HARRY SHEARER INTERVIEWS ALEXA O’BRIEN

LE SHOW, MAY 5, 2013

Listen to the podcast here.

Interview recorded Wednesday, April 17, 2013.

HARRY SHEARER:  This is Le Show, and you may have heard the name of Private Bradley Manning here and there for over the last couple of years, but I’ll wager that if you’re like me, or if you just plain like me, you probably haven’t heard much coverage of what’s been going on with him in most of the media. We’re going to try to rectify that situation today. I have a guest in New York City who has been resolute if not absolutely determined in her coverage of the legal proceedings involved with Bradley Manning, and she’s going to take us through it and tell us what’s been happening with him. Alexa O’Brien, welcome to Le Show.

ALEXA O’BRIEN:  Thank you for having me.

HARRY SHEARER:  Let me start by sort of setting the table and saying what I think I know, and then correct me and then we’ll go from there.

Bradley Manning was a private in the Army, got sent over to Iraq in an intelligence position where he had access to the same information that as I understand it about 400,000 Americans are cleared to have access to. In that position he saw information that was increasingly distressing to him regarding America’s role in the war in Iraq, the war in Afghanistan and other activities, and he ultimately liberated that material, is one way of putting it, the government says stole it, and made it available over a period of time anonymously to the WikiLeaks organization.

And what was released was first of all a videotape called Collateral Murder showing U.S. helicopter crews killing folks from the air, including one or two people from the Reuters news service, and then coming back and shooting at the rescuers who were coming in to tend to the bodies of those who had been originally killed, a videotape which came to be known as Collateral Murder, and then sequentially released war logs from the Iraq war, the Afghanistan war, and ultimately, about 250,000 is the number that comes to mind, diplomatic cables from U.S. embassies and legations abroad to Washington which were profoundly embarrassing to the United States and to certain foreign leaders.

And at some point he went into contact with an anonymous chatter on a chat board, Internet chat link, who I believe assured Private Manning that the conversation should be treated as if he was talking to a priest or a doctor, that it was confidential and confessional in nature, and that person turned out to be a once-convicted hacker named Adrian Lamo who at some point decided to change his position on the material and went to the FBI and told them of what was going on. Private Manning was arrested, served for about 11 months in – despite the fact that he was an Army private – in the Marine Corps brig at Quantico, Virginia, in conditions that some people have described as abusive, and is now undergoing pre-military-trial proceedings.

And Alexa O’Brien, you have been covering those proceedings scrupulously and in depth.

First of all, do I have anything wrong about the background?

ALEXA O’BRIEN:  Yeah, there’s a couple of things.

HARRY SHEARER:   Okay.

ALEXA O’BRIEN:  I just wanted, just because the scale is important – actually 4 million federal employees and contractors –

HARRY SHEARER:   Mmm!

ALEXA O’BRIEN:  – have access to the level of information that Manning leaked. Manning leaked Secret to below, so he actually leaked unclassified material as well. In fact, the video that you referred to, Collateral Murder, is unclassified, and also defense will argue contains a transcript that was published in a 2009 book by David Finkel at the Washington Post, so these were before the charged offenses against Manning. So the question is, for that piece of material, is really how closely held was this quote unquote national security information? The other thing is that half a million individuals, according to the Washington Post, had access to the State Department cables that Bradley Manning leaked, so these were marked SIPDIS, which means they were similarly low-level classified or unclassified e-mails or cables by the State Department and were intended for wide distribution outside of the network that Manning had access to them on.

HARRY SHEARER:  So nothing Top Secret.

ALEXA O’BRIEN:  No, and in fact if you compare that to Daniel Ellsberg’s leak, he did leak Top Secret material. Bradley Manning didn’t.

HARRY SHEARER:  Okay. So, now his pretrial proceedings commence, and how do you become involved in all of this? What’s your background?

ALEXA O’BRIEN:  I had been covering the WikiLeaks releases from late 2010 into early 2011 and so I had, you know, covered Manning’s nine months of confinement at Quantico where the judge actually ruled that his treatment was unlawful in her recent ruling, and I went to the pretrial and nobody was covering this trial. This is the largest leak trial in U.S. history. You know, in the secular age of information, we’re going through a type of Reformation of sorts, and these source documents are in a certain sense our Bible in the vernacular language so to speak, and so this is such an important trial and no one was covering it in the way in which I felt that this story needed to be covered, so I started to actually transcribe the trial that was being conducted in secrecy with no public docket.

HARRY SHEARER:  So when you say in secrecy, but you were allowed to attend proceedings – this is at Fort Meade, is that right?

ALEXA O’BRIEN:  That’s right. There are what they call Article 39(a) sessions that are open to the public. However, there’s no public docket for this trial. So whereas in a federal criminal investigation you would go into the PACER system and if a defendant filed something or if a plaintiff filed something, you could read the filing, you could read the court ruling, here we don’t have access to that. In fact, we don’t have access to over 30,000 pages of filings. I have reconstructed the appellate list that doesn’t exist and it looks like we have 518 appellate exhibits that we know of. Of those 518 appellate exhibits, we probably have access to about 10 court rulings, a smattering of defense filings, and no government filings at all.

HARRY SHEARER:  This is being held under the military commissions legislation – is that the umbrella for this proceeding?

ALEXA O’BRIEN:  This is being held under Title X. This is essentially a court martial process –

HARRY SHEARER:   Ah.

ALEXA O’BRIEN:  – for a soldier in the armed forces. In this case the trial is being conducted by the U.S. Army’s First Judicial Circuit, and the trial judge, Colonel Denise Lind, is essentially the chief judge for that circuit.

HARRY SHEARER:  And what’s the normal procedure for court martial trials? Are they similarly held closely in secret and with no public docket?

ALEXA O’BRIEN:  Yes. I mean there is, there certainly is, according to the military expert from the Pentagon, this is standard protocol for lack of access to public documentation of the court filings. However, in a trial of this stature and importance with regard to the First Amendment, Bradley Manning has been charged in a way that has never been seen in military court martials. He’s also been charged with unauthorized disclosure to the press, and his charges include eight or nine charges of espionage as well as aiding the enemy. This trial is of great public interest, and today however we lost our case against the military judge to actually have access to those filings.

HARRY SHEARER:  Let me just backtrack for one second, a question that’s always lodged in my mind since I started following this story:  Why was an Army private held for any length of time in a Marine Corps penitentiary or brig?

ALEXA O’BRIEN:  That’s a very good question, and I have an answer for that. For one thing, if you look at where the headquarters for Army Criminal Investigation Command, or CID, it’s actually at Quantico.

HARRY SHEARER:  Mmm.

ALEXA O’BRIEN:  And so I suspect that they brought him to this run-down brig at Quantico not only to put pressure on him but also because they wanted him to be close to the organization that was leading the military investigation in partnership with the Departments of Justice and State.

HARRY SHEARER:  But of course in the intervening time he has been moved to an Army brig and has been serving pretrial time there. What’s the – you’ve been keeping very close – among the things that you keep rigorous count of is the number of days that he has been in pretrial confinement. It’s way over – it’s way over 300. Is it over 500 at this point?

ALEXA O’BRIEN:  Bradley Manning has been in pretrial confinement for more than 1,000 days.

HARRY SHEARER:   Jeez!

ALEXA O’BRIEN:  By the time of his trial he will have been in pretrial confinement for 1,101 days, and in fact he has been in pretrial confinement longer than any other accused awaiting court martial in U.S. military history.

HARRY SHEARER:  I think all of us who went to school in this country remember there’s a part of the Constitution that guarantees a speedy trial. That has been litigated in this case. What’s been the result of that?

ALEXA O’BRIEN:  The judge ruled that his speedy trial rights had not been violated.

What’s so interesting about the Manning case, in context with the federal investigation into Julian Assange and WikiLeaks, a media organization in the digital age, as well as the sort of socioeconomic changes that have been happening with essentially the maturation of the game generation or the digital generation, you know, vis-à-vis the boomers, is the fact that in many regards this trial encompasses a joining together of all the major issues of our age in the post-9/11 world. For example, the entire interagency process has been zeroed in on this young soldier and the WikiLeaks organization in probably one of the largest criminal investigations in U.S. history, and yet the press hasn’t been covering it.

HARRY SHEARER:  Before we get into the details of the pretrial proceedings, one more question about that. As you sit there day after day working your way through these proceedings and creating these transcripts, what’s your best guess as to why the rest of the press isn’t covering this?

ALEXA O’BRIEN:  I think this has multiple layers to it. I think on one sense, if we look at it purely from the bottom-line perspective, is that WikiLeaks represents a challenge to the market power that the mainstream media organizations have over audiences. And of course you know it costs a lot of money up-front to produce news and especially investigative journalism and entertainment. It costs relatively little in the digital age to distribute it. And so therefore control of audiences is very, very important as these media organizations enter this new era. So I think that they’ve taken a defensive posture towards WikiLeaks because of that fundamentally, and I think also it’s a question of access to information. I mean, WikiLeaks, the reason why it’s so revolutionary is that it allows the janitor to leak and not simply the high-level Obama administration authorized leak to, you know, Bob Woodward, so to speak, to sell war or a particular political agenda of the elites. So there’s a lot going on here that is reason for them not to cover it.

HARRY SHEARER:  Okay. Let’s go to the charges. Now, some time ago earlier this spring Private Manning pleaded guilty to I believe around 10 of the charges in his indictment and made a statement, which was the first time he had been heard from since this whole process began, a statement which subsequently was leaked, the recording of which was leaked.

Bradley Manning clip:  [difficult audio; Alexa’s transcript is here]:  I read not only the cables on Iraq, but also about countries and events I found interesting. The more I read, the more I was fascinated by the way we dealt with other nations and organizations. I also began to think they documented backdoor deals and seemingly criminal activity that didn’t seem characteristic of the de facto leader of the free world.

HARRY SHEARER:  The charges he pled guilty to were what? And as you say, remaining before him are charges that are much more serious including violation of the Espionage Act which carries a possible death sentence.

ALEXA O’BRIEN:  That’s right. Bradley Manning pled to nine lesser included offenses of the Espionage Act and one violation of a lawful general regulation or order under Article 92, which is essentially that, you know, lawful general regulation or a lawful order. In the case of the Espi– he pled to every lesser included offense for every espionage charge against him except for what was called spec 11 of charge 2, which relates to the Garani video, and that dovetails into the grand jury investigating WikiLeaks, and there’s a reason why he didn’t. He pled not guilty to stealing U.S. government property. He pled not guilty to the multiple charges of – there’s two charges of the Computer Fraud and Abuse Act, which are very provocative charges because he had access; he didn’t hack anything. He also pled not guilty to the aiding the enemy charge. And then he pled not guilty to one of the more provocative and disturbing charges against him. It’s never been used before. In fact it’s not tied to any existing federal criminal violation or punitive article under the Uniform Code of Military Justice. It’s what’s called “wantonly publishing.”

HARRY SHEARER:  (laughs)

ALEXA O’BRIEN:  (laughs)

HARRY SHEARER:  I think we both of us do that every day.

ALEXA O’BRIEN:  Yeah. That’s why it’s so terrifying.

HARRY SHEARER:  Mmhmm.

ALEXA O’BRIEN:   But the crazy thing about this charge is that the knowledge element parallels the knowledge element in the aiding the enemy charge, so it essentially dovetails into aiding the enemy.

HARRY SHEARER:  Now, “wantonly publishing” is actually legislative language in some law?

ALEXA O’BRIEN:  Well, in oral arguments early on in the pretrial, the government argued that it was, you know, in terms of punishment that it was analogous to espionage but that it was far, far worse than espionage. And the defense came back and said, “This is a made-up offense. This shouldn’t be allowed.” So, you know, one of the reasons why I’ve been covering it as, I guess, intently is because there are such important things going on here and, you know, I want to empower other people, subject matter experts in military law for example, to be able to actually make commentary on this in a way that’s useful and valuable to the public.

HARRY SHEARER:  So you’ve been wantonly covering it.

ALEXA O’BRIEN:  I’ve been wantonly covering it and publishing transcripts.

HARRY SHEARER:  Yeah. The part that’s attracted my attention most recently has been discussion on this aiding the enemy charge, and I believe much of the recent proceedings have been involved with the judge ruling on elements of this in preparation for going forward with trial. Take us through some of that. What has she ruled and what’s in and what’s out regarding the aiding the enemy charge.

ALEXA O’BRIEN:  Essentially she says that the only thing the government needs to prove to convict Manning of the aiding the enemy charge is that he had knowledge that he was dealing either directly or indirectly with the enemy. In this case it’s indirectly, and according to the bill of particulars, which is like a legal document that the government, the prosecutor has to give the accused so that he knows what he’s being charged with, the indirect means is via the WikiLeaks website. The judge recently ruled that receipt was required, receipt of this information was required to prove aiding the enemy. Manning has been charged with giving intelligence to the enemy, according to this recent court ruling, not communicating with the enemy. There’s different types of aiding the enemy.

And the problem for Manning with this particular ruling is the fact that the government is going to introduce a classified witness who they’ve named John Doe who was involved in the raid of Osama bin Laden in May 2011, and this gentleman is going to come into court, from what we know, and say – or he’s actually going to come into an offsite location in a light disguise dressed in civilian clothes with the name John Doe, and he’s going to essentially say that, you know, all the Afghan war logs as well as State Department information was found on Osama bin Laden’s computer or some digital media. It involved a letter, correspondence between Osama bin Laden and somebody else, and that that is sort of essentially proving not only aiding the enemy, but – once again we come back to this provocative charge – it will also prove, according to the government, “causing to be published.”

HARRY SHEARER:  Now, what WikiLeaks did with this material depended on which of the releases we’re talking about. In some cases they published via the New York Times, The Guardian, El País. In other cases they published concurrently with those newspapers or with a couple of those newspapers and on their own website. But establishment media have been involved in the release or publication of much of this material. Do we know at this point whether what was found on Osama bin Laden’s computer were the documents themselves or reports of them as published by the New York Times or The Guardian?

ALEXA O’BRIEN:  We don’t know. All we know is basically one reference made that was a descriptor by the government when it was talking to the judge in a colloquy about even admitting this evidence; they wanted to have a classified review in camera, which is in chambers with the judge to sort of talk about this evidence. And we know that it consisted of the Afghan war logs and State Department information.

HARRY SHEARER:  So theoretically – I’m speculating here – the evidence could constitute the presence on Osama bin Laden’s computer of stories from the New York Times and The Guardian which included reports on some of this information.

ALEXA O’BRIEN:  Absolutely. You know, it’s interesting because I think Glenn Greenwald, a highly respected former Constitutional lawyer and journalist, has said that, you know, Bob Woodward writes books that have Top Secret classified information in it, and Osama bin Laden has produced videos recommending to everybody to read Obama’s War by Bob Woodward – what’s the difference here?

HARRY SHEARER:  Okay, what are some of the other issues that have been dealt with in the pretrial proceedings that you’ve been covering?

ALEXA O’BRIEN:  One of the other issues earlier on that I really was disappointed there wasn’t enough serious – any, or enough serious coverage of, was the fact that the State Department has really been, in my own words, a bit of a puppet master in this military prosecution of Manning. The criminal investigation of Bradley Manning encompasses the Department of State, the Departments of Justice and Defense. The Department of Defense is leading the military prosecution of Bradley Manning. At the Article 32, which is akin to a military version of a grand jury, essentially everybody else had to leave the courtroom except for members of the Department of State and presumably the Department of Justice for these closed sessions. [The] defense had tried to get information from the Department of State, and they were basically pressuring the military prosecutor to prevent the defense from getting this discovery, namely the damage assessments or the quote unquote lack of damage assessments and the like. And they even came into court and testified that they weren’t aware who amongst them had actually testified to the U.S. Congress about WikiLeaks. So their enormous role in this global multi-agency investigation of not only Manning and WikiLeaks and yet the lack of recognition of their importance and significance in this investigation, combined with the fact that they are looking to prosecute, along with the FBI, Julian Assange and WikiLeaks, is very troubling.

HARRY SHEARER:  Now, a couple questions following up on that. One, I think the casual observer can be permitted for thinking during all this time that the United States government was treating Bradley Manning, shall we say, without the usual niceties of pretrial confinement in an effort to get him to crack to aid the government in its prosecution or its proposed prosecution of Julian Assange and WikiLeaks. Has that been borne out by what you’ve seen so far?

ALEXA O’BRIEN:  Yeah, it really has. I mean, for one thing, if you look at the fact that Manning did not plead guilty to specification 11 of charge 2 – I had mentioned that earlier on – that relates to the Garani video, or alleged Garani video, although it’s pretty clear because that’s been said in testimony by agents, and –

HARRY SHEARER:  The Garani video is what we call Collateral Murder, or is it a different video?

ALEXA O’BRIEN:  No, it’s another video. It was never published by WikiLeaks. Essentially this is a video of a – an agent said it’s a flight over battle space, but the Garani air strike in May 2009 killed hundreds of women and children in the Farah province of Afghanistan. Human rights organizations refer to it as Judgment Day. And it was a very damning incident. The Pentagon had said that they were going to release the video and then they backtracked from it.

And so essentially the timeline of this offense within the Manning case starts in November, early November 2009, and it spans until about January 8^th, which is when we know WikiLeaks tweet, you know, “Have encrypted” – I don’t know the exact tweet but it was basically “Have encrypted video, you know, need super computer time to decrypt.” Well the reason why – you know, Manning had come into court during the pretrial sessions in a period of court where the accused comes in and sort of says, “I might plead to this and I might plead to that,” and then the court says, “Well, that’s a proper plea,” “That wouldn’t be a proper plea.” Well, he came to court and he says, “I might plead to specification 11, but in April, the same time that I might” – and he eventually did – “plead to spec 10,” which included like videos of burn victims and women and children and all the sort of carnage after this Garani air strike, but they were like JPEGs and images and the 15-6 investigation and things like that. And the government came back and said, “Well, we have actually forensic evidence for a November transmission and an April transmission and we could charge him two times.” And the defense said, “It only happened once, and it was on April the 10^th or 11^th of 2010.”

And that’s why Manning didn’t plead guilty to that charge, because if you look at the November timeline, it actually feeds right into the timeline of all the public documents that we have from the grand jury investigating Julian Assange and, what we know from the Manning trial, seven civilians being investigated by the FBI for criminal behavior or wrongdoing. Those dates for those what they call 2703D orders, which are essentially secret subpoenas for information from Twitter of the IP addresses for logging on and the, you know, any kind of metadata or –

HARRY SHEARER:  Identifying information on the –

ALEXA O’BRIEN:  Identifying inf– yes, thank you. Those also start in that November 1, 2009 timeframe. So this really is an attempt to get Manning to plead – I mean there’s a pressure on him. He has 22 charges against him. He’s been kept longer than any other accused. There is certainly the pressure of prosecutorial power upon him to plea out, to get Julian Assange in some kind of conspiracy.

HARRY SHEARER:  Okay. Backtracking on another note. I glossed over the details of the conditions of Manning’s confinement, which, as you noted, a judge had later ruled was unlawful. Take us through the treatment that he experienced during those nine months at Quantico.

ALEXA O’BRIEN:  Bradley Manning was at Marine Corps Base Quantico brig for nine months, from July 29, 2010 until I think April 20, 2011. And while he was there he was on what’s called prevention of injury watch and suicide risk. They’re two different statuses and they allow the brig to do certain things to him. In the case of suicide risk, he’s stripped and he has to put on this basically suicide smock, and he was also precluded from being able to go outside for many, many months except for like I think it was 15 or 20 minutes. And when he first got there he had admittedly tried to – he’d thought about suicide while he was in Kuwait, where he was housed in this cage and, you know, he didn’t have access to his lawyer and he sort of had a bit of a basically a mental breakdown. But by the time he got to Quantico he felt better. And he had also been put on I think anti-anxiety drugs. And so what the court had found was that – there was a period also I should probably mention because it really stood out is where he was, you know, basically ordered to stand naked at parade rest in the morning. The court ruled that one episode in particular while he was at Quantico was considered unlawful pretrial confinement because the brig kept him on suicide risk against the recommendations of his mental health care providers, and –

HARRY SHEARER:  These were mental health care providers hired and paid for by the Marines, right? They weren’t his private –

ALEXA O’BRIEN:  Yes.

HARRY SHEARER:  Okay.

ALEXA O’BRIEN:  Yes. So essentially they – the distinction was that they were always recommending that he not be on prevention of injury watch and that he be downgraded from maximum custody to medium, that he wasn’t a harm to himself. But the brig needed their permission in order to put him on suicide risk. So the brig had the right to keep him on prevention of injury at their discretion. This is according to the judge’s ruling. But the time that the brig essentially treated him as if he was on suicide risk by stripping him without their recommendation was actually a violation of his Article 13 rights.

HARRY SHEARER:  Wasn’t there a period of time where guards were instructed to check on him and if he were asleep to wake him every five minutes?

ALEXA O’BRIEN:  That’s right. He went through that. And essentially every five minutes they would ask him if he was okay –

HARRY SHEARER:  (laughs)

ALEXA O’BRIEN:  – when he was on suicide risk. And they had a logbook specifically just for Manning. And it was so crazy and preposterous, like listening to the testimony, you know, that because they were forced to write this log they would write down everything, and then these items would be brought into court in a very sinister fashion. Like for example we had, you know, essentially commanders of the garrison at Marine Corps Base Quantico describing the fact that they heard that Manning was playing peek-a-boo in the mirror and that this was really very irregular behavior for a maximum custody prisoner (laughs), or that he was rave dancing. But Manning wasn’t allowed to exercise in this 6×8 cell, and so he said in his testimony that he tried to do things that weren’t, I guess, according to procedure exercise but in which he could actually move, because he was going a bit batty.

HARRY SHEARER:  Yeah, and there’s also the matter of atrophying of your muscles. In most cases that involve charges that would be relatively close to the ballpark of wanton publishing, wantonly publishing, one would see friend-of-the-court briefs by other media organizations or other media personnel than the person or persons that are under charge. Have we seen any of that, or is that possible in a military proceeding? Have there been any friend-of-the-court briefs filed by anybody in the media?

ALEXA O’BRIEN:  There’s been a smattering of public commentary about this but there hasn’t been anything formally filed that we know of with the court itself regarding his treatment or the charges against him.

HARRY SHEARER:  Now, you’ve been in court every day of these proceedings, is that correct?

ALEXA O’BRIEN:  Pretty much, yeah.

HARRY SHEARER:  And how many days has that been so far?

ALEXA O’BRIEN:  Oh, God –

HARRY SHEARER:  (laughs)

ALEXA O’BRIEN:  More than 40 days of actually being in court or session, and then of course you have to also factor in cleaning up the notes or, you know, properly formatting them, correcting them, fact checking them, all that kind of stuff.

HARRY SHEARER:  Do you have a legal background?

ALEXA O’BRIEN:  No. (laughs) That’s the crazy thing about this trial, you know. I started off in the pretrial, like, what is going on? Like, especially with just all the military abbreviations. But, you know, I’ve had an education.

HARRY SHEARER:  And is anybody paying you to do this?

ALEXA O’BRIEN:  No. I’m self-funded. I mean, people donate, they make small donations, and people donate services to me. Like, I don’t have to pay for a hotel in the area. I stay locally. So my costs are low.

HARRY SHEARER:  And is there a date yet set for the trial?

ALEXA O’BRIEN:  There is. We go into an Article 39 on the 7^th. It’s supposed to be closed, but I have a feeling they’re going to litigate stuff on the open record, so I’m heading there. And then we go back on the 21^st –

HARRY SHEARER:  These are of May?

ALEXA O’BRIEN:  Of May. Sorry. Yes. And then the trial starts in earnest, according to the court calendar, on June 3^rd and is expected to go 12 weeks.

HARRY SHEARER:  Now when you’re saying these dates, there doesn’t seem to me, from what I read and what you say, to be a really clear, necessarily clear explication of what one can expect in these proceedings. So you’re going there just on the expectation that something will be considered. We don’t know what issues are yet to be litigated in the pretrial situation, do we?

ALEXA O’BRIEN:  According to the last court discussion – any time the government says not to show up, that’s when I show up.

HARRY SHEARER:  (laughs)

ALEXA O’BRIEN:  (laughs) When the government says they don’t plan any open sessions, that’s when I show up, because there’s going to be an open session and there’ll be details that’ll be important for my own understanding and analysis of the case. We know that they’re going to have a closed session on the 7^th or 8^th of May and it’s going to be essentially a dry run so that the court can kind of try to understand how to handle classified information. I just published a transcript a couple days ago with a list of 28 witnesses that the government is trying to have testify at least partially or in their entirety in a closed session away from the public. And of course, you know, this is not how we do things in the United States of America, at least not in theory.

HARRY SHEARER:  Mmhmm.

ALEXA O’BRIEN:  So the court has to go through sort of to see if there are alternatives to closing the court to protect this quote unquote classified information.

HARRY SHEARER:  And we don’t know the nature of this classified information, obviously, right?

ALEXA O’BRIEN:  Well, that’s why I’m really glad that I published that list of 28 witnesses, because today Marcy Wheeler published a piece on one of these individuals, who is Ambassador Stephen Seche from the State Department, and based on her own expertise in the national security arena she expects that he’s going to come and be a sentencing witness probably, I mean this is speculation, and that he’s going to testify that Bradley Manning harmed – he will likely or could testify that Bradley Manning harmed U.S. national security by exposing not only the drone strikes in Yemen and U.S. bombing in Yemen – we were hiding that, or the government of Yemen was hiding that from the people, saying it was their bombs – but also the original, the sort of initial targetings of al-Awlaki, an American citizen who was killed without judicial process by the executive branch.

HARRY SHEARER:  I seem to remember that – and correct me if I’m wrong – was it Robert Gates who said publicly, perhaps in congressional testimony, that as far as he knew there had been embarrassment caused to the United States by these leaks, but as far as he could determine, no harm had come to any specific individual, at least as of the time that he spoke? Was that Gates?

ALEXA O’BRIEN:  That’s right. It was Gates, and it was also Hillary Clinton, and it was also Admiral Mike Mullen. And the fact of the matter is that – and this is, you know, published in a January 2011 article by Reuters – the congressional aide, an anonymous source to Reuters, said that the State Department officials were playing up damage in order to both stir a prosecution of not only Manning but of also WikiLeaks. And if you look at the State Department letter by Harold Koh, their legal adviser who is an Obama proponent of drone warfare also and a former board member of Human Rights First, which I always find a bit strange and weird, but he wrote a letter to Julian Assange essentially right before the publication of the U.S. State Department cables, in response to a letter from Julian Assange to him saying, you know, “We’re willing to redact whatever you need us to redact.” And the State Department essentially said, like, you know, “You’re forbidden from publishing this and this is harmful to U.S. national security.” Well that letter and the language of that letter was used by Paypal and also Visa, MasterCard and the like to actually initiate their banking blockade of WikiLeaks.

HARRY SHEARER:  Now in case listeners might find that two-way communication unusual, it should be said that that is the kind of communication that, let’s say, the New York Times will have with the State Department or with the Defense Department if somebody leaks something to them. Usually before they publish they will go and say, “Tell us what to redact, tell us what might affect national security, we’ll take it out.” Is that not correct?

