Revenue Code Section 382: in the face of a financial crisis (pt. 2)

This follows up my earlier post regarding a presentation I gave to my tax policy class. I have since completed a final draft of my paper (PDF). I turned it in last night. There is much more that can be said about the subject but I realized part way through semester that it would be helpful to have had a background in economics. I checked out several books about economics and even sequestered myself in the libraries more than once but barely skim the top of the subject in the paper. I wish I’d studied economics in college, even if just a class or two. Fascinating stuff.

Since I gave the presentation, Senator Chuck Grassley sent a letter on November 14, 2008 to Inspector General Eric M. Thompson of the United States Treasury requesting a formal investigation into the origins of Notice 2008-83 and conflicts of interest in the Treasury leadership and their relations with bankers who will benefit from the guidance. The investigation is ongoing.

In addition, Senator Bernie Sanders introduced a bill to rescind Notice 2008-83. His web site has more information about the bill – Closing Corporate Loopholes news release, November 18 2008.

I agree with Sen. Sanders that it should be rescinded. It does not make sense, Treasury clearly lacks authority (in my view at least) to waive application of Section 382(h), and the banks should know better than to rely on it. This maxim comes to mind: “If it sounds too good to be true, it is.” If Treasury had wanted to really waive the rule, I think a better choice would have been to apply the waiver temporarily to all corporations that can show the purpose was not to traffic in NOLs and require the ownership change to involve an operating business and a substantial level of business continuity. Such a change in the program will accomplish a few things. It will limit macroeconomic distortions by encouraging investment and recapitalization of all business types. It will ensure that the original intent of Congress, to prevent or limit trafficking in NOLs, is met. And it will be more administrable than ad hoc regulation directed to correct market failures in one industry or group of corporations However, it might not be politically acceptable because it will limit Federal revenues and will increase an already large tab for the bailout of the financial system.

As for fixing the financial system (not my paper topic), the bailout is a failure. It is not targeted to the root causes of the chaos: trust. Or, I should say lack of trust. The Madoff ponzi scheme is just one more nail in the coffin of the bubble that the market is. The real issue is that nobody knows the true value of the assets held by banks, companies, or individuals. Those fancy securities with acronymns for names (CDO, MBS, etc.) are not transparent and escape any real valuation until everyone knows what they contain (not just dud grenades or sour grapes). In addition, the bailouts have come without two necessary components – revenge and accountability. Revenge is not just necessary from the tax payers vantage point but to lessen the moral hazard and prevent this from ever happening again.  If I were in Treasury, and I came very close to applying on, I would set up a separate unit/corporation of government that would take all of the bundled securities from banks and other entities that needed bailouts, enter bankruptcy protection, etc. and have that government entity sort out all the securities, insert transparency and then sell them off. The government would keep a share (say 50%) and give the rest back to the original holder. Such a plan would: 1) allow everyone to trust those securities again; 2) enact some modicum of revenge that lessens the moral hazard and makes it more acceptable to tax payers; and 3) through the first two create some accountability.