“We’ve confidentially submitted an S-1 to the SEC for a planned IPO. This Tweet does not constitute an offer of any securities for sale.” With these words, on September 12th Twitter not so confidentially announced its decision to initiate the transition to becoming a public company. And ever since then, Twitter has appeared in financial news every day regarding its prospects about the IPO process. From talking about the slightest amendments made in the latest version of the S-1 sent to the SEC, or to the growing worry that Twitter is slowly losing user base, few news stories seem more prevalent than Twitter’s IPO.

However, in the midst of the Twitter fervor stands one man who is not necessarily all too hyped about the social media startup. Shai Bernstein, assistant professor at the Stanford Graduate School of Business, in his 2012 research paper Does Going Public Affect Innovation? notes that recent startup businesses entering public equity markets become, overall, less innovative as a firm. Specifically, he notes that post-IPO tend to pursue less-novel projects while experiencing high employee turnover (Bernstein).

According to Bernstein, measuring a firm’s level of innovation is a great proxy for measuring its success as well. Especially within industries where firms heavily rely on product differentiation and out-of-the-box creativity to ensure an edge over competitors, innovation plays an important role directing a company’s future prospects.

In his study, Bernstein compared two types of tech companies: 1) those that went public, and 2) those that were about to go public but had withdrawn IPO plans. What he found was that amongst firms of similar size, R&D spending, and in the same sector, the ones that went public significantly dropped in number of quality and original patents. For instance, he found that the average quality of those patents, as measured by how often they were cited, declined by about 40% in the 5 years after going public. By contrast, companies that remained private stayed on the same track as before (Bernstein).

In addition to patents analysis, Bernstein found that post-IPO firms experienced higher rates of management turnovers. He notes that many executives leave the firm after cashing out on their equity in the company because, and even worse, the ones that stay after the IPO become less productive (Bernstein). This caused a serious brain drain for many of the companies that went through with the IPO, and also led to the overall decrease in the firm’s internal innovation level.

Bernstein notes that there exists a complex trade-off between public and private ownership forms. While private firms are far more ambitious in its projects and innovative in its ideas, public firms have easier access to capital that enables firms to bring other innovative thinkers or are able to acquire small innovative companies (even though the public company itself might not be as innovative) (Bernstein). Certainly, the pressures from outside investors coupled with equity market conditions have a great impact on how companies behave after their IPO, which significantly affect its course of direction moving forward (Bernstein).

So what does all of this have to do with Twitter? Is Twitter going to become less innovative and experience significant decreases in human capital after the IPO? Probably, the answer is a no. Although I am not psychic, I think there are some points of considerations that allow Twitter margins of insulation from the potential harms of an IPO that Bernstein discusses.

The biggest difference is the fact that Twitter is a social media company that relies less on developing new innovative products. It is more focused on generating public recognition and usage. What sets Twitter apart fundamentally from the tech companies in Bernstein’s study is that Twitter is a benefactor of public attention, while for the latter it is a hit or miss. Whether Twitter receives good press or bad press from the media, the very act of public discussion about Twitter keeps its name relevant in the public domain. Twitter users don’t factor in the financial competency of the company to decide whether to use its products. Twitter does not require continuous patent developments to keep thriving; as long as it can provide the same level user experience for people then, for the most part, people do not complain. And as long as people are using Twitter as a medium of social media, then its business will stay afloat. Unless a major breakthrough in social media or changes in social norms of online communication strikes Twitter out of left field, the need for constant innovation is not a requirement for Twitter.

With this said, as Twitter prepares its IPO, scheduled for mid-November, Bernstein’s finding is nonetheless an important warning that Twitter should take heed. Especially in today’s day and age where new Apps pop up in iOS and Android on a daily basis, it is ever important to maintain knowledge of the changing industry and the key players involved.


To taper or not to taper: that is the question that has defined the Federal Reserve, market participants, and the public debates over monetary policy throughout the last twelve months. Following the start of the third round of Quantitative Easing on September 13, 2012, the Fed is currently represented by the uncertainty around the tapering of QE3.

