Credit derivatives rocked by loss at GM finance arm

[This is big. Really big. Not since FTW issued its first economic alert with a detailed description of how derivatives work, has the situation been as dire as Ambrose Evans Pritchard describes here. It looks like the Plunge Protection Team is gearing up for action again. It’s a fool’s paradise for those who cheer at recent highs in the DJIA.

It’s all a smoke and mirrors con game and Delphi may push GMAC over which may threaten to toast every major bank in the country as the derivatives at stake equal 175% of the cash reserves of America’s ten biggest banks.

Our first economic alert was published on September 9, 2001. Of course, two days later came the attacks of 9/11 and a massive inflow of money from the Treasury. We can only wonder what’s coming in March and April of 2006. For any of our readers still in the equity markets, it’s time to cash out… and quickly. – MCR]

In accordance with Title 17 U.S.C. Section 107, this material is distributed without profit to those who have expressed a prior interest in receiving the included information for research and educational purposes.

The discovery of huge hidden losses at General Motors' finance arm has raised fresh fears of bankruptcy at the world's biggest carmaker, sending tremors through the credit derivatives markets.

The struggling group asked for a filing delay after admitting to an extra $2 billion (£1.1 billion) in accounting errors at its finance arm GMAC, raising total losses last year to $10.6 billion. The news triggered a sharp spike in the cost of default insurance on GMAC's bonds, rising 75 basis points overnight.

Car-parts supplier Dana Corp. defaulted last week on $2.5 billion of debt, following Delphi and Tower Automotive last year.

Concern that General Motors may now be sliding towards the brink -- linked to an estimated $200 billion in credit derivatives -- has renewed fears that the overheated credit swap market could seize up in a crisis.

Global investors are already jittery after the crash of the Icelandic krona, which sparked flight from hot assets as far afield as Hungary, Turkey and New Zealand.

There is concern that monetary tightening in Europe, Japan, and America in unison might drain much of the excess liquidity fuelling the global asset boom.

Timothy Geithner, president of the New York Federal Reserve, warned in a recent speech that the $300,000 billion derivatives market had raced ahead of the infrastructure needed to support it.

He said the plethora of new instruments may have led to a more dangerous concentration of risk.

"They have not ended the tendency of markets to occasional periods of mania and panic. They have not eliminated the possibility of failure of a major financial intermediary. And they cannot fully insulate the broader financial community from the effects of such a failure."

"There are aspects of the latest changes in financial innovation that could increase systemic risk in some circumstances, by amplifying rather than dampening the movement in asset prices," he said.

The New York Fed was caught off guard in 1998 when the Russian default caused global bond spreads to widen further than computer models had programmed.

Long Term Capital Management -- a hedge fund with two Nobel laureates on its team -- was left on the wrong side of almost $100 billion in trades on Italian, Spanish, and Portuguese bonds, among others, until it was rescued by the emergency rate cuts. The Fed said at the time the meltdown had put the entire global financial system at risk.

This time Mr Geithner is demanding that the International Swaps and Derivatives Association clean up its act before -- not after -- any credit crunch. He said the "most conspicuous" problems were in the $12,400 billion market for credit derivatives, which has doubled in size every year for the last decade. A "significant" proportion of total trades do not even match up, he said.

Credit derivatives are an easy way to bet on credit quality without having to buy actual bonds, which are less liquid. Mr Geithner said the risk was very heavily concentrated, with America's 10 biggest banks holding $600 billion in potential credit exposure (on $95,000 billion of notional trades), equal to 175 percent of their financial reserves.

"The same names show up in multiple types of positions. These create the potential for squeezes in cash markets, magnifying the risk of adverse market dynamics," he said.

Market traders are scathing about such warnings, accusing the watchdogs of basic ignorance. "Regulators have been going on like this for five years now," said one veteran.

Unconvinced by such blithe assurances, the investor Warren Buffett has been warning since 2003 that derivatives are a ticking "time bomb," although his new metaphor is New Orleans' burst levee.

This month he was explaining it has cost Berkshire Hathaway $404 million to extract itself from derivatives inherited through General Re, the reinsurance group.

He said: "We are a canary in this business coal mine. Our experience should be particularly sobering because we were a better-than-average candidate to exit gracefully.

"General Re has had the good fortune to unwind its supposedly liquid positions in a benign market. It could be a different story for others in the future," Mr Buffett said.

[This is old hat for FTW readers and those who have read Crossing the Rubicon. Our “old friend” Dave Frasca is named yet again for his pre-9/11, premeditated obstructions. Nothing new here except further confirmation that we have had it right for a long time. – MCR]

The FBI agent who arrested Zacarias Moussaoui in August 2001 testified Monday he spent almost four weeks trying to warn U.S. officials about the radical Islamic student pilot but "criminal negligence" by superiors in Washington thwarted a chance to stop the 9/11 attacks.

FBI agent Harry Samit of Minneapolis originally testified as a government witness, on March 9, but his daylong cross examination by defense attorney Edward MacMahon was the strongest moment so far for the court-appointed lawyers defending Moussaoui. The 37-year-old Frenchman of Moroccan descent is the only person charged in this country in connection with al-Qaida's Sept. 11, 2001, attacks on the World Trade Center and the Pentagon.

MacMahon displayed a communication addressed to Samit and FBI headquarters agent Mike Maltbie from a bureau agent in Paris relaying word from French intelligence that Moussaoui was "very dangerous," had been indoctrinated in radical Islamic Fundamentalism at London's Finnsbury Park mosque, was "completely devoted" to a variety of radical fundamentalism that Osama bin Laden espoused, and had been to Afghanistan.

