Streetwise Professor

December 23, 2015

The WaPo Caters a Pity Party

Filed under: Politics — The Professor @ 11:41 am

This story in the WaPo is utterly infuriating, on many levels.

In a nutshell: A British “Asian” Muslim family was denied entry into the United States by DHS.

Rather than even acknowledging the possibility that DHS had a legitimate security interest in doing so, in an alleged news story the WaPo leapt into action, blaming Trump:

Ever since Donald Trump called for a “total and complete” ban on Muslims entering the United States, many people have decried the idea of excluding people from the country just because of their religion. Would such a policy, some wondered, be constitutional? Would it be American? Would it be decent?

Now, a British Muslim family headed to Disneyland has been prevented from traveling to the United States by the Department of Homeland Security. The Guardian reported that a family of 11, headed to the California resort from Britain’s Gatwick Airport, was unable “to board the plane even though they had been granted travel authorization online ahead of their planned 15 December flight.”

Trump had zero to do with this. FFS, it was the Obama administration’s DHS that barred them from the flight, and we have had plenty of evidence that the administration, and the DHS in particular, is consumed by political correctness that leads it to avoid anything that can be even remotely called profiling of Muslims. And it’s not as if the Obama administration genuflects to Trump: Obama has in fact sharply criticized Trump’s ban-all-Muslims gambit. If this DHS has issues with you, that’s saying something.

The WaPo raises the issue of whether the family was all UK citizens. As if that should matter.  let’s not forget that the UK has a huge homegrown radical Islam problem, rooted deeply in the Asian community. The UK government acknowledges this.

Another huge red flag is the fact that the family immediately went into full-blown victim mode:

“We were devastated,” Mahmood told the British TV station ITV. “We’d planned this trip for two months — the kids were excited — and all of a sudden some person just comes and says ‘you’re not allowed to board the plane,’ with no explanation.”

“We were alienated,” he added, “the way we were just taken out the room.”

Mahmood said the children were “devastated” and had “tears in their eyes.”

In an interview with the BBC, Mahmood said he was taken aside by a British border control official just before his family was due to board the flight — and that the children knew almost instantly what was happening.

“We were the only family that were Asian, Muslim appearance. It was embarrassing that we were the only family that were taken out,” he said. “When they saw me shaking my head, the younger ones started crying. They knew straight away.”

No American officials told them why they weren’t being allowed to enter the United States, Mahmood told the Guardian, but he said the reason was “obvious.”

“It’s because of the attacks on America — they think every Muslim poses a threat,” he told the newspaper.

All of this is hyperbolic and manipulative, but the last sentence is particularly egregious. Um, Mahmoud’s experience made the news because it is clearly the exception, not the rule. “Every Muslim” is not denied entry: very few are. Mahmood & family were denied entry.

There is another exception reported in the story, a certain Mansoor who was denied entry to the US, and who also played the victim for all it’s worth.

But rather than take a skeptical or merely even-handed approach to Mahmood and Mansoor, the WaPo catered the pity party.

And that does bring Trump into the story: this clueless political correctness in the political class and its media enablers is exactly what drives Trumpism.

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December 22, 2015

Embarrassing Silliness on Commodity Market Financialization in the FT

Filed under: Commodities,Derivatives,Economics,Energy — The Professor @ 8:04 pm

Satyajit Das writes some smart things. He also writes some silly things. This article in the FT is definitely in the silly category. Embarrassing is more like it.

Das claims that “increased financialisation” has “exacerbated” the downturn in commodities. What does he mean exactly?

Let’s start with the what Das means by financialization. (I’m ‘Merican and I’ll spell it like a ‘Merican, dammit!) This has become a term of art to mean traditional financial investors (pension funds, hedge funds, retail investors etc.) taking on direct exposure to commodity price risks, usually via derivatives (including ETFs). But Das treats anything touching finance as financialization. His use of the word is so broad as to be meaningless.

Cash flows from future sales were monetised to raise large amounts of debt to finance expansion. The collateral value of commodities secured expansion in borrowing and trading.

Uhm, when has this not been true in commodities? Commodity production tends to be highly capital intensive, which requires, you know, capital, which requires tapping the capital markets to, you know, fund. Since the dawn of capital markets, lenders and equity investors have mobilized savings to supply capital to miners, drillers, etc., to fund the digging of mines and the drilling of wells, based on the expectation of being paid back from cash flows from future sales. That’s exactly what finance is. If that is “financialization,” pretty much everything is “financialized” and the term is so general as to lack all meaning and analytical bite.  Modern markets have always been financialized in this way.

Natural resource firms have long been major users of the capital markets. Indeed, many of the earliest stock and bond markets developed to finance commodity investments, and mining and E&P firms have long been leading names in major stock and bond markets. In that respect, commodities have been financialized a lot more for a lot longer than most sectors of the economy.

In fact, it is the very capital intensity of extractive industries (which made natural resource firms reliant on capital markets from the first) that  explains the boom-bust cycle. Most of the costs of natural resource extraction industries are sunk costs. Literally sunk: very expensive, very long-lived holes in the ground that can’t be undug and used for something else. If demand turns down after these investments are made, it usually makes economic sense to continue operating , because the variable costs of operation tend to be relatively low and can be covered even when prices are low. Since the capacity is long-lived, exit does not occur, meaning that low prices can persist for long periods. But that’s economically efficient when investment is largely irreversible.

Which brings me to Das’s next groaner:

The need to maintain cash flow to service debt requires production levels to be maintained, even if it is below cost. This delays the withdrawal of supply and correction of prices. It also destroys the value of equity, making it difficult for firms to raise new capital to reduce debt.

Producing “below cost” (by which I assume he means continuing to produce when prices are below cost) destroys cash flow, rather than maintains it, if cost is measured properly. It is optimal to operate as long as prices cover avoidable costs (e.g., variable costs, and fixed costs that must be incurred as long as output is positive), even if prices are below some measure of accounting cost which typically embeds sunk costs: you can’t judge economic operation by looking at income statements, which have sunk costs baked in.

