Romney is worse than I thought!

I never thought much of Mitt Romney. He has always come across to me as an opportunist with no principles, and worst, a man who has embraced the worst excesses of the extreme Right.

But I, along with many others, including Cory Booker, the distinguished mayor of Newark, felt the attacks on Bain and Romney’s association with it, were misplaced. Booker said: 

“I’m not about to sit here and indict private equity... If you look at the totality of Bain Capital’s record, they’ve done a lot to support businesses — to grow businesses. And this to me, I’m very uncomfortable.”

I bought into this view when I published my commentary entitled "In Defense of Romney" and said:

But what Mitt Romney did at Bain Capital is quintessentially good, beneficial capitalism. It is the essence of “Creative Destruction” so ably described by Joseph Schumpeter, the conservative Austrian economist. See here. Its essence is that inefficient entities must be made efficient or be eliminated, and in the long run the economy as whole will benefit, and while some jobs may be lost in the process, in the long run more will be created.

Booker and I were right about “private equity“ but we ignored the fact that while private equity does, in many cases, practice, “Creative Destruction“ not all do, and it appears that Bain was and is one that was bent on rapacious behavior, getting profits out of “creative accounting“ and very little creative building.

This was driven home to me when I received an e-mail from a Republican former colleague of mine who became interested when one of the subjects of Bain’s creative plunder turned out to be a former subsidiary of our common former employer Schering-Plough Corporation, Wesley-Jessen. In his e-mail my colleague quoted from a recent Daily Beast article by David Stockman, Ronald Reagan’s Budget Director.

My colleague quoted from the article as follows:

Wesley-Jessen was a small specialist firm that did reasonably well in cosmetic eye-color lenses and toric lenses to correct astigmatism. In mid-1995, when Schering-Plough Corp. put it on the block, Bain Capital invested $6 million and reaped a $300 million profit for itself by 1999—making nearly 50X its investment in the same number of months. On an apples-to-apples basis, however, the company’s operating income rose by only 2X during the same period, by my calculations. The rest of the gain was due to massive leverage, the Greenspan bubble, and accounting moves that can fairly be called myopic. 

Bain employed a hoary old dodge—having its accountants write off every dime of plant, equipment, and intangible know-how, reassigning roughly $40 million to the inventory accounts, and then charging it to income in the immediate two or three quarters. This trick eliminated all future depreciation, thereby magically adding $14 million to the pro forma operating income on Wesley-Jessen’s $100 million of sales. Investors were promptly told to ignore the resulting losses, of course, since these inventory charges were “non-recurring”! In fact, savings from pre-deal “restructuring” actions by the seller, plus the accounting magic, generated $24 million of freshly minted “operating income” before Bain’s turnaround squad even showed up at the company’s headquarters. The alleged “turnaround” of Wesley-Jessen was thus largely an artifact of Bain’s PR machine.

In the fourth quarter of 1996, the company borrowed $70 million to acquire a competitor, Barnes-Hind, from Pilkington plc. Before the ink was dry on the merger contract, Bain filed an IPO prospectus. While Barnes-Hind had an operating loss of $17 million the year before the merger, its results for that period were improved by $23 million owing to Bain’s pro forma adjustments—creating the appearance of another dramatic turnaround. 

During the 12 months ending at the merger date, the combined companies had actually incurred a net loss of $27 million, but it vanished with the help of $50 million in pre-tax adjustments for merger accounting and prospective savings. So its pro forma earnings took on a decisively improved aura; it would have booked a $14 million profit, or about $0.73 per share.  

  

Not surprisingly, the stock market eagerly scooped up $45 million of new shares at $15, or 20X these gussied-up earnings, just in time for the Fed to begin a new round of goosing in March 1997. And that proved propitious for Bain. Almost to the day on which its 180-day IPO lockup expired, it sold its first batch of shares in a secondary offering in a now red-hot stock market at a red-hot price that was up 60 percent from the IPO. 

