hedge fund’s investors were U.S. endowments and 51 percent were foreign entities? And what if that calculus was opaque because the capital was disbursed through an offshore fund of funds? Variables such as these can make determining who wins and who loses far from clear-cut.

In the final analysis, it isn’t just what type of company, how big of a stake or what debt or equity instrument is owned that underlies plausible U.S. vulnerability — it is whether we have a strong political alliance in place, and the extent to which our dependence can be used against the U.S. in a negotiation for trade, security, intellectual property or what have you.

For the global economic environment to survive, we must cooperate with each other. The U.S. has a spiraling current account deficit that some argue resembles precrisis Argentina: the dollar has slid precipitously, oil prices have risen.

That we haven’t had a severe avalanche of dollar selling seems to be due to political good will with foreign central banks and the moral persuasion of the Treasury and the Federal Reserve. None of our trailing data are owed to the alpha-decision making of supposedly sovereign-neutral portfolio managers.

Given all this, pointing a finger exclusively at relatively mundane entities, such as Singapore’s GIC, seems like a diversionary tactic to distract the public from much larger, more complex issues.

This post is part of a series following the “Pre-MBA World Tour,” organized by Shoaf and members of the class of 2010.

To better understand the business environment in Italy, we attended a private equity conference, where we had the opportunity to meet with the U. S. ambassador to Italy.

After a successful career at his private equity firm, Freeman Spogli, Ambassador Ronald Spogli entered the U.S. State Department, where he came to believe it was in the best interest of the United States to help modernize the stagnant Italian economy. The embassy recently established an initiative called the Partnership for Growth, which is designed to help foster the entrepreneurial mindset in Italy through four main objectives: (1) stimulate the venture capital industry and promote Italian entrepreneurial role models, (2) modernize the country’s capital markets, (3) spur innovation by protecting intellectual property rights and (4) send Italian students to U.S. schools to learn the American way of doing business.

In fact, the Italian venture capital industry is really quite nascent. A major constraint is that the entrepreneurial mindset — which is quite common to most people here in the U.S. — is foreign to most Italians. One of the reasons for this lack of entrepreneurial drive is the fear of bankruptcy. In the U.S., most new businesses fail . . . and it’s okay to fail and try again. But in Italy, if a new business fails, it’s not just the business that fails, the entrepreneur’s personal life might be ruined as well (e.g., the person would no longer able to vote or get another loan, would experience social failure, etc.).

Italian investors are also not typically comfortable with stomaching the risk required for PE/VC investments; they prefer to invest in more traditional asset classes, such as public equities and bonds. As evidence, consider this statistic: in the U.S., pension funds typically supply nearly 60 percent of the total capital invested in new private equity funds. In Italy, pension funds supply only 1 percent of such capital.

The embassy is already seeing some good results. Last year, it sent several Italian investors to Silicon Valley to learn the American approach to venture capital. Within three months of their return to Italy, these investors have already established a formal angel network and reviewed nearly 200 new business plans! As you can imagine, there was a great amount of energy in the air at the conference.

We’re looking forward to the many opportunities to learn entrepreneurial skills at CBS — which hopefully can inspire a similar energy among our class, and perhaps serve as catalysts for change in the renovation of the Italian economy.

Photo Credit: Diliff

I've been working to have my novel turned into a movie for the past few years (the NYT just wrote on my experiences). Along the way, the process has revealed the truth behind some positive and negative stereotypes of the film industry: it’s full of passive-aggressive people, but it does respect persistence.

If you’re a new filmmaker like me, you’ve got a lot working against you. Most doors will be closed to you because established industry people already have thousands of projects from established filmmakers that they can work on.

But what I’ve found is that if you knock on those doors long enough, eventually someone will notice that you believe in yourself and in your project enough to still be standing there knocking.

I learned that persistence pays off when I was trying to get my book published, a process which took me two years. I learned the hard way that I had to do most of the legwork on my own.

At one point, I had pretty much given up. My agent had refused to send the book to publishers a second time. I called everyone I knew, emailed everyone I knew — nobody could help. I was tired of it all — I was unemployed, I was running out of money. I said to myself: “I’m going to send out one final email. And after that I’ve had it.”

And I sent that one final email, and I fully expected the person to come back and say, “You know, look: you’ve asked me this question 20 times, and I’ve told you no 20 times.”

