Reports From My Nanocosm

You can now download the paper I wrote for a Mass Communications class I took during the fall semester (also with a more practical title): Water Law Principles Applied to Spectrum Opportunities for Wireless Rural Broadband (PDF — 37 pages – with links) (Google Docs – without links).

In the paper, I recommend that the FCC utilize principles from water law to open up radio spectrum to encourage mobile/wireless broadband in rural areas.

From the introduction:

The Federal Communications Commission (FCC) issued an order, [the White Spaces Order], in November 2008 to free up  unused radio spectrum in the television frequency band for unlicensed use by low power devices. A  goal of the order is to help lower the costs of entry to potential wireless broadband providers by making more spectrum available for free to businesses and consumers.

One shortcoming in relation to rural users is the order’s failure to address backhaul between a rural  community and backbone networks. Frequencies in the television spectrum that are the focus of the  White Spaces Order do not lend themselves well to point to point communication necessary for longer  distance backhaul from a community to a backbone connection point. Without access to spectrum for  backhaul, rural communities will be forced to rely on other alternatives such as more expensive fiber cables. As such, the Commission will need to provide spectrum that is better suited for backhaul required for viable and economic high speed Internet services in rural communities. To that end, I suggest that the Commission apply three modified principles of water law that: 1) require spectrum use  be beneficial and reasonable; 2) require the licensee to actually use the spectrum and not hold a license  for speculative purposes; and 3) provide for equivalent replacement of a communications signal.

Applying these principles will free up unused and underutilized spectrum for more productive purposes including point to point backhaul connections.

Continue reading: Water Law Principles Applied to Spectrum Opportunities for Wireless Rural Broadband (PDF — 37 pages – with links) (Google Docs – without links).

I am voting NO on all of the propositions in the May 19, 2009 special election. The legislature needs to do the job it was elected to do. If not, then every one of them not willing to compromise in good faith should resign.

What will it take for the California legislature to do its job? Instead of passing a budget, it delayed the hardest decisions and deferred to voters. At what cost? The propositions do not even balance the budget or structurally change how budgets are made or how money is spent. The propositions only move money from one set of pots to to another in a apparently symbolic move. It is like moving deck chairs on the Titantic as cold Atlantic waters stream into a big gash in the side of the boat. Hello, there are structural problems causing California’s budget woes! Worse, these are temporary measures that delay or exacerbate the problems faced by the state government. Really, what do passing these initiatives get us?

via California Legislature: Where cost-cutting plans go to die – Los Angeles Times.

“Republicans pitched most of the plans to help deal with the deficit — which is expected to hit $8 billion by summer — but even some from moderate Democrats were rejected.

…

State officials have projected the midyear budget shortfall as a result of the recession. And if voters reject the budget-related ballot measures in the May 19 special election, the deficit could top $14 billion.”

via State will need to borrow more than $20 billion S.F. Chronicle.

“California will have to borrow more than $20 billion unless state leaders close another multibillion-dollar deficit that will deepen if voters reject budget-related ballot measures on May 19, according to a report Thursday by the nonpartisan Legislative Analyst’s Office.

…

In addition, California may have to pay hundreds of millions of dollars in additional borrowing costs as a result of the banking crisis. In previous years, the state was able to secure lower interest rates by purchasing loan guarantees from commercial banks.

But banks have told state finance officials that they can at best back about $1 billion in loans, far short of the state’s borrowing needs, said Tom Dresslar, a spokesman for state Treasurer Bill Lockyer.”

The articles say so much more than what I flash here. Really, they are worth reading to educate yourself. Really, these propositions do little to help the situation.

via Californiaâ??s Cash Flow Crisis: May 2009 Update.

Without significant budget-balancing and cash management actions by the Legislature or unprecedented borrowing from the short-term credit markets, the state will not be able to pay many of its bills on time for much of 2009-10.

• $23 billion: Amount in loans from private investors needed in the fiscal year beginning July 1 if voters reject the May 19 ballot measures and the Legislature does not act;
• $17 billion: Amount in loans from private investors needed if voters approve the ballot measures
• $14 billion: Budget shortfall if voters reject Propositions 1C, 1D and 1E (i.e. the measures bring in $6 billion to budget).
• $8 billion: Budget shortfall if voters approve Props. 1C, 1D and 1E

And here are highlights from the Official Voter Information Guide distributed by the Secretary of State followed by my commentary, labeled [DFB]. Highlights are mine.

Proposition 1A:

• “Possible greater state spending on repaying budgetary borrowing and debt, infrastructure projects, and temporary tax relief. In some cases, this would mean less money available for ongoing spending.”
• [DFB] In other words, we will borrow money now but we will be required to pay more for debt servicing and paying interest on that debt in future budgets. Moreover, we will need to cut spending in future years to pay for our budget woes now. Where will that money come from?

