Submerging Markets™

The Curious World of Donald Trump’s Private Russian Connections James S. Henry

 

Donald Trump, Tevfik Arif, and Felix Sater

 Did the American people really know they were putting such a "well-connected" guy in the White House?

 Intro by David Cay Johnston

Pulitizer-Prize winning author, The Making of Donald Trump.

Throughout Donald Trump's presidential campaign, he expressed glowing admiration for Russian leader Vladimir Putin. Many of Trump's adoring comments were utterly gratuitous. After his Electoral College victory, Trump continued praising the former head of the KGB while dismissing the finding of all 17 American national security agencies that Putin had directed Russian government interference to help Trump in the 2016 American presidential election.

 As veteran investigative economist and journalist Jim Henry shows below, a robust public record helps to explain the fealty of Trump and his family to this murderous autocrat and the network of Russian oligarchs.

 Putin and his billionaire friends have plundered the wealth of their own people. They have also run numerous schemes to defraud governments and investors in the United States and Europe. From public records, using his renowned analytical skills, Henry shows what the mainstream news media in United States have failed to report in any meaningful way: for at least three decades Donald Trump has profited from his connections to the Russian oligarchs, whose own fortunes now depend on their continued fealty to Putin.

We don't know the full relationship between Donald Trump, the Trump family and their enterprises with the network of the world– class criminals known as the Russian oligarchs. Henry acknowledges that his article poses more questions than answers, establishes more connections than full explanations. But what Henry does show should prompt every American to rise up in defense of their country, to demand a thorough out in the open Congressional investigation with no holds barred. The national security of United States of America and of peace around the world, especially in Europe, may depend on how thoroughly we understand the rich network of relationships between the 45^th president and the Russian oligarchy. When Donald Trump chooses to exercise, or not exercise, his power to restrain Putin's drive to invade independent countries and seize their wealth, as well as to loot countries beyond his control, Americans need to know in whose interest the president 's acting or looking the other way.

 

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“Tell me who you walk with and I’ll tell you who you are.”

—Cervantes

“I’ve always been blessed with a kind of intuition about people that allows me to sense who the sleazy guys are, and I stay far away.”

—Donald Trump, Surviving at the Top

Even before the November 8 election, many leading Democrats were vociferously demanding that the FBI disclose the fruits of its investigations into Putin-backed Russian hackers. Instead FBI Director Comey decided to temporarily revive his zombie-like investigation of Hillary’s emails. That decision may well have had an important impact on the election, but it did nothing to resolve the allegations about Putin. Even now, after the CIA has disclosed an abstract of its own still-secret investigation, it is fair to say that we still lack the cyberspace equivalent of a smoking gun.

Fortunately, however, for those of us who are curious about Trump’s Russian connections, there is another readily accessible body of published and other Internet material that has so far received surprisingly little attention. This suggests that whatever the nature of President-elect Donald Trump’s relationship with President Putin, he has certainly managed to accumulate direct and indirect connections with a far-flung private Russian/FSU network of outright mobsters, oligarchs, fraudsters, and kleptocrats.

Any one of these connections might have occurred at random. But the overall pattern is a veritable Star Wars bar scene of unsavory characters, with Donald Trump seated right in the middle. The analytical challenge is to map this network—a task that most journalists and law enforcement agencies, focused on individual cases, have failed to do.

Of course, to label this network “private” may be a stretch, given that in Putin’s Russia, even the toughest mobsters learn the hard way to maintain a respectful relationship with the “New Tsar.” But here the central question pertains to our new Tsar. Did the American people really know they were putting such a “well-connected” guy in the White House?

The Big Picture: Kleptocracy and Capital Flight

A few of Donald Trump’s connections to oligarchs and assorted thugs have already received sporadic press attention -- for example, former Trump campaign manager Paul Manafort’s reported relationship with exiled Ukrainian oligarch Dmytro Firtash. But no one has pulled the connections together, used them to identify still more relationships, and developed an image of the overall patterns.

Nor has anyone related these cases to one of the most central facts about modern Russia: its emergence since the 1990s as a world-class kleptocracy, second only to China as a source of illicit capital and criminal loot, with more than $1.3 trillion of net offshore “flight wealth” as of 2016.[1]

 

This tidal wave of illicit capital is hardly just Putin’s doing. It is in fact a symptom of one of the most epic failures in modern political economy -- one for which the West bears a great deal of responsibility. This is the failure, in the wake of the Soviet Union’s collapse in the late 1980s, to ensure that Russia acquires the kind of strong, middle-class-centric economic and political base that is required for democratic capitalism, the rule of law, and stable, peaceful relationships with its neighbors.

Instead, from 1992 to the Russian debt crisis of August 1998, the West in general—and the U.S. Treasury, USAID, the State Department, the IMF/World Bank, the ERDB, and many leading economists in particular—actively promoted and, indeed, helped to finance one of the most massive transfers of public wealth into private hands that the world has ever seen.

For example, Russia’s 1992 “voucher privatization” program permitted a tiny elite of former state-owned company managers and party apparatchiks to acquire control over a vast number of public enterprises, often with the help of outright mobsters. A majority of Gazprom, the state energy company that controlled a third of the world’s gas reserves, was sold for $230 million; Russia’s entire national electric grid was privatized for $630 million; ZIL, Russia's largest auto company, went for about $4 million; ports, ships, oil, iron and steel, aluminum, much of the high-tech arms and airlines industries, the world’s largest diamond mines, and most of Russia’s banking system also went for a song.

In 1994–96, under the infamous “loans-for-shares” program, Russia privatized 150 state-owned companies for just $12 billion, most of which was loaned to a handful of well-connected buyers by the state—and indirectly by the World Bank and the IMF. The principal beneficiaries of this “privatization”—actually, cartelization—were initially just 25 or so budding oligarchs with the insider connections to buy these properties and the muscle to hold them.[2] The happy few who made personal fortunes from this feeding frenzy —in a sense, the very first of the new kleptocrats—not only included numerous Russian officials, but also leading gringo investors/advisers, Harvard professors, USAID advisers, and bankers at Credit Suisse First Boston and other Wall Street investment banks. As the renowned development economist Alex Gerschenkron, an authority on Russian development, once said, "If we were in Vienna, we would have said, "We wish we could play it on the piano!"

For the vast majority of ordinary Russian citizens, this extreme re-concentration of wealth coincided with nothing less than a full-scale 1930s-type depression, a sudden “shock therapy”-induced rise in domestic price levels that wiped out the private savings of millions, rampant lawlessness, a public health crisis, and a sharp decline in life expectancy and birth rates.

Sadly, this neoliberal “market reform” policy package that was introduced at a Stalin-like pace from 1992 to late 1998 was not only condoned but partly designed and financed by senior Clinton Administration officials, neoliberal economists, and innumerable USAID, World Bank, and IMF officials. The few dissenting voices included some of the West's best economic brains -- Nobel laureates like James Tobin, Kenneth Arrow, Lawrence Klein, and Joseph Stiglitz. They also included Moscow University’s Sergei Glaziev, who now serves as President Putin’s chief economic advisor.[3] Unfortunately, they were no match for the folks with the cash.

There was also an important intervention in Russian politics. In January 1996 a secret team of professional U.S. political consultants arrived in Moscow to discover that, as CNN put it back then, “The only thing voters like less than Boris Yeltsin is the prospect of upheaval.” The experts' solution was one of earliest "Our brand is crisis" campaign strategies, in which Yeltsin was “spun” as the only alternative to "chaos." To support him, in March 1996 the IMF also pitched in with $10.1 billion of new loans, on top of $17.3 billion of IMF/World Bank loans that had already been made.

With all this outside help, plus ample contributions from Russia’s new elite, Yeltsin went from just 8 percent approval in the January 1996 polls to a 54-41 percent victory over the Communist Party candidate, Gennady Zyuganov, in the second round of the July 1996 election. At the time, mainstream media like Time and the New York Times were delighted. Very few outside Russia questioned the wisdom of this blatant intervention in post-Soviet Russia’s first democratic election, or the West's right to do it in order to protect itself.

By the late 1990s the actual chaos that resulted from Yeltsin's warped policies had laid the foundations for a strong counterrevolution, including the rise of ex-KGB officer Putin and a massive outpouring of oligarchic flight capital that has continued virtually up to the present. For ordinary Russians, as noted, this was disastrous. But for many banks, private bankers, hedge funds, law firms, and accounting firms, for leading oil companies like ExxonMobil and BP, as well as for needy borrowers like the Trump Organization the opportunity to feed on post-Soviet spoils was a godsend. This was vulture capitalism at its worst.

The nine-lived Trump, in particular, had just suffered a string of six successive bankruptcies. So the massive illicit outflows from Russia and oil-rich FSU members like Kazahkstan and Azerbaijan from the mid-1990s provided precisely the kind of undiscriminating investors that he needed. These outflows arrived at just the right time to fund several of Trump's post-2000 high-risk real estate and casino ventures – most of which failed. As Donald Trump, Jr., executive vice president of development and acquisitions for the Trump Organization, told the “Bridging U.S. and Emerging Markets Real Estate” conference in Manhattan in September 2008, on the basis, he said, of his own “half dozen trips to Russia in 18 months”:

"[I]n terms of high-end product influx into the United States, Russians make up a pretty disproportionate cross-section of a lot of our assets; say in Dubai, and certainly with our project in SoHo and anywhere in New York. We see a lot of money pouring in from Russia."

All this helps to explain one of the most intriguing puzzles about Donald Trump’s long, turbulent business career: how he managed to keep financing it, despite a dismal track record of failed projects.[4]

According to the “official story,” this was simply due to a combination of brilliant deal-making, Trump’s gold-plated brand, and raw animal spirits – with $916 million of creative tax dodging as a kicker. But this official story is hokum. The truth is that, since the late 1990s, Trump was also greatly assisted by these abundant new sources of global finance, especially from "submerging markets" like Russia

This suggests that neither Trump nor Putin is an “uncaused cause.” They are not evil twins, exactly, but they are both byproducts of the same neoliberal policy scams that were peddled to Russia’s struggling new democracy.

A Guided Tour of Trump's Russian/FSU Connections

The following roundup of Trump’s Russo-Soviet business connections is based on published sources, interviews with former law enforcement staff and other experts in the United States, the United Kingdom, and Iceland, searches of online corporate registries,[5] and a detailed analysis of offshore company data from the Panama Papers.[6] Given the sheer scope of Trump’s activities, there are undoubtedly other worthy cases, but our interest here is in overall patterns.

Note that none of the activities and business connections related here necessarily involved criminal conduct. While several key players do have criminal records, few of their prolific business dealings have been thoroughly investigated, and of course they all deserve the presumption of innocence. Furthermore, several of these players reside in countries where activities like bribery, tax dodging, and other financial chicanery are either not illegal or are rarely prosecuted. As former British Chancellor of the Exchequer Denis Healey once said, when it comes to financial chicanery, the difference between “legal” and “illegal” is often just “the width of a prison wall.”

So why spend time collecting and reviewing material that may either not point to anything illegal and or in some cases may even be impossible to verify? Because, we submit, the mere fact that such assertions are widely made is of legitimate public interest in its own right. In other words, when it comes to evaluating the probity of senior public officials, the public has the right to know about any material allegations—true, false, or, most commonly, unprovable—about their business partners and associates, so long as this information is clearly labeled as unverified.

Furthermore, the individual case-based approach to investigations employed by most investigative journalists and law enforcement often misses the big picture: the global networks of influence and finance, licit and illicit, that exist among business people, investors, kleptocrats, organized criminals, and politicians, as well as the "enablers" -- banks, accounting firms, law firms, and havens.

Any particular component of these networks might easily disappear without making any difference. But the networks live on. It is these shadowy transnational networks that really deserve scrutiny.

Bayrock Group LLC—Kazakhstan and Tevfik Arif

 We’ll begin our tour of Trump's Russian/FSU connections with several business relationships that evolved out of the curious case of Bayrock Group LLC, a spectacularly unsuccessful New York real estate development company that surfaced in the early 2000s and, by 2014, had all but disappeared except for a few lawsuits. As of 2007, Bayrock and its partners reportedly had more than $2 billion of Trump-branded deals in the works. But most of these either never materialized or were miserable failures, for reasons that will soon become obvious.

Bayrock’s “white elephants” included the 46-story Trump SoHo condo-hotel on Spring Street in New York City, for which the principle developer was a partnership formed by Bayrock and FL Group, an Icelandic investment company. Completed in 2010, the SoHo soon became the subject of prolonged civil litigation by disgruntled condo buyers. The building was foreclosed by creditors and resold in 2014 after more than $3 million of customer down payments had to be refunded. Similarly, Bayrock’s Trump International Hotel & Tower in Fort Lauderdale was foreclosed and resold in 2012, while at least three other Trump-branded properties in the United States, plus many other “project concepts” that Bayrock had contemplated, from Istanbul and Kiev to Moscow and Warsaw, also never happened.

Carelessness about due diligence with respect to potential partners and associates is one of Donald Trump’s more predictable qualities. Acting on the seat of the pants, he had hooked up with Bayrock rather quickly in 2005, becoming an 18 percent minority equity partner in the Trump SoHo, and agreeing to license his brand and manage the building.[7]

Donald Trump and Tevfik Arif

 Exhibit A in the panoply of former Trump business partners is Bayrock’s former Chairman, Tevfik Arif (aka Arifov), an émigré from Kazakhstan who reportedly took up residence in Brooklyn in the 1990s. Trump also had extensive contacts with another key Bayrock Russian-American from Brooklyn, Felix Sater (aka Satter), discussed below.[8] Trump has lately had some difficulty recalling very much about either Arif or Sater. But this is hardly surprising, given what we now know about them. Trump described his introduction to Bayrock in a 2013 deposition for a lawsuit that was brought by investors in the Fort Lauderdale project, one of Trump’s first with Bayrock: “Well, we had a tenant in …Trump Tower called Bayrock, and Bayrock was interested in getting us into deals.”[9]

According to several reports, Tevfik Arif was originally from Kazakhstan, a Soviet republic until 1992. Born in 1950, Arif worked for 17 years in the Soviet Ministry of Commerce and Trade, serving as Deputy Director of Hotel Management by the time of the Soviet Union’s collapse.[10] In the early 1990s he relocated to Turkey, where he reportedly helped to develop properties for the Rixos Hotel chain. Not long thereafter he relocated to Brooklyn, founded Bayrock, opened an office in the Trump Tower, and started to pursue projects with Trump and other investors.[11]

Tevfik Arif was not Bayrock’s only connection to Kazakhstan. A 2007 Bayrock investor presentation refers to Alexander Mashevich’s “Eurasia Group” as a strategic partner for Bayrock’s equity finance. Together with two other prominent Kazakh billionaires, Patokh Chodiev (aka “Shodiyev”) and Alijan Ibragimov, Mashkevich reportedly ran the “Eurasian Natural Resources Cooperation.” In Kazakhstan these three are sometimes referred to as “the Trio.”[12]

The Trio has apparently worked together ever since Gorbachev's late 1980s perestroika in metals and other natural resources. It was during this period that they first acquired a significant degree of control over Kazakhstan’s vast mineral and gas reserves. Naturally they found it useful to become friends with Nursaltan Nazarbayev, Kazakhstan’s long-time ruler. Indeed, State Department cables leaked by Wikileaks in November 2010 describe a close relationship between “the Trio” and the seemingly-perpetual Nazarbayev kleptocracy.

In any case, the Trio has recently attracted the attention of many other investigators and news outlets, including the September 11 Commission Report, the Guardian, Forbes, and the Wall Street Journal. In addition to resource grabbing, the litany of the Trio's alleged activities include money laundering, bribery, and racketeering.[13] In 2005, according to U.S. State Department cables released by Wikileaks, Chodiev (referred to in a State Department cable as “Fatokh Shodiyev”) was recorded on video attending the birthday of reputed Uzbek mob boss Salim Abduvaliyeva and presenting him with a $10,000 “gift” or “tribute.”

According to the Belgian newspaper Le Soir, Chodiev and Mashkevich also became close associates of a curious Russian-Canadian businessman, Boris J. Birshtein. who happens to have been the father-in-law of another key Russian-Canadian business associate of Donald Trump in Toronto. We will return to Birshtein below.

The Trio also turn up in the April 2016 Panama Papers database as the apparent beneficial owners of a Cook Islands company, “International Financial Limited.” [14] The Belgian newspapers Het Laatste Nieuws, Le Soir, and La Libre Belgique have reported that Chodiev paid €23 million to obtain a “Class B” banking license for this same company, permitting it to make international currency trades. In the words of a leading Belgian financial regulator, that would “make all money laundering undetectable.”

The Panama Papers also indicate that some of Arif’s connections at the Rixos Hotel Group may have ties to Kazakhstan. For example, one offshore company listed in the Panama Papers database, “Group Rixos Hotel,” reportedly acts as an intermediary for four BVI offshore companies.[15] Rixos Hotel’s CEO, Fettah Tamince, is listed as having been a shareholder for two of these companies, while a shareholder in another—“Hazara Asset Management”—had the same name as the son of a recent Kazakhstan Minister for Sports and Tourism. As of 2012, this Kazakh official was described as the third-most influential deputy in the country’s Mazhilis (the lower house of Parliament), in a Forbes-Kazakhstan article.

According to a 2015 lawsuit against Bayrock by Jody Kriss, one of its former employees, Bayrock started to receive millions of dollars in equity contributions in 2004, supposedly by way of Arif’s brother in Russia, who allegedly “had access to cash accounts at a chromium refinery in Kazakhstan.”

This as-yet unproven allegation might well just be an attempt by the plaintiff to extract a more attractive settlement from Bayrock and its original principals. But it is also consistent with fact that chromium is indeed one of the Kazakh natural resources that is reportedly controlled by the Trio.

As for Arif, his most recent visible brush with the law came in 2010, when he and other members of Bayrock’s Eurasian Trio were arrested together in Turkey during a police raid on a suspected prostitution ring, according to the Israeli daily Yediot Ahronot.

At the time, Turkish investigators reportedly asserted that Arif might be the head of a criminal organization that was trafficking in Russian and Ukrainian escorts, allegedly including some as young as 13.[16] According to these assertions, big-ticket clients were making their selections by way of a modeling agency website, with Arif allegedly handling the logistics. Especially galling to Turkish authorities, the preferred venue was reportedly a yacht that had once belonged to the widely-revered Turkish leader Atatürk. It was also alleged that Arif may have also provided lodging for young women at Rixos Group hotels.[17]

According to Russian media, two senior Kazakh officials were also arrested during this incident, although the Turkish Foreign Ministry quickly dismissed this allegation as “groundless.” In the end, all the charges against Arif resulting from this incident were dismissed in 2012 by Turkish courts, and his spokespeople have subsequently denied all involvement.

Finally, despite Bayrock’s demise and these other legal entanglements, Arif has apparently remained active. For example, Bloomberg reports that, as of 2013, he, his son, and Rixos Hotels’ CEO Fettah Tamince had partnered to pursue the rather controversial business of advancing funds to cash-strapped high-profile soccer players, in exchange for a share of their future marketing revenues and team transfer fees. In the case of Arif and his partners, this new-wave form of indentured servitude was reportedly implemented by way of a UK- and Malta-based hedge fund, Doyen Capital LLP. Because this practice is subject to innumerable potential abuses, including the possibility of subjecting athletes or clubs to undue pressure to sign over valuable rights and fees, UEFA, Europe’s governing soccer body, wants to ban it. But FIFA, the notorious global football regulator, has been customarily slow to act. To date, Doyen Capital LLP has reportedly taken financial gambles on several well-known players, including the Brazilian star Neymar.

The Case of Bayrock LLC—Felix Sater

Our second exhibit is Felix Sater, the senior Bayrock executive introduced earlier. This is the fellow who worked at Bayrock from 2002 to 2008 and negotiated several important deals with the Trump Organization and other investors. When Trump was asked who at Bayrock had brought him the Fort Lauderdale project in the 2013 deposition cited above, he replied: “It could have been Felix Sater, it could have been—I really don’t know who it might have been, but somebody from Bayrock.” [18]

Although Sater left Bayrock in 2008, by 2010 he was reportedly back in Trump Tower as a “senior advisor” to the Trump Organization – at least on his business card -- with his own office in the building.

Sater has also testified under oath that he had escorted Donald Trump, Jr. and Ivanka Trump around Moscow in 2006, had met frequently with Donald over several years, and had once flown with him to Colorado. And although this might easily have been staged, he is also reported to have visited Trump Tower in July 2016 and made a personal $5,400 contribution to Trump’s campaign.

Whatever Felix Sater has been up to recently, the key point is that by 2002, at the latest,[19] Tevfik Arif decided to hire him as Bayrock’s COO and managing director. This was despite the fact that by then Felix had already compiled an astonishing track record as a professional criminal, with multiple felony pleas and convictions, extensive connections to organized crime, and — the ultimate prize —a virtual “get out of jail free card,” based on an informant relationship with the FBI and the CIA that is vaguely reminiscent of Whitey Bulger.[20]

Sater, a Brooklyn resident like Arif, was born in Russia in 1966. He reportedly emigrated with his family to the United States in the mid-1970s and settled in “Little Odessa.” It seems that his father, Mikhael Sheferovsky (aka Michael Sater), may have been engaged in Russian mob activity before he arrived in the United States. According to a certified U.S. Supreme Court petition, Felix Sater’s FBI handler stated that he “was well familiar with the crimes of Sater and his (Sater’s) father, a (Semion) Mogilevich crime syndicate boss.” [21] A 1998 FBI report reportedly said Mogilevich’s organization had “approximately 250 members,” and was involved in trafficking nuclear materials, weapons and more as well as money laundering. (See below.)

But Michael Sater may have been less ambitious than his son. His only reported U.S. criminal conviction came in 2000, when he pled guilty to two felony counts for extorting Brooklyn restaurants, grocery stores, and clinics. He was released with three years’ probation. Interestingly, the U.S. Attorney for the Eastern District of New York who handled that case at the time was Ms. Loretta Lynch, who succeeded Eric Holder as US Attorney General in 2014. Back in 2000, she was also overseeing a budding informant relationship and a plea bargain with Michael’s son Felix, which may help to explain the father's sentence.

By then young Felix Sater was already well on his way to a career as a prototypical Russian-American mobster. In 1991 he stabbed a commodity trader in the face with a margarita glass stem in a Manhattan bar, severing a nerve. He was convicted of a felony and sent to prison. As Trump tells it, Sater simply “got into a barroom fight, which a lot of people do.” The sentence for this felony conviction could not have been very long, because by 1993 27-year-old Felix was already a trader in a brand new Brooklyn-based commodity firm called “White Rock Partners,” an innovative joint venture among four New York crime families and the Russian mob aimed at bringing state-of-the art financial fraud to Wall Street.

Five years later, in 1998, Felix Sater pled guilty to stock racketeering, as one of 19 U.S.-and Russian mob-connected traders who participated in a $40 million “pump and dump” securities fraud scheme. Facing twenty years in Federal prison, Sater and Gennady Klotsman, a fellow Russian-American who'd been with him on the night of the Manhattan bar fight, turned "snitch" and helped the Department of Justice prosecute their co-conspirators.[22] Reportedly, so did Salvatore Lauria, another "trader” involved in the scheme. According to the Jody Kriss lawsuit, Lauria later joined Bayrock as an off-the-books paid “consultant.” Initially their cooperation, which lasted from 1998 until at least late 2001, was kept secret, until it was inadvertently revealed in a March 2000 press release by U.S. Attorney Lynch.

Unfortunately for Sater, about the same time the NYPD also reportedly discovered that he'd had been running a money-laundering scheme and illicit gun sales out of a Manhattan storage locker. He and Klotsman fled to Russia. However, according to the New York Times, citing Klotsman and Lauria, soon after the events of September 11, 2001 the ever-creative Sater succeeded in brokering information about the black market for Stinger anti-aircraft missiles to the CIA and the FBI. According to Klotsman, this strategy “bought Felix his freedom,” allowing him to return to Brooklyn. It is still not clear precisely what information Sater actually provided, but in 2015 US Attorney General Loretta Lynch publicly commended him for sharing information that she described as “crucial to national security.”

Meanwhile, Sater’s sentence for his financial crimes continued to be deferred even after his official cooperation in that case ceased in late 2001. His files remained sealed, and he managed to avoid any sentencing for those crimes at all until October 23, 2009. When he finally appeared before the Eastern District's Judge I. Leo Glasser, Felix received a $25,000 fine, no jail time, and no probation, in a quiet proceeding that attracted no press attention. Some compared this sentence to Judge Glasser's earlier sentence of Mafia hit man “Sammy the Bull” Gravano to 4.5 years for 19 murders, in exchange for “cooperating against John Gotti.”

In any case, between 2002 and 2008, when Felix Sater finally left Bayrock LLC, and well beyond, his ability to avoid jail and conceal his criminal roots enabled him to enjoy a lucrative new career as Bayrock’s chief operating officer. In that position, he was in charge of negotiating aggressive property deals all over the planet, even while—according to lawsuits by former Bayrock investors — engaging in still more financial fraud. The only apparent difference was that he changed his name from “Sater” to “Satter.” [23]

In the 2013 deposition cited earlier, Trump went on to say “I don’t see Felix as being a member of the Mafia.” Asked if he had any evidence for this claim, Trump conceded “I have none.”[24]

As for Sater’s pal Klotsman, the past few years have not been kind. As of December 2016 he is in a Russian penal colony, working off a ten-year sentence for a failed $2.8 million Moscow diamond heist in August 2010. In 2016 Klotsman was reportedly placed on a “top-ten list” of Americans that the Russians were willing to exchange for high-value Russian prisoners in U.S. custody, like the infamous arms dealer Viktor Bout. So far there have been no takers. But with Donald Trump as President, who knows?

The Case of Iceland’s FL Group

 One of the most serious frauds alleged in the recent Bayrock lawsuit involves FL Group, an Icelandic private investment fund that is really a saga all its own.

Iceland is not usually thought of as a major offshore financial center. It is a small snowy island in the North Atlantic, closer to Greenland than to the UK or Europe, with only 330,000 citizens and a total GDP of just $17 billion. Twenty years ago, its main exports were cod and aluminum – with the imported bauxite smelted there to take advantage of the island's low electricity costs.

But in the 1990s Iceland’s tiny neoliberal political elite had what they all told themselves was a brilliant idea: "Let's privatize our state-owned banks, deregulate capital markets, and turn them loose on the world!" By the time all three of the resulting privatized banks, as well as FL Group, failed in 2008, the combined bank loan portfolio amounted to more than 12.5 times Iceland’s GDP -- the highest country debt ratio in the entire world.

Iceland 2008 - All Cross-Holdings

For purposes of our story, the most interesting thing about Iceland is that, long before this crisis hit and utterly bankrupted FL Group, our two key Russian/FSU/Brooklyn mobster-mavens, Arif and Sater, had somehow stumbled on this obscure Iceland fund. Indeed, in early 2007 they persuaded FL Group to invest $50 million in a project to build the Trump SoHo in mid-town Manhattan.

According to the Kriss lawsuit, at the same time, FL Group and Bayrock’s Felix Sater also agreed in principle to pursue up to an additional $2 billion in other Trump-related deals. The Kriss lawsuit further alleges that FL Group (FLG) also agreed to work with Bayrock to facilitate outright tax fraud on more than $250 million of potential earnings. In particular, it alleges that FLG agreed to provide the $50 million in exchange for a 62 percent stake in the four Bayrock Trump projects, but Bayrock would structure the contract as a “loan.” This meant that Bayrock would not have to pay taxes on the initial proceeds, while FLG’s anticipated $250 million of dividends would be channeled through a Delaware company and characterized as “interest payments,” allowing Bayrock to avoid up to $100 million in taxes. For tax purposes, Bayrock would pretend that their actual partner was a Delaware partnership that it had formed with FLG, “FLG Property I LLC,” rather than FLG itself.

The Trump Organization has denied any involvement with FLG. However, as an equity partner in the Trump SoHo, with a significant 18 percent equity stake in this one deal alone, Donald Trump himself had to sign off on the Bayrock-FLG deal.

This raises many questions. Most of these will have to await the outcome of the Kriss litigation, which might well take years, especially now that Trump is President. But several of these questions just leap off the page.

First, how much did President-elect Trump know about the partners and the inner workings of this deal? After all, he had a significant equity stake in it, unlike many of his “brand-name only” deals, and it was also supposed to finance several of his most important East Coast properties.

Second, how did the FL Group and Bayrock come together to do this dodgy deal in the first place? One former FL Group manager alleges that the deal arrived by accident, a “relatively small deal" was nothing special on either side.[25] The Kriss lawsuit, on the other hand, alleges that FLG was a well-known source of easy money from dodgy sources like Kazakhstan and Russia, and that other Bayrock players with criminal histories— like Salvatore Lauria, for example—were involved in making the introductions.

At this stage the evidence with respect to this second question is incomplete. But there are already some interesting indications that FL Group’s willingness to generously finance Bayrock’s peculiar Russian/FSU/Brooklyn team, its rather poorly-conceived Trump projects, and its purported tax dodging were not simply due to Icelandic backwardness. There is much more for us to know about Iceland’s “special” relationship with Russian finance. In this regard, there are several puzzles to be resolved.

First, it turns out that FL Group, Iceland’s largest private investment fund until it crashed in 2008, had several owners/investors with deep Russian business connections, including several key investors in all three top Iceland banks.

Second, it turns out that FL Group had constructed an incredible maze of cross-shareholding, lending, and cross-derivatives relationships with all these major banks, as illustrated by the following snapshot of cross-shareholding among Iceland’s financial institutions and companies as of 2008.[26]

Cross-shareholding Relationships, FLG and Other Leading Icelandic Financial Institutions, 2008

 

This thicket of cross-dealing made it almost impossible to regulate “control fraud,” where insiders at leading financial institutions went on a self-serving binge, borrowing and lending to finance risky investments of all kinds. It became difficult to determine which institutions were net borrowers or investors, as the concentration of ownership and self-dealing in the financial system just soared.

Third, FL Group make a variety of peculiar loans to Russian-connected oligarchs as well as to Bayrock. For example, as discussed below, Alex Shnaider, the Russian-Canadian billionaire who later became Donald Trump’s Toronto business partner, secured a €45.8 million loan to buy a yacht from Kaupthing Bank during the same period, while a company

Cross-shareholding Relationships, FLG and Other Leading Icelandic Financial Institutions, 2008

belonging to another Russian billionaire who reportedly owns an important vodka franchise got an even larger loan.[27]  

Fourth, Iceland’s largest banks also made a series of extraordinary loans to Russian interests during the run-up to the 2008 crisis. For example, one of Russia’s wealthiest oligarchs, a close friend of President Putin, nearly managed to secure at least €400 million (or, some say, up to 4 times that much) from Kaupthing, Iceland’s largest bank, in late September 2008, just as the financial crisis was breaking wide open. This bank also had important direct and indirect investments in FL Group. Indeed, until December 2006, it is reported to have employed the FL Group private equity manager who allegedly negotiated Felix Sater’s $50 million deal in early 2007.[28]

Fifth, there are unconfirmed accounts of a secret U.S. Federal Reserve report that unnamed Iceland banks were being used for Russian money laundering.[29] Furthermore, Kaupthing Bank’s repeated requests to open a New York branch in 2007–08 were rejected by the Fed. Similar unconfirmed rumors repeatedly appeared in Danish and German publications, as did allegations about the supposed Kazakh origins of FLG’s cash to be “laundered” in the Kriss lawsuit.

