Northern Country

How globalization changes capitalism, the economy and politics

Posts Tagged ‘Ponzi scheme

Madoff, Valerie Plame and the Magna Carter

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image John of England signs "Articles of the Barons" on June 15, 1215

By the early thirteen century King John of England had become a very powerful and influential monarch in Europe. His empire stretched from the British Islands to the Normandy on the European continent. After his coronation King John increasingly became unpopular and lost support of his barons. At first King Phillip of France confiscated his land in the Normandy, later John’s policies of high taxes resulted in a revolt against him. On June 15, 1215 mighty King John was forced to sign the “Articles of the Barons”. This document later became known as the Magna Carta. Clause 61 of the original Magna Carter established a group of 25 barons who could on occasion and any time overrule the King’s will.

The Magna Carter became the first legal document binding the King to the rule of law, to proclaim certain rights to his citizens and to respect certain legal procedures. It therefore endured history to serve as legal foundation for the constitution of modern democratic states. Of course in this form of government people are the sovereign and not the ruling authorities.

The importance of signing the Magna Carter can not be emphasized enough in that it lay the foundation to control those in power by threatening to hold them responsible for their actions. In the early thirteen’s century that was certainly something out of the ordinary. Today we take it as granted that our governments are entirely based on the rule of law with its twin pillars of public and private law.

It applies to everybody including and in particular to those in power. One example how merciless the law punishes those who break it came to an end this week, when disgraced 71-year-old Wall Street Tycoon Berni Madoff faced judgment day. To atone for his crime of extensive fraud the judge sentenced him to 150 years imprisonment. This was the harshest sentence for any white-collar crime ever committed.

For decades money manager Madoff run a secretive investment fund on Wall Street which year after year promised returns of ten percent or more. When in the fall of 2008 the crisis on Wall Street reached its climax he confessed to his sons that his investment scheme was ‘all just one big lie’. They notified the SEC and Madoff pleaded guilty on security fraud in March of this year.

In a typical Ponzi-scheme Madoff, the investor with a Midas touch, simple used fresh funds to pay out non-realized gains on existing investments. By doing so he swindled investors out of more than $13 billion. Of course he claims that nobody else knew about it but this is hard to believe since this elaborate scheme was going on for too long and was too big to just exist in total obscurity.

The Security and Exchange Commission (SEC), under heavy fire itself, brushed off a whistle blower several times, who alleged to the agency that Madoff’s investment fund was a Ponzi scheme. The SEC charged ten more suspects in the Madoff fraud, and would not say who else faces charges, family members or others, because the investigation is ongoing. In the meantime the scandal became so toxic it reached even into the far corners of Europe, where a fund manager was charged with receiving more than $40 million in kickbacks to funnel billions of dollars to Madoff’s investments.

It certainly has something of a King John moment, when we finally realize that the rule of law applies to everybody. But does it really? In judicial lingo a civil law suit against Madoff would fall into the category of private law, which deals with the relationships between individuals or groups without the intervention of state or government. Public law on the other hand strives to coordinate the relationship of private individuals (private citizens or companies) with their state or government. Constitutional law is a  prominent subdivision of public law. So truly the Magna Carter is the ancient parent of modern public law and of our constitution.

On Tuesday, June 23 2009 the Supreme Court of the United States refused to hear a civil lawsuit filed by Valerie Plame Wilson and her husband, former Ambassador Joseph Wilson, to apply the rule of law to several officials of the Bush administration. The supreme court declined to set a precedent and allow the case to move forward.

In June and July of 2003 senior Bush administration officials disclosed Plame’s identity to the public, who at the time was working as an undercover CIA agent. They did so by leaking her name and employment to Robert Novak, who worked as a Times magazine columnist, which effectively revealed Mrs. Plame’s identity and destroyed her career.

A criminal probe and federal investigation into the identity of the leakers was central to allegations of abuse of power by the White House. A 70 minute interrogation of president Bush by special prosecutor Patrick Fitzgerald featured prominently in the Bush administration’s first term in office. Vice-president Cheney and several other high level officials had also been interrogated in that matter. 

What Fitzgerald’s investigation came up with was basically that Plame and her husband Joseph Wilson were being punished by White House officials for claiming the administration had manipulated prewar Iraq intelligence. When Wilson came back from his ambassadorial mission to Niger and revealed that the famous yellow cake’ documents were forgeries he embarrassed and undermined the administration’s efforts to go to war with Iraq. Something that could not be tolerated and therefore required swift punishment. Undercover CIA agent Valerie Plame’s name had to be revealed and her career destroyed.

To apply the rule of law the Wilson’s sued Dick Cheney, Karl Rove, Cheney’s ex-chief of staff Lewis "Scooter" Libby, and former Deputy Secretary of State Richard Armitage for violating their civil rights. Only Libby was convicted of obstruction of justice and sentenced to 30 months in prison. Bush later commuted the sentence and Libby never served a minute jail time.

The Wilsons still determined to apply the rule of law continued their fight by filing a civil suit, and again were rejected under the claim that government officials had the right to rebut criticism. The blow of the CIA cover was simply a causality of Wilson’s criticism of the administration argued the courts. The supreme court now refusing to proceed leaves the Wilsons without recourse and closes the three year old case.

