Streetwise Professor

March 7, 2016

Clear the Way: LSE (and LCH!) on the Block

The biggest news from the exchange world in a long time is the proposed merger between LSE and Eurex. Both entities operate stock exchanges, but that’s a commoditized business these days, and it’s not the real driver of the merger. Instead, LSE’s LCH.Clearnet, and in particular LCH’s SwapClear, are the prizes. LSE and Eurex also both have valuable index businesses, but its hard to see how their value is enhanced through a combination: synergies, if they exist, are modest.

There are potentially large synergies on the clearing side. In particular, the ability to portfolio margin across interest rate products (notably various German government securities futures traded and cleared on Eurex, and Euro-denominated swaps cleared through LCH) would provide cost savings for customers that the merged entities could capture through higher fees. (Which is one reason why some market users are less than thrilled at the merger.)

A potential competitor to buy LSE, ICE, could also exploit these synergies. Indeed, its Euro- and Sterling-denominated short term interest rate futures contracts are arguably a better offset against Euro- and Sterling-denominated swaps than are Bunds or BOBLs.

The CME’s experience suggests that these synergies are not necessarily decisive competitively. The CME clears USD government security and STIRs, as well as USD interest rate swaps, and therefore has the greatest clearing synergies in the largest segment of the world interest rate complex. But LCH has a substantial lead in USD swap clearing.

It is likely that ICE will make a bid for LSE. If it wins, it will have a very strong clearing offering spanning exchange traded contracts, CDS, and IRS. Even if it loses, it can make Eurex pay up, thereby hobbling it as a competitor going forward: even at the current price, the LSE acquisition will strain Eurex’s balance sheet.

CME might also make a bid. Success would give it a veritable monopoly in USD interest rate clearing.

And that’s CME’s biggest obstacle. I doubt European anti-trust authorities would accept the creation of a clearing monopoly, especially since the monopolist would be American. (Just ask Google, Microsoft, etc., about that.) US antitrust authorities are likely to raise objections as well.

From a traditional antitrust perspective, an ICE acquisition would not present many challenges. But don’t put it past the Europeans to engage in protectionism via antitrust, and gin up objections to an ICE purchase.

Interestingly, the prospect of the merger between two huge clearinghouses is making people nervous about the systemic risk implications. CCPs are the new Too Big to Fail, and all that.

Welcome to the party, people. But it’s a little late to start worrying. As I pointed out going back to the 1990s, there are strong economies of scale and scope in clearing, meaning that consolidation is nearly inevitable. With swaps clearing mandates, the scale of clearing has been increased so much, and new scope economies have been created, that the consolidated entities will inevitably be huge, and systemically important.

If I had to handicap, I would put decent odds on the eventual success of a Eurex-LSE combination, but I think ICE has a decent opportunity of prevailing as well.

The most interesting thing about this is what it says about the new dynamics of exchange combinations. In the 2000s, yes, clearing was part of the story, but synergies in execution were important too. Now it’s all about clearing, and OTC clearing in particular. Which means that systemic risk concerns, which were largely overlooked in the pre-crisis exchange mergers, will move front and center.

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February 21, 2016

The first rule of the Republican Establishment is: You do not talk about the Republican Establishment

Filed under: Politics,Uncategorized — The Professor @ 2:55 pm

The straw man argument is one of the oldest–and lamest–rhetorical tricks. Obama is a master. But he’s by no means alone. Alleged intellectuals (and yet another 5 time Jeopardy champion!) like John Podhoretz play this cheap trick, as in this Podhoretz article denying the existence of a Republican Establishment.

Here’s Podhoretz’s straw man definition:

The Republican Establishment was a subset of the American Establishment. These were not formal entities; they were not entities at all. Indeed, the term for them only came into common currency in England in the 1950s, when the British journalist Henry Fairlie used it to describe a group of people who went to the same schools, ate lunch in the same clubs, and so from childhood came to share the same set of attitudes that permeated the way they exercised power and transmitted cultural messages through the system. It is meaningful that Fairlie described it so pointedly just as it was crumbling away in England; perhaps it was only as it was melting away that its skeletal structure could be seen and its genus and species identified.


an Establishment is a set of people in the elite who share the kinds of cultural and social commonalities that truly define a kind of social and political caste, and for which important matters are transmitted invisibly through family and educational and social ties so that they end up operating almost unconsciously from the same base of experience.

How’s that for crypto-academic argle-bargle?

It’s also completely at odds with the way that the term is hurled as an insult in the ongoing 2016 presidential contest in the Republican Party. In the current political discourse, the term is not used as it would be in a sociology seminar. In fact, those using the term today are referring precisely to people who sound like they are giving a sociology lecture.

Instead, it is used by normal people to refer to a particular group of individuals concentrated in Washington, DC. This group consists of senior elected officials (especially in the Senate), Republican Party functionaries, and assorted courtiers in journalism (notably the Weekly Standard, National Review, and Commentary), think tanks, and lobbying firms. The extended establishment includes businesses who are dependent on regulation and government expenditure (e.g., defense contractors).

