Streetwise Professor

Retiring Congressman Eric Massa is a Naval Academy classmate of mine.  I did not know him at Navy, so I have no direct personal knowledge about him.

I can say, though, that if what is stated here is true, Massa would be a predator.  I couldn’t give a damn about his sexual orientation, but a predator is beyond the pale, regardless of whether the prey is of the same gender or not.

In his defense, Massa claims that these stories are slanders intended to drive him from politics because of his opposition to Obamacare.

But, of course, these stories are not mutually exclusive.  Massa could be a predator whose inclinations and behavior were not a secret, and which were revealed by hatchetmen for purely partisan reasons.  That had he not crossed the wrong people politically, his sick secret would have remained such.  Had he not crossed the Chicago mafia, perhaps he would not be watching his life, and his family’s life, go down in flames.

The sad thing is that if I had to bet, that’s where I’d put my money.  After all, there are many no votes, any one of which would be equally useful for Emmanuel, Pelosi, and Obama to flip or eliminate.  Why Massa?  Most likely because he was vulnerable, because what is being said about him is close enough to the truth that he cannot stand and fight.  I’m sorry to say it, but that’s the most likely explanation.

That doesn’t make it right, even if it is true.  Have we sunk so low that the fate of the health care of hundreds of millions of Americans, and trillions of dollars, hinges on the perversions, alleged or real, of a single congressman, and the willingness of a ruthless and shameless set of opportunists to exploit them, ignoring in the process the vehement opposition of a solid majority of Americans?  Is our polity so decadent that the most solemn offices are held by people who are vulnerable to blackmail, and those who are willing to engage in it?

Greece desperately needs people to buy its bonds.  So what does it do?  It excludes potential buyers, specifically hedge funds:

Greece ordered its bankers to exclude hedge funds from a bond offering this week in an effort to punish the speculators it blames for destabilising its debt markets.

The decision came amid growing anger among European leaders over what they see as the role speculators played in undermining the Greek debt market and driving the country towards a possible default.

. . . .

According to people familiar with this week’s €5bn (£4.5bn) Greek bond issue authorities in Athens told banks handling the sale to make sure they did not allocate any bonds to hedge funds or any bodies that might be a proxy, or front, for them.

Uhm, those hedge funds that want to buy are going to result in lower interest rates for Greece.  Excluding them from the primary market can only make things costlier for Greece.  (Although since these folks can buy in the secondary market, the effect of excluding them from an auction might not be that large.)   You don’t punish bearish hedge funds (not that they deserve punishment in any event–see below) by taking a smack at bullish ones.  How assinine.

The Queen of this Greek drama, Prime minister Papandreou is absolutely over the top with his anti-speculative rants:

Greek Prime Minister George Papandreou, drawing parallels with the 1947 fight to contain communism in Europe, called for trans-Atlantic cooperation to combat “unprincipled speculators” who threaten to bring a new global financial crisis.

“Europe and America must say ‘enough is enough’ to those speculators who only place value on immediate returns, with utter disregard for the consequences on the larger economic system,” he said in a speech today in Washington. “An ongoing euro crisis could cause a domino effect, driving up borrowing costs for other countries with large deficits and causing volatility in bond and currency rates across the world.”

Papandreou and other leaders such as German Chancellor Angela Merkel have blamed much of the surge in Greek financing costs on market speculation, rather than its inability to tame the region’s biggest budget deficit. Germany and France are pushing for curbs on “speculators” using derivatives to bet against Greek debt, which will be ready in June, officials in Berlin and Brussels said today.

Papandreou called the market for credit-default swaps a “scourge” that “haunts Greece and all of us.” U.S. and European regulators need to bolster regulations to curtain such activities, he said, or “a small problem could be the tipping point in an already volatile system.”

Puh-lease.  I mean seriously.  What should haunt you, Mr. Prime Minister, is years of profligacy only partially concealed by financial chicanery (enabled, true enough, by some of the very banks against whom you rail today).  If you are facing some sort of financial  Armageddon, it’s the fault of your government and its predecessors, dating back years.  I would say that it was the governments of Greece–and other countries, the US included–that acted with “utter disregard for the consequences on the larger economic system.”

And which are acting with such utter disregard today.  Only more so.

But the shoot-the-messenger histrionics don’t end with Papandreou.  All of Europe’s government leaders are closing ranks to blame everybody but those who actually spent the money they didn’t have and couldn’t pay back.  Here’s Sarkozy:

“If Greece needs them (the measures), we’ll be there,” he said. “Speculators … must know that ’solidarity’ means something.”

