Société Générale: French Inquiry: Bank’s Inaction Grows as Issue

NICOLA CLARK and KATRIN BENNHOLD
NYT, January 29, 2008

PARIS — The credibility of Société Générale’s management came under fresh scrutiny Monday after Jérôme Kerviel told French prosecutors that his fictitious trading started as far back as 2005 — a year earlier than the bank had acknowledged.

At the same time, the prosecutors said Mr. Kerviel disclosed that at least one of his trades raised a red flag about two months ago at Eurex, the pan-European derivatives market, but that he headed off concerns at the bank by producing a false document.

Mr. Kerviel’s account is almost certain to raise fresh questions about why Société Générale’s auditors did not notice anything amiss sooner. It could also put additional pressure on the bank’s chief executive, Daniel Bouton, to step down.

“When there is an event of this nature, it cannot remain without consequences as far as responsibilities are concerned,” the French president, Nicolas Sarkozy, told reporters while on a visit to a University of Paris campus.

But even as French politicians stepped up their pressure on the bank, they sought to head off any efforts by foreign banks to acquire Société Générale while it is under duress.

Finance Minister Christine Lagarde said the bank was under “no constraints” to merge with another financial institution.

Henri Guaino, a top adviser to Mr. Sarkozy, went further, warning that the government would intervene if any company made a hostile move against Société Générale. “I don’t think the state would remain with its arms crossed if someone, whoever the predator, tried to take advantage of the situation,” he said Sunday night on French television.

France has a long record of protecting its landmark companies, or national champions, from takeovers and bankruptcy.

These fixtures of the French political landscape — “economic patriotism,” as it is known here — have included the bailout of another large bank, Crédit Lyonnais, at a cost of $20 billion to taxpayers in the 1990s and a series of defensive industrial mergers to stave off foreign bids in recent years.

Talk of a possible offer to take over all or part of Société Générale has proliferated since the bank disclosed that it lost 4.82 billion euros, or some $7.1 billion, by unwinding the positions taken by Mr. Kerviel.

On Monday, the speculation intensified. Analysts at Citigroup, in a note to clients, said that HSBC and Barclays might be among bidders for Société Générale.

Citigroup said the bank’s franchise had been “severely impaired,” and it cut Société Générale shares to a sell rating from buy, and its price outlook to 65 euros from 130.

In trading here Monday, Société Générale stock slid 3.8 percent, to 71.05 euros, the lowest level since August 2004. It is down more than 6 percent since Thursday, when the bank announced its losses.

Even Mr. Bouton, who traveled to London on Monday to gain support for a special share issue totaling 5.5 billion euros, has acknowledged that Société Générale could be the object of a takeover bid. “This would not be the first time,” he noted in the newspaper Le Figaro.

Mr. Bouton also said Monday that his offer to resign, which the board rejected last week, remained on the table.

If necessary, the most likely way to keep Société Générale in French hands would be for the government to engineer a merger with another French bank. Its larger rival, BNP Paribas, may be interested in renewing a bid after coveting Société Générale for years, perhaps with the help of another French bank, Crédit Agricole.

A senior government official, speaking on condition of anonymity, denied that the finance ministry had already been in contact with BNP and Crédit Agricole over the weekend. But he acknowledged that those two banks were the most likely ones in France to have an interest in and enough cash to buy Société Générale.

Mr. Kerviel was released Monday after having been questioned by the prosecutors for 48 hours. They have requested that he be charged with forgery, breach of trust and unauthorized access to a computer system.

In France, before formal charges can be brought, a judge must complete an investigation. The Paris prosecutor, Jean-Claude Marin, requested that Mr. Kerviel remain in custody, in part he said because he feared Mr. Kerviel might become suicidal. But a spokeswoman for Mr. Marin’s office, Isabelle Montagne, said defense lawyers persuaded the investigating judges to release Mr. Kerviel under judicial supervision, provided he surrendered his passport.

As an arbitrageur, Mr. Kerviel was entrusted to purchase one portfolio of stock index futures and at the same time sell a similar mixture of index futures with a slightly different value, as a hedge. But while Mr. Kerviel, according to the bank, put sizable, real purchases in one portfolio, he created fictitious sales transactions in the second, offsetting portfolio. This gave the impression to risk managers that the risks in the first portfolio had been hedged when in fact they had not been.

According to Mr. Marin, Mr. Kerviel said he made his first fictitious transactions at Société Générale late in 2005, not long after moving to the trading desk from the risk-management department.

These initial false trades “were certainly not of the same size of those at the start of 2008,” Mr. Marin said. “But through the end 2005 and over the course of 2006 and 2007, he little by little took positions that were purely speculative.”

“This was not a new activity for him,” Mr. Marin added.

Late Monday, one of Mr. Kerviel’s lawyers, Christian Charrière-Bournazel, told reporters that his client had been released from custody while the investigation continued. He did not disclose Mr. Kerviel’s whereabouts.

According to Mr. Marin, Mr. Kerviel also said it was “not exceptional” for traders at the bank to exceed their authorized trading limits. Mr. Marin emphasized that this did not imply that other bank employees engaged in any fictitious trading.

Mr. Kerviel’s account to prosecutors differs from a timeline provided Sunday by the chief executive of Société Générale’s investment banking division, Jean-Pierre Mustier, who said a review of the trader’s records indicated that the fictitious transactions dated to late 2006 or early 2007.

A bank spokeswoman, Laura Schalk, declined to comment on Mr. Kerviel’s account, which, if true, could raise additional questions about the quality of the bank’s risk-management controls.

Mr. Mustier did not return telephone messages seeking comment. But in a phone briefing with reporters on Sunday, he said the bank had already made “extensive checks” of other traders’ portfolios, which did not turn up any activity resembling Mr. Kerviel’s trading.

With regard to Eurex, the pan-European derivatives market operated by Deutsche Börse, the German stock exchange, Mr. Marin said Mr. Kerviel contended that at least one of his trades had prompted a phone call about two months ago. “Eurex alerted Société Générale in November 2007 about the positions taken by Jérôme Kerviel,” Mr. Marin said. “Questioned by the bank, he produced a fake document to justify the risk cover.”

A spokesman for Eurex in Frankfurt, Rainer Seidel, declined to comment, citing confidentiality agreements with bank customers.

Surveillance of Eurex trading activity falls under the responsibility of an independent watchdog, the Market Surveillance Office, which would ordinarily be the first authority to make contact with a bank about suspicious trading.

Ms. Lagarde, the finance minister, is scheduled to deliver a report this week to Prime Minister François Fillon detailing how Société Générale suffered the trading loss. The French central bank is also carrying out an investigation.

Ms. Lagarde said her inquiry would focus on why the bank’s internal controls failed and whether financial companies should be required to institute tighter controls on their businesses.

In another development, reported by Reuters, a French lawyer acting for 100 small shareholders said he had sued Société Générale over the way it unwound Mr. Kerviel’s share deals last week.

The lawyer, Frederik-Karel Canoy, said the bank should have informed the markets about its pending losses before embarking on a selling spree Jan. 21-23 to unwind the 50 billion euros of risk exposure built up by Mr. Kerviel.

James Kanter contributed reporting.

Société Générale: A Quest for Glory and a Bonus Ends in Disgrace

DOREEN CARVAJAL and JAMES KANTER
NYT, January 29, 2008

PARIS — When Daniel Bouton, the chief executive of Société Générale, announced that the venerable bank had lost more than $7 billion in unwinding the positions of a rogue trader, he called the culprit “a terrorist.”

But Jérôme Kerviel, nicknamed “the mad trader” by the French press, told investigators that all he wanted was to be respected, and to earn a big bonus.

Mr. Kerviel, the son of a hairdresser and a metal shop teacher from the provinces — a contrast to his pedigreed superiors — reported to work early, stayed late, and took only four days off in 2007, in a nation where six weeks of vacation is de rigueur. Starting in early 2005, he made small unauthorized trades, a strategy that ultimately wound out of control.

At a news conference, Jean-Claude Marin, Paris’s chief prosecutor, said, “When you have been performing these operations for months without being discovered, there is a kind of spiral, where you ultimately think yourself much stronger than the rest of the world.”

In 48 hours of intense questioning, Mr. Kerviel described growing increasingly daring after no one at the bank detected a series of small, unauthorized trades that he had placed. And Monday, pressure mounted on Société Générale and Mr. Bouton to explain how the bank had missed the illicit trades, and the red flags Mr. Kerviel set off, for so long. French authorities began to snap at one another Monday, even as they closed ranks, promising to repel any hostile takeover bid by a foreign company.

Mr. Kerviel told prosecutors that other traders at Société Générale had used similar tactics but with smaller bets.

He said that he eventually built up a lucrative position that would have earned the bank 1.4 billion euros, or a little more than $2 billion, if it had been cashed out by the end of last year. And he told prosecutors that he thought he deserved a bonus last year of 300,000 euros. Instead, he received 1,500 euros.

Initially, his bets did pay off. The bank’s head of asset management, Philippe Collas, told Bloomberg News last week that Mr. Kerviel was “massively in the money” by the end of December. But then the European market turned down and his losses mounted.

Over time, Mr. Kerviel had increased the size of his bets — he hedged his positions on paper with falsified documents and e-mail messages — but he remained convinced that success was just around the corner.

“He bet on the return of the markets that were extremely low and he imagined that there would be a return of the markets just as large as the losses,” Mr. Marin, the prosecutor, said. “There is an addiction. There is a dependency on this complicated game of betting on the markets, and there is a sort of spiral into which it’s difficult to exit.”

If he is found guilty of abuse of confidence, the charge carrying the most severe penalty, Mr. Kerviel faces a seven-year jail term and a 750,000 euro fine. Mr. Kerviel is also accused of forgery and unauthorized use of someone else’s password to access a computer system.

He said he did not seek to keep any of the bank’s money.

The prosecutor recommended keeping Mr. Kerviel in protective custody, in part because of the danger of suicide once Mr. Kerviel realizes what penalties he is facing.

“One of our concerns is that he needs protection,” Mr. Marin said, adding that Mr. Kerviel had not received any threats. “He’s not depressed at the moment. But once the full measure of behavior hits home you know that the way that human nature operates means that he could take some kind of action.”

Later Monday, Mr. Kerviel surrendered his passport and was released by a judge, who decides such matters separately from the prosecutor. Prosecutors immediately appealed the decision.

Over the course of his interrogation by prosecutors, Mr. Kerviel admitted making deceptive trades. The trades were part of his ambition to succeed in the business and impress his bosses, and to lead them to recognize his “financial genius,” Mr. Marin said.

