the economy

Specifically, we refer to the recent coordinated and highly specific attack on private equity brought forth by Congressman Henry Waxman (D-CA). He proposed additional SEC scrutiny and oversight on the Blackstone IPO from late June and actually called for a halt to the IPO.

Couple that with the tax-based idea to eliminate the long-term capital gains rate treatment on the carried interest for private equity interest proposed by Sens. Chuck Grassley (R-IA) and Max Baucus (D-MT). They suggest converting that to more of a corporate income tax structure, all in the guise of trying to fund AMT tax relief.

This is troubling because it represents an overt effort by Washington, D.C. to impede the free flow of capital.

As you know from our many years in business, we are staunch believers in supply-side economics and free markets. We believe that a reduction in the hurdles and impediments to capital flow is a good thing for markets and investors (and, along with it, the economy).

It’s hard to imagine that the politicians in D.C. want to mess with a good thing. Consider the absolute vindication of supply-side economics since the Bush tax cuts were enacted in 2003.

Revenues hitting the Treasury’s coffers increased dramatically in the following years – up 6 percent in 2004, 15 percent in 2005, 12 percent in 2006 and, so far in 2007, up an estimated 11 percent. At the same time, tax rates were lowered, with capital gains rates falling from 20 percent to 15 percent, dividends from 39.6 percent to 15 percent and marginal income tax rates from 39.6 percent to 35 percent at the highest levels.

We call that proof that capital flows freely along the path of least resistance to the overall long-term betterment of the markets and investors.

In Washington they call it, quite literally, “unanticipated tax receipts.”

We hope you would agree that all of this has spurred economic activity -- a desire by businesses to invest for appreciation and return. Free markets work. No matter how much spin other economic persuasions want to throw at the issue, both the economy and the federal government benefited from the reduction in tax rates. Capital has flowed to the markets and with it, investments were made and returns generated.

Any impediments to this free flow can ultimately be harmful.

Consider the overreaching implications of Sarbanes-Oxley.

Few would disagree that as an effort to regulate corporate America in a post-Enron world, Sarbanes-Oxley, while potentially well-intentioned, was too far‑reaching. Its impact created a disproportionate increase in foreign markets for newly minted stocks -- specifically as a source of IPOs -- when compared to domestic markets.

One only has to look at the interest many companies going public have in using London. New York is no longer considered the defacto choice, which ties directly back to the onerous provisions of Sarbanes-Oxley.

An assurance to the public that financial information being presented is accurate and complete is good. However, the markets have a way of taking care of those companies and sadly, investors along with it, which defies the public good.

Long before Sarbanes-Oxley and Enron, companies that fibbed on their finances became unwelcome at public exchanges and saw capital from investors dry up.

Take a look at what private equity is doing, no longer with relatively small and medium-sized companies, but with many of the biggest companies. One of the reasons private equity is enticing for public companies is to rid themselves of the burden of Sarbanes-Oxley-related regulatory compliances

This is one of the few times in history where on a week-by-week basis large companies are either being taken private or are working in conjunction with private equity. All of this to move to the private side of the aisle for greater flexibility than available under Sarbanes-Oxley-imposed regulations.

As an aside, we note the irony in the Blackstone IPO. This is a firm that said it sought to free the companies it was buying from the costs and hardship of Sarbanes-Oxley compliance. But now it’s willing to subject itself to those same compliance requirements so it can tap public markets for more liquidity to do deals.

That brings us back to the central question: If you believe that free markets work, do impediments – whether they are regulatory, taxation or government oversight – represent the death knell to free markets?

We see the potential for storm clouds brewing.

We see it as evidenced by the recent debate where none of the Democratic presidential contenders – even if the election is a year and a half away – shrugged their shoulders or contested Sen. Hillary Rodham Clinton’s (D-N.Y.) statement that the Bush tax cuts have been a disaster – a “give-away to the rich.” She also said that when they expire in 2010, there will be no attempt to extend them.

That’s troubling -- an increase in taxation is an all-too-common impediment to the free flow of capital. It restricts the ability for individuals to look to invest for a return. If you believe in supply-side economics, a potential increase in tax rates is not for long‑term market health.

This is not a Democrat or Republican issue. This is not politics; it is economics.  

For example, reduction of AMT tax treatment would be welcome in the view of supply-side economics. However, many leaders in both the house and the senate – Republican and Democrat alike – lean toward tax increases to offset their perceived loss in revenue from reduction or elimination of AMT rates. This is the aforementioned Grassley-Baucus idea.

We look at these dark clouds and wonder if they are merely a disturbance that will dissipate or will gain strength and support as they move closer to us in the years ahead.

We look at the sway of the general electorate and, although we cannot directly put our finger on it yet, something is definitely brewing.

For the better part of 25 years, the domestic economy, markets and investors have generally benefited from an overall policy of lower taxes. This has been true under both Democratic and Republican administrations.

So, be diligent in your belief that 2007 holds great promise. We have question marks as the political process heats up for national elections in 2008.

We will keep you posted as we monitor developments that might lead from the general disturbance we see now, into a tempest that could spell significant erosion in prospects for markets and investors.

With no intention of being alarmist, we too do not want to look back through the crystal clear eyeglass of time and be judged to have been naïve as the economic storms clouds began. Isaac Cline was asked long prior to the Great Galveston Hurricane to appraise the city’s vulnerability and he said prophetically: “The opinion held by some—that Galveston at some time will be seriously damaged by some such disturbance (as a hurricane) is simply an absurd delusion.