Rich unlikely to sit and take tax hikes

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The rich are different from you and me, F. Scott Fitzgerald famously observed. And it’s not just because they have more money, as Ernest Hemingway equally famously responded. Unlike the rest of us, they don’t stand still for taxes.

That comes to mind with the proposals outlined in President Obama’s State of Union address Tuesday that would effectively codify the so-called Buffett Rule — that billionaires should not pay a lower tax rate than their secretaries. With the secretary of the chief executive of Berkshire Hathaway seated next to the First Lady, the president proposed that those earnings over $1 million pay a minimum 30% federal tax rate. That would mean no deductions for mortgage interest, health care, retirement savings or child-care benefits, although the deduction for charitable deductions would be preserved.

It also presumably would do away with the preferential treatment of capital gains and dividends, which for 2012 are taxed at a 15% top rate. As things stand, along with the Bush-era ordinary-income tax rates, those taxes on investments are slated to rise to their previous levels: 20% top rate on capital gains and ordinary-income rates on dividends, which would be as high as 39.6%.

Under Obama’s 2012 budget proposals — which at this point are just that, proposals — the hike on capital gains and dividends would be limited to 20% to “upper-income” tax payers, which would be married couples with 2013 taxable income over $241,900. Joint filers below that would still pay 15% on dividends and capital gains — if the Administration’s budget proposals are enacted. For higher earners, it would be 20% on cap gains and ordinary-income rates on dividends.

And don’t forget that “unearned income” will be subject to the 3.8% Medicare tax for couples with “modified adjusted gross income” over $250,000. That would apply to interest, dividends, annuities, royalties and rents.

Along with Occupy Wall Street, it’s apparent Washington has the so-called 1% of top earners in its sights. No matter that the top percentile already accounts for 37% of taxes. And Obama’s call for higher taxes on million-dollar earners comes as Republican presidential candidate Mitt Romney published his 2010 taxes, which showed he was taxed at less than a 15% rate owing to his income coming from dividends and capital gains.

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If elected president, Mitt Romney might consider ending a tax break that helped the former Massachusetts governor accumulate his fortune, an aide suggested Tuesday.

The comments came as the Romney campaign made available more than 500 pages of tax-return data for 2010 and 2011 amid signs the issue was hurting him with some voters.

Later in the day, in a signal of how the tax issue is roiling the GOP campaign, the Romney camp tried to step back from the aide’s remarks, underscoring that the former Massachusetts governor didn’t want to raise anyone’s taxes.

The back-and-forth Tuesday about Mr. Romney’s approach to one particular tax break began when Lanhee Chen, the candidate’s policy director, indicated in a call with reporters the candidate might be willing to reconsider a tax break known as “carried interest” as part of a comprehensive tax overhaul. The break gives private-equity and venture-capital executives a relatively low 15% tax rate on much of their income.

[More from WSJ.com: Megaupload’s Ripple Effect]

Carried interest is a share of profits from an investment fund or partnership given to managers as compensation. Mr. Romney was aided by the tax advantage as founder of private-equity firm Bain Capital.

Mr. Chen noted Mr. Romney hasn’t recently addressed retention of the carried-interest break. He spoke favorably of it in 2008. There are “a number of exemptions, deductions, credits, administrative treatment of income…that would be addressed in tax reform,” Mr. Chen said.

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The Federal Reserve will release its latest policy statement tomorrow afternoon, shortly after which Chairman Ben Bernanke will hold his quarterly press conference. Unlike the obfuscation that characterized the Greenspan era, Chairman Ben loves to verbally get down with the common man, becoming increasingly transparent as his term has progressed.

Increased openness isn’t the only change at the Fed. This is the first meeting for two new voting FOMC members as well as the launch of a program in which each voter actually gives their own economic forecast. “It’s a lot of new information from the Fed,” understates Jim Bianco, president of Bianco Research, in the attached clip.

Given how closely every utterance from the Fed is scrutinized, the increased transparency is apt to be a mixed blessing for traders, at least in the near-term.

“The history of Fed transparency has become very clear,” says Bianco. “Every time the Fed comes up with a new scheme to increase transparency, the market misreads it; the market reads into things that aren’t there and they overreact or they under-react.”

For less active traders the main question is whether or not “QE3” –or another round of quantitative easing– is in the cards.

Bianco says it won’t be tomorrow’s business but an additional round of the stock market’s favorite form of stimulus remains in play.

“QE3 has a less than 50% chance of happening; not completely dead but not completely on,” he predicts. Basically, another round of QE will stay in reserve just in case the economy starts slowing once more.

As for the press conference, if Bianco could hear just one thing from Bernanke it would be a definitive answer to the above-mentioned conflict between time or inflation targeting. Bianco says Bernanke is a closeted inflation target guy. That being the case, Bianco’s dream statement from Bernanke would be a definitive statement of the specific level to watch.

“If the inflation rate goes above this level we tighten, if it goes below this level we ease, and if stays in the middle we do nothing,” he says.

