2012年4月29日 星期日
2012年4月28日 星期六
Bill Ackman on Seeking a New CEO at Canadian Pacific
Once you have a big stake in a company, you can usually influence its strategy. Before we pick a target we run an algorithm we call Return on Invested Brain Damage—the return has to be high enough to justify the work. Most of the time, management is not the problem. At Canadian Pacific (CP) [of which we own 14 percent], you have a CEO who has underperformed for six years and runs the worst-performing railroad in North America. We’ve sought to replace him with a man who had the best track record in the industry at Canadian National (CNI): Hunter Harrison.
Soon after we disclosed our stake, I spoke to [CP] Chairman John Cleghorn. We agreed to meet at the Montreal airport on Nov. 2. Although I’d said we wanted to talk about a management change, he and [CP CEO] Fred Green were there. After three of us made a presentation, Mr. Cleghorn said, “I’ve spoken to the board and want to let you know we’re 100 percent behind Fred.” I couldn’t believe the board made its decision before hearing our case. I asked to speak to him alone and said, “Look, the last thing we want here is a proxy contest, but if you’re not open to alternatives, we’ll go to the shareholders for support.” I got back on the plane. After the doors were closed and the engines started, the pilot said, “Bill, do you recognize this gentleman on the tarmac?” I looked out the window and there was John Cleghorn, standing in front of our plane with his arms folded. We powered down and I got out. He said, “Bill, I’ve had a chance to talk to Fred Green. He’s prepared to step aside for Hunter; that’s how much he hates CN. The board would like to work with you.” I got back on the plane and said, “That was easy.” We were practically high-fiving each other. I expected a call the next day. Thursday passed. Then Friday. On Saturday, I sent an e-mail and he called to say the board wanted Hunter to meet with their CFO. When I said we could join the board and work together on the CEO transition, he paused: “You want a board seat?” We’d already asked for two. I later realized they were determined to stand by their man.
We’ll take our slate of seven board nominees to a vote on May 17. I don’t like public battles. This is only our third proxy contest in eight years. You have to go to the mat if it’s right for shareholders. — As told to Diane Brady
Wall Street's Favorite Democrat
Wall Street doesn’t have many friends in Washington these days—especially among Democrats on Capitol Hill. They pushed through the massive Dodd-Frank financial overhaul and are scrutinizing derivatives trading and similar high-risk practices.
There is one House Democrat who’s shown some sympathy for Wall Street: Jim Himes. A former Goldman Sachs (GS) investment banker who represents Greenwich, Westport, and other affluent Connecticut towns where many bankers rest their heads at night, he isn’t shy about defending the industry or decrying Wall Street bashing. Banking policy has devolved into a “morality play that is good vs. evil, Democrat vs. Republican, which is absurd,” he says. Dodd-Frank “contains some very, very good things and very important things. And it contains some silly things.”
From his seat on the House Financial Services Committee, Himes has sided with Democrats in resisting Republican calls to repeal Dodd-Frank—which he helped to write and voted to pass—but he’s also joined with Republicans who argue the law puts the industry on too short a leash. This year, he has authored legislation to limit the ability of regulators to oversee international swaps trades, and worked out a deal between the parties to water down requirements that financial firms keep their derivatives deals separate from their federally insured banks. He has also leaned on regulators to ease restrictions on the speculative trading banks do for their own accounts.
No surprise that Himes’s efforts win him kind words from Wall Street. “He brings real-world experience to the table,” says Scott Talbott, chief lobbyist for the Financial Services Roundtable, an industry trade association. “He’s somebody we can work with.” Of the $1.7 million in campaign contributions Himes has amassed to fund his campaign for re-election, nearly $219,000 has come from the securities and investment industry, according to the Center for Responsive Politics.
He’ll likely need all the cash he can get: Republicans have put Himes on their hit list of potentially vulnerable House Democrats targeted for defeat in November. “We plan to hold Jim Himes accountable for his record supporting the president’s big government tax-and-spend agenda,” says Nat Sillin, a spokesman for the National Republican Congressional Committee.
Himes’s Wall Street cred isn’t enough to make Republicans forget that he is otherwise a reliable Democrat who backs President Obama’s health-care reform law, favors tough environmental regulations, and believes his GOP colleagues are kidding themselves if they think they can reduce the deficit without raising revenue. It probably doesn’t help that Himes can’t seem to keep his thoughts to himself. An avid Twitter user, @jahimes rarely misses a chance to poke Republicans in the ribs, including House Majority Leader Eric Cantor—a politician not noted for his sense of humor. “So you can support Cantor’s bill or you can be serious about taming the deficit. But you can’t do both,” Himes tweeted on April 20. (He says his staff has laid down the law: no mention of body parts, and no tweeting after more than two drinks or less than four hours of sleep.)
Himes, who won his seat four years ago by defeating a veteran Republican, knew he’d have to fight to keep it. Though he’s personally popular and his district leans Democratic, it’s expected to be a close race. “I gotta be at Rotary clubs, I gotta be at American Legions, I gotta be at people’s events,” he says. “I look at the lifestyle of someone who has a safe seat and I crave that lifestyle, but it’s not good. The country would be a lot better off if everyone’s district looked like mine. I always have to be on my toes.”
The bottom line: Despite Himes’s willingness to buck his party and push bills to ease restrictions on big banks, the GOP has targeted him for defeat.
The Fed's Transparency Is Breeding Confusion
Exactly when does the Federal Reserve expect to start raising short-term interest rates? The Fed emitted conflicting signals today that could confuse the public and the markets. The source of the confusion is the Fed’s laudable effort to increase what it calls “transparency”—letting people see inside the black box of monetary policy.
Joshua Zumbrun of Bloomberg News flagged this problem even before today’s actions in a strong story referring back to the Fed’s January meeting. The headline: “Fed’s 17 Rate Forecasts May Confuse More Than Clarify.”
Here’s the conflict: In its official statement today, the rate-setting Federal Open Market Committee reiterated that economic conditions “are likely to warrant exceptionally low levels for the federal funds rate at least through late 2014.”
No surprise there. But in the interest of full disclosure, the Fed also released members’ assessments of the “appropriate pace of policy firming” (PDF).
Those individual assessments conflict sharply with the overall committee’s forecast. Only four of the 17 committee members think that it will still be appropriate to have the federal funds rate at 0.25 percent, roughly its current level, at the end of 2014.
From there, the numbers go up and up. Three FOMC members think fed funds should be 0.5 percent at the end of 2014; two think it should be 1 percent; one thinks it should be 1.5 percent; two think it should be 2 percent; one thinks it should be 2.25 percent; three think it should be 2.5 percent; and one thinks it should be 2.75 percent.
Another helpful chart shows that only four of the committee members think “policy firming” should wait until 2015 or after. Seven think it will need to begin in 2014, three in 2013, and three this year.
What’s at work here seems to be a powerful example of groupthink. On their own, a majority of members think the fed funds rate is going to have to go up relatively soon and relatively fast. But when they sit down to vote, they coalesce around the views of the chairman. Probably another factor is that many of the hawks didn’t participate in the vote. Although the committee has 17 members, the regional bank presidents rotate through voting roles. Only 10 of the 17 members voted—with one “no,” from Jeffrey Lacker, president of the Federal Reserve Bank of Richmond, who disagreed that the federal funds rate is likely to need to stay low through 2014.
Led by CNBC’s Steve Liesman, journalists pounced on the FOMC’s inconsistency in the press conference Bernanke gave this afternoon. Bernanke responded that people should pay attention to the committee vote, not the individual projections. “These projections are inputs into a committee process,” he said. “The committee had no difficulty coming to a consensus that the guidance we gave is still appropriate.”
That answer wasn’t entirely satisfying, of course. Greg Ip of the Economist asked exactly what the Fed means when it refers to “exceptionally low levels” for the federal funds rate. Perhaps the Fed has an elastic definition that encompasses substantially higher rates.
Bernanke confessed, “One of the reasons that the language in the statement is sometimes a little vaguer than you’d like is that we’re trying to get a consensus among 17 people [the whole committee], or at least 10 [the voters].” Added Bernanke: “Personally, I think it means something close to where we are now.”
Why the Amazon Naysayers Should Be Scared
Another quarter, another blowout earnings report for Amazon.com (AMZN). The online retailer and technology juggernaut blew away analysts’ expectations on Thursday, posting $13.18 billion in revenue for the first three months of the year. The stock is up 13 percent. At this rate, the company will easily become the fastest retailer in history to cross $50 billion in sales for the year (it just missed in 2011). “The March quarterly results showed just enough upside in both revenues and margins to make the naysayers run for cover,” Stifel Nicolaus analyst Jordan Rohan wrote in a research note, sticking the shiv into the vociferous Amazon short-sellers.
