Millions of Americans now receiving their $10.25 individual weekly windfall from President Obama‘s “Making Work Pay” tax credit may be in for a disagreeable surprise next spring.

The government may want some of that money back.

The tax credit is supposed to provide up to $400 to individuals and up to $800 to married couples as part of the economic recovery act voted into law last February.  Workers began receiving the tax credit in paychecks they received after April 1, when employers were required to implement the new tax tables.

Revised withholding tables issued by the IRS extract less from individual paychecks for the tax credit.  The $10.25 individual weekly rate is based on the 39 remaining weeks in 2009.  It’s a simple change, for people who have one job.

There are, however, circumstances that will cause millions of taxpayers to get much more spendable cash than they are entitled to, and Uncle Sam will want this extra funding repaid at tax time.

The IRS is aware of the problems the tax tables will cause many consumers, but is keeping quiet.  I suppose the IRS is hoping many of the over-receivers will be expecting a refund, and will not complain because their refund will be smaller.  The average refund was just below $2,700 for 2008 income.

Taxpayers who plan their withholding close to their expected obligation might be in for a surprise. 

The revised tax tables credit workers with 6.2 percent of their earned income, up to a $400 maximum for individuals and up to $800 for married couples filing jointly.  Ineligible are individuals grossing over $95,000 and couples taking in more than $190,000.

The tax credit was designed specifically to help boost the economy by collecting less from workers and thereby giving more money to consumers. 

In his appraisal of his first 100 days in office, President Obama praised the tax credit as one of his achievements, promoting that 95 percent of working families will qualify for it in the next two years.

The tax tables don’t take into account several common categories of taxpayers:

• A worker with two jobs will receive a potential $400 increase in the take-home pay at each job, up to $800, but is only eligible for a maximum credit of $400. The excess must be repaid at tax filing time, either through a smaller refund or paying in cash.
• Married couples filing jointly are eligible for an $800 credit. If both spouses work, the new withholding tables give them each $600 (total $1200), and the excess $400 must be repaid. The IRS recognized the problem and adjusted the withholding tables, but the fix was imperfect.

Note: Fifty-five percent (33 million) of married couples have both spouses working for a paycheck.

• A college student with a job making $10,000 will receive $400 that must be returned if the student is listed as a dependent on their parent’s tax return.

Fifty million retirees face even bigger potential headaches.

For people who receive Social Security, Supplemental Security Income, Railroad Retirement benefits or Veteran’s Disability benefits, the Social Security Administration is sending out $250 payments in May as part of the economic stimulus package.  These payments are meant to provide a boost for people who don’t qualify for the tax credit.

Several retiree categories will face potential problems from the new tax tables.

• Retirees who have earned income and Social Security will receive the $400 benefit in their paychecks and the one-time $250 payment in their Social Security check. They must pay back the $250 when they file their tax return.
• Retirees who have federal income taxes withheld from pension benefits will receive the $400 benefit due to the new tax tables, but since pension benefits are not earned income, they don’t qualify for the tax credit and it will have to be returned.
• Retirees with working spouses who are having taxes withheld at the married rate will receive an excess of $400 through the working spouses paycheck that must be returned.

Treasury Secretary Timothy Geithner said in March that both Treasury and IRS understood the concerns and were “exploring ways to mitigate that effect.”  No news since.

Don’t be caught in the repay surprise:

• Check all federal withholding amounts with those received before April 1. Include all paychecks (you and spouse), Social Security and Pension payments. Multiply that difference by the number of remaining paychecks and payments for 2009.
• Check federal withholding for children with earned income. Calculate any overage and have them readjust their federal withholding amounts.
• Change of federal withholding rates and additional taxes to be withheld may be requested on Form W-4 available from employers and the IRS.
• The IRS and many private tax preparers have a calculator on their Web site to help taxpayers figure withholding.

Remember, the maximum benefit is $400 per worker, $800 per married couple.  If one spouse receives only Social Security benefits, their benefit is $250 for a total of $650.

If you did not have earned income, you are not eligible for the $400 recovery tax credit.

