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Streetwise Professor

February 27, 2012

Julian FUD

Filed under: Politics — The Professor @ 10:09 pm

In a pitiful attempt to show that it matters, Wikileaks has released a cache of emails stolen from Stratfor, perhaps by Anonymous.

The media is treating this as a serious story, instead of the joke it is.  The only reason–only–to pay attention to this is to heap scorn on Assange, Wikileaks, and Anonymous.  To point out just how colossally lame they are, individually and collectively.  Wikileaks can’t get actual, like, you know, confidential government documents, so it is reduced to accepting “charitable” donations of emails stolen by hackers that opportunistically exploit a private organization culpable of some egregious security lapses. How pathetic is that? (Even Wikileak’s big coup-the State Department cables-was handed to it on a plate by Bradley Manning.  It was hardly an act requiring any technical expertise.)

Is this the best they can do? Really? A private organization, that has some dealings with defense contractors and the like? An organization with a mixed reputation?

Some journalists, like Dan Murphy of the Christian Science Monitor , and Jack Shafer at Reuters, are heaping the appropriate scorn on the losers.  But for the most part, the media is breathlessly reporting the “revelations” like they are real news, or something. Assange, Wikileaks, and Anonymous have jumped the shark, and the media is driving the boat.

The Russians, and Russia Today in particular, take the cake.  Russia Today refers to Stratfor as a “shadow CIA.”  Seriously.  They do.  And there was a kerfuffle in Russia regarding Prosecutor General Yury Chaika, who apparently was a source for Stratfor reporting on Russian “clan wars.” Chaika’s office asserted that claims he had cooperated with “foreign intelligence services” was a provocation.  What, Stratfor is now a “foreign intelligence service”?

How farcical.

I wonder if Stratfor CEO George Friedman is regretting his appearances on RT.

Speaking of Friedman, an email stating he had resigned as CEO was circulated.  But that was apparently a forgery-part of the Anonymous campaign against Stratfor. Friedman posted a video about the leak, in which he was identified as Stratfor CEO.

He should really come out with a video stating conclusively he has not resigned.  Preferably holding a copy of a newspaper with today’s date.  It has really come to that.

Wikileaks and Assange and Anonymous wrap themselves in the cause of openness and transparency.  In fact, they are rather low rent criminals who sow FUD rather than shed light into dark corners.  If the media is going to give them any attention, it should be in the form of scorn and ridicule, rather than the rather embarrassing breathless coverage seen today.  Taking them seriously only encourages the fools.

Some Zero Hedge Questions

Filed under: Politics,Regulation — The Professor @ 9:37 pm

Zero Hedge has largely avoided any serious scrutiny for the past several years, after some critical stories in New York magazine and on Felix Salmon’s blog.  I wonder if that’s about to change.

While waiting for serious reporters to subject ZH to the same kind of critical inquiry that ZH routinely aims at its myriad enemies, I have a few questions that might be worth exploring:

1. Do ZH writers have positions in the market?  Any market?
2. Do they disclose positions when they write stories related to their positions, or post tweets related to their positions?
3. Is the SEC at all curious about a hugely influential, and possibly market moving/market influencing site in which someone banned from the securities industry is deeply involved? (Daniel Ivandjiiski, banned from the industry for insider trading denies being a “founder” of ZH, but this sounds weasel-like, depending on the definition of “founder.”  He is the only publicly identified writer for the site.)
4. Is the fear of SEC scrutiny why ZH is registered and hosted in Switzerland? If that’s not the reason-what is?

I have many more questions, but that will do for now.

Pretty Pathetic

Filed under: Politics,Russia — The Professor @ 9:23 pm

Vladimir Putin has made the United States the centerpiece of his campaign to return to Russia’s presidency.  He fulminates against the US regularly.  His fulminations reached a frenzied peak-one hopes-with publication of an article on foreign policy Moskovskie Novosti.  He rails against the American obsession with “becoming absolutely invulnerable,” claiming “it is the root of the problem.” (What problem would that be?)  He rants that the US is hypocritical, and is always “wielding a cudgel.” (What, not a knout?)  He sputters that the US routinely engages in “political engineering”, especially in “regions traditionally important to Russia”: he doesn’t mention that the Russians are widely loathed in these areas.  Go figure.