Based on what he already knew, Samit suspected that meant Moussaoui had been to training camps there, although the communication did not say that.

The communication arrived Aug. 30, 2001. The Sept. 11 Commission reported that British intelligence told U.S. officials on Sept 13, 2001, that Moussaoui had attended an al-Qaida training camp in Afghanistan. "Had this information been available in late August 2001, the Moussaoui case would almost certainly have received intense, high-level attention," the commission concluded.

But Samit told MacMahon he couldn't persuade FBI headquarters or the Justice Department to take his fears seriously. No one from Washington called Samit to say this intelligence altered the picture the agent had been painting since Aug. 18 in a running battle with Maltbie and Maltbie's boss, David Frasca, chief of the radical fundamentalist unit at headquarters.

They fought over Samit's desire for a warrant to search Moussaoui's computer and belongings. Maltbie and Frasca said Samit had not established a link between Moussaoui and terrorists.

Samit testified that on Aug. 22 he had learned from the French that Moussaoui had recruited someone to go to Chechnya in 2000 to fight with Islamic radicals under Emir Ibn al-Khattab. He said a CIA official told him on Aug. 22 or 23 that al-Khattab had fought alongside bin Laden in the past. This, too, failed to sway Maltbie or Frasca.

Under questioning from MacMahon, Samit acknowledged that he had told the Justice Department inspector general that "obstructionism, criminal negligence and careerism" on the part of FBI headquarters officials had prevented him from getting a warrant that would have revealed more about Moussaoui's associates. He said that opposition blocked "a serious opportunity to stop the 9/11 attacks."

The FBI's actions between Moussaoui's arrest, in Minnesota on immigration violations on Aug. 16, 2001, and Sept. 11, 2001, are crucial to his trial because prosecutors allege that Moussaoui's lies prevented the FBI from discovering the identities of 9/11 hijackers and the Federal Aviation Administration from taking airport security steps.

But MacMahon made clear the Moussaoui's lies never fooled Samit. The agent sent a memo to FBI headquarters on Aug. 18 accusing Moussaoui of plotting international terrorism and air piracy over the United States, two of the six crimes he pleaded guilty to in 2005.

To obtain a death penalty, prosecutors must prove that Moussaoui's actions led directly to the death of at least one person on 9/11.

Moussaoui pleaded guilty last April to conspiring with al-Qaida to fly planes into U.S. buildings. But he says he had nothing to do with 9/11 and was training to fly a 747 jetliner into the White House as part of a possible later attack.

Samit's complaints echoed those raised in 2002 by Coleen Rowley, the bureau's agent-lawyer in the Minneapolis office, who tried to help get a warrant. Rowley went public with her frustrations, was named a Time magazine person of the year for whistleblowing and is now running for Congress.

MacMahon walked Samit through e-mails and letters the agent sent seeking help from the FBI's London, Paris and Oklahoma City offices, FBI headquarters files, the CIA's counterterrorism center, the Secret Service, the Immigration and Naturalization Service, the Federal Aviation Administration, an intelligence agency not identified publicly by name in court (possibly the National Security Agency), and the FBI's Iran, Osama bin Laden, radical fundamentalist, and national security law units at headquarters.

Samit described useful information from French intelligence and the CIA before 9/11 but said he was not told that CIA Director George Tenet was briefed on the Moussaoui threat on Aug. 23 and never saw until after 9/11 a memo from an FBI agent in Phoenix about radical Islamists taking flight training there.

For each nugget of information, MacMahon asked Samit if Washington officials called to assess the implications. Time after time, Samit said no.

MacMahon introduced an Aug. 31 letter Samit drafted "to advise the FAA of a potential threat to security of commercial aircraft" from whomever Moussaoui was conspiring with.

But Maltbie barred him from sending it to FAA headquarters, saying he would handle that, Samit testified. The agent added that he did tell FAA officials in Minneapolis of his suspicions.

Economists at Rabobank have called on the world's central banks to undertake action to prevent the US dollar from plunging against the euro and other currencies.

Citing current "instabilities" such as the US trade deficit and the US national debt in the bank's quarterly economic review released today, Rabobank economists are urging central banks to "undertake a coordinated effort to bring down the value of the US dollar to a more sustainable level" vis-a-vis the euro.

The bank's economists point to the fact that the Chinese central bank has thus far been buying US dollars on a large scale, thus effectively supporting current currency trading levels, but the researchers said that several factors may force the Chinese central bank to stop buying dollars, which could result in a worldwide selloff of US dollars by currency traders as confidence in the currency would fade.

Some of the factors mentioned could be protectionism of the US domestic market by lawmakers, or an oil-exporting country like Iran deciding to switch to the euro instead of the dollar for oil trading purposes as a result of political tensions, the economists said.

The Rabobank economists also argue that the US needs to start reducing its national debt and budget deficit, and decrease the country's trade deficit to prevent a possible loss of confidence in the dollar by currency markets.

The other day, a prominent Canadian journalist paid me a visit to interview me for his book on building a sustainable future. At one point, I expounded on the closed-nutrient cycle of old-school organic farming, contrasting it with what writer Michael Pollan deemed the "industrial-organic" way. In the old-school organic style, which relies on animals, farm wastes are recycled into the soil, providing all the nutrients necessary for the next harvest. The industrial-organic farmer, by contrast, imports his or her soil fertility -- just like the conventional farmer. The difference is that the organic farmer is likely shipping in composted manure from far-flung places, while the conventional grower is hauling in a processed petroleum product.