IRS website calculator and W-4 form

“Attention Pensioners: Pensioners do not qualify for the Making Work Pay credit, unless they receive earned income.  However, the new withholding tables apply to all taxpayers, including pensioners.  The IRS has a withholding calculator pensioners and others can use to make sure enough tax is being withheld from their pay.  Adjustments to withholding can be made by filing Form W-4P, Withholding Certificate for Pension or Annuity Payments.” 

IRS withholding calculator

Another calculator

IndyMac Bank was founded as Countrywide Mortgage investment as a means of handling single family mortgage loans too big to be handled by Freddie Mac and Fannie Mae. 

In 2007, IndyMac suffered significant losses, mostly because it was unable to sell mortgages due to the decline in the secondary market.  IndyMac reported that it had nearly $2 billion in non-performing loans, increasing more than 40% from the previous quarter.

The bank’s risk-based capital reserves reported for March 31 dropped within a fraction of the minimum required by regulatory guidelines.  A rating downgrade reduced the value of assets held by InyMac so it could not meet the June 30 requirements.

In June 2008, several letters from Senator Charles Schumer (D-NY), a member of the Senate Banking committee were released, stating his opinion that “The possible collapse of big mortgage lender IndyMac Bancorp Inc. poses significant financial risks to its borrowers and depositors, and regulators may not be ready to intervene to protect them.”

The effect of these letters caused a run on the bank.  In the 11 days following the disclosing of the letters, depositors withdrew $1.3 billion in deposits.  Shares on the New York Stock Exchange went to $0.31 from a 2006 high of $50.  This was compounded by an alleged fraud issue where an $18 million cash injection from its parent company was backdated to seem like the bank met requirements.  The fraud issue is being investigated by the FBI. 

IndyMac is one of the largest bank failures in American history.

The FDIC stepped in, seized the bank and its remaining assets and placed the bank into conservatorship.  Depositors were assured of continuing access through ATMs, existing checks and debit cards, telephone and Internet.

The FDIC sent two of its top officials to run the bank.  Slashing CD rates and expensive management rewards reduced operating costs and high-priced artworks spread throughout the offices were sold.    Attention was then turned to analyze risky mortgages made in California where home prices had fallen sharply.  IndyMac modified the loans of more than 10,000 borrowers to decrease the option of foreclosure and keep people in their homes.

With the turnaround of IndyMac in a relatively short period, the government has shown it can rescue a bank through nationalization and return it to the private sector rapidly.  The IndyMac exercise was costly ($11 billion) and should be used only in certain cases. 

Since early in 2008, the FDIC has seized 41 failed banks, but normally has a buyer lined up before the takeover occurs.  Failed banks are generally closed on Friday and reopen Monday with new owners and a new name.

With the stress testing proceeding at the largest banks in the country, the outcomes could result in more nationalizations.  The IndyMac example is important to the Obama administration as a “how-to” example of how takeovers can work.

A number of prominent Republicans and fiscal conservatives, including former Federal Reserve chair Alan Greenspan have joined those who support nationalization or at least increased control of troubled banks.

Many Americans and economists are against the idea of nationalization as fundamentally against American tradition.  A recent USA Today-Gallup poll found that 57% of Americans are against “temporarily nationalizing U.S. banks,” but when the word “nationalization” is changed to a less threatening version of “taking over” only 44% oppose the concept.

Examining the example of IndyMac against the other three institutions of Freddie Mac, Fannie Mae and AIG, shows IndyMac is the only bank that has been returned to private ownership.  The others seem to be far from privatization.

As a concerned citizen, I am trying to figure out how we got into this mess, where we are in this mess, and where is the exit door to this mess. Now, I as a concerned citizen have no influence with the powers that be in Washington, but that doesn’t stop me from trying to understand the problem and what is being done.

My focus starts out with Henry Paulson, Secretary of the Treasury. I looked up his record, because he has not impressed me with his financial guidance.

Secretary Paulson is a smart guy. He was an Eagle Boy Scout (for those of you who know, it is a tough rank to achieve for a teenager). He earned a Bachelor of Arts degree (English) from Dartmouth (good school) and an MBA from Harvard Business School. He was inducted as a member of Phi Beta Kappa, an academic honor society. It is considered by many to be the most prestigious college honor society in the United States.

