Risking Retirement on Selling the Business

Sell the business. That sums up how many small business owners hope to fund their retirement years. They are “significantly less likely” to have diversified retirement assets than employees do, increasing their financial vulnerability as they get older, according to a new analysis (PDF) from the Small Business Administration.

“There is a risk of significant consequences if the business goes bad,” says Jules Lichtenstein, the SBA senior economist who authored it. “There’s a double-whammy if something happens to that company because you’ll lose your income and your retirement assets.”

The findings do not surprise Marcus Newman, a vice president at GCG Financial outside Chicago. He has advised small business owners since 1997 and says he has 500 clients who own businesses with 150 and fewer employees in 38 states. “I can’t begin to tell you the number of times a small business owner tells me, ‘Look around—this is my retirement plan.’ Their idea is that someday in the future there will be a buyer for their business, they’ll sell it and the dollars generated is what they will retire on. But practically, in my experience, more clients go out of business than sell their business.”

The SBA analysis is the first time that retirement savings patterns of individuals who earn a high percentage of their income from a business and hold a high percentage of net worth in business assets have been examined in detail. The report draws on data from the U.S. Census Bureau’s Survey of Income and Program Participation. It was collected from August 2009 to November 2009 and includes responses from 4,773 business owners with fewer than 100 employees and 31,512 private wage and salary workers.

A separate study (PDF) also released this month showed that small business owners expect to retire significantly later in life—at the age of 72 vs. 68—than their wage-and-salary counterparts do; some don’t plan to retire at all.

Lichtenstein’s study shows that the owners of the smallest businesses, those with 25 employees or fewer, are significantly less likely to hold retirement assets and more likely to depend on home equity as their largest asset than are owners of larger companies, whose biggest assets are more likely to be in business equity and in stocks or mutual funds. He was unable to get separate data on self-employed individuals, Lichtenstein says, but he suspects they are even more financially vulnerable in retirement.

Newman’s experience backs that up. “Do you know how many former general contractors and plumbers and electricians are now working the aisles in Home Depot (HD)? Small business owners are not known for planning and putting money away, and many would rather invest in their business because they are entrepreneurial,” he says. Many of his clients who had hoped to sell in recent years have put off retirement indefinitely because they can’t get the price they had hoped to obtain for their businesses.

While many policies have been put in place over the years to encourage small business owners to accumulate savings in specially designed accounts such as SEP (Simplified Employee Pension) and SIMPLE (Savings Incentive Match Plan for Employees) plans, those policies have produced only minor gains, the SBA study notes.

The data Lichtenstein analyzed suggests that federal rules may need to be reexamined to help boost retirement savings for entrepreneurs, he says. The Obama administration has proposed new policies to expand retirement savings, including instituting a program of automatic IRAs for the approximately 75 million Americans who are not covered under employer-sponsored retirement plans. Such a program might be usefully expanded to include business owners as well, the study concludes.

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Stocks Await Their Tipping Point

If you really think about it, Fed Chairman Ben Bernanke has this Clark Kent thing going on. By night, he is a soft-spoken family man, more blue collar than blue blood—an academic who carries a Jos. A. Bank charge card. By day, he flexes monetary superpowers, including the ability to conjure up trillions of dollars to buy Treasuries and mortgages.

One thing SuperFed can’t do—at least not directly—is goose the economy and popular confidence by buying stocks. It can, however, do this transitively, by inducing what Wall Street likes to call a “pain trade”—forcing investors out of the perceived safety of risk-lite Treasuries. Then, if all goes as planned, they will find themselves maxing opportunity out of yield-sapped corporate bonds, including higher-risk junk bonds. Bernanke, you see, is making investors grovel for return. And if they grovel long enough, they are bound to finally make that capital-structure leap of faith to the stock market. Retirement-account values will go up. Companies will have more valuable currency with which to make acquisitions. Hiring and consumption could well take heart.

Fifteen years after Bernanke’s predecessor Alan Greenspan famously warned of irrational exuberance in markets, the long-awaited great migration back to equities (following the 2000s’ two growling bear markets) has yet to happen. But if things continue apace, and Bernanke keeps doing what he’s doing, it could take hold any day now.

“We’ve come from financial depths that none of us have ever seen,” says Meg Green, chief executive officer of Meg Green & Associates, an Aventura (Fla.) wealth manager. “As night follows day, though, there’s light at the end of the tunnel. Riding the market waves should become second nature, letting longer-term portfolios travel on an upward trend.”

In the meantime, it’s been all fixed-income, all the time. (Not that stocks have been banished to Vladivostok. The Standard & Poor’s 500-stock index is up 14 percent so far this year, and has more than doubled off its financial-crisis low.) Investors have plowed just under half a trillion dollars into bond funds this year, according to EPFR Global. Thanks in large part to record-low borrowing costs brought on by the largesse of the Federal Reserve and its overseas counterparts, the bond market is putting the finishing brushes on an all-you-can-eat year. Corporate bond sales from the U.S. to Europe and Asia have crossed 2009’s record to reach $3.89 trillion, up from $3.29 trillion last year and $3.23 trillion in 2010, according to data compiled by Bloomberg. In the U.S. alone, issuance also set a record, hitting $1.45 trillion, compared with $1.13 trillion last year.

Amid that feeding frenzy, the extra yield investors demand to own corporate bonds over Treasuries is at a mere 2.23 percentage points, compared with 3.51 at the end of last year, according to Bank of America Merrill Lynch’s Global Corporate & High Yield index. “Junk” is no longer a pejorative.

As the corporate bond market gets its dregs scraped, repeatedly, Wall Street’s capacity to transact the stuff is being strained. An average of $16.93 billion of investment-grade and high-yield bonds traded every day this year, while the value of outstanding corporate bonds rose to $5.72 trillion. Last year’s average daily trading volume of $15.73 billion occurred amid $4.86 trillion of debt outstanding.

Mark Freeman, chief investment officer of Westwood Holdings Group in Dallas, thinks this pigout is primed to relocate to equity markets, which have yet to revisit their records. “A group of investors, which I refer to as ‘bond market refugees,’ have to find a new home in order to meet their income needs,” he says. To underscore how crowded a trade he believes bonds have become, Freeman highlights that the investment-grade universe trades at a price-earnings multiple of 58, while junk bonds change hands at 16 times earnings. He says that “if corporate earnings can show any growth at all next year, which I believe they will, it is very unlikely the Standard & Poor’s 500 index will continue to trade at a p/e of 13, especially given that it has a higher yield and the potential for earnings growth—something bonds cannot offer.” Of the emerging risk-reward calculus, Freeman says: “Given the current environment, bond investors will eventually find high-quality, dividend-paying stocks as an attractive alternative.”

The question is, can the Fed pain trade last long enough—and without a shock that’s out of its control—to push investors en masse into the stock market. For all Bernanke’s superpowers, he’s not omnipotent.

In a Dec. 17 report entitled The “Bond Bubble”: Risks and Mitigants, Fitch Ratings noted that if interest rates were to revert rapidly to early-2011 levels, a typical, 10-year investment-grade corporate bond could lose 15 percent of its market value, while a 30-year equivalent would take a 26 percent hit.

Such a blindsiding—you can actually lose money in bonds?—would spoil the long-awaited rapprochement with equities.

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Newtown Fallout: Cerberus Retreats From Guns

While President Barack Obama and other Democratic politicians clear their throats about proposing new gun control laws sometime next year, the marketplace is responding swiftly to the Newtown, Conn., elementary school massacre.

Dick’s Sporting Goods (DKS), one of the largest retailers in its industry, said Tuesday it is suspending the sale of certain military-style semiautomatic rifles similar to the one used by the Newtown killer. Fox News reported that Discovery Channel (DISCA) has decided to cancel its popular reality show, American Guns.

Less visible to consumers, but no less important, Cerberus Capital Management, a $20 billion private-equity firm based in New York, announced overnight that, under pressure from the California teachers’ pension fund, it will sell its controlling stake in the country’s largest guns-and-ammo manufacturer, a conglomerate called Freedom Group. The semiautomatic rifle used to slaughter 26 people at Sandy Hook Elementary School, 20 of them children, was made by Bushmaster Firearms, one of the companies operating under the Freedom Group umbrella.

The California State Teachers’ Retirement System, which has $751 million invested with Cerberus, said it would review its relationship with the private-equity firm, “given the tragic events last Friday in Newtown, Conn.” Cerberus then followed with its announcement, saying that unloading Freedom Group “allows us to meet our obligations to the investors whose interests we are entrusted to protect without being drawn into the national debate” on gun control.

Bloomberg TV’s Tom Keene asked me this morning on his Surveillance program whether this the beginning of something akin to the divestment campaign aimed at breaking South Africa’s apartheid system. That’s a provocative question. The answer is probably no, and the reasons shed light on the nature of the American gun market.

Gun ownership in the United States is not apartheid. Millions of Americans relish firearms and use them for lawful hunting, shooting sports, and self-defense. To many people, guns represent individualism and self-reliance. The U.S. Supreme Court has interpreted the Second Amendment as protecting an individual right to keep a handgun in the home. Forty-nine states allow people to carry concealed guns. A federal appeals court recently said that the sole holdout, Illinois, violated the Second Amendment by prohibiting concealed carry.

