More Bailout Obscenity

As if the bailout were not were not bad enough, the Wall Street Journal reports that the Treasury Department is, in effect, rewriting the tax code to give away what will easily be tens of billions of dollars.

On the opposite page, the paper reports that the Fannie and Freddie bailout is likely to cost the government considerably more than expected because of court suits charging, probably correctly, that management misled investors.

One can safely as that more will be discovered later.

Drucker, Jesse. 2008. “Obscure Tax Breaks Increase Cost of Financial Rescue.” Wall Street Journal (10 October).

Saha-Bubna, Aparajita. 2008. “Fannie Suit Vexes Regulator, May Pay Shareholders.” Wall Street Journal (10 October).

The $700 billion financial rescue package approved by Congress to shore up banks also carries a parallel bailout of the financial sector and other industries through a series of obscure tax breaks.

Operating mostly under the radar screen, Congress, the Treasury Department and the Internal Revenue Service have been rolling back various provisions of the tax code to help out industries and investors caught up in the turmoil.

The most costly — and most controversial — of the moves provide billions in extra tax relief to big banks such as Wells Fargo & Co. and Spain’s Banco Santander SA. Another change gives aid to investors stung by the auction-rate securities meltdown. Still another shift relaxes tax rules to help big multinationals bring back cash from overseas.

The total sums involved aren’t clear, but the cost will easily amount to tens of billions of dollars, tax experts say.

The latest such move was unveiled on Tuesday, when the Treasury Department declared that the cash infusions for banks won’t be considered “federal financial assistance.” Normally, that type of funding would count as taxable income for the recipients, and could trigger other unfavorable tax consequences for banks receiving assistance that take part in mergers.

A Treasury Department spokesman said the agency is seeking to “provide clarity and certainty regarding tax issues that have come up during market turmoil.”

Tax experts say some of the changes are justified, including a number of technical fixes to protect taxpayers from unintended consequences related to government actions, such as the takeovers of Fannie Mae and Freddie Mac, or the substantial investments in banks. Plus, the broader bailout legislation passed by Congress earlier this month shut some other tax loopholes, including one that permitted offshore hedge-fund managers to get favorable treatment for deferred compensation.

The most controversial move so far is an obscure IRS ruling that gives banks the unfettered ability to use the “tax losses” of banks they acquired.

Typically, companies are permitted to carry over tax benefits from years when they lose money to help offset taxes when they return to profitability. However, for decades, Congress has restricted the amount of those losses that can be used in a given year, to prevent companies from buying and selling other firms solely to benefit from the tax strategy.

In a one-sentence ruling issued on Sept. 30, the Treasury Department effectively lifted that restriction if the company being bought is a bank and the losses are attributable to a portfolio of loans.

Sen. Charles Grassley, the ranking Republican on the Senate Finance Committee, has complained about the sudden loosening of the rules. “Congress should have been informed and consulted before Treasury took such an extraordinary action that likely will add billions of dollars to the deficit,” he said.

Some experts argue that the Treasury has effectively shifted from administering parts of the tax code to changing tax laws on its own. “It doesn’t seem possible that they have this authority,” said Robert Willens, an independent corporate tax analyst.

The biggest beneficiary so far is likely to be Wells Fargo. The big San Francisco-based bank recently agreed to buy Wachovia Corp. of Charlotte, N.C., which has been hammered by huge losses on mortgage-related securities and loans. Wells Fargo has said it expects to take $74 billion in write-downs on the Wachovia portfolio.

Under the old rules, Wells Fargo would have been limited to annual tax deductions stemming from the Wachovia losses of roughly $930 million over the next 20 years, or a total of $18.6 billion, estimates Mr. Willens. Wells Fargo will now be able to use all $74 billion in losses. That will likely mean additional tax savings to Wells Fargo of about $19.4 billion — or more than the total purchase price for Wachovia’s common stock, currently about $14.3 billion.

A Wells Fargo spokeswoman wouldn’t comment on the role of the tax change in its decision to bid for Wachovia, which bested an earlier offer by Citigroup Inc. Wells Fargo’s offer took place two days after Treasury’s move.

The new tax benefit applies to already-completed bank deals done in the past three years, and possibly even older ones, according to the Treasury Department.

Another winner from the new rule is Banco Santander, which recently agreed to buy the rest of Sovereign Bancorp. The Spanish bank will be able to take advantage of Sovereign’s $2 billion in tax losses more quickly than under the old regime, which would have required it to wait nearly two decades to use up the losses.

Because of the Sovereign purchase, Banco Santander also will be one of the many beneficiaries of a separate break, aimed at hundreds of banks that lost money on preferred stock in Fannie Mae and Freddie Mac. The shift allows the banks to count those losses as ordinary losses, rather than less-useful capital losses. The change is expected to cost the federal government $3 billion, according to the congressional Joint Committee on Taxation. [Bailout]

Many investors were caught by surprise when the auctions for auction-rate securites began to fail, leaving them holding notes for which there was no market. New York Attorney General Andrew Cuomo brokered settlements with investment banks and brokerage houses, in which the banks effectively agreed to cover any losses suffered by the investors.

A recent ruling by the Treasury protects the investors in those arrangements, in part by making clear that an agreement by a bank to cover the losses isn’t akin to taxable income. Another ruling protects investors who loaned shares to Lehman Brothers Holdings Inc. from being taxed on the transactions. Ordinarily, they are required to get the shares back within a prescribed time frame to avoid owing taxes. That rule isn’t normally waived, even if the borrower of the shares goes bankrupt. But the IRS made an exception that effectively applies to transactions with Lehman, which filed for bankruptcy protection last month.

And earlier this month, the IRS relaxed the rules covering how U.S. corporations can repatriate cash parked overseas. The ruling allows companies to bring back money for months at a time without incurring a 35% corporate income tax they normally would owe. It is intended to make it easier for companies to borrow money directly from their foreign subsidiaries, instead of in the uncertain short-term lending market. It is unclear how much this will cost the government.

1 comment so far

  1. Gladwyn on

    There will also be huge fees. I saw that EY and Arthur Anderson (off Enron fame?) will advise the government which toxic mortgage to absorb and how to capitalize it on the books.

    This cost should be passed back to the banks.

    LaTimes says that nothing so far will keep home prices from continuing to tumble,0,5064519.story?track=ntothtml

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