Managing Wall Street's 'Winner Effect'

Wall Street is not known for self-examination. Colossally bad bets and spectacular losses are more often treated as individual failures than systemic ones; risky behavior is seen as a sign of intestinal fortitude, not foolishness. In the wake of the multibillion-dollar trading loss at JPMorgan Chase (JPM)—considered the best in the business at risk management—the financial industry has focused on who did what, when, and how big the losses might get. But that doesn’t explain why the firm’s traders and executives doubled down on a position that, in hindsight, looked clearly doomed.

What were they thinking? That question, in essence, is what John Coates has devoted his life to answering. Coates once ran a derivatives desk at Deutsche Bank (DB) in New York, until he decided he was more interested in trying to figure out why people are such poor judges of risk than he was in trying to profit from it. Now a senior research fellow at the University of Cambridge, he is employing the tools of neuroscience to identify the biological basis of what John Maynard Keynes called the market’s “animal spirits.”

In particular, Coates focuses on two hormones: testosterone, which increases our appetite for risk, and cortisol, which makes us shy away from it. Drawing on his Wall Street connections, he has been able to treat the trading floors of investment banks as his labs. The answers he’s finding could help financial institutions understand how the banking culture exacerbates the very tendencies companies should be guarding against. There may not have been a way to prevent JPMorgan’s “London Whale” from making his ill-fated bet on corporate bonds. But Coates’s research does suggest that the trader’s bosses should have seen the trouble coming.

Twelve years ago, Coates was flying home to New York from England and found himself sitting next to a young neuroscientist named Linda Wilbrecht. The two started talking. The dot-com bubble was reaching its high point, and what Coates was seeing around him on Wall Street had made him wonder about the chemical basis of the waves of exhilaration and despair that swept across the trading floor. Wilbrecht invited him to come by and view the work she was doing on how neurons form.

During lulls in the market, Coates started ducking out of Deutsche Bank’s midtown office and catching a cab up to Wilbrecht’s lab on the Upper East Side campus of Rockefeller University. He sat in on lectures and watched as she and her colleagues ran studies. After two years he quit finance and enrolled in the neuroscience Ph.D. program at the University of Cambridge, where he had years earlier earned a doctorate in economics.

The more Coates learned, the more he became convinced that traders were, as he put it, “a clinical population.” The stimuli of a trading floor triggered chemical changes in people’s brains, emotionally whipsawing them. During the tech bubble, he recalls, “People just really slipped their moorings: They were motor-mouthing, they weren’t sleeping, they were on this high. It was initially reasonable to assume it was cocaine, but I don’t know many traders that do that. There was something going on, it was just incredibly noticeable, and I realized that at times I had also felt that way.”

Coates is best known for a study he carried out in 2005. As he describes it in his forthcoming book, The Hour Between Dog and Wolf, he took saliva samples over a two-week period from 250 traders at a London firm, all but three of them men. At the same time, he tracked the profit and loss on their trades. He found that when a trader’s testosterone levels were particularly high in the morning, he went on to make more money than on days when his morning testosterone level was low. Coates calculated that on an annual basis, the differences between high-testosterone and low-testosterone days would add up to around a million dollars in take-home pay.

In species after species, biologists have documented something called the “winner effect.” When two male elephant seals or bighorn sheep fight over females, the victor gets a sharp spike in his testosterone levels, while the loser sees his dramatically drop. The theory is that elevated testosterone levels in the bloodstream of the winner—which in some species last for months—will help him in his next bout. Testosterone doesn’t just boost confidence, it raises the blood’s oxygen-carrying capacity and lean-muscle mass. With each bout the process repeats itself: The winner’s testosterone level keeps climbing, making him fitter, stronger, and more confident, and raising his odds of winning.

With enough victories, though, testosterone can reach levels that make the animal act foolishly. He picks fights he can’t win, tries to claim too much territory, and roams around in the open where predators might pick him off. A human being on a trading floor might take massive, risky bets on the strength of the American housing market or on U.S. corporate bonds. One of the traders Coates studied went on a hot streak, making twice his average profit-and-loss ratio for five days in a row. By the end of it his testosterone levels had risen 80 percent. If Coates had followed the trader long enough, he believes, there was a good chance “he would be irrationally exuberant and blow up.”

For losers, the effect is the opposite: The stress and worry of losing money cause the endocrine system to flood the body with cortisol, which makes people afraid to take even favorable bets. In the wake of a financial crisis, it’s not just Wall Street traders who suffer from this, but anyone making decisions about money, whether it’s an employer who balks at hiring or a bank officer leery of making a loan even when the Federal Reserve is offering her free money to do so.

Coates’s work reinforces the findings of behavioral economics, which looks at how actual human behavior—even that of financial professionals—fails to match up with the classical economic assumption that people are utility maximizers, dispassionately calculating costs and benefits. Because Coates focuses on biology rather than just behavior, his research suggests how these tendencies arise and a few ways we might better corral them. For one thing, he encourages financial firms to educate their employees about the effects hormones have on decision-making. “Traders need to be trained so they can recognize and handle the physiological changes resulting from their gains and losses, and from market volatility,” he writes. Traders conditioned to spot the manic behavior of the winner effect might be more wary about taking risks they otherwise would have unthinkingly embraced.

To reduce volatility, banks should also strive for a sort of hormonal diversity. Testosterone levels decline as men enter middle age, and women have 10 percent to 20 percent the testosterone levels of men; both groups, Coates argues, should be better represented on trading floors. In his book he points to a study by the economists Brad Barber and Terrance Odean that shows that single women investors outperform single men over the long term (because they tend to trade their accounts less). Another study by Chicago-based Hedge Fund Research shows that hedge funds that were run by women significantly outperformed those run by men.

Whether this strategy would have saved JPMorgan its recent embarrassment is unclear. Ina Drew, the banker overseeing the office where the bad trades were made, is a woman—though, according to the New York Times, she was ill when the groundwork for the trades was being laid. Two of the strongest internal critics of the trades were women as well. (Coates is currently studying whether women are susceptible to the winner effect.)

At the very least, Coates says, JPMorgan should have been aware that it was fueling its employees’ most counterproductive hormone-driven tendencies. Risk management systems at many banks give traders more leeway during bull markets and rein them in during bear markets. Compensation schemes similarly reward each year’s winners and punish the losers. As a result, traders on a winning streak are allowed and encouraged to take on the most risk at exactly the time their biology is already pushing them toward recklessness. When the market turns, traders already gun-shy from cortisol are discouraged from taking any risk whatsoever, extending the downturn. Better, Coates says, to calculate pay based on longer timelines (a suggestion that plenty of non-neuroscientists have also proposed).

As for risk management, banks should start paying closer attention to those traders who are on a roll. “We have to start thinking of management as leaning against these tendencies, stabilizing the biology,” Coates says. “Risk management should be looking at the stars. They’re always the ones who succumb to this winner effect and end up blowing up the bank.”

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Now You Can Trade Black Sea Wheat

After Russia’s ruinous 2010 drought, Leo Melamed read a newspaper story that quoted Vladimir Putin saying he wished there had been a way to insure the wheat harvest. “I said, ‘Wait, I know how to insure a crop,’?” recalls Melamed, chairman emeritus of CME Group (CME), the world’s largest futures exchange. That was the beginning of CME’s 18-month effort to develop its first futures contract on an Eastern European crop.

When negotiations with Russian officials stalled, CME Group shifted its efforts to Ukraine. In May 2011, the exchange signed memorandums of understanding with the Ukrainian government and the Ukraine Futures Exchange. “The Ukrainians wanted to be first, they were ready to move,” Melamed says. On June 6, CME Group will start trading in a Black Sea wheat contract on its electronic network, giving investors, producers, and companies that buy grain a chance to lock in prices or speculate on them.

With the new wheat contract, CME Group, the company whose predecessors introduced commodity futures to the world in 1848, is expanding its reach and playing some defense against its much younger rival, Intercontinental Exchange (ICE), the nation’s second-largest futures market. Intercontinental, known as ICE, began trading corn, wheat, soybeans, and soy oil contracts on May 14. While it might seem a quixotic effort—CME Group accounts for 98 percent of all U.S. futures trading—ICE has beat daunting odds before. In 2006 it took 30 percent of the U.S. oil futures market from the New York Mercantile Exchange. CME Group bought Nymex in 2008. “We think we’re in as good a position as any to be successful,” says Benjamin Jackson, chief operating officer of ICE Futures U.S., ICE’s New York exchange, where the grain contracts trade. “At a minimum we’re responding to what our customers want, and if it doesn’t work, they owe us one.”

CME Group is not dismissing the challenge. “We take everything seriously as a competitive issue, even though I don’t think they will succeed,” says Melamed, who adds a note of skepticism: “This is a little crazy.”

