Important:
http://www.nytimes.com/2009/01/30/opinion/30krugman.html
Friday, January 30, 2009
Thursday, January 29, 2009
Good Quote re Madoff
"We should all recognize that the inadequate oversight of all the recent financial scandals can be traced to the political mumbo jumbo of that dynamic duo of the eighties, Maggie and Ron, soulmates of the Transatlantic conservative political Ponzi game. They sold too many voters that “government is the problem” and the markets will regulate themselves. Now their respective nations are smoldering in the ash heaps while the practitioners aree still collecting obscene bonuses. The root problem is greedy capitalismwithout governmental supervision."
From a comment on a Kristoff article on the foundations which were invested in Madoff
JP Morgan and its Pull-Out of the Madoff Fund
This article is a breakthrough. The actual interworkings of a major-firm role in feeding money to Madoff.
Study this article carefully. The "creation" of a triple leveraged instrument led to financial death and violation of JP Morgan's duty to its clients.
http://www.nytimes.com/2009/01/29/business/29madoff.html?hp
Link to "Walter Noel."
Study this article carefully. The "creation" of a triple leveraged instrument led to financial death and violation of JP Morgan's duty to its clients.
http://www.nytimes.com/2009/01/29/business/29madoff.html?hp
Link to "Walter Noel."
Tuesday, January 27, 2009
Flotsam and Jetsam
Sitting in LAX International Airport, it feels like a foreign country already. So I'm "surprised" when my American cell phone works. We're waiting for the 16 hr flight to Manila. Got out of snowy and now icy Cincinnati with no problem other than the expense of a motel room near the Cincinnati airport. And the worry about getting out of Cincinnati.
Herbert -- Just the Right Comments at the Right Time!
http://www.nytimes.com/2009/01/27/opinion/27herbert.html?_r=1&hp
Op-Ed Columnist
The Same Old Song
comments (423)
By BOB HERBERT
Published: January 26, 2009
What’s up with the Republicans? Have they no sense that their policies have sent the country hurtling down the road to ruin? Are they so divorced from reality that in their delusionary state they honestly believe we need more of their tax cuts for the rich and their other forms of plutocratic irresponsibility, the very things that got us to this deplorable state?
The G.O.P.’s latest campaign is aimed at undermining President Obama’s effort to cope with the national economic emergency by attacking the spending in his stimulus package and repeating ad nauseam the Republican mantra for ever more tax cuts.
“Right now, given the concerns that we have over the size of this package and all the spending in this package, we don’t think it’s going to work,” said Representative John Boehner, an Ohio Republican who is House minority leader. Speaking on NBC’s “Meet the Press,” Mr. Boehner said of the plan: “Put me down in the ‘no’ column.”
If anything, the stimulus package is not large enough. Less than 24 hours after Mr. Boehner’s televised exercise in obstructionism, the heavy-equipment company Caterpillar announced that it was cutting 20,000 jobs, Sprint Nextel said it was eliminating 8,000, and Home Depot 7,000.
Maybe the Republicans don’t think there is an emergency. After all, it was Phil Gramm, John McCain’s economic guru, who told us last summer that the pain was all in our heads, that this was a “mental recession.”
The truth, of course, is that the country is hemorrhaging jobs and Americans are heading to the poorhouse by the millions. The stock markets and the value of the family home have collapsed, and there is virtual across-the-board agreement that the country is caught up in the worst economic disaster since at least World War II.
The Republican answer to this turmoil?
Tax cuts.
They need to go into rehab.
The question that I would like answered is why anyone listens to this crowd anymore. G.O.P. policies have been an absolute backbreaker for the middle class. (Forget the poor. Nobody talks about them anymore, not even the Democrats.) The G.O.P. has successfully engineered a wholesale redistribution of wealth to those already at the top of the income ladder and then, in a remarkable display of chutzpah, dared anyone to talk about class warfare.
A stark example of this unholy collaboration between the G.O.P. and the very wealthy was on display in the pages of this newspaper on Jan. 18. The Times’s Mike McIntire wrote an article about the first wave of federal bailout money for the financial industry, which was handed over by the Bush administration with hardly any strings attached. (Congress, under the control of the Democrats, should never have allowed this to happen, but the Democrats are as committed to fecklessness as the Republicans are to tax cuts.)
The public was told that the money would be used to loosen the frozen credit markets and thus help revive the economy. But as the article pointed out, there were bankers with other ideas. John C. Hope III, the chairman of the Whitney National Bank in New Orleans, in an address to Wall Street fat cats gathered at the Palm Beach Ritz-Carlton, said:
“Make more loans? We’re not going to change our business model or our credit policies to accommodate the needs of the public sector as they see it to have us make more loans.”
How’s that for arrogance and contempt for the public interest? Mr. Hope’s bank received $300 million in taxpayer bailout money.
The same article quoted Walter M. Pressey, president of Boston Private Wealth Management, which Mr. McIntire described as a healthy bank with a mostly affluent clientele. It received $154 million in taxpayer money.
“With that capital in hand,” said Mr. Pressey, “not only do we feel comfortable that we can ride out the recession, but we also feel that we’ll be in a position to take advantage of opportunities that present themselves once this recession is sorted out.”
Take advantage, indeed. That, in a nutshell, is what the plutocracy is all about: taking unfair advantage.
When the G.O.P. talks, nobody should listen. Republicans have argued, with the collaboration of much of the media, that they could radically cut taxes while simultaneously balancing the federal budget, when, in fact, big income-tax cuts inevitably lead to big budget deficits. We listened to the G.O.P. and what do we have now? A trillion-dollar-plus deficit and an economy in shambles.
This is the party that preached fiscal discipline and then cut taxes in time of war. This is the party that still wants to put the torch to Social Security and Medicare. This is a party that, given a choice between Abraham Lincoln and Ronald Reagan, would choose Ronald Reagan in a heartbeat.
Why is anyone still listening?
Op-Ed Columnist
The Same Old Song
comments (423)
By BOB HERBERT
Published: January 26, 2009
What’s up with the Republicans? Have they no sense that their policies have sent the country hurtling down the road to ruin? Are they so divorced from reality that in their delusionary state they honestly believe we need more of their tax cuts for the rich and their other forms of plutocratic irresponsibility, the very things that got us to this deplorable state?
The G.O.P.’s latest campaign is aimed at undermining President Obama’s effort to cope with the national economic emergency by attacking the spending in his stimulus package and repeating ad nauseam the Republican mantra for ever more tax cuts.
“Right now, given the concerns that we have over the size of this package and all the spending in this package, we don’t think it’s going to work,” said Representative John Boehner, an Ohio Republican who is House minority leader. Speaking on NBC’s “Meet the Press,” Mr. Boehner said of the plan: “Put me down in the ‘no’ column.”
If anything, the stimulus package is not large enough. Less than 24 hours after Mr. Boehner’s televised exercise in obstructionism, the heavy-equipment company Caterpillar announced that it was cutting 20,000 jobs, Sprint Nextel said it was eliminating 8,000, and Home Depot 7,000.
Maybe the Republicans don’t think there is an emergency. After all, it was Phil Gramm, John McCain’s economic guru, who told us last summer that the pain was all in our heads, that this was a “mental recession.”
The truth, of course, is that the country is hemorrhaging jobs and Americans are heading to the poorhouse by the millions. The stock markets and the value of the family home have collapsed, and there is virtual across-the-board agreement that the country is caught up in the worst economic disaster since at least World War II.
The Republican answer to this turmoil?
Tax cuts.
They need to go into rehab.
The question that I would like answered is why anyone listens to this crowd anymore. G.O.P. policies have been an absolute backbreaker for the middle class. (Forget the poor. Nobody talks about them anymore, not even the Democrats.) The G.O.P. has successfully engineered a wholesale redistribution of wealth to those already at the top of the income ladder and then, in a remarkable display of chutzpah, dared anyone to talk about class warfare.
A stark example of this unholy collaboration between the G.O.P. and the very wealthy was on display in the pages of this newspaper on Jan. 18. The Times’s Mike McIntire wrote an article about the first wave of federal bailout money for the financial industry, which was handed over by the Bush administration with hardly any strings attached. (Congress, under the control of the Democrats, should never have allowed this to happen, but the Democrats are as committed to fecklessness as the Republicans are to tax cuts.)
The public was told that the money would be used to loosen the frozen credit markets and thus help revive the economy. But as the article pointed out, there were bankers with other ideas. John C. Hope III, the chairman of the Whitney National Bank in New Orleans, in an address to Wall Street fat cats gathered at the Palm Beach Ritz-Carlton, said:
“Make more loans? We’re not going to change our business model or our credit policies to accommodate the needs of the public sector as they see it to have us make more loans.”
How’s that for arrogance and contempt for the public interest? Mr. Hope’s bank received $300 million in taxpayer bailout money.
The same article quoted Walter M. Pressey, president of Boston Private Wealth Management, which Mr. McIntire described as a healthy bank with a mostly affluent clientele. It received $154 million in taxpayer money.
“With that capital in hand,” said Mr. Pressey, “not only do we feel comfortable that we can ride out the recession, but we also feel that we’ll be in a position to take advantage of opportunities that present themselves once this recession is sorted out.”
Take advantage, indeed. That, in a nutshell, is what the plutocracy is all about: taking unfair advantage.
When the G.O.P. talks, nobody should listen. Republicans have argued, with the collaboration of much of the media, that they could radically cut taxes while simultaneously balancing the federal budget, when, in fact, big income-tax cuts inevitably lead to big budget deficits. We listened to the G.O.P. and what do we have now? A trillion-dollar-plus deficit and an economy in shambles.
This is the party that preached fiscal discipline and then cut taxes in time of war. This is the party that still wants to put the torch to Social Security and Medicare. This is a party that, given a choice between Abraham Lincoln and Ronald Reagan, would choose Ronald Reagan in a heartbeat.
Why is anyone still listening?
Monday, January 26, 2009
Krugman -- Bad Economics
Don't be fooled by bogus arguments against the stimulus plan of Obama. This article is very valuable:
http://www.nytimes.com/2009/01/26/opinion/26krugman.html?hp
http://www.nytimes.com/2009/01/26/opinion/26krugman.html?hp
Sunday, January 25, 2009
Tech Tips
Update your Microsoft patches now:
http://www.nytimes.com/2009/01/23/technology/internet/23worm.html?em
http://www.nytimes.com/2009/01/23/technology/internet/23worm.html?em
Rich -- No Time For Poetry
The following is brilliantly constructed and said:
Op-Ed Columnist
No Time for Poetry
comments (119)
new_york_times:http://www.nytimes.com/2009/01/25/opinion/25rich.html
if (acm.cc) acm.cc.write();
By FRANK RICH
Published: January 24, 2009
PRESIDENT Obama did not offer his patented poetry in his Inaugural Address. He did not add to his cache of quotations in Bartlett’s. He did not recreate J.F.K.’s inaugural, or Lincoln’s second, or F.D.R.’s first. The great orator was mainly at his best when taking shots at Bush and Cheney, who, in black hat and wheelchair, looked like the misbegotten spawn of the evil Mr. Potter in “It’s a Wonderful Life” and the Wicked Witch of the West.
Post a Comment »
Read All Comments (119) »
if (acm.rc) acm.rc.write();
Such was the judgment of many Washington drama critics. But there’s a reason that this speech was austere, not pretty. Form followed content. Obama wasn’t just rebuking the outgoing administration. He was delicately but unmistakably calling out the rest of us who went along for the ride as America swerved into the dangerous place we find ourselves now.
Feckless as it was for Bush to ask Americans to go shopping after 9/11, we all too enthusiastically followed his lead, whether we were wealthy, working-class or in between. We spent a decade feasting on easy money, don’t-pay-as-you-go consumerism and a metastasizing celebrity culture. We did so while a supposedly cost-free, off-the-books war, usually out of sight and out of mind, helped break the bank along with our nation’s spirit and reputation.
We can’t keep blaming 43 for everything, especially now that we don’t have him to kick around anymore. On Tuesday the new president pointedly widened his indictment beyond the sins of his predecessor. He spoke of those at the economic pinnacle who embraced greed and irresponsibility as well as the rest of us who collaborated in our “collective failure to make hard choices.” He branded as sub-American those who “prefer leisure over work or seek only the pleasures of riches and fame.” And he wasn’t just asking Paris Hilton “to set aside childish things.” As Linda Hirshman astutely pointed out on The New Republic’s Web site, even Obama’s opening salutation — “My fellow citizens,” not “fellow Americans” — invoked the civic responsibilities we’ve misplaced en masse.
These themes are not new for Obama. They were there back on Feb. 10, 2007, when, on another frigid day, he announced his presidential candidacy in Springfield, Ill. Citing “our mounting debts” and “hard choices,” he talked of how “each of us, in our own lives, will have to accept responsibility” and “some measure of sacrifice.” His campaign, he said then, “has to be about reclaiming the meaning of citizenship.” But the press, convinced that Obama was a sideshow to the inevitable Clinton-Giuliani presidential standoff, didn’t parse his words all that carefully, and neither did a public still maxing out on its gluttonous holiday from economic history. However inadvertently, Time magazine had captured the self-indulgent tenor of the times when, weeks earlier, it slapped some reflective Mylar on its cover and declared that the 2006 Person of the Year was “You.”
It was in keeping with the unhinged spirit of the boom that three days after Obama’s Springfield declaration, a Wall Street baron, Steven Schwarzman of the Blackstone Group, a private equity and hedge fund, celebrated his 60th birthday with some 350 guests in the vast Seventh Regiment Armory on Manhattan’s East Side. To appreciate the degree of ostentation and taste, you need only know that Rod Stewart was the headliner, at an estimated cost of $1 million.
That same week the National Association of Realtors told less well-heeled Americans not to fret about its report that median home prices had fallen in 73 metro areas during the final quarter of 2006. “The bottom appears to have already occurred,” said one of the N.A.R. economists. Another predicted: “When we get the figures for this spring, I expect to see a discernible improvement in both sales and prices.”
We have discerned what happened to those sales and prices ever since. As for the Blackstone Group, it went public four months after its leader’s 60th birthday revels. Its shares have since lost 85 percent of their value, and Schwarzman’s bash has become a well-worn symbol of our deflated Gilded Age.
Yet the values of the bubble remain entrenched even as Obama takes office. In the upper echelons, we can find fresh examples of greed and irresponsibility daily even without dipping into the growing pool of those money “managers” who spirited victims to Bernie Madoff.
Last week’s object lesson was John Thain, the chief executive of Merrill Lynch. He was lionized as a rare Wall Street savior as recently as September, when he helped seal the deal that sped his teetering firm into the safe embrace of Bank of America on the same weekend Lehman Brothers died. Since then we’ve learned that even as he was laying off Merrill employees by the thousands, he was lobbying (unsuccessfully) for a personal bonus as high as $30 million and spending $1.22 million of company cash on refurbishing his office, an instantly notorious $1,405 trashcan included.
Thain resigned on Thursday. Only then did we learn that he doled out billions in secret, last-minute bonuses to his staff last month, just before Bank of America took over and just before the government ponied up a second bailout to cover Merrill’s unexpected $15 billion fourth-quarter loss. So far American taxpayers have spent $45 billion on this mess, and that’s only our down payment.
In less lofty precincts of the American economic spectrum, the numbers may be different but the ethos has often been similar. As Wall Street titans grabbed bonuses based on illusory, short-term paper profits, so regular Americans took on all kinds of debt wildly disproportionate to their assets and income. The nearly $1 trillion in unpaid credit-card balances is now on deck to be the next big crash.
This debt-ridden national binge of greed and irresponsibility washed over our culture not just through the Marie Antoinette antics of a Schwarzman and a Thain but in mass forms of conspicuous consumption and entertainment. Cable networks like Bravo, A&E, TLC and HGTV produced an avalanche of creepy programming catering to the decade’s housing bubble alone — an orgiastic genre that might be called Subprime Pornography. Some of the series — “Flip This House,” “Flip That House,” “Sell This House,” “My House Is Worth What?” — still play on even as more and more house owners are being flipped into destitute homelessness.
