Filed under: Market matters, Politics, Headline news

Today, the U.S. Treasury Secretary presented a plan to overhaul regulation of U.S. capital markets. As I posted over the weekend, the plan does not really address the cause of all those economic problems.

However, it is very consistent with the administration’s tendency to use crises as a way to push its agenda. That’s what happened in 2001 when it used the recession to push its $1.3 trillion tax cut. And then there’s the biggest enchilada of all - using 9/11 as an excuse to attack Iraq - a move that’s cost the lives of 4,000 soldiers and is forecast to take $3 trillion out of the U.S. Treasury.

I don’t think the proposal will stand up for long but the deeper issue of what caused the problem and how to keep it from happening in the future remains. And while there are clear answers to either, I definitely think that serious analysis of these questions should be done before changes are made to the system.

From my perspective, the basic issue is that the financial system is set up to make gains private but losses public. If it changes that scenario - for example, to make gains and losses private - then the financiers who make the decisions will have an incentive to enjoy the benefits and the costs of their decisions.

Such a system would make it in financiers’ best interests to be more cautious. But as their incentives currently stand, they get rewarded for doing large deals and when some of those deals fall apart, the government steps in to clean up the system.

This is the result of the political power of financiers’ campaign contributions. Unfortunately, there are only two ways that the system can change from private profit/public loss to private profit/private loss. If the financiers demand that the government changes the system. Or if the campaign clout of those hurt by the current system exceeds that of the financiers.

Neither outcome appears likely at the moment.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter.

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Filed under: Market matters, Economic data, Headline news, Federal Reserve

The plan proposed by Secretary of the Treasury Henry Paulson to revise the United States’ financial system is meant as an initial step in reforming the current regulatory environment and institutions. This would be the largest overhaul of the system since the legislation implemented by the Roosevelt administration during the Great Depression. It is needed to deal with current challenges posed by the recent credit crisis.

This is only a first step in the process. Many government agencies will be merged to create even more powerful agencies. However, the key element that stands out in Secretary Paulson’s proposal is the new role of the Federal Reserve as a regulatory “Supercop.” In essence, the proposal makes the Fed formally responsible for the danger management of our financial system. This would be the third mandate for the Federal Reserve after price stability and full employment.

In several ways, the Fed has already undertaken this role of guaranteeing financial market stability with its assistance in the sale of Bear Stearns (NYSE: BSC) to J.P. Morgan Chase (NYSE: JPM) and the extension of discount window lending to the investment banks acting as primary dealers. This would merely grant the Fed the regulatory authority necessary to do this on a formal basis.

After the elimination of the Glass Steagall Act separating Commercial Banks and Investment Banks, this proposal simply grants the Fed regulatory authority over similar risky activities by both types of institutions, not just that of Commercial Banks.

This proposal is merely the first step in a long birthing process. There will be long discussions between the legislative and executive branches of government. This will occur no matter who wins the White House in November. No one knows the exact form that this legislation will take.

However, this is a good first step in the process of adjusting the existing regulatory environment to financial reality. It also confirms the Federal Reserve’s role as the premiere global central bank, giving something to take into account for those people claiming the Fed is losing its power to influence world financial markets.

Doug Roberts is the Founder and Chief Investment Strategist for ChannelCapitalResearch.com. He previously held executive positions at Morgan Stanley Group and Sanford C. Bernstein & Co.

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Filed under: Politics, Headline news, Housing

Alphonso Jackson resigned this day as Secretary of Housing and Urban Development, becoming the latest Bush administration official to leave under a cloud. No word on a replacement.

Jackson, who most Americans couldn’t name in a bar bet, is under investigation by the FBI. He allegedly helped a friend who was paid $392,000 by HUD in New Orleans after Hurricane Katrina and allegedly punished the Philadelphia Housing Authority (PHA) for nixing a deal with another friend, the record producer/developer Kenny Gamble, according to The Associated Press. The PHA filed a lawsuit.