"The problem," I continued -- my interlocutor's eyes may well have been glazing over -- "is that most small vegetable farms these days, including my own, don't have enough animals to produce the nitrogen we need. So our transition to real organic farming is ongoing."

The journalist then asked me a question that stopped me short: "Do you think real organic farming could feed the world?" I stammered something like "I hope so," and had him jot down a couple of books to look up. It wasn't until after he left that I realized why his question made me so uneasy.

What he was asking me, in essence, was, "can sustainable farming feed the world?" To which the only wise response is, "can unsustainable farming feed the world -- for long?"

To an extent, the problem is one of semantics, centering on the definition of "sustainable." To many green types, places like Whole Foods and Wild Oats teem with "sustainably produced" stuff -- everything from T-shirts to apples, chicken and eggs, even versions of Twizzlers and TV dinners. But the great bulk of it falls under the rubric of industrial-organic -- like the wares on offer at Wal-Mart, only a little less so, these goods depend on a culture of cheap and plentiful crude oil and labor.

The cheap-oil problem has certainly gained traction among greens. Blogs devoted to "peak oil" abound; this very blog seems like one at times. Most of these discussions, though, devolve into sniping about biofuels and hybrids. It's important to wonder how we'd get around in an era of super-high oil prices.

The cheap-labor problem certainly doesn't garner much attention in environmental circles. The amount Americans pay for food as a percentage of income has fallen steadily since 1980, leveling off about at 10 percent -- less than any people in history. Meanwhile, growth in real wages has stagnated. According to Robert Pollin's indispensable Contours of Descent: U.S. Economic Fractures and the Landscape of Global Austerity, real hourly wages peaked at $15.73 in 1973 and by 2000 stood at $14.15 (2001 dollars). And that was after a rare three-year growth spurt provoked by the stock-market bubble; since 2000, stagnation has returned.

What these two facts -- cheap food, stagnating wages -- reveal to me is a vicious circle. We need our food supply as cheap as possible to feed low-wage people; we need lots of low-wage people -- farm workers, slaughterhouse workers, clerks at our number-one grocer, Wal-Mart, and so on -- to sustain our cheap-food system. Whatever else it does -- and it works pretty well, if you're a major shareholder in transnational corporations -- this cycle consumes enormous resources and, yes, severely damages the environment.

How do we keep labor so cheap? One way is by prying open foreign labor markets. Want to agitate for higher wages in the textile plant? Fine. We'll move the plant to China. Better take what the company gives you. Pollin quotes the sometimes-sainted Alan Greenspan on why wage growth lagged productivity growth in the go-go late 1990s: Even then, workers were "traumatized" by the specter of job insecurity, the chairman noted approvingly.

How do we keep food so cheap? One way is by opening our market to foreign-grown food. As Ken Meter has shown, we're about to become a net food importer. If you think Mexican labor is cheap in California's and Florida's tomato fields, imagine how much cheaper it is down in Mexico. Another way, as I have shown here ad nauseam, is subsidies. Last year the federal government cut checks to commodity-agriculture producers amounting to $23 billion -- roughly equivalent to Bolivia's GDP. In those terms alone -- never mind steep environmental and social costs -- cheap food is actually a pretty pricey proposition.

But that $23 billion figure shouldn't make farmers the equivalent of Reagan's welfare mothers of the 1980s. The payments urge overproduction, which pushes prices down and eats into farm incomes. The real beneficiaries of this welfare scheme are grain buyers: processors like Archer-Daniels Midland and Cargill, and feedlot operators like Smithfield Foods. And, of course, their shareholders.

Back to my Canadian journalist visitor. He spoke with great knowledge about energy issues, about fluid local grids where everyone's a producer and everyone's a consumer. About food -- even though he tends a garden plot, even though he shops at farmers markets -- he seemed, like so many environmentalists, like so many people nowadays, out of his element.

Why is it so difficult to get people interested in the politics of food? In a culture where food production takes place in such abstraction, food becomes banalized into minimal rituals of ingestion, digestion, and expulsion. Food, when we do think of it, becomes a kind of sport, another spectacle to consume: chefs puffing like fullbacks on Iron Chef, Emmeril bellowing idiotically like some sort of high-school football coach.

Can sustainable agriculture feed the world? That depends, I suppose, on what you're trying to sustain. But I seriously doubt that industrial agriculture -- or its bastard child, industrial-organic -- can for much longer.

[This Interfax interview with a high-level Chinese official is chock full of tidbits on everything from oil and gas to commodities. As far as I can see the pretty candid comments of Zhang Guobao are an accurate description of what’s happening with Russia’s play on whether to supply Japan and/or China with oil. It’s also clear that Russia is keeping its options open and a significant part of their ultimate decision will be determined by which nation looks to be faring better in the first serious stages of global decline. Russia can’t supply enough energy to keep both countries happy even as it starts to look ahead to its own inevitable decline in production which we can be fairly certain of within the next 2-3 years. – MCR]

Here is a full transcript of an exclusive Interfax interview with Zhang Guobao, the Vice Director of the National Reform and Development Commission (NDRC), on China's position concerning energy cooperation with Russia.

ZHANG GUOBAO: Russia has largely complied with our agreement to export oil by rail to China.