This is a self-perpetuating group whose primary purpose is not ideological or principled, but is instead dedicated to maintaining power, access to power, and the sinecures attendant to power. These are people who speak of the nation, but whose real obsession is much more parochial: their horizons do not truly stretch beyond the confines of the 202 area code. These are people who are mainly interested in being players. Winning the game is actually secondary.

Indeed, the thought of a game that can actually be won or lost is rather terrifying to them, because losing would mean that they could be unceremoniously ejected from their comfortable perches. An unending, static contest is much more to their interest, and their liking.

This group has many mechanisms of social control to keep its members in line. Withholding funding, social ostracization, or providing plum jobs or committee assignments are all used to coerce or seduce loyalty.

This is why Trump and Cruz are so terrifying to the establishment. Trump is not dependent on it in any way. Indeed, he has gained traction precisely because he insults it at every turn, and they can do nothing about it: their levers of social control do not work on him. The establishment recoiled in horror at his remarks about Iraq and 911, but this did not dent his popularity, and likely increased it: the fact that he was willing to say such outrageous things about the establishment signaled that he is the kind of guy that many Americans are thirsting for, because it shows he does not play by the establishment’s rules.

For his part, Cruz has shown that he will not play by establishment rules either, even though as a Senator he is ostensibly an insider. He has fought against the Republican Senate hierarchy (the heart of the Republican establishment) in a very public way from day one, and has expressed his disdain for it while doing so. This has earned him the hatred of the 202 in-crowd: witness the intense anti-Cruz fury of establishmentarian emeritus Bob Dole. But again, this is a feature, not a bug for many Americans.

Establishment political culture is not new. Americans have long been inured to the existence of a governing class consisting of different partisan elements that is more engaged in advancing its interests as a class than national or popular interests. What is different about 2016 is that many Americans believe, with good reason, that the governing establishment is utterly indifferent to their concerns: once upon a time, the establishmentarians were able to fake sincerity, but now they don’t seem to try to do even that. Further, the fact that the establishment has done pretty well for itself in the past decade, while many Americans can’t say the same, feeds anger. Washington seems like pre-Revolutionary Versailles to many Americans.

On the Republican side, immigration has proved to be the issue that has alienated the establishment from those outside of DC. Trump realized this early, and seized on it. It is the issue that will make it difficult indeed for the Republican establishment’s preferred candidate-Rubio-to win. Too many people who vote in Republican primaries identify with Trump on this salient issue, rather than Rubio.

It must be noted that the disdain for the governing establishment is not limited to the Republicans. Hillary’s inability to shake a dotty socialist demonstrates that many Democratic voters are also deeply alienated. Hillary is rightly perceived as the insiders’ insider, and her risible attempt to sound militant comes off as dishonest and phony.

Podhoretz’s attempt to deny the existence of a Republican establishment has a comic element to it. It reminds me of the rules of Fight Club: The first rule of the Republican Establishment is: You do not talk about the Republican Establishment. The second rule of the Republican Establishment is: You do not talk about the Republican Establishment. Podhoretz’s attempt to deny its existence betrays a deep fear. He is very much a part of that establishment, and his access, influence, and income are threatened by the barbarians at the gates. He is not alone, and as a result the desperation is palpable: witness the frenzied attempts to pump up Rubio.

What Podhoretz and his ilk aren’t getting, however, is their efforts are completely counterproductive. Since they are the problem in the minds of many Americans, their attempts to promote one candidate and tear down others hurts the former and helps the latter: their endorsements are an insult, and their insults are endorsements.

They don’t have a positive agenda to offer, and preservation of their class is hardly a selling point in the current political environment. And an establishmentarian’s denial of the existence of an establishment will do nothing to convince anti-establishmentarians that their anger is misdirected. To the contrary, it will come off as another act of condescension-“the establishment doesn’t exist: who are you gonna believe, me, or your lying eyes?”-that will just feed the anger.

I think it is fairly clear that the Republican side of the establishment is doomed, which is precisely why people like Podhoretz are so intent on denying its existence. I sometimes wonder whether the party is in the throes of a collapse comparable to the Whigs in the 19th century. Its passing will not be lamented. What remains to be seen is whether what replaces it will be an improvement.


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January 6, 2016

Ten Years After

Filed under: Uncategorized — The Professor @ 3:38 pm

Today is the 10th anniversary of Streetwise Professor. Hard to believe. What a long, strange trip it’s been.

I started the blog with the intent of focusing on topics directly related to my academic research on derivatives, commodities, and exchanges. I’ve done quite a bit of that, and indeed, blog posts were often the first draft of material that turned up in research papers, or at least, were a way of thinking out loud that shaped what later appeared in more formal work. But, of course, the range of topics I’ve written about has metastasized over the years. I never would have predicted when I first envisioned the blog that Russia would have consumed so much time and attention. And probably a good thing too, because that probably brought more traffic to SWP than any other single topic, and people who came here for my Russia rants stayed for other topics. But it’s not just Russia. I’ve written about politics (Thanks, Obama!), China, broader economic issues, history, military matters, climate change, sports and even punk rock. It’s my blog, and I’ll write what I want to.

