How the Last Big Oil Spill Helped Create the Credit Crisis

My last post casually mentioned credit default swaps, a fancy financial trick that helped create the credit crisis of 2008 (Planet Money did an amazing reporting series on credit default swaps for NPR back while the crisis was happening).

What I didn't know when I started writing that post was that the Exxon Valdez oil spill actually inspired the invention of credit default swaps. In a way, the loan for restoring Prince William Sound was the first-ever subprime mortgage- the ultimate fixer-upper.

Here's how it happened. In the first court judgment against Exxon Mobil for the 1989 Exxon Valdez oil spill, an Anchorage jury awarded the defendants $5 billion in punitive damages. This was in 1994.

Fool's Gold: The Inside Story of J.P. Morgan and How Wall Street Greed Corrupted Its Bold Dream and Created a Financial Catastrophe
by Gillian Tett

Author Gillian Tett, a financial writer who possesses a valuable background in social anthropology, describes what happened next in her book "Fool's Gold," a detailed history of the financial innovations and machinations that led up to the credit crisis. John Lanchester provides a succinct summary in his June 2009 New Yorker review:

Exxon needed to open a line of credit to cover potential damages of five billion dollars... J. P. Morgan was reluctant to turn down Exxon, which was an old client, but the deal would tie up a lot of reserve cash to provide for the risk of the loans going bad. The so-called Basel rules, named for the town in Switzerland where they were formulated, required that the banks hold eight per cent of their capital in reserve against the risk of outstanding loans. That limited the amount of lending bankers could do, the amount of risk they could take on, and therefore the amount of profit they could make. But, if the risk of the loans could be sold, it logically followed that the loans were now risk-free; and, if that were the case, what would have been the reserve cash could now be freely loaned out. No need to suck up useful capital.

In late 1994, Blythe Masters, a member of the J. P. Morgan swaps team, pitched the idea of selling the credit risk to the European Bank of Reconstruction and Development. So, if Exxon defaulted, the E.B.R.D. would be on the hook for it—and, in return for taking on the risk, would receive a fee from J. P. Morgan. Exxon would get its credit line, and J. P. Morgan would get to honor its client relationship but also to keep its credit lines intact for sexier activities. The deal was so new that it didn’t even have a name: eventually, the one settled on was “credit-default swap.”

So the new "credit default swap" allowed Exxon borrow on more attractive terms than it otherwise would have gotten, while J.P. Morgan got to export the risk of the loan to Europe, and free up more of its own money to lend to other borrowers.

To draw a more familiar analogy, Exxon was like the shady homebuyer who might lose his job at any moment, and J.P. Morgan was the mortgage broker who nevertheless assured him that he was still completely qualified to borrow. And the oil-soaked Prince William Sound was the fixer-upper whose cleanup costs were on the bottom line. Thanks to the credit default swap, the actual responsibility for that mess - like the actual responsibility for millions of underwater mortgages today - wouldn't really be owned by anyone.

The irony is that this first-ever credit default swap actually worked out well for its players: Exxon merged with Mobil and the new company, ExxonMobil, now makes around $40 billion in profits in a typical year. The $5 billion punishment was also recently rejected by the Supreme Court. So needless to say, the risky loan never defaulted, and the European Bank of Reconstruction and Development kept its money.

J.P. Morgan, meanwhile, was able to offer more and more credit default swaps, and merged with Chase bank in 2000. By 2008, when it became evident that many of those credit default swaps were tangled up in a worthless house of cards, the company was one of the nation's four largest banks deemed "too big to fail," and received a $25 billion bailout from the federal government.

Most people would agree that ExxonMobil still hasn't served justice for the Exxon Valdez spill, but look at it this way: the company made $45 billion in profits in 2008, but a year later, it pulled in less than half that amount, thanks in large part to the global financial crisis. By seeking a cheap loan to cover its ass and pass the buck back in 1994, the corporation helped invent the financial device that inadvertently brought the world's economy (and the world's thirst for oil) to its knees. ExxonMobil still cleared almost $20 billion last year, though, so the schadenfreude is admittedly dim.

It's more interesting to think about how BP and the global financial markets will cope with the cleanup bill for the much larger Deepwater Horizon disaster. Suddenly, the multi-trillion dollar business of drilling for oil miles below the surface of the ocean looks a lot riskier. But it's still an extremely lucrative enterprise, which means that the world's bankers will inevitably invent new contortions and pyramid schemes to cover those risks and finance more wells.

So what will become of our economy and society when those schemes, like the underwater wells they're designed to finance, inevitably fail one more time?

Related:

Pelicans Meet the Markets

The ExxonMobil Arena/Disaster Shelter

The Real Dr. Frankenstein: Artificial Life Is Here

As of today, artificial life is real. Craig Venter, one of the founding fathers of genomics, has successfully created a new life form built from scratch from a synthetic, engineered genome.

According to Earth2Tech, "The researchers built a synthetic chromosome and inserted it into a living bacterial cell, where it — for the first time and published in the journal Science today — took over the cell and became a new life form."

So the world's first man-made life form is also a body-snatcher.

