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The World According to Derivatives: Part 7 of 7

The implosion of the Carlyle Capitol Corporation just weeks before the Bear Stearns debacle last March is little more than a distant memory in the minds of most people. Yet the facts surrounding Carlyle Capitol, like those surrounding the J.P. Morgan/Bear Stearns/WaMu deals — not to mention the JP Morgan/Enron scandal — certainly deserve further scrutiny.

To be sure, derivatives, along with “innovative” accounting techniques, are a unifying theme of these and similar eye-brow raising, but effectively submerged, stories. Chief among these submerged stories are those which surround Carlyle Capitol and its parent company the Carlyle Group. Here’s what can be said about each.

The derivatives-heavy Carlyle Capitol had been the first of 55 funds the Carlyle Group took public between July 2007 and March 2008. It went belly up as its mortgage-backed assets began to implode and a group of the world’s biggest banks, including JP Morgan, refused to hold off on margin calls and liquidation of assets — moving instead to seize and sell what was left of the fund’s assets. While the losses to the Carlyle Group were “minimal from a financial standpoint”, it nevertheless represented a major embarrassment for the giant private equities firm — which, it must be mentioned, had $76 billion tied up in exactly the same kinds of “derivative investment tools” as its “separate legal and business entity” aka the Carlyle Capitol Corporation.

Perhaps it is mere coincidence that the Carlyle Group is registered in Britain (but based in Washington, D.C.) while Carlyle Capitol was based on Guernsey Island off the British coast. Nevertheless the question persists as to whether Carlyle Capitol was functioning as an offshore entity created as a means of misstating, or perhaps burying, certain material financial statements. You know, the kind of activity that subjected JP Morgan to Congressional Investigation in 2002, proof of which activity the Congressional Investigating Committee was given audiotapes and copies of incriminating emails.

The Carlyle Group itself has what can only be described as a controversial history with trails leading to 9-11, the current war on terror, the first Gulf War, Afghanistan and elsewhere. It also has had extensive “counter party links” to Enron, Arthur Andersen, Global Crossing, the Saudi Royal Family, and yes, even the Bin Ladens.

Its main business is buying and selling large corporations. Described as a powerful merchant bank and leading defense contractor, the Carlyle Group also is a key player in the privatization of public resources within the U.S. Known as the ex-presidents club it is surprising to say the least that so few have ever even heard of the Carlyle Group, especially given the scope of its activities. Perhaps this is because, as an October 31, 2001 Guardian UK article tells it.

This is exactly the way Carlyle likes it. For 14 years now, with almost no publicity, the company has been signing up an impressive list of former politicians – including the first President Bush and his secretary of state, James Baker; John Major; one-time World Bank treasurer Afsaneh Masheyekhi and several south-east Asian power brokers — and using their contacts and influence to promote the group. Among the companies Carlyle owns are those which make equipment, vehicles and munitions for the US military, and its celebrity employees have long served an ingenious dual purpose, helping encourage investments from the very wealthy while also smoothing the path for Carlyle’s defence firms.

… But what sets Carlyle apart is the way it has exploited its political contacts. When Carlucci arrived there in 1989, he brought with him a phalanx of former subordinates from the CIA and the Pentagon, and an awareness of the scale of business a company like Carlyle could do in the corridors and steak-houses of Washington. In a decade and a half, the firm has been able to realise a 34% rate of return on its investments, and now claims to be the largest private equity firm in the world. Success brought more investors, including the international financier George Soros and, in 1995, the wealthy Saudi Binladin family, who insist they long ago severed all links with their notorious relative. The first president Bush is understood to have visited the Binladins in Saudi Arabia twice on the firm’s behalf.

