The Short End of the Long View

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MF Global and the “missing money”… The NY Times reports that investigators know quite well now where all the missing money is. They have not divulged details, given that it might impact their ability to retrieve the funds. It stands to reason that they would know where the money is, as broker/dealers are required to have detailed and reliable records and the movement of wire funds would be easy to trace.

One report has suggested that some of these funds were lost as ‘Hail Mary passes’ in an attempt to ‘double down’ and  bail out the sinking ship on top of the already irresponsibly stupid and risky bets put on by the firm. If so, that would make this theft even worse.

Recovery of the money hinges upon whether or not the counter parties who were due the funds correctly followed the process of asking where the funds came from.  In other words, were they customer account funds? Or general funds of the corporate entity MF Global? Now if this was asked and the people on the MF Global side lied, then there is likely criminal activity but no basis to get at the funds. If on the other hand some —  or perhaps all — of the counter parties failed to inquire as to the source of the funds, then there could be a basis for recovery. Otherwise, all is lost and John Corzine still is walking the streets a free man. That cannot go on for long.


Mitt’s Tax Rate…There was a virtual firestorm when Mitt Romney was forced to divulge his tax return and therefore his implied tax bracket. This dovetailed neatly with President Obama’s ‘paper tiger’ effort to enact what is referred to as the Buffet tax (a minimum tax rate of 30% on all wealthy Americans making over $1.0mm in any given tax year).

The problem of equity (if there is any real issue there) lies within the tax code. The big driver of the controversy in my mind is the notion of carried interest. This is a complex tax ruling that allows partners in private equity funds, venture capital funds and hedge funds to invest their monies which can later be treated as long-term capital gains and not taxable ordinary income.

There is no doubt that this sliver of the top 1% has an advantage over the average taxpayer. However they are still putting their capital at risk. If Governor Romney worked at a firm that did not produce stellar long- term performance (read: capital gains) and lost money on a regular basis, then he would have losses and not a lot of capital built up at a very low tax rate. For argument’s sake we can call this sliver of the 1% the very smart wealthy. They have a God-given talent to make money (capital gains) or at least affiliate themselves with smart people who can do that on a consistent and regular basis (read: Warren Buffet).

“But”, you say, “only wealthy investors have access to this option”. Yes, that is true, due to government regulation of what is called a “Qualified Investment Buyer” (QIB). This rule exists so that Madoff-type knock-off’s cannot sell to less sophisticated investors. Vehicles for smaller investors are generally heavily regulated by the likes of the SEC (i.e., mutual funds). If you were to sign up to invest in Bain Capital it would have a large minimum investment (generally in the $millions) and you would need to sign a document stating that your net worth was at least $1.0mm (the QIB clause).

Now the smart wealthy share that talent with institutional investors who run pension plans for corporations, state and government employees and other non-profit institutions (the press never mentions that of course). One could debate if this “talent” should be taxed as ordinary income (max rates) but this is not the purpose of my writing at this time.

There are other very wealthy people who have other great talents. Some are great actors (Hollywood); others can throw a football or pitch a baseball and the like. It does not mean that they are not smart but they don’t have the ‘carried interest’ option that a number of private investors and partners of private equity and the like have.

They have the option to take some or all of their income currently and pay taxes now at the maximum rate for ordinary income or defer some of that money in approved vehicles which will pay out later as income.  If they invest with ‘smart’ money wealth, and their assets appreciate well, they will make more capital but they will still have to pay the maximum rates when those monies are taken out. If they’d spent it all on real estate in Miami at the top of the market, they will have lost capital. So they too have ‘capital at risk’.

Now you and I can also put capital at risk and buy Apple stock, for example. If we did that several years ago, we would have a long-term capital gain that would be taxed at 15% (sort of like Mitt without the carried interest issues). We could also buy what are called qualified dividend stocks whose dividend income is only taxed at 15%. In both cases we would need to be long-term savers and not spenders (same for Mitt).

What people do not talk about or see in the press is that even people like Mitt Romney likely paid W-2 income in the early years of his career. Otherwise, he would not have had cash to send his kids to college, afford a down payment on a house, etc. Looked at another way, the wealthy pay tax on some W-2 income (cash pay), pay a second tax on investment income and gains and then if they are lucky and accumulate wealth, a third tax which is the Estate Tax (that is a whopper at 50% for an estate above certain thresholds).

So what is unfair about all of this? Is it unfair that Mitt Romney, Warren Buffett and all the hedge fund managers are ‘smart’ and found great companies to invest in that appreciated in value? Is it unfair that George Clooney made millions of dollars in movies that were popular? Is it unfair that Tom Brady makes millions of dollars (probably pays the max rate) because he goes out for 16 plus Sundays and works 3 hours?

Isn’t all of this the American Way? Now we can penalize all the ‘smart’ wealthy people and all the ‘talented’ wealthy people, but history has shown that if we do they will take their capital to other places where on an after-tax basis their capital will grow. After all they are smart and talented……

One Comment

  1. I have been following the MF Global bankruptcy and in the latest news speculators including investment firms and big banks are trying to buy the claims of defrauded MF Global customers at a discount. Speculators are confident about the recovery of missing customers funds and additional return. They believe that Commodity Futures Exchange Commission will not let the customers funds to disappear. This looks like very risky bets to me because there are no certain guarantees about getting the money back. On the top of that, Wall Street Journal reported that money could have disappeared in a final week before company’s bankruptcy, which creates even more ambiguity.

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