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Feds nab insider trader at Nasdaq

2011-05-26T20:19:31Z

Apparently Bernie Madoff wasn't the only bad apple at Nasdaq.

In the latest shining moment for the U.S. stock exchanges, the Securities and Exchange Commission on Thursday charged Donald Johnson, a former Nasdaq managing director, with ripping off investors to the tune of $755,000 by insider trading ahead of the release of corporate press releases.

Johnson, you will be impressed to learn, was in charge through October 2009 of the Nasdaq's "market intelligence" desk, which is surely a misnomer but seems in any case to have afforded him with a lot of info he used to trade profitably on outfits like United Therapeutics (UTHR).

Fearless leader

The SEC has come under heavy fire in recent years for its failure to nab Madoff, a three-term Nasdaq chairman in the 1990s, before he frittered away $20 billion in the biggest-ever Ponzi scheme. But the agency is doggedly trying to restore its good name by putting really catchy quotes in its press releases, an effort that was much in evidence Thursday.

"This case is the insider trading version of the fox guarding the henhouse," said Robert Khuzami, director of the SEC's Division of Enforcement. "Instead of protecting NASDAQ client confidences, Johnson secretly traded on client information for personal gain, even using his NASDAQ office computer to make the trades."

If you can imagine! As it happens, Johnson also pleaded guilty Thursday in a rather more serious criminal insider trading case, the U.S. attorney for the Eastern District of Virginia said. That one could get him 20 years in jail, regardless of whether the fox admits or denies his responsibility in this particular henhouse.

Filed under: Colin Barr, Street Sweep, Term Sheet

The problem with nomadic megabanks

2011-05-26T15:19:48Z

Behold an exciting new feature of the post-bailout era: the megabank that wanders the globe with the weapons of financial mass destruction strapped to its chest.

UBS (UBS), the giant Swiss bank that took $59 billion in bailout funds three years ago in addition to billions of dollars in conveniently cheap Fed loans, is chafing at the restrictions that terrified regulators there are imposing.

All this could be yours!

The government wants to avoid having its Godzilla-scale financial firms – led by UBS and Credit Suisse (CS) – from blowing up the economy in the next downturn the way the reckless Irish banks did. That's bad for re-election prospects and much else.

UBS doesn't like that sort of talk and so wants to move its investment banking unit – the outfit that brought you the Dillon Read fiasco, among others – out of the Alps. All this in the name of creating shareholder value, etc.

The question now is, who would be fool enough to take them? Are a few thousand jobs worth the risk of having to bail out yet another bunch of systemically important Maserati owners?

The risks of taking in an outfit like UBS are apparent enough in an International Monetary Fund report on Switzerland, released Thursday.

"Regulatory capital ratios of the big banks have strengthened, but the quality of the capital is low and leverage remains high," the report says. What a winning combination. Who wouldn't want a piece of that?

Meanwhile, the next financial meltdown stands to pose a particularly tough test for whoever ends up holding this bag. "Swiss banks' foreign exposure represents 58% of total bank assets, the highest among advanced economies," the IMF says. So the problems could come from all directions -- though two stand out.

The biggest exposures for the Swiss are in the United States, where banks hold claims worth more than Swiss annual economic output, and the U.K., where claims equal 40% of Swiss GDP. That is a lot of bailout checks if things go bad -- not that we have ever had a problem with reckless investment banks in this country.

And what global financial hubs are perceived as the leading contenders for the honor of hosting the headquarters of the newly mobile UBS investment bank? Why, New York and London, along with Singapore. May the most reckless jurisdiction win.

Filed under: Colin Barr, Street Sweep, Term Sheet

Is the AIG selloff overdone?

2011-05-25T15:56:41Z

Could it be time to start kicking the tires on AIG?

It hardly seems like an auspicious moment. Shares have lost half their value this year, including a 3% walloping Wednesday, making the New York-based insurer the worst-performing big stock in the market. The supposedly smart money is having second thoughts, and AIG's (AIG) accounting, never exactly a strong suit, is being questioned again in an unwelcome blast from the past.

How low can it go?

Even when the government manages to claw back some of the $182 billion it offered up to bail the insurer out, there's a hitch. An offering that was supposed to bring taxpayers a nice bonus for all their support the past three years turned into a bit of a white-knuckle ride Tuesday. Treasury did cut its stake to 74%, but it sold less stock than initially expected at a barely break-even price.

Yet if you look close enough you see signs that AIG may have turned a corner on the road to recovery. AIG's No. 2 executive, Peter Hancock, told analysts on a conference call this month that the company was done writing new policies for the sake of puffing up its revenue numbers.

"To some extent we are moving away from any kind of top-line targeting," Hancock said. "We think that leads you to do business at the margin which is unattractive, so the top line will be what it will be. We think it will grow at about 6% based on our best estimates, but we are really instead targeting risk-adjusted profitability."

Deciding to target risk-adjusted profitability rather than revenue is not exactly rocket science. But remember, this is AIG we're talking about. It is the outfit that infamously blew up by writing credit default swaps without ever considering it might have to pay out on them.

David Merkel, an investor who is the principal at Aleph Investments in Baltimore and a leading chronicler of the AIG saga, says he hasn't bought any AIG stock but may start taking another look at the company if it shows further signs of having returned to the straight and narrow.

"The best insurance companies focus on underwriting, and I find it encouraging that that's what you are starting to hear out of AIG," says Merkel.

Questionable underwriting hasn't been AIG's only problem by a long shot. It has long had a reputation of making its reported numbers look better by underreserving for future claims – a history Merkel has tracked in some depth.

The impression that the company has spent years cutting corners wasn't dispelled when AIG said in February it would take a $4 billion hit to profits to strengthen its property-casualty claims-paying resources.

The question now is "whether $4 billion fills the hole – or does it just fill this year's hole?" asks Merkel. "The book of business is so complex at AIG that I just can't tell."