When economists dream, they want to know about price targeting. When traders dream, they generally want a huge knee jerk reaction so they can move to the other side. When normal human beings dream, they’d rather they didn’t have to listen to the Federal Reserve at all.

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You can almost hear the catchy notes from the musical “Guys and Dolls” as the U.S. banking sector struggles to put its troubled past behind it.

More than four years have elapsed since the bursting of a housing bubble that caused a devastating financial crisis, but its alleged victims and perpetrators—there is overlap between the categories—are still fighting over the spoils.

Federal and state regulators, consumer groups, large investors and government-owned agencies are pursuing multibillion-dollar claims against banks over the mortgage mess.

“I have never seen anything like this in my career,” the veteran lawyer Andrew L. Sandler, chairman and executive partner of Buckley Sandler, told me. “Everybody is going after each other: consumers, investors, regulators. This focus on blame rather than solutions is not going to solve the problem.”

The result: Legal issues are contributing to the disarray in the housing market, weighing down financial groups with huge provisions for potential losses and bamboozling an investor community already fretting about banks’ returns and business models.

Maybe, just maybe, in the next month or so, large lenders will finally settle most state and federal probes into alleged foreclosure improprieties. But even that long-awaited package of concessions and fines, possibly worth some $20 billion, won’t be enough to spell the end of the legal morass.

Lawsuits from the private sector will continue for years. Rules introduced since the turmoil, such as a controversial cap on debit-card fees, are spawning fresh litigation. New watchdogs, such as the Consumer Financial Protection Bureau, are sharpening their legal knives.

A Wall Street executive put it best: “Banks have become the Big Tobacco of the modern era: a large target with big pockets for people to sue.” But with much smaller margins in their core business, I would add.

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If the theme of tonight’s State of the Union address is fairness, then President Obama would be wise to steer clear of housing; most of the proposals to fix the nation’s still struggling real estate market are intrinsically unfair to a large majority of Americans.

From a mass refinance plan to mass mortgage principal forgiveness, the supposed “fixes” will reward some at the expense of far more.

Let’s start with that principal forgiveness. Some Democrats have been hounding the regulator of Fannie Mae and Freddie Mac (the FHFA and its leader Ed DeMarco) to initiate a program to reduce the value of mortgages where the mortgage is larger than the value of the home, i.e. “underwater”. The idea is that this will keep those borrowers from defaulting on these mortgages.

DeMarco is against this, so Democrats, or at least Rep. Elijah Cummings, the ranking Democrat on the House Oversight Committee, went so far as to request proof of Demarco’s contention that such a program would do more harm than good. This after the Federal Reserve officials, in a recent “White Paper,” suggested, “some actions that cause greater losses to be sustained by the [GSE’s] in the near term might be in the interest of taxpayers to pursue if those actions result in a quicker and more vigorous economic recovery.”

The losses to Fannie and Freddie, according to DeMarco, would be somewhere around $100 billion, if they were to write down principal on all 3 million underwater mortgages backed by the two. That money, DeMarco noted in a letter back to the Congressman, would come from taxpayers, who have already footed a $150 billion bill from Fannie and Freddie.

Then there’s that pesky refi plan that’s been floating around for a few years now. The idea is that Fannie and Freddie would refinance about 14 million of their own borrowers to 4 percent or less, as long as the borrowers are current on their loans. This would supposedly juice the economy with household savings of about $36 billion a year. Administration officials have already told me they are not considering such a program as it is too expensive in too many ways. And then there’s that fairness issue again, as in why should the government fund refinances for borrowers with Fannie and Freddie loans but not for the other half of American borrowers who don’t have Fannie and Freddie loans?

We can, however, look for the president to say something about the current expansion of the government’s refinance program for underwater borrowers, and we’re eager to hear how he thinks it’s going, given that it has fallen under harsh criticism for helping too few borrowers. Perhaps he might want to change/expand that program, but then again details are not exactly popular in State of the Union addresses historically.

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Federal Reserve Bank of Philadelphia President Charles Plosser was answering reporters’ questions two weeks ago when he paused to seek their assistance on the Fed’s campaign to open up to the public.

“Help me out here,” Plosser said after a Jan. 11 speech in Rochester, New York. “There’s a huge confusion about this,” he said, referring to Fed plans to start releasing policy makers’ forecasts for the benchmark interest rate tomorrow.

Plosser said he was concerned investors might misinterpret the projections as a pledge to keep borrowing costs low for a specified period. That could make it harder for the central bank to raise interest rates should the need arise, said Stephen Stanley, chief economist at Pierpont Securities LLC in Stamford, Connecticut.

“It’s not at all clear how people are supposed to react” to the Fed’s new communications policy, Stanley said. “If it does start to take on that sense of being a commitment,” he said, “it runs a great risk in terms of their credibility when they end up not being able to stick to it.”

