Streetwise Professor

October 31, 2015

On the Spot: How a Surfeit of Supply is Transforming LNG Trading

Filed under: Commodities,Derivatives,Russia — The Professor @ 6:22 pm

In September of last year, I gave the dinner speech at the CWC LNG Asia Pacific Summit conference in Singapore. The dinner was held at the Singapore Aquarium, and I spoke in front of the Aquarium’s giant shark tank. I couldn’t help but think of the scene with Kim Jung Il and Hans “Brix” Blix from Team America. Especially after the way my remarks were received, which ranged between cool and rather hostile.

I predicted the demise of oil-based pricing, and increased reliance on the spot market or long-term contracts indexed to spot prices. There were three basic parts to my argument. The first was that the large increase in supplies coming online in 2015-2017 combined with the even-then apparent slowdown in demand in China, and the likely decline from Japan due to the restarting of its nuclear plants, would lead to a large overhang of cargoes that would need to find a home. The trading of these cargoes would lead to increased spot market activity.

The second part of my argument was that the dynamics of liquidity would then take over. Liquidity creates liquidity. More spot market activity reduces the transactions costs of trading spot, which leads to more spot trading. There is a virtuous cycle in liquidity, and the increase in spot trading to dispose of contracted of but now unneeded cargoes would start the cycle.

The third part of my argument was that a robust spot market would support gas indexing, as opposed to oil indexing, in term contracts. Oil indexing is akin to the drunk looking for his wallet under the lamppost, because the light is best there, not because he lost it there. LNG buyers and sellers looking for a price benchmark looked to oil in the early days because in the 70s oil was a substitute for gas in power generation, so there was some connection between the markets, but mainly because oil was the only lamppost around. But especially now, with gas and oil having little fundamental connection in either consumption or production, oil prices are not closely correlated with the marginal value of a ton of LNG. The development of a liquid LNG spot market would-will, in my view-allow contracts to be indexed to a price that reflects gas values. This would also permit the development of a paper hedging market.

My unpopular prediction is now looking much better, though not all are persuaded. There is a huge LNG overhang, with Australian and US supplies about to come on stream. This supply increase is occurring simultaneously with a protracted decline in demand growth. Much of this overhang will find its way to the spot market. That, in turn, will start the virtuous cycle.

The supply overhang will have other consequences. It will force down prices world-wide, and lead to a redirection of supplies from Asia to Europe. One of the biggest losers from this will be Russia, which will face more intense price competition in its biggest export market in Europe, and a reduced Chinese appetite for the gas it had hoped to send east. Another will be Qatar, at present the world’s largest supplier.

Making things even more interesting is that Russia and Qatar are adversaries in Syria. (And by the way, those conspiracy theorists who think that the Syrian civil war was started by Qatar because Assad would not allow the construction of a pipeline to bring Qatari gas to Europe-spare me. Qatar’s big LNG investment dramatically reduced its need for a pipeline, and it anticipated being able to sell all it could to a growing Asian market.)

The next few years will be interesting in LNG. I am even more convinced that in 3 to 5 years the market will look nothing like it does today. It will look more like the oil, iron ore, and coal markets. Furthermore, in the near-to-medium term it will be more of a buyer’s market, and indeed, these things are connected. The surfeit of supply that makes it a buyer’s market will catalyze the development of a spot market.

October 30, 2015

Obama Gets a Little Bit Pregnant in Syria

Filed under: Military,Politics — The Professor @ 11:02 am

The administration is leaking that small numbers (“fewer than 50”) of special operations personnel will operate alongside local forces in Syria.

The military idiocy of Obama is getting just to much to bear. The small numbers is being touted as a virtue, when in fact they illustrate the military futility of this effort. Not enough to accomplish anything, but more than enough to get killed and maimed.

Why the continued use of special operations troops, who have been through the grinder for 14 years straight, in militarily futile operations?

And why in such small numbers? Because it would be bad optics that US soldiers would outnumber those we are “training and assisting?” (This is the case in Iraq, by the way.)

Obama is neuralgic to the idea of intervening in numbers sufficient to be decisive, and I actually agree with this. But he doesn’t want to be seen as doing nothing, so we get these half-assed penny packet interventions that risk our best soldiers and sailors for no purpose.

Special operations are complementary to main force operations. They are a force multiplier. If there is no main force to multiply (and no, some dodgy local insurgents don’t count as a real main force), the entire exercise is pointless.

I also suspect that this is actually announcing as a future plan something that is going on at present. I further suspect that the death of Sergeant Wheeler in Iraq, and the skepticism with which the official story of his death was met, has forced the administration to make this announcement.

I was going to write a longer post on this issue, but I looked back at what I wrote in May, and everything I said then applies now, particularly the closing paragraph:

Obama is categorically opposed to using conventional forces in Iraq and Syria, but feels that he has to do something, and drones and special forces raids are something, even if they accomplish little or nothing of strategic importance. It is pointless to rely  on these instruments of national power, which are only truly useful if joined up with other elements of that power, as the backbone of a campaign against Isis. If there is a more telling testament to the strategic vacuity of Obama’s “slow burn” campaign than the daring raid in Syria, I would be hard pressed to name it. So much professional expertise and courage put at grave risk to achieve a glittering tactical victory that will have no effect on the ultimate outcome in Syria and Iraq. One cannot win wars by special operations alone, and it borders on the criminal even to try.

