Edward Jay Epstein's Web Log

Jobs vs. Milken

2011-11-01T17:13:00.001-04:00

Despite the current hagiography of Steve Jobs and the demonization of Mike Milken, Milken’s revolution of corporate finance is far more important for the US economy than Job’s cool designs for Apple. See my Milken excerpt (From my Money Demons.)

The Money Demons

2011-10-02T11:13:00.000-04:00

It is not for everyone, include the happy horde of well-intentioned protesters who have encamped themselves today in lower Manhattan and the Brooklyn Bridge to “Occupy Wall Street.” But their protest, and its coverage, indicates the extent to which American pop culture prefers to lay the blame for the economic malaise on the greedy money demons of Wall Street. After all, after the 2008 crunch, many people can no longer borrow money to live beyond their means, So some guilty demon must be found, and one obvious candidate is Goldman Sachs, which made billions in profits by trading pieces of paper called derivatives while others suffered losses. Of course, Goldman did not act alone. It was part of a complex global system used by the Fed and other central banks to manipulate interest rates, print money, stimulate economic activities, and fund government debt. The financial alchemy called securitization through which debt is transformed into salable securities, an integral part of this system, produced, among other illusions of wealth, the sub-prime bubble. So the central banks must also be deemed part of the demonic equation.

Despite its popularity in the media and among politicians, not everyone buys into this organized flight from reality. For those who don’t. I offer my new book, The Money Demons: True Fables of Wall Street. It includes essays on such (unpopular) subjects as the Ahabian hunt for the Giant Vampire Squid (Goldman), Mike Milken, The Central Bankers’ Club in Basle, the Yale Endowment Fund, and the criminalization of high finance in Hollywood movies.

(For further details, see http://amzn.to/oBmUKz).

James Jesus Angleton Reconsidered

2011-09-14T14:45:00.000-04:00

In his newly published memoir, Dick Cheney provides such an intriguing coda to his service on the House Intelligence Committee that it could been the opening of a Le Carre novel. He writes that in May 1987 James Jesus Angleton, the former head of CIA counterintelligence, requested an urgent meeting with him to reveal to him something of “vital importance.” He immediately scheduled it but, just days before it was to take place, Angleton died, taking the unconveyed message to the grave with him. At the time, the general consensus in the intelligence community was that Angleton was paranoid about the KGB. His hunt for a mole, which had partly paralyzed the CIA had failed, and when he was fired from the CIA in 1975, CIA director William Colby called his obsession that the CIA could be penetrated by the KGB “sick think.” His idea that the KGB could plant and then sustain a mole in the CIA or FBI had not been substantiated by any evidence in 1975, and his idea that the CIA could be manipulated into cooperating in its own deception seemed totally out of touch with reality,

Yet, as it turned out after his death, he was not as far out of touch with reality as his critics inside the CIA.

First, the discovery of KGB moles Aldrich Ames, Harold Nicholson, and Robert Hanssen showed that the KGB had the capability to penetrate both the CIA and FBI.

Second, the fact that, despite lie detector tests, surveillance, and other counterespionage measures, Ames and Hanssen went undetected for more than a decade– Hanssen worked for the KGB over a period of 22 years– showed that the KGB had the ability to protect and advance their moles. ( Ames headed the CIA's Soviet Russia Division’s counterintelligence unit, Hanssen worked in the FBI’s anti- KGB operations.)

Third, the CIA Inspector General’s finding in 1995 found that in the 1980s and early 1990s the KGB had dispatched at least a half-dozen double agents who provided the CIA with disinformation cooked up in Moscow and that for eight years this disinformation had been passed in blue-striped reports signed personally by the CIA director to three Presidents even thought “senior CIA officers responsible for these reports had known that some of their sources were controlled by Russian intelligence” showed that the CIA would not necessarily expose KGB deception. So Angleton was right on all three scores.

My new book provides the details: James Jesus Angleton: Was He Right?

Tabloid America: Crimes of the Press

2011-08-14T08:29:00.000-04:00

My short new book Tabloid America: Crimes of the Press subject is tabloidization of mainstream media from Lindbergh to O.J Simpson

http://amzn.to/rpnWgP

Killing Castro

2011-08-05T08:56:00.002-04:00

The CIA’s super-secret Report On Plots To Assassinate Fidel Castro was completed in April 1967. All but one copy was destroyed on May 23, 1967. See my new ebook Killing Castro http://amzn.to/olFvcW

My new ebook experiment

2011-07-29T10:16:00.000-04:00

E-BOOKS on Kindle, Nook, Ipad, Smashword

http://www.edwardjayepstein.com/cyberbooktable.htm

THE HOLLYWOOD ECONOMIST

RISE & FALL OF DIAMONDS

AGENCY OF FEAR

HAVE YOU EVEN TRIED TO SELL A DIAMOND?

THE BIG PICTURE

THE JFK ASSASSINATION THEORIES

JIM GARRISON'S GAME

ARMAND HAMMER:

ZIA'S CRASH

MYTHS OF THE MEDIA

WHO KILLED GOD'S BANKER

THE ROCKEFELLERS [August 9]

THE CRUDE CARTEL [Aug 9]

KILLING CASTRO [Aug 9]

TABLOID AMERICA:

CRIMES OF THE PRESS [Aug 9]

The Myth of Bin Laden Lair

2011-05-13T14:34:00.001-04:00

The Lair of Bin Laden is a fictoid that originated in the highly-enterprising British press on November 27th, 2001. The chronology is as follows. On November 26th, the New York Times carried a story based on the account of an a ex-Russian soldier, Viktor Kutsenko, who had served in Afghanistan in the nineteen-eighties in which he claimed that there had seen an elaborate cave complex in Zhawar with "iron doors" that contained " a bakery, a hotel with overstuffed furniture, a hospital with an ultrasound machine, a library, a mosque, weapons of every imaginable stripe; a service bay with a World War II-era Soviet tank inside, in perfect running order." The historic story then added "Mr. bin Laden is reported to have upgraded both it and a nearby camp in the 1990's."

On November 27th, the London-based Independent came up with its own fairly similar troglodyte story, except that it had moved the underground fortress from Zhawar to Tora Bora, where the manhunt for bin Laden was about to begin, and advanced it in time from the nineteen-eighties to the present.
The Independent headlined: "Al-Qa'ida almost 'immune to attack' inside its hi-tech underground lair." In the story, its correspondent Richard Lloyd Parry, in Jalalabad, described a vast redoubt burrowed deep under a mountain, with labyrinthian tunnels sealed by with iron doors. "It has its own ventilation system and its own power, created by a hydro-electric generator. Its walls and floors in the rooms are smooth and finished and it extends 350 yards beneath a solid mountain." It was therefore tunneled almost as deep as the World Trade Center was high. It was also " so well defended and concealed that – short of poison gas or a tactical nuclear weapon – it is immune to outside attack. And it is filled with heavily armed followers of Osama bin Laden, with a suicidal commitment to their cause and with nothing left to lose."
It further claimed that fortress was built " reportedly employing expertise from Mr bin Laden's Saudi construction businesses" and housed "as many as 2,000 Arab and foreign fighters." The story's putative unidentified witness— the lone deep throat— explained, "It's like a hotel, with doors on the left and the right."
The idea that Osama and his followers had entombed themselves in an unassailable fortress under a mountain immediately embedded itself into the imagination of the American press. The Associated Press put The Independent story on its services, which went to hundreds of major newspapers and broadcasting stations. ABC News re-headlined the story "Bin Laden Hide-out Resembles Hotel: Witness," depicting "The cave complex ... filled with bin Laden's fanatical followers." Yahoo noted in its Internet service "Bin Laden has reputedly built a fortress 1,150 feet (350 meters) beneath the mountains, equipped with water, electricity and ventilation and guarded by hundreds or thousands of fighters ready to die for their leader." CBS, expanding the story, reported that an Afghan "commander thinks bin Laden is in a cave fortress known as Tora Bora. The massive hideout was built by the U.S. to house forces fighting the Soviet Army in the 1980s. The complex - nicknamed "bin Laden's ant farm," is burrowed deep into Gree Khil peak -- soaring 13,000 feet above the village of Tora Bora. It is virtually impregnable -- a latticework of tunnels, storage rooms for arms and munitions, and accommodations for up to a thousand fighters. Ventilation shafts bring fresh air 1,200 feet inside the mountain. A nearby river provides hydroelectric power to the complex... at least 2,000 of bin Laden's al-Qaida fighters are believed to be hiding there," In the Los Angeles Times Professor Mark C. Taylor added to his essay on an ancient troglodyte Hittite city in Turkey that "This city and others like it provide the prototype for the underground fortresses where Bin Laden and his followers are presumed to be hiding;" The Atlanta Journal-Constitution put the underground city in context, saying "The bitter and brutal end game between Osama bin Laden and U.S.-led forces is being played out in a mountain fortress the CIA helped build... equipped with ventilation and hydroelectric power." This bunker-fortress, the story continued, "provides bin Laden with significant advantages... it is considered invulnerable even to bunker-busting bombs and impregnable to conventional military attack." The Times of London meanwhile illustrated its story with an artist's rendering of the underground fortress, which dwarfed even Hitler's infamous "eagle's nest" fortress.

The story probably reached its high point on NBC's Meet The Press on December 2nd when Tim Russert, the host of the program, provided Secretary of Defense Donald Rumsfeld with the artist's rendering of bin Laden's fortress. The interview proceeded:
Russert: The Times of London did a graphic, which I want to put on the screen for you and our viewers. This is it. This is a fortress. This is a very much a complex, multi-tiered, bedrooms and offices on the top, as you can see, secret exits on the side and on the bottom, cut deep to avoid thermal detection so when our planes fly to try to determine if any human beings are in there, it's built so deeply down and embedded in the mountain and the rock it's hard to detect. And over here, valleys guarded, as you can see, by some Taliban soldiers. A ventilation system to allow people to breathe and to carry on. An arms and ammunition depot. And you can see here the exits leading into it and the entrances large enough to drive trucks and cars and even tanks. And it's own hydroelectric power to help keep lights on, even computer systems and telephone systems. It's a very sophisticated operation.
Rumsfeld: Oh, you bet. This is serious business. And there's not one of those. There are many of those. And they have been used very effectively. And I might add, Afghanistan is not the only country that has gone underground. Any number of countries have gone underground. The tunneling equipment that exists today is very powerful. It's dual use. It's available across the globe. And people have recognized the advantages of using underground protection for themselves.
A few weeks after the "Meet the Press" interview, US special forces and their Afghan allies occupied Tora Bora. They painstakingly searched Gree Khil mountain and the surrounding area. They found no underground fortress, no hydro-electric power plant, no 2000-room hotel, no ant farm, no iron doors, no ventilating shafts. The troglodyte Lair of Bin Laden turned out to be mythic.
Post script: Bin Laden, along with a number of his wives and children had been living in an above-the-ground home in in Abbottabad, Pakistan on May 1, 2011, when he was killed by US Navy Seals in a "targeted operation."

Who Runs Libya: A Profusion of Names

2011-02-23T09:31:00.000-05:00

Does anyone know who is the head of the so-called Great Socialist People's Libyan Arab Jamahiriya– or even if the first letter of his surname name is A, E, G, K, or Q?

According to the New York Times, he is “Muammar el-Qaddafi,” to the Wall Street Journal he is “Moammar Gadhafi,” to the L.A. Time he is “Moammar Kadafi,” to Washington Post, he is

Moammar Gaddafi, to Reuters, he is “Muammar Gaddafi,” to Bloomberg, he is “Muammar Qaddafi,” the AFP, he is “Moamer Kadhafi,”, to the English edition of the Xinhua News Agency. he is "Muammar Khaddafi," to the US State Department, he is “Mu'ammar Abu Minyar al-Qadhafi,” to the CIA, he is “Mu'ammar al-Qadhafi,” to the US Ambassador in Libya, according to Wikileak, he is “Qadhafi Incorporated.” and to his official site he is “Muammar Al Gathafi".

Can this be a single person, or some kind of transliteration junta? And what is his–or their– job in the Great Socialist People's Libyan Arab Jamahiriya (which means “masses” in Arabic)? CNN calls him “President,” the Boston Globe calls him “strongman,” the Sun (London) call him “dictator,” the Daily Mirror calls him “Mad Dog,” while the CIA factbook, somewhat understatedly, says that he “holds no official title, but is de facto chief of state.” Can Any (other than his voluptuous Ukranian nurse) clarify this issue?

Is Netflix Streaming Its Way Towards Disaster?

2010-12-02T16:03:00.001-05:00

Netflix, through the simple device of using the post office to bypass video stores, has become one of the great success stories of the new entertainment economy. It now claims 16 million subscribers who pay a monthly flat fee for an unlimited number of rentals. For this mail-in business, Netflix did not need the approval of the studios. It simply buys DVDs, as does anyone else, from retailers such as Wal-Mart then mails them out to subscribers. What makes this form of rental legal is the “first sale doctrine,” which holds that once a person buys a DVD, he can rent it out to others without the permission of the copyright holder. Through that court-approved doctrine , Netflix created its mail-in empire. For a monthly charge of as little as $9 a month, subscribers get any movie they choose on the Netfix website. Whenever a subscriber mails back his DVD in a stamped address envelope provided by Netflix he receives the next DVD he has ordered. There are no late fees.
Rather than backing its trucks up to Wal-Marts, Netflix buys most of its DVDs from wholesalers. Its average price of about $15 per copy. (Some studios also supply lower priced DVDs in return for Netflix delaying its mailing them until a month after they are in video stores.)
Last year, Netflix took in $1.67 billion in subscription fees. For its mailing business, its major expense, other than purchasing the DVDs, is postage and handling. It sends out about 2 million discs a day, which requires maintaining 50 distribution centers and buying over a half billion dollars worth of postage. Because of these expenses, its operating profit was only about 12 percent.
Netflix is now attempting to reduce its vulnerability to postage rate hikes by streaming movies over the Internet. Reed Hastings, the chief executive and co-founder of Netflix, explained that this new strategy is part of his concept that Netflix is not just as a mail-order house but a full-service home entertainment distributor since streaming provides movies in digital form on everything from Ipad, and Iphones, to game console and TV sets. Over the last three years, this streaming experiment has garnered a growing number of subscribers partially because it has been absolutely free to the subscribers of its mail-in service. Next year, however, it plans to charge for its streaming service. If it succeeds in converting its mail subscribers to streaming, it will in effect create a virtual channel that directly competes with the three major Pay-TV channels, HBO, Showtime, and Starz.
The problem here is that while streaming movies is a more efficient way of delivering movies than the mail, it requires a radically different business model. Unlike with mail-in DVDs, the first sales doctrine does not apply to streaming. So Netflix needs to license the electronic rights from the studios, and that is extremely expensive. In the case of new movies, studios license slates of 20 or so titles in so-called output deals for hundreds of millions of dollars. The average cost for a single title in such a deal is about $16 million for a two year license. Where Netflix can buy 10,000 copies of a major title for $150,000 to mail out, it will need to spend about $16 million to license it for streaming. Such a 100 fold increase in price can obviously be deleterious to profits especially since Netflix still has to maintain its mailing centers, and buy DVDs, for the subscribers who elect to continuing using the mail-in service either because they prefer DVDs’ higher quality and features or they don’t have the apparatus to receive digital streaming.
For the past 3 years, while building up its streaming service, Netflix found a temporary way around the licensing issue by making a sub-licensing deal with Starz Entertainment, a subsidiary of John Malone’s Liberty Media, which has its own output deal with Disney and Sony. paying Starz only $25 million a year for electronic sub-rights. Disney sued Starz claiming that such a deal violated the output agreement, but Starz held that it could sub-license these rights because Netflix was merely a “content aggregator.” No matter what happens in the litigation, the loophole will certainly be plugged in 2012 when Starz’ output deal expires. Not only will Disney likely demand on a payment for sub-licensing, but Starz itself has recently informed its other licensees that it will no longer discriminate in pricing, which means that Netflix will have to pay what everyone else pays for content.
And Netflix’s renewal problem is not merely with Starz. It also managed to license in 2008 the electronic transmission rights until 2012 for television programs, such as “The Office,” from networks. At that time, syndicators were only interested in the broadcast rights for re-runs of these series, and, as the streaming rights had little value, they licensed them at bargain prices. But the networks now have streaming, and video-on-demand of these programs on their own website, making it highly unlikely they will renew the expiring agreements.
The brutal reality is Netflix’s bargain days for streaming movies and television are coming to an end. As everyone else in the licensing game, Netflix will have to pay real world prices for content. Just the output deal it announced with three of the weakest studios, Paramount, LionsGate and MGM will cost it $200 million a year, a sum that exceeds its operating income last year. And if it wants the kind of output deals the other pay channels have, it will have to pay a great deal more than that.
Netflix, to be sure has brilliantly dominated the DVD mail order business. But, even aside from the immense cost of content, it must overcome three daunting challenges to succeed in the brave new world of cyber space.
First, it will have to compete directly with Pay-TV channels. HBO, which has nearly 40 million subscribers and a yearly cash flow of $1.8 billion, is not about to cede cyberspace to Netflix. It has just launched HBO GO which will stream to HBO subscribers “anything they want to see, anytime, anywhere, over their laptop, Iphone, tablet, Playstation”, according to Jeffrey Bewkes, the Chairman of HBO’s parent, Time Warner Communication. This includes not only the new titles, it acquires through its $500 billion output deals with Warner Bros, Fox, and Dreamworks but its prize-winning original series.
Second, since there are few barriers to entry to cyberspace, Netflix will also have to compete in pricing Internet savvy companies, including Apple, Amazon, Hulu and Youtube, all of whom can offer similar streaming services.
Third, as Netflix’s streaming consumes more and more of the capacity of broadband carriers such as Comcast, it will have to contend with either restrictions or usage charges that will increase the cost of streaming.
If Netflix fails to meet these challenges, its bold move into streaming might be nothing short of a prescription for financial disaster.

Who Killed Hariri

2010-11-28T10:38:00.000-05:00

The crime occurred at 12:56 p.m. on Valentine's Day, 2005. Rafik Hariri, the former prime minister of Lebanon, was blown up, along with most of his armored convoy, in front of the Hotel St. Georges in Beirut. The bomb had been packed into a white Mitsubishi van that had been moved into position by a suicide driver one minute and 50 seconds earlier; the powerful explosion tore a seven-foot deep crater into the street and killed 23 people.
The assassination caused an international uproar, and the Lebanese government turned to the United Nations for help. The U.N. Security Council appointed Detlev Mehlis, a German judge renowned for his pursuit of terrorist bombings, to head its investigation.
Now, after five years, indictments are widely believed to be imminent, and the investigation has recently focused on members of Hezbollah, the Iran-backed political and paramilitary terrorist group that has been a significant factor in Lebanon for decades—and whose rocket attacks on Israel precipitated the Lebanon war of 2006. Even the hint that Hezbollah might have been involved in the Hariri assassination threatens to engulf Lebanon in a civil war.
Early in the U.N. investigation, clues seemed to point to a jihadist suicide bomber. Various Islamist terrorists had used similar Mitsubishi vans in a spate of other Beirut bombings. Elements in the bomb traced back to military explosives used by al Qaeda of Iraq. A convenient videotape sent to Al Jazeera television showed a lone suicide bomber named Abu Addas claiming that he acted on behalf of an unknown jihadist group.
But the U.N. investigative team, which included forensic experts in explosives, DNA and telecommunications from 10 countries, found convincing evidence that the assassination was a cleverly disguised, state-sponsored operation. The Mitsubishi van had been stolen in Japan, shipped via the port of Dubai to the Syrian-controlled Bekka Valley where it was modified to carry the bomb, and then, only days before the assassination, driven over a military-controlled highway to Beirut.
One participant in the planning of the attack was Zuhir Ibn Mohamed Said Saddik, a Syrian intelligence operative. Saddik told investigators that the putative bomber, Abu Addas, was a mere decoy who had been induced to go to Syria and make the bogus video, and then was killed. He further alleged that the actual van driver had been recruited under a false flag in Iraq, so presumably if he defected or was captured he would wrongly identify his recruiters as jihadists.

Saddik said that the "special explosives" in the TNT had been intentionally planted there to mislead investigators in the direction of Iraq. Saddik was arrested for his role in the crime in 2005 and was released without reason the following year. He vanished in March 2008 from a Paris suburb.
Meanwhile, the U.N. team uncovered evidence that the actual conspirators had resources and capabilities—including wiretaps of Hariri's phones—that pointed to a state-level intelligence service. U.N. telecommunications analysts determined that eight new telephone numbers and 10 mobile telephones had been used, along with the wire-tapping, to follow Hariri's movements with split-second precision and move the van into place.
In addition, a former Syrian intelligence agent told investigators that he had driven a Syrian military officer on a reconnaissance mission past the St. George Hotel on the day before the bombing, and that the officer told him that four Lebanese generals, in collaboration with Gen. Rustam Ghazali, the head of Syrian intelligence in Lebanon, had provided "money, telephones, cars, walkie-talkies, pagers, weapons, and ID cards" to the alleged assassination team.
Judge Mehlis's report, issued in October 2005, concluded "there is probable cause to believe that the decision to assassinate former Prime Minister, Rafik Hariri, could not have been taken without the approval of top-ranked Syrian security officials, and could not have been further organized without the collusion of their counterparts in the Lebanese security services." Judge Mehlis had the four Lebanese generals arrested in 2005.
When the judge moved to question Syrian officials—including the intelligence chief, Assef Shawkat, who is Syrian President Bashar al-Assad's brother-in law—the Syrians stonewalled and protested the inquest's direction. In January 2006, the U.N. Security Council replaced Judge Mehlis with Serge Brammertz, a 43-year-old Belgian lawyer who had served as deputy prosecutor at the International Criminal Court in The Hague.
Mr. Brammertz was replaced in 2008 by Daniel Bellemare, Canada's assistant deputy attorney general. In April 2009, Mr. Bellemare requested that the four imprisoned Lebanese generals be released because of the "complete absence of reliable proof against them." And so they were.
Meanwhile, Lebanese investigators working on behalf of the U.N. team had re-examined cell phone records from 2005. They uncovered a network of about 20 mobile phones that had all been activated a few weeks before the attack and then silenced just afterward. This so-called second ring of phones had been calling the same phone numbers as the eight phones that coordinated the attack.
According to a report published by Der Spiegel in May 2009, investigators traced the second ring of phones to a command post of Hezbollah's military wing under the notorious Imad Mughniyeh, who had been responsible, according to U.S. intelligence assessments, for other spectacular bombing attacks, including the 1983 U.S. embassy bombing in Beirut.
But before this cell phone evidence could be further examined, the Lebanese chief investigator working on this complex network was killed in Beirut in 2009. (Mughniyeh, who might otherwise have been called as a witness, had himself been assassinated in 2008.)
In April of this year, U.N. investigators summoned 12 Hezbollah members and supporters for questioning. This spurred rumors that the Special Tribunal for Lebanon, which the U.N. set up in March 2008, was on the verge of finally issuing indictments.
The political reaction in Lebanon was fraught. Hezbollah's powerful chief, Hassan Nasrallah, said ominously in July that Hezbollah would not stand by idly if its members are accused of involvement in the assassination. He also denounced what he called attempts to "politicize" the tribunal—as if political consideration could be omitted from political crime.
Nasrallah then moved to discredit the U.N. by saying that its investigators come from "intelligence services closely linked to the Israeli Mossad." He demanded the establishment of a Lebanese committee to investigate "false witnesses." In September 2010 he went further, claiming that Hezbollah had "evidence" that Israel was behind the assassination. Syria, for its part, is claiming to be the victim of planted evidence.
Sadly, if the agents of Syria or Iran are finally named by the U.N.'s special tribunal, the half-decade delay in justice for Hariri's murder may be little more than prelude. Syria and Hezbollah, which both possess the power to destroy Lebanon's fragile government, will almost certainly denounce such a finding and shift the blame—as Hezbollah has already suggested—to their convenient bete noire: Israel. Such allegations and recriminations, meaningless as they may be, could drag on for another half-decade, if not longer.

Role Reversal: Why TV Has Replaced Movies as Elite Entertainment

2010-10-16T11:37:00.004-04:00

Once upon a time, over a generation ago, The television set was commonly called the “boob tube” and looked down on by elites as a purveyors of mind-numbing entertainment. Movie theaters, on the other hand, were considered a venue for, if not art, more sophisticated dramas and comedies. Not any more. The multiplexes are now primarily a venue for comic-book inspired action and fantasy movies, whereas television, especially the pay and cable channels, is increasingly becoming a venue for character-driven adult programs, such as The Wire, Mad Men, and Boardwalk Empire. This role reversal, rather than a momentary fluke, proceeds directly from the new economic realities of the entertainment business.

Consider what happened to Pay-TV. Back in the 1970s, HBO provided something home viewers could not get elsewhere: movies uninterrupted by commercials. It was, as a HBO executive put it, “the only game in town,” so its subscribers paid a monthly fee, no matter how little or often they watch it, to their local cable provider who in turn forked over a share to HBO. As the cable systems grew, so did HBO. By 2010, it had (including its Cinemax unit) over 40 million subscribers, and just the monthly fees produced cash flow of over $1.5 billion a year. Getting new movies was no problem. HBO simply licensed them from a few major studios for an exclusive period (which began a few months after they were released on video and DVD) in so-called “output deals.” To continue to harvest this immense bounty, HBO had merely to stop subscribers from ending their service.

But that feat became far more difficult as alternatives became readily available, including video stores, Netflix, and the Internet. Why should anyone pay a monthly fee to see movies on pay TV when it could get it else where cheaper and faster? The answer HBO executives found was to create its own original programming designed to appeal to the head of the house. Here it had several advantages over Hollywood. It did not need to produce a huge audience since it carries no advertising and gets paid the same fee whether or not subscribers tune in. Nor did it have to restrict edgier content to get films approved by a ratings board (there is no censorship of Pay-TV). And it did not have to structure the movie to maximize foreign sales since, unlike Hollywood, its earnings come mainly from America. As a result, HBO and the two other pay-channels, Showtime and Starz, were able to create sophisticated character-driven series such as The Wire, Sex and the City, The L Word, and The Sopranos. As this only succeeded in retaining subscribers and also achieved critical acclaim, advertising-supported cable and over-the-air network had little choice but to follow suit to avoid losing market share. The result of this competitive race to the top is the elevation of television.

Meanwhile, Hollywood went in the other direction. In the era of the studio system, the Hollywood studios opened their movies in a few dozen select first-run theaters, most of which they owned, and then, with the help of critical acclaim and favorable word-of-mouth, gradually moved them into local theaters. To accomplish this, they did not need huge advertising or print budgets. Nowadays, confronting a very different economic landscape, they open most of their major movies on 3,500 to 5,000 screens which are owned not by them but by a handful of multiplex chains. Multiplexes are in the “people-moving business,” as on multiplex owner put it, which means moving herds of movie-goers past the concession stands In return for providing their screens, these chains expect the studios to provide them with two things: first, lavishly-produced movies; second, and even more important, a national marketing campaign for each movie that will fill their multiplexes with consumers on opening weekend. Since such campaigns cost about $30 millions of dollars per movie, studios require that their marketing arm sign off on each project before it is greenlit for production. For the marketing executives, the deal-breaker is not the intrinsic merits of the film itself but the absence of the elements needed to build a marketing campaign both in America and abroad (where up to 65 percent of the revenue comes from.) Such campaigns typically require buying time on TV programs around which clusters an audience predisposed to going to the movies every weekend and then hitting it with 7 ads in the week leading up to its opening weekend. The target audience that fits this bill is tweens and teens, which are also the groups with the greatest propensity to consume popcorn and soda.
The least risky way to find movies that lend themselves to campaigns around which a global marketing can be built is to copy the movies for which marketing campaigns have succeeded in driving the requisite audience into the multiplexes; hence, the profusion of comic book-based movies and their sequels. In addition, studios must take into account that their movies must play in overseas markets, such as Korea, Japan, China, Russia, and Brazil, where visual action takes precedence over sophisticated dialogue. So the dumbing-down of movies is no accident.
Its after all show business.

The bank Job

2010-09-29T10:07:00.000-04:00

The idea that Goldman Sachs, Citibank and other big banks duped Fed officials by getting them to buy their distressed pools of debt (CDOs) at 100 cent on the dollar has become a relentless part of the conversation about the financial crises of 2008. To be sure, the NY Federal Reserve Bank used a vehicle called “Maiden Lane III” to acquire billions of dollars of CDOs that had been insured by AIG through credit default swaps from 16 banks and cancel the AIG’s contractual responsibility for this insurance. By doing so, the 16 banks got these plunging CDOs off their books and AIG got rid of an albatross around its neck. But had the Fed made a deal with the devil? “Taxpayers not only ended up honoring foolish promises made by other people, they ended up doing so at 100 cents on the dollar,” the Nobel Laureate Paul Klugman wrote of the deal in the New York Times, “By making what was in effect a multibillion-dollar gift to Wall Street, policy makers undermined their own credibility — and put the broader economy at risk.” Eliot Spitzer, the former governor of New York, was even more severe, terming the payments to the banks a “real disgrace.” And when the Congressionally-appointed Financial Crisis Inquiry Commission held public hearings in July 2010, Brooksley Born, a Commission member, not only expressed bitter indignation that Goldman Sachs was "100 percent recompensed on that deal,” but said that “ the only people who were out money were the American public."

Such charges neglected three pertinent facts. First, the Fed did not pay “100 cents on the dollar.” It paid $29.1 billion for CDOs with a face value of $62.1 billion, which is about 48 cents on the dollar. Second, the Fed did not lose money on the CDOs. It bought these securities very close to their nadir in November 2008, and they went up in value in the bond rally in 2009 and 2010. Actually, as of September 8 2010, the Fed has a $7.9 billion profit on them– at least on paper. Third, these CDOs have continued repaying large amounts of principal and interest. As of September 8 2010, they had paid off $9.3 billion of the Fed’s $24.3 billion loan. At this rate, the remaining loan will be repaid in less than 4 years. Meanwhile, The Fed gets interest of one percent above London Interbank rate on the loan.

But the outrage over this deal is not about the damage it caused the Fed, or even the American tax payers, it is about the lack of damage it caused the 16 banks that had insured their CDOs. These 16 banks wound up getting back roughly all the insured amount they had invested in these CDOs. What happened was that when the CDOs began plunging in July 2007, and their ratings were downgraded, AIG, which had issued their credit default swaps, had a contractual obligation to send them “collateral payments” equivalent to the drop in the CDO’s market value. By November 2008, though AIG teetered on bankruptcy from making these payments, the 16 banks’ actual exposure on the CDOs was only their depressed market value. Consequently, when the Fed bought back the CDOs at their market value, the banks got back what remained of their insured investment. Not unlike Macaulay’s observation that the Puritans objected to the sport of bear-baiting not because of the pain it gave the bear but because of the pleasure it gave spectators, the critics’ complaint is that the banks, and especially Goldman Sachs, did not suffer enough pain in this Fed bail-out. They correctly pointed out that the US government had tremendous leverage over those banks that had received TARP funds and could have used it to force them to accept less than market value, or, a “haircut”in the parlance of Wall Street. Such a “haircut” would not only have allow the Fed to make even more money than it did on the appreciation of the CDOs, it would have benefitted AIG (now 78 percent owned by the US government), which was the Fed’s junior partner in the profits of Maiden Lane III.

Such an accommodation would required the agreement of all 16 banks, raising a problem. 12 of the 16 banks were foreign-owned and held approximately two-thirds of the AIG-insured CDOS. These banks had little incentive to accept anything below the market price for their CDOs because their AIG insurance would cover any further losses. Moreover, the single largest holder of AIG-insured CDOS, the French bank Societe Generale SA, informed the Fed that its regulators in France would not permit it to sell the CDOs below their market value and it was illegal for it to accept a “haircut” so long as the insurer, AIG, was still solvent. This position, which other European banks would also take, ruled out a voluntary “hair cut.”.

There still was the nuclear option: letting AIG go bankrupt. But such a move would open up Pandora’s box. It was not that AIG, with a trillion dollars in assets was too big to fail, it was that it was too interwoven into the skein of the global financial system. To begin with, its subsidiaries operating in 130 countries insured a large part of the commerce flowing between China, America, and Europe, and the seizure of them by state and government regulatory authorities could paralyze world trade. It could also could also cause a panic among those it insured. In the US alone, it insured 30 million people. It also held billions of state and local funds in its guaranteed investment programs that would be frozen. An AIG bankruptcy could cause an even greater financial crisis abroad since European banks depended on AIG, through its French subsidiary Banque AIG, to provide the “regulatory capital” that they needed to meet government-mandated capital-to-debt ratios. AIG did this feat through complex derivative swaps and . A bankruptcy, or even change of ownership in Banque AIG, would require major European banks to call in hundreds of billions of dollars in loans. Rather than risk financial Armageddon, the US government decided to save AIG. So the Fed could hardly threaten, or put, AIG into bankruptcy to pressure the banks to take a haircut.

So Goldman Sachs, Societe Generale, Citibank, JP Morgan Chase and the other counter parties won their huge bet on CDOs. This bet was not merely on the securities, or even on that the insurer AIG, but that, even if AIG’s obligations to pay exceeded their means, the US government would not allow AIG to fail. That assessment got correct. But the Fed which financed the purchase of the CDOs from the banks also not lose. That is because the market price it paid at the depths of the crises– 48 cents on the dollar– turned out to be much less than their actual value. So the Fed now stands to make a multi-billion dollar profit. AIG of course lost heavily, with the US Treasury getting 79.8 percent of the company, but that is the consequences of making a bad bet: that CDOs would not be downgraded and plunge in value. Whether or not the treasury recoups its investment in AIG is still an opened question, but, by saving AIG, it prevented the collapse of the international financial system. So where is the scandal?

.

