Sunday, September 18, 2011

UBS, Connecticut, and The Reverse Protection Syndicate Racket

I went back to Ohio
But my pretty countryside
Had been paved down the middle
By a government that had no pride…
I said, A, O, way to go Ohio
—Chrissie Hynde, The Pretenders

 Well UBS is in the news again, this time for a “rogue trader” who spent three years losing $2 billion of UBS’s hard-earned money before UBS figured out the money was gone.  Good thing the Swiss banking giant has friends in government to support it.
 We’re thinking specifically of the State of Connecticut, our home state, which agreed to pay UBS $20 million to stick around Connecticut for five years.
 That’s $20 million in cash the state’s taxpayers are paying to a company that just tossed $2 billion out the proverbial window.
 Now, the reason Connecticut is paying UBS $20 million doesn’t strictly relate to the rogue trader, who was actually located in London: it’s because the state has become so unattractive to business that our governor has to pay companies to stay.
 We are not making this up.  Here’s how Reuters carried the story recently:
 NEW YORK - UBS AG will receive a forgivable $20 million loan for deciding to stay in Stamford, Connecticut, for five years instead of moving some investment bankers to the World Trade Center complex in New York City…
 “This project [emphasis added] will retain at least 2,000 high-quality, high-paying jobs in the state, spur capital investment and reaffirm the state's reputation as a leader in financial services,” Connecticut's Democrat Governor Dannel Malloy and UBS Group Americas Chief Executive Officer Phil Lofts said in a joint statement.

 Now, this is the first time we have heard a bribe described as a “project.”  But never mind that quibble: we have a bigger one: calling it a “loan.”
 After all, the term “loan,” when preceded by the adjective “forgivable,” renders the thing not a loan, but a flat-out contribution, because if you think UBS has any intention of paying back a forgivable “loan,” you are either a good-government type who firmly believes that the machinations of local politicians are intended to produce something higher and more useful than gainful long-term revenue for those politicians and their friends, or you haven’t talked to an actual businessperson who has received such a “forgivable” loan.
 We have talked to actual businesspersons who’ve gotten forgivable “loans” similar to the UBS deal, and those “loans” are not viewed as “loans” by actual businesspersons, they’re viewed as capital that has been invested in their business in return for short-term promises—such as not moving that business to another state or another country for a certain period of time.
 And while UBS will, we have no doubt, honor the terms of the “loan,” UBS will also, we expect, do nothing above and beyond the specifics of the deal.  Nor will it pay back the $20 million—especially now that the firm just lost the equivalent of one hundred $20 million investments at the hands of a trader who, bright though he may be, looks like he just got out of high school.
 Furthermore, the $20 million contribution by Connecticut taxpayers to UBS’s pockets will certainly not “spur capital investment” in the state, since any business that was planning to invest capital in Connecticut will see straight through this sort of Reverse Protection Syndicate Racket (in which companies are not coerced into making payments for protection, but are paid to be protected) and ask themselves, and their elected officials, what cash can be extracted in return for threats to leave.
 Nor do we see how it will it “reaffirm the state’s reputation as a leader in financial services,” since the deal made it clear to the world the only reason UBS agreed to stay in Connecticut for another 60 months was that the governor paid it to stay.
 In fact, Connecticut’s “reputation” is less “as a leader” and more “as a hard place to do business.”  It ranks 47th in the Tax Foundation’s State Business Tax Climate Index; carries the third highest per-capita tax burden of the 50 states; and is notorious for making local businesses wonder why they much so that UBS was, at the time of its “loan,” preparing to flee Connecticut for New York, which is not much less difficult, business-running-wise.
 Nevertheless, Connecticut must be getting something for its $20 million “forgivable loan” to UBS, and indeed, according to the governor, Connecticut will preserve, for the five years of the deal, as much as $70 million a year in tax revenue that could have been lost if UBS had left the state.
 Now, probably that figure is an exaggeration.  Back-of-the envelope calculations of income taxes, sales taxes and corporate taxes attributable to 2,000 high-earning UBS employees max out at closer to $50 million, even using generous assumptions.
 But, so what, you say?  Spending $20 million over five years to save even $50 million annually sounds like a good “return on investment.”
 The problem is, that is not an investment.  It is a bribe—a form of reverse protection in which businesses that threaten to leave the area receive cash collected from individuals and businesses that don’t threaten to leave.
 As such, it is impermanent, subject to political pressure and favoritism, and short-term in nature.  Worst of all, these Reverse Protection Syndicate deals don’t lower the cost of doing business in the state: they raise the cost for all the other businesses.
 It’s no wonder that Connecticut has lost half its manufacturing jobs in the last 20 years, and has had no net job growth in that time.  And if the UBS deal is any indication, the bleeding in service jobs has just begun.
 A, O, way to go…Connecticut.

