Monday, June 23, 2008

The Game is Over. There Won't Be a Rebound

The Game is Over. There Won't Be a Rebound

Interview with Michael Hudson

By Mike Whitney

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Mike Whitney: Fed chairman Bernanke has been on a spree lately, delivering three speeches in the last two weeks. Every chance he gets, he talks tough about the strong dollar and "holding the line" against inflation. Treasury Secretary Henry Paulson even said that "intervention" in the currency markets was still an option. Is all of this jawboning just saber rattling to keep the dollar from plummeting, or is there a chance that Bernanke actually will raise rates at the Fed's August meeting?

Michael Hudson: The United States always has steered its monetary policy almost exclusively with domestic objectives in mind. This means ignoring the balance of payments. Like the domestic U.S. economy itself, the global financial system also is all about getting a free lunch. When Europe and Asia receive excess dollars, these are turned over to their central banks, which have little alternative but to recycle these back to the United States by buying U.S. Treasury bonds. Foreign governments – and their taxpayers – are thus financing the domestic U.S. federal budget deficit, which itself stems largely from the war in Iraq that most foreign voters oppose.
Supporting the dollar’s exchange rate by the traditional method of raising interest rates would have a very negative effect on the stock and bond markets – and on the mortgage market. This would lead foreign investors to sell U.S. securities, and likely would end up hurting more than helping the U.S. balance of payments and hence the dollar’s exchange rate.
So Bernanke is merely being polite in not rubbing the faces of European and Asian governments in the fact that unless they are willing to make a structural break and change the world monetary system radically, they will remain powerless to avoid giving the United States a free ride – including a free ride for its military spending and war in the Near East.

MW: How do you explain the soaring price of oil? Is it mainly a supply/demand issue or are speculators driving the prices up?

Michael Hudson: It’s true that enormous amounts of speculative credit are going into commodity index funds. But bear in mind that as the dollar depreciates, OPEC countries have been holding back supply largely to stabilize their receipts in euros and to offset their losses on the dollar securities they have bought with their past export proceeds. For over 30 years they have been pressured to recycle their oil earnings into the U.S. stock market and loans to U.S. financial institutions. They have taken large losses on these investments (such as last year’s money to bail out Citibank), and are trying to recoup them via the oil market. OPEC officials also have pointed to a political motive: They resent America’s military intrusion in the Middle East, especially in view of how much it contributes to the nation’s balance-of-payments deficit and federal budget deficit.
The U.S. press prefers to blame Chinese, Indian and other foreign growth in demand for oil and raw materials. This demand has contributed to the price rise, no doubt about it. But the U.S. oil majors are receiving a windfall “economic rent” on the price run-up, and are not at all unhappy to see it continue. By not building more refining and shipping capacity, they have created bottlenecks so that even if foreign countries did supply more crude oil, it would not be reflected in refined gasoline, kerosene or other downstream product prices.

MW:: The Fed has traded over $200 billion in US Treasuries with the big investment banks for a wide variety of dodgy collateral (mostly mortgage-backed securities). How can the banks possibly hope to repay the Fed when their main sources of revenue (structured investments) have been cut off? Are the banks secretly using the money they borrow via repos from the Fed to dabble in the carry trade or speculate in the futures markets?

Michael Hudson: The Fed’s idea was merely to buy enough time for the banks to sell their junk mortgages to the proverbial “greater fool.” But foreign investors no longer are playing this role, nor are domestic U.S. pension funds. So the most likely result will be for the Fed simply to roll over its loans – as if the problem can be cured by yet more time.
But when a bubble bursts, time makes things worse. The financial sector has been living in the short run for quite a while now, and I suspect that a lot of money managers are planning to get out or be fired now that the game is over. And it really is over. The Treasury’s attempt to reflate the real estate market has not worked, and it can’t work. Mortgage arrears, defaults and foreclosures are rising, and much property has become unsaleable except at distress prices that leave homeowners with negative equity. This state of affairs prompts them to do just what Donald Trump would do in such a situation: to walk away from their property.
The banks are trying to win back their losses by arbitrage operations, borrowing from the Fed at a low interest rate and lending at a higher one, and gambling on options. But options and derivatives are a zero-sum game: one party’s gain is another’s loss. So the banks collectively are simply painting themselves into a deeper corner. They hope they can tell the Fed and Treasury to keep bailing them out or else they’ll fail and cost the FDIC even more money to make good on insuring the “bad savings” that have been steered into these bad debts and bad gambles.
The Fed and Treasury certainly seem more willing to bail out the big financial institutions than to bail out savers, pensioners, social Security recipients and other small fry. They thus follow the traditional “Big fish eat little fish” principle of favoring the vested interests.

MW:: According to most estimates, the Fed has already gone through half or more of its $900 billion balance sheet. Also, according to the latest H.4.1 data "the current holdings of Treasury bills is $25 billion. This is down from some $250 billion a year ago, or a net reduction of 90%." (figures from Market Ticker) Doesn't this suggest that the Fed is just about out of firepower when it comes to bailing out the struggling banking system? Where do we go from here? Will some of the larger banks be allowed to fail or will they be nationalized?

Michael Hudson: You need to look at what the Treasury as well as the Fed is doing. The Fed can monetize whatever it wants. And as you just pointed out in the preceding question, it has been buying junk securities in order to leave sound Treasury securities on the banking system’s balance sheets. Government bailout credit will keep the big banks alive. But many small regional banks will go under and be merged into larger money-center banks – just as many brokerage firms in recent decades have been merged into larger conglomerates.
False reporting also will help financial institutions avoid the appearance of insolvency. They will seek more and more government guarantees, ostensibly to help middle-class depositors but actually favoring the big speculators who are their major clients.
What we are seeing is the creation of a highly concentrated financial oligarchy – precisely the power that the Glass-Steagall Act was designed to prevent. A combination of deregulation and “moral hazard” bailouts – for the top of the economic pyramid, not the bottom – will polarize the economy all the more.
Cities and states will preserve their credit ratings by annulling their pension obligations to public-sector workers, and raising excise taxes – but not property taxes. These already have fallen from about two-thirds of local budgets in 1930 to only about one-sixth today – that is, a decline of 75 percent, proportionally. While the debt burden and the squeeze in disposable personal income is pressuring workers, finance and property are using the crisis to get a bonanza of tax relief. Democrats in Congress are as far to the right as George Bush on this, as their base is local politics and real estate.

MW:: According to the Financial Times: "Analysts at Citigroup said a planned tightening of the rules regarding off-balance sheet vehicles would force banks to reconsider arrangements and could result in up to $5,000bn of assets coming back on to the books. The off-balance sheet vehicles have been used by financial institutions to keep some assets off their balance sheets, thereby avoiding the need to hold regulatory capital against them." Is there any way the banks can find investors with "deep enough pockets" to provide the capital they need to meet the requirements on $5 trillion dollars? Are most of these off-balance sheets assets mortgage backed securities and other hard-to-value bonds?

Michael Hudson: The practice of off-balance-sheet accounting already has become quickly obsolete this year. The United States is going to adopt Europe’s normal “covered bond” practice of bank head-office liability for mortgages and other loans. (The Wall Street Journal had a good article on this on June 17, anticipating that the U.S. covered bond market might rise quickly to $1 trillion as early as next year.)
This coverage is what has given European banks protection. In view of the heavy losses of German banks in Saxony and Düsseldorf in the U.S. subprime market last summer, it’s unlikely that investors will buy mortgages that no major bank or government agency stands behind.
Regarding more investor bailouts, I don’t see that it makes sense to lend money to a bank today without getting preferential treatment over existing holders, plus secure collateral. Government guarantees might help, especially for foreign investors. But then, the dollar’s plunge is a problem here.

MW:: Many of the TV financial gurus --as well as Henry Paulson--keep assuring us that the worst is behind us, but I don't see it. Foreclosures are increasing, the dollar is falling, unemployment is rising, manufacturing is sluggish, food and fuel are soaring, and consumers are backed up on their credit cards, student loans and house payments. Where would you say we are in the present cycle? What will it take to rebound from the current slump? Will the stock market take a beating before all this is over? What do you think the greatest problem facing the economy is; inflation or deflation?

