Streetwise Professor

January 29, 2013

Medvedev Speaks the Truth About Gazprom: Money Comes First

Filed under: Energy,Politics,Russia — The Professor @ 8:41 pm

FWIW, there’s been something of a kerfuffle over Medvedev’s statement Davos that Gazprom’s export monopoly may end.  And WIW? Not much: remember, it’s Medvedev.  In Davos.

Let’s go back to basics.  The creation of a state-owned export monopoly (or any monopoly, for that matter) is fundamentally the result of the lack of a state’s fiscal capacity and ability to raise revenue through the tax system.  If a state could collect taxes costlessly, the best way to exploit a resource like natural gas would be to encourage ruthless competition in exports: the competition would minimize costs and maximize the surplus to be created.  A state that can collect taxes costlessly could then maximize its take by charging a tax on exports.

However, an inefficient or corrupt tax service means that the state would never realize much of this revenue.  Firms would conceal sales or income, or bribe the tax authorities, and most of the tax revenue would just vanish, to Cyprus, etc.

An export monopoly can achieve the same revenue outcome.  If it’s easier and cheaper for the state to audit and monitor the state export monopoly than a bevy of exporting firms that are supposed to pay tax, the state will prefer such a monopoly even if it is less efficient.  There is less leakage.  Not no leakage, but less leakage.

Moreover, powerful people in the state can often control and tap into the rent stream of the state firm more easily than a bunch of competing firms, some of which might just be fly-by-night shells of trading firms.

State grants of monopoly privileges are common in polities with relatively undeveloped fiscal and tax systems.

There is a political economy angle too.  Look at oil export taxes in Russia.  Oil companies exert political pressure on the state to reduce export taxes because a ruble not collected by the government goes into the pockets of the owners of the oil companies.  State ownership reduces the power of incentives to lobby for tax reductions.

What this all means is that the elimination, or not, of Gazprom’s export monopoly will be driven by fiscal, taxation, and corruption considerations.  If Putin and the siloviki (Medvedev?-please) deem that  the Russian state has developed sufficient fiscal capacity and capacity to tax, they will substitute a combination of free export and taxation (similar to what is observed in the oil business) for Gazprom’s export monopoly.  Relatedly, if they deem that they can siphon off the tax revenue more effectively than Gazprom’s cash flows, they will treat Gazprom like they are beginning to treat Assad: “Do I know you?”

This is the natural state in action.  The natural state imposes restrictions in order to create a stream of rents that can be distributed to the elite, or to buy political support for the elite.  There are different kinds of restrictions.  Taxes-including export taxes.  Monopoly licenses-including export monopolies.  In a world with no transactions costs, there are a variety of alternative means of generating the maximum stream of rents: setting price or output are perfect substitutes.

Things are different in a world with positive transactions costs, in particular, when monitoring and measuring output/revenue/profit and/or collecting taxes are costly.  With transactions costs, measurement, monitoring, and collection technologies are crucial in determining the best way of creating a stream of rents.  ”Best” from the perspective of the elite, and where the stream of rents reflects the cost of monitoring, measuring, enforcement and collection.

These considerations will drive Gazprom’s fate.

Medvedev did say one sensible (though obvious) thing. “But we mustn’t lose money, that’s the important thing.  Money comes first.”

The crucial thing is who is this “we”, kimosabe? It is the elite, notably Putin and the siloviki.  The technology of transforming natural resource rents into income/wealth for the elite.  Sometimes a grant of monopoly privilege is the most efficient way of making that transformation.  That is often true in relatively crude polities with underdeveloped or corrupt taxing capacity.  That has been a fair characterization of Russia for a very long time.  That is what drove collectivization under Stalin.  That was the rationale for the commune system in tsarist times.  That has been the case with Gazprom since the fall of the USSR.  Gazprom will continue to exist as as long as the taxation capacity of the Russian state is relatively weak, and it is easier to direct Gazprom’s cash flows to elite pockets than it is to direct state tax revenues to that destination.

So don’t expect Gazprom’s monopoly privilege to disappear any time soon.  It is an inefficient monstrosity in some ways: it wastes land, labor, and capital in prodigious amounts. But it is the most efficient way to achieve the rent seeking objectives of the Russian elite.  It is their money that comes first.  They are willing to live with a wretchedly wasteful monopoly that dramatically shrinks the size of the pie, if it allows them to get a bigger piece.

