Financial thoughts

The Federal Reserve, which is urging Congress to let it keep its bank supervising role, may lose oversight of smaller state banks to the Federal Deposit Insurance Corp., Democratic Senator Jack Reed said.

“What seems to be emerging is the consolidation” of two Treasury bank agencies “with FDIC having some responsibility for state banks as regulator in lieu of the Fed,” Reed, a Rhode Island Democrat and a member of the Senate Banking Committee, said yesterday in a Washington interview.

Senate negotiators are working through proposals to put in place the financial rules proposed by President Barack Obama more than eight months ago, a process stalled by disagreements over the Fed’s role and consumer protection.

Lawmakers are negotiating language that may give the Fed oversight of the largest U.S. financial companies along with a new consumer unit, two Democratic congressional aides with knowledge of the talks said yesterday. The consumer proposal from Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, and Republican Bob Corker of Tennessee has so far failed to win lawmaker support.

Republicans and the financial-services industry oppose Obama’s Consumer Financial Protection Agency, and Dodd and Corker have scrapped the plan. Banks lobbied against the proposal, with JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon calling the agency “just a whole new bureaucracy” on a December conference call with analysts.

The Senate plan under consideration would put the Fed in charge of about 20 or 30 bank holding companies, said one Democratic congressional aide who declined to be identified because the talks are private. The Treasury’s Office of the Comptroller of the Currency, which oversees national banks, and Office of Thrift Supervision would merge, Reed said.

Bernanke Setback

A loss of oversight would be a setback for Fed Chairman Ben S. Bernanke, who told the Banking Committee on Feb. 26 it would be a “grave mistake” to remove authority to regulate banks. Giving another agency the power would make it tougher for the Fed to act as the lender of last resort, he said free credit report online.

The Fed won endorsement yesterday from six Washington-based trade groups, led by the American Bankers Association. A letter to the banking committee said “it would be a mistake to limit the Federal Reserve to supervision of only larger, complex institutions headquartered in major financial centers.”

Treasury Secretary Timothy Geithner had asked the leaders to back the administration’s rules overhaul at a Feb. 25 Washington meeting. Later, groups including the Financial Services Roundtable and Securities Industry and Financial Markets Association agreed to write a letter, according to two people with knowledge of the matter, who declined to be identified because the meeting was private.

Small Bankers

The leaders then recruited the Consumer Bankers Association and Independent Community Bankers of America, which represent small banks, the people said. Both support the Fed as overseer of some state-chartered banks. The Senate legislation may give such power to the FDIC, which regulates some state-chartered banks.

A copy of the letter was sent March 2 to Michelle Smith, the Fed spokeswoman and adviser to Bernanke, the people said.

The Fed’s role emerged yesterday as senators negotiated the powers of a consumer unit at the Fed.

“Each of these pieces affects another piece in the bill,” Corker said in an interview. “Today has been by far the very best day we’ve had in the process.”

The plan for the Fed, still under discussion and may change, would abandon the single bank regulator Dodd proposed in his November draft legislation.

Dodd wanted to eliminate the OCC, which regulates national banks, and the OTS, the regulator of savings and loans, and merge their authority into a new Financial Institutions Regulatory Administration that would gain oversight powers of the FDIC and the Fed. The House passed a bill in December that merged OCC and OTS, leaving the Fed’s bank oversight powers intact.

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American taxpayers, if you believe in stereotypes, are scurrying around this time of year, rummaging shoeboxes for receipts and other paperwork to support itemized tax-deduction claims.

In reality, most taxpayers, including me, don’t bother itemizing deductions, which must be reported on a tax form called "Schedule A" and require proof in case of an audit. We don’t bother because the basic standard deduction, which is free for the taking, is higher than all the itemized deductions most of us can legitimately claim. The basic standard deduction requires no documentation and is entered on the main 1040 tax form.

For 2009 returns, thanks to what Congress enacted as temporary measures, the standard deduction will be even higher for many Americans who meet qualifications. The higher the standard deduction is, the lower the taxable income and tax bill are.

