Friday, January 22, 2010

If It’s Thursday, It Must Be Time for a New Tax

From the Desk of Joe Rollins

It seems like once a week, the current administration finds a new tax to put on businesses. This reminds me of the old movie from when I was in college, “If it’s Tuesday, This Must Be Belgium,” a silly film that centered on a group of tourists on a motor coach tour of Europe where they visited a different country every day of the tour. If you’ve ever been on a European tour, I’m sure you can relate; when you wake up in the morning, you’re not quite sure which country you’re in that particular day, but it starts just like every other day before it. Almost every week, I get the same experience when I see the Obama administration proposing a new tax or a new regulation that will hurt the U.S. economy rather than help it.

Last week I wrote about the Wall Street Debacle and President Obama’s proposed “Financial Crisis Responsibility Fee” (Wall Street Debacle – Was It Really Greed? and “We Want Our Money Back, and We’re Going to Get It”). This week, I want to discuss the new regulations proposed on banks. What’s so interesting about these populist proposals by the administration is that there’s almost no chance that any of them will pass Congress. Even if they did pass, which is highly unlikely, they would have very little effect. I’ll try to explain why in today’s post.

I can’t help but think that in some regards, all of these new proposals are a smoke screen to cover up the other issues that now appear to be dead. As I discussed in my January 21st post (“The Health Care Bill is Officially Dead”), the proposed health care reform as written is completely dead. Even though we’ve not had the eulogy on the “Cap and Trade” legislation, it is also dead. A title of “Cap and Tax” would’ve been more appropriate.

Even though no one can argue the importance of saving the environment, the worst way of doing so is by regulating every piece of business in America with a new, prohibitive tax. Of course, the smoke screen is most prevalent on the economy, where the stimulus act has been an incredible failure and unemployment continues to be stubbornly high with no relief in sight.

I suspect that in President Obama’s State of the Union address next week, we will hear a lot of rhetoric concerning his attempt to get the federal deficits under control. As evidenced by the result of the Massachusetts Senatorial election, that is the number one issue on the minds of America. If Obama really wants to deal in populist politics, then he must address the deficits at some point. There is no more important time than now for him to do so.

I’ve written extensively on the TARP and the positive benefits it brought to the financial system in America in 2008. I’ve also pointed out that all the major banks in America have now repaid their TARP loans with significant interest and a premium for their options. The banking industry has done their part to make the TARP whole, even though they continue to be the whipping boy for new taxes in America.

The reason I point this out is because the current administration continues to use TARP money for pet projects that have nothing whatsoever to do with the financial stability of the banking industry. As you recall, the TARP was specifically restricted for the purpose of the financial institutions, and by law, dictated that when the money was repaid to the TARP, that it must be refunded to the federal government. However, that didn’t prevent the current administration from using the money for massive bailouts in the automobile industry and for AIG. Even though neither of those companies were financial institutions, it was clear that the money was used for purposes other than what it was intended.

U.S. Secretary of the Treasury, Timothy Geithner, recently announced that the need for the TARP was over. He said that the financial controls were now in place and the banking industry was stable. In spite of that, the Senate took a vote yesterday about whether or not to wind down the TARP and return all the unused money to the Treasury to reduce the deficit. The Senate voted 53 to 45 to close down the TARP, but the provision failed since it did not have 60 votes.

The purpose of this is to point out that even though your representatives give lip service regarding deficit reduction, it is absolutely clear that they intend to use the rest of the TARP money for their own pet projects. Mark my words that you’ll soon see the balance of the TARP money being spent for pork barrel projects that will do nothing to help stimulate the economy. In essence, the new stimulus money will be designed to bailout the old stimulus money, which has been a categorical failure.

Yesterday, the Dow Industrial Average went down 2% after President Obama’s speech wherein he proposed new regulations on the major banks. That was a classic case of “speak first, think later.” Reports of earnings for this quarter have been spectacular – we’ve seen sterling earnings reports from IBM, Intel, McDonald’s, Google, Goldman Sachs, and J.P. Morgan Chase, among others. Given the current economic environment, earnings have truly been incredible. Even with yesterday’s loss, the market is still up for 2010. It seems strange that the market would react so adversely to a proposal that, as I will demonstrate, will likely be meaningless.