Photograph by Liu Jiansheng/Xinhua Press/Corbis

Melamed has a long history in the Black Sea region, starting with fleeing the Nazis with his parents across the Soviet Union in 1939. Fifty years later, in 1990, he got a call from Mikhail Gorbachev, during the waning days of the Soviet Union. The leader persuaded Melamed to help the Russians set up the Moscow Commodity Exchange, which was meant to show the world that the country was changing. After Melamed cut the ribbon to open the market, the first trade was 1 million Marlboro cigarettes in exchange for a computer, he recalls. “It was not free-market at all, it was just a prearranged trade, which I explained to them is not exactly what I had in mind,” he says. “We laughed all the way home.”

Ukraine will export 23 million tons of wheat and other grain in the 12 months through June. So CME Group’s interest in a futures contract is understandable, says Rodion Rybchinsky, head of business projects at agriculture consulting firm APK-Inform in Dnipropetrovsk in Ukraine. Yet he wonders whether it will take hold. “There are very few market players who are familiar with futures” in the region, he says. Producers and traders will be wary of futures because local corruption could block possession of grain bought via the contracts, according to two grain merchants in Ukraine who asked not to be named for fear of government reprisal. Ukraine also has a long history of government intervention in the grain industry, which discourages customers, says Terry Reilly, an analyst at Citigroup Global Markets in Chicago. “How it starts out will determine if it’s going to be successful,” he says. “Is there going be enough trading volume? Are investors willing to bear risks that local government could intervene and set export restrictions?”

To reassure customers, CME Group is planning as many as four delivery points. When contracts expire, customers who wish to take delivery will be able to pick up their grain in Russia, Ukraine, and Romania, CME Group has said. And it may add a port in Varna, Bulgaria, according to David Lehman, the managing director of commodity research and product development, who spent the last year and a half traveling monthly to Ukraine to set up the contract. “There’s always a risk when you design a new contract,” he says.

The expansion to the Black Sea also fits with CME Group’s larger strategy of partnering with international markets in Brazil and China. “The potential is enormous, and that includes Russia and it includes Kazakhstan” as well as Poland, Melamed says. “They all want to become important market economies, and we are part of that.”

The bottom line: The CME’s new Black Sea wheat contract is aimed at fending off competition from a rival with a record of snatching market share.

Leising is a reporter for Bloomberg News. Ustinova is a reporter for Bloomberg News in St. Petersburg. Tony C. Dreibus is a reporter for Bloomberg News.

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Charlie Rose Talks to Donald Gogel

Tell me about Bain Capital and your perceptions of Mitt Romney’s role there.
I recruited against Mitt Romney when I was running McKinsey’s business school recruiting and he was running Bain Consulting’s business school recruiting. So I’ve seen him in action, and he’s a formidable recruiter, I can tell you that. He was a very personable and effective recruiter. When Bain Capital started, it was one of a small number of firms, and they had the idea that they had some business insights and could invest money behind those insights. It wasn’t more complicated than that. As it’s grown, they now have multiple lines of business, but the core really hasn’t changed. … Private equity firms and their investors can’t make money unless the businesses they are investing in get better. There’s no way to exit or sell them to someone else at a higher value unless you’ve created something that’s sustainable. And that somehow is lost in the debate … [the notion that] all private equity is involved in asset-stripping, and they’re just sort of vultures or vampires leaving carcasses behind—there’s nothing further from reality.
What you’re saying about private equity in general applies to Bain?
It’s a respected firm. That doesn’t mean that they—or anyone else—don’t make investments that they regret. But, you know, there’s a survivorship bias in the world because private equity firms have to perform well on many metrics to succeed and sustain their business. Private equity’s as pure a performance-based and meritocratic business as you can find. The private equity firms that have been in business for more than 20 years, or in our case, since 1978, have made mistakes along the way, but unless you make good investments, create value, build strong businesses, find willing buyers at the end of your holding period, you can’t make money. And your investors can’t make money, and the companies in which you invest won’t succeed.
Would you say that what happened with Bain’s investment in GST Steel was typical?
In any business you can find good stories and complicated ones and ambiguity. Private equity tends to invest in businesses that are in some period of transition. Sometimes you can read those correctly, and in some cases you invest in a business that you think you can save and you can’t. But in the absence of private equity investment, in many cases, those companies go under much sooner, if not immediately. And all the jobs are lost. So that shouldn’t be lost here. Bain has probably made hundreds of investments. So to pick on two is not representative.
You’re saying that some distressed companies will fail and some will yield huge returns and create jobs?
More than 60 percent of private equity transactions are held by the owner for more than five years, and the reason is you can’t fix and build businesses easily. It takes time. Employment in most private equity-owned businesses is declining before we even make the investment. That’s why we’re there. And it continues that decline for a couple of years. So these are nuanced arguments, but all the more reason to resist the simplistic generalizations of private equity.
You’ve been a strong supporter of President Obama in the past, right?
I have been in the past.
But you’re not now?
I’m distressed both by the arguments he’s making against private equity and by implication … the antipathy to businesses that indeed are creating jobs. And I just don’t think it’s productive. So I would like to see some change in that.
So the president has gone too far?
In my view, yes.
The president is basically saying that Mitt Romney and his experience at Bain do not necessarily make for the qualities in a good president. Is he right or wrong?
The standards of leadership for the president of the United States are very demanding, and I think Mitt Romney has had a number of experiences in leadership that do qualify him for some aspects of the job. A lot of this is being able to build a team, set priorities, execute successfully against the stated strategy. Romney’s experience speaks directly to many of those attributes.
It sounds to me like you’re saying you’re more likely to support Governor Romney than President Obama.
I am saying that to you.

Watch Charlie Rose on Bloomberg TV weeknights at 7 p.m. and 10 p.m. ET.

Emmy Award-winning journalist Charlie Rose is the host of Charlie Rose, the nightly PBS program.

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U.S. Stock Outflows: a 12-Year Grudge

For those still reeling from Fleecebook 2012, take heart: Feelings of abandonment are all the rage right now. Money was already fleeing U.S. equity funds, even as the stock market recently visited multiyear highs.

According to the Investment Company Institute, domestic stock funds have seen 13 consecutive weeks of outflows. In the week ended May 16 alone, investors yanked an estimated $3.45 billion from the category—$1.10 billion more than they withdrew the prior week. Year to date, the funds have experienced $38 billion in outflows. This song has remained the same for the better part of a lost decade; last year’s $85 billion flight marked the sixth straight year of outflows from U.S. stock funds, including a $121 billion evacuation in 2008.

The market peaked in 2000, after all, and now is back only to where it was 13 years ago—to say nothing about how inflation has eaten into that stagnation. In 2009, stocks briefly dipped to 1996 levels. Dot-com crash, market-timing scandals, Enron, WorldCom, Panic of 2008, EuroFlu. If you can’t shed a tear for the individual investor, then, well, you’re a brute.

As Twitter lounge lizard Josh “The Reformed Broker” Brown so eloquently put it: “Once the bullies shove you into a locker and hold your head down in the toilet, you learn to take a different hallway to homeroom.”

True. What isn’t as easy to comprehend is the overwhelming drive to keep pulling money out even during bull runs. According to research by the Leuthold Group, while the S&P 500 has gained 107 percent in the 38 months since its spring 2009 low, just nine of those months saw net inflows into U.S. stock funds. Similarly, in the 121 percent market surge of 1974 to 1980—i.e., the heyday of the show Good Times—there were only 15 months of net inflows into the category. (Not getting hassled, alas, meant not getting hustled.)

By comparison, bond funds are now in an era of hot and constant inflows that resemble the rush into tech in the late 1990s. For example, the aforementioned billions of outflows from stocks in mid-May coincided with an inflow of $7.22 billion into taxable and municipal funds. A great piece in the Financial Times points to how this divergence can be setting the stage for another era of buy-high, sell-low regret. After all, from 1900 to 2010, stocks outpaced inflation by 6.3 percent a year in the U.S., according to calculations by the London Business School, compared with only 1.8 percent for bonds.

With Treasury yields daily flirting with record lows, the market keeps doubling down on a monster bet that inflation just won’t be an issue any time soon. If that turns out to be wrong—and it could be very wrong—investors will have to scramble to undo a decade’s worth of self-inflicted damage.

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Chia Seeds, Wall Street's Stimulant of Choice

Christine Kenney, a triathlete who works the equity capital markets execution desk at Citigroup (C) in Manhattan, starts every morning at work with a bowl of low-fat yogurt, honey, and a heap of chia seeds. Throughout the day she subsists on chia snack bars. “It’s better for my job because I’m not supposed to be off the desk very much,” she says, noting how she’s gotten most of the co-workers from her desk hooked on the seeds. “There’s other seeds out there that are nutritious, but this is the best. It’s the alpha seed.”

Photograph by Alexey Kamenskiy/ShutterstockChia seeds are more or less flavorless

Among Wall Street’s trading desks and bullpens, chia seeds are becoming the stimulant of choice. Healthier than coffee, cheaper (and obviously more legal) than cocaine, and less juvenile than a 5-hour Energy drink, chia has undergone a total metamorphosis from 1980s punchline (Chia Pet’s “ch-ch-ch-chia” jingle still haunts Gen Xers) to superfood.

