President George W. Bush cut taxes by $581 billion through 2005, part of what was sold as a $1.35 trillion, 10-year plan in 2001. President-elect Barack Obama looks set to change all that. Ok, maybe not. He is said to be considering $300 billion of tax cuts, the first half of an expected $775 billion, two-year stimulus plan.

With tax cuts the stimulant of choice for presidents seeking to boost the economy, Deal Journal decided to talk with Steve Gordon, the head of the tax practice at white-shoe Wall Street law firm Cravath Swaine & Moore, to discuss a topic that everyone wants to avoid–until it affects them.

Deal Journal: When the credit crisis started in the summer of 2007, one of the first proposals to emerge in political circles was the issue of taxes–particularly, taxes on private-equity funds, which Washington wanted to increase. but as the debate about taxes intensified, it has become friendlier to corporate interests.
Steve Gordon: I think the discussion initially was in respect to raising taxes on the sponsors of the funds, on the fund managers. One issue was the income that many managers were receiving was taxed at long-term capital gains rates, which are far lower than normal income rates–15% compared to 35%. The other was that the fund managers did not have to pay tax on their share currently. They could defer tax on their share of the funds through foreign entities. The conversation centers around the fund managers. That is, among this new Congress, clearly going to be an area of continued contention. I think the new Congress will take up both of those proposals again. I don’t think the opponents of these measures [the private-equity firms and hedge funds] are going to get a lot of traction with the Obama administration. I think the chance that something will be done is high. It will look like a tax increase, but I think it will be regarded as loophole-closing rather than a tax increase because it’s focused on a very specific, narrow, anomalous situation.

Deal Journal: In the fall and winter, the IRS and Treasury allowed auto companies and acquirers of banks to use the financial losses accrued by their targets to offset taxes in something called “the Wells Fargo ruling,” because it helped induce Wells Fargo to buy loss-plagued Wachovia. It was a controversial change. Will it be rolled back at all?
Gordon: The Treasury has actually issued four different notices this fall that have the effect of insulating companies from section 382, the section of the tax code that allows a company to use a limited amount of a target’s net operating losses to offset income after an acquisition.

The first thing the Treasury did was exempt Fannie Mae and Freddie Mac from the application from Section 382. The other thing is Notice 2000-83. In that notice, the Treasury and IRS said that the normal Section 382 restrictions on the ability of a bank to get money on its unrealized losses can be suspended. [Deal Journal explained the controversy around Section 382 tax breaks here.] There are a number of things that are interesting about that. One is that no one really knows how much of a tax benefit that really is. The suspension of 382 applies to net unrealized losses, so unrealized losses minus unrealized gains. You can easily tell unrealized losses, but it’s difficult to tell how much banks might have in unrealized gains. The real tax break is going to be a lot smaller than people first thought. Interestingly, there has been a lot of furor about this but no one really has the idea of the scope of the actual tax break.

There’s also been a lot of discussion in Congress about whether Treasury even had the right to suspend 382 in this way, because it’s part of a statute passed by Congress. There’s an argument that the original bailout legislation gives Treasury and IRS the requisite authority, but a lot of people in Congress don’t believe that’s true. There has been legislation to stop that rollback. [Deal Journal wrote about that legislation, H.R. 3700, here.] My guess is that legislation will be reintroduced in Congress.

Deal Journal: What about this potential Obama tax legislation? What does that add to the mix?
Steve Gordon: The proposal would allow net operating losses in 2008 and 2009 to be carried back five years, instead of two years, which is the current law. What that means is that it would allow companies who were profitable in 2003 to 2007 to get refunds for those years if the companies also record losses in 2008 and 2008. It is precisely like the legislation in 2001, in the wake of the Internet bust, in which the Bush Administration had Congress change the carryback period for net operating losses from two years to five years. It was a two-year temporary measure, and it lapsed. Starting with losses incurred in 2002, we went back to the two-year rule. The Obama plan is only a benefit for companies that paid taxes in those years. For companies that were start-ups or distressed and didn’t pay taxes in 2003, 2004 and 2005, there’s no benefit here.

Deal Journal: What are some of the other times when the government used tax breaks as a stimulus?
Steve Gordon: There are constant changes in the tax code designed to stimulate investment and the like. There have been two in this administration. One was the change in 2001. Another good example was in the Jobs Creation Act of 2004. There was a proposal that allowed U.S. companies that had built up lots of cash in their foreign subsidiaries to bring back that cash at a low tax rate, provided that the repatriated money was used for more things that were designed to create jobs. Tens of billions of dollars of cash were brought back for the ostensible purpose of job creation. There’s a lot of discussion in the academic literature about how effective a stimulation that was.

Deal Journal: What was the impact on the M&A market of all these tax changes?
Steve Gordon: The 2001 and 2004 changes didn’t have an obvious impact on the M&A market. But the stimulus changes we’re seeing right now that Treasury put in–Notice 2000-83–has to facilitate M&A activity. Why? Because Section 382 is only useful when a company with net operating losses is acquired. That has to some degree stimulate M&A with target companies with losses. Parsing out how much it will affect M&A is hard. To do an acquisition, you still have to borrow money, and borrowing money has been a problem. There are other forces at work in the M&A market right now, so it is hard to separate what the effect of the Treasury notice will be. There’s no doubt in my mind, however, that it makes a target company more valuable and more willing to undergo a change in control.

Deal Journal: How would you characterize the current state of the tax laws? Would you call this a positive or negative tax environment?
Steve Gordon: By and large, the state of the tax law hasn’t changed. I don’t think the current credit crisis changes our perspective on whether the tax regime is good for business or bad for business. Our tax rate on corporate profit is 35%, which is high relative to other countries. There is a lot of discussion among companies about whether our high corporate tax rate puts our companies us at a disadvantage compared to other countries.

So is the U.S. heading toward another Great Depression?

Economist Paul Krugman certainly thinks the country is moving quickly in that direction. Unless, of course, the government acts “swiftly and boldly.”

And by “swiftly and boldly,” Krugman means massive government spending to fight mass unemployment, not more monetary policy.

“Under Mr. Bernanke’s leadership, the Fed has been supplying liquidity like an engine crew trying to put out a five-alarm fire, and the money supply has been rising rapidly. Yet credit remains scarce, and the economy is still in free fall.…Friedman’s claim that monetary policy could have prevented the Great Depression was an attempt to refute the analysis of John Maynard Keynes, who argued that monetary policy is ineffective under depression conditions and that fiscal policy—large-scale deficit spending by the government—is needed to fight mass unemployment. The failure of monetary policy in the current crisis shows that Keynes had it right the first time. And Keynesian thinking lies behind Mr. Obama’s plans to rescue the economy.”

The problem is the government might blow it, thanks to a desire for bi-partisanship. (The WSJ reported today that President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses, a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs.)

Joe Weisenthal over at ClusterStock has a question for Krugman and others, who are calling for an increase in government spending: “If government were the answer to preventing recessions, why are we in a recession in the first place? Government has been on a big spending jag for the past several years.”

To let fail or not to let fail?

Economist Anna Schwartz had warned that not allowing banks and financial firms that had brought themselves to the brink to fail was a recipe for economic disaster, writes ClusterStock’s John Carney. And up until a fateful weekend in September the federal government had followed her recipe. But since then it has taken a “no failure” approach. What happened? Carney offers this answer up:

“It strikes us that the problem was just an awful combination of special interest politics and a failure of nerve.”

Tidbits

• From Time: “Madoff never even came close to realizing the gains he reported and paid out to some investors. Yet even funds with fairly accurate estimates of unrealized gains are guilty of engaging in similar Ponzi practices in the short term.”

• While bank robbers are getting busier, the Madoffs of the world are starting to get caught, writes James Surowiecki.

• Paying bankers is still a problem from hell, writes Carney.

• Is Anheuser-Busch InBev poised to rebound? Chad Brand of Peridot Capital Management thinks so.

• Waterford Wedgwood has called in the receivers, reports Reuters’s DealZone. Meanwhile, a string of bankruptcies has hit U.K. retailers, writes Dealscape.

• In the spirit of holiday fun peHUB’s Erin Griffith translates PE speak.

• From footnoted.org: And the footnote of the year goes to…A. Schulman’s fishing camp disclosure.

• The Epicurean Dealmaker’s top posts of 2008.

Private-equity firms are getting clever again.

