But cheaper

Guambat felt, in his prior life and career as a student, that being in some classes was like being in prison.

Yes, but cheaper:

Vermont tops list of states spending more on prison than college

Clones and C-Section babies need not apply

McCain's birthplace in Panama Canal Zone raises eligibility questions

And that language about territories is also a bit concerning. Looks like Baby Bat and That Son of a Guambat ain't gonna be President.

(Sigh) Guambat had such high hopes.

Bernanke's Fed carves rate policy from boomerang tree

Fed Sees Rate Low `for a Time,' Then Chance of `Rapid' Reversal, By Scott Lanman

Federal Reserve officials signaled they are prepared to quickly reverse last month's interest-rate cuts after concluding that borrowing costs need to be kept low for now. They also called inflation "disappointing," and some foresaw raising rates, possibly at a "rapid" pace once the economy recovers.

The threat goes beyond remarks by Chairman Ben S. Bernanke, who last week warned that policy will have to be "calibrated" over the next year to meet both inflation and growth objectives.

Bernanke and his colleagues are trying to avert the first recession since 2001. At the Jan. 29-30 meeting, Fed officials cut their 2008 forecasts for economic growth a third time, by about a half percentage point, and raised unemployment projections, according to the minutes.

At the same time, inflation is accelerating, spurred by higher energy and commodity costs, and officials are concerned about the public's perception of price pressures. "Participants agreed that continued stability of inflation expectations was essential," the minutes said.

"The central bank needs to monitor credit spreads and other incoming data for signs of financial market recovery and should be prepared to take back the insurance once the recovery becomes clearly established," Fed Governor Frederic Mishkin said in a Feb. 15 speech.

"When the time comes, when it's appropriate, we have to move in a timely way," San Francisco Fed President Janet Yellen said Feb. 12. Fed officials will be "thinking" about the last series of rate increases in deciding whether a faster pace would be appropriate, she said.

The reference to a "rapid" change in policy means a change from the "gradualist" approach of 2004 to 2006, when the Fed raised rates in quarter-point steps at 17 straight meetings, [chief fixed-income economist at Morgan Stanley, David Greenlaw] said.

Prepare to reverse engines full and get us out of here, Mr. Sulu.





Maybe the Fed can use some of this stuff.

//

Is Northern Rock partly Granite?

Ah, the (mostly political) trouble you get into when first you try to nationalise a bank (financial troubles don't just disappear, either).

(Guambat has recently talked about the propensity of some to want to nationalize debts, which doesn't impress this stumpy old creature.)

Apart from ideology and idiots, the practical problem of nationalising, or privatizing for that matter, is the financial complexity of modern banking. The bank is no longer that building downtown with the big vault. It's now a web of visible and invisible on and off relationships, onshore and off, on balance sheet and off, and so on and on.

As we learned from the likes of Enron, some off balance sheet "vehicles" are there to hide away and hive off profits. But not all these vehicles are such delightful SUVs. Some are SIVs that leak like seives.

So since Enron we learn we have to discriminate because some off balance sheet off shore vehicles are beneficial and some are not so (and, of course, that begs the question, beneficial to whom ?-- but not today).

Take Northern Rock, as the Brits have now done. It "has" (or does it?) an offshore off balance sheet vehicle thingy called Granite. It's really quite a curious set-up.

You see, Granite was set up rather uncharitably to be a charitable trust cover for Northern Rock's lending expansion:

The Granite charitable trust was set up by Northern Rock in 1999 to raise cash for Down's Syndrome North East Association.

And, we're told, all the other kids do it too:

Granite is a company set up in 1999 by Northern Rock in the offshore tax haven of Jersey. Its technical name is a special purpose vehicle.

Many other banks have these vehicles, including Halifax, Bank of Scotland and Barclays. It is particularly common in the US, where almost all mortgages are held within special-purpose vehicles such as Granite. Northern Rock has two other offshore companies, called Dollarite, which holds some of the loans that the Rock has sold to businesses, and Whinstone, a much smaller vehicle.

So what's the deal here? Well, the government's plan to nationalize/nationalise Northern Rock does not extend to Granite, and some politicians are trying cynically or otherwise to discover and decide if that is good or bad for their constituent taxpaying voters.

Some say it is a case of nationalising the rubbish bits and asset stripping off the good bits.

Others more schooled in real finance than real politik debate that assertion.

If you feel like killing yourself, you can try to follow the various bouncing balls in this saga here.

The problem, as is so often the case in this sound bite era, is that serious errors can occur from failure to pay tedious attention to the brouhaha, as FT Alphaville's Sam Jones is so adept at illustrating. Sam's summation:

Nationalising Granite -as some are now calling for - would be both pointless, ridiculously complicated and utterly unnecessary, if not impossible to do.... The taxpayer, in other words, doesn’t have much to fear from Granite.

You need to read his whole explanation to put that in context, but it is worth doing, particularly if you've made it this far down the page anyway.


APOLOGIES, NIKKIE, not Ikkie; Guambat's fingers don't always listen to his head.

Goldilocks woke up

Our Economic Dilemma By MARTIN FELDSTEIN

[T]he subprime mortgage crisis demonstrated that financial risk of all types had been greatly underpriced, that the market prices of complex financial assets overstated their true values, and that the credit scores provided by rating agencies are not to be trusted. [Yeah, well, duh.]

[P]ast recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation.

In contrast, the real interest rate in 2006 and 2007 stayed at a relatively low level of less than 3%. A key cause of the present slowdown and potential recession was not a tightening of monetary policy but the bursting of the house-price bubble after six years of exceptionally rapid house-price increases. [And exceptionally lax Fed policy.]

[T]he principle cause for concern today is the paralysis of the credit markets. Credit is always key to the expansion of the economy. The collapse of confidence in credit markets is now preventing that necessary extension of credit. [So lower rates won't cure it.]

Securitization, leveraged buyouts and credit insurance have also atrophied. [Plum wore theyselves out from excess, Guambat reckons.]

The lack of confidence in asset prices also translates into a lack of confidence in the creditworthiness of other financial institutions

[F]inancial institutions do not even have confidence in the value of their own capital

It is not clear what can bring back the confidence

Some analysts suggest that confidence would return if the financial institutions declare the true market value of their assets by restating balance sheets at the depressed prices at which they could be liquidated today. But this is not a practical solution, since many complex securities are no longer trading in the market. Forcing an actual sale of these securities at fire-sale prices in order to establish market values could also create unnecessary bankruptcies that would further impede credit flows.

[This is exactly what Guambat tried to tell his broker when the broker insisted on more margin. Why does the argument sound so reasonable when it is the broker/banker making the argument than when it is the wretched little guy??]

There is plenty of blame to go around for the current situation. The Federal Reserve bears much of the responsibility, because of its failure to provide the appropriate supervisory oversight for the major money center banks.

The Fed's bank examinations are supposed to assess the adequacy of each bank's capital and the quality of its assets. The Fed declared that the banks had adequate capital because it gave far too little weight to their massive off balance-sheet positions -- the structured investment vehicles (SIVs), conduits and credit line obligations -- that the banks have now been forced to bring onto their balance sheets. Examiners also overstated the quality of banks' assets, failing to allow for the potential bursting of the house price bubble.

The implication of this for Fed supervision policy is clear. The way out of the current crisis of confidence is not. We can only hope that those who predict nothing worse than a temporary slowdown are correct.

Telecommie prevented from investing in US network security firm

The parties:

Huawei Technologies -- a telecom with strong ties to the Chinese government

3Com, based in Marlborough, Mass., which supplies network security services to the U.S. Defense Department.

Bain Capital Partners LLC, a US private equity firm

CFIUS (Committee on Foreign Investment in the U.S.), an agency led by the Treasury Department that can recommend that the president block foreign acquisitions on national-security grounds; an organization founded in 1975 by President Ford in response to public furor over Arab oil money

The deal: Bain would pay $2.2 to buy out 3Com. Huawei would pay (how much?) to buy out 20% of Bain. Huawei was crucial to Bain securing 3Com; the deal simply would not make since without the telecommie commitment. Why?