The Federal Open Market Committee plans to release all 17 policy makers’ rate projections for the fourth quarter of 2012, the next few years and the long run, as well as an explanation for their assessments. The Fed will provide the information at the conclusion of a two-day meeting tomorrow. The FOMC convened today at about 10 a.m.

Views Voiced

The decision to announce the projections is the latest effort by Chairman Ben S. Bernanke to increase openness and public understanding of the Fed. Since becoming chairman in 2006, Bernanke has begun holding regular press conferences and voiced his views in television interviews and at town hall meetings. He’s also announced forecasts on economic growth, unemployment and inflation four times a year, up from twice annually under his predecessor, Alan Greenspan.

Chicago Fed President Charles Evans, who this month reiterated his call for adding more stimulus, said on Jan. 13 that the central bank’s “enhanced communications” mark a “substantial, first-order improvement” over the Fed’s previous efforts. Publishing the projections will help the public better evaluate the committee’s views, while allowing monetary policy to “respond more strongly in the medium-term when adverse economic shocks impede growth and employment,” he said.

Policy makers want to telegraph their expectations for the appropriate path for the overnight lending rate between banks, Plosser said. That shouldn’t be confused as a commitment on the level of interest rates.

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In some ways it seems fitting – even telling – that the hottest stock in the Dow Jones Industrial Average over the past year comes down with a cold during January earnings season. It would be hard to say that McDonald’s (MCD) did anything wrong given the $27.2 billion record high revenues raked in last year, as well as record net income of $5.5 billion.

And despite beating bottom line estimates by 3-cents and matching sales, McDonald’s shares are shedding more than 2% on the news.

It should be pointed out that the fast-food giant’s decline is from a record high that was attained, as Macke says in the attached clip, through “perennial out-performance that warms my cockles of heart.”

From my standpoint, it is for that very same reason that this super-sized $100 billion business looks increasingly ripe to disappoint. It may be years away, or as soon as next quarter, but the burger baron is on a roll and its trajectory over the past year looks unsustainably steep, making its premium P/E ratio of 19 times 2012 estimates more difficult to justify because the fry oil is heating up.

Verizon (VZ) also reported record revenue growth today that matched expectations, but its muddled path to an ex-items bottom line miss by a penny is cause for concern in some circles.

“Ex-items are not all created equally, and VZ’s ex-items make sense,” Macke says.

What he is referring to is a net loss that came as the result of pension obligations, a legacy problem from the dark days that masks the sizzle of smartphones – which Verizon sold a lot of, and spent a lot doing so. Officially, 56% of 7.7 million smartphones it sold were iPhones (which means 44% weren’t), which drove 13% and 19% growth in its wireless and data businesses.

The other silver lining in this Macke-branded “consumer/utility/IT play” is every dip drives its dividend higher, which at last check was yielding 5.3%, which happens to be about 2.5-times the take on a 10-year Treasury.

And finally, we tear apart Johnson & Johnson (JNJ), the global healthcare conglomerate who’s defensive appeal outweighs its 4% sales growth. J&J comfortably beat on the bottom line with EPS of $1.13 versus $1.09 estimates. While its aforementioned low-single-digit revenue growth met analysts targets, a 10% jump in foreign sales was able to mask a 3.4% slide on the domestic side.

J&J is also one of the few to give full year guidance today. They guided cautiously on 2012, looking for $5.00 – $5.15 per share versus consensus at $5.21.

While Verizon and AT&T pay larger dividends, the fact that J&J is one of only four U.S. companies t0 carry a AAA-rating makes its 3.5% yield even more appealing. As does the fact that if and when they increase it again in April, it will mark the 50th consecutive year they have raised their dividend.

Jan 20 (IFR) – European banks are preparing for a potential worsening of the region’s sovereign and banking crisis, with many firms stockpiling cash and cutting back on loans to new clients as they seek to protect themselves against a possible seizing-up of financial markets.

Faced with 650 billion euros of debt coming due this year – almost 40 percent of which matures before the end of March – lenders are choosing to build up a cash cushion to ensure they can cover redemptions, creating a squeeze on the wider economy in the process.

Such hoarding illustrates the nervousness of lenders even after the European Central Bank injected 489 billion euros of cash into the banking system in December. Cash deposits at the ECB have ballooned since then, reaching a record 528 billion euros this week – higher than after the Lehman Brothers collapse.

“The big concern is that things might get worse,” said Bernd Hartwig, treasury manager at Nord/LB. “Political decisions are taking too long and most banks are building up liquidity just in case something happens. They are very worried that a new crisis could be a bigger than 2008.”

System-wide hoarding is the reverse of what happened the last time central banks injected hundreds of billions of long-term money into the system. Then, banks moved quickly to put the money to work and generate returns, sparking bond and equity market rallies – and economic growth.

The US Federal Reserve almost trebled the size of its balance sheet to more than $2 trillion in the months after the collapse of Lehman Brothers, pumping cash into the banking system through programs such as the Term Auction Facility. The ECB grew its balance sheet by about a quarter in that time.

