Tuesday, January 08, 2013 - Thank You, America

Thank You, America

DOW – 55 = 13,328
SPX – 4 = 1457
NAS – 7 = 3091
10 YR YLD -.03 = 1.87%
OIL +.06 = 93.25
GOLD + 13.20 = 1661.10
SILV + .24 = 30.50

Some people have debated what we should do if the banks get into trouble again; should they be bailed out? The Too Big to Fail Banks of 2008 are even bigger today, and if one collapses, then there would likely be a cascading effect through the global financial system. So, if a big financial institution gets into trouble, should there be a bailout, or do we just say “tough luck”? You probably have an opinion, and reasonable people can debate the issue, or at least there could be room for reasonable debate, until now. As of today, there is no more debate.

If you go to Webster's Dictionary and look up the word “ingrate”, you will find a picture of Maurice “Hank” Greenberg; the guy who founded American International Group, AIG, the huge insurance company that in 2008 accepted a $182 billion dollar bailout from the Treasury. Hank Greenberg, the former CEO of AIG is contending in a lawsuit that the government treated the company’s shareholders too harshly when carrying out its 2008 rescue of the insurance giant. AIG is weighing whether to join the lawsuit, filed by Mr. Greenberg’s investment firm, Starr International Company, which owns about 12% of AIG. In addition to founding AIG, Greenberg gained notoriety for a high profile fraud case in 2005 that pushed him out of his CEO role at AIG. Greenberg was accused of using sham transactions to mask the company's financial position.

So far, AIG has not joined in the suit with Greenberg. The choice is not a simple one for the insurer. Its board members, most of whom joined after the bailout, owe a duty to shareholders to consider the lawsuit. If the board does not give careful consideration to the case, Mr. Greenberg could challenge its decision to abstain. Should Mr. Greenberg snare a major settlement without A.I.G., the company could face additional lawsuits from other shareholders. In other words, the board of directors may have a fiduciary duty to sue the government.

One of Starr International’s major arguments is that AIG’s bailout terms were far tougher than those granted to other large financial firms. Greenberg has accused the New York Fed of using the rescue to bail out Wall Street banks at the expense of shareholders, and of being a "loan shark" by charging exorbitant interest of 14.5 percent on the initial loan. 

The Treasury did force AIG to do things which were against their very nature. AIG was forced to pay full settlement on credit default swaps; one-hundred cents on the dollar, to the tune of more than $12 billion to Goldman Sachs alone. Now remember these credit default swaps were a form of insurance but they weren't insurance, and they were and remain largely unregulated. CDS is not like insurance in that it does not require reserves be held to pay off claims. The whole idea behind CDS was to collect premiums without ever paying claims. To force AIG to make full payment on a CDS claim was unprecedented and now Greenberg claims it was cruel and unusual punishment.

AIG’s cash needs and internal failings were in many ways far more serious than those of other institutions. In fact, the company was in such dire straits after the rescue that the government eased up on the terms. The concessions were considerable.

In early 2009, the Federal Reserve cut the interest rate on a big loan to AIG, saving the company about $1 billion a year in interest. Then the Treasury exchanged $40 billion of preferred shares for new ones that effectively paid no cash dividends to taxpayers. If it had paid the originally agreed 10 percent dividend on all these and other preferred shares, the insurer would have paid roughly $20 billion from the beginning of 2009 to the end 2012. Instead, the preferred shares were converted into common stock, which the government later sold, purportedly turning a profit of about $22 billion.

The bailout eventually worked out for AIG. After losing half its value in 2011, the stock rose more than 52 percent in 2012, tripling the gains of the broader S&P insurance index. Things worked out so well for AIG that they are now running a television ad campaign called “Thank You, America” in which it offers its gratitude for the bailout.

Mark Twain was right; truth is stranger than fiction because fiction is obliged to stick to possibilities.

Seriously, thank you, America.

There has been a lot of talk about breaking up the big banks, cutting them down into smaller banks that don't threaten the global financial system. The Dallas Federal Reserve has called for breaking up the biggest banks. Texas Republican Jeb Hensarling, the new Chairman of the House Financial Services Committee has expressed concern about the Too Big to Fail banks. Elizabeth Warren was elected in Massachusetts and she will sit on the Senate Banking Committee. Even Sandy Weill and John Reid, co-founders of Citigroup, which originally pushed through legislation which destroyed Glass-Steagall; they are now proposing that Glass-Steagall be reinstated and the biggest banks be broken up. The timing would seem to be right. Don't hold your breath.

