The LinkedIn IPO scam?

Was thinking of writing on this a few days earlier. The spectacular doubling of the share price of LinkedIn from its IPO offer prices as it debuted on public trading at the NYSE has had investors and financial media gushing about a possible new wave of IPOs by social media start-ups. However, there has been little discussion about how the investment banks that managed this IPO shafted and scammed LinkedIn.

For the record, LinkedIn's IPO managers, Morgan Stanely and Bank of America (Merrill Lynch division), fixed its offer price at $45 per share to sell 7.84 million shares, raising $352.8 m for LinkedIn, and valuing the firm at $4.3 bn. The share debuted on NYSE at $83, or 84% higher, touched $120, before closing at $94.25 on the opening day, a gain of almost 110%.

In simple terms, the LinkedIn offer price was hugely under-valued. At the advice of its IPO underwriters, LinkedIn sold itself too cheap. Its investors gains were LinkedIn's loss. And for this rip-off, it paid its IPO managers a cool 7% of the deal as their fee! Furthermore, the IPO gave its managers the perfect opportunity to gift their preferred institutional and other high-value investor clients some easy money (and more business from them in the future). And all this at LinkedIn's expense!

This illustrates the deep malaise with Wall Street and financial markets across the world - limited or no accountability and badly mis-aligned incentives. Where else can you get away with a cool $28 m and assured future business deals, for basically short-changing your employer? Where else are the remuneration structure so completely de-linked from the outcome of the activity? If your remuneration is fixed (at 7% here), irrespective of what happens to the IPO, where is the accountability?

Henry Blodget, who knows as much about these things as anyone around, estimates that the fair offer price should have been $60 per share and therefore LinkedIn lost around $175 m. See also this excellent op-ed by Joe Nocera. See also this Blodget article on how ZipCar's IPO underwriter's Glodman Sachs and JP Morgan screwed the company off $50 m.

Goldman and the satanic derivative mills

Great piece by Matt Taibbi, which shows two important things. First, despite all the talk about the sophistication of the mathematical models behind the creation of derivatives, the whole thing was pretty trivial.  According to Taibbi the infamous Timberwolf deal (the sh**ty one):

(...) was built on a satanic derivative structure called the CDO-squared. A normal CDO is a giant pool of loans that are chopped up and layered into different "tranches": the prime or AAA level, the BBB or "mezzanine" level, and finally the equity or "toxic waste" level. Banks had no trouble finding investors for the AAA pieces, which involve betting on the safest borrowers in the pool. And there were usually investors willing to make higher-odds bets on the crack addicts and no-documentation immigrants at the potentially lucrative bottom of the pool. But the unsexy BBB parts of the pool were hard to sell, and the banks didn't want to be stuck holding all of these risky pieces. So what did they do? They took all the extra unsold pieces, threw them in a big box, and repeated the original "tranching" process all over again. What originally were all BBB pieces were diced up and divided anew — and, presto, you suddenly had new AAA securities and new toxic-waste securities.

The other thing, is that there is plenty of evidence in the Levin Report is more than enough to indite several managers at Goldman, in particular, Daniel Sparks, the head of the mortgage division, that lied under oath, when he claimed that they did not expect the securities that they were betting against were going to be downgraded.

PS:  The original post was accidentally deleted by Blogger.  The guy on top is Goldfinger, a lesser villain than the guys at Goldman.

Senate report to reveal mortgage crisis details: WSJ

The Journal said the Senate investigation's findings
would likely expose bad blood between
Goldman and Morgan Stanley
© AFP/Getty Images/File Chris Hondros

AFP

WASHINGTON (AFP) - The Senate will soon issue findings of a probe of the US mortgage meltdown that fueled the global financial crisis, with Goldman Sachs likely to face fresh embarrassment over its role, the Wall Street Journal reported Sunday.

The Senate Permanent Subcommittee on Investigations, whose high-profile inquiry commission subpoenaed Goldman's and other executives last year, is due to release its report on the subprime implosion of 2007 and 2008.

The paper, citing people familiar with the matter, said the report was expected to release emails from securities firms that developed or sold subprime mortgages and financial vehicles including collaterized debt obligations (CDO).

CDOs were used to help Wall Street firms bet against the housing market. When the housing bubble burst, several of the top CDOs were downgraded to "junk" status, and their values plunged.
Goldman, the Journal reported, created CDOs in 2006 and 2007 to shield its exposure to the US housing market, and has been accused of making large bets against the market while selling bullish positions to group that were not expecting the market to fall.

People familiar with the matter said Goldman and Deutsche Bank -- both of which have been criticized for misleading investors in the housing market -- were expected to draw particular scrutiny in the report, the Journal said.

In January, Goldman said it was renewing its commitment to the "primacy" of client interests, and laid out 39 recommendations stressing greater transparency in how the company does business, especially with regard to its own private trading and potential conflicts of interest.

