Streetwise Professor

February 12, 2015

Merkel and Hollande: Insane. Putin: Very Sane. Poroshenko: Sane and Screwed.

Filed under: Military,Politics — The Professor @ 9:39 pm

Einstein famously defined insanity as doing the same thing over and over again expecting different results.

By that definition, there were two insane participants in the “negotiations”over the war in Ukraine held in Minsk, and two sane ones.

The insane ones were the Euro “leaders”, Merkel and Hollande. They went to Minsk to negotiate a new deal with the man who flagrant violated the last deal then lied shamelessly about it, apparently in the hope that he’ll adhere to a new deal. Only the insane would expect that.

The man on the other side of the round table, Putin, is clearly not insane. He did the same thing as he did last time, but very much expected the same result. And he got it. That’s not quite true: he got a better deal this time.

Ukrainian president Poroshenko clearly went into the meetings with no illusions. He could see that Putin was implacable, and that his erstwhile benefactors were intent on playing the roles of Chamberlain and Daladier in a reprise of Munich!, and that he was cast in the role of Eduard Benes, watching his capitulation being negotiated over his head.  He gamely dragged things out, but in reality it was three against one, and that one was in dire straits with a crumbling economy and a desperate military situation. He did the same thing he did in September, out of necessity, but I am sure he expects the same outcome.

The cease fire does not begin until Sunday, and therefore it is inevitable that there will be a flurry of fighting in the next days, especially around Debaltselvo. Putin made it plain today that he expects the 8000 or so Ukrainian soldiers in the pocket to surrender. The implicit threat is that they will be crushed if they do not.

Even if a cease fire takes hold after Sunday, it will not last. Putin has learned that violations have no adverse consequence, and that after some interval the fighting will start again and he will take another slice of Ukraine. And Merkel and Hollande will harrumph and express grave concern but when push comes to shove they will scurry back to Minsk to do it all over again. Insane.

Wash, rinse, repeat. The low, dishonest decade grinds on.

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February 10, 2015

A Whole Lot of Shaping Going On

Filed under: Military,Politics — The Professor @ 7:52 pm

The shaping of the battlefield in northern Iraq that I have discussed over the past several months continues. Most notably, the peshmerga are moving to isolate Mosul:

U.S. and allied warplanes conducted airstrikes in support of Kurdish Peshmerga fighters in Iraq who retook main routes into Mosul from Islamic State forces, officials with the international coalition said Monday.

Coalition officials said the Peshmerga forces seized three strategic corridors that defense officials called bridgeheads north of Mosul along the Tigris River in territory formerly controlled by extremist forces with Islamic State, also known as ISIS, ISIL and its Arabic acronym Daesh, military officials said.

This puts them in position to cut off the roads connecting Mosul to Syria.

ISIS is clearly transitioning from an offensive posture to a defensive one. It has vacated Kobane, and is retreating from the surrounding villages as the Syrian Kurds advance. It has withdrawn from its more distant outputs east of Aleppo. It is digging a trench line surrounding Mosul, though it is unlikely that it has the manpower to fill all of it, which makes it rather useless in the face of an enemy that can see every unmanned section. It has undertaken some offensive operations, in Anbar and Kirkuk, but these seem to be spoiling attacks meant to prevent the peshmerga and the Iraqi army from concentrating. In Kirkuk in particular, it was pounded hard from the air when it came out to play. They had bee able to make some progress when attacking in a fog, but when that cleared they were hammered.

This is their fundamental problem. They cannot maneuver. They would have been similarly vulnerable last summer, but that opportunity passed.

The Kurds are anxious to increase the pace, but the US is counseling patience while elements of the Iraqi army are trained up enough to undertake offensive operations. While that happens, I would anticipate further local attacks by the peshmerga in the north, the cumulative effect of which will be to cut off Mosul from supply and reinforcement. After that, a grind it out battle in the city, most likely. The gradient is apparent, but it is not steep.

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February 9, 2015

Obama: On a Roll. Us: Getting Rolled

Filed under: History,Military,Politics,Russia — The Professor @ 7:19 pm

Obama is on a roll. A roll. It’s hard to keep up!

Last night he delivered an anti-sexual assault bit at the Grammys. Is anybody pro-sexual assault?

Then, in a Vox (!) interview released today, he continued his Terrorism: It Ain’t No Thang tour:

“It is entirely legitimate for the American people to be deeply concerned when you’ve got a bunch of violent, vicious zealots who behead people or randomly shoot a bunch of folks in a deli in Paris,” Obama said. “We devote enormous resources to that, and it is right and appropriate for us to be vigilant and aggressive in trying to deal with that — the same way a big city mayor’s got to cut the crime rate down if he wants that city to thrive.”

But, he added, “we also have to attend to a lot of other issues, and we’ve got to make sure we’re right-sizing our approach so that what we do isn’t counterproductive.”

Um, the people shot in the “deli” in Paris weren’t randomly selected. Well, randomly selected Jews, maybe, which means it wasn’t random. And that is about the most extreme statement of terrorism is a law enforcement issue I’ve ever seen. Let’s get Mayor Quimby on it!