The bank lobby will fight any attempts to break up the banks. Eventually, we will come back around to a big bank or insurance company on the verge of collapse and begging for a bailout; it's inevitable; the banksters continue to gamble in the derivatives markets, and eventually all gamblers lose, and when they lose.., please, please remember the story of Hank Greenberg and AIG.

Alcoa has kicked off the fourth quarter earnings reporting season by posting a profit of $242 million, or 21 cents per share, compared with a net loss of $191 million, or 18 cents per share, in the year-ago period. Excluding one-time items, net income was $64 million, or 6 cents per share, in line with average analysts' expectations of 6 cents.

Alcoa is supposed to provide clues about earnings, but I've never found a good correlation. Instead the earnings season has become little more than an exercise in obfuscation. Take the phrase “excluding one-time items”; that means the cost of doing business. Lucy Kellaway at Financial Times has come up with what she calls the Golden Flannel Awards, a mock celebration of corporate malarkey. Here's an example from one annual report: “In the wholesale channel, Burberry exited doors not aligned with brand status and invested in presentation through enhanced assortments and dedicated customised real estate in key doors.” I don't know what that means, but it might surprise you to learn that Burberry sells raincoats and they don't manufacture doors. Another company, called Record, does manufacture doors, which they call “entrance solutions”.

Sometimes companies create new words, such as: solutioneering, sustainagility, or innovalue. Sometimes, companies say things that are just designed to hide reality; for example, Citigroup issued a press release that talked about “optimizing the customer footprint across geographies,” which means they fired 1,100 workers. Citigroup also got the top prize by declaring that from now on they would offer “client-centric advice”. Sounds good until you think about what they've been offering up to now.

I still think it will be hard to top AIG's “Thank you, America.”

Anyway, welcome to earnings reporting season.

So, I was away on vacation over the holidays, but I'm catching up on the fiscal cliff deal. It has some interesting provisions; lots of little and not so little special deals, especially in the form of tax breaks. For a bunch of lawmakers who were supposedly so busy and so involved in "negotiations," they were remarkably productive when it came to special interests.

There's $9.7 billion over the next 10 years on additional subsidies for student loans or $5.6 billion for adoptions, although both those figures seem like a lot considering that employer-provided childcare is getting only $209 million. More money is at stake in subsidies for various businesses, $46 billion, and $18 billion for alternative energy. 

There's a special 50% tax credit for maintaining railroad tracks is projected to cost $331 million over the next two years.

Tax benefits for certain motorsport racing track facilities, such as Nascar, will cost more than $100 million over the next seven years.

Business property on Indian reservations will receive $660 million in tax breaks over the next three years. Indian employment tax credits will total $119 million over the next four years. Tax breaks for Alaskan Natives receiving trust income will add up to $46 million over 10 years.

More favorable deductions for contributions of food to charities will cost $314 million over two years. For contributions of property, the benefit will be $225 million over a decade.

Film and television production got the last-minute extension of tax write-offs worth $430 million over the next two years.

Businesses in Puerto Rico will receive $358 million over the next two years. In addition, a temporary increase in the excise tax rebate on rum production will give Puerto Rico and the U.S. Virgin Islands $222 million, much of which will go to benefit local rum distillers.

Regulated Investment Companies, such as mutual funds and real estate investment trusts, are to receive $211 million in tax benefits over the next two years. Some of that pertains to dividends paid to foreign investors.

Over the next two years, additional economic development credits for American Samoa will cost $62 million.

Over the next three years, $7 million will go to expand credits for plug-in electric vehicles to include motorcycles. That's a 10% rebate, up to $2,500 for buying an electric scooter.

$59 million in credits for fuel made from algae and expanding benefits for certain other biofuels.

Tax credits for renewable diesel fuel and small agricultural producers of biodiesel will total $2.2 billion over the next five years.

Asparagus growers will get $15 million.

There’s a provision that allows workers to convert conventional 401(k)s into Roth 401(k)s at a cost of $12.2 billion over the coming decade.

There were big breaks for private equity firms and hedge funds, including the

the continuation of the “carried interest” which in effect allows sophisticated investment managers to postpone their earnings from a deal and then often pay taxes at capital gains rates that are lower than the rates for fee income.

And a $9 billion tax break for big banks and manufacturers related to "active financing." Active financing is a special transaction tax break that specifically allows multinational companies to avoid paying US taxes on foreign earnings if those profits resulted from "actively" financing a deal or activity on foreign soil. Not surprisingly, big businesses claim it helps them be more competitive abroad.

Thank you, America.