Mr. Kerviel was striving to break free from his lowly beginnings in the bank hierarchy. He graduated with a degree in finance from a university in Lyon that specialized in training bank employees, and in 2000 he began work in the unglamorous back office and middle office, where trades are monitored.

And once he became a junior trader, his salary of 100,000 euros was paltry in comparison with the bank’s stars.

“He wanted to prove his competence,” Mr. Marin said, “and his capacity to act on the market. He was also seeking a bonus from his results.”

Indeed, when Jean-Pierre Mustier, chief executive of Société Générale’s corporate and investment banking division, called in Mr. Kerviel for questioning on Jan. 19, the day after the trader’s faulty positions were discovered, Mr. Kerviel insisted for several hours that rather than engaging in wrongdoing, he had instead invented a new kind of trade that would make the bank money.

The pressure to perform apparently took its toll on Mr. Kerviel. His family said they had detected signs that he was suffering under pressure from his job and that they had grown increasingly worried.

During an interview with the French radio network Europe 1, Sylviane Le Goff, one of Mr. Kerviel’s two aunts, said he had suffered health problems because of his job. The family, she said, had urged him to quit, but Mr. Kerviel told them he did not know what else he could do.

“He is a boy who is serious, honest and hardworking and is incapable of doing anything wrong,” Ms. Le Goff said, declaring that her nephew had been manipulated and that authorities should examine the actions of his managers.

Mr. Kerviel still remains convinced that the positions he took would not necessarily have harmed the bank in such a drastic fashion if the company had not moved to unwind his actions into a volatile market that was already falling.

“In waiting a little while,” he told the prosecutors, “there could have been fewer losses.”

What does a recession look like, Dad?

Andrew Martin

World markets plunge! Newspapers full of down-pointing graphs and traders with their heads in their hands. In the United Kingdom, some of us have been here before, specifically from 1989 to 1992, but for those who are in their 20s and unsure of what to expect, here’s a beginner’s guide to recession ...

Those weekly shopping sessions will seem like a distant memory, and the merits or otherwise of organic food will suddenly appear less pressing. The empty shop on your high street will no longer be automatically taken over by bouffant-haired real estate agents who install a latte-making machine and a 2m-wide TV as a matter of priority. Instead, nothing will happen to it.

That voice on your mobile answer phone that says, “You have . . . no new messages” will begin to sound rather sadistic, and your boss will suddenly seem less like David Brent, and more like the angel of death. You won’t know where he’ll strike next with the fatal words, “Could you just step into my office, I’d like a quick word ...”

Pop-ups won’t pop-up so often; newspapers will become thinner. The “50 different ways to brighten up your garden this spring” by a star horticulturalist will become a small article on daffodils written by a subeditor. Your property begins to seem less like a lifeboat and more like a millstone, and a lot of chickens come home to roost. That mate of yours who played guitar in a band — but not very well — suddenly takes up teacher training.

On the brighter side, though, you will no longer be welcomed into people’s houses with the dreaded words, “Do you want the guided tour?” and if you are, you can simply ask, “And how much less is it worth now than when you bought it?”

In a recession, it won’t be the people who have got the latest “must-have” gadget who do all the talking. Rather, people who know about root vegetables will come into their own; people who know what to do with a scrag end of lamb or how to fix a broken toaster. Triumphalism will be quelled. Interviewers might cut Victoria Beckham off when she starts talking about the latest additions to her wardrobe, and ask instead whether she leaves the bath water in for David.

Recessions encourage imaginative business ideas, novel-reading, cinema-going, and foster music more akin to the blues than the stridency of Madonna.

The last one gave us Wagamama, loft living and Every Day is Like Sunday by Morrissey. Fear not, kids. You have nothing to lose but your credit cards.

— ©Guardian Newspapers Limited, 2008

How to Stop the Downturn

JOSEPH E. STIGLITZ
NYT, January 23

AMERICA’S economy is headed for a major slowdown. Whether there is a recession (two quarters of negative growth) is less important than the fact that the economy will operate well below its potential, and unemployment will grow. The country needs a stimulus, but anything we do will add to our soaring deficit, so it is important to get as much bang for the buck as possible. The optimal package would contain one fast-acting measure along with others that could lead to increased spending if and only if the economy goes into a steep downturn.

We should begin by strengthening the unemployment insurance system, because money received by the unemployed would be spent immediately.

The federal government should also provide some assistance to states and localities, which are already beginning to feel the pinch, as property values have fallen. Typically, they respond by cutting spending, and this acts as an automatic destabilizer. Federal assistance should come in the form of support for rebuilding crucial infrastructure.

More federal support for state education budgets would also strengthen the economy in the short run and promote growth in the long run, as would spending to promote energy conservation and lower emissions. It may take some time to put these kinds of well-designed expenditure programs into place, but this slowdown looks as if it will last longer than some of the other downturns in recent memory. Housing prices have a long way to fall to return to more normal levels, and if Americans start saving more than they have been, consumption could remain low for some time.

The Bush administration has long taken the view that tax cuts (especially permanent tax cuts for the rich) are the solution to every problem. This is wrong. Tax cuts in general perpetuate the excessive consumption that has marked the American economy. But middle- and lower-income Americans have been suffering for the last seven years — median family income is lower today than it was in 2000. A tax rebate aimed at lower- and middle-income households makes sense, especially since it would be fast-acting.

Something should be done about foreclosures, and appropriately designed legislation allowing those who have been victims of predatory lending to stay in their homes would stimulate the economy. But we should not spend too much on this. If we do, we’ll wind up bailing out investors, and they are not the ones who need help from taxpayers.

In 2001, the Bush administration used the impending recession as an excuse to cut taxes for upper-income Americans — the very group that had done so well over the preceding quarter-century. The cuts were not intended to stimulate the economy, and they did so only to a limited extent. To keep the economy going, the Federal Reserve was forced to lower interest rates to an unprecedented extent and then look the other way as America engaged in reckless lending. The economy was sustained on borrowed money and borrowed time.

The day of reckoning has come. This time we need a stimulus that stimulates. The question is, will the president and Congress put aside politics to get the job done?

Joseph E. Stiglitz, a professor of economics at Columbia and the author, most recently, of “Making Globalization Work,” was awarded the Nobel in economic science in 2001.

Fed’s Action Stems Sell-Off in World Markets

EDMUND L. ANDREWS
NYT, January 23

WASHINGTON — The Federal Reserve, confronted by deepening panic in global financial markets about a possible recession in the United States, struck back on Tuesday morning with the biggest one-day reduction of interest rates on record and at least temporarily stopped a vertigo-inducing plunge in stock prices.

The unexpected decision came after a rare, hastily called policy meeting by videoconference on Monday evening, and it reduced the Fed’s benchmark overnight lending rate by three-quarters of a percentage point, to 3.5 percent.

The Fed’s move was prompted in part by turmoil in global markets on Monday, a holiday in the United States. Shortly after lunch that day, the Fed chairman, Ben S. Bernanke, canceled a planned trip to New York and started organizing the impromptu meeting of the Fed officials who decide interest rate policy. The Treasury secretary, Henry M. Paulson Jr., watching the same market turmoil, was anxious enough that he called President Bush at the White House.

In a statement accompanying the Fed’s decision, which was announced about an hour before the stock market opened for trading, officials hinted that they might reduce rates yet again at their scheduled meeting next Tuesday and Wednesday.

The magnitude of the Fed’s rate cut helped reverse what began as a horrendous day in the stock markets. European and Asian stock prices had already plunged for the second consecutive day, and the Dow Jones industrial average fell 464 points — about 5 percent — as soon as markets opened in New York.

By the close of trading Tuesday, stock prices, after gyrating wildly, had clawed much of their way back. Shares of banks and insurers of mortgage-backed securities, which had been battered in recent days, were among the day’s biggest gainers. Asian markets seemed to calm Wednesday morning with most exchanges opening higher.

“Wall Street is incredibly jittery,” said Len Blum, a partner at Westwood Capital, an investment bank in New York. “They don’t know how to react to it. The last time they did a rate cut in between meetings was after Sept. 11, 2001.”

The Fed’s move came as Mr. Bush and Congressional leaders pledged to work together on a bipartisan measure to jolt the economy with about $145 billion in tax rebates, tax breaks for businesses and possibly additional payments to low-income people.

“I believe we can find common ground to get something done that’s big enough and effective enough,” Mr. Bush told reporters. Senator Harry Reid of Nevada, the Senate majority leader, said he hoped Congress could pass a bill before the recess for Washington’s Birthday on Feb. 18.

Still, it was a nerve-racking day on Wall Street, with the Dow ending down 128 points, or about 1 percent. Even after the rebound, the major market indexes are down about 10 percent so far in January and even further off their recent highs in October. The Nasdaq composite index, which mostly reflects technology stocks, is off 18.3 percent.

Economists said it remained far from clear that the United States would avoid a recession, either because the Fed and the Bush administration had moved too slowly or because the economy’s woes were too acute to solve quickly and painlessly.

“This is unique in the modern history of the Fed,” said Vincent Reinhart, a resident scholar at the American Enterprise Institute who was director of the Fed’s division of monetary affairs from 2001 to 2007.

Even so, it may not be enough to head off a downturn: changes in interest rates usually work with a lag time of at least six to nine months, and many economists say that a recession may already have begun.

Citigroup, citing the severely depressed housing market, the credit squeeze and high energy prices, predicted on Tuesday that the economy was about to start shrinking and would barely eke out any growth for all of 2008.

“Academic definitions aside, we’ll call that a recession,” wrote Steven Wieting, a Citigroup economist.

Fed officials stopped well short of such gloom and doom, but they made it clear they had been alarmed by both worsening data in the United States and the worldwide stock panic that began on Monday.

“Broader financial market conditions have continued to deteriorate,” the central bank said, noting that credit conditions have continued to tighten for many businesses and households, that the housing market continues to spiral downward and that job creation has slowed.

“Appreciable downside risks to growth remain,” the central bank said, its most forceful acknowledgment yet that the United States economy is on the brink of a recession as a result of the triple punch from the severe downturn in housing, the fallout from soured mortgages and the added blow of high oil prices.

The move represented a dramatic shift for Mr. Bernanke, who took over as Fed chairman two years ago. Mr. Bernanke, a former professor of economics at Princeton, had resisted calls for a big rescue effort by the Fed and favored a less personalized approach to monetary policy than his predecessor, Alan Greenspan.

