Stephen’s Posterous

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Ancestry.com Files for $75 Million IPO

Ancestry.com filed for a $75 million initial public offering on August 3, 2009. Ancestry.com is a genealogy website that lets users trace their family origins.

The company plans to list on either Nasdaq or the New York Stock Exchange as ACOM. Morgan Stanley and Bank of America Merrill Lynch are the two lead underwriters.

Ancestry.com was founded in 1983. The company began as a publisher of family history books and moved online in 1997. It later changed its name to Ancestry.com.

In 2007 Ancestry.com sold a majority stake to Spectrum Equity Investors for $300m. Before that it had raised $95 million in three rounds.

The company has almost 1 million paying customers. The company had $107 million in revenue over the last six months, with profits of $8 million.

Ancestry.com offers basic functionality for free, but users have to sign up for a premium subscription in order to access the website's vast library of historical records, which includes billions of documents and photographs.

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Filed under  //   ACOM   Ancestry.com   Bank of America Merrill Lynch   Genealogy   Morgan Stanley   Spectrum Equity Investors  

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Lending To Businesses Down 13% in February

The government’s capital infusion into banks aimed at getting them lending again has achieved only part of its goal, according to a monthly bank lending survey released by the Treasury Department today.

While the banks gave out more home mortgages in February than in January in 2009, they extended less credit to businesses for such purposes as capital expenditure and acquisitions, the survey shows.

The survey reviewed data reported by 21 banks including Bank of America, JPMorgan Chase & Co., Citigroup Inc., Goldman Sachs Group and Morgan Stanley & Co. It found that the median increase in home mortgage lending from January to February was 35% among the banks, showing that lower mortgage rates had spurred demand for such loans.

But commercial and industrial lending saw a median decrease of 13% for new commitments and a 14% decline for renewal of existing accounts.

“Uncertain economic conditions have resulted in borrowers reducing expenses, paying down debt, and delaying capital expenditure,” the Treasury said in a report. “Also contributing to the lower demand was lower overall merger and acquisition activity.” The survey didn’t break down business lending for different purposes.

Bank of America leads the banks with highest amount of both loan renewal and new commitments, lending $11.7 billion and $10.2 billion, respectively in February. JPMorgan comes in second, with $10.7 billion in loan renewal and $8.9 billion in new lending. Wells Fargo is a solid third, with $9 billion in loan renewal and $4.8 billion in new lending.

By comparison, three other large banks lent much less in February, with $2 billion in new loans for Morgan Stanley, $422 million for Goldman Sachs, and $416 million for Citigroup.

“New loan origination has been substantially limited as the current economic environment makes very few deals viable,” Citigroup said in a report to the Treasury.

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Filed under  //   Bank of America   Citigroup   Commercial Lending   Goldman Sachs Group   Industrial Lending   JPMorgan Chase   Morgan Stanley   Treasury Department  

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MGM Mirage Explores Selling Casinos

MGM Mirage has hired Morgan Stanley to handle the potential sales of two of its steadiest cash cows, MGM Grand Detroit and Biloxi's Beau Rivage casino, according to people with knowledge of the matter.

The news comes after a person familiar with the matter said Australian billionaire and gambling magnate James Packer is weighing a stake in City Center, the troubled $8.6 billion Las Vegas development owned by MGM and Dubai World.

The Las Vegas-based MGM Mirage is under intense pressure to raise cash in order to meet looming obligations on its $13.5 billion in debt as well as to salvage an $8.6 billion real-estate project that still needs billions in funding. The company is also grappling with a dramatic decline in gambling revenues as consumers cut spending and companies cut back on travel to Las Vegas.

Morgan Stanley is in discussions with buyers interested in purchasing the Michigan and Mississippi casinos, said a person close to MGM Mirage. Morgan Stanley is also vetting potential buyers to determine whether they have adequate access to cash or credit and whether they would likely to win permission to operate a casino from state regulators.

A sale of the casinos may not go through, and talks could fall apart at any time. Some in the gambling industry with knowledge of the situation have characterized the process as akin to a private auction with qualified potential buyers able to make closed bids to Morgan Stanley. People close to MGM Mirage say the company does not characterize the process as an auction and that the company will not sell the casinos at a cut-rate price.

"The company is going to explore all available options and will develop a comprehensive strategic plan," said MGM Mirage spokesman Alan Feldman.

Industry analysts said a sale of the two casinos, which have held up well even as Las Vegas has seen a sharp decline in revenues, might bring anywhere from $1 to $2 billion, providing major relief to the struggling company.

MGM Mirage recently won a two-month reprieve from lenders, but it also warned that it might not be able to meet a May 15 deadline to comply with loan covenants that require certain cash-to-debt ratios.

"It would be a pivotal event if they do sell" the two casinos, said Joe Fath, a gambling analyst with T. Rowe Price. "I think it's going to go a long way to giving the banks more confidence that they can work through the issues they have."

MGM Mirage's debt woes are compounded by troubles with its $8.6 billion City Center project under construction on the Las Vegas Strip. MGM Mirage is being sued by its joint-venture partner on the project, Dubai World, over mismanagement and cost overruns.

Dubai World, a conglomerate owned by the government of Dubai, skipped its half of a $200 million March payment due to contractors. MGM Mirage received special permission from banks to make the full payment on its own.

MGM Mirage chief executive Jim Murren has said in recent interviews that selling some properties is "part of the solution" to solving the company's debt and cash problems. The casinos in Detroit and Biloxi are two of the most profitable in the company's portfolio. While a sale would raise much-needed cash in the short term, it would also deprive the companies of crucial cash flow in the future.

But Bill Lerner, a gambling analyst with Deutsche Bank said sales of the two properties make sense because "they aren't core" to MGM Mirage's business, which is primarily in Las Vegas. At the right price, Mr. Lerner said, sales could prove more useful to MGM Mirage by relieving pressure on the company and allowing it more breathing room with lenders.

MGM Mirage recently closed on the sale of its Treasure Island casino in Las Vegas to investor Phil Ruffin for $775 million. In 2008, Treasure Island produced $100 million in earnings before interest, taxes, depreciation and amortization, according to a filing with the Securities and Exchange Commission.

By comparison, the Detroit casino produced $131 million in EBITDA and the Beau Rivage casino in Biloxi produced $100 million in EBITDA last year, according to SEC filings.

Both casinos have gone through recent transformations. The first MGM Grand Detroit was a temporary casino located in a former Internal Revenue Service building downtown. MGM Mirage spent $800 million to build a new casino across the street, which opened in 2007 and includes a luxury hotel, spa, and gourmet restaurants.

Detroit casinos have defied gravity recently. As the rest of the gambling industry flails and Detroit itself endures one of its worst financial crises ever, the MGM Grand Detroit has continued to flourish. Even as Las Vegas gambling revenues have been dropping by double digits in recent months, in February, casinos in Detroit posted a 4% increase in gambling revenues compared to February of last year, according to state records.

MGM Mirage spent $500 million to resurrect the Beau Rivage after it was battered by Hurricane Katrina in 2005. The Gulf Coast casino re-opened a year later.

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Filed under  //   Alan Feldman   Beau Rivage Casino   Bill Lerner   City Center Project   Deutsche Bank   Dubai World   James Packer   Jim Murren   Joe Fath   MGM Grand Detroit   MGM Mirage   Morgan Stanley   Phil Ruffin   T. Rowe Price   Treasure Island  

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Q&A with Morgan Stanley Asia's Stephen Roach

Stephen Roach, Chairman of Morgan Stanley Asia and the bank’s former chief economist, answers questions.

