Developments

1. Citigroup Inc has barred investors in its CSO Partners hedge fund from withdrawing their money, according to a Wall Street Journal report on Friday.

Citigroup suspended redemptions in CSO, a fund specialising in corporate debt, after investors tried to withdraw more than 30 percent of the fund's $500 million in assets, said the story.

CSO had an 11 percent loss last year, forcing Citigroup to inject $100 million to stabilise the fund, said the Journal.

2. SOME well-heeled investors got a big jolt from Goldman Sachs this week: Goldman, the most celebrated bank on Wall Street, refused to let them withdraw money from investments that they had considered as safe as cash.

The investments at issue are so-called auction-rate securities, instruments at the center of the latest squeeze in the credit markets.

Goldman, Lehman Brothers, Merrill Lynch and other banks have been telling investors the market for these securities is frozen — and so is their cash.

The banks typically pitch these securities to corporations and wealthy individuals as safe alternatives to cash, investors said. The bonds are, in fact, long-term securities. But the banks hold weekly or monthly auctions to set the interest rates and give holders the option of selling the securities.

Only this week almost 1,000 of these auctions failed. The banks also refused to support the auctions, leaving many investors wondering when they will get their money back.

“Investors have lost confidence in the liquidity of these instruments,” said G. David MacEwen, the chief investment officer for fixed income at American Century Investments, a mutual fund company. “These types of instruments depend on new investors showing up to own the securities.”

The $330 billion auction-rate market is dominated by municipalities and other tax-exempt institutions like the Port Authority of New York and New Jersey, which had issued some auction securities and had its interest rate soar to 20 percent on Wednesday. Closed-end mutual funds, student loan companies and corporations also issue such securities.

A failed auction does not mean the securities go into default, because the issuer continues to pay interest at the higher rate, or “fail rate.”

The market, however, has a troubled history. In 2006, the Securities and Exchange Commission reached a $13 million settlement with 15 investment banks, and the industry agreed to impose a voluntary code of conduct for the auction-rate market.

The S.E.C. investigation centered on how bidding was conducted for these securities. Critics complain that investment banks have the upper hand in bidding because they can bid after seeing what other investors have bid.

Brokerage firms are not legally obligated to make a market in auction securities, or give clients a price even if there is not one in the market. But clients who are unable to sell are likely to argue that they were wrongly put into long-term securities when their intention was to buy shorter-term debt.

“If these were pitched as cash equivalents, if that is what the broker said they were, the banks may be held responsible for losses and clients’ inability to get their money out,” said Jacob H. Zamansky, a securities lawyer who represents individual investors.

Goldman Sachs and Merrill Lynch declined to comment.

The situation is an awkward one for investment banks and brokers that have had to tell clients that their cash is frozen until at least the next auction — if not longer. One affluent New Jersey family has sued Lehman Brothers for the declining value of its cash in auction-rate securities. Lehman has said it acted properly.

Money managers, chief executives and individual investors have been swept up by the latest turmoil in the credit markets. One wealthy investor said Goldman Sachs had sold him auction-rate securities and had described the instruments as equivalent to cash.

“It’s a moral outrage,” said this investor, who asked not to be named because he still has to deal with the bank. “Their pitch was, keep your cash with us, we get a higher rate.”

This year, Bristol-Myers Squibb, the drug maker, took a $275 million write-off on money it had invested in auction-rate securities that it was unable to sell because of failed auctions.

Analysts say the biggest investors in auction-rate securities are individuals and corporations because money market funds cannot own the bonds. Many bond fund managers also shy away from the securities because of the uncertainty.

But the failed auctions do have one upside: the securities are resetting to rates that are far higher than those on other types of bonds.

Mr. MacEwen of American Century said his firm was considering buying auction-rate bonds for the first time because the rates have been reset to an attractive level.

“A lot of the municipalities or the closed-end funds that underlie this are high quality,” Mr. MacEwen said. “Whether its 20 percent or 5 percent, that looks like a good purchase if you are willing to forgo the liquidity.”

Not all auction-rate securities with failed auctions are resetting to very high rates. The penalty rates are governed by the terms of the bond, and in some cases they are tied to short-term interest rates like the London interbank offered rate, which has been falling for much of the year as the Federal Reserve has cut its benchmark interest rate.

