Volume 11 No. 1 SPRING 2010

An Intellectual Stimulus Plan

Smith School Launches New Center for Financial Policy

The heated debate over executive compensation practices generated a lot of heated conversations in the media and around the water cooler. On November 2, under the lights of camera crews from C-span, CNBC, CNN and Bloomberg, the Smith School’s new Center for Financial Policy shone a spotlight on this controversial issue at its first roundtable discussion, “Executive Compensation—Practices and Reform.” The event featured keynote speaker Kenneth Feinberg, the well-known lawyer and mediator appointed to serve as the Obama administration’s special master for compensation.

Pay Practices—and Reforms—in the Spotlight

Two panel discussions allowed the almost 200 participants, mostly high-level executives from the public and private sectors, to explore best practices and engage with experts in the field through question and answer sessions. The discussions were wide-ranging, thought-provoking and occasionally controversial. One panelist argued that companies which took TARP funds should be “wound down” and their top executives fired outright, in order to allow “more prudent organizations” to expand and grow. But there was agreement among many of the day’s speakers as well. Compensation structure and transparency were key issues, but the amount of total compensation seemed to be less at issue. Failures of corporate governance were also pointed out: several panelists said boards needed to be truly independent of both management and CEOs in order to perform properly, and that greater expertise on compensation committees and directors with more expertise in their industries would be better able to judge which incentives were embedded in pay practices and what would create most value for the company. Best practices were few, and many panelists thought it was time to go back to the drawing board to create pay practices that foster long-term firm value yet still allow for safe risk-taking.

The roundtable was one of several events this fall that launched the center, an important initiative of the Smith School designed to mobilize Smith faculty to address critical issues in the complex world of financial markets. “The financial crisis highlighted the need for a broader, interdisciplinary perspective to addressing financial policy and corporate governance issues,” says Lemma Senbet, William E. Mayer Chair Professor of Finance and director of the center. “Our hope is for government financial regulatory agencies, congressional staffers, industry associations, and corporations to look to the center as a partner and champion of best practices in the financial arena.”

Bringing together stakeholders from academia, industry and the policy world is one of the center’s key goals. Over the years Smith’s finance department faculty have forged relationships with executive leadership at the World Bank, the International Monetary Fund (IMF), Fannie Mae and Freddie Mac, staff with Congress and the Obama administration, and insurance and trade organizations.

The center will play a role in bringing state-of-the-art finance research into the public domain by promoting research and education that informs policy. In addition to events like the executive compensation roundtable, the center will issue white papers, work directly with students through a Fellows program, and work with executives through the Director’s Institute, a an intensive two-day program designed for board chairs, corporate directors and senior executive officers of publicly traded companies to address the critical issues facing corporate boards and engage with each other to develop best boardroom practices.

Banking on Industry Expertise

The center is also drawing on the extensive industry experience and connections of Smith alumni. One such alumnus is William Longbrake, PhD ’72, who joined the center as an Executive-in-Residence. Longbrake has extensive experience in finance, macroeconomics and monetary policy, risk management, housing, public policy and academia, government, serving both the public and private sectors. He is chairman emeritus of the Financial Services Roundtable’s Housing Policy Council. He served as chief financial officer of Washington Mutual Inc. for most of the period from 1982 to 2002, except for 1995-1996 when he was chief financial officer of the FDIC.

The center’s managing director, Clifford Rossi, brings industry expertise in the area of risk management. Rossi has nearly 25 years experience in banking and government, having held senior executive roles in risk management at several of the largest financial services companies. His most recent position was Chief Risk Officer for Consumer Lending at Citigroup where he was intimately involved in TARP funding and stress tests performed on Citi. Previous to Citi, Rossi held senior positions at other major financial institutions and worked for a number of years at the Treasury Department and Office of Thrift Supervision working on key policy issues affecting depositories.

A Clear Unbiased Voice

Washington, D.C., has no shortage of think tanks, but the Center for Financial Policy offers something uniquely valuable to lawmakers: an unbiased source of expertise. This is important particularly for complex issues related to financial services markets. “It is important to have deep thinkers involved in the development of policy, people who are not under pressure to further anyone’s political agenda or are affected by the political consequences of the outcome,” says Smith School Dean G. “Anand” Anandalingam. “The challenge for all of academia is to make its voice heard within the corridors of power, alongside the many other voices competing for attention.”

To read the white papers or learn more about the center, visit the Web site.

Big Ideas, Big Impact

Lemma SenbetThe issues facing the financial world are big and complicated. The Center for Financial Policy brings Smith’s intellectual capital to bear in areas where it can make the most impact on federal policy—and through policy, on the day-to-day lives of people doing business all over the world.