The austerity of Obama’s Inaugural Address seemed a tonal corrective to the glitz and the glut. The speech was, as my friend Jack Viertel, a theater producer, put it, “stoic, stern, crafted in slabs of granite, a slimmed-down sinewy thing entirely evolved away from the kind of Pre-Raphaelite style of his earlier oration.” Some of the same critics who once accused Obama of sounding too much like a wimpy purveyor of Kumbaya now faulted him for not rebooting those golden oldies of the campaign trail as he took his oath. But he is no longer campaigning, and the moment for stadium cheers has passed.
If we’ve learned anything since the election, it is this: We have not remotely seen the bottom of this economy, and no one has a silver bullet to arrest the plunge, the hyped brains in the new White House included. Most economists failed to anticipate the disaster, after all, and our tax-challenged incoming Treasury Secretary may prove as evanescent as past saviors du jour. As we applauded Thain in September, we were also desperately trying to convince ourselves that Warren Buffett’s $5 billion investment in Goldman Sachs would turn the tide, and that Hank Paulson, as Newsweek wrote in a cover story titled “King Henry,” would be the “right man at the right time.”
Obama couldn’t give us F.D.R.’s first inaugural address because we are not yet where America was in 1933 — in its fourth year of downturn after the crash of ’29, with an unemployment rate of 25 percent. But no one knows for sure that we cannot end up there.
On Tuesday, our new president did offer one subtle whiff of the Great Depression. His injunction that “we must pick ourselves up, dust ourselves off” was a paraphrase of the great songwriter Dorothy Fields, who wrote that lyric for “Swing Time” (1936), arguably the best of the escapist musicals Hollywood churned out to lift the nation’s spirits in hard times. But Obama yoked that light-hearted evocation of Astaire and Rogers to a call for sacrifice that was deliberately somber, not radiantly Kennedyesque.
That call included the obligatory salutes to those who serve by parenting, firefighting or helping strangers when natural disaster strikes. But he also cited one less generic example: “workers who would rather cut their hours than see a friend lose their job.” There will be — there must be — far larger sacrifices in that vein yet to come. No one truly listening to the Inaugural Address could doubt that this former community organizer intends to demand plenty from us as we face down what he calls “raging storms.”
Last weekend, Bob Woodward wrote an article for The Washington Post listing all the lessons the new president can learn from his predecessor’s many blunders. But what have we learned from our huge mistakes during the Bush years? While it’s become a Beltway cliché that America’s new young president has yet to be tested, it is past time for us to realize that our own test is also about to begin.
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Frank Rich: No Time for Poetry
Bob Herbert: More Than Charisma
Op-Ed Columnist
No Time for Poetry
comments (119)
new_york_times:http://www.nytimes.com/2009/01/25/opinion/25rich.html
if (acm.cc) acm.cc.write();
By FRANK RICH
Published: January 24, 2009
PRESIDENT Obama did not offer his patented poetry in his Inaugural Address. He did not add to his cache of quotations in Bartlett’s. He did not recreate J.F.K.’s inaugural, or Lincoln’s second, or F.D.R.’s first. The great orator was mainly at his best when taking shots at Bush and Cheney, who, in black hat and wheelchair, looked like the misbegotten spawn of the evil Mr. Potter in “It’s a Wonderful Life” and the Wicked Witch of the West.
Post a Comment »
Read All Comments (119) »
if (acm.rc) acm.rc.write();
Such was the judgment of many Washington drama critics. But there’s a reason that this speech was austere, not pretty. Form followed content. Obama wasn’t just rebuking the outgoing administration. He was delicately but unmistakably calling out the rest of us who went along for the ride as America swerved into the dangerous place we find ourselves now.
Feckless as it was for Bush to ask Americans to go shopping after 9/11, we all too enthusiastically followed his lead, whether we were wealthy, working-class or in between. We spent a decade feasting on easy money, don’t-pay-as-you-go consumerism and a metastasizing celebrity culture. We did so while a supposedly cost-free, off-the-books war, usually out of sight and out of mind, helped break the bank along with our nation’s spirit and reputation.
We can’t keep blaming 43 for everything, especially now that we don’t have him to kick around anymore. On Tuesday the new president pointedly widened his indictment beyond the sins of his predecessor. He spoke of those at the economic pinnacle who embraced greed and irresponsibility as well as the rest of us who collaborated in our “collective failure to make hard choices.” He branded as sub-American those who “prefer leisure over work or seek only the pleasures of riches and fame.” And he wasn’t just asking Paris Hilton “to set aside childish things.” As Linda Hirshman astutely pointed out on The New Republic’s Web site, even Obama’s opening salutation — “My fellow citizens,” not “fellow Americans” — invoked the civic responsibilities we’ve misplaced en masse.
These themes are not new for Obama. They were there back on Feb. 10, 2007, when, on another frigid day, he announced his presidential candidacy in Springfield, Ill. Citing “our mounting debts” and “hard choices,” he talked of how “each of us, in our own lives, will have to accept responsibility” and “some measure of sacrifice.” His campaign, he said then, “has to be about reclaiming the meaning of citizenship.” But the press, convinced that Obama was a sideshow to the inevitable Clinton-Giuliani presidential standoff, didn’t parse his words all that carefully, and neither did a public still maxing out on its gluttonous holiday from economic history. However inadvertently, Time magazine had captured the self-indulgent tenor of the times when, weeks earlier, it slapped some reflective Mylar on its cover and declared that the 2006 Person of the Year was “You.”
It was in keeping with the unhinged spirit of the boom that three days after Obama’s Springfield declaration, a Wall Street baron, Steven Schwarzman of the Blackstone Group, a private equity and hedge fund, celebrated his 60th birthday with some 350 guests in the vast Seventh Regiment Armory on Manhattan’s East Side. To appreciate the degree of ostentation and taste, you need only know that Rod Stewart was the headliner, at an estimated cost of $1 million.
That same week the National Association of Realtors told less well-heeled Americans not to fret about its report that median home prices had fallen in 73 metro areas during the final quarter of 2006. “The bottom appears to have already occurred,” said one of the N.A.R. economists. Another predicted: “When we get the figures for this spring, I expect to see a discernible improvement in both sales and prices.”
We have discerned what happened to those sales and prices ever since. As for the Blackstone Group, it went public four months after its leader’s 60th birthday revels. Its shares have since lost 85 percent of their value, and Schwarzman’s bash has become a well-worn symbol of our deflated Gilded Age.
Yet the values of the bubble remain entrenched even as Obama takes office. In the upper echelons, we can find fresh examples of greed and irresponsibility daily even without dipping into the growing pool of those money “managers” who spirited victims to Bernie Madoff.
Last week’s object lesson was John Thain, the chief executive of Merrill Lynch. He was lionized as a rare Wall Street savior as recently as September, when he helped seal the deal that sped his teetering firm into the safe embrace of Bank of America on the same weekend Lehman Brothers died. Since then we’ve learned that even as he was laying off Merrill employees by the thousands, he was lobbying (unsuccessfully) for a personal bonus as high as $30 million and spending $1.22 million of company cash on refurbishing his office, an instantly notorious $1,405 trashcan included.
Thain resigned on Thursday. Only then did we learn that he doled out billions in secret, last-minute bonuses to his staff last month, just before Bank of America took over and just before the government ponied up a second bailout to cover Merrill’s unexpected $15 billion fourth-quarter loss. So far American taxpayers have spent $45 billion on this mess, and that’s only our down payment.
In less lofty precincts of the American economic spectrum, the numbers may be different but the ethos has often been similar. As Wall Street titans grabbed bonuses based on illusory, short-term paper profits, so regular Americans took on all kinds of debt wildly disproportionate to their assets and income. The nearly $1 trillion in unpaid credit-card balances is now on deck to be the next big crash.
This debt-ridden national binge of greed and irresponsibility washed over our culture not just through the Marie Antoinette antics of a Schwarzman and a Thain but in mass forms of conspicuous consumption and entertainment. Cable networks like Bravo, A&E, TLC and HGTV produced an avalanche of creepy programming catering to the decade’s housing bubble alone — an orgiastic genre that might be called Subprime Pornography. Some of the series — “Flip This House,” “Flip That House,” “Sell This House,” “My House Is Worth What?” — still play on even as more and more house owners are being flipped into destitute homelessness.
The austerity of Obama’s Inaugural Address seemed a tonal corrective to the glitz and the glut. The speech was, as my friend Jack Viertel, a theater producer, put it, “stoic, stern, crafted in slabs of granite, a slimmed-down sinewy thing entirely evolved away from the kind of Pre-Raphaelite style of his earlier oration.” Some of the same critics who once accused Obama of sounding too much like a wimpy purveyor of Kumbaya now faulted him for not rebooting those golden oldies of the campaign trail as he took his oath. But he is no longer campaigning, and the moment for stadium cheers has passed.
If we’ve learned anything since the election, it is this: We have not remotely seen the bottom of this economy, and no one has a silver bullet to arrest the plunge, the hyped brains in the new White House included. Most economists failed to anticipate the disaster, after all, and our tax-challenged incoming Treasury Secretary may prove as evanescent as past saviors du jour. As we applauded Thain in September, we were also desperately trying to convince ourselves that Warren Buffett’s $5 billion investment in Goldman Sachs would turn the tide, and that Hank Paulson, as Newsweek wrote in a cover story titled “King Henry,” would be the “right man at the right time.”
Obama couldn’t give us F.D.R.’s first inaugural address because we are not yet where America was in 1933 — in its fourth year of downturn after the crash of ’29, with an unemployment rate of 25 percent. But no one knows for sure that we cannot end up there.
On Tuesday, our new president did offer one subtle whiff of the Great Depression. His injunction that “we must pick ourselves up, dust ourselves off” was a paraphrase of the great songwriter Dorothy Fields, who wrote that lyric for “Swing Time” (1936), arguably the best of the escapist musicals Hollywood churned out to lift the nation’s spirits in hard times. But Obama yoked that light-hearted evocation of Astaire and Rogers to a call for sacrifice that was deliberately somber, not radiantly Kennedyesque.
That call included the obligatory salutes to those who serve by parenting, firefighting or helping strangers when natural disaster strikes. But he also cited one less generic example: “workers who would rather cut their hours than see a friend lose their job.” There will be — there must be — far larger sacrifices in that vein yet to come. No one truly listening to the Inaugural Address could doubt that this former community organizer intends to demand plenty from us as we face down what he calls “raging storms.”
Last weekend, Bob Woodward wrote an article for The Washington Post listing all the lessons the new president can learn from his predecessor’s many blunders. But what have we learned from our huge mistakes during the Bush years? While it’s become a Beltway cliché that America’s new young president has yet to be tested, it is past time for us to realize that our own test is also about to begin.
MOST POPULAR
E-Mailed
Blogged
Searched
No Snickering: That Road Sign Means Something Else
What Do Women Want?
Coffee Linked to Lower Dementia Risk
36 Hours in Carmel-by-the-Sea
Worm Infects Millions of Computers Worldwide
Frank Rich: No Time for Poetry
Bob Herbert: More Than Charisma
Taking Off to Zero HDD Climate
The "dead of winter" is over Monday night. That's when 36 HDD (Cincinnati) notches down (to 35) for the first time, heading to zero this spring. We're going to accelerate this Tuesday afternoon for three weeks by visiting Genny in Manila, where it is now 79 degrees. And humid.
By the time we return on February 16, I expect the Obama administration to have done a lot, and I mean it.
By the time we return on February 16, I expect the Obama administration to have done a lot, and I mean it.
Three Worthy Financial Articles This Morning
Morgenson has two excellent pieces today, one fresh in the New York Times, on exactly what the elephant in the room is and ideas on how to nurse it to health. The first gleam of hope I think. But it will take some time.
http://www.nytimes.com/2009/01/25/business/25gret.html
The other Morgenson article "fresh" in the Cincinnati Enquirer from the syndicated file of a few days ago (missed it somehow in my daily reading of the NYT):
http://www.nytimes.com/2009/01/18/business/18gret.html?scp=3&sq=morgenson%20banking&st=cse
And then a tour-de-force on Bernie Madoff. This one also points out the great, great falacy of deregulation.
"The Talented Mr. Madoff"
http://www.nytimes.com/2009/01/25/business/25bernie.html?_r=1&8dpc
http://www.nytimes.com/2009/01/25/business/25gret.html
The other Morgenson article "fresh" in the Cincinnati Enquirer from the syndicated file of a few days ago (missed it somehow in my daily reading of the NYT):
http://www.nytimes.com/2009/01/18/business/18gret.html?scp=3&sq=morgenson%20banking&st=cse
And then a tour-de-force on Bernie Madoff. This one also points out the great, great falacy of deregulation.
"The Talented Mr. Madoff"
http://www.nytimes.com/2009/01/25/business/25bernie.html?_r=1&8dpc
Saturday, January 24, 2009
Birds -- Heavy Lifting Required
A nice piece for a "dead-of-winter" Saturday:
http://www.nytimes.com/2009/01/25/nyregion/long-island/25Rhome.html
http://www.nytimes.com/2009/01/25/nyregion/long-island/25Rhome.html
Friday, January 23, 2009
Some Excellent and Clear Thinking on the Collapse
Haven't finished reading but so far very, very good:
http://roomfordebate.blogs.nytimes.com/2009/01/22/nationalizing-the-bank-problem/
http://roomfordebate.blogs.nytimes.com/2009/01/22/nationalizing-the-bank-problem/
Krugman -- Stuck in the Muddle
Krugman didn't like the inauguration speech because of its lack of focus regarding the crisis, and neither did I. It's not all of us who are at fault, it's the select few of Wall Street, and let's quote Keynes until the cows come home because he was right and Friedman (not Tom) was wrong, but whatever...
http://www.nytimes.com/2009/01/23/opinion/23krugman.html
Schwab
I opened a Schwab account last night, the first time since I actively, actively traded (oh, say 1987 through 1999 or so, and, no, I didn't fall prey to the Dot-Com Bubble) and then gave it up as futile. Why did I open an account up? I was accumulating too much money in my left pocket. Although US Bank is my bank and is beyond reproach WE THINK, and all deposits are guaranteed by the US Government, it is time to "diversify."
Which leads to the $5,000 minimum to buy and sell options. But why would I do that (buy and sell options)? My long-time experience is that the options are always priced too high to make a profit in the long run. Still, I covered the minimum.
The real issue is that it is now time for us to take command of ourselves and not rely on investment advisors and others.
Along those lines this week's New Yorker has a long, valuable piece on Dmitry Orlov, a 46-year-old software engineer from Leningrad, who has written a book Reinventing Collapse: The Soviet Example and American Prospects.
Which leads to the $5,000 minimum to buy and sell options. But why would I do that (buy and sell options)? My long-time experience is that the options are always priced too high to make a profit in the long run. Still, I covered the minimum.
The real issue is that it is now time for us to take command of ourselves and not rely on investment advisors and others.
Along those lines this week's New Yorker has a long, valuable piece on Dmitry Orlov, a 46-year-old software engineer from Leningrad, who has written a book Reinventing Collapse: The Soviet Example and American Prospects.
"When faced with a collapsing economy, one should stop thinking of wealth in terms of money."
Think bluejeans, vodka, home gardens, boats rather than trucks (to deliver goods).
Thursday, January 22, 2009
Oaf of Office
The slip-up on the 35-word oath of office. Pretty good:
http://www.nytimes.com/2009/01/22/opinion/22pinker.html?_r=1&hp
http://www.nytimes.com/2009/01/22/opinion/22pinker.html?_r=1&hp
Tuesday, January 20, 2009
Text
"Nor is the question before us whether the market is a force for good or ill. Its power to generate wealth and expand freedom is unmatched, but this crisis has reminded us that without a watchful eye, the market can spin out of control - and that a nation cannot prosper long when it favors only the prosperous. The success of our economy has always depended not just on the size of our Gross Domestic Product, but on the reach of our prosperity; on our ability to extend opportunity to every willing heart - not out of charity, but because it is the surest route to our common good."