Over the past two decades, the Federal Reserve has made an effort to increase the transparency of its monetary policy. Since 1994, the Fed has announced its target for the federal funds rate, published Federal Open Market Committee statements, released FOMC minutes three weeks after meetings, and, in 2012, even attached explicit threshold indicators that would alter the Fed’s view of longer run monetary policy goals . This idea of “forward guidance” serves as a way for the central bank to communicate with households, businesses, and market participants about the FOMC’s stance on monetary policy and its future actions. Through forward guidance, the Committee expects that more certainty in the Fed’s monetary policy can push down long- term interest rates, increase capital investment, and improve financial conditions.

Even the Federal Reserve Bank of San Francisco’s research has indicated that the effectiveness of QE2 was largely caused due to the forward guidance of the central bank, where the Fed’s macroeconomic model “suggest(s) that such interest rate forward guidance probably has greater effects than signals about the amount of assets purchased.”

While the Fed has acknowledged the benefits of forward guidance, the Federal Open Market Committee is trying to determine how and when to begin tapering its asset purchases. Following the September FOMC meeting, the FOMC press release statement indicated that the “the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases. Accordingly, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month.” However, despite the fact that the Fed has forward guidance for the federal funds rate, the tapering of QE3 remains up in the air. There was much anticipation that tapering would begin in September, but in a 9-1 vote, the FOMC voted to keep long scale asset purchases at $85 billion per month.

The recent government shutdown has made it harder to forecast and understand the economy. The dismissal of 800,000 “non-essential” government workers includes employees of the Census Bureau, Department of Commerce, and the Department of Labor who attain and analyze economic indicators. Without these economic indicators, there has been more uncertainty in the economy, and it may be more difficult for the Fed to understand current economic conditions. Economists predict that the 16-day government shutdown will shave 0.3% off the 4th quarter of GDP growth in 2013. The government shutdown has also created a gap in the data stream of indicators the Fed needs in order to understand current economic conditions. Due to this hole in the data stream of economic information, the FOMC will be unable to fully assess the economy during its December meeting.

A taper in January is also questionable. Following the January meeting, Bernanke will step down and four new Federal Reserve Bank presidents will fill rotating seats in the committee. It seems plausible that tapering will most likely happen in March, but waiting till then would add another $255 billion to the Fed’s swelling $3.81 trillion balance sheet.

Because the Fed defines “solid economic growth,” the Fed’s tapering is not bound to any concrete threshold. In a June speech, Bernanke predicted that asset purchases would come to an end when the unemployment rate was in the “vicinity” of 7%. Despite a 7.2% unemployment rate, Bernanke has still asserted that a reduction in asset purchases would not begin until there is “solid economic growth supporting further job gains.” Although unemployment has been dropping steadily since April 2010, a lower unemployment rate does not always indicate more jobs. As economist Paul Krugman points out, the declining unemployment rate is mostly due to the paralleled decreasing percentage of Americans participating in the labor force.

As The Economist understands, “The Fed needs to spell out its priorities and plans much more fully.” In our current uncertain and tepid economic recovery, the Fed must consider the positive attributes of more transparency. John Williams, president of the San Francisco Fed, recognizes that “every step we’ve taken toward greater openness and clearer communication has made our policies more effective and has served to enhance the Fed’s accountability and transparency.” It is time for the FOMC to give the market a better understanding of the impending unwinding of the Fed’s balance sheet.


Out of the frying pan and into the fire.  Last month Russell Wasendorf, Sr. attempted to commit suicide via asphyxiation by using a hose to funnel the exhaust from his Chevy into the car. A Good Samaritan thwarted his attempt and saved his life.  He is currently in jail awaiting trail where he will be charged with stealing around $200 million dollars from his own clients for the past twenty years.

Within the financial world $200 million is not a particularly large amount of money.  A scandal of this magnitude, although terrible, would not normally ring many alarms, but following the Madoff Ponzi scheme and the collapse of MF Global, it has done so, and with good reason.  This outright theft, along with the more recent LIBOR fixing scandal, has, to a certain extent, confirmed the public fear that the financial industry cannot always be trusted to keep investors’ money safe. This fear is helping to fuel the current economic downturn as investors continue to lose faith and withdraw money from financial markets.  Although this doubt in the system is certainly justified and is clearly an important issue, these recent scandals also beg a more fundamental question:  Can regulators be trusted to regulate?