Update: There’s another reason to doubt Gazprom’s monopoly privilege is going to end anytime soon.  The Russian oil industry was originally highly fragmented.  There is no export monopoly (though Transneft does have a monopoly: Gazprom is different because it is integrated upstream and downstream) and the industry was largely privatized starting with the collapse of the USSR.  Instead, Russia has collected taxes (export taxes and income taxes) from oil companies-and often had a difficult time doing that.  Moreover, as mentioned in the post, there has been a good deal of conflict over oil export taxes.  But in recent years, the industry is becoming increasingly consolidated under state-owned Rosneft, with the acquisition of TNK-BP making Rosneft by far the dominant company in the industry.  There has been talk of partially privatizing Rosneft, but Sechin has succeeded in preventing this and Putin has been unenthusiastic.  The main supporters have been in Medvedev’s circle.   Thus, the oil industry is moving towards the state-owned model, with Rosneft paying large dividends to the state.  There is thus something of a convergence of the gas and oil models: it would be passing strange if the state company became increasingly dominant in the oil industry and less dominant in gas.

January 27, 2013

Always the Last to Know

Filed under: Economics,Politics,Russia — The Professor @ 2:30 pm

Dmitri Medvedev-prime minister of Russia, at least until Putin needs a sacrificial victim to blame for some failure, that being the main role of a Russian PM-claims that Russian business has not been harmed by the Magnitsky controversy:

Medvedev said the whistleblower’s death in jail, for which no one has been brought to justice, was being used by Kremlin critics to score points but was of no import to business leaders.

. . . .

“It does not interest anyone, except maybe certain citizens who are trying to use it to accumulate political capital,” said Medvedev, who was president from 2008 until Vladimir Putin returned to the Kremlin last May.

“Not a single businessman raises this issue,” he told state television in an interview focusing on his role in the forum. “But unfortunately it has become a factor in political life.”

Biznessmen have a different story-off the record, which is part of the point:

With international concern spreading after the 2009 death of Sergei Magnitsky, some Russian tycoons are worried their legitimate cross-border money transfers involving anything from industrial investments to luxury properties will get hit by red tape.

And they complain that the Kremlin’s hard-line stance on Magnitsky is not doing them any favours.

“The Russian business (community) is absolutely united. The situation is more than bad and things may well spread to the EU and UK and God knows who could be sucked in,” said a Russian billionaire, speaking at the World Economic Forum in Davos.

. . . .

Economist Sergei Guriev said: “Russian business is very upset. The last development they want is to see the EU or UK joining those sanctions. Quite simply it is where the Russian business has huge assets and where their kids are studying.”

Russian officials and bankers say the impact on commerce is becoming far too negative.

“Of course I have concerns about a worsening in (Russian-U.S.) relations. It creates unease for business. And it is a question for both sides – what’s the point of continuing all this? I think it is very important to move on,” said German Gref, head of top Russian bank Sberbank.

And here’s why what Medvedev says doesn’t mean bupkis:

The billionaire asked not to be named as he said the Russian business establishment was still afraid of bringing up the matter with Russian President Vladimir Putin

(And maybe they don’t bring it up with Medvedev because, like it would matter.)

Politicians say things they know are untrue all the time.  Perhaps that’s what Medvedev is doing.  But perhaps it is a reflection of one of the Achilles’ heels of authoritarian systems: fear keeps people from revealing inconvenient facts to rulers. Relatedly: a captive and docile press that is used primarily to disseminate the official line to the populace and which does not serve as an independent check on the government deprives the rulers of vital feedback.  Surrounded by yes men and deprived of independent feedback, authoritarian leaders often live in a fool’s paradise.  Problems are suppressed, and metastasize.  (In another example of our convergence to Russia from above, similar things are happening here, but for somewhat different reasons and in a somewhat different way.)

It is particularly ironic that the supposed crusader against legal nihilism blows off concerns about Magnitsky, and its effect on the business climate in Russia.  Perhaps he knows, but he is also afraid to challenge Putin (and the siloviki) on this.  (I would not rule that out, by any means.)  Or perhaps he is living in the authoritarian leadership bubble, cut off from feedback from planet Earth.  This is one of the sources of brittleness in authoritarian systems generally, and Russian in particular.  Regardless of the cause, the disconnect between what Medvedev says and what the nervous oligarchs say suggests that Russia will continue to underperform due to the failure (or refusal) of the government to address the Magnitsky case, and what it signals about the myriad dangers of doing business in Russia.

Rogozin the Ridiculous Returns!