The $2 billion American gun industry is not the South African economy. The gun market historically has been fragmented, made up of relatively small companies. It consolidated in recent years, driven largely by Cerberus’s having bought companies such as Bushmaster (as well as Remington, Marlin, and Para USA) in hopes of squeezing redundancies from their operations and selling off the roll-up in an initial public offering. To Cerberus’s frustration, the IPO stalled for reasons that have nothing to do with Newtown. (Finding efficiencies and cross-marketing opportunities turned out to be more difficult than the private-equity gurus anticipated.) Now, Cerberus will use the cover of renewed controversy over gun control—and the suddenly shocked sensibilities of the California teachers pension-fund managers (from whom Freedom Group’s business presumably had not been kept a secret)—to dump a guns-and-ammo play that wasn’t working out smoothly.

There are personal elements in play, as well. Stephen Feinberg, who founded Cerberus in 1992, is an avid hunter and gun enthusiast; his father, Martin Feinberg, lives in Newtown and told Bloomberg News that the shooting was “devastating.”

Cerberus’s move—and the prospect that the companies within Freedom Group will get sold off individually or in small clumps—will return the ordinarily fractious gun industry to something closer to what it looked like a half-dozen years ago. Smith & Wesson (SWHC) and Sturm Ruger (RGR), the two publicly traded gun makers in the U.S., will stand a little larger in relative terms. Glock, Beretta, and Taurus will continue to import guns from, respectively, Austria, Italy, and Brazil (as well as assemble weapons in their U.S. plants). And overall, gun makers will likely enjoy increased sales over the next six to 12 months, as consumers buy additional pistols and rifles out of fear that their favorites might be more difficult to obtain if Democrats succeed in pushing through new restrictions.

There will be additional post-Newtown reaction from retailers and from Hollywood. Wal-Mart (WMT) is a major gun seller. It accounts for about 13 percent of Freedom Group’s sales, for example. The world’s biggest retail chain will doubtless come under pressure from anti-gun activists to curb its firearms sales, and the image-conscious company may follow its more specialized rival, Dick’s.

In the entertainment world, the cable channel TLC has already delayed airing a show called Best Funeral Ever. Violent movie trailers might get postponed or edited. The massacre during a showing of The Dark Knight Rises in Aurora, Colo., in July prompted Warner Bros. (TWX) to pull the trailer for the forthcoming Gangster Squad, which depicted a theater shooting. Later the studio cut the scene entirely.

Whether marketplace behavior will change over the long haul is a different question. Gangster Squad‘s opening was delayed but not cancelled. The film, pitting organized crime killers against police in Depression-era Los Angeles, is now slated to open in theaters next month, and it will still include plenty of gunplay.

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The UBS Libor-Fraud E-mails Are a Gift for Regulators

Just a week before Christmas, the Libor scandal is a gift that keeps on giving. The Swiss bank UBS (UBS) has been fined $1.5 billion and two of its former traders were charged with conspiracy in the United States, while U.K. regulators released a report (PDF) that captures the bank’s employees engaging in routine, casual, and brazen manipulation of what has been called the world’s most important number.

“Libor” is an acronym for the London Interbank Offered Rate, a key interest rate that affects borrowers, small and large, around the world. It’s a measure of how much banks pay to borrow from each other, as measured and submitted by themselves. That self-reporting aspect makes it ripe for distortion, as banks have sought to adjust it by fractions of a point up or down to eke greater profits out of their trading activities. UBS was far from alone in rigging the numbers—in June, Barclays (BCS) was fined about $450 million over Libor-fixing allegations, and its chairman, chief executive, and chief operating officer all resigned.

The report on UBS issued on Tuesday by the U.K.’s Financial Services Authority is an incredible document stuffed with colorful interactions among traders, managers, and other bank personnel—and their counterparts at other companies—as they go about skewing Libor numbers to their benefit. Thousands of wrongful requests were made, the regulators say.

On Sept. 18, 2008, according to the FSA transcripts, a trader wrote this to a broker about six-month Libor rates: “if you keep 6s unchanged today … I will f—— do one humongous deal with you … Like a 50,000 buck deal, whatever … I need you to keep it as low as possible … if you do that …. I’ll pay you, you know, 50,000 dollars, 100,000 dollars… whatever you want … I’m a man of my word.”

Earlier, on March 29, 2007, according to the transcripts, a trader asked a manager for low Libor submissions. The manager replied, apparently in pique: “i dun mind helping on your fixings, but i’m not setting libor 7bp away from the truth i’ll get ubs banned if i do that, no interest in that.” (“BP” stands for basis point, or one one-hundredth of 1 percent.) The trader replied that he didn’t want UBS banned, either, but “any help appreciated.” The submission ended up being two basis points less than it should have been. To recap: manipulating Libor by seven basis points is unacceptable; manipulating it by two basis points is far less a problem.

And in July 2009, according to the report, a broker at another firm chatted with a UBS trader about how not to get caught rigging six-month Libor rates—do it gradually, not all at once. He typed: “if you drop your 6M dramatically on the 11th mate, it will look v fishy.” The trader replied: “don’t worry will stagger the drops …”

Brokers and traders refer to themselves and each other as “SUPERMAN,” “HERO,” and “captain caos,” among other nicknames in the transcripts, as they manipulate Libor rates.

The evidence against UBS is strong enough that its Japanese subsidiary pleaded guilty to wire fraud, a rarity in financial enforcement. Banks usually settle charges with a fine and no admission of guilt. Beyond being highly incriminating, the material in the FSA report is embarrassing. As my Bloomberg Businessweek colleague, Karen Weise, advised when she reported in June on the release of another set of damning Libor documents: When participating in a global fraud, don’t talk about it in traceable e-mails.

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The Case for Apple's Stock Price Falling to $270

Apple has been slumping. In September, the stock hit an all-time high of $705. On Monday morning, it briefly traded below $500 in pre-market trading. (As of 11 a.m. ET, it was back up around $507.) At least one analyst predicts it has much further to fall. Since January, Edward Zabitsky of Toronto-based ACI Research has been arguing that Apple (AAPL) is headed to $270 a share. He now sees the stock reaching that level in 12 months. Zabitsky, who is ranked as analyst tracker StarMine’s top semiconductor and semi-equipment stockpicker, says his bear case for Apple comes down to increased competition; the diminishing appeal of its closed-architecture App Store experience; and questions about management and Apple’s ability to innovate more than a year after the death of founder Steve Jobs.

Here’s his case against Apple.

Competition from Microsoft
Microsoft (MSFT) continues to execute on its efforts to regain relevance with consumers and maintain its dominance of the corporate market. Core properties Office, Skype/Lync, Xbox, and Skydrive are becoming available across multiple platforms. Microsoft’s strategy is to extend its dominance in enterprise, desktop, and notebook computing to tablets and phones.

Competition from Samsung
Samsung (005930) is the smartphone leader. The Galaxy S II and Galaxy Nexus allowed Samsung to gain market share from other Android vendors. Now the Galaxy S III and Galaxy Note II are threatening Apple’s dominance of the high end. Samsung has sold more than 30 million GS3s and 5 million G-Note 2s. Those phones are leading the way to larger displays for video consumption. The G-Note’s multi-window interface is probably Samsung’s greatest UI enhancement to date. The GS3 is a serious challenger to the iPhone.

Web Apps vs. the App Store
The rollout of 4G networks is vastly expanding bandwidth, while advances in Web standards are allowing Facebook (FB), Amazon (AMZN), Netflix (NFLX), and YouTube to take control of their presence on phones. They are using Web apps to avoid the App Store, and consumers are noticing. That iPhone 5 customers unhappy with Apple Maps are easily able to switch back to Google Maps (GOOG) shows that Apple’s grip on the consumer—and its ability to extract high profit margins—is weakening.

Leadership
Management discord in Cupertino, as illustrated by the recent ouster of Scott Forstall, the head of Apple’s iOS software group, is another cause for concern. Apple, Zabitsky argues, must “develop a more unified approach between its Mac and iOS groups. More than a great innovator, Steve Jobs was a unifying force who was able to challenge people to bring their best game.” He says he doesn’t believe the Apple Maps fiasco would have happened under the late founder.

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In a World Full of Risk, Why Are Investors So Calm?

The economy and markets of 2012 sport nearly as many risk factors as a Cialis ad: Four years into full monetary tilt, does the Federal Reserve much know what it’s doing, and should we grow to expect QE6? Can a recessionary, politically scattershot Europe apply a cordon sanitaire around the still very real threat of contagion? What will arrest chronically high unemployment and food-stamp usage here at home? What of that beyond-cliche fiscal outcropping: Do you take your tax hit now, or pray that January turns out OK? All this uncertainty makes you want to snuggle up to the warmth of punitively yielding U.S. Treasuries.

And yet at least one measure is telling us that the overall mood of the market has never been so sanguine. I like to read “Perception,” an indispensable monthly analysis by Leuthold, the Minneapolis asset management and research shop. Of all the jagged, funky charts still getting spooled out in the aftermath of the financial crisis, this one keeps grabbing my attention:

Can it be? Leuthold’s monthly Risk Aversion Index, which bakes together various credit and swap spreads, commodity and currency prices, and relative asset returns to offer a broad gauge of skittishness, is at a record low going back to 1980. That span includes the Crash of ’87, the rolling emerging-market contagions of the 1990s, and the multiple human and financial calamities of the past decade.