As for cooperation in other areas, there has been contact, such as between government officials, departments and the private sector, such as during investment conferences. There has been a lot of communication, but there has been little actual progress.

Currently, the Sino-Russia pipeline question is one step forward, two steps back. Today is cloudy with a chance for sun while tomorrow is sunny with a chance for clouds just like a weather forecast. One moment Russia is saying they have made a decision, the next saying that no decision has been made.

There has also been a lot of contact regarding natural gas exports to China. Russia has expressed a great deal of interest in exporting natural gas. Once during a visit to China, Energy Minister (Viktor) Khristenko asked China to provide a report detailing China's natural gas demand conditions and requirements. He said Russia was developing their natural gas plan and wanted China to provide him with a demand forecast, which China provided within the time period he specified.

However, even though there have been a lot of promises expressing Russia's interest in exporting natural gas to China, in truth no real progress has been made.

Deals with Sakhalin, Western Siberia and other regions, have been discussed, but no agreement has been reached.

As for Russian electricity exports, it was Russia who first contacted us about it. I've forgotten his name, but he's currently working for Russia's State Power Company. He brought a delegation to China and we signed a northern network memorandum expressing our mutual interest in electricity sales.

Why did we express such a great interest at that time? Because Heilongjiang (Province) and Russia's lonely far eastern Siberia cannot help but have a pair of power lines that can send electricity from Russia into China.

However, during all the years we've been connected together, Russia has only sent a total of 1 billion kWh of electricity to China. During the peak year, Russia exported 100 million kWh.

Though this area is energy rich, it is not very economically developed, so the electricity sales price should be quite cheap. My impression is it should cost about $0.02 per kWh, so China was very interested. At that time, China's energy demands were very strong and we hoped Russia could sell us all the electric power in Siberia.

Later, they had a lot of communication with the State Grid Corporation of China to sell the electricity. But, why didn't the talks continue? Because Russia's asking price per kilowatt hour was very high, about $0.08 per kWh.

I think they didn't understand China's energy situation. They just didn't understand. They also didn't understand the cost of electricity in China.

China's energy shortage is quite severe, but Russia's offer was not competitive. China's average cost per kWh for thermal power generation in is a little over RMB 0.3 or about $0.04. If their electricity will cost more than domestic electricity, why would we want to buy it from Russia? Why not build a power plant in China, where we could also help reduce unemployment?

If Russia's electricity, which should be very competitive, were more competitive than China's, that would be all right. But they don't understand China, thinking that we have to purchase their electricity. Even though we've had a lot of contact, we haven't continued talks.

If talks were to continue, the main issue would be that Russian electricity exports to China must be more competitive than domestic power generation. If Russia's asking price is higher than the domestic price, then why do we have to buy electricity from Russia?

In my opinion, though both sides have had developments in energy cooperation and communication, in reality there have been few results. The one exception is in crude oil talks, where the two sides have agreed to purchase 7 million tons of crude oil shipped by rail. For the other aspects, it is still only talk.

INTERFAX: Does China have any plan to invest in Eastern Siberia and develop Russian oil reserves? Does China plan to allow Russian companies to construct refineries in China to refine Russian crude oil imports and sell oil products in China?

ZHANG GUOBAO: I think you know, China is making investments and developing oil fields in Kasakhastan, in Sudan, and other places. We even have contacts in Venezuela, in Central America, and in Canada's tar sands. Russia is so close to China, why wouldn't we be willing to invest in Russia?

The first question is easy to answer. We are willing, but will Russia let us? Have I answered your first question? (laughs)

Russia wouldn't let China purchase a small, little-known oil company. Russia's reaction was exactly like America's when we wanted to purchase Unocal, saying they do not want China to acquire their oil assets. You shouldn't ask me whether we are willing or not. We're shown our willingness to cooperate with and invest in other countries, but Russia isn't willing to let us invest.

Truthfully, we've been in contact with Russia for such a long time, but we still don't understand Russia, I feel. We don't know who can make the decisions, or who to seek out.

We have contacted government officials. We've even talked to Putin and department heads. We've talked to everyone in the government. They say they can't make a decision, and we say should talk to the private sector. We've met with every company. They say they can't sign an agreement and we should talk to the government. We don't know who can make decisions.

I can give you an example. I once went on a special trip to Russia to pursue an energy cooperation agreement. I sought out Russia's Nuclear Energy Ministry, the Economy and Trade Ministry, and the Economic Development Ministry, which is Russia's equivalent of the NDRC. I went to all of them, including meeting with Khristenko, and the former Energy Minister Igor Yusufov.

I sought them out because it was said they had talked with Ma Fucai (former head of China National Petroleum Corporation (CNPC) about the Lianyungang nuclear power station. At that time, the Lianyungang nuclear power station deal was a barter deal. They said, if China was willing to make it a cash deal, and pay the entire amount up front, Russia could use this money to construct an oil pipeline from Siberia to China.

The government approved and I went to Russia. In Russia, I sought them out, telling them the Chinese government was willing to give them $1.4 billion, which would then be used to construct the pipeline. We were willing to give them the entire sum then and there so they can begin work on the oil pipeline, but they were just talking in circles and didn't want to reach an agreement.

They had asked us if we would agree to changing the Lianyungang nuclear station barter-agreement into a cash agreement. Ok. So I went to Russia. I went to every government department and told them we were willing to make this change, but after talking with everyone, I couldn't find anyone who could settle it. It was a wasted a trip.

INTERFAX: And regarding China's plans to allow Russian oil companies to construct refineries and sell oil products in China?