After paying billions of dollars in 2006 and 2007 for deals that many considered overvalued and that burdened the targets with too much debt, private-equity firms have before them a potential feast of cheap assets that could be acquired, rolled together and eventually sold for big profits.

There is just one problem. These cheap assets are banks–and federal laws prohibit any company or investor except a bank from owning more than 10% of a deposit-taking bank. And yet, some buyout funds are proceeding, finding ways meant to comply with the letter–if not exactly the spirit–of the federal ownership laws.

The latest exhibit: This weekend, a group of seven private equity firms led by Dune Capital bought the carcass of failed Pasadena, Calif., mortgage lender IndyMac. The private-equity firms plan to rebuild it and use it as a platform to acquire other financial institutions, while overhauling IndyMac’s business model to steer clear of risky subprime mortgage loans. Because each of the firms are pitching in some money, no one firm owns more than 10% of IndyMac, thus appeasing federal regulators.

Similarly, in August, private-equity investor J. Christopher Flowers, a veteran of Goldman Sachs Group’s financial-institutions group, bought a little bank in Missouri called First Cainsville Bank. The bank, with $14 million in assets and just two branches, probably wouldn’t normally be considered worthy of the attention of a financial sophisticate like Flowers, who kicked the tires at such massive potential M&A targets as Bear Stearns, American International Group and Washington Mutual and advised on Bank of America’s acquisition of Merrill Lynch. But Flowers saw the Cainsville acquisition as a way to get a foothold into the banking business and make it easier to buy other banks. And instead of buying the bank as part of his private-equity firm, J.C. Flowers, he bought it under his own name, overhauled the board of directors and informed the Office of the Comptroller of the Currency of his plan to make more acquisitions.

Federal regulators have been amenable to such solutions thus far. Perhaps that has something to do with the fact that roughly 25 banks have already failed, and more are expected.

The benefit to the private-equity firms of participating in federal auctions for failed banks is the chance to own cheap assets and gain a toehold in the rapidly consolidating banking industry, which they know well. Private-equity firms plowed $23 billion of capital into financial-services deals in 2008, and that is down 69% decrease from the $74 billion of 2007, according to data from Freeman & Co.

Meantime, the federal government gets a known quantity: private-equity firms that are experienced players in financial services. This is something of an echo of the late 1980s and early 1990s, when some private-equity firms snapped up assets from the government’s Resolution Trust Corp. amid the savings & loan crisis. They are also willing buyers, which is no small comfort to the government. Federal regulators looked for a buyer for IndyMac for five months before finally handing it over to a private-equity consortium.

Still, in taking over banks, private-equity firms are entering somewhat complicated contracts to accept federal bank regulators as highly involved overlords, something not all PE firms have been willing to do. Blackstone Group abandoned its proposed $6 billion acquisition of Alliance Data Systems–which owned a bank–arguing that it wouldn’t be able to meeting the changing requirements of federal regulators. In addition, some banks are allowed to choose their regulator, which creates a confusing drama of regulatory competition. IndyMac, for instance, chose the Office of Thrift Supervision, which ended up looking the other way at the lender’s financial troubles.

Success isn’t, of course, guaranteed. Investment fund Corsair did nicely on its investment in National City, but TPG was hardly as lucky with its ill-fated investment in Washington Mutual, which was nearly wiped out entirely when WaMu was seized by regulators.

Josh Beckerman and Jennifer Rossa of Private Equity Analyst, look at one of the more notable ripples of the global financial crisis. Though at times, it seemed more deals didn’t get done than did in 2008 - although maybe it was just the never-ending story flow on two deals in particular, BCE Inc. and Huntsman Corp., that made it feel that way. Herein, relive all the pain one last time. Private Equity Analyst is a Dow Jones publication and a contributor to Deal Journal.

PHH Corp.
Deal announced 3/15/07; terminated 1/1/08
At 12:18 AM on Jan. 1, 2008, PHH Corp. announced the termination of its $1.7 billion acquisition by General Electric and Blackstone Group. While no surprise–the mortgage services and fleet management company had previously warned about “revised interpretations as to the availability of debt financing”–the timing proved an appropriate beginning for a year teeming with canceled deals. Blackstone paid a $50 million termination fee.

3Com Corp.
Deal announced 9/28/07; terminated 3/4/08
Bain Capital’s planned $2.54 billion acquisition, alongside Chinese partner Huawei Technologies, of 3Com was one of the few that didn’t run directly afoul of debt markets. Instead, it ran into the regulatory brick wall of the Committee on Foreign Investment in the U.S., which was concerned that Huawei had ties to the Chinese military that could result in improper access to 3Com, which provides anti-hacking software for the U.S. Department of Defense.

Alliance Data Systems Corp.
Deal announced 5/17/07; terminated 4/18/08
This was an unusual one, with Blackstone claiming the Office of the Comptroller of the Currency was imposing unreasonable requirements on the $7.8 billion deal, and Alliance Data saying Blackstone simply needed to try harder. The company sued the private-equity firm not once, but twice, on this point, the first time to compel Blackstone to proceed with the deal (it withdrew the suit when Blackstone assured Alliance Data that is was, in fact, trying) and the second to force Blackstone to pay the $170 million break-up fee for the deal after it became patently clear that the firm no longer was.

Penn National Gaming Inc.
Deal announced 6/15/07; terminated 7/3/08
Compared to many of the other deals on this list, the planned $9.4 billion buyout of Penn National ended well for all parties involved. The deal was terminated without litigation, with Penn National basically saying it didn’t have time for the distraction of that. All parties got on board the “consolation prize” deal, with lenders Wachovia and Deutsche Bank agreeing to cover the $225 million breakup fee and $325 million in fees and expenses for the buyers, while buyers Fortress Investment Group and Centerbridge Partners agreed to a $1.25 billion preferred stock investment in the casino and horse-racing company. In a sad commentary on the state of the market in 2008, this fee ranked as one of the largest transactions in July.

BCE Inc.
Deal announced 6/29/07; terminated 12/11/08
For the longest time, this deal seemed like the giant LBO that could. For the year and a half from announcement to termination, this $41 billion merger overcame hurdle after hurdle, including a dustup with bondholders, scrutiny over whether it would remain sufficiently Canadian, a decline in the Canadian dollar that meant it was no longer the largest announced buyout on record, and grumbling from lenders. But it couldn’t overcome the language in its own agreement that required a positive solvency opinion from auditor KPMG LLC. When KPMG indicated it wouldn’t deliver such an opinion, that was the final straw. The saga continues, though, as BCE has sued the proposed buyers–Ontario Teachers’ Pension Plan, Providence Equity Partners LLC, Madison Dearborn Partners LLC and Merrill Lynch Global Private Equity–over the $1.2 billion breakup fee.

Huntsman Corp.
Deal announced 7/12/07; terminated 12/14/08
Hexion Specialty Chemicals, owned by Apollo Management, said in January that its $10.6 billion purchase of Huntsman “is not expected to close before May 3.” It wasn’t kidding. This was the buyout soap opera of the year, with big egos and hurt feelings on parade, and suits and countersuits flying. As this deal was chronicled in painful detail by us throughout the year–some 32 stories in LBO Wire, a Dow Jones publication–we won’t put either ourselves or you through the pain of reliving it in depth. We’re just happy that things ended amicably, with Huntsman founder Jon Huntsman and Apollo co-founder Leon Black riding off into a Hawaii sunset together, after previously calling each other “pathetic” and “dishonest.” All that’s left is a lawsuit pending between Huntsman and the banks that were supposed to fund the deal.

The market turmoil has reshaped the financial landscape. Financial News, a Dow Jones publication and a contributor to Deal Journal, looks at some individuals entering a make-or-break period following the maelstrom of 2008:

Mark Aedy
The acquisition of Merrill Lynch by Bank of America will put its commitment to European investment banking to the test, and test the mettle of Aedy, who stands at the helm of corporate and investment banking for Europe, the Middle East and Africa.

Until the Merrill deal in September, Bank of America had preferred to build a European investment banking business by recruiting from rivals, rather than through acquisitions. It appeared to send mixed messages about the scale of its ambitions in recent times following trading losses associated with the credit crunch at the end of 2007. Merrill’s European investment-banking business dwarfs that of Bank of America and the merged entity has the opportunity to create a powerhouse. Ambitions are high, but expectations are even higher.