Sixth, there is the peculiar fact is that when Iceland’s banks went belly-up in October 2008, their private banking subsidiaries in Luxembourg, which were managing at least €8 billion of private assets, were suddenly seized by Luxembourg banking authorities and transferred to a new bank, Banque Havilland. This happened so fast that Iceland’s Central Bank was prevented from learning anything about the identities or portfolio sizes of the Iceland banks’ private offshore clients. But again, there were rumors of some important Russian names.

Finally, there is the rather odd phone call that Russia’s Ambassador to Iceland made to Iceland’s Prime Minister at 6:45 a.m. on October 7, 2008, the day after the financial crisis hit Iceland. According to the PM's own account, the Russian Ambassador informed him that then Prime-Minister Putin was willing to consider offering Iceland a €4 billion Russian bailout.

Of course this alleged Putin offer was modified not long thereafter to a willingness to entertain an Icelandic negotiating team in Moscow. By the time the Iceland team got to Moscow later that year, Russia’s willingness to lend had cooled, and Iceland ended up accepting a $2.1 billion IMF "stabilization package" instead. But according to a member of the negotiating team, the reasons for the reversal are still a mystery. Perhaps Putin had reconsidered because he simply decided that Russia had to worry about its own considerable financial problems. Or perhaps he had discovered that Iceland’s banks had indeed been very generous to Russian interests on the lending side, while -- given Luxembourg’s fact actions -- any Russian private wealth invested in Iceland banks was already safe.

On the other hand, there may be a simpler explanation for Iceland’s peculiar generosity to sketchy partners like Bayrock. After all, right up to the last minute before the October 2008 meltdown, the whole world had awarded Iceland AAA ratings – depositors queued up in London to open high-yield Iceland bank accounts, its bank stocks were booming, and the compensation paid to its financiers was off the charts. So why would anyone worry about making a few more dubious deals?

Overall, therefore, with respect to these odd “Russia-Iceland” connections, the proverbial jury is still out. But all these Icelandic puzzles are intriguing and bear further investigation.

The Case of the Trump Toronto Tower and Hotel—Alex Shnaider

 Our fourth case study of Trump's business associates concerns the 48-year-old Russian-Canadian billionaire Alex Shnaider, who co-financed the seventy-story Trump Tower and Hotel, Canada’s tallest building. It opened in Toronto in 2012. Unfortunately, like so many of Trump’s other Russia/FSU-financed projects, this massive Toronto condo-hotel project went belly-up this November and has now entered foreclosure.

Donald Trump and Alex Shnaider

According to an online profile of Shnaider by a Ukrainian news agency, Alex Shnaider was born in Leningrad in 1968, the son of "Евсей Шнайдер," or "Evsei Shnaider" in Russian.[30] A recent Forbes article says that he and his family emigrated to Israel from Russia when he was four and then relocated to Toronto when he was 13-14. The Ukrainian news agency says that Alex's familly soon established "one of the most successful stories in Toronto's Russian quarter, " and that young Alex, with "an entrepreneurial streak," "helped his father Evsei Shnaider in the business, placing goods on the shelves and wiping floors."

Eventually that proved to be a great decision – Shnaider prospered in the New World. Much of this was no doubt due to raw talent. But it also appears that for a time he got significant helping hand from his (now reportedly x) father-in-law,   another colorful Russian-Canadian, Boris J. Birshtein.

Originally from Lithuania, Birshtein, now about 69, has been a Canadian citizen since at least 1982.[31] He resided in Zurich for a time in the early 1990s, but then returned to Toronto and New York.[32] One of his key companies was called Seabeco SA, a "trading" company that was registered in Zurich in December 1982.[33] By the early 1990s Birshtein and his partners had started many other Seabeco-related companies in a wide variety of locations, inclding Antwerp,[34] Toronto,[35] Winnipeg,[36] Moscow, Delaware,[37] Panama, [38] and Zurich.[39] Several of these are still active.[40] He often staffed them with directors and officers from a far-flung network of Russians, emissaries from other FSU countries like Kirgizstan and Moldova, and recent Russia/FSU emigres to Canada.[41]

According to the Financial Times and the FBI, in addition to running Seabeco, Birshtein was a close business associate of Sergei Mikhaylov, the reputed head of Solntsevskaya Bratva, the Russian mob's largest branch, and the world’s highest-grossing organized crime group as of 2014, according to Fortune. [42] A 1996 FBI intelligence report cited by the FT claims that Birshtein hosted a meeting in his Tel Aviv office for Mikhaylov, the Ukrainian-born Semion Mogilevich, and several other leaders of the Russo/FSU mafia, in order to discuss “the sharing interests in Ukraine.”[43] A subsequent 1998 FBI Intelligence report on the "Semion Mogilevich Organization" repeated the same charge,[44] and described Mogilevich's successful attempts at gaining control over Ukraine privatization assets. This FT article also described how Birshtein and his associates had acquired extraordinary influence with key Ukraine officials, including President Leonid Kuchma, with the help of up to $5 million of payoffs.[45] Citing Swiss and Belgian investigators, the FT also claimed that Birshtein and Mikhaylov jointly controlled a Belgian company called MAB International in the early 1990s.[46] During that period, those same investigators reportedly observed transfers worth millions of dollars between accounts held by Mikhaylov, Birshtein, and Alexander Volkov, Seabeco's representative in Ukraine.

In 1993, the Yeltsin government reportedly accused Birshtein of illegally exporting seven million tons of Russian oil and laundering the proceeds.[47] Dmytro Iakoubovski, a former associate of Birshtein’s who had also moved to Toronto, was said to be cooperating with the Russian investigation. One night a gunman fired three shots into Iakoubovski’s home, leaving a note warning him to cease his cooperation, according to a New York Times article published that year. As noted above, according to the Belgian newspaper Le Soir, two members of Bayrock’s Eurasian Trio were also involved in Seabeco during this period as well—Patokh Chodiev and Alexander Mashkevich. Chodiev reportedly first met Birshtein through the Soviet Foreign Ministry, and then went on to run Seabeco’s Moscow office before joining its Belgium office in 1991. Le Soir further claims that Mashkevich worked for Seabeco too, and that this was actually how he and Chodiev had first met.

All this is fascinating, but what about the connections between Birshtein and Trump's Toronto business associate, Alex Shnaider? Again, the leads we have are tantalizing.The Toronto Globe and Mail reported that in 1991, while enrolled in law school, young Alex Shnaider started working for Birshtein at Seabeco’s Zurich headquarters, where he was reportedly introduced to steel trading. Evidently this was much more than just a job; the Zurich company registry lists "Alex Shnaider" as a Director of "Seabeco Metals AG" from March 1993 to January 1994. [48]

In 1994, according to this account, reportedly left Seabeco in January 1994 to start his own trading company in Antwerp, in partnership with a Belgian trader-partner. Curiously, Le Soir also says that Mikhaylov and Birshtein co-founded MAB International in Antwerp in January 1994. Is it far-fetched to suspect that Alex Shnaider and mob boss Mikhaylov might have crossed paths, since they were both in the same city and they were both close to Shnaider’s father-in-law?

According to Forbes, soon after Shnaider moved to Antwerp, he started visiting the factories of his steel trading partners in Ukraine.[49] His favorite client was the Zaporizhstal steel mill, the Ukraine's fourth largest. At the Zaporizhstal mill he reportedly met Eduard Shifrin (aka Shyfrin), a metals trader with a Ph.D. in metallurgical engineering. Together they founded Midland Resource Holdings Ltd. in 1994.[50]

As the Forbes piece argues, with privatization sweeping Eastern Europe, private investors were jockeying to buy up the government’s shares in Zaprozhstal. But most traders lacked the financial backing and political connectons to accumulate large risky positions. Shnaider and Shifrin, in contrast, started buying up shares without limit, as if their pockets and connections were very deep. By 2001 they had purchased 93 percent of the plant for about $70 million, a stake that would be worth much more just five years later, when Shnaider reportedly turned down a $1.2 billion offer.

Today Midland Resources Holdings Ltd. reportedly generates more than $4 billion a year of revenue and has numerous subsidiaries all across Eastern Europe.[51] Shnaider also reportedly owns Talon International Development, the firm that oversaw construction of the Trump hotel-tower in Toronto. All this wealth apparently helped Iceland's FL Group decide that it could afford to extend a €48.5 million loan to Alex Shnaider in 2008 to buy a yacht. [52]

            As of December 2016, a search of the Panama Papers database found no less than 28 offshore companies that have been associated with “Midland Resources Holding Limited.”[53] According to the database, "Midland Resources Holding Limited" was a shareholder in at least two of these companies, alongside an individual named “Oleg Sheykhametov.”[54] The two companies, Olave Equities Limited and Colley International Marketing SA, were both registered and active in the British Virgin Islands from 2007–10.[55] A Russian restaurateur by that same name reportedly runs a sushi franchise owned by two other alleged Solntsevskaya mob associates, Lev Kvetnoy and Andrei Skoch, both of whom are pictured below with Sergei Mikhaylov below. Of course mere inclusion in such a group photo is no evidence of any wrong-doing. (INSERT Picture Link here: https://www.theguardian.com/world/2012/nov/28/man-behind-megafon.) According to Forbes, Kvetnoy is the 55th richest person in Russia and Skoch, now a deputy in the Russian Duma, is the 18th. [56]           

            Finally, it is also intriguing to note that Bori Birshtein is also listed as the President of "ME Moldova Enterprises AG," a Zurich-based company" that was founded in November1992, transferred to the canton of Schwyz in September 1994, and liquidated and cancelled in January 1999.[57] Birshstein was a member of the company's board of directors from November 1992 to January 1994, when he became its President. At that point he was succeeded as President in June 1994 by one "Evsei Shnaider, Canadian citizen, resident in Zurich," who was also listed as Director of the company in September 1994.[58] " Evsei Schnaider" is also listed in the Panama registry as a Treasurer and Director of "The Seabeco Group Inc," formed on December 6, 1991, [59]and as Treasurer and Director of Seabeco Security International Inc.," formed on December 10, 1991. As of December 2016, both companies are still in existence.[60] Boris Birstein is listed as President and Director of both companies.[61]

The Case of Paul Manafort’s Ukrainian Oligarchs

 Our fifth Trump associate profile concerns the Russo/Ukrainian connections of Paul Manafort, the former Washington lobbyist who served as Donald Trump’s national campaign director from April 2016 to August 2016. Manafort’s partner, Rick Davis, also served as national campaign manager for Senator John McCain in 2008, so this may not just be a Trump association.

 

Dymytro Firtash

One of Manafort’s biggest clients was the dubious pro-Russian Ukrainian billionaire Dmytro Firtash. By his own admission, Firtash maintains strong ties with a recurrent figure on this scene, the reputed Ukrainian/Russian mob boss Semion Mogilevich. His most important other links are almost certainly to Putin. Otherwise it is difficult to explain how this former used-car salesman could gain a lock on trading goods for gas in Turkmenstan and also become a lynchpin investor in the Swiss company RosUrEnergo, which controls Gazprom's gas sales to Europe[62]

In 2008, Manafort teamed up with a former manager of the Trump Organization to purchase the Drake Hotel in New York for up to $850 million, with Firtash agreeing to invest $112 million. According to a lawsuit brought against Manafort and Firtash, the key point of the deal was not to make a carefully-planned investment in real estate, but to simply launder part of the huge profits that Firtash had skimmed while brokering dodgy natural gas deals between Russia and Ukraine, with Mogilevich acting as a “silent partner.”

Ultimately Firtash pulled out of this Drake Hotel deal. The reasons are unclear – it has been suggestd that he needed to focus on the 2015 collapse and nationalization of his Group DF's Bank Nadra back home in the Ukraine.[63] But it certainly doesn't appear to have changed his behiavor. Since 2014 there have been a spate of other Firtash-related prosecutions, with the US try to extradict from Austria in order to stand trial on allegations that his vast spidernet "Group DF" had paid $18.5 million in bribes to Indian officials to secure mining licenses. The Austrian court, knowing Firtash like a brother, required him to put up a record-busting €125 mm bail while he awaits a decision. [64] And just last month, Spain has also tried to extradite Firtash on a separate money laundering case, involving washing €10 million through Spanish property investments.

After Firtash pulled out of the deal, Manafort reportedly turned to Trump, but he declined to engage. Manafort stepped down as Trump’s campaign manager in August of 2016 in response to press investigations into his ties not only to Firtash, but to the Ukraine's previous pro-Russian Yanukovych government, which had been deposed by a uprising in 2014.  However, following the November 8 election, Manafort reportedly returned to advise Trump on staffing his new administration.  He got an assist from Putin -- on November 30 a spokeswoman for the Russian Foreign Ministry accused Ukraine of leaking stories about Manafort in an effort to hurt Trump.

The Case of “Well-Connected” Russia/FSU Mobsters

 Finally, several other interesting Russo/FSU connections have a more residential flavor, but they are a source of very important leads about the Trump network.

Indeed, partly because it has no prying co-op board, Trump Tower in New York has received press attention for including among its many honest residents tax-dodgers, bribers, arms dealers, convicted cocaine traffickers, and corrupt former FIFA officials. [65]

Semion Mogilevich

One typical example involves the alleged Russian mobster Anatoly Golubchik, who went to prison in 2014 for running an illegal gambling ring out of Trump Tower -- not only the headquarters of the Trump Organization but also the former headquarters of Bayrock Group LLC. This operation reportedly took up the entire 51st floor. Also reportedly involved in it was the alleged mobster Alimzhan Tokhtakhounov, [66] who has the distinction of making the Forbes 2008 list of the World’s Ten Most Wanted Criminals, and whose organization the FBI believed to be tied to Mogilevich’s. Even as this gambling ring was still operating in Trump Tower, Tokhtakhounov reportedly travelled to Moscow to attend Donald Trump’s 2013 Miss Universe contest as a special VIP.

In the Panama Papers database we do find the name “Anatoly Golubchik.” Interestingly, his particular offshore company, "Lytton Ventures Inc.," [67] shares a corporate director, Stanley Williams, with a company that may well be connected to our old friend Semion Mogilevich, the Russian mafia’s alleged “Boss of Bosses” who has appeared so frequently above. Thus Lytton Ventures Inc. shares this particular director with another company that is held under the name of “Galina Telesh.”[68] According to the Organized Crime and Corruption Reporting Project, multiple offshore companies belonging to Semion Mogilevich have been registered under this same name -- which just happens to be that of Mogilevich’s first wife.

A 2003 indictment of Mogilevich also mentions two offshore companies that he is said to have owned, with names that include the terms “Arbat” and “Arigon.” The same corporate director shared by Golubchik and Telesh also happens to be a director of a company called Westix Ltd.,[69] which shares its Moscow address with “Arigon Overseas” and “Arbat Capital.”[70] And another company with that same director appears to belong to Dariga Nazarbayeva, the eldest daughter of Nursultan Nazarbayev, the long-lived President of Kazakhstan. Dariga is expected to take his place if he ever decides to leave office or proves to be mortal.

Lastly, Dmytro Firtash—the Mogilevich pal and Manafort client that we met earlier—also turns up in the Panama Papers database, as part of Galina Telesh’s network neighborhood. A director of Telesh’s “Barlow Investing,” Vasliki Andreou, was also a nominee director of a Cyprus company called “Toromont Ltd.,” while another Toromont Ltd. nominee director, Annex Holdings Ltd., a St. Kitts company, is also listed as a shareholder in Firtash’s Group DF Ltd., along with Firtash himself.[71] And Group DF’s CEO, who allegedly worked with Manafort to channel Firtash’s funding into the Drake Hotel venture, is also listed in the Panama Papers database as a Group DF shareholder. Moreover, a 2006 Financial Times investigation identified three other offshore companies that are linked to both Firtash and Telesh.[72] 

Anatoly Golubchik’s Panama Papers Network Neighborhood

Of course, all of these curious relationships may just be meaningless coincidences. After all, the director shared by Telesh and Golubchik is also listed in the same role for more than 200 other companies, and more than a thousand companies besides Arbat Capital and Arigon Overseas share Westix’s corporate address. In the burgeoning land of offshore havens and shell-game corporate citizenship, there is no such thing as overcrowding. The appropriate way to view all this evidence is to regard it as "Socratic:" raising important unanswered questions – not providing definite answers.

In any case, returning to Trump's relationships through Trump Tower, another odd one involves the 1990s-vintage fraudulent company YBM Magnex International. YBM, ostensibly a world-class manufacturer of industrial magnets, was founded indirectly in Newtown, Bucks County, Pennsylvania in 1995 by the "boss of bosses," Semion Mogilevich, Moscow’s “brainy Don.”

This is a fellow with an incredible history, even if only one-half of what has been written about him is true. [73] Unfortunately, we have to focus here only on the bits that are most relevant.. Born in Kiev, and now a citizen of Israel as well as the Ukraine and Russia, Semion, now 70, is a lifelong criminal. But he boasts an undergraduate economics degree from Lviv University, and is reported to take special pride in designing sophisticated, virtually undetectable financial frauds that take years to put in place. To pull them off, he often relies on the human frailties of top bankers, stock brokers, accountants, business magnates, and key politicians.[74]

In YBM’s case, for a mere $2.4 million in bribes, Semion and his henchmen spent years in the 1990s launching a product-free, fictitious company on the still-badly under-regulated Toronto Stock Exchange. Along the way they succeeded in securing the support of several leading Toronto business people and a former Ontario Province Premier to sit on YBM’s board. They also paid the “Big Four” accounting firm Deloitte Touche very handsomely to issue glowing audits. By mid-1998, YBM’s stock price had gone from less than $.10 to $20, and Semion cashed out at least $18 million—a relatively big fraud for its day—before the FBI raid its YBM's corporate headquarters. When it did so, it found piles of bogus invoices for magnets, but no magnets. [75]

In 2003, Mogilevich was indicted in Philadelphia on 45 felony counts for this $150 million stock fraud. But there is no extradition treaty between the United States and Russia, and no chance that Russia will ever extradite Semion voluntarily; he is arguably a national treasure, especially now. Acknowledging these realities, or perhaps for other reasons, the FBI quietly removed Mogilevich from its Top Ten Most Wanted list in 2015, where he had resided for the previous six years.[76]

For our purposes, one of the most interesting things to note about this YBM Magnex case is that its CEO was a Russian-American named Jacob Bogatin, who was also indicted in the Philadelphia case. His brother David had served in the Soviet Army in a North Vietnamese anti-aircraft unit, helping to shoot down American jet pilots like Senator John McCain. Since the early 1990s, David Bogatin was considered by the FBI to be one of the key members of Semion Mogilevich’s Russian organized crime family in the United States, with a long string of convictions for big-ticket Mogilevich-type offenses like financial fraud and tax dodging.

At one point, David Bogatin owned five separate condos in Trump Tower that Donald Trump had reportedly sold to him personally.[77] And Vyacheslav Ivankov, another key Mogilevich lieutenant in the United States during the 1990s, also resided for a time at Trump Tower, and reportedly had in his personal phone book the private telephone and fax numbers for the Trump Organization’s office in that building.[78]

________

So what have we learned from this deep dive into the network of Donald Trump's Russian/FSU connections?

¶ First, the President-Elect really is very "well-connected," with an extensive network of unsavory global underground connections that may well be unprecedented in White House history. In choosing his associates, evidently Donald Trump only pays cursory attention to questions of background, character and integrity.

¶ Second, Donald Trump has also literally spent decades cultivating senior relationships of all kinds with Russia and the FSU. And public and private senior Russian figures of all kinds have likewise spent decades cultivating him, not only as a business partner, but as a "useful idiot."

After all, on September 1, 1987 (!), Trump was already willing to spend a $94,801 on full-page ads in the Boston Globe, the Washington Post, and the New York Times, calling for the US to stop spending money to defend Japan, Europe, and the Persian Gulf, "an area of only marginal significance to the US for its oil supplies, but one upon which Japan and others are almost totally dependent.''[79]

This is one key reason why just this week, Robert Gates, a registered Republican who has served Secretary of Defense under Presidents from both parties, as well as Director and Deputy Director of the CIA, critized the response of Congress and the White House to the alleged Putin-backed hacking as far too "laid back." [80]

¶ Third, even beyond questions of illegality, the public clearly has a right to know much more than it already does about the nature of such global connections. As our opening quote from Cervantes suggests, these relationships are probably a pretty good leading indicator of how Presidents will behave once in office.

Unfortunately, for many reasons, this year American voters never really got the chance to decide whether such low connections and entanglements belong at the world’s high peak of official power. In the waning days of the Obama Administration, with the Electoral College about to ratify Trump's election and Congress in recess, it is too late to establish the kind of bipartisan 9/11-type commission that would be needed to explore these connections in detail.

¶ Finally, the long-run consequence of careless interventions in other countries is that they often come back to haunt us.  In Russia's case, it just has.

♥♥♥ 

James S. Henry, Esq. is an investigative economist and lawyer who has written widely about offshore and onshore tax havens, kleptocracy, and pirate banking. He is the author of The Blood Bankers (Basic Books, 2003,2005), a classic investigation of where the money went that was loaned to key debtor countries in the 1970s-1990s. He is a Senior Fellow at the Columbia University's Center on Sustainable Investment, a Global Justice Fellow at Yale, a Senior Advisor at the Tax Justice Network, and a member of the New York Bar. He has pursued frontline investigations of odious debt, flight capital, and corruption in more than 50 developing countries, including Russia, China, South Africa, Brazil, the Philippines, Argentina, Venezuela, Nicaragua, Mexico, and Panama.

 

[1] Author’s estimates; see globalhavenindustry.com for more details.

[2] For an overview and critical discussion, see http://prutland.faculty.wesleyan.edu/files/2015/08/The-role-of-the-IMF-in-Russia.pdf.

[3] See Lawrence Klein and Marshall Pomer, Russia's Economic Transition Gone Awry (Stanford U. Press, 2002); see also James S. Henry and Marshall Pomer, "A Pile of Ruble," The New Republic, 1998, 219 (10), 20-21.

[4] See this Washington Post report, which counts just six bankruptcies to the Trump Organization’s credit, but excludes failed projects like the Trump SoHo, the Toronto condo-hotel, the Fort Lauderdale condo-hotel, and many others Trump was a minority investor or had simply licensed his brand.

[5] For example, the Swiss federal and cantonal corporate registries, available at http://zefix.admin.ch.

[6] For ICIJ's April 2016 "Panama Papers" database of offshore companies, see https://offshoreleaks.icij.org.

[7] Trump’s minority equity deal with Bayrock was unlike many others, where he simply licensed his name. See this March 2008 New York Magazine piece.

[8] “I dealt mostly with Tevfik,” he said in 2007 http://www.thedailybeast.com/articles/2011/05/26/inside-donald-trumps-empire-why-he-wont-run-for-president.html

[9] Case 1:09-cv-21406-KMW Document 408-1. Entered on FLSD Docket 11/26/2013. p. 15. https://archive.org/stream/DonaldTrumpArchive/Branding%20%20DJT%20Fort%20Lauderdale%20Depo%2011-5-2013#page/n19/mode/2up.

[10] https://kazakhbusinessbulletin.wordpress.com/kazakh-businessman/tevfik-arif/.

[11] Bayrock reported its co-ownership of six Rixos hotels in a 2007 press release.

[12] See also Salihovic, Elnur, Major Players in the Muslim Business World, p.107

https://books.google.com/books?id=aSa1DAAAQBAJ&pg=PA107&lpg=PA107&dq=%22the+trio%22+kazakhstan&source=bl&ots=pwxBZWjuGi&sig=v43XY1UxLhub0YayYH6vY1lcAJc&hl=en&sa=X&ved=0ahUKEwigx6Hi08rQAhUJwiYKHSoQACQ4ChDoAQgnMAM#v=onepage&q=%22the%20trio%22%20kazakhstan&f=false; http://www.telegraph.co.uk/finance/newsbysector/industry/mining/8171468/US-ambassador-unimpressed-by-food-at-oligarch-Alexander-Mashkevichs-house.html.

[13] See also http://www.sahistory.org.za/sites/default/files/file%20uploads%20/alastair_fraser_miles_larmer_zambia_mining_anbook4you.pdf; http://www.brusselstimes.com/belgium/3302/the-belgian-billionaire-georges-forrest-denies-any-involvement-in-kazakhgate; http://archives.lesoir.be/le-parquet-de-bruxelles-enquete-kazakhgate-tractebel-co_t-19991228-Z0HNTZ.html.

[14] According to the Panama Papers database, "International Financial Limited" was registered on April 3, 1998, but is no longer active today, although no precise deregistration date is available. See https://offshoreleaks.icij.org/nodes/167402.

[15]According to the Panama Papers, “Group Rixos Hotel” is still active company, while three of the four companies it serves were struck off in 2007 and the fourth, Hazara Asset Management, in 2013.

[16] http://www.ynetnews.com/articles/0,7340,L-4048812,00.html.

[17] See also [17] http://turizmguncel.com/haber/savarona-zanlilari-sorgulanirken-ismailov-adliyeye-gitti-h3325.html; [17] http://www.legrandsoir.info/Machkevitch-et-ses-complices-blanchis-par-la-justice-turque.html.

[18] Case 1:09-cv-21406-KMW Document 408-1. Entered on FLSD Docket 11/26/2013. p. 16. https://archive.org/stream/DonaldTrumpArchive/Branding%20%20DJT%20Fort%20Lauderdale%20Depo%2011-5-2013#page/n19/mode/2up.

[19]The exact date that Sater joined Bayrock is unclear. A New York Times article says 2003, but this appears to be too late. Sater says 1999, but this is much too early. A certified petition filed with the U.S. Supreme Court places the time around 2002, which is more consistent with Sater’s other activities during this period, including his cooperation with the Department of Justice on the Coppa case in 1998–2001, and his foreign travel.

[20] See https://www.ft.com/content/549ddfaa-5fa5-11e6-b38c-7b39cbb1138a; http://www.nytimes.com/2016/04/06/us/politics/donald-trump-soho-settlement.html; https://www.washingtonpost.com/politics/former-mafia-linked-figure-describes-association-with-trump/2016/05/17/cec6c2c6-16d3-11e6-aa55-670cabef46e0_story.html

; [20] http://c10.nrostatic.com/sites/default/files/Palmer-Petition-for-a-writ-of-certiorari-14-676.pdf. Note that previous accounts of Sater's activities have overlooked the role that this very permissive relationship with federal law enforcement, especially the FBI, may have played in encouraging Sater's subsequent risk-taking and financial crimes. See http://c10.nrostatic.com/sites/default/files/Palmer-Petition-for-a-writ-of-certiorari-14-676.pdf.

[21] See http://c10.nrostatic.com/sites/default/files/Palmer-Petition-for-a-writ-of-certiorari-14-676.pdf, 13.

[22] Sater’s 1998 case, never formally sealed, was U.S. v. Sater, 98-CR-1101 (E.D.N.Y.) The case in which Sater secretly informed was U.S. v. Coppa, 00-CR-196 (E.D.N.Y.). See also http://www.thedailybeast.com/articles/2016/11/06/trump-s-russia-towers-he-just-can-t-get-them-up.html.

[23] http://www.nytimes.com/2007/12/17/nyregion/17trump.html. Sater also may have taken other steps to conceal his criminal past. According to the 2015 lawsuit filed by x Bayrocker Jody Kriss, Arif agreed to pay Sater his $1 million salary under the table, allowing Sater to pretend that he lacked resources to compensate any victims of his prior financial frauds. See Kriss v. Bayrock, pp. 2, 18, at https://assets.documentcloud.org/documents/2638421/Kriss-v-Bayrock-Complaint.pdf The lawsuit also alleges that Sater may have held a majority of Bayrock's ownership, but that Arif, Sater and other Bayrock officers may have conspired to hide this by listing Arif as the sole owner on offering documents.

[24] See https://archive.org/stream/DonaldTrumpArchive/Branding%20%20DJT%20Fort%20Lauderdale%20Depo%2011-5-2013#page/n153/mode/2up, 155.

[25] "Former FL Group manager," interview with London, August 2016. Sigrun Davidsdottir, Iceland journalist.

[26] See "Report of the Special Investigation Commission on the 2008 Financial Crisis." (April 12, 2010), available at http://www.rna.is/eldri-nefndir/addragandi-og-orsakir-falls-islensku-bankanna-2008/skyrsla-nefndarinnar/english/.

[27] These loans are disclosed in the Kaupthing Bank's "Corporate Credit – Disclosure of Large Exposures > €40 mm." loan book, September 15, 2008. This document was disclosed by Wikileaks in 2009   See http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5968231/Kaupthing-leak-exposes-loans.html; http://file.wikileaks.info/leak/kaupthing-bank-before-crash-2008.pdf, p.145 (€79.5mm construction yacht loan to Russian vodka magnate Yuri Shefler's Serena Equity Ltd.;   p. 208: (€45.8 mm yacht construction loan to Canadian-Russian billionaire Alex Shnaider's Filbert Pacific Ltd..

[28] Kriss lawsuit, op. cit.; author's analysis of Kaupthing/ FL G employees published career histories.

[29] Author's interview, "Iceland Economist," Reykjavik, July 2016.

[30] http://uniad.com.ua/main/940-dose-aleksa-shnajdera-sovladelca-zaporozhstali.html. The passage in Russian, with the father's name underlined, is as follows: "Родители Алекса Шнайдера владели одним из первых успешных русских  магазинов в русском квартале Торонто. Алекс помогал в бизнесе отцу – Евсею Шнайдеру, расставляя на полках товар и протирая полы. С юных лет в Алексе зрела предпринимательская жилка.  Живя с родителями, он стал занимать деньги у их друзей и торговать тканями и электроникой с разваливающимися в конце 80-х годов советскими предприятиями." "Евсею Шнайде

ру" is the dative case of "Евсей Шнайдер," or "Evsei Shnaider," the father's name in Russian.

[31] The Zurich company registry (http://www.zefix.ch/info/ger/ZH020.htm) reports that "Seabeco SA" (CHE-104.863.207) was initially registered on December 16, 1982, with "Boris Joseph Birshtein, Canadian citizen, resident in Toronto" as its President. It entered liquidation on May 5, 1999, in Arth, handled by the Swiss trustee Paul Barth. The Zurich company registry listed "Boris Joseph Birshtein, Canadian citizen, resident in Toronto," as the President of Seabeco Kirgizstan AG in 1992, while "Boris Joseph Birshtein, Canadian citizen, resident in Zurich," was listed as the company's President in 1993. "Boris Birshtein" is also listed as the President and director of a 1991 Panama company, The Seabeco Group, Inc. as of December 6 1991. See below.

[32] See http://blog.marcelsel.com/2015/02/26/quand-kubla-et-de-decker-tournent-kazakh/.

[33] The Zurich company registry reports that "Seabeco SA" (CHE-104.863.207) was initially registered on December 16, 1982, with "Boris Joseph Birshtein, Canadian citizen, resident in Toronto" as its President. According to the registry, it entered liquidation on May 5, 1999. See also https://groups.google.com/forum/#!topic/soc.culture.ukrainian/1mtgIacNtMw. The liquidation was handled by the Swiss trustee Paul Barth, in Arth.