So it's early yet to dive into this murky water, which stands to be choppy as the government tries to extricate itself from its biggest, most widely criticized bailout. Holding three-quarters of a struggling company at a time when people are shouting every day that the stock market is vastly overvalued cannot be a totally reassuring feeling.

But if the books turn out to be sound and Hancock, a longtime veteran of JPMorgan Chase (JPM), keeps sending the right message, the government's breakeven sale of its first round of AIG stock needn't be an albatross.

"I'm going to look at some more bread crumbs," Merkel says, "but if they lead in the right direction it might be time" to buy the world's most hated stock.

Filed under: Colin Barr, Street Sweep, Term Sheet

The world's most reckless central bankers

2011-05-25T10:32:01Z

Should the guys at the European Central Bank have to sit through a screening of "Too Big to Fail"?

It might remind them that a lesson of 2008 meltdown is that you can't extend and pretend your way out of the abyss, even if you're brandishing a bazooka. If Europe's central bankers accept this fact, they aren't showing it.

Unarmed and dangerous

Take the ECB's decision this month to oppose a restructuring of Greek debt. By now everyone who isn't employed in a policymaking role acknowledges that Greece's finances are unsustainable and getting worse. Even some politicians are coming around.

As Ireland's post-bailout death spiral makes clear, austerity alone simply is not going to do the trick. Balancing a budget that is as out of whack as Greece's "has been known to cause riots if done in a single year," warns Paolo Manasse, an economics professor at the University of Bologna.

Yet officials at the ECB insist the alternative -- inflicting losses on bondholders who until recently were all too happy to foot the bills for the big, fat Greek consumption party -- is still too damaging to even contemplate. Taking a book out of the Tim Geithner playbook, ECB board member Juergen Stark last week called a possible restructuring a "catastrophe" because it would do bad things to the banks.

Meanwhile the real catastrophe plays out before our eyes. Every day that goes by without a restructuring that forces investors to share European taxpayers' pain, the ultimate cleanup tab rises. You only have to survey the mess that is the U.S. housing market -- or the wreck that once was the Irish economy -- to see how that movie ends.

"You cannot really afford to keep buying time, because it is so expensive," says Daniel Gros, who runs the Center for European Policy Studies think tank in Brussels. "Paying out 100% to existing bondholders is just too big a burden to bear in this situation."

Devising a workable restructuring isn't simply a matter of throwing a switch, but it's not impossible either. Gros has been calling for months for policymakers to cook up a rational restructuring program. The market fully expects the holders of bonds issued by Greece, Ireland and Portugal to recoup far less than 100 cents on the euro when repayment time comes. Why not hold investors to that view?

Here is where politics start to intervene. The ECB holds hundreds of billions of euros of exposure to the weaker economies, and thinly capitalized European banks hold billions more. Like the Fed before it, the ECB is sensitive in part because it has staked so much on a muddle-through view that is implausible without costly subsidies to the banks' creditors. And even if the ECB concedes it has to take the hit sooner or later, the decision is not its alone to make.

"This is Jean-Claude Trichet's frustration," says Gros, referring to the ECB chief (pictured above). "He knows Berlin will not go for a restructuring, so preparations are not taking place."

If anything that is an understatement. This week the spreads widened on bonds issued by countries previously resistant to the euro plague, Spain and Italy. This implies the problem is spreading, even as the Greeks get ready to take another round of checks.

"It is hard to acknowledge if you are Trichet that a country can fail," says Gros. "But the longer this goes on, the greater the chance you find yourself stumbling into something like the weekends Paulson became famous for."

If the ECB has been weak, European leaders look little better. They are so cowed by the threat of debt market contagion that some admit they are willing to baldly lie just to smooth the waters for a day or two. Euro area President Jean-Claude Juncker said last month he is willing to mislead the public if the price in terms of market stability is right.

Considering that Greece's problems started in earnest when it came to light it had lied about its debt and deficit numbers, this is quite an ironic position for European officialdom to take.

"When it becomes serious, you have to lie," Juncker said. Either that, or you have to get serious. No prizes for guessing which course Europe will choose.

Filed under: Colin Barr, Street Sweep, Term Sheet

Problem banks list hits 888

2011-05-24T18:35:15Z

The zombie banking industry took another half step forward Tuesday.

The list of banks at risk of failing expanded at its slowest rate since before the credit crisis, the Federal Deposit Insurance Corp. said. The so-called problem bank list rose by just four institutions to 888, FDIC chief Sheila Bair said.

One step up

That's still the highest number in two decades and the highest ratio since 1987 as a share of existing banks. It's a fact that Bair, who is leaving in July after five years on the job, is painfully aware of. When she took the helm at the FDIC in 2006, profits were at a record and the problem banking list comprised just 50 institutions.

"Some will refer to that period as a golden age of banking," she said, but "with the benefit of hindsight we now know that a substantial part of those record profits were illusory."

The profits are coming back now, but in some ways they are just as questionable. Banks posted their biggest quarterly profit since the credit bubble burst in the first quarter, earning $29 billion in the first quarter. That is biggest number since a $36 billion profit in the second quarter of 2007.

But as has been the case in recent quarters, the main driver of bank profitability was not revenue growth but the release of loan loss reserves. Banks took $31 billion worth of loss provisions and turned them into profits in the latest quarter, Bair said.

So-called reserve releases are legitimate but unsustainable, and point to even more pressure on bank profits till the economy turns around and loan balances start to grow.

"There is a limit to how far reductions and loan loss provisions can be in industry earnings," Bair said. "At some point if banks are to continue to increase their profitability, they will have to grow their revenue."

Meanwhile, loan balances dropped at their fastest clip since the end of 2009, marking their 10^th decline in 11 quarters. They dropped at banks both big and small, in what Bair said was a sign of both questionable bank decisionmaking and a weak economy producing soft loan demand.

"Loan balances are down at the smaller banks in the quarter, and they need to make loans to make money," Bair said. "That's the business model and they are having trouble finding creditworthy borrowers."

