Category Archives: Financial
Chamber Of Commerce Says Taxpayers Should Help Pay For BP Spill Cleanup; GOP Leader Agrees, Then Recants
Hey there, Americans! I’m sure, by now, many of you have had some time to reflect on the massive, unfolding Deepwater Horizon oil disaster and thought to yourselves, “My, that really is a terrible, apocalyptic cock-up!” But have you gone so far as to think to yourself, “My, that really is a terrible, apocalyptic cock-up, the costs of which I should logically be burdened with, because I am responsible for everything that happened?” No? Well, you should maybe start thinking that way, because the U.S. Chamber of Commerce thinks you should!
You know, the U.S. Chamber of Commerce typically doesn’t put itself out there as a big fan of socialism. But that all changes when we’re talking about risk and liability. In those cases, they love socialism to death! And that’s basically how Chamber President Tom Donohue is framing his call to put a greater share of the oil spill price tag on you and me:
“It is generally not the practice of this country to change the laws after the game,” said Tom Donohue, the president of the U.S. Chamber of Commerce. “. . . Everybody is going to contribute to this clean up. We are all going to have to do it. We are going to have to get the money from the government and from the companies and we will figure out a way to do that.”
Yes, now is the time for America to come together and demonstrate some communitarian pluck in response to the time that all of us collectively decided that British Petroleum should cut corners, blow up their oil rig, and cause a massive disaster in the Gulf of Mexico.
House Minority Leader John Boehner cosigns this call for collective responsibility:
In response to a question from TPMDC, House Minority Leader John Boehner said he believes taxpayers should help pick up the tab for the clean up.
“I think the people responsible in the oil spill–BP and the federal government–should take full responsibility for what’s happening there,” Boehner said at his weekly press conference this morning.
That’s from TPM’s Brian Beutler, who very helpfully points out that this is one of those times when the words “federal government” is used as a euphemism for “American taxpayers.”
HuffPost asked Boehner’s office to confirm his support of the Chamber’s position, and Boehner spokesman Michael Steel seemed to recant: “Boehner made a general statement about who is responsible for the spill, and the federal government oversight was clearly lacking, but he has said repeatedly that BP is responsible for the cost of the cleanup.”
But it’s worth noting that Boehner’s “general statement” came in response to a very specific question from Beutler: “Do you agree with Tom Donohue of the Chamber that the government and taxpayers should pitch in to clean up the oil spill?”
In any case — wow, it seems like only a couple of years ago that then Vice Presidential candidate Joe Biden was pretty roundly mocked for suggesting that paying taxes in support of the common weal was an act of patriotism. I guess a lot has changed since then!
Some of the nation’s largest and most elite universities stand to gain millions of dollars from selling the names and addresses of students and alumni to credit card companies while granting the companies special access to school events, the Huffington Post Investigative Fund has found.
The schools and their alumni associations are entitled to receive payments that multiply as students use their cards. Some colleges can receive bonuses when students incur debt.
The little-known agreements have enriched schools and some banks at a time when young women and men already are borrowing at record levels, raising questions about whether such collegiate and corporate alliances are in the best interests of students.
“The fact that schools are getting paid for students to rack up debt is a disgrace,” said congressman Patrick Murphy, a Pennsylvania Democrat and former professor at the U.S. Military Academy at West Point. He said that banks’ payments to schools amount to “kickbacks.”
Landmark credit card legislation signed by President Obama one year ago curbed some marketing tactics on campuses but didn’t prohibit the arrangements between colleges and banks, known as “affinity” agreements.
The substance of these deals had been secret. A provision in the law, authored by Murphy, requires their disclosure. But even now, few schools post the contracts online or publicize their existence. Obtaining a copy can take two weeks or more.
Thus it’s unclear how many of the nation’s 2,700 four-year colleges have such agreements, or how many allow credit card companies to target students in addition to graduates. Bank of America, which dominates the market, said it has affinity contracts with some 700 schools and alumni associations, where marketing practices vary. At least 100 schools are believed to have affinity agreements with other financial institutions.
Seventeen contracts obtained by the Investigative Fund from schools and their alumni associations detail the special access granted to banks, such as allowing them to set up booths at football games. All of the agreements call for colleges to provide students’ names, phone numbers and addresses.
For granting such access and information, schools can receive royalty payments based on the number of students opening accounts and the amount they spend, the contracts show.
Most of the schools are entitled to earn more whenever a student carries a balance from year to year.
Some consumer advocates question whether colleges participating in affinity agreements are failing to safeguard the young people in their care.
“Universities should place the welfare of their students as their highest priority and shouldn’t sell them off for profit,” said Ed Mierzwinski, consumer program director for the federation of state Public Interest Research Groups, or PIRG.
Three schools, after being contacted by the Investigative Fund, stopped allowing banks to market to students. Seven other schools and alumni associations, including alumni organizations at Brown University and the University of Michigan, said they have abandoned the practice, even though their contracts appear to require it.
The contracts call for a range of minimum payments by banks. At Brown, Bank of America agreed in 2006 to pay $2.3 million over seven years. At Michigan, the bank in 2003 agreed to pay $25.5 million over 11 years.
The bank says it’s not taking advantage of students; it’s amassing new customers whose loyalties can span a decade or more.
“Our objective in serving the student market is to create the foundation for a long-term banking relationship,” Bank of America spokeswoman Betty Riess said in an email, adding that the bank offers reasonable rates and low credit limits on student cards, and that it primarily solicits graduates and sports fans.
Many schools have renegotiated contracts with the bank to limit marketing to students, she said.
Schools still engaging in the practice defend selling access to students and their contact information. Colleges say the money helps them plug holes in budget shortfalls and shrinking endowments. Some say they use the money to grant more scholarships to students.
Some colleges and alumni organizations also argue that students need to learn fiscal responsibility–and how better to do that than by having a credit card?
The University of Michigan alumni association, facing growing scrutiny from consumer groups, says it reached an agreement with Bank of America to stop marketing to students in early 2008. Jerry Sigler, chief financial officer of the alumni association, said he made the decision begrudgingly.
“Managing credit is as much a part of education and maturation as anything else going on campus,” he said. “Credit isn’t bad, it’s a reality.”
The benefits are not always so obvious for students whose families already face soaring tuition costs and hefty loan payments. College seniors graduated in 2008 with average credit card debt of more than $4,100, up from $2,900 four years earlier, according to data compiled by student lending company Sallie Mae.
On their own for the first time, young credit card users can quickly fall behind on payments.
Despite not having a full-time job or much in savings, Lisa Smith easily found her first credit card on campus–from bank marketers stationed outside her freshman dormitory. Once she racked up charges, new card applications poured in from other companies.
By the time she graduated in 2005, she had the average number of credit cards for a college student – four – as well as $15,000 in credit card debt. Now 28, Smith is still paying $500 monthly in credit card bills, some dating back to purchases from her college days.
“I know that I brought it on myself,” said Smith, who attended High Point University in North Carolina, which says it now prohibits on-campus marketing. “But I really felt like I was preyed on. I didn’t understand how long it was really going to take to pay them back.”
Students ‘Hugely Important’
On May 22, 2009, President Obama signed sweeping new consumer credit card protections into law. All too often, Obama noted at the time, Americans used credit cards as an anchor rather than a lifeline. Students were no exception.
The Credit Card Accountability, Responsibility and Disclosure Act prohibited banks from using some of their most aggressive marketing practices on students. For instance, banks can no longer require students to apply for a card to receive promotional gifts such as pizza or sweatshirts.
Nor can banks supply credit cards to anyone under age 21–most college underclassmen–unless the customer has a cosigner. The law requires only that the co-signer be over 21. The co-signer needn’t be a parent or guardian.
The law does not prevent credit card companies from paying schools for special access to students.