Michael Hudson: The idea that we’re even in a business “cycle” is whistling in the dark. If we’re in a cycle, then that implies there’s an automatic recovery in store. This happy free-market idea was developed at the National Bureau of Economic Research by opponents of government regulatory policy. But the economy doesn’t move by a sine curve. There is a slow buildup, and a sudden plunge, so the shape is ratchet-shaped. This is why 19th-century writers didn’t speak of economic cycles, but rather of periodic financial crises.
Today’s plunging real estate and stock market prices are not a self-correcting ebb and flow in which downturns set in motion automatic stabilizers that produce recovery. Each U.S. recovery since World War II has started out from a higher level of debt. The result is like driving a car with the brakes pressed more and more tightly. Alan Greenspan at the Federal Reserve flooded the banking system with enough credit to enable debts to be carried by borrowing against the rising price of homes and office buildings, corporate stocks and bonds. In effect, the interest charge was simply added onto the debt balance.
But today, the prospects are dim for paying off debts out of further price gains for homes and real estate. Speculators have pulled out of the market – and as late as 2006 they accounted for about a sixth of new purchases. Asset-price inflation fueled by the Federal Reserve – is giving way to debt deflation. The United States and other countries have reached a limit in which scheduled interest and amortization absorb the entire economic surplus of so many individuals, companies and government bodies that new construction, investment and employment are grinding to a halt. Families, real estate investors and companies are obliged to use their entire disposable income to pay their creditors or face bankruptcy. This leaves them without enough money to sustain the living standards of recent years.
This means that there won’t be a rebound, and it will take longer than 2009 to recover.

MW:: I read about 8 or 9 articles every day about the meltdown in housing. I always tell my wife that its like reading a Tom Clancy novel except the ending is less certain. As Yale economist Robert Schiller pointed out last month; the decline in prices is now greater than it was during the Great Depression. Will prices find a bottom in 2009 or will it take longer? If prices keep falling then how are the banks going to sell the hundreds of billions of dollars of mortgage-backed securities that they are presently holding?

Michael Hudson: Prices will keep going down, because they have been fed by plunging interest rates, zero-amortization mortgages and low or zero (or even negative) down payments in recent years. That world has ended.
It means that the banks can’t sell their mortgage-backed securities – except to the government, at a loss except to insiders. The actual losses are much worse than the present price statistics show, because many people are frozen in with negative equity. So instead of price declines, we’ll simply see many more foreclosures.

MW:: How serious is the current crisis in the financial markets and housing and what steps do you think Obama or McCain should take to stabilize the markets, reduce the deficits, strengthen the dollar, increase employment, and put the economy on solid footing? Is it possible to have a strong economy without policies that distribute the nation's wealth more equitably? As chief economic advisor to Rep Dennis Kucinich, what one bit of advice would you give to Obama to restore America's economic vitality and put the country on the right path again?

Michael Hudson: In academic economic terms, America has never been in as “optimum” a position as it is today. That’s the bad news. An optimum position is, mathematically speaking, one in which you can’t move without making your situation worse. That’s the position we’re now in. There’s nowhere to move – at least within the existing structure. “The market” can’t be stabilized, because it was artificial to begin with, based on fictitious prices. It’s hard to impose fiction on reality for very long, and the rest of the world has woken up.
In times past, bankruptcy would have wiped out the bad debts. The problem with debt write-offs is that bad savings go by the boards too. But today, the very wealthy hold most of the savings, so the government doesn’t want to have them take a loss. It would rather wipe out pensioners, consumers, workers, industrial companies and foreign investors. So debts will be kept on the books and the economy will slowly be strangled by debt deflation.
The US can’t reduce the balance-of-payments deficit without scaling back its foreign military spending. Congress is refusing to let foreign governments invest in much besides overpriced junk here, so central banks are treating the dollar like a hot potato, trying to buy foreign assets that can play a role in their own future economic development.
I think that at some point Obama will have to tell the public the bad news that restoring vitality will take radical measures – probably ones that Congress will try to water down so much that things are going to get worse – much worse – before the needed reforms will be made. He can say this before taking office, blaming the Republicans for their regressive tax policies and at the same time bringing pressure on the new Democratic Congress to back a return to progressive taxation and serious financial restructuring. As president, he will have to do what FDR did, and challenge the financial oligarchy with new government regulatory agencies staffed with real regulators, not deregulators as under the Bush-Clinton-Bush regime.
He should make large depositors and “savers” take the losses on their bad bets. And he should repeal the Clinton repeal of Glass Steagall.
Most of all, he will have to make the tax system back progressive again if the domestic market is to recover. He should remove the tax-deductibility of interest payments, and do what the original 1913 income tax did: tax capital gains at normal income rates rather than subsidizing speculation. The great majority of such gains do not accrue to entrepreneurs, but to real estate speculators. A good tax code should encourage equity financing rather than debt pyramiding.
Social Security and medical care should be paid out of the general budget, not as user fees. And until this change is done, FICA withholding should be levied on total income, without an upper cutoff point. There should be a LOWER cut-off point, however: Only people who earn over $60,000 a year should contribute. This would end up being fairly revenue-neutral. Pres. Obama should say that his policy is not to “soak the rich.” It is to make them pay their way once again by favoring a strong middle class.
Unless he does this, what used to be a democracy will be turned into an oligarchy. And oligarchies historically are so short-sighted that they stifle the domestic economy, driving enterprise and emigration abroad. This threatens to reverse America’s long-term affluence, which means literally a flowing-in – an inflow of capital, of skilled immigrants and other labor, of technology, and of foreign support. All this has now been put in danger by the policies pursued at least since 1980.

Michael Hudson is a former Wall Street economist specializing in the balance of payments and real estate at the Chase Manhattan Bank (now JPMorgan Chase & Co.), Arthur Anderson, and later at the Hudson Institute (no relation). In 1990 he helped established the world’s first sovereign debt fund for Scudder Stevens & Clark. Dr. Hudson was Dennis Kucinich’s Chief Economic Advisor in the recent Democratic primary presidential campaign, and has advised the U.S., Canadian, Mexican and Latvian governments, as well as the United Nations Institute for Training and Research (UNITAR). A Distinguished Research Professor at University of Missouri, Kansas City (UMKC), he is the author of many books, including Super Imperialism: The Economic Strategy of American Empire (new ed., Pluto Press, 2002) He can be reached via his website, mh@michael-hudson.com

A Totally Lawless Regime

A Totally Lawless Regime

By Paul Craig Roberts

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Think about this question: In the 21st century what regime is more lawless than the Bush Regime?


Everyone is entitled to his own answer. The only answer I can come up with is the Zimbabwe regime of Robert Mugabe. Voted out of power in the last election, the great man hasn't left. Zimbabweans are going to have to vote again, and the great man has said that any vote that is not for him will be cancelled by a bullet.

Does anyone remember how determined the British and the Americans and everyone else was to turn Rhodesia over to Mugabe in order to save Rhodesia from the evil Ian Smith? What a fool everyone was.

But before we laugh at those fools, we had best laugh at ourselves, or cry.

It is now an incontrovertible fact, known all over the world, that George W. Bush and his regime's operatives lied through their teeth in order to launch wars of aggression against Afghanistan and Iraq, and that the Bush regime is doing the same thing again in hopes of launching an attack on Iran.

There have been a number of memoirs from high ranking Bush appointees who cannot stand all the lies. Bush's first Secretary of the Treasury, Paul O'Neill, told us that an invasion of Iraq was on the agenda prior to 9/11. There is the leaked Downing Street Memo in which the head of British Intelligence told the British Prime Minister and his cabinet that the Americans have decided to attack Iraq and are creating the "intelligence" to justify the attack.

And now we have the White House's own spokesman from 2003-2006, Scot McClellen, ratifying what we already knew, that President Bush deceived us and led us into war based entirely on lies and fabrications, and that he, Scott McClellen, was deceived into issuing a false public denial that top Cheney aide Scooter Libby and White House operative Karl Rove were involved in committing a felony under US law by revealing the identity of a covert CIA operative, Valerie Plame.