Then there was today’s Merkel-Obama presser. Where to begin?

When asked about arming Ukraine, he said he hadn’t quite made up his mind:

“It is true that if, in fact, diplomacy fails, what I’ve asked my team to do is to look at all options,” Obama said. “But I have not made a decision about that yet.”

Sure! Take your time. It’s not like this situation hasn’t been metastasizing since the Minsk accords were signed in September. Why haven’t the options been explored long ago, and contingent decisions been made?

And about that diplomacy thing and contingent decisions. First, negotiation and diplomacy depend on threat points. Bolstering-or even threatening to bolster-Ukraine’s military capacity affects the outcome of negotiations by changing substantially the threat point. This idea that diplomacy floats in a world of its own is just cracked, and in fact dooms diplomacy to failure.

Second, Merkel and Hollande scurried to Moscow because Putin had flagrantly violated the Minsk accords. So now they are going to  . . . Minsk, to negotiate new accords. With the guy who broke the last ones. Have I got that right? Am I missing anything?

Obama emphasized the unity of the allies on the Ukraine issue. Recall that earlier he has said he did not want to get ahead of the Europeans. Translation re unity: leading from behind, and deferring to the least common denominator, which in Europe is very low indeed. Germany is bad enough, let alone France, Hungary, Austria, or Greece.

(Sorry. “Leading From Behind” has been rebranded: It’s now called “Strategic Patience.” Same dog food, different label.)

He praised Russia for its constructive role on talks with Iran, and said he looked forward to their future cooperation. As if Putin has the slightest inclination to help out the US. Well, since the deal Obama is panting for will likely harm US interests, maybe Putin will pitch in on that one.

He said that the Ukrainian people knew that America stood behind them. Really. He said that. He didn’t say how far behind. All Obama is providing is warm blankets and hot air, and I am sure that Ukrainians can muster only a bitter laugh at his claim of support.

Obama reiterated his view that Russia’s isolation would bring Putin to heel:

“Even as we continue to work for a diplomatic solution we are making it clear again today that if Russia continues on its current course, which is ruining the Russia economy and hurting the Russian people, as well as having such a terrible effect on Ukraine, Russia’s isolation will only worsen both politically and economically,” he told a joint news conference after meeting with German Chancellor Angela Merkel.

Yes, Putin is so, so isolated. He’s a hero on the European right. Several nations in the EU are far more sympathetic to Russia than the US. And he was welcomed like a conquering hero in Cairo today: check out the photo here (h/t @libertylynx). Sisi greeted him at the airport-a first. The Egyptians did everything but treat Putin like Pharaoh, complete with a procession down the Nile on a royal barge.

By giving such a lavish reception for Putin, Sisi was also giving Obama the middle finger. Or two middle fingers. If Obama were to visit, Sisi would probably have him picked up in a cab and driven to the nearest Cairo slum.

Obama’s obvious affinity for Morsi and the Muslim Brotherhood is going over very badly in Egypt, and not just among the military and the government. Sisi and many Egyptians believe themselves to be in an existential struggle with the Brotherhood, and Obama’s meddling and continued support for it angers them deeply. (What, mayors can’t handle them?)

So glad he made that Cairo speech. It surely changed the world didn’t it? Really built a bridge between the US and the Muslim world, and healed all those wounds dating from the Crusades down to the evil Bush.

And speaking of the Muslim Brotherhood. Remember that supersecret meeting with Muslim “leaders” I wrote about last week? So yeah, among the “leaders” were ranking members of Muslim Brotherhood-linked organizations, including one that was named as an unindicted co-conspirator in a terrorism case. (But I forget: terrorism ain’t no thang.) No wonder he wanted to keep the guest listees and the subject matter secret.

What a week. The man is on a roll. On. A. Roll. And we’re the ones getting rolled.

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February 7, 2015

Obama Bigfoots Net Neutrality: Wasn’t Screwing Up Health Care Enough of a Legacy?

Filed under: Economics,History,Politics,Regulation — The Professor @ 8:38 pm

Last week the Chairman of the Federal Communications System announced that the FCC will pursue net neutrality regulation by subjecting the Internet to Title II of the Federal Cable and Telecommunications Act. This will essentially treat the Internet as a utility, rather than as an information service as has been the case since 1996. Like telecoms, Internet Service Providers would effectively become common carriers subject to a panopoly of restrictions on the prices they can charge and their ability to control access to their infrastructures.

The issue is an extremely complex one, and moreover, one that has been subjected to a barrage of simplistic, propagandistic, rhetoric. To cut through the rhetoric to see the economics, I recommend this article by Gary Becker, Dennis Carlton, and Hal Sider.

Becker, Carlton, and Hal characterize the goals of net neutrality as follows:

In the FCC’s view,

its proposed net neutrality rules would “prohibit a broadband Internet access provider from discriminating against, or in favor of, any content, application or service.” Broadband access providers would be prohibited from: (1) prioritizing traffic and charging differential prices based on the priority status; (2) imposing congestion-related charges; (3) adopting business models that offer exclusive content or that establish exclu- sive relationships with particular content providers; and (4) charging content providers to access the Internet based on factors other than the bandwidth supplied. [References omitted.]

