|W.I.L. Home Page||Offshore News Digest Home|
|Sign Up||Finance Digest Home|
FED AMPUTATES INVISIBLE HAND
The effects of these actions represents a seismic shift in the history of this country.
The big story this week of course has been the major earthquake that hit Wall Street and the world financial markets. Tremors and widening fissures had been observed for weeks, months, and years. Some had been warning of such a happening for decades. But it is not a stretch to characterize this week's events as the equivalent of "the big one" finally arriving.
We cannot completely blame the fiasco on government. Politicians can have a cliff constructed using stolen funds where once there was a gentle slope, but they cannot really force all the lemmings to go charging off it. And yet, they were responsible for the cliff.
So how did the policy makers react? Exactly as we and other pessimists have been predicting. Certain well-connected lemmings were rescued. In the process bagfuls of sand were thrown into the gears of the economic and financial system. Our capacity to recover from all the poor decisions made heretofore has been impaired in a major way. And the new policies will almost certainly guarantee that the crisis will get worse, perhaps after a deceptive remission.
"I can calculate the motions of the heavenly bodies, but not the madness of people," said Sir Isaac Newton, reacting to the South Seas Bubble frenzy that engulfed Great Britain in 1720. Alas Sir Isaac himself -- one of the great geniuses to have graced this world -- could not refrain from joining the fun, and sustained a £20,000 loss when he turned out to be the greater fool to whom the lesser fools were selling. Almost 300 years later we observe no diminishment in the madness of people, although we think that it is harder for geniuses to obtain an audience. And a look at the franchise granted to the South Seas Company reveals that governments will ever look for a way to get something for nothing.
We were attracted to this article -- posted on Minyanville, a "financial infotainment ®" site -- from among tens of hundreds of others providing commentary on the same subject because we found the headline metaphor so utterly appropriate. Naturally, we will have much more to say as the march down the road to serfdom continues. Be prepared to hang on to your assets with both hands, folks.
A week ago, the United States had the most efficient capital allocation system in the world.
Our free-market economy enabled money, credit and resources to be sent to the economic players who needed it. Entrepreneurs could raise money to start new, innovative businesses. Researchers could seek out cures for diseases that touch millions of lives, as well as those that afflict just thousands. Firms that made enough bad decisions went bankrupt.
The job of regulators was to ensure the system functioned and to set up rules by which honest business could be conducted. It was not a perfect system, but it was better than the alternative.
This is the alternative.
When government invades free markets to the extent it has -- specifically in the last 24 hours -- the system ensuring capital gets where it needs to be breaks down. Money is instead doled out to the firms well connected enough in Washington to lobby for handouts.
Beltway bureaucrats have been trying to rewrite this country's economic rules and protect Wall Street from its own mistakes for over a year. Still, the free market prevailed, punishing the firms that made the most egregious bets during the housing boom: Countrywide, Bear Stearns, IndyMac, Merrill Lynch, AIG, Lehman Brothers, National City, Washington Mutual ("WaMu") and Wachovia.
According to our once-free market, these firms needed to be wiped out, gobbled up and liquidated, so real economic growth could take hold from a stronger foundation.
This morning (Friday), we heard many claim the government's actions -- temporarily banning short selling, the creation of a Treasury Department distressed-asset hedge fund, the establishment of a federal backstop for money markets, to name but a few -- were necessary to prevent a wider financial and economic crisis. The shortsightedness of this argument is astounding.
A couple hundred years ago, Charles Darwin opined that nature has long been engaged in weeding out the weak, protecting the strong. This natural ebb and flow of dominance according to a given species' inherent characteristics has governed the world's socioeconomic landscape for more than 4 billion years.
The actions taken overnight seem to refute Darwin's claim that Mother Nature can manage her own backyard. Adam Smith's invisible hand is capitalist Darwinism, moving the weak aside so the strong can survive.
To take that power away from the market is tantamount to shoving God aside and rewriting the evolutionary playbook.
The effects of these actions, this fundamental ideological shift from capitalism towards socialism, represents a seismic shift in the history of this country. The events of the past week -- and what it says about our collective ability to take our lumps, drink our medicine and recognize that the path to the ultimate goal is one littered with hairpin turns and drop away cliffs -- will not be lost on future generations.
The events of the upcoming months and years, whether we are content to continue to hand over more and more power to the few, elected and non-elected alike, will show the true mettle of the American spirit.
EU TO DELAY COMMON CORPORATE TAX BASE PROPOSALS
EC Tax Commissioner Laszlo Kovacs has delayed proposing a common method of calculating corporate tax bases across the EU ... for now. Despite vociferous opposition from several EU states Kovacs is committed to eventually ramming through a proposal of some sort, on the basis that he knows what is best for everyone.
A common consolidated corporate tax base would enable companies to follow the same rules for calculating the tax base for all their EU-wide activities, rather than having to follow and track the rules of 27 different systems. Sounds great in principle. The objecting states, however, are suspicious that consolidated tax base rules will lead to "harmonized" tax rates. Assurances have been given that no such plans are in the pipeline. Kovacs is rumored to have backed his promise by saying: "Cross my heart and hope to die, poke a needle in my eye." But for some reason the objecting states are unmollified.
Proposals for a common method of calculating corporate taxes across the European Union have been put on hold while the European Commission continues to iron out the plan's finer details, Tax Commissioner Laszlo Kovacs has revealed.
In a recent speech delivered at the Congress of the International Fiscal Association, Kovacs disclosed that certain "detailed technical areas" still need further work, in particular those related to the financial sector.
Despite opposition from several member states to the idea, the Commission has forged ahead with its work on the common consolidated corporate tax base (CCCTB) and had been due to present its highly-anticipated plan this Autumn. However Kovacs told the delegates that it was more important to present "a perfectly elaborated and well justified product," than present an incomplete one "just to meet an artificial deadline."
"I remain fully committed to this project, and when the impact assessment and the proposal are properly ready I will present these to the College," he added.
The CCCTB would enable companies to follow the same rules for calculating the tax base for all their EU-wide activities rather than in accordance with the existing 27 systems, thereby, it is argued, simplifying procedures, improving efficiency and reducing compliance costs.
According to Kovacs, companies would benefit substantially from the CCCTB because it would do away with the need to determine arms length transfer prices for intra group transactions and provide a consolidation mechanism to offset profits and losses of the same company in different member states.
However, several EU countries, most notably those with the lowest rates of corporate tax in the EU, such as Ireland, Estonia and Slovakia, are strongly opposed to the idea of any kind of harmonization of EU member state tax regimes, despite assurances that no plans are in the pipeline for harmonizing tax rates, which is what these countries ultimately fear.
The result of the Irish referendum earlier in the summer, which rejected the new EU constitution, largely on fears that it would erode tax sovereignty, also dealt a blow to the Commission's plan to present its proposals this year, and it is now probable that the proposals will not see the light of day until some time in 2009.
THE U.S. GOVERNMENT’S WAR ON MONEY LAUNDERING
A financial service provider gives a firsthand account of what it is like to interface with the U.S. financial surveillance system, in the hopes that this "small bit of information arouses readers to outrage and indignation." He does a very effective job of accomplishing that.
As a provider of financial services, once again I am required to attest (i.e., declare to be correct and true or genuine), by using the Compliance Attestation System, that I have read and understand and agree to the third-quarter anti–money-laundering training information. I have no effective choice. I cannot disagree. I am to attest or be out of compliance with finance regulations. I am required to do this quarterly or else. This is not new, but I thought it worth revisiting, owing to this quarter's subject matter: "Foreign Accounts."
The opening statement, which concerns foreign clients, reads, "Opening accounts for foreign clients presents various AML (anti–money-laundering) concerns." So immediately if one is from a foreign country and chooses to open an account with me, I am to be suspicious. He may have to be referred to the firm's AML officer (who reports directly to the FBI) so that additional due diligence can be performed and documented. The questions that I may or will have to ask are these:
Also required will be a passport, a U.S. 10-year visa, or a U.S.-issued green card for identification purposes. (Remember, the client is not moving here; he is just opening an account.)
- How did you meet the client?
- Was he a referral from an established relationship? If yes, from whom? (Report thy neighbor.)
- Where did you meet him? In the United States or in his country of origin?
- If he will spend a good portion of his time in his own country then what is the communication plan? Does the client speak English or do you speak his language?
- What is his business or line of work?
- Is he a politically exposed person (PEP), a senior foreign political figure, or an immediate family member of someone who is?
- What is his source of funds and his anticipated account activity?
- Do you have reason to believe he will be making significant transfers of funds to and from his home country?
Many may think all this information legitimate and necessary, but is it really? Obviously when I work for a client, I want to know things about him so that I may do a proper job of advising him concerning his investments. This is understood and expected. But there is much more to this process than meets the eye.
One of the fundamental goals (so-called) of the USA PATRIOT Act was to protect access to the U.S. financial system by requiring records and due-diligence programs for foreign-correspondent accounts. This was never a problem in the past, but now, at least according to our rulers in Washington, it is needed because of the 9/11 terrorist attacks. U.S. Senate investigative reports state that foreign-correspondent accounts are the gateway to the U.S. financial system.