The downside is increased complexity, including a new tax form to fill out called Schedule L.

"The standard deduction isn’t so standard anymore," said Mark Luscombe, principal federal tax analyst for tax publisher CCH, a Wolters Kluwer business. "For some people, filling out this schedule will probably entail as much figuring as taking a few itemized deductions on Schedule A."

For a little bit of work, though, the tax savings can be significant.

For the 2009 tax year, the basic standard deduction is $5,700 for singles and $11,400 for joint filers. Blind people and those 65 years old or older as of Jan. 1, 2010, can claim an additional $1,100 standard deduction for 2009. (Therefore, a couple filing jointly, both 65 or older and blind, would take an additional $4,400 deduction). Higher deductions for seniors and the blind have been part of the tax code for years and are not likely to be discontinued, Luscombe said.

In addition, in what are supposed to be temporary measures to boost housing and the economy:

— Non-itemizers can claim an additional standard deduction for state and local property taxes paid in 2009, up to $500 for single taxpayers and $1,000 for joint filers.

This extra deduction, first available for 2008 returns and later extended for 2009, was part of a legislative package aimed at boosting a sagging real estate market. "Much of the package rewarded people for buying homes," Luscombe said, and the extra deduction benefits people who have no mortgage (like me) or don’t pay enough interest on it to be able to itemize. The deduction expired at the end of 2009 but is likely to be extended to 2010, Luscombe believes.

— Another provision effective since 2008 allows taxpayers who have experienced casualty losses in areas the U.S. president has declared disaster areas to take those losses as an additional standard deduction.

"This is especially valuable to people who may experience a few thousand dollars in losses that they can ill afford, but whose losses are not large enough" to itemize (because the basic standard deduction would be larger), Luscombe said.

This deduction is not available to taxpayers in the Midwest Disaster Area of 2008, for whom different rules apply.

— Subject to income limits, non-itemizers who bought a new car in 2009 on or after Feb. 17 can add to their standard deduction the state and local sales and excise taxes they paid for the vehicle. Eligibility for this tax break phases out for single filers with modified adjusted gross income between $125,000 and $135,000 (joint filers, $250,000 to $260,000), and the deduction is limited to taxes paid on up to $49,500 of the purchase price.

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"Drill baby drill" is so 2008.

More than a year after Republicans rallied around the now-famous call, a growing number of Americans are saying not-in-my-backyard when it comes to more oil and natural gas drilling.

At a recent drilling hearing in New York City the crowd was certainly riled up, but not in a way that might please Sarah Palin.

"We don’t want more hearings, we want a total statewide ban," exclaimed one protestor, jumping on stage at the hearing’s start before being escorted away by uniformed officers. The standing-room-only crowd, many carrying protest signs, erupted in applause.

Most Americans still support increased oil and gas drilling. But opposition is growing, especially when that drilling nears more populated urban areas. Currently there are natural gas booms happening around New York City, Dallas-Fort Worth, Western Colorado, the Midwest, and elsewhere. Opponents fear this new drilling will ruin the drinking water for millions of people, among other concerns.

And energy companies, accustomed to dealing with rural populations familiar with drilling and eager for jobs and lease royalties, are increasingly finding themselves at odds with a more educated and wealthy populace wary of energy development.

This is especially true outside New York City.

Just north of America’s largest metropolis lies one of the country’s most promising new sources of energy: The Marcellus Shale.

Running much of the length of the Appalachian Mountain rage, the Marcellus is thought to hold up to 500 trillion cubic feet of natural gas - more than twice the nation’s current total reserves.

In the age of global warming, natural gas as an energy source is gaining favor. Burned to generate electricity, it emits about half as much pollution as coal.

It can also be used to power cars, and some, including the oil billionaire T. Boone Pickens, are pushing this idea as a way of weaning the country off foreign oil.

