Miami Condo Market Shows a Way to Solve Inventory Glut

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

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

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

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

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

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

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

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

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

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

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

Farzad is a Bloomberg Businessweek contributor.

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If Only T. Boone Pickens Had Died

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Hannan is a Bloomberg Businessweek contributor.

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New Word of Insider Tips at SAC Capital

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

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

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

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

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

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

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

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

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

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

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

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Getting Banks off the Roller Coaster

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

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

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

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

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

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

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

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

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

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

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

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Ready or Not, Homebuilders Are Back

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

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

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

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

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

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

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

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

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

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

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

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

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Using Warhols to Save a Failed Company

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

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

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

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

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

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

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

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

Photograph by Metro Pictures/BloombergCindy Sherman

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

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

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

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Vaclav Klaus on the Czechs' Lessons for the Euro Zone

We are junior members in the European Union, but we’re not part of the euro zone currency system. Our central bank, together with our government, opposes fiscal union. We entered the EU when many things were a given. When you want to join the local golf club, you can’t say, “Well, I’m ready to enter your club on condition you change the rules.” Joining the monetary system was one of the conditions that we accepted with some reluctance. Monetary union is an extreme case of a fixed exchange-rate regime. To start one is easy, when all the parameters more or less fit together. But then economies grow differently, and the real issue is to maintain the arrangement. Milton Friedman said the euro would not survive the first real crisis. That’s been proved to be a reality.

I have a unique position being the last minister of finance of a dissolving monetary union. When we dissolved Czechoslovakia into the Czech Republic and Slovakia, we prepared 25 intergovernmental agreements. Our idea was to keep an open free-trade area and a single currency. When we divided the country on Jan. 1, 1993, and we still had the Czechoslovak crown, we discovered it was impossible without politics and fiscal union. Slovaks put their money in the Czech Republic, where the economy was stronger. This is not a criticism of Slovakia, or a criticism of their behavior. It’s just criticism of entering the monetary union. After several weeks, we had an overnight meeting in Prague with the prime minister, the governor of the Central Bank, and the ministers of finance of the Czech Republic and Slovakia. We more or less accepted that it wasn’t working. At 4 a.m. we made a decision that it would be technically possible to create two currencies.

We announced it and did it. For most Czechs, it was a nonevent. It’s not true, what all the politicians are saying about the disaster in exiting the euro. You have to do it in a prearranged, organized way.

I refuse to be called a euro skeptic. The European integration process is an experiment. I differentiate European integration from European unification. I have no objections to the opening up and liberalizing of Europe. But that doesn’t mean everyone is the same. — As told to Diane Brady

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Bloomberg View: Has the Fed Declared War on Brazil?

Brazil’s president, Dilma Rousseff, and her finance minister, Guido Mantega, are attacking the U.S. Federal Reserve for embarking on a third round of quantitative easing. By aggressively buying bonds, the Fed aims to push interest rates lower, and that will nudge the dollar down as well.

This will hurt Brazil and other developing-country exporters, Mantega says, and what’s more, it’s meant to. To him, the U.S. has declared “currency war.”

The Fed’s primary goal, however, is not to manipulate the dollar but to expand demand at home. It hopes to do this mainly by lowering interest rates and convincing investors that rates will stay low for a good while. This should encourage consumers to spend and companies to hire and invest. If these things happen, U.S. imports will rise, and exporters such as Brazil can expect to benefit.

Although Mantega is wrong about QE3, his wider concern about currency manipulation is right. Indeed, it’s an issue over which Brazil and the U.S. should make common cause.

Let’s be a bit more precise about who manipulates currency. The charge is best limited to nations that block the movement of currencies toward levels that would help balance global trade. If currency manipulation is defined this way, the leading offender is China. One measure is a country’s growth in foreign exchange reserves: Manipulators hold their currencies down by using domestic money to buy foreign assets. Recently, and especially over the past year, China has eased this policy, but its foreign exchange reserves still stand at a colossal $3.2 trillion.

We favor adding currency oversight (and the sanctions that might go with it) to the duties of the World Trade Organization or the International Monetary Fund. This makes excellent sense because currency manipulation can add to trade policy friction and vice versa, in a cycle of mutually assured disadvantage.

Currency manipulation already violates WTO and IMF rules, but there is no enforcement. This should change. Meanwhile, Mantega and other finance ministers need to be more careful about whom they accuse of waging currency war. The U.S. isn’t among them.

To read Edward Glaeser on privatizing government agencies and William D. Cohan on JPMorgan, go to: Bloomberg.com/view.

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Where's the Shareholder Outrage at Hewlett-Packard?