Chase Card Services, a division of JPMorgan Chase & Co., has a handful of such agreements, but Bank of America dominates. It became the market leader in 2006 when it acquired credit card giant MBNA, a pioneer in affinity agreements that often involved pro sports teams and professional associations.
Soon after the acquisition, Bank of America set its sights on colleges. At a March 2006 conference hosted by Goldman Sachs, Bank of America executive John Cochran described students as “an emerging market that we could really capitalize on,” according to a transcript.
From a bank’s perspective, students represent an important demographic: Not only do many first-time cardholders hunger for credit; they are likely to stay customers for quite some time – up to 15 years, according to a 2005 study by Ohio State University researchers.
“Student credit cards are hugely important to a bank,” said Kerry Policy Groth, who negotiated collegiate affinity agreements as an MBNA account executive from 1998 to 2005. “Your first credit card is usually the one you keep.”
Although Bank of America does not disclose how many student accounts it has or what it earns from student credit cards, Cochran, at the 2006 conference, characterized the collegiate affinity market – students, faculty, alumni and sports fans – as “an over $6 billion portfolio.” The portfolio may have declined in recent months as the bank’s entire credit card business has suffered from rising default rates.
Bank of America spokeswoman Riess emphasized that the bank primarily targets alumni and fans as prospective customers, with students accounting for about 2 percent of all open collegiate accounts – likely representing thousands of young consumers.
‘Students as Commodities’
Affinity agreements vary from school to school.
The University of Pennsylvania’s agreement with Bank of America required the school to compile an initial list of 233,000 potential customers, including students, alumni, faculty and staff, to offer the bank. If requested, the school removes potential customers from the contact list.
When Princeton University signed its affinity agreement with Bank of America in 2004, it agreed to provide the names of at least 4,000 students and 75,000 graduates.
After a bank obtains the information, it can send an agreed-upon number of solicitation letters and emails. A 2008 PIRG survey of more than 1,500 undergraduate students found that about 80 percent received mailings from credit card companies.
Some affinity agreements also permit banks to advertise at school sporting events. Banks often have booths at football and basketball games where students 21 or older, alumni and fans can sign up for a card.
Colleges and alumni associations are entitled to rewards for providing special access and information. Bank of America typically pays schools $1 for each student who opens a credit card account and keeps it open for 90 days, according to contracts reviewed by the Investigative Fund.
Some schools also can earn more as students rack up charges–and debt. The University of Oklahoma, among other schools, is entitled to receive 0.4 percent of all retail purchases made with student cards. Most of the 17 contracts obtained by the Investigative Fund entitle schools to extra compensation–up to $3 a card–when students carry a balance from year to year.
“Essentially, contracts with credit card companies are using students as commodities to earn revenue for the universities from companies who don’t necessarily have the students’ best interest in mind,” said PIRG’s Mierzwinski.
As part of many agreements, banks also pay for rights to use school trademarks -mascots, logos and emblems – on their advertisements.
Banks often brand their cards with the familiar images. This marketing tool, known as co-branding, has its critics. Irene Leech, associate professor of consumer studies at Virginia Tech, said the practice leads some to believe that universities have negotiated favorable credit card rates for their students.
“Alumni and students both think that it’s the best deal out there that [the school] could get for me,” an assumption that is not always correct, she said.
Nor do students necessarily get the lowest rates. At Princeton, alumni cards carry an annual percentage rate of 11.9 percent, compared to 14.9 percent for student cards, according to the school’s seven-year affinity agreement, signed in 2004. Rates may have changed since then.
Bank of America currently charges a 14.24 annual percentage rate on its Student Visa Platinum Card, the primary product it markets to students. Students are not locked in; the rate varies depending on the market’s prime rate. The bank said it doesn’t increase rates on students for reasons such as falling behind on their payments. Nor does it impose an annual fee.
“We take a conservative approach to lending to young adults,” Bank of America’s Riess said, noting that the bank limits a student’s exposure to debt. The bank offers credit lines for students that “typically” start at $500 and are capped at $2,500, she said.
The bank, Riess said, also seeks to educate students. “We also provide a number of tools to help young adults better manage their finances,” she added, including free identity theft protection, a student financial handbook and an online educational brochure about building good credit, called “The Essentials.”
“Building a future customer–that was really the goal” of affinity agreements, said former MBNA executive Groth. “You’re not out to gouge them; you want a positive experience.”
This spring, Columbia University, the Iowa State University alumni association and Michigan State University all amended their affinity agreements to prohibit any marketing to students. They did so within a week of receiving phone and email inquires from the Investigative Fund. School officials said they had been working on the amendments for months.
The Investigative Fund requested Columbia’s contract on March 22. Columbia officials signed the school’s amended agreement two days later. The timing was “mostly coincidental,” according to Michael Griffin, executive director of Columbia’s alumni association. He said that the school had never allowed marketing directly to students.
Seven other schools contacted by the Investigative Fund said they no longer allow marketing to students, even though their affinity contracts would appear to obligate them to. School officials said they had no documentation backing up their assertions.
“A lot of schools have student access in their agreements” – but don’t necessarily allow it anymore, said Peter Osborne, who managed the collegiate credit card business at Bank of America until 2007. Schools sometimes informally “just request that marketing stop rather than reopening their entire contract.”
For instance, according to an affinity agreement between the University of Texas alumni association and Bank of America, the association is expected to provide the bank with students’ names and addresses. But the alumni association says it has abandoned that practice.
“We are not marketing to students at this time and we haven’t for some time,” said Bill McCausland, chief operating officer for Texas Exes, the ex-students’ association. “Whether the contract allows us to or not, we are not doing so.”
He acknowledged that students could still sign up for credit cards without the school’s involvement. Bank of America, he said, is “still marketing our card and they are doing a very good job of it.”
At Harvard, the alumni association is supposed to provide a subsidiary of Barclays PLC with “as complete a list as possible of all Harvard alumni and students,” according to the association’s affinity contract. But Harvard spokesman Kevin Galvin said the card was never marketed to students. “We view this card as a service to alumni,” he said.
Other schools acknowledged to the Investigative Fund that they release students’ contact information. These schools staunchly defend their affinity agreements as important sources of revenue. And some royalties benefit students, according to school and bank officials.
“The revenues from this go to vital services that otherwise might not be free and otherwise might not be offered,” said Osborne, the former bank official who now advises universities as they negotiate affinity agreements. Osborne said the revenues “support alumni programs, student scholarships and preserve jobs within alumni associations.”
Some of the royalties from Penn’s contract go to scholarships and helped pay for the development of Campus Express, an online system where students can order textbooks and manage their dining plans, according to university spokesman Ron Ozio.
Princeton uses its profits “to support alumni activities,” school spokeswoman Emily Aronson wrote in an email.
Catherine Bishop, vice president of public affairs at the University of Oklahoma, said affinity agreements are beneficial because they limit the amount of marketing that goes on. “The contract that we have in place,” she said, “is designed to keep multiple companies from soliciting on campus.”
This story was reported in partnership with the Stabile Center for Investigative Journalism at Columbia University. Protess is a staff reporter with the Investigative Fund. Neumann graduated from the Stabile program in May. Amanda Zamora, Lauryn Smith and Joseph Frye also contributed to this story.
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NEW YORK — If you saw a penny on the sidewalk, would you pick it up?
You may think it’s not worth the effort, but a breed of investors who have been in the news do. Using super-fast computers, high-frequency traders in effect bend down to pick up pennies lying about in the stock market – then do it again, sometimes thousands of times a second.
More than a week after the Dow Jones industrial average fell nearly 1,000 points, its biggest intraday drop ever, regulators are still sifting through buy and sell orders to figure out what sparked it. One big focus are orders placed by high-frequency traders, or HFTs, and for good reason. These quick-buck firms barely existed a few years ago but now account for two-thirds of all U.S. stock trading.
