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The Lords of Easy Money; How the Federal Reserve Broke the American Economy Christopher Leonard, 2022

<> <> <> <> Christopher Leonard

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Life at the zero bound pushes banks way down the yield curve. What does a bank have to lose? A risky bet beats nothing. And this is not just a side effect of keeping rates at zero, “That’s the whole point.” Hoenig (Tom Hoenig was the long time president of the Federal Reserve Bank of Kansas City) explained many years later. “The point was to get people willing to take greater risk, to get the economy started. But it also allocated resources. It allocates where that money goes.”…When cash is pushed out onto the yield curve, it leads to the second big problem that Hoenig warned about in 2010: something called an asset bubble. The housing market that collapsed in 2008 was an asset bubble. The dot-com stock market crash of 2000 was the bursting of an asset bubble.

One of his (Ben Bernanke) central ideas was that the Fed hadn’t acted boldly enough back in the 1930’s. The central bank had actually worsened the Depression by tightening the money supply, The solution, Bernanke believed, was to to be as aggressive as possible after a crash. He had spent many years thinking up new ways that the Fed could boost economic growth even after pushing interest rates to zero. He didn’t see the zero bound as an inviolable limit, but just another data point.

To execute quantitative easing, a trader at the New York Fed would call up one of the primary dealers, like JP Morgan Chase, and offer the buy $8 billion worth of Treasury bonds from the bank. JP Morgan would sell the Treasury bonds to the Fed trader. Then the Fed trader would hit a few keys and tell the Morgan banker to look inside their reserve account. Voila, the Fed had instantly created $8 billion out of thin air, in the reserve account, to complete the purchase. Morgan could, in turn, use this money to buy assets in the wider marketplace.

Starting in November (2010), the Fed traders did this transaction over and over again until they had created several hundred billion dollars inside the Wall Street reserve accounts…The primary dealers were not just selling the Treasury bills and mortgage bonds that they happened to have on hand…Instead the Fed set up a conveyor belt of sorts, which used the primary dealers as middlemen. The conveyor belt began outside the Fed, with hedge funds that were not primary dealers. These hedge funds could borrow money from a big bank, buy a Treasury bill, and then have a primary dealer sell that Treasury bill to the Fed for a profit. Once the conveyor belt was up and running, it began magically transforming bonds into cash. The cash didn’t stay safe and sound inside the reserve accounts of primary dealers. It started flowing out into the banking system, looking for a place to live.

He (Hoenig at the FOMC meeting in Sept. 2010) pointed out that the deep malaise in American economic life wasn’t caused by a a lack of lending from banks. The banks already had plenty of money to lend. The real problem lay outside the banking system, in the real economy where the deep problems were festering, problems that the Fed had no power to fix. Keeping interest rates at zero, and then pumping $600 billion of new money into the banking system–money that had nowhere to go but out into risky loans or financial speculation–wasn’t going to help solve the fundamental dysfunction of the American Economy.

During the 1980’s, Hoenig and his colleagues in Kansas City were left to sort out the long-term problems the Fed’s short-term thinking created during the 1970s. The biggest mess they cleaned up was the failure of Penn Square, a bank in Oklahoma that had extended a chain of risky energy loans during the 1970s. When Penn Square failed, it almost took down the entire U.S. banking system with it. It also illuminated a second important pattern that would harden in the coming years. The Fed didn’t just stoke asset bubbles. It found itself on the hook to bail out the very lenders who profited most off a bubble as it rose. Some banks, the Fed was about to discover, had grown too large and too interconnected to fail.

Around 2014 or 2015, (Vicki) Bryan (corporate analyst) noticed that she could bring new revelations (about corporate misbehavior) to the market, but it didn’t seem to matter anymore. “It’s been a result of what the Fed stated to do in 2010, and continued to do later,” she said. “You’ve got an artificial bottom, and the higher part of that bottom is set by the Fed. So you can’t lose in this market. And if you can’t lose, it’s not really a market,” Bryan said.

