Streetwise Professor

August 21, 2010

The Sausage Making Begins. I’m Sure It Will Turn Out Swell.

Filed under: Clearing,Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 7:07 pm

I’ve been writing for some time that Frank-N-Dodd will open a battle over derivatives market structure.  This battle will be waged in the markets, and in the political and regulatory arenas.  In particular, clearing mandates will lead to a protracted conflict.  The nature of the clearing business, with its strong scale and scope economies and the myriad competitive implications of alternative configurations of the clearing business will make this battle particularly intense.  And the stakes will be particularly high given the importance of clearing in the new financial architecture.

In an article forthcoming in the Journal of Applied Corporate Finance, I put it this way (link to follow when it’s available):

It is well known that the effects of central clearing on the costs of bearing counterparty risk and on systemic risk depend crucially on the equilibrium configuration of the clearing industry.  For instance, netting benefits are maximized when clearing is concentrated into a small number of multi-product clearinghouses—and arguably into a single CCP.  But the failure of an immense CCP would have disastrous consequences for the stability of the financial system, and could set off a daisy chain of failures of other CCPs, with further damaging effects.  Moreover, the scale and scope of CCPs are almost certain to affect incentives, governance costs, and the effectiveness and accuracy of risk pricing.  So it is by no means obvious what is the structure of the clearing market that optimally trades off these competing considerations.

It is equally unknown what clearing market structure will evolve, and how close this structure will come to approximating the ideal structure.  In this regard, it is essential to keep in mind two facts.

First, the extensive scale and scope economies associated with clearing make it likely that the clearing industry will be highly oligopolistic, and that strategic considerations will influence decisively the way that the industry develops.   Moreover, scope economies across trade execution and clearing (Pirrong, 2010b) will also affect the strategic and efficiency forces that will shape industry structure.  Strategic considerations will almost certainly drive a wedge between what is optimal for the individual decision makers, and what is optimal for the economy.  This is particularly true inasmuch as there is no market mechanism evident that would induce CCPs to internalize the systemic externalities associated with their failure.

Relatedly, governance and organizational form will matter.  For instance, for profit and not-for-profit mutual CCPs are likely to act differently.  Which choice is preferable?  What will determine CCP choices of organizational form?  CCPs are effectively cooperatives: how will collective action problems affect their incentives  and actions?  What regulations are required to address the governance problems that might arise under each form?  These are not easy questions to answer, but those answers will have an important effect on how clearing works in practice.

Second, industry evolution will inevitably be a highly politicized process.  Dodd-Frank gives regulators enormous discretionary authority over the operation of CCPs.  Interested parties will influence the regulatory process for their private benefit.  Political tradeoffs, rather than efficiency considerations, also threaten to cause serious divergences between the structure that evolves in practice, and the one that would optimize the relevant economic tradeoffs.  The effects of politics are particularly pronounced in this context because finance is a truly international industry, and hence jurisdictional issues and competition between jurisdictions will play a decisive role in determining the industry’s ultimate configuration.  For instance, governments in major financial centers (e.g., the US, London, the EU, and individual countries in the EU, Japan, Singapore, and Hong Kong) have all expressed a strong interest in domiciling CCPs, for both economic and political reasons.  But accommodating these interests would fragment clearing, reducing netting benefits and raising serious concerns about coordination during a crisis.  Moreover, regulatory competition between jurisdictions to favor their local CCPs could compromise financial market stability.

I’ve written elsewhere–long before the crisis, in fact–that there is a fundamental tension in clearing organization.  Risk control and moral hazard considerations provide a strong rationale to limit participation in CCPs, and/or to impose substantial capital requirements on participants.  But limiting membership to CCPs can also be a way of cartelizing the industry: given the strong scale and scope economies, a CCP that has fewer than optimal members can still be large enough to make it impossible for any other competing CCP to achieve the scale economies to compete with it.

What’s the right trade off?  Barney?  Chris?  Gary?

The politicized process is underway.  Bloomberg’s Matt Leising (article not online, it appears) and the WSJ describe how the battle lines began to form at a recent CFTC-SEC public workshop.  The competition-risk trade-off is a main axis of conflict.  First Matt Leising, describing the arguments of those who favor opening up CCPs to encourage competition:

Financial firms should be allowed to become members of over-the-counter derivatives clearinghouses even if they don’t meet current minimum capital requirements, according to an industry group. The Commodity Futures Trading Commission and Securities and Exchange Commission should allow smaller firms that don’t meet clearinghouse guidelines to become members, said Jason Kastner, vice chairman of the Swaps and Derivatives Markets Association.

Kastner spoke at a roundtable discussion today on OTC derivatives clearing at CFTC headquarters in Washington. Clearinghouse operators Intercontinental Exchange Inc., CM Group Inc. and LCH.Clearnet Ltd. in the $615 trillion privately negotiated derivatives markets enforce capital requirements and trading rules intended to bolster the ability of their organizations to withstand losses. Those requirements prevent all but the world’s largest banks, including Goldman Sachs Group Inc., JPMorgan Chase & Co. and Barclays Plc, from sending trades to the clearinghouses, the SDMA told the Federal Reserve in June.

“It’s not just about capital,” Kastner said today, referring to rules such as Intercontinental’s that members of its credit-default swaps clearinghouse have a minimum net worth of $5 billion. Regulators should create and enforce rules so that smaller firms can become members so “that it’s somehow proportional.”

But then Matt notes that some argue that Dodd-Frank is about reducing systemic risk, and has nothing to do with competition:

The main purpose of the financial-reform law, named after its principal authors, Connecticut Senator Christopher Dodd and Massachusetts Representative Barney Frank, was to make the financial system stronger by increasing risk-management standards, said Jonathan Short, a senior vice president at Intercontinental.

“It all sounds great on paper to say ‘let a thousand flowers bloom,’” he said. “I’ve never heard the Dodd-Frank Act
described as something that was done to promote competition among firms.”

[It should be noted that Dodd-Frank does include provisions encouraging competition and enjoining CCPs not to violate anti-trust rules.  How to reconcile that with the injunctions to reduce systemic risk?  Who knows?  Not Dodd and Frank’s problem.  They just wave their wands and presume the broomsticks will take care of it.]

This all makes some people nervous:

Ananda Radhakrishnan, director of the CFTC’s Division of Clearing & Intermediary Oversight, said he would hesitate before telling clearinghouses to lower their capital standards for members.

“As someone in charge of clearing, I’m reluctant to tell someone ‘you should lower the level of capital,’” he said. [In charge of clearing?  Think much of yourself, Al Haig Radhakrishnan?]

