Streetwise Professor

November 13, 2016

Let Them Use Canvas! A Vignette on the Dangers of Majoritarianism & the Benefits of the Electoral College

Filed under: Economics,History,Politics — The Professor @ 12:55 pm

In the aftermath of the stunning election result, we are witnessing much wailing and gnashing of teeth and rending of garments. One common whinge is that the result is illegitimate because Hillary apparently won (barely) the national popular vote, but was trounced in the Electoral College vote. I will pass over some of the issues this raises (e.g., that campaign strategies would have been different had the election been a national referendum/plebiscite) to focus on the benefits of the Electoral College.

The Electoral College is a departure from majoritarianism, one of many that the Founders deliberately incorporated into the Constitution. Meaning that the real debate is not over this particular deviation from national majoritarianism, but whether there should be any such deviations at all.

Put me down as a deviant, because I strongly believe that pure majoritarianism is a disaster. The tyranny of the majority is a real concern. To get all geeky about it, the core is empty in pure majoritarian games: no stable coalitions can form, and the outcome is chaos and shifting alliances of Peters conspiring to rob Pauls. The dangers of this are particularly great when there are few checks on the power of the state to transfer property and power from one group to another. There is also much greater potential for conflict and a greater incentive to spend resources to win the popular vote because small changes in the popular vote lead to discontinuously large changes in the distribution of power–including the power to expropriate. The stakes are much bigger, especially in closely divided polities.

If you want to see an example of what happens when there are fewer checks on the majority, look at California. It is no accident that California is Whinge Central post 11/8/16. The state voted strongly for Clinton: I may exaggerate only slightly that the net-wits called California for Clinton within 30 seconds of the polls closing.

But as Victor Davis Hanson has movingly shown, there are two Californias. (Joel Kotkin has written in a similar vein.) The coastal region, with Silicone Valley and Silicon Valley. Urban, expensive, and wealthy–with large pockets of plutocratic wealth. It draws its wealth disproportionately from high rent industries–entertainment and software tech. But there is another California, the interior. It is far poorer, and far grittier. It is heavily agricultural, and agrarian. It wrests what wealth it has from the earth, with sweat and toil. The only rents are to the land.

This is reflected in the electoral map, which is a microcosm of the US. There is a blue California on the coasts, and a red California in the interior. Even some places with large numbers of Mexican immigrants (e.g., Kern County) went for Trump. But the coast was solid Clinton.

In terms of population as well as wealth, Coastal California dominates. This means that in terms of state legislation and government, the interior of California is largely disenfranchised, and the governing elites have little reason to take the interests of the interior into account. This problem is exacerbated by the heavy use of referendums in California. Referenda are a strongly majoritarian institution, which do have a purpose, namely, placing a check on minorities that can use government to advance their interests. But this comes at a cost of allowing majorities to run roughshod over minorities.

There were several referenda on the ballot in California on Tuesday. Most were advanced by the coastal majority and involved issues that can and should be decided on a local basis, but which a highly ideological majority wanted to force on everyone. One example is the gun control measures that passed. But the example that is most telling to me is the referendum which banned the use of plastic grocery bags.

This is an issue that is virtue signaling par excellence. Around the world (e.g., France) liberals have made the banning of plastic bags a major environmental issue, despite the fact that the environmental benefits of the ban are far more asserted than proven. In California in particular, most major coastal metropolises have banned plastic bags. Bully for them. But that was not enough for the coastal denizens: they had to force their preferences on the entire state.

As Tim Newman wrote several months ago in several excellent posts, the plastic bag ban imposes substantial inconvenience on many normal people, hits lower income people the hardest, and is basically yet another effort by the better thans to instruct the benighted proles:

And that was my point about the Soviet Union: the privileged imposing artificial material restrictions on society which hit those at the bottom hardest, all the while saying it is for their own good.

In summary, I’m not necessarily saying the ban on carrier bags is a bad thing.  I just take objection to people making the assumption that plastic use is in itself bad, alternatives better, and the ban good as if it these were self-evident truths; and the lifestyle preferences of the wealthy middle-classes being imposed on everyone else with nothing but condescending dismissal of the costs and inconvenience to those not so fortunate.

Exactly right.

In California, the coastal majority succeeded in imposing its will on a less wealthy minority. It did so with plastic bags (and bullets) by referendum: it does so on myriad other matters via the state legislature which it dominates. These elites are throwing a post-Trump temper tantrum–which has gone so far as for many to advocate California’s secession–precisely because the Electoral College has thwarted their ability to do the same in the US as a whole.

If you look at what California does to the political minority in the interior, you will see that the tyranny of the majority is a real thing. The majority doesn’t have to pay any heed to the rubes in the Central Valley–let them use canvas! The genius of the Electoral College is that it forces the popular majority to temper its ambitions and moderate its program in order to attract at least some support from–or at least, diminish the opposition from–other constituencies. The urban must make some accommodations to the rural and suburban. The coastal must make some concessions to flyover country.

This serves to reduce conflict between constituencies, and mitigates centrifugal and fissile forces in a large and extremely diverse nation. These are very good things. If you think that politics in the US is contentious and divisive now, you have no idea what it would be like without the Electoral College.

One of the left’s arguments against the Electoral College is that it was adopted in large part as an accommodation to the slave states. There is an element to truth in that, although it should be noted that small non-slave states (e.g., Connecticut) also supported it because they feared being ground under the heel of large states like New York and Virginia. But the role of slavery actually illustrates the politically and socially beneficial role of the institution.