[34] For Seabeco's Antwerp subsidiary, see http://archives.lesoir.be/mafia-russe-la-justice-suisse-fond-sur-anvers-et-bruxel_t-19970317-Z0DFVX.html.

[35] "Royal HTM Group, Inc." of Toronto, (Canadian Federal Corporation # 624476-9), owned 50-50 by Birshtein and his nephew. See https://www.ic.gc.ca/app/scr/cc/CorporationsCanada/fdrlCrpDtls.html?corpId=6244769&V_TOKEN=1481946919835&crpNm=Royal%20HTM%20Group,%20Inc.&crpNmbr=&bsNmbr= .

[36] Birshtein was a director of Seabeco Capital Inc. (Canadian Federal Incorporatio # 248194-4,) a Winnipeg company created 6/2/1989 and dissolved 12/22/1992 )https://www.ic.gc.ca/app/scr/cc/CorporationsCanada/fdrlCrpDtls.html?corpId=2481944&V_TOKEN=1481931998238&crpNm=Seabeco&crpNmbr=&bsNmbr=

[37] Since 1998, Boris Birshtein (Toronto) has also served as Chairman, CEO, and a principle shareholder of "Trimol Group Inc.," a publicly-traded Delaware company that trades over the counter. (Symbol: TMOL). Its product line is supposedly "computerized photo identification and database management system utilized in the production of variety of secure essential government identification documents." See https://www.bloomberg.com/quote/TMOL:US; https://www.sec.gov/Archives/edgar/data/1011733/0000950123-98-005826.txt.

However, according to Trimol's July 2015 10-K (http://www.wikinvest.com/stock/Trimol_Group_Inc_(TMOL)/Filing/10-K/2015/10-K/D20069370) the company has only had one customer, the former FSU member Moldova, with which Trimol's wholly-owned subsidiary Intercomsoft concluded a contract in 1996 for the producton of a National Passport and Population Registration system. That contract was not renewed in 2006, and the subsidiary and Trimol have had no revenues since then. Accordingly, as of 2016 Trimol has only two part time employees, its two principle shareholders, Birshtein and his nephew, who, directly and indirectly account for 79 percent of Trimol's shares outstanding. According to the July 2015 10-K, Birshtein, in particular, owned 54 percent of TMOL's outstanding 78.3 million shares, including 3.9 million by way of "Magnum Associates, Inc.," which the 10-K says only has Birshtein as a shareholder, and 34.7 million by way of yet another Canadian company, "Royal HTM Group, Inc." of Ontario (Canadian Federal Corporation # 624476-9), which is owned 50-50 by Birshtein and a nephew. It is interesting to note according to the Panama Papers database, a Panama company called "Magnum Associates Inc. was incorporated on December 10, 1987, and struck off on March 10, 1989.   See https://offshoreleaks.icij.org/nodes/10213728. As of December 2016, TMOL's stock price was zero.

[38] See the case of Trimol Group Inc above. The Seabeco Group, Inc., a Panama company that was formed in December 1991, apparently still exists. Boris J. Birshtein is listed as this company's Director and President. See "The Seabeco Group Inc." registered in Panama by Morgan Y Morgan, 1991-12.06, with "Numero de Ficha" 254192, http://ohuiginn.net/panama/company/id/254192; https://opencorporates.com/companies/pa/254192.

[39] As of December 2016, the Zurich company registry (http://www.zefix.ch/info/ger/ZH020.htm) listed a Zurich company called "Conim Investment AG" (CH-020.3.002.334-7) was originally formed in May 1992, and in January 1995 was transferred to Arth, in the Canton of Schwyz, where it is still in existence. (CHE-102.029.498). This is confirmed by the Schwyz Canton registery: https://sz.chregister.ch/cr-portal/auszug/auszug.xhtml?uid=CHE-102.029.498. According to these registries, Conim Investment AG is the successor company to two other Zurich campanies, "Seabeco Kirgizstan AG,"formed in 1992, and "KD Kirgizstan Development AG," its direct successor.   (http://zh.powernet.ch/webservices/net/HRG/HRG.asmx/getHRGHTML?chnr=CH-020.3.002.334-7&amt=020&toBeModified=0&validOnly=0&lang=1&sort=).

The Swiss federal company registry also reports the following Swiss companies in which Boris J.Birshtein has been an officer and or director, all of which are now in liquidation: (1) Seabeco Trade and Finance AG (CH-020.3.002.179-4, 4/3/92-11/30/98 ), ; (2) Seabeco SA (CHE-104.863.207,12/16/82-5/9/99) ; (3) Seabeco Metals AG (4/3/92-6/11/96); (4) BNB Trading AG (CH-020.3.002.181-9, 1/10/92-11/19/98 ); and (5) ME Moldova Enterprises AG (CH-020.3.003.104-1, 11/10/92-9/16/94). All of these liquidations were handled by the same trustee, Paul Barth in Arth.

[40] As of December 2016, active Birshtein companies include "Conim Investment AG" (CH-020.3.002.334-7) in the Swiss Canton of Schwyz and he Seabeco Group, Inc. in Panama.

[41] For example, the Zurich and Schwyz company registries indicates that the following have been board members of Birshtein companies: (1) Seabeco Trade and Finance AG: Iouri Orlov (citizen of Russia, resident of Moscow), Alexander Griaznov (citizen of Russia, resident of Basserdorf Switzerland), and Igor Filippov (citizen of Russia, resident of Basel). (2) ME Moldova Enterprises: Andrei Keptein (citizen of FSU/ Moldova; Evsei Shnaider (Russian émigré to Canada); (3) Seabeco Kirigizstan/ Conim Investment AG: Sanjarbek Almatov (citizen of Bishkek, FSU/ Kirgizstan), Toursounbek Tchynguychev (citizen of Bishkek, FSU/Kirgizstan), Evsei Shnaider (Russian émigré to Canada); (4) BNB Trading AG: Yuri Spivak (Russian émigré to Canada; (5) Seabeco Metals AG: Alex Shnaider (Russian émigré to Canada).

[42] Charles Clover, "Ukraine: Questions over Kuchma's adviser cast shadows," FT, October 30, 1999, available at http://willzuzak.ca/lp/clover01.html See also Misha Glenny, 2009. McMafia: A Journey Through the Global Criminal Underworld. (New York: Vintage Books), 63-65.

[43] Charles Clover, "Ukraine: Questions over Kuchma's adviser cast shadows," FT, October 30, 1999, available at http://willzuzak.ca/lp/clover01.html .

[44] See FBI, Organizational Intelligence Unit (August 1998), "Semion Mogilevich Organization: Eurasian Organized Crime," available at http://www.larryjkolb.com/file/docs/fbimogilevich.pdf.

[45] Charles Clover, "Ukraine: Questions over Kuchma's adviser cast shadows," FT, October 30, 1999, available at http://willzuzak.ca/lp/clover01.html

[46] Charles Clover, "Ukraine: Questions over Kuchma's adviser cast shadows," FT, October 30, 1999, available at http://willzuzak.ca/lp/clover01.html .

[47] Toronto Star, Aug 28, 1993 “Boris knows everyone,”

http://www.telusplanet.net/public/mozuz/crime/lemieszewski20001103.html#bottom%288%29.

[48] See Zurich corporate registry for "Seabeco Metals AG" (CH-020.3.002.181-9), formed 4/3/92 and liquidated 6/11/96.

[49] http://www.forbes.com/forbes/2005/0328/132.html

[50] http://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=20412545

[51] http://www.bloomberg.com/research/stocks/private/snapshot.asp?privcapId=20412545.

[52] See Kaupthing Bank, "Loan Book, September 2008," wikileaks: https://wikileaks.org/wiki/Financial_collapse:_Confidential_exposure_analysis_of_205_companies_each_owing_above_EUR45M_to_Icelandic_bank_Kaupthing,_26_Sep_2008

[53]The Panama Papers database provides an address for “Midland Resources Holding Limited" (https://offshoreleaks.icij.org/nodes/12085103) that exactly matches the company's corporate address in Guernsey, as noted by Bloomberg's corporate data base. Here are the 28 companies that are associated with Midland in database:  

Aligory Business Ltd., https://offshoreleaks.icij.org/nodes/10127460;

Anglesey Business Ltd., https://offshoreleaks.icij.org/nodes/10123508;

Blue Industrial Skies Inc., https://offshoreleaks.icij.org/nodes/10130255;  

Cl 850 Aviation Holdings Ltd., https://offshoreleaks.icij.org/nodes/10122735;

Cl 850 Aircraft Investments Ltd., https://offshoreleaks.icij.org/nodes/10122774;

Caray Business Inc., https://offshoreleaks.icij.org/nodes/10131819;

Challenger Aircraft Company Limited, https://offshoreleaks.icij.org/nodes/12155627;

Colley International Marketing S.A., https://offshoreleaks.icij.org/nodes/10123599;

East International Realty Ltd., https://offshoreleaks.icij.org/nodes/10122122;

Filbert Pacific Limited, https://offshoreleaks.icij.org/nodes/10199822;

Gorlane Business Inc., https://offshoreleaks.icij.org/nodes/10210594;

Jabar Incorporated, https://offshoreleaks.icij.org/nodes/10110254;

Jervois Holdings Inc.( https://offshoreleaks.icij.org/nodes/12125131) ,

Kerryhill Investments Corp., https://offshoreleaks.icij.org/nodes/10103732;

Leaterby International Investments Corp., https://offshoreleaks.icij.org/nodes/10202817

Maddocks Equities Ltd.,( https://offshoreleaks.icij.org/nodes/12085103,

Maverfin Holding Inc.( https://offshoreleaks.icij.org/nodes/12130837),

Midland Maritime Holding Ltd.( https://offshoreleaks.icij.org/nodes/12136120),

Midland River-Sea Holding Ltd. (https://offshoreleaks.icij.org/nodes/12136120),

Midland Drybulk Holding Ltd.( https://offshoreleaks.icij.org/nodes/12136120),

Midland Fundco Ltd. (https://offshoreleaks.icij.org/nodes/12136120),

Norson Investments Corp.( https://offshoreleaks.icij.org/nodes/12130837),

Olave Equities Limited, https://offshoreleaks.icij.org/nodes/12155627; https://offshoreleaks.icij.org/nodes/10125740;

Orlion Business Incorporated, https://offshoreleaks.icij.org/nodes/12155627

Perseus Global Inc., https://offshoreleaks.icij.org/nodes/10111891;

Sellana Investments Global Corp., https://offshoreleaks.icij.org/nodes/12155627

Stogan Assets Incorporated, https://offshoreleaks.icij.org/nodes/10206109

Toomish Asset Ltd., https://offshoreleaks.icij.org/nodes/10128146.

[54] With the address "11 First Tverskaya-Yamskaya Street; apt. 42; Moscow; Russia." https://offshoreleaks.icij.org/nodes/10123599;; https://offshoreleaks.icij.org/nodes/12078236; https://offshoreleaks.icij.org/nodes/10125740.

[55] As for the Midland-related offshore vehicles still listed as active, one shareholder in two of them -- -- Stogan Assets Incorporated and Blue Sky Industries Inc. -- happens to have the same name as Russia’s Deputy Culture Minister Gregory Pirumov, reportedly arrested in March 2016 on embezzlement charges. The “Gregory Pirumov” in the Panama Papers (https://offshoreleaks.icij.org/nodes/250440) has a registered address in Moscow (4 Beregkovskaia Quay; 121059), as do the reported agents of these two companies: "Global Secretary Services Ltd. Mal. Tolmachevskiy pereulok 10 Office No.3 Moscow, Russia 119017 Attention: Katya Skupova)." See https://panamadb.org/entity/stogan-assets-incorporated_189367. A "Georgy Pirumov" is also listed separately in the Panama Papers as having been a shareholder in the same two companies (https://offshoreleaks.icij.org/nodes/10206109; https://offshoreleaks.icij.org/nodes/12111401.) For what it is worth, in September 2016, one "Georgy Pirumov" was convicted in Moscow of "illegally taking over a building in Gogolevsky Boulevard," and sentenced to 20 months in a minimum-security correctional facility. See The Investigative Committee of the Russian Federation, Sept 15, 2016, http://en.sledcom.ru/news/item/1067178/. At this point, however, we need to emphasize that there is still plenty that needs to be investigated -- we cannot yet confirm whether "Georgy" and "Gregory" are the same person, whether they are related, how they might be related to Shnaider's Mineral Resources, or whether they are the same people named in the articles just noted above about criminal prosecutions.

[56] http://www.forbes.com/profile/lev-kvetnoi/.

[57] See Schwyz canton corporate registry, https://sz.chregister.ch/cr-portal/suche/suche.xhtml, ""ME Moldova Enterprises AG," CH-130.0.007.159-5.

[58] See Zurich corporate registry, http://www.zefix.ch/info/ger/ZH020.htm, "ME Moldova Enterprises AG," CH-020.3.003.104-1 (11/10/92-9/16/94).

[59] See "Seabeco Group Inc.," Panama Corporate Registry # 254192, https://opencorporates.com/companies/pa/254192, formed 12-6-1991.

[60] See "Seabeco Security Intl Inc." Panama Corporate Registry #254206, formed 12-10-1991," https://opencorporates.com/companies/pa/254206.

[61] Ibid, footnotes 58 and 59.

[62] http://www.independent.co.uk/news/uk/crime/Dmytro-firtash-spain-seeks-extradition-for-ukrainian-oligarch-linked-to-senior-tories-for-alleged-a7439621.html

[63] See http://www.unian.info/economics/1041128-nadra-bank-owned-by-firtash-declared-insolvent.html.

[64] http://www.independent.co.uk/news/uk/crime/Dmytro-firtash-spain-seeks-extradition-for-ukrainian-oligarch-linked-to-senior-tories-for-alleged-a7439621.html

[65] See http://transparency.org.ru/en/news/first-we-take-miami-why-russian-businessmen-and-criminals-move-into-trump-s-towers.

[66] A.K.A. "Tochtachunov." See FBI, Organizational Intelligence Unit (August 1998), "Semion Mogilevich Organization: Eurasian Organized Crime," available at http://www.larryjkolb.com/file/docs/fbimogilevich.pdf., 1.

[67]According to the Panama Papers, as of December 2016, Lytton Ventures Inc., incorporated in 2006, was still an active company but its registration jurisdiction was listed as "unknown." See https://offshoreleaks.icij.org/nodes/207427.

[68] For Telesh’s company the director’s name is given as “Stanley Williams,” as compared with “Stanley Edward Williams” in Golubchik’s, but they have the same address. See https://offshoreleaks.icij.org/nodes/196083. Telesh’s company, Barlow Investing, was incorporated in 2004. In the PP database, as of December 2016 its status was “Transferred Out,” although its de-registration date and registration jurisdiction are unknown.

[69] Westix Ltd., registered in 2005, is still active, according to the Panama Papers. See https://offshoreleaks.icij.org/nodes/214472.

[70] In the Panama Papers, Telesh’s company and Golubchik’s reportedly have the same director, one Stanley Williams. Williams is also reportedly a director of Westix, which shares its address with two other offshore companies that use corporate names that Mogilevich has reportedly used at least twice each in the past. Arbat Capital, registered in 2003, was still active as of December 2016, as was Arigon Overseas, registered in 2007.

[71] See the diagram below.

[72]These three offshore companies are not in the Panama Papers data base. https://www.ft.com/content/29f06170-12a2-11db-aecf-0000779e2340. Firtash acknowledged these connections to Telesh but still told FT reporters that he didn’t know her. The three companies identified in the report are (1) Highrock Holdings, which Firtash and Telesh each reportedly owned 1/3^rd of, and where Firtash served as director beginning in 2001; (2) Agatheas Holdings, where Firtash apparently replaced Telesh as director in 2003; and (3) Elmstad Trading, a Cyprus company owned by Firtash which in 2002 transferred the shares of a Russian company named Rinvey to Telesh and two other people: one of them Firtash’s lawyer and the other the wife of a reputed Mogilevich business partner. See also http://foreignpolicy.com/2014/03/19/married-to-the-ukrainian-mob/.

[73] On Mogilevich, see, for example, http://rumafia.com/en/eksklyuziv/kidala-vseya-strany-pervaya-chast.html.

[74] See also FBI, Organizational Intelligence Unit (August 1998), "Semion Mogilevich Organization; Eurasian Organized Crime," available at http://www.larryjkolb.com/file/docs/fbimogilevich.pdf.

[75] http://www.theglobeandmail.com/globe-investor/personal-finance/how-to-spot-fraud-and-be-a-vigilant-investor/article556022/

[76] See https://archives.fbi.gov/archives/news/stories/2009/october/mogilevich_102109;

 

http://www.slate.com/blogs/crime/2013/08/05/semion_mogilevich_fbi_ten_most_wanted_list_this_obese_mob_boss_is_twice.html.

[77]David Cay Johnston, interview with the author, November 2016. Wayne Barrett, Trump: The Greatest Show on Earth: The Deals, the Downfall, the Reinvention (Regan Arts, 2016).

[78]Johnston, interview; see also http://russianmafiagangster.blogspot.com/2012/12/the-superpower-of-crime.html. [78] In another interesting coincidence, the President of YBM Magnex was also reportedly a financial director of Highrock in the late 1990s, before Manafort-client Dmytro Firtash joined the company as a director in 2001. See note 151. http://foreignpolicy.com/2014/03/19/married-to-the-ukrainian-mob/.

 

[79] http://www.apnewsarchive.com/1987/Trump-U-S-Should-Stop-Paying-To-Defend-Countries-that-Can-Protect-Selves/id-05133dbe63ace98766527ec7d16ede08.

[80] https://www.theguardian.com/us-news/2016/dec/18/robert-gates-russia-election-interference-donald-trump-hillary-clinton.

***

Gaddafi's Fellow Travelers James S. Henry

(An earlier version of this appeared today as a Forbes column.)

I recall one cold wintry Saturday evening about three years ago in Vermont,  and a dinner conversation among a small group of former business colleagues, including  HBS Professor Michael E. Porter, the eminent competitive strategist.

He’d just returned from Tripoli, where he’d been working on what he told us was a  “strategy project” for the Gaddafi regime with a raft of consultants from Monitor Group, the Cambridge-based consulting firm that he’d helped to found in the early 1980s.  

For about thirty minutes or so he shared with us how excited they all were to be working to reform the Libyan economy, and how Colonel Gaddafi and his sons now really seemed to “get it.”

Clearly Prof. Porter felt this was all pretty cool. When asked about the issue of democracy and the rule of law, he rather quickly brushed aside such concerns, suggesting that they were sort of beside the point – after all, as the case of China supposedly demonstrated, all those annoying traditional liberal values sometimes just need to get out of the way of progress.

At the end of all this, there was a brief silence. I suspect that most of those at the table were slightly discomforted by Prof. Porter’s blunt, hard-nosed neoliberal analysis, and certainly by his apparent intoxication with the infamous Libyan dictator. But he was,  after all,  an eminent Harvard professor. And unlike us, he’d not only been to the country, but had met its most senior leaders personally.

Finally, however, my friend Roger Kline, a wise old McKinsey partner, broke the silence with a simple, direct, slightly impolitic question,  which would be answered only by the silence that it provoked from Professor Porter:  “Doesn’t it ever bother you at all, Michael, to be working for a terrorist?”

***

As the spirit of doom hovers over the last remnants of Muammar Gaddafi’s 42-year-long dictatorship, and most Libyans are celebrating his departure with sheer delight, there is much less joy in a handful of top-tier academic and professional-class households in Cambridge, Princeton, Georgetown, Baltimore,  East Lansing, and London.

For Mighty Muammar has indeed struck out -- contrary to the hopes  and  expectations of some of our very best and brightest experts on  “competitive country strategy," “global democratic governance," "the idea that is America,” and “soft power.”

After all, from their perspective, whatever Gaddafi's flaws, his blood-stained but deep-pocketed regime was certainly not like that of Kim Jong Il.

Unlike Kim, Gaddafi had been willing to pay quite handsomely to hear them spout off about their pet aerie-faerie neoliberal theories of political and economic development.

 
Meanwhile, Gaddifi's  government also ordered up an expensive grab-bag of university grants, endowments, special education for Libyan police and diplomats, ginned-up degrees for his dim-witted family members, lots of slick lobbying and lawyering, plus a large number of custom press portraits by leading Western academics gurus – none of whom ever bothered to disclose the fact that they were all on Brother Leader's  payroll.

This sordid tale first began to trickle out about two years ago from the Libyan opposition,  but it really picked up steam after the Revolution began in February 2011.  The interested reader can look here, here, here, here, and here for  the gory details.

But right now, just as the Gaddafis are about to take their rightful place in history’s waste bin, it is worth recalling the highlights  for several reasons.

First, we’d like to make sure that all of the leading academic   collaborateurs who helped to legitimate Gaddafi's abattoir receive their due: the  very first installment of the “Milton Friedman/ "Putzi" Hanfstaengl Iron Cross Award.

Second, we'd like to require all these collaborateurs to donate the millions of dollars of blood money and the  thousands of frequent flier miles they accumulated as unregistered foreign agents for Gaddafi’s regime to Libya’s teeming hospitals and orphanages.

Together, these two simple steps might help to insure that this kind of totally uncool dictatorship rebranding is brought to a screeching halt.

REBRANDING GADDAFI

This tale really began in 2003, when the Gaddafi regime, seeking to end an annoying economic  boycott,  gave its solemn word  to swear off terrorism forever, cease dabbling in nuclear technology, pay compensation for the 1988 Pan Am 103/Lockerbie bombing, and "accept responsibility for the actions of its officials,” whatever that meant.

Not surprisingly, given Gaddafi's horrific track record, most ordinary Westerners, not to mention the hard-pressed Libyan opposition, were deeply skeptical.

But Western leaders and policy experts were curiously much more receptive to Libya’s extraordinary effort to upgrade its image from “terror camp” to “the West’s best new pragmatic partner in the Middle East."

Indeed, it turned out to be a very fertile time for this kind of rebranding effort. First, even though Libya’s U-turn had largely been  motivated by economic self-interest, George W. Bush, Tony Blair, and Silvio Berlusconi welcomed it as a badly-needed victory in the “war on terror.”  Berlusconi and Blair even flew directly to Tripoli to welcome the “reborn” Gaddafi back into the community of nations.

Nor, in the US, was the welcome committee just limited to Republicans. In July  2008, Democrats Carl Levin and (now Vice President) Joe Biden played a key role in guiding S.1330 through the US Senate.

This  scurrilous bill, signed into law by President Bush, controversially granted Gaddafi complete legal immunity for the Lockerbie bombing, so long as he paid a (rather paltry) agreed-upon sum to the victims’ families.

Second, Libya’s U-turn opened the door to a whole bevy of Holy-Water merchants and academic medicine men. These instant Libyan "experts" were eager to offer Gaddafi not only absolution, but also their very latest pet theories about everything from “competitive clusters" and "strong democracy" to “the Third Way.”

They were also eager to see test such theories in Gaddafi’s living laboratory -- especially if the dictator was willing to subsidize the  clinical trials. Not since Boris Yeltsin, General Suharto, and General Pinochet have neoliberal academics had such a golden opportunity to test their theories on real live human subjects at country scale.  

Third, to a large extent mainly for PR purposes,  Western experts also made much of their opportunity to "dialogue" in person with real live Libyans. Well, perhaps not so much with the nascent opposition, which was mainly abroad, in hiding,  in jail, or dead.

 Of course, according to Gaddafi & Sons, confirmed by US intelligence officials like John Negroponte – who got much of his info about Libya from his brother Nicholas, who got it from Gaddafi & Sons (see below) – the Libyan opposition consisted of radical "al Qaeda” sympathizers or the members of “dissident tribes” in Libya’s supposedly “very tribal” society, anyway.

Their received image of Libya, seen through Gaddafi-colored lens, was curiously similar to the self-image that South Africa’s apartheid regime used to project – a deeply “tribal” society that required strong-armed rule to preserve it  from the radical horde at the gates.

In any case,  Western experts were generally quite happy to take the Gaddafis’ word -- and his moolah --  for all this, and to participate in  one-sided “dialogues” with Brother Leader  himself whenever he was able to spare the time.

This delighted Brother Leader. No doubt this was partly because of  his  deep intellectual curiousity about the very latest  economic and political theories. But, more practically, it also meant that prominent Western expert after expert had to fly  thousands of miles to Tripoli and back just to help his regime flaunt its wares on Libyan State TV and lend him unprecedented respectability.

Ultimately, you see, Gaddafi had  all these neoliberal academics pegged to the tee.

He understood from the start that many were frustrated by their powerlessness in (more) democratic Western societies.  Their secret wet dream is the absolute dictator who takes them seriously, and able and willing to test their theories on command, without the need for messy democratic processes.

Indeed, Gaddafi's personal power n Libya was so complete that he never even bothered to give himself a formal title other than "Colonel."

THE CARAVAN

From 2004 on, therefore, Tripoli became a kind of alternative Mecca for a veritable “Who’s Who” of leading Western intelligentsia. Among the key interlocutors were Professor Porter; Cambridge  University/LSE’s   “Baron” Anthony Giddens and George Joffe; LSE’s Director Sir Howard Davies (now resigned), and Professor David Held,  its leading expert on “globalization;”  and Monitor Group’s Rajeev Singh Molares (now at Alcatel), Mark Fuller (recently resigned as its Chair), and Bruce J. Allyn (formerly the head of Monitor’s Moscow office).

Others who tagged along for the camel ride included Ann-Marie Slaughter, Dean of Princeton’s Woodrow Wilson School; Princeton Professors Bernard Lewis and Andrew Moravcsik; the insidious neo-con Richard Perle (2 visits); MIT Professor Emeritus Nicholas Negroponte (several visits), brother of  US DNI John Negroponte, and the former head of the MIT Media Labs,  who was very eager to get Libyan funding for his ill-fated pet “One Laptop Per Child” project; a flurry of other Harvard profs, including the Kennedy School’s Robert Putnam, Joseph Nye, and Marshall Ganz, an organizer-guru who became involved in another tidy little dictatorship, Syria; and Johns Hopkins' "end of history" champion Francis Fukuyama, who made history himself by pulling down a record $80,000 for a single audience with Brother Leader.

 Nor were journalists entirely immune from the attractions of the Libyan honeypot. Here,  the Monitor ringmasters also went for high-profile celebrities, including Al Jazeera's David Frost, who collected $91,429 for a single visit.  They also nearly  recruited several others before the project got terminated.  One Monitor project memo reports, for example,  that:

“Monitor approached (Fareed) Zakaria who said that he is very interested in travelling to Libya in order to meet with the Leader….Monitor also approached ( the New York Times’ Thomas) Friedman who said that he was interested in travelling to Libya at some point in the future.”

Collectively this respectability caravan made dozens of such Gaddafi-tour site visits, logging tens of thousands of First Class miles and receiving millions of dollars in fees to commune about the “New Libya" – all the while helping to launder the regime’s  blood-stained image.

This activity seems to have gone far beyond simply helping Libya to restructure its economy and political system along more open,  competitive lines. Indeed, it is now clear that the regime probably never seriously intended any meaningful reforms, but was mainly trying to curry influence and favors.

The experts’ punch list included such dubious activities as ghost-writing Saif Gaddafi’s PhD thesis; helping to design a “national security agency” for Libya (!), quite probably with inputs from folks like the Negropontes and Richard Dearlove, the Monitor “senior advisor” who ran the UK’s MI6 from 1999 to 2004; offering to ghost-write a puffed-up version of Brother Leader’s collected works;  and, all along, orchestrating a flurry of favorable press coverage in influential papers like the Washingon Post, the New York Times, the International Herald, and the Guardian.

All of this was done without without ever bothering (until this Spring, in the case of Monitor Company) to register as what many of these high-toned folks truly turned out to be:  foreign agents of the Government of Libya.

BETTER SAIF THAN SORRY

There are many glaring examples of outright shilling for the Gaddafis by these brown-nosing academic and consulting mercenaries, but a handful captures the essential odor.

One good example was LSE Professor Emeritus/ Blair confidant/ Baron Anthony Gidden’s bold March 2007 speculation in the UK’s Guardian newspaper that Colonel Gaddafi’s Libya might soon turn out to be “the Norway of North Africa.” The piece mentioned Lord Giddens’ impressive academic credentials, but  it neglected to mention the fact that he had received $67,000 in fees from Libya, plus First Class round-trip travel expenses for at least two hajjs to visit with Brother Leader and his staff in Tripoli.

Another example is Rutgers Professor Emeritus Ben Barber’s even more wildly enthusiastic August 2007 Washington Post endorsement of the “surprisingly flexible and pragmatic” Gaddafi and his “gifted son Saif.” Of course Saif is much more familiar to the rest of us now for his blood-curdling “rivers of blood” speech on February 20, 2011, which contributed mightily to the subsequent polarization and bloodshed.

Professor Barber’s piece reminded his readers that he was a  best-selling author and a Distinguished Senior Fellow at the think-tank Demos. But it neglected to mention the fact that he’d also made multiple all-expense-paid trips to Tripoli, for which he’d been paid at least $100,000 in fees by the Libyan Government.

A third example is HBS Professor Michael E. Porter’s February 23 2007 Business Week interview, in which he reported that he had “taken on” a consulting project in Libya,  as if this were some kind of beneficent act. Gaddafi,  he maintained with a straight face,  wasn’t really a dictator after all: “In a sense, decision-making is widely distributed in (Libya). People [consider Libya] a dictatorship, but it really doesn't work that way. That is another reason for optimism.” (Emphasis added).

Prof. Porter neglected to mention the fact that he and Monitor Group, the Cambridge consulting firm that he, plus HBS grads Joe Fuller and Mark Fuller, had founded in the early 1980s, were not only earning several million dollars for their Libyan strategy work, but were also up to their proverbial eyeballs in a second multi-million dollar PR project to bolster Gaddafi’s image.

THE IMPACT

All this salacious material is interesting.  But did it really have any harmful impacts on Libya?  Or is all this merely frivolous second-guessing?

The answer is that this kind of orchestrated air-brushing of the Gaddafi regime by leading Western consultants and academics clearly was not only enormously harmful to the interests of most Libyans, but also that these negative impacts were entirely foreseeable – and, indeed, were anticipated by many critics who had the same intuitive reaction as Roger Kline (see above.)

✔ The academic white-washing helped to conceal the fact that the Gaddafi regime was enormously unpopular with its own people – that the opposition was broad based, that high-level corruption was rife, and that  the “tribal”/al Qaeda paradigm of the Libyan opposition was simplistic and dangerously misleading, not to mention self-serving for the Gaddafi clan.

✔Academic air-brushing also contributed to the misleading view that “reforming Libya" was mainly just a technocratic exercise for the insider-elite and their Western advisors,  to which constitutive matters like elections, rights, the rule of law, and genuine popular representation could take a back seat.

✔The bevy of  big-name Western intellectuals and consultants who courted the Gaddafis not only inflated their egos even larger than they already were, but also encouraged them to believe they could easily  buy influence, as well as arms, in the West -- and delay fundamental political reforms.

In short, the white-washing and the kid glove treatment of the Gaddafi regime by leading Western academics may well have discouraged that regime from pursuing deeper political reforms much earlier, and from negotiating in good faith once conflict increased.

