WatchingTheHerd

The Republican Bloc Heads Debate

2012-01-23T22:01:00.003-06:00

The January 23 Republican debate in Tampa certainly was enlightening, but probably not in a way the attendees intended.

Newt Gingrich mentioned he formed four small businesses after leaving the House. Bagging million dollar consulting fees by trading on your prior political connections isn't creating a small business, it's about cashing in on your eagerness to trade (perceived) influence for cash. How many small businesses routinely fly on private jets? How many routinely spend $6.6 million in travel charged to a tax-exempt organization, including $74,000 for one trip that coincidentally included stops for promoting one's personal business interests? NBC covered this story on tonight's evening news. Ouch.

Newt continues showing up to debates playing the knowledgeable historian and professor role. I'm surprised he didn't show up to the debate with a plaid sport coat with suede elbow patches smoking a pipe. Playing the know-it-all professor seems like a bound-to-fail electoral strategy. The Republican base still up for grabs that can't stand Romney prides itself on rejecting "intellectuals" and independent voters in any general election will turn corrections of Gingrich history into a drinking game. It only took ten minutes -- the time it took moderator Brian Williams to finally pose a question to Ron Paul -- for the first Newt History Revision to come up. Ron Paul reminded the audience that Newt didn't surrender his Speaker position as an act of self-awareness and taking responsibility for a party shellacking in the polls -- a claim Newt made ten minutes prior. Instead, Newt surrendered the gavel because he didn't even have enough votes to enter the Republican caucus room to ask for a chance to keep it. He left his caucus in chaos and was DESPISED by his colleagues.

In explaining his re-election loss in 2008, Rick Santorum recited his pride at going down with his principles and standing with then-President Bush with a 35 percent approval rating as he fought to privatize Social Security. I'm not sure expressing pride in plans for funneling Social Security contributions into a corrupt financial system after the experience of the 2008 meltdown is a wise political strategy.

No tax return surprises are coming, according to Romney. And by golly, has Mitt got a deal for all of us hard working Americans. He outlined a bold proposal to eliminate taxes on interest and capital gains for "middle class" voters earning under $200,000. Let's stop for a moment to analyze the cynicism behind that bold proposal. Due to Federal Reserve policies, banks have been paying less than one percent on deposits for over three years and that is not likely to change for quite a while. At the same time, the average American has a total net worth of less than sixty thousand dollars so average yearly capital gains income for most households is clearly far less than $60,000. In essence, Romney's bold new proposal is more of the same tax policy slight of hand we already have, promising average taxpayers the illusion of savings that are actually worthless in exchange for ignoring absurdly low taxation on the wealthy who earn millions per year that is taxed at favored capital gains rates.

In one of the few questions posed to Rick Santorum, he managed to make an appropriate follow-up point regarding the Romney / Gingrich tussle over Bain Capital and "destructive capitalism." His point was that any such "debate" completely misses the real point regarding why Gingrich and Romney supported the bailout of Wall Street in 2008 rather than making those firms and their shareholders take those losses and re-capitalize by selling new shares. Of course, what Santorum didn't mention was how properly funding the SEC and other financial regulatory bodies might have prevented the abuses that led to Enron, Worldcom, Countrywide, AIG and the other leveraged meltdowns.

At some point, Romney managed to goad Gingrich into taking credit for actively, publicly supporting Medicare Part D in 2003, a GIGANTIC expansion of government spending enacted by a Republican majority that lied to its own members about the costs and altered voting rules to twist enough arms to assure passage. That's sure to turn up in future primary campaign ads to tarnish Newt's "conservative" small government credentials.

When asked the "Iran question", Santorum stated that the "Obama policy" has been a complete disaster. Santorum never really summarized his view of what the "Obama policy is" but went on to say the theocracy that rules Iran is like Al Qaeda -- they have taken hostages, they have hatched plans to kill the Saudi Arabian ambassador, they have funded the manufacturing of IEDs killing American troops in Iraq. Lost in Santorum's laundry list is the fact that Iran has been doing this for many years, predating the Obama Administration. Why was Santorum proudly standing by GW Bush and his 35% approval rating when Bush was doing nothing to combat Iran's behavior between 2003 and 2008? Why didn't he point out in 2004 how our disastrous war in Iraq had arguably doubled the strength of Iran's Shia influence in the entire Mideast? Nothing done by a Republican is "good", the same "nothing" done by a Democrat is "disastrous"?

Romney is now tackling Obama's failure in space policy that has crippled the Space Coast. Has Mitt come out with a plan to replace the Space Shuttle? What other program is Mitt suggesting we cut to fund more manned space flight? He believes the right approach is for the President to have a policy and a strategy in collaboration with the military, scientific and educational institutions. Uh..... WHAT? Gingrich followed up with his own "big idea" -- PRIZES. Prizes for what? First spaceship to the moon with in-dash 8-track wins ten million dollars?

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The real lesson to learn from the Tampa debate and South Carolina primary is the fact that the "Republican Party" exists in name only. It has fragmented into at least four financial, social and philosophical blocs whose logical tenets are almost mutually exclusive. More importantly, those blocs are occupied by actual people who DESPISE each other and thus refuse to cooperate productively with each other much less anyone else. The fiscal fundies cannot be satisfied by the pragmatists, the pragmatists don't trust the libertarians, and none of the groups are morally uptight enough to satisfy the religious fundies.

For Republican pragmatists, it really should be gut check time. The party framework in which you are trying to function is incapable of providing an effective and productive counterbalance to whatever you might object to on the liberal side of the spectrum. Stopping the other guys isn't good enough when the country is stuck on the tracks with an approaching train if your own party intransigence prevents any movement off the tracks as well.

Lost in the Venture / Vulture Debate

2012-01-15T20:39:00.004-06:00

As the Republican race for the 2012 nomination rapidly shifts from a battle between the improbables to a grudge match against the inevitable, one piece of economic jargon became fodder for two weeks of political theatre. In the process, the media had a chance to get into peak campaign shape by devoting even more hours of time covering the mudslinging and the spin of the mudslinging rather than examining the economic and social issues underneath the mud.

The Debate as Presented

The political and media debates of course focused on the relative degree of sainthood eligibility between those playing the role of "venture capitalist" versus "vulture capitalist" in the true American religion of capitalism. In one corner, Republican inevitable Mitt Romney presented his background as founder and long-serving CEO of Bain Capital as the ultimate qualification of someone who knows what government should do to foster job creation in a struggling economy. For months, Romney made claims of over one hundred thousand jobs being created as a direct consequence of the investments his firm made in a variety of companies.

In the other corner were Rick Perry and Newt Gingrich -- with presumably some of the other improbables crouching in the shadows, too afraid to offend their current political backers to enter the fray -- casting doubts upon Romney's actual job creation record and casting his role at Bain as a "vulture capitalist". Perry was the first to use the vulture term on the stump but, lacking any real momentum, it was up to Gingrich -- still smarting from a PAC funded stomping applied by Romney in Iowa -- to reverse his own "positive campaign" ethos and return fire on the Romney record. Gingrich's primary focus is on Romney's posturing as a conservative versus Gingrich's categorization of Romney as a typical "Massachusetts moderate" but had PAC ads aired to support Gingrich which dramatized some of the failures of the turnarounds attempted by Bain Capital.

After only two weeks of this "venture versus vulture" boxing match in the ring of the Republican primary process, lots of punches have been landed and both camps are likely to suffer some long lasting cuts and bruises, but -- true to form in the current political climate -- neither camp laid a glove on the real issues. More directly, it seems pretty clear that Rick Perry doesn't understand the true mechanics of a capitalist system and Newt Gingrich does understand the difference, but is more focused on settling his own score.

Capitalism, Creativity and Creative Destruction

The debate over the value of "venture capitalists" versus "vulture capitalists" makes about as much sense as arguing over whether sharks are good or bad. Unless you happen to be swimming off the coast of Nantucket while ominous cellos sounds are heard in the background, sharks aren't "good" or "bad" -- sharks just ARE. They are one small part of an extremely complex ecosystem and have evolved over time to fill a particular role in that ecosystem.

Capitalism as a theory of economic organization is akin to the theory of evolution in the biological world. Entities that efficiently use resources available to them can do more with less, allowing that competitive advantage to improve their own immediate situation but also the long term situation of the larger economy. Entities that use resources inefficiently or fail to react to changes in their economic environment will become vulnerable to "disruptions" that can weaken their position in the economy or wipe them out entirely.

Unlike evolution in the biological world, which relies both upon accidental changes to DNA and occasional freak changes in the environment to set a direction, evolution in a capitalist environment depends solely upon human creativity. "Venture capitalists" play a crucial role in supporting that creativity by providing funding that supports new technologies and business models that might provide exponential improvements over current products, Of course, incumbent entities providing current generation products and services have two choices when faced with such competition --- assume the competition might be on to something and investigate alternatives themselves or "focus on their knitting" and assume the competition lacks a viable combination of resources and know-how to pose any threat.

Venture capitalists make money by combining some expertise with the current state of the art (knowing where weakness to exploit might exist) along with expertise in upstart technologies that someone busy "sticking to their knitting" might be too busy to learn or appreciate. Of course, there are cases where some venture capitalists have so many resources at their disposal, they can afford to flat-out gamble on some new idea, without any detail analysis of probabilities or payoffs.

So-called "vulture capitalists" or private equity investors play a distinctly different role in economic evolution. Anyone who works in Corporate America knows how success breeds size which breeds hierarchy which breeds turf which breeds infighting which breeds enormous barriers to communications. These barriers seem particularly effective at slowing or completely blocking any communication involving the emperor's clothing or lack thereof. The human barriers to communication are compounded by technologies changing so fast that the expertise of many executives regarding core technologies used in their business is easily ten to fifteen years out of date. There are thousands of pages of articles in the Harvard Business Review over decades of time devoted to analyzing the defective decision making in companies which ignore signs of a sea-change in their competitive landscape at their peril and the peril of their investors, employees, customers and suppliers.

If one truly believes in the religion of capitalism, one has to believe that one of its cardinal sins is the mis-allocation of limited resources, Those limited resources might be raw materials, know-how or just time spent at work. Private equity investors exist to cut through management paralysis and incompetence that ROUTINELY leave companies drifting towards icebergs that everyone but local management can spot miles away. If management is squandering resources or failing to invest appropriately in an otherwise viable business and poisoning the firm's brand in the process, outside investors who understand those problems and have access to sufficient capital can buy control of the firm. With control, they can either make changes to management that eliminate the problem or provide enough of a cash infusion to improve the company's cost structure to compete more efficiently and get back into the race.

Of course, one technique applied by private equity investors is to only front enough money to gain control of a firm, then use that control to leverage the firm under its own signature even further. This is the business equivalent of having someone sidle up to you at the roulette wheel, toss in an additional $100 chip on your stack but telling the house you're in for another $10,000 then picking your number. When they bet on the right number, everyone's happy. When they're wrong, the damage is not equally distributed.

Private equity investors also serve another vital role in capitalism. For all of the same reasons that prevent management from reacting to obvious threats or opportunities, managers are also notorious for failing to recognize the end of the line. If PowerPoint had existed in 1915, I'm certain the PowerPoint from the sales team at Acme Buggy Whips pointed to nothing but smooth sailing ahead, even though Henry Ford had been selling Model Ts for seven years at that point. If Acme Buggy Whips had been gradually reducing its labor and management staffs as the buggy whip market declined, no one would have a problem with management. If instead its executives reacted to a decline in buggy whip sales by investing in new automated buggy whip making gear, outside investors might be able to "profit" by stopping such an ill-timed "investment" and simply preserving current profitability. If Acme Buggy Whips instead just stood pat with 200,000 square feet of manufacturing space occupied with buggy whip makers that could have been filled with equipment making carburetors for Model Ts at twice the margin, outside investors have a definite interest in trying to work with management (or take it over) and select a more profitable use of that capital.

The private equity industry itself exists because enough people with enough money believe they possess the insight needed to

* identify under-performing businesses
* identity a sub-set of under-performers available at a discount to their already dangerous position
* identify a sub-set of that set where investors actually understand what needs to be fixed

It also exists because these same people realize these opportunities never stop arriving. The same management mistakes are made over and over by new generations of executives who may be too immersed in the day-to-day decision making of their existing business to see the patterns that outsiders see from looking at dozens / hundreds of companies across multiple industries. Equally important, the industry exists because there are many people who made a lot of money doing something else and think they understand WHY they made that money and how to apply that know-how elsewhere. They may or may not be correct in that assumption.

In other words, the private equity industry isn't "good" or "bad" --- it just IS. Its existence is an inevitable consequence of a capitalist system bent on "efficiency" and the most effective allocation of capital while being operated by fallible humans with different ideas and motivations.

What IS Worth Debating?

So if calling Mitt Romney a "vulture capitalist" is about as productive as diving into the water and attempting to shame a shark ---- "BAD shark!" -- what WOULD be productive to debate in a discussion about entrepreneurialism, economic efficiency and job creation?

Why not debate the crippling effects of an understaffed patent office and outdated framework of patent law on innovation? America's patent system was created to optimize the tradeoff between allowing inventors to profit from their ideas for some period of time -- thereby encouraging more innovation -- while also ensuring those same ideas are fed into the larger economy for re-use and further invention -- thereby producing MORE innovation. The system only works when the balance between the window of exclusivity for the inventor and the release of that idea into the larger economy is just right and when the invention itself is actually worthy of protection.

All patent law in the US hinges around key criteria involving the novelty (has someone done this before?), utility (come on, does this do anything USEFUL?) and non-obviousness (could someone with average skills in the field have devised this by extrapolating "prior art"?) of the proposed invention. It's the third category -- non-obvious -- that's melting down businesses of all sizes. Did you know that a cell phone maker who wants to show a picture of the caller when their calling party number arrives has to LICENSE that capability? Sony owns a patent on that "technology." (Google patent # 5907604). The patent was filed on March 25, 1997 and issued May 25, 1999.

At the time this patent was filed, approximately 300 million Americans were already familiar with a different land-line telephone feature that displayed one piece of information (a caller's name) based upon another piece of information (the caller's 10-digit number). That "technology", better known as "Calling Name Delivery" pre-dates this patent filing by at least six years, when telephone companies began deploying SS7 in the early 1990s. That technology has an international patent trail dating back to 1969 in Greece. So how does mapping a picture to a telephone number qualify as "non-obvious" when it is identical in concept to the prior art?

It doesn't. The USPTO should have rejected the patent but didn't. Sony wound up owning the patent and has sued other cell phone makers for infringement, tying up millions of dollars in multiple companies and doing nothing to improve service, reduce costs or otherwise enrich anyone in the economy except the patent holder and an army of lawyers. This is happening ALL THE TIME in the technology field because "algorithms" can be patented and the USPTO cannot keep up with the pace of innovation. The results of this LACK of proper government regulation are ANYTHING but "pro-business":

* companies filing bogus patent claims to bolster their reputations for "innovation"
* companies filing "defensive" patent applications to avoid someone else from capturing the bogus patent
* companies filing "strategic" patent applications to guard their turf from encroachments by startups
* companies ("patent trolls") purchasing existing bogus patents as "intellectual property" then going on lawsuit sprees hoping settlement will be more attractive than litigation for defendants
* hundreds of small and large companies spending MILLIONS of dollars fending off bogus infringement lawsuits

None of the above do anything to foster a healthy economy or support entrepreneurs developing truly innovative technologies that can form the basis of tomorrow's job creating industries.

Why not debate the abuse of bankruptcy law within the realm of "private equity" takeovers and discuss how changes to the priority / standing of different creditors of a firm in bankruptcy have actually ENCOURAGED private equity investors to OVERBID for firms and borrow the money to do so? The net effect in many cases has been to shift those second-round bondholders ahead of prior creditors including PENSION OBLIGATIONS, shifting under-funded pension obligations from private investors to the public via the Pension Benefit Guaranty Corporation. That's not an efficient use of private sector capital and it's absolutely not productive public policy to privatize profits in private equity deals while shifting losses to taxpayers.

Why not debate the treatment of profits earned by private equity firms and their owners as capital gains with significantly lower tax rates? As stated above, no one is saying private equity investors shouldn't exist or aren't serving a useful function in the economic system. However, there's nothing in the religion of capitalism that puts private equity investors AHEAD of other players in the system in the sainthood pecking order. Why should our bankruptcy law and tax system?

There's no shortage of legitimate topics to debate regarding capitalism, job creation and tax policy. There's only a shortage of politicians able to debate those issues -- and possibly a shortage of citizens, taxpayers and voters willing to listen.

The Republican Crazy Train Tackles Foreign Policy

2011-11-13T19:59:00.002-06:00

All of the Republican candidates for President spent the week of 10/7 preparing for a debate in South Carolina focusing on foreign policy. With a few exceptions, the sense of logic and subtlety conveyed by the candidates' answers would be comical if the subject matter didn't involve issues already addressed with the same flawed logic that have cost the United States trillions of dollars over the past twelve years.

A play-by-play analysis of the questions and answers in the so-called "Commander-in-Chief" debate has a very short shelf-life. The details can be read in their entirety at:

http://www.cbsnews.com/8301-505103_162-57323734/cbs-news-nj-debate-transcript-part-1/
http://www.cbsnews.com/8301-505103_162-57323734/cbs-news-nj-debate-transcript-part-2/

It's more useful to organize the insights offered by the candidates into a few key themes -- themes that will come up repeatedly throughout the campaign.

Listening to the Generals -- Principle or Dodge?

Ahhhhh, an oldie but a goodie. This one has become quite popular with novice Presidential candidates in both parties over the past four elections. After the disaster of Vietnam, a certain segment of the political class and voting public came to the conclusion that we lost the war in Vietnam because a bunch of meddling politicians "held back" somehow and didn't leave the battle to the professionals -- the generals. If only we had the manhood to stick it out dumping more tons of bombs on Vietnam, Cambodia and Laos, we would have emerged with our honor intact and another check in the Win column -- completely ignoring the fact that America dropped more bombs on Vietnam (6.7 million tons) than we did during World War II (3.3 million tons).

After fifteen years of relative military timidity, the US became more inclined towards action in the early 1990s using the so-called Powell Doctrine as a proxy for serious thought about when, why and how to deploy military force. Among other things, the Powell Doctrine states force should only be deployed if

a) an obvious national security interest is involved
b) a clear objective is identified and stated
c) a clear exit strategy is defined with objective criteria for executing that exit strategy
d) the country is willing to go all out in the effort
e) every other non-military solution has been tried

These bullets all sound logical but in reality, the Powell Doctrine has NOT been followed. Instead, it has been used to short circuit the analysis process within the government and military and sell poorly thought out missions to the public with a bizarre form of mental jujitsu that allows the Commander in Chief to state as a given that all of the criteria of the Doctrine have been met -- hence this press conference or address outlining the grim choice to the public -- and the very nature of the undesirable action being proposed must mean it is the correct action to take, knowing a politician could never hoodwink voters into a war by making it sound like a cakewalk. After the strategic mistake takes flight, that same jujitsu is used to reinforce the same flawed thinking and continue the mistake. Rather than wuss out, I need to "man up" and continue accepting a variety of difficult choices presented by my military, thus proving I'm capable of making the "tough choices."

For a novice running for President, the "listen to the generals" line is a perfect dodge from answering more pertinent questions about prioritizing resources between guns and butter. Of course, Herman Cain was among those to use the "listen to the generals" dodge in the debate in his responses to questions about the efforts in Afghanistan and Iraq. Saying you'd "listen to the generals" about when to withdraw from Iraq rather than declaring a timetable for doing so overlooks the following facts:

* Iraq refused to renew Status of Forces rules that would exempt American soldiers from criminal prosecution
* a continued presence in Iraq is not improving security on the ground
* a continued presence in Iraq is continuing to reduce troop readiness and supply readiness
* the American people no longer support a continued presence in Iraq
* the American people are clearly unwilling to pay taxes to PAY for a continued presence in Iraq
* the resulting debt from the war has helped to cripple our economy and long term fiscal health

Rick Santorum offered his own frightening twist on listening to the experts in response to a question about the leadership style he would implement as President. His response:

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Well, I'll come into-- to the office of the presidency with a very clear agenda. And we'll-- I'll get people together that will share my point of view. When I was in the United States Senate, I didn't hire people who didn't share how I approach the problem. That's what the people of this country are electing. They're electing someone who's gonna be very crystal clear. And as you heard from my first two answers, I don't mince words. I say exactly what I believe.

And then I follow through and do what I say. I did that when I was in public life before, even though I represented a state that wasn't particularly conservative state. I followed through and did that. And I will surround myself with people who will execute what I promise the American public to do. And then we will go about the process of doing it.
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That might be the single most frightening answer of the entire debate -- and that's saying something. Santorum is basically guaranteeing the American public he will lock himself in the White House surrounded by people who think EXACTLY like him on everything and that he and his team will proceed post haste, hellbent and unflinching, towards the direction he believes voters set by voting for him, any subsequent facts or changes in circumstances after the election be damned. Is this really someone you want within ten miles of the Situation Room or the national checkbook?

Torture Tactics and Tortured Logic

The November 12 debate also raised an interesting parallel to the "listen to the generals" dodge when the topic of torture was discussed. Support or opposition to waterboarding was first posed as a question to Herman Cain who promptly, unambiguously stated he does not support torture --- "Period" -- He said he supports the policies established by our military and would trust the judgement of our military leaders about what constitutes torture. He then promptly stated that he doesn't believe waterboarding constitutes torture and that he would re-instate it as an option. Again, an interesting contradiction to the "listen to the generals" principle, given that the practice was forbidden by the Army Field Manual and was not used by the US military until it was reintroduced by the CIA in Iraq and other black sites under cover of a flawed legal opinion manufactured during the Bush Administration by John Yoo and the DOJ's Office of Legal Counsel AGAINST the guidance provided by the military.

The same question was posed to Michelle Bachman who also stated her unambiguous support for the reinstatement of waterboarding as a legal tactic on the battlefield and elsewhere. Bachmann cites her short tenure on the House Select Committee on Intelligence as one of her foreign policy bona fides but a) wasn't on the committee at the time key decisions were reviewed for major terrorist actors and b) has not apparently considered a huge volume of analysis and reporting from people like Mark Bowden (see #1 for How to Break a Terrorist), Jane Mayer (see #2 for The Dark Side) and former FBI interrogator Ali Soufan (see #3) that shows torture not only failed to deliver actionable intelligence that thwarted attacks but it actually DELAYED and sometimes STOPPED progress that was being made with traditional legal tactics.

Bachmann followed up the debate and her tough-as-nails posturing on torture with an appearance on Meet The Press November 13. Despite a lead-in question from David Gregory stating that her support of waterboarding is in conflict with not only the current head of the CIA, David Petraeus, and tortured POW and former Republican Presidential candidate John McCain but the majority of the Pentagon brass as well, Bachman doubled down on the crazy by stating that taking waterboarding off the table essentially publishes our practices to the enemy, allowing them to train in advance for possible conditions if eventually captured and weakening our ability to capture battlefield intelligence. The only public figure Bachman could cite in support of her position? Dick Cheney.

The only two candidates who demonstrated the presence of any brain cells or a moral conscience were Jon Hunstman and Ron Paul, who both categorically rejected the use of torture in general and waterboarding in particular as ineffective, immoral and un-American.

Fighting a Trade War or Cold War with China

With the exception of some thoughtful caveats from Jon Huntsman, the Republican toolkit for dealing the numerous problems between the United States and China boils down to only two choices --- a trade war or a cold war. Rick Perry attempted to throw the gauntlet down and make a big sound bite splash by saying we need to declare that China will end up on the ash heap of history, as Ronald Reagan stated about the Soviet Union.

Really? That line might work in a 1980s context of cold war between two nuclear powers that had been fighting proxy wars against each other for 30 years. It makes far less sense as a strategy for managing a relationship with a country whose power and influence has grown in direct response to policies and spending by the American government and thousands of individual outsourcing and manufacturing decisions made by Corporate America. How exactly does Romney expect to bury a country on the ash heap of history that has lent our government $1.16 trillion? (#4)

If the Republican Party truly thinks the solution to the "China problem" is "burying" a country with 1.33 billion people on the "ash heap of history," they have a spectacular lack of perception of what's currently happening and a spectacular lack of imagination for alternatives. Why did no candidate speak of reviewing tax rules that might be treating construction of a plant in China with equal benefits as construction of a plant in America? Why did no one mention an effort to support groups within China fighting for improved working conditions and environment regulations -- changes that would drastically weaken the cost advantage China enjoys over US manufacturing because it can still treat workers in iPod and computer factories as mere one-in-1.33-billion disposable units of production?

Foreign Aid and Fits of Pique

Any discussion of foreign aid in a political context has to start by understanding why the issue is coming up and the assumptions made before the discussion even begins. Most American voters think the US spends more on foreign aid than defense. If asked, most Americans think foreign aid spending should be around ten percent of the budget -- an amount approximately TEN TIMES current actual spending. (see #5)

Spending on foreign aid can provide short term and long term benefits in a few key areas:

* providing tactical, short term relief for disaster recovery from floods, earthquakes, etc.
* providing resources to avoid or at least minimize human-led disasters from genocide or famine
* establishing contacts with people below the top tier of a government, providing crucial insight into a country's economic and political power structure

Rick Perry has a vastly different view of the purpose of foreign aid. Based on his comment in the debate, Perry views foreign aid as a major budget savings candidate (it's not) and a form of yearly scorecard keeping by which the United States can punish or reward our friends and allies based upon their behavior and the political trade winds within our election cycle. Perry stated he would zero-base the aid budget for every country every year. While neither debate moderator had the sense to pose a follow-up question about the practical implications, an online viewer did, asking "Would you zero-base Israel's budget too?" Perry immediately recognized the political twilight zone he had fallen into and stated Israel would be zero-based like everyone else but that he assumed they would continue to enjoy a substantial yearly aid budget.

Miscellaneous Head Scratchers

The debate offered a healthy dose of one liners that raise additional questions that best fit thematically under the general category of "Huh?"

The candidates were asked to identify actions they would take that have not been taken by the Obama Administration in response to the conduct of Iran and Pakistan. Newt Gingrich drew an analogy to some sort of top-secret triumvirate between Ronald Reagan, Margaret Thatcher and Pope John Paul II that resulted in the collapse of the Soviet Union and said he'd pursue similar partnerships against Iran. Swallowing the whole Reagan/Thatcher/Pope anti-communist Axis theory as a given, it would then appear that high on Newt's "to do" list upon entering the Oval Office would be "elect Iranian Pope" and "make Catholicism wildly popular in Tehran." I guess the devils are in the details.

Cain and Santorum appeared confused about whether Pakistan was or was not a key ally of the United States. Cain stated it wasn't clear. Santorum stated Pakistan MUST be an ally -- they are a nuclear power. Both seemed to grasp the difficulty of managing a relationship with a country whose geography is strategic but whose internal politics and social divisions prevent their conduct and our response from being neatly categorized into nice boxes. However, Cain and Santorum were either unable to correctly assemble the language to describe those nuances and shades of gray or were unwilling to use such language in front of an audience demanding simple black and white / good or bad answers. Either way, not an inspiring performance. By the way, for future reference, the correct answer to the question would be:

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Pakistan is a country we have treated as a political and military ally whose actual conduct since 1997 has materially harmed its own interests and those of the United States. Pakistan has been attempting to balance the power of moderates and extremists by working with America while still actively supporting Islamic terrorists and would-be nuclear powers by selling nuclear technology to countries like North Korea, China, Iran, Libya and Iraq. America must structure any aid and military support to Pakistan in ways which provide complete transparency to ensure those resources aid moderation in the country and can never be diverted to extremist factions within the country fighting American goals throughout the world.
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Rick Perry was stumped by what should have been an OBVIOUS follow-up question to his debate gaffe earlier in the week and his failure to remember "Department of Energy" as the third target of his cost cutting in the Cabinet. When asked how he would manage the country's nuclear weapons stockpile and program after eliminating the DOE, Perry immediately pivoted towards answering a prior question to another candidate. Either Perry didn't realize that DOE manages the nuclear arsenal and its development or he didn't realize entire departments of the government cannot be eliminated with the stroke of a pen without ensuring continuation of crucial obligations. Come to think of it, with Perry, that's not an "or" scenario.

At one point in the debate, the candidates discussed the merits and legality of killing American citizens acting abroad against America. After a few responses, the net Republican response appeared to converge upon the idea that a person, US citizen or not, acting abroad essentially in a theatre of war against American forces is essentially outside US criminal law and is essentially at war against America and can be taken out. That seems to be exactly the conclusion reached by the Obama Administration which approved a drone attack on September 30, 2011 that targeted and killed Anwar Al-Awlaki and wound up killing Samir Khan who was traveling with him. The two were leading bombing and propaganda efforts for al-Qaeda in Yemen. So much for policy contrast.

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#1) http://watchingtheherd.blogspot.com/2007/04/how-to-break-terrorist.html

#2) http://watchingtheherd.blogspot.com/2008/10/book-review-dark-side.html

#3) http://www.telegraph.co.uk/comment/8833108/Torture-is-not-wrong-it-just-doesnt-work-says-former-interrogator.html

#4) http://www.nytimes.com/imagepages/2011/07/19/business/2110719_yuan_graphic.html

#5) http://www.washingtonpost.com/opinions/five-myths-about-foreign-aid/2011/04/25/AF00z05E_story.html

Gingrich and Cain on the Vital Issues

2011-10-09T21:29:00.005-05:00

Herman Cain and Newt Gingrich appeared on Face the Nation October 9, 2011 (see #1) to tackle three vital issues affecting the future of every American over the next five years:

* Can Mormons be considered sufficiently Christian to a bunch of religious fundamentalists in Dallas, Texas?
* Why are a bunch of economically under-achieving ingrates making it difficult for the people on Wall Street to get to work so they can create more jobs?
* Are subpoenas for federal judges issuing rulings I don't like the best way to get rulings I like?

Let's see how they did.

My Religion's Older Than Yours

The first round of questions involved recent comments about Mormonism versus Christianity and each discipline's proper place on the sliding scale between "cult" and "legitimate faith".

Schieffer: Do you think that Mitt Romney is a Christian?

Gingrich: I think he's a Mormon and Mormons define themselves as a branch of Christianity.

Schieffer: Do you think Mormons are Christians?

Cain: I believe that they believe that they're Christians based on their definition but getting into whether or not they're more Christian than another group, I don't think that's relevant to this campaign.

Both attempted to put the politically correct number of rhetorical miles between themselves and the inflammatory comments of the leader of one religious sect about the beliefs of those in another religious sect. It's a delicate balance, really. One cannot just come right out and label the comments for what they are -- ignorant, moronic and UNRELATED to anything actually happening in the country -- cuz after all, one still needs the votes of a lot of religious conservatives to win the Republican nomination. However, one cannot exactly high five the people supporting those comments without alienating another thirty percent of independent voters needed in the general election.

What both failed to directly address is the Grand Canyon sized fissure within the Republican base that could tank the party in 2012 and beyond. If the larger party cannot prevent an ever-shrinking minority from restricting the candidate pool to a subset of the population pure enough to satisfy the dogmatic preferences of some religious nut in Texas, social and fiscal moderates will leave the party and independent voters will flock to Democratic candidates or those from some future separate party. On the plus side, future Republican primaries will be a cinch. The only ten people pure enough to decide who gets to run will be the only ten left in the party so it will be the same ten candidates for office every election.

I Thought Small Business Created All Jobs In America

Bob Schieffer quickly turned to the protests on Wall Street and in many other American cities. He started by playing a clip of a prior comment from Herman Cain:

And to be angry at somebody because they're successful is anti-0American in my opinion. Secondly, this is a distraction from the failed policies of the Obama administration. Why be mad you don't have a job at the bankers on Wall Street? They're the ones that help create the jobs.

BZZZZZT.

Cain may have won a few style points with the true believers occupying the Cxx level offices in the TBTF banks but earned zero content points with anyone with a brain with an answer that ignores the following facts:

* the executives and traders on Wall Street were spectacularly UN-successful, hence TARP
* all of the failed policies involved with the meltdown (including TARP, if you're so inclined) were all executed during the Bush Administration
* the meltdown of 2008 was so steep that statistics on the collapse took over two years to re-calibrate to the true number -- a drop in GDP of negative 8.9% in 4Q2008 and a net drop of 5.1 percent between 1Q2008 and 2Q2009, the worst performance since 1947 (see #2)
* Who said bankers create jobs? I thought small businesses and entrepreneurs created the majority of jobs in America. At least, that's what the Republican platform says when it's touting the "small-town America, mom-and-pop business and small farmer as the backbone of the economy" tripe every election season.

After Cain's answer, Gingrich rang in with this answer:

I think the sad thing is, this is the natural product of Obama's class warfare. We have had a strain of hostility to free enterprise and frankly, a strain of hostility to classic America starting in our academic institutions and spreading across this country and I regard the Wall Street protesters as a natural outcome of a bad education system teaching them really dumb ideas. I was with 35 realtors in Buford, South Carolina on Wednesday who are looking at a disaster in housing but they know that it's the Dodd-Frank bill, it's the Obama administration, it's Bernanke and Geithner and they're focusing their anger on the people who are causing them pain. They're not angry about other people being successful, they're angry about an Obama administration stopping them from having the chance to be successful.

BZZZZT. BZZZZZT.

Real estate agents are angry? Real estate agents think the Obama Administration is preventing them from being successful?

Real estate agents are right up there with bankers in personal, DIRECT culpability for the meltdown that hit their profession. They ARE professionals, right? Highly versed in the long term trends of local markets and the mechanics of home financing and affordability? Location, location, location and all of that, right? That's what the CEO of ReMax kept telling me in TV ads -- "there's never been a better time to buy a home."

Or are they merely one of many players extracting their cut for merely being present during a very complicated, expensive financial transaction? Shouldn't they have known that prior to 2004, families earning $70,000 per year didn't typically qualify for a $300,000 mortgage unless something was awry in the market? What were those real estate "professionals" telling their clients in 2002 when this started happening with home prices?

http://en.wikipedia.org/wiki/File:Shiller_IE2_Fig_2-1.png

Shouldn't they have known that prior to 2004, long term home price increases never outpaced inflation by more than 0.4% except during WWII after recovering from the Depression? I supposed those 3% and 6% commissions on extra volume on inflated prices paid for a lot of Xanax and Ambien to let them sleep at night.

Newt Explains the Balance of Powers

The final portion of the conversation focused on comments Gingrich recently made about the relationship between the Supreme Court and the Legislative and Executive branches and one particular case involving a judge in San Antonio. You can believe what you want about the San Antonio ruling which barred a prayer at a public school but you should also know that the judge's ruling was OVERTURNED -- in a few days -- by a superior court. Think about that. A case was brought to a judge, the judge reviewed the arguments presented, made a ruling, citizens objected, appealed the case to a higher court and the higher court ruled on this issue of VITAL importance to the future of Texas teenagers in a matter of days. I presume the only way the issue could have been resolved any faster is if it somehow involved the school football team.

Gingrich has his own solution to the problem of out-of-control judges whose decisions are "corrected" in a matter of days. In his speech to the Value Voters summit, Gingrich jokingly (???) suggested punishing "out of control" judges and courts by simply denying them funding for clerks. Or subpoenaing judges issuing rulings with which he doesn't agree to appear before Congress. Intrigued by this novel approach to checks and balances, Bob Schieffer asked Ginrich how such a plan would work. Here's how the dialogue went:

Schieffer: Well how in the world would you do that? They 're in one branch of government...

Gingrich: You subpoena them.

Schieffer: But one branch of government can't subpoena people in the other branches of government..

Gingrich: Of course you can.

Schieffer: They don't have to honor the subpoenas.

Gingrich: Bob if that's true, then the court can't say something to the Congress either can it? By your standards, this Supreme Court cannot dictate to the President and cannot dictate to the Congress. But they do. And there are clear provisions in the Constitution to re-balance it.

BZZZZT. BZZZZZT. BZZZZZT.

I think the Ouija board Gingrich is trying to use to channel the minds of Jefferson, Adams, Paine, Madison and the other authors of the Constitution has been hijacked somehow to the mind of some guy trying to sell term papers for hire on the web to high school civics students destined for Ds trying to steal a C.

The checks and balances in the Constitution don't always provide one branch direct (dictatorial) power over another. Many of the checks are more akin to each branch controlling some of the oxygen supply to the others, giving each an incentive to seek a middle ground allowing all three to continue functioning and serving the public. Before appearing in public again, Newt might want to calibrate his planchette pointer thingy so the board spells out the following basics when asked questions about the balance of power in the Constitution:

1) The Legislative branch gets to MAKE the laws and authorize spending.
2) The Executive branch gets to EXECUTE the laws -- faithfully and consistently -- and SPEND the money.
3) The Judicial branch gets to INTERPRET the laws when disputes arise about meaning or intent.
4) The Executive branch can check the Judicial branch through appointments.
5) The Legislative branch can check Executive appointments to the Judiciary via "advise and consent."
6) The Judicial branch can check the Executive and Legislative branches by declaring laws un-Constitution and hence unenforceable.
7) The Legislative branch can check the Executive branch via the power of the purse, veto overrides and impeachment.
8) The Legislative branch can check the Judicial branch by working for changes to the Constitution and by impeaching judges.

---------------------

So after the final round of this edition of Republican Primary Jeopardy, the scores are Cain minus $4000, Gingrich minus $8000 and the American public an even $0.

=====================

#1) http://www.cbsnews.com/stories/2011/10/09/ftn/main20117827.shtml

#2) http://www.bea.gov/faq/index.cfm?faq_id=1004

What Happened to Those People?

2011-09-11T20:49:00.002-05:00

The memorials to the victims and heroes of the terrorist attacks on September 11, 2001 will be visited by tens of millions of people from all over the world for as far into the future as one can imagine. Each of the memorials provides a unique visual expression of the magnitude of the loss and absence while also conveying a sense of permanence and reverence that hopefully comforts those directly touched by the lives lost.

Whether intended as a thematic group or not, the designs of the memorials individually emphasize different aspects of our national character that served us so well during that day and the months afterwards. The memorial at Shanksville utilizes the space and solitude of the area to highlight the actual point of impact of Flight 93 and the role the forty passengers and crew played as the first literal tip of the spear in America's fight back against the terrorists. The design separates that Sacred Ground area from the surrounding ringed walkway and provides an "inner sanctum" that will be kept off limits to everyone but direct family members. Limiting access helps remind the rest of us that mere familiarity with a tragedy is not comparable to direct experience with a tragedy. Since that experience of limited access isn't practical in a working building like the Pentagon or a downtown area surrounded by millions, the "Sacred Ground" area at Shanksville helps provide a sense of that intimacy and privacy that all of the September 11 families need at some level in such an otherwise global experience. The forty aboard Flight 93 may not have been the first to realize their flight was being hijacked but they were likely the first Americans to be given information via family and friends over air phones and cell phones of the true nature and consequences of what was happening who were also in a direct position to do something about it. And do something they did. Instinctively. Without hesitation. Without a single second to spare. Here is the situation. Here are the alternatives. Here's what's right. Let's roll.

The memorial at the Pentagon provides a powerful counterpoint to the memorial that is the Pentagon's own reconstruction after the attack. In less than a year, the physical damage to the Pentagon building was virtually erased by a massive reconstruction effort. Like a science fiction cyborg with the ability to regenerate damaged parts in seconds and continue the offensive, the rebuilding of the damaged Pentagon provided the nation a chance to prove in tangible terms that mere physical damage alone cannot keep the military or the country from pursuing what needs to get done. Erasing that physical scar within a year to the date of its infliction like it never happened provided a crucial reminder to the world about the focus Americans can apply to any problem. The actual memorial on the grounds just outside the Pentagon provides both a place to marvel at the symbolic invincibility of an emblem of American strength while simultaneously absorbing a visual reminder of the individual citizens who truly provide that strength -- even at the expense of their own lives when necessary.

The design of the memorial in New York City perfectly threaded a needle through distinct, seemingly conflicting needs of family members, a bustling city with a hole torn in its core and a nation that lost a symbol of its ingenuity and drive for ever greater heights. Anyone who visited the World Trade Center towers up close will tell you photos could never convey the awe experienced in person by standing next to one of the monoliths, looking up along the side of the building and absorbing the sight as the building rose up to the vanishing point -- as if to say America sets its sights to infinity and damn it, we're going to get there. The memorial design literally preserves the impression those towers had on anyone who saw them and the sheer magnitude of ambition the creation of those towers represented. At the same time, the design of black granite, falling water and names of those who died in black bronze produces something for the city unimaginable in the days after the attacks -- a place where the sounds of water drown out the normal sonic distractions of a huge city to provide a bubble of isolation allowing contemplation of the magnitude of what was lost, both human and physical. As visitors walk around the perimeters and take in the names of the individuals who died, the vastness of those footprints underlines the hole in the lives of family members left behind. At the same time, visitors can't help but look up from the edges of the former buildings and be reminded that they're still in a country that believes the sky is the limit.

===========================

In some sense, monuments to the dead aren't really for the dead. They may not even be for the living. They're really for those in future generations. Memories and understanding fade and often distort over generations. The memorials for those who died in the attacks on September 11, 2001 are so poignant and effective at conveying the magnitude of the loss on that day that they ensure no future visitor will ever leave without asking one question:

"What happened to those people?"

What was going through their minds when they first realized what was happening? For those that realized their lives would soon end, what occupied their thoughts or provided them comfort in their final moments?

The answers are too painful and too inappropriate for the rest of us not directly impacted to consider. We CAN think about what happened to the rest of us.