ALEXA O’BRIEN:  That’s correct.

HARRY SHEARER:  And the government usually cooperates with the New York Times in that request.

ALEXA O’BRIEN:  That is correct. That’s why the New York Examiner, and I followed suit after them, have FOIAed all the communications between the New York Times and the Department of State about this release.

HARRY SHEARER:  Freedom of Information Act requested is FOIAed, right?

ALEXA O’BRIEN:  Yes.

HARRY SHEARER:  Yes. And you put these transcripts online at alexaobrien.com, is that right?

ALEXA O’BRIEN:  That’s correct.

HARRY SHEARER:  But you also tweet when you’re covering on a minute-by-minute basis, I’ve noted.

ALEXA O’BRIEN:  Yeah, and I try to cover the trial in a very accurate and very sort of – it’s really I do this for subject matter experts, so that’s why I tend to focus on like what case law, or what are the elements of the rulings, to try to empower other journalists who might want to cover the case from afar.

HARRY SHEARER:  And the most severe penalty that awaits, potentially awaits Bradley Manning is a death sentence, is that correct, under the Espionage Act?

ALEXA O’BRIEN:  The government says that it won’t execute him, but that’s really not their decision; they’re just basically recommending that they don’t execute him, and fundamentally the decision is up to the military judge. Bradley Manning faces multiple life sentences for the charges against him, and based on his recent plea to the nine lesser included and then the one Article 92, he already has an exposure of 20 years.

HARRY SHEARER:  Finally, let’s talk a little bit about Bradley Manning the person. You made some observations I think in another interview that I found intriguing. What we had been hearing from I think mainstream media sources were mainly observations or rumors or something about his state of mind in Iraq and his sexual identity issues while he was in the Army in Iraq. You gave us – tell us about that, and then tell us what – you described him in court, I think the words that stood out to me were, “very obedient.” So, contrast those two views of Bradley Manning, if you could, for us.

ALEXA O’BRIEN:  Well, Bradley Manning is really young, first of all. When he leaked these, he was in his, you know, early 20s. He’s currently 25 years old. He’s also very, very bright and precocious, and he’s very methodical and very logical, and he’s incredibly earnest. He’s earnest in the way that really bright, passionate people can be, and so they can oftentimes be also a bit intense. And he was also at a stage in his life where he was sort of figuring out how to deal with adult world. He was never closeted, I mean, from what we know in public reports. I mean I’ve never spoken to Bradley Manning, so I want to apologize if I get any small detail wrong, but from what we know, from what’s already been published, I mean he was always very forthright even in his sexuality. There is evidence from the Article 32 that he wasn’t sure if he had certain gender identity issues with regards to, you know, this time period while he was in Iraq. And he didn’t have a lot of guidance.

I mean, one of the interesting things about the evidence that’s come out related to his sexuality, and I’m not an expert on this particular issue, but he did have a scholarly paper called “Flight Into Hyeprmasculinity,” and it was an article about the fact that there is a higher proportion of people with gender identity complexes within the military and that oftentimes they join the military because it’s a very hypermasculine environment, in the case if they’re male and they have a more feminine identity. So there’s that issue going on.

But you know fundamentally Bradley Manning is actually a very obedient and earnest young man, and if you see him in court he has the kind of personality that would even disarm and has disarmed this very aggressive and boisterous military prosecutor. During the Article 13 when Manning was on the stand for nine hours, by the end of his cross examination with the government, the government prosecutor was smiling at him. There isn’t much mendacity to Bradley Manning, and in many ways he answers questions in the way that you or I would answer questions if we were on the stand for these serious charges. I think he really, really, truly believes that he was doing the right thing and that he couldn’t handle – in a statement he talked about the fact that he didn’t want to work for the Iraqi security police because he knew that these people would be disappeared or would be tortured and he just couldn’t live with that.

HARRY SHEARER:  I guess the question about him that lingers with me is, after following the story of his treatment, his pretrial confinement, especially the treatment at Quantico, the person you describe, I mean certainly within the broad parameters of what we consider normal, sounds utterly normal. He doesn’t sound like somebody who’s been tortured for nine months. It doesn’t sound like he behaves like somebody who’s been tortured for nine months.

ALEXA O’BRIEN:  You know, Bradley Manning isn’t a maniac. He’s a very reasoned person. And even if you see how he’s instructed his lawyer to handle himself with the press, he said to his lawyer that he only wanted text-based documents published, that he didn’t want to do any kind of exposés. This is a person who’s very scientific in his thinking. I think the fact that he leaked source documents is a thread throughout that, that he wanted the public to really be informed, that he believed in the idea of self-governance and the requirement of public information and knowledge as a requirement for that. This is not somebody who is a showboat, a gloryboat, a media whore, so to speak, so I think he can – even in his plea, he said, “I admit guilt, that these actions are service discrediting and prejudicial to the good order and discipline of the U.S. armed services, and I can see how these leaks harmed U.S. reputation as to how it could handle information, and for that I, you know, I take full responsibility.”

HARRY SHEARER:  And finally, I think, just to wrap this up, Alexa, in all of the testimony and all of the evidence that you know of – obviously much evidence that’s been submitted – much evidence won’t be submitted until the trial itself, but much has been submitted in secret – is there any evidence that Bradley Manning has ever been in communication with any representative or associate of Al Qaeda or the Taliban?

ALEXA O’BRIEN:  Absolutely not.

HARRY SHEARER:  Alexa O’Brien, at alexaobrien.com and on Twitter – what’s your Twitter handle?

ALEXA O’BRIEN:  @carwinb. (laughs)

HARRY SHEARER:  You want to explain that? (laughs)

ALEXA O’BRIEN:  Just c-a-r-w-i-n-b. I used to go by a screen name named Carwin Biloquist and I just abbreviated it.

HARRY SHEARER:  Okay then. On Twitter. For the best and most comprehensive coverage of what’s the legal proceedings surrounding Private Bradley Manning. Thank you so much for being with us today.

ALEXA O’BRIEN:  Thank you for having me.

* * *

HARRY SHEARER:  That’s going to conclude this week’s edition of Le Show. The program returns next week at this same time over these same stations except in Los Angeles, over NPR Worldwide throughout Europe, on the USEN 440 cable system in Japan, around the world through the facilities of the American Forces Network, up and down the East Coast of North America via the shortwave giant WBCQ The Planet 7.490 MHz shortwave, on the Mighty 104 in Berlin, around the world via the Internet at two different locations live and archived whenever you want it, harryshearer.com and through kcrw.com/news/news-24 – that’s easy to remember, isn’t it? Now in stereo too. Available as a free podcast at kcrw.com as well as at iTunes and Sideshow Network, and available for your smartphone through stitcher.com. And it would be just like somebody else paying attention to that trial if you’d agree to join with me then. Would you? All righty. Thank you very much, uh huh.

A tip of the Le Show chapeau to the San Diego, Pittsburgh, Chicago in exile, and Hawaii desks. Thanks as always to Pam Halstead, and thanks to Stephen Dixon at POP Sound in Santa Monica and Paul Ruest at Argot Studios in New York for engineering help with today’s broadcast.

This program’s website is harryshearer.com. You can send e-mail there or find out what music is played on the broadcast. And on Twitter, I’m @theharryshearer. Aren’t you?

Le Show comes to you from Century of Progress Productions and originates through the facilities of the Change is Hard radio network.

LE SHOW, APRIL 28, 2013

Listen to the podcast here.

A link to Yves’ IFR e-book is here.

Interview recorded Thursday, April 18, 2013.

HARRY SHEARER:  This is Le Show, and today I’m welcoming back a familiar voice to these microphones, always with useful information, today I think even probably more so than usual because she’s just been doing some spectacular reporting on a subject that has been largely ignored, strangely enough, by the national media. The subject is the ongoing F-bomb, the foreclosure crisis, the foreclosure mess, and specifically the Independent Foreclosure Review. And the guest is the author/editor/owner/proprietor/entrepreneur of nakedcapitalism.com, Yves Smith. Yves, welcome back to Le Show.

YVES SMITH:  Harry, thanks so much. Great to talk to you again.

HARRY SHEARER:  You too. On the broadcast a week or two ago we had a clip of Elizabeth Warren, from the first set of hearings on the Independent Foreclosure Review, browbeating the representative of the Office of the Comptroller of the Currency and the Federal Reserve about their apparent inability or unwillingness to release any of the information they gathered in this review to the public or to possible homeowners filing suit, which was a good little browbeating. But let’s get the larger picture. What was the Independent Foreclosure Review? Who started it and why?

YVES SMITH:  Okay. It was officially entered into in April of 2011, and even the back story sort of explains why it came out – well, a part at least of why it came out the way it came out, which is that in, if you recall, in the fall of 2010 the robosigning scandal became national news. Now that, if you’d been following the story in local courtrooms, there had actually been a lot of foreclosure defense attorneys trying to mount defenses based on the fact that the mortgage securitizations actually had not been done correctly, and you know separately the borrowers would be trying to get modifications from their bank – they’d think that they were good candidates for modifications, and historically if a borrower got in trouble you’d always be better off settling for half a loaf rather than none. But instead, foreclosure attorneys starting increasingly looking at whether the party that showed up at the court was actually the right party to be foreclosing. Then you had the robosigning scandal break. Then you had a big scramble among federal regulators, frankly to try to pretend this was not a problem. You had a big review by 11 regulators that implausibly claimed there were no problems in November, December 2010. Nevertheless a bunch of state attorney generals started getting troubled by this and formed a group that started negotiating with the banks around this issue. A number of federal regulators joined, and again it all goes back to Elizabeth Warren.

Elizabeth Warren was sort of invited into this group and began just using fairly straightforward arguments to basically say the banks pay a lot of money merely based on how much they’d save through bad servicing, not even looking at the harm they had done to borrowers. Well the Office of the Comptroller of the Currency was part of these discussions and they didn’t like the way they were going and so they broke from those negotiations and put this settlement in place in an attempt to torpedo the other negotiations. That’s why this whole discussion of settlements becomes very confusing, because there actually have been two going on. There’s this OCC one that’s created this big brouhaha, and then the big state Attorney General federal one, the rest of the regulators, was concluded a little bit more than a year later in January 2012.

HARRY SHEARER:  That was the one that had the banks paying supposedly $25 billion dollars–

YVES SMITH:  That’s correct, that’s why this – since they all started from the same place, but the OCC split off with this one. And that one, people who had been watching it closely knew that the OCC one, not just from its history but from the consent order itself, was really not a good-faith effort. I mean one part of the consent order was basically that the banks should service the loans better, except “better” was really just an affirmation of existing law. There really was nothing really new in the servicing provisions at all. You know, so you’re just going to tell them again to obey the law when you’ve, you know, not enforced this in the past? Why would we take this seriously?

HARRY SHEARER:  Let me just break in for a second. “Servicing” in the current usage means the agency which may be owned by the bank, or may not be, which collects the money month-to-month on a mortgage and does other things that in the old days would have been done by the bank that made the loan in the first place.

YVES SMITH:  That made the loan. That’s right. That’s the problem we have now is that the roles are all split up, unfortunately. You know, finance should not be complicated. The fact that it’s now become complicated is a bad sign. But you now have, when a mortgage is securitized, meaning it’s been eventually sold to investors, you have a split of roles. So the bank that originates the loan may or may not be the one that services the loan, which as you say it collects the payments, deals with the investors, and also is the one that handles the foreclosure.

And the whole problem goes back to the fact that when they set up these securitizations, they provided for ways for the banks to be paid if they foreclose. They don’t provide for them if they modify a loan, and a modification is actually much more work, so of course the banks foreclose even though foreclosures are worse for the borrower and worse for the investor. You know, the only party that wins out of this is the bank. Nobody else. Everybody else comes out much worse off.

So let’s, so we’ll dial back to the 2011 consent order. So one part was the servicing guidelines which said, “You guys obey the law,” basically. The second part was that they were going to provide for these, what, again, what you correctly called the Independent Foreclosure Reviews, but they were – “independent” is a bit Orwellian. The banks were direct-to-hire, quote, “independent consultants,” except these independent consultants were hired by and paid for by the banks.

And, you know, people for example like Sheila Bair in her book, you know, she’s got a book called Bull by the Horns where she talks about her experiences at the FDIC. And she had one experience where she was sort of forced in a regulatory process with the Fed and Treasury to have a bank use an independent consultant, and she describes, rather colorfully, how egregiously, you know, appallingly bank-favorable the report was. It just wasn’t credible. And so the FDIC has a very dim view of these independent consultants.

The OCC, by contrast, is a very bank cronyistic regulator, the most bank cronyistic regulator. So you could see this whole thing was baked in to basically be a cover-up.

The thing that turned out to be rather strange was that when – the consultants basically appeared to have viewed this as a fee-gouging opportunity and the OCC didn’t give very clear – first, they didn’t really understand the task. You know, there were 4.3 million borrowers that were potentially eligible for review. The OCC strangely defined the objectives as to find all the borrower harm, I mean, which is – you know, no honest review could do that, particularly for so many mortgages. And they set up a very confused process where they had one track where borrowers would write in and ask for their loan to be reviewed, and there was a second track where the servicers and their consultants were supposed to come up with a statistical sample, and somehow they were to sample in a way that would unearth all the borrowers that hadn’t sent in letters. There’s, there is – I mean, I can go through the long-form statistical part of it, but there’s just basically no way to do that. You’ve got sort of two conflicting objectives in the statistical part, because if you wanted to find all the harm, that’s really not a statistical process, and then the way they went out to try to find the patterns of harm led to sampling that wasn’t random. You know, for instance, every state’s got different foreclosure laws. That meant your sampling would have to cover all 50 states. Well, let’s face it. Most of the foreclosures, particularly most of the really bad loans, were originated heavily in a handful of states. I mean, if you’d want to do 80/20, nearly all the bad foreclosures – not nearly all but a just vastly disproportionate proportion of the bad foreclosure activity took place in, you know, Florida, California, Arizona –

HARRY SHEARER:  Nevada.

YVES SMITH:  Nevada! Right. So, you know, if you have 50 states, that’s going to overweight the states that the subprime lenders flew over, like Iowa, and there’s no question that this – I would suspect the consultants understood full well the implications of some of the way the OCC structured its request and went along. And then the OCC began finding problems as they went along with how they were doing it – their guidance wasn’t clear, they had wanted this to at least be consistent across all the servicers or appear to be consistent, they were having consistency issues – so they kept revising their standards with the consultants. So the whole thing just led to this explosion of costs. By the time they got done, they had only reviewed 100,000 loans, at a cost of $2 billion dollars. That’s $20,000 per loan.

HARRY SHEARER:  And a contributor to your blog, Michael Olenick, said in a recent posting that with software he had devised and with the knowledge that he had of how to do this kind of work, adding layer upon layer of profit and overcharging he could only figure out how to spend about, I think his figure was roughly $250 million on something that the consultants ended up spending $2 billion dollars on. Is that right?

YVES SMITH:  Well, that’s correct. You know, and that was one thing that we found in our – I had nine whistleblowers come forward, and one thing that they described was just the incredible managerial incompetence, that, for example at one of the smaller servicers, PNC – when you think of smaller, it should mean it was more manageable. They literally had one person from Promontory, 140 to 150 consultants – you can’t have one person supervise 140 to 150 people, particularly with, you know, sort of a novel, you know, set of tasks. And they would literally sit around in a room for months waiting for instructions for what to do.

HARRY SHEARER:  (laughs)

YVES SMITH:  So that’s part of how they got here, that they hired people and then had them do nothing. And then it was also, at least on PNC and I suspect this happened on some of the other banks, is there were, increasingly there were leaks on the Promontory s– Promontory, now Promontory, back up. Promontory is one of the independent consultants. They handled two of the largest reviews. They handled Bank of America and they handled Wells Fargo and they also handled PNC, which is the third one I mentioned, the small one. And they are believed to have pulled out the overwhelming majority of the fees, because they went and hired outside staff, they had never – they didn’t have a history of running big projects like this, they’re only a 400-person firm.

The other big consultants in this were Deloitte Touche and PricewaterhouseCoopers. They’re both big accounting firms. They at least know something about securitizations. They are regularly used on securitization – I mean they’re not expert in this part of securitization and servicing, but they know the space generally. And accounting firms get called in to do ginormous projects on a much more regular basis, so they weren’t as incompetent at this as Promontory was.

And what happened with Promontory was there were increasingly leaks. Pro Publica had a story in October – the first one. They did several, but the first was in October [2012] where they basically questioned, correctly questioned, the independence of the reviews at Bank of America, because at Bank of America – remember I described two tracks. The one track where they reviewed the borrower letters was being done by temps on a Bank of America site under the direction of Bank of America. Promontory, all Promontory did was provide the software that the answers were logged into. And when that leaked out, there was apparently a huge scramble at the OCC because they had been exposed as not being sufficiently concerned about independence, and apparently at PNC they threw out all of the work that had been done through October. These reviews – this had started in September – now this is from September 2011 to October 2012, all that work was thrown out. So that’s how they got to such big bills. You know, most of the work was not even used.

HARRY SHEARER:  Promontory is an independent consultant increasingly in the news, and I think one of the things that you spotlighted is that the revolving door doesn’t begin to describe the number of former high-ranking members of the supposed regulatory establishment in Washington who have left government and shown up as high-ranking officials at Promontory. Is that correct?

YVES SMITH:  That’s correct. I mean most recently Mary Schapiro, who was the last head of the SEC, has joined Promontory. A bit sus looking is that the last general counsel – sorry, they call them chief counsels. General counsel’s a corporate term. The last chief counsel at the OCC was a woman named Julie Williams. She had been the – she was hired by Gene Ludwig, who is the head of Promontory, when he was Comptroller of the Currency. They have particularly deep relationships at the OCC because, you know, of Ludwig’s tenure there. So Ludwig had hired Julie Williams. She was clearly key in negotiating these consent orders with all of the banks, and then she went to Promontory. Alan Blinder, I believe he’s a former vice chairman of the Fed, is an adviser to Promontory. So they’ve got, you know, very senior people as well as a lot of people at the next layer for pretty much all of the regulators. I mean, if you read – you know, there are a lot of, for example, people at Treasury who were involved in the TARP negotiations. Promontory has roughly 400 professionals, and I think it’s something like 100 of them – of the 400, roughly 100 are ex-regulators.

HARRY SHEARER:  Wow. Now let’s talk about your whistleblowers. The reporting based on the whistleblowers’ evidence, you’ve gathered into an e-book, and we’ll tell listeners how they can get the book at the end of the broadcast, but highlight for us some of what they reported about how they went about this work of reviewing these mortgage files.

YVES SMITH:  I mean, what’s sort of ironic about the whole thing is that Bank of America actually on some level was far more serious about having people look at this. I mean, they actually, they got 18– ultimately it was roughly 1800 people in multiple locations going through files based on the borrower letters, and they hired through various temp agencies people who were pretty well qualified, at least initially. They started downgrading it as it went on, and hiring lower and lower skilled people who were less capable. But the initial people they hired, for example the people I spoke to who all worked in Tampa Bay, the least experienced one had been a paralegal for five years at a foreclosure defense firm. So they all were very knowledgeable about mortgage documentation and mortgage procedures. And they were told by the temp agency that their job was to find borrower harm, so they (laughs) thought their job was to find borrower harm. And they were trained to use the computer systems, they went and dug through stuff, you know, and then the weird part of it was they would find harm and then there’d be layers above them. For example, they called it Quality Assurance, another Orwellian term.

HARRY SHEARER:  (laughs)

YVES SMITH:  But they had a Quality Assurance department which would then look at what the reviewers found, and basically they would undo their work.

HARRY SHEARER:  They would say no harm?

YVES SMITH:  They would say no harm, but then the reviewers were given the opportunity to rebut it. Then it would go to Promontory, which would inevitably find no harm. I mean, so there’s this whole, like, you know, the whole thing was like this bizarre, costly charade. I mean, I’m not, you know, so they – but the point was that because they set these temps (who ultimately obviously have no loyalty to Bank of America because they’re temps) loose on these files, who knew something, they found a lot of stuff. And the most disturbing thing is they found what again foreclosure defense attorneys have claimed has been going on, just because they’ve seen it so frequently it can’t be an accident, they saw patterns of systematic abuse. You know, things that could not be accidents because they happened so often.

For instance, when people would get modifications, they would typically have all of the expenses they’d gotten like – typically people don’t get modifications unless they’ve been late. So they would get a modification. They would have all of the late fees and other charges that were due on the account wrapped into the principal balance. So let’s say, you know, the balance had been 150,000, the bank says you have, you know, X in what you’re behind, plus other fees we’ve incurred, so now your balance is 150,000 + X. The problem is the X at least half the time was an amount that just wasn’t legitimate. They would often show attorneys’ fees of more than $5,000, and there are state guidelines, there are, you know, Fannie and Freddie, the two big investors in mortgages, guidelines that limit – you know in a completed foreclosure you’re not supposed to get to more than $5,000 unless it’s contested, in most states. And in a foreclosure that wasn’t completed, this is a number that’s just not plausible. And yet again and again and again they’d see numbers like that.

Similarly, in bankruptcy, if somebody goes into bankruptcy, the whole idea of bankruptcy is – a chapter 13 bankruptcy – is that the court figures out how much you the borrower can pay to your creditors if you live basically very austerely for 60 months. You live very austerely for 60 months and you make your payments and you emerge from the bankruptcy clean. And during that period, any payment that is made through the court process is on time. So let’s say your mortgage originally said you were supposed to pay on the 10^th but the bankruptcy trustee – a lot of times in a lot of states they pay the bankruptcy trustee rather than writing a whole bunch of checks, and the bankruptcy trustee then pays the bank. Whenever the bankruptcy trustee pays the bank, that’s on time. Well, that’s not how it was done. The banks, Bank of America would accumulate late fees during the bankruptcy. They might also include pre-bankruptcy fees that should have been reported to the court. They’re supposed to report all, anything they think they’re owed to the court during the bankruptcy process. They’d wrap all that stuff and they’d hit the borrower as soon as they emerged from bankruptcy, when the borrower is broke, by definition. The borrower is supposed to emerge from bankruptcy debt-clean with basically no spare cash. So the borrower’s got no money to fight the bank at that point, and a lot of people lose their house that way. I mean at that point, if you’ve got no money, $2, 3, 4, 5,000 of charges post bankruptcy is going to kill most borrowers.

Another one was force-placed insurance. Countrywide was notorious for this. They were the biggest player in this game. Force-placed insurance is where a bank finds that a borrower has – and oftentimes not validly, but they’ll claim that the borrower has either insufficient insurance or the policy has lapsed, and they’ll put their own policy in place which is 5 to 10 times what it should cost in the marketplace, and typically they’ll have some kind of kickback arrangement with the broker so that they skim an extra fee off of this.

HARRY SHEARER:  With the insurance broker.

YVES SMITH:  With the insurance broker. In this case Countrywide had its own captive insurer –

HARRY SHEARER:  Nice.

YVES SMITH:  – so it’s even worse.

HARRY SHEARER:  Nice.

YVES SMITH:  So in any event, if somebody applied for a modification, they would be required to take what is called forced escrow, whether or not their mortgage actually required escrow, and that escrow would include force-placed insurance. And that forced escrow would stay in place whether or not they got the modification.

And there’s more! (laughs) I mean, this is just a partial list.

HARRY SHEARER:  Yeah. I think we’ll probably have to go back for another helping, but let’s bring this up to date. This process then was called to a halt by the Office of the Comptroller of the Currency, the OCC, what, late last year, early this year.

YVES SMITH:  Right. They started negotiating it appeared in December and they shut it down at the beginning of January.

HARRY SHEARER:  And they said, “We’re not going forward with this review because it was faulty and costly.” And then what happened?

YVES SMITH:  Well, and then they negotiated a settlement without knowing who was harmed, but wanting to pay the borrowers money. So, some money. Some token. The excuse was, “Oh, you know, this was taking too long and we needed to get money faster.” Well, what is the good of getting money if you have no idea, as Elizabeth Warren in particular pointed out, if you have no idea if it was enough money because you never finished the work, or never did enough work, to have an idea of what an adequate amount was? Now of course this gets back to that’s assuming these guys had good intention, which I sincerely doubt. So you basically conclude that either they were incompetent or corrupt, so you can take your poison on this one. But in any event, the point was they got this pot of money –

HARRY SHEARER:  $3.2 billion, is that right?

YVES SMITH:  It started out – the number sort of increased. They got initially 3.3, but then a couple of other servicers joined the settlement later so it ultimately was 3.6 billion. And there’s another portion that’s sort of noncash booty, so sometimes you’ll see a number that’s 9 billion-ish reported? Forget about the 9 billion number. I mean, it’s all smoke. That is smoke and mirrors. In fact in the hearings yesterday, there was a separate set of hearings yesterday, Senator Merkley demonstrated that they could basically satisfy the rest of – if they really wanted to game the system, they could satisfy the rest of that 6 billion obligation with basically 12 million, M with a million, of mortgage modifications. That’s how badly the other part was structured. So throw away the other 6-ish billion. The 3.6 billion across 14 servicers, they had to distribute – and there were specific numbers for each servicer. You know, every servicer had their, you know, piece. But they had to figure out how to distribute this money with no idea, with no – with not enough information to do this in any sensible way. So they basically, it emerged in the second round of hearings that effectively the way they did it was they just took the borrowers who were the furthest along in the process and gave them the most money. They’re the first loan in foreclosure, the first – you know, so basically if you were early through the gate you got more.

HARRY SHEARER:  Wow. So it’s a reward for either sending a letter in quickly or having a bank or a servicer respond to you quickly.

YVES SMITH:  Yeah. That’s right. So the whole thing is just – it was going to be arbitrary no matter what, and on top of that the amounts and who got them were determined strictly by the OCC and the banks. So again, as Elizabeth Warren pointed out, this was basically letting, you know, the guys who caused the problem decide who was going to get the money.

HARRY SHEARER:  I think the representative from the GAO who testified at the second set of hearings said that the data are incomplete, the data does not allow us to render any conclusions about error rates at a particular servicer or make comparisons between or amongst servicers despite what’s been reported in the press, so this, the result of this process is sending money to whom, based on what?

YVES SMITH:  Well, no, that’s what I’m saying. I mean, there’s a very tidy looking schedule (PDF) that divides people into categories of harm, but, you know, basically, just think about it. You had a fixed pot of money that you’re going to have to figure out how to distribute not even knowing who was hurt. So any process – I mean, any process is going to be arbitrary. I mean, that’s just inherent. So they produced this pretty-looking schedule, and then I think that maybe what the GAO person is reacting to, whenever people looked at the schedule and said “Gee, they’re claiming that so many people were harmed” – no, this is just made up. (laughs) You know, I mean, this should not be – just because people put numbers on a page does not mean the process had any dignity. You have to understand, the process was baloney and they just came up with some arbitrary way to hand out the money. That’s what this amounts to.