But to my surprise, he came back and said, “Alright — I’ll connect you with someone.”

Had I not sent that one final email, none of this would be happening.

Sanjay Sanghoee is the author of the novel Merger and is working on the film adaptation.

This post is part of a series following the “Pre-MBA World Tour” organized by Shoaf and members of the class of 2010.

In London, we visited with a banker at Blackstone who works in the corporate restructuring group. Following are a few highlights from our conversation:

Restructuring is a recent concept in the EU; not many banks or corporations are familiar with the practice, so it’s a fairly nascent market. The UK has much stricter bankruptcy laws, which means that the concept of restructuring is a bit trickier to deal with.

Blackstone is one of the few firms advising on restructuring deals in the EU; Houlihan Lokey and Lazard are among their main competitors.

At most firms, restructuring generally falls under the “advisory” business, but it is very different from M&A or capital markets. While M&A transactions typically involve a fairly straightforward auction process (build a book, build a list, call the list), restructuring deals are much more complex and unique — they involve several more parties per transaction and are often less predictable. Most companies undergoing restructuring transactions are overleveraged and have serious operational issues in addition to problems with their capital structure (e.g., a liquidity crisis).

Also, there is much more tension and drama involved in a restructuring because there is generally a losing party involved. So unlike an M&A deal where each party is excited about newfound synergies, restructuring generally involves a bit of pain for the equity holders during the deleveraging process. Another difference is that with restructuring, banks are typically brought in and retained (hired) by the creditors, rather than the corporation or the equity holders as is the case with M&As.

As many know, restructuring is a counter-cyclical business, which means that when the market is hot, the restructuring guys get to play golf on the weekdays, but when the market crashes (and all the other bankers get laid off), these guys roll up their sleeves and get to work.

At the first CBS open house, a few of us were talking about going into restructuring in order to capitalize on the anticipated recession.

However, according to my new friend at Blackstone, restructuring isn’t something you get into for the short run; it’s a very specialized practice that takes a few market cycles to really understand the business and get to know the players. It also has a short window of opportunity because, unlike the weather here in London, there are typically more sunny days than rainy days in any given market cycle.

That said, Blackstone hasn’t seen any significant increase in restructuring deals . . . yet. It seems that most of the deleveraging has been taking place in the capital markets and hasn’t yet hit the corporations, which seem to still have a lot of cash on their balance sheets. A few bad quarters and this could change very quickly.

Okay, there’s my report from London. I’ll end with saying that I don’t have a restructuring background, and most of this information was derived from one conversation, so I’d love to hear anyone else’s thoughts about the matter. Is now the right time to get into restructuring?

Next stops: Paris and Frankfurt.

One of the more remote places to do business is Tajikistan, a mountainous republic in Central Asia. Recent events aren’t helping: an energy crisis appears to have set in motion a food shortage, and the IMF claims that the National Bank of Tajikistan misrepresented its creditworthiness to secure loans.

Still, the economy is growing, and we were excited to see it firsthand over spring break. All semester we had been working with a local bank, the First MicroFinanceBank of Tajikistan (FMFB), on assessing the viability of providing commercial loans to small and medium enterprises (SMEs). In mid-March Lukas Bauer ’09 and I traveled there to gather research that could help us identify the factors that would determine whether or not that could work.

After arriving in Dushanbe, the capital, we went first to the bazaar to meet with small-business owners. We found retailing practices that would usually cause great concern: bags of cash were transported hundreds of miles to pay suppliers; there was no maintenance of current accounts or accounting books; and monthly sales tracking (or any, for that matter) was conspicuously absent.

In the framework of commercial finance, these business practices would preclude an assessment of the chance of default, a necessary element to judging the risk that the bank would incur by providing a loan. However, the framework of microfinance allows lenders to protect portfolios through diversification: while a default of the size of most commercial loans could cripple the financier, the combination of multiple borrowers and the small size of individual loans protects the bank’s lending portfolio from collapse.

The next day we boarded a plane for Khorog, the capital of the Gorno-Badakhshan Autonomous Region (GBAO), the remote mountainous province that comprises nearly half of the country’s territory. In ninety breathtaking minutes we flew over the 20,000-plus foot Pamir range, observing the isolated villages and seasonally passable unpaved roads below (we would spend nineteen hours driving back). We were beginning to understand the complexity of the challenges faced by GBAO businesses.

