Here’s how the growing corporate debt bubble could burst

by
Stephen Gandel

@FortuneMagazine

October 4, 2015, 9:00 AM EDT

Wall Street bankers have pushed corporate executives to become more and more comfortable with debt. Perhaps they have pushed too far.

Earlier last week, when worries started to emerge about mining company Glencore and whether it would be able to pay back its $30 billion in debt, fears quickly spread to the rest of the debt market. Investors sold corporate bonds, even investment grade ones, which are now down 2.6% for the year. And the spread between corporate yields and Treasury bond yields are now the highest they have been in three years. Indeed, the rise in the cost of corporate credit was widely cited as the reason why investors were nervous about the stock market this week.

Glencore doesn’t seem to be alone. Charter Communications, after its acquisition of Time Warner Cable, will have as much as $67 billion in debt. And the combination of AB Inbev and SABMiller could create a brewer with over $100 billion in debt.

So how worried should you be?

The message from Wall Street was, not very much. “This is not a Lehman moment” was something investors heard a lot last week. Yes, corporate debt is up, by about $1 trillion in the seven years since the financial crisis. But corporate equity is up as well, even more so. Within the S&P 500, the ratio of debt to equity, a key measure of financial health, dropped in half from around 200% in 2009, to 100% today, according to a June report from Barclays. This suggests that corporate balance sheets are stronger than they appear. “We haven’t seen a real material shift in credit quality,” wrote Jeffrey Meli, a fixed income analyst at Barclays. The June report said that, on average, companies should think about adding more debt, not shedding it.

But while equity has kept up with debt, corporate cash flows haven’t. At the end of second quarter, 62% of all companies had twice as much debt as cash flow from their operations, according to JPMorgan Chase. That’s up from 31% in the first quarter of 2006.

“That’s the stat that has got our attention,” says Tom Attenbury, whose FPA New Income bond fund FPNIX owns no investment grade corporate bonds. (He does own some high yield bonds because he says at least you are getting paid for the risk there.) “The investment grade space has been levering up.”

Still, the added debt has yet to be a problem. The default rate on investment grade corporate bonds over the past 12 months has been a whopping 0%, according to Standard & Poors. On U.S. high-yield bonds, it’s 2.5%, with energy making up a good portion of the troubled companies. Low interest rates mean that the average company has more than enough cash flow to keep paying its debt. But if corporate borrowing rates keep climbing, as they did this past week, or if the economy starts to slow down, that could change.

Josh Rosner, managing director of his own research firm and an early spotter of trouble before the financial crisis, is concerned. Corporate lending has been the fastest growing sector of the loan market. The volume of corporate loans outstanding is now 14% higher than it was before the financial crisis. And, much like the situation in the run up to financial crisis, there’s been a boom in lending to risky borrowers. Last year, investors bought nearly $312 billion high yield bonds, often called junk bonds, up from $146 billion in 2006, which was the peak before the financial crisis.

Later this month, the Federal Reserve will release its annual review of the risks that banks face. The Fed is likely to say that loan quality, particularly to oil industry borrowers, has deteriorated in the past year, according to a person with knowledge of the report. Corporate debt fears are likely to stay with us for a while.

Hype, growth, and chasing unicorns in tech

by
Stephen Gandel

@FortuneMagazine

September 3, 2015, 10:09 AM EDT

During the first tech bubble, I was going to retire by 30. I had stock options in a successful startup, a great career, and new opportunities seemed to be popping up every day. I knew a lot of people in the same boat. The potential of dotcom businesses seemed endless, and you could barely walk a block without tripping over a wheelbarrow of venture capital.

But then came the crash of 2000. Businesses that had been making headlines as game-changers, industry disruptors, revolutionaries, and visionaries, suddenly exploded. Even household tech companies we know today, like Amazon AMZN , saw shares drop from $107 to $7. Cisco’s CSCO stock dropped by 86%.

Today, whenever a new startup surpasses a $1 billion valuation, it’s hard not to think back to what fundamentally went wrong during the first tech bubble. And it’s hard not to wonder if—or when—things could go wrong again. Of course, this era of tech is different than the bubble of 2000, as venture capitalist Marc Andreessen has pointed out. He’s gone as far as saying that there is no bubble.