In 2008, the market imploded thanks to an exotic debt product called the collateralized debt obligation, or CDO. The CDO was a package of home loans (or derivatives contracts based on home loans) stacked together and sold to investors. The CDO made the housing crash possible by creating a seamless assembly line that allowed mortgage brokers to create risky subprime home loans that were quickly packaged and sold to investors, which in turn allowed the mortgage brokers to extend yet more new loans. At that time, the lowly CLO (collateralized loan obligation) was the undernoticed stepchild of the debt markets. There were only about $300 billion worth of CLOs during the Global Financial Crisis of 2008, while in 2006 alone about $1.1 trillion of new CDOs were issued. But the important thing about CLOs was that they didn’t suffer nearly the losses that CDOs suffered.

The pension funds had been settling on a low return from safe corporate bonds, because those bonds were standardized…The bonds were regulated by the SEC and traded on exchanges…The CLO solved this problem. It would standardize leverage loans in ways that make the pension funds feel safe…This meant that a pension could order CLO chunks,…picking between the AAA, mezzanine, and equity slices of the package.

Financial engineering was key to Rexnord’s strategy. Rexnord, like any corporation, responded to the environment in which it operated. And that environment, starting in 2012, was dominated by the influence of ZIRP (zero-interest-rate-policy)…The management team’s biggest maneuvers had to do with leveraged loans and rising stock prices rather than conveyor belts or ball bearings…He (Rexnord employee John Feltner) believed,…that a job at Rexnord might provide him a narrow pathway to a stable middle-class life. All the financial engineering encourage by ZIRP was supposed to make that belief come true. The company owed $1.9 billion and it paid $88 million on interest costs in 2015, which was more than the $84 million it earned in profits…in 2015 Rexnord’s board of directors authorized Adams and his team to buy back $200 million in stock. In 2016, the company bought back $40 million of its own stock. In 2020, the company …bought back another $81 million…In 2016, he (Adams) was paid $1.5 million but the following year he was paid $12 million, mostly in stock awards, and in 2018 he would earn $6 million.

But Rexnord’s stock buybacks were seen by the Fed, as a means to an end. It was OK if CEOs used debt to help engineer multimillion-dollar paydays, as long as the prosperity was eventually dispersed through the “wealth effect” (Cosmic Lie) to neighborhoods like the Feltners’…Rexnord had decided to close the ball-bearing factory and move its production to Monterrey, Mexico. (Feltner lost his job.)

By the end of 2018, the U.S. market for CLOs was about $600 billion double the level a decade earlier…The value of the Dow Jones Industrial Average rose by 77 percent between 2010 and 2016. One hedge-fund trader…described the frothy stock market of 2016 as being like the crowded deck of the the Titanic as it sank…It was getting crowded because people had nowhere better to go.

This money flowed out into the system, and it pushed all the major financial institutions to search for yield. Many wall street traders saw clearly what was happening, and they developed a nickname for it: “the everything bubble.”

By 2016, they (negative interest bonds) accounted for 29 percent of all global debt. About $7 trillion worth of bonds carried negative rates…Bond investors were so desperate to find a safe haven for their cash that they willing to pay a fee to governments like those of German and Denmark to safeguard it.

Hoenig said “You had seven years of basically zero-interest rates. Now what happens in an economic system over seven years. The entire market system develops a new equilibrium–around a zero rate. An entire economic system. Around a zero rate. Not only in the U.S. but globally. It’s massive. Now think of the adjustment process to a new equilibrium at a higher rate. Do you think it’s costless? Do you think no one will suffer? Do you think there won’t be winners and losers?”

Excess bank reserves were about 135,000 percent higher than they had been in 2008. The Fed’s balance sheet was about $4.5 trillion, about five times its level in 2007. Interest rates had been pinned at zero for nearly seven years.

In response to the 2020 Covid epidemic, congress passed the CARES act worth $2 trillion in relief funds:

People who owned businesses were given tax breaks worth $135 billion, meaning that about 43,000 people who earned more than $1 million a year each got a benefit worth $1.6 million. By and large, these billions of dollars were quietly absorbed into corporate treasuries and personal bank accounts around the county. The wildly unequal distribution of money was not made public until months later, after The Washington Post won an open-records lawsuit that made the information public.

The market hit its low point in mid-March, when the Treasury market collapsed. But between that day and middle of June–in just three months–the market’s value surged by 35 percent. By then, stocks were trading at the same value they had when restaurants, movie theaters, hotels, and cruise ships were operating at full capacity. The average monthly returns on leveraged loans were restored as early as April. By August, so many new investment-grade bonds were issued that the previous record, set in 2017, was broken.