The earnings report was yet another rousing movement in the entrepreneurial symphony being conducted in Seattle by Chief Executive Officer Jeffrey Bezos. Everything seems to be going right just now: His company is attracting new customers and third-party sellers, getting existing customers to spend more, and increasing profitability on new ventures such as Amazon Web Services and the Kindle. In the context of those improved margins, its expensive investment in its own operations, normally so disconcerting to Wall Street, now looks much less foreboding. Amazon added almost 10,000 employees in the past three months and now employs 65,600 people, up from 37,900 a year ago. It is building at least 13 new fulfillment centers in the U.S. this year, which will allow it to accelerate delivery and perhaps even expand its nascent grocery-delivery business beyond Seattle.
I say “at least” 13 new centers because there’s new news on that front almost every day. This morning, Amazon and Texas officials announced the company will begin collecting sales tax in Texas by this July and that Amazon will invest at least $200 million in new distribution centers in the state. It’s one more example (California was another) where Amazon essentially blinked in its standoff with a state that wanted it to begin collecting sales tax. Yet Amazon still wins, because it builds the new distribution centers it needs to expand its operations. Bezos has perfected the art of architecting the win-win situation.
Amazon’s founder himself was a no-show in yesterday’s earnings ritual. (Tom Szkutak, Amazon’s chief financial officer, runs the earnings call with an amazingly soporific drone. He could have a bright future narrating Audible audiobooks about medieval history.) One of the most interesting aspects to veteran watchers of Amazon’s earnings report is the quote from the CEO that Amazon includes in its earnings release, because it typically shows what the company wants to draw attention to. Amazon’s two-day Prime shipping club used to get most of the attention. Yesterday, Bezos used the opportunity to flog the thousands of e-books that are exclusive to the Kindle.
“You won’t find them anywhere else,” he wrote. “They include many of our top bestsellers—in fact 16 of our top 100 bestselling titles are exclusive to our store.” Amazon is desperate to put a Kindle in people’s hands, not only to dig a competitive moat around its book business, but to bring customers into the Kindle ecosystem at a time when they might consider entering the digital realms of such rivals as Apple (AAPL) or Google (GOOG) instead. That possibility—not profit margin, investment in operations, and expensive new innovation—is what the short-sellers should be worried about.
High-Speed Trading: My Laser Is Faster Than Your Laser
A few weeks ago I wrote about Project Express, a new fiber-optic cable being built across the Atlantic that will give a select number of high-frequency traders a tiny speed advantage in trading times between New York and London. Currently, data take 64 milliseconds (give or take a few fractions of an eye blink) to travel round-trip between New York and London along a cable built in 1998 called the AC-1.
According to its New Jersey-based operator, Hibernia Atlantic, the $300 million Project Express will be 5.2 milliseconds faster than the AC-1, with an execution time of 59.6 milliseconds. That will make Project Express the world’s fastest transatlantic cable when it opens in 2013 and the first to achieve round-trip trading speeds of less than 60 milliseconds. Unless someone beats them to it.
As of this morning, it appears someone will. A small company called Perseus Telecom, in partnership with a subsidiary of India’s big telecom company, Reliance Communications, has announced the launch of QuanTA, a fiber-optic cable stretching from Long Island to the U.K. with an expected round-trip execution time of less than 60 milliseconds by the end of 2012. Rather than build a brand-new cable like Hibernia-Atlantic did, Perseus made improvements to an existing cable called the FLAG Atlantic-1 North, or FA-1 North, a small portion of a 17,000-mile underwater fiber-optic cable stretching from the east coast of North America to Japan. Until now, the FA-1 North was the second-fastest transatlantic cable after the AC-1.
To make the FA-1 North faster, Perseus first upgraded the cable’s “submarine optical systems,” which essentially means equipping it with faster lasers. The company also improved the backhaul systems connecting the core cable to various land-based subnetworks that spread to trading exchanges and data centers. It will next insert a giant router, or branching unit, a few hundred miles off the coast of Nova Scotia to build a shorter route to New York. With the help of submersible vehicles, a grappling hook hauled the cable off the bottom of the North Atlantic about 10,000 feet below the surface and inserted the branching unit, described as a Y-shaped device roughly the size of a conference room table.
The result will be a shorter cable powered by faster lasers. It cost $10 million to upgrade the lasers and the back-end connections. Asked how much it will cost to insert the branching unit and shorten the cable, Perseus Chief Executive Officer Jock Percy offers the following opaque calculation: It is 125th the cost of the new length of cable. Percy will say neither how much that new length costs nor how long it is. Just like the high-frequency trading industry it serves, the business of building submarine fiber-optic cables can be secretive—and highly competitive.
Although Perseus announced in January it was expanding its footprint in the data center hub at 60 Hudson Street in lower Manhattan, the company built QuanTA on the sly, announcing the project after it was done. That’s what Spread Networks did with the Chicago-to-New York underground trading cable it completed in 2010 after three years of boring through 825 miles of mostly rural, mountainous terrain in secret. Like Spread Networks and Hibernia-Atlantic, Perseus won’t disclose the identity of the trading firms it charges to use its cable, nor will it say how many there are or reveal its fees. CEO Percy will say his new project is highly cost-effective and he’s able to pass savings on to speed-trading clients.
“Market participants are always looking for advantages,” says Percy, meaning that speed traders continually look for ways to trade faster. “The cost of that advantage, though, is significant. The success of a trading strategy relies on how effectively people are able to achieve those last few milliseconds, and so a cost-effective way of delivering [faster speed] is really valuable, because just throwing money at the problem doesn’t solve it.”
The problem these new cables are solving is one of speed, not capacity. There’s plenty of fiber-optic capacity connecting most of the world’s big trading hubs, thanks to the fiber boom of the 1990s and early 2000s. Those cables were built before the era of high-frequency traders, so they rarely adhere to the shortest distance between two points: a straight line. Other than improving the caliber of the lasers shooting beams of light through these miles of cables, the only way to make them faster is to make them shorter.
Percy reckons that through a combination of improved lasers and shortened cables, the day may soon come where traders can execute a trade between New York and London at close to 40 milliseconds. Anything faster is physically impossible, save for drilling through the planet.
Assuming Einstein’s theory of relativity is correct, which the Large Hadron Collider in Europe recently reaffirmed, there’s no going faster than the speed of light, about 300 million meters per second. Since the surface of the earth is curved, a cable running along the bottom of the ocean isn’t flat. To straighten it, and thus shorten it, you’d have to drill through the earth’s crust. “If you did that you could get below 40 milliseconds,” says Percy.
So when will he finish that project? “No comment.”
AIG May Not Be as Healthy as It Looks
American International Group (AIG) has come a long way since its record $182 billion government bailout in the financial crisis. It has been buying back its stock from the Department of the Treasury, helping to reduce Washington’s stake in the company to 70 percent from a peak of 92 percent. It posted a profit of $21.5 billion for the fourth quarter of last year, a showing that helped push the stock price up 40 percent this year through April 24, to $32.40 a share. Analysts for Wells Fargo (WFC) and Bernstein Research (AB) are recommending the shares to investors as the company nears what they believe will be a complete exit from government ownership within a year.
Still, AIG may not be as healthy as it seems. Critics including Neil Barofsky and Elizabeth Warren, who helped oversee the government’s Troubled Asset Relief Program, contend AIG is benefiting from favorable treatment from Washington that amounts to a “stealth bailout,” in Warren’s words. And some analysts, including Morningstar’s (MORN) Jim Ryan, say the insurer’s underlying businesses are struggling.
Photograph by Andrew Harrer/Bloomberg
One point of contention is Treasury’s decision to allow AIG—along with TARP recipients Citigroup (C) and Ally Financial—to use operating losses from previous years to eliminate taxes on current income. The allowance, which typically does not apply to bankrupt or acquired companies, added $17.7 billion to AIG’s fourth-quarter earnings and will allow the company to shield profits from taxes for many years to come. “It’s important to remember that a substantial portion of AIG’s recent earnings were attributable to Treasury’s unilateral decision to preserve AIG’s net operating losses,” says J. Mark McWatters, a law professor at Southern Methodist University who was a Republican appointee to the TARP oversight committee.
Treasury explained its decision on the tax waiver in a March 1 statement: “The government reluctantly” invested large amounts “of taxpayer dollars to prevent corporate failures from causing a collapse of the financial system and resulting in even more severe harm to Americans. Allowing those companies to keep their net operating losses made them stronger businesses, helped attract private capital, and further stabilized the overall financial system.” Mark Herr, an AIG spokesman, said executives could not comment because the company is in a quiet period in advance of announcing earnings on May 3.
Treasury’s rationale doesn’t fly with Warren, the former chairman of Congress’s TARP oversight panel who is now a Democratic candidate for the U.S. Senate from Massachusetts. “That kind of bonus wasn’t necessary to protect the economy,” she said in a joint statement with three other former committee members on March 12. “It also gives AIG a leg up against its competitors at a time when everyone should have to play by the same rules—especially when it comes to paying taxes.”