2006 was a propitious time to start a blog, because the subsequent decade has been chock-full of history, especially in financial and commodity markets. The biggest financial crisis in recent history spawned a huge onslaught of regulation, which provided a lot of grist for my mill. (Thanks, Frankendodd!) Furthermore, the End of History that some forecast at the beginning of the 2000s definitely did not occur in the 2006-2016 decade. Indeed, the world has been as unsettled as in any decade since the 1930s. In 2009 or so, I wondered whether these times were more like the 30s or the 70s, and sadly, the former answer wins. But that has provided considerable material to work with.

In areas related to things I actually know something about–commodity prices, energy, speculation, manipulation, HFT, derivatives market regulation, and clearing–I think it’s fair to say that SWP has had some impact on policy, or at least the way people think about policy. I know that there are more than a few followers in the financial and legal community, and among regulators around the world.

Along the way I’ve made quite a few friends, for which I’m grateful. It has been gratifying over the years to have people approach me and mention this post or that. I have to confess that some people have remembered posts that I forgot writing 😉

I’ve also made a few enemies, for which I’m also grateful. It’s part of the way I know I’ve made an impact, but more importantly, I’ve made enemies mainly by calling out rather forcefully the frauds, follies, fecklessness–and fuck-ups–of those who presume to rule us. (I have it on very good authority, for instance, that I was banned from the CFTC building by Gensler.) Their anger is a sign that I’ve hit the mark.

I would like to extend my sincere appreciation to those who have read the blog, particularly those who have read it regularly over the years, and especially those hardy souls who have ventured into the comment section.

What will then next ten years bring? Since I was so mistaken in my expectations about SWP when I started, I will forego a prediction now, other than to say that I will go where the spirit leads me (recognizing that sometimes the spirit is an evil one :-P). I think eclecticism has worked, and I’ll keep it up.

Thanks again for reading, and I hope you stick around. I hope I give you reason to stick around.

PS. Talk about some sort of fate. I remember distinctly sitting in front of my computer ten years ago, wondering what to call this damn thing. Then this song played, and I knew immediately that Streetwise Professor was the perfect name. And what should begin playing on Pandora when I started the third paragraph? Yup. Lars Frederiksen and the Bastards, playing Streetwise Professor. Too funny.

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September 12, 2015

The Road to Hell is Paved With Good Intentions, German Refugee Policy Edition

Filed under: Uncategorized — The Professor @ 5:37 pm

Germany has opened the floodgates for refugees-and others impersonating refugees-into the country, and into Europe. It is a colossal blunder that will not end well, and which reflects Germany’s political defects.

Merkel’s motives are rooted in German historical neuroses and romanticism. Germany is at pains to prove that it has overcome its Nazi and racist past. As one German historian put it:

“We want to prove that we are good people. Even if no one wants to be reminded of this, the good that we do has to be seen in relation to the crimes that we initiated,” Arnulf Baring, a conservative German historian, wrote in the Bild tabloid this week.

Furthermore, Merkel and others in German (especially in the governing and culture classes) have a romantic view of refugees, more likely to see them as waifs (like the drowned boy in the photograph that marked, and arguably contributed to, the inflection point in the refugee crisis) and women fleeing war.

Other Germans advance more pragmatic justifications: Germany is aging and in demographic decline, and needs a new supply of labor to replacing the retiring and the dying. (Many in Sweden, also very open to the refugees, make the same argument.)

All of these reasons are daft, and ignore much grittier realities. Expiating past guilt seldom results in current good. Further, the romantic view of the migrants is at odds with the reality. They are disproportionately young and male, which is to be expected: young men are more able to withstand the rigors of the trek from Syria (or Eritrea or wherever), and often have little to hold them at home. Indeed, those with the fewest attachments are likely to be misfits, meaning that the migrants are being sampled disproportionately from the less desirable part of the distribution.

Furthermore, they are likely to be fertile ground for recruiting by Islamist radicals. Already German security services are leaking that Islamist recruiters are descending on refugee centers. Germany, which already has an Islamist problem (and has had so for years: witness Mohammed Atta), has just made it that much worse.

As for the labor argument, it is a damning indictment of EU labor markets and labor mobility (and capital and goods markets for that matter). It is not as if Europe as a whole lacks idle labor, and a well-functioning labor market with mobility would match those unemployed and underemployed Europeans (e.g., young Spaniards–or Greeks!) with German employers. If the grandiose European project were in fact working, Germany wouldn’t have to import gastarbeiters qua refugees to replace its retiring workers.

Moreover, this argument reflects an ignorance of, and arguably a disdain for, Germans working in factories and services. Labor is not an undifferentiated mass. Germans are much more productive than the refugees are, and are likely to be, for generations to come. Education, skills, and yes, cultural attributes mean that the refugees are a poor substitute for German labor. Looking at it in a completely mercenary way, those who think that the refugees are going to be productive enough to be taxed enough to support a growing population of pensioners are deluding themselves.

Merkel’s actions also betray the elitism and undemocratic tendencies that characterize the EU generally and Germany in particular. This was not a decision taken after any democratic deliberation whatsoever, and many Germans are decidedly unhappy about it, especially in Bavaria and the Rhineland. (The security services are furious too: why else would they leak so soon about Islamist recruiting?)

And if many Germans are unhappy about Merkel being charitable to refugees at their expense, smaller European nations are furious because the immigrant wave will hit them as well. Denmark-long a thorn in Germany’s side-hit back immediately, stopping passenger rail traffic and closing major freeways into Germany in order to stem the immigrant tide.