Quite a performance.

And just what role will Russia play in the upcoming presidential campaign in the US?  A footnote, at most. It may, in fact, play no role at all.  Zip. Zero. Nada.

And that just drives Putin around the bend.  An also ran with delusions of grandeur, raging against irrelevance, and willing to engage in destructive and ultimately self-defeating acts (e.g., doubling down with Assad) just to get attention.

Pathetic.

The Cassandra Chronicles Continue

The Economist just ran a long piece about the unintended, and largely unforeseen, consequences of collateral and clearing mandates.*  And they aren’t all good.  Anything but.

I say largely unforeseen because I’ve been jumping up and down about these consequences here on SWP, in some academic papers (including one to be published in the next issue of the  Journal of Applied Corporate Finance), and numerous presentations.  I have repeatedly emphasized that it was a fallacy that requiring more collateral would necessarily reduce the amount of leverage in the system, make the leverage in the system less fragile, or reduce interconnectedness among financial institutions. I have consistently argued that market participants would substitute alternative forms of leverage and utilize other financing techniques (e.g., collateral transformation and liquidity swaps) as fragile or more fragile than the leverage embedded in derivatives, and that these new forms of financing would just change the topology of the network of connections among firms in the financial markets, and that the new topology would be as or more complex than the pre-mandate topology.

It was always particularly maddening to see regulators and others present pictures of the OTC derivatives market with a spaghetti bowl of interconnections between market participants, and contrast it to a neat and tidy picture of a cleared market with a few neat lines connecting market participants with the CCP.  There was no consideration of how the necessity of funding collateral and making variation margin payments would lead to the creation of financing arrangements among firms that would resemble the spaghetti bowl picture.  No consideration of how the very complex financial system would adjust on the myriad margins available to it.

In some respects, I can make some allowances for the regulators and legislators who imposed this on the world.   Those allowances are mainly a function of low expectations.  I am less forgiving of the academic community.  Many people smarter than I whom I respect have bought into the neat and tidy picture, and have dismissed concerns that the various Frankendodd mandates (and their European cousins) will create a new set of problems that may be worse than the ones that were supposedly fixed.

I think that in large part, this failure to anticipate the real effects of mandates, and the blithe confidence in the efficacy of collateral in particular, reflects the standard partial equilibrium, ceteris paribus way that economists use to approach problems.  This method is very powerful, and I utilize it regularly, but it has its limits.  In particular, it blinds one to the systemic responses to big changes like Frankendodd, to the fact that market actors will respond to these shocks on many dimensions.  As I’ve said repeatedly, there has been a systematic failure to consider how the financial system as a whole would respond to massive interventions designed to reduce systemic risk.

This is a particularly hard problem to analyze mathematically and formally due to its inherent complexity.  The daunting nature of the task, and the fact that formal mathematical modeling is almost required by top tier journals, has, in my opinion, made it unattractive for academics to pursue these issues.  The constraints of the accepted toolset have led to the slighting of an extremely important and interesting issue.

But this is not to say that the problem is immune to analysis that can generate meaningful insights and falsifiable predictions.  Indeed, largely disdained non-formal (“literary”) approaches can do so-and have done so.  I started from a very simple premise, that there were fundamental economic considerations that had led market participants to choose financing arrangements and contracts with certain amounts of leverage and fragility.  Constraining the ability to use those sorts of financing arrangements would induce actors to substitute towards arrangements with similar properties.  Non-formal analysis also shed light on how these mechanisms would operate during periods of systemic stress.

Based on these non-formal approaches, I made predictions about how the markets would evolve under clearing and collateral mandates.  Those predictions can be tested by empirical observation (though again, more descriptive than formally econometric).  That’s as “scientific” (in the Friedman Methodology of Positive Economics sense) as the densest, or most elegant, mathematical model.

And as it turns out, in this instance, some of those predictions are being borne out.  In ways that make me appreciate Cassandra.

