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Streetwise Professor

March 27, 2008

That Would be a Feature, Not a Bug

Filed under: Politics — The Professor @ 10:03 am

John McCain gives FT commentator Anatol Lieven the vapors. According to Lieven, the muscular neocon McCain makes Bush look like a mild mannered milquetoast: “The problem that Mr McCain poses stems from his ideology, his policies and above all his personality. ” Other than that, Lieven has absolutely no problems with McCain.

Using Walter Russell Mead’s categories, Lieven calls McCain a “Jacksonian nationalist”–and he’s not paying a compliment to our seventh president (and few do these days.) Jacksonians are notably touchy, and are willing to fight–and if they fight, they fight to win. Jacksonians are also American exceptionalists, value personal liberty, and have little patience for international organizations that enable tyrants instead of smiting them. All of which drive postmodern Eurosnobs like Lieven to conniptions.

As an instinctual (if not intellectual) Jacksonian, all I can say is from Lieven’s lips to God’s ear. If McCain is indeed a Jacksonian–and the case can be made–that would be his saving grace in my eyes.

But there is much room to doubt Lieven’s characterization. What is so Jacksonian about supporting Kyoto and other measures to control carbon emissions? What is so Jacksonian about campaign finance reform? And immigration “reform” is Jacksonian? In what universe? I have no doubts that Old Hickory is doing about 1000 RPM at the very thought.

Indeed, John McCain’s big problem is that many Americans, especially many who remember fondly America’s last true Jacksonian president, Ronald Reagan, seriously doubt that he is in fact a Jacksonian. Lieven’s case that McCain is a foreign policy Jacksonian is plausible, and that is quite honestly the only reason that McCain is the Republican nominee. But many fear that his Jacksonianism stops at the water’s edge. Overcoming those doubts is McCain’s daunting task.

And ironically, jeremiads like Lieven’s will go far in building McCain’s cred among the skeptics. The more people like the University of London professor (and I have nothing against professors, believe me) attack McCain for his muscular Americanism, the more McCain doubters will embrace him. Especially if the contest comes down to McCain vs. Obama, the contrast between a Jacksonian patriot and a man who refuses to wear a flag pin accompanied by “Goddam America” fellow travelers will be be decisive. In particular, Reagan Democrats are instinctual Jacksonians who would find Lieven’s characterization of McCain quite attractive (no doubt to the good professor’s horror)–and who no doubt find Obama’s anti-Jacksonianism repellent. So, quite unintentionally I am sure, and perhaps not quite accurately, Professor Lieven has crafted the narrative that is most likely to put McCain in the White House.

The Empresses’s New Clothes

Filed under: Politics — The Professor @ 9:28 am

On one level, the media’s deconstruction of Hillary Clinton’s story about dodging snipers in Bosnia is nothing special. Most politicians are fabulists, and the Clintons are exceptional in this regard only because they are exceptional fabulists. No, what is revealing is that after years of covering up, obscuring, ignoring, diverting attention from, excusing, or explaining away myriad Clinton fables, legacy news media organizations are bringing attention to this particular one. They are saying, after years of raving about the beauty of her (and his) raiments, that the Empress has no clothes.

And, to be (justifiably, I think) cynical about it, this isn’t because they’ve just awoken to the fact that the Clintons are serial liars. It is because Hillary has become disposable because they have a new heartthrob in Obama. Indeed, she is worse than disposable–she is an obstacle to their new idol’s progress. So she must be destroyed.

But maybe not quite yet. After all, there is still an outside chance that she may survive to face McCain. In that event, her wardrobe will again dazzle every media eye. But as soon as it appears that she cannot beat Obama, but may only diminish his chances to defeat McCain, she will face a barrage of negative stories. And not that there will be a shortage of ammunition to use against her. It’s always been there, but the media has never opened the magazine doors. When she is most vulnerable, “use it or lose it” will become the watchword, and nearly 20 years of negativity will unload on her in a few news cycles. So get ready for a media free fire zone.