Bob Diamond
Diamond may have waived last year’s bonus to appease investors, but that might not be enough if the acquisition of Lehman Brothers’ North American business fails to yield the expected rewards. He has been praised for a “fantastically priced,” “outstandingly attractive” and “tremendous” deal. But that was based on potential. Now he must achieve tangible results to justify the acquisition. On a conference call last September, Diamond said the pools of revenue in investment banking and investment management were a little less than a trillion dollars and “growing at double the rate of GDP, notwithstanding the fact that 2008 will be a slow year.” He also said the market conditions offered one of the best opportunities in decades to build an investment-banking business.

Sadeq Sayeed
Japan’s Nomura rewarded Sayeed for his role as chief negotiator on the takeover of Lehman’s European and Asian assets by appointing him vice chairman of Nomura International and chief executive of Europe, the Middle East and Asia. He has been busy recruiting former Lehman staff who weren’t part of the businesses acquired, as well as sorting out leadership for the enlarged business.

Having convinced Nomura to take another stab at Europe, he will now have to call on all of his 25 years of investment-banking experience to realize the Japanese bank’s ambition. On a conference call, Sayeed said he was “extraordinarily optimistic” about the acquisitions.

Greg Coffey
Coffey, the former star manager at GLG Partners, will have to prove his worth in his new role as chief investment officer at the European branch of Louis Bacon’s $20 billion Moore Capital. Coffey gave his former employers at GLG a nasty surprise by resigning in April, precipitating a sharp fall in GLG’s share price and causing investors to demand their money back.

GLG posted a $6.4 billion decline in assets under management in the third quarter, reflecting both investment losses and $1.3 billion of redemptions from hedge funds run by Coffey. He was widely expected to launch his own hedge fund, but resurfaced in November a few floors above his former GLG colleagues in the same building, working for Moore.

Jon Moulton
Jon Moulton, founder of Alchemy Partners, has been one of private equity’s most vocal practitioners in recent years. As the industry’s Cassandra, Moulton long had warned of the dangers of over-leveraging businesses and forecast a downturn.

Now that his predictions have come to pass, he must capitalize on the opportunity. His firm specializes in acquiring distressed companies and turning them around. There should be no shortage of deal opportunities this year as the recession bites – but if Moulton can’t earn returns in this environment, tailor-made for his firm in terms of opportunities (if not the availability of debt financing), he never will.

John Hourican
A former leveraged financier, Hourican is probably the most senior banker you have never heard of. In the middle of October, he was promoted to one of investment banking’s higher profile posts, chief executive of global banking and markets at Royal Bank of Scotland. He started his job at a time when RBS’s global banking and markets division faced a heavy redundancy program and restructuring.

His job shows no signs of getting easier. While his division employs more than 20,000 and is important to the company’s results (accounting for 42% of underlying group profit in the first half), it also is home to the bank’s riskiest assets and most complex businesses, which resulted in billions of pounds in write-downs last year. Now his every move will be scrutinized by RBS’s majority shareholder, the U.K. government.

Journal reporter Dan Fitzpatrick has been following the IndyMac saga and sends this dispatch on the past and future of one of 2008’s last deals.

Steven Mnuchin’s holiday gift was IndyMac, not that it didn’t nearly ruin his own holidays. With a group of seven investment firms racing to get a deal done for the failed mortgage lender by year end, Mnuchin spent the past few weeks holed up in a hotel room ostensibly on a vacation but really putting the deal together, said people familiar with the situation. It wasn’t until Friday night that he had time to buy his family gifts, these people said.

Still, he expects IndyMac to be a gift that keeps on giving. When IndyMac went under last summer, Mnuchin thought he could buy it, rebuild it and use it as a platform to acquire other financial institutions, according to people familiar with the situation. He thus far hasn’t bid for other troubled institutions.

The 46-year-old architect of the IndyMac bid, Mnunchin has been in the mortgage business since 1985. He was with Goldman Sachs during the savings & loan crisis and was involved in buying assets from the Resolution Trust Corp. that was formed by the government to take over troubled S&Ls.

IndyMac’s business model was troubled, and Mnuchin has no intention of repeating its old mistakes. The new investor group intends to remain in the mortgage loan business and will focus nationwide on new loans with appropriate underwriting standards, rejecting the riskier products that IndyMac once offered.

Deals of the Day, compiled by Stephen Grocer and Heidi N. Moore, gathers all the biggest news of the morning related to mergers and acquisitions, bankruptcies, financing and private equity. You can bookmark Deal Journal for easy visiting throughout the day at http://blogs.wsj.com/deals.

Mergers & Acquisitions

Who wants to buy a failed bank at the heart of the country’s mortgage crisis? As it turns out, a lot of Wall Street’s “smartest money.” [WSJ]

Related: Is the government charging too little for the remains of failed mortgage lender IndyMac? [WSJ]

Rogue move: GE’s Universal Pictures has sold Rogue Pictures, a film label that produces and distributes lower-budget films, to Relativity Media. [WSJ]

The Priory: The acute care specialist is pushing for a £2 billion merger with Four Seasons, the care-homes group. [Times of London]

National Australia Bank may put Clydesdale and Yorkshire banks up for sale after it launched a wide-ranging review of the business.[Times of London]

Financial Institutions

Obama’s tax cut: Obama plans a $300 billion stimulus plan full of tax cuts for businesses and individuals to win Congressional support. [WSJ]

The purse strings remain tight: U.K. banks sharply tightened credit to households and companies, intensifying worries that a bank-rescue plan is failing to get money flowing. [WSJ]

Catatonic fear: U.S. consumers are propping up banks that won’t lend to them. [Bloomberg]

Bankruptcy & Restructuring

LyondellBasell: The chemical maker is awaiting clearance by a US court of the appointment of a corporate turnaround specialist. [Times of London]

Woolworths: The retailer’s lenders are in line to collect millions of pounds in controversial fees following the collapse of the retail chain. [Daily Telegraph]

Buyside

Heading out on his own: Paolo Pellegrini has resigned from hedge-fund firm Paulson & Co. and is expected to start his own hedge fund. [WSJ]

Pay is coming under pressure: A Renaissance hedge fund will waive management fees this year following a poor performance in 2008. [WSJ]

Don’t count them out yet: Many hedge funds won’t survive 2009. But there could be some good investment opportunities for those still standing later this year. [Barron’s]

Darn, buyout: Highly leveraged retailers will struggle to meet covenants as the liquidity crisis continues and the M&A market is quiet. [Times of London]

Capital Markets

Completely dry: Just 29 companies went public in the U.S. last year, compared with 215 in 2007 — an 87% drop. No deals are on the immediate horizon for 2009. [WSJ]

Nakheel: The company behind some of Dubai’s best-known landmarks is considering a stock market listing to raise as much as $15bn (£10.3bn) to reinforce its finances. [Daily Telegraph]

J.P. Morgan Chase: With a scarcity of financing for deals in 2008, those that could lend were kings. That’s at least the idea one can take from the global league tables. The giant bank’s relative health in 2008 allowed it to lend and that was one reason J.P. Morgan supplanted Goldman Sachs as the top global deal adviser by transaction volume last year, according to Dealogic.

Bank deals: Bank of America-Merrill Lynch, Wells Fargo-Wachovia and PNC Financial-National City all closed this week. That’s good news for beleaguered merger arbitragers, who were betting they would close. After all, 2008, with its failed LBOs and hostile offers that never crossed the finish line, proved to be a bad year for those who make a living betting on mergers. 2009, then, started on a much more optimistic note.

Cerberus: The publicity shy private-equity firm may well regret its foray into the auto industry. Cerberus and dozens of co-investors paid $7.4 billion in 2006 for a 51% stake in GMAC. This week the Treasury Department committed $6 billion to stabilize GMAC. The Treasury’s $5 billion preferred stake will pay an 8% dividend, putting the government in line ahead of Cerberus’s common-equity holdings. Cerberus and GM will also contribute $2 billion of new equity to GMAC, suggesting that the value of existing equity stakes in the lender will be diluted. And to avoid being classified as a bank holding company the private-equity firm will reduce its ownership to no more than 14.9% in voting shares and 33% of total equity.

