Sunday, December 2, 2012

Human Nature: Jim Sinegal Dividend Tax Decision - Costco Will Borrow To Pay Dividends

Costco's Dividend Tax Epiphany. WSJ Editorial
Obama's fans in the 1% vote to beat Obama's tax increase.The Wall Street Journal, November 30, 2012, on page A14

When President Obama needed a business executive to come to his campaign defense, Jim Sinegal was there. The Costco COST +2.07% co-founder, director and former CEO even made a prime-time speech at the Democratic Party convention in Charlotte. So what a surprise this week to see that Mr. Sinegal and the rest of the Costco board voted to give themselves a special dividend to avoid Mr. Obama's looming tax increase. Is this what the President means by "tax fairness"?

Specifically, the giant retailer announced Wednesday that the company will pay a special dividend of $7 a share this month. That's a $3 billion Christmas gift for shareholders that will let them be taxed at the current dividend rate of 15%, rather than next year's rate of up to 43.4%—an increase to 39.6% as the Bush-era rates expire plus another 3.8% from the new ObamaCare surcharge.

More striking is that Costco also announced that it will borrow $3.5 billion to finance the special payout. Dividends are typically paid out of earnings, either current or accumulated. But so eager are the Costco executives to get out ahead of the tax man that they're taking on debt to do so.

Shareholders were happy as they bid up shares by more than 5% in two days. But the rating agencies were less thrilled, as Fitch downgraded Costco's credit to A+ from AA-. Standard & Poor's had been watching the company for a potential upgrade but pulled the watch on the borrowing news.

We think companies can do what they want with their cash, but it's certainly rare to see a public corporation weaken its balance sheet not for investment in the future but to make a one-time equity payout. It's a good illustration of the way that Federal Reserve Chairman Ben Bernanke's near-zero interest rates are combining with federal tax policy to distort business decisions.

One of the biggest dividend winners will be none other than Mr. Sinegal, who owns about two million shares, while his wife owns another 84,669. At $7 a share, the former CEO will take home roughly $14 million. At a 15% tax rate he'll get to keep nearly $12 million of that windfall, while at next year's rate of 43.4% he'd take home only about $8 million. That's a lot of extra cannoli.

This isn't exactly the tone of, er, shared sacrifice that Mr. Sinegal struck on stage in Charlotte. He described Mr. Obama as "a President making an economy built to last," adding that "for companies like Costco to invest, grow, hire and flourish, the conditions have to be right. That requires something from all of us." But apparently $4 million less from Mr. Sinegal.

By the way, the Costco board also includes at least two other prominent tub-thumpers for higher taxes— William Gates Sr. and Charles Munger. Mr. Gates, the father of Microsoft's MSFT -1.22% Bill Gates, has campaigned against repealing the death tax and led the fight to impose an income tax via referendum in Washington state in 2010. It lost. Mr. Munger is Warren Buffett's longtime Sancho Panza at Berkshire Hathaway BRKB 0.00% and has spoken approvingly of a value-added tax that would stick it to the middle class.

Costco's chief financial officer, Richard Galanti, confirms that every member of the board is also a shareholder. Based on the most recent publicly available data, they own more than 4.1 million shares and more than 1.3 million options to purchase additional shares. At $7 a share, the dividend will distribute roughly $29 million to the board, including Mr. Sinegal's $14 million—at a collective tax saving of about $8 million. Even more cannoli.

We emailed Mr. Sinegal for comment but didn't hear back. Mr. Galanti explained that while looming tax hikes are a factor in the December borrowing and payout, so are current low interest rates. Mr. Galanti adds that the company will still have a strong balance sheet and is increasing its capital expenditures and store openings this year.

As it happens, one of those new stores opened Thursday in Washington, D.C., and no less a political star than Joe Biden stopped by to join Mr. Sinegal and pose for photos as he did some Christmas shopping. It's nice to have friends in high places. We don't know if Mr. Biden is a Costco shareholder, but if he wants to get in on the special dividend there's still time before his confiscatory tax policy hits. The dividend is payable on December 18 to holders of record on December 10.

To sum up: Here we have people at the very top of the top 1% who preach about tax fairness voting to write themselves a huge dividend check to avoid the Obama tax increase they claim it is a public service to impose on middle-class Americans who work for 30 years and finally make $250,000 for a brief window in time.

If they had any shame, they'd send their entire windfall to the Treasury.

How dare Fannie and Freddie try to charge for their risks?

Senators for Housing Busts. WSJ Editorial
How dare Fannie and Freddie try to charge for their risks.The Wall Street Journal, December 1, 2012, on page A14

For proof that politicians have learned nothing from the Federal Housing Administration's insolvency, look no further than a November 19 Senate letter to Edward DeMarco of the Federal Housing Finance Agency (FHFA), which oversees Fannie Mae FNMA 0.00% and Freddie Mac FMCC 0.00% . Mr. DeMarco wants to let the toxic mortgage twins charge higher fees to cover their risks. Oh, the horror.

At issue is a little-noticed September FHFA proposal to discriminate between states with efficient foreclosure practices and those where judicial and regulatory burdens prolong the process. Specifically in Connecticut, Florida, Illinois, New Jersey and New York, foreclosures can take years.

Starting next year, Fannie and Freddie would charge borrowers in those states a one-time upfront fee of between 0.15% and 0.30%, which on a 30-year, $200,000 fixed-rate mortgage equates roughly to "an increase of approximately $3.50 to $7.00" on a monthly mortgage payment, according to FHFA.

The agency explained that the fees Fan and Fred charged before the housing crisis "proved inadequate to compensate for the level of actual credit losses" the duo sustained, which "contributed directly to substantial financial support being provided to the two companies by taxpayers." Total taxpayer cost so far: $138 billion. The change would relieve borrowers in low-cost states from subsidizing those in high-cost states. FHFA would lower or eliminate the levy if states sped up their foreclosure processes, which would also speed up the housing recovery.

Cue the outrage from Capitol Hill. "As you know, certain state and local governments have put in place increased regulatory and judicial scrutiny of foreclosures to protect consumers from mortgage loan servicing and foreclosure abuses," Democratic Senators from New York, New Jersey, Connecticut and Florida, plus Independent Joe Lieberman, declared. They want the higher fees withdrawn.

Translation: The Senators are embarrassed that FHFA is exposing the cost of their antiforeclosure crusade and are trying to pin the blame on bankers. Recall that the "robo-signing" scandal never unearthed a wave of current borrowers wrongly ejected from their homes. The politicians want Fan and Fred to keep churning out below-market-rate mortgage insurance, regardless of the eventual cost to taxpayers.

This is the kind of thinking that led Fan and Fred to supercharge the subprime lending boom and pushed the FHA into its money-losing expansion. As long as politicians run the housing markets, they will continue promoting such behavior. Kudos to Mr. DeMarco, a career civil servant, for trying to impose a more rational policy, but don't be surprised if the Obama Administration tries to replace him in a second term.