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Subsidizing Bad Behavior
by Sinclair Noe
DOW + 18 = 13,507
SPX – 1 = 1470
NAS – 8 = 3117
10 YR YLD – .02 =1.86%
OIL + .64 = 94.20
GOLD + 5.10 = 1668.80
SILV + .64 = 31.18
This morning, President Obama held the final news conference of his first term. The debt ceiling was a major topic. The President demanded lawmakers raise the nation’s $16.4 trillion federal debt limit quickly, warning that, “Social Security benefits and veterans’ checks will be delayed” if they don’t and cautioning Republicans not to insist on cuts to government spending in exchange.
Republican congressional leaders repeated their demand that increases in borrowing authority must be accompanied by spending cuts. Obama, flat out rejected that, saying: “They will not collect a ransom in exchange for not crashing the economy. The full faith and credit of the United States of America is not a bargaining chip. And they better decide quickly because time is running short.”
The president opened his news conference with a statement by saying that a vote to increase the debt limit “does not authorize more spending. It simply allows the country to pay for spending that Congress has already agreed to. These are bills we’ve already racked up and we need to pay them.” Obama said he was willing to consider future deficit cuts, but only if they are done independently from a vote to raise the $16.4 trillion debt limit.
The debt limit must be raised to prevent a default, a series of across-the-board spending cuts is to kick in on March 1, and funding for most government programs will run out on March 27. There has been a lot of talk about an end run around the debt ceiling, including the quite good but a little wild idea of minting a $1 trillion dollar platinum coin. Voila, problem solved. Some people still don’t understand the concept, but it is really quite clever. Still, the White House says it is not the answer.
On Friday, Senate Democratic leaders told Obama to be ready to take “any lawful” steps to ensure that the United States did not trigger a global economic crisis.The debt limit only allows the Treasury to borrow funds to pay for existing obligations that Congress and the president have already agreed upon. Although Congress has routinely increased the limit since it was established in 1917, it has become more contentious since annual federal budget deficits have been topping $1 trillion, with conservatives in Congress using it as leverage to demand spending cuts.
With fears that Congress will not act in time, the 14th Amendment provision has surfaced as a backup plan.The 14th Amendment is best known for extending civil rights protections in the wake of the Civil War. The amendment’s fourth section was designed to guarantee Union debt incurred during the war, including compensation due to Union soldiers and their widows. The clause states: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” So, the idea is to act as if the debt ceiling doesn’t exist.
 Federal Reserve Board Chairman Ben Bernanke delivered a speech at the University of Michigan today; he echoed the president’s call for Congress to raise the debt ceiling. Bernanke also downplayed fears expressed by some more hawkish Fed officials and investors that the Fed’s bond-buying program will lead to higher inflation or future asset bubbles in the future. “I don’t believe significant inflation is going to be the result of any of this.” Whether Fed policy will lead to asset bubbles in the future is “a difficult question,” Bernanke said. The Fed is monitoring markets and toughening supervision to guard against financial instability. And he said, “The worst thing for the Fed to do would be “to raise interest rates prematurely.” So, the Fed has options and they’re not afraid to use them. This means ongoing central bank intervention in the bond markets, and you would have to imagine that it applies to the stock markets.
Temporary success does not imply permanent success or even continued success of intervention. The positive effects of the Federal Reserve’s Quantitative Easing programs are diminishing both in duration and market pricing. The market soared for months on end after QE1, but the rally quickly fizzled after QE4. This reveals the decay factor in intervention: Each intervention must be larger as its efficacy decays.
How do you like the attack on the deficit so far? You’re probably just starting to feel the pinch. Paychecks across the country have shrunk over the last week due to higher federal tax rates, and workers are already cutting back on spending, which will drag on the economy this year. For most workers, rich and poor alike, taxes went up on December 31 as a temporary payroll tax cut expired. That cut – a 2 percentage point reduction in a levy that funds Social Security – was put in place two years ago to help the economy. For a refresher this is what happened: Congress temporarily lowered the Social Security tax withholding rate to 4.2% from 6.2% for 2011 and 2012. But amid continued hand-wringing about deficits and revenue, lawmakers let it expire for 2013. What that means for most workers is 2% less money in their paychecks. The tax caps out at $113,700. Which means that you only pay the payroll tax up to that amount; so if you earn $113,700 and someone else earns $1 million a year, you pay the same payroll tax.
About 160 million workers pay this tax, and the increase will cost the average worker about $700 a year, according to the Tax Policy Center. The payroll tax hike will reduce household incomes by a collective $125 billion this year. That alone could reduce economic growth this year by about 0.6 percentage point. Most economists see economic growth of roughly 2 percent this year. Consumer spending, which drives more than two thirds of the economy, will likely grow at a mere 1 percent annual rate in the first quarter, and 1.5 percent in the second.
Last week we talked extensively about the various penalties being imposed on various banks for a multitude of sins, including: $8.5 billion for ten banks to deal with shoddy mortgage practices; $10 billion for Bank of America; $1.9 billion for HSBC for money laundering. The list goes on and on. Who pays those multi-billion dollar fines?
Think about it. Don’t answer too quick. The correct answer is…, you pay. That’s because some or all of these payments will probably be tax-deductible. The banks can claim them as business expenses. Taxpayers, therefore, ultimately foot the bill. There is nothing new about corporations reaping tax benefits from payments made to remedy wrongdoing. Every so often, though, the topic stirs outrage. After the Gulf of Mexico oil spill, for example, BP received a $10 billion tax windfall by writing off $37.2 billion in cleanup expenses.

With multibillion-dollar mortgage settlements making headlines this year and last, the question has come to the fore again. Why should taxpayers subsidize corporations that are paying to right sometimes egregious wrongs? That is a particularly weighty question, given the urgent need for tax revenue to offset the federal budget deficit.
Under federal law, money paid to settle a company’s actual or potential liability for a civil or criminal penalty is not deductible. But, this being taxes, the issue is complicated. The tax deduction for business expenses is broad enough to include most settlements and judgments. Unfortunately, the government rarely specifies what the tax treatment of a settlement should be, leaving enforcement to the Internal Revenue Service; the SEC is the one notable exception. A report from the Government Accountability Office suggests that tax benefits in settlements are prevalent. Examining more than $1 billion in settlements made by 34 companies, the G.A.O. found that 20 had deducted some or all of the money from their tax bills. In other words, we subsidize bad behavior.
Speaking of banks behaving badly, whatever happened to the Libor rate rigging scandal? This was supposed to be the mother of all bad bank behavior. Now there’s another wrinkle in the private Libor litigation: On Wednesday, the counties of San Diego and San Mateo, the city of Riverside and the municipal utility district of Oakland filed simultaneous antitrust complaints in three different federal courts in their home state of California. And a lawyer from the firm that filed all of the new cases is hoping more California cities and counties will join in.
The allegations in the California suits will be familiar to anyone who has followed the burgeoning Libor scandal, in which banks supposedly falsified reports of interbank borrowing rates to a British banking authority in order to improve trading positions or avoid damaging their reputations. The new complaints aren’t even the first to mine documents released by British and U.S. regulators in connection with UBS’s $1.5 billion settlement in December. And there is already a class action underway in New York, but there might be an advantage to peeling off from the New York class action and having California juries hear the case. More individual suits by municipalities that issued and invested in billions of dollars of securities with Libor-tied rates means more headaches for bank defendants. 


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