… But if the Binladins’ connection to the Carlyle Group lasted no more than six years, the current President Bush’s own links to the firm go far deeper. In 1990, he was appointed to the board of one of Carlyle’s first purchases, an airline food business called Caterair, which they eventually sold at a loss. He left the board in 1992, later to become Governor of Texas. Shortly thereafter, he was responsible for appointing several members of the board which controlled the investment of Texas teachers’ pension funds. A few years later, the board decided to invest $100m of public money in the Carlyle Group. The firm’s magic touch was already bringing results. ((“The Ex-Presidents Club,” by Oliver Burkeman and Julian Borger. Guardian Unlimited, October 31, 2001.))

Despite its lack of notoriety, one can find Carlyle connections turning up everywhere. For example and in addition to the “counter party web” of the Texas teachers pension fund mentioned above, an August 10, 2005 NewsMax article revealed that the Carlyle Group had caught the attention of federal prosecutors after Illinois Teachers Retirement System officials raised concerns about the $4.5 million in fees offered by Carlyle to one Robert Kjellander (a lobbyist, Bush campaigner and newly appointed treasurer of the Republican National Committee) for helping land business with the Illinois teachers pension fund.

A spokesman for Carlyle of course maintained that Kjellander’s fees weren’t unusual and in any case, the average returns on these funds investments was 45% per year. After all, who could complain about that, even if the earnings themselves had the unmistakable taint of blood and corruption written all over them?

Interestingly, the article also revealed that “Kjellander had previously raised eyebrows in 2003 when he received an $809,000 consulting fee from Bear, Stearns Inc. after Democratic Governor Rod Blagojevich picked that investment house to handle $10 billion in pension fund bonds. The firm received $8 million for handling the bond issue…” ((“Feds Probing Carlyle Group’s Payment to RNC,” NewsMax, August 10, 2005.))

Bear Stearns, J.P. Morgan, Carlyle Capitol, the Carlyle Group and a VERY long list of other rarefied corporations are (or were, as the case may be) all heavily involved in derivatives instruments that are still in the process of unwinding themselves from their myriad counter party entanglements across the globe. Many, if not all, of these firms have long used their financial clout to influence government officials, not to mention the media and educational institutions – and many are either directly or indirectly heavily invested in the defense industry among other industries. But when all is said and done, there is no other private business which has so successfully navigated the heady waters of what is known as the Iron Triangle — a place where industry, government and the military converge – than the Carlyle Group. ((The Iron Triangle: Inside the Secret World of the Carlyle Group, by Dan Briody))

A most striking example can be found in Iraq, where we find two former Secretaries of State heading up a secret investment deal involving a “complex transfer of ownership of as much as $57 billion in unpaid Iraqi debts.” Seems that former Secretary of State James Baker (and senior counsel for the Carlyle Group) just happened to be appointed by Bush II as the special envoy to negotiate Iraqi “debt relief”. The objective of this envoy was to see to it that “[t]he debts, now owed to the government of Kuwait, would be assigned to a foundation created and controlled by a consortium in which the key players are the Carlyle Group and the Albright Group, which is headed by another former Secretary of State, Madeleine Albright.” ((“James Baker’s Double Life in Iraq: The Carlyle Group Stands to Make Killing on Iraqi Debt,” Amy Goodman interviews Naomi Klein, Democracy Now, October 13, 2004.))

We also have Frank Carlucci, who not only served as Chairman of the Carlyle Group at the time of the September 11 attack, but had served as a former Secretary of Defense in the Reagan Administration and a Deputy Director of the CIA during the Carter Administration. Perhaps even more curiously — and again at the time of the September 11 attacks — Carlucci was serving on the RAND Corporation Board of Trustees and was also the co-chair of the Rand Center for Middle East Public Policy Advisory Board. The Rand Corporation, it can be said, is one of many nonprofit (non-taxpaying) “think tanks” where people get paid to think, and Frank Carlucci was among those who were being paid to think about the situation in the Middle East. ((“The People We Pay to Think”.))