Over the next three days we visited clients in the rural districts of Roshtkala and Rushan, discussing the finer points of locally significant activities such as Pamiri residential construction and chicken incubation. They pointed to real challenges facing their business, ranging from changing consumer preferences to across-the-board inflation on basic commodities.

We were awed by the lengths to which owners went to start their businesses. One dentist brought fragile equipment over steep mountain passes from China. Other aspiring industrialists drew deeply on capital loans to create outbound supply chains.

By the week’s end, we had a real sense of the needs of the customers. They called for more credit, lower interest rates, less up-front paperwork and most vociferously, longer loan durations. From the bank’s perspective, however, these requests had to be balanced with risk level, transparency and the costs such changes would pose.

Our challenge now is to resolve this disjunction. Over the next month, our team — Ossama Soliman ’08, Gervasio Guareschi ’09 and Michael Hsueh ’09, along with Lukas and myself — will be researching microfinance institutions around the world that make loans in similarly inhospitable terrain.

After final exams, part of our team will travel to Dushanbe to present our recommendations and plan the next steps with the bank.

Microfinance will not be a panacea for Tajikistan; even if the FMFB succeeds in meeting its clients’ financial needs, deeply rooted economic and political problems will still limit business opportunities.

Nevertheless, the bank has already demonstrated that the provision of finance markedly improves the odds that entrepreneurial endeavors will blossom into productive and profitable enterprises. We aim to convey the insight from more mature organizations that will enable the bank to both succeed commercially and make as broad a social impact as possible.

This consulting project was organized by the International Development Club and sponsored by the Social Enterprise Program.]]> Tue, 29 Apr 2008 15:22:00 EDT ]]> Business Economics and Public Policy Corporate Finance Social Enterprise World Business

Once upon a time risk management was a highly technical discipline of interest mainly to risk management professionals, but over the past decade it has become a topic of great interest, particularly among managers, investors and regulators. And recent economic news has put an even bigger spotlight on the profession.

Of interest to me is how, and how well, risk management information has been making its way into governance frameworks of companies, and I had the chance to hear firsthand about this when I was at an assembly of large company chief risk officers in October 2007. The topic of my discussion was how risk management organizations (RMOs) and boards of directors interact — and it was clear from the group interaction that top-level practices differed extensively.

So as a followup to that assembly, my colleague David R. Koenig, the former chairman of PRMIA, and I conducted a survey of very large corporations around the world, and the results confirmed that a standard of best practices for employing risk management within a governance structure does not yet exist.

Our survey results also confirmed something else: there is substantial change occurring within governance structures toward a more robust incorporation of risk management. And we found that while some companies employ ongoing efforts for the communication and improvement of governance and risk management practices within their board and employee populations, a very substantial number of others do not have such capabilities in place.

Our survey shows a wide variety of approaches currently being used to facilitate interactions between RMOs and boards — even within the same industry — and that meaningfully different approaches to risk/governance implementation exist at many levels in the companies: at the board committee and executive level, in the chains of reporting within the executive suite and in patterns of communications to governance structures.

Not surprisingly, an audit committee is the most frequent choice for board oversight of risk management, but still was the choice of less than one third of our survey respondents. The remaining choices span a wide range of board entities. Risk committees are emerging as an important board-level committee, but they only accounted for 17 percent of the risk oversight assignments reported to us. There are many factors that can account for this wide dispersion of choices, but it certainly suggests that the board of directors interface with the risk management organization is far from settled into a widely acceptable pattern, and the relationship will continue to evolve.

We asked participants about their objectives for risk management and found they also differ even between participants in the same industry and are almost always multifold. Most of our survey participants agreed on loss avoidance and control as objectives, while a smaller number — but still a majority of respondents — also identified securing a competitive advantage as an objective.

Finally, we found the most significant task lacking with many (but certainly not all) of our survey group was effective communication and education on risk policies for employees, a surprising gap in this important element of good governance practice.

It’s clear that further study of means for effective communication of the corporate appetite for risk, risk policy and risk data/reporting expectations is warranted to ensure that firms are creating the kind of effective culture that boards are increasingly seeking to foster. And if there is an expectation that employees are engaged in best practice governance and risk management, it must be modeled and communicated from the top to be achieved.