NEW YORK (AP) – Bank of America says it made $2 billion in the last three months of 2011 from selling its stake in a Chinese bank and selling debt. That offset losses and higher legal expenses in its mortgage business.

The bank said Thursday that it earned 15 cents per share, falling short of the 22 cents a share expected by analysts surveyed by data provider FactSet. In the same quarter last year, the bank lost $1.2 billion.

The bank is selling parts of the business that don’t fit into its basic banking model. For the year, the bank made $1.4 billion, compared with a loss of $2.2 billion in 2010.

Bank of America shares are up almost 4 percent to $7.05 in pre-market trading.

Which is to say they sold the most cars. Don’t worry, their corporate culture is still a huge pile of shit.

DETROIT (AP) – General Motors sold just over 9 million cars and trucks worldwide last year to reclaim the title of the world’s top-selling automaker.

The company says it sold 9.03 million vehicles last year, up 7.6 percent from 2010.

That beat Toyota, which took the crown away from GM in 2008. Toyota sold 7.9 million vehicles last year. The March earthquake in Japan cut Toyota’s factory production and hurt its sales.

Germany’s Volkswagen took second place with a record 8.156 million sales in 2011. That was up 14 percent over 2010.

Before 2008, GM had held the title for more than seven decades.

The title doesn’t mean much to GM’s bottom line. But it’s an example of how far the company has come since it nearly collapsed in financial ruin in 2009.

BREAKING:

There is nothing new occuring in the world this afternoon, as everyone seems to have taken the day off.

That is all.

CNBC – 53 minutes ago

Natural-gas futures hit a fresh 10-year low Thursday and will likely decline further as the latest supply data confirms an abundance of U.S. gas supplies amid new predictions for a warm winter.

“We just got a report from NOAA about February temperatures being above average,” said John Kilduff of Again Capital. “That means there’s going to be below normal demand for the time being. It’s good news for consumers, and as far as natural gas prices go, you can only argue for them to go lower and lower.”

Natural gas futures (New York Mercantile Exchange: NGCV1) touched $2.33 per million BTUs Thursday, the lowest price for the front month contract since March, 2002. The U.S. Energy Information Administration reported that total domestic gas inventories fell by 87 billion cubic feet, less than expected, to 3.290 trillion cubic feet.

A new forecast from the National Oceanic and Atmospheric Administration Thursday predicted February temperatures for most of the central and eastern U.S. would be above normal. Temperatures will be most above normal from the southern mid-Atlantic states through the deep south, while the Pacific Northwest will see below normal temperatures.

Kilduff said the storage estimates for the winter season’s end, March 31, range from about 2 to 2.4 trillion cubic feet, well above the average 1.5 trillion cubic feet.

“This is a classic case of oversupply,” said Daniel Yergin, chairman of IHS CERA. done at request for office of fossil energy

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Mitt Romney’s candidacy has pushed the private equity industry to the fore of the political campaign. Romney isn’t basing his candidacy on his technocratic tenure as the governor of Massachusetts. No, he’s fleeing from it the way Captain Schettino fled the stricken Cost Concordia. Rather, Romney is banking on his tenure at the private equity firm Bain Capital — experience that his given him the knowledge to fix the ailing U.S. economy. What the country really needs right now, he argues, is a p.e. guy in the White House.

Detractors and supporters of both Romney and the private equity industry have tossed out a range of arguments, rhetoric and data to support their contentions. And if Romney becomes the nominee, as seems likely, it’s also likely that private equity terms of art such as “carried interest,” “dividend recapitalizations,” and “Further Lane” will fall into common usage. As the debate heats up, here are a few things worth keeping in mind.

Private Equity Pros are People. Private equity executives are not soulless, rapacious monsters who have no concept of how most Americans live. Well, not all of them. In twenty years working in New York, I’ve gotten to know a bunch of them. I’ve interviewed most of the biggest names, profiled some, visited their (massive) homes, observed them in their native habitats (Davos, Aspen, charity galas), shared breakfast with a couple who were interested in hiring me as a ghostwriter (I’ll never tell), and a lifetime ago worked as a research assistant for a book about one of the industry’s pioneers. Private equity firms contain the same mix of personalities and types you find elsewhere in the financial industry, and in the corporate world, albeit with better clothes and a lot more money. There are: Republicans and Democrats; sweethearts and world-class putzes; connoisseurs and philistines; public-minded spirits and greedy pigs. In and of itself, the industry isn’t evil or virtuous. It’s neither the savior of American capitalism nor the trigger of its demise. It just is.

Doing it for the People. Private equity depends largely on other people’s money. And in many instances those “other people” are what Mitt Romney might refer to as the common folk, if you will. From its inception, the private equity industry has relied disproportionately on public employee pension funds for its capital. Oregon’s state employee pension plan was one of the first major backers of Kohlberg, Kravis & Roberts and remains a huge investor. Look at the annual report of the California Employees Retirement System. The section that details the pension funds’ holdings in “Alternative Investment Management” — i.e. private equity and hedge funds — runs 12 pages and amounts to tens of billions of dollars. (You can see it by clicking on the tab that says “Corporate Restructuring” and then scrolling down). The 2010 CALPERS report shows about $800 million invested in the Blackstone Group’s corporate restructuring funds alone. So, yes, private equity firms are trying to make money for themselves, but they’re making more money for DMV clerks in San Bernardino and teachers in Portland. The symbiosis between public employee pension funds and private equity firms is one of the greatest unacknowledged ironies in modern finance.

