Commentary by Kevin Hassett
Jan. 20 (Bloomberg) -- There is one way to be sure that you are complying precisely with U.S. tax law: read the entire code. Problem is, it currently contains about 3.4 million words. That’s like reading “War and Peace” six times.
If you did spend the month that it would take the typical American to read the tax code, and somehow miraculously survived the ordeal, odds are that you might miss the following fun tidbit: If you are employed by the International Monetary Fund, then you have to act as if you are self-employed, and pay your own payroll tax.
While the IMF informs its employees of this special requirement, it and other similar institutions have not done a good job assuring compliance. Indeed, it is so common for employees of international organizations to incorrectly calculate, or evade, their self-employment taxes that, in 2007, the IRS offered a “one-time settlement initiative” for former and current employees. They were offered generous amnesty incentives in order to get “into compliance.”
That might have been the end of the story, except for President-elect Barack Obama’s decision to nominate Timothy Geithner as Treasury secretary. Geithner’s nomination found itself in neutral last week because he made the same error.
Geithner neglected to pay self-employment tax on his IMF income from 2001 to 2004. He was audited in 2006 for tax years 2003 and 2004 and paid back taxes of $12,719 in 2003 and $2,128 in 2004, plus $1,885 in interest payments. The IRS waived tax penalties for these years.
A Vetting Embarrassment
Geithner made similar mistakes in 2001 and 2002, and it was only during his recent vetting for the Obama appointment that he paid $25,970 in taxes and interest for those years.
Since Treasury oversees the Internal Revenue Service, it is certainly an embarrassment for Geithner that he neglected to pay taxes. Such an error should disqualify him for political appointment only if it was intentional, and two bits of evidence do suggest it wasn’t a mistake.
First, IMF employees are given ample notification of their responsibility. Geithner even signed a “Tax Allowance Application,” which confirmed that he wished “to apply for tax allowance of U.S. Federal and State income taxes and the difference between the ‘self-employed’ and ‘employed’ obligation of the U.S. Social Security tax which I will pay on my Fund income.” So his claim of innocence means he was willing to sign a document without reading it.
Second, Geithner knew after his audit in 2006 that he had made the same mistake in previous years, but he only paid up when he was nominated to be Treasury secretary. Some have pointed to this as a sign that he intended to avoid the tax.
Made Correct Call
But it turns out that Geithner probably made the correct judgment in this case. While there is no statute of limitations for tax fraud, the IRS only audits tax returns going back three years. If you made a mistake four years ago, the case is considered closed. It is likely that the IRS auditor told Geithner he wasn’t responsible for the previous mistakes at the time of his audit. He really didn’t need to pay up for 2001 and 2002, except to manage appearances.
So in the end, Geithner’s only real problem is that he signed a paper that informed him that he had to pay self- employment tax, and then didn’t do so. Such a mistake is so plausibly innocent that the IRS itself didn’t impose a penalty on him. (As a result of recent scrutiny by the Senate Finance Committee, Geithner paid additional tax of $4,334 and interest of $1,232 for other errors.)
For me, this tax episode is more reason to support Geithner, not less. I would rather have a person running the IRS who has an appreciation of how Kafkaesque our tax system and its enforcement bureaucracy can be. There probably has never been a Treasury secretary more motivated to simplify the tax code.
Legitimate Policy Concerns
There are legitimate concerns about Geithner. He has been president of the New York Federal Reserve for the past five years. The New York Fed’s primary role is to be the U.S. government’s eyes and ears in financial markets. And yet the carnage that we have seen this year has taken us totally by surprise. The eyes and ears failed us.
It wouldn’t have made sense to promote the man in charge of Hawaiian reconnaissance to be supreme allied commander after Pearl Harbor. Appointing Geithner to Treasury is a similar jump.
Obama’s nominee should have to answer tough questions about his previous failures -- the policy ones, not the personal ones - - before he is confirmed. How is it that Wall Street as we knew it ended on his watch? What did he do wrong? And how can we be sure that he will not do for America what he did for Wall Street?
Americans deserve answers to these questions. They will only get them if everyone agrees before his confirmation that his tax problems are a sideshow.
U.K. Economy Shrinks Most Since 1980
Jan. 23 (Bloomberg) -- The U.K. economy shrank more than economists forecast during the fourth quarter in the biggest contraction since 1980 as the financial crisis crippled the banking industry and mired Britain deeper in the recession.