But when Mr. Bernanke called policy makers together for an emergency meeting on Monday night, with regional Fed presidents participating over secure videoconference lines, he embarked on the boldest policy move in years.

This was only the fifth time that the Federal Reserve had reduced the overnight federal funds rate outside of its regularly scheduled policy meetings. It did so in October 1998, during Russia’s financial collapse, two more times in early 2001 as the economy was sliding into a recession and once more after the terrorist attacks on Sept. 11, 2001.

This was also the central bank’s biggest one-day cut in the federal funds rate, which is its target for the overnight rate at which banks lend their reserves to each other. Until Tuesday’s reduction of three-quarters of a percentage point, the biggest individual cuts were by half a point.

The only comparable rate cuts were in 1982 and 1984, when the central bank, which was following different procedures, reduced the overnight rate by more than one percentage point over the span of several weeks.

Fed officials clearly hoped that a bold and decisive act would calm investors and restore confidence in credit markets, where fears about soaring defaults on subprime mortgages have increasingly forced banks to curtail their lending in other areas.

But while investors did react with relief, the Fed’s move also seemed to validate the fears that the economy is closer to a recession than policy makers had thought.

On Wall Street, many if not most analysts had assumed that the central bank would reduce overnight rates by half a percentage point at the next policy meeting. But with the meeting only one week away, few investors expected the Fed to cut rates before then — a move that could easily be seen as panicky behavior.

The Fed move carries other risks. Reducing the interest rate could push up the inflation rate, even as it bolsters consumer spending.

In a speech this month, Mr. Bernanke strongly hinted that the Fed would reduce rates again at the policy meeting scheduled for next week. Mr. Bernanke had clearly not expected to move before the meeting.

But the Fed chairman became notably more worried by late last week. Most of the incoming economic data pointed toward a slowdown. On top of rising unemployment in December and depressed holiday sales at many major retailers, there were signs of a worsening credit squeeze, new declines in housing starts and worries about the companies that insure mortgage-backed securities.

Mr. Bernanke and other Fed officials contend they do not make decisions in order to calm financial markets. But analysts say they became alarmed about last week’s stock market plunge and Mr. Bernanke was even more alarmed by the huge drops Monday in foreign stock markets like Frankfurt, London and Hong Kong.

The drop in foreign stock prices undermined one of the last bright spots for the American economy — the prospect that a strong global economy, combined with a cheap American dollar, would spur enough export growth to offset a weakness at home.

The growing sense of crisis added urgency to efforts by Mr. Bush and Congressional leaders to bury their political animosities and agree on a short-term fiscal- stimulus package.

A spokesman for Mr. Paulson said that he had been busy reaching out to Congressional leaders all last week and that the market declines of the last few days had not by themselves forced him to quicken the pace.

Mr. Bush and Congressional leaders have both talked about a package that would inject about $150 billion in additional money into the economy. That would equal about 1 percent of the nation’s economic output, which economists and Fed officials said could make a difference if the money gets into people’s hands quickly enough.

But even if Congress passes such a measure by mid-February, which would require Republicans and Democrats to suppress their animosities and their contrasting economic approaches, the earliest that tax rebates would actually reach people would probably be this summer. At that point, it would help soften the blow but a recession might have already been under way for months.

Ultimately, it is the Federal Reserve that has the most power to avert or soften a recession. But its power is finite, and its primary tool — lower interest rates — takes time to work.

“Monetary policy works with a lag,” said Mr. Reinhart, the former top Fed official. “There’s nothing the Fed can do to prevent a recession if it is coming in the first half of this year.”

Steven R. Weisman and Carl Hulse contributed reporting.

Feeling Misled on Home Price, Buyers Sue Agent

DAVID STREITFELD
NYT, January 22

CARLSBAD, Calif. — Marty Ummel feels she paid too much for her house. So do millions of other people who bought at the peak of the housing boom.

What makes Ms. Ummel different is that she is suing her agent, saying it was all his fault.

Ms. Ummel claims that the agent hid the information that similar homes in the neighborhood were selling for less because he feared she would back out and he would lose his $30,000 commission.

Real estate lawyers and brokers say the case, which goes to trial in North County Superior Court on Monday, is likely to be the first of many in which regretful or resentful buyers seek redress from the agents who found them a home and arranged its purchase.

“When your house appreciates $100,000 in the first six months, you’re not quite as concerned that maybe the valuation was $25,000 or $50,000 off,” said Clifford Horner of the law firm Horner & Singer. “But when your house goes down, you ask: ‘Who might have led me astray here?’ ”

Agents representing buyers rarely had the opportunity to make mistakes during the last real estate boom, in the late 1980s, because the job hardly existed then. For decades, residential transactions almost always involved brokers who, whatever assistance they gave the buyer, legally represented only the seller.

The long boom that began in the late 1990s put an end to that one-sided world. As prices spiked, buyer’s agents and brokers became popular as sounding boards, advisers and negotiators. The National Association of Realtors estimates they are now involved in two-thirds of all residential purchases.

That makes this the first housing collapse in which large numbers of buyers had a real estate professional explicitly looking after their interests. The Ummel case poses the question: In a relationship built on trust, where promises are rarely written down and where — as in this case — there is no signed contract, what are the exact obligations of these representatives in guiding their clients through a sizzling market?

“Agents have a lot of fiduciary duties, but they don’t make money unless they close the sale,” said Joel Ruben, a real estate lawyer in Manhattan Beach, Calif. “In an inflated market, there are built-in temptations to cut corners.”

The defendant in the Ummel case is Mike Little, a veteran agent with ReMax Associates. He will argue that Marty Ummel, who brought the case with her husband, Vernon, is trying to shift the blame for the couple’s own failures of research and due diligence.

“They simply didn’t do what is expected of a knowledgeable, sophisticated buyer, and are now looking for someone other than themselves to take responsibility,” Roger Holtsclaw, an agent who was hired by Mr. Little as an expert witness, said in a court deposition.

Ms. Ummel is 60; Mr. Ummel, 71. With retirement on the horizon, they decided in late 2004 to move from the San Francisco Bay area to San Diego, where they would be near their grown children.

Since they were not making the move for job reasons, they decided to take their time and focus on finding a house that was a good value. In a boom, that is no simple task for buyer or agent.

It is clear the Ummels did not rush into a decision: They dismissed one agent and canceled deals on two houses before Mr. Little found them a prospect on a cul-de-sac in a five-year-old luxury development. A deal was struck with the owner, herself a real estate agent, for $1.2 million.

Mr. Little also worked as a mortgage broker. The Ummels say he encouraged them to get their loan through him. Mr. Little ordered an appraisal of the house but did not respond to the couple’s requests to see it, the suit charges.

A few days after the couple moved in, in August 2005, they got a flier on their door from another realty agent. It showed a house up the street had just sold for $105,000 less than theirs, even though it was the same size.

Then they finally got their appraisal, which told them the house up the street was not only cheaper but had a pool. Another flier in early October mentioned a house down the street that was the same size and closed the same day as the Ummels’ but went for $175,000 less.

The Ummels accuse Mr. Little not only of withholding information but of exaggerating the virtues of their house to push them into a deal.

Ms. Ummel said in her deposition that Mr. Little had told them “many times that it was a very good buy.”

“And you believed that?” asked David Bright, the lawyer who represents both Mr. Little and ReMax Associates, which was also named in the suit.

“Yes, we trusted Mike Little,” Ms. Ummel replied.

Mr. Horner, the lawyer, said valuation is a tricky area for brokers.

“Brokers aren’t appraisers,” said Mr. Horner, one of the writers of a guide to suing brokers. “They have no obligation to opine about value. But once they do, it becomes a gray area whether it’s puffery or a misstatement of a known fact.”

Most people who made a bad real estate deal might wince and move on, but people who know Ms. Ummel describe her as unusually determined. She spent a year picketing ReMax offices on weekends.

Mr. Ummel, an administrator at Dominican University, gave her his permission to pursue the case, on one condition: “Don’t tell me how much the legal fees are.” So far, the bills come to $75,000, more than Ms. Ummel’s annual salary as a fund-raiser at California State University in San Marcos.

“I do not think I’m obsessive-compulsive, but I am 114 pounds of absolute perseverance,” Ms. Ummel said.

That persistence has put the Ummels at the forefront of a developing legal question. When buyers have sued their agents in the past, the cases focused on problems with the property itself, often alleging failure by the broker to disclose a known hazard or maintenance issue. After reviewing litigation records for the last five years, the National Association of Realtors could find no cases that revolved solely around the question of valuation.

Ms. Ummel’s original suit included the appraiser, who was accused of skewing his report to make the Ummel’s house seem worth the purchase price, and the mortgage broker. Modest settlements have been reached with both.

In a brief phone interview, Mr. Little called the case “ridiculous,” adding: “The lady’s a nut job. I didn’t do anything wrong.”

Mr. Little said that contrary to Ms. Ummel’s claims, the suit was motivated mainly by the declining market. “When people see their home values and assets declining, they always feel there’s someone to blame,” he said. “This is a dangerous time for all of us in the industry.”

The agent declined several requests to expand on his remarks. His lawyer declined to be interviewed. So did Geoff Mountain, a co-owner of ReMax Associates, which owns the office that the Ummels were dealing with.

Both sides have hired appraisers who have combed the surrounding development. Mr. Little’s appraiser concluded the four-bedroom, 3.5-bath house was worth $1,150,000 to $1.2 million in the summer of 2005. The Ummels’ appraiser said it was worth $1,050,000.

The outlines of Mr. Little’s defense can be seen in his lawyer’s lengthy deposition of the Ummels. Even in a relatively new development, Mr. Bright said, no two houses and no two deals can be seen as identical. For instance, a pool does not necessarily add value because “some buyers like it, some don’t.”

Mr. Little never showed the Ummels the house down the street because the backyard could be viewed from other houses, the lawyer said, and the couple had said they valued their privacy. Ms. Ummel disputes saying this.

The agent who left the flier that led to the case, Margaret Hokkanen, is sympathetic to Mr. Little.

“People are responsible for their own decisions,” said Ms. Hokkanen, who has been subpoenaed as a defense witness.

Her husband and partner, John Hokkanen, is more ambivalent.

“We have seen so much misrepresentation over the last five years,” he said. “So I appreciate where these buyers might be coming from: ‘I’m a lowly consumer, you’re certified by the state of California, you didn’t do X, you didn’t do Y, and I got hurt.’ ”

The Ummels may be on the leading edge of the law, but they are unlikely to be alone for long. With the market falling, many homeowners owe more on their mortgages than their houses are worth. And many of those deals involved brokers who are required to carry professional liability insurance, presenting a tempting target for angry buyers.