Foreign financial institutions maintain and always have maintained accounts with U.S. banks and broker dealers. Obviously that allows them to gain access to services and products that may not be available to them otherwise. This is no different from what U.S. banks and broker dealers do in other countries. With the passage of the USA PATRIOT Act, however, specifically in Sections 312, 313, and 319, certain types of correspondent accounts may be prohibited. Included are accounts held by foreign "shell" banks and banks that do not have the required "regulatory" due diligence necessary to satisfy U.S. officials. From there things get more complicated and restrictive, and one obvious component of current U.S. policy is that of unlimited information-gathering and total control over all business dealings between U.S. citizens and financial institutions on the one hand, and all foreign individuals or entities on the other.
What is desired here is full knowledge by U.S. government officials of all business conducted between any foreigner and any foreign entity or any U.S. citizen or U.S. entity, including mandatory divulging of the names of all owners of securities. No bearer shares (shares owned by anyone holding the security) are allowed and any language allowing that type of ownership in any foreign articles of incorporation has to be changed. In addition, all foreign entities doing business in the United States have to prepare and sign a separate statement attesting (there is that word again) to these facts. All original articles of incorporation, any amendment, and the separate statement are copied and kept on file forever.
OFAC, the Office of Foreign Assets Control is a part of the U.S. Department of the Treasury. It "administers and enforces economic trade sanctions [protectionism and acts of war] based on U.S. foreign policy and national security goals against targeted [emphasis mine] foreign countries, terrorists, international narcotics traffickers, and those engaged in activities related to the proliferation of weapons of mass destruction." OFAC has the power to impose controls on transactions and freeze assets under U.S. jurisdiction. This is nothing less than the power of the U.S. government to steal any foreign assets it chooses and for any reason it sees fit. Every new account, every check and wire, and all stock receipts are compared with an OFAC master list of prohibited names, and all that information is captured. There is no privacy whatever here. OFAC also maintains many sanction programs, including:
Those are broad and sweeping powers indeed, but in addition to all this invasive action against foreigners and their financial transactions, OFAC also maintains sanctions against the Balkans, Belarus, Cote d'Ivoire (Ivory Coast), Democratic Republic of the Congo, Iran, Iraq, The Former Liberian Regime of Charles Taylor, North Korea, Sudan, Syria, and Zimbabwe. Fines for violation of sanctions are substantial and bordering on the ridiculous. Criminal penalty fines can range $50,000 to $10,000,000, with prison time ranging from 10 to 30 years.
- Specially Designated Nationals List (SDN List). This lists individuals and organizations with whom U.S. citizens and residents are prohibited from doing business.
- Anti-Terrorism Sanctions. This executive order blocks property and prohibits transactions with persons who commit, threaten to commit, or support terrorist activities.
- Non-Proliferation Sanctions. These are designed to combat the proliferation of weapons of mass destructions.
- Diamond Mining Sanctions. These are obviously a way for OFAC to monitor and control diamond imports and they, along with other countries, launched the Kimberly Process Certification Scheme (KPCS) as the enforcement arm. (I cannot make this stuff up -- the wording is accurate.)
- Narcotics Sanctions. These block property and interests in property subject to U.S. jurisdiction owned and controlled by significant foreign narcotics traffickers, as identified by the president.
- Cuban Sanctions. These have been in effect since July 8, 1963.
Along with OFAC there is FinCen (Financial Crimes Enforcement Network). FinCen is also a part of the U.S. Department of the Treasury. Its mission is to safeguard the financial system from the abuses of financial crime, including terrorist financing, money laundering, and other [emphasis mine] illicit activity. FinCen administers the Bank Secrecy Act, supports law enforcement, intelligence and regulatory agencies by sharing and analysis of financial intelligence, builds global cooperation with counterpart financial intelligence agencies and networks, people, ideas and information.
Effectively, this means that FinCen monitors everything financial, including standard day-to-day transactions made by all of us. They have a license to snoop that is open-ended and all-encompassing. All Suspicious Activity Reports (SARS) are filed through FinCen. More than 6,000 users representing 1,500 organizations actively access the information through this network. Nothing is private; nothing is sacred. Any and all financial information in this country, whether reported as suspicious or not, is captured and data-based. If reported as suspicious, the information is put on an expansive network for all users to see. That may not bother those who worship the state and expect it to protect them at all costs to liberty, but this invasion should raise the ire in all of us.
With respect to money laundering, terrorist financing, and other financial-crime investigations, SARS filings through FinCen have led to many indictments and guilty pleas. They involve investment fraud, insurance fraud, bank fraud, drug smuggling, tax fraud, identity theft, and Ponzi schemes.
In this article, I am addressing only one aspect of the belligerent and invasive behavior perpetrated by government. I am discussing only the finance industry and foreign transactions, along with their domestic counterparts, and how those business dealings are manipulated, monitored, and controlled by Leviathan owing to language allowing it in the very corrupt and dangerous USA PATRIOT Act.
Obviously, much more sinister activity is constantly taking place. Murderous, immoral, and unconstitutional wars, imperialistic expansion, thievery, property and civil-rights destruction, torture, and more go on every day while the mainstream American citizen goes about his business as if everything is hunky-dory. While I will never understand the complacency and apathy of most Americans concerning their own freedom and liberty, I still must always point out tyranny whenever I possibly can, and hope that this small bit of information arouses readers to outrage and indignation.
GUERNSEY HAS REASONS TO FEAR U.S. “TAX PURGE”
A Guernsey lawyer, Stephen Platt, warns that the U.S. anti-offshore initiative "will no doubt lead to a more onerous and rigorous environment for financial institutions, while banks operating in so-called 'secrecy jurisdictions' may lose one of their strongest selling points." No doubt. "History suggests that aggressive measures introduced by the U.S. Revenue authority one year are often copied by other jurisdictions in the following years and this level of criticism should therefore send out alarm bells to the entire offshore finance industry," he ominously adds.
An illuminating fine-point highlighted by Platt is a proposal emanating from the Senate Homeland Security and Governmental Affairs Committee which requires domestic and foreign institutions to file a statutory report whenever it obtains information that a foreign account is beneficially owned by a U.S. taxpayer. Obviously "requiring" such of a foreign institution means the blandishment of penalties for noncompliance, such as denial of access to the U.S. financial system. So even if one maintains a foreign financial account which never exceeds $10,000 in value, Uncle Sam wants the account's existence on file.
U.S. Senate recommendations that seek to increase disclosure and strengthen enforcement in offshore financial jurisdictions could have far-reaching implications for Guernsey, according to a specialist lawyer.
BakerPlatt Group chairman Stephen Platt was commenting on the Homeland Security and Governmental Affairs Committee, which has been investigating "tax haven banks and U.S. tax compliance."
"The tone and content of their recommendations will no doubt lead to a more onerous and rigorous environment for financial institutions, while banks operating in so-called 'secrecy jurisdictions' may lose one of their strongest selling points," he said. "History suggests that aggressive measures introduced by the U.S. Revenue authority one year are often copied by other jurisdictions in the following years and this level of criticism should therefore send out alarm bells to the entire offshore finance industry."
BakerPlatt has produced a briefing paper on the Senate hearing, which highlights the committee's recommendations including a requirement on domestic and foreign institutions to file a statutory report whenever it obtains information that a foreign account is beneficially owned by a U.S. taxpayer and penalties for 'tax haven' banks that impede tax enforcement, including giving the U.S. Treasury power to bar those banks from doing business with U.S. financial institutions.
TWO UTAH ACCOUNTANTS SENTENCED TO PRISON FOR OFFSHORE TAX EVASION SCHEME
“An awkward, feeble, leaky lie is a thing which you ought to make it your unceasing study to avoid; such a lie as that has no more real permanence than an average truth. Why, you might as well tell the truth at once and be done with it.” ~~ Mark Twain, from “Advice to Youth”
Whenever we run across a news items such as the one below, we wonder ... the perpetrators were obviously convincing salemen. They succeeded in getting a lot of money placed under their care by the clients they generated. Most financial advisors would give their eye teeth to be similarly successful in their sales endeavors. So why did they not create a legally sound business from such a promising base? Lack of patience, arrogance, and greed, we might hazzard. In the long run it would have made life a lot easier -- a lot less confined, so to speak -- for the entrepreneurs, and would have been more remunerative to boot.
Three accountants were sentenced this week (week of September 1-5) in Utah to prison terms for a tax-fraud conspiracy involving offshore companies that cost U.S. taxpayers more than $20 million, the Justice Department said in a statement.
U.S. District Judge Tena Campbell sentenced the men, who pleaded guilty in federal court in Salt Lake City, for helping clients hide income from 1996 to 2005 from the IRS and for creating false tax deductions. The scheme involved offshore bank accounts in the Cayman Islands and Nevis, offshore nominee accounts and letters blessing the legality of phony transactions, according to the statement.
Campbell ... sentenced Reed Barker to 18 months in prison and ordered him to pay $167,608 in restitution, according to the statement. ... Campbell sentenced Stephen Peterson to 35 months and ordered him to forfeit $1.17 million. The judge also imposed a 24-month term on Brent Metcalf.
"These sentences send a firm message to tax professionals, especially accountants and CPAs, that if you assist your clients in defrauding the Internal Revenue Service, you will be punished to the fullest extent of the law," U.S. Attorney Brett Tolman said in the statement.