It is almost laughable how simply Wasendorf was able to fool U.S. regulators as he stole hundreds of millions of dollars through his futures firm Peregrine Financial Group.  The ultimate authority for regulating firms such as Peregrine resides with the U.S. Commodity Futures Trading Commission (CFTC), which, because of its limited resources, delegates most of the oversight, such as regular auditing, to the National Futures Association (NFA).  The NFA, an internal self-regulatory organization, had audited Peregrine three times since 2010 and failed to pick up on the fraud.  Even more shocking is the fact that Wasendorf was able to frustrate the NFA’s attempts to verify Peregrine’s bank statements simply by sending them forgeries.  Instead of picking up the phone or contacting the bank electronically, the NFA relied on written mail to reach Peregrine’s bank.  The only problem was that Wasendorf had provided his own P.O. box as the bank’s address.  Receiving these letters himself, Wasendorf was easily able to falsify records.  He wrote, “Using a combination of Photoshop, Excel, scanners, and both laser and ink jet printers I was able to make very convincing forgeries of nearly every document that came from the Bank.”  When the NFA finally gained enough sense to contact the bank for electronic records, they stumbled upon nearly twenty years of fraud.

Although it is clear that regulators at the CFTC and NFA cannot be blamed for this scandal, it is rather astounding just how incompetent they were at detecting it.  When this failure is seen in aggregate with the several other scandals around the financial world, doubts quickly begin to arise about nearly all regulators’ abilities to provide oversight.  They are clearly struggling to do their jobs effectively.  Blame, however, should not fall solely on their shoulders, for they are playing at a natural disadvantage, which can be seen if we consider the massive disparity in resources between the financial services industry and those organizations that regulate them.  The CFTC for example, which is one of the largest regulatory agencies in the United States, employs roughly 700 people and has a budget of about $200 million.  Goldman Sachs, on the other hand—a single bank that participates in the futures trading regulated by the CFTC—employs about 47 times as many people and has about 22 times as much spending money, with 33,000 workers and $ 4.4 billion in net income for 2011.  With this absurd discrepancy of resources in mind, it should come as no shock that regulators struggle to keep up with financial firms’ attempts to skirt regulations (both legally and illegally).

The problem is exacerbated by the fact that there is no clear solution.   Adding more resources does not seem to be a possible remedy, because of the government’s limited funds.  The U.S. cannot afford to simply throw money at this problem. Attempts to find and incentivize better regulators also run into problems because of the nature of the job.  In addition to being understaffed, regulators are also underpaid compared to those working in the financial sector. Considering this, it is not surprising that the financial industry attracts a much larger array of talented people who can do their work at a much higher level.  Even when people are at their jobs on these opposite sides of the industry, their incentives are vastly different.  A banker who exploits some sort of regulatory loophole or flat-out breaks the law stands to make millions of dollars, while a regulator who manages to do his or her work exceptionally well and stops the banker merely gets a “job well done.”

It seems obvious that regulators are struggling to do their job and provide the policing that the financial industry needs, even if it is not entirely their fault.  Although this may not be the main problem behind financial scandals, it is certainly present and fueling the flames of fraud.  If we wish to change the industry that has caused so much grief though its greed, changing the organizations that are meant to prevent this fraud may be a good place to start.

On March 23, the Better Alternative Trading System (BATS) exchange saw a crash due to technical issues on the same day its own company made its initial public offering. The crash precipitated inquiries into high-frequency trading and the automation of financial markets.

BATS Global Markets planned to offer over seven million shares, at $16 apiece, on its own exchange, a high-frequency trading venue. After the shares opened at $15.25 under the ticker “BATS,” within nine seconds they fell to four cents per share, at one point spiking below one penny per share, forcing a halt and the subsequent withdrawal of the company’s IPOs from its own listings.

“Although our affected market has reopened, in the wake of today’s technical issues, which affected the trading of certain stocks, including that of BATS, we believe withdrawing the IPO is the appropriate action to take for our Company and our shareholders,” wrote Joe Ratterman, BATS chairman, in a statement that afternoon.

It turns out that the crash at the third-biggest U.S. stock-exchange venue was due to a coding error that disrupted trading in firms with ticker symbols from A to BFZZZ. Along with BATS itself, Apple was also affected, with a slump of 9.4% within about five minutes before trading was suspended by circuit-breaker rules.