In a nutshell, NN rules and Title II would limit the pricing policies of ISPs, limit their ability to regulate access to their networks, and limit their ability to vertically integrate upstream or downstream (e.g., by purchasing content providers).

The motivation for all of this is a belief that the broadband industry is not competitive, and that price discrimination, access limitations, and vertical integration are means of exercising market power to the detriment of consumers downstream and suppliers of content upstream.

As Becker et al point out, however, evidence that competition is weak is lacking. Most consumers have choices of broadband providers, and the development of wireless services such as 4G is increasing consumer choice.  (Personally, I would estimate that I have gone from relying 100 percent on wired access to 50 percent wired-50 percent wireless. The focus of Facebook and other social media and content suppliers on mobile indicates how important wireless is becoming.) Moreover, there is considerable switching of suppliers, which is further indication of competition.

Further, as a general matter, price discrimination is often-one might say usually-welfare enhancing when there products are differentiated and the costs of these products differ. Different forms of content utilize different amounts of bandwidth. Services vary in their need for speed (e.g., streaming vs. ordinary web-browsing vs. email). It is more costly to deliver bandwidth-intensive services. Limiting the ability to charge prices that reflect differences in cost and value lead to misallocations in the use of existing bandwidth capacity, and tend to reduce incentives to invest in capacity. Moreover, the “two-sided” nature of the Internet tends to make price discrimination welfare-improving. (This paper by Weismen and Kulick makes the very useful distinction between “differential pricing” and “price discrimination.” The former is based on differences in cost, the latter on differences in demand elasticity across customers.) In addition, when there are strong economies of scale, price discrimination (e.g., Ramsey pricing) can be a first-best or second-best way of allowing producers to cover fixed costs.

Put differently, net neutrality/common carrier access treats the internet as a commons which limits the use of prices to allocate scarce resources. Yes there can be cases in which this is beneficial (as in a textbook natural monopoly, but sometimes not even then), but suppressing the price system and price signals is usually a horrible idea. The rebuttable presumption should be that we rely more, not less, on prices to allocate scarce resources and provide incentives to consume, produce, and invest. Net neutrality betrays a strong animus to the price system and the use of prices to allocate resources.

Vertical arrangements are also frequently looked on with deep suspicion. I wrote about this a lot in the context of exchange ownership of clearing some years ago. But usually vertical arrangements, including restrictive contracts and vertical integration, are contractual means to address inefficiencies in price competition. They are typically ways of internalizing externalities or constraining opportunistic behavior. Moreover, they are often particularly important in information-intensive goods, because of the difficulties of enforcing property rights in information and the pervasiveness of free riding on information goods.

Some of the horror stories NN advocates tell involve an ISP denying access to a service or content downstream consumers value high: usually the story involves a small startup proving a bandwidth intensive service that can’t afford to pay premium access charges. But in a world where venture capital and other forms of funding is constantly on the lookout for the next big thing, these concerns seem vastly overblown. Moreover, permitting ISPs to own content providers is one way of addressing this issue. The demand for ISP services is derived from the value customers get from the content and services an ISP delivers. It is self-defeating for them to exclude truly valuable content because it reduces demand, and they have incentives to structure pricing and terms of access and vertical arrangements with content providers to maximize value. If there are gains from trade, in a reasonably competitive market there are strong forces pushing entities at all segments of the value chain to reap those gains.

Suppressing price signals and limiting the ability to craft creative arrangements to capture gains from trade are bad ideas, except under exceptional circumstances. So color me deeply skeptical on NN. Other features inherent in intrusive regulatory systems like Title II due to public choice considerations only deepen that skepticism. Such systems are extremely conducive to rent seeking. Though usually sold as ways to enhance competition, in practice they are typically exploited by incumbents to restrict competition. They tend to be strongly biased against innovation-precisely because much innovation of the creative destruction variety is intensely threatening to incumbents who have an advantage in influencing regulators. Classical Peltzman-Becker models of regulation show that regulators have an incentive to suppress cost-justified price differentials in order to redistribute rents, thereby creating distortions.

Other than that, NN and Title II are great.

If the substance isn’t bad enough, the process is even worse. FCC Chairman Tom Wheeler was originally leaning towards a less intrusive approach to net neutrality that would avoid dropping the Title II bomb. But Obama orchestrated a campaign behind the scenes to pressure an ostensibly independent agency to go all medieval (or at least all New Deal) on the Internet. Obama added to the backstage pressure with a very public call for intrusive regulation that put Wheeler and the other two Democrats on the Commission in an impossible position. (Another illustration of the consequences of Presidential elections: it’s not just the commander that matters, but the anonymous foot soldiers and the camp followers too.)

