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Monday, September 12, 2005
how a formula ignited a market

When a credit agency downgraded General Motors Corp.'s debt in May, the auto maker's securities sank. But it wasn't just holders of GM shares and bonds who felt the pain.

Like the proverbial flap of a butterfly's wings rippling into a tornado, GM's woes caused hedge funds around the world to lose hundreds of millions of dollars in other investments on behalf of wealthy individuals, institutions like university endowments -- and, via pension funds, regular folk.

All this traces back, in a sense, to a day eight years ago when a Chinese-born New York banker got to musing about love and death -- specifically, how people tend to die soon after their spouses do. Therein lies a tale of how a statistician unknown outside a small coterie of finance theorists helped change the world of investing.

The banker, David Li, came up with a computerized financial model to weigh the likelihood that a given set of corporations would default on their bond debt in quick succession. Think of it as a produce scale that not only weighs a bag of apples but estimates the chance that they'll all be rotten in a week.

The model fueled explosive growth in a market for what are known as credit derivatives: investment vehicles that are based on corporate bonds and give their owners protection against a default. This is a market that barely existed in the mid-1990s. Now it is both so gigantic -- measured in the trillions of dollars -- and so murky that it has drawn expressions of concern from several market watchers. The Federal Reserve Bank of New York has asked 14 big banks to meet with it this week about practices in the surging market.

The model Mr. Li devised helped estimate what return investors in certain credit derivatives should demand, how much they have at risk and what strategies they should employ to minimize that risk. Big investors started using the model to make trades that entailed giant bets with little or none of their money tied up. Now, hundreds of billions of dollars ride on variations of the model every day.

"David Li deserves recognition," says Darrell Duffie, a Stanford University professor who consults for banks. He "brought that innovation into the markets [and] it has facilitated dramatic growth of the credit-derivatives markets."

The problem: The scale's calibration isn't foolproof. "The most dangerous part," Mr. Li himself says of the model, "is when people believe everything coming out of it." Investors who put too much trust in it or don't understand all its subtleties may think they've eliminated their risks when they haven't.

The story of Mr. Li and the model illustrates both the promise and peril of today's increasingly sophisticated investment world. That world extends far beyond its visible tip of stocks and bonds and their reactions to earnings or economic news. In the largely invisible realm of derivatives -- investment contracts structured so their value depends on the behavior of some other thing or event -- credit derivatives play a significant and growing role. Endless trading in them makes markets more efficient and eases the flow of money into companies that can use it to grow, create jobs and perhaps spread prosperity.

But investors who use credit derivatives without fully appreciating the risks can cause much trouble for themselves and potentially also for others, by triggering a cascade of losses. The GM episode proved relatively minor, but some experts say it could have been worse. "I think this is a baby financial mania," says David Hinman, a portfolio manager at Los Angeles investment firm Ares Management LLC, referring to credit derivatives. "Like a lot of financial manias, it tends to end with some casualties."

Mr. Li, 42 years old, began his journey to this frontier of capitalist innovation three decades ago in rural China. His father, a police official, had moved the family to the countryside to escape the purges of Mao's Cultural Revolution. Most children at the young Mr. Li's school didn't go past the 10th grade, but he made it into China's university system and then on to Canada, where he collected two master's degrees and a doctorate in statistics.

In 1997 he landed on the New York trading floor of Canadian Imperial Bank of Commerce, a pioneer in the then-small market for credit derivatives. Investment banks were toying with the concept of pooling corporate bonds and selling off pieces of the pool, just as they had done with mortgages. Banks called these bond pools collateralized debt obligations.

They made bond investing less risky through diversification. Invest in one company's bonds and you could lose all. But invest in the bonds of 100 to 300 companies and one loss won't hurt so much.

The pools, however, didn't just offer diversification. They also enabled sophisticated investors to boost their potential returns by taking on a large portion of the pool's risk. Banks cut the pools into several slices, called tranches, including one that bore the bulk of the risk and several more that were progressively less risky.