Barofsky, TARP’s former inspector general, believes the government is doing AIG—and itself—another favor by permitting the company to repurchase its shares at $29 each. Selling at that price allows Treasury to claim a profit on the government’s investment, based on its cost of $28.72 a share. The department calculated its cost by dividing the $47.5 billion in TARP funds AIG received by the 1.66 billion AIG shares it held before winding down its stake. Matthew Anderson, a Treasury spokesman, says the price is appropriate because it covers the government’s cost in acquiring the shares.
Photograph by James Berglie/Zuma Press/Corbis
Barofsky calls the price “a political manipulation of numbers.” He argues the calculation shouldn’t include 563 million AIG shares that Treasury received from the Federal Reserve in January 2011 because the shares were not acquired as part of the TARP program. Removing those shares from the calculation would lift Treasury’s per-share cost to $43.53, which means TARP would show a $16 billion loss if Treasury sold the rest of its holdings at $29. “Treasury is misleading the market on TARP doing better than it actually is,” says Barofsky, who now lectures at New York University’s law school. “If I were an AIG investor, I’d think if they were being manipulative on this, then what else?”
Joshua Stirling of Bernstein Research sees the government’s eagerness to prop up AIG as a reason to buy the stock. “It seems clear that by allowing AIG to buy shares from the government ‘at cost,’” Treasury is helping AIG boost its earnings, he wrote in an April 4 report in which he changed his rating on AIG to buy from hold. “I’m thinking of this from the shareholder perspective,” he says. “The government and AIG all want it to end. Some of it, of course, is political; you don’t want the Tea Party to keep bringing it up.”
Morningstar analyst Ryan sees weakness in AIG’s basic businesses. He says the company’s property and casualty unit, which accounts for half its revenue, is “not making money selling policies and is having a very difficult time just earning its cost of capital.” Analysts at Sandler O’Neill + Partners expect AIG’s return on equity this year to be 5.1 percent, lagging large property-casualty peers’ average of 8.9 percent and life insurance peers’ 10.3 percent. The problem was made worse, Ryan says, when AIG sold a majority of its high-growth Asian life insurance business in October 2010 to help pay back the government. Keefe Bruyette & Woods (KBW) analyst Clifford Gallant concurs. “Their insurance profits aren’t high enough,” he says. His price target for the stock: $25.
Treasury takes a “passive hand” when it comes to AIG’s operations, says Anderson, the Treasury spokesman. “We’re not saying ‘sell life insurance in this county, but not the other county,’” he says.
Photograph by Reuters
With its basic businesses struggling, Ryan says, “so much of AIG comes down to what it can earn on its investments.” In press interviews in March, AIG Chief Executive Officer Robert Benmosche indicated he wants the company to return to investing in mortgage securities—the very assets that helped take the company down in 2008. Meanwhile, 12 percent of AIG’s fixed-income portfolio is in junk or nonrated securities, according to company filings. That’s almost quadruple the level at Travelers (TRV), another big property and casualty insurer. “It concerns me that Benmosche says they want to be more aggressive in their investments,” says Ryan. “That’s what hammered them in the crisis.”
The bottom line: AIG’s stock is up 40 percent this year, thanks in part to a tax benefit worth $17.7 billion awarded by the Treasury.
Record Euro Zone Debt Makes the Crisis Messier
The Keynesian solution for Europe’s crisis is government spending to rev up economic growth. Restoring growth will generate more tax revenue, the thinking goes, so the fiscal pump-priming will eventually pay for itself. But debt makes the Keynesian fix harder to implement. Heavily indebted countries can’t spend more for fear of losing the confidence of investors.
Debt, in short, takes away countries’ fiscal wiggle room.
That’s why the European Union’s report today on rising government debt in the single-currency euro zone is troublesome. The organization announced that the government debt-to-GDP ratio increased from 85.3 percent at the end of 2010 to 87.2 percent at the end of 2011. According to Bloomberg News, the 2011 ratio was the highest since the euro was introduced in 1999.
What’s doubly scary is that it’s not just the well-known problem children of Europe like Greece that are seeing government debt rise as a share of gross domestic product. Even the Netherlands, one of the four remaining AAA-rated countries in the euro zone, had an increase in its debt-to-GDP ratio from 62.9 percent to 65.2 percent, according to the European Union.
The Dutch have been stalwart supporters of Germany’s austerity drive until now, but they may be getting weak in the knees. RTL television reported that Dutch Prime Minister Mark Rutte will resign after losing the support of Geert Wilders’s Freedom Party in his coalition, following disagreement on an austerity package. “There is a danger that we will see a move to more radical, less Europe-friendly policies in the Netherlands,” Elisabeth Afseth, an analyst at Investec Bank in London, told Bloomberg News.
Here’s an excerpt from the European Union’s announcement with all the relevant figures:
At the end of 2011, the lowest ratios of government debt to GDP were recorded in Estonia (6.0%), Bulgaria (16.3%), Luxembourg (18.2%), Romania (33.3%), Sweden (38.4%), Lithuania (38.5%), the Czech Republic (41.2%), Latvia (42.6%), Slovakia (43.3%) and Denmark (46.5%). Fourteen Member States had government debt ratios higher than 60% of GDP in 2011: Greece (165.3%), Italy (120.1%), Ireland (108.2%), Portugal (107.8%), Belgium (98.0%), France (85.8%), the United Kingdom (85.7%), Germany (81.2%), Hungary (80.6%), Austria (72.2%), Malta (72.0%), Cyprus (71.6%), Spain (68.5%) and the Netherlands (65.2%).
Will Crowdfunding Beget Crowdfrauding?
Crowdfunding websites such as Kickstarter.com have helped small businesses raise millions of dollars via the Internet, and they’ve even gotten the attention of the White House. On April 5, President Barack Obama signed the Jumpstart Our Business Startups Act, which aims to create jobs by making it easier for young companies to raise money, in part by relaxing rules on companies that use crowdfunding sites. Some regulators, though, say the law may lead to losses for well-intentioned backers. “States are concerned that the fraud and scammers will come out of the closets now and start using social networking sites to rip off investors,” says Jack Herstein, president of the North American Securities Administrators Association.
Until now startups generally have been barred from selling shares on such sites in the U.S. Any funds received were considered donations, though many companies offered perks such as product samples in return. The new law lets companies sell as much as $1 million in securities a year via crowdfunding sites. Investors may profit by selling shares after a one-year holding period or if the company goes public. The websites usually charge businesses a fee or take a percentage of the money raised. Individuals contributed about $123 million through crowdfunding globally last year, almost four times the 2010 volume, according to Daily Crowdsource, a San Diego researcher.
Barbara Roper, director of investor protection at the Consumer Federation of America, warns against expecting too much from such sites. Crowdfunding “has precisely the same place in the average person’s investment portfolio that lottery tickets do,” she says. “If you have a little spare cash that you think it would be fun to gamble with, that’s fine, but don’t consider it part of a well-thought-out investment strategy.”
Although the U.S. Securities and Exchange Commission has about nine months to craft detailed rules for the new sites, the law lays out basic guidelines. Businesses must get commitments for a minimum amount of investment before backers can receive shares, and there will be limits on how much any individual can contribute. Those with annual income or net worth of less than $100,000 will be allowed to invest the greater of $2,000 or 5 percent of their income or net worth annually. People with more than $100,000 can invest as much as 10 percent, up to $100,000. “That helps tremendously in reducing the damage a huckster can do,” says David Marlett, executive director of the National Crowdfunding Association, a trade group that formed in March.
Kristine Singer, a consultant in Miami, used Indiegogo.com to give $75 to a business raising cash to market the Scrubba, a small bag designed for travelers to wash clothes on the go. “There are a lot of great products and a lot of people with great inventions,” says Singer, who lives on a sailboat and expects to get two Scrubba bags for her donation. “To also receive profits back in the future if they were able to grow, that would be a win-win for everybody.”
Indiegogo says it may offer investment deals once the SEC finalizes the rules. The site uses algorithms similar to those employed by credit-card companies to detect scams, says co-founder Slava Rubin. The company distributes millions of dollars each month to projects raising money, he says, and less than 1 percent is lost to fraud. “We’ve been very vigilant, and the industry needs to be vigilant,” he says. Kickstarter declined to comment.
CircleUp, a site that launched on April 18, offers a glimpse of crowdfunding’s future. CircleUp was able to start ahead of the rules because it is open only to so-called accredited investors—typically individuals earning more than $200,000 annually or those with assets of more than $1 million. CircleUp, which says it’s weighing whether to open the site to everyone, lets potential shareholders read a company’s unaudited investor presentation and standardized stock-offering and shareholder agreements. Investors can post comments and concerns about the business on a forum and leave questions for the entrepreneurs. Says co-founder Rory Eakin: “There are no longer closed-door conversations.”