NO DEAL: The Pentagon believes that hackers in China conducted a massive cyber attack on its systems last year. 3Com Corp. said it couldn't reach an agreement with CFIUS on national security issues. Bain said last week it offered the federal government several concessions to get national security approval. Bain and 3Com have told federal officials that they would not give Huawei any operational control or ability to make decisions for 3Com if the deal goes through.

The bane in the spin: "Some industry groups worry free-trade efforts will be worn down by growing protectionist fears in many sectors of the economy."

The source: A WALL STREET JOURNAL ONLINE NEWS ROUNDUP

KKRedit KKRunch KKRimps KKR

Kohlberg Kravis Roberts is one of the venerable and survivable buy-out firms. But even it is not immune from the credit crunch.

An offshoot, KKR Financial Holdings, has "delayed repayment of billions of dollars of commercial paper – due Friday - for the second time and begun a new round of restructuring talks."

FT Alphaville looks at KKRFH's SEC filing "disclosing" the event and says,

Talk about obfuscation.

What we think it means is: “The bailiffs are coming round - either in two weeks time or maybe tomorrow.”

Will Kohlberg Kravis Roberts, the buyout house that floated this listed structured investment vehicle, now bail KFH out as it did last summer?

Back in the summer KFH had more than $5bn of mortgages financed by short term commercial paper. Since then that seems to have mutated into a $7.6bn portfolio of corporate debt. (Yes, after the residential property blow up it moved into leveraged loans.) We can assume that unwinding all that on a fire sale basis will hurt - and yet KFH was busy declaring a dividend (of 50 cents) to shareholders just three weeks ago.

What’s even odder is that KFN made no mention of the fact that its finances were seriously gummed up when releasing year-end figures on January 28.

Clearly, we must be missing something.

With apologies to FT Alphaville. Not only did Guambat related most of their post, he also was "inspired" by their story headline. Guambat hopes they chalk it up to the sincerest form of flattery.

UK hiding behind Goldman??

Andrew Hill opines in the Financial Times that Goldman has entered into "the line of fire" aimed at the British Government over its decision to nationalise Northern Rock's debts.

It used to be the case that the UK authorities’ own authority was such that they didn’t need to lean on a private-sector institution for support, at least in public.

Under the circumstances, the imprimatur of one of the dwindling band of global financial firms not to have found subprime bodies in its basement counts for more than that of the British establishment.

The investment bank doesn’t “do” politics.

But the truth is that when a G7 government asks for help, it is hard for a bulge-bracket bank to turn it down – almost irrespective of the consequences.

Doesn't "do" politics??!! Oh, puhleeze don't throw them in that briar patch. (For Brits and others, allude to Uncle Remus' tale of Brer Rabbit and the Briar Patch.)

He obviously hasn't read Goldie as political hedge fund.

(But then, not many other people have, either; Guambat only does this for his own amusement, which, obviously, doesn't require much.)

Fast money (really, really fast money) is transforming Wall Street

Guambat once allowed as how it appeared to him that the market

is becoming dominated by big, lightning quick money.

Oh, the Big Boys have always had a major impact, and in that regard there is nothing new. They've always enjoyed their power to push the market this way or that. They've always enjoyed a clubiness that allowed for information to be shared in ways that didn't quite pass the "insider trading" bright lines. But they usually bought stuff to own it, to manage it, to work it, to put it in thieir trophy room.

But these new guys are not just big bullies; they're bold, cold Matrix-like machines.

[The market now] is a streak of cyberdata, a stateless, motherless virus hellbent to ambush, arbitrage and retreat faster than a ninja.

And they are everywhere, in to everything. Their bytes permeate every conceivable market, like a monstrous whale sieving the nutrients and little, bottom-of-the-food-chain investors and small players from the oceans of cash that trade the world's goods.

They derive their gains from diverse derivatives of incalculable numbers and varieties, trading the shadows of what used to be a currency or a commodity or a stock or a bond, but now come under the most obtuse and arcane of names that only financial rocket scientists can understand.

Their trade is in ideas and concepts and notions and algorithms, not things and companies.

Bloomberg is putting some numbers on the hypothesis, showing the scope of the dealings are even way beyond Guambat's wildest dreams:

Equity Trades Defy Economy as Wall Street Transformers Abound, By Edgar Ortega

The biggest surprise on Wall Street this year is proving to be the record $16.3 trillion of shares traded in the U.S. as stocks show no sign of rebounding from the first bear market since 2002 and the economy teeters on the brink of a recession.

Average daily trading on the London Stock Exchange in December and January was 87 percent higher than a year earlier. Records were also set last month on German exchanges and NYSE Euronext's four European bourses, where 80 percent more trades were completed than a year earlier.

The increase marks a break from history since trading has declined in all but one of the last six bear markets for U.S. stocks.

A major difference now is the proliferation of hedge funds seeking to profit from swings in stock prices, according to Duncan Niederauer, who worked at Goldman for 22 years before being named chief executive officer of NYSE Euronext last year. Hedge fund assets have swelled to $1.87 trillion, almost four times more than in 2000, according to Chicago-based Hedge Fund Research Inc.

Hedge funds are private, largely unregulated pools of capital that use a wider range of trading strategies than most mutual funds, including betting on a decline in stock prices and using derivatives. In total, they account for about a quarter of trading in the U.S. and generate $3.2 billion in commissions

Citadel Investment Group LLC -- Kenneth Griffin's Chicago- based hedge fund named to suggest a stronghold in volatile markets -- uses mathematical models and advanced computer systems to make investments that translate into about 5 percent of U.S. equity trading.

D.E. Shaw & Co., which oversees $35 billion, relies on automated, 24-hour-a-day strategies that exploit shifts in asset prices around the world. The New York- based fund accounts for between 1 percent and 2 percent of trading at the NYSE.

Like the giant, shape-shifting robots featured last year in "Transformers," the movie from executive producer Steven Spielberg, the electronic trading systems tackle a blizzard of tasks in fractions of a second.

Citigroup Inc.'s Automated Trading Desk tries to predict prices for 8,000 stocks 30 seconds into the future to give the largest U.S. bank an edge on rivals.

Credit Suisse Group, Switzerland's second-biggest bank, expanded its rapid-fire algorithmic trading programs to more than 30 countries and almost doubled its equity revenue over two years to 7.75 billion Swiss francs ($7.03 billion).

"Times of extreme volatility tend to favor the stronger players, who have the technology and balance sheet."

So do all other times, Guambat reckons.

Some folks would consider it a steel

Greed is good, but ...

Rio says 65% price rise is not enough

The percentage gain was the second largest on record and at the high end of market predictions, which had already risen several times in recent months due to tight supply.

But Rio, under threat of a takeover by BHP Billiton, last night said it planned to seek an additional freight premium, because it is cheaper to ship iron ore from Australia to Asia than from Brazil to Asia.

In a statement, Rio said it intended to seek at least the 71 per cent increase Vale would receive for its premium Carajas ore, which is of a higher grade than Rio and BHP's Pilbara products.

Booming minerals prices will flood the Australian economy with billions of extra dollars in export earnings this year, making it more difficult for the Reserve Bank to cool growth and increasing pressure on interest rates.

Coincidentally, Malcom Maiden played along with the pun.

Minutes of the Reserve Bank board's meeting on February 5 released today will further steel the Australian market for another interest rate rise.

the minutes reveal that in its discussion, the board noted "that a good case could be made for a larger move" - partly because the rise in inflation that had already occurred was almost certainly embedding expectations that inflation was accelerating: expectations that could in turn induce companies to push for price increases, and workers to push for wages increases.

UK taxpayers pick up Northern Rock's pebbles

I've built walls,
A fortress deep and mighty,
That none may penetrate.
I have no need of friendship; friendship causes pain.
Its laughter and its loving I disdain.
I am a rock,
I am an island.

And a rock feels no pain;
And an island never cries.

Simon and Garfunkel -

The jolly olds in the merry isles of Britain have now purchased the failed Northern Bank.

Yep, just as Guambat feared, they nationalised the bank, darling.

Alistair Darling nationalises Northern Rock

Timeline of the Northern Rock crisis (First entry: "July 25, 2007: Northern Rock issues upbeat trading statement. The outlook for business, it says, is "very positive".)

Has the nationalisation of Northern Rock damaged Britain's reputation?