German statements that other European countries should accept refugees because Germany’s resources are not unlimited add insult to injury. “Hey Germany, salve your conscience on your own Euro, not ours.” This is particularly rankling given that Germany is far richer than many of the countries it wants to take more refugees, and given that many of these countries believe that the Euro has enriched Germany at their expense. But the German leaders have a tin ear on these issues, and are apparently oblivious that this reinforces every negative perception about them and their dominance of Europe.

The EU is doing its part as well, including issuing a diktat to nonmembers Iceland, Liechtenstein, Norway and Switzerland that they accept asylum seekers. Or else:

[The EC]  notes all four countries will have to accept Dublin “and its development without exception.” They will have no say or input in amending Dublin, nor will they have any say on the Commission’s relocation plan.

“They do not take part in the adoption of any acts amending or building upon the Dublin acquis”, it says.

This is going to end very badly. It will impose a substantial economic burden on Germany (and other European nations) in the near to medium term with little or no long term benefit to compensate. It will exacerbate Europe’s jihadi problem. It will reinforce already strong beliefs that the EU is remote, dictatorial, and indifferent to popular concerns. It will drive many moderate Germans (and moderate Europeans) into the arms of the far right because they will (correctly) believe that the governing class is indifferent to the impact of the wave of immigrants on them, and will dismiss their concerns–when they are not insulting them for being racists because they don’t accept the migrants with open arms.

They don’t want to pay for Angela Merkel et al‘s masturbatory do-goodism. They are willing to help, but don’t want to be inundated by alienated and culturally alien immigrants; they want a reasonable, measured response that takes their economic and security concerns into account; and they don’t want to be dictated to by their self-appointed betters. But it looks like none of that is going to happen. It is more likely that the exact opposite will. There will be a price to be paid for that. And it is likely to be a steep one, both in Euros and in social and political peace.


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February 16, 2015

ISIS’s Eschatology Is Its Greatest Vulnerability, Not a Reason to Shrink From Confronting It

Filed under: History,Military,Politics,Uncategorized — The Professor @ 11:09 pm

I am a distant relative of William Tecumseh Sherman: we share a common ancestor (a Puritan who settled in Connecticut n the 1630s). I like to think that my red beard and slightly crazed look is a reflection of that genetic connection. Be that as it may, I do share something of a philosophic affinity for him. Ruthlessly practical and unromantic (even though he lived in a decidedly Romantic era). Nothing demonstrated this better than his views on war, including in particular this quote:

War is the remedy that our enemies have chosen, and I say let us give them all they want.

@libertylynx reminded me of this quote when she was debating a wannabe wonk on Twitter. Said wonk claimed that ISIS should not be confronted militarily, because that is what they want. He therefore condemned the Egyptian bombing raids on ISIS in response to its latest atrocity, the slaughter of 21 innocent Copts for the crime of being Christian “crusaders.” (Copts have been in the Middle East since hundreds of years before Mohammed. Just who are the invading holy warriors here? Continuing its craven refusal to acknowledge the reality of ISIS’s religiously inspired rampage, the White House condemned the murder of “21 Egyptian citizens.” The words “Copt” and “Christian” were absent.)

It is becoming a idée fixe on the Left that confronting ISIS militarily is futile. There will be civilian casualties! Yes, those are inevitable: but how many civilian casualties will there be while such monsters are on the loose? Attacking them will rally recruits to their standard! Apparently the killing ISIS fighters is akin to sowing dragon’s teeth: it will just make more enemies. So we might as well just give up, until their blood lust is sated. Or something.

This meme reached the levels of absurdity in the hands of State Department spokeswoman Marie Harf, who apparently strives daily to make a box of rocks look like John von Neumann by comparison to her, and largely succeeds in her mission:

HARF: We’re killing a lot of them and we’re going to keep killing more of them. So are the Egyptians, so are the Jordanians. They’re in this fight with us. But we cannot win this war by killing them. We cannot kill our way out of this war. We need in the medium to longer term to go after the root causes that leads people to join these groups, whether it’s lack of opportunity for jobs, whether —

MATTHEWS: We’re not going to be able to stop that in our lifetime or fifty lifetimes. There’s always going to be poor people. There’s always going to be poor muslims, and as long as there are poor Muslims, the trumpet’s blowing and they’ll join. We can’t stop that, can we?

HARF: We can work with countries around the world to help improve their governance. We can help them build their economies so they can have job opportunities for these people…

Memo to Marie: when Chris Matthews makes a lot more sense than you do, it’s time to give up.

And yeah. It’s all about jobs and governance.

It’s not really, as this excellent article from the Atlantic demonstrates. ISIS is not of this age, or even of this world. Materialistic concerns projected by western leftists are completely irrelevant to it. Obama’s and other western leaders’ denials to the contrary, it is a fanatical religious movement imbued with a fervor totally alien to comfortable western minds, and progressive minds in particular, who believe that such forces were left behind several turns of the dialectical wheel ago.