Think about the teachers at P.S. 150, a school with 175 children located in the shadow of the World Trade Center towers. They had their own families and children to consider but safely shepherded all of those children through the black soot of the collapsing towers to safety at other schools to the north. Schools don't drill for "collapsing skyscraper and choking dust" disasters yet the teachers remained focused on their students, maintained calm and did the right thing. All in all, over nine thousand children in eight schools in the area were all guided to safety. While the children were off for the next few days, were the teachers off focused on their own families or watching TV coverage like the rest of us? No, they were huddled in other school buildings carefully and thoughtfully planning the experience they would provide to the children upon their return to the classroom, knowing that first experience posed a huge risk of trauma and opportunity for initial healing. They are EDUCATORS. They know these things. It's what they do. And they did it. Perfectly.

Isn't that something you want to know about your children's teachers if YOUR children are ever in a situation like those on September 11, 2001?

Think about the firefighters and police who survived the collapse and spent the next few days amid a flaming, toxic, hazardous waste site attempting to find survivors in the rubble. Think about the search and rescue teams from all over the country who drove non-stop to New York City to help in the search for survivors. Think about the weeks of exhausting hours those same teams spent after rescue became impossible and the remaining goal became recovery of those who perished to provide closure for their families. Sifting through tons of smoking, toxic filth for months and risking their own lives to do it -- even in pursuit of something as noble as providing closure for grieving families -- wasn't in the written job description of any of those who did the work. But it was in their character. It wasn't ever in question.

Isn't that something you want to know about the emergency responders in your community if YOUR family members are ever in a situation remotely like those on September 11, 2001?

So from the perspective of that future visitor decades or centuries in the future, what DID happen to "those people" in the past? US?

After seeing the thousands of individual acts of heroism, sacrifice and simple kindness demonstrated for MONTHS after the horrors experienced on September 11, 2001, how have so many reverted to increasingly divisive, "us versus them" politics in our country? Why have we allowed our political leaders to shift the blame for other unrelated financial disasters onto the shoulders of public employees in the form of layoffs and cutbacks to benefits and pensions previously committed? Why is there any question at all about complete coverage of medical care for anyone associated with those who worked the recovery at the World Trade Center? Hundreds of Americans put themselves in harm's way for others and made the right decisions without the luxury of time yet most Americans cannot be bothered to educate themselves about the social, fiscal and military issues facing the country when we have all the time in the world?

For those of us in the first post-September 11 generation, our most important responsibility going forward is to rethink our relationships with our fellow citizens, our government and the rest of the world and begin respecting the role all of us play in a healthy society, not just a growing economy. We need to ensure that a visitor to any of the memorials fifty, one hundred or two hundred years from now doesn't ask the question "What happened to those people?" in reference to US -- the post-September 11 generation. We saw all of those demonstrations of the decency and generosity of our national DNA in the months after the disaster yet have still grown apart as a people, eyeing each other as culprits for any inconvenience we suffer rather than as partners who can help solve any problem we face. We're better than that. WAY better than that.

Fun and Folly With Facts and Figures

2011-07-31T19:53:00.002-05:00

Perhaps the most maddening aspect of watching the deficit debacle unfolding in Washington, DC is the utter failure of any parties (Presidents, Senators, Representatives, voters, media) involved with the spectacle to analyze the true financial impact of any of the proposals or the likely cost of a failure to formulate a viable solution and explain it to the public. Most Americans avoid any real-life use of mathematics like the plague but this is a situation where a few relatively simple calculations can cut through a great deal of FUD -- fear, uncertainty and DUMB.

The thought exercise below is intended to illustrate the true magnitude of ANY of the proposed spending reduction plans by contrasting them with a few obvious, IMMEDIATE impacts of an increase in interest rates that might result from a spooked credit market as our fiscal situation worsens. Why focus on interest rates? First, short term interest rates have a direct impact on both federal budgets and consumers that lends itself to being calculated, Second, the amount of federal and individual debt is a large enough "nut" that any increase in interest rates will produce additional, immediate and quantifiable "ripples" throughout the economy.

The point of the exercise is to illustrate how any voter in the country can cut through the fog emitted by our politicians using publicly available, politically neutral data and nothing more sophisticated than a calculator and a little bit of algebraic problem solving. Think of it as fun and folly with facts and figures -- and your financial future.

Key Statistics

First, here are the key statistics required for the analysis. Sources for most of these are provided as footnotes. A few of the values are calculated from the other values and a few are estimated and explained in the sections below.

    
2010 United States GDP:                 14,814,922,500,000
2011 Federal Budget:                     3,834,000,000,000
2011 Federal Tax Receipts:               2,334,000,000,000
2011 Federal Deficit:                    1,500,000,000,000
United States Debt:                     14,553,830,999,000
Yearly Federal Debt Interest Cost:         213,226,898,000  
US Households with taxable income:             111,839,400
Consumer Residential Mortgate Debt:     11,297,753,000,000 
Consumer Credit Card Debt:                 799,758,370,000
# Housing Units:                               130,159,000
Home Ownership %:                                       66.5%
Outright Home Ownership %:                              28.0%  
% Federal Debt w/ 1-year Financing:                     40%
% Home Loans with Adjustable Rates:                     25%
1-year Treasury Interest Rate:                           0.20%
Avg HH Balance for those with CC debt:             $15,788
Avg APR on cards with balance:                          14.67%
Avg Penalty APR:                                        27.00%

Any analysis based on these statistics must begin with some obvious caveats. First, federal government budget statistics use the government's fiscal year interval (October 1, 2010 to September 30, 2011 for "2011") while most consumer and business statistics involve calendar years. Figures on home ownership are partly derived from 2010 census statistics which may not be exact for 2011 but should not have changed more than a few percentage points. Finally, the interest calculations below avoid monthly accrual calculations of interest and stick with "simple interest." Since the analysis only looks at one year increments, the complexity of compounding interest over multiple years using monthly interest rates just clouds the underlying concept. If anything, the calculations below will understate the problems slightly.

Immediate Interest Rate Impacts

No person can claim to have a clue about exactly what will emerge from the Congressional sausage making regarding fiscal policies or how world markets will react to those policies. However, interest expense is such a huge portion of overall outlays that it's easy to quantify the impact on the budget of any change in interest rates. Since interest rates are already nearly zero and uncertainty and risk are only going up, it's more likely that rates go up rather down. So what happens in response?

First, we have $14.5 trillion in debt. Roughly 40% of that debt is financed with the equivalent of a 1-year adjustable rate mortgage in the form of Treasuries with maturities of one year or less. That means forty percent of that $14.5 trillion can IMMEDIATELY float to higher interest rates within one year. Here's the impact of a one percent increase in the 1-year Treasury rate:

   additional interest = (total debt) x (short term share) x (one percent)
                       = $14.55T x .40 x 0.01 = $58.2 billion

That's the impact to the government's books. The impact on families can quantified using the same process -- looking at debt floating at short term interest rates keyed off the 1-year Treasury. For families, the most obvious debts in that category are credit card debt and adjustable rate mortgages. There are obviously millions of consumers who use credit cards as a payment convenience only and pay their balances off in full every month or nearly every month. However, according to the credit card industry itself, the average balance carried by households who DO carry a balance at all is an astounding $15,788. For those households, the extra interest for a one percent increase in their rate is:

   addition CC interest = (avg balance) x (one percent)
                        = $15,788 x 0.01 = $158 yearly

Again, that's the yearly increase for each one percent increase in their credit card rate, Not too bad, huh? Well, keep reading.

The story for holders of adjustable rate mortgages is much worse. The math is simple but takes a few steps. The following numbers need to be calculated:

1) the total number of current mortgages
2) the average outstanding balance of current mortgages

For #1, we need the total number of housing units from census figures, the current "home ownership" statistic and the current "free and clear" ownership statistic. The math is simple:

  # mortgages = (total units) x (%ownership) x (1 - % free & clear) 
              = 130,159,000 x 66.5% x (1- 28%) = 62.3 million

For #2, the average mortgage balance can be calculated by looking at Federal Reserve data summarizing ALL mortgage debt, deducting out non-housing related mortgages then dividing by #1:

   avg mortgage balance = (housing mortgage debt) / # mortgages
                        = $11,297,753,000,000 / 62,320,129 = $181,286

The additional interest expense of a one percent jump in an adjustable rate mortgage with the average mortgage balance would then be:

    additional ARM interest = (avg mortgage balance) x (one percent)
                            = $1,813 yearly

Ouch. Now think back to the credit card debt portion of the picture. Interest rates on credit card balances aren't guaranteed of only jumping a few percentage points. Legislation enacted in 2009 prevents Bank B from raising a customer's rate to the default rate if the customer is current with Bank B but late with Bank A. That legislation does NOT block bank B from dropping the customer entirely and certainly doesn't prevent Bank A from raising the customer's interest rate to the default rate that averages 27%. Now that extra $1,813 in mortgage interest expense looms more ominously. That's $1813 less the consumer has to pay their credit card bills, increasing the likelihood of defaulting on one or all of their cards carrying the average balance of $15,883. If that entire balance shifts from an average 14.67% interest rate to the 27% penalty rate, the consumer is now looking at an additional $1947 in credit card interest charges yearly. Combined, at least a few "average" consumers could thus be out a total of $3760 in higher interest expenses.

Interest Rate Impacts on the Aggregate Economy

The real impact of interest rate hikes to individuals isn't fully apparent until those individual impacts are added together into a macroeconomic view. The math here isn't any more difficult. For consumers carrying $15,788 on revolving credit cards, any increase in interest expense is likely going to diminish net spending on new goods and services. If they HAD the money to pay off the balances before while still spending more money, the balances wouldn't be there. To determine the total amount of extra interest spent by consumers for this one percent increase in interest rates, the math is:

   total extra interest = (# households carrying balances) x (per household increase)

The number of households actually carrying a credit card balance can be reverse engineered from the total credit card debt statistic and the average carrying balance:

   # HH with balance = (total CC debt) / (average carrying balance)
                     = $799,758,370,000 / $15,788 = 50,656,091

The total extra interest paid by these households would then be:

   total extra interest = 50,656,091 x $158 = $7,997,583,700 yearly

Determining the total extra interest paid on adjustable rate mortgages from our one percent increase in interest rates takes a bit more doing. The total number of current adjustable rate mortgages isn't directly reported in any easy-to-find sources. However, the Federal Reserve DOES provide statistics on mortgage originations by fixed / adjustable terms and that mix has changed from 40% ARMs in 2007 to only 10% in June 2011. Borrowers who still qualify have grown wary of ARMs and the most aggressive lending practices built upon ARMs have been abandoned by most mortgage lenders. The number clearly isn't 40% but it clearly isn't 10% either. Why?

First, a huge percentage of ARMS originated between 2005 and 2008 likely involve homes whose value has dropped between 10-20 percent. Since the vast majority of those with ARMs paid little down on homes now worth 10-20 percent less, they have no equity. Second, the fact that many were "marginally eligible" borrowers to begin with means virtually none have assets that would allow them to put down a 10-20 percent down payment to re-qualify for a fixed rate mortgage.

Due to these factors, a conservative estimate of current adjustable rate mortgages could be SWAGed at 25%. From that, we can calculate an estimate of the total additional mortgage interest expense produced by a one percent increase in rates as:

   total increase = (# mortgages) x (ARM share) x (interest increase)
                  = 62,320,129 x 25% x $1813 = $28,244,382,500

Wow. That's a big number. Add all of the aggregate interest payment increases together and you get:

    federal interest increase        $58,215,323,996
    credit card interest increase    $ 7,997,583,700
    mortgage interest increase       $28,244,382,500
    ------------------------------------------------
    TOTAL interest increase          $94,457,290,196

Consider what that number means. It means for each one percent increase in interest rates, the US economy faces an additional $94.5 billion dollar drag on economic activity that goes to big banks that aren't lending to jump start the economy and to Treasury holders, many of which are outside the US. This is for a SINGLE PERCENTAGE POINT increase in short term interest rates. The current 1-year rate on Treasuries is an absurdly low 0.2 percent. Over time, a rate between 3 and 7 percent is much more typical.

Political Conclusions

A quick review of various debt reduction plans is enlightening but -- as will become evident shortly -- also infuriating. The April 2011 Obama plan called for $2.5 trillion in spending reductions over twelve years -- averaging $208 billion in yearly spending reductions -- and roughly $1.5 trillion in additional tax revenue. The Boehner plan that died on July 29, 2011 after reaching the Senate called for $1.2 trillion in spending reductions over ten years, averaging $120 billion per year in spending reductions with no additional revenue. The Reid plan still gasping for air calls for $2.2 over ten years averaging $220 billion in yearly spending reductions.

Of course, no one really mentions that NONE of these plans actually BALANCE a yearly budget to STOP ADDING to the cumulative debt. If the purpose of all of this posturing is to calm world credit markets to allow deficit spending to continue while we work on the REAL strategy, how likely are any of these plans to provide that confidence? The prior analysis estimated the yearly hit in additional interest expense on EXISTING debt as $58.2 billion for EACH PERCENT INCREASE in interest rates. If interest rates return to historical norms, interest expense for the Federal government will jump nearly $240 billion, completely wiping out any "spending reductions" claimed by any of these plans.

That impact doesn't even factor in the drag on the larger economy due to interest expenses incurred by consumers. At a time when overall economic growth as measured by GDP has already slowed to 1.3% for the second quarter of 2011, the extra $36.2 billion in credit card and mortgage interest paid by consumers will shrink retail sales by an amount equal to 0.24% of GDP at a time when every tenth of a percent in growth is CRUCIAL to supporting jobs and tax revenue. It can be argued that this $36.2 billion still counts as part of GDP since it is income to banks but given their reluctance to lend, much of this money essentially "dead ends" in the system and doesn't support growth.

In short, none of the interim solutions proposed by any of the parties so far materially move the country towards a long term trajectory that balances expenses and revenues, much less helps pay off actual debt. The question then becomes WHY ON EARTH would our politicians then risk spooking credit markets in the short term playing chicken with the debt ceiling when the downside of any panic in the market is so obvious? The answer is that our political process is selecting politicians who accurately reflect the ignorance of those doing the voting.

Conclusions for Individual Americans

The fatal ignorance of America's politicians and voters can be demonstrated by posing a single question:

You are an average American. Your household has the average American income of $50,000 dollars. Your household has an average size mortgage of $181,000. You are faced with the choice between:

A) a one percent increase in your average tax rate
B) a one percent increase in the interest rate on your mortgage

Quick! Which would you prefer? ____

If you're the average Tea Party supporting taxpayer, you reflexively answered (B) because you don't want more money going to the government. If you're the average Republican politician at the federal or state level, you reflexively answered (B) as well because your party has captured a predictable portion of the overall electorate who vote (B) allowing you to protect your corporate special interests who benefit disproportionately from those tax policies. In reality, (A) costs you well south of $500 while (B) costs you $1,810.

Just to reinforce the point, here's another test:

You are a typical American. Your household has an income of $80,000 dollars. Your household owns an home worth $235,000. Your current state has an income tax rate of 6%. Your CEO has decided to move your company to a state with zero state income tax. Whoopee! He or she makes $6 million yearly and will buy a house worth $2.35 million. You are faced with the following choices:

A) finding a job with identical pay and staying put
B) moving, buying an identical home and enjoying the zero state income tax rate in your new home

Quick! Which would you prefer? ____

This is a trick question. To find the right answer, you need two additional pieces of information -- the property tax rates in your current state and the new state. Let's assume the current tax rate is 2.5% and the new state's property tax rate is 5%.

For you, your state income tax savings won't be any larger than $4800 dollars. (6% of an $80,000 "nut") but your property tax bill will jump 2.5% on a $235,000 "nut" or $5875 dollars. At best, you lose $1075 by moving. Let's see how your CEO fares with the relocation. They save 6% on their $6 million salary "nut" -- $360,000 -- and their property tax bill jumps 2.5% on a mere $2.35 million "nut -- $58,750 -- saving them a net of $301,250. It's good to be the king, isn't it?

If you chose (B) for either question, you're an idiot, plain and simple. Like all things in finance, choosing the right strategy involves understanding the percentages working for and against you and the size of the "nut" to which those percentages are applied. Forget either one of these factors and you will eventually find you've lost a good portion of your "nut" to players who CAN keep them straight in their head.

The real conclusion from all of this analysis is that we are headed towards major problems. Choosing the right solutions or weeding out the bad solutions only requires the simplest of algebra to solve for a few unknowns. Our leaders instead focus on distracting voters from reality using arguments and statistics that amount to first and second order derivatives in calculus (percentage changes of percentage figures of growth or reductions, etc.). This approach will continue to succeed at draining our economy and enriching the few as long as the majority of voters fail to master even simple arithmetic. At least until we bankrupt the country. When we reach the point that we cannot assure soldiers under fire in a war their paychecks will be issued and Apple Computer has more cash on hand than the Treasury of a country that owns aircraft carriers and nuclear warheads, it's pretty easy to argue we're already there.

==============================

Sources:
1) budget -- http://www.gpoaccess.gov/usbudget/fy11/index.html

2) debt / tax payers / households -- http://www.usdebtclock.org/

3) residential mortgage debt -- http://www.federalreserve.gov/econresdata/releases/mortoutstand/current.htm

4) Treasury Rates -- http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield

5) credit card statistics -- http://www.creditcards.com/credit-card-news/credit-card-industry-facts-personal-debt-statistics-1276.php

6) home rent / own stats -- http://www.census.gov/compendia/statab/cats/construction_housing.html

The Battle of the Business Models

2011-07-10T20:54:00.001-05:00

Bob Lutz, noted "car guy" and former executive of various sales, marketing, operations and design functions at BMW, Ford, Chrysler and GM has a new book on the battle between the "car guys" (engineers) and "bean counters" (accountant / finance types) in American business. BusinessWeek (#1) and Time (#2) have both run short reviews of the book, unambiguously titled Car Guys vs. Bean Counters: The Battle for the Soul of American Business. Lutz writes from an obviously biased perspective and both magazine articles point out the tilt. However, there is a great deal of truth to Lutz' main point -- managing every aspect of a business with numbers and dollars as the only "truth" can be fatal to a company, an industry or even an economy. Interestingly, the Time story ends with this note:

Meanwhile, despite all the post-financial-crisis soul searching within the business community about the value of an M.B.A., schools are still churning them out. There are, and will be for the foreseeable future, a lot more bean counters than engineers in this country. But the same may soon be true in China, where the state plans to open 40 new graduate schools of business in the next few years. As Lutz puts it, "That's the best news I've heard in years."

========================

So what are the essences of these two polar opposite extremes of management philosophy? The "bean counter" model (as Lutz might term it) is built around the assumption that key decision factors about a product or business a) can be determined, b) can be quantified, and c) can be folded and abstracted into ever more complicated models whose pieces can be farmed out to armies of middle managers to create and massage then feed up the chain for final decision making. By the time the numbers reach the top, no doubt via a artificially abbreviated 300 character email read on a BlackBerry on a golf course somewhere, the decisions would seem straightforward. "Hmmmm, A>B, I guess we'll do A."

The "car guy" model attempts to differentiate between purely operational / financial factors suitable for number crunching and specialization in middle management while critical "intangible" decisions about style, technology and risk are left to key players professing to have a battle-tested understanding of the entire business and market though that wisdom may not be independently verifiable. Looking in from the outside, the "car guy" approach might either appear akin to management by a all-seeing oracle or cult of personality (if the business does well) or management by the seat of the pants instead of hard numbers (if the business executes poorly).

Bob Lutz obviously views himself as a "car guy" -- as someone who could have saved Detroit if only the morons in finance had listened. The flaw in Lutz's thinking is that he WAS in Detroit when it was producing some of the worst products ever foisted on the public. Maybe a different "car guy" example might be more instructional.

At this point, there probably is no more famous and successful proponent of a "car guy" approach than Steve Jobs and Apple Computer. Given the positive press about Jobs, one might think Jobs single-handedly coded the upgrades to the latest Lion release of OSX or designed the retinal display of the latest iPhones. There's plenty of negative press about Jobs' management and communication styles as well but Apple's financial success operating within a fickle consumer electronics industry cannot be denied.

Is Steve Jobs really that good? Is he really that indispensable? Or is his success at Apple more of an indictment of the broken thinking of most executives about product development and operations? A few observations might make the case that Jobs' success and that of Apple isn't because they practice the "car guy" approach. Instead, Apple is succeeding because its entire management team is truly managing the business properly -- by financials where it's appropriate and by technical factors where it's appropriate.

In January 2011, during Jobs' health sabbatical, BusinessWeek ran a short story on the managers within Apple in the line to succeed Jobs at the head of Apple. (#3) The bio for each of the top players repeated or implied a common theme -- many could EASILY be the CEO at any other Fortune 500 company. Not just because of the sheer sex appeal of "Apple" on their resume but because THEY WERE THAT GOOD.

My reaction?

Well, DUH!

Each of these executives is doing well because a) they are top notch in their respective disciplines AND b) because each of those disciplines is operating TOGETHER with a larger strategy that honors the function each is there to perform. Apple doesn't execute perfectly on everything every time but it beats the normal 85% new product failure rate because that larger strategy internalized a few crucial lessons from the past:

CONSUMER PRODUCTS REQUIRE A COHERENT VISION -- There were and probably still are at least a dozen ways to make an MP3 player or smartphone. However, any single product cannot simply reflect the "average" of dozens / hundreds of individual decisions about technical details and human factors. This is true for virtually all complex products but it is especially true with consumer products. All of those internally inconsistent compromises are directly / viscerally experienced by the end user and when enough don't add up, the product becomes.... well, a Zune. Steve Jobs absolutely gets this. The entire Apple team knows this. They know there's no guarantee that a new product reflecting a single coherent vision will succeed but there is a VERY HIGH likelihood that a product whose requirements and design were assembled by committee will crash and burn in the marketplace.

DON'T WAIT FOR YOUR COMPETITORS TO CANNIBILIZE YOUR CASH COW, DO IT YOURSELF -- Someone WILL eventually figure out how to steal market share from your current cash cows. It's not a matter of IF, only WHEN. So if it's only a matter of WHEN, it's much smarter for you to influence that WHEN by doing it yourself and coming up with better products. You cement your reputation as being innovative and you reduce "brand churn" by training your customers to expect better things from you rather than the competition.

DO YOUR HOMEWORK -- Does anyone think Steve Jobs sits at his kitchen table watching his kids eating pancakes arbitrarily deciding on his own how the user interface in iTunes will be designed or exactly what the gestures should be in the iPhone interface with a coin toss? Apple has armies of people -- yes some of them engineers but also graphic designers, physiologists and psychologists -- who continually analyze the way humans interact with existing hardware and software and how they react to new ideas made possible by new hardware and software. Apple also understands the tradeoff between flexibility and "open platforms" and uniformity / consistency. Personally, I don't like the closed "app store" model for the iPhones and iPads but as someone who spends 50+ hours per week working with crappy, bloated business software for a day gig, I absolutely understand the attractiveness of Apple's streamlined but locked-down model for consumers who just don't care about details and want one-click installation of new toys.

SHUT YOUR MOUTH! -- Don't say A SINGLE WORD about a new product until serial number 0000001 is physically in a box, through the supply chain and ready to hit stores. Jobs was around in 1983 when the term "Osborne Effect" entered the American business vocabulary. The term stems from a period in which a leading maker of "luggable" computers was suffering a sales decline as their original model was being outgunned by the competition. The CEO and founder, Adam Osborne, attempted to right the ship by announcing the firm had a much better product for less coming in a few months. Alrighty then, said all of Osborne's potential customers and current dealers, we won't order any more of these current models, we'll sit tight and wait for the new ones. The firm literally turned off its own cash flow, telegraphed the price point of its new product months in advance, allowed competitors to plan for the new product and beat its price, THEN FAILED TO DELIVER THE PRODUCT ON TIME. Of course, Apple has realized another benefit from this strategy. When Apple DOES communicate anything about its products, it gains literally millions of dollars worth of free advertising as dozens of web and TV outlets re-run its product announcements as news.

Is this really any mystery to anyone? SHOULD it be a mystery to anyone? It apparently is to many of those with business school / bean-counter blinders.

Maybe this is a more effective way to frame the alternatives: Let a bunch of engineers and bean counters do their respective jobs and you might get Apple or Netflix. Let a bunch of bean counters control the engineering and you get General Motors attempting to sell the same garbage under five different brands. Let a bunch of engineers control the accounting and financials and you get Enron, AIG, Bear Stearns and wholesale securities fraud that wipes out trillions of dollars in nominal wealth and threatens the entire world economy.

=================================

#1) http://www.businessweek.com/magazine/book-review-car-guys-vs-bean-counters-by-bob-lutz-07072011_page_2.html

#2) http://www.time.com/time/magazine/article/0,9171,2081930,00.html

#3) http://www.businessweek.com/magazine/content/11_05/b4213006960578.htm

The Republican Circular Firing Squad

2011-05-18T20:48:00.002-05:00

Joshua Green's article "The Tragedy of Sarah Palin" in the June 2011 issue of The Atlantic (see #1) asks a seemingly simple question: What happened to Sara Palin? Green's article does a great job providing many details in Palin's political evolution that make the question more interesting but his answer to the question falls short by failing to explain what "Palinism" truly is.

As background, Green not only delves back into Palin's leap from mayor to governor but provides a useful summary of Alaska's economic and political history. Palin's rise really cannot be understood without understanding the political culture in Alaska that produced the circumstances she leveraged in making her leap to prominence. In a nutshell, Green boils the background down to a few essential facts:

* virtually everything political in Alaska is a function of economics in the state
* the Federal government controls 60 percent of the land in the entire state
* the state itself controls another 28 percent of all land
* the 12 percent of the land left has to serve the entire state economy
* virtually everything left is dominated by oil and natural gas development

In short, the state economy has virtually zero diversity and government budgets are almost entirely dependent upon taxes upon the oil and natural gas industries. As a result, virtually all political battles within Alaska stem from one of the following issues:

1) who (either the federal government or the State Of Alaska) controls energy development plans and leases, and
2) what the tax and lease rates paid by oil and gas producers should be for state resources

The state had gone back and forth on these issues since the scope of its oil reserves first made news in 1969. By 2002, Palin had finished her stint as mayor and gained statewide recognition losing a competitive race for lieutenant governor. She then campaigned for Frank Murkowski, helping him win the governor's race and putting her name on the short list to complete the remainder of his term in the Senate. She failed to get that slot but was given a position on the state's oil and gas commission, identified some ethical lapses on the part of a fellow commissioner in a private letter to the new governor who finally canned the official. Only one problem. That other commissioner was also the head of the state Republican Party. That problem quickly eliminated itself because the governor in the mean time had been renegotiating a new deal for pipeline rights that amounted to a MASSIVE give-away to energy interests at the expense of Alaskan taxpayers.

In Green's narrative of the Sarah Palin biography, this is where all the stars and moons aligned for Palin. She rode the tidal wave of public anger against the governor and his pipeline deal to launch a campaign against him in 2006, easily beat him in the Republican primary then defeat the Democratic nominee in the general election. And this is where it gets interesting for those whose Palin exposure started at the Republican Convention in September 2008.

Palin actually accomplished a great deal in her initial months as Governor of Alaska.

Palin eliminated the cronies who cooked the prior pipeline deal, took back control over construction and licensing of a new gas pipeline and led the charge to enact legislation imposing a new tax regimen on energy profits. She did this by leveraging her prior reputation as a reformer in battling the oil and gas commission, leveraging her popularity with voters after the election to combat existing Republican cronies still bent on preserving the old deals and even worked with Democrats when Republicans wouldn't go along.

How much of a win did Palin provide for Alaska? The new tax regimen on energy profits has produced budget surpluses for the state over a period where virtually every other state is operating in the red. Green cites state officials who estimate the tax bill she helped enact has kept the state budget $12 billion in the black.

And that is the point where Palin entered the national political landscape. John McCain had won the Republican nod for President in 2008 and, like Palin, was in a position outside the mainstream of his party. Few of his first choices for VP would have been palatable to Republican leaders and few of their first choices would have been palatable to him. McCain's selection of Palin as his running mate on August 29, 2008 was quickly pegged for what it was -- an attempt by McCain to "shake things up" by choosing someone with a track record as a "reformer" (albeit a very short track) without picking someone seen as a Republican insider.

In Green's analysis, Palin dutifully assumed the traditional role of VP pit bull by doling out the "red meat" attacks in her speech to the party base. However, her downfall has been her failure to realize that role is just that -- a role, not the defining function of a would-be VP or any political leader. Green goes on to pose the question "what if?" What if Palin maintained a focus on corruption instead of extreme conservative issues and petty personal politics? How might the Republican Party be different? How might the COUNTRY be different?

This is the point where Green seems to miss the key conclusion. Green defines "Palinism" in the same political branding terms that Sarah Palin herself would prefer --- a brand for a "maverick" politician in the best sense of the word -- someone associated with a few clearly articulated principals and long term goals for the public good who is quick on their political feet and capable of leveraging a variety of tactics and cross-political alliances in service to those higher principals.

Palin's true problem is that her dominant brand is something vastly different. Perhaps a more appropriate description of that brand would be three simple words:

Sarah Milhouse Palin

If one had to characterize how Sarah Palin would likely perform for any period of time in any position of power, one only has to picture Richard Milhouse Nixon. Palin has exhibited the exact same combination of pettiness and paranoia as Nixon. Green's story even provides an example of the behaviors and fixations that more accurately reflect that brand.

We already know what happens when someone with those personality traits is subjected to the dueling forces of extreme power and extreme focus and criticism. Even if no criminal activity is involved, there is no way a person with that combination can be productive on the national stage. If you can't live with at least fifty percent of people believing you're wrong or tolerate five or ten percent of your opponents trying to attack you without devoting gobs of mental energy each day to getting even, you simply do not have the temperament to play in the big leagues.

=================================

Perhaps the question Green should have addressed involves the dynamics within the Republican party that are producing such a stunted field of Presidential candidates for 2012. Mike Huckabee decided he preferred a gig in the Fox News commentariat paying him $500,000 yearly for a weekend gig. Nice work if you can get it and Huckabee got it. Donald Trump.... ...well, let's just say we all dodged a disaster there. Michelle Bachman? Right.

So let's look at the remaining contenders.

Ron Paul has sealed his fate by attempting to convince religious conservatives that his support of individual rights in the areas of prostitution and the purchase of heroin is completely one and the same with his support of individual rights providing freedom of religion. Ron, you can try pitching those Libertarian pipe dreams till the cows come home but politically, exactly what voting demographic are you after? The crack-smoking evangelical preacher who likes the ladies? Must we EXPLAIN this to you?

Mitt Romney is having trouble formulating an explanation for his prior legislative work on healthcare in Massachusetts that a) tows the current Republican line on how bad "Obamacare" is for the country, b) doesn't bad mouth his own achievement and cripple his political resume with centrist voters and c) somehow explains ANY difference whatsoever between "Romney-care" and "Obamacare". The best he's been able to do so far is words to the effect of "If a state does X, it's good because it's the right of a state to do the smart thing but if the federal government requires exactly the same X, then it's bad." Uh huh.

Mitch Daniels has yet to formally declare his candidacy and his popularity with the Republican base so far appears to be based upon the fact he's not carrying Romney's health care baggage and he knows many of the Republican power brokers of the Bush II era from his time serving as Bush II's head of the Office of Management and Budget. Given what transpired during the Bush II administration regarding management of the country's affairs and the budget deficits produced, it's hard to see the selling point of that resume. You apparently really have to want to see it.

Newt Gingrich has declared his candidacy for the Presidency and has already managed to alienate critical constituents of the Republican base by speaking his mind. Of course, Newt's entire political brand is based upon being an outside-the-box "idea guy" so it's absolutely no surprise he's already trotted into the doghouse. His offense? He appeared on Meet the Press on May 15, 2011 and labeled current Republican budget proposals as "right-wing social engineering" that have no more place in critical budget negotiations than Democratic attempts at left-wing social engineering.

That leaves Sarah Milhouse Palin. A national name brand making at least a couple hundred thousand dollars a year for occasionally appearing on Fox News while snagging $100,000 per speech who still has enough time to nurse grudges over what some local yocal might have written about her in the Wasilla Examiner or the Anchorage Gazette. Combine that behavior with her continued inability to name a book or magazine she's read in the past two years and she brings the term "small minded" to an entirely new plane.

And that really is the crux of the Republican dilemma. Small mindedness. The Republican faithful demand such rigid compliance with their ideological litmus tests that no potential candidate who has ever reached across the aisle or attempted to balance two or more competing thoughts on critical issues has a chance of escaping the Republican Party's circular firing squad. It's not only their default political battle formation, it seems to be their only formation.

==========================

#1) http://www.theatlantic.com/magazine/archive/1969/12/the-tragedy-of-sarah-palin/8492/

3519 Days for One Psycho?

2011-05-02T00:17:00.002-05:00

The news that United States Special Forces have killed Osama bin Laden and captured his body should provide some sense of justice served to those who lost family or loved ones in the attacks sponsored by al Queda througout the world ranging from the the embassy bombings in Kenya and Tanzania on August 7, 1998 to the USS Cole on October 12, 2000 to the attacks on September 11, 2001 and beyond.

It should also provide a huge sense of satisfaction and the beginning of a sense of "mission accomplished" for the hundreds of thousands who have actively served in our military in the silent and not-so-silent war on terror.

For the rest of us in America less directly affected by the attacks or the wars launched in response, what are we to make of the news?

It's certainly a relief to know one really bad actor in the movie has reached an ending you'd wish on the evil villian in a Hollywood western. But the specifics of his demise point out a few issues that will continue posing problems for the world and the United States in particular.

The news reports now indicate OBL was killed in the city of Abbottabad, located 150km north of Islamabad and 200km east of Peshawer. Here's the description of the town from Wikipedia:

The city is well-known throughout Pakistan for its pleasant weather, high standard educational institutions and military establishments. It remains a major hub for tourism of regions in Khyber Pakhtunkhwa, Gilgit-Baltistan and Azad Kashmir in the summer.

A major hub for tourism? I suspect many Americans thought OBL was supposed to be camped out in a cave, cooking ten year old cans of beans on a can of Sterno wondering when the next dialysis machine treatment would arrive by camel or goat.

Instead, it sounds like OBL was hidden in relative plain sight within a relatively well known city within Pakistan, supposedly a US ally. He obviously moved around over the past 3519 days but he likely spent much of that time in similar settings. Since the Special Operations team presumably killed everyone at the compound housing OBL, we can be certain they will scour every square inch of the facility for cell phones, laptops, tape recorders and correspondence to help reverse engineer the network of contacts that allowed OBL to operate for so long.

President Obama's official announcement regarding OBL's death took pains to state that this effort to capture / kill OBL actually began last August when intelligence provided with cooperation from Pakistani sources was first provided to US intelligence to trigger months of clandestine vetting. Teamwork with our ally, that's nice. Yet other stories are reporting US Special Operations forces alone carried out the attack that killed OBL. Apparently, once vetted, we could not trust our Pakistani peers with details of the operation for fear of a tip-off.

While eliminating one really bad guy, information about the location of the operation and chain of people involved with the original intelligence and those found in proximity to the location where he was hidden is likely to shine a light on many other problems within the Pakistani government and the military's Directorate for Inter-Service Intelligence (ISI). This information is NOT likely to help stabilize and moderate Pakistan in the short term. Far from it.

The most important question posed by the elimination of OBL for the United States is simply "what now?".

OBL is gone but the echos of his madness are not silent, nor are the reverberations from America's responses to his madness. America launched two wars in response to fear of additional terrorism and both continue to exact a horrific toll of loss for American service men and women and an unsustainable economic burden to our economy. Since 2001, America has created a vast new hidden national security apparatus that is off-budget and unaccountable to most in Congress and unknown to most American citizens that is costing tens of billions yearly. Yet those billions spent didn't yield the intelligence that led to the elimination of OBL and they didn't yield leads that stopped the would-be underwear bomber headed for Detroit.

America was supposed to have learned many lessons about the communication needs of our first responders throughout the country but we squandered many of the funds allocated for those improvements to local and state pork projects or "studies" and now many states are so broke they're resorting to laying off first responders rather than equipping them properly as we swore we'd do after 9/11/2001.

3519 days for one psycho?

I certainly hope the families of the victims of al Queda's attacks in America and around the world can gain a sense of relief, justice and closure from the news. I certainly hope those serving in our military and their families can enjoy some sense of satisfaction and a little hope that their jobs might be able to wind down a bit.

For the rest of us? We still have some thinking and reflection to do. It shouldn't have taken 3519 days to nab the most notorious psychopath currently on the planet. The fact that it did indicates our efforts were not directed over much of these past 3519 days in the most effective directions and probably still are not directed where they should be.

Operation Huck Finn

2011-04-03T21:22:00.005-05:00

Sometimes, it's interesting how seemingly unrelated events in the news arrive from different angles and practically SCREAM to be joined together to make a point, if only people were paying attention. Such is the case with these stories from the past two weeks:

Cleaning Up Huckleberry Finn -- Alabama publisher NewSouth Books, Inc. announced plans in January 2011 to publish an updated edition of Mark Twain's classic novel, with all 239 instances of the N-word replaced with the word "slave." The new edition renewed a decades old debate about the value of Twain's language in making the point of the book versus the angst produced by the raw language in modern classrooms for students and teachers alike. (see #1)

America's New Libyan Adventure -- President Obama commits American military resources to establish and support a no-fly zone, making the theatre safe for a rag-tag band of "rebels" to establish a new pax-democracy using nothing but 30-year old Toyota pickup trucks and a few semi-automatic weapons and shoulder-fired missiles. (see #2)

Corporate America Begs for a Tax Holiday Before Repatriating Overseas Earnings -- In the same week that stories of how General Electric not only paid no US federal income taxes for 2010, but actually received a credit for over $3 billion dollars, 60 Minutes took the time to visit the "corporate headquarters" of a few US firms -- in a sleepy little town named Zug in Switzerland -- which allow those firms to pay only 16 percent on major portions of their income rather than the American tax rate of 35 percent. An interview with Cisco CEO John Chambers featured a plea for special "tax holiday" legislation that might tempt firms such as Cisco to bring back hundreds of billions in profits. The key word there is probably "might." (see #3 and #4)

America Remembers a Deadly Milestone in Labor Relations -- Well, sort of. New York City marked the one hundredth anniversary of a deadly fire at the Triangle Shirtwaist factory in New York City that killed 146 workers locked in their factory by management that provided momentum to a labor movement that eventually improved safety for ALL workers. At the same time, many other Americans and pundits continued piling on union labor as one of a few key contributors to all that ails the country. This despite the fact that labor only accounts for 8% of the total US workforce and that many state and local budget issues stem from a collapse in property tax collections caused by the financial crisis and fraud, something produced entirely by Wall Street banks and non-existent regulatory oversight. (see #4)

----------------------------

Probably top on my list of concerns about America is the sheer number of people who are not only ignorant -- of basic finance, of technology, of how the government is supposed to work and what a government is for, or about history and religion -- but PROUD of being ignorant. The origins and rationalization of that pride may vary. They might stem from some sense of religous spirituality that evolved to a point where faith supersedes logic and facts. They might stem from a cynical attempt at populism and a desire to avoid the appearance of "putting on airs". In many cases, they might just reflect the path of least resistance --- bein' ignert's just a lot less work, after all.

Regardless of the origins, the results wind up the same. This is the ignorance that produces ideas like:

AIDS is God's curse on gays. (Uh, noooo, it's a condition resulting from an infection by a virus that kills key defenses against infections humans can normally defeat with ease.)

I'm rich because God chose me. (Uh, that's possible but it's equally possible your fortune is really the result of a few fortunate decisions amid a larger financial bubble and your "prosperity Gospel" belief that God chose you to be wealthy and chose your neighbor to be poor is really after-the-fact rationalization for being in the right financial place at the right financial time.)

A zero-down ARM for a $500,000 house with only $80,000 in income is safe cuz home prices always go up. My real estate agent told me. (Uh, how can home prices continually rise when incomes are flat and productivity is nearly flat? Where are all those dollars being used to pay those ever-growing mortgage payments coming from if not actual hours worked? DEBT. And hey, dummy, your real estate agent could care less if you default on your mortgage six months later. As long as you close, they collect their commission and are out of the equation.)

---------------

Rather than some new military "Operation Odyssey Dawn" in Libya to defend some indirect principle of freedom, America would be better off pursuing a project we'll call "Operation Huck". At $10.00 per copy, Operation Huck would cost a mere $3.07 billion (the cost of about six days of military operations in Iraq and Afghanistan) and provide The Adventures of Huckleberry Finn in its unabridged full glory to EVERY CITIZEN who would be required to read the original text cover to cover. The purpose of the operation would not involve forcing everyone to read a book with "the N-word" in it. Instead, the mission of the operation would be for all Americans to reach the climax of the book at the same time and maybe enable the collective "ah ha" moment we so desperately need.

