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They Believe In A Place Called Hope


Finance

THEY BELIEVE IN A PLACE CALLED HOPE

The Clinton Administration's assault on drugmakers has sent their stocks into a tailspin, precipitating a sharp decline in the broad over-the-counter market. But that hasn't fazed Peter F. Drake, executive vice-president at Vector Securities International Inc., a small investment bank in the Chicago area. He has been focusing on a less visible facet of Clinton's economic plan: a tax break for long-term investors in small companies. Drake is organizing a new $30 million fund to invest in small biotechnology concerns. "The great thing about Washington is they create opportunities," says Drake.

He isn't the only one in the securities business who sees opportunity in the Clinton program. From a new crop of limited partnerships to take advantage of tax breaks, to greater municipal bond issuance, to more mergers and acquisitions, Wall Street is already dreaming up ways to cash in. Says M. William Benedetto, the head of investment banking boutique Benedetto, Gartland & Greene Inc.: "Wall Street thrives on change. This change is going to catapult buying and selling activity, which creates commissions for brokers and opportunities for investment bankers."

True, Wall Street hasn't revved into high gear. Clinton still has to convince Congress to approve his plan. "Nothing will happen for three to seven months," says Ronald L. Gallatin, managing director at Lehman Brothers.

But the Street is already well into serious number-crunching. Take the hike in the top federal income-tax rate to 39.6%. "The plan says to the retail investor, 'The government will take away more of your disposable income and won't provide as much money in your old age in income and for health care,' " says Raymond Worseck, chief economist at retail brokerage A. G. Edwards & Sons Inc. "That creates a lot more demand for our products and services."

The yawning 12% gap between 39.6% and the capital-gains tax rate, which remains at 28%, may spur more investments in stocks. "It may very well make investors more willing to take risk by diverting funds into equity-type investments," says Lehman's Gallatin.

The Street could get a lot of mileage out of Clinton's tilt toward small business. Creating a secondary market for small-business loans by securitizing them got a boost from an endorsement by Federal Reserve Chairman Alan Greenspan. Already, Fremont Financial Corp., a Santa Monica (Calif.) finance company, has been gearing up to issue securities backed by loans to smallcompanies.

'TIDAL WAVE.' More important is a proposed tax break for investors in businesses with capitalizations of $25 million or less. Those who hold their stock for at least five years will be able to exclude 50% of their capital gains from taxation. Most Street firms do not issue stock for companies this small, but PaineWebber Inc. and others are exploring vehicles for investors to pump money into portfolios of small companies, from limited partnerships to hedge funds. "We're looking hard at providing venture capital access to individuals and encouraging long-term investment in small companies," says Daniel H. Case III, president of Hambrecht & Quist.

Merger-and-acquisition activity could get a big push. "There isn't a decent company in the country that isn't asking the question, 'How is this fundamental shift in government affecting our business?' " says Benedetto. For example, one side effect of a more active federal role in health care may be to force U. S. health care companies to look overseas for capital from foreign partners. "If the capital markets in health care and biotech remain closed to new stock offerings for the next three months, you will see a tidal wave of activity on the strategic alliance and M&A front," says Vector's Drake.

New taxes could have a similar effect. For example, the energy tax may favor natural gas, which would mean more transactions in the gas industry, while oil refiners may become less attractive and therefore divestiture candidates.

The market for real estate investment trusts (REITs), publicly traded companies that manage real estate portfolios, could come out a winner. One Clinton proposal would make it easier for pension funds to hold big positions in REITs, which the current tax code discourages. Says Salomon Brothers Inc.'s Michael Giliberto, director of real estate research: "It's great for the REIT biz, great for pension funds, and great for Wall Street."

Municipal bonds should get a double-barreled boost. Most obviously, high-tax-bracket investors will be gobbling them up. But underwriting should also pick up because of the billions Clinton wants to pump into federal spending on state and local infrastructure projects. Municipalities would need to issue bonds to match the federal monies. There's even talk that economic development zones and Clinton's proposed community development banks would become muni issuers. "It's very good for public finance," says Frank G. Zarb, CEO of Smith Barney, Harris Upham & Co.

PENNY FOOLISH. Wall Street doesn't like many of the Clinton proposals. Higher taxes will divert money from the private sector and pump it into big government, many believe. Some see a big downside to tax breaks for companies with capitalizations under $25 million, not the $100 million figure in pending legislation. That could provoke a wave of initial public offerings by disreputable penny-stock firms. Further, says Frank E. Baxter, president of Jeffries & Co., "I can see companies being constructed to meet the guidelines, which leaves a lot of opportunities for abuse."

Closer to home, highly paid bankers, traders, and money managers will be subject to that 39.6% tax rate. Clinton also wants to raise $4.45 billion in the next six years by making firms write off unrealized securities gains.

Wall Street has always felt more comfortable with a laissez-faire Republican in the White House. But despite a few qualms, the Street, at least for the next few years, may do nearly as well under the Democrats. HOW THE STREET MAY CASH IN

ON THE CLINTON PLAN

LIMITED PARTNERSHIPS

Tax breaks for investors in small business could foster a boom in these

vehicles as financing conduits

INVESTMENT BANKING DEALS

Tax changes and increased government intervention in business could hike the

pace of acquisitions and divestitures

MUNICIPAL BONDS

Higher tax rates should spur the underwriting of munis, likely the most popular

income sheltering device

REAL ESTATE INVESTMENT TRUSTS

REITs could get a boost if pension funds receive incentives to plow money into

these trusts

DATA: BUSINESS WEEK

Leah Nathans Spiro in New York


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