Here’s a vastly boiled-down refresher on corporate governance: A public company’s management is accountable to its board of directors, which in turn answers to shareholders, who are, after all, the “owners” of said public company. These holders keep executives and directors honest by casting votes based on tens of millions of shares dispersed across individual brokerage accounts, pension plans, and mutual funds. A management that consistently does wrong by shareholders is liable to be evicted from its seat at the mahogany table. For elaboration, please see Gordon Gekko’s speech in the movie Wall Street.

How then have Hewlett-Packard (HPQ) shareholders largely remained so silent while board infighting, botched multi-billion-dollar acquisitions, multiple strategic false starts, and high C-Suite turnover have combined to lop off more than $90 billion of market valuation—the venerable tech company is now worth just $28 billion—since the end of 2009? After management asked on Wednesday for yet further patience as it restructures HP’s sprawling lines of business, shares plunged to where they traded 10 years ago. One prominent analyst observed in the New York Times that HP was the cheapest big-cap stock in 25 years. And that was before its Oct. 3 plunge.

Aggrieved shareholders, unite! (Cue crickets. …)

What gives?

Increased shareholder vigilance can only do so much to combat the bad business trends that are hitting HP all at once. Its personal computer business is losing out big in the broader trend of iPad and iPhone substitution. The profit pool of overpriced toner cartridges is shallower, and companies’ growing adoption of cloud computing—out of sight, out of mind—makes it harder to convince them to shell out for square-foot-hogging hardware.

But so much of what now ails HP has been self-inflicted—lots of it needlessly. Chief Executive Officer Meg Whitman is the company’s sixth CEO since 2005, a stretch that has seen its culture of corporate governance suborn hacking into the phone records of journalists—and even those of its own directors. With the board’s blessing, management in 2008 paid $13.9 billion to take out EDS, an acquisition so disastrous that HP recently had to write down $8 billion of its value. Mark Hurd, the CEO who sought that deal, got paid $43 million in fiscal 2008, en route to getting fired for questionable human-resources behavior two years later.

The HP board’s ham-fisted handling of that episode might have been forgivable had the directors not then hired a new CEO who hastily made a nearly $12 billion software acquisition and signaled to Wall Street that HP was looking to jettison its PC business. Leo Apotheker lasted less than a year as CEO; the (revamped) board wasted no time in lamenting the decision to hire him.

Meg Whitman, HP’s current CEO, has since been explaining the struggles brought on by Apotheker’s ill-spent billions for Autonomy, not to mention HP’s having squandered its $1.2 billion acquisition of Palm, a false start that has left it without a smartphone or tablet that can compete with Apple (AAPL). Meanwhile, come to think of it, you can rest assured that HP is keeping the PC business it wanted to sell when it was in better shape.

And the board? Earlier this year, in one of the more surreal pieces of business journalism I’ve ever seen, writers James Bandler and Doris Burke chronicled: “Dr. Phil could fill a month’s worth of shows just examining HP’s board, whose dynamics have resembled those of rival junior high school cliques more than what is supposed to be a sage guiding force. At times … HP directors have refused to be in the same room with one another and have accused each other of lying, leaking, and betrayal. Time and again they’ve failed in their choice of CEO—their most important task—selecting a new leader whose most salient trait is that he or she is the opposite of the last one.”

Again, where is the shareholder indignation? HP shares are down 44 percent this year, while the S&P 500 index is up 15 percent and tech-benchmarking Nasdaq is up 20 percent. That is precisely the kind of underperformance that should prompt bloodied shareholders to think board uprising.

According to Bloomberg data, San Francisco mutual fund house Dodge & Cox is the biggest institutional holder of HP stock, accounting for just under 140 million shares, or 7 percent of what’s outstanding, as of the latest filing date. Per company policy, and consistent with what you hear from just about every fund shop, Dodge & Cox won’t comment on individual holdings.

Fair enough. Shareholders can—and obviously have, in droves —vote with their feet on HP. If you don’t like it, don’t buy it, right?

At the same time, some of those holding shares must figure you cannot spell hope without HP. “Many investors are still hoping that we are looking at the early days of Lou Gerstner’s IBM (IBM) rescue in 1993 or Anne Mulcahy’s rescue of Xerox (XRX) in 2001,” says Jeffrey Sonnenfeld, a professor at the Yale School of Management. “I believe that informed investors appreciate that the board is finally much better, with key new directors and a revered chairman in Ray Lane.”

HP’s board already has restless blood—or the potential for it—coursing within. Director Marc Andreesen famously instituted a New York Times (NYT)Deathwatch to convey his displeasure with the newspaper’s family-based management. HP director Ralph Whitworth, the activist investor who shook up Home Depot (HD), has his hedge fund, Relational Investors, in 35 million shares of HP, according to regulatory filings. How long will he tolerate this era of reset after reset?