The common analysis of Huck Finn cites Twain's use of dialect and frequent use of the N-word as literary devices in service of the following dependent series of goals:

A) truly capturing the level of education and sophistication (and lack thereof) of the mid-1800s American population

B) capturing the particular ignorance of the protagonist in the story, Huck, using the literary device of the naive narrator that tricks the reader into thinking ahead of the narrator

C) using a and b to heighten the tension around Huck's gradual realization of the humanity of slaves and the inhumanity of those who kept them, despite their genteel social veneer

D) bringing it all together at the point where a confused little boy thinks he's committing a sin that will damn him to Hell as he finally agrees to help Jim escape when in fact he's doing the moral thing but has been so twisted by his religion and upbringing that he is morally disoriented

E) thus depicting for American readers the true nature of the country's "original sin" and the problems that must be faced with race relations -- if an ignert 10 year old boy can figure out the real truth, surely the rest of us should be able to

In hindsight, I think Huckleberry Finn can be abstracted one more level beyond the moral issue of slavery and its damage to the country. Twain's masterpiece has survived because it's really a universal cautionary tale of the dangers of willful ignorance in any realm -- with slavery just as an example in a period piece setting. Willful ignorance seems to be America's lasting "original sin."

Do Americans think roads pave themselves? Do Americans think sewers just appear wherever they want a home? Do Americans think fresh water aquifers serving millions of people rebuild themselves after 100 years of service? Do Americans think firefighters just show up for free to risk their lives to stop a fire at your home? Do Americans think doctors magically become brain surgeons by "believing" how to do it? Do Americans think three telecom giants owning all the wires and spectrum and TV networks will tell them that GE buried dioxin in their town? Do Americans really believe it's appropriate for the US to continue loaning out military assets for every natural disaster or "humanitarian" intervention while our friends continue to steal our tax base from under us with artificially low tax rates? Do Americans truly believe that 8% of the total workforce belonging to unions produced the financial meltdown of trillions of dollars in complex, fraudulent financial instruments? Do Americans think no other nations have the financial muscle or political / moral interest to cover the cost of a no-fly zone to topple a terrorist dictator in their own regional backyard? Do Americans think all employers will voluntarily ensure safe working conditions and reasonable work hours while the CEO makes 230 times the average worker?

Maybe America IS the world's one indispensable nation. We're indispensable because we're the sucker. We're the sucker at the table in dealing with our own trans-national, tax-dodging corporate goliaths and the sucker at the table in dealing with the rest of the world community, a community more than willing to let us bankrupt ourselves playing cop on the beat for their regional conflicts while blaming us for desecrating their soil as we do their dirty work.

But everything will be all right. We have "faith." And all of us could be rich someday and don't want to pay high taxes.

=========================

#1) http://www.cbsnews.com/stories/2011/03/18/60minutes/main20044663.shtml?tag=mncol;lst;3

#2) http://dailyherald.com/article/20110402/news/704029870/

#3) http://www.theatlantic.com/business/archive/2011/03/did-ge-really-pay-no-us-taxes-in-2010/73178/

#4) http://www.cbsnews.com/stories/2011/03/25/60minutes/main20046867.shtml?tag=mncol;lst;1

#5) http://www.msnbc.msn.com/id/42273592/ns/business-us_business/

SOTU 2011: Ask Not

2011-01-24T21:28:00.003-06:00

The power of a powerfully crafted message is really quite astounding. Fifty years ago, a man stood in the bright sunshine of a bitterly cold January day after taking the oath of office as President of the United States and spoke about the competing interests of two nuclear powers, pledged continued friendship to our cultural and spiritual allies, pledged assistance to countries making their first movements towards democracy and the unique challenges of a society coming to grips with the role it assumed while preserving freedoms for millions in the world while also correcting deficiencies in those freedoms for millions of its own citizens. In his thoughts on those uniquely American challenges, the new President tossed in a little rhetorical flourish towards the end of the address:

And so, my fellow Americans: ask not what your country can do for you--ask what you can do for your country.

Fast forward fifty years since that address and those few words have easily become among the most recognized words in our entire language, much less the American political dialogue.

Fast forward fifty years since those words were first uttered and they now could form the basis for a State of the Union address.

No Money

If a single word had to be chosen to represent the current economy, fumes might be the best choice. Federal, state and local governments not only have little or no reserve resources for "rainy day" surprises (did you know it SNOWS in New York City in winter?), many now have zero resources for routine minimal operations. If the worst of the financial crisis was behind us, toughing it out for 5-10 years might be painful but do-able. That's not likley the case, however.

The financial picture for the individual states and US Federal Government is a microcosm of the worldwide financial system. Like the US Federal Government acting as implicit backstop to possible state defaults in California, Illinois or New York, Germany is filing a similar role in protecting a precarious balance within the European Union states. Those precarious positions are the financial equivalent of an irresistable force encountering an immovable object -- and just about as predictable. The balance depends upon economies inflating local currencies to sop up OLD bad debt while simultaneously avoiding spooking new lenders from being concerned about the shrinking value of future units of currency used to pay back additional borrowing. The exact number of times this has occured in the past according to plan when trillions were involved isn't known but thought to be very close to zero.

No Willingness To Pay

The fiscal crisis hitting many states raises another fundamental problem facing the country. Based on most press accounts, there seems to be ZERO willingness on the part of any tax payers to pay more for existing services, much less additional taxes for additional services that might be required or advisable (little things like bridge repairs, staffing at financial regulatory institutions to detect future mass frauds, etc.). As an example, the State of Illinois recently raised tax rates SIXTY SIX PERCENT in an attempt to close their budget gap. Sounds draconian -- if not downright fiscally suicidal according to some -- until you realize that sixty six percent added on to a really small number is still a pretty small number. The state income tax rates went from 3% to %5 percent for individuals and from 4.8% to 7% for businesses.

Before jumping on a tax increase as a "job killer", stop and do some math. Assume the average small business pulls in about $1 million in revenue and the owner nets about $250,000. The extra 2% in income tax costs about $5000 which might be enough to hire a fry cook in a fast food joint for four months. Not exactly the kind of hit that's going to make or break a decision to buy a new $50,000 CNC machine or hire a full time worker with benefits.

Of course, the stink over a sixty six percent tax increase begs a more important question. Exactly WHAT was Illinois thinking by only having a 3% tax rate in the first place? Did Illinois find a solution to prevent roads from being destroyed by salt and snow plows? Did Illinois find a solution for primary, secondary and post-secondary education that was twice as cost effective as the rest of the country? Here's a summary of the state income tax rates for Illinois' neighbors (#1):

Iowa -- 6.48%
Missouri -- 6%
Indiana -- 3.4%
Kentucky -- 6%
Wisconsin - 7.75%
Michigan -- 4.35% ***

*** While not technically bordering Illinois, Michigan is another Northern industrial state that has suffered far WORSE economic decline than Illinois yet has a debt/GDP ratio no worse than Illinois and lower debt per capita.

Another interesting way to understand the scope of the debt crisis facing Americans is to reduce the national debt down to taxpayers. America's official 2010 population is 308 million. In that 308 million, there are approximately 114,825,000 households and roughly half of them pay no taxes. The $14 trillion in total debt amounts to $45,454 per American, or $121,924 per household or $243,848 per tax-paying household. Of course, no one's expecting us to pay back $14 trillion in one year. If taxes were restructured to reduce the debt (not just the deficit but the DEBT) to zero over 20 years, the average tax payer would have to eat $12,192 in extra principle payments yearly. If no one's willing to pay those kinds of taxes, where is the willingness to cut spending? Not "fraud and abuse" or "foreign aid" but REAL spending?

Here is one final example of tax hypocrisy for all Americans. For those of you opposed to a "government takeover" of healthcare, consider these questions:

* Did you ask your Congressperson to oppose the expanded Medicare drug program enacted in 2003?
* Are you opposed to Medicaid?
* Have you actually worked with a lawyer to "bankrupt" an elderly parent by transferring their assets in advance to family members so by the time they needed nursing home or hospice care, they were officially indigent and eligible for state aid?

Where's the rugged American sense of individualism and personal responsibility in THAT?

No Brains

There are many examples that could fall under this category but we'll keep it limited to military spending and healthcare, probably the two biggest expense categories jeopardizing the future of the country.

In the military area, perhaps the single statistic that best summarizes the insanity of our strategy or lack thereof is this:

* in 2010, America lost more troops to suicides (468 for active duty and reservists) than to combat (462)

That's the second year in a row this has been the case.

That really means the astronomically expensive wars being fought may not be "hot" in the traditional sense but are certainly "hot" in the psychological stress sense. More importantly, they are doing NOTHING to provide worldwide stability or a material reduction in risk from terrorism. Terrorist attacks have continued unabated worldwide and the thwarting of terrorist plots within the United States have had nothing to do with information gleaned from combat operations in Iraq and Afghanistan. Despite this mismatch between tools and results, we continue to spend $533 billion dollars yearly on "defense" -- twenty three percent of the entire federal budget. And that figure does not include additional billions in "national security" spending not even publicly budgeted. (#2) Despite all that spending on "national security", we continue to see cases where suspicious activity is reported directly to American agencies -- sometimes from family members of the would-be terrorists -- that disappears into the new Department of Homeland Security bureaucracy that is surpassing the dysfunction of the agencies it replaced and consolidated.

In healthcare, special interests continue to thwart any effort to change a status quo which is bankrupting the public and private sector alike through the mis-application of a delivery and payment system that provides inefficient / inappropriate care yet creates zero incentive for any of the participants (patients, doctors, payers) to alter the system.

Atul Gawande published a story in the January 24, 2011 edition of The New Yorker entitled The Hot Spotters addressing flaws in primary care delivery that are producing HUGE costs in emergency care. (#3) The story describes statistical analysis performed by a physician operating in Camden, New Jersey who found that one percent of patients in Camden area medical facilities were associated with THIRTY PERCENT of total costs. These one percent patients were not all afflicted with rare diseases only treatable by astronomically expensive cutting edge prescriptions. Instead, the vast majority had relatively straightforward conditions that remained untreated as patients lacking primary care resorted to emergency care from facilities solely designed for trauma care.

In one case, a woman with MIGRAINE HEADACHES lacking regular healthcare wound up making repeated visits to various ERs and incurring multiple CAT scans and MRIs which -- surprise -- turned up nothing actionable. In essence, the patient got no primary care, escalated to ERs when the pain became unbearable, saw a doctor aimed at ensuring she wouldn't DIE from something like an anyurism or stroke, then after finding no risks of imminent life-threatening issues, released her without ever solving the problem and thus without ensuring she wouldn't come back generating the same cycle of wasted tests. In other cases, patients requiring ongoing prescriptions after major illnesses failed to renew subscriptions or failed to take the medicine -- often because they were old and confused and simply needed someone to follow up with them.

OK America. You're not sold on "government healthcare." You think the current healthcare system is bankrupting American businesses and stifling job growth. What if there was a way to fund the cost of providing primary care physician services and in-home nursing follow-ups that could produce thirty-fold savings? What if -- horrors -- it involved a government program to pay for it? OK, you don't like a "government solution" so what if -- horrors -- it instead involved changing the regulation of insurance companies to lessen the fixation on payment and paperwork and allowed more physicians' time to be devoted to actual delivery of care?

No Choice

At this point in 2011, Kennedy's famous line about "ask not what your country can do for you, ask what you can do for your country" seems quaintly naive. Kennedy spoke at a time when a debate could be framed between a choice of people agreeing to work for improvements in society through the active involvement of goverment ("what your country can do for you") or people finding creative ways to work directly with other people for improvements to the country ("what you can do for your country").

Kennedy couldn't possibly imagine the peculiar form of conservatism that has overtaken the political landscape like crabgrass in August -- a cynical conservatism that assumes NOTHING good or efficient will ever come from ANY group of people acting together through government so any attempt to try is doomed to failure. Strangely, this cynical conservatism has no trouble trusting the fate of the country to individuals acting within a business setting with minimal taxes and even more minimal regulation, even as people crawl out of the wreckage of a financial collapse costing more than a trillion dollars and millions of jobs.

If that's what Americans truly believe, there really are no choices or challenges to pose in the State of the Union address. The entire speech could be boiled down and tweeted to the masses:

Ask not.

======================

#1) http://www.taxfoundation.org/files/state_individualincome_rates-20100327.pdf

#2) http://projects.washingtonpost.com/top-secret-america/articles/a-hidden-world-growing-beyond-control/

#3) http://www.newyorker.com/reporting/2011/01/24/110124fa_fact_gawande

BOOK REVIEW: Fatal System Error

2010-12-29T22:32:00.002-06:00

Fatal System Error -- Joseph Menn – 251 pages (paperback)

Whether you follow world markets, macroeconomics or geopolitics, the combination of mysterious “flash crashes”, global banking meltdowns and political turmoil in emerging economies seems to confirm the adage of "everything is one thing." Globalization has linked markets, economies and societies in ways not imagined even five or ten years ago. Current events could be construed as a crash course in what happens when technology is advancing an order of magnitude faster than any laws to manage it. Though principally focused on the particulars of computer network denial of service attacks and identity theft as new tools for organized crime, the book Fatal System Error by Joseph Menn provides frightening insight into how tools created for cybercrime have already morphed into tools for cyberwar.

The Roots of Cybercrime

Menn’s book begins by focusing on a firm called Prolexic, which was established in 2003 by Barrett Lyon to provide web businesses network support and defenses against distributed denial of service attacks (DDOS). By 2003, Lyon already had several years of experience in analyzing, reverse engineering and stopping DDOS attacks perpetrated against firms dependent upon a functioning web site for profits. Web servers providing content for a web site obviously have a finite amount of CPU horsepower on each server to process requests and all share IP bandwidth to the Internet to carry all that content back to the eyeballs of the people attempting to use the site. At the time Lyon started his business, hackers attacked web sites primarily by sending the site huge amounts of requests from a single remote site and either used up the CPU horsepower or IP bandwidth (or both), preventing the site from answering requests of real customers. Lyon’s primary customers and initial lead investors operated online betting / gambling sites in off-shore locations.

Lyon’s business took off quickly and his skill set widened considerably to keep up with the enemy. The enemy quickly realized that originating a denial of service attack from a single location was of limited value. Even if the source site couldn’t be attacked or shut down, as long as the bogus traffic arrived from a single IP or narrow range of IPs, victims and their local service providers could simply block traffic from that range of IPs – problem solved, no need to pay a ransom to stop the attack. The enemy rapidly adopted the use of computer viruses that could infect thousands / millions of computers and originate small amounts of traffic from those endpoints which looked unsuspecting at each source but still added up to a flood at the victim end to implement the denial of service. Stopping these distributed attacks required understanding the communication required BETWEEN the "drones" and a master that timed the start of the attack.

Much of the book tracks this cat and mouse evolution of offensive and defensive tactics. In tracing that history and Lyon’s involvement, Menn provides a disturbing picture of how small-time teenage hacker crimes rapidly became dominated by organized crime. In hindsight, the linkage is painfully obvious.

1) earliest businesses solely dependent on web customers were off-shore gambling sites
2) hackers know gambling sites need visitors but know they can’t complain to authorities
3) once DOS attacks succeed, hackers know victims may seek retribution as well
4) the hacker’s “business” is also illegal, so best source of protection is existing organized crime bosses

If only the evolution stopped there, the book would be an interesting (to techies anyway...) combination of modern technology and cloak and dagger tale.

From Cybercrime to Cyberwar

The real value of Fatal System Error is the line it draws from cybercrime to cyberware. As Menn traces the efforts of British and American law enforcement to work with foreign governments to prosecute and convict major cybercriminals, he extends the evolution of cybercrime at the point it became controlled by organized crime into control by governments. Everything you need to know to make the connection can be summarized in a single word.

Russia.

Even with distributed denial of service attacks, at some point most attacks still require a single point of control, either for the serving of infected content that creates the drones needed for a later attack or to provide the “command and control” to those drones as they prepare to attack a victim. Between 2003 and 2008, more and more of those “single points” mapped to equipment operating inside data centers operated by RBN – the “Russian Business Network” – ostensibly an Internet Service Provider (ISP) much like Equinox, Savvis, Global Crossing or a few other firms you have heard of that provide large-scale server hosting and large IP access circuit service for high bandwidth users.

The problem with RBN is that despite having facilities worth tens, maybe hundreds of millions of dollars – implying MAJOR financial backing – the company hosts no sites anyone in the world would have heard of and most of the content it hosts involves pornography, child pornography and known mal-ware downloads. In Menn’s analysis and that of many others, RBN was founded by a ring of hackers operating from St. Petersburg, Russia and became controlled by a man referred to as Flyman who possibly operates the largest child pornography ring on the planet. “Flyman” also has ties to both organized crime and political figures that make him untouchable throughout Russia.

All one need do is consider what has been heard about corruption in Russia since the demise of the Soviet Union and the rise of the oligarchs and the clarity of Menn’s summary of the criminal / political danger rings like a bell:

----------------------------
Without some cover from above, no organization could have been so deeply involved in everything from DDoS attacks to spyware – and so public that it advertised "bulletproof hosting" and other services and gave out staffers’ names – while escaping prosecution. The RBN gave off an astonishing combination of mystery and openness that made it all the more menacing: it hid in plain sight. The group dated back as far as 1998, according to Zenz and another of the most influention experts on the gang, a security professional using the pseudonym Jart Armin. Armin believes that the RBN started out as conventional, if proficient, circle of hackers. Then it had a merger with one of the most powerful traditional organized crime groups in Russia, the Tambov gang of St. Petersburg.

If this reading is accurate, the combination became a model for other cybercrime groups throughout the country. Although most hackers started on their own, as they got bigger they developed a need for protection by old-school mobsters, who were better connected politically. Even if they didn’t see such a need, the mobsters might point it out to them in a very persuasive manner. It’s not so much that the hackers feared getting arrested; it’s more that they feared that any police who identified them would demand a bribe. The typical way to avoid paying an exorbitant bribe in Russia is to have one’s own mob ally, or "roof," negotiate for you, according to Joe Serio, an American who worked in the Soviet government’s anti-organized crime bureau.
----------------------------

At this point in the book, Menn begins outlining the direct ties between a series of relatively well-publicized Internet events and security breaches with ties back to the RBN.

----------------------------
2003 – The initial version of the “SoBig” virus introduced a new distributed model of providing infected drones with data for spam attacks then rapidly morphed monthly into new versions, leading security experts to realize attackers planned shutdowns into the life of the code to ensure newer more effective versions wouldn’t have to compete for bandwidth with older iterations of their own viruses. SoBig was traced to a Russian firm called Send-Safe that sold spamming tools.

July 2005 – nearly 45 million credit card numbers are stolen from American firm TJX after wireless networks in stores are compromised by hackers. The leak costs TJX nearly $100 million dollars and the theft is traced to hackers in Ukraine, Belarus and Estonia. Those hackers were then linked to an American hacker Albert Gonzalez previously arrested by the FBI for involvement in a smaller-scale credit-card theft ring. Gonzalez was actually acting as an FBI informant while masterminding the even larger credit-card thefts at TJX and later Heartland Systems and CitiBank ATMs. One of his indicted co-conspirators worked at Morgan Stanley (#1)

April 2007 – attacks on web sites of the government of Estonia

July / August 2008 – attacks on Internet infrastructure in Georgia, starting with sites associated with the town of Gori, which was the first town to be bombed by Russian forces.

August 2009 – attempts to block views for a single user’s Facebook site on the anniversary of the Georgian War took down Facebook worldwide– the user was a noted critic of Russian actions in Georgia
----------------------------

So the Russian government is hiding behind the cover of hackers to go after political opponents in a bunch of former Russian states we couldn’t care less about, right?

Wrong. Menn makes the following points in discussing the morphing of cybercrime into cyberwar:

The head of the cybercrime division in our Justice Department believes East European gangs possess about half of the world’s credit card numbers – they just haven’t used them yet.

The author who published a treatise describing the creation and use of the SoBig virus has remained anonymous to this day for fear of his life. That author believes the virus wasn’t released in order to provide drones for generating traditional mindless spam but to serve the needs of an even more powerful group pulling the strings BEHIND the Russian Business Network. Others have taken that hint to suggest release of the virus was actually instigated by the Russian Federal Security Service (FSB) which is pretty much the modern day KGB.

Trojan horse software originating from infected USB drives that attacked the US defense department in 2008 was traced to Russian sources. (#2)

One of the British citizens arrested in 2007 for various terror and the purchase of roughly $3.5 million worth of airline tickets, cellphones, night-vision goggles and other “implements of destruction” was a regular participant on carderPlanet, a Russian site dedicated to sharing credit card scamming and phishing tools. In short, computer crimes are becoming a popular and productive source of funding for terrorist groups.

Menn then summarizes the tug-of-war between Google and the Chinese government as it attempted to offer search and email services in China. Most Americans know Google had to comply with oppressive restrictions on search results (most famously, “tank man” results are very different in China -- #3). A few may be aware of a dust-up in early 2010 over hacking attacks of gmail accounts originating from Chinese network addresses. What most don’t know is that the attacks focused on accounts of Chinese dissidents and that the hacking methods built upon other Google intellectual property stolen by Chinese hackers. In essence, Menn’s summary of the Google experience in China highlights the next mode of operation in cyberwar. In Russia, they’re still maintaining the illusion that hackers are operating independently of the government. The Chinese government wastes no effort on such pretense.

Looking Ahead

The author’s conclusion to the book focuses primarily on the technical and regulatory gaps that must be plugged to mitigate some of the risks posed by criminal organizations leveraging insecure networks and millions of compromised computers. The logistics of educating lawmakers across the world and adopting software and network changes that reflect needed fixes are obviously difficult and justify a great deal of attention. However, Menn doesn’t address the macroeconomic and social dangers associated with the status quo. After reading Fatal System Error, anyone remotely familiar with the mechanics of the current financial industry and the networks of most large corporations will come to one inescapable conclusion. The combination of Russian mafia interests backing Russian hackers and Chinese leaders supporting intellectual property heists of any cutting edge hardware or software virtually guarantees a “black swan” scale event in the near future. The only real question would appear to be whether the swan will have a Russian or Chinese accent.

=========================

#1) http://en.wikipedia.org/wiki/Albert_Gonzalez

#2) http://news.cnet.com/8301-1009_3-10104496-83.html

#3) http://www.pbs.org/wgbh/pages/frontline/tankman/internet/sidebyside.html

Elections and America’s Unholy Trinity

2010-10-31T22:46:00.003-05:00

I’ve worked in management for all of my professional career. Most of that career has been spent in large corporations. For over two decades, it has been fashionable for most large firms to formulate written "Code of Business Conduct" documents and required managers above a certain level to sign yearly statements indicating their understanding of the content of that code. For firms tagged with anti-trust lawsuits or gross safety or accounting failures, the practice was frequently required by judicial settlements. In the post-Sarbanes/Oxley management world, ALL publicly traded American firms are now REQUIRED to have these written codes in place and are REQUIRED to have ALL managers of the firm review them annually.

In the post-Sarbanes/Oxley world, the precise wording of these Codes has become much more critical so reviews of the code by employees who later get caught forging millions of mortgage documents, lying to clients about billions in collateralized debt swaps or inflating earnings provide some limited legal protection for the firm and its top executives. Most Fortune 500 firms don’t actually craft the Code of Business Conduct review material itself. Instead, they farm the task out to consulting firms who deliver it in the form of electronic training. To management, outsourcing of the COBC training has all of the following benefits:

a) no need to employ anyone in HR who is actually capable of explaining the material
b) we know the material will have been used by many firms, providing legal comfort that the language covers the regulatory bases and the firm’s legal you-know-what
c) we can deliver the training electronically and collect electronic proof (date, time, content and employee ID) that employees have seen EVERY SINGLE PAGE of the training

Recently, it was my turn once again to review my firm’s Code material. Like most other firms, my firm’s training is outsourced, electronic on-line material so I logged in from home (you can’t possibly sit through an hour of material during a workday), accessed the corporate intra-net via VPN, and dove in.

The very first section of the material focused on explaining exactly why employees were being asked to dedicate an hour to review the material. I don’t want to quote the material exactly for copyright reasons, but the nutshell version of the stated goal was this:

Reviewing this material ensures employees understand their responsibility to report any conduct by any employees of the firm that violates these codes.

Okay, stop. That much I get. Makes perfect sense. This is the CYA aspect of the training that ensures that if an underling spots wrong-doing but fails to report it, upper managers have some plausible explanation and possible defense. Then it continues:

Prompt reporting of violations is critical to ensure that actions of one or a few employees do not counteract the goals of the company itself.

I haven’t quite paraphrased the sentence perfectly but it struck me at the time that the sentence was very carefully, methodically phrased and the reference to the company was to THE COMPANY, not a collection of executives or the entire employee body.

Can anyone spot the problem in the premise of such a statement?

I’ll give points if you read that sentence and spotted the not-so-subtle assumption that a corporation has only positive, completely legal and thoroughly ethical goals and that any bad goals or actions only arise from individuals.

However, that’s actually not the correct answer.

The REAL problem with that statement is the assumption that a corporation has ANY goals or ethics, either good or bad.

Corporations – Sanctified Legal Fictions

A corporation doesn’t think. A corporation doesn’t feel. A corporation doesn’t have goals. A corporation doesn’t have morals. A corporation is the business equivalent of the Glenn Miller Orchestra. It’s a collection of individuals acting under a single legal identity accepted within the judicial system that can continue operating indefinitely as individual members come and go as long as the group as a whole agrees to continue operating and can maintain a legal tie to the original identity or founding idea, both of which are often long gone.

You can’t assume a corporation will do the right thing. You can’t assume a corporation will learn or remember its lesson from being punished for doing the wrong thing. You can’t assume a corporation with many talented people will overcome a business challenge and survive. The behavior of a corporation is based upon the balance of personalities, talents, management structure and social skills of the individuals in the firm. That balance changes nearly every day as employees come and go.

These truisms apply to ANY collection of individuals. It’s true for collections of people operating as a civic group, people operating as a non-profit business, people operating as a charity, people operating as an army, people operating as a government and yes, even people operating as a religion.

Of course, the one key difference between a corporation and these other types of human institutions is that a corporation’s very legal reason for existence is to simplify the accumulation of economic wealth over time and stimulate that growth by providing limits to the legal and financial liability of its shareholders to encourage risk-taking. That distinction is VITALLY IMPORTANT.

Stone Tablets And Fine Print

Public failures and humiliating embarrassments over the past 50 years of American history have tarnished the reputation of and spiked distrust and cynicism towards every type of human organization – armies, governments, charities, religions. Except one, it would seem. Business. Especially small business, if you paid attention to the four billion dollars of advertising in the 2010 elections. According to the stone tablets governing this religion of business, small business --- accounting for sixty-five percent of all job creation in the country (#1) – is the very bedrock upon which our entire country stands.

Unfortunately, stone tablets are notoriously unsuited for fine print. The fine print to this story is that while small business employs 50% of all private sector employees, small business accounts for far less than 50% of all business profits. Actual PROFITS are highly concentrated in the hands of the largest firms. How many small businesses do you think it takes to equal the profits of Microsoft or Oracle? Microsoft made $18.7 billion for its 2009 fiscal year. The typical definition of a small business is a firm employing less than 500 people and taking in less than $7 million in revenue. That means PROFITS will be even less than $7 million. If a small business had a 10 percent profit margin (enviable) and netted $700,000 in profits, it would take 26,714 small businesses to match Microsoft’s profits.

You don’t have to work for large companies very long to agree that very few revolutionary ideas and improvements are likely to come from large companies. With few exceptions, they’re too lazy, risk-averse and worried about cannibalization of their own product lines to “think outside the box” and come up with the next personal computer, browser, search engine or MP3 player (hint, Apple didn’t invent the MP3 player – it wasn’t even third to market). However, in the evolutionary financial cycle, THEY DON’T HAVE TO INNOVATE. As long as the small businesses who DO innovate are paralyzed, the status quo remains profitable and it is predominately big business that profits most from the status quo.

The Religion of Business and Elections

The central theme of the 2010 election has involved anger over “job-killing” government taxes and wasted stimulus spending that has produced no perceptible improvement in unemployment. If only government would stop its wasteful spending and lower those job killing taxes, we’d bounce right back to the glory days of 2005 and the American dream of the two-SUVs-and-every-child-with-their-new-$300-video-game-or-iSomething perversion of the American dream. All funded by HELOCs funded by ever-rising home prices.

It sounds like an easy diagnosis in a 30-second attack add but the reality is far different.

The reality is:

Taxes have been HIGHER in the past and did not CAUSE these problems.

Our books are out of order in part because we chose to cut taxes by nearly $300 billion per year (for a total cost of $1.8 trillion dollars -- see #2) in mid-2001 then chose to launch two wars of choice costing over $1 trillion dollars.

Unemployment had been rising steadily from January 2008 through September 2009 (see #3) and has leveled out but is unlikely to decline in the near term REGARDLESS of tax cuts. While profits may fluctuate, big businesses remain profitable because, by definition, they have grown big by focusing on segments profitable over the entire business cycle that benefit from economies of scale. Risk-taking is what small companies do best but they’re much more risky during downturns and that’s our situation so why lend to small business?

Financial markets imploded because big firms were not properly regulated and audited. The biggest firms that participated in the practices that produced the meltdown actually got BIGGER during the panic, producing MORE financial uncertainty and risk, not less.

Cutting taxes on big business won’t create jobs, it will simply increase the dollars going to the top executives and shareholders. Payouts to shareholders may stabilize pension funds based upon shares in large companies but that alone will not produce new jobs.

Cutting taxes WILL further impair government’s ability at all levels to properly regulate big business, which may very well produce future meltdowns which destabilize the entire economy and destroy jobs.

Cutting taxes WILL worsen near term deficits, further spooking foreign investors and increasing the risk premium portion of interest rates on US Treasuries, further increasing the long-term cost of our $13.6 trillion in debt. (A one percent increase in interest paid on T-Bills costs us $136 billion in additional interest per year.)

Any true “Tea Party” candidate winning office and who begins working to cut spending will find themselves immediately ostracized by both Democratic and Republican leaders who, if they agree upon nothing else, agree that any actual progress made by “third party” candidates is an attack upon their two-party power which will be defended at all costs.

Any vote to re-institute political gridlock won’t actually prevent more bad policies and wasteful spending. It will only block the pursuit of policies that Americans care about as individuals. Policies beneficial to the biggest of businesses will continue sailing through the government unabated and likely undebated. You tend to get exactly what you want when you get to write the legislation yourself.

America’s Unholy Trinity

So why is it that a country so proud of its rugged individualism and so proud of its Constitutional balance of personal rights and freedoms against group power is so willing to trust the one flavor of human organization whose sole purpose is to outlive its members and concentrate power?

It seems America’s true religion is based upon a uniquely American combination of too-big-to-trust mega-corporations that have more economic power than many countries, a corrupt government of the Democratic and Republican parties, by the two parties and for the two parties, and an American electorate that keeps hearing the same lies and keeps rewarding the same behavior. Call it America’s Unholy Trinity of greed, corruption and stupidity.

So, exactly how stupid is America? We’ll know around 9:00pm Tuesday, November 2, 2010.

==============================

#1) http://www.sba.gov/advo/stats/sbfaq.pdf

#2) http://www.tax.com/taxcom/taxblog.nsf/permalink/chas-89lpz9?opendocument

#3) http://www.shadowstats.com/alternate_data/unemployment-charts

Too Rolling Stoned -- Make That Three

2010-06-28T20:19:00.003-05:00

The week of June 21, 2010 might have been most notable for a Rolling Stone article that resulted in a change of command in the war in Afghanistan after General Stanley McChrystal and his trash-talking staff shot themselves in the foot while complaining of the difficulties of fighting a counterinsurgency war. However, The Runaway General wasn't the only important piece to run in that issue of Rolling Stone. It wasn't even the most important piece to run in Rolling Stone in the month of June. All three of these articles should be must reads for every American:

The Spill, the Scandal and the President

http://www.rollingstone.com/politics/news/17390/111965

BP's Next Disaster

http://www.rollingstone.com/politics/news/17390/120130

The Runaway General

http://www.rollingstone.com/politics/news/17390/119236

Here's why.

The Spill, the Scandal and the President

This story, written by Tim Dickinson, summarizes the gaps between the rhetoric of the 2008 Obama campaign and the policy actions taken by the Obama administration and it's not a pretty picture. Obama campaigned on the need to overhaul a completely corrupt and ineffective Minerals Management Service (MMS) agency. MMS had shown up on the political radar in 2007 after details of mistakes (or favors masquerading as mistakes) were reviewed by Congress regarding dozens of lease contracts awarded between 1998 and 1999 and approved by MMS.

In 1995, legislation entitled the Deep Water Royalty Relief Act (DWRRA) was enacted which waived royalty payments paid by oil producers to the government in the event that oil prices were lower than $28 / barrel. The goal was to provide long term predictability for profits from deep water rigs even if prices temporarily dipped below a point thought to make such wells financially impractical. Unfortunately, ALL leases issued between 1998 and 1999 EXCLUDED the $28 caveat, essentially exempting producers from ANY royalties from wells during that period. (see #1).

The man in charge of the group within MMS that oversaw those lease sales and approved the flawed royalty terms was Chris Oynes, who led the Gulf of Mexico unit within the MMS from 1994 to 2007. Did the mistake cost Oynes his job? Curiously, no. Oynes was promoted in February 2007, two months before the GAO published its findings on mistake. Three months after his promotion, his boss, Ms. Johnnie Burton, resigned over controversy related to her statements made to a House sub-committee found to conflict with the results of an audit conducted by the Department of the Interior itself about when the extent of the royalty mistake was first known. (see #2)

Estimates for the lost royalties vary widely since the value of the royalties depends upon market prices for crude oil and natural gas. For the leases issued between 1998 and 1999, estimates range from $6.4 billion to $9.8 billion. However, a lawsuit on a related issue could widen the range of leases affected by the elimination of the $28 ceiling to cover 1996 through 2000. Cost estimates published by the Government Accounting Office in April of 2007 for losses associated with the larger pool of leases range up to $60 billion if the government loses the lawsuit. (see #3)

The Obama transition team can't really claim they forgot about the campaign pledges about cleaning up the MMS agency in the hoopla between November and January. Dickinson spoke with Rick Steiner, who Dickinson cites as a major scientific contributor to the Exxon Valdez cleanup effort in Alaska.

----------------------------------
Scientists like Steiner had urgently tried to alert Obama to the depth of the rot at MMS. "I talked to the transition team," Steiner says. "I told them that MMS was a disaster and needed to be seriously reformed." A top-to-bottom restructuring of MMS didn't require anything more than Ken Salazar's will: The agency only exists by order of the Interior secretary. "He had full authority to change anything he wanted," says Rep. Issa, a longtime critic of MMS. "He didn't use it."
----------------------------------

Only the explosion onboard the Deepwater Horizon and the resulting eleven deaths triggered his resignation. But don't worry about Oynes. I'm sure his retirement will be as comfortable for him as it was for his former boss. Johnnie Burton is now on the staff of Wyoming Representative Cynthia Lummis. It will come as a shock to no one to learn Rep. Lummis is a member of the House Subcommittee on Energy and Mineral Resources.

Would firing Chris Hoynes in early 2009 after the Obama Administration took the wheel have prevented the Deepwater Horizon disaster? We'll never know. It is clear the Obama Administration failed to formulate any clear plan to address obvious BILLION DOLLAR weaknesses in a agency it had complete latitude to change that had provided fodder for the 2008 election.

A more damning point made in Dickinson's piece involves information provided by scientific teams within various federal agencies and official communications issued by the Obama Administration to the public about the scope of the oil leak. On March 9, 2009, the Obama Administration issued a memorandum (see #4) with a subject of "Scientific Integrity" that stated at the very top of the memorandum the following:

----------------------------------
Science and the scientific process must inform and guide decisions of my Administration on a wide range of issues, including improvement of public health, protection of the environment, increased efficiency in the use of energy and other resources, mitigation of the threat of climate change, and protection of national security.

The public must be able to trust the science and scientific process informing public policy decisions. Political officials should not suppress or alter scientific or technological findings and conclusions. If scientific and technological information is developed and used by the Federal Government, it should ordinarily be made available to the public.
----------------------------------

So how is the Obama Administration doing at meeting this seemingly simple goal?

In its first and possibly most obvious test that involves science, energy, the environment and public trust ALL AT THE SAME TIME, the answer has to be HORRIBLY. Dickinson's story describes information about a meeting held at a NOAA office in Seattle within hours of the blowout to review mitigation efforts and the possible volume of leaking oil. Dickinson writes:

---------------------------------------
Written on a whiteboard at the front of the room is the government's initial, worst-case estimate of the size of the spill. While the figure is dramatically higher than any official estimate issued by BP or the government, it is in line with the high-end calculations by scientists who have monitored the spill.

"Estm: 64k - 110k bbls/Day." The equivalent of up to three Exxon Valdez spills gushing into the Gulf of Mexico every week.

Damningly, the whiteboard also documents the disconnect between what the government suspected to be the magnitude of the disaster and the far lower estimates it was feeding to the public. Written below the federal estimate are the words, "300,000 gal/day reported on CNN." Appearing on the network that same day on a video feed from the Gulf, Coast Guard Rear Adm. Mary Landry insisted that the government had no figure. "We do not have an estimate of the amount of crude emanating from the wellhead," she said.
---------------------------------------

This is within HOURS of the spill yet for WEEKS after, a figure of 5000 barrels per day was continually fed by the Obama Administration and BP to the public.

BP's Next Disaster

The July 8 edition of Rolling Stone includes a second article by Tim Dickinson that looks forward to the next high-tech / high-risk drilling effort being pushed by BP -- a drill site in the Arctic and other Arctic sites being targeted by Shell. The story outlines numerous challenges unique to Arctic drilling such as season access limitations and horizontal drilling extending further than any current wells anywhere in the world. It also highlights numerous question marks about the validity of technical plans by BP and Shell for addressing the unique Arctic challenges, their disaster plans for possible blowouts and the rubber stamp approval provided by MMS to those plans.

In bullet form, the key concerns raised in the article are:

* BP's claim to be able to handle blowout discharges up to 20,000 barrels per day
* use of a man-made gravel island three miles offshore so "off-shore" regulations don't apply
* drilling 2 miles down then 6 to 8 miles horizontally to reach the oil formation
* permits granted to Shell for other Arctic wells specifically exclude any worst-case scenario such as a blowout
* disaster plans filed by Shell for those permits state a limit of 5,500 barrels per day for response capacity, an amount obviously inadequate in light of current experience
* well sites would redefine the word "remote" -- the nearest Coast Guard facility is 1,000 miles away
* the nearest boom supplies to contain spilled oil are in Seattle, 2,000 miles away
* the ocean in these areas is frozen half the year, making access virtually impossible
* Shell claims its operation would be safer than BP's gulf well since the Arctic wells would only be in 150 feet of water but government data shows blowouts are equally likely in shallow water

In light of the Obama Administration's interaction with the scientific community on the Deepwater Horizon disaster, the concerns raised about Arctic drilling are -- pardon the pun -- chilling.

The Runaway General

Michael Hastings' story on General McChrystal and his inner dialog thoughts about his chain of command and diplomatic teammates certainly produced an immediate impact on the public and the war effort in Afghanistan. However, after reading the entire article, one can mask all the comments about individual players (Obama, Biden, Holbrooke, Eikenberry) that triggered McChrystal's demise and STILL come away with a damning picture of the effort in Afghanistan, the strategy behind it and likely outcomes. In the larger scheme of things, that bigger picture is the only picture that should matter, to both the Commander-in-Chief and the American public.

After five pages serving much of the red meat content of inflammatory comments from McChrystal and his staff and some background on McChrystal's career, the final three pages of the story provide the more important part of the story -- the problem McChrystal was experiencing explaining the counter-insurgency (COIN) war plan to troops in the field. Everyone up and down the chain "gets it" in words, but in reality, the implementation of the strategy isn't clicking. From the story, here's one reaction:

--------------------------------------
"Bottom line?" says a former Special Forces operator who has spent years in Iraq and Afghanistan. "I would love to kick McChrystal in the nuts. His rules of engagement put soldiers' lives in even greater danger. Every real soldier will tell you the same thing."
--------------------------------------

McChrystal clearly understood the frustration felt by troops in the field and made field visits to personally explain the 'rubber meets the road" implications of the strategy a top priority. He also understood those visits were crucial for morale by giving troops a chance to vent -- directly to the man issuing the rules. Here's how one visit was described:

--------------------------------------
Then he spends 20 minutes talking about counterinsurgency, diagramming his concepts and principles on a whiteboard. He makes COIN seem like common sense, but he's careful not to bull**** the men. "We are knee-deep in the decisive year," he tells them. The Taliban, he insists, no longer has the initiative – "but I don't think we do, either." It's similar to the talk he gave in Paris, but it's not winning any hearts and minds among the soldiers. "This is the philosophical part that works with think tanks," McChrystal tries to joke. "But it doesn't get the same reception from infantry companies."
--------------------------------------

In short, the McChrystal story should have been a game-changer even if McChrystal and his staff kept their mouths shut about their likes and dislikes in the Obama Administration. Comments from troops in the field reflect the complete disconnect between stated policies and timelines versus reality. The reality is

* our political partner in COIN (the Karzai government) is hopelessly corrupt
* our military is financially and physically exhausted from nine years of war
* our economy is past the breaking point to be able to afford three to five more years of war, even at COIN intensity rather than all-out war
* all of this was understood two years ago
* no President believes it is possible to officially announce a policy of "cut losses and widthdraw"

In other words, we have an irresistible force (a collapsing economy needed to pay for a war) meeting an immovable object (a political unwillingness to withdraw from an unwinnable, uncontrollable, unaffordable military mistake).

Of course, that's not nearly as easy a story to grasp as "top general calls CIC not very engaged."