“At a congressional hearing this month, Jackson repeatedly refused to answer questions about the Philadelphia redevelopment deal,” the story said. “Last year, the inspector general at Jackson’s department found what it called ’some problematic instances’ involving HUD contracts and allows, including Jackson’s opposition to money for a contractor whose executives donated exclusively to Democratic candidates.”

Jackson was a disgrace who should have been forced out months ago. Instead, the Bush administration stood by its man even though most of Washington was calling for his head. This is particularly unfortunate since the American people need HUD at a time of turmoil in the housing market.

Let’s hope that the administration can find a skilled, competent HUD leader who can help the agency become the eyes and ears for the government’s efforts to deal with the subprime mortgage crisis. Nearly anybody would be a significant improvement.

Notice how this announcement came out at about the same time as the Administration’s overhaul of financial services regulation. This wasn’t an accident. Bush officials are hoping that the media will focus on that rather than yet another in a never-ending series of scandals.

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Filed under: Ripoffs and Scams

As a longtime subscriber to Newsweek and a frequent reader of Time, I’ve been appalled at the rapid diminishment of both magazines. Issues once running to well over a hundred pages, full of international news, have shrunk to a shell of their former selves. The latest news from Silicon Alley Insider adds another note to the death knells.

The blog reports that 111 Newsweek veterans have accepted a buyout to retire from the mag. This reinforces my conviction that it has given up on comprehensive, detailed reporting in favor of People Magazine-type copy, heavy on Brittany and such pseudo-entertainment. I’ve also noted a drop in advertising quality. Where once any consumer company worth its salt would place ads in these two giants, we see ads for products once reserved for late night cable TV and supermarket tabloids.

Fortunately, my favorite news magazine, The Economist, continues to provide wide-ranging, authoritative news. As far as Newsweek and Time magazines go, I’d jump on a buyout of my subscriptions if I had the opportunity.

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Filed under: Deals, Venture capital industry, Private equity industry, Public or private?

AirNet Systems, Inc. (AMEX: ANS) has entered into a definitive merger agreement with an affiliate of Bayside Capital. The size of this deal is little when you compare it to the massive billion dollar club deals, but deals of this size also have a much better chance of being able to be financed and the size is such that banks won’t have to come up with three million excuses not to fund.

AirNet Systems is a provider of specialized cargo airline and expedited transportation solutions for time-critical shipments like people that must get somewhere 10-minutes-ago, items like canceled checks and other key parcels. Here is their route structure that it operates in a spoke system if outside of that group. The website says that the company operated 130 aircraft, although that appears to be an old figure.

The company will be acquired for $2.81 per share, a transaction valued at $28.7 million. The offer represents a 94% premium to Friday’s $1.45 closing price.

As already noted, the size here is little. But this niche is one that sees steady interest from public companies and private companies in what feels like a “regardless of the economy stance” over the last decade. What is even more interesting is that the size of a deal like this crosses over with venture capital players, even if it is already a developed company. VC’s have funded many logistic and niche shipping companies over the last decade and there has been a major consolidation of the smaller players.

The Board for the approved the transaction and awaits shareholder approval in a future special meeting. The current management team will continue to manage the company upon completion of the transaction which is expected to close in the second quarter of 2008. AirNet shares are up over 80% this day to $2.63, representing a $26.7 million market cap. The 52-week range is $1.38 to $3.69, so this might not be a 100% assurance that all shareholders will vote along with the deal.

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Filed under: Finance, Internet, Features, Social Software, DLS Podcast, web 2.0

SXSWi 2008: Freshbooks talks to Download Squad from Download Squad on Vimeo.

We’ve written about Freshbooks — the on the web invoicing system — before and have been big fans of their approach and service. We were even more impressed upon meeting Saul and Sunir, two of Freshbook’s team members, at SXSWi 2008.

Allow talked to Saul and Sunir about the service, the importance of community and traveling from Miami to Austin in an RV and stopping along the way to eat breakfast, lunch and dinner with customers.