“If you put someone into a property at the top of the market, you look really bad if it goes down,” said K. P. Dean Harper, a real estate lawyer in Walnut Creek, Calif. “There are a lot of letters going out from lawyers to real estate agents saying, ‘My client would never have purchased if you had properly evaluated the market conditions and the value of the property.’ ”

If Everyone’s Finger-Pointing, Who’s to Blame?

By VIKAS BAJAJ
NYT, January 22

Everyone wants to know who is to blame for the losses paining Wall Street and homeowners.

The answer, it seems, is someone else.

A wave of lawsuits is beginning to wash over the troubled mortgage market and the rest of the financial world. Homeowners are suing mortgage lenders. Mortgage lenders are suing Wall Street banks. Wall Street banks are suing loan specialists. And investors are suing everyone.

The legal and regulatory wrangles could dwarf the ones that followed the technology stock bust and the Enron and WorldCom debacles. But the size and complexity of the modern mortgage market will make untangling the latest mess even trickier. Some cases stretch across continents. Others are likely to involve state and federal regulators.

“It will be a multiring circus,” said Joseph A. Grundfest, a professor of law and business and co-director of the Rock Center for Corporate Governance at Stanford. “This particular species of litigation will be manifest in many different types of lawsuits in many different jurisdictions.”

The legal battles stretch from Main Street to Wall Street and beyond. Homeowners and subprime mortgage lenders are squaring off in scores of cases that claim some lenders engaged in predatory lending practices and other wrongdoing. Cleveland and Baltimore are pursuing cases against Wall Street banks, saying local residents are suffering because the banks fostered the proliferation of high-risk home loans.

Two questions lie at the heart of many of the cases. The first is whether lenders and investment banks alerted borrowers and investors to the risks posed by subprime loans or securities backed by them. The second is how much they were legally obliged to disclose. “Those are the two issues that are frequently raised,” said Jayant W. Tambe, a partner at the law firm Jones Day.

As defaults and foreclosures rise, the various players in the housing market are all pointing fingers at each other. State prosecutors like Andrew M. Cuomo, the attorney general of New York, are investigating whether investment banks that packaged mortgages into securities disclosed the risks to investors and credit ratings agencies. Investment banks, in turn, are accusing lenders and mortgage brokers of shoddy business practices.

“What strikes me here is that this a tainted system from A to Z,” said Tamar Frankel, a law professor at Boston University. “Everybody blames everybody else. If you look at what is being said, there isn’t one who doesn’t blame another and there is half-truth in everything.”

Wall Street banks that sold mortgage investments around the world face legal complaints from as far away as Australia and Norway. Lehman Brothers, the Wall Street bank with the biggest mortgage business, is being sued by towns in Australia that say a division of the firm improperly sold them risky mortgage-linked investments. Lehman has denied the charges and has said the unit, formerly known as Grange Securities, acted properly.

Closer to home, members of a New Jersey family have sued Lehman for $4.14 billion, saying the firm steered them into complex securities that have become difficult to sell, Bloomberg News reported Friday. Lehman denied the accusations.

In the United States, Lehman is suing at least six mortgage lenders and brokers like Fremont Investment and Loan and the Fieldstone Investment Corporation, claiming they sold Lehman dubious loans. Lehman claims that borrowers’ incomes were overstated, appraisals were inflated and the homes were in poor condition. In most cases, the lenders are fighting the allegations and Lehman’s demand that they buy back defaulted or otherwise problematic loans.

In another case, the PMI Group, a mortgage insurer, sued WMC Mortgage, a subprime lender that has stopped making loans, and its corporate parent, General Electric, in California Superior Court. PMI is trying to force the companies to buy back or replace loans that the firm was hired to insure and that it says were made fraudulently or in violation of the standards that the lender said it was using.

According to the lawsuit, a review of loans found “a systemic failure by WMC to apply sound underwriting standards and practices.” Reviewing a sample of the nearly 5,000 loans in the pool, Clayton, a consultant that reviews mortgage loans, identified 120 “defective” loans for which borrowers’ incomes and employment were incorrect or where the borrower’s intention to live in the home was incorrect. WMC offered to buy back 14 loans, according to the lawsuit.

Some of the loans have defaulted, and a trustee’s report on the pool of loans packaged and underwritten by UBS, the Swiss investment bank, shows that losses on some defaulted mortgages are as high as 100 percent. As of November, about 27 percent of the loans in the pool were either delinquent 60 days or more, in foreclosure or had resulted in a repossessed home.

PMI is on the hook for losses on defaulted loans, lost interest and principal payments to investors who own a $29.6 million slice of bonds backed by the mortgages. A senior vice president at PMI, Glenn Corso, said he was unsure how much the company had paid out so far.

A spokesman for G.E., Robert Rendine, declined to comment, citing the pending litigation.

Securities lawyers say cases involving mortgage-backed securities, which were generally sold privately to sophisticated institutional investors, are far more complicated than those involving stocks, which were sold publicly to everyday investors. Class-action lawsuits, a favorite tool of plaintiffs’ attorneys, will be employed less than they were after the plunge in technology stocks a few years ago because mortgage securities tend to vary in composition and disclosure.

“This is going to be much more complicated to prove, and it’s going to be case by case as opposed to class-actions,” said David J. Grais, who is a partner at the Grais & Ellsworth law firm in New York and an author of a recent paper on the legal liabilities of credit ratings firms. “This resembles the S&L crisis in the ’80s much more than it does the tech bubble in the ’90s.”

Class-action filings spiked earlier this decade, jumping to 497 in 2001, from 215 the year before, according to Cornerstone Research, which compiles the figures in cooperation with the Stanford Law School. As those suits were resolved, new filings fell to a low of 118 in 2006. But as of mid-December, filings had jumped to 169, with about 32 of the cases related to the mortgage crisis.

Through the end of 2006, settlements in technology- and telecommunications-related class-action suits brought by shareholders totaled $15.4 billion, with more than a third of that coming from one company, WorldCom, according to Cornerstone. Settlements in Enron-related cases have totaled about $7.2 billion so far; the figure does not include Securities and Exchange Commission fines and settlements.

Bringing securities fraud cases has been made harder by recent Supreme Court decisions that favored Wall Street, companies and professionals like accountants. The court ruled earlier this month that two technology vendors could not be held liable for taking part in a scheme designed by a cable company to inflate its revenue. Last summer, in a ruling favoring the company, Tellabs, the court said that securities cases could be dismissed if investors did not show “cogent and compelling” evidence of intent to defraud.

Some plaintiffs are using other legal avenues like the pension law, the Employment Retirement Income Security Act. Under that law, managers who handle pension funds must act in the fiduciary interest of their clients. State Street Global Advisors, which manages pension money, has set aside $618 million to settle claims that the firm invested in risky mortgage-related securities.

Some legal experts say that the recent Supreme Court decisions, which are largely based on cases bought by shareholders, may not have much bearing on the more complex cases that stem from securitization of mortgages.

“There will be a whole new set of claims that deal with the unique nature of the securitization market,” Mr. Tambe of Jones Day said. “There will have to be new decisions that deal with those claims and a learning process for the bar and judiciary in those cases.”

In Asia, Global Market Decline Accelerates

MARK LANDLER and HEATHER TIMMONS
NYT, January 22,

Amid fears that the United States may be in a recession, the decline in stock markets accelerated Tuesday across Asia.

Markets in Tokyo, Hong Kong and Sydney all fell farther in late trading Tuesday than they had all day on Monday. The Hong Kong market plunged another 8 percent by late afternoon after tumbling 5.49 percent on Monday. In Tokyo, the Nikkei dropped 5 percent, hitting a low not seen since September 2005 and facing its worst two-day drop in 17 years on concern global growth is faltering.

The fears of a recession have roiled markets from Mumbai to Frankfurt on Monday, puncturing the hopes of many investors that Europe and Asia would be able to sidestep an American downturn. Until now, overseas markets had largely avoided the sell-off that has caused steep declines recently in the United States, whose markets were closed in observance of Martin Luther King’s Birthday. But investors reacted with what many analysts described as panic to the multiplying signs of weakness in the American economy.

And in a sign that the United States could join the sell-off on Tuesday, trading in stock index futures pointed to a substantial decline when markets reopen on Wall Street.

The angst about the United States belies the popular theory that Europe and Asia are not as dependent on the American economy as they once were, in part because they trade more with each other. The theory, known as decoupling, has been used to explain why economies like China and Germany have kept growing robustly, even as the United States has slowed.

“The market is not at all convinced about decoupling, and I think the market is probably right,” said Thomas Mayer, the chief European economist at Deutsche Bank in London. “When you look at it more closely, we’re suffering from the same issues.”

Monday’s sell-off was evenly distributed from east to west. The DAX index of the Frankfurt Stock Exchange plummeted 7.2 percent, its steepest one-day decline since Sept. 11, 2001. The 7.4 percent drop in the Sensex index in Mumbai was the second-worst single-day tumble in its history.

Stocks followed suit when markets opened in the Western Hemisphere. Canadian stocks were down nearly 5 percent, and a key market index in Brazil was off 6.6 percent.

Shares of banks led the decline Monday in many countries, underscoring that the subprime mortgage crisis continues to hobble the global financial system. On Monday, a German state bank, WestLB, said it would report a loss of $1.44 billion in 2007 because of its exposure to deteriorating mortgage assets.

“There is indeed some panic,” Mr. Mayer said. “What we’re seeing, in Europe and Asia, is that the markets are pricing in a recession.”

Investors were scarcely comforted by President Bush’s announcement on Friday of an economic stimulus package of as much as $145 billion. Mr. Bush’s “shot in the arm,” economists said, did not persuade the rest of the world that the United States will escape a recession, or that it will either.

In reference to the global stock sell-off, Jeanie Mamo, a spokeswoman for the White House, said: “We don’t comment on daily market moves. We’re confident that the global economy will continue to grow and that the U.S. economy will return to stronger growth with the economic policies the president called for.”

The turmoil will put even more pressure on the European Central Bank, which has charted a different course from the Federal Reserve by warning that it might raise interest rates to curb inflation, rather than cut them, as the Fed has, to ward off a recession. Mr. Mayer and others predict the bank will be forced into an about-face in coming months.