In other words, it probably cost lives.  

 If and when the Gaddafi clan is captured and put on trial, either in  Libya or before the ICC, we hope that these courts seize the opportunity to examine the conduct and responsibilty of these  neoliberal fellow travelers of dictatorship very closely.     

***

So, in the waning hours of the Gaddafi regime,  it is important to recall that Brother Leader and his band of thugs did not simply become a menace to Libya’s people and the world on their own.

Nor was his particular brand of madness simply due to the “usual suspects:” anti-Western radicalism, liberation ideology,  Gaddafi's own imperialistic ambitions in Africa, his idiosyncratic version of political Islam, or even the fact that he spent far too much time spent frolicking in the desert sun with Ukrainian nurses.

No – while Gaddafi’s buddies in Venezuela still portray  him as a stalwart opponent of Western imperialism,  the fact is that in recent years he actually continued to increase his influence in the West only with the really quite extraordinary assistance of prominent, high-priced, incredibly smart, but ultimately quite gullible Western “friends.”

(c) JSH 2011

 

THE GOLDMAN SACHS CASEPart II: "The Crucible"James S. Henry

Whatever the ultimate legal merits of the SEC's case against Goldman Sachs -- and those appear to me to be questionable at best --  its most important contributions are being made right now. They are not judicial, but political. 

'Lord knows I've been about as critical as one can possibly be of Wall Street banks, as well as of unfettered free marktets. (See, for example, a, b, and c.)

However, after listing to today's  showdown hearings before  US Senator Carl M. Levin's Permanent Investigations Subcommittee,  I'm convinced that:

(1) If anyone needs the benefit of the new "financial literacy" program proposed  by S.3217, Senator Dodd's proposed financial reform bill, it is the US Senate. Many  members of the Senate -- and by extension, the House -- don't  seem to understand very basic things about  the structure and role of private capital markets, finance, and business economics, let alone global competition. In the world's largest capitalist economy, this level of ignorance  on behalf of our political elite is really mind-boggling.

(2) After 18 months of intensive investigation, the US Senate's Permanent Subcommittee on Investigations  and the SEC have not so far been able to find anything that is clearly illegal to pin on Goldman Sachs.

(3) On the other hand, on the secondary trading side of Goldman's  business, Goldman traders  clearly have "market maker" ethics, not investment adviser ethics. They've grown accustomed simply to  providing market liquidity for whatever securities clients  happen to want -- or can be persuaded to want, even if Goldman is taking opposite positions at the very same time in the very same securities. 

For example, regardless of what Goldman's own sales people  felt about the terrible quality of the synthetic CDOs they were selling in 2007  -- including many securities packaged out of  "stated income" mortgages --  they continued to sell anything for which there was a current price.  

Goldman's trader culture simply  doesn't  buy the notion that market makers  have any "duty to serve the best interests of their clients. In competitive world, this amoral culture may well be essential to being a successful "market  maker,"  and Goldman is one of the most successful secondary traders in the world  However, if we expect some higher standard of behavior toward clients, this is likely to require new rules; Goldman will never get there on its own.

Of course, in a highly competitive global market,  any such rnew ules might just cause  this entire business to move offshore, to London, Hong Kong, Singapore, or any number of other offshore financial centers.

(4) With great respect to Michael Lewis, the notion that Goldman Sachs engaged in a hugely profitable "big short" in 2007-2008, in the sense of secretly betting systematically against the same securities that it was underwriting for its clients, is easily overstated. Goldman's investment portfolio in mortgage securities turned negative in early 2007,  was net short all year long in 2007, and at times had up to $13 billion of gross shorts, the bank's net profits from all this shorting that year was $500 mllion to $1 billion. The following year, 2008, its mortgage portfolio lost $1.8 billion 

(5) There appears to be enormous pent-up rage and ressentiment in the country at large, right now, driven by the financial crisis, the slow recovery, high unemployment, and the loss of homes and pensions, on the one hand, and the widespread perception that banks not only created the crisis, but have also profited immensely from it.  Most people may not know a CDO from a dustpan, but there is a very disturbing tendency to seek scapegoats, dividing the world into villains and victims. Ironically,  the most obvious targets include companies like Goldman Sachs, one of our most successful, better-managed, if trader-ridden  companies.

(6) Compared to other major US banks, Goldman Sachs' role in the credit derivatives market, the mortgage market, and bank lending in general, as well as in the roots of the most recent crisis, was minor at best. Indeed, compared with the more than $240 billion of past due/non-performing mortgage loans now on the books of the "big four" banks,  the sums involved even in Goldman's most questionable deals were trivial. Why the US Senate and the SEC decided to focus so heavily on Goldman, as compared with Citi, Bank of America, JP Morgan, and Wells Fargo, is an interesting political-economic puzzle.  

(7) On the other hand, these other major  private banks, plus Lehman  Brothers and Bear Stearns, were by far the largest players in the private mortgage market. If they  had followed Goldman's risk management, accounting, disclosure, and leverage practices, the worst of this crisis might well have been avoided.  Indeed, it appears that one reason these generally much larger firms did not adopt such practices was because -- unlike Goldman -- they genuinely believed they were "too big to fail."  

(8) Going forward, the real problem with Goldman market was not, by and large,  illegal behavior, but an excess of perfectly legal behavior that may well be socially unproductive and way under-regulated.  Especially in a world where other countries have fallen behind in the move to  update their financial regulations, dealing with this problem will require much more than lawsuits and investigative hearings.  

IN THE DARK TRUNKS...

Today's hearings probably came as close to fireworks  as investment banking and "structured finance"  ever gets.  In one corner there was Goldman Sach's slightly shaken,  but still-unbent  CEO Lloyd C. Blankfein (Harvard '75/ HLS '78).

 

There was also Blankfein's articulate, amiable  life-time Goldman employee David Viniar  (HBS '80); the now-notorious, side-lined 31-year old Goldman VP Fabrice P. (aka "fabulous Fab") Tourre (Stanford M.S. '01),  architect of the particular "synthetic CDO" at the heart of the SEC case;  and several other  past and present stars from the "devil bank's" specialists in mortgage banking.  

Apparently not pressent was Goldman's President and COO,  Gary D. Cohn (American U, 'whenever)  (aka "Aeolus,"). Perhaps he had flown to Athens to arrange more  cosmetic "dirty debt swaps"  for Greece,   

Ring-side support for the Goldman front line  was  provided by a hand-picked team of  very high-priced trainer/coaches.  This included former Democratic House Speaker Richard Gephardt,  former Reagan Chief of Staff Ken Duberstein, and Janice O'Connell (aka "Puerta Giratoria"), a former key aid to Senator Dodd.

 Senator Dodd, the retiring Chair of the Senate Banking Committee, has been working since November on  S.3217, an epic 1600-page bill that Senate Republicans (with perhaps a little help from Fed staffers who opposed the bill) have  just prevented from coming to a vote. 

Of course Goldman has also hired Obama's own former chief counsel Gregory Craig as a key member of its defense team.

Once taken seriously as a "liberal" Democratic Presidential candidate, Gephardt has gone the way of all flesh, and is now  completely preoccupied with serving such worthy clients as Peabody Energy, the world's largest private coal company; NAPEO, an association of "professional employer organizations" that is trying to dis-intermediate what little remains of labor rights for outsourced workers; UnitedHealthCare, a stalwart opponent of the "public option" in health care reform; and of course, Goldman Sachs, which has also employed the  prosaic Missourian to pitch the (really insidious) idea of "infrastructure privatization"  all over the country to cash-strapped state and local governments.

IN THE WHITE TRUNKS.. 

In the other corner is the aging  heavyweight champion from Michigan. Senator Levin (Harvard Law '59), is a low-key but tenacious warrior, with a mean-right hook; Goldman would do well not to underestimate him.   He's a  veteran critic, investigator, and opponent  of  global financial chicanery, dirty banks, and tax havens -- except perhaps when it comes to GM's captive leasing shells and re-insurance companies in the Cayman Islands and Bermuda (Heh, even a Dem's  gotta eat!)  

Sen. Levin is backed up by several knowledgeable, tough cross-examiners, especially Democratic Sen. Kaufman of Delaware and Republican Senator Collins of Maine. On the other hand, Republican Senators McCain and Sen Tom Coburn  were a bit more  "understanding" of Goldman's basic amoral attitude toward market-making. 

FIRST ROUND

In handicapping this contest, some observers predicted that the best and brightest from our nation's leading  investment bank  would basically roll over the "old folks" from the Senate.

In the first few hours, however, it quickly became clear that the bankers were a little under-prepared for the Senators' often-times impatient, hard-nosed tone, especially from former Prosecutor Levin, Collins, and Kaufman.

Nor were they prepared for the widespread, if perhaps naive and even "Midwestern" view  that there was just something fundamentally wrong with the lines Goldman drew between pure "market-making" and providing investment advice.

LEVIN DOG

For example, Sen. Levin  was a real rat terrier  on the question  of whether it was ethical for Goldman market-makers in 2007 to  be aggressively pushing clients like Bear Stearns  to buy a CDO security called "Timberwolf" that Goldman's own internal analysts had called  "shitty."  Meanwhile, Goldman's ABS group was shorting Bear by buying puts.  The panel of five present or former Goldman executives had trouble recognizing that there was any problem at all -- given the fact that, from a legal standpoint, Goldman had fully informed these clients about the risks they were taking.

For another $2 billion "Hudson" CDO deal that Goldman sold from its inventory, the firm's own sales people characterized the product as "junk," and indicated that more sophisticated customers might not buy it.  Yet, according to Senator Levin,  Goldman's selling documents for a portion of the sale characterized  the deal as one where Goldman's interests and the client's interests were "aligned" because Goldman retained an equity interest in the Hudson package. In Senator Levin's view, this  "retention" was misleading, simply because Goldman took time to sell down its position.

On the question of the Abacus transaction at the core of the SEC law suit,  Sen. Levin was able to establish that the  Goldman's  Tourre never told the German bank that invested in the deal that  John Paulson, the hedge fund manager who helped choose the portfolio, although he claimed to have told portfolio selection manager ACA.  Oddly enough, from what we heard about other "raw deals" today for the first time, this now appears to have been perhaps the weakest deal for SEC to attack.

Similarly, Senator Collins pressed a group of Goldman securities "market-makers"  very hard about whether  or not they felt they had a "duty" to work in the "best interests of their clients." The responses she received indicated that these Goldman executives, while insisting on the organization's high ethical standards, also simply "did not get" the point that there might be some higher ethical, let alone legal,  duties to clients, for pure market makers, beyond just providing them with legally-required disclosure.

CONTEXT

Senator Levin claimed that these hearings have been in the works for more than a year. He says that it is just sheer coincidence that they are occurring soon after the SEC decided to file its case by a narrow 3-2 party lines vote, and right when Senator Dodd's reform bill just happens to be on the verge of being introduced. 

Other sources indicate that Levin's investigation had been scheduled to continue through May, and that it was abruptly rescheduled after the SEC vote.

Furthermore, for someone who is supposedly holding hearings to gather facts and find out what was really went on,  Senator Levin had already formed quite a few strong opinions prior to hearing from any witnesses -- as shown in his latest press release.  

 But so what?  Even if  he's was a little simplistic, filled with anti-bank animus, and eager to portray the financial crisis as a kind of morality play,  and even if there's no big payoff other than the theatrics, it was definitely kind of fun to  watch the "show trial" -- finally  see someone  asking  big bankers tough questions under oath.  After all,  regardless of what  "caused" the financial crisis and its interminable aftermath,  it is pretty clear who is paying for it -- and it is certainly  was neither these Senators nor the bankers in the dock. 

( Stay tuned for Part III, which takes a closer look the Goldman Sachs case in light of these hearings, and consider the broader question of other "big bank" roles in the crisis.)

***

(c) JSHenry, SubmergingMarkets (2010)

THE GOLDMAN SACHS CASEPart I: "Clowns to the Left of Me" James S. Henry

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Goldman Defense PDF

Well, we no longer have to worry only about corrupt bankers in Kyrgystan. Ever since the Goldman Sachs case erupted last week,  there's been plenty of fresh banker blood in the water right here at home, with scores of financial pundits, professors-cum-prosecutors, and political piranha swirling around the wounded giants in the banking industry as if they were a herd of cattle crossing a tributary on the upper Rio Negro.

This feeding frenzy was precipitated by last Friday's surprising SEC announcement of civil fraud charges against Goldman Sachs -- heretofore by far the most profitable, highly-respected, and, indeed, public-spirited US investment bank.     

Despite -- or more likely because of --  Goldman Sach's  relatively clean track record and  illustrious credentials, many commentators  have assumed a certain Madame Defarge pose, reigning  down  censure and derision from the penultimate rungs of their  mobile moral pedestals. 

Over the weekend, for example,  Huffington  featured a  half dozen vituperative columns on the subject, including  a Vanity Fair contributing editor's feverish claim that the whole affair was somehow deeply connected to one high-level Wall Street marriage, and an MSNBC host's denunciation of Goldman for refusing to appear on his show -- his show ! There was also a plea from Madame Ariana for criminal charges.

In fact, this is a case where, as we'll see in Part III, the SEC's civil charges against Goldman Sachs are not only highly debatable, but largely beside the point.  

Meanwhile, Bob Kuttner,  another Huffy perennial, and one of our most prolific popularizers of conventional liberal dogma, asserted  that Goldman demonstrates conclusively that Wall Street en tout  is nothing but an on-going criminal enterprise, up to its eyeballs in outright fraud. 

In a lurch toward financial Ludditism, Bob figuratively placed his hands on his hips, stomped his feet,  and demanded nothing less than a "radical simplification of the financial system" -- leaving it to the reader's imagination to determine just what the hell that means. 

Will we still be permitted to use ATMs, checking accounts and paper currency, or  will we all soon have to return to  wampum beads and n-party barter?   

Elsewhere, the Daily Beast published a de facto job application  from Harvard Law's Prof. Alan Dershowitz -- otherwise well known in the legal profession as "He whose key clients are either fabulously wealthy or innocent."  

Prof. Dershowitz argues -- quite rightly -- that Goldman'  behavior, while no doubt morally reprehensible, was also by no means clearly illegal. On the other hand, he also says the law is so vague that hedge fund investor Paulson might even be charged with conspiracy to commit fraud.

Well, ok -- except for the article's faint suggestion that for a modest  fee, our country's  finest criminal lawyer may just be available to help explain all  this to a judge --  and also to argue that  "only a tiny fraction of investment bankers who abuse their clients actually commit murder."  

THE RECKONING

Finally, there is the omni-present, virtually unavoidable  Simon Johnson, a Peterson Institute Fellow, MIT B-school prof, book author, "public intellectual,"  and  "contributing business editor" at Huffington.

This week has been  Prof. Johnson's heure de gloire, and he is living it to the fullest.

All week long he could be found at all hours on nearly every cable  news channel and web site, pitching his own increasingly Puritanical, if not neo-Manichean views of the banking crisis and Goldman's role in it.

At first,  Prof. Johnson merely expressed delight that the US had finally reached its "Pecora moment" --   referring to the 1933-34 US Senate investigation of Wall Street that, indeed, makes the modest $8 million  Angelides Commission look like a California '68 love-in.

But by mid-week he'd had moved on to a much harsher assessment.

Not only is Goldman guilty as sin, but  hedge fund investor John Paulson, one of the key parties to the Goldman transaction, deserves to be "banned for life" from the securities industry.  If necessary, Johnson says, the US Congress should even  pass an ex post facto bill of attainder!

Now of course Prof. Johnson hails from the UK.

He may therefore not be aware that the US Constitution (Article 1, Section 9) has explicitly prohibited both ex post facto laws and bills of attainder (legislative decrees that punish  a single individual or group without trial) ever since 1788.

Just this month, a US federal  district court in New York struck down Congressional sanctions that singled out ACORN, the community organizing group on precisely these grounds. The case is now on appeal.

Indeed, even in the UK, there have been no bills of attainder since 1798. 

MATERIAL OMISSIONS

Despite Prof. Johnson's limited grasp of US or even UK law, and his Draconian appetites, I've  actually grown rather fond  of him lately -- or at least more understanding.

This is partly because since he left the IMF in September 2008, he's apparently had a kind of  road-to-Damacus epiphany.

He now realizes, as if for the first time, the enormous carnage that has been inflicted by a comparative handful of giant global banks, as well as  the huge potential rewards  of  decrying these outrages from the roof tops.

One of only nine "former IMF Chief Economists" who still walk amongst us,  Prof. Johnson may have only served in that post briefly,  from March 2007 until September 2008. 

But that 1+ year was more than enough  time for him to leave a lasting impression at the IMF. 

He is still fondly remembered at the IMF not only for  having entirely missed the 2007-08 mortgage crisis even as it was unfolding, but also  for deciding in July 2008,     less than 3 months before the entire global financial system nearly collapsed, to sharply increase the IMF's growth forecast for both 2008 and 2009. 

That was  just one month before the otherwise-feckless Bush SEC initiated the 18-month investigation of Goldman Sachs that  ultimately led  to last week's charges. 

If and when the Goldman Sachs case ever comes to trial, therefore, it may be interesting for Goldman's attorneys --   perhaps Prof. Dershowitz -- to consider calling Prof. Johnson as a witness for the defense.

After all, he probably qualifies  as an expert on the heart-rending experience of just how difficult it was even for highly-trained experts to have clear peripheral vision, much less perfect foresight, back in the heady days of the real estate boom.

He may also be able to instruct the jury on the fine arts of concealing what one really believes  in order to reconcile the divergent interests of multiple clients. 

In Prof. Johnson's case, these included IMF senior management,  executive directors, and a myriad of country officials who were all pressuring the IMF to inflate its forecasts back in 2008,  just as housing markets and financial markets were beginning to crumble.

In July 2008, on Prof. Johnson's watch,  they temporarily prevailed.

From this angle, the IMF Chief Economist's role might even be compared to that of a certain young Goldman Sachs VP. 

CONSOLATIONS

Even in the dark days ahead, therefore,  Goldman Sachs execs have at least a few consolations.

First, they can remind themselves that there were very damn few heroes in this sordid tale -- journalists, politicians,  public intellectuals, and economists included. 

Indeed,  Brooklyn-born investor John Paulson may turn out to have been, if not quite a "hero," at least  one of the few relatively  straightforward and consistent players in the lot.  

At least in his own investing, he consistently opposed the systematic distortions about the housing miracle and  the exaggerate  forecasts --  dare one say frauds? -- that institutions the US Treasury, the Federal Reserve, and Prof. Johnson's own IMF employed in the final stage of the real estate bubble, in a failed attempt to achieve a 'soft landing.'  

Second, while it may be hard for us to imagine,  things might actually have turned out a whole lot worse. 

Goldman Sachs might well have relied on Prof. Johnson's sophisticated, bullish forecasts rather than on  John Paulson's intuitive short-side skepticism. 

How much money would Goldman's clients, investors, and the rest of us have lost then?

☀☀☀

© JSH, SubmergingMarkets, 2010.

ORDINARY INJUSTICEEven Beyond Guantanamo, Rendition, and Torture, the US Criminal (In)Justice System Is a National Disgrace James S. Henry

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(click on graph to expand)

In 1840, Tocqueville, otherwise usually an astute observer of American society, proclaimed that “there is no country where criminal justice is administered with more kindness than in the US.” 

In the modern-day  “Law and Order”/ Perry Mason made-for-TV  version of this story, the US is still viewed by many as having,  in author Amy Bach’s words,  “the world’s finest criminal justice system.”

Certainly this is the preferred self-image when, as it is wont to do, the US criticizes the quality of criminal justice in other countries.

 In this sanguine view, US prosecutors, police, investigators, and judges leave no stones unturned to see that crimes are punished, justice is done, and the  US Constitution is respected.

Juries take their independence seriously and fight tooth and claw for the truth;  parole officers and prison wardens are all deeply committed to “correction.”

Public defenders are not only thoroughly informed about  the latest nuances of criminal law,  but also work tirelessly to insure that each and every defendant has his day in court.  

Fortunately, Ms. Bach, a young New York attorney and law professor,  has provided a compelling, well-researched antidote to this conventional fairy tale. 

Her new book, the product of seven years of first-hand research in the bowels of the state and local court systems of New York, George, Mississippi, and Chicago, focuses on “ordinary injustice” -- the routine failure of judges, prosecutors, and defense attorneys as a community  to deliver on the Constitution’s basic promises.

EXCEPTIONS?

Tocqueville was not alone in his naivete'. Initially, the sheer amount of attention given to criminal justice in the US Constitution as well as state constitutions led many observers to  expect that the US  really might be distinctive.

Indeed, criminal rights are the subject of Article I’s explicit reiteration of habeas corpus, plus four  of the first ten amendments (known  collectively as the “Bill of Rights”), and their extension to states and non-citizens by the XIV th  Amendment.

Of  course legal scholars have long been aware of serious gaps between theory and practice  with respect to such rights.  But the gaps have usually been regarded as exceptions. 

Many of the exceptions have occurred in times of war or perceived security  threats  – for example, the Sedition Acts of 1798 and 1918, the World War II internment of Japanese-Americans, the frequent persecution of labor unions, civil rights workers,  and Left wing dissidents from the 1880s right up through the 1970s,  the 2001 Patriot Act, the NSA's illegal spying program, and the systematic mistreatment of "enemy combatants" at Guantanamo and elsewhere. 

Other exceptions have involved the application of "Jim Crow justice” to native Americans, Afro-Americans, and other minorities.

Overall,  however,  most legal scholars have treated these episodes as abnormal deviations. In the long run,  the system as a whole is supposedly always improving,  always trying to do the right thing. 

On this theory,  the US Constitution and the courts that interpret it  are a kind of homeostatic machine, with built-in stabilizers that eventually prevent any serious rights violations from becoming permanent.

THE REALITY: FAST-FOOD JUSTICE

Ccritics on the Left have long maintained that in practice, no such automatic stabilizers  exist. From this perspective,  securing human rights is not ever accomplished once and for all, but  requires a constant, repetitive struggle.

It is also conceivable that "path dependency" and "feedback loops" in the legal system may  be destabilizing. The erosion of rights in one period may increase the chance that rights continue to erode later on.

Critics of the conventional view have also argued that rich people and poor people – including the indigent defendants who now account for about 70 to 90 percent of all felony cases –  essentially confront two very different US criminal justice systems,  especially in state and local courts. 

Only a tiny fraction of mainly affluent criminal defendants ever receive   full-blown Perry Mason/ Alan Derschowitz-type adversarial trials -- and even there, as Harvey Silverglate's recent book emphasizes, even the affluent still face the hazards of vague statutes and prosecutorial zeal. 

Meanwhile, 90 percent of criminal defendants soon learn the hard way that their nominal "rights"  consist of one brief collect call from a jail cell, followed by a tango with an alliance of police, prosecutors, and public defenders whose shared objective is to talk them into pleading guilty.

As Clarence Darrow said in his 1902 address to the inmates at the Cook County Jail, “First and foremost, people are sent to jail because they are poor.” And as the American Bar Association  -- not usually aligned with wild-eyed radicals -- reiterated in 2004, “The indigent defense system in the US remains in a state of crisis.”

  This pervasive “fast food”/ assembly-line plea bargain system  is hardly new, although it has recently become a much greater problem than ever before because of soaring rates of incarceration in the US, as we'll see below. 

DETAILS FROM THE FRONT

 The special merit of Ms. Bach’s book  is that she takes such pat generalizations  about “ordinary injustice” down from the shelf  and brings them to life with a series of extraordinary case studies.

In doing so, she tackles one of the main challenges that confronts any investigator who seeks to understand how the criminal justice system really works. This is the fact that “ordinary injustice,” while pervasive,  is very hard to observe without detailed, painstaking field work.

 As Ms. Bach emphasizes,  this lack of transparency also prevents the public from being able to tell  just what they are getting for the hundreds of billions of  taxes  spent on the criminal justice system --  as well as  how the courts are doing with respect to delivering what is supposed to be their key product – justice. 

 One immediate benefit of Ms. Bach's field work is a rich trove of amazing real world stories about how the system actually works.

 ✔   For example,  in her book we meet a Troy New York city judge who routinely fails to inform defendants in his court of their rights to counsel, imposes $50,000 bails for $27 thefts and $25,000 bails for loitering, and enters guilty pleas for defendants without even bothering to tell them.  

 ✔  We meet a Georgia public defender who runs a “meet’ em, greet’em, and plead ‘em”  shop that delivers just 4 trials in 1500 cases, with guilty pleas entered in more than half of these cases without any lawyer present or any witnesses interviewed. 

 ✔  We meet Mississippi prosecutors who are so concerned about their win/loss records and reelections  that they simply “disappear” all the harder-to-prosecute cases from their files. 

✔  We meet a Chicago prosecutor who allows two iinnocent young people to sit in jail for 19 years before he finally works up the gumption to examine the relevant DNA evidence. This new evidence not only cleared them, but it also helped to disclose a much larger  police conspiracy.

✔  Ms. Bach also reminds us of the unbelievable 2001 case before the Fifth Circuit Court of Appeals (Texas)  where the court labored hard to overrule a lower court decision that would have permitted a defendant on trial for his life to receive the death sentence, despite the fact that his attorney had been fast asleep through much of the trial.  

PATTERNS

Amy Bach’s  book is more than just a series of such horror stories, however.  By doing  painstaking legal anthropology in multiple locations, she's been able to go beyond the limits of the typical one-off journalistic expose about the courts. (See, for example,  A, B, and C.) 

Bach's focus is on identifying recurrent patterns of misbehavior. These patterns were unfortunately  not “exceptional” at all,  but routine and widespread.

Most important, her research underscores the fact that  ordinary injustice is not just due to isolated “bad apples.”  There is a system at work here.  Indeed, injustice thrives on a culture of tolerance for illegal practices  cultivated in whole communities of lawyers, judges, and police over many years.  This culture, and the “fast food”  plea bargaining  that  it facilitates,  are at the root of all her cases. 

Unfortunately Ms. Bach offers no real solutions to the problems that she has described so well. She ends up leaning rather heavily on a fond hope that “new metrics”  will be developed to measure how well individual courts actually deliver “justice” -- sort of the legal equivalent of "No Child Left Behind."  

There may be something to this. But in my experience,  metrics, whether in education or judicial policy,  are the last refuge of the policy wonk.  They will  undoubtedly be a  long time coming. This is  partly because of budget constraints. But  it is also because if the metrics are really worth a damn, they will  provoke stiff resistance from the  very same bureaucratic interests that Ms. Bach had to overcome  in her own research. 

Pending the dawn of this brave new world of  metrics,  I suspect that we will just have to depend on a handful of dedicated lawyers,  investigative journalists, and creative legal scholars like Ms. Bach to keep an eye on the courts,  root out what’s really going on,  and insist that all of the rights we have on paper and take for granted are  still around when we really need them.

ROOT CAUSES

So where does “ordinary injustice” come from, and what can we do about it?  Fundamentally, as noted, the kind of ordinary injustice described by Ms. Bach basically exists because of the “fast food” plea bargaining system. But as she also recognizes,  it would be a waste of time to outlaw this directly. This is  because the plea bargaining treadmill basically derives from the unsuccessful attempt to reconcile several deeply-inconsistent public demands. 

First,   9/11, the war on terror and GWB notwithstanding, most Americans still fundamentally believe in freedom.  Most of us still want to preserve the Bill of Rights --  at least on paper. 

Second,  we all want to save money – especially in these times.  Implementing the full-blown version of the adversarial trials in  every case would be very costly. While taxpayers value human rights, they’re not all frothing to pay a whole lot for them. This is partly just because at any given point in time   their value is a little abstract --  like health insurance before you become ill.

Of course the truth is that the  “fast food” system is anything but cheap. The entire  system –  courts, prisons and police – now costs US taxpayers over $250 billion a year.  That figure has been growing like Topsy – it  is now at least three times the 1990 level.

Over  80 percent  of these costs are born by the hard-pressed state and local governments.  Most of the funds are digested by police and prisons;  courts only account for about one fifth.  Even so, it is far from clear that ordinary  taxpayers  – most of whom never expect to see the inside of a criminal court or jailhouse  themselves --  would be willing to pay anything more to help defend the poor  or curb ordinary injustice. 

Third, what US taxpayers do care about, at least until now,  is “fighting crime,” especially drug-related and lower-level  street crime. Ever since the 1970s, these have been the fastest growing contributors to system-wide criminal justice costs.

For many  taxpayers, under the influence of thirty  years of campaign propaganda from  the “war on drugs” industry and “tough-on-street crime” politicians, this has usually been reduced to  “lock ‘em up  and throw away the key, as fast as possible.” 

The result is that today, in the US, the number of inmates in our local jails and state and federal prisons is at an all-time high: over 2.3 million, 6.8 times the number in 1974.

This means the US has the highest per capita incarceration rate in the world. It is  754 per 100,000, higher than Russia (610), Cuba (531), Iran (223), and China (119),  let alone developed countries like the UK (152), Canada (116), France (96), Germany (88), and Japan (63).

  Indeed, southern states like Louisiana (1138), Georgia (1021), Texas (976),  Mississippi (955), Oklahoma (919), Alabama (890),  Florida (835), and South Carolina (830) have distinguished themselves with even higher rates -- by far the highest rates of incarceration in the world.   This policy appears to be driven in part by the political benefits of so-called "prison gerrymandering," which permits prisoners to be counted as residents of the places where prisons are located, rather than where they come from, for purposes of allocating legislative seats. 

This alone helps to explain the fact that annual cost of all US prisons now exceeds $80 billion a year. Indeed, the annual cost of warehousing prisoners in California and New York prisons is at least $50,000 per year per prisoner – much more than the cost of providing them with full time jobs outside!  In addition, in the US, there are over 9 million former prisoners who are now outside prison. More than  5.1 million others remain under supervision, on parole or probation.

All told,  the US now has more than 11.3 million past and present inmates. This is  the world’s largest domestic criminal population, an incredible 23.5 percent of all current prisoners in the world.  No doubt the sheer scale of our “criminal industry experience curve”   gives us at least one  clear national competitive advantage -- in crime.  

Indeed, because of our  propensity to throw people in jail regardless of what becomes of them there,  we now account for over a third of the entire world’s living past and present prisoners.  Not surprisingly, this also affords us by far the most costly judicial and corrections systems that the world has ever seen.

For all these costly incarcerations, despite the vast sums and short-cuts associated with processing all of these millions through the pipeline as rapidly as possible, there is not one speck of evidence that this system has contributed one Greek drachma to falling crime or safer streets. 

Indeed, the best evidence is just the opposite. Over two-thirds of US offenders who are released from prison are likely to be re-arrested within three years.  Reactionary voices may argue that this just shows we should hold more of them longer, a sure recipe for system bankruptcy. What it really shows is the complete lack of  any real “correction” or retraining in most US prisons. The system that the entire criminal justice machine works so hard to get people into as fast as possible has become the world’s largest training ground for serial offenders.

In short,   if we really want to understand the roots of "ordinary injustice,"  as well as  the intense pressure that each and every player in the US criminal justice system feels to cut corners and slash costs each and every day,  we need to look no further than this self-perpetuating  failed prison state-within-a-state.

After all, this particular failed state already has a total population of current inmates and former inmates under supervision that is greater than Somalia’s!

