No More <s>Wire Hangers</s> WaMu's... Ever!
On September 30, 2008, the Treasury issued an edict innocuously titled "Notice 2008-83," published in the equally innocuously titled "Internal Revenue Bulletin 2008-42." Perhaps it is just our paranoid side, but we suspect you could return the country to the gold standard in "Internal Revenue Bulletin 2009-63" and no one would catch on for 6 months. Add to this the fact that Congress, and the rest of the planet, was already quite literally possessed by the upcoming vote on Emergency Economic Stabilization Act of 2008 (the underpinnings of what would later become the Troubled Assets Relief Program or "TARP") and it isn't hard to see why the "notice" went, ironically, somewhat unnoticed. It shouldn't have.
As government prose goes, it is almost haiku like in its size:
The Internal Revenue Service and Treasury Department are studying the proper treatment under section 382(h) of the Internal Revenue Code (Code) of certain items of deduction or loss allowed after an ownership change to a corporation that is a bank (as defined in section 581) both immediately before and after the change date (as defined in section 382(j)). As described below under the heading Reliance on Notice, such banks may rely upon this guidance unless and until there is additional guidance.
For purposes of section 382(h), any deduction properly allowed after an ownership change (as defined in section 382(g)) to a bank with respect to losses on loans or bad debts (including any deduction for a reasonable addition to a reserve for bad debts) shall not be treated as a built-in loss or a deduction that is attributable to periods before the change date.1
Its effect, however, wasn't quite so demure.
Let us turn, for a moment, the way-back-machine to last September:
On Thursday, September 25, 2008, Washington Mutual was seized by regulators, departing from the normal Friday action. On a conference call that evening FDIC Chairwoman Sheila Bair blamed the circumstances and the unusual speed of the bank's decline for the unusually prompt corrective action. "This is the big one that everybody was worried about," she warned.2 Apparently, she was taken very seriously.
As an aside, it is not hard to see why scrutiny began to fall to short-sellers and the like in this period. Sean Egan is quoted in Bloomberg that Saturday thus:
"WaMu's takeover has proven that there's an easy way, if the FDIC is involved,'' said Sean Egan, president of Egan-Jones in Haverford, Pennsylvania. "You kick the hell out of the equity holders and bondholders. That may be the new model for bank takeovers."3
The seizure of Washington Mutual ends all doubt that even large retail banks are in serious trouble. In its last days, Washington Mutual lost $16.7 billion in cash to panicky depositors. The Office of Thrift Supervision press release tells the tale:
Pressure on WaMu intensified in the last three months as market conditions worsened. An outflow of deposits began on September 15, 2008, totaling $16.7 billion. With insufficient liquidity to meet its obligations, WaMu was in an unsafe and unsound condition to transact business. The OTS closed the institution and appointed the Federal Deposit Insurance Corporation (FDIC) as receiver. The FDIC held the bidding process that resulted in the acquisition by JPMorgan Chase.4
On Friday September 26, Goldman Sachs' credit analyst Louise Pitt quite sagely warns that Wachovia, already facing shareholder revolt, could face a run on deposits similar to the giant sucking sound at WaMu. Wachovia, then headed by newly appointed former Treasury Undersecretary and former Goldman Sachs Vice Chairman Bob Steel, loses $5 billion in deposits in a single day as customers scramble to draw their accounts down below what was then the $100,000 FDIC depository insurance limit. The Office of the Comptroller of the Currency, it being their job to notice such things, raises the alarm and the FDIC, with what today would be considered blinding and dangerous speed, presses Wachovia to offer themselves up for sale. Now. In particular, to Citi. The much underrated Charlotte Observer commented thus:
New York-based Citigroup is buying Wachovia's banking operations as well as most of its assets, with help from the Federal Deposit Insurance Corp. Left behind is a standalone public company, still called Wachovia and based in Charlotte, that will house the brokerage, Evergreen asset management and insurance units.5
Of course, Citigroup didn't buy Wachovia.
In the pre-bailout world, when a bank fails, it fails like Washington Mutual. The regulators (FDIC most likely) take over, they wipe out equity and bondholders and then sell the remains. It's quick. It's brutal. It's decisive. This is what Bair apparently proposed. Enter New York Fed President Tim Geithner (as characterized by David Wessel):
Geithner blew up. Wachovia has to open on Monday, he argued. It must be sold this weekend, the buyer needs government assistance, and the debt holders need to be protected. “It has to be this way,” he said. “We just went to Congress for $700 billion. The policy of the U.S. government is that there will be no more WaMu’s.”6
Wachovia, instead, was declared "systemically important" a first since that term was written into law, and auctioned off whole.
You know the rest.
Enter "Notice 2008-83." Once obscure, the small memo has begun to attract a lot of attention, not least of which from Senator Chuck Grassley of Iowa who wrote this weekend:
Treasury’s issuance of the Notice apparently enabled Wells Fargo to take over Wachovia despite a pending bid from Citibank. Without the issuance of the Notice, Wells Fargo would have only been able to shelter a limited amount of income. Under the Notice, however, Wells Fargo could reportedly shelter up to $74 billion in profits. It also potentially enabled Wachovia’s senior executives to qualify for parachute payments that may not have been available under the Citibank deal.7
Authorization has become a huge and lingering question with respect to ongoing conduct by executive agencies and departments since Bailout Nation was founded last fall. Notice 2008-83 effectively rewrites tax law. While the Treasury, a part of the Executive branch, is entitled to issue regulations with respect to the various tax laws in the United States, wholesale change of this kind would normally require bicameralsim and presentment, as per the clauses of the Constitution of the same name. (The requirement that law be passed by both houses and presented, i.e. signed by the President or subject to veto override). There is, of course, good reason to prevent the Executive branch from running hog wild in cases like these. We aren't the only ones to have noticed this either.