Why Russia Spies On America

2010-08-04T19:43:00.004-04:00

Anna Chapman (nee Anna Kushchenko) was a comely Russian agent living on Exchange Place in Manhattan and masquerading as a Wall Street real estate agent. In spytalk, she was an "illegal" because, unlike an agent working under diplomat cover, she had no immunity from arrest. On June 26, 2010, she met with "Roman," an undercover FBI agent, masquerading as an officer of the Russian intelligence service. He then assigned her a task that "illegals" are trained to do: to surreptitiously deliver a bogus passport to a putative Russian secret agent (who was actually another FBI undercover agent.) But instead of carrying out her assignment. she called her control officer in Moscow who instructed her to immediately turn in the fake passport to the nearest police station and report the fake Russian spy. This move effectively ended the cat and mouse game between Moscow Center and FBI counterespionage. When called by the police, the FBI arrested Chapman and 9 other Russian illegal agents, and then, after making a deal with Moscow, released them in Vienna in exchange for 4 Russian prisoners, three of whom had been for allegedly working for the CIA and British intelligence.While the 10 "illegals" were part of the Russian espionage apparatus in America, they were not spies, at least not in the sense that they stole secrets. Whereas their cover was sufficient for them to blend into American society, rent apartments, join Facebook, and get ordinary jobs , it was far too shallow to withstand the sort of security investigation necessary to get access to classified information. Indeed, if asked, these "illegals" could not even furnish their high school records. But they did not need a deeper cover to perform the courier work done by an "illegal": picking up data from a spy who has penetrated the US government– such as, for example, Aldrich Ames, Harold James Nicholson, Robert Hanssen and Earl Pitts-- and delivering it to a Russian case officer. For this basic mission, the "illegal" needs to be able to surreptitiously service a dead drop, make a so-called "brush pass," or make a delivery– as Anna Chapman was supposed to do with the bogus passport. Unlike a "legal"Russian diplomat in America, who is under 24/7 FBI surveillance, an "illegal," who only may be called upon once every few years to go somewhere, provides a relatively safe means of servicing a mole so long as the FBI is unaware of his or her existence.In this decade-long case, however, the FBI identified these 10 illegals via a source in Moscow soon after they began arriving in America in the 1990s, and had each of them under full surveillance. The fact that none of them ever led their FBI tails to a mole suggests that Moscow Center was not totally blind to its operation. After all, up until November 2000, the Russian intelligence service had its mole Robert Hanssen strategically placed in FBI counterintelligence. Sp it might have learned from him (or other sources) about the FBI surveillance.The criminal complaint filed in federal court against these 10 illegals shows just how transparent this spy game had become to both sides. The FBI gratuitously reveals that it had decrypted the Russian code used by Moscow Center to communicate with these illegals. Under most circumstances, security services such as the FBI go to extraordinary lengths to keep secret their sources and methods, especially communication intelligence that allow them to read adversaries' coded messages. It is even claimed that in World War II, the British city of Coventry was not alerted to an impeding German bombing raid because, according to Group Captain Frederick W. Winterbotham in his book The Ultra Secret, British intelligence feared that issuing such a warning could reveal to Germany that it had broken its cipher. Certainly, the FBI would only reveal that it had decrypted the Russian cipher if it had fully established that Russian intelligence already was aware that it had cracked its code and was reading itd messages. But this meant Moscow would likely use it to send messages to an FBI audience. Consider, for example, the mission statement it sent to its agent "Richard Murphy" in the final stages of the game in 2009 and which the FBI duly decrypted. It informed its audience which included the FBI: "You were sent to USA for long-term service trip. Your education, bank accounts, car, house etc. all these serve one goal: fulfill your main mission, i.e. to search and develop ties in policy making circles in US." What made this mission statement exceedingly odd was that the recipient had been operating in America for more than a decade and would not need to be told again at this late date over a compromised channel the nature of his mission. So its purpose may have been to divert the FBI focus away from the possibility that their mission was to service a mole.Whatever their actual mission, they were part of an ongoing Russian espionage enterprise in America. Though the arrests were largely treated by the media as some bizarre throwback to the Cold War, they show that the Russia intelligence has been expending resources over the past 20 years to install the plumbing necessary to service penetration agents and other sources. This raises the question: Why does Russia continue to spy on America after the end of the Cold War?The short answer is that the spy war never ended. The CIA still has a division dedicated to recruiting and managing moles inside the Russian government. And the Russian intelligence service, though it may have changed its name from the KGB to the SVI or FSB, continues to recruit its own moles such as Ames and Hanssen at the heart of American intelligence. Nor can either side stop without leaving itself vulnerable to undetected penetrations. The Game of Nations is thus self-perpetuating.

Why The CIA went haywire on Iran

2010-07-31T14:27:00.004-04:00

US intelligence proved disastrously wrong in concluding in 2007 that Iran had ended its quest for nuclear weapons, including, as it stated in a footnote, its "nuclear weapon design and weaponization work and covert uranium conversion-related and uranium enrichment-related work". In reaching this flawed verdict the CIA depended heavily on information supplied by its secret agents in Iran. This raises the question: was the CIA misled by its own spies into believing that the threat of sanctions had worked in ending Iran’s surreptitious effort to obtain nuclear weapons?When US intelligence analysts prepared to write the National Intelligence Estimate (NIE) for 2007, they were confronted much the same mountain of evidence that led their predecessors to conclude with high confidence in the 2006 NIE that Iran was secretly engaged in a nuclear weapons program. The CIA still had verified reports that Iran had experimented with Polonium 210, a key ingredient in the trigger of early-generation nuclear bombs. It had documents recovered from a stolen laptop describing Iran’s efforts to fit a warhead in the nose cone of its Shahab 3 missile that would detonate at an altitude of 600 meters, which is too high for anything but a nuclear warhead to be effective. It had a detailed Iranian narrative, written in Farsi, describing how a Russian scientist helped Iran conduct experiments to configuring high-tension electric bridge wire to detonate simultaneously at different points. And according to IAEA experts, the only use for such precise coordination is to detonate a nuclear weapons. It also had found Iranian technical drawings for a 400-meter long tunnel rigged with the kind of precise remote sensors used to measure pressure from a nuclear underground test. They had reports that Iran had most likely acquired a digital copy of a Chinese nuclear warhead design from the A. Q Khan’s network. It had further established that Iran had the blue prints for a high voltage block, called a TBA 480, necessary to assure the proper compression of the nuclear core in the warhead. And it had satellite surveillance of Iran’s crash program at Natanz to build a nuclear enrichment plant– a facility US intelligence estimated could house up to 50,000 high-speed centrifuges.To be sure, taken individually, such suspicious activities might have a non-nuclear explanation. For example, according to Iran, the purpose of its Polonium 210 experiments was merely to find a power source for an Iranian spacecraft (though Iran did not have ant known space program at the time of their Polonium 210 extraction.) But taken together these efforts added up in all the CIA’s estimations prior to 2007 to an inescapable conclusion: Iran was going Nuclear.So what had changed in 2007? One answer is that the CIA was the receipt of new secret intelligence from Iran. It provided convincing evidence that the facilities of the weapons-design program revealed on the stolen laptop, code named Project 111, had been closed down by Iran in 2003. This was confirmed by satellite photographs showing that a buildings involved in it had been bulldozed, communications intercepts revealing that scientists were no longer working at the location, and a high-level defector from the Iranian Revolutionary Guard reporting that "Project 111," had stopped functioning. Since the CIA had revealed it knew about Project 111, and even supplied technical drawings from it to the IAEA, it was not that surprising that the Revolutionary Guard, which runs Iran’s nuclear activities, would shut down a compromised project.The real intelligence issue was how to interpret the closure of Project 111. Had the design work been secretly moved to another location by the Revolutionary Guard to avoid further scrutiny by the CIA and IAEA? Had it been closed because the warhead design had been solved with the acquisition of the digital blueprints of the Chinese nuclear weapon which Iran got from the A.Q. Khan network? Or had the Revolutionary Guard closed it because Iran had abandoned its decade-long quest for a nuclear weapon?Deciphering the intentions behind a Revolutionary Guard action is no easy task in a closed and terrorized society in which the US has no diplomatic relations and little direct access to decision-makers. It therefore had little choice but to rely on the human "assets" in its espionage apparatus to illuminate the intentions behind the shut-down of project 111. Over the years, the CIA had recruited a network of Iranian agents which had, or claimed to have, access to nuclear work. These agents provided reports about Iran's nuclear program that allowed the authors of the 2007 NIE to cite secret evidence in support of the conclusion that "Tehran’s decision to halt its nuclear weapons program suggests it is less determined to develop nuclear weapons than we have been [previously] judging."As a result, in a stunning departure from the previous assessments on Iran by US intelligence, the 2007 NIE declared in its summary: "We judge with high confidence that in fall 2003, Tehran halted its nuclear weapons program." Even more astonishingly, It attributed the "halt" to "increasing international scrutiny and pressure resulting from exposure of Iran’s previously undeclared nuclear work" which meant that the threat of sanctions had worked in ending Iran’s surreptitious effort to obtain nuclear weapons.As we now know the Revolutionary Guard, instead of ending its secret nuclear program, was secretly completing new facilities in 2007. For example, at Fordo, 20 miles north of the holy city of Qum, it was reinforcing tunnels leading inside a mountain cavern designed to house a new uranium enrichment plant. (This underground facility was only disclosed by Iran to the IAEA in late 2009.) Clearly, Tehran’s intentions was not to abandon, a nuclear program in which it had invested tens of billions of dollars.What may have misled the CIA was a gaping flaw in its espionage apparatus in Iran after 2004. New York Times reporter James Risen reveals in his book "State of War" that since the CIA had no embassy base in Iran, it relied on state-of-the-art satellite transmissions to communicate with its agents. Then, in 2004, a CIA communications officer made a disastrous mistake. She accidentally included in a satellite transmission to an agent the data that could be used to identify "virtually every spy the CIA had in Iran." The error was compounded, , according to Risen, because the recipient of the transmission turned out to be a double-agent controlled by the Iranian security service. If so, the Iranians knew the identity of all the agents that the CIA had arduously maneuvered into positions of access as well as the technical methods by which the CIA communicated with them after 2004. The CIA's putative agents in Iran would have little choice but to allow the Iranian security service to control all the information they delivered to the CIA. If not, they would be eliminated and replaced. One of the agent who the CIA used for its 2007 NIE was Shahram Amiri. In 2004 and 2005, he had been working at Malek Ashtar University of Technology in Tehran, where research was done for Project 111. He reportedly provided details to the CIA about the termination of Project 111. Of course, to be credible, misinformation is designed so it will check out. And, according to the CIA, it did check out with the information it was receiving from its other sources. So it, and the 2007 NIE, had "high confidence" in its conclusion that Iran had given up on weaponization. In 2009, Amiri agreed to meet a CIA officer in Saudi Arabia. After that rendezvous, he was flown back to America (he now claims against his will.) The CIA, according to the Washington Post, offered to pay him $5 million. Meanwhile, Iran claimed he had been drugged and kidnapped. Then this July, he re-defected back to Tehran via a taxi trip to the Pakistan Embassy in Washington DC. Rejoined with his wife and young son at a press conference, Iran claimed that he had been operating as its double-agent in an espionage game. That he was willing to walk away from the CIA's $5 million bonus and into the waiting arms of Iranian intelligence officers leaves little doubt that the Iranian security service had the ultimate leverage over him. Did they control his secret reports when the CIA was preparing its NIE in 2007? That question no doubt will be hotly debated within the intelligence community for years to come. If Risen is correct that the CIA's sources and methods had been compromised after 2004.But the willful blindness factor should not be underestimated. The most effective deception tells an audience what it wants to hear. Members of the newly-reorganized Nation Intelligence unit who authored the NIE may have wanted to believe that Iran would quit its nuclear weapons program, since it confirm their hope that US sanctions were working.Whether the misleading conclusions in the CIA’s 2007 NIE proceeded from Iranian deception or American self-deception, they were not without consequences. The immediate effect of the 2007 NIE was to undercut the case for taking more drastic action. To the extent that it was believed that Iran had already ended its nuclear program, other countries had little incentive to join in imposing further sanctions. It also provided time for Iran to upgrade its centrifuges and increase its stockpile of lowly-enriched Uranium gas. Indeed, by 2009, it had enough fuel, if it chose to further process it in its centrifuges, for at least one nuclear bomb.The moral of this sad spy story is that the information exchanged in an espionage game cannot be taken for granted. Spies that are viewed "assets" in a closed country can turn out to be a very risky liabilities.***

The War on Wall Street

2010-05-21T17:57:00.005-04:00

When President Obama signs the new financial regulation act the government will assume sweeping new powers over Wall Street. The passage of this bill did not occur in a vacuum. The administration carefully laid the groundwork by inculcating public fear that the great financial houses betray investors by rigging securities to fail. Exhibit A: the SEC's recent fraud case against Goldman Sachs.
The agency's complaint alleges that Goldman Sachs defrauded the investors in its Abacus 2007-AC1 fund by not disclosing the role played in the fund's creation by John Paulson, a hedge fund operator who stood to make an immense profit if the fund failed. It might be a great conspiracy case-if the SEC could come up with a plausible conspiracy.
Mr. Paulson wanted to make a billion dollar wager that subprime-backed mortgages would collapse. So he went to Goldman Sachs, which, like the other major financial houses, is in the business of creating such customized gambling products for clients.
For a $15 million fee from Mr. Paulson, Goldman created Abacus 2007-AC1. It provided exposure to a portfolio of 90 subprime home mortgage-backed securities. If the underlying securities did not default, those who took the long side of Abacus would collect handsome profits. If the housing bubble burst, those who took the short side would win heavily.
Goldman found three participants to bet long-ACA Capital Holdings, a bond insurer, IKB Deutsche Industriebank (a Germany-based specialist in mortgage securities), and itself. ACA went long on the deal. It sold a $900 million credit default swap on Abacus and even invested about $40 million in the Abacus deal itself. ACA's wholly owned subsidiary, ACA Management, had sole authority to pick every one of the 90 securities in the portfolio. IKB bought $150 million worth of Abacas's notes, and Goldman put up $90 million to complete the financing.
Mr. Paulson was the lone short, buying ACA's credit default swap from Goldman. All four participants in the Abacus deal had the same data about the 90 underlying securities. What separated them was their opinion of the direction of the housing market. Mr. Paulson felt it was headed toward a collapse; ACA considered this so unlikely that it gave nearly 20 to 1 odds on its credit default swap. Mr. Paulson won the bet.
So where is the fraud? The SEC says Goldman withheld material information from ACA and IKB by not disclosing the history of the deal, including Paulson's role in the creation of Abacus. Of course, ACA knew someone was short the deal, since it sold Goldman a $900 million credit default swap precisely for that purpose. Goldman did not say that Mr. Paulson was that counterparty. But his identity may not have been a mystery to ACA.
Mr. Paulson's top lieutenant in the deal, Paolo Pellegrini, testified to the SEC in its investigation of the matter in 2008 that he had informed ACA Management that Paulson's hedge fund was betting against the transaction. If so-and Mr. Pellegrini had no reason to perjure himself since he had no obligation to disclose anything-ACA possessed the information that Goldman withheld, and went ahead with the deal. IKB bank, which bought Abacus's AAA-rated notes, may not have known about Mr. Paulson's role in Abacus.
The real issue here turns on the term "material," which the SEC defines as facts an investor would reasonably want to know before making an investment. The agency contends that Mr. Paulson's role in suggesting securities to ACA was "material." Prior to this case, the SEC did not always consider a deal's history material, taking the position in hundreds of other such deals that how a fund was constructed, including how its rating was achieved with rating agencies, did not require disclosure. That was before Wall Street became a political bete noire.
Nevertheless, the SEC voted in split decision (all the Republicans voting against) to accuse Goldman of civil fraud. It alleges that Mr. Paulson "heavily influenced" ACA Management to pick losers but provides no theory as to why ACA Management, whose corporate parent was risking $940 million, would do anything but pick the least risky subprime bonds. As it turned out, the subprime securities ACA picked for the portfolio failed. But so did the vast majority of securities based on subprime mortgages. Since 99% of them were marked down by the rating agencies by the end of 2008, Abacus would have likely suffered the same fate had ACA picked 90 other such securities.
ACA's losses on Abacus were less than 5% of the $22 billion in losses it suffered in its other subprime funds (in which Mr. Paulson was not involved). When the time came to pay off the Abacus wager, ACA, hit by $68 billion in credit default swaps, couldn't make good. Its Abacus debt fell to the Dutch bank ABN-AMRO, which had back-stopped ACA. The Royal Bank of Scotland, which had the misfortune of merging with the Dutch bank, paid Mr. Paulson.
No one can fault the SEC for wanting to restore faith in Wall Street by ferreting out financial frauds. But its case against Goldman Sachs does not add up. It implies a conspiracy without co-conspirators. If Goldman had designed its own fund to fail, it could have retained the credit default swap it got from ACA for its own account rather than selling it to Mr. Paulson. Instead, it invested $90 million of its own money into Abacus. Goldman's records showed it lost $75 million (after taking its $15 million fees into account). The SEC has issued no complaint against Mr. Paulson in this deal.
Not only is there no motive or logic for Goldman to have sabotaged its own fund, but the SEC complaint fails to cite any evidence it did. Nevertheless, it has brilliantly succeeded in implanting that idea in the media. On April 18, Paul Krugman stated in his New York Times column that "the S.E.C. is charging that Goldman created and marketed securities that were deliberately designed to fail, so that an important client could make money off that failure. That's what I would call looting." In fact, the SEC complaint never alleges that Goldman deliberately designed any securities to fail.
Even though the widely echoed "designed to fail" charge is an invention, it helped convert a civil case of nondisclosure into one of Grand Theft Wall Street in the public imagination. The message-Wall Street deliberately betrays investors-served a political end. It helped provide cover for the government's desire to manage the financial universe.

(This piece was in Wall Street Journal May 22)

The Dubai Hit

2010-03-28T11:27:00.003-04:00

James Jesus Angleton, the legendary CIA counterintelligence chief, once discussed a series of suspicious deaths in Germany with me. "Any gang of thugs could murder someone," he said, "but it took an intelligence services to make a murder appear to be a suicide or natural death."
According to this precept, the assassination of Mahmoud al-Mabhouh in Dubai on the evening of Jan. 19, 2010 was almost certainly the work of an intelligence service. When Mabhouh's body was discovered the next day in his room in the five-star Al Bustan Rotana hotel, it appeared he'd died in bed of natural causes. There were no wounds, bruises or other signs of foul play.
Room 230 had no balcony or windows that could be opened, and the electronic door latch appeared to have been locked from the inside. If an ordinary tourist died under such non-suspicious circumstances, investigators would routinely assume he had died in his sleep from natural causes.
But Mabhouh was no ordinary tourist. He was a senior commander and a co-founder of Hamas's military wing, Izzedine al-Qassam Brigades. His activities including the abduction of Israeli soldiers, and he was wanted in three countries: Israel, Egypt, where he had been imprisoned for almost a year, and Jordan.
Based in Damascus, Syria, Mabhouh was also a key intermediary in the covert arms traffic between Iran's Revolutionary Guard, the Syrian intelligence service, the Hamas government in Gaza, and other militants. He was ordinarily protected by a team of armed bodyguards. But they had not been allowed to accompany him to Dubai on Jan. 19 because there was no room on the flight, according to a Hamas spokesman in Damascus, Talal Nasser. So whether by design or accident, he was stripped of his protection, making his assassination easier to accomplish.
When the Dubai police, under pressure from Hamas, looked more closely into the crime scene, they found that the electronic lock on the door of his room had been reprogrammed to allow others entry. The electronic lock can be accessed directly at the hotel room door by a sophisticated hacker.
Then a Dubai forensic lab retesting his body fluids discovered traces of succinylcholine. This is a quick-acting, depolarizing, paralytic drug that, by rendering Mabhouh incapable of resisting, could account for the lack of bruise marks on the body.
In February, Dubai's chief coroner, Fawzi Benomran, reversed his verdict of a natural death. Instead, describing the death as "one of the most challenging cases" in the history of the emirate, he concluded it was a disguised homicide "meant to look like death from natural causes during sleep."
Meanwhile, Dubai investigators examined 645 hours of videos from surveillance cameras at the hotel and elsewhere. They saw that, after Mabhouh left his hotel room, four suspicious-looking individuals got out of the elevator on the second floor near his room. Several hours later, at 8:25 p.m., Mabhouh returned to his room (according to the electronic lock). Shortly afterwards, the four men were seen via the cameras leaving the floor.
The police theorized that these men had surreptitiously entered Mabhouh's room while he was out, incapacitated him with the paralytic drug on his return, induced a heart attack by suffocating him with a pillow, and reprogrammed the electric lock to make it appear it had been locked from the inside.
With the aid of facial recognition software, Dubai police then identified 26 suspects. All had been in Dubai at the time of Mabhouh's brief visit. All had entered Dubai using fake or fraudulently obtained passports from countries not requiring a Dubai visa, including Britain, Ireland, France, Germany and Australia.
All the passports turned out to be stolen identities with faked passport photos. The charge cards, airline tickets, and pre-paid phone cards these suspects used were also in the name of their stolen identities. The only real clue to their real identities was that eight of the identities had been stolen from people with dual Israeli citizenship. As Mossad, Israel's national intelligence agency, had previously used dual citizens' passports to fake identities, Dubai authorities concluded the suspects were from Mossad.
Dahi Khalfan Tamim, the head of the Dubai police force, stated on a government-owned Web site, that he "is 99 percent, if not 100 percent, that Mossad is standing behind the murder." While this authoritative finger-pointing was largely accepted as am "aha" moment by the media, Dubai is not exactly an uninterested party in the Mabhouh affair. It is, after all, the principal transshipment points for the lethal arms trade between Iran and Hamas-and Mabhouh had been one of the major players in this trade.
The much-publicized hotel surveillance videos, while highly diverting on YouTube, do not show any of the 26 suspects engaging in any illegal activities other than using false identities, a practice which is not unknown in Dubai (Mabhouh himself reportedly had five different passports). Even if all 26 identity thieves were intelligence operatives, as seems the case, it does not necessarily follow that they were all in Dubai on the same business, or even working for the same side.
Since Iran maintains its largest offshore financing facility in Dubai-which is used by the Revolutionary Guard, among others, to support its traffic in covert weapons- more than one intelligence service might be interested in Mabhouh's trip. Consider, for example, the peculiar fact that two of the 26 Dubai suspects exited by boat to Iran, according to Dubai authorities; this is not a likely escape route for Mossad agents.
Two other individuals whom the Dubai police had named as suspects worked for the Palestinian Authority, an arch enemy of Hamas. (They were arrested in Jordan and turned over to Dubai). Another person wanted by Dubai for questioning returned to Damascus just prior to the killing. And then there is the question of who in Syria played a role in stripping Mabhouh of his protection just hours before his flight to Dubai.
The key missing piece in the jigsaw remains Mabhouh's mission to Dubai-apparently important enough for him to travel there without his normal contingent of bodyguards.
Mabhouh arrived from the airport at his hotel shortly before 3 pm, and after changing his clothes left for an unknown destination. He was gone for several hours. But even with its state-of-the-art surveillance cameras in Dubai, and extensive interviews with all the taxi drivers at the hotel, authorities claim they cannot determine either his whereabouts during these hours or the identity of whom he met.
The world-wide focus on the spooks-whose false identities allowed many of them to vanish in the intelligence netherworld-has diverted attention from the potentially embarrassing mission that brought Mabhouh to the Dubai. The real intrigue here is not who killed a wanted terrorist, but what he was up to. Without this missing piece, any rush to judgment about who his killers were may be premature.

The MGM Conference Call

2010-02-26T09:57:00.002-05:00

The bad news came in a non-public conference call this Monday (February 22nd) to the 140 banks and hedge funds holding nearly $4 billion in MGM debt. MGM CEO, Stephen F, Cooper, the turn-about specialist brought in to save the one-proud studio, revealed in the call that the secret numbers memo circulated to potential buyers in the confidential deal had been seriously inflated by MGM’s own over-optimistic estimate of its 201o television revenue. The memo, which had been sent out by Moelis & Company to solicit offers from potential buyers, stated that "Television distribution has generated over $500 million of Library cash receipts in each of the last four fiscal years ," estimating it would produce "$529 million" for fiscal 2010 (which ends March 31, 2010). A library is made of two components: DVD sales and the licensing of movies and TV series to pay channels, cable networks and broadcast television. So, with the DVD market collapsing in 2009, the stability of television revenue, as represented in the memo, was (at least until Monday) a key selling point to the remaining potential buyers– Time Warner, Lionsgate, John C. Malone’s Liberty Media, Rupert Murdoch’s News Corporation, Ryan Kavanaugh’s Relativity Media, Anil Ambini’s Reliance ADA Group, and Leonard Blavatnik's Access Industries.lain . Now, Cooper had stunning news. He told the 140 creditors that the library sales had been anything but stable, and plunged in the fourth quarter (so far) to the extent that the estimate had to be reduced by almost $30 million for that quarter. If annualized, that would amount to a decrease of about $120 million in revenue. Even worse, this severely reduces the value of the library since, as those in the business know, when MGM renews its multi-year contracts, the money it will get for aging product will drop precipitously.In MGM’s case, as I pointed out previously, a large part of these revenues must be split with "third parties." This includes producers, stars, directors, writers and Hollywood guilds, and, in 2009, amounted to over 40 percent of the total take.
The forbearance that MGM’s creditors extended to MGM in October runs out in 10 weeks so Cooper can sell it. Now all the remaining bidders will have to drastically recalculate, if not, reconsider. the amount they are willing to gamble. The Wall Street investors who put up most of the equity for the 2004 takeover have already seen their investment effectively wiped out. The suspense that remains in this Hollywood thriller is the degree to which the bond-holders will suffer the same fate. The bond holders cannot put the company in bankruptcy without jeopardizing the valuable remake rights to James Bond movie. So if the bidders pull out, or offer only pennies on the dollar, the only alternative open to the bond holders is to themselves take-over MGM by swapping their debt for equity– but this is not the Hollywood ending they want.
My book The Hollywood Economist is out today.

The Secret Numbers Behind The MGM Fiasco

2010-02-19T18:30:00.002-05:00

MGM, once the shiniest studio in the Hollywood galaxy, has fallen on hard times. Last October it failed to make the interest payment due on its $3.7 billion debt, and even with the six month forbearance granted by its creditors, it is hovering the threshold of bankruptcy. Its equity investors — including three big hedge funds — have been all but wiped out. The 140 banks that financed the leveraged part of the leveraged buyout deal are in danger of losing over $3 billion. With the creditors demanding their money, and the clock running on its forbearance, MGM had put itself up for sale, retaining investment bankers Moelis & Company to solicit offers from potential buyers that were due in mid January 2010. For a movie studio that was bought for $4.85 billion in 2004 (which is over $5 billion in 2010 dollars), the bids that have come in so far are shockingly low. Time Warner, for example, is offering under $2 billion and the bid from Lionsgate, once the leading contender, is worth even less.

The secret numbers in the confidential information memorandum sent out by Moelis explain the problem, which goes to the root of what is happening to the movie business today. MGM's main asset, as is true in the case of all Hollywood studios, is its library comprised of 4,100 film titles, including all the James Bond movies, and 10,600 television episodes. The money that comes in through this library comes from DVD sales — mainly older titles sold in discount bins at Wal-Mart and other retailers -– and television licensing packages to Pay TV, cable networks, and television stations around the world.

The bet that the hedge funds made when they put up most of the equity for the $4.85 billion LBO in 2004 was that DVD revenue from the library would hugely increase when people replaced their standard DVDs with the Blu-Ray high-definition format that was just being introduced. But their projections proved to be pipe dreams. Instead of expanding, MGM's DVD revenue plummeted, according to the confidential memo. MGM's DVD revenues fell from $394.7 million in 2008 to just $69.8 million in the 2010 fiscal year (which ends March 31).This huge drop was attributed to a host of factors, ranging from the worldwide downturn in DVD sales to fewer new MGM releases. What turned out to be the real killer for MGM's library was what the memo termed "significant price erosion." Wal-Mart, pressured by competition from Netflix, Red Box, and video downloading, drastically reduced the "price point" that it would buy older (or so-called "catalogue") DVDs, driving prices down to less than $5 a copy. So studios' saw the stream of profits from older DVDs wither away.As with other studios, the larger part of MGM's library's money comes from television licensing. At first glance, these revenues appear remarkably stable, declining a mere one percent from $535.1 million in 2008 to $529 million in 2010. But like other phenomena in Hollywood, appearances can be deceptive. MGM had structured its long-term licensing contracts so the cable networks wind up underpaying for the early years and overpaying for the later ones, which is a common practice at studio libraries. As a result, even as properties lose value over the course of the contract (old films are worth less than newer ones), the illusion of stability is maintained . Of course, when MGM renews these multi-year contracts, the money it gets will drop precipitously.And as impressive as $529 million in revenues may seem, it is not the amount MGM actually gets to keep since it must split these proceeds with various "third parties," including producers, stars, directors, writers and Hollywood guilds. For example, the revenues from the 24 James Bond movies — which are the library's most valuable asset generating nearly 30% of its revenue — have to be split 50-50 with Danjaq LLC, the holding company for the Broccoli family that originally created the franchise. These participations and residuals (which is what the guilds get for their pension funds) totaled $235.2 million in 2010. In addition, there were $33.2 million in other expenses, such as calculating and issuing more than 15,000 different checks per quarter to participants.MGM also had to pay Fox a fee of $22.2 million for distributing its DVDs. What MGM kept turned out to be not enough to pay its overhead — $135.9 million in 2010 — and other costs, leaving it with a negative operating cash flow of $52.4 million. The bottom line here is that MGM cannot pay off its $3.7 billion in debt. And even if a white knight gallops in to carry off the library, the investors and creditors will take a bath.

Will Nextflix Be The Next HBO?

2010-02-15T09:54:00.004-05:00

Netflix, through the simple device using the post office to bypass video stores, has become one of the great success stories of the new entertainment economy. It now has 11.8 million subscribers who pay a monthly flat fee for an unlimited number of rentals. It gets its DVDS from wholesalers and even retail stores. It can then rent them because of a court-approved "First Sale doctrine," which says that once a person buys a DVD, he can re-sell it or rent it out. Last year Netflix took in $1.67 billion in subscription fees, but because of the high cost of mailing some 2 million discs a day from 50 distribution centers, it only eked out a profit of $115 million.
So it is moving onto the Internet, substituting digital streamed movies for ones that are delivered by the postman. Subscribers get them on their TV via a set top box or game console without any additional charge. This "Watch Instantly" service effectively creates a virtual channel that directly compete with Pay-TV for the wallet and clock of viewers. Such a challenge by Netflix could also result, as Frank Biondi the former head of HBO, terms it, "a terminal career decision if you get it wrong."
The problem is that the First Sale doctrine does not apply to streaming or downloading DVDS so Netflix must buy digital rights, which is exceedingly expensive for new titles. In late 2008, Netflix found a temporary way around this stumbling block by making a deal with Starz Entertainment, a subsidiary of John Malone's Liberty Media, to sub-license the streaming rights of the titles it had obtained from Disney, Sony and smaller studios in output deals. Starz held it could sub-license these rights because Netflix was merely a "content aggregator," but the studios took a dimmer view of this loophole. Disney, according to a top executive involved in the dispute, has warned Starz that it will not renew its output deal (which expires in 2012) unless it either cuts Netflix out or pays Disney a rich premium.
Netflix chief content officer Ted Sarandos portrays the issue as merely a communication glitch, saying, "We have to fight against their fear that we~ll destroy the ecosystem." Despite this well-meaning new-age talk, what is really at stake here is old-fashioned money. The most profitable part of Hollywood's "ecosystem" is the output deals through which studios license movies to Pay TV channels, cable networks and broadcast stations. According to the studios's internal all-source revenue numbers, the six major studio took in $16.2 billion from pay-TV and television licensing of their movies in 2007, which was almost all profit. So the threat of sub-licensing for Internet circulation involves a good more than studio paranoia.
As for HBO, a subsidiary of Time Warner, it is the undisputed leviathan of Pay-TV. It has over 40 million subscribers, $4 billion in revenues, and a cash flow of $1.3 billion. And, unlike Netflix, it owns the digital rights to a large amount of exclusive material, much of which it produced. Over the past decade it invested heavily in original programming, creating such series as The Sopranos (which cost $2 million an episode) to retain subscribers. This made economic sense because cable systems paid it about $6 a month for each subscriber. As a top Time Warner executive who had authorized much of this original production explained to me, the name of the game is subscriber retention.
So HBO is not about to cede cyberspace to Netflix. It's in the process of rolling out an Internet service called HBO Go which will allow all HBO subscribers to get, as the executive puts it, "anything they want to see, anytime, anywhere, over their laptop, Iphone, tablet, Playstation." Bolstered by its exclusive content, HBO will initially offer some 800 hours a month of programming a month. Its 40 million subscribers can get at no additional charge over the Internet the linenew titles HBO acquires through its output deals with Warner Bros, Fox, and Dreamworks, past and present original series, HBO boxing, and even so-called "late night" fare such as Alien Sex Files.
Netflix, on the other hand, has almost no exclusive content with which to compete with HBO. Back in 2006, it attempted to produce its own original content through a subsidiary called Red Envelope Entertainment, but closed it down in 2008. The brutal reality is that Netflix, with only one-eighth the cash flow of HBO, does not have the scale to produce its own material. Of course, whether or not the Starz deal is renewed, Netflix can exclusively license programming through output deals. But competing in this game, in which the licenses for a slate of two dozen movies can cost in excess of a quarter of a billion dollars, could prove prohibitively expensive. Last year Netflix reportedly spent $100 million on licensing just non-exclusive rights to movies for streaming from Starz and studio libraries. Although this saved postage, Netflix still has to pay the overhead for its distribution centers. Adding hundreds of millions of dollars in output deals to this equation could wipe out much, if not all, of its profits.
Netflix has brilliantly carved out for itself a niche audience who largely enjoy the convenience of receiving older movies, which accounts for about two-thirds of its revenue. It will no doubt continue to satisfy and expand this audience via mailing and streaming. But what it lacks is the wherewithal to do is to replace HBO.
Edward Jay Epstein is the author of 14 books, including two examining the movie business: The Hollywood Economist: The Reality Behind The Movie Business will be published by Melville House later this month, which follows his 2005 book The Big Picture: Money and Power in Hollywood.