The full study is scheduled for publication by Wiley-Blackwell later this year in their monograph series, “Corporate Boards: Managers of Risk, Sources of Risk.”

This new standard formalizes the accounting industry’s age-old concept of fair value. It redefines fair value as the present-day cost to sell an asset or transfer a liability in an orderly transaction.

Previously this definition was used only to define investments in debt and equity securities, but now it has been expanded to include most assets and liabilities that take up space on corporate balance sheets. And it requires both public and private companies to adopt it.

As a result, companies — particularly those that invest in the alternative investment space — will find it increasingly challenging to mark many of their complex investments according to the new fair value definition. In addition, accountants will be required to dust off older contracts and agreements previously held at historical cost in order to comply with new requirements. (Valuation of publicly quoted investments, however, remains straightforward).

Although market volatility and subjectivity will riddle this process with uncertainty, one thing is for certain: this new fair value landscape will stimulate growth in several related career paths in 2008. Companies will need to employ more quantitative gurus in order to price these securities. In addition, regulators and auditors are likely to place a higher level of reliance on third-party valuation estimates, thereby creating a larger demand for independent valuation experts.

More good news is that this will enhance the tradability of assets and liabilities among firms by making the values of such investments more transparent to both buyers and sellers.

This new pronouncement presents fresh challenges for public and private organizations, many of which have long struggled with placing a value on complex financial instruments. Now that companies are filing quarterly financial information, we’re likely to see the effects of improved measurements and a clearer concept of what an asset or a liability is really worth.

Before working at a venture capital company, I tried for years to figure out how to quickly determine if something is a venture capital investment or a private equity investment.

Some suggested that private equity is a super-umbrella term that is called venture capital when the investment is at an early stage. However, some companies have operated for 6–10 years before they come for venture funding.

Others believe that venture capital is the original term that became popular after World War II, and private equity is the term coined in the 80’s after famous people like Henry Kravis ’69 invested in bigger companies.

But I’ve found that determining by size of the company gets tricky, as revenue of $2 million might be considered small in a developed country but large in a developing country.

The size of the investment doesn’t work either if you base it on country. An investment of $10 million in a U.S.-based company would be considered a venture investment, but might be considered a private equity investment in the developing world.

Some professionals strictly define private equity as a leveraged buyout (LBO) activity. But in developing countries like India, there is almost no LBO activity due to banking regulations, and yet billions of dollars are invested in large corporations by private equity players as equity or convertible debt. This sure looks like private equity investment, but does not fall under the LBO or management buyout (MBO) category.

There is also conventional wisdom that says if a company is not yet successful but the promoter is very confident, it is a venture capital investment, but if the reverse is true — if a company is successful but the promoter is not that confident and wants to either restructure using LBO or wants to exit — it is for sure a private equity investment.

Though there may be some truth in that, it’s not quite scientific enough and does not cover all investment scenarios.

So here’s my own litmus test: if a company has no additional bank-debt carrying capacity due to its current financial state, an investment in it should be considered a venture capital investment. Otherwise, it should be considered a private equity investment. This works for companies of any size, stage or location.

On March 21 I flew to Omaha — along with 150 of my classmates — to meet Warren Buffett, MS ’51, a man I have admired (some friends would say fanatically idolized) for close to 15 years.

After a tour of the Berkshire Hathaway-owned Nebraska Furniture Mart, we were brought to a room at the Omaha Field Club. Warren Buffett stood at the front — two of his five daily cans of Cherry Coke nearby — and for the next two and a half hours, answered our questions.

The questions covered a wide range of issues, including what he looks for in a business, the current financial situation, recent events at Bear Stearns, ethics, emerging markets, commodities, his relationship with Benjamin Graham and his typical day. His answers were a powerful reminder of his unique ability to distill complex issues down to their bare essence.

When asked about how long the current financial crisis would last, he replied, “I don’t know. I have never made money on macro calls.” Buffett said that even if he had perfectly predicted macro conditions in 1973–74, he would not have bought See’s Candies in 1972 going into a recession and would have missed out on a company that he has referred to as “the prototype of a dream business.”

After joking that our graduation was not perfectly timed, Buffett warned that we should not be discouraged from pursuing a career in finance. Finance is only going to become more important as time goes on, he said, and it is a field where one can truly stand out and be recognized.