In particular, as the Atlantic piece brings out, ISIS has an apocalyptic vision, and crucially, its adherents fervently believe in an imminent eschatology, culminating in a climactic battle against the “Romans” on the Plains of Dabiq in Syria. (Note that the latest ISIS snuff film documenting the beheading of the innocent Copts included a warning that they were coming to Rome.)

So yes, they want a battle. In the worst way.

So why not give it to them? Now usually, one tries to avoid doing what the enemy wants. But when the enemy’s firmest desire is based on delusion, that rule no longer applies. ISIS has no real conception of how militarily mismatched it is. Yes, Kobane gave them something of an inkling, but even there the US deployed and displayed only a fraction its capabilities. Nothing like an Arc Light raid of the Vietnam War, or the kind of power unleashed in Desert Storm.

This does not mean rushing in to fight on their terms. It means forcing or maneuvering them into a position where they have to stand and fight in a way that makes them vulnerable to a pounding. To use their eagerness to fight a climactic battle to lure them into a fight they cannot win.

The closest historical analog to ISIS is the Mahdist War of 1881-1899. This conflict culminated in the Battle of Omdurman, in which a massive Islamist army was lured into attacking a much smaller British-Egyptian army equipped with the latest in small arms, machine guns, and artillery, which resulted in the Mahdists’ utter destruction: they lost over 50 percent casualties. The very fanaticism that had carried the Mahdists to victory after victory was the cause of their utter ruin. That could be a model for the war on ISIS.

We only defeated the fanatical Japanese and the fanatical Nazis in WWII by killing them in vast numbers. That is the only way to defeat the current breed of fanatic. And fortunately, ISIS is neither so numerous, nor militarily capable, as either such foe, and current American capability makes the forces of the 1940s look like toys by comparison.

So rather than being a reason to shrink from fighting it, ISIS’s eschatological vision and mad thirst for battle against the New Romans is its greatest vulnerability. The smart thing for them to do would be hit and run: but we can use their fanaticism to get them to stand and fight. American strategy should be focused on making their dearest wishes come true. As Sherman said, War is the remedy ISIS has chosen, and I say let us give them all they want, but on our terms, exploiting our advantages.

ISIS needs to be introduced to the America of Billy Sherman and Andy Jackson. But we have Barry Obama.

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February 2, 2015

Arms and the Man

Filed under: History,Military,Politics,Russia,Uncategorized — The Professor @ 9:26 pm

The Obama administration is apparently reconsidering its refusal to provide lethal military assistance to Ukraine, although reading between the lines I suspect Obama is reprising his star turn as Hamlet. The security establishment seems solidly behind the idea, but Obama frets about getting into a proxy war with Russia.

Merkel came out steadfastly against the idea:

“Germany will not support Ukraine with guns and weapons,” said Merkel, speaking in Budapest. “We are putting all our bets on sanctions and doing our best to find a diplomatic solution.”

Telegram from Mr. Trotsky to Barack and Angela: you may not be interested in war, but war is interested in you.* Nattering on about diplomacy is pathetic given where things stand now, with the collapse of the Minsk accords and the dramatic escalation of conflict all along the contact line, but especially in the Debaltseve pocket. Merkel is engaged in wishful, not to say magical, thinking. Diplomacy and force are complements, and Putin will be uninterested in talk, except as a diversionary or delaying tactic, as long as the military option is viable.

One of the weapons the US is supposedly considering supplying to Ukraine is the Javelin anti-tank guided missile (ATGM). This could be a decisive weapon, and some wicked turnaround for Putin. Hezbollah inflicted great losses on Israel using Russian-made Kornet ATGMs in 2006.  If supplied in quantity, Javelins could neutralize Russia’s substantial advantage in armor, and dramatically raise the cost to the Russians and their proxies in blood, treasure, and equipment in any attempt to expand military operations in Ukraine.

How would this affect Putin? We don’t know what he is willing to pay for various outcomes in Ukraine, but making Ukrainian defenses substantially more effective could make the price for an outright conquest of part or all of Ukraine greater than Putin is willing to pay.

Putin has been able to get by so far by having his proxies bear the brunt of the casualties, and by suppressing news about Russian casualties. But even he would be unable to keep a lid on a large spike in losses. What’s more, his manpower and material resources are in fact quite constrained. Substantial losses could render his forces largely combat ineffective and incapable of a decisive victory.

The main risk is that it may be too late. The arms won’t magically appear in Ukraine overnight, and it would take some time to train the Ukrainians in their use after they arrive. If arms start to flow, Putin may conclude that he has a time window in which to advance, and therefore decide to move now, whereas he might be inclined to wait and rely on other means to dominate Ukraine if he believed that he could invade later if need be. Ironically, the more effective the arms we provide (or more accurately, the more effective Putin and his generals believe those weapons will be) the greater the incentive he has to move before those weapons arrive. Thus, the interval between the decision to arm and the time that the weapons are in Ukrainian hands will be quite fraught, and the US would need to be prepared to deter Putin in other ways during that interval.

There are widespread concerns that Putin would react to the arming of Ukraine by escalating elsewhere, such as the Baltics. He is clearly trying to signal his truculence, as with a provocative flight of nuclear armed Bear bombers through the English Channel. Thus, the issue becomes whether he can be deterred from challenging Nato directly in Estonia, Latvia, or Lithuania, or Poland for that matter. If he can’t be, Ukraine is the least of our problems. Or put differently, we need to revitalize our deterrent regardless of what we do in Ukraine, because Nato countries would be at risk.