How Wall Street Hedge Funds Got Taken On A Billion Dollar Ride in Hollywood

2010-02-02T08:58:00.001-05:00

Back in 2003, after Kirk Kerkorian 1et it by know that he was (yet again) prepared to sell MGM, Viacom, which owns Paramount, considered buying it. Although MGM no longer had sound stages, backlots or other physical facilities, and now produced only a handful of movies, it owned an incredibly valuable asset: a film libraries with 4,100 motion pictures and 10,600 television episodes. The crown jewels of this collection was its James Bond movies, which was possibly the most valuable entertainment franchise ever created. By licensing these titles over and over again to Pay-TV, cable networks, and television stations around the world, and selling DVDs from it,, this library brought in roughly $600 million a year. But that gross was an elusive number as it had to be split with others who had rights in the titles. Each title had its own contractual terms governing payments to partners, talent, guilds, and third parties.. Just making these payments entailed issuing more than 15,000 checks per quarter. Not only did titles have different pay-out requisites, but their future revenue stream depended on factors specific to each movie, such as the age of its stars, its topicality, and its genre. To figure it out, Viacom assigned a team of 50 of its most experienced specialists to estimate the how much each and every title would bring in over a decade. The Herculean job took the team two months. From this analysis, as well as considering other benefits of merging MGM with Paramount, Viacom’s executives agreed MGM was worth between $3.5 and $4 billion. But before they could arrive at a bid price, Viacom’s President, Mel Karmazin, asked them whether the value of the MGM vast library go the way of the music industry, which had been decimated by Internet down-loading. When none of the executives could rule out that possibility, Karmazin said "In that case, we are not bidding on MGM." Disney, after a similar deconstruction of MGM’s complex library, valued it at $3 billion, and also opted not to bid on the company.
Sony had a very different agenda for MGM. Since it had staked much of its corporate future on Blu-Ray as a high-definition format, it needed to get other major studios to choose it over a competing format, backed by Toshiba and Microsoft, called HD-DVD. Sony had learned from bitter past experience that format wars are often decided not by superior technology but by side payments made to studios. Toshiba and Microsoft (which had X-Box) were already offering huge cash inducements– one studio would get $136 million– to put their titles exclusively on the HD-DVD format. Such a pay-off competition could prove extremely expensive given the deep pockets of Toshiba and Microsoft, so Sony, which needed to establish Blu-Ray for its Play Station 3 as well as its movies, sought another route to victory. If it could put the huge library of MGM titles exclusively on Blu-Ray, together with its own library and the Columbia Tristar library (which it also owned), Toshiba and Microsoft, no matter how many side payments they made, would not be able to establish their rival format. To this end, Sony did not need to itself spend billions to acquire MGM, it only had get effective control of MGM’s library for a few years. So it put together a consortium that would be financed mainly by Wall Street private equity funds. And it would lead the consortium.
Even though the LBO would wind up costing $4.85 billion, Sony invested only $300 million of its own funds (and for that it got the profitable right to distribute MGM movies). Another $300 million came from the Comcast Corporation in return for the rights to put the MGM’s library on Pay Per View on its vast cable system. The rest of the equity money came from renowned Wall Street investors Providence Equity Partners, Texas Pacific Group, DLJ Merchant Banking Partners, and Steve Rattner’s Quadrangle Group. These savvy funds put in a cool billion dollars. The leverage part of the deal was organized by JP Morgan Chase, which very profitably arranged, since it also got a fee, for the consortium to borrow $3.7 billion (or up to $4.2 billion, if needed) from some 200 banks. The deal closed in September 2004.
For Sony, the gambit succeeded brilliantly. Putting some 1,400 MGM titles exclusively on Blu-ray, helped established Blu-Ray as the industry standard for high-definition, and it won the format war. It also made back a large share of its $300 million investment just on the distribution fee it earned on two new Bond movies (Casino Royale(2006) and Quantum of Solace (2008). But for the Wall Street players, it was nothing short of a disaster. To cut to the chase, they lost almost all their entire billion dollar investment. They had relied, perhaps naively, on impressive-looking projections showing that the net cash flow from the MGM movie and television library would be sufficient to pay the interest on the nearly $3.7 billion of debt over s decade. What they had not counted on was a sea change in DVD sales. In the US alone, MGM’s net receipts from DVDs fell from $140 million in its 2007 fiscal year (which ends March 31st 2008) to just $30.4 million by 2010. As a result of collapsing sales, higher pay-out for participants, increased distribution costs and other distribution problems, MGM’s crucial operating cash flow catastrophically fell from $418.4 million in 2007 to minus $54.2 million by 2010. In addition, it owed Fox Home Video $60 million for an "adjustment" in the DVD distribution contract it had taken over from Sony. By October 31, 2009 MGM, sinking in a sea of red ink, found itself unable to make its mandated interest payments on the $3.7 billion it owed banks.
Ordinarily when a company fails to make such payments, its bank creditors can seek to recover their money by forcing the company into bankruptcy. With MGM, however, the bankruptcy option presented a real problem since many of its intellectual property rights, including those to make sequels in the James Bond franchise, stipulate that in the event of bankruptcy they would automatically revert to another party. In the case of the James Bond franchise, for example. the sequel rights would revert to Danjaq, LLC. (These bankruptcy clauses are not mentioned, even in a footnote, in the 38-page "Confidential Information Memorandum" that MGM sent out to prospective buyers in the winter of 2009.) So the creditors learning that bankruptcy would destroy a significant part of the remaining value of MGM, gave it a three month "forbearance," which meant it had until January 31, 2010 to come up with the money. The idea was that MGM would sell itself to a white knight and use the proceeds to repay the banks. The deal book was sent out to a dozen or so prospective buyers calling for bids by January 15th. The replies, according to a source close to Moelis & Company, which is MGM’s financial advisor, have, as of January 22nd, have been "disappointing," with none of the serious bids coming within $1.6 billion of what MGM owes its creditors. As for the hedge funds, they have already written down 85 percent of their billion dollar investment in preparation for what may be a near total wipe-out. The lesson here for Wall Street that when a Hollywood deal seems to good to be true– it may not be.
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Flirting With Disaster: Can Indie Movies Survive?

2010-01-21T18:30:00.005-05:00

The Achilles’ heel of the independent movie business is American distribution. No matter how brilliant an indie movie may be, and no matter how many awards its wins at film festivals, it needs to get into theaters to be seen. That feat is no longer easy for an indie movie.
The Big Six 6 studios– Disney, Paramount, Universal, Warner Bros. Fox, and Sony– are also distribution juggernauts. They dominate both American and foreign distribution . Each of them employs a small army of salesmen, publicists, media buyers, theater-relations liaisons, merchandising specialists, and lawyers to get its movies and coming attractions on the best screens in theaters, its stars on the top TV shows, and its DVDs in the prime space at video stores. Because of their enormous clout with theater chains, the Big 6 can open their movies on 4,000 screens in the US and thousands of additional screens overseas. They also have long-standing merchandising deals with fast-food chains, toy companies, and other mass retailers to assist these global openings. Since their distribution machines have enormous overhead, the Big 6 studios need to confine their releases to potentially huge grossing movies. The size of the gross is crucial– even if there is no net profit– because studios, take a hefty cut of it off the top in the form of a distribution fee– typically, on movies that studios finance, it is 30 percent– which helps offset the overhead. The requisite, however, often leaves producers of smaller films out in the cold. Consider, for example. the sad story told to me by one of the most successful indie producer. In 2009, he brought to a major studio a project that had a budget of a mere $20 million with a well-regarded director and stars. After running the numbers, the studio estimated that its potential box-office was $100 million, which would yield it, just from the distribution fee and the output deal with HBO, a 100% profit on its investment. Yet, it flatly turned down the project because, as its executive told the producer, "We don’t do films that do not have a projected box-office of at least $150 million." The reason is that each studio has only a limited number of slots for their releases, and they have to fill them with so-called "high value" films with a potential to generating hundreds of millions of dollars in revenue to pay their overhead. Indie film, even if they return a profitable on a relatively small investment, cannot be counted on to do that job.
So how does an indie producer get an American distributor? Unlike studio producers, indie producers rarely, if ever, have a US distribution deal in advance of shooting. To raise the money to shoot a film, they must either find an outside investor or borrow it. As for the latter course, since the 1970s indie financing has used pre-sales agreements in foreign territories as collateral to borrow from banks. After the film is shot and edited, they then seek distribution either through screenings or by taking it to film festivals– a process that can take years. What made the gamble on finding distribution feasible was that, at least up until 2008, there were over a dozen so-called specialty distributors handling indie films, including both studio-owned "indie" companies, such as Miramax, Fox Searchlight, Fox Atomic Films, Paramount Vantage, Warner Independent Film, Picturehouse, New Line, Fine Line Features, Focus Features, and Sony Pictures Classics, and truly independent companies, such as Lionsgate Releasing, the Weinstein Company, and Summit Entertainment. Even those these specialty distributors have an order-of-magnitude less overhead than the majors, they still have to fund it. Since cash flows from indie films is erratic , they depended for a steady stream of revenue from "output deals" with the three pay TV channels. HBO, Showtime, and (later) Starz originally entered into these deals, offering to buy the entire output of a studio/distributor, to get new titles to attract subscribers to their pay channel. But as these payments were pure profit, since they entailed no expenses, they proved to vital for the smaller distributors. In 2008, for example, New Line Cinema, received slightly over $80 million for 8 titles from HBO, which paid its annual overhead. Bob Weinstein, the co-chairman of the Weinstein Company, not only described them in 2008 as "the bedrock of the business," but said "not one company in this business could survive and succeed without one." His words proved prophetic. When the pay-channels found they needed fewer titles, and began cutting back on their output deals, the bedrock crumbled into clay within a matter of months. In May 2008, as top tier indie producers gathered at the Cannes festival to seek distribution for their movies, they witnessed to their horror, as one put it in an email, "the landscape change before our eyes." In short order no fewer than six specialty distributors– New Line Cinema, Fine Line Features, Picturehouse, Warner Independent Films, Fox Atomic, and Paramount Vantage– closed while a seventh, the Weinstein Company, announced it was sharply cutting back on acquiring new titles because of cash-flow problems. A few months later another domino fell, when Miramax, which had been the linchpin of indie distribution for two decades, announced it was closing its main office in New York. Even the few players who remained moved to change their acquisition strategy, with Lionsgate, investing more heavily in exploitation films, such as Saw I, II, and III, and Focus Features, seeking co-production deals with Asian studios.
As indie distribution shrunk, financing through pre-sales became vastly more difficult. In the past, foreign buyers had been willing to make advance commitments for indie films because they assumed that they would get the sort of distribution in America that would provide publicity and credibility for their own release. Without such a prospect, European buyers were loathe to commit themselves to a pre-sales. As the executive of a major French distributor wrote me " except for auteur directors, such as Woody Allen, Wong Kar Wai, and Pedro Almodovar, we no longer make any pre-sales deals."
Even suffering such blows, the indie business is not dead, at least not yet. Indie producers have always demonstrated incredible resourcefulness in piecing together financing, even if it comes in the form of exotic tax credits, government subsidies, or indulgences from American egomaniacs, Arab oil sheiks, or Asian tycoons entranced with a movie fantasy. So even if the pre-sales game is moribund, they will likely find other ways of raising money to make movies. But unless they also devise a new model to distribute them in America, no one will see them.
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(My new book, The Hollywood Economist , will be published next month by Melville House)

Quivering On The Edge Of The Digital Abyss

2010-01-20T17:14:00.002-05:00

The video pirates of Shanghai have developed an amazingly successful business model for exploiting the home market. In the back rooms of video stores, shoppers fill their baskets while choosing from an almost endless inventory of DVDs that includes all of the studios’ new movies as well as a full compliment of Oscar screeners. You can also buy current television series—even the latest episodes of House, Lost, and 24. In addition, in a non-Internet form of video on demand, if a title is not on the shelves, the store gets it bicycled over from some other location in a matter of minutes.
In this business model, unlike Hollywood’s, there are no "windows" or artificial delays before a new movie is released on DVD, no ratings restricting audiences, and no zone restrictions that can prevent DVDs from being playable. Most are professionally burned from digital masters made from copies of the studios’ own DVDS. While their quality may not always be up to Hollywood’s standards they are priced to sell. Even at high-end stores I visited in Shanghai, a DVD cost less than $1.25. Other retailers—including street hawkers— charge much less. As a result of this aggressive pricing, people in China rarely go to movie theaters. Instead, they buy shopping baskets full of pirated DVDs. According to the most recent estimates, Chinese manufacturers sold well over 1.5 billion pirated DVDs in 2009, which, if true, exceeded the major studios’ sales of legal copies in America in 2009. Not surprisingly, China is by far the world's largest manufacturer of blank discs and DVD packaging (which they provide to the American studios as well). Since they do not pay any licensing fee, their main enterprise cost, aside from blank discs and boxes, are the pay-offs involved in stealing advanced copies of DVDs (which is greatly facilitated by studios’ practice of storing their DVDs for months in warehouses around the world while they wait for the DVD window to open at video stores.) The economic principle that the pirates have amply demonstrated in China is that the demand for entertainment is exquisitely elastic: DVDs priced at $15—the studios’ retail price—hardly sell in China; pirated DVDs priced $1.25 a copy (or lower on the street) sell like hot won-tons.
This economic lesson has not always played well in Hollywood. Up until the late 1990s, the studios placed a wholesale price of $55-$60 on most videos because video stores wanted a high price to protect their rental business. Even after the DVD was launched in the late 1990s, some studios still wanted to price them high to protect the video rental business. Sumner Redstone, who then controlled both Paramount and Blockbuster, famously argued: "The studios can't live without a video rental business—we [Blockbuster] are your profit." Despite such warnings, Warner Bros. and Sony decided to move DVDs in another direction. They offered Wal-Mart new titles on DVDs priced as low as $15.50 as traffic builders. With two years, Wal-Mart was selling 8 million DVDs a month, making it a major player in Hollywood. Under relentless pressure from Wal-Mart, which by 2005 accounted for 40 percent of the studios' DVD sales– and nearly 50 percent of their "bin sales"– the price for older DVDs was cut to as low as $6 a copy. Wal-Mart cut its own price under the $15 wholesale price on traffic-building new DVDs, losing money on each sale to draw more people into their stores. Other stores followed suit, leading one Warner Bros DVD executive to quip, "We have the only business in which the wholesale price is more than the retail price." These reduced prices, which turned DVDs into a retail juggernaut, only increased the studios' DVD revenue, which reached an all time high of $21 billion in 2005.
As DVD sales began to slide in 2006, and became less attractive as magnets to draw customers into its stores, Wal-Mart, briefly considered a plan to burn its own copies of DVDs in kiosks in its stores. Like the Shanghai pirates, the retail giant would stamp out copies for customers from blanks discs and cheap boxes (which would probably come from China). But, unlike the Shanghai pirates, they would pay a licensing fee to the studios for each copy it sold. The advantage to the customer would be that he could choose a title from among the tens of thousands of movies in the studios' libraries, and also possibly have it in the language and rated-version (G, PG, R, or NC-17) he prefers, while the studios would save the cost of manufacturing, packaging warehousing, and returns. When Wal-Mart's scheme was proposed to an executive from Warner Brothers, he pointed out that the delay for the customer might be as long as a half-hour before he could pick up the DVD. "Great. Could you make it an hour?," the Wal-Mart executive shot back. From the point of view of Wal-Mart, the DVD need not make money itself, as long as it serves to draw—and keep—potential customers in its stores. The plan never got off the ground. The DVD was the cash cow and studios were unwilling to accept a licensing fee that could gradually reduce until it became, as one studio executive put it, "pocket change."
Fast-forward to 2010
Rapid increases in the availability of high-speed broadband threatens Hollywood with the same fate as the music industry, which saw much of its lucrative CD business replaced by downloads of MP3 files (which are much smaller than the digital files of movies). By 2010, the security codes protecting the DVD (and even the Blu-Ray) from digital copying had been irreparably broken so that virtually anyone, anywhere in the world, could download a movie. In addition, new forms of online storage, such as so-called "cyber-lockers," which are web sites capable of storing movie-sized files that can be downloaded by anyone who has been given a password, had become almost impossible to police for pirated content. So almost any new title can be downloaded free from the Internet before it is released in video stores (or, for that matter, on Pay-Per-View TV.) The studios could see the hand writing on the wall in South Korea, which, because of its online gaming culture, is ahead of America in broadband speed. In 2006, the studios had a rich $1.3 billion DVD market in South Korea. But after an increase in the bit-rate of its broadband in 2007 its DVD sales fell to $80 million with two years. What happened was that Koreans found it more convenient to download movies from cyber-lockers than to buy or rent DVDs. After all, a DVD is nothing more than a way of storing a movie’s digital formula, and if the same formula, can be as easily retrieved from the Internet, there is little reason to buy a DVD.
So the light Hollywood sees at the end of the tunnel is on a locomotive heading directly for it. The concept of licensing their titles for downloading, or as one executives put it, " "trading digital pennies for analog dollars," is anything but appealing to the studios. When Apple’s Itunes Music Store, Amazon’s Unbox Movies, and other Internet stores offered to sell (and rent) downloads of their titles at their on-line stores, the studios decided to price them at the same price as DVDs, even though they entail no manufacturing, packaging, warehousing, or other costs. The reason that the studios insisted on such a high price was, in a word, Wal-Mart, which in 2009 still accounted for 38 percent of their DVD sales. Wal-Mart executives had made it crystal clear that they would not pay a penny more for its DVDs than any competitor, including Apple or Amazon, paid. So the studios charge Internet stores the same $16-17 per copy to download as they charged Wal-Mart for DVDs. (Some stores, such as Apple’s Itune store, decided to sell studio movies at a loss to help sell other products, such as the Ipods.) By pricing downloads high, the studios in effect were replaying their losing battle against the Shanghai pirates. This time around, however, the pirates, were operating cyber-lockers in places such as Moldavia. Latvia, and Pacific islands that are unlikely to enforce US copyright law, and, As a Warner Bros. technical operations chief explained in 2008, a large number of cyber-lockers now serve as "facilitators to access pirated content." Unlike the Shanghai pirates, these pirates do not even need to buy blank discs or packaging. So they could provide free downloads of Hollywood movies and make their profit from ads on or memberships to their site.
Even with declining sales, DVDs, still provided the 6 major studios with slightly over $16 billion in 2009, and constituted their main source of revenue. But what of Hollywood’s imminent future? South Korea demonstrates that a DVD market can be wiped out within a year or so of broadband improvements that make it possible for anyone to download a free movies in 15 minutes from the Internet. So quivering on the edge of this digital abyss, the studios remain paralyzed by their fear of losing their once almighty Wal-Mart accounts.
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Why Journalists Don't Understand Hollywood

2010-01-16T10:50:00.004-05:00

There was a time, around the middle of the twentieth century, when the box office numbers that were reported in newspapers were relevant to the fortunes of Hollywood: studios owned the major theater chains and made virtually all their profits from their theater ticket sales. This was a time before television sets became ubiquitous in American homes, and before movies could be made digital for DVDs and downloads. Today, Hollywood studios are in a very different business: creating rights that can be licensed, sold, and leveraged over different platforms, including television, DVD, and video games. Box office sales no longer play nearly as important a role. And yet newspapers, as if unable to comprehend the change, continue to breathlessly report these numbers every week, often on their front pages. With few exceptions, this anachronistic ritual is what passes for reporting on the business of Hollywood.
To begin with, these numbers are misleading when used to describe what a film or studio earns. At best, they represent gross income from theater chains’ ticket sales. These chains eventually rebate about 50 percent of the sales to the distributor, which also deducts its outlay for prints and advertising(P&A). In 2007, the most recent year for which the studios have released their budget figures, P&A averaged about $40 million per title— more than was typically received from American theaters for a film in that year. The distributor also deducts a distribution fee, usually between 15 and 33 percent of the total theater receipts. Therefore, no matter how well a movie appears to fare in the box office race reported by the media, it is usually in the red at that point. So where does the money that sustains Hollywood come from? In 2007, the major studios had combined revenues of $42.3 billion, of which about one-tenth came from American theaters; the rest came from the so-called back end, which includes DVD sales, multi-picture output deals with foreign distributors, pay TV, and network television licensing.
The only useful thing that the newspaper box office story really provides is bragging rights: Each week, the studio with the top movie can promote it as "Number 1 at the box office." Newspapers themselves are not uninterested parties in this hype: in 2008, studios spent an average of $3.7 million per title placing ads in newspapers. But the real problem with the numbers ritual isn’t that it is misleading, but that the focus on it distracts attention from the realities that are reshaping and transforming the movie business. Consider, for example, studio output deals. These arrangements, in which pay-TV, cable networks, and foreign distributors contractually agree to buy an entire slate of future movies from a studio, form a crucial part of Hollywood’s cash flow. Indeed, they pay the overhead that allows studios to stay in business. The much more frequently in about 2004, can doom an entire studio, as happened in 2008 to New Line Cinema, even though it had produced such immense box office successes as the Lord of the Rings trilogy. Yet, despite their importance, output deals are seldom mentioned in the mainstream media.
As result, a large part of Hollywood’s amazing money making machine remains nearly invisible to the public. The problem here does not lie in a lack of diligence or intelligence on the part of journalists. It proceeds from the entertainment news cycle, which generally requires a story about Hollywood to be linked to an interesting current event within a finite time frame. The ideal example of such an event is the release of a new movie. For such a story, the only readily available data are the weekly box office estimates; these are conveniently reported on websites such as Hollywood.com and Box Office Mojo. If an intrepid reporter decided to pursue a story about the actual profitability of a movie, he or she would need to learn how much the movie cost to make, how much was spent on P&A, the details of its distribution deal and its pre-sales deals abroad, and its real revenues from worldwide theatrical, DVD, television, and licensing income. Such information is far less easily accessible, but it can be found in a film’s distribution report. But this report is not sent out to participants until a year after the movie is released, so even if a reporter could obtain it, the newspaper’s deadline would be long past. Hence the media’s continued fixation on box office numbers, even if reporters themselves are aware of their irrelevance in the digital age.
The purpose of my forthcoming book The Hollywood Economist is to close gaps like these
in the understanding of the economic realities behind the new Hollywood.

Who Burned Down The Reichstag-- And Brought Hitler To Power

2009-12-27T09:47:00.005-05:00

On the night of February 27, 1933 in Berlin, the Reichstag, the home of the German Parliament and the symbol of the German state, was ablaze. While it was still smouldering, German police arrested Marinus Van der Lubbe, a Dutch communist with a history of setting buildings on fire. Also at the crime scene was Adolph Hitler, the newly appointed leader of a shaky coalition government. Only hours later he proclaimed that the crime was not the work of a lone arsonist but part of a wider Communist plot to overthrow the German government calling the it a warning"sign from heaven" of the impending Communist Putsch. With such rhetoric, he persuaded President Paul von Hindenburg to sign the Reichstag Fire decree, which temporarily suspended civil liberties in Germany and allowed the mass arrest of Communists, including its members in parliament. After a snap election, Hitler’s Nazi party had the majority necessary to pass the laws that would make Hitler dictator.
To provide evidence of a Communist plot, German authorities arrested Georgi Dimitrov, a Bulgarian Communist, and Stalin’s chief of covert operations in central Europe. They also arrested two his Communist associates, Vasil Tanev and Blagoi Popov. Together with Van Der Lubbe, they were charged with a conspiracy to overthrow the government. The Show trial ran from September to December 1933, and by almost any measure qualified as the trial of the century. It was presided over by judges fromGermany's highest court. It had Hermann Goring, the creator of Hitler’s Gestapo, and other senior Nazi leaders, as star witnesses, and it was one of the first trials to be broadcast live via radio to the entire world. It began on the morning of September 21, 1933 with the rambling testimony of Van der Lubbe. He admitted setting the fire but claimed he had acted entirely on his own. The prosecution then produced evidence found by firemen, including twenty bundles of inflammable material strategically located in different parts of the Reichstag, that cast doubt on the idea that Van der Lubbe, who was half blind, could himself have placed and rigged all these incendiary devices without help. Next Dimitrov, the operative accused of masterminding the conspiracy, was called to the stand. Though not a lawyer, he acted as his own defense lawyer. He agreed with the prosecutors that the fire had been set by a conspiracy, but, turning the tables on them, he argued that it was a Nazi not a Communist conspiracy, With great dramatic flair, he cross-examined Goring about his role in the investigation and the sequence in which evidence was uncovered. Allowing a worldwide radio audience to hear Stalin’s principal agent brutally interrogate Hitler’s alter ego in a German court room about inconsistencies in the investigation. At one point, he provoked a heated exchanges between himself and Goring on the nature of Communism. Dimitrov’s defense proved so effective that he, as well as his two Communist associates, were acquitted. Hitler and Goring were outraged at the verdict, but the chief judge explained that whereas the court was convinced that the fire resulted from a Communist conspiracy, the prosecutors had failed to prove Dimitrov and his associates was part of it. The only person convicted was the hapless Van der Lubbe, who was beheaded in 1934.
While the Leipzig trial was still under way, a counter-trial was staged in London by Willi Münzenberg, the brilliant propaganda chief for the Stalin-controlled Communist International. The evidence it produced took the form of dramatic revelations from masked men who claimed to be Nazi defectors, including one who identified himself as a former storm trooper and testified that his unit in Berlin had set the fire on direct orders from Goring. Another witness identified Van der Lubbe as the homosexual lover of a top Nazi commander and was used as a fall guy. At the end of the one week counter-trial, Goring was convicted of burning down the Reichstag fire to bring Hitler to power. But though the counter-trial provided much grist for the media mill, it turned out that all its evidence had been faked by Münzenberg’s staff. The masked witnesses were not Nazi defectors but Communist loyalists acting out scripted parts. The "Nazi storm trooper," for example, was played by Albert Norden, the editor of the leading Communist newspaper in Germany. By blending together a cocktail of fact and fiction, the counter-trial served to further pollute the evidentiary waters.
When the Red Army captured Berlin in 1945, it also captured the Gestapo archive. Stalin ordered this trove of documents, including some 50,000 pages of legal proceedings and Gestapo investigations bearing on the Reichstag fire, transported under seal to Moscow. For over three decades, they remained a state secret. Then, after the collapse of the Soviet Union in 1990, part of this archive was opened to researchers. The documents , which presumably had been vetted (and possibly added to) by the KGB, showed no evidence that Stalin or Communist party officials had burnt the Reichstag. They did, however, contain evidence showing that the Nazis had been preparing to arrest Communists before the fire. In addition, there was one intriguing report suggesting that the fire had been set by the Nazis themselves. It described a Berlin prison guard telling police investigators that Adolf Rall, a prisoner arrested for theft, had been overheard bragging to other prisoners that he had been part of a Nazi squad that entered the Reichstag through a tunnel and sprinkled flammable liquid inside the building. German investigators were unable to confirm this story. No record of Rall’s interrogation by the Gestapo was ever found and Rall himself had been murdered on the outskirts of Berlin in November 1933 (while the trial was still in progress). So the lead was a literal dead end. In any case, since both the Gestapo and KGB had custody of an archive, and neither agency was above with tampering with documents, the evidentiary value of the documents is at least questionable.
As a result, little more is known seven decades later about one of the most political explosive crimes of the twentieth century. Indeed, all that is known for certain that the Reichstag was deliberately destroyed. Whether a lone arsonist or a conspiracy, the resulting conflagration forever changed history.
***

The Anthrax Case Falls Apart

2009-12-21T17:30:00.004-05:00

The vast anthrax investigation, code-named Amerithrax, ended as far as the public knew on July 29 2008 with the death of Dr. Bruce Ivins, a microbiologist/wiki/Biodefense at the United States Army Medical Research Institute of Infectious Diseases in Fort Detrick, Maryland, at the nearby Frederick Memorial Hospital. The proximate cause of death was an overdose of the pain-killer Tylenol. No autopsy was performed, and there was no suicide note. Less than a week after his apparent suicide, the FBI declared Dr. Ivins to have been the sole perpetrator of the 2001 Anthrax attacks, and the person who mailed deadly anthrax spores to the NBC, the New York Post, and Senators Tom Daschle and Patrick Leahy accompanied by a photo-copied warning. These attacks killed 5 people, closed down the Senate’s Office Building, caused a national panic, and nearly paralyzed the postal system. The FBI’s 6 year investigation of it was the largest inquest in its history, involving 9000 interviews by its agents, the issuance of 6000 subpoenas, and the examination of tens of thousands of photo-copiers, typewriters, computers, and mail-boxes.
But., as massive as it was, it failed to find a shred of evidence that identified the Anthrax killer– or even a witness to the mailings. With the help of a task force of scientists, it found a flask of anthrax that closely matched through its genetic markers the attack anthrax. This flask had been in the custody of Dr. Ivins, a senior biological warfare researcher, who had published no less than 44 scientific papers over three decades, and who was working on developing vaccines against anthrax. As custodian, he provided samples of it to other scientists at Fort Detrick, the Battelle Memorial Institute, and other facilities involved in Anthrax research. According to the FBI’s reckoning, over 100 scientists had been given access to it. Any of these scientists (or their co-workers) could have stolen a minute quantity of this anthrax and, by mixing it into a media of water and nutrients, used it to grow enough spores to launch the anthrax attacks. Consequently, Dr. Ivins, who was assisting the FBI with its investigation, as well as all the scientists who had access to it, became suspects in the investigation. In what approached an inquisition, they were intensely questioned, given polygraph examinations, and played off against one another in variations of the prisoner’s dilemma game. And their labs, computers, phones, homes, and personal effect were scrutinized for possible clues.
As the Amerithrax proceeded over more than a half a decade, the FBI ran into frustrating dead ends, such as its relentless 5 year pursuit of Steven Hatfill, that ended with his exoneration in 2007 and his receiving a $5.8 million settlement from the US government as compensation for the damage inflicted on him. Another scientist became so stressed by the FBI’s games that he began to drink heavily and died of a heart attack. Eventually, the FBI zeroed-in on Dr. Ivins. Not only did he have access to the anthrax, but FBI agents suspected he had subtly misled them into their Hatfill fiasco. A search of his email turned up pornography and bizarre emails which,, though unrelated to anthrax, suggesting that he was a deeply disturbed individual. As the FBI turned the pressure up on him, isolating him at work, and forcing him to spend what little money he had on lawyers to defend himself. He became increasingly stressed. His therapist reported that Ivins seemed obsessed with the notion of revenge and even homicide. Then came his suicide (which as Eric Nadler and Bob Coen show in their documentary The Anthrax War was one of four suicides among bio-warfare researcher.) Since Dr. Ivins odd behavior closely fit the FBI’s profile of the mad scientist it had been hunting, his suicide provided an opportunity to finally close the case. So it pronounced Dr. Ivins the anthrax killer.
But there was still a vexing problem– Silicon.
Silicon was used in the 1960s to weaponize anthrax. Through an elaborate process, anthrax spores were coated with silicon to preventing them from clinging together so as to create a lethal aerosol. But since weaponization was banned by international treaties, research anthrax no longer contains silicon, and the flask at Fort Detrick contained none. Yet, the anthrax grown from it had silicon, according to the US Armed Forces Institute of Pathology. This silicon explained why when the letters to Senators Patrick Leahy and Tom Daschle were opened, the anthrax vaporized into an aerosol. If so, then somehow silicon was added to the anthrax. But Dr. Ivins, no matter how weird he may have been, had neither the set of skills nor the means to deliberately attach silicon to anthrax spores. At minimum, such a process would require highly-specialized equipment, such as a jet mill, that did not exist in Ivins’ lab– or, for that matter, anywhere at the Fort Detrick facility. As Richard O. Spertzel, a former bio-defense scientist who worked with Ivins, explained, the lab didn’t even deal with anthrax in powdered form, adding "I don't think there's anyone there who would have the foggiest idea how to do it." So while Dr. Ivins’ death provided a convenient fall guy, the silicon content still had somehow to be explained.
The FBI’s answer was that the anthrax contained only traces of silicon and those, it theorized, could have been accidently absorbed by the spores from the water and nutrient in which they were grown. No such nutrients were ever found in Ivins’ lab, nor, for that matter, did anyone ever see Dr. Ivins attempt to produce any unauthorized anthrax (a process which would have involved him using scores of flasks.) But since no one knew what nutrients had been used to grow the attack anthrax, it was at. least possible that they had traces of silicon in them which accidently contaminated the anthrax.
Natural contamination was an elegant theory that ran into problems after Congressman Jerry Nadler pressed FBI Director Robert S. Mueller III in September 2008 to provide the House Judiciary Committee with a missing piece of data: the precise percentage of silicon contained in the anthrax used in the attacks. The answer came seven months later. According to the FBI lab, 1.4% of the powder in the Leahy letter was Silicon. "This is a shockingly high proportion," explained Dr. Stuart Jacobson, an expert in small particle chemistry. "It is a number one would expect from the deliberate weaponization of anthrax, but not from any conceivable accidental contamination." Nevertheless, in an attempt to back up its theory, the FBI contracted scientists at the Lawrence Livermore National Labs in California to conduct experiments in which anthrax is accidently absorbed from a media heavily-laced with silicon. When the results were revealed to the National Academy Of Science in September 2009, they effectively blew the FBI’s theory out of the water. The Livermore scientists had tried 56 times to replicate the high silicon content without any success whatsoever. Even though they added increasingly high amounts of silicon to the media, they never even came close to the 1.4 percent in the attack anthrax. Most results were indeed an order of magnitude lower, with some as low as .001 percent. What these tests inadvertently demonstrated is that the anthrax spores could not have been accidently contaminated by the nutrients in the media. " If there is that much silicon , it had to have been added, " Jeffrey Adamovicz, who supervised Ivins work at Fort Detrick, wrote to me. He added that the silicon signature in the attack anthrax could have been added via a large fermerntor– which Battellle and other labs use" but "we did not use a fermentor to grow anthrax at USAMRIID [and] We did not have the capability to add silicon compounds to anthrax spores."
If Dr. Ivins had neither the equipment or skills to weaponize anthrax with silicon, then some other party, with access to the anthrax, must have done it. Even before these startling results, Senator Leahy had told Mueller , "I do not believe in any way, shape, or manner that [Ivins] is the only person involved in this attack on Congress." So, even though the public believed that the Anthrax case had been closed more in 2008, the FBI investigation was back to square one in late 2009.

Who Killed God's Banker

2009-12-12T15:36:00.003-05:00

On June 11, 1982, Roberto Calvi, the chairman of the Banco Ambrosiano, who had become know as "God’s Banker" because of the investments he made for the Vatican, vanished from Italy with a black briefcase full of documents. One week later, his body was found hanging from an orange noose under Blackfriar's Bridge in London; his feet submerged in the swirling waters of the Thames. His black bag was gone. Also missing was $1.2 billion from bank's subsidiaries in the Bahamas, Nicaragua, Peru, and Luxembourg. And the Vatican was missing one-half billion dollars in loans. How did God’s banker come to be dangling at the end of a rope over the Thames?
When the London river police cut down his body from scaffolding under the bridge on the morning of June 19,1982, they found seven large bricks stuffed in his pockets and grey suit. He did not appear to be the victim of a robbery since he had an expensive Patek Phillippe watch on his wrist and about $14,000 in Swiss francs, British pounds and Italian Lire in his wallet. He also had in his pockets a bogus Italian passport in the name of "Gian Roberto Calvino" (which he had used to get into Britain.)
The autopsy, conducted by Professor Frederick Keith Simpson, one of England's most experienced pathologist, only intensified the mystery. There was no river water in his lungs, so he had not drowned. Instead, the cause of death was asphyxia by hanging. Since his neck had not suffered the kind of injury that would have occurred in a free-fall, Professor Simpson determined that Calvi could not have dropped more than 2 feet before his fall was broken by the water. There was no medical evidence whatsoever of foul play such as marks on the arms to indicate he had been restrained, puncture marks on to indicated he had been injected with a drug and no traces of suspicious chemicals in his stomach of drugs (other than the residue of a sleeping pill he had taken the previous night).
The time of the death added further to the mystery. His Patek Phillippe watch, which was not water-proof, stopped at 1:52. While the watch could have stopped for reasons other than water damage, the water marks on the face of it, when taken together with the dropping level of the tide that night at Blackfriar's Bridge, established the latest time at which his body could have been suspended from the scaffolding. After 2:30 am, the level of the water in the Thames at Blackfriar's bridge would not have been high enough to have reached Calvi's wrist (as was calculated from the length of the rope he was hanging by when he was found), so he must have been hanging before then. But he could not have hung himself before 1 a.m. because the river level then would have been above his mouth and left river water in his body. So, if he committed suicide, it he could only have been between 1:00 and 2:30 a.m.
The coroner's jury in 1982, finding no evidence of murder, concluded that Calvi had hung himself.
But suicide during these hours, if possible at all, would require extraordinary activities from a sixty-two year old man, who was over-weight and suffered from vertigo. Despite the darkness, he would have had to find the scaffolding from the walkway along the river, which, since it was nearly submerged, could be seen only by leaning over the parapet wall at a strategic point. He would also have to have found in the dark the bricks (which were identified as coming from a construction site about a block away) and the rope to hang himself. Next, he would have to had hoisted himself over the parapet on the bridge and climbed twelve feet down a nearly vertical iron ladder to the level of the temporary scaffolding. He then would have to step across the two and one-half feet gap onto the scaffolding's rusty poles, which were arranged like monkey-bars in a children's playground, and edge his way about 8 feet along them to tie the rope to the eyelet. After that, he would to shimmy down to the next level of the scaffolding (otherwise the drop from the higher level would have resulted in far more neck damage than there had been.) Finally, after having put the bricks in his pockets and pants fly, and his head in the noose, he would have had to ease himself into the swirling water three feet below by clutching onto the poles (again, avoiding a free fall).
While such an acrobatic maneuver is possible, it would presumably leave some traces such as rust under his fingernails, splinters or abrasions on his hands, tears in his suit. "The long and short of it is we do not know how Calvi's body got onto the end of that rope," Deputy Superintendent John White explained to me. "We don't even know how he got from his hotel, four and one half miles away, to Blackfriar's Bridge."
Since he was "God’s Banker," and in the headlines of every major newspaper, the British authorities, aided by MI-6, continued to investigate even after the suicide verdict. They established that Calvi had arrived in London on June 15 in a chartered plane under a false name (Calvino) and checked into an inexpensive suite in the Chelsea Cloisters, a second-rate residential hotel. When the police searched it after his death, they found his personal belongings-- including his toilet kit-- neatly packed inside two locked suitcases, as if they were waiting to be picked up by someone, but no other trace of his stay there. No hotel employee recalled seeing Calvi leave. the London police spent months canvassing taxi drivers and other potential witnesses, but they could not find anyone in London who had seen him that night. Nor could they find in London any witness to his activities during the three days he had been in London prior to his death. During these London days, he was, as Superintendent White put it, "the invisible man."
Italian authorities ran into a similar stone wall. His flight from Italy was clearly aided by an elaborate conspiracy. He used three false identities, eight separate private plane flight around Europe, a speed boat, four different cars, and 14 temporary residences in getting to the Chelsea Cloisters, in a convoluted itinerary that took him from Rome to Venice by plane, then to Trieste by car, Yugoslavia by a smuggler’s motor boat, Austria by car. He flew to London in a leased jet, and disguised as a Fiat executive. His facilitators included Flavio Carboni, a Sardinian businessman ( who had received $11 million from Calvi for organizing the escape,) Silvano Vittor, a cigarette smuggler, who served as his bodyguard in London, and two strikingly beautiful Austrian sisters, Manuela and Micheala Klienszig. . When they were later arrested, they all denied seeing Calvi the night he disappeared. So there were no witnesses at all.
Seven years later, Carlo Calvi, Calvi's only son, hired Kroll Associates to re-investigate the case. After locating, authenticating and re-assembling the original scaffolding Calvi had hung from, forensic experts retained by Kroll conducted a simple experiment. They had a stand-in for Calvi— same size and weight— walk the possible routes along the scaffolding poles that Calvi would have to walk if he tied the rope and hung himself. The stand-in wore pairs of Calvi's hand-made loafers that were similar to the one he had on when he was found, After each trial, these shoes were then put in water for the same time Calvi's shoes had been submerged, and then microscopically examined by a forensic chemist, who had worked in the London police laboratory for 18 years. In each case, he found that the soles of the stand-in's shoes had picked up yellow paint smears that matched those on the scaffolding poles. Given the pressure of the shoe on the narrow pole, he concluded such tell-tale traces were "unavoidable." Yet, when he examined the soles of the shoes Calvi had actually worn that day with a microscope, he found no traces of yellow pain on the soles. Since there was no way he could have hung himself except to have walked on the scaffolding, Kroll concluded "Someone else had to have tied him to the scaffolding and killed him."
After the Kroll investigation, The coroner's jury quashed its verdict of suicide and declared it was unable to decide between murder and suicide. So like God’s banker, the question of how he met his end was left dangling.
But how could Calvi have been murdered. He couldn't have been forced, alive, onto the scaffolding, without leaving signs of struggle on his body. Nor could he have been drugged unconscious without the drugs showing up in the autopsy examination. But he could have been strangled somewhere else with a rope– death was by asphyxia not drowning and then transported to the scaffolding. Kroll’s investigators came up with the theory that his dead body was taken to the bridge in a small boat sometime around midnight when the high tide would make it possible to moor the boat to Blackfriar’s Bridge, tie the rope to the scaffold, and unload Calvi’s body. The problem with this murder scenario is that it would be visible to anyone passing by the bridge on either bank– hardly a recipe for a perfect crime– and there were many potential potentials. Yet, neither the police nor Kroll could ever find any witness to such a bizarre scene.
As a result, the case remains unsolved.