The WSJ article notes that people have picked up on the tension inherent in the issue:

James Hill, a global credit-derivatives officer at Morgan Stanley, warned that if companies without proper risk management expertise were allowed into the clearinghouses, “they will become the next “too big to fail,” and we don’t want to do that.”

After J.P. Morgan Chase & Co. managing director Jeremy Barnum said regulators would have to weigh “very complicated tensions” in determining how to write the rules, Mr. Kastner shot back that “it’s not credible to say it’s complicated.”

Not credible, indeed.

So, barely weeks after the passage of Dodd-Frank, we are seeing the sausage making process begin.  Efficiency and rent seeking and competitive considerations are all going into the hopper.  Who the hell knows what will come out the other end?  The potential for a colossal mistake–or mistakes–is great.  And these mistakes will be systemic in the effect.  For as I also say in the JACF piece:

This change is fraught with potential unintended consequences.  It is predicated on a belief that market participants systematically chose the wrong ways to trade derivatives and allocate the default risks inherent in them, but there strong reasons to believe that in fact many of the institutions adopted prior to the crisis had a strong economic rationale.  This means that forcing the implementation of a particular market infrastructure via legislative fiat runs the serious risk of reducing the efficiency of the financial markets.  In particular, although it is intended to reduce systemic risk, the mandating of expanded clearing carries its own systemic risks.  Moreover, the future evolution of market structure is highly uncertain, especially given the cost characteristics of clearing and the fact that this evolution will occur in a highly regulated environment in which political—and rent seeking—influences will play an important role.  Very bad evolutionary paths are certainly possible.  In brief, the effects of Dodd-Frank on the efficiency and stability of the financial markets are highly uncertain at best, and highly unfavorable outcomes wholly unintended by the authors are quite possible, and indeed, likely.

One final thought about systemic risk.  It is worth remembering that the imposition of a single, one-size-fits-all infrastructure is inherently systemic in its effects.  Any flaw or failure in that standard structure will have systemic consequences.  A mandate that is ill-adapted to the fundamental economic conditions in the derivatives markets creates a systemic risk because (a) ill-adaption makes failure more likely, and (b) the sweeping breadth of the mandate means that the effects of such a failure will be system wide in scope.

But have no worries, Gary Gensler tells us: “U.S. regulators won’t succumb to Wall Street efforts to weaken financial-market oversight as they implement the biggest rules overhaul since the Great Depression.”

Just how is this supposed to happen?  Yes, interested parties–and not just the big banks–have an incentive to shape the rules to benefit them.  But interested parties also have the best information and the greatest knowledge.  Are Genlser and the other regulators to shut their eyes and ears to what industry participants tell them?  That would mean ignoring the good advice, as well as the bad, self-interested kind.  If not, how are they to distinguish between the good and the bad?  Mistakes are inevitable.

This information problem is inherent in regulation, especially when involving something as incredibly complex, dynamic, reflexive/responsive, and interconnected as the financial markets.  Painting this as a morality play between the good government types (the “Goo goos” in Boston Mayor James Curley’s trenchant phrase) and the malign self-interested banks is insultingly simplistic.

Congress and Obama have given regulatory agencies the authority to lead the industry, but no map to show them where to go.  The blunder potential is huge.  The cacaphony  of voices, reflecting differences in information, interest, and motivation, will make it difficult to avoid such blunders.  Last week’s meeting gives just an inkling of the conflicts to come.

But I’m sure it will all turn out well.  It always does, doesn’t it?

You don’t have to answer that.

August 18, 2010

EFF-ing Up

Filed under: Commodities,Derivatives,Economics,Exchanges,Politics — The Professor @ 9:52 pm

There was a kerfuffle earlier this week when the CFTC said that Exchange of Futures for Futures transactions–EFFs–were legal, despite the CME’s claim that they were banned wash trades.  There has been some breathless commentary that this is a grave competitive threat to CME, and raises the specter of “fungibility,” meaning that clearing and execution would effectively be unbundled.  A trade could be traded on one exchange, and then cleared elsewhere.  This would, supposedly, increase the competition that the CME would face.

I rolled this rock up the hill too many times pre-crisis, when fungibility was a headline issue before it was overshadowed by the crisis and its effects.   For instance, this was a big issue in the DOJ’s infamous passive-aggressive letter in the winter of ’08.

So, let me say it yet again.  As the Chicago School of Antitrust Economics pointed out long ago, if clearing is the source of the CME’s market power (as the advocates of fungibility claim), the CME could maximize the profits it earns by charging the appropriate price for clearing services.  It would have no incentive to tie execution and clearing.  Indeed, it would have an incentive to encourage competition in execution in order to maximize the derived demand for its (monopoly) clearing services.

So, the argument that tying execution and clearing is anti-competitive is fundamentally flawed.  There is another purpose for it.

I should also note that even with fungibility, the CME competitor ELX will face daunting obstacles in challenging CME in execution.  That’s because clearing is not the only source of scale economies in providing trading services.  Due to the effects of liquidity, there are huge scale economies in execution as well.  Price impact costs are far smaller in bigger, more liquid markets.

Indeed, it is the existence of large scale economies in clearing and execution which, in my view, drive the integration/bundling of the two services.  Integrating back-to-back monopolies economizes on transactions costs.

But integration does not require bundling of the services.  So why does CME insist on doing so?  (I.E. why do you have to trade on the CME to clear on the CME?)  The most likely explanation is that it wants control over access to the clearinghouse for risk management and control reasons.  The CME wants control over whose risk it takes and whose risk it guarantees.  EFFs could call that into question.  But if that’s the case, the CME would be advised to make it straight up, rather than relying on the wash trade argument.

I called this a kerfuffle because I don’t think EFFs will catapult ELX into contention in head-to-head competition with CME.  The CME’s liquidity advantages are too great.  This will get ELX some headlines, but not much business.

Update (1145 CT, 8/19/10). Last night, after posting this, I read something from the CME that was sent to me before I’d written the post.  It makes the “clearinghouse control” argument “straight up.”  Responding to a Consultative Paper issued by Center of European Securities Regulators, CME CEO Craig Donohue wrote:

[F]ungibility (i.e., one contract could be substituted for another contract) is not necessary or desirable.  Fungibility for OTC derivatives contracts across multiple exchanges or trading venues serves only to provide linkages, or interoperability, among various clearing houses providing clearing services for the exchanges or trading venues listing such contracts.  Interoperability among clearinghouses increases systemic risk to each clearing house and the financial system as a whole.  Indeed, when one side of a matched trade is transferred, the original clearing house automatically becomes exposed to the risk of the other clearing house.  As transfers build and links between clearing houses increase, the ability to contain a single failure decreases and the risk throughout the system increases.