Actually,  I would change one thing. It doesn’t border on the criminal. It crosses the line.

October 28, 2015

Could Be Dedovshchina in Syria: Definitely Mendacity in the US

Filed under: Military,Politics,Russia — The Professor @ 10:41 am

Russia has acknowledged the first fatality in the force it has deployed to Syria. The Russians claim the 19 year old soldier committed suicide. The family is having none of it, and one anonymous source told Novaya Gazeta the body had a broken jaw, a smashed skull, and a broken neck. Given the curtain Russia draws over military deaths (including those that occur in Russia where it is not necessary to maintain fictions about involvement, or not, in combat) it is likely that we will never know for sure. Indeed, the family may never know.

But if the Novaya Gazeta report is correct, it sounds like dedovshchina, which would be all too believable. The abuse-often resulting in death-of young soldiers is just one of the dysfunctions that afflict the Russian military.

The Russians are not alone in drawing a curtain over the deaths and maiming of its military personnel. The United States is doing so as well, all to maintain a fiction that the US has no combat presence in Iraq, a fiction that is maintained purely to allow Obama to continue to insist that he ended the war in Iraq (or at least, the US involvement therein). First, the story about the circumstances of the death of the truly remarkable Delta Force soldier (11 Bronze Stars, 4 with the valor device!) in the raid on the ISIS prison in Iraq are being challenged:

Master Sgt. Joshua Wheeler died leading his Delta Force team on the primary assault into an Islamic State compound in Iraq — a stark contrast from the Pentagon’s account that American commandos were there only to support Kurdish forces during the rescue mission, according to a U.S. military source.

The body of the 39-year-old native of Roland, Oklahoma, was flown to Dover Air Force Base in Delaware on Saturday as more details began to emerge of the Oct. 22 night raid on a prison run by militants affiliated with the Islamic State in Iraq and Syria, or ISIS.

Video footage, released by the Kurdistan Regional Government, shows American and Kurdish forces freeing 70 hostages that were held by ISIS militants near the town of Hawija, about 30 miles south of Kurdish-controlled Kirkuk. In a news report, a Pentagon official confirmed its authenticity to CNN.

Wheeler was the first U.S. combat fatality of the campaign against ISIS, but U.S. officials maintain that his death was not the result of a direct combat role.

Second, the military is refusing to release any information about the circumstances surrounding the wounding of 5 personnel:

Five other service members have been “wounded in action” since the U.S. first sent troops back into Iraq last year, according to statistics from the Pentagon and interviews with officials in Iraq (PDF). But how and when they were injured, the Pentagon refuses to say.

As the Obama administration holds to the increasingly dubious claim that U.S. troops are not engaged in combat against the self-proclaimed Islamic State, the Pentagon is withholding details about its wounded that would give key insights into the kind of fight American troops are facing in Iraq. Were any of the five shot by the Iraqi forces they are training? Did a mortar round shot at their base injure a soldier? Has ISIS wounded a U.S. service member?

It is a sad day when the US military channels Russian duplicity about casualties, all to protect the amore propre of Barack Obama. Recent news about creeping escalation by the US in Iraq and Syria also reeks of deception. More on that later.

October 24, 2015

Creeping Recognition that Regulation Has Created a Liquidity Death Star

Reason number one (by far) that I believe that clearing and collateral mandates increase systemic risk is that they transform credit risk into liquidity risk. Large price moves during stressed market situations require those with losing positions to make large variation margin payments in a very tight frame. These payments need to be funded, and funded immediately. Thus, variation margining causes spikes in the demand for liquidity. Furthermore, clearing in particular creates tight coupling because failures-or even delays-in making VM payments can put the clearinghouse into default, or force it to liquidate collateral in an illiquid market. The consequences of that, you should shudder to contemplate.

To be somewhat hyperbolic, clearing mandates create a sort of liquidity death star.

Recognition of how dangerous spikes in liquidity demand precisely when liquidity supply evaporates creates a major systemic risk is sadly insufficiently widespread, particularly among many regulators who still sing paeans to the glories of clearing. But perhaps awareness is spreading, albeit slowly. At least I hope that this Economist article indicates a greater appreciation of the collateral issue, although it fails to draw the connection to central clearing, and how clearing mandates can dramatically exacerbate collateral shortages:

WHEN the financial system teetered on the brink of collapse in 2008, the biggest problem was a lack of liquidity. Banks were unable to refinance themselves in the short-term debt markets. Central banks had to step in on a massive scale to offer support. Calm was eventually restored, but not without enormous economic damage.

