Relevant and even prescient commentary on news, politics and the economy.

Pethokoukis Blaming Congress

by Mike Kimel

Pethokoukis Blaming Congress

From his perch at Reuters, James Pethokoukis writes (and this is his title) about 4 ways Congress caused the financial crisis. He quotes from a paper by Ross Levine. I have not read the Levine paper yet but the abstract does seem to indicate what Pethokoukis wrote. The abstract does not seem to indicate blame is placed with Congress, but rather that the regulatory agencies (which presumably includes Congress) should have seen the signs of the growing fragility of the financial system associated with their policies during the decade before the crisis and yet chose not to modify those policies.

Thus, I don’t know if Levine also blames Congress for the crisis or whether he would merely indicate (as many would) that Congress could have done something to stop it, but the abstract seems to indicate that .

In any case, Pethokoukis quotes 4 reasons this is Congress’ fault:

1. Congress did not prevent ratings agencies from behaving poorly
2. Congress did not prevent bankers from engaging in excessively risky CDS trades
3. When the SEC allowed investment banks to leverage up, Congress did not step in
4. Congress did not engage in enough oversight of Fannie and Freddie

If I understand Pethokoukis correctly, his view is that Congress caused the financial crisis by forcing private sector players to behave recklessly, which it did by not regulating them. Which seems odd to me. Particularly since, having read a lot of what Pethokoukis wrote over the years, I cannot believe he would have advocated having Congress do more regulating of ratings agencies, banks, investment banks, or even Fannie and Freddie. (Which would almost imply Pethokoukis is in favor of financial crises of this magnitude, wouldn’t it?) And he certainly wouldn’t have credited Congress had Congress engaged in more regulating and things turned out well. (Who would?)

As I said – this is seems very odd to me.

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There’s a tax angle to everything–including the DeepWater Horizon oil spill

by Linda Beale
crossposted with Ataxingmatter

There’s a tax angle to everything–including the DeepWater Horizon oil spill

There’s a tax angle to everything–including the DeepWater Horizon oil spill
Oil is still pouring out into the Gulf ocean from the well head of the DeepWater Horizon. The entire gulf is beginning to look like an oil slick, as we learn that oil companies like BP, rig owners like TransOcean, and contractors like Halliburton (the cement plug provider in the Gulf spill) never bothered much abouit preparing for potential disasters–especially not spending money to research solutions to potential catastrophes. Quelle surprise!

There are lots of tax benefits for natural resource extraction–many that we should eliminate asap, if we are serious about preserving the environment and moving on to less destructive sources of energy (while activating our economy with real production instead of the financialization, and creating jobs, preventing reliance on middle East oil–all at the same time).

Senator Grassley wants to know just what the tax benefits and subsidies for the major contractors in the spill have been. See Grassley letter to chair of BP, May 17, 2010, asking for an accounting of all tax breaks/subsidies and royalty relief from 2005 to the present and what benefits, tax and otherwise, are received by DeepWater Horizon’s operating under the flag of the Marshall Islands; Grassley letter to chair of TransOcean, May 17, 2010, asking for the same information about TransOcean and information about its other rigs operating under foreign flags (and who made the decision to replace mud with seawater, leading to the explosion, among other things) .

Sounds like a good line of questioning to pursue to me. When we see the greed-centered decision-making of companies like BP and TransOcean, we should see as clearly as possible the way we’ve provided tax expenditure “handouts” to them over the years. Welfare for corporations is a growing item in our budget–that will likely be added to by the “extenders” bill under consideration at this time in Congress.

Grassley also is seeking full information on the Minerals Management Services lax regulatory effort. Not surprisingly, this agency absorbed the lesson of four decades of deregulatory thinking quite well, as evidenced by the “sex for leases” scandal a few years back. See Grassley’s letter to Salazar seeking accountability from the agency (May 17, 2010). A similar letter to Halliburton seeks information on the cement and the regulatory oversight of its use. See Grassley letter to Halliburton, May 17, 2010.

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Maybe Bristol Palin is Right

No, not that anyone should pay her $15,000-$30,000 to talk to teenagers about why they should be abstinent. (Short version: “As with my mother, I wasn’t, and look what I’m doing now. Uh, well…”)

But, via Andrew Samwick, a study from the Pew Foundation (PDF) using PSID data finds that:

Among children who start in the bottom third of the income distribution,
only 26 percent with divorced parents move up to the middle or top third
as adults, compared to 42 percent of children born to unmarried mothers
and 50 percent of children with continuously married parents.

Or, in ratio terms, it is only 19% more likely that the child’s eventual economic status will be improved if the mother marries someone and stays married until the child is eighteen, compared to a 61.5% improvement in the expected well-being of the child if the mother remains unmarried for the entire eighteen years.

Meanwhile, twice as many children have parents who divorce before the child is nineteen (14%) than are raised by unwed mothers (7%).

There may also be elements of selection bias in the data: a woman who opts to raise a child on her own instead of getting married is more likely to instill that independence of spirit in her child than someone who enters into what turns out to be a bad marriage.

The other interesting table in the study shows how severely income inequality increased across a generation.