I think it is more important to focus on important problems and find the best tools for the job at hand, rather than let narrow conceptions about the appropriate tools define and the problems you work on.  The latter mindset has limited academic economists’ influence on big things like Frankendodd.

The one-eyed man is king in the land of the blind.  Non-formal methods provide sight-and insight-on issues to which formal methods are often quite blind.  Given the incentive structure in academia, however, I am skeptical that the lesson will be learned.

* Link fixed. H/T Phil R.

February 26, 2012

Energy Is Scarce: Stupidity Is Abundant

Filed under: Climate Change,Economics,Energy,Politics,Regulation — The Professor @ 9:13 pm

It is difficult to figure out which commodity induces more mass stupidity-gold or oil. Upon reflection, it seems that the stupidity is price dependent, and given the rise in gasoline prices the oil-related stupidity is taking the lead.

Glibfinder wrote a comment and friend R told me about a particularly distilled example of oil induced insanity-the Bill O’Reilly-Lou Dobbs discussion last Friday.  I am well familiar with O’Reilly’s cluelessness on energy.  Whenever prices are high, he asserts that oil companies can charge whatever they want for oil, and are overcharging: which always raises the question of why they would let prices fall to around $30/bbl (2008-2009) or $10/bbl (1998).

Being a glutton for punishment, I watched.  Or tried to, anyways.  I could take it for only about 3 minutes. O’Reilly spewed his usual story, this time with a bit of a new spin: Prices are “subjective” so companies can charge whatever they want.  Believe me: he wasn’t making a subtle, Austrian-economics based point.  Then he and Dobbs went on crude Mercantilist rants that would have been an embarrassment in 1775.

O’Reilly, while denying he was a socialist, claimed that the government has a legitimate right to control oil prices because it is “our oil.”  I was waiting for him to channel Woody Guthrie, and break out singing “This oil is your oil, this oil is my oil.”

But O’Reilly and Dobbs are just talking (empty) heads. Barack Obama is president of the United States, but he is as idiotic about energy (and economics generally) as they are.  He’s just idiotic in a different way.

He has repeatedly ridiculed increased production of hydrocarbons, saying that it is impossible to drill our way out of dependence.  In Saturday’s radio address, he said that drilling isn’t a plan, “it’s a bumper sticker.”

Typical Obama false choices. Obama says we are already drilling.  The questions are, though, whether restrictions on drilling should be eased, whether more federal lands should be opened for exploration and production.  Obama, in his typical three card monte fashion, attempts to avoid answering those questions by suggesting that since drilling is not the entire solution, it is not worth discussing.

He then demonizes oil companies and their profits, playing on the class warfare theme.  Would he be willing to compare return on capital of oil companies to those of his biggest Silicon Valley donors?

Here’s a laugh:

I’ve directed my administration to look for every single area where we can make an impact and help consumers in the months ahead, from permitting to delivery bottlenecks to what’s going on in the oil markets.

Permitting? Delivery bottlenecks? Really? You mean like Keystone? Looked at the differences between Bakken prices and Cushing prices, or between Gulf prices and Cushing, lately? Plenty of evidence of a bottleneck, which Keystone II and other projects would alleviate.  The biggest bottleneck, arguably, in the world oil industry right now.  One that Obama could have alleviated-but consciously decided not to.  Now that’s chutzpah.

And speaking of bumper stickers, he drones on about a subject on many a bumper sticker plastered to Priuses and Volvos: renewable energy:

It’s time to end taxpayer giveaways to an industry that’s never been more profitable, and use that money to reduce our deficit and double-down on a clean energy industry that’s never been more promising. Because of the investments we’ve already made, the use of wind and solar energy in this country has nearly doubled – and thousands of Americans have jobs because of it.

Uhm, to the extent that the oil industry is profitable, it is because it provides a product that people are willing to pay more for than it costs to produce.  Looking past his risible claim that anything he proposes is to reduce deficits, he proposes to “double-down” on an industry that only survives because of subsidies, because it produces energy that is far less valuable than the cost of producing it. (Actually, “doubling down” is a very appropriate characterization, a phrase usually applied to desperate gamblers trying to dig themselves out of a deep, losing hole.)