Absent departures from majoritarianism like the Electoral College, it is unlikely that highly disparate regions like the North and the South could have come together to form a nation in the first place, or would have long avoided secession and armed conflict if they had. The Civil War occurred precisely when demographic and economic changes threatened to permit the majority North from imposing its will on the minority South. Anti-majoritarian institutions (not just the Electoral College, but the Senate) permitted a nation to be formed in the first place, and prevented secession and military conflict for over 70 years.

In the instance of slavery, the anti-majoritarian provisions of the Constitution protected an evil institution for decades.* But that fact does not mean that anti-majoritarian features are inherently bad. To the contrary. Pure majoritarianism can be oppressive, and that increases the potential for political division and conflict. The Electoral College requires a party to moderate its appetites and broaden its appeal. It does not eliminate conflict, but it does temper it. And it does so precisely because it constrains the ability of arrogant majorities to impose their will on diverse minorities. The Electoral College gives greater voice to minorities: without voice, the minorities are more likely to resort to exit or combat.

Which is exactly why the left in the US is currently freaking out about the Electoral College. Their hysteria is the best advertisement for this institution that I could possibly imagine.

* As a practical matter, a purely majoritarian Constitution, or a Constitution with fewer anti-majoritarian features, would not have shortened the life of slavery, and likely would have extended it. One possible result would have been that there was no United States, and the Southern states would have been free to perpetuate their institutions without interference. The Northern states would have had little or no incentive to interfere. (One strong economic motive for the North to fight secession was that the tariff system redistributed income from the South to the North, and secession undermined that. That provided an economic incentive for Massachusetts and New York to cohabit with South Carolina and Alabama, and to oppose their moving out.)

If through some miracle a nation embracing North and South had formed under a more majoritarian Constitution, it is highly likely that a more purely majoritarian system would have resulted in secession at a far earlier date, when the economic (especially industrial) and population balance was much closer, and the North probably would have been powerless to prevail over the South militarily. The Civil War came in a non-purely majoritarian system only when the economic imbalance between the sections became so pronounced that military advantage rested with the North, and even given that preponderance, it was barely able to prevail, and then only after epic bloodshed.

Thus, adopting the William Lloyd Garrison position that the Constitution was a bargain with the devil and the North would be morally purified by a separation with the South might have salved his conscience and those of other (primarily evangelical) abolitionists, it would not have freed one person from bondage, and may indeed have cursed many more to suffer from it for much longer.

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November 9, 2016

Blessed Are Ye Who Are Long Gamma

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

Hillary Clinton made history last night. Just not quite the way she had expected. Rather than “shatter the glass ceiling” (gag), she was crushed as the roof caved in on a complacent, corrupt, and clueless establishment of which she was the exemplar. Donald Trump was the personification of the forces that defeated her and the “elite”, but pretty much only that: either by canny calculation or dumb luck he rode a deep current of popular discontent to achieve a stunning victory that saw at least five, and likely six, strongly Democratic states flip from D to R. The Democrats prevailed only in the leftist strongholds of the P-Coast, the Northeast, The Illinois Salient, and Governmentlandia (Virginia and Maryland). The rest of the country went red. Trump was the effect, not the cause. The vessel that floated on the tide, not the tide itself.

Blessed are ye who are long gamma. Those who have the flexibility and optionality to respond to uncertain developments are the winners here, for there will be uncertainty aplenty. The future with Hillary would have been drearily predictable: the future with Trump will be a wild ride.

Consider few representative areas.

The Supreme Court: Hillary would have chosen rigid leftist ideologues intent on remaking the country–not just its government and economy, but its social fabric. Trump? I have no clue, and either does anyone else. My guess that his court picks generally will be highly idiosyncratic with no unifying philosophical orientation–because Trump lacks one as well.

Government appointments: Hillary would tap from the Empire’s vast array of apparatchiks, most of whom would be statist to the core. The middle and lower level appointments would have teemed with the kinds of political cockroaches revealed in the light of the Podesta emails. As an outsider, Trump has no similar pool of bureaucrats-in-waiting. The transition process will likely be chaotic, and he will have to rely on a Republican establishment that he distrusts (and which distrusts him) to advance candidates. Again, the outcome is wildly unpredictable, and will probably result in a hodgepodge of appointments with no unifying ideology or philosophy, who will often work at cross purposes.

There will be new blood, which is a good thing: people from outside the ranks of the courtiers in DC and the coastal metropolises are desperately needed. These people will inevitably be high variance. But that is an inevitable part of the process of change.

Economic policy: Hillary would have continued the onslaught of regulations that has been producing an Amerisclerosis that rivals Eurosclerosis. Agencies like the EPA would have continued to propose and implement burdensome, growth-sapping regulations. She would have pushed the kinds of taxes on capital that are also inimical to growth (although her ability to get those through Congress would have been a very open question). Trump? He is an economic ignoramus, but it is likely that Congress will temper some of his wackier ideas. Further, he is open to reducing many of the regulatory monstrosities like those that the EPA has imposed, and to removing barriers to energy production and transportation. His tax ideas are unpredictable, but again they are not relentlessly hostile to investment and capital. And a big thing: there is an opportunity to fix Obamacare. Hillary would have fixed it by moving to single payer. There is an opportunity to move away from government control, not doubling down on it.

Regulatory policy and taxes will require cooperation with Congress. The relations between Trump and the Republican leadership are fraught, at best. Idiots like Max Boot are delusional if they think that a Republican House and Senate will give Trump carte blanche. But Trump views himself as a negotiator, and will no doubt engage in negotiations with Congress with zest. The outcome of those negotiations? Impossible to predict. Likely something best described by the old joke: “What is a giraffe? A horse designed by committee [or negotiation].” Again, tremendous uncertainty.

