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I'm a retiree who manages our mostly bread and butter investments myself.  I also prepare and file my own tax returns including Partnership K1s  which gives me a perspective, however limited, on the Mitt Romney's returns  -- and why he hasn't released more.

The conclusion I've reached is that there is far more buried in those earlier returns than just low taxes and tax avoidance schemes, and that there are important nuggets of information that we can see but interpret with difficulty. We know that he deliberately overpaid his taxes for political reasons. It's not quite as obvious, but his taxes aren't finished. He states that he intends to take a (very large) foreign tax credit against his 2011 taxes at a later date. That will further reduce his tax rate. More below the squiggly.

If nothing else, I think those tax returns demonstrate what many already believe, that Mr. Romney is just a financial manipulator who games his income tax,  using tactics available only to the rich and using methods that more than a few think cross the line.

The length of Romney's 2011 return and the myriad supporting statements is enough to confound anyone. I'm no professional, but what I found was disturbing, not just in how he reduced his taxes but where his money was invested. What I found suggested some of his investments were directly related to those which brought on the financial crisis in 2008 and perhaps, a subsequent attempt to profit from that crisis, in particular hard-hit Spain.

I doubt that Mitt Romney's individual investments made much difference in the various crises standing along, but neither did the ethics make any difference to him. I do think it likely that he has a major reluctance to disclose his earlier tax returns, not just because he doesn't want to give details on how he ducked taxes, but because he doesn't want anyone raising questions about where he invested, e.g. his known investment in CNOOC, the Chinese oil company and his not so well known in destablizing investments.

In looking over Romney's taxes, I found a couple of curious references to CLOs and CDOs, i.e. Collaterialized Loan Obligations and Collaterialized Debt Obligation. According to his statements, Romney owned interests in outfits called Bryant Park Capital CDO #1 and Alpstar Capital CLO #2, both of them "synthetic CDO" bundlers. They didn't have to own the CDO, but could hold derivatives leveraging their investment and insurance that could cover their losses.

Insurance? Remember AIG and the the other insurers who bought into things like collateralized sub-prime mortgages that received very high ratings for security that turned out to be trash. CDOs all but destroyed the credit markets, the banks and the housing market and left millions destitute.

The tax returns (specifically for the family trust section) make it clear that Romney was investing in the overheated CDO sector and apparently still owns paper from that time. It's hard to tell -- because we don't have his income tax returns -- and the 2011 return is a long way from being complete, i.e. he not only failed to take the full charitable deduction, there is no credit claimed for foreign taxes paid and there is no form 8621 which is required for the "Information Return by a Shareholder of a Passive Foreign
Investment Company or Qualified Electing Fund" which a note says will be filed later. We may see that tax percentage come down to single digits.

If you're looking for Bryant Park, it's behind the New York Public Library along 42nd Street. The promoters of this CDO package had multiple units with other parks used to name other CDO packages, e.g. Hyde Park. You don't have to look very far to find Goldman Sachs, which established the Bryant Park through a hedge fund partnership with Blackstone. Citibank, another star in the financial debacle, arranged the deal.

There is not a lot of public information floating around on the secretive hedge fund business and it takes more money than I have to get my foot in the door.  But the bundlers of CDOs and CLOs, pretty much the same for our purposes, saw them as a way to make a lot of money. Setting up the "synthetic CDO" units was even better. They could deal solely in derivatives or combine them with actual CDOs. Created before the meltdown, derivatives were seen as a sure profit multiplier.

Both Bryant Park CDO #1, established in 2005 and Alpstar Capital CLO #2, established  in 2007, were setup as  synthetic CDOs. Each combined multiple tranches of debt or debt derivatives. The debt was also insured -- or so it seemed until the security insurance trade demonstrated insurers didn't have a prayer of actually paying for what collapsed.

This is the world Mitt Romney was playing in, at least after leaving Bain.

Ethically challenged Goldman Sachs not only filled much of Romney's overall investment portfolio, heavily invested outside the United States, it was also a prolific issuer of CDOs partnerships.  These weren't sold to just anyone and not traded on major exchanges. With Bryant Park CDO, already delisted in Dublin, it's remaining equity assets were acquired in August by Citibank for 66 Cents on the dollar.

Bryant Park and Alpstar Capital established what are known as Master Feeder setups to make these investments attractive to the Mitt Romney's of the world. Using Alpstar as the example, the CDOs and credit derivatives would be purchased through a feeder unit in the Cayman Islands with it's almost non-existent taxation. An Alpstar unit  set up in Geneva would be the Master organization, holding all the stock in the Cayman feeder. Other countries or jurisdictions are sometimes used, e.g. the Isle of Jersey, for these offshore outfits.

Still more arrangements were made to sell Geneva unit shares through another feeder in the United States, e.g. Goldman-Sachs. It would work like this. The Cayman feeder would own the debt instruments and accumulate the interest and any other payments. The Master holding unit would in effect mark up its stock to reflect the underlying value as it moved up with the interest in the Caymans. The use of derivatives would allow in theory a multiplier effect. The intent is to maximize the return both from interest payment and capital gains through appreciation. The complication is in US tax treatment but clearly the arrangement maximizes return and minimize taxes to the extent possible.  

