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Streetwise Professor

September 29, 2012

No Theory? No Evidence? Big Problem!

The title of my 2010 Regulation piece on CFTC position limits characterized the agency’s attitude as: “No Theory? No Evidence? No Problem!”  I had a problem with that attitude.  So did a couple of industry groups, ISDA and SIFMA, and they sued seeking to block imposition of the limits.  And Federal District Court Judge Robert Wilkens has a problem with it too.  He vacated the rule and remanded it to the agency for reconsideration, and granted the plaintiffs’ summary judgment motion against the rule.

The decision turned on whether the CFTC had to find that position limits were necessary to prevent and diminish excessive speculation.  The agency said no: it had no discretion, that Congress had mandated that it impose limits.  The plaintiffs said yes: the plain language of the statute requires the CFTC to make a finding that limits are necessary because speculation is excessive and is causing unwarranted fluctuations in prices.

The agency further argued that imposition of limits were mandatory, whereas plaintiffs pointed to statutory language saying that Congress had granted the authority to impose limits “as appropriate.”

The judge was quite firm in his findings regarding necessity:

The precise question, therefore, is whether the language of Section 6a(a)(1) clearly and unambiguously requires the Commission to make a finding of necessity prior to imposing position limits. The answer is yes.

But the plaintiffs’ victory was not so clearcut as has been portrayed in the initial reporting on the decision.  The judge noted that the two sides had unambiguous, but diametrically opposed interpretations of the statute.  The judge disagreed with both, finding the statute ambiguous:

In sum, although each party believes the statute is clear and unambiguous, their respective “plain readings” compel different results. Ultimately, however, this Court need not choose between the competing interpretations. As explained below, Section 6a is ambiguous as to the precise question at issue: whether the CFTC is required to find that position limits are necessary and appropriate prior to imposing them. Because the Position Limits Rule is based on the CFTC’s erroneous conclusion that the CEA is unambiguous on this issue, the Court “may neither defer to the agency’s construction nor endorse plaintiffs’ construction.” See Humane Soc’y of U.S. v. Kempthorne, 579 F. Supp. 2d 7, 15 (D.D.C. 2008). Instead, the Court must remand this rule to the agency.

As a result, he chose not to choose between the parties’ diametric interpretations.  So the rule will go back to the Commission.  Presumably it will make a finding of necessity based on some attempt to stitch together some empirical evidence on the adverse impact of speculation.  Presumably the plaintiffs will find this evidence unpersuasive (with good reason) and challenge the Commission’s finding, thereby setting up a further round of litigation.  The results of this litigation would presumably depend on what is a satisfactory basis for a finding of necessity by the Commission.  This seems to me to be a potentially far more contentious issue in which the courts may be more likely to defer to the agency’s discretion and judgment.

This decision does not address another challenge to the limits: that the CFTC failed to perform an adequate cost-benefit analysis as required by statute.  That’s another big issue that would require a more discriminating critique of the substance of the Commission’s analysis by the courts.

So this decision is not the end of position limits.  It is probably the end of the beginning, at best.

The concrete results in the short and medium term are beneficial, however.  A bad rule that has no firm grounding in good economic thinking or empirical evidence, and which would impose substantial costs on markets and market participants, will not go into effect next week as planned.  The Commission will be forced to confront these economic and empirical issues, and defend its judgments on these grounds: “Congress made me do it” will not suffice.

No doubt this process will be time consuming.  It will certainly extend well past the election, and depending on the outcome of the election the matter may become moot.  A Republican CFTC is much less likely to pursue position limits with the Javert-like intensity of a Gensler-led agency.  But even under a Democratic administration, the CFTC’s will to pursue position limits will be sorely tested.  It now faces a greater burden of providing some theory, and providing some evidence, or else it will continue to experience big problems in court.

A good day, a good result, but not a final one.  The position limit wars will continue, but the battlefield looks far different today than it did when Frankendodd lurched out of the castle on The Hill, and when the CFTC did what it perceived to be the monster’s bidding.

September 24, 2012

First They Came for Anderson Cooper, and the MSM Remained Silent. Then They Came for Ann Compton.