With respect to economic policy, personnel will matter here. Again, Hillary’s appointments to agencies like EPA, SEC, FERC, FTC, FCC, and CFTC would have been tediously predictable statists intent on extending government control over the economy. Trump’s appointments are much more likely to be a very mixed bag, leading to less predictable outcomes. I do think it is likely, however, that there will be many fewer regulatory control freaks. Thus, I expect that at the CFTC, for instance, a Trump commission will jettison economic inanities like Reg AT and position limits.

Foreign policy: Hillary has a strong interventionist, not to say warmongering, streak, and would have almost certainly been more aggressive in Syria than Obama has been, with very sobering consequences (including a substantially increased risk of confrontation with Russia). Trump’s predilections seem much less interventionist, but events, dear boy, events, can lead presidents to do things that they would prefer not to. And given Trump’s mercurial nature, how he will respond to events is wildly unpredictable.

He will have to deal with other major issues, notably China. He will approach these like a negotiator–including, I expect, large doses of bluff and bluster–and the outcomes of these negotiations will be even harder to predict than those of his negotiations with Congress. (One issue that could have both domestic and foreign policy effects is that I conjecture it is likely that the Sequester will die under Trump, whereas it would have continued with a divided government.)

It is clear, therefore, that Trump will disrupt the system, both domestically and internationally, whereas Hillary would have perpetuated it. And I am not unduly concerned about extreme disruptions, because the inherent complexity of the American system of government, the tension between Trump and Congress, and quite frankly, Trump’s limited attention span will temper his more extreme impulses.

Further, shaking up the system is a good thing, for the system is dysfunctional and corrupt. Hillary would have continued our relentless slouch to cryptosocialism and would have cemented the rule of a contemptible and remote establishment: the possibility of an upside is greater with Trump, even if by accident. Hillary would have delivered us sclerosis on purpose.

I would also suggest that a Hillary victory would have increased the likelihood of a bigger cataclysm in the future. She and her acolytes would have disdained and dismissed the forces that in the event propelled Trump to victory. She would have doubled down on the policies that have contributed to our present discontent. As a result, that discontent would have only increased, thereby increasing in turn the likelihood of an even bigger political spasm in the future.

To put things differently: with Trump, we will be on a roller coaster. With Hillary, we would have been on the luge.

I think Trump will be a transitional figure. Transitioning to what, I have no idea. But given the deeply dysfunctional nature of the status quo, transition holds out hope. Shaking up a decrepit and corrupt system creates the possibility for change. Creative Destruction is a possibility with Trump. With Hillary, no.

All this said, the Empire will strike back. It will wage a relentless war from its redoubts in the media, and to a lesser degree, the courts. Look at what the Remain crowd is doing in the UK in its attempt to undo its loss at the polls. That will happen here too: there will be a Thermidor, or at least an attempted one. And that battle will produce uncertainty.

And not all of the Empire’s minions are Democrats: the Republican establishment will fight Trump from within the citadel. This political warfare adds the prospect of even more uncertainty. Again, a reason to be long gamma.

I cannot say I predicted this, because I didn’t. I do think it is fair to say that I limned the outlines of what has transpired. This came in two parts. First, I noted that as with Brexit, this possibility was far more likely than elite opinion believed. A complacent elite sat smugly atop the volcano, blithely ignorant of the pressure of deep popular disdain pushing up the earth under their feet, disdain powered by the financial crisis, bloody and inconclusive wars, and an anemic economy. Talking only to one another, the elite received no feedback about what voters were thinking and feeling.  Existing in an echo chamber made them vulnerable to shock and surprise. Moreover, their contempt for those not in their class also led them to think that such feedback was irrelevant, because these little people didn’t matter. They knew better.

But the little people, largely without voice in the forums in which the elite communicate and interact, nursed their injuries, bided their time, and took their revenge.

Second, Hillary is a horrible person, and a horrible candidate–or should I say deplorable? Look at the vote totals vs. Obama in 2012. To say she underperformed is an extreme understatement. She underperformed because she had nothing new to offer, and indeed, the old conventional liberal stuff she was offering was long past its sell-by date. Add to that her horrible personal packaging (the corruption, the endless scandal, the inveterate lying) and she was crushed by an inarticulate political novice carrying more baggage than the cargo hold of an Airbus A380.

I did not have the courage of my convictions to predict that these two factors would result in a Trump victory. I thought Jacksonian America was too small to prevail. I too was in the thrall of conventional wisdom to some degree.

If you asked me to describe my mood, I would echo the title of a Semisonic song: Feeling strangely fine. Part of that feeling, I must admit somewhat guiltily, is due to schadenfreude: the hysteria of those whom I despise is quite enjoyable to witness. But part of it is that I think I am long gamma, and that the US is long gamma too. The old system and the old establishment have crushed American dynamism. Shaking up that system has more upside than downside, and whatever you think about Trump, you have to know he will shake things up.

I’ll close by quoting about the most un-Trump-like president I can think of: Eisenhower. “If you can’t solve a problem, enlarge it.” In other words, disrupt. Get out of the box. Don’t continue down the same endless path: try something new. The United States has been facing many insoluble problems, political, economic, strategic. The establishment had no clue at how to solve these problems, and their attempts to try the same things expecting different results put us on a slow road to ruin. Or maybe not so slow. A disruption was needed. An overthrow of the elite was imperative. Those things will in some respects enlarge our problems, by creating turmoil. But out of that enlargement there is the prospect of solutions–and yes, the prospect of catastrophe.

I don’t think that Trump himself will be the architect of those solutions. His role will be to tear down–he’s already done that to a considerable degree. Others will have to build up. Who that is, I don’t know. What construction will emerge, I don’t know. But there is far more upside now than there would have been with President Hillary Clinton. And that is reason to feel fine, strangely so or not

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November 8, 2016

WTI Gains on Brent: You Read It Here First!