This kind of continued operation doesn’t “destroy the value of equity.” To the contrary, it is shutting down when price more than covers avoidable cost that destroys the value of equity. The fact that avoidable costs in natural resource extraction tend to be low relative to total costs means that not exiting even when prices are low is economically efficient.  (Another implication of the cost structure of natural resource production is that it is typically efficient to produce either at capacity or shut down altogether.)

Debt costs reflect the sunk costs of investment. Sometimes–like now–cash flows are insufficient to cover the costs of servicing this debt for many firms. That’s what bankruptcy laws are for. If they work well, the continued operation (or not) of insolvent firms will depend on current and expected future margins between price and avoidable costs, not the Ghost of Sunk Costs Past.

Then there’s this:

For industries like shale gas and oil which were cash flow negative even at high oil prices because of the need to invest in new wells to maintain production, reduction in the supply of capital affects the ability of firms to operate.

Again, Das is apparently utterly confused about the proper cash flow concept to apply. If “maintain production at all costs” was truly the mantra of the E&P industry, the problem would not be financialization, but management retardation. Finance would be implicated only to the extent that financiers are similarly retarded and gladly shovel good money to them to permit continued value destruction. If anything, it is the need to access the capital markets that prevents retarded managements from wreaking havoc: few things are more destructive of value than CEOs with bountiful free cash flows that relieve them of capital market discipline. Cutting off capital from negative NPV projects is a boon, not a burden.

Finally we get to derivatives!:

Hedging ameliorated the effect of declining prices. Derivative gains contributed in excess of 30 per cent of revenues in the US shale industry in 2015

And this is a problem why? This is exactly the way “financialization” is supposed to work. It transfers price risks to those (namely, well-diversified financial investors) who can bear them at a lower cost. Yes, investment probably would have been lower, and prices higher, had this risk transfer mechanism not existed. But this doesn’t mean that the level of investment with an efficient risk transfer mechanism is too high: it means that the level of investment without one is too low.

More bad derivatives stuff:

Margin calls further complicate matters. An airline that has hedged future oil purchases at high prices may face margin calls that make unexpected claims on its cash flow.

Yes, cash flow mismatches on hedges can be a problem. Which is exactly why corporate end users strongly preferred (and prefer) OTC hedges which embedded credit to mitigate these problems.

More financialization evils, according to Das:

Financialisation altered fundamental industrial structures. Traditionally high barriers to entry, such as technology, expertise and access to capital, led to domination by large producers who planned and controlled production.

Now specialised resources service firms provide access to technology and the willingness of capital markets and non-traditional lenders to provide finance allows easier entry resulting in a more fragmented industry.

These are features, not bugs! These are benefits of financialization! Breaking down oligopolistic and monopolistic market structures is good, not bad!

At the same time, trading in financial claims on future commodity cash flows has encouraged institutional investment in the sector as part of diversification into new asset classes. Hedge funds and trading firms now act as quasi banks financing and facilitating risk management by commodity market participants.

So facilitating the flow of capital from savers to investors is a bad thing? Facilitating risk management is bad too? Who knew?

This is just bizarre:

This activity is marked-to-market daily or secured by the value of the commodity. Any change in value can trigger calls for additional collateral complicating cash flow management or force liquidation of holdings. Capital market investors may lack the ability to ride out prolonged corrections. It complicates dealing with financial distress and the necessary restructuring.

Tapping into a deeper pool of capital, which financialization (as defined by Das) allows, spreads the risks and makes it easier to ride out prolonged correction (which, again, are an inherent consequence of the cost structures/operational leverage of natural resource extraction), not harder. And the statement about complicating dealing with financial distress and restructuring is completely conclusory, with no supporting argument or evidence.

Yes, in a world with poorly developed financial markets, large scale investments in industries characterized by irreversibility and large scale (like natural resource extraction) are expensive to fund. “Financialization”–which in Das’s expansive usage, apparently just means lower cost access to bigger pools of investment and risk capital–indeed leads to a bigger natural resources sector. Yes, by its very nature this sector will inevitably go through protracted periods of low prices, which will impose losses on investors. But that’s a risk that they willingly choose to bear, in exchange for an expected return that they consider compensatory.

Das appears to be afflicted with Bastiat Disease, i.e., the inability to distinguish between the seen and the unseen. Das sees the financial carnage that the current natural resources depression has created, but hasn’t considered what would happen if the world was less financialized. What are the unseen consequences of that?

I can tell you: a poorer world.

There are some forms of finance that are wealth-destroying rent seeking. The financing and risk management of the production of minerals and energy are not among them.

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December 21, 2015

Adam Smith Goes to Syria: How Bad Government Policies Turned Drought Into Famine

Filed under: Climate Change,Commodities,Economics,Energy,History,Politics,Regulation — The Professor @ 7:39 pm

The myth that global warming caused a drought which caused the civil war in Syria has been flogged repeatedly by the left, especially in the lead-up to the Paris farce: another example of the “elites” letting no good crisis go to (political) waste. As I discussed in March, there was indeed a drought in Syria, but no credible scientific evidence links the drought to climate change.

Droughts happen. What turned the drought into catastrophe in Syria was the depletion of groundwater by previous government-driven efforts to spur production:

Syria was such a successful producer that it became a net exporter of wheat for the better part of two decades — almost unheard-of in a region where most governments imported cheap wheat from abroad. According to ICARDA Director General Mahmoud Solh, the increased productivity netted the Syrian government more than $350 million a year . The country also kept a strategic reserve of wheat — usually about 3 million metric tons, enough to get it through a lean year or a price spike. In this most stable of dictatorships, nobody dreamed of a war.

But all that productivity came at a price. To produce these remarkable gains, Syria’s agricultural sector “mined” groundwater to irrigate farms. Experts predicted that this would lead to severe water Shortages. When a four-year drought struck in 2006, devastating 60 percent of Syria’s agricultural lands, the country’s groundwater was already depleted.

(This sounds a lot like Soviet agricultural malpractice.)