The bottom line: While the JOBS Act may make it easier for startups to raise funding, some regulators caution that it could lead to increased fraud.
Rise of the Barter Economy
When Toronto-based financial planner Shannon Simmons offered her expertise to a professional clown, it wasn’t exactly business as usual. Simmons advised her new client to switch from a “couch fund” to a high-interest-bearing account with limited market risk. In exchange for her advice, Simmons received trapeze lessons.
Surprisingly, it isn’t the weirdest way that Simmons has been paid in the last year. Since leaving a full-time job at investment management firm Phillips, Hager & North in 2010 and embarking on a year-long experiment as a barter-only financial consultant, she’s been compensated with a tutorial in butter-churning, a large bag of toiletries, and a chance to perform with the University of Toronto cheerleaders. “I had a guy come up to me once and say, ‘I’m a fire-breather and I’d like to barter with you,’?” Simmons says. “I was like, ‘I don’t think I can say no to that.’?”
She ended her experiment in November, and not a moment too soon. She’s broke, she says, and not sure if she could survive much longer with a barter-only business model. “It’s a great idea in theory,” she says. “But there are things you don’t think about…. You can’t barter with your landlord. Trust me, I tried.” Despite the hardships, she still believes that bartering is the future. While she looks for gainful employment, she’s shopping a book about her bartering experiences. “Bartering has changed the way I think about how I spend my money,” she says.
Photograph by Pam Francis/Getty Images
Bartering may sound like a style of commerce more fitting to a backwater marketplace than a modern capitalist environment. According to the International Reciprocal Trade Association—an organization created to promote “just and equitable standards” in modern bartering—the U.S. barter market is a staggering $12 billion annually. In other words, $12 billion worth of goods and services are traded every year without any currency changing hands. Scott Whitmer, founder of trade exchange company Florida Barter, says that while 2011 saw positive signs of an economic recovery, many small and medium-size companies are still struggling. “Bartering has continued to help many [of these] companies grow and conserve cash,” he says. Though Florida Barter enjoyed a record 2011—a 12 percent increase in total trade volume; more than $17 million worth of trades among the 1,600 clients—Whitmer says bartering as a business practice is still in its infancy, “on the cusp of exploding.”
People often require some encouragement to give bartering a shot. Debbie Lombardi, president and founder of Barter Business Unlimited, a Connecticut-based exchange network, says that despite her company’s track record and 4,000-plus registered members, she still regularly encounters resistance and confusion from prospective customers. “Nobody comes to me and says, ‘I’ve always wanted to try bartering,’?” she admits. “It’s more like, ‘I don’t get it. Is this some kind of scam?’”
It’s no scam, but it can be complicated to the uninitiated. As Lombardi explains, “We run like a little bank.” Members are paid in “barter dollars,” which they can exchange with other members for goods and services. Within the bartering community, it’s the only acceptable currency. “It’s like going to a barter mall,” Lombardi says. “They can do all their holiday shopping. They can get the carpets cleaned. They can pay for their child’s orthodontic work. It’s almost limitless.”
Limitless—and occasionally bizarre. Lombardi has brokered barters on everything from tattoos to real estate to headstones. “Don’t laugh, but we’ve had people who’ve bartered for boob jobs,” she says. “If that’s what you really want and it’s not in your budget, with bartering you just have to do a few more carpet cleaning jobs and eventually you’ll have new boobs. That’s a wonderful thing.”
Dave Evans, a Barter Business Unlimited member who operates an online ticket reseller in Plainville, Conn., called EasySeat, was first attracted to bartering as a means to sell distressed inventory. “Our inventory is 100 percent speculative,” he says. “Bartering is a way for us to liquidate inventory that we might not be able to sell for cash.” He’s bartered tickets to New York Yankees championship games and Lady Gaga concerts, and in exchange he’s received everything from a fresh paint job at a company building to an overhauled office alarm service. Sometimes, though, he’s bartered for services that weren’t exactly essential to his business. “I used some of the barter money to get Lasik surgery for myself,” he says. “I guess that’s a little counterintuitive.”
Finding a way to make a profit from bartering isn’t just a challenge to the people putting up their livelihood for trade. Even the brokers who act as bartering middlemen are searching for creative ways to make money from a service that isn’t about making money. A website like Swap.com—which connects people who want to exchange their unused household items—looks, at least on paper, like a financial windfall. Jeff Bennett, Swap.com’s CEO, claims that “the business has been doubling every year.” They’re closing in on 450,000 registered users, who’ve taken part in more than 4 million barter exchanges valued at approximately $13 million since the site’s inception in 2010. But as no part of that $13 million is in actual money, how exactly does Swap.com cover its overhead? Most of its capital comes from “related aspects of the business,” says Bennett, such as shipping fees and corporate sponsorships. “We’ve had very good experiences with companies like Gallo wines, LuLu’s Clothing, and ModCloth.” He also hopes to introduce a Swap.com subscription service in the near future that offers customers incentives for forking over a monthly fee, like an ad-free environment and early access to their favorite items.
Swap.com has also generated revenue by selling tickets to live events, like the popular Sip & Swap bartering mixers that’ve been held nationwide in cities from New York to Los Angeles. Ticket holders bring in items from their home that they want to trade—including clothing, books, DVDs, and baby supplies—and everything is up for grabs. “When we let everyone in,” says Melissa Massello, one of the self-appointed “Swapaholics” who host the gatherings, “it’s sort of a mad dash to get the best stuff.” There is shoving, she says, and it can get physical.
Whitmer of Florida Barter says that limited and strategic bartering is best. “We’re not going to help anybody pay their electric bill or their mortgage,” he says. “But we can help them maintain their business and get sales they never would’ve had otherwise.” The best barters, he says, are for things you might normally have spent cash on anyway, “like printing, advertising, marketing, or promotional T-shirts with your logo on it.”
Florida Barter’s clients cover a vast range of services, from doctors, lawyers, and accountants to electricians, plumbers, and massage therapists. “If a client makes a request and we don’t have it,” he says, “we’ll go get it.” He claims to have more faith in Florida Barter’s “trade dollars”—which aren’t all that different from Barter Business Unlimited’s “barter dollars”—than U.S. government-issued currency. “Trade dollars, unlike U.S. dollars, are backed by goods and services,” he says. “It’s like the gold standard that we dropped.”
His unwavering belief in bartering, however, doesn’t necessarily apply to the 12 percent commission that Florida Barter takes with every exchange between its members. “That’s how we pay our sales people,” Whitmer explains. “Everyone signs our agreement to pay the 12 percent in cash, and we do not make any exceptions.”
E.F. Hutton Gets Its Voice Back
Brands spend so much time and money getting into our psyches. Why not bring back old slogans, jingles, and logos to tap antediluvian reservoirs of goodwill and nostalgia? Who didn’t love Jordache jeans resurrecting its classic 1979 ad in 2000? Or the unlikely comeback of defunct scary-old-guy brew Rheingold Beer, which is reprising its Miss Rheingold Pageant with the help of irony-craving New York barmaids? I personally want long-neglected RC Cola to make a big marketing comeback (yes, RC still exists). Sun Drop already has. Ditto Throwback Pepsi and Mountain Dew.
Now that spirit of nostalgia has come to Wall Street, whose recent era of scandals and crisis makes the old ones look so lo-fi by comparison. Case in point: E.F. Hutton, a brokerage brand that has been defunct for a quarter-century and was briefly part of the old Lehman Brothers empire, is coming back as a boutique run by former executives.
Mention of the brand (est. 1904) will immediately bring to mind those ubiquitous ads from the ’70s and ’80s that reminded you: “When E.F. Hutton talks, people listen.” For several decades it was the country’s second-largest brokerage house, at its peak employing 19,000. But in the era of Bud Fox and Gordon Gekko, E.F. Hutton was done in by a check-kiting scandal and the crash of ’87, and had to sell itself to Shearson Lehman American Express. Such a golden age for Lower Manhattan stationery suppliers.
As reported in the Wall Street Journal, former E.F. Hutton exec Frank Campanale said Hutton 2.0, with him as chief executive officer, will announce the hiring of brokers and other suits over the coming weeks. “We’re trying to create a great firm with great culture, something E.F. Hutton had,” he said. “We have a clean slate.”
It’s a curious time for any Wall Street brand to return from the dead. “How will a philosophy of hard work and ‘earning it,’ expressed in a blue blood voiceover, fly in a post-Occupy, economically volatile environment in which more consumers than ever have trust issues with financial institutions?” asks James Othmer, global creative director at Y&R New York. “On the other hand, I’m intrigued by the boutique idea. It sounds more appealing than a monolith and could have more sophisticated customized services than a local bank. Most importantly, since the brand was dark during the most gruesome of financial times, it’s one of the few to have both recognition and no blood on its hands.”
