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By now you have memorized those three ugly words, “subprime mortgage mess.” Get ready for three more: “credit default swap,” called CDS on Wall Street but barely known on Main Street, where it may well spread financial disease as lethal as subprime and sundry exotic mortgages. The sagacious financial expert who almost alone has warned of such looming woes for more than a decade is Frank Partnoy, professor of law at the University of San Diego.

In its simplest form, a credit default swap is essentially insurance against default or some other calamity on a debt instrument, such as a bond or a loan. For example, a bank holds a bond and wants to be sure it gets its steady interest payments and its principal when the bond matures. So the bank buys a contract from a third party — say, a hedge fund, insurance company, pension fund — which promises that the bond will be paid off in full. In return, the bank pays the third party a regular premium. The calamity for which the bank gets insurance might be bankruptcy of the bond issuer, failure to pay interest or principal, and the like. Call this bond protection.

The vehicle by which this quasi-insurance is carried out is a derivative — a financial instrument whose value is derived from some other security, such as a stock, bond, or commodity. Most derivatives are bewilderingly complex — often created by Harvard and MIT mathematics PhDs. Sometimes both the buyers and sellers of derivatives don’t understand them. After all, the essence of white-collar fraud is contrived complexity. The investment banking world is expert at creating such mares’ nests. Trouble is, the firms are often not smart enough to unravel their own self-made messes. A low-level trader cost the second-biggest French bank $7.2 billion by making trades the bank had not detected. The U.S. can’t be smug: big Wall Street houses such as Merrill Lynch and Citigroup have lost billions of dollars in mortgage-related products, and the chief executives raking in $60 million or more a year in salary had no idea what was going on.

Now some financial experts are asking if the credit default swap phenomenon is a protection racket — or a Ponzi scheme. People are wondering what happens when the third party promising protection doesn’t have the money to pay off. This could cause a chain reaction. Protection sellers could default. Protection buyers, which had wrongly assumed they were covered for calamities, would find themselves in deep doo-doo. Worrisomely, public disclosure of swap deals is very slim. There is a stark lack of information. The swaps are sold over the counter, not traded on an exchange, and are largely outside the scrutiny of regulators.

Bill Gross, managing director of Newport Beach–based PIMCO, which runs the world’s largest bond fund, recently pointed out that through use of derivatives, hidden off the balance sheet, America’s banks evade the reserve requirements that once backed up the system to prevent runs. Gross’s January report put it in stark words: “Our modern shadow banking system craftily dodges the reserve requirements of traditional institutions and promotes a chain letter, pyramid scheme of leverage [debt], based in many cases on no reserve cushion whatsoever. Financial derivates of all descriptions are involved, but credit default swaps are perhaps the most egregious offenders.” If something goes wrong in the economy — and a national recession looks increasingly likely — the banks may well not have adequate reserves. There are $45 trillion of swaps and $500 trillion of all kinds of mysterious derivatives floating around the world, often undetected.

Gross says that in the course of the coming (perhaps underway) economic woes, swaps could account for $250 billion of losses — the same as subprime mortgages. “Casualties and shipwrecks are the inevitable consequence,” says Gross.

University of San Diego law professor Partnoy sold derivatives on Wall Street for two years. In 1997, his book F.I.A.S.C.O.: Blood in the Water on Wall Street warned of coming problems with derivatives. His 2003 book, Infectious Greed: How Deceit and Risk Corrupted the Financial Markets, specifically zeroed in on swaps. He showed how they were critical in the Enron and WorldCom frauds. “Banks had done an estimated $10 billion of credit default swaps related to WorldCom,” wrote Partnoy. When WorldCom collapsed, the banks were owed billions in the bankruptcy, but they didn’t worry: they had sold the risk to somebody else. There were 800 swaps amounting to $8 billion of bets on Enron, wrote Partnoy. Then–Federal Reserve chairman Alan Greenspan applauded this risk-shifting, saying it took pressure off U.S. banks. But because the swap market was “opaque and unregulated,” wrote Partnoy, “no one could be sure where the risk had gone.” Property, casualty, and reinsurance companies took hits, as did pension funds and hedge funds.