Even if this quarter does mark the peak on the problem bank list, it's going to be a very long time before we see another reading in the double digits.

Filed under: Colin Barr, Street Sweep, Term Sheet

Big-bank CEOs: the billion-dollar bust

2011-05-24T10:45:28Z

The deal of a lifetime

Has any group ever been more richly rewarded for failure than the CEOs of the six biggest U.S. banks?

Over the past decade the too-big-to-fail banks have showered a staggering $1.15 billion in cash and stock on a changing cast of hard-charging if inept chief executives, according to regulatory filings. That works out to an average paycheck of $19 million a year – this in a decade in which the biggest banks ripped off everyone in sight on their way to very nearly turning the lights out on the U.S. economy. Well played.

If the banks' customers and U.S. taxpayers were the biggest losers, shareholders weren't far behind. Say you plowed $100 into a market-weighted basket of shares in Bank of America (BAC), JPMorgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), Goldman Sachs (GS) and Morgan Stanley (MS) on Jan. 1, 2001. How much would you have had by the end of last year?

The answer is a princely $81.60, according to an analysis by Kevin Kelly of Capital IQ in Denver. Even a buyer of the S&P 500 at the start of stocks' lost decade would have $115. Imagine the sums these wise bankers could command if they ever did right by anyone but themselves!

The winners in this zero-sum game are, naturally, the guys who move other people's money around to such effect. They are led by CEOs Lloyd Blankfein of Goldman, Jamie Dimon of JPMorgan Chase and Dick Kovacevich, who led Wells Fargo till 2007.

Even by the standards of the bailout age, the sums they have taken down are mindboggling. Blankfein, paragon of self-denial, has scraped by on $233 million since taking over as CEO for Hank Paulson in 2004. Dimon, known as banking's golden boy for good reason, has subsisted on $177 million since replacing William Harrrison in 2003. Kovacevich, evidently as much an ascetic as a loudmouth banker, eked out a living on a miserly $97.5 million between 2001 and 2007 before giving way to John Stumpf. How tough it is nowadays to make ends meet!

What's most absurd is that these are, for the purposes of this discussion, the good guys. Shareholders in those three banks actually made a little money over the past decade (see chart, right), if not enough to justify these sums – and not without trillions of dollars of help from the U.S. taxpayer.

It is hard to muster any such defense, however half-hearted, for the proud chieftains of the other big banks. All three have lost shareholders gobs of money over the past decade – in Citi's (C) case, nearly all of it -- even as they took tens of billions of dollars of bailout funds.

This rogue's gallery includes Ken Lewis, who was forced out of Bank of America after taking $150 million of shareholder money between 2001 and 2009; John Mack, who received $118 million for overseeing a majestic 25% decline in Morgan Stanley's stock price; and the immortal Chuck Prince, who took $113 million over four short years as he waltzed Citigroup to the brink of insolvency.

The good news, such as it is, is that all three of those losers have been shown the door by now. Whether their replacements represent any improvement remains to be seen, however.

Take Citi, where the board this month gave Vikram Pandit a retention package worth at least $22 million (and perhaps double that) after he oversaw an 87% stock price plunge that stopped short of zero only because Tim Geithner bought that line about the banks being the heart of the economy. Part of the argument in favor of this curious arrangement, supposedly, was Pandit's unparalleled sacrifice in having taken a dollar in salary for the previous year and a half.

But emphasizing that Pandit was earning $1 a year "is disingenuous since it ignores the $38 million of pay in 2008 and the $165 million he received in 2007 for Citi's purchase of the CEO's hedge fund, which has since been closed due to performance and outflows," writes CLSA analyst Mike Mayo.

There is also the curious case of Brian Moynihan, who took over after Lewis got a long overdue ax in late 2009. You'd think it would be hard to do worse than the guy whose last two acts were saddling BofA with the lawsuit magnet Countrywide and the massively overpriced Merrill Lynch. But Moynihan, to his sort of credit, has been so reckless in his promises to do right by shareholders that he has even roused the somnolent Fed. At least he is making less than Lewis did.

So now the focus turns to whether the banks are indeed going to ignite a recovery. There is not a lot of evidence so far in their numbers, which show loans shrinking even as deposits flow in, and the economy is not exactly going great guns lately. But hey, imagine the bonuses Dimon and Moynihan and their pals can command when they do eventually start lending.

Filed under: Colin Barr, Street Sweep

The silver lining in falling bank stocks

2011-05-23T15:50:37Z

Summer is a month away yet, but the financials are already wilting. If we're lucky, this trend is just getting started.

Bank stocks fell for the second straight day Monday, as Bank of America (BAC) and Morgan Stanley (MS) sank within 5% of their 52-week lows. Another big trading bank, Goldman Sachs (GS), rose modestly but remains just 6% above its low of the past year.

Chart of the future?

The selloff is the latest sign of investor nerves over the banks' true health. Both BofA and Morgan Stanley are trading substantially below Wells Fargo analyst Matthew Burnell's estimates of their tangible book value, and Goldman Sachs is trading just above.

That's unusual in itself, as banks over the past 20 years traded at an average multiple of 2.6 times tangible book – a rough proxy for the amount a bank might fetch in a fire sale, not that it would ever, ever come to that.

In any case, the implication is the market doesn't trust the bankers any more than any of the rest of us. In part that's because it seems reasonably clear the costs of the banks' bubble-era misbehavior aren't going to be neatly tallied any time soon.

That will, sniff sniff, hold down returns that already are nothing to write home about, except in anger and exasperation. And there lies the promise in this trend.

Fow now, Burnell blames the selloff trend on factors including "renewed headline risk related to potential legal actions against MBS providers" – such as the government lawsuits being pursued against Deutsche Bank and being considered against other big banks.

There is also, of course, the trading slowdown that stands to sap results at the big Wall Street players, and a slowing economy that may yet hold up the banks' efforts to lend more money for what seems like the millionth time.