Since E.F. Hutton went silent, the brokerage business has gone through light years of disruption and evolution. Think cut-rate online trading. ETF-only model portfolios. Nonstop data online and on cable. Record numbers now swear by do-it-yourself index-fund investing.
The Hutton brand hibernated for years beneath a layer of metamorphic rock two miles underneath Citigroup (C) and its Smith Barney brokerage—which then morphed into Morgan Stanley Smith Barney. Campanale and his partners registered the Hutton name this month, after it had been held by Retriever Brands, a warehouser of orphaned trademarks. (Paging Kidder Peabody?)
Campanale said Stanley Hutton Rumbough, a grandson of founder Edward Francis Hutton, will also be involved in the relaunch. No word yet on how many Quotron machines they’ll need.
Look for the return of Lehman Brothers sometime in 2033.
Why Half the World Doesn't Have Bank Accounts
In the U.S., bank accounts are nearly ubiquitous, with almost 90 percent of adults having formal accounts. But in poor countries, only a quarter of people report having have accounts. All told, more than 2.5 billion adults around the world—about half—are unbanked, according to a new World Bank data project funded by the Bill & Melinda Gates Foundation and based on Gallup polling in 148 countries. The World Bank launched the Global Financial Inclusion initiative, which it calls Global Findex for short, with both a database and a white paper on the new stats.
A leading reason for the disparity between rich and poor countries is both dispiritedly intractable and painfully obvious: poverty itself. Two-thirds of people without accounts said they simply don’t have enough money to use a bank. The data, though, show some less daunting problems to tackle. People said financial institutions are too far away and too expensive to use. In some regions, including Latin America, people said the institutions required too much documentation. The white paper says fully 35 percent of the unbanked report barriers that are solvable through public policy.
They pointed to success of models that break down distance and costs, as in Sub-Saharan Africa, where 16 percent of adults said they had used a mobile phone to pay bills or send or receive money in the past year. (The World Bank project doesn’t consider mobile money to be a formal bank account; they reserve that definition for accounts at a bank, credit union, cooperative, post office, or microfinance institution.) In Kenya, two-thirds of adults said they received payments on their phone, likely because of the inroads the telecom company Safaricom has made with its M-PESA offering, which transforms mobile phones into virtual wallets.
There are many more facets to the data—how people use accounts, what they save money for, where they get loans if not from banks. The idea is that armed with more on-the-ground data, policy makers can try to find ways to bring more people into the financial mainstream. After all, having formal banking relationships can have all kinds of benefits for people, from promoting savings to borrowing money at rates that aren’t usurious.
Consumer Protection Faces a 'Tsunami' in Court
A year ago today, a split Supreme Court issued a ruling that fundamentally changed the way consumers can pursue claims of corporate wrongdoing. In a 5-4 ruling in AT&T Mobility v. Concepcion, the Supreme Court said companies have the right to force consumers who sign contracts—like debit-card agreements and cell phone plans—to accept terms that require them to settle all disputes in private arbitration and waive their right to band together in class actions.
In just the first year, the ruling’s impact has been dramatic. “There is no case in the history of consumer law as harmful as Concepcion,” says Paul Bland, a senior attorney at the public interest law firm Public Justice. In a report released this week, the National Association of Consumer Advocates and the legal advocacy group Public Citizen, which represented the Concepcions before the Supreme Court, said they have identified 76 cases in the past year where potential class actions were shot down by judges citing Concepcion.
Companies have rushed to add class action waivers into the contracts or make existing clauses more bulletproof. Wells Fargo, for example, tightened up the language in its contracts in February to make clear that the only exception to arbitration is small claims courts. (The bank told the Berger Record that is policies are “are consistent with the industry.”) “There is a realistic possibility that the decision will lead to a virtual end of class actions against businesses,” Vanderbuilt law professor Brian Fitzpatrick told the audience on Apr. 26 at a conference on the topic at Cardozo School of Law in Manhattan.
In a law review article, Jean Sternlight, the director of the Saltman Center for Conflict Resolutionat the UNLV Boyd School of Law, wrote that judges have thrown out class actions because of arbitration clauses in cases involving “consumer fraud, consumer debt, violations of federal and state wage and hour legislation, and unpaid wages.” She and other advocates say individual claims are often too small for to justify a lawyer’s time—the Concepcion case involved a $30.22 bill—so consumers have little recourse.
As part of Dodd-Frank financial reform, the Consumer Financial Protection Bureau was tasked with studying the effect that mandatory arbitration for financial products have on consumers. Dodd-Frank also gave the CFPB the authority to issue rules on the matter to protect consumers if the bureau deems it necessary. This week the CFPB formally launched the study by putting out a request for input (PDF) on what it examines. Comments are due by June 23.
Sternlight says such agencies as the CFPB, the SEC, and the FTC can take some small steps to help consumers, but their mandates are limited. Only Congress, she says, can really stop the “tsunami wave” that will wipe out class actions and the consumer protection they provide.
A Dodd-Frank Regulatory Exemption Grows by 7,900%
For two years, regulators and business tussled over which companies that trade derivatives must submit to strict oversight as part of the Dodd-Frank financial reform. Credit default swaps and other derivatives, of course, were a major cause of the 2008 financial crisis. In meetings, reports, hearings, and letters, they sought to resolve issues like “What is a swap dealer?” and “What is a ‘financial entity?’”—questions that sound almost existential but have real-world ramifications in the $700 trillion global derivatives market.
Federal regulators made their first proposal in 2010, saying that only small players that trade less than $100 million a year would be exempt from rules requiring them to hold more capital and report more information on their trades. Regions Financial (RF), energy giant BP (BP), and other companies that write and use derivatives pushed back. They argued that a broader exemption makes more sense because derivatives trading is highly concentrated. According to the Office of the Comptroller of the Currency, five large banks—JPMorgan Chase (JPM), Bank of America (BAC), Citigroup (C), Morgan Stanley (MS), and Goldman Sachs (GS)—hold almost 96 percent of the notional value of all derivatives contracts. The smaller players, the argument goes, shouldn’t be burdened with extra requirements that would ultimately drive up costs for consumers.
The counterargument was that relatively small players can still create systemic risk. Before the financial crisis, American International Group (AIG), for example, was not a top-five trader, but, as we all learned, was still a linchpin in the interwoven world of mortgage derivatives. Indeed, the OCC also says (PDF) that the notional value “does not provide a useful measure of either market or credit risks.” It says risk can hinge on a lot of different factors, like leverage, liquidity, and volatility.
This week, the regulators finally settled the issue, and generally the industry won out. Regulators expanded the exemption to include companies that do less than $8 billion in swaps a year—80 times more than the initial proposal. By one estimate, that means 60 percent of swap dealers will now be exempt. Those companies, ranging from banks to energy and agricultural firms, can breathe easier now that they’re exempt. As for what the new rules mean for risk in the market, regulators say they’ll reevaluate in five years, when the threshold defaults down to $3 billion.
Why Hasn't the Euro Fallen More in the Crisis?
As Europe’s sovereign debt crisis has ground on and the once unthinkable prospect of a breakup of the Continent’s currency union has become a realistic possibility, the euro itself has remained surprisingly resilient, especially against the dollar. With a few exceptions, the euro has traded over $1.30 for the past couple of years. Why, I wondered, hasn’t all of the hemming and hawing among Europe’s leaders taken more of a toll on the common currency? This is a matter of particular importance to me as I plan a move to Berlin, where I might consider buying an apartment—if I could be confident that my investment won’t lose a big chunk of its value due to a strengthening dollar.
So I figured I’d call some experts to find out what gives. The bottom line: It’s not so much a case of a strong euro as it is a weak dollar, and neither is particularly attractive when compared with such superstars as the Swiss franc, Australian dollar, and the Japanese yen. The dollar-euro “market is a battle of ugly currencies,” Neil Mellor, a currency strategist at Bank of New York Mellon (BK) in London, told me. Since the U.S. Federal Reserve shows no signs of tightening monetary policy, there’s not a lot of incentive for traders to buy dollars. “There has been a policy of debasement of the currency by the Fed, and I don’t think that’s going to change any time soon,” Mellor said.
Fair enough, but still worrisome for someone considering a big purchase in euros, so I decided to get a second opinion. Sara Yates from Barclays (BCS) didn’t disagree about the euro’s performance against commodity-based currencies such as Australia’s and Canada’s dollars. But she did note some sensible reasons traders have largely supported the euro for the past year or two. While there has been no shortage of dire headlines out of the euro zone, Yates believes enough news has been positive to keep the currency from collapsing. Despite the dithering and dickering across the Continent, Europe’s leadership has managed to put together a bailout for Greece, and the European Central Bank has propped up commercial banks with €1 trillion in three-year loans. “There are problems remaining,” Yates said, “but in a sense the euro area is better protected against a blowup than it was a couple of years ago.”
