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Nov-04-2009Buffett joins Goldman bid for Fannie Mae tax credits(topic overview)
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Fannie Mae and Freddie Mac were seized by the government last year and the Treasury Department has invested close to $100 billion in the housing-finance giants. Almost all their business decisions are vetted by government officials. What would have been simple deal a couple of years ago is now fraught with political calculations, such as the perception of aiding a Wall Street giant at a time of populist anger against bankers. The credits are virtually worthless to Fannie Mae and require the company to take losses each quarter as their value declines. Companies such as Berkshire Hathaway and Goldman Sachs could use them to offset federal tax expenses. [1] The Wall Street Journal reported that Goldman Sachs is attempting to buy tax credits from Fannie Mae, the mortgage giant put into a government conservatorship last year to avoid its failure. Fannie qualifies for lots of government tax credits for its efforts to secure housing for low income Americans. Since turning a profit isn't in the cards for Fannie this year, it can't use the credit to offset taxes: you don't pay taxes on a loss.[2]
Warren Buffett's Berkshire Hathaway Inc. has joined Goldman Sachs Group Inc. in the investment bank's bid to buy $3 billion in tax credits from government-owned mortgage giant Fannie Mae, according to people familiar with the matter.[1]
If you allow Goldman to buy the tax credits, then you move tax payments from the future to today. If you let it buy the credits, Goldman pays $900 million this year and Fannie Mae pays nothing. Five years from now when Fannie Mae is profitable again it has to pay $1 billion in taxes because its credits are gone and Goldman has to pay its tax bill because it already spent the credits it bought. If you do not allow Goldman to buy the credits, you get a $100 million more from Goldman this year, but you lose $1 billion in taxes in the future when Fannie Mae is profitable and cashes in its credits.[2] By comparison in 2007, a developer could expect 95 cents on the dollar. Goldman's interest in credits "is very good for the market," said Ghebre Selassie Mehreteab, an adviser to affordable-housing developers and the former chief executive of NHP Foundation, a nonprofit developer that had to scale back its Gulf Coast development last year from 3,000 to 1,500 units because of a lack of investment. Fannie Mae said in August losses from partnership investments, such as tax credits, increased to $571 million in the second quarter of 2009, "largely" due to losses on their holdings of low-income housing tax credits.[1] On Sunday the Journal reported that Goldman, the largest and most profitable U.S. investment bank, is in talks to buy millions of dollars of tax credits from Fannie Mae.[3]
Case in point: Word yesterday that it wants to buy tax credits from Fannie Mae (NYSE: FNM ) -- which, we'll remind you, is almost entirely owned by the U.S. Treasury. The deal would go something this like: Fannie Mae got its hands on a bunch of tax credits over the years. Since it's light years away from profitability, those tax credits, in Fannie's eyes, are useless.[4] The IRS is a division of the Treasury; the Treasury secretary who took over Fannie Mae was the former CEO of Goldman Sachs; Goldman is swimming in profits due almost entirely to policies implemented by the Treasury and Federal Reserve. It doesn't get any more incestuous than a three-way deal between Goldman, Fannie, and the Treasury. That's what makes people mad. Someone should buy these tax credits; it doesn't have to, and shouldn't, be Goldman. There are things in life that might be beneficial for both parties, but make you look like such a jerk that it's not worth doing.[4]
Assuming you think Fannie Mae is going to be profitable again some day, the government gets more tax revenue if you let Goldman buy the credits.[2]
Buffett injected $9 billion into Goldman last fall through purchases of preferred stock. The credits are worth little to Fannie Mae, which also records losses each quarter as their value declines.[3] Scenario 1: Goldman purchases the credit and pays, say, 90 cents on the dollar for a $1 billion tax credit.[2] "We'll owe you $1.5 billion in taxes next quarter. How about this: We'll buy $1 billion worth of tax credits from you for $500 million, and in turn, our tax bill gets cut down to $500 million.[4] Four years after the low-income housing tax-credit program was established in 1986, Mr. Buffett launched a plan to invest $25 million to create housing in areas ranging from Houston, Los Angeles, Detroit and Chicago. Demand for affordable-housing tax credits, a key mechanism for increasing the supply of below-market-rate apartments, evaporated when the economy went into recession and financial companies--the traditional buyers of the credits--could no longer use the credits because they were without profits that needed shielding from taxes.[1] Most developers sell the credits to large financial institutions that want tax breaks or need to comply with the 1976 Community Reinvestment Act, which mandates that banks invest and make loans in traditionally under-served neighborhoods. Investments in low-income housing tax credits dropped to $5.5 billion last year from $8.4 billion in 2007 and are expected to fall further this year to $4.5 billion, according to a recent survey by Ernst & Young.[1] The company had tax credit partnership investments of $5.8 billion at the end of June, according to a Securities and Exchange Commission filing.[1]