The bad news for those holding financial stocks is that the banks are looking like just as bad a bet as they did over the past decade, when they were the sole sector of the S&P 500 to turn in negative annual returns.

The good news is that if investors keep losing money on these dogs long enough, they may do what our political "leaders" have been too craven to do and demand that the bankers break up their idiotic, unsafe-at-any-speed empires. It seems like a stretch now, but a long run of zombie stock performance has a way of changing things.

Filed under: Colin Barr, Street Sweep, Term Sheet

Why oil prices will spike again soon

2011-05-23T13:25:25Z

How long till the next oil shock?

Energy prices have been coming down this spring as fears of a Middle East blowup fade. But persistent global demand, tepid supply growth and easy money mean it may not be long till the next damaging spike, Goldman Sachs economists say.

Higher and higher

Oil prices could surge again by the end of 2012, economists Jan Hatzius and Andrew Tilton wrote in a note to clients this past weekend. They say the snail-like pace of global oil supply expansion – which Goldman projects at 1% or so annually – can't keep a petroleum-addicted world economy rolling without prices rising, perhaps sharply.

So don't get too used to paying a mere $3 and change for gasoline. Higher prices are on the way soon enough, thanks to stretched supplies and a Federal Reserve spigot that is likely to remain wide open for years to come.

"The fundamental story of increased oil scarcity is unchanged, and our commodity strategists now see distinct upside risks to their current forecast of $120/barrel for Brent crude by late 2012," Hatzius and Tilton write. "So the impact of scarcer oil and higher oil prices on economic activity remains at the top of our list of worries."

What makes higher oil prices almost inevitable is the depth of the jobs deficit in the United States. Unemployment is officially 9% but is more like 13% if you consider the low rate of labor force participation, says Bernstein Research strategist Vadim Zlotnikov. That number has fallen this year to levels not seen since 1985.

High joblessness and weak inflation will keep the fed funds rate near zero at least through next year and perhaps longer, Hatzius and Tilton write. That should help keep pushing unemployment slowly toward its long-run average of around 6% -- but at the expense of further dollar depreciation, stronger global demand and, ultimately, higher oil prices.

So the selloff that has taken the crude price down to $100 or so in New York and $112 in Europe, where Brent is traded, may persist through much of 2011. But it won't last forever, Goldman warns.

"The only way to bring both the labor market and the oil market into equilibrium is likely to be through a further increase in the real oil price," the Goldman economists write. "This would presumably increase oil supply by making exploration and production more attractive, and reduce oil demand by increasing energy efficiency."

They add that this policy trade-off is often unfairly portrayed as transferring income from the poor to the rich. The Goldman economists concede that those in the bottom fifth of the U.S. income distribution spend more of their funds on gas than do those in the top fifth, by 4.6% to 3.5%.

But they note that those losses by the poorest consumers are offset by the job creation enabled by the loose Fed policy, which "will lead to significant gains in real income for a subset of households drawn disproportionately from the lower end of the income distribution."

And while no one is likely to turn cartwheels about higher oil prices, Hatzius and Tilton point out that there's an obvious way for the United States to turn that trend in its favor: By imposing higher taxes on energy use.

In doing so the government could both hold down consumption (through higher prices) and boost federal revenues (which could use some boosting nowadays, you may have noticed), mostly at the expense of foreign governments that are at best our frenemies. But needless to say, something that makes that much sense has about as much chance of seeing daylight in the current Congress as the return of dollar-a-gallon gas.

Filed under: Colin Barr, Street Sweep

Central bankers vs. Bill Gross

2011-05-20T17:35:43Z

Do central bankers have it in for the world's most widely cited Treasury bond bear?

You might well ask after reading the latest report from the rates strategists at Bank of America Merrill Lynch. They contend that global central bankers are about to spring off the sidelines to buy Treasury debt, in what stands to be the latest setback for the Pimco bond fund manager's giant bet against U.S. government bonds.

10-year yields: more of the same?

Since the Fed's latest round of bond buying started last November, BofA says, cash -- mostly in the form of dollars -- has been piling up in places like Brazil and India as money rushes toward faster-growing economies, in the form of trade surpluses as well as Fed-fueled capital inflows.

But in a familiar refrain, the bankers getting deluged by this money torrent have been sitting on their hands. Foreign exchange reserves held as bank deposits recently hit their highest level since the collapse of Lehman Brothers, BofA says, while the ratio of securities held for each unit of bank deposits has been dropping back to its post-panic low. What's more, the pace of foreign official Treasury accumulation slowed sharply in the fourth quarter.

There is, in short, a good deal of pent-up demand for Treasury bonds -- which is why BofA strategist Priya Misra sees solid support for the U.S. government bond market even after the Fed kicks its $75 billion-a-month habit.

"We believe the most likely explanation is that some reserve managers are awaiting the end of QE to put cash to work in the Treasury market, perhaps driven by the belief that rates are being kept artificially low by the Fed's steady buying," writes Misra.

The fog of foreign reserve data means that it's impossible to say for sure what is going on with the central bankers. That goes particularly for the mandarins perched atop the elephant in this room, China (which controls a third of the world's $9.2 trillion in foreign exchange reserves).

Even so, there are some clear signs that the Fed's decision to support the U.S. economy with a flood of dollar liquidity caused some behavioral changes among the globe's other dollar accumulators, from Indonesia and Poland to Japan and Russia.

"Beginning in November 2010 some of these central banks began to put a sizable amount of new cash into deposits at official institutions such as the Bank for International Settlements (BIS) and, to a lesser extent, at commercial banks," Misra writes. "Note that this marks the first sustained increase in deposits since the onset of the financial crisis."

Of course, as much as you might like your friendly local banker at the Bank of International Settlements, no one likes collecting 0.1% annually at a time when inflation is on the march. That's why BofA expects foreign reserve managers to start marching back into the Treasury market -- particularly in two-to-seven-year notes, all of which are being auctioned next week.