Credit for chia’s second coming belongs partly to the 2009 bestselling book Born to Run by Christopher McDougall, about a remote Mexican tribe of marathon-running Tarahumara Indians who have been bullish on chia since Aztec days—eating it ground, mixed into drinks, or raw. After reading it, Dan Gluck and Nick Morris, a manager and trader at a New York hedge fund, began supplementing their post-workout breakfasts with chia seeds, rich in protein, fiber, and omega-3 fatty acids. They spread the chia gospel to friends in finance and soon had a following. In 2011 they launched Health Warrior, which markets chia seeds and snack bars boasting chia’s purported benefits, from sustained energy to enhanced focus and better digestion.

While research on those benefits is relatively sparse, Wall Street chia heads aren’t waiting for further studies. “Instead of snacking on the trading desk, I will make a chia smoothie or grab one of their Health Warrior Chia Bars,” says Jason Feinberg, managing director of U.S. equity trading at Barclays Capital (BCS). Shane Emmett, Health Warrior’s chief executive officer, says an investment bank and a hedge fund have begun buying in bulk. “I’m sure the ‘warrior’ speaks a little bit to the aggressive nature of folks on the Street,” he says.

Sax is a Bloomberg Businessweek contributor.

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Geeks on a Plane Search for Startups

It’s Thursday night in the heart of Miami’s financial district. At Novecento, a buzzing bistro, salsa and flamenco music blast while waitresses circulate Malbec and mojitos. Businessmen in fitted European suits survey the scene.

In walks angel investor Dave McClure, fresh off a flight from San Francisco. People rush to shake his hand as he makes his way into a private room packed with bankers, programmers, and executives. After a welcome from the mayor of Miami-Dade County, McClure, clad in jeans and a wrinkled blazer over a faded red T-shirt, takes the podium to talk about his impending tour of South America. Foreigners, he tells the audience, like to complain about their countries’ lack of Silicon Valley-like entrepreneurship. “Bull-s–t!” thunders McClure. “You’re the one that’s full of s–t! You’re the one not investing in your entrepreneurs.”

“Right on!” yells a guy in the back of the room.

So began the latest installment of the three-year-old traveling venture capital show McClure calls Geeks on a Plane. After dinner and a night of partying in South Beach, the 50-person delegation, which includes entrepreneurs, techies, attorneys, and investors, flew to Mexico City, Sao Paulo, and Buenos Aires for 10 days of mixers, lectures, and a competition to find Argentina’s best hacker. Along the way, McClure hoped to discover a startup or two to invest in.

Over the past three years, the Geeks have visited 30 cities, including New Delhi, Shanghai, Amsterdam, Prague, and Honolulu. McClure “is becoming an entrepreneurship rock star in countries like Brazil and India,” says Vivek Wadhwa, a former software developer who has lectured at Duke University. Over the next 18 months, they will descend on Tallinn, Berlin, Moscow, Dubai, Istanbul, Tel Aviv, and Amman, as well as cities in sub-Saharan Africa. “We’re one of the few VC firms to get outside a 30-mile radius of Sand Hill Road,” says McClure.

The tour is an offshoot of McClure’s Mountain View (Calif.)-based fund 500 Startups, whose letterhead lists the 45-year-old as its Sith Lord. The fund provides early-stage startups—those just trying to figure out how to convert an idea into an enterprise—with $10,000 to $250,000, along with hand-holding from its global network of 175 mentors, including tech executives, venture capitalists, and intellectual-property experts. McClure gets paid as a general partner and collects a cut of the fund’s profits. He would not disclose the fund’s returns. Punchd and TeachStreet, which were acquired by Google (GOOG) and Amazon.com (AMZN), respectively, are among 500 Startups’ winning investments.

The fund has invested in 300 companies, including Farmeron, a Croatian startup that makes software to help farmers organize data on their livestock, and Mexico’s Ovia, which lets companies set up video interviews of job candidates. Both got the chance to operate out of 500 Startups’ 10,000-square-foot Silicon Valley workspace, where they learned from other companies in residence.

“Working with Dave gets you both generosity and adventure,” says Demian Bellumio, chief operating officer of Senzari, an online radio service that in May received $1 million from a group of funds led by 500 Startups. “It’s like joining a global family of mentors, with relationships you keep building as you grow.” In Miami, Bellumio was chatting with Adriana Cisneros, scion to the Venezuelan conglomerate Cisneros Group, who said that traveling with the Geeks is helping her learn how to better nurture her company’s media acquisitions. “Instead of just giving them money, they give them space, mentors, and coaching, says Jeff Cornwall, a professor of entrepreneurship at Belmont University in Nashville. “It’s like a minor league that feeds players into the bigger VC system.”

In April, McClure filed with the Securities and Exchange Commission for a second fund, the $50 million 500 Startups Fund II, to follow the original $30 million fund launched in 2009. “Dave gets it,” says Steve Blank, a professor of engineering at Stanford University, explaining why he invests in 500 Startups. Blank says McClure has a knack for finding and nurturing companies that are too small to command attention from traditional VCs.

Seeding numerous small investments around the world makes sense, McClure says, because at least 75 percent of tech startups don’t survive longer than three years. “Some folks will call this ‘spray and pray,’?” he says. “But we call it going global, and not wasting money at failing. Fail on a small budget and you save a lot of money and heartbreak.” He says the recent shift toward cloud computing, which eliminates the need to buy a lot of expensive computer hardware, has helped drop the cost of launching a tech startup by a factor of 100.

Wadhwa thinks that while McClure has the right approach, he may be spreading himself too thin. “In some of the places he is investing, the ecosystem for entrepreneurial support and success doesn’t exist,” says Wadhwa. “What is needed is more mentorship and hand-holding. Dave can’t possibly provide this to the large number of startups he is investing in.”

McClure says his own career has made him sympathetic to startups. In 1988, after graduating from Johns Hopkins University’s applied math program, he worked as a software developer and started his own e-commerce business. He later jumped to PayPal, where he managed a group of Web designers and developers. McClure used $300,000 of his profits from PayPal’s 2002 initial public offering and subsequent sale to EBay (EBAY) to make small investments in 13 tech startups, including Mint.com (acquired by Intuit (INTU) in 2009) and SlideShare, which LinkedIn (LNKD) bought in early May.

In 2007, McClure co-taught a course at Stanford on building Web applications for Facebook (FB). Then, while at San Francisco venture capital firm Founders Fund, he ran the Facebook fbFund, which invested in companies developing apps for the social network. FbFund helped launch Wildfire Interactive and TaskRabbit.

After two hours of pressing the flesh at his Miami launch party, McClure finally sits down to dinner. An attendee taps his shoulder and offers a business card. “Sir,” he asks, “do you speak Spanish?” “Um, no,” replies McClure. “But I can learn. I picked up Japanese.”

The bottom line: McClure has used his $30 million fund to invest in 300 startups around the world. Now he’s raising $50 million for a new fund.

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Bidding Wars Are Back for Los Angeles Luxury Homes

A week after Christine Lynch listed her five-bedroom, six-bathroom house in the Brentwood neighborhood of Los Angeles for $3.625 million, she had seven offers. Within 10 days, she had a deal—for $225,000 more than the asking price. The all-cash transaction was completed on April 23. “My first reaction was, ‘Wow, I guess we’re really doing this,’?” says Lynch. “I was really surprised by this level of interest and how quickly it sold.”

Bidding wars are breaking out for luxury homes in such wealthy enclaves as Brentwood, Beverly Hills, and Bel Air as an increasing number of buyers bet on rising home prices and investors return to the market. Even properties in need of extensive renovation are being fought over by shoppers who expect to resell them for more after a remodel or rebuild. “The percentage of people who think prices are only going to go up is the greatest I have ever seen in my career,” says Syd Leibovitch, president of Rodeo Realty in Beverly Hills.

The number of sales of Beverly Hills homes priced at $2 million and higher climbed 11 percent in the first quarter from a year earlier, to 39, according to DataQuick, a provider of property information. In Brentwood they increased 56 percent, to 25, and in Malibu they gained 64 percent, to 23.

U.S. residential property sales of $1 million and higher rose 7.2 percent in March, the most recent month for which figures are available, from a year earlier, according to the National Association of Realtors. Demand has been rising for high-end homes in the northeastern U.S., including Boston and New York; on the California coast; and in parts of the southern U.S. amid a recovery in financial markets, according to Paul Bishop, vice president of research at the Realtors group.

In Brentwood and Beverly Hills, homes on smaller plots in low-lying areas usually start at $2.8 million to $3.2 million. Houses with larger plots can sell for as much as $20 million, according to John Gould, manager of Rodeo Realty’s Beverly Hills office. Properties in the hillier areas, which usually are larger and boast views, can range anywhere from $5 million to $75 million.