Say a pool holds 100 bonds. An investor can buy the riskiest tranche. It offers by far the highest return, but also bears the first 3% of any losses the pool suffers from any defaults among its 100 bonds. The investor who buys this is betting there won't be any such losses, in return for a shot at double-digit returns.

Alternatively, an investor could buy a conservative slice, which wouldn't pay as high a return but also wouldn't face any losses unless many more of the pool's bonds default.

Investment banks, in order to figure out the rates of return at which to offer each slice of the pool, first had to estimate the likelihood that all the companies in it would go bust at once. Their fates might be tightly intertwined. For instance, if the companies were all in closely related industries, such as auto-parts suppliers, they might fall like dominoes after a catastrophic event. In that case, the riskiest slice of the pool wouldn't offer a return much different from the conservative slices, since anything that would sink two or three companies would probably sink many of them. Such a pool would have a "high default correlation."

But if a pool had a low default correlation -- a low chance of all its companies stumbling at once -- then the price gap between the riskiest slice and the less-risky slices would be wide.

This is where Mr. Li made his crucial contribution. In 1997, nobody knew how to calculate default correlations with any precision. Mr. Li's solution drew inspiration from a concept in actuarial science known as the "broken heart": People tend to die faster after the death of a beloved spouse. Some of his colleagues from academia were working on a way to predict this death correlation, something quite useful to companies that sell life insurance and joint annuities.

"Suddenly I thought that the problem I was trying to solve was exactly like the problem these guys were trying to solve," says Mr. Li. "Default is like the death of a company, so we should model this the same way we model human life."

His colleagues' work gave him the idea of using copulas: mathematical functions the colleagues had begun applying to actuarial science. Copulas help predict the likelihood of various events occurring when those events depend to some extent on one another. Among the best copulas for bond pools turned out to be one named after Carl Friedrich Gauss, a 19th-century German statistician.

Mr. Li, who had moved over to a J.P. Morgan Chase & Co. unit (he has since joined Barclays Capital PLC), published his idea in March 2000 in the Journal of Fixed Income. The model, known by traders as the Gaussian copula, was born.

"David Li's paper was kind of a watershed in this area," says Greg Gupton, senior director of research at Moody's KMV, a subsidiary of the credit-ratings firm. "It garnered a lot of attention. People saw copulas as the new thing that might illuminate a lot of the questions people had at the time."

To figure out the likelihood of defaults in a bond pool, the model uses information about the way investors are treating each bond -- how risky they're perceiving its issuer to be. The market's assessment of the default likelihood for each company, for each of the next 10 years, is encapsulated in what's called a credit curve. Banks and traders take the credit curves of all 100 companies in a pool and plug them into the model.

The model runs the data through the copula function and spits out a default correlation for the pool -- the likelihood of all of its companies defaulting on their debt at once. The correlation would be high if all the credit curves looked the same, lower if they didn't. By knowing the pool's default correlation, banks and traders can agree with one another on how much more the riskiest slice of the bond pool ought to yield than the most conservative slice.

"That's the beauty of it," says Lisa Watkinson, who manages structured credit products at Lehman Brothers in New York. "It's the simplicity."

It's also the risk, because the model, by making it easier to create and trade collateralized debt obligations, or CDOs, has helped bring forth a slew of new products whose behavior it can predict only somewhat, not with precision. (The model is readily available to investors from investment banks.)

The biggest of these new products is something known as a synthetic CDO. It supercharges both the returns and the risks of a regular CDO. It does so by replacing the pool's bonds with credit derivatives -- specifically, with a type called credit-default swaps.

The swaps are like insurance policies. They insure against a bond default. Owners of bonds can buy credit-default swaps on their bonds to protect themselves. If the bond defaults, whoever sold the credit-default swap is in the same position as an insurer -- he has to pay up.

The price of this protection naturally varies, costing more as the perceived likelihood of default grows.

Some people buy credit-default swaps even though they don't own any bonds. They buy just because they think the swaps may rise in value. Their value will rise if the issuer of the underlying bonds starts to look shakier.