California, which generally seeks loose conformity with federal income tax in its own state revenue regime, and in what must be a rare bit of indictment, explicitly disavowed the IRS Notice:
Internal Revenue Service Notice 2008-83, 2008-42 I.R.B. 905, issued on October 20, 2008, relating to the treatment of deductions under Section 382(h) of the Internal Revenue Code following an ownership change, shall not be applicable for purposes of taxes imposed under Part 11 (commencing with Section 23001) of Division 2, of this code with respect to any ownership change occurring at any time. 8
Nothing motivates California legislators to faster or clearer action than a threat to their dwindling tax revenues. Accordingly, the legislative history of this bill has a stark and effective description of the issue that we quote here in part.
Section 382, originally added to the IRC in 1954 and completely rewritten in 1986, is intended to guard against “trafficking in loss carryovers.” The current version of Section 382 prescribes mechanical rules known as the “Section 382 limitation” that effectively preclude a buyer from using the net operating and built-in losses of the acquired entity at a faster rate than the acquired corporation could have used them if it had sold its assets and invested the proceeds in tax-exempt governmental obligations. The purpose of this rule is to make losses a neutral factor in a corporate acquisition. Prior to the enactment of this limitation, corporations with large losses were being purchased by corporations with large taxable incomes simply because the acquired corporation’s losses could be used to reduce the buyer’s taxable income and therefore reduce the net cost to the buyer of the acquisition.
“The sweeping change to two decades of tax policy escaped the notice of lawmakers for several days, as they remained consumed with the controversial bailout bill. When they found out, some legislators were furious. Some congressional staff members have privately concluded that the notice was illegal. But they have worried that saying so publicly could unravel several recent bank mergers made possible by the change and send the economy into an even deeper tailspin.”
“Did the Treasury Department have the authority to do this? I think almost every tax expert would agree that the answer is no," said George K. Yin, the former chief of staff of the Joint Committee on Taxation, the nonpartisan congressional authority on taxes. "They basically repealed a 22-year-old law that Congress passed as a backdoor way of providing aid to banks."9
California's outrage is necessarily somewhat polite. The reality is that on September 30, 2008, the Executive Branch of the United States flirted with a full-on constitutional crisis, apparently so that Tim Geithner's sweeping vision of "no more WaMu’s" could be realized. It is ironic that Mr. Geithner, now elevated to "Secretary of the Treasury Geithner" would phrase the issue in this fashion:
"The policy of the U.S. government is that there will be no more WaMu’s."
Since when do we accord even a president of the New York Federal Reserve Bank such latitude that he may articulate the whole of U.S. Government policy?
On February 17, 2009, President Barack Obama signed the American Recovery and Reinvestment Act of 2009 (Public Law 111-5), which in part asserts that Notice 2008-83 is inconsistent with the congressional intent in enacting Section 382 of the IRC. While questioning the legal authority of Notice 2008-83, Congress grandfathered transactions that occurred after the Notice was issued and on or before January 16, 2009, in order to protect the reliability of guidance generally, and avoid punishing taxpayers that rely on this guidance.10
In effect it appears that to prevent the FDIC from seizing another major bank and breaking it into pieces (WaMu was the 3rd largest mortgage lender in the country), to preserve the image that (some) large banks simply do not fail, and to "inspire confidence" the Treasury rewrote tax law, facilitated a number of illegal acquisitions (that, without being too sinister, clearly benefited senior management at the acquired firms), doubtlessly tampered with auction results at least indirectly and somehow managed to get the whole matter swept (mostly) under the rug with a grandfather clause by using the argument that it would be too disruptive and inconvenient to do something so drastic as to actually follow the law in these cases. No wonder Chairwoman Bair looks like she's on anti-psychotics these days. The FDIC bears almost no resemblance at all to its mid-2008th self. If you wanted to see an agency that had been irrevocably perverted from its original purpose, well, actually we'd point to the FHA, but surely second in line must be the FDIC.
Given this experience, and the lessons learned, for example, in the Chrysler bankruptcy or the structure of PPIP and given that Tim "No More WaMu's" Geithner has now been elevated to the Secretary of the Treasury, how many other "Notice 2008-83"'s are out there that we have not yet seen?
To touch on earlier work here on Zero Hedge, we might also posit this question:
Who exactly regulates the many government attorneys whose sign-off is required to issue notices such as these. Mark S. Jennings, at the Internal Revenue Service is listed as the Notice's primary author, but who penned the opinion that posited its legality?
In the years to come we suspect many theories will emerge with respect to the day we should sing the bailout anthem to commemorate the creation of Bailout Nation. We think that day might well be September 30, 2008.
- 1. http://www.irs.gov
- 2. "Government Seizes WaMu and Sells Some Assets," The New York Times, September 25, 2008."
- 3. "Wachovia Suitors May Delay Bidding After Dimon's Deal for WaMu," Bloomberg, September 27, 2008.
- 4. "Washington Mutual Acquired by JPMorgan Chase," Office of Thrift Supervision, September 25, 2008.
- 5. "Stunningly Swift Fall For Wachovia," The Charlotte Observer, September 30, 2008.
- 6. "In Fed We Trust," Wessel, David.
- 7. "Grassley Seeks Inspector General Review of Treasury Bank Merger Move," Chuck Grassley.
- 8. California Assembly Bill No. 11, Chapter 401, Approved by the [Governator] October 11, 2009.
- 9. Quoting the Washington Post: "A Quiet Windfall For U.S. Banks," November 10, 2008.
- 10. "Initial Statement of the Reasons for the Adoption of California Code of Regulations Title 18, Section 24451," California Franchise Tax Board, Undated.