This brings to mind Adam Smith’s argument that bad government policy turns “dearths” caused by nature into famines:

The seasons most unfavourable to the crop are those of excessive drought or excessive rain. But as corn grows equally upon high and low lands, upon grounds that are disposed to be too wet, and upon those that are disposed to be too dry, either the drought or the rain which is hurtful to one part of the country is favourable to another; and though both in the wet and in the dry season the crop is a good deal less than in one more properly tempered, yet in both what is lost in one part of the country is in some measure compensated by what is gained in the other. In rice countries, where the crop not only requires a very moist soil, but where in a certain period of its growing it must be laid under water, the effects of a drought are much more dismal. Even in such countries, however, the drought is, perhaps, scarce ever so universal as necessarily to occasion a famine, if the government would allow a free trade.

It as not just the  Syrian government that contributed to spiraling food prices which created popular unrest in the Middle East that culminated in 2010-2011 (which the Muslim Brotherhood exploited in Egypt and Syria in particularly): US government policy contributed to the problem. In particular, US biofuels mandates that stimulated the production of ethanol drove up the price of corn by an estimated 30 percent, and as Brian Wright has shown, drove up all other grain prices as well (because corn is a substitute for other grains in both consumption and production). (I strongly recommend reading at least the introduction of the Wright paper: I’d quote in detail, but the online versions embed some devious feature that makes it impossible to copy-and-paste.)

It is sickly ironic that policies intended to reduce global warming pushed by the same crowd that falsely blame the Syrian drought and subsequent civil war on global warming (a) do nothing to reduce global warming, and (b) have done far more to exacerbate poverty and create social unrest  in the Middle East than global warming ever has or ever will.  Ethanol is an unmitigated disaster environmentally, economically, and socially. Yet the people Thomas Sowell trenchantly calls “the anointed” colluded with agricultural lobbies in the United States (encompassing both growers and processors) to inflict this monstrosity on the world.

How dare they–how fucking dare they–presume to lecture anyone on their obligations to “save the planet” and help the poor? Through biofuels policies alone they have inflicted huge misery and privation, and yet they have the audacity to try to exploit one of the consequences of these policies in order to ram more of their brilliant ideas down our throats.

Haven’t they done enough? Can they please now just go away?

Alas, we won’t be so lucky. These are our elites, after all, and we are stuck with them, like a case of malaria. And they are actually proud of stupid policies like biofuel mandates. There is no stupid that can equal the stupid of not just not learning from mistakes, but reveling in them.

Do you still wonder why the Trump phenomenon exists? The global reaction against the elites, of which Trump is just the most prominent example, is yet another baleful consequence of the failure of these so called elites. The reaction may be as bad as the disease, but let the blame fall where it should: squarely on the shoulders of those condescending fools whose allegedly good intentions have paved a superhighway to hell.

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December 20, 2015

Russia v. Ukraine: Will the Concept of Odious Debt Have Its Day in Court?

Filed under: Economics,History,Politics,Russia — The Professor @ 4:39 pm

Ukraine has announced that it will default on the $3 billion debt to Russia incurred in the waning days of the Yanukovych government–or is it regime? For that distinction could prove to be important.

It is somewhat surprising to me that as of yet Ukraine has not formally invoked the concept of “odious debt,” even though it seems apposite. Although there were earlier legal precedents (notably, US repudiation of Cuban debts incurred by the Spanish government prior to 1898), the concept was formalized in the 1920s by (ironically) a Russian emigre, Alexander Nahum Sack. Sack wrote:

When a despotic regime contracts a debt, not for the needs or in the interests of the state, but rather to strengthen itself, to suppress a popular insurrection, etc, this debt is odious for the people of the entire state. This debt does not bind the nation; it is a debt of the regime, a personal debt contracted by the ruler, and consequently it falls with the demise of the regime. The reason why these odious debts cannot attach to the territory of the state is that they do not fulfil one of the conditions determining the lawfulness of State debts, namely that State debts must be incurred, and the proceeds used, for the needs and in the interests of the State. Odious debts, contracted and utilised for purposes which, to the lenders’ knowledge, are contrary to the needs and the interests of the nation, are not binding on the nation – when it succeeds in overthrowing the government that contracted them – unless the debt is within the limits of real advantages that these debts might have afforded. The lenders have committed a hostile act against the people, they cannot expect a nation which has freed itself of a despotic regime to assume these odious debts, which are the personal debts of the ruler.

The key criteria established by Sack fit in the Ukraine-Russia case quite well. Yanukovych’s regime quite clearly utilized the debt to “strengthen itself” and “to suppress a popular insurrection.” If anything, the debt was used contrary to the interests of the nation. Putin provided the debt in order to make it financially feasible for Yanukovych to reject an EU association agreement, even though this agreement was widely popular in Ukraine. Furthermore, it is quite clear that the lender–Russia/Putin–were knowledgeable of the purposes for which the debts were “contracted and utilised.” Indeed, Putin offered the loan precisely in order to achieve these purposes, which suited Russia.

Russia, of course, argues that Yanukovych’s government was legitimate, and the current government is an illegitimate regime. Given the history, the facts seem to be on Ukraine’s side.

If the case proceeds, I anticipate that Ukraine will eventually invoke this doctrine. At the very least, it would strengthen its negotiating position.

Putin evidently has given up on a wholesale invasion of Ukraine, or even the eastern Ukrainian regions that he once (but no longer) referred to as Novorossiya. Militarily it was likely to be too difficult, and it would likely lead to further western measures that crush the already weakened Russian economy.

Instead, Putin is resorting to measures to prevent the consolidation of the Ukrainian state. The conflict in Donbas is kept on simmer. There is evidence of Russian active measures in the parts of Ukraine under government control. To these military and paramilitary means, Putin is adding economic conflict. Last week he announced that Russia was suspending a free trade agreement with Ukraine. Russia’s rigid negotiating stance on the $3 billion loan is another way of weakening Ukraine, and also creating strains between the Ukrainian government and the west (in the form of the IMF). Rather than striking a death blow, Putin is inflicting multiple ulcers on its recalcitrant neighbor.