Nationalising Northern Rock was the right move

Northern Rock: prepare for another Alistair Darling cockup

Northern Rock shareholders wait on compensation

Now the story will get very interesting: His master's voice

Guilty plea in offshore shell game

The Refco tale was first thrown into the Stew back in 2005.

It involved some of the biggest and brightest finance wizzes on both sides of the Atlantic pond, a Bermuda backdrop, and financial entanglements that wormed into a staid old German bank, that ultimately, like Northern Rock Bank in England, led to taxpayers bailing out the bank and picking up the tab for Refco's losses.

The most recent chapter in the drama finds the former Refco CEO crying in his fear as he pleads guilty to a bit of dastardly dalliance in the finances of the company, which led ultimately to the then fourth largest bankruptcy in US history.

Former Refco CEO pleads guilty in NY securities fraud case

Crying as he faced a judge, Refco Inc.'s former chief executive said he knew he was wrong to keep quiet about big losses at what was once one of the world's largest commodities brokerages.

"I know I was wrong. I deeply regret it," Phillip R. Bennett, a British citizen, said as he pleaded guilty Friday to conspiracy and fraud charges that carry a possible prison term of more than 300 years.

"I knew failing to disclose these filings was wrong," Bennett said.

Bennett declined to comment as he left court. His lawyer, Gary Naftalis, said: "Mr. Bennett has candidly acknowledged his involvement in the matter. He was forthcoming and candid and wants to put this matter behind him."

It wasn't always thus. When the investigation began Bennett steadfastly refused to acknowledge any wrongdoing.

According to Reuters and the FT,

Bennett had been scheduled to go on trial in March, along with former chief financial officer Robert Trosten and former president Tone Grant, in a case that drew comparisons to the furore over a massive accounting fraud that drove giant telecommunications company WorldCom into bankruptcy.

The 20-count indictment charged Bennett with conspiracy, securities fraud, bank fraud, wire fraud, false filing with the US Securities and Exchange Commission, material misstatements to auditors and money laundering.

US District Judge Naomi Buchwald, who accepted Bennett's plea, set a sentencing hearing for May 20. Bennett, who is a British citizen, faces a maximum of 315 years in prison and deportation.

The case is far from closed. As Bloomberg report last week,

Five former Refco Inc. executives were co-conspirators in a swindle that cheated investors in the bankrupt futures brokerage out of $2.4 billion, U.S. prosecutors said.

William Sexton, Joseph Murphy, Stephen Dispenza, Philip Silverman and Thomas Hackl were among 14 people identified in a Feb. 8 court filing in New York. Designating them unindicted co- conspirators allows prosecutors to introduce statements into evidence that might otherwise be excluded, said Henry Putzel, a lawyer for Dispenza.

"It's not a judgment by anyone with respect to guilt or innocence," Putzel said in an interview. Dispenza, who was chief operating officer of the Refco Capital Markets currency- trading unit, "absolutely asserts that he engaged in no misconduct," Putzel said.

Dispenza now heads FX Clear LLC, part of futures and options broker MF Global Ltd., which bought some of Refco assets. Diana DeSocio, a spokeswoman for MF Global, declined to comment.

Prosecutors say Bennett, who was also chief executive officer, Trosten and Grant hid losses by making them appear as debt owed to Refco by a holding company controlled by Bennett. All three men have pleaded innocent.

In the civil lawsuit pending in Manhattan federal court, investors say Sexton, Murphy and Silverman approved the firm's deceptive October 2004 bond registration statement and its initial public offering registration statement. Also named as defendants are auditors and banks including Chicago-based Grant Thornton LLP and units of Credit Suisse Group and Deutsche Bank AG. They're not named as conspirators in the government filing.

According to the indictment, Bennett, Trosten and Grant lied about Refco's losses, moved operating expenses off the firm's books, and padded Refco's revenue.

Through their years-long fraud, the men were able to obtain lines of credit, sell notes, gain financing and take the company public in August 2005, prosecutors said. Among the victims was Boston-based buyout firm Thomas H. Lee Partners, which purchased a $453 million stake in Refco in 2004, prosecutors said. The case is U.S. v. Bennett, 05-cr-1192, U.S. District Court, Southern District of New York (Manhattan).

FOLLOW THROUGH: Naked Shorts has some deep data on other personalities in the Refco action, and USA Today has this old story on some of its founding fathers and the Washington Post has an old story linking said fathers with controversy regarding Hillary Clinton. As Guambat said before, "someday it will be a very good film".

Guns don't kill ....

NYT:

In a stark, puzzling contrast to the usual image of a rampaging gunman, Mr. Kazmierczak, 27, was described Friday as a successful student — “revered,” the authorities said, by his professors — who had served as a teaching assistant and received a dean’s award as an undergraduate here at Northern Illinois University, where he returned Thursday, killing himself and five students and wounding 16 others.

The gunman bought his weapons legally from a Champaign gun dealer, officials said. He also bought some accessories [ammunition] from the popular Internet dealer who sold a gun to the gunman in the Virginia Tech massacre last year.

ABC News:

The Remington shotgun and the Glock 9 mm were purchased Feb. 9, 2008. The Hi Point 380 was purchased Dec. 30, 2007 and the SIG Sauer 9 mm was purchased Aug. 6, 2007 from the same gun dealer.

Authorities were still checking where he obtained two other pistols, a 9 mm Sig Sauer and a Hi Point 380.

He brought the shotgun in a guitar case, police said, and hid the [handguns] underneath his jacket.

D.C. Gun Law Under Fire, Fox News, Monday, December 02, 2002

"If you look at the guns used in crime in the District and trace them to their origin, how many of those guns came from D.C.? Virtually none of them, they all came from Virginia and other states with much less restrictive gun laws than D.C. has,"

But Levy said that the only people being denied guns are law-abiding citizens. And he argues that the numbers skew in favor of those using them lawfully.

"All of the evidence that has been introduced suggests that guns are used about 2 million times a year for defensive purposes. There are only 500,000 gun-related acts of violence a year. So on a four-to-one basis guns are more widely used for self-defense than they are for committing acts of violence. And that suggests that if we had more guns in the hands of law-abiding citizens we would have less crime in D.C.," he said

House Votes to Repeal D.C. Gun Limits, September 30, 2004

The U.S. House of Representatives overwhelmingly approved a bill yesterday repealing most of the District's gun laws, in a vote that handed an election-season victory to gun rights groups and was denounced by the city's leaders as a historic violation of home rule.

By a vote of 250 to 171, the House passed the D.C. Personal Protection Act, which would end the District's 1976 ban on handguns and semiautomatic weapons, roll back registration requirements for ammunition and decriminalize possession of unregistered weapons and possession of guns in homes or workplaces.

The bill also would prohibit the mayor and D.C. Council from enacting gun limits that exceed federal law or "discourage . . . the private ownership or use of firearms."

Bill supporters note that the D.C. homicide rate was 72 percent higher in 2001 than it was in 1976, while the national rate had dropped by 36 percent.

Opponents say that the D.C. rate is at a 20-year low and has fallen 55 percent since 1994.

In a sign of how the politics of gun control have changed in Congress, the vote was almost the opposite of a 1999 House attempt to repeal the District's gun laws, which failed 250 to 175. Thirty-four House members -- 24 Republicans and 10 Democrats -- who voted five years ago to preserve the city laws switched sides and co-sponsored Souder's bill.

Repealing the DC Gun Ban by Rep. Ron Paul, MD, Before the US House of Representatives, October 4, 2004

Mr. Speaker, I rise in support of HR 3193, the District of Columbia Personal Protection Act. I am a cosponsor of this legislation that ensures greater respect for the right to bear arms in Washington, D.C.....

The Case For Reforming The District of Columbia`s Gun Laws

D.C. Gun Case Will Affect All Americans,Thursday, February 14, 2008, By Col. Oliver North, FoxFan

the U.S. Supreme Court has a chance to both make our capital safer — and ensure that the Second Amendment to our Constitution is enshrined as an individual right for every law-abiding American.

the Department of Justice (DOJ), filed an egregiously weak amicus — friend of the court — brief in the case. The argument, submitted by U.S. Solicitor General Paul Clement, essentially urges the Supremes to waffle on the issue and send the case back to the lower courts.

So this militiaman walks into the Senate with a loaded gun...


DC's gun control law in Supreme Court's sights


etc.