Wesley-Jessen had not then filed financial statements with even $1 of GAAP (generally accepted accounting principles) net income. But when Bain’s underwriters wired the proceeds in August 1997 the selling price was $23.50 per share. That’s 52X the $0.43 per share it had paid for the stock 25 months earlier. At the end of the day, massive leverage, fancy accounting, and bubble finance, not entrepreneurial prowess, were the source of Bain’s 50-bagger.

I urge the reader to read at least portions of the article because it is replete with other similar rapacious examples. See here.

One comment in the article particularly calls for quoting as follows:

...Mitt Romney was not a businessman; he was a master financial speculator who bought, sold, flipped, and stripped businesses. He did not build enterprises the old-fashioned way—out of inspiration, perspiration, and a long slog in the free market fostering a new product, service, or process of production. Instead, he spent his 15 years raising debt in prodigious amounts on Wall Street so that Bain could purchase the pots and pans and castoffs of corporate America, leverage them to the hilt, gussy them up as reborn “roll-ups,” and then deliver them back to Wall Street for resale—the faster the better.

There is more that no one seems to have focused on. We are constantly told that we must work hard and play by the book. But what about people like Romney? He may have worked hard while he was the head of Bain Capital, but he was there from 1983 to February 1999. For the past thirteen years he has not expended any effort on the firms behalf. He isn’t 65 so he is not entitled to a pension, but without working he received $3,012,775 in salary, $3,649,567 in dividends and another $6,810,176 in Capital Gains, for a total $13,709,606 in income. Not bad for not working.

But the tax code allows him to pay a tax of 15%. Poor Romney, he thinks it is too high.

But there is more that comes from Romney’s released tax return. G-d knows what may be in the hidden ones. The assumption is that he gave most of his charitable contribution to the Mormon Church. But in fact he gave substantial contributions to family trusts. $89,000 to one family trust. One of his charities was The Tyler Charitable Foundation, an anti-gay group. 

The following is a quote from a website whose URL I have lost. I state this to avoid being accused of plagiarism.

He donated Appreciated Low-Basis Stock to a Private Charitable Foundation. Mitt and Ann donated about $1.5 million appreciated low-basis stock (mostly stock in Domino’s Pizza Inc.) to their private charitable foundation (The Tyler Charitable Foundation). This donation provided Mitt and Ann with five interrelated tax benefits:

Legally Excluded 2010 Capital Gains. Mitt and Ann legally excluded from their 2010 capital gains income the appreciation in the value of their donated stock. This legally excluded capital gain must be added back to Mitt’s and Ann’s 2010 reported income to arrive at their total 2010 income. I note that this exclusion saved Mitt and Ann as much as $225,000 in income taxes, assuming that the donated stock was worth $1.5 million and had close to a zero tax basis (tax cost). I used the 15 percent long-term capital gains rate to compute the tax savings on $1.5 million of gain since that is the long-term capital gains rate for both the regular tax and the alternative minimum tax.

Deductions in Excess of Tax Basis. Mitt and Ann deducted the full value of the stock – even though it is likely that their tax basis in the stock was far LESS than the value of the stock at the time they donated it to their private charitable foundation.

Donation Offsets Highly Taxed Income/Computation of Tax Benefit. The $1.5 million charitable donation offsets income that otherwise would been taxed at the 28 percent maximum alternative minimum tax rate. The tax savings associated with the charitable contribution deduction is approximately $420,000, or 28 percent of $1.5 million. This tax savings is in addition to the approximately $225,000 in tax savings arising from legally excluding the $1.5 million gain from income. Thus, the total tax savings is $645,000, as follows:

Exclusion of Gain on Disposition of Stock    $225,000

Charitable Contribution Deduction            $420,000

Total Estimated Tax Savings                  $645,000

Delayed Contribution to Final Recipients. Mitt’s and Ann’s private charitable foundation contributed $648,500 to various charities, including $145,000 to the Church of Jesus Christ, Latter Day Saints. The foundation held the balance of the $1.5 cash contribution – over $800,000 – at the end of calendar year 2010. Thus, although Mitt and Ann received a charitable contribution deduction of $1.5 million, less than half of that money was contributed to final recipients by the end of calendar year 2010. In contrast, Americans who cannot afford to set up private foundations must complete their contributions to final recipients by the end of the calendar year to take their charitable contribution deductions.