Dow Chemical: The chemical maker’s multi-billion dollar joint venture deal with Kuwait fell apart, throwing Dow’s planned acquisition of Rohm & Haas in doubt. The plan was for a Kuwait-owned petroleum company to pay Dow $7.5 billion for a 50% stake in several chemical plants. Dow intended to use that money to help finance its $15.3 billion purchase of Rohm & Haas. That has put Dow’s CEO between two immovable financial forces: his vow to protect Dow’s $78 a share offer for Rohm & Haas and the company’s rich 8.8% dividend. But if Dow were to press ahead with the deal, it would also be left with net debt topping $29 billion, or 4.5 times estimated 2009 earnings before interest, taxes, depreciation and amortization. That is very risky during a time of such economic uncertainty.

LyondellBasell: Another deal from 2007 comes back to haunt the company that pulled the trigger. Dutch chemical company Basell International paid $12.7 billion to buy Houston-based Lyondell Chemical toward the end of 2007. The resulting debt burden is proving too heavy amid a decline in sales. And this week LyondellBasell told lenders it is considering filing for bankruptcy protection.

Deal Making: From the numbers, 2008 didn’t look all that bad. Global volume fell 29% to $3.06 trillion, on par with 2005, which was a robust year by any historical measure. But by the last quarter there was no denying the gloom as deal making came to a stand still and layoffs hit the ranks of M&A bankers hard. Fourth-quarter deal volume dropped 53% from a year earlier to $115 billion in the U.S., according to Dealogic, the worst quarter in six years.

For those who believe in a Goldman Sachs conspiracy to take over the world, it must be some comfort that it probably only extends to financial services.

The impending Federal Deposit Insurance Corp. sale of IndyMac will likely restart the debate all over again. According to Dow Jones Newswires, seven investors will buy IndyMac. Two of them are notable firms started by Goldman Sachs alumni: Dune Capital, founded by former Goldman Sachs partner Daniel Neidich and former vice president Steve Mnuchin, and J.C. Flowers & Co., the financial-services investing firm founded by preternaturally cautious former partner Christopher Flowers. The others are Stone Point Capital; Paulson & Co.; a fund controlled by billionaire George Soros’ Fund Management; a fund controlled by Silar Advisors LP, and MSD Capital, billionaire Michael Dell’s financing vehicle.

Mnuchin, 46, will be the new CEO of the IndyMac holding company, which the FDIC has been trying to sell off since July.

The first thing most Wall Streeters would say about Mnuchin is that he has deal making — and a certain level of Manhattan glamor — in his blood. He is the son of former Goldman Sachs banker Robert Mnuchin, who is now a prominent player in the art world, has a regular table at upscale restaurant Cafe Boulud and runs a $1,000 a night luxury bed and breakfast, The Mayflower Inn in Connecticut, which he sold last year to a hotel chain. Steve Mnuchin’s brother is former Bear Stearns and Lehman Brothers banker Alan Mnuchin, who now runs his own advisory firm, AGM Partners. The entire family is active in New York charities; Steve Mnuchin sits on the board of the Whitney Museum, the Hirshhorn Museum and Sculpture Garden Board, Riverdale Country School and New York Presbyterian Hospital.

Mnuchin himself started his career at Goldman Sachs. He worked there for 17 years, rising to become an executive vice president and chief information officer, leaving in late 2002 at the age of 39 with a reported $46 million stake in the bank. In 2003, Mnuchin left to join Eddie Lampert’s hedge fund, ESL, as a vice chairman. Mnuchin and Lampert had been college roommates at Yale, and they both joined Goldman Sachs after graduation in 1985. (Lampert joined Robert Rubin’s risk-arbitrage unit; Mnuchin made his way over to fixed income, currency and commodities, where he oversaw mortgages, U.S. governments, money markets and municipal bonds.) In 2003, Lampert picked Mnuchin to sit on the board of retailer Kmart, which had just emerged from bankruptcy.

He stayed only a matter of months before jumping to a George Soros-backed fund, SFM Capital Management, as CEO. With Soros’ $1 billion backing at SFM, Mnuchin lent money to companies in financial trouble. Only a few months after that, Mnuchin left SFM to co-found Dune with former Goldman colleagues Daniel Neidich and Chip Seelig.

Dune’s specialty in the beginning was real estate loans and properties, a legacy of Neidich’s expertise. Neidich had founded and run Goldman’s Whitehall Funds, a sprawling and successful real-estate investing operation.

If one follows Neidich’s past with Whitehall, one can find the first hints of why Dune might now be interested in IndyMac. Whitehall unveiled its $150 million inaugural fund in 1991. After the savings & loan debacle of the 1990s, Whitehall was the second largest buyer of distressed assets from the government’s Resolution Trust Corp.

Over the years, however, Dune expanded its mandate. Mnuchin carved out a niche in the entertainment industry, putting Dune in the then-popular craze of film financing. In 2006, he struck a financing deal with Fox, then in 2007, helped clinch a three-year deal with Fox that would have Dune invest more than $500 million in a series of Fox movies.

At Dune, Mnuchin kept in touch with his old Goldman Sachs contacts. When Merrill Lynch CEO — and former Goldman Sachs president — John Thain was looking to sell $32 billion in toxic collateralized debt obligations this summer, he contacted Mnuchin at Dune to buy the lot for just $8 billion, according to a report in the New York Times. (Merrill eventually sold $31 billion of the CDOs for $6.7 billion to private equity firm Lone Star, which Merrill also lent $5 billion to finance the deal.

Mnuchin founded New York-based Dune Capital Management LP in 2003 with f after a stint at billionaire George Soros’ hedge fund. Dune’s investments have included stakes in Viacom Inc.’s DreamWorks LLC film library, and the 802-room Hyatt Regency hotel in San Francisco.

Sometimes, it feels like the whole world is working against you. If Dow Chemical CEO Andrew Liveris is thinking that, maybe he’s right.

Suddenly his pending $15 billion acquisition of rival Rohm & Haas looks like an uphill battle, with myriad competing interests who can’t all be kept happy. In the past week alone, Dow has seen its crucial petrochemicals joint venture with Kuwait collapse, its credit rating cut from the top levels of investment grade to near-junk levels, and its lenders chomp at the bit for new terms on $13 billion bridge loan. Deal Journal tracks the obstacles on Liveris’ path to closing the deal.

Rohm & Haas: The chemicals company has remained steadfast in expecting Dow to come through on its $78-a-share offer. Rohm stuck to its guns when Liveris publicly implied the deal was highly overpriced (something analysts have said for a while, too) and started cutting 30% of Dow’s production capacity to get the deal done. After the collapse of the Kuwait joint venture, Rohm issued a statement reminding Dow that it “entered into a definitive agreement on July 10, 2008 providing for the acquisition of Rohm and Haas by Dow, subject to the terms of that agreement. Rohm and Haas Company shareholders approved this agreement on October 29, 2008. Rohm and Haas Company continues to work diligently towards completing the proposed transaction with Dow in early 2009.” Renegotiating a lower price looks like a long shot–and, even if it were to happen, it may not be enough.

The Dividend: Dow’s quarterly stock dividend is a point of pride for the company. When Dow approved its latest, 42-cents-a-share dividend last month, it crowed on its Web site, “This is the 389th consecutive cash dividend issued by Dow. Since 1912, Dow has paid its shareholders cash dividends every quarter and has either maintained or increased the quarterly dividend amount throughout that time.” But that costs roughly $1.5 billion a year–money the chemicals concern could certainly use to complete the Rohm & Haas deal.

Stockholders: Liveris could, theoretically, set a multilbillion-dolllar stock offering to raise enough money to buy Rohm & Haas, as some analysts have suggested. But how would issuing stock go over after a year like 2008, when Dow’s shares sell nearly 65%. An equity offering would dilute the holdings of current holders and could increase the total cost of the dividend.

Ratings providers: Perhaps Dow Chemical’s toughest constituency right now. In the wake of Kuwait’s cancellation of a $17.4 billion joint venture with Dow last week that would have provided at least $7.5 billion to finance the Rohm deal, Moody’s Investors Service cut Dow’s credit rating to Baa1 from A3. That is dangerously close to Baa3, the tripwire that allows the company’s lenders to renegotiate the terms of the $13 billion bridge loan they promised to provide the company. “Dow’s credit profile would be weaker than previously anticipated and its ratings could fall below the Baa2 rating in a worst case scenario,” Moody’s vice president John Rogers wrote Dec. 29. In addition, Moody’s will closely scrutinize any asset sales or issuance of convertible debt, because of the uncertainty inherent in the financial environment. The kinds of things that will put Dow back in Moody’s good graces will be very difficult to complete: “Moody’s continuing review will focus on Dow’s ability to terminate or negotiate a lower price for the Rohm and Haas acquisition, resurrect the K-Dow venture at a lower price, and/or make meaningful changes to the financing for these transactions,” Rogers wrote.

