Warrantless surveillance "Stellar Wind" data took down Eliot Spitzer. And very nicely timed that was, too...
[Nobody seems to have noticed this, so I'll sticky it. I think the "Stellar Wind" story is interesting for many reasons, one of which is that it merges two stories we've followed for some time: warrantless surveillance and The Big Shit Storm. -- lambert]
A throwaway paragraph in Spiky's scoop:
[Under the secret and illegal "Stellar Wind" program of domestic warrantless surveillance,] NSA was also able to access, for the first time, massive volumes of personal financial records—such as credit-card transactions, wire transfers and bank withdrawals—that were being reported to the Treasury Department by financial institutions. These included millions of "suspicious-activity reports," or SARS, according to two former Treasury officials who declined to be identified talking about sensitive programs. (It was one such report that tipped FBI agents to former New York governor Eliot Spitzer's use of prostitutes.) These records were fed into NSA supercomputers for the purpose of "data mining"—looking for links or patterns that might (or might not) suggest terrorist activity.
Now, that's very, very interesting, isn't it?
First, how on earth did the Stellar Wind SAR get from the NSA to the FBI? Could it be that the "massive domestic dragnet" was being used -- gasp -- for ratfucking (Democrats, under Bush) -- as we prematurely, but correctly, said it was in 2006?
Second, wasn't the timing rawther convenient? Because, at the time, Spitzer was blowing the whistle on the monoline insurance companies* (after having already made the investment banks his enemies):
A lot of attention has been spent and will continue to be spent on what Eliot Spitzer was up to at the end of the day on Feb. 13  in Room 871 of the Mayflower Hotel.
But officially, at least, Spitzer was in Washington to kick off his Valentine’s Day morning with testimony to Congress, using his prominence as governor to warn of an impending massacre of the municipal bond market.
Municipal bonds themselves were solvent, Spitzer explained, and local governments were in no danger of defaulting on the promises made to municipal bond holders. But, he told the Capital Markets Subcommittee, the financial instability at monolines—insurance companies that underwrite municipal bonds—threatened to damage the credit ratings at these insurance companies. Without reliable insurance, municipal bond credit ratings would devalue, increasing the difficulty and expense of local governments’ efforts to issue bonds and raise money.
Well, here's how that industry views Spitzer's efforts. Seeking Alpha:
The first is the point of view of the companies involved: the monolines, their investors, and individuals who believe that corporate legal entities have rights, even when they're closely regulated. These companies have a range of businesses, some of which are profitable and some of which turn out to have been profoundly misguided. Spitzer is essentially seeking to swoop down and grab the profitable, sustainable bit of the business, leaving the crazy structured-finance bit to wither and die (it likely won't be mourned) [Except by thieves, fraudsters, and looters, of course].
"Structured finance," eh? You mean the "complex","innovative" investment vehicles that comprise The Big Shitpile?
Er, yes. Because who are the monoline insurance companies? And what do they do? Nouriel Roubini:
The conventional wisdom is that state and local government rarely default; thus, there is a viable business for monolines that insure only state and local government. We will argue in this article that such conventional wisdom – behind the current plans to split the monolines’ business in a “good” muni insurance component and a “bad” structured finance insurance component [what Seeking Alpha says was Spitzer's idea] – may be wrong…
Of all the problems described above currently state regulators care more about the effect of a downgrade on the ability of state and local governments to borrow at reasonable rates, especially now that we are entering a painful recession. While federal financial authorities are also worried about the effects of a monoline downgrade on the balance sheet of banks, investment banks, money market funds and other investors that bought the toxic structured finance products insured by the monolines. Additional losses of the order $150 billion for these insured structured products would be a severe shock to the capital and balance sheet of financial institutions.
Of course, back in February, $150 billion seemed like a lot of money. Now we know that it's only 3 Madoff Units.
Let us assume for the moment that the muni business is “sound” (I will later in this paper challenge this conventional wisdom).Then, the effect of splitting the monolines into two parts is similar to the Super-SIV rescue plan for the SIVs: i.e. if you put the “good” assets in one new bucket and allocate most of the existing capital of the firm to the good bucket then the losses for the other “bad” assets bucket – the one containing the bad apples – become even more severe.
So, in principle we can think of rescuing the good muni business of the monolines; but then the losses on the insurance of the structured products would be even bigger as you put all the “bad” apples into one bucket an provide that bucket with little or no capital.
That means that every "bad" apple had a motive to take down Spitzer, no? **
Now, let me put on the foil. Because it would be irresponsible not to speculate. Let's imagine -- implausible as it may seem -- a ruling class that isn't particularly concerned about obeying the law, is greatly concerned with getting away clean as The Big Shitpile implodes, and has come into possession of an extremely valuable intelligence source.
And let's further assume that, at the very highest levels, politics, government, finance, and intelligence are all seamlessly merged into a single group dynamic. Sort of like a polymorphically perverse Village High School where the Kool Kidz all know who's fucking who, and with what, but don't tell anyone else. Of course, in this scenario, you'd have to assume that crazy things happen like former heads of the CIA become President, or investment bankers become heads of the Treasury (and vice versa), or the talking heads on the teebee are all paid by the Pentagon. Or the President flies to Omaha to meet with the country's biggest billionaire*** on the very day of 9/11 itself. Or corporations and the government have merged. Or that they all go to the same parties.