As a consequence of Bush's lies, there are a million dead Iraqis, mostly women and children, and four million displaced Iraqis, 4,100 dead American soldiers and tens of thousands of seriously wounded. No one knows how many dead in Afghanistan. And there is the ongoing Israeli slaughter of Palestinians and Lebanese that has fallen under the rubric of the "war on terror."

The only ones pleased with these wars are the American neoconservatives, the Israeli right-wing, the US corporate military-security complex, and Osama bin Laden.

The Bush regime has created enormous hatred and disrespect for the United States. A recent world wide poll found that George W. Bush ranks at the bottom of world leaders as one of the least trusted along with US Pakistani puppet Musharraf and the Iranian president, Ahmadinejad, who has the disadvantage of being the victim of demonization by the US and European corporate-controlled media, which serve as ministries of propaganda for the governments that control their broadcast licenses. The American and European media lie for their living.

The two leaders with the highest approval rating are UN Secretary General Ban Ki-Moon and Russian President Vladimir Putin.

So, the old adversary, Russia, now has a more respected leader than the "leader" of the Great Free Nation, a Great Free Nation that has sat on its hands while its "leader" destroyed America's civil liberties, America's reputation, the jobs of Americans, and committed the US to a course of war crimes punishable by the International Criminal Court at the Hague.

A number of readers took issue with my recent column, "Elect Obama or Fall Into Tyranny." Echoing former Alabama Governor George Wallace, readers said Obama would make no difference. But that is what I wrote.

My point was not that Obama would make any difference, as he has put himself and his administration into the hands of Wall Street and the Israel Lobby. I said that the American people could make a difference by rejecting the Republicans, as it was the only accountability that the Republicans were likely to suffer.

If Americans return a Republican regime, Americans will validate the right of the president to violate with impunity US and international law. Americans will validate the use by the president of the United States of deception and lies in order to initiate wars of aggression, aggression that is a war crime under the Nuremburg standard established by the US. Americans will validate the infringement of US civil liberties in the name of "safety" and "national security." Americans will disembowel the US Constitution and leave themselves at the total mercy of the government.

Reelecting Republicans means the end of the United States as a land of liberty.

I am sympathetic to the argument that we, as a country of liberty, are near our end regardless. Look at the Democrats. Today, June 20, the House of Representatives, which the voters gave to the Democrats in the 2006 congressional elections in order to end the pointless barbarity that the US has brought to Iraq, voted the largest war-spending bill ever. The "antiwar" Democrats completely collapsed, giving the warmonger Brownshirt Republican regime everything it wanted.

The House Democrats, led by "impeachment-is-off-the-table" Nancy Pelosi, added to the Democratic Party's shame by passing today, June 20, a bill that shields from punishment the criminal Bush regime and the telecommunications corporations that the Bush regime coerced into committing felonies under US law by cooperating in Bush's illegal spying on American citizens.

The great hope of the Founding Fathers, the people's house, the House of Representatives, has passed an unconstitutional retroactive law making acts legal which were illegal when they were committed.

If a Democratic House of Representatives will pass a retroactive law in order to legalize the criminal violations of a Republican regime, the same House will pass a retroactive law making illegal what you did legally yesterday. No one is any longer safe in America. By abandoning the US Constitution, Republicans and Democrats have made America as potentially unsafe as Zimbabwe for anyone who takes exception to the government.

The total collapse of the Democratic Party and the House of Representatives signals the end of liberty and democracy in America. Henceforth, led by the Republican Federalist Society, we will gravitate toward the beautiful regime of "energy in the executive" that has been achieved in Zimbabwe by Robert Mugabe.

Dr. Paul Craig Roberts, an assistant secretary of the U.S. Treasury during the Reagan Administration, is a former associate editor of the Wall Street Journal and coauthor of The Tyranny of Good Intentions.

Reporters Say Networks Put Wars on Back Burner

Reporters Say Networks Put Wars on Back Burner

Getting a story on the evening news isn’t easy for any correspondent. And for reporters in Iraq and Afghanistan, it is especially hard, according to Lara Logan, the chief foreign correspondent for CBS News. So she has devised a solution when she is talking to the network.

“Generally what I say is, ‘I’m holding the armor-piercing R.P.G.,’ ” she said last week in an appearance on “The Daily Show,” referring to the initials for rocket-propelled grenade. “ ‘It’s aimed at the bureau chief, and if you don’t put my story on the air, I’m going to pull the trigger.’ ”

Ms. Logan let a sly just-kidding smile sneak through as she spoke, but her point was serious. Five years into the war in Iraq and nearly seven years into the war in Afghanistan, getting news of the conflicts onto television is harder than ever.

“If I were to watch the news that you hear here in the United States, I would just blow my brains out because it would drive me nuts,” Ms. Logan said.

According to data compiled by Andrew Tyndall, a television consultant who monitors the three network evening newscasts, coverage of Iraq has been “massively scaled back this year.” Almost halfway into 2008, the three newscasts have shown 181 weekday minutes of Iraq coverage, compared with 1,157 minutes for all of 2007. The “CBS Evening News” has devoted the fewest minutes to Iraq, 51, versus 55 minutes on ABC’s “World News” and 74 minutes on “NBC Nightly News.” (The average evening newscast is 22 minutes long.)

CBS News no longer stations a single full-time correspondent in Iraq, where some 150,000 United States troops are deployed.

Paul Friedman, a senior vice president at CBS News, said the news division does not get reports from Iraq on television “with enough frequency to justify keeping a very, very large bureau in Baghdad.” He said CBS correspondents can “get in there very quickly when a story merits it.”

In a telephone interview last week, Ms. Logan said the CBS News bureau in Baghdad was “drastically downsized” in the spring. The network now keeps a producer in the country, making it less of a bureau and more of an office.

Interviews with executives and correspondents at television news networks suggested that while the CBS cutbacks are the most extensive to date in Baghdad, many journalists shared varying levels of frustration about placing war stories onto newscasts. “I’ve never met a journalist who hasn’t been frustrated about getting his or her stories on the air,” said Terry McCarthy, an ABC News correspondent in Baghdad.

By telephone from Baghdad, Mr. McCarthy said he was not as busy as he was a year ago. A decline in the relative amount of violence “is taking the urgency out” of some of the coverage, he said. Still, he gets on ABC’s “World News” and other programs with stories, including one on Friday about American gains in northern Iraq.

Anita McNaught, a correspondent for the Fox News Channel, agreed. “The violence itself is not the story anymore,” she said. She counted eight reports she had filed since arriving in Baghdad six weeks ago, noting that cable news channels like Fox News and CNN have considerably more time to fill with news than the networks. CNN and Fox each have two fulltime correspondents in Iraq.

Richard Engel, the chief foreign correspondent for NBC News, who splits his time between Iraq and other countries, said he found his producers “very receptive to stories about Iraq.” He and other journalists noted that the heated presidential primary campaign put other news stories on the back burner earlier this year.

Ms. Logan said she begged for months to be embedded with a group of Navy Seals, and when she came back with the story, a CBS producer said to her, “One guy in uniform looks like any other guy in a uniform.” In the follow-up phone interview, Ms. Logan said the producer no longer worked at CBS. And in both interviews, she emphasized that many journalists at CBS News are pushing for war coverage, specifically citing Jeff Fager, the executive producer of “60 Minutes.” CBS News won a Peabody Award last week for a “60 Minutes” report about a Marine charged in the killings at Haditha.

On “The Daily Show,” Ms. Logan echoed the comments of other journalists when she said that many Americans seem uninterested in the wars now. Mr. McCarthy said that when he is in the United States, bringing up Baghdad at a dinner party “is like a conversation killer.”

