Author Archives: MIT Sloan Finance Group

MIT Sloan, friends celebrate life of Nobel laureate Franco Modigliani


Stewart Myers, Robert Merton, and James Poterba

The late Franco Modigliani, who won the 1985 Nobel Memorial Prize in Economic Sciences, was celebrated April 9 for his many contributions to the field of economics and his lasting legacy at MIT, where he taught for more than four decades.

Fellow economists, former students, Boston-area professionals, and family gathered at the MIT Faculty Club for the two-hour long “A Celebration in Honor of Franco Modigliani” to delve into the academic giant’s work in economics and finance and to share stories about the man whose infectious enthusiasm affected so many.

“It’s very hard to believe Franco passed away almost a decade ago,” said Stewart C. Myers, professor of finance at MIT Sloan. “I remember him so vividly I can expect him to walk through that door. And if he did, I think he’d have the same combination of energy and happiness about the field of economics, ideas about economics, and absent-minded generosity he was famous for.”

Modigliani won the Nobel Prize for his pioneering analysis of savings and financial markets. He taught at MIT from 1962 until his death in 2003. Nobel laureate and MIT Sloan professor Robert Merton said Modigliani’s work remains relevant.

“There’s no question his work has a long shelf life,” said Merton. “In 2013, it’s still cutting edge.”

A lasting impact on economic foundations

Franco Modigliani

Merton, speaking on the panel “The Life and Times of Franco Modigliani,” said that before Modigliani’s Life Cycle theory, economists tried to explain how people save and consume by looking at a single year in a person’s life.

Modigliani’s insight was that people plan their consumption and savings over a lifetime in order to spend in retirement.

“He believed most people believe a standard of living in work or retirement should be similar—they don’t want to live on dog food and dine on crystal in retirement, or the reverse,” Merton said.

Modigliani’s work led to the commonly used income-replacement ratio. It remains relevant in today’s MIT Sloan classrooms.

MIT economics professor James Poterba compared Modigliani to Isaac Newton—someone whose work formed the building blocks studied in today’s classrooms.

“Franco’s work is timeless,” Poterba said. “The issues he worked on are the big questions. They are as important today as when he wrote his papers.”

Poterba said Modigliani’s work on monetary theory and stabilization in 1944 “clarified for the rest of the world…sometimes you couldn’t influence the macro economy any more by pushing on interest rates.”

Modigliani also built, along with economist Albert Ando, a large-scale model of the U.S. economy to test the impact of monetary policy.

“We learned enormous amounts about individual sectors of the economy,” Poterba said. “No part of the economy was safe from Franco’s microscope. It was tremendously influential.”

Modigliani was also a pioneer in behavioral economics, currently a hot field of study. In the early 1980s he believed the stock market was underpriced because people weren’t choosing to account for high inflation. As a result, he cautioned investors to hold stocks for a long time so their value could rebound.

Myers said Modigliani left his fingerprints on the way corporate finance is studied and practiced. In 1958, he and economist Merton Miller devised the Modigliani-Miller theorem, which says a corporation’s value is unaffected by whether it is financed by debt or equity.

“It moved corporate finance from the Dark Ages to the Renaissance,” Myers said.

Today, bank regulators want lenders to have greater debt to equity ratios. Bankers oppose this, saying that would hurt their corporations. Myers believes Modigliani would conclude that’s wrong—the theorem says the amount of debt and equity shouldn’t affect the value of a corporation.

“Modigliani would say that’s a freshman-level mistake,” Myers said. “Informed corporate finance always starts with Modigliani-Miller.”

Fervent inquiry into pressing problems

Born in Italy in 1918, Modigliani was always interested in Italian and European economics, long after he and his wife, Serena Calabi, immigrated to the United States in 1939.

A second panel, “The Fate of the Euro,” considered how Modigliani would react to the financial crisis affecting Europe and Italy today.

Panelist Francesco Giavazzi, a professor of economics at Bocconi University in Milan and a regular visiting professor at MIT, noted that in 1998 Modigliani predicted a crisis if wages and labor costs fell out of line.

“You see Franco was right,” Giavazzi said. “Prices did go out of line and the issue today is how to bring these prices back in line with each other.”

Modigliani’s granddaughter, Leah Modigliani, said her grandfather would have liked an opportunity to fix today’s euro crisis. In fact, he never stopped trying to solve the world’s economic problems. She remembered a trip to the beach with a childhood friend that was cut short when her grandfather suddenly had an idea to save Social Security.

“My friend asked, ‘What is your grandfather talking about?’ Well, he has an idea to save the U.S. Social Security system,” Modigliani recalled. “And he would in fact write a letter to The New York Times, and by the time I got home he’d have gotten (Federal Reserve Chairman Alan) Greenspan on the phone to discuss his ideas.”

“He said these things about trying to make the world a better place,” Modigliani added. “His ideas were contagious.”

Beyond his lasting imprint on the study of economics, Modigliani left an impression on many people around MIT.

Serenella Sferza, co-director of the MIT-Italy program, said Modigliani was among the faculty who advised her on establishing the program, which now sends 50 students to Italy annually. Like other panelists, she said she learned that all doors in Italy opened to Modigliani.