It's an investment area that regulators and the government have tried to rein in for decades. There's a rule that would generally require the investor to declare ownership of a Passive Foreign Investment Company. It's an incredibly complex area I don't understand very well, and I'd need a lot more information that is not public to draw any conclusions. But the Romney's aren't doing this to increase their taxes. It's part of a tax avoidance strategy.

The Caymans have become wealthy through tax rules that work so well for wealthy individuals or offshoring companies. Employment is provided for Cayman Islanders who act as officers or other functionaries. It buys and holds all the actual debt instruments or derivatives. The Caymans are especially popular for this kind of tax manipulation, but there are plenty of other places.

Bermuda is another. I once looked into investing in a Norwegian shipping company which as it turned out has its headquarters in Bermuda. Aside from increasing Bermuda tax receipts with no fuss and minimal payments, the company found company officers in Bermuda including a Secretary I recall as also being secretary to about 40 other companies from the same address.

The other funny thing was that Alpstar was involved in high risk subprime CDOs which backfired on many, contributing to the housing collapse in Spain and other countries and destroying some pension funds.

Alpstar, thefund that Romney invested with, specializes in snapping up the distressed companies and properties in Spain left destitute by the financial collapse that it helped bring about through "synthetic CDOs" which played with derivatives and occasionally the CDOs themselves.

Romney was deeply involved in these and other Goldman Sachs interests that helped create the problems -- and then sought to take advantage after the fact. And that clearly suggests he benefited in some direct way from the bailout of the financial industry.

Warren Buffet labeled these derivatives "“financial weapons of mass destruction."

Former trader Satyajit Das, in a fictionalized 2006 account of his life as a trader,"Traders, Guns, and Money: Knowns and Unknowns in the Dazzling World of Derivatives," argues: "No money is ever really made in financial markets. Markets merely transfer wealth. As to how to make money? Well, it is basically theft, misrepresentation, lies, cheating, deception or force. It is impossible to make the staggering amounts made in derivatives in good years honestly."

“CDO logic is perverse. You buy loans and other credit risk from the market, then you cut it and dice it and sell it to investors. It should be impossible to make money. Then why are CDOs so profitable?" “In the credit trading age, dealers were taking massive ‘model risk’ to provide investors with higher returns. It was the geeks and their masters who were writing the cheques; they had placed their faith in the credit models; they had started to believe in their lies. Perversely, they were showing massive profits. That’s the beauty of mark-to-model. If the model fails, the profit will disappear like a chimera.“In 2002 and 2003, benign conditions in the credit market prevailed. Few companies defaulted; people became foolish or brave and lent to companies at ever lower returns; the credit spread on junk bonds reached record lows. Credit standards declined. “In 2004, one bank suffered a loss of around $50 million in a single day on its credit dealt books. Nobody really knew why: it was the first tremor.”
Das fictionalized his life, but not the reality he had seen but all the early warnings of the risk in the market were ignored and sometimes deliberately overlooked.

Goldman Sachs was one of the leaders of the herd of lemmings that took the financial industry to the edge of doom -- requiring a government bailout from George Bush to avoid the complete failure of too big to fail. Goldman Sachs, a name that laces throughout the Romney tax returns seriously tarnished itself. In perhaps the most notable incident, Goldman packaged CDOs and then bet against them.

Earlier this year, Alexander Eichler wrote in the Huffington Post about Warren Buffett and Goldman.

"Buffett, the billionaire CEO of Berkshire Hathaway, has recently come out looking like a major winner in Goldman Sachs' big loan sell-off of last year, according to The Wall Street Journal. Among the debts that Goldman unloaded in 2011 was about $85 million of loans in Lee Enterprises, an Iowa-based newspaper publisher."If the reports are accurate, then the Lee loans represent another sneaky payoff for Buffett, who once famously counseled that investors should "try to be fearful when others are greedy and greedy only when others are fearful.""Goldman took about a $13 million loss on that sale, according to the WSJ. And the buyer in that sale, reportedly a unit of Berkshire Hathaway, has since cleaned up nicely."

On the upside, assuming it wasn't just typical wealthy harvesting of losses, Romney managed to lose 2.9 million in 2011 which helped bring his tax rate down and it looks less like a real loss but one which was booked and harvested for tax purposes.

That's not illegal. I do it myself, i.e. if you've got a capital gain, either a short term or long term gain offset it equally.  Where we differ is that I'm just one guy without many fancy tactics available and I don't really want to cheat on my taxes or even push too close to the edge of compliance.

The truly wealthy rarely lack for tactics or have a shred of guilt about not paying their fair share.

Mitt Romney is a disgrace.

Originally posted to bamjack on Fri Sep 28, 2012 at 03:40 PM PDT.

Also republished by The Bain Files, The Royal Manticoran Rangers, and Keynesian Kossacks.

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