Streetwise Professor

July 29, 2014

The FUD Factor At Work

Filed under: Commodities,Economics,Energy,Politics,Regulation,Russia — The Professor @ 9:35 am

Going back to the original round of sanctions, I have been arguing that the terms of US sanctions have been left deliberately vague in order to make  banks and investors very cautious about dealing with sanctioned firms. Spreading fear, uncertainty, and doubt-FUD-leverages the effect of sanctions.

When I read the last round of sanctions, I had many questions, and hence many doubts about actually how far the sanctions would reach. I was not alone. Professionals-lawyers at banks and Wall Street law firms-are also uncertain:

But compliance officers at some U.S. banks and broker-dealers say the sanctions, issued by Treasury’s Office of Foreign Assets Control (OFAC), are not clear enough. That has left financial institutions guessing, in certain instances, at how to comply. They worry they are vulnerable to punitive action by U.S. regulators.

Fear, uncertainty, and doubt, all in one paragraph. The fear part is particularly interesting, and quite real, especially in the aftermath of the truly punitive action by U.S. regulators in the BNP-Paribas case.

OFAC-The Office of Foreign Asset Control, which is in charge of overseeing the sanctions-is in no hurry to clarify matters:

Another senior compliance officer at a major U.S. bank said bankers “are frustrated that OFAC is not providing more guidance.”

The day after the sanctions were issued, OFAC held a conference call with hundreds of financial services industry professionals in an effort to answer concerns. Although some issues were cleared up, others were left undecided, said two sources who were on the call.

Dear Mr. Senior Compliance Officer: that’s on purpose. Believe me.

A new round of sanctions may be imminent. I am hoping to be proven wrong in my forecasts, because reports are that the Europeans are going to do something serious. Add serious doubts to serious action, and American and European banks won’t touch most Russian banks or major companies with a 10 foot pole while wearing a hazmat suit. That will cause some major economic problems for Putin and Russia. Not 1998-magnitude problems, but maybe something bordering on 2008 problems, although a $100+ oil price will help contain the damage, despite the added difficulties that sanctions will create for the Russians to cash the checks for that oil.

Then it will be Vlad’s move. What that move will be, I do not know.

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July 28, 2014

Deciding Not to Decide on Providing Intel to Ukraine: The Negation of Presidential Leadership

Filed under: History,Military,Politics,Russia — The Professor @ 10:57 am

The NYT ran a long article yesterday describing the administration’s Hamlet-like agonizing over whether to provide Ukraine with real time intelligence useful for targeting rebel forces. (For the record, I called for this in the immediate aftermath of the flight of Yanukovych. It should be an easy decision.)

One part jumped out at me:

“We’ve been cautious to date about things that could directly hit Russia — principally its territory,” but also its equipment, the official said. A proposal to give the Ukrainians real-time information “hasn’t gotten to the president yet,” the official said, in part because the White House has been focused on rallying support among European allies for more stringent economic sanctions against Moscow, and on gaining access for investigators to the Malaysia Airlines crash site.

There in a nutshell is the passivity of this president, and his negation of executive leadership.

An active and engaged leader would not be waiting for things to reach him. He would be demanding that a full range of options be presented to him immediately, if not sooner. This situation has been metastasizing for months. What’s more, in the aftermath of the MH17 atrocity, and the rebels’ ongoing use of artillery and MLRS systems against civilian targets, the suppression of their weapons systems is both a military and humanitarian imperative. The time for action passed long ago, but it is incomprehensible that 10 days after MH17 that Obama has personally avoided considering, let alone ordering, a reasonable, measured US action that would materially assist Ukraine to defend itself, and which would not put one US serviceman or woman at risk.

Also look at the excuse: he’s focused on the diplomatic channel. This is particularly rich a week after Obama flacks in the administration and media responded to criticisms about his fundraiser-dominated schedule by saying that he can multi-task. So, he can’t simultaneously push the Europeans and evaluate steps to aid the Ukrainian government? What happened to that vaunted multi-tasking capability?

Further, military and diplomatic measures are complementary, and need to be processed in parallel rather than serially.

Another thing that stands out in the article is the hand-wringing about “provoking Russia”:

“The debate is over how much to help Ukraine without provoking Russia,” said a senior official participating in the American discussions.

Look. To Putin, anything short of outright capitulation by Ukraine, and the complete abandonment of Ukraine by the US and the EU is a provocation. Let’s not forget what “provoked” this crisis in the first place: Ukraine’s temerity in moving to sign a trade deal with the EU. Continued Ukrainian resistance is all the provocation Putin needs. Anything the US or EU does will have the merest of effects on Putin’s insatiable desire to subjugate Ukraine.

That’s not quite true, actually. Continued passivity, and waiting for the USPS to deliver military options to POTUS, encourages Putin’s aggressiveness. Weakness and passivity are extremely provocative to Putin.