Lenders: Dow Chemical can get its $13 billion bridge loan as long as it keeps to its covenants. According to the funding agreement, that means keeping its credit rating above Baa3 from Moody’s and BBB- from Standard & Poor’s. It also means keeping its total leverage ratio at less than 4.25 times the company’s trailing earnings before interest, taxes, depreciation and amortization. The leverage-ratio covenant won’t get tripped if Dow is downgraded again within the next few months, but it is a looming threat. Despite the Moody’s ratings cut and warning note, Dow hasn’t reached out to its lenders about a potential renegotiation, several people familiar with the situation told Deal Journal. The lenders, who don’t want to take on any more risks, can’t be happy about Dow’s fall from ratings grace. Dow could wait until it actually violates it covenants to start horse-trading with its lenders, but then negotiations could quickly get ugly.

In addition, even if Dow does get the $13 billion bridge loan, the lenders will have to wonder: how will the company refinance it come next year? Dow’s production has been cut by one-third, and its entire industry is suffering. BasellLyondell has is mulling a Chapter 11 bankruptcy filing, while rivals Hexion Specialty Chemicals and Huntsman scuttled their deal amid insolvency fears. It now looks as though the Rohm & Haas acquisition was a wrong-way bet on the price of commodities, which have fallen markedly since the summer. Liveris is likely to be in trouble whether he gets the deal done or not.

One more thing about the whole deal stands out: the markets had priced in a huge “spread,” or difference between Rohm’s trading price and its merger price. That wide spread means many investors have been skeptical about the deal getting done. That skepticism seemed odd when Dow had Kuwait on its side, especially since Berkshire Hathaway also is supporting the Rohm & Haas deal. Now, it looks as if the markets predicted correctly that the deal would teeter. But will it fall?

Update: We clarified the situation with the leverage-ratio covenant to clarify that it has to do with trailing Ebitda.

Related on Deal Journal

Dow Chemical’s breakup fee as down payment?
Will Rohm & Haas Be Enough For Dow Chemical CEO?
Dow Chemical: Cutting Jobs Instead of the Merger Price
Spooked Investors Fear Dow Chemical CEO’s Words on Merger
Romeo and Pedro’s Not-So-Excellent Dow Chemical Adventure
Jamie Dimon: The Man in the Middle at Dow Chemical

Deal Profile: Dow Chemical’s Big Deal for Rohm & Haas
Banking Ethics 101: How J.P. Morgan Fought Itself on Dow Chemical and Won
Banking Ethics 202: J.P. Morgan and ‘Plausible Deniability’ on Dow Chemical

Should the New York Fed have called together the big banks to recapitalize LTCM in 1998?

The answer for Tyler Cowen, a professor of economics at George Washington University, is no. Of the meeting, he argues in a piece for The New York Times that “If regulators had been less concerned with protecting the fund’s creditors, our current problems might not be quite so bad…With the Long-Term Capital bailout as a precedent, creditors came to believe that their loans to unsound financial institutions would be made good by the Fed—as long as the collapse of those institutions would threaten the global credit system. Bolstered by this sense of security, bad loans mushroomed.”

Brad Setser is not entirely sure this is the case.

“If LTCM had failed, I suspect that policy makers would have stepped in to prevent any major regulated financial institutions from failing as a result of its exposure to LTCM, or its own LTCM-style bets. Rather than ending the expectation that big banks and big broker-dealers were too big-to-fail, the failure of LTCM might have reinforced that sense.”

In fact, Setser believes the real moral hazard of the financial system stems “from the expectation on the part of those lending to places like Lehman and Goldman that these institutions are too big and too important to the financial system to fail, and thus it is safe to lend to them at low rates…no matter how leveraged they are or how many risky bets they are making.” In essence, if in 1998 the moral hazard was to be ended it would have required a bank like Lehman to have failed, and many believe that letting Lehman fail wasn’t a good idea.

The real failure of regulators, Setser argues, was not clamping down on leveraged institutions once the markets calmed.

Tidbits

• The Washington Post’s three part series on the fall of AIG. (The Beautiful Machine, A Crack in the System, and Downgrades and Downfall)

• From interfluidity: “Good morning 2009″

• How did George Soros ring in the New Year? The NY Post has the answer.

• Mergers & Inquisitions tackles everything from pay and fashion to banking in different regions, business school, different strategies for breaking in, and even some more questions on the new interview guide in its New Year’s Q&A.

• The top IPOs of 2008, from Reuters.

• “We may never know how much money was lost (or stolen) this year, but the human toll is starting to add up,” writes Charlie Gasparino over at the Daily Beast.

• The Church of England’s Church Commissioners are investing £150 million with Al Gore’s environmentally focused investment firm, reports Religious Intelligence.

For Bank of America, being a hero won’t come cheap.

Bank of America officially married Bank of America on New Year’s Day, culminating an engagement that began Sept. 15 when Merrill Lynch President Greg Fleming persuaded BofA to save his investment bank from a fate worse than Lehman Brothers Holdings. The combination always was expected to be challenging, with the markets even believing the deal wouldn’t go through.

There were several reasons for the skepticism. Many doubt a commercial bank can successfully integrate an investment bank. Then there is the culture issue. Bank of America is Southern charm; Merrill is sharp elbows and a 17,000-strong brokerage force known as the Thundering Herd. In addition, market observers wonder if Bank of America’s eyes have been bigger than its stomach, with the bank simultaneously integrating both Merrill Lynch and Countrywide Financial, which it bought in February. Most of all, many wonder if Bank of America is jumping into the investment-banking business at the most painful possible time.

Bank of America CEO Ken Lewis certainly is saying all the right things: “We created this new organization because we believe that wealth management and corporate and investment banking represent significant growth opportunities, especially when combined with our leading capabilities in consumer and commercial banking. We are now uniquely positioned to win market share and expand our leadership position in markets around the world.” (Of course, he hasn’t always been so high on investment banking.)

Still, Deal Journal looked at the Merrill Lynch assets being acquired and what Bank of America might be really getting.

The Merrill Lynch name

If there is one kind of deal that has earned a dubious reputation it is the marriage of a commercial bank and an investment bank. Usually what happens is that, after a honeymoon period in which the commercial bank promises the newly acquired investment bankers that it will preserve and retain their culture, it starts slowly phasing out all vestiges of its investment-banking history. The investment bank’s old name is then allowed to survive in some corner of the wealth-management business. This wiping-out of the old investment bank’s brand is usually done to “break down the silos” within the bank. What goes unsaid is that the silos came into being because commercial bankers and investment bankers have different working styles and completely different pay scales and often try to avoid sharing clients with each other.

Germany’s Deutsche Bank bought several investment banks in the 1990s, from London’s Morgan Grenfell in 1990 to Alex. Brown and Bankers Trust in 1998 and 1999, respectively. The only name that still exists is Alex. Brown on part of the wealth management group. Citigroup inherited Salomon Brothers and Smith Barney in 1998, then after a series of scandals rebranded the whole thing Citigroup in 2001. The Smith Barney name lives on in wealth management.

At Credit Suisse Group, the First Boston legacy remains only in a logo that evokes that investment bank’s famous clipper ship logo, while Donaldson Lufkin & Jenrette lives on only at Credit Suisse’s private-equity arm, DLJ Merchant Banking. If history is any guide, look for Bank of America to keep the Merrill Lynch name on its brokerage–and nowhere else.

Overall Business

Times are tough, but you knew that. Standard & Poor’s recently predicted of Merrill Lynch, “we anticipate a slowdown in all major business lines for 2008, and we expect a sizeable drop in net revenues and earnings for 2008 before a rebound in 2009.” Still, BofA’s biggest risk is getting the integration right, according to a note Friday from Fitch Ratings: “Integration risk is significant, due to MER’s size and complexity as well as the cultural differences between a commercial bank and an investment bank. Also, management is already faced with the integration of [Countrywide] and the 2007 acquisition of regional bank LaSalle Corporation.” Lewis is cutting as many as 35,000 jobs to save the combined bank $7 billion by 2012, but he can’t cut the jobs that matter most. Lewis has $25 billion on tap from the Treasury’s Troubled Asset Relief Program, but with many of Merrill’s securitized loans declining even further in value, that government money may not be enough to offset future write-downs. BofA has already sliced its dividend once, in October; analysts expect more cuts.