Prison, USA

Since 9/11, and seemingly without the notice of most Americans, the federal government has assumed the authority to institute martial law, arrest a wide swath of dissidents (citizen and noncitizen alike), and detain people without legal or constitutional recourse in the event of "an emergency influx of immigrants in the U.S., or to support the rapid development of new programs."

Beginning in 1999, the government has entered into a series of single-bid contracts with Halliburton subsidiary Kellogg, Brown and Root (KBR) to build detention camps at undisclosed locations within the United States. The government has also contracted with several companies to build thousands of railcars, some reportedly equipped with shackles, ostensibly to transport detainees.

According to diplomat and author Peter Dale Scott, the KBR contract is part of a Homeland Security plan titled ENDGAME, which sets as its goal the removal of "all removable aliens" and "potential terrorists."

Fraud-busters such as Rep. Henry Waxman, D-Los Angeles, have complained about these contracts, saying that more taxpayer dollars should not go to taxpayer-gouging Halliburton. But the real question is: What kind of "new programs" require the construction and refurbishment of detention facilities in nearly every state of the union with the capacity to house perhaps millions of people?

Sect. 1042 of the 2007 National Defense Authorization Act (NDAA), "Use of the Armed Forces in Major Public Emergencies," gives the executive the power to invoke martial law. For the first time in more than a century, the president is now authorized to use the military in response to "a natural disaster, a disease outbreak, a terrorist attack or any other condition in which the President determines that domestic violence has occurred to the extent that state officials cannot maintain public order."

The Military Commissions Act of 2006, rammed through Congress just before the 2006 midterm elections, allows for the indefinite imprisonment of anyone who donates money to a charity that turns up on a list of "terrorist" organizations, or who speaks out against the government's policies. The law calls for secret trials for citizens and noncitizens alike.

Also in 2007, the White House quietly issued National Security Presidential Directive 51 (NSPD-51), to ensure "continuity of government" in the event of what the document vaguely calls a "catastrophic emergency." Should the president determine that such an emergency has occurred, he and he alone is empowered to do whatever he deems necessary to ensure "continuity of government." This could include everything from canceling elections to suspending the Constitution to launching a nuclear attack. Congress has yet to hold a single hearing on NSPD-51.

U.S. Rep. Jane Harman, D-Venice (Los Angeles County) has come up with a new way to expand the domestic "war on terror." Her Violent Radicalization and Homegrown Terrorism Prevention Act of 2007 (HR1955), which passed the House by the lopsided vote of 404-6, would set up a commission to "examine and report upon the facts and causes" of so-called violent radicalism and extremist ideology, then make legislative recommendations on combatting it.

According to commentary in the Baltimore Sun, Rep. Harman and her colleagues from both sides of the aisle believe the country faces a native brand of terrorism, and needs a commission with sweeping investigative power to combat it.

A clue as to where Harman's commission might be aiming is the Animal Enterprise Terrorism Act, a law that labels those who "engage in sit-ins, civil disobedience, trespass, or any other crime in the name of animal rights" as terrorists. Other groups in the crosshairs could be anti-abortion protesters, anti-tax agitators, immigration activists, environmentalists, peace demonstrators, Second Amendment rights supporters ... the list goes on and on. According to author Naomi Wolf, the National Counterterrorism Center holds the names of roughly 775,000 "terror suspects" with the number increasing by 20,000 per month.

What could the government be contemplating that leads it to make contingency plans to detain without recourse millions of its own citizens?

Cut-Off Big Oil; A Case Study

AFTER winning a new term as president by a landslide a year ago, Hugo Chávez decided that it would be a nifty idea to squeeze the remaining private oil companies operating in Venezuela. So he ordered the tearing up of the contracts they signed in the 1990s, under which they were investing to develop deposits of super-heavy crude. In their place would come joint ventures in which Petróleos de Venezuela (PDVSA), the state oil company, would wield the controlling share. A year on, however, one of the multinationals, Exxon Mobil, is fighting back. This has prompted Mr Chávez to complain that the United States is waging “economic warfare” against his country. But such fiery talk cannot disguise the fact that both he and PDVSA are in a swamp of trouble.

