Posted by Marc Hodak on May 6, 2009 under Collectivist instinct, Invisible trade-offs | 
That quote is in reference to Obama’s proposal to enhance the U.S.’s global taxing power over corporations incorporated here.
Here’s how it works now. P&G and Unilever can set up a soap plant in Ireland and sell soap in India. Unilever pays the Irish tax rate of 12.5% on its profits. P&G pays the same, but retains an additional 22.5% tax liability with the United States. P&G will have to cough up that cash as soon as it brings it back to the U.S. Lo and behold, they see an opportunity to build a warehouse in Ukraine, or a call center in Bangalore. They use their foreign profits to do this, paying a net tax that is exactly the same as Unilever’s for all these activities.
Obama says he wants that tax money now. As soon as P&G makes it. On money that never reaches the U.S. In Obama’s rose world, P&G is “shirking its responsibility” to the American people by shielding their profits from among the highest corporate taxes on Earth. Obama’s does not consider that the American government is shirking its responsibility to American companies by charging them among the highest rates on
Earth for the use of the house brand.
There’s actually a funny part to this story: Obama believes that this change in policy will encourage more jobs in the U.S. That’s right, by taking more of P&G’s foreign profits away from them, they will build that warehouse in Utah or that call center in Buffalo.
Only the U.S. has the arrogance to levy taxes on a global basis. This arrogance is born of the liberal hubris that these companies have nowhere else to go (“they wouldn’t dare reincorporate in Bermuda”), or that contemplating it constitutes a sort of treason. It is born of the conviction that a extra few billion in the hands of Congress is better for Americans than having it in the hands of American companies. They really believe that.
The really funny thing is that Obama believes the people telling him that he will actually see all those taxes rolling in. If history is any guide, some of those companies will, in fact, reincorporate in Bermuda, or Ireland, or Holland. It doesn’t cost much for even a fairly large, global company, certainly less than 20+ percent of their foreign profits per year. The ones that don’t re-incorporate outside of the U.S. will, instead, spin off their international divisions to their shareholders. Others will use any of dozens of other loopholes, presumably more expensive measures than they must use today, to keep from getting raped by Congress. Under no circumstances do I believe that Unilever or Arcelor or Nestle or any of the other challengers to our major businesses will reincorporate in Delaware and move their headquarters to New York. The few businesses that suck it up for whatever reason will simply have to adapt to becoming uncompetitive in a hungry world, resulting in less profits here to tax.
And we will not see a significant increase in tax revenue from our multinationals.
Posted by Marc Hodak on May 5, 2009 under Collectivist instinct, Invisible trade-offs |
The American Republic will endure, until politicians realize they can bribe the people with their own money.
– Alexis de Toqueville
We have seen how effective it is for people running for office to promise goodies to “the people” while pretending that it would be paid for by other people. This fakery works perfectly well with one layer of democracy. How much better can this corrupting mechanism work when you add a second layer of democracy?
Well, for the first time, the biggest source of state tax revenue is…federal tax dollars. Here is how it works: After the state has taxed your sales, income, and property, and spent that money on police, schools, and medicaid fraud, they still have a huge gap to fill. The federal government, financed largely by your income taxes, steps in to fill it. Yes, the tax dollars that you sent to Washington, D.C. gets rerouted via some incomprehensibly complicated, and very costly bureaucratic maze to your state capital, to be spent on whatever your (relatively) local politicians say is good for you.
It’s one thing to accept your local politicians telling you that you can’t figure out for yourself what your money should be spent on, that you can’t be expected to act as responsibly or charitably as your assemblyman or senator. It’s quite another thing for the federal government to say, in essence, that your state is not taxing and spending enough of your money, and so they (the feds) will tax you more and give your state more to spend.
Of course, the federal government is in fact shifting tax dollars from one state to another. The responsible (and largely Republican) citizens of Montana and Texas are paying for the profligacy of (largely Democratic) California and New York. Because that is the new American Way!
Posted by Marc Hodak on April 28, 2009 under Executive compensation, Invisible trade-offs |
It had to come to this. After months of bonus baiting, with everyone asking “where else could they go?” After Andrew Cuomo invited every banker unfortunate enough to find himself in the Journal or Times into his office to ask why they made so much money. After the press smacked Geithner around like a pinata. We’re finally at the moment when it all comes down to taking responsibility for a choice:
Citigroup Inc., soon to be one-third owned by the U.S. government, is asking the Treasury for permission to pay special bonuses to many key employees, according to people familiar with the matter.