But, noted Partnoy, just as banks used derivatives to skirt reserve requirements, insurance companies used them to avoid legal rules that blocked them from taking on too much risk. Banks were dodging regulation by shifting risk to less regulated insurance companies, which were also doing illegal gambling. Because of the swap boom, the world financial system might be creating instability, not reducing it. Banks are in the best position to monitor a loan; they have access to data that the third parties don’t have. An insurance company — especially one based offshore, as so many are — can only look at public documents. It doesn’t have the inside scoop, as banks supposedly have.

Now the chickens are coming home to roost. Consider Ambac Assurance and the Municipal Bond Insurance Association (MBIA). They had done very well insuring tax-free municipal bonds. (For example, Ambac insured the San Diego ballpark bonds.) Ambac and MBIA had the highest AAA ratings — ergo, so did the municipal bonds they guaranteed. But then they got greedy. They decided to insure debt instruments that were loaded up with mortgages that turned out to be kinky. These bonds are collapsing. There is a question of whether Ambac and MBIA have the money to provide the protection they promised. The stock prices of Ambac and MBIA have dropped precipitously, oscillating on rumors. There is talk of a bailout of these companies by big banks (themselves lacking funds) or even the federal government.

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Anon92107 Feb. 6, 2008 @ 1:55 p.m.

Don, we must do whatever it takes to reboot the home building and buying industries in San Diego ASAP.

X & Y, and even older workers, NEED GOOD JOBS TODAY and someone has to start doing something to make the right things happen or the San Diego economy will become a third world economy the way politicians in San Diego, Sacramento, Washington, and the corruption on Wall Street and at the Union-Tribune are sabotaging San Diego and America.

It's time to expose the Union-Tribune editorial board and corrupt politicians like Murphy and Sanders for sabotaging the San Diego economy to satisfy their "to hell with everyone else" greed. And it's time to kick every U-T politician out of office ASAP.

If X & Y won’t fight back now, they will run out of opportunities as fast as the new consumption economy is crashing and burning due to the corruption and incompetence of all our current politicians in San Diego, Sacramento and Washington.

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Don Bauder Feb. 6, 2008 @ 7:53 p.m.

Response to post #1: Corruption is destroying San Diego -- no argument there. But I disagree that San Diego should reboot the home building and buying industries. San Diego does not need any more residential development or more hotels. It needs to repair its dismal infrastructure. However, the real estate developers and tourist industry lead most of the politicians around by the nose -- or by the pocketbook. There are two exceptions: Frye and Aguirre. And they get slammed by the U-T for being honest. Best, Don Bauder

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Don Bauder Feb. 7, 2008 @ 7:06 a.m.

Response to post #3: Condos are already vastly overbuilt, particularly downtown. There isn't room for more residential development, and there aren't the people to fill new homes, since population and jobs aren't growing. San Diego must work on its infrastructure. That will provide jobs. That is true of the U.S., too. The pols talk about programs to stimulate consumer spending. That's the last thing that is needed. Excessive consumer debt and spending got us into this mess. A program to rebuild roads, bridges, dams, etc. throughout the U.S. is urgently necessary and would provide jobs. Best, Don Bauder

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Anon92107 Feb. 7, 2008 @ 4:22 a.m.

1 - We need good paying jobs, and rebooting construction will provide a great many. Right now far too many skilled laborers are sitting around waiting for housing construction and infrastructure improvements to reboot, and that is a totally unacceptable waste of skilled labor in a time when there is a demand for their labor. BTW, it is hard working, dedicated skilled laborers who pay taxes that have been stolen by political corruption.

