The business of banking has changed profoundly over the past 15 years, and some of these changes have come to entail serious problems during periods of severe stress in financial markets. In part, banking changes have contributed to financial instability (actual and potential), and in part banking instability has reflected economic pressures. Recognizing the complexity of these influences, the need to anticipate problems–to keep “good” banks from going “bad,” as well as to keep “bad” banks from failing–is particularly urgent, especially since the economic environment in the years just ahead appears likely to be at least as unsettled as that of the recent past.

My comment was requested by the Chairman to be directed especially toward Dr. Robert Holland's excellent and thoughtful account of the changes, past and prospective, springing from the development of bank holding companies in American banking markets.

Recent trends in capital budgeting have been toward more complex decision rules with increasingly sophisticated treatments of risk. Although they have the virtue of simplicity, undiscounted methods such as the payback do not account for the time value of money. Net present value and internal rate of return consider the time value of money but many questions remain about the proper discount rate, the reinvestment assumption, and the statistical interrelations among projects. The latest approaches, referred to as portfolio models, are substantially more complicated but are the only methods that consider the statistical interrelations among the various assets. The most popular portfolio approach has been the mean-variance (E-V) model developed by Sharpe [10] and Lintner [5].

If I have read Professor Mayer's paper correctly, its basic message is that large banks should be permitted to fail. I agree with that position. Moreover, there have been two large-bank failures of late, and it is safe to infer that at least in a technical sense, the regulatory authorities also agree with Professor Mayer's position. However, implementation of that basic policy raises questions about the continued use of what have proved to be important institutional arrangements. As is well-recognized, failure carries with it a host of socially undesirable consequences, and for that reason an elaborate system of bank examination has been created at both the state and federal level to minimize the frequency of its occurrence. Thus, a policy position which permits any bank, large or small, to fail could imply the abandonment of bank supervision. I for one am not willing to go that far and I do not believe Mayer is either.

In their 1958 article Modigliani and Miller showed that if two firms are in the same risk class and in an economy with a perfect capital market having no transaction costs, taxes, or no bankruptcy costs, then their relative market values are independent of their capital structures.

This paper develops a hypothesis regarding the factors which influence the average maturity of corporate debt, and the hypothesis is tested with a cross-sectional sample of large industrial firms. The sample consists of 159 companies from the Fortune 500 list of the largest industrial firms as of 1971. A linear regression model is developed with the firm's average debt maturity expressed as a function of the firm's asset maturity, size, variability of income, growth, and the proportion of debt in the firm's capital structure.

The growing sensitivity of savings deposits to flow in response to changes in interest rate differentials has become so commonplace in the past decade that the term “disintermediation” has become a part of the economists' vocabulary. It is a major conclusion of this paper that the volatility of savings deposits began to increase as early as 1950 for savings and loan associations and credit unions and as early as 1945 for mutual savings banks. As an indication of this, we proxy changes in the competitive environment for savings deposits by making yearly estimates of the elasticity of savings deposits with respect to deposit rates at savings and loan associations, mutual savings banks, and credit unions.

A well-known model of asset returns is the index equation

in which Rj, t is the observed rate of return on asset j during time period t; Rm, t is the return on a market index; βj, t is a parameter which measures the risk of asset j; αj, tis another parameter which has been given several interpretations by different authors; and εj, t is a stochastic disturbance term with zero mean. We discuss techniques for avoiding some of the pitfalls caused by nonstationarity. We explain a technique of robust regression; when the disturbances do not have all the standard spherical Gaussian properties so familiar from econometrics texts. We then describe a methodology for regression with a nonstationary model. It utilizes orthogonal polynomials of time to track the paths taken by the risk coefficient. This is a very robust specification and it has the potential to side-step many of the troubling theoretical and econometric problems of the model. By using the simple model we are not obliged to take sides on the question of which particular theory is “true” because this specification will be an approximation to all of the currently suggested theories (for a particular data sample). It is also reasonable to assert that the specification will approximate currently unknown models that may be developed in the future.

