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<DIV><FONT size=2><STRONG><FONT size=5>A Quiet Windfall For U.S.
Banks<BR></FONT></STRONG><FONT size=3>With Attention on Bailout Debate, Treasury
Made Change to Tax Policy<BR></FONT>
<P><FONT size=-1>By Amit R. Paley<BR>Washington Post Staff Writer<BR>Monday,
November 10, 2008; A01<BR></FONT></P>
<P></P>
<P>The financial world was fixated on <A
href="http://www.washingtonpost.com/ac2/related/topic/Capitol+Hill?tid=informline"
target="">Capitol Hill</A> as Congress battled over the Bush administration's
request for a $700 billion bailout of the banking industry. In the midst of this
late-September drama, <A
href="http://www.washingtonpost.com/ac2/related/topic/U.S.+Department+of+the+Treasury?tid=informline"
target="">the Treasury Department</A> issued a five-sentence notice that
attracted almost no public attention.</P>
<P>But corporate tax lawyers quickly realized the enormous implications of the
document: Administration officials had just given American banks a windfall of
as much as $140 billion.</P>
<P>The sweeping change to two decades of tax policy escaped the notice of
lawmakers for several days, as they remained consumed with the controversial
bailout bill. When they found out, some legislators were furious. Some
congressional staff members have privately concluded that the notice was
illegal. But they have worried that saying so publicly could unravel several
recent bank mergers made possible by the change and send the economy into an
even deeper tailspin.</P>
<P>"Did the Treasury Department have the authority to do this? I think almost
every tax expert would agree that the answer is no," said George K. Yin, the
former chief of staff of the Joint Committee on Taxation, the nonpartisan
congressional authority on taxes. "They basically repealed a 22-year-old law
that Congress passed as a backdoor way of providing aid to banks."</P>
<P>The story of the obscure provision underscores what critics in Congress,
academia and the legal profession warn are the dangers of the broad authority
being exercised by Treasury Secretary <A
href="http://www.washingtonpost.com/ac2/related/topic/Henry+M.+Paulson?tid=informline"
target="">Henry M. Paulson</A> Jr. in addressing the financial crisis. Lawmakers
are now looking at whether the new notice was introduced to benefit specific
banks, as well as whether it inappropriately accelerated bank takeovers.</P>
<P>The change to Section 382 of the tax code -- a provision that limited a kind
of tax shelter arising in corporate mergers -- came after a two-decade effort by
conservative economists and Republican administration officials to eliminate or
overhaul the law, which is so little-known that even influential tax experts
sometimes draw a blank at its mention. Until the financial meltdown, its
opponents thought it would be nearly impossible to revamp the section because
this would look like a corporate giveaway, according to lobbyists.</P>
<P>Andrew C. DeSouza, a Treasury spokesman, said the administration had the
legal authority to issue the notice as part of its power to interpret the tax
code and provide legal guidance to companies. He described the Sept. 30 notice,
which allows some banks to keep more money by lowering their taxes, as a way to
help financial institutions during a time of economic crisis. "This is part of
our overall effort to provide relief," he said.</P>
<P>The Treasury itself did not estimate how much the tax change would cost,
DeSouza said.</P><B>A Tax Law 'Shock'</B><BR>
<P>The guidance issued from the <A
href="http://www.washingtonpost.com/ac2/related/topic/Internal+Revenue+Service?tid=informline"
target="">IRS</A> caught even some of the closest followers of tax law off guard
because it seemed to come out of the blue when Treasury's work seemed focused
almost exclusively on the bailout.</P>
<P>"It was a shock to most of the tax law community. It was one of those things
where it pops up on your screen and your jaw drops," said Candace A. Ridgway, a
partner at <A
href="http://www.washingtonpost.com/ac2/related/topic/Jones+Day?tid=informline"
target="">Jones Day</A>, a law firm that represents banks that could benefit
from the notice. "I've been in tax law for 20 years, and I've never seen
anything like this."</P>
<P>More than a dozen tax lawyers interviewed for this story -- including several
representing banks that stand to reap billions from the change -- said the
Treasury had no authority to issue the notice.</P>
<P>Several other tax lawyers, all of whom represent banks, said the change was
legal. Like DeSouza, they said the legal authority came from Section 382 itself,