Say somebody wants default protection on $10 million of GM bonds. That investor might pay $500,000 a year to someone else for a promise to repay the bonds' face value if GM defaults. If GM later starts to look more likely to default than before, that first investor might be able to resell that one-year protection for $600,000, pocketing a $100,000 profit.

Just as investment banks pool bonds into CDOs and sell off riskier and less-risky slices, banks pool batches of credit-default swaps into synthetic CDOs and sell slices of those. Because the synthetic CDOs don't contain any actual bonds, banks can create them without going to the trouble of purchasing bonds. And the more synthetic CDOs they create, the more money the banks can earn by selling and trading them.

Synthetic CDOs have made the world of corporate credit very sexy -- a place of high risk but of high potential return with little money tied up.

Someone who invests in a synthetic CDO's riskiest slice -- agreeing to protect the pool against its first $10 million in default losses -- might receive an immediate payment of $5 million up front, plus $500,000 a year, for taking on this risk. He would get this $5 million without investing a dime, just for his pledge to pay in case of a default, much like what an insurance company does. Some investors, to prove they can pay if there is a default, might have to put up some collateral, but even then it would be only 15% or so of the amount they're on the hook for, or $1.5 million in this example.

This setup makes such an investment very tempting for many hedge-fund managers. "If you're a new hedge fund starting out, selling protection on the [riskiest] tranche and getting a huge payment up front is certainly something that's going to attract your attention," says Mr. Hinman of Ares Management. It's especially tempting given that a hedge fund's manager typically gets to keep 20% of the fund's winnings each year.

Synthetic CDOs are booming, and largely displacing the old-fashioned kind. Whereas four years ago, synthetic CDOs insured less than the equivalent of $400 billion face amount of U.S. corporate bonds, they will cover $2 trillion by the end of this year, J.P. Morgan Chase estimates. The whole U.S. corporate-bond market is $4.9 trillion.

Some banks are deeply involved. J.P. Morgan Chase, as of March 31, had bought or sold protection on the equivalent of $1.3 trillion of bonds, including both synthetic CDOs and individual credit-default swaps. Bank of America Corp. had bought or sold about $850 billion worth and Citigroup Inc. more than $700 billion, according to the Office of the Comptroller of the Currency. Deutsche Bank AG, whose activity the comptroller doesn't track, is another big player.

Much of that money is riding on Mr. Li's idea, which he freely concedes has important flaws. For one, it merely relies on a snapshot of current credit curves, rather than taking into account the way they move. The result: Actual prices in the market often differ from what the model indicates they should be.

Investment banks try to compensate for the shortcomings of the model by cobbling copula models together with other, proprietary methods. At J.P. Morgan, "We're not stupid enough to believe [the model] is omniscient," said Andrew Threadgold, head of market risk management. "All risk metrics are flawed in some way, so the trick is to use a lot of different metrics." Bank of America and Citigroup representatives said they use various models to assess risk and are constantly working to improve them. Deutsche Bank had no comment.

As with any model, forecasts investors make by using the model are only as good as the inputs. Someone asking the model to indicate how CDO prices will act in the future, for example, must first offer a guess about what will happen to the underlying credit curves -- that is, to the market's perception of the riskiness of individual bonds over several years. Trouble awaits those who blindly trust the model's output instead of recognizing that they are making a bet based partly on what they told the model they think will happen. Mr. Li worries that "very few people understand the essence of the model."

Consider the trade that tripped up some hedge funds during May's turmoil in GM securities. It involved selling insurance on the riskiest slice of a synthetic CDO and then looking to the model for a way to hedge the danger that the default risk would increase. Using the model, investors calculated that they could offset that danger by buying a double dose of insurance on a more conservative slice.

It looked like a great deal. For selling protection on the riskiest slice -- agreeing to pay as much as $10 million to cover the pool's first default losses -- an investor would collect a $3.5 million upfront payment and an additional $500,000 yearly. Hedging the risk would cost the investor a mere $415,000 annually, the price to buy protection on a $20 million conservative piece.