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 8:22 pm

Streetwiseprofessor, August 2011:

WTI’s problems arise from the consequences of too much supply at the delivery point, which is a good problem for a contract to have.  The price signals are leading to the kind of response that will eliminate the supply overhang, leaving the WTI contract with prices that are highly interconnected with those of seaborne crude, and with enough deliverable supply to mitigate the potential for squeezes and other technical disruptions.

. . . .

Which means that those who are crowing about Brent today, and heaping scorn on WTI, will be begging for WTI’s problems in a few years.  For by then, WTI’s issues will be fixed, and it will be sitting astride a robust flow of oil tightly interconnected with the nexus of world oil trading.

Bloomberg, November 2016:

In the battle for supremacy between the world’s two largest oil exchanges, one of them is enjoying a turbo charge from the U.S. government.

Traders bought and sold an average of almost 1.1 billion barrels of West Texas Intermediate crude futures each day in 2016, a surge of 35 percent from a year earlier. The scale of the gain was partly because of the U.S. government lifting decades-old export limits last year, pushing barrels all over the world, according to CME Group Inc., whose Nymex exchange handles the contracts. By comparison, ICE Futures Europe’s Brent contract climbed by 13 percent.

WTI and Brent have been the oil industry’s two main futures contracts for decades. In the past, the American grade’s global popularity was restrained by the fact that exports were heavily restricted. Now, record U.S. shipments are heading overseas, meaning WTI’s appeal as a hedging instrument is rising, particularly in Asia, where CME has expanded its footprint.

“You have turbo-charged WTI as a truly waterborne global benchmark,” Derek Sammann global head of commodities and options products at CME Group, said in a phone interview regarding the lifting of the ban. “You’re seeing the global market reach out and use WTI — whether that’s traders in Europe, Asia and the U.S.”

This should surprise no one–but the conventional wisdom had largely written off WTI in 2011. Given that economic price signals were providing a strong incentive to invest in infrastructure to ease the bottleneck between the Midcon and the sea, it was inevitable that WTI would become reconnected with the waterborne market.

Once the physical bottleneck was eased, the only remaining bottleneck was the export ban. But whereas the export ban was costless prior to the shale boom (because it banned something that wasn’t happening anyways), it became very costly when US supply (especially of light, sweet crude) ballooned. As Peltzman, Becker and others pointed out long ago, politicians do take deadweight costs into account. In a situation like the US oil market, which pitted two large and concentrated interests (upstream producers and refiners) against one another, reducing deadweight costs probably made the difference (as the distributive politics were basically a push).  Thus, the export ban went the way of the dodo, and the tie between WTI and the seaborne market became all that much tighter.

This all means that it’s not quite right to say that CME’s WTI contract has been “turbocharged by the federal government.” Shale it what has turbocharged everything. The US government just accommodated policy to a new economic reality. It was along for the ride, as are CME and ICE.

ICE’s response was kind of amusing:

“ICE Brent Crude remains the leading global benchmark for oil,” the exchange said in an e-mailed response to questions. “With up to two-thirds of the world’s oil priced off the Brent complex, the Brent crude futures contract is a key hedging mechanism for oil market participants.”

Whatever it takes to get them through the day, I guess. Reading that brought to mind statements that LIFFE made about the loss of market share to Eurex in early-1998.

The fact is that there is hysteresis in the choice of the pricing benchmark. As exiting contracts mature and new contracts are entered, market participants will have an opportunity to revisit their choice of pricing benchmark. With the high volume and liquidity of WTI, and the increasingly tight connection between WTI and world oil flows, more participants will shift to WTI pricing.

Further, as I noted in the 2011 post (and several that preceded it) Brent’s structural problems are far more severe. Brent production is declining, and this decline will likely accelerate in a persistent low oil price environment: not only has shale boosted North American supply, it has contributed to the decline in North Sea supply. Brent’s pricing mechanism is already extremely baroque, and will only become more so as Platts scrambles to find more imaginative ways to tie the contract to new supply sources. It is not hard to imagine that in the medium term Brent will be Brent in name only.

Since WTI will likely rest on a strong and perhaps increasing supply base, Brent’s physical underpinning will become progressively shakier, and more Rube Goldberg-like. These different physical market trajectories will benefit WTI derivatives relative to Brent, and will also induce a shift towards using WTI as a benchmark in physical trades. Meaning that ICE is whistling past the graveyard. Or maybe they are just taking Satchel Paige’s advice: “Don’t look back. Something might be gaining on you.” And in ICE Brent’s case, that’s definitely true, and the gap is closing quickly.



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November 3, 2016

Jesus Just Left Chicago

Filed under: Sports — The Professor @ 7:03 pm

Last night occurred the greatest World Series game in modern memory. The good guys won.

My dad used to say “I wouldn’t stand in line to watch Jesus Christ pitch for the save in the 9th inning of the 7th game of the World Series.” (He never indicated whether that statement was conditional on the Cubs being in the World Series. Perhaps he thought that was a set of measure zero, and not because he didn’t believe in the Second Coming.) I guarantee that he would have stood in line for last night’s game, Jesus or no Jesus.

And speaking of The Savior, it looks like Jesus just left Chicago, after having performed a miracle. The Cubs did not make it easy, either in the series as a whole, or in the deciding game. They fell behind 3 games to 1. Then after a dicey win in game 5 and a semi-blowout in game 6, they got a 4 run lead in game 7, only to watch it fall apart with two outs in the 8th. After an agonizing rain delay, they raced out to score two runs in the 10th, and hung on to win. A truly miraculous comeback.