In other words, all those TV pictures of the stately New York Stock Exchange building on the evening news are an illusion. The real action on Wall Street is far away in Kansas City, Mo., and in New Jersey, in towns like Carteret and Red Bank, where HFTs named Tradebot and Wolverine and Tradeworx ply their trade.
High-frequency trading firms, which number over 100, use computers programmed with complex mathematical formulas to comb markets for securities priced too high or too low because traders haven’t had to time to react to the latest data. The computers then buy or sell in a split second, locking in a profit.
The opportunities seem hardly worth noting. They’re not just fleeting, but small, often a penny or less.
But those pennies can add up to a lot of money, enough to draw the attention of Goldman Sachs Group Inc., the giant Chicago hedge fund Citadel Investment and other big financial firms. In recent years they’ve paid hundreds of millions of dollars for stakes in high-frequency trading companies.
The money has stoked what was already fierce competition among the firms for a leg up.
To spot opportunities and act on them before others, HFTs are constantly hunting for faster computers. They also locate themselves close to the big exchanges’ data centers. That can cut their trade times by milliseconds.
One way these traders make money is by exploiting the fact that stock indexes sometimes don’t immediately reflect falling or rising prices of their component stocks, said Manoj Narang, chief executive at Tradeworx of Red Bank, N.J. If Microsoft shares rise 5 percent but an index fund that includes it such as the SPDR S&P 500 lags by a fraction of second to adjust, his computers will automatically buy shares of SPDR S&P 500 at the lower price and then sell them again when they are fully valued.
Or maybe Microsoft is trading in London at a penny less than it’s trading at the same moment in New York. A high-frequency trader will buy shares in London and wait for them to rise.
Since the discrepancy lasts a mere fraction of a second, speed is key.
Narang boasts it takes only 15 millionth of a second for his computers to place a buy or sell order after detecting an opportunity.
Or, as he puts it, “If you try to pick up the penny, we’ll probably beat you to it.”
So is that good or bad for the market?
If you listen to HFTs, all their fast trading benefits big and small investors alike. More trading means more bids and asks for shares, and that cuts the time needed to find someone willing to buy what you’re selling or vice versa. Costs also fall. With more bids and asks, the difference between the price you seek and the price offered (what traders call the “spread”) will likely narrow. You get to keep more of your money.
High-frequency traders see themselves as part of a long tradition of using technology to shake up Wall Street.
For decades an order to buy or sell a security went to a person in a trader’s jacket standing on the floor of an exchange, often at the NYSE in Lower Manhattan. If you wanted to sell stock in General Electric, for instance, these so-called specialists would find a buyer. If they couldn’t find one, they bought it themselves.
In exchange for their services, the specialists pocketed some of the difference between the price at which you were willing to buy and the price at which a GE holder was willing to sell.
This system came under attack in the early 1980s from Nasdaq, a rival marketplace for stocks, which began using computers to make trades. The pitch was it could match buyers and sellers faster than humans, and for less money.
Then, starting in the late ’90s, the NYSE specialists got hit again, this time with a series of blows: new rules encouraging computer matching of buyers and sellers, a shift to quote stock prices in minute increments of decimals instead of fractions, and a decision to cut the minimum spread that specialists or other middlemen could grab for themselves from 6.25 cents per share to a penny.
“It used to be an oligopoly, an old boy’s club,” said Irene Aldridge, head of an HFT shop called Able Alpha Trading and author of “High-Frequency Trading.” “But now it’s a completely level field.”
Critics of high-frequency trading say all this talk about narrowing spreads for ordinary investors distracts from a key problem: Split-second trading without human supervision is a recipe for disaster
Exhibit A: the May 6 crash.
One theory about the drop is that, unlike the NYSE, the new exchanges and trading networks catering to HFTs didn’t apply any “circuit breakers.” These are designed to halt trading momentarily during a freefall to stop selling from feeding on itself.
In others words, without circuit breakers the computers went crazy.
Another theory holds that it wasn’t quick-fire trading by HFTs that made things worse but a lack of it. Some reportedly pulled back when stocks started dropping, removing liquidity when it was needed the most.
Whatever the answer, this much is true: These secretive firms are likely to grab the spotlight for a while now. And their trading might get even more frenetic.
After the May 6 freefall, all manner of trading rules are up for debate. But it’s worth noting that until recently regulators were considering cutting the minimum spread again, possibly to half a penny.
“People will be needing even better computers,” said author Aldridge.
May 14 (Bloomberg) — Tyler Hurst swiped his debit card at a Walgreens pharmacy in central Phoenix and kicked off an international odyssey of corporate tax avoidance.
Hurst went home with an amber bottle of Lexapro, the world’s third-best selling antidepressant. The profits from his $99 purchase began a 9,400-mile journey that would lead across the Atlantic Ocean and more than halfway back again, to a grassy industrial park in Dublin, a glass skyscraper in Amsterdam and a law office in Bermuda surrounded by palm trees.
While Forest Laboratories Inc., the medicine’s maker, sells Lexapro only in the U.S., the voyage ensures most of its profits aren’t taxed there — and they face little tax anywhere else. Forest cut its U.S. tax bill by more than a third last year with a technique known as transfer pricing, a method that carves an estimated $60 billion a year from the U.S. Treasury as it combines tax planning and alchemy. (See an interactive graphic on Forest’s tax strategy here.)
Transfer pricing lets companies such as Forest, Oracle Corp., Eli Lilly & Co. and Pfizer Inc., legally avoid some income taxes by converting sales in one country to profits in another — on paper only, and often in places where they have few employees or actual sales.
After an economic bailout in which the U.S. government lent, spent or guaranteed as much as $12.8 trillion, the Obama administration faces a projected budget deficit of $1.5 trillion this year. In February, the administration said it would target some of the techniques companies use to shift profits offshore — part of a package intended to raise $12 billion a year over the coming decade.
Losing $60 Billion
That’s only about a fifth of the $60 billion in annual U.S. tax revenue lost to thousands of companies’ income shifting, according to a study published in December in the National Tax Journal by Kimberly A. Clausing, an economics professor at Reed College in Portland, Oregon.
The lost revenue could pay the federal government’s share of health coverage for more than 10 million uninsured Americans, such as Hurst — more than a third of the people who will gain insurance under the health-care overhaul passed in March. The administration’s proposed tax on certain financial institutions would take almost seven years to generate $60 billion.
“Transfer pricing is the corporate equivalent of the secret offshore accounts of individual tax dodgers,” said Sen. Carl Levin, a Michigan Democrat and chairman of the Senate’s Permanent Subcommittee on Investigations, in a statement to Bloomberg News. Levin has overseen hearings on tax shelters including those sold to wealthy people by KPMG LLP. “Now that progress has been made in addressing offshore tax abuse by individuals, transfer pricing is an issue that deserves scrutiny.”
Tea Party Signs
The anti-tax activists of the national Tea Party movement haven’t put transfer pricing on signs in their demonstrations, yet it deserves attention, said Mark Skoda, chairman and founder of the Memphis Tea Party.
“I find the issue of corporations paying no tax or little tax in the United States, when the majority of their operations are here, problematic,” Skoda said in an interview. “The problem is that this is sort of the level of micro that people don’t look at.”
The trek taken by Forest’s profits on Hurst’s $99 purchase involves a corporate structure nicknamed “the Double Irish,” registered offices that occupy no real estate and a set of U.S. rules that one tax attorney calls “unenforceable.” It provides a case study in how U.S. companies use transfer pricing to avoid paying taxes.
“The fact the profits aren’t reported in the U.S. seems ridiculous,” said Hurst, 30, a self-employed marketing consultant, after hearing about the journey his money was undertaking. He began using Lexapro to counteract years of mood swings, including depression and anxiety he started experiencing in college, he said.
