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China’s Resource Buys

by rziemba
February 20, 2009

Note: This post is by Rachel Ziemba of RGE Monitor (where this first appeared) thanks again to Brad for letting me fill in while he’s on vacation.

note: I’ve made a slight update to the discussion on the price Russia will pay for its loan.

China development bank must be busy…. Over the last few weeks, loans worth over $50 billion have been confirmed with the oil companies of Russia, Brazil and the Australian mining company Rio Tinto, all of which have found themselves with financing issues in light of the collapse in commodity prices and credit crunch. While $50 billion is a relatively small in terms of China’s foreign exchange liquidity, this is a significant investment on China’s part in the resource sector, and shows that it is trying to get higher returns on its capital – while coming to the rescue of those who cannot tap the still relatively frozen international capital markets. And given some of the dire predictions for energy sector investment (including warnings from the IEA) might avoid a severe drop off in investment, allowing some of these countries and China to get more bang for the buck as global deflationary trends lower costs.  Most significantly, it increases the share of oil supplies that are pre-contracted, perhaps a desire from both China and its suppliers to have a somewhat more predictable price environment for at least some of its supplies. And given the financing needs, China may be able to push for lower prices.

Leaving aside Rio Tinto, to which I’ll return in a bit, these indicate an increase in long-term oil supply deals between customers and producers both of which are state-backed enterprises, bankrolled by the government backed development bank. It thus increases the role of governments and may trigger greater concerns if not from the recipient countries then from others. It further reinforces the increased role of government and quasi-government influence in the energy and resource sectors as state-backed resource companies have an increasing role in the energy sector in terms of production and supplies. Several of these companies have some private funding but ultimately governments have a key influence on decisions, backstopping decisions.

Russia and Brazil will repay China’s loans in oil. In the case of Russia, estimates from uob kay hian suggest that given an interest rate of 6%, Chinese companies are getting access to supplies at approx $22/ barrel.  This seems low, even at today’s prices given the long-term oil prices that most of these companies assume.  Other estimates seem to suggest that that the price is closer to $70 a barrel, which presumably is the notional value of the loan. But much will depend on the interest rate which is apparently between 5-5.5% according to other sources and pegged to libor, which leaves Russia vulnerable to further libor volatility.  Update: Based on a helpful commentator, it seems that the loan will buy access to oil but not oil itself, with the price being obtained monthly from Argus and Platts quotes.

China has already had oil supply deals with Venezuela and Japan signed a 5 year 120,000 barrel a day deal with Abu Dhabi’s ADNOC these deals are somewhat larger. Russia has promised the equivalent of 300,000 barrels per day or almost as much as china imports from its largest supplier, Saudi Arabia.

Speaking of Saudi Arabia, Hu Jintao just visited the kingdom and left with contracts to build the train to Mecca, an extension of a natural gas joint venture, another joint effort on two refineries, in which Chinese companies will provide assistance but will not own a stake. The natural gas cooperation is of particular interest to both countries. Saudi Arabia (and most of its neighbors except Qatar) are short on natural gas and in recent years the fuel has attracted more exploration activity than oil given its role in power generation and as a feedstock in petrochemical production, a key growth industry aiming at the Asian market. Most of Saudi Arabia’s natural gas is found with oil, making it more difficult to exploit. In fact, Jadwa notes that natural gas demand might actually restrain further and sustained oil production cuts.  In Saudi Arabia, Chinese companies already operate much of the construction in Saudi Arabia and China is the largest source of imports for Saudi Arabia. However, Aramco remains relatively flush despite the Saudi spending increases and revenue declines, raising capital in recent years to fund its expansion.

But the Russian oil companies and Petrobras clearly need funds.

Russian oil companies, like Russian banks, borrowed heavily abroad when credit was cheap. In the case of the oil companies,  the Russian tax structure, especially export taxes limited profits with the government itself taking most of the revenues above $25/barrel. Oil and Gas companies went cap in hand to the government some months ago asking for funds to maintain their investment plans and refinance their debt. Russia’s oil companies had previously insisted that maintaining production required well over $70 a barrel oil.

In exchange for $25 billion over 20 years Russian oil companies, Rosneft and pipeline operator Transneft have agreed to supply China with around 300,000 barrels per day in oil and build a pipeline extension to China. The oil supplied would be equivalent to 8% of China’s daily oil imports (and 4% of daily oil demand).  FT’s Lex suggests that Rosneft’s $15bn share of the $25bn loan package will comfortably cover its $8.5bn debt maturing this year, 60% of which is owed to foreign banks half due in Q2 and allow it to make the investment increases to meet the needs of its supply deal with China. With its share of the funds, Transneft, the pipeline monopoly, will finance new pipeline spur to China which had been held up on price discussions as well as US$5.5–7.3bn capex in 2009, part of its future mid-term investments, including the US$3.6bn on the Baltic pipeline. Furthermore ING notes that the inflows associated with such a loan could relieve some of the pressure on Russia’s finances. Despite a very sharp contraction in imports (preliminary data suggest an almost 40% decline of imports from non-CIS countries in January) Russia’s current account surplus is likely to shift to deficit this quarter. Inflows from China could offset some of the growing financing gap depending on when it is delivered.

Brazil: CDB will loan Petrobras $10 billion helping the company continue its investment plan, especially relating to pre-salt oil and to aid in refinancing its outstanding debt. Details of the loan have not yet been released but will be finalized before a May visit to China by the Brazilian prime minister. Petrobras agreed to sell as much as 100,000 barrels of oil this year to Sinopec and increase it over time.     Petrobras is planning to invest well over  $100b over five years as it develops the pre-salt finds announced last year. The company has been seeking alternatives to international bank lending and bonds to finance its spending plan in the face of an international credit crunch. Petrobras already sells a some oil and products to China and signed a cooperation agreement with Sinochem in 2004 and CNPC in 2005

Petrobras has repeatedly stated that pre-salt production is still feasible even with a lower oil price. Yet, statements suggest the pace of development of pre-salt production could be slowed and that associated projects, such as plans to build two new refineries for export, could be put on hold. Collectively this means Petrobras is more reliant on its joint venture partners – Global Insight suggests that Petrobras may be able to keep diversifying its funding sources. But since Petrobras’ shares have come under such pressure, and financing terms at home and abroad are costly while the cost of hiring rigs  has not softened very much, Chinese funds could keep investment in the pre-salt area on course. Doing so supports the economic development and political goals of the Brazilian government.

In Australia, Chinalco, the Chinese largest state-owned company, financed by the China Development Bank, agreed to lend Rio Tinto $20b through a convertible bond to help it pay off its debts (it has $9b coming due in Oct2009 and $10b in 2010, mostly accrued during its purchase of Alcan). Chinalco will buy $7.2bn in convertible bonds, eventually increasing its stake in Rio from 9% to 18% and invest $12.3bn in strategic partnerships in Rio’s copper, aluminium and iron ore divisions. In exchange for providing capital as a very competitive rate Chinalco should get access to these prime assets for a key rate. The convertible bond structure was likely chosen to avoid restrictions on equity purchases.  Perhaps it is not a surprise that the Australian treasury is planning to change legislation to treat debt as equivalent to equity, possibly blocking the transaction.

Although Australia has been receiving an increased amount of investment from China with an estimated 10b in Australian dollars approved in 2008 (on top of an existing stock of A$6.2b according to Mark Thirwell.) Trade with China rose to 13% of Australia’s total. This is the first major test of of a new investment review process Australia introduced last year which clearly distinguishes between state and non-state investors meaning all state-backed investors are subject to increased review. Chinalco, a state-backed company will prompt significant scrutiny especially given the fears it will aquire the most profitable of Rio’s assets and increased bargaining power at price discussions. If regulators were concerned about the pricing power of a joint Rio Tinto/BHP Billiton, the Chinese funded Rio may also shake up the market. However unlike the oil deals, the investment in Rio is not explicitly linked to a supply deal with iron ore pricing still in progress.

For China, these investments seem to be a relatively efficient way to use its financial resources given the likely long-term appreciation of resource prices and uncertainty about financial assets. Like other cash-rich investors, it can set the terms and may provide the opportunity for its energy companies to really enter the global stage even if it may limit their intermediary role and tie them into their domestic political structure. It may also suggest that China can take advantage of the nascent reversal of resource nationalism that seems to be underway. When oil prices rise, so does the uncertainty of fiscal regimes in the sector and vice versa. For those receiving the funds, it provides a way to get cheaper loans than possible though other means. However in some cases, it may undermine the rights of existing shareholders – such concerns are more obvious in the case of Rio Tinto where existing shareholders may be disadvantaged when the new shares convert. Furthermore its joint interests as a shareholder and one of Rio’s largest customers may counteract

However, China may be getting access to supplies, but aside from some limited joint ventures, its companies are not getting access to reserves but to guaranteed end product. Over all,  the desire to lock up supplies may reflect a shift away from China’s policy of seeking out investment opportunities in a range of oil projects wherever they could be found, mostly in unstable states in Africa.  Erica Downs notes that the early go global efforts of China’s national oil companies left them with a range of investments in many countries a portfolio that was difficult to manage efficiently – now they may be trying to concentrate. There were other costs too.  Raghuram Rajan noted that buying stakes in opaque companies in poorly governed foreign countries might not be the best way to go. The security of a country’s ownership of oil assets in poorly governed foreign countries likely diminishes when the oil price rises. While China did not face nationalism pressures per se given their often minority stakes, events of recent years including attacks on Chinese workers in Nigeria have illuminated the economic costs of the production.

Most of the Chinese oil production abroad was sold on global markets with the profits used to cross subsidize losses on domestic refining segments given fixed prices. In fact only about 10% of Chinese oil imports are supplied through the equity stakes that China has in oil projects abroad. Instead China imported oil from a range of countries in Africa which supplies 1/4th of China’s oil (especially Angola) and the middle east, which supplies 50% (mostly Saudi Arabia, Iran and to a lesser extent Oman.)

It also increases the amount of oil that is officially locked up for long-periods of time which will boost predictability for some producers and consumers even as it raises costs for others. Already the Asian market tends to have more long-term contracts than in other regions, because of the long transportation time and need of Asian countries for imported oil unlike other locations where the spot market is more developed. Longer term supply contracts may not only provide a more stable source of energy but may provide more opportunity for joint venture for somewhat lower costs, increasing the ability to plan given that most new production remains expensive by historical averages. Yet deferring investment in new resources would surely boost the price for all, including China.