And the only thing that I believe probably happened is that the banks have been very sensitive to violations under the Servicemembers Civil Relief Act, and that’s longstanding law where basically active-duty servicemembers are not supposed to be foreclosed on. And there were also additional provisions where they were supposed to have interest rates lowered to, if they were in a high-interest loan, the ceiling was 6%. And there were a lot of SCRA violations. And the banks don’t want to – you know, it’s a real media problem for them if they beat up on, you know, if they’re mean to, you know, soldiers. Plus the Veterans Affairs Committee – you know, the banks don’t spend money on those senators. So they’re more likely to –

HARRY SHEARER:  They’re not captives?

YVES SMITH:  They’re not captives. So they’re really afraid of blowback from there. So I would say it’s possible that the abused servicemembers may have gotten something approaching adequate relief. Any other category, forget it.

HARRY SHEARER:  We heard numbers I think in the bit of media coverage of the settlement that the relief would average out to about – and I think Elizabeth Warren used these figures as well – like $500 to $600 for somebody who had lost their house.

YVES SMITH:  Right. Yeah. And the other thing is you’ve got people – you know, like I had one person show up on my blog who said – remember this, again, because it’s arbitrary, you’ve got people getting money who actually should have been foreclosed on. I mean, who really were behind, who you know knew they couldn’t save their house, who you know they just threw it in and left, you know threw it in and left or threw it in and got a deed in lieu or whatever. I mean, I had one of those show up on my blog, clearly somebody who was expecting not to – you know, didn’t think they deserved any money. I think he got a $500 check.

HARRY SHEARER:  And most recently you reported that some of the first recipients of checks from this process reported that the checks bounced.

YVES SMITH:  That’s correct.

HARRY SHEARER:  (laughs) That’s insult to injury, is it, or – ?

YVES SMITH:  Yeah! Well, and it also looks like, you know there’s also this disconnect in that it looks like again like they’re not making good-faith efforts, because – and this the GAO criticized the first time around. The GAO said, when they were setting up the mailings, the same firm that’s handling the payments is the one that handled sending the letters trying to find people who were eligible for review. And so what was the first thing they tried doing? I am not making this up. They sent letters to the addresses where people had been foreclosed on.

HARRY SHEARER:  (laughs)  Nobody home.

YVES SMITH:  Nobody home. So the GAO sort of got all over them and told them that they had to do – embarrassed them enough that they started doing more outreach, like, you know, advertising in certain communities, so forth and so on. But even then when the letters were sent out they were written at basically a second-year college level when the federal guidelines for sending out any kind of official communication is it should be written at the sixth- to eighth-grade level. So, you know, again, is this incompetence or is this bad faith? I mean, I’m inclined to bad faith but you can argue incompetence, but either way you go back to this firm Rust Consulting. So, this is the second time they’ve had a settlement where they haven’t had the cash in the bank. They had one in 2006, ironically on force-placed insurance, where they didn’t have the money all there before they started sending checks out. You know, that’s – a lot of pla– you know I thought check kiting was a crime, you know? I don’t understand why they aren’t being fined or sanctioned for this.

And then there’s all sorts of stuff. Like, for example, letters – the checks have to be cashed in 90 days. You know, why is that? You know? I mean aren’t most checks, my understanding is they’re normally good for, you know, 180 days to a year minimum. I mean, they’re sort of putting – you know, and then the flip side is at the hearings – you, you know, it sounds like you looked through the hearing testimony, but in the hearings the Rust guy sort of went on and on and stressed the lengths and the processes they used to find if they, you know, if the letter came back or they couldn’t find the right address. Well, again, I had somebody show up – you know, and how many readers do I have? I mean, you know, I don’t have that enormous a readership base. I mean it’s pretty good but it’s not, you know, it’s certainly not like the New York Times or major media. You know somebody shows up on my blog today and says, you know, a couple days ago, and says, “Oh, hi. You know, our law firm doesn’t do anything in the mortgage and foreclosure space and Rust Consulting sent us a check on behalf of a woman we never heard of.”

HARRY SHEARER:  (laughs)

YVES SMITH:  And according to Rust Consulting process, it’s not conceivable that if they had used the process they described for finding people who are hard to find, that this law firm would have gotten the check. And then when he called Rust to find out what to do, he got, you know, they got this enormous runaround.

HARRY SHEARER:  Let’s talk a little bit more about the specifics of what these people were doing during the review process itself. I mean, you did a five-day series of very detailed reports from these people, and it seemed a lot of the problems were definitional. Harm was defined away. Can you get into that a little bit?

YVES SMITH:  Yeah. Well they were doing their best to narrow the scope of the reviews. So for instance they had different teams handling different aspects. So one group of reviewers would handle modifications only. And modifications were ones where there were some of the biggest problems. So the reviewers would go in, and one thing that happened quite often, at least at Countrywide and Bank of America, was if somebody applied for a modification and then got a trial modification – well actually two bad things would typically happen. One would be, and this one was reported frequently in the media, that they were supposed to send in documentation of their status, their financials, and the bank would keep saying, “We didn’t get it.” You know. And they would make them fax it in again and again and again and again and again to different numbers and they kept claiming they didn’t get it and then would not give them the permanent modification. Well of course these temps would find in fact that the borrower had sent the paperwork in. They would find the scanned images of the paperwork in the system. It was just an out-and-out lie that they didn’t have the paperwork. Which isn’t surprising, but that’s what happened.

But the second bit was that, you know, when somebody had a trial modification they would be told to send in – you know, obviously a trial modification payment is smaller than the original payment. Those payments would be sent in and instead of being credited to the borrower’s account, they wouldn’t know where to put them. They somehow hadn’t set up the systems for what to do with these smaller payment amounts, and they would be put in something called “suspense” –

HARRY SHEARER:  (laughs)

YVES SMITH:  – so not credited to the account, and then the borrower would be treated late, and late fees would start being accumulated, and then they’d be, you know, rejected for the modification, and then they’d be foreclosed on. And they came on just sort of numerous examples of this sort of activity happening.

The other case would be just a computer screwup error, not on sort of the HAMP mods, which were the most – there were multiple modification programs, but there were also cases of just where the mod wasn’t, as they put it, the term of art is “boarded.” Somehow, even though the borrower had sent back a signed – the bank had, you know, sent the letter out, the borrower had sent the letter back with the first payment – somehow it wasn’t boarded, it wasn’t loaded into the system as being modified, even though, again, the reviewer could see the scanned borrower document that they had signed it. And there was one case which was particularly charming, back to your defining away harm, where the bank just sent the check back. They would send the checks – you know, they had an approved mod, the bank just sent the checks back and said, “Oh, they’re not sending a sufficient payment amount,” because the mod hadn’t been boarded, right? They thought the old payment amount was in place. And so the reviewer flagged that as being harm. That was sent up the line and Quality Assurance rejected it. You know, they tried sending it back, and Promontory said, “Well, the payments were being returned because the borrower wasn’t making any.”

HARRY SHEARER:  (big laugh)

YVES SMITH:  That’s literally what the notes said. So this was the kind of stuff you saw. I mean, and this, this was kind of normal in terms of the crazy ways things would get rejected. And then there were other things that were just of, you know, sort of more scandalous and troubling. I mean, for instance, one of the things that they were asked to – this was a different test, but they were asked to check on, was whether the borrower had been, and the term of art is “breached properly.” That the first step in a foreclosure is to send out what is called a breach letter which says, “You’re in trouble, you’re behind, you know, we’re going to start a foreclosure action unless – but there is a way you can get yourself out of the hot soup. If you send us this amount of money by this date to this address, you’ll be okay.” So there are specific things that have to be in a breach letter for it to be a legal breach letter. Well, for a whole class of borrower – you know, there was a whole set of borrowers where the breach letters were missing. Then suddenly all at once these missing breach letters appeared. They were on – they had the wrong Bank of America – they were Countrywide loans. Not only did they have a Bank of America logo for loans that were Countrywide loans, it was the 2011 Bank of America logo when there was a different logo in 2009 and 2010.

HARRY SHEARER:  Meaning that it’s been manufactured after the fact.

YVES SMITH:  They’d been manufactured after the fact.  And they weren’t even proper breach letters. Okay, because a proper breach letter should say, “Dear –” you know, it should have the borrower name and address, you know, it should have as I said the payment amount and a payoff mailing address. And these letters would be “Dear Customer,” no address, no name, and they wouldn’t have the payoff amount. And one of the temps, you know, went and brought it to one of the better managers and just said, “This doesn’t even wash,” and the manager looked at it and said, “Yeah, you’re right.” And then all those breach letters disappeared.

So there’s evidence – what’s very troubling is that there’s evidence – and this may be another reason why the cost escalated. You know, I question whether there was – you know, there’s evidence at Bank of America that there was basically document fabrication going on, so was the reason that some of these costs got so high is that the consultants were helping the banks fabricate documents on the side? I mean that’s, frankly the evidence at Bank of America says that was at least some of the activity, and that the costs of the Promontory reviews look to be out of line with the ones by the accounting firms. Was Promontory doing this sort of thing at the other banks too that it was reviewing?

HARRY SHEARER:  Now you have probably legally astute readers, people in the law business. Has anybody weighed in with the analysis that this rises to the level of fraud?

YVES SMITH:  No one has said that yet because we don’t quite have a smoking gun.  This certainly looks like fraud because it was – well, I – the flip side is, I’ve got – there are – I am in contact with a fair number of foreclosure defense attorneys and they have been saying fraud for a very long time. So the problem is, even before this there have been people saying fraud. Again to your point about the national media, the national media doesn’t want to hear this because the implications for the banks would be too devastating.

You know, one firm that I’d really hoped would get busted was one called Lender Processing Services, which does a large portion of the mechanical activities of the best way to – they call themselves a software platform, but one of the things they do is that they manage the relationship with the attorneys, and about 60% of the servicers use them. Bank of America uses them. One of the things that one of the consultants at PNC said was very clear was that the OCC in the later stages said that they wanted backup for the third-party charges, which would be the attorney fees. And they said that Lender Processing Services could not deliver any support for the attorneys’ fees. And Lender Processing Services got paid by basically getting kickbacks from the attorneys. So, again, LPS would have a huge incentive to inflate the attorneys’ fees in order to inflate their compensation. So –

HARRY SHEARER:  Is Lender Processing Services not the firm one of whose subsidiaries was DocX, a business now out of business whose business model was document fraud– fabrication?

YVES SMITH:  That’s correct. So, yeah. And Attorney General Masto in Nevada was going after them fairly systematically. She launched a criminal case against some lower-level employees and she was clearly hoping to sort of roll that up to more senior employees. And that’s just, you know, that was basically abandoned when the big federal/state attorney general settlement I mentioned was entered into. That was, she just dropped that.

HARRY SHEARER:  So, we have very detailed reporting by you on the activities of these whistleblowers inside the Independent Foreclosure Review. How can listeners – it’s in the form of an e-book. How can people access it? What’s the, where do they go?

YVES SMITH:  The easiest way would be to google “Naked Capitalism” in quotes and “e-book.”

HARRY SHEARER:  Okay, that’s your only e-book?

YVES SMITH:  That’s my only e-book. Yeah. So you will –

HARRY SHEARER:  So far.

YVES SMITH:  Yes, so far. So that way you will find it.

HARRY SHEARER:  And it’s free.

YVES SMITH:  And it’s free.

HARRY SHEARER:  Okay. And, it’s –

YVES SMITH:  And when you find it, it’s got a little sad piggy (laughs) on it, a broken piggy bank.

HARRY SHEARER:  Aww, no, a sad pig.

YVES SMITH:  Yeah. Yes.

HARRY SHEARER:  How could you? It’s – I read the whole series. It’s stunning. You have given us just a glimpse of the horrors inside the places where these reviews were going forward, and it is – even for people who think themselves unshockable, which I think you and I both do, it’s pretty shocking stuff.

YVES SMITH:  Yeah, I was really stunned when the whistleblowers came forward. And even when you know it’s bad, when you hear just the detail and the extent of it, it’s really frankly nauseating.

HARRY SHEARER:  One more point, which I think I recall from your series. Were certain reviewers even told that “we are not, it’s not in our mandate to look at what’s illegal, what’s been illegally done to these people”?

YVES SMITH:  Oh, yeah, there were several points where the reviewers at Tampa Bay would find things and they would, for example, be told, “We’re not looking at that. That’s federal law. Federal law is not our responsibility.” You know, for example on the bankruptcy violations. When, again, the consent order specifically said they were supposed to review state and federal violations. I mean, the instructions were just completely inconsistent with what was claimed was being done.

HARRY SHEARER:  All right then. The New F-Bomb continues to spread its particles among us. Yves Smith, the mistress of nakedcapitalism.com, incredible job of reporting on this story. Thank you for sharing it with us today, and I hope to talk to you again – I hope it’s not necessary to talk to you again soon but I think it probably will be.

YVES SMITH:  Unfortunately, I’m afraid, yes, this is, as we discussed before we started taping, this is a target-rich environment and it’s sad. Finance should not be complicated and certainly shouldn’t be criminal.

HARRY SHEARER:  Right. That sounds hopelessly naïve, but all right, we’ll buy it for the moment.

YVES SMITH:  (laughs)

HARRY SHEARER:  Yves, thank you again.

YVES SMITH:  Thank you. Take care.

HARRY SHEARER:  You too.

*  *  *

HARRY SHEARER:  That’s going to do it for this edition of Le Show. The program returns next week at the same time over these same stations, over NPR Worldwide throughout Europe, on the USEN 440 cable system in Japan, around the world through the facilities of the American Forces Network, up and down the East Coast of North America via the shortwave giant WBCQ The Planet, on the Mighty 104 in Berlin, around the world via the internet at two different locations live and archived whenever you want it, harryshearer.com and kcrw.com. Available for your smartphone through stitcher.com and available as a free podcast through iTunes Sideshow Network and kcrw.com. And it would be just like the banks playing by the rules if you’d agree to join with me then. Would you? All righty. Thank you very much, uh huh.

A tip of the Le Show chapeau to the San Diego, Pittsburgh, Chicago in exile, and Hawaii desks. Thanks as always to Pam Halstead. Thanks to Stephen Dixon at POP in Santa Monica and Paul Ruest at Argot Studios in New York for engineering help with today’s broadcast.

The e-mail address for this broadcast and where you can find the playlist of the music featured hereon, it’s all at harryshearer.com.

And I’ll see you at Twitter, if you like. Join the more than 85,000 …suckers!… who follow this program @theharryshearer.

Le Show comes to you from Century of Progress Productions and comes to you over the Change is Hard radio network.

On the other hand, Le Show is leaving KCRW Radio.  Not of my volition.

On Monday, April 15, I had an Income Tax Day to remember.  I was invited to hear a “proposal” from the general manager of KCRW.  The proposal was, in fact, a notice of a fait accompli.  Le Show was being cancelled from the airwaves–something I had suspected might be the nature of the proposal, but the surprise was the timing: “effective immediately”.  Thus does public radio, in one more small way, come to resemble ever more closely commercial radio’s way of doing business.

In fairness, KCRW gave me a weekly hour for nearly 30 years, and our deal was simple: they got my program for free, and they left me completely alone.  That deal is over.

Le Show will continue to air on the many wonderful affiliated radio stations around the country, and on our outlets overseas.  It will continue as a podcast, as well.  And I’m in the process of seeking an alternative broadcast outlet in Los Angeles.

I’m not saying I haven’t thought about ending the series.  I think about it every week as I contemplate another Saturday with no idea yet of what I’ll do on Sunday.  But, nearly halfway through the 30th year of the broadcast, I know there’s much more to say, and, sadly, much more information that isn’t being shared with the audience anywhere else on the dial.

Le Show was not the only victim of management’s ax last weekend.  But Tom Schnabel, the architect of the station’s longtime “eclectic” music format, was allowed to say goodbye on air.  I was not, because, management said, I have “a national platform”.  I guess this is it.

This, or my nightly show on….Sorry, I went dreamy for a minute there.

If any of this pisses you off, aside from my staying married to Judith, you might want to let KCRW know.  If you couldn’t care less, congratulations on your equanimity.

This may, for a while, affect the Le Show archives.  So listen while you can.

Thanks for listening to Le Show.

-Harry

LE SHOW, JANUARY 27, 2013

http://harryshearer.com/le-shows/january-27-2013/

http://harryshearer.com/wp-content/uploads/2013/01/ls130127le_Show_-_January_27.mp3

Listen to the podcast here.

Here it is! From deep inside your radio.

HARRY SHEARER:  This is Le Show, and we’re coming up on the tenth anniversary of the beginning of the invasion of Iraq, of shock and awe. I know, kids, look it up. And so it seemed to me that before we can look forward to what may or may not happen with regard to Iran this year, it might be time to spend a few minutes looking backward. And my guest today is Greg Thielmann, who is a senior fellow at the Arms Control Institute in Washington, D.C., and during the period in question leading up to the Iraq war was a member of the Bureau of Intelligence and Research, which is an intelligence agency inside the State Department. Do I have it right? Welcome, Greg, and do I have it right so far?

GREG THIELMANN:  That’s pretty good. The Arms Control Association –

HARRY SHEARER:  Ah.

GREG THIELMANN:  – in Washington, D.C. is my current employer, and I was indeed in 2002, until the fall of 2002 I was in the State Department’s intelligence bureau. I retired then at the beginning of October, and exactly 10 years ago I was listening to, with some incredulity, at what the Bush administration was saying about the Iraq WMD threat.

HARRY SHEARER:  Well, your name became known to me, and I think most people who were paying attention to the English and Australian news media at the time, along with two other people, Dr. Brian Jones in Britain and Andrew Wilkie in Australia, as three people inside the intelligence world who were saying publicly that what we were being told the intelligence said, the intelligence wasn’t saying. Did you see Colin Powell on his recent appearance on Meet the Press?

GREG THIELMANN:  I did not see the interview, no.

HARRY SHEARER:  All right. Let me just review something he said. This is on Meet the Press, January 13th of this year.

COLIN POWELL:  We were basing all of our actions on a National Intelligence Estimate that the Congress asked for. It was provided to the Congress by the CIA. And all of us in the Bush administration at that time accepted the judgment of our 16 intelligence communities. I presented it to the UN. We subsequently found out that a lot of that information was not accurate, and that is very unfortunate, but that’s the way it unfolded… The president had more than sufficient basis to believe that there were weapons of mass destruction that were a danger to the world, and the possibility of those weapons going to terrorists, and so he undertook military action. I think that was the correct thing to do and it was well supported by the intelligence.

HARRY SHEARER:  Is that an accurate statement?

GREG THIELMANN:  I’m very sorry to hear him put it that way, because I had a lot of respect for Colin Powell as Secretary of State. I felt honored working for him as Secretary of State.

One of the things that I particularly dislike about what he just said was, in the fall of 2002 there was a National Intelligence Estimate on Iraqi WMD. On the most important assessment in that estimate concerning the Iraqi nuclear weapons program – and there was a nuclear weapons program prior to the first Gulf war, but 15 agencies in that estimate said that Iraq had reconstituted the nuclear program, which had been dormant and had ended after the first Gulf war. One agency, Colin Powell’s own agency, the intelligence bureau of the State Department, said that the evidence did not support that conclusion. That is, that the evidence showed that Iraq had not reconstituted its nuclear weapons program.

And of all the various assessments about chemical weapons, about biological weapons, about missiles, that was the most critical assessment. And the State Department not only dissented, as the State Department would sometimes do, with an asterisk and a one-liner, it was basically a dissent with the entire judgment requiring a lot of words and was on the front page of the executive summary of the estimate. It was on the one-pager that went to the president of the United States. And that should raise alarm bells, not because the State Department intelligence bureau is always right, although I would argue that INR, which is its acronym, INR was more often right than not when we dissented from the majority, but that Colin Powell in particular, who knew or should have known from our memoranda and from his conversations with the head of our bureau the reasons, the detailed reasons why the evidence was not sound behind that conclusion.

It’s very disappointing that he would put it this way, and I have a little bit of sympathy for his political position at the time. Colin Powell had been arguing that we had to take this to the United Nations if we were going to have international support for something as risky and dangerous as invading Iraq, and the rest of the Bush administration was very reluctant to do that but Powell prevailed. And then we got UN support for returning the UN inspectors to Iraq. They had just hit the ground when one week later the Bush administration said that these feckless inspectors are not going to be able to find anything. In fact, the inspectors found out a great deal of information when they were on the ground. They found out that the claim that there was a mobile biological weapons lab was untrue, they found out that what the president had said, almost exactly 10 years ago, about the Iraqis obtaining uranium from Africa, that that was also untrue based on a forged document, they succeeded in getting Saddam Hussein to destroy the short-range ballistic missiles that had gone over the range that they were permitted, and on the nuclear front the inspectors found out that the aluminum tubes that the intelligence community had said were being used to spin and enrich uranium so that it could be made into weapons-grade material, these aluminum tubes were, as we in the intelligence bureau assessed at the time, were being used for artillery rockets, having nothing at all to do with nuclear weapons.

Why is the nuclear part of it so important? Because in the fall of 2002 Condoleezza Rice, the National Security Advisor; Dick Cheney, the vice president of the United States; and various others of the administration were conjuring up images of mushroom clouds. George Bush was saying that we cannot wait five years until the first indication of a nuclear capability is a mushroom cloud. So they were very much using this kind of scare tactic to win support for an invasion of Iraq when the evidence, particularly on the nuclear side of the question, was very weak, and it was very frustrating for me as a recently retired intelligence analyst who had seen all the information, who knew that there were differences of opinion on this, to not only hear the administration try to sell this line but for it to be received with such credulity by the Congress and by much of the press, even though members of the Congress, some members of the Congress on the intelligence committees, had access to the details. In fact, very few people read the detailed intelligence assessment that got into some of these details and got into some discussion of what the evidence was.

HARRY SHEARER:  You read the intelligence assessment. You said a moment ago, I think, that the front page contained a reference to the State Department bureau’s dissent. Was that – how would you characterize their reference to your bureau’s dissent?

GREG THIELMANN:  The way it appears in the estimate is that the Assistant Secretary of State for Intelligence disagrees with the judgment rendered. So it’s not, as Condoleezza Rice said on Meet the Press in the fall of 2002 when – or perhaps it was 2003 – when she was read a statement that I had made about the administration ignoring the dissent on this issue, she said, “I cannot be responsible for what everyone in the bowels of the bureaucracy –

HARRY SHEARER:  (laughs)

GREG THIELMANN:  – thought about this issue.” Well, this wasn’t the bowels of the bureaucracy (laughs), this was the head of one of the 16 intelligence bureaus, and in fact one of the very few bureaus who renders analytical judgments on all sources of intelligence. I mean, the Defense Intelligence Agency, the Central Intelligence Agency and the Bureau of Intelligence and Research are the three principal agencies that look at all the intelligence and render these kind of judgments. Condoleezza Rice I think said at the time that she didn’t even read the INR dissent from the majority opinion, which is rather odd as the president’s National Security Advisor as the nation is getting ready to go to war.

HARRY SHEARER:  Even odder if you consider that a couple years later she was going to be Secretary of State.

GREG THIELMANN:  Indeed.

HARRY SHEARER:  What can one, from the outside – how can one from the outside assess the Secretary of State’s relationship to this intelligence agency? Does the head of INR meet with the Secretary of State on a regular basis? Does he get briefed on a regular basis by the head of INR, or does INR just work away in the bowels of the bureaucracy and hope that their stuff gets read?

GREG THIELMANN:  There are two ways that the product of the State Department’s intelligence bureau reaches the Secretary of State. The head of the bureau does meet on a daily basis with either the Secretary or the Deputy Secretary of State, and other senior officials in the building meet on a daily basis with the intelligence bureau. The reason for that is not so much that there is such a keen respect for the brilliant minds in the bureau, although there certainly are brilliant minds in the bureau, but rather much of the intelligence that all of the intelligence agencies of the U.S. government collect is, in the vernacular, top-secret code word. And there are special handling instructions for that intelligence. And when I was in the State Department the only bureau that could carry that intelligence and store it overnight was the intelligence bureau. So it was a very necessary connection between the senior officials and the intelligence bureau to make sure that on a daily basis they got the intelligence, not just the headlines and the raw data but some analytical content. Those of us in the bureau who were familiar with the subjects would both explain what the raw intelligence coming in said and also what it meant.

And Colin Powell was in general receptive, interested in the intelligence product. He actually even gave instructions to the State Department that he would like it to be organized a little bit more like a military command, so in the military you have a G2 function, the intelligence function, and every commander has a G2 officer to turn to, and he wanted the intelligence bureau of the State Department to be very much on this model. Now I had personal problems with that when under Powell’s instructions I would appear each day to Undersecretary John Bolton –

HARRY SHEARER:  (laughs)

GREG THIELMANN:  – who was Undersecretary for International Security Affairs.

HARRY SHEARER:  I can’t imagine, I can’t imagine what those problems might have been. (laughing)

GREG THIELMANN:  Well, on the fourth day, Bolton’s staffer informed me that the undersecretary had decided that he wanted to keep these briefings inside the family. To which I responded something like, “Well I thought I was in the family.” (laughs) “Moreover, the Secretary of State has asked that we do this.” But that was the end of our daily personal contact. It was not the end of the intelligence flow. I mean, every day John Bolton received a very thick collection of intelligence reports, some of them direct from the agencies, some of them with some value added by the State Department intelligence bureau. There was no cutoff to the intelligence, but let’s say there was a certain disinterest in certain quarters in what the State Department was trying to share with the senior officials.

HARRY SHEARER:  This, I guess, calls upon you to speculate a hair, but why do you think – and correct me if I’m wrong – the INR was correct about the aluminum tubes in advance of the inspectors, I think you just said that, the INR – I don’t recall whether they had weighed in correctly on the yellowcake issue of Saddam trying to buy uranium, supposedly trying to buy uranium –

GREG THIELMANN:  INR had sent a memorandum in the winter of 2002 to the Secretary of State basically warning him off that piece of intelligence. We suspected a forgery or something that didn’t ring right and we expressed great skepticism about it. And frankly, as the supervisor of the analyst who was rendering that judgment, I really almost forgot about the issue because I thought everyone in the intelligence community accepted that as a not very credible report. And so I was personally shocked months later, after I had retired, and the president included a line in his State of the Union address referring to the uranium from Africa. And my first reaction was, well there must be some new intelligence received since I left. And then I slowly realized that he was talking about the same discredited intelligence that we had told Secretary Powell about that I thought had been already thoroughly discounted at the time.

But I’m afraid that there were many in the Bush administration who wanted to go to war and saw intelligence not as a way to objectively understand what was happening, but to cherry pick the intelligence, and any time there was something, whether it was of high credibility or not, if it was something that would make the case that Saddam had to be stopped through military action, that would be used, and the ears were plugged if we explained about something that seemed not to be very credible like the Curveball source that the West Germans had used on the biological weapons laboratories.

HARRY SHEARER:  So you, I guess, have partly answered my question. The question was going to be, why among all the intelligence agencies did the INR not get the memo?