The BATS exchange’s largest investors include trading firm Getco and investment banks such as Citigroup, Morgan Stanley, Credit Suisse, and Bank of America. These banks, in addition to Deutsche Bank, Sandler O’Neill, Wedbush Securities, Raymond James, Rosenblatt Securities and Nomura were to be lead and co-managers of the exchange’s IPO. The underwriting agreement, however, was canceled on March 23 according to BATS.

BATS appeared to be quite undamaged by the crash as a venue for trading. By March 27 the exchange’s market share has recovered to 11%, about two-thirds of NASDAQ, and close to the New York Stock Exchange – the only two exchange venues surpassing BATS in volume. However, BATS’s credibility as a venue for IPOs was hurt. It is rare for a company to withdraw its IPO after the IPO has been priced, as BATS did.

More importantly, the crash renewed alarmed inquiries into the use of high-speed trading and the automation of financial markets, and recalled attention to the May 6, 2010 flash crash, where the Dow Jones Industrial Average crashed around 700 points before recovering the losses within minutes. During the 2010 flash crash, bursts of giant stock orders had flooded the high-speed equity trading markets. It was after the flash crash that the Securities and Exchange Commission and Commodity Futures Trading Commission launched circuit breakers for single stock and index product trading, which was triggered in halting Apple’s trades on March 23.

The SEC has announced a new probe into high frequency trading. In particular, the SEC plans to probe into whether high frequency traders used their relationships with automated stock exchanges like BATS to conduct “quote stuffing” and other practices, potentially leading to market drop, according to the Wall Street Journal. The inquiry may extend to the May 23 glitches at BATS.

Georgetown University financial markets professor James Angel, who had testified before Congress on the risks of high frequency trading, noted that the stoppage in the trading of Apple shares on March 23 indicated the problem with circuit breakers, according to the International Financial Law Review.

“If there was a systemic thing hitting Apple you want the circuit breakers to kick in, but there was no change in supply and demand [of Apple stock],” Angel told the IFLR. Angel supports use of limit up – limit down bands, proposed last April by a group of national securities exchanges that included BATS, NASDAQ, NYSE and the Chicago Stock Exchange. According to Angel, such bands would have prevented the halting of the market by introducing a band outside of which trade cannot happen for individual securities.

However, the calculations involved to determine the price bands would be very complex, as Angel acknowledged. He advocates a simpler limit up – limit down plan that has a less complicated algorithm, so that the risk of a bandwidth overload computing error could be lower, while trading stoppages of equities, such as happened with Apple on March 23, could be prevented. As BATS recovered from the crash, there does seem to be a need to probe further into the infrastructures of high-frequency trading.

With the world’s second largest economy after the United States, China has definite potential to exert strong influence on the global economy. However, largely due to the government’s reluctance to laissez faire, it hasn’t yet fully capitalized on its clout, especially in the global financial sector. But all that may soon change, as China’s central bank chief said in early April that China may loosen overseas investment regulations for private investors.

Historically, China first voluntarily opened up to foreign trade and investment under Deng Xiaoping in 1978 with his new capitalist-inclined system that promoted market forces. Since then, China’s financial sector has undergone significant reforms but it still exhibits the legacy of a centrally- planned economy in which the government, to this day, plays an instrumental role in credit allocations and pricing of capital. In addition, the government instituted a myriad of regulations that control both foreign investment into China and Chinese investment in foreign investments. Hindered by a maze of administrative procedures, foreign investors in China have complained that the Chinese government does not allow them to compete fairly with native businesses. Chinese investors that want to invest overseas, too, are heavily limited by esoteric guidelines.

However, beginning in October of 2011, the Chinese government took a significant step toward freeing up its hold of the financial sector. The deregulations include allowing foreign companies with RBM deposits outside of China to use their offshore account to directly invest in China, and allowing direct investment overseas for private Chinese investors in Wenzhou, also known as a “general financial reform zone” experiment. The government, afraid of the volatile international financial sector, decided to allow Wenzhou–a city in China recognized as the “birthplace of China’s private economy” due to its role as leader in developing a commodity economy, household industries, and specialized markets in the early days of economic reforms–to experiment with direct investment overseas. Concerns over inflation and property risks have held back the Chinese government from allowing a larger-scale deregulation, but nonetheless the Wenzhou experiment is widely acknowledged by the international community as a significant step forward.