Venter's research is being funded largely on the hopes that it will produce new organisms to help convert sugars into ethanol, or to engineer a new algae that not only absorbs CO2, but also could be used as a transportation fuel. In fact, Venter's startup, Synthetic Genomics, Inc., has been operating in partnership with ExxonMobil's research and development office.

There's a strain of environmentalism that believes that climate change is catastrophic and unavoidable, and the best option for us now is not to reduce greenhouse gas emissions, but to embark on large-scale "geo-engineering" projects to reverse-engineer the Earth's atmosphere into a cooler state. Ideas range from pumping smoke into the upper atmosphere to give us more shade, to seeding the oceans with iron to promote plankton growth.

These ideas horrify mainstream environmentalists because there's nothing to indicate that these ideas would work, or that they wouldn't inflict serious unforeseen consequences. To me, the worst thing about the geo-engineers is that they think it's a good idea to spend a lot of money and exert massive efforts in order to treat the symptoms of climate change - not the causes.

It seems to me that Dr. Venter's devotion to synthetic life has too much in common with the geo-engineers' perspective, even though his work is on a microscopic (instead of planetary) scale.

It's a huge effort, a science-fiction fantasy come to life, and for what? So we can fuel our minivans with the world's agricultural crops instead of with oil. Thanks, science - I guess.

Protesting oil is worse than Cobra and Barbie's credit limit COMBINED.

I've already written a little bit about the oil rig museum in Galveston, Texas. Here's a photo of one of their sillier exhibits:


Click the image to read the sign if it's not legible in the thumbnail above.

Now, I can appreciate their efforts to inform people that plastic stuff is made from oil. But telling kids that their dolls and stuffed animals rely on oil companies for their very survival seems a bit much. When I re-read this sign, I envision G.I. Joe, Barbie, and the Care Bears joining forces to fight the Sierra Club over the Arctic National Wildlife Refuge, a wondrous Cabbage Patch where millions of new toys are just aching to be born.

Of course, this exhibit sign takes on another layer of irony with all the recent brouhaha over toxic toys: Barbie's polyvinyl chloride skin (made from oil, of course) has come under particularly heavy fire from regulators and concerned parents. Maybe G.I. Joe should wage war against the precautionary principle.

In the museum gift shop there was a whole corner given over to a bunch of toys that had no apparent connection to the oil industry or Texas or anything else in the museum. But a sign explained: "Products of petrochemicals!" Just don't put them in your mouth.

The Sunshine State!

Some recent news stories and links related to urban nature in Florida:

• In Port St. Lucie, a luxury golf course developer conserved about 120 acres of prime lakeside real estate for a pair of nesting bald eagles. As golfer habitat, the land could have netted $40 million. But according to developer Bobby Ginn, the eagles are more valuable: "For me, it's as big an amenity as golf or tennis or a pool," said Ginn in a Palm Beach Post article. "People want to see and enjoy wildlife and they should be able to do it from home." Watch the birds and their new eaglets on Audubon of Florida's web site.


• In Delray Beach, the sewage treatment plant added some native plants to its percolation ponds, built a boardwalk for visitors, and created a wildlife park replete with herons and large predators. Check out the photos from Peter and Sally's visit.


• 30 to 50 kilometers over Texas, but presumably launching from Cape Canaveral, there could soon be a giant banana floating in the sky in a geostationary orbit. But only if our space program can get its priorities straight. Visit www.geostationarybananaovertexas.com for more information. Judging from the project team, this actually appears to be an initiative of the Canadian space agency.
  
  If someone acts quickly, the domain name geostationarylycheeovermanitoba.com is still available for purchase. Who's going to step up for America to ensure that Canada doesn't win the geostationary-fruit-in-space race?

The Photo They Don't Want You to See

PS - This is the forbidden photograph of the inside of Plum Creek's "hospitality room" (read the previous post for the hilarious story behind it).


It looks innocent enough, but as I left I could have sworn I heard them start chanting in tongues. On my way down the hall I passed some shaved sheep that were being led back to the room I'd left. They were completely shaved and tattooed in unintelligible symbols that nevertheless filled me with a vague sense of dread. The weirdest thing was a few minutes later, downstairs in the big hearing room, when a big bloody mass of entrails just fell through the ceiling onto the LURC commissioners' desk. Probably just a freak accident.



Just kidding! Totally joking! Haha. You Plum Creek guys have a great sense of humor, you know?

Bizarre flying cubes in Prospect Park

Under the ruse of a movie shoot, a mysterious and well-organized cabal released these luminous cubes into the air above Prospect Park a few weeks ago. Vaguely evocative of the park's blinking fireflies, the cubes produced a pleasantly alluring psychological effect to attract dozens of curious bystanders.




The cubes began to advance northward, towards downtown Brooklyn and Manhattan beyond. But to what diabolical purpose? Perhaps they are behind the inexplicable fad of bottled water from Fiji.





In this last photograph (completely undoctored), a cube glows brightly as it prepares to suck in a cyclist. I made haste to arrange my own escape before I could document or witness the gruesome outcome.