2 - X & Yers, and far too many others, need low cost housing today, and this demand continues to grow. Warren Buffett likes the low-cost funds, it's the trade deficit that bothers him most, and as he said yesterday the U.S. economy will "do very well over time." So let’s get people back to work who can make the right things happen for our economy and quality of life.

Don, stay focused on increasing good paying jobs and housing, things we need the most. Like McCain says “just calm down” in more ways than one. And as Buffett also said yesterday, the woes in the U.S. financial sector are "poetic justice."

MOTTO: Let’s get people back to work in good jobs building what San Diegans and Americans need to restore the American Dream and quality of life, NOW!

As for the scumbags who are destroying San Diego, it’s time to expose those who are causing the most problems such as the U-T editorial board, the U-T establishment and their political scumbag puppeticians at the top of the food chain of corruption.

Exposing destructive scumbags is the job that Don Bauder does best by cleaning out the San Diego political sewer of puppeticians like Sanders and Dumanis, corrupt judges, U-T business establishment robber barons and U-T editorial board.

It’s time to send scumbags to jail whose corruption and greed are causing San Diego’s destruction with their larceny and gross criminal negligence. Many of the most destructive scumbags are easy to recognize, they attack Aguirre and Frye.

What San Diego needs most is construction, and to eradicate the scumbags of destruction.

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Anon92107 Feb. 7, 2008 @ 12:43 p.m.

Condos downtown suck, that's why they "are already vastly overbuilt," people got tired of being screwed downtown.

OK, let me rephrase this, I emphasize:

1. multiple occupancy dwellings and smaller homes, and

2. lower cost mortgages, then

3. they will sell once developers and politicians stop screwing San Diegans, but

4. Don Bauder has to expose the scumbags who have been screwing San Diegans and causing the housing crisis so the screwers will be sent to jail, along with corrupt politicians like Golding, Murphy and Sanders, and corrupt judges who enable the corruption to screw San Diegans, and finally

5. More jobs will be produced by dwelling and infrastructure construction so even more people can buy dwellings.

If things continue out of control getting worse because of corrupt and incompetent politicians and establishment special interests then it will be time for WPA v.21C old time Ocean Beach type cottages with less than 1000 sq ft where most families were raised in spite of small size, etc.

Time to send the corrupt to jail Don so San Diegans can afford houses and get good paying jobs again.

Go Get-'Em Don! Right now you and The Reader are the only way to make the right things happen for X & Y.

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Don Bauder Feb. 7, 2008 @ 7:13 p.m.

Response to post #5: I agree developers and politicians are screwing San Diegans. First, the developers pay off the politicians. Then the pols screw the public. Best, Don Bauder

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JohnnyVegas Feb. 7, 2008 @ 9:03 p.m.

I think you can also interchange developers with Big Business and Public Unions, and that would be the trifecta of gov screwing the poor and what's left of the middle class, the backbone of America.

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Don Bauder Feb. 7, 2008 @ 10:16 p.m.

Response to post #7: Good point. In San Diego, in particular, the unions and big business sleep together, but it's the public that gets screwed. Best, Don Bauder

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Anon92107 Feb. 8, 2008 @ 2:57 a.m.

Response to post #6: OK Don, you and JV have points to emphasize. But let me emphasize one other point that really is the root cause of never-ending, out of control corruption by San Diego politicians and the Union-Tribune establishment, the fact that entire San Diego courts have been watching and doing nothing to stop the corruption from getting out of control for decades, for example:

Former San Diego Mayor Roger Hedgecock was found guilty of political corruption by two juries after his indictment in 1984, but the corrupt judiciary gave him a “Get Out Of Jail Free” card. This proved that Union-Tribune puppet-mayors never have to go to jail, as well as destroying the San Diego jury system.

Former San Diego Presiding Judge Greer and two of his judicial henchmen were convicted of mail fraud and racketeering conspiracy in 1996 after the entire Greer court spent a decade watching and doing nothing to stop massive judicial corruption.

