Thursday, May 12, 2016

A Quiz

It was as true as turnips is . . . It was as true . . . as taxes is. And nothing is truer than them.
—Charles Dickens, David Copperfield

This week’s column is a quiz. For purposes of the quiz, assume that you are in charge of running a business. Your business makes money by providing services to your customers for which the customers are expected to pay. Most of your customers pay as they are billed but, as in almost all businesses, there are a few people, known as deadbeats, who do not want to pay, and sometimes there are customers who need help in understanding how to calculate what they owe. One of your tasks is to decide how to deal with people who don’t pay for services they have received and as you analyze the situation, you realize that you have two choices.

Choice number one is to turn over the accounts of people who owe you money to a collection agency. It agrees to keep one-third of all the amounts it collects and to turn over the rest to you. Choice number two is to hire additional employees whose job is to collect the money your customers owe. Although you have to pay salaries to those employees, you keep all the money they collect and their salaries are not affected by their success rate. You know from past experience that for every dollar you invest in the in house collection process, your return is almost $5.00. What do you do?

Now an additional element is added to the quiz. Some years ago you hired an outside collection agency to collect the money you were owed. You were owed $1.4 billion. The collection agency led you to believe it would be able to collect that entire amount. Instead, it collected only $49 million, missing the goal you had set for it by $900,551,000. Do you keep working with the collection agency or bring the business in house?

Here is the next question. When the board of directors reviews the foregoing statistic one member of the board says: “the real choice is whether we use private collection agencies or let these tax debts go uncollected. I hope we don’t take an enormous step backward in our efforts to close the tax gap by eliminating a program that’s working.” Do you ask the board member what he means by “working” or do you just ignore him?

Now we introduce another factor. A majority of your board agrees that debt collection should remain in house and should not be farmed out to outside firms because of the very poor performance by the outside firm used in the past. But some members of the board are unhappy with a high ranking employee.That employee has tenure and has engaged in some activities that have nothing to do with the company’s collection efforts since they do not fall under the disliked employee’s jurisdiction. Since you lack the ability to fire the employee described above, do you express your displeasure with the activities of that employee by cutting funding for the collection department?

Here are your last two questions. Because the product you are selling is complicated, similar to, for example, a furniture product sold by Ikea, those dealing with your product frequently have questions as to how to assemble the information they have to provide you so you can tell them the cost of the services they have received. In order to make the process simpler you have historically hired people to answer questions on the telephone. In a typical year you got as many as 110 million calls from people wanting to pay their bills and needing help. Some of your board members are still unhappy with the above described employee. Do you reduce funding for the collection department so it can only answer 43 percent of the calls you receive each year? That is the end of the quiz. Here are the answers according to the Center on Budget and Policy Priorities:

“The Internal Revenue Service (IRS) budget has been cut by 17 percent since 2010, after adjusting for inflation, forcing the IRS to reduce its workforce, severely scale back employee training, and delay much-needed upgrades to information technology systems.  These steps, in turn, have weakened the IRS’s ability to enforce the nation’s tax laws and serve taxpayers efficiently . . . . As seven former IRS commissioners from both Republican and Democratic administrations have written:  “Over the last fifty years, none of us has ever witnessed anything like what has happened to the IRS appropriations over the last five years and the impact these appropriations reductions are having on our tax system.” Here is an additional bit of information: ignoring past experience Congress has decided that in some circumstances the IRS can once again use private debt collection agencies. Go figure.

Thursday, May 5, 2016

Blessed Are The Poor

Worm or beetle-drought or tempest-on a
Farmer’s land may fall,
Each is loaded full o’ ruin,
But a mortgage beats ‘em all. — Will Carleton, The Tramp’s Story

Houses are the gifts that keep on giving to rich and poor alike. Just ask Dan Sparks-or the poor. The gift for Mr. Sparks is the opportunity to increase his wealth and the gift for the poor is shelter. Years ago that was accomplished by selling a house to the less fortunate using the subprime mortgage, and today it is accomplished by selling the same house to the same people using the contract for deed.