Text
My fellow citizens:
I stand here today humbled by the task before us, grateful for the trust you have bestowed, mindful of the sacrifices borne by our ancestors. I thank President Bush for his service to our nation, as well as the generosity and cooperation he has shown throughout this transition.
Forty-four Americans have now taken the presidential oath. The words have been spoken during rising tides of prosperity and the still waters of peace. Yet, every so often the oath is taken amidst gathering clouds and raging storms. At these moments, America has carried on not simply because of the skill or vision of those in high office, but because We the People have remained faithful to the ideals of our forbearers, and true to our founding documents.
So it has been. So it must be with this generation of Americans.
That we are in the midst of crisis is now well understood. Our nation is at war, against a far-reaching network of violence and hatred. Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age. Homes have been lost; jobs shed; businesses shuttered. Our health care is too costly; our schools fail too many; and each day brings further evidence that the ways we use energy strengthen our adversaries and threaten our planet.
These are the indicators of crisis, subject to data and statistics. Less measurable but no less profound is a sapping of confidence across our land - a nagging fear that America’s decline is inevitable, and that the next generation must lower its sights.
Today I say to you that the challenges we face are real. They are serious and they are many. They will not be met easily or in a short span of time. But know this, America - they will be met.
On this day, we gather because we have chosen hope over fear, unity of purpose over conflict and discord.
On this day, we come to proclaim an end to the petty grievances and false promises, the recriminations and worn out dogmas, that for far too long have strangled our politics.
We remain a young nation, but in the words of Scripture, the time has come to set aside childish things. The time has come to reaffirm our enduring spirit; to choose our better history; to carry forward that precious gift, that noble idea, passed on from generation to generation: the God-given promise that all are equal, all are free, and all deserve a chance to pursue their full measure of happiness.
In reaffirming the greatness of our nation, we understand that greatness is never a given. It must be earned. Our journey has never been one of short-cuts or settling for less. It has not been the path for the faint-hearted - for those who prefer leisure over work, or seek only the pleasures of riches and fame. Rather, it has been the risk-takers, the doers, the makers of things - some celebrated but more often men and women obscure in their labor, who have carried us up the long, rugged path towards prosperity and freedom.
For us, they packed up their few worldly possessions and traveled across oceans in search of a new life.
For us, they toiled in sweatshops and settled the West; endured the lash of the whip and plowed the hard earth.
For us, they fought and died, in places like Concord and Gettysburg; Normandy and Khe Sanh.
Time and again these men and women struggled and sacrificed and worked till their hands were raw so that we might live a better life. They saw America as bigger than the sum of our individual ambitions; greater than all the differences of birth or wealth or faction.
This is the journey we continue today. We remain the most prosperous, powerful nation on Earth. Our workers are no less productive than when this crisis began. Our minds are no less inventive, our goods and services no less needed than they were last week or last month or last year. Our capacity remains undiminished. But our time of standing pat, of protecting narrow interests and putting off unpleasant decisions - that time has surely passed. Starting today, we must pick ourselves up, dust ourselves off, and begin again the work of remaking America.
(more to come)
http://www.nytimes.com/2009/01/20/us/politics/20text-obama.html
I stand here today humbled by the task before us, grateful for the trust you have bestowed, mindful of the sacrifices borne by our ancestors. I thank President Bush for his service to our nation, as well as the generosity and cooperation he has shown throughout this transition.
Forty-four Americans have now taken the presidential oath. The words have been spoken during rising tides of prosperity and the still waters of peace. Yet, every so often the oath is taken amidst gathering clouds and raging storms. At these moments, America has carried on not simply because of the skill or vision of those in high office, but because We the People have remained faithful to the ideals of our forbearers, and true to our founding documents.
So it has been. So it must be with this generation of Americans.
That we are in the midst of crisis is now well understood. Our nation is at war, against a far-reaching network of violence and hatred. Our economy is badly weakened, a consequence of greed and irresponsibility on the part of some, but also our collective failure to make hard choices and prepare the nation for a new age. Homes have been lost; jobs shed; businesses shuttered. Our health care is too costly; our schools fail too many; and each day brings further evidence that the ways we use energy strengthen our adversaries and threaten our planet.
These are the indicators of crisis, subject to data and statistics. Less measurable but no less profound is a sapping of confidence across our land - a nagging fear that America’s decline is inevitable, and that the next generation must lower its sights.
Today I say to you that the challenges we face are real. They are serious and they are many. They will not be met easily or in a short span of time. But know this, America - they will be met.
On this day, we gather because we have chosen hope over fear, unity of purpose over conflict and discord.
On this day, we come to proclaim an end to the petty grievances and false promises, the recriminations and worn out dogmas, that for far too long have strangled our politics.
We remain a young nation, but in the words of Scripture, the time has come to set aside childish things. The time has come to reaffirm our enduring spirit; to choose our better history; to carry forward that precious gift, that noble idea, passed on from generation to generation: the God-given promise that all are equal, all are free, and all deserve a chance to pursue their full measure of happiness.
In reaffirming the greatness of our nation, we understand that greatness is never a given. It must be earned. Our journey has never been one of short-cuts or settling for less. It has not been the path for the faint-hearted - for those who prefer leisure over work, or seek only the pleasures of riches and fame. Rather, it has been the risk-takers, the doers, the makers of things - some celebrated but more often men and women obscure in their labor, who have carried us up the long, rugged path towards prosperity and freedom.
For us, they packed up their few worldly possessions and traveled across oceans in search of a new life.
For us, they toiled in sweatshops and settled the West; endured the lash of the whip and plowed the hard earth.
For us, they fought and died, in places like Concord and Gettysburg; Normandy and Khe Sanh.
Time and again these men and women struggled and sacrificed and worked till their hands were raw so that we might live a better life. They saw America as bigger than the sum of our individual ambitions; greater than all the differences of birth or wealth or faction.
This is the journey we continue today. We remain the most prosperous, powerful nation on Earth. Our workers are no less productive than when this crisis began. Our minds are no less inventive, our goods and services no less needed than they were last week or last month or last year. Our capacity remains undiminished. But our time of standing pat, of protecting narrow interests and putting off unpleasant decisions - that time has surely passed. Starting today, we must pick ourselves up, dust ourselves off, and begin again the work of remaking America.
(more to come)
http://www.nytimes.com/2009/01/20/us/politics/20text-obama.html
The Gound Has Shifted!
"What the cynics fail to understand is that the ground has shifted beneath them — that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works - whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified."
"It is not just 'What works,' It's 'what works' within our moral system."
"What the cynics fail to understand is that the ground has shifted beneath them - that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works - whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified. Where the answer is yes, we intend to move forward. Where the answer is no, programs will end. And those of us who manage the public's dollars will be held to account - to spend wisely, reform bad habits, and do our business in the light of day - because only then can we restore the vital trust between a people and their government."
"It is not just 'What works,' It's 'what works' within our moral system."
"What the cynics fail to understand is that the ground has shifted beneath them - that the stale political arguments that have consumed us for so long no longer apply. The question we ask today is not whether our government is too big or too small, but whether it works - whether it helps families find jobs at a decent wage, care they can afford, a retirement that is dignified. Where the answer is yes, we intend to move forward. Where the answer is no, programs will end. And those of us who manage the public's dollars will be held to account - to spend wisely, reform bad habits, and do our business in the light of day - because only then can we restore the vital trust between a people and their government."
Sure-Fire Investment Goes Sour -- Bank Sues Deutche Bank
Lots of lawsuits, banks vs. investment bankers, dupes vs. the dupers:
http://www.nytimes.com/2009/01/20/business/20gem.html?_r=1&ref=business
http://www.nytimes.com/2009/01/20/business/20gem.html?_r=1&ref=business
Monday, January 19, 2009
Kristol -- Always Worth Reading
As always I hold my nose when reading him, but...
http://www.nytimes.com/2009/01/19/opinion/19kristol.html
http://www.nytimes.com/2009/01/19/opinion/19kristol.html
The Question That I Have
Are our government financial bailouts reducing the toxic assets while creating more of them?
Sunday, January 18, 2009
Tech Tips -- Cloud Computing in New York Times Article Today
This article is good and I downloaded Syncplicity and started saving. Trouble is, it really slows down your computer, so I uninstalled it and I'm back to good speed.
http://www.nytimes.com/2009/01/18/business/18novel.html?_r=1&scp=1&sq=cloud%20computing&st=cse
http://www.nytimes.com/2009/01/18/business/18novel.html?_r=1&scp=1&sq=cloud%20computing&st=cse
Just Testing With This Incomprehensible Tax Memorandum
Do I understand any of this? No. Imagine spending your life as an accountant in this area!
Comment: Cracks in the façade –
risk management transactions of hedge fund managers
Selva Ozelli, an international tax attorney, certified public accountant and
international tax editor with the Thomson Reuters Corporation in New York,
examines the tax consequences of structured mortgage-backed assets held by
foreign hedge funds.
The healthy facade of the US economy began cracking during the summer of 2007,
when the deterioration in the US housing market rendered the valuations of
securitised or structured mortgage-backed assets volatile. These assets had been
valued dramatically bullish on inflated marks and misrepresented credit grades by
brokers who earned substantial commissions by pushing the more than 600 different
types of MBS onto hedge fund managers through repos1 that were leveraged without
regulatory bounds.
The resulting contracting demand for MBSs precipitated the tightening of unsecured
term funding, leading to credit downgrades2 and massive write-downs of MBS assets
by financial institutions according to mark-to-market accounting rules and illiquidity.
Losses mounted from forced liquidation of MBSs at low valuations triggered by
redemption notices from hedge fund investors (some got out ahead of other investors
based on side-letter agreements with preferential redemption terms) and margin calls
from brokers trying to make up for the difference in the value of securities used as
collateral on repos. The result was that most prominent veteran hedge funds were
financially wounded and two of Bear Stearns’s funds were bankrupted.
Many hedge fund managers were caught unprepared when the credit crisis hit during
the summer of 2007. Only a few had short positions in credit derivatives that they
initiated two years earlier, when these contracts were priced low, to profit from the
deterioration in MBS values.3 Some hedge fund managers transferred their poorly
performing, illiquid MBS assets to side-pockets and valued them separately from the
remainder of the fund’s portfolio to immunise the fund’s net asset value calculation
from the performance of these hard-to-value assets, effectively freezing the illiquid,
MBS-affected portion of the hedge fund’s portfolio to avoid writing these investments
down or selling them at a large loss.4
Other hedge fund managers who were not as astute (or not willing to absorb the
losses on their risky, long, leveraged positions in MBS assets sitting in funds they
managed) transferred their risky MBS assets – valued favourably with the help of
their administrators, who were compensated based on a fee set as a percentage of
the fund’s performance5 – not to a side-pocket, but to another fund, the MBS Loss
Fund (MBSLF), and then floated the MBSLF publicly in stock exchanges in foreign
jurisdictions (Transaction I).
Next, in a move straight out of the 2003 mutual fund scandal, in anticipation of the
deterioration in overvalued MBS assets in MBSLF’s portfolio, hedge fund managers
purchased basket index credit swaps – a contract that simulated the credit of the
MBSLF’s portfolio holdings from a US broker dealer - that were constructed based on
the hedge fund manager’s non-publicly available knowledge of MBSLF’s MBS
portfolio holdings (credit swap)6 held between two affiliated funds of the hedge fund
manager, with MBSLF holding the risk side of the swap (Transaction II).
The credit crisis, which highlighted the various credit risk management techniques of
hedge fund managers, struck a milestone in February 2008 when the MBS yield
premiums widened to levels not seen in 15 years, bankrupting many hedge funds,
including the prestigious USD22bn Carlyle Capital Corporation, a Dutch-listed,
Guernsey-based MBS hedge fund, that was advised by the Carlyle Group, one of the
world’s largest private investment firms, which had a 15 percent interest in CCC.7
The Carlyle Group first floated CCC’s shares at USD19 per share on the Euronext
Amsterdam stock exchange in July 2007. The share price fell sharply to USD0.43 per
share by the middle of March this year when CCC defaulted on nearly USD17bn of
debt (borrowed from financial institutions including Bear Stearns, which also
succumbed to the credit crisis because of excessive exposure to MBS assets and
financing).8
Anticipating that CCC and Bear Stearns will not be the last victims of the credit crisis
despite the Federal Reserve Bank’s easing of interest rates9 and offering favourable
credit lines to financial institutions, the Securities and Exchange Commission and the
Department of Justice, in partnership with the FBI and the IRS Criminal Investigation
Division, have announced investigations of the USD2trn hedge fund industry for
misvaluation of MBS assets, illicit transfers of capital by hedge fund managers
between onshore and offshore funds, and inappropriately billed expenses to hedge
funds.10
The credit-crisis-induced risk management transactions of hedge fund managers
may also have unintended US tax consequences to the hedge fund, its investors,
and its managers as outlined below.
I. The credit crisis
A. US tax implications to a foreign hedge fund
Depending on the locale and based on regulatory, tax, and investor considerations,
foreign hedge funds are structured as limited liability partnerships, limited liability
companies, unit investment trusts, corporations, insurance companies, or masterfeeder
funds that use a combination of offshore master partnerships with onshore
and offshore feeder funds. Foreign hedge funds that trade in the US financial
markets avoid US taxation on their trading income by relying on a trading safe
harbour,11 which renders the hedge fund manager’s act of trading in securities –
which includes an MBS12 as well as a credit derivative13 – for his or her own account
in the secondary market not effectively connected income with a US trade or
business.14
Foreign hedge funds nevertheless remain subject to withholding taxes15 on their USsource
fixed or determinable annual or periodic income16 except for interest under
the portfolio interest exemption,17 which doesn’t apply when the foreign lender is a
controlled foreign corporation and the US borrower is a related person.18
1. Foreign hedge fund may be deemed a dealer
During the credit crisis, hedge fund managers – whose financial interests are aligned
with their hedge fund investors as far as being averse to MBS asset loss absorption
since they keep substantial assets of their own in a fund and earn most of their
compensation from incentive fees set as a percentage of a fund’s performance – may
have entered into affiliated account trades between their US and foreign hedge
funds, since funds established in the US or sold to US investors are prohibited from
manipulating or otherwise misrepresenting the fund’s NAV under the antifraud
provisions of the federal securities laws.
Accordingly, hedge fund managers who manage several onshore hedge funds,
foreign hedge funds, investment accounts, or MBSLFs may have bought or sold
illiquid MBS’s as described in Transaction I above or entered into credit swap
transactions between affiliated funds as described in Transaction II above.
These types of risk management transactions initiated by a hedge fund manager
among its affiliated offshore and US funds or accounts, based on all facts and
circumstances,19 may deem the hedge fund manager a dealer subject to the mark-tomarket
accounting rules.20 A non-resident alien individual or a foreign corporation is
considered to be engaged in a US trade or business if the partnership of which the
non-resident alien or foreign corporation is a member is so engaged by virtue of the
foreign partner’s interest in the partnership, through the partnership’s fixed place of
business in the US.