As late as last year, many luxury properties in the Los Angeles area lingered on the market for weeks or months, according to Stephen Shapiro, co-founder of Westside Estate Agency in Beverly Hills. Now, he says, offers come in on the day of the first showing, a phenomenon that was common during the 2007 buying frenzy. “In recent history, buyers would look at homes and return six months later to find the same home was still on the market,” he says. “Now if buyers hesitate, the house is often sold by the time they come back. And each time one sells, the next one comes on at a higher price.”

Sales of homes priced $5 million and higher at all of Coldwell Banker Previews International’s West Los Angeles offices were up 35 percent this year through May 8 from a year earlier, according to Joyce Rey, head of the company’s estates division. “There’s an added degree of confidence in the future and that prices are likely going to go up,” Rey says. “There is a definite change in consumer attitude.”

Some of the fresh demand for high-end properties is coming from investors looking to make a profit, a buyer pool that’s been almost nonexistent for the past couple of years, according to Rey. Since the beginning of the year, she says, investors have grown to about 20 percent of the shoppers she represents. Throughout Southern California, the portion of investor purchases was close to a record last month, and the share of buyers who paid cash was double the historical average, according to DataQuick. “This is the first time since 2007 that I have investor clients again,” says Rey. “The speculative buyer is back.”

The bottom line: Almost 90 homes sold for $2 million or more in Brentwood, Malibu, and Beverly Hills during the first quarter, a sign of renewed confidence.

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Oil Drops, But the Energy Market Is Still Wacky

Oil prices got another push lower this week as talks with Iran over its nuclear program appear to be progressing. For the first time in five years, it looks like the International Atomic Energy Agency will have access to the country’s Parchin military complex, easing concerns about an eventual Iranian supply disruption.

Five months ago the market was terrified about the possibility of war with Iran and the effect this would have on the world’s oil supply. Just to be sure they were ahead of the curve, oil speculators piled into futures contracts like crazy, pricing at the equivalent of a nine-month Iranian supply disruption by early March. Now that the threat seems to be dissipating (and Europe is deteriorating again, further depressing demand), speculators are rushing for the exits, liquidating their net long positions by more than half since peaking in March. So in the span of eight months, largely because of threats that never materialized, the price of oil jumped more than 30 percent, only to fall about 16 percent. Isn’t that a bit like the boy who cried wolf? Or Chicken Little? Probably, but that’s the nature of the futures market. Better to discover the price early than late, or so they say.

As threats over Iran have waned, and the euro crisis has picked up steam, the oil market has refocused on actual supply-demand fundamentals—which don’t come close to supporting oil at its current price. “If you remove the speculators, supply and demand fundamentals support oil prices at barely $80,” says Fadel Gheit, an oil and gas analyst at Oppenheimer (OPY). On Wednesday the price of West Texas Intermediate oil, the benchmark for North American crude, fell to less than $90 for the first time since November, as U.S. oil supplies rose to a 22-year high. WTI has largely been immune from international chaos, which has been more reflected in the price of Brent crude, the international benchmark oil contract. Brent has shed nearly $15 this month and closed just above $107 on Wednesday.

But here’s where it really gets weird. From a pure science perspective, there’s still a total disconnect between the price of oil and the price of natural gas. A barrel of oil contains about 6 million BTUs of energy; 1,000 cubic feet of natural gas contain about 1 million BTUs. That means on a pure unit of energy measurement, a barrel of oil should be about 6 times more expensive than 1,000 cubic feet of natural gas, a 6 to 1 price ratio. So if natural gas is trading at $2.72 per million BTUs, which it is, then a barrel of oil should be about $16.

Of course, that’s a reflection of perfect parity and doesn’t take into consideration such things as transportation and extraction costs. Or supply and demand, for that matter. The world doesn’t function in a vacuum. But if you go back over the past 20 years, that price ratio stayed mostly consistent, hovering around 10 to 1 from the early 1990s until about 2009. During the past two years, though, as the price of oil has risen and natural gas has tanked, the ratio has spiked, peaking to almost 50 to 1 this spring.

“It’s a very quirky situation,” says Gheit. “It’s like having a hailstorm when the sun is shining. You cannot model it or make a bet on it. It’s completely unpredictable.”

That ratio has gone off kilter for several reasons. For one, natural gas supplies have far outpaced our ability to use the stuff. The U.S. is still in the early stages of retooling its economy around natural gas. Also, the warm winter cut way down on demand for natural gas, which has pushed supplies up and prices down. At the same time, oil rebounded steadily from its lows in early 2009 as global demand ramped up (the world was coming out of recession) and as chaos in the Middle East fueled fears of supply shortages.

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Guide to Right Investments

Lobbying to Become Lobbyists for Crowdfunding

Startups looking to take advantage of a new law allowing them to sell their stock online to the public can’t count that seed money just yet. The U.S. Securities and Exchange Commission, which will oversee what’s expected to be a fast-growing market in crowdfunding for emerging businesses, must weigh in first. The agency has until early next year to write rules governing who can buy and sell the stock and to establish safeguards against fraud—basically, erect a whole new regulatory bureaucracy. One group that’s not sitting by and waiting: the lobbyists competing to be the new industry’s voice in Washington.

When you think of crowdfunding, Kickstarter is likely the first—and maybe the only—business that springs to mind. This is something different. With Kickstarter’s help, a musician or a guy with an idea for a better bottle opener can raise startup cash in exchange for a copy of the completed album or one of the first bottle openers to roll off the line. The new law, part of President Obama’s JOBS Act, is for businesses that will offer equity—not IOUs—to investors.

Even before Obama signed the legislation in April legalizing crowdfund investing, which he praised as a way to spur entrepreneurship and create jobs, two new lobbying groups had sprung to life. The leaders of the dueling organizations—the National Crowdfunding Association and the Crowdfunding Professional Association—don’t yet have pricey offices in the nation’s capital. In fact, they don’t have offices at all. Or staff. Or experience lobbying, for that matter.

David Marlett is a Dallas securities lawyer who came up with the idea for the National Crowdfunding Association when he realized all these now-obscure startups would need someone to represent them. He figured it might as well be him. Along with his background in financial law, Marlett points to his brushes with politics: A Democrat, he’s helped run the campaigns of two unsuccessful challengers to Texas Republican Representative Ralph Hall. “I’m kind of a troublemaker, and you need somebody like me,” he says. Businesses can join his group for a $600 fee. So far he claims scores of takers, among them EarlyShares.com and Return On Change, two startups that hope to become Kickstarter-like portals connecting businesses with investors willing to buy their stock.

Photograph by Michael Friberg for Bloomberg BusinessweekBerkeley Geddes

Marlett’s chief rival is Berkeley Geddes, a self-described serial entrepreneur. He says his Crowdfunding Professonal Association is a natural outgrowth of his day job as chief executive officer of a Salt Lake City company that helps new businesses get off the ground. To encourage new members (and, perhaps, outmaneuver Marlett), Geddes is waiving dues for the first year. “Anybody who believes in entrepreneurship should sign up immediately,” he says. His members include crowdfunding portal Vim Funding and Gate Technologies, an online trading platform.

The two men don’t have much nice to say about each other. Marlett calls Geddes’s free group “a terrier, chewing at your heel. We wish them well.” Geddes is more philosophical. He says Marlett’s group represents “the actions of one individual. We represent the crowd.”

Both spend their days pitching businesses, spreading the word at conferences, and preparing to make their case to the SEC officials they hope to keep off their members’ backs. Because the agency’s main mission is to protect investors, it’s expected to set a high bar for who can sell stock online. If there’s “too much bureaucracy, crowdfunding will die,” says Geddes.

Marlett and Geddes may be in competition, but startups don’t necessarily see a need to take sides. Maurice Lopes, a co-founder of EarlyShares, joined Marlett’s group and sits on its board. He also signed up with Geddes, though he doesn’t have an active role. “It doesn’t matter how many associations we have,” Lopes says. “The more people involved in making this legitimate, making this work in a cohesive way, the better.”

The bottom line: Two rival lobbying groups are competing to sign up crowdfunding startups, which will soon be allowed to sell stock to the public.

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Bid & Ask: The Deals of the Week

1. Moving further from its roots in auto parts, Eaton (ETN) is buying Cooper Industries (CBE), a maker of electricity distribution equipment, in a stock and cash deal valued at $11.8 billion.

2. Yahoo! (YHOO) plans to sell half of its 40 percent stake in Alibaba Group, China’s largest e-commerce site, back to the company for $7.1 billion.

3. Barclays (BCS) is selling its entire $6.1 billion stake in the fund manager BlackRock (BLK) before new banking regulations take effect that would require the bank to set aside capital against the holding.

4. Dialysis provider DaVita (DVA) agreed to pay $4.4 billion for HealthCare Partners, which manages medical groups and physician networks.

5. SAP (SAP), the largest maker of enterprise software, expanded its cloud computing offerings with its $4.3 billion purchase of Ariba (ARBA), an online commerce platform for businesses to trade goods and services.

6. Formula One is planning to raise as much as $3 billion in an initial public offering in Singapore, three people with knowledge of the matter said.