Unfortunately, Ukraine is adding self-inflicted wounds to those dealt them by Putin. In particular, it has failed signally in its attempts to get corruption under control. Oligarchs still control the country. Struggles between oligarchic factions are reflected in bitter conflict in the Rada, culminating in the farcical events of last week, when a legislator lifted up Prime Minister Arseniy Yatsenyuk (grabbing him in a very delicate place in the process) while Yatsenyuk was addressing the parliament. Ukraine keeps copious quantities of inflammables piled up, making Vlad the Arsonist’s job very easy. Old Sovok habits die hard, and Putin is exploiting that.

Realpolitik, geopolitics, and western exhaustion and frustration with Ukrainian dysfunction are leaving Ukraine increasingly isolated. This is why Putin is pushing on many fronts, including on the matter of the $3 billion of debt. Ukraine’s best legal option is to declare the debt odious, and fight it out in court. It will at least buy time, and it has a reasonable chance of success given the, well, rather odious history of this loan.

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The Crude Export Ban Is Gone, But Don’t Get Your Hopes Up

Filed under: Commodities,Energy,Politics,Regulation — The Professor @ 2:50 pm

Well, ding dong the wicked export ban is dead. The repeal was included in the wretched omnibus deal passed in the dead of the night last week.

As a matter of economic principle, banning the ban is a good thing. Trade restrictions are almost always inefficient, and the oil export ban was no exception to that rule. In the near term, however, the practical impact of the sunsetting of the ban will be limited. At present, Louisiana Light Sweet is trading about par with Brent on a spot basis, and at only a few cents discount on a forward basis. Even given the quality premium for LLS, the differential is too narrow to make it economical to transport oil to Europe. This situation differs dramatically from the conditions that sparked the move to eliminate the ban, namely, a double digit discount of US oil prices from Brent.

The narrowing of the spread was due to many factors, but probably the most important of these was the fact that although oil exports were banned, exports of refined products were not. The low domestic oil prices made refining, including refining for export, to be very profitable. This encouraged investment in refining capacity that increased the demand for US crude, which narrowed the spread.

The repeal of the ban essentially creates an option, and this option is valuable. Although exporting crude is not economic now, it will be in response to some economic shocks. For instance, a disruption of European supplies, a spike in US production, or a big refinery outage in the US would all tend to depress the US price relative to the price in Europe, and if the shock is big enough, this could open the arb.

As for those who think that the lifting of the ban will help US producers in their hour of need, get ready for disappointment. The price difference between the export and no-export worlds is capped by the no-export-world spread: if absent the ban the price difference is greater than transportation costs, lifting the ban raises the domestic price and lowers the foreign price until the spread equals the cost of transport. When the arb channel is closed (as is currently the case), lifting the ban has no effect. Any price effect from lifting in the ban will occur in the future, and will be contingent on future supply and demand conditions. My guess is that the elimination of the ban will periodically give a couple of bucks boost to the US oil price. Not a huge deal.

The lifting of the ban will help traders, to the extent that arbs periodically come into play. It will also periodically benefit infrastructure owners (e.g., pipelines, terminals, and ports) that hand exports. Refiners  will lose when the arbitrage opens: this is why the compromise included a modest tax break for refiners, to secure their support.

Perhaps the biggest losers are those who bet on the continuation of the ban by building condensate splitters: minimally processed crude and condensate could be exported, so the splitters were a way to circumvent the ban. They are now white elephants, as the crude can be exported directly.

All in all, the lifting of the ban is not a big deal. Perhaps the main effect of this development, at least in the short term, is to show that 239 years after the publication of the Wealth of Nations, bad arguments about trade survive and even thrive. But even this didactic effect is overshadowed by circumstances, because the continued success of Trump shows the same thing, and much more forcefully.

In sum, I’m glad to see the ban go, but am underwhelmed by the near-term effects of its demise.

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December 16, 2015

Barack “The Bourbon” Obama: Learning Nothing, Forgetting Nothing

Filed under: History,Military,Politics — The Professor @ 9:53 am

The linchpin of Obama’s recalibration of his anti-ISIS campaign (for it is little more than that) is the deployment of US special operations forces in direct actions targeted on ISIS leadership. This represents further proof of Obama’s intellectual rigidity, and his utter inability to learn from experience–or to admit error.

For this is exactly what Obama did in Afghanistan starting in 2009:

Each year during the Afghan “surge” that President Barack Obama initiated in 2009, one declassified document shows, the manhunting task force ran many more missions than the year before–about two per night countrywide in August 2009; six per night a year later, when the Norgrove mission went south; and eleven per night a year after that, at the time of the “Extortion 17” tragedy. By 2011, the JSOC task force numbered more than 3,800 personnel — huge in special operations terms, but still just 2.4 percent of the overall U.S.-led force in Afghanistan, as one briefing slide notes.

Accompanying the overall surge was a “Ranger surge” that put more and more platoons of the elite light infantry regiment into the field alongside the SEALs, allowing more targets to be struck. Operators from the Army’s Delta Force were present as well, some of them providing what a JSOC staff officer calls a “very special capability”: the ability to track a moving convoy of cars or trucks by helicopter and raid it on the go, as depicted in the movie “Black Hawk Down” and numerous YouTube videos. The documents describe one joint Delta-Ranger team specializing in this task as an “expeditionary targeting force”—the same term defense secretary Carter used this week to describe the new JSOC raid force deploying to Iraq.

 

And this has accomplished what, exactly? The Afghanistan hamster wheel spins and spins and spins, regardless of how many SEAL and Ranger raids are mounted, and how many “high value targets” are killed. The main result of these operations–if “successful”–is to provide promotion opportunities for aspiring guerrillas and terrorists. It certainly has not changed things on the ground.

Actually, the operations have accomplished something: getting highly trained and difficult to replace special operators killed and maimed and just worn out. The details of the operations were only discovered because they were included in FOIA’d reports about two raids that went horribly wrong.