We’re talking tens of millions for certain people. Choose your outraged retort:
How can anyone be worth that much? Surely they don’t need the money.
How can they be so greedy? This is just extortion!
Why should taxpayers be paying bonuses for failure?
Why should people need incentives to do their job?
Now that you’ve gotten it out of your system, put yourself in Geithner’s shoes. Phibro generates a huge amount of profit for the Citibank. It’s not the machines. It’s not the building or furnishings. It’s not the computers. It’s the people. The people create the profit. As with anything else, it’s most likely that 20% of the people create 80% of the profit. If you don’t pay the key 20%, they walk. You lose 80% of the profit. So, we can enjoy our two minute hate, the clever rants about evil bankers, and emotional complaints about how bankers are no more special than the “working man.” Then someone has to decide what to do about bonuses.
I think the right answer may be to spin off the unit; Citibank is unwieldy and inherently unprofitable. They need to get leaner. They need to undo the failed “financial supermarket” strategy that got them here if there is any chance of creating a profitable remnant. That, or pay enough to keep the best.
But that’s the economic decision. That’s what a conscientious board mindful of their fiduciary responsibilities would likely decide. Congress is a different kind of board. What would you do?
Posted by Marc Hodak on March 24, 2009 under Invisible trade-offs, Unintended consequences |
Shall we dance?
The market reacted to Geithner’s asset sale plan yesterday the way you would expect, if you expected a massive transfer of wealth from taxpayers to large publicly-traded banks. The banks are basically waiting to sell assets at above-market valuations, and Mr. Geithner is delivering the buyers.
But how good of a deal is this for the buyers of the assets? Consider a casino advertising a new game that pays out 2-1 for a game with odds of 4-1. That’s a lousy game on a straight bet. But this guy with a high forehead and curly hair is offering to loan you money on the bet. And you don’t have to pay all of it back if the bet goes sour. So your willingness to play this game depends on how much Curly is willing to lend you.
Now, Curly seems like a reasonable guy. But standing behind Curly are a couple of big guys who just recently beat the sh*t out of a recent winner, shaking him upside down until his winnings dropped out of his pocket.
Now, how willing are you to play with Curly?
“If it’s structured correctly, it could really be a very attractive opportunity for private investors, but it also could actually have the government get its money back,” Canning said.
The heavy criticism by lawmakers of the compensation at giant insurer American International Group (AIG.N), which was bailed out by the U.S. government, is the reason he would prefer to avoid public-private partnership.
“I don’t need the government’s help in structuring my compensation,” Canning said. “I get all the help I need from my partners.”
…says the partner in a $5 billion fund.
Posted by Marc Hodak on March 22, 2009 under Invisible trade-offs |
They’d better be good. They will have to induce private investors to risk investments in assets so toxic that they threatened to bring down the entire global financial system. Are these assets worth 60 cents (bankers wish)? Thirty cents (closer to the market)? Twenty-two cents?
Here is the game the government is playing: the lower the bids, the more likely the banks all go “boom” since they will have to recognize the low bids on their books, revealing most of them as insolvent. The higher the bids, the fewer banks will be seen as insolvent, but the more likely taxpayers will get sodomized, yet again. Is there a fair price that threads the spread?
Unfortunately, the government has been working overtime to keep that spread wide by compounding the uncertainty that will be faced by investors. That uncertainty significantly reduces the value of those “bad” assets to them. Will the loans have to be paid back according to the contracts that were written? Or will the contracts be modified by judicial fiat? Will Treasury and the Fed provide sufficiently clear rules for their participation? Will they then change the rules? And then, there’s the newest and biggest uncertainty: What does the winning investor get to keep? Joe Wiesenthal plays the rest of the tape:
Picture it: John Paulson makes $500 million buying distressed assets, after only putting up $10 million of his own cash, while the government puts in $90 million. The bet works out. Some newspaper reporter explains what happened, and next thing you know, Barney Frank is talking about how those are the “people’s profits” and how this is no time for hedge funds to be feasting off our carcasses — even though that’s the exact point of the TALF.