I agree. While these things come and go in cycles (and I’ve lived through two of them), the landscape this time around is much different. Billions of people around the world use the Internet. Entire digital ecosystems have come to life across mobile devices and changed the way we live our day-to-day lives.

What really throws people off today are the sky-high price tags of some valuations. Right now, more than 100 startups are valued over $1 billion. Some are warranted. Uber, Airbnb, and Spotify, for example, are all fundamentally changing markets. But sometimes, both investors and companies alike buy into a hype cycle that can inflate the valuation beyond what’s realistic.

The challenge now is to make sure that the hype of the valuation doesn’t completely outpace the business model. That’s how you can build long-lasting, innovative companies.

Hunting for unicorns

The word “unicorn” is often used to describe any startup that reaches a valuation of over $1 billion. No matter what service or product the business provides, a valuation that gets that high often invites skepticism.

But it’s important to keep in mind that there are some big winners. When Facebook FB first went public, there was a lot of skepticism about whether the magic would last. The IPO was one of the biggest in tech history, with a market capitalization that reached $104 billion. But, after going public at a share price of $38.23, the company’s shares are worth more than $90 apiece. Analysts have raised Facebook’s stock target to $120.

So unicorns—and dreams—do come true. It just isn’t easy. Venture capitalist Fred Wilson says that the expected batting average for early-stage investors breaks down to “1/3, 1/3, 1/3.” That means one out of three investments gets totally lost, one out of three returns the investment, and one out of three provides the bulk of the return.

Given that reality, it’s understandable that investors try to hunt down the big unicorns with big valuations. That’s also part of the reason why valuations start to spiral out of control as investors and attention follow “hot” companies. If you’re raising valuation based on hype instead of a true business model, that’s when it can spell trouble for investors, employees, and customers alike.

Growing between hype and high valuation

Every startup that depends on venture capital to stay in business is at the whim of the market. And the market is notoriously unpredictable, especially when it comes to the tech industry. New competitors can emerge literally overnight, or a new device or app can render your startup more or less obsolete.

If a valuation is based on hype, that’s when the music stops. Once the hype dies, the business has to stand on its own two feet.

That’s why, at Bitly, we don’t chase unicorns. Instead, we’ve focused on creating value and a sustainable growing business, with the belief that good things, including increased valuation for our shareholders will follow. It’s worked. We’ve built a loyal customer base ranging from artists and entrepreneurs to enterprise marketers and agencies. And our customers have helped us add immeasurable value to the business. We’ve doubled growth year over year and, at the same time, reached profitability as of this year.

That commitment to value and sustainability has put us in a good position. We can recruit the top talent we need and innovate on our product offerings without constantly looking over our shoulder worrying about things out of our control. At the same time, we can keep focusing on growing our business at a fast pace as we keep scaling.

Our investors and employees alike know that we’re building our business for long-term success, not just short-term gains. The same goes for our employees: Everyone knows that they’re going to have a job, regardless of whether we raise more money or not.

And, when you’re not always worried about funding, you can focus on what really matters: building a great product and providing an unforgettable customer experience.

Mark Josephson has been CEO of Bitly since July, 2013. He was previously CEO of Outside.in, a hyperlocal media company that was acquired by AOL in 2011 and merged with Patch.com, where he then served as a senior vice president. Prior to that, Mark was president of Internet marketer Seevast, and before that, he was general manager and executive vice president of About.com.

What unicorns can do when the bubble bursts

by
Stephen Gandel

@FortuneMagazine

July 1, 2015, 9:13 AM EDT

Entrepreneurship 101 suggests that smart startups conserve their cash, particularly if they are the kinds of startups that are trying to create entirely new markets. Savvy investors are supposed to reward the founders who adhere to this principle, and investors in public companies are even more likely to ask questions about where their money is going. Why then, is so much money sloshing around the so-called unicorns, the 90-plus firms worth more than a billion … more than 10 billion … more than 50 billion …?