Besides de jure governmental regulations, there are many de facto barriers to Chinese involvement in foreign trade. The most prohibiting factor to foreign trade is not what the laws say, but rather the existence of confusing, and often conflicting, laws at all levels of government. A unitary state with 23 provinces, 5 special autonomous regions, 4 self-governing municipalities, 2 special administrative regions, and a hierarchy of departments at all levels, China has innumerable bodies with legislative and enforcement powers that can influence foreign firms’ operations. Many foreign, and even native, companies have vocalized the impossibility of navigating the Chinese bureaucracy. A common phrase in Chinese business circles is, “It’s okay since no firm is 100% in compliance with regulations.” This trend poses significant legal risk for potential foreign investors.

Another substantial barrier to investment in Chinese markets is the inability of foreign private equity firms to freely convert RBM into other currencies. In terms of entry into Chinese market, foreign entrants must obtain special permission from the Ministry of Commerce to make investment in China using foreign currency-denominated funding pools. The Ministry of Commerce, then, picks certain transactions that it considers beneficial for the country and its policies. Later, the lack of RMB convertibility means that it’s difficult for a company to get its profits out of China. Again, companies require Ministry of Commerce permission, and are subject to different regulations depending on which individual in the Ministry handled the case, and his or her interpretation of the laws. Currently, successful foreign companies in China exploit the murky financial environment by taking advantage of unpredictable legal enforcement and shady accounting through local knowledge and networks.

However gloomy and risky foreign investors view the opportunities in China, one thing is for certain: they all want a slice of the large economic pie. “The more open China is to the world, the more benefits China will get and the more competitive local industry will be,” said Li Xiaogang, director of the Foreign Investment Research Center at the Shanghai Academy of Social Sciences. Following a similar philosophy, the Chinese government has begun responding to international pressure and removing itself as the referee in the financial markets. Ironically, Chinese deregulation may eventually level out the playing field in China’s financial sector, and with foreign companies as players, all the participants may reap benefits.

On July 21, 2010, President Barack Obama signed the Dodd-Frank Wall Street Reform and Consumer Protection Act into law. Touted by the left as a remedy to Wall Street’s excess and opacity, the bill severely increases regulations on the financial industry. But is it effective? In an address to the media, Obama claimed:”The American people will never again be asked to foot the bill for Wall Street’s mistakes. From now on, every American will be empowered with clear and concise information you need to make financial decisions that are best for you.”

It has been almost a year since the act’s passage and American consumers have yet to see substantial benefits from the reform. On the flip side, however, the banking and financial industry have been hit hard by Dodd-Frank, with the numerous regulations increasing costs and cutting into profits. Clearly, there is value to transparency on Wall Street, but the cost of reform begs the question of whether Dodd-Frank is truly a worthwhile endeavor.

Within its 2,300 pages, Dodd Frank has some merit, such as calling for greater accountability in rating agencies. But Alan Greenspan, former Fed Chairman, claims that the entire reform is flawed in theory. Citing Adam Smith’s “invisible hand,” Greenspan asserts that these massive regulations will inevitably create market distortions that could have devastating effects on the economy. Believing regulators are being given too much artificial authority, Greenspan stated that, ”regulators are being entrusted with forecasting, and presumably preventing, all undesirable repercussions that might happen to a market when its regulatory conditions are importantly altered. No one has such skills.”

Greenspan’s theoretical objections to Dodd-Frank have already begun to materialize as the legislation has had unintended consequences. For instance, regulations preventing banks from placing certain charges on consumers—such as capping interchange fees at 7 cents a transaction—have caused banks to search for alternative means to charge clients. These alternate methods have included charging annual fees on debit cards and increasing ATM fees. Thus, just as Greenspan warned, regulations that distort the market can yield unpredictable consequences. In this particular example, consumers may actually be worse off, as banks are now levying more fees on consumers to account for their losses due to Dodd- Frank.