The bailout of 2020–the largest expenditure of American public resources since WWII–solidified and entrenched an economic regime that had been quietly and steadily constructed, largely by the Federal Reserve, during the previous decade. The resources from this bailout went largely to the entities that were strengthened by the policies of ZIRP and QE. It went to large corporations that used borrowed money to buy out their competitors. It went to the very richest of Americans who owned the vast majority of assets; it went to the riskiest of financial speculators on Wall Street, who used borrowed money to build fragile positions in global markets; and it went to the very largest U.S. banks, whose bigness and inability to fail was now an article of faith.

And all of this happened at a moment when Americans were more distracted, more beleaguered, and more financially distressed than at any moment in modern history. It was difficult to even comprehend the impact of what had happened. But the impact would make itself visible in the months, years, and likely decades to come.

By the end of 2020, companies issued more than $1.9 trillion in new corporate debt, beating the previous record that was set in 2017…A zombie company was a firm that carried so much debt that its profits weren’t enough to cover its loan costs. The only thing that kept zombie companies out of bankruptcy was the ability to roll their debt perpetually. During 2020, nearly two hundred major publicly traded companies entered the ranks of the zombie army…These weren’t just marginal or risky firms, but included well-known firms like Boeing, ExxonMobil, Macy’s, and Delta Airlines.

In many important ways, the financial crash of 2008 had never ended. It was a long crash that crippled the economy for years. The problems that caused it went almost entirely unsolved. And this financial crash was compounded by a long crash in the strength of America’s democratic institutions. When America relied on the Federal Reserve to address its economic problems, it relied on a deeply flawed tool. All the Fed’s money only widened the distance between America’s winners and losers and laid the foundation for more instability. This fragile financial system was wrecked by the pandemic and in response the Fed created yet more new money, amplifying earlier distortions. The long crash of 2008 had evolved into the long crash of 2020. The bills had yet to be paid.

Christopher Leonard is also the author of Kochland

The New Climate War: The Fight To Take Back Our Planet, Michael E. Mann, 2021

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Mann has devoted much of his professional life and focus in an effort to educate the public about climate change. His role model was Carl Sagan who had a remarkable ability to communicate complex science to ordinary people.
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Mann, Bradley and Hughes 1998 Hockey Stick Chart

How quickly are temperatures rising?

The true warming rate is about 0.2%C per decade. Since current warming stands at about 1.2%C, it would at current rates take a decade and a half to reach 1.5%C warming, and another two and a half decades to reach 2%C warming.

Without CO2 reductions, we would expect a rise of 1.5%C by 2035 and of 2%C by 2060.

Researchers believe renewables can be scaled up to meet 80% of global energy needs in ten years and 100% in thirty years. Clearly that last 20% which would include air travel and other hard to solve problems will take time and research.
Guardian’s Fiona Harvey:

investments amounting to trillions of dollars (estimated 1 to 4 trillion) in fossil fuels–coal mines, oil wells, power stations, conventional vehicles–will lose their value when the world moves decisively to a low-carbon economy. Fossil Fuel reserves and production facilities will become stranded assets, having absorbed capital but unable to be used to make a profit…If the bubble bursts suddenly, as it might, rather than gradually deflating over decades, then it could trigger a financial crisis.

Banks are already reducing their investments and many University endowments are pulling their funds out under pressure from their students.

Why look at non solutions when a solution is in hand. Solar costs about $50, wind $30-$40, and nuclear $100 per megawatt hour. Fossil fuels cost about $50. If fossil fuel subsidies were removed and a carbon tax were added to reflect the real cost of CO2 emissions, the cost of fossil fuels would rise dramatically.

One group of climate experts has in fact published a set of “concrete interventions to induce positive social tipping dynamics.” They propose as key ingredients, “removing fossil-fuel subsidies and incentivizing decentralized energy generation, building carbon neutral cities, divesting from assets linked to fossil fuels, revealing the moral implications of fossil fuels, strengthening climate education and engagement, and disclosing greenhouse gas emissions information.

Air travel is often sited as a way to reduce CO2 but air travel accounts for about 3% of global carbon emissions. if everything is taken into account, travel by train can have an even higher carbon footprint than air travel.

We know that we can eliminate most CO2 emissions by converting to renewable sources of energy like solar, wind, geothermal, etc. Those who wish to continue to rely on fossil fuels for energy often propose “non-solution solutions” as a deflection tactic.