Retail brokerage

This business was the deciding factor in drawing Lewis to save Merrill Lynch rather than Lehman. This acquisition makes BofA the largest wealth-management business in the world, with approximately 20,000 financial advisers and more than $2 trillion in client assets, it predicted.

The “Thundering Herd” was dubbed the “crown jewel” by Lewis. Flattery will get him everywhere; Merrill Lynch’s brokers are considered the single most powerful and intransigent political force within the firm. They are also, even in these dark times, the most profitable. In Merrill Lynch’s most recent third-quarter earnings, brokerage revenue fell only 5%, compared to the 27% decline at the investment bank. Keeping them happy won’t come cheap, but Lewis has promised to open the wallet: Stay-bonuses for the brokers are “something we have the capacity to do. We plan to do something, because they are the crown jewel of the company….The sweet spot for Merrill is [BofA’s] client group. The financial advisers need to get ready to receive a lot of referrals,” he said in September.

Asset management

Where you have brokers, you generally want to have products they can sell–things like stock and debt mutual funds. Merrill Lynch sold half of its asset management–or mutual fund–business to BlackRock in 2006 in return for a 49.5% stake in BlackRock. The stake, valued this June as much as $13 billion, has become a valuable part of Merrill’s business. Lewis will get the benefit of BlackRock’s expanded value–but good luck to him if he wants to call the shots there. BlackRock is reportedly rearranging its common and preferred shares, and the result is BlackRock cutting Merrill Lynch’s voting stake to a paltry 4.9%.. The change comes because of a clause in Merrill’s agreement with BlackRock that governs any change in control, as our colleague Dan Fitzpatrick noted. Still, Bank of America can take that somewhat personally: BlackRock is give PNC Financial Services Group, which owns only 33% of the asset manager, 47% of the voting rights. Ouch.

Investment bank:

December was the cruelest month. Global announced M&A deals fell 54% from a year earlier, with U.S. deals plummeting 82%. Global debt underwriting volume in the second half of the year fell $3.1 trillion, with $2.2 trillion of that coming in the U.S., according to research from Oppenheimer analyst Meredith Whitney. In the last quarter, investment-banking revenue at Merrill fell 27%. The M&A slowdown will continue to hit Merrill Lynch’s bankers. Still, Merrill’s investment banking team hasn’t done too shabbily: Thomson Reuters data rank the investment bank No. 5 in debt and equity underwriting and a robust No. 3 in merger advice. And, after all, Merrill’s bankers were savvy enough to sell the firm to Bank of America.

Capital markets

This is the business that could cause Bank of America the most trouble, according to analysts. Research analysts have approached Merrill’s write-downs with wariness. Sanford C. Bernstein analyst Brad Hintz wrote:

From BAC’s point of view Merrill Lynch may look less attractive as Mr. Lewis’s management team realizes that they have purchased a massive portfolio of troubled asset classes (residential and commercial mortgages, RMBS, CMBS, leveraged loans and CDOs) and significant CDO underwriter’s liability claims. Certainly there is concern that Merrill’s troubled assets and counterparty exposure could continue to drive new writedowns for Bank of America after the MER acquisition closes and that unhappy purchasers of MER’s 2005-2006 CDOs will likely bring substantial claims against BAC under sections 11 and 12(2) of
the Securities Act of 1933.

Fitch Ratings, which applauded the deal, also said today:

BAC continues to face mark-to-market pressures in its holdings of ABS CDOs, and in leveraged loans and commercial mortgage related assets held for sale. In its loan portfolio, BAC has needed to build provisions to cope with weakening trends in home equity loans, credit cards, and homebuilder-related credits. While the portion of the commercial and industrial loan portfolio not related to homebuilder finance has performed well to date, asset quality in this portfolio may also weaken as the economic downturn progresses.

Related on Deal Journal

Is Bank of America Getting a Bargain in Merrill Lynch?
John Thain Hearts Merrill Lynch Wealth Management
Thain Disses Goldman
Why Merrill Lynch Should Hold On To Its BlackRock Stake

Ben Wright, of Financial News, peered into the clearing mists of his crystal ball to predict the big financial-system issues for 2009. Here are a few highlights. Financial News is a Dow Jones publication and a contributor to Deal Journal.

•Bank boards will be overhauled
More than a year and a half into the global financial crisis, board members are being held accountable for failing to maintain controls while employees chased revenue with little regard for risk. Chief risk officers already have been elevated to the top table, at UBS and Merrill Lynch, for example. Nonexecutive directors, whose job it is to challenge the board, stand accused of failing to do so, or of lacking the requisite skills, something RBS and UBS have already tried to rectify. More changes, in both personnel and responsibilities, are afoot and the new generation of chief executives will not be allowed to run their banks like their more autocratic predecessors.

•Bank mergers spark culture wars
After unprecedented consolidation among banks in 2008, buyer and seller now have to live together. If their cultures were as unique and important as their senior managers claimed, watch for clashes now that they are under the same roof. Barclays Capital staff are already said to be unhappy about former Lehman Brothers bankers being given senior positions. The combination of Lehman’s European and Asian operation with Nomura is an even drier tinderbox. “These mergers are always horrible,” one headhunter says. “People are always worried about the hidden politics that come with these deals.”

•Simplicity is the new sophistication
Plain speaking, sensible ideas and simple concepts will make a comeback. Regulators, particularly in the US, have made threatening noises about banning some derivatives outright and forcing banks to use standardized building blocks for others. “For many years there was a fashion for expensive, complex investment strategies with high returns,” said Alisdair MacDonald, an investment consultant at Watson Wyatt. “Now everything has come full circle, and there is an appreciation that you can make reasonable risk-adjusted returns without using excessively clever or sophisticated methods.”

•Bankers learn how to say the hardest word
A public-relations push to rehabilitate the image of bankers and hedge-fund managers is bound to emerge. “It would certainly need to start with some very public displays of contrition in which bankers admit that they, along with others, were, at least partly, responsible for the economic mess we’re in,” said one corporate communications and public affairs consultant.

Already Alan Greenspan and Eddie George, the former heads of the Federal Reserve and the Bank of England respectively, have held up their hands to admit they didn’t fully understand the risk building up in the financial system under their watch. If those in the private sector are to defuse public anger and political posturing, they will soon have to do the same.

Deals of the Day, compiled by Stephen Grocer and Heidi N. Moore, gathers all the biggest news of the morning related to mergers and acquisitions, bankruptcies, financing and private equity. You can bookmark Deal Journal for easy visiting throughout the day at http://blogs.wsj.com/deals.

Mergers & Acquisitions

MIA: Merger and acquisition activity all but screeched to a halt in the last quarter of 2008, with global deals volume falling 29% for the year. [WSJ]

PCCW’s share price remained far below Richard Li’s latest buyout offer, reflecting investor concerns that minority shareholders will reject the bid. [WSJ]

Related: Investors should take their money. [WSJ]

Financial Institutions

Bank of America, Wells Fargo and PNC completed acquisitions of Merrill Lynch, Wachovia and National City this week. [WSJ]

Citigroup: The bank’s chief executive and chairman agreed to take no bonuses for 2008, the latest sign that regulators are keeping the New York company on a tighter leash following its massive government bailout. [WSJ]

Related: Citigroup boss Sir Win Bischoff says the blame for last year’s collapse of the financial system should not rest on bankers alone. [Times of London]

Bank failure central? Alpharetta, Ga., is a suburb of wide boulevards, sleepy cul-de-sacs and bustling red-brick shopping centers. It also is the bank-failure capital of the U.S. [WSJ]

Dusting off the old playbook: The FDIC is dusting off a tool used during the S&L crisis as it braces for a wave of bank failures in 2009. [WSJ]

UBS sold its 1.3% stake in Bank of China for $808 million amid talk other companies could also raise cash by selling holdings in Chinese lenders. [WSJ]

Are you there, Barack? It’s me, Wall Street: The Economist sends an open letter to Barack Obama’s BlackBerry about the future of Wall Street. [The Economist]