He advised MBA students to learn as much about accounting as possible, adding that, “accounting is the language of business.” He also said that writing and verbal communication are extremely important in the business world and that students should seek out ways to improve these skills every chance they get.

Buffett urged students looking for jobs not to pay too much attention to salary. “Who you work for is extremely important, so choose carefully,” he counseled, adding that the most important decision of his own career was going to work for Benjamin Graham.

As MBA students, we are beginning our careers in an age where the image of a corporate executive has been bruised. Spending time with Warren Buffett — an astute businessman, a legendary investor, a rational and disciplined person and a generous philanthropist — afforded us the opportunity to learn much more than just how to pick stocks.

Before the trip, I was certain that no one could ever live up to the sincere, humble and generous image depicted of him in books, shareholder letters and TV interviews. I was wrong. Even that lofty image did not hold a candle to the man I was lucky enough to spend half the day with in Omaha.

And many experts such as Professor David Beim agree that Lehman is no Bear Stearns.

“Lehman has much stronger and more broadly based businesses” than Bear, Beim told a Dow Jones reporter. “There is some anxiety about it, but I don’t think it will be fatal to the firm.”

The Fed’s intervention also helped. “I think that we’ve seen very possibly the last major problem of a large financial institution,” said Professor Charles Calomiris during an interview on NPR yesterday. “And what we’re going to see now is even more aggressive action by the Fed to create liquidity for other institutions to avoid a repeat.”

“The essential problem,” he wrote, “is that our models — both risk models and econometric models — as complex as they have become, are still too simple to capture the full array of governing variables that drive global economic reality.”

Says Professor Paul Glasserman: “Mr. Greenspan’s article highlights the shortcomings in risk-management systems that result from limited historical data — particularly data from good economic times. Taking this point a step further, financial innovation can end up focusing — sometimes unwittingly — on the weak points in risk measurement. When correlations are misjudged, as in Greenspan’s example, the greatest strains get put on the weakest links.”

Photo credit: Toni Lozano

Blankfein insisted that this is not pure philanthropy, but that it is in Goldman’s business interest. Shareholders should like it.

Here’s his argument: Educating women — especially in business — promotes growth. If developing economies grow faster, that’s good for Goldman’s business. The firm manages IPOs from the newly formed companies, gets to finance them, merge them, invest in them through private equity deals, etc. So promoting global growth is good for Goldman, and promoting women’s education is a cost-effective way of promoting global economic growth.

Mark Tercek, a senior executive at Goldman, spoke to my class last week about Goldman’s environmental policies, which are equally spectacular. The firm gave away a huge parcel of land in Patagonia to the Wildlife Conservation Society; built some of the greenest buildings in the United States; acquired a fleet of hybrid limos; forced TXU to drop plans for eight new coal-fired power station in the recent buyout of TXU by Goldman, KKR and TPG; invested heavily and early in renewable power; and has persistently and forcefully promoted green behavior by its clients. Tercek gave similar arguments for why they do this: it’s good for Goldman. Why?

We need a healthy environment to survive and prosper, and only if we survive and prosper will Goldman do likewise. There were some other arguments too, in both cases, the most interesting being about motivating the firm’s employees and making them proud to work for Goldman.

Bottom line? What’s good for the world is good for Goldman. Remember the old saying — attributed to “Engine Charlie” Wilson, the then CEO of GM — “What“s good for General Motors is good for America”? There’s been an interesting order reversal here. And we’ve gone global too.

It’s a striking claim: by giving money away, we make ourselves better off — not just psychologically or ethically, but financially too. For every $1 we give away, more than $1 comes back.

Can this be true, or is someone deluding him- or herself here?

I have to plead the economist’s occupational disease — skepticism. But there is a possibility of validity.

Analytically, the issue is whether someone gains from providing a public good at his or her own expense. Global growth is a public good, as is a better environment. Generally the answer is no, it doesn’t pay any individual to provide a public good. But if the provider is also a major consumer of the public good, it could be the case.

So the issue is whether Goldman is dominant enough in its field to be sure that the lion’s share of the new banking business generated by growth anywhere in the world comes to it. Maybe that’s the case; certainly that’s what they are banking on.