Read

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Filed under: Market matters, Politics, Headline news, Federal Reserve

The last time Washington took a fundamental rethink of how ideal to regulate the financial markets was during the 1930s. Now it’s decided to try again. The New York Times reports that on Monday Treasury Secretary Hank Paulson will announce a plan to substitute an alphabet soup of regulatory agencies with three new ones.

I think it’s a clever way to use the current credit crisis to loosen regulation on the financial industry while doing little to fix the current problem or prevent future ones. A superior way would be to nip future problems in the bud by changing financiers’ incentives — requiring them, rather than taxpayers, to foot the bill for the bad deals they originate — and shedding far more light on their dealings.

Paulson’s proposal brings many questions to mind:

• Would the proposed scheme have prevented the current credit crisis?
• Could the scheme actually be passed by Congress?
• Would it prevent future crises?
• Is there a superior way to manage the capital markets?

I think the answers are no, no, no, and yes. Before addressing these questions, though, let’s analyze what Paulson is proposing. Specifically, he wants to create three new agencies detailed as follows:

• Market stability. This regulator would expand the Fed’s powers — enabling it to send a SWAT team to examine the books and gather other information about any financial institution (FI) it thought was putting the system at risk. This might be a good idea if the Fed had a way to identify and fix the problems of a risky FI before it was too late to do anything about it.
• Prudential financial. This bureau would consolidate the specific agencies that regulate various depository institutions — S&Ls, banks, and credit unions. This isn’t a great name — it’s the same as that of a large insurance company — Prudential Financial (NYSE: PRU) — and the Treasury Secretary must know this. More importantly, by creating a single agency, regulatory costs would be reduced but it’s unclear whether the new agency would achieve greater effectiveness.
• Business conduct. This new bureau would protect consumers from bad conduct from all FIs, subsuming the role of the SEC. If this new agency were staffed with vigilant experts in each of the financial products sold to consumers coupled with massive budgets for investigating consumer fraud, it would be a valuable new service for consumers. But in all likelihood, the FIs would be able to stymie the Business Conduct agency’s effectiveness with their campaign contributions.

I don’t think the proposed scheme would have prevented the current credit crisis. What is this credit crisis? What caused it? I think of the credit crisis as the drying up of bank’s willingness to lend because they have lost trust in other banks’ capability to pay back their loans. I believe this loss of trust resulted from the large volume of complex securities with no market value — e.g., there are $6.1 trillion worth of collateralized debt obligations (CDOs) — on the books of FI’s that borrowed too much money — for example, investment banks and hedge funds borrowed $32 for each dollar of equity.

Paulson’s plan wouldn’t have prevented this problem because it does nothing to change the decisions of the people who take these risks in the first place. Risk management is a form of Quality Control (QC) — a basic principle of which is that the sooner in the process you nip a problem, the less it costs to repair.

As I’ve posted, current incentives reward participants for generating huge volumes of securities and deals. The players enrich themselves by getting a percentage of these volumes as a fee or bonus. If those volumes ultimately prove to be worthless, those players still get to keep their winnings. This scheme encourages financiers to push big deals, regardless of their ultimate profit.

If the government keeps these incentives in place, the players will keep ignoring risk as they invent new ways to get paid the big bucks. And Paulson’s proposal will continue to reward their mistakes by sticking the bill for their failure with the taxpayers — letting the proposed Market Stability bureau clean up moments before the problem is about to reach crisis proportions.

I don’t have a good sense of whether Paulson’s scheme will be passed by Congress. Many members will need to weigh the concerns of their constituents who have suffered from the credit crunch against pressure from the industry — with its campaign contributions — which might favor the looser regulation that Paulson proposes. Furthermore, it is unlikely that much will get done in Congress that does not benefit those running for President. Unless some proposals are seen as benefiting the 2008 combatants, regulatory changes in this area are likely to get deferred until 2009.