But the model's hedge assumed only one possible future: one in which the prices of all the credit-default swaps in the synthetic CDO moved in sync. They didn't. On May 5, while the outlook for most bond issuers stayed about the same, two got slammed: GM and Ford Motor Co., both of which Standard & Poor's downgraded to below investment grade. That event caused a jump in the price of protection on GM and Ford bonds. Within two weeks, the premium payment on the riskiest slice of the CDO, the one most exposed to defaults, leapt to about $6.5 million upfront.

Result: An investor who had sold protection on the riskiest slice for $3.5 million had a paper loss of nearly $3 million. That's because if the investor wanted to get out of the investment, he would have to buy a like amount of insurance from somebody else for $6.5 million, or $3 million more than he was getting.

The simultaneous investment in the conservative slice proved an inadequate hedge. Because only GM and Ford saw their default risk soar, not the rest of the bond world, the pricing of the more conservative slices of the pool didn't rise nearly as much as the riskiest slice. So there wasn't much of an offsetting profit to be made there by reselling that insurance.

This wasn't really the fault of the model, which was designed mainly to help price the tranches, not to make predictions. True, the model had assumed the various credit curves would move in sync. But it also allowed for investors to adjust this assumption -- an option that some, wittingly or not, ignored.

Because numerous hedge funds had made the same credit-derivatives bet, the turmoil they faced spilled over into stock and bond markets. Many investors worried that some hedge funds might have to dump assets to cover their losses, so they sold, too. (Some hedge funds also suffered from a separate bad bet, which relied on GM's bond and stock prices moving in tandem; it went wrong when GM shares rallied suddenly as investor Kirk Kerkorian said he would bid for GM shares.)

GLG Credit Fund told its investors it lost about 14.5% in the month of May, much of that on synthetic CDO bets. Writing to investors, fund manager Jean-Michel Hannoun called the market reaction to the GM and Ford credit downgrades too improbable an event for the hedge fund's risk model to capture. A GLG spokesman declines to comment.

The credit-derivatives market has since bounced back. Some say this shows that the proliferation of hedge funds and of complex derivatives has made markets more resilient, by spreading risk.

Others are less sanguine. "The events of spring 2005 might not be a true reflection of how these markets would function under stress," says the annual report of the Bank for International Settlements, an organization that coordinates central banks' efforts to ensure financial stability. To Stanford's Mr. Duffie, "The question is, has the market adopted the model wholesale in a way that has overreached its appropriate use? I think it has."

Mr. Li says that "it's not the perfect model." But, he adds: "There's not a better one yet."
lawyer helps chart foreign policy shift
In June, about 100 people gathered at the American Enterprise Institute, a conservative Washington think tank, to hear a lecture by John Yoo on "fighting the new terrorism." Mr. Yoo recommended an unusual idea: assassinating more suspected terrorists.

A law professor at the University of California at Berkeley, he said his proposal would require "a change in the way we think about the executive order banning assassination, which has been with us since the 1970s." Such a change is needed, he said, because it is wartime: "A nation at war may use force against members of the enemy at any time, regardless of their proximity to hostilities or their activity at the time of attack."

Mr. Yoo, 38 years old, is no ordinary ivory-tower theorist. During a two-year stint at the Justice Department from 2001 through 2003, he wrote some of the most controversial internal legal opinions justifying the Bush administration's aggressive approach to detaining and interrogating suspected terrorists.

Some of those memos have become public, but not all of them. Asked after his AEI talk whether there is a classified Justice Department opinion justifying assassinations, Mr. Yoo hinted that he'd written one himself. "You would think they -- the administration -- would have had an opinion about it, given all the other opinions, wouldn't you?" he said, adding, "And you know who would have done the work."

A spokesman for the Justice Department declined to comment.

Mr. Yoo is playing an instrumental role in redefining the murky area where law intersects with foreign policy. The change underpins President Bush's claim that he possesses the sort of far-reaching emergency powers exercised by past presidents during conventional wars.