For perspective, consider that office-sharing startup WeWork just announced a financing round that would put the company’s market capitalization at over $10 billion, more than half the market capitalization of Boston Properties, Inc., an office leasing competitor. Boston Properties owns more than 45 million square feet of real estate, with a focus on high-priced areas for offices. WeWork, in contrast, leases 3.5 million square feet scattered around the U.S. and in a few global locations. Clearly, investors’ expectations are that the small firm is going to revolutionize the way people work, then later maybe the way they live, and then perhaps even the form corporations will take.

Or maybe not.

The early warning signs of a bubble potentially deflating (if not popping outright) are many. One is the widespread disregard of Entrepreneurship 101—burn rates at some of these venture-backed companies are very high. So far, so good, if investors keep pouring in cash. But it can leave a company like WeWork vulnerable, because it takes out long leases at fixed cost and rents out spaces to small players in the short term. If demand dries up for those spaces, WeWork is still stuck with the leases. The golden rule in entrepreneurship 101 is to keep your fixed costs as low as possible to ride through any such scenario.

Here’s the problem: Once the cash stops coming in from people who are basically not customers, money has to start coming in at a pretty good clip from people the companies actually sell things to. If history repeats itself, the arrival of an “emperor has no clothes” moment is a tipping point which can shut off the fund flows pretty quickly. That in turn means that companies whose business models depend on continued, significant investment—like many of the so-called unicorns—will either be able to sweet talk now-wary investors into continuing the party, or they are going to run into serious trouble.

A few other early warnings—some investors are starting to question startups’ accounting practices. Like the eyeball-counting and talk of new business models that fueled the last tech bubble, eventually these companies have to agree on numbers people can trust. Some entire sectors are being declared off-limits by investors, such as dating websites.

Observers are already noting that the public markets can’t absorb all those unicorns at once. Moreover, as Marc Andreessen has observed, today’s startup founders have never made decisions in a tight-money environment. They are likely, as he picturesquely observed, to be “vaporized.”

All right, knowing all this, what does it mean? What is very hard to predict is who the winners and losers will be. What is much less hard to predict is the aftermath.

For the established organization that is well prepared, the opportunity presented by a crash is potentially staggering. An awful lot of very talented people, facing an actual loss of their jobs or the prospects of working for a money-losing venture that isn’t getting traction, are going to suddenly get a lot more interested in talking to the recruiters from Big Old Company X. Crazy salary levels and demands for equity will come back to more historical norms. Office space prices will drop (ahem, WeWork?). Good technologies that have not yet been scaled will be far more readily available, and at far better prices.

Moving a little further away from the immediate impacts, you’ll see the ripple effects in the services provided to the tech companies, which can again create affordable opportunities to make acquisitions or consolidate a sector. But not only big companies can benefit if they are smart and well-prepared. The entrepreneur who did heed the lessons of Entrepreneurship 101 is also likely to be among the beneficiaries.

Rolling Stone, bias, and the pitfalls of the human brain

by
Stephen Gandel

@FortuneMagazine

April 6, 2015, 3:31 PM EDT

On Sunday evening, Rolling Stone magazine released a bombshell retraction and apology for their “A Rape On Campus” story from November 2014. After the publication of an independent review by Columbia Journalism Review of the editorial process associated with the story, Rolling Stone offered the following excuses for publishing an account of a brutal gang rape at a University of Virginia fraternity that could not be substantiated:

1. The alleged victim was very specific about the details of the sexual assault and appeared to be traumatized, and thus deserved the benefit of the doubt;

2. A member of the University of Virginia faculty had originally connected the alleged victim with the reporter, thus lending the story some official imprimatur;

3. The alleged victim was able to manipulate RS’s journalistic process, with Jann Wenner referring to her as “a really expert fabulist storyteller”;

4. The reporter interviewed the alleged victim on eight separate occasions. Meanwhile, the three supposed witnesses were not interviewed, despite the fact that their quotes were used based on the recollections of the alleged victim.

5. The magazine didn’t think through the implications of what they were reporting and the potential for damage to innocent people.

