WHEN THEMUSIC STOPPED

EXCERPT BY ALAN BLINDER

EVOLTUION AND OUTLOOK OF

ENTREPRENEURSHIPBY SHAWN P. O’CONNOR

THE DEALOF THE CENTURY

BY JULIAN HE, CHRIS WU, AND RYAN AZARRAFIY

Spring 2013 issue

The Princeton

FinancierSPRING 2013

Volume 2 | Issue 2

EDITOR-IN-CHIEF

Darwin Li ‘16

MANAGING EDITORS

Hannah Rajeshwar ‘14

Seth Perlman ‘14

DESIGN & LAYOUT

Michelle Molner ‘16

You-You Ma ‘16

CONTRIBUTORS

Jonathan Ma ‘15

Hadley Chu ‘15

Julian He ‘14

Chris Wu ‘14

Ryan Azarrafiy ‘16

William Beacom ‘15

Christopher Huie ‘16

PCFC BoardSPRING 2013

PRESIDENT

Hannah Rajeshwar ‘14

CLUB MANAGEMENT

Ambika Vora ‘15

EDUCATION

Jonathan Hastings ‘15

MENTORSHIP

Dalia Katan ‘15

MARKETING

Michelle Molner ‘16

COMMUNICATION & TECHNOLOGY

John Su ‘16

INDUSTRY INSIGHT

Sunny Jeon ‘14

Julian He ‘14

Alex Seyferth ‘14

FINANCE

Jason Nong ‘15

ALL CORRESPONDENCEMAY BE DIRECTED TO:

The Princeton Financier

0666 Frist Center

Princeton, NJ 08544

pcfc@princeton.edu

www.princetoncfc.com

LETTER FROMTHE EDITORThe improved economic conditions and

financial metrics of the United States

point toward continued growth in 2013,

both in the financial industry and in

the broader U.S. economy. For the first

time in several years, the recovery of the

real estate and housing sectors is creating

optimism that is reflected in the equities

and commodities markets. Yet despite

these glimmers of hope and recovery,

there are still reasons to worry. The nearly

$17 trillion national debt and the large

income disparities across classes have

caused public concern and unrest. This

issue of The Princeton Financier focuses

on this theme—improvement tinged

with uncertainty—on both a domestic

and global level. This issue begins by

addressing an issue pertinent to many

current citizens and future generations

of citizens: the recent events concerning

our national debt and the legislation

that has revolved around it. As this issue

of The Princeton Financier progresses, we

hope to instill in the reader both a sense

of confidence as they learn about the

growth prospects in different regions of

the world and also a sense of caution as

they understand the uncertainty in other

areas. We hope to leave the reader not only

more knowledgeable about current global

affairs but also cautiously excited about the

future prospects of the global economy.

As has been the case for the past several

issues, The Princeton Financier features

work from the Princeton Corporate

Finance Club’s Industry Insight Team,

which publishes weekly newsletters

that keep members of the Princeton

community well-informed on prominent

market activities around the world. Even

a cursory perusal of the magazine clearly

demonstrates their well-researched work,

which has undoubtedly contributed

significantly to the broader theme of

global economics. Furthermore, for the

second consecutive semester, dedicated

staff writers have been instrumental in

the magazine’s publication. Through

their efforts, this issue is able to cover

the topic of Canadian energy investment

policy and feature an interview with

Scarlet Fu, a chief markets correspondent

for Bloomberg, which provides a look

into the journalism industry. Finally,

this issue was also fortunate enough to

include two professionally contributed

pieces from Stratus Prep President

Shawn O’Connor, a column writer for

Forbes Magazine, and from renowned

American economist Alan Blinder, author

of After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead

and a Gordon S. Rentschler Memorial

Professor of Economics & Public Affairs

at Princeton University. We are extremely

grateful for the continued support from

our undergraduate contributors and

from leading industry professionals.

In addition to the efforts of the magazine

contributors and editors, the successful

publication of the fourth issue of The Princeton Financier was made possible by

the tenacity of many officers of its parent

organization, the Princeton Corporate

Finance Club (PCFC). From diligent

design and layout planning to tireless

fundraising and marketing campaigns,

it took the hard work of many divisions

of PCFC to create this final product.

If you find this issue of The Princeton Financier to be fascinating, I recommend

exploring many of the other exciting

opportunities PCFC has to offer as well.

On a final note, similar to a theme expressed

in this issue, the young yet burgeoning

PCFC sees a bright future ahead. With

a growing student officer team and

increased reach on campus, PCFC hopes

to continue and improve upon its current

operations for future semesters. With

your support, the backing of committed

corporate sponsors, and a creative team

with big plans for the future, the continued

growth and success of the PCFC is

viewed with great optimism. Thank you.

- Darwin Li

The mission of the Princeton Corporate Finance Club is to provide an educational and networking platform for Princeton students interested in investment banking, private equity, venture capital, and the field of corporate finance at large. Established in March 2011, the Princeton Corporate Finance Club has quickly become a prominent club on the Princeton campus with over 400 student members and 30 officers working in seven divisions: Education, Mentorship, Industry Insight, Finance, Marketing, Communication & Technology, and The Princeton Financier. Our core values are fraternity, entrepreneurship, leadership, responsibility, integrity, professionalism, and mutual respect.

ABOUTPCFC

Kicking the Can Down the Road

by Jonathan Ma

An Inside Look at Financial Journalism: Interview with Bloomberg’s Scarlet Fu

Interview by Hadley Chu

BP & Rosneft: Deal of the Century

by Julian He, Chris Wu, and Ryan Azarrafiy

When the Music Stopped: An Excerpt From After the Music Stopped

by Alan Blinder

Entrepreneurship: Individual Accomplishments, National Impact

by Shawn P. O’Connor

The CNOOC-Nexen Deal and the Future of Foreign Direct Investment in Canada

by William Beacom

Southeast Asia: The End of the Ride?

by Christopher Huie

The Princeton

Financier

INSIDE:

46912161922

Erskine Bowles. This Bowles-Simpson

Committee was tasked with identifying

“policies to improve the fiscal situation

in the medium term and to achieve fiscal

sustainability over the long run.”

The Committee’s proposal would have cut

$4 trillion in debt by 2020, which would

reduce the ratio of national debt to GDP

from its current level of 73% to 60%

by 2023 and to 40% by 2035. Bowles-

Simpson took a balanced approach, by

raising revenue and cutting entitlement

against the wishes of Republicans and

Democrats alike.

The Committee proposed putting limits

on discretionary spending and also

proposed eliminating all tax expenditures,

decreasing the current tax rates and then

later deciding which deductions to add

back on and then raising the tax rates

accordingly. Furthermore, the committee

proposed raising the scheduled retirement

age in an effort to reform Social Security.

Although the proposal tackled the debt

as diplomatically as possible, it ultimately

failed in December 2010 as it received

only 11 out of the 14 required votes to be

considered by Congress.

United States Debt Ceiling Crisis of 2011

In the middle of 2011, the Treasury

needed Congress to raise the national

debt ceiling because the United

States’ debt obligations had increased

from the previous year. To address

the nation’s high level of debt,

Republicans and some Democrats

In order to understand the budget

sequester of March 2013, it is necessary

to understand the events that came before

it. In 2007, the U.S. national debt was

34% of GDP. By March 2011, this figure

had ballooned to 75%. This increase

was primarily due to not only lower

tax receipts produced by a recovering

economy, but also major stimuli from

the Federal Government. The national

debt was and is predicted to grow due to

the combination of an aging population

with a higher demand for healthcare and

social security and compounding interest

payments on the current debt.

According to Harvard Economics

Professor Martin Feldstein, the United

States cannot afford to continue this

trend. At some point, when a nation

has too large of a ratio of debt to GDP,

investors will suspect the nation’s ability

to repay the debt and will demand higher

interest rates to account for the added

risk. Higher interest rates will not only

add to the existing national debt but also

affect consumers who would have to pay

a higher interest rate for borrowing. There

are two primary methods of lowering

the debt: raising taxes and cutting

expenditure. Both of these methods,

however, slow economic growth.

Bowles-Simpson Committee

In 2010, President Barack Obama

created the National Commission on

Fiscal Responsibility and Reform which

was co-chaired by former Republican

Senator Alan Simpson and former

Democrat White House Chief of Staff

tried to create a sustainable budget

before raising the debt ceiling, but

the ideological gulf between the sides

proved too large to bridge.

In the days directly prior to the

Department of Treasury exhausting its

borrowing ability, Congress passed the

Budget Controls Act of 2011. The act

raised the debt ceiling by $900 billion

in exchange for $917 billion in cuts

over 10 years.

Furthermore, a Joint Select Committee

of six Democrats and six Republicans

was created to devise a plan that would

decrease the deficit by $1.5 trillion over

the next 10 years. The only caveat was

that if the super committee could not

reach a decision, then increasing the debt

ceiling by $1.2 trillion would result in

a $1.2 trillion sequester, or automatic

spending cuts, which would be split

between defense and nondefense. The

sequestration was designed to be so

painful that the super committee should

be forced to find a compromise to avoid

the horrid automatic cuts.

The Super Committee

Political commentator Fareed Zakaria

described the super committee as “one

more occasion where Congress...basically

punted, kicked the can down the road.”

Zakaria argues that the super committee

was doomed to fail, as “the Democrats

are saying no cuts to entitlements…

The Republicans are saying no taxes…

that’s great except we all know the only

solution to our long-term debt problem

THE PRINCETON FINANCIER | 4

taxes. The optimal compromise is then the

solution the United States had all along:

the proposal by the Bowles-Simpson

committee. In February 2013, Bowles

and Simpson released a proposal similar to

their 2010 version, except this time they

included a means-test for the Medicare

beneficiaries as well as the suggestion of

raising Medicare eligibility age, which

ultimately made the proposal highly

unattractive to left wing Democrats.

But equally unattractive is the removal

of $1.1 trillion tax deductions. The new

Bowles-Simpson proposal would reduce

debt by $2.4 trillion in the next 10 years.