Proposition 1B: Fiscal Impact:

• “Potential state savings of up to several billion dollars in 2009â??10 and 2010â??11.”"Potential state costs of billions of dollars annually thereafter. “
• [DFB] There are no estimates attached to this future cost. The voter guide says “it is difficult to know how this measure would change the state’s finances.” Voter Guide, page 21.

Proposition 1C:

• “Impact on 2009â??10 State Budget: Allows $5 billion of borrowing from future lottery profits to help balance the 2009â??10 state budget.”
• “Impact on Future State Budgets: Debt-service payments on the lottery borrowing and higher payments to education would likely make it more difficult to balance future state budgets. This impact would be lessened by potentially higher lottery profits. Additional lottery borrowing would be allowed. “
• [DFB] Get this part: “would likely make it more difficult to balance future state budgets”? Yes, the authors of this measure are trying to address a difficult to pass budget by hamstringing future legislators by making it difficult to balance/pass future budgets. Isn’t that how we got into this mess? It infuriates me to no end to see this level of misfeasance. [bleeped out so I do not make a statement against my penal interests - sorry, I had a Criminal Procedure exam earlier this evening ]

Proposition 1D:

• “Redirects existing tobacco tax money to protect health and human services for children, including services for at-risk families, services for children with disabilities, and services for foster children. “
• [DFB]: This is an example of moving money from one pot to another. It is temporary and lasts five years. What happens in five years? This whole mess begins anew.

Proposition 1E:

• “Amends Mental Health Services Act (Proposition 63 of 2004) to transfer funds, for a two-year period, from mental health programs under that act to pay for mental health services for children and young adults provided through the Early and Periodic Screening, Diagnosis, and Treatment Program.”
• “The proposed temporary redirection in Proposition 63 funding would make less money available for mental health programs. To the extent that such programs are reduced, state and local governments could incur added costs for homeless shelters, social services programs, medical care, law enforcement, and county jail and state prison operations. The extent of these potential costs is unknown and would depend upon the specific programmatic changes that resulted from the redirection of Proposition 63 funding.”
• [DFB] This is another temporary measure lasting two years that moves money from one pot to another. As the analysis shows, there is a big budget gap that will be left for cities and counties to make up, perhaps from thin air.

Proposition 1F:

• “Encourages balanced state budgets by preventing elected Members of the Legislature and statewide constitutional officers, including the Governor, from receiving pay raises in years when the state is running a deficit.”
• “Minor state savings related to elected state officialsâ?? salaries in some cases when the state is expected to end the year with a budget deficit.”
• [DFB] This is like being bitten by a minnow. A Delta smelt, perhaps? It lacks teeth big enough to pierce the skin. Worse, it will have a negligible effect on the budget. I’d rather see a sliding scale that forces the legislature to deliver a structurally balanced budget by July 1. Every week after would see a 10% reduction in pay for that period. If a legislator was paid $100,000 per year they would be paid based on $90,000/year the following week and $81,000/year the following week. At week 29, they would be paid based on $5,233/year salary. See the chart below. Now that ought to get their attention in contrast to the slap with the pinkie finger the legislature has given itself.

Of course I only cherry picked the items that caught my eye or that I should call attention to. Read the propositions yourself.

To be fair, voters are part of the problem. We have tied the hands of the legislature with proposition after proposition to support our pet projects, idealogical views, and pocket books. What we have collectively done is force legislators to do the equivalent of cloud seeding. Fortunately, we’ve had a prosperous enough time where money came easily in coincidental alignment with those revenue seeding experiments. Now, the magic is gone and we need to fess up to reality. Money does not grow on trees or fall from the sky. Debt is not cheap. And California’s budget is a briar patch that needs to be dethorned.

There should be no “third rail” to this debate. That overused political colloquism should go out the window in this conversation. There is nothing that should be held too sacred in conversations about how to fix – how to truly fix – the state budget. Prop 13, Prop 98, Prop XX, all need to be considered without reservations. It may take a vote of the people to undo some of the mess we created but at least put something valuable and constructive for us to debate and vote on instead of something from a sewage plant, spit-shined and treated like Cinderella’s glass slipper. At the end of the day, the conversation must be about the balance sheet: revenue versus expenditures; and how to make each more stable and controlled.

I personally do not mind paying taxes. After all, I prefer not to live in anarchy, like to drink clean water, drive the roads, ride the rail, etc. All those are paid by my tax dollars. That doesn’t mean don’t care where those tax dollars go. One place I do care about is how much we pay for interest payments and loan servicing. In Sacramento, they call it Debt-Servicing.