Growing fear about contaminated water

New horizontal drilling technologies have made the gas in the Marcellus shale and other shales across the country more accessible. But extracting it requires breaking the shale rock with a mixture of chemicals, water and sand, blasted down the well hole. While the process, known as hydraulic fracturing, has been around for decades, it’s never been done on this scale, and so close to major population centers.

The shale lies thousands of feet below the water line, and both energy company officials and state regulators across the country say the chemicals used in the fracturing process have never resulted in ground water contamination.

But across the country a few high profile mishaps have occurred, resulting in contaminated drinking wells, flammable tap water, and even houses exploding. Radiation, often naturally occurring in rocks, has also been found in drinking water.

Regulators from various states said the contamination is not due to chemical fracturing but to drilling or surface spills. And while acknowledging they are unfortunate, state officials note these incidents make up only a fraction of the hundreds of thousands of wells drilled nationwide.

The federal Environmental Protection Agency has just begun looking into the issue. EPA had been largely sidelined from regulating this practice thanks to a 2005 law exempting the drilling from the Clean Water Act and declaring the chemicals trade secrets not subject to disclosure.

"EPA is reviewing available information to determine whether hydraulic fracturing fluids have contaminated drinking water," the agency said in a statement to CNNMoney.com.

That’s of little consolation to many New Yorkers.

"I consider it a grave threat to our resources," said Joe Lavine, an architect from Brooklyn with a weekend house near the drilling. "Nobody knows if [the chemicals] are migrating."

So Levine helped organize a group called Damascus Citizens for Sustainability. Named after a nearby town, its members are calling for stricter drilling regulations.

Unlike many grassroots opposition groups that are often initially unfamiliar with the nuts-and-bolts of an issue, this one has plenty of technical expertise. It includes a former head of New York City’s water system and a Columbia-trained geophysicist.

"We’ve had a great handle on this from the beginning," said Levine.

They’ve networked among other grass roots groups in New York State, traveling to Ithaca, Binghamton, and other towns dealing with increased drilling.

Levine said there are now some 50 groups in New York State alone that receive emails and get their members out to sign petitions or turn up at public hearings.

This activism likely played a part in a recent decision by Chesapeake Energy (CHK, Fortune 500), one of the country’s largest natural gas companies, to not drill on any of the land it has leased in the New York City watershed.

In a press release, the company said "the concern for drilling in the watershed has become a needless distraction from the larger issues of how we can safely and effectively develop" other gas fields in New York. Chesapeake noted the watershed leases are just a tiny part of their overall holdings in the state, and that they were the only company holding leases in the watershed.

It seems clear that calls from activists seeking a complete state-wide ban are making energy companies nervous.

Beyond New York

The activism in New York is firing-up concerned citizens in other parts of the country.

In Fort Worth, Texas, hardly an area known for anti-drilling sentiment, Don Young said the number of people on his email list has gone from 200 to 400 in the last few months.

Young, a stained-glass artist who lives right across from a natural gas well situated next to a public park, started the blog FWCanDo five years ago. It acts as a sort of clearing house for information on natural gas drilling.

He said many people are now singing up from the New York area, but he’s also getting inquiries from Michigan, Arkansas, Ohio and elsewhere.

In Fort Worth where the Barnett Shale is located, natural gas drilling and hydraulic fracturing has been going on literally right under the city for roughly a decade. Opposition here is getting a bit hotter, he said.

"The crowds are greater, and the hard questions are a little more frequent," said Young, "At first it was all about the money, but now it’s about health, safety and the environment too."

In Western Colorado, public awareness of drilling and the potential dangers has increased as wealthy people from nearby resort towns have become interested in the cause, said Theo Colborn, president of the Endocrine Disruption Exchange, a group studying the effects of drilling chemicals on humans.

Colborn recounted the story of a nearby town where the local officials were considering allowing more drilling. Soon after, residents had their cars leafleted with pamphlets describing the associated dangers. Turns out, a local resident had hired a public relations agency to come in and run the campaign.

"A lot of wealthy people have been affected, and they can afford the lawyers or PR firms to come in and do stuff like this," she said.