But has the underlying problem of liquidity gone away? A research note from Michael Howell of Crossborder Capital argues that, in the modern financial system, central banks are no longer the only, or even the main, providers of liquidity. Instead, the system looks a lot like that of the Victorian era, with banks dependent on the wholesale markets for funding. Back then, the trade bill was the key asset for bank financing; now it is the mysteriously named “repo” market.

. . . .

Bigger haircuts mean that borrowers need more collateral than before in order to fund themselves. “When market volatility jumps, funding capacity drops in tandem and often substantially,” writes Mr Howell. The result, a liquidity squeeze at the worst possible moment, is a template of how the next crisis may occur (although regulators are trying to reduce banks’ reliance on short-term funding).

And again, it is at these times when the need to fund VM payments will kick in, exacerbating the liquidity squeeze. Moreover, clearing also ties up a lot of the assets (e.g., Treasuries, or cash) that firms could normally borrow against to raise cash. Perversely, that collateral can be accessed only if a clearing member defaults on a variation margin payment.

Just what the liquidity supply mechanism will be in the next crisis in the new cleared world is not quite, well, clear. As the Economist article (and the Crossborder Capital note upon which it is based) demonstrate, central banks lend against collateral, and the collateral constraint will already be binding in stress situation. Presumably central banks will have to be much more expansive in their definition of what constitutes “good” collateral (a la Bagehot).

It still astounds me that even though every major financial crisis in history has been at root a liquidity crisis, in their infinite wisdom the betters who presume to govern us thought they were solving systemic risk problems by imposing a mechanism that will sharply increase liquidity demand and restrict liquidity supply during periods of market stress. That should work out really, really swell.

October 23, 2015

Massad’s Recent Speech: Flashy, But Misleading, and Beside the Point

Filed under: Derivatives,Economics,HFT,Regulation — The Professor @ 8:53 pm

The other day CFTC Chairman Timothy Massad gave a speech about “flash events” in futures markets that has attracted a lot of attention. Most of the attention was given to Massad’s claim that there had been 35 flash events in WTI futures this year, and between 9 and 25 events per year combined in corn, crude, e-minis, 30 year Treasuries, gold, and the Euro from 2010-2014. Flashy results indeed. But the method for identifying them is misleading, and makes big flash moves seem more likely than they really are.

These results, and specifically the WTI finding for 2015, is an artifact of the definition of a flash event (which Massad acknowledged is somewhat arbitrary):

[E]pisodes in which the price of a contract moved at least 200 basis points within a trading hour— but returned to within 75 basis points of the original or starting price within that same hour.

The problem is that the number of flash events will depend on volatility.  Two percent moves are more likely in high volatility environments, or for high volatility contracts.

This is clearly what’s going on in oil. As this chart of the oil volatility index (OVX) shows, oil volatility was extremely low through most of 2014, but increased sharply in late-2014 through mid-2015, and then has picked up again in recent months:

Screen Shot 2015-10-23 at 7.45.39 PM

With volatility in the 60-70 percent annualized range, you will have a much greater likelihood of a 200 basis point move (and a subsequent 125 bp or so reversal) than with 15 percent vols. The flashy 2015 crude oil results are a reflection of this year’s high underlying volatility, which has been fundamentals driven, rather than the microstructure of modern electronic markets.

The 200/75 basis point standard was chosen because that’s what happened in the Treasury market on 15 October, 2014. But a 200 basis point move in something like Treasuries, which have a volatility of around 10 percent, is a bigger number of standard deviation move than a 200 basis point move in crude, especially with a volatility of 70. So the more appropriate cutoff would have been standard deviations (sigmas) rather than percent. But if Massad had done that, he would have identified a lot fewer events, and his speech would have been met with yawns, rather than the attention it has received.

Let’s also put things in perspective. The contracts considered trade 17-23 hours per day. 252 days a year times (say) 20 hour per day times 6 contracts and 20 events/year gives the odds of a .06 percent of an event in any hour. Using a more realistic sigma standard would reduce the odds of an event comparable to the Treasury flash event to a much smaller number than that.

Put differently, the Treasury event was truly anomalous, and Massad’s way of analyzing the data makes it seem more common than it really is. To get a flashy, eye-catching result, Massad had to use a misleading standard to identify flash events. Objects in his mirror are smaller than they appear.

The taking off point for Massad’s speech was the report on the 2014 Treasury flash crash. Like the infamous May, 2010 equity flash crash, there was a sharp decline in liquidity leading up to the price break. Massad attributes this to the way algorithms are programmed:

We also know that as with humans, the modern algorithms have risk management capabilities embedded within them. So when there is a moment of sudden, unexpected volatility, it may not be surprising that some in the market pull back – potentially faster than a human can.

The report describes how on October 15, some algos pulled back by widening their spreads and others reduced the size of their trading interest. Whether such dynamics can further increase volatility in an already volatile period is a question worth asking, but a difficult one to answer. It is also very difficult for individual institutions of any type to remain in the book, opposing price headwinds, or worse, to try and catch the proverbial falling knife. For many, this decision can be the difference between risk mitigation and significant losses. Contrary to what some have suggested,

This makes perfect sense. Some algorithms-especially HFT algorithms-attempt to determine when order flow is becoming toxic (and hence adverse selection risks are elevated) and reduce exposures when they do. Holding depth constant, greater information flow makes prices more volatile, and the reduction in liquidity that the greater information flow causes makes prices even more volatile.