Another reading, the JPMorgan (JPM) G7 volatility index, is at lows unseen since peak swell of the private equity bubble, when Blackstone’s (BX) Steve Schwarzman hoarded $40 crab claws and few suspected that Greece’s and Spain’s books were sauteed. (Speaking of a private equity bubble, don’t look now, but it seems like 2012 is staging a redux.)

How does this overwhelming calm jibe with the prevailing uncertainty of our times?

“The so-called Bernanke put—or, more accurately, global central bank put—is suppressing most of the risk and fear gauges,” says Leuthold’s Chun Wang. “And just about all asset classes, risky or risk-free, have been bid up.” Wang finds that low-fear backdrops like this historically last much longer than high-fear ones, and that increasing signs that housing and China are on the mend only add to the general chill-out.

It’s been a paradoxical climate for investors, who have seen the rather unique confluence of low economic growth with double-digit global equity returns—something that normally doesn’t happen in the absence of post-recession relief rallies and/or significant interest-rate declines.

Some are already conflating all this calm with complacency, warning that danger lies ahead.

Myles Zyblock, chief institutional strategist at RBC Capital Markets, worries that the market isn’t sufficiently taking into account the risk of an economic-policy debacle. In a note to clients last week, he plotted the Chicago Board Options Exchange Volatility Index (“the VIX”) against a policy-uncertainty index developed by Stanford University and the University of Chicago. The VIX, wrote Zyblock, appears to be “a coiled spring,” as the performance gap between the index and the policy gauge shows investors are too focused on rising home and car sales, improving unemployment, and other promising indicators, all while giving short shrift to big policymaking hazards. “A predilection for government can-kicking” hasn’t eliminated the risk stemming from the fiscal-cliff negotiations and other policy decisions, he wrote. “And, from our lens, the risk is large.”

In October, at Grant’s Fall Conference, Artemis Vega Fund manager Christopher Cole gave a presentation—contrarian, if you buy today’s calm—entitled “Bull Market in Fear” (PDF). “Imagine the world economy as an armada of ships passing through a narrow and dangerous strait between the waterfall of deflation and hellfire of inflation,” he wrote, in a slide adorned with vivid apocalyptic art. “Our resolution to avoid one fate may damn us to the other.” Cole then channeled Donald Rumsfeld to urge the audience to “hedge unknown unknowns and sell known unknowns.”

Dizzy? Blurred vision? Consult your doctor.

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Citigroup Downgrade Pushes Apple Shares Near $500

Shares of Apple (AAPL), one of the most popular stocks among retail investors and hedge funds alike, broke through a psychological level this morning by falling to $499 in premarket trading. The stock is down 28 percent from its all-time high of $702 two months ago (but it’s still up more than 25 percent on the year).

Some of the movement is due to a Citigroup (C) report, published today, that downgrades Apple to a “neutral” rating over concerns that it has scaled back orders from its Asian suppliers. At least four other banks have lowered their guidance on Apple this month, according to Bloomberg data, although 84 percent of analysts still rate the stock a buy. Fewer than 5 percent label it a sell.

Plenty of Apple bulls still exist—one example being Brian J. White, an analyst at Topeka Capital Markets, who this morning reissued his Apple price target of $1,111 per share. White cited record iPhone 5 sales in China of 2 million, in the device’s first three days in stores.

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What We Know About Trading at SAC Capital

The investigation into insider trading that circles around SAC Capital is moving billionaire hedge fund manager Steven Cohen to attempt to shore up morale.

Cohen and his top lieutenants have been trying to calm SAC employees, telling analysts and traders who work for SAC that Cohen is confident he has done nothing wrong, according to a person familiar with the matter, who is not authorized to speak publicly about the case. SAC received a Wells Notice from the Securities and Exchange Commission in November, but no charges have been filed against Cohen.

Nonetheless, the atmosphere in the firm’s offices—hardly a bastion of good cheer, even under the best of circumstances—is described as tense, with the intimidating Cohen even more intimidating than usual.

Here are a few things we know about what it’s like to work and trade at SAC Capital:

The firm is intensely competitive, with more than 100 portfolio managers running their own pools of money and their own research staffs, essentially in silos isolated from one another. Camaraderie and chit-chat are minimal. Information flows vertically—up to Cohen—not horizontally among portfolio managers.

Sundays are important days for Cohen and SAC. That’s when the firm’s portfolio managers typically call in to update the boss on important positions and to pitch him on trading ideas, usually after sending Cohen an IM message to find out when he’ll be free to talk, according to a former investment professional with the firm. Cohen is very hands-on and accessible, this person adds.

There is a director of research at the firm one can bounce ideas off—the position is currently occupied by Perry Boyle, who has been with SAC since 2004—but Cohen generally likes to hear any ideas himself. Conversations tend to be brief, with Cohen asking whether his trader feels better or worse about something. It’s not uncommon for Cohen to blow in and out of a position in a short period of time. And if he’s not sure about the soundness of one idea, he may summon other analysts to poke holes in the investment thesis, leading to lively—and sometimes tense—debate.

Cohen also always wants to know a portfolio manager’s conviction level in a particular trade: A rating of 9 out of 10 means Cohen might take a position in his own portfolio, according to a person familiar with the investigation.The SAC model is to make very large bets over short time horizons with potentially huge payouts, so Cohen wants catalysts that are likely to make stocks move the right way—a future distribution deal in China, a positive earnings announcement—quickly. As the former SAC investment professional puts it: Everyone is trying to get an edge.

On Dec. 17, former hedge fund managers Anthony Chiasson, a co-founder of Level Global Investors, and Todd Newman, a former portfolio manager at Diamondback Capital Management, were found guilty of securities fraud, leaving intact the government’s perfect insider trading conviction record. Both Level Global and Diamondback were founded by former SAC traders. Chiasson and Newman face up to 20 years in prison.

Kolhatkar is a features editor and national correspondent at Bloomberg Businessweek. Follow her on Twitter @Sheelahk.

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The Best and Worst Investments of 2012

Best International Stock (+283%): India consumes more than $20 billion worth of whiskey each year—the most in the world—and United Spirits (UNSP) is the nation’s largest distiller. The company’s sales doubled in four years. The United Kingdom’s Diageo (DEO) bought a controlling stake in United Spirits in November.

Best U.S. Large-Cap Stock (+224%): The good news for Regeneron Pharmaceuticals (REGN) shareholders included strong sales for a treatment for eye diseases. Total revenue jumped fourfold last quarter. The Tarrytown (N.Y.)-based company also won approval for a chemotherapy drug and is developing treatments for rheumatoid arthritis and high cholesterol.

Best Bond Fund (+26%): The GMO Emerging Country Debt Fund (GMCDX) invests in debt issued by emerging-market countries, a strategy that’s worked in nine of the last 10 years. Its top holding is Venezuelan bonds, a sign that its managers are willing to take risks in particularly unstable countries.

Best Initial Public Offering (+105%): Retailer Five Below (FIVE) sells candy, stationery, and beauty products priced at $5 or less and aimed at teenagers. Sales are growing 47 percent a year.

Best Equity Mutual Fund (+39%): The Fidelity Select Biotechnology Portfolio (FBIOX) spreads $2.7 billion in assets over 131 biotechnology stocks. A top holding: Gilead Sciences (GILD), the California-based biopharmaceutical company.

Best Commodity (+24%): Wheat prices rose in 2012 as drought cut into supply from the grain belts of Russia, Australia, and the U.S. Wheat is a $14.4 billion crop in the U.S., where it ranks fourth behind corn, soybeans, and hay.

Best Exchange-Traded Fund (+77%): Signs of a housing recovery sent shares of homebuilders soaring this year, boosting the IShares Dow Jones U.S. Home Construction Index Fund (ITB).

Worst Exchange-Traded Fund (-79%): The ProShares VIX Short-Term Futures ETF (VIXY) holds futures contracts that are profitable when the VIX index, a measure of U.S. stock market volatility, rises. 2012 was a calm year.

Worst Commodity (-35%): Abundant supply is depressing coffee prices. Brazil, the world’s largest grower, has almost doubled its output in the past decade, producing another record crop this year.

Worst Equity Mutual Fund (-17%): The Federated Prudent Bear Fund (BEARX) holds gold mining stocks and other investments it expects will do well in times of financial stress. That strategy suffers in years such as 2012, when stocks rise.

Worst Initial Public Offering (-30%): Facebook (FB) plunged as much as 53 percent after its $16 billion debut in May. The stock rallied on news that third-quarter sales rose 32 percent, beating analysts’ estimates.

Worst Bond Fund (+.12%): While the GMO U.S. Treasury Fund (GUSTX) may just barely be holding its value at yearend, its extremely cautious strategy means returns aren’t keeping up with inflation. The fund is invested entirely in U.S. Treasury bills, government debt that matures in less than a year.

Worst U.S. Large-Cap Stock (-43%): Hewlett-Packard’s (HPQ) annus horribilis was marked by a third-quarter loss that was its worst ever, including an $8 billion writedown related to the dwindling value of its enterprise services business. HP later took an $8.8 billion writedown related to accounting problems at Autonomy, a software maker it acquired last year. In September, HP announced plans for 29,000 job cuts.