As of November 2008, debt-servicing is expected to cost us about $6 billion this fiscal year, or about 5.8% of the state’s revenues. Since the early 1990′s debt-servicing generally cost between 3 and 5% of revenues. It is now expected to reach 9% or more in the next 5 years. And since the last set of projections made in November 2008, the special election was set and we are now urged to increase that debt service ratio further. Proposition 1C will cost us $350 to $450 million more each year for debt-servicing. The governor and Department of Water Resources are also drumming up support for $20 billion in upgrades to our water infrastructure (Peripheral Canal, part II). That would potentially cost $1.3 billion per year more in debt servicing. Those are not figured into the numbers, either.

More costs are expected. Worse yet, CALPERS “has been reporting an expected rate of return of 7.75 percent for the past eight years, and 8 percent before that…. Its annual return during the decade from Dec. 31, 1998, to Dec. 31, 2008, has been 3.32 percent, and last year, when markets tanked, it lost 27 percent.” (via Bloomberg). We’ll need to borrow to bail it out as well since the pension fund is guaranteed by the state treasury.

via  California’s Fiscal Outlook: LAO Projections 2008-09 Through 2013-14 (issued Nov. 2008)

“The Spending Forecast. General Fund spending for debt service on bonds used to fund infrastructure is estimated to be $4.3 billion in 2007â??08, $5 billion in 2008â??09, and $5.9 billion in 2009â??10. In total, debt service is projected to grow at an annual pace of 9.9 percent annually over the forecast period.

Debtâ??Service Ratio (DSR). [T]he ratio of annual General Fund debt-service costs to annual General Fund revenues and transfers [abbreviated DSR] — is often used as one indicator of the stateâ??s debt burden…. We estimate that:

• The DSR for infrastructure bonds will rise to 7.8 percent in 2011â??12 before falling to 7.5 percent by 2013â??14. Thereafter, it will steadily decline as outstanding bonds are paid off.
• If the stateâ??s deficitâ??financing bonds (known as Economic Recovery Bonds) are included in DSR, it would peak at 9.4 percent in 2011â??12. It is anticipated that these bonds will be paid off following our forecast period, at which time the DSR will drop down to reflect only infrastructure bonds.

As noted in the figure, the DSR we are projecting is considerably higher than in past years. In part, this reflects the sharp fallâ??off in General Fund revenues we are projecting, which has the effect of driving the ratio up for a given level of debt service. It also is important to note that to the extent additional bonds are authorized and sold in future years beyond those already approved, the stateâ??s debtâ??service costs and DSR would be higher than projected above. For example, each additional $1 billion of bonds authorized would add roughly $65 million annually to debtâ??service costs once they are sold.”

Debt is not evil. It is not the work of the devil or some other unearthly creature.

Debt is a useful tool to people and governments to build infrastructure that costs a lot of money up front but lasts for many years and, more importantly, provide the tools necessary to build an economy. Using it to pay down past debts and for operating costs is a misallocation of resources. It puts a the state into a precarious perch and positioned for a spiral downward that is hard to recover from. We should all be mindful that, instead of paying for necessities such as teachers, police, and repaving, we will end up cutting services to pay for the extra debt payments. I think returning to the historical norm should be the goal and will allow us to build and restore infrastructure without putting on too much debt servicing burden.

I think the Catholic bishops are wrong to complain about Notre Dame University inviting President Obama to speak at its commencement ceremonies and honoring him for his achievements. Unlike a church, a university is intended to be an open environment that is tolerant of many different viewpoints. Notre Dame and the dozens of other Catholic universities in the U.S. have built well earned reputations as just such open environments.

Refusing to invite a diverse set of speakers based on a singular issue is clueless, as one bishop characterized Notre Dame’s decision. Do the bishops intend to expel all faculty, students, and staff who disagree with their position on abortion? Will they insist Notre Dame hold back degrees of students who voted for Obama, have had an abortion, supported a friend who had an abortion, or are supportive of a woman’s right to choose? Until they are ready to do either or both, then the bishops should let Catholic universities remain open academic environments, confer honorary degrees based on objective standards, and invite any speakers chosen by the school. God forbid the bishops should take any affirmative steps toward either action because we might just see an outright revolt by university trustees in addition to students choosing other universities. I, for one, would then not qualify to earn a law degree from Santa Clara Law School as I hold similar views to Mr. Obama with regard to a woman’s right to choose and stem cell research.

Need I even go so far as to point out that the bishops are not speaking from a very good spiritual position and the church is already struggling for relevance. This is, after all, the same set of bishops who played active roles in the still-fresh sexual abuse scandals.