For my part, I was fairly laid back throughout the playoffs. This was, in retrospect, a psychological defense against yet another disappointment. But by the middle innings of game 7, what had appeared a remote prospect only a few days before seemed a real likelihood. I was no longer laid back, but instead hung on every pitch and watched with rising anticipation only to be crestfallen when the Indians tied it in the 8th. I sweated through the bottom half of the 9th, exulted during the top half of the 10th, and then hung on for dear life through a shaky bottom half.

Although I slept in late this morning, I awoke exhausted. I felt like I had played all 10 positions–including DH!–for all 10 innings.

It didn’t have to be that hard. Their defense–which some claim is the best in baseball history–had some breakdowns. I am loath to criticize Joe Maddon, given what the Cubs have achieved under his managing, but some of his moves in the last 2 games put me on edge. I couldn’t understand leaving in Chapman to pitch the 9th inning in game 6 with a 6 run lead. I figured they were very likely to need him in a tighter situation in game 7, and worried about him having little left in the tank on Wednesday after pitching extended stints in consecutive games. And so it was.

I groaned when he removed Lester in the 8th inning of game 7. He had retired the first batter on a routine grounder, struck out the next batter, and the hit he then surrendered was a weak infield grounder. He was still in command–leave him in until the tying run was at the plate, at least. They used to call Sparky Anderson Captain Hook for his haste in yanking pitchers. Madden makes Sparky look like a piker.

Then Chapman’s pitch selection freaked me out. Nothing but fastballs, even though Cleveland was not swinging and missing. I don’t care if you throw 100+: if you don’t change speeds major league hitters will eventually catch up with your fastball, and the Indians did. As my friend Tom Kirkendall pointed out, this might have been an indication of fatigue: tired pitchers are worried about hanging the breaking ball. But I seriously believe that it would have been better to throw an 89 MPH spinner than to throw only fastballs when hitters are sitting on them. (He got strikes on the 3d out in the 8th with his slider, and threw some good ones in the 9th as well.)

At the plate, I was mystified that Heyward–a double play waiting to happen–wasn’t bunting with a runner on first, especially since Maddon is usually fond of the bunt. Then Baez (on his own?) tries to bunt with two strikes and the lead runner on third.

I shudder to think what my blood pressure was at this point.

But all’s well that ends well.

Ben Zobrist drove in the go ahead run on a piece of excellent two strike hitting, and was named series MVP. Other than that hit (which is a big caveat, I know) he didn’t do much, so I don’t think he deserved it. If Chapman had held on, he would have won it in a walkover. But, as we know, he didn’t. I would have given it to Kris Bryant, who hit consistently and played an excellent third base. But he arguably won game seven with his legs: how often do you say that about a third baseman? He scored on a short fly ball to left, and from first on a Rizzo double. Those were not routine runs. They were truly difference makers in the game, but were sort of lost in the extra inning drama. And the smile on Bryant’s face when the game ending ground ball was hit to him will be an enduring memory.

What is perhaps most remarkable about the series is that a very young team came through in the clutch time and again. One would normally expect that a young team–and the Cubs are extremely young–would buckle after falling behind in the series and being on the schneid for the entire middle games, and especially in game 7 after surrendering a decent-sized lead. But they rallied in adversity. I can’t think of any parallel in recent baseball history. You couldn’t expect a veteran team to do what a collection of young players did.

One of the indications of youth throughout the series was a tendency to expand the strike zone, and to refuse to go with the pitch even though it was apparent that the Indians were intent on keeping it away, and even when a single would have been big. But last night, two of the biggest culprits–Contreras and Baez–drove the ball the opposite way on outside pitches and drove in runs, Contreras with a double, Baez with a homer.

When these guys mature and become more disciplined at the plate, the Cubs could have Murderers’ Row II.

I said at the outset that the good guys won. This is not to say that the Indians were bad guys, either in personality or performance. To the contrary. They were worthy and admirable adversaries. They didn’t lose. The Cubs won, and barely. The Indians played well, played hard, and have nothing to hang their heads about.

The Indians’ main weakness was depth in starting pitching. Kluber was excellent, but you can’t expect a pitcher to dominate the same team three times in a week. Familiarity doesn’t breed contempt, but it does tend to breed hits. The Indians’ other deficiency was outfield defense. A slip in right field in game 2. An Alphonse and Gaston routine in game 6 that allowed 2 runs to score. A high throw on the sac fly that Bryant scored on. When in Wrigley, Cleveland outfielders played the wall like it was covered in poison ivy, as if they were channeling old time Cub Lou “The Mad Russian” Novikoff.

“Wait ’til next year” was a recurrent theme in the Pirrong household, and in many other Cub fan households for literally decades. I will look forward to next year, but the waiting is over. After more than a century of futility, they have finally won it all. After years of looking forward to next year, 2016 is a year that all Cubs fans will look back on with fondness, for decades to come, even if success becomes the norm, rather than the extreme exception.

I know that there are many families like mine, for whom the championship came too late for a life-long Cubs fan to witness. I’ve already written about my dad and grandfather. A Naval Academy classmate wrote me that the experience was bittersweet, because his grandparents weren’t around to see it. I know there are many more like us. But I will rejoice not just for me, but for my dad. And my daughters (who have also become avid fans) will not have to regret that their dad never saw the Cubs win the World Series. For that I am deeply grateful.

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November 2, 2016

God Exists. QED.

Filed under: Sports — The Professor @ 11:09 pm

He has just been testing my family’s faith for 108 years.

Fly the W. That has never happened when the season’s last out has been recorded.


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October 31, 2016

A Brexit Horror Story That Demonstrates the Dangers of Clearing Mandates

Filed under: Clearing,Derivatives,Economics,Regulation — The Professor @ 12:43 pm

When I give my class on the systemic risks of clearing, I usually joke that I should give the lecture by a campfire, with a flashlight held under my chin. It is therefore appropriate that on this Halloween Risk published Peter Madigan’s take on the effects of Brexiton derivatives clearing: it is a horror story.