Filed under: Politics — The Professor @ 5:20 pm

Once upon a time CNN was known as the “Clinton News Network”-and for good reason.

Let’s just say that romance is so over.  CNN’s Anderson Cooper obtained slain ambassador Christopher Stevens’s diary, and reported that Stevens had written that he was concerned for his security, and “and specifically about the rise in Islamist extremism and growing al Qaeda presence.”  This completely contradicted Hillary Clinton’s claim that Stevens had never, ever given any inkling about his concerns.

In response, the State Department has gone completely non-linear on CNN about this:

‘Given the truth of how this was handled, CNN patting themselves on the back is disgusting,’ Mr Reines [a Foggy Bottom spokesman-and personal spokesflack for HRC] said in his statement.

‘Whose first instinct is to remove from a crime scene the diary of a man killed along with three other Americans serving our country, read it, transcribe it, email it around your newsroom for others to read and then call the family?’

First, an aside: note the reversion to the bad old days of treating terrorism as a law enforcement issue: “remove from a crime scene.”  Is that what the consulate in Benghazi is?  A crime scene?  On 9/11?  Seriously?  Tragically, I think he is.

Second, the intensity of the State Department response is rather, uhm, undiplomatic.  Although they are framing their outrage in terms of the violation of Stevens’s family privacy, it is clear that their anger derives first, foremost, and almost exclusively from the highly damaging nature of the revelations.  (Indeed, hiding behind the family makes their attack all the more disgusting, as hard as that is to wrap one’s head around.)  This demolishes every aspect of the pathetic narrative that the White House, Hillary, and Susan Rice have attempted to spin in order to obscure the ugly facts.  That a US ambassador was left virtually defenseless in an extremely violent area crawling with Salfist jihadis, and notably lacking in Chicago-esque gun control laws (which obviously are so efficacious).

Would that the State Department was as vituperative in addressing our adversaries.  Please contrast this, for instance, with the “thank you sir may I have another” response to Russia’s ejecting USAID for having the temerity of supporting democracy in Russia.

I wonder if CNN will hit back, or whether it will get its mind right.  Sadly, I am betting on the latter.

But it gets better.  Or worse, depending on how you look at it.  When a reporter queried the SD on the whole fiasco, the aboveforementioned Phillipe (!) Reines snarled back at the offending questioning reporter in an email exchange that culminated with Phillipe (!) telling the reporter to “fuck off.”

When questioned about this on 60 Minutes (and I use the term “questioning” very generously, given the, uhm, Lewinskyish approach of Steven Kroft), Obama said that there had been a “few bumps in the road” in the Middle East.  Although the usual suspects screamed that to say that Obama was referring to the Benghazi fiasco was to rip his remarks out of context, given the events in the ME, of which the attack on the consulate and the killing of Ambassador Stevens is certainly the most important, it beggars the imagination that there is any context in which Obama’s remarks were anything but desperate and offensive.

But in the best-defense-is-a-good-offense tradition,to the administration it is not Obama’s remarks that are desperate and offensive, it is questioning him about them that is.  The loathsome Jay Carney (who actually makes me pine for the somewhat less loathsome Robert Gibbs, as unimaginable as that is), ripped into the rather inoffensive Ann Compton for having the indecency to ask: “The complaint this morning about the line ‘bump in the road’ is not that it’s minimizing the Arab Spring but that it’s minimizing the death, the violent death, of the U.S. Ambassador, three others and — what, when he said ‘bump in the road,’ did he mean? Not to draw parallels, not to define that event in Benghazi?”

To which the preternaturally offensive Carney (who should really follow his name and become a carnival barker-if they’ll have him, which is doubtful, having standards like they do) replied: “I appreciate the question Ann because that assertion is both desperate and offensive.”

Hey, Jay.  I suggest you follow Phillipe’s (!) advice to the reporter.  Or, as Clint said-why don’t you try something physically impossible?

As Walter Russell Meade has noted, the media would be baying like hounds after a wounded fox had Bush suffered such an egregious series of failures in the ME, but is averting its gaze from the implosion of Obama’s ME policy (such as it is), and the callous and obfuscatory response to these failures.