==================================

#1) http://www.gao.gov/products/GAO-08-792R

#2) http://issa.house.gov/index.php?option=com_content&task=view&id=321&Itemid=28&tmpl=component

#3) http://www.gao.gov/products/GAO-08-792R

#4) http://www.whitehouse.gov/the_press_office/Memorandum-for-the-Heads-of-Executive-Departments-and-Agencies-3-9-09/

Memorial Day 2010

2010-05-31T20:56:00.003-05:00

Memorial Day weekend in America, 2010. A weekend of images of kids at the pool, barbecues in the park and piercing blue sunny skies shining down on former battlegrounds which have all the trappings of a beautiful park -- if one can overlook the thousands of well-tended graves marked with American flags set by young scouts to honor thousands who sacrificed their lives for the greater good as they saw it. For many years, the Norman Rockwell imagery of Memorial Day in American we'd like to have has been increasingly crowded out by the normal crassness of modern America that morphs the holiday into another opportunity for sales on furniture, autos, or whatever else Madison Avenue has decided to convince us to want and buy.

However, something's definitely different about Memorial Day today, May 31, 2010. The clash between the true purpose of the holiday (or even its Norman Rockwell idealization) and our current priorities and collective behavior as a country could not be more jarring. This holiday weekend, the failure of the latest effort to stop the leaking of tens of thousands of barrels of oil into the Gulf of Mexico became apparent and with that failure, a more important series of failures have become apparent. These failures go to the heart of what is really "American" and the causes for which so many American service men and women have fought and given their lives. These failures involve business, government and citizenship itself.

Business

To understand the true magnitude of the business failure of the Deepwater Horizon disaster, one only has to start with four key points raised in a story aired on 60 Minutes on May 16, 2010. (see #1) The story contained an in-depth interview with a TransOcean employee, Mike Williams, who worked on the Deepwater Horizon and survived the blowout of the well and resulting explosion on the rig. The Williams interview and that of another BP employee, Ken Abott, responsible for auditing thousands of engineering and disaster contingency documents for a similar deep-water rig named Atlantis operated by BP point out a chilling pattern of conduct by BP and its partners:

1) BP knew it was drilling beyond its experience and in unpredictable geologic formations when its first drilling attempt stretched from the predicted 21 days to six weeks, only to lose the first hole when they split open the hole, lost tools used to try to seal that failed attempt and had to start over.

2) BP continued drilling operations despite information that one of the two electronic control pods governing the blow-out preventer was not functioning.

3) Sloppy work by BP and TransOcean employees during a routine test of the blow-out preventer damaged a key seal in the BOP when someone moved the drill pipe FIFTEEN FEET up and down while the BOP was clamped around the pipe. The movement ground up large pieces of the seal which reached the deck of the rig and were identified as pieces of the crucial seal. BP continued operations despite proof the seal was irreparably damaged.

4) Despite all of the above -- high deep-sea pressure, damaged BOP control electronics, damaged annular seal around the pipe within the BOP and consequently suspect pressure tests -- BP operations managers wanted to save some time during the conversion from drilling to production by reducing the quantity of "mud" in the well before all of the three cement plugs had fully cured.

An article in the The Washington Post (see #2) referenced information that BP and its contractors also reduced the number of spacers -- from 21 to only 6 -- used within the well that ensure concrete poured around the center drill pipe produced an evenly thick outer casting. Fewer spacers along the length of the pipe increased the likelihood of the inner pipe shifting to one side, narrowing that portion of the outer wall, reducing the amount of pressure that portion of the wall could withstand. (see #3)

In short, the disaster in the gulf was not TECHNCALLY inevitable from an engineering perspective. Additional precautions could have been taken but weren't and those precautions that WERE taken produced incontrovertible data indicating that work should have been stopped and re-organized. Instead, those signs were CONSISTENTLY overruled by business managers in what can only be described as a COLLOSAL failure of imagination in considering what might be worse then spending a few extra days re-drilling or re-re-drilling a well.

Was the series of management decisions aboard the Deepwater Horizon that allowed the catastrophe to occur a one-time lapse in judgment on the part of BP and its contractors? Absolutely not. As Ken Abott indicated in the 60 Minutes piece, BP operates another deepwater facility called Atlantis for which EIGHTY NINE PERCENT of its disaster planning and engineering documents required by law are incomplete or unaudited. BP also recently lobbied the Canadian government to relax current Canadian regulations requiring secondary "relief wells" to be drilled in the same season as a primary well to ensure avenues to cut off deep-water leaks are already in flight once the primary well drilling nears the actual formation where oil could begin leaking. (see #4)

BP's behavior is most disturbing because it's not unique to BP. It's not even unique to the energy industry or even "dangerous" industries. The heads-we-win, tails-someone-else-pays mentality dominates every sector of business. Despite the pattern of behavior and its disastrous consequences, the default position in any debate over business ethics and limits on size, etc. remains one in which business MUST be trusted as corporate angels until (apparently) people die, billions are destroyed or stolen, miles of coastline are irrevocably fouled or ALL THREE occur in one event.

Is there anything in the Declaration of Independence or Constitution that places the well-being of even a single corporation above that of a single citizen? Do people really fight and die for America to defend the right of an oil executive to ignore dozens of safety regulations and test results and insist on drilling to increase profits for shareholders?

Government

The drilling disaster in the Gulf seems like the latest in a long series of bad 1970s disaster movies. We've all seen them. An interchangeable plot involving a giant cruise ship, modern high rise or jet airliner with all the latest technologies enabling us clever humans to ignore all the precautions required of "old technology" as we place higher and higher bets on everything working perfectly. Of course, the entire system is still crucially dependent upon one component -- humans -- that can NEVER work perfectly and disaster (and really bad theme music) ensues.

Let's review some of the more notable disaster movies of the past decade, shall we?

December 2, 2001 -- Enron, a firm ranked #7 on the 2001 edition of the Fortune 500 with $100 billion in "revenue" and $979 million in "profits" files for bankruptcy. Its bankruptcy filing listed about $63 billion in "assets" and $13 billion in liabilities. Among the genius firms heavily invested in the firm at the time of its bankruptcy were Citigroup ($3 billion), JPMorgan ($2 billion) and Bank of New York ($2 billion). (see #5) In essence, the bankruptcy was triggered after a single journalist, Bethany McLean, had the temerity to ask a simple question -- For a firm claiming ONE HUNDRED BILLION in revenues, shouldn't it be easier to find any sign whatsoever of the $979 million in profits? (see #6) Apparently, the only thing more difficult than finding cash in Enron's treasury was finding fraud in its books. At least for its auditors, Arthur Andersen. Despite the cover story question posed on March 5, 2001, it still took nearly nine months for the "professionals" on Wall Street to see through the fog and fraud and head for the exits.

July 21, 2002 -- Worldcom, the second largest long distance company in America and #42 on the 2002 Fortune 500, files for bankruptcy listing $107 billion in assets and $41 billion in liabilities. Interestingly, among the bankers willing to line and throw more dollars to the firm prior to its bankruptcy filing were Citigroup, JP Morgan and GE Capital. (see #7) The bankruptcy was triggered after identification of $3.8 billion in incorrectly capitalized charges for access circuits used to terminate calls to local telephone companies. The cost of trunk terminations is among the most basic components of a telephone company and can be predicted within single percentage points based upon minutes of use which are directly correlated to revenue. Yet Worldcom's auditors, Arthur Andersen, the same firm that failed to spot YEARS of fraud at Enron, failed to catch the fraud. In layman's terms, this is the equivalent of conducting an audit of the hot dog concession at Yankee Stadium and signing off on books stating

Hot Dog Revenue = $6,000,000
# Hot Dogs Sold = 1,000,000
Hot Dog Cost = $200,000 ($0.20 per dog)

The Year 2008 -- The entire American financial system experienced nearly eight months of cascading failures after millions of bad home mortgages triggered a meltdown in valuations of multiple layers of derivative securities manufactured from those bad mortgages and stamped with quality ratings manufactured out of thin air. In a nutshell, the entire collapse was caused by

* twelve years of blind faith in the infallibility of "free markets" on the part of the Federal Reserve
* legislation in 1999 removing any remaining separation between retail and investment banking
* legislation in 1999 explicitly protecting derivative contracts from ANY regulation
* artificially low interest rates created by the Fed's attempt to sustain growth after terrorist attacks

The banking meltdowns of 2008 destroyed TRILLIONS in (paper) wealth and cost taxpayers an additional $700 billion in bailouts and, perversely, triggered further concentration among the biggest surviving banks which will undoubtedly yield similar problems in the future.

As if to rub our collective noses in the sheer incompetence of the government entities responsible for enforcing any semblance of regulation in the financial sector, the year 2008 ended with the arrest of Bernard Madoff after his $50 billion dollar "investment management" firm was found to be a ponzi scheme. The Securities and Exchange Commission had the fraud case handed to them -- TWICE -- on a silver platter by an outside analyst who definitively proved it was impossible for Madoff's operation to have executed the quantity of trades claimed (and thus be exposed to the broader market and its performance) while producing the steady returns he claimed on his clients' monthly statements. Stop and think about that for a moment. A complete and total fraud of $50 BILLION DOLLARS operated in plain site for over twenty years, even after the authorities were notified TWICE over a period of nine years.

In the case of the drilling disaster, it's hard to blame the Obama administration for over twenty years of inertia that defanged virtually every applicable agency. The drilling permits for the Deepwater Horizon were approved under the Obama Administration but it would have proven very difficult for the Obama Administration to pick yet another battle and fight for tighter safety audits and more stringent safety designs for the permit in the absence of a prior disaster.

However, it's not hard to cite the Obama Administration for a failure of imagination in reacting to the blow-out once it occurred. It took a couple of days for reports to get out that the sinking of the rig had broken off the riser and disclose the fact that the blow-out preventer at the sea floor had in fact failed. Once that news became public, it shouldn't have taken more than a day for someone in the EPA, DOE, MMS and any other alphabet agency to do some basic math:

* oil is flowing through a 9-inch diameter drill pipe (63.5 square inches)
* reviews of the leak video reflect a flow of 100 centimeters per second (39 inches)
* 9 inch diameter = 63.5 inch area x 39 inches/sec = 2479 cubic inches / sec = 10.7 gallons/sec
* 10.7 gallons per minute = 924,480 gallons per day = 22,000 barrels per day

Curiously, an even simpler calculation yields almost the same result:

* BP attempted to accelerate drilling because NOT producing was costing them $2 million per day
* $2 million per day with $74/barrel oil equates to lost production of 20,000 barrels per day

So with a bit of sixth grade math to gauge the problem as MASSIVE in scale, why did agencies in the Obama Administration not IMMEDIATELY force BP to develop parallel path strategies (sub activation of remaining valves on the BOP, containment hat, siphon pipe, secondary wells, etc.) to solve the leak? Why didn't the simple leak estimate calculation drive a more aggressive plan with local communities for boom containment efforts or more booms closer to the accident site?

Even if one thought BP is "responsible" for the accident and capable of covering the damage, that's not really the point once the accident happens. The point isn't to simply accept the damage and send BP the bill. The point should have been to leverage every resource imaginable to MINIMIZE the damage. That concept seems to have been bred out of nearly every layer of government. If the Deepwater Horizon had been the first disaster to befall America in ten years, one might excuse the lack of worst-case imagination. America hasn't had that kind of luck and responsibility for the lack of imagination goes directly to Barack Obama.

Citizenship

Ronald Reagan declared war on government itself in his first inaugural address:

In this present crisis, government is not the solution to our problem; government is the problem. From time to time we've been tempted to believe that society has become too complex to be managed by self-rule, that government by an elite group is superior to government for, by, and of the people. Well, if no one among us is capable of governing himself, then who among us has the capacity to govern someone else? All of us together, in and out of government, must bear the burden.

Read those words carefully. Reagan didn't say BAD government or CORRUPT government or STUPID government was the problem. GOVERNMENT was the problem. All government. But self-rule of the corporations, by the corporations and for the corporations was the ideal.

Let's be clear. GOVERNMENT is not the problem. BAD GOVERNMENT is the problem. And that's exactly what the Reagan Revolution wrought. Government that did less yet cost us far more in direct terms and in indirect, long-term costs. The Reagan Revolution further cemented the habit of filling the smaller number of regulatory positions left with industry insiders. And to top it all, the Reagan Revolution didn't force ANYONE to bear the burden -- at least anyone in favored tax brackets. Instead, the Reagan Revolution ran up the cost of bad government and passed it on to future generations. American voters have continued to support the fantasy of defecit financed, do-nothing government for the next twenty eight years.

So how is a shell government filled with insiders bent on ignoring any regulations that might limit their friends in business any more effective than Reagan's alleged collection of "government elites"?

If you couldn't answer this question previously based upon the past thirty years, you should be able to answer the question now. And that's why the drilling disaster in the gulf also reflects a fundamental failure of citizenship. At this point, it should be crystal clear to every American what the true costs of our Potemkin, do-nothing government and outsized appetite for cheap energy are:

* an outsized military focused on maintaining stability (NOT democracy) around world oil supplies
* industrial policy aimed at protecting big oil until the last drop is pumped at the expense of developing any alternatives
* three wars fought in twenty years to protect oil resources financed with dollars borrowed from our biggest economic competitor, China
* big businesses engaging in repeated, multi-billion dollar criminal frauds who write off the few fines levied as a mere cost of doing business

There's nothing "American" about any of this. There's nothing American about using SUVs and trucks that get 18MPG as commuter vehicles. There's nothing American about building a 4000 square foot McMansion 30 miles from work and paying to air condition it or heat it. There's certainly nothing American about giving our hand-me-down gas guzzlers to teens to drive to high school, further clogging roads during rush hour. There's absolutely NOTHING American about sending other families' kids to war to protect cheap oil and forcing your own kids to foot the bill through trillions in deficit spending.

Memorial Day 2010 may very well turn out to be the first of a new kind of Memorial Day. But which kind? A day of remembering those who fought and died for ideals only granted lip service in our day to day decisions as individuals and citizens? Or a day of remembering an economic, ecological and social downward turning point created by that same lip service? Or a day of stepping back and remembering the ideals that drove generations to fight and die for something bigger than themselves -- for us and future generations.

There's no doubt about it. Things are going to be tough for many Americans in the coming months and years. But there's no day like Memorial Day to realize we still have it easy. They did the hard work.

===========================

#1) http://www.cbsnews.com/stories/2010/05/16/60minutes/main6490197.shtml

#2) http://www.washingtonpost.com/wp-dyn/content/article/2010/05/27/AR2010052705613.html

#3) http://www.chron.com/disp/story.mpl/business/deepwaterhorizon/7027665.html

#4) http://www.reuters.com/article/idUSN1326556220100513

#5) http://www.thestreet.com/story/10004757/enron-files-for-chapter-11-bankruptcy-protection.html

#6) http://money.cnn.com/magazines/fortune/fortune_archive/2001/03/05/297833/index.htm

#7) http://money.cnn.com/2002/07/19/news/worldcom_bankruptcy/

BOOK REVIEW: 13 Bankers

2010-04-26T23:56:00.002-05:00

13 Bankers -- Simon Johnson and James Kwak -- 222 pages (304 with notes and index)

There seems to be no shortage of books being published with the aim of explaining what transpired during the financial meltdown and how it occurred despite an alphabet soup of regulatory agencies nominally created to prevent such singularities. While many books have aimed at the target, few hit it more precisely and concisely than 13 Bankers by Simon Johnson and James Kwak. The pair is already followed widely via their blog entitled The Baseline Scenario.at which they provide running commentary on the financial and regulatory forces producing the instability in the market.

In 13 Bankers, they provide a thorough explanation of the mechanics of the practices involved, the end-runs by financial institutions around already crippled regulatory controls aimed at avoiding such frauds and -- most importantly -- the true cost to our economy of depending upon such a concentrated, fraudulent, inefficient banking system. Anyone assuming we've put the worst behind us really needs to read this book before jumping back into the pool.

IT ALL STARTS WITH ONE FLAWED ASSUMPTION

The authors chose their title from a meeting held March 27, 2009 between the Obama White House and CEOs from the thirteen biggest banks in the country. The meeting was Obama's first chance to speak directly to them as a group and twist arms to gain their public buy-in for squelching outsized compensation packages that were raising the ire of voters and taxpayers at the time. The authors focus on the key talking point to emerge from that meeting -- "We're all in this together" -- and use it to emphasis the key flawed assumption behind the meltdown itself and any attempt to correct the systems that produced it.

In a nutshell, their point -- the correct point to make -- is that we NEED a financial system in place to

* handle payments,
* collect deposits for people needing a safe place to stash funds,
* identify and provide funding for business opportunities that produce new goods and services or improve productivity
* quantify the risks of such efforts through credit terms and interest rates and open markets

However, we don't need THIS PARTICULAR system. THIS PARTICULAR system we have, when properly understood and measured, isn't even particularly good at what it is supposed to be doing. As long as politicians and regulators remain trapped in the thinking that THIS PARTICULAR system and THIS PARTICULAR collection of big bank survivors is the only way to safely and efficiently meet the needs of the economy, nothing will change and nothing will prevent bigger meltdowns in the future.

In the meeting with the thirteen bankers, the new Administration essentially threw its backing behind the thirty year old principle that led to the collapse in the first place -- the idea that a variety of technical regulatory policies were primarily to blame, that a large financial sector is critical to our economy and big banks --- these big banks in particular -- were critical to the financial system and worthy of protection at any cost.

WHAT REALLY HAPPENED

In the chapter Too Big To Fail, Johnson and Kwak provide what has to be the clearest, most concise summary of the cascading failures that produced the crisis, from summer 2007 through early 2009. Before providing those details, the book first recounts key events in the Asian crisis of the late 1990s and how those firms handpicked to survive Korea's meltdown (LG, Samsung, Daewoo and Hyundai) consolidated their position while recapitalizing with help from the IMF. The authors make a point of replaying the policy advice of key figures in world finance at the time -- an insistence on tighter monetary policy (no printing money to inflate yourself out of a collapse), tighter government spending controls (no stimulus plans to ease the blow on citizens), no write-down of loan amounts (okay, that part's similar…) and no restrictions on foreign capital to come in and control more of the Korean economy. The authors later point out multiple times the irony (or hypocrisy) of American policymakers' refusal to follow the same prescription domestically.

Many may be familiar with the events itemized below but after providing the background of the Asian crisis and its hand-picked winners and the history of deregulation and lax supervision, the summary within 13 Bankers drives the events home with particular clarity:

* summer 2007 -- Bear Stearns and BNP Paribas find problems with their hedge fund operations tied to subprime mortgages -- this triggers a liquidity crisis seemingly out of nowhere between August 9 to August 11 (see Financial Markets: Running on Empty #1)

* winter 2007-2008 -- investor concerns shift to the structured investment vehicles (SIVs) banks had rigged to further leverage bets on derivates while keeping the instruments off their books and avoiding increased capital requirements -- key banks attempt to create an internal credit facility to cover potential shortfalls but soon scuttle the idea, requiring investments from abroad to shore up Bear Stearns, Citigroup, Morgan Stanley and Merrill Lynch

* March 2008 -- continued concerns about the value of derivatives focuses attention on Bear Stearns which is nearly 100% dependent on overnight loans to fund daily operations -- once overnight funding dries up, Bear Stearns cannot meet its obligations without a sell-off of assets and is sold off to JPMorgan within inches of hitting the pavement of bankruptcy

* July 2008 -- continued worries over mortgage related derivatives drive down the holdings of Fannie Mae and Freddie Mac, putting them near insolvency -- the Treasury attempts to provide a more explicit public guarantee of Fannie / Freddie assets but both wind up under government control by September

* mid September 2008 -- solvency concerns move from the GSEs to the next weakest player, Lehman Brothers, and the government assumes the markets have assumed the Bear Stearns and GSE rescues were "it" and that market forces would have to figure out a Lehman collapse on their own -- in fact, the banks saw the system getting weaker and assumed the government WOULD step in -- when no rescue materializes, the Lehman bankruptcy within hours and days triggers ..

* the collapse of AIG

* the collapse of a major money market fund, which triggers a lockup in the commercial paper market affecting short term lending to hundreds of thousands of small, medium and large businesses

* the failure of Washington Mutual

* the collapse of Wachovia and its takeover by Wells Fargo

In eight pages (156 thru 164), Simon and Kwak do a better job of summarizing and tying together these events than nearly any other book or blog available.

WHAT HAPPENED BEFORE

Besides explaining the eerie similarities of the "Asian contagion" dry run to the most recent American meltdown, 13 Bankers also analyzes nearly forty years of regulatory changes that inexorably positioned our financial system and the economy perched atop it closer to the ledge. The summary chapter in the book summarizes "business as usual" for the megabanks as:

* using their TBTF discount in regular banking to subsidize higher leverage / higher risk gambles
* using consolidation to capture more market insight from trading to use for their own accounts
* inventing highly complicated "products" for consumers and businesses alike that generate higher fees
* using convoluted "structured finance" practices to hide leveraged investments to avoid higher capital requirements
* applying political pressure to regulators to ignore what few paper laws and regulations remain

The legislative and regulatory changes that produced this current state are analyzed in detail throughout the book. Here's just a partial list of the changes discussed: (all near direct quotes from the book)

* May 1, 1975 -- fixed fees on stock trades eliminated on the NYSE by ruling from the SEC, allowing major trading firms to profit from churn on higher trading volume from large institutional investors and mutual funds

* 1982 -- Garn-St. Germain act eliminated restrictions on bank / S&L mergers across state lines, beginning 20 years of consolidation and blurring of the regulatory boundaries (page 72)

* 1983 -- OCC lifts all restrictions on loan-to-value ratios, loan durations and amortization schedules, essentially permitting the types of mortgages that dominated during the bubble (page 72)

* 1984 -- Secondary Mortgage Market Enhancement Act is authored by Solomon Brothers' principle trader Lewis Ranieri and eliminated complexities of state regulations and tax laws making mortgage securitization operationally practical and profitable (page 73)

* 1996 -- Fed raises the upper limit on revenues derived from securities from 10 percent to 25, beginning the dismantling of Glass-Steagall (page 133)

* 1998 -- Federal Reserve Board of Governors unanimously vote to forego any investigations of complaints involving non-bank subsidiaries claiming no jurisdiction (page 142)

* 1999 -- Glass-Steagull restrictions on bank / investment bank separation completely eliminated after Citibank and Travelers merge and force the issue

* December 2000 -- Congress enacts the Commodity Futures Modernization Act which explicitly cordons off derivatives from any government regulation (page 136)

* 2001 -- federal regulators issue new capitalization rules allowing banks to base capital required for pools of securitized assets upon third party ratings rather than the prior more conservative rules (4 percent for mortgages, 8 percent for commercial loans) (page 139)

* August 2003 -- Office of the Comptroller of the Currency issues ruling negating efforts in several states (New Jersey, North Carolina and Georgia) to limit sub-prime lending abuses (page 144)

* April 28, 2004 -- SEC agrees to let biggest banks use their own internal models for calculating capital requirements (page 140)

The single most fascinating (in the trainwreck sense) observation made in the authors' description of the distorted regulatory and political framework supporting the current system involves the concept of "regulatory capture." In finance, the normal idea of regulatory capture doesn't remotely begin to describe how dysfunctional the system has become. The normal revolving door problems all apply but banking has its own twists. Here's a direct quote from page 96:

---------------------------------------
But banks also had a more direct means of putting pressure on their regulators -- the market for regulatory fees. The Federal Reserve makes the money for its day-to-day operations from its banking activities, and the FDIC makes its money from insurance premiums levied on banks. But the other major regulators, including the Office of the Comptroller of the Currency (OCC) and the Office of Thrift Supervision (OTS), are funded by fees levied solely on the bnaks that they regulate. And while each regulator nominally had its own sphere of jurisdiction -- bank holding companies for the Fed, national banks for the OCC, and so on -- financial institutions that fell under multiple regulatory agencies were allowed to select their primary regulator. As a result, regulatory agencies had to compete for funding by convincing financial institutions to accept their regulation, which created the incentives for a "race to the bottom," in which agencies attract "customers" by offering relatively lax regulatory enforcement.
---------------------------------------

The authors then point out that OTS seemed bent on winning in the worst way -- AIG wound up "choosing" OTS as its regulator after opening an S&L, Countrywide Financial actually converted itself from a bank holding company to an S&L to switch to OTS roughly one year before its collapse.

THE HIDDEN COSTS OF TOO-BIG-TO-FAIL BANKING

A quick poll of Americans on the street might find a relatively large percentage could cite $700 billion as the "cost" of the banking crisis in 2008. Some might also cite several trillions in lost value in homes, stocks and 401ks. A much smaller percentage might take the next step and cite the drops of quarterly GDP in real 2005 dollars of -2.7, -5.4 and -6.4 percent in 2008Q3, 2008Q4 and 2009Q1 (#2) and estimate another $430 billion or so in lost economic activity.

In 13 Bankers, Johnson and Kwak raise more subtle but potentially more important points about the true cost of our outsized financial sector and the most recent collapse. First, they tackle the combination of "moral hazard" and the risk subsidy provided to "TBTF" banks by implicit (now explicit) government backing. After nearly 20 years of consolidation, big banks enjoyed a TBTF discount of 0.29 percent when borrowing money over their smaller competitors. That comes from direct resources such as access to the Fed's discount window and pricing in the larger open market resulting from depositors and investors accepting lower interest rates from big banks versus small banks. After the bailouts of 2008, that TBTF discount widened to 0.78 percentage points. How material is that advantage? The book cites a study by Dean Baker and Travis McArthur indicating the value of that subsidy in 2009 produced $34 billion in profits for the eighteen biggest banks -- nearly HALF of their profit. (#3)

The authors also address the misallocation of resources caused by the combination of lax regulation and flawed monetary policy with a series of insightful points:

Home ownership not only isn't a sure thing as a savings vehicle for individuals, for many with little savings elsewhere, putting much of their available savings into a home not only puts all of their assets in one sector (housing), it puts it all in one specific ASSET in one fixed LOCATION, arguably one of the dumbest things one can do in investing.

Lax financial regulation in the 1990s and 2000s actually DISCOURAGED businesses form using tax cuts and low interest rates to invest in productive assets and instead ENCOURAGED deployment of those savings in areas with the most leverage but highest risk. As a result, actual INVESTMENT went DOWN in the 2000s meaning we not only misallocated capital into McMansions but crippled future economic growth and incomes by not properly funding improved manufacturing capabilities and basic infrastructure.

Perhaps the more interesting analysis about the impact of growth in the financial sector involves its impact on the allocation of intellectual capital in the economy. The authors cite studies indicating financial sector jobs accounted for roughly 4 percent of Harvard graduates in the 1960s but grew to 23 percent in recent years. Like bees to honey (or flies to ____), compensation in the financial sector helped attract new graduates. Based on data from the Bureau of Economic Analysis, average wages in banking were in line with the rest of the economy until 1979, at which point they began growing to a point where now the average banking employee wage is twice that of workers in the rest of the economy, even when factoring in similar educational backgrounds.

FULL CIRCLE

The most effective aspect of the entire book lies in the final pages of the technical narrative at the point where results of the "stress tests" were announced in May of 2009. Everyone remembers the snickering that accompanied the formal announcement of results that -- VOILA! -- not a single bank analyzed turned out to be undercapitalized and in need of new taxpayer assistance. Johnson and Kwak pronounce the stress tests a failure for that reason, but also a success -- for the TBTF banks. The tests failed to instill any confidence in the wider financial community or the voting public that the megabanks wouldn't face another crisis. However, by publicly stating the banks passed the government's "rigorous" analysis and had shored up their balance sheets to the government's satisfaction, the government explicitly provided its backing to the institutions as TBTF. At that point, the banks achieved an even stronger position of leverage because any remaining regulatory pressure to write down the toxic assets on their books that produced the uncertainty and instability in the first place vanished while their TBTF backing became explicit instead of implicit.

In other words, we went through a multi-trillion dollar crisis only to come full circle with trillions of bad assets still sitting on the books of a smaller set of even bigger banks with the explicit support of taxpayers. The final chapter of the book, entitled The American Oligarchy, sums up the key lessons to take away from the crisis to date in very clear terms.

1) The bailouts of 2008 may have stabilized the system in the short term but they increased concentration in banking. This has allowed the survivors to further exploit their TBTF benefits while exposing the entire system to more risk, not less.

2) Solutions involving highly complicated technocratic measurements and regulations will be completely ineffectual. Banks can hire armies of accountants to adjust books to satisfy any arbitrary rule for capital ratio, etc. As the authors state, both Lehman Brothers and Bear Stearns were healthy on paper by any common measurement, yet both collapsed within days.

3) Continuing to allow TBTF institutions to operate while providing "resolution authority" to regulators ignores the politics of existing regulatory conflicts of interest and the public politics that would result from the government or Federal Reserve attempting a takeover of a struggling TBTF while the bank itself protests in public that it is perfectly healthy and the government is just taking over for political gain.

4) The use of resolution authority as a solution is virtually useless for large multi-national banks since such authority would not be able to impose controls on the valuations and handling of assets abroad. Without multi-lateral agreements, countries that impose the strongest limits first in response to a crisis will minimize local damage while transferring it to other countries with weaker rules.

5) Despite any claims made during merger press conferences, the TBTF banks achieve ZERO economies of scale as they grow larger. The authors cite a study by Kevin Stiroh which found all of the improvements in efficiency in the banking sector during the 1990s were due to modernization of information technology systems, not the size of the firms per se. In other words, if the individual banks had made the same investment in IT, the same efficiencies would have resulted. Getting gobbled up by NationsBank or CitiBank or countless others didn't produce ANY efficiency.

With the entire book and these points in particular, Johnson and Kwak make a convincing argument for the only change likely to actually address the problem from TBTF banking -- breaking up TBTF banks and enforcing rules to prevent any banks from exceeding a TBTF thresholds. What would those be? They recommend a limit of 4 percent of GDP for depository institutions and 2 percent for investment banks. Would such limits take us back to the 19th century? Hardly. More like the mid-1990s, hardly an era of economic decline.

In summary? Get this book. Read it.

======================

#1) http://watchingtheherd.blogspot.com/2007/08/financial-markets-running-on-empty.html

#2) http://www.bea.gov/national/xls/gdpchg.xls

#3) http://www.cept.net/documents/publications/too-big-to-fail-2009-09.pdf

BOOK REVIEW: Too Big To Fail

2010-04-12T19:31:00.002-05:00

Too Big To Fail -- Andrew Ross Sorkin -- 539 pages (600 with notes and index)

Too Big To Fail is one of many books written by financial journalists in the aftermath of the series of financial crises that hit world markets in 2008. Andrew Ross Sorkin, a daytime reporter for The New York Times, begins his book with an "Author's Note" explaining that much of the content comes from interviews with over 200 direct participants in the events. He further notes that most of the participants refused to allow direct attribution of their comments due to the blizzard of outstanding civil and criminal investigations impacting many of the participants and firms. That's a nice way to put it.

With virtually zero written documents for reference, Sorkin doesn't help matters much with his writing style. Like Bob Woodward, he relies on needlessly detailed expositions of people's inner thoughts and motivations, such as this opener to Chapter 11:

------------------------
Robert Wilhumstad could feel the perspiration begin to soak through his undershirt as he strode along Pearl Street at 9:15 a.m. on Tuesday, July 29 in Manhattan's financial district. Although the humidity was oppressive that summer morning, he was anxious about his upcoming appointment with Tim Geithner at the Federal Reserve Bank of New York.
------------------------

These types of "inside the head" narrative details might make it easier to humanize some of the characters and tie the narrative together but seem inappropriate at best when regurgitating weeks of daily print stories into a full length book. Of course, a more detailed analysis of the real numbers and deal terms would have taken much more work.

Much of the book reads like a long, disjointed hodgepodge of Post-Its notes randomly taken from people's day planners, Wikipedia biographies, and a few chapters of Ulysses. The effect upon the reader is somewhat akin to

Lorem ipsum dolor sit amet, Dimon consectetuer adipiscing elit. Phasellus non erat eu dui old friend from Dartmouth dignissim dictum. Integer iaculis napping in the back of his Gulfstream nulla at nisl. Proin ut enim non ipsum varius former banker at Goldman Sachs laoreet. Integer feugiat, ante fringilla blandit convallis, leo sapien egestas (F-bomb) velit, non condimentum nulla sem vitae risus. Mauris aliquam planning to borrow $5 million for the $6.4 million space auctor quam. Sed ac enim. Donec mattis dui id ligula. Integer vel sem eget ante cursus tristique. Nullam vel orci vitae Lehman Brothers sem interdum placerat. In eget lectus. Donec blandit. Quisque lacus urna, malesuada vel, Sullivan & Cromwell mollis sit amet, rutrum nec, est. Proin blandit ornare nibh. Duis et felis. Lorem ipsum dolor sit amet, consectetuer adipiscing elit. Phasellus non order to appear at the New York Fed erat eu dui dignissim dictum. Integer iaculis nulla at nisl. Proin ut enim non ipsum varius laoreet. Integer feugiat, ante fringilla How about $700 billion? blandit convallis, leo sapien egestas velit, non condimentum nulla sem vitae risus. Mauris aliquam Flowers and Fox-Pitt would earn a combined $20 million in fees auctor quam. Sed ac enim. Donec mattis dui id ligula. Integer vel sem What kind of protections can you give us on changes in compensation policy? eget ante cursus tristique. Nullam vel orci vitae sem interdum placerat. In eget lectus. Donec blandit. Quisque We're screwed lacus urna, malesuada vel, mollis sit amet, rutrum nec, est. Proin blandit ornare nibh. Duis et felis.

So what -- if anything -- does come from a read of Too Big to Fail?

After following the flurry of references to emergency meetings, private jet flights of CEOs to Fed offices, frantic calls between regulatory agency heads, and profanity laced diatribes from CEOs about press stories triggering panics in the market, one common theme begins to emerge from the chapters.

No one --- ABSOLUTELY NO ONE -- involved with the firms that collapsed, the firms forced at gunpoint to hide the collapse of the failing firms, the regulators attempting to right the ship or the politicians signing away billions of taxpayer dollars had a clue what was really happening, why it was happening, and how severe the problems were or might become. Once that reality sinks in, a more important point becomes evident. The odds of the multiple $50 billion dollar shotgun marriages and $700 billion dollar TARP infusions mitigating or curing any underlying problem with the financial system are nil. They may have deferred the reckoning but cured nothing.

How haphazard was the thinking during the heart of the financial crisis? It's an interesting exercise to skim Too Big To Fail and jot down the date and time of each not-so-subtle matchmaking attempt or outright frantic plea from government players to a major bank to buy up some other failing bank. It takes some doing due to Sorkin's unwillingness to provide any exact calendar date reference for PAGES at a time but here's the picture that emerges:

-----------------------------------------

7/21/2008 -- private meeting between Lehman CEO Fuld and BoA CEO Lewis at NY Fed arranged by Paulson and Geithner (page 204)

9/8/2008 -- three calls from Treasury assistant Ken Wilson to Dick Fuld encouraging talks with BofA (page 240)

9/10/2008 --- Geithner calls Bob Diamond of Barclays to encourage him to call Fuld of Lehman (page 261)

9/17/2008 -- Kevin Warsh of Fed calls CEO Steele of Wachovia encouraging him to call CEO Mack of Morgan Stanley to arrange a deal

9/20/2008 -- Geithner calls CEO Blankfein of Goldman demanding he call CEO Pandit of Citigroup regarding a Goldman purchase of Citigroup (page 457)

9/20/2008 -- Warsh of the Fed calls CEO Steele of Wachovia suggesting he call CEO Blankfein of Goldman regarding a merger (page 459)

9/20/2008 -- Geithner calls CEO Dimon of JPMorgan directly suggesting JPMorgan purchase Morgan Stanley and also calls CEO Mack of Morgan Stanley encouraging him to take the call (page 461)

9/20/2008 -- after no success with Goldman + Citigroup or JPMorgan + Morgan Stanley, Geithner encourages Morgan Stanley + Citigroup (page 462)

9/21/2008 -- Paulson calls Wachovia board member Joseph Neubauer during a Wachovia board meeting to encourage the board to take a Goldman merger deal (page 475)

9/21/2008 -- after the collapse of current deal talks on Goldman + Wachovia, Paulson calls CEO Dimon pushing a JPMorgan + Morgan Stanley deal to save MS. (page 478)

9/21/2008 -- Paulson, Geithner and Bernanke JOINTLY call CEO Mack urging him to close a deal with JPMorgan before markets open on Monday 9/22. (page 480)

9/21/2008 -- in the span of seven minutes, Geithner, then Paulson, then Geithner again call CEO Mack to push a JPMorgan deal while he's in the middle of negotiations with Mitsubishi to obtain a $9 billion dollar infusion which eventually was approved that evening, saving the firm (page 482)

-----------------------------------------

The blue ribbon in the This! No THAT! No STOP! No HURRY! insanity sweepstakes has to be the deal struck under the watchful eye of the Fed, Treasury and the FDIC allowing Citigroup to gobble up Wachovia. Actually, they didn’t so much as "allow" Citigroup to gobble up Wachovia, they demanded Citigroup absorb Wachovia and its first $42 billion in losses for $1.00 per share. FDIC Chair Sheila Bair actually called Wachovia CEO Bob Steel at 4:00am September 29, 2008 to personally inform him of the sale. By 9:00pm the same day, after watching the first TARP proposal go down in Congress like the Hindenburg, a panicked Treasury and Fed changed their minds and allowed Wells Fargo to submit a new bid for Wachovia and instantly granted approval to the new deal, despite Citigroup committing $4.9 billion to its soon-to-never-be new affiliate in the form of emergency liquidity loans. Bair wound up calling Citigroup CEO Pandit at 1:00am on 9/30 to wake him up and tell him the government had just allowed a competitor to steal the lunch literally off his plate.

Of course, one other theme emerges if you haven't fallen asleep from the litanies of meetings, CEOs, lawyers and "deal guys." Potential conflicts of interest abounded throughout the entire fiasco.

* Treasury hired Morgan Stanley as adviser in handling the Fannie / Freddie meltdowns (page 210)

* Legal work for the takeover of Fannie and Freddie was farmed out by Treasury to the law firm Wachtell, Lipton, Rosen & Katz which had previously assisted JPMorgan in the March 2008 takeover of Bear Stearns. (page 223)

* Law firm Sullivan & Cromwell was hired by AIG for M&A consulting. The firm's own website indicates its client list includes BofA, Barclays, Goldman Sachs, JPMorgan Chase, Morgan Stanley and UBS.

* The Federal Reserve hired Morgan Stanley to provide opinions on AIG bailout terms (page 387)

* After Lehman provides a confidential brief to Treasury on 9/9 that they would lose $3.9 billion, a call from Goldman Sachs is made to Treasury is made in less than one hour offering to "help" (page 237)

Sorkin spends virtually zero time analyzing any such potential conflicts. However, one of his "inside the head" narratives on page 413 implies that Hank Paulson only grasped the true systemic risk at hand after the Lehman BK and BoA deal for Merrill Lynch. Within a day, the market had moved on to panic over AIG defaults, putting pressure on both Morgan Stanley and his beloved Goldman Sachs. The implication being that "if GOLDMAN is in trouble, well, harrumph, this IS different and we can no longer be high and mighty about moral hazard -- we must ACT boldly and decisively."

After completing the entire book, one can't help but go back and re-read the author's introductory note. In doing so, the real story becomes clear. Namely, that virtually nothing is understood by any of the players about:

* the exact inter-relationships between the blizzard of complex financial contracts between megabanks
* the exact dollar values of failures the system could and could not survive
* what sequence of unwinding transactions could provide any reduction in systemic risk
* which remedial actions helped, which actions hurt and which had no effect whatsoever
* who will eventually emerge as hero and goat from the entire period

The result is that none of the players yet want to risk burning any bridges by providing dirt on anyone who still might emerge as a hero and no one wanted to accidently add any information confirming their own potential role as goat.

Maybe the books on Financial Meltdown Round II will be more entertaining. It's already clear the actual plot will be identical.

SOTU 2010: No Traction, No Roadmap

2010-01-26T23:24:00.006-06:00

President Obama has been behind the wheel for just over one year. At the time he took over, the American economy had been skidding down an embankment for nearly a year, On January 27, 2010, he gets his chance to explain the trip route so far and outline where America is going next and how we're going to get there. In what has become an occasional tradition, here is an alternative summary of the State of the Union 2010 for the United States.

THE AMERICAN DASHBOARD

Before diving into any analysis of specific problems or proposed solutions, it's useful to start with a review of the dashboard -- the "idiot lights" that should be getting the attention of not only the driver but everyone in the car.


Component                       Jan 2009          Jan 2010
============================================================
DOW:                             8,228             10,173
Nasdaq:                          1,470              2,287
S&P 500:                           836.57           1,091.76
BLS Unemployment:                   11.6 M (7.6 %)     15.3 M (10 %)
BLS Long-Term Unemployed:            2.6 M              6.1 M
BLS Involuntary Part-Time:           7.8 M              9.2 M
BLS Marginally Attached Workers:     2.1 M              2.5 M
Shadow Unemployment (*):            21.5 M (14.1%)     27.0 M (17.6%)

(BLS numbers taken from #1 and #2)

* Shadow unemployment = officially unemployed + 
  involuntarily part-time + long-term discouraged workers

If the flashing lights and warning tones from the dashboard are disconcerting, the view out the front windshield at other economies isn't very encouraging either. The words "sovereign default" have come up in conversations about Greece, Dubai, Iceland, Ireland, Portugal, Spain, France, Italy and Britain. Skyrocketing debt loads abroad make it more difficult to count on exports to boost domestic employment to ease our crisis.