Two more side notes (digressions) as this has been a big week in energy politics. Not only is a country like China trying to diversify their suppliers but some exporters are trying to diversify their customers. Russia trying to boost oil exports to china, it is trying to boost and diversify its natural gas exports to Asia by opening up a LNG plant on the east coast. The first cargos from Sakhalin-2 began to be loaded earlier this week. Most (65%) of the pre-contracted cargos are bound for Japan, which is the largest demander of LNG. Russian supplies may help to partly offset the decline in supplies from Indonesia which is consuming more at home. The rest of the LNG supplies are bound for other Asian countries, with a small amount going to a regassification plant in Mexico for the Latin American market. Given the obstacles in shipping, the reduction in distance and transport time, might reduce prices in Asian LNG market. However in both oil and gas, diversification of partners may divert supplies from existing customers, especially in Europe. Russia in particular is facing constraints in increasing supplies given relative under investment. Russian domestic natural gas exports have been on the decline for some years as domestic demand grew. While 2009 will likely prove a short reversal, the cheap power and gas prices will keep domestic demand high, meanwhile oil production is falling as fields mature.

Given that the focus of this note has been bilateral producer consumer deals, it seems apt to conclude with the energy ‘deal’ that President Obama and Prime Minister Harper announced yesterday. Details are still uncertain but the two countries have pledged to co-invest in technologies that will reduce the environmental impact of energy sources like coal and the bitumen harvested from Canada’s oil sands. In part it reflects the producer, Canada taking seriously the concerns of its largest customer – Canada is the largest supplier of energy to the U.S.. It takes the funds already allocated in the recent U.S. and Canadian fiscal packages to carbon sequestration and other clean energy investments (much more expansive in the US than in Canada). The economic incentives of finding cheaper, more efficient technology are clear. With California and other states moving ahead to seek cleaner fuels, the carbon footprint of the oil sands is a major burden. And given that the U.S. government now has a political consensus around a new climate change deal, as Annette Hester notes, it is in Canada’s interest to start making the changes that will make sure its supplies are not priced out of the carbon market which will eventually come.  the same goes for U.S. based refiners who were counting on Canadian refined crude. Given the regulatory changes relating to emissions, the high costs of production given that the swarm of producers into Alberta led to sky-rocketing prices (now reversing) oil sands projects have been frozen or deferred. This is a case where the government can create the incentives for the private sector to invest – and can best signal the direction of the developing new climate regime.  Given that the oil sands are often cited as one of several examples of more expensive supplies that will provide a price floor for oil production, it may be important development to watch.

70 Comments

  • Posted by DJC.

    “No Hedge Fund Manager Left Behind Program”

    Treasury Secretary Geithner plans to subsidize hedge funds and private equity investors’ holdings of securitized assets. The Treasury Department and the Federal Reserve plan to spend as much as $1 trillion to provide low-cost loans and guarantees to hedge funds and private equity firms that buy securities backed by consumer and business loans. The Fed is expected to start the first phase of the program, which will provide $200 billion in loans to Hedge Funds, in early March.

    And why should the Fed and Treasury subsidize hedge funds and private equity? It looks suspiciously like a massive transfer of wealth as well as financial power to hedge funds. At best, it is a dismal idea, an attempt to restore the supply of credit precisely at the point at which demand for credit has collapsed (because households want to save). At worst, it is a kleptocratic exercise of African proportions.

    http://blog.atimes.net/?cat=1

  • Posted by DJC.

    “China’s Resource Buys”

    The Chinese are VERY UPSET About The Devaluation Of The U.S. Dollar! The Federal Reserve is purposely destroying the monetary value of the US dollar by expanding its balance sheet by over $2 billion. Finally, the Chinese are diversifying from the fiat paper US Dollar into “real wealth” natural resources.

    A Quote from the Official China government People’s Daily newspaper:

    “For those countries holding large amount of dollar assets, dollar devaluation simply means disaster”.

  • Posted by DJC.

    Correction:

    “China’s Resource Buys”

    The Chinese are VERY UPSET About The Devaluation Of The U.S. Dollar! The Federal Reserve is purposely destroying the monetary value of the US dollar by expanding its balance sheet by over $2 trillion. Finally, the Chinese are diversifying from the fiat paper US Dollar into “real wealth” natural resources.

    A Quote from the Official China government People’s Daily newspaper:

    “For those countries holding large amount of dollar assets, dollar devaluation simply means disaster”.

  • Posted by Twofish

    DJC: And why should the Fed and Treasury subsidize hedge funds and private equity?

    Because they have money to lend, but won’t unless they get some guarantees that they won’t lose it all.

    DJC: At best, it is a dismal idea, an attempt to restore the supply of credit precisely at the point at which demand for credit has collapsed (because households want to save).

    If households want to save, but there is a huge supply of credit, then it will be made available to businesses and for investment, which I thought you thought was a good idea. All those wonderful productivity-creating businesses that you keep talking about. Where do you suppose the money to fund them comes from?

    DJC: At worst, it is a kleptocratic exercise of African proportions.

    As opposed to anything you’ve suggested which is to let the economy totally fall apart, without any thought as to how things will recover.

  • Posted by Twofish

    DJC: The Chinese are VERY UPSET About The Devaluation Of The U.S. Dollar!

    What devaluation? The US dollar has been appreciating markedly over the last few months.

    DJC: Finally, the Chinese are diversifying from the fiat paper US Dollar into “real wealth” natural resources.

    No they aren’t. These deals are all being done by commercial corporations which while being state owned, act in ways that Western commercial corporations do. You will note that most of the oil produced by Chinese oil companies actually doesn’t make it back to China, because of price controls.

  • Posted by Twofish

    Also its not a good idea to talk about “the Chinese” since different Chinese think different things (and I should point out that I’m Chinese). Also people wildly misquote the People’s Daily. Not everything in the People’s Daily has been signed off by Hu Jintao, and for a lot of economic issues, there is quite a bit of open discussion within the Chinese press.

  • Posted by DJC.

    Twofish,

    The Federal Reserve plan is ludicrous and absolutely won’t work for one simple reason:
    Home prices are still way too high for any stabilization and/or housing bottom to form. Moreover, trillions of US taxpayer dollars given to Wall Street banks, who horde every last penny to invest in US T-bonds and refuse to lend to any creditworthy businesses, doesn’t help the US economic situation one iota. The Federal Reserve plan represents a massive transfer of economic wealth from American middle class savers to politically-connected Wall Street Hedge Funds. The entire plan is borderline criminal to steal the wealth from people who have behaved responsibly.

  • Posted by DJC.

    Twofish: These deals are all being done by commercial corporations which while being state owned, act in ways that Western commercial corporations do.

    DJC: That’s alot BS and you know it. While the State Council doesn’t usually directly get involved in any specific foreign acquistion deals, the state-owned Chinese corporations have a general strategic mandate from the government to acquire overseas natural resources. In the most recent deals, oil-for-loans agreements the Chinese government signed with Brazil, Venezuela and Russia this week were government to government. State-owned China Development Bank Corp provided the finance. Chinese oil companies are fortunate to be able to leverage on their government’s vast financial war chest to acquire overseas assets.

  • Posted by Freude Bud

    The Russian deliveries are scheduled to begin in 2011 and will be priced at the prevailing market prices at the time of delivery, ie probably at a discount to BWAVE on ICE.

    This sort of arrangement between Russia and China is not new, when Rosneft’s purchase of the remaining Yukos assets in 2005 was financed via a loan from CNPC.

    The big energy security question is whether China will built a pipeline to the Pacific to diversify the Asian Pacific supply menu … was always pretty clear that China was the growing market and that it would get a pipeline spur, but now it seems confirmed.

  • Posted by Twofish

    DJC: Home prices are still way too high for any stabilization and/or housing bottom to form.

    Home prices are an increasingly small part of the problem. If you have people with jobs, they can pay down their mortgages to the point where they can absorb drops in home prices.

    The problem right now is that unemployment is growing. Once you have unemployed people, and the banks foreclose, then depositors are faced with absorbing the losses.

    DJC: Moreover, trillions of US taxpayer dollars given to Wall Street banks, who horde every last penny to invest in US T-bonds and refuse to lend to any creditworthy businesses.

    This isn’t true. Banks are lending. The trouble is that non-bank lending has collapsed, and what people are trying to figure out is how to get that restarted.

    DJC: The Federal Reserve plan represents a massive transfer of economic wealth from American middle class savers to politically-connected Wall Street Hedge Funds.

    No. There are two problems. The first is making sure that middle class savers have protected bank accounts. The money to pay middle class savers has got to come from somewhere.

    The second problem is that most hedge fund investors have gotten soaked in the last year, so they are not interested in making any new loans. This is bad because this means that you don’t have new loans going out to start businesses.

    DJC: The entire plan is borderline criminal to steal the wealth from people who have behaved responsibly.

    No. It’s to make sure that people who behaved responsibly don’t get soaked, which is what is happening now with all of these job losses and broken banks.

    Do you have any better ideas? I don’t think you realize it, but everything you have proposed will leave the middle class saver without jobs, credit, savings, or a house. All those middle class savings you talk about. Where do you suppose that money went?

    If this happens as it did in Mexico or Russia, then it gets very bad, because at that point people rationally figure out that the way to do well is to behave badly, which means that it is decades before you can get any economic growth.

  • Posted by rziemba

    twofish – I agree that in many ways China’s NOCs are commercial, trying to find any ways to make profits in the face of price controls that have at times restricted their margins considerably. Furthermore the transport cost encouraged selling their production on global markets. However, they do have the benefit of access to government funds.

    As noted by a variety of commentators these deals only guarantee the access to oil not the price paid which will fluctuate. I’ve amended the post accordingly.

  • Posted by Twofish

    DJC: The state-owned Chinese corporations have a general strategic mandate from the government to acquire overseas natural resources.

    No they don’t. The State Council doesn’t micromanage, and in the case of CNOOC and some of the other deals, the oil companies were far more enthusiastic than the State Council was.

    DJC: In the most recent deals, oil-for-loans agreements the Chinese government signed with Brazil, Venezuela and Russia this week were government to government.

    No they weren’t. They were state-owned enterprise to state-owned enterprise. No government funds were involved at all, and that is intentional. If the deals go bad, then the government can walk away, and the government isn’t going to planning on putting state money into CDB.

    DJC: Chinese oil companies are fortunate to be able to leverage on their government’s vast financial war chest to acquire overseas assets.

    They actually can’t, and none of the Chinese companies are getting any government money for what they are doing.

    Oil companies and Chinese banks are expected to be profitable and not to expect any government bailout at all. It’s like parents and adult children. If you don’t expect your kids to make their own money and live on their own means, then they won’t.