But faced with another difficult situation, this time in Syria and Iraq, rather than contemplating soberly the all pain, no gain lessons of the “Expeditionary Targeting Force” model in Afghanistan, Obama goes to it again.

What Talleyrand said of the Bourbons applies with even greater force to Obama: He has learned nothing, and forgotten nothing.

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Russia’s Shambolic Logistics in Syria

Filed under: Military,Politics,Russia — The Professor @ 9:39 am

In responding to Micheal Weiss’s idiotic hyperventilating (but I repeat myself) about Russian intervention in Syria, I quoted the old adage: Amateurs talk tactics, professionals talk logistics.  I noted that logistics severely constrained Russia’s military capacity in Russia. Look no further than this for evidence of how shambolic Russia’s logistics are:

Earlier this year, an old refrigerator ship called the Georgiy Agafonov, built to transport fruit and vegetables for the Soviet Union, was quietly gathering rust in the Ukrainian port of Izmail where the Danube flows into the Black Sea.

Its owners, a Ukrainian state company, assumed it would never sail again. When a Turkish company offered to buy it for $300,000, they watched as the hulk was towed away, presumably for scrap.

Nine months later the ship is back at sea, renamed Kazan-60, reflagged as part of Russia’s naval auxiliary fleet, and repurposed as an unlikely part of Moscow’s biggest military operation outside the old Soviet boundaries since the Cold War.

. . . .

The need for the extra cargo ships arose because Russia’s warships did not by themselves have enough capacity to supply the mission, said Vasily Kashin, senior research fellow at the Moscow-based Centre for Analysis of Strategies and Technologies.

“Before we had to use amphibious landing ships to carry supplies to Syria. But now they are not sufficient and we are creating a new class of military transports which are part of the navy but in fact are pure cargo ships,” he said.

An icebreaker called the Yauza was also sent to the Mediterranean from the Arctic to beef up Moscow’s logistics. According to publicly available shipping data, it made two trips to Syria in October and November.

Buying old cargo ships gives Moscow more control than contracting out its transport to commercial carriers, said Gerry Northwood, chief operations officer with British maritime security firm MAST.

 

Russia has utilized some flashy weaponry–such as surface and submarine launched cruise missiles–in its Syria campaign. But this is military Potemkinism, a dazzling facade that distracts from the shabby and creaking structure beneath. Especially now, with rumblings about Turkey closing the Bosporus to Russia, those freaking out about Russia’s involvement in Syria need to look beneath the facade, and understand how the realities of logistics, which have doomed far more campaigns than anything that has transpired on battlefields, fundamentally limit what Russia can even hope to achieve.

 

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December 9, 2015

Guns, Laws, and Money

Filed under: Politics,Regulation — The Professor @ 8:49 pm

The San Bernardino massacre unleashed an all-too-common phenomenon: literally (and I am using the word properly) before the bodies were even cold, politicians, pundits, and the hoi polloi (especially on Twitter) were using the atrocity to advance their own preferred narrative. The most common of these on the left was the gun control narrative. Hillary Clinton was one of the first off the mark to use San Bernardino to call for more stringent gun control measures. You know, before anyone–most notably one Hillary Rodham Clinton–knew anything about what had happened, beyond the fact that more than a dozen people had died. Obama was actually somewhat reserved, by his standards on this issue, and unexpectedly soft-pedaled his gun control message in his Oval Office speech on Sunday. But on the left the gun control drum was pounded for all it was worth, notably in a New York Times front page editorial.

Mass shootings like San Bernardino and Colorado Springs catalyze a flurry of calls for further restrictions on gun ownership, though these calls are frequently lacking in specifics, and are often more like ritual acts and political signaling of right-thinking (or should I say left-thinking?) views than concrete proposals. Moreover, mass shootings also unleash a volley of bad and misleading statistics. So bad, in fact, that those using them are almost certainly doing so in bad faith.

This phenomenon is not limited to activists, or the left generally. Even allegedly reputable mainstream publications like The Economist also peddle agitprop. The MO is to claim that mass shootings occur almost daily in the US: when brought up in the context of a Newtown or Aurora, the clear intent is to suggest that these types of mass shootings are representative. But even a cursory look shows that this is definitely not the case.

The mass-shooting-a-day statistics are based on a very expansive definition of mass shooting, such as three or more victims (not necessarily fatalities). Moreover, they lump together a very heterogeneous collection of episodes, which differ materially from the mass shooting events like those that have occurred in San Bernardino and Colorado Springs. For instance, they include gang drive by shootings or the likely gang-related shooting at a park in New Orleans 3 weeks ago. They also include a brawls at biker bars and other such criminal mayhem involving more than two people.

The one-size-fits-all term “mass shooting” doesn’t fit such varied phenomena, and one-size-fits-all-policies are unlikely to work either.  Indeed, even the most deadly mass shootings that get the most attention, are highly idiosyncratic. Newtown is very different from Colorado Springs is very different from San Bernardino is very different from Charleston is different from Fort Hood in terms of the perpetrators, methods,  and targets.

Contrary The Economist’s risible claim that “such atrocities are still drastically underreported,” the attention that  they get may arguably overstates their importance. The Newtown-type attacks  kill about as many Americans in a year as the average daily homicide toll. The United States does have a high murder rate (both gun and non-gun) compared to other high-income nations, although the rate has about halved in the last two decades.

Furthermore, murder, including murder with firearms, is not uniformly distributed across the US. To the contrary, it is highly concentrated geographically, and demographically. The statistics are quite shocking.

About 75 percent of murders occur in 3 percent of the counties in the US. Demographically, the concentration is even more pronounced. It is not exclusively, but overwhelmingly, a young, black, male phenomenon. The white murder rate is about 2.5 per 100,000. That’s roughly double of European rates, but not nearly as anomalous as the US rate overall. Indeed, white murder rates outside the South and Southwest are pretty much the same as European rates.

The truly horrific rates are among young black urban males, with especially high rates in Southern cities. Whereas the US firearms homicide rate is about 4/100,000, among African American men 20-24, it is almost 90. Yes: more than 22 times higher.  Even black women in that age cohort have a high rate, 7 per 100,000, or about 5 times the white female murder rate.