Former Greer court acolyte Judge Dick Murphy became San Diego’s most corrupt Mayor in 2000 to achieve international recognition as one of the three worst mayors by Time magazine, resigned in 2005 in total disgrace after five years of extending the tradition of judicial corruption that he learned during the Greer court era. The most hellacious consequences of Murphy corruption are the hideous deaths and destruction in 2003 and 2007 Firestorms that no one seems to care about anymore.

That takes us up to today where the era of Union-Tribune corruption continues into the 21st century under their latest Puppet-Mayor Sanders who was a former police chief, which is another story.

Think maybe you and The Reader can take the expose of San Diego Union-Tribune establishment corruption from here Don? It’s way past due time to overthrow the U-T era of corruption that has devastated the future for X & Y and further generations.

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Don Bauder Feb. 8, 2008 @ 8:08 a.m.

Response to post #9: I think the Reader has done a lot covering the collapse of the U-T, as well as the dishonesty in its editorials and so-called news stories. Best, Don Bauder

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Anon92107 Feb. 8, 2008 @ 10:22 a.m.

Response to post #10: I respect that you have done "a lot" Don, but "more" is imperative.

The U-T establishment orchestrated vilification campaign against Aguirre has ramped up so they can perpetuate City Hall corruption against families and taxpayers of San Diego, even after they have caused excessive firestorm deaths and destruction due to their criminal fraud.

Now the U-T establishment is even running their puppet-judge Goldsmith against Aguirre to carry on the tradition of Greer court corruption.

Don, you spent three decades witnessing egregious U-T corruption in action and are the best investigative reporter in San Diego. In this election cycle, it’s more imperative than ever before for you to turn up your spotlight to expose the true depth of betrayal and destruction that the U-T establishment has perpetrated against the people of San Diego for far too many decades.

Even though the fact is that you have done “a lot” no one else is really fighting back yet, except Aguirre and he is going to going to be purged by the corrupt U-T establishment if you don’t tell the whole truth like it is to support him against the forces that are destroying San Diego.

You and Aguirre, and possibly Frye, are the only champions that can end the U-T era of corruption. So the future for your X & Y readers is in your expert hands as the only San Diego journalist in a position to make the right things happen.

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Don Bauder Feb. 8, 2008 @ 10:39 a.m.

Response to post #11: Yes, the U-T touts candidates who will continue the city's deeply-embedded corruption -- no argument there. It has been true for decades and hasn't changed an iota. The one good thing is that the U-T is losing readership so fast that its deleterious influence is waning noticeably. The Reader will continue to expose the entanglements among the developer and hotel industries that manipulate the politicians, and the mainstream media that let it happen. Best, Don Bauder

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Anon92107 Feb. 8, 2008 @ 11:40 a.m.

One reality your readers should focus on was a Foreign Policy magazine column published in the L.A. Times this morning: "Can the world afford a middle class?" http://www.latimes.com/news/printedition/opinion/la-oe-naim8feb08,0,233776.story

This column provides an excellent frame of reference for the new world they have to compete in for resources and quality of life today, and the local corruption is just putting X & Y at an even greater disadvantage.

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Don Bauder Feb. 8, 2008 @ 7:29 p.m.

Response to post #13: Good article. Best, Don Bauder

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Anon92107 Feb. 9, 2008 @ 8:53 a.m.

Response to post #14:
OK Don, now how about a READER sponsored "Keep Mike Aguirre As City Attorney To Save and Protect The Future of San Diego" or lose it all to the corrupt U-T establishment campaign?

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Don Bauder Feb. 9, 2008 @ 11:05 a.m.

Response to post #15: I agree that Aguirre should be reelected. Best, Don Bauder

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JohnnyVegas Feb. 9, 2008 @ 7:52 p.m.

Mike will get re elected, there is no question about it.

If Peters and others throw their hat in that is even better- because then you will get a vote split on challengers.

Also, I called it 6 months ago that Sanders is not going to be re elected. I do not really think Francis is the answer, but anyone is a step above Sanders.