Worst International Stock (-81%): The biggest target for the European Union’s bailout fund for Spanish banks, Bankia (BKIA), forecasts it will lose $25 billion in 2012. The bank, formed last year from the merger of seven regional savings banks damaged by Spain’s real estate downturn, is in the midst of cutting more than a quarter of its workforce.

Data compiled by Bloomberg from Dec. 31, 2011, to Dec. 17, 2012. Criteria - Bond Funds: 725 bond mutual funds based in the U.S. with assets of $500 million or more. Commodities: 18 global commodities tracked by Bloomberg. Equity Mutual Funds: 796 U.S.-based equity mutual funds with assets of $1 billion or more. Exchange-Traded Funds: 1,062 U.S.-based ETFs, excluding those that use leverage. Initial Public Offerings: 103 U.S. IPOs with an offer size of at least $100 million. International Stocks: The MSCI AC World Index. Large-Cap Stocks: 367 stocks on U.S. exchanges with market value of more than $10 billion.

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Fidelity Investments' Abby Johnson, the Invisible Heir

Those who know her describe Abigail Johnson as steely and extremely serious, qualities that come across in photographs: Whippet-thin, she’s almost always wearing glasses, her fine features and blue eyes rarely revealing more than a slight smile. An heiress to a Boston family fortune—with a personal net worth estimated by the Bloomberg Billionaires index at $10 billion—she’s one of the world’s richest women. She’s also one of the most driven and hardworking. In her 24 years at Fidelity Investments, the mutual fund company founded by her grandfather, Johnson worked through two pregnancies and, according to press reports, a serious illness in 2007 that she never discussed with her colleagues.

Through a spokesman, Johnson declined to comment for this piece. Silence has been her mode for years. She even said little when she was named president of Fidelity Investments Financial Services in August, making her second in command at the $3.8 trillion mutual fund company, the nation’s second largest. She reports to her father, Fidelity Chairman and Chief Executive Officer Edward “Ned” Johnson III, and her elevation to the No. 2 position arguably makes Abby—nobody calls her Abigail—the most powerful woman in finance.

With her ascension, Johnson, 51, has become the leading member of what today is still a very small club. In the financial world, only a handful of women have reached the top ranks. They include Sallie Krawchek, former president of Bank of America’s (BAC) investment management division, who has been discussed as a possible candidate for the chair of the SEC; Ina Drew, JPMorgan Chase’s (JPM) former chief investment officer, who resigned in May after the bank suffered a $6.2 billion trading loss; and Mellody Hobson, president of Ariel Investments, the $3 billion Chicago-based money management firm.

Johnson joins this group as Fidelity faces some of the biggest threats in its 66-year history. Fidelity still churns out big profits; it racked up operating income of $3.3 billion in 2011 on revenue of $12.8 billion, primarily from brokerage commissions and fees in its asset management, investment advisory, and record-keeping businesses. But Fidelity is no longer the largest mutual fund company in the country based on assets under management. It lost that position to Vanguard in 2010. And its target customers are increasingly moving away from actively managed stock funds—long Fidelity’s signature product—and into passive stock funds and more conservative fixed-income funds.

To fix the family business, Johnson can rely on input and guidance from a large team of executives, including her formidable father, now 82, who took the small Boston investment firm founded in 1946 by his father, Edward Johnson II, and turned it into a colossus. On at least one issue, though, she’ll likely be operating alone. Financial firms, particularly in wealth management, often prosper with a personal touch. Think Charles Schwab or John Bogle at Vanguard. A woman atop the company—guiding strategy in the boardroom and delivering the message on TV—could attract a raft of new customers. The question is: Does Abby Johnson want to be that woman?

Born in 1961, Johnson is the eldest of Ned and Elizabeth “Lillie” Johnson’s three children. Raised on Boston’s North Shore, she had a classic Boston Brahmin upbringing, attending the tony Buckingham Browne & Nichols school in Cambridge, summering at the family estate in Maine, and majoring in art history at Hobart and William Smith Colleges. Despite the family’s fortune, estimated at about $22 billion today, she grew up with a flinty distaste for public displays of wealth, working as a waitress one summer, answering customer service calls at Fidelity during another. The Johnsons were rarely in the newspapers; even today, Ned can walk down the street in Boston unrecognized, says John Bonnanzio, the editor of Fidelity Monitor & Insight, an investment newsletter.

After graduating from college in 1984, Johnson went to work not at Fidelity, but as an associate at the management consultant Booz Allen Hamilton (BAH). She went to Harvard to get her MBA, graduated in 1988, and was married that summer to Christopher McKown, a health-care entrepreneur she’d met when they both worked at Booz. They moved into the home they live in today with their two teenage daughters in the Boston suburb of Milton. The seven-bedroom house on a wooded 5.6-acre estate belonged to her grandfather.

Abby went to work for Fidelity shortly after her marriage, beginning a rigorous and long-running apprenticeship. She started as a stock analyst and then became a portfolio manager. From 1988 to 1997, she worked at six different funds and clocked in as one of Fidelity’s top managers in the first six months of 1995, with 25.2 percent returns on Fidelity’s $1.9 billion OTC Portfolio (FOCPX).

Johnson moved out of portfolio management in 1997 and into Fidelity’s middle-executive ranks. During the next 14 years, she worked in virtually every key area of the company, running its equity information technology systems, the equity division, and its immense, now $1.5 trillion mutual fund operation. She also ran Fidelity’s vast retirement and benefits administration business, the area that includes Fidelity’s 401(k) division.

In the process, Johnson gained respect for her mastery of technology and management processes, says Ronald O’Hanley, Fidelity Investments’ president of Asset Management and Corporate Services, who adds that “she is really driven by things that others might find exhausting or even uninteresting.” And by an almost obsessive focus on the needs of Fidelity’s customers, “even if it’s not the best thing, from the point of view of our bottom line,” he says.

Soft-spoken and understated, she became known as a manager with a collaborative style, more in the mold of her collegial grandfather than her brusque father. “She is very much a person who encourages debate and discussion,” says O’Hanley. “She doesn’t lead by fiat or by raising her voice or by asserting that she is the smartest person in the room.”

By 2007, Johnson had climbed to the senior-most executive ranks. In August of that year, Fortune reported she had lost weight and that so much of her hair had fallen out that she was wearing a wig. Inside Fidelity and in the media there was speculation that she had cancer; it was never openly discussed at the company, which refused to comment publicly. Throughout this period, Johnson rarely missed a day of work.

Over the years, other executives who might have run the company have left one by one. Robert Pozen, the mutual fund chief, departed in 2001. In 2007, Ellyn McColgan, who’d helped build Fidelity’s brokerage system and who was a rival for the top job, left, as did Robert Reynolds, the company’s chief operating officer and now president and CEO of Putnam Investments.

Among her biggest challenges, according to analysts, is repairing the hit Fidelity has taken to its market share. Since the end of 2008, Vanguard’s stock and bond mutual funds have attracted $274 billion from investors, according to Lipper Analytical Services, compared with $52 billion for Fidelity. The company was particularly bruised by the huge market drops from the dot-com bust and the 2008 meltdown, which sent investors fleeing managed funds for such lower-cost vehicles as index and exchange-traded funds.

Fidelity almost completely dropped the ball in developing ETFs, fearing they would cannibalize its managed funds. Despite the thin profit margins on ETFs for fund companies, says Bonnanzio, Fidelity’s decision not to move aggressively into the $1.8 trillion market “was a mistake.”

Fidelity’s O’Hanley questions the emphasis on market share. The company, he says, does not just focus on assets under management, now at $1.6 trillion, but also on its assets under administration—funds it holds for its customers but does not direct—which account for another $2.2 trillion. This includes non-Fidelity products like mutual funds and ETFs of other firms, such as BlackRock (BLK), which Fidelity sells on its “open architecture” platform. Still, Fidelity may be playing catch-up. This month it filed an application with the SEC for permission to introduce ETFs that would be run by Fidelity’s active stockpickers.

The issue is not that Fidelity lacks good products, it’s that the firm hasn’t done as well as it needs to in marketing itself, says James Lowell III, chief investment officer of Adviser Investments and editor of Fidelity Investor, an independent newsletter. “Where they have failed utterly is to attract inflows,” says Lowell. “That’s where they’re getting smoked by literally inferior products, even high-priced products. Fidelity’s indexed funds are lower priced than Vanguard’s, and yet Vanguard continues to be able to convince investors that it’s got the low-priced product,” he says. Fidelity has “the product. They have excellent service, they have an excellent platform, they have an excellent understanding of their business. They just need to let people know about it.” With Abby Johnson at the helm, he says, it’s the perfect moment for Fidelity to revitalize its image.

Here Johnson, who possesses many of the qualities of a public leader, could step in. Lowell is betting that, like Schwab and Bogle, Johnson will rise to the challenge. She has started to be comfortable making speeches and appearing at large events. “She has got to do a better job of being a little bit more public,” he says. “Replacing one CEO with a very dynamic, committed CEO—and in this case gender matters—that is your moment to rebrand. And she knows it.”

