European Banking System Undergirds Firm Investment
This paper explores the tellativeness of short selling on identifying firm investment fraud, finding that most short sellers adjust their short portfolios well before the release of a company’s financial statements, in order to use their prior information advantage to facilitate fraudulent transactions. We also look at whether firms change their portfolio holdings to take advantage of higher interest rates after the issuance of company reports. Finally we look at whether the timing of portfolio distribution and portfolio allocation changes as a result of economic weakness or strength. The paper concludes by looking at the likely impact of the Homebuyer tax credit on firms in the short sale industry.
Most firms would prefer to find higher long-term value for their capital investments, but are deterred by the higher risk associated with short-term bonds and equity bonds. Short selling makes sense only for those firms willing to accept a higher risk in exchange for increased capital gains over a relatively short time frame. However, the current economic climate has had a significant adverse impact on capital budgeting across most industries. While many industries are reporting positive long-term economic growth, a number of industries have been hit hard by the overall weakening of the global economy.
In the United States, there is little evidence of firm investment fraud related to bank supervision and the housing boom. However, this is not the situation throughout the developed world. Some European countries, such as Ireland, have seen increases in bank supervision and bank fraud, with some analysts claiming that Ireland is suffering the largest decline in housing market value in the past twelve months. As a result, the banking union has been threatened with regulation by the European Union, the United Kingdom, and Spain.
In addition to banking unions having the ability to provide quality supervisory support, there are other institutional players with the ability to provide effective supervisory support. For example, the United States Federal Reserve can provide effective supervision of the banking industry. If the Federal Reserve were to take the initiative and initiate regulation of its member banks, it would most likely prove effective in terms of addressing the problems associated with excessive leverage and deficient internal controls. However, since the current regulatory regime is insufficient to address these issues, the costs borne by the banking sector through increased risk-taking behavior, combined with the lower returns from these activities, could lead to a reduction in the quality of supervision, and ultimately to higher risks, more frequent fines, and in some cases, the forced exit of firms operating below the required standards.
Many international finance experts believe that the lack of international cooperation regarding currency swap rate ceilings and other possible solutions is another key factor behind the recent increase in financial crises across the globe. The inability of some European countries to provide adequate supervisory architecture to their financial markets has resulted in a situation where financial institutions have experienced heightened exposure to market risks, coupled with the risk associated with default rates rising above benchmarks. Many international finance experts believe that the future of the euro area will be characterized by heightened banking regulation. The European Central Bank has been repeatedly asked by European governments to increase its role in the supervision of banking systems in the euro area nations. However, with some European countries resisting the demands of the Central Bank, the outcome may be insufficient to rein in the increasing losses experienced by euro area banks over the past few years.
In conclusion, the recent economic crisis has had a profound impact on global investment practices. Most importantly, it led to a withdrawal of confidence from global investment theory, and resulted in a search for alternative investment approaches. However, many of these alternative investment strategies are not considered viable due to the deficiency of effective supervisory architecture. Supervisory architecture refers to the application of market based risk management principles to ensure the protection of investment objectives. Given the recent increase in the number of uninsured banks worldwide, and the increasing importance of bank supervision to mitigate the effects of bank failures, the future of the euro area will be underpinned by increased efforts towards market based supervision of banking systems.