So, third, wouldn't Our Betters use "Stellar Wind" to their advantage? You know they would. That's not foil; that's common sense.
Try walking a few steps in ruling class loafers (or stilettos). Think about what "Stellar Wind" means in terms of information and leverage. It means access to massive amounts of transactional data and, through record linkage, access to all email and phone conversations about the transactions.
1. Think of the opportunities for arbitrage. If you've got "Stellar Wind" data, you'd know what the market was going to do before it did it. It would be like playing poker while looking directly into your competitor's hand.
2. Think of the opportunities for blackmail. Just as we have to ask ourselves how many Madoffs there are, we should also ask ourselves how many Spitzers there are. We know that the Village is full of every kind of oddity -- not that there's anything wrong with (most of) that -- and it all has to be there in "Stellar Wind." It's like the "world is flat" version of oppo.
3. Think of the opportunities for scoping the Big Shitpile. Everybody's wringing their hands because the Big Shitpile is so complicated that nobody can unravel it. But "structured finance" is designed to be complicated, because, at least in many cases, it's designed to conceal fraud; think of the thousands of shell companies created by Enron, for example. But isn't it also the case that most con games are, at their heart, very simple? If that is true, than the data to prove it is in "Stellar Wind" somewhere -- because "Stellar Wind" hoovered up everything.
"Stellar Wind" was totally and massively abused. Spitzer isn't even the tip of the iceberg. Believe it. It's what these guys do.
NOTE * Here's Spitzer's testimony.
NOTE ** And here's the rest of Roubini on this topic; it's off point for this post, of interest nonetheless; remember that one of the prime goals for Democrats in the session to come should be to cushion states and municipalities from shocks:
But let us reconsider next whether the muni business of the monolines is as sound as the conventional wisdom makes it. The usual argument for the soundness of the muni insurance business of monolines is that state and local governments rarely default and thus the actual default risk for such governments is lower than the one implied by their formal credit rating. State and local government with different levels of debt relative to their revenues and different levels of fiscal balances receive different ratings from credit rating agencies. Thus, the borrowing costs for a single A rated local government are very different from those of a AAA rated government.
This is where monoline insurance of muni bonds enters in the picture. By buying insurance from the monolines state and local government can borrow at AAA rating spreads even if their underlying creditworthiness is much lower, say A. How is that insurance beneficial for both the buyers and sellers of insurance? If this insurance market was truly actuarially fair a local government should be indifferent between issuing a bond with a AAA rating that was obtained only after insurance is bought and instead issuing a bond at a spread reflecting its lower actual rating – say A – but without the cost of insurance. The reason for this indifference is simple: fairly priced insurance would imply an insurance premium paid by the borrower that – in expected terms – is equivalent to the difference in the spread between, say, a A rated bond and a AAA rated bond. So, a borrower should be indifferent between buying such insurance or not buying it.
So why do municipalities prefer buying insurance? The reason is that if they can convince insurers that their actual risk of default is lower than the one reflected by their formal rating the premium paid on the insurance is lower than the differential in spreads between a lower rated bond and a higher rated bond. ...
This is also the reason why folks like Warren Buffet want to buy the part of the monolines business that is muni insurance and the reason why some private equity firms or other investors want to enter into the business of muni insurance. For the last 20 years insuring muni bonds has been a cash cow for such insurers with little paid out as muni defaults have been extremely rare. It is like providing life insurance to folks who never die; or provide fire insurance to organisms living underwater with no fire risk.
But is it true that muni bonds are that safe because once state or local governments are under financial stress tightening the belt – in the form of spending cuts and/or raising revenues – is almost always preferred to the option of defaulting on their debts?
The relative safety of muni bonds is based on the relatively low rates of default on their bonds in the last quarter of a century. But there are several reasons to worry that default rates by state and local governments may sharply increase during the coming US recession.
First of all, the previous two US recessions – in 1990-91 and 2001 – were relatively shallow – lasting only 8 months - and did not affect as severely the finances of municipalities. ....
Second, state and local governments rely heavily on three sources of revenues: fees paid by real estate developers; property taxes; and sales taxes. All three sources of revenue are now under severe stress and will sharply fall further during a recession. ....
Third, an economy-wide recession will have much more severe effects on the fiscal conditions of state and local governments in regions where the housing boom and the home prices bubble were particularly large. ...
Fourth, many state and local governments will have very large fiscal financing needs in the next couple of years. These financing needs come from two sources: one is the need to rollover – or reissue – the existing outstanding muni bonds that are coming to maturity; the second is the need to issue – on net – new bonds if there is an increase in the fiscal deficit of such a locality.
The four factors discussed above suggest that the conventional wisdom that state and local governments rarely default will be seriously tested during the current economic recession.
NOTE *** A monoline insurance investor. As of February 13, 2008. Oddly, or not.