How should capitalism evolve to create a sustainable economy and limit the occurrence of boom and busts and asset bubbles, while at the same time creating opportunities and incentives for innovation and wealth creation?

Stephen Roach: The demise of capitalism is greatly exaggerated. As the free-enterprise system survived the Great Depression of the 1930s, I have little doubt it will reinvent itself and endure the current crisis. Yet we can and must do much better in making market-based capitalism a safer, more stable and sustainable system. There has been a major systemic failure of the model that has held the world together since the 1930s.

Governance, or the lack thereof both within the private sector as well as by those charged with regulation and oversight proved to be the weak link in the chain. As a first priority, that shortcoming now needs to be addressed head on.

In one key respect, that is already happening: Wall Street is being turned inside out right before our eyes. But the new post-crisis regime must also include a revamped code of governance not just regulatory streamlining and reform but also the hardwiring of financial stability into the policy mandates of central banks.

Independent central banks that operate apolitically and free of ideology could well be the most important stewards of a post-crisis capitalism. But they can’t do it alone. Only through better discipline and more effective governance of regulators, rating agencies, and the political oversight function, can the invisible hand of Adam Smith start to work its magic once again.

How should global imbalances, the savings glut in the U.S. funded by China and Japan, be addressed?

SR: The theory is simple: spenders need to start saving and savers need to start spending. Easier said than done, of course. Execution is the problem for a world that simply doesn’t seem to have the appetite, i.e., political will, for the heavy lifting of global rebalancing.

Significantly, powerful market forces have already sparked the early stages of an endogenous rebalancing. In the US, the simultaneous bursting of property, equity, and credit bubbles is forcing households to shift from asset-based saving strategies back to income-based saving strategies. The ageing of 77 million US baby boomers, the first of whom started retiring last year, underscores the urgency of this adjustment, as a large generation of Americans now comes face to face with the imperatives of retirement security.

In China, a massive external demand shock has brought its export-led growth strategy into serious question. If a multi-year compression in US consumer spending growth leads to a protracted slowing in the growth of China’s external markets, Chinese policymakers will have no other choice than to accelerate the transition to a more balanced, and increasingly consumer-led, growth.

Critical in this regard is for China finally to put in place policies that will expand its social safety net, especially social security, private pensions, unemployment insurance, and public support to education and healthcare.

The United States is adding to its already great national debt to fight the recession. Should the US enact laws now, which state that we will raise taxes and cut spending in the future to guarantee that we will stand behind our national debt and prevent catastrophe, e.g. increased interest rates if our debt is considered worthless or has reduced credit worthiness?

SR: The good news is that the coming explosion of federal debt starts from a relatively low base, just 40 per cent of GDP at the end of 2008. The bad news is that open-ended deficit spending seems likely to take the debt-to-GDP ratio toward 60 per cent by 2013 and to over 100 per cent by 2022.

The real problem is the lack of a credible exit strategy from fiscal and monetary stimulus, alike. Post bubble economies are very fragile and not easy to wean from the life support of fiscal and monetary accommodation. Just ask Japan. Twenty years after the bursting of its big bubbles, public sector debt-to-GDP is nearly 150 per cent and the Bank of Japan’s zero interest rate policy is celebrating its 10th anniversary.

While I am not worried about a debt default of the United States government, I am very sympathetic to your suggestion that we codify an exit strategy to the massive fiscal expansion now under way. Toward that end, I believe that the Congress and the White House should collectively declare a formal fiscal emergency and empower a bi-partisan task force to develop new guidelines for federal budgetary control.

Washington did this once before in an effort to contain the runaway budget deficits of the Reagan era, deficits that now look like child’s play when compared with what lies ahead. The automatic spending caps and sequestration mechanisms prescribed by the Gramm-Rudman-Hollings Balanced Budget and Emergency Deficit Control Act of 1985 succeeded in taking some of the optionality out of the fiscal debate.

This problem is too big and the long-term stakes are too high for fiscal sustainability to be entrusted to the oft-politicised whims of the year-by-year discretionary budgeting process.

Given the balance sheet repair needed by the Western consumers, do you see Asia growing at all over the next two years? And more specifically, is there any way that China can juice its economy now that global demand has evaporated?

SR: In light of prospects for a multi-year compression of US consumer demand growth, together with persistent sluggishness of private consumption in Europe, Japan, and elsewhere in the developed world, there can be no mistaking the challenges faced by export-led Developing Asia.

Those challenges are all the more acute in light of Asia’s sharply increased dependence on exports. Over the past decade-plus, the export share of Developing Asia’s GDP went from about 36 per cent in 1997-98 to fully 47 per cent by 2007. This strategy worked brilliantly while global trade was booming. But now that this boom has gone bust, Asia has been hit extremely hard leaving it with no choice other than to come up with a new growth strategy.

The answer for Asia is obvious, to embark on the heavy lifting of structural rebalancing and stimulate internal private consumption. Nowhere is that more evident than in China, where the private consumption share has fallen to a record low of about 36 per cent of its GDP.

In the meantime, Developing Asia will still grow, driven by ongoing infrastructure-led investment and less than optimal growth in personal consumption. I suspect the growth rate for the region over the next few years will average only around 5 per cent about half the pre-crisis norms and not strong enough to prevent unemployment from rising further. For a region that has long worried about social instability, this is a disconcerting outcome, to say the least. It underscores the critical imperatives of Asian rebalancing.

What is the likelihood of Anglo-Saxon-style capitalism morphing toward a more state-involved Chinese approach, along with more draconian penalties for moral lapses?

SR: Your point is provocative and well taken, but I just can’t get on board this ideological spin to the twists and turns of a post-crisis capitalism. The history of capitalism is very much a continuum of tough tests. Yet in the end, it is a system with strong survival instincts, one that periodically reinvents itself. Financial panics, periodic recessions, and even the Great Depression are all part of the stress testing that has long shaped the rough and tumble evolution of market-based capitalism.

Notwithstanding the claims of a sensationalist media, the scale of state-directed intervention in America’s privately-held corporations remains relatively small.

According to US Commerce Department statistics, the value added by banks, securities firms, and other financial intermediaries collectively accounted for 6.2 per cent of the private sector’s gross domestic product in 2007; the insurance sector made up another 2.8 per cent, whereas the share going to motor vehicles manufacturers was just 0.8 per cent.

Private employment shares of these newly protected industries are even smaller, 5.3 per cent for finance and insurance and just 0.7 per cent for motor vehicles.

These figures provide an outside estimate of the US government’s recent intervention share of around 6-10 per cent in the private economy. That means, of course, that more than 90 per cent of the private sector in the United States is still operating largely as a free-enterprise system. That is not exactly consistent with the widely popularised image of a bail-out nation that has been offered up to depict a US economy in chaos and a market-based system on the brink of collapse.

Still, there is good reason to be concerned about the implications of these recent interventions. Emergency government investments in privately-held companies, capital injections as well as backstop financing, have become an all-too-frequent outgrowth of what started out as a mere sub-prime crisis. At the same time, compensation caps, home mortgage foreclosure mitigation efforts, and politically-engineered consumer lending programs all smack of a quasi-socialisation of American finance.

Add to that, Washington’s new-found aggression on trade policy, “buy America” government procurement policies, along with Chinese currency bashing and it seems as if the US strain of capitalism is being turned inside out. The US body politic is rushing headlong toward a very slippery slope!

The intro asks what is to be done to restore ”faith” in the free market. Is anyone using reason to re-examine free-market ideology itself, or considering the possibility that free markets might be less lethal if they were a little less free?

