On August 10, 2007 we posted "The Day the Music Died--The Mortgage Business".
That was about as much of a heads up for stock investors on what was to follow as anyone needed to bail from the market (emphasis in original):
May 7, 2006
WACHOVIA TO ACQUIRE GOLDEN WEST FINANCIAL, NATION'S MOST ADMIRED AND 2ND LARGEST SAVINGS INSTITUTION "...Herbert M. Sandler, Golden West chairman and chief executive officer, commented, "I’ve been a keen observer of the market and the mortgage and banking industries for nearly 40 years...."
The San Francisco Chronicle covered it as a human interest story May 9.
Why Sandlers sold their S&L
Wachovia's deal for Golden West called a good fit
While Sandler talked animatedly about her favorite causes, she broke down talking about her feelings about closing a book that's represented more than half of her life.
"I can't talk about it without crying," she said. "Some part of me certainly is very emotional."
On May 10, 2006 India Daily said:The market hit its all-time high two months later, closing at 14,164.53 on October 9 and intraday at14,198.10 on October 11.
Sell of Golden West Financial to Wachovia signifies burst of housing bubble
This is a month late for the anniversary but I wanted to memorialize it on the blog, I have a feeling I'll be coming back to it.We had a lot of posts subsequent to that one:
April 23, 2008
Now He Tells Us-Wachovia CEO: 'Golden West was an ill-timed acquisition' (WB)
Sept 8, 2008
Management Changes at Lehman, Washington Mutual, Wachovia (LEH; WB ...
Sept. 15 2008
Sept 29, 2008
Sept 30, 2008Sept 30, 2008
And many more.
From Tax Notes (sub reqd):
Happy Anniversary, Wells Fargo and Wachovia!
by George White
George White is a Tax Notes contributing editor and retired national tax partner with Ernst & Young LLP. Recently he was with the American Institute of Certified Public Accountants. He is the author of several publications on consolidated returns and tax accounting and is an adjunct professor at the George Washington University School of Business, where he teaches graduate courses in tax accounting and corporate tax. White is an attorney and CPA. The Financial Crisis Inquiry Commission recently revisited the September 2008 acquisition of Wachovia Bank by Wells Fargo Bank NA; White comments on the commission's findings.
* * * * *Last month marked the second anniversary of the engagement announcement between Wells Fargo Bank NA and Wachovia Bank, at the time the fifth- and fourth-largest U.S. banks, respectively. It was not exactly a match made in heaven -- more like a marriage arranged in Washington.
In September 2008 the U.S. financial industry was tottering, staggered by a series of punishing blows. Major institutions like American International Group Inc. (AIG) were near collapse or disappearing altogether, like Lehman Brothers Holdings Inc. Still others, such as Wachovia, survived only by virtue of government-sponsored takeovers.1 Last month, these troubled times were revisited in two days of hearings conducted by the Financial Crisis Inquiry Commission (FCIC).
At the hearing, the vice chair of the FCIC, Bill Thomas, retired Republican representative from California, focused on the Wachovia takeover. He called attention to the government action that made the takeover possible, Notice 2008-83.2 Thomas made several claims about the notice.3 First, he said the IRS was responsible for the notice; second, the IRS usurped Congress's legislative powers; and finally, the notice was a bad deal for taxpayers. Thomas's charges were all the more provocative because he is a former chair of the House Ways and Means Committee.