Any member of a partnership, limited partners, general partners,21 or offshore
corporate feeders22 that is deemed a dealer in stocks or securities, either in the US or
abroad, is barred from relying on the trading safe harbour, and will be subject to net
basis taxation in the US on ECI from a US trade or business23 including three
categories of foreign source income or loss or their economic equivalents, which
include interest and dividend equivalents when the taxpayer has an office or other
fixed place of business within the US.24
While all US-source income may be treated as ECI with a US trade or business,25
only some foreign source income is so treated, and tax treaties may reduce the US
tax on that foreign source income. Deductions attributable to ECI are allowed in
computing the net amount subject to tax26 with interest expense attributable to ECI
with a US trade or business being determined under special rules.27
When a foreign hedge fund is deemed a dealer that is engaged in a US trade or
business, the other US tax consequences that should be considered are:
a. The mark-to-market accounting’s effect on illiquid MBS assets and credit swaps. If
the foreign hedge fund is deemed a dealer, but has a valid mark-to-market election
already in effect28 (most hedge funds make a mark-to-market election), it should be
able to exclude an illiquid MBS asset transferred to a side-pocket from mark-tomarket
accounting provided that the security is “clearly identified” as such.29
A side-pocket can be viewed as a separate sub-fund within the hedge fund that
immunises the remainder of the fund’s portfolio from the poor performance of the
assets held in the side-pocket. When an illiquid MBS asset is transferred to a foreign
hedge fund’s side-pocket – either at cost or valued at the time of transfer with the
help of committees, appraisers, fund administrators, investment bankers, or brokers
– the fund investors at the time of the transfer are deemed to own their proportionate
interest in that investment and later investors in the fund are not. Redeeming
investors retain their proportionate interests in the side-pocket’s investments until
they are sold or otherwise transferred out of the side-pocket.
While the use of side-pockets artificially enhances a foreign hedge fund’s NAV,
boosting the fund’s performance record and the incentive fees paid to the hedge fund
manager, if a taxpayer fails to clearly identify the illiquid MBS asset transferred to a
side-pocket, it will have to mark the illiquid MBS asset to market, write the relevant
investment down, and report the resulting loss as ordinary. The mark-to-market
accounting treatment will also apply to any notional principal contract (NPC) or any
derivative security30 transferred to a foreign hedge fund’s side-pocket since the
‘clearly identify’ exemption is inapplicable to any NPC or derivative security that is
held by a dealer in those securities.31
b. The withholding tax considerations of a foreign hedge fund deemed a dealer
engaged in a US trade or business. If a foreign hedge fund is deemed a dealer that is
engaged in a US trade or business, any outbound interest payments (including
original issue discount)32 relating to an MBS asset that would otherwise be exempt
from the 30 percent withholding tax based on the portfolio interest exemption, or
outbound credit swap payment that would not otherwise be subject to withholding
tax, since these payments are sourced to the residence of the recipient if the hedge
fund has no US office,33 will be treated as US-source ECI, subject to net basis
taxation.34
c. The deductibility of a foreign hedge fund’s fees and expenses against its ECI from
a US trade or business. If a foreign hedge fund is deemed engaged in a US trade or
business, it is normally allowed deductions only if and to the extent that the fees and
expenses are ECI with the conduct of a US trade or business. The allowable
deductions under IRC 873(a) and IRC 882(c) are determined based on the
taxpayer’s status as a partnership, trust, or corporation, the character and source of
its expenses determined under the regs or tax treaty provisions, the reasonableness
of the hedge fund manager’s compensation expenses, as well as the accounting
method adopted by the taxpayer.
While a detailed discussion of the deductibility of expenses of a foreign hedge fund
that is engaged in a US trade or business is beyond the scope of this article,35 foreign
hedge funds are not regulated regarding their fees and expenses and therefore have
the ability to charge their investors asset-based management fees (1 percent to 5
percent based on the foreign hedge fund’s assets) in addition to incentive fees (20
percent to 50 percent of the foreign hedge fund’s profits).
Furthermore it is not uncommon for a foreign hedge fund to pay incentive fees to
non-investment professionals at the hedge fund manager’s discretion.36 Nor is it
uncommon for hedge fund managers to defer the receipt of all or a portion of their
incentive fees in a segregated account or in an offshore rabbi trust,37 reinvested in
the master fund, where it continues to participate in the fund’s future gains but not
losses.
The IRS has discretion to redetermine a foreign hedge fund’s compensation
expenses that might have been calculated based on misvalued MBS assets.
Compensation payments are deductible by a taxpayer only in an amount that is
reasonable under all the circumstances38 that “would ordinarily be paid for like
services by like enterprises under like circumstances”.39
In one case, the Tax Court disallowed a taxpayer’s deductions for alleged salary and
bonus payments to the owner-president-controlling shareholder and his relative. The
owner was a small investment firm’s principal manager and marketer, worked long
hours, ensured its compliance with all relevant regulations, and closely supervised all
of its investment and trading activities.
The court found the owner’s compensation paid by the taxpayer unreasonable based
on an independent investor analysis, which found unreasonable the taxpayer’s
practice of paying the controlling shareholder large bonuses in loss years as well as
in profitable years. The court also found that the lack of any strong linkage between
the taxpayer’s performance in a given year and the shareholder’s bonuses and
compensation for that year rendered the taxpayer’s compensation deductions
unreasonable.
The Tax Court limited the taxpayer’s bonus payments made to the owner to 20
percent of pre-tax earnings of the taxpayer, citing incentive fees paid to hedge fund
managers as a comparable in determining the reasonableness of the owner’s bonus
payments. The Tax Court found the entire amount of compensation paid to the
owner’s relative unreasonable because the taxpayer presented no evidence, other
than the owner’s testimony, that the relative had performed any services for the
taxpayer.40
The IRS also has the discretion to disallow deductions under IRC section 162(c)(1)
for any incentive fee, management fee, other fee, expense reimbursement, kickback,
rebate, surcharge, commission, derivative contract, or rent paid to non-investment
professionals by the foreign hedge fund at the hedge fund manager’s discretion when
the payment falls within the scope of the US Foreign Corrupt Practices Act (FCPA).41
Foreign hedge funds pay premium brokerage commissions to their brokers that
exceed the lowest rate available from other broker-dealers for basic execution
services, or as is in the form of soft dollar brokerage commissions that are not limited
to brokerage or research (including office space, clerical support, and marketing
support). These excessive brokerage fees may taint the objectivity of a broker, which
is part of the valuation process of a foreign hedge fund’s MBS assets.42 Foreign
hedge funds also deduct organisation, operation, marketing, insurance, and some
personal expenses of the fund manager, including extensive indemnification for the
fund manager for liabilities incurred in managing the fund, except in the case of gross
negligence or wilful misconduct.
However, to get the benefit of otherwise allowable deductions and credits for a tax
year, a foreign hedge fund43 must file (or cause to be filed) a true and accurate
return.44 The return must reflect the foreign hedge fund’s income that is ECI, or
treated as ECI, with the conduct of a US trade or business; and deductions and
credits allowed a non-resident alien who elects under a tax treaty to be taxed on a
net basis may be claimed by filing a return in the manner prescribed by the regs (if
any) under the tax treaty or any other guidance issued by the IRS.45 A foreign
corporation that did not file returns (because it unsuccessfully took the position that it
was an investment management business conducted through a US agent that did not
cause it to be engaged in a US trade or business and that did not cause it to have
ECI with a US trade or business) was unable to claim a deduction for the costs
incurred in its business.46
2. Transfer Pricing Considerations
Hedge fund managers also may trigger the application of transfer pricing rules to a
foreign hedge fund.
Under IRC section 482, the IRS has the discretion to “distribute, apportion, or
allocate gross income, deductions, credits, or allowances” among two or more
organisations, trades, or businesses that are under common control so as to prevent
the evasion of taxes or to clearly reflect the separate incomes of the corporation and
partnership income. For these purposes control is any kind of control, direct or
indirect, whether legally enforceable, and however exercisable or exercised that
results in income or deductions being arbitrarily shifted.47 This includes income and
expenses between a corporation and a partnership that is treated as an entity
separate from its partners (Cir. 1987).48 While there is limited case law dealing with
the application of transfer pricing rules to partnerships, the courts have applied
transfer pricing rules when partners are related or are under common control.49
The standard to be applied for purposes of IRC section 482 would be whether the
MBS asset valuations in Transaction I or the pricing of the credit swap in Transaction
II were set at arm’s length with an uncontrolled taxpayer. If the illiquid MBS assets or
credit swaps mentioned in Transaction I and Transaction II were not set at arm’s
length but were favourably valued to accommodate the financial agenda of the hedge
fund manager, his broker, or the foreign hedge fund’s administrator, they may trigger
the application of a section 482 allocation.50
While a side-letter agreement is not likely to affect how the foreign hedge fund’s
income or loss is computed (unless the foreign hedge fund is forced to liquidate its
MBS assets at great losses to come up with the side-letter preferenced investor’s
redemption proceeds), it will distort the partnership’s allocation provision, which is in
substance a contract among the partners of the foreign hedge fund as to how they
will share the partnership income or loss among the partners, and thereby may
distort the income of the partners regarding each other, possibly triggering the
application of an IRC section 482 allocation.51
3. ERISA Considerations
Many tax-exempt investors invest in hedge funds through an offshore corporate
vehicle – either through a master-feeder fund’s foreign corporate feeder or a parallel
foreign corporate fund, which may include an MBSLF to avoid IRC section 514 from
recasting the leveraged investments of the hedge fund as a direct investment in debtfinanced
property subject to unrelated business taxable income on gains.52
A manager of a corporate foreign hedge fund that takes in capital from plans or funds
subject to the Employee Retirement Income Security Act of 1974 avoids the ERISA
plan asset look-through rules when the equity participation in the hedge fund by
benefit plan investors is not “substantial” – less than 25 percent of any class of equity
securities. For purposes of the 25 percent calculation, investments of the hedge fund
manager and governmental and foreign plans are not taken into account.
The 25 percent asset test is applied on any date, immediately after the most recent
acquisition, redemption, or intra-family transfer of any equity interest in the corporate
foreign hedge fund. However, there is no regulatory oversight of the 25 percent asset
test. Hedge fund managers – who enter into side-letter agreements and credit-crisisinduced
risk management transactions with affiliates – have the responsibility of
notifying their benefit plan investors when and if the plan’s fiduciary rules are
triggered.
The losses from MBS assets induced by the credit crisis and the risk side of credit
swaps, coupled with early redemption of investors with side-letter agreements, may
leave benefit plan investors of a corporate foreign hedge fund with a more than 25
percent ownership interest in any class of equity securities of the corporate foreign
hedge fund. If that happens, the underlying assets of the corporate foreign hedge
fund may be treated as “plan assets” subject to ERISA, with one result being that
transactions (including incentive fee arrangements) involving hedge fund assets
deemed prohibited under ERISA’s party-in-interest and self-dealing rules, with
prohibited transactions also being subject to taxation under IRC section 4975.
4. MBSLF’s US Tax Classification
An MBSLF set up by a hedge fund manager as indicated in Transaction I above may
also elect, for US tax purposes, that the fund be classified as a qualified foreign
company (QFC) that distributes qualified dividend income53 to lure US investors,
especially tax-exempt investors that prefer corporate foreign hedge fund investment
structures for their hedge fund investments.
In IRS LTR 200752029 a publicly traded investment fund was an open-ended, limited
purpose trust established under the laws of a foreign jurisdiction for investment
purposes (an MBSLF), and held foreign country insurance company54 stocks through
a tiered partnership. For federal income tax purposes, the MBSLF was not a unit
investment trust, but a foreign corporation because it was not simply an arrangement
to protect or conserve property for its beneficiaries. The MBSLF was a device to
carry on a profit-making business. Also, the trust document gave the MBSLF’s
trustees broad power to vary its investments. This determination was made by
looking at US tax laws rather than foreign tax laws.
Even though not every recognised business entity can elect its tax classification (and
the letter ruling did not mention MBSLF’s entity form in the foreign jurisdiction to
ascertain whether it was mandatorily classified as a corporation for US tax
purposes55) the MBSLF for its highest tier entity elected to be treated as a QFC,
based on the taxpayer’s representation that the MBSLF did not qualify as a passive
foreign investment company.56 The letter ruling did not address the US federal tax
elections of the tiered partnerships that held stocks of foreign insurance companies.
Furthermore, the letter ruling expressed no opinion as to whether the MBSLF was a
resident of a foreign country for purposes of a tax treaty, nor whether the MBSLF
satisfied the requirements of the limitation on benefits article of a tax treaty, whereas
the MBSLF will not make a QFC election without being eligible for benefits of a
comprehensive income tax treaty with the US under IRC section 1(h)(11)(C)(i).
5. Tax Treaty Considerations
A hedge fund’s US tax classification or the US taxation of a foreign hedge fund’s
activities may be subject to different rules under US tax treaty provisions, which
should be considered if a foreign hedge fund or MBSLF is claiming US tax treaty
benefits.
For example, an MBSLF’s QFC classification under US tax law may be challenged
under the Ireland-US treaty since companies holding shares through fiscally
transparent entities such as partnerships or trusts are subject to a look-through
approach and are considered to hold their proportionate interest in the shares held by
the intermediate entity. This limits the treaty benefits in some circumstances for
companies holding shares through these entities.57
6. Tax Shelter Transaction Considerations
The credit-crisis-induced cross-border affiliated transactions of a hedge fund
manager between US and offshore funds may be scrutinised for distressed asset and
debt (DAD) transactions entered into for the purposes of shifting economic losses
from a tax-indifferent party to a US taxpayer.58 The IRS has indicated that DAD
transactions may be challenged on the basis of the judicial doctrines, including
substance over form, lack of economic substance,59 the economic effect and
business60 test as well as step transaction, and in the case of distressed debt, that
the distressed debt was worthless under IRC section 166.61
7. RICO Considerations
If a foreign hedge fund is found to have deprived a foreign government of tax
revenue, either for being a dealer and engaged in a foreign trade or business, or for
transfer pricing or withholding tax or tax treaty adjustments arising from the hedge
fund manager’s credit-crisis-induced cross-border affiliated transactions, then it may
be subject to penalties under the Racketeer Influenced and Corrupt Organizations
Act, since RICO applies to taxpayers that deprive a foreign government of tax
revenue.62
B. US Tax Implications for Hedge Fund Investors
1. Investors of a Foreign Hedge Fund Deemed Engaged in a US Trade or Business
When a foreign hedge fund is deemed engaged in a US trade or business, any
investor in the fund – in the US or abroad – is barred from relying on the trading safe
harbour and is subject to net basis taxation in the US on ECI from a US trade or
business.
If a foreign partner disposes its interest in an MBS loss foreign hedge fund deemed
engaged in a US trade or business, the foreign partner’s gain or loss from the
disposition of its interest in a foreign or domestic partnership that conducts business
in the US through a fixed place of business is not realised directly from the active
conduct of the US trade or business. However, the gain or loss is US-sourced if it is
attributable to the foreign partner’s fixed place of business in the US. Also, US tax
treaties may require the activities of the partnership to rise to the level of a
permanent establishment in the US.63
The character of the gain or loss is determined under the asset use test by applying a
look-through approach and is treated as a disposition of an aggregate interest in the
partnership’s underlying property for purposes of determining the source and the
effectively connected character of the gain or loss.64
2. Tax-exempt investors in an MBSLF
US investors in an MBSLF with a QFC election should evaluate the fund annually for
the PFIC classification to avoid being subject to its anti-deferral rules, since a foreign
corporation’s PFIC status is determined on a year-to-year basis.65 The PFIC
classification of the MBSLF will affect the US federal tax liability of its US
shareholders because a QFC doesn’t include any foreign corporation which for the
tax year of the corporation in which the dividend was paid, or the preceding tax year,
is a PFIC.66 However, controlled foreign corporations67 are not excluded from the
definition of QFC so long as they are not also a PFIC.68 Accordingly, US investors of
the MBSLF may be well-served by making a prophylactic qualified electing fund
election.69
US tax-exempt investors of an MBSLF should also evaluate the fund for the
application of CFC provisions because under a look-through rule, some tax-exempt
investors’ subpart F insurance income is recharacterised for unrelated business
income tax purposes.70 The CFC classification of the MBSLF will also allow US
shareholders of the CFC71 to use the subpart F tax provisions of the Internal
Revenue Code and the US tax treaties to access an MBSLF’s accounting and tax
records and bring it within the reach of the US federal legal system.72
C. US tax implications for the hedge fund manager
1. Incentive fees deferred offshore in a rabbi trust
A hedge fund manager’s incentive fees that are deferred offshore in a rabbi trust may
not result in the deferral of income, because incentive fees directly or indirectly set
aside in a trust for purposes of paying deferred compensation to a hedge fund
manager under a nonqualified deferred compensation (NQDC) plan are treated, for
purposes of IRC section 83, as property transferred in connection with the
performance of services.
