The brave new post-crash financial world

In this new textbook, David Stowell writes, “The world has changed.” This “pracademic” (practitioner/academic), who has worked at Goldman Sachs and Northwestern, demystifies the “heavily interconnected” world of finance. (1/3)

	Title:	An Introduction to Investment Banks, Hedge Funds and Private Equity
	Author:	David P. Stowell
	Pages:	578pages
	Publisher:	Academic Press
	Price:	$79.95

David Stowell’s textbook, published in 2010 by Elsevier Academic Press, offers a rare well-documented and highly intelligent view into the “epic battle for investor funds and corporate influence” that is playing out around the world now, in the wake of the global financial meltdown of 2007-09.

The book was written for MBA, MSF, and Executive MBA students and upper-level undergraduates interested in finance and investments; Stowell’s objective is to reveal the “key functions, compensation systems,” and “unique role in wealth creation and risk management” of the mighty three—investment banks, hedge funds, and private equity.

The transformed financial landscape that he documents and explains is one in which “attitudes about risk, transparency, regulation and compensation have changed.”  These intertwined institutions are seeking new ways to create value in a new environment of, ostensibly, lower risk and greater regulation (which has yet to fully materialize).

The book’s three sections include:  1. ten chapters on investment banking, 2. five chapters each on hedge funds and private equity firms, and 3. ten cases Professor Stowell wrote that focus on recent developments in the financial markets and that are cross-referenced in the prior chapters.      

The cases alone are worth the (not inconsiderable) textbook price of $80 (in fact, Kellogg charges $6 per case, versus Harvard’s $6.95); these ten cases illuminate concepts that require and benefit from the rigorous quantitative analysis presented.  In fact, the case subjects read a little like a financial intellectual’s version of (the recently shuttered) News of the World:  
•    the rise and fall of Bear Stearns
•    Procter and Gamble’s “Deal” for Gillette?
•    how a hedge fund became the owner of the world’s largest retailers Kmart and Sears
•    how hedge fund activism affected McDonald’s and Wendy’s
•    how derivatives drove Porsche and Volkswagen
•    and finally (my favorite) Cerberus—the mythical three-headed dog that guards the gates of Hell!—and the U.S. auto industry.

Another significant benefit of this textbook is its online ancillary materials (click here to view).  These include a Powerpoint Presentation Template on one case, for example, and Excel spreadsheet models for two cases.

Lest you should fear that this book is too focused on the U.S., let me reassure you that Professor Stowell speaks Japanese fluently, lived for some time in Hong Kong and Tokyo, and writes intelligently about international finance and differences in approach and regulation around the world, such as, for example, the difference between U.S. GAAP accounting standards and internationally prevalent IFRS accounting standards.  His Chapter 8 focuses on international banking, and examples from around the globe are utilized throughout the book.

The two most closely watched metrics
And speaking of GAAP and IFRS, Professor Stowell puts right up front (page 5) charts showing the latest figures on two bellwether (the sheep that wears the bell and leads the flock!) metrics of investment banks—return on equity and value at risk.  

The first of these, return on equity, is best examined in the context of “leverage”—total assets divided by total equity (the topmost portion of the balance sheet divided by the bottommost portion of the balance sheet).

As the chart shows, the average return on equity for the nine key global investment banks from 2004-2008 was healthy for all but two of the firms, UBS and Citigroup.  Even more interesting is the footnote about the difference between U.S. GAAP, showing assets NET of amounts from sophisticated financial tools such as derivatives, and IFRS, showing assets GROSS of amounts from those same financial tools.  The result of that difference is that, for example, Deutsche Bank’s yearend 2008 leverage is high under IFRS at 71.7, but under GAAP, eliminating the effect of the sophisticated financial tools, the leverage is 60% lower, at 28—a significant and telling difference.  

The average 2008 daily value at risk, in rank order, for these same nine firms was as follows:
1.    Barclay’s               $798 million    vastly more at risk than its competitors!
2.    UBS                      $347 million
3.    Citigroup                $292 million
4.    JP Morgan Chase   $202 million
5.    Goldman Sachs      $180 million
6.    Deutsche Bank       $179 million
7.    Credit Suisse          $163 million
8.    Morgan Stanley      $135 million
9.    Bank of America    $111 million
 
Tracking and understanding these two metrics helps one understand the recent news in which Goldman Sachs explained that its poor quarterly performance was due to its having made the wrong decision about risk, resulting in its putting too little value at risk.

Structural divisions at investment banks
Professor Stowell explains in detail how investment banks are organized—very interesting given that the nine firms listed above had a total of 1,237,422 employees in 2008!  Differences in function are clearly described for the investment banking division, the trading division, trading and investing for the house account, and the asset management division.

A succinct well-written chapter on the history of regulation follows, including the now fateful moment in November 1999 when the Great-Depression-derived Glass-Steagall Act of 1933, separating commercial and investment banks, was overturned in favor of the Gramm-Leach-Bliley Act.  Professor Stowell presents background and context information that are illuminating on this change.

Then he tackles, in turn, financings, mergers and acquisitions, trading, asset management and research, credit rating agencies and exchanges, international banking, and finally convertible securities and Wall Street innovation.  The tenth chapter is very useful for the job seeker and career changer, as it lays out information on investment banking careers, opportunities and issues.

In part two, we’ll review Professor Stowell’s section on hedge funds and private equity.
   

Published in July 2011 by Christine Arrington

Next installment September 7