Coverage of the war in Afghanistan has increased slightly this year, with 46 minutes of total coverage year-to-date compared with 83 minutes for all of 2007. NBC has spent 25 minutes covering Afghanistan, partly because the anchor Brian Williams visited the country earlier in the month. Through Wednesday, when an ABC correspondent was in the middle of a prolonged visit to the country, ABC had spent 13 minutes covering Afghanistan. CBS has spent eight minutes covering Afghanistan so far this year.

Both Ms. Logan and Mr. McCarthy noted that more coalition soldiers were killed in Afghanistan in May than in Iraq. No American television network has a full-time correspondent in Afghanistan, although CNN recently said it would open a bureau in Kabul.

“It’s terrible,” Ms. Logan said in the telephone interview. She called it a financial decision. “We can’t afford to maintain operations in Iraq and Afghanistan at the same time,” she said. “It’s so expensive and the security risks are so great that it’s prohibitive.”

Mr. Friedman said coverage of Iraq is enormously expensive, mostly due to the security risks. He said meetings with other television networks about sharing the costs of coverage have faltered for logistical reasons.

Journalists at all three American television networks with evening newscasts expressed worries that their news organizations would withdraw from the Iraqi capital after the November presidential election. They spoke only on the condition of anonymity in order to avoid offending their employers.

Corporate Spies Targeted Activists

Corporate Espionage Detailed in Documents

Defunct Md. Agency Targeted Activists

By Jenna Johnson

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They scavenged through trash and tailed people for hours. They used undercover operatives to infiltrate private meetings. The targets were not agents of foreign powers but advocacy groups that had been critical of corporations.

In the 1990s, a Maryland-based private detective agency composed of former CIA agents and law enforcement officers spied on such activist groups as Greenpeace, the firm's records show.

The agency, Beckett Brown International, had an operative at meetings of a group in Rockville that accused a nursing home of substandard care. In Louisiana, it kept tabs on environmental activists after a chemical spill. In Washington, it spied on food safety activists who had found taco shells made with genetically modified corn not approved for human consumption.

BBI, which was founded in 1995, disbanded in 2000, and the activists might never have learned they were spied on. But a disgruntled BBI investor began digging through company records two years ago and has been contacting the former targets. He also gave The Washington Post access to the records, which provide an unusually detailed look into the secretive world of corporate spying.

"These people were victims," investor John C. Dodd III said. "They were trying to make things better or just do their jobs, and these guys were spying on them."

Although the targets were surprised when Dodd called, many said they had suspected they were being watched. Elder-care activists in Rockville had long wondered how Hebrew Home nursing facility officials seemed to predict their every move, former activist Ilene Henshaw said.

"They were absolutely one step ahead of us," she said. "I never knew why."

Not all of BBI's work targeted activists: Lysol wanted details of a New Jersey high school student's science fair project about cleaning products. Mary Kay executives sought a secret "psychological assessment" of a fellow executive. A consultant working for Nestlé wanted information about rivals Mars and Whetstone Candy.

"I always thought they were trying to sabotage me," said Henry M. Whetstone Jr., who recently reviewed the BBI records. "Everyone thinks that the candy industry is this happy world. It's not. It has a really dark side."

BBI was renamed in 1999, and it dissolved the next year. Dodd, who said he invested $700,000 in BBI, sued his former partners for breach of contract. He lost, but he kept more than 100 boxes of records from the firm's office in Severna Park.

Former targets have paid Dodd or a lawyer working with him, in some cases as much as several thousand dollars, for access to and assistance with the material, he said. At least one plans to sue.

In an interview, BBI founding partner Richard M. Beckett said his work focused on executive recruitment, a service for which The Washington Post Co. paid the firm $27,000 in 1998. Beckett said he knew little about the investigative work and left in 1999.

Former BBI investigator Timothy S. Ward, a retired Maryland State Police officer, said BBI did nothing illegal. He declined to comment on methods or specific investigations, citing what he said were confidentiality requirements under Maryland law.

The legality and ethics of such methods as dumpster diving and infiltration are widely debated and vary from state to state. Many private investigators and corporations have abandoned the practices since 2006, when it became known that Hewlett-Packard's chairwoman used investigators to spy on board members and reporters.

Experts said corporations are typically insulated from such investigations by confidentiality agreements and multiple layers of subcontractors, making the BBI documents rare for more than the methods they reveal.

"I don't know of many cases where you get to see the whole chain of people involved," said Ari Schwartz of the Center for Democracy and Technology, which researches privacy issues.

That chain included Jim Daron, a D.C. police officer who helped seize trash from outside activists' offices. "If he can't get it with the shield, it will be difficult," Ward wrote in an e-mail about dumpsters in a gated alley.

In an interview, Daron said he was present during trash pulls but served only as a driver. He said he stopped even that after BBI asked him to use his badge to gain access to restricted areas. "I said, 'No, it's over,' " he said.

D.C. police officers must obtain permission to have outside jobs; Daron, who still works for the department, said he did not do so.

The chain often included public relations consultants who hired BBI or urged clients to do so. The documents show that many of BBI's clients were referred by Nichols-Dezenhall Communications Management Group, a D.C. crisis management firm.

Before Nichols-Dezenhall disbanded in 2003, founding partner Eric Dezenhall promoted his firm's willingness to aggressively respond to what he called "the culture of the attack."

"We are the last resort, the Navy SEALs of the communications business," he told The Post in 1999. "Our only objective is to make the problem go away."

In a statement, Dezenhall said neither he nor anyone else at his former firm authorized or condoned unethical activity. "Although at times we have recommended that our clients protect themselves by retaining security and investigative experts, we have not supervised or directed those activities because that has never been our area of expertise," he wrote.

Dezenhall said his current firm, Dezenhall Resources, does not share Nichols-Dezenhall's "strategic focus." Managers, employees, clients and vendors "have turned over almost entirely since that time," he wrote.

Nick Nichols, Dezenhall's former partner, was traveling and unavailable, an associate said recently. In his book "Rules for Corporate Warfare," Nichols wrote that he hired former law enforcement officials to investigate when clients were "the target of shakedown artists and other lowlifes. And, we're proud of it."

'It's a Little Scary'

In 1997, at a community center in Montgomery County, activists held meetings to discuss Hebrew Home. The group, made up largely of residents' relatives, alleged poor medication controls and rough treatment of residents. As they strategized, an undercover operative was paying close attention.

Her reports -- along with meeting agendas, license plate numbers and descriptions of advocates -- were relayed to Hebrew Home officials, the records show.

"It's a little scary they were doing this," said Henshaw, whose father lived in the home in 1997.

Over a year, the nursing home paid BBI about $50,000 for investigative work, according to invoices addressed to chief executive Warren Slavin, who still directs the home.

Hebrew Home said in a statement that it hired BBI on a recommendation from its public relations consultant because the activists were "threatening staff, interfering with care, and putting the health and well-being of our elderly residents at risk."

"We are not aware of anyone on behalf of Hebrew Home having approved or directed, nor would we condone, any unethical activity that may have been undertaken by Beckett Brown," the facility said.

In an interview, the operative identified in the documents, Madeline "Maddie" Cole, denied that she had worked for BBI. She said she attended activists' meetings about Hebrew Home but did not recall whether she had relayed information to anyone else.

Hebrew Home made changes after state health officials found deficiencies, but Henshaw said she is certain her group would have been more effective if it had not been compromised.

Getting to the 'Inner Circle'

In 1998, at the urging of Nichols-Dezenhall, chemical company Condea Vista hired BBI to help with the fallout from an ethylene dichloride spill in Louisiana, Peter Markey, who oversaw public affairs for Condea Vista, said in sworn testimony. Thousands of workers said they were sickened in one of the largest spills in U.S. history.

Markey said in a videotaped deposition last year that he, the company's president and its general counsel were aware that BBI was sifting through trash and infiltrating meetings but did not question the practices.

Contacted recently, Sasol North America, which bought Condea Vista in 2001, said it could not comment on events that took place before it acquired the company.

According to BBI documents, investigative targets included the law firm that represented many of the workers; lawyer Tom Filo and his activist wife; Beth Zilbert, who led a Louisiana advocacy group called CLEAN; and Greenpeace's Washington offices. Mother Jones magazine has reported on aspects of BBI's work.