If Putin’s madman strategy-real or feigned-is potentially effective in intimidating the West into acquiescing to his subjugation of Ukraine, magical thinking and Hamlet-like fretting are certainly effective at egging him on. People like him sense weakness as a predatory beast can. Arguably the strongest argument for arming Ukraine in the face of Putin’s threats is that it could get him to reassess the strength of American resolve. Obama’s record of temporizing-on Syria, on Isis, on Ukraine-has given Putin considerable reason to believe that when pushed, Obama will back down. It will take something rather dramatic, such as arming Ukraine in a big way, to convince Putin otherwise: even that is merely necessary, rather than sufficient. But if it’s done, it must be done lavishly, and not in a token fashion. But given how stingily we are with arms to the Syrian opposition and even the Kurds (who are actually accomplishing something against Isis), I find it hard to believe that Obama will do that.

The conundrum is that Putin will view American (and European) passivity as an invitation to keep pressing forward. Those who oppose doing something more robust, such as arming the Ukrainians, argue that this action will goad him forward as well: they are deluding themselves if they think he can be appeased. So it seems that regardless of what course is taken, Putin will keep trying.

At least Bloomberg is somewhat consistent. It says that we’re not going to seriously oppose Putin anyways, why give the Ukrainians any false hopes by giving them weapons? Just tell them to get used to living under Russian domination again and don’t encourage them to wage a futile war on their own.

But if you don’t want to acquiesce to Putin dominating the entire Warsaw Pact space, you have to make a stand somewhere. If the Ukrainians are willing to make that stand, give them the means to do it.

* This phrase is widely attributed to Trotsky, but the closest anyone can find written by him is “you may not be interested in the dialectic, but the dialectic is interested in you.”

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December 21, 2014

The End of the World As We Know It?*

Filed under: Uncategorized — The Professor @ 8:04 pm

I have been named to the CFTC’s Energy and Environmental Markets Advisory Committee, at the invitation of Commissioner Christopher Giancarlo. Given how I was viewed during the Gensler years, this is a sign that the winds have shifted at 1155 21st St. NW. Or maybe it’s a harbinger of the impending apocalypse. It is particularly ironic, given that Frankendodd specifically mandated that the Commission create the EEMAC: there’s a mandate I can get behind!

Kidding aside, I very much appreciate the opportunity to contribute to the debate in a forum that has policymakers’ ears. The position limits issue is still very much on the table: the hedging definitions are particularly challenging, as is how to determine when speculation is causing unwarranted fluctuations in prices. I definitely have things to say about these matters, and will take the opportunity to say them.

* This is the title of the only REM song that doesn’t have me hitting skip or switching channels.

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December 20, 2014

Can a Money Launderer Truly Come Clean?

Filed under: Energy,History,Politics,Russia,Uncategorized — The Professor @ 8:07 pm

During his press conference, Putin made a very arch reply to a question about Khodorkovsky’s ambition to be president: “Of what country?”

Well, Khodorkovsky is making it clear that the answer to that question is “Russia.” He gives voice to his ambitions in an extended interview in the FT, and repeats his forecast that Putin’s main danger comes from within his “entourage”.

In some respects, Khodorkovsky’s re-emergence and frank statements of his political ambitions and his vision of himself as savior of Russia are a favor to Putin. Especially in times that bring back uncomfortable memories of the 90s collapse, the most notorious oligarch from that era makes a perfect foil for Putin. Breaking the oligarchs was one of the primary foundations of Putin’s reputation and popularity (with the war in Chechnya being another). What better way for Putin to remind Russians of why he is needed than the reemergence of Khodorkovsky?

And Khodorkovsky is definitely a very flawed vessel. Even if his prosecution and imprisonment was a travesty of justice, that’s not to say that he couldn’t have been convicted in a fair trial. For contemporary reporting, both Russian and non-Russian, makes it clear that Khordorkovsky was a ruthless operator who used every trick in the book to avoid taxation, and expropriate minority shareholders and creditors. This article from April, 2000 provides the chapter and verse.

Most of these tricks involved offshore shell companies that he owned. For instance, Khordorkovsky would engage in asset stripping, whereby assets of his Russian enterprises were transferred to the shell companies he owned. Another trick was stock watering, whereby his entities would issue large numbers of new shares of stock that were sold to his shell companies, thereby diluting the ownership of outside investors. He used these devices to great effect in the immediate aftermath of the  financial crisis. Non-Russian banks who had made loans to Khodorkovsky’s Menatep Bank collateralized by Yukos shares saw the values of these shares plummet when he stripped Yukos assets and watered the stock in a way that would have made Daniel Drew and Jay Gould blush.

Khodorkovsky was also the past-master at transfer pricing schemes, whereby output of his Russian companies would be sold to offshore entities at a fraction of the world price; the offshore entities would then sell at the world price. According to the Foreign Affairs article, during the first nine months of 1999, Yukos sold 240mm barrels of oil at about 10 percent of the world price to offshore entities, pocketing $800 million.