Any one of us could have made these mistakes, given the emotions and sensitivities involved with a story like this. But what Rolling Stone didn’t do is admit what’s likely the main reason why they ran with an uncorroborated, under-reported story like this: They desperately wanted it to be true.

All of the other reasons and justifications are key, but none of them would have mattered if it weren’t for the underlying desire on the part of the reporter and the publication to skewer UVA’s “fraternity culture”and take some privileged scalps in the process.

The alleged victim’s story did not fall into the reporter’s lap, after all. According to CJR’s report, Rolling Stone was actively looking for a story just like this. When you’ve already decided on the truth, it’s just a matter of time before you’ll be able to mount enough evidence to prove it to yourself.

The implications of Rolling Stone’s mistakes, and how they’ll shape the debate over the very real problem of sexual assault on college campuses, are topics the media will be battling over for weeks to come. But as something of an investing monomaniac, it’s hard for me to read stories like these and not connect them to the challenges of being a good investor. The parallels between Rolling Stone’s journalistic failure and the failings that we all face when allocating our assets in the investment markets are too obvious to ignore.

Very often we find ourselves hoping to believe that a story is true. We arrange our minds so that nothing can stand in the way of how we think things should be. We give the facts that confirm our preconceived notions more intellectual weight in our minds, and we omit the elements that may contradict our beliefs.

Confirmation bias is the primary reason why otherwise intelligent people get caught up in asset bubbles that are obvious in the unforgiving light that comes the morning after.

Take the housing bubble, for example: The disconnect between average home prices and wage growth had become massive, despite the fact that the fundamental link between the two is as old as time. Historically, people have had to make real estate choices that they could afford. And then, suddenly, those shackles disappeared. In the middle of the last decade, we had decided that this link was no longer important because of:

a) An influx of foreign buyers;

b) The financing innovations of Wall Street;

c) The “ownership society” promoted by the (George W.) Bush Administration;

d) A few decades worth of data in which home prices almost never declined;

e) Fill in your favorite ad hoc reason for why it should be different this time.

We bought into these ideas, both financially and culturally, because we wanted them to be true. We wanted everyone to be in a position to own the home of their dreams—maybe even two of them. Wall Street wanted the non-stop financing party to continue, as did the real estate brokerages, mortgage servicers, and even the media, which was doing a fair amount of business in classified ads and home listings thanks to the boom.

Sometimes, confirmation bias takes hold because of a political opinion; think about how many people missed out on the economic recovery or the bull market in stocks because of the hyper-inflation story or because they don’t support President Obama. Sometimes it happens for the most old-fashioned of reasons: because it’s good for our bank accounts. As Upton Sinclair said, “It is difficult to get a man to understand something when his salary depends on his not understanding it.”

I could draw similar parallels and tell tales of willful ignorance surrounding the original dot-com boom, or the current echo boom in venture-backed startups, or even the recent gold and silver bust. Investors have been latching onto convenient stories since the South Sea bubble of the 1700s.

When we go looking for a narrative that fits with our existing predilections, we will find one. Remaining vigilant and aware of our tendencies to behave this way is the best defense against disaster.

Hedge fund vet: The bubble is about to bite

by
Stephen Gandel

@FortuneMagazine

September 22, 2014, 11:03 AM EDT

Julian Robertson, the founder of Tiger Management and one of the most successful hedge funds managers ever, says we’re about to get bit.

While Robertson agrees that the economy is recovering, he feels one of the biggest drivers of the recovery are bubbles in the financial markets. He says those bubbles are eventually likely to “bite us.”

“The bubble will burst in a very bad way,” says Robertson.

Robertson made the comments as part of a panel discussion at the Bloomberg Markets Most Influential Summit on Monday in New York City. During the panel discussion, Robertson said he is most concerned about the bond market. Governments have been buying bonds to boost their economies. That’s driven down interest rates. As a result, according to Robertson, savers have no place to put their money. That’s driven more people into the stocks, creating a bubble in that market as well.

Robertson didn’t quantify why he thought bonds or stocks were in a bubble, or at what point they became overpriced.