Doubling of wind and solar-from nearly infinitesimal to twice infinitesimal.  BFD.  And at what cost?  Regarding jobs-Obama emphasizes the seen jobs supported by subsidies derived from distorting taxes, but what about the unseen lost jobs (and lost wealth) as resources are pushed into uneconomic uses?

Renewables are a colossal waste. Wind. Don’t make me laugh. There is a strong negative correlation between wind and temperature, meaning that wind doesn’t produce power when you need it, and produces power when you don’t-requiring the costly shutdown of conventional plants when the wind is blowing hard (costly, as indicated by negative prices for power). Its unreliability also requires the maintenance of backup thermal generators, and the fact that wind resources are often distant from loads necessitates additional investment in transmission.

Who couldn’t love it?

Insofar as solar is concerned, even the Germans, who went whole hog into dreams of replacing fossil fuels with the sun, have realized it is utter folly.   The Europeans generally, especially the Spaniards and the Germans, have realized that unicorn dreams will not keep the lights on.

But Obama refuses to heed the Ghost of Christmas Future, and insists on repeating the same follies.  One can excuse the Germans and the Spaniards for making the mistake in the first place.  It is inexcusable to repeat the mistake-and glory in it-with their example before his eyes.

Apparently the stupidity is the most renewable part of green energy.

Not to mention that wind or solar don’t address the most pressing energy problem-motor fuels-and the one that does-biofuels-is a disaster in its own special way (apologies to Tolstoy).

Obama also touts fuel economy standards, another fundamentally misguided policy, and one that has wreaked havoc with the US automobile industry for decades.

Milton Friedman said there is no problem government couldn’t make worse. Virtually everyone advancing government solutions to address high energy prices, from O’Reilly to Obama, seem hell bent on proving Friedman correct.

Update: Literally 3 clicks after modifying this post to add the dig at biofuels, via Climateer Investing I came across this post summarizing the views of a Nobel winning chemist: “The Nonsense of Biofuels.”  Hear, hear.

Getting Clear Yet?

Filed under: Military,Politics — The Professor @ 3:49 pm

See how quickly it takes you to call bull on this story (h/t R):

Two United States advisers who were shot dead in Afghanistan’s interior ministry by an Afghan colleague had been mocking anti-US protests over the burning of the Koran, a government source said.

. . . .

Describing the sequence of events that led to the interior ministry shootings, the source said the US advisers were “scolding the protesters and calling them bad names” as they watched videos of protests in Kabul.

“They called the Koran a bad book in the presence of (an Afghan colleague). After all this the guy had verbal arguments with the advisers and was threatened by them. He gets angry and shoots them. Eight rounds were fired at them,” the source added, requesting anonymity.

“He then sneaks out and disappears. No-one knew about the incident for more than an hour because the room is soundproofed,” he said, adding that CCTV cameras had been viewed in the investigation of the shooting.

The source apparently knows what went on in a soundproof room from which shots were not heard.  Look at the odd formulation at the end of the story.  He “adds” that CCTV cameras had been viewed.  But he does not say explicitly, in his earlier description, that what he described was on the CCTV tapes.  He leaves the implication.

I will believe it when-if-these tapes are made public.

Another reason to call bull: why was the driver of an officer who was not present in a secured, soundproof room with 2 US officers? It might have made sense-might-if the officer himself were in the room. Or if the officer had left, momentarily-not for an hour.  But his driver there alone? And would an O-4 and O-5 with obviously very sensitive jobs, who were detailed to work with Afghans and hence almost certain to be careful of what they said about them, be spouting off in front of a driver, for crissakes, given the circumstances then prevailing in Kabul then?

This story is apparently illustrating Mark Twain’s adage that a lie gets around the world while the truth is getting its boots on.

The fact that some Afghan source would be peddling such a story does not surprise me in the least.  It also does not surprise me in the least that he is peddling it primarily through foreign sources.  It further does not surprise me that journalists are credulously repeating the story despite the fact that it is farcical on its face.  The key to getting a lie believed is that the target wants to believe it.

And I wonder. Who is standing up for the two US officers who cannot defend themselves? Why is the US military seemingly way behind the Afghan agitprop OODA loop here?