DEFLECTION DELAYISM
The most common of these is “clean coal” using carbon capture and sequestration (CCS). Global CCS Institute reports 51 facilities globally are under development. When fully deployed they would collectively capture nearly 100 million tons of C02 annually. We emit about 40 billion tons of CO2 annually so 100 million tons would represent about 0.25% of total emissions. It will take decades (which we don’t have) to determine the actual amount of CO2 that has been captured and stored successfully. Coal generators are rapidly being phased out. CCS is not a solution.

There has been much talk of geoengineering and Bill Gates has hired geoengineers to look into shooting reflective particles, sulfate aerosols into the stable upper part of the atmosphere. This is feasible and a muti-billionaire like Gates might even be able to try it without government assistance or approval. The big problem is “we don’t know what we don’t know.” Would Ozone layer destruction accelerate? Would polar ice melt faster? Would the sulfur falling back to earth result in catastrophic acid rain? If we don’t sustain the layer with continuous injections the earth’s temperature would rise suddenly. The danger here is not only from billionaires but from other countries that might attempt to solve their own problems without regard for the rest of the world. And we already have a known solution – renewable energy – so why even look at such a crazy unproven idea with huge unknown risks to the entire planet?

Reforestation sounds promising but at best, combined with modified agricultural practices, at absolute most 20 billion tons of CO2 could be captured or 50% of our current emissions. It would take decades to reach these levels of CO2 removal and meanwhile we would continue to increase emissions every year. We already have a real and proven solution, renewables, that can be implemented now so why focus on this. Reforestation and agricultural reform are important and should be undertaken but they are not a solution to our immediate CO2 problem.

Then there is the nuclear power option, forgetting the meltdowns at Three Mile Island, Chernobyl, and Fukushima. Nuclear cost is double that of renewables. Mann suggests we leave existing nuclear plants operational since the investment has already been made until they are decommissioned at the end of their useful lives, hoping they continue to have access to adequate cooling water and avoid other accidents. Building new Nuclear plants would also take far too long to displace existing fossil fuels.

Much of this important book is dedicated to educating the public in the tactics developed by monopolistic companies whose products are harmful in attempts to convince the public otherwise. These tactics no doubt originated in the 19th Century but came to public awareness over the dangers of tobacco, plastic trash, chemicals like DDT, CFC refrigerant destroying the ozone layer, Roundup, etc., Fossil Fuels and CO2 levels, etc. The playbook was even attempted for COVID-19 because the pandemic posed a threat to companies wanting business as usual (Urging us to take one (die) for the sake of the economy). The successes of these campaigns is due to the enormous resources available to these companies, their willingness to sponsor fake research (Koch and Mercer), their control over messaging and media (Fox WSJ, the petrostates led by Russia and Saudi Arabia), and exploiting the ignorance of the public about science and research (disinformation). Who does the powerful global fossil fuel industry most fear? Greta Thunberg and the international climate youth movement. Mainstream media is notorious for failing to report on climate change. Young climate activists have succeed in making the front page of major newspapers around the world, something climate scientists have been unable to do. As Bob Dylan would say “The times they are a changin”.
Stephan Schmidt, former presidential campaign co-advisor to McCain tweeted about the COVID-19 campaign “The injury done to America and the public good by Fox News and the bevy of personalities from Limbaugh to Ingraham will be felt for many years in this country as we deal with the death and economic damage that didn’t have to be.”

The Coronavirus crisis, in fact, underscored the importance of government. The need for an organized and effective response to a crisis, after all, one of the fundamental reasons we have governments in the first place. Crises, whether in the near term like COVID-19 or in the long term like climate change, remind us that government has an obligation to protect the welfare of its citizens by providing aid, organizing an appropriate crisis response, alleviating economic disruption, and maintaining a functioning social safety net.

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The book includes discussions of social media and the role of bots and troll bots, artificially generated internet postings with the ability to automatically analyze real people’s postings and create artificial responses. So then bot sentinel is created that uses machine learning and artificial intelligence to classify accounts and their postings as being the creation of bots and trollbots and to automatically generate a trollbot score for the likelihood that the the account is automated. This is not a fictional dystopian world. Users of social media are facing this mad world of bots where it may be impossible to know if you are having a conversation with a machine or a person. Imagine an entire discussion thread generated completely by warring bots with no actual human participation. Forget annoying automated phone calls. This is total out-of-control madness.