Demand for Treasury debt has been picking up anyway, thanks to slowdown signs in the U.S. economy and the fear that Europe's debt crisis is about to spiral out of control again. But unless Congress goes through with its threat to blow up the country in a stupid fight over the debt ceiling, lower Treasury yields look like a pretty good bet for the rest of 2011.

Filed under: Colin Barr, Street Sweep, Term Sheet

Do falling gas prices spell recession?

2011-05-20T15:51:11Z

Sick of high energy prices? You may soon have more relief than you'd like.

After two commodity price spikes in four years, $100-a-barrel crude and $4-a-gallon gasoline are starting to seem like the new normal -- the price we pay, unhappily enough, for an expanding economy. Every twitch in the Middle East sounds the alarm for a new oil shock.

How low can they go?

But those cursing the wallet-thinning impact of high energy prices should be careful what they wish for. Sagging economic expectations, after all, are the likeliest route to lower energy costs, as we have seen with the recent decline in oil prices.

Retail gas prices haven't come down much yet, averaging $3.91 a gallon at last check -- a sign, says oil watcher Richard Soultanian, that "maybe even the refiners don't trust the pullback in crude prices." But if current trends continue, the pullback could go further than people expect.

There are plenty of signs economic growth is slowing. U.S. gasoline demand has fallen more than 2% over the past year, suggesting that high prices have already started to weigh on the economy. Uber-bear David Rosenberg cites recent declines in architectural billings, small business optimism, house price and manufacturing indexes. Goldman Sachs strategists note that while manufacturing employment has rebounded, recent gains are proceeding at just a quarter of the pace of the average monthly manufacturing job loss (a depressing 52,000) over the past decade.

Better late than never, economists everywhere are cutting economic growth forecasts that started 2011 in the 4% range – if probably not as much as they should. The wishful thinking impulse dies hard.

"Everyone's demand and GDP forecasts for the next six to 12 months are just way overblown," says Soultanian, whose NUS Consulting in Park Ridge, N.J., helps big companies plan for energy price shifts. "I think there is quite a good chance we will be revisiting $80-$85 oil by year-end."

That forecast, mind you, presumes that the economy continues to limp along at a 2%-3% annual clip. But with the Federal Reserve scheduled to end its bond-buying program next month and federal support for overstretched state budgets ending as well this spring, a half-hearted U.S. expansion looks considerably more vulnerable than it did coming into 2011.

Fiscal tightening and monetary neutrality are hardly shocking developments, of course. But talk of the Fed heading for the exit ignores the impact of higher energy prices themselves. One rule of thumb has it that the economy goes into recession after the oil price triples -- which it has done since its 2008 panic low.

And though almost no one talks about the dreaded double-dip recession any more, the soft data and the many shocks we have already taken this year, from the Mideast unrest to the Japanese tsunami, should remind us we are hardly out of those woods.

"I don't see how we're going to fill the vacuum" of all the federal money that has been pumped into the economy, says Soultanian. "That doesn't mean you end up in a recession, but the chances are a lot higher than people appreciate. Maybe 25%?"

It is impossible to say how far oil prices might drop in a substantial U.S. slowdown, of course. A plunge to the 2008 lows seems implausible, but then until a few months ago so did a return to $4 gasoline.

In any case, a slowdown stands to undermine the fragile jobs recovery that Ben Bernanke has staked so much on. And the higher unemployment goes, the more people will be apt to remember that a little inflation pressure, as unpleasant as it is, beats the alternative.

Filed under: Street Sweep

Goldman leaves LinkedIn party early

2011-05-20T15:46:20Z

Is Wall Street's savviest trading firm leaving a LinkedIn fortune on the table?

The LinkedIn (LNKD) buying frenzy Thursday is a windfall for most of the business networking company's longtime shareholders, led by founder Reid Hoffman and his private equity backers.

Past: Is it prologue?

The 115% surge in LinkedIn shares at midday Thursday sent the value of Hoffman's stake, for instance, soaring from a merely huge $852 million to a surreal $1.8 billion.

But one sizable LinkedIn investor, Goldman Sachs (GS), decided to sit out the secondary-market fun. Practically alone among big holders of the stock, Goldman decided to dump it all in Thursday's debut, selling its entire 871,840-share stake at the IPO price of $45 a share. What gives?

Goldman declined to comment, and it's not like the firm is taking a bath by selling out. Goldman stands to make something on the order of $34 million by selling the LinkedIn shares at the IPO price, three years after it bought the shares. In mid-2008 LinkedIn was paying $5.56 a share to buy back stock from its chief technology officer, so it stands to reason Goldman's per-share profit on this deal is around $39.

Yet Thursday's blastoff says Goldman could have made even more. The firm's supposed to excel at this sort of value-maximizing activity, after all. And even if LinkedIn's valuation is on the bubbly side, the massive for the stock this week seems to suggest that particular bubble is in no danger of imminent collapse.

Or is it? Goldman may be banking on a replay of this month's other hot IPO, the May 4 debut of Chinese social networking company Renren (RENN). Its shares jumped more than 70% (see chart, right) when trading started, topping out at $24 early on their first day after pricing at $14.

But how quickly the Renren craze faded. The stock dropped 25% from its peak on opening day to close at $18, then dropped in each of the next six trading sessions before bottoming out at $12.60, 10% below the IPO price. The stock was up 4% in Thursday's social networking party but is only just above $14.

LinkedIn mania may well last longer than Renren's run did. But it's easy enough to see the case for selling any stock that is trading, as LinkedIn is at a recent $108.55, at 666 times earnings.

Filed under: Colin Barr, Street Sweep, Term Sheet

Pandit's preposterous pay landslide

2011-05-20T15:46:20Z

Four more years! Four more years!

That's what Citigroup's (C) board was inexplicably chanting this week as it signed up for another term under Vikram Pandit, the CEO whose signal accomplishments include repaying a giant government bailout and executing a reverse stock split that rescued Citi from penny stock purgatory.