which says the secretary can write regulations to "carry out the purposes of
this section."</P>
<P>Section 382 of the tax code was created by Congress in 1986 to end what it
considered an abuse of the tax system: companies sheltering their profits from
taxation by acquiring shell companies whose only real value was the losses on
their books. The firms would then use the acquired company's losses to offset
their gains and avoid paying taxes.</P>
<P>Lawmakers decried the tax shelters as a scam and created a formula to
strictly limit the use of those purchased losses for tax purposes.</P>
<P>But from the beginning, some conservative economists and Republican
administration officials criticized the new law as unwieldy and unnecessary
meddling by the government in the business world.</P>
<P>"This has never been a good economic policy," said Kenneth W. Gideon, an
assistant Treasury secretary for tax policy under President <A
href="http://www.washingtonpost.com/ac2/related/topic/George+H.W.+Bush?tid=informline"
target="">George H.W. Bush</A> and now a partner at Skadden, Arps, Slate,
Meagher &amp; Flom, a law firm that represents banks.</P>
<P>The opposition to Section 382 is part of a broader ideological battle over
how the tax code deals with a company's losses. Some conservative economists
argue that not only should a firm be able to use losses to offset gains, but
that in a year when a company only loses money, it should be entitled to a cash
refund from the government.</P>
<P>During the current Bush administration, senior officials considered ways to
implement some version of the policy. A Treasury paper in December 2007 --
issued under the names of Eric Solomon, the top tax policy official in the
department, and his deputy, Robert Carroll -- criticized limits on the use of
losses and suggested that they be relaxed. A logical extension of that argument
would be an overhaul of 382, according to Carroll, who left his position as
deputy assistant secretary in the Treasury's office of tax policy earlier this
year.</P>
<P>Yet lobbyists trying to modify the obscure section found that they could get
no traction in Congress or with the Treasury.</P>
<P>"It's really been the third rail of tax policy to touch 382," said Kevin A.
Hassett, director of economic policy studies at the <A
href="http://www.washingtonpost.com/ac2/related/topic/American+Enterprise+Institute+for+Public+Policy+Research?tid=informline"
target="">American Enterprise Institute</A>.</P><B>'The Wells Fargo
Ruling'</B><BR>
<P>As turmoil swept financial markets, banking officials stepped up their
efforts to change the law.</P>
<P>Senior executives from the banking industry told top Treasury officials at
the beginning of the year that Section 382 was bad for businesses because it was
preventing mergers, according to Scott E. Talbott, senior vice president for the
Financial Services Roundtable, which lobbies for some of the country's largest
financial institutions. He declined to identify the executives and said the
discussions were not a concerted lobbying effort. Lobbyists for the
biotechnology industry also raised concerns about the provision at an April
meeting with Solomon, the assistant secretary for tax policy, according to
talking points prepared for the session.</P>
<P>DeSouza, the Treasury spokesman, said department officials in August began
internal discussions about the tax change. "We received absolutely no requests
from any bank or financial institution to do this," he said.</P>
<P>Although the department's action was prompted by spreading troubles in the
financial markets, Carroll said, it was consistent with what the Treasury had
deemed in the December report to be good tax policy.</P>
<P>The notice was released on a momentous day in the banking industry. It not
only came 24 hours after the <A
href="http://www.washingtonpost.com/ac2/related/topic/U.S.+House+of+Representatives?tid=informline"
target="">House of Representatives</A> initially defeated the bailout bill, but
also one day after <A
href="http://www.washingtonpost.com/ac2/related/topic/Wachovia+Corporation?tid=informline"
target="">Wachovia</A> agreed to be acquired by <A
href="http://www.washingtonpost.com/ac2/related/topic/Citigroup+Inc.?tid=informline"
target="">Citigroup</A> in a government-brokered deal.</P>
<P>The Treasury notice suddenly made it much more attractive to acquire
distressed banks, and Wells Fargo, which had been an earlier suitor for
Wachovia, made a new and ultimately successful play to take it over.</P>
<P>The Jones Day law firm said the tax change, which some analysts soon dubbed
"the Wells Fargo Ruling," could be worth about $25 billion for Wells Fargo.