We develop a household portfolio selection model that (1) generalizes some aspects of the conventional theory of the portfolio selection process; (2) integrates the investment and financing decisions, and (3) reflects the liability structure of the household. We incorporate the above influences by placing restrictions on the portfolio maximand in the form of probabilistic and deterministic constraints. The maximand is a tradeoff between the expected net value and the volatility of the portfolio as measured by Sharpe's beta coefficient. The maximization of the objective function is restricted by (1) the Cash Flow, (2) the Credit Limit, (3) the Adding-Up, and (4) the Non-Negativity constraints.

At the beginning perhaps it would be appropriate to say that three assumptions have been made throughout the entire discussion. They include:

1. An assumption that there are approximately 45 classroom hours available to the instructor,

2. An assumption that for many students it is the only finance course they will take,

3. An assumption that the course is oriented toward business finance, and not, for instance, capital markets, or money and banking.

A financial decision model of the firm, in which most prior deterministic decision models' assumptions were relaxed, was developed and solved for its policy and state variables' time-optimal trajectories. In particular, the three alternative modes of corporate financing, with their respective explicit and implicit costs, were treated as distinct, time-variant decision variables. In addition, their dynamic interdependent relationship with the firm's investment-possibilities schedule was clearly delineated. Besides eliminating the usual constant returns assumption, our model further introduced a dividends discount factor which was an explicit function of the firm's debt-equity ratio.

Furthermore, despite the generality of the model solutions, valuable economic implications were determined; namely, (1) conditions for the existence of a steady-state equilibrium were established with the critical role of nonproportional external equity flotation costs being observed; (2) the firm's dynamic equilibrium path was locally unstable in the initial, high-growth phase of its life cycle and was locally stable in its declining-growth stage–a result consistent with the growth literature in security valu ation theory; and (3) the usual assumptions of the balanced-growth path models are sufficient for the optimality of their decision policies.

From an historical perspective, the Federal funds market has evolved from primarily a receptacle for residual funds into a leading money market. During the market's formative years, banks borrowed Federal funds strictly as a reserve adjustment measure to supplement their discount window borrowings. Gradually, money market pressures have created a situation in which banking institutions find it profitable to finance some of their loan expansions and to expedite various types of transactions with the temporary use of these funds. Consequently, banks have reversed their earlier views and are presently treating discounting as being subservient to the purchasing of Federal funds. Initially, banks lent only their idle reserves in the funds market. In due succession, the practice of selling Federal funds replaced call loans as the predominant secondary reserve and has presently grown into a leading liquid asset in many banks' portfolios. Paralleling this rapid expansion has been the diversification of the funds market. Presently, one-third of the total volume of funds in this market originate from institutions other than commercial banks, i.e. U. S. Government Security Dealers and large corporations. Not only have the number and types of participants enlarged, but they tend to participate continuously rather than on an occasional basis.

The efficient market hypothesis implies that the issuance of market information is quickly, reflected in price changes and that the opportunity to profit from its content is highly improbable. This hypothesis has encouraged empirical research, and based on the consensus of evidence, the value of traditional security analysis is strongly questioned. Despite the rigor of these analyses the argument against traditional security analysis remains behaviorally and theoretically limited.

Previous research suggests that earnings growth rates are random in nature such that reliable earnings projections cannot be made based solely on the earnings time series. The purpose of this study was to determine whether earnings forecasts made by security analysts remain a random variable when the information set is expanded to include publicly available information about firms whose earnings are being projected. This was accomplished by relating firm financial variables to the forecast errors resulting from corporate earnings forecasts.

This paper by Hughes, Logue, and Sweeney offers an excellent summary of recent theoretical work on the advantages of multinational firms in providing opportunities for international diversification. In addition, some interesting empirical tests of an international version of the capital asset pricing model (IAPM) are reported. Neither of these topics is original as several writers have explored the theoretical advantages of the multinational firm providing international diversification, including this discussant [1]. The IAPM has been tested by Solnik [2] and others who find that systematic risk is lower in international financial markets than in domestic ones.