According to a recent issue of Bloomberg Businessweek, acquirers are currently creating value through acquisition (see Markets Love a Buyer, ht Ajay).

Bloomberg analyzed takeovers worth at least $200 million in which the buyer was a public company and no more than 10 times as large as the target. For each transaction it calculated the stock market return from the day before the announcement to the day after, minus the return in a benchmark stock index, to eliminate the impact of broad market movements. Last year the median share price gain for companies that announced an acquisition was 1.11 percent, the most for any full year in the study. So far this year, the figure is 1.18 percent. The worst performance was in 2000, when the median decline was 1.77 percent.

The increase challenges the notion on Wall Street that acquirers are punished for spending money…

Or does it?

As I’ve mentioned on this site many times, over long periods of time, the evidence suggests that acquisitions generally fail to create value for shareholders (see Where Have the Strategic Bidders Gone?, More Deals Gone Bad, Great Shareholder Ripoff, Why M&A Deals Go Bad, Dumbfounded by the Data, and The Complexity of Strategic Acquisitions)

So what gives??

It could very well be, as the Bloomberg Businessweek article suggests, that acquisitions have, on average, created value for shareholders over the past two years. I have not had a chance to evaluate the specifics of the event study methodology the authors use. And I do not dispute the evidence.

Indeed, there is evidence in the literature that under certain conditions, or at certain times, acquisitions generally perform better. For example, literature demonstrates that acquisitions generally perform better when managers of the acquiring company own a greater percentage of the outstanding shares in their company.

The bottom line: Acquisitions do not uniformly destroy value.

In my opinion, therefore, the key take-away from the Bloomberg Businessweek article is that in depressed markets (like we’ve experienced the past few years), there are some real bargains to be had, …and it helps to be a cash rich, counter-cyclical buyer.

The Economist recently published an interactive cross-country comparative global housing bubble tool. I’ve pasted a screen shot below, but visit the site to play with the various combinations and permutations of country-specific housing variables (see Global Housing Prices).

What I found striking from examining different countries and time periods is that although the housing bubble is nearer the bottom than the top in the US, there are many countries in which housing prices still seem lofty (e.g., Hong Kong, France, China, Australia, Switzerland, Belgium). Moreover, I didn’t fully appreciate how much larger the bubble was in countries like the UK, Ireland, and Spain than in the US. I knew the housing bubbles in those countries were larger, but in some cases (depending upon the specific time period), the bubble was up to 5x larger than in the US.

Interesting stuff!

Interesting article in the NY Times summarizing a recent Asia Society report about the prospects for Chinese direct investment in the United States (see Chinese Investment Bypasses U.S.).

Flush with capital from its enormous trade surpluses and armed with the world’s largest foreign exchange reserves, China has begun spreading its newfound riches to every corner of the world — whether copper mines in Africa, iron ore facilities in Australia or even a gas shale project in the heart of Texas.

[A new study]…forecasts that over the next decade China could invest as much as $2 trillion in overseas companies, plants or property, money that could help reinvigorate growth in the United States and Europe.

But the report…also warns that the United States risks missing out on a large share of the Chinese investment boom because of politics, a growing rivalry between the two nations and deep-seated perceptions that Chinese investments are unwelcome in America.

Chinese firms engaged in about $5 billion in direct investment in the U.S. in 2010 (see the Asia Society Report on Chinese Direct Investment), representing 10% of China’s total outward direct investment of around $50 billion.

With China’s vast reserves, my expectation, consistent with the conclusions of the Asia Society report, are for that figure to grow exponentially in the next few years. Of course, that’s from a very low base – Chinese outward direct investment currently accounts for only 5% of global outward direct investment flows (by comparison, the U.S. accounts for 25% of such flows).

Insofar as political meddling in Chinese direct investment into the U.S. is concerned, I am generally against political interference in cross-border M&A and greenfield transactions. If a transaction truly raises national security concerns then I see a reason to examine the deal more closely; however, such transactions are extremely rare. My hunch, though, is that politicians (on both sides of the aisle) feel compelled to weigh in on deals when they ought not to, …largely for the purpose of scoring political points.