Perhaps her plight will evoke my sympathy. But I seriously doubt it. What goes around comes around.

Stop it–you’re killing me.

Filed under: Energy,Politics,Russia — The Professor @ 9:11 am

Russiablog is usually good for a few laughs, but Yuri Mamchur’s piece “Russia Who” had me doubled over in laughter when it referred to Dmitry Medvedev as “a 42 year old entrepreneur.” There are many words that come to mind in describing Medvedev’s career. Entrepreneur ain’t one of them. A board position in one of the most malign corporations in the world does not qualify one as an “entrepreneur,” Yuri, old buddy.

Is This Show in Syndication?

Filed under: Energy,Politics,Russia — The Professor @ 9:02 am

The Russia-BP/TNK episode has all of the suspense of an old Rockford Files re-run. The familiar plot devices–the tax investigation, the national security angle, the environmental theme. Cameos by the usual heavies, such as Oleg Mitvol. No need to wake me to see the outcome. I know how it will end.

What is illuminating about this affair is that it is playing out against the background of Dmitry Medvedev’s turn at the Debutante Ball. He is making public statements, meeting world leaders (though usually it seems with his chaperone), and giving interviews in western papers. And the contrast could not be more stunning. While Medvedev says soothing things about the rule of law, freedom, yada, yada, another lawless act is playing out in plain sight.

To those swooning over Medvedev–or who are at least willing to give him the benefit of the doubt when he says seemingly liberal things–I would suggest that deeds, not words, are all that should matter. And the deeds speak volumes. The farcical voting (as Edward Lucas calls it, refusing to dignify the process with the word “election”); the continued harassment–and worse–of those who dissent; the BP shakedown; the declaration of more and more industries as “strategic.” All these things–and many more–say loud and clear that Russia is continuing to move away from a rule of law and freedom, and that it is continuing its steady march to corrupt and corrupting authoritarianism.

The contrast between Medvedev’s words and the ongoing acts of the government that he will soon head suggest either (a) he has power, and his words mean nothing because he really does not believe them or intend to put them into practice, or (b) he believes what he says, but he has no power to put them into action, in which case his words are still meaningless. Perhaps one could argue that we should wait until his inauguration and he has the chance settle into his new position before judging him on the basis of what is going on in Russia today. Perhaps. Since he is so much a part of the system that has methodically progressed to this point I am deeply skeptical that things will change once he becomes president. Maybe I’m wrong. I hope so, but I doubt it.

March 13, 2008

Russian Price Controls Redux

Filed under: Economics,Politics,Russia — The Professor @ 8:41 am

Last year I blogged about Russian price controls, and was interviewed on the subject on Robert Amsterdam’s blog. Apparently the idea was not just a expedient to get Putin and Medvedev past the election:

Economic Development and Trade Minister Elvira Nabiullina took time out from a real estate forum in France to warn that attempts to impose long-term price controls on basic foodstuffs could lead to shortages, casting doubt on the prospects of a proposed anti-inflation bill.

The bill, which is being prepared jointly by the Agriculture and Economic Development and Trade ministries, would introduce maximum markup prices on staple foods to help consumers already reeling from spiraling inflation. It would also include methods for voluntary price freezes and outright price regulation by the state.

Nabiullina’s comments, made on Monday at the MIPIM forum in Cannes, appeared to have been in response to a suggestion last week by Agriculture Minister Alexei Gordeyev urging the introduction of long-term price controls on socially significant foods.

Gordeyev told reporters after a government meeting Thursday that staple foods, including bread, milk, meat and eggs, should have retail markups capped in the range of 10 percent to 15 percent.

Oi. At least somebody in the Russian government sees this as idiotic. Unfortunately, there are some folks in the private sector who don’t get basic economics:

“Price capping is good only as a stop-gap measure,” said Anton Saraikin, a spokesman for dairy producer Wimm-Bill-Dann, which led the group that initiated the price-freeze agreement in October.

