WASHINGTON WEEKLY
Keeping the Markets Informed from the Capital
March 7, 2008
SIFMA Says H.R.4912 Would Tax Phantom Income
Testifying before the House Ways and Means Subcommittee on Select Revenue Measures, SIFMA expressed concern that H.R.4912 would impose an overly complex tax regime that would single out prepaid derivative contracts for unfavorable treatment by requiring that investors include amounts in income that they have no right to receive and may never receive. Leslie Samuels, Cleary Gottlieb Steen & Hamilton LLP, testifying on behalf of SIFMA, justified the current tax treatment of prepaid derivatives contracts and noted the differences between exchange-traded notes (ETNs) and mutual funds, which currently qualify them for different tax treatment.
The Senate Judiciary Committee began considering legislation that would authorize bankruptcy judges to modify loans on primary residences during Chapter 13 bankruptcy proceedings. Further action on the bill was postponed until next Thursday. SIFMA joined other members of the Bankruptcy Coalition in a letter of opposition to the bill.
SIFMA sent a letter to members of the House Ways and Means Committee urging them to include legislation that would authorize the Federal Home Loan Banks to issue letters of credit for certain tax-exempt municipal bonds in any legislative package related to the current challenges in the credit markets.
SIFMA also sent a letter to the Treasury Department asking for removal of the guarantee capacity limit for State public school trust funds, including the Texas Permanent School Fund (PSF).
Federal banking regulators testified before the Senate Banking Committee this week on the state of the banking industry.
During a joint hearing of two House Financial Services Subcommittees on sovereign wealth funds, Chairman Barney Frank called on the Treasury Department to consider regulations clarifying the misconception that foreign investment under 10 percent is automatically considered passive and did not merit review by the Committee on Foreign Investment in the United States.
Senate Banking Committee Chairman Chris Dodd (D-CT) said he hopes to markup a government-sponsored enterprise (GSE) reform bill soon.
SIFMA Says H.R.4912 Would Tax Phantom Income
Testifying before the House Ways and Means Subcommittee on Select Revenue Measures, SIFMA said the tax treatment of prepaid derivative contracts and exchange-traded notes (ETNs) should be clear, consistent and administrable and recognize that such products are complex instruments. Leslie Samuels, Cleary Gottlieb Steen & Hamilton LLP, testifying on behalf of SIFMA, expressed concern H.R.4912, introduced by Select Revenue Measures Subcommittee Chairman Richard Neal (D-MA), would impose an overly complex tax regime that would single out prepaid derivative contracts for unfavorable treatment by requiring investors to recognize phantom income. Samuels noted the differences between ETNs and mutual funds, which currently qualify them for different tax treatment—1) ETN investors have no right to receive cash distributions; and 2) ETNs do not represent ownership of any assets. In light of the complexity of the issues that need to be resolved in order to arrive at fair and administrable tax rules, SIFMA suggested the legislative review be coordinated with the Treasury Department’s consideration of these issues.
Chairman Neal said legislative action was needed on the issue because the Treasury Department would not move quickly enough. Michael Desmond, Tax Legislative Counsel, Treasury Department, said the emergence of ETNs at the retail level creates unique policy questions that have caused the Treasury Department to renew their examination of prepaid derivatives. He emphasized that Treasury has not reached any conclusions about the appropriate tax treatment of ETNs and prepaid derivative contracts. Alex Raskolnikov, Associate Professor of Law, Columbia Law School, recommended subjecting all derivatives to a mark-to-market tax regime and taxing gains and losses at the top marginal tax rate for individuals or corporations. Reuven S. Avi-Yonah, Irwin I. Cohn Professor of Law, University of Michigan Law School, suggested treating the source of all payments on notional principal contracts as the residence of the payor, instead of the residence of the recipient. William M. Paul, Covington & Burling, LLP, on behalf of Investment Company Institute (ICI), said H.R.4912 does not go far enough, and suggested ETNs be taxed under a constructive ownership regime. Michael Shulman, Partner, Shearman & Sterling LLP, testified in favor of the current tax treatment of prepaid forwards and warned there must be a good reason to abandon current law.
Senate Judiciary Committee Begins Action on Bankruptcy Bills
The Senate Judiciary Committee began consideration of the Helping Families Save Their Homes in Bankruptcy Act of 2007 (S.2136) this week. During the markup, Sen. Richard Durbin (D-IL) offered the bankruptcy title of the Foreclosure Prevention Act (S.2636) as a substitute to S.2136. The bill would amend the bankruptcy code to allow bankruptcy judges to modify residential mortgage loans in Chapter 13 bankruptcy proceedings. Homeowners would be required to pass a means test to verify their inability to pay off the current mortgage. Under the bill, bankruptcy judges would be allowed to reduce interest rates on nontraditional and subprime mortgages originated as of the date of enactment of the bill, to the prime interest plus a reasonable premium for risk, and could extend the life of the loan up to thirty years minus the period the loan has been outstanding. Also, under the bill, if a borrower sells their home within five years of the mortgage modification, the lender would receive any increase in market value up to the original loan amount.
