OK, but in that case people shouldn't be allowed to put up securities they own as collateral for loans ( a popular kind of financial engineering among very wealthy people).
> shouldn't be allowed to put up securities they own as collateral for loan
Is that because the people making the loan aren't sophisticated enough to price those securities correctly in this context and so are being taken advantage of?
> a popular kind of financial engineering among very wealthy people
To use assets without a single universal price as collateral? I think everyone does this.
No. Say you just made $1 billion in capital gains but you don't want to turn it into cash and pay taxes. So what you do is take out a loan of say $100 million against some of your securities, which gives you plenty of cash to play with. In fact you can keep doing this, just raising another loan to pay off the first one, and so on, until you die - at which point your estate can pay off the outstanding loan, and your legacy is exempt from capital gains taxes. It's called 'buy, borrow, die'.
> Is that because the people making the loan aren't sophisticated enough to price those securities correctly in this context and so are being taken advantage of?
No, it's because using stock (and other securities) this way allows them to "convert" the stock into money without actually realizing the gains. Thus they derive benefit from the gains without actually paying capital gains tax.
They're not converting anything. If they don't pay back the loan the stock must be surrendered. If the stock does not have the face value required to satisfy the loan more money must be paid in to settle the debt. If the stock loses value you may very well get a call from the bank reducing the size of your loan facility or requiring you to put more collateral into the contract.
They're deriving secondary benefit from ownership and they're paying interest for the facility with the ultimate expectation that they pay back the loan and the stocks never actually trade hands.
This is not much different from any interest bearing account. Should it be that you have to take all your money out of savings and ensure you earn nothing from it if you intend to offer it as collateral on a loan?
> This is not much different from any interest bearing account. Should it be that you have to take all your money out of savings and ensure you earn nothing from it if you intend to offer it as collateral on a loan?
The difference is taxes. Interest on a savings account used as collateral is still taxed. Gains used as collateral in a loan are not taxed.
The parent poster is suggesting this loophole be closed - that the practice either be disallowed or considered realizing the gains for tax purposes.
