naked capitalism

Andrew Ross Sorkin has a rather curious piece up today at the New York Times in that it purports to explain why the banking industry is up in arms about Obama, yet buries and/or omits some key issues.

It’s pretty well known that big financial firms have been throwing their weight around, no doubt encouraged by how successful that strategy has been throughout Obama’s tenure. So throwing another tantrum might be a shrewd strategy. Sorkin reports:

Daniel S. Loeb, the hedge fund manager, was one of Barack Obama’s biggest backers in the 2008 presidential campaign…

So it came as quite a surprise on Friday, when Mr. Loeb sent a letter to his investors that sounded as if he were preparing to join Glenn Beck in Washington over the weekend.

“As every student of American history knows, this country’s core founding principles included nonpunitive taxation, constitutionally guaranteed protections against persecution of the minority and an inexorable right of self-determination,” he wrote. “Washington has taken actions over the past months, like the Goldman suit that seem designed to fracture the populace by pulling capital and power from the hands of some and putting it in the hands of others.”

So why this type of volte face? As Sorkin tells us:

Mr. Obama was viewed as a member of the elite, an Ivy League graduate (Columbia, class of ’83, the same as Mr. Loeb), president of The Harvard Law Review — he was supposed to be just like them. President Obama was the “intelligent” choice, the same way they felt about themselves. They say that they knew he would seek higher taxes and tighter regulation; that was O.K. What they say they did not realize was that they were going to be painted as villains.

Yves here. Please. Are you going to seriously tell me big financial players are up in arms because Team Obama occasionally calls them bad names? That explanation is so obviously bogus as to call for a look for the real reason. There’s a much more straightforward explanation, and it’s called “follow the money.”

The key omission from this story is the name Rahm Emanuel. Rahm, a former partner at Wasserstein Perella, was particularly effective at fundraising from private equity funds and hedge funds.

So re-read this key phrase: ” They say that they knew he would seek higher taxes and tighter regulation; that was O.K.” But what the article buries in plain sight is the fact that the plans to tax hedge and PE funds carried interest at ordinary income tax rates, rather than a preferential capital gains tax rates, has the 2 and 20 crowd seeing red. And in case you had any doubts, there was no justification for this special treatment in the first place. Loren Steffy of the Houston Chronicle noted (hat tip Independent Accountant) provides a deft skewering:

Dear IRS: Please note that beginning this year, I am no longer earning an income. From now on, I am compensated through what I like to call column interest. It isn’t pay. It’s a capital gain that I receive in exchange for providing about 2,000 words a week to this newspaper. Please lower my tax rate accordingly. hey, you can’t blame me for trying. After all, a similar strategy has worked for years for money managers at hedge funds and private equity firms. … The private investment community is decrying the move as a massive tax increase, is if oblivious to the fact that it’s enjoyed an unfair tax break for years. … Let’s set aside the rather silly notion of private equity as an engine of job creation–most buyouts result in big job cuts–and focus on the inequality. Private equity managers typically collect a 2 percent annual fee on assets in the fund, which is taxed as income. They also scoop up 20 percent of their funds’ annual profits, which is known as carried interest. … Profit-sharing plans for just about everyone else are taxed as income. … Tax law is a murky world, but one basic principle of our tax code is that people who perform similar jobs for similar pay should receive similar tax treatment. That’s not the case in the investment world.

Sorkin does mention Steve Schwarzman’s infamous outburst (“likened the administration’s plan for taxes on private equity to ‘when Hitler invaded Poland in 1939.’”) but does not indicate the fact that this is the major reason for the falling out among Obama’s former backers. It’s one thing to raise taxes generally, the big boys can stomach that. But it’s quite another to raise taxes in a way that targets them. (And note, by the way, that this measure failed, but the industry was still deeply offended at this show of disloyalty).

Similarly, Sorkin later argues for the reasonableness of the revolting businessmen:

Mr. Loeb’s views, irrespective of their validity, point to a bigger problem for the economy: If business leaders have a such a distrust of government, they won’t invest in the country. And perception is becoming reality.

Just last week, Paul S. Otellini, chief executive of Intel, said at a dinner at the Aspen Forum of the Technology Policy Institute that “the next big thing will not be invented here. Jobs will not be created here.”

Yves here. This is patently ridiculous and disingenuous. First, Sorkin chooses to overlook that Otellini’s comments about inventions and jobs is based on his throwing in his weight with the venture capital industry, which was one of the groups that fought the proposed taxes on carried interest. The argument, implicitly is that the VC industry would shrink or disappear were there no carried interest tax break, and that we’d therefore see much less new business formation.

Both those ideas are questionable. Yes, the VC business as it is currently constituted might shrink, but a lot of angel investors do deals as principals or with small syndicates. One can as easily argue with so many people now possessing Wall Street experience, we’d likely see capital move through new channels to small ventures.

But more important, the idea that VC is critical to new business growth is complete urban legend. Amar Bhide, in the first systematic study of successful new ventures, determined that VC contributes very little to the funding of new businesses, even the most successful ones (his proxy was the Inc. 500).

Second, the line that Sorkin parrots from big businesses, “Be nice to us or we’ll quit investing,” is also bunk. Guess what? As we’ve indicated, big businesses were net disinvesting even during the corporate-friendly Bush Administration. And to the extent they are leery of investing now, far and away the biggest reason is macro uncertainty. It’s awfully hard to plan if you aren’t sure whether the outlook is for inflation or deflation. But businesses will cavil like crazy about government intervention because it is one of the few variables they might be able to influence.

And it’s also remarkable that Sorkin can treat the self-serving and misleading canard, “We’re mad that Obama is treating us like bad guys” seriously. For anyone at the TBTF firms, it’s patent rubbish. The firms got overt and back door bailouts so they could shore up their equity capital, and what do they do? Pay a big chunk of government-provided largesse out to themselves in record 2009 bonuses. It’s one of the most blatant acts of looting on record, and the industry deserves every bit of scorn the authorities can muster dumped on its head.