ZHANG GUOBAO: If you ask me this question, I'll reply with a question of my own. As I just said, China is investing in Kazakhstan, going to Sudan and Latin America, why not in Russia? The American firm Exxon Mobile can setup a joint venture in Fujian, Saudi Aramco can set up a joint venture in Fujian. BP can set up a joint venture in Shanghai. Why couldn't Russia do the same? China's government has never said Russia can't do it.

Russia has just emerged from the planned economy and hasn't done it as quickly as China has. They don't understand international cooperative ventures.

It's not as though we've told Russian companies they couldn't invest here. They've never asked if they can invest here. Other countries have come to China, why can't Russia?

ZHANG GUOBAO: International oil prices have been rising. Last year, international crude prices hit $70 per barrel and have fallen back to about $60. Such high prices will obviously raise the cost of kerosene, gasoline and oil products.

About half of China's oil is imported from abroad and import oil costs are very high. However, the effect raising oil product prices would have on society would be too great. Many weak industries would be heavily affected, like agriculture which needs oil for tractors and fertilizer. Agricultural costs would rise. Taxi prices would have to rise. It would directly affect the lives of common people.

Other industries, like airlines, would have to raise ticket prices, along with ticket prices on public busses. Because of this, we have to consider society's ability to accept price hikes.

Two years ago, even though international oil product prices rose, domestic oil product prices remained stable. At present, domestic oil product prices are more than RMB 1000, or more than $100 below international prices. If we were to close the gap between domestic and international oil product prices, it would affect a lot of weak industries.

We have not finished thinking over this aspect. There are a lot of opinions from different departments, but we have yet to reach an agreement. However, we are committed to moving in the direction of using market price measures.

ZHANG GUOBAO: If you enter the International Energy Association (IEA), they require member states to hold a strategic reserve of 90 days. China still isn't a member of the IEA but when a country becomes an energy consumer, it should develop a reserve for energy security. However, there are two types. One is a government reserve. The other is commercial reserves.

China also, for energy security, needs commercial and government reserves. Commercial reserves are reserves held by energy companies, like CNPC and Sinopec, for their commercial needs. We will encourage companies to slowly start building up their reserves.

As for the government reserves, have marked out a plan for government reserves, but I don't want to imply we want to have reserves comparable to those abroad. Whether the best reserve quantity is 90 days or 30 days or 100 days, it should be decided by every country's unique circumstances.

For example, Japan said 90 days wasn't enough and felt they should have 100 days or 120 days reserves. But Japan's justification is that 100% of its oil is imported from abroad. More than 60% of China's oil is produced domestically. Only a bit more than 30% is imported. Why should we establish a reserve as large as theirs when the conditions are completely different?

During a visit to the U.S., a reporter asked me about the construction of our strategic reserves. He immediately reported my statements that China wanted a strategic reserve, and international oil prices spiked. Everyone blamed the price spike on China.

As long as oil prices are this high, I definitely will not announce China will begin filling the strategic reserves, as it might affect international prices. I won't allow my position to be used by price speculators who will say 'China wants a strategic reserve' to push the market price higher. Then China gets blamed for the price increase.

With prices over $60 a barrel, if we began filling the reserves and the price of oil fell to $50 per barrel, China would suffer a large financial loss.

INTERFAX: I have a very simple question. Russian President Putin will come to China in March. During an interview with Russian television, he said China and India should join the G8, especially in discussions of energy issues and problems. What is your opinion of this?

ZHANG GUOBAO: First, you must look at how the G8 emerged. In the beginning it was the Group of Seven, all western countries. Later, Russia joined. Some people call this the Group of Wealthy Countries. China cannot yet be considered wealthy, but the Group of Wealthy Countries should realize the importance of China's economic development on international trade and development.

China is currently the second largest energy producer in the world, as well as the second largest energy consumer, trailing the U.S. This isn't just crude oil production but also includes coal and other energy sources.

If the second largest crude oil consuming country isn't allowed to attend, is it a truly international conference? China should definitely attend. If the second largest energy producer and consumer doesn't attend, is it internationally representative?

INTERFAX: What is the government's attitude towards the ongoing iron ore price negotiations?

ZHANG GUOBAO: In the international iron market, there are two monopolists, Australia and Brazil, if you go by country. But China also imports some iron from India as well.

Last year, international iron markets were tight and prices rose 41.7%. This year prices are expected to continue to rise. The two largest iron exporters have expressed their desire to see prices continue to rise.

However, China's steel price is already quite low due to China's large production capacity. We would not be able to accept another large rise in the price of iron ore. We would not agree with another 41.7% rise in ore prices.

[PROMIS software is not new news to FTW readers and those who have read Crossing the Rubicon. Here, journalist and former intelligence operative Dave Dastych, brings us up to date on this never-ending saga. I note with irony that also breaking today are two PROMIS- related stories about the FBI’s new Sentinel program and how Lockheed, CSC and other FBI contractors seem to be having a hard time handling money and equipment without losing it. Think of it not as theft, but as a sloppy way of shipping equipment and programs out the door for black programs that can’t be publicly accounted for.

More data back doors in government programs? This is the kind of thing that Dick Cheney loves.