Many unhappy returns

That's not much of a record, but Citi is grateful anyway. It signed Pandit to a deal that will hand him more than $20 million in retention payments as long as the bank doesn't blow up.

That's in addition to whatever compensation he'll earn in normal course. The board this year boosted his salary to $1.75 million after a year and change at an outrage-placating $1.

Predictably, Citi painted the awards as having been earned through stellar performance.

"Vikram has done an outstanding job since coming on board as the financial crisis began," chairman Dick Parsons said. "Under his leadership, the management team has navigated Citi through the crisis, returned Citi to profitability and is executing a strategy for sustainable growth."

But Pandit was able to navigate Citi through the crisis mostly because Tim Geithner et al. decided that propping up the banks at all costs would lead to a faster recovery. And while the government made a $12 billion profit on the Citi bailout, it is clear that taking that course had its pluses and minuses.

It's impossible to say for sure what would have happened if the government had taken the likes of Citi to the cleaners, throwing out management and all. But with the banks still shrinking their loan books at a time when unemployment is at 9%, it is hard to make the argument the decision was a winner for taxpayers.

Things sure worked out well for Pandit and his cronies, though. Under the incentive plan Citi adopted this year for its top five executives, the bank stands to hand out $18 million in pay if Citi simply stays on its current profit track, which has so wowed investors that the bank recently resorted to a 1-for-10 reverse stock split.

And he'll get 500,000 stock options, mostly at the recent stock price of $41 and change -- which itself represents a 10% or so decline from this time last month. Citi's selloff may well be overdone, as Deutsche Bank analysts contend in a recent note, but certainly no more so than the weakling bank's top-heavy pay structure.

Filed under: Colin Barr, Street Sweep

Silly season at United Airlines

2011-05-20T15:46:21Z

What's in a number?

A good-sized headache if you're United Airlines, which was lampooned after it came to light that it had resumed using the flight numbers of the two United planes that terrorists took over and crashed in the Sept. 11 attacks.

A little light chop

United quickly backtracked, taking UA93 and UA175 out of service Wednesday after the news emerged. But inviting further mockery, the airline explained that the numbers had been "inadvertently reinstated" into United's systems as they are merged with those of its newly acquired sister airline, Continental. How's that integration going, guys?

Surely adding to the discomfort in United's executive suite is the timing of this fiasco. United's parent, United Continental Holdings (UAL), issued a press release Wednesday saying it was introducing procedures that would provide "a more consistent travel experience for customers" on both United and Continental.

The flight number flub is certainly consistent with the widely made observation that the airlines have a knack for screwing things up. On the other hand, United did quickly acknowledge its mistake and take the numbers back out of service. Perhaps a bit of forbearance is called for?

Not a chance. Refusing to be outdone on the absurdity scale, the union representing United's pilots lashed out at the company's "insensitivity and unconscionable disrespect of these sacred flight numbers."

Taking the memory of 9/11 lightly would be "reprehensible," as the pilots say, if United were actually doing that. But it's not like the airlines or the pilots are any strangers to honest mistakes. Is everything sacred anymore?

Filed under: Colin Barr, Street Sweep

How foreigners will buy the U.S.

2011-05-20T15:46:21Z

Think we're in hock up to our eyeballs now? Wait till 2025.

That's the message behind a World Bank report this week that imagines what the global economy will look like in a decade and a half. It is, to be blunt, a world in which Americans have sold everything that isn't nailed down to finance our fabulous lifestyles.

But what's $3 trillion among friends?

Yes, the United States will still have the biggest economy, and the dollar is likely to continue to play a prominent if probably reduced reserve-currency role. But Americans will find themselves paying for those exorbitant privileges, and how.

The World Bank projects that while the U.S. economy will expand by perhaps 40% in constant dollar terms, net foreign ownership of U.S. assets – stocks, bonds and property in the hands mostly of China and other emerging Asian countries -- will expand fivefold. This is the ownership society, though with others doing the owning.

The U.S. net international investment position – which compares the value of foreign-owned U.S. assets with the value of U.S.-owned foreign assets -- will hit a staggering minus-69% of annual gross domestic product by 2025, in the World Bank scenario. That compares with minus-18% now.

If you accept the World Bank's view, by 2025 the rest of the world will own something on the order of $13 trillion more of U.S. assets than we own of theirs. China alone will hold an $8 trillion investment surplus against the rest of the world, mostly the United States.

Those sums dwarf the deficits the United States has run up even in its past two decades of profligacy. It had a $2.7 trillion (see chart, right) negative international investment position as of 2009, the last date for which figures are available. If anything that understates the degree to which America has been living on borrowed money: U.S. current account deficits over the past two decades add up to almost $7 trillion, but we made much of that back on valuation changes (thanks to factors such as an ever-weakening dollar).

It wasn't too long ago that a mere $2 trillion or so in net foreign ownership of U.S. assets was viewed as something to fret over. Warren Buffett did so in the pages of Fortune in November 2003, at a time when the trade deficit was just starting to blow out and the dollar was on the verge of paying the price.

He compared the U.S. practice of running 12-digit trade deficits for the purpose of financing domestic consumption to "an extraordinarily rich family that possesses an immense farm. In order to consume 4% more than we produce — that's the trade deficit — we have, day by day, been both selling pieces of the farm and increasing the mortgage on what we still own."

Buffett made that point in the service of arguing for a policy to limit imports and encourage exports. Congress, predictably, did nothing. Since then, the trade-weighted dollar index has dropped 20% and imports have risen by half. Coincidence?

No one has any earthly idea what the global economy is going to look like in 2025, of course. But it's easy to see why predicting more dollar depreciation and U.S. irresponsibility is not a very hard sale nowadays.

Filed under: Colin Barr, Street Sweep

The momentum for higher commodity prices

2011-05-20T15:46:22Z

If you're weighing the long-term case for higher commodity prices, consider this comment from Bank of Canada governor Mark Carney.