As to another objection-that disloyal individuals in the Ukrainian leadership will provide the information to Russia: this is a non-issue. Yes, such leaks could undermine the effectiveness of the intelligence, by permitting the rebels to move to avoid a strike. But if they are moving, they aren’t shooting. What’s more, given the realities of communication, it is highly unlikely that  truly real-time information useful for targeting could make it to the rebels before it reached the Ukrainian air or artillery units tasked to strike them. Further, attempts by disloyal elements to communicate with the rebels could actually facilitate their discovery, especially if the information is tightly compartmentalized.

As for the Ukrainians getting to rambunctious if they have better information, the US has the option to cut off the information at any time, and to place conditions on its use. If anything, provision of this intelligence will focus Ukrainian military efforts leading to less risk of misguided strikes on civilians or Russia.

In sum, this should be about as easy a decision as a commander in chief should have to make. But because he has clearly signaled that he wants to distance himself from serious involvement with the Ukrainian military efforts against insurrectionists, subordinates and bureaucrats are consciously choosing not to present him with the options that a real leader would be demanding from them.

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July 26, 2014

Is Girkin in a Pickle? Or Is Putin?

Filed under: Military,Politics,Russia — The Professor @ 9:40 pm

The Daily Beast (what a moronic name, but whatever) ran an article yesterday quoting the commander in the Donetsk People’s Republic, Igor Girkin, whinging about the impending doom of his forces, and the lack of support from Putin. (And no, I will not indulge his vanity by referring to him by his self-chosen nom de guerre.)

Maybe. But coming as it did barely a week after the destruction of MH17 by Girkin’s forces, I can think of another explanation. By seemingly attacking Putin, Girkin is actually helping him.

Putin has been striving mightily to maintain the fiction that the forces in Donetsk and Luhansk are not under his control. That they are an indigenous movement battling against the fascist regime in Kiev.

The need to do this has only increased in the aftermath of the shoot down of the Malaysian jetliner, and the murder of 298 individuals. Now the connection between Russia and the rebels is even more threatening to Putin.

What better way to do this than have the head of the rebels complain about a lack of Russian support?

So maybe Girkin’s complaints are genuine. But it is all to convenient for Putin for him to claim that he has been abandoned by the Russian president, precisely at the time when connections with the rebels are a threat to Putin. Yes, that could cause problems for Putin with the nationalists in Russia, but he likely figures that he can control internal dissenters. The international dynamic is more threatening. The Girkin complaint therefore on balance works for Putin.

Note that this is occurring at a time when if anything, Russian support for the insurgents in the Donbas is increasing, with the US claiming that Russia is shelling Ukraine from Russian territory, and arranging to dispatch even more powerful multiple rocket launch systems over the border.

So take anything that Girkin says with a huge dose of skepticism. Paradoxically, Putin is better able to provide more support to the rebels, the more plausibly he can disclaim that he is supporting them. Girkin is providing Putin the cover he needs.

We are dealing with KGB/FSB and GRU spooks here: Putin, obviously, and Girkin is allegedly a long-time FSB operative. Deception and misdirection are their most tried and true methods. You cannot take anything they say at face value. Public pronouncements are constructed to achieve a strategic or tactical objective. Right now, Putin needs to blur the connection with the Russian combatants in Ukraine. And lo and behold, Girkin delivers. It is Putin that is in the pickle, and Girkin is doing his best to get him out.

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July 24, 2014

The Stamp of Authority: Definitive Proof that the “Separatists” Are Truly Russian

Filed under: Military,Politics,Russia — The Professor @ 7:24 pm

Stamps. That’s the proof.

Russians are obsessed with stamps. Nothing is official unless it is stamped. The most trivial document must be stamped. Preferably several times.

Stamps have magical power. They transform a simple piece of paper with dry, nondescript prose into something talismanic.

Consider this from a long (and horribly written and edited) WSJ piece on the process of brokering a deal between Malaysia and the mouth breathers of the Donetsk People’s Republic to obtain the black boxes from MH17:

Just after 1 a.m., Col. Sakri signed an agreement with a top separatist official confirming the handover of the black boxes.

The stamp of the National Security Council of Malaysia is misspelled, “Sekurity,” suggesting a hasty effort to fulfill bureaucratic protocol by having the stamp made locally.

I know exactly what happened. The deal was painstakingly negotiated over hours. Then the time for signing came. And the mouth breathers said: “It’s not official unless it is stamped.” The Malaysians looked at one another, then replied: “Stamped? WTF?” “It must have your stamp.” So the Malaysians scrambled around, desperately seeking someone who would make them a stamp. They found Ivan the Stampmaker, who of course would pronounce “c” as “s” and spell a hard “c” with a “k”.  But the mouth breathers didn’t know any better-indeed, they might have been suspiciously of a “c”-and were satisfied. They had their stamp. The deal was well and truly official.