AP, Y! News: Notre Dame’s Obama invite riles Catholic bishops.

This coming week, Bishop Thomas Wenski of the Roman Catholic Diocese of Orlando, Fla., will take the unusual step of celebrating a Mass of Reparation, to make amends for sins against God.

The motivation: to provide an outlet for Catholics upset with what Wenski calls the University of Notre Dame’s “clueless” decision to invite President Barack Obama to speak at its commencement and receive an honorary doctorate May 17.

The nation’s flagship Catholic university’s honoring of a politician whose abortion rights record clashes with a fundamental church teaching has triggered a reaction among the nation’s Catholic bishops that is remarkable in scope and tone, church observers say.

At least 55 bishops have publicly denounced or questioned Notre Dame in recent weeks, employing an arsenal of terms ranging from “travesty” and “debacle” to “extreme embarrassment.”

The bishops’ response is part of a decades-long march to make abortion the paramount issue for their activism, a marker of the kind of bishops Rome has sent to the U.S. and the latest front in a struggle over Catholic identity that has exposed rifts between hierarchy and flock.

Bishops who have spoken out so far account for 20 percent of the roughly 265 active U.S. bishops â?? a minority, but more than double the number who suggested five years ago that then-Democratic presidential hopeful and Catholic John Kerry should either be refused Communion or refrain from it because of his abortion stance.

The Senate passed its version of the stimulus package today (HR 1.AS2). As is often the case, it seems there is something for everyone. For example, the Senate generously left intact Wells Fargo’s gift from Hank Paulson and crew, Treasury Notice 2008-83, although the notice has been restricted from further use. The gift is likely to make it into the final bill because the text came from the House version of the bill and was left untouched by the Senate.

SEC. 1281. CLARIFICATION OF REGULATIONS RELATED TO LIMITATIONS ON CERTAIN BUILT-IN LOSSES FOLLOWING AN OWNERSHIP CHANGE.

In other words, Congress is letting stand any bank mergers before Jan. 17 which might have relied on Treasury Notice 2008-83 which gave banks (and only banks) a pass on section 382(h) of the tax code. I provide a basic summary in an earlier post: Revenue Code Section 382: in the face of a financial crisis

Update: This made it through conference and was signed into law by President Obama.

The House passed an economic stimulus bill today. It includes the slap-down of Treasury Notice 2008-83 that the House Ways and Means Committee had previously included. I hope the conference with the Senate disallows all reliance on the notice.

H.R.1

American Recovery and Reinvestment Act of 2009 (Introduced in House)

---

PART 4–CLARIFICATION OF REGULATIONS RELATED TO LIMITATIONS ON CERTAIN BUILT-IN LOSSES FOLLOWING AN OWNERSHIP CHANGE

SEC. 1431. CLARIFICATION OF REGULATIONS RELATED TO LIMITATIONS ON CERTAIN BUILT-IN LOSSES FOLLOWING AN OWNERSHIP CHANGE.

(a) Findings- Congress finds as follows:

• (1) The delegation of authority to the Secretary of the Treasury under section 382(m) of the Internal Revenue Code of 1986 does not authorize the Secretary to provide exemptions or special rules that are restricted to particular industries or classes of taxpayers.

• (2) Internal Revenue Service Notice 2008-83 is inconsistent with the congressional intent in enacting such section 382(m).

• (3) The legal authority to prescribe Internal Revenue Service Notice 2008-83 is doubtful.

• (4) However, as taxpayers should generally be able to rely on guidance issued by the Secretary of the Treasury legislation is necessary to clarify the force and effect of Internal Revenue Service Notice 2008-83 and restore the proper application under the Internal Revenue Code of 1986 of the limitation on built-in losses following an ownership change of a bank.

(b) Determination of Force and Effect of Internal Revenue Service Notice 2008-83 Exempting Banks From Limitation on Certain Built-in Losses Following Ownership Change-

• (1) IN GENERAL- Internal Revenue Service Notice 2008-83–

• • (A) shall be deemed to have the force and effect of law with respect to any ownership change (as defined in section 382(g) of the Internal Revenue Code of 1986) occurring on or before January 16, 2009, and

• • (B) shall have no force or effect with respect to any ownership change after such date.

• (2) BINDING CONTRACTS- Notwithstanding paragraph (1), Internal Revenue Service Notice 2008-83 shall have the force and effect of law with respect to any ownership change (as so defined) which occurs after January 16, 2009 if such change–

• • (A) is pursuant to a written binding contract entered into on or before such date, or

• • (B) is pursuant to a written agreement entered into on or before such date and such agreement was described on or before such date in a public announcement or in a filing with the Securities and Exchange Commission required by reason of such ownership change.