This means that looking at the depth reductions and associated increases in volatility focuses on a symptom, not the underlying cause. What deserves more attention is what causes the increase in the informativeness of order flow that makes the liquidity suppliers cut back. This hasn’t been done in any study, to my knowledge, nor is it likely to be possible to do so.

And as Massad notes, this phenomenon is not unique to electronic markets. Meat puppet market makers also take a powder when adverse selection risks rise:

Contrary to what some have suggested, I suspect it was difficult for market makers in the pre-electronic era to routinely maintain tight and deep spreads during volatile conditions. They likely took long coffee breaks.*

It’s beyond suspicion, actually. It happens. Look at the Crash of ’87 when locals fled the pits and OTC market makers stopped answering their phones.

These reductions in liquidity are inherent in any trading environment where private information is important, and the rate of information flow varies.  Regardless of trading technology or market microstructure, liquidity suppliers will cut the sizes of their quotes, or stop quoting altogether, when order flow turns very toxic.

Given all this, Massad’s policy prescriptions are oddly disconnected from the flash phenomenon that prompted his talk:

The focus of our forthcoming proposals will be on the automation of order origination, transmission and execution – and the risks that may arise from such activity. These risks can come about due to malfunctioning algorithms, inadequate testing of algos, errors and similar problems. We are concerned about the potential for disruptive events and whether there are adequate measures to ensure effective compliance with risk controls and other requirements.

Now of course, you could have errors before, in the days of pit traders and specialists. You could have failures of systems in less sophisticated times. But generally the consequences were of lesser magnitude than what we may face today. And that’s in large part because the errors were easier to identify, arrest or cure before they caused widespread damage.

I expect that our proposals will include requirements for pre-trade risk controls and other measures with respect to automated trading. These will apply regardless of whether the automated trading is high or low frequency. We will not attempt to define high-frequency trading specifically. I expect that we will propose controls at the exchange level, and also at the clearing member and trading firm level.


That’s all great, but really beside the point. If rogue or fat-fingered algos were the problems in any of the alleged flash events Massad identified (including the Treasury event of a year ago), he would have been able to say so. But he admits that the causes of the various events are all unknown. So it’s a bait-and-switch to pose the problem of flash crashes, and then advance remedies that have nothing to do with them. It’s the regulatory equivalent of applying leeches.

In sum, Massad overstates the flash event problem, and offers policies that have nothing to do with them. The fact remains that these things are probably beyond a policy fix anyways. They inhere in nature of the trading of financial instruments when order flow can become toxic.

*Gillian Tett of the FT gets Massad’s point exactly backwards:

The crucial point is that these automated trading programs — like Hal — lack human judgment. When a crisis erupts and prices churn, computers do not simply “take a long coffee break”, as Mr Massad says, and wait for common sense to return; instead they tend to accelerate trading, fuelling those flash crash swings.

Sheesh. Please read, Gillian. Massad’s point is that the algos do take a metaphorical coffee break. They don’t speed up, they pull back.



October 17, 2015

An Innocent Abroad: Fred Hof and the Intellectual Failure of American Foreign Policy

Filed under: History,Military,Politics — The Professor @ 10:05 am

Fred Hof, former “special advisor for transition in Syria at the U.S. Department of State,” has written a self-flaggelating flagellating piece about his-and the United States’-failure in Syria. It is part damning indictment of himself and the State Department, and part damning indictment of Obama.

A recurrent theme-implicit, not explicit-is Hof’s incredible naiveté. He was repeatedly fooled by the man he was supposedly working with-Bashir al-Assad-and the man he was working for-Barack Obama. He was fooled because he romantically projected his own beliefs on them, and because he engaged in wishful thinking, when he would have been better served to live by Lily Tomlin’s credo: “We try to be cynical, but it’s hard to keep up.”

Hof was-and remains-genuinely shocked that Assad reacted brutally to the first outbreak of opposition to his regime:

I did not think it inevitable that Assad—a computer-savvy individual who knew mass murder could not remain hidden from view in the 21st century—would react to peaceful protest as violently as he did, with no accompanying political outreach.

. . . .

By firing on peaceful demonstrators protesting police brutality in the southern Syrian city of Deraa, gunmen of the Syrian security services shredded any claim Assad had to governing legitimately. Indeed, Assad himself—as president of the Syrian Arab Republic and commander in chief of the armed forces—was fully responsible for the shoot-to-kill atrocities.

Hof actually believed that computer savviness was some marker for civilized values? He believed that Assad would actually care if his crimes were witnessed by the world? Cringemaking.

Look. Dictum 1 of the Dictator’s Handbook says, in bold, italicized type: “Every dictator who has attempted ‘political outreach’ to opponents has ended up at the end of a rope or bleeding in the dirt. Crush all dissent mercilessly.”