It is absurd. It is Kafkaesque.

It is Russian.

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The EU’s Non-Paper and Its Non-Sanctions Show Europe is Non-Serious About Russia

Filed under: Military,Politics,Russia — The Professor @ 7:01 pm

There was a brief frisson of excitement late last night and this morning, because of a rather startling headline in the FT: “Ukraine Crisis: EU to Weigh Far-Reaching Sanctions on Russia.” Oh joy! Maybe they are actually growing a pair:

The sanctions measure, contained in a 10-page options memo prepared by the European Commission and distributed to national capitals, also proposes barring the Russian banks from listing new issues on European exchanges, preventing them from using London or other EU stock markets to raise funds from non-Europeans.

But the Euros didn’t want to go too far:

The proposal would not initially include a similar prohibition for Russian sovereign bond auctions out of fear the Kremlin could retaliate by ordering an end to Russian purchases of EU government debt, the document states.

These conclusions were based on a leaked document that had been circulated among the member states before a highly guarded meeting held today to consider future measures against Russia.

Then further details came out about the document, and when that happened, frisson was replaced by resignation, and an understanding that the Euros are still short more than a pair: their testicular deficit makes the Greek budget deficit pale in comparison.

As it turns out, the document was what in Eurospeak is referred to as a “non-paper.” (Doc embedded here.) Yes, they have things called “non-papers.” How Orwellian is that?

So just what would a non-paper be? This is what it be:

These surreal-sounding documents crop up quite often in Brussels. Non-papers are discussion documents drawn up either by one of the EU’s institutions or by a Union government. They are designed to stimulate discussion on a particular issue and do not represent the official position of the institution or country which drafted them. Non-papers have no official status, but can be very useful in starting debates on particularly sensitive issues, allowing EU decision-makers to talk about issues they would find it politically difficult to take a firm line on. They can also be used to test the water on subjects without obliging countries to take a stand, thus avoiding potential diplomatic rows.

So, at best, non-papers are the start to a conversation. A straw man proposal to shoot at. The country circulating one does not even really take ownership of what is proposed in it. It’s a “so what do you think of this?” sort of thing.

In other words, hardly an action item on the immediate agenda. And definitely not anything being “weighed” seriously, even in the aftermath of the murder of 298 people, and the ongoing maskirovka invasion of Ukraine. It represents the outer limit of maybe, someday: it doesn’t represent anything likely, today.

So rather than moving on the quite robust sanctions proposed in the non-paper, the Euros moved forward with a flaccid enhancement of its sanctions. While the caskets were being carried off of a transport plane in the Netherlands, the stalwart Euros took a strong stand: they added some individuals and a few non-Russian companies to their list of the sanctioned. In other words, rather than taking the advice of the non-paper and doing something robust, the Euros voted in favor of non-sanctions, thereby proving that they are non-serious.

This is apparently the sort of sanctions that Merkel and others consider “prudent.” Not prudent in the sense of accomplishing anything. Quite the contrary, prudent in the sense of not accomplishing anything, because accomplishing something might make Vlad cross, and we can’t have that, can we?

If this is the most the Euros can muster when the corpses of those murdered are still above ground, just imagine how little they can do when the bodies are finally buried. Actually, I think that the prospect of any serious action against Putin will be interred long before the last poor victim reaches her final resting place.

This ineffectual action (but I give it too much credit by calling it ineffectual; or an action) followed a week of rather sordid bickering between the grandees of Europe. No country was willing to agree to measures which imposed more costs on it than on another EU nation. So when the UK urged France to forego the billion plus dollar sale of the Mistrals, the French refused, and heatedly pointed out that the British were hypocrites because they were not volunteering to do anything that would cut off the flow of oligarch cash into London. This was the diplomatic version of: “Don’t call me a crack whore: You’re the real crack whore.”

But I do a grave insult to crack whores by comparing them to European governments.

(With respect to the Mistrals, note well that the French give the same reason for delivering them as Russia gave for delivering arms to Assad: “we are obligated to perform on existing contracts.”)

This matters not just because the pressure on Putin is reduced if the Europeans go AWOL. It also matters because Obama has made it abundantly clear that he will not get too far out front of the Europeans. Numerous anonymous administration officials were busy peddling that message. Meaning that since the Europeans are doing a little more than nothing, Obama will not say to hell with them, and shame them (if they are capable of shame) by implementing measures that will grievously harm Russia. He will do a little more than a little more than nothing, so they won’t look bad.

Meaning that if Putin’s Botox-frozen face was capable of cracking a smile, he’d be grinning from ear to ear. Because he knows he is living the psychopath’s dream: getting away with murder. 298 and counting, to be precise.

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July 22, 2014

Obama Laying Groundwork Through Leaks of Charging Putin With the Geopolitical Equivalent of 3d Degree Manslaughter

Filed under: History,Military,Politics,Russia — The Professor @ 6:49 pm

There were disturbing, but not surprising, signs today that the Obama administration is backing away from holding Putin & Russia to account in any serious way for the MH17 Massacre.