Wells Fargo declined to comment for this article.</P>
<P>The tax world, meanwhile, was rushing to figure out the full impact of the
notice and who was responsible for the change.</P>
<P>Jones Day released a widely circulated commentary that concluded that the
change could cost taxpayers about $140 billion. Robert L. Willens, a prominent
corporate tax expert in New York City, said the price is more likely to be $105
billion to $110 billion.</P>
<P>Over the next month, two more bank mergers took place with the benefit of the
new tax guidance. PNC, which took over National City, saved about $5.1 billion
from the modification, about the total amount that it spent to acquire the bank,
Willens said. <A
href="http://www.washingtonpost.com/ac2/related/topic/Banco+Santander+SA?tid=informline"
target="">Banco Santander</A>, which took over <A
href="http://www.washingtonpost.com/ac2/related/topic/Sovereign+Bancorp+Inc.?tid=informline"
target="">Sovereign Bancorp</A>, netted an extra $2 billion because of the
change, he said. A spokesman for PNC said Willens's estimate was too high but
declined to provide an alternate one; Santander declined to comment.</P>
<P>Attorneys representing banks celebrated the notice. The week after it was
issued, former Treasury officials now in private practice met with Solomon, the
department's top tax policy official. They asked him to relax the limitations on
banks even further, so that foreign banks could benefit from the tax break,
too.</P><B>Congress Looks for Answers</B><BR>
<P>No one in the Treasury informed the tax-writing committees of Congress about
this move, which could reduce revenue by tens of billions of dollars.
Legislators learned about the notice only days later.</P>
<P>DeSouza, the Treasury spokesman, said Congress is not normally consulted
about administrative guidance.</P>
<P><A
href="http://www.washingtonpost.com/ac2/related/topic/Chuck+Grassley?tid=informline"
target="">Sen. Charles E. Grassley (R-Iowa)</A>, ranking member on the Finance
Committee, was particularly outraged and had his staff push for an explanation
from the Bush administration, according to congressional aides.</P>
<P>In an off-the-record conference call on Oct. 7, nearly a dozen Capitol Hill
staffers demanded answers from Solomon for about an hour. Several of the
participants left the call even more convinced that the administration had
overstepped its authority, according to people familiar with the
conversation.</P>
<P>But lawmakers worried about discussing their concerns publicly. The staff of
Sen. <A
href="http://www.washingtonpost.com/ac2/related/topic/Max+Baucus?tid=informline"
target="">Max Baucus</A> (D-Mont.), chairman of the Finance Committee, had asked
that the entire conference call be kept secret, according to a person with
knowledge of the call.</P>
<P>"We're all nervous about saying that this was illegal because of our fears
about the marketplace," said one congressional aide, who like others spoke on
condition of anonymity because of the sensitivity of the matter. "To the extent
we want to try to publicly stop this, we're going to be gumming up some
important deals."</P>
<P>Grassley and <A
href="http://www.washingtonpost.com/ac2/related/topic/Charles+Schumer?tid=informline"
target="">Sen. Charles E. Schumer</A> (D-N.Y.) have publicly expressed concerns
about the notice but have so far avoided saying that it is illegal. "Congress
wants to help," Grassley said. "We also have a responsibility to make sure power
isn't abused and that the sensibilities of Main Street aren't left in the dust
as Treasury works to inject remedies into the financial system."</P>
<P>Carol Guthrie, spokeswoman for the Democrats on the Finance Committee, said
it is in frequent contact with the Treasury about the financial rescue efforts,
including how it exercises authority over tax policy.</P>
<P>Lawmakers are considering legislation to undo the change. According to tax
attorneys, no one would have legal standing to file a lawsuit challenging the
Treasury notice, so only Congress or Treasury could reverse it. Such action
could undo the notice going forward or make it clear that it was never legal, a
move that experts say would be unlikely.</P>
<P>But several aides said they were still torn between their belief that the
change is illegal and fear of further destabilizing the economy.</P>
<P>"None of us wants to be blamed for ruining these mergers and creating a new
Great Depression," one said.</P>
<P>Some legal experts said these under-the-radar objections mirror the
objections to the congressional resolution authorizing the war in Iraq.</P>
<P>"It's just like after September 11. Back then no one wanted to be seen as not
patriotic, and now no one wants to be seen as not doing all they can to save the
financial system," said Lee A. Sheppard, a tax attorney who is a contributing
editor at the trade publication Tax Analysts. "We're left now with congressional
Democrats that have spines like overcooked spaghetti. So who is going to stop
the Treasury secretary from doing whatever he
wants?"</P></FONT></DIV></BODY></HTML>