More Bailout Fallout: Non-buyer’s Remorse

Michael Sykuta —  12 March 2012

An interesting story in the WSJ Online today about American International Group (AIG)’s use of a standard tax write-off and the political firestorm it is creating…all because the Washington establishment thought it could hide behind semantics during the bailout era.

The benefits at issue were accrued by AIG as it amassed record losses amid the financial crisis; the U.S. tax code allows businesses to “carry forward” such net operating losses to offset future tax obligations, in effect saving on future tax bills. But those carry-forwards can vanish if a company is taken over or sold, an exception that prevents healthy companies from avoiding taxes by buying firms with significant losses.

The criticism from the former members of the congressional panel stems from a series of Treasury determinations beginning in late 2008 that said the federal government’s bailout of AIG, General Motors Co. and other firms didn’t constitute a sale.

The US government acquired as much as 90% ownership in AIG during the bailout era. Under most any definition, such a shift would be considered a change in corporate control. However, because the Treasury Dept. wanted to maintain the illusion that government was not taking over large swaths of the US economy, it pronounced that these bailouts were not what any student of financial markets understood them to be: an exchange of equity control and strings on management for access to cash. In short, a sale of control.

Now the Treasury Department’s ruling is coming back to bite. Under the US tax code, AIG and its investors have a legal right to carry forward losses from the financial crisis to offset taxable earnings now. But now legal-scholar-turned-bureaucrat-turned-politician Elizabeth Warren, and others, want to change the rules after the fact. Warren is calling on Congress to “end this special tax break”. I’m not sure what exactly is so “special” about this tax break, since it applies to any business, not just those bailed out by the Feds. So is Warren suggesting all businesses should be prohibited from carrying forward losses? Or only businesses whose losses the Federal government wasn’t willing to tolerate in the first place? After all, if the Treasury had let nature take its course, AIG (and many other bailout recipients who are now wondering about their own ability to carry forward losses) would have been bought–albeit likely in pieces–and this whole issue would be moot.

What’s really interesting about this whole argument is that Treasury still holds 70%–a controlling interest–of AIG’s stock. AIG reported their beneficial tax breaks weeks ago. Presumably Treasury is paying attention to their investments and knew about that decision, possibly even before it was publicly released. So why didn’t they exercise their controlling interest and stop management from electing to use the carry forward? More importantly, Treasury is the “owner” that stands to gain the most from this tax benefit. So what exactly is Ms. Warren and others complaining about?

Either way, this is a mess of Treasury’s own making with its semantic gamesmanship on whether the bailout should be named for the government take-over that it was. Seems like we have a bit of non-buyer’s remorse.

5 responses to More Bailout Fallout: Non-buyer’s Remorse


    AIG wasn’t bailout because not saving it would hurt the fragil economy. The only reason for such a big bailtout whit tax payers was to save the politicians in Washington and the banks exposed to AIG.

    AIG always has been a good source of money for politicians. Many USA banks were making deals whit AIG in Europe. Those deals went bad and the company loss tons of money.

    So do the math, if AIG goes broke,who else goes broke?

    More bailouts are coming to save many other bad companies. But the question is who is going to bailout the USA when it goes officially bankrupt . The dollar is losing value every day. The only thing that is keeping the USA from being bankrupt is the dollar status as world currency.

    If we think that 2008 recesion was bad, wait until there is a depression. Then nothing is going to save the USA and any country holding US dollars.

    If anybody would like to talk more about this, just writte me a line.


    I’m a little confused about why you wouldn’t be allowed to carry forward losses after a sale. After all if the point is to only tax net profits rather than tax the profits in good years and ignore the losses in bad then surely that applies whether or not ownership changes. The idea is surely to avoid penalising risk-taking by allowing the upside and the downside to have equal effect after taxes. By nullifying the tax break if the firm is sold this means that the downside has more of an effect if the firm isn’t bought before more profits are made. This changes both the relationship of the firm to risk and to being bought out. A firm is taxed and therefore valued differently as long as it remains in current ownership. How could such an economic distortion not be bad?

      Michael Sykuta 14 March 2012 at 7:13 am

      The rationale is that firms with recent losses could become merger bait for companies with large profits so the acquirer could use the target’s carry forward to reduce the acquirer’s tax burden. On the surface, that might kinda-sorta make sense. One might imagine buyouts of the Carl Icahn ilk where acquirers buy carry forward-rich targets, use the tax benefit, then flip the target and its assets.

      The question is just how realistic an incentive that is except in the rarest of instances. Given the costs of acquisition, how much carry forward value typically exists to make it worthwhile? I’m not familiar with any empirical research on that issues.

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