“The government will need to improve the agricultural sector greatly to make basic foodstuffs affordable for ordinary people,” he said.

Er, Anton old buddy, if you expect “the government . . . to improve the agriculture sector” at all, let alone greatly, you haven’t been paying attention to, oh, say the last several millennia of history. During which time, governments–including quite prominently the Tsarist, Soviet, and RF governments–have an amazing track record at screwing up the agriculture sector of their countries.

The problems in the Russian agricultural sector are so acute that it is hard to know where to start a list. One thing for sure, these inefficiencies–especially the inefficiencies in transportation and marketing–will mean that any attempt to control margins will lead to acute consumer shortages.

I wish Nabiullina luck. She’ll need it.

It’s Catching

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges — The Professor @ 8:29 am

According to the FT, the UK’s Office of Fair Trading (the British antitrust authority) has apparently caught a case of the stupids from the USDOJ:

In the row over the ICE, which is planning to move clearing in-house and away from LCH, the matter is under review by the UK Office of Fair Trading. There are signs that the OFT, which has long been troubled by the competition issues raised by exchanges owning clearers, is studying the application closely. Two weeks ago, it sent out questionnaires to market participants querying the level of competition for the mostly widely traded ICE contracts in London.

If ICE forces customers to use only its own clearer, bankers say they will press the Commission to block the deal. Last week, in a separate initiative, Nymex launched a suite of products in direct competition with ICE that will clear through LCH.

Meanwhile, customers are also threatening to bring LCH to the attention of European authorities over a deal it tentatively struck with Liffe last week that would see the exchange take some of its clearing in-house but stop short of forming its own in-house operation and ending its relationship with LCH.

It would be nice, if just once, somebody, somewhere in some antitrust authority would actually step back and do a thorough analysis of economics of vertical integration in clearing and execution. The monomaniacal focus on (likely chimerical) anti-competitive effects, to the complete exclusion of any consideration of the possibility that vertical integration, might, just might, have some efficiency rationales will inevitably lead to bad policy. As I have said before, this is throwback antitrust analysis–BC, as in before Chicago.

One simple question for the OFT: if exchange control of clearing is the big obstacle to competition in execution, why hasn’t LIFFE faced competition in its products? And for that matter, why hasn’t LSE? (Okay, that’s two questions.) And who owns a big chunk of LCH? (Okay–three.) It wouldn’t happen to be the banks that are complaining about LIFFE moving clearing in-house, would it? (I know.)

On that last point, before one canonizes the poor, martyred banks who suffer at the hands of those cursed exchanges, consider the following story by the excellent Natasha (may I call you dahlink) de Terán:

LCH.Clearnet has operated SwapClear, a much used and admired swap clearing service, for nearly a decade. SwapClear has its critics and limitations but the one that could prove to be most damaging is its membership criterion.

A self-qualifying circle of dealers, OTCDerivNet, guard SwapClear’s gates. The buyside and other smaller dealer firms are kept outside. LCH.Clearnet might have wanted to roll out a similar service to that of the CME. But it has been hamstrung by OTCDerivNet.

Imagine that, a cooperative that restricts entry! Never heard of that before. (Yeah, well, except for the NYSE and pretty much every traditional US derivatives exchange and many overseas exchanges.) Think that such entry restrictions might well enhance the profitability of the members that are on the inside looking out? That certainly was the case with exchanges, as my 1999 J. Financial Markets paper showed.

Thus, perhaps the European Commission and OFT should take a break from obsessing about exchange vertical integration, and take a gander at some other possible competition issues in clearing. As I wrote in my clearing paper, disintegration combined with the formation of a cooperative clearing venture is no guarantee that a thousand competitive flowers will bloom. Execution venues that discover prices are likely to remain monopolies after disintegration; even cooperative clearers can exercise market power by restricting entry or supercompetitive pricing (and don’t be fooled by big rebates to members–that can be perfectly consistent with the exercise of market power); and the parallel operation of an exchange and a clearer both with market power can lead to inefficiencies in the form of double marginalization and higher transactions costs.