And of course, there is the way that he acquired Yukos, via the Loans for Shares deal, and the rigged auction that followed the (inevitable) government default on the loans.

Khodorkovsky was definitely not the hero of western investors back then. In fact, he was a villain.

For all this, Khodorkovsky exhibits little remorse. Arguably none:

I ask about the “loans-for-shares” auctions in 1995 when a handful of businessmen — the oligarchs — lent money to the near-bankrupt Russian state and received stakes in state businesses as collateral. When the state failed to repay the loans, the oligarchs sold the stakes to themselves at knockdown prices. Today the auctions are seen, I remark, as a kind of “original sin” hanging over Russian business.

“I wouldn’t entirely agree,” Khodork­ovsky says. At the time it looked, he continues, as if a Communist candidate would beat President Boris Yeltsin in the elections, which would have spelt the end of private business. Given the risks, no foreign investor was interested. So the shares were worth only what Russian investors would pay — in Khodorkovsky’s case, about $300m, for just under 80 per cent of Yukos.

. . . .

The tax “minimisation” schemes — selling oil through onshore tax havens — at Yukos that were the heart of the trials against him were known to the authorities and even senior ministers, he insists. “In tax law, it’s a crime in most countries if you’ve hidden something. But we didn’t hide anything.” [This remark is particularly disingenuous.]

Note that his justification of the loans for shares fails altogether to address the issue of the rigged auctions. If no other investors were interested, why were the auctions rigged in order to ensure that none could possibly win?

The unapologetic attitude towards not paying taxes is not new:

Khodorkovsky was robustly unapologetic. ‘ As long as the tax regime is unjust, I will try to find a way round it.’

What complicates the Khodorkovsky story is his apparent conversion in around 2000, when Yukos adopted GAAP accounting and western governance standards, and began hiring American managers, including Bruce Misamore as CFO. Was this a Road to Damascus conversion, or a calculated strategy to make the company attractive to western supermajors? Certainly this was the effect: at the time of his arrest, he was on the brink of selling a large stake in Yukos to either Exxon Mobil or Chevron.

His late-in-the-day embrace of western business practices and his persecution are relevant in evaluating his character and motives today, but his history cannot be overlooked. I for one am very skeptical that he has undergone a fundamental change. The failure to repudiate some of his more outrageous actions certainly raises doubts. Someone should address them.

There’s a possible candidate. One of the initiatives that Khodorkovsky funds in order to advance his agenda is Interpreter Magazine, edited by Michael Weiss. This is beyond passing strange, because Weiss has crusaded against Russian money laundering through the use of shell companies and transfer pricing schemes-the very techniques that his paymaster refined into an art 20 years ago. Interestingly, I can find no evidence that Weiss has subjected his patron to similar scrutiny. Not even an acknowledgment that the denizens of Londonograd that he excoriates are pikers compared to his pioneering patron, let alone an inquiry that could attempt to determine whether the man who emerged from prison a year ago is different from the man who went into prison in 2003, and who did the things that put him there.

This would be a truly valuable investigation, far more important than anything Weiss or Interpreter has done. This is particularly true given Khodorkovsky’s return to political life.

There is another strange twist here. Khodorkovsky has come out in opposition to sanctions, and in support of Russia’s annexation of Crimea: he claims that returning it would be undemocraticthe act of a dictator. Given that Putin also claims to be carrying out the public will, this raises questions about how differently Khodorkovsky would act if he were in Putin’s place. It also raises questions about his commitment to the rule of law, which he claims to support.

In sum, Khodorkovsky is playing a political role. Indeed, he is holding himself out as the man who can put Russia on the path away from autocracy towards the rule of law and respect for civil society. He has a past. A very disreputable one, though one perhaps redeemed by reform and punishment. But one can never be sure that the past is truly gone. Given that the most scurrilous acts in the past involved money laundering and shell companies, you’d think that a journalist who has crusaded against those things would be the man to find out.

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August 24, 2014

With Friends Like Merkel, Ukraine Doesn’t Need Enemies

Filed under: Uncategorized — The Professor @ 9:30 pm

Merkel visited Ukraine yesterday, on the 75th anniversary of the Nazi-Soviet pact. She did not quite play the role of Frau Ribbentrop, but she, and the German government, are greatly assisting Putin.

Yes, she said that Germany cannot accept Russian control over Crimea. But this is cheap posturing, because, in fact, it does. Germany refuses to accept the seizure de jure, but it does accept it, through its deeds, de facto.

Beyond those words, Merkel and the German government say things that Putin finds very congenial. She called for an unconditional cease-fire in eastern Ukraine. So has Putin. He wants this to give his battered forces in Ukraine relief so that he can regroup, reinforce, and adjust his tactics. Merkel wants to oblige him, even though her ostensible subjective reasons are different: but objectively, she is pro-Putin. Then, her Vice Chancellor (of the SPD) Sigmar Gabriel said that the only solution to the conflict in Ukraine was federalization. That’s the Russian line. (Merkel quickly said he had misspoke, and meant “decentralization”, but it is clear that he committed a Kinseyesque gaffe: he had spoken the truth.)

So the top two officials in the German government have endorsed the measures called for by the Russian government, and opposed by the Ukrainian government.