Peterson, of Coalville [Utah]; Metcalf, of Cottonwood [Utah]; and Barker, of Littleton, Colorada, pleaded guilty in January. They were indicted in 2005 with three other people, including attorney Dennis Evanson, of Sandy, who was convicted at trial in February. He was sentenced last month to 10 years in prison and ordered to forfeit $2.78 million, as well as property and two cars.
JERSEY DIVORCE RULING COULD SEE FORTUNES MOVED OFFSHORE
Jersey court rules that trust assets cannot necessarily be included in a divorce settlement.
The headlined ruling is straightforward when stripped to its essentials: A London court ruled that the ex-wife in the divorce case was entitled to a share of the assets of a Jersey trust, and order the ex-husband/trustee to hand it over. The Jersey court looked at the trust and noted that the trust's own terms forbade this, and refused to order the husband to violate the trust's rules.
Forgive us for being surprised that this ruling should be surprising, or pathbreaking. But apparently British territories have been prone to resolving conflicts between British court directives and the rule of law in favor of the former. Now the thinking is that at long last this is changing, and that other British territories may also acquire stiffened spines now that Jersey has led the way. Another surprise is that British subjects would have not heretofore used non-British territory asset protection havens, given the territories' apparent kowtowing to arbitrary edicts from the motherland.
A court in Jersey has decided that a divorced husband or wife does not necessarily have the right to plunder their former spouse's riches if they are banked offshore. The island's Royal Court rejected an order by the High Court in London that a millionaire Indian jeweller must hand over a share of his assets, held offshore on the Channel island in a trust previously shared with his ex-wife.
The decision means that estranged spouses could in future be blocked by their ex-partners from claiming wealth held on Jersey, or other Channel Islands and tax havens including British territories and dependencies in the Carribean.
Divorce law experts believe it will now encourage the wealthy increasingly to shift savings and large parts of their wealth to offshore accounts, shortly before or after they marry.
Grant Howell, a family lawyer at Charles Russell, said the judgment "provided an obstacle" for divorcees planning a raid on an ex-spouse's wealth, highlighting that it could inspire rich Britons to shift assets to places such as Jersey.
Mr. Howell said that the Channel island court's snub to the mainland signaled the end of English courts "riding roughshod" after a series of recent cases in which the island's authorities agreed to comply with orders to send millions of pounds back to divorcees.
"This ruling essentially states that Jersey courts should make their own decisions," Mr. Howell said. "English courts have just assumed that Jersey courts will comply. What this ruling shows is that might no longer be the case."
The move could also persuade tax havens in other British territories and dependencies, such as some Carribean islands and the Isle of Man, to follow suit, in an attempt to attract lucrative investment.
The Jersey ruling was made in the case of Mubarak v Mubarik, a long-running dispute over the wealth of Iqbal Mubarik, who owns the Dianoor jewelry chain, which has a shop on London's New Bond Street.
Mr. Mubarik was last year ordered by the High Court to give his wife Aaliya -- who disagrees with her ex-husband over the spelling of their surname, claiming it should be Mubarak -- money from a trust in Jersey thought to be worth about £18 million. Shortly before their divorce, Mr. Mubarak removed his wife as a trustee.
However, the Jersey Royal Court found that under the trust's own rules, Mr. Mubarik was not legally entitled to pay his wife money from it -- and refused to force him to do so.
The decision is likely to catch the eye of super-rich bankers and hedge-fund managers wary of settling down due to London's reputation as Europe's costliest place to divorce.
In England's largest ever divorce payout, the businessman John Charman was last year ordered to pay his ex-wife Beverley £48 million after the High Court ruled that assets he held in a Bermudian trust should be included in their settlement. Mr. Charman's Bermudian lawyers are contesting the English courts' right to make decisions about offshore trusts on the island.
Mark Harper, a partner at the city law firm Withers, said: "The judgment will be influential in other offshore jurisdictions."
EXIT TAX FOR U.S. EXPATRIATES TO BECOME LAW
New rules will impose tax on expatriates and withholding requirements on trustees.
The land of the free has joined those historical regimes well known for their respect for individual liberties, Nazi Germany and Soviet Russia, in imposing an exit tax on citizens who choose to give up their U.S. citizenship and exatriate. Such a tax had been proposed multiple times over the years, but failed to become law until this past June.
The new law mandates that unrealized gains on the qualifying expat's worldwide assets be calculated, and any gains in excess of $600,000 be added to taxable income. Such assets include interests in grantor trusts, as defined by the tax code, whose existence as independent legal entities are basically ignored for purposes of the act. The $600,000 doubles to $1.2 million for a married couple filing jointly, and will be inflation indexed going forward. Details are covered below.
Mark Nestmann points out possible unpleasant effects of the new law here. His metaphor that the idea is to "keep the slaves on the plantation" sums up our sentiments as well. We would add that the planation is tottering financially, and requires all the funds it can grab to delay the day of reckoning.
“Welcome to the Hotel California. ... You can check out any time you like, but you can never leave!” ~~ The Eagles
Giving up a U.S. passport will soon carry a steep price tag. A new law passed by the U.S. Congress and sent to the President will subject certain individuals who expatriate or give up their green cards to immediate tax on the inherent gain on all of their worldwide assets and a tax on future gifts or bequests made to a U.S. citizen or resident.
Tax practitioners had been made to feel like the boy who cried wolf in recent months as the U.S. Congress repeatedly threatened to enact legislation aimed at U.S. citizens who expatriate. Congress finally made good on those threats by unanimously passing the Heroes Earning Assistance and Relief Tax (HEART) Act (the 'Act'), which provides tax relief for active duty military personnel and reservists.
The new tax regime applies to certain individuals who relinquish their U.S. citizenship and certain long-term U.S. residents (i.e., green card holders) who terminate their U.S. residence (hereafter referred to as 'expatriates'). The so-called 'mark-to-market' tax will apply to the net unrealized gain on the expatriate's worldwide assets as if such property were sold (the 'deemed sale') for its fair market value on the day before the expatriation date. Any net gain on this deemed sale in excess of $600,000 will be taxable.
In addition, trustees of (U.S. and non-U.S.) non-grantor trusts must withhold and pay over to the IRS 30% of the portion of any distribution (whether direct or indirect) that would have been taxable to the expatriate had he not expatriated. Failure to withhold the tax could subject the trustee to direct liability for the unpaid U.S. tax.
The Act applies to any expatriate if that individual (i) has a net worth of US$2 million or more; (ii) has an average net U.S. income tax liability of greater than US$139,000 for the five year period prior to expatriation; or (iii) fails to certify that he has complied with all U.S. federal tax obligations for the preceding five years (the 'covered expatriate').
The Act contains two exceptions, which are broader than those contained in current law. An individual is not a 'covered expatriate' if he certifies compliance with U.S. federal tax obligations as specified in item (iii) above, and: (i) he was at birth a citizen of the U.S. and another country, provided that (a) as of the expatriation he continues to be a citizen of, and a tax resident of, such other country, and (b) he has been a resident of the U.S. for no more than 10 of the 15 taxable years ending with the taxable year of expatriation; or (ii) he relinquished U.S. citizenship before reaching the age of 18 1/2, provided that he was a resident of the U.S. for not more than 10 taxable years before relinquishment.
The Act consists of three key elements:
As noted above, the mark-to-market tax will apply to the net unrealized gain on the covered expatriate's worldwide assets as if such property were sold for its fair market value on the day before the expatriation date to the extent that the net gain exceeds US$600,000.
- The mark-to-market tax on the covered expatriate's worldwide assets;
- A tax on certain gifts and bequests made by the covered expatriate to any US person; and
- A repeal of the current so-called 10-year shadow period for covered expatriates.
However, the mark-to-market tax will not apply to (i) certain deferred compensation items; (ii) certain specified tax deferred accounts; or (iii) any interest in a nongrantor trust.
A. Deferred Compensation Items
Under the Act, certain deferred compensation items will be subject to the mark-to-market tax. For purposes of this calculation, the covered expatriate is deemed to receive the present value of his accrued benefit on the day before the expatriation date. No early distribution excise tax applies by virtue of this treatment, and appropriate adjustments must be made to subsequent distributions from the plan to reflect such treatment.
Other qualifying deferred compensation items will not be subject to the mark-to-market tax; however, the payor must deduct and withhold a tax of 30% from any taxable payment to a covered expatriate. A taxable payment is subject to withholding to the extent it would be included in the gross income of the covered expatriate if such person were a U.S. citizen or resident.
B. Specified Tax Deferred Accounts
Under the Act, the mark-to-market tax will apply to certain specified tax deferred accounts. In the case of any interest in a specified account held by a covered expatriate on the day before the expatriation date, the expatriate is deemed to receive a distribution of his entire interest in the account on that date. Appropriate adjustments are made for subsequent distributions to take into account this treatment. Such deemed distributions are not subject to additional tax.