Buyside

The worst of the worst: GLG Partners has capped one of the worst years for hedge funds with the suspension of its dividend payments and by giving no date for resuming them. GLG shares have fallen by 84 per cent in the past year. [Times of London]

Weekend at Bernie’s: Bernard Madoff gave authorities a list of assets, but investigators have yet to determine where all the money in an alleged Ponzi scheme went. [WSJ]

Capital Markets

Japan Post Bank’s IPO: The firm’s relative health comes thanks to an uncommon simplicity in how it conducts its business. But more work is needed before it will be tempting to investors. [WSJ}

Companies & Industries

Microsoft: Up to 15,000 jobs worldwide are at risk as the computer software giant prepares for first layoffs in its 32-year history. [Times of London}

Warren Buffett: Berkshire Hathaway slumped 32% last year, the worst performance in more than three decades, as the U.S. recession forced down the value of the firm’s equity holdings and derivative bets. [Daily Telegraph]

Millenials: The crisis has made Gen Y, the Net Generation, Millenials — whatever you call them — lose their infamous sense of workplace entitlement. “Such griping may reinforce the stereotype of young workers as being afraid of hard work—more American Idle than American Idol.” The problem could be solved by IM: “Charlotte Gardner, a 25-year-old Californian who was made redundant by a financial-services firm in November, has since been using online job and social-networking sites, as well as micro-blogging services such as Twitter, to promote her skills to potential employers.” [The Economist]

Looking Back at 2008

The doomsayers who got it right: For years, they were the party poopers: financial prognosticators who warned of trouble. In hindsight, they’re the ones who got it right — at least some of it. [WSJ]

2008 in Review: Starting with Northern Rock on the rocks and ending with what is believed to be the biggest financial scam in history, 2008 will be remembered as the year the financial system as we know it was brought to its knees. [Times of London}

Related: For most people, 2008 will go down as 366 days best forgotten. [Daily Telegraph]

Dick Fuld and Jimmy Cayne: As the Kenny Roger’s song goes: “You got to know when to hold em, know when to fold em, Know when to walk away and know when to run.” Pity Cayne and Fuld didn’t. As the worsening financial crisis imperiled their firms, neither could pull the trigger on a deal until it was too late. In the process billions of dollars of shareholder value were lost. Few were hit harder than Cayne by the implosion of his Bear Stearns. The perception that he was unengaged resulted in the loss of his CEO title, but his wallet took the deepest cut. Just 12 months before J.P. Morgan Chase agreed to acquire Bear in March, Cayne’s stake was valued at around $1 billion. At the $10-a-share price, that was down to about $60 million. Fuld wasn’t perceived as unengaged, quite the opposite. But his attachment to Lehman Brothers Holdings seemed to make it impossible for him to pull off a deal that would have saved his firm. It probably is no coincidence that both were the longest serving CEOs on Wall Street.

Jerry Yang and Steve Ballmer: The two seemingly will be forever entwined after the soap opera that was Microsoft’s unsolicited bid for Yahoo. And neither emerged with their reputations intact. Yang engaged in a scorched earth tack to block Microsoft’s bid for his Internet advertising and search giant, demanding $37 a share. Microsoft refused to offer more than $33 and walked. Now Yahoo’s shares are trading around $12, and its ad deal with Google has fallen apart. For Ballmer, the deal was an attempt to better compete with Google and would have gone down as the signature move of his tenure in the Microsoft corner office. But unlike InBev’s Carlos Brito, who acted decisively, Microsoft took months to put the pressure on Yahoo. On top of that, Ballmer’s pronouncements after Microsoft walked away that the deal still made economic sense only highlighted the software giant’s struggles taking on Google.

G. Kennedy Thompson: Few deals have turned out as poorly as the Wachovia CEO’s acquisition of mortgage lender Golden West Financial in 2006, at the height of the housing bubble. By July 2008, the entire market value of Golden West–which Wachovia bought for $25.5 billion–had for all intents disappeared. By the October Wachovia itself had disappeared, scooped up by Wells Fargo for $14.5 billion. Needless to say, Thompson lost his job.

Private Equity: Not too long ago the “Golden Age” of private equity was proclaimed to be upon us. Oh, how Kolhberg Kravis Roberts’ Henry Kravis must rue those words now. Many of the biggest buyouts announced in 2007 fell apart before crossing the finish line, including the $41 billion deal for Canadian telecommunications operator BCE, the largest announced buyout in history. A number of those that did cross the finish line now are lining up to file for bankruptcy-law protection. Perhaps more troubling for the industry, the financial crisis put the spotlight on its business model. Their lifeblood, leverage, is out. The easy money to be made taking companies private is gone. And with IPO market frozen, firms will be holding on to their purchases much longer. Perhaps we have entered private equity’s “Ice Age.”

Cerberus Capital Management: Many private-equity firms have had a rough go of it. Apollo Management comes to mind. Then there was Cerberus. The publicity shy firm was thrust into the spotlight by two bad bets on the U.S. auto industry–GMAC and Chrysler, both of which received government bailouts. And as if the auto bets weren’t bad enough, the firm suspended withdrawal requests from investors after suffering sizable losses in October and November from a wrong-way bet on the fixed-income markets.

Christopher Cox and the Securities and Exchange Commission: The disappearance of Wall Street means the agency’s regulatory sphere has shrunk. The SEC’s decision in the past few years to remove the uptick rule and loosen the capital requirements on investment banks resulted in the SEC getting a degree of blame for worsening the financial crisis. Cox now concedes the ban on short-selling was a mistake. And though it didn’t happened solely on his watch, Bernard Madoff’s alleged Ponzi scheme cast the regulator in a poor light. At the height of the financial crisis it got so bad for the SEC that John McCain called for Cox’s head.

Henry Paulson and Ben Bernanke: It has been an up and down year for the pair tasked with saving the U.S. financial system. On the plus side, they expanded the powers of the offices they hold. Yet they have been criticized for being behind the curve amid the financial crisis, and even the praise they did win for getting $700 billion from Congress evaporated when they flip-flopped over how to use the TARP money.

Lloyd Blankfein and John Mack: The two are CEOs of the only big publicly traded Wall Street investment banks to survive the financial crisis–Goldman Sachs Group and Morgan Stanley. Yet their problems are hardly in the rear-view mirror. Many of their most profitable business lines are dried up–and in some cases gone for good. More importantly, their decision to become bank-holding companies means the business model they employed so successfully for so many years has changed. Now we will find out how they adapt.

Warren Buffett: Few were as active on the deal-making front in 2008 as the Oracle of Omaha. He acquired 60% of Marmon Holdings for $4.5 billion; Berkshire Hathaway joined forces with Mars to acquire Wm. Wrigley Jr. for about $23 billion; he scooped up stakes in General Electric and Goldman Sachs (the latter on more generous terms than the U.S. government received for its stake). And even when he lost, say with his bid for Constellation Energy, he won, doubling his money. Still, there is the unnerving thought that Buffett may have committed his capital too early. Two derivatives bets showed sizable paper losses, and he may have received even more generous terms if he waited longer to invest in Goldman. But then Buffett isn’t one to worry about the short term. He is a long-term investor, and his defenders say his derivative bets will pay off in time.

Jamie Dimon and Ken Lewis: Wall Street desperately needed a hero in 2008. And while calling either a hero might be an overstatement, the leadership of both men enabled their firms to not just ride out the storm but to take advantage of opportunities that developed to expand their businesses. This year the federal government turned not once but twice to Dimon and his J.P. Morgan Chase to scoop up failing banks. In March, J.P. Morgan acquired Bear Stearns at the bargain price of $10 a share. In September, J.P. Morgan grabbed Washington Mutual. For his part, Lewis snatched up troubled mortgage lender Countrywide in February and then acquired Merrill Lynch. Lewis had long wanted to show up Wall Street. The Merrill Lynch acquisition vaulted him to its summit. Still, risks and questions abound. How hard will both banks be hit by the coming credit-card storm? And have the pair swallowed too much to digest?

Carlos Brito: Deal making was dominated in 2008 by hostile offers–ones that often failed. InBev’s hostile offer for Anheuser-Busch was an exception. And in getting the deal across the finish line, Brito proved a consummate deal maker. First, there was his sense of timing. Had he made the offer a year earlier or even three months later, it most likely would have failed. But A-B’s stagnant share price and a sagging dollar made late spring the right time to pounce. Unlike other CEOs who held too fast to their original offer, Brito quickly raised his to seal the deal. Perhaps his most impressive feat was arranging $52 billion in funding.