Will the profits get confiscated via some clever spread-the-wealth tax scheme that non-hedge-fund public wildly applauds? How does an investor build that risk into their decision-making?
That’s what Obama and Geithner are sweating out right now.
Update: Obama is seriously backpedaling from governing out of anger.
Read more of this article »
Posted by Marc Hodak on March 19, 2009 under Invisible trade-offs, Scandal |
The question originally was whether the infamous AIG bonuses hurt the taxpayers. Certainly not, at least from a bread and circus approach, the cleansing nature of the two minute hate, and all that. I’ve gotten my share of $165MM in entertainment watching the blowhards in Congress making fools of themselves, again.
But now, we’re hearing that we didn’t even need to pay these people, because…they had already completed what was required of them! Who gets worked up that a company would pay exactly what it promised to people who did exactly what they were paid to do? The Washington Post (picked up by Reuters):
The work of defusing the most dangerous bets placed by American International Group Inc was largely concluded long before the company gave bonuses to employees it said it needed to retain to avoid a financial meltdown…
The most explosive contracts largely were the creations of AIG’s Financial Products unit, and employees of that division — the recipients of the controversial bonuses — worked through the fall to unwind old deals, the report said.
By the end of December, the outstanding volume of risky and highly complex derivatives had been reduced to roughly $13 billion from $78 billion, the Post said, citing the company’s financial filings.
So, at some point early last year AIG realized that this group of brilliant but clueless financial engineers, the Rain Men of financial services, had created a ticking bomb in their midst. When they saw what happened at Bear Stearns in March of ’08, AIG panicked, and offered their Rain Men fixed retention payments–what the media insist on calling “bonuses”–to stick around for a year to defuse the bomb they had created. Most of them stayed. By the end of eight months, they had largely finished that task. And–this seems to be the gist of this article–the company paid them at the end of the year anyway.
Another outrage!
Posted by Marc Hodak on March 9, 2009 under Executive compensation, Invisible trade-offs |
When I saw the headline, “Activists Push for Lid on ‘Golden Coffin’ Death Benefits,’ I immediately thought, oh God, what manner of micromanagement are the activists trying to impose on hapless boards now?
Golden coffin is the perjorative term, loved by unions and the media, for a form of tax-efficient deferred compensation. They are somewhat complicated structures, but they have two two salient properties: (1) they can sometimes be low-cost ways of providing senior executives with certain estate-planning or tax benefits that they greatly value, and (2) they provide a stream of payments, instead of a lump-sum, to the beneficiaries–what one might call a form of guaranteed pay.
Boards and the executives they hire clearly like the first property. They probably would be just as happy to provide this perk in the form of a straight salary, but the tax code makes that the most expensive way of delivering marginal compensation to the top five executives. Boards and managers, looking for a more tax efficient way, came up with this deferred compensation method.
Critics are fixated on the second property. Read more of this article »
Posted by Marc Hodak on March 2, 2009 under Executive compensation, Invisible trade-offs, Unintended consequences |
Nassim Nicholas Taleb has written a good description of what is now widely understood to be one of the key perverse incentives that fueled the recent credit bubble–i.e., the trader’s option:
Take two bankers. The first is conservative. He produces one annual dollar of sound returns, with no risk of blow-up. The second looks no less conservative, but makes $2 by making complicated transactions that make a steady income, but are bound to blow up on occasion, losing everything made and more. So while the first banker might end up out of business, under competitive strains, the second is going to do a lot better for himself. Why? Because banking is not about true risks but perceived volatility of returns: you earn a stream of steady bonuses for seven or eight years, then when the losses take place, you are not asked to disburse anything.
Like like many others cognizant of the moral hazards of the trader’s option, Taleb throws up his hands and recommends hiving off the risky portions of banking from the “utility” parts of banking, and heavily regulating the compensation of the latter. So easily said, isn’t it?
Read more of this article »
Posted by Marc Hodak on February 6, 2009 under History, Invisible trade-offs |
…I offer this little commentary:
There are men regarded today as brilliant economists, who deprecate saving and recommend squandering on a national scale as the way of economic salvation; and when anyone points to what the consequences of these policies will be in the long run, they reply flippantly, as might the prodigal son of a warning father: “In the long run we are all dead.” And such shallow wisecracks pass as devastating epigrams and the ripest wisdom.