SR: The current mess is deeply rooted in an ideological approach to economic governance, namely, America’s recent penchant for market libertarianism. Alan Greenspan, the high priest of this approach, framed most of the Federal Reserve’s critical policy choices in the context of this ideology.

As seen through this lens, asset bubbles were not judged to represent a dangerous build-up of speculative excesses instead, they were repeatedly perceived by Greenspan as outgrowths of America’s thriving free enterprise system. The equity bubble of the late 1990s was justified by the breathtaking acclaim accorded to IT-enabled, productivity-led advances of a New Economy.

Property bubbles were presumed to be local, not national,  especially in an era of rising homeownership at the lower or subprime end of the income distribution. And the credit bubble, together with the risk bubble it spawned, was offered as testament to the genius of financial innovation and American creativity. Market libertarians simply looked the other way as the US lurched recklessly from bubble to bubble.

Bubbles, of course, are always based on a shred of truth. But the post-bubble wreckage of the US economy begs for a very different interpretation than that which became conventional wisdom over the past decade. So, too, does the Fed’s blatant abrogation of its regulatory responsibilities during the Greenspan years.

Nowhere was that more apparent than in the central bank’s failure to make the distinction between financial engineering and financial innovation. Far from playing the widely popularised role as the ultimate shock absorber, the originate and distribute hallmark of the derivatives explosion became a lethal transmission mechanism of cross-border and cross-product shocks.

Ideology blinded America’s central bank, as well as its political overseers, to the imperatives of discipline. That same ideology let an unregulated and increasingly unstable free-enterprise system veer unnecessarily out of control. I don’t think that markets have to be any less free, as you suggest.

We just need to be more vigilant in attending to their potential for instability and in recognising the repercussions such destabilising adjustments can have on increasingly asset-dependent real economies. Market risk must be taken far more seriously by the Authorities in the future.

Some form of regulation is undoubtedly needed, but it can sometimes be counter-productive, merely adding layers of costs and giving more business to corporate lawyers and auditors. Sarbanes-Oxley is a perfect example of this form of regulation. In light of such issues, what in your opinion is the ideal form of regulation, and do you foresee a return to Glass-Steagall?

SR: While I agree that misplaced regulation can be counter-productive, I also believe that our system of self-regulation failed miserably in an increasingly complex and globalised economy. An important corollary of this failure is the dangerous and destabilising implications of bubble-dependent economic growth.

We must be very careful, however, in rushing to judgment in designing a new regulatory approach in this post-bubble era. The search for scapegoats can become an obsession; in effect, a lightning rod for national angst. But scapegoating can play an even more destructive role as it can bias and eventually undermine the re-regulatory fix that invariably follows any crisis.

Therein lies one of the greatest potential pitfalls in the post-crisis backlash of 2009. Wall Street has been singled out as the villain in this crisis. On one level, this is understandable. Financial service firms did make many serious and regretful mistakes from faulty risk management models and perverse incentive systems to misguided business strategies and momentum-driven capital deployment. But they were hardly alone.

The modern US financial system has long been under the purview of an institutionalised network of checks and balances controlled by regulators, a politically-independent central bank, and congressional oversight. Rating agencies were empowered as the arbiters of risk assessment. Yet every single one of those safeguards failed to temper the systemic problems that were building for years in the Era of Excess.

The task ahead is to pick up the pieces, learn the lessons of this crisis, and take actions to insure these types of problems never occur again. The post-crisis fix can succeed only if it is grounded in the premise of shared responsibility. A targeted politicised fix is not a solution to a systemic problem. Fix the system that gave rise to the crisis not just the banks that have defined ground zero of a wrenching credit crunch.

It is hard to know where the re-regulatory fix will end up. I would not be surprised if new Glass-Steagall-like regulations were enacted in order to shield the credit intermediation function from riskier activities. Moreover, a much broader umbrella is likely, covering banks and non-bank financial institutions, alike.

In the face of government picking winners and losers both of businesses and individuals have we had a free market in reality during the last 40 years? Isn’t it correct to state that what we have had is a hybrid economic system that depended on government manipulation of the financial system to exist?

SR: To the contrary. During the Era of Excess, market libertarians were in charge, embracing a regime of self-regulation and unbridled free-market capitalism. Led by Alan Greenspan, there was very little of the manipulation you seem to believe in.

Those days appear to be over at least for the time being. With many of the once proud icons of Corporate America now on the skids, emergency government intervention has become the norm in this crisis. That is closer to the hybrid system that you seem to be alluding to. As I noted above, the real trick will be to wean the patient from the life support measures of such interventions without triggering a relapse.

To what extent might governments try to influence the business strategies of the financial institutions, which agreed to state aid?

SR: That is a little close to home. The words “might” and “try” should be stricken as this train has already left the station. The feeding frenzy of US Congressional bonus bashing has taken on a life of its own with extreme “clawback” legislation having already passed the House of Representatives and now working its way through the Senate.

If signed into law, these draconian measures would severely impact talent retention, as well as the willingness of any financial institution to accept government “assistance” in the future. Your choice of the word “influence” is a massive understatement of the destructive intent of America’s increasingly vengeful body politic.

Personally, I am sickened by the hypocrisy of the blame game that has been spawned by this wrenching crisis, a politically inspired witch-hunt that has now singled out Wall Street as the villain in this mess. While our industry is hardly blameless for developments that gave rise to the so-called sub-prime crisis, it is dead wrong to lay it all on Wall Street.

Yes, we made many serious mistakes from faulty risk management models and perverse incentive systems to misguided business strategies and momentum-driven capital deployment. I personally have great regret for these errors, honest mistakes that were made by a few but with implications for far too many.

But the verdict must be rendered in context. Governance of the modern US financial system has long been relegated to an institutionalised network of checks and balances, controlled by regulators, a politically-independent central bank, and congressional oversight. Rating agencies were empowered as the arbiters of risk assessment.

Yet every single one of those safeguards failed to temper the systemic problems that were building for years in the Era of Excess. In short, the system failed. And in this new era of responsibility, as President Obama calls it, all of us must accept shared responsibility for that, from Wall Street to Washington to Main Street.

America’s politicians, the stewards of a system that went to excess, apparently can’t stomach the possibility that they, too, played an important role in shaping the endgame. They prefer, instead, to opt for the blame game, in particular, singling out Wall Street as the major culprit in this devastating crisis.

Focusing on the fall guy deflects attention away from the tough choices that ultimately must be made by elected leaders to avoid the repetition of a crisis like this in the future. Never mind the hypocrisy. It is as if the people’s representatives were innocent passengers on a runaway train.

The blame game is the darkest side of any crisis. The search for scapegoats often becomes an obsession, in effect, a lightning rod for national angst. And it brings out the very worst in an otherwise great nation. Accountability is, indeed, a critical issue in any post-crisis debate. But it must be adjudicated objectively and fairly.

Capitalism is failed in the form it is in and will fail again. If the only target of a system is to accumulate wealth for the minority, it is a worthless system. What do think about the ideas of Mahammad Yunus and his Grameen Bank?

SR: I stand by what I said above. The failure is not capitalism but the system of governance or should I say, the non-governance of self-regulation, that was put in place to manage the capitalist system. Fix that, and capitalism will be fine.

No one could reasonably have expected the boards of directors of major financial institutions to foresee the devastation caused by the financial crisis, but was it not reasonable to expect them to be much more effective in forcing their chief executives to protect against the demise of their banks? If not, what real value can boards play in a governance system if they cannot be relied on to do the right thing when it is most critical?