March 5, 2008

A Fearless Prediction

Filed under: Derivatives,Economics — The Professor @ 10:07 am

There are widespread conjectures that the credit crisis will soon roil the corporate bond market, leading to an appreciable increase in defaults. Apropos a piece from almost exactly two years (and 200 posts) ago, I fearlessly predict that this will lead to multiple squeezes and manipulations in the credit default swap (CDS) markets for defaulting securities. This will happen regardless of whether ISDA and market participants agree to alternative settlement mechanisms, such as cash settlement and auctions.

A wave of defaults will lead to a tsunami of litigation. Myriad issues will be litigated. Squeezes will be one. The legitimacy of changing settlement mechanism (from delivery to cash settlement, for instance) will be another. I also imagine that given the still creaky backoffice and confirmation systems in the CDS market, there will be numerous disputes over the validity of contracts. Many insurance sellers will attempt to walk away from their obligations to pay in the event of defaults, pointing to defects in–or complete absence of–trade confirmations.

What fun will be had by all.

The DOJ and the Options Markets

Filed under: Commodities,Derivatives,Economics,Exchanges — The Professor @ 9:51 am

In my earlier posts on the DOJ’s jeremiad on clearing, I questioned whether its analysis of US options markets was apposite. I have finally had a little time to research the issue, and the answer is a resounding “NO!”

In my original post pointed out a couple of possible important issues–intermarket linkages and payment for order flow–that could mean that the survival of multiple options exchanges does not imply that network effects are immaterial in financial trading. Indeed, as several SEC studies document, both features are very relevant in US options markets.

As part of the exchanges’ antitrust settlement with the government, the exchanges adopted an intermarket linkage plan and agreed to adhere to order handling rules. Though not as streamlined as those eventually adopted for the equity markets under RegNMS, these measures provided considerable linkage between the different option markets. That is, though they did not go as far as creating a central limit order book (“CLOB”), the rules did go a long way towards creating a central price discovery venue. That is, options exchanges are not competing price discovery venues; they are competing portals to a central price discovery mechanism. Linkages and order handling rules sharply reduce the centripetal forces that would otherwise induce trading to “tip” to one exchange

Moreover, the SEC studies report that a very large fraction of order flow served by the options exchanges is purchased. As I have written in my academic work, purchased order flow is typically uninformed order flow that does not contribute to price discovery. Moreover, as I have also shown in that work, multiple “cream skimming” venues servicing uninformed order flow can coexist. That is, segmented uninformed order flow does not tip. The survival of multiple exchanges servicing uninformed traders via payment-for-order-flow and internalization arrangements in no way contradicts the tipping/natural monopoly of price discovery framework.

Thus, the survival of multiple exchanges in options is not attributable solely to the fact that the industry operates a cooperative clearing “utility” as the DOJ claims. Rather, this survival reflects the facts that (a) linkage and order handling rules have effectively socialized order flow and created a central price discovery venue, and (b) much of the uninformed order flow is “skimmed” and segmented, and thus not susceptible to tipping.

This implies that creation of a clearing cooperative is NOT sufficient to lead to competition in execution, and the survival of multiple, competing price discovery venues as the DOJ letter asserts. Much more radical steps are required. Specifically, no execution venue can be allowed to own and control its order flow. Absent any obligation to redirect order flow to another market offering a better price, and the creation of technological linkages that make this redirection quick and efficient, trading activity will tip to the market that offers the best expected terms of trade. This becomes a self-fulfilling process, resulting in the survival of a single market.