Fortuitously for the Carlyle Group, it “cashed out many of its investments when the stock of defense companies rose dramatically in the aftermath of September 11 and the buildups to the Afghanistan and Iraq wars.” ((“Investing in War: The Carlyle Group Profits from Government and Conflict,” M. Asif Ismai, The Center for Public Integrity, November 18, 2004.))

In the aftermath of the September 11 attack, the Carlyle Group, together with Halliburton, has made millions of dollars off the Iraq War. In addition Carlyle has “reaped millions of dollars from government contracts on things such as cleaning up anthrax-infected buildings — including the Hart Senate Office Building – making X-ray scanners, providing logistics support to the U.S. military, making metal-bond structures in fighter jets and missiles, and providing employee background checks for the government.” ((“Carlyle Group, Halliburton Getting Rich off the Iraq War,” Chuck Baldwin. News With Views, March 27, 2003.))

Although Carlyle’s counter party webs are seemingly endless, its growing involvement in public/private partnership ventures is also exceedingly troublesome, and strangely under-reported. In addition to the already established afore-mentioned partnering activities, the announcement of a newly formed team whose sole objective was to engage in public/private ventures came after a public furor had been created over the fact that DP World, a company owned by the United Arab Emirates, had acquired a British company that manages operations at six U.S. Ports. Soon after this news became public, the House Appropriation Committee voted on March 8, 2006 to prevent DP World from taking control of six U.S. Ports, and that story quickly faded into oblivion.

Perhaps by happenstance and the very next day after the House vote — the Carlyle Group announced that it had established an eight-person team co-headed by Robert Dove, former executive vice-president at Bechtel and Barry Gold, former managing director and co-head of the structured finance group at Citigroup/Salomon Smith Barney. According to the Media Room section of its own website, the team’s objective is to invest “in the [public] infrastructure sector, including investments in transportation and water facilities, airports, bridges, ports, stadiums and other public infrastructure … primarily in … transactions ranging from $100 million to more than $1 billion. The team will engage in public-private partnerships (PPP) with governments at all levels as well as purchase projects outright or through long term concessions.” ((“The Carlyle Group Establishes Infrastructure Investment Team,” Press Release, The Carlyle Group, March 10, 2006.))

Increasingly, cash strapped local governmental entities are looking to these public-private partnerships for relief for their liquidity problems. To be sure, the argument for such projects carries a certain appeal because, as the logic goes, what other options do state, county and municipal governments have, after they downsize and increase taxes, besides holding what amount to giant fire sales in which public assets are sold to the highest bidder or public-private partnership deals are struck? What all too often is not clearly and completely understood by the average citizen — or even for that matter, his elected officials — is that “[i]n this arrangement, government and business “co-own” the former government asset and their purpose is to make a profit.” ((“Chicago Inc.,” Joan Veon, News With Views, August 31, 2003.))

Moreover, and given the allure of very handsome profits that stand to be generated by this “new asset class” it is no surprise that “banks and private investment firms have fallen in love with public infrastructure. They’re smitten by the rich cash flows that roads, bridges, airports, parking garages, and shipping ports generate—and the monopolistic advantages that keep those cash flows as steady as a beating heart. … But are investors getting an even better deal [than the public]? It’s a question with major policy implications as governments relinquish control of major public assets for years to come. The aggressive toll hikes embedded in deals all but guarantee pain for lower-income citizens—and enormous profits for the buyers. … What’s more, some public interest groups complain that the revenue from the higher tolls inflicted on all citizens will benefit only a handful of private investors, not the commonweal.” ((“Road to Riches,” Emily Thornton, Business Week, May 7, 2007.))