Melanie Sloan, Wilsons’ attorney: “The Wilsons and their counsel are disappointed by the Supreme Court’s refusal to hear the case, but more significantly, this is a setback for our democracy," said Melanie Sloan, executive director of Citizens for Responsibility and Ethics in Washington, an attorney representing the Wilsons. "This decision means that government officials can abuse their power for political purposes without fear of repercussion. Private citizens like the Wilsons, who see their careers destroyed and their lives placed in jeopardy by administration officials seeking to score political points and silence opposition, have no recourse."

In many ways the court’s decision in this case runs counter and abolishes what the Magna Carter has achieved in almost 800 years. It seems that some are indeed above the law and not bound by it. Certainly what King John’s barons intended with their articles is called into question when the Supreme Court as the ultimate leveler in our courts refuses to apply the rule of law to all of us. By not going forward and being resolved properly this case indeed serves a terrible precedence: Criticism of the government will not be tolerated and may result in severe punishment. Even though there is some judicial scope left this does not necessarily mean final judgment for those in power. Valerie Plame’s case reveals an issue of privilege for those who are too powerful even for the courts. It reveals that our political system is still wrenched with imperfections and as a sign of our times foreshadows worse things yet to come. Madoff’s harsh sentence does not make me fell any better, when ultimately our political system and the rule of law does not sufficiently distinguish itself from rough regimes similar to those we like to criticize.

The myth that keeps Keynesians going

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– it is never quite the cigarette butt.

US economist and noble price winner, Paul Krugman, writes in his newest Times’ column about the "origins of the current disaster". In short lack of financial regulation that started during the Reagan administration turned us in and caused the current financial and economic crisis. The Reagan mantra and later neoconservative mantra ‘government is the problem’ becomes the focus point of criticism in the pre/post- prevention discussion.

For the more one looks into the origins of the current disaster, the clearer it becomes that the key wrong turn — the turn that made crisis inevitable — took place in the early 1980s, during the Reagan years.

The world class economist is in trouble. Krugman is a declared disciple of Keynes and his hand is leading the cavalry of government interference against "the worst economic crisis since the Great Depression". This is Keynesianism in its purest, something German Finance Minister Steinbrück and declared Krugman villain called “crass Keynesianism”. Why is the professor in trouble, well not really in trouble but lets say academically challenged?

The followers of Keynes like Milton Friedman, Alan Greenspan, Ben Bernanke, Paul Krugmann etc. believe in the almighty power of money that flows through the pipes of the economy. It is according to their believes, that manipulation of total amount of money available in an economy determines its direction. It is mainly in this context that the Federal Reserve finds the appropriate level of interest rates. A Keynesian will always believe in the dogma of inflating one’s way out of every macroeconomic problem by lowering interest rates and devaluing the nations currency.

Why not? It worked at least till now. Though the current crisis clearly shows the limitations and flaws of this philosophy. If Keynes was right how can he explain the current economic disaster? He can’t. In the words of past time guru, Alan Greenspan, ”shocked disbelieve” takes hold among Keynesians these days.

Since Keynesians cannot understand they try even harder to explain it. Krugman’s column in the NYT goes to the point. He writes about regulation and the lack thereof, taking hold during the Reagan administration. He even identifies the Garn-St. Germain Depository Institutions Act, that Ronald Reagan introduced into law in 1982, as the bill that "did it".

When Krugman blames the Reagan administration for scrapping "precautionary rules" he is absolutely right. It is just not the complete picture. To pinpoint our current problems to mortgage deregulation is part of the truth but not all of it. It is like pinpointing a bush fire to a single carelessly dropped cigarette butt when the real cause is climate change. Finding it and neglecting climate change will not prevent another fire down the road.

The idea that mere lack of regulation causes an economy and its financial infrastructure to overheat is not seeing the big picture because no matter what regulation always comes second to macroeconomic events. To Krugman’s second point, higher interest rates would have helped to improve the low savings rate of the private sector. How could regulation have helped to do the job?

At the height of the real estate bubble the whole mortgage market in the US was about 11 trillion dollar and subprime, the unregulated part Krugman writes about, was only 1.3 trillion dollar. At a delinquency rate of 40 percent and a recovery rate of 50 percent the cumulative losses should be about 200 to 300 billion dollar.

The US economy produces services and goods worth about 14 trillion dollar every year. The budget for military and defense in the US is about 500 billion dollar and that does not include the spending on the wars in Iraq and Afghanistan. The ensuing economic disruption caused by ‘mere’ lack of regulation is hard to grasp even after taking into account leverage and the Ponzi scheme of the securtitsation market in the financial industry.

In conclusion the Federal Reserve and its rate setting policies, that were guided to no small part by the ideas of Keynes, contributed substantially to the current crisis. It seems though that Krugman and his Keynesian friends are not ready to acknowledge it. How can we learn and get better, and at this point this is the best we can hope for, if our brightest do not strive to identify the root cause of the problem?