In sum, gun laws are fairly uniform across the United States, and gun ownership is widespread, but gun murder is not: if anything gun laws are most restrictive in places where gun crime is most rampant. Therefore, relatively easy access to guns is not sufficient to explain America’s elevated (compared to other OECD countries) murder rate. The regional and demographic variation shows that cultural and socioeconomic factors are important drivers. (The fact that non-firearm murder rates in the US are high compared to other countries, and also exhibit similar geographic and demographic variations reinforces this point.) Again contrary to The Economist, it is not true that “the link between guns and gun violence” is obvious. There are a lot of guns where there’s not a lot of violence. Guns don’t exercise a malign mesmeric effect on anyone who touches them. There is a mixture of social and cultural factors and guns that produce violence.

This tends to undercut the proposition that increasing restrictions on gun ownership will have much of an impact on murder rates. That said, even if other factors drive murder rates, greater restrictions on guns could still be beneficial: guns are complements to these other factors in the production of violence, including mortal violence, and the taxation of complements can be a way of reducing the frequency and severity of bad conduct produced using them.

But it is highly doubtful whether any remotely politically possible law–that is a law that would not have large effects on the hundred million-plus law-abiding gun owners in America, many of whom are very politically active–will have a meaningful impact on the pathologies that inflict many communities in the US.

In brief, it is evident that those who commit crimes with guns are highly inelastic demanders. Most of the high-murder rate localities already have draconian gun control laws, which include substantial penalties for violations. Furthermore, those most likely to kill (and be killed) with firearms are engaged in illegal conduct (e.g., drug dealing) that is subject to severe legal sanctions, and believe that guns are necessary for them to engage in this conduct. Thus, those most likely to kill with a firearm possess them despite the fact that they incur a large cost to do so. Further restrictions are unlikely to induce them to adjust on either the intensive or extensive margin (e.g., by changing “careers”), because they will lead to only small increases in the cost they incur to possess and use weapons.*

(Those bent on mass mayhem, be they terrorists, or psychotics, or narcissists looking for fame, or racist losers looking to spark a race war, are also likely to be inelastic demanders. These acts are the productive of obsessions that will drive those in their grip to go to great lengths to circumvent any attempt to prevent them.)

And we know prohibitionism doesn’t work. It didn’t work with alcohol in the 20s and 30s. It hasn’t worked with narcotics for decades. It doesn’t work with guns now, even in places like France, where terrorists clearly have had no problem obtaining deadly arsenals. (Take a look at reports of how many guns French and Belgian police seized in raids in the days after Friday, November 13.) The world is awash in guns. Guns that are quite functional for criminals are quite easy to manufacture. (Anybody remember the days when “Saturday Night Specials,” not Glocks or AKs were the bane of society–back when murder rates were far higher, by the way?) Those who think that passing laws against guns, including outright bans, will keep them out of the hands of those most likely to commit crimes with them–including mass murder–has their eyes closed to reality.

It is also ironic that many of those who are most vocal in calling for draconian restrictions on guns are also loudest in their condemnations of how the burdens of drug prohibitionism fall most heavily on minorities, who are imprisoned at high rates for drug crimes. Whom, pray tell, do they expect will be most frequently imprisoned for gun possession or trafficking, given that the same demographic is responsible for a greatly disproportionate fraction of gun crimes?

It should also be noted that minority communities are not enthusiastic about gun control, and for understandable reasons. Gun laws in cities like Chicago and DC are (a) almost wholly ineffective in curbing gun crime, and (b) render law-abiding people, mainly minority, defenseless against the (illegally) armed predators that live among them.

Americans recognize all this for the most part. Even though Obama and Hillary and others on the left furiously attempt to exploit any mass slaying to advance the gun control agenda, a solid (and growing) majority of Americans disagree. Indeed, they tend to vote with their wallets: a mass shooting, and political posturing about gun control, is followed by a spike in gun sales as surely as day follows night. Some wags have suggested that Obama must own shares in Ruger and Smith & Wesson, because he is so good for business.

The gun debate has become repetitive and sterile, more of a political Punch & Judy show than a constructive conversation. It is particularly appalling that innocent victims are seldom no more than political props in these debates.

Gun murders, which range from crimes of passion to political terrorism, are too diverse and complex to be addressed with simplistic, one-size-fits-all solutions. Prohibitionism, or draconian restrictions that approach prohibition–to the law abiding–despite (or is it because of?) its popularity on the left, is particularly counterproductive.

Murder, including murder by firearms, has declined substantially in the past 20 years. We should be grateful for that, and focus on ways to extend that decline: revising drug laws and punishments is likely to be a more productive way to do this than revising gun laws. But progress will at best be incremental. And the most difficult area to make progress will be mass shootings, given the extreme motivation of the perpetrators, and the diversity of their motives.

* This is related to the “Mickey Mouse Monopoly” effect that Walter Oi wrote about years ago. Oi noted that the demand for tickets to Disneyland was highly inelastic because the ticket itself contributed a relatively modest amount to the total cost of going to Disneyland. For everyone but locals, trip to the park required extensive travel (e.g., a plane trip or long car trip), lodging for several nights, dining out, etc. If the price of a ticket represented say 10 percent of the total cost of the trip, doubling the cost of a ticket only increased the cost of the entire trip by 10 percent. This made the demand for tickets inelastic. If the demand for a visit to Disneyland had an elasticity of 1, the demand for tickets had an elasticity equal to 1 times the share of a trip represented by the ticket. So if that share was 10 percent, the elasticity for tickets was only .1, meaning that Disney could raise ticket prices substantially without reducing the number of visitors much at all.

 

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December 7, 2015

Clearing Mandates: Would That Regulators Had Remembered Takeoffs are Optional, But Landings Are Not

Filed under: Clearing,Derivatives,Economics,Politics,Regulation — The Professor @ 9:41 pm

ln 2010 and 2011 I was a clearing Cassandra, sounding warnings about the potential systemic risks arising from clearing mandates. Prominent among those dismissing my criticisms were “macro prudential” regulators, notably the Federal Reserve and the Bank of International Settlements.