Kochland; The Secret History of Koch Industries and Corporate Power in America, Christopher Leonard, 2019

The Fred C. Koch Family
Fred C. Koch died Nov 17, 1967 Mary R. Koch died December 21, 1990 Charles Koch died Aug 23,2019.

Charles Koch

In a 1974 speech (Charles) Koch attacked the entire narrative behind the New Deal (based on Keynesian Economics), claiming that Roosevelt’s legislation was not, in fact, in response to a lack of federal-level regulation. Koch said that when the New Deal was passed, the economy was already “polluted by massive governmental manipulations of the money supply.”…The business community needed to wage a long-term campaign that would change the way Americans thought about the markets and the role of government (Hayek, Mises, Friedman). Koch said that the campaign should have four elements; 1) Education; 2) Media outreach; 3) Litigation; and 4) Political Influence.

David and Charles Koch

Based on his long term vision, Koch founded the Cato Institute, contributed to the Heritage Foundation and other right wing think tanks; rebuilt the law and economics departments of George Mason University near Washington in the image of the Chicago school, and created the Mercatus Center another free market think tank. This center offered free seminars to more than 4,000 federal judges from all 50 states. Koch was central to the creation of ALEC, the American Legislative Exchange Council, which writes right wing laws and pressures state legislatures to pass them. Koch is behind the Americans for Prosperity lobby that was central to defeat of the Obama era cap and trade legislation in 2010, the only serious effort by congress to limit carbon emissions. In the 2010 midterm election, the Republicans gained control of the house and senate, in large part due to the emergence of tea party candidates and Koch’s Americans for Prosperity efforts.

David and Charles Koch

Koch Industries was to benefit enormously from Federal Action, particularly from the Clean Air Act of 1970. Refineries already operating in 1970 (Koch had two) were “grandfathered” in to the era of clean air regulation. The unintended consequence of this legislation was to halt the construction of new refineries, assuring that no new competition would enter the business. Existing refinery owners immediately started gaming the act; for example companies could be exempted if curbing pollution would be unreasonably expensive. This assured that new technologies would never be implemented in the existing refineries. The EPA was to enforce the New Source Review program which prohibited new refineries from entering the game. The last refinery built in the US was completed in 1977. The EPA needed to rely on state regulators to enforce the New Source Review and these state regulators were simply outgunned and overwhelmed by the giant refinery corporations. Koch’s two refineries were able to increase their capacity more than ten fold and were able to introduce new outputs and products at will. Much of this expansion was achieved without first obtaining permits that would have limited pollution from the plants. Koch refused to invest in suggested new pollution control measures.

Pine Bend Refinery Rosemount, Minnesota

In mid 1996 a sour water stripper that limits the amount of ammonia that was pumped into the wastewater treatment plant ceased operating properly. Repairing the stripper would require shutting down the refiner which Koch refused to do. Instead Koch flushed the ammonia rich waste into large detention pools on the far end of the refinery. When these filled they began spraying the contaminated water onto the surrounding wetlands and fields. In January 1997, Heather Faragher, The only employee trained in waste water management at Koch’s refinery but without the authority make changes at the refinery, told the Minnesota Pollution Control Agency, which was responsible for enforcing federal EPA standards, everything that Koch had been doing at the refinery. in 1998 the MPCA fined Koch $6.9 million for pollution. Federal criminal charges in 1999 resulted in a criminal fine of $6 million, $2 million to the County Park system. Koch also agreed to pay the EPA a $3.5 million fine. Similar events happened at Koch’s Texas refinery, causing Charles Koch to initiate a new program to assure that Koch was in compliance with all state and federal regulations (100% compliance, 100% of the time). He hired a group of regulatory compliance attorneys locating them at company headquarters in Wichita Kansas with the authority to force all company divisions to comply with regulations and with the authority to shut facilities down if necessary. He was driven to this measure to avoid future big fines, to protect Koch’s now tarnished reputation, and to prevent state and federal officials from inspecting and investigating his operations. Privacy and secrecy are Charles Koch’s highest priorities.

