Montana’s forest products industry is staring extinction in the face, Kirk Johnson reports in Tuesday’s New York Times. Johnson describes a scramble "to save the historically important, culturally resonant timber industry — once a pillar of the state’s identity, now under siege as demand for housing and wood products has plummeted in the national economic downturn.”
Welcome to the modern economy, where there’s 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’s 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’re 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’s College of Forest Resources on The Future of Washington’s Forests and Forest Industries. “Forestlands 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.”
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. “Objectives of protecting endangered species habitat and fish-bearing streams lack incentives and lead to unintended consequences,” says the report. “Many ecosystem services are being provided by landowners at low cost to consumers, but at great cost to landowners.” That's not likely to keep happening. In exchange for giving up potential profit, land owners get increased regulatory hassle. “Non-industrial owners are . . . in the path of growth and extremely frustrated by some of the rules and regulations,” the report warns. “You can’t log trees as close to a stream as you can build a house.”
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’t clear that a REIT could own and manage timber land, but Plum Creek persuaded the government to say that it could.
Since then, “Wall Street has become very interested in timber-growing as a long-term investment,” says former Weyerhaeuser CEO Jack Creighton. “Pension funds started it,” Creighton explains, “and now Wall Street has picked it up. They’ve come to the conclusion that the REIT is the way to go,” Creighton observes. “I can’t argue with the financial logic, but to achieve that, you’ve go to isolate the timber in an REIT.”
That's because there’s a big string attached to the tax break: You can’t 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, “you’ve got to get rid of everything else.” 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’t want the timber without the tax breaks. A lot of traditional forest products companies have restructured accordingly.
Plum Creek’s 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’s timberland. Thanks to the GP purchase, Plum Creek has supplanted Weyerhaeuser as the nation’s 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’t 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.
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