On April 15, the deadline for Americans to file their personal tax returns, the Internal Revenue Service said it would add new agents, attorneys and economists to ensure companies are following the rules for transfer pricing. The United Nations set up a panel in October to devise guidelines for the practice in developing countries.
“If multinationals cannot be prevented from shifting profits to low-tax jurisdictions, then it becomes impossible to maintain the domestic corporate tax base,” said Reuven S. Avi- Yonah, director of the international tax program at the University of Michigan Law School in Ann Arbor. If that bleeding can’t be stanched, “we might as well abandon the income tax.”
$1 Trillion Offshore
U.S. companies amassed at least $1 trillion in foreign profits not taxed in the U.S. as of the end of last year, according to data compiled by Bloomberg. That cumulative total, based on filings by 135 companies, increased 70 percent over three years, from $590 billion in 2006.
While some of the offshore earnings reflect sales abroad, much of the growth results from expanding use of transfer pricing, said Martin Sullivan, a tax economist who formerly worked for the Treasury Department and Arthur Andersen LLP.
The system allows for creating paper transactions between subsidiaries of the same company to allocate expenses and profits to selected countries. For instance, when technology firms license their patents to offshore subsidiaries in low-tax countries, profits from sales overseas are booked to the foreign units, not the U.S. parents. The tax savings add to profits.
“A very significant part of this accumulation of profits offshore is the artificial shifting of profits using transfer pricing,” said Sullivan, now a contributing editor to the trade publication Tax Notes. “There’s been a significant increase in its aggressiveness over the past decade.”
Like Churchill Said
Criticisms of transfer pricing “remind me of what Churchill said about democracy: It’s the worst system — except for all the others,” said Karl L. Kellar, a partner at Jones Day in Washington, who advises companies on their taxes and who formerly worked for the IRS and the U.S. Justice Department.
Companies try to extract as much tax benefit as possible from transfer pricing to protect shareholders’ interests, proponents say, particularly in the U.S., which imposes one of the world’s highest tax rates on corporate income, 35 percent.
Frank J. Murdolo, Forest’s vice president of investor relations, declined to comment on the company’s tax planning.
The Journey Begins
It’s about 2,100 miles from the Phoenix Walgreens, operated by Walgreen Co., to Forest’s corporate headquarters on Third Avenue in New York. There, Howard Solomon, the drugmaker’s chief executive officer, became interested in treating mood disorders as he watched his son, writer Andrew Solomon, struggle with depression in the 1990s.
He led Forest to Lexapro, whose sales last year ranked behind only Pfizer’s Effexor and Eli Lilly’s Cymbalta among antidepressants, according to IMS Health Inc., a health-care data provider in Norwalk, Connecticut. Since its 2002 debut, Lexapro has generated $13.8 billion in sales, according to Gary Nachman, an analyst for Leerink Swann LLC, in New York. The drug accounted for 58 percent of Forest’s sales for the fiscal year that ended March 31.
Forest declined to discuss how much it received from the $99 that Hurst paid for his Lexapro. For top-selling prescription drugs, the retailer would keep about $12, and $2 would go to a drug wholesaler, according to Helene Wolk, a health-care distribution analyst at Sanford C. Bernstein & Co. in New York. While the amounts differ for purchases covered by health insurance, the proportions are similar, Wolk said.
Of the $85 left for Forest, most doesn’t stay on Third Avenue for long. It heads first to Ireland, where workers in lab coats and goggles make and test the medicine in a low-slung, off-white factory near a soccer pitch on Dublin’s north side. A rock the size of a Smart car rests beside the parking lot, inscribed with one word in bright blue letters: “Forest.”
This subsidiary, called Forest Laboratories Ireland Ltd., sells Lexapro to its U.S. parent, according to Dan L. Goldwasser, a Forest board member and an attorney with Vedder Price PC in New York.
That transaction is at the heart of transfer pricing: With each tablet Forest buys from the Irish unit, it shifts profits to Ireland, where corporate income is taxed at rates between 10 percent and 12.5 percent, compared with 35 percent in the U.S.
“Part of the object is to generate some of the profit in Ireland,” Goldwasser said.
The company won’t disclose what it pays the Irish subsidiary for Lexapro or other medications made there. Tax accounting analysts say they can’t calculate the pill’s precise price either.
Overall, Forest’s Irish operations, which employ about 5 percent of its 5,200 workers, reported $2.5 billion in sales during fiscal 2009, the most recent year for which figures are available. That equals about 70 percent of the parent company’s $3.6 billion in net sales. Lexapro alone generated $2.3 billion in revenue in 2009, according to company filings.
Scores of U.S. pharmaceutical and technology companies have set up similar operations in Ireland, lured by an educated workforce, political stability and access to European markets, as well as low taxes, said Alan Mahon, a spokesman for the Irish Department of Finance.
“Ireland’s 12.5 percent corporation tax rate has become an international ‘brand,’” he said.
Exporting Intellectual Property
U.S. tax laws have sought to regulate transfer pricing in various forms since 1921. Treasury Department regulations in 1968 created standards for pricing inter-company transactions. Thousands of pages of rules have followed, and the tax code was amended in 1986 because of concerns that companies were shifting profits from the U.S.
For U.S. regulators, the key questions in transfer pricing are whether the parent pays too much to its offshore subsidiary or whether the subsidiary pays too little to its U.S. parent. Treasury Department regulations require “arm’s length” prices, or the amounts that would be paid between unrelated parties.
Those rules are “based on a fiction,” said Michael C. Durst, special counsel at Steptoe & Johnson LLP, in Washington, who advised companies on transfer pricing for 15 years and has emerged as a leading critic of the system.
Many of the transfer pricing transactions between a U.S. parent and its offshore units would never take place between unrelated parties, Durst said. So it’s often impossible to compare the prices paid in those deals to prices in real-world transactions between separate companies, he said.
“As a result of resting on this basic fallacy, transfer pricing rules have for many years been unenforceable,” said Durst, who formerly worked for PricewaterhouseCoopers LLP and the IRS.
U.S. Sen. Byron Dorgan, a North Dakota Democrat, calls transfer pricing “an unbelievable scandal.” He favors scrapping the rules in favor of a system that allocates profits as most U.S. states with a corporate income tax do. That method is based on factors including sales, number of employees and property in a particular state. Enforcement of the current rules is “impossible to do,” he said.
“It’s the equivalent of asking the Internal Revenue Service to connect the ends of two different plates of spaghetti,” Dorgan said.
Forest derived the undisclosed price that it pays its Irish unit for Lexapro from a 2001 arrangement the parent company struck with Daiichi Sankyo Co., Japan’s third-largest drugmaker, according to Goldwasser, the board member. That deal was to co- promote the hypertension medication Benicar, he said.
“You’re attributing to Forest Ireland more bargaining power than probably it actually had, but, you know, that’s life,” Goldwasser said.
A crucial step in calculating where a drugmaker’s profits belong under transfer pricing is determining who owns a drug’s patents for tax purposes, said Durst, the corporate tax attorney. While Forest’s Irish subsidiary controls Lexapro’s patents for the U.S. market, it didn’t come up with the formula. Forest licenses the use of those patents from H. Lundbeck A/S, a Danish pharmaceutical company. The Irish unit paid for the drug’s U.S. clinical trials, Goldwasser said.
The IRS claimed in 2007 that Forest didn’t adequately value its U.S. marketing operations, allocating too much in profit to its Irish subsidiary, according to a person familiar with the matter. That person asked not to be identified because he wasn’t authorized to discuss it publicly. The dispute involved profits from another antidepressant, Celexa, in 2002 and 2003, according to the person and filings by Forest.
Such disagreements sometimes grow to involve hundreds of pages of studies by rival economists over comparatively small differences in costs that cumulatively add up to hundreds of millions of dollars. GlaxoSmithKline PLC, the U.K.’s largest drugmaker, settled a transfer pricing case with the U.S. in 2006 for $3.4 billion. Since December, the U.S. has lost two court cases with Silicon Valley companies: a $24.3 million dispute with Xilinx Inc., a programmable chipmaker, and a $545 million case with Symantec Corp., a software company.