In ’96, Robert Dole rather pathetically asked “Where’s the outrage”?  1996 pales in comparison to what is happening today: the reasons for outrage are far greater now.  But barely a peep of protest is heard from the legacy media and the alleged cultural and political elite.  Indeed, most of the media remains silent when the administration unleashes  search-and-destroy missions against rather well-respected colleagues for having the audacity-the audacity!-to report facts and ask obvious questions.  All out of political allegiance and expediency.  And that is truly desperate and offensive.

September 19, 2012

Pick Yer Poison, or, If It Ain’t Baroque, Don’t Fix It

Filed under: Derivatives,Economics,Financial crisis,Financial Crisis II,Regulation — The Professor @ 6:47 pm

The BofE’s Andrew Haldane is getting a lot of attention-and rightfully so-for his critique of complex financial regulation, most notably Basel Faulty.  Yes, there is a lot to criticize in complex financial regulation-and lord knows, I’ve indulged-but it’s essential to emphasize that simplicity is no panacea.  Indeed, complex regulations evolve precisely from the deficiencies of simpler ones.

That is, you have to ask: Why did the rules become complex?  Was complexity valued for complexity’s sake? Or did complexity develop/evolve because of the recognized defects of simpler structure?

Most likely.  Rules become more complex in an attempt to respond to attempts to exploit simpler rules.  There is a regulatory dialectic.  The regulators and the regulated interact in a way that leads to spiraling complexity.

Take bank capital requirements.  Simple capital requirements specify, say, capital equals a certain percentage of assets.  This is fine if assets are identically risky, or the regulated have no ability to tilt their portfolios towards risky assets.

But that’s exactly what happened in the old, simple world with simple capital requirements.  Banks looked for riskier assets in order to expropriate their depositors, lenders, and deposit insurers.  With capital requirements insensitive to risk, banks had a tremendous incentive to make their assets as risky as possible.

There are two responses to this.  One is to limit the nature of the assets banks can hold.  The other is to make capital requirements depend on the riskiness of assets.

Both are great in theory, devilish hard in practice.  Risk-based capital requirements (or limitations on the assets that banks can hold) demand that regulators have the ability to make discriminating evaluations of the relative riskiness of assets.  Even more crucially, they demand that regulators know at least as much as those they are regulating.

Neither condition is likely to hold in practice.  And again, there is a regulatory dialectic, as banks sniff out-or create-assets that are “underpriced” from a capital requirements perspective.  That is, they identify-or create-assets with risk prices implicit in capital charges that do not reflect true risks, and which satisfy the restrictions on the nature of assets that banks can hold.  (Think of AAA ABS of various types.  They’re AAA!  What could go wrong?)  Thus, portfolios end up being riskier than regulators had anticipated.

So they adjust the capital requirements.  But as in any regime of price controls-and capital requirements are essentially risk price controls-the regulators don’t have the necessary information to set the prices properly, meaning that some risks are always underpriced.  The capital requirements become more complex, setting off a new round of attempts to identify the underpriced and overpriced risks.

What starts simple becomes progressively more complex.  Regulations and capital requirements end up being bizarrely baroque not because people like it that way, but because the less baroque rules were exploited.

Put differently: complexity is endogenous, and almost inevitable.  Simple sounds nice, but simple is easy to exploit, and complexity blooms in order to counter this exploitation.

Haldane argues that during the last crisis institutions subject to simple rules were less likely to fail than those subject to more complex ones.  This is superficially plausible, but again, remember that the rules are endogenous, complexity is endogenous.  There was no experiment, natural or otherwise, that randomly assigned some institutions to simple rules and others to more complex ones.  The rules and the institutions co-evolved, endogenously.  I would bet that there was some other constraint on the complexity of the firms subject to the simple rules that made it unduly costly for them to outwit the simple rules.  They stayed simple as a result, so the rules could stay simple too.

Maybe Haldane is right.  Maybe there is a simple but robust way of regulating financial institutions.  But I have my doubts.  Complexity results from the failures of the simple.

Haldane is stating, in an ironically more complex way, the old Indian story of the village beset by mice that brought in cats to rid itself of the rats, then brought in dogs to rid itself of the infestation of cats, then brought in elephants to drive out the resulting packs of dogs-and responded by bringing back the mice to scare away the elephants.  Seeing the effects of complexity (elephants) the simpler problems (mice) don’t look so bad.