The credits are taken over the course of several years. They're going to demand an even bigger discount. The USG doesn't mind waiting for its money. It wouldn't bother it as much to get that $1 billion in taxes from Goldman over time, instead of accepting a smaller amount immediately.[2] The government gets $1 billion. It wouldn't have gotten that in the first scenario because Goldman would have claimed a credit against those taxes.[2] Fannie gets $900 million; Goldman pays $1 billion less in taxes. Since Fannie is wholly owned by Uncle Sam at this point that means the government receives a cash infusion of $900 million.[2]
I stress again that the government would still have more money without selling the credit by just collecting Goldman's taxes -- so it could just give Fannie whatever cash infusion it would have got from selling the credit and keep the discount that would have padded Goldman's profits.[2] Goldman, on the other hand, is making money hand over fist. By buying the credits at a discount to face value, Goldman gets to offset its tax bill, while Fannie gets cash for an otherwise worthless asset.[4] I can't see why Goldman would bother buying the credit without a discount. One argument for allowing the purchase is that it will provide Fannie with more cash and that will benefit tax payers because they will fund more mortgages.[2]
I understand the time-value-of-money component here, but I don't see how Goldman would take the deal if the present value of the deal still didn't benefit them, and consequently make taxpayers worse off. Okay, let's think again about this. Goldman certainly has a higher rate of return on its capital than the U.S. government. It can do a lot more with the x millions it pays immediately for the credits.[2] The government can be quite patient. Its investing practices aren't nearly as effective as Goldman's. Again, I just don't see how this could benefit taxpayers, even if you consider the time value of money.[2]
The Treasury Department is considering blocking any potential sale on the grounds that it wouldn't benefit taxpayers; the money Fannie Mae would earn would be offset by the fall in the government's tax income.[1] The Treasury Department, which controls Fannie Mae and Freddie Mac after pouring $100 million into the housing-finance giants, may block the sale on the grounds that it wouldn't benefit taxpayers, WSJ said.[3]
Goldman Sachs and Fannie Mae declined to comment. Treasury officials say they are still reviewing the proposal.[1]
Goldman Sachs, however, has plenty of profit. It would love to offset some of its huge tax bill.[2]
Goldman, which received federal bailout money last fall, in particular has come under fire for generating out-sized profits and preparing record bonuses as the economy continues to struggle.[3]
As you can see, if Goldman doesn't buy the credit, the government gets more money, equal to whatever the discount is on the credit.[2] Unless I'm missing something (and if anyone can see what I'm missing, please correct me), then I can't see how taxpayers would be better off if Goldman buys the credit for a discount.[2] Goldman will only buy the credits at a discount -- there would be no point if paying full price.[2]
While the bank's reputation has been tarnished by the financial crisis, Mr. Buffett is widely respected in Washington and on Wall Street. Both Mr. Buffett and Goldman could reap large returns from investing in these credits. One investor who has considered a similar transaction said they promise annualized returns of at least 30%.[1] From time to time, we will send you e-mail announcements on new features and special offers from The Wall Street Journal Online.[1]
Closed for 15 months ''' opening 10 days only! Get notified ahead of time as our expert portfolio manager invests $1 MILLION in the best opportunities from across The Motley Fool'''s premium investment services. This is the first open since August 2008, by invitation only. [4] In the past two months the company has closed on three new purchases including a $28.6 million purchase in Syracuse, N.Y., and a $38 million transaction in Far Rockaway, N.Y. and has five more in the pipeline. He added, "five of the eight are being funded with stimulus money" in part Mr. Carbone said, referring to a tax-credit exchange program included in the economic stimulus package enacted in February.[1]
A few weeks ago, I said the public feet-stomping surrounding Goldman's deal with now-bankrupt lender CIT (NYSE: CIT ) was totally baseless. How is this different? Because when Goldman struck the deal with CIT in the summer of 2008, public money wasn't involved. It was pre-TARP. Pre bailouts.[4] Some are complaining that the government will be criticized for continuing to do business with Goldman. That's true, but it's a ridiculous reason not to act in taxpayers' best interest, if in fact selling the credit satisfies that criterion. Frankly, the way these things should be done is by bidding.[2] If I'm missing something, and selling the tax credit would be pure gravy for the government, then the buyer shouldn't matter.[2] Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment icon found on every comment. Since the government owns these credits, and the government would get the taxes from GS, they should sell the credits for the full amount of tax reduction.[4]
The tax credits are incentives designed to bring more investment to low-income housing developments.[3]
Without a discount it might as well just pay the taxes the credits would offset.[2]
Berkshire Hathaway and Goldman could not be reached immediately for comment. Treasury officials told the paper they are still reviewing the proposal. [3]
SOURCES
1. Buffett Joins Goldman in Bid for Fannie Mae Tax Credits - WSJ.com
2. Goldman's Attempt To Buy Fannie's Tax Credits - The Atlantic Business Channel
3. Buffett joins Goldman bid for Fannie Mae tax credits | Reuters
4. Goldman Sachs vs. the Tax Man (GS)
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