It has also probably been getting substantial support from China and the Middle East. While most countries still hold their currency reserves in dollars, there’s little doubt that many would like to diversify their holdings. It’s hard to find figures that show what central banks are up to, but it’s pretty clear that when the euro starts falling, banks around the world start buying. As the price of crude has surged, Middle Eastern countries have found themselves with lots of cash, and “they have to diversify some of the dollars they get from oil sales,” said Chris Walker, a currency strategist with UBS (UBS) in London.
Nick Bennenbroek, head of currency strategy for Wells Fargo (WFC) in New York, pointed out that some of the euro’s resilience this year is because much of the negative sentiment had already been priced into the euro-dollar rate in late 2011. Still, he and the other currency strategists I spoke to all predicted a further weakening of the euro against the dollar in the next six to 12 months, to somewhere between $1.20 and $1.25. (Bloomberg’s survey of 54 traders or strategists is predicting the euro will trade at $1.30 in the fourth quarter.) “Investors are still worried about the longer-term fundamentals of the euro,” Bennenbroek said. “We’re going to see slow growth or even recession in Europe, [which] will cause the euro to weaken over time.”
And what if the euro disintegrates? None of the people I spoke with would rule it out. Richard Franulovich, a strategist at Westpac Banking (WBC) in New York, said his “base case” is that Greece will exit the euro zone within 12 to 18 months. “At some point, the population will say they’re better off outside the euro,” Franulovich said. And after that? “If Greece were to exit, you could easily see the ECB shedding all its conservatism and guaranteeing all euro bonds to keep other weak countries in the currency union.” Of course, he allows, the opposite could also happen and the ECB might say it’s best to let other weak economies go their own way. “If the euro breaks up, there could be an incalculable chain of events,” he said with what sounded like a grimace over the phone. Predicting what might happen “is like trying to unscramble an egg.”
Maybe I’ll hold off on buying that apartment after all.
No More Junk in Ford's Trunk
When I was in grade school, Dad thought he was doing the household a favor by buying a pair of silver 1983 Ford Thunderbirds. What a disaster. A case study in halfhearted manufacturing and product design, the twins were always in the shop. Soviet-inspired electrical wiring. A/C always on the fritz. Ford truly meant Fix or Repair Daily.
So how meshuga is it that I now lust after a Ford (F)? The 2013 Fusion Hybrid is slated to get 47 mpg in the city. It can drive up to 62 mph on electric alone. And this from the only U.S. carmaker not to take a bailout.
Do call it a comeback. And give props to the turnaround leadership of Ford Chief Executive Alan Mulally, who arrived in September 2006 and focused the multinational on streamlining operations, procurement, and marketing. Critically, he took advantage of a still-promiscuous lending environment to borrow $23.4 billion, which was used to avoid bailouts and bankruptcies. Ford earned $29.5 billion in the last three years, reversing $30.1 billion in losses from 2006 through 2008. Its stock price has more than 10-bagged from its November 2008 low of $1.26.
On Tuesday, Dearborn got back its investment-grade credit rating from Fitch, which cited improved earnings and reduced pension costs. Fitch, the lesser-followed Mr. Pibb of credit raters, had ranked Ford’s debt as junk since December 2005. Standard & Poor’s and Moody’s could follow soon.
Ford’s huge debt load would just adore credit upgrades. The company’s bonds yield three points more than government debt on average, vs. 36 percentage points at the peak of the credit crisis in March 2009, says Bloomberg. Companies rated at the lowest investment-grade rating borrow at an average spread of 2.55 percentage points. During the worst of Detroit’s meltdown, things got so dicey for Ford that it had to put up not just its headquarters for collateral, but even its famous blue logo. Thanks to the credit upgrade, Ford can now declare from the rooftops that it actually owns its icon, fair and square.
Don’t knock that high before you’ve tried it.
“Getting the collateral back, getting the blue oval back has been a huge rallying cry and one that we all feel emotionally connected to,” Ford Treasurer Neil Schloss told reporters last month. “Investment-grade companies feel better about themselves.”
A Tax Windfall From the Housing Bust
As Karen Jacobs, an economist in Arizona’s Department of Revenue, was reviewing income tax data for 2010, she came across a puzzling trend: Refunds were down and tax liability was up even though the state’s unemployment rate peaked that year, at 10.8 percent. “My first thought was: ‘Taxable income? Why would that be up if people are losing jobs?’?” says Jacobs.
With new houses sitting vacant in the desert and foreclosures soaring, it didn’t take long to figure out the reason. Home ownership rates, real estate prices, and interest rates were all falling, so fewer people were deducting mortgage interest and mortgage holders had often borrowed less or had refinanced at lower rates. The value of itemized deductions dropped 20 percent for the year—led by a decline in the tax break for mortgage interest. “I was shocked about how much I owed,” says Stephen Buckman, who had to pay the Internal Revenue Service $1,500 when he filed his 2011 taxes. In December 2010, a bank foreclosed on his Phoenix townhouse, which had plunged in value to $50,000 from the $196,000 he paid in 2006.
Like Buckman, people across the U.S. have seen their tax bills increase due to the housing bust. On federal tax returns, claims for the mortgage interest deduction dropped by 14 percent, from 2007 to 2009, IRS data show. For 2010, preliminary data indicate that use of the write-off fell by a further 7.2 percent. The decline saved the U.S. government between $13 billion and $26 billion from 2007 to 2010, estimates Andrew Hanson, an assistant professor of economics at Georgia State University who has researched the tax break. The shift “is not surprising, given what we know happened to the housing market,” Hanson says.
Use of the mortgage interest deduction peaked in 2007 when it showed up on 40.8 million returns. That fell to 36.5 million for 2009, according to the IRS, and the amount deducted declined from $491 billion to $421 billion for those years. Preliminary data show the number of returns on which taxpayers claimed the tax break edged up to 36.9 million in 2010, though the dollar value of the write-offs fell to $387 billion. “You’re seeing 5 million fewer returns between 2007 and 2009 claiming the deduction,” says Matthew Gardner, executive director for the Institute on Taxation and Economic Policy, a nonprofit research group. “It is a real drop.”
In Arizona, the change led to about $170 million in unanticipated revenue for fiscal 2011, a pleasant surprise after a $3 billion drop in tax revenue during the previous three years, says John Arnold, Governor Jan Brewer’s budget director. “We’re in a budget crisis, and an extra $170 million shows up,” Arnold says. “We understand that is the result of people losing their homes. If I could say it was the result of people refinancing, we’d be all smiles.”
Other states, especially where foreclosures have been high, have seen a similar trend. In California, just behind Arizona with the third-highest foreclosure rate in the U.S. last year, the number of filers taking the deduction for mortgage interest fell 9 percent while the value of the write-offs fell almost 20 percent from 2007 to 2009, according to data from the state’s Franchise Tax Board. “It’s helping the state governments,” says David Albouy, assistant professor of economics at the University of Michigan at Ann Arbor, “because they are not giving away as much as they were before in the mortgage interest deduction.”
The bottom line: Mortgage interest deductions have dropped by more than $70 billion as the housing bust means fewer Americans qualify for the write-off.
Britain's Future May Be Darker Than People Think
Financial markets have shrugged off the surprising news that Britain’s economy shrank again in the first quarter, putting it into a recession. The positive spin is that the number may well be revised back into positive territory. IHS Global Insight said it was “hugely skeptical” of the official numbers. In London, British stocks rose today as good earnings reports outweighed concern about the economic contraction.
But economists at London-based Capital Economics warn today that worse may be ahead for the U.K. economy—with the bad news mostly emanating from the Continent. They estimate that a 10 percent drop in exports to the euro zone could cost as many as 1.5 percentage points of British gross domestic product. That would be three times as large as the hit on the U.S.
“This would be particularly unhelpful at a time when the U.K.’s economic plans rely on a boost from the external sector,” notes Capital. That’s a reference to the austerity measures of Prime Minister David Cameron, which hinge on the notion that export-led growth will compensate for a decline in government spending.
Capital Economics is looking for a 0.5 percent contraction in U.K. output this year. That puts it at the bottom, according to 27 forecasters surveyed by Bloomberg News. The median is 0.6 percent growth, and the high is 0.8 percent.
The Global Dealmaking Slump Continues
The flurry of multibillion-dollar global deals involving companies such as Nestle, Express Scripts, and GDF Suez so far this April might make you think mergers and acquisitions are making a comeback. Not so fast.
Bloomberg data indicates the total value of pending and completed company takeovers from April 1 through April 24 in 2012 is $62.8 billion. The values for the same period in 2011 and 2010 were $91 billion and $92 billion, respectively.
Global dealmaking has slumped over the past three quarters. Mergers and acquisitions last quarter fell 14 percent from the previous quarter, making it the slowest three-month period in two and a half years, according to Bloomberg. During that time, Glencore International’s (GLEN) $45 billion acquisition of Xstrata was the only purchase that topped $8 billion.