The Journal said the Senate investigation's findings would likely expose bad blood between Goldman and Morgan Stanley, another Wall Street giant, over their roles in a deal involving a CDO called Hudson Mezzanine Funding 2006-1.

According to the Journal, Goldman had sold insurance on the CDO, allowing the company to make money if and when the loans backing the deal began to default.

The Senate report was expected to disclose that Morgan Stanley was a key counterparty in the Hudson deal, said the paper.

It said Morgan Stanley's involvement in the deal was one of the company's bad mortgage bets that contributed to its $9.0-billion trading loss in 2007, while Goldman's mortgage division lost some $1.2 billion in 2007 and 2008, the worst years of the crisis.

© AFP -- Published at Activist Post with license

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The consequences of widening inequality

Inequality is fast emerging as one of the biggest challenges facing the global economy. Conservatives have long argued that inequality underpins the incentive system that drives economic growth. They claim that it is not inequality but poverty that should agitate policy makers.

The most famous proponent of the "inequality is bad for the economy" hypothesis is Raghuram Rajan. In his book, Fault Lines, he blames the political response induced by growing inequality for the sub-prime mortgage bubble and the Great Recession. He argues that governments, especially in the US, found in credit an easy route to propping up living standards of those at the bottom. The asset bubbles that followed generated an income effect that would paper over the widening real inequality.

The concentration of wealth is stunning. Credit Suisse estimates that there were 24.2 million people in mid-2010 across the world who had assets exceeding $1 million. This 0.5% of the global adult population control $69.2 trillion in assets, more than a third of the global total. The richest 1% of adults control 43% of the world’s assets; the wealthiest 10% have 83%. The bottom 50% have only 2%.

Consider this superb and cognitively striking illustration of inequality in the US by Jean Pen

"Imagine people’s height being proportional to their income, so that someone with an average income is of average height. Now imagine that the entire adult population of America is walking past you in a single hour, in ascending order of income.

The first passers-by, the owners of loss-making businesses, are invisible: their heads are below ground. Then come the jobless and the working poor, who are midgets. After half an hour the strollers are still only waist-high, since America’s median income is only half the mean. It takes nearly 45 minutes before normal-sized people appear. But then, in the final minutes, giants thunder by. With six minutes to go they are 12 feet tall. When the 400 highest earners walk by, right at the end, each is more than two miles tall."

The Economist had a recent survey on inequality that laid down the conservative defence (or atleast rationalization) of inequality. It documented the spectacular rise in income inequality across the world and draws several conclusions. However, the survey is shockingly disingenuous in both what it presents as its conclusions and what it ignores.

The omissions first. I can think of two concerns about rising inequality and resultant concentration of wealth that screams out to any reasonably perceptive observer. The series of articles in The Economist has conveniently overlooked both, without even a passing reference.

1. The first is a political economy issue. The extreme concentration of wealth in the hands of the richest 0.1% has naturally raised questions about its impact on the political balance of power. There is enough meat from sociology and political science that highlight the inevitability of gravitation of power into the hands of those who populate the top of the income and wealth ladder.

In addition, of relevance to our times, there is a growing body of literature that documents how this extremely narrow group of people are fast becoming the new "power-elite". The Economist article itself points to the work of David Rothkopf who shows how the world economy is disproportionately influenced by 6000 politicians, chief executives and other bigwigs (remember Government Sachs!).

However, it ignores the most obvious conclusion and rationalizes by arguing that democratic electoral politics takes care of such concerns. This, as again widely documented, is doubtful, since an electoral change only replaces one group of "power-elite" with another. This is all the more so since political parties across the spectrum owe their existence to moneyed interests.

All this is not to say that the "power-elite" have edged out all other shades of opinion. I would only claim that the extent of their influence on important political decisions (which have deep economic and social implications) grows as inequality widens and concentration of wealth increases. And no right-minded individual would dispute the harmful effects of this trend.

The recent example of the US Government's response to the sub-prime crisis is a case in point. No stone was left unturned to bail out the too-big-to-fail financial institutions and repair corporate balance sheets. However, nothing remotely similar in commitment and urgency was evident when it came to bailing out homeowners stuck with negative equity and repairing household balance sheets.

The era of financial deregulation that preceded the two decades leading to the sub-prime crisis is another example of the power of this new elite. A small clique of Wall Street bankers and lobbyists, supported by politicians and regulators who stood to benefit, led a movement that systematically dismantled all regulatory oversight on dubious ideological grounds.

2. The second issue is socio-economic. The rich beget the rich. The world economy is increasingly one where the superstars, be it any field, rule the roost. By their very nature, superstars have to be a small sliver of the working population. This path to super-stardom is ever so more determined by the capricity of an ovarian lottery.

It is increasingly true that there are considerable entry-barriers to accessing opportunities that enables people gain a seat at the top-most income table. The major share of opportunities in the knowledge-driven economy are linked with either wealth endowments or educational attainments.

The wealthy inherit the business or assets of their parents. Their achievements are built on this formidable foundation. It is almost like running a marathon where a privileged few join the race at the last lap!