SR: It is premature to judge the most critical failures in the system of corporate governance that guided financial institutions into the eye of this storm. Was it directors, senior managements, risk managers, credit departments, incentive systems or a lethal interplay between all of the above?

Or was it a siloed decision making process and a related failure to communicate effectively across these different constituencies? Getting to the bottom of these concerns is an urgent matter for every financial services firm.

But there is a very human piece to this sad tale, as well. Call it greed, blind greed, for that matter. Like it or not, booms, artificial or real, distort incentives. Booms also warp values and blind us to downside risks. And denial, that most powerful of human defenses, leads us to dismiss the tough questions that might draw the staying power of a boom into question.

In the now-ended boom, there was everything to gain from keeping the magic alive. And much to lose by drawing it all into question. But it wasn’t just Boards of Directors that failed. It was the American body politic – from Wall Street to Main Street to Washington that was consumed by the hopes and dreams of a bubble-induced boom.

As long as the music kept playing, went the painfully accurate metaphor, no one wanted to stop dancing. We even found heroes to worship: Alan Greenspan, anointed as the Maestro, knighted by the Queen, lionised by US Congress, and yet derelict in his responsibilities as a tough and disciplined central banker was the champion of the Era of Excess.

In the end, the ultimate seduction came from the appearance of unbridled wealth accumulation, soaring stock prices, surging home values, and the ultimate in retirement security. But it wasn’t just us. The rest of the world was delighted to go along for the ride, especially export-led developing economies whose newfound prosperity was built on selling anything and everything to over-extended American consumers. Literally, no one, not even you guys in Shanghai, Peter, wanted this party to end.

If the core reason for the current financial crisis was the failure of the American consumer to save, how will policies designed to simulate spending massively at a time when the consumers’ financial position is even more precarious be conducive to the long term change in behaviour needed to really solve this crisis?

SR: There is enormous push-back to my pro-saving prescription for a saving-short US economy. “America needs to spend,” is the increasingly desperate cry of the born-again Keynesians steeped in fear of the dreaded “Paradox of Thrift.” Greg, you have your finger on one of the biggest issues of this crisis: do we want to go back to the failed macro of bubble-and debt-driven consumption that got us into this mess, or do we have the guts to try and break the mold of years of excess?

The answer is clear to me: the US needs to shift its growth dynamic away from excess consumption and de-minimus saving toward enhanced saving and increased investment. The surplus savers of the world need to do the opposite. To do this, we need to rethink our views on the “paradox of thrift”, viewing this phenomenon in the context of an open global economy rather than something as seen through the lens of a closed domestic economy.

I am not suggesting that the world boost its saving rate. What I am suggesting is a critical shift in the mix of global saving with the US doing more of it and Asia doing less of it. As Developing Asia moves to more of a consumption-driven economy, its currencies should also appreciate, allowing the US dollar to work its way lower and helping American boost its export competitiveness.

If the Obama Administration delivers on other aspects of its competitiveness agenda, namely, infrastructure, educational and healthcare reforms, and energy independence, the excesses of bubble-dependent consumption growth should give way to increasing support from export-led growth.

If, however, the US backtracks and goes back to the well for another dose of excess consumption growth, imbalances will only build again, culminating in an even more treacherous endgame. The ever-expedient quick fix must be avoided at all costs. It is a recipe for disaster.

What would be the very first sign that you will be looking for to tell you that this crisis has come to an end and recovery should begin soon? Do you think there will be a long gap between the end of this crisis and the start of recovery?

SR: I wish it were that easy, one magical indicator turns and the end would finally be in sight. This is a lethal and very complex crisis, with many moving parts. The first stage was the credit market contagion that started with the bursting of the subprime bubble in the summer of 2007 and then spread like wildfire in a cross-product contagion that engulfed the remainder of the capital markets.

Moreover, courtesy of the “originate and distribute” technology of the derivatives explosion, toxic instruments found their way all over the world. This interplay between cross-product and cross-border contagion has created a crisis of truly epic proportions.

The second stage of this crisis is the impact of the capital markets contagion on the real side of asset-dependent economies. The asset-dependent American consumer has been first to tumble. But quick to follow has been export-led economies elsewhere in the world – especially in Asia, Europe, and now Latin America. The decoupling dream was just that – actually a bad dream, bordering on a nightmare.

The third stage of this crisis involves the adverse feedback loop between a deteriorating real business cycle and the loan quality of the same financial institutions that bore the brunt of the credit market contagion in the first stage. That stage is now unfolding with a vengeance. Unfortunately, these stages tend to feed on each other – creating the true vicious circle that is exceedingly difficult to break.

Politicians, policymakers, media pundits, and many business leaders have argued for quite some time that this is mainly a crisis of confidence. If only we all just started smiling more and spinning the good news, then the vicious circle would magically turn virtuous and the worst would be over. As I said, I wish it were that easy.

What will be the global consequences of the Fed’s decision to buy US government bonds and bad bank debt on such a massive scale? Will we see hyper-inflation in the US, and will the creditor nations in Asia now want to stop lending them money? What strategic opportunities/risks do you see as a result of this situation?

SR: For a world in recession, the immediate impact of Helicopter Ben’s unconventional monetary easing is not nearly as problematic as you seem to imply. Given the slack in the global economy, together with its still massive imbalances, it is highly unlikely that inflation will spontaneously ignite or that the world will stage a buying protest against dollar-denominated assets.

Keep in mind that trend growth in the world economy has been about 3.7 per cent per annum over the past 35 years. That means if global GDP contracts by over 1 per cent this year as many, myself included, now suspect, such an outcome will open up about a five percentage point gap relative to the global economy’s longer-term growth potential. Given the multi-year sluggishness I envision, I suspect that the global output gap will expand further in the years immediately ahead, possibly peaking at around 7 per cent to 10 per cent of world GDP.

Such a huge global output gap implies a lingering risk of deflation rather than the immediate risk of an outbreak of inflation. If, however, the gap starts to narrow and the Authorities have been unable to develop effective and credible exit strategies for their massive monetary and fiscal stimulus campaigns, then there will be good reason to worry about inflation. Those worries are distant, however, at least three years, and maybe even five years out in time.

In the meantime, I doubt if the export-dependent surplus savers in Asia would stop lending capital to the US. If they did, their currencies would appreciate, undermining their export competitiveness and thereby threatening a key source of their economic growth.

However, if Asia is successful in migrating to more of a consumption-dependent growth strategy, it will start to absorb its surplus saving and have less capital to send to the US. And then, Asians can truly afford to be far more demanding in seeking better terms on dollar-denominated assets. Doesn’t sound very symbiotic to me.

If banks are too big to fail,  too important to our economy, are they not also too important to be owned and managed by capitalists alone? How can we have smart and well-paid bankers and traders make the right decisions for the long-run benefit of their organisations, and not just churn and burn for short-term bonuses?

SR: Having worked for one firm on Wall Street for over 26 years, I am obviously biased in attempting to answer this critical question. But I believe very strongly that financial institutions are too important to be turned back into state-owned public utilities. In an era of globalisation and interdependent markets, financial intermediation and capital allocation have taken on new dimensions of complexity and risk. These are critically important functions in any economy’s quest for prosperity.

Alas, as we have painfully learned, that quest can cut both ways. That provides one of the most important lessons for the financial services industry, the need to redress the asymmetries of reward and compensation. Remuneration, in my view, can no longer be paid out on a point-of-sale basis. It must be aligned with the longer-term risk-adjusted returns of individuals and their companies. Only then, can we avoid the distorted incentives that encouraged short-term payouts from bubble-driven momentum in trading and banking activities.