NO TRACTION

Even a cursory glance at the American dashboard leads to one inescapable conclusion -- the American economy has achieved absolutely ZERO traction on any road to recovery. The zero traction metaphor has an important dual meaning as well. The skyrocketing official unemployment and involuntary part-time employment obviously mean consumer spending will not fuel a recovery for quite some time. The huge jump in long-term unemployment is more troubling. Americans had never saved much during the boom years and many of these long-term unemployed will be burning through savings, likely down to nothing. This will further destabilize home prices, further depressing construction jobs and durable goods. Most troublesome of all is it will continue to stress the books of major banks, who are only "sound" when asking if they are strong enough to pay billions in bonuses but are in no position to withstand another panic or continued downturn. In other words, the economy not only lacks any traction to resume climbing UP the hill, it hasn't gained any traction to prevent a further slide.

A Real Market Rebound?

The rebound of the American stock indexes is seen by many as some form of stabilization or recovery. However, a review of what happened in the market to tank the indexes and actions taken by the Federal Reserve during 2009 shows the rebounds are completely meaningless. First, much of the decline in the stock indexes was due to massive sell-offs in mega-banks, insurance firms and other capital intensive firms who were dependent upon lending for sales and complex derivatives to hedge default risks and currency fluctuations. The declines in the market didn't stop when Obama took office but continued until March 2009.

In March 2009, the Federal Reserve announced it would purchase up to $300 billion of long term Treasuries and a staggering $750 billion in mortgage backed securities on the books of Fannie Mae and Freddie Mac. This action bid up prices on 10-year Treasuries, effectively lowering interest rates by half a percentage point. It also soaked up large amounts of highly suspect MBSs off the books of Freddie and Fannie, allowing them in turn to soak up more junk from the vaults of the big banks, significantly reducing the perceived risk facing investors in these firms.

The Fed action obviously contributed over $1 trillion in liquidity to major banks but, more importantly, it publicly reiterated support for the Too-Big-To-Fail entities. At that point, all the investors who (rightly) fled these stocks in 2008 piled right back in, driving markets back up. But is anything different? The bad mortgage backed securities are still out there, they've just changed vaults and books.

Real Profits?

The Fed strategy also had the perverse effect of helping most megabanks to book substantial paper profits selling securities to the Fed and borrowing FROM the Fed at lower short term rates while not lowering most consumer / business loan rates. There are two major concerns with the nature of those profits. First, most of those profits were created by the Fed literally printing money to buy up the Treasuries and mortgage backed securities from the banks at inflated prices. It's easy to pay inflated prices, after all, when you own the printing press for dollars. These printed dollars will pose a huge threat to the economy once the massive contraction of credit stops producing de-inflation.

The paper profits produced by the Fed's printing spree have made it easier to mask the more pressing problem for bank health -- credit and loan loss provisions. These provisions are charges to earnings that reflect the likelihood of losses on revolving lines of credit and loans. Though most quarterly statements for 2009 show banks increasing their loan loss provisions throughout 2009, the worry is that those increases are not keeping up with the real level of impairment of those assets. In essence, the banks are reporting profits while failing to report the increase in water leaking into the boat that is erasing much or all of those profits.

How critical are these loan loss provision levels to the real valuations for the megabanks? Just look at what happens when investors get surprised by a change to these numbers. On January 15, 2010, JPMorgan Chase announced its 4Q2009 results that showed its allowance for loan losses for the year increased from $21.0 billion (3.62%) at the end of 2008 to $32.5 billion (5.51%) at the end of 2009. The 4Q adjustment was "only" an additional $1.1 billion but it appears many investors who viewed JPMorgan as best-in-breed looked at the final year-over-year delta with great fear. If the smartest guys in the room had to drastically increase their loss reserves, how healthy can the other players be? Here the 4Q2009 numbers for a few TARP recipients: (see #3 thru #9)


           Loss
Bank      Reserve      Reserve%    2009 Profit
==============================================
JPM       $32.5 B       5.5%          $11.7 B
BoA       $37.2 B       4.16%          $6.3 B
WFC       $25.0 B       3.2%          $12.3 B 
Citi       $36.0B       6.1%          ($1.6 B)
Regions   $  1.2B       3.52%         $(1.3B)

With the exception of Citi, already widely recognized as a risk management basket case for twenty years, the other big guys have lower loss reserve percentages than the geniuses at JPMorgan. Feel better? Neither did the market. JPM stock dropped 10 percent in the next four trading days -- shaving about $15 billion off its market capitalization. The Dow dropped 136 points the day the JPM earnings were announced.

NO ROADMAP

By ANY objective measure, the Obama Administration inherited an unfathomable number of critical problems in virtually every segment of the economy and public policy.

* long term structural deficits reaching $400 to $500 billion with honest accounting
* a collapsing auto industry driven by flawed economic and energy policies
* a poorly regulated, unstable financial system
* parallel wars being fought with incoherent strategies by an overstretched, worn out military
* oh yea, some nut in a cave still managing to steer a loose affiliation of terror cells attacking western interests throughout the world

The oddest part about these problems is that despite being delivered multiple object lessons in their VITAL importance to nearly every single American, the vast majority of these issues still BORE THE LIVING DAYLIGHTS out of eighty percent of voters.

That's a huge problem for Obama whose preferred mode of public address is more akin to an extended philosophical discussion between people who may choose to continue disagreeing but appreciate a thorough examination of the issues. His target audience loathes such details and prefers to get their information in easily digested (but over-simplified) factoids (truth optional) and DON'T YOU DARE schedule a presidential address that conflicts with the season premier of the final season of Lost. Such a climate virtual assures all issues will ultimately be trivialized down to demagoguery.

The only hope of fitting into a sound-byte ADD addled culture is to identify a small, consistent, coherent set of policies that target the most elemental roots of the problems and provide two or three degrees of synergy with each other to strengthen their impact and provide some protection against roll-back.

Obama has succeeded at doing exactly NONE of these things.

Examples abound in financial regulation, anti-trust, privacy rights in the digital age, etc.

Meaningful Financial Regulation

In reality, the American economy operated on the absolute brink from roughly August 7 of 2007 when inter-bank credit markets seized up with no apparent warning or reason through March of 2009. We are now SIXTEEN MONTHS from the nadir of the crisis (so far…) yet not a SINGLE regulatory change regarding derivatives, mortgage backed securities, collateralized debt obligations, conflicts of interest between ratings firms and (ahem…) "clients" or separation of commercial and investment banking has been proposed, much less enacted. A great deal of commotion has been raised about "clawback" provisions on bonuses or surcharge taxes on TARP winners to recover funds to pay back TARP losses but the incentive powers of such changes are virtually nil. None improve the transparency of the markets involved and none reapply enough risk to the principals of the game to discourage undue amounts of leverage that inevitably melt the entire system down.

Meaningful Anti-Trust Enforcement

Many of the biggest bank mergers were already water under the bridge by the time President Obama took office. The herd psychology in the market is still irrational enough that one might not blame the Obama Administration for moving to immediately undo these mega-mergers or even impose new guidelines that would clearly block such mergers in the future, whether by choice or (ahem…) "persuasion" by the Fed and Treasury in a darkened conference room on a Friday night after a disastrous market close.

Ok, then look elsewhere.

The Obama Administration era DOJ has published perfunctory "concerns" regarding the purchase of NBC Universal by Comcast but there is zero doubt the purchase will be approved. On January 25, 2010, the DOJ announced approval of the merger of TicketMaster, seller of roughly 80 percent of all music concert tickets in the country, with Live Nation, which operates 135 venues (all seemingly named "Verizon Wireless Amphitheatre"…) in every major market in the country. Together, the combined company will control nearly every aspect of the music touring business except for the pot dealer outside the gates of the Bonnaroo Festival. Oh, but there was one condition imposed. The new Live Nation had to ensure competition by divesting an offshoot unit to competitor AEG Live and sell another affiliate Paciolan that handles smaller college and arts-oriented venues to..

…noted communications and entertainment underdog…

Comcast.

Privacy Rights in a Digital World

The Obama campaign was famously effective at harnessing email and social networking systems to identify and rally supporters. The Obama Administration has become notable for a very pro-corporate, non-transparent approach to virtually all matters related to digital technology. A treaty governing anti-counterfeiting measures first proposed by the Bush Administration but held in secret due to NATIONAL SECURITY claims (?????) was subsequently supported by the Obama Administration and access to the terms of the proposal further tightened under the same reference to Executive Order 12958. (#10)

What language in the treaty could possibly involve state secrets? News that the treaty offers American Internet Service Providers legal cover for adopting any deep packet inspection sniffing technology they choose on ALL customer traffic in the interest of preventing thirteen year olds from stealing Jonas Brothers MP3 files? Or confirmation that such data transmissions have already been undergoing monitoring at centralized "drain' points for years without legislative approval or legal justification?

WHAT'S ON TAP?

Much ado was made about the Republican win of the open Senate seat in Massachusetts serving as a repudiation of Obama policies and an omen for the 2010 mid-terms. According to the theory, loss of the 60-seat filibuster proof majority in the Senate has finally shocked President Obama back to political reality and triggered a more aggressive rollout of populist strategies.

Uh huh.

Obama never had a 60-seat, filibuster proof majority in the Senate. Senator Lieberman, Senator Nelson and probably five other Senators saw to that. At any given time, any Senator sitting in the #60 chair on a particular issue is capable of switching sides at the drop of a hat (or drop of a bill in their campaign coffer).

If you want a real dose of political dark humor, Senator Kent Conrad (D) and Senator Judd Gregg (R) proposed a special "bi-partisan task force" of Senators to formulate budget cutting plans with rules requiring "super-majority" votes for all cuts to provide political cover for all the "hard choices" such a group would have to make. Yea, cuz the super-majority based process in the Senate has been such a huge help so far.

Their proposal died January 26, 2010. It seems they couldn't obtain a super-majority to allow the proposal to stay piggy-backed on pending debt-ceiling relief legislation, which of course is needed because super-majorities are needed to materially restructure government spending that has produced half-trillion dollar structural deficits.

You couldn't write material this thick with irony if Comedy Central paid you a trillion to do it.

The Obama Administration has publicized a series of proposals, never mentioned in the past twelve months as priorities, to begin helping the middle class. The proposals range from tax credits for elderly parent care, additional child tax credits, tax credits for new hires at small businesses and new taxes on banks to make up for losses on some of the TARP recipients.

Read that list a couple of times and count the number of changes that affect the basic rules of the game that encouraged unsafe levels of borrowing, masked broken auditing and risk rating processes in the financial world and nationalized all the downside to taxpayers.

Did you get zero? That's what I got too.

WTH

==========================================

#1) http://www.bls.gov/news.release/archives/empsit_02062009.pdf

#2) http://www.bls.gov/news.release/pdf/empsit.pdf

#3) http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-newsArticle&ID=1308706&highlight=

#4) http://files.shareholder.com/downloads/ONE/828416421x0x283416/66cc70ba-5410-43c4-b20b-181974bc6be6/2008_AR_Complete_AR.pdf

#5) http://files.shareholder.com/downloads/ONE/828416421x0x344208/e19957ae-9c36-4e7b-bd64-4d42e3ebd8e9/4Q09_Earnings_Press_Release_Final.pdf

#6) http://investor.bankofamerica.com/phoenix.zhtml?c=71595&p=irol-newsArticle&ID=1376998&highlight=

#7) https://www.wellsfargo.com/pdf/press/4q09pr.pdf

#8) http://www.citigroup.com/citi/fin/data/qer094.pdf?ieNocache=977

#9) http://phx.corporate-ir.net/phoenix.zhtml?c=65036&p=irol-newsArticle&ID=1378875&highlight=

#10) http://news.cnet.com/8301-13578_3-10195547-38.html

Painful Lessons from a Lost Decade

2010-01-03T21:21:00.002-06:00

Ahhhh. January 2000. Remember what the world looked like in January 2000? Budget surpluses (on paper, anyway...), no cold war, the end of a war in Kosovo, a booming stock market, low unemployment, 401k savings growing 11 percent per year, twenty four year olds creating some web site and "going public" and pocketing millions.

WHAT HAPPENED?

The first decade of the new millennium can arguably be crowned the worst decade in the entire history of the United States. The "worst" crown comes not from the nature and the magnitude of the troubles that visited us -- the Civil War and the two World Wars had much larger impacts on daily American life and individual lives. The "worst" crown for the 2000s decade instead derives from the nature of the choices the country made that contributed to the arrival of our current troubles and the choices America has made (or failed to make) in responding to them.

If You Don't Learn Your History, Your Enemy Will -- Osama bin Laden learned a great deal from his involvement in the Russian war in Afghanistan. He learned a super-power could be baited into an expensive war in a desolate landscape that made traditional warfare difficult amidst a population so individualistic and hostile to central power that political and social structures required for a "modern" society were virtually impossible to achieve, much less impose by force. He learned this during a war which Americans helped initiate, in a bid to hand Russia its own Vietnam. When it came time for bin Laden to re-use the strategy for another of his enemies -- America -- the superpower failed to recognize the danger of the very strategy it had employed against its own arch enemy. Intervention in Afghanistan was warranted by the collusion between Al Qaeda and the Taliban but the American government immediately starved the effort in Afghanistan to launch a parallel war under nearly identical circumstances then proceeded to botch the execution of BOTH wars. American leaders and voters are not only too lazy to study history, they fail to even retain any grasp of events occurring in within recent memory -- less than 25 years ago.

Too Big To Fail or Too Big To Tell The Truth? -- There is no such thing as a bank or financial institution too big to fail. Unfortunately, it is very clear there ARE institutions too big to allow the truth to be told. The truth is that there are still a large number of banks -- including TARP recipients -- who are walking zombies -- banks that are only solvent on paper due to a variety of unprecedented policies that produced billions in profits while the banks have done virtually nothing to address the risk of their existing portfolios. The short term assistance produced enough cash for most TARP recipients to pay back their assistance checks and eliminate executive compensation limits (just in time for fiscal 2009 results) but the banks will all return to the ICU if another wave of commercial real estate loans melt down in 2010 (as feared) or if another wave of prime mortgages begin defaulting in 2010 (also feared).

The Less People Know, the More Risk They're Willing to Take -- The average American probably cannot calculate simple compounded interest for P dollars at five percent annual interest over ten years. The average American CERTAINLY cannot explain the mechanics of the amortization of a thirty-year fixed rate mortgage, much less perform the actual calculation. Yet these same Americans had no problem signing for MILLIONS of vastly more complicated, esoteric loan terms on hundreds of thousands of dollars of principle. Of course, professional bankers and fund managers controlling TRILLIONS of dollars of those very same mortgages weren't one iota brighter. In fact, they compounded the problem by synthesizing new "products" out of mathematically blended combinations of these risky mortgages then further leveraged their gamble by attempting to buy insurance against possible defaults of these derivative instruments. As writer Kevin Phillips stated in his book Bad Money, no civil engineer takes a perfectly good design for a bridge that holds up the span, carries the expected load plus a margin of safety and meets its construction cost goal then ADDS stuff that no one understands to the design. In finance and banking, that happens all the time. A society that responds to complexity and uncertainty by MAGNIFYING that complexity and uncertainty at every level of the economy is destined to suffer some catastrophic failures.

If I'm Paying for My Own Grade, I'll Take an A -- (Or AAA...) After emerging from the rubble of he collapse of Fannie Mae and the crash in the larger Mortgage Backed Securities market, investors and taxpayers both asked the same simple question --- How could trillions of dollars in triple A rated securities crash to pennies-on-the-dollar valuations? Few understood the ethical and fiduciary conflict of interest produced by a market in which the bond rating agencies were making a huge portion of their profits from fees collected from institutions whose products were being rated. Most investors big and small assumed Moody's or Standard and Poor were the literal equivalent of Underwriters' Laboratories of the bond world, performing a physical disassembly of every rated product and verifying the product wouldn't shock the customer or trip the power for an entire city block under load. What investors failed to understand and what these rating agencies failed to disclose is that the products being rated were

* based upon mathematical models which had not been thoroughly tested
* used inputs reflecting quality (income, asset value) which HAD NOT been verified
* used inputs which COULD NOT be verified because the paper trails of member securities could not be produced (and STILL cannot be produced)

In effect, the rating agencies and their true customers conspired to unload millions of 1000-watt hair dryers in cracked housings with frayed power cords on an (often willfully) ignorant public soaking in a bath tub. Shocking, huh?

More Information Isn't Producing More Understanding -- Internet based technologies have created more paths of communication and a torrent of information arriving via those paths. People can share ideas instantly with virtually anyone on the globe via blogs, YouTube videos, cell phone videos, Facebook or Twitter. One would expect an EXPLOSION of new ideas to burst forth for solving the country's problems. One would be disappointed. In reality, all the new avenues of communication simply tend to regurgitate the same (often flawed) ideas and "gotcha" stories because media ownership continues to consolidate into fewer corporate hands bent on "leveraging" existing "content" as much as possible across as many outlets (broadcast TV, cable TV, web portals, print, books) as possible. The result is as predictable as the sun rising in the east and setting in the west. Literally. An actor or writer hawking a new movie or book gets up and does Today and the Early Show in New York City, stays that night and does Letterman, then flies to Los Angeles and does Leno then maybe Tavis Smiley, then Conan then Ferguson or Kimmell. There might be seven or eight different shows you watch that week and you'll hear about the same movie or book on all of them, often from the same celebrity. The same thing happens with "news." The same reporters (ahem..) "covering" the news during the week comment on it on Friday night and again on Sunday morning. It's Groundhog Day meets The McLaughlin Group.

Terrorism Isn't an Existential Threat - Fighting Terrorism as a War IS -- America in particular has become trapped in a mental mode of imagining the absolute worst scenario for every single individual terrorist attack. Imagining every single suspected terrorist could be THE lynchpin to some cataclysmic attack produces the false justification for "whatever means necessary" that leads to torture tactics that don't work and degradation of our moral authority in the world. It also leads to spending millions or billions in response to attacks costing hundreds or thousands. It doesn't matter if dollars, euros, yen or real are involved, that math doesn't add up and will bankrupt any country pursuing such a strategy. Instead, we should be focusing on language skills, improving staffing levels in civilian police and passport handling agencies and improving technology to share EXISTING non-private data that can better correlate patterns of potential risk earlier in the A-Z chain of events leading to a would-be attack. The goal is not to increase the number of terrorists caught at step Y just before an attack, the goal is to catch more people at step M or N so even if we miss that step, we have steps P, Q, etc. where the number of chances are far higher but the costs of a miss are far lower.

The "oughts" have been a simply awful decade for America. We are literally running out of dollars trying to solve problems with the wrong strategies. Let's hope leaders and citizens alike wake up and choose something new for a change. Before too long, we won't have a choice.

Getting In and Getting Out

2009-11-22T20:35:00.002-06:00

Despite several leaks of "final decisions" regarding troop levels in Afghanistan, people all over the political spectrum seem frustrated by the delays in the communication of a new strategy by the Obama administration. Those on the left worry about delays in stemming the loss of troops in a war with few (if any) tangible, quantifiable milestones for success. Those on the right worry of communicating doubt or uncertainty to "the enemy" that will improve their ability to tailor their end-game for our departure.

We have no way of knowing if it will be the final answer but the next answer is due from President Obama by the end of November 2009. We know quite a bit about some of the opinions being presented for consideration but not much about the framework Obama is using to make his decision. When you remove all the cynical realpolitik mumbo jumbo and poll-tested catch phrases meant for domestic consumption by die-hards on the extremes, the problems the United States faces in selecting a strategy for Afghanistan really arise from our failure to truthfully answer these two questions about our foreign policy initiatives:

Why are we getting in?

How are we getting out?

Getting In

Several books published in the past five years such as COBRA II and Fiasco provide details on the clarity of thought (or lack thereof) that went into the United States' decision to launch the war in Iraq, the planning of the actual invasion and the problems in the war directly arising from those deeply flawed, incoherent plans. It might be easier to accept the situation and propose an new direction if one could conclude the current situation is solely due to catastrophic mistakes made by one Presidential administration after a shocking terrorist attack and the failure of the American voters to recognize the damage within three years to vote a change of direction in 2004 when the failure of the Bush approach was already becoming apparent.

It might be easier, but it wouldn't be the truth. Reporter and writer Mark Danner's recent book Stripping Bare the Body makes a convincing argument that the problem we face in choosing a direction for Afghanistan and Iraq is a sign of a much deeper problem in our policymaking framework for the past fifty years. The book itself is a collection of Danner's writing and reporting from 1986 to the present on events ranging from the elections in Haiti after the flight of "Baby Doc" Duvalier to genocides in the territories of the former Yugoslavia to American involvement in Afghanistan and Iraq. The book title comes from a comment made by Leslie Manigat, who managed to serve as President of Haiti for a whopping four months in 1987 who stated:

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Political violence strips bare the social body, the better to place the stethoscope and track the life beneath the skin.
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That comment stuck with Danner for the next twenty years and, in Danner's mind, came to symbolize the disconnect between our public perceptions of crucial foreign policy issues and America's official stated interests in engaging in those situations and the reality on the ground, the latter having very little to do with the former. Per Danner, the quote reflects how America has repeatedly been distracted by the faces of the public villians associated with violence seen around the world. Fixating on the violence and the villain without understanding the history and organization of the society that produced both the violence and the villain virtually assures us of entering into situations we have little chance of improving, much less solving.

As a literary work, the content and organization of Stripping Bare the Body do not exactly make it an enjoyable read. The content itself is quite detailed and frankly grim as Danner writes first hand about mass murders, ethnic cleansing and International Red Cross findings regarding American use of torture. As chapters progress from events in Haiti to events seemingly unrelated in Yugoslavia to events in Afghanistan and Iraq, the lack of a larger obvious "plot line" is a bit tiring. However, Danner includes a few crucial points of analysis amid the chapters that DO make clear a larger pattern to American policymaking that continues to produce these no-win situations.

Boiled down to a nutshell, Danner makes the point that for the past fifty years, America has had no earthly clue about the local history in which it has immersed itself as it goes about intervening in the world in the name of fighting tyranny and threats to our ideals, whether those threats come in the form of communism or now terrorism. Our adversaries seem to understand much more about us, however:

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The United States gazes out upon the world with a self-satisfied confidence in the superfluity of its power, the mistakes flowing from its ignorance it can and does survive, for the costs are borne by the objects of its gaze. They, for their part, look back at us clear-eyed, with calculation and cunning; they know us much better than we know them. They have no choice. (page xix in the introduction).
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Examples abound in the book:

* The looting and destruction of public infrastructure after the toppling of Saddam was not mere "untidiness" as characterized by Donald Rumsfeld, but the result of a key strategy communicated by Saddam well before the beginning of the war, planned with the knowledge that the resulting chaos would destroy the political authority of any government arising from the ashes. Saddam was thinking two years ahead of his neo-con adversaries even before the war began.

* Besides killing thousands and embarrassing the United States by the attacks on September 11, 2001, Osama bin Laden's true goal behind the attacks was to entice America into an invasion of Afghanistan where it could suffer the same slow, expensive loss by attrition suffered by the Soviet Union twenty years before. Bin Laden was thorough in his planning. Knowing the Americans would soon be on their way, he further destabilized the country by eliminating the head of the Afghan Northern Alliance via two suicide bombers posing as reporters two days prior to 9/11.

* Slobodan Milosevic correctly interpreted four years of side channel communications from both the Bush and Clinton administrations as political paralysis both within the American government and within the NATO alliance that would allow Milosevic to preserve territory captured via years of ethnic cleansing while distracting the West with the details of the Dayton "peace accord" as he planned the final onslaught on Kosovo. To hear the United States describe it, we "won" the war in Kosovo. We dropped over 23,000 bombs and didn't lose a single soldier. Yet Milosevic created over 85,000 refugees and used the turmoil to essentially complete the ethnic cleansing of ethnic Serbs from Kosovo.

Late in the book, Danner concisely summarizes the larger problem in the context of our failed attempt and understanding our position in Iraq as follows:

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Increasingly during the past year the newspaper reader and especially the television viewer has been looking at the great complicated tableau of occupied Iraq through a highly constricted lens, as if trying to examine an enormous history painting by squinting through a straw. (page 424).
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Whose Doctrine Dominates?

Doctrine. What a great word. It sounds so... substantial. A "doctrine." A clear statement to guide decisions about present and future issues based upon a set of well-analyzed, coherent principles. For most of the past two decades, political debate in the United States has frequently revolved around the so-called Powell Doctrine, which basically states the US should avoid any conflict unless a series of questions can be answered in the affirmative, among them being:

* is a clear security interest at stake?
* have all non-military means to solving the problem been exhausted?
* does the initiative have the support of the American people?
* have objective criteria for defining success and "the end" been identified?
* does the action provide for a clear exit strategy upon success or upon failure of achieving success criteria?

In his book, Danner uses the events leading up to the waves of violence in the former Yugoslavia to effectively illustrate the logical and moral straightjacket that incorporation of the Powell Doctrine has imposed upon American policymaking. Danner coins his own term for the result -- "self-deterrence" -- while explaining its role in the violence that took place in the former Yugoslavia as the world watched on TV and did very little to stop it -- for years.

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Since in the case of any given forceful action, one cannot be sure the Serbs will be deterred, and since, if one takes an action and they are not deterred, one must take another action to see that they are (for not to do so would destroy America's credibility) -- any given action, if one can't be absolutely certain of its success, holds within it the clear risk of unlimited and uncontrolled involvement. It is as if, having taken a single small step, the United States will inevitably lose all control of its policy. (page 140)
---------------------------

Danner then quotes another author, Wayne Bert, who summarized it even more concisely:

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Eagleburger seemingly had no misgivings about the value of American credibility unless some overt threat was made for which there was no follow-through. Complete inaction, in his view, did not compromise U.S. credibility. (page 140)
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In other words, instead of creating a coherent foreign policy based upon support of a small but critical set of principles regarding justice, freedom, peace and prosperity, American foreign policy has been abandoned to a feckless, futile effort at "saving face" and preserving American prestige which can only be lost by acting with less than 100% involvement. Doing NOTHING is OK, cuz if we don't get involved, we can't lose prestige.

It might be tempting to blame this feckless, futile strategy for fashioning foreign policy solely upon the current generation of politicians. Danner stepped back and reviewed American strategy over a longer arc and found much of the problem rooted in a much older "doctrine" -- the Truman Doctrine. The key line of the Truman Doctrine, taken from his speech to a joint session of Congress in 1947 was this:

I believe it must be the policy of the United States to support free peoples who are resisting attempted subjugation by armed minorities or by outside pressures.

But that's not how the line originally read. The content of the doctrine came from a brief prepared for Truman by Clarke Clifford in response to Winston Churchill's famous "Iron Curtain" speech the prior year. The Clifford brief stated the Soviets were "on a course of aggrandizement designed to lead to eventual world domination by the U.S.S.R" and that the United States "should support and assist all democratic countries which are in any way menaced and endangered by the U.S.S.R." In modern parlance, the "victim list" was broadened from democratic countries to free peoples and the "enemies list" was broadened from the Soviets to "outside pressures."

Mission creep, anyone?

What led to the change in language? The new national security apparatus being assembled felt the American public wouldn't support such a sweeping policy couched solely in negative terms as thwarting a single enemy but would support those goals if included as part of a positive campaign to support American ideals -- making the world safe for democracy. Apparently, they were correct. We fell for it hook, line and sinker.

Getting Out

So can reviewing fifty years of flawed rationals for action (and inaction) do anything to inform a decision on what to do to next in Iraq and Afghanistan? For starters, it might provide a broader perspective about whose goals -- ours or those of our enemies -- are served by continuing current strategies. One theme that seems to appear frequently in news reports filed from Iraq and Afghanistan involves the measure of success used by those doing the fighting. Inevitably, the first measure of success cited is simply "bring everyone back to base in one piece." I certainly can't fault those doing the fighting for listing that as Job #1 but

1) get in a big HUMVEE
2) drive around all day
3) avoid getting shot or bombed by IEDs
4) get back to base

as a strategy does nothing to create any stability, create any confidence in the local government or kill any bad guys. In short, it does nothing to create an environment that would allow us to leave under conditions that look like a win.

That's the core problem facing President Obama right now. Sadly, it's very familiar territory for the United States. We faced nearly the same situation in 1965 as President Johnson reviewed the advice of his staff regarding the trajectory of the Vietnam War. The November 20, 2009 edition of Bill Moyers Journal on PBS included extended excerpts from numerous conversations between LBJ and various advisors about the calculus of adding troops to the conflict. In a June 8, 1965 conversation with Senate Majority leader Mike Mansfield, Mansfield posed the question: As you said earlier, it's 75,000, then it's 150,000, then it's 300,000. Where do you stop? Johnson's reply: You don't. To me, it's shaping up like this, Mike -- you either get out or you get in… We've tried all the neutral things. And we think they are winning. Now if we think they're winning, you can imagine what they think.

Despite public pronouncements at the time to the contrary, many key advisors had stated blunt concerns about the wisdom of escalating or continuing any involvement and the President himself intellectually knew the war could not be won. Yet the President never left the trap of circular logic resulting from a misguided attempt to "save face" and "prevent more dominos from falling" to review the logic behind the original "getting in" decision to realize 'getting out" was the only viable strategy. As of June 1965, approximately 2200 American lives had been lost. More than 56,000 more Americans would die over the next ten years and the end result was a lost war, a Communist Vietnam and a nearly complete loss of trust in the American government by its citizens.

As was the case with Johnson in Vietnam in 1965, there are no easy answers for American's involvement in Afghanistan and Iraq. There are no good answers. But when you cannot define a mission and you cannot directly associate your strategy with specific goals and finite timeframes, there ARE right answers.

Terrorists and Hackers? Or Amateurs?

2009-11-08T19:16:00.002-06:00

The November 8 edition of 60 Minutes included a sensational story on the state of cybercrime and cyberterrorism in the world and our preparedness for it.

http://www.cbsnews.com/stories/2009/11/06/60minutes/main5555565.shtml

The story had some examples of a theoretical test in which a generator at an electrical facility had its control systems altered in ways which destabilized and burned up the generator and an actual attack that caused a complete power outage for two days in Brazil.

More disconcerting were the examples of ATM network hacking and financial network hacking. In one case, hackers working from three different locations (China? Russia? The Americas?) worked together over two days to steal --- are you sitting down? -- ten million dollars.

Yawn.

Wow. Ten million dollars.

Ten million dollars is a rounding error on the amounts stolen from world financial institutions by CEOs, executives and board directors entering and leaving the facility by the front door in luxury SUVs and limousines. Bernie Maddoff destroyed $65 billion with a single AS-400 computer that probably didn't even have an Ethernet card in it.

Who do you think is more likely to wipe out your bank account or retirement savings? A teenaged Boris Badanov toiling away somewhere in his mom's basement in a suburb of Kiev? Or a bank executive in Charlotte, NC or Treasury Secretary / regulator in Washington DC? It's no contest. The bank executive and Treasury Secretary have already destroyed TRILLIONS. Or, stated more accurately, they fostered a climate that created TRILLIONS in phantom wealth then subsidized the big boys as they cashed out then stuck everyone else with the worthless debt.

If our country melts down, it won't be because of cyberterrorists and cybercriminals working from unseen basements in remote countries. Our country will melt down because of decades of short term thinking fostered by distorted compensation schemes and corrupt regulators that allowed trillions of phantom profits to generate hundreds of billions in bonuses for those at the top while starving key industries and infrastructure of investment dollars needed to protect the keys to the kingdom.

WTH

Lost in the Debate on Afghanistan

2009-10-07T00:20:00.001-05:00

The October 6, 2009 edition of Charlie Rose featured an interview with CBS reporter Lara Logan discussing the inputs to the strategic decisions facing the US regarding Afghanistan and Pakistan.

While talking about the ongoing Washington parlor game about what number Obama, Congress and the Pentagon will eventually land on for any change in troop deployments, Logan made a very crucial point about a truth being totally lost in the current debate. Paraphrasing here, the point was essentially this:

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The counter-insurgency approach being used to support the addition of more troops states those troops will be used in conjunction with forces pulled from combat outposts back to more populated areas to ensure we protect civilians to win hearts and minds and improve economic stability.

Oooooookay. That's the key foundation of counter-insurgency tactics. The strategy that "worked so well in Iraq." Let's take that as truth. When you reduce or eliminate troops from the remote command outposts, ignoring all the rationalizations and mental and political justifications, what are you doing? You are surrendering territory. Now maybe that's what you do when fighting a counter-insurgency. But that's NOT what you do when fighting any traditional war. (Parenthetically, the argument being made here is not that we care about territory per se, but you CERTAINLY cannot cede territory to an enemy whose primary ingredients for mayhem are space and time in which to operate.)

Okay. So assume we focus on populated areas and reduce or eliminate troop deployments in desolate areas. Assume the populated areas turn around and provide economic stability. Let's even fantasize and assume we get an honest government as a partner (eventually) elected in a clean election.

Have we "won"?

We've just reverted to the situation in Afghanistan that existed in the late 1990s and early 2000s that allowed Al Qaeda to set up training camps in remote, uncontrolled areas and eventually launch terrorist attacks on targets around the world.
-----------------------

The goals set out by the Bush Administration for the war in Afghanistan and any variation of goals stated since then by Bush or Obama have focused on eliminating any capability by terrorists to operate with impunity from remote, uncontrolled regions of places like Afghanistan.

The status quo strategy and troop levels have allowed vast areas of Afghanistan to return to Taliban control while destabilizing tribal areas of Pakistan as well. Pulling out completely will obviously create a vacuum that will likely lead to a complete meltdown in Afghanistan and possibly Pakistan (which already has nukes). Ramping up troops requires a human and financial commitment the US possibly cannot afford. Reverting to a stronger counter-insurgency based strategy might stabilize cities but surrender most of the country to the fundamentalist terrorists that initiated the entire struggle nearly a decade ago.

Does anyone have any other ideas? It appears we may be close to exhausting all possible remaining mistakes regarding this war.

Wake-Up Call or Snooze Button?

2009-09-13T20:21:00.002-05:00

Perhaps the most maddening aspect of watching government at work is recognizing the enormous disparity between the number of things obviously screwed up in the country and the number of those things actually addressed by anything the government does, even when vast amounts of time, energy and money are spent supposedly focused on them. The week of September 6, 2009 is a case study of the phenomenon in the realm of healthcare. Unfortunately, the healthcare debate is not the only consequential example of the problem. It's not even the most important example.

All in One or One at a Time?

Virtually all political coverage in the week of September 6, 2009 was devoted to whether President Obama would formally and publicly support a "public option" in any healthcare legislation then, when his September 9 address to Congress obliquely referenced a public option, more time was spent analyzing if he really meant it and what exactly he meant. Voters and politicians with centrist views watched the fixation from the same vantage point: why, with so many things wrong with healthcare that most agree upon, does Congress insist on giant omnibus bills too large for anyone to understand that include deal-breakers for extremists on the far left or far right? Why can't the Federal government break the problem down into manageable pieces and vote on issues individually?

The reality of our current political dilemma is that NEITHER an all-in-one approach aimed at producing compromise in the interest of progress or a one-at-a-time approach to the legislation aimed at electoral accountability has much of a chance of achieving reforms that truly improve the situation. Why?

The all-in-one approach that uses a single massive piece of legislation to try to fix as much as possible poses the deal-breaking dilemma for extremists. The bigger the bill, the greater the chance it will include SOMETHING that offends SOMEONE on "principle" and will give them cover for rejecting the entire bill. That's really not the most dangerous outcome, though. The real danger of an all-in-one bill is that NO ONE VOTING FOR IT WILL READ IT in its entirety and certainly NO ONE WILL BE CAPABLE OF UNDERSTANDING all the special interest language inserted into the bill and understand the origins of those terms to understand whether they should remain or be axed.

What that really means is that the all-in-one approach poses a substantial risk of containing one or two or dozens of clauses which replace some fatal flaw of the current system with new fatal flaws that could prove equally inefficient or corrupt. One could argue the all-in-one approach DOES help fight special interests by forcing them to attack on multiple fronts at once which may dilute their message and focus and lessen the chance of blocking the debate with demagoguery. However, past history with giant omnibus legislation seems to confirm the risk of really dumb / bad language that defeats any value in a bill remaining in a large bill outweighs the benefit of that bill passing.

The one-at-a-time approach would seem to provide a few benefits but again, recent history proves otherwise. In theory, use of small bills to address issues should increase the probability that members of Congress actually READ the entire bill and UNDERSTAND its mechanics, claimed benefits and claimed costs precisely. In theory, use of small bills to address issues should also then provide voters a better ability to understand exactly what their elected official voted for or against to hold them accountable at the polls with "no excuses".

In reality, the one-at-a-time approach is virtually NEVER used for anything in Congress for exactly this reason. It provides no "cover" for officials to say they only voted for a study to determine why college kids like beer because it was in a bill that funded up-armored humvees for our troops in Iraq. This allows special interests to focus on one issue at a time and pick off opponents via any means necessary. It also eliminates the ability to use counterbalancing pork projects to forge coalitions large enough to pass bills. Any junior high school student of American history recognizes the process -- logrolling. In essence, that type of waste represents the tax imposed by an inefficient, corrupt political process because the only way to get anything through the gauntlet of corrupt politicians and lobbyists is to grease the skids with pork projects.

Political Paralysis Doesn't Stop Change

On any issue, there are always some who aren't comfortable with current proposed solutions and seem to almost take comfort in what appears to be our political paralysis. Their operating philosophy seems to be "I don't like the current ideas, let's just do nothing, keep the status quo and wait for a better idea." Unfortunately, an unchanging status quo only exists in our government. The real world continues to change in ways which are shifting investment capital out of America, shifting jobs out of America, concentrating more power with a smaller number of international corporations and widening the disparity in income and wealth throughout the world.

Normally in a republic, the voters should step in and use the ballot box to demand change and "throw the bastards out." That assumes the voters are paying attention and understand the mechanics of the issues well enough to discern fact from fiction. In the case of America, that also assumes our primary political parties actually present distinct choices and solutions. If the parties are failing to provide meaningful alternatives, use of the ballot box to make a change presumes that it is possible for a new party to be formed and gain enough power to make a difference. In reality, procedural rules at the federal and state government levels virtually assure any vote for a non-traditional party is wasted due to seniority rules for committee membership, leadership positions and election funding.

Wakeup Calls and the Snooze Button

The sad reality is that our political process is being strangled by corruption and special interests and has brought the country to the point where the only force capable of producing material change is massive failure and collapse. How massive? Just consider these examples.

The collapse of the Internet bubble in April 2000 didn't lead to any material change in obviously corrupt practices for IPO stock offerings and bogus mark to mark accounting that fed much of the bubble. It took the near simultaneous collapses of both WorldCom and Enron nearly 18 months later for Congress to make any attempt to improve regulations on accounting fraud and even those changes were toothless due to a lack of funding for enforcement.

The terrorist attacks of September 11, 2001 didn't produce any effort to re-orient America's energy policies to lessen our dependence on oil and reduce the volume of American dollars flowing into the coffers of states promoting militant Islamic terrorism. Indeed, the aftermath of the attacks led us to attack one nation that NEVER HAD nuclear weapons while starving a war in another country for resources that allowed that war to destabilize another country that DOES have nuclear weapons and has repeatedly engaged in proliferation of the weapons and the technology to make them to numerous other countries.

One year ago on September 15, 2008, the bankruptcy of Lehman Brothers triggered a month of near-constant financial failures which nearly triggered the collapse of our entire financial system and led to TRILLIONS of dollars being given away with zero accountability for the recipients. Yet twelve months after that wakeup call that made the market crashes of October 19, 1987 and October 29, 1929 look relatively benign in comparison , NOT A SINGLE CHANGE has been made to the regulation of the institutions that brought our entire economy to the brink. Indeed, we instead are seeing stories about executives of banks receiving TARP money using foreclosed properties of their institutions as personal vacation resorts.

In other words, NONE of these events -- arguably among the biggest "black swan" events to impact the United States in its entire 233 year history and all within the last decade -- have altered the behavior of our government or the behavior of We The People in the slightest.

Stop and think for a moment how shocking those events were to your retirement savings, your livelihood and your loved ones. If none of THOSE events could wake up Americans and force a change, how shocking do you think the event that CAN force a change will be? Believe it or not, healthcare is NOT an existential problem for the United States. Failure to address it will not lead to the collapse of the country, just a sudden, painful collapse of a few related industries and a shifting of spending between employment sectors within the country. Healthcare is a mere warm-up issue to practice our problem solving skills in preparation for vastly more important issues --- energy and finance -- which ARE existential to the future of America as we know it. Both have the ability to cripple the core of our economy and both are currently acting to cement Americans in a role as debtors to the world rather than its leaders.

Wake up, America. The snooze button won't work forever.

The Speech We Needed

2009-09-09T23:50:00.002-05:00

President Obama's speech of September 9, 2009 had three crucial goals:

1) replace the current sense of paralysis for one of momentum and progress
2) outline a core set of principles that justify the structure of the proposals he's promoting
3) recast the core of the debate from a partisan political battle to a moral reflection of our collective American character -- an appeal to our "better angels"

At this point, any debate about whether the speech achieved those goals may be moot (or "mute" if yous ignert).

The more appropriate question would be -- What was the speech we needed?

Answering that question requires an understanding of the portion of the voting public that's still capable of moving the debate. Based upon most news stories over the past month of "town hall meetings", that audience is actually the large percentage of workers who actually have insurance coverage right now. To date, this group hasn't become terribly concerned or involved with the debate because even though they may not be thrilled with their employer-provided coverage, they have concluded

1) unemployment is high but I still have a job
2) my job provides coverage
3) I may not like the terms of my coverage but I've covered for the big stuff

In short, I got mine, I don't understand all this stuff, so just leave it alone.