    Chinese state-owned companies are expected to make a *profit* for the state so that the state can use profits to pay for health and education. Giving free money to oil companies defeats the purpose of this. They are expected to *give* money to the state rather than *take* money from it.

  • Posted by Twofish

    rziemba writes: . However, they do have the benefit of access to government funds.

    No they don’t. The Chinese government expects state-owned banks and Chinese state-owned industries to make a profit and contribute money to the state. The reason the China is acting now rather than last year is that oil prices seem to have hit a bottom and now is a great time to lock in low prices.

    If you have governments give large amounts of money to companies no questions asked, you end up with extremely inefficient companies that keep asking for more and more money until you run out.

    If you have a company make a loss and there isn’t an obvious reason to keep it open (like employment) then it gets shut down.

    One of the ironies is that you’ve ended up with the situation in which Chinese banks had more effective shareholder oversight than American banks. Shareholders in most large American companies are essentially powerless.

  • Posted by Twofish

    There is a lot of world experience on how not to run a state owned enterprise, and a lot of Chinese policies are based on that experience.

    One thing is that if you give SOE’s free money then then will just keep taking it. China spent the 1990′s fixing the state owned enterprises with a view to making them profitable modern corporations.

    There is a lot of experience with what to do and what not to do, and one thing that worries me is that the United States government is doing things with respect to General Motors that I think are going to lead to trouble.

  • Posted by Cedric Regula

    The Bankerman and BankerRobin Show

    We now regret that we must break for a commercial endorsement.

    Westinghouse nuclear reactor division(now a unit of Toshiba) has announced they are purchasing Pebble Bed Modular Reactor technology from Eskom in South Africa.

    These are small, inherently safe nuclear reactors. Eskom built one that fits on a rail car bed.

    Westinghouse said there is interest on the part of Tar Sands producers to adopt PBMR as their superheated steam source.

    There are two types of tar sand recovery. One is to burn NG to make steam that is injected down drill holes to loosen oil and pump it to the surface. The other type is open pit mining, but the “ore” needs to be processed by melting out the oil in a similar way.

    Burning all that NG is a big source of CO2, plus it’s dumb because there are better uses of NG (home heating, electric power plants, making fertilizer).

    So PBMR is a great way to cut CO2 emissions and have our energy too. Plus Canada’s Cameco is the largest single producer of uranium in the world.

    Public Service Announcement:

    If the world emerges half alive from securitization, we will surely die from carbon trading.

    There are some technologies that will never become feasible or cost effective no matter how long they get subsidized. Carbon trading will subsidize these forever.

  • Posted by Indian Investor

    Rachel: Russian domestic natural gas exports have been on the decline for some years as domestic demand grew. While 2009 will likely prove a short reversal, the cheap power and gas prices will keep domestic demand high, meanwhile oil production is falling as fields mature

    Me: According to the official export volume statistics at the Bank of Russia web site, NG exports were 193.9 billion cubic meters in 2000, and 191.9 billion cubic meters in 2007. The export volumes peaked in 2005 @ 209.2 billion cubic meters.
    The USD value of Russia NG exports increased from $16.64 billion in 2000 to $ 44.83 billion in 2007.
    Surprisingly, the Bank of Russia stats are updated till Q3 2008, and they don’t show a decrease in export value either for crude oil exports or for NG exports for Q3 2008.

    Gas exports data link:

    Crude oil exports data link:

    (PS: I had to remove the links because putting in the links takes the comment to moderation. Searh the ‘Statistics’ Page on the Bank of Russia English version web page and you get it)

    Rachel: Oil production is falling as fields mature.
    Me: I’m not sure whether oil has a biogenic origin or an abiogenic origin, and I have an open mind on that issue.
    It would be useful to hear some experts on this issue. If oil is just something plentiful that comes from the Earth’s core, then all the concern around different oil companies striking these deals wouldn’t be valid.

    For example, is there any scientific proof that shows
    a) that oil wells just sort of ‘dry up’ after some time
    b) that when this happens there won’t be new oil wells to get oil from?
    I’d like to share the non scientific data that creates doubts:
    a) The Russians discovered really huge reserves of oil in Siberia, that were unknown till they were forced to explore by the neccessity arising from US domination over the Middle East oil.
    b) Till even the 1970s the Middle East was thought to be the only major source of oil. But even now, oil is getting discovered in all kinds of geographies where it wasn’t thought to exist before.e.g. there’s oil in Angola,Sudan,Nigeria,Sri Lanka, India, Burma,Cuba (Gulf of Mexico), Mexico, Kazakhstan, Azerbaijan, Iran, Iraq, UAE,Saudi Arabia, Canada… I’ve even read some speculative reports about oil reserves in Egypt and in the East China Sea!
    c) Modern petroleum engineers don’t accept the Bible’s implications for the Earth’s age while drilling for oil; they routinely note thousands of feet of sediment, that couldn’t have been there if the Earth were something like 6000-7000 years old.
    Early oil explorers and geologists in the 19th century came up with the abiogenic theory but they were perhaps constrained because abiogenic origin implies the Earth is much older than the Bible suggests.
    d) The crude price fluctuations were earlier explained as being a result of ‘peak oil’, i.e. an inflection point had been reached in the Earth’s total supply of oil. These days the popular mythology is the demand for oil in China and India. I wonder how many Indians know that in 2007, they consumed just enough oil to keep the price @ $68. By 2008, they were using so much crude that the price went up to $146. These days Indians aren’t moving around anywhere. So the crude price has come down to $38!

  • Posted by RebelEconomist

    Freude Bud, Rachel,

    Thanks for the additional information about the oil deal. It did not seem right that $25bn could buy so much oil! I too did the NPV calculation based on the story in the FT, and got a similar result to uob kay hian.

  • Posted by Indian Investor

    @Rachel:
    I’d like to add a couple of other deals: a) Russia made out a loan of $350 million to Cuba. The Cuban authorities promised to hand over their existing data and provide rights to Russian oil firms to exlore for oil in the Cuban part of the Gulf of Mexico. (that wasn’t all the deal was about, but these were two items agreed between Raul Castro and Russia)
    b) Angola opened up some new blocks for oil exploration for competitive bidding in Jan. (don’t have the latest status)
    c) Russia is working on two Petroleum Gas pipelines for exports to Europe; one is the Nord Stream project, that takes gas to Germany (Gerhard Schroeder is heading the Nord Stream project); the other is the more recently agreed South Stream project, that takes gas to Italy from Russia.
    d) On Jan 07 2009 Gazprom suspended petroleum gas supplies to the Ukraine utility, demanding higher prices. This also disrupted around 70%+ of Europe’s supplies. The dispute was resolved by Jan 20, 2009. Europe didn’t really support Ukraine’s demand for continued low prices. In a sense the resumption of supply at higher prices for Ukraine shows a thaw in relations between Russia and Europe.
    There’s a strong possibility that the interests of Russia, Europe and China with respect to oil and gas have converged much closer recently.

    There are 2 more points. Here I’d like the reader to think for themselves whether it’s relevant to energy politics or not:
    e) On Thursday, the Kyrygyztan Parliament voted to evict the United States from the Manas Air base, located outside the Kyrygyz capital of Bishkek. The US base has to be closed within 180 days.
    f) Russia agreed to allow non military supplies to move through its territory. A train with 100 wagons started off this week from the Latvian capital city of Riga on the Baltic sea. It has a 4000 kilometer journey to cover(to Afghanistan). If the route is successful, Russia will allow 20 to 30 trains per week, after inspections to ensure there is no military hardware on those trains.
    g) The Department of Defence announced deployment of 17,000 additional troops by mid summer 2009. They’re 8000 from the Marine Expeditionary Brigade, 4000 from the Second Infantry Division and another 5000 yet to be identified.

  • Posted by rziemba

    Thanks all.
    Twofish – China’s go global policy does encourage outward investment by Chinese companies especially the large state owned ones and has contributed to increased FDI. Yet they are expected to contribute to the state, to pay dividends to their owners. However, they have also frequently received payments from the government to compensate for the gap between the cost of oil on the global market and the fixed price of products on the domestic market (eg for much of 2007 and 2008). these payments were often ad hoc. In general though this gap contributed to the incentives to find and sell resources abroad on the global market –
    thanks for your insight.

    Indian Investor –
    re russian gas I was refering to the reduction in volume not in value, given that natural gas prices rose over the period you mention even if they rose at a slower pace than oil that doesn’t negate. Russian domestic consumption of energy and especially natural gas has been on the rise.
    Re maturing oil fields.
    oil is not a renewable resource. . As some wells are tapped there is a need to dig new wells. After a certain point of time the amount of oil in a given field decreases – this is one of the reasons that production is down 40% in Mexico’s Cantarell. However some fields that oil engineers thought were depleted are still producing, taking advantage of new technologies. examples are fields in algeria.

    thanks for adding the other examples of deals. I didn’t mean this to be an exhaustive list just to highlight a few recent dynamics but its very helpful to see the spectrum of deals

  • Posted by Cedric Regula

    indian: “I’m not sure whether oil has a biogenic origin or an abiogenic origin, and I have an open mind on that issue.

    Modern petroleum engineers don’t accept the Bible’s implications for the Earth’s age while drilling for oil; they routinely note thousands of feet of sediment, that couldn’t have been there if the Earth were something like 6000-7000 years old.

    The crude price fluctuations were earlier explained as being a result of ‘peak oil’, i.e. an inflection point had been reached in the Earth’s total supply of oil. These days the popular mythology is the demand for oil in China and India. I wonder how many Indians know that in 2007, they consumed just enough oil to keep the price @ $68. By 2008, they were using so much crude that the price went up to $146. These days Indians aren’t moving around anywhere. So the crude price has come down to $38!”

    1) Babylon had crappy geologists.

    2) If oil was still being created at the center of the earth(I’ve heard that theory too) then, by randomness, it should refill depleted and capped onshore Texas oil fields. Instead it is filling reservoirs located 1 to 4 miles under the ocean. This suggests a malevolent intelligence behind the distribution of oil in the Earth’s crust.

    The Babylonians were right about the Devil.

    3) Indians did not stop moving around. Goldman Saks and others stopped buying oil futures. The commodities regulators did a study last summer and found out that 80% of all oil futures contracts were held by speculators. Tho I believe we are headed for Peak Oil or Expensive Oil on a more permanent basis in the not too distant future, what we had last summer was Peak Speculator.

  • Posted by Twofish

    rziemba: China’s go global policy does encourage outward investment by Chinese companies especially the large state owned ones and has contributed to increased FDI.