Gross domestic product fell 1.5 percent from the previous quarter, the Office for National Statistics said in London today. Economists had predicted a 1.2 percent drop, according to a Bloomberg News survey. The economy has now shrunk in two quarters, the conventional definition of a recession.
The pound dropped against the dollar and U.K. stocks fell after the report. Prime Minister Gordon Brown said that the government is using “every weapon at our disposal” to fight the crisis. Bank of England Governor Mervyn King says officials may start buying up securities soon as interest rates lose their potency to aid the economy.
“This is undeniably grim,” said Stewart Robertson, an economist at Aviva Investors in London, which manages about $230 billion in assets. “Two or three quarters more like this and you’re talking about depression, not recession. This should hasten activity to address the credit and money market issues.”
Service industries shrank by 1 percent on the quarter, manufacturing dropped 4.6 percent and construction fell 1.1 percent, the statistics office said. Business services and finance, accounting for 30 percent of the economy, contracted 0.5 percent and also slipped into a recession.
‘Not for Turning’
The last time the economy shrank so fast in a three-month period was in 1980. That October, Prime Minister Margaret Thatcher responded to criticisms of a U-turn on the economy and her handling of labor unions by declaring that “the lady’s not for turning.” The next month, Ronald Reagan defeated Jimmy Carter in a landslide U.S. presidential election.
“We are building the foundation stones of a recovery plan,” Brown said on BBC Radio 4 today. “You need coordinated international action to deal with the global banking problems.”
Six polls published this year show Brown’s Labour Party trailing further behind David Cameron’s Conservatives. Brown pledged Jan. 19 to extend the bank rescue announced last year and boost the government’s stake in Royal Bank of Scotland Group Plc to 70 percent. RBS may post an annual loss of 28 billion pounds ($39 billion), the biggest in British corporate history.
Conservative View
“What is completely lacking is public confidence in policy and international confidence,” George Osborne, a Conservative lawmaker who speaks on finance, told Sky News. “They are not commanding confidence and sadly that is what is lacking.”
The FTSE 100 index dropped below 4,000 to a two-month low. The pound fell as low as $1.3506 and traded at $1.3605 as of 1:02 p.m. in London. The currency’s slide to a 23-year low against the dollar this week signals investors are betting Britain will lose its AAA credit rating, Merrill Lynch & Co. strategists wrote in a report yesterday.
“The pound sterling is going to be under pressure,” Jim Rogers, chairman of Singapore-based Rogers Holdings, said in an interview on Bloomberg Television. “The U.K. hasn’t got much to sell to the world anymore.”
The European Commission forecasts the British economy may contract 2.8 percent this year, the most since 1946 when the country was in the grip of mass demobilization after World War II. U.K. GDP rose 0.7 percent in 2008, the least since 1992, officials said today.
Darling’s Forecast
Chancellor of the Exchequer Alistair Darling today told broadcasters that the GDP reading was “undoubtedly sharper than many people expected” and suggested it may force him to scale back predictions of a recovery in 2009. In November he forecast the economy would shrink as much as 1.25 percent this year.
“A pronounced contraction in spending and output is under way,” King said on Jan. 20. “In the first half of this year, the rate of contraction is likely to continue to be marked.”
U.K. manufacturing confidence fell to the lowest since 1980 in the past quarter, a survey by the Confederation of British Industry showed yesterday. TT Electronics Plc, the U.K. maker of car sensors for Bayerische Motoren Werke AG, said Jan. 21 it will cut 700 jobs to weather the automobile industry slump.
“At the moment, I would expect things to continue getting worse rather than better,” British Airways Plc Chief Executive Office Willie Walsh said in a speech today in India.
Rate Cuts
King, who has overseen cuts in the benchmark interest rate to 1.5 percent, the lowest since the bank was founded in 1694, is also planning alternative means to stimulate the economy. He said this week that officials may start buying corporate bonds and commercial paper within weeks to help the economy.
“The slowdown is much sharper than expected,” Lena Komileva, head of G-7 market economics at Tullett Prebon in London, said on Bloomberg Television. “The risk is that the right policy is not being administered quickly enough. The economy is falling off a cliff.”
Retail sales increased 1.6 percent on the month on a seasonally adjusted basis, the statistics office said. Officials said that the data should be treated with caution as they reassess their method of accounting for seasonal swings. They advised people to focus on the unadjusted data, which showed a 1.8 percent increase in December from a year earlier.