Note that the bottom tier improves the least, that the 50th percentile grows much slower than even the 75th, and that the percentage change in the Mean is greater than the percentage change at any tier except the 90th percentile.

So much for the rising tide having lifted all boats—clearly, it capsized a few.

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Swiss Banks; State tax subsidies to corporations

by Linda Beale
crossposted with Ataxingmatter

Swiss Banks; State tax subsidies to corporations“>

Busy day today, so just a note to point out an interesting blog posting at on Swiss banks and the impact of banking secrecy on tax evasion. It’s Demystifying Swiss Banks, May 15, 2010,

Just another reason that tax reform and bank reform go together. Banks serve corporate and high wealth individuals by creating derivative products that arbitrage tax and regulatory requirements, and by permitting them to move resources to tax havens that serve no function other than offshoring profits. Will Congress enact a strong enough reform bill? Or will it spend more of its efforts on “extending” the costly Bush tax cuts yet again?

Another interesting piece in the New York Times on Companies we keep, and pay for”, Jim Dwyer, NY Times, May 14, 2010. Since corporations have no loyalty to locale anymore–not even to the US, much less to a particular state or city–it is foolhardy for states and cities to mete out huge subsidies to keep a particular corporation in town in the hopes of creating new jobs (or keeping old ones). It would likely be much more beneficial for the community to use that money to do something directly beneficial–like fixing bridges, funding computers in schools, hiring more police, teachers, gardeners, and greeters. That money would create instant jobs, and those jobs would create instant demand for things people have to have to live, like food shelter, clothing, and other consumer products. That would help fund local businesses, and that would be a much better use of state and local subsidies, since it would tend to help ordinary people instead of the Big Muckety-Mucks (as my Dad used to say) that get the main dough out of the deal from corporate tax subsidies.

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Carried Interest: some senators want venture capitalists to get a CG ride on their compensation income

by Linda Beale
crossposted with Ataxingmatter

Carried Interest: some senators want venture capitalists to get a CG ride on their compensation income

Everybody knows by now that managers of partnerships who have “profit interests” have been claiming that they do not have compensation income but merely a return of capital on their “carried interests” (and that may be long-term capital, they claim, when they hold the profits interest for some time and there are long term gains in the partnership that are allocated to them).

Many tax experts, including myself, have argued that these profits should be taxed as compensation. At ordinary rates, like the janitors and clerks and other employees of the firm. Immediately and without deferral, like others who work for a living. And subject to payroll taxes (FICA, FUTA), since wages are supposed to be subject to payroll taxation.

Managers of private equity, hedge, venture capital, real estate and other partnerships have been able to avoid such real world consequences of working for a living in most part. They are generally paid a fee (usually about 2% of assets under management, in hedge and private equity firms) and a “carried interest” (usually about 20% of assets under management, each year, and sometimes amounting to 30% or 50%, for the really big-time managers). They do treat the fee as compensation, but claim that the carried interest is not.

Congress is finally quite likely to pass a bill that will treat carried interest as the compensation that it is. So of course each type of partnership management is lobbying for an exception for itself–tax the others, but I’m so important that you ought not to tax me because continuing to give me this incredible tax break will keep me doing this really important stuff.

That line is garbage. These managers generally make kaboodles of money. They will still do the work and making kaboodles of money even if they have to pay taxes more like ordinary employees.

But some senators seem to be falling for this crappy argument. For example,Republican Scott Brown of Massachusetts and Senators Patty Murray of Washington, Mark Warner of Virginia, Bob Casey of Pennsylvania and Jeanne Shaheen of New Hampshire want to exempt venture capital firms from the change in the treatment of carried interest. The claim boils down to saying that if you tax these managers on their compensation like you tax “regular” workers, it will hurt the work that these venture capital firms do in encouraging entrepreneurialism. See Donmoyer, Senators Seek Venture Capitalist Waiver from Fund Tax Increase,, May 13, 2010.

Can these senators really think that taxing the worker will make the managers stop managing billions of dollars?

Lobbying is underway. Listen, Congress, to your head and not your pocketbooks. Managers of partnership perform services and get paid for those services. All of that payment should be treated as compensation, be taxed at ordinary rates, and be subject to payroll taxation. To do otherwise is to let very wealthy people off the hook for their share of the tax burden, and to impose a greater tax burden on everybody else–especially on the little people.

Can the voters put two and two together to realize that any senators who end up supporting an exemption for the real estate industry or the venture capital industry (or any other industry) are more worried about losing the support of big money than they are about ensuring that big money managers pay taxes fairly just like so many ordinary American workers do?

And if you are wondering whether firms like hedge funds and private equity funds–significant parts of the “shadow” banking system–add real value to the economy, you might enjoy this article by Harlan Platt about private equity, The Private Equity Myth. Download Platt. The Private Equity Myth.

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Tuesday voting

Far more knowledgeable people will be discussing results today. but here are some pointers.

Poilitics Dailey has a short note on yesterday’s primaries:

…Kentucky Republicans struck the first blow by choosing political newcomer Rand Paul as their Senate nominee. Paul, an ophthalmologist and Tea Party favorite, defeated Secretary of State Trey Grayson, who had been championed by Senate Minority Leader Mitch McConnell of Kentucky.