//

Well booger me

Ground-dog day as woman pays $50,000 to clone dead pitbull

The South Korean stem cell scientists who produced Snuppy, a cloned Afghan hound, have received the world's first commercial order to clone a dog and are now preparing to recreate Booger, a pitbull terrier from California. It is an order they hope will lead to the production of as many as 500 born-again pets each year.

The price for cloning a dog is set to be $150,000, but because this is the first order, and because the woman agreed to allow the event to be publicised, she is only being charged $50,000.

It seems the woman will send bits of her booger to Korea where they will copy it and send a full-fledged booger back to her.

Isn't that how Japanese manufacturing got started post-WWII??

Cerberus to partners: Eat our humble pie

As the year 2006 drew to a close, a MarketWatcher opined

U.S. stock market shrinks by $600 billion [but] Fueled by LBOs and buybacks, contraction may bode well for 2007:

2006 was the year of the incredible shrinking stock market, when a record amount of shares left public markets amid a flurry of leveraged buyouts and share repurchases. If the supply of equities continues to dwindle and retail investors also rediscover their former penchant for U.S. stock mutual funds, it could mean the market in 2007 would get a significant push higher, some strategists said.

Still, others are dubious about the benefits of the recent LBO boom and warned that an unexpected spike in interest rates next year could derail stock markets.

The U.S. stock market is on course for its best year since 2003, with the Standard & Poor's 500 Index up more than 13% through Dec. 28. The benchmark has climbed for four straight years and recently hit six-year highs.

For some observers, this bull market can be partly explained by the fundamentals of supply and demand: The supply, or number of shares outstanding, has declined while demand, in the form of investor optimism, has stabilized and recently begun to increase. [The ceteris paribus assumption is that demand will continue.]

"The more you shrink it, the more it has the potential to rise, all other things being equal," said Rod Smyth, chief investment strategist with Wachovia Securities. "If you're shrinking the market with buyouts, you're putting money back into people's pockets, which in a bull market they're likely to keep re-investing in the market."

In 2006, a pair of record-setting factors took a major chunk of supply off the market. More than $400 billion worth of new cash takeovers have been announced this year, while companies bought back in excess of $600 billion worth of their own stock, both records, according to estimates compiled by TrimTabs Investment Research, a Santa Rosa, Calif.-based firm that tracks market trends for institutions.

One of those monster take-overs was the private equity purchase by Cerberus (who also bought out Chrysler) of GMAC, as reported by BusinessWeek:

Cerberus To KKR: Eat Our Dust

It was an epic showdown between legendary buyout king Henry R. Kravis and New Age hedge fund manager Stephen A. Feinberg -- and Feinberg won. On Apr. 3, General Motors Corp. (GM ) announced that it would get about $14 billion over the next three years for selling a 51% stake of its highly profitable [sic] GMAC finance division to a group led by Feinberg's firm, Cerberus Capital Management LP.

Ever since, Wall Street has been buzzing over how the 46-year-old Feinberg snapped up a huge financial-services company for little more than its book value from Kravis, age 62. Kravis may someday look wise for having turned his back on a deal heavily laden with risk. But losing to Cerberus has to sting.

A big battle between established buyout firms such as Kohlberg Kravis Roberts & Co. and scrappier hedge fund groups like Cerberus -- named after the three-headed dog in Greek mythology that guards the gates of Hades -- has been brewing for a while. In a 2004 speech to a few hundred private-equity investors and bankers, Kravis warned that hedge funds had little experience managing companies or "creating value."

Since then, Kravis has been forced to fend off Feinberg multiple times to buy companies. In 2005, a KKR group beat out Cerberus for troubled retailer Toys 'R' Us Inc. by paying $6.6 billion for it. In January, a Cerberus group picked up the grocery chain Alberston's Inc. (ABS ) that KKR had been eyeing.

The next round came when GM sold most of GMAC's commercial mortgage unit to a group led by KKR on Mar. 23. (GMAC sells auto financing, mortgages, and insurance.) Little more than a week later, Cerberus beat out KKR for the big kahuna -- a majority stake in GMAC itself. That means Cerberus is indirectly a part-owner of KKR's commercial mortgage business. Kravis may have to deal with Feinberg whether he likes it or not.

For Feinberg, snagging GMAC means much more than besting Kravis. He hopes the deal will propel Cerberus from a behind-the-scenes operator into a well-respected financial-services company. That's a big leap for a private investment firm that started with a grubstake of $10 million in 1992. Cerberus now manages $18 billion in assets, excluding the GMAC deal (BW -- Oct. 3).

GM's advisers presented what were expected to be the final two bids for majority stakes in GMAC to the board. KKR, with Wachovia Corp. (WB ), had submitted a highly conditional letter and term sheet. By contrast, Cerberus, which had code-named the GMAC deal "Hercules," had marked up every section of a purchase agreement and had spent tens of millions of dollars for roughly 300 people to pore over 8,000 GMAC files and other documents.

Feinberg won the day in part by accepting risks that every major bank and marquee buyout firm that GM approached about the deal turned down. For starters, Cerberus will take control of more than $300 billion of leases, loans, mortgages, and insurance policies. The auto-related leases and loans could be a drag if GM's problems get worse. Feinberg also agreed to invest GMAC's aftertax earnings and dividends for five years, and not to break GMAC apart without GM's consent. In addition, he promised to continue to support loans to dealers and leases to buyers of GM autos for 10 years.

Nevertheless, Wall Street is agog over the unprecedented $6 billion check that Cerberus and some of its limited partners are writing.

Fast forward to January 22, 2008. Mr. Feinberg is writing to his investors. The letter is reproduced by the WSJ here and is must reading. Some excerpts below:

Dear Investors,

The last six months have been brutal for the credit markets. [Thus begins a "dog ate my homework" explanation.]

Banks were far to easy with credit for too long. Their aggressive lending practices have caused them to be stuck with large amounts of loans on their balance sheets that they cannot sell. [This from a hedgie- cum- privateer!]

Nobody, no matter how big, has been unscathed. UBS, Bear Stearns, Merrill Lynch, Morgan Stanley, and even Citigroup .... [Oh come on Mom, everyone's doing it. Well, jeez, Dad, everyone was doing it.]

The stock market has also declined sharply.

We do not know what will happen with the markets or the economy. We are not macroeconomists....

[N]ow is the time to raise cash.... We also expect to use some of the committed but uncalled capital to take advantage of possible buying opportunities....

Speaking of pain [oh, let's] brings us to United Rentals .... [W]e negotiated an exit arrangement that allowed us to walk away from the deal for any reason and incur a maximum exposure of $100 million dollars, a loss of 1/2 of 1 percent for [y]our funds.

[W]e will protect you even if we have to take a lot of grief in the process.

In general, we despise all the public attention we are getting. We do our best to avoid the spotlight but, unfortunately, when you do some large deals, such as Chrysler and GMAC, it is hard to avoid.

If any one, two or even three deals fail, fail, however, our people will feel awful and will find it unacceptable, but it will not hurt the funds terribly. Because Series Four is very diversified, its overall success does not depend on the future of GMAC, Chrysler, or any other single investment.

One the one hand we must have a thick skin, and on the other hand, we must keep our humility... because once you lose your humility you will collapse as a money manager. We must remain humble and also hungry.

We need to remain vigilant, humble .... Most of all, we must have humility....

We must also have a thick skin.

Management fees are expensed as incurred and tend to be heavily front-end loaded. [So, we'll tend to get ours before you get yours, especially if the markets tank.]

Sincerely,

//

If Bill was the first black president, will Hillary be the first chicana?

With Obama siphoning away from the Clinton Clan the black vote, Hillary is changing her colours:

Clintons Have Deep Roots With Hispanics

Clinton told ABC News' Kate Snow that she has deep roots in the Hispanic community.

"This is something that is not easily developed," she said. "You have to work on it. It is part of who I am, part how I live, part of the reason I have so many people working for me across Texas."

Clinton seeks to lure Valley's Hispanic voters

[L]abor contractor Sara Lopez was already wrapping reception tables in red, white and blue paper.

"We believe in her, this is Clinton country," said Lopez, who spent the last five years shuttling migrant workers to onion fields in New Mexico. "The Latino vote will make the difference for once in the history of the United States."