    The “go global” policy is like the “buy American” policy. It consists of moral suasion and slogans, but no money. Companies are expected to “go global” with their own money and to make a profit doing it. Putting money into the pot defeats the purpose of the policy. Also the government has said “no” to global investments in some situations, most notably when Chinese companies wanted to invest in US banks.

    This is one thing I think that the US is getting very seriously wrong with General Motors. Chinese companies are commericial companies, and are structured to stand on their own and make a profit. If they don’t make a profit, then the management gets fired and replaced by people who will. The “commercial” and “non-commercial” aspects of the state are separated with different and often conflicting agencies.

    What I predict is going to happen with GM is that in one year they are going to come back looking for more money and more money. With Chinese companies, if you are in trouble, and ask for money, you will get it once, and then your management will be fired.

    rziemba: However, they have also frequently received payments from the government to compensate for the gap between the cost of oil on the global market and the fixed price of products on the domestic market (eg for much of 2007 and 2008). these payments were often ad hoc. In general though this gap contributed to the incentives to find and sell resources abroad on the global market.

    Precisely which illustrates how the oil companies are profit oriented. In the middle of 2007, there were fuel shortages all over China while Chinese oil companies were selling oil oversees. If the purpose of Chinese oil companies was to acquire resources, then the Chinese government could have just ordered the oil companies to sell their oil in China at a loss. They didn’t.

    *Why* they didn’t is interesting. They didn’t force companies to sell oil in China at a loss because that would have killed profits and would have hurt the state’s role as shareholder.

    This points out another thing that the US is getting wrong with GM and the banks. People are willing to buy stock in PetroChina and Sinopec because the rules are set up so that what helps the Chinese government helps shareholders and what hurts shareholders also hurts the Chinese government.

    In the case of GM and the big banks, the fact that the US government has pumped money in as preferred stock rather than common stock makes private shareholders wary of putting money into those companies, because they are afraid that the government will come in and just take it.

    The other thing that the US could do with GM is come up with a consortium of state governments to serve as shareholders. The way that this would work is to have the Fed lend money on a non-recourse basis to state pension funds which would then buy common stock in GM and the banks and then exercise supervision over management.

    What’s interesting about CDB is that they have an ownership stake in Barclay’s and a seat on the Board of Directors which means that CDB indirectly owns Lehman’s American operations.

    It’s not that the Chinese leadership is brilliant about SOE management. It’s just that the government has made all sorts of mistake until it came up with something that seems to work. What I worry about the banks and GM is that the US government is going to go through the same learning process and make very similar mistakes.

  • Posted by Twofish

    One thing about oil is that you start to run out, you need to make more and more investments in technology in order to keep things pumping, and if you don’t do things right you can wreck a field.

    This is why the oil for cash deal makes a lot of sense. Russia gets cash to buy the technology to pump the oil to pay for the cash.

  • Posted by Twofish

    The other thing is that I’m seeing all sorts of numbers that suggest that China has hit bottom. Retail sales never stopped growing. Electrical and coal usage has stopped shrinking. The price of oil and Baltic dry goods are going up. Stock and real estate prices are stable, and sales volumes are going up. One other thing is that Walmart is still profitable and sales are up.

    You might be able to argue that the numbers are just government cook statistics and propaganda. Maybe. But even having things in a situation that you can get people to believe that things have hit bottom through cooked statistics and propaganda says something.

    What may have happened was that when exports stopped you had a shock to the system that resulted immediately in the loss of tens of millions of jobs. However because you had large amounts of savings, it appears that the Chinese economy could absorb the shock of these job losses and react in a way that keeps things from getting worse, so China has hit bottom pretty quickly, and can think about long term strategic goals.

    In the case of the United States, there was a shock, but no reserves so that the system was less able to absorb the shock to the system, which means that things are still getting worse. The basic difference between the United States and China right now is that in the United States the firehouses are on fire, which makes things much more complicated to fix.

    I would argue that part of the reason that the Chinese economy is in good shape is that over the last decade, you’ve had lots of lectures from Wall Street bankers to Chinese banks about the importance of risk management and of capital reserves. It’s very much a case of “do what I say” and not “do what I do” and part of the reason that you had so many Western academics and business people end up in China is that no one in the West would listen to them.

    But the solutions of today become the problems of tomorrow. At some point China will become arrogant, the West will be humble, and then the Chinese economic system will collapse and the Western one will remain standing, at which point things will reverse once again. The only thing that you can really change is when it will happen.

    It’s the same sort of dynastic cycle that has existed in China for thousands of years. You are poor, you behave well, you get rich, you start behaving badly, you end up poor again. If you understand the dynamics of the cycle, you can moderate it somewhat, but you can’t stop it, because wealth and success breeds arrogance and arrogance breeds poverty and failure.

    You can see why I end up arguing with DJC. It’s because I don’t think he understands the basic lesson of Chinese history, and demonstrates what I think is a destructive arrogance. He believes that China is destined to succeed. This is false, no one is destined to succeed, and the second you think that you are destined to succeed, you are doomed. Even pointing out how successful you were in the past is pointless. Past is past. The fact that you were successful in the past can make it *harder* for you to succeed in the future.

    Even if you do understand the fundamental lesson of Chinese history, there are limits to how much you can change things. Rich and successful people end up arrogant over time. But if you don’t understand this lesson, then things get very bad very quickly as southeast Asia and Japan illustrated in the 1990′s when they became very arrogant, very quickly.

  • Posted by Indian Investor

    Twofish: The other thing is that I’m seeing all sorts of numbers that suggest that China has hit bottom.

    Me: China has very much hit bottom and soon the US will, too. It’s easy to see what’s holding the US back once you manage to filter the US propaganda out from the facts.
    a) The o/s mortgage credit was $11 trillion and let’s assume that home prices dropped something like 30% on a national average basis (that’s a liberal estimate). So, in terms of market value of the securitized bonds issued against that $11 trillion debt, you have a mark to market loss of $3 trillion +. Here I’m doing a back of the eenvelope whereas the IMF, Dr. Roubini, etc have made a better estimate and their estimate of the mark to market loss is something like $1.7 trillion.
    b) The corresponding loss in terms of actual reduced recovery from foreclosures is much lesser.
    c) In 2008, the Treasury lent $200 billion to the Fed through the supplementary financing route and this was leveraged up close to 10 times by the Fed to expand its balance sheet by around $ 2 trillion. So around $2 trillion of new credit flowed to the banking system in 2008, either in exchange for loan securities, or just as a new Fed loan to the banks. To get the break up you need to look at the H41 release to see how much of new doubtful debts the Fed has on its assets side. And you need to look at the increase in the banking system’s reserves borrowed from the Fed number.
    d) $350 billion from the Treasury was directly added to the banking system capital accounts through TARP I.
    e) As you’ve seen from Paul Swartz’s previous post credit extensions haven’t grown much in Q4 CY2008. If you look carefully you’ll see that the banking system’s reserves held at the Fed increased tremendously in December 2008. So much of the $2 trillion new credit from the Fed is still being held by banks as of Dec ’08 data and it hasn’t been made out to the household/business sector.

  • Posted by Indian Investor

    @Twofish:
    Overall, the situation is that there’s a mark to market loss of something like $2 trillion (let’s keep the numbers simple). When the Fed takes doubtful assets from banks and lends new credit to banks, the banking system’s losses reduce.
    What the banks want is a kind of force majeure excuse from their mark to market losses. They expect that either the doubtful assets will be taken on to the Fed’s books, or that they will get a re capitalization which covers for their losses. They’re unlikely to extend credit further unless this situation is sorted out. Not extending credit leads to further deterioration of businesses and individuals’ balance sheets, and further reduces the home prices as well.
    Now, there are different approaches and solutions being debated.
    Geithner’s idea seems to be that something like #100 b will be lent out to the Fed, and the Fed will leverage that amount and recapitalize banks for $1 trillion with it. Also, the TALF will help to take more doubtful assets off the banks’ books. Some of the proposed mortgage modifications hit the banks’ books while soem other don’t.
    Roubini and Simon Johnson are asking for the banks to be nationalized. So the existing banks’s shareholders will lose everything. Also there’s a call for across the board mortgage cramdowns to reduce the liabilities of the household sector to banks. Third, they’re asking for private equity players and others to be allowed to bid for the banks after the nationalization, or for them to start new banks after the existing debts are cancelled.
    The Dems. want to revive the Agencies and the Reps. are opposed.

  • Posted by Stefan

    Inspite of all talks of the opposite,

    THE FED HAS FAILED TO INFLATE.

    Quite contrary, the US offers to China, the opportunity of buying the world’s assets at fire-sale prices.

    Inflation is currently the SOLUTION.

  • Posted by Stefan

    …to continue

    If US banks were to be nationalized and “resold”. Among the most logical buyers would be:

    THE COUNTRY OF CHINA

  • Posted by ReformerRay

    I apologize in advance to Ms. rziemba. This post is too long and it goes beyond the topic. I just had to say it.

    Clever economists Paul Krugman is upset that current efforts to stop the downturn do not seem to be working. An equally clever columnist (David Brooks) says that sometimes we just have to swallow our sense of outrage at the people that caused this problem and give them more money. No! Because I have a sense of outrage I don’t want them to get any more money. Maybe the answer Krugman is seeking can be found in respecting the perspective of the ordinary citizen.

    Current efforts to stop the downturn are not working because the people in charge persist in trying to avoid punishing the culprits. Outsiders like me would gladly support additional federal funds aimed at speeding the death of the big players in this game – AIG and Citigroup for starters. And all the firms to whom they owe credit default swaps can go down the tubes as well. We don’t need these kind of bankers, insurance companies and hedge funds.

    I want to see a task force set up in the U.S. Treasury Department assigned the responsibility of drawing up new rules controlling the procedures for dealing with the creditors and counterparties to these firms that are insolvent without federal aid. Current rules and procedures were not designed for current circumstances. Congress will need to pass new bankruptcy laws for banks and insurance firms.

    Begin with the procedures currently set up for taking non-bank businesses through Chapter 7. There is a hierarch of which creditors shall be paid in what order. Set up a new hierarchy appropriate to the banks and insurance firms today. First in line would be insured deposits, individual annuities, other contracts whose essential nature was set up years ago, before 2000, that do not involved derivatives or futures or any instruments made legal by the Commodities Futures Modernization Act of 2000. Experts will be needed to define in advance and make public the new order of payments for the existing assets that will protect individual consumers and firms that did not play the game that created the problem. Next will come payback to the Federal government. After all of the “legitimate” liabilities have been taken care of, the remaining assets of the firm can be distributed among remaining creditors. As in Chapter 7, when all the assets have been distributed, all other claims against the firm are worhless.

