The New Yorker Radio Hour - After the 2008 Financial Crisis, the Economy Was Fracked Up

Episode Date: November 13, 2018

The American Recovery and Reinvestment Act injected almost nine hundred billion dollars into the U.S. economy to help the nation recover from the 2008 financial crisis. Ninety billion dollars went to clean energy, with the intention of jump-starting a new “green economy” to replace aging fossil-fuel technologies. Instead, the bill may have done the opposite. Low interest rates, which made borrowing easier, encouraged a flood of financing for the young fracking industry, which used novel chemical techniques to extract gas and oil.  Fracking boomed, and made the U.S. the leading producer of oil and gas by some estimates. The financial journalist Bethany McLean and the investor and hedge-fund manager Jim Chanos tell The New Yorker’s Eliza Griswold that something in the fracking math doesn’t add up. If interest rates rise, reducing the flow of cheap capital, they believe that the industry will collapse.   Then, the former Treasury Secretary Hank Paulson tells Adam Davidson what went wrong in Obama’s policy. Subsidies for specific industries, like solar, can’t change the market significantly enough, Paulson says. In his view—one shared by a growing consensus of economists—we need to correctly assess the costs of carbon emissions to society, and charge those costs to the emissions’ producers: a carbon tax. Then, with a more level playing field, the market can pick the best source of energy.   New Yorker Radio Hour listeners, we want to hear from you.  We have a few questions about the show and how you listen to it. The survey takes about twenty minutes, and your feedback will help us make our podcast better.  Take the survey here.

From One World Trade Center in Manhattan, this is the New Yorker Radio Hour, a co-production of the New Yorker and WNYC Studios. Welcome to The New Yorker Radio Hour. I'm David Remner. In some parts of the country right now, that sound, hydraulic drills and compressors used in fracking is a constant presence. In Texas, the Dakotas, Pennsylvania, and other places, too, fracking has given us an energy boom. It's made the U.S. into the world's leading producer of oil and oil. and gas by some estimates. Fracking, of course, has been controversial. It creates a lot of methane, which is a greenhouse gas. It's been blamed for poisoning water tables and other environmental consequences. Eliza Griswold's been writing a lot on the fracking industry, and she's discovered

that it's controversial in other ways as well. Here's Eliza. I've been looking into fracking for seven years. I've been in people's farms and in their backyards, looking at the human costs of America's energy boom. One of the things about fracking that has always been true is that for the companies, it's very expensive. The key ingredient in fracking isn't so much chemicals as it is capital. It's an extraordinarily expensive proposition. That's Bethany McLean. She's a financial journalist who brought down Enron, and she's written a new book, Saudi America. One of Bethany's key insights is that fracking wouldn't have been possible without the 2008 financial crisis. What happened is that the Federal Reserve lowered interest rates dramatically.

And that made borrowing money very cheap. That meant companies could raise money hand over fist, and fracking companies, many of which weren't really turning a profit, were suddenly a wash in cash just because the cost of borrowing money was so low. Jim Channos, a very well-known hedge fund manager, agrees that this was the moment critical to the industry. There was no way this would have happened on the scale of it had. without Wall Street embracing it and willingly providing capital to this industry. Growth in this industry has been remarkable.

Tens of thousands of wells have gone in all over the country. Hundreds of thousands of miles of pipeline crisscross the landscape. If you look at all of this infrastructure that has sprung up as a result of easy money, you could say that fracking is a monument to the 2008 financial crisis. So I met with Bethany and Jim, not at some rural well site, but where the action really happens in a swank office in Midtown Manhattan. So fracking was initially sold as an environmental positive, that it would be a bridge fuel to cleaner energy economy. Did that turn out to be the case? So I think it's complicated.

I think natural gas, there's some arguments that it is a cleaner fuel because of the, because it's replacing coal and thereby lowering carbon. emissions. But as the frackers produce so much natural gas that they totally crushed the price of natural gas, they instead switched to oil. And so most of the value in fracking or most of what people think about with fracking today is not so much natural gas. It's actually oil. As Bethany points out, the frackers have been so successful in producing natural gas prices that they collapse at the price. And so it is very cheap. And a lot of it's just simply flared off these days, not even used. So a crisis is always an opening for new ways of thinking.