Update: This made it through the Senate and conference session, and was signed into law by President Obama.

It looks like Congress is about to squelch Treasury Notice 2008-83 but will provide a gift to banks that already relied on it. I think of it as much a parting gift to outgoing Treasury Secretary Paulson.

The draft economic recovery/stimulus package that is starting to wind its way through Congress essentially says that the Treasury Department went beyond its powers by issuing Notice 2008-83 but that banks that already relied on the tax guidance provided by the notice may still take advantage of the huge tax breaks it provides them.

Relevant text from the bill:

PART 4 â?? CLARIFICATION OF REGULATIONS RE-LATED TO LIMITATIONS ON CERTAIN BUILT-IN LOSSES FOLLOWING AN OWNERSHIP CHANGE

SEC. 1431. CLARIFICATION OF REGULATIONS RELATED TO LIMITATIONS ON CERTAIN BUILT-IN LOSSES FOLLOWING AN OWNERSHIP CHANGE.
(a) FINDINGS.â??Congress finds as follows:
(1) The delegation of authority to the Secretary of the Treasury under section 382(m) of the Internal Revenue Code of 1986 does not authorize the Secretary to provide exemptions or special rules that are restricted to particular industries or classes of taxpayers.
(2) Internal Revenue Service Notice 2008â??83 is inconsistent with the congressional intent in enacting such section 382(m).
(3) The legal authority to prescribe Internal Revenue Service Notice 2008â??83 is doubtful.
(4) However, as taxpayers should generally be able to rely on guidance issued by the Secretary of the Treasury legislation is necessary to clarify the force and effect of Internal Revenue Service Notice 2008â??83 and restore the proper application under the Internal Revenue Code of 1986 of the limitation on built-in losses following an ownership change of a bank.
(b) DETERMINATION FORCE EFFECT OF INTERNAL REVENUE SERVICE NOTICE 2008â??83 EXEMPTING BANKS FROM LIMITATION CERTAIN BUILTâ??IN
LOSSES FOLLOWING OWNERSHIP CHANGE.â??
(1) IN GENERAL.â??Internal Revenue Service Notice 2008â??83â??
(A) shall be deemed to have the force and effect of law with respect to any ownership change (as defined in section 382(g) of the Internal Revenue Code of 1986) occurring on or before January 16, 2009, and
(B) shall have no force or effect with respect to any ownership change after such date.
(2) BINDING CONTRACTS.â??Notwithstanding paragraph (1), Internal Revenue Service Notice 2008â??83 shall have the force and effect of law with respect to any ownership change (as so defined) which occurs after January 16, 2009 if such changeâ??
(A) is pursuant to a written binding contract entered into on or before such date, or
(B) was described on or before such date in a public announcement or in a filing with the Securities and Exchange Commision required by reason of such ownership change.

Full Text of The American Economic Recovery and Reinvestment Plan

The bill was posted today and will be officially introduced by Rep. Rangel to the House Ways and Means Committee over the coming days. Apparently, this is hot off the presses. A Committee press release about the bill is dated Saturday, Jan. 17, 2009 although it does mention the bill blocking Notice 2008-83.

The AP provides more commentary on the stimulus package and the repeal of Notice 2008-83.

via Stimulus plan repeals big tax break for banks – washingtonpost.com.

House leaders moved this week to repeal the tax break for banks even as the Senate voted to help many of those same institutions by releasing the second $350 billion of the widely unpopular Wall Street bailout. Many lawmakers are unhappy with the results after the Bush administration spent the first $350 billion, making them wary of helping banks in the stimulus package.

…

Repealing the tax break would negate those savings in future bank mergers. It would not, however, affect mergers already under way, according to a summary of the stimulus package released by the tax-writing House Ways and Means Committee.

I personally think Congress should prevent any party from taking advantage of the guidance from Notice 2008-83. The banks that did knew or should have known that it was likely not legal, outside the powers of the Treasury Department, and would be slapped down by Congress. I wrote more about that in my last post about Notice 2008-83.

Related posts:

• Revenue Code Section 382: in the face of a financial crisis (presentation/outline of the tax policy issues)

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

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. http://finance.senate.gov/press/Gpress/2008/prg111408c.pdf

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 change.gov, 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.

I’m saddened by what we’ve done to our environment. There must be a way for us to live well without completely destroying the ecosystem in the process. I read the following while researching for a water law paper.