So, CME is making the risk control argument in a straightforward way.

This is a good response to Bill’s question in his comment.  The key issue is one-sided transfers.  Before an EFF, trader A’s counterparty is the CCP of the original exchange (CCP1).  CCP1 has an offsetting position with A’s original trading party, B say.  If A executes an EFF with an exchange using CCP2, since both CCP1 and CCP2 have to have zero net positions, and the EFF doesn’t change CCP1’s position with B, the chain of contracts is now:  A has a position with CCP1; CCP1 has an offsetting exposure with CCP2; and CCP2 has its original exposure with B.  Thus, giving A the unilateral right to EFF into CCP1 allows him to create an inter-CCP exposure without CCP1’s consent.  CCP1 may not want to be exposed to CCP2, for both risk and operational reasons.  From a systemic risk perspective, too, this creates the dread interconnections that clearing is intended (by the ignorant, admittedly) to eliminate.

Hope that helps, Bill and BwO.

As an aside, the Donohue letter does go on to say that the CME endorses “open access” to CCPs.  The distinction is that open access as the CME uses the term means that end users can choose their clearinghouse when doing a cleared OTC deal, and if they enter into offsetting trades with different dealers, direct the trade to the original CCP in order to liquidate a position.

In response to BwO’s comment.  The argument in a nutshell is that monopoly leveraging is generally unprofitable.  Assume that product M is monopolized, and product C is competitive.  Can the monopolist increase profits by requiring that anybody who buys M also buy C from it?  Except under special conditions, the answer is no.  This is because consumers may not like the monopolist’s variety of C.  They are willing to pay less for the M+C bundle provided by the monopolist than they are for a bundle of M and their preferred variety of C.  This means that bundling reduces the demand for M, reducing the price that the monopolist can charge.  The demand for his product–and his profit–is greatest when he lets customers choose their preferred variety of C, and he charges the monopoly price corresponding to this higher demand curve.  (A similar argument holds with respect to the case where the M monopolist is not the low cost producer of C).

So, except under highly unusual circumstances (which I discuss next) it is absolutely NOT the case that “tying is anti-competitive bundling that parlays one monopoly into another monopoly.”  This has been widely understood in economics and anti-trust since the 1960s.  So yes I can argue that, and it has been argued since Bork, Posner, Director and others first addressed the issue, and virtually every model on the subject implies this result except if you build in some special (and usually contrived) conditions.  Even Whinston, who made his name on these alternative models, admits that there aren’t good practical examples of the factors he identifies leading to the anti-competitive result.

There are some counterexamples in the literature.  Hart and Tirole (1990) have one.  Whinston (1990) has several.  None of these models is remotely applicable to the case of clearing.

Carlton and Waldman (2002) have a very nice model specifically designed to address the Microsoft bundling issue in a two period model.  The key assumptions in their model is that the tied products are durable goods, and that any entrant cannot produce the monopoly product in the first period, but can produce the competitive one.  They show that under some conditions–not all–anti-competitive bundling might work here.  Neither of these assumptions is relevant in the clearing/execution context: these are not durable goods, and simultaneous entry by an integrated competitor is possible.  Nor is their assumption that one good is competitive and produced subject to constant returns to scale: in trading, both clearing and execution are subject to strong scale economies.  In this working paper I modify the Carlton-Waldman model, and show that in conditions that are most plausible in the clearing/execution setting, anti-competitive bundling is not likely to be a profit increasing strategy for the clearing monopolist.  That paper discusses the literature in some detail, and examines other transactions-cost based reasons for integration of clearing and execution.

Thanks for the comments.

Without a TRACE

Filed under: Derivatives,Economics,Exchanges,Politics — The Professor @ 7:14 pm

In a semi-follow up to yesterday’s post on trading mechanisms, today I’m going to explore post-trade price transparency.

One example that has been brought up repeatedly in the context of increasing transparency in the OTC derivatives markets is the introduction of TRACE in the corporate bond market.  TRACE mandated the disclosure of all corporate bond trades, including information on price and trade size.  Currently, the information has to be reported within 15 minutes of the trade.

It has been argued that TRACE improved the efficiency of the corporate bond market, and reduced trading costs and dealer profits.  This supposedly occurred because the opacity of the market pre-TRACE gave the dealers market power that they could exploit to their benefit.

The empirical basis for these pro-TRACE claims is a couple of studies.  One compared round-trip trading costs pre- and post-TRACE, and found that post-TRACE costs were smaller.  Another exploited the fact that TRACE was phased in over time, and ran cross-sectional regressions that compared trading costs for bonds that were TRACE-eligible and those that weren’t, while controlling for other observable factors.  This study also found that TRACE lowered costs.

I am always a little leery about these kinds of studies.  They implicitly assume that the characteristics of the transactions in the TRACE and non-TRACE samples are the same, or can be controlled for based on observable variables.  I’m not quite so sure, especially given some of the other things that transpired post-TRACE–as I’ll discuss now.  (In social sciences, you always have to worry about endogeneity problems.  They’re devilishly hard to control for; natural experiments or good instrumental variables are hard to come by.)

Most notably, there is anecdotal evidence that post-TRACE, corporate bond dealers dramatically reduced the size of their trading teams, and reduced their inventory holdings.  They effectively transitioned from dealers to brokers.  The reduction in inventory means that they reduced their capital commitments to this business.

Now this is hard to square with a story that TRACE reduced dealer market power, which in turn reduced trading costs.  Typically, firms exercise market power by restricting output and capacity.  Thus, something that increases competition should lead to an expansion of output and capacity.   The opposite happened, apparently.

You can tell a kind of monopolistic competition story.  Dealers had market power due to opacity, but competed away the rents by overinvesting in capacity, or in “quality” by investing excessively in inventory that allowed them to accommodate customer needs more readily.  But even in a monopolistic competition story, increasing competition (by reducing customer search costs, for instance, through better disclosure) makes individual firm demand curves more elastic, meaning that those firms that continue to operate should increase output and operate closer to their minimum average cost point.  That’s hard to square with what happened post-TRACE.

It should also be noted that the theoretical foundation for the contention that improved disclosure reduces profitability by increasing competition is weak.  Madhavan (RFS, 1996) has a sequential trading model in which dealers can choose not to disclose trades, but are in competition with one another.  In equilibrium, dealers don’t disclose a trade that occurs today because the order flow is informative, and the information they get when they do a trade allows them to trade more profitably in the future; a dealer that trades today has a competitive advantage over other dealers in trading in the future.  But in equilibrium, dealers don’t earn any profits.  This is because they compete aggressively to attract order flow today.  Some trades are “loss leaders” that they use to attract order flow that increases the profitability of future trades.  Thus, lack of disclosure is not necessarily profitable for dealers because competition for market power dissipates rents.