Until a recent New York Times story and editorial once again brought him to our attention, Mr. Sparks was remembered, if at all, for his last years at Goldman Sachs during 2007 and 2008. Mr. Sparks is not remembered for the Goldman Sachs activities that were brought to mind in April 2016, when Goldman Sachs agreed to pay $5.1 billion as a civil settlement because of its participation in the subprime mortgage market. During that period Goldman Sachs was bundling and selling securities that had been created by companies that specialized in converting subprime loans into bonds and selling them to unsuspecting investors. When the loans went bad, Goldman Sachs was left holding the money it had received from the sale of the bonds, purchasers of the bonds were left holding the bag, and former homeowners went from owning homes to becoming renters or homeless. Mr. Sparks, however, was remembered for something else.

During his last 1 ½ years at Goldman Sachs, Mr. Sparks was involved in creating something called a “synthetic collateralized debt obligation.” Unlike the securities Goldman Sachs sold to unsuspecting investors, the debt obligations Mr. Sparks helped create did not include actual bonds but, instead, instruments whose value was based on the the performance of sets of junk bonds. Those instruments were sold to unsuspecting investors by Goldman Sachs knowing they were worthless. (For those who would like more detail than is provided by the foregoing, that practice is described in some detail in a report on Mr. Sparks’ testimony before Congress) What both activities had in common, however, was that both were part and parcel of the financial collapse that took place in 2007-2008. As a result, in hundreds of thousands of cases, buyers defaulted on their mortgages and lost their homes. And that brings us to the present.

Many companies have been formed that are buying up houses that were foreclosed on during the housing crisis. Those houses are being sold to investors in bulk at distressed prices, and the investors, in turn, sell them to people too poor to qualify for mortgages. One of the companies that has been formed to buy and then resell these houses is Shelter Growth Capital Partners, a company founded by Mr. Sparks and two of his former colleagues at Goldman Sachs. That firm was founded in 2014. The word “shelter” in its name, describes the product it is buying and selling. The word “growth” refers to the increased wealth Mr. Sparks and his colleagues hope to enjoy from their new business. Shelter Growth has bought more than 200 distressed homes and resold them to low income buyers. Since subprime mortgages have fallen out of favor, the homes are sold by Shelter Growth using contracts for deed. Unlike a mortgage, the contract for deed is a better vehicle for getting rich quick than was the mortgage. A contract for deed does not offer the protection for the buyer that a mortgage provides. Whereas a mortgage requires certain legal proceedings to be followed before an owner can be forced out of the house, and there is some supervision by a court in most cases, contracts for deeds offer no such protections and the seller can not only charge a high rate of interest, but is not encumbered by the need to go to court in order to retake possession of the house and force the buyer out. That, from the seller’s perspective, is a big advantage. It is less of an advantage for the buyer. And here is a curious coincidence.

The house Mr. Sparks is now selling pursuant to a contract for deed, is almost certainly one of the millions of houses that were foreclosed on during the heyday of foreclosures that took place because of the subprime crisis that was caused by Mr. Sparks and his fellow bankers. Indeed, it might even be one of the houses whose mortgage was part of a worthless bundle of mortgages sold by Goldman Sachs to unsuspecting investors. And now that house is once again being used to enhance the wealth of Mr. Sparks and his colleagues and to provide shelter to the less fortunate. Here is another part of the same coincidence.

If a buyer defaults on the terms of the contract, the people at Shelter Growth who kick the buyer out of the house, are the same people whose subprime mortgage activities caused there to be lots of cheap houses available for Shelter Growth to buy and resell. And Shelter Growth may very well be selling those houses to the same people who lost them in foreclosures 10 years ago. Were that to happen it would merit an entry in Ripley’s Believe It Or Not!

Thursday, April 21, 2016

Crimes and Punishments

Obedience to the law is demanded as a right; not asked as a favor.
— Theodore Roosevelt, Third Annual Message (1903)

A number of readers have written inquiring whether it is acceptable to have state attorneys general continue to serve in that capacity when they have been charged with criminal conduct and/or have lost their licenses to practice law. The reason for the inquiry is that readers know that the attorney general of a state is the chief law enforcement officer of the state, serves as the state’s principal legal advisor, and represents the state in litigation. Those tasks have to be done by someone who is licensed as a lawyer. Those are good questions and, happily, there are two real life examples that enable me to provide the answers to both those questions.