But as an MIT student, Sferza studied political science and not economics.

“I envied fellow Italians doing their PhD in economics,” Sferza said. “They had better fellowships, shorter dissertations, and they had Franco Modigliani, who was a magnate, full of authority, good humor, and generosity.”

The Celebration in Honor of Franco Modigliani was held as part of the 2013 Year of Italian Culture in the United States, and Pioneer Investments’ U.S. Colloquia Series.

MIT Sloan Private Equity Symposium addresses the need for new markets

Private equity firms must expand beyond their traditional geographic interests and industry expertise to be successful, Bain Capital’s Steve Pagliuca told a gathering of industry professionals at the 10th Annual MIT Sloan Private Equity Symposium on April 5.

Steve Pagliuca

“The successful players are going to have a huge value-added focus,” said Pagliuca. “You’re going to have to have a global reach, deeper expertise, and the ability to find and evaluate the best deals in the market.”

Pagliuca, managing director of the global investment firm and co-owner of the Boston Celtics, was the closing keynote speaker at the symposium, headlined, “Growth Beyond Traditional Markets.” It was held at the MIT Media Lab.

Pagliuca explained that private equity firms need to search for new markets now that tough economic times are reducing returns investors can expect from U.S. and European investments.

He noted that Chinese leaders “wake up every day” looking for ways to put capital to work to lift their people out of poverty. India’s government is working to become friendly to investment. And Brazil and Latin America are “very exciting places these days,” with strong natural resources.

As those countries grow, Pagliuca said, businesses need capital and expertise to grow, creating opportunities for private equity firms.

Global presence isn’t enough. Private equity firms must have deep knowledge of many industries to “grow and transform and build” businesses in those regions. For instance, Bain has energy, health care, retail, industrial, and high technology divisions. It also offers companies every level of capital—venture, debt, and private equity.

Pagliuca, a member of the nonpartisan Campaign to Fix the Debt, said that the federal government must do more to control the national debt, which he called a drag on the economy and private equity investment.

The national debt could be cut in 15 years by raising taxes and cutting spending by .3 percent annually, Pagliuca said.

MIT Sloan students organized the symposium, which was attended by approximately 250 private equity and venture capital industry leaders and students. Students selected the theme and the panels on creating middle market operational value, energy, health care in Latin America, technology, and finance.

Phil Canfield, managing director of Chicago private equity firm GTCR, and Gary Loveman, CEO of Caesars Entertainment Corp., also gave keynote addresses.

“This is a great example of action learning—working an event outside the classroom, finding it relevant to the industry you aspire to work in, and gaining management experience,” said Mike Reynolds, MBA ’14, one of the organizers of the symposium.

The symposium was sponsored by Choate Hall & Stewart LLP, Ernst & Young, Mekko Graphics, and Pitchbook.

Fear of the Future-ization of Swaps

Dr. John Parsons (right)

Title VII of the Dodd-Frank Act mandates the regulation of the OTC swaps market in a fashion that parallels the pre-existing regulation of futures markets. Although the Act was passed in 2009, many of its provisions are only now beginning to take effect. One current manifestation is the resorting of derivative trades across the two marketplaces as traders reassess the relative cost of swaps versus futures in light of the changed regulations, moving important pieces of the business from the OTC swaps marketplace over to futures exchanges. The futures industry is actively encouraging the trend as it designs new “swap futures” products designed to mimic the payoffs to swaps while benefitting from the regulatory rules applicable to futures markets.

The process is being called the futurization of swaps.

In January, the Commodities Futures Trading Commission (CFTC) hosted a public Roundtable to get input from the industry and academic experts on the process. Dr. John Parsons, Senior Lecturer in the Finance Group at Sloan and Head of the MBA Finance Track, was one of the invited participants. Dr. Parsons has covered the futurization process on his blog, “betting the business” since the first big waves began in August of 2012.

His comments at the Roundtable made 3 points:

1. They’re all just derivatives.

For any liquid swap contract, the futures exchanges can produce products which mimic the financial properties of the swap. So from a social point of view, it’s a matter of indifference whether the risk is marketed on a futures exchange or on the new regulated swap execution facilities.

2. Dodd-Frank leveled the playing field.

The swap industry complains that futurization is a case of regulatory arbitrage. But the truth is the other way around. It was the lack of regulation pre-Dodd-Frank that gave the OTC swaps market its edge. By imposing (i) universal regulatory supervision, (ii) transparency and (iii) clearing on the majority of swaps contracts, the Dodd-Frank act has erased the major regulatory differences between the two markets. Furturization is a natural result of eliminating regulatory arbitrage.

3. Keep your eye on the ball.

The OTC swaps market continues to be the only option for illiquid and customized derivative products. It makes no sense to try and fashion duplicative rules for two parallel market structures – one for futures exchanges and a second for swap execution facilities – that are both well suited for liquid and standardized derivatives. Instead, regulators should tailor the rules for the swap marketplace to suit the service that the swaps marketplace is uniquely capable of providing.

A video of the Roundtable is available on the CFTC website, here, and the transcript is available here.

A set of Dr. Parsons’ blog posts on various aspects of the subject of futurization can be found here.