Contributions to Final Recipients Equals Approximate Tax Savings. I note that the $648,500 in total grants made by Mitt’s private charitable foundation in 2010 approximately equals the estimated tax savings of $645,000.12

Foreign Tax Credit. About 8 percent (about $1.5 million) of Mitt’s and Ann’s income came from sources outside the United States. To avoid double taxation, Mitt and Ann received dollar-for-dollar reductions in their United States tax liability for income taxes paid to foreign countries. In 2010, Mitt and Ann used the foreign tax credit to reduce their income taxes on foreign income by $129,000. They did this (1) by paying $67,000 in income taxes to foreign countries in 2010 and (2) by utilizing $62,000 of unused foreign tax credit carryforwards from prior years.

END OF QUOTE

It appears to all be legal. But that is the disgrace. WHY IS IT LEGAL!!! WHY DOESN’T ROMNEY TALK ABOUT ELIMINATING THESE EXEMPTIONS! All we hear about is lowering tax rates. DOES ANYONE REALLY BELIEVE THAT HE WILL ADVOCATE ELIMINATING THESE WONDERFUL MEANS FOR ESCAPING TAXES? BUT HE HAS ALREADY MADE CLEAR THAT HE DOESN’T PROPOSE TO INCREASE CAPITAL GAINS TAXES AND DIVIDENDS, EXCEPT FOR LOW INCOME PEOPLE WHO RARELY HAVE THEM.

YES, WE HAVE PEOPLE WHO ESSENTIALLY DON’T PAY TAXES. BUT IT IS NOT THE POOR OR THE ELDERLY!!!

And worse of all, these ill-gotten-gains then start an aristocratic dynasty through inheritance tax laws, which not only allow most of the ill gotten gains to be passed on to their heirs for generation after generation, but even forgive the few capital gains taxes incurred by the decedent.

In Defense of Romney – Discussion

On January 19^th I posted my commentary "In Defense of Romney."

In response thereto Pam Tisza of Branchburg, NJ wrote:

You did not comment on Senator Bernie Sanders bill to counteract the big money in the elections---or did I miss it ????

To which I replied:

No, I didn't and I am not sure what bill you are referring to. Do you mean his introduction of a Constitutional amendment to overrule Citizen United? If so, I am glad he did that, but it is not very newsworthy, since it is not likely to go anywhere. I expect it will not even get out of committee and if it does it will not get a majority, at least at this time around, and it need 2/3 of both houses in order to go to the states for ratification, where it needs 3/4 of the state legislatures (both houses) to become part of the Constitution, given that Democrats now control 35 total chambers while Republicans are the majority in 60 chambers. See here. There are three tied chambers with the addition of the Virginia State Senate.

Article. V. of the Constitution provides:

"The Congress, whenever two thirds of both Houses shall deem it necessary, shall propose Amendments to this Constitution, or, on the Application of the Legislatures of two thirds of the several States, shall call a Convention for proposing Amendments, which, in either Case, shall be valid to all Intents and Purposes, as Part of this Constitution, when ratified by the Legislatures of three fourths of the several States, or by Conventions in three fourths thereof, as the one or the other Mode of Ratification may be proposed by the Congress;…”

If you were referring to something other than the above, please advise. In fact please let me have your further comments in any case.

Her rejoinder was:

Thanks for correcting me. I went back and read the original e-mail I got on this and they mention "constitutional amendment”; but then go on as if it is a bill. Poor reading on my part. I agree with you. Nice idea--no hope.

