March 30, 2007

Bank of America Credit Card Scam 2

I little while back I wrote about a B of A credit card minimum finance charge scam.

Recall, they sent a notice out saying they would start charging a $1.50 minimum finance charge, UNLESS they received a written request to reject the charge. Recall that I heard about this from a friend who also has a pseudo liberal Working Assets Visa. At the time I wrote that blog entry, I hadn't even found the small print describing this fee, which I thought was buried in the Privacy Statement.

Well, I found the notification of the finance charge, and Bank of America has a reason for assessing this finance charge:

We added a Minimum Finance Charge to your account primarily due to a change in our business practices.

Well NO KIDDING. They've changed their business practices to ... collect a finance charge.

Bank of America has also changed its Monthly Minimum Payment. Before, there was a cap on the minimum payment required each month. Now, the minimum payment is simply a fixed percentage of the outstanding balance. OK, I can live with that. But, again, the reason they give is a bit pathetic:

As a result of federal guidance, we are changing the minimum payment calculation on your account.

This surely is intended to make it sound like the government is forcing B of A remove the cap on the minimum required monthly payment. However, the reality is probably more like the following. Credit card industry lobbyists bought off Congress to "modernize" the credit card laws and create more "flexibility" so they could compete in the global economy. Then, the credit card regulators were lobbied to change the regulations to remove the cap on the minimum payment. In response, the regulators revised their guidance, allowing credit card companies to remove the cap on the minimum payment. This might even be a part of the bankruptcy reform law, in which the credit card holders receive a favor from big brother, designed to help them keep up with paying down their debt and avoid bankruptcy.

A year or so later, the credit card company, B of A in this case, turns around and tells the public, "As a result of federal guidance," we're going to add a little more pain to your life.

Surely, if the people were in charge of this country, they wouldn't let this kind of thing happen.

How to Reject the Finance Charge:

By May 1, 2007

B of A
PO Box 15088
Wilmington, DE 19850

Identify yourself and your card number

Say: "I reject the minimum finance charge of $1.50."

March 29, 2007

Payday Loan Business

Wow. Google payday loan business and you'll get over 2 million hits. Many are singing the praises of this business:

How to Start a Payday Loan Business

Why should you buy a payday loan or other money lending business?

You'll also see snippets like this one:

H&R Block To Settle More Payday Loan Suits ...

Some call it Legal Loansharking. Thought the 24% APR on a credit card was tough? On the average payday loan of $300 for eight days, a 15% fee equates to an APR of 459% according to Maureen Rooney.

But there's a story within the story. These seedy store fronts you see in depressed neighborhoods are "Big Business" posing as a little businesses, like Citigroup.

According to Danny Schechter, who appeared on Media Matters March 25, 2007 points to a similar operation.

One of the phenonomena that is very topical is people who go to various tax preparation services to get their refunds right away... they end up paying an exhorbtant fee charge on this. What we discovered was that there were these rat trap kind of little store fronts in the ghetto ... and behind the scenes was the HSBC Bank which was taking $1.6 Billion dollars out of poor neighborhoods with these tax refund businesses brokered through all kinds of differerent companies including H&R Block.

We tried to interview the head of this program at HSBC, and of course they refused to go on camera. Just the other day HSBC reported a $10 Billion dollar loss on its subprime loan situation. So, a lot of these people who are predators, predatory lenders, are now facing a big problem because these people have defaulted and they are left holding the bag, though they have made a small fortune on it.

One of the things I also found out about was a hundred thousand veterans coming back from Iraq, who are in hock up to their eyeballs, and have these payday loans, and down in Norfolk, Virginia, where we did some filming we found out that there were like three payday lenders around the base in Norfolk a year ago. Today there are twenty-six lenders

Danny Schechter continues to describe the Naval and Marine Corps relief society, which has researched the situation. They've discovered that the problem payday lenders are causing serious pain for military families.

Schechter continues to point out that the progressive community "by and large has not really spoken out on this."

People who are in MoveOn and other groups... and a lot of the bloggers are totally focused on every burp in Washington, every mini scandal problem to show that Bush is a liar, he's a liar, he's a liar, how many times have we heard that? But they don't really look at the institutional issues. And they don't look at the economic issues too often. So what I'm encouraging ... is that we have to focus on the economic realities, not just the political realities.

Schecter expands on this in an March 26, 2007 article entitled, "Lets Broaden Our Focus To Include Economic Issues: It’s Time To ‘Stop The Squeeze’" not Scheckter

March 28, 2007

Dear Yahoo: Windows Vista Adds are Annoyance

Dear Yahoo:

The Vista adds embedded in your Yahoo News are very disruptive; perhaps you've noticed. They splash themselves across the page, with no obvious way to close them. Clicking on a part of the page that doesn't appear to be part of the add then opens another window. It seems emblematic of the monopolistic practices of Microsoft to take control of my news-browsing experience.

Please do what you can to undo this problem.

March 25, 2007

Bank of America Privacy Policy Credit Card Scam

If you're like me, you receive "Privacy Policy" statements from various corporations, and you either file them or toss them. Recently, Bank of America hid a little gem in their Bank of America Privacy Policy of for Consumers 2007.

How do I know? Well, as I write this, it's NOT because I've found it in the small type. Instead, a friend who also has a Working Assets Visa card told me. "You need to send a letter to Working Assets (AKA Bank of America) to opt-out of a $1.50/month finance charge by May 1, 2007." It's a legalized scam.

Yes, that bastion of liberal innovation, Working Assets, once affiliated with Fleet Credit Card Services, is now serviced by FIA Card Services, National Association (Bank of America). Working Assets is now party to this legalized scam.

The scam is simple. Bank of America is allowed by the U.S. Congress to impose a $1.50 monthly finance charge, with the presumed Democrat compromise language that the "consumer" has to be given the option of saying "No, I don't want to pay." Gee thanks. Great opposition party, eh?

So, who pays? People who don't read the fine print. I blame Working Assets.

Contact Working Assets. Tell them that you blame them too.

Side Note 1: Bank of America started the credit card concept, according to Wikipedia.

Side Note 2: A Bank of America branch in Santa Barbara (Isla Vista) was burned to the ground April 18, 1970. Kevin Moran was shot and killed by Santa Barbara City Police after working put out the fire.

Side Note 3: At least the B of A Privacy Policy write the USA PATRIOT Act correctly (all capital letters to indicate it is an acronym for Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism).

Side Note 4: How to Reject the Finance Charge:
B of A
PO Box 15088
Wilmington, DE 19850

Identify yourself and your card number

Say: "I reject the minimum finance charge of $1.50."

March 21, 2007

Is Stagflation Making a Come Back?

"Analysts said the central bank (Fed) appeared to acknowledge it is in a bind, caught between an economy being dragged down by troubles in the housing industry and stubbornly high inflationary pressures." - A recent AP article.

Although many people view the U.S. Federal Reserve as being at the center of power, its power has waned over time. What happens when the Fed "turns the knob" to control the economy and nothing happens? Well, first, the mythic power of the Fed is shown to be.... er, mythic. Second, people and institutions get nervous about the economy. And third, these same people and institutions quickly forget about their nervousness and continue to exhibit signs of "irrational exuberance;" they continue to move money around in speculative activities that are disconnected from reality as described in John McMurtry's The Cancer Stage of Capitalism.