What should likewise come as no surprise in all this is the fact that “[i]nvestment firms including Goldman Sachs, Morgan Stanley, and the Carlyle Group are approaching state politicians with advice to sell off public highway and transportation infrastructure. When advising state officials on the future of this vital public asset, these investment firms fail to mention that their sole purpose is to pick up infrastructure at the lowest price possible in order to maximize returns for their investors. Investors, most often foreign companies, are charging tolls and insisting on “noncompete” clauses that limit governments from expanding or improving nearby roads.” ((“Privatization of America’s Infrastructure,” Student researchers Rachel Icaza and Ioana Lupu, Faculty Evaluator: Marco Calavita, Ph.D. Top 25 Censored Stories for 2008. Project Censored.))

With respect to the Carlyle story in particular, what is most unfortunate is that “[o]utside of the conservative Judicial Watch and the muckraking Center for Public Integrity, there has been little public interest in the Carlyle system of capitalism and where it is going. Congress, meanwhile, is too busy seeking Carlyle’s advice even to ask the question. The people who run Carlyle may hate the word secrecy, but their words and actions make it impossible to know where the policy-making ends and the money-making begins.” ((“Crony Capitalism Goes Global,” Thomas Shorrock. The Nation, March 14, 2002.))

So it seems that the military/industrial/governmental complex — and the Carlyle Group in particular — is perfectly positioned to profit handsomely from both the endless war on terror and the privatization of public resources, with nary a complaint from government officials and next to no meaningful media coverage of the long term ramifications of such “profit centers”. Behind it all are the Faustian bargains which are struck daily through the speculative derivatives markets in the increasingly rapacious quest for the “fast money” that only these markets can provide.

In his 2002 Enron-related testimony before Congress, attorney Frank Partnoy makes the following important observations concerning the effect derivatives have on business (and it might be said government) behavior:

The temptations associated with derivatives have proved too great for many companies, and Enron is no exception. The conflicts of interest among Enron’s officers have been widely reported…. But too much focus on Enron misses the mark. As long as ownership of companies is separated from their control — and in the U.S. securities market it almost always will be — managers of companies will have incentives to be aggressive in reporting financial data. ((Testimony of Frank Partnoy Professor of Law, University of San Diego School of Law, Hearings before the United States Senate Committee on Governmental Affairs, January 24, 2002.))

As Mr. Partnoy’s comments reveal, the lure of “fast money” promised by derivatives can be as morally deadly as it is irresistible. What gets lost in the mix are the nuts and bolts for which a company (or indeed our country) was founded — even as an unending parade of enticements are created for exaggeration of profits and a host of other forms of deceptive and even unscrupulous behavior.

Without question, mammoth, globally-scaled financial empires and unfathomable personal wealth have been created through derivatives. But all this has come at a heavy price that must be measured not just in dollars but in terms of blood and honor as well.

It falls to ordinary citizens to reclaim the practical tools and the moral high ground established by America’s founding documents — which not only created the United States but which once served as a beacon of hope to the rest of the world.

  • Read Part 1, 2, 3, 4, 5, and 6.
  • Geraldine Perry is the co-author of The Two Faces of Money and author of Climate Change, Land Use and Monetary Policy: The New Trifecta. Read other articles by Geraldine, or visit Geraldine's website.

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    1. Ron Horn said on January 12th, 2009 at 1:05pm #

      It is clear to me that this is the next wave of privatization, and many US States are ripe for it due to their enormous budget shortfalls, and the appalling public ignorance that has been carefully cultivated by corporate media.

      Thanks G. Perry for this report which provides so many details on this latest theft of the commonwealth by the capitalist ruling class.

    2. Eric Planey said on January 13th, 2009 at 7:36pm #

      This would almost be hysterical if it wasnt so ridiculously wrong. First you have piece-mealed other conspiracy theories written over the years. Second, like them, you have an abundance of factual errors on Carlyle’s fund locations, performance, etc.

      Your points on derivatives have merit, and there is something to be said about the mentality that you can always structure risk away (that is moral hazard at its finest). But enough of the Carlyle Group started the war in Iraq to profit from it etc… Frank Carlucci and Mady Albright joined together several years ago to confront the hubris of American foreign policy. Where was that noted here?