Yes, part of Obama’s insistence reflected his beliefs: after all, he is a big government control freak. And yes, part reflects the fact that some of his biggest supporters and donors are rabid NN supporters-primarily because they will benefit if they don’t have to pay the full cost that they impose.

But what convinced Obama to make this a priority was his personal vanity and his determination to engage in political warfare by pursuing initiatives that he can implement unilaterally without Congressional involvement. Read this and weep:

While Obama administration officials were warming to the idea of calling for tougher rules, it took the November elections to sway Mr. Obama into action.

After Republicans gained their Senate majority, Mr. Obama took a number of actions to go around Congress, including a unilateral move to ease immigration rules. Senior aides also began looking for issues that would help define the president’s legacy. Net neutrality seemed like a good fit.

Soon, Mr. Zients paid his visit to the FCC to let Mr. Wheeler know the president would make a statement on high-speed Internet regulation. Messrs. Zients and Wheeler didn’t discuss the details, according to Mr. Wheeler.

Mr. Obama made them clear in a 1,062-word statement and two-minute video. He told the FCC to regulate mobile and fixed broadband providers more strictly and enact strong rules to prevent those providers from altering download speeds for specific websites or services.

In the video, Mr. Obama said his stance was confirmation of a long-standing commitment to net neutrality. The statement boxed in Mr. Wheeler by giving the FCC’s two other Democratic commissioners cover to vote against anything falling short of Mr. Obama’s position.

That essentially killed the compromise proposed by Mr. Wheeler, leaving him no choice but to follow the path outlined by the president.

Read this again: “Senior aides also began looking for issues that would help define the president’s legacy. Net neutrality seemed like a good fit.” So to achieve a legacy, the Narcissist in Chief decides to interfere with the most successful, innovative industry of the past half-century, and perhaps ever.

What, screwing up the health care industry isn’t enough of a legacy?

I guess not. No price is to high to pay to stick it to the evil Republicans. And if you get stuck too, well, omelet, eggs, and all that. You are expendable when there’s a legacy at stake.

What comes out of the FCC as a result of Obama’s arm-twisting will be a beginning, not an end. It will no doubt set off a flurry of legal challenges.(Among lawyers and lobbyists, as always in such things, there is much rejoicing.)  Congress may get involved, and although Obama can block anything for the next two years, it  may take longer than that to finalize the rules (look at how long it is taking to get a simple-by-comparison position limit rule through the CFTC), and a new president in 2017 might not be so enamored with burnishing Barry’s legacy. Well, one can hope, can’t one? Looking for silver linings here.

I had thought that old school Progressive and New Deal style regulation had been largely discredited in the 70s and 80s. Indeed, Democrats (including Carter and Ted Kennedy) played vital roles in dismantling regulations in transportation in particular. But Obama is going all back to the future, and attempting to impose a regulatory paradigm that was all the rage when men all wore fedoras to what is arguably the most dynamic and innovative industry ever. Because, legacy.

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February 6, 2015

Get Off Your High Horse! Whatabout the Crusades?

Filed under: History,Military,Politics — The Professor @ 1:10 pm

On Wednesday, 4 February, 2015, ISIS released a film that ended with the immolation of a Jordanian pilot, Muath al-Kaseasbeh, whom it had captured after he bailed out from his malfunctioning F-16 in December. The production is a bizarre and disturbing mix of snuff porn and slick, special-effects laden filmmaking. It is beyond vile. The product of twisted minds inflamed by a monstrous ideology.

There are likely multiple audiences for this depravity. The first, and probably most important, is young Muslims especially in Europe whom ISIS wants to recruit. ISIS is being attrited at a rather rapid pace, and needs new bodies to feed into the meat grinder. The sense of power and control that the these depraved videos convey is no doubt intoxicating to aimless youths seeking to fill empty lives and to transcend their tedious existence. But such people get bored easily. Beheadings had no doubt have become routine. Something new was needed to rejuvenate excitement. ISIS had to outdo itself: burning a man alive certainly did that.

But then of course there will have to be a succession of new and more horrible ways of killing people. I shudder to think at what their sick imaginations will turn to next.

The other audience was the outside world. Outraging the world is a way of demonstrating power, and sadly, since the world appeared to becoming inured to beheadings, something novel was necessary. Moreover, ISIS actually wants to provoke a confrontation with the world. Note that its slick online publication is named Dabiq, a city in Syria that will supposedly be the scene of an apocalyptic confrontation between the “Romans” (i.e., the West) and the Muslims, that will result in the triumph of the latter (who will be aided by the Mahdi). In their twisted minds, such vile acts serve a higher purpose.

This is what the world has come to.

Disturbing in a different way has been Obama’s reaction to this. Jordan’s King Abdullah happened to be in DC when the video was released. He met with Congressional leaders and vowed revenge. He had not been scheduled to meet with Obama, but a meeting was hastily arranged. Obama’s remarks after the meeting were perfunctory, diffident and oddly detached.