C. Interests in Non-Grantor Trusts
The Act makes a distinction between grantor trusts and non-grantor trusts. A grantor trust is ignored as a taxable entity for U.S. federal income tax purposes. The "owner" of a grantor trust must include in computing his personal tax liability the items of income, deduction and credit that are attributable to the trust. Therefore, in the case of the portion of any trust for which the covered expatriate is treated as the owner under the grantor trust provisions, the assets held by that portion of the trust are subject to the mark-to-market tax.
The mark-to-market tax does not generally apply to non-grantor trusts. Rather, in the case of any direct or indirect distribution from the trust to a covered expatriate, the trustee must deduct and withhold an amount equal to 30% of the distribution portion that would be includable in the gross income of the covered expatriate if he were subject to U.S. income tax. The covered expatriate waives any right to claim a reduction in withholding under any treaty with the U.S. The Act does not explain how the withholding will be enforced against a non-U.S. trustee of a trust.
In addition, if the non-grantor trust distributes appreciated property to a covered expatriate, the trust recognizes gain as if the property were sold to the expatriate at its fair market value.
If a non-grantor trust becomes a grantor trust of which the covered expatriate is treated as the owner, such conversion is treated as a distribution to the covered expatriate and will trigger the 30% withholding tax.
Conversely, if a grantor trust becomes a non-grantor trust after the individual expatriates, it appears that the mark-to-market tax will apply to assets in the grantor trust, and the 30% withholding requirement will not apply to the trust once it becomes a non-grantor trust. This is an important point because the grantor's expatriation commonly converts grantor trusts into non-grantor trusts.
Tax on Gifts and Bequests to U.S. Citizens or Residents
The Act taxes certain "covered gifts or bequests" received by a U.S. citizen or resident. The tax, which is assessed at the highest marginal estate or gift tax rate at the time of the gift or bequest, applies only to the extent that the covered gift or bequest exceeds $12,000 during any calendar year. The tax is reduced by the amount of any gift or estate tax paid to a foreign country with respect to such covered gift or bequest. No allowance appears to exist for the $1 million exemption from U.S. gift tax or the $2 million exemption from U.S. estate tax normally granted to U.S. persons. Gifts or bequests made to a U.S. spouse or a qualified charity are not subject to the tax.
In the case of a covered gift or bequest made to a U.S. trust, the tax applies as if the trust were a U.S. citizen, and the trust is required to pay the tax. In the case of a covered gift or bequest made to a foreign trust, the tax applies to any distribution, whether from income or corpus, made from such trust to a recipient that is a U.S. citizen or resident in the same manner as if such distribution were a covered gift or bequest.
Current law subjects expatriates to a so-called 10-year shadow period, which results in a covered expatriate being taxed as a U.S. citizen in any of the 10 years following expatriation in which the expatriate spends 30 days in more in the U.S. In addition, current law taxes expatriates on all U.S. source income and gain during the shadow period.
Under the Act, individuals who expatriate on or after the date of enactment will not be subject to the shadow period but will instead be subject to the mark-to-market tax and the tax on gifts and bequests to U.S. citizens and residents. ...
In light of the Act, individuals who are considering expatriation should consider the substantial new tax burdens that this action will generate. Those persons who expatriate after the enactment date and who are considering making gifts or bequests to U.S. persons in the future should also review their planning. In addition, trustees should very carefully consider whether trust beneficiaries are covered expatriates before making any distribution without withholding U.S. tax. Trustees who fail to become familiar with the new rules do so at their peril.
LONE ACCOUNTANT TAKES ON IRS AND WINS
Minnesota accountant Charles Ulrich thought the IRS's method for calculating the cost basis of stock shares distributed to policy holders when a mutual insurance company demutualized was not right. The IRS claimed the basis was zero -- the shares were like manna from heaven -- so when shares were sold the capital gain per share sold was the full sale price. Ulrich concluded that policyholders had paid for their ownership rights through their past premiums, so the cost basis should be the IPO price, or some calculation of a similar nature.
Obviously this would likely make a big difference in taxes paid by the beneficiaries of the stock distributions. Of course the IRS maintained that their interpretation was correct. Ulrich took the IRS to court on the matter. A federal appeals court has now sided with Ulrich. The IRS may appeal the ruling. Be grateful for small victories.
It took seven years, but Charles Ulrich did something many people dream about, but few succeed at: He beat the IRS in a tax dispute. Not only that, but tax experts say potentially millions of other taxpayers could benefit from his victory.
The accountant from Baxter, Minnesota, challenged the method the IRS has used for more than 20 years to tax shares and cash distributed by mutual life insurance firms to their policyholders when they reorganize as public companies. A federal court recently agreed with his interpretation.
"There's a tremendous amount of money at stake," said Robert Willens, a New York City-based tax analyst at Robert Willens LLC. "Tens of thousands of people could be in line for a refund."
Don Alexander, an IRS commissioner in the 1970s and now a tax attorney in Washington, said while it is not unusual for individuals to take on the agency, "most of them lose." Alexander called it "quite a significant case."
The dispute arose when more than 30 mutual life insurance companies became publicly traded corporations in the late 1990s and earlier this decade, in a process known as "demutualization."
Mutual companies are owned by their policyholders, so the companies provided stock and cash to compensate them for the loss of their ownership interests when they went public. All told, roughly 30 million policyholders received distributions, Ulrich estimates. MetLife Inc. provided over $7 billion of stock to about 11 million policyholders when it went public in 2000, while Prudential distributed $12.5 billion in stock to another 11 million.
The IRS held that the recipients had not paid anything for the shares and owed taxes on the full amount when the shares were sold. Cash distributions also were fully taxable, the IRS said.
That did not sound right to Ulrich, 72, an accountant for 49 years. He began researching the issue in 2001, when he received shares from two companies, Prudential and Indianapolis Life. Ulrich concluded that policyholders had paid for their ownership rights through their premiums so the distributions should have been tax-free.
That could make a significant difference in what a taxpayer owes. If a company distributed shares worth $30 and a recipient subsequently sold them at $32, under the IRS's view they would pay taxes on all $32. Under Ulrich's interpretation, they would owe taxes only on the $2 per share gain
In 2003, Ulrich publicized his views by contacting tax and insurance experts and setting up a Web site. "Largely I was regarded as a lunatic," he said, who "would never prevail against the IRS."
Still, some people who had paid taxes contacted Ulrich and asked him to file refund requests, which he did, for a fee. Some of those refunds were granted, he said. Tax experts say the IRS does not always closely scrutinize small refunds. ...
But the IRS was not pleased with Ulrich, accusing him of promoting abusive tax shelters and demanding the names of his clients, which he said he refused to provide. The agency backed off in 2004 with help from the IRS's Taxpayer Advocate office, Ulrich said. ...
One of Ulrich's clients, Eugene Fisher, a trustee for a Baltimore, Maryland-based trust, sued the IRS in February 2004 after being denied a refund. Judge Francis Allegra of the Court of Federal Claims in Washington sided with Fisher and called the IRS's view "illogical" in an August 6 decision. He ordered the agency to refund $5,725 in taxes plus interest to the trust overseen by Fisher.
It is not clear how many people could benefit from the ruling. Many of the 30 million policyholders are probably too late to seek refunds, since claims must be filed within three years of the April 15 tax deadline. That means the statute of limitations for taxes paid for 2004 ran out April 15, 2008. ...
The government could appeal the ruling and likely will fight future refund claims, perhaps hoping for a different outcome in a separate court, tax experts said. Charles Miller, a spokesman for the Justice Department, said the government has not yet decided whether to appeal.
Still, taxpayers should request refunds if they are eligible, the tax experts said, because even if the IRS rejects the claim, doing so extends the deadline for a potential refund for two more years.
Ulrich will prepare refund requests for interested taxpayers, for a fee, and has posted additional information at his Web site. But he said the principle is more important to him. "I think it's important that taxpayers' rights be protected," he said. "We should have had a Boston Tea Party over this."
NICOLAS CAGE FORCED TO PAY BACK-TAX TO THE IRS
The U.S. tax code allows the deduction against gross income of expenses used to generate that income. What constitutes allowable can be in the eye of the beholder. Taxpayers' eyes tend to be less discriminating here than the IRS's. The IRS decided that certain expenses incurred by celebrity/actor Nicolas Cage, such as limo rides and the maintenance of a private jet, came under the category of lifestyle maintenance rather than business necessity. We suspect if Cage had legally structured his one-man empire as a business, many of those "expenses" would passed muster.
Oscar-winning actor Nicolas Cage has been forced to pay more than half a million dollars in back taxes and penalties to the Internal Revenue Service, after it was revealed he had improperly deducted millions of dollars in personal expenses from his professional income. He has been forced to pay £378,000 after he was accused of wrongly writing off close to £1.9 million that was actually used to maintain his lifestyle between 2002 and 2004.
Necessities claimed as business expenses included limousine rides, meals and the maintenance of a private jet. "Household help" at Cage's homes around the world cost more than £100,000 -- he keeps properties in Los Angeles, the Bahamas, Rhode Island and Midford Castle, near Bath.
His salary was also a source of dispute -- in 2003, he reported £243,000 in taxable income, the IRS claiming it was more than £1 million, while in 2004, the year he starred in National Treasure, he admitted making close to £9.6 million, although the IRS thought the figure was closer to £10.5 million.
