Taxes are being collected to help end the financial crisis that ended nearly a decade ago.
The Emergency Economic Stabilization Act of 2008 created the Troubled Asset Relief Program, the $700 billion tool used to deal with the subprime mortgage fiasco by bailing out Wall Street banks. This “emergency” measure, seemingly temporary when instituted, contains a tax provision that may take billions from hedge fund managers this year, long after the fires of crisis have gone out. The EESA also gave the U.S. Treasury secretary tremendous power to “stabilize” the financial system amid severe conditions including contractions of liquidity.
October 3, 2008, the date of the legislation’s signing by President George W. Bush, was the “tipping point” that ensured the “triumph of crony capitalism” and enshrined the idea of Too Big to Fail, wrote David Stockman in his book “The Great Deformation: The Corruption of Capitalism in America.” “There was no longer any pretense that the free market should determine winners and losers and that tapping the public treasury requires proof of compelling social benefit.”
The EESA and the Troubled Asset Relief Program could be repealed with a modicum of political will because there hasn’t been a recession since and no one has any idea when the next rainy day will occur or what it would look like. Canceling TARP would save taxpayers tens of billions of dollars, said the fact-checking website PolitiFact.com during the last repeal effort, five years ago. The effort died in committee in the House of Representatives. PolitiFact rated the failed effort “a broken promise” by Republicans two years after becoming the House majority.
Extraordinary powers given to the Treasury secretary by the EESA were diluted by the Dodd-Frank banking law, passed in 2010, which removed the power to create new TARP programs and ended the Treasury’s ability to reuse TARP funds that had been repaid.
Besides the power boost, opponents have criticized the EESA as vaguely worded, too expensive, an unfair benefit to investors, and unhelpful for addressing the immediate crisis or long-run impact on the economy. TARP planted seeds for future economic instability, Simon Johnson of the Peterson Institute for International Economics told Congress in 2011. His work includes the book “13 Bankers: The Wall Street Takeover and the Next Financial Meltdown.”
“Adjustments to our regulatory framework, including the Dodd/Frank financial reform legislation, have not fixed the core problems that brought us to the brink of complete catastrophe in fall 2008,” Johnson said. “Powerful people at the heart of our financial system still have the incentive and ability to take on reckless risk — through borrowing large amounts relative to their equity. When things go well, a few CEOs and a small number of others get a huge upside. When things go badly, society, ordinary citizens, and taxpayers get the downside.”
The EESA is a prime example of what happens in government amid panic. Henry Paulson, Bush’s Treasury secretary, who proposed the legislation, was not acting Machiavellian when he asked for more power for his office, said Thaya Brook Knight, associate director of financial-regulation studies at the Cato Institute. Facing unchartered financial waters, “this is not the kind of power anyone would want,” she said.
Lack of clarity about government actions regarding bailouts and the subsequent bankruptcy of Lehman Brothers led to pessimism on Wall Street and a ballooning crisis, she said. “Congress had a strong motivation to do something; it was kind of desperate,” Knight said. “Giving out a lot of power would please their constituencies, showing people that they were addressing the crisis. Once that power is delegated it’s hard to get it back.”
Paulson praised Capitol Hill’s actions in his book “On The Brink: Inside the Race to Stop The Collapse of the Global Financial System.” The EESA failed to pass the House on September 29, 2008. The Senate then went into action, and a second bill was approved by both chambers after many representatives changed their positions. Opponents, including the two-thirds of House Republicans that voted against the first bill, were forced to “walk the plank a second time,” Stockman wrote.
“Indeed, it was remarkable that in the closing days of its session, one month away from a hotly contested national election, a Democratic-controlled Congress had responded so quickly to the pleas for an outgoing, and unpopular, [Republican] administration for a combination of spending authorities and emergency powers that were unprecedented in their scope and flexibility,” Paulson wrote.
Paulson and Federal Reserve Chairman Ben Bernanke posited a domino theory, in which bank failures would cause national and international havoc. Stockman, former Michigan congressman and Reagan administration budget director, saw it differently.
“Panic-stricken Fed and Treasury officials had issued a financial ukase; namely, that an AIG bankruptcy had to be prevented at all hazards because it would bring the entire financial system tumbling down,” he wrote. “Never in the inglorious history of Washington’s financial misdeeds has such a large proposition been based on such a threadbare predicate.”
The Treasury secretary was immediately authorized to spend up to $250 billion. An additional $100 billion would become available if the president confirmed that the funds were needed, and a further $350 billion would be authorized upon confirmation by the president and Congress, according to Jeannette L. Nolen’s summary in “Encyclopedia Britannica.”
After meetings in Washington with finance ministers from other member countries of the International Monetary Fund and the World Bank, Bush and Paulson announced plans to use $250 billion immediately to buy stock in troubled banks, a move designed to increase the banks’ capital bases directly so that they could begin lending again as soon as possible.
The crisis died down, although the legislation remains on the books. The EESA’s provisions include a change to Section 457A of the IRS code, closing what a 2007 New York Times story had called a loophole that enabled hedge funds to defer taxes through offshoring. Congress took note of the story in 2008 and decided to change the tax code as a way of raising revenue and proposing to stabilize the financial sector during the then crisis.
Steven Cohen, founder of SAC Capital Advisors, has deferred offshore income of more than $1 billion that is probably subject to taxation, The Wall Street Journal reported on July 20 of this year. David Einhorn of Greenlight Capital and Daniel Loeb of Third Point are other hedge fund managers liable for taxes in excess of $100 million. Total payments from all such hedge fund executives were predicted in 2008 by the Joint Committee on Taxation to be $25 billion. Some tax experts now put the tab at $100 billion or more, the Journal reported.
The act covers federal, state, and local taxes. Connecticut, long a center for the hedge fund industry, could see a spike in tax payments amid budget woes years in the making. The managers are looking for ways to raise cash through lowering their stakes in their funds or limiting their liability through charitable giving, the Journal said.
Congress may have created the most roundabout way to increase charitable giving in the history of the world. Likely there’s a better and more direct way. And taking money out of productive entities to fight a non-existent crisis is counter to the goal of growing the economy. We can do better than that.