Whatever Works. Like Mitt Romney, private equity pros tend to be highly pragmatic. They don’t invest based on an ideology, or a social goal, or a cause. (When they do — i.e., when former Reagan official David Stockman set up Heartland Industrial Partners, aimed at reviving Midwestern industrial companies — they tend to strike out.) All this talk about whether private equity firms, or Bain, or Romney, created or destroyed jobs is irrelevant. Private equity firms exist to make profits. If they can do so by taking a small business and making it much larger and hiring tens of thousands of people, that’s what they’ll do. If they determine that the only way to turn a profit is to restructure and fire people, that’s what they’ll do. Raise wages or lower wages. Offshore or onshore. Innovate or milk existing technologies. Pollute the environment or clean it up. They’re like the honey badger. They don’t care. Methods and optics don’t matter. Only the result. Contributing to the public good and being a useful citizen is something you do with the fortune you’ve made in public equity.

Free Enterprise? Try Fee Enterprise. One of the most ludicrous parts of the private equity debate has been Mitt Romney’s efforts to equate an attack on Bain Capital with an attack on the free enterprise system itself. Yes, private equity firms rely on, and in some ways personify, the free market system. But there are plenty of aspects of the business model that Adam Smith might not recognize. In theory, private equity firms live and die based on the returns they generate for investors. They take 20 percent of the profits. Free Enterprise-y!

But fees that are totally unrelated to performance also play a very large role in the business model, especially for the largest firms. Private equity firms charge investors annual management fees of about two percent. The Blackstone Group says it had $37 billion in fee-earning assets in private equity funds as of September 30, 2011. In other words, Blackstone will collect a minimum of $740 million in fees — whether it has an up year or a down year. (Not so Free Enterprise-y!) And that’s just the beginning. Some private equity firms charge fees to investors when they execute a deal. Others charge fees to the companies they buy for providing management and oversight services. Again, these fees are paid regardless of performance. (Even less Free Enterprise-y!)

Here’s something that is not at all Free Enterprise-y. To a degree, the incentives of the investment firms and their clients are aligned: The firm gets to keep 20 percent of the profits it generates. No profit, no performance fee. But there’s no loss-sharing to go along with the gain-sharing. If a private equity fund makes a series of bad investments, the outside investors’ downside is unlimited. But firms don’t “share” the losses with their clients, or refund fees.

Some Call it Profits. Private equity funds also have a funny way of defining investment returns. In theory, the model is rather simple: buy low, fix a company, build a business, make it more attractive to investors, sell high and bank the profit. It can take several years, which is why most private equity funds lock up their investors for several years. Historically, that’s how the most successful firms have conducted business. That’s capitalism. And it can be very hard work.

But in recent years, the industry frequently looked for an easy way out. Try this on for size: Buy a company for $200 million, putting $100 million down and borrowing $100 million. Once you gain control of the company, have it issue $200 million in debt and then use the proceeds to pay a dividend to the new owners — i.e., you. Boom: a 100 percent return, $100 million in profits. But it has nothing to do with the company’s performance. This is known in the trade as a “dividend recapitalization.” Bain Capital did it several times, and so has every other private equity firm. The problem? Well, if the underlying business sours, or if market or economic trends turn down, companies may find they can’t service the new debt and wind up filing for bankruptcy. And that causes all sorts of problems for lenders, employees, suppliers and the government. Besides, this isn’t really capitalism or investing. It’s just borrowing money and calling it income. Private-equity-backed companies that do dividend recapitalizations and then go bust are no different than homeowners who take home equity lines of credit on their already mortgaged homes, treat it as income, spend it elsewhere, and then walk away from the mortgage.

Failure is an Option. A certain percentage of private-equity deals fail. Not every investment works out. Many succeed, some tank. That’s a trope Romney has sounded time and again, and will likely continue to do, in his defense. But here’s the thing: In many of these instances, the investments failed because the private equity backers were simply unwilling to make the sort of efforts that other business owners and consumers do to make their financial ventures succeed. To a degree, the viability of the industry relies on being able to walk away.