It doesn’t matter whether the assets are technically available to satisfy claims of
general creditors if:73 (1) at the time set aside, the assets (or trust or other
arrangement) are located outside of the US;74 or (2) at the time transferred, the
assets (or trust or other arrangement) are later transferred outside of the US.75 Thus,
offshore rabbi trusts (that in effect protect assets from creditors) are treated as
funded arrangements that do not result in the deferral of income for a hedge fund
manager.76
Accordingly, a hedge fund manager with an NQDC plan may be required to include
amounts in income because of the application to the plan (or to any trust or assets
associated with the plan) of IRC section 83, IRC section 451, the economic benefit
doctrine, or other applicable law, even though the plan, trust, or assets comply with
IRC section 409A(b) or Notice 2006-33.77
II. Conclusion
With the International Monetary Fund estimating that the credit crisis will continue to
spread worldwide with losses approaching USD1 trillion, and more hedge funds
rumoured to be in trouble because of their leveraged MBS asset investments, the
credit-crisis-induced risk management transactions of hedge fund managers hidden
in the shadows of hedge fund accounting improprieties should be closely scrutinised
for their US tax, foreign tax, US tax treaty, ERISA, RICO, as well as FCPA
consequences for the hedge fund, its manager, and its investors.
This article was first published in Tax Analyst
FOOTNOTES
1 A repurchase agreement (repo) is economically similar to a secured loan, in which the borrower (seller/cash receiver) sells
securities for cash to a lender (buyer/cash provider) and agrees to repurchase those securities at a later date for more cash.
The buyer receives securities as collateral to protect against default. The legal title to the securities passes from the seller to the
buyer. Coupons (instalment payments that are payable to the owner of the securities) that are paid while the repo buyer owns
the securities are usually passed directly onto the repo seller. This might seem counterintuitive, because the ownership of the
collateral technically rests with the buyer during the repo agreement.
2 Securities Law Daily, “Credit Ratings: S&P May Downgrade Subprime Securities, Also Plans Review of Affected CDO
Portfolios,” July 11, 2007, pp. 1-2.
3 Kate Kelly, “Goldman’s Subprime-Bet Star Is Leaving,” The Wall Street Journal, Apr. 26, 2008, p. 1.
4 Gregory Zuckerman, “Vranos May Try to Reopen Ellington Credit Fund,” The Wall Street Journal, Dec. 7, 2007, p. 1; Simon
Hildrey, “Multiple Challenges Make Tricky Work,” Financial Times, Nov. 5, 2007, p. 1; Sophia Grene, “Side-Pocket Solution to
Illiquidity,” Financial Times, Jan. 20, 2008, p. 1; and Miles Costello, “Shareholders Will Demand Investigation Into Absolute
Funds Strategy,” Times (UK), Oct. 29, 2007, p. 13.
5 Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, LLC, (S.D.N.Y., 2007), Slip
Copy, p. 8 of 16; Nicholas P.B. Bollen and Veronika K. Pool, “Do Hedge Fund Managers Misreport Returns? Evidence from the
Pooled Distribution,” Oct. 1, 2007, pp. 1-5.
6 Such a derivative contract - similar to ones used during the mutual fund scandal to economically short equity mutual fund
shares and profit during the 2000-2003 equity bear market - would not meet the definition of a notional principal contract (NPC)
under reg. sections 1.446-3(c)(2) and (4) and therefore will not fall under the trading safe harbour.
7 The Carlyle Group, Hoover’s Basic Company Records, Apr. 16, 2008, p. 1.
8 “Carlyle Capital on the Brink of Collapse, Fund Now Expects Banks to Seize Some USD16 Billion in Assets,” Associated
Press, Mar. 13, 2008, p. 1; Greg Robb, “Bear Stearns Bailout Called a Huge Blunder,” MarketWatch, Apr. 29, 2008, p. 1.
9 Greg Ip, “Fed Cuts Rate, Signals Pause Ahead,” The Wall Street Journal, Apr. 30, 2008, p. 1.
10 Federal Bureau of Investigation, San Diego Division, press release, “Hedge Fund Manager Sentenced to 72 Months in
Prison,” Apr. 7, 2008, available at http://sandiego.fbi.gov/pressrel/2008/sd040708.htm.
11 IRC section 864(b); Treas. reg. section 1.864-2(c)(2)(i); Treas. reg. section 1.864-2(d)(2).
12 Based on the manner in which payments are made and the form of the entity issuing the security, an MBS may be classified
for tax purposes either as debt or equity under IRC section 385(b).
13 Prop. reg. section 1.864(b)-1(b) expanded the scope of the trading safe harbour to permit transactions in derivatives that
meet the definition of an NPC for the taxpayer’s own account, provided that the taxpayer qualifies as an “eligible non-dealer.”
The proposed regulations would be effective for tax years beginning 30 days after the date final regs are issued, but taxpayers
may take any reasonable position regarding the application of the securities and commodities safe harbours to derivative
transactions before the final regs are issued. Positions consistent with the proposed regs are considered reasonable. [Preamble
to prop. regs 6/12/98.] For these purposes, credit swaps (defined above) are not likely to meet the definition of an NPC under
the trading safe harbour rules.
14 IRC section 871(b) and 882.
15 IRC section 1441.
16 IRC section 871(a), 881.
17 IRC section 871(h)(1).
18 IRC section 881(c)(3)(C).
19 Reg. 1.475(c)-1(a).
20 IRC section 475(c)(1); Lee A. Sheppard, “News Analysis: US Officials Preview Guidance for Financial Intermediaries and
Hedge Funds,” Tax Notes Int’l, Jan. 31, 2005, p. 354, Doc 2005-1157 [PDF], or 2005 WTD 21-7 ; Needham & Brause, 736 T.M.,
Hedge Funds, BNA Portfolio 736: Hedge Funds, Sec.(F) Investments in Debt Securities.
21 Vitale, Alberto, (1979) 72 TC 386.
22 IRC section 875(1).
23 IRC section 871(b)(1); IRC section 882(a)(1); Treas. regs. 1.864-2(c)(2)(ii) and 1.864-2(c)(2)(iv)(a).
24 IRC section 864(c)(4); Rev. Rul. 2004-3, 2004-7 IRB 486.
25 IRC section 864(c)(3); Treas. reg. section 1.864-4(b).
26 IRC section 873; IRC section 882(c)(1).
27 Treas. reg. section 1.882-5T(a)(1)(i).
28 IRC section 475(f).
29 IRC section 475(f)(1)(B).
30 Defined in IRC section 475(c)(2)(D) or IRC 475(c)(2)(E). A credit swap, as defined above, or other credit derivative contract
may meet the definition in IRC section 475(c)(2)(E) giving rise to mark-to-market accounting of a side-pocket that contains credit
swap or other credit derivatives of a foreign hedge fund that is deemed a dealer in these derivatives since the clearly identified
exception is inapplicable.
31 IRC section 475(b)(4).
32 IRC section 871(a)(1)(C)(ii).
33 Treas. reg. section 1.863-7(b)(1).
34 Treas. reg. section 1.863-7(b)(3).
35 Federal Tax Coordinator, Volume 19A, O (part 2), Decks O-10500 thru O-10600, Research Institute of America; Needham &
Brause, 736 T.M., Hedge Funds, BNA Portfolio 736: Hedge Funds.
36 John R. Emshwiller, “Bill Clinton May Get Payout of USD20 Million,” The Wall Street Journal, Jan. 22, 2008, p. 1.
37 A rabbi trust is an unfunded and unsecured nonqualified deferred compensation arrangement under which an employer
places assets in a fund or trust to be used to provide deferred compensation benefits to employees. A rabbi trust creates an
agency relationship (rather than a trust) since the assets and income of the fund or trust are subject to claims of the employer’s
creditors if the employer becomes insolvent, the employees receive no beneficial ownership or preferred claims on the assets,
and the fund administrator or trustee does not have discretionary authority to invest fund assets or to make payments to
employees and their beneficiaries. For further information, see IRS LTR 9015008 or IRS LTR 8936082.
38 Miller Mfg. Co. v. Comm’r, 149 F.2d 421 (4th Cir. 1945), 33 AFTR 1383, 45-1 USTC para. 9293.
39 Treas. reg. section 1.162-7(b)(3).
40 Wechsler & Co. Inc. v. Comm’r, T.C. Memo. 2006-173, RIA TC Memo para. 2006-173.
41 Selva Ozelli, “Is This Bribe Deductible? Tax Implications of the US Foreign Corrupt Practices Act,” Tax Notes Int’l, Dec. 17,
2007, p. 1171, Doc 2007-25721 [PDF], or 2007 WTD 245-8 .
42 Kira Nickerson, “High Fees Could Lessen the Impact of Hedge Funds’ Foray Into Retail Market,” Financial News Online US,
Jan. 23, 2008.
43 For these purposes, a nongrantor foreign trust, which is taxed as a non-resident alien individual, may, in rare circumstances,
be subject to tax under IRC section 871(b) on its undistributed income that is effectively connected with a US trade or business
under IRC section 875(2). If that foreign trust files a delinquent US federal income tax return, it is likely that the IRS would
disallow deductions and credits under IRC section 874(a).
44 IRC section 874(a).
45 Treas. reg. section 1.874-1(a).
46 Inverworld Inc. v. Comm’r (1996), T.C. Memo. 1996-301, RIA T.C. Memo. para. 96301, 71 CCH TCM 3231.
47 Treas. reg. section 1.482-1(a)(3).
48 US v. Basye, 410 U.S. 441 (1973); Dolese v. Comm’r, 811 F.2d 543, 547-548 (10
49 Rodebaugh v. Comm’r, 33 TCM 169 (1974), aff’d per curiam, 518 F.2d 73 (6th Cir. 1975); Dolese v. Comm’r, 811 F.2d 543
(10th Cir. 1987).
50 Treas. reg. section 1.704-1(b)(1)(iii); TAM 9319003 (Jan. 28, 1991).
51 Id.
52 IRC section 512.
53 IRC section 1(h)(11).
54 Hedge funds may be structured as insurance companies; see Needham & Brause, 736 T.M., Hedge Funds, BNA Portfolio
736: Hedge Funds, Sec (D) Hedge Funds Disguised as Insurance Companies.
55 Reg. section 301.7701-2(b)(8)(i).
56 IRC section 1(h)(11)(C)(iii).
57 Treas. Tech Expl. p. 33.
58 Coordinated issue paper, (Distressed Assets Tax Shelters), April 18, 2007.
59 Long Term Capital Holdings v. U.S., 330 F.Supp 2d 122 (D.Conn. 2004), aff’d 2005 U.S. App. LEXIS 20988 (2d Cir. 2005).
60 Supra note 52.
61 Notice 2008-34, 2008-12 IRB.
62 Pasquantino v. US, 541 U.S. 972 (2004); Guy Chazan, “Hermitage Capital Management Runs Into Trouble in Russia - U.K.
Fund Accuses Authorities of Trying To Steal Its Assets,” The Wall Street Journal, Apr. 4, 2008, p. 1; “Moscow Court Postpones
Bank of New York Case,” The Wall Street Journal, Apr. 8, 2008, p. 1; PR Newswire, “The Bank of New York Mellon Provides
Update on Russian Court Case,” Apr. 7, 2008, p. 1.
63 South Africa-US treaty, art. 13(3); Thailand-US treaty, art. 13(1), Treas. Tech. Expl., pp. 43-44.
64 Rev. Rul. 91-32, 1991-1 CB 107, as corrected by Announcement 91-86, 1991-24 IRB 120.
65 Federal Tax Coordinator, Vol. 19, O (part 1), Deck O-2200, Research Institute of America.
66 IRC section 1(h)(11)(C)(iii).
67 Federal Tax Coordinator, Volume 19, O (part 1), Deck O-2300 thru O-2700, Research Institute of America.
68 Notice 2004-70, Sec. 4.01, 2004-44 IRB 724.
69 LTR 90204086.
70 IRC section 512(b)(17).
71 CFCs are subject to US accounting and corporate governance rules; Treas. reg. section 1.952-2(b)(1).
72 Selva Ozelli, “Shareholder Leverage in the Face of Corporate Inversions,” Tax Notes Int’l, Feb. 17, 2003, p. 661, Doc 2003-
4192 [PDF], or 2003 WTD 32-13 .
73 IRC section 409A(b)(1).
74 IRC section 409A(b)(1)(A).
75 IRC section 409A(b)(1)(B).
76 H.R. 108-548 (PL 108-357), p. 343.
77 IRC section 409A(b)(1)(A).
Comment: Cracks in the façade –
risk management transactions of hedge fund managers
Selva Ozelli, an international tax attorney, certified public accountant and
international tax editor with the Thomson Reuters Corporation in New York,
examines the tax consequences of structured mortgage-backed assets held by
foreign hedge funds.
The healthy facade of the US economy began cracking during the summer of 2007,
when the deterioration in the US housing market rendered the valuations of
securitised or structured mortgage-backed assets volatile. These assets had been
valued dramatically bullish on inflated marks and misrepresented credit grades by
brokers who earned substantial commissions by pushing the more than 600 different
types of MBS onto hedge fund managers through repos1 that were leveraged without
regulatory bounds.
The resulting contracting demand for MBSs precipitated the tightening of unsecured
term funding, leading to credit downgrades2 and massive write-downs of MBS assets
by financial institutions according to mark-to-market accounting rules and illiquidity.
Losses mounted from forced liquidation of MBSs at low valuations triggered by
redemption notices from hedge fund investors (some got out ahead of other investors
based on side-letter agreements with preferential redemption terms) and margin calls
from brokers trying to make up for the difference in the value of securities used as
collateral on repos. The result was that most prominent veteran hedge funds were
financially wounded and two of Bear Stearns’s funds were bankrupted.
Many hedge fund managers were caught unprepared when the credit crisis hit during
the summer of 2007. Only a few had short positions in credit derivatives that they
initiated two years earlier, when these contracts were priced low, to profit from the
deterioration in MBS values.3 Some hedge fund managers transferred their poorly
performing, illiquid MBS assets to side-pockets and valued them separately from the
remainder of the fund’s portfolio to immunise the fund’s net asset value calculation
from the performance of these hard-to-value assets, effectively freezing the illiquid,
MBS-affected portion of the hedge fund’s portfolio to avoid writing these investments
down or selling them at a large loss.4
Other hedge fund managers who were not as astute (or not willing to absorb the
losses on their risky, long, leveraged positions in MBS assets sitting in funds they
managed) transferred their risky MBS assets – valued favourably with the help of
their administrators, who were compensated based on a fee set as a percentage of
the fund’s performance5 – not to a side-pocket, but to another fund, the MBS Loss
Fund (MBSLF), and then floated the MBSLF publicly in stock exchanges in foreign
jurisdictions (Transaction I).
Next, in a move straight out of the 2003 mutual fund scandal, in anticipation of the
deterioration in overvalued MBS assets in MBSLF’s portfolio, hedge fund managers
purchased basket index credit swaps – a contract that simulated the credit of the
MBSLF’s portfolio holdings from a US broker dealer - that were constructed based on
the hedge fund manager’s non-publicly available knowledge of MBSLF’s MBS
portfolio holdings (credit swap)6 held between two affiliated funds of the hedge fund
manager, with MBSLF holding the risk side of the swap (Transaction II).