France, Germany and Greece will take a common initiative to fight speculation, and the euro zone’s two biggest economic powers “have decided to do what’s necessary so that Greece is not isolated,” Sarkozy said.

And Merkel:

German Chancellor Angela Merkel said that Greece doesn’t need financial aid, as she turned her focus to restricting the use of derivatives to halt “speculators” from exploiting countries’ budget deficits.

“Credit-default swaps, where you insure your neighbor’s house just to destroy it and make money from it, that’s exactly what we have to curb,” Merkel said at a joint press conference in Berlin yesterday with Greek Prime Minister George Papandreou.

. . . .

“We must succeed at putting a stop to the speculators’ game with sovereign states,” Merkel said. “We can’t allow speculators to be the profiteers of Greece’s difficult situation.”

So the Merkel story is, effectively, that the Greek financial house was all in order, nice white stucco and all, until one day, out of a clear blue Aegean sky, some malicious speculators decided to burn that house down.

What a crock.

It would be more accurate to say that the Greek financial house was used to store gasoline, while the family was busy puffing away on cigarettes (the Greeks being among the greatest smokers in Europe, BTW) and throwing their butts and matches around with abandon.  Some people noticed this, figured out something bad was almost inevitable, and put their money where their eyes were.  Yes, they probably made a few bucks for themselves, but also did the service of accelerating the inevitable fiscal reckoning, not just in Greece, but in Europe as a whole.

Oh, and even Merkel’s own German financial regulator, BaFin, denies that speculation caused the Greek crisis:

German market regulator BaFin said Monday that so far, it doesn’t see any sign of massive speculation in credit default swaps against Greek government bonds, despite some recent press reports suggesting this.

A significant reason behind widening CDS spreads is the increasing demand for insurance against Greek risk, BaFin said in a statement, adding that it closely watches the government bond and credit derivatives markets for selected euro-zone countries.

. . . .

BaFin said data published by the U.S. Depository Trust & Clearing Corporation don’t signal an increase in new open positions and don’t indicate massive speculation. It is true, however, that the gross volume of outstanding CDS contracts for Greek government bonds amount to around $83 billion as of Feb. 12, according to DTCC, more than twice the $41.1 billion a year earlier.

In other words, Papandreou, Sarkozy, Merkel et al are saying: “Don’t bother me with the facts.”  They don’t want to face up to fiscal realities, so they are trying to direct blame elsewhere.

Politics as usual, in other words.  And it is politics as usual that put Europe in this positions in the first place, and politics as usual that will prevent any fundamental change.

Roseanne Rosannadanna has apparently weighed in on Russia’s highly touted policy to replace a 19th century-style mass conscription army with a volunteer force based on “contract” soldiers:

Roseanna Rosannadanna Nevermind

Specifically, Russian Chief of the General Staff Nikolai Makarov has announced that the army will continue to rely on conscripts rather than transition to a volunteer force (per EDM):

Controversy returned to the Russian Chief of the General Staff and First Deputy Defense Minister, Army-General Nikolai Makarov, following an interview on February 25, during which he seemed to signal a policy reversal on the issue of further developing contract personnel numbers (Kommersant, Russia Today, Interfax, February 25). Makarov pointedly asserted, “We are not going to switch to contract service. Too many mistakes have been made, while the task of building a professional army has not been fulfilled. So the decision was made that conscript service will remain in the armed forces,” adding that, “We are increasing conscription and cutting down the contract component. We have realized that contract servicemen must be trained using new methods.” Sensationalist interpretations of his comments were offered, among others, by Gazeta.ru, which claimed that he was in effect “tearing up contracts” (www.gazeta.ru, February 26). Moreover, some critics suggested that his plans contradicted part of the new military doctrine signed by President Dimity Medvedev on February 5.

Nevertheless, Makarov was actually simply highlighting that for the time being the possibility of using kontraktniki as the basis of the armed forces is unrealistic. This reflects the awareness that the future backbone of the line units will be the new professional non-commissioned officers (NCO’s), trained in courses lasting two years and ten months at Ryazan, and these will not serve in units in any meaningful numbers until 2013-2015 at the earliest. Equally, had Makarov fallen into the trap of advocating professionalizing the force structure and abandoning conscription, his critics would have denounced him for promoting unaffordable plans.

