Knowledge that Transforms

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Professors Fraser, Phillips, and Rose's paper on canonical analysis of bank performances is another welcome addition to the growing body of literature in the area of measurement of bank performances. Since the purpose of the paper is to report the results of the application of canonical correlations in measuring the performance of commercial banks in Texas (a unit banking state), my observations are restricted to the statistical aspects of the paper.

My remarks are divided into two sections. The first section briefly summarizes the major points of the two papers. I should acknowledge that I agree with almost all of the conclusions by Farrar and Mendelson regarding the reforms which have taken place and the beneficial effects of these reforms. The second section briefly discusses one adverse effect of the institutional market not remedied by the reforms. This adverse consequence is only briefly mentioned by Farrar, while it is discussed by Mendelson, but the full implications are not considered.

M. W. Jones-Lee, A Note on a Property of the Inverse of a Bordered Matrix and Its Implication for the Theory of Portfolio Selection, The Journal of Financial and Quantitative Analysis, Vol. 9, No. 6 (Dec., 1974), pp. 1081-1087

Bernell Stone's paper extends the single-factor market model to a two-factor model to “better” explain the stochastic process that generates security returns. The inductive search for new models (of which his paper is one) presumably is predicated upon some unsatisfactory results of joint tests of the single-index market model and the capital asset pricing model. It is well known that there are other components of systematic or covariance risk that are not explained by the single-market factor. In the most general sense then, one would conclude that the truth of the return generating process is a multiple factor model, given that the process is indeed linear in the factors. Professor Stone chooses a two-factor (or index) model, in which the known factors are: (1) the return on an equity index, and (2) the return on a bond index. To this extent his interesting work is a special case of the more general work of others.

Edward Kane alleges that the Federal Reserve System recently has taken a turn for the worse, with respect to monetary policy, in that Chairman Burns has re-politicized the System beyond prudent bounds. It is interesting to note that Kane changed the title of his paper from “The Politicization of the Fed” in his first draft (and before he had heard my comments at the meeting) to “The Re-Politicization of the Fed” in his second draft (after he had heard my comments). In my view, Kane's latest title is closer to the truth–though still somewhat misleading–in that, over time, the Fed has necessarily factored political and social considerations into the formulation of economic and monetary policy. But so what, and what else is new? The examples cited by Kane to “document” his case can best be characterized as allegations that illustrate a certain behavioral pattern over time, but these examples fail to support his case that–because of the repoliticization of the Fed–recent monetary policy has been at times counterproductive to the public interest. Perhaps a more legitimate conclusion that Kane could have reached from his observations of public policy in recent years is that the appointment of Dr. Burns as Chairman of the Committee on Interest and Dividends tended to formalize the quasipolitical nature of the position of the Chairman of the Federal Reserve Board.

Recently, there has been no shortage of proposals for reforming the U.S. financial system. Proposals have been offered by the Hunt Commission, the Administration, and several other groups. All these proposals contain many common elements, attesting to the difficulty of obtaining comprehensive financial reform. The analysis here focuses primarily upon the Administration's 1973 recommendations.

Structural reforms of a fundamental nature now under way in Wall Street have been proclaimed so often of late as to become commonplace. The fact that many of these changes are not welcomed by established and influential persons who make their living in or around Wall Street is not news. What may be news, however, is that neither of these facts is particularly new.

Marion L. Chiattello [1] has provided additional empirical support for the suggestion that, because of the high degree of linear interdependence between many of the variables commonly used in banking regression studies, it may be necessary to interpret explanatory variables in a cross-sectional regression equation, not as representing individual influences, but as representing more general factors. Further, he has provided more empirical support for the suggestion that principal component analysis might be useful in helping to isolate and identify some of these general factors.

Marion L. Chiattello, Comment: "On the Use of Principal Components Analysis to Interpret Cross-Sectional Differences Among Commercial Banks", The Journal of Financial and Quantitative Analysis, Vol. 9, No. 6 (Dec., 1974), pp. 1047-1051