July 24, 2007

Nice work if you can get it

From Mahalanobis on energy trader genius Brian Hunter, who lost $6 billion betting on natural gas for Amaranth:

As he lost $6B, one would think that is punishment enough, but he does seem to be getting away with murder, in that he put on a really large calendar spread on oil, bet big and personally pocketed around $75mm in 2005, then lost $6B and got no bonus the next year on the same dumb trade. That annualizes at $37.5mm/year, not bad. As a further reward, some Middle Eastern investors are giving him $650mm for his next venture (he lost $6B? Brilliant!).

This seems to reflect a general tendency among incentive structures for the extremely well-paid, whether Wall Streeters, CEOs, movie stars, or athletes: heads you win, tails you don't lose.

My published articles are archived at iSteve.com -- Steve Sailer


Mark said...

Yep, par for the course. I don't think I'm going out on a limb to suggest that we're one medium-sized recession away from the renewal of serious class warfare.


1) We haven't had a recession since Bush's 2002 tax cuts for the rich. Bush claims that's because of the tax cuts, but realistically it's because lately recessions are coming about every 10 years, meaning the next one's due in 2011.

2) Bush's tax cuts have led to deficits of around $300 billion during a boom. That means you can reasonably expect deficits in the $600-$700 billion range during the next slump. We won't be able to spend our way out of the next one.

3) Most of the folks in the middle and working classes haven't been seeing many gains during this boom. What will happen when the economy reverts to a bust? It won't be good.

4) The next recession will be the first one occurring under the new bankruptcy laws, which make it harder than ever to get out of debt. In spite of that, few credit card companies have gotten rid of their so-called "default rates" (i.e., one late payment and you're hit).

5) It's fair to say that, given the ubiquitousness of outsourcing that when companies start slashing jobs in the next go-round, many of those jobs really won't be coming back.

The fact is, unhappy with the standard pace of growth, big business has been juicing their numbers by bribing Congress to affect all sorts of laws that speed up growth: open borders, H-1b's, tax cuts on cap gains and dividends, and a whole lot else. Are the rich getting richer? No doubt, and undeniably it's at the expense of everyone else.

Add to that this little gem I learned from Vanguard, the financial behemoth that manages my 401(k):

Assets left in your retirement accounts after your death may be taxed heavily. In fact, estate and income taxes can erode more than 60% of your retirement savings. You can avoid these taxes by leaving some or all of your retirement account assets to a charitable institution. Doing so protects your heirs from a hefty tax burden while giving a boost to your favorite charity. Because the charity won't have to pay tax on the money, it will receive 100% of what you leave to it.

This approach gives you more flexibility to leave nonretirement assets to your heirs, which can put them in a more favorable tax position. Upon your death, such assets receive a "step-up in basis." In other words, when your heirs sell the assets, any capital gains they owe will be based only on appreciation that occurs after your death, rather than on total appreciation since the date you originally acquired them. The assets will be subject to federal estate tax, but unlike retirement account assets, withdrawals are not taxed as ordinary income.

One of the arguments Republicans use to oppose the "death tax" is that the money has already been taxed. But that, in fact, isn't true. Say rich daddy buys $1 million in stock. It then appreciates to $10 million, at which point rich daddy dies. After he dies it appreciates to $11 million, at which point junior decides to sell. Does he pay taxes on the $10 million gain? Nope - only on the $1 million gain since daddy died. Sans estate tax, he won't be paying any other taxes either - and that's exactly the system we're headed towards when the estate tax goes to zero in 2010.

Now for a lot of middle/working class folks, their retirement account (401(k), IRA, etc.) is the only investment account they have. And yet after death these are the highest taxed.

So who's getting the best tax deal? You know who.

Fred said...


Vanguard is trying to sell you a charitable remainder trust or some other such estate planning product. Don't let them scare you. A few clarifications on taxes for you:

1) The inheritance tax repeal is set to expire after 2010, and revert back to 55% the next year (with an exemption of $2 million, I believe).

2) If you own stock in a taxable brokerage account, you pay income taxes on the dividends while you are alive, and capital gains on your cost basis if you sell any stock. After you pass away, your heirs will pay income taxes on the dividends as well and their cost basis will be the price of the stock when you died -- that's true if you leave them $10,000 or $10 million.

3) If you leave your heirs money in an IRA or 401(k), your heirs will pay income taxes on the money as they take it out but (this is new), they will be able to stretch out their distributions over their life expectancy.

4) Bottom line: if you leave your heirs less than $2 million, and you aren't an idiot about it, your heirs will get the vast bulk of that money unmolested by the tax man.

Re the hedge fund comp structure:

There was a British fellow on CNBC recently arguing rather convincingly that the sort of incentive structure prevalent among hedge funds increases systemic risk, since the upside for hedge fund managers is virtually unlimited but the downside isn't, i.e., no hedge fund manager is going to get a negative salary if he loses a huge amount of money. What's driving this is a tremendous amount of global liquidity -- so much money is sloshing around that even mediocre hedge fund managers get second chances. Once this liquidity starts drying up, there will be a lot fewer hedge funds though, and a lot of weak funds and managers will go away.