Some of the high-profile Chinese deals that were politically overly-scrutinized include Lenovo’s acquisition of IBM’s PC business and CNOOC’s attempted acquisition of Unocal. In fact, CNOOC walked away from the Unocal deal, one which did not pose much of a security risk, because they felt that the political hurdles were too great.

In this sense then, I agree with the findings of the Asia Society report that the U.S. should openly encourage Chinese direct investment. In addition, the inward direct investment process should be safeguarded from undue political interference and/or influence.

Inward investment (not just from China, but from any country) brings jobs, tax receipts, and an increase in consumer welfare; it provides an alternative investment outlet for Chinese reserves; and it affords Chinese firms an opportunity to learn valuable skills and capabilities from their acquisition targets (see Chinese Acquisitions for more on this topic).

To me, all the political posturing toward Chinese investment into the U.S. is reminiscent of that which took place in the 1980′s when Japan was the investment scapegoat of choice. As it turns out, many Japanese investments had a positive impact on the U.S. economy (think automakers like Toyota and Honda opening assembly facilities in the U.S.). In some cases, however, Japanese investors ended up buying high only to eventually sell low (think Rockefeller Center and Pebble Beach).

I, for one, wouldn’t be surprised if many Chinese investments followed that latter path…

Wonderfully rich exposition of the economic competition between China and the U.S. from The Economist (see China Overtakes U.S.).

Constant worrying about exactly when the superpower will fall into second place is causing anxiety throughout American society…[but] in some important fields, China has already surpassed America.

Great stuff!

I was on Fox news the other day discussing the ways in which the costs of operating State prisons impact the New York State budget (click on the video below or see High Cost of Prison Workers).

I spent a fair amount of time discussing the issues, but very little of the material was used. However, I did echo the commissioner’s sentiment that the State is currently hamstrung by existing contracts with the unions representing State prison employees.

The practice of increasing overtime hours in the last three years of employment in order to goose one’s pension (which is based on a percentage of one’s pay in their final three years of employment) is not new. Nor is it limited to the Department of Corrections. The bad news for the State budget is that the practice is contractually protected by agreements put in place long ago between the various unions and the State.

Politicians, and those managing the various State agencies, have long been aware of this problem. In fact, the legislature recently approved sweeping changes to the pension system (creating a new Tier 5 employee system) that would limit this practice moving forward (see State Lawmakers Approve Deal to Fix Hyper Pension).

Overtime will no longer be included in the calculation of the last three year’s salary upon which employee pensions are based. This will be effective for all new State employees beginning in 2010.

Unfortunately, these changes won’t help the beleaguered New York State budget for some 20 years or so. In the meantime, the New York State budget remains in a fragile state…

I received a call yesterday from Nin Hai Tseng, a reporter at Fortune, asking my opinion of the tax credit portion of Obama’s recent stimulus proposal (see Why Obama’s Plan Won’t Buy Votes).

President Barack Obama heads to Cleveland, Ohio today to unveil more measures aimed to jolt the country out of a frustratingly slow economic recovery ahead of the November mid-term elections. In an effort to create jobs, the administration’s proposal includes a $50 billion infrastructure spending plan and a tax write-off for businesses that invest in new equipment.

…as far as Obama’s proposal to allow companies to deduct from their taxes the full value on purchases of new equipment through 2011, it remains to be seen if this would be a big enough incentive to get businesses to invest more and hire more. Companies can already deduct these expenses, but the plan would allow them to make the deductions upfront.

If the tax break pans out anything like consumers’ response to Obama’s tax credit on home purchases, then that’s a bad sign, says Robert Salomon, professor at New York University’s business school. The tax credit supported home sales briefly. When it expired in April, sales of previously owned homes dipped in July to their slowest pace in 15 years.

Salomon supports more stimulus spending. He adds the tax credit holds promise, but it could act as a “misincentive,” merely giving tax relief to businesses who were going to buy new equipment anyway. The hope is that the incentive prompts businesses to buy things they otherwise might not have without the tax break.

