The Inversion of Finance

There's an interivew with FedEx's CEO Fred Smith in the Wall Street Journal online, and he makes one of the most intelligent and perceptive comments about the financial services industry that I've yet to see:

He attributes the financial crisis to "the intersection of four long-term developments." Reckless mortgage lending policies; high energy prices; mark-to-market accounting rules; and national policies that favor what he calls "the financial sector over the industrial sector."

"Rather than in our business where you have to have a dollar of equity for, 10 cents or 15 cents of debt," he explains, "it's exactly the opposite in the financial sector where you have one dollar of equity for 10, 25, 50 times risk." "Things became so flipped upside down," he explains, that "the assets at these banks became the liabilities and the liabilities became the assets. These people were making these fantastic returns -- at places like Fannie Mae and Freddie Mac -- but in reality they weren't adding a lot of value. I have said time and again that there is a fundamental tendency in good times in the financial sector to over-leverage. Our national policies actively encouraged all this debt."

The concept of assets becoming liabilities and liabilities becoming assets is so completely apt as to be startling in its simplicity.

I'm not sure I agree with his appeal to change the tax structure allowing capital purchases to be treated as out-of-pocket expenses. The question is whether you drive accounting rules by tax policy or tax policy by accounting rules. The reason for amortization is to more throughly match up expenses with revenues. At the same time, to be fair, once you've paid for that Boeing 777, you're not getting to return it and the money is gone. But what if it's financed and you're paying over time. It doesn't seem reasonable to allow the immediate expensing of the entire amount.

He mentions that he things the corporate tax rate should be lowered, and that at 38% it's even higher than Germany's 25%. My question would be not what the tax rate is on the books, but what the average realized tax rate is. I have a suspicion that most large corporations are managing to write off enough that the effective tax rate is far lower.