Things are rather different now. Regulators, including notably the Fed and the BIS, are now making the rounds expressing recognition, and arguably concerns, about systemic risks in clearing.

Case number one: Fed Governor Daniel Tarullo:

However, as has been frequently observed, if the financial system is to reap these benefits, the central counterparties to which transactions are moving must themselves be sound and stable. Extreme but plausible events, such as the failure of clearing members or a rapid change in the value of instruments traded by a CCP, could expose it to financial distress. If the CCP has insufficient resources to deal with such stress, it may look to its clearing members to provide support. But if the problems arise during a period of generalized financial stress, the clearing members may themselves already have been weakened or, even if they remain sound, the diversion of their available liquidity to the CCP may prevent customers of the clearing members from accessing needed funding. If the CCP fails, the adverse effects on the financial system could be significant, including the prospect that the CCP’s default on its obligations could amplify the stress on other important financial institutions.

. . . .

While the question of what constitutes the optimal default fund standard needs more analysis and debate, I think there is little question that more attention must be paid to strengthening stress testing, recovery strategies, and resolution plans for significant CCPs. The typical CCP recovery strategy does not take a system-wide perspective and is premised on imposing losses on, or drawing liquidity from, CCP members during what may be a period of systemic stress. Many of these members are themselves systemically important firms, which will likely be suffering losses and facing liquidity demands of their own in anything but an idiosyncratic stress scenario at a CCP. Moreover, in at least some cases, uncertainty is increased by the difficulty of estimating with any precision the extent of potential liability of members to the CCP, thereby complicating both their recovery planning and efforts by the official sector to assess system-wide capital and liquidity availability in adverse scenarios.

The failure of regulators to take a “system-wide perspective” in their analysis of systemic risk generally, and in the effect of clearing mandates on systemic risk in particular, was one of my oft-expressed criticisms.

Tarullo is an interesting case. When I made a presentation  expressing my warnings about the systemic risks of clearing before the Fed Board of Governors in October, 2011, Tarullo was sitting right next to me at the big table in the Fed Board Room. He was, to put it mildly, dismissive of what I had to say.

Glad to see he’s coming around.

Case number two: Fed Governor Jerome Powell. I was particularly pleased to see that Powell recognizes that the picture that was repeatedly used to sell the benefits of clearing is highly misleading because it fails to take a system-wide approach: I criticized this picture in presentations as early as 2011, and also in some published work. Though I would say that Powell still omits many of the other connections between major financial institutions in a cleared world.

More from Powell:

I am a believer in the potential benefits of central clearing under the right circumstances. But central clearing is not a panacea. Charts similar to that in Figure 1 are often used to illustrate the netting of exposures and simplification that central clearing can bring to an OTC market. The tangled and highly opaque picture of a purely bilateral market is replaced by the neat hub-and-spoke network in which a CCP is buyer to every seller, and seller to every buyer, allowing netting and greater transparency for participants and regulators alike. Of course, reality is not so elegant, as Figure 2 illustrates. There are multiple CCPs, even within product classes, and major dealers act as clearing members across a broad network of CCPs. Clearing members also perform a range of services for CCPs, including custody, liquidity provision, and settlement. By design, increased central clearing will concentrate risks in CCPs; it is essential that, as these risks accumulate, the CCPs build up their ability to manage them. It is often noted that CCPs made it through the recent financial crisis without direct government assistance. But many of their major clearing members did receive such assistance. CCPs must now plan for a world in which these large firms will fail and be resolved without government support.

. . . .

All of these efforts are directly aimed at strengthening FMIs. But the strength and resilience of a CCP ultimately depends on the strength and resilience of its clearing members. I’d now like to shift focus to the relationship between these market utilities and the institutions that use them.

Barring an operational event, CCPs only face credit or liquidity risk when one of their members fails to make a payment when due. Thus, one effective way to make a CCP safer is to make its members safer. In that sense, the post-crisis reforms that have greatly strengthened our largest and most systemically important banking institutions have directly benefitted CCPs and other FMIs.

This last part, of course, raises the obvious question: would measures to “[strengthen] our largest and most systemically important banking institutions” been sufficient to address macro prudential concerns about OTC derivatives, making unnecessary clearing mandates?

But the biggest, and most surprising case is the BIS:

Clearing though a CCP creates a centralised network of trading exposures. Conceptually, this may influence systemic risk in two main ways. First, central clearing may affect the propagation of an (exogenous) shock through domino effects: the losses deriving from a counterparty default could trigger further defaults and spread the shock through the system. Second, central clearing, and the associated risk management practices, may affect the likelihood and impact of endogenous “run and deleveraging” mechanisms even in the absence of an initial default. While, in practice, both mechanisms may interact, considering them separately helps us to understand possible changes in the nature of systemic risk.

. . .

For example, the size of a shock would matter for systemic risk to the extent that defaults inflict a liquidity shortage on a CCP. If one or more clearing members fail to meet their clearing obligations, the CCP itself must provide liquidity in order to make timely payments to the original trading counterparties. The CCP’s own liquid assets and backup liquidity lines made available by banks may provide effective insurance against liquidity shocks resulting from the difficulties of one or a few clearing members. But they can hardly provide protection in the event of a systemic shock, when a large number of clearing participants – potentially including the providers of liquidity lines – become liquidity-constrained, thereby triggering domino effects.

. . . .

A centralised structure of trading exposures may also affect the likelihood and nature of endogenous shocks in the form of forced deleveraging, fire sales and runs. The critical issue in this regard is the interaction between CCPs’ risk management practices and those of clearing participants. On the one hand, if stringent risk management by a CCP replaces lax counterparty risk management in bilateral markets, central clearing would tend to reduce the risk of such procyclical behaviour. On the other hand, an unexpected tightening of CCP risk management could still lead to liquidity pressures on participants that could ultimately trigger fire sales and a self-reinforcing deleveraging (Morris and Shin (2008)).