Jan. 23 (Bloomberg) -- Crude oil rose to $47 a barrel in New York, a two-week high, on speculation that stockpiles will decline as OPEC implements promised production cuts and as investors purchased commodities as a safe haven.
The Organization of Petroleum Exporting Countries will curb supplies by 5.4 percent this month to 26.15 million barrels a day, according to preliminary estimates from consultant PetroLogistics Ltd. Gold led commodities higher today as the deepening recession left few investment options.
“A lot of the surplus supply will probably disappear in a few months because of the OPEC cuts,” said Sarah Emerson, managing director of Energy Security Analysis Inc. in Wakefield, Massachusetts. “This is a very low OPEC number. They are serious about taking this problem on and will do whatever they think is necessary to support prices.”
Crude oil for March delivery rose $2.53, or 5.7 percent, to $46.20 a barrel at the 2:30 p.m. close of floor trading on the New York Mercantile Exchange. Prices are up 3.6 percent this year and are 47 percent lower than a year ago.
Starting this month, the members with production targets, all except Iraq, have a combined quota of 24.845 million barrels a day. The 12-member group needs to make the deepest supply cuts in its history to comply with the revised quotas.
“Just about every commodity, with the exception of natural gas, is up today,” said Phil Flynn, senior trader at Alaron Trading Corp. in Chicago. “You are seeing a rush of funds going from treasuries to gold and other commodities as investors look for a safe haven.”
Gold Rises
Gold futures for February delivery climbed $37, or 4.3 percent, to settle at $895.80 an ounce on the Comex division of the Nymex, the most since Dec. 10.
The Reuters/Jefferies CRB Index of 19 prices rose as much as 2.7 percent today to 224.65, the highest since Jan. 12.
Crude-oil supplies rose four times more than forecast to the highest since August 2007 as refineries cut operating rates, the Energy Department said yesterday.
“An indicator that the market possesses inherent strength is its strong performance in the face of bearish information,” said Michael Fitzpatrick, vice president for energy at MF Global Ltd. in New York.
Brent crude oil for March settlement increased $2.69, or 5.9 percent, to $48.08 a barrel on London’s ICE Futures Europe exchange.
“The big question right now is when demand is coming back,” said Chip Hodge, a managing director at MFC Global Investment Management in Boston, who oversees a $9 billion natural-resource-company bond portfolio. “Until the economy reaches a bottom and we begin to see a recovery, energy prices will remain under pressure.”
U.S. Stocks Fluctuate as Stimulus Plan Offsets Earnings Concern
Jan. 23 (Bloomberg) -- U.S. stocks swung between gains and losses as better-than-estimated earnings at Google Inc. and progress on a government plan to revive the economy offset profit drops at companies from General Electric to Xerox Corp.
Google, operator of the most popular Internet search engine, jumped 6.4 percent. Citigroup Inc. rallied 7 percent to lead gains in the Dow Jones Industrial Average after a Senate committee announced parts of its stimulus plan and President Barack Obama pushed congressional leaders to reach a consensus on the $825 billion spending package. GE and Xerox fell more than 7 percent.
“We’re getting closer and closer to details about the financial package that could be quite beneficial to stocks that have sold off hard,” said John Massey, who manages $1.1 billion at SunAmerica Asset Management in Jersey City, New Jersey. “To the extent that plays out, these stocks could go significantly higher.”
The S&P 500 rebounded from an earlier 2.6 percent loss, rising 0.04 percent to 827.79 at 3:32 p.m. in New York. The Dow slipped 88.01, or 1.1 percent, to 8,034.79 after tumbling 213.77 point earlier. The Russell 2000 Index decreased 0.2 percent.
The S&P 500 was poised to post its third straight weekly decline. The benchmark index for U.S. equities has fallen 3 percent this week and is down 8.6 percent on the year. The Dow also slipped 3 percent in the week and is down 8.5 percent in 2009.
Down Trend
“Certainly the trend in the market is down, and if you’re a trend follower, you’re not going to be too anxious to put money in,” said Bruce Bittles, the Nashville, Tennessee-based chief investment strategist at Robert W. Baird & Co.
Google gained $19.65 to $326.15 after the company sustained profit growth by cutting expenses as revenue growth slowed.
Citigroup, once the biggest U.S. bank by market value, rose 22 cents to $3.33. Citigroup shares traded under $3 this week for the first time since July 1992. The company lowered its quarterly dividend to a penny a share from 16 cents to comply with the terms of the $20 billion capital injection in received from the U.S. government in November.