GREG THIELMANN:  (laughs) Well, I sometimes joke to my friends that we would rather be feckless and ignored than wrong and unobjective. And it was a very, a very bright line in the tradition of INR written between the policy bureaus of the State Department, the Americans, the foreign service officers and civil servants who would try to carry out the policies of the president of the United States in various regions of the world and the analysts in the intelligence bureau whose job was to try to do their best to objectively describe what was happening in the world and how that impacted U.S. interests. And there were certainly a lot of times when the policy bureaus of the State Department disagreed strenuously with our analysis and they didn’t want to hear it and they would become less interested in hearing any more of it. But that was okay. I mean, obviously intelligence analysts want their products read, but we tried very hard when I was at the State Department intelligence bureau not to let policy reactions affect analytical content.

And I would even argue that we were more successful in doing that than the Central Intelligence Agency, who I think it’s pretty clear now, George Tenet very much valued his daily meetings with President Bush and knew that telling the president, reminding the president repeatedly that he was not really accurately conveying the intelligence as the CIA understood it, was not something that Tenet seemed particularly interested in doing.

HARRY SHEARER:  Okay, let’s widen the scope a little bit, because we get into the nutty coincidence area here, and then shortly we’ll move to the future. But at around the same time, Dr. Brian Jones, who was head of the WMD analysis branch of the Defence Intelligence services in Great Britain, says that the intelligence advice received by the government that Iraq possessed significant stocks of WMD was wrong; “real intelligence analysts did their best to ensure a balanced assessment reflecting the uncertainty about this, to ensure that that emerged to the public, but they were overruled at the most senior level by those without the appropriate experience and expertise.” That’s a quote from Dr. Brian Jones, who passed away last year, about the process of preparing the so-called “dodgy dossier” that was the British government’s chief public defense for the war in September of 2002.

And then Andrew Wilkie, who was in the Australian Office of National Assessments and is now a member of Parliament, said, quote – and he said this in May of 2003:  “Some in the Australian intelligence community had latched onto the dodgy American intelligence, resulting in partial contamination of assessments with an overestimation of Iraq’s WMD capability. But Australian intelligence agencies made it clear to the government” – the Australian government – “all along that Iraq – did – not – have a massive WMD program.” So, this seems to be almost an echoing in America’s two major English-speaking allies of the same thing that was going on in Washington. Is it just a nutty coincidence?

GREG THIELMANN:  It’s certainly more than a coincidence. It’s a fascinating subject, because the U.S., the British and the Australians have a very deep and intimate intelligence-sharing relationship. The intelligence seen by British analysts or Australian analysts is virtually identical to that seen by American analysts. We obviously have a much larger intelligence establishment and can, particularly on a technical level, produce a lot more into the system.

But I know Wilkie personally, have great respect for him, have dealt obviously with the British and Australian counterparts, and there was a very similar thing happening in all three countries. There was some bad intelligence tradecraft, I would certainly be free to admit, on the U.S. side. Much of that has been I think successfully addressed after the Iraq WMD fiasco, but more troubling than the bad tradecraft was the way that the political leadership, in all three countries really, spun the information that they had. The already flawed information made it far worse in terms of jumping to conclusions or exaggerating what the intelligence actually said, and I very much see a parallel story going on in the three countries at the time.

And one of the wonderful things that historians have to try to sort out this whole episode is the results of British contacts with the Americans in the summer of 2002 when very senior British agency heads, intelligence officials, Foreign and Defence Ministry officials, came to the United States, met with their counterparts, and then prepared a report for the British prime minister on what was going on in the United States with respect to Iraq. It’s now called the Downing Street Memo, and it is uncanny in its accuracy and the vividness of the picture that it portrays, and it has a very descriptive sentence in it about the American administration is fixing the intelligence around the policy. This is a devastating indictment by one of our closest friends about what was actually going on here, and the worst part is of course that the British were later complicit in that fixing, in a sense, but that only came out of course after the invasion. And even when it came out a couple of years later, it took one week after the story broke in Britain for it even to get into the American press, and it was treated in the American press as some sort of a British domestic issue when in fact it was one of the most damning pieces of evidence against what was going on inside the U.S. administration about the use of intelligence and the determination to attack Iraq no matter what the intelligence said.

HARRY SHEARER:  One more question about the workings inside the State Department. Col. Lawrence Wilkerson, who was the I guess chief aide to Colin Powell, said publicly within a couple years after the event that he “participated in a hoax” – those were his words – in the preparation of Colin Powell’s remarks before the United Nations, the mobile bio weapons van and other wonderful demonstrations. What was your assessment of Col. Wilkerson at the time, and why do you think that Secretary Powell continues to act as if Col. Wilkerson never said that?

GREG THIELMANN:  (laughs) Well, it’s kind of a damning comment. I have respect for Col. Wilkerson. I didn’t have a lot of contact with him inside the State Department. I’ve actually seen him up close and personal more since that time.

One of the oddest things at the time was that Colin Powell, Col. Wilkerson disappeared for like four days into the CIA and relied exclusively at that point on CIA analysts for packaging this intelligence, and they’re the ones who really prepared the remarks that Powell would give.

There are two things to say about this, and both of them really come from one of the little-known things that happened at the time, and that is that Powell provided drafts of his remarks to the analysts who had been working for me. This was several months after I had retired, but those analysts wrote back to him some warnings about what to use, where things were not faithfully rendered on the basis of the intelligence. And anyone in the public can now read this. It was part of the unclassified Senate Select Committee on Intelligence report on the whole Iraq WMD fiasco, and it’s an annex to one of these reports. You can actually see the memoranda written by these mid-level INR intelligence analysts warning the Secretary of State not to say this, not to say that, not to put it this way because that would be misleading, and so to Powell’s credit he didn’t just seclude himself with the CIA, he actually did get a text back for comment. One only wishes that he would have taken the head of his bureau along for this experience and that could have saved him a lot of grief.

The speech that he gave in February of 2003 was a lot better than the speech that he was given, but it was certainly not purged of the exaggerations and the unfortunate characterizations of the intelligence. And there’s no way but to hold Secretary Powell partly guilty for doing that, even though one has to be very sympathetic about the position that he was put in.

It’s easy for me to say, but I dearly wish that Powell would have gone to the president at that point and said that “You are asking me to do something that I cannot in good conscience do. I will either have to resign or you will have to change the way we put this.” That is not really what I think Colin Powell understood his job to be. His job was to be to argue forcefully behind closed doors for what he thought was right and then if the president makes a decision he saluted smartly and carried out his orders. That is pretty much what he did, and I think it’s kind of a model now of what not to do. There is a time when you have to be able to say, “I cannot in good conscience do this. I’ve got to go.”

HARRY SHEARER:  You came out publicly and said some of what you’ve been saying on this program, at the time. Did you experience – but you’d already retired I believe by that point, although maybe you said something publicly before you retired, I’m not sure – but did you experience any personal splashback from that?

GREG THIELMANN:  To my relief, I did not. Frankly, there was concern at the time – I mean the oaths one takes to protect secrets are pretty explicit, and the consequences of betraying those oaths are also explicit. The way I looked at it in the fall of 2002 and during the next year was that I did not release top-secret classified information other than commenting on the top-secret information that had been very highly classified until the president of the United States started talking about it publicly and mischaracterizing it. And I publicly disagreed with that version of the facts. Now I think a lawyer could probably argue that it’s not up to me to decide when and when I cannot publicly engage in discussion; only the president of the United States can decide to declassify certain sensitive information.

So I guess there was some level of risk there, but frankly the thing that worried me more than anything else was that in making public comments about this I might lose the respect of the people with whom I worked and had spent a 25-year career in the foreign service with, that they would think that I had not characterized things accurately or I was somehow betraying what my own job had been, and fortunately I heard some people who were not happy but for the most part a lot of people seemed to think that I had said, as a retired former foreign service officer, what many of them were thinking at the time but did not say because they were constrained by their official duties.

HARRY SHEARER:  More with Greg Thielmann here on Le Show coming up.

* * * * *

HARRY SHEARER:  This is Le Show. We’re talking with Greg Thielmann of the Arms Control Association. Let’s turn now to the present and possibly the future. Are we seeing today an echo, in regards to the nuclear possibilities of Iran, an echo of what we saw with regard to the nuclear possibilities of Iraq a decade ago?

GREG THIELMANN:  I like the word you used, “echo.” It does remind me of that saying that history doesn’t repeat itself but it rhymes, and whether it’s an echo or whether it’s a rhyme, I’m hearing a lot of that now in discussions about Iran and its future weapons of mass destruction capabilities. There are a lot of similarities, but I want to mention some of the critical differences, I think.

And one of the critical differences is that the intelligence community itself is I think performing in a much more professional manner than it did in 2002, and a lot of it is because of some soul searching by the leadership of the intelligence community, by congressional oversight and investigation of what went wrong, and as a result of all that there were a lot of reforms undertaken. There were reforms in terms of strengthening the intelligence committees of the House and the Senate. There were reforms in terms of methodology used by analysts, more specific assignment of analysts to do red teaming analysis, to have as their jobs either out-of-the-box contrary thinking to the majority opinion or intensive thinking of how things look from the antagonist’s perspective.

And one of the shocking things about Iraq was that the idea that Iraq could be thinking about bluffing both his own people, in terms of how advanced Iraqi WMD capabilities were, or convincing potential enemies, like Iran or the United States, that he was more capable than he actually was, that he was actually too clever by half. He did convince the U.S. and many people in the U.S. that he had more than he actually had, but that’s not necessarily an excuse for the intelligence community. The intelligence community should have been on to his potential motivation of exaggerating his capabilities. He was at the same time, of course, trying to convince most of the world that he was following the strictures that had been placed on him by the United Nations.

So that was one thing that I would note happily that the intelligence community has gotten better at its trade. And you can see that in subsequent National Intelligence Estimates. They are now more transparent. You can understand more about some human being or some agent’s account of things, where it came from, what the circumstances were, that the people reading the estimates have a lot more information about where the information is coming from than previously. So that’s one thing that has changed.

The other thing, frankly, that has changed is, in 2002 – (laughs) and you clearly had a president who wanted a chance to go to war and get back at Saddam Hussein – in this case I think few people would say that President Obama is eager to engage the Iranians militarily. This is clearly a president who is very reluctant to use massive military force against Iran. So those are two critical changes in the situation that make things different.

The unfortunate similarity that keeps haunting me is the way members of Congress talk about Iran, the way the press often characterizes Iran, is so much like what happened with Iraq. Most people would get the impression that Iran is moving out smartly to develop and build nuclear weapons.

It is still the official position of the U.S. intelligence community that Iran halted its nuclear weapons program in 2003, that the Iranian leaders have not decided to actually go that final step to build a nuclear weapon and deploy a nuclear weapon. So that’s the official position of the intelligence community today, and this mostly came out in the 2007 National Intelligence Estimate, the bottom line of which has been repeated in yearly fashion since that time, so that discrepancy between the way the issue is handled politically, by the political class, and what we think that we know from what the intelligence shows is very important.

You also have other important differences, of course. You have a clerical government in Iran, which I actually find quite odious in most ways, but that government does say that nuclear weapons are immoral, that they are un-Islamic, that the country will not develop nuclear weapons, that all nuclear weapons should be destroyed. This is not what Saddam Hussein said about nuclear weapons. It’s certainly not what North Korea says about nuclear weapons, or Pakistan or other states of proliferation concern. So whether it’s true or not, this is another thing that makes it a little bit easier for us to engage the Iranians, because as Secretary Clinton once said, if the Iranian fatwa or religious declaration says that nuclear weapons are immoral and that Iran will not develop them, then let’s operationalize that. Let’s make it very clear through the International Atomic Agency inspections that Iran is living up to that religious mandate.

So there are a lot of things that we can play with now that we didn’t have earlier.

HARRY SHEARER:  One other difference, perhaps, that I want to get your view on, we seem to be told a lot that U.S. intelligence capabilities in Iran, specifically human intelligence capabilities in Iran, are pretty thin, which compares with – I mean, we had penetrated Iraq following the first Gulf war and certainly had reason to know more about what was going on in Iraq than maybe we have capability to know about what’s going on in Iran. Is that understanding accurate?

GREG THIELMANN:  I have to be careful about my answer here for two reasons. Some of what I know I shouldn’t talk about and there’s much that I don’t know, in order to give a good answer to your question, but I’ll say a couple of things.

One is, those of us on the inside often said at the time of the Iraq WMD affair that we thought the U.S. had very poor human intelligence from inside the country, and while I think there’s a lot of truth in that assessment even today, I was shocked to realize after I had retired and after some revelations that the clandestine services of the United States had actually penetrated Iraq with relatives of family members who were working on Iraq’s WMD programs prior to the first Gulf war, and there were almost three dozen contacts of this nature, people going back to Iraq, talking to their relatives, finding out a little bit about what they were doing, and all of the reports came back and reported that they weren’t engaged any longer in these programs.

The only problem was, the CIA didn’t find that very interesting, and they didn’t even share it with all the other intelligence agencies, this incredible intelligence coup and penetration into Iraq. So I would say now that our human intelligence on Iraq was actually better than I had understood at the time.

As for our success today, I won’t talk about what is or may be going on inside Iran, I would only say that there have been more than one public stories about Iranian defectors or high-level scientists or generals who knew something about what Iran was doing who left Iran, and obviously that kind of thing gives us a window, although a partial one, it at least gives us a window into what was going on inside, so you can at least say that we have scored some coups in that way. And the other thing that one has to note is that in discovering the Fordo deep underground mountain facility that the Iranians seem to want to keep secret, that showed that Iran does have difficulty keeping the big secrets from the United States. So I have some reasonable confidence that we’re not going to have a Pearl Harbor type situation.

HARRY SHEARER:  And you just mentioned a word that sparks in my thinking a similarity to the Iraq situation, the word being “defectors.” Curveball was a defector. Ahmed Chalabi proffered a number of defectors in the pre-Iraq-war period whose accounts later were found to be wanting in accuracy, and there are similar groups active in and outside of Iran today who are, although we are not as aware of it as we were of the Chalabi operation, apparently offering defectors with who knows what level of accuracy about the information that they’re spreading. Is that really what’s going on now? Is it at a Chalabi level, both numbers and accuracy wise?

GREG THIELMANN:  I think there are some very significant differences on that front as well between the two situations, Iraq and then Iran. In the case of Iraq, you had the Iraqi National Congress which produced – this was Chalabi’s organization – which produced a lot of very unreliable information. I mean, they tailored their stories very much to play to what the Bush administration wanted to hear, to a number of congressmen who were very gullible about whatever they told them, and they basically told them whatever they needed to say to convince them that Saddam Hussein was moving forward on WMD programs.

There’s really, the closest equivalent to the Iraqi National Congress at the time is a strange group called the MEK that was, you know, a socialist group that actually went in league with the Iraqis to fight against the Iranians, and they’re ironically at least the apparent source of information about the large facility in Natanz where the Iranians first started enriching uranium, and they’ve been the source of some other tips. Whether they were the original source or just the flow-through from other countries in the region is another issue, but much of the information they’ve provided is very unreliable.

You do have a group of Iranian-Americans, the National Iranian-American Council, NIAC, that I find to be a very professional and responsible organization in terms of how it characterizes what’s going on in Iran. So I think we’re better off, in terms of Americans who have an ethnic tie to Iran and some knowledge of the political context of what’s going on, we’re much better off than we were in the case of Iraq on that front too. So for those who want to work at it, I think there are a lot more sources and more reliable information on what’s actually happening in Iran than there seemed to be at the time on Iraq.

HARRY SHEARER:  On the other hand, should it have set off alarm bells when MEK succeeded in getting, in paying large sums to members in both political parties to speak on their behalf and to lobby for the removal of the State Department’s designation of them as a terrorist organization which was successful last year?

GREG THIELMANN:  It certainly set off alarm bells for me. I’m still shocked at seeing the list of some of the Americans who received money from the MEK for making its case. And it’s very odd to have so many politicians lined up in support of a terrorist organization that at least some years ago was involved in activities that resulted in the death of American citizens. It’s very odd.

And I have some sympathy for Secretary Clinton’s ultimate removal of the group from the terrorist list partly because, you know, there’s a very delicate negotiation going on with the Iraqis. These people have been kept in a camp in Iran for years after the end of the war against Iraq, and there was a lot of concern that they would be massacred by the Iraqi government and, you know, there was an humanitarian impulse here and there were clearly some changes in the organization’s orientation. There was at least a lawyer’s case to make that they were no longer a terrorist organization.

But the enthusiasm with which they were represented and the advocacy for their removal from the list I thought was very unfortunate because there’s hardly anything that the U.S could have done that would more convince the Iranian government that the U.S. government wants regime change in Tehran and wants to destroy the regime than doing anything favorable to the MEK. And I don’t – that’s just not the Iranian regime, by the way, it’s virtually the entire population of Iran hates the MEK, so we did not do ourselves any favors with the Iranian people with our handling of this matter.

HARRY SHEARER:  I’ve taken more of your time than I promised, and it’s been incredibly informative. Greg Thielmann of the Arms Control Association, thank you very much for joining us today on Le Show.

GREG THIELMANN:  You’re welcome, Harry.

HARRY SHEARER:  Well, ladies and gentlemen, that’s going to conclude this week’s edition of Le Show. The program returns next week at the same time over these same stations, over NPR Worldwide throughout Europe, the USEN 440 cable system in Japan, around the world through the facilities of the American Forces Network, up and down the East Coast of North America – think of it – at WBCQ The Planet 7.490 MHz shortwave – think of that!on the Mighty 104 in Berlin, around the world via the Internet – it’s already been thought of – at two different locations, live and archived whenever you want it, harryshearer.com and kcrw.com. Available for your smartphone – or your dumbphone –  through stitcher.com, and available as a free podcast or schmodcast at kcrw.com. And it would be just like Colin Powell were coming clean – heh! – if you’d agree to join with us then, or me then! There’s only one of me. Would you? All righty, thank you very much, uh huh.

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OFFSHORING GOES ONSHORE

LE SHOW, DECEMBER 2, 2012

Listen to the podcast here.

From deep inside your radio.

HARRY SHEARER: This is Le Show, and we’re not in tax season yet. We’re in gift season. But taxes are on the minds of at least some folks in London, where I’m recording this broadcast. There has been a great deal of attention in the newspapers and the news media in the last couple of weeks to the tax affairs of multinational corporations such as Google, Amazon and Starbucks. A parliamentary committee held hearings the last couple of weeks and there has been a great fuss made about whether these companies are in fact paying what, a term of art we would use as “their fair share” of taxes. And this put me in mind of a book on the subject of multinationals and taxation that I read a couple of years ago, and it is still incredibly relevant to what’s going on now. And so my guest today is the author of that book, NICHOLAS SHAXSON. The book is called Treasure Islands. It’s available both in the United States and in the U.K. And Nicholas is joining us from his home city of Zurich, Switzerland. Welcome.

NICHOLAS SHAXSON: Hello, thank you.

HARRY SHEARER: Thank you. What made you take on this subject and write this book?

NICHOLAS SHAXSON: Well, really it was a couple of things. There were kind of like moments of illumination for me. Several years ago I was confronted with evidence that the offshore system of tax havens was so much bigger than I or perhaps nearly everybody imagined. I think in the popular imagination it’s always been a kind of, you know, these tax havens have been a sort of exotic sideshow to the global economy; they’ve been places where a few kind of, you know, mafiosi and celebrity tax dodgers and a few bankers go and stash their ill-gotten gains. But I began to see that this system was actually much, much bigger and much more central to the global economy than I’d ever suspected.

One of those moments of illumination came when I was talking to a U.S. lawyer and he was explaining to me that the United States itself had over the last few decades been turning itself into a tax haven. In other words, providing secrecy facilities to foreigners to attract hot money from around the world and essentially trying to kind of copy Switzerland and copy other tax havens to bring all this money into Wall Street. And not only that, but he was saying that the U.S. had had this kind of under the radar as a central pillar in its strategy to finance its external deficits.

And that conversation told me two things: One, that the geography of tax havens, that tax havens weren’t where I thought they were, not just the Cayman Islands and places like that, but the United States itself, and I subsequently found out my own country, the United Kingdom, arguably even more important, the most central player in the system.

So there’s the geography of tax havens, but also the size of it. I mean, this is absolutely huge stuff we’re talking about. The offshore economy has been growing much faster than the supposedly onshore economy for decades, and as a result it’s grown up to something of absolutely enormous proportions.

HARRY SHEARER: So when we hear tax havens, is there any justification for – these are, let me, let’s get definitional for a minute. These are jurisdictions, whether they’re Jersey off the coast of Britain, or Cayman Islands, notoriously, where tax rates are quite low and corporations may appear to locate some or all of their most important business affairs. Is there any – in the literature of the folks who defend tax havens, is there any rationale for their existence, beyond hiding from taxation in a home country?

NICHOLAS SHAXSON: Well, first of all, I want to – this definitional aspect is actually very important indeed. Tax havens are – you know, I tried in Treasure Islands to drill down into what exactly is it these places offer. And, you know, tax, the name is a little bit of a misnomer. Tax is certainly an important aspect of what they offer, but there’s a lot more to it as well. I mean, secrecy is another part of it. And there are various other aspects such as financial regulation, escape from criminal laws – all these different aspects sort of come together in a package in these places, in these – you know, they tend to be large, important financial centers.

And drilling down to what, you know, what this package is all about, I eventually got down to the bedrock of two words. And one is this word “escape.” So, you take your money elsewhere and you escape from domestic rules at home, whether those rules be tax laws or whether they be financial regulations or whether they be criminal laws or whatever. So there’s this issue of escape from the rules of society that bind most people, and usually it’s the wealthiest elites in a society that can escape.

And the other word is “elsewhere.” So you’re taking your money to another jurisdiction. And with that taking your money elsewhere, you know, effectively the lines of democratic accountability are cut.

So the laws of one jurisdiction of the British Virgin Islands or the Cayman Islands, for example, are not designed directly for the benefits of the citizens of those small jurisdictions. They are designed to target, you know, the business operations and citizens of the United States, of Latin America, of other parts of the world. And these laws are made in consultations, in kind of small, private consultations with insiders, and they’re not made in consultation with the U.S. public or the citizens of other, you know, of Latin American countries. And so there’s absolutely no kind of democratic accountability for how these laws are made. So that kind of almost from a definitional point of view, you have a problem there. This is kind of an anti-democratic system right from the outset.

Now you asked a second question about, you know, what are the defenses that tax havens make for themselves. Well, there are a series of defenses that are put forward that I believe, you know, all of them kind of fall apart once you unpick them.

One of the defenses is that, I mean a common one is of course is that taxes are bad and anything that helps you escape taxes is good. And, you know, you can have a whole debate about the relative benefits of taxes and how high or low they should be, but I – and I, you know, I deliberately try not to sort of say that taxes should be higher or lower or whatever, I just think that, you know, democracies need to decide what level the taxes are at. But that’s kind of a debate one can have, so, from a defense of tax haven point of view.

Another very common defense is that they make the international financial system more efficient. In other words, they help capital flow around the world more smoothly. They remove obstacles from the path of international financial flows. And I’m very deliberately using the word “financial.” I’m not talking about trade here, necessarily. Of course there’s a relationship, but I’m talking about capital flows, financial flows. And that sounds great. You know, efficiency, who could argue against efficiency? But, again, if you unpick that, you work out that, you know, what are these obstacles that are put in the way of international financial flows? And you know these obstacles are things like tax, are things like financial regulation, things like criminal laws. And these places kind of strip these things out, you know, and in a sense that does make it more efficient in terms of the actual free flow of movement, but that doesn’t necessarily make the whole system more efficient, and that’s kind of one of my big beefs with tax havens.

HARRY SHEARER: That language sort of dates from an earlier era where countries would oppose capital flight restrictions to strengthen their national currencies, doesn’t it?

NICHOLAS SHAXSON: Well, yes. I mean, there’s a whole chapter in Treasure Islands looking at the period after the Second World War, the kind of quarter century that followed the Second World War roughly. That was a period when there was a great, kind of, you know, under the Bretton Woods cooperative international arrangements, there was a kind of agreement to heavily restrict the cross-water flow of capital, and this was kind of as a result of the lessons learned from the Great Depression when there had previously been, you know, financial deregulation and, you know, wild cross-water capital flows, and a realization that these could actually be harmful for economies.

And so after the second World War, it was a kind of unique period in history, they put into place these very tight controls on the financial sector domestically in the United States on Wall Street and so on, and to a lesser extent in the U.K., but also these kind of controls on cross-border flows of capital. And that period of what’s known as financial repression was actually the greatest period of growth world-wide in history. And this was broad-based economic growth. This was not the kind of growth we’re seeing, we’ve been seeing in the last few decades, where a lot of people at the top are getting hugely wealthier and most of the middle classes are kind of stagnating. This was really broad-based growth with, you know – many people call it the Golden Age of Capitalism now, and that was a period of tightly restricted financial flows. And the period –

HARRY SHEARER: So we wouldn’t want, we wouldn’t want that.

NICHOLAS SHAXSON: Well – (laughs) The thing is, I mean something like that, it’s kind of politically impossible to imagine these days. I mean, you’ve had huge advances in technology. It’s – you know, how would you return to such an age? And people also say that, you know, correlation isn’t causation. You can’t prove that those restrictions are what caused that high growth. But you can say that it is quite possible to have very high growth amid very tight restrictions on the financial sector and cross-border flows.

And you are seeing now the IMF and other bodies that, you know, previously it would have been complete anathema to even mention a word such as “capital controls” controlling the flow of finance across borders. They’re beginning to timidly mention it. And there has been a real sort of reassessment in light of all that’s happened in the financial crisis of, you know, these kind of tools and whether they could be useful again.

HARRY SHEARER: Let’s get a sense of perspective. I think in The Guardian newspaper this very day, there was an estimate of the amount of money that’s involved in the offshore economy –

NICHOLAS SHAXSON: Yeah.

HARRY SHEARER: – and it’s in the low trillions? Would that be correct?

NICHOLAS SHAXSON: Well, again, because nobody agrees on what a tax haven is, there’s no definitional agreement, all these estimates are subject to, you know, a lot of leeway. But there was a very influential report put out a few months ago by the Tax Justice Network, a U.K.-based group, estimating that the amount of assets sitting offshore range between 21 and 32 trillion dollars. That’s trillion, not billion.

HARRY SHEARER: Mmhmm.

NICHOLAS SHAXSON: Which, you know, if you look at sort of total estimates of world financial wealth, that’s kind of 10% or 15% of the total. So it’s a very significant chunk. Again, you know, those numbers are subject – you know, what is a tax haven, what is offshore, nobody agrees, so you could make a lot of estimates in different directions. But we’re talking, we’re talking many trillions of dollars, that’s for sure.

HARRY SHEARER: We’re talking real money, as they say.

NICHOLAS SHAXSON: We’re talking real money, yes.

HARRY SHEARER: So when, when did all this start? I mean, when did – who set up the first tax haven, and when was it?