Annals of Unsolved Crimes: Who Killed Zia?

2009-11-27T17:08:00.004-05:00

On August 17, 1988, at 3:58 PM, Pak One, an American built Hercules C-130b transport plane,
carrying its VIP capsule the President of Pakistan, General Zia-ul-Haq, most of his top generals,as well as two American guests– US Ambassador, Arnold L. Raphel and US military missionhead General Herbert Wassom– crashed to earth only 18 miles from the airport in centralPakistan from where it took off. It had been a. bright clear day, and dozens of eye witnesses could see the giant aircraft lurch up and down three times in the sky, as if were on an invisible roller coaster, and then plunge straight into the desert and explode in a fire ball. All 30 persons on board, including four crew members, were dead. Within hours, army tanks sealed off public building and television stations, signifying the change in power. Zia’s reign, which had begun with his own military coup on July 5, 1977, now had ended with his death. But even though the crash altered the face of politics in Pakistan in a way in which no simple Presidential assassination or coup d'etat could have done, its cause remains a mystery.
Former Prime Minister Benazir Bhutto, whose father he had allowed to be executed (and who
herself was assassinated in 2007,) said in the epilogue to her book, Daughter of Destiny "Zia's
death must have been an act of god". But divine intervention is not what brought the plane
down. According to the 365-page report of the forensic investigation done by six American Air
Force experts, headed by Colonel Daniel E. Sowada, no evidence of a accidental mechanical
failure or pilot error had been found. A conclusion of assassination was all but inescapable.

The aviation investigators, following the precepts of Sherlock Holmes, used on a process of
elimination. First, they ruled out the possibility that the plane had blown up in mid air. If it had exploded in this manner the pieces of the plane, which had different shapes and therefore
resistance to the wind, would have been strewn over a wide area-- but that had not happened. By re-assembling the plane in a giant jigsaw puzzle, and scrutinizing with magnifying glasses the edges of each broken piece, they could established that the plane was in one piece when it had hit the ground. They thus concluded structural failure--ie. The breaking up of the plane-- was not the cause. Next, they eliminated the possibility of a missile attack. If the plane had been hit by a missile, it would have generated intense heat which in turn would have melted the aluminum panels and, as the plane dived, the wind would have left tell-tale streaks in the molten metal. But there were no streaks on the panels. And no missile part or other ordinance had been found in the area.
They further rule out the possibility that there was an inboard fire while the plane was in the air since, if there had been one, the passengers would have breathed in soot before they died. Yet, the single autopsy performed, which was on the American general seated in the VIP capsule, showed there was no soot in his trachea, indicating that he had died before, not after, the fire ignited by the crash.
If it was not a missile or fire, the power might have somehow failed in flight. If this had
happened, the propellers would not have been turning at their full torque when the plane crashed, which would have affected the way their blades had broken off and curled on impact. But by examining the degree of curling on each broken propeller blades, they determined that in fact the engines were running at full speed when the propellers hit the ground.
Had the fuel been sabotaged? They ruled out the possibility of contaminated fuel by taking
samples of the diesel fuel from the refueling truck, and, by analyzing the residues still left in the fuel pumps in the plane, they could also tell that they had been operating normally at the time of the crash. They then ruled out any problem with the electric power on the plane because both electric clocks on board had stopped at the exact moment of impact, which they determined independently other evidence.
The final possibility of mechanical failure was that the controls did not work. But the Hercules
C-130 had not one but three redundant control system. The two sets of hydraulic controls were
backed up, in case of a leak of fluid in both of them, by a mechanical system of cables. If any one of them worked, the pilots would have been able to fly the plane. By comparing the position of the controls with the mechanisms in the hydraulic valves and the stabilizers in the tail of the plane (which are moved through this system when the pilot moves the steering wheel), they established that the control system was working when the plane crashed. This was confirmed by a computer simulation of the flight done by Lockheed, the builder of the C-130. They also ruled out the possibility that the controls had temporarily jammed by a microscopic examination of the mechanical parts to see if there were any signs of jamming or binding.
That left the possibility of pilot error. But the crash had occurred after a routine and safe take
off in perfectly clear daytime weather and the hand-picked pilots were fully experienced with the C-130 and had medical check-ups before the flight. Since the plane was not in any critical phase of flight, such as take off or landing, where poor judgment on the part of the pilots could have resulted in the mishap, the investigators ruled out pilot error as a possible cause. Based on this investigation, Pakistan’s Board of Inquiry concluded that the only other possible cause of the crash of Pak-One was a criminal act “leading to the loss of control of the aircraft." It suggested the pilots must have been incapacitated but this was as far as it could go since there was no black box or cockpit recorder on Pak One and no autopsies had been done on the remains of the pilots.
What had happened to the pilots during the final minutes of the flight? When I went to
Pakistan in February 1989, I attempted to answer that question. There were three other planes in the area tuned to the same frequency for communications– the turbojet carrying General Aslam Beg, the Army’s vice chief of staff, which was waiting on the runway at Bahawalpur airport to take off next; Pak 379, which was the backup C-130 in case anything went wrong to delay Pak One; and a Cessna security plane that took off before Pak One to scout for terrorists. With the assistance of the families of the military leaders killed in the crash, I managed to locate pilots of these planes-- all of whom were well acquainted with the flight crew of Pak One and its procedures-- who could listen to the conversation between Pak One and the control tower in Bahawalpur. They independently described the same sequence of events. First Pak One reported its estimated time of arrival in the capital. Then, when the control tower asked its position, it failed to respond. At the Same Time Pak 379 was trying unsuccessfully to get in touch with Pak One to verify its arrival time. All they heard from Pak One was "stand by" but no message followed. When this silence persisted, the control tower got progressively more frantic in its efforts to contact Zia's pilot, Wing Commander Mash'hood. Three or four minutes passed. Then, faint voice in Pak One called out "Mash'hood, Mash'hood". One of the pilots overhearing this conversation recognized the voice. It was Zia's military secretary, Brigadier Najib Ahmed who apparently, from the weakness of his voice, was in the back of the flight deck (where a door connected to the VIP capsule.) If the radio was switched on and was picking up background sounds, it was the next best thing to a cockpit flight recorder. Under these circumstances, the long silence between "stand bye" and the faint calls to Mash'hood, like the dog that didn't bark, was the relevant fact. Why wouldn't Mash'hood or the three other members of the flight crew spoken if they were in trouble? The pilots aboard the other planes, who were fully familiar Mash'hood, and the procedures he was trained in, explained that if Pak One's crew was conscious and in trouble they would not in any circumstances have remained silent for this period of time. If there had been difficulties with controls, Mash'hood instantly would have given the emergency "may day" signal so help would be dispatched to the scene. Even if he had for some reason chosen not to communicate with the control tower, he would have been heard shouting orders to his crew to prepare for an emergency landing. And if there had been an attempt at a hijacking in the cockpit or scuffle between the pilots, it would also be overheard. In retrospect, the pilots of the other aircraft had only one explanation for the prolonged silence: Mash'hood and the other pilots were unconscious while the thumb switch that operated the microphone had been kept opened by the clenched hand of a pilot..
The account of the eyewitnesses at the crash site dove-tailed with the radio silence. They had
seen the plane slowly pitching up and down. According to a C-130 expert I spoke to at
Lockheed, C-130's characteristically go into a pattern known as a "phugoid" when no pilot is
flying it. First, the unattended plane dives towards the ground, then the mechanism in the tail
automatically over-corrects for this downward motion, causing it to head momentarily upwards. Then, with no one at the controls, it would veer downward. Each swing would become more pronounced until the plane crashed. Analyzing the weight on the plane, and how it had been loaded on, this expert calculated the plane would have made three roller-coaster turns before crashing, which is exactly what the witnesses had been reported. He concluded from this pattern that the pilots had been conscious, they would have corrected the "phugoid"-- at least would have made an effort, which would have been reflected in the settings of the controls. Since this had not happened, he concluded, that they were paralyzed or unconscious
One hypothesis he advanced was that the flight crew might have been incapacitated by an
extremely rapid acting chemical agent, such as "VX" nerve gas. It is odorless, easily
transportable in liquid form, and a soda-sized can full would be enough to causes paralysis and
loss of speech within 30 seconds. Nerve gas would leave behind traces of phosphorous, and, as it turned out, the chemical analyzes of debris from the cockpit showed such traces of phosphorous.
So why were autopsies not performed on the bodies of the flight crew to determine whether a
nerve gas or other toxic agent had paralyzed them? The explanation given in the report was that Islamic law requires burial within 24 hours. But this could not been the real reason since the bodies were not returned to their families for burial until two days after the crash, as relatives confirmed to me. Nor were they ever asked permission for autopsy examinations. And, as I learned from a doctor for the Pakistan Air Force, Islamic law not withstanding, autopsies are routinely done on pilots in cases of air crashes. I was further told by doctors at the military hospital in Bahawalpur that parts of the victims' bodies had been brought there in plastic body bags from the crash site on the night of August 17, and stored there, so that autopsies could be performed by team of American and Pakistani pathologists. But before the pathologists had arrived, the hospital received orders to return these plastic bags to the coffins for burial.
These orders to literally bury the evidence came directly from the Army which was now
under the authority of General Beg, who, after having his turbojet pilot circle over the burning
wreckage of Pak One, few immediately back to the capital, Islamabad, to assume command.
For its part, Pakistani military authorities concentrated their investigation on the possibility
that Shi'ite fanatics were responsible for the crash. The co-pilot of Pak One, Wing Commander
Sajid, was a shi'ite (as are more than ten per cent of Pakistan's Moslems), as was one of the
pilots of the back-up C-130. This pilot, though he protested his innocence, was kept in custody
for more than two months and roughly interrogated about whether Wing Commander Sajid had discussed a suicide mission. Finally, the army abandoned this effort after the Air Force
demonstrated that it would have been physically impossible for the co-pilot alone to have caused a C-130 to crash in the way it did.
The government then appointed a commission headed by Justice Shafiur Rehman, a wellrespected judge on the Supreme Court, to establish the cause of the crash. Five years later, in 1993, it issued a secret report concluding that the Army's had so effectively obstructed the
investigation that the perpetrators behind the crash could not be brought to justice. The one
uncounted casualty of Pak One was thus the truth

The Enduring Mystery of Lee Harvey Oswald

2009-11-20T18:13:00.004-05:00

The endless tangle of questions about bullets, trajectories, wounds, time sequences and inconsistent testimony that has surrounded the assassination of President John F. Kennedy in 1963 and has obsessively fascinated, if not entirely blinded, two generations of self-styled assassination investigators, probably never will be satisfactorily resolved. Each new release of documents from the various bureaucracies involved in the nearly half century old investigation may only deepen the apparent contradictions.
Within this morass of facts. however, there is a central actor, Lee Harvey Oswald. His rifle, which fired the fatal bullet into the president, was found in the sniper's nest at the Texas Book Depository. So was his palm print. He had also bought the ammunition. His cartridge cases were found near the body of a murdered policeman on the route of his flight.
In light of such evidence, the issue that ought to have concerned Americans was not Oswald's technical guilt but whether he was involved with others in the assassination. Oswald was not a "loner- in the conventional sense. Ever since he was handed a pamphlet about the Rosenberg prosecution at the age of 15, he was a joiner, seeking affiliations with groups at home and abroad. When he was only 16. he wrote the Socialist Party "I am a Marxist and have been studying Socialist Principles for well over five years" and he requested information about joining their "Youth League. He subsequently made membership inquiries to such organizations as the Socialist Workers Party, the Socialist Labor Party, The Gus Hall-Benjamin Davis Defense Committee, The Fair Play for Cuba Committee and the Communist Party, USA— correspondence that brought him under surveillance by the FBI.
Oswald also joined the Marine Corps. And after a two-year stint as a radar operator, Oswald sought still another affiliation: in October 1959 he became the first Marine to defect to the Soviet Union. In Moscow, he delivered a letter stating. "I affirm that my allegiance is to the Union of Soviet Socialist Republics." Not only did he renounce his American citizenship but he told the U.S. consul that he intended to turn over to the Soviet Union military secrets that he had acquired while serving in the Marines, adding that he had data of "special interest" to the Russians. Since he indeed had exposure to military secrets such as the U-2 spy plane, his defection had serious espionage implications. Oswald thus had not only compromised the secret data he had come in contact with in the Marines, but put himself firmly in the hands of another country. He was now completely dependent on Russia for financial support, legal status and protection.
Before disappearing into the Soviet hinterland for a year, Oswald spelled out his operational creed in a long letter to his brother. From Moscow, he wrote presciently of his willingness to commit murder for a political cause: "I want you to understand what I say now, I do not say lightly, or unknowingly, since I've been in the military .... In the event of war I would kill any American who put a uniform on in defense of the American Government --", and then ominously added for emphasis, "Any American." His willingness to act as an assassin was now known to anyone who read this letter, which included not only his Russian hosts but American intelligence, since his letter was intercepted by the CIA and microfilmed.
Oswald returned from the Soviet Union in June 1962, joined by his Russian wife Marina, and settled in Dallas. He then acquired the means for killing. He purchased a rifle with telescopic sights and a revolver from a mail-order house under a false name. He also lectured a small circle of friends on the need for violent action rather than mere words. His particular focus was General Edwin A. Walker, an extreme conservative, who had been active in Dallas organizing anti-Castro guerrillas. For example, he suggested to a German geologist, Volkmar Schmidt that General Walker should be treated like a "murderer at large". He did not stop at fierce words. For weeks, he methodically stalked Walker's movements, photographing his residence from several angles. He then had his wife photograph him, dressed entirely in black, with his revolver strapped on a holster on his hip, his sniper's rifle in his right hand, and two newspapers, The Worker and The Militant, in his left hand. He made three copies of the photograph-- one of which he inscribed, dated "5--IV-63" and sent to a Dallas acquaintance, George De Mohrenschildt (who had also seen his rifle). He then left with his rifle wrapped in a raincoat, telling his wife he was off to "target practice", but his target, General Walker, was out of town that night. Five nights later, Oswald returned to Walker's house, and fired a shot at him that missed his head by inches, demonstrating to those that saw the photograph that he had the willingness to kill.
After the failed assassination, another friend, Ruth Paine, drove Oswald and his family to New Orleans, where he became the organizer for the Fair Play for Cuba Committee, which opposed the efforts of the Kennedy administration to overthrow Castro. . Aside from printing leaflets, staging demonstrations, getting arrested and appearing on local radio talk shows in support of Castro that summer, Oswald attempted to befriend leaders of and infiltrate anti-Castro groups that were organizing sabotage raids against Cuba. By this time, he apparently considered himself a sleeper operative, writing in August 1963 to the central committee of the Communist Party USA, and asking "Whether in your opinion, I can compete with anti-progressive forces above ground, or whether I should always remain in the background, i.e. underground." During this hot summer, while practicing sighting his rifle in his backyard, according to his wife, he told her about his plan to hijack an airliner to Cuba, saying he might earn a position in Castro's government. Then, on September 9th, in a report that appeared on the front page of the New Orleans Times-Picayune, Castro, who had been the target of a number of assassination attempts by the CIA, warned that if American leaders continued "aiding plans to eliminate Cuban leaders ... they themselves will not be safe".
The implication of this warning was not lost on Oswald. Telling his wife that they might never meet again, he left New Orleans two weeks later headed for the Cuban Embassy in Mexico City. To convince the Cubans of his bona fides-- and seriousness-- he had prepared a dossier on himself, which included a 10 page resume, outlining his revolutionary activities, newspaper clippings about his defection to the Soviet Union, documents he had stolen from a printing company engaged in classified map reproduction for the US Army, his correspondence with the Fair Play for Cuba Committee executives, and, as if to demonstrate his lethal capability , the photographs linking him to the Walker shooting.
Oswald applied for a visa at the Cuban Embassy on the morning of September 27th 1963. He said that he wanted to stop in Havana en route to the Soviet Union. On the application the consular office who interviewed him, noted: "The applicant states that he is a member of the American Communist Party and Secretary in New Orleans of the Fair Play for Cuba Committee." Despite such recommendations, Oswald was told that he needed a Soviet visa before the Cuban visa could be issued. He argued over this requisite with the Cuban counsel, Eusebio Azque, in front of witnesses, and reportedly made wild claims about services he might perform for the Cuban cause. During the next five days, he traveled back and forth between the Soviet and Cuban embassies attempting to straighten out the difficulty. When he telephoned from the Cuban embassy to arrange an appointment at the Soviet Embassy with an officer called Valery Vladimirovich Kostikov, he set off alarm bells at the CIA, which had been surreptitiously monitoring the phone line. Kostikov was a KGB officer who had been under close surveillance in Mexico by the FBI. By the time the CIA had identified Oswald, and notified the FBI, he had left Mexico.
When he returned to Dallas, Oswald assumed a different identity--"O.H.Lee-- and, separating himself from his family, he moved to a rooming house. He also forbade his wife from divulging his whereabouts.
On October 18th, Oswald's visa was approved by the Cuban Foreign Ministry despite the fact that he had not officially received a Soviet visa, as required. Apparently unaware of this development, he wrote another letter to the Soviet Embassy, referring to his meeting with Kostikov in Mexico, and adding cryptically: "Had I been able to reach the Soviet Embassy in Havana as planned, the embassy there would have had time to complete our business." When FBI counterintelligence intercepted this letter in Washington. it urgently requested its field agent in Dallas to question him.
The FBI agent, James Hosty, unable to locate Oswald, warned his wife she could be sent back to Russia. When his wife told him about the FBI warning he threatened to bomb its Dallas office. By this time, Oswald had a menial $1.50 hour job at the Texas Book Depository, which overlooked the convergence of the three main streets into central Dallas.
On November 22nd, at 12:30 PM, as the President’s car passed the book depository, a burst of rifle fire fatally wounded him. Less than two hours later, a Dallas policeman had been shot and killed, and, near the shooting, Oswald was arrested with the murder weapon in his hand. He was charged with killing the policeman and, shortly afterwards, assassinating the President. Then, on November 24th, Oswald was shot to death in Dallas police headquarters by night club owner Jack Ruby.
The Warren Commission concluded– rightly I now believe– that Oswald fired all the shots that killed the President. But conspiracies do not necessarily require multiple rifleman to accomplish their purpose. And what the Warren Commission could not absolutely rule out, as two of its members pointed out to me, was the possibility that Oswald had acted at the behest of others. After all, he had advertised his willingness to undertake a high-profile assassination by circulating photographs connecting himself to the shooting of General Walker. Any party who was monitoring his activities in Dallas, New Orleans or Mexico City could have discerned from them that he was a potential assassin awaiting a mission. With his mind set on such violent actions as hijacking a plane, blowing up the FBI office, or killing "any American," not much would be required to prod him to violence. He had sought liaisons in dangerous quarters and someone could have provided him with an inducement. But with Oswald forever silenced by Ruby, and intelligence services capable of expunging embarrassing data about their contacts with a Presidential assassins from their files, it is doubtful that we will ever know who, if anyone, influenced Oswald to act on November 22nd 1963.

The Case Of The Radioactive Corpse

2009-11-14T10:20:00.003-05:00

November 23rd is the third anniversary of the radiation death in London of the former KGB officer Alexander Litvinenko. By now, most, if not all, the crucial evidence in the case has either vanished or been suppressed. The radioactive isotope to which he was exposed was an extremely exotic isotope that has only a brief half- life of 138.4 days. After nine half-lives, over 99 percent of it is gone. Traces of other isotopes made with the Polonium 210, and which could have possibly identified the nuclear reactor that produce it, and which have even briefer half-lives, no longer exist in identifiable quantities. So there is no longer a radioactive trail, if indeed there ever was one.
Even before the disappearance of the Polonium 210, the crime scenes in London had been too badly compromised to determine any clear chronology of the contamination. Police did not initially seal off the places where Litvinenko and his associates visited because they did not know that they were dealing with a radioactive poison. It took the hospital over two weeks to correctly identify the Polonium 210 and, during this time, the sites were scrubbed clean and walked through. So, several weeks later, different radiation levels at these sites could be due to nothing more than cleaning or traffic. Nor was the container ever found in which the Polonium 210 was transported or were there any witnesses to its existence. Consequently, the only evidence as to where, when and how Litvinenko was exposed to Polonium 210 comes from the autopsy performed on his radioactive body which was done on December 1, 2006 at the Royal London Hospital. But the pathologists’ findings– as well as the autopsy slides, autoradiography films, and toxicology report– have been kept secret from not only the public and Litvinenko’s family members, but from Britain’s partner in the joint-investigation, Russia.
When I asked a former top official of Scotland Yard about the autopsy, he told me authoritatively that "there is good reason for its secrecy." He then added that there was one leak that "caused a near panic at the Crown Prosecutors office" because it was "accurate."
The leak he referred came from Scotland Yard and was published on January 7, 2007 in the London Telegraph. It revealed that Litvinenko’s "post-mortem examination revealed two ’spikes’ of radiation poisoning," meaning that Litvinenko was exposed to Polonium 210 on at least two different occasions. This finding alone, if accurate, undermines the initial hypothesis of investigators that Litvinenko had been poisoned only once: in the Pine Bar of the Millennium Hotel on November 1st, 2006. If Litvinenko had multiple encounters with the same Polonium 210, it would require a different explanation. Had Litvinenko wittingly or unwittingly been in possession of a vial of the Polonium 210 that leaked on him twice? Did a poisoner administered Polonium 210 to him on two different occasions? Or was there some other way to account for his multiple exposures? But even though this finding made the case much murkier, Scotland Yard already had a prime suspect, Andrei Lugovoi, a former Russian intelligence officer, who had been with Litvinenko in the Pine Bar just hours before he fell ill.

The Suspect

Lugovoi, a 42 year old Russian businessman, had tested positive for Polonium 210, as did his hotel rooms. He also admitted that he had met with Litvinenko both on November 1st and in mid October. So he had opportunity. Even though he denied any part in Litvinenko’s death, or any knowledge about the Polonium 210, to British detectives in Moscow, Britain’s crown prosecutors decided he should stand trial in London and they requested his extradition. Since Britain had no extradition treaty with Russia, and the Russian Constitution prohibits the extradition of its citizens, Russia rejected the request. Britain then retaliated by expelling Russian diplomats and effectively ending the Russian involvement in the joint investigation.
When I went to Moscow that December to interview the Russian investigators, and examine the evidence the British had furnished for its extradition request, the Russian inquiry was at a complete standstill. The special prosecutor said that without access to the pathology reports, or being allowed to talk to Litvinenko’s doctors, it was not possible even to establish "the cause of death of Litvinenko" or that culpability of anyone, including Lugovoi.
I next went to see Lugovoi, who just had been elected to the Russian Dumas. Since as a member of the Dumas he was invulnerable to prosecution, I found him eager to discuss his relationship with Litvinenko. They both had been intelligence officers in the 1990s, but then Lugovoi had become a supporter of Putin while Litvinenko had done everything he could to discredit him, So how did they come together? Lugovoi answered in a single word: "Berezovsky."
Boris Abramovich Berezovsky, a billionaire now living in London, had been the single most powerful oligarch in Russia in the 1990s. He not only controlled whole sectors of the Russian economy, and the country's largest television channel, but he was part of the Kremlin apparatus, serving as the deputy secretary of its National Security Council. Both Litvinenko and Lugovoi acted a his protectors in the FSB, which was the successor agency to the KGB. Litvinenko was deputy head of its organized crime unit, while Lugovoi was in the 9th Directorate, which was responsible for guarding top Kremlin officials, including Berezovsky, before becoming head of security at Berezovsky’s television channel. They both also performed extraordinary services for Berezovsky. Litvinenko saved Berezovsky when, with a gun in one hand and his FSB credentials in the other, he prevented Moscow police from arresting him on a murder charge. He then ended his own career in the FSB by exposing a FSB faction’s alleged plan to assassinate Berezovsky. As a consequence, Litvinenko was imprisoned. Lugovoi meanwhile helped Berezovsky’s partner break out of a Moscow prison–an act for which he served prison time. During this tumult, Berezovsky moved to London and became Putin’s arch foe. He repaid Litvinenko by helping him to escape to England in November 2000, where he financially supported him and his investigations for the next six years. How did he repay Lugovoi?, I asked. Lugovoi answered with a wry smile, by "bringing me to Litvinenko."
The reunion came in January 2006 in London. Berezovsky had rented Blenheim Palace– the birthplace of Winston Churchill– to give himself a lavish 60th birthday party. There were some 300 guests in formal attire and, in the center of the room, a giant ice sculpture representing St. Basil's Cathedral on Red Square covered with Caspian caviar. Berezovsky’s seating plan placed Lugovoi at a small table with three men: On his right was Litvinenko, who now engaged in conducting investigations into Russian atrocities in Chechnya. Across from him was Akhmed Zakayev, the exiled leader of the Chechen resistence who headed the Committee on Russian War Crimes in Chechnya. On his left was Alexander Goldfarb, who ran Berezovsky’s foundation which help support both Litvinenko’s and Zakayev’s activities. These men at the table would be among the last to see Litvineko before his death ten months later. Lugovoi would meet with him in the Pine Bar at 5 pm on November 1st. Zakayev then would drive Litvinenko from the Pine Bar to Berezovsky’s office (and the next day to the hospital). At the hospital, Goldfarb would write Litvinenko’s dramatic death bed statement accusing Putin of assassinating him.
But that evening, as Lugovoi recalls it, there was nothing but good cheer and celebration toasts. There also emerged a joint venture between him and Litvinenko. The idea, according to Lugovoi, was to use his connections in Moscow to gather "business data" that Litvinenko could sell to London clients, including Berezovsky.
As this project developed, much of the "business data" concerned individuals connected in one way or another with the Russian energy giant Yukos Oil. Yukos was no ordinary oil company: With tens of billions of dollars stashed away in accounts in Cyprus, Gibraltar and other offshore havens, it had become by the early 2000s a virtual counter-state to the government. In the battle that ensued between it and the government, it was charged with tax fraud and, through enormous fines, its assets in Russia were effectively expropriated. The two principal owners of its holding company were Mikhail Khodorkovsky, who was imprisoned in Siberia. And Leonid Nevzlin, who fled to Israel. In Tel Aviv, Nevzlin set up a private intelligence company, ISC Global, with divisions in London and Tel Aviv, to gather information that would help him fight Russian efforts to get Yukos’ offshore accounts. After a re-organization in 2005, the London branch, changed its name to RISC Management, Ltd. Shortly thereafter it called in Lugovoi and Litvinenko, and according to Lugovoi, retained them on behalf of its anonymous client to gather information in Moscow. Initially, it asked for relatively innocuous reports, such as one entitled, "Main characteristics of Russian Organized Crime in 2003-2005." But soon it was asking for more sensitive data, including government files on corrupt Russian tax officials. When Lugovoi resisted these requests, Litvinenko suggested that he might have a "problem" renewing his British visa, and then his visa was indeed held up. When he agreed to cooperate, his visa was instantly renewed. Lugovoi also got $8,000 wired into his bank account.
Then, in September 2006, Litvineko made a trip to Tel Aviv to meet personally with Nevzlin and to personally hand=deliver "The Yukos file." Nevzlin admits receiving the dossier from Litvinenko, but said it was unsolicited. After Litvinenko returned from Israel. Lugovoi says he found him increasingly on edge. On October 27th, after Lugovoi was summoned to London by Berezovsky, Litvinenko retrieved the cell phone he had been using for RISC business, and removed the SIM card, which contained a digital trail of his contacts. When he next saw Litvinenko on November 1st at the Pine Bar to discuss their planned meeting the next day at RISC, he seemed even edgier. Then the next day Litvinenko called to say he was sick and cancelled the meeting. Lugovoi returned to Moscow, and 2 weeks later, learned that Litvinenko was dying and that he was contaminated with the radioactive isotope.
When I asked Lugovoi who was providing the expenses for his trips to London, he said Litvinenko gave it to him in cash but it obvious to him that Litvinenko himself did not have the resources to finance him, Clearly there was a missing element. Was the elephant in the room Berezovsky?
After all, Berezovsky not only had been financing Litvinenko even since he had defected to London, he owned the house in which he lived and the office which he used (both of which had been contaminated by Polonium 210). Lugovoi had also seen him at the RISC office on one occasion. Berezovsky also shared a common interest with the former owners of Yukos in opposing Putin’s efforts to seize offshore accounts and in blocking Russian extradition requests for both him and Nevzlin. Berezovsky was the only person, other than Litvinenko, to call Lugovoi on the cell phone reserved for RISC activities . So he could hardly have been unaware of Litvinenko’s and Lugovoi’s information-gathering business.

The Compramat game

For a further insight into this business, I went to the person who accompanied Lugovoi to London for two meeting, Dmitry Kovtun, a compact man in his mid forties who had served in a Soviet Army intelligence unit in Germany. After leaving the military, he became a consultant first in Germany and then in Russia attempting to broker energy deals. I him at the Porto Atrium, a restaurant on the Leninsky Prospect know for its extensive wine cellar. He explained that Lugovoi, who had been his close friend since childhood, had proposed he go to London with him on October 16th 2006 to find new consulting work. Lugovoi’s contact there turned out to be Litvinenko, who spent most of his next two days with them. He recalled that Litvinenko first took them to a building owned by Berezovsky in Mayfair for a meeting with a security company before going to another one at RISC. That evening Litvineko invited them to a trendy Moroccan restaurant for dinner and then escorted them to various night spots, including a lap dancing club called Hey Jo His next encounter with Litvinenko came 2 weeks later. He had gone to Hamburg to renew his German residency permit when Lugovoi invited him to come to London for a major soccer match (for which Berezovsky was providing tickets.) When he arrived on November 1st, he went to the Millennium hotel, where Lugovoi was staying with his family, and met him at hotel’s Pine Bar. Then they were joined by Litvinenko for a pre-game drink. That was his last contact with Litvinenko.
After he returned to Moscow, he tested positive for Polonium 210. So did the visa form he had signed in Hamburg on October 29th, the London nightclubs they visited on October 16th and 17th, and his room at the Great Western Hotel where he stayed on October 16th. But the Transaero plane on which he arrived in London on the morning of October 16th had no traces of Polonium 210. So he deduced he must have been exposed on the 16th and then left a radioactive trail in London and Hamburg. (German prosecutors concluded in November 2009 that the Polonium 210 traces in Hamburg did not constitute enough evidence to continue their investigation of Kovtun.)
When I pressed him about what had happened at the meetings, he said they seemed like just "courtesy meetings" through which Litvinenko could show that he had contacts in Moscow. After leaving RISC, however, Litvinenko made an extraordinary proposal to Kovtun. He said that a number of Russian billionaires had established residence in Spain. He suggested that he and Lugovoi should work with him in Spain to "solve problems" for these Russian expatriates. When Kovtun asked,"What kind of problems?", Litvinenko laughed "Don’t worry. We’ll provide their problems and then fix them." It became clear to him that the "game" that Litvinenko was proposing was dealing in "compramat," or compromising information.

The Italian Job

Litvinenko’s game may have involved more than merely unearthing existing Compramat. Consider, for example, his collaboration with Mario Scaramella, who was the third of Litvinenko’s associates contaminated with Polonium 210, Scaramella, a lawyer and self-styled nuclear waste investigator, had met Litvinenko while working for a highly-controversial Italian Parliamentary Committee attempting (without success) to uncover putative KGB penetrations in Italy. Scaramella also believed that their was a "Red Mafia" of ex-KGB men who smuggled arms, including nuclear components, from eastern Europe. So Litvinenko, who had himself monitored organized crime in the KGB, helped Scaramella organize operation to entrap them. One of their targets was an ex-KGB agent living in Naples. To compromise him, they arranged for a box of contraband Russian rocket grenades to be delivered to him, and then tipped-off the Naples police that he was planning to use them to assassinate someone. He was duly arrested but then the scheme backfired because Scaramella and Litvinenko’s plotting was overhead by SISMI, the Italian intelligence agency, which was tapping Scaramella’s phone. So the ex-KGB man was released from custody and other information Scaramella had provided police came under scrutiny, including his tip that led police to a suitcase containing enriched uranium rods that supposedly belonged to other "Red Mafia"agents trafficking. in nuclear component. By the time, Scaramella flew to London on November 1st 2006 to meet Litvinenko at the Itsu Sushi restaurant, Italian authorities were preparing to criminally charge Scaramella with planting false evidence as part of a compramat plot. And when Scaramella was released from the London hospital where he tested positive for Polonium 210, he was imprisoned in Naples on charges of calumny and arms smuggling. (He is currently under house arrest awaiting trial scheduled for May 2010.)
Whatever their merit or legality, Litvinenko was involved in covert activities that went beyond those ordinarily engaged in by a political dissident. But were they related to the Polonium 210 that caused his death?