Some of the people who fall behind on mortgages or other financial obligations default right away. But most people don’t. They do what is necessary to stay current. They cut spending elsewhere, stop saving, sell a car, or silverware, or jewels, or borrow from their 401(K)s, or put their ski house on the market. Private equity firms don’t do this. Let’s say a portfolio company runs into trouble, and needs $50 million to stay current on its debt, or to meet pension obligations. The company itself may not have the cash. But the guys who own it — the fund, the firm, the individuals behind the firm — certainly do. Cerberus, the private equity firm that sent Chrysler spiraling into bankruptcy, is run by a multi-billionaire, Kenneth Feinberg. Most of the private-equity-backed companies that filed for bankruptcy could have been saved. Their owners could have deployed unused cash in their funds, or sold successful investments within funds to provide new capital. Partners could have tapped into their own massive resources to help. But that’s not how they roll. Private equity is a highly unsentimental business, and one in which it is perfectly acceptable not to meet financial obligations. Private equity almost never throws good money after bad. And so we have this recurring dichotomy of companies controlled by private equity firms failing, refusing to make debt payments, ripping up leases, cutting off employees’ health insurance, and puking pension obligations onto the Pension Benefit Guaranty Corp. — all while their owners buy new jets, make splashy charitable donations, or spend millions running for elected office.

Taxing Issue. Finally, the special tax treatment that private equity receives is a joke. And it helps explain why Romney is a problematic messenger for a party that wants to cut taxes on the wealthy while reducing services to the middle class. Private equity firms take 20 percent of the profits they generate as a fee. It’s a fee they get paid for putting other people’s money at risk. But thanks to the “carried interest” loophole, it’s taxed at the low capital gains rate of 15 percent. In other words, the government treats this income as if they were putting their own money at risk. As one well-known capitalism-hating, left-wing class warrior tweeted the other day: “Can understand [Occupy Wall Street’s] resentment of extreme inequalities, but how about fund managers only paying cap gains tax without risking a penny?” Oh wait, that was Rupert Murdoch.

You have to feel for Romney. He didn’t make the rules, or invent the industry. He went into an established field, performed remarkably well, went into public service, and benefits from a tax regime that others put into place. And I don’t expect that, if elected president, he would run the country the way private equity firms run their own business. In the “quiet rooms” where he wants income inequality to be discussed, I’m sure he’d agree that it wouldn’t kill the industry to be taxed at a higher rate.

Don’t hate the player, hate the game. That certainly applies here. But if the game is so unlovable, do you really want to put one of its best players in charge of setting the rules?

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The big Wall Street banks have achieved so much control over their industry that they amount to an illegal cartel, says William Cohan, a former banker and the author of many books and articles about Wall Street, including “Money And Power,” a book about Goldman Sachs.

The pricing power and profits that the big banks have is similar to that of Standard Oil, Cohan argues, referring to the gigantic oil monopoly owned by John Rockefeller that was broken up a century ago.

Cohan observes that prices of transactions like IPOs and M&A deals are basically fixed across the industry and produce humongous profits. And smaller “boutique” firms are not able to compete on price because they lack the distribution and influence of the biggest banks.

Cohan believes that the government should intervene, breaking the cartel’s stranglehold. He notes, however, that a prior case brought against the industry 60 years ago failed. And even if the government were to successfully intervene, the specific remedy is not clear.

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Another one bites the dust.

Companies fail all the time, but the last few years have seen an unusual parade of marquee names that once transformed or dominated their industries headed for bankruptcy court: General Motors, Chrysler, Blockbuster, Borders, Circuit City, and of course Lehman Brothers.

Now Eastman Kodak has declared bankruptcy, yet another victim of a technology revolution that moved too fast for a big, lumbering firm to keep up with. Kodak, of course, dominated consumer photography for more than a century, first with its inexpensive cameras and then with its ubiquitous film and photographic paper. For years, Kodak was one of the most recognizable brands in the world.

As with many fading giants, Kodak’s demise took place over decades and was imperceptible at first. Kodak invented the digital camera in the 1970s, yet sat on the technology, fearful that filmless cameras would cannibalize its core business. Competitors such as Fuji, meanwhile, nibbled away at its market share, often undercutting it on price. By the early 2000s, digital cameras finally became affordable and commonplace, and film was out.

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Yesterday on Breakout we featured Yossi Beinart, the CEO of a company trying to get CFTC clearance to legalize the trading of futures contracts on the outcome of the 2012 elections. Beinart’s firm would allow traders to, in effect, wager on the winner of the Presidency as well as control of the House and Senate.

Suffice it to say Beinart’s is a controversial idea.

I sat down with my co-host, Matt Nesto to debate the merits of “wagering” on political events in general.

Taking the con side of the debate, Nesto’s arguments are as follows:

*The CFTC has a spotty, at best, record of regulating the markets that exist today. They have enough to do without adding a gimmick like election futures.

*Capping the nominal value of contracts purchased at $250,000 in itself invalidates the argument of the trading activity adding any economic value. Firms looking to “hedge” various outcomes need a much higher limit to impact their economic fate. Individuals have no way to justify bets of a quarter of a million on election results.

*There’s no economic need being met here; it’s simply wagering.

Read the whole remark here:

My remarks today will focus on some of the issues faced in developing the interagency proposal. As I have previously noted in Congressional testimony, the goal of the Federal Reserve with respect to this and all other provisions of the Dodd-Frank Act, is to implement the statute in a manner that is faithful to the language of the statute and that maximizes financial stability and other social benefits at the least cost to credit availability and economic growth.