On February 7th Exxon announced that it had obtained interim court injunctions in the United States, Britain, the Netherlands and the Dutch Antilles preventing PDVSA from disposing of over $12 billion in assets. It had sought the freeze as a preventive measure, to ensure that PDVSA could pay Exxon's claim for compensation for the seizure of its operation in the Orinoco heavy-oil belt.

Several rivals accepted the government's new terms. Exxon, along with ConocoPhillips, another American firm, chose to invoke the arbitration clause in its contract (which had over two decades to run). More than the money, it is reputed to want to send a firm message to the world's resource nationalists. Or, as Venezuela's deputy oil minister, Bernard Mommer, put it, to “intimidate other producers”.

Such procedures grind slowly. The International Centre for the Settlement of Investment Disputes, a body linked to the World Bank, has yet to convene the panel that will hear the case. In parallel, and seemingly without PDVSA's knowledge, Exxon sought the court rulings. The Venezuelan government insists that the freeze applies directly only to one American bank account (with $315m) belonging to PDVSA. That ruling was upheld at a full hearing in New York on February 13th.

Mr Chávez responded, not for the first time, by threatening to halt oil exports to the United States. These run at around 1.2m barrels a day (b/d) and represent about three-quarters of Venezuela's total export earnings. Under Mr Chávez, Venezuela's economy has become heavily dependent on imports, especially of food. Few believe he can afford to implement his threat, and the oil price rose only slightly.

Not so PDVSA's bonds, whose value dipped sharply on investors' fears that lenders may face a higher risk of eventual default. On the face of things, that makes little sense. With around $100 billion in assets worldwide, including refineries in the United States, the Caribbean and Europe, PDVSA can easily pay any compensation award, which is unlikely to total more than $6 billion at most.

But there are many signs that the once-mighty PDVSA may be running short of cash. Since January 8th, for instance, its customers have been required to settle their bills eight days after shipment, rather than 30 days after receipt, as is customary. By the end of the month it was offering eight super-tanker loads of fuel oil at below market price for cash. In 2007 the company's debt burden rose from under $4 billion to over $16 billion. The uncertainty caused by the Exxon dispute means its borrowing costs may rise.

PDVSA is no longer just an oil producer. Mr Chávez has made it into what Elie Habalian, a former Venezuelan governor of the Organisation of Petroleum Exporting Countries (OPEC), calls a “parallel state”. The company has transferred billions of dollars to funds controlled by the president, and directly finances and runs a range of social projects. “There's a ministry of education—but PDVSA educates too,” says Mr Habalian. “There's a housing ministry, but PDVSA builds houses, and so on.” In response to shortages of basic foodstuffs, last month Mr Chávez ordered PDVSA to create a new subsidiary to distribute food, most of it imported.

At the same time, PDVSA's investment spending has been slashed, leading to a decline in oil output, the motor of the economy, for ten consecutive quarters, according to José Guerra, a former Central Bank director. A much-trumpeted government plan to increase oil production to 5m b/d by 2012 does not seem to have got off the ground. Officials claim that daily production is holding steady at over 3m barrels, but other sources (including OPEC) put the figure at less than 2.5m, and falling. Venezuelans use more oil themselves, thanks to a consumer boom and Mr Chávez's reluctance to raise the price of petrol. Officially, consumption is 600,000 b/d; it may be a third higher, reckons Ramón Espinaza, a former chief economist for PDVSA. Meanwhile, Mr Chávez is shipping 300,000 b/d to Caribbean neighbours (notably Cuba) at subsidised prices.

No important new deposits have been found since the president took office in 1999. Officials admit that PDVSA is short of drilling rigs for exploration (though Mr Chávez recently loaned two rigs to Ecuador). Much therefore hangs on the development of the Orinoco belt, with its estimated 250 billion barrels of heavy crude. But many of the companies recently invited (without competitive tender) to take part in these projects are state-owned outfits from countries, such as Iran and Belarus, whose governments are friends with Mr Chávez; most lack both the expertise and the financial muscle to develop them.

Several years of high and rising oil prices, along with PDVSA's policy of secrecy, have helped conceal its difficulties. With a slowing world economy making a further rise in the oil price unlikely in the short term, concealment will get harder. Waiting in the wings is ConocoPhillips, with a compensation demand much higher than that of Exxon. Venezuela's oil company will “fall apart the moment that prices drop to realistic levels,” Mr Habalian says. Unless he changes course, so might Mr Chávez's government.