Issued on September 30, 2008, Notice 2008-83 was less than 300 words long. But it amounted to virtually an engraved invitation to Wells Fargo to acquire Wachovia. The notice gave Wells Fargo access to billions in tax benefits not previously available. For those not keeping score at home, a bit of history about the notice may be in order.4
When I first started out in this noble profession, one could actually read ads in The Wall Street Journal offering to sell companies with tax losses. It was not until 1986 that Congress finally put an end to this practice. As part of the Tax Reform Act of 1986, Congress passed a radical new regime to stop trafficking in loss companies. The new regime ("new" section 382) was based on the premise that a company's losses were the burden of its shareholders, who should not be permitted to mitigate their losses by selling them to new shareholders. The mechanism for enforcing this rule is a draconian formula that limits the amount of losses that the company could use, following a change of ownership, in any given year.5 The formula is a function of two variables: the total cap of the loss company and an assumed rate of interest.6 Multiplying the two yields an annual dollar limit on the amount of losses available to the new shareholders. The lower the value of the company at the time of the ownership change, the fewer company losses that can be used. It doesn't take much imagination to see that as a company's losses mount and its equity value falls, its losses become less and less attractive to new owners.
Having settled on an annual dollar limit, the next step in the new regime was to define the target -- that is, decide what losses should be limited. Prof. James Eustice has identified three phases in a loss company's history.7 On one end of the timeline are losses already recognized, the net operating losses. At the other end are operating losses that may (or may not) occur in the future. In between are losses that have accrued economically but have not yet been recognized for tax purposes. These are the so-called built-in losses (BILs). Section 382 subjects both NOLs and BILs to the same annual dollar limit.8
Notice 2008-83 was stunning because it called off the limits on BILs for banks.9 Wachovia, by virtue of its ill-fated 2006 acquisition of Golden West Financial Corp., was awash in BILs two years later. Before its acquisition, Golden West seems to have made a serious effort to corral a major portion of the adjustable-rate mortgage market. By September 2008, Wachovia was believed to be holding as much as $74 billion in bad mortgage notes.10 Assuming that Wells Fargo expects to fully use all these BILs (and why else would it have acquired Wachovia?), the notice allowed Wells Fargo to potentially realize roughly $25 billion in tax benefits (35 percent x $74 billion). Not a bad return, considering that Wells Fargo acquired Wachovia for $15 billion in Wells Fargo stock.
There can't be much doubt that the notice played the decisive role in Wells Fargo's decision to acquire Wachovia. By the weekend of September 27-28, 2008, the only bid for Wachovia was a $2 billion offer from Citigroup Inc. On Sunday night, September 28, Wells Fargo informed Wachovia that it would not compete with Citigroup's bid. On Monday morning, Citigroup announced that it had agreed to acquire Wachovia.11 A day later, the notice was issued and Wells Fargo immediately informed Wachovia that it proposed to acquire Wachovia for $15 billion in Wells Fargo stock.12
Thomas is most probably correct in claiming the notice read a big chunk of section 382 out of the code to make the Wachovia deal work. But to lay the blame on the IRS seems unfair. A policy decision of that magnitude would never have been originated by the career employees in the IRS. The notion that they concocted a deal facilitating the combination of the fourth- and fifth-largest U.S. banks is ludicrous. That policy call could have been made only at the highest levels within Treasury. Indeed, shortly after the notice was issued, Senate Finance Committee ranking minority member Chuck Grassley, R-Iowa, fingered the prime suspects, asking for an investigation of the actions of Treasury's senior officials.13
So much for Thomas's attempt to blame the IRS for the notice. What of his second charge that the notice "usurped" Congress's legislative authority? Thomas has a lot of company on this score. Early in 2009 Congress passed H.R. 1, the American Recovery and Reinvestment Act of 2009. Among its provisions was the (prospective) revocation of the notice. The act stated:
- the delegation of authority to Treasury under section 382(m) "does not authorize (Treasury) to provide exemptions or special rules that are restricted to particular industries or classes of taxpayers";
- the notice is "inconsistent with the congressional intent in enacting such section 382(m)"; and
- the legal authority to prescribe the notice "is doubtful."14
Can't get criticism more explicit than that. But if Congress expected Treasury officials to be chastened by their criticism, it didn't happen. With the change in administration on January 20, those officials had done their Elvis impression: They had left the building. Plus, the new law had zero effect on Wells Fargo and Wachovia because the law was prospective only; it left intact the deals that had already occurred.15
What of Thomas's final charge that the deal was bad for taxpayers? He was referring to the $25 billion loss in tax revenue resulting from Wells Fargo's use of Wachovia's BILs. But what were the alternatives? If Wells Fargo had not acquired Wachovia, it seems likely that Wachovia would have failed, and the FDIC and the Federal Reserve Board would have been forced to step in. Just days before, on the night of September 25, the FDIC had seized Washington Mutual Inc. (Wa-Mu), the largest bank failure in U.S. history. There was even talk at the time that the FDIC had actually taken steps to take over Wachovia. On September 26, the day after the FDIC seized Wa-Mu, Wachovia's business customers started a run on the bank because of reports that Wachovia would be unable to redeem its money market accounts at par. Thomas argued that the notice "cost the taxpayers." The general counsel of the Federal Reserve testified last month before the FCIC that on September 28, 2008, the Fed had approved intervention by the FDIC to forestall even greater harm to the economy. If the FDIC had been forced to come to the rescue, who would have paid that bill? The Greeks? After a decade-long tsunami of government aid, who's to say that $25 billion to salvage Wachovia was foolishly spent? Compared to the hundreds of billions of dollars spent on the Troubled Asset Relief Program, $25 billion doesn't seem like such a bad deal.