Strategy Page has more:

It was thought that getting rid of conscripts would do the trick [of getting rid of дедовщина; search on that term in Youtube if you want to see more videos of the practice--and if you can stand watching gratuitous brutality]. Not so. Although the volunteers were in for more than three years, rather than two (and now one) for conscripts, the lack of effective NCOs saw the bad habits persist. Thus the need to develop professional NCOs to keep things under control in the barracks.

Volunteers cost a lot more than conscripts, but there is not enough money to do away with conscription. Russia uses some volunteers, especially for combat duty in places like Chechnya. These troops get paid on a scale equal to, and, with combat pay, above civilian wages. Conscripts get a few dollars a month. The volunteers expected better living conditions, and often didn’t get it. So they left.

The hazing has been one of the basic causes of crimes in the Russian armed forces. The hazing accounts for 20 to 30 per cent of all soldier crimes. This has caused a suicide rate that is among the highest in the world. Poor working conditions in general also mean that Russian soldiers are nearly twice as likely to die from accidents, or suicide, than American soldiers.

With hazing, and the resulting poor morale and discipline, the military is also unable to keep many of its experienced and capable NCOs. Many of the best ones have been leaving the military, despite better pay and living conditions. All noted the problems, caused by hazing, as a major reason for getting out.

Conscription itself, and the prospect of being exposed to the hazing, has led to a massive increase in draft dodging. Bribes, and document fraud, are freely used. Few parents, or potential conscripts, consider this a crime. Avoiding the draft is seen as a form of self preservation.

The Russian lack of sergeants (praporshchiki) has been difficult to fix. Just promoting more troops to that rank, paying them some more, and telling them to take charge, has not done the job. So going back to look at how Western armies do it, the Russians noted that those foreign armies provided a lot of professional training for new NCOs, and more of it as the NCOs advanced in rank.

So the Russians opened an NCO Academy. It will eventually take 2,000 NCOs a year, and put them through a 34 month course in how to be a superior NCO. Much of the instructional material is being borrowed from the West, where similar NCO schools have been around for decades. None of these schools, however, keep their students for nearly three years. But the Russians know that they have to break a chain of tradition (hazing among troops, deferring all decisions to officers, and so on) that has crippled the Russian army for over half a century. Thus the long course, in an attempt to drill the bad old ways out of these carefully selected troops, and inculcate new methods borrowed from successful professional armies in the West. The graduates of these academies will become platoon and company sergeants (1st Sergeants) and sergeants major for battalions. They will, as in the West, have the respect and trust of the troops, and serve as an intermediary between the officers and the troops. As in the West, the new NCOs will look after the welfare of the troops, especially when the officers are not paying as much attention as they should. The new NCOs will be paid as much as a high ranking officers ($1,100 a month), which will help attract the most suitable candidates. [This pay compresssion will also serve to tick off the officers, and thereby create other kinds of morale and leadership problems.]

A three year training program is bizarre, and a testament to how bad the problem must be.  It essentially means that training of NCOs must be hermetically sealed from what transpires in the units and the barracks, for long periods of time, for fear that exposure to the prevailing unit/barrack culture will ruin the NCO.  But this will just create more problems.  In the US military, and the British and French and other capable forces, NCOs develop by coming up through the ranks and experiencing what the privates and lance corporals experience; learning by doing is the essence of becoming “an intermediary between the officers and the troops.” This informs their actions as NCOs.  Moreover, in addition to their shared experiences, the continued connection between NCOs and their charges is what builds trust and respect (for those who deserve it–and leads to trouble for those who don’t).  The grunts know that the sergeants know what it is like to be a grunt.  That’s unbelievably important.

In contrast, Russian NCOs parachuting into units from their three year isolation will be viewed with suspicion, as out-of-touch outsiders.  Moreover, knowing the way that identifying anyone as “special” affects they way that they view others not so designated, and the way that the unspecial view them, the new NCOs will tend to look down on their subordinates, and their subordinates will resent them.  Their subordinates will also doubt whether their sergeants really know what it is like to be a Russian private.  Moreover, the pay compression is hardly calculated to make the officers all that fond of the NCOs either.

In brief, the Russian military, and the army in particular, seem stuck in a very bad equilibrium with no way out.  The current system has led virtually anybody but the most marginal and desperate to attempt to avoid conscription; Wellington’s description of his soldiery seems to fit Russia’s:

A French army is composed very differently from ours. The conscription calls out a share of every class — no matter whether your son or my son — all must march; but our friends — I may say it in this room — are the very scum of the earth. People talk of their enlisting from their fine military feeling — all stuff — no such thing. Some of our men enlist from having got bastard children — some for minor offences — many more for drink; but you can hardly conceive such a set brought together, and it really is wonderful that we should have made them the fine fellows they are.