Now, there is an argument to be made that such rules and linkages are efficient; in fact, I’ve made it in my JLEO article “Security Market Macrostructure.” But the DOJ does not make that argument–or even provide any inkling that it even understands the issue. It merrily suggests that cutting the baby in half–splitting execution and clearing–alone will allow the proliferation of many competing execution venues. Wrong. Wrong. Wrong. Look at the history of equity trading 1975-2005 for abundant proof of that. If the formation of a clearing cooperative was sufficient to create competition in execution, why did the SEC feel it necessary to push ahead with RegNMS and its socialization of order flow decades after the creation of a securities clearing cooperative?

Indeed, if followed, the DOJ’s prescription could be very damaging, leading to no improvement in competition in exchanges, but resulting in reductions in efficiency due to double marginalization, and higher transactions costs. Without measures to break the network effect–to socialize order flow through mandated market linkages and order handling rules, or the creation of a CLOB–shearing clearinghouses from exchanges will do nothing–zip, nada, zero–to increase in competition in execution, but it will lead to wasteful “friction” at the interface between the independent clearer and exchange. All pain. No gain.

It is also interesting to note something that the DOJ ignores altogether. Not only is exchange ownership of futures clearinghouses the standard worldwide, it is actually increasing in importance. ICE has brought its clearing in-house in the US, and is endeavoring to do so in the UK, though that is running into some obstacles–regulatory and in implementation. As another example, LIFFE, which had historically secured clearing from LCH (and subsequently LCH.Clearnet) is now moving to integrate clearing. This is quite consistent with the transactions costs arguments I have advanced.

There are two stark choices: either keep the status quo, or undertake a thorough remaking of the regulatory structure in futures markets along the lines of what has been done in equity (and latterly options) markets in the past 30 plus years. The DOJ’s nostrum either goes too far, or not far enough. Since there has been absolutely no debate regarding the organization and regulation of futures markets along the lines of that which has roiled the securities markets for decades, it is highly unlikely that the more radical alternative is in prospect any time soon. I only fear that the pressure to do “something” leads Congress and the regulators to take the DOJ’s middle ground–to the detriment of the markets and their users.

Abandoned Lands

Filed under: Politics,Russia — The Professor @ 9:16 am

Sources from the time of the Mongol (Tatar) Yoke refer repeatedly to the “pustoshi” –the abandoned lands. According to Blum’s Lord and Peasant in Russia, “in document after document in the fourteenth and fifteenth centuries much land and villages are described in this manner.”

The Mongols are gone, and the driving forces are different, but the pustoshi are returning. In Mongol times, the scourge was external. Today, it is homemade. Russia recovered, in a long and torturous process, from the legacy of Tatar domination. Will it rebound from its self-inflicted decimation? The omens are not favorable:

Even as Russian officials celebrate and Western media report a small uptick in the number of births in the Russian Federation, demographers in that country’s Academy of Sciences are predicting that life expectancy among Russian men will continue to fall over the next four decades, possibly to below 50 years from birth.
If these projections are correct – and they are based on internationally accepted models — they mean that any demographic gains for the country from declines in infant mortality and from any increase in the birthrate will be more than wiped out, with all the economic, political and military consequences that entails.

And that in turn suggests that the Russian government will need to devote at least as much attention and resources to the far more intractable problem of male mortality as it is currently giving in its efforts to boost birthrates by providing new benefits to women and families who have more children.

In an article in the current issue of Demoscope Weekly, Yevgeny Andreyev says that current research suggests that in the best case, male life expectancy will fall another year or so by the middle of the century, with the possibility that it might decline as much as eight or nine years (http://demoscope.ru/weekly/2008/0321/tema03.php). Such declines not only would wipe out most if not all of the benefits of the pro-natalist policies that Moscow is currently promoting but would also, because the incidence of male mortality is higher among ethnic Russians than most other groups, contribute to an even more rapid shift in the ethnic balance in the population.

It should be noted, moreover, that the uptick in births trumpeted by the Russian government probably has little–if anything–to do with “pro-natalist” policies. Instead, it is the cresting of a demographic wave 20-odd years following the last crest in Russian/Soviet birthrates in the early-to-mid-1980s–a crest that is smaller than its predecessor.