First, Obama had a call with Dutch PM Rutte while on AF1 on his way to (wait for it!) a West Coast fundraising junket. (You are shocked, I’m sure.) He said that he was “concerned” about continued Russian infiltration of weapons into Ukraine. Not gravely concerned. Not deeply concerned. That is soooo last week. Just, “Concerned”. Prediction: Next week it will be “meh.”

Second, the AP ran this very disturbing article, which describes a briefing by anonymous “Senior U.S. intelligence officials.” They bend over backwards to minimize Russia’s-and Putin’s-culpability:

But the officials said they did not know who fired the missile or whether any Russian operatives were present at the missile launch. They were not certain that the missile crew was trained in Russia, although they described a stepped-up campaign in recent weeks by Russia to arm and train the rebels, which they say has continued even after the downing of the commercial jetliner.

In terms of who fired the missile, “we don’t know a name, we don’t know a rank and we’re not even 100 percent sure of a nationality,” one official said, adding at another point, “There is not going to be a Perry Mason moment here.”

White House deputy national security adviser Ben Rhodes said the U.S. was still working to determine whether the missile launch had a “direct link” to Russia, including whether there were Russians on the ground during the attack and the degree to which Russians may have trained the separatists to launch such a strike.

“We do think President Putin and the Russian government bears responsibility for the support they provided to these separatists, the arms they provided to these separatists, the training they provided as well and the general unstable environment in eastern Ukraine,” Rhodes said in an interview with CNN.

Note the emphasis on stating what we (allegedly) don’t know, not on what we do. Note the use of the word “direct” in discussing the linkage to Russia. Classical defense attorney tactics in creating reasonable doubt about the truth of a top charge, like capital murder.

High level intelligence officials brief the press anonymously for two reasons: (1) to kneecap the administration in opposition to policies they dislike, or (2) to prepare the ground for future administration announcements or actions. The fact that the statements of the anonymous officials dovetail with what Rhodes says, (1) is highly unlikely. The fact that multiple officials are saying this further undermines possibility (1). So (2) it is.

Briefings like this do not occur by accident. They are planned. They have a purpose. And here the purpose is to shape expectations, and to lay the groundwork for Obama (and the Euros) to  move on from the horrid, ugly scenes in Donetsk and back away from any confrontation with Putin.

I therefore predict that within a very short interval, we shall see Obama sally forth, and deliver an indictment of Putin for the geopolitical equivalent of Third Degree Manslaughter: “causing the death of another person either through criminal negligence or through the commission of an unlawful act not amounting to a felony.”

Obama-with the Euros nodding furiously in agreement-will accuse Putin of negligently creating the conditions that led to the deaths of 298 innocent people, but no more. Since this is a mere misdemeanor, no harsh penalty will be demanded. Putin will be sentenced to a period of isolation from the international community, not to exceed six months. Which Vlad will probably consider this a vacation, given how much he loathes pretty much every European “leader,” not to mention Obama.

Note: this is not even a plea bargain. Putin will have to make no allocution. It is a preemptive surrender by the prosecutor.

I predict this result primarily because I believe Obama and the Euros have zero appetite to confront Putin. They can live with the low-level warfare in eastern Ukraine. (Not so low-level for the Ukrainians, of course, who have a much harder time living with it: indeed, they often die with it. But they should look out for themselves, because Obama, Merkel, Hollande, et al are casting them in the role of Czechoslovakia in a gala production of Munich!) Conversely, they blanch at the prospect of going eyeball to eyeball with Putin, even with economic weapons alone.

Of course the Panic! in the Kremlin Disco gang interpret the AP interview as “an unforced error.” A mistake that mis-states administration policy. They are invested in the belief that a steely Obama will force Putin to capitulate in panic.

Deluded fools. Denial ain’t a river in Egypt. I understand Obama and the Euros. More importantly, Putin understands Obama and the Euros. They will run to form. Meaning that they will run.

I do not write this with joy, to the contrary.

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July 21, 2014

The Dogs of Accounting Have to Hound Putin, Not the Average Oligarch With Dirty Money

Filed under: Economics,Politics,Russia — The Professor @ 6:48 pm

An idea to combat Putin and Russia that is gaining traction is to go after dirty Russian money in places like Londongrad and New York and Switzerland. Superficially it is an attractive idea, but upon further analysis it will be ineffectual, and perhaps counterproductive.

I say this as an early recommender of asymmetric financial warfare against Russia. In the immediate aftermath of the invasion of Georgia almost 6 years ago, I wrote that the US should “cry havoc and let slip the accountants of war.” But I recommended pointing the forensic accountants directly at Putin and his chief henchmen. Now, that would include Sechin, Ivanov, Yakunin, and the like.