Nationwide, few expect rising public concern to put a stop to new natural gas development.

"On balance, future regulation will likely attempt to accommodate industry in order to preserve the energy security and climate change policy benefits of expanded domestic gas production," Robert Johnston, director of Energy & Natural Resources at the political consultancy Eurasia Group, wrote in a recent research note.

But the days of this industry operating in relative obscurity and with little federal oversight are likely numbered. 

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A former top executive at hedge fund firm ValueAct Capital is one of seven people charged with trading on inside information in Acxiom Corp.

Ronald Yee, who had been the San Francisco-based hedge fund firm’s chief financial officer until June 2008, was named in a civil suit filed by the Securities and Exchange Commission on Friday.

The SEC did not identify Yee’s former employer.

ValueAct, a nine-year-old firm that invests roughly $3.5 billion in undervalued securities, said it has been cooperating with the SEC since the agency began probing Yee in 2008.

The firm, which made national headlines when its co-founder Jeffrey Ubben became the chairman of Martha Stewart Living Omnimedia Inc, put Yee on administrative leave in April 2008. In June 2008 the partners accepted Yee’s request to resign.

ValueAct said it requires all employees to participate in rigorous training on how to handle non-public information and immediately told investors about the probe into Yee in 2008 and then wrote to them on Friday to detail the charges against him.

The hedge fund is not implicated in the scheme in any way and received a no-action letter from the SEC, confirming that it is not a target in the investigation, said George Hamel, ValueAct’s co-founder and chief operating officer.

Yee’s lawyer said he is innocent and will contest the charges.

The matter has drawn attention because it comes only two weeks after prosecutors charged prominent hedge fund firm Galleon Group’s founder Raj Rajaratnam with insider trading companies making payday loans.

At that time sources familiar with regulators’ insider trading probes said there would likely be more charges, but they did not give details about specific cases.

The cases are very different however. In the Galleon matter, the fund’s founder has been charged while in the Yee matter the hedge fund and its current partners have not been implicated in the scheme.

The SEC alleges that Yee, who joined ValueAct as chief financial officer in 2005, tipped off his brother-in-law, Chen Tang, who then traded on the information through personal accounts. Tang was employed at private-equity firm Friedman Fleischer & Lowe. The two men had previously founded a financial consulting firm together.

In 2007 Tang learned from Yee that ValueAct was trying to acquire Little Rock, Arkansas-based data management company Acxiom, the SEC said. Yee later found out that the deal was in jeopardy and passed the information to Tang, who then tipped his friends and family.

According to the complaint, Yee did not make any trades himself. Tang and the others used Yee’s tips to trade Acxiom’s securities and earned more than $6 million in illegal profits, the SEC said.

“Mr. Yee denies the charges against him and intends to vigorously contest them,” said Yee’s lawyer, Michael Celio, a partner at Keker & Van Nest in San Francisco. 

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Airline passenger revenue plummeted 19% in September year-to-year, an industry trade group said Tuesday — but it’s not for lack of business.

Passenger volume slipped just 2% in September year-to-year, according to the Air Transport Association. The group blamed the sales plunge on a decline in air fares, noting that the average price to fly one mile fell 18% in September, compared with a year ago.

"The demand for air travel remains weak," said ATA Chief Executive James May, in a statement. "While other sectors may be seeing signs that the economy is getting back on track, the airline industry has faced challenges in its effort to generate revenue."

September was the 11th consecutive month of declining passenger revenue versus a year ago, and the 10th consecutive month of ticket price declines, the ATA said.

ATA spokeswoman Elizabeth Merida said her group’s figures do not include revenue from the fees that airlines started imposing last year on services that once came for free, such as checked baggage, pet travel, non-alcoholic drinks and food. Nor would the ATA provide an estimate on how much those fees totaled.

According to the U.S. Department of Transportation, the extra fees added up to $1.15 billion last year.