Of course, in the Era of Excess, we ended up with a very different system. The profusion of bubbles distorted everything, from the financial system to the real economy. If we do a better job in containing the excesses of asset and credit bubbles in the future, I think we will go a long way in establishing a stable and secure market structure that will force the financial services industry to adopt a more reasonable and equitable system of incentives and rewards.

This critical adjustment can not be taken for granted. The trick will come in aligning a new financial system with the industry’s contribution to broader measures of national prosperity. That is a very contentious point.

Former Fed chairman Paul Volcker put it all too well in an April 2008 speech to The Economic Club of New York when he said, “It is hard to argue that the new (financial) system has brought exceptional benefits to the economy generally. Economic growth and productivity over the last 25 years has been comparable to that of the 1950s and 60s, but in the earlier years the prosperity was more widely shared.” Volcker concluded that. “The bright new financial system, for all its talented participants, for all its rich rewards, has failed the test of the market place.”

If the next financial system fails the Volcker-like test of the market place, its rewards, or lack thereof, should be aligned with its failed returns. If, however, the outcome is more favorable, remuneration to its workforce, and presumably to its shareholders, should follow. This is the crux of the challenge for our industry and for those charged with its governance. It is an especially critical challenge for the central bank, an institution, which owes its very existence to the crises of yesteryear.

The role of the central bank is, in fact, testament to one of capitalism’s most important covenants, that finance cannot be entrusted to self-regulation. That is the most painful flaw of the Greenspan era. Never again should we let ideology guide central banking and its regulatory responsibilities.

Central banks need new mandates that explicitly tie their policy targets to the requirement of containing the excesses of asset bubbles and the severe economic distortions they spawn. Then, and only then, can the new financial system be on much sounder footing than the old one. But that’s not to say that we in the industry shouldn’t take a long and hard look in the mirror before we embark on our own Herculean task of attempting to rebuild a failed financial system.

Source.

Filed under  //   Adam Smith   Alan Greenspan   Asia   Buy American   Capitalism   China   Emergency Deficit Control Act of 1985   Era of Excess   GDP   Glass-Steagall   Gramm-Rudman-Hollings Balanced Budget   Great Depression   Japan   Morgan Stanley   Paradox of Thrift   Stephen Roach  

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Interview with David Ellison of FBR Equity Funds

In recent years the FBR Large Cap Financial Fund has lost a lot of money, but outperformed the vast majority of its peers, in great part because its skipper, David Ellison, ramped up his cash position. The same holds true for FBR Small Cap Financial (FBRUX), which Ellison also runs.

Over the past year, the large-cap fund (FBRFX) was down 31% through March 18, 2009, while besting the Standard & Poor's 500 by 7.6 percentage points and outpacing 83% of its Morningstar peers. None of this is cause for celebration.

But Ellison, 50 years old, whose tenure at Fidelity included learning from the estimable money manager Peter Lynch, maintains there are some very good opportunities in the financials, given their dirt-cheap valuations.

Ellison, who is chief investment officer of FBR Equity Funds, recommends buying a basket of these stocks, rather than picking one or two, though he thinks there is probably downside before things turn around in the sector.

Barron's: You have been very aggressive about raising cash in your financial-services funds. How much cash do you have now in those funds?

Ellison: It has come down a bit. It is about 50% in the small-cap fund, and it is in the high-30s for the large-cap fund.

Why the reduction?

Primarily because some of these stocks were so cheap, relative to book value and relative to assets. I figured if they are all going to go to zero, I wasn't going to have a job anyway. So I might as well see what happens.

How far along is the repairing of the banking system?

The big collapse of the system has been taken off the table, primarily because of the trillions of dollars the government has put into it, along with other things that they have done. So we don't have to worry about a collapse, and that is a big step.

Now, the question is: Will the government allow these banks enough time to earn their way into the appropriate capital ratios and the appropriate reserve positions? Or is the government going to try to rush it?

In what way?

If you were to mark to market everything that the big banks hold on their books, they would all be technically insolvent in terms of their nonperforming assets. But that isn't how the world works. Not everybody is born a millionaire; they have to earn it.

So, in a sense, the banks have to earn their way out of this. If the government makes some adjustments on capital requirements, mark-to-market accounting and a few other things to give the banks more time, they will, in almost every case, be able to earn their way out of this crisis.

What is the outlook for equity investments in the sector?

The government clearly wants to keep as much of the banking system intact as it can, and certainly doesn't have any interest in shutting these big companies down. They want to keep the infrastructure in place. So now the question is: When is new private capital going to start coming into the business?

I'm looking for the first bona fide recapitalization where a company comes in and says, "We have taken our losses, we have circled the wagons, we have taken the appropriate charges, and we are really thin on capital. But we have cut our expenses, downsized our assets, and now we need new capital to grow."

There will be plenty of new shares to buy, and you will have a chance to buy on these recapitalizations. If that works, we have a banking system that can now start to grow again. Once that begins, you have a real opportunity because you have plenty of names to choose from. The valuations aren't as good as they were earlier this month, but you have plenty of opportunities in the sector. It is just a question of not being in a hurry.

So the return of private capital to the banking system is crucial?

Absolutely. The problem is that these banks have lost so much, and they need to have private capital come into the system and create the necessary discipline. In a sense, many of the banks have done a lot already, as they have gone from paying dividends to not paying dividends.

They have gone from thinking about growth to thinking about growing appropriately, and everybody has cut expenses dramatically. The underwriting process is being examined across the entire industry, which is a good thing for the equity players. That means they are setting themselves up for a period of much better loan quality over the next five to 10 years.

There is a widely held view that there are too many banks in the U.S. and that the industry needs more consolidation. Is that an investing theme to look at?

You are going to see more consolidation. The past five or six years were very quiet because, until fairly recently, everyone had been doing well. Nobody has needed to sell and, of course, the banks that did sell did quite well by getting big prices, which haven't been good for the buyers.

If you are a buyer now, you are in position to buy from others' weakness, as opposed to their strength. Their weakness is not having enough capital, pressure from the FDIC [Federal Deposit Insurance Corporation] or whatever.

That is a good thing for people like me because I own the stock. I don't want to see every bank go down, but I see the potential for tremendous opportunities.

Where in particular do you expect to see M&A activity?

For a Bank of America to buy a $2 billion bank doesn't mean much. But for a $3 billion bank to buy a $2 billion bank from the FDIC at no cost and therefore it is incredibly accretive you probably want to own that $3 billion bank.

How is the first quarter shaping up for the banks?

Nonperforming assets will be up and spreads, that is, between the yield on loans and the cost of deposits, will be stable. Fee income is going to be uneven, depending on the type of company. Expense cuts are going to be a little better than expected, because everybody is working really hard to cut expenses.

And these banks are going to have to continue to build their reserves. Nobody is going to really care if they make money, because it is really all about repairing the balance sheet and preserving book value. If you can break even and use all of your core profitability to build reserves and take care of severance costs and charge-offs, that is good.

This year is about getting the balance sheet repaired; last year was trying to figure out how bad it was going to be...and it is bad now.

What is your advice to investors when it comes to bank stocks?

This isn't the get-rich-quick option; it is going to take time. If you have patience and are willing to sit with a portfolio of bank stocks, that makes more sense than buying one or two stocks. I would try to buy 10 to 20 stocks. Having said that, we could give back the recent rally, especially if the quarter is worse than expected or unemployment goes a lot higher or the government does something stupid.