There are other post-TRACE developments that are hard to square with the Gary Gensler & apple pie story.  (The details can be found in a JEP paper by Bessembinder and Maxwell.)  Notably, if you believe that trading costs really fell, this should have benefited corporate issuers.  Ultimately, investors are willing to pay less for bonds, the greater the costs of trading them later.  If trading costs fell, publicly traded bonds should have become a relatively more attractive form of finance for corporations.  But in fact, post-TRACE, firms relied much more on privately placed bonds; corporate bond issuance fell; and CLOs (collateralized loan obligations–securities backed by bank loans) grew dramatically.  So, corporations relied much less heavily on instruments that should have become relatively cheaper to issue if trading costs really fell as a result of TRACE, and relied more on stuff that couldn’t be traded at all (private placements) or traded in dealer markets (the CLOs)!  This is inconsistent with the view that transparency reduced corporate bond trading costs dramatically, and rather implies the opposite.  (Of course, a lot of other stuff was going on during this period, so it’s a stretch to lay all this on TRACE, but still, it is facially not supportive of the claim that TRACE reduced trading costs.)  (This also raises the question: if the dealer structure without disclosure was so inefficient, why didn’t issuers use their leverage to mandate disclosure, e.g., by conditioning participation in underwriting syndicates to firms that committed to disclose trade information?)

Why might trading costs have gone up?  Anecdotally, it became harder to trade in size post-TRACE as dealers weren’t willing to take on big positions once they had to disclose that they had done so.  That is, dealers were at risk of being front run once they took on big positions from a customer/counterparty.  So they offered less liquidity, making it more expensive for the insurance companies and pension funds that dominate the market to trade.  This would explain why they reduced their head counts, cut back on inventory, and essentially shifted from dealing to broking.

This all suggests that the effect of TRACE was to lower the transactions costs for some (primarily small retail traders), increase trading costs for others (mainly big investors), and change the composition of trades (in favor of trades that were easy to broker).  Put differently, TRACE made “wholesale” trades more expensive–pricing some out of the market altogether.  Not an unalloyed benefit, and arguably quite the reverse.  If the corporate bond market is primarily a wholesale market, the effects of transparency could have been detrimental on net, even if some benefitted.)

This isn’t dispositive, but it should give pause.  In particular, when evaluating the effect of a market structure change, or of a mandated change in transparency, you need to look beyond simple before and after or cross sectional price comparisons, as these may be incomplete and misleading.  Moreover, you need to look at things other than price.  If a policy change results in exit of firms and reductions in the size of firms, and substitution away from the product affected by the change, you have to seriously question whether the change increased competition.  Usually you’d expect reductions in barriers to competition to lead to entry, increased output, and substitution towards the product that became more competitive.   When the exact opposite happens, you better have a really good story–which I haven’t seen anybody advance–or you better seriously entertain the hypothesis that the supposedly pro-competitive change had the exact opposite effect.

So, rather than being the feel good story of the summer, upon closer examination TRACE appears to be an ambiguous tale at best, and more likely a highly cautionary one.  And those who constantly prattle about the wonders of transparency–and you know whom I speaking of–should be pressed to address all of the dimensions of the TRACE experience.   Because it is quite plausible that interventions into wholesale markets, including mandates to make trading more “exchange like” with more pre- and post-trade transparency, can increase the costs that customers in those markets pay.

August 17, 2010

How Do You Like Them Apples?

Filed under: Commodities,Derivatives,Economics,Exchanges,Politics — The Professor @ 9:35 pm

I’ve written a lot about clearing mandates, but less on the Dodd-Frank Act’s attempts to alter the way derivatives trades are executed.  In part, this reflects the incredible uncertainty about just what a “swap execution facility” must be and do.

But, it is pretty evident that there is deep suspicion about bilateral OTC market dealings, both in Congress and especially among regulators.  CFTC Chairman Gary Gensler in particular has criticized bilateral trading mechanisms.  He, and many others, want to move the vast bulk of trading activity to exchange-like systems.  The standard argument is that the opaque OTC markets work to the advantage of dealers and to the disadvantage of customers.  The greater pre- and post-trade transparency in auction-based, order driven exchange markets, the story goes, will undermine the information advantage that dealers have in OTC markets, thereby eroding their profits.

As was routine in the clearing debate, this begs crucial questions.  Most importantly, why would customers choose to trade in opaque dealer markets?  Why can’t exchanges win in competition for customers with OTC dealers, if the former offer a better deal?

There is a tremendous diversity of trading mechanisms across products, and within products.  In products where exchanges compete with dealer markets, dealer market shares vary widely.  The dealer share is virtually 100 percent in FX and FX derivatives.   It is large–on the order of 80 percent–in linear interest rate derivatives.  It is closer to 50 percent in interest rate options and equity derivatives.  In the cash equity markets, a lot of trading took place on anonymous exchanges, but a good deal once took place in non-anonymous upstairs markets.  Nowadays, the upstairs markets are less important, but dark pools serve similar functions, notably facilitating large trades.  Cash Treasuries were long dealer markets, and still are to a large degree, although electronic markets have made in-roads.

There is also time series variation.  Biais and Green have an interesting paper that documents how the municipal and corporate bond markets migrated from exchange trading (on the NYSE) to a bilateral dealer market.

The simplistic “dealers scalp their poor customers” story doesn’t explain this cross sectional and time series variation in the market shares of “wholesale” dealer markets.  There must be something else going on.

What many of these off-exchange markets have in common is that they screen out informed trading.  Dark markets and third markets utilize screening technologies, or trading mechanisms that are unattractive to informed traders (e.g., crossing networks).  Others, like the upstairs markets, block markets, and OTC derivative and bond markets (govvies, corporate, and munis) rely on reputation, and are not anonymous.  Dealers reduce their risk of dealing with counterparties with private information by knowing who they trade with.  They are “opaque” in the sense that there is little pre- or post-trade transparency.  But they are far less opaque than exchange markets–especially electronic markets–in the crucial dimension of the observability of the identity of the counterparties.

The empirical evidence shows pretty conclusively that big traders incur much smaller trading costs by trading in these venues.  Which is pretty obvious: the big traders aren’t stupid, and are going to trade where they get the best prices.  The Biais-Green piece is interesting in this regard.  The market moved from exchange to OTC when insurance companies and pension funds began to dominate bond trading.

