Economic dominoes: the seeds of Bush's defeat were sown under Reagan - but not in the way the media think; toppled by tax reform

National Review, Nov 30, 1992 by Paul Craig Roberts

MANY factors contributed to George Bush's defeat, but polls report that the economy played the biggest role. In the end, the Bush Presidency was destroyed by economic dominoes toppled by the Tax Reform Act of 1986. Ironically, this disastrous legislation was the work of Bush advisors James A. Baker III and Richard Darman, who were running the Treasury Department at that time.

As experts such as George Washington University professor John W. Kendrick have concluded, the 1986 Act raised the cost of capital, thus reducing productivity growth and taking out a lot of the juice that Reagan had put in the economy. Its biggest effect, however, was in destroying a tremendous amount of real-estate wealth, thereby collapsing savings & loan associations and commercial banks.

The legislation greatly lengthened the depreciation period for commercial real estate. The longer payback period substantially reduced the values of properties. Simultaneously, the act took away the normal tax deductions from most real-estate investors, resulting in negative cash flow, which caused investors to walk away from their investments. A third blow was the 40 per cent hike in the capital-gains tax rate. This made it certain that no investor would hold on for the long haul.

The gratuitous destruction of $1 trillion or more in wealth was a political fiasco in itself. However, the Bush Administration greatly magnified the destructive effects with the 1989 S&L act, which destroyed the value of thrift charters. With the deposit-insurance fund exhausted, the cost of bailing out the depositors was shifted to taxpayers. Fearful of what their stupidity had wrought, the policymakers hid behind allegations of private real-estate fraud, and this is when Mr. Bush's political troubles began in earnest.

In towns and cities all over the country, it had been a mark of local prominence to serve on the board of the bank or S&L. Now these business people, doctors, and lawyers--the backbone of the Republican Party-- are being ruined by government suits alleging breach of fiduciary duty for approving real-estate loans that later declined in value because of the 1986 Tax Reform Act ! It is not the fault of these board members that federal legislation thoughtlessly destroyed the value of real-estate projects that their institutions had financed. But the Federal Government could not care less. The Resolution Trust Corporation and the Federal Deposit Insurance Corporation have set in motion a powerful mechanism for a total miscarriage of justice. They have hired private law firms that bill by the hour to try to recover from thrift and commercial-bank executives and board members, and from their accountants, legal advisors, and insurance companies, as much of the cost of the deposit-insurance bailout as possible--regardless of any real malfeasance.

The lawyers, thus, have an incentive to sue anyone ever connected with a failed financial institution. As Gretchen Morgenson shows in the September 28 issue of Forbes, the government's lawsuits are terrorizing innocent people. In one instance, an allegedly negligent director had been comatose in a hospital bed at the time the allegedly negligent loan was approved. In another instance, the estate of a dead man is being sued--thereby disrupting the education of his children-because of real-estate evaluations that were perfectly sound before the 1986 Act. The RTC makes the incredible claim that 81 per cent of S&L failures involved fraud and misdealings. As Forbes says, "That simply isn't so." Scarcely any of the 2,100 financial institutions that have been closed would have failed had it not been for the 1986 Act.

The persecution of the private credit system by the FTC and the FDIC-- permitted by the Bush Administration-has disrupted local business throughout the country and put the economy on hold. Recently, Alfred J. T. Byrne, general counsel of the FDIC, bragged in the Wall Street Journal that "the FDIC's current litigation load numbers some 34,000 cases, and non-litigation items add 10,000 matters to our legal responsibilities." To handle all the work, he has "a staff of 850 attorneys and 1,200 support personnel" together with "more than 1,400 outside law firms." Democrats on the Senate Banking Committee have encouraged the large number of frivolous lawsuits precisely because. the targets are Republican business men and women.

Deficit Phobia

THE STUPIDITY of the Bush Administration's approach to the made-in-Washington S&L debacle reflects the Republican establishment's deficit phobia--it blindly destroys its own in pursuing a smaller deficit. Indeed, the real-estate crash that brought down the S&Ls was itself a product of the same deficit phobia. The 1986 Tax Reform Act was constructed on the rotten basis of static revenue estimates, which mistakenly assumed that taking away real-estate "tax preferences" would raise revenues to pay for lower tax rates. Instead, we got a $200- to $500-billion (depending on how it is measured) taxpayer bailout of federal deposit insurance caused by the collapse in real-estate values. It should have been obvious to policymakers that real-estate prices, already under pressure from unexpected disinflation, could not absorb the massive change in tax treatment. And yet the Treasury Department, Congress's Joint Committee on Taxation, and the Congressional Budget Office still employ the people who assumed that they would.