 

***

"WE HAVE LIFT-OFF!" What a Difference a Day Makes to Obama's "Base" James S. Henry

It was altogether fitting and proper that yesterday's historic House vote on health care reform took place on the first day of Spring 2010. All across the country, progressive activists -- including many of us who worked hard for President Obama's election not only in November 2008 but in endless primaries before that --  have been  in a deep funk about the Administration's "failure to launch" on a wide range of issues, from health care and immigration reform to climate change and financial regulation, to Guantanamo and Middle East peace talks.

For months it seemed as if our two-party system had been surrendered to  a one-party veto,  that  Hill Democrats had become feckless and supine,  and that  "Si Se Puede" had somehow been translated into "Beltway" as "No Way, Jose."

Now the clouds have lifted, at least temporarily, and the first rocket soars skyward. Of course this is only the beginning. But it sure feels good for a change to be staring up at the sky, watching that baby split the clouds.

PURISTS

 Some purists on the Left are already denouncing the House bill as a handout to insurance companies that falls far short of the "single payer" or "public option" alternatives of their dreams. Of course the bill also does not extend public subsidies to cover abortions -- although that was already the case under existing Federal law.  

 Despite these shortcomings, most progressive observers -- including Krugman, Kucinich, and Michael Moore -- see this as a critical step forward.

They realize that the only alternative to passing the House bill was a Republican victory that would not only have jeopardized the rest of the Democratic agenda for the rest of this year, but would have also led to a catastrophic defeat at the polls in November.

Short of organizing yet another doomed Third Party quest, they  also realize that there is simply no alternative to pushing for further reforms within the Democratic Party.

BAGGERS

Meanwhile, on the Right, as usual, there is Sturm, Drang, und Zorn, all of which add up to a strong prima facie case for providing free anger management coverage to qualified Republicans  in the final Senate health care bill.  

Vulture capitalist Mitt Romney, author of a not-wildly-dissimilar Massachusetts health plan, has already promised to seek to "repeal" the bill, while a group of mainly Red State attorney generals is threatening  to challenge the bill's constitutionality.

Meanwhile, the rag-tag "Tea Bag" army has completely lost control, exposing its frothing bigotry and astounding ignorance for everyone to see.

Far from being intimidated by these reactionaries, Democrats should be delighted. Not only is all the adolescent right-wing rage unappealing, but it is a sure sign that our policies are finally shaking things up.

BASE JUMP

Net net, the impact of this bill's passage on Obama's  "base" is one of its most important consequences -- in addition to  the series of health care reforms that are now much more likely to follow.

Eventually these  reforms really will help the millions of Americans who struggle each and every day with our high-cost,  minimally-efficient health care system. 

Meanwhile, this victory has an immediate short-term payoff. It reminds Obama's  "base"  that, as President Obama said last night, "Big changes are still possible in America." 

It also  reminds us of how good it feels to actually win.

Far beyond health care,  as the American Right clearly fears more than anything else, this  could provide a huge lift for many other progressive reforms.

Houston, we have lift off!

***

THE ROBIN HOOD TAXWhy Doesn't Obama Support This Very Modest Progressive Tax?Just Guess Who Opposes It!James S. Henry

While we wait patiently for any signs whatsoever of progressive change in America, progress is still being made, deo gratis, elsewhere. Of course this is no thanks to the banker-minded Spartans who still occupy the Trojan Horse that is become the US Treasury Department.

Today the European Parliament adopted a resolution supporting the kind of global financial transactions tax that is discussed in the extraordinary performance by Bill Nighy below. For more information about the European action, please follow this link.

NGOs like Tax Justice Network International, Oxfam GB, Global Financial Integrity, Action Aid, New Rules, Christian Aid have all been working hard to support this proposal. They could use your active involvement and support -- right now.

As the Puritan minister Stephan Marshall once said in a sermon addressed to Parliament in 1641, "You have great works to do, the planting of a new heaven and a new earth among us, and great works have great enemies."

(If for some odd reason the video does not appear below, please travel here to get it.)

True Unemployment: 20% and Still RisingSend Geithner Home to Wall Street!His Legacy: 30+ MM Underemployed, Failed Stimulus, No Bank Reform, Soaring Deficits, Sinking $$James S. Henry

With official US unemployment now at 10.2 percent,  the third highest among the 29 OECD countries,  and unofficial unemployment at least two times  higher, more than 30 million American workers and their families are now being forcefully reminded  every day that "the reserve army of the unemployed" is not just pure Marxist rhetoric.  

While China and most developing countries are already recovering nicely from this First World-made debt crisis, all indications are that US unemployment is still rising, and that we will soon see a new postwar record -- -- two years after the "Great Recession," the longest and deepest since the 1930s,  began in December 2007. 

UNEMPLOYMENT:  GET REAL

To get the real unemployment picture, we need to adjust the official statistics upwards. First, as the Bureau of Labor Statistics' own data shows, the "official" rate leaves out many workers who are (a) underemployed, working only part time when they'd prefer full time jobs (9.3 million now); (b) fully unemployed,  and desirous of jobs, but not counted in the official statistics because they've given up look (2.3 to 5.6 million). Allowing for these two adjustments already boosts "underemployment" to the 17.5% figure cited in some recent press reports.

But even that figure is too low.  First,  it omits the country's 20 million "self-employed" (incorporated and unincorporated), a growing share of the labor force. All  are counted as "employed" in the official statistics, no matter how underutilized they are. Yet other surveys report that this group is also experiencing serious underemployment.

Furthermore, the official statistics also leave out  about 1.6 million who are now serving in the military, plus the record 2.33 million  US prison inmate population. Both populations are heavily young, male,  and undereducated, and would therefore experience relatively high unemployment. This is especially important for the sake of historical comparability  -- say, for comparisons with the 1930s, when the US military  and the prison populations were both tiny. 

In addition, of course, when the Great Recession started there were at least 8 to 10 million undocumented workers in the US, none of whom appear in the official statistics. Whatever we think of illegal immigration, the fact is that most of these workers have not been able to return to their homelands, and are still here, quietly suffering through this recession. Indeed, to the extent that they are unable to draw on unemployment benefits and other social programs to cushion the blow, they are being forced to compete with the rest of us more fiercely than ever.

All told, therefore, as shown in the adjacent chart (click to pop up), this makes the "real" US unemployment in October 2009 at least 20 percent or more -- twice the official rate.

TO WHOM DO WE TURN?

One might have expected this historic jobs crisis to have provoked a quick, decisive response from Washington  Unfortunately, American workers have also recently been reminded that, disturbingly, the Democratic Party can simply no longer be counted on to put labor's interests ahead of capital's. 

This was evident to some of us when Obama's first stimulus package was being designed -- given that it was loaded up with so many Christmas goodies for special interests and so many regressive tax cuts. 

But by now it should be clear to anyone but the most bullet-headed diehard party ideologues.

Whatever else Obama's February 2009 stimulus package has accomplished, it simply hasn't created nearly enough new jobs, fast enough.

Nor has it provided nearly enough aid to debt-ridden homeowners --  as the continued record-setting pace of home foreclosures and bankruptcies testifies.

These basic policy shortcomings are not due to some Herbert Hoover or Ronald Reagan.  While Obama obviously inherited a mess, by now enough time has passed that his administration has become responsible for  its continuation.

How high does unemployment have to go for the Obama Administration to actually  want to do something more about it?

When FDR took office in March 1933, unemployment stood at nearly 25 percent of the labor force, and he immediately took decisive action to make sure that unemployment was reduced, by establishing targeted federal job creation programs, attacking anti-competitive practices by large banks and corporations, and making sure debt relief got through to small businesses, farmers, and homeowners. 

What is it about the character of the Obama Administration that has made its response so different?

THE FIFTH COLUMN

As we've argued for some time (See "The Pseudo Stimulus," The Nation, February 3, 2009, and "Too Big Not to Fail," The Nation, February 23, 2009),  one basic problem seems to be that Obama's Administration, unlike FDR's, has been overly dependent from the get-go on pro-Wall Street insider/ fifth columnists, captained by the Supreme "Jimmy Do-little"/  Andrew Mellon of the period,  Treasury Secretary Timothy Geithner. 

Not only has Geithner  been far too slow to recognize that the first stimulus was woefully inadequate.

Time and again, he and his x Goldman groupies at Treasury have also piled out of the Trojan horse to defend traditional Wall Street prerogatives. They have:

• ☛Opposed serious restrictions on executive compensation and perks for senior bank staff that are unrelated to performance;

• ☛Opposed  clawbacks or windfall profits taxes on the hundreds of millions in stock options  granted by bailed-out banks last spring;

☛Opposed serious debt relief for homeowners, and failed to strengthen the loan modification program introduced last spring, even after it had clearly failed;

☛Failed to fight hard for "cram-down" legislation that would have required banks to accelerate loan modifications;

☛Opposed   the establishment of a new independent consumer protection agency for financial products; 

☛Opposed forcing banks that have accepted US aid to accelerate lending to small business and homeowners;

☛Opposed proposals for a "Tobin tax" on financial transactions, as suggested by the UK and France, as a way of financing climate change aid;

☛Opposed G20 proposals to clean up a wide variety of tax haven abuses by major bank and companies around the globe;

☛Failed to achieve any serious reforms whatsoever  of financial regulation, more than a year after the crisis;

☛Failed to get anywhere with the vaunted "toxic asset buyback" program;

☛Insisted that any reforms leave the ultimate regulatory authority in the hands of the US Federal Reserve  -- an anti-democratic, pro-Wall Street institution if ever there was one, whose policy errors  have contributed significantly to this costly crisis. 

LOSE THE BOZO

Of course at this stage, with US budget deficits at a postwar high, and controversial measures like health care reform, climate change, Afghanistan, and immigration still in stuck in traffic, plus a mid-term Congressional election fast approaching,  it may well be too late for the Obama Administration to propose a second stimulus. If this were going to happen, it  would have needed Treasury and White House leadership already. 

It is not too late, however, for Obama to send a signal that he actually holds his own senior executives accountable.

Secretary Geithner, I'm told, already has multiple job offers from at least a half a dozen leading banks and hedge funds, so he will only profit from this exit  -- which he probably anticipated all along. 

By clearing the decks and bringing in a fresh team with some new, more progressive ideas,  more daring-do, and independence, this could  help prevent Obama from repeating Jimmy Carter's sad, rapid one-term involution. 

In any case, when the history of the Obama Administration is written, it is worth remembering that at least a few progressives warned about all this very early  --  the risks of adopting a "pseudo-stimulus," failing to aid small debtors and businesses, and failing to exert strong control over the banks.

Ultimately, that may be one of the biggest costs of this crisis --  the lost opportunity to show that Democrats really are still capable of providing the country with outstanding, disinterested economic leadership in times of crisis. 

(c) SubmergingMarkets, 2009

TWO MEMORABLE SEPTEMBER 11ths James S. Henry

Many of us have our own strong private recollections of September 11, 2001.  I happened to have been at  Boston's Logan Airport that morning, boarding a prop plane for an American Eagle flight to Long Island's Islip Airport. It was leaving around 8 am from Gate 22,  at roughly the same time that Mohammed Atta and four other reputed Saudi hijackers of Flight 11 were taking off from Gate 26 at the very same terminal, along with 86 other passengers and crew.  We must have passed each other, but I didn't notice them. I do have a distinct recollection that security at the check-in  that morning was very lax, but other than that, my own flight was uneventful -- until we landed in Islip and heard the shocking news that two planes had just hit the twin towers. So "death  reached by and took another....."

My heart goes out to all who lost loved ones on that awful morning. May we redouble our efforts to establish a Truth Commission, and determine the full story, yet untold.

***

But it is important to put our 9/11 in context. This was not the only September 11th that is etched indelibly in my memory -- let alone the most important case of international terrorism.  

I also distinctly recall the Chilean coup of September 11,  1973  very clearly.  I was at­tend­ing a graduate economics course at Harvard  taught by a protégé  of  Chicago Professor Milton Friedman. One of my fellow  students was Sebastian Pinera, a member of one of Chile's oldest fami­lies, the future owner of the airline LanChile,  and right now the leading conservative candidate  in Chile's upcoming December 2009  Presidential elections. 

Sebastian had somehow  gotten word  halfway through  the class that Allende  had been ousted.  He was  absolutely jubilant -- “We won!,”  he cheered.                                                        

The profes­sor, a prominent econometrician from the University of Chicago,  shared Sebastian's de­light. Like   many other American  econo mists, he saw the overthrow as a victory for the neoliberal doctrines preached  by leading Chicago economists like Friedman and Arnold Harberger,  who both later consulted directly for Pinochet’s  junta.

Over  the next twenty years, these “Los Chicago Boys” came to       exert  a strong influence on Chilean  economic policy.   The label was  perhaps a little  un­fair  to Chicago -- there was certainly no shortage of Harvard  disciples of  brutilitarian free-market doctrines.

  For example,   Jose Pinera,   my classmate’s brother,  was also  Harvard- trained.  He eventually became one of the main architects  of Pinochet's labor policies,  which included a  ban on strikes and  closed shops,  the privati­zation of all pension funds, and sharp cuts in  real wages, jobs, and  unemploy­ment benefits.  

In hindsight,  Pinochet’s little laboratory conducted the first in a series of   experiments by the New Right  that culminated in the neoliberal programs of Margaret Thatcher  and  Ronald Reagan  in the First World, and a lengthy list of Third World imitators.  Among  First World democracies, their programs were  mod­er­ated  somewhat by the need for popular support. But  in countries like  Chile, Brazil, Mexico,  and Argentina,  where the lines between rich and poor were starker  and the political systems were basically rigged, much  less time was wasted on democratic  niceties.  

 To their credit, a few principled  conservatives were bothered by  the resulting dirty little al­liance between dic­tatorship and  liberal economic reform. But  many others -- including Sebastian, who opposed  holding plebiscites on Pinochet  in 1980 and 1988 --   got lost in the thorny thicket of distinctions between “authoritarian” and “totalitarian”  regimes. 

  In Chile’s case,  the resulting repression produced at least 3197 murders, disappearances and extra-judicial killings (about the same number as 9/11 in this country). [i] There were also thou­sands of secret arrest s and tortures (including 35,000 identified victims of torture and abuse ). All told, Chile spent six­teen long  years without  free elec­tions, in what  had previously been  one of Latin America’s  most  democratic coun­tries.

Of course we now know that all this state terrorism was tolerated, supported and indeed encouraged by the Nixon Administration and its dictator friends elswhere in Latin America -- presumably on the cocka-mamie theory that othewise we'd have Fidel running Santiago.  In fact the narrowly-elected Allende would have held elections when his term was up, and he probably would have lost.

 However, these points are pretty general -- repression is very concrete. As Herr Friedman reportedly told General Pinochet at a Santiago audience in l975,  “When you cut the tail off a dog you don't cut it off inch by inch. You cut it off at the root.”  I   remember a 1974 lecture by another Chilean economist, Orlando Letelier, who was killed  in l976 by a car bomb  planted by the DINA, Pinochet’s secret police, in Washington D.C.  And I remember  Victor Jara, a  talented Chilean guitarist whose music I greatly admired.   When the junta seized power he was arrested and transported  to a soccer stadium in Santiago where “political”  prisoners were held. The police took him out in front of the crowd  and they cut off his hands.........

***
 

 

 The overthrow of Salvador Allende's elected Popular Unity government in September  1973  was greeted with jubilation by Chile's propertied  classes.  He’d been elected with a 36 percent plurality  in l970, and  the Popular Unity coalition’s  support in­creased to 44 per­cent in the March 1973 Congressional elections. But   the  elite  was  eager for a change by any means.  From l968 to l973, at first under the Christian Democrat  Eduardo Frei Montalva and then Salvador Allende,   government spending as a share of GNP had in­creased from fifteen  to forty percent.  A third of  large farms and many  pri­vate companies had been nationalized at  low prices;   there was   700 percent infla­tion and frequent shortages of consumer goods; Chile’s foreign debt  had reached the un­precedented  level of $2.5 billion. Foreign investment dried up and  flight capital was pouring into  accounts at Bankers Trust, Chase and JPMorgan, Chile’s leading creditors.

The good old CIA, multinationals like ITT, and the USG certainly played a prominent role in 1970-73 coup activity that followed -- with a hefty dose of financial chicanery, in order to, in Nixon’s words’ “make the economy scream.” But intervention had not started there.

For example, according to former CIA agent Philip Agee, who had been stationed in Uruguay in the early 1960s, future Bush Pioneer and Presidential Library trustee John M. Hennessy, Chairman of Credit Suisse First Boston (CSFB) from 1989 to 1996, had been the Assistant Manager at Citibank’s Montevideo branch in 1964, and reportedly helped to transfer substantial funding to the campaign of Eduardo Frei Montalva,  who was running for President against Allende that year. Frei won the election, and served as President from 1964 to 1970.  In the early 1970s, Hennessy later became Assistant Secretary of the Treasury for International Affairs in the Nixon Administration, reportedly coordinating economic pressures against Allende’s government.[ii] In 1974, having succeeded at that Hennessy returned to Wall Street, where he became Managing Director of First Boston Corp., which was later acquired by Credit Suisse.    

In any case, despite the CIA’s involvement, the sufficient conditions for the 1973 coup against Allende were provided by a “Francoist” alliance of military officers, the Catholic Church’s hierar­chy, the top ten percent of landowners and industrialists, and the next twenty per­cent of the income distribution, the so-called “middle class.”  Immediately after the coup  these folks began to get what they thought  they wanted.

LOS CHICAGO BOYS
 

The junta turned to a small band of inexperienced but supremely self-righteous  economists, “los Chicago boys,” so named because their mentors University of Chicago economist and future Nobel laureate Professors Milton Friedman and  Arnold Harberger.

After Pinochet took power, there was actually a prolonged period when several different economic camps competed for the junta’s favor. But Friedman and Harberger,  who was Dean of the Chicago Economics Faculty,  seem to have tipped the balance when they visited Chile in March 1975. Since the 1950s, with the support of the Rockefeller and Ford Foundations, Harberger had developed a close relationship between the University of Chicago  and Chile’s Catholic University, where he had taught as a Visiting Professor.  With support from the Rockefeller and Ford Foundations, scholarships were provided for bright young Chileans who wanted to study economics.  Many of these Chicago-trained economists returned to Catholic University to teach, and later served in Pinochet’s government.

 Their trip was sponsored by the Chilean businessman Javier Vial, head of the business group BHC, one of the country’s largest conglomerates, the eventual owner of Banco de Chile, the country’s largest private bank at that time, and 60 other companies. He was also a very strong supporter of Pinochet’s dictatorship, on personal terms with the General.[iii]  Friedman reportedly got $30,000 for the three-day trip. His wife Rose  reportedly objected to the visit because Pinochet’s hard right regime and the goose-stepping Chilean military  reminded her of Nazi Germany.  But Professor Friedman tried to assuage her guilt by requesting the release of two Jewish political prisoners who were supposed in the custody of Pinochet’s police.

 Just one month after the visit, in April 1975,  the junta introduced an orthodox monetarist “shock plan,” along the lines that Friedman and Harberger had recommended.  And Professor Friedman’s  Chicago-trained protégé Sergio de Castro replaced Fernando Leniz as Minister of the Economy. Other key neoliberals  on Pinochet’s economic team included Pablo Baraona, President of the Central Bank, Alvaro Bardon and Jorge Cauas Lama at Treasury, Rolf Lüders as Treasury Minister and Minister of the Economy, and Juan Carlos Mendez as Director of the Budget.  Unfortunately the two Jewish prisoners were never located.

 This tiny band’s shared vision of Chile’s future was one that later became common among neoliberal Third World governments -- sort of a low-wage, export-oriented  Asian tiger, complete with weak unions, low inflation, privatized pension funds, and a minimal state --  apart from the police, the military, and the national copper company, of course, whose income went to the military. 

To pursue this anti-Marxist utopia they started out with a sharp recessionary  shock. They banned strikes, abolished price con­trols for  food and housing, and slashed tariffs from 100 percent to 10 percent in just two years. The  junta also intro­duced Latin America’s most radi­cal  privatization program ever. In l973-74, more than  250 nationalized companies were re­turned to  their former owners and 200 more were sold off at bargain prices.  These were not the  mid­dle-class privatiza­tions  of France, Japan, or  the UK, where the buyers  included  millions of small investors.  Like other developing countries,  Chile had a very  thin capital market, and hard times had  made it even thinner. So the big buyers at this fire sale were a handful of closely-held   grupos  like  Javier Vial and Cruzat-Larrain, which owned most of the local banks,  and also had very strong ties to foreign  banks.[iv]

All these changes set the stage for the dictatorship’s 1977-81 phase,  which was de­scribed at the time by the Wall Street Journal’s neoconservative editorial page in even more glowing terms than it reserved for the Argentine junta --   as “the Chilean economic mira­cle.” Indeed, during this brief period, when the economy was recovering from the sharp recession that los Chicago Boys had engineered, growth averaged  5-8 percent a year. 

 But what was perhaps most miraculous was the regime’s inability to foresee  that its  economic policies -- in addition to increasing poverty and inequality --  were about to cave in on each other, completely bankrupting the country and forcing  the national­iza­tion of the entire private sector. 

THE CHICAGO ROAD TO SOCIALISM -- AND BACK
 

By l977,  the junta had wiped out  any organized political opposition  and achieved most of its early economic goals. But the neoliberal  ideologues  pushed  it on to new extremes.  Under José Pinera’s 1979 radical right “Plan Laboral,” the government abolished closed shops for unions and tried to privatize everything from  health care and pensions to education. The 1980-81 pension fund privatization, which substituted a “fully funded” system administered by privately-managed pension funds – managed by institutions like Citigroup and Aetna, which came to dominate the highly-concentrated private system -  for the old “pay-as-you-go” government system,   was probably the most successful of these reforms. [v]  Many others succeeded only  in cutting social spending, while sacred cows like mili­tary spending and the nationalized copper company were  spared. 

The copper company was fa­mous because of the uproar provoked when Allende seized it from Anaconda in 1971. But Pinochet kept it nationalized --  a secret law  gave the military  ten percent of its profits.  So even under the junta, Chile’s largest  enterprise and exporter remained “socialist.”

In any case, the junta’s most important  neoliberal experiments -- and worst mistakes -- concerned macroe­conomic policy.  Here the point man was  Sergio  de Castro,  the los Chicago Boy who became Pinochet’s second Finance Minister in l979. Like Argentina’s “Wizard”  de Hoz,  De Castro was a strict believer in the monetarist view that the best way  to fight inflation in “small” economies like Chile  was  by  eliminat­ing tar­iffs, deregulating capital and trade, and maintaining a fixed exchange rate.[vi]   So he fixed Chile’s peso at 39 pesos to the dollar and held it there  from July l979 until June l982.   With copper prices in a slump and the size of the state sec­tor shrinking,  this was only possible be­cause foreign banks were willing to lend money hand-over-fist to Chile’s private sector.  Foreign  banks were sympathetic to  Pinochet’s conservative economists, much as they had been to the Argentine junta’s de Hoz;  they were also flush with cash and  very compet­itive, given Chile’s high real domestic interest rates.  

So, just as in Argentina,  many domestic borrowers took advantage of  fixed exchange rates and the temporary generosity of their foreign bankers to make lucrative  back-to-back deals.  For example,  Javier Vial, the sponsor of Friedman’s 1975 visit, and Chile’s richest man by 1978, acquired control over Banco de Chile in the late l970s and used it as a front to borrow heavily from foreign banks like Bankers Trust and  Chase. When he was its President,  Banco de Chile, in turn, reloaned the dollars to Vial’s many other private companies, including sev­eral that were based in Panama, like Banco Andino.  All these shenanigans be­came public af­ter Vial’s empire cracked in 1983.  In 1997, after a 14 year investigation, he was sentenced to 4.5 years in jail for bank fraud, and former Economy and Treasury Minister  Rolf Lüders, who’d owed 10 percent of BHC, was sentenced to four years.[vii]  Chile had gotten  stuck with his debts when the bank failed and was nationalized.   All this was no surprise to his foreign bankers -- as one former Bankers Trust officer who had personally  handled Vial’s Panama accounts told me, “We knew he was lending to himself, but  no one wanted to pull the plug.” [viii]  

As a result of de Castro’s policies,   Chile’s private foreign debt boomed  during  the “miracle” years.  In  l981 alone,  $6 billion of new credits were issued by foreign banks, a huge amount for this small economy, mainly  to  the leading domestic private banks like Banco de Chile, Banco de Santiago,  Banco Internacional, and Banco Colocadora, whose grupos,  in turn, owned a huge equity stake in Chile’s private sector.  From l980 to l982, private  foreign debt doubled; by l982  the total foreign debt had ap­proached $20  billion,     two-thirds of  it private.  The Central Bank re­peatedly warned  that it was not responsible  for the  private debt, but  it  al­lowed the spree to continue.  Given   all the “cheap” dollars and low tariffs, im­ports  also soared --   luxury imports became  Chile’s equivalent of flight capi­tal.  

A NEOLIBERAL CRISIS

The whole situation  finally began to  unravel in  May  1981  when Crav, a leading sugar company, failed.  The real crunch came in the summer of l982  when the Latin American debt panic dried up new loans, forcing  Chile to devalue and tighten interest rates, a lethal combination.  By January 1983 unemploy­ment   was thirty  percent,  and the six top private banks and the country's two largest pri­vate “grupos,” Vial  and Cruzat-Larrain, had also both folded. 

At this point Finance Minister de Castro began to get  intense pressure from foreign banks  like Chase and Bankers Trust to “nationalize”  the private foreign debt.  For a while he stuck to his free-market principles, reminding them of his  earlier warnings -- that such a move  would be no more justified than Allende’s nationalizations, and that this was, after all, private foreign debt, freely contracted, presumably with compensation for the risks of default built into the interest rates.  

But  the great big banks were not concerned with  such abstract princi­ples -- any more than they are today.   In January 1983,  they  quietly cut off  all Chile’s foreign trade credit lines – to the point where oil tankers en route to Santiago started to turn around and head home.   De Castro was forced to resign, and his replacement quickly declared that, indeed, the junta would as­sume responsibility for the private foreign debt (though not its offshore flight assets!) after all.  In the words of one Chilean banker, “Pinochet achieved what Allende only dreamed of -- the complete so­cialization of  our private sector.”[ix]   

Nor was this  the end of the story. When Pinochet’s fourth Finance Minister, a de Castro protégé named Hernan Buchi, took office in l985, he had to em­bark on  yet another, even larger  round of privatizations, simply  to rid the government of all the debt-ridden companies that the government had just acquired through the forced nationalization.  

(To his credit, General Pinochet did support the compulsory nationalization of Chile's largest banks -- as compared with the far more generous, CEO-friendly bailouts that the US Treasury has recently employed.)

Subsequently,  foreign bankers, the World Bank, Wall Street, and the IMF all gave Buchi  and the Pinochet regime rave re­views for their brilliant privatization strategy,  designed to attract foreign investment, boost savings,  and downsize Chile’s state.  But they never seemed to acknowledge why his privatization program  had been necessary  and possi­ble  in the first place  -- because  in 1983, neoliberal policies had produced a disaster, and   the junta and Chilean taxpayers had been forced by its  foreign credi­tors to take the fall for so many bad debts.

Finally, capping it all,  whom do you suppose were the main beneficiaries of Chile’s latest round of priva­ti­za­tions?  To  avoid the insider-trading outrages that had characterized many of the 1970s privatizations – helping groups like Vial and Cruzat to grow quickly --   Buchi did offer low-cost loans to workers and pension funds to help them buy stock.  By l988 worker-owned funds owned 14 percent of the privatized shares,  not a bad achievement in worker control for an ostensibly right-wing regime.

But two other kinds of investors became even more important.  The first were  foreign  investors, especially Sergio de Castro’s old friends, the foreign banks. In l986, under the  Central Bank’s “Chapter 19” program,  they  were al­lowed to swap their  (dubious) nationalized loans for equity in state-owned companies that were  priva­tized on very  fa­vorable terms.  

 As a result,  Bankers Trust obtained forty percent  of Provida, the country’s largest pension fund, plus  Pilmaiquen, a power plant, for   half its book value;   Aetna Insurance bought the country’s second largest pension fund;   Chase, MHT, and Citibank  also acquired major  local interests. Already by 1990,  a handful of foreign-managed pension funds   controlled seventy percent of  Chile’s pension system,  its largest pool of  capital.  Alan Bond, the er­ratic  Australian investor whose  financial em­pire  later collapsed,  was even permitted to buy the fa­mous telephone company that ITT  had fought Allende so hard for.  COPEC, Chile’s oil company, which had been privatized for a song to Grupo Cruzat-Larrain in 1976, had since turned into a debt-ridden conglomeration of fishing, mining, forestry, and finance companies, including half of Banco de Santiago.   When Cruzat cratered in 1983, Chile’s government re-acquired ownership of the now-heavily indebted COPEC, which was also by then Chile’s largest private enterprise. Four years later, it reprivatized COPEC to Grupo Angelini, another leading Chilean private conglomerate, again at fire-sale prices. And so the cycle continued.....[x] 

All told, this  “Chapter 19”  debt-equity swap program was credited  by its supporters -- especially the banks -- with reducing Chile’s debt by more than $2 billion. Of course it was a little ironic for the banks to be praising this achievement. Many others saw  the program  as a dead give-away.  By assuming  all the pri­vate foreign debt in the first place, Chile had rewarded bad lending.   And after a decade of tight-fisted government  many of the  privatized assets had actually been in pretty good shape.  Except for the copper company and a few military sup­pliers, the only ones the government retained were “dogs” no one else wanted.  It made little sense to let foreigners trade du­bious loans for valuable equity  at rock-bottom prices  -- maybe even less sense than Allende’s    nationalizations.  It seems that Chile hadn’t really eliminated state intervention; it had merely inverted its class bias.

The other key investor in Buchi’s  privatizations was the good old Chilean elite -- like Sebastian and his brother.   As we’ve seen, while the government nationalized  private debts,   it didn’t touch  private foreign assets.  And Buchi now offered flight capitalists  a gener­ous tax amnesty  if they brought their money  home.  His “Chapter 18” program  allowed them to buy   debt from the banks and swap it for  government bonds or equity in state companies at very  favorable prices.  By l990,  this program had brought in another $2 billion. Again, the banks and their clients  naturally sang Chapter 18’s praises. However,  it re­warded tax evasion and effectively swapped for­eign  for domestic debt that may  well prove more costly to service in the long run. Such criticisms meant little to the  officials in charge of the program, however -- some of them even benefited  from it personally. Soon after he left government, for example, Jose Pinera be­came president of an electric utility that had been privatized. And his brother ended up owning the privatized national airline – which he proceeded to turn into quite a profitable enterprise, even while serving in Chile’s Senate.

So the  circle was complete:  having been bailed out of their foreign debts by the government,  Chile’s  elite and the foreign banks now bought back their assets at less than fifty- sixty cents on the dollar, often with the very same flight dollars  that the original loans had financed! 