Fidelity has said Ned Johnson has no plans to retire, making it hard to predict how long his lion-in-winter phase will last. It won’t last forever. In April, the Greater Boston Chamber of Commerce dinner honored the Johnson family for their contribution to the city. It was a rare public appearance for Ned Johnson, who looked frail. Abby, dressed in a simply tailored silvery blue suit, stepped to the podium, adjusted her glasses, and began to speak on behalf of her family. “On some level, the curtain was closing,” says Bonnanzio.

“I think it’s been difficult to give Abigail her due,” he says, “difficult for her to really make her mark, given that she has always been in the shadows of her father. It’s going to be fascinating when her father leaves the stage.”

Andrews is a Bloomberg Businessweek contributor.

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Miami Condo Market Shows a Way to Solve Inventory Glut

Don’t look now, America, but Miami might actually be setting a positive example for the rest us.

Never mind how my hometown’s biodiversity features corruption, gaping income inequality, and octagenarians who floor their 30-foot sedans to make early-bird dinner specials. More recently, South Florida was a hotbed of subprime excess that gave rise to an absurd number of half-financed, quarter-occupied condo towers. That overdependence on glass, concrete, and teaser mortgages left the local economy devastated once housing collapsed.

A cautionary tale for the ages … or for all of five years.

No less an authority than the Federal Reserve Bank of Atlanta has issued a report (PDF) that highlights how Miami is successfully shedding its inventory overhang, so much so that the local real estate market is suddenly hungry for new condos. It brings to mind this recorded interview Mitt Romney gave to a newspaper in Nevada, which sits right beside Florida in terms of pain felt from the housing crisis. The lessons: allow investors—all walks of them—to buy distressed properties; fix them up and fill them with renters; let increasing rents and the natural push of demography drive increased property prices.

“The presence and health of birds,” the report begins, with a flourish of taxpayer-funded metaphorical license, “often signal the health of an environment. An abundance of waterfowl, for example, can signal that the surrounding wetlands are healthy. An unhealthy canary in a coal mine indicates the presence of toxic gases. One ‘bird’ that indicates the health of the real estate development industry is the construction crane, and it appears to be making a comeback [in Miami].”

Florida, like the bottoming national market for new homes, is benefitting from a growth in population. A headcount of nearly 20 million Floridians has the state on track to become the nation’s third-largest by 2013, when it’s expected to surpass New York. Next year is also when nearly all of the area condos developed during the bubble are on pace to sell out; as of the second quarter of 2012, just 3,400 units out of 49,000 condos created were unsold in South Florida’s seven largest coastal markets, according to Peter Zalewski, principal of Condo Vultures, a local brokerage and research firm that was quoted by the Atlanta Fed.

“South Florida’s newest condo boom-and-bust cycle is just getting started,” he says. “Developers are already rushing into the market to secure their sites.” Zalewski says he has tallied 70 proposed towers in South Florida, with nearly 10,500 condo units planned—18 percent of them already sold. “The only thing they’re waiting for,” he says, “is the return of condo construction financing, which is still elusive in South Florida.”

Zalewski says South Americans with strong currencies are prodding developers to overcome their financing hurdles by offering cash installments of 30 percent to 80 percent of a new condo’s contracted purchase price. And so nearly 20 construction cranes have been ordered to return to South Florida in short order.

As for all that inventory from the Great Miami Overbuild of 2005? The Atlanta Fed report notes how a re-prioritization of renting—by both new renters and condo owners who were previously fixated on flipping for gains—has helped fill a skyline full of empty boxes: “The past several years’ distressed housing market—including the limited access to financing—may have forced many residents (and visitors) into renting. The now-flourishing rental market may be helping to bolster condo development, as the sharp growth in rents may be causing some consumers to reconsider alternatives such as trading down to rent a cheaper multifamily unit or trading out to rent a single-family home or to pursue homeownership.”

Yes, much of this rebound is idiosyncratic to Miami, which is already one of the nation’s more idiosyncratic cities. “While it would be nice if the anticipation being felt in Miami could be translated to a rosier picture for the broader economy,” concedes the report, “factors such as international demand make the South Florida condo market not necessarily representative of the rest of the country.”

Still, the mere fact that a sense of fundamentals-driven investment can take hold in a market never quite known for sober capital allocation should give some a reason for hope.

Farzad is a Bloomberg Businessweek contributor.

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If Only T. Boone Pickens Had Died

One morning in September 2007, billionaire oilman T. Boone Pickens and 27 men and women gathered in the lobby of Oklahoma State University’s Gallagher-Iba Arena to celebrate that they were all, one day, going to die. Three things united the orange-and-black-clad Cowboy fans: They all were more than 65 years old; they all loved their alma mater; and they all had passed a rigorous physical. “We’re partners in a deal,” Pickens, a graduate of the class of ’51, said once the chatter had died down. “It’s a good deal.”

The deal in question was called Gift of a Lifetime, a name meant to be read literally. Each of the 28 partners had allowed the school to take out a $10 million insurance policy on his or her life, with the annual premiums to be paid by Oklahoma State. For donors, the appeal was simple. The plan cost them nothing. In return they received a bronze statue of the school mascot (a bucking bronco named Pistol Pete), a plaque on the side of the stadium, and the knowledge that their deaths would enrich the school they loved.

Photograph by Tony Gutierrez/AP PhotoPickens, with Holder in 2007, has given his alma mater nearly half a billion dollars

For Oklahoma State, life (or, more appropriately, death) was not so simple. To make money, the school had to outsmart Lincoln Financial Group (LNC), the insurance company behind the polices. Pickens believed he had found a better formula than Lincoln had for figuring out when people were going to die. With this edge, the school predicted that Gift of a Lifetime would eventually net its athletic department as much as $225 million. “Imagine endowing all of OSU’s Athletic Scholarships,” read the program literature. “Sound too good to be true? It’s not.”

Life insurance is the rare investment where policyholders don’t mind losing money, since doing so means living longer. The practice of investors trying to make money on death did not take hold until the 1980s, when they sought out people with AIDS, paid out part of their death benefits, and then waited to collect the profits once the patients died at an early age. Pickens and Oklahoma State envisioned something different: Instead of making money on existing policies, they’d take out their own. And they weren’t the only ones considering the plan. “Everybody is looking at it,” Pickens assured the crowd at the Gift of a Lifetime launch.

Many of the school’s biggest rivals were doing their best to cast Pickens’s plan as morbid. “It has a bad feel to it,” Joe Castiglione, University of Oklahoma’s athletic director, told the Los Angeles Times. Privately, more than 100 schools, hospitals, and nonprofits were already looking to create their own version of Gift of a Lifetime, including four universities that, like Oklahoma State, belong to the Big 12 Conference.

This dynamic—criticized in public, copied in private—was a familiar one for Pickens. Early in his career he’d gained infamy as a corporate raider, making the cover of Time in 1985 after trying to buy energy giant Gulf Oil. At 79 years old, he now was eager to see his alma mater’s fortune change, and in possession of nearly $3 billion to make more change happen.

The Cowboys needed the help. When a pay-to-play scandal put the football team on probation in 1989, the school began treating its athletic department the way a family might treat a member who gambles compulsively. Spending on basic maintenance dropped so low that rivals began referring to the football team’s Lewis Field as “Rust-Oleum Stadium.” In a conference full of billion-dollar endowments, the Cowboys were paupers. Then came Pickens.

After helping install his own handpicked athletic director, Pickens opened his wallet. From it flowed nearly half a billion dollars, half of it earmarked for sports. Gift of a Lifetime would create its own billfold of cash, and Pickens was so confident he had begun looking to sell the idea to others in exchange for a healthy commission.

Unfortunately for Oklahoma State, Pickens, and the other men and women who thought their demise would benefit their favorite university, Gift of a Lifetime has turned into the Present from Hell. First it fell apart. Then came the lawsuits. And this past March came a decision from a federal judge who declared that not only was the university not entitled to a refund of $33 million in premium payments, it was also responsible for the court costs incurred by the people it had sued.

So how did a sure bet turn into a lost cause? Pickens and the school aren’t talking, as they’ve since appealed the judge’s decision. Neither are the insurance brokers and agency that sold the policies. Yet because it’s a matter of interest in federal court, the arc of Gift of a Lifetime’s downfall can be traced in the thousands of pages of internal e-mails and deposition testimony that are now a part of the public record. Those documents reveal a plan sunk by impatience, hubris, and a belief that the hour of death could be predicted. One that all began when Pickens took his shirt off.
According to his autobiography, The First Billion Is the Hardest, the seeds of Gift of a Lifetime were planted during a routine physical. An athlete all his life, Pickens had adopted racquetball as his sport of choice at age 30. Mesa Petroleum, his first company, had once been named the fittest in the U.S. by the President’s Council on Physical Fitness and Sports. And though he was almost 80, Pickens still woke at 6:30 every morning to work out—a fact not lost on his doctor, who told him he was in such good shape he could be insured at a standard rate. “I had an immediate thought,” wrote Pickens: “Can you monetize good health?”