It isn't really news that the Fed's breaks and accelerator have gotten mushy lately. In addition to the phrase "irrational exuberance," coined by former Fed Chairman Alan Greenspan, is the word "conundrum," which has meaning in this context. It's a fairly simple concept. (Conundrum1)

When someone invests money to make a profit, say on bonds that pay back at a certain interest rate, their money will be locked up for a period of time (unless they back out and pay a penalty). A thirty-day bond locks up the money for thirty days, and a ten-year bond locks it up for ten years. The longer a person is willing to bear the inconvenience of having their money locked up, the higher the interest needs to be to entice them into such an investment. That is, longer term bonds (10-yr) should pay a higher interest than short term bonds (30-day). The "conundrum" voiced by Greenspan is that the bond yields were reversed fairly often during 2006 (long-period bonds were paying lower interest than short-period bonds). This is also known as an inverted bond yield curve (here's a good site that shows the yield curve changing over time). Despite trying to control this, the Fed seemed powerless.

Now the Fed has another conundrum (Conundrum2). Usually, the Fed "controls" the economy by adding or removing dollars; more available dollars means more economic activity, which in a healthy economy translates into more jobs (but more potential for price inflation, AKA an over-heated economy). If the Fed provides fewer available dollars, it helps to bring down price inflation, but this reduces economic activity. In simple terms, the Fed strives to control interest rates at which money is borrowed; lower interest rates means more money is likely to be borrowed and thus fuel the economy (and inflation); higher interest rates means less money available, and prices should come down.

What happens when the economy is not doing well, but at the same time price inflation is going up? The Fed might be tempted to pull dollars out of the economy (increase interest rates) to control the inflation, but this will also further dampen the economy and put more people out of work. If the Fed tries to do the opposite, put dollars into the economy to stimulate the economy, inflation will go up. This situation is known as "stagflation;" the economy is stagnant, but at the same time there's inflation. It's a counter-intuitive situation in which the Fed has lost control in terms of Conundrum2, even assuming Conundrum1 isn't in effect.

Today, both conundrums seem to be in effect: We are facing stagflation (Conundrum2), and when the Fed turns its control knobs, nothing happens (Conundrum1).

The reason for all of this, I believe, is simple. The economic system isn't healthy, which is different than saying the economy isn't healthy. Our corporate free market system has allowed obscene amounts of wealth to be concentrated into a few hands, and the money is stuck there. In a healthy economy, the money moves around, in and out of every one's hands, even the little people who are not part of the inside crowd. We are witnessing the failure of trickle-down economic theory, or worse, outright corruption among the wealthy political elite. Either way, the signs of failure are emerging.

There's much more to this story, and we will watch it unfold in terms of an unraveling economy starting with subprime mortgage defaults that bring down corporations and institutions that have invested in real estate financial instruments. The challenge of this time will be for society to rise to the occasion and re-define the economic system so that it becomes a healthy one.

March 20, 2007

National Mortgage Bad News

From a skim of today's National Mortgage News, the news is not good. Mortgage lenders are cutting staff, purchase agreements for the sale of mortgage companies are being amended drastically to cut the sale price, Senate hearings are being scheduled, forclosure guidelines are getting lots of attention, Fannie Mae is selling off assets, the rating compainies can't seem to keep up with analyses to downgrade mortgage backed securities and mortgage companies.

The talk all seems to be about the secondary mortgage market. But one article stands out:
Wall Street wants to get its arms around rising subprime loan defaults as fast as possible so it can move forward with the least disruption to the markets...
In other words, Wall Street wants to staunch the spread of a liquidity crisis to other sectors of the economy.

NovaStar Cans 17% of Its Staff

Struggling subprime funder NovaStar Financial trimmed its work force by 17% -- 350 positions -- on Friday, citing the changing landscape of the mortgage industry. Click here for more...

People's Choice Shedding Workers?

People's Choice Financial Corp. -- which recently pulled a key registration statement with securities regulators -- is contemplating significant layoffs and has not funded a loan in more than a week, according to industry sources. Click here for more...

Accredited Facing Delisting

Accredited Home Lenders, San Diego, has been notified by the NASDAQ stock exchange that it will be delisted because it did not file its annual 10-K report by March 15. Click here for more...

Fieldstone Sale Price Cut by 28%

Credit-Based Asset Servicing and Securitization LLC will pay 28% less for Fieldstone Investment Corp., Columbia, Md., under an amended purchase agreement disclosed March 16. Click here for more...

Dodd Sets Subprime Hearing

Senate Banking Committee Chairman Christopher J. Dodd, D-Conn., says he is looking for ways to prevent millions of subprime borrowers from losing their homes and will be pressing regulators and industry representative for solutions at a March 22 committee hearing. Click here for more...

Reich: B&C Guidance Frowns on 2/28 'Steering'

The recently proposed federal subprime lending guidance reminds lenders that they should help consumers make informed choices and not steer them into 2/28 adjustable-rate mortgages when they might qualify for another product, according to Office of Thrift Supervision Director John Reich. Click here for more...

FTC Cites Foreclosure Guidelines

Servicers should not start foreclosure proceedings until a borrower has missed three monthly payments of principal and interest, according to a Federal Trade Commission attorney. Click here for more...

Street Seeking to Get Handle on B&C Defaults

Wall Street wants to get its arms around rising subprime loan defaults as fast as possible so it can move forward with the least disruption to the markets, according to a loss mitigation firm hired to get a fix on polls of nonperforming mortgages. Click here for more...

CoreLogic Predicts 13% ARM Foreclosure Rate

A study by First American CoreLogic predicts that 1.1 million of the 8.37 million adjustable-rate mortgage loans originated between 2004 and 2006 will end up in foreclosure over a six- to seven-year period. Click here for more...

Citi Buys Fannie LIHTC Portfolio

Citibank NA has purchased from Fannie Mae a portfolio of investments representing approximately $676 million in federal Low Income Housing Tax Credits, according to the two companies. Click here for more...

Fannie Adjusts Series K Dividend Rate

Fannie Mae has announced a dividend rate adjustment for its series K variable-rate noncumulative preferred stock. Click here for more...

Fitch: Subprime Exposure Drops for ABCP

Subprime-related mortgage exposure for U.S. asset-backed commercial paper programs fell sharply in the fourth quarter, though it remained high by historical standards, according to Fitch Ratings. Click here for more...

Fitch Downgrades Morgan Stanley MBS Classes

Twenty-seven classes from 15 Morgan Stanley subprime mortgage-backed securities have been downgraded by Fitch Ratings. Click here for more...

Moody's Downgrades GSAMP MBS Classes

Six certificates from three GSAMP Trust deals issued in 2006 have been downgraded by Moody's Investors Service. Click here for more...

MASTR MBS Classes Downgraded

Three tranches from two deals issued by MASTR Second Lien Trust have been downgraded by Moody's Investors Service, and one tranche has been placed under review for possible downgrade. Click here for more...

SACO MBS Class Downgraded; 9 on Review

Class B-3 of SACO I Trust 2004-3 has been downgraded from B3 to Caa2 by Moody's Investors Service, and nine other certificates from various SACO I deals have been placed on review for possible downgrade. Click here for more...

Moody's Eyes New Century MBS Classes

Five certificates from New Century Home Equity Loan Trust series 2006-S1 have been placed on review for possible downgrade by Moody's Investors Service. Click here for more...

Terwin MBS Classes on Review

The ratings of five classes from three Terwin Mortgage Trust securitizations have been placed on review for possible downgrade by Moody's Investors Service. Click here for more...

Fremont MBS Classes Under Review

Four certificates from Fremont Home Loan Trust series 2006-B have been placed on review for possible downgrade by Moody's Investors Service. Click here for more...

Ace MBS Classes Under Review

Four certificates from Ace Securities Corp. Home Equity Loan Trust have been placed on review for possible downgrade by Moody's Investors Service. Click here for more...

Moody's Eyes Long Beach MBS Classes

Classes M-7, B-1, and B-2 from Long Beach Mortgage Loan Trust series 2006-A have been placed on review for possible downgrade by Moody's Investors Service. Click here for more...