In Forest’s case, the IRS sought an additional $206.7 million in tax, according to the company’s disclosures. Forest said in November it agreed to pay an undisclosed amount that “did not have a material impact” on its results.
Beginning in 2005, the company found a way to reduce its taxes even further by sending most of its Lexapro profits from Ireland to Bermuda.
‘The Double Irish’
On advice from Ernst & Young, Forest Laboratories Ireland reorganized that year, dropping the country from its name. The newly dubbed Forest Laboratories Holdings Ltd. established a registered office in Hamilton, Bermuda, declaring the island its tax residence. This unit took control of licensing the patents.
A second subsidiary in Ireland inherited the old name. It handled the manufacturing, sublicensing the rights to the patents, according to a corporate disclosure and an internal Forest flow chart tracing the arrangement that was reviewed by Bloomberg.
The change helped the Irish subsidiary cut its effective tax rate to 2.4 percent from 10.3 percent the year before the reorganization, according to its annual reports. It did so by deducting from its taxable income the fees that went to Bermuda, which has no corporate income tax. Charlie Perkins, a spokesman for Ernst & Young, one of the so-called Big Four accounting firms, declined to comment on its work for Forest.
International tax planners have a nickname for the type of structure the drugmaker adopted: the Double Irish.
“Double Irish More than Doubles the Tax Savings,” was the headline in a 2007 issue of the trade publication International Securitization & Finance Report over an article describing the model by a pair of U.S. tax attorneys, Joseph B. Darby III and Kelsey Lemaster.
Layover in Amsterdam
Ireland faces its own budget gap after real estate values collapsed. The deficit, pegged at 14.3 percent of gross domestic product last year, represented the biggest shortfall of any member of the 27-nation European Union, according to data released in April by Eurostat, the statistics office of the EU.
To avoid another Irish tax, Forest’s profits don’t fly direct to Bermuda. They have a layover in Amsterdam.
Fees paid to the Bermuda unit pass through yet another subsidiary, Forest Finance BV in the Netherlands, according to the internal Forest document, Dutch corporate records and a person familiar with the transaction.
That route bypasses a 20 percent Irish withholding tax on certain royalties for patents, according to Richard Murphy, a U.K. accountant who worked on similar transactions and is director of Tax Research LLP. The structure takes advantage of an exemption from the levy if payments go to a company in another EU member state, Murphy said.
Forest established its Dutch company in July 2005, two months before its Irish subsidiary got permission from Bermuda regulators to conduct business. The Amsterdam unit operates largely as a conduit, records show. In 2007, Forest Finance collected $1.19 billion in licensing income and paid out 99.6 percent of it in licensing expense, according to its annual report.
The Dutch company lists its office at an Amsterdam building used by Fortis Bank Nederland NV, the lender nationalized in 2008 by the Dutch government. Forest has no employees there, said a receptionist at Intertrust Group Holding SA, a business that manages financial records for companies. The receptionist wouldn’t give her name. Intertrust was sold in January by Fortis Bank to a private equity firm.
The Dutch Channel
The Netherlands has more than 13,000 such entities “established by foreign multinational corporations for the purpose of channeling financial assets from one country to another,” according to published research by the Dutch Central Bank. More than 12.3 trillion euros ($15.5 trillion) flowed in and out of them during 2008, the Dutch Central Bank said.
Forest’s income tax savings from international operations almost doubled after its Irish-Dutch-Bermudan reorganization took hold. In fiscal year 2007, the company’s effective tax rate dropped by 21.8 percentage points, or $155 million, because of the effect of foreign operations, according to U.S. securities filings. In 2009, the international tax benefit lopped 18.9 percentage points, or $183 million, off Forest’s income tax bill.
International tax benefits boosted Forest’s net income in 2009 by 31 percent, according to an analysis of its tax footnotes by Robert Willens, president of Robert Willens LLC, a consulting firm that advises investors on tax issues.
‘Place of Business’
Even though Forest described its Bermuda office as the Irish subsidiary’s “principal place of business” in a 2008 court filing, it has no employees on the island. The closest it comes to an actual presence is its registered office at Milner House, at 18 Parliament Street in Hamilton, a beige building nestled among the pastel structures of the island’s main commercial area.
There, Coson Corporate Services Limited, part of law firm Cox Hallett Wilkinson, provides “corporate administrative services” for Forest Laboratories Holdings, according to Jeannette Monk, who identified herself as the company’s corporate administrator. Asked whether Forest had any employees there, she said, “This is a law firm.”
It’s also the last port of call for about two-thirds of the profits Forest derived from sales of Lexapro and its other drugs in 2009. U.S. corporations can avoid taxes on such overseas profits indefinitely, until they decide to bring the earnings back home.
The Bottom Line
Unlike most deferred taxes, future levies on most foreign earnings don’t count against income in reports to shareholders, said Michelle Hanlon, an associate professor of accounting at the Massachusetts Institute of Technology’s Sloan School of Management.
So lower taxes from earnings kept overseas go straight to the bottom line, she said, and U.S. companies rarely repatriate significant portions of that income. They’re permitted to use it in overseas operations or certain investments, or to let it sit as cash in bank accounts, Hanlon said.
An exception came in 2004 when Congress enacted a one-time break allowing companies to bring back their earnings at an effective tax rate of 5.25 percent, less than one-sixth the top corporate rate. As a result, 843 corporations brought $362 billion to the U.S., with $312 billion qualifying for the tax break, according to the IRS. Forest returned $1.2 billion to the U.S. under the legislation.
While it remains offshore and shielded from federal income taxes, most of the $1 trillion in foreign profits for U.S. multinationals cannot be used in the U.S. That doesn’t make Tyler Hurst very happy about his Lexapro transaction.
“If I’m purchasing it from Walgreens two blocks away, that money isn’t going to anything local, or anything national,” he said. “I’m giving my money to Ireland.”
Last Updated: May 13, 2010 15:00 EDT
While the much-maligned credit rating agencies lost some power today after the Senate approved two measures pushing the government into the ratings business, they dodged a bullet in the exclusion of another.
The agencies, which rate the creditworthiness of corporations and the financial obligations they sell to investors, like bonds and commercial paper, have been blamed for playing a major role in exacerbating — if not causing — the worst financial crisis since the Great Depression. By slapping flawed AAA ratings (*allegedly sometimes knowingly) on financial products like mortgage-backed bonds and other mortgage-linked securities, the agencies lulled investors and regulators into thinking they were risk-free. Then, after they finally woke up to the inaccurate ratings, they downgraded them in near-unison, compelling many big investors to dump the securities and causing a downward spiral in prices that resulted in losses totaling in the hundreds of billions.
But because of the protections the agencies have been afforded in law, investors and others have been unsuccessful in exacting monetary revenge. Worse, the government’s stamp of approval on the ratings the agencies issue — federal rules compel institutional investors and regulators to use them — virtually guarantees the major credit raters’ oligopoly, and the public’s continued reliance on them.
Investors, legislators, academics and policymakers all agree that the agencies — and the way they do business — need to be reformed.
But in passing a measure that attempts to end their oligopoly, the Senate purposely did not include a provision in the House bill that forces major credit rating agencies to be accountable to investors by scrapping a Securities and Exchange Commission rule that has shielded them from civil lawsuits for nearly 30 years.
The provision, known as Rule 436(g), insulates the 10 credit rating agencies recognized by the government as “Nationally Recognized Statistical Rating Organizations” from liability if they knowingly make false or misleading statements in connection with securities registration statements to dupe investors. Other experts — like the rating agencies not part of the group of 10 — are legally liable for their statements “to assure that disclosure regarding securities is accurate,” according to a 2009 SEC document supporting the removal of the exemption.
