BOOK REVIEW: Fatal System Error

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

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

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

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

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

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

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