The differences are that: (a) the Russian army is theoretically on the French model in which everyone serves, and has all the disadvantages thereof without any of the compensating benefits, and (b) it is highly doubtful that the Russian system has made its soldiers “fine fellows.”

But the alternative of creating a professional force with elan and morale is beyond reach, and the extreme measures intended to achieve it are unlikely to succeed.  What Russia needs is NCOs that are essentially the best of the men whom they command, only older and more experienced; a special caste of NCOs will come with its own special problems.

This makes the second part of the EDM article all the more amazing.  It states that Russia is attempting to move to network centric warfare, based in part on the less than stellar performance of the army in the Georgian War (which is pretty amazing since the units involved were among the best in the service).  But network centric warfare depends crucially on trained and motivated soldiers.  A conscript army is unlikely to cut it, even (especially?) if leavened with a number of NCOs created in isolation from the units they are supposed to lead.

I continue to believe that it is a very clear understanding of the debilitating dysfunctions of the Russian military that is a major source of the government’s paranoia about NATO.  Look, even if it wanted to, NATO couldn’t realistically invade Russia; the numbers are too small, and the logistical obstacles too daunting.  And it really, really, really, doesn’t want to.  But to Russian leaders already marinated in paranoia, the knowledge that their military is really an empty shell–at best–can only intensify that paranoia.

* Maybe it’s Nirvana instead of Roseanne Rosannadanna: Nirvana Nevermind

I’m just back in Houston from speaking at a conference at the Columbia Law School, titled “The Financial Crisis: Can We Prevent a Recurrence?”  It was probably the best conference I have ever attended.  It was a gathering of a truly talented group of academics (mainly legal scholars, but some economists), practicing lawyers, finance practitioners, central bankers (US and non-US), and government folks, all of whom offered excellent insights on various aspects of the crisis, and policy responses to it.  The organizers, Jeff Gordon of Columbia and Howell Jackson of Harvard Law School, are to be congratulated for putting on a phenomenal event.  It was a privilege to participate.

I spoke on clearing.  (Go figure.)  My remarks were well received, I think.  Robert Pozen of MFS Financial Management said in his remarks that he didn’t agree with a lot of what I had to say, but that any supporter of mandated clearing (which he is) had to take my critique seriously, and address the concerns I’d raised.  Which is quite fair.  I don’t claim to have all the answers, but I think I have good questions, and hope that posing them will contribute to the formulation of better policy.  (I started my talk with Hayek’s quote “The curious task of economics is to demonstrate to men how little they really know about what they imagine they can design.”  I think that some in policymaking circles think they know far more than they do about the systemic implications of clearing, and all I aim to do is what Hayek says economists should do.)

The conference finished up with a session on “Radical Solutions.”  Charlie Calomiris and Luigi Zingales gave very interesting talks that echoed two major SWP themes, namely that too big to fail is the result of governments’ inability to commit credibly not to bail out, and that the ultimate source of moral hazard and the excessive growth of financial institutions is that their creditors are convinced that they will be bailed out, and hence are willing to lend on terms that do not reflect risk.  They offered interesting proposals to address these problems.

One thing that struck me throughout the event is the widespread belief that financial reform efforts are dead in the water.  Some considered that unfortunate.  Others, including yours truly, were not so negative; not that I/we don’t believe that some sort of reform is needed, just that the alternatives on offer are likely to be counterproductive.

Today’s luncheon speaker was Henry Hu, a University of Texas law prof now heading up the SEC’s new Division of Risk, Strategy, and Financial Innovation.  I don’t always agree with Henry–I have criticized his analysis of the “empty creditor” problem, for instance–but he is obviously a thoughtful man who is bringing tremendous energy and enthusiasm to his DC job.  In his talk, he asked the audience to let him know whether they observed any new product or trading strategy that threatened to destabilize the financial system.  That’s fine, but I would also hope that he would be equally alert to regulations or legislation that could have deleterious effects; and be particularly alert to the creation of policies that could encourage the development of problematic strategies and products in direct response to such policies.