But don’t be deceived.  If Haldane were to get his way, the cycle would begin again.  This is the fallen condition of homo economicus.

HFB

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 3:58 pm

Meaning “High Frequency Blogging.”  Some quick takes on things that caught my eye.

  1. Echoing my looking back, looking forward point (made in July) re Libor, lawyers are very nervous that changes in the rate setting mechanism will call existing contracts-with outstanding amounts in the mere hundreds of trillions-into question.  Yeah, it’s broken, but be damned careful how you fix it-especially if you expect those “fixes” to be retroactive, and affect existing contracts.  Unless you want to subsidize corporate litigators and wreak widespread economic havoc.
  2. OTC derivatives rules may be delayed due to “squabbling” among international regulators.  What a shock.  I mean, Carnac the Magnificent couldn’t have seen that coming.
  3. The White House is backing off on its claims that the Mohammed video is the sole cause of the assaults on US diplomatic facilities throughout the Middle East.  On 9/11/12.  Jay Carney has a new explanation: an absence of gun control.  Seriously.  When asked about the attack on the US Consulate in Benghazi in which US ambassador Stevens was killed, Carney said: There is an abundance of weapons, including heavy weapons, and there are certainly groups that carry those weapons and look to take advantage of those circumstances—as there are around the region and the world.”  So, on 9/11, some heavily armed dudes were just walking around and decided: “Hey.  Let’s attack something.  Eenie, meenie, meiny, mo [NOT referring to Mohammed, mind you]-The American Consulate!”  Totally random.  Totally.  Not anti-US.  Not at all.
  4. The Taliban attack on a US airbase in Afghanistan that destroyed six USMC AV-6 Harriers was a total clusterf*ck.  But O didn’t let that interrupt Jay-Z, Letterman, etc.  Priorities.  Have to have priorities, dontcha know.
  5. This piece on China’s Solyndra Economy echoes several points I made in my earlier post recommending that we lose any competition with China on green energy technology.
  6. The very excellent Michael Pettis rightly points out dangers for commodities emanating from China’s fraught economic condition.  Like me, Michael is somewhat amazed that people who would decry central planning and heavy handed government efforts to direct the allocation of capital in the US or Europe are in awe of Chinese genius in using central planning and heavy handed government efforts to direct the allocation of capital in China.  This will not end well.  Yeah, I’ve been saying that for a while, but I am convinced that in a few years (if not sooner) China will wish to have Japan’s problems.
  7. Finally, to that point, consider the fact that large quantities of inventories of steel in China-allegedly in China, I should say-don’t exist.  And if it happens in steel, it can happen in copper or soybeans or whatever, and likely does.  Phony warehouse receipts have been used to collateralize billions of loans-or the same warehouse receipts have been used to collateralize billions in loans.  Either way, China’s shadow banking system-which depends heavily on loans collateralized by commodities inventory-arguably is far more shadow than bank.  Remember that even modest slowdowns in economic activity can unravel fraud schemes in a hurry.  Such a slowdown is happening in China right now, and it is extremely likely that numerous such frauds will be revealed.  Given the dependence of China on shadow banking, the consequences of this could be seismic.  What say you, Tooltime Tom Friedman?

And on that happy note, I am pulling the kill switch on this HFB experiment.

Oil Leak

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics — The Professor @ 8:14 am

The regulatory and trading world is all up in arms over the big price drop in WTI, Brent, HO and RBOB on Monday. Fat finger? Runaway algo? Round up the usual suspects!

I say none of the above, especially in light of yesterday’s  story that Saudi Arabia is going to increase oil output.

The price pattern is not typical of a liquidity event, such as arises from a trading or algo error.  In such an event, the price usually retraces quickly to its pre-error level.  That is, price impacts are almost purely transitory if it is understood that the order was an error, or simply a demand for liquidity.  Indeed, a paper by Bayuksahin, Haigh and Harris documents that prices of trades subsequently identified by the exchange as errors reverse well before the official announcement: the market participants figure it out on their own.