Paulson rose to be CEO of Goldman Sachs, amassing a personal fortune along the way. In 2006, his income was projected to be $16.4 million. That year, after 32 years at the firm, he accepted the job as Treasury Secretary at a salary of $191,300 (all Cabinet Secretaries make the same).

Treasury Secretary

The Secretary of the Treasury is the head of the IRS, the U.S. mint, the Bureau of Printing and Engraving, and all other agencies concerned with money and finance matters of the U.S. He gets to sign all the currencies issued while he is in office (neat!).

Duties from the U.S. Department of the Treasury website:
“The Secretary of the Treasury is the principal economic advisor to the President and plays a critical role in policy-making by bringing an economic and government financial policy perspective to issues facing the government. The Secretary is responsible for formulating and recommending domestic and international financial, economic, and tax policy, participating in the formulation of broad fiscal policies that have general significance for the economy, and managing the public debt. [more …]

Paulson’s record

OK, let’s see how he has played up to now.

2004: at the request of major Wall Street investment houses, including Goldman Sachs, which at that time was headed by Paulson, the U.S. Securities and Exchange Commission agreed unanimously to repeal the net capital rule. The SEC net capital rule states the requirement that brokerage houses hold reserve capital limiting their leverage and risk exposure.

That year, SEC Chairman William H. Donaldson then established a “voluntary” risk management program for investment bank holding companies to monitor signs of any problems. This office was eventually discontinued by current SEC Chairman Christopher Cox, after discussions with Paulson because not one firm volunteered to show their books.

Changes to the net capital rule are thought to be an important factor in the credit market meltdown of 2008 due to unrestrained capitalism allowed to do anything in the name of profit with no one to say, “No”, or “Stop.”

Spring 2007: Secretary Paulson told an audience at the Shanghai Futures Exchange that “An open, competitive, and liberalized financial market can effectively allocate scarce resources in a manner that promotes stability and prosperity far better than governmental intervention.”

In other words, let things shake themselves out. Those are thoughts that can be expected from a wealthy free market advocate, who has no clue what it means in terms of financial change for us of the common class. More in another post on this view of economics.

July 2008: After the failure of Indymac Bank, Paulson reassured the public by saying, “it’s a safe banking system, a sound banking system. Our regulators are on top of it. This is a very manageable situation.” (Translation, “Don’t concern yourself with the iceberg collision. The Titanic is an unsinkable ship.”)

Paulson was then designated as leader of the Bush administration’s efforts to nationalize the cost of bad loans made by financial institutions. He led government efforts which he said were aimed at avoiding a severe economic slowdown.

August 2007: Paulson explained that U.S. subprime mortgage fallout remained largely contained due to the strongest global economy in decades. (Translation, “The rising sea water is contained in only the forward compartments of the ship. The Titanic will be fine.”)

August 2008: Paulson told NBC’s Meet the Press that he had no plans to inject any capital into government agency mortgage giants Fannie Mae or Freddie Mac. (Translation, “We have enough lifeboats for everyone.”)

September 2008: Paulson pushed through the conservatorship of Fannie Mae and Freddie Mac. (Translation, “Women and children to the lifeboats while we see if we can save the ship.”)

Questions arise

A note about Treasury Secretary Henry Paulson. No one would disagree that he is a smart guy who became wealthy mostly through his own efforts, but some questions come to mind:

· Why did he leave Goldman Sachs after 28 years, where he was CEO and expected to earn $16+ million in 2006, to take a job in government where his pay was roughly 1.2 percent of what he was making?
· What did he know that made him make the jump?
· Was he advised that Goldman Sachs would soon be in financial trouble and he would be able to help from the government side?
· Is he counting on a prestigious job after Treasury due to his high profile and insider contacts?

Appointing someone to Treasury secretary with an bachelor’s degree in English and an MBA does not make sense. The job requires more than an administrator. It requires an economist. It is evident to me that Secretary Paulson had no idea of the interconnectivity of financial elements of the economy. It is evident to me that he was acting on the guidance of advisors, who were following the supply-side economic policies of the administration, which as I understand it, comes down to throwing money at the problem.

In Paulson’s defense, it is easy to second-guess the people on the front lines, but looking at Paulson’s education and work history, I don’t know if his MBA qualifies him to perform “policy making by bringing an economic and government financial policy perspective to issues facing the government.”