Going after oligarchs and minigarchs in Belgravia or other similarly fashionable enclaves would certainly discomfit them, but would hardly cause VVP to lose a minute’s sleep, let alone to tame his aggressive ways. Only to the extent that these individuals are straw buyers for Putin would threatening their assets with confiscation for having been acquired illicitly bother the Russian president in the slightest.

Indeed, going after Russians with large investments overseas could actually redound to Putin’s benefit. The ability to spirit their wealth out of the country is the main protection that rich Russian have against Vlad’s predations. He has been campaigning for “on shoring” of Russian wealth squirreled away abroad: he has a variety of reasons to do so. A vigorous investigation of foreign investments and holdings of Russians would help spur the very on shoring that Putin wants (for others, I mean). I can just see him saying: “Come to Vova!” This would be a self-inflicted wound.

Pressuring Putin requires going after his money, and that of his closest cronies, not the wealth of the Abramoviches or Deripaskas. That said, this is a daunting task, given the labyrinth of shell companies and straw buyers that no doubt connects Putin et al to property, investments, and accounts. Indeed, it is likely the case that there is no document with Putin’s name on it: a verbal agreement, backed by the very credible threat of a serious health or legal problem in the event of breach, may suffice. Or if such a document exists, it is in Putin’s safe. (With all the appropriate stamps, of course: it’s not official without stamps!) These documents would say something like “I, Gennady Timchencko, hold in trust for Vladimir Vladimirovich Putin 40 percent of the shares in Gunvor.” Or, “I, Arkady Rotenberg, do pledge to pay to Vladimir V. Putin 20 percent of the gross revenues from state contracts or contracts with OAO Gazprom paid to my companies.” (Putin would probably prefer dividends to ownership per se.)

Thus, attacking Putin’s wealth will be a challenge, and one that no doubt requires the active involvement of US and other intelligence agencies. Moreover, given that definitive ownership would no doubt be difficult to establish, no doubt the US would have to lean on financial institutions which it has strong, but not definitive proof, are the repositories of Putin’s billions, in order to put those monies at risk.

But that’s where investigative efforts should be directed. Harassing even the most obscene, obnoxious oligarch with the dirtiest money in London or the south of France won’t affect Putin’s  policy in Ukraine or anywhere else in the slightest. It might be psychologically satisfying to do this, but it will be ineffectual at best, and counterproductive at worst.

 

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I’m Battling Confirmation Bias, But Obama and the Euros Make It Damned Hard

Filed under: Economics,History,Military,Politics,Russia — The Professor @ 10:45 am

Last night I said to bet on form, and that Putin would be doing so. And indeed, it seems that everyone is reverting to form.

The Euros are talking tough and angry, but when it comes to actually doing something, pretty much nothing. As is their wont, they are squabbling over how to divide the costs. No major country will agree to sanctions that require it to bear a greater burden than other EU members. So the response is, as usual, driven to the least common denominator. Cameron proposes that future arms sales to Russia be stopped: but that conveniently lets the French proceed with the Mistral sale. Other proposals involve adding a few more names to the lists of sanctioned individuals, but no companies, and certainly no level 3 sanctions.

Perhaps taking a cue from the Europeans, to whom he has largely deferred, Obama spoke this morning and just hit the replay button. Russia risks becoming more isolated. Unless Russia acts to de-escalate, “the costs for Russia’s behavior will only continue to increase.” Yadda, yadda, yadda. A remake ofGroundhog Day, with Obama threatening costs and isolation replacing “I Got You Babe” in the soundtrack.

Check out that last phrase. Note the passive voice. Very telling. Just who, pray tell, is going to impose these costs, and how? God? Santa Claus? More seriously: The “international community”? The “community of nations”? What is the US going to do? What are you going to do, Barry?

There is no way this pablum is going to induce panic in the Kremlin. Quite the reverse. Doesn’t Obama realize that repetitions of vacuous statements unaccompanied by serious action only embolden Putin, and are exactly why we are where we are?

That question was completely rhetorical.

The only people who would panic when hearing such empty statements directed at them are those more timorous and craven than those uttering them. If such people exist.

Another disturbing fact that strongly suggests that Obama is shying away from any robust action. His statement focused disproportionately on access to the crime scene, rather than who carried out the crime itself. Although Obama has hinted at Russian culpability in the past, this statement made no connection between Russia and the shootdown. He just made a brief remark about getting the facts out there and holding people accountable.

Look. The public record makes the guilty party obvious for all to see. Obama, with access to US intelligence sources, certainly knows far more. The fact that he continues to be reticent is damning. Five days after KAL007, Reagan had given a national address from the Oval Office (not a quickie on the WH lawn), laid out in detail the case for Soviet guilt, and played tapes of intercepted Soviet communications. We are five days out, and if anything, Obama is being less forthcoming about US information on Russian responsibility.