A big disappointment in this 600 page book is the failure to address the extent to which Koch benefits financially from direct government subsidies. The topic receives one short mention with no figures of the scale of corporate welfare or crony capitalism enjoyed by Koch. Charles Koch often speaks about his opposition to government subsidies but there is no evidence in this book that Koch has ever turned down a single subsidy. The book does mention that fracking was developed largely due to government subsidies and Koch indirectly benefited as fracking increased the production of oil and natural gas so that the US is now energy independent. One would dearly love to know the extent to which Koch’s remarkable success was due to direct government subsidies.

The fossil fuel industry has always depended on trading, the buying of crude oil, natural gas, etc. and on selling refined or manufactured products. Historically this trade has not been done using established commodity markets. Koch established a separate trading division located in Houston. Charles Koch insisted that his traders have the best available information including the best weather forecasts. Koch invested heavily in computers and developed elaborate models of the relevant markets. Central to the success of Koch trading was the availability of inside industry information which can be used freely and legally in Koch’s markets. Market volatility is what drives profits in trading and Koch’s traders became expert in exploiting volatility. In the cold winter of 2000, one trader placed large bets on the volatility of natural gas prices and earned Koch $75 million. The trader’s base salary was $60,000 and he earned $4 million in a bonus. Koch keeps a close leash on its traders and knows on a day to day basis company exposure to its trader’s bets. Unlike banks, wall street firms and insurance companies, Koch has never experienced unexpected losses from a rogue trader. In 2000, as Clinton was leaving office, his administration passed the Commodity Futures Modernization Act, leaving the market for derivatives unregulated and in the dark. Thus Clinton set the stage for the 2008 subprime mortgage crisis. This book explores how fossil fuel industry traders quickly learned and adapted to this new age of unregulated financialization. We think of Wall Street, the banks, and the insurance companies, but the fossil fuel industry reaped enormous profits from exotic and dark trades.

How Koch Became an Oil Speculator Powerhouse

Companies like Enron and Koch all engaged in illegal trading activity, best exemplified by California’s electric utility deregulation fiasco that started in 2000. ALEC was instrumental in getting the disastrous neoliberal bill passed in 1998. The New Deal Era public utilities system for electrical power was replaced by a radical new system. The existing utilities retained their geographic monopolies with set maximum electric rates, but they were stripped of their generators. Power generation was privatized and the utilities were required to buy power on a daily basis. An emergency state agency was created to buy electricity when the markets failed. A massive daily trading system emerged. The new system was quickly overrun by unusually hot weather. The scale of Koch’s illegal trading activities in California electric power were dwarfed by the scale of Enron and other huge energy companies and largely escaped being tarnished further by its illegal trading. Charles Koch’s 100% compliance order somehow did not include the trading division. Enron’s fraud and illegal activities forced it out of business in 2007.

California Electricity Crisis of 2000-2001

Charles Koch was a keen student of the latest management theories. Early in his career, he adopted the teaching of Edward Deming who revolutionized Japanese manufacturing practices after WWII. His typical management hire was a young graduate of a midwestern university often with an engineering degree and often someone raised on a farm with midwestern work habits. Charles Koch believed he could educate the young graduates to his philosophy and new hires spent hours in seminars and training. The new hire would then be assigned a job and his performance closely watched. If he was successful, he would then be reassigned to another position that might be totally alien to the experience and training of the employee. They might find themselves moved from a refinery to a trading desk where a whole new set of skills is required. If successful there, the employee might be moved to another position, maybe in fertilizer or pipelines or most anything. If the employee does not succeed in their new assignment they are terminated from Koch. Its a bit like the father that throws his child in the deep water to see if they sink or swim. In spite of this style of management, employees at Koch, if they succeed, seem extremely loyal to Charles Koch and enjoy long careers. In 1969, two years after Charles Koch became CEO, Laurence J. Peter published a book describing what became known as the Peter Principal. Organizations continue to promote their workers until they reach a point where they are no longer able to successfully perform the functions required by their position. This book makes no mention of the Peter Principal but Charles Koch, whether he knew the principal or not, seemed to embrace it and used advancement within Koch to test and challenge his employees until they break at which point they are removed.