And Jim, where did you and others of your contemporaries, where did your associates see opportunities after the crash in energy? So I began to educate myself and my team here on the economics of fracking and how it was different from, say, the integrated oil business. When Exxon would drill a deep well after a lot of testing, they were pretty certain. that if they said the well had probably a 20 to 40 year life, it probably had a 20 to 40 year life. And that once the well was drilled, it was annual maintenance and worker salaries, whatever, to keep the rig going, it was different in the fracking. There, because the nature of the technology, the energy was released at the front end of your drilling process and then declined rapidly.

it meant that you had to keep putting more and more money in to keep your production even steady. So, Jim, you started seeing flaws in the numbers in 2010. We were starting to see evidence in Chesapeake and some of the others, the earlier frackers, that if you just did some calculations and you realized how much money they were reinvesting back in the business, it should have yielded even more production than it was. And so what it meant to us basically was, was that they were, overstating profits. And so it had this vicious cycle because what happened was money flooded in, not only because of the Federal Reserve's easy policy, but because the companies looked better than

they really were. They've managed to convince Wall Street, typically on the back of a lot of debt raised, that 2 plus 2 is 5. And Wall Street loves that equation. The most famous example from that is actually before the crisis. It's from the bankruptcy of Worldcom back in the early 2000s. And the WorldCom scandal essentially was WorldCom taking all of the costs that should have been running through its income statement and figuring out ways to put them on its balance sheet instead so that its reported profits looked much better than they were. And that was the essence of the WorldCom fraud. And that's probably the most famous one you can point to.

Am I wrong? And the CEO is still in prison for that, doing that. Wow. Why don't we call it accounting fraud when it comes to fracking? It's a good question. Well, sometimes things are only accounting fraud after a bankruptcy, right? So that's one issue. But accounting is an art rather than a science,

and there's an awful lot of latitude in it. So sometimes things you can look at and say are misleading are not necessarily something that a prosecutor would find illegal. One of the little thing to note on this, and it's, you find these things in the places that are sort of the harder to look. One of the reasons that kept us attracted to this industry as short sellers is all the ways in which the fracking management was able to enrich itself off the top, if you will. Often management, you had to look at their incentive compensation and how they were paid.

And in many cases, it was on production, which is kind of an important point, because even when it was uneconomic to produce, if they could raise money, they would be. produce because their bonus pool would be bigger based on production, not profitability. Bethany, you have been really careful to say that the verdict is still out on fracking, but you've also described fracking as an unintentional Ponzi scheme. What do you mean by that? And what are the consequences for the future? Because eventually all Ponzi schemes collapse.

There are some companies that are making some money today. And so to me, the key question isn't so much the financial one. It's actually kind of the more existential one. If the company stopped being funded by this avalanche of cheap capital, how much energy can they actually produce? How much oil and gas can they actually produce? How the good acreage there, the really key acreage in the core? How far does that extend? And so to me, that's the key question is what will this be revealed to be eventually?

I don't know from a financial standpoint that it ever becomes a calamity, but it becomes a calamity if we depend on this oil and gas and think it's going to grow forever. I think Jim may have a slightly more skeptical take than I do. Well, as you know, we did just a look back in the last five years of the industry. And the reason that was sort of convenient was it took us over a period of better and better fracking technology, but prices that were very high, that went very low, and are back to high. The five years also coincides with basically the average life of one of these ones. And the figure was negative for the entire industry.

So for the entire industry in a complete cycle, price cycle and fracking, and it was uneconomic. It was free cash flow negative for the investors. And so Wall Street will be willing to overlook that when times are good, but when they get fearful, they shut off capital. So is there a parallel then to be made between fracking now and mortgages in the 2000s? I don't, let me see. I think there is a parallel to be made in that during a bubble capital can be put to uses that in retrospect will clearly be seen to be uneconomic, right? And so in the run-up to the financial crisis, you had banks, lenders making mortgages to people who didn't have a hope of paying them back. And afterwards, you say, how could that have happened?

And there's an explanation for it, but most of it was a mania. forgot about the idea that somebody had to pay the money back. And so I think there's an analogy to this today when I get asked the question, why on earth would Wall Street fund these guys? This is un-economic. You must be wrong. I say, no, no, no, just look at the history of Wall Street. They funded plenty of things that are uneconomic at the end of the day. And you realize Wall Street's incredibly short-term. The idea that they're going to be taking into account something that might happen even in a decade is just, it's beyond the reach of today's capital markets, I think. That's Bethany McLean.

Her new book on the fracking economy is called Saudi America. We also heard from hedge fund manager Jim Channos. They spoke with Eliza Griswold who writes about fracking and politics and many other subjects for the New Yorker. I'm David Remnick and I'm here with our ace financial reporter, Adam Davidson. We're talking about the connections between the 2008 financial crisis and the climate crisis. Bethany McLean and others link fracking very directly. to the crash of 2008, which seems ironic because the stimulus package was supposed to be

very, very strong on renewable energies. Green Jobs was a major theme as Obama sold the recovery to the American people. What happened to all that? So whenever you essentially pump huge amounts of money into an economy, you know, the Federal Reserve was doing that through its central bank mechanisms, the government was doing that through its stimulus programs, those were necessary at the time. They really were. and they prevented our lives from being dramatically worse. But you're inevitably, I mean, truly inevitably going to create perverse outcomes. You're going to create bubbles somewhere out there.

Also, the way the stimulus was adjusted because of Republican opposition made it even more of a transfer to incumbent industries. They tried to put in a little bit of stuff for green energy. I don't think it was very well designed. In terms of the amount or in terms of where it was directed? A lot of the green energy and specifically green jobs programs were very poorly designed. There's something called Pathways Out of Poverty that it was just an ugly, clujy device that tried to get very, very poor people to be trained to insulate homes. I did a lot of reporting on it.