. . . .

Turning to the risk of endogenous deleveraging, the assessment of the impact of post-crisis trends is similarly ambiguous. The fact that an increasing share of trading positions is subject to daily variation margin payments has arguably reduced the risk that counterparties are confronted with sudden big losses, as was for instance the case with AIG. However, the shift towards the centralised risk management of trading positions, including collateralisation and high-frequency margining, is also likely to affect market-wide liquidity dynamics. For example, extreme price movements in cleared financial instruments could result in large variations in the exposure of clearing members to the CCPs and therefore in the need for some of them to make correspondingly large variation margin payments. Such payments can be large, even if margin requirements remain unchanged. But they may be exacerbated if the CCP increases initial margins and/or tightens collateral standards in the face of unusually large price movements.

 

I made all of these points, or closely related ones, going back as far as 2008-2009, at times to the disdain of the BIS. One example occurred when made a presentation at the Notre Dame Financial Regulation Conference in May, 2011, where two BIS economists said I was being alarmist. Another was at a conference sponsored by the BofE, ECB, and Banque de France in September, 2013.

So it’s nice to see them come to their senses.

The last point in what I quoted is particularly amazing. One BIS position that I have ridiculed was that variation margin flows created no liquidity demands because they were zero sum: every dollar paid by the loser is received by the winner, allowing the collateral to be recycled. Presumably by having the winners lend to the losers. Even overlooking the operational impossibilities of this, what’s the point of variation margin (which reduces credit exposure in derivatives contracts) if variation margins are funded by credit? And there are operational issues. Liquidity is needed precisely because payments are not frictionlessly and instantaneously recycled. Timing mismatches create a need for liquidity and credit.

So it’s particularly nice to see the BIS get beyond its risible dismissal of the possibility that variation margins can create systemic risks via a liquidity channel, and recognize that this is a serious issue. Because it is. The most important risk in clearing, in my opinion, and one that becomes even more important when regulators take other measures to protect CCPs.

All in all, it’s good to see regulators starting to grapple with the potential systemic risks inherent in clearing. It is better than continued cheer-leading, as was the norm from 2009 until very recently.

But that said, the time to start worrying about potential major design flaws in an aircraft isn’t when it is just reaching cruising altitude. Takeoffs are optional, landings are not. It’s best to make sure that a safe landing, rather than a crash, is highly likely before taxiing down the runway. In their wisdom, legislators and regulators in a hurry didn’t do that. They rushed a new, complex, and untested design into the air. Let’s hope that the newfound awareness of the potential risks allows them to make in-flight repairs and adjustments that will make a crash unlikely.

 

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December 5, 2015

Can You Shave an Islamist’s Beard With Occam’s Razor?

Filed under: History,Military,Politics — The Professor @ 12:10 pm

Not if the barber is Barack Obama. Two days after it was blindingly obvious that the atrocity of San Bernardino was a terrorist attack carried out by Islamists, Obama clung to the possibility that this was workplace violence (yeah, of the Nidal Hasan variety). He also grudgingly admitted that it was possibly terrorism, but even then he would not speak its name. Rather than name the specific ideology that inspired this brutal act, Obama retreated to his usual circumlocution of “people succumbing to violent extremist ideologies.” Then he descended into the vapidity of calling for more gun control: after all, no crisis should go to waste, right?

Truth be told: gun control will do nothing to impede people like Syed Farook and Tashfeen Malik, who broke numerous state and federal firearms and explosives laws, and who engaged in an attack that they knew would certainly result in their deaths. Such people (and I use that term loosely) are extremely infra marginal demanders of firearms and bombs. The increase in the cost of obtaining these instruments of mass mayhem caused by any even remotely plausible gun laws would still put that cost below their very high willingness to pay, and if they are not deterred by the prospect of violent death, the punishment for violating gun laws is clearly not going to deter them either.

Although Obama has seen fit to lecture us in the aftermath of Charleston, Sandy Hook, Ferguson, and even Louis Gates, for Christ’s sake, his statements in the aftermath of San Bernardino were limited primarily to his weekly radio address, recorded before he went to party down at the White House holiday party, with, among others, BLM luminary Deray McKesson. Priorities, you know.

One of the obvious early tells of the Islamist nature of the attack was that mere hours after Farook had been identified, his family members were participating in a press conference with Muslim Brotherhood front organization CAIR. Another tell came yesterday, when the Farook family’s scumbag lawyers gave a press conference that can be summarized as: “Who is the real victim here?” Hint: Farook, Malik and Muslims generally. After all, somebody teased Farook about his beard, and that might have set him off.

The administration picked up the victimhood narrative, with Attorney General Lynch saying that  her “greatest fear” is the “incredibly disturbing rise of anti-Muslim rhetoric” and promising to prosecute speech that “edges towards violence” (whatever the hell that means). So, along with trashing the Second Amendment, the administration has its sights set on the First. No doubt the 5th can be jettisoned too, if guns or politically incorrect speech are involved.

No doubt the administration’s denial of reality and its attempt to suppress speech has many causes. For one, San Bernardino totally contradicts the administration’s narrative on terrorism. For another, it creates serious problems for the administration’s plans to bring in large numbers of Syrian refugees. Within a few hours of her being named, Tafsheen Malik’s numerous family connections to Islamists in her home country of Pakistan and her adopted country of Saudi Arabia were documented. Pakistani intelligence said that the family had well known extremist connections: Now they tell us. Her father was an extremely conservative and rabidly anti-Shia immigrant to Saudi Arabia.

Yet the State Department and the immigration authorities failed to uncover these facts in their investigations of potential terrorism connections before granting her a fiancee visa. So yes, we can’t vet someone who has lived in countries with functioning governments that are (allegedly) our allies, but we can evaluate the risk of tens of thousands of people coming from a country embroiled in a  civil war, for whom it will be impossible to obtain any documentation whatsoever. And so much for the women pose no risk thing.

With Obama’s obduracy, we can expect more of the same. The demonization of domestic opposition, and the turning of a blind eye to real enemies within and without.

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