Here we have one of the purest cases of abusive banking,  one that poses the ques­tion of the foreign banks’ responsibility very clearly. For  Chile’s  1983 debt crisis obviously had little  to do with  inefficient public enterprises, excessive public debts,  godless Marxists, welfare-state liberals,   or  all the other usual suspects blamed by neoliberals.   At that point, fully two-thirds of  its  foreign debt was  private, and Pinochet and Co. had long since elimi­nated much of the state’s inefficiency, not to mention the political opposition.  Yet by the end of l983,  Chile  had ended up with one of the highest per capita foreign debts in the world, as well as  one of the developing world’s largest state sectors.

And this “Chicago road to socialism,” it seems, was taken in part because there was no  political opposition, no ac­countability – no one to say “enough” to the foreign banks, the domestic elites, their unregulated domestic banks, and the generals. So perhaps democracy had its uses, after all; perhaps  “free markets” alone were not sufficient. 

One could almost imagine the righteous tail-cutters in Chicago, taking a break for a micro-second from their round-the-clock crusade for more-perfect markets, experiencing perhaps just a momentary tremor of self-doubt.

*** 

 

---

 

[i] As of 2001, Chile officially recognized the existence of 3197 disappearances and extrajudicial killings  between September 11, 1973 and March 11, 1990, when the elected government  of Patricio Aylwyn assumed power. See “Korean Panel To Cooperate with Chile To Reveal Truth over Mysterious Deaths,” Korean Herald, February 7, 2001.  

 

[ii] See Morton Halperin, Jerry Berman, Robert Borosage, and Christine Marwick, The Lawless State.  The crimes of the U.S. Intelligence Agencies. (New York: Penguin Books, 1976), 16.

 

 

[iii]  For more about Vial, see “La Nueva Derrota,” Que Pasa, November 10, 1997; S. Rosenfed and J.L. Marre, “Chile’s Rich,” NACLA Report on the Americas, May/June 1997.

 

 

[iv]  See “Milton Friedman: Gurú a regañadientes, “ Revista Qué Pasa, February 28, 1998.

 

This account of the l973-78 period benefited greatly from  an excellent paper by Paul E. Sigmund, “Chile: Privatization, Reprivatization, Hyperprivatization.” (Princeton University, unpublished, July 1989).

 

 

[v] See, for example, Rodrigo Acuña R. and Augusto Iglesias P., “Chile's Pension Reform After 20 Years,” The World Bank -  Social Protection Discussion Paper No. 0129, December 2001.  Chile’s pension reform, which substituted a privately-funded system for the traditional “pay as you go” government system, was enabled by the fact that its military government could simply mandate the substitution. Subsequent attempts at privatization in more democratic countries like Argentina and Uruguay proved much less successful. 

 

 

[vi] This theory, espoused by arch-monetarists like Colombia University’s  Robert Mundell, argued that this policy would constrain inflation to the world rate by making a large share of the money supply endogenous.  It basically ignored exchange rate specu­lation and capital flight.

 

 

[vii]  For Vial’s and Lüder’s October 28, 1997 sentences, see “La Nueva Derrota,” Que Pasa, November 10, 1997, available at www. quepasa.cl/revista/1386/18.html..

 

 

[viii] "Chile Military Analyst,"  Sao Paulo, 2.21.89; “Miami Banker,” 5.91.

 

 

[ix] Raul Fernandez, former Director of Public Credit for Costa Rica, International Bank of Miami,  4.22.88. 

 

 

[x] See the account of COPEC in S. Rosenfed and J.L. Marre, “Chile’s Rich,” NACLA Report on the Americas, May/June 1997.

TOO BIG NOT TO FAIL? James S. Henry

(A version of the following story appeared in the Nation on February 23, 2009, here )

Even if a global economic recovery still eludes us, has President Obama's new team at least already achieved a stunning turnaround in US economic policy?

Or has the administration just been fighting the last war,paying far too much attention to ancient history, special interests, political correctness, and its own pre-recession agenda, in its programs to stimulate the economy, fix the banks and providing debt relief to homeowners?.

For lifelong students of the Great Depression like Federal Reserve Chairman Ben Bernanke and Larry Summers, it probably seems that Obama's economics team is on track.

In less than a month, Obama has pushed his record $787 billion stimulus bill through a highly partisan Congress. The resulting projected federal deficits will be even larger as a share of of national income than those incurred under FDR, until World War II. At a time when unemployment is rising sharply, this should be good news for the economy--- if the plan is sufficiently stimulating.

On February 10, Treasury Secretary Timothy Geithner announced a bold, if somewhat imprecise, $2.5 trillion program to relieve US banks of dodgy assets once and for all. Combined with trillions in other loans and guarantees from the US Treasury and the Federal Reserve, this is designed to avoid another costly Great Depression-type error, in which scores of banks were allowed to fail and credit markets seized up. If the plan really is expected to work, that should also be good news for the economy.

Bernanke also concluded from his lengthy studies of the Great Depression that the Federal Reserve had blown it way back then by keeping monetary policy too tight. So ever since last summer he's made the US money supply as loose as loose can be, ballooning the Fed's balance sheet to nearly $1 trillion and driving real interest rates down to zero, while pressuring his counterparts in Europe and Japan to folllow suit.

Obama's team also has emphasized the importance of avoiding the beggar-thy-neighbor "protectionism" of the 1930s--aside from a little "Buy American" language in the stimulus bill and a few remarks from Geithner about China. If loose monetary policy and tighter lips are sufficient for recovery, it should be just around the corner.

Finally, in the course of Obama's drive to pass the stimulus, he traveled to troubled communities in Indiana, Florida and Arizona and heard first-hand that millions of American homeowners and small businesses could use a little financial aid of their own right now. So Obama has committed $275 billion of the remaining TARP/"Financial Stability" funds to this purpose. In principle, this should also be good news for the economy--if we really believe that the plan has what it takes to stem the galloping pace of foreclosures and bankruptcies.

Obama and his team may really believe that their first month in office compares favorably with FDR's in 1933. Historical pitfalls have been avoided, and there has been no shortage of good intentions, optimism and action. The new president has also assembled a team that includes, by its own admission, the nation's brightest economists and its most experienced veterans of the Fed and the Treasury.

But something seems to be missing. During FDR's first few months in office, and well into his second term, he received an overwhelmingly positive response not only from the public at large but also from the stock market, despite the fact that FDR and Wall Street generally detested each other.

In contrast, the reaction of global stock markets and market analysts to Obama's flurry of policy initiatives has been overwhelmingly negative. In the past week alone, since the passage of the stimulus, the announcement of the Geithner plan and the president's new plan for mortgage relief, the stock market has declined more than 10 percent. Indeed, the country's largest banks and auto companies, which were supposed to be the beneficiaries of much of these new programs, are on the brink of bankruptcy.

So what's the problem? Actually there are several problems. The first, as I noted in part one of this series, "The Pseudo Stimulus," there really is much less to Obama's stimulus than meets the eye and far less than will be needed to head off the dramatic increase in unemployment that is fast approaching.

For reasons of political convenience and a desire to move quickly, Obama and his advisors decided to appease a handful of key Republican senators, rather than seize the bully pulpit and rally support around a larger, more direct spending package with more debt relief for homeowners.

Ultimately Obama succeeded in getting just three "moderate" Republican senators and zero House Republicans to support the package. (Eleven House Democrats also voted against it.) These votes were costly. The final bill ended up slashing almost $40 billion from the package, while boosting the share of tax cuts to nearly 40 percent--including almost half of all relief provided in the critical first year when it is essential to get the downturn under control.

Most macroeconomists still believe that under conditions of excess capacity, tax cuts generate much less employment per dollar of lost revenue than almost any kind of spending, because upper-income types will save the proceeds or use them to pay down debts. Furthermore, many of the tax cuts in Obama's bill are regressive, even allowing for his favorites, "Make Work Pay," the earned income credit and child care credit. This means their impact on jobs will be even more limited.

For example, of $214 billion of individual tax cuts in the first two years, $100 billion will go to the top 20 percent, while the bottom 60 percent gets $81 billion. Indeed, for one of the largest single tax cuts in the bill, the $70 billion reduction in the "alternative minimum tax," 70 percent will go to the top 10 percent, while the bottom 60 percent--including most unemployed workers--get .5 percent. So Obama's vaunted plan relies on this premier-class AMT cut, plus another $100 billion of business tax breaks, for 27 percent of its first two years of "stimulus."

On top of this, Republicans like Arlen Specter also have shown that they give no ground to Democrats when it comes to sausage-making. I won't repeat part one's list of trinkets, except to note that almost all the worst projects survived, and indeed were only enhanced by the solons' scrutiny.

As a former Minnesotan I'm all in favor of free WiFi for each and every one of the nation's two million farmers; I've also recently written here in glowing terms about the merits of government- sponsored research and development and "green housing." But this kind of spending has little to do with putting millions of unemployed people--most of whom are in urban areas--back to work.

All told, at least $200 billion of this stimulus spending, on top of the $200 billion of wasteful tax cuts, is not remotely related to the urgent goal of creating as many jobs as possible in the next twelve to eighteen months. The cause of recovery was hijacked by a weird coalition of environmentalists, energy companies, venture capitalists, public-sector unions, state governors, tax-cut nuts and other special interests.

The stimulus program was supposed to realize Obama's declared goal of saving or creating at least 4 million new jobs by 2012--even then, at the average cost of $200,000 per job. According to the Congressional Budget Office, even that level of job creation would only reduce the US unemployment rate by an average of less than one percentage point a year by 2012, for a cumulative reduction of 2.5 to 3 percent relative to the CBO's projections of what unemployment will look like without the program.

By the time the Senate got through with it, Obama's stimulus became much weaker. So most economists now agree that it will be lucky to create or save even an extra 2.5 million jobs by 2012--about a 1.5 to 2 percentage-point cumulative reduction in the official unemployment rate by 2012, at an average cost to taxpayers of $315,000 per job.

The contrast with FDR's focus on spending programs that really did put people back to work, is striking.

THE REAL UNEMPLOYMENT RATE

Recent trends in unemployment help us to understand just how much work we will have to do to define victory and to see how close we really may come to another Great Depression.

All the standard measures of unemployment are woefully inadequate, but the shortcomings change with the times. In good times, with tight labor markets, conservative economists find it satisfying to remind us that the degree of "involuntary" unemployment is probably overstated, because workers can afford to game the welfare system--for example, by collecting unemployment insurance while refusing reasonable job offers.

In hard times like these, however, official unemployment rates seriously understate the degree of slack and hardship in labor markets. For example, in addition to the 13 million people now unemployed (that's 8.5 percent of the labor force) another 7.8 million workers report that they are underemployed; at least 2.1 million to 5.9 million more (none of whom are collecting unemployment) say they're not in the labor force because they've given up looking. By another measure, the peak labor force participation rate, established when labor markets were very tight in 1999 and 2000, shows the potential supply of labor not counted as unemployed is even larger--10.6 million right now.

All told, this means by now there are already at least 23 million to 33 million American adults who are already experiencing increased unemployment, up from 13 million to 17 million from a year ago. By the end of 2009, as the official unemployment rate passes 10 percent and the other indicators of slack labor markets grow as well, this figure will swell to 40 million American adults--at least 9 million to 18 million more under-utilized workers than we have now.

A majority of these people have families. Furthermore, the unemployed population constantly turns over, with a median duration of joblessness that now exceeds ten weeks. This means that during the next year, up to one-third of the entire US population will personally encounter someone facing the harsh realities of involuntary unemployment, and perhaps homelessness and poverty as well.

These figures omit several other kinds of "hidden" unemployment that are not recorded in conventional labor force and unemployment statistics: the 1.44 million people on active duty in the military and the unemployment they would face if and when they return to civilian life; the 2.3 million inmates in federal, state and local prisons, all of whom are omitted from labor force and unemployment statistics; and the estimated 8.1 million undocumented workers in the United States who are in the labor force.

In many ways undocumented workers are the most vulnerable victims of the crisis. Most support families either abroad or home. Many also have been working hard here for years and have now lost their jobs, without any unemployment insurance, healthcare, rights to Social Security or other benefits. And since Congress has not been able to agree on a decent immigration reform bill, they may not even be able to count on achieving US citizenship, after years of working and waiting. Now they face a hard choice between remaining here, unemployed, or returning to violent, corruption-ridden "Bantustans" in Mexico, Central America, the Philippines and elsewhere.

It's important to take these factors into account when we consider how this downturn compares with earlier financial crises. Unemployment statistics for the 1930s are difficult to compare with our current situation, given the different statistical procedures employed and the very different demographics in the two eras. But my analysis shows that it is possible that this crisis may turn out to be comparable to the situation in 1933, when unemployment peaked at roughly 25 percent of the US labor force.

This analysis provides a context for assessing Obama's original goal of creating/saving 3 million to 4 million jobs by 2012. The fact is, even that original goal simply wasn't anywhere close to being ambitious enough--and it certainly won't be met under the sadly compromised final "stimulus" plan. The negative reaction of global stock markets markets to Obama's plans so far appears to confirm this. We're going to have to stop the political games and get serious.

GEITHNER'S TARP II

What about the second leg of Obama's new post-Depression economics policy initiatives, Geithner's plan to inject yet another $2.5 trillion of ("public-private") capital into US banks to get rid of their toxic assets?

Markets reacted negatively to the plan not because investors necessarily opposed his new toxic asset buyback scheme. Most analysts felt that his long-anticipated statement was long on rhetoric about "stress tests and transparency" but short on digestible content--like being invited to dinner and then served pictures of food.

Indeed, like his website, FinancialStability.gov, Geithner's plan remains under construction. But critics may have missed the point--this lack of detail actually may be a political necessity. If the American people understood just how high a price the Obama adminstration may be willing to pay simply to keep our country's largest failing private banks private, we might need a few more guards at the Winter Palace.

Tim Geithner is not a former Wall Street insider in the Paulson/Rubin mold, nor was he ever for a single day a community organizer. He's an ambitious and cautious policy technocrat, whose lucrative private-sector career and board seats are still in front of him. We'd be hard-pressed to find anyone who, at age 47.5, had already punched more establishment tickets. His grandfather was a Ford Motor executive and Eisenhower adviser; his father is a Ford Foundation officer who raised Tim on three continents. He graduated from Dartmouth and Johns Hopkins, became a consultant for Kissinger Associates, a protégé of Robert Rubin and Larry Summers at Treasury in the 1990s, an IMF policy director in 2001-2003, a Council on Foreign Relations fellow and finally head of the Federal Reserve of New York. As of the end of 2008, he was still a member of the CFR, the Group of Thirty and the Economic Club of New York, organizations not routinely associated with sponsoring deep reforms in post-capitalist economies.

Geithner has seen his share of banking crises firsthand: Mexico in 1995, when the entire banking system had to be re-nationalized; Thailand, Indonesia and Russia in 1997-98; Argentina in 2001; and now the biggest one of all right here. All of the Third World crises just noted ended badly--costly, poorly-managed fiascos that did nothing to enhance the reputations of the US Treasury and the IMF. But perhaps Geithner was just an apparatchik. He worked closely last year with Hank Paulson and Bernanke on Bear Stearns bailout, the Lehman/Merrill decisions, the AIG takeover and TARP I. So he probably understands full well not only the gory details of program design but also two fundamental political realities.

The first is that while nationalizing top-tier global banks may be politically acceptable in places like Norway, Sweden, Chile, Iceland, Ireland and even Japan and the UK, it is still viscerally opposed by most members of the power elite in New York and Washington--including most of his former club members.

The second is that by now, most American taxpayers have simply had it with huge Wall Street bailouts, supine members of Congress, overpaid banker chutzpadiks and high-handed Treasury secretaries. If they were ever asked, there is no way in Naraka that taxpayers would ever approve yet another open-ended injection of public capital into banks--especially one costing three times the entire "stimulus" and three-and-a-half times TARP I.

So the trick is to not ask them. With bank stocks sinking every day, the credit crunch hampering recovery and high expectations about policy changes, Geithner had to say something. But not too much. The whole subtext of his vague announcement was to finesse the question of precisely where all the money would come from. The hope was that this would buy time to line up private capital, perhaps by negotiating some kind of insurance subsidy that would induce it to participate. The hope was that this would do enough to stem the decline in bank stock prices and redirect attention away from the new "N"-word--nationalization. 

WELFARE FOR BIG BANKERS

The public outrage is justified. Since October, more than 360 US banks (out of 8,367) have already received at least $353 billion of TARP I funds from the Treasury. This is by far the largest corporate bailout in US history, more than twenty times the original $17.4 billion auto industry bailout.

Of this, more than half went to the top fifteen banks in the country. This includes $145 billion of capital injections awarded to Citigroup, Bank of America, JP Morgan and Wells Fargo, the top four US commercial banks; another $10 billion each for Goldman Sachs and Morgan Stanley, two worthy investment banks that decided to become commercial banks to avail themselves of federal aid; and a grand total of $84 billion to the rest of the US banks. There was also $40 billion in capital injections and $113 billion in credit in AIG, the profligate insurance company that sold so many flaky credit derivative swaps to investment banks like Goldman that it pioneered a whole new new "too fraudulent to fail" rule. In addition, by now US banks have also received at least $1.82 trillion of federal loan guarantees and $872 billion in federal loans.

These sums need to be viewed in the context of the staggering amount of government assistance that has recently been provided to private financial institutions all over the world. By February 2008, by my reckoning, banks and insurance companies have already absorbed at least $817 billion of government capital injections, $251 billion of toxic asset purchases, $2.6 trillion of government loans and $5.9 trillion of government debt guarantees. If we added the guarantees for once quasi-private entities like Fannie Mae and Freddie Mac, the loan guarantees double to $10.9 trillion.

To put all this in perspective, the 1980s savings and loan crisis cost taxpayers from $150 billion to $300 billlion in comparable 2007 dollars. The 1998-99 Asian banking crisis cost $400 billion. Japan's prolonged banking crisis in the 1990s cost $750 billion. And the total amount of debt relief received by all Third World countries on the $4 trillion of dodgy foreign debt that they incurred from 1970 to 2006 was just $310 billion.

Those crises are completely over, while this one is still unfolding, so its ultimate cost is still uncertain. Already it is clear that ordinary taxpayers around the world are on the hook for total losses that will easily dwarf all the costs of all these other recent banking crises combined--including $2 trillion to $4 trillion of further bank write-offs beyond the $1 trillion of losses already recognized. Since no government on earth has the surpluses on hand needed to fund such largesse, this means that we will be paying for this bailout one way or another for the rest of our lives, and probably for our children's lives as well, through increased inflation, taxation and reduced government services.

Never has so much been given to so few by many. Yet despite all this public generosity, much of the US banks' recent behavior been execrable. For example, in December we learned that the US Treasury got preferred securities in exchange for the first $254 billion of TARP funds that, right off the bat, were worth $78 billion less than the funds they received.

We've also watched with amazement as they've continued to fund corporate jets and other perks, and as several of the largest recipients of TARP funds have paid extravagant bonuses to senior executives for "performance" in 2008--a year when the banking industry contributed mightily to the tanking of the entire global economy. Nor have most banks been forthcoming about what they've actually done with all the TARP money--except to to concede that they haven't done much new net lending. After all, they say, in this economic environment, with regulators suddenly breathing down their necks about leverage and toxic assets, they are not eager to take risks.

That's all well and good at the micro level, but at the level of the overall economy, we badly need banks to swallow hard and start churning out new loans--and not just to gold-plated borrowers who don't really need the money. Since TARP I funds were not dedicated to new lending, and, indeed, since policy makers like Paulson, Bernanke and (presumably) Geithner decided to leave TARP I's use entirely up to the banks' discretion, this period of extreme largesse and low interest rates has also coincided with tight credit markets--except for well-off corporations and elite borrowers and refinancers, who have actually been the main beneficiaries of Bernanke's low-interest rate policy.

So while both the Federal Reserve and the Treasury have been busy demonstrating that they have finally taken the lessons of the Great Depression to heart, and have been setting records for generosity and loose lending, at the end of the day they still allowed the private banking system to keep its elephant in the hallway, blocking the road to recovery.

In the four months since receiving the first TARP Installment, the US banking industry has become a supersized version of the US auto industry--on the verge of bankruptcy, kept afloat by government capital, loans and loan guarantees, with no long-run strategy other than to continue its well-funded lobbying efforts and heavy campaign contributions and to occasionally show up in DC before toothless Congressional committees for well-choreographed rituals of contrition.

Since October 2008, the net worth of the entire US banking system-- all 8,367 domestic-owned US banks--has declined by $420 billion, to just $540 billion. In other words, TARP was one of the worst investment decisions in corporate history--the banks' net worth has declined by more one dollar of equity value for each additional dollar of TARP funds injected.

Indeed, the net worth of two of the largest banks in the system, Citigroup and Bank of America, is now around $30 billion, less than half of the $70 billion in government capital that they have received from TARP I, on top of $424 billion of federal loan guarantees. Not only has their own "value added" during this period evidently been negative. For a fraction of the funds we've given these two banks, we could have stopped begging them to clean up their balance sheets, restructure their mortgages, stop wasting money, change their compensation plans and initiate sensible new lending programs. We could have bought a controlling share, hired new management from the droves of idle bankers now out on the street and re-privatized them at a profit for taxpayers in two to three years--just as successful "turnaround nationalization" programs have done again and again in these situations, from Norway to Chile.

No wonder that growing numbers of critics--not just hard-core lefties and Nobel laureates like Paul Krugman and Joseph Stiglitz but even pragmatic politicians like South Carolina Republican Senator Lindsey Graham--have started to break the taboo and talk explicitly about "nationalization."

But in an important sense the taboo had really already been shattered by TARP I, last year's expansion of FDIC deposit insurance and all the other new federal loan guarantees for the bank. In effect, these already "nationalized" the banks' debts. Now we're just talking about the other side of the balance sheet, where there might at least be some value, if only under new management.

TOXIC ALTERNATIVES

Geithner is hardly unaware of this short-term nationalization approach to the credit crunch, or of the success it has in many other markets. But he has apparently rejected it in favor of a much more costly and uncertain route--establishing a public-private bailout fund that will somehow entice the banks to sell off their lousy assets and still have enough equity left to survive as private entities.

The limitations of this approach are best understood by taking another close look at Citigroup and Bank of America, two of the most troubled institutions in this story. On their most recent balance sheets reported to the FDIC, these two big banks alone accounted for $4.1 trillion of official on-balance-sheet "assets"--mostly loans and federal securities, but also a hefty amount of potentially dodgy mortgage-backed securities and other asset-based securities.

Right off the bat, therefore, at least by the accounting numbers, these two top banks alone now account for more than 30 percent of all the assets outstanding in the entire US banking industry. Indeed, the top fifteen banks account for over 60 percent. This represents an incredible increase in banking industry concentration since the early 1990s, when Citibank and Bank of America held just 7 percent of all US bank assets, and the top fifteen banks held 21 percent.

This increase in industry concentration was hardly an accident. It originated in the desires of bank executives to grow, boosting market share, short-term earnings, stock prices and the executive bonuses driven by those metrics. But it also reflected the gloves-off stance that Congress, regulators and antitrust enforcement took toward bank expansion during this period. And that, in turn, was probably related to the more than $1 billion contributed by the financial services industry, their lobbyists and law firms, to politicians of both major parties since 1990, which turned the Senate Banking Committee the House Financial Services Committee and other key Congressional committees, in effect, into wholly owned subsidiaries of the banking industry.

Now how much might all these assets on the banks' balance sheets actually be worth? There is no active exchange for most bank assets, especially those that are hardest to value in this environment, like mortgage-backed securities. And by law, the banks are permitted to value the assets on their books at "fair market value"--in essence, whatever their accountants tell them they are likely to be worth, given historical experience with loan losses. But the difference between these accounting numbers and today's market value for these assets may be huge--up to half or more of book value. And the banks have a strong incentive to hold on to the loans and hope that things get better, rather than sell them off right now at whatever the market will bear. After all, as soon as they start selling down one loan bundle, they may be required to "mark to market" all similar ones. And the resulting writedowns might well be enough to wipe out all stockholder equity, leading to insolvency.

This whole situation is reminescent of the 1980s Third World debt crisis, when banks like Citibank, Morgan and Chase resisted for years the demands of policy makers and developing countries to write down or sell off the billions of overvalued loans on their books--for no other reason than, as one former Chase banker put it, "a rolling loan gathers no loss." Similar behavior occurred during the prolonged Japanese debt crisis of the 1990s, when banks stubbornly resisted the efforts to get them to "mark to market" because several of them realized they would be bankrupt and no longer with us if they did so.

There's not really much moral culpability here. At ground level, from the standpoint of any individual bank, this behavior is understandable. After all, they have just gone through a period of careless underwriting, and are trying to reduce their loan losses and improve their capital ratios--just like most bank regulators want them to do. The larger banks have balance sheets that are best described as follows: "On the left side (assets), nothing is right; on the right side (deposits and other capital), nothing is left." And since the economy is still slipping at an unpredictable pace all around them, no loan officer is eager to take on more risks. So it is hardly surprising that in the last quarter of 2008, even as the TARP money started to flow, US bank lending suffered its sharpest decline since 1980. It also makes perfect sense for them to resist selling off its loans and securities at what may eventually turn out to have been fire-sale prices.

While all this may be well and good for bankers, however, for rest of us it means that even after all those trillions in federal bailouts and loan guarantees, the economy is still starved for credit. The fact that major banks as a group continue to sit on all these lousy loans at book value, rather than selling them off and writing them down, means that they don't have much room on their balance sheets and in their capital/asset ratios for new loans. So the credit crunch continues. And banks that we eventually may find out were really insolvent may walk around in a trance for months or even years, like a scene from Night of the Living Dead. We're not talking about restoring the loose lending of the 2005-2007 bubble; we're talking about the essential liquidity needed to keep the wheels from coming off, stimulate demand and stem the decline in housing prices.

The importance of all this becomes clearer when we take a close look at the composition of Citigroup's and Bank of America's $4.1 trillion of assets outstanding. It turns out that these include $1.3 trillion of real estate loans and mortgage-backed securities (22 percent of the US industry's total), $153 billion of credit card loans (38 percent of the total) and $150 billion of auto loans, student loans and other loans to individuals (25 percent). Clearly all these book values may be severely at risk in the current economic crisis.

But these potentially troubled categories of assets only add up to about $1.6 trillion; why is Geithner talking about a $2.5 trillion program? The FDIC's latest statistic a provides a clue. It reveals the dominant role that the country's top banks have also played in issuing derivatives, including not only interest rate and currency swaps, but also in more notorious debt-based over-the-counter derivatives. As of September 2008, JPMorganChase, Citigroup and Bank of America accounted for an incredible 90 percent of $7.9 trillion of these "off-balance sheet" credit derivatives that have been guaranteed by these banks themselves--including $2.6 trillion guaranteed by B of A and Citi. So when Secretary Geithner was talking about running "stress tests"--scenarios for future housing prices, default rates and interest rates--against the balance sheets of particular banks, he was not talking about First Federal of Tuscaloosa or Suffolk County National in Riverhead. They've probably never guaranteed a credit derivative in their lives, much less tucked anything away in some Cayman Island "special purpose vehicle." Clearly, Geithner had his friends on Wall Street in mind.

REALLY A POLITICAL PROBLEM

In short, we have a choice to make: we can spend perhaps $150 billion to $200 billion buying out the equity of a handful of leading banks that have gotten themselves in this mess and reform them. This would involve taking them over immediately, installing new managers, giving their creditors a haircut, writing down the toxic assets (which the government-owned bank could do without fear of market reactions) and then preparing them for privatization when the market recovers.

Or we can follow Secretary Geithner's lead, fiddle around for months, throwing trillions more of government capital, loan guarantees and portfolio insurance at the problem, without any guarantee that the resulting cockamamie approach to creating a "public-private" toxic bank will ever work--while the same old troubled institutions are left standing, no longer encumbered by their dodgy assets perhaps, but still encumbered by dodgy managements.

There are lots of technical issues to be weighed in making this choice. But after reviewing all the objections to the kind of short-term, temporary, partial nationalization, I'm convinced that the most important issues are simply political, a choice between our commitment to a failed, hands-off model of bailouts and banking regulation and decisive, FDR-like action.

It is precisely because it is so hard to value these dodgy assets at all that we are even having this discussion. Given the absence of competitive markets for the assets, the uncertain environment and their dependence on taxpayer subsidies and insurance, the prices established are intrinsically political. Either they will be set so low that banks will have to take such massive writedowns that their shareholder equity will disappear entirely anyway, or--more likely--the prices or insurance arrangements will be set so that even more taxpayer wealth is transferred to these very same top-tier banks.

Meanwhile, the whole economy is hostage to this decision. We have no time to waste. We should get on with it, making use of one of the clearest market signals available in this situation--the current value of Citibank and Bank of America shares.

This argument is not at all anti-market, or necessarily even anti-bank. At their best, private markets, entrepreneurship and innovation are absolutely essential. My real objection is to a very specific kind of bank-dominated political economy. To call this "capitalism" is to have Ayn Rand and Friedrich von Hayek turning somersaults in the crypt. Time and again, this pathological form of pro-bank development has jeopardized the prosperity, stability and innovation of the small businesses, inventors and would-be savers who are the backbone of market economies. Bank-dominated political economies don't really deserve to be called "capitalism," since big bankers have never really been entrepreneurs who are content to stick to the capitalist rules of the game. Instead, they periodically demand the divine right to take unlimited risks, privatize the resulting gains and stick the rest of us with any resulting losses.

It is time for accountability, we are told by our new president. If so, we should start by holding the world's largest banks, hedge funds, insurance companies, mortgage brokers and private equity firms, together with their many friends in accounting, law, public relations, credit rating, central banking and higher office accountable for this crisis--if in no other way than by refusing to award them this even more massive TARP II bailout, permitting them to rob us, once again, with both hands.

***

Obama's Pseudo-Stimulus

(This article appeared in The Nation on February 4, 2009 here.)

First of a three-part series on the economic crisis.

You, telling me the things you're gonna do for me.
I ain't blind and I don't like what I think I see.
   --Michael McDonald, The Doobie Brothers,
    "Takin' It To the Streets"

For what is the crime of robbing a bank, compared with the crime of owning one?   --Berthold Brecht

So now that President Obama is in office, his economic team is in place, the largest stimulus package in  US history is nearly complete, real interest rates are negative and the Treasury is about to announce a "big bang" version of TARP that provides even more capital to private banks, we're good, right?

Lo siento, no, as shown by last week's steep stock market slide, even after his program passed the House. For once, the Republican wingnuts may be right. There really is much less to Obama's stimulus than meets the eye.

His new plan for ridding the banks of toxic assets--"cash for trash," as economist Joseph Stiglitz has aptly described it--is also likely to be way too kind to bank executives and shareholders, and he appears to be remarkably ignorant about the indisputable successes that capitalist countries like Norway, Chile, and Japan have had with temporary, partial bank nationalizations that make the taxpayers "owners of last resort."

There has been far too little debt relief provided to the growing number of homeowners facing foreclosure, small business owners facing bankruptcy, and other debtors. This step is urgently needed to stem the free fall in housing prices and the rising tide of layoffs among small businesses, where most of the country's jobs are.

  There are rumors afloat that Obama's team may soon announce something like this, but the numbers that we've heard from key Congressmen--$50 billion to $100 billion--are far too modest. We need to pressure the president for a "People's TARP," no less generous than the ones that the banks are receiving.

