So, Steve Forbes thinks that Rudy Giuliani is the best free market candidate in the upcoming U.S. Presidential election.
Forbes is wrong. As noted in earlier posts here and here, Giuliani has a legacy of dubious prosecutions of businesspeople — most prominently Michael Milken — to further his own career. Forbes’ failure to mention Giuliani’s duplicity in the prosecution of one of the most important and productive businesspersons of the latter part of the 20th century reflects a troubling blindspot and a very short memory.

Gretchen Morgenson may be a credit snob, but U of Chicago economist Austan Goolsbee isn’t:

. . . When Senator Christopher J. Dodd, Democrat of Connecticut, gave his opening statement last week at the hearings lambasting the rise of ìrisky exotic and subprime mortgages,î he was actually tapping into a very old vein of suspicion against innovations in the mortgage market.
Almost every new form of mortgage lending ó from adjustable-rate mortgages to home equity lines of credit to no-money-down mortgages ó has tended to expand the pool of people who qualify but has also been greeted by a large number of people saying that it harms consumers and will fool people into thinking they can afford homes that they cannot.
Congress is contemplating a serious tightening of regulations to make the new forms of lending more difficult. New research from some of the leading housing economists in the country, however, examines the long history of mortgage market innovations and suggests that regulators should be mindful of the potential downside in tightening too much.
A study conducted by Kristopher Gerardi and Paul S. Willen from the Federal Reserve Bank of Boston and Harvey S. Rosen of Princeton, Do Households Benefit from Financial Deregulation and Innovation? The Case of the Mortgage Market (National Bureau of Economic Research Working Paper 12967), shows that the three decades from 1970 to 2000 witnessed an incredible flowering of new types of home loans. These innovations mainly served to give people power to make their own decisions about housing, and they ended up being quite sensible with their newfound access to capital. [. . .]
Also, the historical evidence suggests that cracking down on new mortgages may hit exactly the wrong people. As Professor Rosen explains, ìThe main thing that innovations in the mortgage market have done over the past 30 years is to let in the excluded: the young, the discriminated against, the people without a lot of money in the bank to use for a down payment.î It has allowed them access to mortgages whereas lenders would have once just turned them away. [. . .]
And do not forget that the vast majority of even subprime borrowers have been making their payments. Indeed, fewer than 15 percent of borrowers in this most risky group have even been delinquent on a payment, much less defaulted.
When contemplating ways to prevent excessive mortgages for the 13 percent of subprime borrowers whose loans go sour, regulators must be careful that they do not wreck the ability of the other 87 percent to obtain mortgages.
For be it ever so humble, there really is no place like home, even if it does come with a balloon payment mortgage.

Read the entire op-ed. And then think about the controlling mindset of the folks who decry the beneficial innovation that resulted in the subprime mortgage market. Are those the ones who we really want setting policy for the creation of jobs and wealth in America?

EGL chairman and CEO Jim Crane’s proposed private equity-financed buyout of Houston-based EGL, Inc is generating some interesting bidding action.
In an unusual move for a private-equity firm, Apollo Management LP sued EGL, Crane and the EGL board on Tuesday in Houston in an attempt to block the proposed sale of the company to Crane’s group and to seek access regarding due diligence inforamation that it contends that the company has refused to divulge to Apollo. At the same time, Apollo also raised its buyout offer by $1 a share to $41.
In a letter sent on Tuesday to a special committee of EGL’s board, Apollo complained that Crane had meddled in the sale process and said that the suit was an action “unprecedented in the almost 20-year history of our firm.” The new Apollo offer, valued at $1.9 billion, tops a $38-a-share bid from Crane’s group that the company accepted last week. It is conditioned on access to the information demanded in the suit and the elimination of a $30 million breakup fee that is a part of the Crane-led deal. Apollo contends that it is interested in EGL so it can combine the Houston-based company with another logistics company that it owns, CEVA Logistics.
Given that EGL’s stock price has increased by over 30% since Crane’s initial management-led bid for the the company spurred all this bidding, I wonder what Ben Stein would say about that?

Circling back to the topic of subprime mortgages, Marginal Revolution’s Alex Tabarrok cleverly notes that credit snobs such as the NY Times’ Gretchen Morgenson and the Houston Chronicle’s Loren Steffy have redefined the definition of loan shark:

Old definition:
A loan shark is a scumbag who charges the poor obscenely high rates of interest.
New definition:
A loan shark is a scumbag who charges the poor obscenely low rates of interest.