But the tragedy is that, on the contrary, we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore. The long-run consequences of some economic policies may become evident in a few months. Others may not become evident for several years. Still others may not become evident for decades. But in every case those long-run consequences are contained in the policy as surely as the hen was in the egg, the flower in the seed.
This wisdom was offered in 1946. Which reminds me of this wisdom.
Posted by Marc Hodak on February 5, 2009 under Invisible trade-offs, Politics |
I have gotten a number of inquiries about my thoughts on the new executive compensation rules laid out by President Obama. So, here they are:
1) The rules look like they’re about executive compensation, but they’re not. They’re about getting congressional and public support for the fabulous spending orgy that has the president’s congressional colleagues in a state of priapic delirium. Obama is using “$500K” to buy “$500B” (the spending portion of the “stimulus”).
2) If you have any doubt about the political intent, check out the requirement of an “Adoption of Company Policy Relating to Approval of Luxury Expenditures.” This the clearest example yet of of how the institutionalized greed of Wall Street is being replaced by the institutionalized envy of Washington.
3) As little economic training as Obama has, he knows that real wage controls will not work in America (if anywhere), so he is promoting these reforms knowing their potential danger, and acceding to various loopholes in their implementation. He may mistakenly believe that these dangers can be well contained (see #8 and #10 below).
4) Yes, we compensation consultants will be able to use the proposal’s loopholes to work around the limits to a considerable extent. Obviously, we have restricted stock, albeit with a few extra restrictions, that enable us to greatly improve the value of the plans to the executives. Less obviously, we have a large variety of long-term incentive arrangements we can create well within the letter of the law. All of these will be costlier to the shareholders than the arrangements they replace.
5) Ironically, these newer compensation structures will also be dramatically riskier for the shareholders in ways the government cannot contemplate, despite their mandate to limit risk. We might be able to create equity compensation instruments that can limit these risks, but the SEC will inevitably drag their feet on them, and Congress will likely block them, so we will probably not even try.
6) In the cases where we can’t get around the limits imposed by this plan, you should sell those companies short. They will lose talent at an unconscionable clip.
7) Outside of my professional capacity, I actually have no qualms about these firms losing their competitiveness and going under as a result of the plethora of unintended consequences of this proposal. If these rules accelerate that process, all the better. Replacing market discipline with political discipline will not help these companies, and they won’t get our economy back on track.
8) The worst part of this proposal is not the nominal effect it will have on firms getting TARP money; it will be the precedent of Congress legislating pay. As the shortcomings of these rules come into focus, and as the contortions necessitated by business imperatives become plainer, and spread to other parts of the economy via a misguided attempt to satisfy political constraints at the expense of shareholder value, Congress will inevitably feel the need to “fix” these rules, enlarging their scope and increasing their complexity.
9) We’re one step closer to widespread adoption of “Say on Pay” if not outright legislation of it. Anyone who has kept up with my writings on this knows that, while I don’t believe “Say on Pay” will be the end of civilization as we know it, I think it will significantly step up the politicization of executive compensation, pulling it further from the market-driven/shareholder-friendly ideal that many of its proponents nominally favor.
10) Congressional involvement in executive pay will quickly spawn a cottage industry in compensation lobbying. In fact, very few areas of congressional intervention will get the attention of executives faster than messing with their pay. Congress is basically increasing the rift between the interests of managers and those of the shareholders. It’s hard to think of anything adding greater agency costs than mandates along the line of, “well, you can choose this constraint on your pay, or that policy that will help your firm.”
11) So, in a political fight over executive compensation between the concentrated interests of highly effective, type-A executives, and the dispersed interests of shareholders defended by ivory tower intellectuals and effete guardians of the “public interest,” guess who will win?
12) That’s right: private equity. It’s fashionable to remark “where will these overpaid Wall Street stiffs go in this environment when we slash their pay?” And it’s true, the private equity markets are as far down as anyone these days. But the market won’t stay down forever. And when it comes back, the PE firms will only have economic hurdles to get over. The political hurdles being set up will still be there for public companies.
Where the title comes from: An excerpt of White House deliberations.