Merrill MBS Classes Placed on Review

Two subordinated certificates from Merrill Lynch Mortgage Investors Trust series 2004-SL1 and 2004-SL2 have been placed on review for possible downgrade by Moody's Investors Service.

March 19, 2007

Carry Trade

Carry Trade: A series of transactions where you borrow and pay low interest in order to buy something else that pays you a higher interest. For example, if a Bank can receive a short-term loan at 4% and re-loan that money out at 6%, they can pocket the 2% difference. Because they deal in large sums, 2% translates into huge flows of profit.

The term, "carry trade," has also been used recently in relation to currency trading. It's a classic arbitrage. Here's an example or a "yen carry trade":

Let's say a trader borrows 1,000 yen from a Japanese bank, converts the funds into U.S. dollars and buys a bond for the equivalent amount. Let's assume that the bond pays 4.5% and the Japanese interest rate is set at 0%. The trader stands to make a profit of 4.5% (4.5% - 0%), as long as the exchange rate between the countries does not change. Many professional traders use this trade because the gains can become very large when leverage is taken into consideration. If the trader in our example uses a common leverage factor of 10:1, then she can stand to make a profit of 45%. [1]

The risk is that the underlying rates could change. First, in the first example of the bank, if the short term rates increase above 6% the bank will be loosing money, and will need to quickly pay off the short-term loans. This is called "unwinding" the loans. If the bank does not have funds to pay off (unwind) the short-term loans, they could bleed to death.

Recently, there has been a lot of talk about unwinding the yen carry trade. It's part of the story of recent Wall Street stock drops, and the subprime real estate market "unwinding" process.


1. Investotopia

March 17, 2007

Pentagon Protest: Police Line on Washington Blvd

This is the final in a set of three photo essays about the Pentagon protest on March 17, 2007. The other two photo essays are:

Overview and Miscellaneous Photos

Speaker Stage Area Photos

As noted in the "Overview," the march led to a speaker's stage set up with the Pentagon in the background. The second area of activity was a police barrier across Washinton Boulevard at the bridge crossing Route 110 (Jefferson Davis Highway). The bridge is in the background of the photo below. The police line was formed on the left side of the bridge relative to the photo below.
Crowd listening to Speakers at the Pentagon Protest.
Washington Blvd. bridge in background.
March 17, 2007.

Upon arriving at the bridge, some people were saying that somebody had been arrested and sprayed with mace. A small crowd stood in front of the police comprising a group of direct action protesters, other marchers, and a variety of journalists.

Crowd standing in front of a police line the on
Washington Blvd. bridge crossing Rt. 110.
Pentagon Protest, March 17, 2007.

The line was composed of a variety of different police forces including State police, park police, and local police.
Police line blocking off Washington Blvd. looking South-East
toward the Pentagon. Note grass median and exit lane markings.
Pentagon Protest, March 17, 2007

Police line blocking off Washington Blvd. looking Nouth-West
away from the Pentagon. This is about half of the police line.
Pentagon Protest, March 17, 2007

The dynamic weather and setting made for some interesting photo opportunities. Despite good intentions, the Air Force memorial, seen in the background of the following photo, can't help but look a bit evil, like barbs of satan emerging from the ground.

Police line with helicopter and Air Force Memorial
in the background. March 17, 2007.

A group of direct-action protesters were assembled behind me from the vantage point of the police line photo immediately above. They were debating whether or not to confront the police line.
Direct-action protesters debate options at
the Pentagon Protest March 17, 2007.

The protesters decide to pull back, standing and conducting an organized retreat saying that they would meet the authorities again some day.

Anarchist protesters on Washington Blvd.
perform an organized retreat from the police blockade.
Pentagon Protest, March 17, 2007

A chartered bus got trapped on the Washington Blvd. bridge. The poster displayed in the window made the Vanderhoof bus company appear to be in support of the impeachment of George Bush.
Charter bus trapped on the Washington Blvd. bridge.
Pentagon Protest, March 17, 2007

Charter bus trapped on the Washington Blvd. bridge.
Pentagon Protest, March 17, 2007

Eventually, the police line started to slowly move forward to clear people off of the bridge. The process involved the line taking a few small steps forward, then stopping. The process was briefly altered when the police line reached a yellow school bus that had been trapped on the bridge, which it eventually let pass through the line.

Advancing Police line encounters a trapped school bus
on the Washington Blvd. overpass of Rt. 110
March 17, 2007

Police line allows trapped school bus on the Washington Blvd. overpass
to pass through. March
17, 2007

School bus passes into the distance beyond the
advancing police line clearing Washington Blvd overpass
March 17, 2007

Protesters stayed several steps ahead of the advancing police line.
Advancing Police line encounters a hoolahoop peace sign
on the Washington Blvd. overpass of Rt. 110
March 17, 2007

Advancing Police line encounters a bicycle rider
on the Washington Blvd. overpass of Rt. 110
March 17, 2007

This sign was prominantly displayed as the police line advanced
on the Washington Blvd. overpass of Rt. 110
March 17, 2007

One couldn't help but see the stark resemblance of the State Police riot gear and the Darth Vadar.

March on the Pentagon, 03/17/07.

Pentagon Protest: Speaker Stage Photos

This is the second in a set of three photo essays about the Pentagon protest on March 17, 2007. The other two photo essays are:

Overview and Miscellaneous Photos

Police Line Road Block on Washington Boulevard

As noted in the "Overview," the march led to a speaker's stage set up with the Pentagon in the background. Former US Attorney General Ramsy Clark was speaking when the following two photos were taken.

Speaker stage at the Pentagon Protest, March 17, 2007.
Pentagon in the background.
Photo taken from the media stand. (click photo for larger image)

The following photo shows part of the crowd listening to speakers. In the background is Washington Blvd bridge. It was blocked off by a police line at the lefthand side of the bridge relative to the photo below. Route 110, Jefferson Davis Hwy, goes under the bridge. The stage and Pentagon are to the left.

Crowd listening to Speakers at the Pentagon Protest.
March 17, 2007.

A fairly significant group of journalists, including Indymedia, and corporate media, covered the protest, reflected in the photo of cameras on the raised platform below.
Media cameras covering the Pentagon Protest.
March 17, 2007

To the left of the stage, Carlos Arredondo set up a display honoring his son, Alexander, who was killed in Najaf in August 2004. According to DemocracyNow, "Carlos has traveled across the country with an empty coffin and a picture of his son's open casket and funeral." He was in Times Square with his display on March 12 and conducted an interview on DemocracyNow the following day.

Carlos Arredondo being interviewed next to
the display in honor of his son in photo seen in upper left.
Pentagon Protest March 17, 2007

Carlos Arredondo's display, AKA "Camp Alex," at the
March 17, 2007 Pentagon Protest.
Note his son's uniform and boots on the back of the van, and an enlarged
photo of his son's open casket near the front of the van.

I found the display of Alex Arredondo's uniform and boots haunting.

Alex Arredondo's uniform, on display by his father Carlos
as part of "Camp Alex," at the March 17, 2007 Pentagon Protest.

I urge you to click on the following photo of Alex Arredondo's boots.

Alex Arredondo's boots and dog tags, on display by his father Carlos
as part of "Camp Alex," at the March 17, 2007 Pentagon Protest.

See the first in this three-part photo essay, Overview and misc. photos. See also the third in the series, Police Line Road Block on Washington Blvd.

Pentagon Protest 2007

Pentagon Protester 2007Here is a woman who celebrated St. Patrick's Day by protesting outside the military's Pentagon building in Washington, DC.