Friday’s dinner speaker was Simon Johnson.  I have an extremely mixed reaction.  I share his concern about too big to fail, and the potential for legislative and regulatory capture by the finance industry.  But given that I consider much of the proposed legislation to be counterproductive, unlike Johnson I don’t believe that it is axiomatic that bank opposition to this legislation is an outrage.  His is a very Manichean world view, with big finance as the epicenter of evil, and those who fight big finance as the avatars of goodness.  Not quite that simple, IMHO.

It was weird, to say the least, to hear someone channeling Andrew Jackson in a Brit accent.  He started out talking about TR taking on the trusts, and FDR taking on the banks, but I was thinking that his real hero should be Andy Jack.  Sure enough, a few minutes later he said that the true first opponent of financial oligarchy was Jackson.

Again, I have some sympathies; much of Jackson’s critique was correct, as is some of Johnson’s.  But much of Jackson’s criticism was misguided, and what’s more, the system that he advocated to replace the corrupt Second Bank of the US was plagued by chronic instability and crisis.  Johnson was less than candid about Jackson’s banking legacy: he would only admit that the post-Jackson banking system was “complex.”  But to admit that a previous populist response to concentrated financial power was hardly ideal would undermine Johnson’s populist jeremiad against today’s concentrated financial power.  That failure to confront the possibility that a populist reaction can be destructive undercuts Johnson’s credibility in my eyes.

Johnson’s tone was also extremely off-putting.  It was snide and arrogant.  He came off as a populist provocateur poseur.  Not particularly appealing.  But worth hearing nonetheless.

At the conference, there was a lot of agreement about the underlying causes of the crisis.  There was, however, less agreement about policy responses going forward.  That’s not surprising, but given the caliber of the people at the conference, it does suggest that we are in for a long debate over policy going forward.

And while I was at the Columbia conference, SWP daughter Renee was at a conference at Texas A&M, sitting 10 feet from George H. W. Bush and Barbara Bush.  And someone really important: Chuck Norris.  And she lived!  (He gave the death glare to one of her friends who was laughing too hard at something.)  Nobody quite that famous at Columbia, but it was worth the trip nonetheless.

For a moment last night I had my doubts about that (Jethro Tull) wisdom, at least insofar as fairly hardcore punk is concerned.  After class my eldest and I headed a couple of miles cross town to The Warehouse to see the Dropkick Murphys.  The crowd was, uhm, interesting.  The Rancid/Rise Against crowd was mainly awkward kids.  Social D, aging X-ers.  Everclear, upscale fuddy duddies.  Murphys: mainly folks in their 20s, very high testosterone levels, and higher alcohol and controlled substance levels.  Haven’t seen that many wasted people in a very long time.  Maybe ever.  But then I’ve lived a pretty boring life.

There was a huge amount of pent up energy that was released in a frenetic explosion at the first chords from the Murphys.  A good part of the people in the crowd near us (about halfway to the stage) immediately began pumping both arms alternately in the air at high speed.  They looked like those punching nun puppets.  Then  the bodies started flying as several rather chunky guys began hurling themselves to-and-fro, looking to get pinballed by those around them.

Then the casualties started to stream out.  One girl came from near the stage with her nose pointed in a direction that God didn’t intend.  Then a guy with a gushing cut over his left eye.

A good time was had by all!

One guy next to me was way out of control, lurching wildly from side to side.  He banged into me once.  The second time I fended him off with a forearm to the left kidney.  The third time he came harder, and almost trampled Renee, so I sent him semi-sprawling with a two handed push.  The next time, I thought it was going to get ugly because he came at me squared up, with both arms in the air.  But all he did was give me an I-love-you-man hug, and then shouted in my face: “Murhpys! Yeeeeaaaaahhhhhhhhh!”  before his friends sort of dragged him away.  After catching his breath full force in the face, I don’t think I could pass a drug test today

After the first several songs and the associated release of energy, the crowd settled into a less excited state.  It was still rocking, but not frenetically crazed.

As for the Murphys, they were all that I expected.  Fast, loud, entertaining.  (Heh.  “Wild Rover” just came on my Pandora.)  Interesting mix of instruments.  Bagpipes, of course, but also banjo, mandolin, and accordion.  Not a lot of talk, just song piled on song, almost all fast.  The stage set was attractive, with several Celtic crosses on the speakers.  The backdrop for most of the show was a Celtic Church Gothic scene.  Later there was the obligatory punk rock band smiling skull (with an eyepatch), and lastly a dawn skyscape.

All in all, very much worth it, despite my initial reservations.  One weird thing.  Being there you got the impression that the show was very spontaneous and unscripted, but it started precisely at 10:30 and ended exactly at midnite.  Exactly.  So exactly, it couldn’t have been an accident; instead, a very tight, well-rehearsed, 90 minute set.  I wondered if the two huge tour bused parked outside were about to turn into pumpkins or something.