In short, if a Standard & Poor’s or Moody’s Investors Service knowingly tries to deceive an investor, under current law that investor can’t sue.
The SEC document references a paper prepared by Frank Partnoy, a professor at the University of San Diego School of Law and an expert on securities law, who “argues that in order to make [major credit rating agencies] more accountable, they must be subject to a credible threat of liability,” according to the SEC.
Public employee pension funds, like the California Public Employees’ Retirement System, the largest in the country, support the removal of the exemption. So does the Council of Institutional Investors, a nonprofit association of public, union and corporate pension funds with combined assets that exceed $3 trillion.
“[T]his would represent a large step forward in deterring harmful conduct by the [credit rating agencies] in the area of structured finance,” CalPERS wrote in an April 21 letter to the SEC.
The major credit rating agencies are “financial gatekeepers” whose “actions have a significant impact on the health and well-being of the financial markets, both at home and abroad,” the Council wrote in a Wednesday letter to top Senate leaders. “As experts, they have the ability to analyze and verify mountains of information for investors who do not have the capabilities to do so for themselves.” The major agencies also have access to “material non-public information” which in part makes them “even more important to the functioning of the market” because “financial products have become more complex and opaque.”
“In the eyes of investors, regulators and the market at large, rescinding the exemption would remove [the 10 major credit rating agencies] from the pedestal they have come to occupy,” according to the Council’s letter.
Those who support a removal of the exemption argue that by subjecting the credit raters to the possibility of lawsuits, it will force them to be more thorough and careful when issuing their ratings. In other words, it will discipline them.
In a January op-ed published in the Wall Street Journal, Deven Sharma, the president of S&P, wrote: “Currently, rating agencies face the same liability standards as accountants and securities analysts.”
That’s not true, retorted a top SEC official less than two weeks later in a letter to the editor.
“Nearly 30 years ago, the SEC adopted a rule that effectively exempts recognized credit rating agencies from experts’ liability under the Securities Act,” wrote David Becker, the SEC’s general counsel and senior policy director. “No other experts have this protection.”
The three biggest rating agencies — S&P, Moody’s and Fitch Ratings — oppose the removal of this protection.
The House bill, which passed in December, calls for its removal. The Senate bill that hit the floor, though, did not, and after the chamber passed an amendment Thursday offered by Sens. George LeMieux (R-Fla.) and Maria Cantwell (D-Wash.) that copied some of the language in the House bill (except for this particular provision), it probably never will. Sen. Sherrod Brown (D-Ohio) offered an amendment that would get rid of the exemption, but because the Senate is reportedly allowing its members to bring just one amendment up for a vote, and a Brown amendment was already voted on, the Senate likely will not have an opportunity to vote on his amendment.
The LeMieux-Cantwell amendment passed by a 61 to 38 margin (one Senator didn’t vote). Of the 38 votes against it, 37 were cast by Democrats; the other dissenter was Joe Lieberman, a Connecticut Independent who caucuses with Democrats.
At least one of the dissenters, Virginia Democrat Jim Webb, cast his vote against the provision “because it wasn’t strong enough,” Will Jenkins, Webb’s deputy communications director, said in an e-mail.
But the Senate bill, like the House bill, does provide investors with an improved ability to sue credit raters for faulty ratings. A spokesman for LeMieux pointed to these provisions when asked why his amendment did not include the House language on the 436(g) rule.
The agencies have enjoyed a near-perfect legal record by claiming that their ratings fall under the protection of the First Amendment — free speech, they’ve successfully argued. The House and Senate bills attempt to address this by strengthening investors’ hand when it comes to suing the rating agencies, but the First Amendment defense may be hard to overcome, as ultimately the courts decide — not Congress.
Still, according to experts like Barbara Roper, director of investor protection at the Consumer Federation of America, the bills are a big improvement over the status quo. Many consumer groups say the provisions approved Thursday strengthened the Senate bill.
Elsewhere in those amendments were measures that remove various references in federal law to credit ratings, which had compelled their use and guaranteed the majors’ oligopoly, and a government mechanism that would inject government officials into deciding which agency rates which securities.
Regarding the removal of the references, federal regulators will largely be forced to define creditworthiness, rather than regulations that currently rely on the credit rating agencies for that.
However, there are open questions about the LeMieux-Cantwell provision. The House bill, largely authored by Rep. Paul Kanjorski (D-Pa.), directs the various federal agencies that would need to modify their rules, like the Office of the Comptroller of the Currency, the SEC and the Federal Deposit Insurance Corporation, to harmonize their standards of creditworthiness “to the extent feasible.” The Senate provision includes no such language.
Also, the House bill compels federal agencies to look for other such references to credit ratings in their rules and regulations, and modify them so they instead refer to government-defined standards. The Senate amendment doesn’t include this, either.
The measures in the LeMieux-Cantwell amendment won’t take effect until two years after the bill is enacted into law; the House provisions take effect within six months.
As for the other amendment, offered by Sen. Al Franken, it calls for a panel overseen by the SEC to pick which rating agencies will rate new securities. Should issuers choose to pick their own rating agencies, any differences between the ratings would have to be made public.
The Minnesota Democrat’s amendment aims to end the alleged conflict of interest that exists when issuers of securities get to shop around for who rates them.
It passed 64 to 35. One of the dissenters was prominent reformer Sen. Jack Reed, a Rhode Island Democrat who chairs the Senate subcommittee that oversees the securities industry. He’s consistently been among the few Senators trying to fundamentally clean up and reform the credit ratings business.
*This story has been updated to reflect that the major credit rating agencies are alleged to have knowingly applied misleading ratings to financial products. An earlier version of this story did not include the word “allegedly.”
By Marcus Baram
The unemployment crisis continues to stymie a full economic recovery, with ripple effects from credit card delinquencies and rising food stamp participation indicating new hardships for millions of Americans, according to the latest update of Huffington Post’s Real Misery Index.
The index for March/April 2010 was 33.1, a slight increase from 33.0 in February, representing another new high in the 26 years going back to 1984 analyzed by HuffPost. Though there have been some encouraging signs, from higher housing prices (which have an inverse relationship to the index) to declining home equity delinquencies, the jobless numbers continue to increase the misery. In addition, nearly 40 million American were enrolled for food stamps in February, which has been described by anti-hunger groups as the highest share of the population ever in the assistance program.
Though the Real Misery Index has increased 16% from March 2009 to April 2010, the stock market has increased 56% during that period, reflecting an alarming discrepancy between the two metrics.
Lynn Reaser, the incoming president of the National Association of Business Economists, calls it a two-tier economy, with those who are employed doing better amid rising consumer confidence while the unemployed suffer.
Stock prices, meanwhile, are driven by the behavior of investors, who make up a small portion of the population — not those who are underemployed, says Karen Dynan, the vice president of economic studies at the Brookings Institution.
She notes that employment tends to be a lagging indicator, meaning that it is one of the last numbers to turn around during a recovery, and that the stock market has a forward-looking predictive element to it. The hope is that a rising stock market will “stimulate spending and that will eventually create more jobs,” she says.
To formulate our index, which provides a better snapshot of the economy than the often-criticized misery index (inflation added to unemployment), we used a more accurate unemployment statistic (the U6 formulation), with the inflation rate for three essentials (food and beverages, gas, medical costs), and year-over-year percent changes in credit card delinquencies, housing prices, food stamp participation, and home equity loan deficiencies. We gave equal weight to the broad unemployment numbers and the combination of the other seven metrics (with housing prices having an inverse relationship to the index). Thus, we added the broad unemployment U6 statistic (note: the current U6 was first introduced in 1994 so we used a similar number — the U7 — for the years 1985-1993) to the average of the seven other statistics.