In the end, it comes down to whether you think Treasury policymakers were justified in flouting the tax law to avoid financial panic. In other words, do you believe the end can sometimes justify the means? Many years ago, my Jesuit teachers taught me that it did not -- "One should never do evil so that good may come." However, you might prefer the wisdom of a more contemporary philosopher like the late George Carlin, who asked, "If the end doesn't justify the means, what does?"
1 For an absorbing account of this period, see Andrew Ross Sorkin, Too Big to Fail (2009). Many of the details in this article are drawn from Sorkin's work. 2 Notice 2008-83, 2008-2 C.B. 905, Doc 2008-20957 , 2008 TNT 191-3 .
3 "Financial Crisis Panel Member Blasts IRS Over 2008 Rule Change on Bank Losses," 69 DTR G-7, Sept. 2, 2010.
4 See George White, "Notice 2008-83: The Ripples Keep Spreading," Tax Insider, Feb. 2, 2009.
5 A defined term (section 382(g)) measuring generally a more-than-50-percent change in the ownership of a loss company over a three-year period.
6 The rate is published monthly by the IRS. For October 2010, the rate is 3.98 percent. Rev. Rul. 2010-24, 2010-40 IRB 400, Doc 2010-20452 , 2010 TNT 181-15 .
7 James S. Eustice and Gerald G. Portnoy, "The Destiny of Net Operating Losses," 22 San Diego L. Rev. 115 (1985).
8 Section 382(d) and (h)(1)(B), respectively.
9 As defined in section 581.
10 See Jones Day comentaries (Oct. 2008), 2008-21588, 2008 TNT 197-27 .
11 For Citigroup, the principal attraction in the deal was Wachovia's deposit base.
12 Sorkin attributes this abrupt volte-face to a "little-noticed change in the tax law that had occurred on Tuesday." Little noticed by whom? By the public for sure, and maybe even by general tax practitioners, but certainly not by Wells Fargo's posse of high-priced advisers. By 2 a.m. on Wednesday, Wells Fargo's investment bankers, Goldman Sachs and Perella Weinberg, had delivered fairness opinions on the deal to Wachovia's board of directors. You don't suppose the Wells Fargo team had an idea what was coming, like Bobby Thomson in the '51 playoff game, do you? Just asking.
13 Grassley was right on in his letter to the Treasury Inspector General, asking for an investigation of Treasury's action in issuing the notice. For Grassley's letter, see Doc 2008-24260 or 2008 TNT 222-73 .
14 American Recovery and Reinvestment Act of 2009, P.L. 111-5, section 1431.
15 Besides the Wells Fargo-Wachovia deal, other bank acquisitions reportedly took advantage of the notice, e.g., PNC's acquisition of National City Bank of Cleveland in October 2008.
END OF FOOTNOTES