From: Natural Resources Defense Council v. Patterson, 333 F.Supp.2d 906 (E.D. Cal 2004)

I. Undisputed Facts

A. THE SAN JOAQUIN RIVER BEFORE FRIANT DAM

B. THE BUILDING OF FRIANT DAM

Perhaps we can see the salmon return one day. Congress may help that happen during the next session when it votes on whether to support a court settlement that would return some flows to the river (see: Senate puts [San Joaquin] river restoration plan on hold, Modesto Bee, November 18, 2008). If not, I’d like to see the public trust doctrine invoked by the State of California to require the Bureau of Reclamation to restore some river flows as part of its license to appropriate water. In addition, we should use our ingenuity to look to find alternative solutions to our water needs, whether it be water recycling like Singapore, desalination, or a mix of those and other solutions not yet created.

FDA sets melamine standard for baby formula – Yahoo! News.

WASHINGTON â?? Less than two months after federal food regulators said they were unable to set a safety threshold for the industrial chemical melamine in baby formula, they announced a standard that allows for higher levels than those found in U.S.-made batches of the product.

Food and Drug Administration officials on Friday set a threshold of 1 part per million of melamine in formula, provided a related chemical isn’t present. They insisted the formulas are safe.

The setting of the standard comes days after The Associated Press reported that FDA tests found traces of melamine in the infant formula of one major U.S. manufacturer and cyanuric acid, a chemical relative, in the formula of a second major maker. The contaminated samples, which both measured at levels below the new standard, were analyzed several weeks ago.

The FDA had stated in early October that it was unable to set a safety contamination level for melamine in infant formula.

If I were a betting guy, I’d put good money down to say courts strike this as “arbitrary and capricious,” which is a standard used by courts when considering adminstrative action taken by a government agency. It means that there is no reasonable basis for making an administrative rule or that the agency did not give the rule proper consideration.

How exactly is it that the FDA refused to issue a rule less than two months ago based on lack of information but, based on the same information, can come out with a rule a couple days after news reports of melamine in U.S. formula? It smells like milk gone bad.

I gave a presentation in my tax policy seminar today, scratchy throat and all, based on the topic of a paper I am writing for the class. The U.S. Treasury Department intrigued and scared me with some of the moves it made in September and October so I ended up writing my paper on the actions it is taking. In particular, I focus on one notice of guidance issued by the I.R.S. that essentially waives application of a section of the code – 26 U.S.C. 382(h) – for banks only. This waiver is credited with Wells Fargo snatching up Wachovia, which had already agreed to a sale to Citibank. The drama of it all. I estimate Wells Fargo will save about $26 billion in taxes and enlarge itself to boot.

The slides below are followed by my notes, including for the missing slide. Keep in mind that this presentation greatly simplifies one of the most complex sections of the code. Comments are welcome. Enjoy!

• I am interested in how the tax code is being used to help combat the current financial crises.
• one place Treasury started was 382, which limits the use of losses and gains by a new loss corporation

We will quickly cover …

The treasury department has been active in identifying trouble spots and issing guidance to corporations to help deflect some of the market turmoil.

• it started with the rescue of Fannie Mae and Freddi Mac, which remain publicly traded corporations
• then it was confronted with AIG
• then it decided to help recapitalize corporations so it gave a safe harbor from the law
• The last one is the topic of my paper
  • treasury excuses banks from 382(h) which restricts trafficking in built-in losses
  • we’ll come back to this, but first …382

NOL:

• Occurs when tax-deductible expenses exceed taxable revenues
• carry back: to offset income during the previous two tax years;
  • OR
• carry over for a 20 years before they expire.
• considered a tax asset under GAAP accounting standard and shows as an asset on balance sheets
  • Good example: GM took a $39 billion write-down in September 2007 to realize losses on tax assets that were expiring or it did not expect to redeem.  GM lists â??Other current assets and deferred income taxesâ? in its 10Q. In the August 2008 10Q, it is  $3.58 Billion.Key terminology:

Loss Corporation is entitled to use the loss

• Old loss corporation is the one that generated the loss before the change date
• New loss corporation is the one that can use the NOL after the change date

382(b) â?? places annual limits on NOLs after ownership change

Change in ownership is complex

• Just know it can be triggered by a number of things:
• sale of the corporation, reorganizations, recapitalization, capital injection, stock transfer, IPO.The old and new loss corp can be the same
• Assumption here: corporation acquired all at once

Annual limit

• equal to, or less than, the value of the old loss corporation times the long-term federal tax-exempt bond rate – set by the IRS monthly 4.65%
• Carryforward allowed, carry back prohibited.
• Wachovia example: 24.5 Billion * 4.65% = 1.14 Bill.
• GM example: 3.64 Billion * 4.65% = 169 million

NOLs expire after 20 years.