While Asia has been less buffeted by the credit crisis than Europe, the Bank of China now appears vulnerable, with analysts predicting it will have to write-down the value of its American mortgage holdings.

Investors in Asia have been in a state of denial about a possible recession in the United States, said Adrian Mowat, JPMorgan’s chief strategist in Asia. But now, he said, many believe “there’s no debate about it.” The only question, he added, is “how long and deep” a recession might be.

In Japan, which may be facing a new recession of its own, most indexes were off Monday by more than 3 percent .

In Europe, the housing market, after a long boom, is cooling, especially in Britain, Spain and Ireland. That will depress the growth rate in those countries, which are among the region’s economic pace-setters.

European banks continue to make unwelcome disclosures about write-downs of mortgage assets, even if the losses are not as dire as those reported by Citigroup or Merrill Lynch. Bank loans across Europe are being constrained, according to a recent survey by the European Central Bank.

German banks, in particular, are haunted by the American subprime crisis. The troubles of WestLB came a week after a German property lender, Hypo Real Estate, lost a third of its market value after it disclosed higher-than-expected losses from the credit crisis. WestLB, after warning that its 2007 losses would be more than twice its earlier estimate, said its biggest shareholders, the state of North Rhine-Westphalia and regional savings bank, had agreed to inject up to 2 billion euros ($2.9 billion) of capital into the bank to stabilize it.

Also on Monday, Commerzbank warned it would make additional write-downs in the fourth quarter of 2007. This caught analysts off guard.

“The amounts are not so significant,” said Simon Adamson, an analyst at CreditSights, an independent research firm in London. “It was more the way the market was caught by surprise.”

Shares of Commerzbank fell 10 percent Monday, Deutsche Bank declined 6.7 percent, Société Générale of France dropped 8 percent, BNP Paribas decreased 9.6 percent and the ING Group of the Netherlands fell 10.5 percent.

But the damage extended to the shares of energy companies like BP and Royal Dutch Shell, which dropped on worries that a global economic slowdown would crimp the demand for oil and gas.

“The problem is more deeply rooted in anxiety about the global economy than it is in Germany,” said Boris Boehm, an asset manager at Nordinvest in Hamburg. “People are really afraid. But it’s a good thing because fear, along with action, gets the market to its proper level quickly.”

Those jitters extended to fast-growing markets, like China and India, that are thought to be relatively insulated from the United States. The Shanghai composite index, which had risen nearly 88 percent in the year through Friday, closed down 5.1 percent on Monday, while Hong Kong’s Hang Seng fell 5.5 percent, also the most since Sept. 11, 2001. It had been up 24 percent in the year through Friday.

While emerging markets may have been poised for a drop after their run-up, the rout on Monday may also signal a basic shift in sentiment, analysts said. Mr. Mowat of JPMorgan said that it did not matter whether markets were separated by geography or asset class because, he said, “we trade together in corrections.”

No matter how many bridges, roads, and power plants China builds, or how many new cars India sells, a downturn in the United States will ripple across the economies of Asia, experts said.

“If the United States consumer quits buying things, it is going to hurt in Asia,” said Deborah Schuller, an Asia regional credit officer for Moody’s Investors Service. She said most rated corporations there would be able to withstand a nine-month recession in America, but if it were to stretch to 12 months or more, there could be serious problems.

Worries about China are adding to Asia’s uneasiness. Its private property market is in the midst of a shakeout, and scores of small developers have gone out of business.

In both Asia and Europe, there may be further shocks as banks tally the fallout from their investments in the American mortgage market.

“There’s an old saying in the market that banks lead us into recession and banks lead us out,” Mr. Boehm of Nordinvest said.

Mark Landler reported from Frankfurt and Heather Timmons from New Delhi. Gardiner Harris contributed reporting from Washington and Keith Bradsher from Hong Kong.

Overseas Investors Buy Aggressively in U.S.

PETER S. GOODMAN and LOUISE STORY
NYT, January 20, 2008

Last May, a Saudi Arabian conglomerate bought a Massachusetts plastics maker. In November, a French company established a new factory in Adrian, Mich., adding 189 automotive jobs to an area accustomed to layoffs. In December, a British company bought a New Jersey maker of cough syrup.

For much of the world, the United States is now on sale at discount prices. With credit tight, unemployment growing and worries mounting about a potential recession, American business and government leaders are courting foreign money to keep the economy growing. Foreign investors are buying aggressively, taking advantage of American duress and a weak dollar to snap up what many see as bargains, while making inroads to the world’s largest market.

Last year, foreign investors poured a record $414 billion into securing stakes in American companies, factories and other properties through private deals and purchases of publicly traded stock, according to Thomson Financial, a research firm. That was up 90 percent from the previous year and more than double the average for the last decade. It amounted to more than one-fourth of all announced deals for the year, Thomson said.

During the first two weeks of this year, foreign businesses agreed to invest another $22.6 billion for stakes in American companies — more than half the value of all announced deals. If a recession now unfolds and the dollar drops further, the pace could accelerate, economists say.

The surge of foreign money has injected fresh tension into a running debate about America’s place in the global economy. It has supplied state governors with a new development strategy — attracting foreign money. And it has reinvigorated sometimes jingoistic worries about foreigners securing control of America’s fortunes, a narrative last heard in the 1980s as Americans bought up Hondas and Rockefeller Center landed in Japanese hands.

With a growing share of investment coming from so-called sovereign wealth funds — vast pools of money controlled by governments from China to the Middle East — lawmakers and regulators are calling for greater scrutiny to ensure that foreign countries do not gain influence over the financial system or military-related technology. On the presidential campaign trail, the Democratic candidates have begun to focus on these foreign funds, calling for international rules that would make them more transparent.

Debate is swirling in Washington about the best way to stimulate a flagging economy. Despite divided opinion about the merits, foreign investment may be preventing deeper troubles by infusing hard-luck companies with cash and keeping some in business.

The most conspicuous beneficiaries are Wall Street banks like Merrill Lynch, Citigroup and Morgan Stanley, which have sold stakes to government-controlled funds in Asia and the Middle East to compensate for calamitous losses on mortgage markets. Beneath the headlines, a more profound shift is under way: Foreign entities last year captured stakes in American companies in businesses as diverse as real estate, steel-making, energy and baby food.

The influx is the result of a confluence of factors that have made the United States both reliant on the largesse of foreigners and an alluring place for opportunistic investors. With American banks reeling from the housing downturn and loath to lend, businesses are hungry for cash.

The weak dollar has made American companies and properties cheaper in global terms, particularly for European and Canadian buyers. Even as Americans confront the prospect of a recession, economic growth remains strong worldwide, endowing oil producers like Saudi Arabia and Russia and export powers like China and Germany with abundant cash.

As the German company ThyssenKrupp Stainless broke ground in November on what is to be a $3.7 billion stainless steel plant in Calvert, Ala., its executives spoke effusively about the low cost of production in the United States and the chance to reach many millions of customers — particularly because of the North American Free Trade Agreement, which allows goods to flow into Mexico and Canada free of duty.

“The Nafta stainless steel market has great potential, and we’re committed to significantly expanding our business in this growth region,” said the company’s chairman, Jürgen H. Fechter, according to a statement.

Foreign giants like Toyota Motor and Sony have been sinking capital into American plants. Investment in the American subsidiaries of foreign companies grew to $43.3 billion last year from $39.2 billion the previous year, according to the research and consulting firm OCO Monitor.

“This is a vote of confidence in the American economy, the American marketplace and the American worker,” the deputy Treasury secretary, Robert M. Kimmitt, said. “These investments keep Americans employed and keep balance sheets strong.”

Five million Americans now work for foreign companies set up in the United States, Mr. Kimmitt said, and those jobs pay 30 percent more than similar work at domestic companies. Nearly a third of such jobs are in manufacturing, which explains why Rust Belt states have been wooing foreign investment.

“We’ve lost 400,000 manufacturing jobs,” said Michigan’s governor, Jennifer M. Granholm, a Democrat, who has traveled three times to Europe and twice to Japan in pursuit of investment since taking office in 2003. “I’ve got to get jobs for our people.”

Some labor unions see the acceleration of foreign takeovers as the latest indignity wrought by globalization.

“It’s the culmination of a series of fool’s errands,” said Leo W. Gerard, international president of the United Steelworkers. “We’ve hollowed out our industrial base and run up this massive trade deficit, and now the countries that have built the deficits are coming back to buy up our assets. It’s like spitting in your face.”

Other labor groups take a more pragmatic view.

“We need investment and we need to create good jobs,” said Thea Lee, policy director for the A.F.L.-C.I.O. in Washington. “We’re not in the position to be too choosy about where that investment comes from. But it does bring home the consequences of flawed trade policies over many, many years that we’re in this position of being dependent.”

At the center of concern is the growing influence of sovereign wealth funds, which invested $21.5 billion in American companies last year, according to Thomson. Analysts say they could skew markets by investing to improve the fortunes of their national companies or to pursue political goals.

“This is a phenomenon that could be called the growth of state capitalism as opposed to market capitalism,” said Jeffrey E. Garten, a trade expert at the Yale School of Management. “The United States has not ever been on the receiving end of this before.”

Perhaps emblematic of national ambivalence, in an appearance on CNBC last week, the voluble market analyst Jim Cramer spoke in menacing terms about the growing role of state investment funds from the Middle East and China.

“Do we want the communists to own the banks, or the terrorists?” Mr. Cramer asked. “I’ll take any of it, I guess, because we’re so desperate.”

Proponents of investment from overseas note that finance from sovereign wealth funds is a mere trickle of the overall flow from abroad. Indeed, the bulk comes from Europe, Canada and Japan. Just as Americans have scattered investments around the world in pursuit of profit — with holdings of foreign stock and debt exceeding $6 trillion in 2006, according to the Treasury Department — foreigners are looking to the United States, with their capital generating economic activity, proponents say.

If fear of foreign money now inspires Americans to erect new barriers, that would damage the economy, said Todd M. Malan, president of the Organization for International Investment, a Washington lobbying group financed by foreign companies.

“The policy choices on the negative side would have enormous economic implications that would make the current situation look like a bubble bath,” he said.

Tensions spawned by foreign investment hark back to the 1980s, when Japan snapped up prominent American businesses like Columbia Pictures, and some intoned that the American way of life was under assault. The new wave of foreign money is washing in at an even more important time, analysts say.

The United States has lost more than three million manufacturing jobs since 2001, with foreign trade often taking the blame. Foreign-made goods now account for roughly one-third of all wares consumed in the United States, roughly tripling their share over the last quarter-century. The soaring price of oil and a widening trade deficit underscore how the American economy is increasingly vulnerable to decisions made far away.