It’s certainly not for investors who are faint of heart, but private equity powerhouse The Blackstone Group is selling a portion of its equity in a widely-discussed initial public offering. Who better to dissect the delicious irony of a firm that specializes in taking public companies private making its own public offering than Larry Ribstein, who has been predicting for quite some time that partnership-type business entities would evolve to reshape the modern corporate entity. In this American.com piece, Professor Ribstein notes the implications of the Blackstone IPO for the future of the public corporation:

. . . [W]e shouldnít be surprised [by the Blackstone IPO]. The public offering is a glimpse into a business that is fundamentally transforming, and perhaps replacing, the modern corporation.
As Blackstone emphasizes in its offering materials, its proposal would create a different kind of public firm. Blackstone is not so much going public as going ìprivlic.î Initial public offerings once transferred control from entrepreneurs to dispersed public investors. Blackstoneís IPO doesnít transfer a smidgeon of control. . . . If all this seems confusing, the prospectus is at least clear about the bottom line: the real power at Blackstone lies above and below the publicly held entity thatís being inserted in the middle. The public investors can’t elect or replace the manager of their own firm, let alone those of the lower-level holding companies and the still lower level operating companies in Blackstoneís gigantic portfolio. Any voting power the new limited partners have amounts to a right to be outvoted by the existing owners. [. . .]
While the business columnists prate about ìshareholder democracy,î this prospectus shows us where business is really headed. These partnerships make publicly held corporations, which activists disparage as dictatorships, look like New England town meetings. The owners are not protected by voting, shareholder proposals, majority voting for directors, or any of the other paraphernalia of the publicly held firm. Rather, the ownersí solace lies in the regular distributions of cash, the managers’ high-powered incentive compensation, and the portfolio companiesí debt load, which concentrates their managersí attention producing enough cash to avoid bankruptcy. [. . .]
In short, vast chunks of corporate America are devolving back into the partnership form from which they grew back in the 19th century. This should not be so surprising. There were always tradeoffs between the benefits of diffuse public ownership of firms and the costs. Public markets enabled entrepreneurs to capitalize their ideas, owners to diversify risk, and information to be rapidly discounted in the price of firmís securities. But since thousands of diffuse owners cannot easily watch over their firms, managers are left free to serve themselves. Devices like independent directors, auditors, and takeovers might mitigate the problems, but they have costs and weaknesses, too. Hence the repeated calls for more managerial accountability, coupled with escalating regulation and criminal and civil liability. Blackstone and other private equity firms replace this whole structure with a new approach to accountabilityóexpert monitors, strong incentive compensation, and a commitment to distribute excess cash.

Read the entire piece, which is an example of how the blogosphere and the Internet are changing the way in which specialized information is processed and distributed. As recently as just a few years ago, this type of analysis would be found buried in the op-ed pages of a bricks and mortar publication such as the Wall Street Journal or Forbes, and even then the op-ed would likely come weeks after the announcement of the corresponding event. Now, the Blackstone IPO is announced last week and, by this week, multiple experts around the blogosphere and the Internet have provided extensive analysis and discussion of the legal and business issues raised by the IPO for all the world to see. Business law academics such as Professor Ribstein and Stephen Bainbridge have been at the forefront of this remarkable development, which is literally redefining the way in which the informed public will come to understand and act on important issues of our day and the future.
That’s a pretty darn good legacy in my book.

These earlier posts touched on what is often ignored among the handwringers in regard to the current downturn in the subprime mortgage market — that is, the beneficial risk-taking that resulted from innovation in the securitization of subprime mortgages. That risk-taking helped fuel the robust mortgage market over the past several years for folks who otherwise would not have had an opportunity to choose whether to take the risk of home ownership. Following along those lines, MR’s Alex Tabarrok makes a good point about the bias of many of the handwringers:

Yeah, we get it. Credit is ok for us, the “sober” borrowers but poor people can’t handle credit. Too much credit among the poor generates decay and social pathology. Credit must be regulated. We can’t, for example, have credit stores in poor neighborhoods. Don’t you know that credit is bad for people without self-discipline? Let the poor buy on installment credit? That’s unconscionable. Today’s furor over sub-prime mortgages is the same old story. [. . .]
The fact that there are defaults is partly a learning process in response to financial innovation, and thus evolution, but also partly a simple matter of risk. Defaults are to be expected. I see no reason to expect contagion. All lending statistics must now be marked to the global financial market which means that diversification is now more extensive than ever before and thus net risk is lower. Moreover, the whole point of recent financial innovation (and reformed bankruptcy law) has been to reallocate risk away from borrowers and towards those lenders in the world wide market for capital who are in the best position to handle the risk.
The democratization of credit worries the credit snobs. The credit snobs fear that capitalism isn’t just for the rich.