William Conway, one of the founders of private equity firm Carlyle, who was also on the panel, said that he also sees signs of a bubble, especially in the credit market. He said pressure from bank regulators doesn’t seem to have stopped banks from handing out loans. “We can get all the leverage we want, and are often offered more than we want,” says Conway. “Not sure that’s all that healthy.”

But even if prices are high, Conway said he didn’t see a “catalyst” for stocks or bonds to go down now. “The American economy is the best place to invest right now,” says Conway.

Robertson countered that bubbles always burst, and that the reason bubbles form is because it’s often hard to see why prices will go down. “The drop in 1987 came out of the blue,” says Robertson.

Understanding Bernanke — and the economy

by
Stephen Gandel

@FortuneMagazine

January 22, 2008, 1:01 AM EDT

Like anyone who wants to know where our economy is going, I’ve been scouring the economics news more than usual of late. It’s confusing stuff. Market pros typically say the Fed under its newish chairman Ben Bernanke isn’t doing enough to lower interest rates. People who don’t make their living in the markets tend to point out that it’s not Bernanke’s job to bail out investors who made stupid investments. A third layer of complexity is what, if anything, the administrative and legislative branches should be doing to help in the form of stimulus measures (spending more money, lowering taxes, or both).

The single best article I’ve read recently to make sense of it all is Sunday’s cover story in the New York Times Magazine: “The Education of Ben Bernanke,” by the great Roger Lowenstein. Perhaps with the exception of my colleague Allan Sloan, there isn’t anyone in America who writes as clearly about the complexity of economics as Lowenstein. Over Christmas I read (I’m ashamed to say, for the first time) his “When Genius Failed,” an absolute must read to understand what the mortgage crisis of 2007 does and doesn’t have in common with the collapse of Long-Term Capital Management in 1998.

Taking advantage of his three, count them, three interviews with Bernanke, Lowenstein does an outstanding job of explaining the history of the Federal Reserve, how Bernanke is different from his predeccesor, Alan Greenspan, and how the current crisis unfolded. I’ve been baffled that Bernanke failed to see the problem of the mortgage meltdown sooner, and in the article I found a clue. In his teachings at Princeton, Bernanke became if not a fan, then at least a consumer of econometrics, the study of the economy as it is reflected in the economics data published by the government and others. Greenspan, in comparison, is far more anecdotal and driven by hunches. Had Bernanke paid more attention to anecdotes about how out of the control the mortgage situation was he might have caught on more quickly.

Finally, a small-C criticism of Lowenstein’s article, and not just that it twice misspells Treasury Secretary Henry Paulson’s surname. Fine as it is by way of explanation, Lowenstein, at least to my read, never offers up a suggestion as to what Bernanke, the president and Congress ought to be doing. Immediately after finishing the article, I caught up with a Saturday editorial in the Wall Street Journal I found far more helpful in this regard. It’s called “The Panic Stage,” and here’s the kicker:

So what to do? Pass a tax cut that is immediate, marginal and permanent. In the “stimulus” grab bag that President Bush is contemplating, the only growth driver is bonus depreciation. Congress will be worse. As for the Fed, continue with the regulatory triage, but ease as little as it can get away with and slowly restore the monetary credibility that was so painfully earned in the 1980s.

This recipe may or may not prevent a recession, though we’d note that so far the underlying economic indicators suggest slower growth rather than a contraction. What these policies would do is prevent today’s panic from becoming something much worse.

This short and punchy editorial, together with Lowenstein’s leisurely and masterly narrative, will bring you up to speed on the economy. For now.

Sure signs of an alt-fuels investment bubble

by
Stephen Gandel

@FortuneMagazine

January 4, 2008, 1:29 PM EDT

I’ve written a handful of times in the past year about signs of a green backlash and a bubble in alternative-energy investments. I’m not one of those global-warming deniers, though. Nor do I think reducing carbon emissions is a waste of time and money. (After all, I spent oodles of time co-writing generally favorable articles about ethanol in 2006 and Al Gore in 2007.) I just know a good old-fashioned investment bubble when I see it. A smart idea first attracts true believers, then clever opportunists, then momentum investors and finally the rubes who invest their money at the top of the cycle. Bubbles are productive, by the way, as they usually lead to positive change. You just don’t want to be the investor left holding the bag.