The crime scene issue is pretty much done with now, anyways. Moreover, it is relatively easy for Putin to make pleasant noises on this issue, now that his thugs have be in control of the place for 5 days.

Further on the panic meme, this article from Bloomberg has gotten huge play. It claims that the Russian economic elite is horrified by Putin’s course in Ukraine. Maybe they are, but the article just quotes some think tank guy who claims that’s what the business class is thinking.

And it’s not as if it matters. Even if they are horrified, will they challenge Putin? Their silence-not a single one was quoted-speaks volumes. If these individuals united in opposition, perhaps they could threaten Putin. But they show no signs of doing so, and some basic game theory says they almost certainly will not. They face a coordination problem. Who will go first in opposition, and lose everything with virtual certainty?: better to stick with Putin, and take a big hit to one’s wealth but be left with something. Including one’s freedom (and maybe one’s life). Everyone  will play Alfonse and Gaston, letting the other guy go first. Trying to conspire secretly is extremely dangerous, given the inability to trust anyone and the omnipresent surveillance and informants.

So even if the business elite is horrified, and indeed panicked, this means exactly squat politically.

One last thing about playing to form. The Russian Ministry of Defense gave its X-Files versions of the causes of the destruction of MH17. The only thing that surprised me is that they did not blame HAARP, for which they have blamed crop failures, earthquakes, and the loss of a space probe. Maybe they’re holding that one in reserve, just in case the other stuff doesn’t pan out.

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July 20, 2014

There’s No Panic! in the Kremlin Disco Because Putin Has Weighed His Foes and Found Them Wanting

Filed under: Economics,History,Military,Politics,Russia — The Professor @ 9:17 pm

As the evidence of Russian guilt for the MH17 massacre mounts and becomes irrefutable, there is widespread conjecture that Putin has been backed into a corner, and that he and the siloviki may be in a state of panic. Color me skeptical. I don’t sense any panic! in the Kremlin disco.

Of course the massacre creates huge complications for Putin. But he will not even begin to panic until he is confronted with something far more threatening than has come out of western capitals in days since the atrocity.

Yes, there have been expressions of outrage. This outrage has been intensified by the desecration carried out by Putin’s thugs on the ground. But outrage is easy. Action is hard.

Here, the signs are much more encouraging to Putin. Merkel made it plain that she still thought it was essential to maintain good relations with Russia, and did not say anything serious about an increase in sanctions. France and Italy have been almost completely silent. Even the nation that suffered worst-the Netherlands-was still willing to give Putin “one last chance.”

Obama and Cameron may actually be playing the role of B’rer Fox to Putin’s B’rer Rabbit. Obama said the US will not provide arms to Ukraine, and again stated-as if this was necessary-US troops would not be deployed. Moreover, he called for an immediate cease fire in eastern Ukraine.

Well guess what. Putin is adamantly opposed to western arms flowing to Ukraine, and is also calling for a cease fire. Precisely because this would buy time and breathing space for his increasingly beleaguered creatures in Donetsk and Luhansk, and precisely because he knows that the obligations under any cease fire would be enforced asymmetrically, with Ukraine being under much more pressure from the west to conform than  the Russian proxy forces would be.

Meaning that Putin might throw Obama just like he did in Syria with regards to chemical weapons. By agreeing to what Obama has demanded, and which Germany and other Euros have demanded-a cease fire-Putin can defuse the pressure for now, and use the respite to bolster the battered rebels, and to give them time to continue to fortify the territories they hold. So by demanding a cease fire, Obama (and other western leaders) are throwing B’rer Rabbit Putin right into the briar patch.

Cameron demanded that Russia guarantee access to the site where MH17 landed. Putin could well grab at this too, and say that the only way he can do that is if Russian “peacekeepers” move in. This is another thing he’s wanted to do. (There are many pictures of armor in Russia with peacekeeping insignia painted on them.) Again into the briar patch.

But the main thing that Putin needs to do is to stall for time. He is no doubt calculating that previous spasms of outrage have dissipated rapidly, especially when corporate champions in Europe ramp up the pressure on their governments, and that this one will too. He has heard the “last chance” mantra before, and his experience is that each last chance is followed by another one. He knows that the Euros have no stomach for a confrontation, even one conducted purely with economic weapons, and that Obama has only little more appetite.

Even while the bodies remain unburied, Europe is divided over intensifying sanctions. Those divisions will only increase as time passes. And you may rest assured that Putin’s connections and agents of influence in the west are working overtime to exploit those divisions, and stoke the well-established tendencies in western governments to procrastinate and avoid confrontation. He saw it after Georgia. He saw it after Crimea. He has seen it repeatedly in the past 3 months over Ukraine.

Certainly Putin could have done without this. The massacre served no military purpose, and has interfered with his schemes in Ukraine. But it has not created an existential, panic-inducing threat to him or his regime. He views it as a setback, but one that he can manage with his usual mixture of double-talk, pacific gestures, and behind the scenes pressure exerted by his corporate allies in Europe and to a lesser extent the US.