Obama also met with a group of 15 Muslim-American “leaders”, who are actually better described as activists. The main topic of discussion was not the crime committed in Syria, or the threat posed by Islamism, but an entirely fictitious, or at least heavily exaggerated, wave of Islamaphobia:

My next comment echoed the sentiment we heard often in the meeting. In fact, it was clearly the No. 1 issue raised: The alarming rise in anti-Muslim bigotry in America.

If you want to find bigotry in a country of 316 million people, you can find it. Against any identifiable group you can think of. But this is hardly issue No. 1. Indeed, it should hardly make the top 100.

But Obama outdid himself at a prayer breakfast attended by the Dalai Lama. He said some of the right things about ISIS, and about the depraved killing of the Jordanian pilot: specifically he referred to ISIS as a “death cult”, which it is. But then he completely undermined this with a bizarre turn of whataboutism that insinuated that Americans must temper their criticism of Islamist barbarism because of the sins of our forefathers. Our forefathers going way, way back. Like to the Crusades:

And lest we get on our high horse and think this is unique to some other place, remember that during the Crusades and the Inquisition, people committed terrible deeds in the name of Christ.  In our home country, slavery and Jim Crow all too often was justified in the name of Christ.  Michelle and I returned from India — an incredible, beautiful country, full of magnificent diversity — but a place where, in past years, religious faiths of all types have, on occasion, been targeted by other peoples of faith, simply due to their heritage and their beliefs — acts of intolerance that would have shocked Gandhiji, the person who helped to liberate that nation.

So this is not unique to one group or one religion.

The  invocation of the Crusades is a pitch perfect imitation of the narrative spun by Islamists and their enablers, notably the Muslim Brotherhood, who bring it up any time Westerners criticize anything in the Arab world, no matter how depraved: like all whataboutism, it is intended to silence critics. What’s more, the invocation of Jim Crow in this context is almost a parody of the classic Soviet whataboutism: “And in America you are lynching Negroes.” (And although there were definitely appalling religious justifications of slavery in the South, I’m hard pressed to recall it being even a minor theme in the justification of Jim Crow.)

Obama’s exegesis is profoundly ahistorical. But even overlooking that unsurprising fact, of what relevance are Godfrey of Bouillon or Richard Plantagenet or Louis VII or Gregory IX or Bull Conner to a serious discussion of or response to the mass slaughter that is plaguing Syria and Iraq today? Of what relevance are these people and events to the thoughts or actions of any living American? About as relevant as the Trojan War. So religion-inspired violence isn’t historically unique. So what? How does that matter when trying to confront a particular outbreak religion-inspired violence that is raging today? The fact that it isn’t reveals Obama’s true motivation: he is trying to avoid confronting it.

Further, the apparent need to reach back centuries, and almost a millennium, to find reasons to knock “us” off our “high horse” actually cuts the other way. For it demonstrates that the Christian West has transcended bloody religious struggles and religiously justified violations of human freedom: indeed, the very fact that Christianity is hardly the West’s distinguishing characteristic in 2015 makes these historic comparisons utterly irrelevant straw men.

The contrast with Islam could not be more stark, as the rampages of warriors clinging to their guns (and knives and torches) and religion from the Philippines to Syria to Nigeria attests. Even slavery (of the most brutal and demeaning kind) can be filed under current events in parts of the Muslim world, including notably in the areas controlled by ISIS, and its practice is vehemently defended by Islamists who cite Koranic authority. The problem is not that religion motivated war and conquest in the West in the historical past: it is that it does today in the Middle East, Africa, the Subcontinent, and Asia. The problem in the Muslim world today is that the past isn’t even past: in the present it is still mired in its medieval pathologies. Dealing with the orgy of violence of which the immolation of Lt.  al-Kaseasbeh is only the most recent lurid example requires facing that reality head on.

But the “high horse” slur, and the stubborn refusal to acknowledge the undeniable religious roots of ISIS , Boko Haram, Al Qaeda and numerous other groups and movements wreaking havoc from Tripoli to Thailand (a denial repeated in the prayer breakfast remarks), demonstrate that Obama is dead set against such an honest reckoning. In fact, he wants to stifle any such discussion because, you know, Crusades.

The tragic irony of this is that by so doing, Obama empowers the most retrograde forces in Islam, and that the primary victims of their ascendance are Muslims. Obama’s moral equivalence kills Muslims. Pace Orwell, that is an objective reality, regardless of Obama’s subjective motivations. His exquisite sensitivity to Muslim feelings costs Muslim lives.

Obama’s remarks provide yet another example of his superciliousness towards his fellow citizens whom he believes need to be knocked off their high horse, because of misguided belief in their exceptionalism makes them unfit to judge others. They spring from the same place as the slap about bitter clingers and their guns and religion. In a weird way, this actually contributes to the rather disturbing tendency of those who belong to that maligned demographic to admire Putin: at least he praises his folk, rather than disdains them.

In sum, Obama’s behavior and words in the days after one of the most horrific and obscene acts in an era of them reveal a great deal about his beliefs and thinking. And what they reveal is disturbing indeed.