Since the clearing mandate was a gleam in Barney Frank’s eye (yes, a scary mental image–so it fits in the theme of the post!) I have warned that the most frightening thing about clearing and clearing mandates is that they transform credit risk into liquidity risk, and that liquidity risk is more systemically threatening than credit risk. This view was born of experience, slightly before Halloween in 1987, when I witnessed the near death experience that the CME clearinghouse, BOTCC, and OCC faced on Black Monday and the following Tuesday. The huge variation margin calls put a tremendous strain on liquidity, and operational issues (notably the shutdown of the FedWire) and the reluctance of banks to extend credit to FCMs and customers needing to meet margin calls came perilously close to causing the CCPs to fail.

The exchange CCPs were pipsqueaks by comparison to what we have today. The clearing mandates have supersized the clearing system, and commensurately increased the amount of liquidity needed to meet margin calls. The experience in the aftermath of the surprise Brexit vote illustrates just how dangerous this is.

As a result of Brexit, US Treasuries rallied by 32bp. The accompanying move in swap yields resulted in huge intra-day margin calls by multiple CCPs (LCH, CME, and Eurex). Madigan estimates that these calls totaled $25-$40 billion, and that some individual banks were asked to pony up multiple billions to meet margin calls from multiple CCPs. And to illustrate another thing I’ve been on about for years, they had to come up with the money in 60 minutes: failure to do so would have resulted in default. This provides a harrowing example of how tightly coupled the system is.

Some other crucial details. Much of the additional margin was to top up initial margin, meaning that the cash was sucked into the CCPs and kept there, rather than paid out to the net gainers, where it could have been recirculated. (Not that recirculating it would have been a panacea. Timing differences between flows of VM into and out of CCPs creates a need for liquidity. Moreover, recirculation by extension of credit is often problematic during periods of market stress, as that’s exactly when those who have liquidity are most likely to hoard it.)

Second, each CCP acted independently and called margin to protect its own interests. With multiple CCPs, there is a non-cooperative game between them. Each has an incentive to demand margin to protect itself, and to demand it before other CCPs do. The equilibrium in this game is inefficient because there is an externality between CCPs, and between CCPs and those who must meet the calls. This is ironic, because one of the alleged justifications for clearing mandates was the externalities present in the OTC derivatives markets. This is another example of how problems have been transformed, rather than truly banished.

This also illustrates another danger that I’ve pointed out for some time: building the levies high around CCPs just forces the floodwaters somewhere else.

Although there were some fraught moments for the banks who needed to stump up the cash on June 24, there were no defaults. But consider this. As I point out in the Risk article, Brexit was a known event and a known risk, and the banks had planned for it. Events like the October ’87 Crash or the September ’98 LTCM crisis are bolts from the blue. How will the system endure a surprise shock–especially one that could well be far larger than the Brexit move?

Horror stories are sometimes harmless ways to communicate real risks. Perhaps the Brexit event will be educational. Churchill once said that “Nothing in life is so exhilarating as to be shot at without result.” The market dodged a bullet on June 24. Will market participants, and crucially regulators, take heed of the lessons of Brexit and take measures to ensure that the next time it isn’t a head shot?

I have my doubts. The clearing mandate is a reality, and is almost certain to remain one. The fundamental transformation of clearing (from credit risk to liquidity risk) is an inherent part of the mechanism. It’s effects can be at most ameliorated, and perhaps the Brexit tremor will provide some guidance on how to do that. But I doubt that whatever is done will make the system able to survive The Big One.

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October 30, 2016

Hillary’s the One!

Filed under: Politics — The Professor @ 7:01 pm

No. I have not lost my mind and decided to come out in support of Hillary. The reference in the post title is to Richard Nixon’s 1968 campaign slogan, and Hillary epitomizes all of the worst of Nixon’s traits.

Nixon infamously said “if the president does it, it’s not illegal.” Hillary’s version of this is actually more ambitious: by deed, if not word, her credo is: “If Hillary does it, it’s not illegal.” The email saga is just the latest in a series of events going back almost 40 years (to her work on a Watergate committee, ironically) in which Hillary has acted as if the rules do not apply to her. Any rules. Any laws.

The Podesta emails reveal that even many of those around her were shocked and chagrined at her audacity to flouting the law and democratic and republican mores by operating a private server. But there was no adult who was willing to challenge her. Instead, everyone–and this arguably includes Obama, who corresponded (under an alias!) with her on her private email–enabled and excused her lawlessness.

One of Hillary’s rationalizations for her behavior is that everyone is out to get her–her paranoia is another Nixonesque trait. This most recent episode will only deepen that paranoia.

Which means that if Hillary is actually elected next Tuesday, the nation is in for a continuing series of these scandals. As president, her sense of entitlement and superiority to the law and paranoia will only only increase. In her mind, if Hillary does it, it’s not illegal, especially because she does it because otherwise her enemies (who are everywhere!) will destroy her.

Put differently, the woman is constitutionally unfit for any position of public trust, let alone the most powerful office in the land. Because of her constitutional unfitness, she is a walking (well, sometimes) Constitutional crisis.

The truly dispiriting thing about all this is that it is not news. The standard Clinton excuse for everything is “this is old news.” Well, Hillary’s defective character is very, very old news: the country has been on notice since at least 1993, and those paying attention knew about it well before that. Nonetheless, she was elected to the Senate from New York twice; appointed to the most senior cabinet position; nominated to run for president by the oldest political party in America; and is on the cusp of being elected president.