Congress recently asked Secretary Geithner whether proprietary trading had anything to do with the financial meltdown in 2007 and 2008. He responded that proprietary trading had virtually nothing to do with the meltdown; rather, it was due to poor lending habits. Duh?!?! Why would new regulations be proposed if that wasn’t the problem?

I find it interesting that the current administration continues to blame the large banks for the financial meltdown when they didn’t even cause the problem. The source of the problem is clearly traced to the sub-prime lending market that Congress basically created. Congress forced Freddie and Fannie to provide the sub-prime loans that ultimately led to the financial meltdown.

Every problem that we can identify today regarding the financial meltdown is traced to the sub-prime loans created by Freddie and Fannie, which were ultimately syndicated by the brokerage houses and sold into the public market. In spite of that, none of the current administration’s proposals have anything to do with regulate the real bad guys – Congress, Freddie and Fannie. It seems that since our representatives cannot take responsibility for their own failures, they’ll simply find someone else to pin the blame on.

Isn’t it interesting that combined, Freddie and Fannie have lost a staggering $250 billion over the last three years. It’s also interesting that Freddie’s former CEO walked away with a total compensation package of close to $90 million when he left to join the administration. I find it incredibly confusing that the presidents of both Freddie and Fannie each received annually bonuses equaling $6 million for 2009, when they lost a combined $50 billion for 2009. No one complained about their compensation. Why?

On Friday, Congressman Barney Frank recommended that Freddie and Fannie be eliminated in its current form – a very good start. It seems that Congress has its focus on all the wrong people in this matter. Rather than the major banks being the problem, it was Freddie and Fannie, the auto companies and AIG, and they are not being assessed new taxes or new regulations.

Philosophically, who wouldn’t support the proposal as advertised? It’s doubtful anyone would support money that carried a government guarantee being utilized by the financial institutions that would then use those funds for proprietary trading or high risk taking at the government’s expense. However, that’s not occurring now anyway.

The four major banks in the United States that have government-guaranteed deposits are Bank of America, J.P. Morgan Chase, CitiBank and Wells Fargo. When I say “government guarantees,” I mean FDIC insurance on the deposit accounts in these major banks. As reported by The Wall Street Journal, of these four banks, Bank of America has 1% of its total revenues in proprietary trading accounts. Likewise, J.P. Morgan Chase has only 1% of its companywide revenue in proprietary trading accounts. Wells Fargo has no proprietary trading accounts at the current time, and only CitiBank (which is 30% owned by the U.S. government) has 5% of its revenues in proprietary trading accounts.

Because of President Obama’s speech, all of these stocks except Wells Fargo took a major beating on Thursday. This happened even though the purpose of the proposed regulation is moot because these accounts are basically a non-existent portion of the banks’ annual revenues. The fear isn’t this particular item; rather, investors are concerned with what other types of regulations the government may institute that will bog down banking and prevent them from loaning to businesses that need money to expand and increase employment.

There are only two remaining Wall Street firms – Morgan Stanley and Goldman Sachs, which represent the only true brokerage houses left in the U.S. Only 5% of Morgan Stanley’s gross revenues and 10% of Goldman Sachs’ revenues are in proprietary trading accounts. Interestingly, neither of these firms takes customer deposits, and therefore, they do not have government guarantees on their accounts. Each owns a very small bank in order for them to qualify for federal banking protection, and it would be easy enough for them to sell those small banks to avoid all the regulations being proposed.

As for the four major banks discussed above, each of them has brokerage divisions. It would be easy for them to reposition the proprietary trading accounts into their brokerage divisions and avoid the proposed regulations. As such, even though the administration made a big deal yesterday regarding these proposed regulations, from an economic standpoint they mean absolutely nothing. Again, the concern is what these types of regulations ultimately lead to in our economic landscape.

As I think will be demonstrated, the Congress today is less in the mood to restrict business since they need to stimulate employment. Given that they’ve wasted an entire year with proposed legislation that will not pass and which would have hurt business and employees, such as health care and Cap and Trade, now is the time for them to do something worthwhile.

I wonder if we could get through a few weeks without the current administration proposing a new tax or a new regulation that would hurt employment rather than improve it. It seems to me that the focus should be entirely and completely on increasing employment, but 12 months into the new administration, it appears that employees have been totally ignored.

As always, the foregoing are my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

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