Carney's speech Monday focused on Canada's role in a changing world, but it included this aside about the price of stuff like oil, copper and grains:

Coming back for more?

The expanding urban middle class in emerging economies is having a major impact on a wide range of commodities. Whether it is travel, housing or protein, consumption levels in major emerging markets are currently fractions of those in advanced economies.

With convergence still a long way off, the demand for commodities can be expected to remain robust for some time. Based on the experiences of Japan in the 1960s and Korea in the 1980s, emerging Asia's energy and metals intensities should gain momentum in coming years.

Commodity prices have been falling lately, of course, and they may continue to do so as the economic recovery sputters through the balance of 2011. And over time there will be a supply response that will ease prices for many goods, if not necessarily as quickly as we might like (and perhaps not at all in the case of oil, except at much higher prices).

But reading Carney's remarks – and looking at a commodity index chart covering the past five years (see right) – says we shouldn't get too used to the good news of the past month.

Filed under: Colin Barr, Street Sweep, Term Sheet

Sizing up the LinkedIn bubble

2011-05-20T15:46:22Z

Would you believe the value of LinkedIn has risen 19-fold in just over two years?

You must if you are planning on buying into its initial public offering. LinkedIn is expected to go public this week at a price above $40 a share. That's a far cry from the $2.32 a share the networking-for-professionals outfit valued itself at as recently as the spring of 2009.

The sky: it is the limit

That said, the company admits in offering documents that it has moved the goalposts at least once in estimating what its shares are worth. That nifty move, you'll be shocked to learn, stands to benefit insiders such as LinkedIn's founders and executives at the expense of those buying in at the inflated IPO price. Does any of this sound familiar?

LinkedIn is looking to sell shares at between $42 and $45 each this week. An IPO that prices in that range would value the company, which made $15 million last year, at $4.1 billion. That's 267 times earnings if you're keeping score at home.

It is not too hard to make the case that this valuation puts LinkedIn and its social networking peers firmly in bubble territory. But it's interesting all the same to watch the bubble inflate month by month, which LinkedIn allows us to do in a section of its latest filing with the Securities and Exchange Commission.

That document contains a section that explains how the San Francisco-based company's board decided to price the $611 million worth of stock options it granted employees in LinkedIn over the past two and a half years.

When the company granted options in February 2009, for instance, it valued them at $2.32 a share. It maintained that price in three subsequent grants that year. Among the factors in those valuations, LinkedIn said, were "continued weakness in our business" and "uncertainty surrounding the U.S. and global economies."

But as business picked up and the economy started to recover, the company raised the strike price to $3.50 that September. It maintained that price for the rest of 2009, before citing improving revenue growth, strengthening financial markets and the increasing likelihood of an IPO for seven grant-price increases in 2010 and 2011.

Even after all those increases, the company said a "contemporaneous valuation of our common stock as of March 17, 2011" put the value at just $22.59 a share -- barely half the expected offering price specified in the latest filing this month.

The company, eager to explain away that rather large gap, now attributes it at least in part to the use of a substantially different set of comparable companies to determine our price range as compared to the comparable companies utilized in our valuation report. Specifically, the comparable company analysis used to determine our anticipated offering price range focused more on Internet businesses that have similar rates of growth as we do, rather than smaller companies that do not share these characteristics.

That is to say, LinkedIn is either A) using actual comparable companies now after previously choosing dogs to justify its underpriced stock option grants, or B) using hyped-up comparisons now in order to justify the bubbly market-will-bear price. Which do you prefer? A spokesman didn't immediately return an email seeking comment.

In any case, there is one characteristic that practically all IPO companies share, and here LinkedIn is no exception: A desire to enrich insiders at the expense of public offering buyers. Be very careful indeed before you accept the invitation to join the LinkedIn investor club.

Filed under: Colin Barr, Street Sweep, Term Sheet

U.K. inflation and the limits of austerity

2011-05-20T15:46:23Z

Think you've got stagflation? Check out the U.K.

Inflation hit 4.5% in April, the government said Tuesday, up from 4% in March. Year-over-year price increases are on their way to 5% this summer, according to official forecasts.

Another unfriendly trend

Yet there is no rush at the Bank of England to raise interest rates, with the economy spinning its wheels. The U.K. economy contracted in the fourth quarter and barely expanded in the first, as the effects of the government's belt-tightening hammered spending and pushed up prices via higher taxes.

"It is now clear that underlying activity growth slowed markedly around the turn of the year," BoE governor Mervyn King said last week. "Looking through the volatility associated with heavy snow last December, the level of output appears to have been broadly flat over the past two quarters, and remains about 4% below its peak prior to the crisis."

So for now U.K. consumers, like their counterparts here and for that matter around the debt-soaked Western economies, are feeling the sting of higher prices without any offset from a hiring boom or surging wages. The message, in the age of austerity, is get used to it.

That's not to say there isn't a bit of relief in sight. Oil prices have come down over the past month and with the global growth outlook weakening, that may well continue.

"With commodity prices down almost 9% from their peak earlier this year and oil prices continuing to slide, it is therefore very likely that inflation could fall faster than the Bank of England expects later this year," says Markit economist Chris Williamson.

But the bigger problem is that with wages weak (see U.K. wage chart, right) and jobs not exactly growing on trees, everyone's standard of living is getting squeezed – unless they work at a too big to fail bank, that is.

Financial bubbles, we now learn, are like the old Fram oil filter ads: you can pay now or later. Looking around the Western world lately, it's pretty clear we're going to be paying for our past sins for a long time.

Filed under: Colin Barr, Street Sweep, Term Sheet

Buffett reaches for Mastercard

2011-05-20T15:46:23Z

Flashing a little plastic can come in handy even if you're a billionaire.