In 1987, an investigative report published in the Arizona Republic charged that the oil companies were stealing oil from native American reservation oil fields. Several US Senators got interested and the largest oil companies told them to look at Koch. The Senators got an FBI agent assigned to investigate and he started observing Koch trucks and gaugers as they pumped oil from the field tanks to their trucks, measuring the amount of oil taken using gauge sticks inserted into the field tanks before and after the pumping. The drivers would record the amount of oil taken and leave a ticket at the site. This ticket determined what Koch owed for the oil taken. When the truck was emptied at its destination an accurate measure of the oil taken could be obtained. The work of the guagers is only approximate and Koch trained the drivers never to be short, i.e. never to have the oil actually delivered be less then the ticket left at the site. To be short meant an immediate termination. The drivers were never instructed to steal oil, they were instructed never to deliver less oil than Koch was obligated to pay for. The obvious and only was to assure that they were not short was to always be long. The Senate passed the investigation to the Justice Department which made Koch hand over its records for three years. In each of these years Koch received an average of 400,000 Barrels of oil per year worth about $10 million that they didn’t pay for. The Justice Dept. didn’t want to charge individual drivers but thought it would be difficult to charge the top executives for the theft. The case did go to trial and was settled for an undisclosed amount. There was bad publicity for Koch but no lasting consequence. This is just another example of Koch pushing beyond the limits of legal and normally understood ethical behavior.

Additional Details on Oil Theft from Christopher Leonard

Two sections of the book deal with Koch treatment of unions, first the union at the Minnesota refinery, and second the Georgia Pacific division unions. The stories are different but similar. Koch refuses to negotiate, changes the work rules, slowly squeezes wages, moves union pensions to 401K s and interferes with health care programs. It is pretty miserable to work a union job at Koch but the alternatives are worse. Charles Koch’s toughness is illustrated by his reaction to a union strike at the Pine Bend refinery in Minnesota, which in 1970 was still a strong union state. Charles Koch hired a Texas oilman whose hero was George Patton to run the refinery. When the workers voted to go on strike, he hired enough non union workers to keep the refinery running and flew them on site by helicopter. The skeletal crew lived on site with their boss. When the teamsters refused to cross the picket line, Koch negotiated a deal whereby Koch drivers would replace the teamsters for the drive through the picket line, load the truck, and return it to the teamster driver. When the strike extended, Koch built a separate road entrance bypassing the picket line and convinced the teamsters to drive their trucks through the new entrance. For specialized maintenance requiring workers from other unions, Koch eventually convinced them to make repairs in spite of the strike. In this way the refinery union was slowly isolated and weakened. They eventually settled on Koch’s original terms, but after losing more than a year of wages.

Georgia Pacific’s plants and warehouses were subjected to modern software systems designed to increase worker productivity. This increased productivity was accompanied by a corresponding increase in injuries, some of them fatal. These injuries would result in OSHA investigations and modest fines, but any government interventions were anathema in Koch’s culture. While trying their best to prevent injuries, the numbers stayed stubbornly high. Stressed employees will make mistakes and the only solution is to decrease the pressure. On the contrary Koch would fire employees that were considered too cautious and careful because that meant they worked slower. Had the OSHA fines been in the millions, I have no doubt Koch would have figured things out to reduce or eliminate injuries.

Koch created a Value Creation Group but this got subdivided and one of the subdivisions was Koch Agriculture. Koch had virtually no experience in agribusiness volatility. In 1997 Koch saw an opportunity to buy century old Purina Mills headquartered in nearby St. Louis. The problem with private equity acquisitions is that is drew Koch into businesses where it had no expertise. They agreed to pay $670 million for a company worth $109 million. Koch borrowed $570 million and put up $100 million of its own money for the purchase. Koch tried to impose the Koch culture on a company with its own very different and well established culture with the result that key employees left the company in droves. Due diligence failed to uncover massive contracts between Purina and hog feedlots which required Purina to produce piglets that the feedlots were under contract to buy and grow using Purina food. When the hog market imploded, the feedlots defaulted on their contracts (that Koch didn’t know existed) and Purina was forced into bankruptcy. Purina and the creditors lawyers believed the Koch corporate veil that was supposed to protect the holding company, was flawed, and Koch was forced to settle by putting up another $60 million in cash to get rid of Purina. Charles Koch fired everyone associated with this disaster and closed the entire acquisitions division.