Two other possible solutions are evident

in Senate and House budgets for fiscal

year 2014. The largely Republican-

driven House budget seeks to reduce the

national debt by $4.6 trillion in the next

decade, increasing reliance on spending

cuts, capping government spending

on Medicare, and lowering taxes, all of

which are ideas that Democrats disagree

with. The Senate budget that was largely

spearheaded by Democrats seeks to

reduce the debt by $1.85 trillion in the

next decade. Of the $1.85 trillion in

the Senate budget, $1 trillion will come

from tax revenue, a solution that remains

unpalatable to Republicans.

Neither budget looks slated to receive wide

support from both parties. The best hope

is then to have a compromise that includes

both increases in revenue and cuts to

entitlement. Hopefully in 2013, Congress

and the President will decide to take the

House’s stance of reducing entitlement,

the Senate’s plan for raising taxes, or reach

another conclusion similar to the Bowles-

Simpson plan, rather than simply kicking

the can further down the road.

is cuts in entitlements and new taxes.”

On November 21, 2011, the super

committee announced it could not

reach a solution. Without a plan from

the super committee, America had to

brace for the automatic budget cuts

that were about to go into effect in

January 2013 unless Congress and the

President were able to find a way to

put the nation on a sustainable path

and to avert the cuts.

United States Fiscal Cliff of 2012

Due to the budget sequestration, the

Budget Controls Act of 2011, and

the expiring Bush Tax cuts, Congress

and the President were tasked with

preventing a massive increase in

taxes and sudden spending cuts.

The Congressional Budget Office

predicted that if Congress did not

act, unemployment would rise from

7.9% to 9.1% and the U.S. economy

would have a mild recession with

-0.5% GDP growth in 2013. Once

again, both sides clashed and a

grand bargain did not materialize.

President Obama, who had just been

re-elected, pushed for and succeeded

in passing the American Taxpayer

Relief Act of 2012 (ATRA) which

permanently extended the Bush Tax

cuts for individuals earning less than

$400,000 and raised the top marginal

tax rate for those earning more than

$400,000 from 35% to 39.6%, and

raised capital gains tax from 15% to

20%. Furthermore, ATRA phased out

certain tax deductions, raised estate

taxes, allowed payroll tax cuts to expire,

and extended federal unemployment

benefits for a year. However, the act

delayed the budget sequestration for

two months to March 1, 2013 and

did not address the issue of raising the

debt ceiling. The American Taxpayer

Relief Act is estimated to bring in

$600 billion in revenue over 10

years. However, in the February 2013

Budget Outlook, the Congressional

Budget Office projected that in 2023,

the United States’ national debt would

be 77% of its GDP and on an upward

path, which suggests that futher work

would need to be done.

Budget Sequester 2013

The automatic cuts from the Budget

Control Act of 2011, which were delayed

by two months by the American Taxpayer

Relief Act of 2012 became a concern in

March 2013. The sequestration was

supposed to cut $85 billion for the Fiscal

Year 2013, half in defense and half in

non-defense. After weeks of discussion,

once again no middle ground was found

and on March 1, 2013, President Obama

reluctantly signed an order putting the

cuts into effect.

Moving Forward

The debt limit is set to be breached on

May 18, 2013, which both Congress and

the President will again attempt to come

together to find a compromise to reign in

the United States’ national debt. There

are a few possible solutions.

The most pessimistic one is identified

by Harvard History Professor Niall

Ferguson, who laments, “is there a single

member of Congress who is willing to

cut entitlements or increase taxes in order

to avert a crisis that will culminate only

when today’s babies are retirees?” The span

of time between when the crisis will come

to a head and the present day may make

compromise politically inexpedient. If

this aversion continues for too long, the

crisis will become unpreventable by the

time action is taken.

However, Princeton Economics Professor

Paul Krugman suggests that in last year’s

election, “American voters made it clear

that they wanted to preserve the social

safety net while raising taxes on the rich.”

In this case, the solution may be to raise

THE PRINCETON FINANCIER | 5

There are two primary methods of lowering the debt: raising taxes and cutting expenditure. Both of these methods, however, slow economic growth.

THE PRINCETON FINANCIER | 6

AN INSIDE LOOK AT FINANCIAL JOURNALISM:

INTERVIEW WITH BLOOMBERG’S SCARLET FU

[ ]How do you choose your stories?

We decide the day before which guests will

be joining us. The show lasts from 6:00 to

8:00 AM, and then after it ends, I return

to my desk and see what else is going on in

the news, and then we have a meeting at

8:30 AM. You basically have half an hour

to go from one day to the next and so we

have to know all the headlines and news

pegs. The segment producers will have

booked around these stories and we will

have suggestions, but sometimes there are

holes to fill. We usually have a pretty good

idea of what 80% of the show will be

about but we won’t necessarily know what

the top stories will actually be. Based on

what is happening today, we can usually

provide you with an idea but that idea will

obviously be updated the next morning.

After the meeting, I go back to my desk

and then later, I contribute to the 10:00

AM to 12:00 PM show.

What was your first job?

I was a history major in college and after

I graduated, I moved to Hong Kong

because at the time, the economy was not

doing very well which meant my options

were ‘go to law school’ or ‘be a temp.’

Since neither of those options was very

appealing, I went to Hong Kong to look

for a job and got one at General Electric.

They had a financial management training

program, which sounded really good, but

after about two weeks I realized that job

was not the right fit for me.

How did you get from there to Bloomberg?

I did not want to be a mid-level finance

manager, so I talked to the manager of

the GE training program. At the time,

GE owned NBC which owned CNBC,

and CNBC was just launching. I told

the manager that I wanted to switch to

CNBC, and he helped me move over to

the editorial and production side, where I

started off as an intern. After that switch, I

had to prove myself indispensable so that

they would hire me full-time.

Why the switch from Hong Kong to New York?

I stayed at CNBC Asia for slightly over

two years and then I moved to Bloomberg

after seeing a job advertisement in the

newspaper. Back then, in Hong Kong,

it was common to get jobs by reading

advertisements in the newspapers. Since I

was on the print/production side, and so

I was ordering graphics, booking guests,

writing scripts, and writing questions

for the anchors to ask the guests, but I

was never on camera. Television is one of

those funny places where it takes a village

to put together a show but there are only

one or two people who actually get the

credit. I moved to Bloomberg because I

realized that as a television reporter, you

are only re-writing wire copy instead

of actually going out and doing the

reporting yourself. I wondered ‘where

do wire-copy people get their stuff? Why

did they say Hong Kong stocks rose or

fell? Where do they get this information

from?’ Bloomberg was the place to do all

of it because they have the information

and wrote all those stories. I moved from

CNBC to Bloomberg, started writing

those stories, and after I returned home

to the U.S., I eventually moved back to

television.

What have been the most interesting stories you’ve ever covered?

In Hong Kong, I covered the handover

which was certainly eventful but in the end

turned out to be extremely orchestrated, so

not a lot of news was generated from that.

But the financial crisis afterwards really

took everyone for a spin. That was really

volatile—no one knew what was going

on initially. I got trained to stare at the

Bloomberg screen just to watch the index

move. I remember watching it plunge, and

then all of a sudden, it would go back up

again. The government was buying stock

because people were attacking the Hong

Kong dollar and trying to break the peg.

Basically, the Hong Kong government

came in and defended the currency and

bought up shares as a show of force which

made a really great story. Of course, the

financial crisis overall in 2008 and 2009

was also just stunning to watch unfold.

Tell me about covering the recession from the inside.

Unfortunately, bad news creates more

interesting days for a news reporter. The

boring days were those when the stock

market was doing great in the summer

of 2007. It was like ‘oh look it’s another

buyout, it’s another M&A, another

takeover, another quarter-record profits,

and another record for the Dow.’ It lost

its luster after a while, and even then,

you would always get this unsettling

feeling because you knew it couldn’t go

on forever, but you didn’t know what

was going to make the music stop.

The financial crisis was fascinating, but

thinking back, I feel like we missed a lot

of the stories at the time because there was

so much misinformation flying around.

We knew what was going on with AIG

and Lehman Brothers but we didn’t know

the depth of the problems. Uncovering

those problems took more investigative

reporting by everyone.

Do you think being at Bloomberg at this time gave you a different perspective on the recession?

It’s possible—although when you fixate so

much on the day-to-day, you often miss

the bigger picture. I think what you are

able to appreciate is how interconnected

everything is and that there are a lot of

warning signs here and there. There are

always people who will be contrarians;

when times are good you give them the

opportunity to say it, but not everyone

wants to believe it. The other thing about

markets and Wall Street is that people

might be convinced that the good times

can’t last but that doesn’t mean that you

THE PRINCETON FINANCIER | 7

Scarlet Fu is the chief markets correspondent for Bloomberg Television. She covers trading activity in Asia, Europe and the United States, contributes to “Bloomberg Surveillance”, and is featured on Bloomberg Television, Bloomberg Radio, and Bloomberg.com. Fu began her career at Bloomberg News covering Asian equities and worked as a U.S. stocks editor before switching to Bloomberg Television. Prior to working at Bloomberg, she worked at CNBC Asia in Hong Kong. She graduated from Cornell University with a bachelor’s degree in history and a concentration in Asian American Studies.

sit it out either. You still have to make

money and you don’t have to believe in

something to make money off of it.

Who are the most interesting people you’ve interviewed?

Outside the world of finance? I

interviewed Adrian Grenier from

Entourage once. But what is really the

most interesting is talking to people who

head up companies and finding out how

they navigate the waters in this extremely

uncertain economy. It is always more

interesting to hear people who have a lot

of responsibilities; who have to take care

of people in their company and who are

really accountable for everything they do.

I like that. Sometimes we spend a lot of

time talking to economists and getting

their GDP forecasts. But after a while that

can sound the same, even though it’s not.

When the Federal Reserve is so involved

in the market, there is always a caveat

that everyone has to give when making

projections about the economy.

What’s the hardest part of your job?