Filed under: Military,Politics,Russia — The Professor @ 12:44 pm

Russian motormouth and snazzy Cossack-costume wearing Deputy Prime Minister Dmitri Rogozin has been somewhat silent lately.  But he is in the news again, this time throwing cold water (in more ways than one) on the Russian acquisition of French-built Mistral assault ships.  RtR says that these ships “won’t work” in temperatures below 7 C:

Two amphibious assault ships bought for the Russian Navy from France in a 1.2 billion euro deal will not be able to operate in temperatures below seven degrees centigrade, Russia’s Deputy Prime Minister Dmitry Rogozin admitted on Saturday, in critical comments about the contract.

“It’s very odd that ships for offloading a landing force, floating in our latitudes won’t work in temperatures below seven degrees,” said Rogozin, who has special responsibilities for the defense industry, in a meeting of the Academy of Military Science on Saturday.

“Maybe they thought we’re going to undertake special operations in Africa but I doubt that’s going to happen,” he added. He did not elaborate on why the ships would not work in cool temperatures. It was also unclear whether he meant plus seven degrees or minus seven, as Russian-speakers often leave out the word for minus when they assume it is clear which side of freezing they are talking about

I am at a total loss even t0 conjecture how a ship “could not operate” at temperatures less than +20F (or 45F if RtR meant +7 C rather than -7).  Seriously.  I cannot think of anything on a modern warship that couldn’t withstand such temperatures.  But facts have never been RtR’s strong suit.

As the article notes, another official, Military-Industrial Commission Deputy Head Ivan Kharchenko, also attacked the purchase of the Mistrals.  And the name of Kharchenko’s organization tells you what is really going on here: the attacks on the Mistral purchase are all about the Russian military-industrial complex trying to undo Serdyukov’s attempts at reform of weapons acquisition.  Serdyukov had been engaged in a battle with Russian arms manufacturers over quality and especially cost.  Buying abroad was a way of getting access to more advanced technology, and putting competitive pressure on Russian suppliers.  The idea of competition is an anathema to the arms industry, and they want to ensure that Russia is dependent on it exclusively for weapons.  That saves them face and makes them money.

This is a case of the empire strikes back.  The arms makers want to restore the status quo, and this also appeals to nationalists like Rogozin. And it is not just the arms makers.  Another target of Serdyukov-the officer corps-is also striking back.

Putin has pledged to spend trillions rearming the Russian military.  He will, but won’t get much rumble for the ruble if an inefficient, corrupt and uncompetitive arms industry continues to dominate the procurement process.  The outcome of the cold war on the Mistrals may be quite revealing in that regard.

January 26, 2013

Robert Amsterdam: Strange Bedfellow With Legal Nihilists

Filed under: Politics,Regulation,Russia — The Professor @ 9:42 pm

One of the primary reasons I became interested in Russia was the Khodorkovsky prosecution.  (The expropriation of Shell’s Sakhalin II was another.)  My writing about Khodorkovsky brought me in contact with Robert Amsterdam, a member of his legal team.  Amsterdam was one of the first to link to my blog, and add me to his blogroll.  I broadly agreed with his highly critical views of Russia, and Putinism in particular.  I have met him once, and conversed on the phone several times.  Although I concluded that he was likely fairly progressive in his leanings, based on his views about Russia and his work in Thailand, and some of his writings about resource nationalism, I believed that he believed in the rule of law, applied impartially, and that he believed that private property is a bulwark of liberty.

I was therefore extremely dismayed to see that he has joined the Kim Dotcom legal defense.  Amsterdam offers several justifications for this choice.  First, that the prosecution is “essentially bogus.”  Second, that the US government, with the complicity of the government of New Zealand, utilized excessive force in arresting Dotcom.  Third, that the US government took this action for crass political reason, namely, to retain the political and financial support of the motion picture industry.

I find none of these persuasive.  The crucial issue-without which none of the others would arise-is the legitimacy of the prosecution.  That is, is there a legitimate basis for the charges brought against Kim Dotcom and his (alleged) co-conspirators?

Here’s what Amsterdam says:

The prosecution’s case is essentially bogus.  Kim’s lawyer Ira Rothken has picked apart the allegations in a number of interviews, exposing the flaws in every point of the indictment.  As an Internet services intermediary, Megaupload diligently complied with takedown requests to remove infringing materials, and went even further to allow some 180 content-producing companies direct access to the servers to delete infringing materials themselves, which was unprecedented for any cloud storage provider.  Despite never once having been sued by any movie studio or record company, the DOJ wants to hold Megaupload liable for infringement via third party cases of piracy by users – however there exists no federal criminal statute for secondary copyright infringement, so essentially they are trying to unlawfully apply civil law in a criminal law context.  As Rothken has argued, the aggressive persecution of Kim Dotcom and other Megaupload founders has been full of “dirty tactics” by U.S. prosecutors.The prosecution’s case is essentially bogus.  Kim’s lawyer Ira Rothken has picked apart the allegations in a number of interviews, exposing the flaws in every point of the indictment.  As an Internet services intermediary, Megaupload diligently complied with takedown requests to remove infringing materials, and went even further to allow some 180 content-producing companies direct access to the servers to delete infringing materials themselves, which was unprecedented for any cloud storage provider.  Despite never once having been sued by any movie studio or record company, the DOJ wants to hold Megaupload liable for infringement via third party cases of piracy by users – however there exists no federal criminal statute for secondary copyright infringement, so essentially they are trying to unlawfully apply civil law in a criminal law context.  As Rothken has argued, the aggressive persecution of Kim Dotcom and other Megaupload founders has been full of “dirty tactics” by U.S. prosecutors.

Here is the indictment.  Compare and contrast with what Amsterdam writes.

It alleges that although Dotcom and Megaupload took some actions to remove copyrighted material from their sites, it provided financial incentives for users to upload copyrighted material; failed to terminate access from known copyright infringers; made no significant efforts to identify or remove copyrighted material, or prevent it from being uploaded; impeded copyright holders from identifying those using the sites to upload copyrighted material; did not delete material they knew to be copyrighted, even after being informed by the copyright holder;  complied selectively with obligations to remove copyrighted material, but failed to do so when it was in their financial incentive to do so; falsely represented to copyright holders that they had removed copyrighted material, when in fact they had only removed a subset of the links that provided access to that material; monitored law enforcement surveillance of Mega sites, and took active measures to conceal copyright infringement taking place on these sites; personally uploaded pirated copyrighted material; and on and on.

Let’s not pretend like we all fell off the cabbage truck.  It is more than obvious that Megaupload was created to facilitate the uploading and distribution of pirated copyrighted material.  That’s what it was used for.  Megaupload profited from this by selling premium subscriptions and by selling advertising to those who visited the site to view copyrighted material. It’s not hard to connect the Dotcoms here, though Amsterdam pretends there are none to connect.  Megaupload had a direct financial stake in facilitating the uploading and downloading of pirated material.  That’s what brought people to the site.  That’s what induced them to pay for premium subscriptions.  That’s what brought the eyeballs that paid for the ads.  That’s what the indictment alleges.  That it was, in essence, a fence of stolen property.  Intellectual property, yes, but property nonetheless-under United States law.  (More on this below.)  An entity that facilitated the marketing of stolen property, and made money for providing this service.

The indictment’s allegations flatly contradict Amsterdam’s claims that Dotcom and Megaupload were “diligent” in their efforts to protect copyrights.  In contrast, the indictment alleges that these efforts were perfunctory, and intended to feign compliance as a means of covering a concerted scheme to facilitate the distribution of pirated copyrighted materials.  Read some of the emails in the indictment.  It is clear that Dotcom and the others indicted were aware that copyrighted material was being accessed via Mega, that making money off of providing access to these materials was the essence of their business model, and that they took some actions that gave the illusion of compliance while taking other actions to protect the business model.  Sort of reminds one of a fence that runs a legit pawn shop on the side, and from time to time turns over stolen property to the cops.

It is interesting to note that Dotcom’s defense’s attempts to dismiss the charges focus on the very narrow issue of the service of the indictment on Megaupload, rather than the substance of the charges.

Let’s also not pretend that Kim Dotcom has no history.  He has a very long and disreputable history, in fact.   Hacker.  Inside trader.  Fraud.  More than a history, a rapsheet-complete with a conviction.  What’s more, he revels in his outlawry.  Flaunts it, in fact.  For going on two decades, he has reveled in breaking the law and profiting from it.

Dotcom also operates in a milieu that denies the legitimacy of most intellectual property law: some, in fact, deny the legitimacy of any IP law.  These people rationalize that since it is costless to copy, copies should be costless.  That is the socialism of the wired fool (or is it “efool” or “iFool”?).  What is copied has to be created.  If it is copied for free, it is far less likely to be created.

This is the fundamental tension in intellectual property.  It is hard to balance the incentives, but these “copyleftists” (as Catherine Fitzpatrick trenchantly and accurately characterizes them) don’t even recognize there is any need to balance.  This is, quite frankly, idiocy.  I could give lectures on the subject.  Oh.  Wait.  I have.