Touche’!

Ben Stein won’t like it, but the board of directors of global logistics company EGL, Inc. approved a $1.7 billion private equity buyout of the company by a group headed by chief executive officer Jim Crane, who is also the largest shareholder of the company. Previous posts on the private equity plays for EGL are here, here and here.
Crane will have 51% of the privatize company and the other 49% will be owned by private-equity firm Centerbridge Partners LP and Canada’s Woodbridge Co., which is the investment vehicle of the Thomson family, one of Canada’s wealthy Canadian family. The price of $38 a share represents over a 25% premium over the $29.75 price of EGL’s shares in late December. Crane’s previous buyout offer, which tanked after the release of less-than-stellar fourth quarter numbers, was based on a $36 per share price. EGL’s shares closed at $34.96 in Nasdaq Stock Market composite trading this past Friday.
Meanwhile, the Chronicle’s Bill Hensel is reporting today that a letter from New York-based Apollo Management has surfaced stating that it had put together a group that had offered an all-cash deal for EGL worth $2 a share more than the management-led buyout. No word yet on whether EGL’s board, in approving the management-led offer, had considered the competing bid, which will remain open until this Friday. The NY Times/Reuters story on the Apollo bid is here.
In its letter, Apollo claims to have left several voicemails and e-mails with the boardís special committee, its financial advisers at Deutsche Bank and its counsel at Andrew & Kurth. Also, Apollo claims that EGL refused to open its books to allow Apollo to conduct due diligence. Finally, Apollo asserts that the last written communication from the company was last Thursday, when EGL advised that ìbest and finalî bids were due March 26. As late as last Sunday, Deutsche had told Apollo that no deal was imminent. The following is from the letter:

We wonder what urgency the company saw in cutting this process short (without informing us or giving us a chance to exceed the C.E.O.ís bid) or in suddenly negotiating a deal at an inferior price and with, we suspect, breakup fees and other deal protections for the benefit of the CEO. That would not seem in the best interests of your shareholders, other than Mr. Crane personally.

So, even if Crane’s group is the winning bidder for EGL, he and the board will likely have to endure a shareholder’s lawsuit that they favored Crane’s lower bid over the non-insider, higher bid. Public equity is not looking all that attractive these days. Frankly, is anyone surprised?

The New York Times (see here and here) is not the only major metropolitan newspaper that employs a business columnist who doesn’t appreciate the benefits of a robust market in mortgage financing.
Channeling the Times’ Gretchen Morgenson, the Chronicle’s Loren Steffy decries the irresponsibility of those involved in the overheated subprime mortgage market. In so doing, he passes along an anecdote on how he resisted the temptation to take out a subprime mortgage to finance a home in Houston before he had sold his home in Dallas. Steffy suggests that he has financial discipline that both the subprime lending industry and most of the subprime borrowers lack. Maybe so, but what is clearer is that he doesn’t appreciate the benefit to him and other consumers of risk-taking in the subprime mortgage financing market.
Sure, there were a substantial number of people who took out subprime mortgages who didn’t have the financial capacity to pay them. A large number of those folks will default on their mortgages and lose their homes, which is unfortunate. However, the bigger losers will be the holders of the equity tranches of mortgage-backed securities (“MBS’s”) and subprime originators who are now left holding the bag with mortgages that they can’t sell. Don’t feel too sorry for them, though. Given that those investors made a lot of hay during the boom years, they are now simply enduring the risk of relaxing underwriting standards too much in an attempt to sustain the hot market. These are sophisticated investors and financial institutions that are willing and able to take the risks of these investments and to bear the losses associated with such risks.
Going forward, the number of subprime mortgages originated will go down, as will the number of subprime MSB’s sold into the market. Yields on the subprime MBS’s will likely rise and the underwriting standards will get stricter, so the supply of subprime mortgages will constrict to meet the reduced demand. The MBS’s and other financial products that have been developed to hedge risk in the subprime market are valuable tools to facilitate such a correction.
Which brings us back to Steffy. Perhaps he is more financially disciplined than those involved in the subprime mortgage market. Or perhaps he is has the same aversion to risk as Suze Orman. Whatever the reason, he decided not to take the risk of carrying two mortgages, which is fine. But another homeowner in the same position as he was might decide that taking on the subprime mortgage was worth the risk, which is fine, too.
The point is that the financing market for subprime mortgages gave Steffy a choice to engage in what could have been wealth-creating risk-taking. Nothing is wrong with electing not to take that risk. But it is wrong not to acknowledge that it is a good thing to have the opportunity to make that choice, which is what the subprime mortgage financing market provided.