Most recently, five of the major carriers including U.S. Airways (LCC, Fortune 500), AMR Corp.’s (AMR, Fortune 500) American Airlines, UAL Corp no fax payday loan.’s (UAUA, Fortune 500) United Airlines, Continental Airlines (CAL, Fortune 500) and Delta Air Lines (DAL, Fortune 500) added a $10 surcharge to holiday flights instead of raising fares.

ATA spokesman David Castelveter said the extra fees are "the airline industry’s attempt to generate the revenue that it needs to return to profitability."

But he said he expects more pressure on airline revenue going forward, given the recent rally in fuel prices. He said that every $1 increase in the price of crude oil means an extra $430 million in costs for the airline industry.

"That means that are costs are going to continue to go up at a time when the economy is continuing to be weak," said Castelveter.

Raymond Neidl, an airline consultant, said the fees "partly offset" the decline in revenue, but they’re not nearly enough to fix the problem. He said that airlines will continue to struggle until a recovery can stem the decline in business travel.

"Business travel is way off and that’s where the airlines get half their revenue," he said. "That’s the crux of the problem." 

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New orders received by U.S. factories posted their first drop in five months in August, government data showed on Friday, going against Wall Street expectations that they would rise.

Orders fell 0.8% after rising 1.4% in July, which was originally reported as a 1.3% increase, according to the Commerce Department. Analysts polled by Reuters were expecting them to gain by 0.3%. The drop was the first since March, when they fell 1.9%.

Factory orders were also down when compared to August 2008, by 22.5%.

Unfilled orders dropped 0.4% in August. They have now fallen for 11 months in a row, which is the longest streak of consecutive monthly decreases on records dating to 1992, the Commerce Department said.

Inventories fell 0.8%. They have decreased for 12 months in a row, the longest streak since 2002.

Durable goods orders had their steepest drop, of 2.6%, since January, when they fell 7.8%. Orders of durable goods — big ticket items meant to last — were originally reported as declining 2.4% in August. 

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The first two funds involved in the government’s plan to purchase toxic assets have raised about $1.13 billion, the U.S. Treasury Department said Wednesday.

Invesco Ltd. and Trust Company of the West, or TCW, are the first of the so-called Public-Private Investment Funds to raise the necessary capital to launch the program.

Treasury said it expects the seven other funds will complete their initial closings throughout October.

The launch of the program comes nearly a year after the U.S. Congress authorized a $700 billion fund to cleanse banks’ balance sheets of toxic assets. Officials shifted away from that idea and switched its focus to directly injecting capital in the banks.

The Public-Private Investment Program, or PPIP, has been dramatically scaled back as banks have proven that they can raise capital in the private markets without first unloading troubled assets, many of them tied to bad mortgages. 

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Finally!

After nearly two years of declines, the net worth of Americans rose by $2 trillion to an estimated $53.1 trillion in the second quarter compared with the first three months of the year.

The soaring stock market accounted for much of the gain. Stock holdings rose by 22% to $6.3 trillion, while mutual funds’ value jumped 15% to $3.7 trillion, according to a Federal Reserve report released Thursday.

To be sure, these are not exactly flush times for many people. Unemployment stands at 9.7%, the highest level in 26 years. And many people have yet to see their home values and portfolios recover from their recent trouncing.

Since only half of Americans own stocks, with even fewer having significant holdings, only a narrow group of people benefited from Wall Street’s springtime gains. The Dow Jones industrial average and the Nasdaq had their best performances since 2003 and the broader S&P 500 since 1998.

Homeowners, who make up about two-thirds of the population, also saw a little relief. Real estate rose in value for the first time since the end of 2006, climbing 2% to $18.3 trillion.

Still, Americans have a long way to go before they recover the wealth they once had. U.S. net worth peaked at $65.3 trillion in the third quarter of 2007. That’s 18.7% higher than the current level.

Much of the nation’s wealth had been tied to the recent booms in the housing market and on Wall Street allstate insurance company. At the end of 2006, Americans’ homes were valued at nearly $22 trillion.