Household names like Apple, Caterpillar and Whirlpool are part of a coalition of companies lobbying Congress to allow Wall Street to escape tough new rules on derivatives trading, potentially sowing the seeds for another AIG-like disaster.
In a letter sent to senators late last week, the Coalition for Derivatives End-Users — companies that ostensibly use derivatives to hedge future risks like rising interest rates or a depreciating dollar — argue that the current bill pending before the Senate goes too far in regulating what famed investor Warren Buffett once called “financial weapons of mass destruction.”
So the coalition wants exemptions — lots of them:
Big banks like JPMorgan Chase, Citigroup and Goldman Sachs shouldn’t be forced to have more cash to cover its derivatives deals; firms, including those financial behemoths, needn’t be compelled to post margin to cover their bets; financial firms, save for the megabanks, should be treated like manufacturers and other industrial companies, and hence should be able to continue trading their derivatives contracts with little government oversight; and up to two-thirds of all over-the-counter derivatives trades should continue to be traded in the dark.
A close reading of the coalition’s letter, and the accompanying suggestions for legislative fixes, reveals that the coalition doesn’t really support the central aim behind reforming the derivatives racket: forcing the vast majority of now-unregulated trades that occur over telephone conversations and email onto central exchanges and exchange-like facilities.
“It appears to be a total evisceration of the bill,” said Adam K. White, director of research at White Knight Research and Trading, an independent research consulting firm.
The benefit of derivatives reform, according to reformers on Capitol Hill, in the Obama administration, and outside Washington, is a less-risky system with more safeguards and more transparent pricing of these contracts, so firms that use derivatives to hedge against future risk get market prices rather than one determined by an oligarchical system.
The downside, according to the coalition, is “many companies across the country that had no role in the financial crisis and do not pose risks to the financial system will have to post billions of dollars in working capital to meet new regulatory requirements.”
It’s like gambling in Las Vegas for years with Monopoly money, and then all of a sudden being forced to front real cash.
“As it is, the end-user exemption will decrease the transparency and stability of the financial market, and in the current bill the end-user exemption definition is expansive to the point where lots of the wrong types of firms could qualify,” says Mike Konczal, a fellow at the pro-financial reform Roosevelt Institute. “What the Coalition…[is] asking for is to radically make this regulation worse, by essentially saying that everyone gets to be an end-user and that everything gets to be exempt from regulation.”
One of the signatories to the coalition’s letter, the National Association of Manufacturers, did not respond to a request for comment. Another, the U.S. Chamber of Commerce, did not respond to an immediate request for comment.
“I don’t think true end users want an evisceration of this bill because I don’t think they want to go through another near-death experience like we did when the financial system almost collapsed,” White said.
Among the coalition’s requested carve-outs:
- Deleting provisions in the current Senate bill, authored by Banking Committee Chairman Christopher Dodd (D-Conn.) and Agriculture Committee Chairman Blanche Lincoln (D-Ark.), that call for swaps dealers, like JPMorgan Chase, Goldman Sachs, Bank of America, Citigroup, Morgan Stanley and Wells Fargo, to hold higher amounts of capital to support their derivatives bets;
- Deleting a term defining major derivatives users, which calls for higher capital requirements and mandates that they clear their derivatives deals through transparent venues that require parties to post margin. By deleting this provision, the coalition wants to exempt an entire class of derivatives users from having to post cash upfront to support their bets.
- Changing the definition of what constitutes true hedging. Derivatives are traditionally used to hedge future risk. Firms like Coca-Cola and General Electric use derivatives to hedge fluctuations in currency and interest rates. But they can also be used to make wild bets. The coalition wants to broaden the definition of what constitutes actual hedging to include transactions in which a firm — like a hedge fund (Long-Term Capital Management) or large insurance company (AIG) — seeks to hedge anticipated assets and liabilities, like a future purchase of a share of a collateralized debt obligation based on home mortgage-backed bonds. These kinds of derivatives contracts should continue to be traded with little government oversight, the coalition argues.
- Doing away with margin requirements that compel megabanks to post upfront cash on their derivatives deals with non-megabanks that reflect changes in the contract’s value and guarantees the trades.
The net effect of these changes would keep between 60 to 66 percent of over-the-counter derivatives in the shadows and away from government oversight, according to statistics from the Bank for International Settlements.
“These changes would be worse than having no bill, as it would create the assumption that regulation has occurred when in fact nothing of relevance has changed,” Konczal said.
The coalition’s proposals are “loopholes that swallow the law,” said Michael Greenberger, a professor at the University of Maryland Law School and former director of trading and markets at the Commodity Futures Trading Commission.
He added: “The American people are just going to have to decide whether they want to continue playing Russian roulette.”
By ALAN ZIBEL
WASHINGTON — Fannie Mae has again asked taxpayers for more money after reporting a first-quarter loss of more than $13 billion.
The mortgage finance company, which was rescued by the government in September 2008, said it needs an additional $8.4 billion from the government to help cover mounting losses.
Fannie Mae says it lost $13.1 billion, or $2.29 per share, in the January-March period. That takes into account $1.5 billion in dividends paid to the Treasury Department. It compares with a loss of $23.2 billion, or $4.09 a share, in the year-ago period.
The rescue of Fannie Mae and sister company Freddie Mac is turning out to be one of the most expensive aftereffects of the financial meltdown. The new request for aid will bring Fannie Mae’s total to $83.6 billion. The total bill for the duo will now be nearly $145 billion.
Late last year, the Obama administration pledged to cover unlimited losses through 2012 for Freddie and Fannie, lifting an earlier cap of $400 billion.
Fannie and Freddie play a vital role in the mortgage market by purchasing mortgages from lenders and selling them to investors. Together the pair own or guarantee almost 31 million home loans worth about $5.5 trillion. That’s about half of all mortgages.
The two companies, however, loosened their lending standards for borrowers during the real estate boom and are reeling from the consequences.
With the housing market still on shaky ground, Obama administration officials say it is still too early to draft any proposals to reform the two companies or the broader housing finance system.
But Republicans argue the sweeping financial overhaul currently before Congress is incomplete without a plan for Fannie and Freddie. They propose transforming Fannie and Freddie into private companies with no government subsidies, or shutting them down completely.
The legislation “touches nearly every corner of the economy,” Alabama Sen. Richard Shelby said in the GOP weekly radio and Internet address over the weekend. “But these major contributors to the crisis are left unscathed,” he added, singling out Fannie Mae and Freddie Mac.
The 60-day delinquency rate slipped to 6.77 percent, from 6.89 percent in the fourth quarter of 2009. That was the first decline after 12 consecutive quarters of steady increases, TransUnion said.
The first-quarter figure still represents a substantial jump from a year ago, when delinquencies were at 5.22 percent. But FJ Guarrera, vice president in TransUnion’s financial services business unit, said it’s still good news.
“To see it turn down is a very, very strong sign,” Guarrera said, adding that positive economic indicators like Friday’s increase in job creation make the outlook even better.
“We cannot characterize it as a trend yet, but we anticipate that things will continue to improve.” TransUnion expects another decrease for the current quarter, and then for the delinquency rate to stabilize for the rest of the year.
TransUnion measures the rate using mortgage payments that are 60 days late, or two skipped months. The figure is considered an important indicator of likely foreclosure, because of the difficulty someone in financial distress would have coming up with three payments to bring their mortgage current.
The company forecasts the delinquency rate will be about 6.3 percent by the end of the year.
In the first quarter of 2011, TransUnion expects late mortgage payments to start a significant decline. By the end of next year, the rate could be close to 5 percent, Guarrera said.
Historically, mortgage delinquencies hovered around 1.5 or 2 percent.
Delinquency rates remain the highest in the four states hit hardest by the housing market collapse: Nevada, at 15.98 percent, Florida, at 14.65 percent, Arizona, at 10.94 percent and California, at 10.68 percent.