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Don Bauder Feb. 9, 2008 @ 9:01 p.m.

Response to post #17: Francis is saying all the right things. He realizes how corrupt the system now is. He realizes the stranglehold the developers have on the pols. He wants to change that. Hooray. Best, Don Bauder

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Anon92107 Feb. 10, 2008 @ 3:05 a.m.

Response to posts #17 & 18:

You guys are right on, but I still never cease to be amazed by the San Diego U-T lemming subscriber mentality that the U-T keeps proving with the success of their deranged rant editorial power, especially when Sanders was elected in spite of the fact that Francis was the GOP candidate in last election.

As long as the U-T has any subscribers it appears that they will always be able to dominate San Diego politics by brainwashing enough lemmings to get their mayoral puppeticians elected.

You must educate the lemmings Don, keep trying, harder.

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Don Bauder Feb. 10, 2008 @ 7:57 a.m.

Response to post #19: Be patient. Things are changing. Note the difference between the Steve Francis of the last election and Steve Francis now. He has access to polls and uses them to form his campaign approaches. The public is beginning to realize how the developers/hoteliers run the politicians. The city is run for the financial benefit of a handful of people who line the pockets of those pols, while the U-T applauds. San Diegans are figuring all this out, and the U-T is slowly dying. Best, Don Bauder

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Anon92107 Feb. 11, 2008 @ 2:38 a.m.

Response to post #20:

Don, I think your readers are basically the only people who are really aware of the severity of the destruction that the corrupt U-T establishment is causing. Beyond The Reader, there really doesn't appear to be much awareness or sense urgency to vote against these destructive U-T political forces.

I hope you are right about Francis, and that he will do a much better job of informing San Diegans about the needs for immediate political changes than has been done in the past.

Right now it still looks like Aguirre is in very great trouble because of the successes that U-T editorials still have with brainwashing San Diego’s lemming voter population to continue voting for U-T “Ballot Recommendations” against Aguirre and Francis without thinking.

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Don Bauder Feb. 11, 2008 @ 7:06 a.m.

Response to post #21: The U-T's dishonest smears have no doubt hurt Aguirre's chances. However, everybody who has professed interest in running against him is carrying a lot of baggage that has not been brought out yet. It will be, although not, certainly, in the U-T. This will get very interesting. Guaranteed. Best, Don Bauder

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Anon92107 Feb. 11, 2008 @ 11:51 a.m.

Don, it is not just the U-T now that controls San Diego voter lemmings but also the sycophant editors at Voice Of San Diego who parrot the U-T’s deranged rant editorials attacking Aguirre.

And now VOSD has even attacked you because they fear your highest journalistic standards of honor and integrity that exposes the destructive establishment corruption that VOSD represents.

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Don Bauder Feb. 11, 2008 @ 9:08 p.m.

Response to post #23: The Voice has a right to attack me or anybody else. We journalists whack others; we have to be able to take it. And that's what blogs are all about: people excoriating each other in a battle of ideas. The author of the blog is ideally one of the main targets of the blasting. Best, Don Bauder

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Anon92107 Feb. 12, 2008 @ 1:42 a.m.

Response to post #24:

I appreciate your humble opinion of yourself Don, but nevertheless the point I am making is that Voice has most sadly turned into Voice Of "U-T Establishment Corruption" and forfeited all right to claim to be Voice Of "San Diego" that Barbara Bry had created in the first place back in the founding days when Voice still had integrity.

After Barbara left, the new U-T sycophant Voice editorial board joined in jackboot step with the U-T editorial board to write the same deranged rants against Aguirre and anyone who dares to challenge their corrupt establishment demagoguery.

It is most hideously ironic that the Voice’s most respected columnist from an international journalism perspective is James Goldsborough who was forced to resign from the U-T by the same corrupt parochial establishment which now controls Voice.