Support for Obama is spotty in the Valley, a region with very few black residents.

Hispanic vote crucial in Texas' Democratic primary

Former President Bill Clinton is so popular in South Texas that his photograph hangs in many Mexican restaurants, an honor often reserved for favorite local politicians or a portrait of Our Lady of Guadalupe, Mexico's patron saint.

Hillary Clinton boasts of her own ties to Texas Democrats, dating back to her work for the ill-fated George McGovern presidential campaign in 1972.

Clinton has support from U.S. Reps. Silvestre Reyes, Henry Cuellar, Ruben Hinojosa and Solomon Ortiz and former San Antonio Mayor Henry Cisneros — a former Clinton Cabinet member — and prominent Houston politician Carol Alvarado.

Latinos comprise 36 percent of Texas' population. By far, most are Mexican-American, some whose families have been in the country for hundreds of years. Twelve percent of the state's population is black.

Hola, Hillary

Hillary Rodham Clinton addressed an overflow crowd at the Richard M. Borchard Regional Fairgrounds with a populist speech that emphasized jobs and the economy, as well as her longstanding familiarity with South Texas.

"I know where South Texas is. I have been to South Texas," she said. "You will have a president who will work with you to improve the lives of the people of South Texas."

NY Hispanics Question Clinton Aide Exit

Two New York Hispanic leaders said they would be upset if Hillary Rodham Clinton's Hispanic campaign manager was replaced because of primary losses they believe should be blamed on former President Clinton and others.

Patti Solis Doyle, whose parents were Mexican immigrants, stepped down as Clinton's campaign manager this weekend as Clinton was losing five Democratic contests to Illinois Sen. Barack Obama. Clinton has said Doyle's decision was a personal response to a grueling campaign, not about job performance. She added that Solis Doyle would remain a senior adviser

Solis Doyle responded: "This my decision, my choice, my timing."

"I was really, really proud to be the first Hispanic woman to run a presidential campaign and particularly proud of the way Hispanics turned out and they turned out for Hillary," Solis Doyle added, "There was no pressure and while I'm sad not to have the role, I am so happy to be able to be home more with my kids."

Clinton may win Texas and lose it

for reasons that actually make sense if you dig deep enough, in Texas the Hispanic votes don't count as much as the black votes Obama can count on receiving in overwhelming numbers.

So, it's possible Hillary could whip Barack by eight to 10 points and yet split about even on Texas delegates.

Texas Democrats could even give Clinton more votes but give Obama more delegates.

In what can only be considered a historical irony, the state's two heavily African-American districts get at least 50 percent more delegates than the average senatorial district.

These are people who were counted as three-fifths of a person in the nation's original representational scheme.

The Houston senatorial district represented by state Sen. Rodney Ellis will send seven delegates to Denver.

By contrast, the district represented by Houston Sen. Mario Gallegos will send three. The same is true for Brownsville Sen. Eddie Lucio.

When it comes time to draw the lines at least once a decade, the last thing the party in control wants is districts that are evenly divided. So they try to pack as many members of the opposing party into as few districts as possible.

Should a senatorial district that is three-quarters Democrat get the same number of delegates as a district that is only one-quarter Democrat? Party rules quite reasonably say no. That would make each primary vote in the heavily Democratic district worth only a third as much as a vote in a heavily Republican district.

So, the number of delegates awarded to each district is determined by the number of votes cast in that district for governor in 2006 and president in 2004.

Simply put, Hispanics, who historically vote in smaller percentages than African-Americans, did not turn out for either John Kerry in 2004 or Chris Bell in 2006.

Clinton has been doing well among Hispanics, having received about 65 percent of the Hispanic vote in several important states on Super Tuesday.

But Obama has been doing even better among black voters. He not only has won 80 percent and more of their vote but also has significantly increased their turnout.

The result is that Obama is likely to carry the two districts represented by black senators (Ellis and Royce West of Dallas) by larger margins than Clinton will carry Hispanic senatorial districts.

it is not hard to imagine Clinton winning the popular vote in a tough Texas election, but actually losing ground in the delegate count.

After a close vote and recount, Clinton managed to squeek past Obama to win the New Mexico vote.

The candidates must play to their constituencies; that's what it's all about. But they will both have to play it very carefully and diplomatically to keep this primary race from turning into primarily a race race. Especially if the Democrats, as a united party, hope to replace the Republican party at the helm.

McCain-Obama Race Could Redraw Electoral Map

Mr. McCain might enter a race versus Mr. Obama with an advantage among Hispanic voters. During the primaries so far, Mr. McCain has done well with Hispanics, while Mr. Obama has not.

Guambat doesn't get to vote for President anyway, so has no dog in this fight. Any way you look at it, this election has all the makings for setting a record of some kind or other: oldest, woman or black. Guambat is just delighted that it won't be an evangelist. (It won't, will it??)

What's my bid for this billion?

The WSJ has a sad story about the Maher family. Father Maher worked hard and long for 50 years to build up a shipping and port business. But the author, Robert Frank, tells it better:

Their billion-dollar windfall was the fruit of a classic American success story -- more than 50 years spent on the gritty docks of New Jersey, battling unions, the mob and fierce competition to build a shipping-port empire. Maher Terminals, the company founded by their father, operates one of the biggest container ports on the East Coast.

The Maher fortune started in the early 1950s with Michael Maher, the son of an Irish immigrant in New York City's Queens borough, who worked as a longshoreman on the docks of Brooklyn and Manhattan to pay his way through law school.

In 2006, they began thinking about selling. Another era was dawning in the shipping business: Cash-rich global investors -- private-equity funds as well as some foreign-government-associated investment funds -- were on a shopping spree for ports, bidding up prices in the once-stodgy business as global trade boomed.

So when one of Deutsche Bank's investment units offered to buy the company for more than $1 billion, the Mahers agreed to sell. The deal closed in mid-July.

The two brothers handed much of it to Lehman Brothers Holdings Inc. with marching orders to make only the most conservative, cashlike investments. Within weeks, however, they had lost access to more than a quarter-billion dollars.

The Mahers rank among the earliest victims of "auction rate" securities, a once-obscure type of bond now sending shock waves through broad swaths of the U.S. economy. Auction-rate securities -- an unusual type of long-term bond that behaves like a short-term bond -- have become a keystone of modern finance. They are routinely used to fund everything from college student-loan programs to municipal road-and-bridge projects.

The market for auction-rate securities has dried up amid fears about fallout from the subprime-mortgage crisis. This week, New York's Port Authority saw the interest rate on some of its debt jump to 20% from 4.2% amid disruptions in this market.

The Mahers are demanding that Lehman buy back the securities at their original value, plus interest.

In a statement, Lehman said: "We cannot control the credit markets which have seen unprecedented dislocation, which unfortunately has affected most participants." The company says it believes it has "meritorious defenses" against the Mahers' claim.

Merrill Lynch & Co. recently bought back $13.9 million in debt securities that it sold to the city of Springfield, Mass.

There is much, much more to the story than outlined here and worth the read.

Movement grows to nationalize US bank debt

Worried Bankers Seek to Shift Risk to Uncle Sam (WSJ)

The banking industry, struggling to contain the fallout from the mortgage debacle, is urgently shopping proposals to Congress and the Bush administration that could shift some of the risk for troubled loans to the federal government.

Last fall, the government backed a plan by banks to rescue bank-affiliated funds that had invested in mortgage-backed securities, but it fell through. More recently, a hotline set up with Washington's support for troubled borrowers has helped only a small fraction of those in need.

Politicians and bankers are now abuzz with talk about broader ideas

Just a few months ago, such proposals would have been considered far-fetched, but these and other unorthodox ideas are gaining credibility.

Senior Treasury Department officials have been wary of proposals that could expose taxpayers to losses and bail out lenders, but they have been willing to entertain most ideas. Some congressional Republicans are becoming worried that as more bad news and data are released about the housing market, some proposals could expose taxpayers to severe losses.

The latest coordinated moves to have the US taxpayers take the hit from the bad debts created by Wall Street banks was flagged by Howard P. Milstein, the chairman and chief executive of New York Private Bank and Trust, a few days ago. See, More Wall Street socialism.

Guambat remains unimpressed.