What It Is Ain’t Exactly Clear (To Some People)

Filed under: Music,Politics — The Professor @ 2:18 pm

Some updates on the Afghanistan situation from the WSJ (h/t R).

First, an alternative biography of the suspected shooter:

Western officials said Mr. Salangi was a driver for an Afghan intelligence official at the ministry who may have had access to the restricted area where the U.S. advisers were shot in the head.

A driver? Really?  With independent access to a highly secure area? There is something not right about that.  Either the facts as presented are wrong, or the security procedures in the Interior Ministry are outrageous.  And what explains the huge difference between the different characterizations of the shooter.  First reports: Afghan intel officer with high responsibilities.  This report: driver for the intel official.

The Karzai response-properly, the lack thereof-is an outrage:

Mr. Karzai didn’t even mention the American deaths in his opening statement during a news conference on Sunday. He expressed his condolences—but not an apology—only when asked by a reporter about the shootings of Americans.

While his Interior Ministry earlier Sunday identified Mr. Salangi as the chief suspect, Mr. Karzai also kept alive speculation—explicitly rejected by U.S. military officials—that the two Americans may have been killed by another Westerner.

“It is not yet clearly known as to who has committed this and where he was from, whether Afghan or foreigner or any other element involved,” he said.

Mr. Karzai’s response was “unfortunate,” one senior American official said.

Unfortunate? Is that what they call it now? How big is the euphemism dictionary, anyways?

Even worse:

Mr. Karzai’s remarks Sunday focused instead on the investigation into how the Qurans were burned at Bagram, and on attempts to launch peace talks with the Taliban.

Hello! The cluephone is ringing.  Some people-including a former Ranger and Afghan War vet who now works for a think tank-aren’t picking up:

“The Afghan leadership has been painfully slow to realize the gravity of these events and to understand how little patience Americans have for the war in Afghanistan,” said Mr. Exum. “President Karzai has to understand that patience for the continued commitment to Afghanistan is wearing very thin.”

Karzai understands perfectly.  Perfectly.  That is the point.

Need another clue? The Afghans are flogging the Koran angle for all it is worth:

Afghan officials describe Saboor as a man who never never suggested any radical tendencies, leading them to assume that he was inspired by the accidental burning of Qurans by U.S. troops last Tuesday.

They are playing this for all it is worth. They are fanning the flames-almost literally. Why?

It may not be clear to some-or maybe some who do understand are playing very dumb-but is seems pretty obvious that this is all part of a concerted effort by Karzai and his Pashtun and Pakistani allies to push out NATO and the US.  Why is virtually all of the media pretending otherwise? And why is the administration enabling the Muslims-legitimately-outraged-by-Koran-desecration meme? That is less clear to me, but none of the explanations that immediately come to mind are encouraging-or any other word associated with “courage.”

There’s Something Happening Here

Filed under: History,Military,Politics — The Professor @ 9:34 am

It looks like the lid is about to blow in Afghanistan. The riots over the latest episode of Koran burning–stoked, not banked by Obama’s obsequious apology–are getting all the coverage.  But the most important–by far–development is the murder of two American officers, a major and lieutenant colonel inside a secure area of the Afghan Interior Ministry.

The media coverage is portraying this as just a part of the explosion of medieval rage in Afghanistan, but the details suggest something more planned-and sinister:

An Afghan security source said the American officers killed on Saturday had been found dead with gunshot wounds deep inside the heavily fortified Interior Ministry.

“There is CCTV (closed-circuit television) there and special locks. The killer would have had to have the highest security (clearance) to get to the room where they were killed,” the source told Reuters.

There is one report naming a suspect:

Afghan authorities said on Sunday they believe an Afghan police intelligence officer may have been involved in the shooting deaths of two U.S. officers inside the interior ministry a day earlier, prompting NATO to recall all its staff from ministries.

Abdul Saboor, 25, is the main suspect in the killing, which took place at close range well inside the heavily fortified ministry in the centre of the capital, Kabul, senior security sources told Reuters on condition of anonymity.