NICHOLAS SHAXSON: Well, the offshore – I mean, in a sense offshore has always been with us. I mean, going back hundreds of years, it’s always been possible to take your money to another country where, you know, your rulers can’t, you know, see at all. You know, it’s invisible to people at home. The first real big tax haven was Switzerland, and in fact even before Switzerland came together to become a country. It was a place that for various reasons has been not only very stable politically – they’ve kind of, because they have a lot of divisions inside Switzerland, they set up these very clever constitutional mechanisms to kind of deal with conflict, and that has created a very stable society. And also its neutrality; it’s historically been a neutral country. And that has meant that when there’s been, you know, times of turbulence, you know, conflict, the First and Second World Wars, you’ve seen huge flows of money into this kind of stable, uh, uh –

HARRY SHEARER: Safe haven.

NICHOLAS SHAXSON: Safe haven, exactly.

HARRY SHEARER: Yeah.

NICHOLAS SHAXSON: And with the latest financial crisis, you’ve seen a lot of that as well. I mean, it’s not conflict-related, but it’s, you know, Greeks worried about their country being ejected from the euro and all that kind of stuff, so you’ve seen this flight to Switzerland. There’s been huge amounts of money coming in, and the Swiss central bank’s been buying up very large foreign exchanges there to kind of stem the, you know, the currency appreciation.

And so that’s kind of – you know, the safe haven aspect of it has been always very important. But that safe haven aspect has also come with the fabled Swiss banking secrecy, which back in 1934 it was kind of enshrined in law. It was already a kind of de facto tax haven. People already knew that Swiss bankers were going to take their secrets to the grave, but in 1934 it was enshrined in law. This was in response to some banking scandal in France that this happened. And since then, Swiss bankers have kind of been very influential in the politics and made sure that secrecy has been a kind of bedrock of Swiss society ever since.

So Switzerland was kind of really the first, the first big one. But then you had – when the period of globalization started in the, you know, kind of from the ’60s and the ’70s especially onwards, you had a kind of second system grow up that I would describe as sort of the Anglo-Saxon system, which fundamentally Britain was the most important part of this. And it was a kind of slightly different. Rather than Swiss bankers who, you know, stayed quiet, secretive, sitting with vast kind of stores of wealth in the Bahnhofstrasse here in Zurich, you had kind of much more high-octane Anglo-Saxon finance running through these tax havens, and there was a lot more kind of getting away from financial regulations, and – but also secrecy’s an important part of it.

And Britain is – as I describe it in Treasure Islands, there’s what I call a spider’s web where essentially you have the City of London right at the center, and around it you have this series of kind of concentric rings of tax havens. So you have tax havens like Jersey in the English Channel. You have tax havens like the Cayman Islands, the British Virgin Islands, Gibraltar, so even today they are so-called British Overseas Territories. And they’re kind of half in and half out of Britain. They’re partly controlled by Britain, their governors are still appointed by the queen, but they have their own independent politics. And outside of that there’s another, you know, whole ring of Commonwealth Countries which are tax havens. And this kind of network acts as a sort of feeder system. So it’s kind of grabbing business and the business of handling money from around the world and feeding it into London, into the City of London.

So that’s kind of, for me, the second big aspect of it. And of course the United States is a sort of third major component of the system. And they’ve grown up – the two latter ones have grown up very much, very substantially, in the last few decades.

HARRY SHEARER: Now, for Americans, the concept of the City of London is a strange one. It is not to be confused with the metropolis that we know as London, England. It’s a very special part of it. And in your book there’s a lot of revealing information about what the City of London actually is and its particular peculiar legal status. So could you go into that a little bit?

NICHOLAS SHAXSON: Yeah, I was really astonished when I researched this bit about the City of London. And this is stuff that very few people in Britain knew about. And, you know, it’s getting a little bit more attention now. But the City of London, in the popular language it means a couple of things. First of all, it just means U.K. financial services, the sort of international finance center. And that’s, quite often, when people just talk about the City, they’re talking about all this money coming into Britain. But more specifically, there is a jurisdiction inside London which is one of the local authorities. It’s geographically right at the center of London. It’s very small. It’s only got about I think at the moment 9,000 people living in this small borough. It’s known as the Square Mile as well, as it’s slightly larger than one square mile. And this is where the Bank of England is and, you know, the headquarters of major banks. And this local authority is known as the City of London Corporation. And it’s a completely unique body in Britain. It is a local authority, but it’s unlike all of the others. It is also officially a lobbying organization for the deregulation of finance. I mean, you will find them saying this, and for keeping finance deregulated in the United Kingdom and internationally. The City of London has a Lord Mayor who is not to be confused with the Mayor of London, currently known as Boris Johnson.

HARRY SHEARER: Boris Johnson.

NICHOLAS SHAXSON: The Mayor of London looks after, you know, 10 million people, and the City of London Corporation, the Lord Mayor, he’s just responsible for a few thousand, for 9,000 or so. And it has its own very strange constitutional position inside U.K. as a local authority. Elsewhere in Britain, you know, people just vote and vote in the, you know, local elections, but in the City of London corporations are able to vote as well. It’s a remarkable fact. And corporations get a vote allocation according to how big they are.

HARRY SHEARER: So this is the reification of Mitt Romney’s famous dictum that corporations are people too.

NICHOLAS SHAXSON: Well (laughing), in a sense, yes. And this has been going on for, you know, hundreds and hundreds of years. I mean, this is an ancient – they call themselves the world’s most ancient constitutional democracy. They say, you know, there’s no record of the corporation actually coming into existence, the City of London Corporation.

And it is also this incredible sort of old boys’ network, and it’s full of these old livery companies, which are old trade associations, but they’re still very much alive, and many of the top people in the professions, in various different professions, are members of these livery companies. So you have, as of a few years ago, the Worshipful Company of Tax Advisers, which (laughs) contains some very powerful people in it. And these livery companies are dedicated to supporting the Lord Mayor of the City of London, whose role is officially to support the deregulation of finance. It sounds extraordinary. I mean, you know, when I was writing this, I was kind of worried I was going to sound like some sort of, you know, conspiracy nut writing about it, but it’s just there, you can go and look at, you know, the City of London Corporation. Go and look at their website and have a look what’s in there. It’s remarkable.

HARRY SHEARER: How does it relate to the regulatory structure of British law generally? Are they under it, totally? Do they have – have they carved out exemptions?

NICHOLAS SHAXSON: Well, they are not the regulators for the financial center. The City of London Corporation is not the regulator. But they are incredibly influential. And they’re influential through this kind of old boys’ network that is, you know, incredibly pervasive. And they have – you know, they stand heavily on ceremony and the Lord Mayor goes around in these gilded coaches and they have these banquets and, you know, they have sort of fingers reaching out, and legislation that’s, you know, that’s passed will have had a lot of attention paid by the City of London Corporation. And the corporation has an official who is known as the Remembrancer who sits in the British Houses of Parliament and he kind of monitors legislation that’s out there and, you know, watches out for, you know, populist attacks on finance and things like that. (laughs)

And so they’re very influential. And it’s very hard to quantify, I mean, just how powerful they are. I mean, they say, “Well, we’re just a sort of funny old, you know, group of people, and we – ”

HARRY SHEARER: “We’re quaint.”

NICHOLAS SHAXSON: Yeah, exactly! I think they hide behind their quaintness. But they do put out these regular reports, you know, kind of saying, you know, “The City of London is losing its competitiveness, there’s too many taxes, too much regulation” – these reports just come out like a drumbeat, and quite often the newspapers just kind of parrot them, you know, they just say, “City of London say London is losing its competitiveness,” and then all the politicians get frightened and say, “Oh, we mustn’t tax them too – tax the banks too much.” And so it’s a very curious phenomenon. It’s unlike anything else. I mean, it’s something that, you know, an economist will not be able to get their heads around this thing, and political scientists find it hard enough. It’s just a very curious sort of anomaly, but a very important one.

HARRY SHEARER: We’ll get back to the role of London in the offshoring phenomenon, but there was an article in the, I think in the Washington Post a couple of years ago, before I even read your book, that first opened the door to part of this world, which has, as I said, since become better known through the parliamentary inquiry into Google, Amazon and Starbucks, which is a tax avoidance scheme, as they call it in Britain, without the derogatory implication that it has in the United States, called the Double Irish with a Dutch Sandwich?

NICHOLAS SHAXSON: Mmhmm.

HARRY SHEARER: (laughs)

NICHOLAS SHAXSON: Yep. (laughs)

HARRY SHEARER: Could you walk us through that?

NICHOLAS SHAXSON: Well, this is, that one is actually quite a common one. I think there was a good Bloomberg report that looked at that particular one. So essentially you will have multinationals looking to find pathways through the international tax system that result in them paying very little tax. And there are lots of jurisdictions. I mean, Ireland and Luxembourg are two very, very important tax havens. Most people don’t really think of them as tax havens, if people – most people we don’t really think about Luxembourg at all –

HARRY SHEARER: (laughs)

NICHOLAS SHAXSON: – but in Europe it is very, very important. And Ireland – you know, the Irish Financial Services Centre is a great big kind of Wild West area of deregulated finance that has actually, if you looked deep into it, it’s got a lot of implication in the latest financial crisis, a lot of Wall Street stuff was parked there. And, you know, the Netherlands is another big one, Switzerland is another big one, the United Kingdom is another big one, where multinationals basically are looking to cut their tax bills.

And the way they do this, generally, is each multinational is treated by the international tax rules as a collection of separate entities. They have subsidiaries all over the world. And these entities trade with each other. And they can adjust – these are internal trades inside the multinationals, and they can adjust the prices of these trades to suit their tax bills.

So what they can do, for example, a tax haven subsidiary will buy something from another subsidiary of the multinational – maybe it’s a cargo of bananas or something. This is all happening on paper. It’s not – the bananas aren’t actually going to that tax haven. So they will buy a cargo of bananas at a very cheap price and then they will sell that cargo onto the U.K. subsidiary or the French subsidiary at a very expensive price, and so they’ve bought cheap and they’ve sold expensive and they’ve made a huge profit, and that profit is now sitting in a tax haven, because that’s where that entity is, and it’s untaxed. Meanwhile, in the U.K., where they’re selling it on, they will sell that cargo at a very, very high price to a retailer, so there’s no profit in the U.K. there to tax. And a similar thing, when they’re buying it from, you know, Ecuador, the cargo of bananas from Ecuador, they’ll buy it at a very low price, they’ll buy it basically at cost price in Ecuador. So they’ll tell the tax authorities in Ecuador, you know, this is how much we sold this cargo of bananas for and it’s the same price as the cost, so there are no profits there. So what you are seeing here is you’re seeing profit shifted from both the sale and the production end into the tax haven, and that’s the sort of essence of the game.

And, you know, countries do take – there are all sorts of countermeasures that countries do take against this, and it is a constant dance between the countries and the multinationals, but developing countries in particular find it impossible to challenge these incredible – you know, they will find themselves faced with armies of lawyers and accountants and there’s just nothing they can do. And particularly companies with, you know, intellectual property. If you have – you know, you can locate a company’s brand or a logo in a tax haven and then you say it’s worth this much, and the tax authorities try and challenge that, and, you know, how much is Coca-Cola’s brand worth, or how much is Google’s brand worth? Well, you know, it’s really worth what the company’s accountants will say it’s worth, and it’s very difficult to challenge.

So you have an international tax system that is incredibly dysfunctional. It was kind of set up decades ago and it just hasn’t kept pace with globalization.

HARRY SHEARER: One would think that if the Peace Corps were still – the Peace Corps is still in business, they might want to be sending armies of lawyers to developing countries to really help them out.

NICHOLAS SHAXSON: Well, that’s an inter– that’s actually, what you’re talking about there is there is a fledgling organization being set up. It was originally conceived as something called Tax Inspectors Without Borders –

HARRY SHEARER: (laughs)

NICHOLAS SHAXSON: – which is exactly what you’re suggesting. And I know that the OECD, the group of rich countries, has taken this idea on board. I don’t happen to know where it’s running with it. But this would be, this is exactly a very good idea indeed and I hope it becomes a great success. Another thing that we’re just beginning to see happening is people talking about running training courses for journalists to try and – particularly in developing countries, to try and help them understand how to look at the offshore system, how to understand it and how to investigate it. And so these are just kind of new initiatives that are just bubbling up and I think that, you know, they could go a long way to helping expose what’s going on.

HARRY SHEARER: Well, let’s talk about your background for a minute. Before you delved into this subject, what were you doing? Were you –

NICHOLAS SHAXSON: Well, I spent –

HARRY SHEARER: Are you a journalist, an economist, or – ?

NICHOLAS SHAXSON: I’m a journalist by background, a sort of economic and financial journalist. I spent many years writing about oil-producing countries in Africa. I wrote a book called Poisoned Wells that was published in 2007 that was the result of nearly 15 years’ work of going, you know, visiting these countries, and I spent the whole time trying to understand why it was that these countries were not realizing the benefits. So you had countries like Nigeria, Angola – hundreds of billions of dollars flying into these countries, and yet the people of these countries just, you know, seemed to be as poor as any other African countries. You know, it was a very sort of depressing time to spend. I mean it was very interesting, of course.

But over that time when I was researching it, academics were beginning to put together this thesis, this set of research that nowadays goes by the name of the resource curse. In other words, many countries that find minerals like oil seem to not only find it hard to harness them for national development but in some cases seem to be even worse off than if they hadn’t found anything. And I strongly believe Angola, the country that I know best, which is a big oil exporter, really has been cursed by its minerals, oil and diamonds, and if they hadn’t found any I think their people on average would be much better off than if they’d just been, you know, a nonresource country.

But one of the most interesting things about this is, having moved, made the transition from oil, the resource curse, to tax havens and financial centers, I began to see so – I have seen so many similarities in terms of the political dynamics. Countries that are dependent on finance, like the U.K., are also finding it terribly hard to harness all this money. There’s trillions of dollars coming in and out of the City of London and huge sums of, tides of money coming into, you know, the U.K. property market and stuff, and yet you look at the sort of real human development statistics for the U.K., you know, infant mortality and health outcomes and things like that, and the U.K. is doing, you know, it’s doing worse than France or Germany or, you know, other countries that, you know, with which you could compare it.

And a lot of the reasons for this, I think, are quite similar. I mean, you have a single dominant sector – in Angola’s case it was oil, in the U.K.’s case it’s finance – sucking all the best talent out of the rest of the economy, out of both the private sector and the public sector, and focusing it on this one single sector. You also have, you know, exchange rate effects where, you know, the dominant sector will raise price levels, making it much harder for other sectors to compete.

And all these kinds of factors add up to what I am increasingly beginning to call a finance curse. You know, and this goes way beyond what most people are angry about, what’s happened on Wall Street and what’s happened on the City and all this financial crisis stuff. This goes way beyond that. This is something much more fundamental. This is something that was afflicting countries long before the economic crisis, the financial crisis came along. So this is a thesis I’m kind of currently developing and I’ll be publishing something on this early next year.

HARRY SHEARER: Okay. We’ll await that. In the meantime, you mentioned among your list of tax haven type countries one that may surprise a lot of listeners, i.e., the United States of America. Now I last year happened to be in Wilmington, Delaware, for a couple of days, and I walked through downtown Wilmington, a downtown festooned with a lot of tall buildings with the names of banks on them, and at midday I think I was about one of three people walking the (laughs) streets of downtown Wilmington.

NICHOLAS SHAXSON: (laughs) Okay.

HARRY SHEARER: And I thought, what’s in these buildings if not people?

NICHOLAS SHAXSON: Yes, Wilmington’s a fascinating little place, and it’s got its own little financial center, and that results from – the main sort of impetus for that was the so-called Financial Center Development Act of 1981, and this was initially a project to essentially offsh—what I regard as offshore activity, poaching activity off other states by deregulating. You know, it’s a kind of race-to-the-bottom activity. And at the time there were strong curbs on interest rates and, you know, what banks could charge, the interest rates.

HARRY SHEARER: You mean the so-called usury laws.

NICHOLAS SHAXSON: Yeah, the usury laws, exactly. And essentially there was a court case in which it became clear that individual states were allowed to export their own interest rates to other states. They were allowed to roll out, you know, credit card operations or whatever and use them in other states, use the same rules in other states. So, I mean, South Dakota tried to be the first to get on this bandwagon but South Dakota’s, you know, quite off the beaten track compared to Delaware, which is halfway between New York and Washington D.C., and so Delaware got onto this one and it created this Financial Center Development Act.

And what really struck me about it was, you know, I researched this in detail and I had a very good researcher working with me, and we discovered that essentially this was a project that was done with absolutely no local consultation. There was a small group of insiders who decided they wanted this thing. There was no consultation even with the population of Delaware, let alone the states that were going to be affected by all this legislation. It was a deal that was done. The Democrats were brought in on it. It was a Republican governor at the time but he brought the Democrats in and the Democrats agreed not to make any noise about it until after the election. And it was a deal that was just kind of presented. It was created by the finance industry and there was no, there was just no democratic consultation.

And, you know, that’s kind of my main point. I mean, one can argue about whether or not usury laws should have been repealed or not, but – and, you know, some people argue that it has been a very negative thing. But the thing that struck me was just this kind of small, kind of – it was just like what I’d seen in other tax havens. It was just small groups of people coming together in private, talking to the financiers, “What do you want, we’ll give you what you want, and that’s it, and we’ll make the laws and no one will need to know about until we’ve created the laws.” And in these very small jurisdictions you have, you know, usually there’s not very much expertise and people just essentially saying, “Okay, we trust you on this. You know, you’re going to make this legislation; we don’t really understand it, but, you know, we’ll vote for it, that’s fine.”

And, you know, I saw exactly the same thing in other tax havens. It’s just the sort of small jurisdiction mentality where finance comes in and gets what it wants and no questions are asked really.

HARRY SHEARER: But this grew out – Delaware had always been, or had long been a, a prime site for incorporations, right?

NICHOLAS SHAXSON: Yes.

HARRY SHEARER: That didn’t start in the –

NICHOLAS SHAXSON: That’s another – yes. And that’s another important aspect of it, yes. So Delaware has always been, for over a century, been a prime site for incorporations, and that is offering a slightly different package there and that’s particularly to do with corporate governance. So you offer corporate governance services that are particularly favorable to managers, often at the expense of shareholders, and that encourages corporate managers to incorporate there, and it’s just a kind of very simple business model. You relax your laws and the money will come.

And there are many types of reasons that companies incorporate in Delaware, but one of them is secrecy. And this is part of what I was talking about earlier, the United States as a secrecy jurisdiction. The U.S. offers secrecy both at a federal level and also at a state level, and Delaware corporations – and Delaware’s not alone; Nevada is another one, Wyoming is another, and there are various others. States offer secret corporations. In other words, they will allow you to set up a corporation for just a few hundred dollars that provide extraordinarily strong secrecy, in some cases as strong as Swiss banking secrecy.

And they do this through a completely different route. They do it by allowing you to set up a company with nominee shareholders and nominee directors. And so, you know, these people who are nominees, they will be the directors of hundreds if not thousands of companies, and you can find out as much information as you like about these people, but that brings you no closer to the real warm-blooded person who owns that corporation. Those people, you know, the real owners, the beneficial owners, will stay secret.

And there has been a lot of dirty money running through all of these corporations, and drugs money, and so on, and there’s been quite a lot of noise about it recently. But still, you know, the lobbyists have managed to say, “Oh, it’s going to be difficult. It’s inefficient to make us, you know, have more onerous due diligence requirements to check up on, you know, who owns these companies.”

So still, you know, there’s a lot of work to be done to clean up this sector. Delaware is, you know, is a massive provider of state-level secrecy through its corporations.

HARRY SHEARER: Now recently I’ve been reading about, in Yves Smith’s Naked Capitalism blog, among other places, about a blossoming of this kind of stuff in New Zealand.

NICHOLAS SHAXSON: (laughing) Ah, yes. New Zealand is a kind of – there are so many tax havens around the world that seem to have this sort of blemish-free existence, and New Zealand has the distinction of being ranked as the cleanest country by Transparency International (laughs) at the moment. But if you look at some of the things they’re providing – I was looking at this recently, and Naked Capitalism is a site I visit regularly and enjoy very much, and they helped give me a tipoff in a couple of cases here – but New Zealand has a couple of different strings to this particular bow.

One is, again, secret corporations. There have been investigations into – you know, you have these little houses. There’s a house in Auckland that’s just sitting there with thousands and thousands of corporations in filing cabinets, and no information, and the government’s not asking them for any information, and all sorts of – you know, they’ve been linked to all sorts of nasty, you know, East European mafia and drugs money and stuff.

And New Zealand also has a trust sector. Now, trusts are another whole can of worms. Offshore trusts in particular can be very slippery creatures and very – again, very, very strong providers of secrecy. And New Zealand trusts have been implicated in all sorts of, you know, Mexican drug money and stuff like that.

And so here you have this country that has, you know, in many cases it has a very clean reputation and yet on the other hand it has this incredibly dirty financial thing going there.

And that’s the same of many jurisdictions. I mean, you know, the City of London tries to portray itself – you know, U.K. – people generally regard the U.K. as a very warm and friendly place and British as trustworthy and it’s got very strong courts and legal system and, you know, all this sort of stuff, stuff is true, but on the other hand you have this kind of ocean of dirty money that sits alongside this, you know, all this probity. And it seems like an incredible paradox to have these two sitting side by side.

HARRY SHEARER: In the final moments, and I’m speaking with NICHOLAS SHAXSON, author of Treasure Islands. In the final moments we have together, there are some efforts by some governments to exert what might be called tax transparency upon all this stuff. How’s – who’s on what side of that?

NICHOLAS SHAXSON: Well, there are a series of measures going on. I mean, the biggest and most important are, there’s one project that’s going on in the European Union and there’s another project going on in the United States that are the most serious efforts. Now the U.S. effort is kind of a unilateral thing. It’s protecting the U.S. tax system from offshore erosion. And the United States has been very fierce. It in recent years has had a huge fight with Switzerland in particular. They’ve caught – the Justice Department has had cases against Swiss banks and they’ve caught them red-handed helping Americans evade taxes with all sorts of colorful stories about, you know, hiding diamonds in toothpaste tubes and, you know, poaching, you know, going to the America’s Cup and trying to, you know, just looking for customers and helping them, you know, get their money offshore.

So, you know, that kind of thing has really stuck in the public craw and the Obama administration, under the Obama administration there’s been a certain, you know, a fair degree of attack on Switzerland in particular, but also they have this legislation coming in, the Foreign Account Tax Compliance Act, which requires foreign financial institutions to identify any American clients that they have and pass information about their assets to Uncle Sam. So that’s a kind of unilateral U.S. thing. It’s an interesting and sort of positive development, but it’s not – and the U.S. is kind of pushing, you know, this out to make it more reciprocal with other countries.

So that’s one – you know, it’s kind of, I see that as one pillar of an emerging architecture.

And another big pillar is the European Union, it’s got this scheme going which is currently full of loopholes but it’s essentially an information-sharing mechanism as a way governments share information with each other about their wealthiest citizens’ assets and income so that they can tax each other properly. And, you know, it’s geographically limited to there are 42 jurisdictions in here, but it’s – I see this as a sort of the first stirrings of something new, of an emerging architecture of transparency which is still in its early stages and still, you know, full of holes and, you know, still not raising huge amounts of money, but it is new. It’s the start of something new.

And I think with governments, you know, facing austerity and looking for tax revenues everywhere, I think the political momentum behind this kind of thing is really growing now. And I think, you know, there’s a long way to go and I think there are positive things happening.

HARRY SHEARER: To close, let me go back to where we were at the beginning. There has been a lot of publicity about Starbucks in England and Amazon in England making significant profits, to some eyes, and yet paying negligible income taxes because of tax-avoidance procedures that are strictly legal under current English law. And there’s been talk about boycotting these companies. If you lived in England, which you don’t, would you be patronizing or boycotting Starbucks and Amazon?

NICHOLAS SHAXSON: I’d be boycotting them, because, for the simple reason – I mean, this defense they come up with, “It’s legal, so it’s fine,” it doesn’t hold water. For various reasons. One is, when you’re talking about corporate tax affairs, you are talking about an incredibly complex arena, and between the legal and illegal there is a large gray area, and these corporations operate frequently in this gray area, and you only find out which side of the law they really are on once there’s been a court case, the tax authorities have taken them to court and you get a resolution one way or the other. So, you know, there’s a question – you know, how aggressive – the question is how aggressive are these companies going to be, and it seems that Amazon and Starbucks have been particularly aggressive, you know, pushing into this gray area where it’s not quite clear. You know, you certainly can’t say they’ve broken the law, but you can’t say either that they haven’t broken the law, and it’d be interesting to see what the tax authorities would say.

But more fundamentally, I think, you have corporations that are coming in to the U.K. and taking all the benefits, the services, the infrastructure, the well-educated work forces, the rule of law, the courts, all these fine things which are all paid for out of tax dollars – they’re taking these things and then they’re making their profits and not paying for the services. And that is something that sticks, and it’s a very simple thing, it’s something you can get people in the streets very angry about, and it makes me very unhappy to see this happening.

And even worse than that, perhaps, these corporations are competing with domestic companies that are doing, trying to be in the same business but they’re being killed by the multinationals on this factor, tax, which has nothing to do with real productivity, with real economic efficiency, nothing to do with making better, you know, goods and widgets and services, but everything to do with transferring money away from others, transferring wealth to them from others. And there’s nothing productive at all about this. This is simply a gigantic distortion in the market. And, you know, so it’s profoundly, it’s damaging to – you know, it’s – in a sense, this whole thing is anti-business, even though multinationals are getting lower tax rates, they are harming, you are harming domestic businesses, smaller, more local businesses, which are often the job creators and the innovators, and they’re being killed on this as a result of this gigantic distortion.

So it’s a huge problem, and it’s not – you know, hiding behind there saying, “Well, it’s all legal,” is just not going to work.

HARRY SHEARER: NICHOLAS SHAXSON, I highly recommend Treasure– is the American version the same as the British version?

NICHOLAS SHAXSON: It’s pretty similar, yeah. It’s essentially the same, though it’s a little bit shorter, but –

HARRY SHEARER: (Laughs)

NICHOLAS SHAXSON: It’s essentially the same, yeah.

HARRY SHEARER: Treasure Islands is the book, and it’s fascinating. The story of offshore in all its ramifications which continue to this day. Thanks so much for sharing your time with us on today’s show.

NICHOLAS SHAXSON: Thank you. Great to talk to you.

HARRY SHEARER: You too.

Now, ladies and gentlemen, the Apologies of the Week. We won’t even ask why the American version is slightly shorter than the British version. Now to the Apologies of the Week….

That’s going to conclude this week’s edition of Le Show. The program returns next week at this same time over these same stations, on NPR Worldwide throughout Europe, the USEN 440 cable system in Japan, around the world through the facilities of the American Forces Network, up and down the East Coast of North America via the short-wave giant WBCQ The Planet 7.490 MHz shortwave, on the Mighty 104 in Berlin, around the world via the Internet at two different locations, live and archived whenever you want it at harryshearer.com and kcrw.com, available through your smartphone through stitcher.com, and available as a free podcast at kcrw.com. And it’d be just like us getting to offshore our profits too if you’d agree to join with me then. Would you? All righty, thank you very much, uhhh huh.