Sen. Arlen Specter (R-PA) introduced his legislation, the Home Owners Mortgage and Equity Savings Act (S.2133), as a substitute amendment. Under the Home Owners Mortgage and Equity Savings Act, bankruptcy judges would be authorized to reduce the amount of outstanding principal on a mortgage if both the lender and the borrower agree. The bankruptcy judge would be authorized to change the interest rate on a primary residence if the debtor meets certain income-level thresholds. S.2133 would sunset seven years from enactment. Further action was postponed due to a number of votes on the Senate floor. The Senate Judiciary Committee is expected to continue consideration of bankruptcy legislation on Thursday.
SIFMA and the other members of the Bankruptcy Coalition sent a letter in opposition of S.2136 and S.2133 to members of the Senate Judiciary Committee. The Coalition said the bills would increase the cost of buying a home and would price many Americans out of the housing market and make owning a home more expensive for others.
SIFMA Supports Giving FHLBs Credit Enhancement Authority
SIFMA sent a letter to members of the House Ways and Means Committee urging them to include H.R.2091 in any legislative package related to the current challenges in the credit markets. H.R.2091, introduced by Rep. Sander Levin (D-MI), Rep. Phil English (R-PA), Rep. Paul Kanjorski (D-PA) and Rep. Deborah Pryce (R-OH), would authorize the Federal Home Loan Banks (FHLB) to issue letters of credit for certain tax-exempt municipal bonds. SIFMA said H.R.2091 would offer limited relief to issuers as they look for additional tools to affordably finance necessary infrastructure projects, such as water treatment facilities and long-term care for the elderly. H.R.2091 would also expand access to credit for rural communities and urban areas that have struggled in the past to raise funds for education and health facilities. SIFMA said the impact of recent problems in the capital markets has made enactment of H.R.2091 a top priority.
SIFMA Asks Treasury to Remove Guaranty Capacity Limits for PSF
In a letter this week, SIFMA asked the Treasury Department to remove the guarantee capacity limit for state public school trust funds, including the Texas Permanent School Fund (PSF), in order to allow them to continue to provide credit enhancement during the current credit crisis. The PSF bond guarantee program has provided credit enhancement to Texas school districts for the last 24 years. As the program has grown, without history of default, it has almost exceeded the guarantee capacity established by IRS regulations. The current capacity ceiling is the lower of two and one-half times cost or market value of the PSF. SIFMA supports increasing the availability of financial tools at the disposal of state and local government officials to meet the needs of their constituents and urged Treasury to consider the PSF’s request for the continued opportunity to provide credit enhancement for school districts in their state.
Banking Committee Examines State of Banking Industry
During the Senate Banking Committee hearing on the state of the banking industry this week, Chairman Chris Dodd (D-CT) said he would have a follow-up hearing in sixty days with the banking regulators to hear their recommendations to: address the lax federal oversight prior to the subprime crisis, review the Basel II accord requirements, revive the credit markets and the economy, and reform the credit rating agencies. Sheila C. Bair, chairman, Federal Deposit Insurance Corporation (FDIC), said while the banking industry decreased earnings in the fourth quarter 2007, the industry entered the current difficult economic environment well-capitalized. She said the lack of transparency in structured finance and the over-reliance on credit ratings contributed to the current situation. Bair said she is encouraged by the efforts of the HOPE NOW Alliance, but she is concerned the repayment plans may become a problem if borrowers cannot meet the new obligations. Bair would prefer to see affordable solutions which would be fixed over the long-term. John Dugan, Comptroller of the Currency, said some areas which need to be addressed going forward are potential downgrades of monoline insurance companies, significant funding problems in the auction rate securities market, and severe constriction in the securitization markets for residential mortgage-backed securities, commercial mortgage-backed securities, and leveraged loans.
Chairman Dodd said the current economic situation has demonstrated that the U.S. implementation of the Basel II Accord is a big issue, especially in the area of adequate bank capitalization. Bair said she believed the current economic system would be worse if Basel II was already in effect and said she was concerned about the Basel II internal models to calculate capitalization. Dugan said the losses under Basel I and Basel II would not be the same, and that under Basel II things would be better, because it contains more risk management processes. He said Basel II has the mechanism and time throughout implementation for the U.S. to adjust capital requirements and risk models as necessary. Donald Kohn, vice chairman, Federal Reserve, said the Pillar II safeguard combined with the parallel implementation and three year phase-in will create a better capital system upon completion.
