Unintended Consequences – Man Bites Dog

Often when the government “fixes” things something else gets broken in the process. Two examples of that in the news recently. One deals with global hot money, the other with Ambac.

Tim Geithner announced that Treasury is going where no man has gone before. They are going into the disclosure business. Big time. Under the proposed new regs EVERY account held by foreigners would have to be reported separately and income earned related to that account could be reported back to the host country. (CCH Link)

Under proposed regulations issued in 2002, reporting of U.S. bank deposit interest is required only if the interest is paid to a U.S. person or a nonresident alien individual who is a resident of Canada.

The new proposed regulations withdraw the 2002 regulations and extend the information reporting requirement to include interest paid to nonresident alien individuals who are residents of any foreign country. This extension is expected to strengthen the United States exchange of information program.

It’s hard to argue with this proposal (unless you’re a foreigner with hot money in a US account). After all, just a few years ago the US Justice Department damn near took out UBS and a chunk of the Swiss government over the issue of banking secrecy and offshore accounts. What’s good for the goose has got to be good for the gander, right? I’m not sure how much money is involved. I know it is a very big number. The tax-lawyer fellow that sent me the link had this to say:

This is huge. There’s over a trillion in deposits by non-resident aliens in US banks. Fear of losing all that capital ended up slowing the proposal under Clinton, and then leading to its withdrawal under Bush 41.

Does this mean that a Tril or so is leaving the USA? “No” is the answer to that. It probably will not be over $250 billion. A quarter trillion shouldn’t make much difference should it? That is only 15% of M1. It’s not even two months of funding for Treasury. $250b is less than the market cap of Apple these days. It probably won’t make any difference at all. Maybe. I hope….

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The Ambac (ABK) file is thick. This is just an update on a slightly bizarre aspect to this very bizarre story.

ABK got hit from all sides in 07, big losses. In an interesting trick, they reshuffled the books to restate their income from prior years. The restatement showed they actually made no money and as a result they had over paid federal income taxes to the tune of $708MM. Now get this; the IRS refunded them the $708 million!

Guess what? A year later the IRS looks at it again and concludes that the refund should never have been paid. They sued ABK to get the money back. (They wrote a monster check, regretted it and then sued. What were they thinking of?) Bond Buyer

The IRS argues this is not an insurance dispute, but a tax one. It points out that Ambac’s “tentative” tax refund was granted before the segregated account was ­created, and a corporate restructuring ­cannot escape its repayment.

This matter is presently before The U.S. District Court for the Western District of Wisconsin. I’m not sure who I’m rooting for. It is quite possible that I (we) could lose either way.

ABK is a chapter filing story. So it is immune from claims from creditors. The Wisconsin insurance commissioner oversees its operations. The commission’s job is to protect what assets are left at ABK so that it can pay claims on policies that it has written.

ABK was sort of split into parts. One is a very bad problem, the other just a bad problem. The bad problem had about $313 million in the bank as of mid-year. What did they have on the other side? Ready? $223 BILLION of municipal bond insurance.

It’s not like the world thinks ABK is money good. But ABK is still collecting premiums and paying claims. That might have to come to a halt if the IRS wins in court. (they have a 90+% success record) From the normally mild-mannered Bond Buyer:

A move by federal authorities to seize Ambac’s assets to satisfy tax claims could detonate a catastrophic chain of events: state regulators could assume control of Ambac Assurance, causing a technical default that would trigger a $3 billion payment to terminate swap policies. Any resources the company has to pay claims on municipal bond policies would be trampled.

The muni market is already walking a tightrope. A complete balls-up with Ambac would be just another kink in the system. Once you get a big kink, it is hard to forecast where it will lead to.

Think of where we are on this. ABK is alive (but mortally wounded) as a result of an emergency ‘equity injection’ of $700b from, of all places, the IRS. But the IRS is claiming they never should have paid the money in the first place. Does that mean that Ambac should have self-destructed a year ago, bringing down with it a bunch of muni paper? If the IRS gets its way in Wisconsin does it mean that the muni paper now goes smoke?

Tim Geithner is on all sides of this. He runs the IRS. He is also responsible to see to it that the muni market doesn’t hit a mountain. He sets policy on foreign bank accounts. He is also supposed to be looking out for the financial system. Our boy has lots of conflicts on his plate. These two examples seem to be of his own making.

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