Mr. Yoo, like others in the academic clique known as "sovereigntists," is skeptical of international law and the idea that international relations are ever based on principle, as opposed to self-interest. Mr. Yoo argues that the Constitution gives Congress limited authority to deter presidential actions in foreign affairs. The judiciary, he says, has almost none.

At the Justice Department, Mr. Yoo crafted legal arguments for the president's power to launch pre-emptive strikes against terrorists and their supporters. He molded a theory for not applying the Geneva Conventions to captured terrorist suspects. And he interpreted the federal antitorture statute as barring only acts that cause severe mental harm or pain like that accompanying "death or organ failure."

In the wake of the Abu Ghraib prisoner-abuse scandal, the Bush administration has backed away from Mr. Yoo's most extreme ideas about interrogation. But that hasn't discouraged him from waging an intellectual offensive in speeches, articles and a forthcoming book to be published by the University of Chicago. His claim is that American law permits the president to go to almost any lengths in the name of fighting terrorism.

The Yoo Doctrine, as it might be called, fits with the broader Bush-administration view that pursuing American interests is best for the country and the rest of the world. Before 9/11, Mr. Yoo helped lay legal groundwork for some of the president's high-visibility withdrawals from treaties, including the antiballistic missile pact with Russia and the agreement underpinning the International Criminal Court in the Netherlands, established in 1998 to deal with the gravest international crimes.

Another illustration of the Bush mind-set was the president's recess appointment last month of John Bolton as U.S. ambassador to the United Nations, an institution Mr. Bolton had derided as largely superfluous.

Not surprisingly, Mr. Yoo is reviled on the political left. Students at Berkeley last year circulated a petition demanding that he recant his Justice Department work or resign his professorship. (He has done neither.) Human-rights advocates suggest he might be a war criminal and compare his memos with Nazi legal documents. Amnesty International urged in May that state bar associations consider sanctions against Mr. Yoo and others.

Within the Bush administration, former Secretary of State Colin Powell warned in 2002 in an internal memo that Mr. Yoo's ideas about treatment of detainees would "undermine the protections of the law of war for our troops." In July, senior uniformed military lawyers deplored his analysis in Senate testimony.

In person, the academic is disarmingly mild and defends his views calmly. He has had plenty of practice, and not just in media interviews and on campus. His wife, Elsa Arnett, he says, disagrees with almost everything he believes about politics and policy. "We have some heated discussions," he says. "I welcome it. It keeps me honest."

Mr. Yoo has always enjoyed being a conservative fly in the liberal soup. He met his future wife when they were both Harvard undergraduates on the staff of the campus daily, where he relished the role of token right-winger. She is the daughter of veteran war correspondent Peter Arnett. "Elsa was always a smart, interesting person, and that was attractive to John, even though they disagreed about everything political," says David Lazarus, a friend since college who affectionately refers to Mr. Yoo as "the evil one." Ms. Arnett, a writer, declined to be interviewed.

Mr. Yoo inherited conservative instincts from his parents, who emigrated from South Korea when he was an infant. Both physicians, they hated communism and admired Ronald Reagan. They sent their son to a private Episcopal high school in Philadelphia where he studied Greek and Latin and attended chapel three times a week.

At Yale Law School in 1989, he joined the Federalist Society, a national group of right-leaning lawyers that sponsors debates and serves as a job-referral network.

With help from Federalists, he snared prestigious clerkships: first with Judge Laurence Silberman, an appellate jurist in Washington much admired on the right, and then with Supreme Court Justice Clarence Thomas. A good word from the justice, Mr. Yoo says, helped him obtain a top staff job with Republican Sen. Orrin Hatch of Utah, then chairman of the Senate Judiciary Committee.

While on Sen. Hatch's staff, Mr. Yoo clashed with Democrats over Clinton judicial nominees. In 2000, he aided the Republican legal contingent that helped win the decisive electoral brawl in Florida.

Even by the standards of elite Washington legal circles, Mr. Yoo earned a reputation for what Justice Thomas calls "a very high level of confidence in conclusions he might reach." In an interview, the justice warmly recalls his former clerk as "a real showman and a real intellectual -- a smooth talker who made good arguments." Mr. Yoo had an unusual degree of certainty that he knew the "original intent" of the Constitution's authors, Justice Thomas says. "We'd kid him sometimes that he was right there at the founding."