Merkel also said no more sanctions for now.

Further, Reuters reports that Germany/Merkel are now focusing on pressuring Ukraine to cease its military offensive in the Donbas, lest Putin suffer a loss of face that would compel him to invade.

After months of ratcheting up pressure on Vladimir Putin, concern is mounting in Berlin and other European capitals that an emboldened Ukraine’s military successes in the east are reducing the chances of a face-saving way out of the crisis for the Russian leader.

As a result, the focus of German-led diplomatic efforts has shifted, according to senior officials, towards urging restraint from Ukrainian President Petro Poroshenko and averting a humiliating defeat for pro-Russian rebels, a development that Berlin fears could elicit a strong response from Putin.

If followed, this advice will create another frozen conflict that Putin will use to eat away at Ukraine, to continue to bleed it and prevent it from reforming, and growing, and most importantly (from Putin’s perspective) keep it from moving closer to Europe. A persistent conflict in the region will also result in mounting civilian casualties and misery, things that Merkel claims to want to stop.

Frau Merkel gives the impression of someone who is willing to consign Ukraine to purgatory, to avoid dealing with Putin today. This is foolish, because it’s not as if Putin is going to go away satisfied. He will continue to pressure Ukraine, perhaps attempting to expand his covert and ambiguous military operations to other parts of the country. He will turn his attention to the Baltics. Merkel is just delaying the inevitable, and there is little certainty that the west will be in better shape to confront Putin later than now.

Merkel went to Ukraine proclaiming friendship. With friends like her, Ukraine-and the rest of Eastern Europe-don’t have to go looking for enemies.



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June 26, 2014

Understand This: Germany Won’t Sanction Russian Companies, But Will Sanction American Ones

Filed under: History,Military,Politics,Russia,Uncategorized — The Professor @ 3:13 pm

Both the US and Germany are making noise about ratcheting up sanctions on Russia. Kerry told the Russians to disarm separatists “within hours” or else. That was hours ago, and nothing has happened.

Germany’s Merkel has also toughened “sanctions talk.”

Angela Merkel, German chancellor, has raised the prospect of broader economic sanctions against Russia, just two days before an EU summit at which her hardening stance against Moscow is expected to steer the diplomatic agenda.

One theory is that Merkel and Steinmeier are playing good cop, bad cop, with Angela in the role of the heavy. If Merkel is the bad cop, Putin and his clique have absolutely nothing to worry about.

Merkel has talked (relatively) tough before, but has always found some reason to back off. This time, no doubt Putin’s transparently phony call for his senate (and it is his, in the same sense that his dog is his) to repeal the authorization to invade Ukraine will give Merkel the excuse she needs to keep her finger off the sanctions trigger. That plus Putin’s typically convoluted (and contradictory) support for a ceasefire. Meanwhile, the war of subversion in Donbas goes on, transparently supported by Russia. Only those who will not see don’t understand this.

But Angela has found someone to sanction: the US, or more specifically, US telecom Verizon. German outrage over the Snowden revelations was a major reason for the decision.

Yes, there is reason for outrage here–outrage directed at Germany. Here is a nation that bends over backwards to find reasons not to sanction any Russian company. Even the pathetic sanctions  it has meted out (as part of the EU) are directed primarily at individuals, most of whom are nobodies. Talk of sanctioning Russian companies elicits howls of anger and pain from the German business community. There is constant talk of the need to “understand” the Russians, with the result being described by the French proverb “to understand all is to forgive all.” All including the anschluss in Crimea and the ongoing subversion in Ukraine. There is even a German phrase to describe this lot: Putin Verstehers. Putin understanders. Germans-and Merkel in particular-look for the slightest sign of compromise by Putin, and when they see it, they back off doing anything to penalize him, Russia, or any Russian company. Russia/Putin get the benefit of every German doubt.

But evidently the US does not get the benefit of any German doubt. So they sanction Verizon (not my favorite company, by the way) in their very narcissistic pique and outrage over US surveillance of Germany. No attempt to understand the US whatsoever, let alone an attempt to be as understanding as the Germans are with the corrupt autocrat and oligarchic thugs and espionage-crazy security service in the nation to their east.

But oh, there is a lot that the Germans need to understand about why they are a surveillance target, and not given the same deference as the Five Eyes nations. (I will let pass in silence the fact that Germany’s intelligence service the BND has long cooperated with the US.) One thing to understand: the fact that 911 hijackers made themselves at home in Germany. Another thing to understand: German politics and government has long been penetrated by Soviet, and then Russian, agents and collaborators. And yet another thing to understand: the fact that the German business community and government have clearly been suborned by Russian money. German companies (notably Siemens) have been deeply involved in corrupt dealings in Russia. And yet another thing: although it has cleaned up its act some lately, for a long time German businesses assisted Iran in its efforts to develop nuclear weapons.

In brief: Germany has earned the scrutiny that it has received from the NSA. Indeed, its continued enabling of Putin’s behavior just provides further evidence that it is an unreliable partner and uncertain ally that needs watching.

Germany only has the luxury to engage in its moral preening and biting American ankles and corrupt canoodling with the Russians because the US kept out the Russians for 45 years. And I thought the French were ingrates.

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