    The purpose of this exercise is to treat the players in the game as piranha and leave them with as little as possible. Low and behold, satifying my thurst for vengance will cleanse the finance system of a large number of the “toxic assets” that are holding back lending. Get rid of toxic assets by insisting that these private contracts with AIG and Citigroup and others do not extend beyond the ability of these firms to pay. If AIG and Citigroup can’t pay, the claim is void.

  • Posted by ReformerRay

    The above post by
    Twofish about success, arrogance, greed and failure is excellent. I think his generalizations are a good starting point for understanding how we got in this fix.

  • Posted by ReformerRay

    Twofish’s view of the future should be qualified. The cycle he discusses took centuries of being poor in China with much pain to set them up for success.

    If we were smart, which apparently we are not, we would focus our attention resolutely on avoiding this historical determinism and avoiding the centuries of being poor.

  • Posted by Twofish

    Investor: Overall, the situation is that there’s a mark to market loss of something like $2 trillion (let’s keep the numbers simple). When the Fed takes doubtful assets from banks and lends new credit to banks, the banking system’s losses reduce.

    That’s not the problem right now. The problem is that with unemployment increasing, you are ending up with new losses that have nothing to do with initial problem. That’s the point of my remark that the fire house is on fire.

    Right now the US hasn’t hit bottom, and things are still getting worse. It may or may not hit bottom in a month or so.

    Investor: What the banks want is a kind of force majeure excuse from their mark to market losses.

    That’s not the big worry. If it was just a matter of taking old losses and wiping them out, then we could just do it and be done with it.

    The big worry are the *new* losses that coming down the pipe as a result of rising unemployment. The US problem is more difficult because you have a chicken and egg problem. I think that over the next two to three months, the problems will get resolved, but they haven’t been resolved yet.

  • Posted by Cedric Regula

    indian:”c) In 2008, the Treasury lent $200 billion to the Fed through the supplementary financing route and this was leveraged up close to 10 times by the Fed to expand its balance sheet by around $ 2 trillion. So around $2 trillion of new credit flowed to the banking system in 2008, either in exchange for loan securities, or just as a new Fed loan to the banks. To get the break up you need to look at the H41 release to see how much of new doubtful debts the Fed has on its assets side. And you need to look at the increase in the banking system’s reserves borrowed from the Fed number.

    Geithner’s idea seems to be that something like #100 b will be lent out to the Fed, and the Fed will leverage that amount and recapitalize banks for $1 trillion with it. Also, the TALF will help to take more doubtful assets off the banks’ books. Some of the proposed mortgage modifications hit the banks’ books while soem other don’t.”

    The Fed does not magically “leverage up”. Leveraging means you are borrowing from someone. The only one the Fed borrows from is the Treasury.

    They borrowed the first 200B because they used up all the cash and marketable treasuries on the balance sheet by swapping them for bad assets, foreign currency swaps, and cash for stock in bailout deals. They had a lot of cash at one time. Somewhere between a half trill and trill.

    The initial $100B from the treasury on the TALF TRILLION, is just that. The Treasury will lend more to the Fed as the program program progresses. The GAO will add these treasury sales to the national debt. This is the kosher way things are done among civilized countries that have financial markets and the Bank of International Settlements watching them. Even Krugman said the Fed is doing it this way when he reported on it last week. Zimbabwe does it different.

    So TALF is another sugar coated bank bailout, will add another TRILLION in treasury sales over the next 2 years, and another TRILLION to the National Debt.

  • Posted by Twofish

    ReformerRay: Current efforts to stop the downturn are not working because the people in charge persist in trying to avoid punishing the culprits.

    The former CEO’s of AIG and Citigroup have all been fired. You want to punish individuals by firing them for not doing their jobs, but that’s different from punishing a corporation. I don’t think it makes much sense to punish a corporation since a corporation is an abstract legal entity.

    ReformerRay: Outsiders like me would gladly support additional federal funds aimed at speeding the death of the big players in this game – AIG and Citigroup for starters.

    I think you are talking about corporations as if they were people. Corporations are abstract entities. Suppose you dissolve Citigroup and AIG, then what happens to all of the insurance contracts and deposits that Citigroup and AIG used to have?

    ReformerRay: And all the firms to whom they owe credit default swaps can go down the tubes as well. We don’t need these kind of bankers, insurance companies and hedge funds.

    But you need some sort of bankers, insurance companies and hedge funds. If you think that Citigroup is one too many banks, then split it up and merge it with the other three. But I really think that is a bad idea, since that would increase the too big to fail problem. OK, so let’s split up Citigroup. How and into what pieces, and who decides?

    ReformerRay: Begin with the procedures currently set up for taking non-bank businesses through Chapter 7.

    The first thing that happens when a business goes bankrupt is that they get emergency financing from a bank to pay for the costs of liquidation or restructuring. If the business is a bank, then this isn’t going to work.

    In practice banks and insurance companies all have special procedures for shut downs. In the case of banks what happens is that FDIC comes in, shuts the bank down and then immediately pays out deposits.

    ReformerRay: First in line would be insured deposits, individual annuities, other contracts whose essential nature was set up years ago, before 2000, that do not involved derivatives or futures or any instruments made legal by the Commodities Futures Modernization Act of 2000.

    That’s not going to work. It takes Congress months or years to change the rules, and the second someone even breathes that a bank may be in trouble, then you have a few hours before you have a run and the bank is dead.

    You have at most two to three days to shut down a bad bank. In the case of the big megabanks, you have a problem because if you shut it down, then FDIC would have to within hours pay several hundred billion dollars of deposits that hasn’t been appropriated by Congress, and even having Congress talk about appropriating money will cause a run that will cause a bank to meltdown within hours.

    Right now, it’s obvious to everyone that whatever happens, Citigroup is not going to be allowed to default. It may be nationalized. It may be split up. Who knows, but somehow Uncle Sam is going to make sure that people with money in Citigroup will get it.

    If you have anything that makes people think otherwise (say if Geithner or Bernanke were to even hint that Citigroup would be allowed to default), then you have a major global financial crisis that has to be resolved within *hours*. Ten seconds after people think that there may be a problem, everyone is going to start pulling their money out.

    ReformerRay: Experts will be needed to define in advance and make public the new order of payments for the existing assets that will protect individual consumers and firms that did not play the game that created the problem.

    The rules are already there, and there are limits to which you can change the rules. In any event, when you have an insolvent bank, it’s a come as you are situation. In the major bank failures that we’ve had so far, a lot of the effort was to just buy enough time to get to the weekend when all of the markets are closed, and in the case of WaMu, there wasn’t enough time to even do that.

    A lot of finance involves dealing with time mismatches. Legislation takes months to pass, and for something as big as bankruptcy law, it will take *years* to get something through. In the case of a banking crisis, things happen on the time scale of hours, and in the general economic crisis we are in, things are happening on the time scale of weeks.

  • Posted by Twofish

    Regula: So TALF is another sugar coated bank bailout, will add another TRILLION in treasury sales over the next 2 years, and another TRILLION to the National Debt.

    Which given the size of the US economy isn’t a terribly huge amount of money. One trick is not to think of “one trillion”, but just think of “one”. The US GDP is about 15. The amount of mortgages outstanding is about 11. The total amount of public debt is about 5. China’s GDP is about 2 in nominal terms. Market capitalization of the NYSE is about 7.

    The human mind simply cannot comprehend a trillion or a billion. So don’t even try. Think about 1′s and 10′s and 5′s.

    How to think about large numbers is one of the more useful things that I used to teach in my basic astronomy class. The only way you can sensibly think about large numbers is to turn them into small numbers which is what astronomers do.

    If you start talking about TRILLIONS and BILLIONS, you lose the ability to think about the numbers.

  • Posted by Cedric Regula

    2fish:The human mind simply cannot comprehend a trillion or a billion. So don’t even try. Think about 1’s and 10’s and 5’s.

    I tried that tactic during annual pay reviews, but since we all had engineering degrees, the boss would always remind us about scientific notation. It works for great big numbers and teensy weensy ones too, with only the addition of a negative sign on the exponent.

    In econ 101 they told us to use Percent of GDP notation.

    That’s like saying the moon is one fifth the size of Earth, and is therefore one fifth as useful.

  • Posted by Indian Investor

    Rachel: oil is not a renewable resource. . As some wells are tapped there is a need to dig new wells.

    Me: The abiogenic theory basically assumes that there are inorganic processes that lead to formation of oil and petroleum gases. For instance, the metal iron is a constituent of certain ferrous rocks that are available in plentiful. If the abiogenic theory of oil is correct, it doesn’t make sense to talk of peak oil, just as it doesn’t make sense to talk of peak steel.
    The main believers in the abiogenic petroleum theory are Russian geologists and petroleum engineers. Applying this theory, they discovered large oil reserves in parts of Siberia and Central Asia, which weren’t thought to exist till then.
    So it’s true that a particular oil well runs out of oil after some time. There are some isolated where oil is found to have seeped into the same wells after they were capped for 25 years.
    There are some recent developments which support the abiogenic thesis.
    a) NASA discovered the existence of methane on one of the moons of Saturn. Astronauts don’t believe there was any biological life on the Saturn moons, so they think that the methane there is of abiogenic origin. Since petroleum gas is mostly methane, this indicates that Earth methane could also be of abiogenic origin.
    b) An oceanologist discovered methane fuming up to the surface from some tower-shaped rock formations at the bottom of the mid-Atlantic, on the ocean floor. Again it’s thought that that methane isn’t of biogenic origin.
    c) Experimentally, of course it has long been known that you can synthesize methane and other hydrocarbons inorganically without a biogenic process.
    Overall, if the abiogenic theory is correct, it doesn’t matter which company ties up what existing supplies at what price.

  • Posted by ReformerRay

    As always, Twofish has reasonable responses to my attempt to cut the gregorian knot of insolvent banks.

    He says the rules we have are what we have to live with because any hint that the rules might be changed will start a run on banks like Citigroup.

    His hole card is that Congress never moves fast. It took a whole 2 or 3 weeks to get bills out of Congress that spent over $700 billion. Assume a month to get the change through. What should be done about insolvent banks while Congress debates?

    The same thing we are doing today. Provide the banks with federal money but put limits on which bills they can pay in the interim. No more payoffs to credit default swaps or other deriatives that are part of the toxic assets. Only payoffs to firms or individuals who have put their money in the bank on a termporary basis and is legally entitled to the money.