The overall value of M&A deals so far this quarter seems to indicate further decline. One sign of hope, however, may be that the deals made this month are somewhat bigger than those from last quarter, with several topping $8 billion in value. Express Scripts (ESRX) in early April completed its $29 billion purchase of rival drug benefits manager Medco Health Solutions. GDF Suez acquired International Power for $11 billion. And on Monday, Nestle announced it will pay $11.9 billion for Pfizer’s (PFE) infant-nutrition unit.
Investment bankers interviewed by Bloomberg in late March said they expect the global dealmaking slump to reverse as the economic recovery gains momentum. “If we find ourselves in June having these same low activity levels, I’d be really surprised,” says Peter Tague, co-head of global M&A at Citigroup (C).
The Folks Who Called Apple's Big Quarter
The financial press was breathless over Apple again yesterday as the world’s most-valuable company blew past analysts’ estimates for earnings in the second quarter on the strength of 35.1 million iPhones sold. “[A]nother amazing quarter from Apple … is single handedly driving markets this morning,” wrote Peter Boockvar of Miller Tabak. Apple posted earnings per share of $12.30 and $39.2 billion in sales. The Street, or at least the sell-side analysts who carry that tag, predicted $10.02 in earnings per share and $36.9 billion in sales, according to data compiled by Bloomberg. The surprise pushed Apple’s stock up nearly 10 percent and kick-started a worldwide rally.
Who saw this coming? A crowd of 115 people at Estimize did. The startup is opening up earnings estimates to all comers—and, so far anyway, beating the Street. The Estimize crowd predicted $11.68 in earnings per share and actually overshot on sales with $39.5 billion. So next quarter, maybe check “Xiath,” a self-identified buy-side analyst at Estimize who anticipated $12.25 in earnings per share and $39.6 billion in sales.
Why Lower Natural Gas Prices Help the U.S. Only a Little
There’s a rule of thumb that says a $10 rise in the price of a barrel of oil reduces gross domestic product growth by anywhere from 0.2 to 0.5 percentage points. Applied over the past six months, when crude prices rose by about $30 from early October to the end of March, that means dearer oil might’ve chewed as much as 1.5 percent out of GDP growth during the last two quarters. Not a trivial amount considering GDP increased 3 percent in the fourth quarter of 2011. Economists surveyed by Bloomberg tend to think the economy grew just 2.2 percent in the first three months of 2012, when the price of gas really took off.
Oil is our economy’s most important raw material. The price of it (and therefore, gasoline) impacts the price of just about everything we buy, from groceries to clothes to appliances. The more expensive oil is, the more expensive a whole lot of other stuff becomes. But what about that other gas, the kind that we’re practically swimming in these days? Natural gas is now 80 percent cheaper than it was four years ago. How much has that price decline counteracted our recent pain at the pump?
Unfortunately, not much. On the consumer side, at best you’ve seen a small reduction in your electricity bill. Natural gas has certainly played a part in slowing the pace of rising residential electricity prices, from an average annual increase of 5 percent between 2003 and 2008, to 0.8 percent from 2009 through 2013. Rates are actually forecast to fall 1.4 percent next year. According to the consumer price index, the cost of utility gas service for heating declined 9.1 percent over the past year. But that’s a relatively tiny portion of what we spend our money on—less than 1 percent. Motor fuels, on the other hand, carry a relative importance of 5.8 percent and have increased 9 percent in price over the past 12 months. So whatever you might’ve saved on your electric or home heating bill, you probably plowed right back into your gas tank.
Cities with public buses that run on compressed or liquefied natural gas have benefited from lower fuel costs. And if you happen to be one of the handful of people in the U.S. who drive a natural gas car, you’re probably coming out ahead on your fuel bill every month—especially in California, which has the bulk of the country’s 400 public natural gas fueling stations, and where regular gasoline prices are among the highest.
Manufacturers have certainly benefited from lower natural gas prices. The fuel is a particularly critical input for the petrochemical and refining industry, giving U.S. firms a big cost advantage over international competitors—as much as 70 percent over manufacturers in South Korea and Europe. Whether cheap natural gas is propelling any of the strong job growth in the manufacturing sector over the past couple years is debatable. It’s certainly making a lot of manufacturers more profitable. On the flip side, it’s been bad for producers. As prices have plummeted it’s become uneconomical to keep drilling for gas. There’s a good chance that if you were working on a natural gas drill rig a year ago, you’re not anymore.
Big picture as of today, cheap natural gas hasn’t done much to counteract the run-up in oil prices. “So far it’s been a pretty small positive,” says Mark Zandi, chief economist at Moody’s. That doesn’t mean that in the future it won’t pay big dividends for the U.S.—particularly, as Zandi points out, if we’re able to get more natural gas into our transportation network. T. Boone Pickens wants to retrofit our long-haul trucking fleet to run off natural gas. There’s evidence that’s starting to happen. If done on a large enough scale, that could take a big bite out of the impact high oil prices play in driving up the costs of goods.
We’re also severely limited in our capacity to export natural gas right now. The U.S. has just one export facility, in Alaska. A recently approved LNG export terminal in Louisiana will bring that to a grand total of two once completed in 2015. Regulators aren’t likely to approve any more LNG export projects in the coming year, though they probably will in the future. Depending on domestic demand, abundant natural gas could significantly reduce the U.S. trade deficit and perhaps turn us into a net exporter.
Although we have massive amounts of natural gas—an estimated 2,214 trillion cubic feet, enough to last 100 years by some measures—we still don’t use that much of it. Case in point: We’re drilling so much and using so little, it’s conceivable that we’ll max out our 4.3 trillion cubic feet of storage capacity at some point this year. Americans burn about 22 trillion cubic feet of natural gas every year, enough to fill up about 595,000 Empire State Buildings. But we could use a whole lot more, and certainly will soon. Until we do, the U.S. economy won’t see that big of an upside from cheap prices.
Japan's Stock Market Signals Better Times
After plunging in the aftermath of last year’s earthquake and nuclear disaster, Japanese stocks may be poised for a comeback. Profits for the large-cap companies in the Nikkei 225 Stock Average will rise 69 percent this year after plunging 31 percent in 2011, according to more than 2,600 analyst estimates compiled by Bloomberg. “The worst is over for Japan in terms of earnings,” says Masafumi Oshiden, an investment manager at ING Mutual Funds Management (Japan). “Consumer spending is improving and corporate earnings are rebounding. The cautious mood following the quake is gone.”
Investors are betting the profit forecasts will turn out to be accurate. Trading at 24.5 times reported earnings, Japanese equities are the most expensive among the world’s 60 biggest markets, data compiled by Bloomberg show. If profits rebound as analysts forecast, Japanese price-earnings ratios will fall back in line with global stocks.
Bulls say the current high valuations are justified because an economic recovery will help Japanese stocks make up some of the ground they have lost to other major equity gauges since global markets bottomed on March 9, 2009. The Nikkei 225 is up 35 percent since then, compared with 89 percent for the MSCI All Country World Index (ACWI) and 104 percent in the Standard & Poor’s 500-stock index. One reason: Policy makers in Tokyo have committed to spend 20 trillion yen ($246 billion) to rebuild towns and spur economic growth. Bank of Japan Governor Masaaki Shirakawa pledged during a speech in New York in April to continue adding monetary stimulus.
Pessimists point to combined annual losses from Sony (SNE) and Sharp of 900 billion yen and an economy that has contracted three of the past four years as evidence the Nikkei 225 has come too far, too fast. Japan still faces a shrinking population and the world’s highest debt burden. “There are several drags on Japanese shares,” says Shane Oliver, the Sydney-based head of investment strategy at AMP Capital Investors. “One of them is ongoing deflation, which acts as a disincentive to spending and is also a huge constraint on company profits. The other is a relatively strong yen, which is actually a drag on growth and competitiveness.” A strong yen makes Japanese products more expensive abroad, inhibiting exports.
There are signs that the yen’s strength may be ebbing. So far this year the currency has fallen 8.7 percent vs. nine developed-nation peers as the Bank of Japan set an inflation goal of 1 percent and expanded asset purchases by 10 trillion yen in February. The currency is forecast to decline 3 percent, to 84 per dollar, by the end of the year, according to the median estimate of 75 analysts surveyed by Bloomberg.
That will help boost corporate profits and stock prices, according to Rob Taylor, a fund manager at Chicago-based Harris Associates. Japanese executives “have been taking a lot of costs out and trying to be able to make money in this very harsh environment,” says Taylor, who owns shares of Toyota Motor (TM). “Then you get the yen weakening, and then you’ll start to really see those earnings snap back.”
The bottom line: Japanese stocks’ high price-to-earnings ratio of 24.5 indicates investors expect companies to show robust profit growth.