The hardest part of my job is waking up at

3:00 AM! Being able to think clearly and

quickly when you are sleep deprived is a

huge challenge. But I think doing it day

after day is the only way you get better at

it because that’s the only way you build up

the muscle memory and the institutional

knowledge of everything since you can’t

predict what kind of news is going to break

at any given time.

Just to give you an example, the other

day there was breaking news on Fedex.

Earnings reports were coming out, and

they cut their forecasts for the full year,

which was a surprise. You have to know

the backstory to these delivery companies:

what is going on with the economy, how

leveraged they are to the economic cycle,

etc. You also have to know that Fedex in

particular is going through a big program

of restructuring. If you don’t know any of

that information, then the headline that

comes out does not make sense. You have

to know all of that information to be able

to add context to the headline and thus

make it a bigger story.

Quite simply, how much finance do you have to know to be a financial journalist?

You know a little bit about a lot of

different things, but you pick up a lot

of it on the job. Part of it just is reading

every day—constantly reading other

news stories, reading Bloomberg stories,

reading the Op Eds, reading the research

reports that people send us when they

come on as guests, and reading research

reports people send us because they were

guests. You have to read constantly.

Who are your competitors and how do you differentiate yourselves from them?

Anyone and everyone who covers business

and financial news are our competitors,

from the Wall Street Journal and the

Financial Times to various blogs. In

comparison to other TV networks, I feel

we’re less solely focused on the markets.

We also compete for the same guests,

but we try to ask smarter questions, and

I think we usually succeed.We try to

avoid the pattern of a CEO giving us the

standard patent answer, us letting it go,

and then moving on to the next topic. We

will really challenge them.

The way I see it, you’re both a mirror and a catalyst for Wall Street. What role does Bloomberg play in the industry today? Perhaps more generally, what do you think the role of financial journalism is today?

I think it’s interesting how a lot of

people in the financial world will use

media as a means to their own ends.

Take the battle between Bill Ackman

and Carl Icahn—they’re playing it

out in the media and we’re covering

it. We like the angle of ‘here’s Carl

Icahn—this big corporate raider guy

who’s inspired Gordon Gekko—he’s

got a personality larger than life, and

they’re battling each other.’ They

both have billions of dollars at stake,

and we contribute to that, so we

don’t help matters either. You have

to sift through a lot of information

to get to what it is they really believe

in. They use the media to push their

agendas and we allow it to happen

fairly often.

But on the other hand, the media has

done an incredible service to everyone

by explaining what happened with the

financial crisis. Were we responsible

for helping drive stock prices up the

way they were? Maybe, or maybe we

were a mirror of what was actually

going on too.

We try to be as hype-free as possible

but even as a financial news channel,

we are still part of the entertainment

business. We need to give people a

reason to watch. I’m sure you’ve heard

about the whole Lululemon story

right now about the see-through yoga

pants. People are joking ‘who’s going

to do the bend-over test?’ So even

though the problem resulted in a $20

million hit for the company, but it

was still entertaining.

What keeps you going every day?

The fact that I’m accumulating

knowledge and that I’m always

trying to learn something new. That

motivation is probably the best part

of the job. In two hours, I could be

interviewing someone on a topic I

know nothing about but I have an

hour beforehand to figure it out. You

probably won’t ask the best questions

in the world but all you can do is

make the best of what you have at the

moment and fly by the seat of your

pants knowing that you have built up

enough knowledge about the business

world and the economic world to be

able to ask an intelligent question.

Best advice you’ve ever been given?

While the tiger mom didn’t

personally give me this advice, there

is a certain truth to it: you don’t

enjoy something until you’re good

at it. The only way to get better at

something is to do it over and over

again and then it becomes fun. You

start to feel like you’re in control of

the material and so you can have a

higher-level discussion about it than

you were capable of having before.

THE PRINCETON FINANCIER | 8

Russian oil giant Rosneft has completed

a deal with British Petroleum (BP)

that has an expected worth of over $55

billion. The Daily Telegraph has dubbed

this deal the “deal of the century” as it will

make Rosneft the world’s third largest

oil producer after ExxonMobil and

Chevron and also secures BP a foothold

in one of the world’s largest and richest

oil regions. Rosneft reached agreements

with not only BP but also Alfa-Access

Renova (AAR) in order to secure their

ownership stakes in the Russian oil firm

TNK-BP—which is currently the third

largest oil firm in Russia and one of top

ten largest oil firms in the world. The

deal is expected to have wide-ranging

consequences for not only the Russian

oil sector, but for the Kremlin and future

foreign investment activity as well.

Background

The firm at the center of this deal

is TNK-BP, a vertically integrated

corporation that operates primarily

in Russia and the Ukraine. Formed

in 2003 as a “strategic partnership”

between BP and Russian business

consortium AAR, TNK-BP now

produces nearly 1.7 million barrels

of crude per day and currently has a

market value of $37 billion. In 2003

TNK-BP acquired natural gas firm

Rospan, and in 2004 began to pursue

international interests by purchasing

50% of Slavneft, a Russian-Belorussian

firm. Ownership of TNK-BP is

currently divided in an equal 50-50

split between BP and AAR.

Rosneft is an even larger firm. It is the

largest oil producer in Russia, both in

terms of extraction and refinement, and

is valued at nearly $85 billion. Similar to

TNK-BP, Rosneft is vertically integrated

and owns production facilities from

Chechnya to Siberia as well as shipping

and pipeline systems and refineries near

the Black Sea and the Pacific Ocean.

The firm’s first major expansion occurred

in 2003 via its acquisition of facilities

from the now-defunct Yukos Group, a

Russian firm whose former owner was

convicted of fraud and tax evasion. Much

of Rosneft’s complex organizational

structure is indebted to its origins as a

state-run enterprise from the early days

of post-Soviet Russia. At this time, policy

makers had appointed the executive

leadership of the firm and provided oil

fields originally run by the Soviet energy

department in an attempt to ultimately

push the fledgling corporation into the

private sector. Even after a 2006 IPO

that raised an impressive $10.7 billion,

over 75% of the firm is still owned by the

Russian government—and the Kremlin

regimes under both Putin and his

subsequent protégés have not been shy

about protecting their interests in both

Rosneft and other domestic firms.

As a “supermajor”, or one of the world’s

six largest public owned oil and gas

companies, BP is also accustomed to

governmental intervention. In 2008,

AAR leaders forced a power play by

spreading allegations that TNK-BP

British executives had violated Russian

visa laws. The threat of litigation led to

the removal of BP-backed CEO Bob

Dudley, an American national who

was subsequently replaced by Mikhail

Fridman, the president of AAR. Since

the Russian courts were favoring AAR’s

claims, and 25% of BP’s revenue

originates from its Russian venture, the

British chose to acquiesce to AAR to

avoid losing part of their investment.

BP was once again impeded by the

Russians in 2011 amidst the planning

of a joint venture with Rosneft for the

development of oil fields in the Arctic

shelf. In addition to expanding into

new sources, the two firms had hoped

to test cold-weather drilling technologies

Although BP is relinquishing its stake in TNK-BP, the British oil giant views the planned sale as an opportunity to secure a much stronger foothold in the rich Russian oil sector.

THE PRINCETON FINANCIER | 9

THE PRINCETON FINANCIER | 10

agreed to ship up to 67 million tons of oil

over five years. As the deal nears completion,

Rosneft has since borrowed another $6

billion from Gazprombank.

After the deal, Rosneft will become the

world’s largest energy company in terms

of liquid hydrocarbon extraction and

the third largest by estimated net profit

($21.46 billion). This deal will enable

Rosneft to extract half as much oil as

that of Saudi Arabia. The merger will

also initiate a powerful alliance between

Rosneft and BP and most notably, mark

the end of TNK-BP, Russia’s third largest

oil supplier that while profitable, was often

harmed by boardroom disagreements.

Rosneft’s acquisition of TNK-BP has

garnered widespread approval since

the deal was announced. Former

Russian President Vladimir Putin has

demonstrated strong support for the

merger, since it will make Rosneft’s Chief

Executive Officer, Igor Sechin, one of

Russia’s most powerful individuals, thus

increasing Rosneft’s and therefore, the

Russian government’s power. According

to Putin, “this is a good, large deal that is

necessary not only for the Russian energy

sector but also the entire economy.” In

early March, the European Union also

approved the merger, though according to

the EU anti-trust authority, “the merged

entity would continue to face constraints

from a number of strong competitors.”

Although BP is relinquishing its stake in

TNK-BP, the British oil giant views the

planned sale as an opportunity to secure

a much stronger foothold in the rich

developed exclusively for the Russian

Arctic. However, this undertaking was

blocked in Russian courts by AAR due

to claims that the partnership would

violate previous exclusivity contracts that

were signed during the creation of TNK-

BP. The case languished in court until

ExxonMobil offered Rosneft a cut in its

Texas and Gulf operations in exchange

for BP’s spot in the partnership. This

proposition was accepted because it

was favorable to both firms. The Exxon-

Rosneft deal was ultimately worth $3.2 billion

and is thus seen by many as a huge loss for BP.

The Deal

In 2012 Rosneft announced its plans to

acquire TNK-BP in a deal that could

quite possibly make Rosneft the largest

publicly traded energy company in the

world. The deal is worth $61 billion and

requires Rosneft to pay BP $17 billion in

cash and provide12.84% of its own shares

in return for the British’s 50% stake in

TNK-BP. As part of the deal, Rosneft

will assume control of AAR’s share as well

in what will become the largest global

M&A transaction in the past three years

and the largest oil deal in the past decade.

In addition, BP will gain two seats on

Rosneft’s Board of Directors.

In order to finance the deal, Rosneft has been

massively borrowing from multiple lenders.

Since December 2012, Rosneft has borrowed

more than $30 billion from multiple banks

across countries including the U.S. and

China. Rosneft also secured $10 billion in

advance payments from commodity trading

companies Vitol and Glencore and in return,

Russian oil sector. The British stand to

gain a significant stake in Rosneft which

will become one of the largest oil firms in

the world at the conclusion of the merger.

The move also allows BP to protect

its financial interests in the area while

removing it from direct involvement,

which should lessen Russian political

interference. Yet the underlying question

is which firm got the better end of the

bargain: BP or Rosneft?