The credit crisis, which highlighted the various credit risk management techniques of
hedge fund managers, struck a milestone in February 2008 when the MBS yield
premiums widened to levels not seen in 15 years, bankrupting many hedge funds,
including the prestigious USD22bn Carlyle Capital Corporation, a Dutch-listed,
Guernsey-based MBS hedge fund, that was advised by the Carlyle Group, one of the
world’s largest private investment firms, which had a 15 percent interest in CCC.7
The Carlyle Group first floated CCC’s shares at USD19 per share on the Euronext
Amsterdam stock exchange in July 2007. The share price fell sharply to USD0.43 per
share by the middle of March this year when CCC defaulted on nearly USD17bn of
debt (borrowed from financial institutions including Bear Stearns, which also
succumbed to the credit crisis because of excessive exposure to MBS assets and
financing).8
Anticipating that CCC and Bear Stearns will not be the last victims of the credit crisis
despite the Federal Reserve Bank’s easing of interest rates9 and offering favourable
credit lines to financial institutions, the Securities and Exchange Commission and the
Department of Justice, in partnership with the FBI and the IRS Criminal Investigation
Division, have announced investigations of the USD2trn hedge fund industry for
misvaluation of MBS assets, illicit transfers of capital by hedge fund managers
between onshore and offshore funds, and inappropriately billed expenses to hedge
funds.10
The credit-crisis-induced risk management transactions of hedge fund managers
may also have unintended US tax consequences to the hedge fund, its investors,
and its managers as outlined below.
I. The credit crisis
A. US tax implications to a foreign hedge fund
Depending on the locale and based on regulatory, tax, and investor considerations,
foreign hedge funds are structured as limited liability partnerships, limited liability
companies, unit investment trusts, corporations, insurance companies, or masterfeeder
funds that use a combination of offshore master partnerships with onshore
and offshore feeder funds. Foreign hedge funds that trade in the US financial
markets avoid US taxation on their trading income by relying on a trading safe
harbour,11 which renders the hedge fund manager’s act of trading in securities –
which includes an MBS12 as well as a credit derivative13 – for his or her own account
in the secondary market not effectively connected income with a US trade or
business.14
Foreign hedge funds nevertheless remain subject to withholding taxes15 on their USsource
fixed or determinable annual or periodic income16 except for interest under
the portfolio interest exemption,17 which doesn’t apply when the foreign lender is a
controlled foreign corporation and the US borrower is a related person.18
1. Foreign hedge fund may be deemed a dealer
During the credit crisis, hedge fund managers – whose financial interests are aligned
with their hedge fund investors as far as being averse to MBS asset loss absorption
since they keep substantial assets of their own in a fund and earn most of their
compensation from incentive fees set as a percentage of a fund’s performance – may
have entered into affiliated account trades between their US and foreign hedge
funds, since funds established in the US or sold to US investors are prohibited from
manipulating or otherwise misrepresenting the fund’s NAV under the antifraud
provisions of the federal securities laws.
Accordingly, hedge fund managers who manage several onshore hedge funds,
foreign hedge funds, investment accounts, or MBSLFs may have bought or sold
illiquid MBS’s as described in Transaction I above or entered into credit swap
transactions between affiliated funds as described in Transaction II above.
These types of risk management transactions initiated by a hedge fund manager
among its affiliated offshore and US funds or accounts, based on all facts and
circumstances,19 may deem the hedge fund manager a dealer subject to the mark-tomarket
accounting rules.20 A non-resident alien individual or a foreign corporation is
considered to be engaged in a US trade or business if the partnership of which the
non-resident alien or foreign corporation is a member is so engaged by virtue of the
foreign partner’s interest in the partnership, through the partnership’s fixed place of
business in the US.
Any member of a partnership, limited partners, general partners,21 or offshore
corporate feeders22 that is deemed a dealer in stocks or securities, either in the US or
abroad, is barred from relying on the trading safe harbour, and will be subject to net
basis taxation in the US on ECI from a US trade or business23 including three
categories of foreign source income or loss or their economic equivalents, which
include interest and dividend equivalents when the taxpayer has an office or other
fixed place of business within the US.24
While all US-source income may be treated as ECI with a US trade or business,25
only some foreign source income is so treated, and tax treaties may reduce the US
tax on that foreign source income. Deductions attributable to ECI are allowed in
computing the net amount subject to tax26 with interest expense attributable to ECI
with a US trade or business being determined under special rules.27
When a foreign hedge fund is deemed a dealer that is engaged in a US trade or
business, the other US tax consequences that should be considered are:
a. The mark-to-market accounting’s effect on illiquid MBS assets and credit swaps. If
the foreign hedge fund is deemed a dealer, but has a valid mark-to-market election
already in effect28 (most hedge funds make a mark-to-market election), it should be
able to exclude an illiquid MBS asset transferred to a side-pocket from mark-tomarket
accounting provided that the security is “clearly identified” as such.29
A side-pocket can be viewed as a separate sub-fund within the hedge fund that
immunises the remainder of the fund’s portfolio from the poor performance of the
assets held in the side-pocket. When an illiquid MBS asset is transferred to a foreign
hedge fund’s side-pocket – either at cost or valued at the time of transfer with the
help of committees, appraisers, fund administrators, investment bankers, or brokers
– the fund investors at the time of the transfer are deemed to own their proportionate
interest in that investment and later investors in the fund are not. Redeeming
investors retain their proportionate interests in the side-pocket’s investments until
they are sold or otherwise transferred out of the side-pocket.
While the use of side-pockets artificially enhances a foreign hedge fund’s NAV,
boosting the fund’s performance record and the incentive fees paid to the hedge fund
manager, if a taxpayer fails to clearly identify the illiquid MBS asset transferred to a
side-pocket, it will have to mark the illiquid MBS asset to market, write the relevant
investment down, and report the resulting loss as ordinary. The mark-to-market
accounting treatment will also apply to any notional principal contract (NPC) or any
derivative security30 transferred to a foreign hedge fund’s side-pocket since the
‘clearly identify’ exemption is inapplicable to any NPC or derivative security that is
held by a dealer in those securities.31
b. The withholding tax considerations of a foreign hedge fund deemed a dealer
engaged in a US trade or business. If a foreign hedge fund is deemed a dealer that is
engaged in a US trade or business, any outbound interest payments (including
original issue discount)32 relating to an MBS asset that would otherwise be exempt
from the 30 percent withholding tax based on the portfolio interest exemption, or
outbound credit swap payment that would not otherwise be subject to withholding
tax, since these payments are sourced to the residence of the recipient if the hedge
fund has no US office,33 will be treated as US-source ECI, subject to net basis
taxation.34
c. The deductibility of a foreign hedge fund’s fees and expenses against its ECI from
a US trade or business. If a foreign hedge fund is deemed engaged in a US trade or
business, it is normally allowed deductions only if and to the extent that the fees and
expenses are ECI with the conduct of a US trade or business. The allowable
deductions under IRC 873(a) and IRC 882(c) are determined based on the
taxpayer’s status as a partnership, trust, or corporation, the character and source of
its expenses determined under the regs or tax treaty provisions, the reasonableness
of the hedge fund manager’s compensation expenses, as well as the accounting
method adopted by the taxpayer.
While a detailed discussion of the deductibility of expenses of a foreign hedge fund
that is engaged in a US trade or business is beyond the scope of this article,35 foreign
hedge funds are not regulated regarding their fees and expenses and therefore have
the ability to charge their investors asset-based management fees (1 percent to 5
percent based on the foreign hedge fund’s assets) in addition to incentive fees (20
percent to 50 percent of the foreign hedge fund’s profits).
Furthermore it is not uncommon for a foreign hedge fund to pay incentive fees to
non-investment professionals at the hedge fund manager’s discretion.36 Nor is it
uncommon for hedge fund managers to defer the receipt of all or a portion of their
incentive fees in a segregated account or in an offshore rabbi trust,37 reinvested in
the master fund, where it continues to participate in the fund’s future gains but not
losses.
The IRS has discretion to redetermine a foreign hedge fund’s compensation
expenses that might have been calculated based on misvalued MBS assets.
Compensation payments are deductible by a taxpayer only in an amount that is
reasonable under all the circumstances38 that “would ordinarily be paid for like
services by like enterprises under like circumstances”.39
In one case, the Tax Court disallowed a taxpayer’s deductions for alleged salary and
bonus payments to the owner-president-controlling shareholder and his relative. The
owner was a small investment firm’s principal manager and marketer, worked long
hours, ensured its compliance with all relevant regulations, and closely supervised all
of its investment and trading activities.
The court found the owner’s compensation paid by the taxpayer unreasonable based
on an independent investor analysis, which found unreasonable the taxpayer’s
practice of paying the controlling shareholder large bonuses in loss years as well as
in profitable years. The court also found that the lack of any strong linkage between
the taxpayer’s performance in a given year and the shareholder’s bonuses and
compensation for that year rendered the taxpayer’s compensation deductions
unreasonable.
The Tax Court limited the taxpayer’s bonus payments made to the owner to 20
percent of pre-tax earnings of the taxpayer, citing incentive fees paid to hedge fund
managers as a comparable in determining the reasonableness of the owner’s bonus
payments. The Tax Court found the entire amount of compensation paid to the
owner’s relative unreasonable because the taxpayer presented no evidence, other
than the owner’s testimony, that the relative had performed any services for the
taxpayer.40
The IRS also has the discretion to disallow deductions under IRC section 162(c)(1)
for any incentive fee, management fee, other fee, expense reimbursement, kickback,
rebate, surcharge, commission, derivative contract, or rent paid to non-investment
professionals by the foreign hedge fund at the hedge fund manager’s discretion when
the payment falls within the scope of the US Foreign Corrupt Practices Act (FCPA).41
Foreign hedge funds pay premium brokerage commissions to their brokers that
exceed the lowest rate available from other broker-dealers for basic execution
services, or as is in the form of soft dollar brokerage commissions that are not limited
to brokerage or research (including office space, clerical support, and marketing
support). These excessive brokerage fees may taint the objectivity of a broker, which
is part of the valuation process of a foreign hedge fund’s MBS assets.42 Foreign
hedge funds also deduct organisation, operation, marketing, insurance, and some
personal expenses of the fund manager, including extensive indemnification for the
fund manager for liabilities incurred in managing the fund, except in the case of gross
negligence or wilful misconduct.
However, to get the benefit of otherwise allowable deductions and credits for a tax
year, a foreign hedge fund43 must file (or cause to be filed) a true and accurate
return.44 The return must reflect the foreign hedge fund’s income that is ECI, or
treated as ECI, with the conduct of a US trade or business; and deductions and
credits allowed a non-resident alien who elects under a tax treaty to be taxed on a
net basis may be claimed by filing a return in the manner prescribed by the regs (if
any) under the tax treaty or any other guidance issued by the IRS.45 A foreign
corporation that did not file returns (because it unsuccessfully took the position that it
was an investment management business conducted through a US agent that did not
cause it to be engaged in a US trade or business and that did not cause it to have
ECI with a US trade or business) was unable to claim a deduction for the costs
incurred in its business.46
2. Transfer Pricing Considerations
Hedge fund managers also may trigger the application of transfer pricing rules to a
foreign hedge fund.
Under IRC section 482, the IRS has the discretion to “distribute, apportion, or
allocate gross income, deductions, credits, or allowances” among two or more
organisations, trades, or businesses that are under common control so as to prevent
the evasion of taxes or to clearly reflect the separate incomes of the corporation and
partnership income. For these purposes control is any kind of control, direct or
indirect, whether legally enforceable, and however exercisable or exercised that
results in income or deductions being arbitrarily shifted.47 This includes income and
expenses between a corporation and a partnership that is treated as an entity
separate from its partners (Cir. 1987).48 While there is limited case law dealing with
the application of transfer pricing rules to partnerships, the courts have applied
transfer pricing rules when partners are related or are under common control.49
The standard to be applied for purposes of IRC section 482 would be whether the
MBS asset valuations in Transaction I or the pricing of the credit swap in Transaction
II were set at arm’s length with an uncontrolled taxpayer. If the illiquid MBS assets or
credit swaps mentioned in Transaction I and Transaction II were not set at arm’s
length but were favourably valued to accommodate the financial agenda of the hedge
fund manager, his broker, or the foreign hedge fund’s administrator, they may trigger
the application of a section 482 allocation.50
While a side-letter agreement is not likely to affect how the foreign hedge fund’s
income or loss is computed (unless the foreign hedge fund is forced to liquidate its
MBS assets at great losses to come up with the side-letter preferenced investor’s
redemption proceeds), it will distort the partnership’s allocation provision, which is in
substance a contract among the partners of the foreign hedge fund as to how they
will share the partnership income or loss among the partners, and thereby may
distort the income of the partners regarding each other, possibly triggering the
application of an IRC section 482 allocation.51
3. ERISA Considerations
Many tax-exempt investors invest in hedge funds through an offshore corporate
vehicle – either through a master-feeder fund’s foreign corporate feeder or a parallel
foreign corporate fund, which may include an MBSLF to avoid IRC section 514 from
recasting the leveraged investments of the hedge fund as a direct investment in debtfinanced
property subject to unrelated business taxable income on gains.52
A manager of a corporate foreign hedge fund that takes in capital from plans or funds
subject to the Employee Retirement Income Security Act of 1974 avoids the ERISA
plan asset look-through rules when the equity participation in the hedge fund by
benefit plan investors is not “substantial” – less than 25 percent of any class of equity
securities. For purposes of the 25 percent calculation, investments of the hedge fund
manager and governmental and foreign plans are not taken into account.
The 25 percent asset test is applied on any date, immediately after the most recent
acquisition, redemption, or intra-family transfer of any equity interest in the corporate
foreign hedge fund. However, there is no regulatory oversight of the 25 percent asset
test. Hedge fund managers – who enter into side-letter agreements and credit-crisisinduced
risk management transactions with affiliates – have the responsibility of
notifying their benefit plan investors when and if the plan’s fiduciary rules are
triggered.
The losses from MBS assets induced by the credit crisis and the risk side of credit
swaps, coupled with early redemption of investors with side-letter agreements, may
leave benefit plan investors of a corporate foreign hedge fund with a more than 25
percent ownership interest in any class of equity securities of the corporate foreign
hedge fund. If that happens, the underlying assets of the corporate foreign hedge
fund may be treated as “plan assets” subject to ERISA, with one result being that
transactions (including incentive fee arrangements) involving hedge fund assets
deemed prohibited under ERISA’s party-in-interest and self-dealing rules, with
prohibited transactions also being subject to taxation under IRC section 4975.
4. MBSLF’s US Tax Classification
An MBSLF set up by a hedge fund manager as indicated in Transaction I above may
also elect, for US tax purposes, that the fund be classified as a qualified foreign
company (QFC) that distributes qualified dividend income53 to lure US investors,
especially tax-exempt investors that prefer corporate foreign hedge fund investment
structures for their hedge fund investments.
In IRS LTR 200752029 a publicly traded investment fund was an open-ended, limited
purpose trust established under the laws of a foreign jurisdiction for investment
purposes (an MBSLF), and held foreign country insurance company54 stocks through
a tiered partnership. For federal income tax purposes, the MBSLF was not a unit
investment trust, but a foreign corporation because it was not simply an arrangement
to protect or conserve property for its beneficiaries. The MBSLF was a device to
carry on a profit-making business. Also, the trust document gave the MBSLF’s
trustees broad power to vary its investments. This determination was made by
looking at US tax laws rather than foreign tax laws.
Even though not every recognised business entity can elect its tax classification (and
the letter ruling did not mention MBSLF’s entity form in the foreign jurisdiction to
ascertain whether it was mandatorily classified as a corporation for US tax
purposes55) the MBSLF for its highest tier entity elected to be treated as a QFC,
based on the taxpayer’s representation that the MBSLF did not qualify as a passive
foreign investment company.56 The letter ruling did not address the US federal tax
elections of the tiered partnerships that held stocks of foreign insurance companies.
Furthermore, the letter ruling expressed no opinion as to whether the MBSLF was a
resident of a foreign country for purposes of a tax treaty, nor whether the MBSLF
satisfied the requirements of the limitation on benefits article of a tax treaty, whereas
the MBSLF will not make a QFC election without being eligible for benefits of a
comprehensive income tax treaty with the US under IRC section 1(h)(11)(C)(i).