So, the claim that customers are victimized in dealer markets is hard to square with the evidence.  Big customers often benefit by trading in markets that are opaque in some dimensions, but transparent in others.  Dealer-based “wholesale” markets favor a particular kind of customer, and those customers choose to trade there.  They aren’t victims.

I am also less than persuaded that OTC market customers are all that ignorant about values.  For instance, a customer buying or selling an OTC interest rate swap can look to the Eurodollar futures market and to the Treasury futures as a source of information on the yield curve that they can utilize to evaluate the bids and offers of OTC dealers.  It’s even easier in the energy markets, to compare a dealers bid and offer on a NYMEX lookalike product with the real McCoy trading on the screen.  Moreover, those who are trading OTC have the opportunity to trade these close substitutes in highly liquid exchange markets–but they don’t.  Presumably because it is cheaper to trade off exchange than on, even though they are allegedly trading with rapacious dealers who keep them in the dark.

And this raises an issue that has been the focus of debates about “fragmentation” between exchange and dealer markets in the past, but which has strangely disappeared from sight in the current debate.  Once upon a time, a major objection to off-exchange trading was that “free rides” off of exchange price discovery, and worsens liquidity on the exchange market.  In essence, those who can verifiably demonstrate they are not privately informed can get lower trading costs by trading off exchange, thereby leaving those who cannot demonstrate that they are uninformed more vulnerable to trading against the informed, and incurring higher trading costs as a result.  That is, off exchange venues like block markets and dealer markets “skim the cream.”

This can’t be the case in some markets.  In corporates and munis, for instance, there’s no market to free ride off of, for all intents and purposes.

Even in markets where cream skimming and free riding are possible, it is not clear that the net effect of this is welfare reducing.  If the exchange market is perfectly competitive–and this is a huge if, and a huge implicit assumption in most of the literature on fragmentation and cream skimming–then the externality associated with price discovery means that off-exchange trading is welfare reducing.  But exchange markets are not necessarily perfectly competitive.  As I’ve shown in my academic work, exchanges exercise market power, through entry limits (e.g., limits on the number of exchange members), organizing member cartels, and super-marginal cost pricing.  They can do so because the “tippiness” of anonymous markets tends to make price discovery a natural monopoly.

If exchanges exercise market power, we aren’t in a first best world anymore, and therefore what would normally be considered a market failure–like an externality–can actually improve welfare.  I show this explicitly in a couple of papers, one published in the JLEO, and in a working paper titled “Third Markets and the Second Best.”  In these models, competition from off-exchange markets reduces exchange market power, leading to lower total execution costs (and higher aggregate surplus).

But even if this happens, off-exchange trading has distributive effects.  Those who can avail themselves of the off-exchange opportunities gain, those who can’t, don’t.  But the gains of the former are bigger than the losses of the latter.  These distributive effects are the reason, though, for the intense controversy over market structure.

This means that forcing trading onto exchanges can reduce competition and increase total trading costs.  Ironically, the biggest losers in this would be those who are ostensibly being helped: those who voluntarily choose to trade in dealer markets, like the OTC derivatives markets.

Some who fret about the persistence of opaque bilateral markets attribute their persistence to the “tippiness” of financial markets.  For instance, Biais and Green argue that muni and corporate bond markets have remained OTC because it is hard to tip order flow away from established markets.

I find this argument unpersuasive for two reasons.

First, and most importantly, tipping occurs in anonymous markets, as a consequence of informed trading.  The uninformed like to cluster in a single market because that minimizes their losses to the informed.  But the whole thing about many wholesale markets is that they allow the uninformed to avoid losing to the informed through another mechanism–transparency about trader identity and type.  Markets fragment between price discovery natural monopolies (where informed and uninformed trading take place) and other markets where less price discovery occurs because these trading mechanisms screen out many of the informed, making the uninformed who trade there better off.

Second, the tipping argument may be plausibly persuasive in corporates or munis, but not in many OTC derivative markets.  For instance, there are extremely liquid markets for Eurodollar and energy futures.  Traders who choose to trade OTC could avail themselves of this liquidity–but they don’t.  Again, because it is cheaper to trade someplace else.  Put differently, tipping may be able to explain something like munis where there’s only one market (though I doubt that): it cannot explain the side-by-side survival of two big markets, like Eurodollars and interest rate swaps.

In brief, there is a diversity of trading mechanisms because there is a diversity in trader types.  Forcing trading onto a one-size-fits-all platform will inevitably have distributive effects, and will almost certainly have efficiency effects too.   These efficiency effects are likely to be adverse, because anonymous trading venues where trades with private information can buy and sell tend to have market power.  Reducing competition from non-anonymous trading venues, like OTC dealer markets enhances the market power of the anonymous markets, and their owners can profit accordingly.  Moreover, in profiting, they price their services in a way that creates deadweight market power losses.

We should never expect financial markets to approximate even remotely perfectly competitive markets.  But fragmented markets in which some traders participate in face-to-face dealer markets can be better than having everybody trade on “transparent” exchanges.   This is because usual descriptions of transparency focus on price transparency, and that’s not all that matters.  Markets that offer the most price transparency often offer the least counterparty transparency.

Gary Genlser has repeatedly used the analogy of going to the store and buying an apple at a posted price to argue that everybody should want to trade on markets with pre-trade transparency.  But there is diversity even in apple markets: wholesale and retail markets are different, and offer different degrees of transparency.  The same can be said with even greater force in financial markets.

Which is why I conclude that if Gensler and those of like mind get their way, and succeed in forcing–yes, it would be by force–more trading onto anonymous, exchange-type markets, trading costs will rise and welfare will fall.  And the biggest losers will those who are the alleged victims of the lack of price transparency in OTC markets.  They will be losers because that lower price transparency is more than offset by other advantages of trading in non-anonymous markets.

August 16, 2010

Doing Donuts

Filed under: Economics,Financial crisis,Politics — The Professor @ 7:28 pm

In today’s WSJ Jerry O’Driscoll summarizes quite well something I was saying at the depths of the crisis in late-’08 and early-’09, and during the debate on the stimulus:

The financial panic and ensuing great recession was a classic balance-sheet recession. As balance sheets shrank in value, demand collapsed. There was a liquidity crisis as well, centered around Lehman’s collapse, but the driving force was collapsing balance sheets, impaired capital values and, for many, insolvencies.