“Abdul Saboor is at large right now. He is the main suspect for us but we can not draw any conclusions over whether or not he is the killer,” one of the sources said, adding that CCTV footage shows that Saboor had access to the Command and Control Centre where the slain Americans were found.

That last connection seems extremely weak: CCTV shows he had access, but when? Does CCTV show him entering or leaving at the time of the slayings?

The BBC has more detail on Saboor:

He had served in several Afghan ministries and had worked at the interior ministry for some time, with responsibilities for security arrangements and access to top level intelligence briefings and secure radio communication channels.

Yes, this may be a case of autojihad syndrome, detonated by the Koran burnings, but the targets, the location, and the background of the possible perpetrator suggest something more. This guy was not an ignorant hothead from the sticks.  Or at least one should hope that such types are not given responsibilities for security arrangements, etc.

The jobs of the killed Americans has not been disclosed, which is interesting in itself. One reasonable possibility is that they were counterintelligence specialists. Afghan security forces are riddled with Taliban sympathizers/operatives-and Pakistani ISI agents, and Americans responsible for identifying them and rooting them out would be prime targets.  The riots would provide background noise that would be quite useful in obscuring the motive for the murder.

And even the riots themselves cannot be viewed as purely spontaneous reactions to an outrage against local religious sensibilities.  There is a war in the shadows in Afghanistan.  Karzai and his family are corrupt to the core, and deeply enmeshed with Pakistan, and in particular Pakistani intelligence.  Karzai resents US/NATO anti-corruption and anti-drug efforts, which strike very close to home.  The ISI is hell-bent–as it has been for decades–in securing control over Pakistan and getting the Americans out.  The Taliban are its creation and its creature.  The US/NATO commitment to Afghanistan is equivocal at best.  Obama has made it clear that he has no stomach for the conflict, and is looking for a way out.  The Koran burnings provide a perfect pretext for unleashing violent protests that will push a wavering Obama and NATO closer to the exits.  Killing Americans in a secure location-even if these individuals were not targeted specifically based on their jobs and expertise-would only intensify the push.

NATO is responding in a way that probably delights Karzai and the ISI: they are withdrawing all personnel from Afghan ministries.

The whole way this is being handled in the media is extremely annoying.  The entire herd is running with the outraged Islamic sensibilities theme, and refusing to entertain the very real possibility-certainty, in my mind-that these sensitivities are being manipulated and stirred up by Karzai and the ISI as part of a war against NATO and the US.  In so doing, they are obscuring the real issues and choices facing the US and NATO.

The administration response, notably the aforementioned obsequious apology delivered by the president personally, only helps cement that narrative.  (Which could well suit Obama just fine, given his evident preference to bug out.)

The contrast between Obama’s personal apology for the burnings, and the more diffident and muted response to the murder of two people he commands is quite stunning.  The most stern criticism of the killings was delivered by the US commander in Afghanistan, General John Allen.  The Pentagon was highly critical.  But Obama’s response was limited to expressing condolences to Allen, and his flack Jay Carney praised Karzai for his efforts to maintain calm in Afghanistan. (Gag me.)

Two things about this. The first is the signal it sends to Karzai, the ISI, etc. It signals weakness. That Obama is definitely not of the better to be feared than loved school. Which is only an invitation to further, more bold actions.

The second is the signal it sends to the US military.  He hung them out to dry in his rush to make a public apology and to promise that those responsible would be held accountable, an apology that ignored key facts in what led up to the burnings-which if anything only validated the motives of the rioters. The complete lack of any presidential outrage at the assassination of two men under his command, and the buttering up of the already slippery Karzai, hardly sends the message “I’ve got your backs and I’ll stand up for you.” Loyalty has to run both ways, and I am sure that there is considerable dismay and disgust within the military at the perfunctory, almost blasé, presidential reaction to the murder of two men doing their duty under his command.  Maybe we just have to wait until he has another opportunity to give a shout out to Dr. Joe Medicine Crow.

The end game is approaching in Afghanistan. It may not end with helicopters taking out personnel from the American embassy in Kabul, but an ignominious end is looking more likely by the day.