Here, the price fell dramatically, then only partially recovered.  Thus, there was a persistent/permanent component to the price move.  This combination of temporary and persistent price impacts means that market participants viewed that there was some likelihood that the order/orders was/were submitted by somebody with private information. (The fact that the move occurred on all major energy markets simultaneously supports that view, although with algorithmic trading one cannot be as confident: one can be more confident it wasn’t 4 or 5 fat human fingers.)

Put that together with yesterday’s Saudi announcement (into which they were probably dragooned by a threat from the IEA and the administration to tap the SPR) and the most likely explanation is that the announcement was leaked, or that the individual or individuals behind the decision decided to make a little money on their information and control.  Which they did, because prices traded off more after the story was released publicly.

Therefore, IMO Monday’s event was an oil leak: somebody spilled the news of the Saudi decision, and that triggered a big trade that pushed down prices.

Not a tech issue.  Just old fashioned front running of an announcement.

September 17, 2012

Whatever Happened to “Pedicaris Alive or Raisuli Dead”?

Filed under: Military,Politics — The Professor @ 4:35 pm

The cringing, PC, and pusillanimous response of this administration to the concerted assault on US embassies around the Middle East beggars description, and can only encourage further attacks.

Here’s an opportunity for redemption.  The First Vice President of the Iranian government has announced that Iran will “track and pursue” the maker of the film that is the pretext for the spate of riots breaking out in the ME.

The appropriate response: touch a hair on his head, and we’ll obliterate every Iranian government facility.  Then we’ll make the rubble bounce for grins.  He exercised his rights as an American.  Problem with that?  Talk to the B-2.  The updated version of “Pedicaris Alive or Raisuli dead” (the background for a Sean Connery film, The Wind and the Lion.)

Our action: bringing in the pathetic sod for “voluntary questioning” on a parole violation, and attempting to get Google to pull the vid on a terms of use violation.

Gimme Back My Bullets

Filed under: Military,Politics — The Professor @ 4:22 pm

There are reports originating on USMC blogs now ricocheting around the interwebs that US Marines guarding the US Embassy in Cairo were not permitted to carry live ammo.  (The Beaufort Observer located near Paris Island also reported on this.)

FWIW. The Pentagon denies this.

And WIW?  Not much.

Regardless of the truth of this particular rumor, it is plain that the security in Cairo, and especially in Benghazi, was criminally lax.  Local security-clearly vulnerable to penetration by terrorists.  Insecure building.  No robust US military presence.

Not that you’ll learn this with the MSM, which is one-half of the beast with two backs-the administration being the other  half.

September 13, 2012

A Better Brand of Billionaire?

Filed under: Economics,Energy,Politics,Regulation — The Professor @ 11:21 am

The FT reports a huge boom in rail in the Midcontinent, with oil shipments from the Bakken driving this growth.  And who is capturing the bulk of this traffic?

The exports have helped North Dakota become the second-biggest oil producing US state, behind only Texas. Customers of BNSF, the railway that handles 44 per cent of the region’s oil exports, have built terminals on its routes through the region capable of handling 1m barrels of oil a day.

. . . .

Mr Smith says BNSF should retain between 25 and 37 per cent of the Bakken Shale’s export market once pipelines arrive, and when the field is fully developed, that should provide more traffic than its current 44 per cent market share.

“As long as we can provide transportation services to markets that pay better than [the market served by] the pipeline, we’re going to maintain and retain our market share,” Mr Smith says.

And who owns BNSF?  Berkshire Hathaway, of course.

I’m sure that’s totally immaterial to the government’s failure to approve the building of the northern piece of the Keystone XL pipeline.

Speaking of Buffett, his most famous utterance is about derivatives being financial weapons of mass destruction.  That quote is recycled over and over and over again when anyone wants to warn about the dangers of derivatives.

But Buffett doesn’t take his own advice.  In 2007-well after his FWMD quote-Berkshire sold credit protection on municipal bonds.  $8.25 billion in notional, to be exact.  He exited that trade last month, but remember it whenever Buffett’s quote is used.  Also remember his big sale of S&P 500 put options right before the crisis.