• If the annual limit is $5 million dollars due to 382, the maximum deductible amount is $100 million dollars.
• Wachovia ex: 1.14 Billion * 20 years = $22.79 Bill.
• GM example: 169 million * 20 years = $3.4 billion – based on market cap on Y! Finance
• These are the  NOLs that can be utilized by the new loss corporation over the 20 year carry forward term.

• 382(h): Limits new loss corporations from using net unrealized built-in gains or losse (I’ll cover losses only)
• Without 382(h), a loss corporation could speed up or slow down recognition of gains or losses.

NUBIL: net unrealized built-in losses

• includes depreciation, amortization, and depletion.
• When built-in loss is recognized, that loss is then added to the pre-change NOL carryovers and limited as such.
• limits are only placed on losses recognized during the five years after the change date.
• Elements
  • must be accrued at the time of the ownership changes
  • the amount must be substantial (>=15% fmv of the assets or $10mill) â?? de minimis rule
  • recognized within a limited period (five years).
  • After year 5, the built-in losses are carried over without limitation.

Burden on the new loss corp. to establish that a loss recognized during the recognition period is not a RBIL.

IRS Notice 2008-83

• Waives application 382(h) for banks
• Applies only to banks
• Has no termination date

Immediately after the merger is complete

• Wells can recognize NUBILs it owns through its acquisition of Wachovia
• apply those losses through carry back mechanism to offset income during the past two tax years.
• gets a refund check from the I.R.S.

Wells expects to eventually write down $74 Billion in value from Wachovia’s loan portfolio – NUBIL.

• once recognized, those $74 billion in losses would be attributed to Wells Fargo, rather than Wachovia.
• immediately be used to offset income
• Any remaining amount can then be carried over as NOL to subsequent tax years, to offset future gains, either as NOLs that are carried forward or that offset income during a given tax year.

Possible scenario for carryback:

• Taxable income â?? 2007: $11.6 Billion
  • annual report: 3.57Bill. tax paid / 30.7% effective tax rate
• Taxable income â?? 2006: $12.7 Billion
  • annual report: $4.23 Billion tax paid / 33.4% effective tax rate

• Unequal treatment creates macroeconomic distortions.
• Generally, similarly situated taxpayers should be treated similarly.
• Others w/ large NUBIL: insurance companies, investment banks, manufacutures, real estate developers or holding companies, and

Similarly situated taxpayers can include both small and large corporations and span across different industries because the corporations follow the same tax laws and regulations. It can also be used more narrowly to only apply to companies large or small or only companies within a particular industry. I think it should apply broadly and inclusively.

argument for providing the banks (under 581) a bypass around 382(h).

• perhaps saving the financial system could trump economic efficiency arguments.
• Counter: Citibank bid for Wachovia without this provision.
  • Citi had the gov’t assume certain risks. Here Wells assumed the risk and paid a premium for Wachovia, versus Citi.
• Counter what about all the other companies part of the finanical system not covered? And other important industries?

distortions are pushing non-bank financial servicers to become banks or bank holding companies

• take advantage of tax breaks and other government assistance that is being provided to banks.
• take advantage of 2008-83.
• GMAC announced on Nov. 5
• Amex on Monday
• Investment banks Goldman Sachs and Morgan Stanley have already received permission to become bank holding companies.
• Will insurance companies be next?

Moral Hazard â?? taxpayer behavior distorted by removing some risk of failure

Missing slide:

Start by asking what is this regulation intended to correct? Does it actually accomplish that goal or are there other intended or unintended consequences

• Seems this guidance is intended to help recapitalize banks.
• If so, compare to other methods to recapitalize banks. Are there better ways? Direct capitalization? Bankruptcy?

Direct capitalization

• Wells: $74 billion write off – Assume 35% tax rate â?? expect $25.9 billion in taxes lost
• Is $25.9 billion in lost tax revenue better used recapitalizing Wachovia?

Bankruptcy or receivership?

• 382 includes a bankruptcy exception that provides what amounts to a waiver of 382.

Creates super bank

• Is Wells taking risks it would not otherwise take (moral hazard)?
• What if Wells Fargo is mistaken about the risks inherent in the bank it acquires or their own portfolios?
• Is it worth the risks to have two banks fail rather than one if there are bigger losses than anticipated in the new loss corporation as a result of the acquisition?

[no notes]

• Notice 2008-83 has received public attention of Senators from both parties
  Charles Schumer (democrat)
  Charles Grassley (republican)
  Both are upset because Congress was not consulted, yet this will cost hundreds of billions of dollars.

Poor tax policy to give only one industry a waiver to 382(h) requirements.

Better choice?

