A pledge drive for toxic assets
Three months after the Obama administration proposed the Public-Private Investment Program, banks remain lukewarm to the notion of selling ailing securities at a deep discount. Potential hedge fund buyers, meanwhile, are wary about government officials looking over their shoulders.
But it’s not too late for team Obama to change course and put in place a program that might actually entice the banks and hedge funds to participate, while also serving a civic good.
Let’s call this new bank detox plan CDOs for Charity. It may sound a bit wacky but the idea is quite simple: Encourage the banks through a series of favorable IRS rulings to donate ailing collateralized debt obligations and other untradeable real-estate related securities to private investment trusts set up by charitable organizations.
The banks that donate to these charitable trusts would be able to take a corresponding tax deduction, enabling them to reduce their corporate tax rate. The charities could then go out and hire asset managers, including hedge funds, to oversee their investments with an eye toward generating a profit if the securities recover in value.
The CDOs for Charity program would make it easier for banks to take big haircuts on the value of the securities they donate, since they’ll be able to offset some of that loss with a charitable tax deduction.
Any investors holding credit default swaps — insurance-like derivatives — on bank-donated securities probably would also have to qualify for a charitable tax write-off.
Cash-poor charities, which have seen donations dry up during the recession, get a chance to make up lost funding. In this instance, all sides win.
The federal government, to be sure, would take a hit on the lost tax payments from the banks.
But under PPIP, the government is committed to spending at least $100 billion to subsidize the plan and the runs the risk of absorbing additional billions of dollars in losses if the toxic securities decline further in value.
A CDOs for Charity program, on other hand, has the advantage of keeping the government from the messy of business of trying to create a market for these securities.
Of course, there will be issues determining the fair value for a security backed by collateral of dubious quality. But tax lawyers deal with this kind of issue all the time when a wealthy benefactor donates a sculpture or a painting to a museum.
It will require negotiations with the IRS, but Treasury Secretary Tim Geithner should be able to work that out since he’s the agency’s boss.
And there’s certainly precedent for Wall Street banks donating to charities assets they either don’t want or can’t sell. In 2004, Goldman Sachs donated 680,000 of unspoiled wilderness in Tierra del Feugo, Chile to the Wildlife Conservation Society.
Goldman took possession of the land when it acquired a portfolio of distressed loans in 2002 for about $60 million. One of the loans was secured by the land in Tierra del Feugo. Goldman, according to regulatory filings, “valued the land at $35 million, presumably taking a tax deduction in that amount.”
The Chilean government, according to the filing, had valued the land at $100 million. To be fair, Goldman didn’t just get a tax break from donating the land. It also spent millions of dollars to help maintain the site as a nature preserve.
Goldman, which declined to comment for this column, would go on to trumpet its charitable work and effort to save the environment. In a glossy brochure (see pdf) published shortly after the deal was announced, Goldman’s chief executive wrote: In determining the disposition of this wilderness, our team looked beyond traditional options and identified a rare opportunity. We determined this huge tract of unspoiled land should be preserved for the benefit of future generations.
The author of that lofty statement? Treasury Secretary Henry M. Paulson, Jr., who first proposed using federal money to buy up toxic assets from the banks in September.
Funny that Paulson never gave his Goldman experiment with Chilean land preservation a whirl when it came to dealing with unloved CDOs. Instead of being just charitable to banks, now may be the time to let charity help fix the banks.