The only thing that has the possibility of inducing anything approaching panic in Putin is for Obama and Merkel and the lesser lights in Europe to upset his calculations by playing against type. Impose crippling sanctions with the promise of removing them if Putin essentially capitulates on Ukraine, rather than threatening to impose more costs if he keeps it up.

That is, all the talk about a cornered, panic Putin is so much wishful thinking. It presumes that the shock of the event has caused western governments finally to see Putin as a monster who must be confronted robustly. There’s no evidence that this is the case even while emotions are running their hottest. And past experience suggests that the image of Putin as a monster can actually work to his advantage, because it makes timorous governments all the more intimidated from confronting him.

I would like to believe that the deaths of 298 innocents has not been in vain, and that their murders will resolve western leaders to do what it takes to confront Putin’s aggression. But I’m betting on form. And I am sure Putin is too.  He has weighed his foes, and found them wanting.

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July 18, 2014

Sanctions: Pinprick or Sledgehammer Blow, With Little In Between

Filed under: Commodities,Derivatives,Economics,Energy,Military,Politics,Russia — The Professor @ 11:27 pm

Before the massacre over Donetsk, the big Russia-related story was the new sanctions imposed on Wednesday. Although those sanctions were overshadowed by yesterday’s atrocity, the wanton destruction of MH17 raises the possibility that more intense sanctions will be forthcoming. Therefore, it is worthwhile to examine what the US did Wednesday to see what would be necessary to impose truly crippling costs on Russian companies and the Russian economy generally. (Forget what the Euros did. That is so embarrassing that it should be passed over in silence.)

The sanctions imposed Wednesday are very weak beer. (Here is an FAQ from the Treasury outlining them.) They were different than previous sanctions in that these were directed at companies, rather than individuals. Moreover, some of the targeted companies are on the commanding heights of the Russian economy: Rosneft, VTB, Gazprombank, and Novatek. (Notable absences: Gazprom and Sberbank.)

Under the sanctions, “US Persons” (which can include US subsidiaries in foreign countries) are prohibited from buying new debt from or new making loans to these companies with maturities of 90 days. (Existing loans/bonds are not affected.)  US persons are also precluded from buying “new” equity from the financial firms: they can buy new equity from Rosneft and Novatek.

Since US banks are major lenders to foreign companies, this might seem to be a major impediment to the affected companies, and indeed  Rosneft’s and Novatek’s stock prices were both down more than 5 percent on the news. But in my opinion, this reaction is more related to how the announcement raised the likelihood of more severe sanctions in the future, rather than the direct effects of these new sanctions.

That’s because although the sanctions will constrain the capital pool that Rosneft and the others can borrow from, other lenders in Europe and Asia can step into the breach. The sanctions do make it more difficult for the sanctioned companies to borrow dollars even from foreign banks, because although the sanctions do not bar foreign banks and investors from accessing the US dollar clearing system for most transactions, they could be interpreted to make it illegal to process the banned debt and equity deals:

U.S. financial institutions may continue to maintain correspondent accounts and process U.S. dollar-clearing transactions for the persons identified in the directives, so long as those activities do not involve transacting in, providing financing for, or otherwise dealing in prohibited transaction types identified by these directives.

Some have argued that this is a serious constraint that will effectively preclude the sanctioned companies from borrowing dollars other than on a very short-term basis. This is allegedly a big problem for Rosneft, because its export revenues are in dollars, and borrowing in other currencies would expose the company to substantial exchange rate risk.

I disagree, because there are ways around this. A company could borrow in Euros, for instance, and  sell the Euros for dollars. It could then deposit, invest, or spend the dollars just like the proceeds from dollar loans because it would have access to the dollar clearing system. Alternatively, the companies could borrow in Euros and immediately swap the Euros into dollars. This is because derivatives transactions are not included in the sanctions, and the payments on those could also be cleared. This would add some expense and complexity, but not too much.

The sanctions even permit  financial engineering that would allow US banks  effectively to provide credit for the sanctioned firms because derivatives on debt and equity of the sanctioned firms are explicitly exempted from the sanctions. For instance, a US bank could sell credit protection on Rosneft to a European bank that would increase the capacity of the European bank to extend credit to Rosneft. Syndication is one way that US banks can get credit exposure to Rosneft and reduce the amount of credit exposure that foreign banks have to incur, and even though the sanctions preclude US banks from participating in syndicates, the same allocation of credit risk could be implemented through the CDS market. This would permit foreign banks to increase their lending to the sanctioned firms to offset the decline of US direct lending. (This would still involve the need to convert foreign currency into dollars if the sanctioned borrower wanted dollars.)