The declines in home values, investor portfolios and 401(k) plans, and the uncertainties surrounding retirement plans, have all had a big impact. The solution lies in restoring balance sheets. For financial firms, that means raising capital. For consumers and businesses alike, that means saving more of their reduced incomes.  [Note the symbiosis between raising capital and household saving.]

Yet public policy has focused almost exclusively on stimulating spending without much regard to why spending, especially consumption, has flagged. Until balance sheets (corporate and household) are restored, increased spending cannot be sustained.  [This failure to ask “why” is endemic in current policymaking.  It’s been my pet peeve in the whole debate over changing financial regulation.]

Temporary spending and tax breaks are always dubious, and especially so now when the rational motivation is to save more and consume less.

Amen to that.

The way I put it during the stimulus debate is that while people clearly wanted to rebuild their balance sheets and delever in the aftermath of a huge wealth shock that occurred at a time they were highly leveraged, the government decided that it had to re-lever on their behalf.   For their own good, dontcha know.

Under this interpretation, it is not at all surprising that the stimulus, and government spending in the US generally, has been anything but stimulating, and has indeed been highly counterproductive.  People, seeing the splurge of spending and associated debt, add that to their consolidated mental balance sheet–what they see in their bank account and loan statements plus the future liabilities they are being forced to assume.  The greater the liabilities forced onto them, the more they have to save to get their balance sheets in some semblance of order.  (That’s doubly true when what the assumed liabilities are spent on doesn’t provide that much–if anything–of value to households.)  (The argument is analogous to the one in classical finance whereby investors can undo firm capital structure choices.)

Uncle Sam stomps on the gas, we stomp on the brakes.  All that is produced is a lot of burning rubber and the car doing donuts.

What should raise questions is that Europe, especially in Germany and the UK, are making appreciable progress despite their having banking systems that are in as bad or worse shape than ours.  But, crucially, they have sworn off the stimulants and are making efforts to restore some fiscal sanity.  This isn’t dispositive, but it is suggestive.

Merkel and the Germans are openly contemptuous of US policy.  With good reason.  But Team Obama seems committed on personifying the definition of insanity as doing the same thing repeatedly in the expectation of getting a different result.

Don’t hold your breath.

Capital, My Boy. Or, A Triumph of Hope Over Experience

Filed under: Economics,Financial crisis,Politics — The Professor @ 7:01 pm

A good deal of my summer reading has been focused on books about the financial crisis.  The more that I read, the more that I am convinced that capital rules were a major contributor to it.  Not a sufficient condition, but a condition of first order importance.  A good chunk of the problematic securitization, subprime, SIVs, the lot, was a direct response to capital rules and the efforts of banks to minimize the amount of capital that they had to hold.  “Optimizing” structures with respect to the ratings and the capital rules allowed leveraging of subprime securities to 50:1 or better.   Moreover, since all major institutions faced the same incentives, the capital rules encouraged them to crowd the same trades, greatly exacerbating the systemic effects of the real estate meltdown.

The capital rules are also heavily implicated in other problems in the news recently, e.g., the sovereign debt problems at many European banks.

Which is why I shudder whenever I hear capital requirements ritually invoked as a crucial component of policies intended to prevent the next crisis.  Talk about your triumphs of hope over experience.

My trepidation was heightened even further when I read the excellent Deus ex Macchiato this morning:

Basel III, as one might expect for something written in an awful hurry and without the luxury of much impact analysis, will make this situation worse. It adopts the same approach to regulatory capital as I apply to wrapping parcels: keep on adding things piecemeal until it looks bulky enough to survive. I can go through half a roll of tape for a big parcel, and the result is always ugly. Sadly the consequences of adding extra lumps of capital here and there are equally ugly but less likely to result in safety: they could well result in risk leaving the banking system, and/or banks optimising the channels of their risk taking. The fact that these consequences are not obvious to the Basel Committee is deeply dispiriting. It isn’t quite too late to fix these problems, but with the full Accord due in October, the clock is ticking…

Dispiriting indeed.  I have seen this movie before.  I don’t want to watch it again, but feel that I am–we are–fated to.


PS.  Feel better, David.  I had a virus that kicked my backside a couple of weeks ago, so I can relate.

Continuing the Theme

Filed under: History,Military,Politics — The Professor @ 6:01 pm

Of US-Chinese naval rivalry.  Last week there were a bunch of breathless stories about the Chinese DF-21 “carrier killer” ballistic missile.  I’m not that worried about it by itself.  The oceans are large, and carriers are small by comparison.  Target acquisition and tracking are daunting challenges: you can’t hit what you can’t find and follow.  Moreover, electronic countermeasures will create further obstacles that the DF-21 has to overcome.  Finally, US shipborne anti-ballistic missile capability is maturing rapidly.  Indeed, the ostensible justification for the termination of the missile defense efforts in Poland and the Czech Republic was that the Navy’s Aegis system could do the job more effectively and cheaply.

So why the sudden spate of stories about something that’s not really news?  I think it has little to do with any change in the perception of the threat posed by the DF-21, but has everything to do with AMD.  I think that the Pentagon wants to make it very clear that ballistic missiles are a growing threat in all theaters, and that missile defenses are a key component of American military strength not to be bargained away in some dreamy deal with the Russians.  Raised in the context of increased tensions in the South China Sea and Yellow Seas, moreover, it signals Pentagon efforts to draw attention to Chinese investment in its naval and sea denial capabilities, and the strategic implications thereof.

I would therefore not be surprised to see a steady stream of stories on DF-21 and other Chinese naval initiatives.  This is the biggest long-term strategic issue the US faces, by comparison to which Russia or even Iran pale in comparison.

How Do You Say “Mahan” in Chinese?

Filed under: Economics,Energy,History,Military,Politics — The Professor @ 5:04 pm

When I gave a talk about the national energy policies of Russia, China, and Venezuela to a group of State Department and intelligence people a few weeks back, my summary on China was: “If you want to understand Chinese policy as it relates to energy, read Mahan.”  Mahan being Alfred Thayer Mahan, late-19th/early 20th century admiral, and the author of The Influence of Sea Power on History, and other influential works.

If you’ve been following things for the last several months, you’ll have read that things are getting testy in the South China Sea*, specifically over the issue of the Spratleys, a chain of microscopic islands that are believed to hold large amounts of oil.  China has been quite bellicose in asserting its claims over the Spratleys (against competing claims from Viet Nam, the Philippines and ohter countries).  It has basically told the US and the world that the South China Sea is a Chinese lake, and that any US naval presence in that area is unwelcome.

All of this is taking place in the context of a concerted Chinese effort to bolster its naval forces and strengthen its naval presence along the sea lines of communication (SLOCs) over which raw materials flow to feed Chinese factories.  All very Mahanian.