7. China’s largest entertainment conglomerate, Dalian Wanda Group, agreed to buy AMC Entertainment Holdings for $2.6 billion in a deal that creates the world’s largest cinema chain.

8. Private equity firm Blackstone Group (BX) plans to buy the Motel 6 chain from European hotel operator Accor (AC) for $1.9 billion. The deal includes 1,102 Motel 6 and Studio 6 extended-stay hotels in North America.

9. Benihana (BNHN) is selling itself to the private equity unit of Angelo, Gordon & Co. for about $296 million. Benihana runs 95 Japanese-themed restaurants in the U.S., including the RA Sushi and Haru chains.

10. A torch used to carry the Olympic flame to London in May sold for $238,000 on EBay (EBAY) to benefit a British charity.

Clockwise from top: Wolfram Scheible; Matt Cardy/Getty Images; Vladimir Rys/Getty Images; Julie Dermansky/Corbis; Comstock Images/Getty Images

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Playing the Facebook Blame Game

The Facebook (FB) initial public offering—preceded by an epic lawsuit over ownership, an Oscar-nominated movie, a great leap forward for sweatshirts, and the constant feedback of roughly a billion customers—was always going to be more than just a financial event. It was a cultural event, too, a global party with a get-rich-quick theme. If nothing else, the poor performance of Facebook stock in the immediate aftermath of the IPO proves that on Wall Street, those who are late to the party don’t profit.

There’s more to it than that, though. Investors are faulting everything from Morgan Stanley’s (MS) role in setting the terms of the offering to Facebook’s greed and the Nasdaq (NDAQ). And regulators including the Securities and Exchange Commission say that they may examine the deal. “It was like the gang that couldn’t shoot straight,” says Michael Mullaney, chief investment officer at Fiduciary Trust in Boston, who says he placed Facebook orders for clients. “The underwriters misestimated what actual demand was, and there was pure execution failure coming out of the Nasdaq.”Left to right: Photographs by Ronaldo Schemidt/AFP/Getty Images; Nadine Rupp/Getty Images

Morgan Stanley, which led the 33 firms Facebook hired to manage the $16 billion sale of stock, is taking the most heat. The bank and Facebook executives decided to boost the size and price of the offering days before the May 17 IPO, ignoring advice from some co-managers, say people with knowledge of the matter who declined to be identified because the process was private. “They overplayed the enthusiasm and probably just misread the atmosphere of the marketplace,” says Keith Wirtz, chief investment officer at Fifth Third Asset Management in Cincinnati, who bought some stock in the offering.

Barry Ritholtz, chief executive officer of investment firm Fusion IQ, faults Facebook for allowing so many of its shares to change hands on trading sites such as SecondMarket while the company was still private. Morgan Stanley, he writes, was “hemmed in by the inefficient, opaque, clumsy secondary markets that had overpriced the shares.”

Facebook CFO David Ebersman was the point person on the deal, while CEO Mark Zuckerberg and COO Sheryl Sandberg weighed in on major decisions, said people with knowledge of the matter, who declined to be identified because the process was private. Facebook increased the number of shares being sold in the IPO by 25 percent to 421.2 million and raised its asking price to a range of $34 to $38 from $28 to $35. Had Facebook kept the original terms, investors may have had a better shot at a first-day pop. Instead, Morgan Stanley had to buy shares on the first day to prevent the stock from falling below the IPO price of $38. Spokesmen for Facebook and Morgan Stanley declined to comment on the size and price of the offering.

Lower sales forecasts for Facebook may have helped deflate the IPO. Investors filed suit in Manhattan federal court on May 23 against Facebook, Zuckerberg, and bankers including Morgan Stanley, Goldman Sachs Group (GS), and JPMorgan Chase (JPM), accusing them of misleading them about the company’s financial prospects. William Galvin, Massachusetts’ secretary of the commonwealth, says his securities division subpoenaed Morgan Stanley to learn more about talks between Scott Devitt, a Morgan Stanley analyst who follows Facebook, and the firm’s institutional investors about Facebook’s revenue.

Morgan Stanley says it sent a copy of a revised prospectus that Facebook filed on May 9 to all of its institutional and retail investors. The filing disclosed that Facebook’s advertising growth hasn’t kept pace with the increase in users. Pen Pendleton, a Morgan Stanley spokesman, said in an e-mail that many analysts in the syndicate of underwriters reduced their earnings estimates to reflect that information, and that those revised views were reflected in the pricing of the IPO. “Morgan Stanley followed the same procedures for the Facebook offering that it follows for all IPOs,” Pendleton said. A spokesman for Facebook said in an e-mail: “We believe the lawsuit is without merit and will defend ourselves vigorously.” Spokesmen for Goldman Sachs and JPMorgan declined to comment.

Morgan Stanley and Facebook consider problems with Nasdaq’s computer systems among the reasons for the stock’s disappointing performance so far, according to two people close to the companies who declined to be identified because they are not authorized to speak publicly. Nasdaq’s trading platform was overwhelmed by orders and cancellations that made the stock market operator unable to finish the auction required to open trading. Nasdaq CEO Robert Greifeld said on a call with reporters on May 20 that the glitch “had no apparent impact on the stock price.” A spokesman for Nasdaq declined to comment further.

Underwriters did accomplish one of their goals: turning paper into cash for pre-IPO holders. “It was successful for the liquidating owners, absolutely,” says Peter Sorrentino, a fund manager who helps oversee $14.7 billion at Huntington Asset Advisors in Cincinnati. The banks also earned total fees of $176 million on the deal. For the investors, it was a different story. Sorrentino, whose firm didn’t buy stock in the IPO and tried to talk clients out of purchases, says disappointed investors have only themselves to blame, because the company’s financial statements were available to anyone who cared to look. “Do the math,” he says. “Everyone wanted to be caught up in the glamour offering of the year. People just had stars in their eyes.”

The bottom line: After increasing the price and size of its IPO, Facebook found that Morgan Stanley had to buy shares to keep them trading above $38.

Saitto is a reporter for Bloomberg News. Spears is a reporter for Bloomberg News. Ciolli is a reporter for Bloomberg News. Moore is a reporter for Bloomberg News.

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A Nobel Economist Fears for the Poorest Greeks

Christopher Pissarides won a Nobel Prize in economics in 2010, but he hasn’t forgotten his roots in a modest, Greek-speaking village on the island nation of Cyprus. He was born in 1948. Although his father had a successful business selling materials for making clothes and other items for the home, Pissarides lived among people who scratched out a meager living as farmers. “Work on the fields would begin at dawn with mules and donkeys and end at sunset,” he recalled in his Nobel autobiography.

That sensitivity to the lives of the poor shines through in an interview that Pissarides gave today to Jennifer Ryan of Bloomberg News. He is talking about capital flight—the movement of euros out of Greece into bank accounts abroad. Capital flight increases the chance that Greece will be forced to abandon the euro. People who move their euros abroad are betting that if Greece does return to the drachma, they will be able to buy big piles of them with their euro stash.

“It’s the wealthy who will benefit because that’s who’s able to move their money abroad,” Pissarides tells Ryan. “Wealthy Greeks have already done it, whereas the small saver is not going to do it.”

Even the middle class is at a disadvantage to the rich, says Pissarides, who is a professor at the London School of Economics.

“Foreign banks do not always accept small deposits from non-residents even though they’re part of the euro system,” he says. “If you’re a small shop owner in Athens or one of the smaller towns, how do you find a foreign bank to open a foreign account, do you take your cash in hand and fly off to Italy or Switzerland or wherever? It’s not that easy.”

Read Pissarides’s Nobel autobiography and you sense where his concern for the poor comes from. Here’s an excerpt:

We were a happy family and I had a good upbringing. I have particularly fond memories of our family evenings at home before television, and our summers on the coast of Kyrenia and the mountains and valleys of Agros. I used to spend the time with my cousins, fishing in Kyrenia (mostly unsuccessfully) or playing in the riverbeds and springs of Agros. Cultivation in the village was still at subsistence level, in small plots, and occasionally we would stray into some vegetable patch or tomato bed, to be chased away by hard-working men and women in their traditional village clothes. Work on the fields would begin at dawn with mules and donkeys and end at sunset. On Sunday everything changed, as the whole village gathered at the church to pray, gossip and hold memorial services for their dead, distributing to everyone the traditional home made “kolliva” (boiled wheat with dried fruit, almonds and pomegranate seeds). Service in the Greek Orthodox Church was in the original Byzantine Greek of the bible, so I doubt whether anyone in the village, except perhaps the priest and the teacher, understood much. But it was certainly a great social occasion that I enjoyed very much. Watching how my relations who stayed behind in the village worked and how generous they were with their crops when we visited taught me a lot about family and inner well-being.

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Kvetch in May: Why Market Timing Isn't Everything

All hail Memorial Day weekend. In the tradition of my Miami childhood, ‘tis the season to don Crockett & Tubbs white pants and flaunt the right to bare arms. Hedgies and traders clad in Sperry Docksiders bolt Gotham for the leafy, saltwater-sprayed indolence of the Hamptons. The market’s volume dips to a trickle.