He certainly did not act decisively and quickly enough, and tried to minimize the impact of the spreading economic blaze, on its way to becoming a four-alarm fire.

Bailout philosophy

Folks have asked me why the bailout money is going to the institutions rather than the people.

In receivership or bankruptcy, all possible assets and receivables are called in, converted to cash, mostly through auction, and the proceeds distributed among the creditors. Let’s say a large investment banking house goes bankrupt, because more credit defaulted than they had reserves for. Some of their assets might be mortgages that would be called in for their cash value.

Homeowners who faithfully paid their monthly mortgage payments would be presented with a notice that their entire outstanding amount was due. Not many people have that kind of cash, so they would lose their house. That would just aggravate the housing crisis.

This problem would be the same for businesses who were debtors of the bankrupt institution. Businesses rely on credit for operational cash flow. If they could not come up with cash, then their business would fall bankrupt in this game of financial dominoes.

The cascading bankruptcies would release vast numbers of workers into the unemployment arena, as well as put tremendous burdens on the shrinking number of remaining firms who would pick up some of the assets at auction and try to work them.

U.S. government bailout of 2008

September 2008: The bailout begins. Paulson is the point man for the bailout, but it is easy to see he is starting to listen to wiser financial minds.

Paulson was harshly criticized by economists for initially refusing to consider injecting large amounts of cash into financial institutions directly through stock purchase. Other countries in similar circumstances had led the way with this option, it had historical precedence in this country, it was the path favored by Federal Reserve Chairman Ben Bernanke, and it was the one that was eventually followed.

Bernanke and Paulson influenced the creation of a credit facility through bridge loans & warrants to American International Group for up to $85 billion to avoid bankruptcy. From the government’s viewpoint, it was investing in AIG with the hope they could sell the stock at more than a loss when the crisis was over.

Paulson, now joined by Bernanke and SEC chairman Christopher Cox, led the effort to help financial firms, using $700 billion dollars of Treasury funds to purchase bad debt they had incurred. The money was to cleanup nonperforming mortgages that threatened the liquidity of those firms.

Since Paulson was the most visible through public appearances on this issue, it became known as the “Paulson financial rescue plan.” He became the manager of the United States Emergency Economic Stabilization fund with the passage of H.R. 1424 (the $700 billion). He also sits on the newly established Financial Stability Oversight Board that oversees the Troubled Assets Relief Program.

See, it pays to be an Eagle Scout.

The Emergency Economic Stabilization Act of 2008 is the law authorizing the bailout. The Act authorizes Paulson as the Secretary of the Treasury to spend up to $700 billion to make capital infusions into banks and buy distressed assets, especially mortgage-backed securities.

The Troubled Assets Relief Program (TARP) is another law which created the Emergency Economic Stabilization fund, authorizing Treasury to spend up to $250 billion for immediate use, with the next $100 billion certified by the President that they are needed. The final $350 billion is subject to Congressional approval.

Within two weeks of enactment, the rules changed. Mortgage-backed securities took a back seat. As of November 25, Treasury spent $250 billion on preferred stock and equity warrants for 8 national banking institutions and $36.5 billion for senior preferred stock in 44 other banks under the Capital Purchase Program as part of TARP. Treasury also gave $40 billion to AIG.

Confused yet?

The Financial Stability Oversight Board was created to review Treasury’s actions. The chairman is Ben Bernanke, Chairman of the Board of the Federal Reserve system. Other members include the Chairman of the SEC, Secretary of Housing and Urban Development (HUD), Director of the Federal Housing Finance Agency, and Paulson.

A Congressional Oversight Panel also reviews Treasury’s actions and reports to Congress every 30 days on the management of TARP, the state of the markets and the current regulatory sytem. To be fair, the five members were chosen (one each) by:
· the Speaker of the House,
· the minority leader of the House,
· the majority leader of the Senate,
· the minority leader of the Senate,
· the Speaker of the House and the majority leader of the Senate jointly.

Will it work?

Historically, our government has done this before. In the 1930s, the Herbert Hoover administration bought stock and made loans to 6000 banks, spending $1.3 billion (equivalent to $200 billion today). When the economy stabilized, the government sold its holdings for about the same amount it paid.

We’ll see.