The two stories following Promisgate are dated today. Lockheed-Martin has been a court-documented PROMIS player for decades and—in case you don’t recall—about two years ago CSC bought one of the biggest names in the PROMIS story, DynCorp. Yes, Virginia, that’s the same DynCorp that’s all over Iraq and Colombia and which back in the late 90s was exposed as having run child prostitution rings in the Balkans. – MCR]

The so called PROMIS affair would never have happened if the software invented by an American computer specialist, Mr. William A. Hamilton, had been a technical failure. But this case management and data mining software, developed in the early 1980s by a small Washington D.C. company, Inslaw Inc., had proven itself to be a perfect intelligence tool. Originally made for the Department of Justice to help the country’s prosecutor offices in their case management, it drew the attention of corrupt officials and of Israeli Intelligence. Stolen by ruse from its owner, Inslaw Inc., the software was hacked and provided with a "trap door", a sort of a Trojan Horse hacker’s trick, that enabled the retrieval of information from the foreign intelligence services and banks it had been sold to on behalf of Israeli and U.S. intelligence. Without the knowledge of the software’s owner, and in violation of copyright laws, the PROMIS software was sold to over 40 countries and used in an unprecedented "sting operation", which yielded huge financial and intelligence benefits to the United States and Israel.

In February 1985, Inslaw Inc. filed for Chapter 11 bankruptcy protection because the Justice Department had withheld payments totaling almost $1.8 million U.S. due Inslaw Inc. under a PROMIS Implementation Contract for U.S. Attorneys Offices. The PROMIS affair, broken by investigative journalists, two federal courts, and a congressional investigation and published in thousands of media stories and in several books, has never been resolved.

But "blowback" from the U.S. Government's theft of PROMIS in 1982 soon turned into a series of painful losses for U.S. national security, into criminal financial benefits for corrupt officials, and into intelligence "scoops" for the secret services of adversaries. "It’s far worse than Watergate"--commented former U.S. Attorney General and Inslaw counsel Elliot Richardson.

The history of this world-famous computer software goes back a quarter of a century, and its applications by intelligence, organized crime and terrorist organizations began almost from the start. The software helped the United States win the Cold War against the Soviet Union, but it also served the Russian mafia, Saddam Hussein’s regime, Osama bin Laden’s al Qaeda, and an unspecified number of foreign spies and criminals. As far back as 1985, when the late British media tycoon and top [Israeli] Mossad spy, Robert Maxwell, revealed the software’s "trap door" secret to Chinese Military Intelligence (PLA-2), while selling them a copy of PROMIS for $ 9 million, the powerful software was turned against the United States. The Soviet KGB purchased PROMIS from Robert Maxwell, but they also [later] received a copy (together with the Trojan Horse secret) from Robert Hanssen, a spy planted in a most sensitive office of the FBI. The Soviets and their East European allies, including Poland, used PROMIS to spy on the U.S. State Department and 170 American Embassies and Consulates all over the world. This practice may have continued as late as 1997, and the post-communist intelligence agencies of Russia and other countries, including Polish Military Intelligence (WSI), may have been able to retrieve information from U.S. Government agencies, because as many as 64 of them [are believed to have] used modified versions of PROMIS. Using the same PROMIS software, purchased from Russia, Saddam Hussein and members of his regime could shift huge sums of money undetected through the banking system. Some of these funds are still supporting the anti-Coalition insurrection in Iraq and terrorists. In the mid-1990s, Chinese Military Intelligence (PLA-2) organized their own hackers department, which [exploited] PROMIS to penetrate [database systems] [in the] Los Alamos and Sandia national laboratories to steal U.S. nuclear secrets.

No over-all damage assessment has been prepared yet. But the losses to the U.S. economy may be in billions of dollars, and damage to the national security of the United States and its allies may be incalculable.

An American intelligence officer, whose name cannot be disclosed, made the following comment on the consequences of the illegal operations performed with the use of PROMIS:

(…) "Yes, we gave PROMIS to the Russians and Chinese to back door their intel. Worked like a charm. The only problem was ‘blowback’. As we gave it to our enemies in order to back door them through the trap door Trojan horse asset in PROMIS, we left sixty-four federal agencies wide open in the U.S. Government who also used PROMIS. The powers-that-be felt that the information obtained far outweighed the damage done to the security of the 64 federal agencies. Just think, federal agents exposed, witness relocation programs compromised, etc. Just a matter of time."

There were also two reported connections between the U.S. intelligence failure relating to the terrorist attacks on 9-11 and unauthorized derivatives of the PROMIS software.

First, unnamed government sources familiar with the debriefing of Hanssen in 2001 reportedly told the Washington Times, Fox News, and the washingtonpost.com that year that someone in Russia had sold copies of PROMIS-derivative software source codes, which Hanssen had stolen from the FBI and U.S. intelligence agencies for the Russians, to Osama bin Laden for $2 million and that al Qaeda had used the stolen U.S. intelligence software to access the U.S. intelligence database systems in order to evade detection and monitoring before 9-11 and to move funds undetected through the banking system.

Osama bin Laden received PROMIS software, bought for him by wealthy Saudis through their connections with the Russian mafia. An American intelligence expert told us: "Salah Idris, along with members of the Saudi Royal family, arranged for the sale of PROMIS to Bin Laden. Yes, it came from the Russians, but not in as big a part as the spook community would have you believe. Nor was it entirely the work of Robert Hanssen. He was merely available to point the finger at." Thanks to PROMIS, computer wizards working for al Qaeda could move funds and avoid tracking by U.S. and other intelligence, at least until the assaults on the United States, on September 11, 2001.