Winners and Losers

BP looks to gain the most from this deal,

since it will likely catalyze the end of

its difficult marriage to AAR. The four

oligarchs of AAR who collectively own

the other half of TNK-BP (Len Blavatnik,

Mikhail Fridman, German Khan, and

Viktor Vekselberg) have had historically

testy relations with BP. An argument

between AAR and the CEO Bob

Dudley concerning the relative merits

of dividend payments versus retention

of earnings led to Dudley’s removal in

2008. During this time, Dudley claimed

to be under “constant harassment”

from both his business partners and the

Russian government. Furthermore, AAR

was responsible for blocking the previous

$7.8 billion Arctic development deal

between BP and Rosneft which led to

BP’s rival ExxonMobil cashing in on the

opportunity and further souring relations

between BP and AAR.

This deal will dissolve the toxic

relationship between BP and AAR while

also smoothing relations with the Russian

government. Thus this deal seems to

secure BP’s future in the oil-rich nation.

In past years, Russian authorities have

raided BP’s offices in Moscow, and at

one point even sought to detain Dudley,

who was the CEO of BP at the time.

With BP’s 10% stake in Rosneft, the deal

provides an alliance with Russia’s state-

owned oil giant and opens a gateway to

Russia’s immense oil riches.

However, there are reasons to be skeptical

of BP’s future in Russia. Combined with

Rosneft’s continual underperformance,

the power struggle in the Kremlin only

adds increasing amounts of uncertainty to

Historically, state-run behemoths

not only are they prone to develop excessive internal bureaucracy, they are also susceptible to external political

THE PRINCETON FINANCIER | 11

the potential benefits of the deal. A 10%

stake is not insignificant in a venture filled

with uncertainties. Obviously, supporters

of the deal argue that BP will bring better

management and expertise to Rosneft

and revive the Russian oil giant. But that

logic is built upon an uncertainty. In

fact, many BP shareholders would rather

walk away from the TNK-BP venture

after many profitable years with a cash

settlement. However, a cash-only deal is

not being offered by Rosneft.

The lesson of the day is that there is no

free lunch. BP’s alliance with Rosneft,

though full of promises, is also full of

uncertainties and risks.

That being said, Rosneft’s gains are

accompanied by fewer downsides. After the

deal, Rosneft will become the world’s largest

listed oil producer, with 4.5 million barrels of

oil production per day, which is equivalent

to 45% of Russia’s oil output. Rosneft will

most likely not dominate the oil industry

to the degree that Gazprom dominates

the gas industry, but the deal will create a

comfortable margin between Rosneft and its

closest rivals, Lukoil and Surgutneftegaz.

On the other hand, the AAR oligarchs

seem to be in the sole losers of this deal.

They stand to lose their very profitable

alliance with TNK-BP, and even worse,

Rosneft has held the upper hand in

negotiations since the beginning, since

Rosneft already had a firm agreement

with BP to buy its half of the company.

Therefore, if the oligarchs had decided

to end the negotiation because they did

not approve of the terms, they would

find themselves in a 50-50 partnership

with Rosneft, and thus the Russian

government as well. The oligarchs will do

everything to avoid this situation as the

government would undoubtedly move to

remove whoever controls the other half.

Even though the deal helps Putin in

achieving his goal of state dominance

in key sectors, it does not necessarily

guarantee Russia’s success in the long run.

In the short term, the deal helps Russia

improve its image as a foreign investment

destination by ending BP’s troublesome

relationship with AAR, but in the long

term, inefficiency and capital flights could

present enormous difficulties for Russia.

Historically, state-run behemoths are

doomed to inefficiency because not only

are they prone to develop excessive internal

bureaucracy, they are also susceptible to

external political influence. Capital flight is

also another potential byproduct of state-

run behemoths. Net capital outflows from

Russia have been continually increasing

and reached $80 billion in 2011. The re-

emergence of state-run behemoths might

serve to further aggravate the problem.

Whether BP, with its newfound access to

the promised land of Arctic riches, and

Rosneft, with its fresh dominance in the

Russian oil industry, can be successful in

the future remains to be seen. Thus the

BP-Rosneft “deal of the century,” as one

of the biggest mergers in history and the

largest oil deal since the Exxon-Mobil

merger, might just prove to be more than

hype and could permanently change the

landscape of the oil industry.

THE PRINCETON FINANCIER | 12

By 2006 the United States had built an

intricate financial house of cards—a

concoction of great complexity,

but also of great fragility. Like

most houses of cards, this one was

constructed slowly and painstakingly.

The sheer ingenuity was impressive.

But when it fell, it tumbled suddenly

and chaotically. All that was necessary

to trigger the collapse was the removal

of one of its main supporting props.

The jig was up when house prices

ended their long ascent; after that,

the rest of the crumbling followed

logically. Unfortunately, not many

people had penetrated the tortured logic

beforehand; so few were prepared for

the devastation that ensued.

The end of the house-price bubble itself could

hardly have come as a surprise. By 2006 the

“is there a bubble” debate was just about

over, and seemingly everyone was wondering

how much longer the levitation act could

last. The disagreement—and it was a serious

one—was over how far house prices would

fall. Optimists thought prices would just

level off, ending their unsustainable climb,

Alan S. Blinder is the Gordon S. Rentschler memorial professor of economics and public affairs at Princeton University, vice chairman of the Promontory

Interfinancial Network, and a regular columnist for The Wall Street Journal. Dr. Blinder earned his A.B. from Princeton University, his M.Sc. from the London

School of Economics, and his Ph.D. from the Massachusetts Institute of Technology—all in economics. He has taught at Princeton since 1971, and was founder

of the university’s Center for Economic Policy Studies, where he served alternately as director and co-director from 1989 to 2011. He also served as vice chair-

man of the board of governors of the Federal Reserve System from June 1994 to January 1996. Before that, he served as a member of President Clinton's original

Council of Economic Advisers, from January 1993 to June 1994. He served as economic advisor to the Democratic presidential candidates in 2000 and 2004,

and he continues to advise numerous members of Congress and elected officials. He also served briefly as deputy assistant director of the Congressional Budget

Office when that agency was founded in 1975, and testifies frequently before Congress on a wide variety of public policy issues. Dr. Blinder is the author or co-

author of 20 books, including the textbook Economics: Principles and Policy (with William J. Baumol), now in its 12th edition, from which well over two and a

half million college students have learned introductory economics. His latest book, After the Music Stopped: The Financial Crisis, the Response, and the Work

Ahead, was published in January 2013 (Penguin Press). He is based in Princeton, NJ.

WHEN THE MUSIC STOPPED:

AFTER THE MUSIC STOPPED

By Alan Blinder

AN EXCERPT FROM

[ ](REPRINTED BY PERMISSION OF THE AUTHOR AND THE PENGUIN PRESS)

The real wake-up call didn’t come until

August 9, 2007, when BNP Paribas, a huge

French bank, halted withdrawals on three

of its subprime mortgage funds—citing as

its reason that “the complete evaporation

of liquidity in certain market segments of

the US securitization market has made it

impossible to value certain assets fairly.”

Loose translation: Dear Customer, you

can’t get access to the money you thought

was yours, and we have no idea how much

money that is. To people acquainted with

American history, Paribas’ announcement

brought to mind the periodic “suspensions

of specie payments” in the nineteenth

century—times when some prominent

bank precipitated bank runs by refusing to

exchange its notes for gold or silver. The big

French bank had just refused to exchange

its fund shares for cash. Whether you were

French or American, the signal was clear:

It was time to panic. And markets dutifully

did so, all over the world.

At some point, and in this case it didn’t

take long, the interplay of falling asset

values with high leverage starts calling

into question the solvency of heavily

exposed financial firms like Bear and

Paribas. Thus, market-price risk, which is

already acute and getting worse, conjures

up visions of counterparty risk: worries

that firms that owe you money might not

be able to pay up.

Once such seeds of doubt are sown,

the scramble for liquidity begins in

earnest, because, like it or not, markets

are fundamentally built on trust— in

particular, on trust that the other guy will

pay what he owes you in full and on time.

In worst cases, markets seize up. In less

severe cases, enormous “flights to quality”

are triggered, typically to U.S. Treasury

bills. In any case, the bond bubble, which

was predicated on blissfully ignoring risk,

ended with a bang on August 9, 2007.

Fear was taking over.

At the Fed’s Annual Watering Hole

In late August of each year, most members

of the Federal Open Market Committee

(FOMC) doff their gray suits, don their

cowboy boots (if they own any), and

head off to Jackson Hole, Wyoming.

There they meet with a select group of

anticipated this virtually unprecedented

collapse. (True confession: I was not one

of them.) For decades, Americans had

witnessed periodic housing bubbles, which

blew up and popped in particular parts of

the country. But when home prices fell in,

say, Boston, they kept rising in, say, Los

Angeles—and vice versa. The period after

2006 was different. House prices fell all

over the map, undermining the trumpeted

gains from geographical diversification.

That was a forgivable error. The proverbial

hundred-year flood actually happened.

But when the housing market began to

crater, we also learned that many of the

MBS were not nearly as well diversified

geographically as had been claimed. In

fact, it turned out that a distressingly

large share of the bad mortgages came

from a single state: California. Many

of the rest came from Florida, Arizona,

and Nevada—collectively known as

the “sand states.” For these and other

reasons, the MBS turned out to be much

riskier than advertised.

Second, the securities were not as widely

distributed as had been thought. Yes, there

were holders all over the world—from

hamlets in Norway to Italian pension

funds to billionaires in Singapore. But

when the crash came, we learned that

many leading financial institutions had

apparently found mortgage-related assets

so attractive that they still owned large

concentrations of them when the bottom

fell out. One reason was that there was so

much profit in selling the other tranches

of MBS, CDOs, and the like that

investment banks were willing to hold

the lowest-rated (“toxic waste”) tranches

themselves. The failures and near failures

of such venerable firms as Bear Stearns,

Lehman Brothers, Merrill Lynch,

Wachovia, Citigroup, Bank of America,

and others were all traceable, directly or

indirectly, to excessive concentrations of

mortgage-related risks.