The Pentagon protest on March 17, 2007 was part of many protests going on at this time. The Pentagon protest itself started with a march from the mall near the Vietnam War and Lincoln memorials. The march route crossed the Memorial Bridge over a blustery Potomac River, followed a the grass-lined Potomac parkway through Lady Bird Johnson Memorial Park, and ended at a parking area separated from the Pentagon by a Route 110 (Jefferson Davis Highway), at the intersection with Washington Blvd.

Relative to the picture above, created by the ANSWER Coalition, the march stopped near the last dot before the arrowhead (it didn't cross Route 110, except in as much as the smaller protest on the Washington Blvd bridge barely crossed beyond Route 110).

This photo essay is organized into three parts.

1. Protest Speaker's Stage.

2. Road Block with Police Line on the Washington Boulevard bridge crossing Route 110.

3. Miscellaneous Photos, continued below.

See: Out-takes at Baltimore Indymedia

The following photo shows a view of marchers on the Virginia side of the Potomac as viewed from the Memorial Bridge. It was cold and windy on the bridge. Counter-demonstrator's, mostly motorcycle bikers, were coming back across the bridge in the opposite direction when we were crossing at the tail end of the march.

View of the Virginia side of the Potomac and marchers
during the March 17, 2007 march on the Pentagon.
Photo from the Memorial Bridge

The march passed through Lady Bird Johnson's Memorial Gardens. Daffodils were starting to bloom despite the ice and snow storm of the night before, which prevented some protesters from attending.
Pentagon Protesters nearing their destination after walking
through Lady Bird Johnson's Memorial Gardens.

We ran into the devil himself on the way to the speaker's stage.

Protester dressed as "George Bush the Devil" (AKA diablo)
Pentagon protest March 17, 2007

The march led up over a hill. Upon cresting the hill, the Pentagon came into view. The speaker's stage was to the left and the Washington Blvd police line was to the right, relative to the photo below.
Peace Protest Pentagon 2007Pentagon Protesters crest a hill nearing the end of their march.
The Pentagon can be seen in the background.

One sees many creative signs at peace and justice demonstrations. This official, permanent sign summed up a fundamental message, "Stop the Nation's Turn to the Right."

Stop Turn To RightStop the Right Turn, official sign at the March 17, 2007 Pentagon Protest.
Hill leading down from Washington Blvd towards the speaker's stage.

Upon arrival, most people went to the Speaker's Stage. Others continued on Washington Blvd. to confront a police line blocking passage to the Pentagon.

March on the Pentagon. March 17, 2007.

March 15, 2007

Privatizing War - Part 3

Guest Writer: L. Vincent Sebastian

FINAL in a Three-Part Series,

My recent posting, “Privatizing the War in Iraq”, describes the Bush administration’s growing reliance on private contractors such as Blackwater USA to conduct military operations in Iraq. Yet, the issues and potential problems with private contractors described in that posting are only the tip of the iceberg. In the new posting below, the many problems surrounding private military firms (PMFs) are more fully laid out. The source material for this posting is: P.W. Singer, “Corporate Warriors: The Rise and Ramifications of the Privatized Military Industry”, International Security, Vol. 26, No. 3, Winter 2001/2002. Although Singer’s article, turned into a book, was published before the U.S. invasion of Iraq, its relevance has only increased in the last five years.

Impacts of the Privatized Military Industry on Conflict, Security, and Public Policy

The likely consequences of PMF activities fall into three broad categories: contractual dilemmas; military market dynamics and disruptions on security relations; and the policy impact of PMFs as alternative military actors.

(1) Contractual Dilemmas. Three types of contractual dilemmas are considered: the financial bottom line; monitoring and oversight, and the dependences of states on PMFs.

(a) The Bottome Line. At issue here are divided loyalties and different goals. Clear tensions exist between the client's security objectives and the PMF’s desire to maximize profit, so that the public good and the PMF’s good often conflict. In spite of claims to the contrary, the PMF may not act only in its client’s best interests. Given that the PMF’s focus is on the bottom line, it may have an incentive to cut corners to increase profits. For example, during the Balkans conflict, Brown & Root (a subsidiary of Halliburton) is alleged to have failed to deliver or severely overcharged the U.S. Army on four out of seven of its contractual obligations. In addition, PMFs have similar financial incentives to prolong their contracts and to avoid taking undue risks that might endanger their own corporate assets. The result may be a protracted conflict that could have been avoided. Finally, it is no stretch to imagine two arms of a large PMF contracting to support opposing sides in a conflict.

(b) Monitoring and Oversight. Few clients have experience in contracting with PMFs, and frequently there is little oversight and/or a lack of clearly defined requirements. Add in the fog of war, and proper monitoring becomes extremely difficult. Moreover, the actual consumer may not be the contracting party. Some nation-states pay PMFs to supply personnel on their behalf to their allies or to international organizations. The accountability gap between the server and served is becomes much wider in such cases.

(c) Dependence. As the use of PMFs becomes increasingly popular, so too does the danger that clients will become overly dependent on PMF services. Reliance on PMFs means that the client’s strategic success is vulnerable to changes in market conditions and to the client-PMF balance of power. This can result in three potential risks to the client. First, the PMF might leave its client in the lurch. A PMF may have no compunction about suspending a contract if a situation becomes financially or physically too risky. Because they are typically based elsewhere, and in the absence of applicable international laws to enforce compliance, PMFs face no real risk of punishment if they defect from their contractual obligations. The employees of PMFs cannot be forced to stay at their posts in the face danger. To the extent that entire military functions such as weapons maintenance and supply have become privatized, the entire military machine would break down if even a modest number of PMF employees chose to leave.

Second, the PMF might gain dominance over the client. In weak or failed nation-states, PMFs, which are often the most powerful force on the local scene, may take steps to protect their own interests. Thus early termination of a contract, dissatisfaction with the terms of payment, or disagreements over specific orders could lead to unpleasant repercussions for a weak client. For example, it is suspected that in 1996 Executive Outcomes helped to oust the leader of Sierra Leone, who headed the very regime that had hired it, in favor of another local general with whom the firm’s executives had a better working relationship.

Third, the PMF might engage in economic imperialism. Clients of (type 1, military provider) PMFs are often those most in need but least able to pay and thus at the highest risk of default. This imbalance can lead to the mortgaging of valuable public assets to the PMF or its associates in an attempt to align the client’s and firm’s incentives. For example, the PMF may obtain mineral rights following the fulfillment of its contract, or possibly in exchange for protecting those very resources and their production. A variation of this is the client’s promise to pay the PMF in public resources or assets currently held by enemy forces, following a successful campaign. Ultimately, the result is that valuable resources for the nation as a whole are lost in order to meet short-term exigencies.

(2) Military Market Dynamics and Disruptions. Military market dynamics and disruptions can complicate international security because military powers are no longer exclusively sovereign states but include private players. The privatized military industry is an independent, globalized supplier operating beyond any one state’s domain. Non-state actors can access formidable military capabilities, and where state structures are weak, the result is a direct challenge to state sovereign authority. Even when PMFs are hired by strong states, decision making shifts beyond the states’ immediate control and is subject to the PMF’s own motivations, with all of the uncertainty that these processes entail. The very act of military outsourcing also runs counter to the tenet that states seek to maximize their power through self-sufficiency in order to minimize their reliance on others. Five potential impacts or disruptions on the state or global security environment caused by the private military industry are considered below.

(a) The New Fungibility of Power. Today, the entire spectrum of conventional forces can be obtained in a matter of days or weeks, for a price. A state or non-state entity need not have a large population, institutional support or expertise in order to wield capable military might. The barriers to acquiring military strength are lowered, making power more fungible than ever.
This ability to quickly transform money or other economic assets into force – that is, into a military threat – makes economic power itself more threatening, contrary to conventional assumptions. The capitalist ethos tends to assume only what is positive about the profit motive, and the spread of capitalism and globalism is seen, conventionally, as a way to reduce the incentives for violent conflict. However, the emergence of the PMF as a new type of private transnational firm, which relies instead on the existence of conflict for its profits, counters the assumption that non-state economic actors are generally peace orientated.