I gained more confidence in my thesis this week when I learned that Firsthand Funds, a San Jose, Calif.-based mutual fund company, has started a new Alternative Energy Fund (ALTEX). Firsthand is a near-perfect bubble indicator. It’s run by a smart guy named Kevin Landis who has been particularly adept over the years at starting new funds and attracting new investors to them.

Three important disclosures. First, Kevin’s a nice guy who, back when I started covering stocks in Silicon Valley, was always generous to me with his time — though media exposure, of course, is central to the mutual-fund game of attracting more assets and collecting more fees. Second, Kevin’s performance, especially at his only big fund, the Technology Value Fund (TVFQX), hasn’t been half bad. Its 15.3 percent annualized return since its inception in 1994 has trounced the 10.8 percent performance in the same time frame of the Nasdaq composite index. As you can see here, its 1-, 3-, and 5-year performance has been great too. Only Tech Value’s 10-year numbers stink. Which leads to my third important disclosure: I bought into the fund in 2000, when its net asset value per share was twice what it is now. I’ve hung onto the investment as a reminder of the perils of buying a hot sector fund.

The Firsthand Funds lesson, though, isn’t so much about Tech Value, which at $300-some million in assets is a shell of its formerly hyped self. It’s in the other funds Landis has started along the way. Importantly, it’s also about when he started them. The Global Technology Fund, for example, launched in Sept. 2000. Ooops. It has had good years and bad, but it’s down overall and has just $13 million in it. Similarly, the e-Commerce Fund looks great if you’ve owned it for five years. If you bought when it began in Sept. 1999? Not so much.

Which gets us back to the new alternative energy fund. Landis started it in October. This week he disclosed its top holdings include the likes of Applied Materials (AMAT), Corning (GLW) and Suntech Power (STP). (Corning is a top holding in two other Firsthand Funds, which is how you know Landis really likes it.)

What’s funny about all this is that Landis always billed himself as an expert in information technology, which is why investors should trust his, ahem, first-hand knowledge. In this regard he’s no different than the scores of other Silicon Valley professionals who are busy re-branding themselves as alternative-energy experts. (Landis has help in this fund, by the way, who presumably have first-hand knowledge of their own. They are the noted investors Audubon, Defenders of Wildlife, National Wildlife Federation, the Sierra Club and World Resources Institute.)

Will the new fund do well? Who knows. Is this a time when everyone and their sister are investing in alternative energy? Sure feels like it. Has Kevin Landis called a top in a market again by starting a new fund? That’s what potential investors will need to judge for themselves.

Leaks in the alternative-energy bubble

by
Stephen Gandel

@FortuneMagazine

January 3, 2008, 11:59 PM EDT

Fittingly for the day of the Iowa caucuses – a day when presidential wannabes pay obeisance for the last time of the year to the ethanol gods – a high-profile renewable energy company announced a setback.

Imperium Renewables, a Seattle company founded by a former executive at Microsoft (MSFT), the noted energy company, withdrew its plans for an IPO, citing poor “market conditions.” The company didn’t elaborate on just what market conditions it referred to. But clearly it’s not the market for IPOs. NetSuite (N), despite early criticism from ill-informed pundits, proved that the market always is receptive to the right kind of IPOs. No, the market conditions Imperium must mean are the markets for alternative fuels, like ethanol and biodiesel, Imperium’s particular blend of non-petroleum elixir.

Imperium had hoped to raise $345 million, which would add to the gusher of money flowing into ethanol and other alt-fuel projects. (Reuters has lots of good details in its dispatch on the withdrawal.)

It’s been clear for some time now that the renewable fuels investment craze is a classic bubble. That’s not to say ethanol and biodiesel make no sense. They do make sense at some scale and over some time period. But it means that not every project makes sense and that a whole lot of investors will lose plenty of money.