Secondly, the 9-11 Commission in the United States reported, in its April 14, 2004 report on the U.S. intelligence failure, that the FBI had failed to connect the dots between leads in its computerized case management system from two different field offices during the summer of 2001 about Arab men taking flight training courses, blaming the FBI’s failure on the fact that its case management software "employs 1980’s technology that is by all accounts user-unfriendly."

What was the main reason for the FBI’s failure? The inventor of PROMIS and President of its producer, Inslaw Inc. company in Washington D.C., Mr. William L. Hamilton, told me that:

"The 9-11 Commission called attention to the fact that the FBI did not install the current version of its case management software, called the ACS (Automated Case Support) system, until October 1995 and [to the fact] that ACS was obsolete from the time the FBI developed it in the mid-1990s because it was based on ‘1980s technology’. Although the 9-11 Commission offered no explanation for why the FBI used obsolete technology to develop its ACS case management software in 1995, the apparent explanation is that the FBI simply re-named its 1980s technology case management software, which was called FOIMS and was based on PROMIS, and translated it in October 1995 into a different computer programming language in order to obstruct a court hearing that the U.S. Senate had ordered earlier that year. The Senate had ordered the court in May 1995 to determine whether the United States owes Inslaw compensation for the government’s use of PROMIS, and the court ,in turn, ordered outside software experts to compare the FBI’s software with PROMIS, but the FBI modified its software and told the court that it no longer retained the unmodified first 11 years (1985 through 1995) of its own case management software."

" A June 2001 front-page story in the Washington Times quoted unnamed federal law enforcement sources familiar with the Hanssen case as stating that al Qaeda had been able to use a copy of the FBI’s FOIMS software, [purchased on the Russian black market], for espionage against the United States as late as 2001, six years after FOIMS had supposedly been replaced by ACS. This may be an additional indication of what the FBI actually did in 1995. Instead of using its ACS software project in 1995 to take advantage of early 1990s improvements in computer technology in order to make FOIMS easier for FBI agents to use, the primary purpose of the FBI’s ACS project in 1995 was obstruction of justice."

To put this into simpler words, the FBI (and possibly a number of other agencies of the U.S. Government) still use unauthorized derivatives of the PROMIS software. This means that foreign intelligence agencies, which have bought or otherwise acquired PROMIS, can easily "break in" into such FBI and U.S. intelligence data bases, posing a serious threat to the national security of the United States.

In September 2005, the FBI arrested one of its own intelligence analysts for computer-based espionage. The arrest of Leandro Aragoncillo, an FBI intelligence analyst, has rekindled concerns about computer security at the F.B.I. that were first raised in the wake of the February 2001 arrest of FBI Agent Robert Hanssen for computer-based spying for the Soviet Union and the Russians. On October 7, 2005 an article in the New York Times, for example, entitled "New Spy Case Revives Concerns Over Security at F.B.I." reported that the arrest of Aragoncillo was probably the result of happenstance, rather than the result of the pro-active auditing by the FBI, which the FBI was supposed to have begun because of the Hanssen case, into the actual uses of its case management system.

The FBI complaint against Aragoncillo stated that he emailed to associates in the Phillipines more than 100 sensitive intelligence documents that he had downloaded from the FBI’s computer-based ACS case management system. There have, moreover, been U.S. press reports, including a report by ABC, that Aragoncillo spied for the Phillipines by downloading classified information from the computer systems of other agencies. Prior to joining the FBI, Aragoncillo was a U.S. Marine assigned to the Office of the Vice President, and reportedly used computers in that office to download classified documents from computer systems at the Pentagon and at the CIA.

The case of Aragoncillo can be compared to the earlier case of Robert Hanssen. The FBI complaint filed against Hanssen in February 2001 stated that Hanssen had made "extensive use" of the FBI’s computer-based case management system to steal U.S. intelligence secrets for the Russians, and that he had also given the Russians a copy of a technical manual on the COINS II (Community On-Line Information System, 2d version), a software system used by various U.S. intelligence agencies to track the intelligence information they produce. A report by the washingtonpost.com in 2001 stated that Hanssen had also stolen U.S. intelligence secrets from the computer systems of other agencies such as the CIA, NSA, the Pentagon, and the White House.

In both cases, the spies planted in the FBI had evidently been able to gather information by using the PROMIS-derivative software system underpinning all of these U.S. intelligence community database systems.

Reporting on the recent Phillipino spy case, John Diamond of USA Today wrote: "After the Hanssen case, the FBI began a $170 million upgrade of its computer network. Severe technical problems led that upgrade to be scrapped, and only now is the FBI seeking bids for a new system, called Sentinel." The FBI has serious problems.

U.S. Attorney General Alberto R. Gonzales accompanied President Bush on his November 2005 trip to China, primarily to talk turkey to the Chinese authorities about their need to better enforce the copyrights protecting U.S. intellectual property. A recent study estimated that 90% of all software sold in China has been stolen from its copyright owners. On November 10, 2005, just days before the President’s visit to China, Gonzales unveiled proposed legislation called the Intellectual Property Protection Act of 2005. The proposed legislation seeks to promote full restitution to companies victimized by copyright infringement.

The new legislative proposal and lobbying of the Chinese Government expose the Bush Administration and its Justice Department to charges of hypocrisy. The United States is attempting to convince China to do a better job of enforcing software copyright rights, and, where necessary, to see to it that "victim companies" receive full restitution. But the U.S. Government has set a poor example by refusing for two decades to make any restitution to Inslaw. Moreover, the Justice Department, which is the U.S. Government’s main agency for enforcing copyright rights, has instead obstructed attempts to get to the bottom of the Inslaw affair, according to the fully-litigated findings of two federal courts and the investigative findings of two congressional committees.