New research from Professor Maria Guadalupe suggests that high CEO salaries do pay off. Guadalupe and her research partner Vicente Cuñat found that as global competition grows, so does the link between executive pay and performance.

Two other scholars — W. Gerard Sanders (Brigham Young) and Donald Hambrick (Penn State), formerly of CBS — did a different study and found that CEOs whose compensation packages include a large percentage of stock options tend to make risky decisions that generate share-price losses more often than gains.

According to Forbes, the average CEO salary for an American company is $15 million, with top salaries in the hundreds of millions.

On Friday, I moderated a panel at CBS’s annual Private Equity and Venture Capital Conference. The topic: Pushback — Private Equity’s Social Impact.

The rabble-rouser among the panelists was Andrew Stern, the outspoken president of Service Employees International Union (SEIU). On the other side, defending the private equity industry, was Gwyneth M. Ketterer ’91, the COO of Bear Stearns Merchant Banking and John Franchini, Partner, Milbank, Tweed, Hadley & McCloy.

With the panel taking place less than a month after the SEIU staged a massive protest that drew police to the scene in the middle of a presentation by Carlyle Group’s David Rubenstein at a Wharton conference, the organizers of this conference were understandably nervous. They took precautions by having undercover officers in the audience, which quickly became standing-room only.

While there were no protesters this time, Mr. Stern didn’t disappoint: he threw several proverbial grenades into the room that caused sparks to fly. He derided private equity on its tax treatment, its debt load and its treatment of its employees. By constantly wrapping his arguments against the industry in the context of being an American patriot and by framing the debate as one about inequalities, he quickly gained some sympathy from the audience members (most of whom were either in private equity or students seeking to enter the industry). But when it came to offering concrete ways to improve the industry and its relationship with labor, he was short on details.

Ms. Ketterer, a feisty veteran of the industry, sparred with Mr. Stern, calling him out on his lack of specific suggestions. For example, she asked why unions were typically not willing to take equity in lieu of cash as a way to incentivize the workforce. Mr. Stern said he agreed that they should be more progressive in their thinking.

Several vocal members of the audience lit into the private equity industry, at times becoming quite emotional while Ms. Ketterer and Mr. Franchini tried to explain the dynamics of the marketplace.

Towards the very end, in effort to reach a common ground, Ms. Ketterer said she appreciated how explosive the issues had become and expressed an interest in finding a solution. But the fight seemed to never end.

Like Mr. Springer’s show, the panel ended with audience members still involved in a raucous debate.

Stay tuned for the next episode.

“We suggested a very difficult problem to him,” said Donaldson of Pandit’s dissertation, “and he made substantial progress on it.”

“His topic was to assess whether an appropriately structured dynamic heterogeneous agent model could shed light on the equity premium puzzle. The puzzle points out the implausibly high risk aversion necessary for standard homogeneous agent models to reconcile the high historical returns of stocks versus risk-free T-bills.”

A full resolution of the equity premium puzzle has yet to be found.

“In terms of theoretical explorations, he was way ahead of the curve,” said Donaldson. “His choice of dissertation topic shows that he is willing to think very carefully about complex equilibrium questions.”

Pandit’s move is good for Columbia Business School — he is an ’86 PhD graduate of the School, and is an active member of the School’s Board of Overseers. But the move also has much to say about business and leadership today.

The analytical Pandit, a former finance professor, is less a deal guy than an entrepreneur — fresh from the success of his own hedge fund Old Lane selling to Citi in 2007 — and a risk manager par excellence. Running a big financial institution today is principally about identifying and capturing emerging opportunities (the essence of entrepreneurship) and assessing and managing exposures to narrow market factors (the essence of risk management).

Pandit’s rise also sheds light on the two key leadership factors from business school onward. First, today’s business leaders must think globally and understand the forces of globalization. The Mumbai-born Pandit immersed himself in the analytical and international setting of Columbia Business School, and two decades later, he is running a business that generates about half of its profits outside the United States. Today’s young business leaders must think of the world as the source of investment opportunities.

The second factor is entrepreneurial agility — being a corporate leader is less likely the key to success than being open to opportunity. Pandit moved from president and chief operating officer of Morgan Stanley’s Institutional Securities Group, to Old Lane, to Citi’s top job within 2 years. And today’s MBAs are likely to assume leadership positions after 5 to 10 years.

Congratulations, Vikram.