Hillary’s character failings are her responsibility alone. Tens of millions of people are responsible for the fact that she remains a carbuncle on the body politic. The most culpable are the alleged elite in this country, who plague us from their dens in DC, Manhattan, the Hamptons, Boston, and California. They are the main accessories in the degradation of the rule of law that is the result of the relentless rise of this woman who believes herself above the law.

One last thing. My comparison of Hillary to Nixon is terribly unfair to the latter. Hillary has none of the intelligence and strategic insight of Nixon. Hillary has ridden the coattails of her husband, whereas Nixon was as close to a self-made man as there has been in American politics in the 20th century. Most importantly, for all of his ethical and legal lapses, from time to time Nixon betrayed having a conscience: Hillary has exhibited no such weakness. (I think Obama knows this too. When the email scandal broke anew and Obama advised Hillary to “follow her conscience,” I think he was engaged in trolling on an epic scale.)

But this is the woman who, barring a staggering development in the most recent episode of the email saga, is likely to be the next president. God bless America. We’ll need it.

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October 29, 2016

James Comey: From Hero to Demon

Filed under: Politics — The Professor @ 9:02 pm

In July, FBI Director James Comey was a hero on the left. He made a contorted presentation of the law and the facts relating Hillary Clinton’s email in order to justify not recommending charging her with any crime. Yes, he said some very critical things about Hillary, but the end result was that she appeared to be out of legal jeopardy.

For her part, Hillary misrepresented what Comey had said, and claimed that he had found nothing discreditable about her conduct. That wasn’t true, but it didn’t really matter. What mattered was that this particular obstacle to her election appeared to have been cleared.

As a result, Comey was lionized on the left, and the Democrats attacked Republicans who criticized him. Donna Brazile, for instance, tweeted  link to a Washington Post article that claimed that Republican criticism of Comey was an attack on the rule of law.

But that was then! Now the left is in paroxysms of rage because yesterday–on a Friday afternoon, natch–Comey sent a letter to Congress claiming that new information found in the–get this–Anthony Weiner investigation had led him to re-open the Hillary investigation. Comey’s letter was equivocal and hedged, but the fact that 11 days before the election the email issue had risen from the dead (just in time for Halloween!) has unleashed leftist furies.

Hillary was informed of this new development while on her plane. She did not leave it for 25 minutes while it sat on the ground in Iowa. Maybe she was doing her best Keith Moon impersonation. You know she’s capable of it.

Yesterday and today the left has been out in full force, demonizing Comey for being a partisan hack attempting to throw the election to Trump. Yesterday I Tweeted in jest “Does the FBI work for the Russians?” because they have become the explanation for all of Hillary’s travails of late. (Joe McCarthy, call your office!) But some people apparently take this seriously. Like Howard Dean, who tweeted “Ironically, James Comey put himself on the same side as Putin.”

The absurdity just keeps on metastasizing.

And just how does this work, exactly? If Comey is a partisan hack intent on torpedoing Clinton and electing Trump, why would he twist himself into knots to exonerate her (well, at least put an end to any thought of charging her) in July? He could have well and truly put her in political peril then. Further, the accommodations he made to Clinton and her close staff were truly extraordinary, and would not have been extended to you or me or pretty much anybody other than Hillary. That’s hardly the kind of thing some partisan Javert would have done. This late in the day modified limited hangout is certainly not a welcome development to Hillary, but is not nearly as threatening as a recommendation to charge would have been in July.

So it is wildly implausible that Comey is attempting to swing the election. Washington being Washington, the most likely explanation for what Comey is doing is CYA. It’s what they do best on the banks of the Potomac.

There was no doubt tremendous discontent in the ranks at the way he handled the Hillary investigation. The (probably unexpected) discovery of information on Anthony Weiner’s and Huma Abedin’s devices would have come out eventually, and if Comey had sat on it until after the election there would have been a political explosion that would have cost him dearly. He also had to calculate that there was a high likelihood that some agent outraged at how the investigation had been handled would leak the new development, which would be the worst of both worlds for him: the information would be out, and it would look like he had tried to suppress it.

So I am guessing that Comey felt himself to be in the position of the weasel in a snare, and chewed off his leg to escape. Yeah, it’s not something he wanted to do, but given the alternatives, it was probably the best course of action available to him.

Just moments ago I read that the FBI did not have permission from Justice to actually read what they had discovered. Given its harrumphing today about how Comey violated department policy by taking actions that could affect an election, no doubt DoJ will not give such permission. And no doubt, Comey knew that they wouldn’t. He could therefore issue his CYA letter in the knowledge that its practical and legal ramifications would be very limited. Justice would stop the investigation dead in its tracks, meaning that no compromising information would be released before the election.

I therefore sadly conclude that this will mean little in the end. The most likely outcome is that Huma Abedin will be sacrificed to save the queen. But the queen will live. And James Comey will limp off into obscurity.


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October 27, 2016

Michael Morrel, One of Hillary’s Camp Followers Slouching Towards Washington

Filed under: History,Military,Politics — The Professor @ 8:19 pm

Back in the 1970s there was an entire genre in popular fiction, film, and television in which the CIA was the arch-villain, engaged in vast conspiracies to subvert free government at home or abroad. The stock personal villain in these works was invariably a tightly wrapped, bloodless, controlling, manipulative and often psychopathic CIA official.

At the time, I was not a big fan of these dramas. They were formulaic and seemed overwrought. But I am reconsidering that after the recent rise to public prominence of one Michael Morrel, the ex-deputy director of the CIA. Morrel is straight out of 1970s central casting–tightly wrapped, bloodless, controlling, manipulative and arguably psychopathic.