For Imperium’s part, it had intended to use $240 million for three additional biodiesel plants. One wonders if the market conditions will be right for those either.

Why private equity will have to pay up

by
Stephen Gandel

@FortuneMagazine

June 28, 2007, 6:00 PM EDT

In a contentious debate the fun begins when one side or the other starts slinging mud to confuse people. It has started in the battle over taxation of “carried interest,” otherwise cast as whether partners in investment partnerships ought to be paying a higher tax rate. (In an earlier post, Tax the Rich, I provide links to a handful of other articles that review the “Blackstone (BX) tax” fairly thoroughly.)

The obfuscation began this week in response to a bill filed last week in the House by Rep. Sander Levin that would remove the capital-gains treatment for carried interest, which is the portion of profits that private-equity partnerships take when they distribute winnings to their investors. Opponents of this proposal cleverly, but disingenuously, are trying to frame the debate as Congress trying to raise the rates on ALL capital gains. The Wall Street Journal has a good round-up today, and here are the money quotes, deep in the article:

In the House, bill opponents are being marshaled by Rep. Eric Cantor (R., Va.), a member of Mr. Rangel’s tax-writing committee and a big recipient of campaign support from the financial-services industry. He hopes to portray the legislation as the first step by Democrats toward repealing the 15% rates on capital gains and dividends.

“I don’t think people realize how much this has become a proxy fight for the 15% capital-gains rate itself,” said David Hirschmann, the president of the capital-markets division of the U.S. Chamber of Commerce.

Mr. Cantor, who is the top vote-counter for Republicans in the House, could win votes from most Republican lawmakers if he successfully defines the issue as a fight over the capital-gains rate, which the Republican-controlled Congress approved and Mr. Bush signed into law in 2003.

See, the interesting thing here is that neither Levin nor anyone else who is looking at this issue has said anything about changing the capital gains rate. They’re only looking at changing how carried interest is taxed.

Economist and TV personality Larry Kudlow posted a similarly dishonest article at the National Review Online in which he said that raising the tax rate on “risk capital” is just the first step toward eliminating the preferential treatment for capital gains altogether.

In his efforts at confusing people, Kudlow at least has put his finger on the issue with the expression he has fabricated, risk capital. Private equity shops, which include venture capital firms, argue that the profits their partners make years after they make an investment should be considered a capital gain because they’ve taken a risk. In fact, the risk is in reputation and time only, not capital. (If they do invest capital, nobody is arguing that shouldn’t be subject to capital-gains treatment.) At issue is how to tax the money they make if their investments — with other people’s money — pan out. The obvious answer: the same tax rate other rich people pay when they make money, 35%.

In an editorial this week, the New York Times summed up the reasoning for this change:

With income inequality surging along with the need for tax revenue, the bills’ supporters rightly conclude that it is untenable for the most highly paid Americans to enjoy tax rates that are lower than those of all but the lowest-income workers.

Confusing sloganeering aside, the issue is really that simple.

For ethanol, the money keeps flowing

by
Stephen Gandel

@FortuneMagazine

June 22, 2007, 1:53 PM EDT

It’s almost comical the amount of money that keeps getting invested in ethanol. I’ve commented on this before, how despite the weak performance of the existing crop of ethanol companies, like VeraSun (VSE), Aventine, (AVR) and Pacific Ethanol (PEIX) investors keep pouring in more money. The latest example: the tepid showing of BioFuel Energy (BIOF), which lowered its offering range from as high as $18 before going public last week at $10.50, where the stock has pretty much stayed. Unlike the others, BioFuel hasn’t even built any plants yet, though it does have a tight tie-up with privately held power Cargill.

On Thursday, a California company called AltraBiofuels announced that it had raised $165.5 million in debt to build more ethanol plants. Last week the Wall Street Journal ran a curious article speculating on ethanol-industry consolidation. I say curious because there doesn’t seem to be any evidence, only wishful thinking of the inevitable.

This is, of course, how bubbles work. They expand and expand well beyond where the pundits expect. Then they pop. This one will too.

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