In 2005, Congressional opposition scuttled a bid by the state-owned Chinese energy company Cnooc to buy the American oil company Unocal. The following year, furor on Capitol Hill prevented DP World, a company based in the United Arab Emirates, from buying several major American ports.

No such outcry has greeted the purchase of stakes in major Wall Street banks by state investment funds in the United Arab Emirates, Kuwait, China, Singapore and South Korea. This is largely because the banks sold passive slices and ceded no formal control, which would have set off a federal review of the national security implications. But the silence also reflects the imperative that these enormous institutions swiftly secure cash.

“It would be good if these companies didn’t need all this capital and better if the capital was available in the United States,” said Senator Charles E. Schumer, Democrat of New York, who was a vocal opponent of the DP World deal. “But given the situation that these institutions find themselves in and the fact that there’s a pretty strong credit squeeze, there’s only two choices: Have foreign companies invest in these firms or have massive layoffs.”

In years past, particularly when Japanese money washed in, many foreign purchases proved not to be so prudent in the end. This time, with the dollar weak and troubled American companies in a poor bargaining position, the prices really do seem cheap, some economists say.

“They’re buying financial assets at well under book value,” said Gary C. Hufbauer, a trade expert at the Peterson Institute for International Economics.

Trade experts assume tensions will rise as developing countries — which tend to have more state companies — continue to expand their share of investment in the United States.

Canada still spends the most money buying stakes in American companies — more than $65 billion in 2007, according to Thomson. But other countries’ purchases are growing rapidly. South Korea’s investments swelled to more than $10.4 billion last year from just $5.4 million in 2000. Russia went to $572 million from $60 million in that span; India to $3.3 billion from $364 million.

But even if political tension increases, so will the flow of foreign money, some analysts say, for the simple reason that businesses need it.

“The forces sucking in this capital are much bigger than the political forces,” said Mr. Garten, the Yale trade expert. “If there is a big controversy, it will be between Washington on the one hand and corporate America on the other. In that contest, the financiers and the businessmen are going to win, as they always do.”

VIRUS IN THE PLAN - Bizarre fiscal arrangements between the Centre and the states

Ashok Mitra
The Telegraph, 21 January

The quinquennial event — the National Development Council’s approval of the five-year plan as prepared by the Planning Commission — is now no more than a charade. A plan is supposed to set rigorous targets for the economy as a whole as well as for its individual sectors, at the same time indicating meticulous measures to reach such targets. All that has fallen by the wayside in the free-for-all milieu of the liberalization era.

The 11th five-year plan, as ratified by the NDC last month, is nonetheless not an altogether vacuous exercise; it is intended to serve a particular objective: imposing the will of the Centre on state governments. This or that state chief minister may be totally opposed to the approach and contents of the plan. He or she must still walk the plank and fall in line with what is archly referred to as the consensus on the plan. Were a state government to refuse to go along, the Planning Commission will cut it out of all plan assistance; since the state disagrees with the projects and programmes constituting the plan and would like to go its own way, it cannot, it will be told, expect any financial accommodation from the commission.

Two outflows from the national exchequer form the lifeline of a state government: (a) statutory allocation recommended by the Finance Commission as per provisions of the Constitution, and (b) grants recommended by the Planning Commission for approved schemes under the five-year plans. The Finance Commission is formally appointed by the president every five years and empowered to decide the distribution between the Centre and the states of the revenue receipts collected by the Centre through income tax and excise duties; it also determines the inter se allocation among the states of the amount going into the state pool. In addition, it is authorized to recommend grants-in-aid to the states for specific purposes.

On paper, this constitutional arrangement for equitable distribution of funds between the Centre and the states looks fine. Given Article 74 of the Constitution, which makes the president a tool in the hands of the Union council of ministers, it is, in effect, the Centre which decides the Finance Commission’s composition and terms of reference. This Commission has in course of time become the deus ex machina to thrust the fiscal philosophy of the Central ministry of finance on the ambit of activities of the state governments; their statutory dues are now subject to conditions set by the commission on behalf of the Centre.

The experience of the states with the Planning Commission is not any different. This commission is not even a constitutional body. It was set up, way back in 1950, by a resolution of the Union cabinet, and functions just like any Central ministry. It acts as the eye and the ear of the Centre; it proposes what the Centre wants it to propose.

Consider the 11th five-year plan as prepared by the Planning Commission. It endorses New Delhi’s pet views on appropriate modalities for national development. The pursuit of free-market policies, it is confident, will ensure that the spurt of growth, already evident in the services and industry sectors, will continue during the 11th plan period, thereby engineering ±10 per cent annual rate of growth in gross domestic product. The only question mark is apparently with regard to agriculture, where the current annual rate of growth is only 2 per cent. For GDP to grow at 10 per cent, the rate of growth of farm output, the commission thinks, must double. Such an eventuality can take place, it further thinks, in case corporate bodies are invited to enter the rural sector and engage in contract farming.

The ruling idea of the Centre is the ruling idea of the commission; other considerations are of no consequence. Common sense suggests that once contract farming invades agriculture, small and middle farmers — as well as landless agricultural workers — will be at the mercy of corporate entities. Even if, for argument’s sake, it is assumed that farm growth will pick up, thanks to invocation of corporate magic, there will be no surcease though of distress in the countryside. Corporate bodies can be expected to insist on greater mechanization of farming, rural unemployment is therefore bound to grow. With peasant masses being no match in bargaining power to the giant invaders, both wage rates and prices at which small farmers sell their output will decline. The social unrest likely to ensue will nullify the prospects of accelerated farm growth too.

To nobody’s surprise, the plan says not one word on what is, by far, the most effective means for reducing agrarian unemployment: land reforms. Close to 40 per cent of the country’s farming population, the National Sample Survey estimates indicate, are either landless or very nearly so. Land redistribution, along with provision of cheap credit, could have provided these hapless millions with gainful work, which might have contributed to higher output as well. But it is a different sort of land redistribution the Planning Commission has in mind: transferring land from the poorer peasants to the care of sponsors of the special economic zones. What is envisaged is a state-of-the-art version of Cornwallis’s Permanent Settlement; the new set of landlords will have total sway over the commandeered land and, what is more, will allow huge tax concessions and licence to brush aside the country’s labour laws.

This must be one of the reasons for the plan document waxing extra eloquent on the supposed boons of labour-market flexibility. The expression is a euphemism for a regime that permits entrepreneurs to introduce the hire-and-fire practice, a most common feature in the United States of America. Should the change sought for come about, with industrial units increasingly opting for capital-intensive technologies, labour would be ruthlessly weeded out on the pretext of the need for efficiency to meet global competition. The same situation will then emerge in the urban sector as contract farming will bring about in the countryside: segmented growth of output accompanied by aggravated unemployment. Till now, labour displaced from agricultural and industrial sectors could try to eke out a living by joining activities like petty trading in the informal sector. That possibility will evaporate if, egged on by New Delhi, big business enters the retail trade.

It is in this context that the existing fiscal arrangements between the Centre and the states appears so bizarre. Agriculture, land use, industrial relations, et al belong to the State List in the Seventh Schedule of the Constitution and exclusively under the jurisdiction of the states. No matter, the Planning Commission, an extra-constitutional body, putty in the hands of the Centre, directs the states on policies and measures to be enforced in these areas. In case the states demur, they will be cut off from funds.

The day after the NDC met in December last to approve the 11th plan, the prime minister held a separate meeting with state chief ministers to discuss what he described as the virus of Maoist violence; a special Central force has been proposed to tackle the problem. The prime minister can rest assured: with the kind of plan he and his colleagues are plotting in New Delhi, discontent among the poor and the deprived will progressively multiply, often exploding not just in Maoist depredations, but in the form of interminable caste, ethnic and communal clashes too. If states are starved of funds, or are advanced funds on condition that they agree to implement the Centre’s carefully crafted anti-poor policies, viruses of diverse genres are to have a field day in the country.

EAT, DRINK AND BE SECURE - Food security and water security go hand in hand

ASHOK GANGULY
The Telegraph, 22 January

There was a record fall in global foodstocks last year owing to a number of factors. These include changing dietary patterns in developing countries, diversion of agricultural land used for wheat, oilseeds, and so on, to grow corn for bio-fuel production in the United States of America and Europe, and the impact of climate change resulting in unusually heavy rains, floods and storms in some parts of the world and prolonged drought in others.

The rise in world prices of food- grains, after many years, has led to the coining of a new term, ‘agflation’. This is a primary cause of rising inflation, especially in poorer countries, where 50 per cent or more of family income goes towards food consumption.

Some see the rise in international food prices as an advantage for farmers since, logically, their incomes should be increasing. However, in developing countries, because of a complex mix of subsidies, price support and procurement mechanisms, much of the gain from rising food prices remains unrealized in the hands of the farmers.

The fall in global foodstocks, the rise in the prices of cereals, oilseeds and pulses, and the reluctance of governments to interfere with subsidized farming, are primarily why the World Trade Organization’s Doha round remains in limbo, and may not even see the light of day.

The growing consumption of fossil fuels, together with its impact on global warming and climate change, is now universally acknowledged, although how to deal with the problem remains unresolved. Non-conventional and renewable energy sources are being aggressively promoted as substitutes. These fall into three categories: unconventional energy sources which are ten to twenty years away from commercialization, such as hydrogen fuel cells and silicon nano chips. Then there are currently applicable technologies such as solar cells and wind energy although they need financial subsidies to be viable. Furthermore, nuclear power is, once again, gaining acceptance as an important source of clean energy. In addition, there are the agro-based renewable sources such as corn, sugarcane and rapeseed, which, though subsidized, are already being commercially used around the world.

Somehow the impression that bio-fuels are environment friendly has gained popularity, although there is no basis to this assumption in scientific reality, as these contribute equally to carbon dioxide emissions. On the contrary, while diverting more land to growing crops for the production of bio-fuels may provide psychological relief for energy security, such land diversion is already pushing up food prices and depleting world foodstocks.

Although the technology to convert agricultural waste into bio-fuels is a more attractive proposition and may become commercially attractive in the future, the process technologies are still at an early stage of development and, in any case, are unlikely to be any more climate-friendly compared to the crops being used at present to produce fuel supplements. Thus, the problem of energy security remains far from clear at this point in time, while the issue of food security is emerging as a serious problem.