The system began to crack in July 2007, when

Bear Stearns told investors in one of its mortgage-

related funds that there was “effectively no value

left.” The music was stopping. A variety of

financial markets started twitching nervously,

which should have been taken as an omen. But

wishful thinking dies hard.

or perhaps decline only a little. Pessimists

were talking about price declines of

20 percent, 30 percent, or even more.

What about the market? Futures traded

on the Chicago Mercantile Exchange

on September 16, 2006 indicated that

investors expected a 6.4 percent decline

in the Case-Shiller ten-city composite

index. That proved to be way too small.

In the end, the more pessimistic you

were, the more prescient you were.

The Cards Tumble

The bond bubble was far less visible to

most people, vastly more complicated,

and appreciated by few. It also burst

with devastating effect. But the

bursting came in stages.

Once house prices stopped rising,

subprime mortgages that had been

designed to default started doing

precisely that. At first, many of us wrongly

believed that subprime constituted too

small a corner of the financial market

to do much damage to the overall

economy. We soon learned better. To

pick two nonrandom examples, Treasury

Secretary Hank Paulson said in an April

2007 speech that the subprime mortgage

problems were “largely contained.” A

month later, Federal Reserve Chairman

Ben Bernanke told a Fed conference that

“we do not expect significant spillovers

from the subprime market to the rest of

the economy or to the financial system.”

Unfortunately, the huge amounts

of leverage multiplied the damages

many-fold, and the untoward degree

of complexity helped spread the ruin

far and wide. Financial industry

executives—allegedly the smartest guys

in the room—had every incentive to

keep the party going for as long as they

could, and they certainly tried. The

regulators, still asleep at their various

posts, allowed them to go on for far too

long. The day of reckoning was delayed

but not avoided. Why did the house of

cards tumble so hard and so fast?

First, when the national housing

bubble burst, home prices fell almost

everywhere—an “impossible” event

that had not occurred since the Great

Depression. In fairness, few observers

THE PRINCETON FINANCIER | 13

unlimited amounts—is the central bank.

Both the Federal Reserve and the European

Central Bank (ECB) did so massively,

starting on Paribas Day, August 9, 2007. In

so doing, they were performing a function

that central banks have performed for

centuries: serving as the “lender of last

resort” in order to get their financial systems

through liquidity crises. The volume of new

dollars and new euros spewing forth from

the world’s two largest central banks was

unprecedented. But the actions themselves

were time-tested and routine, part of every

central banker’s DNA.

Back in 1873, Walter Bagehot, the

sage of central banking, had instructed

central banks on what to do in a liquidity

crisis. His triad was lend freely, against

good collateral, but at a penalty rate.

Why? Because the acute shortage of

liquidity in a panic can push even solvent

institutions over the edge. Customers

come in demanding their money. If the

banks don’t have enough cash on hand,

word gets around, and bank runs start

sprouting up everywhere. The disease is

highly contagious.

By serving as the lender of last resort,

the central bank is supposed to stop all

that from happening. And every central

banker in the world knew Bagehot’s

catechism. So that’s basically what most

of them did in August 2007. In fact,

one can argue that the ECB stuck with

the Bagehot script until late 2011. The

ECB refused to cut its interest rates

until October 2008 (yes, that’s 2008,

not 2007), and even then it gave ground

grudgingly. The 4 percent European

overnight rate that prevailed in August

2007 did not fall to 3.25 percent until

November 2008 and did not get as low

as 2 percent until January 2009. By

contrast, the Fed had virtually hit zero by

December 2008.

Was this mess nothing more than

a big liquidity event, as the ECB’s

actions suggested? Perhaps not. An

alternative, and darker, view of the crisis

conceptualized what was happening as

a serious impairment of the economy’s

normal credit-granting mechanisms. On

this broader view, the scarcity of liquidity

that “the downside risks to growth have

increased.” That was a healthy step; they

demoted inflation from its singular status

as the predominant risk. But the FOMC

still refused to cut the funds rate. (It did

reduce the less-important discount rate.)

Looking back, it’s hard to see how this

could have been a close call on August

16, and many Fed critics said so at the

time. But thirteen days later, as FOMC

members from Washington and around

the country boarded planes to head to the

beautiful Grand Tetons, the funds rate

was still stuck at 5.25 percent.

We learned later that Bernanke took the

opportunity to cloister away several FOMC

members in a small upstairs conference

room to figure out what to do next—as their

initial efforts were clearly inadequate. There

must have been many other interesting

sidebar conversations. But still, rates weren’t

touched until the FOMC’s next regularly

scheduled meeting, which was on September

18—a full forty days after Paribas Day. Yes, a

lot of rain can fall in forty days and nights—

and it did. The Fed cut the funds rate by

50 basis points on September 18, observing

that “the tightening of credit conditions

has the potential to intensify the housing

correction and to restrain economic growth

more generally.”

That last thought was important. Before

the cataclysmic failure of Lehman Brothers

a year later, there were two competing

views of what the crisis was all about. In

the narrower, technical view, the financial

world was experiencing a liquidity crisis—

an acute one, to be sure, but still a liquidity

crisis. In plain English, that meant that

frightened investors and institutions wanted

to get their hands on more cash than was

available—partly because of the heightened

counterparty risk just mentioned, partly

because assets formerly deemed safe now

looked risky, and partly because banks and

investment funds feared that their customers

might show up at the electronic door one

day, seeking to make hefty withdrawals. The

Paribas approach—just say no—was not an

appealing way to cope with such a problem.

The dash for cash was on. The one

institution in any country that can provide

more cash in a hurry—in principle, in

academic economists and a highly select

group of bankers and Wall Streeters, for an

invitation to the Jackson Hole conference

is the hottest ticket in Lower Manhattan.

While plenty of time is set aside for hiking

and whitewater rafting, the dominant

activity at Jackson Hole is shoptalk. It was

in great abundance in August 2007.

The annual conclave, which is the Fed’s

premier event, is hosted by the Federal

Reserve Bank of Kansas City, and its

conference planners hit the jackpot

in selecting the topic for the 2007

edition: “Housing, Housing Finance,

and Monetary Policy.” When the group

convened on the evening of August 30,

housing was going to the dogs, housing

finance was cratering, and a monetary

policy response to all this was growing

increasingly urgent. Few people wanted

to talk about the weather—which, as

usual, was gorgeous.

Too bad the conference didn’t take place

four weeks earlier. At its August 7, 2007,

meeting, the FOMC had concluded

that “although the downside risks

to growth have increased somewhat,

the Committee’s predominant policy

concern remains the risk that inflation

will fail to moderate as expected.”

How’s that again?, many of us thought

when we read the statement. The

predominant concern is inflation?

Many Fed watchers blinked in disbelief.

What were those guys thinking?

Two days later in Paris, the financial

world started coming apart at the seams.

The next day, the FOMC held a hurriedly

arranged telephonic meeting. This time

their statement assured the financial world

that the Fed was “providing liquidity

to facilitate the orderly functioning of

financial markets.” (Translation: We are

pumping out cash like mad.) But the

federal funds rate was kept right where

it had been since June 2006, at 5.25

percent. Was the Fed still seeing inflation

as the “predominant policy concern”?

Okay, give them a break. Only three days

had passed since their August 7 meeting.

The Fed would fix things soon. Right?

Wrong. The committee met telephonically

again six days later, noting correctly

THE PRINCETON FINANCIER | 14

but the committee was not yet ready

to cut interest rates. Undaunted,

Bernanke got them all on the phone

again on January 21. The minutes

of that call observed that “incoming

information since the conference call

on January 9 had reinforced the view

that the outlook for economic activity

was weakening.” Only twelve days had

elapsed between the two calls. How

much could have changed?

What had changed was that the FOMC

was now ready to act—dramatically.

With just one dissenter, the members

agreed to announce an almost-

unprecedented 75-basis-point cut in

the federal funds rate early the next

morning. In the entire eighteen and a

half years of the Greenspan Fed, the

FOMC had moved the funds rate by

75 basis points only once—and that

was an increase. Furthermore, federal

funds rate announcements always come

at exactly 2:15 p.m. This one came at

8:30 a.m. The Fed clearly wanted to be

heard on January 22—and it was. Eight

days later, at its regularly scheduled

meeting, and again with one dissenter,

the FOMC dropped the funds rate

another 50 basis points, down to 3

percent, leaving federal funds trading

125 basis points lower than they were

only nine days previously. The Fed was

on DEFCON 1.

The FOMC majority now clearly saw

the task ahead of them as a two-front

war, and it was gearing up for battle on

both fronts. It needed to provide massive

amounts of liquidity, for well-known

reasons that Bagehot had articulated

135 years earlier. But it also needed to

cut interest rates to fight an imminent

recession, as Keynes had prescribed 72

years earlier. Chairman Bernanke did not

want to preside over another episode like

the 1930s. In Europe, however, overnight

rates were going nowhere. The ECB was

fighting the shortage of liquidity hard,

maybe even harder than the Fed. But it

was far from convinced that recession was

in its future. At the ECB’s headquarters

in Frankfurt, there was lots of Bagehot

but not much Keynes.

step that it repeated at its next regular

meeting on December 11. A number

of FOMC members were less than

convinced of the need for easier money.

After that, however, the Fed seemed

to step it up a notch. The next day it

announced two new liquidity-providing

facilities. The first was a series of currency

swap lines with foreign central banks,

which were finding themselves seriously

short of dollars. In a currency swap,

the Fed, say, lends dollars to the ECB

in return for euros. When the dollar

liquidity crisis in Europe passes, the ECB

pays back the dollars and gets back the

euros. The initial announcement was for

just $24 billion, which was considered

sizable at the time. But the swap lines

eventually topped out at a whopping

$583 billion in December 2008.

The second facility was the Term Auction

Facility (TAF), designed to do Bagehot-

type lending to banks, though for periods

longer than normal—up to four weeks.