Thomasson is a reporter for Bloomberg News in Hong Kong. Nohara is a reporter for Bloomberg News in Tokyo. Wang is a reporter for Bloomberg News in New York.Fannie Mae's Former Chief Fights to Clear His Name
After Daniel Mudd was forced out as chief executive officer of Fannie Mae (FNMA) when the government seized the company in September 2008, he headed for the river. In the weeks following his dismissal, the 6-foot-4 former Marine, a onetime U.S. Olympic rowing prospect, buzzed his receding gray hair into military style and took a boat out on the Potomac—gathering strength to rebuild his career, according to his friends.
Ten months later, Mudd left Washington, taking the helm of a New York-based hedge fund, Fortress Investment Group (FIG), and putting his mansion up for sale. Yet Mudd didn’t really leave Fannie Mae behind. In December 2011 the Securities and Exchange Commission sued him for allegedly misleading Fannie Mae investors about the company’s stake in subprime loans. Fortress directors offered to let Mudd stay on if he settled the matter quickly, according to two people with direct knowledge of the board’s thinking. Instead, he left Fortress to fight the charges full-time. His stint at Fannie Mae “cost me two jobs,” says Mudd, 53. “I’ve told my legal team, ‘If you use the word “settle,” I will fire you.’?”
In March, Mudd asked a federal judge to dismiss the SEC complaint on grounds that during his tenure Fannie Mae filed detailed data on risky loans the company held. His lawyers also argued that the SEC failed to show Mudd had a motive, financial or otherwise, to deceive shareholders. No ruling is expected on the motion to dismiss before June.
The stakes are high for both Mudd and the agency. Losing the case could cost him some of the millions he earned during his four years as Fannie Mae’s CEO and make him a symbol of the excesses that blew up the housing market. For the SEC, a failed lawsuit would heighten criticism from lawmakers and others that the agency hasn’t held enough top executives accountable for taking risks that led to the worst recession since the 1930s. “They’ve got to show some scalps,” said Adam Pritchard, a University of Michigan law professor who previously served in the SEC’s Office of the General Counsel. “Anybody can file a case. It’s another thing to win it.”
Mudd is the most prominent of six former executives of Fannie Mae and its smaller cousin, Freddie Mac (FMCC), who are accused in the SEC’s Dec. 16 lawsuit of deceiving investors about Fannie’s and Freddie’s subprime portfolios before souring mortgages sent the companies to the verge of bankruptcy. Shareholders were wiped out, and U.S. taxpayers have so far spent about $190 billion keeping the companies afloat. “Fannie Mae and Freddie Mac executives told the world that their subprime exposure was substantially smaller than it really was,” Robert Khuzami, director of the SEC’s enforcement division, said when the suit was filed, calling the disclosures “material misstatements.”
Mudd says his reputation and future are on the line in what he considers a witch hunt by an agency responding improperly to outside pressures. “I worked honestly and honorably, and I’m not going to roll over in the face of a baseless, politically motivated work of fiction,” he says.
The son of TV news anchor Roger Mudd, he grew up in Washington and attended Sidwell Friends, a Quaker school where presidents and other members of the capital’s elite send their children. He graduated from the University of Virginia and earned a degree in public administration from Harvard’s Kennedy School of Government.
By the time Mudd joined Fannie Mae as chief operating officer in 2000, then-CEO Franklin Raines and his predecessors had built the company into a dominant force in the market for 30-year fixed-rate mortgages. Fannie Mae and Freddie Mac operated like private businesses, while also benefiting from a congressional charter and implied government backing. They provided liquidity to the home loan market by buying mortgages from lenders and packaging them into securities that they guarantee.
Fannie Mae’s troubles began before Mudd became Raines’s deputy. The company’s accounting practices manipulated earnings statements so executives could maximize their bonuses, its regulator later reported. The regulator, the Office of Federal Enterprise Housing Oversight, also found that Mudd had failed to act on a subordinate’s report when accounting irregularities were brought to his attention in 2003. Mudd told the Senate Banking Committee that he had been “as shocked as anyone” to learn of the manipulation when it surfaced publicly in 2004. Most of the public blame fell on Raines. He was ousted and in 2008 settled a lawsuit filed by Fannie Mae’s overseer saying he wasn’t acknowledging guilt while agreeing to pay back $25 million of the $90 million he had earned as CEO since 1998.
Fannie Mae’s board installed Mudd as CEO in Raines’s place in 2005. Colleagues nicknamed him “Harry Houdini,” according to one former staff member, since he was promoted rather than sanctioned. “Mudd should never have been permitted to be Raines’s successor,” says William K. Black, a professor of economics and law at the University of Missouri at Kansas City and a former bank regulator. “Mudd was part of the Raines regime. It was just an unconscionable mistake.”
Mudd says he saw the move as a call to duty: “I took the job at the request of the board with the approval of the government in the middle of an accounting scandal where, in the middle of the night, the CEO, the CFO, the accountant, the internal auditor, the outside auditor, and the lawyer had all been fired.” From 2006 to 2008, the time at issue in the lawsuit, Mudd earned almost $24 million in taxable compensation, according to the SEC.
At the core of the SEC’s suit is the question of how to define subprime loans and reduced-documentation loans known as Alt-A mortgages. The agency alleges that Mudd and his codefendants failed to disclose the full amount of such mortgages held or guaranteed by Fannie Mae. Mudd and his codefendants say there was no universal definition. In his motion to dismiss the lawsuit, Mudd says Fannie Mae “explicitly defined” subprime and Alt-A loans in its public filings and then “accurately disclosed the amounts” that were in the company’s portfolio.
Part of the SEC’s legal theory against Mudd and the other executives failed last year before U.S. District Court Judge Paul Crotty, who will be hearing the matter in New York. Crotty threw out shareholder claims, based on financial disclosures, that Mudd and other Fannie Mae executives didn’t warn investors about the company’s exposure to subprime mortgages. Ruling in a suit filed on behalf of government pension funds in Massachusetts and Tennessee, and other investors, the judge found that Fannie Mae’s public filings explicitly warned about the risks of subprime and Alt-A loans. Crotty allowed the shareholder suit to move forward with claims based on internal company e-mails—messages that also are part of the SEC suit. They allegedly show that Mudd and other executives knew the company’s risk management was flawed. The SEC suit “will be a very complicated and long case,” says Charles Carberry, a partner at law firm Jones Day, who isn’t representing any of the parties. “It’s going to be a battle of the experts.”
Now that he has his legal team in place, Mudd says he won’t keep his life on hold and he’s begun to think about what his next job might be. He says he would be up for the challenge of managing or restructuring a private company. “At some level,” Mudd says, “I’m not really afraid of messy situations.”
The bottom line: Refusing to settle, Dan Mudd quit his hedge fund job to fight an SEC suit stemming from the collapse of Fannie Mae and Freddie Mac.
Benson is a reporter for Bloomberg News in Washington. Gallu is a reporter for Bloomberg News in Washington.Bid & Ask: The Deals of the Week
1. Nestle (NESN) will pay $11.9 billion for Pfizer’s (PFE) infant-nutrition unit and may sell as much as $1.8 billion of the assets to address antitrust concerns in countries including Mexico, say people with knowledge of the matter.
2. Russia’s No. 2 mobile-phone operator, MegaFon, will pay owners TeliaSonera, AF Telecom, and Altimo $5.2 billion in dividends and pursue an IPO in London.
3. Banco BTG Pactual, led by Brazilian billionaire Andre Esteves, raised almost $2 billion in the biggest IPO for an investment bank in two years.
4. Royal Dutch Shell (RDS.A) is acquiring African oil explorer Cove Energy for $1.8 billion to secure a stake in gas fields discovered off Mozambique.
5. The world’s No. 1 wireless operator, Vodafone (VOD), will purchase Cable & Wireless Worldwide (CW/) for $1.7 billion in cash, adding a U.K. fixed-line network to its mobile-phone system.
6. London Heathrow Airport owner BAA is selling its Edinburgh terminal to U.S. buyout firm Global Infrastructure Partners for $1.3 billion after antitrust regulators ordered a breakup.
7. Thomson Reuters (TRI) will sell its healthcare unit, which provides data and analytic services to hospitals and health-care providers, to an affiliate of Veritas Capital for $1.3 billion in cash.
8. Amgen (AMGN) is buying closely held Mustafa Nevzat Pharmaceuticals for almost $700 million to expand in Turkey, where economic growth is boosting demand for medicines.
9. Illinois-based Beam (BEAM) will purchase the Pinnacle Vodka and Calico Jack rum brands from White Rock Distilleries for $605 million to expand in the fast-growing spirits business.
10. Facebook will beef up its intellectual property arsenal by paying $550 million for some of the patents Microsoft (MSFT) recently agreed to buy from AOL (AOL).