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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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January 31, 2015

A Devastating Critique of the Worst of Frankendodd: The SEF Mandate

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Politics,Regulation — The Professor @ 9:05 pm

On the day of its passage, I proclaimed the Swaps Execution Facility (SEF) Mandate to be the Worst of Frankendodd. Somewhat later, I called the Made Available for Trade (MAT) process to be the Worst of the Worst. Nothing that has happened since has led me to change my mind. To the contrary.

Many considerations led me to these conclusions. Most notably, the SEF mandate, especially as implemented by the CFTC, substituted government judgment for user choice in how to execute swaps transactions. In particular, the mandate imposed a one-size-fits-all execution model on a very diverse marketplace. In the swaps market, heterogeneous participants with varying objectives want to engage in heterogeneous transactions, and over time a variety of execution methods evolved to accommodate this diversity. The mandate ran roughshod over this evolved ecosystem.

Congress, and especially the CFTC, took the futures market with centralized exchanges as its model. They liked the futures markets’ pre-trade and post-trade price transparency. (Remember Gentler and his damn apples?) They liked counterparty opacity (i.e., anonymity). They liked centralized execution and a central limit order book. They liked continuous markets.

But swaps markets evolved precisely because those features did not serve the needs of market participants. The sizes of most swap transactions, and the desire of participants to transact in such size relatively infrequently, are not handled efficiently in a continuous market. Moreover, the counterparty transparency available to the parties of bilateral trades each to evaluate the trading motives of the other, thereby limiting exposure to opportunistic informed trading: this enhances market liquidity. Limited post-trade transparency makes it cheaper for dealers who took on an exposure in a trade with a customer to hedge that risk. The inter dealer broker model also facilitates the efficient transfer of risk among dealer banks.

But those arguments were unavailing. Congress and the CFTC were deeply suspicious of the bank-dominated swaps markets. They viewed this structure as uncompetitive (despite the fact that there were more firms engaged in that market than in most major sectors of the economy), and the relationship between dealers and end users as one of greatly unequal power, with the former exploiting the latter. The protests of end users over the mandate did not move them in the slightest.

I predicted several consequences of the mandate. Fragmentation along geographical/jurisdictional lines was the most notable: I predicted that non-US entities that could avoid the strictures of Frankendodd would do so.  I also predicted a decline in swaps trading activity, due to the higher costs of an ill-adapted trading system.

These things have come to pass. What’s more, it’s hard to discern any offsetting benefits whatsoever. Indeed, when compliance costs and the costs of investing in and operating SEF infrastructure are considered, the deadweight losses almost certainly run into the many billions annually.

If you want detailed chapter and verse describing just how misguided the mandate is, you now have it. Thursday CFTC Commissioner Christopher Giancarlo released a white paper that exposes the flaws in the mandate as implemented by the CFTC, and recommends reforms. It is essential reading to anyone involved in, or even interested in, the swap markets.

Commissioner Giancarlo may be talking his ex-book as an executive of IDB GFI, but in this case that means he knows what he’s talking about. He carefully demonstrates the economic purposes and advantages of pre-Dodd Frank swaps market structure and trading protocols, and shows how the CFTC’s implementation of the mandate undermined these.

The most important part of the white paper is its demonstration of the fact that the CFTC made the worst even worse than it needed to be. Whereas Congress envisioned that a variety of different execution methods and platform would meet its purposes, CFTC effectively ruled out all but two: a central limit order book (CLOB) and request for quote (RFQ). It even imposed unduly restrictive requirements for RFQ trading. As the commissioner proves, the statute didn’t require this: CFTC chose it. Actually, it would be more accurate to say that Gensler chose it. Giancarlo does not name names, for obvious reasons, but I operate under no such constraints, so there it is.

Commissioner Giancarlo also goes into great deal laying out the perverse consequences of the mandate, including in addition to the fragmentation of liquidity and the inflation of costs the creation of counterproductive tensions in relations between American and foreign regulators. Perhaps the most important part of the paper is the discussion of fragility and systemic risk. By creating a more baroque, complex, rigid, illiquid, and fragmented marketplace, the CFTC’s SEF regulations actually increase the likelihood and severity of a market disruption that could have systemic consequences. This is exactly contrary to the stated purpose of Dodd-Frank.

Seemingly no detail goes unaddressed. Take, for instance, the discussion of the provision that voids swaps that fail to clear ab initio, i.e., a swap that fails to clear for any reason-even a trivial clerical error that is readily fixed-treated as if it never existed. In addition to raising transactions costs, this provision increases risks and fragility. For instance, a dealer that uses one swap to hedge another loses the hedge if one of the swaps is rejected from clearing. If this happens during unsettled market conditions, the dealer may need to re-establish the hedge at a less favorable price. Since there are no free lunches, the costs associated with these risks will inevitably be passed on to end users.