Bottom line?  I can’t reject the Tull hypothesis.  Not yet anyway; the Streetwise Professor lives.  So bring on the next show!

The Greek crisis (or, more generally, the EuroSov crisis) is leading to increasingly shrill calls to line up short sellers–and especially “naked” CDS buyers–against the wall for summary execution.  Among the shrillest is this piece by Wolfgang Munchau (sorry about the missing umlauts):

I generally do not like to propose bans. But I cannot understand why we are still allowing the trade in credit default swaps without ownership of the underlying securities. Especially in the eurozone, currently subject to a series of speculative attacks, a generalised ban on so-called naked CDSs should be a no-brainer.

Naked CDSs are the instrument of choice for those who take large bets against European governments, most recently in Greece. Ben Bernanke, the chairman of the Federal Reserve, said last week that the Fed was investigating “a number of questions relating to Goldman Sachs and other companies in their derivatives arrangements with Greece”. Using CDSs to destabilise a government was “counter-productive”, he said. Unfortunately, it is legal.

I only have time for a few comments.

• Like Wretched Gretchen Morgenson (whom I adamantly will not link to, not wanting to corrupt impressionable minds), Munchau lumps together CDS and other kinds of derivatives, namely currency and interest rate swaps that oh-so-pure European governments used to conceal their debts.  Is he ignorant?  Is he duplicitous?  Does it matter? It is incorrect, and it is misleading.
• He trots out the tired “CDS are insurance-insurance law prohibits buying insurance without insurable interest-so we should ban naked CDS purchases” argument.  Beware misleading analogies.  Try to understand the particular reasons why, in general, an insurable interest is required to by life insurance on, say, Wolfgang Munchau or fire insurance on his dwelling.  Moral hazard, for instance: Wolfgang’s life and home could be in some jeopardy if this were allowed.  Of course, resources could be devoted to investigate anything untoward that happened to Mr. Munchau, thereby deterring such abuse, but this is costly, and it is difficult to see any social benefit at all from permitting others to bet on Mr. Munchau’s longevity or the reliability of the wiring in his home.
• Which brings us to Mr. Munchau’s most important point: that there is NO social benefit associated with naked CDS.   He says:
  

  It is a purely speculative gamble. There is not one social or economic benefit. Even hardened speculators agree on this point. Especially because naked CDSs constitute a large part of all CDS transactions, the case for banning them is about as a strong as that for banning bank robberies.

• Not a single social benefit?  All speculators agree on this?  That’s a pretty strong assertion, which is just that: an assertion, offered with little argument and less evidence.  I agree that it is unlikely that the social benefits and social costs of speculation do not align with the private benefits and private costs.  For instance, a good deal of speculation is rent seeking activity, where individuals expend resources to collect information which they trade on in order to receive a transfer from some less-informed sucker.  But that’s different from saying that speculation has no benefit whatsoever.
• In particular, the information that is embedded in prices by informed speculators can lead market participants to make better decisions, or more timely ones.  This was no part of the speculators’ intentions, but it is a benefit of speculation nonetheless. To the extent that speculation leads to a speedier, and more credible, revelation of the wasteful profligacy of spendthrift governments (or banks, or corporates), the sooner and more effectively this waste can be curbed.  For instance, if you think corporate fraud is wasteful (think Enron), you should also think that short sellers that detect it and profit from it and lead to its ultimate revelation are providing a valuable social benefit.
• Again, there’s no clean alignment between the individual incentives of speculators and the benefits of their activities, but that’s quite a different thing from saying that there is no benefit at all.  And as Mr. Munchau’s article demonstrates, there’s a real choice involved since it’s impossible to quantify the costs and benefits of any particular speculative trade: you either ban it or let it go (with, perhaps, rules against purely opportunistic activity, such as spreading false information to enhance the value of a speculative position).
• Mr. Munchau has absolutely no data on how much CDS purchasing is naked.

Muchau’s outrage is shared by virtually every government in Europe.  Spare me.  This is clearly shooting the messenger.  As James Carville noted long ago, the bond market (and now, the CDS market), disciplines governments, and they don’t like it one bit.

This article from Bloomberg hits the nail squarely:

Blaming derivatives for governments’ financial problems is like faulting the “mirror for your ugly face,” according to analysts at Citigroup Inc.

