How Wall Street is destroying the timber way of life

Montana'ꀙs forest products industry is staring extinction in the face, Kirk Johnson reports in Tuesday'ꀙs New York Times. Johnson describes a scramble "to save the historically important, culturally resonant timber industry — once a pillar of the state'ꀙs identity, now under siege as demand for housing and wood products has plummeted in the national economic downturn.'ꀝ

Welcome to the modern economy, where there'ꀙs no chance that in Montana, or any place else, the forest products industry of the future will look anything like the forest products industry of the past. Even before the U.S. economy tanked, traditional forest products companies operating under their traditional names and corporate structures had become as rare in the Northwest woods as the northern spotted owl.

The old forests on which those traditional companies once grew fat are, by now, mostly gone. By the early 1990s, when battles over the northern spotted owl and other old-growth-dependent wildlife shut down logging in the national forests, an estimated 85 percent of the Northwest'ꀙs original old growth had already disappeared. Just about all the remaining old growth was already protected in national parks and wilderness areas. The environmental battle focused on the last bit of unprotected old growth that still grew on federal land.

The Northwest Forest Plan, created by the Clinton administration to settle the owl wars, placed almost all of those trees off limits. The Forest Plan was supposed to protect habitat for the owl and a host of other species, including wild salmon, and still permit loggers to cut a billion board feet of timber each year in the national forests. A billion board feet was never realistic, but the Bush Administration has portrayed it as a solemn commitment and has been trying to loosen logging restrictions for the past eight years. So the battles continue. Fourteen years after the Forest Plan went into effect, environmentalists still fight federal agencies over the fate of the owl and its habitat. The upshot has been very little logging in the national forests. The mills built to process old growth logs have shut down. The curtain was coming down on the legendary business of the old Northwest.

But not on the forests themselves, ironically. Once upon a time, environmentalists — and some timber workers — worried that we were logging the forests at an unsustainable rate. At least in the national forests, we were. Now, the trees are growing a lot faster than they'ꀙre being cut.

To be sure, on the urban fringe a lot of the old forests keep disappearing, not because of logging but because growing houses is a lot more profitable than growing trees. "A continuation of the converstion of this land to non-forest uses seems inevitable, particularly in the Puget Sound region," states a 2007 report by the UW'ꀙs College of Forest Resources on The Future of Washington'ꀙs Forests and Forest Industries. 'ꀜForestlands are declining by more than 30,000 acres per year. . . . Higher and better uses attract values that are many times larger than forestry use values.'ꀝ

So the fight over our forests has shifted to a new front: real estate development in the exurbs and in the resort-rich Mountain West. 'ꀜObjectives of protecting endangered species habitat and fish-bearing streams lack incentives and lead to unintended consequences,'ꀝ says the report. 'ꀜMany ecosystem services are being provided by landowners at low cost to consumers, but at great cost to landowners.'ꀝ That's not likely to keep happening. In exchange for giving up potential profit, land owners get increased regulatory hassle. 'ꀜNon-industrial owners are . . . in the path of growth and extremely frustrated by some of the rules and regulations,'ꀝ the report warns. 'ꀜYou can'ꀙt log trees as close to a stream as you can build a house.'ꀝ

At the same time, industrial forest-land owners have felt financial pressure to do nothing but grow trees. And here's where the story becomes not one about spotted owls but about the federal tax code and the Wall Street financial engineers. (If the following story has echoes of the mortgage-derivative frenzy in the housing market, you are not far off.)

Let's take the saga of Plum Creek, which led the way toward the current brave new financial world. It followed a long, winding path to get here. In 1864, Congress authorized huge land grants as a reward for anyone who built a railroad from the Great Lakes to Puget Sound. The Northern Pacific laid the rails and got the land. Eventually, after a big merger in 1970, the remaining land wound up in the corporate hands of the Burlington Northern Railroad. BN spun its land holdings off to Burlington Resources. Next, the timberlands went to a master limited partnership called Plum Creek. In 1999, Plum Creek reconstituted itself as a real estate investment trust (REIT).

At this point, the forest story of old-style timber barons becomes a tax-code story. As a corporation, Plum Creek paid income taxes at the corporate rate. As an REIT, it did not, since earnings were distributed to the investors, who paid taxes on individual capital gains. The REIT structure was an artifact of 1960s legislation aimed at making every man and woman a real estate speculator. (Shades of Fannie Mae and getting everyone a mortgage.) Until then, relatively small investors were frozen out of major real estate developments, which were primarily financed and owned by limited partnerships favored by the wealthy. The REIT got similarly favorable tax treatment for small investors and also shielded investors from liability, which a limited partnership did not. At the end of the 1990s, it wasn'ꀙt clear that a REIT could own and manage timber land, but Plum Creek persuaded the government to say that it could.

Since then, 'ꀜWall Street has become very interested in timber-growing as a long-term investment,'ꀝ says former Weyerhaeuser CEO Jack Creighton. 'ꀜPension funds started it,'ꀝ Creighton explains, 'ꀜand now Wall Street has picked it up. They'ꀙve come to the conclusion that the REIT is the way to go,'ꀝ Creighton observes. 'ꀜI can'ꀙt argue with the financial logic, but to achieve that, you'ꀙve go to isolate the timber in an REIT.'ꀝ

That's because there'ꀙs a big string attached to the tax break: You can'ꀙt qualify as a timber REIT if more than 20 percent of your assets consist of things other than timber land. So if a corporation wants REIT tax advantages, 'ꀜyou'ꀙve got to get rid of everything else.'ꀝ In other words, once Plum Creek got the federal government to agree with this scheme, the advantages of the old vertically integrated forest products company were outweighed by disadvantages created by the federal tax code. Wall Street doesn'ꀙt want the timber without the tax breaks. A lot of traditional forest products companies have restructured accordingly.