The white paper suggests many reforms, most of which comport with my original critique. Most importantly, it recommends that the CFTC permit a much broader set of execution methods beyond CLOB and RFQ, and that the CFTC let the market evolve naturally rather than dictate market structure or products. Further, it recommends that market participants be allowed to determine by contract and consent acceptable practices relating to, inter alia, confirmations, the treatment of swaps rejected from clearing, and compression. More generally, it advocates a true principles-based approach, rather than the approach adopted by the CFTC, i.e., a highly prescriptive approach masquerading as a principled based one.

One hopes that these very sound ideas get a fair hearing, and actually result in meaningful improvements to the SEF regulations but I am skeptical. The Frankendodd SEF monster has long since escaped the confines of the castle on 21st Street. Moreover, in the poisoned and reductionist political environment in DC, Dodd Frank is treated by many (Elizabeth Warren and the editorial board of the NYT in particular) as something carved on stone tablets that Barney brought down from Mount Sinai, rather than Capitol Hill. The Warren-NYT crowd considers any change tantamount to worshipping the Golden Calf of Wall Street.

But to reform the deformed and inform the uninformed you have to start somewhere, and the Giancarlo white paper is an excellent start. One hopes that it provides the foundation for reasoned reform of the most misbegotten part of Dodd Frank. I challenge the die hard defenders of every jot and tittle of this law to meet Giancarlo’s thorough and thoughtful contribution with one of their own. But I’m not holding my breath.

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Russian Central Bank Roulette: Rubble the Ruble or the Banking System?

Filed under: Economics,Politics,Russia — The Professor @ 2:53 pm

On Friday the Central Bank of Russia surprised pretty much everyone by cutting its policy interest rate from 17 percent to 15 percent. Bloomberg lays responsibility at Putin’s feet, and no doubt he had to approve. But the evidence the article cites is not dispositive by any means. Yes, Central bank Governor Elvira Nabiullina had sworn up and down a little more than a week ago that the bank would not cut rates: if she’d said anything differently, she would have set off a speculative attack on the ruble, so she had to say that even if a policy change was being considered.

The fact is that CBR faces a terrible trade-off. Keeping the interest rate high damages severely the banking system, and is a drag on the real economy. Lowering the interest rate undermines the ruble (which indeed fell sharply on the news) and stokes inflation, which is already high and accelerating, and which has a disproportionate adverse impact on low and middle income individuals. Significantly, the RBC’s pubic statements have shifted from mentioning only inflation as a policy target, to a Russian version of Humphrey-Hawkins balancing of inflation and growth.

No doubt there is substantial political support for this that extends far beyond Putin. In particular, domestic banks are central bankers’ most important constituency and responsibility. Indeed, central banks are at risk of capture by domestic banks, and a banking crisis is frequently a greater fear than a sharp depreciation in the currency (though those things are of course related). Major Russian bankers, notably Sberbank’s German Gref have been lamenting the damage that high interest rates are doing to banks. Further, a mid-tier Russian bank (SB) began to limit deposit withdrawals, and the entire sector is suffering funding difficulties. Given all this, the CBR decided to rubble the ruble rather than the banking system. This is a piece with the government’s plans to recapitalize the banking system.

In sum, given the choice between supporting the ruble and the banking system, it chose to support the banking system. That appears to be the more imminent danger, and one that is of primary concern to the CBR. No doubt Putin agrees, but it’s unlikely he had to force an unwilling Central Bank into that decision. If another sharp selloff in the ruble occurs, the bank may reverse course, but for now, it has chosen the banking system (and Russian corporate borrowers) over the ruble and inflation.

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January 30, 2015

ISIS May Be Heeding SWP’s Military Analysis, Unfortunately

Filed under: History,Military,Politics — The Professor @ 10:46 pm

ISIS has acknowledged that it was defeated in Kobane:

The first fighter said that “it was fated for us to retreat from Ayn al-Islam [Ayn al Arab, or Kobane] bit by bit, because of the bombardment and because some of the brothers were killed.”

The second fighter said that “the reason behind our retreat is that we did not find points in which to remain garrisoned. We stayed in garrisoned positions inside more than 70% of Ayn al-Islam, but the aircraft did not leave any buildings and destroyed everything.”

“They flattened the land with their rockets, so we were forced to retreat,” he continued. Later, he stated that the aircraft “bombarded day and night.”

What I found most interesting is the statement that ISIS would shift tactics to hit-and-run:

The second jihadist warned that the Islamic State would “return” to Kobane, presumably once Coalition aircraft turn their attention elsewhere.

“This is the style of hit and run since the days of the Messenger … We will return once again and we will disperse them [the Kurds],” the second fighter said.

Compare that to what I wrote in December:

T. E. Lawrence and other British officers assigned to the Arab rebels during WWI despaired of making them conventional soldiers. Lawrence, per his telling in the grips of dysentery-induced delirium, conceived that their genius was as irregulars who utilized mobility to carry out a war of hit and run attacks on a relatively immobile Turkish army of dodgy morale. Keegan’s History of Warfare states that this form of warfare was the Arab way going back to the times of Mohammed. For the Arabs, there was no dishonor in retreat. Hit weaker forces at a vulnerable point, don’t engage in standup fights, and run when a superior force appears.