Companies have been sitting on record amounts of cash, but the lack of demand has largely kept many from spending more.

This more or less represents my view. Overall, I am in favor of some form of stimulus to help combat stubbornly-high unemployment. Therefore, I view Obama’s stimulus proposal, however small, as something that’s better than nothing.

That said however, I wonder whether the business tax credit portion of the stimulus could be better spent on efforts that have a more direct impact on employment. My fear is that the business tax credit will work much like the home-buyer tax credit, either by pulling demand forward thereby leaving a demand void once the stimulus expires, or by wrongly rewarding firms that were planning to make capital investments anyway, again failing to meaningfully influence future demand.

As I see it, the goal of any tax-related stimulus should be to encourage economic actors to make purchases/investments that they otherwise might not have made, in the hope that it will improve confidence and kick-start a virtuous private demand/investment cycle. I’m not sure that this specific business tax credit accomplishes that goal, especially in an environment in which final demand remains extraordinarily weak.

In this sense then, I believe it’s a poorly-targeted stimulus. Instead, I think the $30B estimated total cost of the tax credit program would be better spent on additional infrastructure projects and/or additional employment tax relief. I view those alternatives as having a more direct, immediate impact on employment.

A wonderful chart courtesy of the Council on Foreign Relations depicting what I described several weeks ago: Since announcing its renewed commitment to currency flexibility in the days leading up to the G20 summit, the appreciation of the yuan has been more symbolic than substantive…

click on the chart for a crisper image, or visit China’s Head Fake

As I wrote several weeks ago (see Currency Manipulator):

China’s strategy of publicly announcing a more flexible yuan policy in the days leading up to the G20 summit effectively deflected the debate away from the yuan. What’s more, China’s announcement was seemingly rewarded by a Treasury now more reticent to label it a currency manipulator.

The interesting thing to me about the whole thing is that the yuan has barely budged since the announcement, rising less than 1% since late June. For a currency that some claim is undervalued by as much as 40%, that’s not likely to make much of a dent in persistent trade imbalances.

According to the CFR

In the run-up to the June G20 summit in Toronto, China came under significant U.S. pressure to loosen its currency peg to the dollar…Then one week before the summit, China announced that it would relax the peg, and indeed the renminbi (RMB) began to rise. The political tension dissipated. Yet since July 2^nd, five days after the summit, the RMB has ceased rising.

Taking stock then, China’s most recent flexible yuan policy announcement seems to have been wildly successful. It quelled political criticism. It effectively avoided having the yuan become a topic of discussion at the G20 meetings. And it was rewarded by both the Treasury and the IMF, neither of which labeled it a currency manipulator in post-G20 currency assessments – opting instead for the much more benign label “undervalued” (see the Treasury’s Interim Report on Exchange Rate Policy and IMF Yuan Debate).

So in effect, China’s cheap talk has worked, …so far. The nagging question for US policymakers: Now what??

…at least not according to the US Treasury (see the Treasury’s Interim Report on Exchange Rate Policy).

According to the Treasury’s report:

China’s continued foreign reserve accumulation, the limited appreciation of China’s real effective exchange rate relative to rapid productivity growth in the traded goods sector, and the persistence of current account surpluses even during a period when China’s trading partners were in deep recession together suggest that the renminbi remains undervalued.

It was easy to overlook the recently released Treasury report in the wake of the G20 summit, where much of the debate centered on austerity versus stimulus rather than China’s mercantilist policies (see Agreeing to Disagree).

In this sense then, China’s strategy of publicly announcing a more flexible yuan policy in the days leading up to the G20 summit effectively deflected the debate away from the yuan. What’s more, China’s announcement was seemingly rewarded by a Treasury now more reticent to label it a currency manipulator. And the timing of the report’s release (after months of delay) seemed rather coincidental: It was released after the conclusion of the G20 meetings, and only after China seemed to mollify critics with its announced policy shift.

