IRS rule would deepen cost of credit default swap debacle

Paul McMorrow’s excellent column about the Abacus deal involving Goldman Sachs and investor John Paulson stops short of what may be the most outrageous chapter of the credit default swap debacle (“Banks dodge accountability for financial collapse,” Op-ed, Jan. 8).

As reported in my forthcoming article in the University of Massachusetts Law Review, in 2000 the securities industry was so concerned that credit default swaps were illegal gambling that the industry persuaded Congress to exempt them from state gambling laws. Though Congress agreed to decriminalize them, Congress did not change the tax laws, so, while now legal, credit default swaps are still gambling, taxable at ordinary income tax rates. Notwithstanding this clear state of affairs, last year the IRS quietly proposed regulations that would grant favorable capital gains treatment to the gargantuan profits made by Paulson and others placing these naked bets against the economy. This is a tax break potentially worth hundreds of billions of dollars.

Considering the cost to the US Treasury of bailing out a financial system collapse caused at least in part by credit default swaps, this is the last place where the IRS should be handing out tax breaks, especially when they haven’t been authorized by Congress.

James Blakey