That thought led him to consult Glenn Turner Jr. and John Ridings Lee, two brokers who had recently sold the billionaire $100 million worth of life insurance. The pair concocted a plan that required the university to take out a $165 million loan to cover the annual premiums, with the interest on that loan paid through a $20 million gift from Pickens. The loan would be gradually paid back as the alumni died, which the broker’s “matrix”—the name they’d given to the actuarial table of their own design—forecast would start happening in the third year. That meant the school thought it would be out no more than $20 million—itself a gift from Pickens—before the money started rolling in. Even if the alumni lived years longer than the matrix indicated, Lee and Turner predicted the school’s final take would be $157 million. Assuming that the university stuck to the plan.

Over the next six months, Lee and Turner presented their plan multiple times to members of the Oklahoma State University Foundation, the school’s fundraising body. Each time it found something different to fret over. At one meeting, a foundation board member, Ross McKnight, said “people never die as soon as anticipated.” The foundation’s president wrote in an e-mail that “it looks too good to be true” and hired outside consultants who warned that wealthier people—the program’s target audience—tended to outlive even the most optimistic predictions of actuaries. When another consulting group raised even more pointed questions, Bobby Stillwell, Pickens’s personal attorney, complained about their “rude and confrontational manner” and asked of the foundation’s president, “Why would he want to drag this down?”

To Pickens and Stillwell, the foundation was a permanent source of frustration. Not only did it control the university’s purse strings, it was reluctant to open them. Fortunately there was a way around the foundation.

As Oklahoma State’s notoriously hard-charging golf coach, Mike Holder had won eight national titles, mentored such future PGA Tour pros as Bob Tway and Scott Verplank, and raised every cent needed to build what many consider the best college golf course in the country. For years, Holder had made pilgrimages to Pickens’s 65,000-acre ranch in the Texas Panhandle, where the two hunted quail and talked about Oklahoma State’s future. Holder’s investments in Pickens’s various ventures had made him wealthy, and each saw in the other a determination to improve the school they loved. Holder was instrumental in getting his friend to donate $70 million to the school in 2002. But he wanted more.

In 2005, Holder asked for a commitment of hundreds of millions of dollars to upgrade Oklahoma State’s sports facilities. Pickens told him he’d agree to donate the money only if Holder applied for the school’s vacant athletic director position. Holder was soon hired. Not long after, Pickens cut a check for $165 million, the largest donation in the history of collegiate athletics, which was soon moved to his hedge fund, BP Capital, with a promise that he’d manage the money while waiving his normal fees.

While the foundation dragged its feet on Gift of a Lifetime, Holder created a nonprofit called Cowboy Athletics to house Pickens’s donation. Where the foundation insisted on taking votes and keeping minutes, the new entity, so named to reflect a narrower focus on just Oklahoma State sports, was nimble and flush with cash. Its board had only four members, including Holder, Pickens, and his attorney Stillwell, whom he referred to as his “point man.” In January 2007, Pickens called Stillwell. “Let’s get this done,” he told him.

Cowboy Athletics began rounding up prospects, sending out brochures with Gift of a Lifetime written in elegant script and cold-calling elderly donors. Eventually 50 people volunteered, each one visited at home by a doctor and a nurse with a portable EKG machine, where they received what Donna Cummins (class of ’61) called “one of the best physicals I’ve ever gotten.” As the insurer, Lincoln Financial got to approve who could sign up and selected 27 people—15 men and 12 women, including Cummins.

Photograph by James Schammerhorn/OStatePhotoBy the time the stadium was renamed in 2009, Gift of a Lifetime had become the Present from Hell

While Cowboy Athletics was out searching for participants, Pickens was pressuring Holder and Stillwell to finish the deal by Feb. 7, 2007. That’s when he was hoping to present the program to the Ronald Reagan Presidential Foundation & Library, where he was a trustee along with Rudy Giuliani, Steve Forbes, and Rupert Murdoch. (Meeting notes suggest the trustees in attendance were unimpressed.)

“To repeat the obvious,” wrote Stillwell in an e-mail a week before the meeting, “all our heads will roll if the OSU plan is not announced as ‘done’ by the Feb 6 or 7 date.”

“If this isn’t complete by Feb 7 you won’t find me in this country,” wrote back Holder in a response included in court filings. “I will be in a cave with Bin Laden.”
The original plan had been for Oklahoma State to take out a long-term loan to finance the premiums. Yet just two weeks before Pickens’s deadline, insurance brokers Lee and Turner learned Cowboy Athletics could not get the loan. In a phone call with Holder, they discovered that every cent of Cowboy Athletics’ investment in Pickens’s hedge fund, BP Capital, had already been pledged as collateral to Bank of America (BAC) in exchange for a $100 million line of credit to upgrade the football stadium.

Lee was irritated. For the past six months he’d been sending Cowboy Athletics’ balance sheets to prospective lenders. What once looked like $300 million of free and clear cash—BP Capital’s investments in oil and natural gas were bringing back huge returns—was now spoken for.

Turner e-mailed Stillwell, reiterating the risk of starting the program without the loan. Stillwell, presumably speaking for Pickens, disagreed. “Go ahead and release the funds,” he wrote. “The risk [of losing money] is low to nonexistent.”

So began a pattern. Every month, Lee and Turner would pepper Stillwell and Holder with e-mails and phone calls about the need to secure a loan. (Pickens wasn’t e-mailed because he didn’t and still doesn’t have an e-mail address.) And every month they’d receive some variation on the same response: “We’ll handle it.”

To pay the initial $16 million premium, Cowboy Athletics had taken a short-term loan from Stillwater National Bank (OKSB). It could have paid the bill from its investment gains in BP Capital, but the hedge fund was returning 30 percent a year (Cowboy Athletics’ initial $200 million stake would eventually peak at $407 million), and Holder wanted that money to keep working for them.

Meanwhile, in phone calls with Lee and Turner, Pickens began discussing ways to market Gift of a Lifetime—which he was now calling the Pickens Plan—to other nonprofits and universities. The Humane Society was interested. So was Brown. Yale said it wanted 50 alumni participants. Even the once-reluctant OSU Foundation had changed its mind. Now it not only wanted its own plan, it also wanted a Gift of a Lifetime program big enough to raise $1 billion. The conversation had just turned to Pickens’s fee—he wanted a 50 percent cut of the commission, to be split between him and Stillwell—when the stock market collapsed.

In four months, Cowboy Athletics lost $282 million. “Looks to me like you are going to have to take a little ‘pause’ in your construction,” wrote Stillwell to Holder on Sept. 3, 2008. “I don’t know about relying on [Pickens] for more money?…?it’s ugly around here.”

When Bank of America made a margin call on its line of credit, Cowboy Athletics was forced to liquidate its investment with BP Capital to pay off the stadium loan. With all of its Gift of a Lifetime alumni still above ground and another premium payment due, Cowboy Athletics was suddenly stuck with a $16 million bill it couldn’t pay. Pickens flew to Charlotte to persuade Lincoln Financial officials to let the university out of its deal, to no avail.

Photograph by Zach GrayPickens picked up the cost of the premiums after the deal fell apart

Pickens and Holder soon seized on a counter narrative: They’d been duped. Holder revealed that he had been in such a rush to meet Pickens’s deadline that he never read some of the insurance papers. Cowboy Athletics insisted this meant that the policies weren’t valid, so after having spent two years and $33 million under the impression that they were very real, it canceled them and asked for its money back. Cowboy Athletics and Pickens sued this past January in Oklahoma district court, alleging they had been defrauded by Lincoln and the brokers Lee and Turner. Lincoln filed its suit on the same day in federal court in Dallas.

Federal Judge Jorge Solis did not buy the argument that Lee and Turner had pulled a scam. In March he awarded summary judgment to Lincoln, Lee, Turner, and another insurance broker, while also ordering Cowboy Athletics and Pickens to reimburse their court costs. They’ve since appealed.

Oklahoma State’s athletic department may not be funded in perpetuity, but Boone Pickens Stadium is now fully renovated, thanks to its namesake. Pickens also made sure that his alma mater didn’t lose a penny in the deal; it was his guarantee that allowed the school to take out the loan to pay the premiums, and he’s now the one repaying Stillwater National Bank at a cost of $3 million per quarter. The football team finished 12-1 last season, its best showing ever. And the 28 men and women who half a decade ago were considered safe bets to die sooner rather than later? All are still with us, not the least being Pickens himself. As Roy Scott (class of ’56) put it, the problem may have been as simple as picking the wrong people: “We just live too long, I guess.”

Hannan is a Bloomberg Businessweek contributor.

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New Word of Insider Tips at SAC Capital

Steven Cohen’s SAC Capital Advisors, one of the biggest and most successful hedge funds, has landed repeatedly in the crosshairs of the federal crackdown on insider trading. Cohen was deposed by the U.S. Securities and Exchange Commission earlier this year about whether he illegally bought and sold stocks using inside information, two people familiar with the matter said in June. U.S. prosecutors said last year they were looking at trading accounts at SAC, including one run by Cohen that draws on the best ideas from the firm’s portfolio managers and analysts.

Some of those ideas apparently came from questionable sources. A former SAC portfolio manager told the FBI that it was “understood” that people assigned to give their best recommendations to Cohen would deliver insider information, according to an agent’s notes of the conversation. The former fund manager, Noah Freeman, pleaded guilty to securities fraud in February 2011 after speaking to FBI agents and federal prosecutors in New York in late 2010. “Freeman and others at SAC Capital understood that providing Cohen with your best trading ideas involved providing Cohen with inside information,” according to a Dec. 16, 2010, memo written by FBI Special Agent B.J. Kang.