The first comes to us from Texas, where the attorney general is Ken Paxton. Ken was elected attorney general of Texas in November 2014. His official webpage says he is “known for his principled and uncompromising devotion to America’s founding values.” He served as attorney general with uncompromising devotion to America’s founding values for 8 months before being iindicted for three different crimes that took place before he was the attorney general.

One crime involved directing his legal clients to a friend’s investment company without being properly registered as an “investment adviser representative,” a third-degree felony. The other two charges were first-degree felony fraud charges. In addition to having been criminally indicted, on April 11, 2016, the SEC filed civil charges against Mr. Paxton accusing him of breaking federal securities laws. He allegedly pressured five people to invest in a tech firm without disclosing that he was being paid a commission for the sales. He himself had not invested in the company because, he said, the president of the company said: “I can’t take your money. God doesn’t want me to take your money.” Apparently God didn’t have the same reservations about the president accepting money from Mr. Paxton’s investors. As of this date, Mr. Paxton faces three criminal indictments and the civil SEC suit filed in early April. He continues to serve as attorney general of Texas.

Mr. Paxton sees nothing wrong with continuing his work as attorney general while the assorted charges are pending. Indeed, commenting on the immigration case that Texas and 25 other states brought against the Obama administration that was argued in the United States Supreme Court on April 18, 2016 he said: “Our goal was pretty basic, defend the Constitution and stop President Obama’s lawlessness.” The word “lawlessness” may soon be used to describe Mr. Paxton’s conduct. The Texas Board of Disciplinary Appeals has ordered the Texas State Bar to pursue disciplinary hearings against Mr. Paxton because of his alleged criminal conduct. If that body finds he violated the disciplinary rules governing the conduct of lawyers he may lose his law license as well as the ability to continue to serve as attorney general.

Mr. Paxton’s predecessor as attorney general is Texas Governor Gregg Abbott. Commenting on the accusations against Mr. Paxton when the criminal charges were first filed, the Governor said that the legal process simply had to “run its course.” Republican legislators have remained silent. There have been no calls for the attorney general to resign nor has there been talk of impeachment. In that respect, Texas is a bit behind Pennsylvania, the state that answers the question of whether an attorney general can continue to serve when his or her law license has been suspended. Pennsylvania’s contribution to the oeuvre is Kathleen Kane.

Kathleen was sworn in as Pennsylvania’s attorney general on January 15, 2013. She was considered a rising star until August 8, 2014, when assorted criminal charges, including perjury, were filed against her. Although she had not been tried for the alleged offenses, on September 21, 2015, the Pennsylvania Supreme Court responded to a request by the court’s disciplinary board for lawyers, that it issue an “emergency temporary suspension, ” by ordering that: “Respondent Kathleen Granahan Kane is placed on temporary suspension.” Under Pennsylvania law, a person serving as attorney general must be licensed to practice law.

February 5, 2016, the Pennsylvania Supreme Court unanimously rejected the attorney general’s request to reinstate her license to practice law. As of this writing, the attorney general faces 12 criminal charges including felony perjury. Nonetheless, she has refused to resign and continues to act as attorney general even though she is no longer licensed.

February 10, 2016, the Pennsylvania House of Representatives voted to begin the impeachment process against the attorney general by a 170-12 vote, Democrats and Republicans alike voting in favor of the process. The attorney general’s criminal trial is to take place in August 2016. It is, of course, not possible to know how that trial will come out. What is known is that as of this writing she is still in office and, like Attorney General Paxton, sees no reason to resign.

The difference between Texas and Pennsylvania is that the legislators in Pennsylvania are willing to take steps to remove someone from office who fails to see why she shouldn’t continue to serve. Legislators in Texas see nothing wrong in having an attorney general under indictment continuing to serve. That tells us as much about Texas as the criminal charges filed against Attorney General Paxton tell us about him-none of it good.