. . . .

“We would do better to spend our time addressing the defects the mirror shows than blaming the mirror,” Citigroup analysts led by Michael Hampden-Turner in London wrote in a note to investors. “After all, banning mirrors does nothing at all to make the world a prettier place.”

Damn right.  Nobody likes market discipline, especially governments.  But they’re the ones who usually need it the most.  Hence we should resist cynical, self-interested calls to terminate CDS speculators, and instead pay more attention to the message they are sending about the unsustainability of fiscal policies in Europe, and around the world.

The Russians have got their Jockskis in a bunch (I know, so what else is new?), this time over the US plan to base missile defenses in Romania, and perhaps Bulgaria and the Black Sea.   Two particular aspects of the US-Romanian announcement frosted the Russians.

The first is that Russia found out about the deal through the press.  To which I say: (a) if that’s really true, perhaps the FSB is going the way of Russian Olympic sports if it can’t get advanced information about something like this from former satellite countries, (b) Russia is hardly noted for consulting with us on its diplomatic and military moves, and (c) given that Russia would no doubt have responded to any advance warning by pulling out all the stops to torpedo the deal, the administration was quite right in keeping it under wraps and announcing a fait accompli.

The second is the fact that the Russian Foreign Ministry spokesman Nesterenko (any relation to Blackhawk legend Eric Nesterenko, the Man from Flin Flon?) used the word “unilateral” more than once in his denunciation of the agreement.  What this means is that Russia expects to be not just consulted, but deferred to, on any military agreement involving sovereign nations in what it fancies to be its sphere of privileged interest.  For refusing to countenance a Russian veto, the administration is to be congratulated.  (You can stop rubbing your eyes–yes, I complimented the Obama administration not once but twice in a single post.)

The Aegis/Standard missile systems in the western Black Sea pose even less of a threat (meaning zero threat) to Russian ICBMs than did the aborted Czech-Polish BMD sites.  (Though they could be used against some Russian IRBMs–interesting, that.)  Which means that the hyperventilating by the Russian FM and military about the threat to its nuclear deterrent is just so much baloney.  What really gets them is the thought that their former vassals would have the temerity to exercise their own sovereignty without even a by-your-leave to Russia.  This is also the case with the Russian apoplexy over the basing of Patriot missiles in Poland.

Which leads me to say again: if you have nothing attractive to offer, what do you expect?  Flies, sugar, gall, remember?

This is important as a potential counter to Iran, and as a statement to the eastern Europeans that they are not being left to the tender mercies of Russia.  I would have preferred that this missile defense initiative would have been undertaken in addition to the Czech-Polish BMD initiative.  But something is better than nothing.  And again, the sites are important in and of themselves, but they have a broader importance in bolstering shaky nerves in eastern Europe, as argued in this Wess Mitchell and Robert Kron oped:

North Central European allies have been concerned by marked increases in Russian revisionist rhetoric and behavior (remember Georgia?). They have been alarmed by the perception of U.S. disengagement, embodied by the Obama administration’s decision to abandon plans for a ground-based Ballistic Missile Defense (BMD) system anchored in Central Europe. Their calls for “strategic reassurance” have sparked a debate in NATO about the security needs of the region, centering on the question of whether Polish and Baltic-State threat assessments vis-à-vis Russia are accurate.

This is the wrong question to be asking. Lost in the debate is the detrimental effect that insecurity among Central European allies has on the Alliance and U.S. national interests–irrespective of the nature and extent of Russian capabilities and intentions. This state of affairs is ultimately unhealthy for theUnited States, the Atlantic Alliance and European integration.

. . . .

Washington need not adopt a policy of confronting Russia to assuage its regional allies, but would be wise to take action now, or risk allowing allied concerns to fester and pay the costs down the road.

That is, this is about more than missile defense and Iran per se.  Which is why the Russians are so apoplectic about it.  And which is why the administration should continue to proceed, Russian tantrums and all.

I wonder when the next tu quoque deal with Hugo Chavez or Nicaragua will be announced.  Maybe they’ll have to wait until Hugo can get the lights back on.

AEI’s Peter Wallison’s opinions on matters related to the financial crisis and financial regulation are highly and positively correlated with mine.  He has an excellent oped in today’s WSJ which echoes my views on the real source of moral hazard and too-big-to-fail: namely, bailouts don’t directly distort the incentives of bank executives and equity holders, but they do seriously distort the incentives of those who lend to banks:

The same failure to understand the power of moral hazard is what makes the administration’s call for a resolution authority most inapt and troubling. Although the administration has argued, and some in Congress believe, that moral hazard and too-big-to-fail would be curbed by a resolution authority, the opposite is true. Both would be enhanced.