The memo turned up in court filings in a related case. It doesn’t quote Freeman saying Cohen, 56, knew the information came from illegally obtained tips, ordered Freeman to provide them, or traded on the data. Neither Cohen nor Stamford (Conn.)-based SAC, which manages $14 billion, has been accused of criminal or civil wrongdoing. “Mr. Freeman testified under oath that he went to great lengths to hide his illicit activities from SAC by, for example, using code words and communicating off of firm systems,” says Jonathan Gasthalter, a spokesman for SAC. “His testimony makes clear that SAC did not condone his activities.”

The federal assault on insider trading burst into public view in October 2009 with the arrest of Raj Rajaratnam, co-founder of Galleon Group. Freeman is one of five current or former SAC employees implicated so far. Michael Steinberg, a portfolio manager at SAC’s Sigma Capital Management unit, has been placed on leave by SAC, a person familiar with the matter says. He’s an unindicted co-conspirator in the case against Jon Horvath, a former SAC analyst he supervised, people familiar with the case say. Horvath pleaded guilty to charges of securities fraud on Sept. 28. Steinberg hasn’t been charged with a crime.

Prosecutors in the office of Manhattan U.S. Attorney Preet Bharara last year accused Freeman and another SAC fund manager, Donald Longueuil, of being part of an insider-trading scheme while at SAC. Freeman, Longueuil, and two others charged in the case have pleaded guilty to criminal insider-trading charges. Longueuil, 36, is serving a 2?-year prison term. Freeman is cooperating with prosecutors and hasn’t been sentenced. In April 2011, Jonathan Hollander agreed to settle SEC allegations that while working as an analyst at SAC he traded in his personal account using inside information about a pending takeover of the Albertson’s grocery chain.

Freeman, 36, a 1999 Harvard graduate who said he once managed a $300 million portfolio of technology stocks at SAC, spoke at length with the FBI. Excerpts of his interviews were filed in federal court in New York by Winifred Jiau, a former consultant with Primary Global Research who was convicted last year of insider trading and is appealing her conviction.

At one point in his career at SAC, Freeman, who worked in the firm’s Boston office, said he sat next to Cohen. “Freeman pitched to Cohen many trading ideas over the 18 months he was at SAC and some of the trading ideas involved dirty information,” according to the memo by Kang. “At SAC Capital you were paid a percentage of Cohen’s trade if Cohen placed a trade based on your tip,” Freeman said, according to the Kang memo. “It was clear to Freeman that to survive at SAC Capital, you had to feed Cohen with trading tips.”

Benjamin Rosenberg, a lawyer for Freeman, declined to comment on the memos filed about his client. Ellen Davis, a spokeswoman for the U.S. attorney, also declined to comment, as did FBI spokesman Jim Margolin. Steinberg’s lawyer, Barry Berke, declined to comment on his client’s status at SAC. Steve Peikin, a lawyer for Horvath, didn’t respond to a request for comment.

Bradley Simon, a former federal prosecutor, says FBI memos like the one about Freeman aren’t taken under oath and aren’t admissible at trial because they’re hearsay. Still, lying to federal investigators in such situations can constitute a felony. “By ultimately giving Freeman a cooperating agreement, the government made a determination in their view that what he said was true,” says Simon. “Otherwise, they wouldn’t have signed him up.”

Legal experts say that while federal probes usually take time, new guilty pleas, such as the one by Horvath, signal that they’re progressing. “While there’s no way to know if Mr. Cohen is or isn’t a target, everyone is at risk,” says Anthony Sabino, a law professor at St. John’s University in New York. “Not just someone like Cohen or people who worked at SAC, but anyone who’s dipped their toe into the pool of insider trading better watch out as more people plead guilty and agree to cooperate.”

The bottom line: A former portfolio manager at Steve Cohen’s $14 billion hedge fund told the FBI that he gave his boss tips based on inside information.

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Getting Banks off the Roller Coaster

Bank executives like to say that their most important job is managing risk. This does not mean they’re good at it. Banks the world over have often failed to monitor hazards properly, blowing up spectacularly every few decades. Regulations drafted in the wake of the global financial crisis were supposed to curb dangerous behavior. Yet the complex new rules repeat a mistake that led to the banks’ troubles in the first place: They assume bank executives and regulators can figure out what is risky.

Now a handful of regulators on both sides of the Atlantic are pushing for a less complicated approach. They argue that the only way to make sure financial institutions don’t fail when their bets go bad is by relying on dead-obvious restrictions on leverage. For every dollar of capital a bank has, it can lend a fixed amount, say $10, regardless of how risky or non-risky it claims that loan to be. That way the bank can take any risk it wants as long as there’s enough shareholder equity to cover the potential losses—so taxpayers aren’t stuck with the tab if it collapses.

Andrew Haldane, executive director of financial stability at the Bank of England, and Thomas Hoenig, a board member of the U.S. Federal Deposit Insurance Corp., are the leading voices in this back-to-basics movement. “There’s scope for significant simplification of the rules,” says Haldane. “An advantage of the leverage ratio is that it doesn’t pick certain assets as winners and others as losers.”

Banks in some 100 countries are bound by the Basel Accords, a set of regulatory standards named after the Swiss city where officials gather to forge those rules. Under Basel, the minimum capital requirement is determined by looking at a bank’s risk profile, which institutions calculate using their own complex formulas. The third installment of the Basel framework, which countries will start phasing in next year, ratchets up the minimum ratio to 8 percent; it does not question whether banks do a decent job of estimating the risk of their own loan portfolios. “The whole Basel approach has failed miserably because it allows the banks to focus on gaming the system,” says Anat Admati, a finance professor at Stanford University. “The simpler you make the capital rule, the harder it becomes to game it. That’s why simple leverage can work better.”

In a paper presented at a gathering of central bankers in August, Haldane showed that the simple leverage ratio would have been a better predictor of failures in the last crisis. He also noted that the models banks use to measure risk involve millions of variables and assumptions, rendering them impossible to monitor for accuracy by regulators. Using its secret in-house formulas, Deutsche Bank (DB) calculates its risk to be 20 percent of assets. JPMorgan Chase (JPM) says about half its balance sheet is risky.

The latest Basel rules do introduce the simple leverage concept for the first time, though as a secondary requirement to the minimum capital ratio. Haldane has said the Basel target of 3 percent of assets is lower than he would like, though he has shied away from offering his own number. Hoenig has proposed 10 percent. Sheila Bair, former chairman of the FDIC, favors 8 percent. Senator Sherrod Brown (D-Ohio) has introduced legislation that would set a 10 percent leverage limit.

If U.S. regulators adopted Hoenig’s proposal as part of their implementation of Basel III, the four largest U.S. banks would have to increase their capital by $300 billion, according to Bloomberg Businessweek calculations. That would mean selling new shares or holding on to profits. Bank of America (BAC) would have to suspend its dividend for 12 years.

Banks have resisted calls for higher capital requirements, saying they would end up curtailing economic growth. Because there isn’t enough investor demand for bank shares, financial firms would have to reduce assets to comply with a higher ratio, bank executives say. That means less lending for companies and consumers. The Institute of International Finance, a lobbying group, estimated in 2010 that new financial regulations would shave 3 percent from global economic output. The International Monetary Fund recently published a study refuting such claims.

Unlike Hoenig, Haldane doesn’t advocate ditching Basel altogether. Bringing simple leverage to the forefront and pushing risk-based calculations to the background would make Basel much more powerful, Haldane argues. Bair agrees, especially if banks aren’t allowed to rely on their own risk models but are given standard risk scores for different asset categories. “Simpler and standard across-the-board risk weighting can help the leverage ratio in restraining banks,” she says.

Yet even standardized measures can fail to spot risk in advance. Before the subprime crisis, mortgage lending was assigned a very low risk factor, while the sovereign bonds of most developed nations were seen as risk-free. If there’s one lesson the world should have learned about banking risk by now, it’s that it’s unpredictable.

The bottom line: Banks are resisting calls for the introduction of simple restrictions on leverage, saying they would restrain lending and dent growth.

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Ready or Not, Homebuilders Are Back

Standing on a rough plateau in the foothills of Orange County’s Santa Ana Mountains, Seth Ring swears that on a clear day, you can see the Pacific Ocean. That vista is part of what makes Ring, a vice president at the nation’s largest luxury homebuilder, Toll Brothers (TOL), excited about the land under his feet, an undeveloped 387-acre site 50 miles south of Los Angeles. Toll plans to put up as many as 1,780 houses in a joint venture with Shea Homes. Here, orange earthmovers have begun digging into the shrub-strewn soil to make way for the sewers, roads, and other infrastructure that must be in place before model homes can open in 2014. “This,” says Ring, “is our big ‘we’re back in’ play.”

The development is one more sign that homebuilders are putting the bust behind them. As a group, the 13 publicly traded builders tracked by Bloomberg Industries turned a third-quarter profit for the first time in five years. D.R. Horton (DHI), which builds the most homes in the U.S., reported operating income of $76.1 million in the period, up almost 50 percent from a year earlier. On Aug. 22, Toll announced third-quarter net income of $61.6 million, up 46 percent from the previous year. On Sept. 21, KB Home (KBH), which targets first-time buyers, reported quarterly earnings of $3.3 million—its first third-quarter profit since 2006. KB’s results, Barclays (BCS) analyst Stephen Kim wrote in a note, “confirmed that the pace and breadth of the housing market gained momentum over the summer. … We continue to believe that 2012 is proving to be the beginning of a sustained housing recovery.”