In addition to creating market distortions, Dodd-Frank fails to achieve its main purpose. Created in reaction to the 2008 Financial Crisis, the reform’s primary purpose is to prevent another potential meltdown. Yet Dodd-Frank’s insistence on consumer protection may actually be fueling another credit bubble—the underlying cause of the 2008 disaster. Regulation over the past decade has consistently resulted in the expansion of mortgage credit, which in turn created the housing bubble. While Wall Street was indeed partly at fault for the crisis, due to its proliferation of collateralized debt obligations and faulty credit ratings, government sponsored mortgage lending was the leading driver of the collapse. Supporting the subprime market through Fannie Mae and Freddie Mac, the government enabled the accumulation of high-risk loans that ultimately precipitated the meltdown. But instead of changing the government’s approach to mortgages, Dodd-Frank still maintains “government-imposed lending quotas” on banks, leading America down the same path that led to the financial crisis.

Rather than focusing on complex regulations, a simpler approach would be to address the dangers of easy credit. As demonstrated by Greenspan, the more complex economic regulations become, the more unpredictable the market becomes. While Dodd-Frank clearly attempts to aid the average American consumer, it may be doing more harm than good, while simultaneously ignoring the larger issue of credit.

The House has already voted to repeal Dodd-Frank, and GOP leaders in the Senate have introduced a repeal bill as well. However, this repeal bill has almost no chance of getting past a Democrat controlled Senate.

Regardless of what happens to the status of Dodd-Frank, it is important that policymakers know that regulation is not always the answer. In continuing to stress lending-quotas, Dodd-Frank is perpetuating a dangerous precedent that will ultimately need to be addressed.

Due to high gas prices, consumers have paid more attention to the price per barrel of crude oil, as well as the Islamic communities that are reaping the benefits. The massive amounts of wealth stemming from the high price of oil have tremendously impacted Islamic communities. Places like Dubai and Abu Dhabi have come to epitomize the explosion of available capital within the Middle East. As Islamic communities begin to use their capital to invest with other non‐Islamic communities, principles of Islamic law come into play and issues become much more complicated.

In 2007, estimations reported that the American Islamic community, the Muslims living in the U.S. who govern their investments according to the laws of the Sharia and the Quran, had over $170 billion in purchasing power. This niche in American society has recently become a major player in the world of banking and finance due to this enormous wealth.

While firms are scrambling to access this largely untapped resource, they must first overcome Islamic laws that restrict the usage of their capital. Islamic banking operates with the same intentions as standard Western banking, except for one caveat: finance must follow
the rules set forth by the Quran. Under the
laws of the Quran, Muslims are prohibited
from collecting any form of interest. The
problem this created for the traditional
banking world has led to the introduction
of Islamic banking techniques into the
Western world. The following is an
examination of three techniques used
today to help avoid the zero‐interest‐payments rules of the Quran.

The first of these techniques is called Mudharabah. This technique utilizes the principle of profit sharing. While the lender does not charge interest, they do share in the profits and successes of the entrepreneur, similar to venture capital. The second technique is called Wadiah. With this technique, Islamic banks utilize depositors’ funds at their own discretion, and will often reward the depositor with gifts of cash payments for allowing the bank to use the funds. These cash gifts are similar to interest payments, but are not always guaranteed and do not have a set rate of payment. Recently, there has been some controversy in the Islamic community over the issuance of these Sharia‐compliant Islamic bonds, as some religious scholars question whether these bonds adhere to the religious laws outlined by the Sharia. Consequently, the issuance of Islamic compliant bonds has plummeted recently, falling to $14 billion this year from up to $50 billion last year. The third technique is called Ijarah. This practice essentially rents an asset that corresponds to the principal and interest that conventional Western financing would use. In other words, Ijarah is a sale‐leaseback, where the seller begins leasing the asset back and makes rental payments that correspond to the Western concepts of interest payments.

Islamic banking is still in its infancy and has yet to be fully refined. The vast amount of available capital throughout the Islamic communities has created a niche in the banking world that will continue. Large banking firms and even countries like Japan, England, and Malaysia, are catering to these communities by pledging Islamic‐ compliant‐banking‐services. Banks will certainly not forego the opportunity to enter into this competitive market, as the wealth held by oil‐rich American Islamic communities is a perfect target for Western banks looking to utilize their available capital. Islamic banking should continue to be a major factor in the world economy in the future.