The interesting thing to me about the whole thing is that the yuan has barely budged since the announcement, rising less than 1% since late June. For a currency that some claim is undervalued by as much as 40%, that’s not likely to make much of a dent in persistent trade imbalances.

Now I’m as much a proponent of free trade as anyone (see Globalization Revisited and Globalization Discontents), but my view is that trade should be allowed to take place in an environment in which economies adjust as a consequence. Explicit policies that prevent such adjustment can be damaging to all parties.

With my bias now laid bare, it seems to me that China is simply paying lip service. It wants to appear accommodating, publicly declaring its intention to allow the yuan to strengthen against the dollar, while continuing to rely on exports to the US as its main growth engine.

Given the recent turmoil in Europe (China’s second largest trading partner), maintaining its exports to the US has taken an even heightened importance (see Revaluation Postponed and Revaluation and Euro Weakness). And in a world where everyone suddenly wants to play beggar-thy-neighbor (China, Japan, and now even Europe), the US is now everyone’s neighbor (for a brilliant treatment of the issues see Capital Tsunami).

This cannot continue indefinitely.

Against that backdrop, don’t be surprised if the trade deficit and cries of unfair trade practices begin to occupy a more prominent place in political discourse.

It’s been a long time since I’ve thought about the JP Morgan/Bear Stearns shotgun wedding (see Rescue for Bear? and Rescue Update for background). Back when I wrote those blog entries, I wondered aloud whether, in addition to preventing Bear’s collapse, the Fed also orchestrated a backdoor bailout of JP Morgan in the process.

Anyhow, as part and parcel of the JP Morgan/Bear Stearns deal, the Fed acquired a host of assets that were packaged into what would become known as the Maiden Lane portfolio. The Maiden Lane portfolio housed approximately $30B “worth” of assets, with JP Morgan agreeing to assume the first $1B in losses associated with the portfolio, and the Fed assuming any losses thereafter.

Last week an interesting article in Bloomberg questioned when the Fed knew about the poor quality of the assets it acquired in the Maiden Lane deal, and how it communicated what it knew about those assets (see Fed Made Taxpayers Unwitting Junk-Bond Buyers).

According to Bloomberg:

Federal Reserve Chairman Ben S. Bernanke and then-New York Fed President Timothy Geithner told senators on April 3, 2008, that the tens of billions of dollars in “assets” the government agreed to purchase in the rescue of Bear Stearns Cos. were “investment-grade.” They didn’t share everything the Fed knew about the money.

The so-called assets included collateralized debt obligations and mortgage-backed bonds…that were so distressed, more than $40 million already had been reduced to less than investment-grade by the time the central bankers testified.

At the time Maiden Lane was created, the Fed claims that the assets were solid, credit-worthy, and investment grade.

“As was noted in testimony, all of the cash securities in the Maiden Lane portfolio were investment grade on March 14, 2008, when the deal was agreed to in order to facilitate the acquisition of Bear Stearns and to prevent the systemic consequences of its sudden and disorderly failure,” Michelle Smith, a spokeswoman for the Fed’s Board of Governors, said in an e-mail.

“The Federal Reserve considered not just credit-rating valuations, which have varied some over time based on economic conditions, but also relied on a separate assessment from an independent investment firm, which advised us that over time, we would likely fully recover our principal and interest,” Smith said. “We continue to expect the loan to Maiden Lane to be fully repaid.”

“You’ve got about $30 billion of collateral. And some comments have been made that you feel comfortable because it’s highly rated,” Senator Jack Reed, a Rhode Island Democrat, told Bernanke, according to a transcript. “But a lot of highly rated collateral these days is being subject to questions.”

“Senator, as was mentioned, it is all investment-grade or current performing assets,” Bernanke responded. “We do not know for sure what will transpire,” he said. “But we have engaged an independent investment-advisory firm who gives us reasonable comfort that if we can sell these assets over a period of time that we will recover principal and interest for the American taxpayer.”