February 25, 2012

Shapiro Not Too Swift About HFT

Filed under: Economics,Exchanges,Politics,Regulation — The Professor @ 9:21 pm

Mary Shapiro weighed in on high frequency trading again.   Well, sort of:

The rules the SEC is contemplating are vague, but could involve fees on high volumes of order cancellations or a minimum time enforced for quotes. “While we haven’t landed on concrete things that we will do next,” Schapiro said, “all these ideas are live and subject for discussion within the agency.”

The WSJ has a little more:

Among the ideas the agency is considering, she said, is the implementation of obligations for certain high-frequency traders to provide quotes near the national best bid and offer prices—the highest buy and lowest sell orders across the market—during a certain percentage of the trading day.

The SEC also is weighing imposing fees on order cancellations, which constitute “a vast majority of orders” submitted by high-frequency firms, Ms. Schapiro said. An estimated 95% to 98% of orders submitted by high-speed traders are canceled as the firms rapidly react to shifts in prices across the stock market, according to Tabb Group, which tracks trends in electronic trading. The possible fee, previously mentioned in a joint advisory committee of the SEC and CFTC, would likely be a tiny fraction of a cent per canceled order, experts say.

Imposing obligations is not costless.  Requiring people to quote when they don’t want to quote means that they will quote poorer prices. With respect to cancellations, yes, some abusive HFT strategies do allegedly involve quote stuffing followed by cancellations.  But many salutary HFT strategies, including the cyber equivalent of scalping-market making-also involve large numbers of cancellations. Market makers are at risk of being picked off, or of trading at stale prices, and hence want to cancel orders, and perhaps submit new ones at different prices, when new information arrives.  And in an electronic environment, new information arrives rapidly.  Locals scalping in futures pits were only obligated to trade at their quotes “as long as their breath was warm” to limit their exposure to these problems: cancellations by HFT traders making markets serve the same purpose. Taxing cancellations could well impair these legitimate uses of cancellations more than the abusive ones, leading to less liquidity and costlier trading.  This is a very blunt tool indeed.

The fundamental issue is that HFT is not one thing.  There are a variety of HFT strategies, some of which are beneficial, others arguably opportunistic.  Moreover, it is quite possible that a given HFT firm uses a variety of strategies, some of which are beneficial, some of which are opportunistic.  The focus should be on trying to identify order submission patterns that are characteristic of opportunistic strategies, and those that are characteristic of beneficial ones (e.g., market making) and develop pricing or enforcement measures that are targeted at the abusive strategies.  Meat axe approaches like taxing cancellations are indiscriminate, and risk doing far more harm than good.

Shapiro doesn’t inspire confidence when she says things like this:

Schapiro expressed concerns of her own Wednesday, lamenting the current volume of trading that is “unrelated to the fundamentals of the company that’s being traded.”

“It’s got very little to do with whether you think IBM’s got a great business plan and solid earnings growth in its future … and a lot more to do with what’s the minuscule aberrational price move that you can take advantage of because you’ve co-located your computer with the exchange and can jump on that in microseconds,” she said.

“And that worries me in some ways.”

There has always been trading unrelated to fundamentals, that has been technical in nature and focused on profiting from minuscule price moves. That’s what most market making is about. Indeed, the existence of that kind of trading produces the liquidity that facilitates long term trading.  And there have always been time and space advantages in trading. Why do you think people paid hundreds of thousands, and sometimes millions, of dollars to be on the exchange floor? The views? The charming company? No.  Because being on the floor gave you an edge.

Shapiro’s testimony suggests that the SEC is befuddled by HFT.  This is understandable, because there’s a lot about it that is not well understood, and because it is surrounded in a fog of mystery and controversy. But her testimony also suggests a deep-seated suspicion of HFT, and preference for indiscriminating solutions that will throw the baby out with the bath.

Not too swift.

February 24, 2012

Again With the Speculators

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 10:46 am

For years I have been saying and writing that every spike in energy prices results in a replay of the final scene from Casablanca: “Round up the usual suspects,” with speculators being at the front of the line.   No exception now. With rising gas prices being the main threat to his reelection prospects, Obama and other Democrats are doing their best Captain Renault imitation.  Obama:

Obama sought to deflect growing Republican attacks over rising prices at the pump, blaming recent increases on a mix of factors beyond his control, including tensions with Iran, hot demand from China, India and other emerging economies, and Wall Street speculators taking advantage of the uncertainty.