Ward, the former investigator, hired Jay A. Bly, a former Secret Service agent, to follow Zilbert and do weekly trash pickups. Bly wrote that he found little of value in the activist's trash: "no newspapers, magazines, flyers, envelopes. . . . It appears that they may be recycling all their trash."

Reached by phone, Bly referred questions to Ward. Zilbert said: "See? Recycling pays."

BBI obtained law firm documents, including one lawyer's tax returns, medical assessments and financial information about the firm's clients. "This stuff is stuff we never, ever would have thrown away," Filo said.

An undercover operative not identified in the documents was named to the governing board of CLEAN. "I will be in the 'inner circle' and included in all the planning meetings," he wrote in an e-mail.

The operative reported on meetings held at the law office after business hours and on private conversations about lawsuits, one of which took place in a parking lot because of concern that meeting rooms were bugged.

In the years since, several class action lawsuits stemming from the spill have been settled. One remains, and lead lawyer Perry R. Sanders Jr. said he intends to use the information about BBI's intelligence gathering to press his claim.

"It's just not okay this happened," Sanders said.

Lawn Gardens Won't Save You -- Fighting the Corporations Will

Lawn into a Victory Garden Won't Save You -- Fighting the Corporations Will

By Stan Cox

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I didn't mean to lead anyone down the garden path. Adding my small voice to those urging Americans to replace their lawns with food plants wasn't, in itself, a bad idea. But now that food shortages and high costs are in the headlines, too many people are getting the idea that the solution to America's and the world's food problems is for all of us in cities and suburbia to grow our own. It's not.

Don't get me wrong: Growing food just outside your front or back door is an extraordinarily good idea, and if it's done without soil erosion or toxic chemicals, I can think of no downside. Edible landscaping can look good, and it saves money on groceries; it's a direct provocation to the toxic lawn culture; gardening is quieter and less polluting than running a power mower or other contraption; the harvest provides a substitute for industrially grown produce raised and picked by underpaid, oversprayed workers; and tending a garden takes a lot of time, time that might otherwise be spent in a supermarket or shopping mall.

So it was in 2005 that our family volunteered our front lawn to be converted into the first in a now-expanding chain of "Edible Estates," the brainchild of Los Angeles architect/artist Fritz Haeg. We already had a backyard garden, but growing food in the front yard (which, as Haeg himself points out, is a reincarnation of a very old idea) has been a wholly different, equally positive experience.

Our perennials and annuals are thriving, we've gotten a lot of publicity, and I've been talking about the project for almost three years. Yet neither of our gardens, front or back, can stand up to the looming agricultural crisis. Good food's most well-read advocate, Michael Pollan, has written that growing a garden is worth doing even though it can make only a tiny contribution to curbing carbon-dioxide emissions. He might have added that growing food is worth it even if it does very little to revive the nation's food system.

World cropland: the pie is mostly crust

The edible-landscaping trend is catching on across the country, and with food prices rising, it has taking sadly predictable turns. A Boulder, Colo. entrepreneur, for example, has tilled up his and several of his neighbors' yards and started an erosion-prone, for-profit vegetable-farming operation. It will supplement his income, but it won't make a nick in the food crisis.

That's because the mainstays of home gardening -- vegetables and fruits -- are not the foundation of the human diet or of world agriculture. Each of those two food types occupies only about 4 percent of global agricultural land (and a smaller percentage in this country), compared with 75 percent of world cropland devoted to grains and oilseeds. Their respective portions of the human diet are similar.

Suppose that half of the land on every one-acre-or-smaller urban/suburban home lot in the entire nation were devoted to food-growing. That would amount to a little over 5 million acres (pdf) sown to food plants, covering most of the space on each lot that's not already covered by the house, a deck, a patio, or a driveway. (And in many places it couldn't be done without cutting down shade trees and planting on unsuitably steep slopes).

That theoretical 5 million acres of potential home cropland compares with about 7 million acres of America's commercial cropland currently in vegetables, fruits, and nuts, and 350 to 400 million acres of total farmland. The urban and suburban area to be brought into production would not approach the number of healthy acres of native grasses and other plants that are slated to be plowed up to make way for yet more corn, wheat, soybeans, and other grains under the newly passed federal Farm Bill.

A nationwide grow-your-own wave would send good vibes through society, ripples that could be greatly amplified by community and apartment-block gardening. But front- and backyard food, even if everyone grew it, would not cover the country's produce needs, much less displace our huge volume of fresh-food imports.

We could, instead, plant every yard to wheat, corn, or soybeans, which would account only for a little over two percent of the US land sown to those crops. Other policies, like dispensing with grain-fed meat and fuel ethanol, would free up far more grain-belt land than that.

Not even a poke in the eye

I've played a part in the promotion of domestic food-growing, and I now I seem to hear daily from people who believe that it's the best alternative to industrial agriculture (as in, "I'll show Monsanto and Wal-Mart that I don't need their food!"). Even though most prominent home-lot food efforts, like the "100-Foot Diet Challenge," also try to draw attention to bigger issues, the wider message can get lost in the excitement. Whatever its benefits, replacing your lawn with food plants will not give Big Agribusiness the big poke in the eye that it needs, nor will it save the agricultural landscapes of the nation or world.

To do that, the big-commodity market must be not just modified but overthrown. Until then, most of that two-thirds or more of the human calorie and protein intake that comes from grains and oilseeds (directly in most of the world or among Western vegetarians, largely via animal products for others in this country) will continue to be served up by a dirty, cruel, unfair, broken system.

Essential for providing vitamins, minerals, and other compounds, a highly varied diet is important, and home gardens around the world help provide such a diet. But with a world population now approaching seven billion people and most good cropland already in use, only rice, wheat, corn, beans, and other grain crops are productive and durable enough to provide the dietary foundation of calories and protein.

Grains made up about the same portion of the ancient Greek diet as they do of ours. We've been stuck with grains for 10,000 years, and our dependence won't be broken any time soon.

The United States emulate Argentina and a handful of other countries by raising cattle that are totally grass-fed instead of grain-fed and thereby consuming less corn and soybean meal. But most of the world is utterly dependent on grains. The desperate people we saw on the evening news earlier this year, filling the streets in dozens of countries, were calling for bread or rice, not cucumbers and pomegranates.

Capitalism: It doesn't go well with food

Humanity's attachment to cereals, grain legumes, and oilseeds has acquired a much harder edge in the industrial era, but as a base for political and economic power, the staple grains have always been unsurpassed. Because they hold calories and nutrients in a dense package that can be easily stored for long periods and transported, the more fortunate members of ancient societies could accumulate surpluses. Those surpluses are recognized by the majority of scholars as necessary to the birth of market economies, which allowed the prosperous to exercise control over society's have-nots. Eventually, states used control over grains to exert political power over entire populations.

Few foods could have filled that role. Noting that before grain agriculture came along, ancient Egyptians might have gathered a surplus of various foods from nature, most of them highly perishable, economic historian Robert Allen once wrote, "If all a tax collector could get from foragers was a load of waterlilies that would wilt by next morning, what was the point of having them?" The Pharaohs managed to exert control over the area's population only after people started farming wheat and barley.

The even bigger problem with grains -- which are short-lived annual plants, grown largely in monoculture -- is that they supplanted the diverse, perennial plant ecosystems that covered the earth before the dawn of agriculture. We've been living with the resulting soil erosion and water pollution ever since.

Then, when grains became fully commodified a couple of centuries ago, things really started to go downhill. In discussing his new book Stuffed and Starved: The Hidden Battle for the World Food System, Raj Patel cited India as an example: "The social safety nets that existed in India under feudal society had been knocked away by the British. If people couldn't afford food, they didn't get to eat, and if they couldn't buy food, they starved. As a result of the imposition of markets in food, 13 million people across the world died in the 19th century. They died in the golden age of liberal capitalism. Those are the origins of markets in food."

Indeed, if capitalism were a wine, it would be a wine that doesn't go well with any type of food.