5. Tax Treaty Considerations
A hedge fund’s US tax classification or the US taxation of a foreign hedge fund’s
activities may be subject to different rules under US tax treaty provisions, which
should be considered if a foreign hedge fund or MBSLF is claiming US tax treaty
benefits.
For example, an MBSLF’s QFC classification under US tax law may be challenged
under the Ireland-US treaty since companies holding shares through fiscally
transparent entities such as partnerships or trusts are subject to a look-through
approach and are considered to hold their proportionate interest in the shares held by
the intermediate entity. This limits the treaty benefits in some circumstances for
companies holding shares through these entities.57
6. Tax Shelter Transaction Considerations
The credit-crisis-induced cross-border affiliated transactions of a hedge fund
manager between US and offshore funds may be scrutinised for distressed asset and
debt (DAD) transactions entered into for the purposes of shifting economic losses
from a tax-indifferent party to a US taxpayer.58 The IRS has indicated that DAD
transactions may be challenged on the basis of the judicial doctrines, including
substance over form, lack of economic substance,59 the economic effect and
business60 test as well as step transaction, and in the case of distressed debt, that
the distressed debt was worthless under IRC section 166.61
7. RICO Considerations
If a foreign hedge fund is found to have deprived a foreign government of tax
revenue, either for being a dealer and engaged in a foreign trade or business, or for
transfer pricing or withholding tax or tax treaty adjustments arising from the hedge
fund manager’s credit-crisis-induced cross-border affiliated transactions, then it may
be subject to penalties under the Racketeer Influenced and Corrupt Organizations
Act, since RICO applies to taxpayers that deprive a foreign government of tax
revenue.62
B. US Tax Implications for Hedge Fund Investors
1. Investors of a Foreign Hedge Fund Deemed Engaged in a US Trade or Business
When a foreign hedge fund is deemed engaged in a US trade or business, any
investor in the fund – in the US or abroad – is barred from relying on the trading safe
harbour and is subject to net basis taxation in the US on ECI from a US trade or
business.
If a foreign partner disposes its interest in an MBS loss foreign hedge fund deemed
engaged in a US trade or business, the foreign partner’s gain or loss from the
disposition of its interest in a foreign or domestic partnership that conducts business
in the US through a fixed place of business is not realised directly from the active
conduct of the US trade or business. However, the gain or loss is US-sourced if it is
attributable to the foreign partner’s fixed place of business in the US. Also, US tax
treaties may require the activities of the partnership to rise to the level of a
permanent establishment in the US.63
The character of the gain or loss is determined under the asset use test by applying a
look-through approach and is treated as a disposition of an aggregate interest in the
partnership’s underlying property for purposes of determining the source and the
effectively connected character of the gain or loss.64
2. Tax-exempt investors in an MBSLF
US investors in an MBSLF with a QFC election should evaluate the fund annually for
the PFIC classification to avoid being subject to its anti-deferral rules, since a foreign
corporation’s PFIC status is determined on a year-to-year basis.65 The PFIC
classification of the MBSLF will affect the US federal tax liability of its US
shareholders because a QFC doesn’t include any foreign corporation which for the
tax year of the corporation in which the dividend was paid, or the preceding tax year,
is a PFIC.66 However, controlled foreign corporations67 are not excluded from the
definition of QFC so long as they are not also a PFIC.68 Accordingly, US investors of
the MBSLF may be well-served by making a prophylactic qualified electing fund
election.69
US tax-exempt investors of an MBSLF should also evaluate the fund for the
application of CFC provisions because under a look-through rule, some tax-exempt
investors’ subpart F insurance income is recharacterised for unrelated business
income tax purposes.70 The CFC classification of the MBSLF will also allow US
shareholders of the CFC71 to use the subpart F tax provisions of the Internal
Revenue Code and the US tax treaties to access an MBSLF’s accounting and tax
records and bring it within the reach of the US federal legal system.72
C. US tax implications for the hedge fund manager
1. Incentive fees deferred offshore in a rabbi trust
A hedge fund manager’s incentive fees that are deferred offshore in a rabbi trust may
not result in the deferral of income, because incentive fees directly or indirectly set
aside in a trust for purposes of paying deferred compensation to a hedge fund
manager under a nonqualified deferred compensation (NQDC) plan are treated, for
purposes of IRC section 83, as property transferred in connection with the
performance of services.
It doesn’t matter whether the assets are technically available to satisfy claims of
general creditors if:73 (1) at the time set aside, the assets (or trust or other
arrangement) are located outside of the US;74 or (2) at the time transferred, the
assets (or trust or other arrangement) are later transferred outside of the US.75 Thus,
offshore rabbi trusts (that in effect protect assets from creditors) are treated as
funded arrangements that do not result in the deferral of income for a hedge fund
manager.76
Accordingly, a hedge fund manager with an NQDC plan may be required to include
amounts in income because of the application to the plan (or to any trust or assets
associated with the plan) of IRC section 83, IRC section 451, the economic benefit
doctrine, or other applicable law, even though the plan, trust, or assets comply with
IRC section 409A(b) or Notice 2006-33.77
II. Conclusion
With the International Monetary Fund estimating that the credit crisis will continue to
spread worldwide with losses approaching USD1 trillion, and more hedge funds
rumoured to be in trouble because of their leveraged MBS asset investments, the
credit-crisis-induced risk management transactions of hedge fund managers hidden
in the shadows of hedge fund accounting improprieties should be closely scrutinised
for their US tax, foreign tax, US tax treaty, ERISA, RICO, as well as FCPA
consequences for the hedge fund, its manager, and its investors.
This article was first published in Tax Analyst
FOOTNOTES
1 A repurchase agreement (repo) is economically similar to a secured loan, in which the borrower (seller/cash receiver) sells
securities for cash to a lender (buyer/cash provider) and agrees to repurchase those securities at a later date for more cash.
The buyer receives securities as collateral to protect against default. The legal title to the securities passes from the seller to the
buyer. Coupons (instalment payments that are payable to the owner of the securities) that are paid while the repo buyer owns
the securities are usually passed directly onto the repo seller. This might seem counterintuitive, because the ownership of the
collateral technically rests with the buyer during the repo agreement.
2 Securities Law Daily, “Credit Ratings: S&P May Downgrade Subprime Securities, Also Plans Review of Affected CDO
Portfolios,” July 11, 2007, pp. 1-2.
3 Kate Kelly, “Goldman’s Subprime-Bet Star Is Leaving,” The Wall Street Journal, Apr. 26, 2008, p. 1.
4 Gregory Zuckerman, “Vranos May Try to Reopen Ellington Credit Fund,” The Wall Street Journal, Dec. 7, 2007, p. 1; Simon
Hildrey, “Multiple Challenges Make Tricky Work,” Financial Times, Nov. 5, 2007, p. 1; Sophia Grene, “Side-Pocket Solution to
Illiquidity,” Financial Times, Jan. 20, 2008, p. 1; and Miles Costello, “Shareholders Will Demand Investigation Into Absolute
Funds Strategy,” Times (UK), Oct. 29, 2007, p. 13.
5 Pension Committee of the University of Montreal Pension Plan v. Banc of America Securities, LLC, (S.D.N.Y., 2007), Slip
Copy, p. 8 of 16; Nicholas P.B. Bollen and Veronika K. Pool, “Do Hedge Fund Managers Misreport Returns? Evidence from the
Pooled Distribution,” Oct. 1, 2007, pp. 1-5.
6 Such a derivative contract - similar to ones used during the mutual fund scandal to economically short equity mutual fund
shares and profit during the 2000-2003 equity bear market - would not meet the definition of a notional principal contract (NPC)
under reg. sections 1.446-3(c)(2) and (4) and therefore will not fall under the trading safe harbour.
7 The Carlyle Group, Hoover’s Basic Company Records, Apr. 16, 2008, p. 1.
8 “Carlyle Capital on the Brink of Collapse, Fund Now Expects Banks to Seize Some USD16 Billion in Assets,” Associated
Press, Mar. 13, 2008, p. 1; Greg Robb, “Bear Stearns Bailout Called a Huge Blunder,” MarketWatch, Apr. 29, 2008, p. 1.
9 Greg Ip, “Fed Cuts Rate, Signals Pause Ahead,” The Wall Street Journal, Apr. 30, 2008, p. 1.
10 Federal Bureau of Investigation, San Diego Division, press release, “Hedge Fund Manager Sentenced to 72 Months in
Prison,” Apr. 7, 2008, available at http://sandiego.fbi.gov/pressrel/2008/sd040708.htm.
11 IRC section 864(b); Treas. reg. section 1.864-2(c)(2)(i); Treas. reg. section 1.864-2(d)(2).
12 Based on the manner in which payments are made and the form of the entity issuing the security, an MBS may be classified
for tax purposes either as debt or equity under IRC section 385(b).
13 Prop. reg. section 1.864(b)-1(b) expanded the scope of the trading safe harbour to permit transactions in derivatives that
meet the definition of an NPC for the taxpayer’s own account, provided that the taxpayer qualifies as an “eligible non-dealer.”
The proposed regulations would be effective for tax years beginning 30 days after the date final regs are issued, but taxpayers
may take any reasonable position regarding the application of the securities and commodities safe harbours to derivative
transactions before the final regs are issued. Positions consistent with the proposed regs are considered reasonable. [Preamble
to prop. regs 6/12/98.] For these purposes, credit swaps (defined above) are not likely to meet the definition of an NPC under
the trading safe harbour rules.
14 IRC section 871(b) and 882.
15 IRC section 1441.
16 IRC section 871(a), 881.
17 IRC section 871(h)(1).
18 IRC section 881(c)(3)(C).
19 Reg. 1.475(c)-1(a).
20 IRC section 475(c)(1); Lee A. Sheppard, “News Analysis: US Officials Preview Guidance for Financial Intermediaries and
Hedge Funds,” Tax Notes Int’l, Jan. 31, 2005, p. 354, Doc 2005-1157 [PDF], or 2005 WTD 21-7 ; Needham & Brause, 736 T.M.,
Hedge Funds, BNA Portfolio 736: Hedge Funds, Sec.(F) Investments in Debt Securities.
21 Vitale, Alberto, (1979) 72 TC 386.
22 IRC section 875(1).
23 IRC section 871(b)(1); IRC section 882(a)(1); Treas. regs. 1.864-2(c)(2)(ii) and 1.864-2(c)(2)(iv)(a).
24 IRC section 864(c)(4); Rev. Rul. 2004-3, 2004-7 IRB 486.
25 IRC section 864(c)(3); Treas. reg. section 1.864-4(b).
26 IRC section 873; IRC section 882(c)(1).
27 Treas. reg. section 1.882-5T(a)(1)(i).
28 IRC section 475(f).
29 IRC section 475(f)(1)(B).
30 Defined in IRC section 475(c)(2)(D) or IRC 475(c)(2)(E). A credit swap, as defined above, or other credit derivative contract
may meet the definition in IRC section 475(c)(2)(E) giving rise to mark-to-market accounting of a side-pocket that contains credit
swap or other credit derivatives of a foreign hedge fund that is deemed a dealer in these derivatives since the clearly identified
exception is inapplicable.
31 IRC section 475(b)(4).
32 IRC section 871(a)(1)(C)(ii).
33 Treas. reg. section 1.863-7(b)(1).
34 Treas. reg. section 1.863-7(b)(3).
35 Federal Tax Coordinator, Volume 19A, O (part 2), Decks O-10500 thru O-10600, Research Institute of America; Needham &
Brause, 736 T.M., Hedge Funds, BNA Portfolio 736: Hedge Funds.
36 John R. Emshwiller, “Bill Clinton May Get Payout of USD20 Million,” The Wall Street Journal, Jan. 22, 2008, p. 1.
37 A rabbi trust is an unfunded and unsecured nonqualified deferred compensation arrangement under which an employer
places assets in a fund or trust to be used to provide deferred compensation benefits to employees. A rabbi trust creates an
agency relationship (rather than a trust) since the assets and income of the fund or trust are subject to claims of the employer’s
creditors if the employer becomes insolvent, the employees receive no beneficial ownership or preferred claims on the assets,
and the fund administrator or trustee does not have discretionary authority to invest fund assets or to make payments to
employees and their beneficiaries. For further information, see IRS LTR 9015008 or IRS LTR 8936082.
38 Miller Mfg. Co. v. Comm’r, 149 F.2d 421 (4th Cir. 1945), 33 AFTR 1383, 45-1 USTC para. 9293.
39 Treas. reg. section 1.162-7(b)(3).
40 Wechsler & Co. Inc. v. Comm’r, T.C. Memo. 2006-173, RIA TC Memo para. 2006-173.
41 Selva Ozelli, “Is This Bribe Deductible? Tax Implications of the US Foreign Corrupt Practices Act,” Tax Notes Int’l, Dec. 17,
2007, p. 1171, Doc 2007-25721 [PDF], or 2007 WTD 245-8 .
42 Kira Nickerson, “High Fees Could Lessen the Impact of Hedge Funds’ Foray Into Retail Market,” Financial News Online US,
Jan. 23, 2008.
43 For these purposes, a nongrantor foreign trust, which is taxed as a non-resident alien individual, may, in rare circumstances,
be subject to tax under IRC section 871(b) on its undistributed income that is effectively connected with a US trade or business
under IRC section 875(2). If that foreign trust files a delinquent US federal income tax return, it is likely that the IRS would
disallow deductions and credits under IRC section 874(a).
44 IRC section 874(a).
45 Treas. reg. section 1.874-1(a).
46 Inverworld Inc. v. Comm’r (1996), T.C. Memo. 1996-301, RIA T.C. Memo. para. 96301, 71 CCH TCM 3231.
47 Treas. reg. section 1.482-1(a)(3).
48 US v. Basye, 410 U.S. 441 (1973); Dolese v. Comm’r, 811 F.2d 543, 547-548 (10
49 Rodebaugh v. Comm’r, 33 TCM 169 (1974), aff’d per curiam, 518 F.2d 73 (6th Cir. 1975); Dolese v. Comm’r, 811 F.2d 543
(10th Cir. 1987).
50 Treas. reg. section 1.704-1(b)(1)(iii); TAM 9319003 (Jan. 28, 1991).
51 Id.
52 IRC section 512.
53 IRC section 1(h)(11).
54 Hedge funds may be structured as insurance companies; see Needham & Brause, 736 T.M., Hedge Funds, BNA Portfolio
736: Hedge Funds, Sec (D) Hedge Funds Disguised as Insurance Companies.
55 Reg. section 301.7701-2(b)(8)(i).
56 IRC section 1(h)(11)(C)(iii).
57 Treas. Tech Expl. p. 33.
58 Coordinated issue paper, (Distressed Assets Tax Shelters), April 18, 2007.
59 Long Term Capital Holdings v. U.S., 330 F.Supp 2d 122 (D.Conn. 2004), aff’d 2005 U.S. App. LEXIS 20988 (2d Cir. 2005).
60 Supra note 52.
61 Notice 2008-34, 2008-12 IRB.
62 Pasquantino v. US, 541 U.S. 972 (2004); Guy Chazan, “Hermitage Capital Management Runs Into Trouble in Russia - U.K.
Fund Accuses Authorities of Trying To Steal Its Assets,” The Wall Street Journal, Apr. 4, 2008, p. 1; “Moscow Court Postpones
Bank of New York Case,” The Wall Street Journal, Apr. 8, 2008, p. 1; PR Newswire, “The Bank of New York Mellon Provides
Update on Russian Court Case,” Apr. 7, 2008, p. 1.
63 South Africa-US treaty, art. 13(3); Thailand-US treaty, art. 13(1), Treas. Tech. Expl., pp. 43-44.
64 Rev. Rul. 91-32, 1991-1 CB 107, as corrected by Announcement 91-86, 1991-24 IRB 120.
65 Federal Tax Coordinator, Vol. 19, O (part 1), Deck O-2200, Research Institute of America.
66 IRC section 1(h)(11)(C)(iii).
67 Federal Tax Coordinator, Volume 19, O (part 1), Deck O-2300 thru O-2700, Research Institute of America.
68 Notice 2004-70, Sec. 4.01, 2004-44 IRB 724.
69 LTR 90204086.
70 IRC section 512(b)(17).
71 CFCs are subject to US accounting and corporate governance rules; Treas. reg. section 1.952-2(b)(1).
72 Selva Ozelli, “Shareholder Leverage in the Face of Corporate Inversions,” Tax Notes Int’l, Feb. 17, 2003, p. 661, Doc 2003-
4192 [PDF], or 2003 WTD 32-13 .