The Federal Reserve, the Office of the Comptroller of the Currency (OCC), the Federal Deposit Insurance Corporation (FDIC), and the Securities and Exchange Commission (SEC) (collectively, the “agencies”) in November sought public comment on a proposal to implement the Volcker Rule. The Commodities Futures Trading Commission (CFTC) recently issued its substantially similar proposal for comment. Because of the importance and complexity of the issues raised by the statutory provisions that make up the Volcker Rule, the agencies initially provided the public a 90-day opportunity to submit comments. We recently extended the comment period for an additional 30 days, until February 13, 2012. The Federal Reserve welcomes comments on Volcker Rule implementation and has had numerous meetings with members of the public on this subject. We continue to post on our website all the comments that we receive and a summary of all the meetings that the Federal Reserve has had with members of the public about the Volcker Rule and all other provisions of the Dodd-Frank Act.

Summary of statute and proposal
The statutory provisions that make up the Volcker Rule generally prohibit banking entities from engaging in two types of activities: 1) proprietary trading and 2) acquiring an ownership interest in, sponsoring, or having certain relationships with a hedge fund or private equity fund (each a covered fund). These statutory provisions apply, in general, to insured depository institutions; companies that control an insured depository institution; and foreign banks with a branch, agency, or subsidiary bank in the United States, as well as to an affiliate of one of these entities.

Under the statute, proprietary trading is defined as taking a position as principal in any security, derivative, option, or contract for sale of a commodity for future delivery for the purpose of selling that position in the near term or otherwise with the intent to resell to profit from short-term price movements. The statute applies only to positions taken by a banking entity as principal for the purpose of making short-term profits; it does not apply to positions taken for long-term or investment purposes. Moreover, the statute contains a number of exemptions, including for underwriting, market making-related activities, and risk-mitigating hedging activities. The implementing rule proposed by the agencies incorporates all of these statutory definitions and exemptions. The statute also authorizes the relevant regulatory agencies to permit additional activities if they would promote and protect safety and soundness of the banking entity and the financial stability of the United States.

The second major prohibition in the statute forbids any banking entity from acquiring or retaining an ownership interest in, or having certain relationships with, a covered fund. Again, the statute contains a number of exceptions, including for organizing and offering a covered fund, making limited investments in a covered fund, sponsoring and investing in loan securitizations, and risk-mitigating hedging activities. The statutory definition of a fund covered under the Volcker Rule is quite broad. The statute also quite broadly prohibits any banking entity that serves as the investment manager, adviser, or sponsor to a covered fund, or that organizes and offers a covered fund, from engaging in certain transactions with the fund, including lending to, or purchasing assets from, the fund.

The statute also prohibits otherwise permissible trading and investment activities when there is a material conflict of interest with customers, clients, or counterparties, or when the activity results in an exposure to high-risk assets or trading strategies. These are significant provisions and the agencies have specifically solicited comment on disclosure requirements and other approaches to implementing these parts of the statute.

Differentiating proprietary trading from market making
One of the more difficult tasks in implementing the statutory prohibitions is distinguishing between prohibited proprietary trading activities and permissible market-making activities. This distinction is important because of the key role that market makers play in facilitating liquid markets in securities, derivatives, and other assets.

At the ends of the spectrum, the distinction between pure proprietary trading and market making is straightforward. At one end, for instance, trading activities that are organized within a discrete business unit, and that are conducted solely for the purpose of executing trading strategies that are expected to produce short-term profits without any connection to customer facilitation or intermediation, are not difficult to identify. These “internal hedge fund” operations existed at many bank affiliates for quite some time before the Volcker Rule was enacted. Firms that either are or were engaged in these non-client-oriented, purely proprietary trading businesses can readily identify and wind down these activities. Indeed, some have already done so for a number of reasons, including anticipatory compliance with the Volcker Rule.

At the other end of the spectrum, a textbook example would be a pure agency-based market maker that acts as an intermediary, instantaneously matching a large pool of buyers and sellers of an underlying asset without ever having to take a position in the asset itself. Profits are earned either solely by charging buyers a higher price than is paid to sellers of the asset, or in some cases by charging a commission. Buyers and sellers willingly pay this “spread” fee or commission because the market maker is able to more quickly and efficiently match buyers with sellers than if they were left to find each other on their own.

I refer to this as a textbook example because instances of such riskless market making in our trading markets are rare. In actual markets, buyers and sellers arrive at different times, in staggered numbers and often have demands for similar but not identical assets. Market makers hold inventory and manage exposures to the assets in which they make markets to ensure that they can continuously serve the needs of their customers.

