KeNo's Housing and Economic Portal: Monday October 19 Housing and Economic stories

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Offshore Haven Considers a Heresy, Taxation - (www.nytimes.com) GEORGE TOWN, Cayman Islands — What happens to a tax haven when it has to raise taxes? The Cayman Islands may soon find out. Caught in a vise of shrinking revenue and stubbornly high public spending, the Caymans averted a fiscal crisis this week by securing a $60 million overseas loan. But the Foreign and Commonwealth office in Britain, which oversees the Caymans and can veto foreign lending requests, has delivered an ultimatum: The rest of the $284 million the Cayman government says it needs will not be forthcoming until this offshore financial center imposes spending cuts and considers some form of direct taxation on businesses here and its 57,000 residents. For a tropical paradise that has never taxed income, property, corporate earnings, retail sales or capital gains, such a suggestion borders on heresy. The Caymans have built their prosperity less on tourism, like most other Caribbean islands, and more on serving as a tax-free home for 9,253 hedge funds and many more banks and companies that pay small fees to establish the Caymans as their official domicile while operating mostly elsewhere around the world. With the explosion of global finance, the Cayman model flourished, and fees from financial institutions, together with tourism, made up as much as half of government revenue. Duties on imported goods accounted for the other half. In June, the full effect of the financial crisis touched shore with the effect of a hurricane. A drop in financial and tourism revenue transformed a projected surplus into a deficit of about $100 million — a huge gap for an annual budget of some $800 million — and the leader of the Cayman government, W. McKeeva Bush, warned of a fiscal crisis. Mr. Bush is desperately trying to find a way out of his quandary, caught between the demands of local business leaders to keep things the way they are and insistence from London that the economic model of the Cayman Islands must change. “The U.K. has to be practical,” he said, warning that too bold a new tax program could prompt Cayman-based financial firms to leave. “They don’t want me to go belly up.” Perhaps not, but there is no getting around the fact that the balmy days for exotic offshore financial centers like the Caymans could be coming to an end. With pressure building in Europe and the United States for a systemwide crackdown on offshore tax havens — the Caymans prefer to call themselves a tax-neutral portal — Britain appears determined to make an example of a place that has become a symbol of secrecy and intrigue.

Great Year, but S.&P. Closes in on its Worst Decade Ever - (www.nytimes.com) THE decade now ending could be called the Zeroes, but for the fact that stock investors only wish they had done so well. But it is ending with a bang. The total return of the Standard & Poor’s 500-stock index through the end of September was almost 17 percent, and that was after adjusting for inflation. Even if the index does nothing in the final three months of the year, it will have turned in its best year since 2003. The stock market has not been the best place to be. As 2009 began, the credit crisis was a dominant theme, with worries of huge corporate defaults and an inability of companies to find lenders. There have been plenty of defaults and bankruptcies, but junk bonds have managed to regain all of the ground they lost during a horrible 2008. The accompanying charts show the performance — for the current decade and for the 1990s — of the S.& P. 500 and of five Merrill Lynch indexes measuring total returns for fixed-income investments. The figures are adjusted for inflation, as measured by the Consumer Price Index. The Merrill Lynch Master II high-yield index — the polite name for junk bonds — gained 45 percent in the first nine months of 2009, even after adjusting for inflation. That index, which dates back to 1986, has never experienced a full year nearly that good. The annual record, an inflation-adjusted gain of 35 percent, was recorded in 1991, another year after a major sell-off of junk bonds. But even with the huge gain so far this year, the junk bond index has climbed only 38 percent for the decade. It had lost money in the first nine years of the decade. If all junk has been good this year, bad junk has been outstanding. Merrill’s index of bonds rated CCC or lower — the very bottom of the credit pool and indicating a substantial risk of default — has gained almost 75 percent in 2009, adjusted for inflation. That index, not shown in the graphic, had fallen 38 percent in 2008. Even with that gain, such bonds are still a little below the peak reached in 2007. The reverse quality relationship also applies for investment-grade bonds. Corporate bonds from companies with excellent credit — rated AAA or AA — have produced a total return, adjusted for inflation, of a little over 5 percent this year. Those at the lower end of investment grade — rated A or BBB — have returned more than 18 percent. Someone who stayed invested in Treasury securities, whether six-month Treasury bills or 10-year Treasury bonds, failed to keep up with inflation in 2009.