Most food today is produced not as an end in itself but as a by-product of a global economy with the singular goal of turning maximum profit. That is a dysfunctional arrangement, as Nicholas Georgescu-Roegen, the founder of ecological economics explained almost 40 years ago in his book The Entropy Law and the Economic Process: "So vital is the dependence of terrestrial life on the energy received from the sun that the cyclic rhythm in which this energy reaches each region on the earth has gradually built itself through natural selection into the reproductive pattern of almost every species, vegetal or animal ... Yet the general tenor among economists has been to deny any substantial difference between the structures of agricultural and industrial productive activities."

Industrial or commercial output can be increased by building more capacity, stepping up the consumption of inputs, taking on more workers, and pushing workers harder and for longer hours. Farming, by contrast, is inevitably bound by the calendar -- by month-to-month variation in the capacity of soil and sunlight to support the growth of plants. It depends fundamentally on the productivity and the habits of non-human biological organisms over which humans can exert control only up to a point.

That clearly isn't the ideal pattern for efficient wealth generation, so the past century has seen relentless efforts to mold agriculture into the factory model as closely as possible and, where that can't be done, to graft more easily regimented industries -- farm machinery, fertilizers, chemicals, food processing, the restaurant industry, packaging, advertising -- onto an agricultural rootstock. In the US, the dollar outputs of those dependent industries are growing at two to four times the rate of agriculture's own dollar output, putting ever-greater demands on the soil.

With a wholesale shift toward mechanization of US agriculture, 75 percent of economic output now comes from fewer than 7 percent of farms; furthermore, there has been a steep rise in the proportion of farms owned by investors living in distant cities (some of them perhaps avid urban gardeners).

Because, as Georgescu-Roegen showed, there's a fundamental difference between the farm and the factory, the well-used term "factory farming" represents more an aspiration than an accomplished fact. Nevertheless, agribusiness's attempts to defy natural rhythms and achieve industrial efficiency have been ecologically devastating. The biofuel craze, encouraged by subsidies that continue in the new Farm Bill, compounds the problem.

"We must cultivate our garden," and ...

To repair the broken system that supplies the bulk of the nation's diet will require Americans to step out of the garden and into the public arena. Beyond working to get a better Farm Bill passed five years from now, we have to work together to break the political choke-hold that agribusiness has on federal and state governments.

With land and wealth being concentrated in fewer and fewer hands (and with more prisoners than farmers in today's America) we have actually reached a point at which land reform is as necessary here as it is in any nation of Latin America or Asia. Only when we get more people back on the land, working to feed people and not Monsanto, will the system have a chance to work. Most home gardeners know that the root of the problem is political, but the agricultural establishment would like nothing better than to see us spend all of our free time in our gardens and not in political dissent.

Ironically, it's that great troublemaker Voltaire who has too often been trotted out (and too often misquoted) as an advocate of withdrawing from the tumult of society, into tending one's own property. Voltaire was indeed a gardener, and he did end his most famous novel by having Candide, after surviving so many far-flung hazards, utter those famous words to his fellow wanderer Dr. Pangloss: "We must cultivate our garden."

However, with the publication of Candide in 1759, Voltaire entered the most politically active part of his life, as he "went on to a series of confrontations with the consequences of human cruelty that, two hundred-odd years later, remain stirring in their courage and perseverance," in the words of Adam Gopnik.

If Voltaire could find the time for both gardening and radical political action, then all of us can do it.

How a Shady Citigroup Subsidiary Secretly Makes Billions in the Oil Market

How a Shady Citigroup Subsidiary Secretly Makes Billions in the Oil Market

By Pam Martens

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If you want to flush out market manipulation, don't turn to the sleuths in Congress. They've been probing trading of the oil markets for two years and completely missed a company at the center of the action. During that period, a barrel of crude oil has risen from $50 to $140, leaving a wide swath of Americans facing a choice this coming winter of buying food or paying their heating bill.

The company that Congress overlooked should have been an easy suspect. It launched the oil trading career of the infamous fugitive Marc Rich, pardoned by President Bill Clinton in the final hours of his presidency. It was at one time the largest oil and metals trader in the world. In the late '90s it bought up 129 million ounces of silver for legendary investor Warren Buffet's company, Berkshire Hathaway, in London's unregulated over-the-counter market. In 1990, it was one of the first entrants into an ill-fated Russian oil venture called White Nights. In 2005, while part of Citigroup, the largest U.S. banking conglomerate perpetually scolded for obscene executive pay, it handed its chief and top oil trader, Andrew J. Hall, $125 million for one year's work. According to the Wall Street Journal, that was five times the pay package for Chuck Prince, CEO of the entire Citigroup conglomerate that year and $55 million more than the CEO of Exxon-Mobil.

Given this storied history and two years of congressional testimony on oil trading skulduggery, one would expect to find volumes of current information available about this oil trading juggernaut. Instead, this company's activities are so secret that its website, phibro.com, is a one-page affair and lists only the addresses, phone and fax numbers of its offices in the United States, London, Geneva and Singapore. No officers' names, no bios, no history, no press releases. And while the Wall Street firms of Goldman Sachs and Morgan Stanley have been fingered by Congressman Bart Stupak, D-Mich., for gaming the system, Phibro has completely escaped scrutiny during a seven-year period when crude oil has risen an astonishing 697 percent.

Phibro is the old Philipp Brothers trading firm that has resided secretly and quietly on Nyala Farms Road in Westport, Conn., as a subsidiary of the banking/brokerage behemoth Citigroup since the merger of Traveler's Group and Citicorp (parent of Citibank) in 1998. Traveler's Group owned Phibro at the time of the merger. Despite the fact that Phibro has provided Citigroup with $2 billion in revenue over the past three years, the 205-page annual report for Citigroup in 2007 carries only the following one-sentence footnote on commodity income that acknowledges the existence of this company: "Primarily includes the results of Phibro Inc., which trades crude oil, refined oil products, natural gas, and other commodities."

Combing through government archives, the first noteworthy appearance of Phibro occurs on April 6, 2001, when the Wall Street law firm of Sullivan & Cromwell sent a letter to the Commodity Futures Trading Commission (CFTC), the federal regulator of oil and other commodity trading, acknowledging that it was representing "the Energy Group." The letter was noteworthy because it delineated just who had teamed up to grease the oil rigging in Washington: namely, two investment banks (Goldman Sachs and Morgan Stanley); a house of cards that would later collapse (Enron); a proprietary trading firm inside a Frankenbank (Phibro inside Citigroup); and two real energy firms (BP Amoco and Koch Industries).

What the Energy Group had long lobbied for and finally received from its federal regulator was the breathtaking ability to trade oil contracts and oil derivatives secretly in the over-the-counter (OTC) market, thus avoiding the scrutiny of regulated commodity exchanges, its CFTC regulator and Congress. The April 6, 2001, letter was essentially to say thanks and interpret the new rules as favorably as possible for the Energy Group.

The change in the law occurred via the Commodity Futures Modernization Act of 2000 (CFMA) and is called the Enron Loophole. (Since Enron's trading room went belly up along with the company, and Phibro is still trading oil secretly all over the world, it should perhaps now be called the Phibro Loophole.)

What the CFTC also granted the big Wall Street trading firms was a license to sneak under the radar by using computer terminals located in the United States while trading oil on foreign exchanges like the Intercontinental Exchange (ICE) located in London but owned by an Atlanta, Ga., outfit that was funded and launched by Wall Street firms and big oil.

On June 3 of this year, Dr. Mark Cooper, director of research for the Consumer Federation of America, correctly outlined the problem to the Senate Committee on Commerce, Science and Transportation:

The speculative bubble in petroleum markets has cost the economy well over half a trillion dollars in the two years since the Senate [hearings] first called attention to this problem. Public policies have made these markets the playgrounds of the idle rich, while consumers suffer the burden of rising prices for the necessities of daily life. We have made it so easy to play in the financial markets that investment in productive long-term assets are unattractive. The most blatant mistake occurred when Congress allowed the Commodity Futures Trading Commission to forego regulation of over-the-counter trading in energy futures. Because there is no regulation of this huge swatch of activity, regulators have little insight into what is going on in energy commodity markets. Large traders who trade in commodities in the U.S. ought to be required to register and report their entire positions in those commodities here in the U.S. and abroad. If traders are unwilling to report all their positions, they should not be allowed to trade in U.S. markets. If they violate this provision, they should go to jail. Fines are not enough to dissuade abuse in these commodity markets because there is just too much money to be made.