Obama's speech ended with a fabulous rhetorical flourish related to goal #3 -- We did not come to fear the future. We came here to shape it. None of that is going to click with the "I got mine" crowd.

What would click?

Here's an abbreviated speech that would have made the appropriate point to the appropriate subset of Americans that could really drive their elected officials to ensure substantive change is made to both health care and health insurance.

--------------------------------------------
My fellow Americans, on the issue of healthcare, we Americans are divided into several distinct camps based on a combination of long-held ideological views and short-term indifference. Frankly, for those of you out on the fringes of the left or right of this issue, nothing I say here will convince you of the merit of any change in your views. We already know how many don't have insurance. We already know the costs of emergency care for those without insurance is being subsidized by those of us with coverage or by taxpayers. We already know insurance companies want to be free to cherry pick low-risk customers yet at the same time preventing lower-cost alternatives from being provided to those excluded from coverage.

For those who have been comfortably indifferent to this issue, it is you who need to listen to what I'm going to state here. I'm talking about you out there with jobs, with families, with employer-paid healthcare insurance who are still ambivalent about the dangers posed by our current insurance and care delivery systems. I'm talking about those of you out there comfortably retired with a pension and retiree health care coverage and a 401k.

Wake up.

You have a job now, but we have fifteen percent real unemployment. Your wages have been flat but you haven't aggressively sought higher paying jobs because at least you have healthcare coverage. Even if you have a job you may not like or sub-par pay, you worry about changing employers because you worry about taking a chance with a new employer who might lay you off with no way to come back to your prior job and resume coverage. Even if you don't worry about the employer change, you worry about whether the new employer's insurance will exclude coverage for a pre-existing condition for you or a family member. The feeling of healthcare coverage limbo between jobs isn't the real issue though.

The real issue you need to understand is the very real chance you don't actually have the coverage you think you do. You've been tolerating a possibly crappy job, possibly crappy pay, a possibly crappy corporate employer to hang on to dear life for insurance coverage that when you REALLY need it may turn out to be a phantom -- an very expensive illusion. The minute you file a claim for a serious (expensive) condition, you encounter a giant corporation bent on finding rules allowing them to exclude payment or allowing them to drop you entirely. After you've paid thousands in premiums for years. After being diagnosed with a condition that will now likely allow any other insurance company to exclude you leaving you completely alone.

The real issue you need to understand is that any healthcare coverage you may enjoy as a retiree of any large company faces grave dangers in the current financial climate. The financial contraction is not over, tighter credit markets will continue to squeeze weak financial institutions including banks and insurance companies and investment firms, further squeezing company pension plans, 401k balances, and reserves for employee / retiree healthcare coverage. If your former employer goes bankrupt, obligations for retiree healthcare are the first to be jettisoned in any bankruptcy.

The current system of healthcare insurance and providers is acting as a growing drag on EVERY sector of the American economy and has reached critical mass in its ability to kill jobs, bankrupt firms and bankrupt families. The only way to break the downward spiral, stabilize the economy and begin re-orienting the delivery of care is to

1) force insurance companies to compete without exclusions or retroactive denial of coverage
2) provide alternate sources of coverage to break the death grip of employers on insurance pricing
3) combine meaningful tort reform with objective, public reporting on care quality to eliminate defensive medicine

That's what the American people deserve, that's what I aim to deliver and that's what you should demand from your Representatives and Senators in this chamber.
--------------------------------------------

THAT'S the speech I would have preferred hearing to kick-start reform.

Recess Bullies and Town Hall Tantrums

2009-08-16T20:58:00.005-05:00

Without exaggeration, the three most important issues facing the United States involve its fossil fuel addictions, a systemically corrupt and incompetent banking and financial system and a healthcare system that is bankrupting our real economy. Each has been neglected for so long that the danger posed by each has reached existential proportions for the country and have become intertwined in their impacts and the barriers each poses to solving any of the three.

After seven months of meandering, the new Congress not only failed to produce concrete proposals for debate in the area of healthcare, it failed to even define a framework of three or four key areas in which changes must be made and explained / sold to the public. Where there's a void, there's uncertainty and where there's uncertainty, there is fear to be sowed and exploited -- by all sides.

And so it has. As 535 elected representatives returned to their districts for summer recess, attempts at explaining current proposals or "listening" to voters became opportunities for free media exposure of pre-planned verbal bullying and the adult equivalent of temper tantrums that probably embarrassed many children. The hype around these recess bullies and town hall tantrums merits a bit of analysis in one key area but a return to focusing on the fundamentals is urgently required.

Politics -- Obama's Colossal Mistake

Define the terms and you define the debate -- and often the results. Healthcare constitutes seventeen percent of GDP in the United States (see #1). Nothing that massive and complicated can be changed in the slightest regard without massive resistance from those currently benefiting from that status quo. Despite campaign rhetoric that tagged healthcare reforms as a do-or-die issue for America, despite abundant examples in recent political history of issues being distorted or shut down entirely by poll-tested catch-phrases like "death tax" or "defense of marriage" and despite recent history in the very specific area of healthcare of any attempts at reform being labeled socialist, President Obama kicked off the healthcare reform initiative by doing…

...virtually nothing.

No strawman proposal. No prescribed limit on total cost. No prescribed limit on offsets in other spending to help cover the cost. No concrete timeline for the overall process that might help triage the problem and allow a more focused, informed debate.

Outsiders have no way of knowing what the thinking was among Obama's advisors that led to this approach. The only plausible explanation is that Team Obama felt financial stability in the banking and auto industries was still not assured as of January 20, 2009 and a collapse in either area could magnify an economic meltdown. Those issues required the new Team Obama to continue a very heavy-handed, top-down approach to intervention begun by Team Bush that was wildly unpopular with the public. As such, healthcare reform could be tossed to a Democratic Congress for the initial grunt work and a wildly popular Obama with a perceived electoral mandate to fix healthcare could step in at the last minute to iron out any wrinkles or remove a few sticking points while avoiding the appearance of even more micromanagement of the economy by the Executive Branch.

That might have been the thinking but it has turned out to have disastrous consequences. The most damaging outcome of the initial hands-off strategy by the Obama Administration is that Obama failed to establish a vocabulary for the debate. In the absence of a common vocabulary, any parties with an interest in preserving or expanding the status quo have been able to fill the void with their own spin with millions in paid advertising. Better yet, opponents have scored millions of dollars worth of free coverage created by equally uninformed reporters covering ginned up "conflict" with someone screaming at their Senator or Representative in front of hundreds. That makes much better television than video of hundreds of the uninsured lined silently lined up in the dark in the middle of the night waiting for a free clinic to open so they can try to get dental care or an eye exam.

Many say a Presidency comes down to the first eighteen months in office. Beyond that, Congress has to focus on fundraising and mid-term elections. Beyond twenty four months, the incumbent President has to worry about re-election and nothing controversial or important has a chance of being enacted. At this point, President Obama could be viewed as nearly halfway through his "real term" and the healthcare issue is nearly dead in the water. Miracles might happen and some improvements might come out of nowhere but Congress has never done its best work on short order. The failure to define the terms of an honest debate on healthcare lies predominately with President Obama and time and support are rapidly dwindling to salvage ANYTHING out of a reform effort, much less the changes that are really required.

So what vocabulary needs to be established for a legitimate debate of healthcare reforms? All of the following terms are being used and abused in the current debate:

* competition
* tort reform
* death panels versus death taxes
* status quo

Reality -- Competition in Health Care and Health Insurance

Any discussion of government involvement in expanding coverage quickly highlights significant confusion about the difference between health CARE and health INSURANCE as well as the competition in each segment. That confusion, whether incidental or intentional, helps mask many of the problems in both segments and the flaws with proposed changes. Health CARE involves analysis of symptoms by medically trained doctors and nurses, diagnosis of potential causes and the delivery of treatments to correct or at least mitigate diagnosed illnesses. Heath INSURANCE is a financial product that exchanges uncertain costs with uncertain timings and individually uncertain probabilities of occurrence for a fixed cost. Our system has linked care and insurance in amazingly inefficient ways but they have to be analyzed separately.

Increased government involvement in providing insurance is opposed by many for fear a cheaper government solution will somehow steal customers away from large publicly traded insurance companies by offering cheaper, subsidized coverage -- as if the government was going to complete in the computer market by offering a cheaper, more desirable computer than either Apple or numerous Wintel style manufacturers. This argument conveniently omits mentioning that the business model of most insurance companies is NOT to sell MORE policies to produce more profits. The model for the past ten to fifteen years has morphed into one involving statistically discriminating against entire classes of customers to sell to a smaller and smaller base of wealthier customers able to pay higher and higher premiums who never get sick and never generate charges for treatments and drugs.

Open your Econ 101 textbooks and review the chapter on supply and demand when prices are higher and supply smaller than aggregate demand would normally dictate. Theoretically, the only time that’s possible is when supply is met by so few competitors such that each competitor in the market place is large enough that their "supply curve" begins approximating the overall "supply curve" of the industry -- the classic definition of a monopoly. At first, it's hard to argue the insurance industry acts as a monopoly given the hundreds of firms in the business. However underlying economic theory says that's exactly what's happening. Your experience should bear this out as well. Every November when your employer requires re-enrollment for the next year's healthcare coverage, do YOU get to pick among any insurance plans in your state or only those pre-selected by your employer? Do you have more or fewer choices this year than last year? Even if you get a choice between three or four different plans, is that REALLY a choice? Is your favorite doctor or dentist available under all the plans?

The truth is that insurance companies don't want to serve huge swaths of the population because their business model isn't based upon efficient claim service, it's based upon collection of premiums and denial of payouts. While they can't efficiently serve large segments of the population, they sure don't want anyone else serving them either. This is perfectly logical from their selfish perspective but completely illogical from society's perspective. It's as though Lamborghini, Ferrari, Porsche, Mercedes and Lexus only wanted to sell $100,000 autos but didn't want anyone else trying to sell $20,000 autos. Also note that one proposal put forth by the insurance industry involves eliminating state-by-state licensing so firms don't have to manage fifty unique sets of rules to offer coverage. That sounds like they want to compete for more business but more than likely, only under their existing business model of selective coverage and denial of payouts.

Problems with the lack of competition for healthcare insurance are getting worse with time. In 2002, the Government Accounting Office produced a report for Missouri Senator Christopher Bond (see #2) summarizing key statistics for insurance carriers selling "small group" coverage in the 50 states. In 2002, the median number of firms offering "small group" insurance was 28 per state and the five largest firms represented 75% of the market in 19 the 34 states that responded but more than 90% in seven states.

In 2009, the GAO provided a similar report to the same Congressional committee (see #3). How have things changed? Quoting from the report:

--------------------------------------------
* The median market share of the largest small group carrier has increased to about 47 percent in 2008 from the 43 percent reported in 2005 and the 33 percent reported in 2002. Twenty-four of the 29 states providing information in both 2002 and 2008 saw increases in the market share of the top carrier that ranged from about 2 to 39 percentage points. In contrast, the top carriers in 5 states lost market share with decreases ranging from about 1 to 16 percentage points.
• The number of states with a combined market share of the five largest carriers of 75 percent or more has also increased since our 2002 survey. The combined market share of the five largest small group carriers represented three-quarters or more of the market in 34 of 39 states, compared to 26 of 34 states reported in 2005 and 19 of 34 states reported in 2002.
--------------------------------------------

Reality -- Tort Reform and Insurance Costs

Understanding the lack of competition within the healthcare and health insurance industries is also crucial to understanding motivations of those proposing so-called tort reform measures. The term "tort reform" is usually used as a label for proposals which would impose caps on "giant malpractice damages" that increase malpractice insurance premiums for individual doctors and institutions which in tern drive up care costs which drive up consumer insurance costs. Proponents of this type of tort reform also claim -- with some validity -- that the risk of sky-high malpractice judgments against doctors and hospitals drives additional unnecessary medical tests as "defensive medicine." Perhaps worst of all, high malpractice insurance costs drive many doctors out of particular specialties (obstetrics for one) or out of practice entirely -- "who needs the aggravation?"

This argument for tort reform sounds very logical and reasonable but ignores two problems with the current system. First, most "tort reform" proposals also aim at strengthening restrictions protecting HMOs and insurance staffs from lawsuits for malpractice when, in fact, many patients' care is DIRECTLY affected by employees who are NOT licensed to practice medicine, prescribe drugs or second-guess the decisions of those who ARE so licensed. It also ignores the fact that many of the unneeded tests and procedures being performed and referrals being ordered aren't "defensive medicine" at all. A better term might be "offensive medicine" because many are ordered because the doctors participate in the profits of the labs or hospitals doing the work -- a direct conflict of interest. When patients think the doctor is the expert and some third party is paying the bill, offensive medicine can be highly profitable.

An imaginary problem? Tell that to the 25 percent of heart patients at a hospital in Redding, California operated by Tenet Healthcare who were treated with bypass surgery despite having no serious health problems (see #4). Redding is a small town with a population of about 80,000 yet it led the country in the number of bypasses performed on Medicare patients at the time the FBI shut down the cardiac practice in 2002. Despite the obvious fraud and criminal malpractice, neither Tenet Healthcare nor its two cardiologists who performed the procedures were criminally prosecuted (#5). They paid a fine of $54 million to the government and Tenet paid $395 million to about 796 patients involved. SEVEN HUNDRED AND NINETY SIX patients. Average costs for CABG procedures vary widely (see earlier notes on that) but charges at this facility averaged $300,000 PER PROCEDURE during that time.

There are clearly thousands of lawsuit-happy patients and lawyers exploiting insurance companies and driving up costs for healthcare. However, tort reform that simply caps damages to individuals will simply reduce the uncertainty of legal fees for insurance companies and bad doctors, making lawsuit damages a predictable cost of doing business which can be budgeted like the cost of tongue depressors and magazine subscriptions for the waiting room. To balance out the risk between providers and patients, tort reform proposals MUST require doctors and hospitals to collect and report auditable statistics on patient acuities, treatments and outcomes. If doctors are operating within statistically normal ranges of patient acuity and procedures performed for those conditions and a bad outcome happens, the tort reform caps apply. If a doctor's choice of treatment for a given condition lies outside some boundary of "normalcy" and a bad outcome occurs, patients have a right to sue without caps on damages.

Improved use of statistics to trend treatments and outcomes is possibly the SINGLE most important strategy for improving virtually every aspect of the healthcare and health insurance problem. Suppose a patient presents with symptoms W, X, Y and Z and a doctor proscribes a few tests but decides tests A, B and C are not required. Under the current system, if a bad outcome occurs and later a lawyer decides the doctor should have ordered test A, the doctor faces an expensive and time consuming battle that takes even more resources away from patient care. If the doctor had the backing of a national database of independently certified results saying that 99 percent of the time, patients with symptoms W, X, Y and Z never benefited from having those tests performed, the inclination to order those tests defensively might be reduced. If the database statistics came with clear-cut limits on malpractice judgments, such defensive tests could easily be reduced 20 to 30 percent.

Some doctors and hospitals have seen the light on improving access to statistics. However, only a minority offer access to statistics regarding cases and outcomes like this summary (see #6) for Dartmouth-Hitchcock hospital. Virtually NONE publish actual costs of procedures performed. As another interesting exercise, try to find statistics for average costs of a heart bypass operation (a coronary artery bypass graft or CABG). You'll find numbers ranging from $20,000 (see #7) to $68,367 (see #8) to even $135,000 (see #9). How would a prospective patient reconcile cost variances like that?

Reality -- Death Panels and the Real Death Tax

Ask most people what comes to mind after hearing the term "death tax" and the vast majority will respond with "inheritance" or "estate tax" -- and somewhere Republican pollster Frank Luntz smiles. In a masterstroke of linguistic and political manipulation / fraud, he helped link the two concepts to help efforts aimed at reducing or eliminating the federal estate tax. The majority of Americans think estate taxes harm them when the vast majority of Americans (certainly NOW after the financial meltdown) will not die with an estate worth over $1,00,000.which is the ACTUAL final trigger point at which the tax applies after the un-sunset of the sunset that expires after 2009 (see #10).

Republicans tried the same tactic with healthcare reform by inventing the term "death panel" which was immediately shot down after finding similar proposals in Republican legistlation in the last decade. Instead of being clever with language, it might be useful for once to be PRECISE with language when debating public policy and end-of-life healthcare costs and taxes provides a great opportunity. The real "death tax" in America is imposed when families of elderly patients headed for long-term assisted living or skilled nursing facilities for hospice care coordinate "planned giving" of assets of the patient to family members in the years / months leading up to hospitalization so by the time the real bills arrive, the "patient" is technically impoverished and eligible for Medicare so US taxpayers pick up the tab for the final months. Many state Medicaid websites and law firm web sites provide advice on exactly how to do this (see #11).

Here's a common scenario. In the final years of life, an elderly person with some financial means begins transferring up to $12,000 per year to family or friends on a tax-free basis. As long as they stay below the $12,000 limit for a five year "look-back" period from the time the nursing home stay begins, those gifts don't hurt the patient's eligibility for Medicaid payment of their nursing home bills. Neither does up to $500,000 in home equity. The net result is a "half-millionaire" can manage to protect up to $60,000 in cash funds (in addition to the equity on a principle residence) from being used to pay a bill other taxpayers wind up covering. That $60,000 would cover roughly fifteen months in a typical nursing facility.

This sounds harsh, it sounds like class envy, it sounds crass, even cruel somehow. Is it though? If you are elderly and you have FIVE HUNDRED THOUSAND dollars or, more precisely, you have FIVE HUNDRED AND SIXTY THOUSAND dollars, why ON EARTH should I or any other tax payer be picking up ANY of the cost of an expense that is now a very predictable part of life? This is the true "death tax" -- a tax liability you impose on OTHER PEOPLE when you die. By transferring the cost of a predictable cost of later years to "other people's money", it removes any incentive for patients and their families from making more appropriate financial decisions for covering those costs. Perhaps more importantly, it removes any incentive for many families to make more appropriate ethical decisions concerning end-of-life treatments, many of which are not improving quality of life under any objective standard.

Reality - Is There Any Such Thing as a Status Quo?

Let's give opponents of particular health care reform proposals or ANY reform whatsoever the benefit of the doubt for a moment. Let's assume they have principled objections to some perceived flaw in reform proposals and prefer our leaders simply stop, take an electoral breather and regroup for a more thoughtful attempt in another year or two. The assumption is that if left unchanged, things will remain about as bad as they are right now, within some range of tolerable certainty. Opponents might even argue that this in fact happened in the 1990s with the Clinton plan and nothing melted down after doing nothing then. We can choose "nothing" again and get the status quo.

BZZZZZZZZZZZZZTTTTT. Nope. Uncontrolled healthcare costs are one of the three existential problems facing the United States economy and perhaps our society. We face nearly 16 percent unemployment (9.5 percent "looking" plus 6.5 percent "given up") and continued declines in factory orders are driving continued declines in manufacturing which will continue to generate job losses which will continue to drive bankruptcies from mortgage foreclosures and medical bills, feeding a horrific downward financial spiral in the entire economy. Reducing healthcare spending through improved efficiency on procedures provided and elimination of needless procedures is REQUIRED to stabilize the economy. Not three or five years down the road but AS SOON AS POSSIBLE. Failure to do so will make American labor and products less competitive on the world market, accelerate further job losses, increase the rolls of the uninsured, and further expose families to bankruptcy and an utter collapse in their standard of living. For the long term, failure of American business to reduce health care costs will cost America the jobs of the future, be they in electric cars, solar or wind energy technology or the next big thing. If you think this is hyperbole, note that the China's exponential growth coincided not only with new trade policies but with the collapse of healthcare reform efforts in the Clinton era.

Doing nothing now might be an option but keeping the status quo is not. The current situation will get markedly worse -- not only for those without coverage but even for those currently employed and covered.

==========================================

#1) http://www.nchc.org/facts/cost.shtml

#2) http://www.gao.gov/new.items/d02536r.pdf

#3) http://www.gao.gov/new.items/d09363r.pdf (2009)

#4) http://www.usatoday.com/money/industries/health/2003-08-06
-tenet-settlement_x.htm

#5) http://www.sfgate.com/cgi-bin/article.cgi?f=/c/a/2007/02/18/INGN1O5DUM1.DTL

#6) http://www.dhmc.org/qualityreports/list.cfm?metrics=CT

#7) http://www.consumeraffairs.com/news04/2005/bypass.html

#8) http://www.dane101.com/current/2006/05/10
/where_is_heart_bypass_surgery_the_cheapest

#9) http://www.crd.york.ac.uk/CRDWeb/ShowRecord.asp?View=Full
&ID=22003001376

#10) http://en.wikipedia.org/wiki/Estate_tax_in_the_United_States

#11) http://www.markfreemanelderlaw.com/myths.asp

Everyone to the Lifeboats!

2009-06-16T22:37:00.003-05:00

It's nearly impossible to watch television without seeing ads for firms setting up card tables at local hotels wanting to "turn your old, broken, unwanted gold jewelry into cash." Better yet, call an 800 number to have a padded envelope mailed to your home, stuff it with all your unwanted gold jewelry, mail it back, and someone will melt it down, tell you exactly how much actual gold there was, and send you a check for that amount of gold.

Okay, quick question. How many people would trust a firm they've only heard of via television to honestly report the amount of real gold in the junk sent in and cut a check at the current exchange rate? Assuming you get a check at all? Of course, sophisticated investors are too smart to mail in their money to someone else who will tell them after the fact how much they'll really get for their investment.

Right?

The interesting thing about economics, money and human psychology is that when everything seems to operating within a range of predictability, everyone involved begins thinking they understand more than they really do about the mechanics of the system. Indeed, participants begin thinking they understand more than can be known about the system. The longer things operate within that predictable range, the greater the tendency to extrapolate that current behavior (as they (mis)understand it) beyond the range supported by the underlying fundamentals.

Treasuries provide one recent example of this phenomena. In December of 2008, demand for three month Treasuries skyrocketed so much that yields actually went negative for a brief period of time before cooler heads prevailed and realized paying $1.01 today for $1.00 three months from now made no sense. Buyers caught up in the frenzy lost track of the fact that the Treasury market does not exist to provide a zero-risk piggy bank for investors to stash an unlimited amount of money. It exists to produce cash for the government when it needs to borrow funds. When it has what it needs, supply goes to zero. When the number of investors needing an extremely low risk place to keep cash for short intervals is relatively small, the Treasury market satisfies that need as a side-effect of the government meeting its fiscal needs. When the demand for short term safety drastically outweighs the government's need for short term cash, the mechanism breaks down from the perspective of the investor seeking a safe haven.

Treasuries aren't the only example. Between summer 2007 and summer 2008, investors looking for both safety and quick profits piled into crude oil and drove the price to $145 dollars before reality kicked in and the price dropped like a stone -- 75 percent in five months. Demand didn't drop 75% but the distortion created by an influx of cash from speculators trying to avoid liquidity issues in other segments (MBSs / CDOs) evaporated once the mismatch between supply and demand became too large to ignore.

When markets are volatile and people feel economically insecure, the psychological urge to look for a "lifeboat" is not only unavoidable, it's a rational reaction. However, a quick look at another common "lifeboat" investment -- gold -- points out that every lifeboat has its limits. For those first entering the lifeboat who are able to time a graceful exit, lifeboats can be extremely profitable. However, making money off a lifeboat is vastly different than PRESERVING money in a lifeboat. Understanding the difference requires understanding three key factors:

1) how big is the lifeboat?
2) what is it good for?
3) when does a lifeboat make sense?

How Big Is the Lifeboat?

Here are some basic facts about gold:

* there are roughly 145,000 metric tonnes of gold in existence as of 2001 (#1)
* precious metals like gold, silver and platinum are measured in troy ounces (12 troy ounces per pound)
* there are 32,150 troy ounces per metric ton
* the price of gold as of June 14, 2009 is $937.05 per troy ounce or $30,126,157.50 per tonne

Thus, the total value of all known gold reserves in the world is $4,368,292,837,500 or $4.4 trillion dollars. A staggering amount of money.

Or is it?

The gross domestic product of the United States for 2008 was $14.29 trillion (#2). For the European Union, $18.39 trillion (#3). For the world, $60.69 trillion (also #3). Hmmm. That means all gold reserves are only worth about 7.25 percent of yearly economic activity.

What Is It Good For?

The answer isn't "absolutely nothing" but the correct answer is much less obvious than it would appear to casual investors. Gold obviously has decorative value as it has for centuries in jewelry and it has some utilitarian value in dentistry and as a conductor in computer circuit boards, etc. For most people, gold's true value is perhaps its most intangible -- as the ultimate, perfect medium of exchange -- MONEY. Gold is worth something because it's gold and it's always been worth something.

Skipping that ultimate metaphysical argument, let's just accept that at face value. After advancing beyond gold coins as a medium of exchange to fiat coins and currencies, gold has always been viewed as the financial medium of last resort any time faith in fiat money waned or outright collapsed. Psychologically, people feel a desire to pile into gold as a life raft when they fear an economy based on fiat money is about to capsize.

The "lifeboat" analogy of gold really doesn't make sense though. To see why, one has to understand three key inequalities in economics:

money does not equal GDP does not equal wealth

In the American economy of $14.29 trillion for 2008, there wasn't $14.29 trillion in cash in existence all at once in the wallets of consumers and cash registers of businesses. A much smaller amount of actual cash cycles through the economy multiple times throughout the year. Each time it changes hands as part of a transaction that produces net value, it gets counted and increments GDP.

More importantly, GDP does not equate to wealth because GDP is an immediate measure of simple economic activity and does NOT reflect the source of funds that paid for the activity. Wealth on the other had DOES reflect the source of funds of economic activity and it reflects the cumulative result over time. If you spend $50,000 per year, you're creating $50,000 of economic activity but if you're borrowing $50,000 per year to do it, your wealth is certainly not increasing $50,000 per year.

Gold's current role in the worldwide economy is that of ballast -- a psychological / economic backstop for fiat currencies to ensure any fluctuations in percieved value of any one currency can be acted upon without a free-fall drop. Current worldwide stores of gold cannot act as a final last resort store of value without producing massive, crippling fluctuations in values and halting virtually all worldwide trade. In other words, gold's role is to stabilize a very small part of worldwide MONEY to ensure money continues to flow to produce GDP which over time produces long term wealth. It does not and cannot scale to protect wealth itself.

Imagine for a moment that every single American household attempted to shift all of their non-home net worth into gold. According to the Federal Reserve's Flow of Funds report for 1Q2009 (see #4), home equity accounted for 41.4 percent of household net worth so the balance not tied up in homes amounts to $29.51 trillion. What would happen?

When $29.51 trillion dollars go searching for $4.4 trillion in gold, two disastrous things happen -- simultaneously.

Since the supply of gold is relatively unchanged over any short period of time and demand has skyrocketed, the price of gold skyrockets. More importantly, the price of all other assets being sold falls as people unload stocks, bonds and other commodities. Anyone pursuing this trade sells at an artificial low to buy at an artificial high. They are also climbing into a very crowded lifeboat. The more rapidly the price goes up as more people climb in, the more danger they face from a few people deciding to suddenly cash out and make it evident how little liquidity there is in holding gold at 2x to 7x normal prices. Now imagine how volatile the climate would be if everyone in the world was trying to get into the boat, not just American investors.

When Does a Lifeboat Make Sense?

The above thought experiment is sheer hyperbole. Clearly, gold has played a valuable role for decades in calming nerves and allowing investors to hedge concerns about exchange rates between individual currencies. But what if currencies around the globe are in decline? What if the combination of collapsing banks (and contracting credit) and mushrooming fiscal deficits (and possible inflation) are paralyzing investors who aren't sure what do? In particular, what if doubts about the American economy in particular are sowing doubts about the use of the US dollar as a world currency? Are investments in commodities -- gold in particular -- a useful hedge against drops in dollar-denominated wealth?

The pro arguments are relatively straightforward. What about the con arguments? Are the fears driving people to the boat well founded?

Here are a few things to consider:

1) How practical is an "un-wind" of a US dollar-denominated investment? -- For example, if China decides to reduce purchases of new Treasuries due to concerns over mushrooming US deficits, a precipitous drop in demand for new Treasuries will also tank values of existing Treasuries, crippling China's existing holdings. China understands this very well. This doesn't mean they'll continue pouring more into Treasuries but it puts a lower bound on how quickly they can diversify their holdings, for their own selfish bottom line. Given the amount we owe, they clearly have the upper hand, but in a very real sense, they are trapped and cannot literally exit their position without damaging their own export-dependent economy as well.

2) What are the alternatives for a world currency? -- Does anyone think the Russian ruble can provide a more trusted medium of exchange for international contracts for goods / services? Do you want Vladmir Putin as the world's central banker? How about the Chinese yuan, the currency of a country trying to walk the tightrope of leveraging high tech in its economy while hiding "tank man" from Google search results twenty years after the Tiananmen Square massacre?

3) Who plans on financing the international cop on the beat? -- If the rest of the world has grown tired of America serving as the world's policeman around oil shipping lanes and keeping bitter enemies with nuclear weapons (Pakistan / North Korea) in opposite corners from high growth economies (India / South Korea), what's going to happen when we pull our troops home? Will North Korea suddenly open the border, stop starving its citizens and turn on the lights at Bally's Casino in Pyonyang? Which economies will suffer most when those uneasy stalemates return to full conflicts?

4) How much do you really know about accounting standards, corporate law and property rights in emerging countries? -- Would you really be comfortable directly investing most of your wealth in a Russian or Chinese firm? Or how about a European Union country? Despite the attempt at a single currency adopted by most members, those members all still pursue a hodge-podge of fiscal policies. Any confidence their politicians will be able to resist deficit spending for local constituents without tanking the shared currency?

4) Where are alternatives for high-growth investment and what currency do you want to use for profits? -- See questions #2 and #3.

Takeaways

With all of the monumentally stupid things the United States has done to our own banking system and economy, it's important to keep in mind several key things. First, when we did this to ourselves, many other countries copied us and wound up damaging their economies as well -- in some cases, inflicting more damage than we did.

Second, in economics, everything is relative. Capital won't flee a market that drops 40% if a 40% loss is the best return available.

Third, nothing in economics scales to infinity. Finding an investment capable of growing $1 million or even $1 billion at 10 percent per year is vastly more feasible than finding an investment that can absorb $100 billion or $1 trillion and grow that 10 percent per year. Any attempt to swing large amounts of capital from one asset class to another or from one economy to another overnight will inevitably produces bubbles and subsequent crashes.

Finally, in economics and society, everything is linked. If things tank badly enough in the United States for you to be worried about converting a large portion of your net worth into gold, MANY aspects of society throughout the world will be vastly different than they are now. Even if the pyramid of industrial economies collapse, will your position be any more desirable if your assets are invested in a firm operating in one of the economies at the bottom of the pile?

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#1) http://en.wikipedia.org/wiki/Official_gold_reserves

#2) https://www.cia.gov/library/publications/the-world-factbook/geos/US.htm

#3) http://en.wikipedia.org/wiki/List_of_countries_by_GDP_(nominal)

#4) http://www.federalreserve.gov/releases/z1/Current/z1r-5.pdf

The Dealer Debacle

2009-05-19T00:10:00.002-05:00

The news about the shutdown of hundreds of Chrysler and GM dealers across the country has been covered ad nauseum (or add nausea?) on the local and national news. Despite the flurry of coverage and interviews of long-time dealers standing in front of empty lots, no one's really asking very useful questions about the process and the real impact to the economy at the national or local level.

Here are a few questions I haven't heard addressed.

How much PROFIT opportunity is really being eliminated by the closing of hundreds of dealers? For dealers of American cars who have been dependent on factory rebates and huge discounts from sticker prices for over a decade, it seems relatively little money was made off actual new car sales after factoring in interest payments as the cars sat on the lot, inventory taxes, insurance, etc. I've heard most dealers make their money off after-the-sale service because (amazingly) many buyers still feel obligated to take cars back to the dealer even for routine service.

If dealers actually made most of their money from service -- not sales -- and car quality doesn't miraculously improve by an order of magnitude, is there not the same net opportunity for service profits and employment hours off the same amount of cars that are being sold right now? If the market used to be 9 million and has now shrunk to 6 million cars sold per year, the same number of labor hours will be required to service those cars whether they were sold by 5500 dealers or 4400. There would seem to be a path to daylight for dealers who maintained a good reputation for customer service and honesty as a pure service play in the industry. It might be MORE profitable to focus on service rather than worrying about carrying costs for new cars featuring iffy styling changes for notoriously fickle buyers.

How will dealer closings REALLY affect local and state tax revenues? Assuming aggregate demand for new or used cars is NOT a function of the number of dealers, the total number of cars sold will remain roughly the same, whether 5500 dealers sell them or 4400. Granted, in some local communities, the closing of dealerships may shift city tax revenues from hamlet A to hamlet B but at the state level, overall tax revenues should be roughly a wash.

Why are soon-to-be-former dealers being forced to sell all of their inventory in an arbitrary one-month interval? The technical answer lies in the institutions backing the "bridge loans" used by the dealer to cover the inventory on the lot. It also has something to do with coverage for warranty work for cars bought from an "unauthorized" dealer, thought this is a fuzzy area. This may be the single most damning action GM and Chrysler can take to burn every last remaining bridge they have to potential buyers. The car is the car, regardless of who handles the retail sale. Forcing the wholesale liquidation of nearly 20 percent of the current national inventory when there is already weak credit and at least a two-month glut of unsold vehicles does nothing but harm:

* it pits soon-to-be-former-dealers against survivors in price competition, potentially weakening the survivors
* it depresses retail prices of ALL cars across the entire country
* it depresses resale values, again hurting survivor dealers and owners
* it undermines confidence in potential buyers of GM and Chrysler in those firm's true ability and interest in standing behind their products

How big is the harm? Do some simple math. Assume the domestic market has shrunk to 6 million cars or about 500,000 units per month. Most dealers have at least a two-month inventory on hand or at least 1,000,000 cars. GM's and Chrysler's combined share is about 35 percent of the market so the inventory on the dropped dealers' lots adds up to roughly 70,000 vehicles. If you figure the average car is about $22,000 dollars, this forced liquidation might drop prices on those units another 30 percent or $6600 per car or about $426 million. However, those price cuts won't just affect prices at the dealers going under. It will drive down prices on the ENTIRE backlog of roughly 350,000 GM and Chrysler cars. That's $2.31 billion. With a B.

What were the surviving dealers thinking for the past six months? Heck, some poster on the Fool (me, in fact) figured out in November that American manufacturing capacity was going to see a 33 percent cut. It doesn't take a genius to see the retail operations would see a similar cut. When dealers saw the backlog of cars building between November 2008 and May 2009, could they not see a liquidation coming that would further depress prices? Why did they take any more inventory and take on more loans for that inventory? Why did they not pursue more aggressive discounting before the predictable liquidation flood hits and (hopefully only temporarily) drops prices 30 to 40 percent? The wider losses that might have been suffered by accelerating clearance sales would have been NOTHING compared to the losses they will suffer on their inventory now.

The War on Terror and Logic -- 2009 Edition

2009-05-17T19:44:00.004-05:00

It's May 2009 and we're about five months into a new Presidential Administration and new Congress. The new players have had a chance to orient themselves, take a few meetings, read a few intelligence briefs and make a few decisions regarding the War on Terror (TM) and Logic. So how are they doing? Well, judging from recent events, terror seems to be holding up quite nicely. Logic? Not so much.

The Obama campaign ran on a pledge to close the Guantanamo Bay internment camp for terrorist suspects. Obama the candidate also ran on a pledge to eliminate the use of military tribunals to decide the fate of the terrorist suspects, citing material flaws with the process. Obama the President initially made good on the pledge to close Guantanamo and began pushing to move detainee trials to civilian venues but flip-flopped on the civil trials stance in the past week. That change will in turn jeopardize the ability to transfer detainees to civilian facilities and close Guantanamo as desired by January 2010.

The debate over these issues has not only drawn Dick Cheney out of his undisclosed retirement bunker back into the spotlight, but has pitted the Democratic Speaker of the House Nancy Pelosi against the entire CIA, requiring its current Director and long-time Democratic power broker Leon Panetta to defend his agency from his own party. These debates and the resulting press coverage have featured several new fallacies of logic which are likely to crop up repeatedly and are thus worth documenting and discussing.

Picking up where we left off from the Bush era... (see links #1 through #5)

FALLACY #13: Enhanced interrogation techniques are required because they are uniquely capable of forcing bad guys to divulge vital security information unavailable by other means.

FALLACY #14: Enhanced interrogation techniques are not torture.

#13 and #14 are flip sides of the same bad coin. Former VP Cheney has repeatedly claimed information was gleaned from enhanced interrogation of prisoners that thwarted attacks on the United States. He claims there is a laundry list of vital facts obtained from the enhanced interrogation of key suspects and has filed a petition (rejected by the Obama Administration and CIA) to make that list public. Even if such a document exists, the fact that terrorist A provided fact X under enhanced interrogation does not prove fact X wasn't already known via other methods or that fact X could not have been learned by other means and other sources without "enhanced interrogation."

If enhanced interrogation techniques are so effective at reducing hardened terrorist suspects to compliant, truth-telling snitches, one would think one, maybe two, okay maybe FIVE trips to the interrogation room would do the trick. In reality, numerous journalists (Seymour Hersch and Jane Mayer to name two) and internal military and CIA records show that DOZENS of suspects were "interrogated" DOZENS and HUNDREDS of times over the course of months and years. So much for #13. If #13 isn't true, the continued administration of "enhanced interrogation techniques" which provided no useful information over the course of months / years is nothing BUT torture serving no strategic purpose.

FALLACY #15: Bi-partisan support of a strategy means the strategy is correct. -- The occasion of long-time political opponents suddenly agreeing upon something is often touted as a certain guarantee that X simply MUST be the correct thing to do. In reality, it doesn't mean X is right, it doesn't mean X is wrong. It simply means a multitude of political and legal forces have mysteriously shifted to temporarily align goals which may have nothing to do with the benefit of We the People. Keep in mind that until about August 2007, the vast majority of people agreed that low interest rates and zero-down mortgage loans were a great way to keep the economy moving.

#15 is currently being used by Democrats and Republicans alike to support the Obama Administration's sudden reversal on the use of military tribunals instead of American civil courts for detainees. The Obama Administration's new rational hasn't been well explained much but is clearly resulting from a combination of feedback from the military and CIA about protecting information that might come up in trials and feedback from states fearful of having "terrorists" kept in Federal or state prisons should convictions occur.

Wow. Where does one start?

The terrorist attacks on September 11, 2001 were not aimed at freeing those convicted and imprisoned for the 1993 World Trade Center bombing. There's no proof that holding terrorist suspects without trials or International Red Cross access in Camp X-Ray produces any less risk of future domestic terrorist attacks than keeping them in the SUPERMAX SHU at Florence, Colorado. Arguments about where terrorist trials take place and their impact on terrorist recruitment are entirely misplaced. Recruitment of new terrorists has relatively little to do with Internet access to photos of a few naked, abused prisoners or even a few dead prisoners. Recruitment has EVERYTHING to do with the breakdown of public education in not only Iraq and Afghanistan but Pakistan as well. The militias aren't gathering recruits by holding up prison abuse photos, they're recruiting by destroying the fabric of local society and holding guns to the heads of teenage boys left with no alternative for survival.

FALLACY #16: We cannot close Guantanamo Bay because European countries are refusing to take released prisoners, Middle East countries don't want them returning to destabilize their countries and we don't want terrorists on American soil.

First of all, if any current detainees are given a fair trial and found guilty of aiding and abetting terrorism or direct attacks against the United States, they're not GOING to be released, they'll be kept in prison. If someone is worried about a convicted terrorist escaping from a SHU at an American SUPERMAX prison facility, they probably should plan a weekend drive to one of our fabulous federal prison complexes and check the place out. If we trust those facilities to hold convicted cocaine cartel bosses controlling armies of narco-terrorists, I think they can handle a few more twenty-something brain-warped Islamic terrorists. They won't get out, they won't have anyone to talk to promote more terrorism here in America or anywhere else, they'll virtually disappear.

The argument behind #16 really involves the fear of what will happen when we have to release detainees held for years without a fair trial who are IN FACT innocent or whose prosecution was compromised by gross incompetence of American officials responsible for their interrogation or subsequent internment. Arguing against releasing a detainee who is in fact INNOCENT is essentially an argument that "if they weren't a terrorist going in, they might be so angered by their unjust capture / detainment that there's a high likelihood they will BECOME a terrorist when we release them."

Wow. That's a stunningly perverted take on the most basic concept of justice and liberty. If you are falsely accused of murder and framed by a career-minded, get-tough-on-criminals DA and an accomplice providing bogus forensic tests then we find one year or ten years or twenty years later you are innocent, you STILL have to rot in jail for life because you might be really pissed and might actually kill someone upon your release? That's EXACTLY the argument being made about detainees at Guantanamo.