With financial stocks, you make most of your money going from bad to good, not from good to great. The recent rally aside, everybody knows that all of these stocks are near their 52-week lows and that conditions are bad. Everybody is losing money. Companies need government bailouts. So this is as bad as it gets. But things are going to get a lot better. Still, you have to say to yourself that if you buy today, you may go down 20% before you go up 200%.

Where have you been nibbling lately?

In the past couple of months, I have owned and added to names like KeyCorp [KEY]. But as I mentioned, now is the time to buy a portfolio of names, because if I give you one name out of the 10, it would be the one that will underperform. That is the Peter Lynch rule: Give a lot of names, and your chances of being right are pretty good.

Good Advice. So what do you like about KeyCorp, a large regional bank?

KeyCorp isn't quite as cheap as it has been, and the same is true for SunTrust Banks [STI]. But both are true value propositions. There is nothing unique about these companies in the sense that they all have balance-sheet issues and the stocks have come way down. On a price-to-book basis, these banks are trading as low as you are going to get them.

They have cut their dividends, and they have built their reserves. Right now, it is all about what the managements are doing to correct things. They are working on that. A big question for many of these banks is whether their stocks are cheap enough. Another is: Do they have enough capital to survive a severe write-down so they don't have to raise a whole bunch of additional equity that would dilute my equity holding?

What are some other names you like?

JPMorgan Chase [JPM] is in the same boat. It is a little more expensive than KeyCorp or SunTrust, based on book value. But JPMorgan has been very proactive in dealing with reserves. You have heard [CEO] Jamie Dimon speak, as I have, and clearly I want to own that company.

I may not want to own the stock right now, but he is doing everything he can to get to the other side. To me, that is the most important part here; there are managements saying, "OK, now it is time to really get to the other side and we are going to do everything we can to get there." You would be surprised what a company's management can do when it is in full survival mode.

Where does JPMorgan Chase trade on book value?

With the stock at around 26.27 last week, it was trading north of tangible book value, which is about 22 a share.

What about Bank of America [BAC]?

I have been nibbling, although it has gone up a lot recently. But they are doing everything they can [to improve]. We can argue about the yin and yang and all the bad stuff there. But Bank of America trades at about half its book value.

That is a huge discount.

Yes, because everybody thinks it is going to zero. Its book value is $10 or $11 a share. The stock was at 3 earlier this month, and now it is over 7. Unfortunately, it has had a significant move recently, which makes things feel a little different.

I also like Wells Fargo [WFC], one of the better-run companies historically. They have made an acquisition of Wachovia that they are going to have some issues with, notably problem loans. But everybody knows that. And Wells Fargo's management is fully engaged in saving this company as it is.

What about Citigroup [C]?

Citi is a little more complicated. I own some, but you have to watch it like a hawk. It is sort of the Enron of the financial-services industry; there is a lot of stuff going on there. I would not recommend that anybody own it who didn't understand the industry really well.

But you own it?

Yes, but it is a small position, under 1%. I would encourage everybody to own more traditional names where they can understand what is happening with a company. Plus, the government [basically] controls Citi, so you have to wonder what they will do. I have never seen that in my lifetime. As an investor, you are given another metric to look at, which is unknown.

How does this downturn for the banks compare to the one in the late 1980s and early 1990s?

Back then, the quality of the managers wasn't anywhere near as good as it is today in the industry as a whole. Unfortunately, you could argue that, if today's managers were so smart, why did they get into these issues?

Exactly. So what went wrong?

It is called 10 years of a very good economy. On top of that, it was 10 years of these companies trying to compete with each other on making their numbers and looking good on CNBC and everything else. They had to compete on underwriting, on price, on volume. And they had to compete for people who want to get paid a lot of money.

But now we are setting ourselves up for a complete overhaul of the intellectual thought process in the business, which had been corrupted by a good economy. The Fed lowered rates and suddenly everybody could borrow money real cheap. That is when the wheels came off and the regulatory climate became looser and looser.

What does that mean for equity investors?

It is a good thing, because now you are going to see more stable returns, more honest returns, and cleaner returns. For the next five or 10 years, this sector is going to be a good place to be, although it may not be good right now, meaning it could go back down a little bit.

Thanks, Dave.

Source.

Filed under  //   Bank of America   Citigroup   David Ellison   FBR Large Cap Financial Fund   FBR Small Cap Financial Fund   FDIC   JPMorgan Chase   KeyCorp   Morgan Stanley   SunTrust Banks   Wells Fargo  

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Hedge Funds Buy into Gold

Hedge fund investors who made money last year by betting against investment banks are now buying gold as a way of betting against central banks.

The gold bulls include David Einhorn, founder of hedge fund Greenlight Capital, who last year came under the spotlight for his short selling of shares in Lehman Brothers, after arguing that the bank did not have enough capital to offset its exposure to falling property prices. Other funds looking at gold include Eton Park and TPG-Axon, investors said.

Their belief in bullion is being expressed even as gold prices have retreated from last month’s break above the $1,000 an ounce level. Spot gold in London closed last Friday at $939.10, after falling last week to $900.95 an ounce. Investors such as Mr Einhorn are turning to gold because they are worried about the response of the US Federal Reserve and other central banks to the global economic crisis. A bet on gold is essentially a bet against all paper currencies.

“The size of the Fed’s balance sheet is exploding and the currency is being debased. Our guess is that if the chairman of the Fed is determined to debase the currency, he will succeed,” Mr Einhorn wrote in a recent letter to his investors. “Our instinct is that gold will do well either way: deflation will lead to further steps to debase the currency, while inflation speaks for itself.”

Mr Einhorn’s comments, and the revelation he is buying gold itself, are in line with the views held by other large institutional investors in Europe, according to bankers in London. The head of commodity sales at one major bullion bank told the Financial Times that he had never been so busy dealing in gold for large investors in his life.

Goldman Sachs, Morgan Stanley and UBS all forecast the gold price will surge above $1,000 this year. Peter Munk, chairman of Barrick Gold, the world’s largest miner of bullion, told investors last week that all countries have embarked on policies that will favour gold.“The only option to governments is to print and print more money,” he said. “That will end in tears.”

In the past, hedge funds, which depend on absolute returns to earn high fees, had avoided gold because it does not produce any yield and costs money to store and insure. But those issues have become less important as central banks have pushed interest rates to nearly zero, reducing the yields on currencies.

Source.

Filed under  //   Barrick Gold   David Einhorn   Eton Park Capital Management   Gold   Goldman Sachs Group   Greenlight Capital   Morgan Stanley   Peter Munk   TPG-Axon   UBS  

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Charities Hurt By Pay Limits

Nonprofits already face the prospect of fewer donations amid turmoil at Wall Street firms and other companies. Now, they could face another donation deterrent: Washington's plans to curb executive pay. Americans gave more than $300 billion to charity in 2007, according to the most recent figures. Some of the largest gifts from that pot have come from wealthy Wall Street bosses.

Now nonprofit leaders, especially in and around New York's financial hub, are worried these big donors could feel squeezed further amid government edicts to limit pay packages.

The economic stimulus package President Barack Obama is expected to sign Tuesday includes a measure barring any firms that have received federal bailout money from paying top earners bonuses exceeding more than one-third of their total yearly compensation.

The measure also empowers the Treasury Secretary to "claw back" previous bonuses in certain instances if they're deemed excessive. It remains unclear exactly how the rules will be implemented, raising questions about corporate America's future compensation practices.

