Sunday, May 23, 2010

Press Briefing

May 24, 2010

A Legal Analysis of the New Arizona Immigration Law

Rand Paul's Constitution - The Kentucky candidate's bad history

An Obama-Bush Victory. WSJ Editorial

A court upholds Presidential war powers
WSJ, May 24, 2010

It isn't often we can say that the Bush and Obama Administrations have won a joint triumph in the war on terror, but they got one on Friday from the D.C. Circuit Court of Appeals. A three-judge panel ruled unanimously that detainees held by the U.S. military at Bagram Air Force base in Afghanistan do not have habeas corpus rights under the Constitution.

The anti-antiterror lobby filed the case on behalf of three unlawful enemy combatants to extend the reach of the Supreme Court's 2008 Boumediene v. Bush decision that gave habeas rights to Guantanamo detainees. The Bush Justice Department had opposed this intrusion on Presidential war powers, and to its credit the Obama Administration maintained the same position. A district court judge found for the detainees, but the D.C. Circuit reversed.

As the opinion by Judge David Sentelle points out, extending habeas to a facility in an active war zone such as Afghanistan would mean that any prisoner held anywhere by the U.S. military would have such rights. The opinion doesn't say so, but such a policy would put unelected lawyers in the middle of every wartime decision on military detention. Such meddling would put U.S. soldiers at greater risk, while giving them far less incentive to detain terrorists on the battlefield lest GIs have to play "CSI: Kandahar" to gather evidence so our enemies won't be released at the prodding of the ACLU.

The lawyers for the detainees vow to appeal to the Supreme Court, but it's notable that the D.C. Circuit panel included a Carter (Harry Edwards) and Clinton appointee (David Tatel) as well as Mr. Sentelle, who was appointed by Reagan. This is a bipartisan show of judicial deference that is worth applauding.

Weekly Address: President Obama Establishes Bipartisan National Commission on the BP Deepwater Horizon Oil Spill and Offshore Drilling

The New Lords of Finance - Why Wall Street and Washington both like 'reform'

'60 Minutes' Gets it Wrong on Phthalates
CBS' 60 Minutes may be known for its investigative news, but on Sunday it failed to thoroughly examine the claims against phthalates, a group of chemicals that help to make plastic flexible. Sunday's segment perpetuates baseless allegations against these everyday chemicals, creating unfounded health scares in homes nationwide.

Strategic and Economic Dialogue Opening Session. By Hillary Rodham Clinton, Secretary of State. Great Hall of the People, Beijing, China

Congress's Carried Interest Tax Folly - The latest soak-the-rich scheme will mean less capital investment and fewer new jobs

No Dietary Cure for Autism

EPA to BP: Disperse a Different Dispersant

A Message from the President: "They backed down". By Christopher Hass,
On Thursday, the Senate passed historic Wall Street reform. This movement proved again that the strongest special interests, who for so long have called the shots in Washington, can be beat.

America's new culture war: Free enterprise vs. government control. By Arthur C. Brooks

Secretary Clinton Highlights Importance of American Exports to Overseas Markets During Visit to Boeing Maintenance Facility in Shanghai, China

Goldman and Washington's Wall Street Takeover - The SEC's case is weak, but it helped the government justify sweeping new powers over the financial industry

Macroprudential instruments and frameworks: report published by the Committee on the Global Financial System (CGFS)

Remarks At USA Pavilion Gala Dinner, by Hillary Rodham Clinton, Secretary of State, U.S. Pavilion at Shanghai Expo, Shanghai, China

Americans Can’t Afford the Democrats’ $23 Billion State Bailout

Return of the Nervous Weekend - Two years ago the world looked to Washington and its 'Sunday night specials.' Now it's Europe's turn

Goldman and Washington's Wall Street Takeover - The SEC's case is weak, but it helped the government justify sweeping new powers over the financial industry.

Goldman and Washington's Wall Street Takeover. By EDWARD JAY EPSTEIN
The SEC's case is weak, but it helped the government justify sweeping new powers over the financial industry.WSJ, May 22, 2010

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 effectively invested most of the $40 million it got from selling the swap to Goldman 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 Mr. 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 Mr. 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 a 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.

Mr. Epstein is the author of "The Hollywood Economist" (Melville House, 2010).

Press Briefing

May 23, 2010

Remarks At The Council On Foreign Relations, by James B. Steinberg, Deputy Secretary of State. Washington, DC, May 19, 2010

Five Questions for Pres. Obama on Fuel Economy Standards

Travel Diary: Secretary Clinton Op-Ed on U.S.-China Achievements Beyond Expo

Gross National Debt: $13 trillion and counting

Born to Veto - Christie saves New Jersey from a tax increase
"New Jersey does not have a tax problem; New Jersey has a spending and size of government problem."

Dennis Blair Departs - Another victim of intelligence reform

Intelligence disputes are usually murky, though the sacking of Dennis Blair isn't among them. Explanations for the Director of National Intelligence's exit this week range from Mr. Blair's turf wars with the CIA and at the White House to the failure to pre-empt three domestic terror attacks, two of which failed out of blind luck. But Mr. Blair is really a casualty of the failed "intelligence reform" of the last decade.

Mr. Blair's successor will be the fourth DNI in the five years since the office was stood up in 2005, and this unfortunate man or woman will also supposedly integrate and manage the 16 intelligence satraps. As we and other critics predicted at the time, however, the DNI has merely become another bureaucracy layered on top of the other bureaucracies, with some 1,500 employees often doing what others elsewhere also do. In a bureaucratic classic, Mr. Blair and CIA chief Leon Panetta clashed last year over naming intelligence chiefs abroad. Mr. Panetta won.

As good an illustration as any of the dysfunction is the report that nominally precipitated the former Admiral's pink slip. The Senate Intelligence Committee identified 14 gaps that might have prevented Umar Farouk Abdulmutallab from boarding his Christmas Day flight, one being that "no one entity within the IC [intelligence community] has sole responsibility nor bears the entire burden of either connecting dots or accountability for failing to do so." Except that isn't a Senate conclusion: It comes from the official statement the National Counterterrorism Center—the only agency Mr. Blair controlled day to day—gave to investigators.

The Senate indictment is damning, though its Senate authors unfairly exempt themselves. The 2004 bill that putatively made the Counterterrorism Center the government's one responsible, accountable entity—a kind of antiterror CEO—passed the House 336-75 and the Senate 89-2, rushed along by the cheerleading of the 9/11 Commission. Mr. Blair is another memento of how pointless if not detrimental this reshuffling of the bureaucratic deck chairs was for the realities of the w— on t——.

Plotting a Democratic Comeback - Pennsylvania's governor, Ed Rendell, says the tea parties will throw up flawed GOP candidates like Rand Paul and that his party should run on the success of the stimulus.

Lessons From a Torpedo - Placating Kim Jong Il doesn't change North Korea's behavior.