The Pebble and the Avalanche

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Current Revolutions in Business and Technology

by Dr. Moshe Yudkowsky,

author of The Pebble and The Avalanche: How Taking Things Apart Creates Revolutions


Tue, 2009-Feb-03, 09:01

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Paint, Paintings, and the Financial Crisis

Last week I wrote about the financial crisis and the idea that many people have floated — to require that loan originators retain an equity stake in the financial instruments they originate. I pointed out that this was a terrible idea, akin to requiring paint manufacturers to retain an equity stake in every project that uses the paint they sell.

Instead of paint, let's discuss paintings. Brandies University recently decided to close its famous Rose Musuem of art and sell its collection of art in order to keep the rest of the university afloat. Of course some donors to the museum are up in arms, but what's interesting to our discussion is that, in essence, some donors have retained what amounts to an equity stake in the art they donated:

Under the Related Use Rule of the 2006 Pension Protection Act, the recipient organization -- the Rose [Museum] -- is required to make substantial use of the donated property (such as hanging the art on a wall) within a three-year period or else the deduction is disallowed. Now, in the case of a museum that is closing, the requirements of the related use rule still could be met if museum officials notify the Internal Revenue Service that either the institution had intended to use the donated artwork but that the situation has become impossible or that the school simply wants to sell it. (It is not at all clear if Michael Rush or Brandeis officials plan to do anything of the sort.) It is quite possible, according to Ralph Lerner, a New York tax attorney and co-author of "Art Law" (Practicing Law Institute), "that the IRS might disallow the [donor's] $10 million deduction and only permit a deduction of $1 million," the amount the donor of the Warhol had paid originally.
To date no donors have filed lawsuits, but that may happen, especially if a Brandeis sale results in liability to the donor.

All this fuss is over a few thousand works of art, given as gifts. Now imagine if you will what will happen if mortgage originators must keep an equity stake in the hundreds of thousands of loans they originate: they will not only have to take some risk, but they will also have to monitor the actions of any company that subsequently deals in the loan and seek legal relief if that company takes actions which result in tax liabilities or lowered value for the equity stake. The result would be legal and business nightmare — which is exactly why eliminating disaggregation of ownership is such a terrible idea.

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