But the copyleftists self-righteously (how’s that for irony?) shriek that any attempt to constrain their ability to access IP is an unconscionable infringement of freedom.  From this, it is a short step to rationalizing the taking of intellectual property.  If you believe “(intellectual) property is theft” there is no moral bar against appropriating it-”liberating” it.  And from there, it is a shorter step still to believing that any attempt to enforce intellectual property law is a gross injustice, and that the enforcers are the corrupt creatures of the real thieves-those who claim for themselves what should be freely available to everyone.

And that is exactly what Robert Amsterdam is buying into when he defends Dotcom.  If you believe that copyright is legitimate property, and recognize that there laws-including criminal statutes-to protect this property, then you have to acknowledge there is a legitimate basis for the prosecution of Dotcom.

But in arguing that US prosecutors are the corrupt creatures of Chris Dodd and the movie industry, Amsterdam buys into the whole IP as theft meme.  Lord knows I am no fan of the guy who put the Dodd into Frankendodd, but in this instance he is representing a legitimate interest that expects and deserves that its property be protected by law enforcement.

Let me put this another way. Amsterdam has been a vociferous critic of legal nihilism in Russia.  With considerable justification, and I am in agreement with him on this.  But Dotcom and his defenders are total legal nihilists. Some of the copyleftist community are nihilists on what they consider to be principled grounds: the IP is theft principle, to be specific.  Aaron Swartz fell into this category.  Dotcom is a legal nihilist for purely mercenary reasons: to support his .1 percent lifestyle.   But the motive is not really material, even when it is materialistic.  A nihilist is a nihilist.   These people want to annihilate IP law.  For different reasons, but they want to annihilate it.  By signing onto the Dotcom defense Amsterdam is abetting the same legal nihilism that he excoriates in Russia.  There are legitimate means to change the law: breaking it isn’t one of them.

There is further Russia-related irony here.  Who has been among Dotcom’s most vociferous defenders? None other than The Media Outlet Formerly Known as Russia Today.  Yes, that RT.  The Kremlin agitprop operation.  An operation that is, shall we say, hardly Khodorkovsky friendly, and which is the puppet of Khodorkovsky’s main tormentor: Vladimir Putin.  RT loves-loves-Kim Dotcom.  Mikhail Khodorkovsky, not so much.  Does your strange bedfellow steal the covers, Robert?

And further the we-didn’t-fall-off-the-cabbage-truck theme.  Russia is one of the main sources of pirated material, and one of the main consumers of pirated material.  Each VKontakte user watches an average of 8.5 hours of video a month, virtually all of which is pirated. Russia is notorious for its IP piracy-and for the studied refusal of the government to do anything about it.  Indeed, it is equally notorious that the security forces provide the krysha for all varieties of cybercrime, including piracy.

As the operator of the largest market for pirated material (and by market, I mean a venue where buyers and sellers can interact to engage in exchange), Kim Dotcom was in a highly symbiotic relationship with such types.  Highly symbiotic: Dotcom provided a venue-an exchange, if you will-where these types could sell their ill-gotten goods, and made a very lucrative living by doing so.

Meaning this was not a Six Degrees of Kevin Bacon sort of association between Dotcom and the Russian security services.  There are far fewer degrees of separation of Kim Dotcom from the very people who persecute (by his own characterization) Amsterdam’s most famous client: the client who propelled Amsterdam to international prominence (and large billings), yet who continues to rot in a jail cell in Chita. Losing any sleep with your new bedfellow, Robert?

One last point.  Amsterdam makes a big deal out of the fact that Megaupload/Dotcom were “never sued by any movie studio or record company.”  A similar claim is heard repeatedly in regards to JSTOR, MIT, and Aaron Swartz.

Please.  Presumably Amsterdam makes this point to insinuate that the movie studios or record companies didn’t believe that Dotcom was costing them any business: if they did, why didn’t they sue?  But how can he possibly reconcile this insinuation with his other claim: that the movie industry collectively pursued Dotcom with Javert-like obsessiveness?   If movie companies were individually unharmed by Megaupload, why would they fund collective action to force the government to prosecute him?   You can’t have it both ways.

Moreover, taken at face value, Amsterdam’s claim (and similar claims made regarding Swartz) would imply that there is no need for state civil or criminal enforcement of any property right.  Just leave everything to private right of action.  If that’s his position, I would like to hear his defense of it.

There are in fact strong arguments on the other side.

For one, economies of specialization in investigation and enforcement are one reason to have state enforcement.

Free rider problems are another.  Indeed, the Dotcom case illustrates that point clearly.