What about detainees with indirect or direct ties to actual terrorist plots or actual terrorist attacks? Those who use the argument behind #13 are essentially claiming others who SUPPORT the closing of Guantanamo actually want to release detainees who might have been tortured or whose convictions might be jeopardized by evidence obtained under torture -- REGARDLESS of the detainee's actual culpability. No such argument is being made. The tighter rules of evidence suggested by the Obama Administration's revised tribunal policy are virtually identical to those of civilian law. Civilian courts do not require the release of a suspect if fact X confirming his guilt was divulged via unlawful coercion of the suspect or someone else. If fact X can be proven through testimony or evidence from other sources unrelated to the tainted evidence, fact X can still be introduced to the trial and used to support a conviction. The only time the suspect must be freed is if the ONLY source of fact X is the testimony obtained via illegal means and no alternate facts obtained via legal means exist to support a conviction.

FALLACY #17: If members of both parties knew about X and said nothing to object, X must be acceptable. -- This argument is being used to damage House Speaker Nancy Pelosi, who lately seems to require no outside help in undermining her credibility on virtually any issue. Dick Cheney and others have claimed Pelosi was among a handful of Congressional members who received secret briefings about both the domestic surveillance program and enhanced interrogation techniques. Giving Dick Cheney the benefit of the doubt momentarily, silence on Pelosi's part at the time doesn't indicate the programs were justified or legal. Silence on Pelosi's part merely indicates Pelosi is part of the problem and her actions require investigation like the rest of the players. The other aspect to this fallacy is that it assumes that information shared with Congress at the time about X was complete and factual. If the information conveyed what we know now, then certainly, silence on the part of those receiving it is quite daming. However, what if the information -- by mistake or intent -- was framed as "contingencies being reviewed for legality and effectiveness" and not yet actual operational policy? In that event, any defense of the actions taken using this logic collapses.

FALLACY #18: The existence of dozens or hundreds of documented cases throughout Iraq, Afghanistan, Guantanamo Bay and other secret CIA black sites does NOT prove abuse was directed at the highest levels of government. -- New York Representative Peter King (R) was interviewed on the May 17 edition of Face the Nation and explicitly rejected any claim that abuse and torture were condoned as a matter of policy. He said the following: (#6)

--------------------------------
No, because there was no connection at all between the CIA memos, the interrogations that were carried out, the extra interrogations of Khalid Sheikh Mohammed and the others, have nothing to do with with MP reservists might have been doing at Abu Ghraib. That was out-and-out torture, that was out-and-out humiliation and debasing of prisoners, and there is no way that they knew what was going on as far as the CIA examining Khalid Sheikh Mohammed. That is a phony argument that’s thrown out there to try to meld it all together.
--------------------------------

King's argument ignores the fact that descriptions of the abuse by the victims and of those inflicting the abuse are nearly identical across many sites, despite the majority of enlisted personnel having no advanced training in interrogation techniques. He also ignores the fact that military facilities like Abu Ghraib had CIA officers on site providing guidance on targets and techniques. Finally, he ignores the fact that the photos of the abuse taken by Lynndie England and her cohorts did not involve the worst of what took place at Abu Ghraib. As author Jane Mayer documented in her book The Dark Side, the worst abuse was administered in an isolated prison block referred to as "Tier Alpha One" reserved for the exclusive use of "OGAs" -- "other government agencies" -- without Army MPs present. How did the CIA officers remain on base without an agreement between Army and CIA leaders? How was that agreement not known to brass within CENTCOM, the Pentagon and Langley?

King's argument also reflects a profound ignorance of the tactics used by groups pursuing such extra-legal activities. Compartmentalization of those enlisted to do the dirty work is a key component of the strategy to guard against discovery of the larger program and chain of command when a portion of the operation is compromised. Compartmentalization is core to the strategy of the very terrorist organizations we claim to be fighting. Apparently, King understands so little about the tactics of our opponent he cannot recognize them when we use them ourselves.

The key point to remember about Peter King's appearance on Face the Nation is that he did directly state that the abuses at Abu Ghraib constituted torture. "Out-and-out torture" were his exact words (see above). He just doesn't believe that abuse was performed under the direction of senior government or military officials. Watch this space for future flip-flops.

FALLACY #19: Releasing 200 new photos of prisoner abuse will further derail our campaign against terrorism by providing more recruitment material for Al Qaeda and the Taliban. -- Let's assume that the 200 photos in question don't constitute 200 unique cases of abuse and that there might be five or ten photos of the same incidents, yielding 20 to 40 new actual cases of abuse. The United States has already publicly confirmed the existence of these photos, thus confirming the actual incidents themselves and confirming their severity as being similar to previous documented cases. If progress in the war on terror is jeopardized by photos of abuse we've already publicly confirmed, the war on terror isn't in danger of being lost due to PR on an Internet scale. It is being lost at the local level in impoverished villages where local and state governments in Iraq, Afghanistan and Pakistan are failing to provide basic public services and protect the safety of their citizens. The war is being lost through brutal intimidation applied directly at the local level through grisly public dismemberments and beheadings.

The additional photos WILL be released at some point. It's only a matter of months, years or decades. The debate over the photos is really a debate about the ability of the American government and the American people to face facts and change course. We need to understand how our country came to the conclusion that organized, systemic torture was effective and appropriate in defending the country when it is neither. More importantly, we need to understand why our country continues to involve itself in so many strategies that require secrecy that is antithecal to a properly functioning government and society.

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#1) http://watchingtheherd.blogspot.com/2006/05/war-on-terror-and-logic.html

#2) http://watchingtheherd.blogspot.com/2006/05/democrats-came-to-same-conclusion.html

#3) http://watchingtheherd.blogspot.com/2006/05/constitutional-crisis.html

#4) http://watchingtheherd.blogspot.com/2006/09/war-on-logic-continues.html

#5) http://watchingtheherd.blogspot.com/2007/07/war-on-terror-and-logic-have-shovel.html

#6) http://www.cbsnews.com/htdocs/pdf/FTN_051709.pdf

Grades Are In -- A Banker's F

2009-05-10T19:21:00.002-05:00

On May 7, 2009, the Federal Reserve officially released the results of the so-called stress tests applied to America's biggest banks. If you believe the Fed, the tests were intended to identify remaining vulnerabilities in banks to additional declines in the overall economy so they can shore up any minor problems and install confidence in the markets that the system is sound and capable of providing credit to businesses and consumers.

So what were the final grades? Officially, ten of the nineteen banks analyzed were found to be in need of additional capital. Not "insolvent" mind you, not in danger of an "imminent collapse", just in need of a few billion here or there so they can be counted on to lend money even if employment or GDP drop a few more percentage points. The banking equivalent of a little repointing around a few loose bricks. Sounds like the equivalent of a Gentlemen's C.

That's what you might believe from the commentary on the results from the Fed and Treasury, who tried to dance a fine line between the forgiving but stern dean clearly telling the struggling students they need to endeavor to improve their grades "or else" without panicking their parents into pulling them out of school entirely. If you analyze the true financial position of the ten in trouble and the circular logic trapping the Fed, the Treasury and (by proxy) American taxpayers into a never-ending chain of conflicting interests and self-defeating financial positions, the real grade for these ten has to be a Banker's F.

The Mechanics of Banking

Traditional banks make money by

1) attracting deposits (counted as liabilities on their books) by paying interest
2) lending money (counted as assets on their books) and collecting interest from borrowers
3) using interest payments from loans to pay interest owed to depositors
4) pocketing the difference

They also make money by charging interest rates on credit cards that make loan sharks envious, charging huge fees for using foreign ATMs, paying bills late or overdrafting checking accounts, but that's not really germane to the analysis here (smile).

If the bank is successful at managing this delicate balance and can prove it can make money with its practices, the bank can attract additional capital by selling shares to investors then loaning out a fraction of that additional money like they do the deposits to start the cycle and make even more income.

An extremely conservative bank nervous about having enough money on hand for withdrawals by depositors would keep virtually all depositor dollars in the vault but would then never make any additional money to pay the depositor's interest and would quickly go out of business. A bank that lent every depositor's dime out to borrowers would not have enough on hand to satisfy withdrawals by depositors which would quickly destroy any confidence of depositors to put their money in the bank and it would collapse.

The trick to banking is deciding how much to lend and how much to keep on hand. This balance is usually represented as the reserve ratio, the fraction of assets on hand (numerator) versus deposits (denominator). The REAL trick of banking is that this ratio is not only critical to the profitability of individual banks but it has a huge impact on the entire economy because the lower the ratio, the more fiat money is being created out of thin air for the economy to use. If the ratio isn't low enough, the money supply cannot keep up with population growth, much less economic growth. If the ratio is too low, an excess of fiat money beyond what's needed to keep pace with population growth and "safe" economic growth will be created, causing the excess to chase phantom profits and pipe dreams, producing inflation and/or bubbles in specific asset classes.

This all sounds relatively scientific but the usefulness of the ratio as a guardrail is only as good as the quality of the assets used in the numerator. Therein lies the flaw with the reserve ratio rule, the recent track record of financial regulation and the attempt to use stress test results to instill confidence in the system.

Truth or a Really Good Story?

The key takeaways from the release of the stress test results were that

* all of the nineteen banks tested proved to be solvent in the current economic state…
* BUT that ten of them would technically fall short of the desired reserve ratio…
* IF a few key economic statistics worsened by X amount

One of the key variables used in the model was unemployment which was tested at a worst-case level of 10.3 percent. How much of a "margin" is a 10 percent worst-case estimate when unemployment is already at 9 percent and has jumped 4 percent in one year? Higher unemployment will produce lower household incomes, more mortgage defaults and lower demand for homes, all of which will drastically impair the value of major asset classes counted in the numerator of these banks' reserve ratios.

Another key limit tested by the analysis was a drop in home prices by 22 percent. This actually sounds like a much more severe worst-case test than the 10.3 percent assumption on unemployment but it likely ignores a major "location, location, location" factor of the housing bubble and the compound fraud in mortgage backed security ratings and credit default swaps that fueled it. There are several areas of the country which saw home prices jump over one hundred percent over the past six to eight years. As starry-eyed homebuyers and speculators began chasing ever-rising prices, huge numbers of loans were issued against those inflated values, then fed into the MBS wholesale chop shop to be carved up and traded as high-quality rated securities among investors which then became assets on the banks of books to fuel additional fiat money expansion which expanded demand for housing in a circular loop.

The real point is that large numbers of empty homes in bubble markets won't simply drift back down to "normal" values. They are likely to decline far below that -- even to zero -- as vandalism, damage from the elements and failed models of ex-urban living drive future buyers elsewhere. In essence, what has to be modeled is not the aggregate value of all homes but the value of homes directly involved with the most risky mortgages that will default and the chain of mortgage backed securities and credit default swaps piled on top of those bad loans. That drop is very likely to be far greater than a mere 22 percent, again rendering the stress test results meaningless.

Circular Logic / Circular Firing Squad

The pattern of intervention established so far by the Treasury and Federal Reserve Bank renders the entire stress test effort pointless as a confidence building exercise. As the PR team hit the news shows to promote the test results, a subtext of the message sent to banks and the public was basically that no banks were found to have gaps that reasonable efforts in the private sector could not fill and therefore once the banks plug those gaps, that's it -- no more money from taxpayers. Unfortunately, nearly two years of haphazard public policy and private, inscrutable decision-making at the Fed have firmly planted the following ideas in the minds of bankers, investors and the public:

1) housing prices cannot be allowed to find a new floor for fear of triggering more collapses in the value of mortgage backed securities on the books of banks worldwide

2) further drops in MBS values held by banks cannot be allowed for fear of rendering many large banks insolvent under normal reserve ratio requirements

3) banks failing to meet reserve ratio requirements will further tighten credit to businesses and consumers, further accelerating economic contraction

4) banks rendered insolvent by collapsing MBS valuations and direct mortgage portfolios will trigger further payments of credit default swap contracts in amounts that none of the counterparties to those swap contracts can actually fulfill

5) the Federal Reserve is willing to print as much money required -- devaluing the dollar -- and hand it over as many formerly-non-member institutions as necessary to prevent a collapse of non-member institutions from exposing the insolvency of its members

6) the Treasury is willing to inject as many taxpayer dollars as needed to into failing automakers to defer massive job cuts that would deepen and prolong the economic slowdown

7) the more the government borrows to drop into bailouts, the more reluctant foreign holders of Treasury investments become of buying more US debt, reducing demand for Treasuries, which lowers Treasury prices which poses interest rate pressures on an economy already critically dependent on low interest rates for any recovery / expansion

8) to prop up the value of Treasury bills to satisfy foreign investors, the Fed will do everything in its power to maintain low short term interest rates, punishing savers and encouraging more to attempt to invest in stocks, commodities or derivatives to combat the risk of inflation produced by printing trillions of dollars

What are investors, bankers and consumers / taxpayers to conclude from this list of self-defeating policy goals? First, these banks ARE still in trouble and WILL need more capital to survive. Second, by failing to force divestitures and downsizing of the trouble firms as part of the risk remediation, the government is allowing them to remain "too big to fail" which means the government WILL have to bail them out when the time comes. Third, by leaving these banks TBTF, the government is encouraging private investors to keep their capital out of the banks so the government can cover the losses until a point of equilibrium is reached. Finally, these philosophically incoherent goals are likely to produce economic statistics and performance like few have experienced or can predict. The level of risk facing every type of investor has never been higher and has room to grow.

The Permanent Imperial Presidency

2009-05-10T17:49:00.003-05:00

Mr. Sunshine, former Vice President Dick Cheney, appeared on the May 10 edition of Face the Nation to advance his lobbying campaign for releasing memos which supposedly confirm the amount of crucial intelligence gleaned from torturing Al Quaeda suspects. A full transcript of his appearance is available on the CBS News website (#1). A quick review of the actual reality of our "War on Terror" (TM) and the claims advocated by Cheney make it clear he is really just continuing to advocate for his real goal -- the permanent imperial Presidency.

In the interview, Cheney cited the following points:

* the Obama campaign promoted the idea of halting "enhanced interrogation techniques" and the terrorist surveillance program and now as the Obama Administration is fulfilling those promises

* the Bush Administration had all the proper paperwork authorizing their "enhanced interrogation" and terrorist surveillance programs

* these programs were responsible for filling in many of the blanks not known about Al Qaeda and were instrumental in preventing attacks on America and battling Al Qaeda for eight years

* Cheney has filed requests to de-classify CIA reports which summarize all of the valuable information obtained from these practices

* by rolling back these programs, the Obama Administration has made America less safe

The reality is that:

* the Obama Administration made no claim during the campaign of ending domestic surveillance (a continuing point of frustration for many Obama supporters), only ending domestic surveillance without warrants under existing FISA law

* the Obama Administration now is attempting to do exactly what the Obama campaign promised to do after winning an election won in large part due to those pledges

* the Bush Administration implemented policy changes which classified vast categories of documents about Executive Branch actions and EXTENDED classification periods of documents dating back to the Bush I Administration

* yet the Bush Administration and Cheney himself played a principle role in divulging personal information about a CIA agent responsible for researching firms providing money conduits between clean oil dollars and potential terrorist groups, all in an attempt to discredit an opponent who questioned the integrity of yellowcake claims included in the State of the Union address which were instrumental in scaring the American public and Congress into authorizing the Iraq war

* the Bush administration claimed new rules were required because there was a gap in policy for detainees and had new guidelines drafted by appointees which omitted any reference to longstanding guidelines within the UCMJ and US code

* even proving suspect X provided piece of information Z after being tortured does not prove Z was not already known or could have been learned more effectively via other means and sources

There are several comments Cheney made that are worth explicitly recapping and refuting. In response to Bob Schieffer's question about the documents which "prove" the torture and domestic surveillance prevented attacks, Cheney said this:

-----------------------
I say they did. Four former directors of the Central Intelligence Agency say they did, bipartisan basis. Release the memos. And we can look and see for yourself what was produced. The memos do exist. I have seen them. I had them in my files at one time. Now everything is part of the National Archives. I'm sure the agency has copies of those materials, and there's a formal way you go through, once you're a former official, a formal way you go through requesting declassification of something, and I started that process, as I say, six weeks ago. I haven't heard anything from it yet. I assume...
-----------------------

Wow. FOUR former directors of the CIA have seen these classified documents? I presume he is referring to Michael Hayden, Porter Goss, George Tenet and current Secretary of Defense Robert Gates who was CIA Director during the first Bush Administration. Support from four former CIA Directors, three of whom could be indicted for war crimes for their role in implementing and continuing these practices hardly constitutes unbiased, bi-partisan agreement on the legality or worth of these practices.

Or maybe he's counting support from James Woolsey, the man who proudly referred to the Iraq War as the beginning of World War IV. The same man whose law firm acted as a registered agent for the Iraqi National Congress, the ex-patriot consortium of cons who brought us Ahmen Chalabi, who brought us "Curveball", the man who brought us the "proof" we needed to invade Iraq. Woolsey may believe the documents Cheney cites somehow "prove" the torture and domestic surveillance but if Woolsey has actually SEEN the documents, Cheney has a bigger problem because Woolsey had absolutely no right to see those documents since he left the CIA before they existed. (#2)

Or maybe he's counting support from John Deutsch, another CIA director with a strong track record of protecting vital, highly confidential information. Deutsch, as most probably don't recall, was found to be taking home highly sensitive CIA documents on his CIA laptop computer then surfing the Internet from that laptop on his unsecured home Internet connection. He exited the CIA rather unceremoniously and was pardoned by Bill Clinton as he left the White House. As is the case with Woolsey, any support from Deutsch for these documents "proving" these programs prevented attacks against the United States can only be based on faith because Deutsch also had no legal right to see those classified documents created well AFTER he left the CIA. If he HAS seen these documents, again Cheney and the Bush-era CIA directors should face more legal troubles from the disclosure of those documents (if they exist).

Finally, I'm not an expert in document handling procedures for information stamped SUPER-DUPER TOP SECRET but I suspect that authorization to read is not the same as authorization to possess or duplicate. I wonder why copies of such highly secretive documents on the successes of our torture and illegal domestic spying campaigns would have or should have been kept in Dick Cheney's office. Maybe there's a story there worth investigating.

Schieffer then asked Cheney about his unusual campaign to sway public opinion on the issue of these programs and the release of information about memos drafted to provide legal cover for them. Cheney said the following:

Certainly. I've made it very clear that I feel very strongly that what we did here was exactly the right thing to do. And if I don't speak out, then where do we find ourselves, Bob? Then the critics have free run, and there isn't anybody there on the other side to tell the truth. So it's important -- it's important that we...

Schieffer then interrupted and asked if Cheney would be willing to testify under oath. The answer was less than an emphatic "hell yeah":

I'd have to see what the circumstances are and what kind of precedent we were setting. But certainly I wouldn't be out here today if I didn't feel comfortable talking about what we're doing publicly. I think it's very, very important that we have a clear understanding that what happened here was an honorable approach to defending the nation, that there was nothing devious or deceitful or dishonest or illegal about what was done.

I presume Cheney's conditions on Congressional testimony would involve a lead-lined room, blindfolds on all of the committee members, and no pens, pencils or note-taking apparatus of any kind. Cheney would also have twenty-four hours to answer each question and first contact all Bush Administration officials to get their story straight before providing a final answer.

The coup de grace (or coup de no grace perhaps) of Cheney's appearance was his comment on Rush Limbaugh being preferred over Colin Powell as a "loyal Republican". After being fed a mountain of bogus, manufactured intelligence and being asked to put his own reputation as a clear-thinking, cautious military professional on the line to sell the Bush war on Iraq to the United Nations and holding his tongue for the remainder of the first term, Powell's endorsement of a Democrat for President disqualifies him as a member of Cheney's Republic -- I mean Republican Party.

While annoying, Cheney's periodic emergences from his secured, underground bunker of paranoia and fear-mongering do serve a few useful purposes. By resurrecting these bogus rationalizations for the torture and illegal domestic wiretapping conducted by the Bush Administration, he puts the issue back on the front burner at a time when the widened presence of Al Qaeda and Taliban forces in THREE countries jeopardizes ACTUAL nuclear weapons. There's no more effective contrast that could be drawn between the flawed priorities of the Bush Administration and what those priorities should have been. Cheney's comments also help remind Americans of what the Republican brand really stands for…

* ignoring the real sources of terrorist threats and launching a war we didn't need
* keeping EVERYTHING secret, even documents of prior administrations
* EXCEPT when classified information can be used to discredit opponents
* EXCEPT when releasing information might help defuse efforts to investigate your wrongdoing
* sliming fellow party members who were hung out to dry by your conniving

Cheney never accepted the rule of law in his Nixonian era career or Bush era career. He fails to grasp that even if you can abuse the law while you're in power, you can't remain in power forever and once you're out of power, you don't get to pick and choose the laws the next guy enforces. That's the chance you take by abusing the law while in power.

Keep up the good work, Dick. I hope you're around for the next four years to help drive the final wooden stake into the heart of the party you love above all else.

=================================

#1) http://www.cbsnews.com/htdocs/pdf/FTN_051009.pdf

#2) http://www.thenation.com/blogs/capitalgames/546

Where's the Bar?

2009-04-30T21:06:00.003-05:00

Countless other pundits have weighed in on the results of the first one hundred days of the Obama Administration, what those results mean for Obama's long term political capital and even the usefulness of the 100 day milestone itself which compares every President's trajectory with that of FDR's first term. Have the first 100 days of the Obama Administration been successful? Who knows? A more crucial question has to be answered first.

Where's the bar?

With an appropriately fuzzy goal, proponents can always claim success or rationalize falling short due to extenuating circumstances. Opponents can always incorrectly claim "I told you so" even when the right solution is chosen if something unrelated to the original debate intervenes and derails progress. For people to see the right solution was chosen or the wrong solution avoided, a clear, quantifiable goal has to be established BEFORE making a change and a reasonable explanation of the linkage between the change and the result has to be provided to justify support or opposition.

Since the financial meltdown began in earnest in March of 2008, the only goals provided for any multi-billion dollar program or bailout or geopolitical strategy change have been overly generic "avoid a worldwide depression" or "avoid a nuclear terrorist attack" goals. These types of overly broad, cataclysmic goals do nothing to help the public and politicians understand tradeoffs between goals and the compromises needed in a world of limited resources and tax dollars. As anyone in business will tell you, most products and business ideas fail -- the key is to quickly recognize the failures, stop digging and move on to the next idea to find the winner.

Given the variety, complexity and criticality of the problems facing the United States, everyone involved in the process is going to have to do a better job of establishing criteria for measuring success or failure. If you're a supporter of whatever it is the Obama Administration plans on doing on all these fronts, you have to recognize not all of the plans will work on their first, second or even third incarnation. If you're an opponent, you'll need to provide enough detail into WHY you're right and Obama is wrong in order to point to the failure early enough when a course correction will still do any good.

Stop and think about what's on the United States' plate right now:

Iraq -- We're trying to wind down our combat presence, leave a stable social and political environment and focus our military efforts elsewhere. If violence re-escalates, where's the bar for sticking with the current plan, slowing down withdrawal, or cutting our losses and speeding up the withdrawal?

Afghanistan -- We're trying to ramp up forces in Afghanistan to re-contain the Taliban and re-establish a more moderate political environment so we can eventually get out of Afghanistan as well. What's the timeframe for sticking with the current troop levels and plan versus escalating under some new approach or cutting losses?

Pakistan -- Our failure to corral and defeat the Taliban in Afghanistan has allowed them to take over provinces within Pakistan and seriously threaten the stability of a government that has multiple working nuclear bombs and has actively proliferated that bomb technology to numerous countries. Where's the bar for standing pat and letting the Pakistani military fend off collapse versus actively engaging with them against the Taliban?

Automakers -- Chrysler Motors was forced into bankruptcy on April 30, 2009 and GM is highly likely to do the same within 30 days. Hedge funds controlling 30 percent of Chrysler's $6.9 billion in debt felt they could net more for their junk bonds by triggering a bankruptcy that would trigger payouts on credit default swaps on that debt than accepting 28.9 cents on the dollar under the umbrella debt restructuring deal accepted by a majority of creditors. (#1) Where's the bar for deciding between paying on the TARP bailout side versus the direct cash side versus withholding all funds and then spiking unemployment another 3-4 percent?

Banks -- Stocks of financial firms soared in March and April of 2009. Despite "better than expected" earnings and grumblings from some TARP recipients about wanting to pay back their "loans" to get out from under the government's thumb, the risks to the system have by no means been eliminated. Virtually all of the unexpected earnings by major banks was due to investment gains as the Federal Reserve dumped over $1.2 trillion dollars into the market via bulk purchases of bonds and Treasuries. (#2) Despite that not-so-subliminal support, an April 28 story in The Wall Street Journal indicated Citi and Bank of America may actually require more capital from new stock issues or cash from the government. (#3) Both banks passed the Treasury Department's "stress test" (?), yet the Treasury notified each that the test results indicated their capital reserves were not sufficient and they needed to raise more capital (???), yet there's NO NEED TO PANIC (????????).

Now step back from the list above and think about these problems from a different perspective. In normal times, any ONE of these issues would have merited weeks or months of debate and would have been viewed as the great problem of our day. Kinda makes you nostalgic doesn't it? At this point, many of these problems are actually DIRECTLY related. How?

Taking too long to leave Iraq will short-change our staffing in Afghanistan, jeopardizing our chances of stabilizing that country and increase deficits, spooking Treasury borrowers and further impairing our economy. Leaving Iraq too soon allows the chaos to return to Iraq, drawing us back in for an even more expensive return engagement or destabilizing the middle east and spiking oil to $120 per barrel again.

Failure to stabilize Afghanistan heightens the pressure the Taliban is putting on Pakistan, placing actual working nuclear weapons in serious jeopardy of falling under the control of militant Islamic fundamentalists. Over-escalating our effort in Afghanistan traps us in another expensive war of occupation, continues to wear out our military families and continues deficit spending that further destabilizes the economy, employment and credit markets.

Continuing to place billion dollar band-aids on GM, Chrysler and Ford may defer a spike in unemployment that could cripple many local communities but masks the moment of truth these firms require to fundamentally re-orient their product lines. How many quarters of $5 billion dollar bridge loans should be made before they are forced to sink or swim alone? In a battle between idiotic auto executives and speculative, sleazy hedge funds who bought automaker bonds in the past ten years, who do you choose or when do you decide to choose neither?

Continuing to bail out the largest financial firms each time they find bigger losses does… ….does….Well, it does NOTHING. Nothing helpful anyway. Bank executives see no incentive to review the true value of their own portfolios, write them down to realistic values and allow markets to stabilize and return liquidity. Even if the American economy instantly adapted to a lower level of credit utilization, the current lending climate cannot support that reduced level because of doubts about true valuations for homes, property and income stability. The longer this credit paralysis exists, the more nervous international investors will be about US dollar denominated assets, the less willing they will be to use US dollars for trade and the lower the demand for US treasuries will become. Once demand for US dollars and Treasuries begins waning, American's $11.1 trillion dollar national debt will begin dragging us to the bottom of the lake.

As bleak as all of this sounds, there is one bright spot. Nearly every other industrialized economy is just as screwed up as the United States is, only they don't have nearly the track record of innovation and productivity that can help begin eating away at the debt and generating growth in better directions. However, finding the right combination of solutions will require quick identification of the wrong solutions and a clear-cut framework for prioritizing the limited resources for the best overall result. Throwing everything at every problem won't work.

Then again, given the track record of our politicians and the mindboggling danger posed by any ONE of the multitude of problems we face, maybe we should just pose the question a different way.

Where's the bar?

=========================

#1) http://www.nytimes.com/2009/04/29/business/29auto.html

#2) http://www.washingtonpost.com/wp-dyn/content/article/2009/03/18/AR2009031802283.html

#3) http://online.wsj.com/article/SB124088901025362487.html

Open Secrets - Then and Now

2009-04-19T19:07:00.003-05:00

The May 2009 issue of The Atlantic has a joint book review written by Benjamin Schwartz covering a series of books published recently about Nazi Germany:

The Third Reich at War -- Richard J Evans
Life and Death in the Third Reich -- Peter Fritzsche
Germany and the Second World War – Volume IX: German Wartime Society 1939-1945 -- (various)
Hitler, The Germans and the Final Solution --Ian Kershaw

Schwartz’s piece, entitled Hitler’s Co-Conspirators (#1) addresses a common theme covered in all of these books that has not drawn much focus in prior historical summaries of Nazi Germany – how could millions of Germans citizens NOT know what was happening?

As the authors of these books found and as Schwartz summarizes, the answer is very simple. Hundreds of thousands, if not most, Germans DID understand exactly what the Nazi regime was doing. Soldiers wrote home about mass shootings. The German tendency towards methodical efficiency meant thousands of mid-level bureaucrats saw reports of killing squads and mass murders. Towards the end of the war, a principle motivating factor for German troops to continue the slog was the fear of possible treatment of Germany by the Allies should Germany lose when the full scope of the Final Solution became apparent. Here is a quote from the Evans book repeated in The Atlantic piece:

----------------------------------------
Railway timetable clerks, engine drivers and train drivers and other staff on stations and in goods yards could all identify the trains and knew where they were going. Policemen rounding up the Jews or dealing with their files or their property knew as well. Housing officials who reassigned the Jews’ dwellings to Germans, administrators who dealt with the Jews’ property—the list was almost endless … The mass murder of the Jews thus became a kind of open secret in Germany from the end of 1942 at the very latest.
----------------------------------------

There’s the key phrase. An open secret.

Here is the key point of Schwartz’s commentary on these books and their conclusions about mass psychology, fear and unspeakable criminality:

----------------------------------------
As the social historians of the Reich probe more deeply, it’s increasingly clear that although knowledge of the Final Solution prompted action by only a heroic few, that knowledge—and Germans’ accompanying quiescence—nevertheless loomed large in the mind, and in many cases the soul, of the nation. This was deliberate on the part of the regime. In their public pronouncements Hitler, Goebbels, and Alfred Rosenberg married the bluntest language about an exterminationist policy toward the Jews with a complete absence of detail regarding implementation of that policy. Or the regime would wink at the population, as in a famous speech Goebbels made in 1943: when describing Nazi plans for the Jews, he said “exter—” and then theatrically corrected himself with the word exclusion. By establishing the murder of the Jews as an open secret—open enough that awareness of it pervaded society but secret enough that it couldn’t be protested or even openly discussed—the Nazis devilishly nudged the nation into complicity, and further bound the population to its leaders.
----------------------------------------

Read that paragraph a couple of times, slowly and carefully.

Sound familiar?

=======================

America has maintained many notable “open secrets” of its own over the past years.

Remember Dick Cheney’s appearance on Meet the Press on September 16, 2001 after the September 11 attacks? Here’s the first reference to working on the “dark side”: (#2)

---------------------------------
VICE PRES. CHENEY: I’m going to be careful here, Tim, because I — clearly it would be inappropriate for me to talk about operational matters, specific options or the kinds of activities we might undertake going forward. We do, indeed, though, have, obviously, the world’s finest military. They’ve got a broad range of capabilities. And they may well be given missions in connection with this overall task and strategy.
We also have to work, though, sort of the dark side, if you will. We’ve got to spend time in the shadows in the intelligence world. A lot of what needs to be done here will have to be done quietly, without any discussion, using sources and methods that are available to our intelligence agencies, if we’re going to be successful. That’s the world these folks operate in, and so it’s going to be vital for us to use any means at our disposal, basically, to achieve our objective.
MR. RUSSERT: There have been restrictions placed on the United States intelligence gathering, reluctance to use unsavory characters, those who violated human rights, to assist in intelligence gathering. Will we lift some of those restrictions?
VICE PRES. CHENEY: Oh, I think so. I think the — one of the by-products, if you will, of this tragic set of circumstances is that we’ll see a very thorough sort of reassessment of how we operate and the kinds of people we deal with. There’s — if you’re going to deal only with sort of officially approved, certified good guys, you’re not going to find out what the bad guys are doing. You need to be able to penetrate these organizations. You need to have on the payroll some very unsavory characters if, in fact, you’re going to be able to learn all that needs to be learned in order to forestall these kinds of activities. It is a mean, nasty, dangerous dirty business out there, and we have to operate in that arena. I’m convinced we can do it; we can do it successfully. But we need to make certain that we have not tied the hands, if you will, of our intelligence communities in terms of accomplishing their mission.
---------------------------------

TRANSLATION: I’m going to be careful here (you true patriots know I can’t say the truth so read between the lines here…), we’re going to have to work on the dark side (what could be “darker” than war?), if you will, without discussion, to use any means at our disposal (what means are there beyond bombing and killing people?). It is a mean, nasty, dangerous dirty business out there and we have to operate in that area. But we need to make certain that we have not tied the hands, if you will, of our intelligence communities. (No translation required).

Was there any doubt what was being conveyed with those comments?

Remember Cheney’s appearance on Meet the Press on September 8, 2002 prior to the October debates over a war resolution for Iraq? Here’s his mock restrained comment on the link between Saddam Hussein and the September 11, 2001 attacks: (#3)

---------------------------------
Mr. RUSSERT: But no direct link?
VICE PRES. CHENEY: I can’t-I’ll leave it right where it’s at. I don’t want to go beyond that. I’ve tried to be cautious and restrained in my comments, and I hope that everybody will recognize that.
---------------------------------

TRANSLATION: I don’t want to go beyond that (implying there is a “beyond” when there wasn’t), I’ve tried to be cautious and restrained in my comments (famed protector of state secrets that I am except when they help my cause) and I hope everyone will recognize that (and read between the lines to absorb what I’m trying to imply while not actually saying it so I can be convicted later).

Of course, open secrets aren’t just limited to genocide, terrorism, torture and war. How many thousands of people were employed in the financial and real estate sectors who knew of the trillions in fraud being perpetrated?

* how many thousands of loan officers approved no-document loans for hundreds of thousands of dollars?
* how many thousands of real estate agents encouraged people to buy homes they couldn’t afford as long as their commission was paid at closing?
* how many thousands of appraisals for properties were written on a drive-by basis or site unseen?
* how many county tax assessors said nothing as appraisals on dilapidated properties jumped ten or twenty percent on flip after flip as long as the next sucker paid the property tax on time?
* how many thousands of accountants working for banks and insurance companies knew their firms could not cover their CDS bets?
* how many thousands of stock brokers ignored their fiduciary duty to their clients by convincing them to buy crappy stocks their own internal analysts categorized as dogs?
* how many executives approved securitization and CDS strategies for their firms they didn’t understand for fear of being caught short in earnings compared to their competitors or for fear of losing millions in bonuses?

The key point about open secrets is the willful suspension of disbelief and mass psychology involved aren’t used to merely trick millions into buying Snickers bars when they should have been buying Milky Ways – harmless mis-directions in the overall scheme of human activity. They produce a culture and society in which unimaginable harm is produced and unspeakable crimes can be (and often are) committed. Americans need to start thinking very seriously about the broken mechanisms in our government, media, society and ourselves that allow these kinds of “open secrets” to remain unaddressed for years / decades. No guns have been held to our heads to ignore the realities in front of us and look away. Willful ignorance is the primary enabler and it’s entirely avoidable.

=====================================

#1) http://www.theatlantic.com/doc/200905/nazi-germany

#2) http://www.emperors-clothes.com/9-11backups/nbcmp.htm

#3) http://www.mtholyoke.edu/acad/intrel/bush/meet.htm

Yellow Ribbons, Pink Slips and Extortion

2009-04-08T19:27:00.006-05:00

I admit it. After the resignation of Donald Rumsfeld as Defense Secretary in November of 2006, I was not in favor of the nomination of Robert Gates to replace him. (#1) The concerns at the time were:

1) he's an intelligence guy, not a "big iron" and weapons systems kind of guy and might be tempted to do his old job rather than his new job
2) he had prior work involving illicit arms sales to Iran, Iraq and Nicaragua
3) he was a trusted member of the inner circle of "Daddy's fixers" surrounding GWB, which means his ideas are still very much like those that got us into the war in the first place
4) as an insider, his selection made it more clear the Bush Administration was suffocating from within because of the toxic environment they created in the first six years

I'm still not a fan of Gates' work under item 2 and still think item 4 held true but Robert Gates has proven to be not only the best leader President Bush appointed to the Cabinet but one of the most effective Defense Secretaries ever. Gates demonstrated superior leadership virtually from Day One by immediately reorienting the Pentagon's lackadaisical approach to correcting shoddy facilities and shoddy care given to returning veterans. After appalling conditions at Walter Reed Medical Center came to light in February of 2007, Gates pressured the Secretary of the Army to can the head of Walter Reed. That was done but the when it was found the replacement had been aware of the poor conditions from a prior stint as commander of the facility in 2003 and had taken no actions at that time, Gates IMMEDIATELY fired the Secretary of the Army, pressured the new replacement out of the Army and appointed a widely respected General and doctor over the Walter Reed facility. In a matter of days. Talk about sending clear messages.

Gates has also done well at the task of leading the Pentagon organizationally while allowing career military personnel to lead at the purely military strategic and tactical levels. There's no better proof of this balance and its benefits than the recent budget proposal provided to Congress by the Pentagon. Key highlights of the new budget plan include: (#2)

* cancelling purchase of a replacement for Marine One
* an end to the F-22 fighter program, a 16-year old design superseded by the JSF
* a halt to the vehicle portion of the Future Combat Systems program (roughly $87 billion)
* increasing the budget for intelligence, surveillance and reconnaissance by $2 billion
* adding 2800 personnel to Special Operations
* replacement of 11,000 contractors with 9,000 permanent employees in the Pentagon's procurement organization

Even ignoring the current financial meltdown that demands budget reductions, these changes prove beyond a shadow of a doubt that Gates GETS IT. He understands the nature of the wars we have been fighting, understands we can't afford to have it all and understands that we can't use many of the toys favored by Pentagon desk jockeys, defense contractors and corrupt politicians.

Put quite bluntly, the new 2010 Pentagon budget proposal is the near perfect crystallization of the financial and moral choice America must make between merely claiming to "support our troops" and crassly protecting local parochial and political interests in the name of "jobs". You can't have it both ways. You can't claim to support the troops by insisting on the building of aircraft carriers we can't use to protect jobs in Virginia and Connecticut. You can't claim to support the troops by insisting on the development of lightweight, fuel efficient troop transports loaded with electronics that can't protect troops from roadside bombs to protect jobs at Boeing, SAIC, BAE Systems and General Dynamics.

The final 2010 budget level and specific contents are far from finalized but the political debate in the coming months could best be described as the ultimate choice between yellow ribbons and pink slips with vast amounts of hidden political extortion between defense contractors, politicians and constituents over who feels the pain the most or least.

Robert Gates has laid out an effective budget for critical military needs in a desperate financial climate and has framed the rational for spending priorities so effectively that any argument against the plan will expose members of both parties for the charlatans and hypocrites they are if they choose to fight it wrapped in the flag claiming to protect our troops and our jobs. For this alone, Robert Gates deserves a hearty thank you from taxpayers.

===================================

I had planned on posting all of the above based solely upon the terms of the latest Defense Department budget proposal and the difficult choices between truly productive support of our troops and political protection of jobs for favored states and defense contractors.

The trade-offs between true security and jobs takes on an entirely different dimension in light of the investigation broadcast April 7, 2009 on the PBS show Frontline concerning systemic international bribery paid by huge corporations to corrupt government officials.

The Frontline show, entitled Black Money (#3), examined cases involving Germany's Siemens and Britain's BEA dating back as far as 1990. Thirty minutes into the program is a STUNNING series of findings involving an investigation by Britain's Serious Fraud Office (a "major case squad" within the equivalent of their DoJ) into payments to Saudi Arabia's Prince Bandar made by BAE. The SFO had collected significant amounts of evidence about illegal payments made by BAE and was beginning to apply pressure to officers of BAE and thus to Bandar and the Saudi government.

In the weeks following the July 2005 terrorist bombings in London, the SFO was within weeks of pursuing action in its case against BAE. In that tense, post-attack climate, Prince Bandar himself hand-delivered a personal letter from Crown Prince Sultan of Saudi Arabia to Tony Blair at 10 Downing Street that threatened a halt to any Saudi cooperation in the war on terror if Britain pursued any continued investigation of the BAE payments -- essentially stating the investigators would have blood on their hands for any attacks that might occur after they continue their criminal investigation and the Saudis halt cooperation on terrorism. Tony Blair shortly thereafter held a meeting with all of the heads involved with the BAE investigation, relayed the same message, and the British investigation has gone exactly nowhere since.

At present, the only country moving forward with any investigation is the United States but even that has a twist. Former FBI director Louie Freeh is now representing Prince Bandar who is now arguing the US has no role in investigating potential bribery payments, even though BAE is the fifth largest defense contractor for the United States Department of Defense.

Let's review, shall we?

1) Saudi Arabia, a supposed ally of the United States in the "war on terror",
2) within DAYS of a Islamic terrorist bombing of a United States ally,
3) hand-delivered a written letter directly to the head of state of that ally,
4) threatening to halt any cooperation on terrorist investigations current and future,
5) unless said ally ceased all criminal investigations of a British firm involved with bribe payments to Prince Bandar and other Saudi royal family members

Does anyone think Saudi Arabia has the ****s to extort the United States like it did Britain?

Does anyone think the United States would cave like Tony Blair did?

Does anyone still think these are purely hypothetical questions?

================================

#1) http://watchingtheherd.blogspot.com/2006/12/bush-ignores-everyone-surprises-no-one.html

#2) http://thehill.com/leading-the-news/gates-forecasts-change-for-obama-pentagon-budget-2009-04-06.html

#3) http://www.pbs.org/wgbh/pages/frontline/blackmoney/

(Another) American Psycho

2009-04-05T19:40:00.001-05:00

The April 13, 2009 edition of Fortune has a fascinating (in the train wreck sense) article on New York attorney Marc Dreier and the multi-million dollar fraud he perpetrated for more than a decade. The article, entitled The Imposter (#1) summarizes more than a decade of alleged legal malpractice, investment fraud and frivolous lawsuits on behalf of a New York real estate developer. As the author puts it, the story of Dreier's fraud reads like another version of the movie Catch Me If You Can -- the story of someone seemingly addicted to living on the edge and perpetrating their fraud in the spotlight, rather than minimizing their risk.