It’s not as if I’m shocked that multi-billionaires are out to make money, and will use a variety of means (e.g., influencing government policy to benefit an investment from competition, taking risks that they damn in public-perhaps thereby scaring off competition, cornering markets) to make it.  Just saying don’t fall for the folksy shtick, and think that Buffett is a better brand of billionaire.

The Poor Dear Had A Tough Day. He Deserves Vegas.

Filed under: Military,Politics — The Professor @ 8:27 am

On September 11, 2012, the US Embassy in Benghazi, Libya was attacked.  The highly insecure facility caught fire, and the Ambassador, Christopher Stevens, died of smoke inhalation.  Three other Americans died there.  Several dozen other people from the embassy fled to an alleged safe house, but that was almost immediately attacked. A team of US military personnel sent to rescue them (variously described as Marines and “commandos”) took fire that killed two of them.

Meanwhile, Obama flew to Las Vegas for a glittery fundraiser, where he said “we had a tough day.”

We?

He certainly faced no risk of smoke inhalation, except perhaps from the cigarettes which pesky rumors suggest he just can’t give up.  Certainly no risk of incoming mortar fire in Vegas.

Just another example of his inability to resist inserting himself into everything, to make himself the center of attention always.  This is a tragic example of that: for an absurd one, check out his “tribute” to Neil Armstrong, which is a picture of Obama looking at the moon.

There are reports that Obama was sleeping while these events occurred.  I wonder if the media will give him as hard a time for this as it gave Reagan in 1981 when Ed Meese declined to wake him after receiving news that US F-14s from USS Saratoga had splashed two Libyan Su-22s in the Gulf of Sidra.

Somehow I doubt it.

I also wonder whether the media will now point out that Obama’s big triumph, the killing of Osama, is obviously of very little import in the war against Salafist/Islamist extremism, and that the  world’s longest-lasting end zone dance rings pretty hollow in light of the fact that the entire Middle East is erupting.  (Complete with mobs shouting “Death to Obama” in Morocco-the most benign Arab state.  Sure glad that Cairo speech made America respected in Arab eyes.)

Somehow I doubt that too.

I further wonder if selfsame media will scream “intelligence failure” from the rooftops.  After all, near simultaneous attacks-the one in Libya obviously well-planned and executed-on the anniversary of 911 suggest considerable coordination.  Why wasn’t this suspected or detected? The attack on the safe house obviously demonstrates an egregious security breach.  Will the buck stop on Obama’s desk?

I doubt that as well.

In light of this, I wonder if the media will question the provenance of the alleged spark to these events-the dodgy film that blasphemes Mohammed.  It has the feel of the Protocols of the Elders of Zion to me-right down to its attribution to a shadowy group of Jews.  That is, it is more than plausible that this was an Al Qaeda or Iranian production planted to provide a pretext to rally mobs that served as a cover for long-planned attacks on US embassies.

Kinda doubting that the media will push that line either.

September 11, 2012

That’s Their Story, and They’re Sticking To It

Filed under: Commodities,Economics,Exchanges,Politics,Regulation — The Professor @ 7:09 pm

According to this Greg Meyer piece in the FT, Barclays estimates that $6 billion have flowed out of commodity index investments in 2012, and that many institutional investors are reducing exposure to commodities.

The anti-speculation frenzy that reached a peak in 2008, but has never gone away, is predicated on the belief that index investing-”massive passives” in the words of CFTC Commissioner Bart Chilton-exert a disproportionate influence on prices.  So, this outflow of indexing money should have led to a decline in commodity prices right?  But they have been up over 2012: one broad index, the UBS Bloomberg CMCI is up from 1520 at the end of 2011 to 1628 today, about a 7 percent increase.

But the anti-speculation folks have their story, and they’re sticking with it.  Sayeth Dennis Kelleher of “Better Markets”, “There’s excessive speculation in commodity markets which is driving up prices.”  QED.

Evidence? We don’t need no steekin’ evidence.

Ironically, I am in NY to speak at the CME Group’s First Annual Global Commodity Investment Roundtable, an event aimed precisely at fund managers, where I will be on a panel discussing the role of speculation.  Greg’s article tees that up very nicely.

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