The Fed’s earlier attempts to lend to

banks had been stymied by bankers’

fears of being stigmatized by asking the

central bank for a loan. Didn’t that mean

you were on the ropes? The TAF sought

to overcome the stigma problem in two

ways: It was set up as an auction in which

any bank could show up to bid; the bank

didn’t need to be in bad shape. And since

the bank wouldn’t receive the cash for a

few days, a TAF loan would not save a

bank that was on the brink of disaster.

TAF was important—at its peak in

March 2009, it was lending $493 billion.

It was shut down in March 2010--no

longer needed.

But the Fed was just warming up.

Over the Christmas–New Year

holidays, Bernanke must have got to

thinking—or to having nightmares—

about the 1930s. On January 9, 2008,

he convened an FOMC conference

call—ostensibly to review recent

developments but perhaps actually to

shake the committee out of its lethargy.

The minutes of that meeting noted

that “the downside risks to growth had

increased significantly since the time

of the December FOMC meeting,”

was just the tip of the iceberg. The real

problems lurked down the road—in

gigantic losses of wealth; in massive

deleveraging and possible insolvencies of

major institutions; and, as just mentioned,

in severe damage to the banking system,

the shadow banking system, and other

credit-granting mechanisms. If all that

happened—and in August 2007, it hadn’t

happened yet—the whole economy

would be in big trouble. Economies that

are starved of credit fall into recessions,

or worse. Businesses decline and fail.

Workers lose their jobs.

The Fed Springs into Action

Well, maybe not exactly “springs.”

Bernanke, who was a noted scholar of the

Great Depression, was slowly bringing

his rather hawkish committee around to

the view that this was something big—

not just a major liquidity event, but

potentially the cause for a big recession.

But old habits die hard, and while the

Fed was way ahead of the ECB, it was

not quite there yet. At its September 18

meeting, the FOMC qualified its view

that “the tightening of credit conditions

has the potential to . . . restrain economic

growth” by adding that “some inflation

risks remain.” It was a finely balanced

assessment of risks—far too balanced,

given the emerging realities. Just five

days earlier, the Bank of England had

intervened massively to save Northern

Rock, a huge savings institution, from

the first bank run in Britain since 1866.

Things were coming unglued in England.

Our problems here were strikingly

similar. Could we be far behind?

While the Fed’s speed made the ECB

look like the proverbial tortoise

watching the hare, this particular hare

wasn’t actually running that fast. After

its 50-basis-point rate cut on September

18, 2007, the Fed waited another

six weeks—until its next regularly

scheduled meeting—to move again.

By that time, many mortgage-lending

companies had failed, and Citigroup

and others had announced major write-

downs on subprime mortgages. But the

Fed chipped in with only another 25

basis points on October 31—a baby

THE PRINCETON FINANCIER | 15

The concept of “the office,” aside from

conjuring up images of Steve Carell, of-

ten makes Americans think of cubicles,

sticky notes, 9-to-5 hours, a steady yet

modest salary, and most of all, safety

and security for their families. Today,

however, “the office” is changing—in-

deed, empirical evidence suggests that

for more and more Americans, home

and office are one and the same. Many

individuals today freelance, take on con-

tract positions, and/or work from home,

options which used to inspire a fear of

insecurity due to the lack of a consistent

paycheck and ancillary benefits. Work

is not only changing in physical space,

but also in expectations, responsibili-

ties, and the replacement of the concept

of an employee with that of what I will

call a “Value creator.” Given the state of

the macroeconomy and the political in-

transience in Washington, Americans are

beginning to solve this country’s finan-

cial crisis themselves through the often

lauded American ingenuity; through

innovation and with incredible determi-

nation, Americans are beginning to re-

inforce the nation’s future through small

business creation, intrapreneurship, and

community development efforts that are

not dependent on the government. In-

deed, the individual accomplishments

of intrepid entre- and intrapreneurs are

permitting us to envision a solution to

the funding crisis in Social Security and

Medicare: economic growth.

First, let’s take a historical look at tradi-

tional employment in the United States.

Beginning in the years after World War

II, after obtaining a college degree, many

new graduates secured their first job and

established a long-duration (often de-

cades) career within that firm. Loyalty

and commitment were the prerequisites

for advancement within a company even

for relatively inefficient workers who

might only create dubious value. We

see the costs of such a system in the 20+

year economic morass in Japan which

continues to preserve such an employ-

ment structure. Recently, the realities of

work in America have changed dramati-

cally. According to recent data from The

Bureau for Labor Statistics, the median

Shawn P. O’Connor is an honors graduate from Harvard Law School and Harvard Business School, where he was recognized as a Baker, Ford, and

Thayer Scholar for his academic accomplishments. Mr. O’Connor is a summa cum laude, Phi Beta Kappa graduate of Georgetown University’s School

of Foreign Service where he was valedictorian. Mr. O’Connor currently serves as the Founder and CEO of Stratus Prep (a global test preparation and

admissions counseling firm), Stratus Careers (a career counseling and corporate training organization), The Stratus Foundation (an educational

non-profit) and The Startup Stand (an entrepreneurship non-profit). He has published more than 50 articles in publications such as Fortune and The

Financial Times and is a weekly contributor to Forbes and US News and World Report. [ ]

THE PRINCETON FINANCIER | 16

number of years that workers have been

with their current employers is just 4.6

(“Employee Tenure Summary, 2012”).

Employees are always seeking new oppor-

tunities, facilitated by LinkedIn and on-

line job sites, like Monster and The Lad-

ders, which have significantly reduced the

investment required to seek out a new

position and enhanced the efficiency of

recruiters. However, in this more trans-

parent employment environment, work-

ers must differentiate themselves through

their demonstrated value creation.

According to Seth Godin’s “The Last

Days of Cubicle Life” in Time, “The job

of the future will have very little to do

with processing words or numbers (the

Internet can do that now). Nor will we

need many people to act as placeholders,

errand runners or receptionists. Instead,

there’s going to be a huge focus on find-

ing the essential people and outsourcing

the rest” (Godin, 2009). In other words,

especially for relatively low-skilled office

workers, it will no longer be enough to

show up at the office and meet expecta-

tions; the successful employees of tomor-

row will be creative problem solvers with

differentiated skill sets, innovative ideas,

and a commitment to “getting the job

done.” In other words, they will need

to be entrepreneurs (or at least intrapre-

neurs, the term given to those who per-

form as entrepreneurs within a broader

corporate context). The need for workers

to be entrepreneurial has been increasing

for at least the last decade and thereby

changing “the office” as we and our par-

ents and grandparents once knew it.

Entrepreneurs, rather than financiers, are

now revered by society. But the major-

ity of entrepreneurs look very little like

Mark Zuckerberg. Many are not twen-

ty-something technologists but middle-

aged Americans starting a small business

after losing their job at a large corpora-

tion and being unable to find similar

work as companies demand more from

current employees and contractors rather

than hiring new permanent employees,

as exemplified by the rising productiv-

ity levels but the still relatively anemic

economic picture. To support this the-

sis, Godin postulates that in the future,

“Work will mean managing a tribe, creat-

ing a movement and operating in teams to

change the world. Anything less is going

to be outsourced to someone a lot cheaper

and a lot less privileged than you or me”

(Godin, 2009). There will be a lot less

“busy work” in small and large companies

alike, requiring all workers to be entrepre-

neurial and innovative if they hope to sur-

vive in relatively well-paid positions in the

developed world.

Such entrepreneurship is critical to the

success of the United States and other

developed economies. The United States

has a long history of government support

for entrepreneurship, perhaps most evi-

dent in its bankruptcy laws, some of the

world’s most forgiving. Furthermore, in

1953 with the passage of the Small Busi-

ness Act, the Small Business Administra-

tion (SBA) was established to promote

the growth of small ventures, particularly

those founded by minorities and other

traditionally disadvantaged populations,

by helping such companies secure loans

and develop management skills. The gov-

ernment recognized the importance of

small business to economic growth, and

therefore set policies to incentivize entre-

preneurs to turn their ideas into lucra-

tive business. Later, during the last pro-

longed period of economic malaise, the

Small Business Economic Policy of 1979

was enacted, which required Congress to

“establish a national policy to implement

and coordinate the policies, programs,

and activities of all Federal departments,

agencies, and instrumentalities in order to

provide an economic climate conducive

to the development, growth, and expan-

sion of small and medium-sized business”

(Clark & Saade, 2010). While given to-

day’s fiscal realities, the next generation

of entrepreneurs cannot count on the

government for similar support, they are

again leading the nation’s recovery and

collectively, if unintentionally, suggesting

a growth path out of our economic woes.

Data from the SBA strongly supports

my hypothesis regarding the impact of

small businesses on the U.S. economy.

According to the SBA, “Small businesses

currently represent 98 percent of all busi-

nesses in the United States and they gen-

erate nearly 64 percent of all net new jobs

in this country” (Clark & Saade, 2010).

Because of the power of small businesses

and the continued economic stagnation

and political paralysis in Washington,

Americans do, can, and indeed must,

continue striking out on their own not

only to ensure their own economic future

but also that of the nation.

Americans clearly have the power and

determination to address our vast fis-

cal challenges through the free mar-

ket. When I observe debates between

our two major political parties’ budget

proposals, I am distressed by the lack

of a long-term, sustainable method

to controlling our country’s national

debt and funding Social Security and

Medicare. But because of the fun-

damental shifts in the definition of

“work” outlined above and the dem-

onstrated power of entrepreneurship

as a driver of economic development, I

am confident that growing out of this

crisis through ingenuity is not only

possible, but likely.

THE PRINCETON FINANCIER | 17

Because of the power of small businesses and the continued economic stagnation and political paralysis in Washington, Americans do, can, and indeed must, continue striking out on their own not only to ensure their own economic future but also that of the nation.

Considering Law, Business, or Graduate School?Discover Your True Potential With

Our Industry Leading Instructors and Counselors Offer:

LSAT Prep Law School Admissions Counseling Law School Bootcamp GMAT Prep

Find us on

Call us today at 212-307-1788 or email consult@stratusprep.com to schedule a free consultationAll trademarks referenced herein are the property of their respective owners. No association between Stratus Prep and any trademark holder is expressed or implied. No endoresement of Stratus Prep or our services is expressed or implied by the mention of such trademarks.