A tip of the Le Show chapeau to the San Diego, Pittsburgh, Hawaii and Chicago desks for help with today’s broadcast. Thanks as always to Pam Halstead. Thanks also to Andy Stallabrass at De Lane Lea studios in London and Tom Wenger at Tom Studio in Zurich for help with production of today’s broadcast. And thanks to the Chicago desk for being right here in New York. Is it you who left the toilet seat in the ladies’ room up? Yeah. That’s what I thought.

The e-mail address for this broadcast and the playlist for the music heard hereon is part of the welter of new stuff at harryshearer.com. Hey, there’s a store there now! You can buy Unwigged and Unplugged, you can buy my little comic novel Not Enough Indians, and if you’re in Chicago Tuesday night at Space in Evanston, Judith and Harry’s Holiday Sing-along benefiting the New Orleans Musicians Clinic with a lot of great Chicago musicians. Please come and support a good cause.

This broadcast is represented on Twitter. Join the more than 77,000 followers @theharryshearer.

Le Show comes to you from Century of Progress Productions and originates from the facilities of KCRW in Santa Monica, the community recognized around the world as The Home of the Rubber Promise and The Home of the Homeless. Put that seat down now!

LE SHOW, OCTOBER 28, 2012

Listen to the podcast here.

Interview recorded Thursday, October 25, 2012.

Here it is! From deep inside your radio.

HARRY SHEARER:  This is Le Show, and we are frightfully close to Election Day, and I think some of us are heaving a sigh of relief, if not utter, utter, utter joy, that this will soon be over one way or the other. And one of the sources of joy is that we will no longer have to hear the bipartisan consensus about the economy, our state of finances, being yelled from every rooftop.

I’ve been reading and seeing video seminars on the Internet, which we have these days, from a source of somewhat differing perspective on what we’ve been led to call the fiscal cliff and all the rest of it – the danger of the deficit, the crime we’re committing upon our grandchildren – so I’ve invited one of those folks who’s been writing and appearing on these video seminars in to be my guest today on Le Show. Sitting in – are you in Kansas City?

STEPHANIE KELTON:  I am, yes.

HARRY SHEARER:  Dr. Stephanie Kelton, who is an Associate Professor at University of Missouri Kansas City and a Research Associate at the Levy (“lee-vie”)? Levy (“levee”)?

STEPHANIE KELTON:  Levy (“lee-vie”).

HARRY SHEARER:  Levy Institute in New York City. And welcome, first of all.

STEPHANIE KELTON:  Thank you so much for having me.

HARRY SHEARER:  My pleasure. The university and the institute seem to be the loci of this group of economists and people who study the economy who have a – I’m tempted to say a radically different understanding, than what we’re given by the Washington-New York consensus. Is that right?

STEPHANIE KELTON:  Well, there certainly are a large number of us that are affiliated with one or both of those institutions. There are people, you know, all over the place, and as the understanding about how things work grows, we continue to pick up numbers, and so we’ve got people not just all over the U.S. in academic institutions, but also outside the U.S.

But interestingly what we have is really a growing number of people who are subscribing to what we’re doing, paying attention to what we’re doing, inviting us to come and speak to their groups, and they come from the finance industry, and so that’s been kind of a surprise. But I guess in some ways, you know, a lot of these folks have training and background in accounting, and so a lot of what we do emphasizes through the other side of the ledger, and every time someone talks about the government’s deficit, you forget that when the government spends more than it collects from you, that somebody else ends up with the difference, and that’s the other side of the ledger. So these finance and accounting types seem pretty intrigued by this.

HARRY SHEARER:  So let’s start at the beginning. What’s money?

STEPHANIE KELTON:  Well, money is a relationship that exists between two parties, and it signifies a party who is the debtor and a party who’s the creditor. So money is a balance sheet relationship where you’ve always got both sides of the balance sheet at work. You know, somebody’s asset is somebody else’s liability. Somebody’s IOU is somebody else’s balance sheet asset.

So money isn’t this thing. We tend to think of money as a thing, something that you can pick up, something that exists in physical form, and there’s only, you know, so much of it. Or if there isn’t only so much of it, most people think there should be a limit. And really, in the modern era, money is something that we create with keystrokes. We use computers. When you walk into a bank and you sit down with the loan officer and you say, “I’ve got this plan for a small business I’d like to start,” or “I’d like to expand my business,” or “I want to buy a car or a computer or pay for school” or whatever it is – the loan officer doesn’t get up from the desk and say, “Just a second. Let me go and find out if we have any money we’re lending out today.”

HARRY SHEARER:  (laughs)

STEPHANIE KELTON:  That doesn’t happen. Right? The loan officer doesn’t look in the vault to find out if they can make the loan. They look at you, and they look at your work history and how much you make, how long you’ve been there, what kind of debt you have. You know, they look at your balance sheet, not their balance sheet. And if they think they can make money by extending credit to you, then they simply use the computer. They credit your bank account. You get money and they get this asset called a loan.

HARRY SHEARER:  Or in the last decade they didn’t even look at you.

STEPHANIE KELTON:  They didn’t even look, right.

HARRY SHEARER:  Yeah. So did – your point of view is that this changed when the United States and ultimately a lot of other countries went off the gold standard and money ceased to be a representation of something payable ultimately by the provision of certain – you could always go and demand certain precious metals for your piece of paper?

STEPHANIE KELTON:  Right. Right. Exactly. So before 1971 the monetary system that we had in the U.S. looked very different from the one that we have today. It was based on a system of fixed exchange rates. It was a global monetary system where you had 44 countries participating. This is something that was an outgrowth after the end of World War II. It was called the Bretton Woods system because it was designed and put into place, conceived at a place called Bretton Woods, New Hampshire. And so 44 countries got together and decided to fix the value of their currency, so the Mexico peso would be convertible into so many U.S. dollars, and the French franc into so many U.S. dollars, and the German mark into so many U.S. dollars, and then through the dollar those currencies would be convertible into gold. So a fixed price, you know, $35 an ounce. So you convert your deutschmarks into dollars and then your dollars into gold.

And when you have a system like that in place, of course you have to be careful about how much you allow your money supply to expand, because you’re promising to convert the dollar on demand into this very finite resource called gold.

Well, after 1971, President Nixon took the U.S. off of the Bretton Woods system. We don’t have this old archaic gold standard convertibility currency system anymore. We have what’s sometimes referred to as just a pure fiat money system. It’s – our money isn’t backed by anything physical. It’s not convertible on demand into any other country’s currency or into any hard asset or anything like that. We quite literally can have an infinite supply of U.S. dollars. Okay? There is no inherent limit to the amount of currency that can be created in the modern era.

And this isn’t, you know, a crazy idea that I dreamt up. This is something that Alan Greenspan has been really candid about. And he’s said it over and over again. You can find the videos, read the testimony. He says quite plainly that there is no limit to the government’s capacity to create the currency.

And that’s why all of these, you know, these debates that you hear about, all this hand wringing over the size of the national debt, and what if we can’t pay it back, and the rating agencies, and what if the U.S. defaults on its debt, and all this, and Greenspan comes out and he says, “This is ridiculous. The debt is denominated in the U.S. dollar. The U.S. dollar comes from the U.S. government. We always have the ability to pay the debt, always.”

HARRY SHEARER:  We hear the United States government, especially during the election campaign, being compared to two different entities – to a household and to Greece. Might you explain why the U.S. economy does or doesn’t resemble a household in America and/or Greece?

STEPHANIE KELTON:  Sure. I would be very happy to. If I could dispel and disabuse people of these two myths, we would have an entirely different national conversation.

So, first the household debt analogy. This is a really powerful one. And the finances that most people are familiar with, of course, are their own personal finances. And so I think it resonates with them when they hear people make the argument that the federal government faces the same kinds of constraints that you and I face, that we have to tighten our belts when times get tough, and the federal government should do the same thing. And the person who really I think hammered this home so was Ross Perot with his little charts and his feisty little attitude, you know, telling the American people that we’re on the verge of bankruptcy in this nation and if he ran his business the way the government runs its operations, why, he’d be broke, and all this. So that’s where that really, really comes from. And today, you know, it’s the Peterson – Pete Peterson and his ilk that are pushing this.

So ask yourself, what is the difference? Why is it that a household has to live within its means? Why is it that a household can only borrow so much before it runs into possibly a situation where a bill comes due and the household can’t pay? Why is it that businesses sometimes go bankrupt? Why is it that state governments or, you know, Orange County – why is it that some of these folks can actually go bankrupt?

The fundamental difference between a household, a business, a state or a local government and the U.S. federal government is that the U.S. federal government is the issuer of the currency, and everybody else that I mentioned is merely the user of the currency. We all have to go out and get the dollar in order to spend the dollar. We either have to earn it, we have to borrow it, we make investments, we may have interest income – whatever, but we have to come up with the currency from some source.

The U.S. government in contrast is the source of the currency, right? The U.S. dollar comes from the U.S. government. Congress has given itself a monopoly over the issuance of the U.S. dollar. If you and I try to do it, we go to jail. It’s called counterfeiting, right? But the U.S. government has the monopoly right to create the currency. And as the issuer of the currency, it can, as Alan Greenspan has said, as Ben Bernanke has said, it can never run out, it can never go broke, and it can never be forced to miss a payment.

Greece, you asked about Greece.

HARRY SHEARER:   Mhmm.

STEPHANIE KELTON:  So this is a very interesting, a very interesting example. Because what you have in Europe is, you know, this collection of countries that decided at various points in time – not everybody adopted the euro at the same time – but they all decided to give up their individual sovereign currencies. Eleven of them did this in 1999 and then gradually six more countries joined, so today there are seventeen. But all of these countries used to have a currency that came from them. The lira –

HARRY SHEARER:  The franc, the lira –

STEPHANIE KELTON:  Right! Right. Right. And today they have this currency that they can’t issue. And in order to spend they have to go out and get the currency from somebody else. And so you look at Italy, that today has a debt-to-GDP ratio that is almost exactly where it was 15 years ago, only 15 years ago you didn’t have a debt crisis and today you do. What’s the difference? How come they could always pay before? Same debt load. And the difference is because they had promised to pay lira, and the lira came from the Italian government.

Same for Greece. High debt is not something entirely new to Greece, but it was always sustainable before because the debt was denominated in the drachma, and they could always come up with the currency when they needed to make a payment.

HARRY SHEARER:  Just incidentally, who does issue the euro?

STEPHANIE KELTON:  That would be the European Central Bank. They have the monopoly over the issue of the currency, and that’s why, you know, time and time again when we’ve seen governments get into trouble where they’re reaching the point where their debt levels are unsustainable and there’s the possibility that they actually might miss payments, the only place the currency can really come from, the only entity that can deal with the solvency crisis, is the ECB. So the ECB steps in, provides the funds, and, you know, this thing can go on. As long as the ECB is willing to do that, the euro can survive, but there’s just really no other, no other alternative under a system like that, because these countries are borrowing in a currency that doesn’t come from them.

Financial markets realize that they’re lending to currency users and not currency issuers, which is exactly why the financial markets have so much power. It’s why they’re able to bully these countries in a way that they can’t bully the U.S., they can’t bully Japan, they can’t bully the U.K.

Look at Japan’s debt-to-GDP. It’s twice ours. It’s 200% debt relative to the size of their economy. Ours is about 100% debt to GDP. Where are Japan’s interest rates? Right where ours are. Zero short-term and about 1% long-term. Why? Why is Japan’s debt twice as big as ours and their interest rates are at zero, U.K. same thing, U.S. same thing, and in Europe interest rates are all over the place – 6%, 6½ , 5, 7? It’s because financial markets recognize that they’re lending to currency users, that there’s a real possibility of default, and in order to compensate them for the risk they’re taking in lending to these currency users, they want a premium. And so they’re able to extract that higher interest rate by virtue of the fact that, you know, you might default, so you’ve got to compensate.

HARRY SHEARER:  Those are so-called bond vigilantes that we keep hearing about.

STEPHANIE KELTON:  Right.

HARRY SHEARER:  Let’s get back to us. The corollary of what you’re saying would be the question, does the United States have to either tax or borrow to get money to spend? The federal government?

STEPHANIE KELTON:  No. It doesn’t need to finance itself by raising taxes or collecting money through the sale of bonds, which is what we call borrowing. No. That is not that purpose of either of those operations. The currency comes from the government. So, could the government write checks on its account at the Federal Reserve and just allow the balance in that account take an overdraft? Right? So allow the balance in its account at the Fed to go negative, deeper negative, deeper negative? And the answer is yes, it could. Currently there are laws in place that prevent the federal government, that prevent the Treasury, from running its account at the Fed into the negative. But who came up with that rule? Congress, of course. So, there is no financial constraint. The U.S. government is not revenue constrained in the way that private business is or in the way that we’re constrained.

HARRY SHEARER:  Well if that’s true, why are they taxing us?

STEPHANIE KELTON:  Well, taxes play an important and historically very interesting role. You know, if you look at the history, one of the examples that we often use is we talk a little bit about the colonization of Africa by the British. You say, “You know, the British sail over and they have a look around and they say, ‘You all have some really terrific res–’” I’m paraphrasing.

HARRY SHEARER:  Yeah! (laughs) You’re putting it mildly, too.

STEPHANIE KELTON:  “You all have some really –” (laughs) “You all have some really great resources here. How’s about we make a deal and you sell us some of this great stuff and we’d be happy to pay you for it, and here are some British pounds.” And the Africans, you know, look at the currency and they say, “Well, it’s lovely, but no thanks, cheerio, and safe trip home.” And the British said, “Well, no, actually, we really, really want the resources, so here’s what we’re going to do. We’ll start imposing taxes – it could be a head tax, it could be a village tax – but we’re going to impose a tax liability on you, the tax liability is payable only in the British currency, and the penalty for not paying the tax is –” And then, you know, use your imagination. The penalty was pretty stiff. So all of a sudden these African people who had no interest in working to get the British currency suddenly became very willing to work and provide resources in order to get the currency. And the reason is that the currency had no value to them until the tax was imposed and the liability was imposed on them. In other words, until they were forced into debt. And the only way –

HARRY SHEARER:  You’re saying that taxes create the demand for the currency?

STEPHANIE KELTON:  Historically you can find this. You can find this in the literature. Historians are very good on this, anthropologists are very good, numismatists are very good, and economists are really terrible at this –

HARRY SHEARER:  (laughs)

STEPHANIE KELTON:  – because they’re lazy scholars by and large. And so, yes, the literature, the work is out there, and historically you can find this.

And look, if you had asked the German people – and they did ask the German people – hey, poll after poll, do you want the euro? Would you like to give up the deutschmark? And the Germans said “Absolutely no. We are not signing onto this. We like the deutschmark. We’ve been through a lot with our currency here. This thing is stable. We’re keeping it. We don’t want to take any risks.” And the German government said, “Wait a minute. We’re going to go ahead and introduce the euro. From this point forward, all payments by government will be made in this new currency, and all payments to government will be collected in this new currency.”

And it’s that decision by the government about how it’s going to make its payments and what it’s going to accept in payment to itself that drives the currency, that ends up making that currency the currency that circulates within the national borders.

HARRY SHEARER:  So they didn’t have to confiscate lira and francs, they just were not payable as debts to the government.

STEPHANIE KELTON:  Exactly. And they quickly stopped circulating as widely accepted.

HARRY SHEARER:  Okay. The other half of the question. Why does the United States government borrow?

STEPHANIE KELTON:  Well, it’s a relic of an old monetary system, and one that was designed to ensure that you didn’t have too much of the currency created when you had a convertible currency. So, you know, currency was convertible into gold. So at this point the answer with the new monetary system, the one we have today, the answer is that when the government sells bonds, it’s a way for the government to hit and maintain positive interest rates. This gets a little bit complicated, but if you think about the government running deficits, that is, spending more money than it collects from us in the form of taxes – well, what that does is it leaves the private sector, and in particular the private banking system, with a bunch of extra money that economists refer to as reserves. So if banks are sitting on lots of reserves because the government is –

HARRY SHEARER:  Let me, let me – sorry, let me –

STEPHANIE KELTON:  Yeah.

HARRY SHEARER:  – slow down to –

STEPHANIE KELTON:  Go ahead.

HARRY SHEARER:  – for a show business person’s understanding of this –

STEPHANIE KELTON:  Okay. (laughs)

HARRY SHEARER:  This is the surplus in the private sector you were referring at the beginning to as the offset on the other side of the ledger sheet from the government deficit.

STEPHANIE KELTON:  That’s right. So if the government buys a $100 billion aircraft carrier – it’s harder to do just a single purchase, but I’ll try to do this – a $100 billion aircraft carrier, and it collects in only $90 billion in taxes, well, the person who put the $100 billion into their checking account, that bank has $100 billion in what we call reserves. And now let’s say the customer at that bank pays the $90 billion tax liability, 90 comes out, but there’s still an extra $10 billion in the banking system and in the private sector. And if you’re not doing anything to get rid of those extra reserves… Bank reserves circulate between banks, and so what happens is banks are required in the U.S. to hold reserves. That is, they keep checking accounts at one of the twelve Federal Reserve banks, and they hold reserves against a fraction of what their customers keep on deposit with them.

HARRY SHEARER:  This is so-called fractional reserve banking?

STEPHANIE KELTON:  Fractional reserve banking. And sometimes the banks have more reserves than they want to hold and sometimes banks don’t have as many as they’re legally required to hold. And so you have this market out there called the federal funds market. And the banks with too many can get together with the banks with too few and they make a loan, and the price that you pay for those reserves is the federal funds rate. And a lot of people will have heard that, you know, when they talk about the Federal Reserve changing interest rates or something, you hear about the fed funds rate.

Well, if the government is putting more in than it’s taking out by spending more than it’s collecting in taxes, then the banks are accumulating reserves. And if this is happening on a wide scale, right? All the banks are accumulating more reserves, then everybody wants to be a lender and nobody wants to be a borrower. And so the price goes to zero. And so your overnight interest rate, the federal funds rate, quickly falls to zero.

Today it’s a policy decision to keep it at zero, but that’s not how things normally work. Normally the government wants the interest rate above zero, and so what they’ve done historically, for decades now, is they sell bonds. They say, “Well, the interest rate is zero, because you all have all of these reserves and you’re trying to get rid of them because they don’t pay you any interest. Let’s sell you some bonds, and then you hold U.S. government bonds that pay you interest and I’ll take those reserves from you.” And so it allows – the bond sale is a way for the government to maintain positive interest rates. This is the short answer to a kind of complicated question.

HARRY SHEARER:   Mhmm, mhmm. Well, it leads to the question of, which we hear constantly talked about in the political context of who’s buying U.S. debt, U.S. federal government debt, and we’re depending on the Chinese and we’re putting our grandchildren in hock. Let’s examine both halves of that one. Are the Chinese the main holders of U.S. Treasury debt at this point in time.

STEPHANIE KELTON:  No. Not by a long shot. No. They hold about a trillion dollars out of the total roughly $16 trillion, so, no, it’s not a trivial amount, but it’s also –

HARRY SHEARER:  Well, I got that on me.

STEPHANIE KELTON:  (laughs) Yeah. It’s not a trivial amount, but it’s also not – it’s also not something we should be wringing our hands over the way we do today.

Look, China has U.S. dollars because China has a strategy for domestic growth that relies heavily on China’s desire to produce things and ship them to other people to enjoy. So as long as this is part of their strategy and they want to grow their industries by making things and shipping them to foreigners, they’re going to end up with the currency of foreign countries. And in the case of the U.S., when the Chinese send us more goods and services than we send them, they end up with U.S. dollars. Which is fine. So, we get the stuff and they get the credit to their bank accounts. Now, what they do is they say, “Well, we have all these U.S. dollars in our bank account, but they don’t pay us any interest. So, why don’t we flip these out of our checking account into our savings account, which is basically what the U.S. Treasury is to them. It’s like having a savings account instead of a checking account.

HARRY SHEARER:  So they get interest paid on the bonds.

STEPHANIE KELTON:  They get interest, and because the U.S. government is only promising to pay to U.S. dollars, and because it’s the issuer of the U.S. dollar and it can never run out, it can always pay the interest, it can always pay back the principal, and when they do, we put the money back into China’s checking account, and then what does China do? Do they say, “Oh, good, we have lots of dollars. Now we can go buy more goods and services from the U.S.”? No, they say, “Put it back in our savings account,” right? “We want the Treasury.” So they just keep flipping it back and forth from checking into saving, all the while they’re toiling away the day in conditions none of us would want to be working in, producing things, cheap things, sending them to us to enjoy. And what do they get in return? They get more credits to their checking account that they flip into their savings account. And we act like they’re winning and we’re losing. And we send convoys of, you know, high-level government officials over there to tell them to stop allowing us to abuse them this way.

HARRY SHEARER:  (laughs) The other half of that. What’s happening to our grandchildren? Who’s doing what to our grandchildren?

STEPHANIE KELTON:  Well, we’re not doing them any favors at the moment, that’s for sure. Cutting education, laying off teachers, letting our infrastructure fall into disrepair to the tune of, you know, $2.2 trillion, and a D rating overall. I mean, we’re not leaving them a whole lot to be proud of., in energy and environment and any number of things, and a, you know, retirement system, Social Security, the cuts that they – the programs that may not be there for them when they need them and so forth. So we make all of these choices and the excuse is always, “Well, we’d love to do better but we can’t afford it.” Because we don’t understand our own monetary system. We think the dollar comes from China.

HARRY SHEARER:  Made right on the same assembly line as iPad. I left one question hanging from the previous question. Who does own most U.S. Treasury debt then, if not China?

STEPHANIE KELTON:  Oh, well, it’s on the books of financial institutions, banks, pensions, corporations. I mean, these are good, safe, default-risk-free –

HARRY SHEARER:  Mainly American?

STEPHANIE KELTON:   Mainly American, sure. Sure.

HARRY SHEARER:  So if I were listening casually to you – I’m trying to pay more attention – but if I were a casual listener, I would say, “Well, she’s just sort of fronting for a policy of just spend it all and, you know, raise taxes.” I mean, is this just an ideological water carrier for the Democrats?

STEPHANIE KELTON:  Well, no, because they frustrate me more than anybody does.

HARRY SHEARER:  Well, welcome to the club!

(laughter)

STEPHANIE KELTON:  I mean, you know, who wants to strike the Grand Bargain? Who said “go big”? Who said “four trillion”? No, most of this kind of talk is actually coming from the Democrats. It’s not a free lunch. There are lots of things that we don’t do today to recover the economy to where we should recover it, and you’re just sitting here looking at still very close to 8% unemployment, and we’ve chased so many people out of the labor force that the real numbers are much higher than that. And every single day we’re leaving around $10 billion on the table in lost output, lost income, because of all of the unemployment.

And you know all the social problems that go alongside that – a housing market that we haven’t addressed the problems there, and so on and so forth. So there are real costs, and there are lots of things that we forgo every day because we don’t do what we should be doing.

But this is not – what I’ve been saying shouldn’t be interpreted to mean, because you can spend and you can create the currency in an infinite way, that you should go out and spend to infinity. That’s not it at all. What I’m saying is that when you have about 23 million Americans who want to work and they want full-time work and they’re unable to find it, when you have things that need to be done, useful things that need to be done – like, I mentioned the $2.2 trillion in infrastructure investment that needs to be made, and you have folks who want to work, and you have useful things that need to be done, and you have the financial wherewithal to make that happen, it’s not financially responsible.

We hear a lot about fiscal responsibility.

HARRY SHEARER:  Mhmm.

STEPHANIE KELTON:  What could be more fiscally irresponsible than being the monopoly issuer of the currency and keeping it so short that people can’t get the currency when they want to work in exchange for the dollars so that they can buy things. And so you put people to work, you pay people to work, people go out and spend, businesses have customers, businesses hire – this is not really rocket science.

I’m sort of dumbfounded every day I go through life at the complexity that apparently people – people can’t figure out the simplicity of this. You know? You run your economy at full employment. If there’s unemployment, it’s an indication that the deficit is too small. If you get inflation, it can be an indication that you’re spending too much. That is, if the inflation is the result of, as they say, too much money chasing too few goods. But if your economy is starting to heat up and you begin to see inflationary pressures that are coming because there’s too much demand and you don’t have the supply capacity, you can’t produce enough goods and services, then you have to slow that demand down, and you do that either by cutting spending or by raising taxes.

Right now we have this national conversation taking place about, you know, the debt and the deficit and the Chinese and the burdens and the rating agencies and all this kind of crazy talk that we need to start cutting now, raising taxes and cutting spending, and we’ve got 23 million people without work. You know, this isn’t – you’re supposed to do the opposite in this situation.

HARRY SHEARER:  Okay, you did mention the “I” word, which I’m sure some people have been screaming at their radios for some time now. So let’s tackle it head on. If the government doesn’t need to tax and it doesn’t need to borrow in order to spend and it spends willy-nilly, people will say hyperinflation, wheelbarrows full of paper money just to buy a loaf of bread, the familiar images in our heads of the Weimar, which certainly still scares the Germans if nobody else. Inflation is a constraint. You’ve acknowledged that. How great a constraint is it?

STEPHANIE KELTON:  Well, it would be a significant constraint if we didn’t have the excess capacity and the millions and millions of unemployed workers. So you expect price pressures when your markets get tight, when you’re running your factories very near their capacity, when the labor market gets so tight that, you know, you have basically a job opening for every job seeker. Then you know you’re really close to full employment.

You know, you don’t get hyperinflation by running your economy at full employment. Let’s not forget that under the Clinton years, the so-called Clinton boom, we had full employment in this country. We had as close as what I am comfortable referring to as full employment where we actually had one job vacancy for every job seeker. And that was the first time in 35 years that we’d achieved those kinds of numbers. Our inflation rate was so low, nobody even talked about inflation. Inflation was not even on the radar screen. We had high rates of growth of GDP, our unemployment rate officially was 3.7%. We had high growth, low unemployment, and modest inflation. So we did this before and we did it in the not-so-distant past.

All I’m saying is that the way we’re running the economy right now, this is not fiscally responsible. This is dysfunctional finance. We’re getting everything wrong. We’ve got all kinds of room to run here and we can safely crank up aggregate demand. We can safely cut taxes on those that we think will be most likely to go out and spend, and that spending leads to the sales that then lead to job creation, and we can safely increase government spending on programs like infrastructure, education and the kinds of things that we believe generate real economic growth and prosperity and leave our children and grandchildren better off than they would be otherwise.

HARRY SHEARER:  Your colleague Warren Mosler, I believe, says that the decision whether to cut taxes or to increase spending, or the balance between those, remains a political decision, that this understanding of economics does not dictate one or the other or the particular formula for the combination – is that correct?

STEPHANIE KELTON:  Sure. Absolutely. I mean, look, I sometimes use the phrase, “Cash registers don’t discriminate.” You know, when you go to the grocery store, somebody might say to you, “Paper or plastic?,” but nobody will ever say to you “Private or public?” And so whether the additional spending comes because we had a payroll tax holiday and millions of Americans have more take-home pay and more money to eat or pay down debt or to go out and buy something new, or whether it comes from, you know, direct government spending, cash registers don’t discriminate. So, yes, it is very much a political decision.

