A Quiet Windfall for US Banks
By Amit R. Paley
The financial world was fixated on Capitol Hill as Congress battled over the Bush administration’s request for a $700 billion bailout of the banking industry. In the midst of this late-September drama, the Treasury Department issued a five-sentence notice that attracted almost no public attention.
Section 382 of the tax code was created by Congress in 1986 to end what it considered an abuse of the tax system: companies sheltering their profits from taxation by acquiring shell companies whose only real value was the losses on their books. The firms would then use the acquired company’s losses to offset their gains and avoid paying taxes.
Lawmakers decried the tax shelters as a scam and created a formula to strictly limit the use of those purchased losses for tax purposes.
But from the beginning, some conservative economists and Republican administration officials criticized the new law as unwieldy and unnecessary meddling by the government in the business world.
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> Strange that this only gets disclosed after the election.
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Agreed!
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This was actually very well commented on when it happened. Even Warren Buffett mentioned on CNBC that Wells Fargo’s acquisition of Wachovia would result in very important tax benefits from the new ruling.
Despite the tone of the article, there is another one to look at the Sect 382 changes. First of all, the NOL’s represent real losses. Looking at the banking industry in aggregate, the policy choice seems to be whether the NOL’s are transferred within the industry, versus simply being dissolved and lost forever.
If the NOL’s are lost, it lowers the acquisition value for a bank like Wachovia. Note that immediately prior to the ruling, Wells Fargo walked away from a deal, and Citibank made its offer dependent on the FDIC backstopping the losses. Citibank also would have dissolved much of Wachovia, since they were interested only in the bank, and none of the financial services and advisory businesses.
After the ruling, Wells Fargo came in with a substantially improved offer that took away the FDIC backstop and promised less severe job losses (Sect 382). That is because WFC did a tax free merger, rather than a taxable asset purchase / liability assumption. In the former, the acquiring bank inherits the historical tax basis (getting lots of NOL’s).
Another benefit of the change to sect 382 is that very large recapitalizations would lose the use of the NOL’s if a majority of the ownership changed.
So, it seems to me that one of the issues is the means of transmission/realization of these losses. Should they occur as a transfer of NOL’s to a stronger bank? The stronger bank then pays less in future taxes. As an example, let’s say $5 billion. Or should they be completely dissolved, and the FDIC realize those losses? In that case, it would be the same $5 billion.
Finally, congress could have addressed the situation. They could have increased the tax loss carryback provisions, and targetted it at specific industries. The damaged bank has already paid taxes on the gains from their business, but are restricted in taking the current NOL’s and reaching back far enough to recover previous taxes paid.
Interestingly enough, in the case of a “failed” bank like Wachovia, the losing bidder (Citibank), after first requiring an FDIC subsidy, turned around and sued for something like $60 billion in damages after Wachovia accepted the higher competing bid from Wells Fargo.
There are real values in these banks. Notwithstanding the immediate losses, the deposit franchises have tremendous value, and the realized losses might be much less than assumed. As with many of the pockets of damage in this upheaval, the focus is on the immediate losses, and not the future earnings of the entity.
Warren, as you like to say, the housing bubble did create real assets, in the form of homes, and people tend to lose track of that. This is simply the other side of that real production–how to allocate the financial losses. I’d rather have Wells Fargo take over the entire Wachovia business than to have the FDIC take on another situation. The FDIC will already have enough IndyMac situations to address.
No doubt, the change to section 382 is a big deal, but that article casts the whole story in terms of power/legality/sneakiness. Seems that is a better understood paradigm in D.C. than the aggregate balance sheet of the banking system.
“Warren, as you like to say, the housing bubble did create real assets, in the form of homes,”
Hold up there speedy gonzales – real assets that are a drag on you because of carrying costs are not GOOD long term are they? Lets not praise the bubble before all the chickens come home to roost – that takes you down a dangerous slippery slope that your mop may not be big enough to clean up mr. greenspan:
Aug. 17, 1931. I just came back from a short stay at Geneva-on-the-Lake. Summer resorts seem to be particularly hard hit. Hotels are empty and everybody is bidding for business at cut-rate prices. This is a good time to buy summer resort homes or even large mansions of the rich people. Nobody wants them at any price because they are too expensive to carry. Many formerly rich families are living in the chauffeur quarters above the garage while the mansion stands closed
http://www.newsweek.com/id/168045
well stated, roger!