And so “Sell in May and Go Away” becomes the mantra of choice. Indeed, this strategy has been especially useful over the past two years, with markets rallying to start the year and plunging between the onset of summer and autumn. One minute, the world’s not so bad, come to think of it, and stocks are hitting new highs. Then, with complacency all the rage, another PIIGS-led panic ripples across the pond. Maybe Europe’s denial about the urgency of its financial crisis is directly proportional to the temperature outside. Plus every man, woman, and baguette on the continent gets 30 weeks a year of paid vacation, I’m told, complete with a government-issued spa stay. But I digress.

Point is: Can you time the market?

The folks at Leuthold Group did a surprising analysis of the merits of going defensive in May—a strategy they call “Sell in May … without actually selling.” (After all, portfolio managers cannot just liquidate their portfolios and sit on cash for several months.) But they could sell volatility to go long the fuddy-duddy.

Leuthold calculated that if you had owned cyclical sectors (say tech and financials) from November through April and then switched into defensive sectors (utilities and health care, for example) from May through October, you’d have posted an annual return of 15.5 percent since 1989, compared with the S&P 500’s 8.6 percent annual gain. While 23 years of data does not prove an immutable market fact, this is a huge differential, making an original $10,000 investment compound into $275,000, vs. $67,000.

But anyone who’s taken college-level finance is supposed to know that timing the market is a fool’s game. “A look at the actual data shows that the intense focus on this seasonal trend might be yet another case of investors placing too much weight on the most recent events,” writes Daniel Putnam of InvestorPlace, who analyzed the past 40 years of performance for the S&P 500 Index during the May 1-Sept. 30 interval. He found that stocks are as likely to rise through most or all of the period as they are to fall. True, the S&P 500 hit its high in May on nine occasions. But  it peaked in September on 13 occasions, in June three times, July eight times, and seven times in August.

“The lesson,” Putnam writes, “is that more often than not, an investor who took the saying literally and sold on May 1 almost invariably gave up some upside.”

So why the endurance of the “Sell in May” meme? Maybe it’s summer’s recent knack for hosting market disasters, from 2001 and 2002?s tech wrecks to 2008?s mortgage meltdown and last year’s renewed kvetching over Europe and the U.S. credit rating. The mid-section of 1974, a brutish time for the American psyche, saw a 30 percent plunge. But back out these calamitous episodes and the S&P 500?s average May-September price return has been 3.55 percent over the past four decades. Putnam says investors should resist the urge to indulge their recency bias.

For my part, I have no recency bias. So if you’ll excuse me, there’s this party out in the burbs that I must get to.

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Goldman's Jobs Act

Dina Powell, the head of the Goldman Sachs (GS) Foundation, breezed into an Upper East Side restaurant on the morning of April 19 and flung a red dress over a chair. “I’m traveling,” she said apologetically, referring to both the dress and her slight tardiness. After breakfast, she had a flight to Washington. As she scrutinized the menu—deciding on scrambled eggs with scallions and cream cheese—she contemplated the generous impulses that drive many of her colleagues at Goldman Sachs: “I think we attract people who want to work for an institution that is having a meaningful impact on the world,” she said brightly. “Did you know that Goldman Sachs has fielded more individuals who have served on nonprofit boards in the last 15 years than any other public or private institution? It’s remarkable!”

The Goldman Sachs Foundation is one of the largest corporate foundations in the world, and Powell is in charge of deploying its $500 million-plus in assets. Attractive and polished, she’s a gatekeeper and an ambassador of Goldman’s good deeds. She’s also a talisman to ward off regulators, Occupiers, and anyone else who might regard the investment bank as a less than benevolent force. It’s about as much money as Goldman paid the Securities and Exchange Commission—$550 million—to settle civil claims that it misled investors in mortgage securities whose selection was influenced by a hedge fund client that had secretly bet against them. Goldman settled without admitting or denying liability.

Clint Spaulding/patrickmcmullan.com/SIPA PressPowell touts the 'meaningful impact' of Goldman's charity. It totaled $337 million in 2011

Managing the charitable activity for a company that has come to symbolize corporate predation is just the sort of delicate role Powell has experience with. She was hired in 2007 by Goldman Chief Executive Officer Lloyd Blankfein and Chief of Staff John Rogers after spending six years as a member of the George W. Bush administration. Her last job there was Deputy Under Secretary of State for Public Diplomacy and Public Affairs under Karen Hughes, where Powell worked to put a friendly face on the Bush government. Her ascent through the private sector has been swift: Powell was promoted to Goldman partnership in 2010. (Powell’s husband is head of communications for Bloomberg L.P., the owner of Bloomberg Businessweek.)

The bank’s leadership had recently decided to reorganize the way they practiced philanthropy, and Powell was put in charge. Rather than scattering money around museums and opera houses, or donating only to education, which was a previous focus, Goldman executives wanted to center their efforts on economic growth, which was more aligned with their business. Powell’s first project under this new formula was 10,000 Women, a global economic development initiative to support female entrepreneurs in the developing world, which launched in 2007. The program was a success—Goldman was given an Excellence Award in Corporate Philanthropy by the Committee Encouraging Corporate Philanthropy in 2011.

Next, Goldman decided to try something even more ambitious: helping small businesses in the U.S. grow and create jobs. The firm dedicated $500 million to the cause, called 10,000 Small Businesses, with $300 million going to loans and grants and the remainder to fund educational programs for small business owners. The idea was to pour resources into small companies in urban areas by offering specialized training, mentoring, and access to capital. So far the program has launched in six U.S. cities: New York, New Orleans, Houston, Los Angeles, Chicago, and Long Beach, N.Y. The seventh will be Cleveland, it was announced in early May. The program was launched in London, Manchester, Leeds, and Birmingham in the U.K. as well. “Even though we began this work in 2007, when the downturn hit, we stayed fully committed,” Powell says. “We did not decrease by one penny the commitment of the firm, even through the difficult economic times.”

Big corporate donations always make a statement. An army of consultants exists to help companies figure out how to give money away in a manner that makes the statement they want. At a time when Goldman Sachs is often held up as the worst example of Wall Street greed and excess, it’s only natural to wonder about the company’s motivations for a $500 million philanthropy. When Powell is asked what Goldman’s sponsorship of the small business program says about the firm, she replies, rather stiffly, that “effective philanthropy has been a core value of the firm for 140 years.” Perhaps it doesn’t matter what Goldman’s reasons for promoting small businesses are. Maybe the only important question is whether it works.
Precisely how to “create” jobs is an endless struggle for economists and policy makers. When governors such as Chris Christie of New Jersey brag about job creation during their tenure, often they are referring to the process of enticing a corporation, usually through tax breaks, to leave one state and move to another, bringing jobs with them. The alternative approach is more organic, and arguably more difficult: Individual companies that show potential are nurtured and given the resources they need to expand, optimally leading to actual new job creation. In either scenario, precise cause and effect are difficult to measure.

To get Goldman’s program going, Powell wrangled institutions such as Wharton business school and Babson College, which designed the curriculum, and celebrity business minds, including Warren Buffett and Harvard’s Michael Porter, to serve as advisers. “She’s just good,” chortles Buffett, when asked why he decided to participate. “In a very, very nice way, she gets all the rest of us to work quite hard. I hadn’t seen her in action until I got involved in this. I think I probably oughta hire her.”

Actually helping small businesses is more complicated than simply throwing money at the problem; the elements necessary for job creation include all levels of education first and foremost, according to Guy Michaels, a labor economist at the London School of Economics and Political Science. “There’s [also] evidence that teaching best practices is correlated with doing better,” Michaels says. Access to capital is also critical, he adds, particularly in an environment where large banks aren’t making many loans to smaller companies.

“There are a lot of disastrously managed small companies out there,” says Nicholas Bloom, an economist at Stanford University. But, he adds, aiding them is not so easy at it seems: “It all sounds very inspiring and fantastic, but it turns out that the evidence from large samples is less encouraging.”

According to Bloom, it’s large companies that would potentially benefit from the kinds of interventions Goldman could offer, places where advice on corporate finance might actually be relevant. “The types of things a pie baking shop needs to know are either very detailed skills the Goldman Sachs guy won’t know about, or very basic things like how to keep accounts in Excel, which they typically already know,” Bloom says. Some studies he cites suggest that training small business owners can actually cause harm by taking up precious time that could be spent running their companies, and often the instruction quality isn’t great. Even the higher level of teaching that Goldman is reaching for might not be enough. Plus, the failure rate for small businesses is extremely high, around 75 percent. Those that survive tend to show “fantastic” job growth, according to Bloom. A study by the National Bureau of Economic Research released in 2010 found that most job growth actually happens at startup companies rather than the sorts of established small enterprises that Goldman has been targeting.

Still, Goldman executives say they are encouraged by the results they’ve seen. Powell and her team felt they could overcome the obvious obstacles by applying what they’d learned through the 10,000 Women program and by being rigorous in how they did it.