73 IRC section 409A(b)(1).
74 IRC section 409A(b)(1)(A).
75 IRC section 409A(b)(1)(B).
76 H.R. 108-548 (PL 108-357), p. 343.
77 IRC section 409A(b)(1)(A).
Saturday, January 17, 2009
Update on the Missing Arthur Nadel of Sarasota
Florida Fund Manager Missing; Clients Say Money Gone (Update2)
By Saijel Kishan and Susan Decker
Jan. 17 (Bloomberg) -- Arthur Nadel, a hedge-fund manager in Sarasota, Florida, has disappeared and clients are concerned they may have lost hundreds of millions of dollars, according to law enforcement officials.
Nadel, 76, is president of Scoop Management Inc., which oversees funds including Valhalla Investment Partners LP. He was reported missing three days ago after he called his stepson, Geoff Quisenberry, and told him to go to his house where he had left a note, Lieutenant Chuck Lesaltato of the Sarasota County Sheriff’s Office said yesterday in a telephone interview.
Nadel’s wife, Peg, and Quisenberry, were “concerned about his welfare,” Lesaltato said. Nadel had sounded “distraught,” Lesaltato said, citing the note. Nadel’s partner, Neil Moody, said today he believes Nadel is alive and has spoken to his wife since then.
Scoop may have managed as much as $350 million, although “that may be high because performance results were exaggerated,” Moody said in an interview. He said he contracted with Nadel to manage three funds on his behalf, while Nadel alone had three others and did the trading for all six. Moody said he didn’t know anything was wrong until Nadel was reported missing Jan. 14.
Suicide Note
Moody called his broker “and the amount did not jibe with what Mr. Nadel said we had.” As much as $12 million of the Moody family’s money may be lost and how much remains is not known. “It looks very bleak,” Moody said.
Moody said he has sent notes to investors in his three funds alerting them to the possible missing funds.
The note left by Nadel “could be construed as a suicide note, but he’s still alive,” Moody said. “He called his wife a couple of times.” Moody hasn’t read the note and didn’t know the details of the calls between Nadel and his wife.
Nadel was last seen by his wife at 8:45 a.m. on Jan. 14 when he left for work, Lesaltato said. Peg Nadel didn’t answer her home or mobile phone.
Sarasota police opened an investigation yesterday after receiving calls alleging “hundreds of millions of dollars” are missing, Captain William Spitler said in a telephone interview.
Social Circles
The Federal Bureau of Investigation and Securities and Exchange Commission have been called in to investigate, said Sarasota Police Lieutenant Stanley Beishline. The officer said he believes Nadel is alive.
“I think he is, at least until a couple of investors find him,” Beishline said in an interview.
The Herald-Tribune in Sarasota yesterday on its Web site described Nadel as a “prominent player in Sarasota social and philanthropic circles.”
Nadel, who graduated from New York University Law School, was a real estate developer during the 1960s, according to marketing documents for the Valhalla fund, which was incorporated in 1999. The Nadels and others started a firm two years earlier that used computer-generated investment and trading programs, according to the documents. Calls to Scoop’s offices were answered by voice mail.
Scoop provided trading services for Valhalla, Viking and Viking IRA funds under a contract with Moody. Scoop also handled trading for three Nadel funds: Victory, Victory IRA and Scoop Real Estate, Moody said. Moody holds no position in Scoop Management, and was a partner with Nadel only on the Vahalla and two Viking funds.
Fraud
The disappearance of Nadel comes more than a month after Bernard Madoff, 70, was arrested for securities fraud after allegedly using billions of dollars from new investors to pay off older ones.
Madoff told authorities that investors may have lost $50 billion in a “giant Ponzi scheme,” prosecutors said.
Indiana investment adviser Marcus Schrenker was taken into custody by police in Gadsden County, Florida, earlier this week after he allegedly attempted to fake his death in a plane crash and use a motorcycle to escape. Authorities said Schrenker may have defrauded investors through three companies he owns in a suburb of Indianapolis, CNN reported yesterday.
To contact the reporter on this story: Saijel Kishan in New York at skishan@bloomberg.net; Susan Decker in Washington at sdecker1@bloomberg.net. Last Updated: January 17, 2009 17:09 EST
Andy Redleaf -- You've Gotta Read This
I know, I just used this header yesterday. But it got me a lot of readers. Using it today is an experiment. I don't put the following in the same category as yesterdays. Hence I'll take a hit on credibility for the purpose of experimentation.
Still, Andy Redleaf deserves credit for forseeing what happened in the market. Read on.
http://www.nytimes.com/2007/10/03/business/03hedge.html?pagewanted=1
And then this CNBC interview a day later (note where the Dow was that day, etc.):
http://www.youtube.com/watch?v=iUMC81nNabg
Still, Andy Redleaf deserves credit for forseeing what happened in the market. Read on.
http://www.nytimes.com/2007/10/03/business/03hedge.html?pagewanted=1
And then this CNBC interview a day later (note where the Dow was that day, etc.):
http://www.youtube.com/watch?v=iUMC81nNabg
WTRG in Cincinnati
With natural gas prices so low, and with Duke Energy apparantly buying primarily on the "spot" market for residential users, one would expect their rate for January to be lower than it is, although it is admittedly lower than last year.
In reviewing my last Duke bills I would venture that there are overcharges hidden in the new, much higher, customer charge. Would take a rate case to decipher, though.
For the current rate click on "ebills" and go to the last bills.
14 ccf Used For 885 Greenville the Coldest 24 Hours
Much less than the figure obtained by my "rule of thumb" of dividing HDD by three. Downstairs thermostats set at 48 and 45; upstairs "off." Reading upstairs was at 45 nonetheless.
14 ccf from noon to noon.
Still cold in Cincinnati. It's 9 now, 5:50 am Saturday.
Let the faucet in the kitchen drip a little. Opened up the doors to the pipes under the sink, to allow the indoor heat to get into the cabinet.
14 ccf from noon to noon.
Still cold in Cincinnati. It's 9 now, 5:50 am Saturday.
Let the faucet in the kitchen drip a little. Opened up the doors to the pipes under the sink, to allow the indoor heat to get into the cabinet.
Friday, January 16, 2009
Snow and Pickup Sticks
Driving in this near-record, sunny, crisp morning, with the nice dusting of snow highlighting the beautiful Victorian houses and the Lyceum Club, and its next-door neighbor, Swedenborgen Church, my mind flips to...pickup sticks. That's what the government is doing with BofA and the banks. This stick must be pulled out or picked up c-a-r-e-f-u-l-l-y, so no other comes crashing down.
It's -4 Degrees Now in Cincinnati
and was -6 an hour ago. Will be 12 as a high today. Average, say, 3 degrees. Makes 62 heating degree days. Divide by 3 for each house. 20 ccf for each house. 40 ccf x $1.10. You do the math.
But it'll quickly go back to normal. Not so in Siberia. Glad I don't live in Siberia. Cincinnati is about perfect -- long, wonderful springs, long, wonderful falls. Temperate winters.
How about that New York miracle! I feel good!
But it'll quickly go back to normal. Not so in Siberia. Glad I don't live in Siberia. Cincinnati is about perfect -- long, wonderful springs, long, wonderful falls. Temperate winters.
How about that New York miracle! I feel good!
Laura Goldman -- You Must See This
A video clip that is so, so good. Not complex. She had two lunches with Bernie Madoff. She discusses Robert Jaffe and Ezra Merkin. "Everyone in the business has been hit by a fraud." "It's not so easy to get out."
http://cosmos.bcst.yahoo.com/up/player/popup/?rn=289004&cl=11559131&src=finance&ch=1316259
On Robert Jaffe -- "not smart enough to be in cahoots [with Madoff]."
On Ezra Merkin -- "he's smart...but doubt that he was in cahoots."
http://cosmos.bcst.yahoo.com/up/player/popup/?rn=289004&cl=11559131&src=finance&ch=1316259
On Robert Jaffe -- "not smart enough to be in cahoots [with Madoff]."
On Ezra Merkin -- "he's smart...but doubt that he was in cahoots."
Krugman -- Yes!
Op-Ed Columnist
Forgive and Forget?
comments
new_york_times:http://www.nytimes.com/2009/01/16/opinion/16krugman.html
By PAUL KRUGMAN
Published: January 15, 2009
Last Sunday President-elect Barack Obama was asked whether he would seek an investigation of possible crimes by the Bush administration. “I don’t believe that anybody is above the law,” he responded, but “we need to look forward as opposed to looking backwards.”
Post a Comment »
I’m sorry, but if we don’t have an inquest into what happened during the Bush years — and nearly everyone has taken Mr. Obama’s remarks to mean that we won’t — this means that those who hold power are indeed above the law because they don’t face any consequences if they abuse their power.
Let’s be clear what we’re talking about here. It’s not just torture and illegal wiretapping, whose perpetrators claim, however implausibly, that they were patriots acting to defend the nation’s security. The fact is that the Bush administration’s abuses extended from environmental policy to voting rights. And most of the abuses involved using the power of government to reward political friends and punish political enemies.
At the Justice Department, for example, political appointees illegally reserved nonpolitical positions for “right-thinking Americans” — their term, not mine — and there’s strong evidence that officials used their positions both to undermine the protection of minority voting rights and to persecute Democratic politicians.
The hiring process at Justice echoed the hiring process during the occupation of Iraq — an occupation whose success was supposedly essential to national security — in which applicants were judged by their politics, their personal loyalty to President Bush and, according to some reports, by their views on Roe v. Wade, rather than by their ability to do the job.
Speaking of Iraq, let’s also not forget that country’s failed reconstruction: the Bush administration handed billions of dollars in no-bid contracts to politically connected companies, companies that then failed to deliver. And why should they have bothered to do their jobs? Any government official who tried to enforce accountability on, say, Halliburton quickly found his or her career derailed.
There’s much, much more. By my count, at least six important government agencies experienced major scandals over the past eight years — in most cases, scandals that were never properly investigated. And then there was the biggest scandal of all: Does anyone seriously doubt that the Bush administration deliberately misled the nation into invading Iraq?
Why, then, shouldn’t we have an official inquiry into abuses during the Bush years?
One answer you hear is that pursuing the truth would be divisive, that it would exacerbate partisanship. But if partisanship is so terrible, shouldn’t there be some penalty for the Bush administration’s politicization of every aspect of government?
Alternatively, we’re told that we don’t have to dwell on past abuses, because we won’t repeat them. But no important figure in the Bush administration, or among that administration’s political allies, has expressed remorse for breaking the law. What makes anyone think that they or their political heirs won’t do it all over again, given the chance?
In fact, we’ve already seen this movie. During the Reagan years, the Iran-contra conspirators violated the Constitution in the name of national security. But the first President Bush pardoned the major malefactors, and when the White House finally changed hands the political and media establishment gave Bill Clinton the same advice it’s giving Mr. Obama: let sleeping scandals lie. Sure enough, the second Bush administration picked up right where the Iran-contra conspirators left off — which isn’t too surprising when you bear in mind that Mr. Bush actually hired some of those conspirators.
Now, it’s true that a serious investigation of Bush-era abuses would make Washington an uncomfortable place, both for those who abused power and those who acted as their enablers or apologists. And these people have a lot of friends. But the price of protecting their comfort would be high: If we whitewash the abuses of the past eight years, we’ll guarantee that they will happen again.
Meanwhile, about Mr. Obama: while it’s probably in his short-term political interests to forgive and forget, next week he’s going to swear to “preserve, protect, and defend the Constitution of the United States.” That’s not a conditional oath to be honored only when it’s convenient.
And to protect and defend the Constitution, a president must do more than obey the Constitution himself; he must hold those who violate the Constitution accountable. So Mr. Obama should reconsider his apparent decision to let the previous administration get away with crime. Consequences aside, that’s not a decision he has the right to make.
Forgive and Forget?
comments
new_york_times:http://www.nytimes.com/2009/01/16/opinion/16krugman.html
By PAUL KRUGMAN
Published: January 15, 2009
Last Sunday President-elect Barack Obama was asked whether he would seek an investigation of possible crimes by the Bush administration. “I don’t believe that anybody is above the law,” he responded, but “we need to look forward as opposed to looking backwards.”
Post a Comment »
I’m sorry, but if we don’t have an inquest into what happened during the Bush years — and nearly everyone has taken Mr. Obama’s remarks to mean that we won’t — this means that those who hold power are indeed above the law because they don’t face any consequences if they abuse their power.
Let’s be clear what we’re talking about here. It’s not just torture and illegal wiretapping, whose perpetrators claim, however implausibly, that they were patriots acting to defend the nation’s security. The fact is that the Bush administration’s abuses extended from environmental policy to voting rights. And most of the abuses involved using the power of government to reward political friends and punish political enemies.
At the Justice Department, for example, political appointees illegally reserved nonpolitical positions for “right-thinking Americans” — their term, not mine — and there’s strong evidence that officials used their positions both to undermine the protection of minority voting rights and to persecute Democratic politicians.
The hiring process at Justice echoed the hiring process during the occupation of Iraq — an occupation whose success was supposedly essential to national security — in which applicants were judged by their politics, their personal loyalty to President Bush and, according to some reports, by their views on Roe v. Wade, rather than by their ability to do the job.
Speaking of Iraq, let’s also not forget that country’s failed reconstruction: the Bush administration handed billions of dollars in no-bid contracts to politically connected companies, companies that then failed to deliver. And why should they have bothered to do their jobs? Any government official who tried to enforce accountability on, say, Halliburton quickly found his or her career derailed.
There’s much, much more. By my count, at least six important government agencies experienced major scandals over the past eight years — in most cases, scandals that were never properly investigated. And then there was the biggest scandal of all: Does anyone seriously doubt that the Bush administration deliberately misled the nation into invading Iraq?
Why, then, shouldn’t we have an official inquiry into abuses during the Bush years?
One answer you hear is that pursuing the truth would be divisive, that it would exacerbate partisanship. But if partisanship is so terrible, shouldn’t there be some penalty for the Bush administration’s politicization of every aspect of government?
Alternatively, we’re told that we don’t have to dwell on past abuses, because we won’t repeat them. But no important figure in the Bush administration, or among that administration’s political allies, has expressed remorse for breaking the law. What makes anyone think that they or their political heirs won’t do it all over again, given the chance?
In fact, we’ve already seen this movie. During the Reagan years, the Iran-contra conspirators violated the Constitution in the name of national security. But the first President Bush pardoned the major malefactors, and when the White House finally changed hands the political and media establishment gave Bill Clinton the same advice it’s giving Mr. Obama: let sleeping scandals lie. Sure enough, the second Bush administration picked up right where the Iran-contra conspirators left off — which isn’t too surprising when you bear in mind that Mr. Bush actually hired some of those conspirators.
Now, it’s true that a serious investigation of Bush-era abuses would make Washington an uncomfortable place, both for those who abused power and those who acted as their enablers or apologists. And these people have a lot of friends. But the price of protecting their comfort would be high: If we whitewash the abuses of the past eight years, we’ll guarantee that they will happen again.
Meanwhile, about Mr. Obama: while it’s probably in his short-term political interests to forgive and forget, next week he’s going to swear to “preserve, protect, and defend the Constitution of the United States.” That’s not a conditional oath to be honored only when it’s convenient.
And to protect and defend the Constitution, a president must do more than obey the Constitution himself; he must hold those who violate the Constitution accountable. So Mr. Obama should reconsider his apparent decision to let the previous administration get away with crime. Consequences aside, that’s not a decision he has the right to make.
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