Finally, while US policymakers have been throwing gargantuan sums of borrowed money at the wall, mollycoddling Wall Street, and dithering on debt relief for the rest of us, the global crisis has deepened. All across Europe and Asia--from Athens, Chongqging, London, Moscow, Paris and Prague, to Rekyavik, Riga, Seoul, Sofia and Vilnius--people have become completely fed up with their governments and are taking it to the streets.

So here's a message for our new president, from someone who worked hard for his election long before it was fashionable: if you dally and temporize, the very same thing could easily happen here--perhaps just in the form of a massive tax strike, in solidarity with Messrs. Geithner and Daschle.

While Americans are usually much less militant and certainly less well organized than our comrades around the world, the serious deficiencies in the first drafts that we've seen of Obama's stimulus and financial plans really do need to be corrected in short order.

We also need to see much tougher action with the financial services industry, which bears a disproportionate share of the responsibility for this nightmare. At a minimum, this means a return to a more orthodox and tightly regulated banking system, a renewed assault on tax havens and the anarchy of the world's financial order, strict limits on executive pay plans that reward unbalanced risk-taking, and a 1930s Pecora Commission-style investigation of the industry's misbehavior--complete with subpoena power.

In the words of FDR's first inaugural address in March 1933--which, by the way, was harder-hitting and much more memorable than Obama's--it is time for the "money changers" to be forced to flee from "their high seats in the temple of our civilization" once and for all. The only thing we have to fear is Obama's temerity.

THE CONTEXT

By now everyone has had just about enough bad economic news, but just to set the stage for the discussion, it is important to review the basics. 

It's is already a cliché to describe this crisis as "the deepest global downturn since the Great Depression." Actually in many ways it threatens to become even worse--faster, sharper and far more global. Here at home there are already more than 11.1 million unemployed, close to the 11.4 million peak that was reached in 1933, when 20 percent of the population still lived on farms and, apart from the Dust Bowl and bank repossesions, could at least count on having a place to grow their own food. In 2008 alone there were already 2.3 million residential foreclosures filed and 861,664 completed in the US, compared with the 600,000 total that was recorded from 1930 to 33. Obviously, relative to the size and wealth of the economy, conditions were worse back then, partly because the social welfare system provided less help and more bank depositors got wiped out. But in absolute terms the sheer number of our fellow citizens who are already experiencing serious hardship is really disturbing. And we are only a few months into this.

Since October, growth rates have plummeted and unemployment has soared worldwide. Just last week, the International Monetary Fund cut its latest forecast for world growth in 2009 to .5 percent, and for the United States to negative 1.6 percent, as fourth-quarter US growth plunged by over 5 percent, apart from inventory accumulation. Other credible observers are far more gloomy.

Each day brings news of massive layoffs, corporate losses, foreclosures, the bankruptcies of well-known brands like Waterford Wedgwood and Circuit City, continuing house price declines, bank failures, abandoned projects, soaring government deficits and bailouts and widening spreads on loans to some First World countries, not to mention financial frauds, robberies, suicides and other indexes of deep financial distress.

This is the world's first post-globalization debt crisis, and the worldwide effects are catastrophic. From Labuan, Jakarta and Guangdong to Chicago and Detroit, London and Moscow, the ranks of the unemployed are expected to swell by 51 million by mid-2009, and of those living in dire poverty by at least 176 million. Beyond impersonal statistics, there are also innumerable tragic stories of personal hardship, involving people and families that have suddenly lost jobs, careers, businesses, homes, life savings, healthcare, scholarships and, most important, hope for the future.

WHAT ARE WE STIMULATING?

  Given this situation, the US economy's influence on the global situation, and the importance of resetting expectations, the stakes for Obama's very first economic initiatives are enormous. Unfortunately, the first drafts already adopted by the House and under debate in the Senate are disappointing.

Surely, at these prices we deserved a much more carefully targeted anti-Depression program. Instead, over 63 percent of Obama's $825 billion-plus in new spending and tax cuts won't even be felt for at least a year, and more than $100 billion won't show up until 2012 or beyond. Even if the plan works as advertised, it would only reduce unemployment by less than one percentage point a year, relative to the more than 9 percent baseline projection we are facing.

But this plan will almost certainly not work as advertised. It has been weighed down with $275 billion in tax cuts that would have very modest short-term multipliers. At least 21 percent to 25 percent of Obama's tax credits would go to recipients in the top 20 percent, with incomes above $113,000. These folks are more likely to save the money than those with lower incomes--and right how what we need is spending, not saving.

Evidently these tax cuts were included out of some broad-minded attempt to reach out to Republicans and Blue Dog Democrats. One might have thought they were already sated by a decade of record tax cuts for upper-income groups, starting with Bill Clinton's sharp reduction of capital gains taxes in 1997--even larger, by the way, than George W. Bush's. But Obama's diplomatic gesture yielded not a single Republican vote in the House last week, and also failed to win over eleven Democrats. Welcome back to Earth, Mr. President.

Even Obama's $550 billion of extra spending will not be sufficiently stimulative. First, around $200 billion will be channeled through state aid. On average, this will have an even lower multiplier than tax cuts, because of bureaucratic delays and the fact that our political system always channels a disproportionate share of aid to less-needy states. At one end of the spectrum, six states with unemployment rates above 9 percent now account for about one-fourth of the nation's unemployment--2.8 million people. Under Obama's program these states would get less than 20 percent of all this state-channeled aid, an average of $8,623 per jobless person. But ten mainly Western states with unemployment rates below 5 percent will get nearly $20,000 per unemployed person.

Second, despite the sales rhetoric about promoting recovery and saving jobs, these were clearly not the plan's only--or even its most important--objectives. If they had been, there'd be far more up-front spending on direct job creation and programs with higher multipliers and faster paybacks, like unemployment benefits and populist debt relief. There'd also be more top-down control.

Instead what we have is a dog's breakfast of pet projects, spread across 104 federal agencies, from the Administration on Aging and the Bureau of Indian Affairs to Fish and Wildlife and the National Endowment for the Arts. Dozens of projects were evidently extracted from various liberal wish lists, dusted off and dressed up in the latest "recovery-jobs" couture. Almost anything can qualify so long as it carries a big enough price tag: digital TV conversion ($640 million, on top of the $1.3 billion already spent for this worthy cause), port security ($600 million), research on biomass and geothermal ($1.2 billion), constructing the "smart grid" ($4.4 billion), climate science ($390 million), fixing Amtrak ($800 million), developing satellites ($460 million), restoring wildlife habitats ($400 million), preserving forest health ($850 million), special education ($13.3 billion), immunization ($954 million), STD prevention ($350 million), water projects ($13.7 billion), preparing for a flu pandemic ($620 million), grants to local police ($4 billion), advanced batteries ($2 billion), wireless broadband ($6 billion), a new data center for Social Security ($400 million)...

The overall impression is a parody of bloviated corporate liberalism. It is as if every deep-sea creature in the ocean suddenly came to the surface at the same time. There they all are, writhing and waiting for someone to make sense of the overall game plan.

Road and bridge repair be damned! Why worry about being unemployed when there's so much else to do? Soon we'll all be firing up the clean-coal stoves and sewage-fired generators, recharging our federally subsidized Volts and the underground battery farms and heading on over to new neighborhood health centers, where we'll download some interactive broadband training on aging and avoiding STDs. Then perhaps we'll plant a tree or apply for grants to "weatherize" or found a "rural enterprise." By then it will be time to pick up Little Dorothy at Early Head Start, get her vaccinated, say hey to the new federally funded "local" police chief, artists and high school teachers, then kick back in front of the converter box with a long cool draught of federal H₂O and a generous helping of nutritious cuisine from the "local" Emergency Food store--making sure that the CO₂ that we generate is properly sequestered and not bubbling up through the neighbor's brand new geothermal system.

By the laws of probability, of course, at least a few of these schemes may actually turn out to have some merit. But it is clear that Washington's finest lobbyists and law firms--second only to Wall Street in terms of sheer venality--have already been hard at work to insure that no key client has been left behind: electric utilities, the coal industry, telecoms, agribusiness, the IT industry, the teachers unions, the Asphalt Pavement Alliance, the Portland Cement Association ("we pour strength into our recovery"), commercial real estate developers and even venture capitalists, are all lined up to profit from Obama's extraordinary spending spree.

I'm beginning to sound like a Republican wingnut. But really, at lightning speed, we've gone from booting single mothers off the dole in the interests of "personal responsibility" (saving a grand total of--what, Bill Clinton?--maybe $5 billion per year at most, while finding jobs for only half of the 60 percent who got the boot) to having almost every single key interest group in the country lining up with a tin cup, right behind the banks.

More important, from a global perspective, Obama's program takes the eye of the ball. What the world economy desperately needs most right now from the US economy--remember, we're the ones who originated this debacle--is not "reinvention," or some hastily-assembled collection of alternative energy demonstration projects, but a good, old-fashioned healthy US market recovery.

Once that is in place, there will be plenty of time and money to save the planet. But unless that is in place, there will be no serious worldwide attention paid to climate change, global warming or alternative energy, nor will there be necessary funds and economic incentives that are required to really fix the the problem. At a time when tens of millions are having a hard time feeding their families, these are luxury goods. I defer to no one in my hardcore environmentalism--but Obama's plan has had a little bit too much input from Al Gore's "green limousine" set, and is putting the green cart before the debt-ridden horse

In fact, this program somehow manages to be neither reinvention nor recovery. Nor is it very thoughtful. Rather, it is a Jackson Pollack approach to social and economic policy. That kind of action painting may have been OK for hip Hamptons artists way back in the 1950s, but in these times it is dangerously blithe. It also risks discrediting everything that progressives should stand for, if we want to see government taken seriously again as an agent of social change. If we continue with this scattershot, favorite-liberal-interest-group approach, creditors like China may soon begin to wonder whether we've become just another Banana Republic--not the chain store, but the political pathology--or an aging superpower that has an acute case of ADHD.

Of course it is easy to criticize. The real test is to come up with a superior, politically feasible alternative. Later on in this series, I'll suggest one--a combination of high-multiplier spending and serious popular debt relief that would command more support, provide a much greater direct stimulus, stem the decline in housing prices and small business closings and placate foreign creditors who are worried about our sanity. It might even permit Obama to finally win a few Republican votes for his program.

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INVEST IN INNOVATION!!!Instead of Eating the Seed Corn...James S. Henry and Jim Manzi

We are called the nation of inventors. And we are. We could still claim that title and wear its loftiest honors if we had stopped with the first thing we ever invented, which was human liberty."  

-- Mark Twain

(The following is a longer version of a piece that appeared this week in The Nation.)

In the midst of our deepening recession, the US faces another  economic crisis that is less visible and dramatic than house foreclosures, bank failures, plant closings,  or stock market avalanches, but even more important in the not-really-that-long run: systematic under-investment in technology and innovation.

Indeed, nothing less than our global economic leadership may be at stake because of this underinvestment.

On the other hand, with a little bit of funding,  foresight, and determination, we believe that it may be possible to kick-start an innovation revival.

Especially at the federal level, for a  modest investment,  there’s an opportunity to create a whole new generation of idea-growing, job-creating  technology hubs all across the country – perhaps even an “automotive Silicon Valley”  in otherwise moribund Detroit.

  This revival would not just be about investing more heavily in R&D. Especially in troubled times like these, we need to remind ourselves that innovation has always been a critical American tradition, a crucial part of our patrimony. It is as much a by-product of our political system and cultural norms as of our business and scientific practices.

This patrimony is now at risk, not only from our failure to invest,   but also from the failure to reward and honor scientists, technicians, engineers, and inventors above lawyers, bankers, and hedge fund managers, and to recognize the central role that real innovation of all kinds has always played in our story.

NEW IDEAS

For more than two centuries America has led the world in innovation.  This has been true not only in science and technology, but also in business management practices, the design of new approaches to service delivery, and, indeed,  sports,  political institutions and civil rights as well. Over the long haul, this consistent track record of ingenuity and invention, complemented by heavy investments in education and science, has contributed mightily to America’s leadership role in the world economy, to our democratic culture and the prosperity of our people.

Indeed, most students of economic growth now agree that the contribution of technical innovation to US national wealth has been at least as important as that of so-called “natural” resources like abundant farm-land, labor, capital, and energy.

In the post-globalization economy, where access to such resources is being commoditized, innovation has become an even more important source of competitive advantage.  In principle, this should be good news for the US. This is not only because of its past successes, but also because innovation-based competition is  “win – win,” not “beggar thy neighbor.”  Over time, every player in the competitive game stands to benefit from  the discoveries made by others. 

On the other hand, if the US stakes its future on resource-based competition  -- or the kind of low-innovation, “big houses/big debts/big cars” model favored by Detroit, New York, and Houston until very recently  --   the competitive game will become “win-lose.”  And long-term competitive advantage then shifts to those countries with the largest supply of cheap resources, the lowest taxes, and the cheapest, most oppressed workers -- not a favorable formula for a healthy democracy.

HIGH RETURNS

Unfortunately, the US’ global leadership in innovation has been placed at risk by years of failure to invest adequate resources in R&D.

To begin with, virtually every analysis of the “social returns”  -- private profits and social benefits, including employment -- to R&D investments  finds these returns to be very high. They average at least 30- 50 percent per year or more in real terms, compared with the meager 5-7 percent returns typically generated by the US stock market – or the minus 46 percent returns earned by stocks earned in the last year.   

These high returns to R&D are explained by its peculiar nature. Once discovered, new ideas  can be used over and over at low – or even zero – marginal cost. So R&D not only boosts productivity in the industries that do  research; it also yields “spillover” benefits for other industries. And it speeds up  future innovations. There is NOT a finite body of good ideas sitting out there waiting to be mined. Rather, from a knowledge standpoint,  we live in an expanding universe, where each new discovery reveals whole new territories to be explored.

Consistent with this, those industries that are the most R&D intensive have also consistently achieved the highest growth rates and profitability, and have also made the largest contributions to skilled employment and high incomes. The notable exceptions -- financial services, lawyering, real estate development, accounting,  plus cartelized industries like autos, cable television, and oil and gas -- are ones where clever chicanery, market power, and anti-competitive regulations have permitted vast fortunes to be achieved without much fundamental innovation at all –- until the recent collapse.

THE INNOVATION GAP

These high rewards for investments in R&D also suggest the presence of a substantial innovation spending gap. This is the gap between the current level of R&D spending and the optimal level, from the standpoint of generating growth, employment, and the many other social benefits of new ideas. Indeed, we are so far from the competitive margin that the US might be able to profitably invest several times the current $370 billion per year that US industry and the federal government now spend on R&D without driving “social returns”  below the long-term (federal) cost of capital – just 1 percent these days after inflation.

Let’s put it this way: at these interest rates, and the high expected returns, it would cost the US Government just $400 million per year in interest to double its entire current budget for civilian R&D – which might then yield an incremental $12 billion in returns. It’s about time that we realized such high multiples for the country, and not just Wall Street executives.  

RECENT TRENDS

Yet the recent trend in US R&D investment has been in precisely the opposite direction.

First, while US R&D spending as a share of national income has been relatively high for decades, compared to other Western countries, since the mid-1980s it has stagnated. Indeed, it now is well below the 1960s level, when the Kennedy/ Johnson Administrations’ visionary drive to reach the moon, combined with the arms race and the rise of mainframe computing, produced a sharp boost in US R&D spending.

Federal funding is one key to this gap.  While it still accounts for about 28 percent of all US R&D spending, it has recently been especially sluggish. In real terms, the federal budget for basic and applied R&D has fallen for five years in a row, and will continue to slide  next year under the budget just approved by Congress.

This recent trend is even more disturbing, once we take into account the fact that nearly 60 percent of the Federal Government’s current $100 billion of R&D funding   is devoted to military and “national security” programs at the Pentagon, DOE, and the Department of Homeland Security.

The $42.6 billion left over for non-military research in FY 2009 has to fund everything from DOE’s basic research on alternative energy to the National Institute of Health’s vital medical research program for peer-reviewed science, to NASA’s entire space budget.  As a share of national income, non-military budget for R&D now amounts to a paltry .3 per cent – the lowest share since the early 1950s, and just half the average in the late 1970s.

The $43 billion budgeted for all federal civilian R&D pales by comparison with the $700 billion that the US Treasury is injecting into US banks, in return for some combination of non-voting stock, very low dividends, and toxic assets. It also pales by comparison with the $29 billion bailout of Bear Stearns, the $135 billion bailout of AIG, the $200 billion bailout of Fannie Mae and Freddie Mac,  let alone the $800 billion cost (to date) of the Iraq War.

But of course that must simply be because government R&D spending is a risky venture whose outcomes are highly uncertain! 

DON’T LOOK BACK

The other disturbing point about R&D spending is that American leadership has been slipping. Relative to other countries, the US has long devoted a relatively high share of national income to R&D investment. Even now it still accounts for a disproportionate share of all global R&D  -- at least 25 to 34 percent. 

However,  while US R&D spending has recently stagnated, many other countries, including key new competitors like China and Malaysia as well as more mature ones like Korea, Singapore, and the Nordic block, have been sharply increasing R&D spending. So the gap between these leading competitors and the US in overall R&D spending is rapidly shrinking.
Since innovation is by definition a matter of human skill and creativity, not just finance, it also matters that these new competitors have also sharply increased the share of skilled researchers and technicians in their labor forces. The US’ slippage has also been aided by the “hegemon tax” --  the fact that none of these countries spend anywhere near the 50-60 percent share of R&D that the US devotes to military R&D.

Overall, many high-growth developing countries have already grasped a key point about economic national security that the US is still struggling to grasp. This is the fact that, as noted above, the global competitive marathon increasingly depends on productivity, innovation, and scientific skill, not just command over natural resources or vast pools of untutored “hewers of wood and drawers of water.” 

Indeed, US companies that once moved offshore simply because of cheaper inputs, lower taxes, and weaker regulation are now finding that it pays to move their R&D centers offshore as well. This is partly because of the growing availability of engineering skills in places like India, China, and Singapore, but it is also because  of the higher barriers to immigration that foreign skilled workers have faced in the wake of 9/11. This policy may or may not have had much impact on terrorism, but by forcing these workers to remain at home, it has certainly had a negative impact on our economic security. 

TROUBLED WATERS – PRIVATE R&D

These disturbing trends in federal R&D spending have also been reinforced by recent trends in private sector spending. As we saw earlier, private investment now accounts for more than 70 percent of all US R&D. Unfortunately, because of the current financial crisis and the emerging recession, this funding is drying up even as we speak.

This is especially true for venture capital funds that have relied heavily on so-called “limited partners” like pension funds and university endowments. Such investors often manage their portfolios with fixed allocations – reserving, say, 10 to 20 percent of investments to “alternative investments,” especially the “D” side of R&D-intensive ventures. Given the stock market’s steep decline, this approach to portfolio management and the need to rebalance asset allocations have virtually dictated a steep decline in private R&D funding.
on how deep this recession is, and how much father stock markets fall, this allocation effect  will easily trim private R&D spending by 10-20 percent or more – for a budget that is already, as we’ve seen, under-funded.

At the same time, in uncertain times like these, many private corporations and investors become less patient. – they become much less willing to invest in the kind of  low-probability/ long-lead time projects that are the essence of basic research.  It is hard to diversify away such project risks, so private capital markets tend to demand more immediate, sure-fire payoffs just when “capitalism” is most in need of  real breakthroughs.
In the aggregate, this helps to explain why the primitive “Capitalism R 1.0”  version of a market economy -- one  that relies exclusively on private investment to fund innovation – is likely to grow much more erratically than one that allows government to play a complementary role, stabilizing support for basic research in good times and bad.
WHAT TO DO

So what should we do about the innovation gap? 

¶ First of all, we need to make investing in innovation the  national priority that it deserves to be – because future US competitiveness depends on it. In the 21st century, as global competition increases, we cannot simply “Wal-Mart” our way to  prosperity. 

At a minimum, this implies a significant boost in the current level of R&D funding, especially in civilian funding, and perhaps increased tax credits and other incentives as well.
Of course, such measures would require increased federal spending, precisely at a time when the federal budget is already severely strained. As we’ve seen, however, the current level of spending is so modest that the US is just “one-half bank bailout” away from the kind of increase  in R&D funding that is needed. The alternative of just continuing to stagnate should really be characterized as “eating the seed corn.”

¶ Second, like most enterprises, our country really needs a national technology strategy. 

This is not a matter of “industrial policy” or “picking winners,” much less of displacing private funding with government venture capital.

Rather, it is  matter of figuring out  creative new ways to partner with private capital – including philanthropic donors  and university endowments.  The aim is to multiply the benefits, by focusing on what the government has always done best – replenishing the “seed-corn” with fundamental longer-term research.

This requires a fresh look at the appropriate role of government in innovation. From this angle,  the recent financial crisis is not all bad.  Given the disastrous example of excessive reliance on under-regulated markets that we’ve just seen, on the one hand, and the relatively successful long-term track record of government R&D on the other, this is an historic opportunity.

WALKING BACKWARDS FROM SUCCESS

¶ Third, there’s a real opportunity to learn from our own innovation history, and use the lessons to propagate a nation-wide series of innovation hubs.

  It is especially instructive to walk backwards from the successes realized by several US examples of public-private collaboration in “technology hubs” like Silicon Valley, Boston, and Austin Texas.
In all these cases, private venture capital and entrepreneurs  were crucial. But the fact is that federal dollars also played a pivotal role. For decades the federal government generously subsidized basic research in fields like engineering, biology, physics, chemistry, and computer science at premier universities like MIT, Harvard, Stanford, Carnegie Mellon, and the University of Texas.

For example, in the case of Stanford, one of Silicon Valley’s mainstays,  the university has received enormous federal research subsidies ever since the 1940s. Combined with the Valley’s highly-competitive venture community, this provided the foundations for a technology hub that has transformed the world, with innovations like semiconductors, computer graphics,  and wireless communications, and companies like Intel, Apple, and Google.
In the case of Boston, the National Institute of Health has recently played a key role in helping the community become a technology hub for biotech and pharma research. Boston’s new leadership in this arena is based on enormous NIH funding, channeled to peer-reviewed researchers at regional teaching hospitals. Over time, the steady provision of federal tax dollars has supplied the  grist for what has since become a self-sustaining  innovation mill. Rather than “crowd out” private funding, federal funding has actually galvanized it, providing a base load of support that allowed a strong technical community – the key to any successful hub -- to take root.

The key issue is whether we can replicate  new “Bostons” or “Silicon Valleys” in other geographies,  targeted towards priority arenas for innovation like energy, health care, the environment, education, and transportation.

Each of these arenas offers a wide range of subfields. For example, in the energy arena, there’s already path-breaking work under way on clean energy, new electric distribution systems, and new forms of automotive and non-automotive  transport. In health care, innovations that lower costs (e.g. EMRs) may be just as important as clinical innovations like new devices, treatments, and compounds.

The point is not to dictate  precisely what gets worked on, but to marshal the human resources and infrastructure needed for innovation, build the partnerships with private institutions, and insist on excellence.

In this “incubation” approach, for example, we might  ask, what conditions would be needed to yield a period of sustained innovation in the automobile sector? Why not reserve, say, just  a few percent of the $25  billion that the federal government has already committed to that sector’s “bailout” for the creation of an “automotive Silicon Valley?” In such a hub, just as in Boston and Austin,  a virtuous cycle of innovation and product development would be generated. Pockets of entrepreneurial companies would spawn each other, one after another, competing aggressively and helping to free people and capital from big, slow-moving companies. Universities, communities, and corporations would complement each other’s very different styles and skills.

¶ This renewed emphasis on innovation as a source of national competitive advantage also requires us to beef up our education system, in order to deliver tens of thousands of  skilled technicians and engineers.  As we’ve seen, there’s also a need for immigration reform that provides greater access to foreign-trained skills – an alternative to the current “scarce visa” system, which basically encourages our competitors to staff up their own technology-based industries. In this case, we’re not just eating the seed corn; we’re giving it away.

Finally, the other crucial requirement of an innovation revival is a national culture that reminds young people of their innovation heritage, and encourages them to become engineers, designers, and scientists,  rather than just lawyers, accountants, and bankers -- whose preferred form of ingenuity, in Thornstein Veblen’s words, has always been “clever chicanery, or the thwarting thereof.”  As we’ve argued, now more than ever, we need to curtail all this chicanery and return to the much better American tradition, innovation on the real side of the economy.

(c) SubmergingMarkets, 2008

Jim Manzi was Chairman of Lotus Development Corporation, and is now Chairman of Thermo Fisher Corporation, a $10 billion life sciences company based in Waltham Massachusetts. 

BUSH SPEAKS: "HOW DID WE EVER GET IN THIS MESS? WHERE HAVE I BEEN?"James S. Henry

Last night on national television, Comrade Bush presented his own miniature 14-minute "Cliff Notes" version of the roots of the current US financial crisis, and a heart-rending appeal for the most generous act to date of his Administration, the $700 billion blank-check Wall Street bailout. 

By now the man has established a bit of a pattern --  customarily trying to scare us all into granting him unlimited powers,  while arguing that there is simply no alternative to whatever bitter pill he happens to be pushing at the moment. 

You are of course free to believe him if you like. Hundreds do.

In fact, as we argued yesterday, there are all sorts of improvements to be made to the proposed Whale of a Bailout package.   

These include things like, at a minimum, (1) equity investment and warrants for taxpayers, to provide some upside returns in proportion to the risks we are taking on any purchases of bank assets; (2) stronger oversight; (3) more assistance for the millions of Americans who are experiencing home foreclosures; (4) compensation ceilings, clawbacks, and stiff progressive tax rates on incomes over $1 million and estates over $10 million, to offset the cost of all this; (5) a Financial Products Safety Commission; (6) a new Treasury-backed competitive insurance market for mortgage securities,  available to banks and homeowners; (7) expanded FDIC reserve fund rather than buy "toxic" bank securities up now, set up an  -- since all the "I-banks" are commercial banks now, anyway; (8) a new installment of the 1932 Pecora Commission, complete with subpoena power, to investigate the origins of the crisis and hold people accountable.

(For more details, here is the testimony that Dr. Brent Blackwelder, Friends of the Earth, and I submitted to Rep. Frank's House Financial Services Committee yesterday: BAILOUT.pdf)

Even more important, the President's central claim that there is no alternative to this bitter pill is a triple whopper with cheese.    

As the IMF -- not our favorite institution, but it does know a thing or two about recapitalizing broken banking sectors --  has suggested just this week, long-term "swaps" of mortgage-backed securities for government bonds could be used to clean up the banks' balance sheets while completely sparing  taxpayers the risks of a huge loss on the $billions of toxic assets we'll soon be owning. 

There are also numerous other approaches  to broken-banking sector restructuring  that have been employed by governments all over the planet in more than 124 banking sector crises since 1970 -- for example, in Chile, Korea, Germany, Mexico, and  Japan.

Doesn't anyone else find it odd that none of this expertise is being put to use?

Or that, with losses on complex derivative and structured securities at the core of this debacle, and thousands of "quants" from MIT and Wharton on Wall Street, we cannot design some simple security vehicles to help taxpayers reduce their personal or collective exposure to its potential costs? 

Perhaps Bush & Co. are not familiar with the IMF or the World Bank/ IFC's "Capital Markets Group." Perhaps Secretary Paulson never bothered to understand the first thing about derivatives and options during his 32 years at Goldman Sachs.   

For their information, the World Bank/ IMF/ IFC  are located at 700 19th St. NW, Washington D.C., three blocks from the White House.

Their staffs are not especially busy at the moment -- indeed,  15 percent of the IMF's professionals are being laid off, so they may have some time to help out.

We've been assured by the Bush Administration, however, that the IMF's assistance is not really needed at this point.

"What are we," Bush asks,  "Some sort of two-bit corrupt, debt-ridden plutocracy  that can't manage its own affairs?"

Indeed, the President,  Secretary Paulson, and a weird new assortment of  bottom-feeding Wall Street investors  (Omaha's Warren Buffet, Tokyo's Nomura Holdings and Mitsubishi UJF), and, of course, those who are still left on Wall Street itself are in a white heat to get this deal done, and are trying to create a stampede. 

They are also clearly not interested in improving the bailout. They just want our money -- and a loosey-goosey, behind-closed-doors process for distributing it that hasn't even been designed yet.

Unlike US taxpayers, Buffet, who is reportedly investing $5 billion in Goldman Sachs, was saavy enough to get preferred shares and warrants for his money -- worth up to 8 percent of the premier bank's share.

At that rate, just think how much Wall Street real estate our  $700 billion would buy -- if only Paulson and Bernanke and the US Congress would follow in Buffet's footsteps and insist on some equity and warrants in exchange for a bailout. 

Meanwhile, Bush has the temerity to intermeddle (once again) with the orderly conduct of a US Presidential election, by inviting the two leading Presidential candidates to the White House just to help him close the deal with Congress. (Ralph Nader and Bob Barr are reportedly already camped out in the White House basement.)

As if the candidates don't have anything else to do, like debate each other,  41 days before the election.

As if Secretary Paulson and Chairman Bernanke were not already the world's consummate sales team!

Of course both Obama and McCain will accept the President's hospitality -- they have no choice.

So both have now been roped into making this deal happen. 

Alas,  it probably will -- minus almost all of the possible improvements noted above. The largely symbolic CEO comp limit is probably the only exception

To those to whom much has been given, even more will be given.

We do have one consolation, however,  as we prepare to pay the check for this lousy meal. We've located a different version of the history of this crisis that is more accurate -- and more entertaining -- in this must-see video:

(c) SubmergingMarkets, 2008

SO, FORREST, WHAT DO WE DO NOW?Ten Steps to Fix the Paulson Plan and Solve the US Debt CrisisJS Henry and Brent Blackwelder

The US Congress is busy working hard on US Treasury Secretary Henry M. Paulson Jr.'s $700 billion TARP bailout plan  -- at least everyone except Alabama's Rep. Spencer Bachus, the ranking Republican on the House Financial Services Committee, who has spent much of the day explaing why a senior official in his position has the time, much less the ethical license,  to be making scores of options trades during office hours.

While we have every confidence that Rep. Bachus and his peers will provide masterful oversight of the Secretary's proposal, it is understandable that with less than six weeks left to the November election, and Congress set to adjourn on Sept. 29, we appreciate that they may have more important things to worry about than the greatest US financial crisis since the Great Depression. 

So it is time to help them out. Given the widespread dissatisfaction -- indeed, revulsion -- at Paulson's initial request for a $700 billion blank check  -- on top of the other $500 - $700 billion that the Treasury/ FDIC and the Federal Reserve have already committed to Fannie/ Freddie, AIG, Bear Stearns, and other banks this year -- it is clear that revisions are needed. But time is short -- not just because of election imperatives, but because global financial markets are on pins and needles, waiting for a clear solution.

Any time there is this kind of sea-changing economic event, it tends to surface every interest group's Christmas wish list of long-delayed "essential reforms."

In this situation, indeed, the crisis has brought forth everything from proposals for "nationalizing the banks" and new regulatory agencies to "clawbacks" in executive severance plans and income tax reform.  There are also a substantial number of people who are concerned about the implications of the initial Paulson proposal for constitutional democracy -- some have called it as nothing less than an "economc coup d'etat" by "Commandate Paulson,"   because of all the unreviewable authority it would have vested in the Secretary and his minions. 