Unlike real super majors (who can borrow unsecured, or secured by physical assets), Rosneft is unusually dependent on prepaid oil sales for funding, and these agreements are almost exclusively in dollars. This has led to some debate over whether the sanctions will seriously cramp Rosneft’s ability to use prepays.

There are a couple of reasons to doubt this. First, after the initial round of sanctions raised the specter of the imposition of sanctions on Rosneft, many prepay deals were re-worked to include sanctions clauses. For instance, they permit the payment currency to be switched to Euros, or to another currency in the off chance that the Europeans grow a pair and shut Rosneft out of the Euro payment system. Again, as long as access to the dollar system is not blocked altogether, those non-dollar currencies could be converted into dollars.

Second, there is some ambiguity as to whether prepays would even be covered. The sanctions specify the kinds of transactions that are covered:

The term debt includes bonds, loans, extensions of credit, loan guarantees, letters of credit, drafts, bankers acceptances, discount notes or bills, or commercial paper.

It is not obvious that prepays as usually structured would fall into any of these categories, and prepays are not specifically mentioned. A standard prepay structure is for a syndicate of banks to extend a non-recourse loan to a commodity trading firm like Glencore, Vitol, Trafigura, or BP. The trading firm uses the loan proceeds to make a prepayment for oil to Rosneft. In return, the trading firm gets an off take agreement that obligates Rosneft to deliver oil at a discounted price: the discount is effectively an interest payment.

The banks lend to the trading companies, not Rosneft. But (except for a small participation of 5-10 percent by the traders) the banks have the credit exposure. So this does not fall under any of the listed categories, except for perhaps “extension of credit.” Insofar as the trading firm is the borrower who faces the banks, it’s not clear the banks fall afoul of the sanctions even though that banks bear Rosneft’s credit risk. What about the trading firm? It’s not a US person, and a prepayment is not explicitly listed as a type of debt under the sanctions: again, this would turn on the “extensions of credit” provision. Under prepays, payment is usually with an irrevocable letter of credit, but these generally have maturities of less than 90 days, so that’s free of any sanctions problem.

So, there’s a colorable argument that prepays aren’t subject to the sanctions. But there is a colorable argument that they are. Economically they are clearly loans to Rosneft, though done via a trading firm acting as a conduit. But whether they are “debt” legally under the sanctions definition is not clear.

But especially in this regulatory environment, bank (and trading firm) tolerance for ambiguity is  pretty low. So the FUD factor kicks in: even though they could make a plausible legal argument that prepays fall outside the definition of debt under the Treasury rules, the risk of having that argument fail may be sufficient to dissuade them from doing dollar prepays. This is especially true in the post BNP Paribas world. So it is likely that future prepays may be in currencies other than the dollar, and as long as dollar clearing is open to it, Rosneft will just have to convert or swap the Euros or Sterling or Swiss Francs or whatever  into dollars if it really wants to borrow dollars. Again, an inconvenience and an added expense, but not a major hurdle.

All this means that the most recent round of sanctions are  sound and fury, signifying not very much. Indeed, by deliberately avoiding the truly devastating sanction, this round signifies a continued reluctance to hit Putin and Russia where it really hurts. Someone like Putin likely interprets this as a sign of weakness.

What would the devastating sanction that was deliberately avoided be? Cutting off altogether access to the dollar clearing system. Recall that the just-imposed sanctions say “U.S. financial institutions may continue to maintain correspondent accounts and process U.S. dollar-clearing transactions for the persons identified in the directives.” Change that to “U.S. financial institutions are prohibited from maintaining correspondent accounts and processing U.S. dollar-clearing transactions for the persons identified in the directives” and it would be a whole new ballgame. This would mean that the sanctioned companies could not receive, spend, deposit, or invest a dollar. (Well, they could if they could find a bank insane enough to be the next BNP Paribas. Good luck with that.)

I discussed how this would work in a post in March, and the Banker’s Umbrella provided a very readable and definitive discussion about that time. Basically, every dollar transaction, even one handled by a foreign bank, involves a correspondent account at a US bank. Cut off access to those accounts, and the sanctioned company can’t touch a dollar.

This would close off the various workarounds I discussed above. The sanctioned companies would have to restructure their operations and financing pretty dramatically. This would be particularly challenging for Rosneft, given that the currency of choice in oil transactions is the USD. This would be like the sanctions that have been imposed on Iran and on Sudan.

This would represent the only truly powerful sanction. And that’s one of the issues. Anything short of cutting off all access to the dollar market is at most an irritant to the sanctioned companies. Cutting off all access imposes a major cost. There’s not much in between. It’s a choice between a pinprick and a sledgehammer blow, with little in-between.

But if a Rubicon hasn’t been crossed now, with the murder of 298 people and continued battles in places like Luhansk waged by Russian-armed rebels, it’s hard to imagine it will ever be. If Putin and Russia are going to pay a real price for their wanton conduct, the sledgehammer is the only choice.

 

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