    The important question is whether this idea has merit – not whether it will take some ingenuity to make it happen.

    There is a whale of a lot of difference between a Treasury Sectretary who has a clear sense of what needs to be done that will be supported by public opinion and a Treasury Secretary who is afraid to move because he will offend some interest group. Obama will decide this issue.

    The Treasury will have to figure out a way to limit withdrawls – and to provide enough funds to permit all the withdrawls that are legal.

    This will be money well spent in that it will buy time for a constructive and final resolution of our bank crisis.

  • Posted by ReformerRay

    TWofish says: “I don’t think it makes much sense to punish a corporation since a corporation is an abstract legal entity”.

    Abstract legals entities should pay for their mistakes just like any other entity.

    Do you prefer that taxpayers should pay for their mistakes?

  • Posted by ReformerRay

    The important factual question hanging beteen me and Twofish is the composition of the assets on the books of the big banks. If the assets are mostly deposits that can be called at the disgression of the owner and the Secretary of the Treasury cannot specify the uses to which the Federal money can be spent, then my idea will not work.

    If the Treasury Secetary provides the banks will sufficient funds BEFORE the word leaks out and he can force the banks to sign an agreement as to the use they will make of these funds, then it would work. With this agreement in hand, the Treasury SEcretary calls a press conference at which he details the amount of money he has transferred to specific banks with the limited uses to which that money can be put. Then the run can start, all the legal withdrawls will take place and other people will not be able to get their money – until the Congress passes a new bankruptcy law.

  • Posted by ReformerRay

    Second paragraph above, first line, make that “with” rather than “will”.

  • Posted by ReformerRay

    “Suppose you dissolve Citigroup and AIG, then what happens to all of the insurance contracts and deposits that Citigroup and AIG used to have:?

    They would be taken over by other banks, in the normal practive of FDIC. Only the toxic assets would be segregated for special treatment.

  • Posted by Cedric Regula

    indian:abiogenic thesis

    1) Many Russians are crazy.

    2) Methane most commonly comes from decaying matter.

    3) Methane gets generated in landfills. But no one is drilling into landfills for oil. Not even Russians.

    4)Methane is a simple hydrocarbon and has probably been around ever since the Earth cooled from superheated gas. That doesn’t mean there is some active abiogenic process going on underground making oil. Or iron ore.

    5)If there is anything going on, abiogenic or otherwise, it’s too slow to matter to humans.

  • Posted by ReformerRay

    “The first thing that happens when a business goes bankrupt is that they get emergency financing from a bank to pay for the costs of liquidation or restructuring. If the business is a bank, then this isn’t going to work”.

    TWofish is talking about old times. Today, many business firms cannot get money to go through refinancing, so Chapter 11 is not open to them. They go trough Chapter 7, which results in disolving the company. That reality is why I suggested Chaper 7 as the template for a new bankruptcy law for banks and insurance companies in the current reality.

  • Posted by Indian Investor

    Regarding nationalization: it’s been a very busy week for the financial N-option.At a sold out club luncheon, Fed Chair Ben Bernanke stated that if nationalization were needed it would be for a short duration since, according to him, the administration believes in that.Greenspan surfaced from somewhere and said that temporary nationalization might be needed. Roubini reiterated his N-demand in various upbeat interviews. Simon Johnson talked of ‘classic oligarchy-breaking strategy.’
    Obama himself stressed the need for a more ‘bite the bullet’ approach than what Japan had.
    Here’re some tidbits on India’s bank nationalizations. Once in while, some old man who’s been in the thick of action through life refuses to retire peacefully. He gets a new secretary and pens down his dangerous memoirs, which send tsunamis through the political establishment.
    These extracts are from the memoirs of IG Patel who was a former Economic Affairs Secretary and Governor of the Reserve Bank of India, in the good old days.

    (note: IG Patel was the Econ. Affairs Secy. at this time, and ‘she’ here is Mrs. Indira Gandhi, the then Prime Minister. The context is that Indira Gandhi had just returned from an All India Congress Committe enclave in Bangalore where she had briefly mused on demands from the Young Turks for nationalization of banks. Other than this there was no indication or parliamentary discussion about any such plans)

    “It was, I think, later in July 1969 that I was sent for once again. Without any fanfare, she asked me whether banking was under my charge. On my telling her it was, she simply said, “For political reasons it has been decided to nationalize the banks.You have to prepare within 24 hours the bill, a note for the Cabinet, and a speech for me to make to the nation on the radio tomorrow evening.Can you do it and make sure there is no leak?
    There was no pretence that this was not a political decision, and the message was clear that no argument from me was required.”

  • Posted by Indian Investor

    The nationalization of 14 of the largest commercial banks in India in July 1969 is one of the biggest political decisions ever made in independent India. It has been propagandized as one of the main sources of India’s economic progress. Soon after the banks were nationalized, Indira Gandhi ordered them to set up branches in all nooks and corners of the rural countryside, lend to various sectors of policy choice, write off debts for socially underprevileged sections like farmers in areas with no irrigation, etc. Employment in the banking sector boomed tremendously, and even a few days back, Sonia Gandhi made a speech praising her late mother in law for her 1969 decision. Sonia Gandhi claimed, ahead of the general elections in March 2009, that Indira Gandhi’s decisions have saved Indian banks from going the Lehman/Wa Mu way!
    So you see the significance of IG Patel’s memoirs, in which he claims that the decision was just a political backlash against Indira Gandhi’s Congress Party rival Morarji Desai.
    Imagine what you would think, if, after 30 years, Henry Paulson writes his memoirs and say something like “We had decided to save only Citigroup and Bank of America. All other banks had to be allowed to fail, and I had to give reasons along with Bernanke for this.”

  • Posted by Indian Investor

    @Cedric: Oil might just be an infinite resource, like iron ore. I’m not sure of this, but I have an open mind.
    Between 1971 and 1973, the crude price rose 400% because we’d reached ‘peak oil’. How do you expect me to believe that the petroleum engineers from the American oil firms are telling the truth when they say that oil is a finite resource? Besides, there’s no scientific evidence that oil was formed from decaying dinosaurs. Microorganisms can be found in oil for a variety of reasons other than oil having been formed from decaying fossils.
    All those billions of barrels of oil may have never come from decaying microorganisms. They might just be part of the Earth. How do we know?

  • Posted by ReformerRay

    Indian investor: I love your quotes from IG Patel.

    However, Henry Paulson’s memoirs will be less important because the decision is now Obama’s to make, not Bush.

  • Posted by Indian Investor

    @Reformer: If you’d been from India you’d’ve found these revelations much more startling and also rip roaringly funny. He has more reminscenses on his interactions with the prima donna on the nationalizations:
    (Continuing)
    “I assured her that we will keep to the timetable and keep the secret.I summoned courage, however, to make two suggestions:to leave the foreign banks alone, and to nationalize only the mjor ones. The former was intended to avoid sharp reaction abroad; and the latter because the purpose would be served by taking only the major banks and leaving the scores of small banks alone. She immediately agreed and added that she could trust the details to me.”

    (Note:In 1980, after many more adventures, Indira Gandhi was back in power again; and this time round, IG Patel is a full Governor of the Reserve Bank of India.)

    “Such is the irony of life that one of the first steps I had to recommend to Mrs. Gandhi was that she should nationalize another swathe [sic] of private banks. The Reserve Bank had the responsibility to supervise private banks …it was not easy to control their activities in practice…Some of them, like the Punjab and Sind Bank, and the Vijaya Bank, had become the personal fiefdoms of individuals who disregarded all rules and advice with impunity…They, with their shady dealings, were offering unfair competition to the nationalized banks…I decided that the only way to tackle the problem was to nationalize the banks…
    But it must be said that she had no appetite for nationalization now and that this particular initiative for the second phase of bank nationalization came entirely from me.”

  • Posted by Cedric Regula

    indian:

    It wasn’t just dinos. It was biomass. Even it it was something else, it’s static. Exploration hasn’t been static, which is why we find more static deposits. Tech improved recovery too.

    Presidents Johnson and Nixon caused Peak Oil in the 70s(with the help of Fed policy and going off the gold standard).

    Ultimately ’70s peak Oil ended when the Saudis realized that Ghawar reserves were much larger than they thought and they expanded production capacity from the field.

  • Posted by Cedric Regula

    indian:

    Some geologist lingo about where oil comes from:

    Ghawar occupies an anticline above a basement fault block dating to Carboniferous time, about 320 million years ago; Cretaceous tectonic activity, as the northeast margin of Africa began to impinge on southwest Asia, enhanced the structure. Reservoir rocks are Jurassic Arab-D limestones with exceptional porosity (as much as 35% of the rock in places), sourced from the Jurassic Hanifa formation, a marine shelf deposit of mud and lime with as much as 5% organic material (1% to 2% is considered good oil source rock). The seal is an evaporitic package of rocks including impermeable anhydrite.

    http://en.wikipedia.org/wiki/Ghawar

  • Posted by gillies

    our story is mostly about the monkeys burning the trees.

    - first the trees in the form of timber. then in the form of ancient deposits of coal. (note that there was a threatened timber crisis, ‘peak timber’ if you like, and coal came to the rescue.) then the steam locomotive gave way to the internal combustion engine, and oil took the place of coal, in transport at least. but it is still the monkeys burning the trees . . . .

  • Posted by Twofish

    ReformerRay: The same thing we are doing today. Provide the banks with federal money but put limits on which bills they can pay in the interim.

    1) We are talking about several hundred billion dollars of money that has not been appropriated by Congress.

    2) You just can’t say, we will pay X but not Y without having huge consequences. Once you say that we will not pay Y, then people who are owed X will wonder about things.

    Trying to figure out what you will pay and what you won’t is a tricky thing that will take months. Ultimately, what you want to do is to set up a “good bank” with assets and liabilities that will be paid, and a “bad bank” with assets and liabilities that won’t. That’s actually what has been suggested for Citigroup, but there are two problems……

    ReformerRay: No more payoffs to credit default swaps or other deriatives that are part of the toxic assets. Only payoffs to firms or individuals who have put their money in the bank on a termporary basis and is legally entitled to the money.

    1) The problem here is that you can screw people over…… Once. Once you screw someone over financially, then it becomes difficult to go back to them and ask for money again.

    In order to figure out what assets can need to be paid and what assets can be dropped, you need either need the cooperation of people within the bank. The guy (or more accurately hundreds of guys) in charge of the database is not going to be that cooperative if he thinks he is going to fired the next day.