And as I posted in October, I think the way to prevent future crises is to change incentives and increase transparency. Specifically, the government should require financiers to put a massive portion of their bonuses in an escrow account. If their deals didn’t “blow up” after a period of time, state eight years, the funds would get paid out of escrow to the bankers. If their deals did blow up, the escrow accounts would be used to pay for their mistakes. Such incentives would make financiers pause before pushing risky, massive deals. If they knew they would have to pay for the ultimate costs, financiers would either reduce the deal risks or not do them.

As for transparency, I would appoint an independent group to assess the value of the future cash flows of asset-backed securities or other risky financial positions such as derivatives. If those cash flows couldn’t be quantified, then the securities would not be traded. If they could be measured, then the values and the underlying assumptions would be made public in real time. This transparency approach would slash the size of the market but keep honest the portion that remained.

This administration has used crises in the past to justify its agenda of tax cuts and reduced regulation on business. For instance, it used the 2001 recession to justify $1.3 trillion worth of tax cuts much of which went to the wealthiest 1% of Americans. Paulson’s proposal is a thinly veiled attempt to use the current credit crisis to slash regulation on financial institutions without addressing its real cause.

Peter Cohan is President of Peter S. Cohan & Associates. He also teaches management at Babson College and edits The Cohan Letter. He has no financial interest in the securities mentioned.

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Filed under: International markets, Other issues, Rumors, Rants and raves, Google (GOOG), Microsoft (MSFT), Yahoo! (YHOO), Apple Inc (AAPL), Ford Motor (F), India, Private equity, Scandals, Citigroup Inc. (C), JPMorgan Chase (JPM), Merrill Lynch (MER), Oil, Headline news, Bear Stearns Cos (BSC), Federal Reserve, Recession

Every day another story about our recession and the related fallout pops up. Are we in a recession or not? Or will we just teeter on the edge? The debate continues between those anal retentive types that must see all the actual facts, and those that see the signs all around and proclaim that “if it looks like a duck and it quacks like a duck, then by golly…”

The Federal Reserve Board has acted as if we’re in a recession. They sit on one side of the teeter totter lowering interest rates to counter balance the weak economy and moderate the impact of potential negative growth. Clearly they’re throwing ballast off a sinking ship.

There has been much debate recently about the Fed’s dramatic bailout of The Bear Stearns Companies, Inc. (NYSE: BSC) with the cooperation and maybe hand rubbing of JP Morgan Chase & Co. (NYSE: JPM). Some feel Bear Stearns should have been granted to collapse and others feel that the Fed had no choice in the matter and wasn’t protecting BSC, but the overall confidence in world financial markets.

I take the latter position because I think it’s self evident that BSC’s rapid fall two weeks ago was simply a modern day run on the bank, one resulting from a lack of confidence. The Federal Reserve has an imperative to maximize market confidence. Maybe Bear Stearns falls to it’s doom by itself and maybe it is the first in a series of dominoes. Those that say let it collapse are proponents of taking a risk that might begin an unstoppable tidal wave of financial ruin.

You could no more let BSC go bankrupt than you can wait to see the two consecutive quarters of negative growth before taking recession watch action. It is interesting that some wizards would take action in one case but not the other without seeing the contradiction in their positions. Citicroup Inc. (NYSE: C) and Merrill Lynch & Co., Inc. (NYSE: MER) are not out of the woods yet. Both companies had such nightmare investments in their portfolios that they had to clean house at the top by firing their chief executive officers. They certainly have some of the same ailments of Bear Stearns and resemble large dominoes in my eyes.

Unemployment is going up. On Wall Street and there’s no debate about that. On the other hand on the west coast, the housing market is having a crippling effect on parts of the economy, and the Say budget is a disaster. The only thing this has not affected is the tech sector and Apple, Inc. (NASDAQ: AAPL), with its CEO Steve Jobs. Apple has mountains of cash and a strong product line, and has sworn to maintain full employment and expand R&D no matter what. The tech sector may be down in 2008 in terms of sagging stock prices but jobs seem to be stable — both Steve Jobs and your tech job.