In February, Cage's business manager, Samuel J Levin, said deducting the cost of food, domestic staff and travel from declared earnings was "customary in the entertainment industry" and necessary to finance Cage's "security needs."
The settlement emerged this week, however, demanding he pay £378,000 in back taxes. A note on the U.S. tax court's internet site revealed 20% of the sum was a "penalty fee", but made clear the IRS considered the matter a case of non-criminal negligence, rather than something more serious.
The magazine Forbes recently ranked the actor 49th in its annual Celebrity 100 list, claiming his income for the past 12 months was £21.5 million, although a good portion of his fortune is tied up in his latest movie Bangkok Dangerous.
It also emerged Cage had put his 11,000 square foot mock-Tudor mansion in Bel Air on the market for £16.4 million, and was moving into a smaller, leased flat. The house Cage is selling was once owned by Dean Martin, and boasts nine bedrooms and bathrooms, with an Olympic-size pool and 35-seat home cinema.
In February, fellow actor Wesley Snipes was acquitted of felony charges of fraud and conspiracy but was convicted for failing to file tax returns or to pay taxes from 2002 to 2004.
RANGEL TO PAY BACK TAXES OWED
Last week we posted in item detailing Democrat Rep. Charles Rangel's failure to report income from offshore sources on his tax returns. Oops ... mistake, he now says. He agreed to pay any back taxes owed. No mention is made about whether penalties will be added, as they were for Nicholas Cage (see above).
Rangel is continuing to refuse Republican recalls to resign as chairman of the powerful House Ways and Means Committee, which presides over tax legislation. After all, everyone makes an occasional mistake. An ethics panel is also looking into how Rangel came to control and occupy four rent-controlled residential apartments in New York City, one of has been illegally used as a campaign office. We suppose that such laws are just meant for the little people.
Amid growing allegations of unethical conduct, U.S. Representative Charles Rangel has said that he intends to pay any taxes he owes on foreign investment income, although he is refusing to relinquish his chairmanship of the powerful House Ways and Means Committee, which writes tax legislation.
In a news conference to explain his position, the flamboyant New York Democrat insisted that he had "done nothing morally wrong," and that any irregularities in his financial affairs were errors of omission rather than deliberate deception. He announced that his tax attorney is looking at his filings going back some twenty years, and that he fully intends to pay back any federal, state or local taxes that he owes, which have been estimated at $10,000.
"I do hope that my explanation will be sufficient to say that we do make errors, even though we consider ourselves experts in terms of tax policy for the nation," he said by way of an explanation.
However, Rangel is continuing to stand firm in the face of Republican attempts to unseat him as chairman of the Ways and Means Committee, and he insists that this is something for a special House ethics panel set up to investigate the affair to decide. "I really don't believe that making mistakes means that you have to give up your career," he argued.
House Republican leaders recently wrote to House Speaker Nancy Pelosi, urging her to remove Rangel from the post, at least until the ethical issues are resolved, arguing that his alleged conduct makes his position as chairman untenable.
Rangel is accused of failing to declare at least $75,000 in income from a luxury vacation property located in the Dominican Republic, which he bought in 1988.
The ethics panel is also examining how Rangel came to occupy four rent-controlled apartments in New York City, one of which he has used as a campaign office.
The Secret Adventures of the Offshore HypocriteSeptember 17, 2008
Bob Bauman contributes his say on the Rangel affair. Bauman once served in the U.S. House of Representatives and has fairly fond memories of his personal dealings with Rangel. Having gotten that out of the way, Bauman then drops the gloves, filling in details on Rangel's current scandal, intermixed with pointed commentary.
House Speaker Nancy Pelosi has referred the Rangel matter to the House Ethics Committee, but as Bauman writes: "Don't hold your breath. Knowing the ways of Capitol Hill as I do, I seriously doubt that this will mean an exit for 'Exit Tax Charlie.'"
When a state tax agency plays Dirty Harry, who pays for the damage?
California's Franchise Tax Board has a well-earned reputation for being about the most intrusive and abusive of the state tax agencies. Unlike with the IRS, such abuses occasionally do get punished. One aggrieved victim has instituted a civil rights suit in federal court. Another one was awarded $388 million after initiating a suit in a Nevada court -- this after the U.S. Supreme Court ruled that tax-collecting officials from one state are not immune from suits initated in another state.
Asleep at his girlfriend's Modesto, California home at 7:00 a.m. on February 23, 2006, orthopedic surgeon Thomas Kaschak was no doubt having nightmares about endless meetings with California tax auditors. California's Franchise Tax Board was after Kaschak for $138,000 in income taxes he allegedly owed between 2000 and 2004. Though he claimed to be a 15-year resident of Nevada, which does not tax income, Kaschak worked at a hospital in California, which does. If he was expecting accountants and tax lawyers, he says he got instead some 20 FTB agents who raided the house, rousted him out of bed and refused to let him contact his attorney during a two-hour interrogation.
Kaschak was later criminally indicted for failing to file state income tax returns, but if these tactics get your blood boiling, rejoice. Mad as hell, Kaschak, now 49, filed a federal civil rights suit in Fresno in June. More satisfying: In August a different taxpayer won a tort suit against the Franchise Tax Board. A Nevada jury ordered the California publicans to pay $388 million to Gilbert Hyatt for such shenanigans as rummaging through his trash and passing out his Social Security number to the media. The state had claimed that Hyatt, an engineer, was still living in California when he made $40 million in licensing fees from a patent on a lucrative microprocessor technology. Hyatt insisted he had already moved to Nevada.
The jury decision is likely to give pause to tax collectors -- from California, especially -- who make a habit of going after wealthy ex-residents who set up house in another state. These investigations can get pretty intrusive, as state auditors poke into credit card bills, telephone calls and doctor visits to determine where you really hang your hat. They can almost make the IRS, which is boxed in by taxpayer rights laws, seem like a softie.
"Many states model their audit programs on residency after what the Franchise Tax Board does," says San Francisco tax attorney Brian Toman, a former FTB chief counsel. "So if the Franchise Tax Board gets stung, the other states are in line to get stung."
Hyatt's case was aided by a U.S. Supreme Court ruling that should make it easier for other aggrieved taxpayers to fight back. California had argued that its tax-collecting officials had immunity from suits under state law and thus, under the Constitution, could not be sued in another state. Nineteen state governments filed an amicus brief in support of the FTB's position. But in 2003 the justices ruled unanimously that the suit could proceed.
The Nevada jury's verdict included $250 million in punitive damages. It is improbable that Hyatt will ever collect the full amount, but he could wind up with some extra spending money. The California authorities have not decided on an appeal yet but are pursuing Hyatt for over $50 million in back taxes including interest.
It is not the first time a California-Nevada dispute has sparked a national tax policy dilemma. In the early 1990s California tried to tax pension benefits of former state employees who had retired to Nevada. In 1995, following intense efforts by Nevada's delegation, Congress passed a law prohibiting state income taxation of nonresidents' pension income, including that from a 401(k).
New York is another state not above streetwise methods. Manhattan tax lawyer Mark Klein says state auditors have been known to show up at a target's building and interview his doorman. New York also recently began going after taxes on stock option grants to nonresidents based on the number of days they worked in the state. But so far New York has not been hit with any civil lawsuits like those brought against California.
William Comiskey, New York State's tax enforcement czar, makes no apologies. Tough scrutiny that gets publicity has a deterrent effect, he says, pointing to what he calls "the Koz Bump," named for now-imprisoned former Tyco chief L. Dennis Kozlowski. In 2002 New York authorities launched a criminal case against Kozlowski for dodging use taxes on pricey pieces of artwork by keeping them in New York while shipping empty boxes to New Hampshire. The next year the state collected $61 million in use taxes from apparently nervous individuals, though it was expecting only $16 million. "We're appropriately aggressive," Comiskey says.
Still, Kaschak's attorney James Rowe says that when it comes to playing bad cop, California's FTB is in a precinct all its own. "They've almost become, in some respects, a gestapo of sorts," he says.
REGULAR FOLKS WHO HATE WAR
Here is another review of Bill Kauffman's Ain't My America: The Long, Noble History of Antiwar Conservatism and Middle American Anti-Imperialism, a review of which we previously posted here. Jeffrey Tucker, editorial vice president of the Ludwig von Mises Institute, notes that today the pointy-headed, granola-munching, Kumbaya-singing lefties are antiwar while the average Joe "conservative" is pro-war. But it was hardly always such.
As recently as the 1990s there was a reflexive rightist "Clinton is for war so we are against it" position, which would have benefited the country greatly if it had survived a change in the figurehead. Far more significantly, Kaufmann shows that middle America has traditionally been the largest and more effective countervailing force to the statist agendas of war and imperialism. The history of domestic anti-imperialism is interesting enough, due to its having been suppressed in the standard state-glorifying history curricula of American public education. The political philosophies of the movement's prime movers is icing on the cake.
In my hometown, the peace rallies are always sponsored by the Unitarians. Actually, it is they who are the participants too. This is not a highly heterogeneous group. In fact, you know them already: highly educated, ideologically driven according to conventional left-wing moorings, attracted to fashionable causes like global warming and the mortal threat posed by plastic grocery bags, and hyper-tolerant of all points of view except those with which they disagree.