(b) New Complexities in the Balance of Power. The privatized military industry lies beyond any one state's control. The uncertainties of a dynamic global market creates major complications for the already-difficult task of assessing the balance of power between states. In an open market, where a wide range of military services can be procured, likely outcomes become increasingly difficult to discern. Once-predictable deterrence relationships can rapidly collapse, and the hire of PMFs can quickly and unexpectedly tilt local balances of power. Arms races might become instant bidding wars on the open market, with adversaries competing first for PMF services before taking to the battlefield. The result is that the pace of the race is accelerated, and first-mover advantages are heightened. Indeed, such changes could well increase the likelihood of war initiation and preemptive strikes. In addition, conventional arms control is made more difficult with the existence of this market. A nation-state can reduce its in-house force capacity, perhaps to comply with a treaty or avoid sanctions, without reducing its overall threat potential.

(c) Changes in Strategic Relationships. The privatized military market has fundamentally altered the former patron-client relationships of the Cold War. Instead of bowing to the demands of their superpower patrons in exchange for support and protection, weaker states can buy the military skills, training, and capabilities that they need on the open market. As a result, the patron’s leverage is diminished, and weaker states are no longer bound by their patrons’ prerogatives.

Traditionally, states in alliances have divided up their military tasks, making them more dependent on one another in the process. Now that PMFs can perform some of these tasks, mutual reliance among allied states is effectively reduced. A state may then feel less need for the approval of its allies in conducting its own affair, and ultimately the alliance may become weakened. For example, NATO members rely on the U.S. to supply much of its external deployment capacity (e.g., lift capacity, logistics, intelligence gathering and analysis). However, this capacity could also be adequately supplied by type 3 PMFs (military support firms).

The PMF market also makes available new forms of aid and alliances. Because PMFs allow the easy conversion of financial resources into military might, allies can provide military aid in the guise of simple cash infusions. The rationale for this new form of aid is that it lowers potential risks for donors by reducing the likelihood of their becoming embroiled in their allies’ fighting. In addition, possible donors are no longer restricted to states. With equal ability to pay, non-state actors, including even rich individuals, can become valuable allies, able to bolster local forces and shift military balances from a distance.

(d) Non-State Actors Empowered. The global private military industry provides easy access to military services, and therefore provides non-state actors with new options and paths to power not imagined until recently. The increase in military capability of non-state groups has resulted in a widening of conflicts and a lessening of weak states’ ability to put down internal opposition. In the current unregulated market, PMFs decide for whom they work. Thus far, they have contracted with all types of clients, from reputable governments to unsavory customers; the only limitation being the ability of the client to pay. Although some PMFs contend that they work only for reputable states, both the structure of the market and the record so far argue against this. Because firms make decisions that are in their own (financial) interest, single-shot payoffs from disreputable clients might prove too great a temptation, especially if the relationship can be hidden. PMFs that have difficulty attracting the business of reputable clients in the competitive market are the most likely to work with violent non-state entities.

(e) The Military Market Human Rights Abuses. Tensions exist regarding the impact of PMFs on human rights during conflict. On the one hand, PMFs point to market incentives for engaging in good behavior, as their long-term profits are partly dependent on having a good public image. PMFs also emphasize the positive impact that they might have in helping to professionalize local forces. On the other hand, however, war is a business in which nice firms might not finish first. PMF aspirations of corporate responsibility and a good-guy image may be overridden by the need to fulfill a contract or by the desire to be seen as the kind of firm that gets things done. Thus, in certain situations human rights may be transgressed for the corporate interest. For example, Executive Outcomes is known to have used fuel air explosives (FAEs or vacuum bombs) in its Angola operations. International organizations regard the use of FAEs as a transgression of human rights, because they inflict particularly torturous injuries. But FAEs are also highly effective, which explains why a firm would choose to use them.

The private military industry is an outlet for those naturally drawn to mercenary work and is likely to attract disreputable players looking for the cover of legitimacy. As employers, PMFs want to hire individuals who will be effective, even if this means casting a blind eye on past human rights abuses. As a result, many members of the most ruthless military and intelligence units (from the Soviet Union and the apartheid regime in South Africa) have found employment in the industry. Even when firms scrupulously screen prospective employees (which is easier said than done, given that most CVs do not have an “atrocities committed” section), it is still difficult to monitor troops in the field. If employees do commit violations, there is little incentive for firms to report them. A firm that does so risks scaring off both clients and prospective employees. Even if external legal action or sanctions were attempted, it is doubtful whether any PMF would allow its employees to be tried in a client state’s judicial system.

The ultimate problem with PMFs is that they diffuse responsibility. Questions about who monitors, regulates, and punishes employees or companies that go astray (“rogue firms”) have not been fully answered. That many of these firms are chartered in offshore accounts complicates the matter even further. In sum, privatization provides no greater assurance of moral military behavior and may even produce countervailing incentives.

(3) The Policy Impact of PMFs as Alternative Military Actors. The civilian-military relationship is a story of institutional balance (and sometimes imbalance), where civilian control over the military vies with the military’s need for autonomy to do its jobs. The privatized military industry may upset this balance because it supplants core military positions and functions. PMFs may be attractive to leaders, to the extent that they allow them to get rid of politically unreliable or untrustworthy military officers. Of course, local militaries know this and may seek to preempt such action if PMFs are to deploy. Additionally, the hire of PMFs would be destabilizing if any of the following conditions applies: (a) PMF employees receive higher pay than local soldiers for performing similar tasks; (b) PMF employees have vastly better equipment, (c) PMF employees are kept separate and distinct from local forces, or (d) PMF officers are placed in command positions or their presence blocks normal promotion tracks. At least (a) and (b), and possible (c) and (d) as well, are common in the relationship between U.S. troops and private forces currently in Iraq.

The rise of the privatized military industry provides a new means for leaders to evade public policy restrictions. In the U.S., for example, the executive branch can use PMFs as a means to circumvent limits placed on it by the Congress or by public opinion. The president, as commander in chief, may resort to using PMFs if he wishes to avoid the potential political costs of other actions (e.g., reinstating the draft), or if Congress places limits on troop numbers. Recourse to PMFs therefore has negative implications for the democratic principle of checks and balances. It may allow the executive branch to gain too much autonomy and power and undertake public-private activities against the intent of Congress.

The use of PMFs also allows the executive branch to avoid both public debate of its policies and accountability for results. Responsibility and accountability on the part of public officials are greatly diminished because the use of PMFs moves decision making power one step further away from elected representatives. The use of PMFs instead of official covert action provides the cover of plausible deniability that public forces lack. If an operation goes awry, the activities of a firm are easier for a government to deny and the blame easier to shift. But, without public debate and monitoring, the actions of PMFs may prove embarrassing or worse. In Colombia, for example, Airscan was implicated in coordinating the bombing of a village in which eighteen civilians (including nine children) were killed. In addition, PMF operations might even backfire and ultimately involve the client in direct fighting without the requisite public debate.


The rise of the modern privatized military industry has created a host of new problems and challenges. Nation-states no longer have an exclusive role in the military sphere. International institutions, non-state organizations, corporations, and even individuals can now lease military capabilities of the highest level from the global market. In terms of policy, just as Western militaries recently had to develop a system for working with NGOs during humanitarian operations, they now must also consider how to deal with PMFs, which they will increasingly encounter in the field. At the decision-making level, governments and international organizations must develop standard contracting policies and establish vetting and monitoring systems attuned to PMFs, including the assurance of legislative oversight. A policy that defers to the market will not curb threats to peace. PMFs, to the extent that they are, or are part of, publicly traded corporations, have a legal requirement to generate maximum profits for their shareholders. Not only is this a mandate for PMFs to seek out conflict wherever they can find it, but it is also a strong incentive to promote the escalation of existing tensions and even instigate new conflict where it does not yet exist. After all, they are in the business of war.