PS: Naked Capitalism is also blogging about the "New Socialists"

We've often observed that the reason to keep the banking industry (and Wall Street, now that some firms are too big to fail) on a short leash is that it plays with the public's money: gains go to employees and shareholders but losses are socialized.

No one seems to be learning the lesson playing out before our very eyes from the bond insurers: guarantees can become very costly when entered into casually. The promises of various government sponsored enterprises, such as Fannie Mae and Freddie Mac, live in a dubious never-never land, where they are nominally private enterprises but everyone expects that if things got ugly and their mortgage guarantees were to look questionable, the GSEs would be supported by the Federal government.

James Hamilton, at the Fed's Jackson Hole conference, pointed out that Freddie and Fannie were undercapitalized and overextended; this was before their ceilings were raised to include jumbo mortgages. Now we are gong to add even worse credits to the burgeoning pile of government guaranteed paper.

When I was much younger, I took a business school course taught by Henry Cabot Lodge, Jr. He said that he could remember the day in 1968 when he realized that there were limits on what the US could do, that it could not simultaneously combat poverty, fight a ground war in Asia, and send a man to the moon.

It's 40 years later, and most of Washington seems unable to accept what Lodge saw back then, that America is no longer so powerful and economically dominant that it can have whatever it wants.

What is particularly disturbing about this latest salvage operation is that it involves no penalty to the firms that created this mess. Of course, that's one of the beauties of the originate and distribute model: there are so many parties in the food chain that it is hard to parse out culpability.

Private equity taxing credulity

There's a report in The Independent that private equity is saying it is responsible for tax "contributions" so great that it would be enough to "pay for every nurse and police officer in the country."

Fair dinkum.

Guambat hasn't seen the report and wouldn't know enough to parse it most likely anyway, but he remains dubious. For instance, the news story related as how "Private equity-backed companies have contributed £140bn in tax to the UK economy over the past five years".

Bearing in mind that these companies were existing and paying taxes before private equity bought them out, how much of that total amount would have been paid in any event? Indeed, were it not for off-shoring and off-balancesheeting and stripping jobs and assests, etc., how much more might have been paid?

In other words, even if this is an accurate gross figure, what did private equity do in and of itself to increase or decrease this lump sum? What is the net effect after adjusting for the costs of private equity? For instance, had private equity been taxed as the "equity" it says it is instead of the debt it uses and deducts to acquire the businesses and provide their dividends, would they have actually "contributed" more?

Guambat, being the silly old fool that he is, always has more stupid questions than bright answers.

See,

Private equity – who’s paying for their profits?

Private equity or private debt? Beware the Ides of March.

When private equity players are paying ‘less tax than a cleaning lady’, the question is: are we being taken to the cleaners?

Private equity tax rules examined

Restricting tax deductibility for private equity debt in the UK

Etc.

//

China's stake turning into a Bear hug

According to FT Alphaville according to Reuters, "Chinese brokerage CITIC Securities is looking to renegotiate the stake purchase it agreed with Bear [Stearns] back in October:"

the Chinese firm wants 9.9 per cent of Bear, rather than the 6 per cent originally agreed.

CITIC Securities is the brokerage arm of China CITIC, which is owned directly by China’s cabinet, the State Council.

See,
The very essence of corporate democracy and

China takes a stake in Australian banks

//

Living and dying by the sword

The Greeks couldn't write a better story of competing goods and gods, set in modern times, than the William Lerach tale. It's a class-ic, as it were, in which no one is spared the splattering mud.

Read this and this and this and this and this and this and this, etc.

In typical Greek fashion, its the little humans who get stomped on when gods do battle.

Credit Default Swamped

Bloomberg has reported that AIG, the world's largest insurer, has overvalued their credit default swaps meant to insure it against declines in its assets. It owes this bad mark to mark to market, the real world version of the mark to model virtual world of the credit melt-up phantasmagoria. (More on the story at MarketBeat.)

Trying to allay investor concerns, AIG's CEO Sullivan told everyone way back in December (2 months ago), no worries, she'll be right. But, the story reports, "The contracts lost about $4.88 billion in value in October and November according to the estimate in today's filing."

AIG produced the revised figures after its auditors, PwC, concluded that there was a “material weakness” in the way it valued its exposure.

The WSJ also kindly provided a link to an earlier story it ran in its Heard On The Street column on this same subject, back in August 2007:

The insurance giant did its best to reassure markets late last week that it wasn't going to get slammed by the crisis gripping mortgage and debt markets. Although AIG sees mortgage delinquencies rising, executives said during an earnings conference call that the bulk of its mortgage insurance and residential loans aren't at risk.

The company also said it didn't see problems related to a kind of insurance contract, or derivative, it has written against financial instruments that include some subprime debt. AIG based its all-clear signal for those derivatives on the fact that its internal models show that losses are extremely remote in the portions of the investment vehicles it's insuring. No likely losses means no reason to worry, the company reasoned.

Yet the company's valuation models seem to ignore the fact that those derivatives would likely take a haircut if sold in today's depressed market. "There's no way these aren't showing a loss," says Janet Tavakoli, president of Tavakoli Structured Finance Inc., a Chicago research firm. That's simply a market reality, she adds, that should be showing up in AIG's results.

"We disagree" with those questioning the company's valuation, said Elias Habayeb, chief financial officer for AIG Financial Services, a division of the insurer. "I believe we come up with our best estimate of the fair value [of these instruments] based on all the information available to us and that's reflected in our financial statements."

Stock analysts seem satisfied .... [They would say that, wouldn't they?]

As this develops, expect some kind of the "Paper Moon" defense that MBIA is trying to run with. The context for that was presaged in that Heard on the Street column:

Accounting experts don't fault AIG for using models to value the derivatives since there isn't a ready market for them.

The conflict over a slice of AIG's books and subprime exposure underscores a bigger question facing investors: Are companies and investment funds realistically pricing hard-to-value securities, or are they basing values on in-house models that reflect wishful thinking [i.e., the Paper Moon]?

AIG's Mr. Habayeb says the company records all its derivatives at fair, or market, values as per accounting rules. In the models it uses to derive this fair value, the company says it looks to the performance of the underlying assets, expected losses, credit ratings and interest rates as well as what's happening in the market.

Ms. Tavakoli, the research-firm president, argues that the drastic change in mortgage markets since April should gain greater weight in those estimates of value. And that, she says, should result in AIG showing some loss on the derivatives.

If that occurred, the loss would be taken as a charge to profit. The extent of any charge would be difficult to estimate. Even though it would likely be small compared to AIG's recent second-quarter net profit of nearly $4.3 billion.... [which, coincidentally, is slightly less than the mark to mark downs they took today, as mentioned above].

Barry Ritholtz is characterizing the whole "insurance" concept (of which the credit default swap is a part), as described by Bill Gross, as "Massive fraud on a widespread structural basis."

Free lunch program costs a lot more than advertised

Cost of Business Tax Cuts Underestimated (WSJ)

A round of business tax cuts in Congress's economic-stimulus package passed Thursday will cost nearly triple the official government estimate, tax experts said.

The tax breaks in the package will cost more than $22 billion over the next 11 years, or roughly $15 billion more than the government's long-term estimate of $7.5 billion.

The difference comes from the failure of the government to take into account the "time value of money"....

The largest business break in the package is called "accelerated depreciation,"....

In theory, the tax break provides an incentive to speed up business-equipment purchases, thus stimulating the economy.

Congress passed a nearly identical "bonus depreciation" tax break in 2002 that lasted for almost three years. most of the tax break went to companies that were planning to make purchases anyway.

Not just whistleblowing Dixie

Guambat recently posted about that monstrously large "settlement" that Merck coughed up to avoid testing in court its claims that it did nothing wrong in its sales of certain drugs to the government. See, Meanwhile, down on the pharm.

In that post, Guambat asked, where did all that money from the settlement go?

Well, it appears some of the money has gone to someone who blew the whistle on that little trade.

The WSJ reported, in Merck to Pay Over $650 Million To Settle Pricing Suits, that

H. Dean Steinke, a former Merck district sales manager for a region including Michigan and Wisconsin, filed a so-called whistleblower suit under the False Claims Act in U.S. District Court for the eastern district of Pennsylvania in 2000, which concluded with yesterday's settlement announced in Philadelphia. That suit alleged both pricing and kickback schemes detailed in the settlement. Mr. Steinke, who left Merck in 2001, filed a separate suit in Nevada in 2005. He will receive $44.7 million from the federal share of that settlement and $23.5 million from the states' share.