That was then. This is now:

More than 88 percent of Maiden Lane’s CDO bonds and 78 percent of its non-agency residential mortgage-backed debt are now speculative grade, according to data compiled by Bloomberg based on holdings as of Jan. 29.

Casablanca moment: I’m shocked, shocked…

Needless to say, I’ve been stewing over that article for the better part of a week now, and several thoughts came to mind:

1. The Fed was fleeced. It was in over its head – unable, and unequipped, to properly value extremely complex derivatives – and as a result, was on the wrong side of the Maiden Lane trade.
2. The Fed knew best. It was a liquidity problem and not a solvency problem. The Fed bought assets that no other party was willing to buy because potentially interested parties were scared (wrongly pricing Armageddon). The assets still had value and the Fed paid a fair price. To its credit, even the CBO estimates that the Fed will end up realizing a $200 million return on its Maiden Lane investment. So the Fed was on the right side of the trade.
3. It doesn’t matter whether the Fed made a good or bad trade. It failed to properly disclose information about the true state of the Maiden Lane assets. That is, the Fed knew that the assets were largely junk but bought the assets anyway in an effort to wind Bear down in an orderly manner and stave off the risk of a systemic collapse.

I hope the answer doesn’t lie behind Door #1. It oughtn’t. There are some pretty sharp minds at the Fed, so I highly doubt they got taken. If the Fed executed a horrible trade, then how could it possibly be seen as a credible central bank, especially in light of the increased regulatory powers that the financial reform bill looks set to grant it? And as Kevin Warsh stressed in a recent speech: “The Fed’s institutional credibility is its most valuable asset…”

I am also skeptical that the answer lies behind Door #2. I keep coming back to the absence of suitors for Bear (and/or those assets). Why was there no market for Bear? Why was nobody interested in what were then largely “investment grade” assets? Did the market really have it that wrong?? As the Bloomberg article notes:

“Why wouldn’t JP Morgan want a bunch of AAA assets?” said Mark Calabria, a former Senate Banking Committee staff member…“The answer is it was all borderline junk.”

The CBO even leaves a wide range for expected returns on Maiden Lane’s assets recognizing in its report that, “the returns realized on asset-backed securities such as those in the Maiden Lane portfolios could deviate significantly from what is expected…”

And so we come to Door #3. Whether the Fed executed a good or bad trade is, in some ways, immaterial. It’s about the way it was handled.

I understand the desire, and the urgency, on the part of the Fed to step in and wind down Bear, much as the FDIC acts as a receiver to failed banks. I am one of those who believes that the alternative (letting Bear fail in a disorderly manner) might have had catastrophic consequences for the global financial system. Of course, we will never know, not having the opportunity to observe the counter factual.

But to me, this is starting to look like a case in which it’s debatable whether the ends justify the means.

As I understand it, the issue is that the Fed did not (at the time) have resolution authority over non-bank financial institutions such as Bear. Therefore, it invoked Section 13(3) of the Federal Reserve Act, which enables it to provide credit to corporations like Bear in extraordinary circumstances, but only in exchange for high quality collateral. Moreover, whereas the FDIC is funded by the premiums collected from member banks and draws upon the Deposit Insurance Fund when winding down a bank, in this case the Fed put taxpayer money directly at risk.

And therein lies what bums me out so. It’s not the kind of assets acquired by the Fed. It’s not the price at which the Fed acquired the assets. It’s not whether the assets will ultimately get paid back, though that’s important (and debatable). It’s not even whether the Fed, through its actions, effectively rescued the financial system from the brink.

In the end, it’s about what the Fed knew about the quality of the assets when it structured the rescue, and the possibility that the Fed put taxpayer money at risk in violation of Section 13(3) of the Federal Reserve Act, perhaps knowing ex ante that it was acquiring collateral of dubious quality.

This is why, in my opinion, Bernanke was so careful with his language in his April testimony. Yes, technically, the assets were investment-grade rated and/or performing assets when Maiden Lane was created. Therefore, at the time, the assets were likely meet the “indorsed or otherwise secured” criteria. Brilliant really, if you think about it.