This concludes the three-part series.

Part 1: The Privatized Military Industry in the Global Context

Part 2: Organization and Operation of the Privatized Military Industry

March 13, 2007

Privatizing War - Part 2

Guest Writer: L. Vincent Sebastian

SECOND in a Three-Part Series,

My recent posting, “Privatizing the War in Iraq”, describes the Bush administration’s growing reliance on private contractors such as Blackwater USA to conduct military operations in Iraq. Yet, the issues and potential problems with private contractors described in that posting are only the tip of the iceberg. In the new posting below, the many problems surrounding private military firms (PMFs) are more fully laid out. The source material for this posting is: P.W. Singer, “Corporate Warriors: The Rise and Ramifications of the Privatized Military Industry”, International Security, Vol. 26, No. 3, Winter 2001/2002. Although Singer’s article, turned into a book, was published before the U.S. invasion of Iraq, its relevance has only increased in the last five years.

Organization and Operation of the Privatized Military Industry

The privatized military industry is neither a capital-intensive sector, nor requires the heavy investment needed to maintain a public military structure. The barriers to entry are relatively low, as are the economies of scale. Unlike state militaries, which require substantial budget outlays, PMFs need only a modicum of financial and intellectual capital. All the necessary tools are readily available on the open market, often at bargain prices from the international arms bazaar. The labor input – predominantly skilled former soldiers – is also relatively inexpensive and widely available. Spurring their recruitment is the comparatively low pay and declining prestige of many state militaries. PMF employees tend to receive two to ten times as much as they did in the military, allowing the best and brightest to be lured away, as mentioned above.

Estimates suggest that annual revenues for the private military industry as a whole were $100 billion in 2001. Since then, revenues have increased by over 85 percent in industrial countries and 30 percent in developing countries, an indication of the industry's robust health and growing power. Many PMFs operate very efficiently as virtual companies with little investment in fixed (brick and mortar) assets. Most PMFs do not maintain standing forces but instead draw from databases of qualified personnel and specialized subcontractors on a per-contract basis. In 2001 the overall number of firms in the industry was in the high hundreds, although the industry is consolidating into fewer, larger transnational firms. Armor Holdings, for example, was listed among Fortune magazine’s 100 fastest-growing companies in 1999 and 2000 following its string of global acquisitions. However, niches will remain for smaller firms that can make informal deals and barter arrangements that bigger firms cannot. Such practices are less tenable for large “brand name” firms, which have formal accounting practices and may be subject to the oversight of institutional investors.

PMFs can be divided into the following three types, based on their capabilities and clients. (1) Military Provider Firms engage in actual fighting, direct command and control of field units, and/or the provision of weapons. In many cases, they are utilized as force multipliers, with their employees distributed across a client’s force to provide leadership and experience. Clients of type 1 firms tend to be those with comparatively low military capabilities facing immediate, high-threat situations.

(2) Military Consulting Firms provide advisory and training services. They also offer strategic, operational, and organizational analysis that is often integral to the function or restructuring of armed forces. The primary difference between type 1 and type 2 firms is that consultants do not to engage in combat. Type 2 clients are usually in the midst of force restructuring or are attempting a transformative gain in capabilities. Their contract requirements tend to be less immediate and more long term than those of type 1 clients.

(3) Military Support Firms provide rear-echelon and supplementary services. Although they do not participate in the planning or execution of direct hostilities, they do fill functional needs (including logistics, technical support, and transportation, among others) critical to overall combat operations. Clients of type 3 firms are typically engaged in long-duration interventions and have standing forces requiring a surge capacity.

End of the SECOND in a three-part series.

Part 1: The Privatized Military Industry in the Global Context

Part 3: Impacts of the Privatized Military Industry on Conflict, Security, and Public Policy


March 12, 2007

Democrats Reject Fox as Illegitimate

The story reads that "the Nevada State Democratic Party is pulling out of a controversial presidential debate scheduled for Aug. 14 in Reno." But the story should read that a grassroots movement pressured the National Democratic Party to reject Fox.

This rejection goes far beyond a "snubbing" of FOX News Chairman and CEO Roger Ailes, though Nevada Democratic party chairman Tom Collins and Senate Majority Leader Harry Reid (D-Nev) didn't pass on the opportunity. No. This rejection is far deeper in the minds of many people. It is a challenge to the legitimacy of Faux News.

John Edwards deserves significant credit for taking a principled stand early on that led to the unraveling. collected more than 265,000 petition signatures sent to the Nevada State Democratic Party. also deserves credit for laying the groundwork with their distribution campaign of Glenn Greenwald's documentary "OUTFOXED: Rupert Murdoch's War on Journalism."

This represents significant evidence of a maturing social movement; is building on social capital invested over several years. First, they have a legitimate base that is truely mainstream (not extreme) and grassroots (read small-d democratic, not a phony corporate front group).

Second, the MoveOn base and others have been educated by documentaries like Greenwald's, and web sites like News Hounds whose motto is "We Watch Fox So You Don't Have to."

Third, the buzz about Fox's lack of credibility has reached the ears of politicians. The popular discontent is so... popular that politicians are willing to risk giving a major media outlet like Fox the snub. Given the weak knees of politicians toward the media, this is a truly significant shift.

Though Fox Vice President David Rhodes spun it to say, the "Nevada Democratic Caucus... appears to be controlled by radical fringe, out-of-state in interest groups," the fair and balanced version of the news is that the Nation rejected Fox's role in co-hosting a presidential primary debate of national significance. A deeper analysis is that the Nation is rejecting Fox. Media Life Magazine reported a 24% drop between 2005 and 2006.

Fox will need to moderate its abuse of journalism or it will find itself disregarded by the public.

The Problem with Privatizing War

Guest Writer: L. Vincent Sebastian

FIRST in a Three-Part Series,

My recent posting, “Privatizing the War in Iraq”, describes the Bush administration’s growing reliance on private contractors such as Blackwater USA to conduct military operations in Iraq. Yet, the issues and potential problems with private contractors described in that posting are only the tip of the iceberg. In the new posting below, the many problems surrounding private military firms (PMFs) are more fully laid out. The source material for this posting is: P.W. Singer, “Corporate Warriors: The Rise and Ramifications of the Privatized Military Industry”, International Security, Vol. 26, No. 3, Winter 2001/2002. Although Singer’s article, turned into a book, was published before the U.S. invasion of Iraq, its relevance has only increased in the last five years.

The Privatized Military Industry in the Global Context

(a) Introduction: Private military firms are profit-driven organizations that trade in professional services intricately linked to warfare. They are corporate businesses that specialize in the provision of a wide range of military skills and services, including tactical combat operations, strategic planning, intelligence gathering and analysis, operational support, logistics support, troop training, military technical assistance, and post-conflict resolution. PMF capabilities extend across the entire spectrum of military activity, from a team of commandos to a wing of fighter jets. PMFs actively advertise their services, and one can gain access to them simply by becoming a business client.