Noted energy expert, Nancy-natural-gas-is-not-a-fossil-fuel-Pelosi also chimed in:

“Wall Street profiteering, not oil shortages, is the cause of the price spike,” Pelosi said in a statement. “Unfortunately, Republicans have chosen to protect the interests of Wall Street speculators and oil companies instead of the interests of working Americans by obstructing the agencies with the responsibility of enforcing consumer protection laws.”

And, again at the risk of sounding like a broken record (responding to a vast collection of broken records): no theory, no evidence.

With respect to evidence, a heads up: The opponents of the “financialization” of commodity markets have flogged the Singleton paper on oil index trading for all it is worth. I am putting the finishing touches on a far more extensive study, the conclusion of which is quite simple: the Singleton results do not stand up in a broad sample of commodities, or even in oil for a longer sample period.  Watch this space.

In other words: try again, guys.  But that would actually presume, I guess, that evidence matters to these people, anyways.

One thing struck me about the Obama and Pelosi statements: the deliberate inclusion of “Wall Street” in their formulation, as in “Wall Street speculators.”  What, London, Geneva, and Singapore don’t rate?

Which brings another movie image to mind: the scene in Frankenstein in which the villagers storm the castle.  Obama and Pelosi are just following the #OWS-themed, Valerie Jarret-inspired class warfare campaign script. Be prepared to be bombarded with similar rhetoric for the next eight months.  And the shrillness of the attacks will vary directly and exponentially with the price of gasoline.

I don’t have a lot more to say on the subject, primarily because there’s not a lot new to say.  Obama and Pelosi are being good greens, and recycling well-used rhetoric.

I was interviewed on the subject Tuesday for an NPR piece.  It does a pretty good job of summarizing what I said in a 20 minute interview.  A few brief comments:

  1. The CFTC claims that it has brought numerous energy enforcement actions and collected large fines.  This is highly disingenuous.  Highly.  These have not been in the oil market (except for the Arcadia case which I criticize in the piece, echoing what I’ve written on SWP).  They have not shown any connection between speculation and manipulation and high oil prices. Virtually all of these cases relate to price reporting fraud and wash trading in the natural gas markets during the merchant energy boom, prior to the demise of Enron and the merchant energy meltdown in 2002.  I was highly involved in efforts designed to prevent these abuses from recurring.  Efforts that did not come to fruition, but which focused on a solution (the creation of transaction data hubs with mandatory reporting) that has now been adopted for the derivatives markets worldwide-not just natural gas in the US.  That is arguably one of the only sensible things in Frankendodd.
  2. The piece mentions John Arnold making a billion in speculating.  Yes, he did.  In gas.  The price of natural gas is at near-historic lows, demonstrating that speculative activity does not inevitably cause prices to be high.  Indeed, the disconnect between natural gas prices and oil prices is a huge embarrassment to the anti-speculation mob, especially those who claim that index investing (which results in highly correlated trades in oil and gas) is a dominant force in driving commodity prices.
  3. It drives me to distraction that “speculation” and “manipulation” are used interchangeably.  No. No. No.
  4. Manipulation definitely occurs in commodity markets, including the energy markets: for instance, manipulations were common in the Brent market in the late-90s and early-00s, and may become more common again as BFOE production continues to diminish.   These manipulations lead to highly temporary and localized price distortions.   Most of the Brent squeezes resulted in elevations in Brent prices for days, or a few weeks, and didn’t push up prices of other types of oil: indeed, the main symptom of these squeezes was the rise in Brent relative to other grades and locations.  As another example, the BP propane squeeze (a case I was involved in) resulted in a spike in TET propane prices for about two weeks.  They don’t explain persistent, global prices spikes.

Hopefully I will have the results on the expanded Singleton analysis available within a few weeks.  Until then, get prepared for a continued onslaught against “Wall Street profiteers and speculators.”  La plus ca change . . .

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