Former co-clerk Saikrishna Prakash recalls teasing, "John, break out the crystal ball and tell us what the framers thought." Mr. Yoo would fire back, "Yes, I consulted the framers. You're all wrong, and I'm right."

When he wasn't drafting opinions in the Thomas chambers, Mr. Yoo sometimes played squash with Justice Antonin Scalia, another conservative hero. Mr. Yoo says he didn't let the justice win, as some other clerks did. A Supreme Court spokeswoman says the justice recalls the matches but doesn't remember losing.

In 1996, Mr. Yoo moved to liberal Berkeley, where he had taught briefly before. He explains this fish-out-of-water situation in careerist terms: Berkeley was the best law school that offered him a tenure-track job.

Mr. Yoo challenges an academic consensus that for decades has promoted international law and other legal restraints on U.S. war making. This thinking grew out of the post-World War II goals of resolving conflict at the United Nations and checking executive-branch excesses during the long nuclear standoff with the Soviets.

The majority view relies heavily on constitutional provisions, such as the one stating that Congress, not the president, has the power "to declare war" and "raise and support armies."

Years before he joined the Bush administration, Mr. Yoo was writing law-review articles arguing that this consensus is at once outdated and -- despite the Constitution's language -- in conflict with the intentions of the founding fathers.

Seeking to play down the seemingly clear wording of the declare-war clause, for example, he argues that Alexander Hamilton and his colleagues adapted the British idea that Parliament could declare the existence of an all-out war, but such a statement wasn't necessary before the king could launch hostilities. Congress, Mr. Yoo contends, was given only two ways to counter the commander-in-chief: impeaching him or cutting off funds for the military. In James Madison's words: "The sword is in the hands of the British king; the purse in the hands of the Parliament. It is so in America, as far as any analogy can exist."

In practice, Mr. Yoo's assertion that the commander-in-chief has vast "inherent" authority in times of crisis pretty accurately describes what past presidents have done. Since the nation's earliest days, when George Washington waged war against Indians in the Ohio River Valley and John Adams sent American ships against the French, presidents have ordered troops into scores of conflicts without formal congressional declarations. In fact, Congress has declared war only five times.

Mr. Yoo likes to point out that Bill Clinton sent U.S. forces to Bosnia, Kosovo, Iraq, Sudan and Afghanistan -- all without formal congressional declarations. And war presidents from Washington to Abraham Lincoln to Franklin Roosevelt used military commissions to try enemy soldiers without the usual panoply of courtroom niceties.

It's vital, says Mr. Yoo, to see the antiterrorism effort as a genuine war. Facing terrorists who don't obey treaties and can't be disciplined at the U.N., the president must be able to act swiftly and flexibly, he contends.

Mr. Yoo got a chance to put his ideas into practice in 2001, when he received a midlevel political appointment in the Justice Department's Office of Legal Counsel. The small office opines on the legality of executive-branch actions.

When the planes hit on 9/11, anxiety raced through Justice Department headquarters on Pennsylvania Avenue, recalls Robert Delahunty, then a lawyer in the counsel's office. He says Mr. Yoo immediately asserted himself, declaring, "This is war. The law operates differently." He "came to this first, before others," says Mr. Delahunty, who now teaches at the University of Saint Thomas School of Law in Minneapolis.

In the months that followed, the White House asked Mr. Yoo's office for memos on antiterrorism authority. He served as primary draftsman of key documents, such as one dated Sept. 25, 2001, that said the president had broad constitutional power to launch military attacks on terrorist groups or states that support them, "whether or not they can be linked" to 9/11.

A Jan. 9, 2002, memo concluded that neither the federal War Crimes Act nor the Geneva Conventions constrained the administration in its handling of al Qaeda and Taliban detainees held at Guantanamo Bay.