Jeff Matthews
Author “Secrets in Plain Sight: Business and Investing Secrets of Warren Buffett”
(eBooks on Investing, 2011)    Available now at

© 2011 NotMakingThisUp, LLC
The content contained in this blog represents only the opinions of Mr. Matthews.   Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews’ recommendations.  This commentary in no way constitutes investment advice, and should never be relied on in making an investment decision, ever.  Also, this blog is not a solicitation of business by Mr. Matthews: all inquiries will be ignored.  The content herein is intended solely for the entertainment of the reader, and the author.


Brad Reid said...


At least in the past, if an individual abandoned a property and left the mortgage holder with an unpaid debt, the mortgage holder would dispose of the property and eventually "forgive" the debt . . . and the IRS would qualify such forgiveness as tantamount to the receipt of taxable income. A big tax bill ensued for the individual who walked away.

I wonder if this is applicable to corporations for which debts are forgiven?

Brad Reid, Fort Worth, TX

Anonymous said...

Paying companies for relocations and new jobs is poor practice but at least results in some growth. Bribing them to stay is indefensible. And kudos for pointing out that it is the rest of us, both individuals and corporations, who are subsidizing UBS. It's no different from a certain speech given today asking coporations and a few individuals to subsidize the rest of the population.

Anonymous said...

Unfortunately, most if not all states do this.

When government tries to pick winners (Solyndra?), it puts the people on the hook if and when they fail. Instead of the investors shouldering the risk and reward, all risk is transferred to the taxpayer.

Illinois, for example, recently jacked their business taxes to the moon. The small businessman, who can't move, is stuck. A big business -- Boeing or Catepillar, I think it was -- simply threatens to move, and the politicians fell over themselves offering bribes and "rebates" to get them to stay. It's insidious.

This is, let's be honest, a form of fascism, where business and government collude to pick who stays in business and which competitors get gouged. In this way, the bribery runs in both directions. It's very unhealthy and misdirects capital from useful work.

Kyle S said...

Hi Jeff -
This is not related to the current topic but I thought you might find this article from the NYT about the process HP used to hire Apotheker interesting: Voting to Hire a Chief Without Meeting Him.

The article takes pains to give credit to Mark Hurd for HP's revival and blame Apotheker for its subsequent stumbles, including this unbelievable line:

"Almost from the day Mr. Apotheker arrived, H.P.’s operating results declined with dizzying speed..."

Earlier in the article was this description of Hurd:

"Though not without detractors, Mr. Hurd pulled off one of the great rescue missions in American corporate history, refocusing the strife-ridden company and leading it to five years of revenue gains and a stock that soared 130 percent"

I know the media loves to give all credit or blame for a company's successes and failures to its CEO, but this seems beyond the pale. What a coincidence that HP's performance started unraveling the moment Apotheker arrived. It isn't at least slightly possible that the seeds of this were planted by the guy who preceded him? That the well of accounting tricks and adjusted non GAAP measures Hurd preferred would eventually run dry?

I'm not an Apotheker fan, but the hagiography of Hurd offends my sensibilities.