Accordingly, in the broad middle that exists between these two clear examples, the distinction between prohibited proprietary trading and permissible market making can be difficult to draw, because these activities share several important characteristics. In both activities, the banking entity generally acts as principal in trading the underlying position, holds that position for only a relatively short period of time, and enjoys profits (and suffers losses) from any price variation in the position over the period the position is held. Thus, the purchase or sale of a specific block of securities is not obviously permissible or forbidden based solely on the features of the transaction itself. The statute instead distinguishes between these activities by looking to the purpose of the trade and the intent of the trader. These subjective characteristics can be difficult to discern in practice, particularly in the context of complex global trading markets in which a firm may engage in thousands or more transactions per day. A similar challenge attaches to efforts to distinguish a hedging trade from a proprietary trade.

Implementation framework
The agencies have proposed a framework for implementation of the Volcker Rule that combines: 1) an explanation of the factors the agencies expect to use to differentiate prohibited activities from permitted activities, 2) a requirement that banking entities with significant trading activities implement a program to monitor their activities to ensure compliance with the statute, and 3) data collection and reporting requirements, to facilitate both compliance monitoring and the development of more specific guidance over time. In addition, the agencies will use their supervisory and examination processes to monitor compliance with the statute.

The third element of the interagency proposal bears some additional comment. In order to help differentiate between permitted market-making activities and prohibited proprietary trading activities, the agencies have proposed to collect data from trading firms on a number of quantitative measurements. These metrics are designed to assist both the agencies and banking entities in identifying the risks and characteristics of prohibited proprietary trading and exempt activities. The proposal makes clear that metrics would be used as a tool, but not as a dispositive factor for defining permissible activities. The agencies instead propose to use metrics to identify activity that merits special scrutiny by banking entities and examiners in their evaluation of the activities of firms. The proposed rule does not include specific thresholds to trigger further scrutiny for individual metrics, but requests comment on whether thresholds would be useful, and notes that the agencies expect to propose them in the future. The proposal also makes clear that the agencies expect to take a heuristic approach to metrics, revising and refining them over time as greater experience is gained in reviewing, analyzing, and applying these measurements for purposes of identifying prohibited proprietary trading.

Additionally, since some banking entities engage in few or no activities covered by the statute, the proposal also includes a number of elements intended to reduce the burden of the proposed rule on smaller, less-complex banking entities. In particular, the agencies have proposed very limited compliance programs and have reduced or eliminated the data collection requirements for these banking entities.

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In the after market shares of Yahoo! (NASDAQ: YHOO – News) landed on the trader radar after word hit the Street that former CEO Jerry Yang resigned, suddenly, from his position on the Yahoo! board of directors.

Yang is the controversial figure who spurned a $33 offer from Microsoft in 2008, saying the offer was insufficient. At the time the stock was trading around $14.

Microsoft subsequently walked away from the negotiations and Yahoo! has been in a state of flux, ever since. Although the company later hired Carol Bartz to turn around its fortunes, she was removed from her position this past September, via phone call.

What should you make of these developments?

“Yang’s out – that’s very bullish,” says top trader Guy Adami.

NEW YORK (Reuters) – At least two senior hedge fund employees were being arrested as part of the government’s sweeping probe into insider trading, people familiar with the matter said on Wednesday.

The arrests reflect a widening of the government’s long-running probe into the alleged sharing of confidential information on publicly traded corporations with hedge fund managers and analysts. In the biggest case so far, onetime billionaire Raj Rajaratnam was convicted of insider trading and is now serving an 11-year prison term.

Anthony Chiasson, who co-founded the Level Global Investors hedge fund, is among those expected to face charges, and is turning himself in to authorities, one of the people said.

Todd Newman, who headed technology trading for Diamondback Capital Management from Boston, has also been arrested, another person said.

Newman had been placed on leave of absence in 2010 and subsequently was let go by that firm. Reuters in November reported the government’s interest in Newman.

Overall, charges against at least four people are expected to be unveiled on Wednesday, the people said. The charges are expected to be filed in U.S. District Court in Manhattan.

Jon Horvath, who is currently employed at Sigma Capital Management, a unit of Steven A. Cohen’s $14 billion hedge fund SAC Capital, was also arrested, one of the people said. A spokesman for SAC Capital could not immediately be reached for a comment. The identity of the fourth person could not immediately be confirmed.

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Goldman Sachs was once legendary for its trading prowess.

The traders were so admired and envied on Wall Street that people were convinced they had some kind of edge over their counterparts at other firms.

The theories varied, depending on who you asked. They were front-running hedge fund clients, manipulating markets, or using government connections to game policy. Other folks just thought the Goldman traders were smarter than every one else. People said that Goldman was a hedge fund disguised as an investment bank.

That all changed after the financial crisis.

Lawmakers passed rules to clamp down on proprietary trading by regulated banks. Goldman (NYSE: GS – News) reorganized itself to be, or appear to be, more client oriented, shutting down some internal hedge funds and eliminating proprietary trading desks. Trading at Goldman was no longer supposed to be about Goldman betting its own money, but about Goldman servicing client orders.

Whatever it was that once made Goldman the envy of Wall Street traders seems to have taken flight.