The Importance Of Polonium

Polonium 210 is tightly controlled by the International Atomic Energy Agency (IAEA) for a singular reason: it can be used trigger an early-stage nuclear bomb. The United States and Russia both used Polonium 210 in their early weapons before moving on to more sophisticated (and stable) triggers. Almost every country secretly attempting to build nuclear weapons, including Israel, South Africa, Iraq and North Korea, have also experimented with Polonium 210. Consequently, its detection anywhere outside a known nuclear facility is considered, as noted in a US intelligence report, "a key indication of a nuclear weapons program in its early stages."
The small quantity of Polonium 210 found in London could have been made in any country that has an uninspected nuclear reactor– a list in 2006 that included Russia. Britain, China, France, India, Israel, Pakistan and North Korea (which manufactured a substantial quantity for its October 2006 nuclear tests. It also could have been stolen from stockpiles in the former Soviet Union or America, where, according to the International Atomic Energy Agency’s Illicit Trafficking Data Base, there had been 14 incidents of missing industrial Polonium-210 since 2004.
Wherever it originated, we know that it was smuggled into London and that it contaminated at least four men– Litvineko, Lugovoi, Kovtun and Scaramella– as well as offices, restaurants, and automobiles. The possible time it arrived could be narrowed down by the autopsy report, which remains, even 3 years after Litvinenko’s death, a state secret. Beyond that evidence, there is only conjecture. What remains unanswered is the crucial question: why was a component for an early stage nuclear bomb was brought to London in 2006.
***

Death Of A Witness

2009-10-28T13:05:00.004-04:00

On Sunday, October 25th 2009, Jeffry Picower drowned in the swimming pool of his Palm Beach mansion, the victim of an apparent heart attack. His untimely death left in limbo, if not totally silenced, crucial questions about the role he played in what may be the greatest disappearance act in the annals of financial history. Picower was the main (though not the only) conduit through which most of the stolen money in the Madoff Ponzi scheme was systematically siphoned out of the accounts of other investors. As Irving Picard, the court-appointed Trustee, notes in complaint, Picower got "either directly or through the entities he controlled, more than $7.2 billion of other investors’ money." He did not get this money by his good luck, fortunate timing, or random chance. He made regular quarterly withdrawals of the putative profits credited to his accounts. Nor did his profits proceed from his acumen at picking stocks since, as we know by now, all the profits Madoff reported were the result of his invention, not his trading. Picower, a long time associate of Madoff’s, had special access to Madoff’s operation. According to the Trustee’s complaint, he must have been aware that what was going on was highly-irregular since his accounts reported "profitable trading before they were opened or funded; execution of trading instructions that hadn’t yet been given; inexplicable changes in account positions; and – at Picower’s direction – the accomplishment of investment results over time periods that already had expired." In other words, his trades were invented afterwards and back-dated. Unlike other investors, he was advised in advance of Madoff’s monthly profit "targets," or the amounts with which Madoff planned to pad Picower’s accounts, and, through this knowledge, he or his assistant could request higher or lower "profits" for various accounts. Moreover, to amplify Picower’s fictional profits, Madoff extended him so much fictional credit that his accounts had, as the Trustee reports, a "negative net cash balance of approximately $6 billion at the time of Madoff’s arrest." Picower even collaborated in his spectacular, if fictitious, trading success by, as the Trustee notes in the complaint, as he had " specifically directed such fictitious activity." For example, at one point, he faxed Madoff back-dated letters to support fabricated trades. In some of the faked trades, Picower’s reported "profit"s ran as high as 550% . As a result, the Picower was able to withdraw over $2.4 billion just between 2002 and 2008.
Why were such staggering notional profits systematically credited to the Picower accounts? Unless Madoff was channeling a large part of the money he stole to Picower for reasons of friendship or charity, the multi-billion dollar skim must have been part of the scheme itself. If so, was Picower following Madoff’s instructions in re-depositing the $7.2 billion he withdrew? And, if this was part of the exit strategy– and all Ponzi schemes need an exit strategy-- where is that money today? Unfortunately, the answer to these crucial question may have died in the drowning pool along with Picower.
***

A Nobel Perspective

2009-10-17T12:11:00.005-04:00

President Obama’s Nobel Peace Prize has sparked an understandable range of reactions, from surprise and outrage to apologetics for the Nobel Committee’s decision to honor him so prematurely. It’s worth remembering that nominations for the Peace Prize must be received by February 1 of each year, meaning that Obama was nominated less than two weeks after becoming president.
Then again, getting nominated is not difficult. Nominations can be made by, among others, any members of national assemblies and governments; judges on the Inter-Parliamentary Union Permanent Court of Arbitration, the International Court of Justice, or the International Court of Justice; or university professors of history, political science, philosophy, law, or theology. This year saw a record 205 nominations. Unlike the Academy Awards, the Nobel Committee keeps the full list of nominations secret for several years. It was revealed well after the fact, for example, that Hitler, Stalin, and Mussolini received nominations—though in Hitler’s case, before he decided to invade Norway.
Perhaps that’s not so ironic when one recalls that Alfred Nobel was an arms dealer and dynamite inventor. But he specified in his will in 1895 that a five-person Nobel Committee elected by the Norwegian Parliament should award the Peace Prize to “the person who shall have done the most or the best work for fraternity between nations, for the abolition or reduction of standing armies and for the holding and promotion of peace congresses.” Nominations are considered at a meeting attended by permanent advisers to the Nobel Institute, which consists of the Institute’s director and research director and a small number of Norwegian academics with expertise in subject areas relating to the prize. Some nominees have even campaigned for the award during this evaluation period. Oil magnate Armand Hammer spent an estimated $5 million in 1989, for instance, trying to sway the Norwegians’ decision. He made it to the short list, but lost out to the 14th Dalai Lama.
The five-person committee selects the laureate in October. The prize is presented annually in Oslo, in the presence of the king, on December 10, the anniversary of Nobel’s death. In 2009, four out of the five key deciders were women. Though the committee seeks a unanimous decision, the winner may receive a simple majority of three votes.
So considering the Nobel Committee’s inner workings and its history, President Obama’s award is perhaps not so surprising after all.

Mystery Of The Arctic Sea

2009-10-01T14:19:00.007-04:00

The surfeit of imaginative speculation in the world press about the disappearance and reappearance in the Atlantic of a Maltese cargo ship named the "Arctic Sea," includes even a scenario in The Harvard Crimson – taken no less from a video game– in which a team of masked Israeli Commandos drop out of the sky from a helicopter onto the Arctic Sea, "subdue the crew and remove weapons unlisted on the ship’s manifest." Eye-popping headlines such as "Was Russia's 'Hijacked' Ship Carrying Missiles to the Mideast?" (Time Magazine), "Arctic Sea ghost ship 'was carrying weapons to Iran'" (Daily Telegraph) and "Missing channel pirate ship carried Russian arms for Iran"(Times Of London) floated through the media world but no one could be found who actually claimed to have seen a cargo of missiles or other arms aboard the so-called "ghost ship." Nor was there a scintilla of evidence that it was headed to Iran. What is known to date is that the Arctic Sea is far more prosaic. It is registered in Malta and owned and managed by two Finnish corporations, Arctic Sea Ltd and Solchart Management Ab, which in turn are owned and controlled by Victor Matveev, a Russian citizen. and is manned by a Russian crew. Its last voyage began uneventfully on July 23, 2009, in Jakobstad, Finland. After a routine inspection by Finnish authorities for contraband, it left with a timber cargo on a 2 week trip to Algeria. Its route would take it through the English Channel to the Atlantic and then, via the narrow strait of Gibraltar to the Algerian port of Bejaia, in the Mediterranean. For the first week of the voyage, the ship’s Automatic Identification System sent out signals indicating that it was on its prescribed course. All appeared normal when it made radio contact with British authorities on July 28th as it passed into the Atlantic. But on July 30, its Automatic Identification System stopped sending out its position and the Arctic Sea did not go through the strait of Gibraltar. On August 3rd, Renaissance Insurance Group, the ship’s insurer in Moscow, received an phone call demanding a ransom of 1.5 million Euros.
Meanwhile, Israel got into the act. According to a highly-reliable source close to Mossad, Israel informed Moscow through intelligence channels that it suspected the Arctic Sea was carrying a hidden cargo of missiles and was on a course that could take it to Iran. This warning helped galvanize the Russians into action. The Russian Defense Ministry, after determining that the ship was in the sea lanes off Africa, dispatched the frigate Ladny to pursue it. On August 17th, after finding the Arctic Sea in the Cape Verde Islands, Russian troops boarded it and arrested 8 Russian non-crew members from Estonia and Latvia– six of whom had served time in prison. According to crew members, this gang had hijacked the ship only a day after it left Finland, having allegedly arrived an inflatable motor launch early in the mourning of July 24th. After diverting the ship from its course, the hijackers painted a new name on the ship, "Jon Jin 2" in an apparent attempt to disguise it. According to Russian defense ministry, the subsequent search of the ship did not find missiles or other contraband. In addition, a crew member interviewed by the New York Times confirmed that "There was only lumber on board." He said "I was personally in all areas and in the ballast tanks. There was nothing else in there. I can say this with 100 percent certainty."
If so, why was Israel concerned that the ship might be carrying a secret arms cargo? Such suspicion could well have been triggered by the motor launch that the Russians found concealed under a pile of timber on deck. Presumably, the hijackers planned this vessel for they get away, but such a partially camouflaged object with its pontoons could have be misinterpreted by aerial surveillance as a hidden arms cargo.
The Russian search also found an intriguing discrepancy in the cargo. According to the Russian news service RIA Novosti, the Russians discovered that instead of the 6,000 tons of relatively-valuable hardwood listed on the ship’s manifest there was cheap pine timber. If so, it raises the question: why would a cheap cargo be substituted for an expensive one– unless it was not intended to reach the buyer in Algeria..
A key piece of the puzzle may be the ransom demand the insurer received on August 3rd. Modern pirates typically hijack a ship not for its cargo but to extort a ransom or other payment from its insurer, and the Arctic Sea was heavily insured. According to the security chief of its insurer, Renaissance Insurance Group, the anonymous caller claiming to represent the hijackers threatened to scuttle the ship unless the company paid the 1.5 million Euros. But the caller provided no instructions for paying this money, so apparently the purpose of this call was merely to establish to the insurer that this missing ship was in imminent danger of being sunk. If not for the misguided intelligence about missiles that set off an international search for it, the Arctic Sea might have been quietly disappeared in the Cape Verde Islands, making the insurer liable for insured value of the lost ship and cargo. I
The Russian investigation headed by the celebrated deputy chief prosecutor Alexander Bastrykin is now reportedly examining such issues as to whether the ransom demand was actually made by the captured hijackers, whether there was any complicity by any crew members, and whether there is any connection between this incident and the loss of the Arctic Sea’s sister ship, the MV Teklivka which capsized off Egypt in 2006. Since Bastrykin is now interrogating all the parties involved, the answer may prove less elusive than the missing ship– or its cargo.

The Madoff Exception

2009-08-26T10:40:00.013-04:00

On September 4th, 2009, the Securities and Exchange Commission’s Inspector General revealed that Wall Street’s watchdog agency failed to adequately investigate six "detailed and substantive complaints" that, if properly pursued, could have exposed Bernard Madoff’s massive Ponzi scheme. The real issue is why the SEC did not pursue these leads?
Clearly Madoff had enormous influence at the SEC. Since the 1980s, he had served on its advisory panels and was constantly consulted by its top officials on issues such as computerized trading. During one investigation of his own firm, he confided to a SEC investigator that he was on "the short list" to be the next SEC Commissioner, which would make him his boss. While Madoff was not appointed to the SEC, that investigation was, as the SEC inspector general points out, prematurely terminated Madoff had become so closely identified with the SEC by the early 2000s that a controversial SEC short-selling exception that benefitted Madoff became famously known on Wall Street as "The Madoff Exception."
Even as early as 1992, Madoff had become such a trusted figure in the eyes of the SEC officials that he was able to help them dispose of what appeared to be a possible Ponzi scheme. The alarm bells were set off when SEC investigators discovered that an unregistered investment company named Avellino and Bienes was offering "100% safe investments" . As noted in the Inspector General’s report, such "high and extremely consistent rates of return over significant periods of time to "special" customers" were viewed by at least 4 SEC examiners as "red flags" of a fraud involving over $441.9 million, which in the early 1990s was a sizable sum in the investment world. Indeed, it was reminiscent of the now infamous Charles Ponzi in the 1920s who paid the guaranteed "interest" to old investors out of the funds of his new investors. Neither Frank Avellino or his junior partner Michael Bienes had been licensed to sell securities, yet they and their associates had sold these guaranteed notes to 3100 investors between 1962 and 1992. The different rates they offered was yet another red flag. Larger investors got a guaranteed annual return of a 20 percent– which in some years was more than ten times the banks’ interest rate– while smaller investors got between 13.5 and 15 percent. Adding to the SEC’s concern, the firm was unable, or unwilling, to produce financial records with Avellino telling the court appointed auditors that he did not keep detailed records because "My experience has taught me not to commit any figures to scrutiny." He insisted that furnishing his own trading data was unnecessary since "every single dollar, it is invested in long-term Fortune 500 securities" with a single broker, who makes every investment decision/ And that broker was Bernard Madoff, with whom he had 5 accounts. To prove no money was missing, Avellino provided the SEC examiners with the most recent statements he received from Madoff. The New York Enforcement Staff Attorney handling the case did not find "Avellino and Bienes’ testimony altogether convincing." The next step was to verify the statements with Madoff. When on November 16, 1992, SEC examiners conducted an examination of Madoff’s firm "to verify certain security positions carried for the accounts of Avellino & Bienes," Madoff was well prepared for their visit/ He provided them with putative copies of records from the Depository Trust Corporation (DTC) showing that he had made the trades listed in the Avellino and Bienes accounts. Madoff’s stock record exactly matched the DTC statement. The examiners did not go any further. They concluded that there was no Ponzi scheme, and merely fined Avellino and Bienes $500,000 for their illegal brokerage business, which they closed down.
What the SEC did not do was to go to the DTC and verify that the records Madoff gave them were authentic. If its investigators had merely made a phone call to the DTC, they would have discovered in 1992 that those records were hastily forged and that the Avellino and Bienes accounts were only a small part of Madoff’s much larger Ponzi scheme.. As we now know from the testimony of Frank DiPascali, Jr , Madoff somehow knew the SEC examiners were about to descend on his office and demand these records. In his 2009 debriefing by the SEC, Dipascali specifically identified the SEC’s Avellino & Bienes investigation as an occurrence when "Madoff scrambled to ... fabricate credible account records to corroborate the purported trading in the accounts." The rush to fake the records described by DiPascalini suggests that Madoff might have had advance knowledge as to the SEC’s actions.
In any case, the SEC’s failure to verify Madoff’s records is difficult to explain in light of Madoff’s long-term relationship with Avellino’s firm. Madoff and Avellino had both worked together in the small accounting office of Madoff’s father-in-law Sol Alpern, who was deeply involved, if not the organizer, of the money-raising operation. Alpern also helped set up Madoff’s brokerage operation in 1960 by providing him with $50,000 to finance it and then funneling into it the guaranteed investments his firm sold. When Alpern retired, Avellino and his junior partner, Michael Bienes, took over the business and changed its name to Avellino and Bienes.
That Madoff’s name is not even mentioned by the SEC actions against Avellino and Bienes, even though his records were central to the quashing of the case, may be some indication of the influence he had developed at the SEC. Such influence would also explain why six subsequent complaints against Madoff himself were not fully investigated and why the SEC consistently neglected to verify Madoff’s accounts against the readily-available DTC records. But how could Madoff have such influence over his regulators? As Madoff’s dealing with the Fairfield Greenwich Group in 2006 demonstrates, he had advanced knowledge about the SEC’s moves. In that investigation, the SEC was dealing with an allegation that he was hiding his role as a money-manager for its funds. According to phone records that came to light in a lawsuit filed by the state of Massachusetts, Madoff called two of Fairfield Greenwich’s top executives in Bermuda, and informed them of the question that SEC investigators would ask them about their relation with him. He then furnished the answers that would satisfy them without revealing Madoff’s true role. As for the SEC investigators themselves, he pointed out, "They work for 5 years for the [SEC] Commission and then become a compliance manager at a hedge fund." The implication here was that SEC officials had a powerful incentive to be cooperative in this matter since their future lay with hedge funds, not the SEC.
He clearly had one or more reliable sources. The SEC kept to the Madoff script and, when it got the answered he provided, it did not pursue the investigation. Such high-value feed-back, which could have come from unwitting sources or from someone cooperating with him. In either case, it would explain how Madoff evaded SEC scrutiny. ***

[UPDATE 9/5/2009]

Can Diamonds Survive A Free Market?

2009-08-06T16:09:00.007-04:00

Despite its celebrated slogan "Diamonds Are Forever," De Beers, which has dominated the diamond business for over a century, is discovering that diamond profits are not forever. It reported in July that its profits for the first half of 2009 fell by no less than 99%. The problem is not that the mining giant is running out of diamonds. Its highly-efficient diamond mines in South Africa, Botswana and Namibia still supply about 40 percent of the world’s gem-sized diamonds. Nor have diamonds lost their value. They not only remain a vital part of the engagement ritual but their retail price of engagement rings has actually risen in 2009. What is killing De Beer’s profits is the prohibitive cost of running a cartel. The cartel arrangement is necessary to sustain the illusion that diamonds are rare.
Diamonds, to be sure, once were exceedingly rare. Then, in the late 19th century, huge pipes full of diamond ore were discovered in South Africa, and the diamond prices fell to less than one dollar a carat. Cecil Rhodes, who by 1890 had consolidated almost all the pipe mines into his De Beers Company. wrote in a letter that diamonds were on the verge of becoming a "frightful drug" on the market unless production was restricted. To create the balance between world supply and demand, Rhodes proposed that the annual production be limited to roughly the number of "licit relationships," as he termed engagements, in the United States., which was then the main market for diamonds. Ernest Oppenheimer, who took over De Beers after Rhodes’ death, further perfected the cartel by taking over the Diamond syndicate in London. This arm of the cartel, run by Oppenheimer’s brother Otto, gave De Beers control over the global distribution market and evolved into the innocuous- sounding "Central Selling Organization," The Oppenheimers used it to allocate the world’s rough diamonds to diamond cutters in Antwerp, Tel Aviv, and other cutting centers according to its terms. If a cutter wanted to be part of the arrangement, he had to blindly accept all the diamonds offered to him in a box by De Beers, and follow its rules. Ernest Oppenheimer wrote: "the only way to increase the value of diamonds is to make them scarce." Working through an intricate system of bankers, shell corporations, and buying agents, De Beers bought up diamonds wherever they were found, acting as the buyer of last resort, and, if necessary, adding them to its stockpile. When demand for diamonds collapsed in the great depression, Oppenheimer closed all major mines, cutting production from 2,242,000 carats in 1930 to 14,000 carats in 1933. His son Harry, who succeeded him in 1957, continued this strategy, telling shareholders that De Beers had no choice but to tightly control the global supply of diamonds because "wide fluctuations in price, which have, rightly or wrongly, been accepted as normal in the case of most raw materials, would be destructive of public confidence in the case of a pure luxury such as gem diamonds, of which large stocks are held in the form of jewelry by the general public." In other words, if prices were allowed to go down, the diamonds-are-forever illusion would shatter, and people would begin to sell their diamonds. Under his regime, when new diamond mines were discovered any place in the world, De Beers negotiated through one of its front companies to buy all those diamonds, even if it meant locking them up in its vaults in London. No distinction was made between friends and foes. At the height of the Cold War, when diamonds were discovered in Siberia, De Beers arranged with the Soviet Union to take its entire output. This deal required De Beers in the 1980s to buy from the Soviet Union 2.6 million carats a year– nearly one-quarter of the world's production– which provided Moscow with so much hard currency that the head of the Russian Diamond Administration said, "We call ourselves the country's foreign exchange department."
While this global cartel succeeded in sustaining the illusion of scarcity, by the 1990s it began to put increasing financial strain on the company’s finances. Ironically, what sealed the cartel’s fate was the Oppenheimer family’s effort to tighten its iron grip on De Beers through a leveraged buyout in 2004. Up until then, the Oppenheimers, who only owned about 8 percent of De Beers relied on a maze of interlocking companies to control it. After the buy-out, 40 percent of the company was directly owned by Oppenheimer family’s holding company and 45% was owned by the Anglo-American Corporation, in which the Oppenheimers were major share-holders. But to effect the buy-out De Beers had borrowed over $ 4 billion from banks, who imposed covenants that restricted its ability to borrow further to buy diamonds for its stockpile. "Debt drove the deal, as it always does," one shrewd London banker observed. As a result, he added "The new De Beers is not the old De Beers."
When the recession collapsed demand for diamond in 2008, De Beers could still shut down its mines– and in 2009 it reduced its production by 91%– But, given its debt burden and covenants, it could not borrow to buy the growing surplus of diamonds from other mines around the world. So it could not continue the century-old cartel arrangement. The European Union, which had found that De Beers had violated its anti-monopoly rules by stockpiling Russian diamonds, provided a convenient fig leaf for its exit strategy . Instead of renewing its deal to buy Russia’s rough diamonds in 2009, De Beers handed over the job of stockpiling surplus diamonds to the Russian-government backed diamond monopoly, Alrosa. For Alrosa to support prices, it not only had to stockpile the enormous production from the Siberian mines but after new pipe mines had been discovered in Angola, it had to negotiate a De Beers-style arrangement with the Angolan government to buy up its diamonds. "If you don’t support the price," Andrei V. Polyakov, an Alrosa official told the New York Times, "a diamond becomes a mere piece of carbon," while a top Alrosa strategist said, "We have to tell people that diamonds are valuable...We are trying to maintain the price, just as De Beers did, But what we are doing is selling an illusion." But even if the Russians fully understood the requisites of the cartel, they faced an almost intractable problem in the form of $5 to $7 billion worth of diamonds that were already in the "pipeline" that extended from the cutters and jewelry manufacturers to the wholesalers.. With the dearth of retail sales in 2008, these diamonds could only be contained in the pipe line for a limited time before the banks who had financed their purchase in 2007-8 at the height of the bubble, took action to get repaid, which would cause fire sales at the wholesale level. Alrosa has not as yet intervened to absorb these diamonds, and it may not have the resources to do so. According to a major diamond dealer affiliated with De Beers "Alrosa is not De Beers. It doesn’t have the network of connections with dealers and financiers, or experience, to control the pipe line." If so, diamond prices could go into a free fall, and finally test Harry Oppenheimer theory that the diamond illusion cannot survive the destructive price swings of a free market.
***

Did Madoff Act Alone

2009-07-26T13:24:00.006-04:00

Madoff did not share the credit for perpetrating the biggest Ponzi Scheme in the annals of crime. After his arrest on December 11th 2008 he insisted to the FBI and federal prosecutors that he, acting entirely alone, organized and ran the confidence game that created over $50 billion in imaginary profits and that resulted in more than 6,500 investors losing $13.2 billion in real money. According to him, here is how the lone swindler operation worked. He confined the fake part of his enterprise to a sealed-off suite of offices called "House 17." It was located one floor below his legitimate market-making business in the Lipstick Building on 3rd Avenue Manhattan. Access required a coded key-card and was limited to only about 20 clerical employees. In the back of suite was the so-called "cage" in which three clerks logged in all the checks and wires that were deposited or withdrawn in the JP Morgan Chase bank account for Madoff’s "Investment Advisory" service (which was the cover for the Ponzi Scheme swindle). They manually recorded the amounts on index cards for Madoff. This tally gave him a running total of how much actual money was available. Outside the "cage" was an open area in which three young researchers filled in the historic prices of stocks and options that Madoff requested, using tables from the Bloomberg wire service and other public sources. This data helped him verify the forged trades. Next, he gave data-entry clerks in a glass-enclosed area in the center of the room called the "fish bowl" a list of the trades he supposedly had made and they would punch it into an 1988-vintage IBM AS 400 computer (which was not connected to any external system.) The computer then calculated "commissions" as well as "profits" or "losses," and generated daily and monthly customer statements for each account, which were then printed and posted by regular mail. As the "profits" were consistently greater than the "losses", the value of the accounts increased accordingly. All these operations were done under the eagle-eyed supervision of Madoff’‘s long-time deputy, Frank DiPascali, who is pleading guilty for his part in the criminal scheme and currently cooperating with the FBI investigation. According to Madoff, neither DiPascali nor anyone else in House 17, had any inkling that the trades they were processing were fictional. As for his 18th floor employees, and his accountants– he used a two-man accounting firm that worked out of a 700 square foot office in Westchester– they saw nothing more than the wealth of computer-generated statements showing the trades for the Investment Advisory accounts.
The flaw in his lone swindler story became evident to me when I was allowed to examine Madoff’s actual confirmation slips. These were made available to me at a global business intelligence company founded by former American and British intelligence officers, which specializes in investigating, as they put it, "opaque business environments". The person there who had obtained these Madoff files from off-shore "feeder" funds that had been supplying Madoff with more than half the money funneled into the Ponzi scheme since 1998. Unlike hedge funds which invest money, feeder funds simply raise money and then turn it over to a hedge fund with which it has an arrangement. Ordinarily, the feeder fund gets a relatively small percent of the money it corrals from the hedge fund– typically 1 percent– while the hedge fund charges the investors both a hefty performance and net asset fee. Madoff had, however, offered select feeder funds a much better deal. Instead of charging them anything for managing their money, he would work for them for free, allowing them to collect the entire performance fee, which could be as much as 20 percent of the profits. This provided a bonanza for feeder funds which deducted the performance fee from their clients’ accounts each year, transferred it to their own "carry" account, and then withdrew it. To justify these fee, these funds verified that the trades reported in Madoff’s confirmation slips were in keeping with the conditions specified in the trading authority that they had agreed upon. Since conditions often varied between feeder funds, and even their sub-funds, Madoff could not make all the same fictional trades for all the funds. As a result, by 2008, he needed to invent a huge number of transaction in order to keep turning over the $64 billion that supposedly was in his accounts (especially since he "sold" all his holding and went to cash before each reporting period). The typical "trade," as far as I could concern from the file, was well under $500,000, which meant he needed to invent hundreds of thousands of trades a year that both conformed to the different conditions in the trading authorizations, was consistent with the price of that security that day, and resulted in his achieving his overall "targeted earnings." Each slip I reviewed contained every relevant details of the transaction, including even the securities "cusip number"
"It is impossible that Madoff could do all this work himself," the person at the private intelligence firm said as he pushed over to me a foot-high stack of Madoff confirmation slips.. "Every price on every slip had to be checked against the actual high and low that day. Just the paperwork for these feeder funds would require the full-time services of a group of people who knew exactly what they were doing." He estimated that "at a minimum, you would need 5 people." These operatives would presumably also have to be willing and discrete participants in a con game.
Furthermore, these feeder funds were not the only part of the criminal enterprise that required systematic forgery. A handful of Madoff’s long-time associates had about 100 accounts that had been used between 1992 and 2008. to siphon off billions through redemptions. To get fictional profits into these men’s accounts Madoff faked transactions on a very different scale from those faked for the feeder funds. Some were credited with fictional trades that produced a rate of return 40 times greater than that of the off-shore feeder funds, In one such favored account, according to the Trustee for the bankruptcy, Madoff "purported
to earn over 950% in 1999" [emphasis Trustee’s], while most of the feeder funds were earning a mere 15 percent. In another favored account, according to a SEC complaint, not a single loss was reported in thousands of trades over a ten year period. These were bespoke accounts, custom- tailored to produce enormous profits. Just two of his long time associates were thus able to withdraw $8.8 billion (which is more than half the money actually lost in the Ponzi scheme.) In addition, such customized padding of accounts was used, according to the SEC, to pay some associates off the books, and, via back-dating, to minimize tax bills. These customized transactions exponentially added to the fraudulent paperwork.
In reality, this was not a financial scandal, but a well-run confidence game. Not a penny of the $13.2 billion that disappeared was lost in the stock market. The lion’s share of this loot exited through a few accounts that had been systematically inflated with non-existing "profits" over two decades and its ultimate whereabouts still remains a mystery. To be sure, Madoff, was the impressive face of the criminal enterprise. As a former Chairman of the NASDAQ stock exchange and well-respected doyen of Wall Street, he lent what is crucial in any confidence game: credibility. As federal prosecutors themselves pointed out before he was sentenced to 150 years in prison, "his demonstrated ability to lie, mislead, and deceive is staggering." If so, his claim that he was the sole employee and sole author of this criminal enterprise can hardly be accepted at face value, especially since he may have a interest, such as fear of the consequences, in not fully sharing the credit.
***

Madoff's Incredible Money Laundry

2009-07-15T11:00:00.004-04:00

Bernard Madoff did not merely plead guilty to running a multi-billion dollar Ponzi Scheme.
He’ also pleaded guilty to multiple counts of "international money laundering." This latter
criminal enterprise has not fully come to light because while Madoff talked freely to prosecutors
about the mechanics of the swindle itself, he stonewalled the court-appointed Trustee Irving Picard’s effort to unravel his tangle of money laundering to the extent that his counsel, David Sheehan, wrote the court just before his sentencing that Madoff has "not provided meaningful
cooperation or assistance to the trustee since his arrest." So even looking at a 150 year prison sentence, his money laundering operation therefore remains a crucial missing piece in the puzzle. At stake is the $13.2 billion that his investors lost.The Ponzi scheme itself was relatively simple. Madoff had investors wire their funds into his bank account at JP Morgan Chase for him it for them through his proprietary strategies in the
stock market. But he made no investments. Instead he forged trading tickets providing them with a fictional profit in their account. These imaginary profits exceeded $50 billion by the time
the scheme was exposed in December 2008. As far as the actual money went, Madoff shuffled between two different bank accounts, siphoning off some of it to pay the clients who withdrew their money. He also wrote checks to pay for his life style and operating expenses (both licit and
illicit). These banking records as well as the checks he wrote and credit card bills are now in the hands of the Trustee’s forensic accountants. Their analysis shows that all the money that Madoff withdrew for himself and family members, including everything from his expenditures
on yachts, country clubs, real estate, plane and travel to loans to his children, gifts, and capital calls on his wife’s private equity investments, amount to less than one percent of the stolen money. The money Madoff withdrew from all his bank accounts to run his scam, including rent
for his offices in the Lipstick building in Manhattan, his payroll (which included his boat crew), commercial taxes, accounting, legal bills, and even the surreptitious kickbacks to fund managers through his London subsidiary amounts to, at most, another 4 percent. He paid these expenses by wiring money to his London subsidiary which then wired it back to his account at Bank Of New York Mellon. So the money he withdrew from all his banks account for himself and his business expenses amount to less than 5 percent of the missing $13.2 billion. What happened to the other 95 percent of the looted money? "That is the $13 billion question", a lawyer involved in the liquidation process answered, adding "Lets not forget Madoff was a truly ingenious money launderer."
Madoff’‘s notional system of book-keeping that provided an ideal way to launder money. Unlike the classic Ponzi scheme in which all investors are credited with uniform "profits," Madoff favored some accounts with what the Trustee called "implausibly high" profits and
allowed through large redemptions to convert imaginary to real profits (which of course came out of other investors’ money). This money could then be deposited some place else, such as a numbered account in a off-shore haven. There is no doubt Madoff had some purpose in stuffing
some accounts with notional profits. For example, according to a SEC civil fraud action filed in June against the brokerage firm Cohmad (which operated out of his Madoff’s own offices),
Madoff padded the account of one close associate with $100 million in fake profits by awarding him roughly triple the putative return others were getting. The SEC alleges this was done as a surreptitious pay-off for his steering over $1 billion of investments to him (Madoff also,
according to the SEC, accommodatingly back-dated the non-existent transactions for this associate so that his fake profits taxes were taxable only at the minimal capital gains rate.)
Others Madoff clients got even larger "profits" put in their accounts through this device. The Trustee’s investigation found instances in which Madoff credited accounts with returns more than 40 times greater than his others investors (even though Madoff was supposedly using the
same trading strategies for all his accounts.), For one such favored account, Madoff "purported to earn over 950% in 1999" [emphasis Trustee’s]. The Trustee alleges that such "implausibly high purported returns" resulted in 84 accounts controlled by two of Madoff’s long-time clients withdrawing the lion’s share of the money that other investors lost, and he filed law suits against both of them.
One of these favored clients is Jeffry Picower, a lawyer, accountant, deal-maker, tax shelter promoter, and philanthropist, who knew Madoff for about 30 years. According to the Trustee’s suit , Picower redeemed no less than $6.7 billion from 24 accounts under his control.
Where did this huge sum come from? According to analysis by the Trustee, "at a minimum, more than five billion dollars [came from] other people’s money." One reason that some much money accrued to some Picower accounts is that Madoff favored them with extraordinary
returns. According to the Trustee, a few of them "enjoyed 14 instances of supposed annual returns of more than 100%" (while other clients got returns of only between 10% and 15%.)
The other favored client sued by the Trustee (and the SEC) is Stanley Chais, a former resident of the Bronx who established himself in Beverly Hills an unregistered investment advisor to a wealthy clientele. Like Picower, Chais had known Madoff for three decades, and his access was
such that his name came up first on Madoff’s office speed dial. According to the Trustee’s complaint, Chais withdrew $1.15 billion from 60 accounts for himself, family members, corporations in which he held interests, funds into which he consolidated his clients, and other
entities. He was also favored with inexplicably high phantom profits, with rates of returns in some accounts, according to the complaint, "in excess of 100 %–or even 300%– a year."
The Trustee alleges that Chais and Picower together withdrew a total of $7.9 billion between 1995 and 2008– most of which came from the phantom profits Madoff allocated to them.. If so, they, or the accounts they represented, took away nearly one-hundred times as much money as
Madoff himself siphoned off by writing checks for his personal and family use.
For their part, Chais and Picower, via their respective lawyers, deny any wrong doing and both men say they are themselves victims of the massive swindle and suffered ruinous losses.. Chais even wrote the federal bankruptcy judge that he is so short on cash that he has a "serious problem" paying a lawyer to defend him, Meanwhile, Picower virtually closed down his foundation because of the losses it suffered. Perhaps these men did not ultimately get the billions that the Trustee
alleges were withdrew from accounts under their control. After all, Madoff was not above forging his internal records. As one prosecutor pointed out, "Madoff’s " demonstrated ability to lie, mislead, and deceive is staggering." But if the $7.9 billion moved to other hands, where did it end up? This issue may be cleared up when Picower, Chais, and others have their day in court this summer (if the proceedings are not delayed ). But given Madoff’s international money laundering skills the $7.9 billion may already have been swallowed up by what the Trustee modestly describes as " a labyrinth of interrelated international funds, institutions, and entities of almost unparalleled complexity and breath."
***