"As long as there is uncertainty about what's going to happen with executive compensation, that could really hold a lot of people back from giving, and not just on Wall Street," says Melissa Berman, president and chief executive of Rockefeller Philanthropy Advisors.

Of course, Wall Street executives, and employees lower on the ladder, still have more resources to give than many Americans. But they, like everyone else, are feeling less wealthy these days amid the financial crisis. In some cases, they're telling charities they can't be as generous as they've been in the past. The new compensation regulations could give them another justification for scaling back giving.

Jilly Stephens, executive director of City Harvest, a New York charity that combats hunger, says giving isn't driven solely by how much people earn. But, she says, it remains her "job to be worried" about finding alternative funding sources as dependable Wall Street bonuses dry up.

Many New York-area charities depend on both big gifts from executives and smaller donations from mid-level bankers to fuel their operations. The deepening recession has already trimmed revenue for these charities just as demand for services skyrockets.

"I hope we don't vilify everybody in the financial services sector," says Lisanne Finston, the executive director of Elijah's Promise, a New Jersey soup kitchen. Ms. Finston depends in part on Wall Street bankers' bonuses to fund her operations. She says her donations for food programs, typically $400,000, fell 19% last year, while the number of meals served jumped by about 15,000, or 15%.

Wall Street's biggest players have been among the largest benefactors for food pantries, antipoverty initiatives, museums and universities. Many declined to comment on their gifts or whether they may reduce them. Recipient charities, too, often are reluctant to discuss donors for fear of upsetting benefactors.

But many big Wall Street donors funnel money through private foundations, which must document annual grants through tax forms that offer a window into their charitable habits.

Morgan Stanley Chief Executive John Mack and his wife gave more than $8.6 million to charity in 2007 through their family foundation, according to the latest tax documents. Their gifts have gone to hospitals, historic preservation and charities aiding inner-city poor.

Morgan Stanley received $10 billion in federal assistance last year after its stock-price tumbled amid broader market fears. The year before, Mr. Mack received an $800,000 salary and realized about $8 million in exercised options. He hasn't taken a bonus in the past two years. He declined to comment through a spokeswoman.

Top executives at other banks that have received aid have also given at least several hundred thousand dollars to charity annually in recent years, including Goldman Sachs Group Inc. Chief Executive Lloyd Blankfein and J.P. Morgan Chase & Co. Chief Executive James Dimon. Spokesmen for Messrs. Blankfein and Dimon didn't return messages seeking comment.

Exactly how donors will react to new rules affecting their pay remains to be seen. But the emerging political climate could make many of them hesitant to dole out cash when their compensation remains uncertain. However the rules are implemented, boardrooms -- even at companies that haven't received bailout money -- appear poised to revise pay policies to reflect new political realities.

The evolving compensation landscape isn't limited to Wall Street. General Motors Corp., the cash-strapped Detroit auto giant, will likely need more government aid to avoid bankruptcy after already receiving billions of dollars in loans.

GM Chief Executive Rick Wagoner lowered his annual salary to $1 and relinquished any bonus for 2008 and 2009 as a condition of that aid. In response to lawmakers' fury over big executive paydays, GM also cut total cash compensation for its next four senior executives by 50%.

Detroit's cultural institutions, homeless shelters and other nonprofits are already cutting back as the city's auto makers retrench and scale back giving. Pay curbs on top of the Motor City's economic pain "will certainly have an impact," on giving, says Peter Remington, president of The Remington Group, a nonprofit consulting firm in Beverly Hills, Mich.

A GM spokesman declined to comment on executives' giving plans, saying "individual charitable giving is a private matter."

Source.

Filed under  //   Charity   City Harvest   Goldman Sachs Group   J.P. Morgan Chase & Co.   James Dimon   Jilly Stephens   John Mack   Lisanne Finston   Lloyd Blankfein   Melissa Berman   Morgan Stanley   Obama   Peter Remington   Rick Wagoner   Rockefeller Philanthropy Advisors   The Remington Group   Treasury Secretary  

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How to Successfully Place an IPO

On Wednesday, February 11, 2009, Morgan Stanley and Citigroup managed to rush an initial public, IPO, offering into the market on the only day this week that the market was up.

Mead Johnson, a maker of Enfamil baby formula that is being spun off from Bristol-Myers Squibb, managed to get through the slamming gate of the stock market to go public successfully, raising $720 million in an initial public offering. Not only did the IPO price at $24 a share — or the high end of its $21 to $24 range — but the stock also jumped 10% in value in its first day of trading to close at $26.43.

The offering was also 10 times oversubscribed, according to a person familiar with the matter, which means that investors put in orders for 300 million shares, or 10 times more than the 30 million the company planned to sell. The underwriters expanded the final sale of shares from 25 million.

As a measure of how difficult it is for companies to try to go public these days, remember that Mead Johnson was the first company to go public in three months. Two other companies didn’t make it; both security company O’Gara Group Inc. and green energy company Changing World Technologies failed to price their initial public offerings.

What made Mead Johnson different from other IPOs?

1. Don’t dally. The company’s lead underwriters at Morgan Stanley and Citigroup ran an abbreviated “road show” to pre-sell the stock to selected investors in only nine days — seven days in the U.S., and two days in Europe, people familiar with the matter say. Usually, the road show for an initial public offering takes weeks — particularly in tough markets — as bankers and their salesmen travel all over the country to woo fund managers. The banks hurried, knowing that they had a brief window of time to take Mead Johnson public before its September financial statements became outdated and the company would have to refile its financials, providing all-new information.

2. Pick your buyers. Mead Johnson’s bankers capitalized on familiarity. The IPO has been expected since Bristol-Myers’s announcement last year. In addition, Morgan Stanley and Citigroup harnessed their large retail sales forces on Wall Street — through the old Dean Witter and Smith Barney — to distribute millions of shares to retail clients of their firms. Morgan Stanley and Citigroup also targeted a specific group of midcap fund managers and consumer-products investors that had been sitting on the sidelines, bathed in cash, and starving for new investing ideas. As with the debt markets, bankers are making an educated bet that the difficult year for the stock markets in 2008 would leave many fund managers sitting with plenty of cash on their balance sheets and antsy to start using it. United States IPOs, as few as they are, rarely find buyers overseas. But Mead Johnson draws nearly half its revenues from Europe, where demand was high for the shares.

3. Fundamentals still matter. The bankers pitched the shares to investors by stressing solidity and comfort: Mead Johnson had a familiar name, a veteran management team, a comforting product — baby formula — and the parentage of one of the biggest pharmaceutical companies in the world, which also has a strong investment-grade credit rating. In addition, the business had fat cash flows with revenues of $2.88 billion last year. All of these factors convinced the banks to make Mead Johnson the first IPO of the year.

4. Be lucky in your timing. Volatile equity markets are the enemy of IPOs, but those are the only markets that exist these days. Mead Johnson was running smack into earnings seasons, widely publicized disagreement over the $2 trillion stimulus bill and Congressional hearings — all of which meant that aiming for a quiet news day would be impossible. The timing of the IPO on Wednesday — a day with much positive movement in stocks — had a big element of luck.

Source.

Filed under  //   Bristol-Myers Squibb   Changing World Technologies   Citigroup   Initial Public Offering   IPO   Mead Johnson   Morgan Stab   Morgan Stanley   O’Gara Group  

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LA Investment Firm Wedbush Preps for IPO

This may be the worst of times in the modern history of the financial services industry, but Wedbush Morgan Securities Inc., a small investment bank in downtown Los Angeles, has proceeded as if it’s the best of times.