As the principal private actors in warfare, today's PMFs have evolved far beyond ad-hoc groups of mercenaries. PMFs operate and compete openly on the international market, and provide military skills and services to a wide variety and number of clients. PMFs can gain a competitive advantage in serving niche markets through specialization within the military sector. PMFs are often tied through complex financial arrangements to other firms, both within and beyond their own industry. Many of the most active PMFs are subsidiaries of larger corporations listed on public stock exchanges. For a large multinational corporation, the addition of profitable military services to their list of offerings may help support their bottom line. Because PMFs maintain permanent corporate hierarchies, they can make use of complex corporate financing schemes and can engage in a wide variety of deals and contracts. As legal entities, PMFs are at least nominally tied to their home nations through laws requiring registration and licensing, although codified standards for corporate behavior vary widely among countries. PMFs are contractually bound to their clients and can work for multiple clients in multiple markets or theaters at once.

(b) Historical Background: The private provision of violence was a routine aspect of international relations before the twentieth century, and every empire from Ancient Egypt to Victorian England utilized contract forces. By the twentieth century, a system of state sovereignty had spread across the globe, and with the rise of superpowers the social-political norm ran against private armies. But, the 1990’s witnessed a resurgence of private military activity around the world. Every major U.S. military operation in the post-Cold War era (Iraq 1991, Somalia, Haiti, Zaire, Bosnia, Kosovo, Afghanistan, and Iraq 2003) has involved significant and growing levels of PMF support. In addition, corporations, international organizations, and even individuals now rely increasingly on military/ security services supplied by the private market.

The growth in the private military industry has resulted from the changed global security environment at the end of the 20th century compounded by the Bush administration’s global war on terrorism. The end of the Cold War resulted in massive disruptions in the supply and demand of capable military forces. In the 1990s, the world’s armies shrank by more than 6 million personnel, and a huge number of individuals with military skills found themselves looking for work, including for example an estimated 70 percent of the former KGB. Many elite units, such as apartheid South Africa’s 32nd Reconnaissance Battalion, simply kept their structure and formed their own private companies. At the same time, massive arms stocks flooded the market. Machine guns, tanks, and even fighter jets became available to anyone who could afford them. With the end of superpower pressure for stability, new security threats began to appear, many involving ethnic or internal conflicts.

(c) PMF Services: Supply and Demand No longer strategic pawns of the Cold War and shorn of their superpower support, many nation-states have suffered breakdowns in governance, and have seen a decrease in their ability to respond to internal and external threats. This has been particularly true in developing areas, where many regimes lack any real political authority or capability. The security apparatuses – local military and police – of these regimes are likely to be deficient to some extent, and PMFs have aimed to fill the void. As one company executive explained, “The end of the Cold War has allowed conflicts long suppressed or manipulated by the superpowers to reemerge. At the same time, most armies have got smaller, and live footage on CNN of U.S. soldiers being killed in Somalia has had staggering effects on the willingness of governments to commit to foreign conflicts. We fill the gap.”

Two other trends have helped raise the demand for PMF services. First, the military operations of great powers have become more high-tech, and civilian specialists are relied on more than ever to run these increasingly sophisticated military systems. With sophisticated military technology, strategic objectives can be achieved by a relatively small number of soldiers who may not even be on the battlefield. Fewer individuals are doing the actual fighting, while massive, high-tech, and information-intensive support systems are required to maintain modern forces. Economic realities are creating an in-house vacuum of high-tech military support personnel, and the armed forces of nation-states must rely increasingly on specialized expertise provided by the private sector. Such expertise is in demand in all sectors of the economy, not just the military, so the best and brightest in the public armed forces are often lured away by the higher salaries of private employment.

Second, the primary tools of warfare – conventional weapons – have both diversified and become more available to a broader array of actors. Non-state actors with newfound ability to disrupt world society are increasing in number, power, and stature: regional warlords, terrorist networks, and drug cartels. The opportunity for profit may be as much a cause of conflict as socio-political factors. With the global spread of cheap infantry weapons, individuals and small groups can purchase and wield disproportionately large military might. Almost any group operating inside a weak nation-state can acquire at least limited military capabilities, which lowers the bar for creating viable threats to the status quo. Furthermore, this shift in the balance of power from states to non-state actors encourages the proliferation and criminalization of local warring groups. With enough money anyone can equip a powerful military force, and with a willingness to use crime, anyone can generate enough money. Many local conflicts have lost the ideological motivation they once had and instead have become grabs for local resources. As a result, warfare itself becomes self-perpetuating, as violence generates profit for those who wield it most effectively (which often means most brutally), while no one group can eliminate the others. PMFs thrive in such profit-oriented conflicts, either working for these new conflict groups or reacting to the humanitarian disasters they create.

The last few decades have seen a shift toward the marketization of the public sphere, which has gone hand in hand with globalization. Both are premised on the belief that the principles of comparative advantage and competition maximize efficiency and effectiveness. Privatization, with an emphasis on downsizing government, is the economic policy of choice among many of the world’s elite. At the same time, outsourcing has become a dominant strategy of the modern corporation and a huge industry in its own right. Global outsourcing expenditures topped $1 trillion in 2001, a doubling from three years earlier. Thus, the use of profit-motivated military service providers has become not only a viable option but frequently the favored solution for both public institutions and private organizations. The successes of privatization programs and outsourcing strategies in other sectors of the economy have helped give PMFs the stamp of legitimacy.

End of the FIRST in a three-part series.

Part 2: Organization and Operation of the Privatized Military Industry

Part 3: Impacts of the Privatized Military Industry on Conflict, Security, and Public Policy

March 11, 2007

Gonzales: Nice Guy but Corrupt

It's a basic principle of our republic; the United States Justice Department and Attorney General represent the people, not the President. Attorney General Alberto Gonzales has shown a pattern of crossing that line, both personally and via actions of the Department. Now, the pressure is building for Gonzales to resign.

There is a petition drive to impeach Alberto Gonzales. According to former Nixon Attorney John Dean:

The Constitution's Impeachment Clause applies to all "civil officers of the United States" - not to mention the president, vice president and federal judges... the group certainly includes a president's cabinet and sub-cabinet, as well as the senior department officials and the White House staff (those who are issued commissions by the president and serve the President and Vice President).
The list of abuses is long, and the dark depths are chilling:

  • Creating a new legal category of humans: "Enemy Combatant."

  • Applying the principle of "guilt by association" in defining someone as an enemy combatant

  • Finding that the Geneva Conventions do not apply to this new category of humans.

  • Legalizing Torture for this new category of humans.

  • Legalizing kidnapping, international transport, detention and torture without legal representation.

  • Opening private mail without a warrant.

  • Massive program for sweeping up e-mails without warrants.

  • Surveillance of domestic phone calls without warrants.

  • FBI Abuse of the USA PATRIOT Act to obtain private records without warrants.

  • Firing U.S. prosecutors who posed political threats because they were honest.


March 9, 2007

OFHEO Warning of February 2003

The February 2003 warnings of Armando Falcon are beginning to emerge as people start to default on mortgages and investors start to bail out of real estate holdings on declining prices. Falcon, Director of the Office of Federal Housing Enterprise Oversight (OFHEO), warned Congress that many large financial institutions were systemically linked to Fannie Mae and Freddie Mac. If Fannie and Freddie, or real estate in general, tumbled, the rest of the economy could likely be pulled down as well.

In "Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO, [PDF]" Falcon advised Congress: Give the US Government the authority to take Fannie and Freddie into receivership during a financial crisis. This would avoid a domino effect that would "lead to large looses in the aggregate economy." Falcon's reward for this honest insight and advice was to be fired by the Bush Administration.

It's four years later and Falcon's ghost has returned in the form of "concerns about sub-prime mortgages." That's the tip of the iceberg according to the OFHEO study and current indications.

Role of Fannie Mae and Freddie Mac

The OFHEO report explains that the government creating Fannnie Mae and Freddie Mac (FMFM) to provide low interest financing for low income people even during tight financial periods. The low interests were accomplished in part, by creating a secondary mortgage market and by the perception of lower risk due to being government-backed. In recent years, as a result of relaxed legal restrictions on access to nationwide funding, Fannie Mae and Freddie Mac have been joined by private sector firms that perform the same function.