While many private builders went under during the recession, large, publicly traded builders, which construct almost 30 percent of the nation’s new homes, survived by cutting back production, renegotiating land contracts, and bargaining harder with suppliers. They used cash on hand to scoop up cheap properties and take advantage of opportunities such as Baker Ranch. Toll paid $110 million in June for a 50 percent share in the project, which city officials approved last year. Finding large parcels of buildable land in coastal Orange County is “pretty much unheard of,” Toll Chief Executive Officer Douglas Yearley told investors in August.

Builders cut back so much during the downturn that they didn’t add enough homes to keep up with population growth, Ring says. Nationally, there’s been a little more than six months’ supply of new and existing homes for sale this year—about half as much as when supply peaked in summer 2010. A June report by data firm CoreLogic (CLGX) found that inventory is particularly tight in places such as California, Nevada, and Florida, where homeowners often owe more on their mortgages than their homes are worth and therefore don’t want to sell.

Meanwhile, demand is picking up. Ring says Toll started looking at the Baker Ranch project last fall, as the company saw more visitors to its sales offices and more people buying its higher-priced homes in California. “Think about what happened to your life in the past seven years,” he says. “I got married and had two kids. Your life’s needs may outweigh your trying to buy at the bottom of the market.” Plus, there’s been an influx of international buyers. “That’s the buzzword right now,” Ring says, estimating that Chinese families make up as much as 40 percent of Toll’s buyers in some Southern California developments.

Photograph by Bear Guerra for Bloomberg BusinessweekRing says buyers from China represent 40 percent of sales in some developments

As Ring heads north to another Toll project, maneuvering his slate-gray Prius down the hillside, it becomes clear that Toll is not the only optimist. Those hunched-over strawberry pickers in that nearby field? They’re on a corner of what will be an almost 5,000-home development financed by Lennar (LEN) and other builders. “We’re looking to buy sites here, maybe,” Ring says, before hopping on a highway that snakes north along the Santa Ana foothills. Twenty minutes later, he swings past Amalfi Hills, a 113-home site that Toll bought from a developer that mothballed it. A mile down the road is Vista Del Verde, a 1,750-home community that Toll began developing in the late ’90s. After slowing during the crisis, sales have doubled this year. Only 200 homes remain unsold. The Tuscan, Mission, and Federal-style houses max out at about 6,000 square feet.

At Baker Ranch, the largest homes will be about half that size, and those going up during the first stage of construction will be even smaller. Plans include community centers where residents will have more room to entertain. “When the economy is booming, people tend to want something bigger and better,” Ring says. Now, “people are a little more discerning. Maybe we don’t need that fifth bedroom.”

Toll signed contracts on 3,061 homes this year through Sept. 30. While more than in any full year since 2007, that’s well below the peak of 10,796 in 2005. Analysts say the going may get tougher from here. As they ramp up activity, Toll and other builders have been able to restart older projects and concentrate on prime locations. After those opportunities are exhausted, “at some point you are going to have to start going to the periphery,” says David Goldberg, an analyst at UBS (UBS). When builders move further out into the exurbs, Goldberg says, they’ll face more competition and will find their profit margins squeezed. Another concern, he says, is the overall state of the economy: “It’s going to be tough to keep growing at 20, 30, 40 percent a year if we don’t have more macroeconomic improvement.”

Investors have already benefited from the homebuilders’ rebound. The Standard & Poor’s (MHP) homebuilders index has climbed 79 percent this year. That surge has made Goldberg and other analysts cautious about the outlook for further homebuilder stock gains this year. On Sept. 26, the U.S. Department of Commerce reported August new-home sales fell 0.3 percent from July, to an annual rate of 373,000 new homes, less than the 380,000 analysts expected.

Ring starts descending from Vista Del Verde to head back to Toll’s nearby office, itself a reminder of how big a hit the company took in the bust. Toll used to occupy an entire floor of a five-story building. Now about a dozen people work in one suite, sharing the floor with a law firm and a stockbroker. Ring wears a lot of hats, and now he’s running late for a meeting with a decorator. They need to pick out furnishings for a model home at Amalfi Hills that’s supposed to open early next year.

The bottom line: A new Orange County development is a sign of a housing recovery, even as construction remains well below levels of the boom.

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Using Warhols to Save a Failed Company

Long before Peter Brant became a billionaire, he was collecting paintings by Andy Warhol, buying his first while he was in college. Today the 65-year-old industrialist, and husband of supermodel Stephanie Seymour, ranks as one of the largest contemporary art collectors in the U.S.

Brant lost his billionaire status when his family’s newsprint company, White Birch Paper, filed for bankruptcy in February 2010 after newsprint prices tumbled. In a court filing, Brant said his net worth slipped from $1.4 billion in 2007 to less than $500 million in 2010.

Now Brant is using his Warhols to help recapitalize White Birch. The Brant family and Greenwich-based Black Diamond Capital Management, an investment firm that buys distressed debt, announced on Sept. 18 that they had purchased White Birch’s assets, which include three pulp and paper mills in Quebec and a fourth in Ashland, Va. Brant’s collection backed a loan that provided at least some of the capital to complete the deal, according to a person familiar with his plans who was not authorized to speak publicly.

Photograph by Joe Schildhorn/Patrick McMullanBrant (right) with Jeff Koons, one of the artists whose work he collects

Brant pledged 56 works of art as collateral for a loan from Sotheby’s Financial Services (BID), according to a filing by the auction house with New York State. The filing, which did not state the amount of the loan, said Sotheby’s was holding pieces from Brant’s collection including works by Warhol, Jean-Michel Basquiat, Roy Lichtenstein, Jeff Koons, and younger artists such as Elad Lassry and Wade Guyton. Also on the list was Deodorized Central Mass with Satellites, a room-size installation that hedge fund manager Adam Sender sold in 2006 for $2.7 million, an auction record for the late artist Mike Kelley.

A unit of Deutsche Bank (DB) disclosed in an August filing with the Connecticut secretary of state that it received five works of art from Brant as collateral for a loan dated July 31. The works include a 1986 version of Warhol’s Last Supper that’s identical to a piece that sold at Sotheby’s for $6.8 million almost two years ago, as well as a color photograph by Cindy Sherman that sold for $2.9 million at Christie’s in May. Along with investing in White Birch, Brant will use part of the proceeds from the borrowings to finance the purchase of another major piece of artwork, says the person familiar with his plans. Brant declined to comment.

Sotheby’s lends as much as 50 percent of the value of collateral and sometimes allows a higher loan-to-value ratio, according to its annual report. “Most banks are not lending to operating businesses today, so people are looking for alternative sources” of capital, says Andrew Rose, founder of Art Finance Partners, a New York firm that arranges loans to owners of unconventional assets, including art, antiques, and collectibles. “If you already have a home-equity loan and a margin balance on your stock portfolio, where else do you go?”

Brant made monthly visits to the Frick Collection with his father while growing up in Queens, New York, and began collecting art while at the University of Colorado with the purchase of two Warhols and a Franz Kline, according to his website and a profile published by Sotheby’s. He paid for them with money he earned trading securities, including convertible bonds of Occidental Petroleum (OXY), according to a January 2010 interview in the New York Times. Brant went on to buy so many Warhols that the artist eventually asked to meet him, the Times said. He became part of Warhol’s inner circle and, after the artist died in 1987, purchased Warhol’s Interview magazine and made it part of Brant Publications, which includes Art in America and The Magazine Antiques.

Photograph by Metro Pictures/BloombergCindy Sherman

White Birch’s predecessor company was co-founded by Murray Brant, Peter’s father, in 1941. Brant went to work for the company, rising to chief executive officer, a title he still holds. As CEO, he bought additional manufacturing operations from 2004 to 2006, including a Quebec plant once owned by Enron, turning it into the second-largest newsprint manufacturer in North America, with a 12 percent market share at the end of 2009, according to bankruptcy court filings. White Birch’s 2010 bankruptcy filing stated that the recession and rising Internet usage had cut demand for newsprint, costing the company $380 million in revenue since the fourth quarter of 2008.

With top artwork fetching record bids at auction, Brant joins wealthy collectors such as former hedge fund manager Michael Steinhardt in taking out loans backed by paintings to fund other ventures. Steinhardt and his wife last year pledged 20 paintings and drawings, including five by Picasso and one by Jackson Pollock, as collateral for a loan from JPMorgan Chase (JPM), according to New York State records. They used the money to help finance a project that calls for the former American Stock Exchange building to be converted into a retail and hotel complex. Citigroup’s (C) Citi Private Bank has seen a “real uptick” in art-related financing over the past five years, says Suzanne Gyorgy, head of its art advisory and finance group. “This is partially due to the fact that there are more art collectors,” she says, “and also that the value of their collections has increased dramatically.”

The bottom line: With the help of Warhols and other modern art with seven-figure price tags, Brant has bought the assets of his family paper company.

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