Since summer, the company has made three acquisitions, opened several branch offices and added 200 employees. And in what may be its boldest move, its parent company, Wedbush Inc., now wants to go public, perhaps even as early as this year although it likely will be later.

Founder Edward Wedbush said last week that the firm could benefit from a public offering, and it already has begun exploring the possibility.

“Our philosophy is to become a public company,” said the 76-year-old executive. “We will logically become a public company somewhere downstream, but we have to get past all of this worldwide financial turmoil.” In addition to Wedbush Morgan, the parent company also owns private and public equity funds, and a small commercial bank that opened in February. Though the company has not officially begun preparing an IPO filing – and Wedbush said it could be more than a year before it begins – its structure is similar to that of a public company, which could make the transition simpler.

“We’re already prepared: Our boards of directors are outside directors; we run it as if we were a public company; we have all the audit committees and other risk management activities,” he said.

If the company went public it would be unusual because the IPO market, which hasn’t been strong in recent years, all but disappeared in recent months, said James Cameron Spindler, a USC law professor and IPO expert. Also, Sarbanes-Oxley and other regulations can make life tough for newly public companies.

“Going public imposes some pretty onerous requirements on public companies – you’re subject to a whole bunch of regulations,” he said. The IPO market has not been particularly strong since the technology bubble burst in the early 2000s, he said. “It hasn’t been a very good environment for initial public offerings in the United States in the last few years.”

Founded in 1955, Wedbush Morgan has become one of the leading correspondent clearing services in the Western United States. The company provides a range of services, but its bread and butter is in processing stock trades for broker-dealers. In December, Wedbush Morgan ranked as Nasdaq’s top liquidity provider, or market maker, beating out big-time rivals such as Morgan Stanley (No. 2) and Goldman Sachs & Co. (No. 5). Wedbush Morgan has been at or near the top of that list for more than two years.

The company was one of the early investors in Bats, an electronic securities exchange founded in 2005 that is now the third largest U.S. equities market. Approved by the Securities and Exchange Commission, the exchange, essentially a Web site, allows investors to trade quickly and anonymously.

With the growth of new trading platforms such as Bats and Chi-X Europe, liquidity providers have gained in stature and Wedbush Morgan is now mentioned in the same breath as Citigroup Inc. and Morgan Stanley. But the growth has not been purely organic. In late September, Wedbush Morgan announced the acquisition of Phoenix-based broker-dealer Peacock Hislop Staley & Given – a deal Wedbush said would provide both a greater presence throughout the Southwest and a leg-up on the municipal bond market in Arizona. Wedbush Morgan followed up that transaction with the December purchase of First Wall Street Corp., a brokerage in San Diego.

Then this month Wedbush Morgan announced the acquisition of Pacific Growth Equities, an institutional brokerage in San Francisco. The deals have helped Wedbush Morgan increase its head count to nearly 1,000 employees from about 750 in the summer. By comparison, Thomas Weisel Partners Group Inc., a mid-sized brokerage based in San Francisco, laid off 60 employees in the past quarter and axed 200 during all of 2008 as the deepening recession took a major bite out of the firm’s revenue.

“We are exposed to volatility and trends in the general securities market and the economy, and we are currently facing difficult market and economic conditions,” the company said in a recent regulatory filing. “We are focused on making the necessary adjustments to our business and adapting to the current environment.”

Thomas Weisel Partners made a splash in early 2006 with a highly successful public offering. With an initial per-share price of $15, the stock gained a third in its first day and hovered above $20 per share for some time. But the share price has nosedived this past year, closing Jan. 22 at $3.89. Wedbush said his company has been in a strong financial position in large part because it didn’t do what most of its peers did during the boom times.

“We have not used leverage like other firms have, and we’ve managed the finances of our firm in a careful manner,” he said. “We’re in excellent financial condition because we’re extremely liquid and we don’t have the pressures that some of these other firms have.” With $260 million in revenue, Wedbush Morgan is nowhere near the size of Wall Street titans, though the recent financial crisis has helped to close the gap. Indeed, the financial turmoil in the past few months knocked several of Wedbush Morgan’s competitors, including Lehman Brothers and Bear Stearns, from their lofty perches.

Stephen Massocca, who served as chief executive of Pacific Growth Equities before it was purchased by Wedbush Morgan, said with so many firms on the mend, Wedbush Morgan is wise to move in and grab market share.

“There was a vacuum created by all the troubles and difficulties of 2008,” said Massocca, now a managing director with Wedbush Morgan. “The landscape is changing dramatically. A lot of competitors in our space have gotten in trouble and significantly changed their business plan or disappeared.”

Source.

Filed under  //   Edward Wedbush   Goldman Sachs   Goldman Sachs Group   Morgan Stanley   Thomas Weisel Partners Group   Wedbush Morgan Securities  

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Morgan Stanley Says Hyperinflation Possible

Morgan Stanley’s Joachim Fels and Spyros Andreopoulos look at the possibility of hyperinflation hitting the western shores of the UK, Europe and the US in their latest note. 

One stark lesson from the ongoing financial and economic crisis is that so-called black swans — large-impact, hard-to-predict and seemingly rare events — can occur more frequently than generally believed. With policymakers around the world throwing massive conventional and unconventional monetary and fiscal stimuli at their economies, we think that it is worth exploring the black swan event of very high inflation or even hyperinflation.

While such an outcome is clearly not our main case, the risk of hyperinflation cannot be dismissed very easily any longer, in our view. We discuss the historical evidence, the conditions that can lead to very high or hyperinflation, and whether and how it might happen again.

Hypinflation is a black-swan event that, given all the other black-swan events of late, should not be dismissed. As they remind, the classification of hyperinflation is: an episode where the inflation rate exceeds 50 per cent per month. In history this has occurred in the 1920s in Austria, Germany, Hungary, Poland and Russia. Germany in 1923, for example, experienced a 3.25 million per cent inflation rate in a single month. Since the 1950s hyperinflations have been experienced in Argentina, Bolivia, Brazil, Peru, Ukraine and Zimbabwe, so confined largely to developing and transitioning economies.

The root cause of hyperinflation is: 'excessive money supply growth, usually caused by governments instructing their central banks to help finance expenditures through rapid money creation.’

Back to whether it could happen to Europe or the US? Morgan Stanley says possibly yes, under certain conditions.

Firstly, the rapid expansion of the monetary base by the Fed, ECB and BoE would have to continue and feed into a more rapid and sustained expansion of money in the hands of the general public. Secondly, Morgan Stanley says governments would have to face difficulties financing their bailout packages and funding their debt. Lastly, public confidence in the government’s ability to service debt without resorting to the printing press would have to disappear, as well as the government’s actual ability to withstand the pressure to do so in the first place.

And while all of the above is an extreme scenario, the Morgan Stanley analysts say:

…given the size of the current and prospective economic and financial problems, and given the size of the monetary and fiscal stimulus that central banks and governments are throwing at these problems, investors would be well advised not to ignore this tail risk, especially as markets are priced for the opposite outcome of lasting deflation in the next several years. Put differently, we believe that buying some insurance against the black swan event of high inflation or even hyperinflation makes sense and is relatively cheap currently.

Of course, when hyperinflation occurred in the eastern block countries towards the end of the communist era, most citizens hedged via significant purchases of black-market US dollars, the US dollar becoming the effective proxy store of value. This time round, that would not be an option.

Source.

Filed under  //   Black Swan   Hyperinflation   Inflation   Morgan Stanley  

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