The US response to this has been, to put it politely, supine.  The limp-wristed US response to the Cheonan sinking–and to the complete lack of any Chinese condemnation–is emblematic of this.

But apparently things are changing.  Hillary Clinton’s recent trip to the region–on which SecDef Gates went as well–represents an effort to reverse this.  This is based on a dawning recognition in Washington that American pusillanimity emboldens China and weakens our position in that area of the world.

For a typically Spenglerian interpretation of the situation, read this Mark Helprin piece in the WSJ.  I think Helprin is great for understanding the worst case, and what must be done to to avoid it.  As a prognosticator, he is too gloomy even for me.

Information Dissemination, a naval blog, is also alarmed, though.  And I must emphasize that ID is NOT a habitual, reflexive anti-administration, anti-Obama source.  Indeed, it has been broadly supportive of Obama policy initiatives.  But it also recognizes that risks have risen in Asia because of the administration’s palpable weak policies:

Beginning in 2010 a lot of folks began to legitimately question whether the Obama administration had the balls to stand up to China. The private jokes that Tim Geithner was hired to kiss ass in Asia are actually very funny – but worse, hard to argue with. In virtually every policy area, at the beginning of 2010 the United States was beginning to look weak and inept, and when the Cheonan was sunk off South Korea – it perpetuated the image of weakness by the United States once it became clear the Cheonan sinking was an attack, but the US wasn’t going to do anything in response – for several legitimate reasons.

By July the US appeared to be on the brink of a serious perception and credibility problem in the Pacific, and at the same time Russia and China was heading to Seoul to discuss the Cheonan sinking. I strongly believe that China made a strategic miscalculation, because had China and subsequently Russia backed Seoul regarding the sinking – it would have been recognized by the region that China’s influence on this major regional security event was greater than the influence of the US. Because China could not support the findings of the international Joint Investigation Group, it signaled to the rest of the region that China is still not a responsible or reliable partner in the security conditions of the Pacific. Despite what the tone of the TIME magazine article suggests, the government of every single major Pacific nation besides Russia and China believes the report that North Korea sank the Cheonan with a torpedo.

In mid-July I heard the questions being asked again – is there anyone in Washington that has the balls to stand up to China? Well, timing is everything, and after a year and a half of attempting a soft approach with China in an effort to open up the relationship – an attempt that had clearly failed – the Obama administration has changed policy in the Pacific.

The announcement by Hillary Clinton that the United States intends to play a prominent role in a new regional effort toward resolving territorial disputes in the South China Sea is the single most important foreign policy action by the United States directed at China in the 21st century. While a lot of serious people have been wondering who has the balls in Washington to stand up to China, it turns out that they have been hiding up Hillary Clintons skirt the whole time. Robert Gates was in the room in Vietnam when Hillary Clinton made this announcement – so this policy change isn’t just some State Department rogue moment by the Secretary of State.

We do not know how this will play out or what is coming next, but this is an enormous change in policy towards China. I don’t think the Obama administration wants a war with China, but they have no longer decided to be nice to China – because China sent the message that nice guys will finish last with them.

It’s about time.  Ditto with the administration’s much tougher line with Turkey.  (A lot of what has happened in Turkey is obviously domestically driven, but US policy towards Turkey has been a disaster since early in the Bush administration.  We are paying the price for this in the Middle East, the Caucasus, and the Caspian.)

In any event, as if we don’t have enough fires to deal with, keep an eye on the South China Sea, and US naval policy and foreign policy towards China.  This is a big deal.

And it relates to bigger themes.  I’ve mused whether the current historical era is more like the 1970s or the 1930s.  In my “optimistic” moments, I think the former, as dismal as that is to contemplate.  But more and more I think the 1930s is the better analogy.  And the events in east Asia are just one thing nudging me to that conclusion.

* Ironically, this morning my wife was doing some genealogy, and listening to recordings of her grandmother reminiscing about her family.  She mentioned one relative, a beauty, who said she would “walk into the China Sea when she was no longer attractive to men.”  The weird part is that her husband died in Taiwan.

August 15, 2010

Spinning Like a Dervish

Filed under: Politics — The Professor @ 9:15 am

The one complimentary thing I said about Obama’s iftar disquisition on the Ground Zero mosque was his honesty in endorsing the concept.  Now I have to take that back too, because stunned by the manure storm that his remarks unleashed, he and his aides have been spinning furiously.  First, he came out and stated he was only commenting about the legality of the mosque–a red herring issue, because nobody is disputing the legality–and not the wisdom of building it.  But then his deputy press secretary Bill Burton (i.e., Gibbs headed for the tall grass) adamantly claimed that Obama was not backing off his original remarks at all:

Just to be clear [arrrrgggghhh!], the President is not backing off in any way from the comments he made last night.

It is not his role as President to pass judgment on every local project. [Who said it was?  And is this just another, garden variety local project?] But it is his responsibility to stand up for the Constitutional principle of religious freedom and equal treatment for all Americans.

Let’s not BS the troops here, folks.  Everybody knew exactly what Obama meant.  Want evidence?  Read this encomium to Obama’s brave stand:

A few quick thoughts about Obama’s forceful speech yesterday expressing strong support for Cordoba House, which will go down as one of the finest moments of his presidency.

Obama didn’t just stand up for the legal right of the group to build the Islamic center. He voiced powerful support for their moral right to do so as well, casting it as central to American identity. This is a critical point, and it goes to the the essence of why his speech was so commendable.

Today, I’ll bet, the guy who wrote that–Greg Sargent of the Washington Post–is channeling Emily Latella.

By sanctimoniously wrapping the issue in bromides about the First Amendment and American identity and religious freedom and the Founders Obama was making it quite plain that he believes that anyone who opposes the mosque is a religious bigot and un-American.  (Isn’t that rich.)  Burton’s clarification of Obama’s clarification reinforces that point.

Along these lines, it’s also worth reading the invaluable Wretchard, who understands codetalkers. The almost as invaluable (?) but all too silent lately Beldar gets it about “getting it” too.

There’s too much wickedly mordant commentary on the Obama-as-whirling-Dervish routine to link it all; if it’s as hot as hell where you are as it is here (a shout out to my Moscow readers!:), you can spend an entertaining afternoon panning the web for comedy gold.  Just One Minute has a line that stands out though:

I have an idea our President will love – maybe we can open an Islamic Waffle House in a building damaged in the 9/11 attacks.  Obama can be the first customer.