Richard Kovacevich: Passed over by Citicorp CEO John Reed to head the bank’s consumer banking business, Kovacevich quit to take a job at Norwest. There he developed a reputation as a highly skilled acquirer, which continued when he moved to Wells Fargo. And at the height of the financial crisis, he got a measure of revenge, blowing up Citigroup’s deal to buy Wachovia and acquiring the struggling North Carolina bank for $14.5 billion. Reed now says passing over Kovacevich “probably was a big mistake.”

Mark Hurd: The Hewlett-Packard CEO has proved a master of execution. On Hurd’s watch each of H-P’s businesses has become more profitable, giving the company financial balance and stability. This year he added deal maker to his list of accomplishments. The acquisition of EDS for $13.2 billion helps fulfill Hurd’s quest to build a “one-stop shop” for corporate digital-data needs and take on International Business Machines. The addition of EDS should boost profits and profit margins, one reason H-P is forecasting profit growth next year when most everyone else is expecting declines.

John Thain: True, the Merrill Lynch CEO received plenty of criticism for his rosy statement about the problems weighing on Merril’s balance sheet, but his decision to sell the brokerage house to Bank of America earns him a spot on this list. After all, Thain didn’t create the mess, and he was among the most aggressive Wall Street CEOs in attempting to right the ship, offloading toxic assets and selling Merrill’s stake in Bloomberg. When he realized these efforts wouldn’t be enough, he quickly struck the $50 billion deal with BofA. In doing so, he saved shareholders and employees billions.

Japanese banks: More than a decade ago, Japanese banks were the ones damaged badly from loan problems. After years of caution and weathering the economic woes at home, Japan’s banks had the balance sheets to take advantage of the financial crisis and expand their global reach. Mitsubishi UFJ Financial Group, Japan’s largest bank by market cap, acquired 20% of Morgan Stanley and paid roughly $10 billion for the 35% of UnionBanCal it didn’t already own. Nomura Holdings, Japan’s largest brokerage house by market cap, snatched up Lehman Brothers’s Asian and European operations.

Bob Diamond: For a dozen years, Diamond helped expand Barclays from a middling London bank into a broad-based European investment house. But Barclays lacked a big-league business in the U.S. The financial crisis provided that opportunity. In the biggest gamble of his career,  Diamond agreed to pay $1.75 billion to acquire Lehman’s U.S. broker-dealer unit.

Wall-E: This story of a winsome love-struck robot turned a flashing LED light on the dangers of American consumerism with both a cautionary tale and a hopeful message. The movie’s depiction of plump, careless, infantilized American consumers was well timed, released on June 27, after Bear Stearns had collapsed and the financial crisis intensified scrutiny of reckless borrowing and spending habits. The movie’s childlike humans roll around on a mother ship that contains everything they could ever need, from food to entertainment; it isn’t difficult to see the U.S. government, with its bailouts this year, in the same paternalistic role. In the end, however, Wall-E and his sweetly iPod-like love interest, Eve, go to great lengths to save the last vestiges of life and round up a group of humans to return to earth and clean up the mess they made. If only someone could do the same for the credit markets.

Bartering: Manhattan Island was sold for some beads and wampum, but ever since Alexander Hamilton whipped the U.S. Treasury into shape, lucre has been on the rise. Bartering has had a somewhat rustic, backward, almost medieval connotation ever since. As Treasury Secretary Hank Paulson pulled strings and stayed up nights to save the markets, wags made gloomy predictions of America’s return to a “barter economy” if he failed. Bartering was the easy butt of too many jokes, taking its place alongside dark-humored quips about bread lines and the WPA, the inevitable Depression-era consequence of a devalued dollar and a marketplace in which everyone ceased to trust each other. There is no such thing as bad publicity, and in 2008, “the barter economy” expanded to at least $3 billion in the U.S. Trading something you have for something you want used to be the function of money, before money came from ATMs and plastic cards and home loans. It still isn’t a bad idea.

There is no such thing as a free bailout.

Like so many of their compatriots on Wall Street, Citigroup CEO Vikram Pandit and chairman Win Bischoff have decided to forgo 2008 bonuses, the bank revealed in a Securities and Exchange filing Wednesday–and they won’t take any golden parachute payments, either, as long as they own Citigroup stock.

To call it a “decision” may be overstating the matter, since Citigroup agreed to the terms in return for receiving a giant passel of federal funds. Citigroup revealed those terms in this 8-K filing. The juicy compensation part starts on page 31.

Citigroup acted more because of government pressure than because of the “all the cool kids are doing it” Wall Street lockstep. Pandit and Bischhoff follow the grudging lead set by John Thain–who had hoped for $10 million–and the voluntary examples set by Morgan Stanley’s John Mack, Goldman Sachs Group’s executive board, including Lloyd Blankfein, and even Citigroup’s own executive board, led by Robert Rubin.

The agreement with the government dictated that executives could get as much as 60% of 2007’s bonus, but Pandit, Bischoff and Rubin all agreed not to take any bonus at all. The members of the leadership committee and others will get drastically reduced bonuses. “The harsh realities of 2008, primarily our earnings results, mean that our bonus pool is dramatically lower than last year,” Pandit said in a memo quoted by Bloomberg.

Even harder than getting a bonus would be holding on to it. The government agreement has a “clawback” provision that says that, if executives violate the terms of the agreement, they will have to give back any compensation. Citigroup also instituted its own clawback if executives get rewarded based on financial results that later don’t hold up.

Below, Deal Journal prints Pandit’s memo to employees today.

To: All Colleagues From: Vikram Pandit Date: December 31, 2008 Re: Year-End Compensation

As certainly all of us know, this year has brought Citi and our industry unprecedented challenges and profound change. One of the most significant developments is the re-examination of executive compensation principles and practices. This has been a key priority at Citi, and we have worked hard during the year to create new approaches to compensation. As a result, we have established a set of principles, and already taken several actions, that reflect both our objectives as a company and the environment in which we live.

In 2008, Citi and other institutions have also been fortunate to receive investments from the United States government. In fact, we have now finalized the agreement for the government’s investment of 20 billion dollars in Citi that was announced last month. During the investment process, we presented to the Treasury Department the approaches to executive compensation that we developed. I am very pleased to say that the government found them to be consistent with their objective as an investor in Citi, and our concepts have been incorporated into the agreement. (Details on Citi’s agreement with Treasury will be in a Form 8-K filing that will be made today.)

In the face of the extraordinary pressures of 2008, you have been instrumental to Citi’s accomplishments. Each of you has contributed in your own way, and each of you has done this extremely well. Unfortunately, the harsh realities of 2008, primarily our earnings results, mean that our bonus pool is dramatically lower than last year. Our focus, however, is on the future, and I believe we will continue to make progress in 2009 — much more of it and much faster than we did in 2008.

As we move forward, the simple, fundamental principles that will guide us in rewarding individual contributions to the growth of Citi are:

* Pay for performance. Naturally, talent is our bedrock asset. We are fully committed to paying for high-performance people at all levels of the organization and at competitive rates — in the context of the company’s overall financial results.

* Meritocracy requires differentiation in pay. Compensation will vary based on each person’s performance — again, relative to the overall performance of the company.

* The most senior leaders should be affected the most. That is why Win Bischoff and I will receive no bonus for 2008. Win and I believe this is fair, in light of the challenges of the year and the need for compensation elsewhere in the organization.

* The senior management team as a whole must demonstrate leadership. Consequently, the bonuses for the Senior Leadership Committee will be reduced substantially. Those for the Executive Committee will be cut even more. In addition, the Executive Committee members will receive significantly larger proportions of their bonuses in deferred compensation than will other employees.

* The ability to “clawback” is essential. We now have instituted a policy under which we can recoup executive compensation that over time proves to be based on inaccurate financial or other information.

* Severance compensation must be restricted. We also have placed significant new limitations on the amount of severance compensation that can be awarded to executives. Moreover, the five senior executives whose compensation is listed in our proxy statement no longer can receive severance.

I also want you to know that Bob Rubin, although he is an advisor to the company and has no direct management responsibilities, has elected to take no bonus for the second consecutive year. Bob again feels that at this stage of his career and in his circumstances, the money should be directed to the bonus pool for others.

The overall objective for all of us at Citi is t