‘Abusive Swaps’ Would Be Banned Under Frank’s Derivatives Plan - (www.bloomberg.com) Legislation tightening oversight of the $592 trillion over-the-counter derivatives market would give regulators authority to ban so-called abusive swaps. The Securities and Exchange Commission and Commodity Futures Trading Commission would get the power to “prohibit transactions in any swap” that regulators determine “would be detrimental to the stability of a financial market or of participants in a financial market,” according to a 187-page draft measure released yesterday by House Financial Services Committee Chairman Barney Frank. Opaque financial products, including some derivatives, have contributed to almost $1.6 trillion in writedowns and losses at the world’s biggest banks, brokers and insurers since the start of 2007, according to data compiled by Bloomberg. Among fallen companies are Lehman Brothers Holdings Inc., the investment bank that filed for bankruptcy, and insurer American International Group Inc., which has been surviving on government loans. “Lacking and lagging regulation of OTC derivatives was a major contributing factor to last year’s crisis, including the highly leveraged credit-default swaps at AIG that prompted government intervention,” Representative Melissa Bean, an Illinois Democrat who serves on Frank’s committee, said in an e- mailed statement. The legislation offered by Frank, a Massachusetts Democrat, would require the most common and actively traded over-the- counter derivatives contracts to be bought and sold on exchanges or processed through a regulated trading platform. ‘Clear Window’: “We can’t effectively protect American consumers -- and make sure they are paying fair prices for food, gas and other commodities -- unless we have a clear window into the trading that affects commodity pricing,” Bart Chilton, a CFTC commissioner, said in a statement that described Frank’s proposal as helping “to move this discussion down the road.” The measure also would give the Treasury Department the final say if the SEC and CFTC couldn’t agree on joint regulations, including setting position limits or the treatment of products that are economically similar, such as stock options and stock futures. A three-page proposal released by Frank in July would have given that power to a new Financial Services Oversight Council.

Too Rich to Worry? Not in This Downturn - (www.nytimes.com) IT turns out the other half — or at least the tiny slice who live at the top of the wealth pyramid — are not sleeping any better than the rest of America. Paul Sullivan writes about strategies that the wealthy use to manage their money and their overall well-being. At a closed-door meeting of advisers to family offices — which serve families who typically are worth more than $500 million — I learned that the super-rich are just as concerned about the future as everyone else. Even though the stock market has rebounded from its March 9 low, the family office advisers said many of their wealthiest clients were bracing for more bad news and wondering how it would affect their family unity. “They are now looking at financial planning and things middle-class families live by,” Kathryn McCarthy, a leading adviser to wealthy families, including the Rockefellers, said at the gathering this week convened by Bessemer Trust. Before you start laughing up your sleeve, be advised that this is not a good thing. When the super-rich get cold feet, the rest of America gets swine flu. They are, after all, the people who might finance new companies that create jobs, make big investments to support existing companies and spread their wealth throughout the economy. According to a study the Family Office Exchange plans to release this month, the super-rich are most worried about what they do not know. Some 45 percent of the 108 ultrahigh-net-worth families surveyed in August ranked the economy and financial markets as their No. 1 concern. They were most concerned about government intervention in the financial markets and a commercial real estate bust. Historically, the super-rich have focused mostly on family dynamics, since so much of their wealth is linked together and could be endangered by a rift. But the sudden decline in wealth — even if they still have hundreds of millions of dollars — has prompted soul-searching. The bad news is they are not confident about the American economy. The better news is they are looking at their families in a way that the average American could learn from. MORE THAN MONEY What is most interesting is that many of the super-rich are looking at the risks of their relatives. One of the big problems is how differently people within a family spend, save and invest money that has been managed as a pool for many generations. When the credit markets froze and the stock market tumbled, not every cousin agreed to tighten his alligator-skin belt. That caused friction. Some family members with money in individual trusts are opting to go off on their own. The bigger issue is when families have to cooperate to run the business the patriarch set up. In the past, family businesses and family wealth were commingled. If the business was struggling, the patriarch would often finance shortfalls. “Now the kids are upset about where the money is going,” said Holly Isdale, managing director at Bessemer. “Intrafamily dynamics are playing a bigger part in decisions.”