Furthermore, Hof’s optimistic view was completely oblivious to Syria’s history. In the 1970s and early-1980s, Assad’s father faced an extreme threat from the Muslim Brotherhood. The Brotherhood came close to assassinating him, and he responded by extirpating the organization in Syria, most infamously by attacking Hama with armor, artillery, and air power, resulting in the deaths of thousands (which Brotherhood propaganda has succeeded in inflating to 40-50,000). Assad no doubt had intelligence about the resurgence of the MB within Syria, and throughout the Middle East generally. He no doubt understood that the “Arab Spring” was largely the Muslim Brotherhood Spring-something that those in the West generally and the US in particular still fail to grasp. Even if he didn’t know these things, he certainly feared them, and was not going to take any chances that the protests in Deraa were fronting for, or would be exploited by, the Brotherhood.

In other words, the chances he would not have responded to any protest with extreme force were somewhere between zero and none.

But the US, and this administration in particular, not only seems oblivious to the Muslim Brotherhood’s malignity, it actually thinks that it is a progressive force in the Middle East.

Hof also took at face value Assad’s representation that he would sever all ties with Hezbollah in exchange for a return of the Golan heights. This was wishful thinking in the extreme. Just how far did Hof think that the Iranians would let Assad proceed down this path? Iran’s interest in Syria is primarily because it is their vital bridge to Hezbollah. Iran is dedicated to Israel’s destruction. If he had tried to sell out Hezbollah to achieve a deal with Israel, the Iranians would have been in a race with the Brotherhood to kill him.

Indeed, Hof understood this at some level, but chose to ignore it:

Fully complicit in the Assad regime’s impressive portfolio of war crimes and crimes against humanity, Iran relies on its client to secure its overland reach into Lebanon.

As for the man he worked for, Hof reminds me of Flounder in Animal House: “You fucked up! You trusted us!“:

My failure to predict the extent of Syria’s fall was, in large measure, a failure to understand the home team. In August 2011, Barack Obama said Assad should step aside. Believing the president’s words guaranteed decisive follow-up, I told a congressional committee in December 2011 that the regime was a dead man walking. When the president issued his red-line warning, I fearlessly predicted (as a newly private citizen) that crossing the line would bring the Assad regime a debilitating body blow. I still do not understand how such a gap between word and deed could have been permitted. It is an error that transcends Syria.

“Such a gap between word and deed” is the essence of the Obama way. And please. Obama ran in 2008 on disengaging militarily from the Middle East. He ran on the view that US military intervention was inevitably counterproductive. He ran in 2012 bragging about ending the war in Iraq, and took the opportunity to remind the world yet again of his belief of the futility of American military engagement in the Middle East.

You see, there are some words that Obama utters that conform to his deeds almost exactly. The key is understanding which words he means, and which ones he doesn’t. Hof again let his magical thinking delude him into believing that Obama meant the things he said that Hof agreed with, instead of realizing that these words contradicted Obama’s core beliefs, and were uttered for the sole purpose of meeting “a communications challenge: getting Obama on “the right side of history” in terms of his public pronouncements.”

Hof deserves credit for admitting his failures so openly, and I can sympathize on a human level. What is disturbing is that his failure is symptomatic of deeper institutional failures in the United States foreign policy establishment. The examples are many, but Syria alone provides some particularly damning ones. How long has the US been chasing the Assad chimera? Remember Warren Christopher panting after Assad père during the Clinton administration? Nancy Pelosi meeting with and gushing over the Chinless Ophthalmologist in 2007? John Kerry chasing after Assad for years, finally dining with him and his wife in Damascus, then saying this?:

“I have been a believer for some period of time that we could make progress in that relationship,” he said. “And I’m going to continue to work for it and push it.”

In the same year, when he once again wanted to go to Syria, his visit was blocked by the Obama administration.

“President Assad has been very generous with me in terms of the discussions we have had,” he said after his March speech. “And when I last went to – the last several trips to Syria – I asked President Assad to do certain things to build the relationship with the United States and sort of show the good faith that would help us to move the process forward.”

He mentioned some of the requests, including the purchase of land for the US Embassy in Damascus, the opening of an American cultural centre, non-interference in Lebanon’s election and the improvement of ties with Iraq and Bahrain, and said Mr Assad had met each one.

“So my judgment is that Syria will move; Syria will change, as it embraces a legitimate relationship with the United States and the West and economic opportunity that comes with it and the participation that comes with it.”

A few years later, of course, Kerry was comparing Assad to Hitler and pressing for air strikes- a call that Obama spurned. A perfect demonstration of Kerry’s lack of judgment, discernment, and just plain seriousness.

No. Fred Hof is not the problem. Fred Hof is a symptom of a bigger problem: the intellectual failings of American foreign policy.

October 12, 2015

From the Ridiculous to the Absurd Is But A Single Step: A New Rebel Group Magically Appears in Syria

Filed under: History,Military,Politics,Russia — The Professor @ 6:23 pm

If there’s been a bigger debacle for the US military since St. Clair’s Defeat in 1791 than the fiasco of arming the “moderate” Syrian resistance, I would be hard pressed to name it.