Bank of America Corp., the largest U.S. bank by assets, rose 5.8 percent to $6.04. Financial companies in the S&P 500 climbed 2.2 percent collectively, the biggest gain among its 10 main industry groups.
Obama said that, while there are “some differences” between his administration and lawmakers on the details, the legislation is “on target” for passage by mid-February.
‘Bad’ Bank
Administration officials also are studying repairing the financial system by creating a “bad,” or “aggregator,” bank to remove impaired assets from bank balance sheets that are curbing their ability to make new loans, Timothy Geithner, Obama’s nominee for Treasury secretary, said during confirmation hearings this week.
Aflac Inc. led gains by insurers in the S&P 500. The largest seller of supplemental insurance said it had at least $500 million in excess capital as of Dec. 31 and doesn’t need to raise more. Aflac climbed 14 percent to $25.99.
Hartford Financial Services Group Inc., the Connecticut- based life insurer whose stock fell 81 percent last year, rose 15 percent to $13.97 for the biggest gain in the S&P 500. XL Capital Ltd., the Bermuda-based business insurer that was the second-worst performing stock in the index last year falling 93 percent, climbed 8.3 percent to $3.26.
Wyeth advanced 12 percent to $43.56. Pfizer Inc., the world’s biggest drugmaker, is in talks to buy Wyeth in an effort to replace revenue it expects to lose to generic competition in three years, according to three people familiar with the discussions.
Profit Slump
Profits have decreased 60 percent for the 69 companies in the S&P 500 that have released fourth-quarter results since Jan. 12. Analysts now estimate a 28 percent drop in profits for the entire index, which would mark the fifth straight quarter that earnings slumped. In March 2008, analysts projected that income would rise as much as 55 percent in the fourth quarter, according to data compiled by Bloomberg.
“As companies come in, I would say 90 percent of the earnings estimates are coming down, so people are having a tough time, struggling as to what the real multiples of stocks are,” Scott Black, who oversees $1.4 billion as president of Delphi Management Inc. in Boston, said on Bloomberg Television.
General Electric fell 11 percent to $12.02 for the biggest drop in the Dow average, and led industrial companies to a 3.5 percent slid. The world’s biggest maker of power-plant turbines, jet engines, locomotives and medical imaging equipment forecast $10 billion in credit losses this year, $1 billion more than its prior estimate.
Xerox, Capital One
Xerox slid 7.4 percent to $7.03. The world’s largest maker of high-speed color printers said fourth-quarter profit dropped on job-cut costs and slowing demand for its machines. Sales fell 10 percent to $4.37 billion, missing the $4.72 billion average estimate of analysts surveyed by Bloomberg.
Capital One Financial Corp. had the second-biggest decline in the S&P 500, tumbling 11 percent to $19.44. The Virginia- based credit-card lender posted a $1.42 billion fourth-quarter loss on goodwill charges tied to its auto lender and a $1 billion boost to reserves for soured loans.
Harley-Davidson Inc. fell 6.6 percent to $11.58 and earlier retreated to $10.07, the lowest price since May 1997. The biggest U.S. motorcycle maker reported 8.5 percent less fourth- quarter profit than analysts estimated as the recession reduced demand.
Southwest Airlines Co. fell the most in S&P 500, dropping 20 percent to $7.87. The largest U.S. low-fare carrier was cut to “sell” from “underperform” by Clayton Securities analyst Ray Neidl. The company faces “little growth” in business and higher risk of rising fuel costs after it reduced hedging on oil, Neidl wrote in a report.
Expect the World Economy to Suffer Through 2009
Expect the World Economy to Suffer Through 2009
Political risk is a bigger factor than ever.
IAN BREMMER and NOURIEL ROUBINI
Some optimistic experts are now saying that though this will be a turbulent year for global markets, the worst of the financial crisis is now behind us. Would it were so. We believe that 2009 will be tougher than many anticipate.
We enter the new year grappling with the most serious global economic and financial crisis since the Great Depression. The U.S. economy is, at best, halfway through a recession that began in December 2007 and will prove the longest and most severe of the postwar period. Credit losses of close to $3 trillion are leaving the U.S. banking and financial system insolvent. And the credit crunch will persist as households, financial firms and corporations with high debt ratios and solvency problems undergo a sharp deleveraging process.