Stratus Prep experts are regularly featured in the following publications:

Stratus Prep has unprecedented success rates at all top schools including:

MBA Admissions Counseling GRE Prep Graduate School Admissions Counseling

While publications as varied as The

Economist and GQ have called Fort

McMurray, Alberta (a small town

brimming with oil rents) a tough

epicenter with the potential to change the

global geopolitical map, it has yet to do

so. The Canadian federal government has

made numerous poor decisions, leaving

its energy policy in disarray. Observers

both in and out of Canada are watching

anxiously as energy markets take

shape with no clear signaling from the

Canadian government. The investment

climate in the Canadian natural resource

sector remains uncertain.

The generous endowment of natural

resources and relatively relaxed

controls on foreign investment have

historically made Canadian oil sands a

generally sound investment choice. A

diversified economy that weathered the

economic crisis relatively well allows

Canada to open its doors to foreign

investment without public outcries

of “neocolonialism” or fear of losing

national sovereignty. With Venezuela

and Saudi Arabia (the two countries

with the largest quantity of known

oil reserves) closely protecting their

national treasures through state-owned

enterprises, the oil reserves available

for private ownership in Canada are

the largest in the world. Remarkably,

they represent a massive 50% of global

market share. This opportunity has been

left available for foreign investment in

part because Canada recognizes that

its domestic capital is insufficient to

further catalyze development of its

export-led economy. The opportunity

that investment into Canada presents

to the world is clear: a stable political

economy with relatively free access

to foreign investors, but recent

developments have put this favorable

investment position into question.

Canada suffers severe price differentials

between its own crude and its global

counterparts. For Canadians, this practice

seems unjust, especially since Canada, in

contrast to the Middle East, represents

the United States’ most secure energy

supplier, so political stability in Canada

should represent a premium not a discount.

Although this idea lacks common economic

sense, the wedge between West Texas

Intermediate (WTI) and Western Canada

Select (WCS) prices of crude oil, which is

as large as $20 a barrel, is starting to spook

investors. Oil extraction from sand is costly,

and even slight price differentials are more

than enough to turn investments sour

and undermine Canada’s terms of trade.

As the Royal Bank of Canada pointed

out in a recent report, unfavorable terms

of trade “would ultimately first manifest

themselves in the form of reduced business

investment.” This loss affects the average

Canadian. Current losses in real domestic

income are valued at about $1,200 per

Canadian per year. Although the Canadian

economy is outwardly oriented, its

inaccessibility to the global market only

worsens price differentials. Rectifying

these price differentials is the first step

in improving market efficiency and the

investment climate.

The pipelines solution to market access

has also been the focus of intense

controversy. Although the price

differentials are in part due to difference

in quality, a surplus in supply is the

main culprit. Pipelines would bridge the

distance between high global demand

and high Canadian supply. Americans are

familiar with Keystone XL, which would

transport Canadian crude to American

buyers and export the remainder along

THE PRINCETON FINANCIER | 19

This development might at least be imagined to offer some certainty to the investment climate, but that view seems too charitable. The Canadian government is without a clear strategy.

the Texan coast. The proposal, while well

publicized, was rejected for the time being

on environmental grounds. However, oil

is fungible and its high demand tends

to overcome supply interventions. Tar

sand oil continues to travel south by

tanker and train. Unfortunately for

environmentalists, this is even more

carbon-costly than building Keystone.

Unfortunately for investors, the price

differential remains.

The rejection of Keystone sparked a

reactionary turn by Prime Minister

Harper towards Asia. Since the Enbridge

Northern Gateway pipeline set to export

oil to Asia through ports in Vancouver

already in the works, he established a

plan for diversification. Harper has

felt emboldened to softly push against

Canada’s given position as unequivocally

aligned with the U.S. As expected, this

option predicates entirely on China’s

eagerness to invest in Canada.

With the Trans-Pacific Partnership coming

into the foreground, Harper could be seen as a

chief strategist leveraging himself between the

United States and China. This development

might at least be imagined to offer some

certainty to the investment climate, but that

view seems too charitable. The Canadian

government is without a clear strategy.

Lobbying in China by the Canadian

government for closer economic ties after

the Keystone rejection was eventually

reciprocated by an equally aggressive

bid by CNOOC (China National

Offshore Oil Company) for Nexen, a

major Canadian oil and gas company.

Investment Canada, the governmental

body tasked with regulating large foreign

investment into Canada, has very flexible

criteria for making its decisions. It is

generally believed in Canada that politics

fill in the gaps and so the decision was

somewhat influenced by the federal

government. With CNOOC providing

the necessary capital, it was difficult for

Harper to reject a deal for which he had so

earnestly supported, but the acquisition of

Nexen would surrender Canada’s control

of some of its most important assets. To

much public surprise and dissent, the

government approved the deal and Nexen

was acquired for $15.1 billion. Canadian

commenters have argued that Investment

Canada should have rejected the deal

and opted for a joint venture agreement

instead. Canada did not outright reject

the CNOOC bid as a “national security

threat” like U.S. bureaucrats did when

CNOOC bid for Unocal for $18.5

billion, but Harper cautioned publically

that any forthcoming investment would

not enjoy such favorable treatment. A

bid by Petronas, Malaysia’s state energy

company, faced unexpected resistance

from Investment Canada. Nothing

undermines investor confidence like

unsystematic application of government

intervention, and Harper has given

no clear signals to potential investors

or concerned Canadians about how

Canada’s investment policy is shaping up.

Harper has faced even more drama over

the recent renegotiation of Canada’s

FIPA, or Foreign Investment Promotion

and Protection Agreement, with China.

Although FIPAs are common-place, few

are negotiated in private in Vladivostok,

ratified with minimal parliamentary

debate, and made legally binding for

decades to come. The rash turn, which

would grant Chinese companies the right

to sue the Canadian government in private

international courts for protectionism,

has provoked public outcry. To Canadian

observers, it appears that Harper turned

to China after being slighted by Obama

over Keystone, but he discovered that this

direction was unpalatable to the Canadian

public. In the long run, reacting, and

not leading, will not serve Canada, its

investors, or Harper well.

If Harper is simply responding to

events rather than driving them,

it is worth evaluating the different

currents in this moment of transition.

Under Canadian investment policy,

will Canada favor the American

investment, the Chinese investment,

or will both enjoy equal treatment?

The fact that the Canadian public

has taken great notice of this ongoing

debate, is undoubtedly a factor. Although

the Canadian press likes to pretend

emotionalist and alarmist fears about

foreign encroachment never factor into the

country’s decision-making, the control of

“national assets” by a state-owned enterprise

tied up with a Communist regime does not

sit well with the majority of Canadians.

Even the overwhelmingly centrist

Canadian public has been suspicious of

surrendering control of its “national” assets

to China. Does this translate into greater

access to American investors? American

investment in Canada has been a long-

standing tradition. The Canadian public

seems indifferent to American ownership

of most iconic Canadian conglomerates

from Molson Canadian, which runs by the

slogan “I am Canadian!” to Tim Hortons, a

fast food restaurant named after a Canadian

hockey player. Capital-rich Europe and the

United States have both enjoyed a favorable

investment position in Canada, and there

has been no outcry from the Canadian

public. There is a certain partiality in

Canada towards Canada’s traditional

partners, which suggests doors will remain

open to their investors.

There are, however, also more rational

reasons for the national politic to be wary

of this new China-based investment. From

a qualitative perspective, natural resources

are not just the fuel but the engine to

Canada’s economy. As Canada’s expertise is

resource extraction, its quaternary sector is

inextricably linked to the primary natural

resource sector. CNOOC’s strategy is

also more concerning. As argued in The

THE PRINCETON FINANCIER | 20

From a qualitative perspective, natural resources are not just the fuel but the engine to Canada’s economy.

ownership of its own resources. As a result,

PetroCanada was privatized and became a

retail subsidiary of Suncor Energy in 2009.

The rise of investment from abroad, which

threatens Canada’s foreign and domestic

capital positions, is enough to revive

protectionist sentiments.

Generally speaking, Harper is left with

two main options. The first is to continue

bandwagoning the United States and

accept the severe price differentials or wait

for Keystone approval. The second option

is to accept Chinese capital, but, in order

to placate the public, investment policy

will have to restrict large market share

ownership while welcoming in capital. The

first option does not necessarily signal an

unequivocally good investment climate for

American investors. Price differentials will

continue to disadvantage any company

that invests in Canada. The second option

would reflect a growing trend away from

American dependency. American investors

will have to compete with companies both

around the world and in Canada to secure

ownership. Preferably for Canada, Harper

could forge a path between the two. By

relying on the United States as a traditional

partner, but also taking advantage of Asian

investment for leverage and to resolve the

price differentials, Harper could forge

Canada’s new economic position in an

evolving global order.

Harper is in an unenviable position

of knowing that while Canada needs

capital, he also needs to satisfy the more

protectionist demands of some of his

constituents. A viable way forward is to

craft an energy policy that controls not

the level, but the kind of investment

into Canada so that Canada’s favorable

position is maintained while capitalizing

on a changing global market. We should

expect Investment Canada to restrict

its approval to only mergers and joint

ventures, not outright acquisitions, as they

pose less of a threat to Canadian control.

Most importantly, such a policy must

be conveyed clearly and transparently to

Canadians and foreign investors. In the

meantime, investment into Canada will

be uncertain. CNOOC closed the door

behind it and there are uncertainties as to

how to reopen it.

manufacturing companies were able

to use Canadian capital to help them

develop at breakneck speeds. On this

framework, Canada vastly improved its

national real income and improved its

terms of trade by negotiating a series of

FIPAs. As countries like China transition

out of the manufacturing-dependent,

capital-poor phase, the reciprocity is

less clear. Canada could be the relatively

capital-poor, labor-poor partner in some

of its trade agreements. The graph above

depicts Canada’s net investment position

has deteriorated rapidly with respect to

the Asian tigers and Brazil. The capital

deficit with the U.S. may be greater in

absolute terms, but the relative imbalance

with China is much greater.