The only correction I would make to the otherwise flawless argument above is that Wall Street is far from the playground of the "idle" rich. Wall Street executives spend every waking minute thinking about (and, I've heard, even dreaming about) how they can separate us from our money, our homes and a voice in Washington. How appropriate that Citigroup's slogan is "the Citi never sleeps."

Let's say the CFTC was not a compromised regulator, was not an audition stage and revolving door for million-dollar jobs in the industry it regulates. Let's say it genuinely wanted to report back to Congress on just how big a player Citigroup is in the oil markets. According to a Feb. 22, 2008, filing with the Securities and Exchange Commission (SEC), Citigroup has more than 2,000 principal subsidiaries (meaning it really has more but it's not naming them). Of these, a significant number are secret offshore entities where records are unavailable to regulators. (Consider this mind-boggling look at this sprawling octopus.)

So the CFTC can't get its hands on all records, and even in jurisdictions where it can, it first has to know under what names, out of a possible 2,000, Citigroup is trading oil and then aggregate the positions.

On May 6 of this year, Tyson Slocum, director of the energy program at the nonprofit watchdog Public Citizen, testified before Congress on yet another roadblock preventing a meaningful investigation of oil price manipulation:

Thanks to the Commodity Futures Modernization Act, participants in these newly deregulated energy trading markets are not required to file so-called Large Trader Reports. These Large Trader Reports, together with the price and volume data, are the primary tools of the CFTC's regulatory regime. So the deregulation of OTC markets, by allowing traders to escape such basic information reporting, leave federal regulators with no tools to routinely determine whether market manipulation is occurring in energy trading markets. The ability of federal regulators to investigate market manipulation allegations even on the lightly regulated exchanges like NYMEX [New York Mercantile Exchange] is difficult, let alone the unregulated OTC market.

Next comes what can only be described as an act of insanity on the part of the Federal Reserve. After allowing for the repeal in 1999 of the Depression-era investor protection legislation known as the Glass-Steagall Act in order to let Citigroup house retail bank deposits, investment banking, insurance, stock brokerage and speculative proprietary trading under one roof (the perfect storm that intensified the Great Depression), the Federal Reserve decided on Oct. 2, 2003, that Citi wasn't scary enough. It needed to allow this company that had already been named in hundreds of lawsuits for securities frauds and manipulations and could not remotely manage itself as a financial firm to ramp up its oil trading business by allowing it to take possession of crude oil on tankers because it would "reasonably be expected to produce benefits to the public." Here are excerpts from the Fed's release suggesting the expansive plans Citi had in the oil storage and transport business:

Citigroup has indicated that it will adopt additional standards for Commodity Trading Activities that involve environmentally sensitive products, such as oil or natural gas. For example, Citigroup will require that the owner of every vessel that carries oil on behalf of Citigroup be a member of a protection and indemnity club and carry the maximum insurance for oil pollution available from the club. Citigroup also will require every such vessel to carry substantial amounts of additional oil pollution insurance from creditworthy insurance companies. Furthermore, Citigroup will place age limitations on vessels and will require vessels to be approved by a major international oil company and have appropriate oil spill response plans and equipment. Moreover, Citigroup will have a comprehensive backup plan in the event any vessel owner fails to respond adequately to an oil spill and will hire inspectors to monitor the loading and discharging of vessels. Citigroup also has represented that it will have in place specific policies and procedures for the storage of oil. The Board believes that Citigroup has the managerial expertise and internal control framework to manage the risks of taking and making delivery of physical commodities. For these reasons, and based on Citigroup's policies and procedures for monitoring and controlling the risks of Commodity Trading Activities, the Board concludes that consummation of the proposal does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally and can reasonably be expected to produce benefits to the public that outweigh any potential adverse effects.

Voting in favor of this unprecedented action was then Federal Reserve Chairman Alan Greenspan as well as the current chairman, Ben Bernanke.

Could the Fed have been more wrong about Citigroup having "the expertise and internal controls to integrate effectively the risk management?" Two years later, in March 2005, the bipolar Fed had this to say about Citigroup: "Given the size, scope and complexity of Citigroup's global operations, successfully addressing the deficiencies in compliance risk management that have given rise to a series of adverse compliance events in recent years will require significant attention."

Today, the situation is as follows: Citigroup has taken $42 billion in credit losses and write-downs in the past year and has just announced that more write-downs are coming, and the Fed has an intravenous money feeding tube hooked up between its vault and this banking/brokerage/subprime mortgage lending/oil trading mad scientist experiment.

In addition to the secretive Phibro oil trading unit, Citi has formed Citigroup Energy and moved it to Houston. In a "help wanted" ad placed in Canada, it described itself as follows: "Citigroup Energy is a global energy trading, marketing and risk management company based in Houston with offices in Calgary, New York, London, and Singapore. Our goal is to become the premier global energy commodities marketing and trading organization. Currently our capabilities include trading and marketing derivatives/structured products in power, natural gas, crude and crude products."

Enron also called itself the "premier" energy trading organization. Apparently impressed with that model, Citigroup Energy has hired a significant number of former Enron traders.

Pam Martens worked on Wall Street for 21 years. She has no securities position, long or short, in any company mentioned in this article. She writes on public interest issues from New Hampshire.

Corporate Spies Targeted Activists

Brokers threatened by run on shadow bank system

Regulators eye $10 trillion market that boomed outside traditional banking

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A network of lenders, brokers and opaque financing vehicles outside traditional banking that ballooned during the bull market now is under siege as regulators threaten a crackdown on the so-called shadow banking system.

Big brokerage firms like Goldman Sachs (GS) , Lehman Brothers (LEH) , Morgan Stanley (MS) and Merrill Lynch (MER) , which some say are the biggest players in this non-bank financial network, may have the most to lose from stricter regulation.

The shadow banking system grew rapidly during the past decade, accumulating more than $10 trillion in assets by early 2007. That made it roughly the same size as the traditional banking system, according to the Federal Reserve.

While this system became a huge and vital source of money to fuel the U.S. economy, the subprime mortgage crisis and ensuing credit crunch exposed a major flaw. Unlike regulated banks, which can borrow directly from the government and have federally insured customer deposits, the shadow system didn't have reliable access to short-term borrowing during times of stress.

Such vulnerability helped transform what may have been an uncomfortable correction in credit markets into the worst global credit crunch in more than a decade as monetary policymakers and regulators struggled to contain the damage.

Unless radical changes are made to bring this shadow network under an updated regulatory umbrella, the current crisis may be just a gust compared to the storm that would follow a collapse of the global financial system, experts warn.

"The shadow banking system model as practiced in recent years has been discredited," Ramin Toloui, executive vice president at bond investment giant Pimco, said.

Toloui expects greater regulation of big brokerage firms which may face stricter capital requirements and requirements to hold more liquid, or easily sellable, assets.

'Clarion call'

"The bright new financial system -- for all its talented participants, for all its rich rewards -- has failed the test of the market place," Paul Volcker, former chairman of the Federal Reserve, said during a speech in April. "It all adds up to a clarion call for an effective response."

Two months later, Timothy Geithner, president of the Federal Reserve Bank of New York, and others have begun to answer that call.

"The structure of the financial system changed fundamentally during the boom, with dramatic growth in the share of assets outside the traditional banking system," he warned in a speech last week. That "made the crisis more difficult to manage."

On Thursday, Treasury Secretary and former Goldman Chief Executive Henry Paulson said the Fed should be given the authority to collect information from large complex financial institutions and intervene if necessary to stabilize future crises. Regulators should also have a clear way of taking over and closing a failed brokerage firm, he added. See full story.