Recession's end marks start of states' budget woes - (news.yahoo.com/s/ap) The recession is probably over, which means states' financial troubles have only begun. History suggests it could take six or more years for sales and income taxes — which make up roughly two-thirds of states' revenue — to return to pre-recession levels. That augurs deeper cuts to state jobs and services in order to maintain funding for core programs such as public schools and Medicaid. What's different from the three previous recessions, which took states three to five years to recover from, is that employment and consumer spending aren't expected to bounce back as quickly. To balance their budgets in the meantime, states are likely to further raise taxes on the money people earn and spend; increase college tuition; reduce funding for the arts and other cultural programs; and push costs into the future by delaying pay raises for employees and repairs of government buildings. Some states, including Massachusetts, Missouri and Arizona, already are making or considering fresh cuts just months after lawmakers agreed on new budgets. Rising unemployment and a decline in consumer spending have put a big dent in states' tax revenues. Census figures show states' income taxes plunged almost 28 percent in the second quarter of 2009, falling even further in places such as Arizona and California that were among the hardest hit by the housing market collapse. States' quarterly sales taxes fell almost 10 percent compared to the previous year. Unlike the federal government, states generally must balance their budgets. That's why one-third of states have raised taxes this year. They've hit the wealthy with income tax surcharges, hiked sales taxes that disproportionately affect the poor and targeted smokers, drinkers and motorists with higher taxes and fees. Hundreds of thousands of state employees have been furloughed. And government "rainy day" funds have been diminished to half their highs of just three years ago.

The Cost of Saving These Whales - (www.nytimes.com) During the credit bust, our leaders embraced the too-big-to-fail policy, reluctantly bailing out large institutions to save the system from collapse, they said. Yet even as the crisis has abated, these policy makers have shown little interest in cutting financial monsters down to size. This is especially disturbing given that some institutions have grown even larger as a result of the mess. It is perverse, of course, to reward big banks’ mistakes with bailouts financed by beleaguered taxpayers. But the too-big-to-fail doctrine benefits the banks in other ways as well: the implication that an institution will not be allowed to fall gives it significant cost advantages over smaller, perhaps more responsible competitors. Quantifying these advantages is difficult, though. While bailouts have numbers attached to them, hidden benefits, again subsidized by the taxpayer, are harder to assess. The result is that taxpayers may mistakenly believe that when a bailout recipient repays a loan, subsidies received by the institution have stopped. Because our government wouldn’t dream of calculating the hidden costs associated with the bailout binge — taxpayers might become even angrier than they already are — it is gratifying that the Center for Economic and Policy Research, a liberal research group in Washington, has taken a stab at the task. Dean Baker, an economist and co-director of the center, and Travis McArthur, a research intern, analyzed banks’ costs of money to compare the interest rate that smaller banks pay to attract deposits and borrow funds with the rate paid by behemoths perceived as too big to fail. Using data from the Federal Deposit Insurance Corporation, Mr. Baker’s study found that the spread between the average cost at smaller banks and at larger institutions widened significantly after March 2008, when the United States government brokered the Bear Stearns rescue. From the beginning of 2000 through the fourth quarter of 2007, the cost of funds for small institutions averaged 0.29 percentage point more than that of banks with $100 billion or more in assets. But from late 2008 through June 2009, when bailouts for large institutions became expected, this spread widened to an average of 0.78 percentage point. At that level, Mr. Baker calculated, the total taxpayer subsidy for the 18 large bank holding companies was $34.1 billion a year. Mr. Baker is the first to note that the expanding gap may not be attributable solely to the too-big-to-fail policy. Banks’ cost of money has risen during other times of economic uncertainty, like the recession of 2001. After that downturn, the cost-of-funds spread between small and large banks rose to 0.69 percentage point.