What’s not stable is the price of oil, as oil dips to $106 on renewed flows from Iraq pipeline, or gold with its own bubble which are near all time highs. They were showing signs of temporary softness earlier in the week but that’s nothing a good war like the one in Iraq can’t sway in a moments notice.

While Wall Street suffers in the east and housing suffers in the west, Ford Motor Company (NYSE: F) has been busy hoping to minimize their employee and shareholder suffering by selling off Jaguar and Land Rover to Tata Motors ADR (NYSE: TTM) of India. I am not sure which will help them more: the infusion of $1.7 billion or simply having a few less things on their plate to worry about.

Consumer confidence is down, no surprise, the market has been mostly up lately… which is a massive surprise. Google Inc. (NASDAQ: GOOG) remains a center of attention as the guessing game about earnings growth and the value of a click continue and while that remains massive news, even larger news, the acquisition of Yahoo! (NASDAQ: YHOO) by Microsoft Corporation (NASDAQ: MSFT) has gone silent. And the silence is deafening. Are they hammering out a deal?

Recession or not, the market will remain very active and the guessing games will go on. Have a good week end. Hopefully the Fed can take a rest so that we might too.

Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: We own shares in BSC & TTM.

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Filed under: Management, Private equity, Mutual funds, Headline news, S and P 500

In fascinating endowment news yesterday, Harvard University turned to one of its former investment stars to take the helm of the Ivy League’s biggest endowment of $35 billion.

Currently chief investment officer at Wellesley College, Jane Mendillo has been tapped o become the president and chief executive of Harvard Management Company. She fills in the slot vacated by Mohamed El-Erian, the emerging market bond guru, who left last year after less than two years in the job to return to his previous post with Bill Gross’ PIMCO.

Famed uber-investor Jack Meyer racked up impressive returns in his tenure at Harvard Management Company during the 1990s. According to Wikipedia, Meyer grew an endowment “worth $4.8 billion to a value of $25.9 billion (including new contributions). During the last decade of his tenure, the endowment earned an annualized return of 15.9%.”

Not too shabby.

It’s great to see a woman take over the helm of such a high-profile investment fund. The ideal part of this whole move is that Mendillo is a Yale grad!

Zack Miller is the managing editor of IsraelNewsletter.com and a former equity analyst for a leading multinational hedge fund.

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Filed under: International markets, Competitive strategy, Ford Motor (F), India, Headline news, Tata Mtrs Ltd (TTM)

It was reported long ago that Ford Motor (NYSE: F) was shopping its Jaguar and Land Rover brands. This day it finally announced it has closed the deal to sell these premier British brands to Tata Motors (NYSE: TTM) of India for $2.3 billion. Ford, which has been losing money, found its share price way down, closing yesterday at $5.96 (now up a few cents in premarket trading) and was in need of a cash infusion.

Tata Motors, having just introduced a low-end $2,500 vehicle to the Indian market, is now filling out the upper end of the spectrum by bringing these two well known British brands to a country with a tradition and heritage long ago saturated with British “imperialist” remnants like cricket and tea time. If Jaguar and Land Rover are to be revitalized, then Tata Motors probably has a better chance of success than most.

Ford purchased Jaguar for $2.5 billion in 1989 and Land Rover for $2.7 billion in 2000. Nine months ago I posted Chasing Value: Tata Motors LTD - patience, patience, GOT IT! and now Tata has got it! What it hopes to do with these brands is gain some international credibility, based on a solid Indian foundation.

Tata’s stock closed yesterday at $17.36, up slightly on the rumors. It is about midway between its 52-week low of $14.71 and its high or $21.30. This deal could send both companies forward humming a new tune. I would even speculate more wildly just for fun that in this world of expanding markets, integrated economies and corporate consolidation, Ford and Tata Motors could one day find reason to unite.

Sheldon Liber is the CEO of a small private investment company and the principal for design and research at an architecture & planning firm. He writes the columns Chasing Value and Serious Money. Disclosure: We own shares in TTM.

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