In some way, they stand in proxy for all the "gownies" in this college town, but distinguish themselves for actually practicing what they preach. Most of the professors are sympathetic to their antiwar cause, and are rather disgusted by the dumbed-down and reflexive foreign-policy belligerence of the "townies," who regard every new war as a test of national pride. The professors are not activists, so they let the Unitarians do the heavy lifting of driving the townies crazy with "unpatriotic" protests.
In this, they are united against the bourgeois Baptists at the middle-brow churches in town, who hear sermons about the how God is a man of war and how Islam threatens our very way of life, so we had better get them before they get us. Their "patriotism" is summed up by hyper-loyalty to the Republican party and pledging allegiance to the flag and treating it and other symbols of the nation-state as if they were holy relics.
This is a summary my town's politics concerning war, and I suspect that it is not unlike your town. The intellectuals of the left are antiwar; the average Joe on the street is pro-war. So entrenched is this demographic that we just take it for granted and presume it has never been otherwise.
The world as portrayed in Bill Kaufmann's fantastic new book is radically different, even upside down from the one we know. And yet the world he presents seems to make more intuitive sense. The title gives you the flavor: Ain't My America: The Long, Noble History of Antiwar Conservatism and Middle-American Anti-Imperialism (NY: Metropolitan Books: 2008). What he has done in 281 pages is write a super-entertaining, very-well researched, and enormously enlightening history of how middle America has traditionally been the largest and more effective force of resistance to the imperial garrison state.
This has been true from the early years of the Republic, in which founders warned not only against foreign intervention but even any standing army at all, through the interwar period, when the largest mass movement in American history to the point rallied against entering World War II. In great detail, he alerts us to the politics of the least-discussed and least-understood war of them all: the Great War or World War I.
In this episode, the left was on the side of the war, with the hope that the state would try an experiment in national economic planning, crush Old World forms of government abroad, and usher in progressive policies such as income taxes, central banking, and presidential dictatorship. They got their way, while the group we might call the right cried foul. Opposition came from farmers, main street Republicans, and old-school classical liberals. The author provides fantastic quotations from speeches in Congress that opposed entry into year, generally viewing it as a war by and for elites against the people. It was patriotism that drove the opposition. "As I love my country," said Isaac Sherwood of Ohio, "I feel it is my sacred duty to keep the stalwart young men of today out of a barbarous war 3,500 miles away in which we have no vital interest."
Many of the speeches he quotes are downright inspiring, not only because of the words but also because it is great to see them all resurrected again. Official historians have tended to act as if the opposition had no good points or did not exist at all. Kaufmann shows that they were principled and even prophetic. More than that, he shows that the opposition to war here stemmed from conservative values.
But this turned out to be a warm-up for the opposition to the entry to World War II. We are supposed to believe that because we won that one unequivocally, the opponents of entry had nothing to say worth remembering. In fact, the opponents saw FDR's war as provoked as the second part of the New Deal: Instead of dealing with unemployment, send them to foreign lands to kill and be killed. The drive to war was opposed by the American First movement, which was huge and marvelous in so many ways, even if they did get crushed by wicked propaganda then and now.
The author revisits their arguments and refutes the myths surrounding them, e.g., they were fascistic or ignorant or provincial or underestimating risk abroad. But his main point is demographic and intellectual: Here to be against war was to be for America, for patriotism, for the love of home and liberty. He demonstrates this many times over.
He goes further to dip into the early history of the Cold War to show that the American Right was against intervention. They had seen the way war politics was used to build the state, and had enough of the tendency to give up ever more liberty. Many heroes emerge here from the early '50s, with right-wing pundits and politicians sounding not that much different from how the New Left sounded only a decade and a half later.
What Kaufman has done here is more than merely sketch a history, though it is wonderful and detailed history. He has fashioned a new way to look at the breakdown of the politics of war. I found it interesting that during the 1990s, it was the Republicans who emerged as the anti-nation-building party and the Democrats embraced their Wilsonian heritage. After 9-11, the roles switched yet again, and today the Republicans are guilty of trafficking in the worst forms of jingoistic patriotism baiting.
The author urges us to rethink what it means to be a conservative. In part it means to favor the human scale and to oppose far-flung attempts to remake the world through elite manipulation. Is it really so unreasonable that conservatives should make the anti-war cause their own? Read Kaufmann and see if you rethink your position.
"There is nothing conservative about the American Empire," he writes. "It seeks to destroy – which is why good American conservatives, those loyal to family and home and neighborhood and our best traditions, should wish, and work toward, its peaceful destruction. We have nothing to lose but the chains and taxes of empire. And we have a country to regain."
THE SOCIAL IMPERATIVE OF SOUND MONEY
The incredible superstition that waving the magic money wand can make reality just go away seems to be the official position of the entire U.S. establishment.
A speech from Lew Rockwell, eloquently (as always for him) puts the financial bailout/nationalizations of the day in context. Behind all the euphemisms -- bailouts, "conservatorship," Fed liquidity injections, etc. -- the bottom line it that the U.S. is now more socialist than China, as investor Jim Rogers has accurately expressed it. Central planning and socialism has not worked in the past, ever, and it will not work this time. The only hope is to abandon it.
This past week, the government announced that it would take Freddie Mac and Fannie Mae, the mortgage giants, under conservatorship, which is a nice way of saying that they will be nationalized.
We don't use the word nationalize any more. We can try an experiment and read the new term "conservatorship" back into history. In fact, we might say that Stalin and Lenin put Russia's industries under a kind of conservatorship. Or we might say that Mao pushed a kind of land conservatorship, or that Hitler's policy was one of national conservatorship. Marx's little book could be re-titled: The Conservatorship Manifesto.
You see, the government keeps having to make up new names for these things because the old policies, which were not that different in content, failed so miserably. The old terms become discredited and new terms become necessary, in an effort to fool the public.
It is as if a restaurant served a shrimp dish that gave all the customers food poisoning, and so each night it decides to serve the same shrimp but name the dish something new: crangon cocktail, prawn pasta, scampi salad, or what have you. But no matter what they call it, it is still poison.
Such a restaurant would be out of business in a matter of days. People would not be fooled. But the government gets away with it mainly because we have no real choice about the matter, and because people are predisposed to believe the government far more than they should. It does not help that the media are willing to echo the government line on this, adopting every new phrase as if it were the gospel.
Hence the same is true of the word bailout, which you might consider unexceptionally descriptive of this move by the government to protect Freddie and Fannie from further losses. No, that word is not allowed either. President Bush told Fox the other day, "I wouldn't call it a bailout. I'd call it a stabilization."
We will soon put out a new edition of Mises's 1922 book Socialism. Maybe to keep up with the time we should call it Stabilizing Conservatorship.
What I also find striking is the way in which this move was announced. Let me read to you from the New York Times: "The Bush administration seized control of the nation's two largest mortgage finance companies on Sunday. ... It could become one of the most expensive financial bailouts in American history."
Even the most sophisticated observers of our present scene had to blink their eyes in reading such words. Without debate, without votes, without anything other than an executive fiat, the White House just decided, on its own, to seize the mortgage market. Harry Truman, who seized the steel industry, would be proud. Actually, this is an action to excuse dictators the world over, past, present, and future.
This sort of thing makes a mockery of the Constitution and the very idea of freedom and the free market, to say nothing of the idea that we have a limited government. What is more, if we can believe press reports, President Bush had very little to do with the decision. It was the work of Henry Paulson, the secretary of the Treasury and former head of Goldman Sachs, working on behalf of the nation's most well-connected financial elites. Nobody elected this guy. Most Americans do not even know his name.
And look at how he throws around trillions of our money. The New York Times says that this is expensive. That is one way to put it. It makes the S&L bailout look like the warm-up.
Freddie and Fannie carry about $5.3 trillion in mortgage commitments and another $2.4 trillion in financial exposure. The total cost of this operation is unknown; it could reach to $2 trillion, with untold amounts of future exposure.
These two New Deal institutions were founded to speed up the home ownership process for people that banks would otherwise consider unqualified. In time, under LBJ and Nixon, they were given legal permission to expand without limit, in the name of privatization, of all things.
The motive was a classic bipartisan effort: universal home ownership. The left favored the redistribution. The right favored the supposed moral virtue associated with the nuclear family and its suburban abode. Thus was born the greatest wealth transfer in American history outside Social Security and the warfare state.
In a free market with sound money, borrowing is connected with the ability to pay. At first, this is only available to the rich. As prosperity spreads, so does credit worthiness. Any government intervention designed to inject steroids in this process is going to end in what Rothbard called a cluster of errors.
It is completely disingenuous that so many people are today decrying the banking system's failure to discriminate between those who should and should not be carrying a mortgage. The banking system in a free market handles this just fine. Ferreting out the difference between those who can handle loans and those who cannot is a main job of the competitive system. The market precisely calibrates this. If one lender fails in its assessments of borrowers, another is there to correct the problem.
If you rush the process of prosperity, and insist that everyone who wants a loan should get one, you set up a situation in which there will be problems down the line. That is precisely what the regime has done. It created Freddie and Fannie to subsidize loans. It engaged in a phony privatization that secretly socialized losses. The legal status of these privately owned, publicly traded, and government-protected agencies was always unclear, but the markets had long assumed that they would be bailed out.