Given that Congress is moving at the speed of light, we need to "tier" these proposals according to their importance.  There are also a few more innovative ones that deserve immediate attention. Here's our own "Top Ten Improvements" wish list.

WISH LIST

1.  Equity  “Upside” and Voting Power.

In return for the undeniable new risks that US taxpayers are taking on, and the poor management track record of leading Wall Street institutions,  it is reasonable to insist that they receive an “upside” on the value of participating financial institutions (FIs) themselves as well as on the potential increased value of acquired mortgage-backed assets.  This proposal commands widespread support in this panel.

Technically, this could be accomplished by demanding preferred shares (with anti-dilution provisions) from any financial institutions (FIs) that receive assistance, as was routinely done by Bank of Japan in exchange for financial assistance during the Japanese bank restructuring of the 1990s, and by the Chilean government during the February 1983 bank nationalization.

Warrants might also be used, as was done in the case of the 1979 $1.2 billion Treasury loan guarantee to Chrysler. (According to Sen. Bradley, the Federal Government eventually made money on those warrants.) We believe that while warrants are easier to implement, it is vital to insist on actually equity (including voting power). This will provide the Treasury with much more direct influence over management behavior, will be easier to value, and will also be easier to explain to the public than warrants.

2. Clawback Provisions for Executive Severance Pay.

The basic  principle here is that for  senior FI executives, there should be accountability for some time period even after they leave office – at a minimum, any future compensation or severance that they receive should be subject to stiff taxes or repossession in bankruptcy court. Insisting on compliance with this standard should be a condition for participation in the bailout.

3. Share the Pain.
   
A.  Emergency Taxes. 

Since this very costly bailout package may severely limit the ability of the Federal Government to afford vital programs like health insurance reform and alternative energy, it is important that we deal now with the substantial “tax justice” implications of the bailout.

One way to do this would be to start treating this as the national emergency that it really is, and help ordinary taxpayers pay for it by: (1) eliminating the carried-interest benefits for hedge fund managers; (2) cracking down on offshore havens – no FIs should be permitted to establish subs or place SPVs  in them;   (3) imposing at least a temporary increased  income tax rate on all people with incomes above $1 million and on all estates above $10 million.

B. Compulsory Write-Down/ Debt Reduction of Residential Mortgages.

Given the failure of this summer’s relief packages for ordinary mortgage holders to have much impact, and the fact that foreclosures are still increasing (to a record 100,000+ per month, and that housing prices are still falling in a majority of key markets, this is an another essential measure. The debt restructuring should be implemented quickly, affect large numbers of people, and be inversely proportional to mortgage size. It might also be means –tested.

Such a measure would not only provide equitable relief to millions of would-be homeowners; it would also help to kick-start a US economy recovery.

4. Financial Products Safety Commission.

This would review and certify the quality of all financial products offered to the general public. Products like zero-down payment mortgages would require special labeling, and might not qualify for government incentives like interest deductibility, access to the government insurance window, and so forth.

5.  A New US Treasury-Created Market for MBS Insurance.

A novel idea suggested by our good friend Prof. Lawrence Kotlikoff of Boston University  is that the US Treasury might be able to use current authority to offer ABX-like insurance at a fixed price per tranche  to institutions that hold MBSs.  According to Professors Kotlikoff and Merlin, if such a government-backed insurance market were in place, backed by a significant reserve against losses, it might even obviate the need for the entire $700 billion, while creating a market-based workout alternative.

This could be combined with #1, if FIs were allowed to pay for the insurance with  equity or warrants.  This would also have the benefit of helping to recapitalize troubled FIs.

6.  New “Pecora Commission” (ala 1932): a congressional committee with subponae power to investigate the root causes of this crisis and recommend further steps.

 

SOCIALISM FOR BANKERS, SAVAGE CAPITALISM FOR EVERYONE ELSE? Bailout Jeopardizes the Entire Progressive AgendaJames S. Henry

"“There’s class warfare, all right, but it’s my class, the rich class, that’s making war, and we’re winning.” --  Warren Buffet, June 2008

Ladies and gentlemen: pardon my intemperance,  but it is high time for some moral outrage --  and a little good old-fashioned class warfare as well, in the sense of a return to seriously-progressive taxation and equity returns for public financing.

After all, as this week's proposed record-setting Wall Street bailout with taxpayer money demonstrates once again,  those in charge of running this country have no problem whatsoever waging "class warfare" against the rest of us -- the middle classes, workers and the poor -- whenever it suits their interests.

At a time when millions of Americans are facing bankruptcy and the risk of losing their homes without any help whatsoever from Washington DC,  the CEOs and speculators who created this mess, and the top 1 percent of households that owns at least 34 percent of financial stocks, and the top 10 percent that owns 85 percent of them, have teamed up with their "bipartisan" cronies in Congress, the US Treasury and the White House to stick us with the bill, plus all of the risk, plus none of the upside.

Upon close inspection, the Treasury's proposal is nothing more than a bum's rush for unlimited power over hundreds of $billions, to be distributed at Secretary Paulson's discretion behind closed doors and without adequate Congressional oversight.

This time they have gone too far.

As discussed below, the cost of this bailout could easily jeopardize our ability to pay for the entire economic reform program that millions of ordinary citizens across both major parties have been demanding.

Some kind of bailout may indeed be needed from the standpoint of managing the so-called "systemic risk" to our financial system.

However, as discussed below, the Paulson plan does not really tackle the real problem head on. Thsi is the fact that many financial institutions, including hundreds of banks, are undercapitalized, and need more equity per dollar of debt, not just fewer bad assets.

To provide that, we may well want to mandate debt restructurings and debt swaps, or provide more equity capital .

If private markets can't deliver and we need to inject public capital into financial services companies on a temporary basis, so be it. But it should only be in return for equity returns that compensate the pubilc for the huge risks that it is taking.

Call that "socialism" if you wish -- I think we are already well beyond that point -- sort of like Chilean economists became in 1983, when the entire private banking sector collapsed and was nationalized -- successfully -- by the heretofore "Los Chicago Boys."

To me, public equity investment, in combination with increased progressive taxation, should be viewed as just one possible way to get these companies the equity they need, while providing fair compensation to the suppliers of capital and participation in any "upside," if there is one.

Absent such measures, progressives certainly have much less reason to support this plan. After all, the increased public debt burdens that it would impose are so large that they could easily jeopardize our ability to pay for the entire economic reform program that millions of ordinary citizens (across both major parties) have been demanding.

From this angle, the Paulson program, in effect, is a cleverly-designed program to "nationalize" hundreds of billions of risky, lousy assets of  private financial institutions, without acquiring any public stake in the private institutions themselves, and without raising any tax revenue from the class of people who not only created this mess, but would now like to be bailed out. 

Any mega-bailout should come at a high price for those who made it necessary.

In particular, we must make sure that the butcher's bill is paid by the tiny elite that was responsible for creating this mess in the first place.

This is not about retribution. It is about insuring taxpayers are truly rewarded for the risks that they are taking -- isn't that the capitalist way?  And it is also about making sure that this kind of thing never happens again.

After all, the real tragedy of this bailout is its opportunity cost. Consider a well-managed $1 trillion "matching" investment in strategic growth sectors like energy and health....If we really wanted to insure our competitive health, we would not be investing $1 trillion in lousy bank portolios generated by the chicanery-prone financial services sector.

CAPITALISTS AT THE TROUGH

In financial terms, this latest Wall Street bailout is likely to cost US taxpayers at least $100-$150 billion per year of new debt service costs -- just for starters.

This estimate is consistent with the $700 billion ("at any point in time") that President Bush and Treasury Secretary Hank Paulson are requesting from Congress this week to fund their virtually-unfettered ("unreviewable by any court") new "Troubled Asset Relief Program." (TARP)

The sheer scale of Paulson's proposal implies that federal authorities plan to acquire at least $3 trillion of mortgage-backed securities, derivatives, and other distressed assets from private firms -- on top of Fannie/ Freddie Mac's $5.3 trillion mortgage securities portfolio. How the Fed and the Treasury actually propose to determine the fair market value of all these untrade-able assets is anyone's guess. But since  40 percent derive from the exuberant, fraud-prone days of 2006-7, they will probably all be subject to steep (60-90 percent) discounts from book value.

That's consistent with the 78 percent  "haircut" that Merrill Lynch took on the value of  its entire mortgage-backed securities portfolio earlier this month -- actually, more like a 94.6% haircut, the portion that it received in cash.

This implies, by the way, that if the Federal Government were required to "mark to market" their $29 billion March 2008 investment in Bear Stearns' securities, it would now have a cash value of just $1.6 billion. Not a very hopeful sign from a taxpayer's standpoint.

Paulson's latest proposal dictates another sharp increase in the federal debt limit, to $11.313 trillion. This limit stood at just $5.8 trillion when Bush took office in 2001.  By October 2007 it stood at $9.8 trillion. Then it jumped again to $10.6 trillion in July 2008, during in the Fannie/Freddie meltdown. As of March 2008, the actual amount of Federal debt outstanding was $9.82, just six months behind the limit and gaining.   

All this new TARP debt will be on top of $200 billion of new debt that was issued to buy Fannie/Freddie's preferred stock, plus the assumed risk for their $1.7 trillion of debt and $3.1 trillion of agency mortgage-backed securities.

It is also in addition to  the $85 billion 2-year credit line that Federal Reserve just extended to AIG, the $29 billion "non-recourse" loan provided for the Bear Stearns deal noted above; $63 billion of similar Federal Reserve lending to banks this year; $180 billion of newly-available Federal Reserve "reciprocal currency swap lines:" $5 billion of other emergency Treasury buybacks of mortgage-backed securities;  $12 billion of Treasury-funded FDIC losses on commercial bank failures this year (including IndyMac's record failure in July); perhaps another $455 billion of Federal Reserve loans already collateralized by very risky bank assets;  and the FDIC's request for up to $400 billion of Treasury-backed borrowings to handle  the many new bank failures yet to come.

There is also the record $486+ billion budget deficit  (net of $180 billion borrowed this year from Social Security trust fund) that the Bush Administration has compiled for 2008/09, drivem in part by the continued $12-$15 billion per month cost of the Iraq and Afghan Wars and the impact of the deepening recession on tax revenues. Longer term,  there is also the projected $1.7 trillion to $2.7 trillion "long run" cost of those wars (through 2017). 

All told, then, we're talking about borrowing at least another $1-1.4 trillion of federal debt to finance a record level of lousy banking.

COMPARED TO WHAT?

By comparison, Detroit's latest request for a mere $25 billion bailout looks miserly. And if we were in Vienna, we would say, "We wish we could play it on the piano!"

Compared to other bailouts, this is by far the largest ever.

For example, the total amount of debt relief provided to all Third World countries by the World Bank/IMF, export credit agencies, and foreign governments from 1970 to 2006 totaled just $334 billion ($2008), about 8 percent of all the loans. (Henry, 2007).

The savings and loan bailout in the late 1980s cost just $170 billion ($2008).

And the FDIC's 1984 bailout of Continental Illiinois, the largest bank failure up to this year, was (in $2008) just $8 billion (eventually reduced to $1.6 billion by asset recoveries).

Meanwhile, compared with other countries that are well on their way to building forward-looking "sovereign wealth funds" to make strategic investments all over the world, the US seems to be on a drive to create this introverted "sovereign toxic debt dump." 

CASH COST

No one has a very precise idea of how much all this will cost, not only because many of the securities are complex and thinly traded,  but also because their value depends to a great extent on the future of the US housing market. Housing prices  have already fallen by 20-32 percent in the top 20 markets since mid-2006, and they continue to fall in 11 out of 20  major markets, especially Florida,  southern California, and Arizona, where the roller-coaster has been the most steep.

At current T-bond rates (2-4 percent for 2-10 year bonds, the most likely maturities), near-term cash cost of this year's bailu is likely to be an extra $40 to $60 billion a year in interest payments alone. 

Furthermore, since the borrowed funds will be invested in high-risk assets, the most important potential costs involve  capital risk. There's a good chance that, as in the case of Bear Stearns, we'll ultimately get much less than $.50 for each $1 borrowed and invested. For example, Fannie and Freddie alone could easily be sitting on $500 billion of losses (=$2 trillion/$5.3 trillion* 50% default*50% asset recovery).

This could easily make the long-run cost of this bailout to taxpayers at least $150 billion a year.   

No wonder traders on the floor of the New York Stock Exchange reportedly broke out singing "the Internationale" when they heard about the bailout.

But the direct financial costs of the bailout are only the beginning....

HIJACKING THE FUTURE

Last week's events produced terabytes of erudite discussion by an army of Wall Street journalists, prophets and pundits about short-selling rules, "covered bonds," and the structure of the financial services.

This is absolutely par for the course, as modern financial crisis journalism is concerned -- the "story" is always told mainly from the standpoint of what's in it for the industry, the banks, the regulators, and the investors.   

For the 90 percent of Americans who own no money-market funds, and less than 15 percent of all stocks and bonds, however, this bailout means just one thing.

All of the money has just been spent.  And it has not been spent on you.

For example, unless we demand an increase in taxes on the rich, big banks, and  big corporations, as well as some public equity  in exchange for the use of all this money, we can expect that the long-term costs of this bailout will "crowd out" almost all of the $140 to $160 billion of new federal programs that Barack Obama proposed. It will certainly make it impossible for Obama to finance his programs without either borrowing even more heavily, or going well beyond the  tax increases (on oil companies and the upper middle classes) that he has proposed.

Without such changes, there will be no federal money available for comprehensive health insurance, or the reform of the health care delivery system.

There will be no additional funding for pre-school education, child care, or college tuition.

There will be no additional funding for investments in energy conservation, wind, or  solar power.

There will be no additional investments in national infrastructure (e.g., the reconstruction of our aging roads, highways, and bridges to "somewhere.")

Highway privatization and toll roads, here we come.

There will be no money to bail out the millions of Americans who are on the brink of losing their homes.

The supply of housing loans and other credit will remain tight, despite the bailout.

Indeed, if the economic elite has its way,  the long-sought dream of "a home for every middle-class American family" may be abandoned as a goal of government policy.

Meanwhile, the government-sponsored consolidation of the financial services industry will make financial services more profitable than ever.

This is good news for the "owners of the means of finance." For the rest of us, it means steeper fees and rates.  And if we fail to keep up with the new charges, we'll  face the rough justice delivered by the latest  bankruptcy "reform," which was rammed through the Congress in 2005 with support from many top Democrats.   

There will be no money to shore up the long-run drain on Social Security or Medicare.

Indeed, ironically enough, this latest bank bailout may even increase the financial pressure to privatize these comparatively successful government programs.

There will be no extra money to house our thousands of new homeless people,  relieve poverty, rebuild New Orleans, or support immigration reform.

There will be no additional funds for national parks.

Indeed, we might as well start  by privatizing our national and state parks, and drilling for oil and gas in the Arctic National Wildlife Refuge,  Yosemite,  the Grand Canyon, and right off the Santa Barbara coast. We're going to need those federal lease royalties. (Perhaps the oil barons will lend us an advance.) 

There will be no funds available for increased homeland security.

There will certainly be no "middle-class" tax cut.  Absent a progressive tax reform, the only "cut" the middle class is going to receive is another sharp reduction in  living standards.

TRUMPING REAGAN

All told, the Bush/Paulson "permissive banking/ massive bailout" model  beats even the old 1980s vintage Reagan formula, which tried to force government down-sizing with huge tax cuts. 

Contrary to the sales pitch, those cuts never produced any incremental tax revenues, let alone any significant down-sizing.  It has simply proved too easy for the federal government to borrow. And "conservatives" can always find wars, farm subsidies, defense contractors,  and "bridges to nowhere" to spend the money on, just as fast as liberals. 

Lately, however, it appears that US debt levels may indeed be reaching the point where they could impose a limit on increased spending.  Given the sheer size of the new federal debt obligations, foreign creditors,who have recently been supplying more than half of new Federal borrowing, have been muttering about taking their lending elsewhere. And outside the financial services industry, Main Street companies are concerned being "crowded out" by record federal borrowing.

THE ALTERNATIVE -- THE "GET REAL" NEW DEAL

To make sure that real economic reform is still feasible, we need to demand a "Get Real/ New Deal" from Congress right now. 

At a minimum, this Get Real/New Deal package should consider measures like: 

(1) The restoration of stiff progressive income and estate taxes on the top 1 percent of the population (with net incomes over $500,000 a year and estates over $5 million) -- especially on excessive CEO and hedge fund manager compensation;

(2) Much more aggressive enforcement and tougher penalties against big-ticket corporate and individual tax dodgers;

(3) Tougher regulation of financial institutions  -- possibly by a new agency that, unlike the US Federal Reserve, the SEC, and the US Treasury, is not "captive" to the industry;

(4) A crackdown on the offshore havens that have been used by leading banks, corporations,  and hedge funds to circumvent our securities and tax laws;

(5) The immediate revision of the punitive bankruptcy law that Congress enacted in 2005 at the behest of this now-bankrupt elite; and

(6) While we are at it, stiff "pro-green" luxury taxes on mega-mansions, private jets, Land Rovers, yachts, and all other energy-inefficient upscale toys. 

We also need (7) a National Commission to investigate the root causes of this financial crisis from top to bottom, and actually (unlike the hapless, ineffectual 9/11 Commission) hold people accountable.

Finaily, if the pubilc is going to provide so much of the risk capital for this restructuring, we should demand (8) public equity in the private financial institutions that receive so much of our help.

This will permit taxpayers to share in the upside of this restructuring, rather than just the downside risks.

Along the way, this will require that we explain to Secretary Paulson that this country is not Goldman Sachs. Even after 8 years of President Bush, this is still a democracy. 

Secretary Paulson is not going to be given unfettered discretion to hand out closet "liquidity injections" to his buddies on the street -- no matter how worthy they are. 

Over time, this progressive Real/ New Deal would help raise the hundreds of billions in new tax revenue needed to offset the costs of this bailout.

This will be essential, if the Federal Government is to be able to afford key reforms like health insurance, clean energy, and investments in education.

These may not matter very much to Wall Street executives, financial analysts, Treasury and Federal Reserve executives, or the more than 120-130 Members of Congress and 40-45 US Senators who earn more than $1 million a year -- and are already covered by a generous "national health care" package of their own design.

But these  are the key "systemic risks" that ordinary Americans face. 

These reforms may sound ambitious. So is the bailout.  And the reforms that we are discussing are only fair.

After all, we the American people have recently been the very model of forgiveness and understanding. 

We have tolerated and footed the bill for stolen elections,  highly-preventable terrorist attacks, gross mismanagement of "natural" disasters, prolonged, poorly conceived, costly wars, rampant high-level corruption, pervasive violations of the US Constitution,  and the systematic looting of the Treasury by politically-connected  defense contractors, oil companies, oligopolistic cable TV and telecommunications firms, hedge fund operators, big-ticket tax evaders, and our top classes in general.

Does "class" still matter in America?  You betcha -- perhaps more than ever. But enough is enough.  Call your Congressperson now. Demand a"Get Real/ New Deal" qualifier to the bailout package before it is too late. We deserve to get much more for our money. So do our kids.

(c) SubmergingMarkets, 2008

NARRATIVES, NOT IDEASMcCain's Contradictory, Fearful Vision of the Next Four YearsJames S. Henry

Outside the Republican convention hall, Twin City cops and National Guardsmen in full-scale battle gear were arresting credentialed journalists like Amy Goodman and pepper-spraying peaceful demonstrators -- though you didn't hear much about that from the respectable TV commentators who were safe inside, battling balloon drops.   

Inside the hall, we were treated to an odd combination of "Naughty Librarian" Gov. Sarah Palin, John McCain trying for the nth time to appear natural while reading the teleprompter and bashing his own party, and 2380 raucous Republican delegates -- 1.5 percent black, 5 percent Hispanic, 32 percent female,  80 percent over 50, and nearly 100 percent over-fed  -- trying to appear jubilant, grinding to the heavy-metal rhythms that someone in the RNC hierarchy must have thought were a cool idea.   

We also had yet another recapitulation of the Arizona Senator's horrific five years in a POW camp, after being shot down on his 23rd mission over Hanoi back in 1967.

Indeed, if McCain somehow manages to win this election, he will have no one more to thank than Nguyen Van Dai, the 68-year old retired  Vietnamese colonel who actually launched the SAM missile that downed McCain's A-4 Skyhawk on October 27, 1967.

In any case, after watching the Republican Convention from mind-numbing start to finish, it is now crystal clear that,  apart from McCain's 41-year-old combat narrative -- supplemented by the less familiar narrative about Palin's decade-long  battle to combine procreation, small-time government, and the Assembly of God's "Plan for Alaska" -- the Republican Party has become the equivalent of the US housing industry.

It is intellectually bankrupt, with almost no new ideas. As former Reagan speech writer Peggy Noonan correctly put it, "They went for this, excuse me, political bullshit about narratives."

Worse than that, the Republican Party has also turned its back on many of its old favorite best ideas and brand values -- for example,  "small government," "balanced budgets," "non-intervention," "environmental protection," and "the US Constitution."

Palin's first 15-minutes of fame temporarily blinded many commentators  to this basic fact.  But even the most faithful die-hard Republican strategists now agree that, apart from the novelty of her Bat Mitsvah,  this abbreviated convention was a gigantic, expensive messaging mess -- and, on balance,  a gift to the hapless Democrats -- who are otherwise still fully capable of losing this race, even with a full-scale political and economic gale at their backs.

We'll explore the numerous contradictions in McCain's program below.

(c) SubmergingMarkets, 2008

CONTRADICTIONS EVERYWHERE

I. CHANGE WE CAN BELIEVE IN?

Obviously McCain is trying to jump on the "party of change" bandwagon. This is hardly a strategic insight,  given overwhelming popular discontent with the "country's direction" and Obama's success with this theme.

On the level of practical policies, however, it is a little late. 

Indeed, it has really been McCain's policy team that has been doing most of the "changing." 

>For example,  McCain has adopted the idea, which he once opposed,  of extending Bush's tax cuts for corporations and the rich -- the $10 trillion long-run cost of which  is even larger than th $7 trillion that Bush's cost.

Even if we abolish all future Congressional "earmarks," this scheme would cause the US deficit to soar even higher than its record $500 billion current level.

If we have learned anything from the last eight years, it is that such tax cuts don't pay for themselves or reduce government spending; they just produce larger government deficits. 

>McCain's gone completely quiet on the constitutional issues of torture, closing Guantanamo, and illegal surveillance.

To some extent so has Obama. But these were supposed to be the kind of "vintage maverick" issues where McCain spoke truth to power.

>He's got nothing to offer on the deepening economic recession or the national housing crisis, beyond more of the same.

His close friend former Senator Phil Gramm has resigned as Co-Chair of the campaign, but he is still likely to be named McCain's Secretary of the Treasury. 

Yet he is a leading banking industry shill and an opponent of tougher regulation, whose efforts helped contribute to the lax lending policies that have produced the joint housing/banking crisis.

> McCain's ideas about privatizing education, health insurance, Medicare and Social Security are all warmed- over versions of the same proposals the Republicans have tried and failed to implement for over a decade, despite their control of Congress for much of this period.

Especially with the new, probably Democratic-controlled House and Senate, these proposals will be dead on arrival. We will not have "change," but four more years of stasis.

> McCain's only ideas for solving the energy crisis are (1) drilling offshore or in Alaska, and (2) building more nuclear power plants.

Regardless what one thinks of them, these two tactics would both take years to have any impact.

Even if they could overcome the substantial state and federal regulatory obstacles in their way,  they would not produce any additional energy for at least 10 to 12 years.

In contrast, conservation and alternative energy sources like wind and solar produce benefits very quickly.   

> McCain has nothing interesting to say about a whole host of pressing international economic issues, including the faltering WTO round, addressing global poverty, and reviving the global Kyoto accords on the environment.

>On the question of Iraq,  McCain still opposes the idea of a definite timetable for withdrawal, which even the Iraqi Government now supports.

> On the questions of Iran and Georgia, McCain has sounded even more aggressive than VP Cheney, who wisely did not even bother to attend his own Party's convention.

II. "ANTI-WASHINGTON?" 

At least since Barry Goldwater, the Republican Party simply can't get enough of portraying itself as "outside the Beltway," the underdog from the hinterland, and the victim of some vast liberal media conspiracy.

A visitor from another planet might be surprised to learn that  the Republican Party has actually won the White House 9 out of 16 times since 1948. And John McCain, in particular, has been a member of Congress since 1982.

Furthermore, it also controlled the US House of Representatives from 1996 to 2006, and the US Senate from 2000 to the present, with enough seats to prevent any Democratic initiatives.  It  has of course controlled the White House from 2000 to the present. Along the way, it has also taken control of the US Supreme Court and the leadership of key "independent"  federal agencies, like the Federal Reserve.

The Republican Party has also recently compiled a record number of convictions for illegal lobbying activities -- indeed, shortly before McCain was deliver his acceptance, the legendary White House intimate Jack Abramoff was receiving a four-year jail sentence for corruption and bribery. 

The only "change" we can be sure of will come when -- as now appears likely -- the Republican Party  loses control of all these institutions this November.

III.  A BIPARTISAN MAVERICK? 

As noted above,  McCain has actually become less and less of a maverick, and more and more partisan, as time goes by.

The night before his own address to the convention, his own VP candidate could not have been more partisan in her feral attacks on Obama.

Indeed, just by nominating this hard-right, anti-choice, anti-gay, anti-environment, anti-libertarian for VP despite her self-evident lack of credentials,  rather than choosing any number of more talented, moderate Republican women (or men), McCain has clearly helped to polarize the national debate.

This puts paid to all the rhetoric about bipartisanship in his acceptance speech.

IV. OPPOSED TO BIG BROTHER? 

We were amazed and delighted to hear Mitch Romney describe his party not only as "the party of ideas," but as being opposed to "Big Brother."   

It seems that Mitch should stick to pillaging troubled companies, his forte. Is he really not aware that it is the Bush Administration that has been conducting illegal wiretaps and e-mail surveillance on millions of Americans during the last six years?

V. NATIONAL SECURITY EXPERIENCE? WHERE'S OSAMA? 

 To listen to McCain, Bush, Giuliani, Romney, and Co., our visitor from another planet would probably conclude not only that 9/11 did  not happen on the Republican Party's watch, but also that the Iraq War was eminently justified -- indeed, in candidate Palin's memorable words, it is "a task from God".

According to the rhetoric at the Republican convention, the war against Osama Bin Laden and  the Taleban in Afghanistan and Pakistan (remember them?  the original perpetrators of 9/11?)  must also be going so well that we can:

(1) Afford not to mention Osama or Afghanistan at all;

(2) Afford to extend NATO to Georgia and the Ukraine, right on Russia's borders;

(3) Afford to call Iran "the biggest supporter of state terrorism," and threaten it  with military force! 

When it comes to national security, Republicans do have this praiseworthy tendency to recall over and over again great moments of courage and honor that occurred long ago -- say 41 years ago.

But when it comes to all the shameful events that have happened on their own watch in just the last eight years,  they become forgetful.

In my experience, Republicans are systematically incapable of apologizing for anything, even when they are grossly in the wrong.  Indeed, that is a pretty good litmus test for a Republican.

>Lest we forget, Osama bin Laden, still safely ensconced in Pakistan (our putative ally), was the author of 9/11. Next week we'll commemorate the 7th anniversary of that date -- why has he not been brought to justice in seven years?

> Lest we forget,   it was the Bush Administration -- especially Condi Rice and George Tenet -- that ignored numerous signals that allowed 9/11 to happen.

> Lest we forget, Mayor Giuliani was the genius who located the World Trade Center's  emergency command post right across from the Twin Towers with a diesel fuel tank (even though they'd been an obvious target since at least 1993),  ordered the cheap Motorola radios for NYC first- responders, and recommended the mobbed-up former Police Commissioner Bernard B. Kerik to be head of the Department of Homeland Security. 

>Lest we forget, it was the Bush Administration -- with the so-called "maverick/military expert" John McCain toeing the party line, unlike Obama -- that took us to war in Iraq on a pack of lies.

Lest we forget, it was the Bush Administration that, once we got there, completely mismanaged the war effort -- for example, by choosing Kissinger protege  L. Paul Bremer to administer the situation.

Bremer's very first decision was to disband the Iraqi Army -- alienating all those thousands of Sunnis who have recently become our best friends in the "Awakening,"  and setting the stage for Al Qaeda's first real entry into the country -- on US coat-tails!

THE IRAQ/ AFGHAN CONUNDRUM

Finally, returning once more to the question of Iraq, it seems as if the Republican Party is trying to pull off the same game it played with 9/11.

Rather than talking about responsibility for the original fiasco, the Republicans want to focus on claiming credit for what transpired after the event. 

In the case of 9/11, they took credit for managing the crisis after the attack, ignoring their utter mismanagement before.

In the case of Iraq, they are even more cynical:  McCain and the Republicans like to take credit for the progress since January 2007, ignoring the nearly four years of disastrous management after the March 2003 invasion.   

In this spirit, McCain also likes to talk about the "surge" a lot, which he claims is a big success. 

The surge was not his idea, but he takes credit for having supported it ever since General Petraeus and President Bush first introduced it in early 2007. 

Obama, he says,  opposed it,  preferring a timetable that  would have "lost the war."

In fact Obama has never insisted on such any such timetable.

He did, however, courageously oppose entering Iraq in the first place, which would have made the surge unnecessary.

In retrospect,  Obama's fundamental political and military judgment looks pretty astute, compared with "experienced" McCain.

If Obama had been in charge, we might have saved $2 trillion and thousands of young lives.

On the other hand, in McCain's case, despite saying that he "hates war," he has yet to ever oppose one.

He still actually believes, like George W. Bush, that the US made a terrible mistake by withdrawing from Vietnam in 1973! 

True, if we'd followed Obama's course, Saddam & Co. might still be in power, just like Kim Jong Il or Robert Mugabe or the tyrants in Burma (and China!)   

But Saddam would not have any more "weapons of mass destruction" than he ever had. Under the pressures of continued isolation, backed by the UN, his own people might have overthrown him, or he might have died of a heart attack. We can never say.

What is clear is that the main reason that the surge has "worked" is that we are now working closely with many of Saddam's former supporters among the Sunni "Awakening," who have turned on al Qaeda.

The Sunnis have "awakened" partly just because we finally decided to pay them, and partly because they got sick of being ordered around by these fanatical extremists -- who'd never taken root in Iraq before the US invaded the country, outraged the local population, and created a seedbed for insurgency.

It is also because many Shiites have wisely decided that the fastest way to get the US out of Iraq is to quiet down, supporting the Maliki government, probably with the backing of Iran.

Ironically, for someone so concerned about Iran's supposed threat to the region, McCain does not acknowledge the fact that the Iraq invasion, and the continued US presence there,  have only strengthened Iran's hand.

So it is as misleading for McCain and the Republicans to take credit for the surge as it is for them to take credit for fighting the (very incomplete) war against al Qaeda and the Taleban in Afghanistan, in the wake of 9/11.

Once again, however, if you have no original ideas or solutions of your own, it is tempting to concentrate on telling stories about the past.

(c) SubmergingMarkets, 2008

OBAMA: "PALIN/MCCAIN HAVE NOTHING TO OFFER BUT PERSONAL ATTACKS"