This is because the principal danger of moral hazard—the key to its adverse effects on private decision-making—is its impact on creditors and counterparties. The fact that shareholders and managements will lose everything in a government resolution is largely irrelevant. What really matters are the lessons creditors draw about how they will be treated. And it is clear creditors will be treated far more favorably in a government resolution process than in a bankruptcy.

To understand why this is true, consider the administration’s reasons for preferring a government resolution process. The claim is that large, interconnected firms will drag down others when they fail. The remedy for this is to make sure their creditors and counterparties are fully paid when the takeover occurs. That’s why the Fed made Goldman Sachs and others whole when it rescued the insurance giant AIG. It’s also what distinguishes a government resolution process from a bankruptcy, where a stay is imposed on most payments to creditors when the bankruptcy petition is filed.

Creditors will realize that by lending to large companies that might be taken over and resolved by the government, their chances of being fully paid are better than if they lend to others that might not. Thus a resolution authority will enhance moral hazard not reduce it—and as creditors increasingly assume that large firms will be rescued, the too-big-to-fail phenomenon will grow, not decline. In the end, a resolution authority becomes, in effect, a permanent Troubled Asset Relief Program.

Exactly so.  The effects of this can be far-reaching.  For instance, it can make it rational for banks to take on excessive leverage.  Moreover, it can distort the types of leverage banks use; it tends to favor short-term debt and fragile capital structures, because it is that kind of debt that provides the greatest systemic risk, and hence is most likely to induce the government to ride to the “rescue.”

On these lines, note that the widespread belief that the government stood behind Fannie and Freddie debt allowed these entities to grow immense and highly leveraged.  Funny, isn’t it, that even though F&F are gulping down government money in quantities that make AIG look like a piker (another $15+ billion last quarter for Fannie, with NO end in sight), that this goes largely unnoticed, and draws nothing of the outrage that the AIG bailout does?

Wallison also expresses skepticism about the importance of contagion and interconnection in driving the financial crisis:

Then there is the proposal to give a government agency the authority to take over and “resolve” failing financial firms. Here, the administration has pointed to the chaos that followed the bankruptcy of Lehman Brothers in September 2008. To prevent that kind of breakdown, the administration says all large and “interconnected” financial firms in crisis should be dealt with by a government agency, rather than by a judge in bankruptcy proceedings.

The term “interconnected” is important here. It implies that when one large firm fails it will carry others down with it, causing a systemic crisis. But that is clearly not the lesson of Lehman. Although the company went suddenly and shockingly into bankruptcy, none of its large financial counterparties failed. The systemic significance of “interconnectedness” proved to be a myth.

There seems to  be a tendency to attribute any simultaneous implosions among financial firms to a contagion effect.  I think it is more plausible, however, that the observed correlation in distress reflected correlations in investment strategies across financial institutions, making them simultaneously vulnerable to a common shock.  In the event, it was exposure to real estate prices.

Look at the week or so beginning September 7, when the Feds took over Fannie and Freddie, followed by the Lehman collapse and the AIG bailout.  All of these were heavily exposed to real estate prices.  The most heavily damaged survivors, Citi, Merrill, and BofA most notably, also had big exposures.  Before them, it was Bear.  It wasn’t a single bad firm dragging healthy ones to which it was interconnected down with it; it was an epidemic of financial sickness caused by exposure to a single, common pathogen that simultaneously brought many firms low.

It is important to understand the relative importance of contagion and correlated solvency shocks in contributing to the crisis.  Most of the proposed “solutions” seem motivated by a belief that the crisis was a chain reaction made possible by excessive interconnectedness.  If this diagnosis is wrong, the prescriptions are likely to be either useless, or positively harmful.  The same is true with the diagnosis of the true source of moral hazard underlying TBTF.  Unfortunately, as Wallison suggests, we seem to be misguided here as well.  This doesn’t bode well for avoiding the next crisis.

My testimony at trial (in Chicago) in Trading Technologies v. eSpeed was quoted in the Court of Appeals for the Federal Circuit’s decision on the case.  I testified on behalf of TT.  The good guys won, at trial, and before the Federal Circuit.

The underwriters of the Rusal IPO have declined to exercise their “greenshoe option” to buy additional shares.  Surprise, surprise, surprise.