There was a moral hazard at the heart of this policy. But the real point is that the free market judgment about who should get what was being over-ridden. Surely, that is not a problem when it comes to promoting the alleged American dream! In fact, we are paying for this mistake a half century after the policy became a national priority. As the evangelical ministers like to say, the wheels of justice grind slowly, but they grind mighty fine.
There is only one problem with applying the principle to this case. There will be no justice. If justice prevailed, the losses would be borne directly by those responsible.
If we pursued a free-market policy from here on, the answer would not be complicated. The assets and liabilities of Freddie Mac and Fannie Mae would be auctioned today in the free market. It is true that many loans would be defaulted on.
What level of crisis would be precipitated by such a genuine privatization policy? It is true that the press would be screaming bloody murder, and the big players in finance would suffer. But in time, the markets would revalue the resources and an important lesson would be learned. Sound loans would be picked up by financially responsible firms and carried to term. Home values would fall and many people would have to move to cheaper homes. We would then be back on sound footing again.
From an administration that purports to favor free markets, this possible solution was not even considered. Instead, they proclaimed their regrets that they would have to spread the costs of this error over the entire population. Instead of fixing the problem, however, they only worsen it, underscoring the principle that America will not tolerate failure in business, and the bigger the failure, the more likely it is to be bailed out.
Note that this socialistic bailout and nationalization -- to use two forbidden words -- were enacted by a Republican administration. Isn't it ironic that when you look back at the big upticks in government intervention over the economy, you often find Republicans at the helm.
As for McCain and Palin, they wrote in the Wall Street Journal that this bailout is "sadly necessarily" even as they promise reforms that will "require the highest standards of accounting, reporting and transparency ever demanded in government." Well, here is the thing: no one demands higher standards than the market itself, but you have to turn these institutions over to the market in order to elicit such standards.
Congress's role has been and will be to yammer. Only Ron Paul of Texas will have anything sensible to say about this fiasco. In fact, it was more than five years ago that Ron said the following: "If Fannie and Freddie were not underwritten by the federal government, investors would demand Fannie and Freddie provide assurance that they follow accepted management and accounting practices. ... By transferring the risk of a widespread mortgage default, the government increases the likelihood of a painful crash in the housing market. This is because the special privileges granted to Fannie and Freddie have distorted the housing market by allowing them to attract capital they could not attract under pure market conditions. As a result, capital is diverted from its most productive use into housing. This reduces the efficacy of the entire market and thus reduces the standard of living of all Americans."
It is remarkable to observe that hardly anyone dares be against this policy. On the day following the nationalization, a day that will live in infamy, the Wall Street Journal editorialized against the Democrats and their reform efforts, but did not actually oppose the bailout. The New York Times called it "a reasonable and reassuring move." The Los Angeles Times wrote that the bailout was "inevitable." Steve Forbes in his magazine wrote that "drastic action" had to be taken because a default would "have trigged the worst financial meltdown since the Great Depression."
It is interesting, isn't it, that all these people believe that waving the magic money wand can make reality just go away. That incredible superstition seems to be the official position of the entire U.S. establishment. And we like to flatter ourselves into believing that we live in an age without illusions!
As for those who should know better, Greg Mankiw, author of the leading economics textbook, writes that because "it was likely to happen eventually" it is "better to get on with it." The supposedly free-market economics blog Marginal Revolution warns that without the bailout, "most of the U.S. banking system would be insolvent," failing to point out that a system that needs a bailout with fiat money is already insolvent. Econlog had lots of good thoughts, but did not actually oppose the bailout.
The Cato Institute agrees that the Treasury had to bail out the mortgage industry because it "was forced to do so," and that Fannie and Freddie are indeed "too big to fail." The Heritage Foundation agrees that it was a "necessary step" and a "vital move toward reform."
Sure, these people have plenty of recommendations about what should have been done in the past, and lots of ideas about what should be done in the future. As for the present, they are ready to propagandize for the largest socialist operation in American history. In all of these latter cases, we are looking not at a problem of economic education but rather the courage to stand up to the state when it is needed most. They did not do so after 9/11. And now they have caved again.
Part of the problem is the belief in the great myth propagated by Milton Friedman. As good as he was on many issues, he was not correct on his specialty of American monetary history. His view was that the Depression was caused by a Fed that failed to fully bail out the banking system. Ben Bernanke and many others are pleased to accept this view of history, and they are determined not to let it happen again. In fact, the Fed did attempt to bail out the banks, and was far too successful. This is the basis of the problem.
In the end, we are talking about a price system that has rendered a verdict on the housing market. Prices do not lie and there is nothing we can do to reverse them. Even the most powerful government in the world cannot do so. The attempt causes calamity. The Austrians understand this, whereas it seems as if hardly anyone else does.
Pretty much alone in both predicting the calamity and actually opposing the bailout are those who have learned from the Misesian tradition, who have said plainly and clearly that this is a dreadful error, one that makes the U.S. more socialistic than China.
Let us address this claim that not bailing out the system, and not nationalizing the mortgage market, would lead to a financial meltdown on the level of the Great Depression. People talk as if the Depression were some sort of natural disaster that the government had to fight. In fact, it was the very fighting of the Depression that deepened it and caused it to last all the way through World War II. We have to understand that if we are to understand the real lesson of the Depression. Instead of letting prices fall and letting the bad investments wash out of the system, the government tried for years and years to keep prices high, employ people in make-work programs, and generally centrally plan the economy.
The 1920-22 financial meltdown solved itself, and is a forgotten event. We should be so lucky this time.
In 1920 through 1922, we had a financial meltdown just as bracing and systematic as the one in 1929. The difference was that the government did not do anything to try to fix it. As a result, it solved itself and it is a forgotten event. Hoover and FDR, in contrast, attempted to use their power over the economy and monetary system to try to keep prices floating high and to keep liquidity in the banking system -- precisely as everyone is attempting now. The result was to forestall the inevitable readjustment process.
They believed that the low prices were the cause and not the effect of the recession. Does that error sound familiar? In other words, the Great Depression only became the Great Depression because the government followed exactly the same policies that the Bush administration is following now with regard to the mortgage market.
It makes no sense to warn that we will repeat the past if we do the same things that actually made the past as bad as it was. To avoid another Depression-sized downturn, we need to avoid the mistakes of the past, among which were the policies that attempted to keep failing firms and industries afloat in difficult economic times.
What should have happened in 1929 is precisely what should happen now. The government should completely remove itself and let the market reevaluate resource values. That means bankruptcies, yes. That means bank closures, yes. But these are part of the capitalistic system. They are part of the free-market economy. What is regrettable is not the readjustment process, but that the process was ever made necessary by the preceding central bank and other interventions.
Let me state this very plainly: I do not believe for one second that if the government fails to nationalize Freddie and Fannie that the world as we know it will come to an end. Those who are saying that are trying to scare the population, the same as with every other major demand by the regime. It was the same with NAFTA, the WTO, the war on terror, the war on bird flu, the nationalization of airport security, and everything else.
If the government did nothing but sell off the assets of the mortgage giants, we do not know for sure what would happen, but the market has a way of finding value and readjusting. I would expect about 18 months of difficulties. Banks would fail just as many businesses in the free market fail every day. Housing prices would fall more, just as all market prices are subject to change. But the process of readjustment would be smooth and rational. And we would all stop living a lie and believing an illusion.
Contrary to what the blogging heads say, there is nothing that makes this nationalization inevitable. If we had leaders who had courage, who understood economics, who could think about the long run, we would let the market handle the entire process, come what may. I guarantee that this solution is a better one than creating another trillion or so to bail out failing enterprises.
And yet this is not just another longing for courageous leaders. We cannot hope for that. We need a guarantee. We need a system that would make it impossible for government to do these things even if it wants to. That system is called sound money. Think about the preconditions that made it possible for the Bush administration to decide one evening to dump a trillion plus to guarantee three-quarters of the home mortgages in this country. It is a system that is premised on the government's capacity to print unlimited amounts of money.
If it could not do that, no one would be talking about conservatorship. No one would be talking about guaranteeing the liabilities of the automotive industry either. War on Afghanistan, on Iraq, on Russia, and troops in another 100 plus countries, would be out of the question. These would not be issues. If government had to tax people directly for all its spending priorities, we would see Washington's ambitions in every area scaled back dramatically. Every suggestion of a new program would be met with the demand as to how it would be funded.
Fiat money with central banking, on the other hand, tempts corrupt politicians and bureaucrats, and it also further corrupts them. It is the great occasion of sin of our public life. The tragedy is that their use of the printing press not only corrupts them; it imposes dreadful and intolerable costs on the rest of society, in the form of price inflation and business cycles.
We have seen the corruption grow worse over time. We are living now in the 37th year of fully fiat money with central banking. The politicians of the past were a bit reticent to use all the power they had. They are becoming ever more brazen. The sense of shame seems to be gone forever, their consciousness completely papered over by the ominous power they possess. The pundit class is following them, believing that there are no limits.