Worse, all of the world's advanced economies are in recession. Many emerging markets, including China, face the threat of a hard landing. Some fear that these conditions will produce a dangerous spike in inflation, but the greater risk is for a kind of global "stag-deflation": a toxic combination of economic stagnation, recession and falling prices. We're likely to see vulnerable European markets (Hungary, Romania and Bulgaria), key Latin American markets (Argentina, Venezuela, Ecuador and Mexico), Asian countries (Pakistan, Indonesia and South Korea), and countries like Russia, Ukraine and the Baltic states facing severe financial pressure.
Policy remedies will have limited effect as insolvency problems constrain the effectiveness of monetary stimulus, and the risk of rising interest rates (following the issuance of a wave of public debt) erodes the growth effects of fiscal stimulus packages. Only when insolvent banks are shut down, others are cleaned up, and the debt level of insolvent households is reduced will conditions ease. Between now and then, we can expect further downside risks to equity markets and other risky assets, given the likelihood that markets will continue to be jolted by worse-than-expected financial news.
The U.S. twin fiscal and current-account deficits will rise over the next two years as the country runs trillion dollar-plus fiscal deficits. We're all aware that foreign actors have financed most of this debt over the past several years. During the 1980s, the U.S. also faced the burdens of twin deficits, but relied on financing from key strategic partners like Japan and Germany. This time, the situation is more worrisome because today's financing comes not from U.S. allies, but from strategic rivals like Russia, China and a number of relatively unstable petrostates. This leaves the U.S. perilously dependent on the kindness of strangers.
There's some good news in this interdependence. The mutually assured economic destruction that this relationship implies ensures that China can't simply pull the plug on all this financing without suffering a considerable amount of self-inflicted pain. Reducing its financing of Washington would, among other things, put significant upward pressure on the value of China's currency, sharply undermining its export sector and, therefore, the country's economic growth.
But over time, the ability and willingness of China and others to finance U.S. deficits will diminish as they begin to run fiscal deficits of their own. They'll need to use their financial resources at home just as a tsunami of U.S. Treasury bond issuances peaks.
Politics will make matters worse, primarily because governments in both the rich and the developing worlds are intervening in their economies more broadly and deeply than at any time since the end of World War II. Policy makers around the world are hard at work crafting stimulus packages filled with subsidies and protections they hope will breathe new life into their domestic economies, and preparing to rewrite the rules and regulations that govern global markets.
Why is this dangerous? At the G-20 summit a few weeks ago, world leaders pledged to address the crisis by coordinating their economic policy responses. That's not going to happen, because politicians design stimulus packages with political motives -- to satisfy the needs of their constituents -- not to address imbalances in the global economy. This is as true in Washington as in Beijing. That's why politics will drive the global economy more directly (and less efficiently) in 2009 than at any point in decades. Its politics that is creating the biggest risk for markets this year.
This is part of a worrisome long- term trend. In China and Russia, where histories of command economics predispose governments toward what we've come to call state capitalism, the phenomenon is especially obvious. National oil companies, other state-owned enterprises, and sovereign wealth funds have brought politicians and political bureaucrats into economic decision-making on a scale we haven't seen in a very long time.
Now the U.S. has gotten in on the game. New York, once the financial capital of the world, is no longer even the financial capital of the U.S. That honor falls on Washington, where lawmakers are now injecting populist politics into economics decisions. Companies and sectors that should be left to drown are being floated lifeboats. This drama is also playing out across Europe and Asia. As engines of economic growth, Shanghai is losing ground to Beijing, Mumbai to Delhi, and Dubai to Abu Dhabi.
Global markets will also face the more traditional forms of political risk in 2009. Militancy in an increasingly unstable and financially fragile Pakistan will continue to spill across borders into Afghanistan and India. National elections in Israel and Iran risk bringing the international conflict over Iran's nuclear program to a boil, injecting new volatility into oil markets. The impact of the financial crisis on Russia's economy could produce significant levels of unrest across the country. And Iraq may face renewed civil violence, as recently dormant militia groups compete to fill the vacuum left by departing U.S. troops.
The world's first global recession is just getting started.
Mr. Bremmer, president of Eurasia Group, is co-author of the forthcoming book "The Fat Tail: The Power of Political Knowledge for Strategic Investing" (Oxford University Press). Mr. Roubini is a professor of economics at New York University's Stern School of Business and chairman of RGE Monitor.
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