William St. John LaCourt filed the Louisiana suit in 1999, a False Claims Act case concerning Pepcid price discounts to hospitals. While his exact payout remains to be finalized by the court, it will likely range from $27 million to $32 million, with the portions from the federal and state governments subject to review, based on estimates from Dr. LaCourt's lawyer and Merck.

AP adds a bit more to this part of the story in Merck Whistleblower Wins $68M Award:

Steinke believed that Merck, as it introduced the much-anticipated painkiller Vioxx and tried to ward off competition for Zocor, an anti-cholesterol drug, had crossed the line when it came to inducements to physicians.

The government investigated his sealed lawsuit, which also alleged that Merck overcharged government health plans, under the Federal False Claims Act.

Prosecutors ultimately alleged that Merck paid physicians, hospitals and others excess fees to run supposed educational programs, from lunches to speaking engagements to visiting professorships, in hopes they would favor their products.

Prosecutors also accused Merck of giving doctors and hospitals steep volume-based discounts on Vioxx, Zocor and Pepcid, in the hope that patients would come to rely on them. The company failed to offer Medicare and other government agencies the same price, as required by law, they said.

"It's heroin-dealer economics. Your first shot of dope is free and then it's more expensive," said Pat Burns, a spokesman for the whistleblower group Taxpayers Against Fraud.

As part of the agreement, Merck denied any wrongdoing.

The US Government Accountability Office, in a detailed description of the False Claim Act and its basis and statistics, has said of the False Claims Act:

The False Claims Act (FCA) is one of the government’s primary weapons to fight fraud against the government. The Act, as amended in 1986, provides for penalties and triple damages for anyone who knowingly submits or causes the submission of false or fraudulent claims to the United States for government funds or property.

Under the FCA’s qui tam provisions, a person with evidence of fraud, also known as a whistle blower or relator, is authorized to file a case in federal court and sue, on behalf of the government, persons engaged in the fraud and to share in any money the government may recover.

The Department of Justice (DOJ) has the responsibility to decide on behalf of the government whether to join the whistle blower in prosecuting these cases.
From fiscal years 1987 through 2005, settlements and judgments for the federal government in FCA cases have exceeded $15 billion, of which $9.6 billion, or 64 percent, was for cases filed by whistle blowers under FCA’s qui tam provisions. The whistle blowers share of the qui tam settlements and judgments was over $1.6 billion during this period.

Non-profit corporations

Following prior posts of North Rock Bank in England and proposals to have the US government guarantee bank debts in the US (see, That's what I'm talkin' about), comes the latest hot goss on Chrysler.

In recent times recall that Mercerdes-Benz brought Chrysler in from the cold in a purchase several years ago. When the cold infected the rest of the organization with the flu, Mercedes-Benz dropped it off in one of those Private Equity deals, to be purchased by Cerberus.

Now, with Cerberus-Chrysler under the gun to strip down models and dealers to try to get on top of its business model as a for-profit company, the speculation is developing that they aren't going to make it.

Apart from his drop-top PT, Guambat has no interest or concern what Chrysler does. But the news does bring back the remembrance of a prior episode in Guambat's life. It would have been back around 1977 perhaps. Guambat was in a large lecture hall in his corporations class in law school.

The professor walked in and said, "today we're going to talk about non-profit corporations. No, I'm not talking about Chrysler."

It got a big laugh.

Some Weekend reading from the history pages:

Chrysler's Crisis Bailout
The first Chrysler bail-out; the M-1 tank (Featuring Donald Rumsfield in charge, the first time: same tricks)
A Step Toward Feudalism: The Chrysler Bailout
The Chrysler Bail-Out Bust

Meanwhile, down on the pharm

The US Federal government is probably (just guessing) the largest single purchaser of goods and services in the United States. Since the public purse is involved, many people expect/hope for some degree of accountability, prudence and transparency lest those public monies go to cronies, lobbyists and other parasites of the politics of the day.

Thus, the government sets up a complex spider's web of procurement bureaucracy and regulation to try to achieve at least the appearance of accountability, prudence and transparency in the government's procurement processes.

The stated goal of the process is to obtain the best value for the public's dollar. One of the ways it does this is to require the sellers of goods and services to offer to the government the best/lowest price it would offer to any other purchaser; if a seller offers xyz its lowest price that is available to all its customers, it must offer that same low price (no lower, but it must at least match it) to the government.

That may be a bit tough on sellers but nothing requires them to sell to the government (forced sales are handled a bit differently). But if they do want to sell to the government (and name one major US corporation that doesn't) they should play by those rules.

With that background, consider the news of the day in Big Pharma, particularly involving Merck.

Merck to pay over 650 mln dlrs to settle US drug pricing probe

Pharmaceutical giant Merck & Co. has agreed to pay over 650 million dollars to resolve allegations of fraudulent drug pricing and improper kickbacks, the US Justice Department announced Thursday.

The settlement hinged on two separate lawsuits relating to claims that Merck failed to pay proper rebates to government health care programs and that it made illegal payments to health care providers as inducements to use Merck products.

Attorney General Michael Mukasey said the accord marked "one of the largest healthcare fraud settlements ever achieved by the Justice Department."

"It reflects our continuing effort to hold drug companies accountable for devising pricing schemes that deliberately seek to deny federal health care programs the same lower prices for drugs that are available to other commercial customers," Mukasey said.

Merck to Pay $650 Million To Settle Pricing Probes

The major issue involved the misuse of a practice known as "nominal pricing," in a lawsuit filed by a former Merck employee and joined later by the Justice Department and all states except Arizona.

The nominal-pricing suit concerned deep discounts on drugs Merck allegedly offered to certain customers, but not to Medicaid, the government health-insurance program for the poor. It alleged that Merck offered discounts of 90% and more on the cholesterol pills Zocor and Mevacor and the now-withdrawn painkiller Vioxx to hospitals that helped the company achieve market-share goals, and that it also improperly incentivized doctors to use the products.

Federal law requires drug makers to give Medicaid the best price they offer any customer. But an exception in the 1990 law says medicines sold at a discount of 90% or more don't have to be disclosed or included in the best-price calculation. That steep discount was meant to let companies make inexpensive medicines available to charitable organizations.

The law doesn't specifically say who can receive the special pricing. But federal and state regulators alleged that Merck's pricing for the hospitals didn't qualify for such an exception, because it came in exchange for hospitals agreeing to sell certain volumes of Merck's drug -- at the expense of rival medications.

In essence, the low price was offered for marketing rather than charitable purposes.

Merck Settles With Gov't Over Rebates

From 1997 to 2001, Merck also gave money and perks to doctors and other health care professionals to entice them to prescribe Merck drugs, a practice the government called excessive.

Merck said the settlements do not constitute an admission of any liability or wrongdoing.

"What we have here is a disagreement (over) the rules of the Medicaid rebate program," said Merck spokesman Ronald Rogers. "These civil settlements were the best and most appropriate way to resolve these lengthy investigations and bring these matters to closure."

"At the time that these pricing programs were in place, Merck believes that it acted in good faith and complied with the regulations that were in place at the time," he said.

In what appears to Guambat to be a Merck statement,

"At Merck, we are dedicated to the highest standards of ethics and integrity," said Bruce Kuhlik, executive vice president and general counsel of Merck. "We have taken and will continue to take a leadership position in restoring trust in this industry and in ensuring that our interactions with healthcare professionals support the care of patients and further the public health."

Merck & Co., Inc. is a global research-driven pharmaceutical company dedicated to putting patients first.

Merck also publishes unbiased health information as a not-for-profit service.

How Merck Healed Itself By John Simons Feb 7, 2008

Over the past two years Merck has exceeded expectations on all fronts - scientific, financial, and legal. Since the beginning of 2006 it has gained FDA approval for seven new drugs, more than any of its peers. At the same time, the company has won the majority of the jury trials in its defense of Vioxx, the painkiller it was forced to withdraw from the market in October 2005 after studies linked it to heart attacks and strokes. Those victories enabled the company to settle the bulk of its lawsuits last November for $4.85 billion - considerably lower than the initial estimates of $20 billion. Investors have noticed, sending Merck's stock price up 75% since the beginning of 2006, far outpacing its peers.