The problem of food security is exacerbated by the fact that, in countries like China and India, the diet of the growing middle class now includes more meat, poultry and eggs. To grow farm animals and poultry requires much more agricultural feedstock per unit of output compared to the crops being consumed directly by humans. Amongst vegetarians in India, the per-capita consumption of pulses and edible oils is growing as well, pushing up the international prices of these commodities.

The production of foodgrains and the level of foodstocks have also been adversely affected by climate change. Climate change is considered responsible for prolonged droughts in Australia and in parts of the US. On the other hand, there are now more incidents of unseasonal heavy rains and floods in other parts of the world. In India, the precipitation during the monsoon months may not have changed significantly, but rains have become erratic, with sudden outbursts of heavy rains followed by long periods of lull, besides being unevenly distributed. This is generating a great deal of uncertainty in the agricultural sector and a drop in farm productivity. There are other longstanding factors for the decline in agriculture such as the over-use of soil, fertilizers and chemicals.

Food security and water security go hand in hand. In the absence of good water-management, and with the diversion of irrigation-water to grow crops for bio-fuels, it is important to include water-availability while assessing the equation of food and energy security.

In India, it is claimed that more than 99 per cent of monsoon precipitation flows into the sea. The absence of water-harvesting and other conservation measures is leading to a shortage in per-capita water-availability, in cities as well as in rural areas. Experts claim that water shortage will be even more acutely felt before that of climate change.

The issues of diverting agricultural land for bio-fuel production, the problems related to energy security and climate change and, finally, reducing per-capita potable water availability pose challenges and opportunities of unprecedented dimensions. Renewable sources for bio-fuels have severe limitations which need to be better comprehended and dealt with. Harvesting rain water, in cities and in rural watersheds, has become urgent. Use of genetically modified seeds, and original research and new technologies in manufacturing, transportation and services are the stuff of a new economic revolution. Since all these issues affect each of us, they need to be aired more widely in the public domain. Food and fuel prices edging out of the reach of the common people, compounded with decreasing availability of potable water, needs collective effort and cannot be left solely to experts and policy-makers.

THE COLONIAL HANGOVER - Whatever successful expatriates say is worth its weight in gold

Ashok Mitra
The Telegraph, 1 January

Football, the native variety of it, is a deadly serious business in the United States of America. The good Americans spend their weekend either thronging the stadium or staying glued to the television screen. On Monday morning, as bleary-eyed employees gather in their offices, it is still the spell of the gridiron: through coffee break till lunch hour, animated discussion continues around what dodge the quarterback should have used to break out of the scrimmage, run like mad and score a touchdown, or how the same quarterback could have tackled better the forward line of the opponents and thereby prevented a conversion. This Monday-morning-quarterbacking is, everyone agrees, a useless asinine religiosity; it is nonetheless an integral part of the American way of life.

A phenomenon, belonging more or less to the same genre of fatuity, is of late emerging in our neighbourhood. Expatriate Indians, who have done exceedingly well in academia or public administration or in business overseas, have made a habit of visiting their native land — that is, the land they emigrated from — for a fortnight or thereabouts during December and January each year. It is then beastly cold in both North America and Europe; their choice of the period of the year for the brief homecoming is therefore understandable. Their presence in this season excites the establishment circle, particularly in the metropolitan cities. Invitations crowd in on the glamorous visitors to address meetings and conferences as for closed-door sessions with the power-that-be. The advice of the expatriate eminence is eagerly sought on issues of crucial national or regional importance, for instance, special economic zones, acquisition of farmland for industry, or prevention of school drop-outs. The NRI dignitaries lap it up. At their own workplace in foreign countries, they have competition from other equal eminences; here, in the backwater they had once escaped from, they are taken to be repositories of all knowledge and wisdom.

The dignitaries do not hesitate to be generous with their advice. Not surprisingly, extempore counselling in this harum-scarum season often assumes the form of either generalities or obiter dicta. The expatriates, rushing in and rushing out, are not always familiar with the ground reality. Their approaches to economic and social issues are also by and large coloured by ideas currently dominant in the Western countries where they have lived for long years. Fortuitously or otherwise, this suits well the local hosts who are at the moment desperately anxious to accept, lock, stock and barrel, the ideology of globalization. There is, therefore, an amiable convergence of a sort. The visiting celebrities do not mind putting in a few words of endorsement of what establishment quarters over here are batting for: their Christmassy advice, it is no wonder, has the same flavour as Monday-morning-quarterbacking happens to have in the US.

It will be unfair to castigate the distinguished expatriates. Demand creates its own supply, they cave in to pressure. Much of the advice they render lacks perhaps empirical basis and sometimes even the logic of their rushed statements leans on a wobbly frame. Encounters of this nature still continue to proliferate because of the never-say-die colonial hangover. The country has been independent for more than 60 years. To no avail; the colonial mindset is still strongly entrenched. Whatever foreigners say continue to be worth its weight in gold; whatever expatriates who have excelled overseas say is also worth its weight in gold. There is a hankering after the imprimatur from international celebrities. There is a similar hankering to be seen in the company of such celebrities; to shine in reflected glory is an out-and-out colonial inheritance.

Amusing consequences follow. For theologians subscribing to the so-called post-colonial discourse, suddenly it is now high noon. Aged professors, worn out by the burden of learning, and their bright young acolytes crowd university campuses and coffee shops, flaunting their post-colonial credentials. The nationalists of yore, they were all along convinced, were overly prejudiced against foreign rulers: external domination did not necessarily lead to de-industrialization and cultural degradation; foreign rule actually contributed to heightening native intellectual capability and marked development of social and economic infrastructure.

They now feel vindicated. In an astounding turnaround, former devout nationalists and even veteran, once-the-very-definition-of-rigidity socialists, wizened by the spate of advice from expatriate big shots, are discovering points of agreement between their current thoughts and propositions aired by the post-colonialists. The globalization era has evened out many of the earlier differences on the role of the market and the virtues of private, including foreign, capital. Some amongst those who were radically opposed to the capitalist class, particularly of the foreign ilk, are now keen to invite back foreigners so as to enable the latter to resume the good work they did during their imperial tenure. In a sense it is all pure logic. Imperialism, did not the third great guru suggest, was the highest stage of capitalism? For those who have come to love capitalist growth, reaching the state of admiring empire-builders obviously cannot be far behind.

Barring a few crackpots, the entire constituency, so to say, has gone over and joined the camp of the post-colonialists, who can now proceed further. They can reiterate, with much greater confidence, their long-held notion: the concepts of nationalism and socialism are themselves imperial gifts; the subjugated people learnt about these antiquated ideas from books imported from the imperialist countries of Europe.

What a wondrous conflation has been arrived at: erstwhile nationalists, socialists of yore, those reclining on the post-colonial couch, all think, feel, and act alike. Liberalization has been the great leveller. The only jarring note is struck by the stragglers parading themselves as paragons of post-modernism. They utter smart-sounding expressions such as bricolage and pastiche, they have set their mind on wholesale deconstruction; all institutions are, they assure one another, unmitigated evil, it is their sacred obligation to be against whatever the establishment says or does. They are, it follows, votaries of chaos for the sake of chaos; they are against the government simply because it is there.

This is where the dilemma descends. The grand coalition of once-upon-a-time nationalists, former socialists and post-colonial grandmasters has a formidable look about it. But it leaves the world’s poor in the lurch. The post-modernist snooties too, while great destroyers, have seemingly not a notion what edifice to build on the ruins of the structure they are determined to demolish. The dispossessed and disadvantaged billions will perhaps be tempted to go along with them for a while. But once the ghoulish party of making a bonfire of everything is over, it is bound to be a stark stretch of undefinable wilderness. That apart, let us face it, is not post-modernism too sustained by the shipment of literature from Paris or New York?

Should then one cross over, at least for inspiration if not for immediate praxis, to Latin America? Events are perhaps taking shape in Cuba and Venezuela which bear not a trace of the colonial hangover, or, for the matter, of any other legacy of the past. The brash young band of amateurs who brought off the January 1959 revolution in Cuba had kept their distance from the official communist party; the latter thought it prudent, to merge, ex post, its identity with that of the successful revolutionaries. As for Hugo Chavez’s Venezuela, it is thought to be even more of a sui generis. But who will tell whether distance is not lending enchantment to the view?

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THE SOVIET UNION VERSUS SOCIALISM

Noam Chomsky
OUR GENERATION, Vol. 17, No. 2, Spring/Summer 47
1986


When the world's two great propaganda systems agree on some doctrine, it requires some intellectual effort to escape its shackles. One such doctrine is that the society created by Lenin and Trotsky and moulded further by Stalin and his successors has some relation to socialism in some meaningful or historically accurate sense of this concept. In fact, if there is a relation, it is the relation of contradiction.

It is clear enough why both major propaganda systems insist upon this fantasy. Since its origins, the Soviet State has attempted to harness the energies of its own population and oppressed people elsewhere in the service of the men who took advantage of the popular ferment in Russia in 1917 to seize State power. One major ideological weapon employed to this end has been the claim that the State managers are leading their own society and the world towards the socialist ideal; an impossibility, as any socialist— surely any serious Marxist — should have understood at once (many did), and a lie of mammoth proportions as history has revealed since the earliest days of the Bolshevik regime. The taskmasters have attempted to gain legitimacy and support by exploiting the aura of socialist ideals and the respect that is rightly accorded them, to conceal their own ritual practice as they destroyed every vestige of socialism.

As for the world's second major propaganda system, association of socialism with the Soviet Union and its clients serves as a powerful ideological weapon to enforce conformity and obedience to the State capitalist institutions, to ensure that the necessity to rent oneself to the owners and managers of these institutions will be regarded as virtually a natural law, the only alternative to the 'socialist' dungeon.

The Soviet leadership thus portrays itself as socialist to protect its right to wield the club, and Western ideologists adopt the same pretense in order to forestall the threat of a more free and just society. This joint attack on socialism has been highly effective in undermining it in the modern period.

One may take note of another device used effectively by State capitalist ideologists in their service to existing power and privilege. The ritual denunciation of the so-called 'socialist' States is replete with distortions and often outright lies. Nothing is easier than to denounce the official enemy and to attribute to it any crime: there is no need to be burdened by the demands of evidence or logic as one marches in the parade. Critics of Western violence and atrocities often try to set the record straight, recognizing the criminal atrocities and repression that exist while exposing the tales that are concocted in the service of Western violence. With predictable regularity, these steps are at once interpreted as apologetics for the empire of evil and its minions. Thus the crucial Right to Lie in the Service of the State is preserved, and the critique of State violence and atrocities is undermined.