I must add that despite the fact that at present there is no hope of enacting such an amendment, many liberal organizations are organizing petition drives in support of such an amendment, which is a good idea. It must be kept in front of the public.

Albert Nekimken of Vienna, Virginia challenged me on my views with respect to the activities of Bain Capital, writing:

I don't share all of your enthusiasm about Romney's version of private equity capitalism, but I agree with your view that all income from all sources should be taxed at the same rate. As for the corrosive effect of money on politics, the Harvard professor, Lessig, who (in his new book) proposes that ALL political campaigns be publicly financed through a $1 per taxpayer, voluntary contribution on his tax return, which seems like the most promising solution. 

You were correct to emphasize the dire issue of the high cost of education today--and rising. This is killing social mobility. Student debt (now inextinguishable even in bankruptcy) is the next huge bubble ready to burst. Indebted and unemployed students cannot repay these debts. So long as educational institutions are able to coerce/convince students to incur debt as a condition of enrollment, there are/will be no brakes on the rise in cost. When the bubble bursts, many schools will go with it.

To which I posed the following question:

I am interested in your views on "Romney's version of private equity capitalism.” Do you think it is destructive? Do you think parts of it should be illegal? If so what parts? If you can, please be as specific as possible.

And added:

As for Lessig's proposal, we already have a provision in the tax code for deducting, not $1 but $3 for Presidential campaigns. The tax code provides, for a Presidential Election Campaign Fund which helps pay for Presidential election campaigns. The fund seeks to reduce candidates' dependence on large contributions from individuals and groups and seeks to place candidates on an equal financial footing in the general election. Tax Return 1040 provides: “If you want $3 to go to this fund, check the box. If you are filing a joint return, your spouse can also have $3 go to the fund. If you check a box, your tax or refund will not change."

However this check off has come out of favor. "...participation in the tax checkoff program has declined each year, from a high of 28.7% for 1980 returns, to 7.3% for returns filed with the Internal Revenue Service (IRS) in 2010." See here.

There is a limit in how much one is allowed to spend to get matching funds. In 2008, presidential primary candidates who accepted public funding had a maximum entitlement of $21,025,000 (50 percent of $42,050,000). (Ibid) It was because of this limit that Obama waived the public funding in 2008 to much criticism. He felt he could raise and spend much more than the limit.

As I understand Lessig, all he is advocating is essentially to extend this system to Congress. I would favor this, but unless there is a limit on contribution and spending, it would end up the same as the Presidential fund. As long as Citizen United stands, and I am not hopeful of an overrule in less than two decades, we are stuck, money will rule.

On improving mobility, making decent education available to all, regardless of economic status, is the ultimate class leveler and vouchers can never achieve this. Here too we need to reverse the financing curve. The poor need more financing than the rich, not less. Even in school buildings many are antiquated. No corporation would or could operate in such antiquated buildings. But as long as money rules this will not happen. I hate to say this, but I am not optimistic.

Nekimken responded:

You likely saw the article in today's New York Times entitled “Taxes at the Top” and another one entitled "Romney’s Estate Tax Cut Would Save the Koch Brothers Up to $8.7 Billion Each" but I call them to your attention in case you missed them, it because they bears on the question at hand: Romney's wealth. 

To tell the truth, I have mixed feelings about the role of private equity in modern capitalism. On the one hand, I believe it does serve a useful tool of Schumpeter's "creative destruction" by feeding on weak companies like insects on the forest floor, paving the way for new growth. 

On the other hand, much private equity activity appears to be motivated, not by any long-term desire to turn around failing companies by making new investments and providing new management in order to make them successful and grow and, presumably, to create new jobs, but by a desire to create a transaction that results in a quick profit. 

On the contrary, most of this activity seems to be motivated by a short-term desire to strip assets from a failing company, reduce staff, and (often) to loot the company pension fund. Often private equity owners load a newly acquired company with fresh, unsustainable debt that can be made to "disappear" in bankruptcy, or in a future sale at an inflated price to a bigger fool. 