The most startling memo in this series was an Aug. 1, 2002, analysis concluding the federal antitorture statute forbids "only extreme acts" that cause either "lasting psychological harm" or physical pain "akin to that which accompanies serious physical injury such as death or organ failure." As commander-in-chief, the opinion stated, Mr. Bush could bypass U.S. law and international treaties prohibiting inhumane treatment of prisoners.

These opinions remained secret until abuse at Abu Ghraib came to light in spring 2004. The memos began to leak, and then, in June 2004, the White House released a batch of them as part of a damage-control effort. Alberto Gonzales, then the White House counsel and now attorney general, disavowed the Aug. 1, 2002, memo on interrogation. He dismissed its analysis of presidential authority to disregard antitorture laws as "irrelevant and unnecessary."

By then, Mr. Yoo had completed his planned two-year stint in Washington and returned to Berkeley. Disappointed by the administration's response -- "They kind of ran and hid," he says -- he wasn't surprised when he became a target for Bush critics.

A White House spokeswoman declined to expand on Mr. Gonzales's earlier comments.

Massachusetts Democratic Sen. Edward Kennedy suggested in a speech in April that Mr. Yoo and others deserved formal disciplining. "No action -- criminal, administrative, or otherwise -- has been taken against the high civilian officials responsible for the authorization of torture and mistreatment by U.S. officials," he said.

Jeremy Waldron, a law professor at Columbia University, gave voice to a common view in legal circles, calling the Yoo memo on torture "shocking as a jurisprudential matter" and a mark of "dishonor for our profession."

While publicly the administration has kept its distance from Mr. Yoo, other arms of the conservative establishment, including this newspaper's editorial page, have defended him. (Mr. Yoo worked as a summer intern for The Wall Street Journal's news department before starting law school and has written articles for its opinion pages.)

Mr. Yoo says his former boss, Justice Thomas, no stranger to personal controversy, privately offered moral support but warned that "these things will always be harder on your family than on you." Indeed, Mr. Yoo's wife only learned about the memos along with the rest of the country. While at the Justice Department, her husband hadn't talked about his classified work at home.

In explaining the fallout to her, Mr. Yoo says he stressed that as a lawyer, he had described the reach of statutes and treaties, leaving policy choices to more senior officials. The torture memo, he says, responded to a question posed by the Central Intelligence Agency: "How far are we allowed to go?" A CIA spokesman declined to comment.

Contrary to critics who say his work started the U.S. down a "road to Abu Ghraib," Mr. Yoo says none of his most controversial memos applied to ordinary prisoners in Iraq, only to alleged terrorists who might know about future mass attacks. He says he deplores the abuse at Abu Ghraib, but attributes it to military misbehavior, not legal interpretations.

Mr. Yoo says al Qaeda members don't qualify for prisoner-of-war protections under the Geneva Conventions, because those treaties are between nations. Al Qaeda isn't a nation and doesn't respect rules of war, he says, such as not intentionally attacking civilians.

The president ordered American officials in February 2002 "to continue to treat detainees humanely" and "in a manner consistent with the principles" of the Geneva Conventions. But he added the caveat that this should be done "to the extent appropriate and consistent with military necessity." The Bush administration says that it complies with the United Nations Convention Against Torture, which the U.S. ratified in 1994.

Mr. Yoo takes solace in that most of the ideas he advocated are very much alive in Washington. The military and CIA continue to operate secretive detention-and-interrogation centers. The indefinite imprisonment of terrorism suspects and use of military commissions have survived legal challenges.

In June 2004, the Supreme Court ruled that federal courts can review the grounds for detaining foreign enemy combatants held outside the U.S. The justices separately ruled that American citizens held as terrorism suspects must have access to lawyers and fair hearings.

But beyond providing for the barest sort of judicial oversight, the court seemed to accept the idea that the country is at war and that the president and his subordinates have exceedingly broad latitude to run it. If confirmed, Supreme Court nominee John Roberts is expected to be a strong proponent of this view.

"It seems to me," says Mr. Yoo, "that the leaders in government and the judges and some legal thinkers, too, accept now that the fight against terrorism is a real war."

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