America’s Political Angst
David R Kotok
October 9, 2016.
We publish a few hours before the Sunday night, October 9, 2016 second presidential debate.
This bizarre election cycle unfolds with a constant flow of surreal surprises. We might have thought that House of Cards screenwriters wrote the screenplay. Here is our attempt to comment from the midst of this rapidly shifting chaos.
We’ll begin by referring you to a commentary of ours from a year ago that includes a link to a clip in which Congressman Lee Zeldin (R-NY) answers questions regarding the continuing-resolution (CR) fight in Congress. In a second clip I join WSJ’s John Bussey, Sandra Smith, and Dagen McDowell in discussing the outlook for the economy and markets (see October 28, 2015)
What viewers of the clips don’t see, because it took place off-camera, was a discussion among Dagen, John, Sandra, and me in which we talked about Congressman Zeldin’s answers regarding the debt-limit debate and why we did not take this congressman to task. You can read my additional remarks on the continuing-resolution issue at the link above. Now, it looks like we are going to repeat the political charade again, after November elections, and when the existing CR expires in December.
We have written about politics and the issues of political corruption (money), disingenuous and duplicitous actions (liars and spin doctors), and governance destruction (see Paul Kennedy’s warning at the conclusion of this commentary). We have cited examples during the last year from major countries and smaller ones. As readers know, we are not sanguine about the political outlook. Today’s missive is about the angst that now besets Americans who face a presidential election in only a month.
Our focus is on the US financial markets and how we see them reacting to political outcomes. This note is written in the context of Cumberland’s basic business, which is the portfolio management of separate accounts. That is what we do. We tailor separate accounts without any hidden fee funds or conflicting financial incentives like commissions or custody or product sales, and with full transparency.
As we give speeches around the country, we find that about forty percent of our audience is in turmoil over American politics. We are constantly asked by clients and consultants about the coming election. This past weekend’s revelations about Trump’s lewd behavior and Clinton’s speeches to Wall St. banks only exacerbate the dilemma. Lame alternatives like Libertarian Gary Johnson, who had no clue where or what Aleppo was and couldn’t name a single foreign leader, are only making the situation worse.
The Republican governor of a conservative state, Gary Herbert of Utah, has announced he won’t vote for Trump and cannot vote for Clinton. The CNN anchor asked the camera audience, “What’s he going to do?”
Ironies abound and would be humorous if they weren’t so revealing of the mess we are in. We will cite only a limited few.
Here’s one. Trump’s tax returns have been only partially revealed, but we have seen enough to draw inferences. It appears he did nothing illegal, but he did take huge advantage of a loophole in the tax law that was put there by the Congress.
My friend Jim Lucier is a very sharp-eyed Washington observer. In an email exchange with me, he noted a 2001 Supreme Court case, Gitlitz v. Commissioner, and then wrote:
“At the time, an S corporation that was insolvent did not report cancellation of debt (COD) income on its taxes. But the COD did flow through to the S corp’s shareholders – in Trump’s case, it was likely to the sole shareholder – as an increase in basis. Similarly, the net operating losses (NOLs) from depreciation, interest expense, and operating expenses also flowed through to the shareholder. The shareholder could then use the NOLs to reduce taxable income on his personal tax filing to the extent that his basis, reduced by the same amount, remained above zero. S corporations were commonly used as general partners by real estate developers in the 1990s – and perhaps they still are. Since I don’t move in those circles, I don’t know. But it is likely that Trump would have owned his casinos via a partnership in which an S corporation controlled by him was general partner. The casinos were $3 billion in debt, of which $885 million was personally guaranteed by Trump. Between 1993 and 1995, Trump received debt forgiveness from his creditors for the debt he had guaranteed. This would have created a very substantial COD item for his S corp that would flow through to basis reported on his personal return. This would allow him to draw down NOLs from his casinos, hotels, and airline to that amount.
“The New York Times reported that Trump had a line in his 1995 tax return for 16 million in losses from partnership income, and a line for $909 million in losses in ‘other income.’ which could include NOLs. In Trump’s 1997 book, The Art of the Comeback, incidentally published by Times Books, he says at one point that he is worth “minus $900 million.” In the Gitlitz case, the IRS said, “Wait a minute. If you cancel the debt, the related tax attributes should be canceled as well.” They won in Tax Court, but the Supreme Court overturned that ruling with an 8-1 decision in 2001, saying the law as written might be stupid but did allow the basis and NOLs to flow through to the shareholder even if debt was forgiven at the corporate level. Congress fixed the error the following year with the Job Creation and Worker Assistance Act of 2002, which passed the Senate 85 to 9 and which then-Senator Hillary Clinton voted for. But it included a grandfather clause sheltering tax filings from prior years, which would have included Trump’s, and so he has this to thank her for.”
We offer a hearty thank you to Jim Lucier for these details.
One not-to-be-named fishing friend who is also a real estate professional in Washington DC has emailed me extensively about Trump’s real estate deals and taxes. In our exchange he challenged me to cite an instance of abhorrent Clinton behavior in the real estate arena.