First, there was the fact that the pitifully small number of recruits that we managed to scrape together were either killed or captures no sooner than they had set foot into Syrian territory. Then, other groups turned over arms and equipment to al Nusra to secure safe passage. Then the Russians bombed the snot out of our (CIA-trained) forces while Kerry mewled in protest.

So it was announced that the Pentagon-run train and equip program was being terminated. But check that! The mission has not been ended. Train no: equip yes. We will just give arms to “leaders” we’ve vetted and let them hand them out to . . . whomever.

Meanwhile, in a 60 Minutes interview Obama said that he had been skeptical of arming the opposition from the get-go. (This is no doubt true: remember his dismissive remarks from last year about the futility of arming pharmacists and farmers and expecting them to beat an organized army?)

This immediately raises the questions: (a) then why did you, as commander of chief, permit the program to proceed? (b) if you were going to let it proceed, why didn’t you demand changes to give it a reasonable chance of achieving some success?

What’s more, despite Obama’s alleged skepticism, he is permitting yet another effort. This one would make Rube Goldberg proud. This is so bizarre that you might think I’m playing some sort of joke on you, but I swear, I’m just passing along what’s been reported.

Lo and behold, last night, almost at the exact same time Obama was heaping scorn on the idea of supporting armed opposition groups, a new Syrian resistance group magically appeared: The Democratic Forces of Syria.

It’s sort of the Rainbow Coalition of Syria. Kurds. Arabs. Assyrian Christians. So you should feel all warm and fuzzy about the inclusiveness of the new group.

If you believe the formation this group, and its allegedly ecumenical nature, was spontaneous and indigenous, I have some oceanfront property in Wyoming to sell you.

Bolstered by American arms, the mission of the new group is to advance on Raqqa, and drive ISIS from its Syrian capital. The Kurdish YPG has gained some success against ISIS, and would obviously be the core of any new force.

But we aren’t arming the Kurds! Because that would infuriate Erdogan and Turkey, and he could very well back out of his agreement to allow the US access to Incirlik, and do other nefarious things to kneecap the American efforts (such as they are) against ISIS. So we’re doing this instead:

Officials emphasized that U.S. military aid will go directly to the Arabs, not the Kurds, but the Kurdish fighters stand to benefit from the decision. To date, Washington has hesitated to hand equipment directly to the Kurds. Instead, they send materiel through the central government of Iraq. The new aid will be transported directly to Syria, where Arab groups are expected to launch a new offensive in and around Raqqa, the de facto Islamic State capital, while the Kurds continue to hold border areas where together they have succeeded in routing the militants.

The Kurds are the most effective military force in the region, and the Arabs have been completely unheard from in this sector, so we arm the latter and let the former cool their heels.

From the ridiculous to the absurd is but a single step.

To quote Casey Stengel: Can’t anybody here play this game?

October 10, 2015

Igor Gensler Helps the Wicked Witch of the West Wing Create Son of Frankendodd

Hillary Clinton has announced her program to reform Wall Street. Again.

The actual author of the plan is said to be my old buddy, GiGi: Gary Gensler.

Gensler, if you will recall, was the Igor to Dr. Frankendodd, the loyal assistant who did the hard work to bring the monster to life. Now he is teaming with the Wicked Witch of the West Wing to create Son of Frankendodd.

There are a few reasonable things in the proposal. A risk charge on bigger, more complex institutions makes sense, although the details are devilish.

But for the most part, it is ill-conceived, as one would expect from Gensler.

For instance, it proposes regulating haircuts on repo loans. As I said frequently in the 2009-2010 period, attempting to impose these sorts of requirements on heterogeneous transactions is a form of price control that will lead some risks to be underpriced and some risks to be overpriced. This will create distorted incentives that are likely to increase risks and misallocations, rather than reduce them.

A tax on HFT has received the most attention:

The growth of high-frequency trading (HFT) has unnecessarily burdened our markets and enabled unfair and abusive trading strategies that often capitalize on a “two-tiered” market structure with obsolete rules. That’s why Clinton would impose a tax targeted specifically at harmful HFT. In particular, the tax would hit HFT strategies involving excessive levels of order cancellations, which make our markets less stable and less fair.

This is completely wrongheaded. HFT has not “burdened” our markets. It has been a form of creative destruction that has made traditional intermediaries obsolete, and in so doing has dramatically reduced trading costs. Yes, a baroque market structure in equities has created opportunities for rent seeking by HFT firms, but that was created by regulations, RegNMS in particular. So why not fix the rules (which in Hillary and Gensler acknowledge are problematic) rather than kneecap those who are responding to the incentives the rules create?

Furthermore, the particular remedy proposed here is completely idiotic. “Excessive levels of order cancellations.” Just who is capable of determining what is “excessive”? Furthermore, the ability to cancel orders rapidly is exactly what allows HFT to supply liquidity cheaply, because it limits their vulnerability to adverse selection. High rates of order cancellation are a feature, not a bug, in market making.