Banking bedrock

The bedrock of traditional banking is borrowing money over the short term from customers who deposit savings in accounts and then lending it back out as mortgages and other higher-yielding loans over longer periods.

The owners of banks are required by regulators to invest some of their own money and reinvest some of the profit to keep an extra level of money in reserve in case the business suffers losses on some of its loans. That ensures that there's still enough money to repay all depositors after such losses.

In recent decades, lots of new businesses and investment vehicles have evolved that do the same thing, but outside the purview of traditional banking regulation.

Instead of getting money from depositors, these financial intermediaries often borrow by selling commercial paper, which is a type of short-term loan that has to be re-financed over and over again. And rather than offering home loans, these entities buy mortgage-backed securities and other more complex securities.

A $10 trillion shadow

By early 2007, conduits, structured investment vehicles and similar entities that borrowed in the commercial paper market and bought longer-term asset-backed securities, held roughly $2.2 trillion in assets, according to the Fed's Geithner.

Another $2.5 trillion in assets were financed overnight in the so-called repo market, Geithner said.

Geithner also highlighted big brokerage firms, saying that their combined balance sheets held $4 trillion in assets in early 2007.

Hedge funds held another $1.8 trillion, bringing the total value of asset in the "non-bank" financial system to $10.5 trillion, he added.

That dwarfed the total assets of the five largest banks in the U.S., which held just over $6 trillion at the time, Geithner noted. The traditional banking system as a whole held about $10 trillion, he said.


While acting like banks, these shadow banking entities weren't subject to the same supervision, so they didn't hold as much capital to cushion against potential losses. When subprime mortgage losses started last year, their sources of short-term financing dried up.

"These things act like banks, but they're not," James Hamilton, professor of economics at the University of California, San Diego, said. "The fundamental inadequacy of their own capital caused these problems."

Big brokers targeted

Geithner said the most fundamental reform that's needed is to regulate big brokerage firms and global banks under a unified system with stronger supervision and "appropriate" requirements for capital and liquidity.

Financial institutions should be persuaded to keep strong capital cushions and more liquid assets during periods of calm in the market, he explained, noting that's the best way to limit the damage during a crisis.

At a minimum, major investment banks and brokerage firms should adhere to similar rules on capital, liquidity and risk management as commercial banks, Sheila Bair, chairman of the Federal Deposit Insurance Corp., said on Wednesday.

"It makes sense to extend some form of greater prudential regulation to investment banks," she said.

Separation dwindled

After the stock market crash of 1929, the U.S. Congress passed laws that separated commercial banks from investment banks.

The Fed, the Office of the Comptroller of the Currency and state regulators oversaw commercial banks, which took in customer deposits and lent that money out. The Securities and Exchange Commission regulated brokerage firms, which underwrote offerings of stocks and corporate bonds.

This separation dwindled during the 1980s and 1990s as commercial banks tried to push into investment banking -- following their large corporate clients which were selling more bonds, rather than borrowing directly from banks.

By 1999, the Gramm-Leach-Bliley Act rolled back Depression-era restrictions, allowing banks, brokerage firms and insurers to merge into financial holding companies that would be regulated by the Fed.

Commercial banks like Citigroup Inc. (C) , Bank of America (BAC) and J.P. Morgan Chase (JPM) signed up and developed large investment banking businesses.

However, big brokerage firms like Goldman, Morgan Stanley and Lehman didn't become financial holding companies and stayed out of commercial banking partly to avoid increased regulation by the Fed.

Run on a shadow bank

The Fed's bailout of Bear Stearns in March will probably change all that, experts said this week.

Bear, a leading underwriter of mortgage securities, almost collapsed after customers and counterparties deserted the firm.

It was like a run on a bank. But Bear wasn't a bank. It financed a lot of its activity by borrowing short term in repo and commercial paper markets and couldn't borrow from the Fed if things got really bad.

Bear's low capital levels left it with highly leveraged exposures to risky mortgage-related securities, which triggered initial doubts among customers and trading partners.

The Fed quickly helped J.P. Morgan Chase, one of the largest commercial banks, acquire Bear. To prevent further damage to the financial system, the Fed also started lending directly to brokerage firms for the first time since the Depression.

"They stepped in because Bear was facing a traditional bank run -- customers were pulling short-term assets and the firm couldn't sell its long-term assets quickly enough," Hamilton said. "Rules should apply here: You should have enough of your own capital available to pay back customers to avoid a run like that."

Bear necessity

A more worrying question from the Bear Stearns debacle is why customers and investors were willing to lend money to the firm in the absence of an adequate capital cushion, Hamilton said.

"The creditors thought that Bear was too big to fail and that the government would step in to prevent creditors losing their money," he explained. "They were right because that's exactly what happened."

"This is a system in which institutions like Bear Stearns are taking far too much risk and a lot of that risk is being borne by the government, not these firms or the market," he added.

The Fed has lent between $8 billion and more than $30 billion each week directly to brokerage firms since it set up its new program in March. Most experts say this source of emergency funding is unlikely to disappear, even though it's scheduled to end in September.

"It's almost impossible to go back," FDIC's Bair said on Wednesday.

With taxpayer money permanently on the line to save big brokers, these firms should now be more strictly regulated to keep future bailouts to a minimum, Bair and others said.

"By definition, if they're going to give the investment banks access to the window, I for one do believe they have the right for oversight," Richard Fuld, chief executive of Lehman, told analysts during a conference call this week. "What that means, though, particularly as far as capital levels or asset requirements, it's way too early to tell."

Super Fed

Next year, Congress likely will pass legislation forcing big brokerage firms to be regulated fully by the Fed as financial holding companies, Brad Hintz, a securities analyst at Bernstein Research and former chief financial officer of Lehman, said.

Legislators will probably also call for tighter limits on the leverage and trading risk taken on by large brokers, while demanding more conservative funding and liquidity policies, he added.

Restrictions on these firms' forays into venture capital, private equity, real estate, commodities and potentially hedge funds may also follow too, Hintz warned.

This may undermine the source of much of the surging profit generated by big brokerage firms in recent years.

A newly empowered "super Fed" will likely encourage these firms to arrange longer-term, more secure sources of borrowing and even promote the development of deposit bases, just like commercial and retail banks, the analyst explained.

This will make borrowing more expensive for brokerage firms, undermining the profitability of businesses that require a lot of capital, such as fixed income, institutional equities, commodities and prime brokerage, Hintz said.

Such regulatory changes will cut big brokers' return on equity -- a closely watched measure of profitability -- to roughly 15.5% from 19%, Hintz estimated in a note to investors this week.

Lehman and Goldman will be most affected by this -- seeing return on equity drop by about four percentage points over the business cycle -- because they have larger trading books and greater exposure to revenue from sales and trading. Goldman also has a major merchant banking business that may also be constrained, Hintz added.

Morgan Stanley and Merrill Lynch (MER) will see declines of 3.2 percentage points and 2.2 percentage points in their return on equity, the analyst forecast.

If you can't beat them...

Facing lower returns and more stringent bank-like regulation, some big brokerage firms may decide they're better off as part of a large commercial bank, some experts said.

"If you're being regulated like a bank and your leverage ratio looks something like a bank's, can you really earn the returns you were making as a broker dealer? Probably not," Margaret Cannella, global head of credit research at J.P. Morgan, said.

Regulatory changes will be unpopular with some brokerage CEOs and could result in a shakeup of the industry and more consolidation, she added.

Hintz said the business models of some brokerage firms may evolve into something similar to Bankers Trust and the old J.P. Morgan.

In the mid 1990s, Bankers Trust and J.P. Morgan relied more on deposits and less on the repo market to finance their assets. They also operated with leverage ratios of roughly 20 times capital. That's lower than today's brokerage firms, which were levered roughly 30 times during the peak of the credit bubble last year, according to Hintz.

However, both firms soon ended up in the arms of more regulated commercial banks. Bankers Trust was acquired by Deutsche Bank (DB) in 1998. Chase Manhattan Bank bought J.P. Morgan in 2000.