The more interesting aspect of the Dreier story involves the number of alarm bells Dreier's very public conduct set off in the minds of nearly everyone that dealt with him. Not just in the last few months as the end of his fraud drew near, but for YEARS. A few quotes from the article:

At Fulbright, Dreier was a "lone wolf" who "didn't quite fit in with the other partners," according to someone who worked with him then. "Marc wasn't the kind of guy to stop and say, 'Let's run this past a committee.'"
------------
"He is a thoroughly vile human being," says Kevin L. Smith, an attorney at Manhattan's Stroock & Stroock & Lavan, who litigated against Dreier for many years. "This is really a bad guy."
------------
Kalikow's lawyers brought the phony legal-notice stunt to the attention of U.S. bankruptcy judge Burton Lifland, who had presided over the original Kalikow bankruptcy. At a hearing in June 2004, Lifland suggested that Solow's and Dreier's conduct had been "sleazy," and then read aloud a series of synonyms from a thesaurus: "tacky, shabby, base, low, malicious, petty, nasty, unsavory." In October 2004 he ordered Solow and Dreier to pay $335,000 in sanctions for having violated Kalikow's rights. But today - more than four years later - the fine has still not been paid, since, tellingly, Solow and Dreier are still appealing it.

So how many similar narratives are waiting to be uncovered as the next house of cards collapses and the rats within scurry for cover? It's hard to guess but the more important question might involve what has happened to our legal and accounting professions where people like Dreier can not only exist but thrive? Dreier wasn't leading a silent, double life of fraud behind a "pillar of the community" public persona. This guy was DESPISED by nearly anyone that ever dealt with him. What does it say that someone with this track record could attract clients searching for legal or financial help?

The best part of the article is a perfect analogy made in the conclusion:

There is an unfortunate optical illusion - a variant on the Doppler effect - that besets all frauds. It's unfortunate, because it has the effect of exacerbating the pecuniary losses that fraud victims endure, by unfairly leaving them, like many rape victims, irrationally ashamed of themselves.

The Doppler principle we posit holds that as a victim approaches a swindler, he sees nothing but green lights. But as soon as he realizes that his money is gone, he spins around and beholds, as if by magic, bright red flags as far as the eye can see.

=========================

#1) http://money.cnn.com/2009/03/31/news/newsmakers/parloff_dreier.fortune/index.htm

Corporations, Credit and Criminality

2009-04-03T13:41:00.004-05:00

One of the questions asked most frequently by Americans about the financial crisis boils down to this: With over $11.1 trillion in US wealth destroyed (#1), how is it possible that Bernard Madoff seems to be the only individual yet to be sent to jail? Is it even possible for TRILLIONS of dollars in wealth to be destroyed only by incorrect but innocent mistakes and misguided optimism and greed? Millions or billions, maybe but TRILLIONS?

The short answer is NO.

The full answer requires thinking through the relationships between corporations, credit and criminality. More importantly, answering the question doesn't accomplish anything unless it drives changes in public policy.

Corporations

A corporation is a legal entity that allows a collection of people to act as a single entity under the law and act like any real individual to enter into contracts, own property, pay taxes, etc. Over the past century or so, the laws of most industrialized countries have evolved to grant two crucial benefits to corporations -- limited financial liability of individual stockholders and a perpetual existence of the corporate entity beyond the life of any of its stockholders, directors or employees.

Limited liability creates a layer of indirection between claims against the corporation and its assets and the assets of individual shareholders of the corporation. With limited liability, shareholders can never lose more than the equity they invest, regardless of the size of claims against the corporation itself. Without that protection, far fewer investors would be willing to provide capital to the average business, much less gigantic multinational companies which can incur hundreds of billions in liabilities.

Perpetual life allows companies to continue operating indefinitely without having to "cash out" the assets of the company to new owners periodically like a sole proprietorship. That type of forced reorganization typically limits the size of a company due to the difficulty of finding individuals who are both financially capable of investing in the reconstituted firm AND participating in its daily operation. By eliminating the periodic re-organization and re-capitalization to new owners / operators, perpetual life allows corporations to continue aggregating market share, brand recognition and assets.

The legal fiction of a corporate entity creates complex issues in situations when corporations become involved in criminal acts. Like any human entity, the legal entity of a corporation can be sued, can lose tort cases and can face criminal charges for actions taken by the firm. In practice however, criminal charges may result in financial penalties being applied or regulatory limits being imposed upon the firm but more frequently involve an attempt to identify and prosecute wrongdoing on the part of individual employees. Very seldom (never?) is a "death sentence" applied to a corporation by directly terminating its charter and forcing it out of business.

More about corporate death sentences will be discussed shortly.

Credit

America's Founding Fathers, notoriously famous "smart guys", worried about the operation of banks and the use of money and their effect on the country. In fact, they worried and wrote a great deal about banks and money. Perhaps John Adams summarized their concerns most effectively:

All the perplexities, confusion and distresses in America arise not from defects in the constitution or confederation, nor from want of honor or virtue, as much from downright ignorance of the nature of coin, credit, and circulation.

They clearly understood the temptation and danger represented by the ability to incur long-term, trans-generational debt coupled with the ability to issue credit in the form of fiat money, even in an eighteenth century world that limited documents to quill and pen or hand-cranked printing presses and limited communication to the speed of a horse or sailing ship. Given the communication and computing tools at our disposal today, the concerns of the Founding Fathers over the ability of the tools at their disposal to produce bubbles and crashes seem almost quaint in comparison. They had no possible way to imagine the size and power wielded by modern corporations or the computerized ability we have to exchange BILLIONS of stock shares, commodities, bonds and other financial contracts on a daily basis. A great deal of information is flowing around the world amidst those billions of transactions but a great deal of mis-information also flows with it and mis-information is the lifeblood of the frauds and pyramid schemes that produce bubbles and crashes.

You may have seen this in a hundred blogs and commentaries at this point but the single most important thing to understand about credit is the origin of the very word itself -- from the Latin credere for "to trust or believe." Credit is literally an illusion. It can be useful when the relationship between borrower and lender is direct and the ability and willingness of the borrower to repay a debt is verified and when the lender has not recursively turned the promise of future payments into additional paper assets for additional loans. When these conditions aren't present and computers are used to generate BILLIONS of transactions every day and abstract those data streams down to nice Excel charts "proving" everyone's investments will grow at 7.3 percent uninterrupted, disaster is virtually assured. The combination of multi-national companies manufacturing credit at the speed of light with limited liability for insiders who benefit disproportionately from the inflation of credit is an irresistible temptation and danger.

Criminality

Financial markets aggregate billions of individual decisions and opinions about value and risk into numbers which then drive billions more individual decisions in a never-ending feedback loop. Can the market as a whole or major players within the market be blamed or held to be criminally liable when expectations of future values fail to come true? Clearly not. However, when players in the market create products directly BASED upon such uncertainty and claim to protect parties from losses from the uncertainty and are mathematically unable to make good on those claims, they are perpetrating a criminal fraud. When databases, web servers and emails are used to transmit information to customers touting the ability of a firm to provide insurance against such risks, collect payments for such insurance policies and provide statements about the "worth" of such contracts which cannot be fulfilled with the capital available to the firm, wire fraud is being perpetrated.

If a crime has been committed, what are appropriate next steps?

First, there is likely an unlimited amount of evidence that can be collected from all of the major financial players who dabbled in mortgage backed securities and credit default swaps that would prove numerous employees of those firms did in fact know the numbers did not add up and they were facilitating a ponzi based fraud. Dispatching trained computer forensic experts from the FBI with subpoenas in hand to the data centers of every TARP recipient and blocking the destruction of email archives would be an excellent start.

If criminal wrongdoing is found within the megabanks or any giant corporation on the multi-billion dollar scale, the real question involves the appropriate penalty for the crime. In most billion dollar corporate fraud cases like Enron or Worldcom, the criminal pursuit quickly narrows down to a search for the biggest fish with a direct tie to the alleged crimes. Seeing Bernard Ebbers, Ken Lay or Jeff Skilling at the table hearing their guilty verdict might calm public opinion but does nothing to destroy the corrupt pond in which they operated.

What's missing in the debate over punishment of corporate fraud is recognition that as a artificial creation of the law for the public good, no corporation has any natural "right" to exist. Corporations are granted charters to operate in order to efficiently and legally increase economic activity, provide a good or service or play some charitable / philanthropic role for the society. When a corporation is found to be operating in a way which reflects systemic fraud throughout the corporation and / or inflicts material harm on the larger society it is supposed to be benefiting via its special chartered privileges, society not only has a right but an obligation to terminate that charter and halt the corporation's operation.

The argument against this is that usually ALL of the employees of the firm may not have played a role in the criminal activity. Since the structure of the firm is already established, why destroy the entire company and impact its employees and customers to punish a smaller subset of employees? This argument may make sense if the firm makes candy bars and is found guilty of systematically cheating customers of a tenth of an ounce of chocolate per bar over several years to reduce costs and boost profits. The only people "harmed" are the customer who purchased the candy bar, the harm itself doesn't permanently harm the customer or disrupt the larger economy and the harm doesn't have a feedback cycle that exponentially magnifies the harm over time. Just pay a fine and promise to never to it again.

The "pay a fine and promise to never do it again" approach is NOT a sufficient dis-incentive to firms specializing in banking, insurance and credit because of the unique combination of leverage and disproportionate rewards available in the financial sector. When one bank or insurance company holds hundreds of billions in assets, operates at a three percent reserve ratio and fraudulently creates hundreds of millions / billions in additional assets, the false expansion of credit produced by the fraud ripples throughout the larger economy and harms thousands more than the first customer who signed the first derivative contract that starts the cycle. The benefits of limited liability and perpetual life granted to a firm operating in the financial sector pose a uniquely dangerous risk to society when the firm abuses the leverage available in its business to commit fraud. The unique scale of damage created by such frauds merits a penalty equal to the damage -- the corporate death penalty:

* the orderly dissolution of the firm and its assets (much like an FDIC takeover)
* board members at the time of the crime are banned from serving on the board of any public firm
* pension, healthcare and severance pay for VP or Cxx executives of a convicted firm are nullified
* return of any bonuses paid to VP or Cxxx executives based upon results during the period of the fraud

How likely is it that more corporate death penalties will be imposed? Based upon testimony provided to Congress on April 2, 2009 by former AIG CEO Hank Greenberg, Congress doesn't appear to have a clue. Greenberg is still under investigation by the Securities and Exchange Commission for alleged fraud at AIG during his tenure at the firm that ended in 2005. Greenberg was not only invited by Congress to testify on the effectiveness of the AIG bailout so far ($185 billion and counting) but to outline his recommendations. His recommendation? By all means, keep the company operating as it stands right now rather than breaking it up. Spoken like a man who lost ninety six percent of his net worth --- and is still worth $28 million dollars. (#2)

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#1) http://online.wsj.com/article/SB123687371369308675.html

#2) http://blogs.wsj.com/wealth/2008/09/17/hank-greenbergs-sudden-wealth-loss/

Toxic Assets

2009-03-28T15:58:00.000-05:00

Investors really need to start taking the term "toxic assets" literally in terms of properties affected by the mortgage implosion. The first case in point publicized earlier this week involves -- literally -- the toxic drywall found to be destroying many homes built between 2004 and 2007 from the inside out. Due to back-to-back-to-back hurricanes earlier in the 2000s, tremendous shortages in the supply of drywall led many builders and wholesalers to buy drywall from China. It seems the manufacturing process or just any lack of concern about the raw materials used resulted in extremely high levels of sulphur to be baked into the drywall. As it ages, the sulphur seeps out of the drywall as a gas. If the house is closed up for any period of time, you get the classic "rotten eggs" smell. That's not the real problem, bad as that may seem.

The real problem is the sulphur being emitted attacks ANYTHING in the home made of copper -- like PLUMBING and WIRING. There isn't really a fix -- you can't "seal" the drywall with paint to avoid the problem cuz it's still seeping on the cavity side of the wall where the real damage is being done. Of course, the vast majority of insurance companies are refusing any claims for this problem. The only solution is to completely gut ALL drywall, copper plumbing and copper wiring in the house and start over, at which point you might as well tear the house down and start over from a cost standpoint. Where is this problem most prevalent? Florida -- one of the leaders in foreclosed properties.

The other problem with toxic home assets is the problem with vagrancy and "squatting". A story earlier this week on the NewsHour illustrated the problem in one relatively nice looking neighborhood in California. A real estate agent working for a credit agency visited several properties on the agency's foreclosed list and tried to shoo away squatters attempting to live in the homes or quiz neighbors about anyone that might be currently away from the house but squatting at night. The story described how poor people and illegal immigrants are getting scammed by people running ads in the paper advertising below-market rents who meet them at the property to collect the first month's rent, let them in (presumably replacing the locks so they can give them keys that match) then disappear. The "renter" thinks they're living in the home legally but find out otherwise when the sherrif shows up to evict them. In other cases, people are just breaking in themselves and living there.

Of course, since most of the houses have the utilities shut off, people just stack trash up in the rooms, no dishes get washed, it isn't clear sinks and toilets work so....

You can imagine what these houses look (and smell) like. In the piece aired on television, many look like crack houses or meth labs on the inside with major appliances and fixtures stripped, gang tags spraypainted on the walls, *#)@ on the walls and floors, you name it.

These are the "assets" being unloaded by banks on well-meaning but unsuspecting regulators and government agencies.

The AIG Bailout and Bonus Imbroglio

2009-03-18T21:13:00.004-05:00

Given the incredibly low bar of insight and analytical thinking set for itself by members of Congress, it's hard to be surprised by Congressional hearings anymore. The March 18, 2009 appearance of AIG CEO Edward Liddy in front of a House subcommittee was no exception. If you just heard pieces of Liddy's statements and the indignant questions that prompted them, the transcript of the entire session could be succinctly condensed down to a single word.

HARRRUMPH

The entire spectacle not only failed to enlighten Congress or America about the real nature of the problems at AIG and the larger financial system, but moved the spotlight from the areas that remain unaddressed by the government for any true stabilization effort, much less long term recovery.

Bailouts to Protect WHAT and WHOM?

Nearly an entire day was spent by the House Subcommittee on Finance on the topic of a mere $165 million in bonuses paid to over 73 employees at one firm that has already pulled in two bailouts of $85 billion and a second bailout for another $65 billion as part of a larger $700 billion bailout. Had Congress considered the original $700 billion TARP legislation with equal diligence, we'd be only 150 days into the 4242 days of debate on the bailout plan.

Is this an argument to have done nothing to try to stabilize the market in 2008? Of course not. It's yet another example of the substitution of talking points for progress -- the same substitution that produced the half-baked TARP program in the first place by focusing on "coming together" and "doing something" instead of addressing even ONE fundamental regulatory issue that contributed to the meltdown before flooding failed banks with taxpayer money or one material issue of the mechanics of the TARP plan itself.

Until the past week, AIG had refused to disclose the names of major counter-parties who stood to lose from a collapse of AIG and, consequently, stood to gain by its rescue. (#1) Two areas of concern arose when names were finally released. First, many of the parties are foreign banks. Of course, the immediate reaction from that involved the disgust that US taxpayer dollars were indirectly helping to bail out foreign banks. Of course, that emphasis would totally miss the more important point that such findings indicate all of the major banks in Europe are as close to the brink as US banks, meaning the resistance of the worldwide system to any shock is far less than anyone understood or at least publicly stated until now.

The second point about the disclosure of AIG counterparties is that by any accounting, Goldman Sachs was a major beneficiary of the TARP plan. Given the timing and magnitude of the overall crisis, that's not necessarily surprising. However, after considering the decision made by former Treasury Secretary Hank Paulson to #1) FORCE a rescue of Bear Stearns, #2) ALLOW Lehman Brothers to twist in the wind and die, then 3) LAVISH funds from TARP into AIG to help Goldman Sachs -- his former firm -- behind the scenes, one must conclude that is worthy of serious investigation.

Bonuses to Retain WHAT?

The Liddy appearance focused on bonus payments made to top executives in the division of AIG that concocted most of the highly leveraged schemes that tanked the company. Of course, there are two types of bonus payments offered in Corporate America. Performance based bonuses are intended to encourage employees to make business decisions that increase real profits and increase the real value of the company so stockholders make money. (PLEASE!!! Try to hold your snickering until the end of the point…) "Stay bonuses" are intended to stabilize the employee base during periods where the company's ongoing operations are vital to the survival of the company by encouraging key contributors to stay and avoid a disruption in the company's operation. Think of them as "combat pay" for staying in the foxhole and continuing to fire one's weapon as commanded during a corporate firefight for survival.

In the case of AIG, it really doesn't matter what terms were involved for the bonuses paid out -- they are unwarranted under any circumstance. Payment of any "performance bonus", even if routinely structured in financial firms as an end-of-year lump sum equaling even 50 to 100 percent of "base salary", are still supposedly based on actual profits and proper execution of the employee's fiduciary duties to the firm and its clients. These executives and their underlings failed both tests miserably. The firm's strategies failed to provide the financial protection claimed by the sophisticated products sold and produced catastrophic losses for its customers and the firm itself.

If the payments constitute "stay bonuses", exactly what talent is being kept? Few are actually arguing these key players need to be kept because they are geniuses who can return the company to profitability at some point. The argument is that the individuals who originated thousands of derivative contracts are needed to stick around to reverse engineer their own deals, figure out who all the counter-parties are, and help figure out how to dismantle the house of cards without triggering a collapse, thus "preserving" the American taxpayers' investment in AIG.

Uh huh.

Quite simply, there is NO WAY this will happen. The fact that the only person who can makes heads or tails of any particular contract struck by the company is the single employee who cut the deal is ipso facto evidence the employee did not meet his or her fiduciary duty to his client or to AIG and is not only NOT entitled to performance bonuses, they aren't even entitled to their base pay and are likely criminally culpable under racketeering charges. If you hired a lawyer to help you take your company public and after all the paperwork was signed and shares sold, you didn’t' know where your money was, your shareholders didn't get their shares, and only the one lawyer knows the dollar amounts and location of the paperwork, is that lawyer discharging their fiduciary duty properly?

Again, what's interesting about this situation is that NONE OF THE ABOVE is important in the larger scheme of things. What is important is the recognition of the fact that these derivative contracts of AIG very likely CANNOT be "unwound" AT ALL, much less in an orderly fashion with a predictable timeline in a manner that holds up to court scrutiny. If only ONE PERSON on the planet can reverse engineer a deal gone bad, courts would have to rely on ONE PERSON'S testimony who has overarching conflicts of interest that would render any verdict null and void. That literally means AIG -- and many other firms like it -- are in large part worthless mounds of indecipherable paperwork. What THAT really means is that Congress, the Federal Reserve and the larger financial system have not yet come to grips with the inevitable reality that a different approach is required to mitigate additional damage that WILL come forth as pieces of the system hit a stress point and collapse -- not just within AIG but within the entire system.

Implications for Geithner and Obama

Barack Obama's popularity remains quite high despite the turmoil over the bailout plans for AIG and other banks. The same cannot be said for Treasury Secretary Timothy Geithner. There are going to be many critical moments in the Obama Administration but one has already been reached this week and it really isn't clear if Obama "gets it" yet.

Geithner is in completely over his head. He may have been a competent, even brilliant central banking tactician for the New York Federal Reserve Bank. Unfortunately, we already have a Federal Reserve Chairman and don't need a second. The Treasury's outsized role as executor of huge financial institutions places it in a position where expertise beyond normal monetary policy and fiscal operations like Treasury Bill auctions is required. Expertise in contract law, personnel management and compensation, and criminal / civil law is required for the Treasury to more effectively work with the Justice Department and state Attorneys General to properly prioritize stabilization efforts, investigations and criminal / civil prosecutions. Geithner has failed to demonstrate ANY expertise in any of these areas either as Treasury Secretary or in his prior role at the New York Fed. Believe it or not, the current situation is NOT as bad as it can get. If this is Geithner's best game, he's completely unable to handle anything worse.

While these forces are at work and Congress gets distracted by one admittedly fascinating day of testimony, the press is covering green dye in the White House fountain for St. Patrick's Day and the President's Final Four basketball picks.

Psssssst. Barack!

Seriously. Get your head in the game. THE REAL GAME.

NOW!

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#1) http://money.cnn.com/2009/03/07/news/companies/aig.fortune/index.htm?postversion=2009030910

Still MIA: A Real Recovery Plan

2009-03-10T22:01:00.002-05:00

The financial meltdown still in progress has led most debate within government and the chattering classes to focus on the balance between any short term stimulus benefit and the weight of the long term debt added to pay for it. When the numbers involve "Ts" as in trillions, it seems logical to pay attention to that debate. It's also possible that the size and timing of the stimulus are NOT the most critical issues to resolve first. Until measures are taken to correct the broken financial, legal and regulatory processes that allowed the meltdown to occur, it's HIGHLY likely vast amounts of money will remain on the sidelines and out of the hands of banks, corporations and money managers who enjoy virtually ZERO public trust.

Here's a laundry list of changes that might improve investor confidence in the market to help dissipate the current sense of panic in and anger at the market and replace it with more constructive caution that allows money to flow back into the market for legitimate investment and growth.

Regulatory Reform for Credit Default Swaps

Anyone who has been following the financial news over the past two years know credit default swaps (CDSs) are a key part of the larger meltdown in the financial system. Some may also know that the total nominal value of all of the existing CDS transactions is in the $55 trillion dollar range. Upon hearing that figure, most people would probably assume that SURELY, after events on the ground have proven these instruments to be such a colossal disaster, sophisticated investment firms and hedge funds would have learned their lesson and would avoid entering in new CDS contracts LIKE THE PLAGUE.

They would be wrong.

As stock prices of megabanks head to the penny range, speculators who have already lost their shirt are attempting to make up past losses by betting on the next "sure thing" -- collapsing stock prices of megabanks. There's no certainty any legal change or central bank strategy can gracefully unwind $55 trillion in existing CDS contracts. However, it seems a child of five could understand that it makes NO SENSE WHATSOVER to allow additional CDS contracts to magnify the instability that's already leading to the current remake of The Grapes of Wrath.

The Securities and Exchange Commission and its equivalents in the European Union and Asia need to explicitly restrict new CDS contracts in cases where one or both of the parties are not direct owners of publicly traded stocks or bonds involved with the contract. If the various power brokers can't agree on an outright ban on new CDS instruments, surely a compromise can be reached banning them on securities related to banks and insurance companies.

Regulatory Staffing and Qualifications

The testimony provided by Harry Markopolos to the House Financial Services Committee on February 4, 2009 not only provided a cogent explanation of the Madoff ponzi scheme fraud but also served as an indictment of the entire federal regulatory framework. His testimony made it perfectly clear staffing levels at regulatory bodies were wholly inadequate to keep up with the explosion of complexity of financial arrangements and strategies adopted by banks, hedge funds and insurance firms. He also confirmed the limited staff on hand was completely unqualified to analyze and critique the information they reviewed, even when twenty nine areas of suspicion were handed to them on a silver platter. (#3)

Perhaps the most damning part of his testimony was the revelation that for eight years after he first filed concerns with the SEC about Madoff's firm, not a single staffer had the presence of mind to confirm Madoff was even making the trades claimed in his public explanation of his investment strategy. Had anyone checked, they would have realized the number of trades required to produce the profits claimed would have exceeded all available options on the Chicago Board Options Exchange where those options were traded. (#4) In simple terms, this is like claiming you earned $50 billion dollars making two cents per share in a market that only moved 50 billion shares total. Basic math.

This isn't the first failure of this magnitude due to filings that all added up but failed basic business tests involving simple math. Worldcom inflated profits for years by capitalizing the costs of trunks accepting / terminating call traffic from local telephone companies instead of expensing them. For a telephone company, the relationship between minutes of use that produce revenue and the cost of trunk circuits to carry those minutes of use can be easily calculated. The fact that one carrier in an entire industry had trunking costs one seventh of their competitors should have been a red flag to its own auditors. Even with the failure of Arthur Anderson to flag the fraud, it should have been obvious to SEC staffers reviewing the Worldcom filings.

All enforcement personnel at the SEC should be required to pass a detailed test in "forensic accounting" to retain their jobs. Compensation for enforcement positions should be adjusted to attract more competent, analytical talent and provide incentives for actually pursuing cases for legitimate fraud. Equivalent measures should be taken within the Justice Department as well.

Real Anti-Trust Enforcement in Financial Services

The megabanks we have today are not "too big to fail" -- they're too big to succeed. I made this point months ago (#1). In the panic of 2008 around Bear Sterns and Merrill Lynch, the idea that the shotgun marriages hastily arranged by the Federal Reserve and Treasury were actually compounding the larger problem by further concentrating assets into institutions that had already proven themselves unable to stay away form the dynamite didn't get much coverage. The idea is still out there, however. In so many words, Sheila Bair, head of the FDIC, said the same on the 60 Minutes program aired March 8, 2009. (#2)

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I think taxpayers rightfully should ask, that if an institution has become so large that there is no alternative except for the taxpayers to provide support, should we allow so many institutions to exceed that kind of threshold?"
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For a better picture of the degree of consolidation in the banking industry, check out the market share of banks in your area using this handy web form on the FDIC web site:

http://www2.fdic.gov/SOD/sodMarketBank.asp?barItem=2

For virtually any geographic area selected, you'll find two or three banks each controlling between 8 to 29 percent of the market with roughly 30 other banks sharing what's left. A market share of even 29 percent share doesn't sound like much compared to other industries. However, when you consider that banking is pretty much a commodity function, that level of market share concentration produces opportunities to use leverage to boost short term profits which are -- by all facts in evidence -- irresistible.

Every bailout should be used as an opportunity to "right-size" the mega-banks back to manageable size. If taxpayer money is going to be used to provide an expanded margin of error to avoid panic in the system, that margin of error should be provided in the form of deals that allow assets to be offloaded to smaller regional banks. A new market share limit of maybe fifteen percent should be imposed going forward. Banks currently over the limit are free to continue to operate BUT:

1) absolutely no purchases of other banks will be permitted
2) any request for bailout assistance will force an auction of assets equal to the bailout to competitors to whittle down assets until the losing bank comes in below the cap

Legitimate Analysis of Automaker Bankruptcy Impacts

We are four months after the first round of dollars was thrown at GM and the other automakers yet not one day closer to any realistic plan for handling the impact of a bankruptcy of GM or Chrysler. The question everyone is asking isn't really "if" but "when." However, the real questions should be "how much" and "to whom?". Without a clear technical plan about the brands and specific product lines to survive, no practical analysis can be completed about plants likely to close or suppliers and dealers likely to be affected. Those plans cannot be made overnight but become more cataclysmic in scope as the firms continue burning through cash and poisoning customer confidence in their long term viability.

What all that really means is that any "rescue money" tossed at the automakers needs to be described for what it really is --- unemployment compensation to workers, healthcare subsidies for retired workers and stabilization money for communities with high concentrations of auto related jobs. From an economic standpoint, which alternative is preferable?

1) spend $30 billion to "rescue" GM to protect 70,000 assembly jobs and retirees
2) spend $30 billion on direct assistance to affected workers and retirees

Either way, it's $30 billion we don't actually have. However, option #1 funnels the $30 billion through a layer of incompetent, unimaginative executive management, thereby diluting the final impact and rewarding thousands of players who already pulled down more than their fare share in the glory years of $50,000 SUVs and $1.40 gasoline.

If the federal and state governments are bent on "helping" workers tossed out of work from auto makers, then pass legislation providing cash to bolster state unemployment funds, retraining programs and tuition assistance plans. Don't attempt to accomplish those same goals by passing the dollars first through the rotting management carcass of firms which are fundamentally unable to move transportation and manufacturing to the next level.

The auto industry debacle also poses a more theoretical question.

Tens of thousands of workers have been unceremoniously cashiered out of well paying jobs over the past twenty years, in some cases tempted by "guarantees" of healthcare coverage for life, only to find their employer later went bankrupt leaving them not only without a pension but without healthcare as well. A disastrous, retirement planning "oh-fer". No national effort was made to replace these workers' pensions or make up for promised but lost healthcare coverage. In the go-go, bubble driven economy, I'm not even sure any thought was even given to the topic.

If GM and Chrysler are truly headed to the bottom because of legacy pension and healthcare costs, exactly what qualifies auto workers and retirees for EXTRA pension and healthcare protections that have not been provided to former employees in other industries that hit hard times? This is a very hard nosed question and is not easy to ask knowing the situation facing these workers. Nonetheless, current auto workers and auto retirees are not the first to face this situation. Arguing for special financial treatment for these workers, by either trying to bail out a failed business model or providing direct benefits to these workers not provided to others makes no more sense than bailing out megabanks and their workers.

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#1) http://watchingtheherd.blogspot.com/2008/09/too-big-to-succeed.html

#2) http://www.reuters.com/article/gc06/idUSTRE5256SB20090306

#3) http://www.msnbc.msn.com/id/29009555/

#4) http://money.cnn.com/2009/01/22/news/companies/madoff_tradingfiction/index.htm

An Alternative Unofficial SOTU: 2009 Edition

2009-02-23T19:25:00.004-06:00

President Obama is scheduled to deliver his first address to a joint session of Congress on February 24, 2009. Though not formally promoted as such, the speech will essentially be interpreted as a State of the Union report to Congress and the American people aimed at outlining efforts to be initiated in the coming months to address a litany of dire, vastly complicated and highly interrelated problems facing the country.

So what is the state of the union? A pretty frightening picture emerges from examining trends in just three key areas -- finance, housing and war.

Finance

The first major legislation enacted in the Obama Presidency committed $787 billion dollars over two years to stimulate the economy via spending on a variety of projects at the federal and state level and tax cuts for individuals and corporations. Ignoring the political debate over the need for a stimulus, the size of the stimulus or the nature (spending versus tax cuts) of the stimulus, the impact of the plan on the nation's larger fiscal balance sheet has gone largely unanalyzed.

According to a July 2008 estimate, the Federal deficit for fiscal 2009 (October 2008 through September 2009) was forecasted to be around $482 billion dollars. (#1) Kinda makes you nostalgic, doesn't it? A mere $482 billion. Since those rosy days of July 2008, the following items have been tacked on the nation's credit card:

* $80 billion dollars for Iraq and Afghanistan (only 6 months of war spending was included in the July 2008 estimate)
* $700 billion for the October TARP bailout, half of which is already spent and the other half likely to be spent in the next few months
* $15 billion dollars for immediate cash flow relief to Ford, GM and Chrysler
* $393 for the first half of the two year spending of the $787 stimulus package

That puts the 2009 Federal deficit at $1.67 trillion dollars and the total national debt at $12.47 trillion dollars and doesn't include the cost of the next round of automotive bailouts for Detroit, a mortgage relief bailout for consumers or the next round of bailouts for major banks.

The REAL picture on that debt emerges after a quick review of interest rates on US Treasuries in 2008 and 2009 (see #2 and #3). Interest rates on 30-year T-bills have varied from 2.69 to 4.77 percent and are currently sitting at 3.56 percent. Interest rates on 1-year T-bills have varied from 0.34 percent to 3.17 percent and are currently sitting at 0.64 percent. Short term rates were driven lower in part due to a flight to (relative) safety as investors attempted to sell out of a falling stock market and find a safe place to put their cash.

What's the true cost of this borrowing? For 2008, interest payments on the national debt were $412 billion, nearly a third of the yearly budget. That's an effective interest rate of about 3.8 percent which implies most of the debt has been shifted back to longer term Treasuries since the 30-year bond was re-introduced in 2006. The extra $1.67 trillion (and counting…) in spending will add another $59.4 billion in interest payments for a single year.

A more enlightening picture emerges looking at debt as a percentage of Gross Domestic Product, as show in the graph at Wikipedia. (see #4) In that graph, the 1970s marked the low point of debt as a share of GDP. Ah, the 70s. Weren't those the bad old days of stagflation, oil shocks and high unemployment? For over a quarter century, we've been told that low-tax, pro-business policies were the solution that jolted us out of that funk. The graph of debt as a function of GDP would appear to clarify exactly where the solution came from -- our children's pockets. Only now, it's becoming apparent that solution produced a great deal of phantom growth, in the form of fictitious "financial sector" profits which have been completely erased by the losses over the past two years and an asset bubble in real estate that's destroyed the equity of probably 10 to 15 percent of all homeowners in the country. If the value of that phantom portion of GDP was erased, the percentage of debt as a function of REAL GDP would be skyrocketing even faster.

Finally, there is absolutely zero assurance that American's megabanks will behave predictably and wait to collapse until Congress and the President have time to haggle over a coherent, rational strategy for properly recapitalizing those in trouble. In fact, between February 20 and 22, the US dollar dropped five percent against most currencies over rumors Citi was privately asking the Treasury to provide emergency injections of capital to avoid a collapse. (#5)

Without any exaggeration, the financial condition of the United States is in dire shape. Debt incurred over the past quarter century hasn't improved the competiveness of our manufacturing, hasn't maintained our roads, sewers, bridges and power grid, and encouraged highly speculative business models which have collapsed at the same time the consequences of our mis-investment have made us even more dependent upon the availability of continued credit.

Housing

The same day the 2009 stimulus plan was signed into law, an additional $50 billion dollar plan was proposed to reduce the number of foreclosures driving home prices down even further. Again, seeing the real picture behind the debates about the plan requires digging out a calculator and doing some basic math. Over 274,000 borrowers received foreclosure notices in January of 2009. (#6) Monthly foreclosures throughout 2008 were probably in the 220,000 range each month so that would reflect roughly 2.69 million mortgage defaults for the past 12 months. The $50 billion dollar plan amounts to $18,587 for each of those mortgages. That sounds like a significant amount but what if the economy worsens? If unemployment worsens and another one million jobs are lost triggering another one million foreclosures, the amount per mortgage drops to $13,550 or about one year of mortgage payments.

Analyzing the impact of the $50 billion program requires an attempt at answering two key questions:

1) for individual borrowers, what exactly is the core problem being faced and how big is it?
2) does a micro level solution provide any synergy to help our macro level problems?

For question #1, borrowers face at least one of two problems -- an interest rate jump on their loan that pushes their monthly payment beyond their means or a job loss or other major event that eliminates their ability to handle ANY mortgage amount. Assuming each loan is an average FHA mortgage of $175,000 (#7) with a 30 year term, the monthly payment with a 5% rate would be $939.44. For those facing a rate hike jumping from maybe 3% to current market rates, the monthly dollar jump might be about $240 per month.

A $50 billion dollar program clearly has the potential to keep current borrowers on the bubble of foreclosure from dumping their homes on an already depressed market -- for at least a few months. If the current economic downturn was going to only last 12 months and home prices could stabilize at current prices, we might have a winner. Unfortunately, a twelve month downturn is a long shot. Unemployment may continue to grow for 12 to 24 months and economic output may continue to decline for the same period. If that holds true, the program would only defer the inevitable for a larger portion of loans and continue to prop up home prices at unsustainable levels. At that point, more analysis of the macro impacts of the plan is required.

If a $50 billion program isn't the right answer to the foreclosure problem, maybe we're targeting the wrong problem. If the 3.69 million at-risk borrowers are 15 percent of the overall mortgage pool, that still means there are 20.91 million other homeowners who ARE able to keep their homes in the downturn. Curiously, those homeowners are the real problem. Why? Because they are smart enough to look at the current distorted market and avoid it until prices stabilize and they see neighbors' homes sell in less than nine months. Even families who can afford their current home, afford a new home, and afford to move are unlikely to risk a capital loss on their existing home, risk an additional loss on a new home by buying before the bottom and risk having to pay two mortgage payments while they wait for their existing home to sell.

Stated concisely, the problem is not a meltdown in 15 percent of the mortgage market, the problem is a complete freeze in the other 85 percent. It's worth stating explicitly this is NOT a "psychological" problem that exists merely in the heads of these qualified buyers. This reluctance is a sign of rational thought on their part in an otherwise broken market. The only thing that will return these buyers to the market is stabilization of home prices and a return to more normal velocity in home sales. Unit sales shouldn't return to 2005 levels but inventories should drop well below nine months for "regular" homeowners to consider getting back into the market.

War

We're still fighting two wars. After seven years of effort, more than $600 billion has been spent, more than 4903 American troops have been killed and it is becoming more difficult to answer a single question.

What are these wars really about?

The answer?

Nothing.

We are literally fighting wars about nothing. Afghanistan is a prime example. The country is landlocked with no beaches, ports or major rivers and the terrain is austere and mountainous, making travel difficult and modern farming virtually impossible. The climate doesn't make anyone's list of vacation resort hot spots. The culture is tribal, Islamic and famously hostile to all outside parties. Though it has some potentially valuable natural resources, the other elements mentioned previously have inhibited any serious attempt to begin leveraging those resources. As a result, modern nations have virtually no economic, cultural or political interest in engaging the country. It might as well disappear from the map.

What possible value could such a country be to anyone on the planet? Well, such countries are of great value to two particular types of groups which thrive in such vacuums --- drug dealers and terrorists. Wouldn't you know it, that's exactly what we have in Afghanistan. In fact, we have terrorists participating in opium production which makes up nearly a third of the country's economy to produce funds to aid terrorist activities. Call them narco-Islamic terrorists. A trifecta of trouble. Pashtun areas of Pakistan exhibit many of the same traits and threaten to topple an actual nuclear power

The former Soviet Union spent ten years fighting in Afghanistan and lost 14,453 troops attempting to combat forces using insurgent tactics with conventional tactics. Sadly, America has never been particularly adept at learning from the mistakes of others and the Soviet invasion of Afghanistan would have been a particularly valuable lesson to learn. The Soviet misadventure in Afghanistan was more than an object lesson in the danger of fighting insurgent forces in a desolate climate. It was also a lesson in military jujitsu and the defeat of an enemy by sucking them into a war they were not prepared to fight. What most Americans don’t know is that America actually played a lead role in sucking the Soviet Union into that war. Under a Presidential order, the CIA began conducting propaganda operations against the Communist puppet government months before the full Soviet invasion. (#8) The National Security team for President Carter viewed Afghanistan as a trap waiting to snap on the Soviet army. It did and played a major role in the final demise of the Soviet Union. Yet only twelve years after the Soviets lost and withdrew in 1989, America launched its own war in the same country trying to root out bad guys who actually got their start via American aid during the war against the Soviets.

We are at a crucial point in our battle against terrorism. It took three and a half years for the military to acknowledge we were losing in Iraq and using the wrong tactics. A better mix of tactics was used in Afghanistan but we still shorted troop levels and jeopardized the effort and drove the enemy into neighboring Pakistan, further destabilizing that country as well. We have burned out our military and have contributed over $600 billion to the country's debt load for absolutely zero perceptible benefit to date.

The Coming Social and Economic Ctl-Alt-Del

In prior posts, I've used the idea of an economic and social "Ctrl-Alt-Del" sequence being applied to correct some of the problems we face. The analogy is very apt. In many regards, the United States as an economy and a society is acting like a home computer riddled with viruses, spy-ware and other parasitic processes. We have a tremendously powerful society and economy with virtually unlimited potential yet flaws in our "operating system" are allowing parasitic processes to run inside the machine. For years, despite a few billion dollar glitches like Enron or Worldcom, enough of the system's behavior appeared normal and didn't trigger any major concerns. However, the effects of the parasitic processes have become so ingrained in the larger system, we have lost track of what "normal" is and have failed to realize the degree of impairment.

With computers, rebooting halts everything running in the machine, takes the system back to a known, clean starting point, then reloads the original operating system to allow normal functionality to return while programmers attempt to fix the code before similar inputs produce a similar lockup. Of course, like parasites in nature, many computer viruses poison this reboot process to ensure they get re-installed and remain running. Many of the parasites affecting our society and economy will attempt the very same thing, whether in the form of special tax favors, special regulatory exemptions or entitlements for "one-time" emergencies that somehow become permanent.

The arrival of a "Ctl-Alt-Del" is not really an "if" question at this point. The only question involves the nature of the changes that will result from the reboot. To avoid having the viruses and worms of our economy re-establish control over our rebooted society and economy, Americans need to be re-educated in some of the basic mechanics of a sound business, sound industry and sound regulatory environment. Perhaps the best way to start is for President Obama to create a calendar of topics for the next two months and dedicate a week to a single topic, ranging from personal and government finance, infrastructure, transportation, energy and taxation. Our problems weren't created by 535 people in Congress or 10,000 people on Wall Street. They were created by 300 million Americans, partly out of misplaced optimism but mostly out of ignorance or willful suspension of disbelief.

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#1) http://www.npr.org/templates/story/story.php?storyId=93018389

#2) http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield.shtml

#3) http://www.ustreas.gov/offices/domestic-finance/debt-management/interest-rate/yield_historical_2008.shtml

#4) http://en.wikipedia.org/wiki/United_States_public_debt

#5) http://finance.yahoo.com/news/Govt-reportedly-mulls-taking-apf-14434394.html

#6) http://www.realclearmarkets.com/news/ap/finance_business/2009/Feb/12
/foreclosures_fall_from_dec_to_jan.html

#7) http://mortgagedataweb.blogspot.com/2009/01/fha-average-mortgage-amount-plateaus.html

#8) http://en.wikipedia.org/wiki/Soviet_war_in_Afghanistan