And in the following year, their stock holdings topped out at $10.2 trillion and their mutual fund portfolio at $4.9 trillion.

Thursday’s report is not likely to prompt consumers to resume spending, said Scott Hoyt, senior director of consumer economics at Moody’s Economy.com. Wealth is still down $12 trillion from its peak and many people may see the recent increase as a blip.

"Consumers are still focused on how much wealth they’ve lost," Hoyt said. "They still likely see themselves in a good-size hole."

Less debt

At the same time, consumers continue to pay off their bills. Household debt shrunk by an annual rate of 1.7% in the second quarter, the fourth consecutive decline. Debt loads had never contracted until the current downturn.

Businesses are also pulling back on the debt they carry. Debt contracted at an annual rate of 1.8%, the second decline in a row.

Governments, however, are loading up on debt as they try to prop up the economy. Federal government debt ballooned 28.2%, the fourth straight increase, while state and local governments increased their debt levels by 8.3%. 

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Stocks ended modestly lower Thursday as investors struggled to balance hopes for an economic recovery with fears that equities have surged too far, too fast.

The Dow Jones industrial average (INDU) lost 8 points, or 0.1% after ending the previous session at its highest point since last Oct. 6.

The S&P 500 (SPX) index fell about 3 points, or 0.3%, after ending the previous session at its highest point since Oct. 3 of last year. The Nasdaq composite (COMP) lost 6 points, or 0.3%, after closing at its highest point since last Sept. 26.

The three major indexes have ended higher in 8 of the last 10 sessions.

U.S. stocks surged to almost one-year highs Wednesday on continued optimism about the economy. Thursday brought new reports supporting hopes that a recovery is underway, but the response from investors was more muted as worries persist that the stock rally has outpaced the recovery.

By afternoon, investors were ditching some of the biggest gainers from the last few weeks, including financials, commodities and big industrial names.

Big Dow losers included Alcoa (AA, Fortune 500), General Electric (GE, Fortune 500), American Express (AXP, Fortune 500), Travelers (TRV, Fortune 500) and Verizon Communications (VZ, Fortune 500).

Stocks have surged over the last six months as investors have welcomed a rash of improving economic news and an unprecedented amount of fiscal and monetary stimulus. Since bottoming at a 12-year low in March, the Dow industrials have gained just shy of 50% and the S&P 500 has gained 58%, as of Wednesday’s close. Since bottoming at a six-year low, the Nasdaq has gained 68%.

However, the continuing gains could be a cause for concern.

"This is a playable market rally within a long-term poor economy and bear market," said Robert Loest, portfolio manager at Integrity Funds. "This is not in my view the beginning of a long-term sustainable bull market."

Trading could be volatile and volume could be higher through the quarterly options expiration Friday. On Friday, stock index futures and options, and individual stock futures and options all expire at the same time.

Economy: The number of Americans filing new claims for unemployment fell last week to 545,000 from a revised 557,000 in the previous week, the Labor Department reported Thursday morning. Economists surveyed by Briefing.com forecast that claims would rise modestly.

Continuing claims, a measure of Americans who have been filing claims for unemployment for a week or more, rose to 6.23 million versus forecasts for a rise to 6.1 million.

A rise in apartment construction helped push August housing starts to the highest point in roughly nine months, the Commerce Department reported Thursday.

Starts rose 1.5% to an annual unit rate of 598,000 from a revised 589,000 in July, the government said. That was in line with economists’ forecasts.

Building permits, a measure of builder confidence, rose 2.7% to 579,000 from a revised 564,000 in July.

The Philadelphia Fed index rose to a 27-month high in September, adding to other evidence that the manufacturing sector is recovering. The index, a regional read on manufacturing, rose to 14.1 in September from 4.2 previously. Economists thought it would rise to 8, on average.

Corporate news: FedEx (FDX, Fortune 500) said fiscal first-quarter earnings fell 53% from a year ago, meeting the forecast it issued last week. The package delivery firm reported weaker earnings that met forecasts on lower revenue that was shy of expectations. Shares fell 2.2% Thursday.