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Don Bauder Feb. 12, 2008 @ 7:21 a.m.

Response to post #25: Yes, the Voice's repositioning itself as an establishment mouthpiece is most unfortunate -- for San Diego, and for the Voice's economic future. Goldsborough resigned from the U-T after owner David Copley killed a column. For me, that would not have been a reason to resign. I had had a number of columns killed, and didn't know whether David was involved or not, and didn't care. But I respect Goldsborough greatly. His columns on Iraq prior to our attacking that country were prescient indeed. Best, Don Bauder

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Anon92107 Feb. 12, 2008 @ 11:16 a.m.

Don, I guess what really motivates me most to fight back as aggressively as I can is that the U-T Establishment, which Goldsborough defined in one of his Voice columns by the way, is that too many San Diegans have lost their lives and are at still at unacceptable risk today because of the wholesale larceny by U-T puppeticians (e.g. Golding, Murphy, Sanders) controlled by the establishment who are enabled by too many judges to steal money from public safety funding to the extent that even police and firemen/women in Harm's Way are at unacceptable risk due to lack of resources.

And the worst part is that no one even seems to really care, much less remember the excess 2003 and 2007 firestorm deaths anymore because too much got out of control because of too few resources because of U-T Establishment larceny, and now VOU-TE (formerly VOSD) editors are goosestepping right behind U-T editors.

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Don Bauder Feb. 12, 2008 @ 11:28 a.m.

Response to post #27: Do you remember the approximate date of Goldsborough's column defining the establishment? That interests me. Best, Don Bauder

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Anon92107 Feb. 12, 2008 @ 12:15 p.m.

Don, it was in the April 27, 2005 issue of Voice of San Diego when James Goldsborough wrote a column: “San Diego: What Now?” which defines San Diego’s number one political problem that produced San Diego’s Financial Crises:

“city's power brokers --- the ‘downtown business community,’ which is euphemism for ‘Republican Party,’ and The San Diego Union-Tribune, a Republican newspaper, has corrupted city democracy.”

Don’t forget one defining hellacious consequence of U-T establishment larceny of public funds was when Mayor Murphy refused to continue leasing a helicopter just before the 2003 firestorm, a helicopter that could have prevented some of the fires from getting out of control in the Scripps Ranch and other areas, and this is just one of far too many failures by U-T puppeticians to provide enough resources for firefighters to save lives, protect themselves and property.

Since then San Diego has a lot more helicopters even though the establishment puppets CYA’d each other during the 2003 firestorms that more helicopters wouldn’t have helped.

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JohnnyVegas Feb. 12, 2008 @ 12:19 p.m.

The VoSD does not attack Don. Sure, one guy made a comment a months or so ago, but it was an aberration.

Plus, under the comments sections almost everyone has an opinion about Don, agree or disagree, but they do not attack him.

Now me, I get attacked all the time-when you take the positions I take and make the high octane comments I make you better be able to take some criticism.

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Don Bauder Feb. 12, 2008 @ 9:06 p.m.

Response to post #29: It sounds like that 2005 column by Goldsborough was quite perceptive. Best, Don Bauder

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Don Bauder Feb. 12, 2008 @ 9:09 p.m.

Response to post #30: Johnny, we both get attacked. I'm used to it and so are you. We stick our necks out and have to expect to fight off posses carrying nooses. Best, Don Bauder

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Anon92107 Feb. 13, 2008 @ 1:36 a.m.

Response to post #31:

Don't forget to focus on the death and destruction that the "city's power brokers" have caused.

The San Diego Power Broker Era of larceny, death, disease and destruction must be brought to an end this year.

It is time for The Reader to become the dominant San Diego journal, time to end Union-Tribune corruption that you, Goldborough and Aguirre have exposed.

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Don Bauder Feb. 13, 2008 @ 6:57 a.m.

Response to post #33: Larceny by the establishment has been going on for many decades. I hardly expect it to end this year. Best, Don Bauder

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