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FINANCIAL INTEGRATION. Paula Garrido Mirat. Background. H igh levels of financial integration a hundred years ago. British investment in Argentina, Australia, Canada and US between 1865 and 1890 went mostly into railroads and government bonds. Obstacles for investing abroad then.

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financial integration

FINANCIAL INTEGRATION

Paula GarridoMirat

background
Background
  • High levels of financial integrationa hundred years ago.
  • British investment in Argentina, Australia, Canada and US between 1865 and 1890 went mostly into railroads and government bonds.
obstacles for investing abroad then
Obstacles for investing abroad then
  • INFORMATION PROBLEMS
    • Communications technology of the day
    • Asymmetric information
  • CONTRACTING PROBLEMS
    • US laws VS. Britain laws
  • MACROECONOMIC RISKS
    • Exchange rate risk
    • Unstable and uncertain monetary and fiscal policies
  • ACCOUNTING PROBLEMS
information problems
Information problems
  • Communications technology of the day:
    • Transatlantic cable (1860)
    • Time for cable transmission less than a minute by 1914
    • Equalization in prices in different places of the world
information problems1
Information problems
  • Information asymmetry:
    • Adverse selection
    • Disproportionate share of railway bonds in foreign investment portfolios
    • Family groups and merchant and investment banks
    • Freestanding companies for FDI
contracting problems
Contracting problems
  • Uncertainty of legal security of the claims of foreign investors in the US was an issue for British investors
  • The US prohibited foreigners from serving as directors of the corporations chartered there
  • Freestanding companies were very trusted then because they were subject to British law.
macroeconomic risks
Macroeconomic Risks
  • British investors viewed securities issued by countries not on the gold standard riskier than those of the countries that were.
  • Loans to countries with a fluctuating standard value commanded significantly higher interest rates
absence of adequate accounting standards
Absence of adequate accounting standards
  • Suggestion to create generally accepted accounting principles
  • British investors insisted on the transfer to the US of accounting practices accepted in Britain
  • Need for regulatory intervention: Interstate Commerce Commission for the railroads until the Securities Exchange Commission
  • British accountants set up practice in the US from the mid-19th century
f inancial integration now
Financial integration now
  • Deeper and broader economic integration
  • More complexity of financial markets
  • More regulation
  • More financial innovations
  • Improvements in communication
  • Bankruptcies, scandals and fraud still there
problems the enron scandal
Problems. The Enron scandal
  • INFORMATION PROBLEMS
    • Still asymmetry information
    • Hidden information
  • DEREGULATED MARKETS
    • California deregulated the energy market
  • RISKS
    • Credit rating agencies
    • Enron´s sophisticated financial risk management tools
  • ACCOUNTING AND AUDITING
    • Arthur Andersen downfall with the scandal
information problems2
Information problems
  • Failed investments
  • ENRON formed partnerships to hide $500 Million in company losses
  • People continued buying ENRON stocks and the price didn’t go down
  • NO INFORMATION OF THE REAL STATUS OF THE COMPANY
deregulated markets
Deregulated markets
  • 1996: California deregulated the energy market in order to increase competition
  • Market manipulations and illegal shutdowns
  • State of emergency in January 2001
  • ENRON saw opportunity to make money to cover their huge losses: TAKE ADVANTAGE OF THE DEREGULATED MARKET IN CRISIS
  • Government regulated the market: no more opportunity to make money for ENRON
  • ENRON announced its first losses in more than four years
macroeconomic risks1
Macroeconomic risks
  • Credit agencies:
    • They were giving Enron the highest qualifications, when Enron was facing huge losses, which prevented their stock price from falling.
    • They downgraded Enron´s credit rate too late, when it was already bankrupt.
  • ENRON´s sophisticated financial risk management tools
    • Enron\'s bankruptcy downfall was attributed to its reckless use of derivatives and special purpose entities
accounting and auditing
Accounting and auditing
  • ENRON succeeded in hiding some important facts, such as off-book liabilities, from banks and shareholders
  • ENRON\'s auditor´s firm, Arthur Andersen, was accused of applying reckless standards in its audits because of a conflict of interest over the significant consulting fees generated by ENRON
  • Arthur Andersen fell with the Enron´s fall
  • ENRON was attributed as the biggest audit failure in history
comparissons
COMPARISSONS

After more than a century, similar problems to those that faced British investors still exist but in a more complex and integrated financial system:

  • Asymmetry information: the investors (now and then) didn’t have all the real information of the economic status of the company, despite the improvements in communication technologies
  • British investors and ENRON company also took into account the laws in different places in order to choose the best apparent investment opportunity
  • Even though there have been many improvements in risk management, sometimes it is very hard to measure it
  • Distinction between the auditor´s inspective function and the accountant´sanalytical function emerged in the 20th centurybut it doesn´t prevent conflict of interests
conclusion
Conclusion
  • INFORMATION IS THE KEY ELEMENT IN AN INVESTMENT
  • THERE WILL ALWAYS BE COMPANIES AND PEOPLE THAT WILL HAVE OTHER INTERESTS
  • MORE REGULATION CAN HELP BUT WON´T SOLVE THE PROBLEM COMPLETELY
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