It is also worth noting the great appeal of Leninist doctrine to the modern intelligentsia in periods of conflict and upheaval. This doctrine affords the 'radical intellectuals' the right to hold State power and to impose the harsh rule of the 'Red Bureaucracy,' the 'new class,' in the terms of Bakunin's prescient analysis a century ago. As in che Bonapartist State denounced by Marx, they become the 'State priests/ a "parasitical excrescence upon civil society" that rules it with an iron hand.

In periods when there is little challenge to State capitalist institutions, the same fundamental commitments lead the 'new class' to serve as State managers and ideologists, "beating the people with the people's stick," in Bakunin's words. It is small wonder that intellectuals find the transition from 'revolutionary Communism' to 'celebration of the West' such an easy one, replaying a script that has evolved from tragedy to farce over the past half century. In essence, all that has changed is the assessment of where power lies. Lenin's dictum that "socialism is nothing but state capitalist monopoly made to benefit the whole people," who must of course trust the benevolence of their leaders, expresses the perversion of 'socialism' to the needs of the State priests, and allows us to comprehend the rapid transition between positions that superficially seem diametric opposites, but in fact are quite close.

The terminology of political and social discourse is vague and imprecise, and constantly debased by the contributions of ideologists of one or another stripe. Still, these terms have at least some residue of meaning. Since its origins, socialism has meant the liberation of working people from exploitation. As the Marxist theoretician Anton Pannekoek observed, "this goal is not reached and cannot be reached by a new directing and governing class substituting itself for the bourgeoisie," but can only be "realized by the workers themselves being master over production." Mastery over production by the producers is the essence of socialism, and means to achieve this end have regularly been devised in periods of revolutionary struggle, against the bitter opposition of the traditional ruling classes and the 'revolutionary intellectuals' guided by the common principles of Leninism and Western managerialism, as adapted to changing circumstances. But the essential element of the socialist ideal remains: to convert the means of production into the property of freely associated producers and thus the social property of people who have liberated themselves from exploitation by their master, as a funda¬mental step towards a broader realm of human freedom.

The Leninist intelligentsia have a different agenda. They fit Marx's description of the 'conspirators' who "pre-empt the developing revolutionary process" and distort it to their ends of domination; "Hence their deepest disdain for the more theoretical enlightenment of the workers about their class interests," which include the overthrow of the Red Bureaucracy and the creation of mechanisms of democratic control over production and social life. For the Leninist, the masses must be strictly disciplined, while the socialist will struggle to achieve a social order in which discipline "will become superfluous" as the freely associated producers "work for their own accord" (Marx). Libertarian socialism, furthermore, does not limit its aims to democratic control by producers over production, but seeks to abolish all forms of domination and hierarchy in every aspect of social and personal life, an unending struggle, since progress in achieving a more just society will lead to new insight and understanding of forms of oppression that may be concealed in traditional practice and consciousness.

The Leninist antagonism to the most essential features of socialism was evident from the very start. In revolutionary Russia, Soviets and factory committees developed as instruments of struggle and liberation, with many flaws, but with a rich potential. Lenin and Trotsky, upon assuming power, immediately devoted themselves to destroying the liberatory potential of these instruments, establishing the rule of the Party, in practice its Central Committee and its Maximal Leaders —exactly as Trotsky had predicted years earlier, as Rosa Luxembourg and other left Marxists warned at the time, and as the anarchists had always understood. Not only the masses, but even the Party must be subject to "vigilant control from above," so Trotsky held as he made the transition from revolutionary intellectual to State priest. Before seizing State power, the Bolshevik leadership adopted much of the rhetoric of people who were engaged in the revolutionary struggle from below, but their true commitments were quite different. This was evident before and became crystal clear as they assumed State power in October 1917.

A historian sympathetic to the Bolsheviks, E.H. Carr, writes that "the spontaneous inclination of the workers to organize factory committees and to intervene in the management of the factories was inevitably encouraged by a revolution which led the •workers to believe that the productive machinery of the country belonged to them and could be operated by them at their own discretion and to their own advantage" (my emphasis). For the workers, as one anarchist delegate said, "The Factory Committees were cells of the future... They, not the State, should now administer."

But the State priests knew better, and moved at once to destroy the factory committees and to reduce the Soviets to organs of their rule. On November 3, Lenin announced in a "Draft Decree on Workers' Control" that delegates elected to exercise such control were to be "answerable to the State for the maintenance of the strictest order and discipline and for the protection of property." As the year ended, Lenin noted that "we passed from workers' control to the creation of the Supreme Council of National Economy," which was to "replace, absorb and supersede the machinery of workers' control" (Carr). "The very idea of socialism is embodied in the concept of workers' control," one Menshevik trade unionist lamented; the Bolshevik leadership expressed the same lament in action, by demolishing the very idea of socialism.

Soon Lenin was to decree that the leadership must assume "dictatorial powers" over the workers, who must accept "unques¬tioning submission to a single will" and "in the interests of socialism," must "unquestioningly obey the single will of the leaders of the labour process." As Lenin and Trotsky proceeded with the militarization of labour, the transformation of the society into a labour army submitted to their single will, Lenin explained that subordination of the worker to "individual autho¬rity" is "the system which more than any other assures the best utilization of human resources" — or as Robert McNamara expressed the same idea, "vital decision-making... must remain at the top... the real threat to democracy comes not from overmana-gement, but from undermanagement"; "if it is not reason that rules man, then man falls short of his potential," and management is nothing other than the rule of reason, which keeps us free. At the same time, 'factionalism' — i.e., any modicum of free expression and organization — was destroyed "in the interests of socialism," as the term was redefined for their purposes by Lenin.

The Leninist intelligentsia have a different agenda. They fit Marx's description of the 'conspirators' who "pre-empt the developing revolutionary process" and distort it to their ends of domination; "Hence their deepest disdain for the more theoretical enlightenment of the workers about their class interests," which include the overthrow of the Red Bureaucracy and the creation of mechanisms of democratic control over production and social life. For the Leninist, the masses must be strictly disciplined, while the socialist will struggle to achieve a social order in which discipline "will become superfluous" as the freely associated producers "work for their own accord" (Marx). Libertarian socialism, furthermore, does not limit its aims to democratic control by producers over production, but seeks to abolish all forms of domination and hierarchy in every aspect of social and personal life, an unending struggle, since progress in achieving a more just society will lead to new insight and understanding of forms of oppression that may be concealed in traditional practice and consciousness.

The Leninist antagonism to the most essential features of socialism was evident from the very start. In revolutionary Russia, Soviets and factory committees developed as instruments of struggle and liberation, with many flaws, but with a rich potential. Lenin and Trotsky, upon assuming power, immediately devoted themselves to destroying the liberatory potential of these instruments, establishing the rule of the Party, in practice its Central Committee and its Maximal Leaders —exactly as Trotsky had predicted years earlier, as Rosa Luxembourg and other left Marxists warned at the time, and as the anarchists had always understood. Not only the masses, but even the Party must be subject to "vigilant control from above," so Trotsky held as he made the transition from revolutionary intellectual to State priest. Before seizing State power, the Bolshevik leadership adopted much of the rhetoric of people who were engaged in the revolutionary struggle from below, but their true commitments were quite different. This was evident before and became crystal clear as they assumed State power in October 1917.

A historian sympathetic to the Bolsheviks, E.H. Carr, writes that "the spontaneous inclination of the workers to organize factory committees and to intervene in the management of the factories was inevitably encouraged by a revolution which led the •workers to believe that the productive machinery of the country belonged to them and could be operated by them at their own discretion and to their own advantage" (my emphasis). For the workers, as one anarchist delegate said, "The Factory Committees were cells of the future... They, not the State, should now administer."

But the State priests knew better, and moved at once to destroy the factory committees and to reduce the Soviets to organs of their rule. On November 3, Lenin announced in a "Draft Decree on Workers' Control" that delegates elected to exercise such control were to be "answerable to the State for the maintenance of the strictest order and discipline and for the protection of property." As the year ended, Lenin noted that "we passed from workers' control to the creation of the Supreme Council of National Economy," which was to "replace, absorb and supersede the machinery of workers' control" (Carr). "The very idea of socialism is embodied in the concept of workers' control," one Menshevik trade unionist lamented; the Bolshevik leadership expressed the same lament in action, by demolishing the very idea of socialism.

Soon Lenin was to decree that the leadership must assume "dictatorial powers" over the workers, who must accept "unques¬tioning submission to a single will" and "in the interests of socialism," must "unquestioningly obey the single will of the leaders of the labour process." As Lenin and Trotsky proceeded with the militarization of labour, the transformation of the society into a labour army submitted to their single will, Lenin explained that subordination of the worker to "individual autho¬rity" is "the system which more than any other assures the best utilization of human resources" — or as Robert McNamara expressed the same idea, "vital decision-making... must remain at the top... the real threat to democracy comes not from overmana-gement, but from undermanagement"; "if it is not reason that rules man, then man falls short of his potential," and management is nothing other than the rule of reason, which keeps us free. At the same time, 'factionalism' — i.e., any modicum of free expression and organization — was destroyed "in the interests of socialism," as the term was redefined for their purposes by Lenin and Trotsky, who proceeded to create the basic proto-fascist structures converted by Stalin into one of the horrors of the modern age.1

Failure to understand the intense hostility to socialism on the part of the Leninist intelligentsia (with roots in Marx, no doubt), and corresponding misunderstanding of the Leninist model, has had a devastating impact on the struggle for a more decent society and a liveable world in the West, and not only there. It is necessary to find a way to save the socialist ideal from its enemies in both of the world's major centres of power, from those who will always seek to be the State priests and social managers, destroying freedom in the name of liberation.

Noam Chomsky is Professor of Linguistics and Philosophy and Institute Professor at M.I. T.; recipient of honorary degrees from the University of London, University of Chicago, Delhi University, and four other colleges and universities; fellow of the American Academy of Arts and Sciences, member of the National Academy of Arts and Sciences, and member of the National Academy of Science; author of numerous books and articles on linguistics, philosophy, intellectual history and contemporary issues, including At War With Asia, Peace in the Middle East?, Human Rights and American Foreign Policy, The Political Economy of Human Rights (2 volumes, with E.S. Herman), Toward a New Cold War, Radical Priorities, Binding, The Fateful Triangle: The U.S., Israel and the Palestinians, and most recently, Turning the Tide: The U.S. and Latin America.

Courtesey: Hindol Bhattachrjee