HFSC Subcommittees Hold Joint Hearing on Sovereign Wealth Funds
During a joint hearing of the House Financial Services Subcommittee on Capital Markets and the Subcommittee on Domestic and International Monetary Policy, House Financial Services Committee Chairman Barney Frank (D-MA) called on the Treasury Department as they work on rules to implement the Foreign Investment and National Security Act (FINSA), to consider clarifying the misconception that investments under 10 percent were automatically considered passive and did not merit review by the Committee on Foreign Investment in the United States. Ethiopis Tafara, director, Office of International Affairs, Securities and Exchange Commission (SEC), said government-controlled investment funds may have information advantages over private participants. Tafara said the SEC has the tools to take enforcement action against sovereign wealth funds as necessary. David McCormick, Treasury Under Secretary for International Affairs, said sovereign wealth funds offer a mix of benefits and concerns. He placed some of the blame for the bad publicity regarding sovereign wealth funds on the lack of transparency and the lack of clear communication by the funds. McCormick said the Treasury Department continues to use sound analysis and focused bilateral and multilateral efforts to ensure the United States shapes an appropriate response to sovereign wealth funds, addresses legitimate areas of concern and remains open to foreign investment.
Matthew Slaughter, Associate Dean and Professor of International Economics, Tuck School of Business, Dartmouth College, recommended the U.S. continue to participate in ongoing multilateral dialogues with sovereign wealth funds to generate more transparent information about their governance, goals and strategies and continue to support the non-political operation of the Committee on Foreign Investment in the United States (CFIUS). Martin Skancke, Director General, Asset Management Department, Ministry of Finance, Norway, said transparency about governance structure and investment objectives would be helpful steps to alleviate concerns about sovereign wealth fund investments and expressed support for the IMF's efforts to establish a best practices framework.
Banking Committee Reviews GSE Reform
Senate Banking Committee Chairman Christopher Dodd (D-CT) said he hopes to markup a government-sponsored enterprise (GSE) reform bill quickly, but he is not optimistic a bill will be introduced before the March recess. During the Senate Banking Committee hearing on GSE reform, Dodd said he believes the creation of a strong, independent regulator would be the most effective way to achieve the mission of the GSEs, while creating a mechanism for new and innovative product development. Sen. Robert Bennett (R-UT) supported making the temporary increase in the conforming loan limits permanent. Jerry Howard, Executive Vice President and Chief Executive Officer, National Association of Home Builders (NAHB), strongly supports making the loan limits permanent, but said the NAHB would settle for just a two-year extension. Vincent Malta, National Association of Realtors, said many areas were being priced out of the GSE business and called for a permanent increase in the loan limit to $625,000 nationwide and $729,750 in high-cost areas. Dodd said the Senate GSE bill could include an increase in the conforming loan limit, but not as high as the increase included in the economic stimulus package. Sen. Jack Reed (D-RI) called on the Senate to include an affordable housing fund, similar to the House’s proposal, in its GSE bill. Sen. Tom Carper (D-DE) noted the Federal Home Loan Banks set aside 10 percent of their profits for affordable housing, while the House bill would require 1.2 basis points of the value of the GSEs’ mortgage inventories for similar purposes. Nancy Andrews, president and chief executive officer, Low Income Investment Fund, supported Sen. Reed’s proposal, which would require 4.2 basis points of the GSEs’ total transactions be set aside for affordable housing.
No Bills Introduced This Week
The Week Ahead
- The House Financial Services Committee will hold an oversight hearing on the Department of Housing and Urban Development on Tuesday, March 11.
- Also on Tuesday, March 11, the Senate Banking Committee will hold a hearing on national infrastructure.
- The House Financial Services Committee will examine the municipal bond market on Wednesday, March 12. The hearing was originally scheduled for Wednesday, March 5.
- The Senate Banking Committee will hold an oversight hearing on the Department of Housing and Urban Development on Wednesday, March 12.
- The Senate Finance Committee will examine alternatives to the estate tax system on Wednesday, March 12.
- The Senate Judiciary Committee is expected to continue to markup the Helping Families Save Their Homes in Bankruptcy Act of 2007 (S.2136) and the Home Owners Mortgage and Equity Savings Act (S.2133) on Thursday, March 13.
- On Friday, March 14, the House Education and Labor Committee will examine the availability of student loans.