Mark said...

Actually they are not and have not ever tried to sell me anything beyond the service they already provide. If they have, the effort has been rather subtle.

I'll take your word on the tax status of retirement accounts and the estate tax - I'm no expert. But you seem to acknowledge my point that current estate tax law essentially wipes the slate clean on capital gains before you inherit. If dad makes $20 million in cap gains then leaves it to his son, he pays nothing on that $20 million gain.

That's alright by me if there's a respectable estate tax in place. But will that remain the case if/when the estate tax goes to zero? If/when its elimination is made permanent will the "step up-in" provision remain?

One of the problems in this country is that it's very easy for the rich to accumulate assets while avoiding the tax man. You never owe taxes on the appreciation in an asset until you sell it - unless that asset happens to be a house. And Social Security taxes hit automatically, and aren't subject to tax deductions - but people making over a million a year pay an effective rate of less than 1%, while those making less than $100k pay 14%.

Mark said...


So when the estate tax goes to zero for that single solitary year, can any individual pass on huge sums of money to their heirs and avoid the tax bite, or does that only apply to those lucky rich men who die during that year?

MensaRefugee said...

Think of it from the point of view of what the shareholders want.

If they punished failure - CEOs would take fewer risks - thereby jeopardizing something that cant be measured but that is still vital - AKA future earnings

The important point is this is invisible from today's perspective.

In a high risk/high reward business this makes optimal sense.

Anonymous said...

MensaRefugee --

An honest/non-rhetorical question: If the CEO is not fired or punished, then, since that $6 bn. lost wasn't his money, where exactly is his "risk?"

Normally, when a business owner invests in, say, a new product, and it doesn't sell, he loses HIS money. And that is his *risk.* If the CEO loses nothing, what challenge is he exactly facing?


MensaRefugee said...

Its a question of trade-offs.

The market (or in this case the board or shareholders etc) have decided that the risk of the CEO doing a botched job due to lack of restrictive incentives is smaller than the risk of him not doing risky (but potentially rewarding) stuff in the face of restrictive incentives.

Given that it is a done thing in most (all?) big companies - Id say its at least partly due to hard won experience.

Fred said...


"So when the estate tax goes to zero for that single solitary year, can any individual pass on huge sums of money to their heirs and avoid the tax bite, or does that only apply to those lucky rich men who die during that year?"

Only applies to those who die during that year.

Re the stepped up basis for capital gains on inherited stocks in taxable accounts, there are a few reasons for it. One is that, since the stock is in a taxable account, presumably it was purchased with after-tax money, i.e., money the original account owner already paid taxes on (unlike IRA or 401k contributions). Another reason is the difficulty of establishing a cost basis otherwise, particularly in the case of decades of dividend-reinvestment. A third reason is to encourage long-term ownership of equities -- otherwise investors might dump stocks before they die, depressing the market, or not put their money in stocks in the first place.

Also, it's worth bearing in mind that when stocks are donated to charity, the income tax deduction is similarly based on the stocks' appreciated value, which encourages charitable donations of stock (as Buffett is making to Gates's foundation, for example).

Mark said...

Only applies to those who die during that year.

Interesting. I wonder if we'll be seeing any 80-something billionaires committing suicide in 2010. That would make for an interesting year in news.

Mark said...

One is that, since the stock is in a taxable account, presumably it was purchased with after-tax money, i.e., money the original account owner already paid taxes on (unlike IRA or 401k contributions).

Actually I tried to make my 401(k) contributions after-tax. First, because I'll probably be making a lot more later in life than now, and second, because I have a hunch tax rates will be much higher in 40 years on everyone. My employer won't match after-tax contibutions, however.

Fred said...

"Actually I tried to make my 401(k) contributions after-tax."

You are referring to the new Roth 401(k) option. Your logic makes sense, given your assumptions, but personally, I don't do Roth. I'd rather take the tax deduction now, then hope that the government doesn't change its mind about not taxing distributions from Roth IRAs and 401(k)s. I have a sneaking suspicion that they will change the law to tax Roth distributions in the future.

Anonymous said...

Fred said: "I have a sneaking suspicion that they will change the law to tax Roth distributions in the future."

You are wise, Fred. It's a deferred benefit. Like deferred wages, or a deferred salary. These rarely are paid.

Another analogy is to the shady insurance companies who sell term life policies featuring "premium return." The spiel is that at the end of the term, all your premium money will be paid back to you. The fools who go for this without considering whether or not the company will exist 15-20 years out, number in the millions. Hey, a promise is a promise, right?

But this isn't a shady insurance company. This is the Federal Government! They would never lie to us! They're "here to help." Yeah, right. Help themselves to our stuff.

It's 10 PM. Do you know where your pension is?