It was a disaster. But a $900 billion stimulus, or a little less, a $90 billion or $1,000 or $90 billion, or so of it focus on green energy, you know, there's probably more weatherized homes and more solar panels in America today, which is probably a good thing. But they were very expensive programs that didn't really have the stimulative impact we wanted. You know, I'd say this goes back to the fundamental thing that that's not what we need. That's not enough. And what many Democrat-leaning economists and Republican-leaning economists believe in a carbon tax. It's a very simple thing.

Carbon costs society some amount. We don't know exactly how much, but we can estimate it pretty well. And we should tax companies for the carbon they emit. This is an idea a lot of Democrats. But Hank Paulson, who's like the poster child for mainstream Republican economic views, he's a huge fan. And I talked to him about it last week. I remember when you were named Treasury Secretary, it was my job at NPR to do the quick,

who's this Hank Paulson fellow story. And so I had to kind of do a quick biography of you. And it was a bit hard to map you onto existing political dynamics because you are a Republican or you were at the time. Do you still consider yourself a Republican? I consider myself to be a classic, old-style Republican. So I'm going to take that as a no. that you're right. You're right. I've always been interested in conservation. I've always been interested in the environment that I had come out very early and recommending putting a price on

carbon emissions. It's a pollutant and we don't tax it. As a matter of fact, we do the opposite. There are tax incentives and other incentives for developing and using carbon-based fuels. So that is very, very perverse. It's probably not best politically to call it a carbon tax. You could call it a carbon fee, call it anything you want. But if you put a price... I would call it the jobs bill.

Okay. I think that's a good idea, the jobs bill. Because what it will do is it ultimately will create more jobs. The costs may come early. There will be jobs lost in some areas, but there will be a lot of jobs created, we rebuild infrastructure. But what that does is it changes behavior. Consumer behavior, investor behavior, we won't have to pick winners. I don't believe that the government should be

saying we pick solar or we pick wind. The market will pick them if we eliminate the subsidies which we are giving. And I don't understand any basis for giving subsidies for oil or coal or any carbon-based fuels. It's not like there's any shortage of them. It's not like these are new industries, even if someone didn't believe in the climate risk. It's just a waste of dollars. All you need to do is take away the incentives to invest in fossil fuels and create a level playing field. Hank Paulson talking with the New Yorkers, Adam Davidson. Paulson makes it sound, I don't want to say easy, but at least possible to make some head. way against climate change without the kind of massive job loss that would cripple our economy either.

With Democrats taking control of the House of Representatives, it's conceivable, just conceivable, that a carbon tax, or as Adam prefers to call it, the jobs bill, could at least be up for discussion, but it's never going to pass under this president. But we have to note that climate change is already happening. It's with us right now, as the atmosphere heats up, extreme weather becomes more frequent, more destructive, and very often the people affected most severely are the ones who can least afford it. When Hurricane Harvey dumped a monstrous 40 inches of rain on Southeast Texas,

some 30,000 people were evacuated, and among them was a Houston woman named Felicia Bird. And a year later, despite the efforts of aid agencies, she's still waiting to get back on her feet. I just got released from the hospital when the flood came, and I was staying at an extended care for 30 days. Doing that 30 days is when the storm took place. When my time was up there, I couldn't go back home because I had lost everything.

After that, I went to a place called Georgia-I-Bron Convention Center. They had everything. Everything. They even had a Walmart set up inside the convention. Center and all this stuff was free. The actual physical situation, no, it wasn't good. It was extremely cold, extremely cold. So I stayed there for like two months.

After that, actually what happened, because I would leave sometimes for two or three days and go to a relative, mainly my daughters. The last time I left and went to her house, when I came back, they had moved all my stuff. So I had to go to a temporary shelter. Now, I'm going to be honest, that was horrible. And I stayed there two days. And, I mean, it was horrible. Horrible.

So two days after that, they brought us to a shelter called residents of emancipation. So some of us qualify housing programs. And this apartment complex facility is what was open. And it's called New Hope Housing. So I've been in New Hope housing now for six months. My plan now, I hope to one day be able to live on the southwest side of Houston. That's where the majority of my family, even though parts of that city did flood. I don't know much about piping and drainage and all that, but I know we have a lot of bios.

So I'm not really scared. I keep in the back of my mind that it can happen. It can happen again. I've had to start over because of floods. I was part of the Allison flood in 2001. I was part of the Ike flood in 2008. I'm just going to just see how this goes. That's Felicia Bird in Houston.

That's our show for today. I'm David Remnick. And I want to thank you for joining me. I hope you'll join us next time. The New Yorker Radio Hour is a co-production of WNYC Studios and The New Yorker. Our theme music was composed and performed. by Merrill Garbus of Tune Yards with additional music by Alexis Quadrata.

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