Post-modern attitudes towards family combined with pre-modern medicine and personal behaviors is a toxic demographic mixture. No amount of chest thumping and strutting in the Kremlin is going to change that, not today, and not tomorrow. That is, if there is a tomorrow for Russia.

March 3, 2008

Is There a Third Option?

Filed under: Economics,Energy,Politics,Russia — The Professor @ 9:03 am

I am deeply ambivalent over Kosovo’s declaration of independence, and the support for this move from the EU and the US. Kosovars certainly suffered immensely at the hands of the Serbs, and Serb anger over independence does not move me at all. That said, Kosovo’s leadership hardly inspires confidence, and the very real possibility that Kosovo will serve (if it is already not serving) as a sanctuary for Islamist extremists in Europe is quite disturbing. Lastly–though you might be quite surprised to hear this coming from the likes of me–this seems a bad time to aggravate Russia, and a bad issue to aggravate it about. It is not a central strategic issue to the US, and hardly one for Europe. This plays into the hands of the worst elements in the Kremlin, and in Russia at large, and for what? Why put further strains on a strategically important relationship over what for the US should be a tertiary issue, and on behalf of one entity that is only slightly less unappealing than the other? We certainly will get no props from the Muslim world for rescuing an oppressed Muslim population–yet again. So, what’s the upside?

That said, I doubt that Russia will do anything precipitate in response. In particular, I doubt that it will carry through on its threats to support separatist movements in Ossetia and Abkhazia, and for the very reason that it is so exercised over the Kosovo “precedent.” Russia fears the precedent because it fears the centrifugal, separatist forces within the RF, most notably in the north Caucasus. Justified or no, Putin and others in the Kremlin are aghast at the prospect of a breakup of the RF, or at least the breakaway of certain parts of it. If Kosovo serves as a precedent for separatist movements that Russia fears could fracture Russia, Russia would only reinforce the precedent by supporting such movements in Georgia or Moldova. So, such support would be cutting off Russia’s nose to spite its face. This is not to say that Russia will refrain from stirring the pot in Georgia or Moldova or in the Ukraine (over Crimea, for instance), but they will stop short of supporting and recognizing independence movements.

Stratfor argues that Russia is retaliating by putting pressure on Georgia and Ukraine to “persuade” these nations not to join NATO–but Russia would do that regardless, independent Kosovo or no. At best, Kosovo gives Russia an issue that they can use to put the EU and the US on the defensive, but if the Kosovo argument wasn’t there, they’d just find another. With the Russians, like Roseanne Rosanadana used to say, “It’s always something.” Russia deems Georgian and/or Ukrainian accession to NATO a dire threat to its vital interests, and an intrusion on its sphere of influence, and will pull out the stops to prevent this.

At best–or worst–Kosovo gives Russia more influence over Serbia, and strengthens the pro-Russian nationalist elements in that country. But, the Russians have already demonstrated that their support comes at a huge price–witness what amounts to the theft of Serbia’s national oil company by Gazprom. Soon the Serbians will understand that Slavic/Orthodox solidarity is merely a front for Russian economic and geopolitical interests.

Showing some deference to Russia on the Kosovo issue would by no means assuage Russia. Putin et al have way too many issues, and are feeling their oats, and would take an inch on Kosovo and continue to demand miles on myriad other issues. But giving a bit on an issue of no pressing importance to the US would help to undercut the diplomatic and political influence of Russian complaints outside of Europe, especially as many nations (including European ones) have their own anxieties about separatist movements.

In sum, it is possible to protect the Kosovars from the Serbs without supporting full-blown independence. It raises an issue with Russia that Putin and his coterie can exploit, but does not provide any offsetting benefit to the US or Europe. So it would have been far preferable indeed to craft a third option that would have protected Kosovo; not presented such a stark challenge to the Westphalian system; and deprived the Russians of a hobby horse that they can ride to raise mischief.

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