Amsterdam mentions 180 content providers.   The efforts of any one of these firms to force Megaupload to cease operations, or to operate in a way which protected IP, would redound to the benefit of the other 179.  There is a public good problem/free rider problem here, and given this (severe) problem purely private enforcement leads to too little effort to enforce property rights.  Public enforcement internalizes (at least partially) an externality.

It is interesting to consider what Amsterdam brings to this case.  His law firm’s website does not disclose any experience in US criminal cases, or intellectual property law.  Instead, it primarily touts its expertise in political defense and political advocacy.  That’s quite telling, and of a piece with the efforts of copyleftists and the hacking underworld to politicize every attempt to enforce laws relating to copyright and computer security.  There’s an old saying: if the law is on your side, argue the law.  If the facts are on your side, argue the facts.  If neither the law nor the facts are on your side, pound the table.  In computer and IP related legal matters, the last sentence of the aphorism should be modified to read: “If neither the law nor the facts are on your side, pound the politics.”  That is likely to be Amsterdam’s role in this case.

But in playing this role, he is associating with a very dubious character who facilitated massive theft, and profited therefrom.  Making a political cause celebre of Dotcom will play well with Anons, the EFF crowd, the Googlesphere and others in the anti-IP precincts of the left.  Precincts that are quite well-heeled, by the way, and spend large sums on political influence in order to advance their economic interest-just like the movie industry.  But in so doing, Amsterdam gives ammunition to Putin and his ilk, who will no doubt smirkingly point to Dotcom and say that Amsterdam is willing to defend wealthy guilty-as-sin crooks by politicizing their cases-thereby discrediting his advocacy of Khodorkovsky.  And they’ll have a point.

The Solution To Russia’s Health Problems? More Sports! Yup, That’s the Ticket!

Filed under: Politics,Russia — The Professor @ 1:14 pm

Compare and contrast these two stories:

Russian doctors troubled by growing TB infection rate.

Doctors are concerned about the rising number of Russians infected with tuberculosis (TB). This number has more than doubled over the past 15 years, a senior healthcare official said on Thursday.

“Russia ranks 13th on the list of countries with the highest tuberculosis infection rate. There are over 240,000 patients with active forms of TB, four percent of them are children,” Valentina Aksyonova, Russia’s top TB doctor with the Health Ministry, told reporters in Vladivostok. “Tuberculosis is to blame for 12.2 percent of deaths from infections in Russia,” she added.

Add this to stories about HIV infection rates and alcohol- and drug-related death and illness. Then consider this:

Putin: Use sport to stem population decline:

Sport is a crucial weapon for Russia to fight its demographic crisis by keeping people healthy, President Vladimir Putin said Thursday.

Russia’s population has fallen by more than five million since the collapse of the Soviet Union in 1991 as a result of lower births rates and life expectancy, although recent government estimates show a small rise since the 2010 census.

“We’re carrying out large-scale targeted interventions in the field of demographics, but without instilling a taste for sport, all of our efforts will have little effect on progress,” he said.

Yes, more sports will no doubt get rid of that pesky TB problem, HIV infection, cirrhosis, etc.

I think he is losing his mind.

This Wasn’t How They Told Us It Would Work-But It Was Pretty Obvious That It Would Work Out Like This

More indications that Frankendodd, Basel III, and other measures intended to reduce the risk in the banking system, and to address the too big to fail problem, are leading to greater consolidation of the banking sector:

Investment banks must take further actions to improve returns and more will follow firms like UBS AG (UBSN) and Royal Bank of Scotland Plc  that have exited businesses, McKinsey & Co. said.

Only five or six companies will remain “bulge bracket” firms that offer all investment banking and trading products worldwide, the consulting firm said today in a report titled “After the Reckoning.” Others will step back from some businesses to focus on areas where they have a competitive advantage, according to the report.

. . . .

The top three firms in each asset class account for about two-thirds of trading volume in that product, according to the report. Banks that lack such scale or face higher funding costs will probably focus on businesses such as foreign exchange or structured rates and credit, McKinsey said.

So: increased concentration and reduced competition as some banks exit certain businesses.  The sector overall will almost certainly shrink, but the remaining bulge bracket firms will account for a greater fraction of business, and may grow absolutely.  It is also likely that these remaining firms will be as interconnected, or more interconnected, than was previously the case.

January 23, 2013

Derivatives Regulation: Risk Transformation, Not Risk Reduction

One of the themes of my writing on clearing mandates and other aspects of post-Crisis derivatives regulation has been that although these initiatives have been sold as ways of reducing risk in the financial markets, in reality, they shift many risks, transform others, and create new ones.  It is by no means clear that these new laws and regulations have reduced the overall vulnerability of the financial system.