HARRY SHEARER:  I want to double back to the question of the bond vigilantes for a moment, just to nail something down. This very day I heard a member of the Conservative government – well, the coalition government, actually, it was a Liberal Democrat I think, official in the British government, asked about the fact that the IMF had said, “You know, Britain may need to think about sort of putting the brakes on its austerity program if it wants to enjoy actual growth in the economy.” He said, “We’re not going to backtrack on our policy because our policy” – which is basically sort of an austerity light as compared to what Greece and Italy and Spain and Ireland have been through – “our policy has kept interest rates down, has increased confidence in the market, which has resulted in lower interest rates.” “Confidence in the market” – is that code for bond vigilantes looking for the next, you know, fish in the water that may be emitting blood?

STEPHANIE KELTON:  Yeah, I guess so. I love the taking of credit for something that – you know, interest rates are going to be low as long as the Bank of England says interest rates are going to be low. This is not a reflection of the success of the austerity program or the placating of the bond markets or anything else, it’s simply a reflection of the fact that if the central bank establishes a low interest rate and then pledges to keep rates low, as the Fed had done here, that market participants are going to anticipate low interest rates across some period of time out in the term structure, and so you’re going to have low interest rates. I mean, when you set the interest rate, you’re going to have whatever interest rate you decide upon.

HARRY SHEARER:  Well, then, you mean the Fed decided that interest rates should be 17% in the late 1970s?

STEPHANIE KELTON:  Absolutely! That was Paul Volcker’s doing. Yes, absolutely. This is the first – this was something that was known as the great monetarist experiment. And of course the greatest monetarist who ever lived was Milton Friedman. This is the old Chicago School of Economics.

You know, in the Seventies the U.S. was experiencing that ugly thing called stagflation where we had a period of time where we simultaneously had high unemployment and high inflation. And Paul Volcker, who was the chairman of the Fed before Alan Greenspan, decided he was really going to tackle inflation. And being a good monetarist, he decided that the way to bring down the inflation rate is to try to reduce the rate of growth of the money supply, because they have this idea that if your money supply grows at 6%, you’re going to have 6% inflation, and if you can bring your money supply growth rate down to 2½, 3%, your inflation rate will come down proportionately.

So what Volcker did was attempt, for the first time really, to control the rate of growth of these monetary aggregates. And I’m not going to get into all this because it gets a little bit too technical with M1s and M2s and M3s and all that, but he tried to control how much banks were actually lending, these different measures of the U.S. money supply, and when he decided to target the money supply, he let go the interest rate. And you can do both.

And so, yes, U.S. interest rates went very high. The prime rate, which is the interest rate that banks are supposed to be charging their best corporate customers, went to 21% under Volcker. But that was absolutely a policy decision.

HARRY SHEARER:  What – you mentioned the name earlier, and I want to get back to it. Why is there a bipartisan consensus that’s pretty much written in concrete these days, that the deficit is a bad thing, that the national debt is going to crush our grandchildren, that we can’t afford these things that you talked about before that might be desirable for the state of the economy and for the employment of Americans who want to work, this consensus that we are debt constrained and tax constrained – revenue constrained – and you mentioned the name Peter G. Peterson, so –

STEPHANIE KELTON:  Mhmm.

HARRY SHEARER:  – would you fill us in on that a little bit?

STEPHANIE KELTON:  Well, here’s someone who has made a financial commitment to establishing a narrative in the American psyche and hammering it and hammering and hammering, and recognizing that it would take time, it would take, you know, financial commitment, but that this message if drilled in hard enough and long enough could infect every political party, on both sides. And it absolutely has done that. I watched the first debate between Obama and Romney, and somebody said, you know, “Who do you think won?” And I said, “Pete Peterson.”

HARRY SHEARER:  (laughs)

STEPHANIE KELTON:  It’s obvious. You know, I’m reading just today in – Reuters put something out about the CEOs of more than 80 big U.S. corporations, and these corporations include the likes of Goldman Sachs and Boeing and JPMorgan, and these guys have all gotten together and they’re pressuring Congress to reduce the federal deficit. And what do they want? They want tax cuts, of course, and spending cuts. And what do you think is on the receiving end of the spending cuts? Of course it’s entitlements, right? So these CEOs from more than 80 of these big U.S. corporations got together and wrote a letter in the Wall Street Journal website. It was supposed to go up today in fact. And they’re emphasizing the fiscal cliff and the need to bring down the deficit. Now they want, they’re concerned about, you know, how big the deficit is, and I read that the statement itself was organized by a campaign called Fix the Debt. And this campaign’s been urging Washington to, you know, put aside their partisan differences and let’s all get the U.S. back on a sustainable fiscal path and all that stuff. And Pete Peterson is connected to this group. And so he seems to be in everything and behind everything.

HARRY SHEARER:  Hmm. The economy that you talk about, in terms of – well, you’ve talked about two things. One, the understanding of how money works, and then B, the resultant political decisions that could be made that could affect the economy. The second would seem to be an economy that grows at a fairly healthy rate and that would be – call me a dreamer – good for everybody. Why would those corporate CEOs not want an economy with a lot more people working and able to consume and driving economic growth to a much higher rate than the anemic rate it is at now?

STEPHANIE KELTON:  Well, I don’t – I think they should, right? They should want 23 million more Americans with more money to spend. You would anticipate that that would be in their financial interest and that they would recognize that.

The only thing I can really think is that the national dialogue is so set with the haves and the have nots and the makers and the takers and the 1% and the 99%, and so when anybody in the middle class or anyone who’s poor or any part of the 99% says, “We don’t want you to cut this program because it helps us,” or “We want more investment in education” or whatever it is, the politicians, you know, they pat their pockets and they say, “We’d love to help you but there’s no way to pay for it.” And so the 99% point at the 1%, and they say, “They have all the money. Go get the money from them.” And the 1%, having the power and influence that they have, successfully push back against that. And so you have these two sides pitted against one another as if, you know, in order to pay for something, you have to rob Peter and pay Paul. And what the 1% should really do, I think, is to point at the Congress and say, “Don’t look at me. They have all the money.” You know? I mean, turn the attention where they really could effectively say, “Hey, don’t come to me and say you’re going to raise my taxes. I’m not causing any inflation. You don’t need to raise taxes unless you’re trying to cool something down.”

So at least right now, you know, if you want those programs, this is who you need to go talk to. Go talk to your politician, because these guys can vote and appropriate and the funding will be there.

HARRY SHEARER:  I’m getting the idea that what one of the things you folks are doing, aside from trying to redirect our attention towards the actual way that the monetary system works in the post-1971 era, is – if this is not the purpose, this seems to be the effect – is to take the moralizing out of it. We’ve been taught, by what we’ve been hearing in the so-called national debate, that there’s something immoral about having a high debt. There’s something immoral about having these deficits. There’s something that is against the way people should – again, from the household analogy, obviously – but there’s a morality factor here that I think moves Americans who don’t even, wouldn’t know the Federal Reserve if they walked into the front door of it.

STEPHANIE KELTON:  Yeah, I – for whatever reason, I just started thinking about Murdoch. And, you know, it’s obviously not God’s will that the federal government be in deficit. There is a moralizing – we’re – it’s a de facto sign that you’re behaving imprudently, right? If there’s a negative number on the ledger, we’ve done something wrong. We’ve gone wrong somewhere. And what we’re trying so hard to do is to get people to recognize that if they spend 10 and only take away 9 from us, that we got the extra 10, you know? That their deficit is our surplus, that their redding is our blacking. And it’s a very hard thing to flip that switch and get people to spin the way that they view, you know, the government’s deficit and the debt and so forth, and it’s a very powerful narrative, as you said, playing into morals and fear, and the fear of China, and the fear of the rating agen– there’s, both of those things are extremely difficult to get people to overcome. Both the moral aspect and the fear.

HARRY SHEARER:  What would happen if Ron Paul got his way and the United States went back on the gold standard?

STEPHANIE KELTON:  Well, we had eight depressions on the gold standard and zero off of the gold standard. It is a system that constrains you in a way. You have a flexible system today that provides you with policy space that you simply do not have when you’re on a fixed exchange rate system, a gold standard system, when you’re adopting a currency that you don’t control like the euro – those types of monetary systems, the gold standard and the rest, they place constraints on you that limit your fiscal space. And the reason it’s important is because when you have an economic downturn, and you inevitably will – every single market economy on the planet has cycles. We have booms and we have busts, every one, independent of the type of monetary system you have. So when that bust inevitably comes, you just won’t be able to respond effectively. Which is exactly why countries went off the gold standard every time they went to war and every time there was a serious economic downturn. They all go off gold. Every time. In other words, it works until it doesn’t work.

HARRY SHEARER:  Got it.

STEPHANIE KELTON:  That’s what I would say about gold.

HARRY SHEARER:  So there is a series of seminars or lectures on the Internet right now at Columbia University that you and Warren Mosler and R–

STEPHANIE KELTON:  Randy Wray.

HARRY SHEARER:  Randy Wray –

STEPHANIE KELTON:  Mhmm. Mhmm.

HARRY SHEARER:  – have participated in so far. Does this indicate that an Ivy League school’s economic department has endorsed what you guys are saying?

STEPHANIE KELTON:  Well, no.

HARRY SHEARER:  (laughs)

STEPHANIE KELTON:  What it does indicate is that the law school – and because so much of what we do has legal, you know, underpinnings and implications for government policy and law – the law students got behind this and they organized this. And it’s a year-long seminar. They’re doing four or five this semester and four or five next semester, free and open to the public and all that. But it’s just a really heroic effort that was put together by a young law student at Columbia who discovered our work a few years ago and began following it and then began obsessing about it in some way and then when – you know, as if it’s not enough work to be a student at Columbia Law School, he decided he would raise funds and organize a year-long seminar series about these ideas. But he is getting people to moderate the sessions, people who are in the Journalism Department who are prize-winning journalists, and people from the History Department, and so forth. So it’s really given us an opportunity to interact with some scholars in different fields and collaborate and so forth.

Now, Joe Stiglitz is there at Columbia University in the Economics Department, and you know, this is Nobel Prize-winning economist, former head of the World Bank. This is a very, very smart man who has moved closer and closer over the years to the position that I’ve been espousing, you know, for the last hour or so. And you can just see it. You know, he’s really starting to connect the dots. And so is Paul Krugman. And so is Martin Wolf, who writes for the Financial Times. And so are people at The Economist. And so are people at the Washington Post and the Wall Street Journal. All of these news outlets and magazines and so forth have run stories that develop the ideas that I’ve been putting forward here with you today, and this is exactly what we need. We need more people saying these things and a more diverse, you know, group of individuals from different walks of life and different – you know, media, press, academics and so forth. And eventually I think people will start to recognize that this is – we’re just describing the way things work, and we really do have the capacity to improve conditions without harming people, that this debt and deficit bogey is doing real harm.

HARRY SHEARER:  You are the editor, I believe, of New Economic Perspectives, a web blog, yes?

STEPHANIE KELTON:  Yes.

HARRY SHEARER:  And one of the people who’s written for that, or who writes for it fairly frequently, has been a guest on this program, Bill Black, so if any listeners who were intrigued by Bill Black or what’s been talked about here today want more, neweconomicperspectives – dot com, is that correct?

STEPHANIE KELTON:  Dot org.

HARRY SHEARER:  Dot org. New Economic Perspectives, newconomicperspectives.org would be the place to go.

Dr. Stephanie Kelton, thank you so much for being with me today. You’ve made it clear enough that I can understand it, and that’s a big deal. But thank you very much, and continued good luck to you.

STEPHANIE KELTON:  It’s been an honor and a pleasure. Thank you so much.

HARRY SHEARER:  Thank you.

[…]

Ladies and gentlemen, that interview was recorded on [Thursday] with Stephanie Kelton.  She tweeted me shortly thereafter to say, “It occurred to me that I talked the upside of the Clinton economic situation but didn’t say it was built on the back of private debt, left people to conclude that budget surpluses drove it.” So, that’s from Stephanie Kelton.

Speaking of which, the URL for New Economic Perspectives and for the video seminars being put on by Columbia Law School are on the website at harryshearer.com. Also, because we mentioned the Peter Peterson Foundation, their URL is on our website along with a story in the Los Angeles Dog Trainer– the Los Angeles Times, pardon me. They’re publishing daily now about the Peter Peterson Foundation. All of that is on the website at harryshearer.com.

Thanks to David Greene here at KCRW and the gang at KCUR in Kansas City for helping with the engineering of today’s broadcast. Welcome aboard to our newest affiliate, WFBK, somewhere in North Carolina.

This concludes this week’s edition of Le Show. The program returns next week at this same time over these same stations, over NPR Worldwide throughout Europe, USEN-440 cable system in Japan, around the world through the facilities of the American Forces Network, up and down the East Coast of North America via the shortwave giant WB– I can’t even remember the name of the station! [WBCQ The Planet 7.415 MHz shortwave] – on the Mighty 104 in Berlin, available for your smartphone through stitcher.com, available as a free podcast at kcrw.com. It’ll be just like me remembering what I’m supposed to say if you could agree to join with me then. Would you? All right, thank you very much, uh huh.

Thanks as always to Pam Halstead. This broadcast is on Twitter. Join the almost 75,000 followers @theharryshearer. If you’re in Santa Monica this afternoon at 4:00, your last chance to see the remarkable Cabaret of Souls at The Broad Stage. You will be glad you did. Le Show comes to you from Century of Progress Productions and originates through the facilities of KCRW Santa Monica, a community recognized around the world as The Home of the Homeless.

Fountains of Wayne will also be performing with Harry on Conan on TBS on October 23rd. CLICK HERE to check local listings.

Here it is!

From deep inside your radio.

HARRY SHEARER:  This is Le Show, and it’s time for what appears to be a semiannual visit from Yves Smith, a financial consultant and blogger. You heard her last on this program last fall talking about the European meltdown, and she has been our go-to person on the financial meaning of the foreclosure – as we call it here, the New F-Bomb, the foreclosure crisis. And she is here to talk about her analysis of the much bragged about, at least in Washington, settlement with the banks led by the United States Justice Department and agreed to by 49 of the 50 state attorneys general. A long-winded way of saying here once again is Yves Smith. Yves, welcome to the show.

YVES SMITH:  Thanks so much, Harry.

HARRY SHEARER:  I gather you’re not one of the cheerleaders for the settlement.

YVES SMITH:  No, I’m not.

HARRY SHEARER:  I’ll say, as you’re drawing that breath, you have been basically on this story since the first news broke of Iowa’s attorney general, Tom Miller, heading up the state AGs delegation to discuss this with Washington. This has been in the gestation period for 16 months now, which means that it’s taken about as long to birth as certain kinds of shark.

YVES SMITH:  (laughs) I’ll have to remember that one.

HARRY SHEARER:  I looked up “gestation period” this morning.

YVES SMITH:  Oh that’s very good, that’s really very good. And it’s interesting that you go back to the beginning of this because of course in the beginning, like so many of the administration-related initiatives, the grand things are promised and then are walked back. I mean, Tom Miller at the beginning promised criminal prosecutions, and within weeks he was walking that back.

So we’ve had these negotiations drag on for a year with the banks continuing to maintain that A) these were paperwork problems, and B) they had solved them, when they’ve continued to file the same kind of problematic documents in courts.

You know, the evidence of the banks’ unwillingness – either unwillingness or inability – to fix this problem is partly evidenced by what’s happened in New York. New York implemented a fairly tough standard in its court system. The lawyers had to certify that they were submitting – that they had taken reasonable steps to verify the documents. Now that basically makes it easier for them to be disbarred or sanctioned if they don’t do that.

HARRY SHEARER:  You mean they were legally required to submit documents that they could certify were true and accurate in court?

YVES SMITH:  Right.

HARRY SHEARER:  Imagine that.

YVES SMITH:  I know. Well that’s actually what a lawyer should do anyhow.

HARRY SHEARER:  Yeah!

YVES SMITH:  You’re correct. But this basically made it easier, this procedure made it easier to sanction them if they didn’t do that. And foreclosures have basically stopped in this state. I mean they’ve gone from an average of over 150 a day to an average of less than 5. I mean that’s an admission. I mean, that’s continued now. That’s an admission that they can’t do this correctly.

And so here we had this settlement ballyhooed, where they’re talking about, depending on who’s doing the messaging, they talk about either greater than $26 billion, or some of them try to make the credits sound more impressive and I’ve seen it talked as nearly $40 billion, when it’s $5 billion in cash. Across these banks, that’s not even a meaningful number in a quarter. And the rest of the credits, the rest of the items, are almost certainly going to come from investor pockets and/or they’re a bit phony baloney. I mean, for example, one of the things they’re counting as a credit is $3.5 billion for writing off deficiency judgments.

Now, to unpack that, if someone is foreclosed on and they sell the house, and the proceeds from the sale of the house are less than the mortgage, there’s a deficiency judgment and depending on the type of mortgage they can in theory go after the borrower. Banks – even though banks are now making noise that they’ll do that, they basically hardly ever do. So they’re going to get to count for credit writing off money they probably weren’t going to go after anyhow. I mean that’s the sort of thing that’s in this deal.

But the part that’s really heinous is that of the number that’s credits, a big chunk of that is principal writedowns. So you say, “Gee, principal writedowns are great, how can you object to principal writedowns?” Well, these banks have second liens that they have on their balance sheet, whereas most of the first liens, the first mortgages, were securitized. Which means they are owned by investors, not the banks. And they get credit for writing down those first mortgages. So here they did bad stuff, but they pay for it by getting to get investors, third parties, to take the hit, and in many cases they have second liens on their own books. So if you write down the first mortgage, that makes the second lien better because the borrower’s got less debt and more ability to pay the second lien. Now they will have to knock down the second lien a little bit, but basically the bulk of the dollar value is going to come from the first lien, because the first liens are bigger numbers. So this is benefiting the banks, sort of, in the end.

HARRY SHEARER:  You have been fairly consistent in pointing out the existence – the overhang of these second mortgages, these second liens, and asserting that as long as the banks aren’t forced to write them down to the new lower market value that the housing market has reached, they are able to forestall admitting billions of dollars of losses which in some cases, particularly Bank of America, might render the bank insolvent. Do I have that right?

YVES SMITH:  That’s correct. I mean, Bank of America has, from these second liens, they’ve got about 120 billion dollars in second liens and their book value of – there are different measures of equity – their broader measure of equity is more like $230 billion. I’ve had investors tell me those second liens should be written down by $100 billion dollars, and in fact the market already thinks they’re worth less than that. Their market capitalization is actually $75 billion, so if you were to take the full hit on the second liens, it’s more than the stock is trading for in the market right now.

Now the banks argue they shouldn’t have to take the hit on this because they claim that people are still paying. Well, guess what, most of these are home equity lines of credit – they can play all sorts of games to make them look current, like taking a very minimal payment right before the 90^th day or simply increasing the home equity line so the person pays with it from more money they’re borrowing from the bank.

HARRY SHEARER:  Borrowing money from the bank to pay back the bank.

YVES SMITH:  That’s right.

HARRY SHEARER:  A conservative critique of this settlement alleged that of that 5 billion dollars in hard cash that you mentioned, that’s basically money that the banks got from the government in the bailouts.

YVES SMITH:  That’s another good way of looking at it, yes.

HARRY SHEARER:  But let’s talk about enforcement, because you’re a critic of the enforcement mechanisms that they’ve bruited about this settlement as well.

YVES SMITH:  Well, they keep talking about how the states will have some enforcement power, but what counts here is, first line of enforcement is the banks will make quarterly reports. You don’t have independent parties going into the banks the way you do, for example, with regular bank regulatory abuse where you’ve got examiners come in and sort of kick the tires on a regular basis. Instead you’re going to have a process where the banks report on how they’re doing. Do you think if somebody’s doing their own grading they’re going to give themselves a bad grade?

And similarly, it’s modeled very much on the enforcement process the Office of the Comptroller of the Currency implemented in some consent decrees they had with these same banks over servicing in early 2011, and there’s already been a news report where the OCC found close to 400 million dollars of, you know, things that they thought the banks should be fined for. But they’re not going to charge them the fines, they’re just going to hold the fines in abeyance. And wave their finger at the banks and tell them to do better.

HARRY SHEARER:  You had on your site, which I should mention – I didn’t in the intro. You’re the author of the book ECONned, and you’re the ringmaster of the wonderful website Naked Capitalism. And you had on your site – you had gotten from your sources the template of the press releases which the state attorneys general were to release simultaneously with the announcement of the settlement in Washington, and there was language in that template press release that described widespread fraud, was there not?

YVES SMITH:  Yes. Which was a rather surprising admission. I was sort of shocked that that wound up in there. So they’ve admitted that there’s fraud, and yet they’ve now determined that the price of committing widespread fraud is $2000 per borrower. That’s the restitution that’s going to be paid for borrowers that had their homes foreclosed on from late 2008 through the end of 2011.

HARRY SHEARER:  You’ve also been fairly adamant about the deficiency of this, or the advantage that was given to the banks and other financial organizations by the drawing out of this process of reaching the settlement – that is to say, they’ve passed the –

YVES SMITH:  Statute of limitations, yeah. Yeah. You know, and honestly I don’t know if this was – in retrospect it looks like it was by design. It may have just been dumb luck. But some of the best legal theories are securities law theories, because for most other types of fraud you have to prove intent. And of course these organizations, you know they have all kinds of diffuse responsibility. I mean you see the way these CEOs regularly get up in congressional hearings and suddenly, you know, know nothing and have no memories.

HARRY SHEARER:  It’s a real generation of hands-off management.

YVES SMITH:  Yes, it’s really quite astonishing, isn’t it? But you also have, in the way process related to securitization, you have multiple hands on these things. So for example, you know, servicers foreclose but they use a company called Lender Processing Services as arms and legs, and Lender Processing Services inserted itself as the interface with the foreclosure attorneys. So the servicers have, you know, if you were to try to pin a lot of stuff on them, I mean you know you probably could in the end, but it would take a lot of work because they’ve got all of this, “Well, it was really the foreclosure mills guys,” or “Oh, Lender Processing Services did it.” I mean you have to dig a bit to actually find the smoking gun and paint the picture of how the servicer really must have known or did know what was going on.

But in any event, whereas with securities laws, they’ve got a very simple standard, which is that the foreclosures have to be – they have more technical language but it amounts to accurate and complete in all material respects. So that it’s not just that what you say is true – it can’t be like that sneaky true where you, you know, don’t omit to say certain things – the things you say have to be complete disclosures. So that if it turns out something wasn’t true and it was something you should have disclosed, just the inaccuracy of what you said is securities fraud.

HARRY SHEARER:  Now, just on the issue of fraud for a moment. If I pass a check and I sign it as if I’m the authorized signatory on an account and I’m not, what might I be penalized with?

YVES SMITH:  Yes. I would assume that as soon as they found out, the FBI or somebody like that would be on your doorstep pretty fast.

HARRY SHEARER:  Yeah. And I might be even doing jail time. Is it not possible to interpret this entire affair as another example of, “We’re looking forward. We’re not looking back. We’re not –”

YVES SMITH:  Right. No, I think that’s right. And the appalling part about this is not only is this yet another example that, you know, what does the rule of law mean in this country? I mean this was just the most massive abuse of well established property law imaginable. I mean, the precedents are so well set here. You know there’s no pretending that people didn’t know what they were doing, and these practices were institutionalized. I mean it’s been well publicized about how, you know, these robosigners were producing documents on a mass basis. There’s no question these organizations didn’t know about it. And that’s only the tip of the iceberg.

You know, one of the parts that keeps getting obscured here is the reason a lot of these bad practices happened was because there were other practices that people are aware of them but we still don’t really know the full extent of them because no one’s wanted to go there. The fact that these securitizations originally appear to have been done in a deficient manner in that they established really specific ways that the notes, which is the original – when you sign a mortgage you actually sign a note, which is a promise to pay, and that had to be transferred in a very specific way to the trust, which is basically the legal box that all the mortgages sit in, and then the money goes into that and then it gets distributed to investors. But there were very specific procedures and those were violated, and it looks like on an endemic basis. And that’s part of why we had the robosigning and the other abuses was to sort of fix the problems created by the fact they didn’t observe their own procedures.

So there are whole other layers of this mess that this talk about the robosigning in the settlement, you know, conveniently obscures.

HARRY SHEARER:  Well, you, in our first conversation and in your writings on your website, more than 16 months ago you were on this, you were on the deficiencies of MERS, the electronic registry, which now – and much of what you’ve said has now been discovered and vetted and vindicated by judges in many states and by several attorneys general filing suit, most notably Eric Schneiderman filing suit against MERS. You have said, in your criticism of this settlement as it’s been a-borning, during its shark-like gestation period, how can you settle claims when you have never done an investigation of how widespread the wrongdoing was?

I’m going to quote you from the Justice Department’s own press release about this settlement, and it lists a series of investigating agencies that this settlement resolves their investigations, and it’s Justice, HUD, HUD’s FHA, state Attorney General’s Office, state banking regulators, US Attorney’s Office for the Eastern District of New York, US Attorney’s Office for the District of Colorado, Justice Department’s Civil Division, many US Attorneys office, Federal Trade Commission, Treasury, SIGTARP, which is the special inspector general for TARP, FHFA – Justice says these agencies conducted investigations. Your contention is they haven’t even started, right?

YVES SMITH:  That’s correct. I mean, the two investigations that were the most serious were basically over the administration’s dead body. One was by the inspector general of HUD, which is an independent body within HUD, and they found errors by different servicers in some cases up at a rate of 60%, as high as 60%. The other one was by the US Trustees’ office where they found that the error rate in bankruptcy filings was ten times at the level found by a very limited federal foreclosure task force.

So, yeah, all these – the big investigation that they like to hang their hat on – big, I should put a big irony alert around that word – is one that they had a little more than a year ago, again, right after the robosigning broke. It was an eight-week investigation. It involved 11 different federal bodies, so, you know, those 11 names would all be on that list, but it was HUD, I think the FHFA, definitely the Office of the Comptroller of the Currency, definitely the Fed, and they looked at a grand total of 2800 loan files. They did not do any external verification of the information in those loan files, and they looked at a mere 100 foreclosures. That was considered to be adequate.

HARRY SHEARER:  There have been certain states, certain counties even, that have sued the banks and MERS, trying to reach around MERS to the banks, for all of the fees that were not paid, that would have under normal real estate law have been paid as these mortgages were transferred from one hand to another on their way to trusts. Do those remain in force? Have those been wiped out by the settlement?

YVES SMITH:  The Schneiderman lawsuit is the most recent. That stands. I’m pretty sure the other two – the Coakley and the Biden suits – stand as well. Now Biden only sued MERS and did not name any banks, but he said he would insist on being able to add banks, you know, basically when he developed the evidence.

HARRY SHEARER:  That’s Delaware’s attorney general, Beau Biden.

YVES SMITH:  Delaware, right. Beau Biden, right. Coakley of Massachusetts, Martha Coakley of Massachusetts, already named the five biggest servicers in her suit. Schneiderman named three of the five and he says that he reserved the right to name additional banks.