The firm contracted with Babson, the well-regarded Massachusetts business school, to design a course around practical skills that business owners need and most often lack—accounting, negotiation, hiring. Community colleges, most of them in cities, would host the educational programs, which take about 80 hours spread over 10 weeks. Professors and experts were corralled into teaching them. The first city was announced—New York—and the inaugural pool of business owners was selected, 50 out of about 200 who applied. “We know that startups create jobs. What we also know is that startups fail,” says Len Schlesinger, the president of Babson, explaining why he thought targeting established companies would work. “Goldman Sachs is interested in being able to demonstrate empirically that there is an answer here.”

Rahm Emanuel, the mayor of Chicago, the sixth city to host Goldman’s program, says it dovetailed perfectly with his plan to reorganize the city’s community colleges to focus exclusively on career training for industries that are likely to provide jobs in the future, such as health care, information technology, and hospitality. “I want to talk to Goldman about how to make this permanent,” Emanuel says. Buffett, too, remains a fan. “I talked to a number of graduates who told me they were able to renegotiate leases or franchise fees—they really put it to use, having someone there who is like an outside investor, but isn’t,” he says. “There’s no question that it will work.”

Jessica Johnson, who runs Johnson Security Bureau, a small security firm based in the Bronx, describes her experience with 10,000 Small Businesses as “very surreal.” Johnson’s father had been running the company when he became gravely ill. Johnson was working in Texas for a pharmaceutical company and rushed home to help care for her father before he died, in 2008. Suddenly the daughter was in charge, and she had very little sense of what to do next. “He walked me through some operations, I got to see a couple of runs of the payroll system,” she says. “It was enough that after his death I was able to step in and at least keep things going.”

A friend urged her to apply to 10,000 Small Businesses, then in its debut year. Johnson thought, “I’ll take any assistance I can get.” She describes the program’s workshops as “intense.” They talked about how to get a company’s finances organized in order to apply for loans. There was a human resources session where lawyers came in and discussed employee law. They even covered strategies for expanding and acquiring new business.

“Before, we were like a 10-year-old girl, cute and a little awkward. Now we’re more like a 15-year-old—not quite as awkward, with a better idea of where we want to go,” Johnson says. She’d hoped to finish 2010 with 20 employees; she fantasized about having 25 in 2011. Instead, business picked up, and they reached 40 by the end of 2010. She says this year they’re looking to add 80 to 110 more. “People are starting to take notice,” she says.

Over breakfast, Powell recounted a story about Goldman COO Gary Cohn, who participated in a roundtable discussion about “human capital management” with the 10,000 Small Businesses cohort in Chicago. “It was fascinating,” Powell said. “He was sitting between the owner of a bakery on the South Side of Chicago and a man who owns a construction company.” Both business owners were explaining to the Goldman bigwig, whose 2007 compensation totaled some $67 million, that they didn’t know how to find the best workers or make the most of them once they did.

“He said, ‘That’s our biggest challenge at Goldman Sachs, recruiting the best and training them, retaining them and giving them a path to promotion,’?” Powell recalled. Cohn recounted the story of his own hiring at the firm—he underwent something like 40 interviews, many of them with people who were going to be his juniors. He told them: “?‘Make sure when you’re hiring someone, it isn’t just one or two interviews—make sure everybody on your team interviews them.’?”

Powell is convinced that Goldman Sachs does things better than everyone else, especially when it comes to giving money away. “I think it used to be acceptable to give money, attend galas, those kinds of activities,” she says. “Now I think a higher bar has been set.”

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Private Student Loans Are Becoming More Competitive

Private student lenders are stepping up their game to compete directly with government loans. For several years, private lenders offered mostly variable-rate loans that students used as gap funding to cover their needs above what they could get on government loans. Now private lenders are introducing loans fixed at nearly the same rates as some federal products, seeking to nab a bigger piece of the student loan market as outstanding debts balloon to more than $1 trillion.

The largest student lender, SLM (SLM), known as Sallie Mae, introduced fixed-rate loans earlier this month. On May 21, Discover Student Loans (DFS), the third-largest education lender, started a fixed-rate loan program as well. Wells Fargo (WFC), the second-biggest lender, had launched fixed-rate loans last summer. For families with good credit, the private loans could be as low as 5.75 percent—a full point lower than the 6.8 percent for unsubsidized federal loans.

To understand this change, a brief bit of history is in order. In 2010, President Obama signed into law reforms that reconfigured how students borrowed money for education. It eliminated a program that subsidized private lenders to offer fixed-rate loans that the government guaranteed in case students defaulted. That left private lenders with only variable-rate loans—great for students when interest rates are low but painful when rates shoot up. “It created a huge hole in our product portfolio,” says Steve Olszewski, a senior vice president at Discover Student Loans.

Enter the Federal Reserve, which has been keeping interest rates near zero to try to spur lending and revive the economy. Banks can borrow for almost nothing, so now they can lend at a fixed rate that’s similar to what the government offers. “Clearly the funding environment is very conducive to it,” Olszewski says.

Right now, the fixed-rate loans primarily compete against the 6.8 percent unsubsidized Stafford loans, which are largely for graduate students or families that don’t demonstrate financial need. The rate on subsidized Stafford loans is at 3.4 percent. Federal loans have other benefits too, such as debt-forgiveness for public service work. ”Overall, the unsubsidized Stafford loan still offers a better deal for all except the most creditworthy of borrowers,” writes Mark Kantrowitz, publisher of FastWeb (MWW), a site that helps match students with scholarships. With staggering default rates and so many factors to juggle, the Consumer Financial Protection Bureau is trying to make it easier for students to compare loan offers.

That may be more important if Congress doesn’t act by July 1, when the subsidized rate is scheduled to double, to 6.8 percent. Then the fixed-rate private loans might interest an even broader audience.

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Facebook Falls Below Its IPO Price

(Updated with Monday’s closing price.)

Less than an hour into only its second day of trading, 88 million shares of Facebook (FB) had changed hands and the price was down 12 percent from Friday’s close of $38.23. (The shares closed Monday at $34.03.) In other words, you could buy this most anticipated of initial public offerings at a substantial discount from the price that Wall Street reserved for its preferred clients.

With a valuation of $104.8 billion at the May 18 close, Facebook was already worth more than three times the other 10 U.S. consumer Internet companies to have gone public in the past year; LinkedIn (LNKD), valued at $10.3 billion, is second.

“IPOs are scary things,” says blogger and newsletter writer Eddy Elfenbein. “It’s hard to justify Facebook going for sixty times” next year’s estimated earnings, he adds, “in a market where Apple (AAPL) is going for less than 10 times next year’s estimate.”

So what price can be justified? Elfenbein calculates that Facebook’s estimated 2013 earnings of $1 a share, combined with its projected 50 percent earnings growth rate for the next five years—and there’s no guarantee the company will meet those estimates—give it a fair value of $33 a share. Even so, he says buying the stock would be prudent only at closer to $23.

You may get that chance. Another analyst, PrivCo’s Sam Hamadeh, points to concerns about Facebook’s fundamentals: declining first-quarter advertising revenue; the number of unique visitors to Facebook dropping in the U.S.; the company warning in its most recent S-1 filing that the shift to mobile access vs. desktop access could complicate its ad business. He also anticipates a wave of new stock hitting the market once insiders are free to unload their holdings, and predicts that others will sell to raise money to pay taxes on their gains.

“When you factor in that the lockup expires in November and tax-related selling, we think the shares, once the hype dies down, will be in the $20s by yearend—$24 to $25 per share,” Hamadeh told peHUB.

If Zuckerberg & Co. should want consolation, they need look no further than Google’s (GOOG) 2004 initial public offering. Few remember that the king of Internet search actually had to slash the price of its shares well below its earlier targets. It ultimately IPO’d at $85, which was far lower than management’s earlier indicated range of $108 to $135. And though GOOG did enjoy a nice Day One pop, it went to nowhere and back for the better part of a month—before more than quintupling in less than four years.

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Existing Home Sales Rise--Affordability Helps

To move the merchandise, cut the price. That time-tested formula finally seems to be working in the U.S. housing market. The National Association of Realtors said today that sales of existing homes rose 3.4 percent in April, from March (seasonally adjusted).

No doubt a big reason was the improvement in affordability. The interest rate on a 30-year fixed-rate mortgage has continued falling since the period covered by the NAR report, portending better times ahead. Freddie Mac (FMCC), the mortgage-buying giant, says the rate was 3.79 percent in the week ended May 17, the lowest since it began keeping records in 1971. The Realtors’s index of affordability hit a record high in the January-March quarter. It factors in sales prices of existing homes, mortgage rates, and household income, which is slowly strengthening as the labor market improves.

The median sales price rose 10.1 percent from a year earlier. That hurts affordability, but it could lure buyers who decide they can’t wait for even cheaper prices. “Today’s data provide further evidence that the housing sector is turning the corner,” wrote economist Joseph Lavorgna of Deutsche Bank Securities.