“HP seems like exactly the type of company that should have attracted the attention of activist investors,” says Jonathan Cohn, a finance professor at the University of Texas, Austin, who has studied (PDF) the new shape of activism. “I do think that its size might have made it difficult to target.” Cohn says that perhaps the addition of Whitworth to the board last year is a sign that shareholders will play a more active role in the company now, though he says Relational’s apparent agreement not to seek HP’s sale “takes away an important source of leverage.”

Activism requires time, money, and overhead that the investing world decreasingly wants to pay up for. Last year, HP retained Goldman Sachs (GS) to help it deal with activists or hostile bidders. The biggest single impediment to a shareholder revolt at HP could be the passive mandate of its now-dominant owners: cut-rate index funds and ETF heavies such as Vanguard, State Street (STT) (SPDRs), and Blackrock (BLK) (iShares). That style—be the market, don’t beat the market—has been killing the old business of active management. According to Morningstar (MORN), mutual funds whose managers pick domestic stocks experienced redemptions of $497 billion in the five years ended June 30, while index funds took in $117 billion.

Like it or not, you and I and most American investors increasingly have no choice but to own a piece of HP as it is currently run, boardroom dysfunction and all.

Farzad is a Bloomberg Businessweek contributor.

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Charlie Rose Talks to Joseph Stiglitz

Is the economy finally on the mend?
It’s not really trending upward. There are two big gaps in our economy relative to, say, 2007. One is real estate. Real estate was the big sector. The bubble broke, and now real estate investment is half of what it was. No way that that’s going to recover soon. The only good news is that the houses were shoddily constructed—and in maybe 5 or 10 years we’ll have to reconstruct them. The second problem: consumption. Before the crisis, we were saving close to zero out of our disposable income. That wasn’t sustainable. Now, savings is between 4 and 5 percent. Hopefully, it won’t go lower. But with consumption weak and investment and real estate weak, it’s very hard to get a really robust economy.
You’ve written a book about rising inequality. Tell me why it pinpoints deregulation under Reagan as the turning point?
The Reagan administration did more than just deregulation. They lowered the taxes on the top. After World War II came decades in which the country grew much faster than it did after 1980. And the country grew together. Every group grew. After 1980, we grew apart. One of the things is, we lowered the tax rates on the top. That increased the divide. And the other one is, we deregulated, particularly in the financial sector, which continued under Clinton, under Bush.
You ran Clinton’s Council of Economic Advisers.
I opposed those deregulation movements.?…?Deregulation allowed the banks more scope for moving money from the bottom, all those kinds of predatory lending we saw. Move the money from the bottom to the top. And if you look, a disproportionately large number of people at the top, in that 1 percent, are from the financial sector.
How big has America’s financial-sector economy become?
One way of looking at it is, 40 percent of all corporate profits went to the financial sector. So that shows you, in a sense, that a set of institutions that are supposed to be servants?…?You don’t enjoy financial services directly. They’re supposed to facilitate. They’re supposed to enable the rest of the economy to do what it’s supposed to do. And yet this servant became the master.
How do you correct the income imbalance? With a Buffett Rule tax?
I think what Warren Buffett has argued is absolutely necessary. The consequence of that is that those at the top who are taking advantage of capital-gains rates would pay at least as much as those whose income is much lower.
What impact would that have on investing?
Negligible. Even if you were concerned about investment you could structure our tax code to encourage investment a lot better. Let me give you an example. Land speculation: If you get capital gains from land speculation, does it create more land? The banks that were speculating on credit-default swaps, when they won, they got the capital-gains rate. Does that make our economy grow? No. It makes our economy, in some sense, even more risky. Remember that AIG (AIG) got a $180 billion bailout out of that speculation. So if you wanted to encourage investment, I could see an argument saying corporations that invest in America will get tax preferences. Entrepreneurs that expand their investment and create new jobs will get a tax benefit. But it has to be linked to doing things that make our economy stronger, not to gambling, not to speculation, not to just being wealthy.
With the fiscal cliff ahead, what budget reforms would you focus on?
It turns out that Social Security is not a big problem. Change the age a little bit, change the contribution a little bit. That’s something we can solve fairly easily. The health-care programs are a significant concern. If we had a health-care system that was as efficient as some of the European systems, we’d have no deficit.
How do we put America back to work and make our economy grow?
Invest. The U.S. government can borrow at a negative real interest rate right now. And we have an ample supply of investment opportunities in infrastructure, technology, education.
So you think the deficit obsession is killing our economy?
That’s right. Over the long run we have to have fiscal responsibility. That’s why, during the Clinton administration, in good years, we had a surplus. But we opposed a balanced-budget amendment on the grounds that in good times you want to run surpluses. In bad times you want to run deficits. These are bad times.

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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