    2) The other problem (and I think people have only begun to realize this is a problem) is that if you screw hedge funds and private equity, they stop lending. With all this talk of nationalization and defaults, none of the people who manage money in hedge funds and private equity are interested in lending any new money.

    To get them to lend money, you have to provide government guarantees on any *new* loans, which may cause major problems in a few years.

    In finance there are no “do overs”, once you pull the trigger, what happens, happens which means that people are very slow to pull triggers.

    ReformerRay: There is a whale of a lot of difference between a Treasury Sectretary who has a clear sense of what needs to be done that will be supported by public opinion and a Treasury Secretary who is afraid to move because he will offend some interest group. Obama will decide this issue.

    Treasury Secretaries can’t think out loud. It may be that the Geither has decided that nationalization is unavoidable, but he isn’t (and shouldn’t) breathe a word of this before he actually does this.

    The second issue is that I strongly distrust people with a “clear sense of what needs to be done”. Things are moving so rapidly and we are learning things so quickly that anyone that “knows what needs to be done” is obviously incompetent. For example, the problem in which nationalization talk has been spooking people with money is only something that people figured out was happening last week, and all of this came to a head on Friday when the stock market tanked.

    Geither and his advisors are trying to figure out what to do right now, and we’ll know Monday.

    One reason people in the financial markets are a bit spooked is that everyone knows that the fact that there are Federal bank examiners crawling over the books of every major bank means that Geither is thinking of doing “something interesting.” The thing about “stress testing” is a cover for some ulterior motives.

    Geither (and everyone else in the industry) already knows who is in trouble and who isn’t, but by having people poring over the books of the banks, he will know exactly what liabilities are essential and which one’s aren’t.

  • Posted by Twofish

    ReformerRay: Do you prefer that taxpayers should pay for their mistakes?

    Depends. Which taxpayers? If the former CEO of Lehman Brothers gets a nice hefty tax bill in the mail, I’m not going to shed any tears.

    Part of the reason I don’t care if the “taxpayer” pays is that I don’t see my tax bill going up, unless I make a lot more money in which case I don’t care.

    One reason that I prefer to pay through taxes rather than by just putting in sanctions is that with taxes you have a lot of control over who ultimately pays. With non-tax sanctions it’s sometimes not obvious who is going to ultimately pay, and given the games that people can pay, it’s likely it will be someone you that shouldn’t be paying.

    This is actually one of the problems with taxes. It’s obvious who is paying.

    Talking about the “taxpayer” is a very clever rhetorical trick that Reagan thought up. There are some equally clever rhetorical tricks that you can think of to justify cleaning up the banking system. However, right now people are too focused at fixing the problems to think too much about marketing. Maybe that’s a good thing.

    ReformerRay: No more payoffs to credit default swaps or other deriatives that are part of the toxic assets.

    That’s possible, but if the government orders non-payment of CDS, then you have huge problems because the people who have collateral against those CDS’s will get to keep it, and then will immediately stop extending credit based on those CDS’s.

    Maybe that’s a good thing, maybe not, but it’s a chess game in which you just have to think about four moves ahead.

    Wiping out old losses, is relatively easy to do. The trouble is convincing people that got wiped out once before to start loaning again. One particular problem is that the only area that had serious problems with securitizations was subprime mortgages, but if you wipe out all securitizations because of subprime, then people won’t extend credit for auto loans, credit card debt, student loans, and small business loans.

    ReformerRay: The important factual question hanging beteen me and Twofish is the composition of the assets on the books of the big banks.

    They are liabilities, and not assets. Remember that banks live in a mirror universe.

    ReformerRay: If the assets are mostly deposits that can be called at the disgression of the owner and the Secretary of the Treasury cannot specify the uses to which the Federal money can be spent, then my idea will not work.

    They don’t have to be mostly deposits. Remember that banks are mostly illiquid. They only hold a small amount of cash. In any typical bank, the amount of demand deposits is far, far in excess of cash on hand. Also there are things other hand checking accounts. Callable loans. Collateral. Repurchase agreements.

    When someone signs a derivative agreement, they aren’t stupid. Usually there is some collateral that they force the bank to put up. So if the bank doesn’t pay the derivative, they get to keep the nice shiny Treasury bill that the bank deposited.

    Part of the reason that “cancel all agreements” just doesn’t work is that people thought of that, and put lots of traps and bombs that go off if an agreement gets cancelled. For example, your standard repurchase agreement. I buy a treasury bond from you, and agree to sell it back in a week. If something goes wrong and all agreements get canceled, I don’t care, since I have your bond.

    ReformerRay: They go trough Chapter 7, which results in disolving the company. That reality is why I suggested Chapter 7 as the template for a new bankruptcy law for banks and insurance companies in the current reality.

    Even with Chapter 7, you need massive amounts of financing to pay for the liquidation and the lawyers. You see all of the “going out of business” sales at Circuit City. Some bank has to finance that. Also Chapter 7 is not the end of the story. Even after a company goes totally out of business, someone is going to wind up with assets that can be useful.

    Bankruptcy laws rely very heavily on functioning banks, which is why you end up with a total mess if the banks aren’t functioning.

    ReformerRay: If the Treasury Secetary provides the banks will sufficient funds BEFORE the word leaks out and he can force the banks to sign an agreement as to the use they will make of these funds, then it would work.

    Lots of problems. If you have the money there is no need to play nice. You can have Treasury and FDIC call the CEO to his office and fire them. In fact if you are in this situation you *SHOULDN’T* play nice.

    If you are in a situation in which the CEO can threaten to destroy the world financial system, if they don’t get what the CEO wants, then you aren’t in a good position to force them to agree to anything.

    This sounds silly, but this is *exactly* what General Motors is doing.

    The other problem is that the Treasury Secretary can only spend the funds that Congress has allocated.

    There is clearly not enough money to shut down a megabank. It would take several hundred billion dollars in cash to cover deposits, and a typical megabank has tens of billions of dollars in overnight loans that have to be covered by start of business tomorrow. Treasury doesn’t have this cash, and Treasury can’t get this cash without making a big noise.

    This was a big problem with Fannie and Freddie. Treasury couldn’t shut down Fannie and Freddie until July when Congress passed some key bits of legislation. Once that happened, people knew that the game was up. However Fannie and Freddie got their funds through monthly auctions, and there is no easy way of taking money out of the two. Banks are way, way different.

  • Posted by Twofish

    ReformerRay: They would be taken over by other banks, in the normal practive of FDIC. Only the toxic assets would be segregated for special treatment.

    What other banks? If you try to solve the problem by having banks take over other banks, then eventually you run out of banks. The other problem is that once you have few banks, the ones that are left are “too big to fail.”

    We’ve already long reached that point….

    Who watches the watchmen? Who bails out those that do the bail outs?

  • Posted by ReformerRay

    Twofish is good at thinking up obstacles.
    Where was he when Paulson developed his scheme of buying toxic assets, a scheme that did not work? Where was he when Paulson followed the advice of Paul Krugman? Direct infusion of money into the banking system did not work either.

  • Posted by ReformerRay

    I am adding comments separately because I want to add correctly.

    The public is increasingly waking up to the point that the Federal government was explicitly excluded from any role in these contracts (by the Commodities Futures Modernization Act of 2000) AND THERE IS NO REASON TO BRING IN FEDERAL PARTICIPATION AT THIS POINT.

  • Posted by ReformerRay

    Any private firm, whether a bank or an insurance company, that has taken on obligations that they cannot fulfill should be disolved and their assets distributed among claimants.

    Paulson and his buddies in the finance sector are pretending and maintaining that to allow a big bank to fail will cause other firms to fail and will take out the entire banking system. The last phase is important and it is not true. The only financial firms that will fail if AIG or Citigroup goes under are those firms that participated in buying and selling these toxic assets that brought on the current recession – depression.

    We can live without ANY international banking firms for a while, if that is necessary. Foreigners are not willing to trust U.S. financial firms anyhow, after being burned by the demise of Lehman Brothers. Lets get the destruction over with.

  • Posted by ReformerRay

    Nationalization is possible but it will be a mistake if it saddles the Federal government with the responsibility to make good on contracts that brought down the banks. I think Lindsay Graham wants that form of nationalization.

    Notionalization could be instituted with the provision that the Federal Government would take responsibility for all contracts other than those produced as a result of the Commidities Futures Modernization Act of 2000. Then it would be OK. The Federal government could sell the firms back to the private sector, after the toxic assets have been disolved.

  • Posted by ReformerRay

    There is clearly not enough money to shut down a megabank. It would take several hundred billion dollars in cash to cover deposits, and a typical megabank has tens of billions of dollars in overnight loans that have to be covered by start of business tomorrow. Treasury doesn’t have this cash, and Treasury can’t get this cash without making a big noise.

    Then the Treasury must make a big noise. It cannot be the case that the overnight liabilities exceed the ability of the Tresur y and the Federal Reserve Board to handle the matter. Ben came up with enough money to keep the short term overnight markets going at the scale of all banks. If he can handle all banks, there is no reason he cannot handle one bank.

  • Posted by ReformerRay

    My main point to Twofish is that the Federal govenment should NOT be in the business of covering all the deposits listed on the balance sheet of a mega bank.

    He cannot see the possibility that some of the deposits on the books of banks must be disavowed.

  • Posted by ReformerRay

    The bankruptcy of Lehman Brothers shows what I want to happen to ATG and Citigroup. Lehman was not a bank. So the toxic assets on their books were not transfer to another bank or any other entity. They were resolved by the Depository Trust Clearing Company. All the Credit Defaut Swaps to which they were a party were resolved by the exchange of 5.2 billion dollars among the parties. The private sector settled this among themselves. That is exactly what I want to see happen to AIG and Citibank.

  • Posted by ReformerRay

    I am going to call my proposal “The Lehman Brothers Solution” in honor of the business firm that showed the world how to eliminate toxic assets from the books of banks.

  • Posted by Twofish

    ReformerRay: Where was he when Paulson developed his scheme of buying toxic assets, a scheme that did not work?

    In a cubicle, doing my job…..

    Anyway hindsight is 20-20. Paulson’s proposal was a good idea in October, and at the time I was hoping that it would work. It was worth a try, but things have changed since then. The big thing that has changed is all of those bad employment numbers that started coming out in November.

    ReformerRay: Where was he when Paulson followed the advice of Paul Krugman? Direct infusion of money into the banking system did not work either.

    Work for what? The infusion in November kept the commercial paper market from falling apart. You are looking for a single magic bullet that solves all of the problems, and things just don’t work that way.