A WSJ editorial was published February 22, 1994, within a year of the infamous Trump tax return filing. My citation is from the Wall St. Journal four-volume Whitewater series, edited by Robert L. Bartley.
“So the Federal Deposit Insurance Corp. has determined that Webb Hubbell and the Rose Law firm violated no conflict of interest rules when they worked both sides of the street regarding Madison Guaranty S&L of Little Rock…. To judge by the opinion, the Whitewater partnership between Rose partner Hillary Clinton and Madison owner James McDourgal escaped the FDIC’s legal eagles.” For details see Volume 1 of 4, pages 187–9 of the WSJ briefing on Whitewater. The WSJ concluded that “The lesson of the FDIC memo is that Arkansas forbearance applies only to firms that included the Associate Attorney General and the First Lady. But the same old ferocious rules will apply to ordinary mortals.” Readers who wish to know more may want to read the WSJ editorial from January 2, 1998, entitled “The White House, 1998.”
Enough of real estate and taxes. We could write reams on both Clinton and Trump. She and her trading account. He and his business practices with contractors and subcontractors. But all this has been so fully aired in the media and is now dwarfed by her Wikileaked private speeches for money and his vulgarity and personal treatment of women, so as to make the simple subjects of taxation and investments stale history and small potatoes.
Ladies and gentleman, our country is in serious trouble. We have been failed by governance. Neither political party has clean hands. Presidential politics offer us deeply troubling choices. Congress is stymied by grotesquely gerrymandered districts. Our entire system is corrupted by money. Citizens United is only the latest in a long line of attempts to amass political pecuniary power. We have no viable third-party alternative. We are trapped.
Let’s get to markets. There seem to be a couple of trends.
Stocks want Hillary since her policies may be more predictable. Market levels are close to their all-time highs. Stock prices are discounting the likelihood of Republicans holding the House (narrowly) and maybe the Senate (It’s close but growing doubtful). Stocks seem to be saying that congressional Republicans will counterbalance Clinton in the White House. Our own research suggests that Trump’s shenanigans will trigger a swing to a majority for Democrats in the Senate and losses of 14-20 seats for House Republicans. But this much chaos makes all predictions problematic.
Bonds have already started to adjust (rising yields, falling prices) from the extreme of the Brexit selloff. The 10-year US Treasury note traded to an intraday low of 1.32% after Brexit. It is currently 1.75%. Markets are preparing for a Fed rate hike. We expect it in December.
So what happens after the election? That is really a hard one now. The composition of the Supreme Court is up for grabs. The same is true for the Federal Reserve governor appointments. These depend on Senate confirmation. A Clinton win and a Democrat majority determine these outcomes. Taxes and spending originate in the House. All this is likely to be fought over by a House that shifts to a smaller Republican majority under Speaker Ryan, but the result will be to make the House more conservative while the Senate will be almost evenly split and unable to achieve a 60-vote cloture.
Continued divided and fractious government lies ahead regardless of the outcome of the presidential election. That means volatility rises.
Meanwhile, the world is a very dangerous place, and economies are in serious difficulty worldwide. Geopolitical risks are higher than they were and are still rising.
In his remarkable treatise The Rise and Fall of The Great Powers, Yale’s Paul Kennedy wrote eloquently about his strategic views of the United States. The 1987 edition precedes Trump’s antics and Bill Clinton’s White House behaviors. Kennedy wrote:
“The task facing American statesmen over the next decades, therefore, is to recognize that broad trends are under way, and that there is a need to ‘manage’ affairs so that the relative erosion of the United States’ position takes place slowly and smoothly, and is not accelerated by policies which bring merely short-term advantage but longer-term disadvantage. This involves, from the president’s office downward, an appreciation that technological and therefore socioeconomic change is occurring in the world faster than ever before; that the international community is much more politically and culturally diverse than has been assumed and is defiant of simplistic remedies offered either by Washington or Moscow to its problems; that the economic and productive power balances are no longer as favorably tilted in the United States’ direction as in 1945; and that, even in the military realm, there are signs of a certain redistribution of balances, away from a bipolar to more of a multipolar system, in which conglomeration of American economic-cum-military strength is likely to remain larger than that possessed by any one of the others individually, but will not be as disproportionate as in the decades which immediately followed the Second World War.”
Note: Kennedy wrote this in 1987. Today, he might add Beijing to his list of power centers. His analysis seems to be as applicable today as it was 30 years ago.
Can Clintkaine or Trumpence rise to the level required to deal with such fundamental global issues?
I don’t know about you, but I’m worried – for my country, for my children and grandchildren, for my neighbors and friends.
We can try to protect our clients in the financial realm. We’ve done that since Cumberland’s founding in 1973. But how to fix a broken government is beyond us. And we fear it will take a monumental crisis to shock the nation into a more positive political realignment.
We send this missive as we depart for Cuba. Meetings with medical professionals are tentatively arranged. We seek information on how Cuba is dealing with Zika. Readers know how we feel about our nation’s politicians and the failure of our government to address Zika risk when time was critical.
David R Kotok
Chairman & Chief Investment Officer
Cumberland Advisors Market Commentary.