The Car Czar Quits

2009-07-14T14:23:00.002-04:00

On March 29th 2009, Steven Rattner, the co-chairman of President Obama’s auto task force, met with Rick Wagoner, the chairman of General Motors, in Rattner’s new office in the Treasury Department, and in one of the most dramatic confrontations of the Obama administration in its first 100 days told him he would have to resign because he had lost the confidence of the Obama Administration. Wagoner, a 30-year veteran of GM, fell on his sword. Now, Less than 4 month after disposing of Wagoner, Rattner has announced he himself is resigning.
He now has to deal with the investigation by New York Attorney General Andrew Cuomo into the role that bribes played in inducing public officials to invest pension funds in private equity deals. What brought Rattner, a former golden boy of investment banking, into Cuomo’s investigative cross-hairs was deals he made when he headed Quadrangle Group, which specialized in raising money for leveraged buy-outs in the communications industry. The largest source of money for such buy-out funds was pension funds, which collectively manage about $2.3 trillion, and so he actively recruited money from state and municipal pension funds. To get business. he had employed Henry "Hank" Morris, a top advisor for then-New York State Comptroller Alan Hevesi to act as a placement agent for Quadrangle. In March 2009, Morris was arrested and charged in a 123-count criminal indictment for, among other things, "enterprise corruption" and "money laundering" in regard to selling access to the New York State Common Retirement Fund. Quadrangle had received $100 million from this pension fund just after paying Morris’s firm a placement fee. It also paid Morris for his help in getting money from the Los Angeles pension fund , the New York City pension fund and the New Mexico pension fund.
It is perfectly legal in these states for a private equity fund to pay fees to placement agents for this service so long as it discloses the, Such disclosures are necessary to identify possible conflicts of interest. Rattner presumably was familiar with these requirements since he had himself worked as a placement agent while at Lazard. However, in garnering investments from the Los Angeles and New York City pension funds, Rattner’s firm reportedly failed to disclose the placement fees that went to Hank Morris. In the case of the Los Angeles pension fund, Quadrangle identified two other placement agents it used, but not Morris’ firm. One of the key issues New York’s attorney general is now investigating is whether the New York City Pension Fund was"intentionally misled or deceived "in 2005 by Quadrangle’s failure to disclose paying finder's fees to Hank Morris’s firm.
Further increasing Rattner’s exposure to the bribery scandal, the New York attorney general’s office is also investigating whether Quadrangle might have evaded crucial reporting requirements with New York State Common Retirement Fund in 2005 by having one its private equity holdings buy DVD rights to a movie that was produced by the brother of David Loglisci, New York’s deputy comptroller. Loglisci, a close associate of Morris, was also indicted with Morris on corruption charges. The low budget movie entitled "Chooch," an Italian expression for a bumbling idiot, had failed at the box-office, taking in less than $40,000, before Quadrangle’s private equity holding bought the DVD rights for $88,000. According to a studio executive who deal with DVD distribution, the DVD rights to a movie like "Chooch" would be worth "zilch" since it would "cost more to manufacture the DVDs than a distributer could realistically hope to make from their sales." So was there another benefit to investing in Chooch? About three weeks after buying these DVD rights, Quadrangle got its $100 million from the New York State Common Retirement Fund for which Loglisci was the top investment officer. Adding to the intrigue, an executive at the CarlyleRiverstone fund, a joint venture of the Carlyle Group, which also used Morris’ firm to get money from the New York State pension fund, made a similar investment in Loglisci’s "Chooch." Among the charges against Loglisci (as well as Morris) is "money laundering."
To be sure, Rattner himself may be innocent of any wrong doing in making payments to Morris’ placement agent company and having a subsidiary invest in Loglisci’s "Chooch" venture. But with both the SEC and New York Attorney General Andrew Cuomo investigating these charges, and Morris and Loglisci due to go on trial in New York, Rattner may have unfinished business to settle with Cuomo, and reportedly hired his own lawyer. So ends the brief tenure of Obama’s auto czar.
****

The Feeder Frenzy

2009-07-06T10:10:00.002-04:00

The Third Missing Piece of The Madoff Puzzle is in my article in the Daily Beast today

http://www.thedailybeast.com/blogs-and-stories/2009-07-05/the-madoff-victims-who-came-out-ahead/?cid=hp:beastoriginalsR2

Like the mythic vampire, a Ponzi scheme needs to find new blood to sustain itself. So while Bernard L. Madoff had no problem creating the illusion of constantly expanding profits through the simple device of wholly inventing the transactions in accounts he managed, the only way he could meet requests for redemptions was to find new money. The amounts he needed became staggering in the 1990s, as a handful of his longtime associates cashed in billions of dollars of imaginary profits in their accounts.
To replace these billions, Madoff needed a new source. The mother lode he turned to was the ganglia of so-called feeder funds.
A feeder fund, unlike a hedge or private-equity fund, does not manage investments. It is simply a marketing operation. Its principals raise money from investors—often through their social, country club, and professional connections—that they then consolidate into a single account, which they funnel to a money manager with whom they have an arrangement.
Typically, in return for finding investors for the money manager, the feeder gets a relatively small placement fee of about 1 percent. The money manager then charges for his investing skills, typically deducts a performance fee of 20 percent from the profits as well as an annual "net asset" fee of 2 percent on the investor’s nest egg.
But Madoff offered feeder funds a much more alluring deal for finding him money. Instead of merely giving them the standard placement fee, he allowed them to take the entire cut of profits usually reserved for the money manager by waiving all his fees. This generous accommodation became extremely lucrative for them because Madoff reported profit annually of about 15 percent. So the principal of the feeder could deduct 20 percent of that putative profit from all their clients’ accounts, transfer it to their own "carry" account, and redeem it, with the result that they got cash while their clients’ fictitious profits grew each year.
But why would a highly successful money manager like Madoff make such an accommodation and essentially work for free for feeders? The explanation Madoff gave was that he was not greedy and content making a mere .04 cents a share from trading stocks in the accounts (which he could have made anyhow if he charged them a fee). As incredible as this rationale might sound, feeders had little incentive to look a gift horse in the mouth. This amazing inducement, together with the track record Madoff had totally invented, brought in enough from feeder funds to more than cover the $8 billion in withdrawals made by his longtime associates.
For their part, his feeder funds fared well, earning hundreds of millions of dollars in fees from their 20 percent cut of Madoff’s imaginary profits and their equally imaginary "performance."
Consider, for example, the success of Fairfield Sentry, a unit of the Fairfield Greenwich Group, whose principals included the socially prominent financier Walter Noel Jr., his four well-connected sons-in-law, and Jeffrey Tucker, a former Securities & Exchange Commission official. According to the complaint filed by Irving Picard, the court-appointed trustee for the liquidation of Madoff’s business, between December 1, 1995, and 2008, "it invested approximately $4.5 billion with Bernard L. Madoff Investment Securities through 242 separate transfers via check and wire."
From its cut of Madoff’s notional profits, the Fairfield Greenwich Group "reaped massive fees, in excess of hundreds of millions of dollars, purportedly for investment performance which has proven to be nothing but fiction."
The Wall Street Journal, which reviewed Fairfield Greenwich’s own records, reported that the firm earned $160 million in the fees it garnered from the money it outsourced to Madoff in 2007 alone. Before the Ponzi scheme collapsed in 2008, the trustee alleges that Fairfield Greenwich, and the entities under its control, withdrew more than $3.5 billion from Madoff. Presumably part of those redemptions included its own fees. Fairfield Greenwich denies it engaged in any wrongdoing and insists that it informed its investors of its relation to Madoff.
But some feeder funds failed to disclose their cozy relationship with Madoff, according to complaints filed by authorities in New York, Massachusetts, and Connecticut.
Consider, for example, the charges files against the entities of investment guru Ezra Merkin, who sits on the board of and invests for a number of universities and charities. Merkin’s three funds had (at least on paper) some $2.4 billion invested with Madoff, according to the 54-page civil complaint filed by New York State Attorney General Andrew Coumo.
Cuomo alleges that Merkin collected hundreds of millions of dollars of performance and net asset fees based on the fictional transactions of Madoff while he "actively obscured" that Madoff, not he, was managing money. Merkin’s three funds, called Ascot, Ariel, and Gabriel, all had money with Madoff. Ascot was purely a feeder fund for Madoff, whereas Gabriel and Ariel, which were supposed to perform complex arbitrages on distressed debt, divided their money between Madoff and two other money managers.
"The incentive fee Merkin collected included 20 percent of the profits reported by Madoff, which, of course, were fictitious," the complaint notes. "Even after subtracting expenses and fees paid to other outside managers, Merkin’s fees for Ariel and Gabriel totaled more than $280 million."
Meanwhile, Ascot produced an additional $169 million in net asset fees. And, according to the complaint, these fees were paid directly to Merkin, who did not reinvest them with Madoff via the feeder fund. While collecting these fees, Cuomo alleges, "Merkin’s deceit, recklessness, and breaches of fiduciary duty have resulted in the loss of approximately $2.4 billion" to his investors.
Merkin denies any wrongdoing. In the court papers filed on July 1, 2009, he asserts that his dealings with Madoff were known to his investors and there was no deceit or breach of his duty. Perhaps so, but if Cuomo’s assessment of Merkin’s financial records is accurate, Merkin raked in nearly $450 million in fees by giving Madoff the lion’s share of his investors’ money.
Madoff may have provided even more extraordinary emoluments to some other of his feeders. Consider, for example, what the trustee describes as "The Curious Case of Sonja Kohn." Kohn met Madoff in the mid-1980s, when she had her own brokerage company in New York. She then founded the Bank Medici AG in Vienna and used it as a feeder fund for Madoff.
Raising money from the newly rich oligarchs of Russia and Eastern Europe, she eventually placed (on paper, at least) an estimated $3.5 billion with Madoff. After the collapse, the trustee sorted through the records of one of Madoff’s front companies and found that sizable transfers had been made to Kohn, even though she did not work for that company.
Next, as The Wall Street Journal reported, prosecutors in the U.S., Britain, and Austria launched their own investigations of alleged payments she received from Madoff. According to the affidavit filed by U.S. prosecutors in Vienna, some $32 million was paid by Madoff over a course of 10 years to a New York company that was "owned by Sonja Kohn personally," while, according to a similar British affidavit, $11.5 million was paid by Madoff’s London subsidiary to another company she allegedly controlled.
If such payments were indeed made by Madoff, they provide an additional inducement for money-raisers to feed Madoff’s insatiable Ponzi scheme. Kohn states through her spokeswoman that neither she nor the Bank Medici received any kickbacks from Madoff and describes herself as "the greatest Madoff victim."
Even excluding such alleged side payments, Madoff’s feeders extracted more than $1 billion in performance and net asset fees from his phantom profits. While there is no evidence in any of the litigation that indicates that any of these feeders were privy to Madoff’s grand Ponzi scheme, they had intriguing clues that might have cast their golden goose in a different light, such as Madoff’s inexplicable generosity in relinquishing his entire performance fee just to get his hands on their money, his curious practice of exiting the market entirely at the very end of each quarter so that his quarterly statements to the feeder funds would list nothing but Treasury bills and cash, and, even curiouser, his employment of an unknown two-man accounting firm in New York's Rockland County—operating out of a 13-by-18 office, no less—to audit all his multibillion-dollar operations.
Missing such flashing signs that something was amiss while they harvested their rich bounty of fees may be understandable on Wall Street but, in my book, it hardly qualifies them for victimhood

Madoff's Winners

2009-06-25T09:43:00.005-04:00

The party is over for Bernard L.Madoff. He was sentenced to 150 years in prison and all his property confiscated. His crime was forging all the financial statements of his clients so as to create the illusion that they were making steady profits. In reality their money was being siphoned out of their accounts and given to others. As is now clear from recent court filings by the bankruptcy trustee, Irving Picard, and the SEC, this amazing Ponzi scheme had both winners and losers. While some 4,900 hapless investors, including retirees, family trusts, and charities lost their nest egg, a handful of financiers, all well versed in the arcana of investing other people’s money, made huge fortunes from Madoff’s notional book-keeping. The reason they could profit so handsomely from this shell game, as the Trustee explains in documents filed in U.S. bankruptcy court, was that "The money received from investors was not set aside to buy securities as purported, but instead was primarily used to make the distributions to – or payments on behalf of – other investors." So people who redeemed the imaginary profits in their account got the actual funds put in by the new investors. According to a lawyer involved in the bankruptcy case, the redemptions in excess of investments, as calculated by the Trustee, amount to over $10 billion. If so, the major redeemers took home many billions of dollars. As it turns out, almost all of fortunate redeemers turn out to be close business associates of Madoff who had been involved in his money game for two decades. Consider, for example, Jeffry Picower, who, as a lawyer, accountant, deal-maker, and tax-shelter promoter, who was well-experienced in financial arrangements, and who had dealt with Madoff for more than 30 years. According to the complaint of the Trustee for the bankruptcy of Bernard Madoff’s firm, Picower had 24 Madoff accounts under his control from which he withdrew a staggering $6.7 billion from which he got, for himself and his entities, "at a minimum, more than five billion dollars of other people’s money." Madoff kept meticulous records of correspondence with his early investors which show that Picower, according to the court filings of the Trustee, "was one of a handful of clients with special access" to what Madoff called his "targets" for profits each year. These "targets" could be then achieved by since Madoff since virtually all his trades were fictitious for each accounts. So, If any of his clients with special access requested a higher or lower number than his target for tax or other purposes, Madoff simply adjusted the "profits", and, if necessary, backdated them Picower, the Trustee alleges, frequently specified the profits he wanted for different accounts and, in one case cited by the Trustee, even supplied backdated documentation that Madoff then used in his fabricated book-keeping. Madoff also allegedly shifted billions of dollars of taxable income for Picower’s entities into future years by phony trades. In December 1999, for example, he trustee alleges that Madoff forged nearly $11 billion in short sales in Picower’s accounts in December 1999 "to increase the net cash deficit across these accounts by $2.5 billion" in tax-year 1999. And then reversed these fake trades in January 2000. Such artful legerdemain could defer taxable income and, by doing so, further enhance the value of the $5 billion that Picower, and the entities he controlled, walked away with.
Another intriguing winner, according to a civil fraud complaint filed by the SEC this week (June 22nd), is Stanley Chais. Chais, an unregistered investment advisor with a long roster of wealthy clients in Beverly Hills, Hollywood and elsewhere, also knew Madoff for some 30 years. He was indeed in such close contact with Madoff that his name came up first on Madoff’s office speed dial. Chais had, or controlled, 60 separate Madoff accounts. Some were for himself, his family members, and his foundations; other were for outside investors he had consolidated into 3 feeder funds The SEC states in the complaint , that "unlike the thousands of investors who lost money in the Madoff scheme, Madoff’s enterprise ultimately proved to be extremely profitable for Chais." The SEC says that Chais, along with his family and foundations, "withdrew approximately a half billion dollars more than they had invested with Madoff." As for the outside investors, Chais levied a heavy performance fee of 25% on their putative profits each year based on Madoff’s performance. which, according the SEC complaint, amounted to $269.7 million. Chais also had impressive access to Madoff, according to the separate complaint filed by the Trustee in bankruptcy court, that alleges that Chais was able to specify the size of the "profits" and "losses" in his different accounts "presumably for tax purposes." In all the entities under his control– which includes his fees on :profits", the Trustee calculates Chais withdrew $1.2 billion.
A third winner, according to another SEC complaint filed this week (June 22nd), is Robert Jaffe. A well-know investor in Palm Beach and Boston, Jaffe is a son-in-law of Carl Shapiro, a 95 year old multi-millionaire philanthropist, who was one of Madoff’s earliest financial backers in 1960. He has known Madoff for over 30 years and his brokerage firm Cohmad, which was partially owned by Madoff, operated out of Madoff’s offices in the Lipstick building. The SEC alleges in the complaint it filed against Jaffe and other members of Cohmad, that Jaffe received hidden side payments directly Madoff of over $100 million for recruiting more than $1 billion of investments from his social circles in Florida and elsewhere for Cohmad (which put 99.7% of its investments in Madoff’s scheme). According to the SEC, Madoff channeled this money to Jaffe by crediting his account with at least three times the "profits" that he was crediting to Cohmad investors, and then allowing Jaffe to redeem between 1996 and 2008 over $150 million. Jaffe also made, according to the SEC, "specific requests" to Madoff for "a specific dollar amount of gains for a given period," including ones for "long term gains." A Madoff employee "would then insert a backdated trade going back days, weeks or even months that afforded Jaffe's account that particular gain." By transforming short term gains into capital gains, these "trades" may have helped reduce Jaffe’s tax bill on the $150 million he withdrew.
Picower, Chais, and Jaffe all deny via their lawyers that they had any knowledge of the Ponzi scheme. If so, they presumably believed that Madoff had been gifted with a Midas touch– indeed one so deft it could produce the precise results for which they wished . Was this willful blindness? Financiers’ capacity for self-deception should never be underestimated, especially when it serves to rationalize hundreds of millions of dollars in profits. But to depict such major redeemers as victims of Madoff’s Ponzi scheme stands on its head Balzac’s dictum that "Behind every great fortune is a crime."
***

Madoff's Secret Service

2009-06-15T09:28:00.006-04:00

A missing piece in the Madoff puzzle is the motive of his early wave of investors in Madoff’s operation before he had established an impressive track record. Why did a dozen or so multi-millionaire businessmen put both a large share of their personal wealth and that of their tax-exempt foundation in multiple accounts with Madoff? If these financially savvy investors only wanted to compound their wealth, other highly-regarded money managers, such as George Soros, Julian Robertson and Paul Tudor Jones, offered better track records over longer periods as well as much safer financial controls, including outside custodian and auditing services. Presumably Madoff was able to offer these wealthy investors some other service they could not obtain elsewhere. But what?

The secretive way in which he personally ran his operation from a small office in the Lipstick Building in New York may well have been part of the inducement. Since he alone handled each account and determined its profits and losses from each putative transaction, he was in a unique position to custom-tailor how they were allocated between a client’s taxable personal accounts and his tax-exempt charitable accounts. In fact, presumably unknown to these investors, Madoff was running a Ponzi scheme in which he forged the paperwork to create imaginary profits. Even without such notional book-keeping, it would have been child’s play for Madoff to provide his clients with the results that helped them minimize their annual tax bills. This service became particularly valuable to wealthy individuals after Congress in 1982, at the behest of Senator Daniel P. Moynihan, amended the Economic Recovery Tax Act to prohibit a common practice in which wealthy investors used commodity trades to shift their taxable profits into future years. Madoff’s correspondence with his clients, according to one lawyer involved in the ongoing civil suit, shows that this was precisely the secret service Madoff was supplying his early clients. "If a client needed to offset taxable income in a given year," the lawyer explained, "Madoff would give him a paper loss, and put the off-setting profit in his tax-exempt account and then presumably return it in the next year, or when he needed it." As far as how he did this legerdemain, he apparently had a "Don’t ask, Don’t Tell" policy.

Irving Picard, the court-appointed trustee in the bankruptcy liquidation of Madoff's firm, found correspondence in Madoff’s files showing that investors specified the loss that would be helpful. Indeed, he charges in court papers that one of these early investors, who had $178 million in different Madoff accounts requested, as reported by The Wall Street Journal, "fictitious losses from Mr. Madoff's firm, apparently to offset gains he made through other investments in order to avoid taxes." He cites another early investor, who had nearly a billion dollars in 12 different accounts for his family and foundation who, according to Picard, had an assistant at his foundation request a $12.3 gain for his foundation. According to him, there were wide variations in different accounts. Even though allocations between accounts might raise tax evasion issues, all the investors cited in the Trustee’s suit deny any wrongdoing, and no charges have been brought against anyone to date except Madoff himself, who pleaded guilty to fraud in March 2009, and his firm’s auditor, David Friehling, who is out on bail awaiting trial.
The bespoke tailoring of taxable income was not the only special service. Madoff also provided these early clients with a steady increase in the reported value of their total investments in both good and bad times (such as in the crash of 1987). We now know that he achieved these results by inventing them. And they provided him with the sort of enviable track record he needed to attract a second wave of investors in his Ponzi scheme. As word spread among the rich of Madoff’s amazingly steady returns in both good and bad years, he was approached by numerous"feeder funds." These are essentially money-raising operations that turn virtually all the money they raise over to another money manager. As compensation, they usually get a relatively small placement fee from the money manager, who then charge the investors his own performance fee– typically 20 percent of the profits– and an annual charge– typically one percent of the value of their total investment.

Madoff offered these money-raising funds a far more lucrative deal in which he would waive his fee entirely, allowing the feeder funds to charge the investors a performance fee as well as an asset fee on the profits that Madoff would generate each year. Madoff explained that he could afford to provide this zero-fee service to funds because he earned commissions buying and selling options on the shares. Rather then looking a gift horse in the mouth, feeder funds eagerly outsourced their investors’ money into Madoff. The profits they earned from these fees were staggering. For example, in 2007 alone, Fairfield Sentry, a unit of the Fairfield Greenwich Group, raked in $160 million in fees on the money it had outsourced to Madoff. Such fees, of course, were based on the fake numbers Madoff supplied. After the Ponzi scheme was exposed in 2008 by Madoff himself, many of these funds claim to be victims of his fraud. Perhaps so, but certainly the investors in these feeder funds qualified as the prime victims. As lawsuits brought by bankruptcy trustee Picard and the ongoing federal investigation proceed, and we learn more about the special services Madoff provided "victims," including the bespoken allocations that allowed them to reduce their taxable income and the zero-fee management that allowed feeder funds to harvest a huge bounty from his phantom profits, it may be useful to ponder W.C. Fields famous dictum "You can’t cheat an honest man."
***

The Russian Take Over The Diamond Cartel

2009-05-29T11:36:00.012-04:00

De Beers Consolidated Mines, Ltd., whose mines up until recently produced over 40 percent the world’s diamonds, reduced its output of rough diamonds by about 90 percent in 2009. Moreover, in accordance with the new anti-trust laws of the European Union, it stopped buying diamonds from other producers for its stockpile. By doing so, it effectively relinquished control over the diamond prices to the Russia’s state-controlled monopoly, Alrosa, which is now the largest the world’s largest diamond producer.
For more than a century, De Beers had been the undisputed overlord of a global diamond cartel. Indeed it masterfully created and perpetuated the diamond invention, the idea that diamonds are rare and forever valuable. To be sure, until the late nineteenth century, diamonds were truly rare, found mainly in a few riverbeds in India and South America, and the entire world production of gem diamonds amounted to a few pounds a year. Then in 1870, huge diamond mines called “pipes”
because of their circular shape were discovered in South Africa, where
diamonds were soon being scooped out by the ton by steam shovels. As
these diamonds poured onto the market, the price dropped to loss than
$10 a carat, endangering the investments in these mines. Realizing that
the flood of diamonds from these pipes, if not abated, would destroy the
public’s perception that diamonds were scarce, and that without the
perception of scarcity diamonds would become at best only
semiprecious gems, the mine owners moved to limit the surfeit of
diamonds by merging their properties in 1888 into a single entity, De
Beers. This diamond cartel, which then came under the control of the
Oppenheimer family, maintained the “price security” crucial to the
illusion by releasing onto the market only the number of carats to satisfy
demand at the established price and stockpiling the excess diamonds in
its vaults in London and Johannesburg. When diamonds were found in
more and more countries, it worked through an intricate system of
bankers, shell corporations, and buying agents to keep them in a single
channel of distribution called the “Central Selling Organization.” By
acting as the buyer of last resort, De Beers proved be the most successful
cartel arrangement in the annals of modern commerce. Then, in the
1960s, it was confronted by a new challenge: a huge pipe mine
discovered outside in purview in Siberia. Even though the Russians had discovered it in 1955, the incredibly harsh conditions in Siberia delayed its development until 1962.
Concerned that these small, mainly quarter to half carat diamonds would
disturb the precariously balanced market, Sir Philip Oppenheimer, the
head of the Central Selling Organization, rushed to Moscow to negotiate
a 5 year deal to buy virtually all the Siberian diamonds. De Beers
considered it a good investment, even if had to stockpile all these
diamonds, because, based on the data, it had it could reasonably expect
the production from that Siberian mine to gradually diminish as similar
mine had done in South Africa. Instead, production accelerated at an
incredible pace, and by 1968, it was delivering nearly two million carats
a year to De Beers, most of which were added to its bulging stockpile.
In return, the diamond haul provided the Soviet Union with so much
hard currency that the head of the Mirny Diamond Administration said,
"We call ourselves the country's foreign exchange department."
When Russia delivered some 2.5 million carats in 1976– -almost onequarter of the world's supply– Sir Philip insisted on personally inspecting the mysterious Siberian mine before he would renew thecontract. He was accompanied by Barry Hawthorne, who was then De Beers' chief geologist in Kimberley. By the time they had completed the arduous journey to Mirny– fog delayed the flight for nearly a day–
they had very little time to inspect the mine. "We had about a twentyminute tour of the mine," Hawthorne later told me, and what he saw at the open pit site only deepened the mystery of how the Russians produced vast quantities of gem diamonds from the depth of the excavation he could calculate that less ore had actually been taken from
this mine since 1960 than would be able to produce anywhere near the
quantity of gem diamonds the Russians were shipping to De Beers– at
least by comparison to their South African state-of-the art mines.
Hawthorne theorized that Russia must have “secret mines” elsewhere.
The Siberian diamonds also intrigued the CIA since the hard currency
they provided could fund KGB operations. The CIA’s
counterintelligence staff even looked into the possibility that the
Siberian diamonds were man-made, or “grown”, in hydraulic presses– a
process which had been demonstrated experimentally by General
Electric but proved economically unfeasible (at least in the US)– though
it could not find any evidence to substantiate this theory. In any case,
for de Beers, the enigma became a moot issue: wherever these diamonds
came from– whether the Mirny mine or some other secret sources– they
could not be allowed to inundate the market and destroy the illusion of
scarcity. Whatever their origin, De Beers had to keep them in its
“single channel” of distribution. So though, the price was a matter of
tough negotiations, it continued to bear the burden of sustaining the
illusion of scarcity.
After the Soviet Union collapsed in 1990, De Beers still bought about
half of Russia’s diamonds (with the balance consigned to local
consumption or the Russian stockpile that had been created by the
Communists in 1917 to hold gems taken from the Czar.)
Since acting as buyer of last resort put enormous financial strains on
the company, and mew antitrust laws in Europe made it more difficult to
stockpile diamonds, De Beers sought a new strategy by moving to
establish its brand in the retail end of the diamond business. Then,
facilitating this change, the European Union in 2008 prohibited De
Beers from stockpiling Russian diamonds. Even though the Supreme
Court of the European Union later suspended that prohibition, De Beers
agreed to end its long-standing deal with the Russians by 2009. As a
result, the baton has been passed to the Russian diamond monopoly
Alrosa.
The Russians are aware of the requisites of running the cartel. “If you
don’t support the price,” Andrei V. Polyakov, a spokesman for Alrosa
told the New York Times, “a diamond becomes a mere piece of carbon.”
The immediate problem confronting the Russians is the $5 to $7 billion
worth of diamonds in the so-called pipeline, which are the diamonds
bought by cutters, dealers, and manufacturers, mainly with bank
financing, that because of the collapse in retail sales, remain in their
inventories. On top of that, new pipe mines in Angola and Australia
threaten to further destabilize the market. So the new overlords of the
diamond cartel have their work cut out for them.
But while the Russians may share the motivation and even logic of
De Beers, the diamond invention is far more than a monopoly for fixing
diamond prices; it is a mechanism for converting tiny crystals of carbon
into universally recognized tokens of wealth, power, and romance. De
Beers managed this feat through the intangible but crucial element of
good will. For three generations, the Oppenheimer family built a
network of relationships with diamond cutters in Antwerp, brokers in
Tel Aviv, intermediaries in Africa, and bankers in London which was
based on a long-standing mutual trust. This network furnished, among
other things, much of the pricing intelligence, discipline and public
relations that allowed De Beers to control the diamond trade. If the
Russian monopoly lacks the necessary human capital to run this delicate
mechanism, the illusion at the heart of the diamond invention , along
with the diamond prices it has for so long sustained, may be forever
shattered.
Part II- What Happens If The Russians Fail
Edward Jay Epstein is the author of The Rise and Fall Of Diamonds

Cuomo's Matrix Of Corruption

2009-05-18T11:27:00.013-04:00

The corruption of pension funds by private interest is hardly a new phenomenon. Las Vegas after all was largely built with money from the Teamster’s Central States Pension Fund, with the intermediary Sidney Korshak, a mob- connected lawyer, channeling a large part of it to casino owners. Korshak himself was never conducted of any wrongdoing, but Jimmy Hoffa, the President of the International Teamster Union, was imprisoned on corruption charges in 1971, Then, after getting a pardon from President Nixon in 1974, he literally disappeared without a trace (his body, according to the latest FBI theory, had been cremated by his associates in organized crime). Today, Pension fund financing is a far more respectable and civilized industry. It is also vastly richer, with pension fund s holding over $2.7 trillion in assets, and providing private equity firms with the most of the capital they use for their leveraged buy-outs, real estate acquisitions and other ventures. In return for allowing pension funds to participate in their deals, the private equity firms exact lucrative fees, taking both a percent of their total investment– typically two percent per year– and part of the profits– usually 20 percent of each successful deal. In 2008, the ten largest pension funds had allocated $105 billion to such private equity deals, creating a veritable El Dorado. To mine this mother lode, private equity firm had to first access to the functionaries at the pension fund who controlled these allocations, and while there is no single powerful intermediary in the class of Sydney Korshak, there are legions of less visible intermediaries called, "placement agents," who use their political contacts, financial experience, powers of persuasion, and other means to extract pension fund money for private equity firms. Indeed, it is now a multi-billion dollar industry. In return for inducing pension fund officials to invest in such deals, they get a cut from the private equity firm of usually between 1 and 3 percent of the total commitment. Since placement agents gets nothing if they fails, they have a powerful incentive to do what is necessary to close the deal. The question currently concerning New York State Attorney-General Andrew Cuomo, the SEC, and some 36 other state attorneys general law is: how do they accomplish their amazing feat of inducement?
According to Cuomo, who is spearheading the investigation, there is " a matrix of corruption, which grows more expansive and interconnected by the day." So far six people have been charged criminally and two people have pleaded guilty. Among those charged with "enterprise corruption" are Henry "Hank" Morris, and his friend David J. Loglisci. Morris, a former top aide to former New York Comptroller Alan Hevesi, who was in charge of New York’s $122 billion pension, raked in at least $15 million dollars in "placement" fees from private equity firms. Former deputy comptroller Loglisci, the top investment officer of the state’s pension fund, allegedly got paid from Morris and also had private equity firms steer money into a curious movie venture called "Chooch he and his brother produced, and whose plot, aptly enough, concerns a bag of mystery money. Both Morris and Loglisci deny any wrong doing and are currently awaiting trial.
Cuomo’s game plan, according to one lawyer knowledgeable about the investigation, is "to work his way up the food chain." This strategy, as the lawyer explained, involves making deals with less-culpable parties in return for their cooperation and testimony against other private equity firms whose real exposure comes not from their making payments to placement agents, which is perfectly legal in most states, but from their failure to disclose them or, even worse. "disguising them" as sham transactions.
Consider the recent guilty plea of placement agent Julio Ramirez Jr. to a misdemeanor securities fraud violation. According to Cuomo’s office, Ramirez, , who worked for the placement agent Wetherly Capital Group in Los Angeles, entered into a "corrupt arrangement" with Hank Morris to get private equity firms $50 million in investments from New York's $122 billion Common Retirement Fund. Ramirez then split his fees with Morris, but did not disclose Morris’ involvement. Since that omission made him vulnerable to prosecution, he elected to cooperating with the Cuomo’s investigation, further tightening the prosecutorial vice on Hank Morris.
Cuomo also made settlements with the Carlyle Group, one of the nation’s largest private equity firms and Riverstone Holding a private equity company headed by David M. Leuschen. Their joint venture had paid $10 million to Hank Morris’ firm for its help in getting it $730 million in investments from the New York Pension fund. Leuschen, had also invested $100,000 of his own money in the movie Chooch, a movie venture that involved David Loglisci, the chief investment officer of that pension fund. Since the joint venture had fully disclosed its payments to Morris’s firm and could claim that it was not involved in Leuschen’s personal investment in the Chooch investment, Cuomo made a deal with both Carlyle and Riverstone in which each paid a fine– Carlyle $20 million and Riverstone $30 million and agreed not to use placements agents in any future deals and to fully cooperate in the ongoing investigation. In addition, Carlyle, issued statement saying that it "was victimized by Hank Morris's alleged web of deceit." It also moved to sue both him and his company for more than $15 million in damages, further racheting up the pressure on Morris to make a deal. The settlement did not include Leuschen, who is still, according to Cuomo, "under investigation." It also does not bode well the 20 other investment firms ensnared in Cuomo’s Matrix. The Quadrangle Group, for example, paid Morris placement multi-million dollar fees for assisting it get pension fund money in New York, New Mexico, and California and also invested money in the mysterious Chooch venture. But, unlike Carlyle and Riverstone, Quadrangle failed to disclose it’s the fees it paid Morris’ company to New York City Pension Fund and the Los Angeles Fire and Police Pensions Fund. Nor can it separate itself from its Chooch investment by, as Carlyle and Riverstone did, shifting responsibility to a personal investment, since it had one of its own private equity holdings buy the video rights to movie. One possible problem for Cuomo– as well as the SEC investigation is the prominence of Quadrangle’s then chairman Steven Rattner, who in 2009 became a key member of President Obama’s task force that is presently desperately working to save General Motors and the American car industry.
But Cuomo has pledged that "The investigation will continue until we have unearthed all aspects of this scheme." As he is both a tenacious– and ambitious investigator, he will undoubtedly topple more dominoes as he proceeds up the food chain . But will he break the matrix of corruption? Stay tuned.

(Updated June 12)

The Amazing Chrysler Trick

2009-05-08T09:39:00.007-04:00

The latest casualty of the economic crises is the Rule of Law.
Consider the sad case of Chrysler. Its troubles became manifest in 2007,
when it was owned by the German auto giant, Daimler, and it was unable to come to terms with the United Auto Workers labor union (UAW). Rather than suffer more losses from an unfavorable union contract, Daimler decided to rid itself of Chrysler by handing over 80 percent of its ownership to Cerberus Capital Management, a private equity fund named after the mythical creature guarding the doors of hell. After Cerberus agreed to keep the car company going, Chrysler celebrated with a huge fireworks display and acrobats swinging on ropes from its roof at its headquarters in Auburn Hills, Michigan. Chrysler then borrowed $10 billion from a banking syndicate, led by J.P. Morgan Chase, Citigroup, and Goldman Sachs, to fund its operations. The loan was secured by mortgages on Chrysler's real estate,manufacturing plants, patents, and highly profitable brand licensing rights (Jeep alone earned $250 million a year licensing its name to toys, clothes,and other products.)
The lenders assumed (incorrectly, as it turned out) that their secured loan which was senior to any other Chrysler debt, would be protected even if Chrysler went bankrupt, since the iron rule of bankruptcy held that secured loans get fully paid before unsecured loans. Without this rule, financiers would be reluctant to lend money to corporations on their assets. What these lenders had not reckoned on was the political power of the UAW, especially after the 2008 Democratic landslide.