It is particularly ironic that Hillary pitches this as a matter of protecting “everyday investors.” FFS, “everyday investors” trading in small quantities are the ones who have gained most from the HFT-caused narrowing of bid-ask spreads.

Hillary also targets dark pools, another target of popular ignorance. Dark pools reduce trading costs for institutional investors, many of whom are investing the money of “everyday” people.

The proposal also gives Gensler an opportunity to ride one of his hobby horses, the Swaps Pushout Rule. This is another inane idea that is completely at odds with its purported purpose. It breaks netting sets and if anything makes the financial system more complex, and certainly makes financial institutions more complex. It also discriminates against commodities and increases the costs of managing commodity price risk.

The most bizarre part of the proposal would require financial institutions to demonstrate to regulators that they can be managed effectively.

Require firms that are too large and too risky to be managed effectively to reorganize, downsize, or break apart. The complexity and scope of many of the largest financial institutions can create risks for our economy by increasing both the likelihood that firms will fail and the economic damage that such failures can cause.[xiv] That’s why, as President, Clinton would pursue legislation that enhances regulators’ authorities under Dodd-Frank to ensure that no financial institution is too large and too risky to manage. Large financial firms would need to demonstrate to regulators that they can be managed effectively, with appropriate accountability across all of their activities. If firms can’t be managed effectively, regulators would have the explicit statutory authorization to require that they reorganize, downsize, or break apart. And Clinton would appoint regulators who would use both these new authorities and the substantial authorities they already have to hold firms accountable.

Just how would you demonstrate this? What would be the criteria? Why should we believe that regulators have the knowledge or expertise to make these judgments?

I have a Modest Proposal of my own. How about a rule that requires legislators and regulators to demonstrate that they have the competence to manage entire sectors of the economy, and in particular, have the competence to understand, let alone manage, an extraordinarily complex emergent order like the financial system? If some firms are too complex to manage, isn’t an ecosystem consisting of many such firms interacting in highly non-linear ways exponentially more complex to control, especially through the cumbersome process of legislation and regulation? Shouldn’t regulators demonstrate they are up to the task?

But of course Gensler and his ilk believe that they are somehow superior to those who manage financial firms. They are oblivious to the Knowledge Problem, and can see the speck in every banker’s eye, but don’t notice the log in their own.

People like Gensler and Hillary, who are so hubristic to presume that they can design and regulate the complex financial system, are by far the biggest systemic risk. Frankendodd was bad enough, but Son of Frankendodd looks to be an even worse horror show, and is almost guaranteed to be so if Gensler is the one in charge, as he clearly aims to be.

October 8, 2015

Why Don’t Journalists Scrutinize the Oracle of Syria?

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

One of the most irritating things about coverage of the war in Syria is that virtually every story relies on a single source, the Syrian Observatory for Human Rights, for the bulk of its (alleged) in-country information. This story from Reuters is an example.

The problem is that the Observatory isn’t in country at all. It’s a one man operation run by Rami Abdulrahman from his flat in London,where he’s lived for 15 years.

Despite the distance, and the fog of war, Rami provides exceptionally detailed reports on military operations by all sides in real time. Not a sparrow falls in Syria without Rami’s knowledge. Particularly suspicious are his precise casualty counts. It’s never “around 20 were reported killed.” It’s always “22 were killed” or “27 were killed.” There is seldom that precision in mass casualty reports even in the US, sometimes for days after the event occurs.

Rami’s distance, the extremely fragmented nature of the contestants (the opposition groups number in the dozens), the inherent uncertainties of first person accounts, the incentive of those on the ground to lie, his inability to verify information, and on and on and on should raise serious doubts about his accuracy, even if you don’t wonder about his potential interest. His background strongly suggests a Muslim Brotherhood connection. (The MB was the heart of the anti-Assad opposition for years before the war broke out. That’s who Assad père was trying to wipe out in Hama in 1982.)

Yet I have yet to see one serious journalist inquire about him or his operation, or question his/its reliability. Instead, he is universally treated like some sort of oracle, all knowing and all seeing. Is it just because it’s too hard to report from Syria, and just too easy to pretend that the guy in London knows everything there is to know?

Since the vast bulk of stories rely on this single, doubtful source, it all must be questioned. And he must be questioned, not least by those who rely on him as their primary source. And you must question any article that relies heavily on him. Which means, you must question pretty much every article about Syria.

October 7, 2015

We Need to Choose Our Battles, and Syria Isn’t It

Filed under: History,Military,Politics,Russia — The Professor @ 11:04 pm

The hysteria over Russian actions in Syria continues. The Russians are making token strikes-at most-against ISIS, and are focusing their firepower on other anti-regime forces in the west of the country.

Well, of course they are. Putin’s objective is to save Assad’s regime. Its core area in the west. The greatest threat is in the west. So that’s where the bulk of the blows will fall.