Plum Creek'ꀙs transformation attracted a lot of outside capital. Plum Creek promptly used its new wealth to buy The Timber Company, which owned all of Georgia Pacific'ꀙs timberland. Thanks to the GP purchase, Plum Creek has supplanted Weyerhaeuser as the nation'ꀙs largest private land holder.

While old-line forest products firms have been transforming themselves, companies with no history of timber ownership have come into possession of vast forests. In 2003, Weyerhaeuser decided to sell off its 104,000-acre Snoqualmie tree farm. An environmental trust tried to buy it, but the deal fell through because Congress wouldn'ꀙt approve tax-free financing. Weyerhaeuser promptly sold the tree farm to Hancock Timber Resources, a subsidiary of Hancock Natural Resource Group, which was in turn a subsidiary of John Hancock Financial Resources. Ultimately, the Cascade Land Conservancy brokered a deal in which Hancock sold 90,000 acres to King County, but a lot of people feared the worst when the tree farm wound up in the hands, however indirectly, of a Boston-based financial services company.

Thus the irony of 'ꀜthe tree growing company'ꀝ selling off productive forest land. Once the industry'ꀙs 800-pound gorilla, Weyerhaeuser now looks more like the last of the dinosaurs. It is the last big integrated forest products company left standing. And Wall Street wants it, too, to change.

At the beginning of August, right after Weyerhaeuser announced 1,500 layoffs, Scott St. Clair wrote in Crosscut that 'ꀜstarting a few years ago, Weyerhaeuser began spinning off assets. Always committed to focusing only on businesses in which it could be a major player, it now shifted to getting out of many of those businesses altogether. Its printing and writing-grade paper operations became, in a complex trade, part of Canadian-based Domtar Industries. And just last week, in perhaps the biggest blow of all, Weyerhaeuser closed on the sale of its packaging business to [International Paper]. Some 114 facilities, including paper mills, carton plants, and recycling centers, were sold for $6 billion. . . .What's left of the company represents more of what old Friedrich Weyerhaeuser founded over a century ago: land and trees. Wall Street effectively made the decision that it will no longer measure the value of Weyerhaeuser by what it makes but, rather, by what it owns.'ꀝ

BusinessWeek reported early last year that 'ꀜshares of Weyerhaeuser kicked up 5.3%, to 71.93, on Dec. 15 [2006] when Franklin Mutual Advisers, which owns a 7.6% stake, filed a letter with the Securities & Exchange Commission urging the company to take action to boost profits and unlock its intrinsic value. . . . One option is to turn the company into a real estate investment trust (REIT) for tax advantages and to make it more competitive. On Jan. 18, Weyerhaeuser named Debra Cafaro, a well-regarded REIT executive, to its board. That sends a 'ꀘclear signal that Weyerhaeuser will be looking at moving its huge timberlands into a REIT,'ꀙ says Mark Wilde of Deutsche Bank.'ꀝ (The company's stock price has since dropped to less than half its 2006 high.)

Creighton is suspicious of the explanation that 'ꀜwe want 'to unlock the value'ꀙ in timberland.'ꀝ What that means, he thinks, is to convert the company to a REIT and then sell off the assets. 'ꀜI think the people who want W to turn into an REIT [are really just] in it for the short-term profit.'ꀝ In other words, they hope that conversion drives the stock price up,. If it does, they'ꀙll simply sell.

Last spring, the massive federal farm bill included a tax break for Weyerhaeuser, intended to level — or almost level — the playing field, by dropping the company'ꀙs corporate rate from 35 to 17 percent. Weyerhaeuser had originally lobbied for a stand-alone bill. When that effort failed, 'ꀜWeyerhaeuser officials, including Chairman Steve Rogel, continued to lobby lawmakers face to face, telling them the company's survival was at stake,'ꀝ Les Blumenthal wrote for the McClatchy Newspapers. 'ꀜIn the days after Weyerhaeuser reported a first quarter $148 million loss, Rogel, along with chief executive Daniel Fulton, urged lawmakers to include the [tax break] as a provision in the farm bill." Aided by Representative Norm Dicks and both of Washington'ꀙs Senators, they succeeded.)

Critics were saying 20 years ago that Wall Street'ꀙs myopic focus on quarterly results was a bad fit with the multi-generational perspective one needs to grow timber. Some people see that pressure to focus on the short-term as a reason for the industry'ꀙs re-structuring over the past decade. Others don'ꀙt. Both may be right.

'ꀜI put the pension funds in a totally different category" from the other investors, Creighton says. For the pension funds, 'ꀜgetting into it was a great decision.'ꀝ Timber gives them the cash flow they need over long periods, without losing the value of the underlying assets. Other investors may not have the same abiding interest in the long term. 'ꀜOn the Wall Street side I'ꀙm cynical, in that Wall Street comes and goes.'ꀝ

Creighton says that his critical attitude 'ꀜis ironic to me because when I came to Weyerhaeuser in 1970, I was executive vice president of the country'ꀙs largest REIT.'ꀝ Nevertheless, he can'ꀙt escape the conclusion that 'ꀜthe Wall Street types . . . are driving integrated forest products companies out of business.'ꀙ'ꀘ And he doesn'ꀙt much like it. 'ꀜI view this financial engineering negatively,'ꀝ Creighton says. 'ꀜIt'ꀙs destroying companies. It'ꀙs destroying communities. It'ꀙs destroying people'ꀙs jobs and ways of life.'ꀝ