With automobile manufacturing shifting from the unionized factories of the Big Three– Chrysler, General Motors, and Ford– to the non-unionized factories owned by foreign manufacturers, including those of Toyota, the UAW was rightly concerned that it would lose its grip on the automotive industry. Already, in 2008, these non-union factories‹located mainly in traditionally Red, or Republican, states whose "right-to-work" laws prevented employees from being forced to join a union‹were selling almost as many passenger cars in America as the Big Three. So if Chrysler was allowed to collapse, the UAW stood to lose heavily. As
did the Blue states in the Midwest where its factories are located. So the
UAW had little difficulty in rallying massive support for a rescue among the Democratic leadership of both the House and Senate. By February. President Obama had appointed investment banker Steven Rattner to head his auto task force and come up with a plan.
The solution that Rattner (aka the car czar) endorsed involved dividing Chrysler into two companies‹an old Chrysler, which would be saddled with the debts, and disappear, and a new Chrysler, to which all the valuable assets would be assigned, including those that had been mortgaged to the senior secured creditors.

The new Chrysler would be owned by the UAW, which would get 55 percent of the shares; Fiat, the Italian manufacturer, which would be get 20 percent, with the option of increasing its ownership to 35 percent if it conformed to the targets imposed by the U.S. government; and the U.S. government, which would get most of the remaining shares. Fiat would essentially run the company, supplying its small-car technology and its management (even though, on previous occasions, its managerial efforts in America proved unsuccessful.) The new deal is a win-win for Fiat, since it is not investing any money in the new Chrysler, and can walk away without a penalty.
But what of the people who lent the old Chrysler money secured by its
assets? According to the rules of bankruptcy, they were entitled to be paid
the full $6.9 billion they'd lent the old Chrysler before those assets could be shifted to the new Chrysler‹and before the unsecured creditors, including the UAW's pension fund and auto-part suppliers could be paid a cent. That was not in the car czar's game plan, however, Instead, the creditors were confronted with a take-it-or-else offer of 29 cents on the dollar,
substantially less than the unsecured creditors would receive. (The UAW's
fund, for example, would receive an implied 55 cents on the dollar.) The "else" turned out to be what President Obama described as a "surgical bankruptcy" for Chrysler in a pre-selected U.S. bankruptcy court. Here the administration was able to play its ace in the hole. The four bank that held 70 percent of these loans, namely Citigroup, Goldman Sachs, Morgan Stanley, and JP Morgan Chase, all had received government bailout money, making them vulnerable to government reprisals. So while denouncing hold-outs as "speculators" and "obstructionists" or, as one Congressman from Michigan termed them, "vultures", it was not difficult for officials to strong-arm these banks into accepting the deal.
Using these tactics, Chrysler was able to secure the support of more than two-thirds of its creditors. Once that threshold had been crossed, U.S. bankruptcy judge Arthur Gonzales was within his rights to force the remaining creditors to approve the plan.
Whether or not this extraordinary intervention saves Chrysler, which lost a
staggering $16.8 billion in 2008, remains an open question. After all, even
Fiast's organizational skills may not be enough to persuade
American consumers to buy cars from a company emerging from bankruptcy, especially since its much-heralded small-car technology, meanwhile, will not appear until 2012.
But the consequences of upending the rule of law, even if it was done with
the best of intentions, may prove far more serious than whatever befalls
Chrysler in the Rustbelt. For one thing, it will undoubtedly become far more difficult for an American corporation to borrow money on its assets, since even a senior secured lender can no longer be sure his claim will take priority over those of labor unions and other unsecured creditors.
As one savvy investment banker told me, "Now that we live in a banana
republic, secured lending is anything but secure."

Ruling The Secret World Of Money

2009-04-30T10:46:00.003-04:00

The Bank of International Settlements, better known as the BIS, is now calling for a global currency to replace the dollar as a reserve currency. Such a change would upend a financial system that has been in place since the Great Depression. As I reported well before the current crises, the power of the BIS, though cloaked in secrecy, should not be underestimated. It is, after all, the private club of the world's central bankers.

Is The car Czar Due For a Recall?

2009-04-26T16:37:00.003-04:00

On March 29th 2009, Steven Rattner, President Obama’s newly-appointed car czar, met with Rick Wagoner, the chairman of General Motors, in Rattner’s new office in the Treasury Department, and in one of the most dramatic confrontations of the Obama administration in its first 100 days told him he would have to resign because he had lost the confidence of the Obama Administration. Wagoner, a 30-year veteran of GM, fell on his sword. Now, Less than a month after disposing of Wagoner, Rattner may confront a similar decision about his own tenure.
Up until leaving Wall Street for Washington in, Rattner, a 56-year-old former New York Times reporter, had a golden career in investment banking, working first at Morgan Stanley, then becoming a senior partner at Lazard Freres, and finally, in 2000, co-founding his own firm, Quadrangle Group, which specializes in raising money for leveraged buy-outs in the communications industry. The largest source of money for such buy-out funds was pension funds, which collectively manage about $2.3 trillion, and so he actively recruited money from state and municipal pension funds.
What brought Rattner into the investigative cross-hairs was that he had employed Henry "Hank" Morris, a top advisor for then-New York State Comptroller Alan Hevesi, to act as its placement agen. In March 2009, Morris was arrested and charged in a 123-count criminal indictment for, among other things, "enterprise corruption" and "money laundering" in regard to selling access to the New York State Common Retirement Fund. Quadrangle had received $100 million from this pension fund just after paying Morris’s firm a placement fee. It also paid Morris for his help in getting money from the Los Angeles pension fund, the New York City pension fund and the New Mexico pension fund.
It is perfectly legal in these states for a private equity fund to pay fees to placement agents for this service so long as it discloses them. Such disclosures are necessary to identify possible conflicts of interest. Rattner presumably was familiar with these requirements since he had himself worked as a placement agent while at Lazard Frere. However, in garnering investments from the Los Angeles and New York City pension funds, Rattner’s firm reportedly failed to disclose the placement fees that went to Hank Morris. In the case of the Los Angeles pension fund, Quadrangle identified two other placement agents it used, but not Morris’ firm. One of the key issues New York’s attorney general is now investigating is whether the New York City Pension Fund was "intentionally misled or deceived" in 2005 by Quadrangle’s failure to disclose paying finder's fees to Hank Morris’s firm.
Further increasing Rattner’s exposure to the so-called pay For play scandal, the New York attorney general’s office is also investigating whether Quadrangle might have evaded crucial reporting requirements with New York State Common Retirement Fund in 2005 by having its subsidiary buy DVD rights to movie that was co-produced by David Loglisci, New York’s deputy comptroller. Loglisci, a close associate of Morris, was also indicted with Morris on corruption charges. The low budget movie entitled "Chooch," an Italian expression for a bumbling idiot, had failed at the box-office, taking in less than $40,000, before Quadrangle bought the DVD rights for $88,000. According to a studio executive who deals with DVD distribution, the DVD rights to a movie like "Chooch" would be worth "zilch" since it would "cost more to manufacture the DVDs than a distributer could realistically hope to make from their sales." So was there another benefit to investing in Chooch? About three weeks after buying these DVD rights, Quadrangle got its $100 million from the New York State Common Retirement Fund for which Loglisci was the top investment officer. Adding to the intrigue, a top executive of the CarlyleRiverstone Fund, a joint venture of the Carlyle Group, which also used Morris’ firm to get money from the New York State pension fund, made a similar investment in Loglisci’s "Chooch." Among the charges against Loglisci (as well as Morris) is "money laundering."
To be sure, Rattner himself may be innocent of any wrong doing in making payments to Morris’ placement agent company and having a subsidiary invest in Loglisci’s "Chooch" venture. But with SEC ans New York Attorney General Andrew Cuomo investigating these charges, with law officers in California, New Jersey, and New Mexico preparing their own investigations, and Morris and Loglisci due to go on trial in New York, Rattner needs to weigh whether, like Caesar’s wife, the car czar needs to be above suspicion. If so, just as he had the courage to ask Wagoner to retire for the good of General Motors, he might be prompted to consider the same course of action for himself.

The Placement Agent Scandal

2009-04-22T15:55:00.006-04:00

Is it Placementagent Gate? The placement agent scandal continues to unfold today with Steven Rattner, Obama’s car czar, more and more in the cross-hairs. This afternoon New York Attorney General office announced that it is investigating whether Rattner’s firm Quadrangle Group "intentionally misled or deceived" New York City Pension Funds in 2005 by failing to disclose money paid to a politically-connected placement agent (since indicted.) Meanwhile New York State announced a permanent ban on the use of placement agents. The real scandal here is how these agents of influence are used to corrupt pension funds, as well as college endowment funds, which put over 130 billion tax-free dollars in leveraged buy outs in 2008. For the implications, see my Clog in yesterday’s Daily Beast.

The AIG Bail-Out: A Necessary Conspiracy?

2009-04-03T09:28:00.003-04:00

AIG was a death star on September 15th 2008. One does not need a conspiracy theory to understand why the Fed intervened to prevent financial Armageddon. See my article in the Daily Beast.

Diamonds Are No Longer Forever

2009-03-25T08:32:00.005-04:00

Responding to the global recession in late February, De Beers’ once mighty diamond cartel closed down about half its global production, including Orapa Number 1 in Botswana, the world’s biggest diamond mine. The immediate problem was a nearly 25 percent drop in prices in December. But De Beers’ fear is not just that retail prices will continue to decline - it has managed that problem before - but that the public will begin to sell its hoard of diamonds, or what is called at De Beers "the overhang."
At the heart of this concern is the reality that, except for those few stones that have been permanently lost, every diamond that has been found and cut into a gem since the beginning of time still exists today. This enormous inventory, which overhangs the market, is literally in - or on - the public's hands. Some hundred million women wear diamonds, while millions of other people keep them in safe deposit boxes as family heirlooms.
De Beers executives estimate that the public holds more than 500 million carats of gem diamonds, which is more than 50 times the number of gem diamonds produced by the diamond cartel in any given year. The moment a significant portion of the public begins selling diamonds from this prodigious inventory, the cartel would be unable to sustain the price of diamonds, or maintain the illusion that they are such a rare stone that their value is, as the ad slogan claims, "forever."As Harry Oppenheimer, who headed the cartel for more than a quarter of a century, pointed out, "wide fluctuations in price, which have, rightly or wrongly, been accepted as normal in the case of most raw materials, would be destructive of public confidence in the case of a pure luxury such as gem diamonds, of which large stocks are held in the form of jewelry by the general public."The genius of the cartel was creating this "confidence" in the myth that the value of diamonds was eternal. In developing a strategy for De Beers in 1952, the advertising agency N.W. Ayer noted in a report to De Beers: "Diamonds do not wear out and are not consumed. New diamonds add to the existing supply in trade channels and in the possession of the public. In our opinion old diamonds are in 'safe hands' only when widely dispersed and held by individuals as cherished possessions valued far above their market price."In other words, for the diamond illusion to survive, the public must be psychologically inhibited from ever parting with their diamonds. The advertising agency's basic assignment was to make women value diamonds as permanent possessions, not for their actual worth on the market. It set out to accomplish this task by attempting through subtly designed advertisements to foster a sentimental attachment to diamonds that would make it difficult for a woman to give them up. Women were induced to think of diamonds as their "best friends."This conditioning could not be attained solely by magazine advertisements. The diamond-holding public, which included individuals who inherited diamonds, had to remain convinced that the gems retained their monetary value. If they attempted to take advantage of changing prices, the retail market would be chaotic.
Even during the Great Depression of the 1930s, there was only a limited overhang, since the mass-marketing of diamonds had begun only a single generation before the crash. So even though demand for diamonds almost completely abated, De Beers, by shuttering all its mines and borrowing money to buy up the production of the small number of independent mines that still existed, was able to weather the crisis.Today, however, with many generations of the diamonds it mass-marketed overhanging the market, and most of global diamond production in independent hands, it no longer is in a position to bring supply and demand into balance. Adding to this precarious situation, diamond cutters, manufacturers and dealers, have, as of Feb. 15, an estimated $40 to $50 billion worth of diamonds in mines in the pipeline that will intensify the downward spiral when the gems reach the market later this year.If the current recession so deepens that the desperate need for money trumps the tenacious grip of sentiment, and the public begins selling even part of its hoard, it could finally shatter the brilliantly nurtured illusion that the value of the glittering stones kept on fingers, in jewel boxes, and in vaults is eternal. As the overhang came pouring into the maket, De Beer's nightmare could become a reality.

Sympathy For The Devil: Why AIG Had No Choice But To Pay

2009-03-20T16:38:00.006-04:00

If you want to understand why AIG awarded derivative traders in its Financial Products Group $165 million in bonuses, don’t be distracted by the on-going morality play staged by politicians about the misuse of Federal funds, the blame-shifting game played by AIG executives, or even the disingenuous hand-wringing about the sanctity of contracts. The real decider here is money, specifically, $1.6 trillion worth of volatile derivative contracts. This portfolio, managed by some 400 people in a London-based subsidiary , mainly consists of credit default swaps, interest rate swaps, and other exotic hedging swaps that have the potential of inflicting hundreds of billions of dollars of losses on AIG– and, its de facto partner, the US tax payer.
How did the world’s largest insurer become a hostage to its subsidiary? In 1998, this tiny group got into the newly-created credit default swap business when JP Morgan Chase came to it with a proposition to transform debt on its books into security packages that could be sold off its books. To make these bank debt packages salable to other institution, they needed credible insurance against default to get Triple-A rating. So the AIG financial product group, seeing no risk of default, sold it in the form of credit default swaps. Soon afterwards, with the support of Treasury Secretary Lawrence Summers (now President’s Obama’s economic advisor), the Commodity Futures Modernization Act was passed, which excluded credit default swaps from being considered a "security" under the jurisdiction of the SEC or any other government agency. This act allowed these swaps to be deployed on a massive scale to convert all kinds of debt, including even subprime mortgages and car loans, into triple A securities and turned AIG’s arm, now headed by Joseph J. Cassano, an aggressive Brooklyn-born alumni of Drexel’s back office operations, into a multi-billion dollar profit center for the insurance behemoth. Even though the unit’s 400-odd man group constituted less than one-third of one percent of AIG’s total employees, it produced close to twenty percent of its total operating profits. While Cassano kept the list of his counterparties in the credit default swaps a closely held secret, he bragged at a conference in 2007 that they included a global swath of "investment banks, pension funds, endowments, foundations, insurance companies, hedge funds, money managers, high-net-worth individuals, municipalities and sovereigns and supranationals." One of his more complicated operations involved using a subsidiary called Banque AIG to provide the largest banks in France with custom-tailored swaps that effectively allowed them to evade regulatory capital requirements on hundreds of billions of debt on their books. By 2006, his group was raking in nearly $4 billion in profits, and, as is the tradition in the derivative game, he and his traders got a rich cut of the loot, which on average amounted to roughly $440 million (or about $1.1 million per employee)..
With the collapse in 2008 of the debt AIG was insuring, came such massive losses that Cassano resigned, and AIG, unable to post collateral, faced bankruptcy. At this point in September 2008, the US government rescued AIG, pouring in $173 billion of tax payers’ money. Even so, there remained a $1.6 trillion in potential liabilities that could be triggered by thousands of the credit default and other derivative contracts. To prevent hundreds of billions of losses, these custom-designed contracts, , many of which would not expire until 2012, had to be continually watched, and, if necessary hedged, by traders who understood each one’s particular vulnerability.
. To perform this critical task, key people in the group wanted the same sort of guaranteed compensation in the form of retention bonuses as had in their previous two year contracts. The situation for AIG, and the US government that now owned 77 percent of it, was not unlike the one in Mario Puzo’s Godfather in which an offer is made that cannot be refused. In this case, even without a bloody horse head under the blankets, AIG and its federal overseers could not risk falling into a $1.6 trillion black hole by turning down the demands of those in the financial product group. It was not that they had such unique skills in derivative contracts that they could not be replaced by other people since the managing of these contracts is not overly complex. It is that they knew a proprietary secret, to wit, AIG’s secret book, which included the identities of all the counterparties to the credit default swaps and the unhedged parts of the positions vulnerable to price fluctuations. In addition, replacing some of these operatives in the complex of arcane subsidiaries it had set up technically constituted a change of control and could trigger defaults. For example, as it explained in a secret memo to the staff at the U.S. Treasury in February 2009, just the resignation of two of its Banque AIG executives, Mauro Gabriele and James Shephard, could set in motion renegotiations, and possible defaults in $234 billion in its European derivative contracts with banks. So even key people who had resigned, such as Cassano, were kept on as consultants at fees of up to $1 million a month. The implicit threat was that, if they were simply let go, not only would it cause havoc with the status of the derivative contracts but that traders would be in a position to use the secrets to which they were privy to trade for others against AIG as it attempted to protect the positions in its $1.6 trillion dollar portfolio. Under these circumstances, rather than risking immense losses from having its secret book compromised, AIG paid to keep the key members of the group from defecting. Their compensation, when approved by the Fed and Treasury, would amount to about $500,000 per person a year ( less than half what they had been getting in 2008.) The staff at the NY Fed, while Timothy Geithner was still its head, in fact helped negotiate the terms for these retention bonuses. When Geithner moved on to become Treasury Secretary in January 2009, he presumably understood how financially dangerous it could be to do otherwise, since he intervened with the Senate Banking Committee Chairman in February to get a provision dropped from a bill that would have prevented AIG (and other recipients of federal money) from paying such huge bonuses. In fairness to Geithner, the alternative to making these pay-offs might have proven a thousand times more costly to AIG, and its defacto owner, the US Government. Washington, after all, is ruled by pragmatism, and what difference is there between AIG paying $165 million to the derivative traders who caused the havoc, and the Fed rewarding the rating services that made possible the proliferation of trillions of dollar of toxic debt with $1.2 billion in fees to rate the new debt under its TALP plan to restore the credit markets damaged by its old Triple A rated toxic debt?
***

Buffet Versus The Hedge Funds

2009-03-01T12:39:00.002-05:00

Warren Buffet’s holding company, Berkshire-Hathaway, finally released its numbers on Saturday (February 28, 2009) which showed that it had the largest decline in its book value in its history. But even before this bad news was announced, hedge funds were massively shorting not Berkshire Hathaway itself but the publicly-traded companies in its $50 billion portfolio. Their bet was that Buffet would be forced to dump the stock of these companies was based largely on his vulnerability to massive losses on derivative contracts, including credit default swaps. It turns out that even while Buffet was denouncing derivative contracts as "financial weapons of mass destruction" and " time bombs", he was amassing one of the world’s largest position in them. For example, he sold derivative contracts on four stock market indexes– the S&P 500 in America, the FTSE 100 in the U.K., the Dow Jones Euro Stats 50 index in Europe and the Nikkei 225 Stock Average in Japan– for $4.9 billion that expose his company to over $35 billion in losses. In 2008 alone these contracts had lost on paper nearly $10 billion and with the market in free fall in 2009, they lost another $3 billion. Indeed, each percent these indexes decrease adds another $350 million to the loss Berkshire Hathaway is liable for. He also sold more than $2/4 billion worth of the infamous credit default swaps, not unlike the ones that brought AIG down once it lost its triple A rating. Such contracts insure that companies will not default on their debt. In addition, Berkshire Hathaway subsidiaries sold derivative contracts on energy for "operational purposes."
Although even the multi-billion dollar paper losses on these derivatives don’t require Berkshire Hathaway to put up money to guarantee payment to its counterparts, they weaken its balance sheet. And since Buffet prides himself on maintaining a "Gibraltar-like financial position," the hedge funds are gambling Buffet will protect Berkshire Hathaway balance sheet– and its triple A rating– by selling part of Berkshire Hathaway’s portfolio. If that happens, they expect to profit in their short sales from the plummeting prices. Whether or not their play succeeds against Buffet, remains to be seen.

Madoff's Lucky Investors

2009-02-24T15:55:00.005-05:00

Quick quiz: Would you be better off today if you had invested a half-million dollars a year ago in: a) Bernard Madoff’s infamous Ponzi scheme or b) AAA blue chips such as General Electric, AIG, Citibank or Bank of America?
The answer is, believe it or not, a). It was supplied last week by Irving Picard, the trustee liquidating Madoff's investment firm who, after examining Madoff’s records over the past 13 years, revealed that Madoff was a total fraud who. instead of buying any securities for his victims. swindled them out of their money. This is great news for his investors since it makes them eligible to collect 100 percent of their losses from the Securities Investor Protection Corp, an exchange-backed fund, which indemnifies investors against fraud up to $500,000 per investment account. So if our hypothetical investor was lucky enough to have invested $500,000 with Madoff, he would have zero loss. If on the other hand, he had been unlucky enough to invest this nest egg in the blue chip AAA blue chip selections, he would have lost at least 80 percent of his money (or up to 95% with AIG). So he would be out at least b$400,000. Making matters worse for our blue chip investor would be his tax situation. According to the U.S. tax code, a maximum of only $3,000 a year from an "investment capital loss" can be deducted against ordinary income. So if the unfortunate investor had no investment capital gains to offset the loss, it would take him over 133 years to fully deduct it from his taxes.
On the other hand, even if an investor put more that $500,000 an account with Madoff, the loss (beyond the $500,000 the investor gets back) is, thanks to an odd feature of the US tax code, a theft loss, and can be deducted dollar for dollar from his other non-investment income at present or for the past three years. So, under almost any scenario, an investor with taxable income he would be better off swindled by Madoff than having invested in General Electric, Citibank, AIG or Bank of America. Alas. as the Bonpartist Antoine Boulay de la Meurthe famously said of the assassination of the Duc d’Enghein. "It is worse than a crime, it is a mistake."

A De Beer's Nightmare

2009-02-23T12:06:00.004-05:00

Diamonds, alas, are not forever. I explain in my article in the International Herald Tribune how De Beer's greatest nightmare is now unfolding.

The Oscar Deception

2009-02-20T11:19:00.005-05:00

The 81 th Academy Awards, with its scripted speeches by stars, tearful acceptances, eulogies to the rich and the dead, red-carpet celebrity fashion show, and gold-dipped statuettes, has the same mission that it did when Louis B. Mayer convinced the other studio moguls to create the event in 1927 to: "establish the industry in the public's mind as a respectable institution." Now, televised by ABC in dazzling high-definition color, the evening-long informational will further the long-standing myth that Hollywood is in the business of making great—and original—movies.
This illusion, like all successful deceptions, requires misdirecting the audience's attention from reality of how Hollywood makes its money to a few brilliant aberrations. Take this year's Best Picture nominations: Milk, Frost/Nixon , The Curious Case of Benjamin Button ,The Reader , and Slumdog Millionaire . What all of these films have in common is that they have virtually little to do with the real business of the Hollywood studios, which is global openings on 3000 or more screen of youth-oriented movies that, after a few weeks in the multiplexes, can be mass marketed on DVDs. For the Hollywood elite to choose these atypically adult movies as a public display of its virtue is as absurd as the music industry giving its grammy awards to Mozart, Bach, and Verdim or international oil companies presenting awards to avant-garde artists who happen to paint in crude. While Hollywood studios, or their wholly-owned "independent" subsidiaries occasionally make or distribute artistic and social-commentary films, their principal business is no longer about making movies. It is about creating properties—including TV programs, cartoons, videos, and games—that can serve as licensing platforms for a multitude of markets.
The confusion proceeds from the fact that for the first 20 years of the Academy Awards, the movie business was entirely about movies. In those days nearly two-thirds of Americans went to a movie in an average week, and all the studios' earnings came from the proceeds of the tickets sold at movie houses. But that was before the advent of television in the late 1940s. Once people could watch sports, game shows, and movies at home for free, most of the habitual audience disappeared. By the late 1970s, U.S. movie theaters, which had sold 4.8 billion tickets in 1948, sold only 1 billion. Hollywood, on the verge of financial ruin, had little choice but reinvent itself.
The studios simply followed their audiences home. To do this, they first repackaged the movies shown at theaters Pied Piper-style by making movies that visually appealed mainly to children and teenagers and then recycled them into home products, including DVDs, TV shows, games, and toys, which, in 2008, produced some 80 percent of their revenues. In this business model, alas, art, literary, and social-commentary movies are marginalized, since they cannot be either turned into licensing franchises or used to lure huge opening-week audiences to theaters. And, as satisfying as these more artistic films may be to directors, writers, actors, and producers, they do not lend themselves to sequels, prequels, or other licensable properties. They do, however, perform one function very well: acting as decoys at Hollywood's annual celebration of itself.

The Myth Of The Lost Generation

2009-02-17T17:19:00.004-05:00

"If you delay acting," President Obama warned Congress this month, "you potentially create a negative spiral that becomes much more difficult for us to get out of. We saw this happen in Japan in the 1990s… and as a consequence, they suffered what was called 'The Lost Decade' where, essentially… they did not see any significant economic growth." Actually, Japan’s GNP grew by nearly 10 percent during the 1990s. While such growth is meager, it was only part of the story. Before the United States rushes headlong into printing several trillion new dollars, with all the risks that entails of debasing the currency it is worth considering what was really lost in Japan’s "lost decade."

On the bleak side, Japan lost jobs. Its unemployment rate during these 10 years averaged 3.6 percent which, while high for Japan it was lower than any other country in the G-5 which, like Japan, had to compete with the surge in cheap-labor exports from China in the 1990s, In 1995, the midyear of the decade, while the unemployment rate was 3.2 percent in Japan, it was 5.6 percent in the US, and well over 8 percent in Germany, Britain France. Italy, and Canada.

What Japan did uniquely lose in the "negative spiral" was the incredible price froth that accompanied the 1980a bubble. At its height in 1989, real estate in Tokyo sold for as much as $139,000 a square foot– more than 350 times as much as choice property in Manhattan. Such valuation made the land under the Imperial Palace in Tokyo notionally worth more than all the real estate in California. The Japanese stock market, with some shares selling for a thousand times their earnings, similarly skyrocketed. Indeed. In 1989, the notional value of the stocks listed on the Tokyo exchange not only exceeded all the stocks in America, but represented 44% of the value all the equities in the world. When the bubble burst– as all bubbles do– real estate lost about 80 percent of their former value, and stocks plunged about 70 percent. As a result, the banking system that had extended virtually unlimited credit on pyramids collateral based on these assets, were left, if not insolvent, paralyzed. To the extent that the heady prices of the late 1980s proceeded from a wild flight from reality, their fall represented a cruel regression to the norm.

On the bright side, Japan had no inflation during this decade. So while the Japanese could no longer relish the fantasy that the land under their Imperial palace was worth more than the state of California, they could now more easily afford to buy homes, burial plots, and golf club memberships in Tokyo. The Japanese currency also was not debased in the crises, and a strengthening yen made vacations abroad and foreign imports (including fuel) far less expensive. The Japanese also continued to save. Unlike in America, in which the personal savings declined to a mere 5 percent in the 1990s (and became negative by 2005), Japan’s personal savings rate remained over 20 percent, providing some cushion of safety during this era. And Japan’s life expectancy rose in the 1990s to over 80 years, the highest of any major country, and 5 years longer than that of the United States.

Nor did Japan lose its advantage in international trade. Its automotive manufacturers, with the help of new hybrid and other fuel-efficient engines, gradually displaced their American competitors in world markets. Its electronic manufacturers, launching DVD players, digital camera, and high-definition TVs, changed the global face of home entertainment. Its state-of-the-art robotics and machine tool industry meanwhile provided China with the technological backbone for its economic boom. So even without "significant" growth in this decade, Japan remained the second largest economy in the world.

What was really lost in the crash was a popular delusion– the assumption that something as transient as the notional price of assets had enduring value. Once this illusion was brutally shattered, not even ten government stimulus packages, which totaled more than 100 trillion yen and caused public debt to exceed 100 percent of GDP, could resurrect it.
***

Harvard's Casino Investing

2009-02-09T10:53:00.002-05:00

Harvard Management Corporation (HMC), which runs the world’s largest endowment fund, has had until recently an incredible record. Over the past six years, it succeeded in more than doubling the notional value of Harvard’s wealth to a $36.9 billion in fiscal 2008 (which ended on June 30th) even after paying for about one-third of Harvard’s operating expenses. So its recent loss of $8.2 billion between from July 1 through Oct. 31 2008 came as a stunning blow . This huge loss, as staggering as it sounds, may only be the tip of the iceberg of illiquid investments. According to a source close the Harvard Management Corporation, the damage, if the fund’s illiquid investment are realistically appraised, may be closer to $18 billion.
The lack of clarity as to size of the loss proceeds from the illiquid nature of the financial exotica in which Harvard is now heavily invested. Its team of highly incentivized money managers– who themselves earned $26.8 million in 2008– adopted a strategy aimed at taking maximum advantage of an inflationary global boom in the early 2000s by shifting the lion’s share of Harvard’s money from conventional endowment assets, such as bonds, preferred stocks, Treasury bills and cash, into more esoteric investments that would presumably rise as more money chased after scarcer goods. They bought, for example, oil in storage tanks, timber forests, and farm lands. While by the proliferation of trillions of dollars worth of sub-prime mortgages further expanded the bubble, driving up the price of oil, lumber and land rose, the notional value of Harvard’s portfolio soared. The price of oil, for example, which Harvard and other speculators were storing, more than quadrupled to $153 a barrel on commodity exchanges, allowing Harvard to hugely appreciate the notional value of its portfolio. So, between fiscal 2003 and 2008, Harvard’s "real assets" showed a gain of nearly 25% annually. But even after the subprime mortgage crisis began to unfold and a number of financial institutions. Including Bear Stearns had collapsed, Harvard’s money managers persisted in focusing on countering the risk of "continued longer term inflationary pressures - exacerbated by supply/demand considerations for various commodities."
Consequently, as late as June 2008 , the fund kept no reserve of cash or treasury bills and allocated a mere 6 percent of its money to fixed interest bonds. It also borrowed over one billion dollars to amplify the returns on its less conventional investments. So, by the time the bubble burst in the fall of 2008, only a small fraction of the endowment fund investment was even under the jurisdiction of the SEC. According to the 13F holding report it filed with the SEC in September 2008, Harvard had only $2.86 billion of its funds in exchange-listed stocks, options or other derivatives. What had happened to the rest of the more than $35 billion* it had allocated to investments at the start of Fiscal 2009 (in July) 2008?*
[*- From the $36.9 it had on June 30th, it had distributed $1.6 to the University which financed one-third of its budget, and another $200 million went to pay to HMC for the costs or administration and bonuses.]
Most of the balance had been allocated to investments, which if not totally illiquid, could not be valued by market activity. The breakdown that follows illuminates how far HMC had strayed from the path of traditional endowment investing.
More than a quarter of Harvard’s funds were still sunk in "real assets"; 8% in stockpiled oil, 9% in timber and other agricultural land, and 9% in real estate participation. Then came the financial crises, and prices plunged. Oil fell to under $40 a barrel. Lumber suffered almost as badly. And, with the drying up of bank lending, the value of its real estates holding became at best, problematic. One indication of how steep the loss may be is that CalPERS, the giant pension fund of the California Public Employees’ Retirement System, which owned even more real estate acreage than Harvard, reported in this period a 103% loss on real estate deals in which, like Harvard, it had borrowed to amplify its profits.
Another huge portion of Harvard’s endowment had been farmed out to hedge funds (18%) and private equity funds (13%). While these funds provided some diversification, many of them also impose restrictions on withdrawals, including ones, like Citadel, that suffered substantial losses. To get back its money under such circumstance, it was often necessary to sell at a steep discount to a "secondary" hedge fund. One major player in the private equity business tells me that Harvard had tried this Fall to sell its private equity stakes at 30 to 35 percent discounts but find no buyers even at those prices. Even worse, the typical private-equity fund has a provision for "capital calls," requiring investors to put up another 50 cents to 75 cents for every dollar they already have committed. If so with Harvard, the $4 billion it has allocated to private equity may not only o be drastically reduced in value, but might lead to a massive drain on its remaining capital.
Harvard also allocated nearly $4 billion, or 11% of its fund, to volatile emerging markets, such as Brazil, Mexico, and Russia. Here its money managers bet both that the stocks would go up and that the local currencies would at least hold steady against the dollar, but lost on both counts. First, the thin local stock markets, which had little liquidity, collapsed in the financial crises. For example, Russian stocks, lost almost 80%, of their value in a mater of days. Then, as banks and hedge funds, got out of their currency trades, the local currencies in many of these countries also lost heavily against the dollar. The Brazilian Real, for example fell about 40% . So the endowment fund took a double hit.
Aside from emerging markets, Harvard had invested another 11 percent if its portfolio in more established foreign economies, as those of Britain, Germany, France, Italy, Australia, and Japan. But here the stock markets declined, and, with the exception of the Japanese yen, so did their currencies.
Given the true cost of getting its money out of the hedge funds and other illiquid investments, my knowledgeable source finds the claim by Harvard’s money managers that the fund only lost 22 percent at best "purely pollyannaish." But while Harvard’s money managers may chose to look through rose color glasses at the value of their portfolio , Harvard University, which relies on the interest from distribution from its endowment to fund one-third of its operating budget, needs to be more realistic. As its President, Drew Faust, noted in letter to the Harvard faculty, "We need t\o be prepared to absorb unprecedented endowment losses and plan for a period of greater financial constraint."
To be sure, Harvard Management Corporation flight to illiquid assets strategy did not occur in a vacuum. Harvard’s money managers developed their ideas taking advantage of their "connections to Harvard University researchers and professors," as they say in the 2008 annual report. Up until mid 2006, Larry Summers, a former deputy secretary of the treasury (and now the head of Obama’s Economic Council, was Harvard’s President While it is not known what, if any, direct liaison Summers had with the Harvard Management Corporation,, he seemed to endorse its strategy in 2006 at a speech at the Reserve Bank of India in Mumbai when, citing the high returns that college endowment funds then had been achieving, argued that "By investing in a global menu of assets U.S. institutions have earned substantial real returns over the years."
Nor was Harvard alone in moving from traditional investments to a more"global menu". Yale’s endowment fund, which with $22.5 billion in assets in 2008 was second only to Harvard’s, followed a similar strategy of finding alternate investments including hedge funds, private equity funds, physical commodities, and emerging markets. Its longtime manager David Swensen indeed makes the argument in his book "Pioneering Portfolio Management" that diversifications of this kind are safer than just investing traditional stocks and bonds. And during the decade preceding the present financial crises his fund actually outperformed Harvard’s. But despite his efforts at diversification, Yale lost at least 25% of its fund in the fall of 2008 if one , takes into account the plunging value of its illiquid assets.
Up until the financial crises, comparative endowment fund performance became the financial equivalent of athletic rivalries, with Yale President Richard Levin, for example, pointing to the 2007 results (which beat Harvard), bragged, "The stunning thing is how much we outperformed other endowments," While Harvard, using other yardsticks, noted in its 2008 report that its "annual outperformance... easily places Harvard in the top five percent of all institutional funds." Hoping to match Harvard and Yale’s dazzling records of multiplying the notional value of their endowment funds other universities across the country, who, followed suite, plowing much of their endowment funds into financial exotica and other illiquid assets. In 1995, endowments had less than 10% of assets in these alternative type investments; by 2008, that average had climbed to more than 30%. Consider the plight of Columbia University. As oft June 2008, 41% of its $7 billion endowment fund was in hedge funds and 40% in private equity funds, and is liable for another $1.6 billion in capital calls up until 2012 (which would wipe twice over all its stock, bond , cash other liquid investments.) The collateral damage is yet to be fully reckoned, but the damage is beginning to show. In December 2008, Berkeley Chancellor Robert J. Birgeneau warned in a letter to students and faculty, "As of today, we are already seeing that the leading private universities have experienced significant drops in the value of their endowments and are engaging in severe budget cuts." So institutions of higher education, like other speculators seeking enormous profits in what is essentially a zero-sum game, learned the sad lesson that playing for high stakes in the casino economy inexorably entailed the risk of catastrophic losses.