Koch began a complete reorganization of the business in 1999. Over the years Koch had acquired a wide hodgepodge of unrelated businesses. Koch unloaded many of its pipelines, sold a small chemical company and other odds and ends. At the core of the new structure, Koch Petroleum was rename Flint Hills Resources. Others were simplified and reorganized into Koch Minerals, Koch Supply & Trading, and Koch Chemical Technology Group. New leaders were appointed to run these consolidated businesses. Koch Industries became little more than a holding company protected by a legally impenetrable veil to protect it from problems in its divisions. Charles Koch also finally put to rest the 20 year long legal feud with brother Bill and could totally focus on growing Koch. Koch’s spectacular growth after 2000 was the result of operating one of the largest private equity operations in the country. Private equity finds distressed public companies that can be purchased cheap, converted from publicly traded or coop into privately held companies. Charles Koch from the beginning wanted his company to remain private, to operate in secret, and to forego dividends in favor of reinvesting profits to grow the business. He was proving that he could learn fast from past mistakes, correct them mercilessly and move on. He initiated his “10,000 percent compliance” program discussed earlier at this time to keep the government and regulators off his back. Clinton ushered in the age of financialization in 2000 and George W Bush from Texas and Dick Cheney entered the White House. Koch was set for a decade of spectacular growth.

In 2003, Farmland a depression era coop headquartered in Kansas City wanted to sell a group of liquid nitrogen fertilizer plants all located close to their midwest farm customers. The most expensive component, at 80% in the production of liquid nitrogen is natural gas and domestic natural gas was very expensive. Lower cost imported fertilizer had undermined Farmland’s market. Koch had inside information that fracking was about create a vast increase in the supply of natural gas and prices would plummet. This purchase would mean a significant reentry into agribusiness and the acquisition team didn’t know if Charles Koch was ready to forget the Purina experience but he fully backed acquisition. Natural gas prices plunged and the fertilizer plants became immediately profitable.

Also in 2003 Georgia Pacific approached Koch to see if they were interested in purchasing several struggling pulp mills in Georgia and Washington – Oregon. The mills came with several unionized warehouses for the mill’s products. When the Koch team visited Georgia Pacific’s Atlanta headquarters (51 stories tall) they saw a bloated, hyper luxurious operation. At the same time DuPont came on the market. Overall, Koch was looking at corporate takeovers worth more than $25 billion. Koch acquired both DuPont’s Invista for $4.4 billion and Georgia Pacific for $21 billion. Charles Koch had always disliked borrowing, but borrowing is the foundation of the private equity business. Find an under performing company with lots of cash flow and buy it with borrowed money. Make sure the holding company is protected from the creditors, turn the companies around and use the resulting cash flows to repay the loans. Koch was now willing to borrow seemingly unlimited money to fuel its acquisition appetites. Both DuPont and Georgia Pacific were heavily dependent on the building of new housing which was a hot market right up to the sub prime mortgage crash of 2008. Charles Koch did not panic but scaled back operations at all affected acquisitions and waited to weather the downturn storm.

June 29, 2012 (Reuters) – DuPont Co has settled a $745 million lawsuit brought by Koch Industries Inc’s Invista unit over safety and environmental problems at plants once owned by the large chemical company.

How The Kochs Are Fracking America

The crash of 2008 made fracking economically viable and the supply of natural gas exploded. Then drillers in North Dakota applied fracking to crude oil successfully for the first time. There was an area called the Eagle Ford Shale region near Corpus Christi where Koch’s second light crude refinery was located. Koch’s planners decided on a plan to build pipelines between Eagle Ford and Corpus Christi and to buy and build a ship slip to export any excess crude oil. Charles Koch embraced the plan immediately and only wanted to assure the plans were big enough. Oil from fracking start to flow in 2010 when by the end of the year 139,000 barrels a day were being produced. By 2014 production hit 1.68 million barrels a day roughly 20% of all crude oil produced in the US that year. Because the 1970 Clean Air Act effectively prevented the building of new refineries, Koch’s Corpus Christi refinery enjoyed enormous profits from the newly available light crude.

Koch Brothers War on Renewable Energy

Through this same period the Kochs focused their political attention on fighting renewal energy initiatives at the state level (ALEC), fighting any carbon restrictions at the state and federal level, and rolling back CAFE auto efficiency standards. Charles Koch and his company became much more visible as a result of these massive anti environmental efforts and he started experiencing demonstrations at his gatherings and now requires constant security protection. Gone were the days when Charles could drive his modest old station wagon from the family home to Koch headquarters.