As a result, much of what private equity firms do falls into the category of "financial engineering" that serves no useful purpose except to make a few "engineers" very wealthy. Unfortunately, I can't think of any coherent and effective way to prevent this. 

The situation is so complex that I don't believe there is any way to regulate this area of finance in order to prevent them from plundering weak companies and destroying jobs. Better would be to reform tax policy (i.e., tax all income from all sources at the same rate), reform bankruptcy and pension laws, and protect employees more effectively, perhaps by making company owners pay severance and re-training expenses for employees who lose their jobs--as is the case in Europe. 

I hope this is helpful.

I concluded this discussion with:

I really don't know enough about how a company like Bain operates to agree or disagree with your description of "financial engineering." However, while your description of the European system of "making company owners pay severance and re-training expenses for employees who lose their jobs--as is the case in Europe" has appeal, I fear that it may be counter-productive. It has long been charged that these potential burdens make employers reluctant to hire in the first place, and I fear that there is truth in this.

Comments are welcome and will be distributed with attribution, unless the writer requests that he/she not be identified.

In Defense of Romney

In my last post entitled "Congress and the Public - Kudos to Sarah Palin," which was distributed on Friday the 13^th, I addressed three issues: the huge amount of money influencing, one might say controlling, our public servants; the lies that dominate our public discourse, so as to bring government into greater disrepute; and the insider trading that is prevalent in Congress.

Paul Negri of Clifton, NJ expressed the view that what is behind the money cursing through our political, and indeed our economic system, and is the reason for scandals such as the insider trading in Congress is “greed and opportunism, (and that these) to a greater or lesser degree, are part of human nature, … and develop more in those who have, through circumstance, the best access to ways and means to self-advancement. The question is how do we push the equation to the lesser, rather than the greater, degree?”

I think the answer has to be through effective legislation, which in our present system can only be brought about by the use of money in the cause of fighting the misuse of money, at least until such a time, when money does not dominate our public discourse. One example that illustrates this, is the Gay Marriage issue in NY. Gay Marriage was legalized recently in New York because some courageous Republicans broke party ranks, and supported its legalization. As a result the Conservative Party of New York State threatened to withhold from them their endorsement and the considerable amount of money that goes with it. Now backers of Gay Marriage have countered by promising to offset the withdrawal of money by their own financial contributions. See here. Something similar can be done with respect to insider trading in Congress. Single issue campaigns are always more effective than broad ideological ones, and here it might be possible to draw money from all sides of the political spectrum, demanding of our law makers that they sign a pledge to support a bill drafted by the organization along the lines of the Palin recommendations.

But greed is not always bad. There is little doubt that greed is what drives our capitalist system, and it does not inevitably lead to the destructive greed of a Gordon Gekko in the movie “Wall Street.” But that is why we need laws and regulations. Left unchecked the engine of creation becomes an engine of destruction. The entrepreneur, while lauding competition, hates competition and seeks monopoly, which is why we have anti trust laws that have not been enforced adequately lately. The investor while lauding good research, seeks a leg up, by seeking or selling insider information, which is why we have laws against that, which have not been enforced until lately.

The banks seek to exploit their credit card customers, making them think that they can spend more than they make, and encouraging them to pay back tiny installments, so that they run up their interest debt at outrageously high interest, and then if they overlook one monthly payment hit them with even higher interest rates and penalties, so that their debt often ends up a multiple of their original one, and then using their money clout in Congress to deny them that, which every business has available, i.e. bankruptcy protection and also using its financial clout to prevent the capping of interest rates from becoming usurious. Even the Mafia never charged more. See here and here.