Now, that’s good news. The sort of, you know, bad news of this story is that it isn’t cl– and I’d be delighted to be proven wrong. I mean I would be delighted to be proven wrong. But it’s very clear that recording fees were avoided. I mean in fact MERS brags about this on its website, about one of its big raisons d’etre is that it saved originators the hassle of the multiple trans– again, we discussed earlier the way the notes were transferred multiple times? Well, every time the note was transferred, there was supposed to be a recording fee paid which averaged about $35. Obviously it varies a lot by county, but $35 is not a bad number. And they were able to skip a number of those transfers, and then only transfer the mortgage basically out of the MERS system when they try to foreclose.

Well, the problem is establishing who actually benefited from saving all that money. Now MERS clearly did, because, again, MERS brags about it, and MERS would have probably no business if it weren’t for saving the recording fees and also saving the hassle. But MERS is an itty bitty company with 50 employees. I mean there’s nothing there. There’s nothing to sue there. So to get any money and get any resolution, you’re going to have to recruit other parties.

And the problem is, who benefited from saving the recording fees? The banks are going to argue, “Oh, well it was all the parties to the origination, including these, you know, little shell companies that the notes were passed through, oh and the investors, oh and the borrowers.” I mean, they’re going to claim that, you know, they’re basically going to say, “To the extent we owe anything, it’s us and a zillion other people, and you gotta go after them too. You know, it should be prorated among us and a huge number of people, and we really don’t owe very much of this problem.”

HARRY SHEARER:  But if MERS was formed – let’s look at it in the darkest possible light for a moment –

YVES SMITH:  (laughter) Since we’re in that mode anyhow.

HARRY SHEARER:  Yeah – as a conspiracy to avoid paying recording fees. If homeowners and all these little bitty shell companies were not present at the conception, how can you blame them?

YVES SMITH:  Well I think the issue is, it’s financially who benefit–

HARRY SHEARER:  But if the legal theory –

YVES SMITH:  Yeah. Yeah. Yeah.

HARRY SHEARER:  But if the legal theory would be that you go after the conspirators, and who conspired to organize MERS in the first place?

YVES SMITH:  Well, that’s an interesting way of going about it. I guess the problem I see with that is that normally you can’t reach through and assign liability to a shareholder. So if you were the venture capitalist who, you know – let’s say some high tech company launched a device that really did give everybody cancer very quickly. You know?

HARRY SHEARER:  You can’t go after the venture capitalist investor.

YVES SMITH:  Venture capital company, right.

HARRY SHEARER:  Right. But let’s look at another analogy, use of the RICO statutes.

YVES SMITH:  Everybody talks about that. I haven’t seen anybody willing to do it, and I admit I haven’t looked that hard, but Bill Black has written something and he hasn’t unpacked– Bill Black is a former banking regulator who is now a Professor of Law and Economics at the University of Missouri Kansas City.

HARRY SHEARER:  And a criminologist.

YVES SMITH:  And a criminologist, yes. In fact, he’s trying to promote the specialty of white collar criminology, and let’s hope he succeeds in turning this into a real discipline. But in any event, Black has basically said something in passing that I didn’t see him unpack, but he said basically that effectively that RICO suits are kind of hard to prove and he sounded like he wasn’t so keen about them. But I mean they certainly sound, you know, just in terms of getting to criminality, you know, sort of basically saying that something that was, you know, a pattern and practice, that was deliberate, really is criminal as opposed to civil. I mean, I think that, you know, if – I mean I wish it – I would pursue criminal angles here. I mean I think that that really everybody keeps pooh-poohing that that isn’t a deterrent, and I think that’s – the converse. I think white collar people are very afraid of going to jail.

HARRY SHEARER:  If they’re not, they should be.

YVES SMITH:  They should be. Yes, they need to be.

HARRY SHEARER:  Yeah. There are a couple of videos on YouTube I could point them to if they’re not. The settlement is a release from certain civil cases, but it is not a release of criminal action, is that right?

YVES SMITH:  That’s correct. But again, the only criminal action we’ve seen so far are suits of basically very specific actors. I mean, there was one in Nevada that was of two people who were effectively managers of a robosigning operation. They were sort of supervisory level. And then the other one was just filed in Missouri that goes after a shuttered subsidiary of the company Lender Processing Services. They go after both the company and the president of that company, the former president of that company. So that would be, you know, kind of interesting to see if that one goes anywhere. Because that actually would be a more senior level person. But again it’s related to forgery.

HARRY SHEARER:  Was that DocX?

YVES SMITH:  That was DocX, yes. And people seem remarkably unwilling to call forgery forgery. You know, it’s called all sorts of other things like robosigning or surrogate signing or…

HARRY SHEARER:  Or paperwork problems.

YVES SMITH:  Paperwork errors. Yeah, paperwork problems.

HARRY SHEARER:  Yeah. You’ve also been fairly consistently critical of the impact that any such settlement would have on the buyers, which are identified by you and others as pension funds among others, of the securitized mortgages – the securities based on these sliced and diced mortgages. So, where are they in this, those buyers, those investors?

YVES SMITH:  Well, there are a couple that I’ve been speaking to, and they were extremely unhappy with the provision that I mentioned earlier, that the first mortgages would be written down without the second mortgages being wiped out. Because normally you would always have a second lien eliminated before you would ever modify a first lien. Now that doesn’t mean that they’re opposed to mortgage mods per se, they just want the seconds to take – I mean the seconds got higher interest, you know? That was the whole second in line. And sort of why is this well established hierarchy of who gets paid first being, you know, upended? I mean, this is, you know, from a securities law, securities payment standpoint, this is unheard of.

But the fact is there seems to be no interest in fixing the private securities market. I mean, we’ve had – housing finance has been on government life support since the crisis. I mean, well over 90% – I think it’s close to – it was 99%, I think now there has been one category, a teeny category, that’s picked up a little bit, but basically mortgage finance is now completely coming from the government. There really is no meaningful private mortgage securitization market. Whereas before the crisis, about 60% of the mortgages were non Fannie and Freddy mortgages.

So there’s been a big shift in terms of how that market works. And the experts I speak to all say there’s no way that investors are ever going to come back into that pool. Or at least there’d have to be very, very radical changes. They weren’t even willing to invest before this, because they saw how bad the practices had been, both, you know, as we’ve alluded to earlier in this talk, the fact that the loans were really misrepresented in a very major way when these deals were put together. Investors were told they were better than they were, and then the deals were si–

HARRY SHEARER:  Wasn’t that the purpose of the Triple-A ratings was to mislead investors as to the quality of the underlying loans?

YVES SMITH:  Well, the rating agencies would say that wasn’t the purpose of the Triple-A ratings, but, you know, certainly the people who put them together –

HARRY SHEARER:  Well, the effect of –

YVES SMITH:  The effect? No, the people who were putting together these deals knew that the – knew, understood how the rating agencies models worked and worked hard at gaming them. I mean, that’s, that’s, people in the industry are quite up front about saying that. But they also just affirmatively lied. And the rating agencies will say they weren’t responsible for – you know, they just take the information that’s presented to them and assume it’s truthful. They’re not in the posi– you know, they claim “Our job is not to verify the accuracy of the information.” Again, it’s supposed to be reported accurately in those Securities and Exchange Commission documents, that when somebody’s given a prospectus, the prospectus is supposed to be truthful and complete. You know, and so this is why the lack of securities suits is pretty appalling.

So that part is a mess. And the other part which is a mess, which isn’t as much talked about, but investors are acutely aware of, is a whole another level of servicer abuses that no one is talking about, the fact that the servicers are putting all kinds of junk fees and impermissible fees and just literally making numbers up.

I mean, this was one thing that came up in the US Trustees report, and they are basically the part of the Department of Justice that’s responsible for making the bankruptcy courts work well. And they found abuses literally like somebody in a bankruptcy, a servicer said that the borrower owed $50,000, you know, for one piece of the mortgage. Like, something like $50,000 in fees, and the borrower challenged them, and they said, “Oh, well it’s only $3,000.” I mean, and with no substantiation for either the first or even the second number. I mean, so where’d they get the $3,000 from? You know, that was probably made up too. It’s just $3,000 is better than, you know, $52,000.

But the point is that, as bad as that sounds for the borrowers, when it’s in a foreclosure, remember that all those fees that were thrown onto the borrowers, the borrower doesn’t pay them; it then gets recovered from the investor because when they sell the house, the thing that gets taken out first are the fees that the servicer charged or loaded in there that aren’t legitimate.

HARRY SHEARER:  So that’s first out? That’s first out?

YVES SMITH:  That’s first out. That’s first out. So actually, wait, take it back. The first thing that’s out is servicer advances. Take it back. The first thing that’s out, and that’s still not very good, is that when somebody defaults, the investor still keeps getting paid as if the loan was performing, as if the borrower was paying. So they’ll still keep paying as if the borrower was paying. So let’s say you’ve got a foreclosure that goes on 20, 30 months. The investor’s getting paid, but they’re just basically, you know, taking from one pocket and giving to another because that money then gets taken out of the liquidation of the house, the sale of the house.

HARRY SHEARER:  So they have to turn right around and pay it right back to the people who –

YVES SMITH:  They have to pay it right back. But that also gives the – and now that may sound like it’s a wash, but really it isn’t, because it gives the servicer motivation to keep extending these foreclosures, because as long as they still have the loan in their system and they haven’t actually sold the real estate, they’re still collecting a monthly servicing fee and they still get to collect late fees.

HARRY SHEARER:  So that incentivizes the drawing out of the foreclosure process which people keep saying, “Oh, well we’ve got to clear the market. We’ve got to speed this up.”

YVES SMITH:  Right. And they’re implying it’s all the fault of the court system, when again, you know, I gave the example of New York, but there’s also the example of Florida, where after the robosigning scandal, judges now say that they can’t get a bank in court. You know, that banks – and I heard a report just the other day from somebody in Baltimore saying, you know – now this may change a little with this settlement, but I sort of doubt it – where they said, you know, people who want to do, you know, short sales or buy properties that the banks own, the banks won’t talk to th– or that are in foreclosure and they think the bank is going to sell the property, right? The bank hasn’t actually, you know, finished the last step of eviction and putting the prop– there’s a category called real estate owned. You know they may sort of be in the advanced foreclosure stages, but you know there are cases in Florida where it’s months where from when they have a final judgment, where the bank really in theory owns the house, and they don’t evict. I mean, so there are other reasons they’re dragging it out, and that’s probably the second mortgages. Because once they evict and they actually finally take the property, then they would have to write down the second lien if there was a second lien.

So there are all kinds of – you know, there’s all kinds of behavior which is very dysfunctional, and people are theorizing as to why it is, and the court system does not seem to be anywheres near a sufficient explanation. I mean there are just too many facts out there in terms of what’s happening in the courts on specific cases that say it’s not court backlog.

HARRY SHEARER:  If the investors are – and correct me if I’m wrong, but the investors are characterized, as I say, as pension funds among other things – CALPERS is in big time, right?

YVES SMITH:  Right. And the very biggest ones, PIMCO, the big bond investor, is very big in that space.

HARRY SHEARER:  Why aren’t they going after the banks and the servicers and the misbehavers?

YVES SMITH:  Well, there are a bunch of complicated reasons. One is that they’re really not very well set up to sue people. Bond managers get very little in the way of fees. Most of them are part of bigger fund complexes, so it’s not like even if the manager of a particular fund is really motivated and upset and wants to do something, he can’t go launch a suit. He has to, like, you know, go through a big bureaucratic procedure and get the general counsel on it. You know, he can’t just call up a lawyer and do it. So you’ve got sort of those kind of, you know, internal bureaucratic reasons.

Another big reason is that for many types of lawsuits, there were restrictions. Now I don’t think that actually appl– it probably doesn’t apply to these sort of, you know, stealing from the trust ones, but for the ones that most people have talked about where they were lied to in the beginning of the deal about how good the deal was? Believe it or not, you have to get, in most deals, 25% of the investors together to sue, and it’s not easy to find them because there aren’t lists of who the other investors are. So literally somebody had to form a great big database even for investors to sort of find each other to see if they could get to the 25% number to be able to sue. So you’ve got that problem.

And then the other problem that you’ve got is frankly a lot of the investors are afraid of the banks. I had one of the attorneys, Tal Franklin, who has represented some investors in litigation, and he said to me that, he said that for some of these investors, if Jamie Dimon were to kill their children, they would not call the police. They do business with these banks. They think they depend on these banks. They don’t want to ruffle them too much.

I mean there was one investor – and it’s a completely different kind of abuse, but this is indicative of what the banks are getting away with these days. One former client of mine is a billionaire, and among all the industrial entities that he owns they had about a billion in cash sitting around, and they thought, “Well, a billion in cash, that’s enough, we should like, you know, get it together and have it managed a little better than we are.” And they didn’t have ambitious goals, they just wanted to get a little bit more than if they put it in Treasury bills. And they had all this – I mean I read the agreement. They had all this language about how it was supposed to be managed conservatively and distributed in different buckets and be very liquid – you know, “safe, safe, safe” was all over what they had written. Well, it turns out that on a billion dollars, JP Morgan Chase managed to lose about 100 million, on a billion, yes.

HARRY SHEARER:  A hundred million.

YVES SMITH:  So 10%.

HARRY SHEARER:  Yeah.

YVES SMITH:  And they’re suing them. And this billionaire goes on – and he makes it very clear that his beef is with JP Morgan, that he’s not an enemy of the banks generally, that he does a lot of business with banks and, you know, that he uses them for financing and whatnot. And all these players, you know, have some dependency on the banks.

And so unless you have a lot of big investors get together, individual ones feel very – it’s like the wildebeest, right? You know, if you’ve got one wildebeest on savannah it’s vulnerable? You know, if the wildebeests all go in a herd then they’re safe? You know, so you’ve got to get a really big herd of these investor wildebeests for them to feel safe, and so far they haven’t gotten together in big enough numbers to feel like they can, you know, go across the savannah together.

HARRY SHEARER:  Well, hearing you describe that, my question would be, supposedly these banks compete. So if you sue –

YVES SMITH:  (laughter)

HARRY SHEARER:  Thank you.

YVES SMITH:  Not when there are so few anymore.

HARRY SHEARER:  Thank you. Thanks for the laughs. So, when you sue JP Morgan Chase, maybe Wells Fargo would like your business. So the theory behind this would seem to be that they have bigger fish to fry than competing against each other.

YVES SMITH:  Oh, well, that part is true, but I guess, you know – and I should say that the other reason the billionaire is a different case is that he doesn’t need to work with as many different banks. These big funds typically already need to work with different banks. They typically are in a position where they couldn’t possibly work with one bank for all their business. They’re very horses-for-courses, so they – in particular the very large funds. I would suspect that the big funds like PIMCO probably have relations with all the major Wall Street firms. They use them for – you know, they spread their business around because they get intelligence and they don’t want to be too – they think they get intelligence. Who knows if the intelligence they get is any good. But they spread their business around. So, and even hedge funds that aren’t very large always try to spread their business around two or three banks.

HARRY SHEARER:  So, the –

YVES SMITH:  And there now aren’t that many left, right? So.

HARRY SHEARER:  Yeah, right. So the civil litigation door in many cases is being shut by the settlement – litigation by governments – and the litigation by some of the affected parties, i.e., the investors, is forestalled by fear of bank retaliation. So what’s left is criminal prosecution in these few instances that are not where the statute of limitations has not expired. Is that where we are?

YVES SMITH:  Well, and, individuals still can sue. So we’re going to have this crazy disconnect where borrowers are going – because borrowers are still getting more sophisticated in terms of understanding the problems with how these deals were put together and the bases they have for fighting banks. And this settlement is not going to provide relief – even to the extent it works, right? Because the principal modifications, the banks have three years to do that and I think the admin– I mean, you know, different people throw out different numbers, but at least the number that I’ve seen is 750,000, although I think HUD keeps spinning it as it could be up to 2 million. So either a few are going to get more, or a lot more are going to get less.

HARRY SHEARER:  Out of 11 million people that are underwater.

YVES SMITH:  Underwater. Exactly. Exactly. So, yeah, 2 million is the maximum, and given how well the administration’s past efforts to fix the problems have done – I mean HAMP I think came in at well under, helping well under a quarter of the people it was targeted to help.

But in any event, the point is you still have a large number of people who are not going to get a benefit from this who are under stress, and, AND we’ve got this huge number of foreclosures that are still in some degree of being processed that aren’t going to be affected by this either. So you still have this tremendous overhang of property – you know, what people are calling shadow inventory. Nobody sort of knows how big that number is, but it’s large.

And then you’ve also got the fact that borrowers are still going to be able to fight foreclosures on an individual basis very successf– you know, well, depends on the judge. I mean it all depends on their willingness to fight.

So the effect of taking the AGs out of the picture and the government out of the picture was that we’ve lost a big mechanism for coming up with some – a good – well, not there’s a good resolution to a bad situation, but a comprehensive solution that would really get at much more of the roots of this problem. Instead we’ve basically put a bandage over a gunshot wound that’s now starting to get infected and is on its way to gangrene. I mean this is just crazy.

HARRY SHEARER:  But, had the settlement not occurred, the attorneys general might have pursued investigations, the results of which could have benefited those private parties in litigation. That is to say they could have used the fruits of the investigations –

YVES SMITH:  Oh, yes, absolutely. So this has weakened, yes – even though private parties can still sue, they aren’t in as good a position as they probably would have been if they had, you know, evidence that had been found by attorneys general and legal theorists.

Plus, just the press. I mean, look how the robosigning changed the attitudes of judges. I mean, judges, it used to be that if a borrower came into court and tried saying the bank screwed up, it was just like, “You’re a deadbeat borrower, the bank’s a bank, of course I’m going to believe the bank. I mean, who are you? You didn’t pay.” And the robosigning scandal, the press around that completely changed attitudes of, not all, but a lot of judges. And similarly, if the attorneys general were pursuing suits, again the press around it would have an impact on judicial attitudes.

So, yes, the banks, you know the banks won on, you know, even though private parties still can sue, or fight, this was still a very big win on lots of other levels for the banks.

HARRY SHEARER:  So your overall verdict on this settlement, Yves?

YVES SMITH:  Well it’s stinky. (laughs) It’s really bad. You know, I just am so, I’m just so appalled that the – you know, in some ways I’m actually more appalled by the attorneys general who had been fighting, throwing in the towel. I mean because the administration’s behavior on this was predictable. And the administration really could have done a deal even with the 40 attorneys general – 40 to 44 they were probably going to get anyhow. I mean, all of the Republican AGs were going to go for this, except interestingly for the Oklahoma holdout, and a significant number of the Democratic ones were really not going to pursue any investigations, either for budget or just attitude reasons. But the ones who were pursuing this aggressi– and of course they’re going to maintain they’re still pursuing it aggressively, but they’ve just narrowed what they can do tremendously. They’re basically saying, “Well, you know, we’ve decided that just picking a few spots will be okay, and we’ll live with that.” I mean I just find that really inadequate.

HARRY SHEARER:  So, what’s your view of the state of the law of real estate transactions and financing –

YVES SMITH:  Well, it’s really been thrown – we’re really back to before something called the 1677 Statute of Frauds. I mean, these procedures all came about, the whole, the fact that you have a signature notarized by an independent party, you know that came about because there was a period in England where literally you could basically hire an expert witness and have a person lie and steal someone’s property. And things became so chaotic that they had to basically say, stop, and we’re going to implement some procedures. And those procedures comported themselves very well for hundreds of years. And now we’ve decided to reverse that to a significant degree, because we’ve decided the banks can’t take a hit. I mean this is just crazy.

I mean, you know, even – you sort of alluded to conservatives earlier on, but you know conservatives believe in the sanctity of contract and the sanctity of property rights. I mean this is an issue for people of both sides of the political spectrum, and it’s shocking that if you and I signed a contract we’re held to it, and if a bank signs an agreement they’re not. I mean that they can just, you know, pay a fine, which is not proportionate to the damage they’ve done, and treat it as a cost of doing business. I mean, and there are cases.

You know, I keep coming back to this issue of what is called “servicer-driven foreclosure.” You know, first there – and there are lots of levels of abuses that are less than that. But for example, there’s one attorney that I know who he first got into foreclosure defense when a guy walked into his office at 5 in the evening and said, “You gotta file bankruptcy.” And he says, “What are you talking about? Filing for bankruptcy at 5 in the evening? I mean, can’t this wait?” And he goes, “No, the bank’s about to take my house and I need to file for bankruptcy now,” and he said, “Now I’ve really made all my payments. You know, I’ve been fighting with the bank and, you know, this is why it’s happening at such a late hour, you know, I haven’t been able to get them to pay attention.” And he says, you know the guy goes, he goes, “I’ve done a lot of law,” he goes, “like you know the guy coming in says I made all my payments.” And the guy says, “Yeah, I have,” and he says, “Here.” And he like dumps it on the guy’s desk. And he goes through it and the guy had made all his payments on time. The foreclosure had been precipitated by a single $75 disputed late fee. And the guy still had to cla– And you know then he calls the attorney from the foreclosure firm and said, “Look, this guy’s really right. You know, you got to stop this foreclosure. You know, let’s figure out how we straighten this out.” And the guy said, “No, we’re foreclosing tomorrow.” And so he had to file, he had to like get an emergency petition to the court and the guy had to go through bankruptcy.

I mean but that’s the kind – I mean that, that’s, that’s, you know, a more extreme version, but this kind of thing – you know, when people are close to the edge financially, and that’s where a lot of people are with this economy still being weak and a lot of people having hours cut back or job losses, it doesn’t take much in the way of fee abuses to push somebody who could pay with some strain into being, you know, pushed over the edge, and that’s happening a lot. And it’s just not getting, it’s not getting the attention it deserves.

So the whole notion that the banks are always right and the borrowers are, you know, “Well, it’s not so bad, the borrower lost their house, I mean even if the bank screwed up on the paperwork, you know, they really deserved it.” I mean, to this point of wrongful foreclosure. In many cases it’s not just wrongful because of the problems with the documentation and the fact that the banks screwed up on their own contracts, in many cases, and many and again unknown because nobody has investigated. You know, there is a significant but unknown number of foreclosures which really are not warranted. They really are a bank abuse.

HARRY SHEARER:  Now you’ve used a phrase in the site that I’ve never quite understood in the context of servicer abuses. What’s “forced place insurance”?

YVES SMITH:  Okay. In most home purchases, you write a check to the bank and the bank pays for insurance and taxes. And then if for some reason the insurance lapses, or the bank pretends you’re not insured, they can then put their own insurance policy on, and there have been cases where banks have – and that’s why it’s called “forced place.” You didn’t sign up for the insurance, the bank basically puts the insurance policy on you and demands that you pay for it. And typically these policies are egregiously priced. Bank of America had its own subsidiary that provided insurance so there was a direct conflict in many –

HARRY SHEARER:  How convenient!

YVES SMITH:  Yeah. In many case– sorry, the old Countrywide, but now Bank of America, so this was an old Countrywide thing that Bank of America inherited. But also there have been cases where the servicer has been found to get, you know, commissions, i.e., kickbacks, you know, large kickbacks for the forced place insurance, and there have been cases where they’ve just put insurance on, you know, like the borrower would suddenly have forced place insurance and they already had an insurance policy and the only way the bank should think that they didn’t have an insurance policy would be if the insurer sent them a note saying we’ve canceled the policy. You know? I mean there was no reason, there’s no legally justified reason for the bank suddenly to have put an insurance policy on. So that’s one type of abuse that’s been happening.

HARRY SHEARER:  So, if you grade this settlement. If you were teaching a class and this settlement was presented as a solution to this problem, what grade would you give it?

YVES SMITH:  Oh, it’s an F. I mean, it’s not a solution to the problem at all. I mean, because as I said, there really are much larger problems and what this one does is it takes away from the banks the liability for the behavior that it’s easiest to demonstrate that they did wrong.

And you know the classic way that you prosecute people is, oftentimes when there’s complex behavior that’s difficult to prove, is to go after the easy stuff to hope that you’ll get the evidence of the hard stuff. You know, that you go into discovery and the discovery on the easy – or the classic mob strategy, which is what at least the Nevada Attorney General Masto appeared to have been starting – I don’t know if she’s going to continue on that path or not with the suit she was pursuing – but where she criminally prosecuted a couple of employees for forgery. And that was criminal. But the point is you can do a civil version of the same, right? You target some of the companies in the environment. You go in and you do discovery, and then you find more evidence and you add to the charges as you go in and you pursue the paths that you get from discovery just on the clear abuses.

And you know these were meaty enough, the violations on these were meaty enough that they were worthy targets in and of themselves. I mean, you could, if nothing else, most states have consumer fraud statutes. For example, the New York MERS suit, I think it’s $5,000 per violation. I think in Nevada it’s $10,000 per violation. But a lot of the stuff you could wrap in consumer fraud statutes, and you could define the violations as being pretty specific, like, you know, a bad document filed in court. So you could have gotten to reasonable damages that would make it worthwhile for an AG to pursue this and then see where it led. And, you know, that’s just been cut off now.

HARRY SHEARER:  So basically they killed the low hanging fruit?

YVES SMITH:  That’s right. That’s a good way of putting it, yes, yes.

HARRY SHEARER:  Yves Smith. You make the complex and almost impenetrable so easy to understand daily on nakedcapitalism.com and in ECONned and on your occasional visits to Le Show. Thanks.

YVES SMITH:  Oh, thank you so much. I really appreciate your making the time for me.

HARRY SHEARER:  My pleasure. Vice versa.

* * * *

HARRY SHEARER:  And now, as if that’s not enough, I’m going to read the trades for you. Because you see that interview was recorded on Thursday, the day that the settlement announcement was made in Washington. Less than 24 hours later, this from American Banker magazine. I’ll read it for you.

More than a day after the announcement of that mortgage servicing settlement, the actual terms of the deal aren’t public. The website lists the document as “Coming soon.” That’s because a fully authorized, legally binding deal has not yet been inked. Spokespersons for both the Iowa Attorney General’s office and the Department of Justice told American Banker the actual settlement will not be made public until it’s submitted to a court. A representative for the North Carolina Attorney General downplayed the significance of the document’s non-final status. Other sources who spoke with American Banker raised doubts that everything is yet in place. A person familiar with the mortgage servicing pact says that a settlement term sheet doesn’t yet exist. Instead there’s a series of nearly complete documents that will be attached to a consent judgment eventually filed with the court. Some who talked to American Banker said that the political pressure to announce the settlement drove the timing, in effect putting the press release cart in front of the signed settlement horse.

We got sharks, wildebeests and horses, ladies and gentleman. It’s a wildlife edition of the show.

Whatever the reason for the document’s continued non-appearance, the lack of a public final settlement is already the cause for disgruntlement among those who closely follow the banking industry. Quite simply, saysAmerican Banker, the actual terms of a settlement matter. The devil’s in the details, says the chairman of a law firm, Venable Financial Services Group. Until you see the document, you’re never quite sure what your rights are.” Few news outlets asked for the actual document, and those that did, like American Banker, have been unsuccessful.

So you understand why they didn’t ask. Just the maraschino cherry on top of that particular sundae, evidently. Ladies and gentleman, when I read the trades for you, it is so very much a copyrighted feature of this broadcast.