    Trying things that don’t work is not a bad thing. I’m not a fortune teller and neither is Paulson or Geither.

    ReformerRay: Any private firm, whether a bank or an insurance company, that has taken on obligations that they cannot fulfill should be disolved and their assets distributed among claimants.

    It almost never works that way. Even in Chapter 7 liquidations, the bankrupt entity is not “dissolved.” A bankrupt company is still a company. Also in many (and probably most) bankruptcies, the creditors don’t want the entity liquidated since they end up losing more money that way.

    ReformerRay: The only financial firms that will fail if AIG or Citigroup goes under are those firms that participated in buying and selling these toxic assets that brought on the current recession – depression.

    Which is basically everyone in the world either directly or indirectly.

    ReformerRay: It cannot be the case that the overnight liabilities exceed the ability of the Tresury and the Federal Reserve Board to handle the matter.

    Yes it can be….

    ReformerRay: Ben came up with enough money to keep the short term overnight markets going at the scale of all banks. If he can handle all banks, there is no reason he cannot handle one bank.

    He came up with $50 billion “good faith money” from a slush fund to back money market and commercial paper markets that are in the trillions. It works just like FDIC, which has $50 billion but backs deposits that are in the trillions.

    When people are in panic mode and in a bank run, you can stop it by walking up to the teller window and waving lots of money. Once people calm down and see they aren’t going to lose all their money immediately, they calm down.

    The thing about FDIC and Treasuries backing of commercial paper is that it isn’t nearly enough money to shut down a megabank. Everyone knows it, so that’s why people are pretty confident that a megabank just will not be shut down. Nationalized maybe. Shut down. No.

    ReformerRay: My main point to Twofish is that the Federal govenment should NOT be in the business of covering all the deposits listed on the balance sheet of a mega bank. He cannot see the possibility that some of the deposits on the books of banks must be disavowed

    Really difficult to do, and probably too late.

    Once you’ve guaranteed some of the deposits, then you get sucked in and you end up having to guarantee more and more of the deposits until you end up guaranteeing everything. The Federal government *already* has ended up guaranteeing all checking accounts, all savings accounts, all money market accounts, all mortgages, and backstopping commercial paper.

    ReformerRay: The bankruptcy of Lehman Brothers shows what I want to happen to ATG and Citigroup.

    1) Not all of Lehman Brothers went bankrupt. Lehman’s North American operations stayed solvent and was purchased by Barclay’s.

    2) Lehman is still in business, and they are hiring in fact. It will be another two years before they can permanently shut down their doors.

    3) Lehman was small in comparison to Citigroup or AIG. It had about $250 billion in assets. Citigroup and AIG are both $1 trillion+ companies. Lehman’s mistake was that it was not “too big to fail.”

    4) Nothing Lehman Brothers had was federally insured.

    5) The day after LB collapsed, you had hedge funds and depositors showing up the door of all of the major banks demanding their cash, and if the Fed had done nothing, the whole system would have crashed then and there.

    ReformerRay: So the toxic assets on their books were not transfer to another bank or any other entity.

    Actually they were. It’s more accurate if you think of these things not as “toxic assets” but rather as “horse manure.” If you have tons of what you thought were gold bricks but turned to be “horse manure”, you are trouble if you borrowed money against it.

    However, once you go bankrupt, there will be lots of farmers willing to pay you for your horse manure since it is worth something to them, and right now what the people working at Lehman are doing is going through all of their tons of horse manure, and finding buyers.

    ReformerRay: They were resolved by the Depository Trust Clearing Company. All the Credit Defaut Swaps to which they were a party were resolved by the exchange of 5.2 billion dollars among the parties.

    That’s not what happened…..

    The trouble with this is that one of the parties turned out to be AIG, and they didn’t have the money to cover the CDS’s which they had written. At which point the Fed had to step in.

    ReformerRay: The private sector settled this among themselves.

    No they didn’t. The Fed had to pump in money through AIG. If they Fed hadn’t bought AIG, the whole thing would have collapsed, since AIG has the counterparty for a lot of the CDS. And then it turned out that money market funds had exposure to Lehman, and then the Fed had to cover those too.

    The really scary thing is that the weekend before all of this happened, no one knew that AIG had so much so much exposure to Lehman. This is why Geither is being so slow to do anything. He wants to make sure that he knows who owes what to whom before doing anything.

  • Posted by Twofish

    It’s likely that something dramatic is going to happen in the next few weeks. It’s probably going to happen in late March and early April after first quarter earnings are compiled and we have another round of unemployment numbers.

    It will also likely happen on Friday evening or Sunday evening NYC time.

  • Posted by Twofish

    Just a note as far as why I blog.

    I do not think that it good for democracy if the major decisions are made behind closed doors. Even if good decisions end up being made the public ends up being rather suspicious of who and how those decisions are made.

    The discussion with ReformerRay is the type of discussion that does tend to happen behind closed doors. (We’d like to do that, no that won’t work, well what if we do this, well maybe let’s try that.) The reason these discussions aren’t open is that bad things tend to happen when powerful people think out loud.

    I’m sure Geither has thought about the possibility of shutting down a megabank, and I’m also sure that there is a group of dozens of people in Treasury that have prepared or are in the process of preparing a whole series of memos on how to shut down a megabank and what the consequences are. Even if they don’t do it, they need to have a plan in place, and they also need a plan so that they can think through exactly how.

    However, if Geither thinks out loud in front of camera, he could end up destroying the system. Since I’m very low on the totem pole, I can think out loud, and I think I have a good idea of what is going through his mind, and so does anyone else that works in finance.

    The other thing is for transparency is that people really don’t see what bankers and government bureaucrats do, so people assume they do nothing except take money. A lot of the day of your banker or bureaucrat involves having these sorts of discussions to figure out exactly how to get something done, and going through the check list of everything that needs to get done involves lots and lots of people.

  • Posted by ReformerRay

    Twofish – I am sincere when I say I really do appreciate your contribution. You obviously know much more about the banking business than I do. I am what is called a “naive observer”.

    I remain unpersuaded, however. I spent a bit of time this morning on the website for the Federal Reserve Bank of St. Louis, reading their Timeline of Events. It summarizes all the important actions of governmental agencies each day that it happened for 2007, 2008, 2009.

    The tie-in between the Federal Government and the mega banks that used to be private is amazing. Drip, drip, drip – more federal money dropped on the people that created the problem. This website also has a very short summary of the three interrelated causes of the financial crisis that focuses on description rather than making a political point.

    More to come.

  • Posted by ReformerRay

    Also this morning I stumbled upon a website titled “Seeking Alpha”. A commentary by Christopher Whalen, Feb. 19, titled “Too big to Bail: Lehman Brothers is the model for Fixing the Zombie Banks”.

    Finally the issue I want to see discussed is out in the open.

    His perspective was interesting and much more detailed than mine. He should be jocking with Twofish rather than me. But the equally interesting thing was the 25 comments that followed his article. The followup discussion centered on bondholders, an issue I have neglected.

    Seems I can’t just concern myself the kinds of contracts that the Depository Trust & Clearing Corporation claimed to successfully resolve in their new release dated October 30, 2008. I don’t have any opinion about bondholders. My inclination is to say no to them as well as the kinds of contracts handled by DTCC.

    I have carried this discussion with Twofish as far as I can carry it. I remain convinced that the Federal Government must reverse course. Proping up Zombie banks is a temporary expedient. It will not solve the problem. The Lehman experience should be the template to examine. How the Lehman template should be modified is above my pay grade, as Obama famously said.

    I recommed to anyone interested in this question (which should be all U.S. citizens) that you read up on this matter, beginning with the Whalen post of Feb. 19, 2008, with the commentaries and the DTCC news release of Oct. 30, 2008 and the timeline of official actions provided by St. Louis Fed. Reserve Bank.

  • Posted by Nicholas Dahlheim

    Good to have seen you this weekend at church, Rachel. Wow, this is a great report on the ongoing developments in energy politics. I really respect your broad understanding of complex issues—- I follow finance closely, but I have nowhere near the same balanced and nuanced approach you have for these complicated energy issues.

    It looks as if these developments are really part of the longer-term trend whereby the world economy re-balances itself more firmly around the longer-term prospects for growth and sustained wealth creation in the Far East. Russia and China have already grown much closer since the establishment of the SCO, and Russian exports of oil to China in return for loans to Russian energy companies will further cement their economic dependency on each other—-Russia for credit, China for energy. With US bogged down in Afghanistan and Iraq and with the US still desperate to maintain its dominance in the resource-rich areas of Eurasia from the Persian Gulf to the Caspian Sea, these developments are quite negative for the future of US power in this critically important region. I still think of the book Dr. Zbigniew Brzezinski wrote in 1998 entitled The Grand Chessboard—in it, he argued that whichever global power controlled the resource-rich regions of Central Asia essentially would set themselves up for dominance in the 21st century world. The pieces on the chessboard are shifting rapidly—and a stung and wounded Russia is definitely moving into the arms of the Chinese desperate to extend credit in return for vital energy resources.

    Best,
    Nick

  • Posted by Nicholas Dahlheim

    By the way, some of the earlier talk about abiogenic oil and that oil is a renewable resource is just silly. I can tell you from a contact I have with PIRA Energy and from reading snippets of the latest IEA Report from 2008 (and the IEA has been overly bullish on oil supply projections for some time now) that the global oil production is likely to peak sometime between 2012-2020 at the latest. All of the oil projects coming online to make up for stagnation and decline in older fields are deep sea oil drilling as that which is occurring off the coast of Brazil or it is heavy tar sands oil like that going on in Alberta. Russia was having trouble increasing production even before the credit crunch, and who knows how much oil is really left in Saudi Arabia’s mega-giant field Ghawar. Africa still has some sizeable oil deposits, but not nearly enough to replace peaking production in places like Russia or the US’s own falling oil production. The Caspian Sea basin was thought to have huge reserves of oil to rival the Saudis and the Persian Gulf, but oil discoveries there have turned out to be rather unimpressive…

    Let’s just say for the sake of argument that oil was indeed a renewable resource—I sincerely doubt that oil is renewable on the time scales orientated towards the needs of the energy-hungry modern economy. Even with the drop in price and the drop in world demand caused by the global recession, the world still will demand more than 90 million barrels per day sometime early in the next decade. I don’t know of any giant oil gushers deep within the Earth that are producing oil on that scale…..

    Best,
    Nick

  • Posted by locococo

    Indian s quote of “They, with their shady dealings, were offering unfair competition to the nationalized banks” reminds me to bring your attention to not forgetting nationalizing the fed. It s a bargain.

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