"Inslaw deserves to be compensated. More importantly, the American people deserve to know the truth: Did government greed and bureaucratic hubris lead to a wholesale sellout of our national security? The Bush White House's credibility is on the line," wrote nationally syndicated columnist, Michelle Malkin, in The Washington Times. There is no better way to state it.

FBI to make Sentinel share information more easily
Bureau awards $305m contract to Lockheed

The FBI is taking steps to ensure its new case management system, dubbed Sentinel, will share information among the disparate systems at the Homeland Security Department, Bureau of Alcohol, Tobacco, Firearms and Explosives, and other agencies.

FBI officials said they have specified several such functions including coordination with the N-DEX data sharing system.

The bureau last week awarded Lockheed Martin Corp. a six-year, $305 million contract for Sentinel, which would adopt standardized information sharing features specified in the National Information Sharing Exchange Model. It also would follow the intelligence community’s Metadata Working Group and the Justice Department’s Extensible Markup Language Data Model.

Lockheed beat out Northrop Grumman Corp. for the contract to replace the failed Virtual Case File system, which the FBI abandoned in March 2005 after spending $104 million on it.

Sentinel also would share information with the litigation case management system Justice is buying, officials said.

The bureau said it had informed one of the teams that its proposal was not acceptable, but cautioned that negotiations are still fluid.

The FBI’s latest justification for Sentinel comes after Justice’s inspector general, Glenn Fine, rapped the project for failing to build in strong information sharing capabilities.

The bureau concurred with the IG’s recommendation to coordinate with other law enforcement and intelligence agencies, and described its plans to do so.

In addition, the bureau said it had assigned an information architect to the Sentinel project with responsibility for ensuring Sentinel’s information sharing capabilities.

Despite the bureau’s assurances, the IG report cites statements by other agencies that their involvement in the Sentinel development process has been limited. For example, the Drug Enforcement Administration’s case management system acquired under the Concorde program may have to be modified to link to Sentinel.

Homeland Security Department IT officials told the investigators that they had reviewed information about Sentinel but not participated in its planning.

The IG warned that if connectivity is not built in, other agencies ‘ systems might require costly and time-consuming modifications.

The FBI added that Sentinel would distinguish between law enforcement data and intelligence data, which have to be handled differently.

Strengthening plans for system security
Achieving full staffing of the Sentinel program office
Buying and installing an earned-value management tool
Using a cost-tracking tool
Completing a training plan
Monitoring the effects of taking funds from operational programs to pay for Sentinel.

The bureau concurred with the IG’s recommendations and described how it already had been implementing them.

The IG added that Sentinel might cost $400 million to $500 million, according to information the bureau provided to Congress last year.

Two companies that will share in a new FBI computer contract were singled out in a government audit Monday that questioned $17 million in the agency's computer overhaul.

The FBI and its contractors share the blame for $10 million in questionable costs and for 1,205 pieces of missing computer equipment valued at $7.6 million, the Government Accountability Office said in its review of the FBI's Trilogy program.

Two of those companies, CACI and Computer Sciences Corp., are part of the Lockheed Martin Corp. team that last week won a six-year, $305 million contract to build and run the FBI's Sentinel computerized case management system. The total value of the Sentinel project is $425 million.

FBI officials said they were applying the lessons learned in the Trilogy computer upgrade, including keeping tighter reins on their contractors. Sentinel is the replacement for the failed project that was to have been the final piece of Trilogy.

The questionable costs included first-class air travel for government contractors, excessive overtime and $5.5 million in charges that lacked substantiation, the report by Congress' investigative and audit agency said.

The FBI was "highly vulnerable to payments of unallowable costs" because of lax oversight, auditors said.

El Segundo, Calif.-based Computer Sciences, or CSC, was the principal contractor in the effort to put in place a high-speed, secure computer network and 30,000 new desktop computers for the FBI. CACI of Arlington, Va., essentially reported to CSC.

Auditors identified a $456,211 invoice from CACI for which CSC never received sufficient evidence, but paid anyway. "It's not what we asked for but at this point it doesn't really matter. Approve it," one CSC employee wrote another in an e-mail exchange that was included in the GAO report.

In another bill from CSC to the FBI, all but $44,000 of a $1.95 million invoice was listed as "other direct costs" with no additional explanation provided.

Auditors also identified as excessive the $52,000 CACI spent on 60,000 pens that were custom-made for FBI computer training sessions.

CSC spokesman Chuck Taylor said his company complied with its contract, using first-class travel only to accommodate last-minute schedule changes when lower fares were not available. CSC's billings were within approved limits, Taylor said. CACI did not immediately comment Monday.

A separate report last week from Justice Department inspector general Glenn A. Fine warned that costs could again get out of hand unless the FBI puts strong controls in place. Bureau officials have said they are doing just that.

"The lessons learned from the Trilogy program are guiding us, and the FBI continues to strengthen our internal controls," said FBI spokeswoman Cathy Milhoan.

The CSC unit that worked on Trilogy will not be part of the Sentinel project, Milhoan said. CACI will provide training for new system, as it did for Trilogy, she said.

The FBI has since accounted for more than 1,000 of the missing desktop and laptop computers, printers and servers, she said. The bureau also will seek repayment of inappropriate charges identified by a final audit of Trilogy that has yet to be finished, Milhoan said.