Access to the best education, itself confined to a handful of top universities, is increasingly a function of privileged birth than merit. This is especially so since the number of such educational institutions remain the same, while competition increases exponentially. The super-rich with their deep pockets are many times more likely to pass this competition than the poor or even the mere-rich.

In this context, the argument about merit is positively misleading. We all know that getting a seat in the best university is not merely about studying hard and writing an examination. It is about access to a number of smaller opportunities that spans the entire student-life (especially early childhood and family background), all of which present their own particular entry-barriers, which prepares the ground for accessing and competing successfully in the best educational institutions.

Even accepting the odd brilliant individuals who get past the formidable array of entry-barriers and access such education, it cannot be denied that the probability of such people are small and fast declining. This is in stark comparison to the near certainty of those at the top of the income ladder accessing such education. The competition to even access the opportunities that determine future life outcomes could not have been more unfair.

For every visible example of a person with uncommon intelligence rising from the bottom of the income pile and succeeding, there are numerous untold stories of disappointments suffered by such people. Further, while there cannot be any example of people from the bottom pile with commonplace intelligence striking rich, there is more than an even chance that people with similar biological endowments will find a place at the top of the income table.

The best example of this trend is the growing evidence of the alarming decline in social mobility across the income ladder in the US.

Some of the arguments are factually incorrect or amazingly ignorant in its conclusions. It finds a silver-lining in the way people are becoming rich today. Consider this

"... to become rich in the first place, they typically have to do something extraordinary. Some inherit their money, of course, but most build a better mousetrap, finance someone else’s good idea or at least run a chain of hairdressers in a way that keeps customers coming back. And because they are mostly self-made, today’s rich are restless, dynamic and much keener on change than the aristocrats of old."

This is plain factually incorrect. There is enough evidence to suggest that the major share of the super-rich increasingly inherit their wealth, either directly (by direct inheritance of massive wealth) or indirectly (by accessing privileged education). The examples of Larry Page and Mark Zuckerberg stand out precisely because they are exceptions than the norm.

The lengthy discourse in the header article on the stress and hormonal imbalances created by inequality is a classic case of diverting attention from important issues. This is all the more surprising given the complete avoidance of the almost commonplace political economy failings that inequality generates.

The arguments to debunk the work of Richard Wilkinson and Kate Pickett (the authors of "The Spirit Level: Why Equality is Better for Everyone") - who attributes all manner of social ills to inequality - is plain specious. Consider this rebuttal by Peter Saunders of Policy Exchange,

"Factors other than inequality are often more strongly correlated with the problems described in the book. In American states, for example, race is a far more accurate predictor of murder, imprisonment and infant-mortality rates... He also chides the authors... for glossing over social problems, such as divorce and suicide, that are worse in more equal countries."

This argument overlooks the role of widening income inequality in exacerbating the pre-existing fault-lines. In simple terms, prevailing racial and other social inequalities are one more entry-barrier that those populations face in the race to access the opportunities that enable people to sit at the top of the income table. The already disadvantaged groups face even greater hurdles in this race today.

Certification Systems as Risk Mitigation

Goldman Sachs has recently been lauded for its risk mitigation systems, taking actions months before the sub prime mess broke out. Some people have said that Goldman had a more integrated exposure risk mitigation system, while others attributed Goldman’s success to the use of realistic, hardnosed analysis, unclouded by rose colored glasses. What about companies trying to mitigate against brand risk? After all, brand is where much of the value of firms is tied up.

Economist and certification consultant Michael Conroy just spoke at the Carnegie Council about his new book Branded! How the ‘Certification Revolution’ is Transforming Global Corporations. The books and the seats at the lecture were both sold out.

Conroy said that a revolution in standards certification is underway and has been fueled by successful "market campaigns" by NGOs, the development of outside certification systems, the presence of champions for change within companies, and the growing market for ethical products. Market campaigns call attention to social and environmental problems in a corporate supply chain, problems that go beyond the jurisdiction of the WTO.

The growing power of corporate brands is two-sided. While a brand can help establish a company’s dominance in a particular industry, it also makes a company vulnerable to attacks from the public on that brand. A brand value can be estimated as the total value of a company minus its physical assets. Conroy estimated that McDonald’s brand is about 70 percent of its value and that figure is about 64 percent for Coca Cola.

Certification systems are a set of principles, criteria, and indicators negotiated by all stakeholders impacted by a company’s operations. The result of these negotiations is the highest politically accepted standard. These standards allow consumers and civil society to be more nuanced in signaling their preferences to companies—beyond just saying, “Stop what you are doing!”

The relationship between civil society and corporations allows companies to positively mitigate against brand risk. Certification systems are risk management systems against future attacks on brands, says Conroy.

It was a fascinating discussion and certainly a tribute to the growing power of NGOs. The audio from this event will be up on the Carnegie Council's online magazine Policy Innovations, a project that Conroy also was instrumental in helping to start.

Stay tuned.