In a Pennsylvania contest that both parties promoted as a precursor to the midterm elections this fall, Republicans suffered a blow to their plans for taking over Congress. Democrat Mark Critz, a top aide to the late Rep. John Murtha, defeated Republican businessman Tim Burns in a special election to finish Murtha’s term representing the working-class Johnstown-area district.

In Arkansas, moderate Democratic Sen. Blanche Lincoln was trying to hold off a netroots-fueled primary challenge from Lt. Gov. Bill Halter. Neither cleared 50 percent of the vote Tuesday night, sending the pair into a June 8 runoff election. The winner will face GOP Rep. John Boozman, a rancher and ophthalmologist whose late brother, Fay Boozman, lost to Lincoln in 1998.

Specter was the third incumbent to lose his job this season, following Utah Sen. Bob Bennett’s failure to get the GOP nomination in his state and Democratic Rep. Robert Mollohan’s primary loss in West Virginia…

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The Capitalist & The Entrepreneur

One of the nice things about going to the Kauffman Foundation this year was meeting up again with Peter Klein of Organizations and Markets, who was my first economics professor.* (I liked him as soon as I found out one of his first publications dealt with “moral hazard” and the Designated Hitter.)

Peter has a book out from the Mises Institute, The Capitalist & The Entrepreneur. Subtitled Essays on Organizations and Markets and carrying blurs from Business and Law people as well as the obligatory G-Mu professor (Adam Smith Award winner Peter Boettke), the book, as with Klein himself, is likely well-conceived, sharply written, and worth arguing with and about.

Not to mention that, at $12 from Mises, it’s very reasonably priced.

I’m certain I’ll have more later, after I get a chance to read it. But it seems exactly the type of book that should be getting more discussion here.

*On hearing this, Andrew Samwick said, “But you two are at opposite ends of the spectrum.” What I Should Have Said then I say now: “I said he was a good teacher. I never said I was a good student.”

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Quote of the day

Robert Waldmann

Felix Salmon wrote

“S&P and Moody’s are clearly completely incompetent, and no one should base any investment decisions on the random series of letters they apply to bonds.”

second quote (from comments)

“… But without rating agencies…… who other than big investment companies/funds that have their own in-house muscle to do due-diligence can buy these things?”

Posted by MarshalN

My thoughts after the jump.

So what’s the alternative to the random series of letters they apply to bonds? I see two possibilities.

1) a public ratings agency (not a public option mandatory public rating required for all regulatory purposes). Have the SEC rate bonds.

2) Use the prices of CDSs. Now I don’t think regulations can refer to the market prices of CDSs, which shoot up in a panic causing banks to have to liquidate assets justifying the panic. However, if Goldman Sachs were willing to issue CDS on 10% of the securities at a price typical of CDS on AAA corporate bonds, I’d be willing to buy them (Provided Goldman Sachs promised not to buy CDS on 20% etc).

The point is that as noted by MarshalN only a few big firms have the muscle to rate. We have learned it is unwise to trust raters who don’t put their money where their mouths are. Very few big firms have enough money to put where the major mouth investors respect from raters is.

This will not be cheap. If to issue a security that pension funds can buy, you have to find some entity willing to insure 10% of it (with guarantees that they don’t hedge that risk) then it will be very costly to issue a security.

That’s life. In the real world you don’t get something for nothing and rarely get something hugely valuable for almost nothing. For decades we got immensely valuable ratings from Moody’s, S&P and Fitch for almost nothing. Our luck has run out and it’s time to face reality as it almost always is.

Public ratings would be cheaper, but 2008 taught us as much about regulatory capture as they taught us about trusting private firms which don’t put their money where their mouth is. I’d say public ratings would work OK unless and until a Republican is elected President.

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Financial reform law still in the works this week

Reuters reminds us financial reform law still in the works:

Although a final vote is expected within days on the White House’s top domestic priority, lawmakers have yet to settle disputes on regulating over-the-counter derivatives; curbing risky trading by banks; and the power of state authorities.

There will need to be resolution on these topics before the Senate can approve a massive Democratic bill designed to make the financial system less prone to crises like that of 2007-2009.

Analysts say that could occur as soon as Wednesday or Thursday. Delays could postpone full approval to next week, however.

Major votes on amendments looked unlikely on Monday or Tuesday, due to primary elections involving senators Blanche Lincoln and Arlen Specter, both Democrats. Party leaders were expected to avoid close votes on controversial measures while the two were away on the campaign trail.

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Was I Wrong? Is Oil Trading Primarily a Speculative Market

How else to explain a 20% drop in prices since The Destruction of the Gulf of Mexico?

Oil fell below $70 Monday, reaching a low of $69.27 before rebounding slightly…The turnaround has been sudden — oil hit an 18-month high of $87.15 a barrel during trading on May 3.

The plunge in oil extended to the New York Stock Exchange, where shares of major energy companies were lower.

Is oil the derivatives of hard commodities: the place where liquidity is based on speculation, not fundamentals?

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