TransUnion said the rate could top 18 percent in Florida by the end of the year. Nevada and Arizona will likely remain close to their current rates through 2011.
“I really do believe it will take longer in those states for improvement,” Guarrera said. These states were left with a bigger surplus of housing that remained unsold during the recession. The surplus will likely keep pressure on housing prices, and make it harder for homeowners to refinance or get out from under mortgages that exceed the value of their homes. That increases the temptation to walk away from a mortgage and let the house slip into foreclosure.
California could see a slight decline in delinquencies by the end of 2010.
Delinquency rates remain the lowest in North Dakota, at just 1.76 percent, and South Dakota, at 2.44 percent.
The figures are culled from about 27 million randomly sampled credit files in TransUnion’s database, representing about 10 percent of U.S. consumers who have active loans outstanding.
While the overall news is positive, Guarrera said it’s still difficult to predict what might happen in coming months. “There’s still a lot of uncertainty in the housing market,” he said. “There’s still a lot of delinquency out there, and home values have not started to improve.”
Are you a Wall Street banker, a captain of industry, a financier? If not, then maybe you’ve thought once or twice about buying a credit default swap or a collateralized debt obligation. No? Well, maybe you’ve asked a private equity company to help you hedge your risks through …
OK, OK, we’ll stop now.
If you don’t fit into any of the above categories, there’s only one piece of the massive financial reform bill Congress is considering that would directly affect you – the proposed consumer protection bureau. It’s supposed to help consumers make sense of their mortgages, credit cards and other financial matters, so big companies can’t overwhelm them with pages of fine-print agreements.
After that, the bill goes into the deep weeds of esoteric high finance. More than a year and a half after the height of the financial crisis, Congress is trying to pass some regulations to prevent a repeat of the worst economic downturn since the Great Depression.
What’s in the Dodd bill
For the purposes of this factsheet, we’re focusing on the legislation put forward by Democrats in the Senate, shepherded by Sen. Christopher Dodd, D-Conn. It’s 1,400 pages of new rules that change the way the financial system is regulated. The House passed its version of financial reform in December 2009 that differs on some details. But because the Senate is slow-moving and prone to requiring 60 votes for action, it seems likely the Senate bill will be a baseline for negotiations. Keep in mind this bill is a moving target. It will be amended before passage, and the Senate and House will then have to negotiate their differences before a final vote.
Here are the bill’s main components:
• Consumer protection. This bureau’s mission would be to help people looking for mortgages, credit cards and other financial products to avoid unfair, deceptive or abusive practices. In the Senate version, the new consumer protection bureau would be housed within the Federal Reserve, though it would have its own budget. The House version of the bill creates a standalone agency.
• Policing “systemic” threats. The bill creates a Financial Stability Oversight Council to look for overarching threats to the financial system and to recommend specific steps to rein in large financial companies when necessary. The Federal Reserve would be given new powers to regulate non-bank financial companies. A new Office of Financial Research within the Treasury Department would collect financial data and conduct research and analysis.
• “Orderly liquidation authority.” This part of the bill sets up a panel of three bankruptcy judges who convene and decide, within 24 hours, if a large financial company is insolvent. If a big firm is teetering on collapse, the Treasury Department, the Federal Deposit Insurance Corp. and the Federal Reserve would have to agree to liquidate it, using a special fund created with payments from the largest financial firms. The legislative language says the fund must be used to dissolve failing firms. To pay for the shutdowns, the FDIC would set fees on the financial companies based on their size, raising $50 billion. The fund has become a point of controversy in recent weeks. Opponents have said it means guaranteed bailouts, a claim we ruled False, and some Republicans want the fund removed from the final bill.
• The “Volcker Rule.” This rule would prohibit banks from engaging in proprietary trading, which is trading the bank’s money to turn a profit. Advocates for this rule say these kinds of trades tend to put banks into a conflict of interest with their customers. The rules also would limit banks’ relationships with hedge funds and private equity funds. Nonbank financial institutions also would see new restrictions.
• Derivatives. Most but not all derivatives would be traded on an exchange. A derivative is an investment usually based on some outside event. Here’s an example of a good derivative: Southwest Airlines has to buy jet fuel over the coming year to run its planes. If oil prices skyrocket, Southwest loses money. So the airline invests money in something that will pay out if oil prices increase, lowering its potential for losses.
But derivatives have a dark side: During the financial crisis, derivatives exacerbated losses, especially in the housing market, and investors weren’t sure who was taking the biggest losses. The new regulations are aimed at making clear who is trading in derivatives. A version of derivatives legislation sponsored by Sen. Blanche Lincoln, D-Ark., is considered particularly strict.
• Hedge funds. Generally speaking, hedge funds are investment vehicles for selected groups of elite investors. The name comes from hedge funds’ tendency to be very careful about managing, or hedging, risk. This means they often buy derivatives or other unusual types of investments. Under the new regulations, large hedge funds would have to register with the Securities and Exchange Commission and report their activities. Some exemptions are provided for venture capital funds and private equity fund advisers.
• “Say on pay.” Shareholders of publicly traded companies get to vote on executive pay, though the vote is nonbinding. Translation: The company can choose to disregard the shareholders’ vote. (Yes, this doesn’t seem like much of a say to us. But experts tell us it’s actually progress in the longstanding fight to give shareholders more of a voice in corporate governance.)
• Credit ratings agencies. The credit ratings agencies are the people who said, before the financial crisis hit, that securities built from subprime mortgages could be great investments. Wrong, wrong, wrong. The bill creates an Office of Credit Rating Agencies and puts in place rules for internal controls, independence, transparency and penalties for poor performance.
Concerns and criticisms
Here’s some of the main points of concern raised about the proposal:
• “Too big to fail is too big to exist.” Some economists argue that the idea of resolution authority for large firms is misguided. The large financial firms that pose “systemic” risk cannot be shut down without harming the broader economy, they say, and the big players should be broken up. This issue divides experts who otherwise agree on the need for increased regulation. People like Paul Volcker, the former head of the Federal Reserve, and Simon Johnson, former chief economist of the International Monetary Fund, urge measures that would limit the size of the biggest banks. Democratic senators Ted Kaufman of Delaware and Sherrod Brown of Ohio also support limits. Meanwhile, people like Dodd, and Paul Krugman, the Nobel Prize-winning New York Times columnist, say that breaking up the banks isn’t necessary to avert the next meltdown.
• “To be determined” regulations. Some important restrictions are not detailed in the bill. Instead, the bill says that officials will study and develop regulations on a particular issue. That creates a lot of unknowns about how effective the bill will be. The rules on credit rating agencies are particularly vague. Lawrence White, a professor of economics at New York University, says he is concerned that the yet-to-be-determined rules could discourage new firms from getting into the credit ratings business. “The grand irony of this approach is that we will end up making the current incumbents more important, not less important,” he says.
• The autonomy and authority of the consumer protection agency. Republicans have voiced concerns that the consumer protection agency will be too intrusive, regulating everyday companies that aren’t really part of the financial industry. Democrats, meanwhile, are debating how much independence to give the new agency. Consumer advocates say a stand-alone entity, as proposed by the House, would have more teeth.
• Fannie and Freddie? Fannie and Freddie who? Please tell us you haven’t forgotten about Fannie Mae and Freddie Mac. These are the two government-created companies that back many mortgages. They were supposedly private companies but often thought of as public. Then the financial crisis happened, and the Federal Housing Finance Agency placed them in conservatorship because they were out of money. The federal government now is likely on the hook for huge losses sustained by Fannie and Freddie when the housing bubble popped. The current bill doesn’t address Fannie and Freddie’s losses in any significant way. Experts we spoke with say losses could be anywhere from $200 billion to $400 billion, and the government will have to make good on that eventually. A Republican alternative makes a case for a special inspector general and limits on bailouts.