Restoring Merck's reputation as a scientific partner grew easier as the company began to win Vioxx verdicts. And for that, the credit goes to Ken Frazier, 53. It was Frazier's call to contest, not settle, the Vioxx cases. Merck, according to insiders, wanted to compensate patients whose heart attacks and strokes were caused by Vioxx. But the company also wanted to show that it could defend itself in court against what it saw as frivolous claims, such as events that were the result of existing health problems.

Merck's resurgence is still a work in progress.... The bad news is the company may have another legal melee on its hands. The Justice Department and 32 state attorneys general continue to investigate Merck's marketing practices, including whether the company promoted Vioxx for "off-label," or unapproved, uses. Regulators are also questioning whether Vytorin, a cholesterol-lowering medicine that Merck co-markets with Schering-Plough (SGP, Fortune 500), works as well as claimed.

Others drug makers that have disclosed nominal-pricing probes include Johnson & Johnson, Schering-Plough Corp. and GlaxoSmithKline PLC.


Now, just where does that money go?


And, if it truly is fraud or even something like it, shouldn't Merck be barred from any more government contracting???

Not much chance of that if history is any guide:

Suspensions Are Just a SideShow By Steven L. Schooner May 1, 2002

Every administration purports to be against fraud, tough on government contractors and in favor of accountability in procurement. But this administration isn't.

One of George W. Bush's first actions as president was to eliminate the controversial Clinton administration labor responsibility rule. That so-called "blacklisting" rule would have broadened government buyers' discretion to avoid doing business with questionable firms. Killing that rule was a good decision, but the administration may now regret its timing.

More importantly, oversight of the government's purchasing regime is at unprecedented lows. During the 1990s, Congress systematically eviscerated the government's acquisition workforce, while greatly expanding flexibility for government buyers.

This Faustian bargain - greater buyer discretion in exchange for unjustified but politically popular personnel cuts - left a daunting legacy. Today, government buyers are overworked, under-trained and retirement eligible. The constant deluge of unfulfilled government needs means the remaining workforce must keep buying.

The shadow government described by Brookings Institution scholar Paul Light - which converts civil servants into contractor personnel - increases the government's reliance on service contractors. Good service contracts are difficult to write and even harder to manage. Yet fewer resources remain to plan these procurements, monitor contracts, or supervise the buyers responsible for these activities.

Those affected most dramatically by the 1990s workforce cuts were auditors, quality assurance personnel and accountants. As a result, a growing sense of lawlessness pervades a system that spends more than $200 billion each year.Nowhere is this more evident than with the government's high-volume purchases.

Many Are Caught but Few Suffer For U.S. Military Contract Fraud By RICHARD W. STEVENSON Published: November 12, 1990

Twenty-five of the 100 largest Pentagon contractors have been found guilty of procurement fraud in the last seven years, some more than once. Yet not one has been barred from Government contracting, and the renewed debate over how to discourage such fraud has produced no easy solutions.

The number of convictions and guilty pleas has accelerated in the last two years, with 16 cases involving 14 of the largest weapons makers. They include Boeing, Grumman and Teledyne, which made payoffs to obtain confidential Pentagon documents; Rockwell International and Emerson Electric, which overcharged the Government, and Fairchild Industries and Northrop, which failed to test certain weapons components or falsified the test results.

Spurred by the increase in fraud cases, Congressional committees have held numerous hearings in the last several months, and lawmakers are considering several proposals. One would ban a contractor from all Government business, a process known as debarment, for several years after a second fraud conviction. Another would prohibit companies from earning any profit on their Government work for a specified period. A third would call for a court-appointed "special master" to oversee all of a contractor's operations. Congress adjourned without taking action on the proposals, but legislators said they plan to address the subject in the next term.

US: Wages Of Sin - Why Lawbreakers Still Win Government Contracts by Christopher H. Schmitt, U.S. News & World Report May 13th, 2002

In the mid-1970s, Lockheed Aircraft Corp. was center stage in a scorching bribery scandal. Millions in secret payments were slipped to public officials and political parties around the globe, to curry favor and win government contracts.

Stung by the blowback, the company promised stringent reforms. Two decades later, Lockheed was again in the spotlight, pleading guilty to paying off an Egyptian official to win a deal for C-130 cargo planes. Once more, the company was contrite. Standing before a federal judge in 1995, a top executive pledged Lockheed's "commitment to the highest ethical standards of conduct."

In the years since, however, Lockheed's troubles have only grown. The company has been named in at least 33 more cases covering overcharges on government contracts, improper technology transfer to China, falsifying results of nuclear safety tests, job discrimination, environmental pollution, and more.

These cases, some of which were in motion before the 1995 conviction, have produced at least $145.3 million in penalties, settlements, and restitution. And at least 13 more cases are pending.

Lockheed Martin, as the company is known today, says it has a vigorous ethics and compliance program. And, it turns out, that promise is good enough for the Pentagon.

Lockheed Martin is not the only big federal contractor that continues to do business with Washington despite repeated contract difficulties and other legal and regulatory trouble. In the past dozen years, 30 of the 43 largest federal contractors have racked up more than 400 enforcement cases, resulting in at least 28 criminal convictions, 286 civil settlements, and 88 administrative settlements, mostly involving their government contracts, according to data from the Project on Government Oversight, a nonprofit Washington, D.C., group that investigates government activities, and additional research by U.S. News.

The companies have breached environmental, labor, and securities regulations as well, For their difficulties, the analysis shows, they have paid at least $3.4 billion in fines, penalties, and restitution.

The cases cover a wide swath, including price fixing, bogus testing, polluting, overcharging, hiding product defects, violating export laws, and withholding financial data from the government.

They also represent more than accounting quibbles: Company workers have been killed and seriously injured and national security potentially put at risk. Yet, together, these firms have corralled more than 4 of every 10 federal procurement dollars. "If it was a food-stamp recipient, they'd go to jail," says Rep Peter DeFazio, an Oregon Democrat, who complains about repeat offenders. "If it was a student-loan recipient who wasn't paying, they'd have their wages garnished. It's an extraordinary double standard."

The government actually has a process for cutting off wayward contractors from future work, but in practice, purchasing officers focus on getting projects done, not holding firms accountable for past behavior. And other officials responsible for barring firms can't legally use punishment as a motive, says Robert Meunier, head of a committee of those officials.

"We're here to protect the government's business interest," he says. Even if a current contractor is prevented from doing future business, the company could continue to do billions of dollars' worth of government work under existing agreements. As best as can be determined, the government has cut off only one of the 30 big contractors with problems - General Electric Co. - and, even then, suspended the company for just a few days.

But while the government may be reluctant to move against its biggest suppliers, federal agencies don't have the same qualms about cracking down on small firms. Officials maintain that federal rules are written evenhandedly, but they acknowledge that larger companies can naigate them more successfully.

Take James Verlander, a Houston-area researcher who in early 1990s got tangled up in Operation Lightning Strike, a federal sting operation targeting NASA suppliers. Federal agents drew Verlander and several others into a scheme revolving around a bogus medical device that supposedly could improve monitoring of space-station astronauts.

Threatened with a heavy prison sentence, he pleaded guilty to having accepted $2,000 as part of an effort to win approval and funding for the device, says his attorney, Charles Portz. Barred from government work ever since, Verlander suffered a nervous breakdown and has since become a medical technician.

By contrast, two big contractors that came under scrutiny in the affair - Martin Marietta and General Electric - settled their involvement by paying $1 million to defray the government's expenses.

"They didn't want to make arrests of the higher-up people because it would damage the space program," says Portz, "so they busted a bunch of little people.""They're pretty willing to settle it to stay in business," says Jacques Ganaler, former undersecretary of defense for acquisition, technology, and logistics, who is now a professor of public affairs at the University of Maryland.

Oversight of military and other federal spending has been kneecapped in recent years - through budget cuts and under the banner of streamlining regulation - and new proposals would weaken it further. Reflecting those developments and changing priorities, federal prosecution of contract fraud has fallen sharply in recent years, as have attempts by federal agencies themselves to rein in abuse, according to government data obtained by the Transactional Records access Clearinghouse at Syracuse University.