Morrel is hell-bent on getting the US involved neck-deep into the wars in Syria and Yemen, including doing things that would run the risk of a war with Russia. In August, he advocated killing Russians and Iranians in Syria, “to make them pay a price”:

“The Iranians were making us pay a price. We need to make the Iranians pay a price in Syria. We need to make the Russians pay a price.”

He went on to explain making them “pay the price” would mean killing Russians and Iranians, and said he wants to make Syrian president Bashar al-Assad uncomfortable.

“I want to go after those things that Assad sees as his personal power base. I want to scare Assad.”

This is all but an open call for the US to engage in assassinations of Russians, Iranians, and Syrians in Syria. Perhaps Mr. Morrel missed the part about this being illegal since the 1970s.

Today he advocated intervening on the Saudi side in the war with the Houthis in Yemen, including boarding Iranian vessels. So apparently Mr. Morrel is totally on board with the US being Saudi mercenaries.

This is what America has come to. From fighting against Hessian hirelings to achieve independence, to advocating serving as hirelings for terror funding oil ticks engaged in a pointless war that does not involve American interests in the slightest–and which also risks bringing the US into a broader regional conflict that could easily escalate.

Morrel has also been out front of the attack on Trump’s national security credentials, including making the allegation (based on his ipse dixit alone, of course) that Putin recruited Trump as an “unwitting agent” of Russia.

Just like the stock 70s CIA villain, Morrel obviously burns with ambition. He clearly wants to be Hillary’s CIA director and is willing to say anything to achieve that ambition. Of course, she already owes him, for Morrel was deeply involved in altering the Benghazi talking points in order to support her false version of events.

The thought of someone like Morrel as head of CIA is deeply disturbing. The thought that he likely reflects Hillary Clinton’s foreign policy instincts is doubly so. For getting involved deeply in Syria to overthrow Assad (and confronting the Russians to do so) and in Yemen to advance the Saudi proxy war against Iran are decidedly not in American interests, and would likely result in the waste of great amounts of American blood and treasure, for no strategic purpose whatsoever.

I have long said that you don’t have to worry just about the candidate that is elected to the presidency: you have to pay close attention to her or his camp followers who upon her/his election would be ensconced throughout the vast government bureaucracy, where they can do untold damage with little prospect of being held to account. Michael Morrel epitomizes these dangers. He is a soulless, power-obsessed little man who cavalierly muses about embroiling America in pointless wars, and risking superpower confrontation to do so. He is one of Hillary’s most prominent camp followers. Think of what other ones are currently slouching their way towards Jerusalem on the Potomac in her train.

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October 26, 2016

China Has Been Glencore’s Best Friend, But What China Giveth, China Can Taketh Away

Filed under: China,Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 3:55 pm

Back when Glencore was in extremis last year, I noted that although the company could do some things on its own (e.g., sell assets, cut dividends, reduce debt) to address its problems, its fate was largely out of its hands. Further, its fate was contingent on what happened to commodity prices–coal and copper in particular–and those prices would depend first and foremost on China, and hence on Chinese policy and politics.

Those prognostications have proven largely correct. The company executed a good turnaround plan, but it has received a huge assist from China. China’s heavy-handed intervention to cut thermal and coking coal output has led to a dramatic spike in coal prices. Whereas the steady decline in those prices had weighed heavily on Glencore’s fortunes in 2014 and 2015, the rapid rise in those prices in 2016 has largely retrieved those fortunes. Thermal coal prices are up almost 100 percent since mid-year, and coking coal has risen 240 percent from its lows.

As a result, Glencore was just able to secure almost $100/ton for a thermal coal contract with a major Japanese buyer–up 50 percent from last year’s contract. It is anticipated that this is a harbinger for other major sales contracts.

The company will not capture the entire rally in prices, because it had hedged about 50 percent of its output for 2016. But that means 50 percent wasn’t hedged, and the price rise on those unhedged tons will provide a substantial profit for the company. (This dependence of the company on flat prices indicates that it is not so much a trader anymore, as an upstream producer married to a big trading operation.) (Given that hedges are presumably marked-to-market and collateralized, and hence require Glencore to make cash payments on its derivatives at the time prices rise, I wonder if the rally has created any cash flow issues due to mismatches in cash flows between physical coal sales and derivatives held as hedges.)

So Chinese policy has been Glencore’s best friend so far in 2016. But don’t get too excited. Now the Chinese are concerned that they might have overdone things. The government has just called an emergency meeting with 20 major coal producers to figure out how to raise output in order to lower prices:

China’s state planner has called another last-minute meeting to discuss with more than 20 coal mines more steps to boost supplies to electric utilities and tame a rally in thermal coal prices, according to two sources and local press.

The National Development and Reform Commission (NDRC) has convened a meeting with 22 coal miners for Tuesday to discuss ways to guarantee supply during the winter while sticking to the government’s long-term goal of removing excess inefficient capacity, according to a document inviting companies to the meeting seen by Reuters.

What China giveth, China might taketh away.

All this policy to-and-fro has, of course is leading to speculation about Chinese government policy. This contributes to considerable price volatility, a classic example of policy-induced volatility, which is far more common that policies that reduce volatility.

Presumably this uncertainty will induce Glencore to try to lock in more customers (which is a form of hedging). It might also increase its paper hedging, because a policy U-turn in China (about which your guess and Glencore’s guess are as good as mine) is always a possibility, and could send prices plunging again.

So when I said last year that Glencore was hostage to coal prices, and hence to Chinese government policy–well, here’s the proof. It’s worked in the company’s favor so far, but given the competing interests (electricity generators, steel firms, banks, etc.) affected by commodity prices, a major policy adjustment is a real possibility. Glencore–and other major commodity producers, especially in coal and ferrous metals–remain hostages to Chinese policy and hence Chinese politics.

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