But did the Fed anticipate that the assets would remain high quality? That’s another story.

If the Fed knew that the Maiden Lane assets were likely to become junk assets irrespective of how they were rated at the time (and we might never find out), it would be eerily reminiscent of a “You can’t handle the truth” kind of moment, …which speaks to a whole different kind of credibility.

In January I predicted that “major” bankruptcies in 2010 would number around 300 (see Notable Bankruptcies of 2010: Q1). According to Bankruptcydata.com, there were 59 “major” filings in the first half of 2010. Assuming that bankruptcies are equally distributed throughout the year, this puts us on pace for around 120 bankruptcies. Again, this would be well shy of my prediction.

In previous posts I discussed why I believed “major” business bankruptcies were tracking below expectations (see Notable Bankruptcies of 2010: Q1 and Notable Bankruptcies of 2009). The candidate explanations include: an improving economy; massive government stimulus/liquidity programs keeping structurally weaker firms on artificial life support; and the recovery disconnect between Main St. and Wall St. (i.e., small-firm bankruptcies are on the rise even while major bankruptcies have declined).

Personally, I continue to believe that the significant dip in “major” business bankruptcies that we have witnessed over the past year has a lot to do with the extraordinary government stimulus and liquidity programs. Nowhere has this been more evident than in the disconnect between the bankruptcy patterns across small and large corporations (see Notable Bankruptcies of 2010: Q1 for details). And as I’ve maintained all along, absent a second round of stimulus, we will find out if my hypothesis is correct as the stimulus and liquidity programs begin to wind down. In this sense then, the true test for corporate balance sheets (and by extension, the economy) will come in the second half of the year.

Given the recent troubles in Europe and the softer economic employment and growth numbers at home, it continues to be my expectation that the pace of corporate bankruptcy filings will increase in the second half of 2010. Will we ultimately reach 300 “major” business bankruptcies? At this point, likely not. But I do not think 200 is out of the question.

If fundamentally weak companies are being propped up by an artificially-stimulated economy that cannot structurally support them, it is only a matter of time before bankruptcies begin to reflect true underlying economic fundamentals.

Anyhow, below you can find an updated list of what I see as the “noteworthy” bankruptcies of 2010, as reported by Bankrupctydata.com. New additions since March appear in RED (please note that this is not an exhaustive list):

• Affiliated Media, Inc. (Newspapers)
• American Mortgage Acceptance Company (Real Estate)
• Anthracite Capital, Inc. (Real Estate)
• Atrium Companies, Inc. (Windows and Doors)
• Beach First National Bancshares, Inc. (Banking)
• Black Gaming, LLC (Gambling)
• Chem Rx Corporation (Pharma Services)
• Community Bancorp (Banking)
• Corus Bankshares, Inc. (Banking)
  
• Electrical Components International, Inc. (Manufacturing)
• EnviroSolutions Holdings, Inc. (Waste Disposal)
• Evergreen Bancorp, Inc. (Banking)
• FirstFed Financial Corp. (Banking)
• Haights Cross Communications, Inc. (Publishing)
• International Aluminum Corporation (Real Estate)
• Mesa Air Group, Inc. (Airlines)
• Morris Publishing Group, LLC (Media)
• Movie Gallery, Inc. (Retail)
• Neenah Enterprises, Inc. (Manufacturing)
• Neff Corp. (Construction)
• Orleans Homebuilders, Inc. (Real Estate)
• Penton Business Media Holdings, Inc. (Media)
• Point Blank Solutions, Inc. (Security)
• Regent Communications, Inc. (Media)
• R&G Financial Corp. (Banking)
• Saint Vincent’s Catholic Medical Centers (Healthcare)
• Spheris Inc. (IT Services)
• TierOne Corporation (Banking)
• The Newark Group, Inc. (Paper)
  
• Uno Restaurant Holdings Corporation (Restaurants)
• US Concrete, Inc. (Construction/Basic Materials)
• Xerium Technologies, Inc. (Paper)