Was Mike Milken Right?

2009-02-09T10:46:00.003-05:00

Michael Milken, the financier who revolutionized corporate finance in the 1980s, based his entire concept of junk bonds, on what he claimed was a "fundamental flaw" in Wall Street’s financial structure: the trust it had in the ability of three ratings services– Standard & Poor’s, s Moody's and Fitch Ratings– to evaluate the relative risk of bonds. Since SEC rules prevented anyone else from supplying bond ratings, these rating services had (and still have) what is tantamount to a global monopoly on issuing bond ratings. When one or more of these services give a triple-A rating to a corporate bond, it certifies that there is virtually no risk of default, This seal of approval allows Wall Street underwriters to sell them to insurance companies, pension plans, college endowments, and other institutions, many of which are restricted by regulations from buying bonds with a lower rating that triple-A. In other words rating services determined which corporations are eligible for institutional bond financing.
When I interviewed Michael Milken back in 1987, he railed against the rating services, zeroing-in on Triple-A rated banks such as Citibank. His scathing analysis went as follows: "What is a bank?" he asked rhetorically. "It is nothing more than a bunch of loans." " How safe are these loans?" he continued.
"They are made mainly to three groups that may never repay them in a real
economic crisis-- home owners, farmers and consumers of big ticket items." "What
guarantees these loans?" "Very little since these banks usually have $100 in loans
for every dollar of equity." He pointed out that a number of states such as California required that all home loans be non-recourse loans, which means that the only collateral is the home itself (making them little better than what would later be called sub-prime mortgages.) "Yet,their bonds get a triple-A ratings from the bond rating services." ne continued. "This is crazy" because rating services measure "the past not the future" risk.
Soon afterwards, the financial establishment trounced on Milken. Faced with endless litigation. He pled guilty to the five counts of financial transgression, and went to prison for 22 months. But his downfall did not answer the critical issues he raised about the rating services.
That was two decades ago. Since then the rating services have extended their
Triple A ratings to debt packages, such as Collateral Debt Obligations (CDOs) that
included subprime mortgages and other questionable loans. Since they get much
higher fees for rating complex debt pools than for plain vanilla corporate bonds,
this expansion into CDOs has proved incredibly lucrative for them. Moody's,
which is partly owned by Warren Buffet’s Berkshire Hathaway, raked in over $3
billion in fees from 2002 until 2006 for providing these ratings. Standard &
Poor's meanwhile escalated this race into the abyss in 2000 by extending
their top ratings to "piggy-backed" CD0s. Appropriately named, piggy-backed CDOs multiplied leverage by allowing buyers to simultaneously take out a second loan to finance the first CDO. The logic was that if the initial loan was Triple A, and there could not default, so was the "piggy-back" based on it. Other rating services followed suit, so as not to lose the rich piggy-back rating business to Standard and Poor’s. The result that CDOs were leveraged over and over again, while maintaining the triple-A rating that made
them appear to be almost as safe as a Treasury bond.
Of course, there is an obvious conflict of interest in this enterprise: the rating services are paid by the companies who issue the securities they rate. Moreover, the rating services admit in their fine print that their ratings are based on the data supplied by the companies seeking the ratings. Nevertheless, wheelers and dealers in Wall Street, London, Dubai, and other financial ports of call so leverage these rated CDOs to such an extent that by late 2008 an estimated 18 trillion dollars in marketable debt hung over what remained of the global financial markets. As we all know now. the ratings proved to be wildly out of touch with reality, and the subsequent collapse of the house of cards built upon them, sapped the global financial system of the crucial confidence necessary for it to function..
If Milken’s critique of the rating services had been taken more seriously
in 1987, we might not now be staring into this back hole today,

Buffet's Darker Side

2009-02-09T10:24:00.004-05:00

In the Presidential debates in October, both Barack Obama and John McCain, came up with the same name to save the reeling American economy: Warren Buffet.
Buffet is the chairman of Berkshire-Hathaway, a $120 billion holding company. Known in the media the "Oracle Of Omaha," he had condemned derivative contracts as early as 2003, describing them. "as time bombs, both for the parties that deal in them and the economic system." After derivative contracts on sub-prime mortgages had delivered a near death blow to the financial system in October 2008, he told Charlie Rose in an hour-long televised interview that such derivatives were nothing short of "financial weapons of mass destruction," saying, "They destroyed AIG. They certainly contributed to the destruction of Bear Sterns and Lehman." It light of his lucid explanation of their incredible perils, it seemed gratuitous for Charlie Rose to then ask Buffet if he himself had trafficked in derivatives, If he had asked, the Buffet’s answer might have been surprising since, at the time of that interview, Buffet’s holding company not only had multi-billion dollar positions in derivative contracts but it was the largest single shareholder in one of the principal enablers of the proliferation of sub-prime mortgage derivatives.
As subsequently revealed in Berkshire Hathaway’s third quarter 10-K filing with the SEC in 2008, the Oracle turned out to be one of America’s largest seller of derivative contracts. Not only had he sold over $2.5 billion worth of credit default swaps in 2008– the same notorious derivative contracts that had brought AIG to its knees– but he had sold over $6.7 billion worth of another type derivatives, called "index put option contracts" that essentially bet stock prices would not fall here and abroad. These contracts have a duration of as long as 20 year, and, as the disclosure notes, "generally may not be terminated or fully settled before the expiration dates and therefore the ultimate amount of cash basis gains or losses may not be known for years." Even for the first nine months of 2008, Berkshire’s losses from these derivative already were $2.2 billion.
But Buffet’s involvement in the derivative casino went beyond selling credit default swaps and put options. After Moody’s Corporation, the second- largest credit-rating company, went public in 2000, he had Berkshire Hathaway buy 48 million shares in it– approximately a twenty percent stake– making it by far Moody’s largest shareholder. The role Moody’s was to play in the proliferation of sub-prime mortgage , along with that of the two other rating agencies, Standard & Poor’s and Fitch Ratings, is lucidly described by Nobel laureate economist Joseph Stiglitz in an interview with Bloomberg News: "I view the ratings agencies as one of the key culprits, They were the party that performed that alchemy that converted the securities from F- rated to A-rated. The banks could not have done what they did without the complicity of the ratings agencies.''
The sad history of Moody’s race to the bottom began after it was spun off by Dun & Bradstreet Corp. in September 2000 and after Buffet had invested $499 million in it. Prior to that, Moody’s was a stodgy company in the low-profit business of evaluating credit data supplied to it largely by triple-A companies. The SEC had given it, along with S&P and Fitch’s, an effective lock on the issuance of credit ratings. So the giant corporations needed to get its top rating (AAA, meaning little or no risk) in order to sell their bonds to insurance companies, pension funds, and other regulated institutions. But with the mushrooming of mortgage-back securities, Moody's found a much more profitable business line: rating pools of mortgages called Collateralized Debt Obligations (CDOs). Working on the theory that if these CDOs were structured into different tiers, it could award Triple A ratings to the safer tiers, which, in turn, would allow underwriters to sell CDOs to institutions, Moody’s made additional money advising the underwriters how to structure their CDOs in such a way so that it could provide top ratings. Once they received these ratings they could leveraged them over and over again via so called "piggy back" loans.
Even though sub-prime mortgages accounted for about half of the collateral on CDOs, Moody's manage through this theory to assign triple A grades to nearly 75 percent of them. In August 2004, to get an even larger share of this business, it revamped its credit-rating formula in such a way that it could issue top-ratings to even a larger portion of sub-prime debt. Not to lose market share, Its chief competitor, S&P, followed suit the next week. By 2006, the market for rated CDOs had exceeded $3 trillion.
This enterprise entailed an obvious conflict of interest since Moody’s was being paid by very companies it was rating, but the profits were so enormous it was overlooked by everyone involved. By extracting almost three times the fees on structured CDOs than it got on conventional corporate debt, Moody’s took in an incredible $3 billion between 2002 and 2006. And since it had operating margins above 50 percent on its rating work, most of this new found El Dorado was profit. When Moody’s stock soared, it increased the market value of Buffet’s stake from $499 million in 2001 to $3.2 billion in February 2007. The Oracle of Omaha thus made $2.7 billion profit from the very "time bombs" he was at the time publically damning. Moody’s ratings meanwhile enabled these derivatives to spread like kudzu throughout the global financial pipelines until the entire house of cards collapsed in 2008. Moody's then had to downgrade more than 90 percent of all asset-backed CDO investments issued in 2006 and 2007, and Buffet, alas, lost a good part of the windfall
It is hardly conceivable that Buffet, who famously prides himself on the scrutiny he gives to companies in which he invests, could not have known that the heart of Moody’s money machine was certifying hundreds of billion dollars worth of CDOs for purchase by banks and other institution. If he didn’t know that, what kind of Oracle is he?

The Silver Lining To Madoff

2009-02-09T09:39:00.003-05:00

"You can’t cheat an honest man. He has to have larceny in his heart in the first place."
– W. C. Fields, 1939

Don’t cry (yet) for investors in Bernie Madoff’s grand Ponzi scheme– or at least for those of them who pay taxes. As bad as they may have done in their calculated effort to beat the system by betting with one of the stock exchange’s major market makers, thanks to an odd feature of the US tax code they will probably wind up losing less money than ordinary investors had by buying shares in some of the largest companies on the New York Stock Exchange. If an investor has a net loss in legitimate srock investments, according to the tax code, it is considered an investment capital loss, and the maximum amount he can deduct from his other income is a piddling $3,000 annually. So if he loses a million dollars, it will take him 334 years to deduct it. If, on the other hand, an investor put that million with Bernie Madoff, he could deduct the entire million immediately from other taxes because, as far as the IRS is concerned, it proceeded from a theft, not an investment loss. If the investor was in a 50% bracket– with state and local taxes– and he had other taxable income, his bottom line loss from the million would be only $500,000. Consider, for example, if a prudent investor had bought $1 million worth of shares a year ago in such blue chip stocks as Citibank, Bank of America, AIG, Ambac, General Motors or Barclays Bank, which fell between 81 and 90 percent in value (as of January 19th), which, if he sold them, would leave him with an after-tax loss of over $800,000, or, much more than the loss he would have sustained if he had let Bernie madoff swindle him out of the million.
Even better, to the extent that Madoff’s investors paid taxes on false capital gains booked in their accounts during the prior five years, they are owed tax refunds– with interest. It also turns out that since virtually all hedge fund partners are limited partners, the entity's theft loss flows through to them, and they therefore can also take advantage of the Madoff tax credit for their personal tax returns. So as painful as it is to lose money in a Ponzi scheme is, it is more painful to lose it in a legitimate investments where the loss it is not tax deductible for centuries.
The US government stands to lose a vast amount of tax revenue through the Madoff tax credit– as investors may deduct billions of dollars worth of their loss against other income. But there is also a silver lining for the government. According to my knowledgeable source, Treasury department investigators are now discovering that a great many of Madoff’s investors funneled their money through off shore accounts without reporting them. The IRS thus will be able to level immense penalties on these tax-dodgers for hiding off shore income–even if it was fictive income. But are tax-dodgers really deserving of pity?
The real victims are the tax-exempt players, especially the legitimate philanthropies, that sunk their funds in Madoff’s Ponzi scheme. Alas, they cannot recoup any of their losses. The tragic flaw here was trust. Samuel Johnson adumbrated that danger more than two centuries ago when he wrote about the bankruptcy of merchants, that assumed the splendour of wealth only to obtain the privilege of trading with the stock of other men, and of contracting debts which nothing but lucky casualties could enable them to pay; till after having supported their appearance a while by tumultuary magnificence of boundless traffic, they sink at once, and drag down into poverty those whom their equipages had induced to trust them."

To Russia With Questions

2008-03-16T20:17:00.009-04:00

In December, I went to Moscow to look further into the Litvinenko Affair. The Prosecutor General's office had set up a special unit, the National Investigative Committee, to handle that and other sensitive investigations. It took a resourceful research associate, and a few weeks of vexing paper work, to arrange an appointment. But, once in the door, its investigators proved surprisingly cooperative. See my 4000 word report in today’s New York Sun.

Ten Things We Don't Know About The Death of Litvinenko

2007-11-04T10:21:00.000-05:00

1. We don’t where the Polonium 210 found in Alexander Litvinenko’s body came from.
Russia produces Polonium 210 for export to the US, but it is not the only state with the capability to produce it. Polonium 210 can be produced by any country with a nuclear reactor that is not subject to IAEA inspections. All that is required is the metal bismuth, which is readily available, and a nuclear reactor. In 2006, there were at least nine nuclear weapon states that had nuclear reactors not inspected by the IAEA, including China, Israel, Pakistan, India, and North Korea. ( Polonium 210 has been found in Iran in 2005)
2. We don’t know how the Polonium 210 got to London.

British authorities categorically deny that Polonium 210is produced in any reactor in that country. If so, it was smuggled into England from its country of origin. But no container for it was ever found.
3. We don’t know when the Polonium 210 was manufactured.

Polonium 210 half-life is about 134 days. During that brief period, half of it decays into daughter elements. So the date it was produced can be determined if the quantity of all the daughter elements is compared to that of the remaining Polonium 210. If the daughter elements are missing, which often happens outside the pristine conditions of a lab, the Polonium 210 cannot be dated. In the case of the radioactive corpse, the possible crime scenes were so compromised by weeks of repeated cleaning, vacuuming, and foot traffic that the traces found of Polonium 210 cannot be dated. The same is true of the Polonium 210 found in the corpse itself in the autopsy, since an unknown amount of the daughter elements would have been unable to get through the intestinal wall and would be expelled from the body.
4. We don’t know why the Polonium 210 was smuggled into England

Neither Litvinenko or any of the other men contaminated by the Polonium 210 admitted to having any knowledge of Polonium 210. Litvinenko believed he was poisoned by Thallium.
5. We don’t know when Litvinenko and his associates were first contaminated.
Traces of Polonium 210 was found in offices that Litvinenko and his two Russian associates, Lugovoy and Kovtun, had last visited on October 17th. But, since the Polonium 210 itself cannot be dates, the contamination could have been earlier.
6. We don’t know who contaminated who.

We know that four men were hospitalized with Polonium 210 in their bodies, Litvinenko, Scaramella, Lugovoy, and Kovtun. Scaramella could not have been the source of the cross-contamination since he arrived in London on the evening of October 31 and met only with Litvinenko. So he could not have contaminated (or been contaminated) by Lugovoy or Kovtun. But Litvinenko, Lugovoy, and Kovtun all met in offices that were contaminated by Polonium 210 on October 17th, so any of them– or anyone else present at that meeting or who visited those offices– could have been the proximate source of the cross-contamination.
7. We don’t know how anyone was contaminated?
Polonium 210 can be spread, as the Israeli investigation of a 1960s leak determined, by clothing fibers, dust, shoes, or even by shaking hands. In the case of the London Polonium cases, it remains a mystery how minute particles spread to the four men hospitalized.
8. We don’t know if the Polonium 210 was released by design or accident.
All the known Polonium 210 deaths in France, Israel, and Russia prior to the radioactive corpse in London resulted from an accidental leak. In the London case, since there were no witnesses to anyone deliberately poisoning Litvinenko and no since no aerosol sprayer, dispenser or other delivery device was found, the is no evidence that the contamination was intended.
9. We don’t know the findings of the autopsy examination .
The British authorities have not released these findings. So we don’t the amount of Polonium 210 found in Litvinenko’s body or the sites.
10. We don’t know the findings of the Coroner .
The British authorities have not released the Coroner’s Report, if it was completed. So there is no official cause of death.

My FAQs on the Litvinenko Case

2007-08-07T09:09:00.000-04:00

How did Litvinenko die?

Litvinenko died from damage to his organs caused by the radiation from Polonium 210 .
What is a lethal dose of Polonium 210?
One-millionth of a gram, if it gets in the blood stream.
How many times did Litvinenko ingest Polonium 210?
Although no Coroner’s Report has been yet released, the toxicology tests from the Litvinenko's autopsy reportedly show two separate spikes in his radiation poisoning, indicating that he swallowed Polonium 210 on two different occasions .
Is Polonium 210 a sure-fire poison?
Only if it injected intravenously. If it is ingested in a beverage or with food, it may not prove fatal. The intestine wall blocks about 95 percent of the particles from getting into the blood stream. As it is slow-acting– Litvinenko lived for at least 3 weeks– the lethal radiation can be nullified with available antidotes. In Litvinenko’s case, his illness was diagnosed incorrectly as Thallium poisoning and he was given the wrong antidote (Prussian Blue).
Could a person accidentally be exposed to Polonium 210?
Yes. All six previous cases of fatal Polonium 210 poisoning resulted from an accidental leak of the isotope.
Can Polonium 210 leak from a sealed container?
Yes. The alpha particles from the decaying Polonium 210 produce increasing heat and pressure as they collide with the walls of a container. Over time, that heat and pressure can force an opening in the seal. Once sub-microscopic particles of Polonium 210 leak out, they can attach themselves to dust and spread from person to person, as happened in the Israeli leak in the 1960s.
Is there evidence to support Scotland Yard’s theory that Litvinenko was poisoned by a Russian associate spiking his tea with Polonium 210 at the Pine Bar on November 1st, 2006?
No evidence that has been revealed. According to the Russian prosecutors, no evidence was included in the extradition request..
Was the container in which the Polonium 210 was carried ever found?
No.
What happened to the Polonium 210 ( if any) that remained in the container?

It is still unaccounted for. Since Polonium 210 has a half-life of 134 days , over 90% of it is has turned into its daughter elements, Polonium 208 and Polonium 206 (which are harmless).

Are there any witnesses who saw anyone put anything in Litvinenko’s tea at the Pine Bar?
No, there are no such witnesses. The closest possible witness was Litvinenko, but Litvinenko initially said that he had been poisoned in a Sushi restaurant where he had gone to earlier for lunch that day. (A waiter cited in news accounts as a "witness" said only that his view was blocked.)
Do traces of Polonium 210 found in the Pine Bar mean that Litvinenko was poisoned there?
No, it only means that someone who visited the Pine Bar had previously been in contact with Polonium 210. At least three people, including Litvinenko, who were at the Pine Bar on November 1st had previously been in contact with Polonium 210.
Were traces of Polonium 210 found in other places visited by Litvinenko?
Yes. Traces were found at Litvinenko’s home, the offices of Erinys, where he consulted, and the offices of Berezovsky.

Were "massive amounts" of Polonium 210 found in Litvinenko's body or anywhere else?

No. The Polonium 210 found were tiny specks, measured in millionths of grams.

What is the status of the possible crime scenes by the time the police examined them?
Compromised. The British police did not seal off access to any of them until at least three weeks after Litvinenko had been exposed. During that interval. the areas were repeatedly cleaned and, in the case of the Pine Bar, walked through.
So is there a "trail"?

No, not a chronological one. The traces that were detected in various places only indicate that that those place were visited by a person in contact with Polonium 210.

In June, 2007, British prosecutors asked Russia to extradite Andrei Lugovoi, one of the Russians who met Litvinenko in the tea bar. Could they reasonably expect that Russia would comply?
No. Russia historically has never complied with an extradition request, and extradition is proscribed by its constitution. In this case, it announced it advance of the request that it would be turned down.
Did the British include a Coroner’s Report or any summary of evidence?
No
Is there a Coroner’s Report establishing the cause of death?
None that has been released.
Is it true that Polonium 210 is available over the Internet?
No. Not in a toxic quantity, Polonium 210 is made in Russian nuclear reactors by bombarding bismuth with neutrons from U-235. Only about 100 grams are produced each year. To keep it from leaking onto the black market, the United States made an arrangement with Russia to import almost all of its production to America. In the US, under tight controls, the Polonium 210 is reduced to traces amounts that contains less that one-ten billionth of a gram and then chemically bonded in plastic or ceramic sheets. It would be virtually impossible to extract Polonium 210 in any toxic quantity from them.
Why is there concern about Polonium 210 reaching the black market?
Polonium 210 could be use to build the initiator for a nuclear bomb. The bomb-builder would also need two other elements, Beryllium and highly enriched Uranium. The Polonium 210 when combined with the Beryllium release the neutrons that start the chain reaction in the highly-enriched Uranium.

Is Russia the only source of Polonium 210?
No, Russia is the only country allowed to produce Polonium 210. But other countries, including Israel, Pakistan and North Korea, could be producing it secretly.
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More Questions Please?

Walking The Cat Back

2007-07-22T09:59:00.001-04:00

Don’t Jump To Conclusion, even if the cat is radioactive

Polonium 210, the extremely rare radioactive isotope that proved fatal to Alexander Litvinenko on November 23, 2006, can be traced back to a meeting that took place at 140 Osier Crescent on Muswell Hill in London in the summer of 2006. That townhouse, valued at over one-million dollars, was owned, along with other town houses on the street, by the billionaire Russian exile Boris Berezovsky. At that meeting were two former KGB officers: Alexander "Sasha" Litvinenko, and Andrei Lugovoi. Litvinenko, who defected from Russia in November 2000, worked as a political advisor to Berezovsky (although Berezovsky was not present that night). Lugovoi had a successful business in Moscow distributing beverages and providing security services. What both men had in common is that they both had worked to protect Berezovsky in Russia when he was at the zenith of his power in the late 1990s and they had both been jailed for services they had done for Berezovsky after he fell from power (See Who’s Who In the Polonium Game). With its off-street parking , the townhouse provided them a secluded venue. Their business, according to Lugovoi, was setting up a "joint venture" between London and Moscow. The idea was that Litvinenko would supply British clients and financial backing and Lugovoi, who still had connections with Russian ex-KGB officers, who had formed a security service in Moscow called the Ninth Wave, would provide the services to help these British businessmen operate in Russia. After the meeting at Osier Crescent. Litvinenko gave Lugovoi a batch of items, including documents, to take back to Moscow that subsequently tested positive for Polonium 210, according to Lugovoi. (Since Polonium 210 has a brief half-life, 138.4 days, before half of it decays to non-radioactive elements, this dating can be verified by spectrographic analysis .) If so, the first appearance of the smuggled Polonium 210 was in the Summer, many months before Litvinenko died. The townhouse itself was so thoroughly contaminated by Polonium 210 that it was still uninhabitable– and unsalable– in the summer of 2007.
The reason that the Polonium 210 was not detected at Osier Crescent at the time, or even after Litvinenko was hospitalized in November, is that Polonium 210 is rarely found outside a nuclear lab. Indeed, its production is so tightly controlled by the International Atomic Energy Agency (IAEA) that when minute Polonium 210 traces were detected on equipment in Iran in the 1990s, it raised concerns that Iran was building a nuclear bomb since Polonium 210, in combination with Beryllium, can be used as the initiator for the chain reaction in a crude nuclear bomb. So IAEA inspectors, rushed to inspect Iran’s reactors but found no evidence that they had produced Polonium 210. The issue of whether the Polonium 210 had been smuggled inti Iran from Russian, Pakistan or other black market source or merely a residue on the equipment that Iran had imported was never resolved.
The London Polonium 210, however, set off no alarm bells. After that summer meeting, the next time its presence could be positively dated was October 16th, 2006. That day Lugovoi returned to London with his associate Dimitry Kovtun (See Who’s Who In The Polonium Game) and met at the offices of Erinys, a British consulting form, which Lugovoi suspected was a front for British intelligence. Litvinenko was present at that meeting as well as a number of British consultants who were interested in the "joint venture." Afterwards, the offices of Erinys tested positive for Polonium 210. So did the two rooms at the Parkes Hotel in Knightsbridge, where Lugovoi and Kovtun stayed on the night of October 16th. Lugovoi also visited the office of Berezovsky (supposedly to help arrange security for his relatives in Russia), and those offices later tested positive for Polonium 210.
Kovtun was certainly contaminated by October 28th 2006. That day he flew to Hamburg, where he had lived for 12 years, to renew his German residence permit. The permit was tainted with Polonium 210. So was the house he stayed in from the 28th to the 30th. These traces could be no more than sub-microscopic particles that attached themselves to dust or fibers.
On November 1st, Litvinenko visited four sites that later tested positive for Polonium 210. First, he went to the Itsu Sushi restaurant for lunch with Mario Scaramella (See Who’s Who In The Polonium Game), who had just flown to London from Italy. After that lunch, Scaramella was found to be contaminated by Polonium 210, and hospitalized . Next, at about 5 p.m., he went to the Pine Bar the Millennium Hotel to meet Lugovoi and Kovtun, who were also carriers. Not surprisingly, a dozen people in the Pine Bar showed traces of Polonium 210. Afterwards, he went to Berezovsky’s Mayfair office, where he used a fax machine, which also tested positive for Polonium 210. He then was driven home by the Chechen leader Akhmed Zakayev (See Who’s Who In The Polonium Game) whose car was tainted with Polonium 210.
Two days later, after cancelling a scheduled meeting with Lugovoi, Litvinenko was hospitalized with acute stomach pains. After he died on November 29th, the autopsy examination found that he had ingested Polonium 210 on two separate occasions, according to the London Telegraph. A tiny speck, as little as one millionth of a gram can be fatal if it is ingested. (The Coroner’s Report has not yet been released).
Meanwhile, Lugovoi and Kovtun, who were both hospitalized in Moscow, also tested positive as did their spouses.
So in the summer and fall of 2006 there was a stealth epidemic of Polonium 210 particles, a few which proved fatal to Litvinenko. But who contaminated who?
Table 1
The Stealth Polonium Epidemic
Contacts, Summer-Fall, 2006

Litvinenko Lugovoi Kovtun Scaramella Zakayev
Litvinenko - X X X X
Lugovoi X - X 0 0
Kovtun X X - o o
Scaramella X o o - o
Zakayev X o o 0 -

[To be Continued]

Who's Who At The Polonium Party

2007-07-16T17:29:00.001-04:00

Berezovsky (cigar) and Zakayev, January 23,2006
Boris Berezovsky held his 60th black-tie birthday party at Blenheim Palace, Winston Churchill's birthplace. In the center of the room was an ice sculpture representing St. Basil's Cathedral on Red Square, coated with black caviar. At one table was Alexander Litvinenko, Andrei Lugovoi, and Akhmed Zakayev. They all had been born in the former Soviet Union and they had all been in prison. Ten months later, they all had another connection: Polonium-210.

The Polonium Players

In this deadly game, you need a program

Boris Berezovsky (a.k.a Platon Elenin)

Position: Financier and Revolutionary-in-exile
Polonium Link: Detected on his office furniture and fax machine.
Litvinenko Link: Employer
Dossier: Born in 1946, Berezovsky made an immense fortune in the 1990s in Russia. He acquired stakes in the national airline Aeroflot, the major automobile manufacturer, key oil companies and set up his own bank to transfer funds around the world. He also bought control of newspapers and television networks, including the powerful ORT channel. After Boris Yeltsen was re-elected in 1996 with Berezovsky's support, he appointed Berezovsky both deputy secretary of the National Security Council and Secretary of the Organization for Coordinating the Commonwealth of Independent States (CIS), which qualified him for protection by the Kremlin's Ninth Directorate of the FSB, the successor to the KGB. After Putin came to power in 2000, Berezovsky lost his political power base. He came under criminal investigation for diverting hundreds of millions of dollars from Aeroflot and faced indictment. He fled Russia to his villa in the French Riviera, he was arrested in there on a Russian warrant. After his release, he moved to Britain, which granted him political asylum. Among his political activities in London, he funded anti-Putin exiles, including Alexander Litvinenko. Berezovsky's stated goal was to overthrow the Putin regime, explaining in a 2007 interview with The Guardian,"It isn't possible to change this [Putin] regime through democratic means. There can be no change without force, pressure." Asked by the reporter if he was effectively fomenting a revolution, he said: "You are absolutely correct."

Status: Target of a Russian extradition warrant. On trial in absentia for fraud in Moscow

Alexander Litvinenko (a.k.a Alexander Volkov, a.k.a Chris Reid)

Position: KGB Defector, Author
Polonium Link: It killed him.
Berezovsky Link: Protector(Russia), Political advisor (UK)
Dossier: Born in 1962, Litvinenko spent most, if not all ,of his career in the intelligence game. In 1986, he served in KGB military counterintelligence. In the Chechen rebellion in the late 1980s, he recruited KGB sources in Chechnya. In 1991, the KGB was renamed the FSB, and he worked in its newly-created Department for the Analysis of Criminal Organizations . His duties included the surveillance and penetration of Russian organized crime. In 1998, he was put in charge of protecting Berezovsky. In 1999, after Litvinenko charged that the FSB planned to assassinate Berezovsky, Litvinenko was fired from the FSB and accused of stealing munitions. With any trial, he was imprisoned. In 2000, he was released on condition that he remain in Russia (and surrender his passport). He then fled to Turkey on a false passport under the alias "Chris Reid." From Turkey, he went to Chechnya . According to Russian officials, his mission in Chechnya in 2000 was "to eliminate evidence of Boris Berezovsky's involvement in funding illegal armed groups there." Berezovsky, for his part, denied illicit channeling money to separationists. Whatever the purpose of Litvinenko's work in Chechnya, he rejoined Berezovsky in London on November 1, 2000, where he received political asylum. With Berezovsky’s backing, he worked ceaselessly to discredit Putin as a sponsor of state terrorism. His book Blowing Up Russia alleged that Putin’s FSB, not Chechen separationists, had blown up six Russian apartment houses in 1999, and that the Chechens were framed for the death of some 300 residents in those buildings. He said that Putin's motive was to create the pretext for re-invading Chechnya. His book Gang From Lubyanka claimed that Putin was deeply involved in Russian organized crime. In interviews he alleged that the 2002 seizure of a Moscow theater by Chechen women was organized by "FSB agents among the Chechens" and accused Putin of personally ordering the assassination of journalist Anna Politkovskaya. He eveb alleged that Putin’s FSB had trained Bin laden’s partner in 9-11, Ayman al-Zawahiri, for half of a year in Dagestan in 1998. Litvinenko may also been involved with Berezovsky a less-public activities According to Vyacheslav Zharko, a Russian official who alleges that MI6 recruited him in 2003, Litvinenko and Berezovsky acted as access agents for MI-6. Under the pretext of a meeting with British businessmen, they introduced him to three MI6 officers– "John Callaghan," "Kenn Philips," and "Paul" –who then recruited him as a spy. Andrei Lugovoi, a former Russian security officer, tells a similar story, saying that Litvinenko brought him to meetings in October 2006 with British businessmen who openly attempted to recruit him as a spy for MI-6. If so, Litvinenko was acting as an access agent for MI6 about the time he came in contact with the Polonium 210.

After his death, Polonium 210 was detected in his home and on his clothes.

Status: Died November 23, 2006

Andrei Lugovoi

Position: security expert

Polonium Link: Polonium 210 was detected on him, as well as his wife, children and possessions.
Berezovsky Link: Protector in Moscow

Litvinenko Link: Prospective business partner
Dossier: Born in Azerbaijan in 1966, Lugovoi enrolled in the KGB at the age of 21. During the Yeltsen administration, when the KGB became the FSB, he worked at the Kremlin's personal security unit, where he met Berezovsky. In 1996, he left the FSB to head security at Berezovsky’s television fiefdom, ORT, . After Berezovsky fled Russia in 2000, Nikolai Glushkov, his top associate in Aeroflot war arrested and put under pressure to provide evidence against Berezovsky. Lugovoi had the task of breaking Glushkov out of prison but the escape went awry and Lugovoi served 14 months in prison. After he was released, he set up Pershin, which provided security services to multimillionaires and sold beverages. When he went to London for Berezovsky's gala birthday party on January 23, 2006, he was seated at the same table with Litvinenko, who he had known from the KGB and FSB. Several months later, according to Lugovoi, Litvinenko asked him to come to London to discuss a lucrative joint venture with British businessmen. In the summer he met Litvinenko at his home who gave him documents and "gifts" to bring back to Moscow. The material later tested positive for Polonium 210. indicating that Litvinko (and Lugovoi) were in contact with Polonium 210 four to six months before Litvinenko died. As the deal progressed, Lugovoi and his Moscow associate Dmitry Kovtun met Litvinenko at Erinys, a British security firm. During that meeting, the British participants, according to Lugovoi, tried to recruit him as source for information about the FSB, leading him and Kovtin to assume that they were MI6 officers . The offices of Erinys later tested positive for Polonium-210. Lugovoi last met Litvinenko on November 1st at the Pine Bar.

Status: Subject of a British extradition warrant

Dmitry Kovtun

Position: Consultant

Polonium Link: Detected in his body, in his hotel room, in his Hamburg residence.

Berezovsky Link: Business prospect.
Dossier: Born in 1966, Kovtun graduated from the elite Supreme Soviet Military Command School in 1985. He then served in military intelligence in Eastern Europe, posted in Prague and Berlin, in the final days of the Cold war . From 1991 until 2003, he lived in Hamburg, Germany, eventually marrying a German national, Marina Wall, and working as a "consultant". After 12 years in Germany, he returned to Moscow (without his wife) in 2003 and, continued a consulting career in "oil and gas." Lugovoi, who had known him since they were in school, suggested he come to London to participate in Litvinenko's "joint venture". Kovtun accompanied Lugovoi to the October 16 meeting at Erinys. On October 28, he flew to Hamburg to extend his residence permit The permit, his residence, and ex-wife later tested positive for Polonium 210, indicating that he was contaminated after the October 16th meeting. On November 1, he again saw Litvinenko at the Pine Bar.

Status: Subject of German investigation into Polonium smuggling.

Akhmed Zakayev

Position: Chechen leader. Foreign Affairs Minister of the Chechen Republic (exiled in London)

Polonium Link: Detected on front seat of his car
Berezovsky Link: Ally, attended his 60th Birthday party
Litvinenko Link: Appointed Litvinenko in 2002 to the Commission on " war crimes committed on the territory of Chechnya by the Russian occupying troops."
Dossier: Born April 1956 in Kazakhstan, Zakayev first achieved stardom as an actor at the Grozny theater. In 1990, after Chechnya seceded from Russia, he was appointed its Minister of Culture. After Russia re-invaded Chechnya, Zakayev first fought with the rebels and then went into exile in Denmark, where he was arrested on a Russian warrant. He then went to Britain, where he receive political asylum. He met Litvinenko in London in 2003, and kept, as he stated in his deposition, "in constant contact" with him. At 6 pm on November 1st, Zakayev picked up Litvinenko from Boris Berezovsky's Mayfair office, where Litvinenko had gone after his meeting at the Pine Bar, and drove him home.

Status: Subject of Russian extradition warrant

Mario Scaramella

Position: Security Consultant

Polonium Link: Contaminated, hospitalized
Litvinenko Link: Source on KGB penetration of Italy
Dossier: Born in 1970 in Naples, Scaramella went to work in 2002 as an advisor to Italy’s Mitrokhin Commission which was investigation allegations of KGB recruitment of Italian politicians. After Scaramella paid Litvinenko to provide information about KGB/FSB operations in 2005, he met again with him around lunchtime on November 1 at the Itsu Sushi. After that meeting (and before Litvinenko proceeded to his meeting with Lugovoi at the Pine Bar), Scaramella was contaminated by Polonium.

Status: In Prison on unrelated charge of calumny

[See Theories Below]