THAT’S BUSINESS

Minor IRS ruling evokes ’08 crisis, ‘bond daddy’ era

“Sounds kinda technical.” That was the subtle warning from my wife when I told her I’d be writing about bonds for this week’s column.

What brings this subject to mind?

The Internal Revenue Service recently decided to lift the tax-exempt status on bonds worth $3 million used to pay part of the cost of refurbishing a Little Rock hotel a decade ago. That means that those who bought the bonds stand to pay taxes on the interest income from the bonds.

Hooked?

OK, what is a bond? It is a form of debt that is bought and sold. Bonds are issued to raise money. They are traditionally seen as a safe bet, compared with the volatile nature of, say, shares of common stock.

Sometimes bonds are not safe.

A kind of bond called a mortgage backed security almost brought this country’s economy to its knees, even if indirectly. Seems that the assets - real estate - that were supposedly solid collateral for certain bonds were shaky. This was during the housing bubble of the mid-2000s.

And little unregulated things called credit default swaps - insurance against default on bond payments by the issuer - were being widely and wildly traded. When the claims against troubled insured bonds went viral, it nearly ruined the financial markets in 2008.

Speaking of wild trading, in the 1980s Little Rock was the epicenter of a subculture in which fast-talking traders gained fortunes and, in some cases, landed prison terms.

Constance Mitchell wrote in The Wall Street Journal in 1989: “Bond Daddies are a nomadic Southern strain of telephone securities salesmen known for their tenacity on the job and ostentation off. From offices lined with banks of phones, they cast for business with ceaseless cold calls, treating the customers they sign up to huge markups, repeated short-term buying and selling, and an array of other trading ploys rewarding chiefly for the broker … selling tax-exempts to senior citizens across the country.”

The aftermath of that party left hundreds of savings and loans associations out of business, the U.S. government with a humongous bailout tab, including for a phenomenon called Whitewater.

I knew a guy who was trading in one of those bond houses. He invited me to drop by one day and eat lunch with him. The house had a handsome brick facade. I must say that when I stepped inside, the intensity and allure of the atmosphere was appealing.

Was this the first step in recruitment? I don’t know. I do know that the fellow got his, got out and opened a stylish shop in Hillcrest.

Enough of the wild side of bonds.

The IRS ruling on the hotel bond issue recently resurrected the story of a citywide referendum in 2002 in which the voters of Little Rock rubber-stamped an issue of up to $19 million in bonds, whose principal and interest were to be paid off by the private investment group.

There was no obligation on the part of taxpayers. They just get to say whether it was a worthy project. The IRS decision has no impact on public funds.

The issuers, a limited liability corporation, were to hire 35 percent of their employees from a surrounding empowerment zone. They didn’t quite make it, according to the group’s bond attorney.

After some back and forth, the IRS lifted the tax-exempt status. So any interest income paid after a certain date was taxable. Which, as was reported at the time, might be a moot point, since the bonds were in default.

In other words, the issuer was not making payments onprincipal or interest.

The bonds were issued through the Arkansas Residential Housing and Public Facilities Board to finance the renovation of the hotel on University Avenue at Interstate 630, which became a Hilton, although it was recently rebranded as a Clarion hotel.

Jane Dickey, the board’s attorney, was asked whether this IRS decision could have a chilling effect on such issues.

Each issue is judged on its own merits, she said.

However, “over the the last decade, [IRS] has been much more aggressive in auditing … any tax-exempt bond issue [whether] random audits or targeted audits.” Dickey wouldn’t venture a guess as to why.

But while some would say that regulation is the bane of free enterprise, there are cases where a certain degree of it could’ve prevented some disasters.

If you have a tip, call Jack Weatherly at (501) 378-3518 or e-mail him at: jweatherly@arkansasonline.com

Business, Pages 65 on 03/17/2013

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