Today’s cruise missile attack, launched from the Caspian is partly showing off (especially showing off the fact that Iran and Iraq had to concur), but it also makes military sense as part of a preparatory bombardment supporting a counterattack by regime forces, which is apparently in progress. This demonstrates that the Russian air campaign is part of a coherent military operation which integrates air and ground elements. This presents a stark contrast to the air-only US campaign against ISIS, which cannot achieve any decisive result whatsoever. (It remains to be seen whether Russian air support is sufficient to overcome the extreme shakiness of the Syrian army, which wasn’t much to start with and which has been relentlessly ground down by four years of brutal war.) (In contrast to the coherent Russian effort, the US attacks in Syria yesterday involved destroying two “crude oil collection facilities.” Really. No excavators were available?)

There is also hysteria about Russian lying about what they are doing.  This is like attacking a cobra for striking. It’s what they do.

Most of the frenzy focuses on the Russians’ targeting of “our” rebels in the Free Syrian Army. Yes, this is quite deliberate, and a strike at the US for having the temerity of supporting the anti-Assad effort. Putin views this as a part of a broader struggle against the US.

So should the US respond to the challenge frontally, in Syria?  No. And it’s not even a close call.

First, what is the strategic objective to be gained? I find it hard to see an important security interest in Syria. And overthrowing Assad because he’s a monster could be justified, except that monsters-and arguably worse monsters than Assad-will take over. An Assad rout would likely result in a bacchanal of sectarian violence which would result in the extirpation of non-Sunni communities in Syria. There has not been one Middle East war that has ended in anything closely resembling peace, and the circumstances in Syria are even less favorable to such an outcome than in Iraq and Libya.

Second, the idea that the there is a serious “moderate” opposition in Syria is not true today, and arguably never was true. The FSA’s day passed years ago, and our track record of identifying moderate, secular forces in this region is appallingly bad.

Those that are pushing this fantasy include John McCain, who is detached from reality on this issue. Others include journalists Michael Weiss and Hassan Hassan, who have been flogging this narrative for four years, and are frantically doing so now: the more implausible the narrative becomes, the more frenzied they become. One should note that Hassan is tightly connected with UAE, which has been the main supporter of the anti-Assad opposition from the beginning, and Weiss’s connections are murky, and his pom-pomming for a Syrian opposition that is lousy with Islamists raises questions.

(And by the way: I thought the CIA program to arm the opposition was supposed to be covert. Why are we blabbing about it?)

Third, what can be done? The idée du jour supported by left (Hillary Clinton) and right (several GOP candidates, including Rubio, Fiorina, and Christie), is a no fly zone. This is superficially appealing because it relies purely on American airpower, and thus does not require a ground commitment. This virtue is in fact a measure of the non-seriousness of the idea.  It would not have been militarily decisive before the Russians arrived because Assad’s air force played only a marginal role in the conflict. Now it would require a confrontation with the Russians, because it is the Russians that are flying. Why engage in a confrontation that could lead to unpredictable developments elsewhere, and which (per the above) would not result in any material strategic gainer the US?

Rubio goes further, plumping for a “safe zone” that somehow will magically be radical Islamist-free. How this would work outside of some Harry Potter-esque fantasy is beyond me. Further, note the “safe zone” idea is a favorite of Erdogan. Who has been a major supporter of the Islamist groups in Syria. It appears for all the world that Rubio has bought a bill of goods from the GCC and the Turks about the Syrian opposition.

If you look at the correlation of forces (as the Soviets put it), and the strategic stakes, deeper US involvement in Syria makes no sense. The odds of prevailing are low, and the gains from winning are trivial, and likely non-existent.

Russia’s aggressiveness is indeed a concern, and someone with Putin’s mindset will be emboldened if he believes that he will meet no resistance. But an asymmetric response, an indirect approach, is more advisable. Russia’s vulnerabilities are economic and financial, and its greatest sensitivities are on in the Baltics, Poland, and Ukraine.

One last thing. The sputtering denunciations of Putin, notably again by McCain and others, are profoundly counterproductive. They only contribute to Putin’s image as some sort of colossus, which only encourages more aggressiveness and more admiration for him. At the other extreme, the administration’s mewling protests that the Syrian intervention is a testament to Putin’s weakness is just plain pathetic, especially since it is not accompanied by any countermoves anywhere.

Unfortunately, this administration is has neither the intestinal fortitude nor the strategic dexterity to respond effectively, or even coherently. We will have to wait another 15 months at least for a reach change. Unfortunately, there’s not much to look forward to on that front, as none of the Republican candidates have impressed in the least. Rubio particularly disappointed not just because of the safe zone inanity, but because of his clueless remark that Syria is a battle for the future of Sunni Islam: (a) this is not our battle, and (b) it it mimics Saudi and Qatar Sunni chauvinism, and their interests are not ours, in the slightest. (How often has our anger at Iran blinded us to the fact that the Saudis are a deeply malign force too? I actually have a grudging respect for the Iranians. At least they are quite open about their hatred for us.)

We need to pick our battles, and Syria isn’t it. The obsession with it is distracting from the true objective, which should be to construct a coherent strategic response to Putin that exploits our comparative advantages, rather than confronting him where he can exploit his.


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