For instance, clearing and collateral mandates are intended to reduce the amount of credit embedded in derivative trades.  But market participants can respond to this by substituting other forms of leverage.  The effects on credit risk and leverage overall are far more equivocal than the advocates of the mandates claim.  As another example, making derivatives more expensive means that some will eschew using them to manage risk.  Risk that was passed to others able to bear it at lower cost will remain with those who bear it at a high cost.  As yet another example-and the one that worries me most-is that clearing and collateral mandates have transformed credit risk to liquidity risk.  Since true crises are usually liquidity crises, this is highly disturbing.

The CFO of Rolls Royce made similar arguments forcefully at a conference a few days back:

European regulatory measures designed to make the financial system safer don’t actually eliminate risk, they simply move it to nonfinancial companies, warns Mark Morris, the finance chief for Rolls-Royce, the British aero-engine maker. And there could be a negative impact on the economy, he says.

Speaking at a conference organized by The Economist Group (a minority owner of CFO), Morris criticized European regulators for seeking to deal with over-the-counter derivatives risk in the financial sector by requiring some contracts to be centrally cleared or to have collateral posted.

The European market infrastructure regulation, known as EMIR, took effect last August but requires the European Commission to enact a series of technical standards before the rules can be fully implemented. Most are expected to be finalized by mid-2013.

“In essence, you can’t destroy risk,” Morris said. “It morphs into something else. If you take market risk and go into a foreign exchange [hedging] transaction with a bank, you’re replacing it with counterparty risk. If you try to replace the counterparty risk by using central clearing or some form of posting of collateral, what you’re doing is you’re replacing counterparty risk with liquidity risk.”

Morris makes some other good points in the article, so I recommend you read the whole thing.

It seems that the Europeans are more sensitive to these concerns than was the case in the US.  The European Parliament may demand changes in EMIR. Apparently they are aware of the legislate/regulate in haste, repent at leisure problem.  Unfortunately, with Frankendodd dismissed such concerns.  Methinks that the repentance stage will come soon.

The Pain is the Gain?

Filed under: Climate Change,Economics,Politics,Regulation — The Professor @ 11:36 am

It is bizarre to observe Obama’s burning desire to reproduce the European welfare state in the US (on full display in his inaugural address) at the same time that model is collapsing before our eyes.  But another element of Obama’s address reveals that his disconnect between a desire to reproduce European policies at the same time as those policies are lapsing into farce is not limited to the welfare state alone. On Monday, Obama pledged a renewed commitment to combating “climate change.”  (When has climate been static, by the way?)  Ironically, on Monday, the FT ran an article describing the near collapse of the EU’s emission trading (cap-and-trade) market:

Carbon prices have fallen to a record low of less than €5 a tonne, pushing the European Union’s eight-year-old emissions trading system into a crisis.

Benchmark EU carbon prices yesterday dropped to a session low of €4.79 a tonne – down nearly 20 per cent over the past week – after Germany’s failure on Friday to sell carbon permits triggered a crisis of confidence.

As the article notes, this follows hard on the collapse of the UN’s Clean Development Mechanism.  Kyoto is dead.  The regional/state markets in the US (REGGI and California) are wheezing, at best.

So why not a new Big Push (cue Douglas Haig) on climate change?  What could possibly go wrong?

Better yet, why bother with the pesky legislative branch when pursuing this endeavor in the face of a truly global record of failure?  After all, Congress might be subject to feedback, and we can’t have that.  Thus, according to Bloomberg, Obama plans to pursue his Quixotic venture (almost literally so, given the prominence of windmills in alternative energy efforts) via executive order and regulation, rather than legislation.  Again: what could possibly go wrong, putting what is arguably the worst, most dangerous government regulator, the EPA in charge of this?

Not to mention that these initiatives at the level of individual nations, or even large multinational blocks, will be costly, and have virtually no impact on global temperatures.  All pain, no gain.  It is utterly insane for California to attempt unilaterally to control emissions: it is only slightly less insane for the US to do so.  But that’s the way Obama wants to go, despite the collapse of similar initiatives around the world.

But maybe that just reflects the fact that these endeavors are driven more by a religious and ideological belief than a commitment to tackle an issue an a practical way that wrestles with empirical and political realities, and weighs costs and benefits.  For people so driven, ostentatious sacrifice and adherence to ritual are valued in their own right, not for their practical consequences.  Incurring a cost signals the depth of commitment, and that’s what matters.  The pain is the gain.  For them, that is.  For the rest of us who are not wedded to such beliefs, not so much.