ISIS is most formidable when it fights in the traditional Arab way. (Chechens were also historically guerrillas and raiders.) It does its opponents a favor when it fights the Western way.

Perhaps ISIS has learned that lesson.

Today they launched an attack on Kirkuk that could be viewed as such a hit and run attack. They hit, and they were pushed back, but it’s not clear whether they intended to take and hold ground but just couldn’t do it, or decided to pull back before getting pounded by airpower when the fog lifted.

Enemies learn. ISIS should have known that standing up against American airpower was foolish, but they tried for months and paid the price. They may be slow learners, but they are learning.

There’s an old adage in the military: the Four Fs. Find ‘em, fix ‘em, fight ‘em, finish ‘em. Our ubiquitous sensors make finding them easier than has ever been the case in military history. Fixing usually involves infantry, and we really don’t have a reliable infantry force at our disposal in Iraq. ISIS did us the favor of fixing themselves in Kobani. They’ve given that up, and hence it will be harder to fight and finish them.

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Can We Hang On For Two More Years?

Filed under: History,Military,Politics — The Professor @ 10:20 pm

In recent days, the administration has looked like a cornered rat, scurrying back and forth to escape a predicament of its own making, trapped by its previous policies and words.

It began when the administration was questioned about the Jordanian negotiations with ISIS to exchange an imprisoned terrorist for their pilot shot down last year. Obama spokesman Eric Schultz implicitly criticized the Jordanians by reiterating the US position of not negotiating with terrorists. This led ABC’s Jonathan Karl to ask what was the difference between what the Jordanians were attempting, and what the US did to secure the release of Bo Bergdahl from the Taliban. Well, Schultz replied, the Taliban aren’t terrorists: they’re an armed insurgency.

The administration’s discomfort was only elevated by leaks that the Army was about to charge Bergdahl with desertion. Although the Army vehemently denied it, the denial had a “depends on the meaning of is” aspect to it. The story said he was about to be charged: the Army’s huffy denial said he hadn’t been charged yet. There are rumors of a dog war under the carpet between the administration and the Pentagon: Obama wants to avoid in the worst way the embarrassment of trading Taliban members for a deserter. The awkwardness of Obama’s position was made even worse by news that at least one of those exchanged was attempting to get back into fighting the US.

And things took a bloody turn when the Taliban claimed credit for a Green-on-Blue attack in Kabul that killed three Americans.

Again: Not Terrorism!!!!!!! Watch spokesweasel Jennifer Psaki refuse to “label” the Taliban. Because labels can be self-fulfilling. Or something. One Democratic analyst said the administration doesn’t want to call the Taliban terrorists because then they won’t negotiate with us. As if the Taliban give a damn what we call them. The problem in Obama’s eyes is if we call them terrorists we can’t negotiate with them.

And tell me. If they aren’t terrorists, just why are we droning them?

The new Taliban ain’t terrorists line clashes loudly with Obama’s previous pronouncements. Remember when he declared Afghanistan “a war of necessity”? Precisely because of Taliban participation in and support of terrorism against the US:

By moving forward in Iraq, we’re able to refocus on the war against al Qaeda and its extremist allies in Afghanistan and Pakistan. That’s why I announced a new, comprehensive strategy in March — a strategy that recognizes that al Qaeda and its allies had moved their base from the remote, tribal areas — to the remote, tribal areas of Pakistan. This strategy acknowledges that military power alone will not win this war — that we also need diplomacy and development and good governance. And our new strategy has a clear mission and defined goals: to disrupt, dismantle, and defeat al Qaeda and its extremist allies.

In the months since, we have begun to put this comprehensive strategy into action. And in recent weeks, we’ve seen our troops do their part. They’ve gone into new areas — taking the fight to the Taliban in villages and towns where residents have been terrorized for years. They’re adapting new tactics, knowing that it’s not enough to kill extremists and terrorists; we also need to protect the Afghan people and improve their daily lives. And today, our troops are helping to secure polling places for this week’s election so that Afghans can choose the future that they want.

But I forgot. Al Qaeda is on the run.

And then there’s this reminder that another of Obama’s interlocutors, Iran, has been neck deep in killing Americans for decades. Very interesting time to leak a story about the assassination seven years ago of the Iranian-backed Hezbollah bastard who was behind the Marine Barracks bombing in 1983, and numerous other terror attacks, isn’t it?

Also rather embarrassing was the fact that a few days after the State Department hosted some Muslim Brotherhood members complaining about the Egyptian government, that the Muslim Brotherhood in that country calls for “a long, uncompromising jihad.”

Terror is exploding around the world, with Americans being killed in Libya and Saudi Arabia not just Afghanistan. Iraq and Syria are nightmares. But Obama’s big initiatives-a deal with Iran, getting out of Afghanistan, depend on the fiction that the war on terrorism has been won. So the administration dissolves into utter incoherence, refusing to call spades spades, and denying things that are as plain as day.

Can we hang on for two more years of this? The butt ends of second terms are usually dreary, but this one could be downright dangerous.

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