Hidden in these previous statements are risks that are strongly coupled to the whole ecomony.

First, Fannie Mae and Freddie Mac aren't fully backed by the US Government. This is central to the 2003 OFHEO study recommendation that Congress authorise government receivership of FMFM in the event of a serious financial crisis. Allowing the Government to take over FMFM could help mitigate a wider economic panic.

Second, are risks associated with the secondary mortgage market that is enabled in large part by the creation of FMFM. On the one hand, allowing mortgages to be resold allows FMFM to offer more loans, thereby making home ownership possible for more people of lesser means. On the other hand, this secondary mortgage market invites abuse, and Congress has enabled this by allowing the private sector to operate in this market.

The secondary mortgage market has turned it into a playground for financial speculators (think "irrational exuberance") and a dumping ground for risk. On the latter point, many mortgage lenders evade the risk of loan defaults by selling their mortgages into the "mortgage-backed securities" (MBS) market. The mortgage lenders get paid up front and wipe their hands clean of risk; their disincentive for making risky loans evaporates, because they can sell off the loans. The risk is passed on to the murky secondary market, into which the broader economy has become significantly invested. Many houses have been financed in the past few years with the lender's knowledge that, if housing prices fail to increase, it is almost certain that the buyers will default. We're at that point today.

People with little experience have also bought investment properties and many have bought second homes. All of this has contributed housing price inflation that is not supported by true value and does not reflect the true risk of the market; lack of transparency, and out right fraud, has undermined market discipline.

The "systemic" part of the risk hinges on who is now holding all of those mortgage-backed securities. Large commercial banks, insurance companies, pension funds, endowments and other institutions are deeply invested in what appears to be a house of cards.

Defining Systemic Financial Risk

The OFHEO report gives basic background on "systemic financial events" defined as
a financial crisis that causes a substantial reduction in aggregate economic activity, such variables as housing starts, home sales, consumption, output and employment.
It discusses stages of a systemic event, the effect of consolidation and use of over-the-counter financial derivatives on systemic risk and the difficulties in assessing indirect interdependencies.

Five stages of a systemic event are explored: The preconditions, economic shock, spreading liquidity problems, institutional response, ensuing financial crisis.

In the present case, the wide-spread investment in over-valued real estate and secondary market are the pre-conditions. To some degree, the slow pace of the cooling market has allowed some of the air to be let out of the bubble in a controlled way over the past year. However, the bubble is still significant.

The downward stock market drops of the past few weeks could be part of the shock. In addition, the Nation has experienced the psychological shock of the Iraq Study Group Report and the 2006 mid-term election results that expose the failure of Bush's adventure in Iraq. The war is causing the national debt to accelerate, and US standing in the World to decline. Meanwhile, the main-street economic statistics that matter are being exposed by U.S. Senator Jim Webb during his prime-time response to the President's State of the Union Address and even in a recent Bloomberg piece on concerns over the growing wealth gap.

The spreading liquidity problem is reflected in statements like,
Data from UBS AG show that the default rate for Alt-A mortgages has doubled in the past 14 months.[3]
Alt-A mortgages are a step above sub-prime mortgages where liquidity problems have been widely reported to have contributed to the jitters in the World stock markets. This is reflected in statements like Saxo Bank analyst Torben Krogh Nielsen, who said,
U.S. sub-prime woes are mushrooming. It's hard to believe they'll be contained and not impact the broader U.S. — and by extension, the global — economy... [2]
or by Lee Cheng Hooi, technical analysis manager at EON Capital in Kuala Lumpur:
The U.S. sub-prime concern has cast a great shadow on Asia. The worry is that it could spill over and cause the U.S. economy to slow down, and this will cause a domino effect on the world economy... There could be more bloodbath to come. [2]
February 28 testimony to Congress by Federal Reserve Board Chairman Ben Bernanke contradicts the UBS research on Alt-A mortgages, sounding like a cover-up, which itself is causing anxiety,
Our assessment is that there's not much indication that subprime issues have spread into the broader mortgage market... [3]
Just the fact that Bernanke is talking about a spreading liquidity problem could suggest there is a problem... but there's more evidence. Bloomberg reports that it's not only sub-prime and Alt-A mortgages that are having liquidity problems:
The Mortgage Bankers Association said foreclosures are climbing on loans to borrowers with the best credit ratings, a sign of broader trouble in the housing market.[5]
And the liquidity problems are spreading to financial institutions:
Investors, bracing for a wilting economy, fled the already deflated subprime mortgage sector on more news that lenders New Century Financial Corp., Accredited Home Lenders Holding Co. and General Motors Acceptance Corp.'s residential unit are facing financial problems. [4]
"Accredited Home contributed to the anxiety after it said it is in need of cash. Its shares plunged $7.43, or 65 percent, to $3.97."[4]

What about Institutional Response? The mortgage industry news is filled with it. Housing and Urban Development (HUD) Secretary Alphonso Jackson wants to pass Federal Housing Administration (FHA) legislation in response to the secondary mortgage melt-down (amending the Real Estate Settlement Procedures Act.). Senate Banking Committee Chairman Christopher J. Dodd, (D-CT) agrees, "We may need to get some forbearance or something like that to give them a chance to work through their problems." New York Attorney General Andrew Cuomo is investigating subprime lenders (a little late). There is a consensus within the National Association of Hispanic Real Estate Professionals that mortgage wholesalers and brokers should be held accountable for the loans they originate (They're working on it). The FBI is investigating mortgage fraud, the House and Senate are considering legislation to place Fannie Mae and Freddie Mac under stricter supervision. In short, the institutions are responding.

And the ensuing financial crisis? We're in one, but the authorities and politicians are down-playing it to avoid panic.

Implications: The OFHEO study assesses several potential implications and considers scenarios in which Fannie Mae and Freddie Mac are either stabilizing or destabilizing factors regarding the spread of a financial crisis to the entire economy. One real factor that suggests a failure of FMFM would result in a domino effect is that many banks hold FMFM instruments as a major part of their reserves.

Table 4 on page 77 of the report breaks down the number of banks, by size, that are holding FMFM (GSE) debt, and the percentage of those holdings. A footnote on page 100 of the report indicates a huge exposure of the banks to a failure of FMFM:

[A]t year-end 2001 over 4,800 commercial banks—over sixty percent of the institutions in the banking industry—held GSE debt in excess of 50 percent of their equity capital. Nearly sixty percent of those banks have less than $100 million in assets; over ninety-seven percent have assets of less than $1 billion. Of banks with assets of more than $1 billion, 123 institutions —over 30 percent of banks of that size —owned GSE debt in excess of 50 percent of their equity capital.

In plain English, if Fannie Mae and Freddie Mac default on their debt, many banks will go under, unless the tax-payer bails them out. If the latter, then we, the people, should demand future part-ownership, and profit-sharing, in the entities we bail out.


1. Office of Federal Housing Enterprise Oversight (OFHEO), "Systemic Risk: Fannie Mae, Freddie Mac and the Role of OFHEO, [PDF], February, 2003."

2. Associated Press, World stocks fall after Wall Street drop, TOBY ANDERSON, AP Business Writer, March 14, 2007.

3. Mortgage Defaults Start to Spread, Ruth Simon and James R. Haggerty, March 1, 2007.

4. Associated Press, Stocks plummet on subprime lender woes, MADLEN READ, AP Business Writer, March 13, 2007.

5. Bloomberg, European Stocks Slide on U.S. Growth Concern; UBS, RBS Decline, Andreas Hippin
March 14, 2007.