In truth, all these bills must be paid. To realize that is to realize the necessity of radical reform. It can be overwhelming to contemplate the glorious results of a full gold standard reform. Inflation would stop eating away our purchasing power. The business cycle would be tamed. International trade would not be disrupted by wild swings in currency values. But of all the benefits, this one is the greatest: it would stop arbitrary rule, dead in its tracks. It would force the government to curb its ways. It would shore up our freedoms.
For this reason, the policy of sound money is very much linked with morality. The Hebrew scriptures, in the nineteenth chapter of the book of Leviticus, warns "you shall have just balances, just weights ..." The 25th chapter of Deuteronomy issues a similar warning: "You shall not have in your bag differing weights, a large and a small." Proverbs says the same: "A false balance is abomination to the LORD: but a just weight is his delight." Another passage says: "Diverse weights, and diverse measures, both of them are alike abomination to the LORD."
All of these relate in some degree to the need for sound money and condemn the act of fraud and monetary debasement. The consequences of monetary sin cannot be contained to the sinners only. They are spread out all over the whole of society, destroying its economic basis and corrupting the morals of society. They foster crazed illusions that we can magically generate wealth through the act of printing money, and the attempt to do so has catastrophic consequences. As Mises wrote: "Inflation is the fiscal complement of statism and arbitrary government. It is a cog in the complex of policies and institutions which gradually lead toward totalitarianism."
I find it sickening that there are so few voices outside the Austrian School that will stand up to this policy. And I fear that the consequences of this policy will be felt for many decades into the future. There is still time to reverse course. There is nothing inevitable about despotism. We are not being forced down this road. We can embrace freedom. If we understand that freedom is inseparable from sound money, we can embrace that too. Until then, we will continue to place our trust in the political establishment to do what is right. Call me a gold bug if you will, but I trust hard money far more than our rulers. And that, ultimately, is the choice we must make.
Beijing worried of financial contagion via Hong Kong.
Mainland China is worried that the puff of wind that blows over its house-of-cards financial system could arrive from Hong Kong. The fundamental worry is legitimate. If the system were sound it would not matter how liberal and open Hong Kong's system was.
Beijing is worried that an overly liberal financial system in Hong Kong could invite financial contagion into China and disrupt critical economic growth, a government economist said ...
"China today has a very unique situation -- it is one country with two financial systems -- the Hong Kong system is very open, very liberal, very efficient, very modern" compared with the Chinese system as a whole, said K.C. Kwok, a Hong Kong government economist. "But at the same time, China is also very worried that if we gradually open up our system and Hong Kong being so open, financial market contagion -- if anything wrong happens in the outside world -- could be brought into China through Hong Kong" ...
Hong Kong, known as a special administrative region of China, is Asia's leading wealth management center, housing some 80 fund management houses ... It is also witnessing an expansion of the Chinese yuan currency-linked business and is the first place outside the mainland with a yuan bond market.
Kwok said Hong Kong was maintaining "very high level of supervisory and regulatory standards" to check any contagion effects on China.
He also said that financial system liberalization was "quite a very sensitive subject" in China. "If you talk to the Chinese decison makers and so on, they believe that the 1997-1998 financial crisis in Asia occurred because of the fact these developing countries liberalized their financial sector too early, before they can have a foundation," Kwok said.
The crisis, sparked by rapid currency depreciation, led to political and economic turmoil in the region, with the IMF having to provide emergency funding to keep some economies afloat.
Bank of China says money laundering allegations in U.S. court unfounded.
A lawsuit brought by Isreali terrorist victims in a U.S. court alleges that the Bank of China helped fund the organizations which perpetrated the terrorist acts. Proving this will be an uphill battle at best, assuming it is true.
Bank of China dismissed as "nonsense" allegations that it is involved in money-laundering to fund terrorist organizations, saying that the bank has always complied with the law. "We have noticed some recent reports about (a) lawsuit in the U.S. These allegations are purely nonsense and without foundation," bank spokesman Wang Zhaowen said in a statement published on its website.
The Wall Street Journal reported that a lawsuit filed in Los Angeles Superior Court, which was brought on behalf of over 100 victims of terrorism in Israel, alleges that the bank transferred millions of dollars to Hamas and Palestinian Islamic Jihad in Iran and Syria.
"Bank of China has always strictly been in compliance with the United Nations rules against money-laundering and terrorist financing. The bank has consistently adhered to the regulatory requirements in China and other jurisdictions," he said. Bank of China is ready to respond the lawsuit, reserving the right to make counterclaims and initiate other legal proceedings, Wang said.
Uruguay’s Monetary Policy Effective Despite Dollarization
The IMF took a look at Uruguary and found, evidently to at least their mild surprise, that monetary policy can be effective (they did not say it was effective, significantly or not) in Uruguay despite the importance of dollarization in the small South American nation. Moreover, the IMF found that a flexible exchange rate can help absorb external shocks even in a system as heavily dollarized as Uruguay's, largely because most nonfinancial transactions are carried out in pesos.
Uruguay, with a population of only 3.5 million or so, was picked for of the IMF's first consultations to combine financial sector surveillance and analysis of the relationship between the financial economy and the real economy for a couple of reasons: (1) Uruguary had a recent major crisis (in 2002) that began in the financial sector and was largely caused by external factors -- primarily a financial crisis in neighboring Argentina, during which Argentines withdrew a large portion of their deposits in Uruguayan banks. (2) Uruguay is a small open economy. While there have been significant studies of industrial economies and large emerging economies, little analysis has been conducted on smaller economies that are open to trade and financial relationships with the rest of the world. (3) Foreign currency plays an important role in the economy -- close to 60% of bank lending is in U.S. dollars, e.g. That so-called dollarization -- reliance on a foreign currency for larger transactions and as a store of value -- presents Uruguay with both vulnerabilities and policy questions.
Uruguay has pursued important monetary and financial reforms since the 2002 crisis. It abandoned an exchange rate peg in favor of a float, improved financial prudential norms and supervision of the banking system, and accumulated significant central bank reserves. Since the crisis, the dollarization of the banking system has declined. Uruguay has been moving gradually from an exchange rate anchor toward an inflation-targeting regime.
The Uruguary economic and financial situation is certainly interesting. With such a small popular one might think/hope there is more room for some logic-driven politics than with the large, out-of-control states of affairs in the rest of the world.
High Tax British Labour Drives Exodus
The Sovereign Society's Bob Bauman chronicles the effects of the British Labour government's self-defeating tax policies. Companies are relocating away from the UK as competing countries actually work to attract business. Wealthy foreigners begin leaving for true tax havens after Labour reverses a long-standing policy to exempt such envy-attracting but mobile parties. And now many wealthy domestics are joining the exodus. Ain't tax competition wonderful? No wonder the high-tax European states want taxes to be "harmonized."
Islamic finance poised for massive growth as London becomes key hub outside the Middle East.
Great Britain at least is doing some things right. English law is highly regarded throughout the world -- evidently reputations die hard -- and is the preferred jurisdiction for many Islamic transactions. The UK has introduced a number of rule changes that have and will attract some of the growing wealth of Islamic peoples and nations. You can bet that such changes do not include imposing excessive taxes and regulations. Quite the reverse.
London is emerging as the key center for Islamic finance outside of the Middle East as financial institutions clamber to become part of a growing market. Currently it is estimated that Islamic banking manages funds of $200 billion. It is predicted to increase by up to 15% a year and be worth a trillion dollars by 2010.
Although Sharia-compliant finance has existed in some form for hundreds of years the world's first Islamic bank was founded in 1975 and it is only in the last five years that this area of finance has surged.
Global banking giants such as HSBC, Barclays Capital, Royal Bank of Scotland, BNP Parabas and Deutsche Bank, are putting their weight behind Islamic finance as they realise many products have a wider appeal than the immediate Muslim community. But it is London that has taken a lead for various reasons. It has been a major financial center for centuries and is regarded as open to innovation and ideas. The UK was the first member of the EU to authorise Islamic banks.
English law is highly regarded throughout the world. It is the preferred jurisdiction for many Islamic transactions.
Also the UK government is actively encouraging the growth of Islamic finance. It has introduced a number of changes to support the growth of Islamic finance. Most notably it acted quickly to introduce changes so that Islamic mortgages would not be subject to double taxation.
Dubai goes after ultra-high net worth families.
While the UK is working to attract Middle Eastern wealth, Dubai is making its own efforts to attract wealth to its budding financial center. In particular Dubai is encouraging the establishment of family-based holding companies there. In the Middle East, where more than 75% of firms are family-run.
The Dubai International Financial Centre [has] relaxed regulations to attract ultra wealthy families and single family offices. The new rules establish a platform for wealthy families to set up holding companies at the DIFC to manage private family wealth and family structures anywhere in the world ...
Dr. Omar Bin Sulaiman, governor of the DIFC said: "In recent times, family offices have become highly significant on the global economic landscape. In the Middle East, where more than 75% of firms are family-run and with total assets in excess of $1 trillion, the need for a specialized legal and regulatory framework is especially acute.
"In contrast to conventional financial institutions, SFOs have no direct public liability as shareholders are bloodline descendants of a common ancestor. As such, their regulatory requirements differ significantly. By establishing the new regulations, the DIFC is once again reaffirming its commitment to family run businesses thus addressing its desire to make the DIFC a hub for local, regional and international family offices."
|Previous||Back to top||Next|