Victory for a Loophole

Capital Gains treatment for "carried interest" now seems likely to survive this session of Congress.

As regular readers of this blog know, I am against cap gains treatment in this area. It is a paradigm of a an inequitable tax loophole.

There is room for reasonable argument about what exactly ought to be done to close this loophole, but that it ought to be closed, nobody who has viewed the situation in a dispassionate way seems to doubt.

Yet year after year, Congress has proven incapable of acting.

As to this year specifically: under the bill approved by the House of Representatives on May 28, 2010, the American Jobs and Closing Tax Loopholes Act of 2010 (H.R. 4213), 75 percent of carried interest will be taxed as ordinary income beginning in 2013. The remaining 25 percent will continue to be taxed as capital gains. During the transition period until 2013, under this bill, 50 percent will be taxed as capital gains, 50 percent as ordinary income.

That was a detail within a big bill with other motives. The overriding purpose of the bill was to extend unemployment benefits further. Republicans didn't like that and demanded budget neutrality -- i.e. assurances the bill would not contribute to the deficit. That set off the search for loopholes to close and, in fixing upon the cap gains treatment of carried interest, the legislative draftsmen found a good one.

On Tuesday, June 8, the Senate Finance Committee, chaired by Max Baucus (D-Mont.) amended the House bill in the form of a substitute. There were some important changes, including some in the provisions dealing with carried interest, but nothing a conference committee couldn't have patched up.

It now appears that there won't be a conference, because the bill can't get through the Senate. The Republicans (with just one Democratic ally, and one Independent ally) have successfully filibustered the unemployment extension there. The provisions closing the loophole weren't the reason for the filibuster, so far as I can tell, but they are casulaties nonetheless.

Three Questions for Senator Clinton

I'm on the list for press releases from the two remaining Presidential candidates in the Democratic Party.

Why am I not on Senator McCain's list, too? Because my presence on any of these lists dates back to last October, when Congress was debating the issue of the taxation of "carried interest" on private equity funds. This is a matter of grave concern for my usual audience, so I contacted the Democratic candidates about it.

There was no "carried interest" story on the Republican side, I assure you.

Anyway: I am on the lists, and on Friday I received an e-mail statement from Hillary Clinton's press office on the new unemployment numbers.

The statement was by-the-book, but I decided: what the hack? why don't I write back. I don't really expect an answer, but I'll share with you the questions:

I'm curious about the matters below that concern: Clinton campaign economic/financial policy. I'd love to have an on-the-record quote from the candidate about these matters.

1. Glass-Steagal. Does Senator Clinton believe, as Senator Obama suggested recently, that the repeal of the Glass-Steagal distinctions between investment and commercial banks was part of the road to our present troubles? If so, did she use her influence within the administration of President Clinton to raise warning flags at the time, or has the problem only subsequently become clear?

2. Yesterday morning, one of the Banking Committee Senators asked Mr. Bernanke: How big does an institution have to be to be 'too big to fail'? I'd appreciate the Senator's views on that. If no institution is too big to fail, then sometimes the right thing for a President to do (invoking the imagery of a certain television ad) would be to let the phone ring, wouldn't it? Why should the CEO of Bear Stearns, or someone in a similar position, expect to be able to reach anybody in the White House at 3 AM?

3. A more minor point, involving personnel issues, but one in which I think our readership will be interested: Would Robert Rubin likely play an important part in the economic/financial policy of a new Clinton administration?

I'd very much appreciate it if you could get back to me on these points. Thanks.

Abu Dhabi Buys Into Carlyle

The Carlyle Group has just sold 7.5% of its equity to an arm of the Abu Dhabi government.

Specifically, the buyer is the Mubadala Development Co., which paid $1.35 billion for the stake. Oddly, the two parties announced that this deal values the whole of The Carlyle Group at $20 billion.

Really? If 7.5% of an enterprise's equity is worth paying $1.35 billion, then a straightforward calculation suggests the parties implicitly value the whole enterprise at $18 billion. Is my math wrong, or is theirs?

My math is right, backed up by my trusty Texas Instruments toy. Their calculation isn't so straightforward, though. They've announced that Mubadala is getting a 10% "liquidity discount" off what would otherwise have been the fair market value for their purchase. A liquidity discount? As in "Carlyle needs the money NOW"???

Carlyle is a very prominent private equity firm -- it owns Dunkin' Donuts, Nielson, and a maker of automobile seats, Britax. This spring, around the time of the Blackstone frenzy, there was talk that Carlyle, too, would go public. But the great market volatility of the summer seems to have put the kibosh on that, so it's evidently selling itself piecemeal.

Actually, there's a lot else that might have had the effect of putting on ice Carlyle's hopes for an IPO this year. There's the continuing debate in Congress about the taxation of carried interest. That debate seems to have been stoked by Blackstone and the honchos at Carlyle simply may not wish to be similarly provocative.

So, yes, Carlyle does need the money NOW. They can't wait until markets calm down and/or the political heat goes away to have their IPO and raise their hypothetical $20 billion. And the 10% liquidity discount is a disturbing sign of how bad the credit crunch has become.