The numbers could well improve in the months to come. Action Economics Chief Economist Michael Englund wrote: “The existing home sales data generally continue to underperform the recovery in the new home market and other indicators of real estate market activity.” But, he added, “the trend is upward.”

Tomorrow the U.S. Census Bureau will report sales of new homes in April. The median estimate of economists surveyed by Bloomberg is that they rose 2.6 percent from March.

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Mitt Romney's Private Equity Nightmare

The Randy Johnson-Ampad video has landed, and that could be bad news for Mitt Romney.

Back in February, we profiled Johnson and gave Bloomberg Businessweek readers a heads-up that he would star in an Obama campaign assault on Romney’s past as a private equity mogul and the Republican’s claims that his years at Bain Capital were devoted to job creation.

Well, the assault began last week with an ad about a former Bain-owned steel company called GST, and today the Obama team sent Johnson into the fray with a video about another ex-Bain property, office-supply manufacturer Ampad, a name that’ll be rocketing around YouTube and the political blogs.

The theme of this attack is familiar: Romney has claimed that during the time he ran Bain Capital in the 1980s and 1990s, the financial firm created tens of thousands of jobs. On occasion, the candidate has even boasted that his financial engineering added 100,000 jobs—a claim that, to put it politely, he has never adequately documented (as my Bloomberg News colleague Lisa Lerer explains here). To the contrary, according to the Obama campaign, Bain under Romney destroyed a lot of jobs when it took over struggling companies, like Ampad, squeezed “efficiencies” out of them (via factory closings and layoffs), and then watched them tumble into bankruptcy.

Randy Johnson, a plainspoken union organizer who once worked for Ampad in Marion, Ind., embodies the blue-collar case against private equity, Romney-style. As we reported in February:

Back in 1992, Bain acquired a manufacturer called American Pad & Paper, or Ampad. Bain then used Ampad as a vehicle to buy and restructure similar companies. Following standard “roll-up” strategy, Bain closed factories and laid off workers in anticipation of selling off a leaner, more profitable company via an initial public stock offering.

Two years into the roll up, Bain had Ampad acquire an office supplies plant in Marion, Ind., a manufacturing town 70 miles northeast of Indianapolis. At the time, Johnson worked the night shift making hanging files. “We come back from the July 4th holiday, and this is what we find posted,” Johnson says, producing from the Romney box a one-page notice: “As of 3 p.m. today, July 5, 1994, your employment with SCM Office Supplies Inc. will end.” Most of the 258 employees were allowed to reapply for jobs at reduced wages and benefits. Johnson’s pay fell 22 percent, he says, from $10.05 an hour to $7.88. Dismayed to see their old union contract torn up, the Marion workers negotiated with Ampad management for several months, then called a risky strike. In early 1995, Ampad called the union’s bluff, closed the plant, and laid off the remaining workers.

Ever since, Johnson has been haunting Romney with the memory of Ampad. The union man helped defeat the former buyout executive during his very first run for political office—an unsuccessful bid to unseat the late Senator Ted Kennedy in 1994. Now Johnson is back, and he makes a formidable foe. He tells his story affectingly and makes what sounds like a simple, straightforward argument.

As we noted when we looked deeply into the Ampad story with Johnson as our guide, that company’s demise is far from a simple morality tale, however. The office supply industry was struggling and consolidating by the time Bain got into the game. As so often happens with a brutal private equity makeover, workers lost jobs they may well have lost anyway, with or without the assistance of the financial engineers. This is the weakness in the Obama campaign’s one-sided and, in a sense, unfair broadside against private equity.

On the other hand, as Randy Johnson astutely observed in our profile, Romney has brought this problem on himself:

“None of what happened in Marion in the 1990s would be very interesting,” Johnson notes, “if Mitt Romney had not built his entire political career on the claim that he’s a job creator.”

We also interviewed Marc Wolpow, a former Romney colleague at Bain, who defended the buyout business as promoting American competitiveness. The main goal at buyout firms, however, is never maximizing employment, Wolpow told us. It’s maximizing returns for investors. “The facts,” Wolpow said, “tend to get lost in the political spin.”

Oh, and there’s one other thing. The optics of Bain and Romney taking millions in profits away from a deal like Ampad, while workers like Johnson lose their modestly paid jobs, just seems … well, unfair. That’s the message the Obama campaign wants to convey.

Barrett is a senior writer for Bloomberg Businessweek.

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IPOs' Job-Boosting Power Is Overblown

When President Obama signed the JOBS Act to make it easier for young companies to go public, he said it “will help entrepreneurs raise the capital they need to put Americans back to work.” Give fast-growing companies easier access to money from public market investors, the thinking goes, and they will expand faster and hire more people. Research published (PDF) by the National Venture Capital Association says that “92 percent of job growth for young companies occurs after their initial public offerings,” suggesting that a company with 100 employees at its IPO could expect to hire an additional 900 in the years that follow. The 92 percent figure was cited prominently (PDF) in lobbying efforts supporting the JOBS Act.

A new report (PDF) from the Kauffman Foundation, which promotes entrepreneurship, suggests the estimate is overblown. “Conventional wisdom is that companies going public create a lot of jobs,” says Jay Ritter, a University of Florida finance professor who co-authored the study. “The numbers that the venture capital lobby keep repeating are grossly overstated in terms of what the average IPO can accomplish.”

Ritter and his co-authors found that companies that went public from 1996 to 2010, in aggregate, increased employment by 45 percent over their IPO headcount. Many of those public offerings, though, were not from “growth” companies but from other sorts of businesses, ranging from leveraged buyout targets to mature companies like UPS (UPS), which was founded more than 90 years before it went public in 1999. Growth companies, which Ritter defines as less than 30 years old (and excluding buyouts, spinouts, and the like), more than doubled employment from their IPO levels through 2010. Still, the Kauffman paper says such companies didn’t have anywhere near the nine-fold employment growth that the NVCA reports they enjoyed after going public.

That figure comes from research by IHS Global Insight, which the NVCA commissioned in 2009. IHS Vice President Mark Lauritano told me the firm measured growth in employment at the 200 venture-backed companies with the largest market caps, counting from the time of their IPOs from 1970 on. It didn’t include results from companies that failed or from smaller companies. “This study does have a built-in survivor bias,” Lauritano says. “The 90 percent growth figure really represents the upper end of the range for job creation because it is based upon the largest publicly traded VC-backed companies that ‘survived’ the ups and downs of the business cycle,” he wrote in an e-mail.

That doesn’t mean the slower pace of public offerings over the last decade hasn’t affected job growth. The Kauffman paper estimates that if companies had gone public in the first decade of the 21st century at the same rate they did between 1980 and 2000, those companies would have created an additional 1.9 million jobs. “It is important to have a working IPO market to facilitate venture capital fundraising and investment,” Ritter says. “If VCs don’t have that exit possibility, it’s going to make it more difficult to raise money to invest in startups.”

Making it easier for more startups to go public, though, may not put as many people back to work as supporters of the JOBS Act thought.

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The Developer Behind a $90 Million Penthouse

You can put your spare $90 million into buying 2 million shares of Facebook (FB), or you can spend it snapping up one luxury penthouse apartment in New York. A 10,923-square-foot duplex atop One57, one of the city’s tallest buildings, has sold for that record price tag. While the buyer’s name isn’t public—all we’re told is that the buyer is a family who are not from a former Soviet state—the name of the man behind the luxury development is no mystery: Gary Barnett, the president of Extell Development.

Barnett, a former diamond trader, started his company in the 1990s and soon took on a number of attention-getting projects, including buying Enron’s new Houston headquarters after the company’s collapse and developing the W Hotel in New York’s Times Square. Barnett has conquered a field dominated by family dynasties and REITs to become the second most powerful person in New York real estate, according to the Commercial Observer. “Long considered a lone wolf for his tendency to ruffle feathers of his contemporaries … the developer is beginning to be taken more seriously by his peers,” the paper wrote earlier this month.

One57 is Barnett’s highest-profile project—literally: The 90-story building is 1,005 feet tall. It has a premier location across from Carnegie Hall, just south of Central Park. In a market where developers are layering on extravagance to attract wealthy buyers from Russia and Asia, Barnett gushes about the luxury of One57. “Look at this kitchen,” he told the Observer. ” Where will you find a kitchen anywhere like this? It’s the best, and we have two of them.” The kitchens feature built-in wine cabinets and custom cabinetry from the bespoke British designer Smallbone of Devizes.

While Barnett’s the developer of One57, he’s not the one who will profit most from the sales. The real money goes to two Abu Dhabi-based funds that have a majority investment in One57 after putting $650 million into the project, according to a 2011 story in the Wall Street Journal. Barnett has just 10 percent.

He has other flashy properties in the works, including a glassy Hyatt in Times Square with a rooftop bar and renovations to convert the old Helmsley Carlton Hotel on Manhattan’s Upper East Side into apartments. He also is hoping to outdo himself, with plans for another tower just one block away from One57 that will be 245 feet taller. No word yet about the kitchens in that one.

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