• Apply waiver temporarily to all corps that can show the purpose was not to traffic in NOLs
  • require sale of an operating business & business continuity

• Limits macroeconomic distortions by encouraging investment and recapitalization of all business types
• Ensures the original intent of Congress, to prevent or limit trafficking in NOLs
• More administrable than ad hoc regulation directed to correct market failures in one industry or group of corporations
• Might not be politically acceptable because it will limit Federal revenues and it will

I think it would have also been better for Treasury to insert this into the discussions of the big bailout package since Notice 2008-83 came out while Congress was debating the bailout.

… now for me to finish writing the paper.

Update (12/18/08): I finished the paper. Sources for the information given above is identified in the paper.

Schwarzenegger: $4.4B in tax hikes to end deficit – Yahoo! News.

SACRAMENTO, Calif. â?? Gov. Arnold Schwarzenegger on Thursday proposed $4.4 billion in new taxes and a similar amount in spending cuts to deal with California’s worsening fiscal crisis, saying, “We must stop the bleeding.”

Much of the new revenue would come from a 1.5-percentage-point increase in the sales tax; the Republican governor described the hike as temporary but did not say how long it would last.

“We have a dramatic situation here and it takes dramatic solutions … and immediate action,” Schwarzenegger said as he called the Legislature back into session to deal with the budget shortfall.

The governor said $4.5 billion in cuts will be necessary across all state programs, including education, social services, health care and prisons.

If this goes through, sales taxes in San Jose will be 9.75% (8.25% currently + 1.5%). That might be a bit too much to handle for a lot of people, especially when one of the issues is lower consumption. This also just gives people more incentive to avoid taxes by purchasing through mail order. I think the state government will eventually need to ask for broad pay cuts – yikes – in addition to cuts to services and lay offs.

Calif. to cut water deliveries to cities, farms – Yahoo News.

The Department of Water Resources projects that it will deliver just 15 percent of the amount that local water agencies throughout California request every year.

This is horrible news. Rationing should have started with the drought, followed the snow level, and definitely followed the drier pumps. We had better all pray for a wetter than usual winter.

BTW: Agriculture accounts for about 80% of water used in California.

SF Chronicle: Panel issues dire warning on Delta

A task force appointed by the governor warns that California must build new dams, canals and desalination plants and amend its laws or face economic and ecological disaster.

The state must elevate environmental needs for water to a standing equal to that of human needs to restore the state’s ailing water network, a report by the Delta Vision Blue Ribbon Task Force said.

…

In addition to new dams and reservoirs, the plan calls for other measures, including: designating the estuary a National Heritage Area by 2010, increasing the amount of recycled water in the state to 1.5 million acre feet annually and cutting California’s water use 20 percent by 2020.

The goals of this report are laudable. One major problem with the plan is that there is only one truly suitable dam site left in the state – Temperance Flat. We will end up relying on desalination and toilet-to-tap plants, like the one Singapore operates. Although I wonder if such projects will provide enough water for agriculture, which uses 80% of the water in the state.

10 Trillion Reasons, originally uploaded by dfb.

In all this talk about bailing out Wall Street (let’s all call a pig a pig; this is a bailout) nobody is really talking about how we will pay for it. Are those assets really worth $700 billion dollars? I don’t think that anyone can say they certainly are worth that, let alone half that much.

The value of those assets is at the heart of the credit crisis. Banks and other financial firms world-wide do not trust lending to each other because nobody knows how much they really are worth. And because nobody knows what they are worth, they are no longer acceptable collateral to use in securing additional debt obligations, even if for the short term. Which brings me back to my initial point. Nobody is really talking about how we will ultimately pay for this bail out. Who, really, will pay? That’s right, regular tax payers.

Fiscal responsibility seems to escape politicians and Wall Street alike.

I do not understand why the Federal Government needs to pay
for toxic securities, or at least pay up front for them. Why can’t the program accept full portfolios of these fancy securities with no known value, and take on all the risk. If that wipes out the capital of an institution, so be it. The Feds will sort everything out, unbundling the securities and re-packaging them into fully transparent securities that can be adequately valued. Those transparent securities will be sold off. Fifty percent (50%) of the value, after factoring in cost of the program, will go to the Federal Government for taking on the risk. The other 50% to the previous holder of the securities or their creditors.

Every bailout must come with some serious revenge, otherwise what is to stop this same issue from happening again. CEO pay caps and small equity stakes in the firms are a good start. But if we really want them to pay for this and to give strong incentive against future, similar behavior, we need to make them pay more. And in the meantime, maybe, just maybe we can pay down the debt a little and not leave it to our children and grandchildren. Oh, that’s right, wishful thinking. The big spenders in both major parties are more interested in waging war, porking it up, and spreading the wealth around, than in responsibly running our government.