Yale School of Management
Origins of Value:
The Financial Innovations that Created
Modern Capital Markets
William N. Goetzmann
K. Geert Rouwenhorst
Yale School of Management
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History of Financial Innovation
• Where and when did the securities
and financial contracts exist today
originate?
• Collaboration
among
Historians,
Economists, and Finance professors
• Different perspectives on finance and
society
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Financial Foundations
• Time
• Chance
• Markets
• Companies
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Time
• Finance transfers value through time.
– Loan is an exchange of value through time
– Stock shares are future dividends.
– Futures are pre-agreed compensation for delivered
commodities.
• Institutions for inter-temporal transfer:
– Family, Bank, Pension, Fund, Government, Non-profits,
Contracts, Companies.
– Institution not as important as the function.
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Chance
• Future is uncertain
– Contract on outcomes
– Fire, market drop, catastrophe
• Options, insurance
– Allow risk-sharing and control of the effect of uncertainty
• “Structured” risk parcels it out to highest bidders.
• Current crisis caused by risk aggregation
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Markets
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Provides broad access to financial technology.
Allows “comparison shopping.”
Allows transferability -- creates liquidity.
Efficiency of allocation.
Prices reveal consensus market beliefs and forces.
The expectation of future liquidity creates
immediate value.
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Companies
• Separation of governance and enterprise.
• Allows innovation and risk-taking.
• Constantly creates benefits and challenges.
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Early Financial History
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Mesopotamia
• Finance created first writing
• Cities
– Central planning
– Accounting
– Local and distant trade.
• Contracts: Loans, partnerships, mortgages, futures.
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A contract for future delivery – records the promise to deliver wooden objects and silver
in the future. 19th Century B.C.
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China
• Coins & monetary policy
• Loans (Warring States Period)
• Paper money (Song)
• Checks and exchange bills (Song)
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Loans, 1000 B.C.
Bamboo loan tallies
Lender and borrower
held identical pieces
15th century Bonds are Stocks
(or “sticks”)
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Pawn shops, 700 A.D.
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Song Dynasty Government Voucher for 500 Wen issued in 1208. Great Ming
Universally Circulating Treasury Note, after 1375 A.D. Yale University Collection.
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First Bond Market, Venice 1172
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Monte di Pieta Florentine Bond
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Corporations
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Rome
Malmendier
“Societas
Publicanorum”
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Amsterdam Exchange
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VOC (1602) Bond and Share
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Debt and Structured Finance
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Bonds and Survival
1648 Perpetuity
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Tontines
Pension Securitization
•
A financial innovation that did not
survive.
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Annuity paid to a group of people to
be divided among the surviving
members
•
Used by governments but also
organized privately in the form of a
private pension fund
•
Private Tontines require collateral in
absence of power of taxation. (Bonds
and/or Stocks (portfolio))
•
Private tontines start to look like
“pension funds”
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Auditing and Interest Payments of Tontines
Coupon Front
Back
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Securitization
Mortgage Bonds
III
Those who furnished money have
authorized (…) to issue bonds and
provide funds to plantation owners
against collateral of their plantations,
including slaves, horses, animals, and
equipment.
IV
For security of the investors, the owners
are committed to consign all products
from the plantation (..) for sale at the
greatest gain upon arrival.
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First (?) Mutual Fund
Eendragt Maakt Magt (1773)
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Closed-end Bond Fund
1% management Fee
Embedded Lottery
Portfolio
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Danish and Viennese banks
Danish Tolls and Holstein
Russia and Sweden
Brunswick and Mecklenburg
Postal services of Saxony
Spanish Canals of Taouste and
Imperial
British Colonies
Essequebo
Berbice
Danish American Islands
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Second Mutual Fund and Diversification
Voordeelig and Voorsigtig (1776)
(It is prudent) … to spread as much as possible monies over good and
solid securities.
Because nothing is completely certain but subject to fluctuations, it is
dangerous for people to allocate their capital to a single or a small
number of securities.
Not everyone has the opportunity to invest his money in a variety of
securities (…). For the sum of 525 Guilders one can participate in
this negotiatie (...), which will be profitable with sufficient certainty.
No one has reason to expect that all securities in this negotiatie will
cease to pay off at the same time, and the entire capital be lost. If
one had reason to fear such general bankruptcy, one never ought to
invest any money.”
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Value Investing
Concordia Res Parvae
Crescunt – 1779
The fund will invest in “…solid
securities and those that based on
decline in their price would merit
speculation and could be purchased
below their intrinsic values, (…) of
which one has every reason to expect
an important benefit”
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Wealth Management and Fraud
All securities of the fund ….
“…..will be placed under the custody of the notary
public in iron chests with three differently
constructed locks and the key of one will be
confided to his care, and those of the two others
to that of the two directors of the fund”
Concordia Res Parvae Crescunt 1779
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First Commodities Bond
addressing inflation concerns
Excerpt from the terms: Both Principal and Interest to be paid in the then current
money of said state, in a greater or less sum, according as Five Bushels of CORN,
sixty-eight Pounds and four-seventh parts of a pound of BEEF, Ten pounds of
SHEEPSWOOL, and sixteen pounds of SOLE LEATHER shall then cost, more or less
than One Hundred and Thirty Pounds current money at the then current prices
of said articles.
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Financing the American Revolution
and the collection of interest
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Collecting Interest on Illiquid
Debt Issued by Russia
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Securitization of Russian Debt
Early 19th Century Depository Receipts
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Securitizing Lives
and
Diversification of
Mortality Risk
Names of young girls