January 22, 2013

I Guess the “One Leader” Part Is Taken as a Given

Filed under: Politics — The Professor @ 10:07 pm

Re-reading the Obama quote in my last post, this jumped out at me:

We must do these things together, as one nation, and one people.

While the whole paragraph containing that line is creepily collectivist, that line is two thirds of the infamous “ein volk, ein Reich, ein Furher” slogan, which is truly creepy-especially given the personality cult that surrounds Obama.  A personality cult that was on grotesque display yesterday in what should have been a civic occasion celebrating the democratic process, rather than the individual selected through that process to hold (temporarily)  executive authority.

Are he and his speechwriters so clueless not to understand the parallel?  I certainly hope so, because the alternative would be truly disturbing.

But more generally, I reject the entire premise.  We are not a herd of bovines that needs to be driven in a single direction.  Indeed, the very attempt to do so is doomed to failure.

Again: people associating freely, in firms, private organizations, churches, or what have you-civil society-acting according to their own private lights and own private interests will be much more successful in achieving things great and small than they would be under some central direction.

It is doubly ironic that in that same paragraph Obama mentions Americans defeating fascism, because the fundamental theme of his speech has far more in common with fascism than it does with the traditions of the American Founding.  Which is not surprising, because progressives (and Progressives) have always been deeply critical of the Founders’ Constitution, and because during the 1920s and early-1930s many progressives openly admired fascism, especially the Mussolini variant.

But it is deeply disturbing that Obama, likely ignorantly (for he is truly an ignorant man), explicitly adopts two thirds of a fascist formulation of a political philosophy.

As for the third part, that seems to be the province of the deed, rather than the word.

If You Had Any Doubts Before Now that Obama Was a Dishonest Intellectual Lightweight, Read His 2d Inaugural

Filed under: Economics,Politics — The Professor @ 6:51 pm

Obama delivered his Second Inaugural Address yesterday.  Despite paeans from the usual suspects (e.g., Chris Matthews, who should really get a freaking room) that compared Obama’s speech to the Gettysburg Address  or Lincoln’s Second Inaugural FFS, in reality it was just a predictably turgid pile of progressive platitudes.

The speech was chock-full of typical Obama tropes.  The most typical-and most despicable-of which was his old standby, the Straw Man.  Is Obama capable of giving a speech without one?  Speech, hell: is he capable of uttering 3 sentences without resorting to this most grating of rhetorical tricks?

To wit:

For the American people can no more meet the demands of today’s world by acting alone than American soldiers could have met the forces of fascism or communism with muskets and militias. No single person can train all the math and science teachers we’ll need to equip our children for the future, or build the roads and networks and research labs that will bring new jobs and businesses to our shores. Now, more than ever, we must do these things together, as one nation, and one people.

Pardon me, but WTF ever said “a single person” can achieve great things?  (And by the way, “training teachers” doesn’t come first in any list of Great Accomplishments, except at an NEA convention.)

Let’s consider Edmund Burke.  Did he assert such a thing? No, that great conservative spoke of “little platoons”-private cooperative endeavors.

What about De Toqueville?  Again-no.  He wrote about the American genius of private associations that citizens formed, spontaneously and independently of government, to achieve the benefits of cooperation.  Yeah.  Collective action. Without government.

The late, great James Buchanan? No.  He showed in his Theory of Clubs how private cooperation could produce (excludable) public goods.

Look.  Firms are cooperative enterprises that engage in collective action to produce things that people value.  Markets facilitate cooperation between diverse individuals who may not even know of each others’ existence, and who do not intend to cooperate, but end up doing so while pursuing their own self-interested objectives due to the way that price signals convey information about benefits and costs, and provide powerful incentives to act on that information.  The price system coordinates, and thereby permits multitudes to cooperate.

In other words, the market system is a mixture of cooperation and competition.

In contrast, in Obama’s cramped vision, government and government alone is the sole nexus of cooperation in society.  That it is coercive “cooperation”, rather than voluntary cooperation (a la Burke, de Toqueville, or firms operating in markets) escapes his attention, or at least doesn’t bother him one whit.  To him the alternatives are: cooperation mediated through government and government alone, or atomistic competition, red in tooth and claw.  A regurgitation of the Social Darwinian crap he heaved up a year or two ago.

I do not know whether Obama’s Straw Man is the product of extreme intellectual limitations or extreme intellectual dishonesty.  I’m voting “both” actually.  But regardless, it is embarrassing to witness such a display, and even more embarrassing to see it praised as some great oration.

The real Straw Man here is Obama.  Straw Man as in the Wizard of Oz.  Because he really needs a brain.

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