Despite Canada’s current affinity for

free trade, the country has a history

of protectionism. In the 1970s, the

nationalization of Fina to create

PetroCanada was largely a response to

public fears that Canada’s natural resources

would be exploited. However, as Canadian

expertise accumulated and its private

companies developed, Canada had no

reason to worry about competing for

Economist, CNOOC has discovered

that ownership of oil wells (upstream

investment) alone does not translate

into control of oil markets. CNOOC,

in the recent spate of acquisitions which

included Nexen, aims to seize managerial

talent. It attempts to buy out not only

Canadian resources but also Canadian

expertise—acquiring the whole Canadian

competitive package in one sitting.

Moreover, Canadians would become the

lower workforce under foreign managers

extracting their own resources.

The U.S.-China dichotomy has

consumed the Canadian press, but the

more troubling and long-term global

trend that could threaten Canada’s

investment position vis-à-vis many of its

partners has been ignored. As Asian tigers

rise, Canada becomes a net recipient of

foreign direct investment (FDI). Capital

dependency is often associated with a

mercantile or developing economy. In

the past, the mutual benefit of free trade

was more apparent. Canada enjoyed the

capital flows it needed to support its

export industries and develop its native

businesses, while labor-rich, capital-poor

THE PRINCETON FINANCIER | 21

that although the trading fundamentals

in these countries are healthy, the cost

to trade is extremely high, which is a

hindrance to the rapid growth of the

Southeast Asian markets. Also, despite

having extreme growth potential, there

exist inherent risks in the Southeast

Asian markets. Previous periods of strong

investment inflows and the resulting

currency appreciation have prompted

government actions in the form of

capital controls. As a result, interest rates

remain at historic lows, raising fears that

inflation problems may return and distort

investment relationships.

In particular, Vietnam’s growth has

been perpetually impeded. Prior to the

financial crisis, many foreign banks,

including those from North Asia,

Australia, and New Zealand, eagerly

bought into Vietnam’s banks. Today,

however, Vietnamese banks are less

inviting. According to HSBC, the

economy has slowed from an average of

7% annual growth since the early 1990s

to 5% last year. Moreover, decreasing

property prices and increasing bad loans

have made banks reluctant to lend,

thereby further obstructing economic

growth. Furthermore, other challenges

have led to rampant inflation, which

averaged approximately 8.9% annually

for the past few years, and annual credit

growth, which exceeded 20% from

2006 to 2010. The lack of transparency

and weak accounting practices have also

Southeast Asia’s enormous growth in

the past decade can be attributed to a

number of factors. As quantitative easing

and weak growth prospects in the West

pushed investors towards emerging

markets, the region experienced and

benefited from a substantial flow of

foreign investments. The combination

of its optimal central location, economic

relationships with other Asian countries,

and low costs spurred tremendous growth

rates in Southeast Asia. The region is the

center of Asia’s economic boom due to

the young population of over 600 million

people, abundant natural resources,

and growing trade connections between

both China and India. Additionally,

local governments have been able to

exploit record-low funding costs while

wages in China have been increasing

which is helping to bring export and

manufacturing businesses to the region.

The substantial growth and the markets’

strong performances, however, have left

equities trading at unstable valuations.

The Philippines index currently trades at

a price-to-book ratio of 2.6 and a price-

to-earnings ratio of 20.8. Similarly, the

Indonesian index is trading at a price-to-

book ratio of 2.7 and a price-to-earnings

ratio of 18. These statistics are highly

contrasted with the emerging markets

average price-to-book ratio of 1.6 and

price-to-earnings ratio of 12.3. These

noticeably higher ratios for the markets

in the Philippines and Indonesia indicate

Even throughout the recent financial

crisis, investors in Southeast Asia

have enjoyed a great ride over the

past decade with stocks in Indonesia,

Thailand, and the Philippines rising

over 220% since 2008. Moreover, in

the past year alone, Indonesia’s and the

Philippines’ GDP grew by 6.2% and

6.6% respectively. Over the same period

of time, the MSCI Emerging Markets

Index, an index designed by Morgan

Stanley Capital International to assess

the performance of global emerging

markets, has increased by 88%. This

growth can be viewed in contrast to the

MSCI ACWI Index, another Morgan

Stanley developed index that provides

a broad measure of equity-market

performance around the world, which

only increased by 52%. The disparity

represents the stark difference between

the rates at which these emerging

regions are growing relative to those of

the rest of the world. However, after this

exciting ride, investors are beginning to

wonder whether the growth in these

markets has plateaued, as countries in

the region have shown signs of both

mixed growth and instability. An

analysis of various economic factors

across the Philippines, Vietnam,

and Indonesia will help us better

comprehend the reasons for Southeast

Asia’s market performances, which will

ultimately help us understand how

investors are responding to these recent

developments.

THE PRINCETON FINANCIER | 22

to boost the infrastructure and the natural

resources sectors, both of which need

foreign investment. Thus, a prolonged

investment slowdown could generate severe

strains later on.

While certain countries of Southeast

Asia are falling out of favor for investors,

other parts of Asia have become more

attractive, particularly China and Japan.

Despite the general increase in wages

in China, since the end of the last

fiscal quarter of 2012, Chinese equities

have risen over 30% on average. This

substantial increase can be attributed to

the country’s efforts to improve economic

data reports, various financial reforms,

and a successful transition of political

power. The relative and recent stability

of China has renewed investors’ interest.

Likewise, reforms have also made

Japanese markets appealing. The Nikkei

225 has risen over 30% since the last

fiscal quarter of 2012 due to the change

in consumer and investor expectations

that the election of Prime Minister

Shinzo Abe will herald the start of a

far more aggressive monetary stimulus.

This change has consequently lead to

the weakening of the yen from 80 to 94

per United States dollar in December

2012, which has actually benefitted

the country with regards to exports. As

a result of these developments, many

investors are switching their focus away

from Southeast Asia towards the larger,

more liquid markets of China and Japan.

The journey for investors in Southeast Asia

has proven fruitful over the past decade.

However, various factors have caused this

ride to decelerate—a momentum that we

should continue to carefully follow and

analyze in the upcoming years.

stable statistics in the past decade.

Interestingly enough, Indonesia’s trade

and current account deficits are factors

that are contributing to its economic

stability. In the beginning of the first

fiscal quarter of 2013, Indonesia recorded

its second consecutive trade and current

account deficit, which is estimated to be

between $1.5 and $2 billion. Analysts

from The Wall Street Journal believe that

this figure is due to its strong growth

in recent years that has attracted many

imports even while global demand and

export prices slide. These imports are used

to upgrade the country’s factories and

infrastructure, which eventually lead to

more value-added exports.

However, though Indonesia may be

performing relatively well, there are still

certain aspects of its economy, much like

those of Vietnam and the Philippines,

that raise doubts for outside investors.

According to a Barclays report, investment

in the economy in the last fiscal quarter of

2012 was 7.3%, which was the lowest in

five quarters. One factor is that weak global

risk sentiment and unfavorable domestic

developments have been putting pressure

on Indonesian assets. The moderation

in investment is consistent with high

frequency indicators such as capital goods

imports and lending for investments. By

contrast, household consumption, the main

driver of the expansion of the Indonesian

economy, increased by 5.4%. With GDP

growth averaging 5.7% over the last decade,

Indonesian markets look to be a safer

investment and are clearly an exception

to the larger trend within Southeast Asia.

It is important to note, however, that

continued investment is required to keep

the momentum going, both in the private

and public sectors. Indonesia is still looking

generated great uncertainty concerning

the quality of loans in the system. The

State Bank of Vietnam (the country’s

central bank) reported in November

2012 that the ratio of bad debt to total

loans was 8.82%, but Moody’s Investors

Service estimated this ratio to be at least

10%. Thus, Vietnam is a prime example

of why foreign investors express caution

in investing in Southeast Asia. Foreign

investors are concerned with the region’s

unstable banking system and would

rather look towards other areas with less

risk and more growth.

The Philippines represents a slightly

different case, as its stable, long-term

growth has only recently been hampered

by a variety of factors. The primary

concern is the difficulty in sustaining

strong economic fundamentals, such as

stock prices and GDP values. Analysts

believe the market is trading at values

that leave little room for further upside.

According to Bill Maldonado, CIO

of Asia Pacific at HSBC Global Asset

Management, the Philippines has

become “relatively expensive compared

to its North Asian peers.” Stocks deliver

return on equity of about 15%, but

in turn, investors must pay more than

three times book value. In contrast,

according to a report by Duncan Mavin

of The Wall Street Journal, Chinese

shares offer a similar return on equity

for only about 1.5 times book value, and

South Korea offers a return on equity

of 12% for only 1 times book value.

Another aspect about the Philippines

that could hinder its growth is its weak

infrastructure. Although the government

has extensive plans for investment in

infrastructure, the Philippines has the

worst infrastructure quality among major

Southeast Asian countries according

to the 2012 World Economic Forum’s

Global Competitiveness report. This low

quality points to increasing instability of

the economy.

While both Vietnam and the Philippines

have demonstrated reasons for foreign

investors to be concerned, Indonesia

shows certain signs of promise. Its stocks

and GDP have both risen by enormous

proportions, and foreign investors are

still attracted because of its relatively

However, though Indonesia may be performing relatively well, there are still certain aspects of its economy, much like those of Vietnam and the Philippines, that raises doubts for outside investors.

THE PRINCETON FINANCIER | 23

Deutsche Bank Securities Inc., a subsidiary of Deutsche Bank AG, conducts investment banking and securities activities in the United States. Deutsche Bank Securities Inc., isa member of FINRA, NYSE and SIPC. Copyright © 2013 Deutsche Bank AG.

Deutsche Bankdb.com

Where many differentminds meet.At Deutsche Bank, a diverse culture is not just desirable:it’s essential. Collectively, our breadth of ideas, skills, andperspectives helps us to deliver better solutions for ourclients every day.