Oracle (ORCL, Fortune 500) reported weaker quarterly revenue that missed forecasts late Wednesday. The software maker also reported higher quarterly earnings of 30 cents per share that were in line with forecasts. Shares fell 2.8%.

American Airlines parent AMR (AMR, Fortune 500) said it raised $2.9 billion, including cash and financing. The airline also said it will shift some flights to more profitable hubs such as Chicago and New York and away from St. Louis and other places. Shares rose almost 20%.

Currency and commodities: The dollar hit a fresh 9-month low against the euro and bounced after hitting a 7-month low against the yen.

The falling greenback has been lifting dollar-traded commodities including oil and gold lately, but prices were muted Thursday.

U.S. light crude oil for October delivery fell 4 cents to settle at $72.47 a barrel on the New York Mercantile Exchange. COMEX gold for December delivery fell $6.70 to $1,013.50 an ounce after settling Wednesday at a record high of $1,020.20.

Bonds: Treasury prices gained, lowering the yield on the benchmark 10-year note to 3.40% from 3.46% Wednesday. Treasury prices and yields move in opposite directions.

World markets: Global markets rallied. In Europe, London’s FTSE 100, France’s CAC 40 and Germany’s DAX all gained. Asian markets surged, with Japan’s Nikkei adding 1.7% after the Bank of Japan raised its economic forecast.

Market breadth was mixed. On the New York Stock Exchange, losers topped winners by eight to seven on volume of 1.52 billion shares. On the Nasdaq, advancers and decliners were narrowly mixed on volume of 2.65 billion shares. 

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Kraft Foods said it was intent on pursuing Britain’s Cadbury, which soared in value after it snubbed a premium-rich bid from the U.S. group, reinforcing hopes of a broader-based pick-up in merger activity.

Analysts said North America’s biggest food group might have to raise its 10.2 billion pound ($16.7 billion) offer by up to 40 percent after shares in the world’s No.2 candy and chocolate maker increased by almost half on news of the approach.

The company’s biggest institutional shareholder, Legal & General Investment Management, said in a statement that it thought the approach materially undervalued Cadbury, and supported management in opposing the deal.

According to Reuters Estimates, Legal & General has a 5.4 percent stake in the company.

Cadbury’s stock closed up 38 percent at 783 pence, having peaked close to its all-time high at 808 and well ahead of Kraft’s 745 pence-per-share pitch.

The price spike reflected analysts’ views the combination would be a success, chances of a counterbid and bankers’ hopes that rallying equity markets and a brighter economic outlook were encouraging companies to view mergers and acquisitions (M&A) prospects with greater confidence.

“If the deal gets done, it sends a positive signal about the M&A market. There is not that much more consolidation to be done in confectionery, but a successful outcome would make global consumer companies more likely to pursue their own M&A targets,” said a senior banking source.

The two firms’ product portfolios are largely complementary.

Top brands at Cadbury, which had sales of 5.4 billion pounds ($8.8 billion) last year, include Bassett’s Liquorice Allsorts, Maynards Wine Gums and trademark chocolate bars while Kraft, which had turnover of $42 billion, is known for Maxwell House coffee, Oreo cookies and Ritz crackers.

Kraft’s cash-and-shares offer, outlined in a letter on August 28, represented a 31 percent premium to Cadbury’s closing share price from last Friday.

Kraft said on a conference call it was comfortable it could fund the cash part of the proposal with existing cash and debt. A source familiar with the situation said that Kraft has already had some discussions about financing the cash component of the deal and did not foresee that getting financing would be problematic.

The timing of the proposal was partly driven by the improvement in the debt markets, particularly for investment grade financing, that source said, and the company’s revitalization plan.

Kraft has been cutting costs and overhauling its portfolio over the past several years.

OPENING SALVO

“Our initial view is that this represents a competitively pitched offer, but something less than a knockout blow,” said Investec analyst Martin Deboo. 

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