The center will encompass the broad range of research in which Smith faculty are already world experts, focusing on areas related to corporate governance, led by Senbet; financial institutions and consumer finance, led by Haluk Unal, professor of finance; emerging markets, led by Vojislav Maksimovic, Dean’s Chair Professor of Finance; asset management and market design, led by Albert “Pete” Kyle, Smith Chair Professor of Finance; and risk management, led by Alexander Triantis, professor of finance and finance department chair, and Cliff Rossi, the center’s managing director.

Senbet is a world-renowned and widely-published researcher in the field of finance. He has advised the World Bank, the IMF, the UN, and other institutions on issues of financial sector reforms and capital market development, and his recent research has taken him into the heart of African economic development.

Senbet has been working with Franklin Allen, a professor at Wharton; Robert Cull, an economist with the World Bank; Elena Carletti, a professor at the European Union Institute; and Qyan Zhie, a professor at Boston College; to study African financial development, courtesy of a grant from the National Bureau of Economic Research. They looked at key indicators of development, such as liquidity and stock market development, using a huge dataset from the World Bank. When compared to other developing economies, most African nations ranked very low on financial development indicators.

But there was variation in the degree to which each African nation lagged behind the norm. Senbet found that there are factors that matter for financial development in Africa that don’t matter so much in other countries. Population density turned out to be very important, because banks need to be able to get to their customers in order to offer financial services. Access to technology can make a big difference here. Mobile banking services based on cellphones—letting people make purchases or pay bills with their phones—have helped Kenya bridge that development gap, says Senbet.

Few financial researchers are looking at Africa, says Senbet, but studying African financial development is important for understanding the impact of policy on an economy. He believes it is important to bring this continent and its billion inhabitants into the financial policy framework—not just to understand Africa, but also to understand ourselves. “We worry about market imperfections. We don’t have final answers on issues like investor protection or asymmetric information,” says Senbet. “Africa is one of the best labs to study the impact of these imperfections .”

Kyle’s Economic Report Card

Pete KyleTimothy Geithner should be glad he is not getting a letter grade for his economic policy performance in both the Obama and Bush administrations. “I’d give him a ‘D’ – and that’s being generous,” says Albert “Pete” Kyle, Smith Chair Professor of Finance. Kyle has been closely following the economy, analyzing how turmoil in the banking system will affect economic recovery.

Kyle says Obama’s Treasury Secretary Timothy Geithner, following in the footsteps of his predecessor Henry Paulson, has done a “spectacularly bad job, letting the banking system bluff its way through a recovery.” Kyle says the TARP program has wasted tens of billions of taxpayer dollars by overpaying for securities of dubious value at the time they were purchased by the Treasury, all with the effect of rewarding investors whose bad decisions caused the financial crisis.

The Obama administration’s fiscal stimulus gets slightly better marks from Kyle – a “C.” Right now, the federal government can tax and borrow more efficiently than the states, Kyle says. The states can make more efficient decisions than the federal government concerning how to spend money locally. By not structuring the fiscal stimulus as fully unrestricted block grants to states, we see states inefficiently insulating homes in poor neighborhoods while funding for schools, police, and fire protection is threatened.

Kyle says the class star has been Federal Reserve Chairman Benjamin Bernanke – “Since the crisis started under the Bush administration, Bernanke has saved the day and well deserves reappointment.” Most of the economic growth we are seeing today comes from Bernanke’s aggressive monetary policy, not from the Treasury’s TARP program and not from the fiscal stimulus, says Kyle.

As the financial system was collapsing in fall 2008, the federal government swept in to clean up the mess and prop up what was left. The Fed, with Bernanke at the helm, did an outstanding job of rapidly lowering interest rates and expanding its balance sheet to stem the liquidity crisis resulting from all of the bank failures, says Kyle.

At the same time, the Treasury spearheaded the $700 billion TARP bailout to inject more capital into the banking system. But Kyle says the cash wasn’t enough to create healthy banks. The problems stemmed from banks being far too undercapitalized to begin with—so when the financial crisis hit, the banks that hadn’t collapsed stopped lending money. And now many of them are so crippled they cannot contribute adequately to economic growth, says Kyle. The Fed has helped offset the loss of banking capacity by expanding its own balance sheet dramatically, says Kyle. Even so, with the expectation of continued writedowns on credit card debt, prime home mortgages, and commercial real estate, it is clear that the economy is nowhere near out of the woods yet.

Kyle says it is important to see how fast the Fed creates inflation, which will help housing prices recover. Bernanke needs to keep the interest rates near zero, mortgage rates low, and the dollar weak until it jumpstarts some inflation, says Kyle. “Bernanke does not want the U.S. to become another Japan.”

“There is a danger that he will overshoot and create too much inflation eventually. Whether it happens or not, it is something the markets will worry about continuously as we go forward.”

The other big worry: rising unemployment. Even when economic growth becomes positive again, the unemployment rate does not come down until positive economic growth is sustained, and “it’s going to be awhile,” Kyle says.

But Kyle is optimistic that the last quarter of the year will see further positive growth.

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