So it is with Warren Buffett, whose Berkshire Hathaway (BRKA) spent $54 million in the first quarter buying shares of the No. 2 U.S. card payment-network operator, Mastercard (MA). The purchase could mark the Berkshire stock-buying debut of Todd Combs, the company's first new portfolio manager in years.

A momentous occasion?

Berkshire bought 216,000 shares of Mastercard at an average price of around $252 apiece, the company said Monday in a Securities and Exchange Commission filing.

Buffett has made a mistake or two in the credit card business, as he noted in last year's annual report. He once tried to offer a Geico credit card in a debacle that cost Berkshire $50 million, all told.

But so far, so good on this wager: Mastercard shares, up 31% over the past year (see chart, right), closed at $279 Monday before advancing to $281 in after-hours trading. That means Berkshire is up almost $6 million on its modest Mastercard bet.

The market rally has lifted the value of the rest of the portfolio as well. Berkshire's listed stocks were valued $53.6 billion at March 31, the company said, up $1 billion from Dec. 31.

The Mastercard purchase is the only new stock that appears in the quarterly listing of Berkshire's holdings. None of the company's other stock positions, led by big stakes in giant companies such as Coca-Cola (KO) and Procter & Gamble (PG), changed materially between year-end and March 31.

That marks a change from the previous quarterly report, which showed numerous changes as Geico investment chief Lou Simpson sold shares ahead of his retirement.

Buffett watchers have been wondering when the influence of Berkshire's new portfolio manager, Combs, would start showing up in these quarterly reports. Monday's filing may offer a glimpse, but it offers few clues as to Combs' style. Those will have to come over time.

Filed under: Colin Barr, Street Sweep

Crisis shoves IMF into real world

2011-05-20T15:46:24Z

Welcome to the post-crisis era, International Monetary Fund.

The IMF's chief, Dominique Strauss-Kahn of France, was arraigned and jailed Monday in New York on charges he tried to rape a hotel maid. He is expected to resign soon. Guys who can't get bail aren't much use when it comes to bailing out others, after all, and propping up debt-soaked states like Greece, Ireland and Portugal is what the IMF does nowadays.

What's French for disgraced?

That said, if you're waiting for Strauss-Kahn's fall to throw a wrench into Europe's extend-and-pretend machine, you're probably going to be waiting a long time.

Bailout decisions "are ultimately a European political question," says Jacob Funk Kirkegaard of the Peterson Institute for International Economics. "The working relationship between those countries and the IMF is so entrenched at this point that it's hard to imagine this causing much more than a hiccup."

The bigger impact of Saturday's alleged incident lies in the shift of economic leadership from the debt-soaked West to the emerging East – an accelerating trend that is almost certain to manifest itself in who gets chosen to pick up the pieces left by Strauss-Kahn.

The head of the IMF traditionally comes from Europe, just as the head of the World Bank has hailed from the United States. But the developing countries whose expansion now accounts for the lion's share of economic growth have been chafed by their exclusion from those roles -- and this weekend's events are going to make upholding those traditions, such as they are, that much more difficult.

"Only a truly exceptional European candidate can have the credibility to replace Strauss-Kahn," says Kirkegaard. "The changes in the world economy mean the IMF needs to be truly global, and that has implications for who takes over next."

He views the sole plausible European candidate as Christine Lagarde, the French finance minister. She has "unique qualifications," including potentially being the first woman in an office that up till now has been held only by men.

But developing countries led by China, India and Brazil now have an opportunity, if they can settle on a suitable nominee, to wrest leadership from the West.

Kirkegaard says the top IMF candidates from the developing world include Tharman Shanmugaratnam, who is Singapore's finance minister, Kemal Dervis, a Turk who is at the Brookings Institution, and Augustin Carstens, who runs the Bank of Mexico.

"Of course, you have the question if a candidate backed by China would ever be acceptable toIndia, and vice versa," says Kirkegaard. "The onus is on them to find someone they can unite behind."

The IMF chief's job isn't the only one that's going to be open. The No. 2 post at the fund, currently held by American John Lipsky, will be up for grabs in August, after Lipsky departs, and the World Bank chairmanship held now by American Robert Zoellick will soon open up as well.

The internationalization of international finance institutions is inevitable, of course. If Westerners are expecting Brazil and China to pick up the slack for our weak economies, we will have to give up something in return.

Now the question is whether the emerging countries handle this opportunity better than they dealt with the commodity price surge that started last fall. Brazil and especially China had a huge role in that affair – yet they unsportingly chose to point the finger at Ben Bernanke.

That sounds more like the nonsense you hear out of Congress than the actions of leaders ready to take a whirl at the helm of the global economy. With any luck they will do better this time.

Filed under: Colin Barr, Street Sweep, Term Sheet

China's Treasury holdings: $1.14 trillion

2011-05-20T15:46:24Z

China's holdings of U.S. government debt inched lower for the fifth straight month.

But America's biggest foreign creditor continued to hold $1.14 trillion of Treasury securities through official channels as of March – 26% more than Japan, the second-biggest lender to the United States.

And with China struggling with its own economic ills, such as slowing growth and persistent inflation, the idea of China dumping its dollar holdings seems more remote than ever -- even as the U.S. hits the debt ceiling, taking the world's biggest bond market into strange territory.

The latest report on the major foreign holders of U.S. debt comes as economists are starting to question the strength of the economic recovery. Those worries tend to boost demand for government bonds, as investors trade out of riskier assets such as stocks and commodities.

All told, foreigners bought a net $24 billion of U.S. securities in March.

At the same time the United States is bumping up against its debt ceiling, a fact that Republicans in Congress are using to push the Obama administration to agree to spending cuts. The political impasse could lead to a technical default on U.S. debt, though that is far from certain and there is no sign the markets are nervous about the same.

The 10-year Treasury recently yielded 3.18%, down from 3.58% in March before economic data turned sour. The world may eventually flee the dollar, but first it will have to have an alternative -- something that isn't even on the horizon right now.

Filed under: Colin Barr, Street Sweep