One other, not funny, thing caught my eye.  Commentary’s Jennifer Rubin catches Obama in a telling contradiction:

Because while Obama believes that Muslims have “the right to build a place of worship and a community center on private property in lower Manhattan, in accordance with local laws and ordinances,” regardless of who it annoys and offends, he considers it an unacceptable affront to him and his Palestinian clients for Jews to build apartments in their eternal capital. Funny, how that works out.

Michael Kinsley once said that a gaffe is when a politician tells the truth.  A corollary to that is that whenever a politician “clarifies” his remarks, it’s because everybody understood perfectly well what the original remarks meant, and that the politician meant them–to his surprise and regret.

Many Democrats are despairing over Obama’s three-left-foot intervention into this extremely touchy issue.  He just threw gasoline on the bonfire that is roaring to roast his party in November.  And the spinning is just blowing air to feed the fire.  Quite a performance.

August 14, 2010

Alienated and Alienating

Filed under: Politics — The Professor @ 9:33 am

By coming out in favor of the Orwellian-named “Cordoba House” Ground Zero mosque, Barack Obama took a huge leap in his relentless effort to alienate himself from the American people, who overwhelmingly oppose the building.  (As for Obama, I suspect he has been alienated from the American people for his natural born life).  I appreciate his honesty, and from a purely political perspective should probably welcome this development, as it will only speed his political marginalization.

But on the substance he is wrong.

Obama started out fine, recognizing that Ground Zero is hallowed, and acknowledging that the events of 911 were traumatic, and traumatize Americans still.


The inevitable but, folded into that annoyingly repetitive, Nixonian formulation: “But let me be clear.”  He then launched into a legalistic defense of the right to build a mosque on private property in New York.

Nobody disputes the legal right.  What people dispute is whether it is right and proper.

What Obama should have said is that given the sacred nature of the place to Americans, if the builders are sincere in their claim that they want to erect bridges between Islam and America, they should put their mosque elsewhere.  As in anywhere else.  He should have given voice to the heartfelt beliefs of hundreds of millions of Americans, and used the bully pulpit to persuade Rauf and his sponsors that they were unnecessarily inflaming deep wounds, and that if they were to proceed they would actually achieve results exactly contrary to their professed aims.

But no.  Rather than representing the strong beliefs of the vast majority of Americans, Obama indulged his own multi-culti, transnational progressive preferences.  Which is his right.  May he pay the price.

Look, our self-anointed “betters” never cease to lecture us on the necessity of sensitivity, on the imperative of never giving offense.  The PC police prowl perpetually, pillorying those who bruise the tender feelings of this group or that.  But when it is our deeply felt beliefs that are traduced, when it is our scabs that are ripped open, we’re told in tones dripping with condescension: Deal with it.  They have a legal right to do it.  You are being intolerant for having the temerity to ask that your heartfelt sentiments be respected.  Shut the hell up and do what you’re told.

It is exactly this attitude, this condescension, which is contributing to the steady drift of the country to a pre-revolutionary situation (as I’ve been saying for some time, and which others like Democrat pollster and iconoclast Pat Caddell said a couple of weeks back).

With respect to the mosque itself, the determination of its sponsors to proceed despite the intense hostility of a very large majority of Americans seriously undermines the credibility of their claims that they aim to build bridges and increase understanding.  For the actual effect of their actions is the exact opposite.  So to proceed in the teeth of such fervent opposition, either they are ignorant the effects of their actions, or they have another, far more sinister, agenda altogether.

Under either interpretation, they are not to be trusted with the stewardship of hallowed ground.  Under the former interpretation, they do not have the knowledge of America and Americans necessary to be trusted with the care of a place so sacred to us.  The implications of the latter interpretation are so obvious as to need no elaboration.

And there is plenty of reason to believe that they have another agenda altogether.  Mosque building has been, from the beginning of Islam, an act of triumphalism, a way of memorializing victory.  (Think St. Sophia in Constantinople as just one example.)  Even if Rauf et al do not conceive of the mosque as an end zone dance, there are tens, perhaps hundreds of millions of Muslims around the world who will; there were certainly many who celebrated the immolation of the Twin Towers on 911.   Moreover, so many mosques throughout the West, not to mention Islamic lands proper, have two faces.  Outside, they project an image of ecumenical tolerance and understanding.  Inside, they are seething centers of jihadist hate.  The Koran-sanctioned practice of Taqiyya–lying, concealing and deceiving in order to advance the interests of Islam–is well known, and should make anyone take the public pronouncements of any Muslim proselytizer with a healthy dose of suspicion.  The choice of the name “Cordoba House” only reinforces the suspicion, given that the whole Cordoba narrative is ahistorical malarky, and mendacious malarky at that.

Maybe Rauf and his supporters are quite genuine.  Maybe Obama and Bloomberg and the rest are right.  But maybe they are not.  But there is a huge asymmetry in the costs of their being wrong and being right.  If they are right, what is the big deal if the mosque is located a few blocks away?  If they are wrong, the harm, and the insult, of locating the mosque on Ground Zero will be incalculable.

There is something else about Obama’s post-Ramadan speech that deserves comment.  Obama follows in the footsteps of too many in presuming to lecture us on just what Islam is, and what it isn’t.  Look.  There is no Muslim Pope, and if there was, Obama ain’t it.  Nor are George Bush, Tony Blair, Michael Bloomberg, John Brennan, nor any of those on the too long list of worthies that have presumed to instruct us on the fine points of Islamic theology.

These persistent and insistent homilies on Islam are just another insult to our independent judgment.  Another “who are you going to believe, me or your lying eyes?” moment.  Anyone who is even intermittently sentient knows that Islam’s borders are, as Samuel Huntington wrote, bloody.  That far from being serenely united on matters of politics and theology, Islam is in virtually perpetual civil war, a seething cauldron of dispute contested far too often by violence of the most sickening and indiscriminate sort.

Don’t insult us by trying to pretend that these things are not true.   Don’t belittle us by giving us palpably misleading lectures about what “true” Islam is.  There is no single “true” Islam, any more than there is a “true” Christianity or a “true” Judaism.  Anyone claiming to know the “truth” is likely a fanatic, intent on imposing his or her vision on those who dispute it.

And given the realities of Islam; the undeniable connection between Islam and 911; and the intense meaning of 911 to the vast majority of Americans; the risks of building a mosque at Ground Zero are too great to be contemplated.  Obama should recognize this, and use all of his powers of persuasion, and all of the symbolic weight of the office that he holds as representing the entire American people, to make that point as forcefully as possible.

He decided to do the exact opposite.  Duly noted.  Consequences to follow.

« Previous PageNext Page »

Powered by WordPress