But what Mitt Romney did at Bain Capital is quintessentially good, beneficial capitalism. It is the essence of “Creative Destruction” so ably described by Joseph Schumpeter, the conservative Austrian economist. See here. Its essence is that inefficient entities must be made efficient or be eliminated, and in the long run the economy as whole will benefit, and while some jobs may be lost in the process, in the long run more will be created. It is ironic that the Right, which claims to be the apostle of free enterprise, should attack Romney for practicing the essence of Capitalism. But I guess the saying that “all is fair in love and war” applies! Is it inter-party war?

What has come out of this, however, is that it illustrates just how unfair our tax system is. The Republican Party has long argued that our “graduated tax system is unfair” in that it taxes the rich more than those with small, or at least much smaller incomes. But what we are seeing is that the system is indeed unfair, it taxes the rich at a rate that is barely distinguishable from the rate applied to much smaller incomes. Romney has now admitted that even though his income is in the millions annually, his tax rate is close to 15%. See here.

I wonder how many of my readers have an effective tax rate of 15%! When Warren Buffett caused a sensation by declaring that his secretary paid taxes at a higher rate than he did, the Right Wing blogosphere went wild with denunciations, and they all stayed on message. One even had a headline, “AP fact check: Secretaries don’t pay more taxes than their bosses," except when the article is accessed no reference to an AP fact check can be found. What percentage of their “income” the rich pay in taxes depends on how “income” is defined. Is it “earned income”, is it “taxable income” or is it total income the way most people would define it?

What causes this anomaly is that as people go up the income ladder more and more of their income comes from capital gains income and dividends. Thus the top 1% of earners on average get 43.4 % of their total income from Capital Gains, Interest and Dividends compared to the next highest quintile who only get 21.4% of their income from Capital Gains, Interest and Dividends, and the lowest quintile only get 1.3% of their income from Capital Gains, Interest and Dividends. The result is that the top 1% who make an average annual income of $1,873,000 pay an effective Income and Payroll tax rate of 20.6% (a lot more than Romney pays) as compared to the top 20% who make a fraction of that at $264,700 (which puts them in the upper middle class) pay almost the same tax rate at 20.1%. See here.

This is neither fair nor sensible. No tax reform, no matter how much the tax is graduated, can deal with this unfair anomaly, unless all types of income is taxed the same. In a country that prides itself on its Puritan work ethic, the discrimination against those who earn their income by working, as opposed to those who earn it by investing, is difficult to understand, and even more difficult to justify. This is even more evident when we consider that most of the rich started out in life with a substantial inheritance, which they could then use to generate more capital and it is further aggravated by our tax law, which forgives even capital gains taxes on inherited stock or other appreciated assets. See here, which is well worth reading.

Romney claims that, “What I got from my parents when they passed away I gave away to charity and to my kids. And so what I’ve earned has been earned through my education, my values, living in the greatest country in the world, through some luck and through hard work.”

Even if that is true, and the reader will forgive me if I am skeptical, he at the very least got an education that most people can only dream of. How often can the child of a blue-collar worker possibly obtain such an education? How likely is a child of a blue collar, or even of the average white collar worker, going to afford a pre-school education beginning at the age of two at $20,000 a year, giving that child a jump by the time it starts grade school. Then when public school begins, how likely is it that it can afford private school at more than the $20,000 mentioned? And even if a “Romney” goes to a public school, you can be sure that it will be an excellent one. On the other hand, with our system, where schools are frequently financed by local property taxes, the schools in a well to do neighborhood will be properly financed, while those in a disadvantaged area will never have what they need to support a first class education. And how many, with all these obstacles will get to, and through college, with their even greater financial burden. Some will. I did. But I would not have made it through college and eventually law school if my college had not been tuition free, something that has long since passed from the scene. 

But none of this should disqualify Romney, except that he is an exponent of this system and an exponent of making it even more unfair.

But most of all I object to his inauthenticity. His father must be turning in his grave, for that former Governor of Michigan, and once Presidential aspirant, put the greatest value on authenticity. See here.

Phoniness is not leadership. Opportunism is a serious character flaw. Inauthenticity is, or should be, disqualifying.

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