Streetwise Professor

March 15, 2016

A Prudent Gambler Cashes in His Chips

Filed under: Military,Politics,Russia — The Professor @ 3:08 pm

Putin has disconcerted many with his abrupt and unexpected announcement that Russia would be removing its “main forces” from Syria. Just what this means is unknown, for he also made plain that it would maintain its main bases there, an air station in Latakia Province, and the shambolic Tartus naval facility. What residual capability will remain is unclear, and it must be noted that planes that fly out today can fly back at some future date, which distinguishes this from the US withdrawal from Iraq.

I consider it somewhat amusing that those who shrieked loudest about Putin getting into Syria are now shrieking loudest about his getting out. I guess they are upset that he will not be so stupid as to get bogged down in a pointless and bloody war that does not advance his strategic objectives.

As someone (surprisingly to some) who was not fussed about Putin getting into Syria, I’m equally indifferent as to his departure. Having no emotional or ideological investment, it is of interest mainly as an opportunity to evaluate his strategies, and his prudence in executing them.

The most obvious explanation is that the risk-reward trade-off no longer favors Russian involvement. On the reward side, Putin has achieved his main objective, and staved off Assad’s destruction. Putin may well prefer that Assad (and Iran) not win decisively: a stalemate may (cynically) advance Russian interests by continuing to make Assad dependent on Russia, and preventing Iran from getting too big for its britches.

The direct costs of this intervention, though not large when compared to American expenditures in the ISIS campaign (let alone what was spent in Iraq and Afghanistan) are nonetheless material given Russia’s straitened economic circumstances. It is not just a choice between guns and butter. Russia has already announced a sizable cut in military procurement, so there is an element of a choice between expending weapons and buying new ones. Putin clearly believes that new weapons will give him leverage in the future, so he is husbanding his limited resources for that purpose, rather than spending a few millions daily to continue high tempo operations in Syria.

On the risk side, pushing the campaign to the point where Assad is on the verge of decisive victory would increase greatly the probability of an open confrontation with Turkey. This would pose large military risks (and costs) even viewed narrowly, and would also result in a highly unpredictable situation with Nato, the US, and the EU. The upsides in such a situation are hard to see, but the downsides are clear and large. Then there are the normal risks attendant to any military operation, including the risk of some strategically irrelevant but spectacular and embarrassing terrorist operation targeted at the Russians. Furthermore, continuing the campaign aggravates relations with the Saudis, which creates economic complications by infusing a geopolitical calculus into delicate negotiations over oil output (which is a first order economic issue to Putin).

Smart gamblers know when to cash in their chips and go home. Putin came to the table with limited objectives, and has achieved them. He can claim victory: why risk losing these gains, when few further gains are in prospect?

Just like his going in was a lot less complicated than people made it out to be, so is his departure: he is leaving because he achieved the limited objectives he set out in October. As for the war in Syria, it will likely continue to grind on and on, in part because Putin wants it that way. His is a cynical move, but since “victory” by either side would likely result in a retaliatory bloodbath (and a war among the “victors” if Assad is toppled), as horrific as the current situation is, it is not demonstrably worse than the alternatives on offer.

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March 9, 2016

Clearing Angst: Here Be Dragons Too

Filed under: Clearing,Derivatives,Economics,Exchanges,Financial crisis,Politics,Regulation — The Professor @ 3:21 pm

We are now well into the Brave New World of clearing and collateral mandates. The US clearing mandate is in place, and the Europeans are on the verge of implementing it. We are also on the cusp of the mandate to collateralize non-cleared swaps.

After years of congratulating themselves on how the Brave New World was going to be so much better than the Bad Old World, the smart set is now coming to grips-grudgingly, slowly-with the dawning realization that not all the financial demons have been slain: here be dragons too. From time to time I’ve written about regulators recognizing this reality. There have been several more examples recently indicating that this has become the new conventional wisdom. For instance, Bloomberg recently editorialized on CCPs becoming the New Too Big to Fail: meet the new systemic risk, not that different from the old systemic risk. The BoE is commencing a review of CCPs, focusing not just on financial risks but operational ones as well. Researchers as Citi are warning that CCPs need more skin in the game. Regulators are warning that CCPs have become a single point of aim for hackers as they have become more central to the financial system. Researchers at three central banks go Down Under back into the not-too-distant past to show how CCPs can get into trouble–and how they can wreak havoc when they try to save themselves. An economist at the Chicago Fed warns that CCPs create new risks as they address old ones. Even the BIS (which had been an unabashed clearing cheerleader) sounds warnings.

I could go on. Suffice it to say that it is now becoming widely recognized that central clearing mandates (and the mandated collateralization of non-cleared derivatives) is not the silver bullet that will slay systemic risk, as someone pointed out more than seven years ago.

This is a good thing, on the whole, but there is a danger. This danger inheres in the framing of the issue as “CCPs are too big to fail, and therefore need to be made fail-safe.”  Yes, the failure of a major CCP is a frightening prospect: as the article linked above about the crisis at the New Zealand Futures and Options Exchange demonstrates, the collapse of even a non-major CCP is not a cheery prospect either.

But the measures employed to prevent failure pose their own dangers. The “loser pays” model is designed to reduce credit risk in derivatives transactions by requiring the posting of initial margins and the payment of variation margins, so that the CCP’s credit exposure is reduced. But balance sheets can be adjusted, and credit exposure through derivatives can be-and will be, to a large extent-replaced by credit exposure elsewhere, meaning that collateralization primarily redistributes credit risk, rather than reduces it.

Furthermore, the nature of the credit can change, and in bad ways. The need to meet large margin calls in the face of large price movements  causes spikes in the demand for credit that are correlated with market disruptions: this liquidity risk is a wrong way risk of the worst sort, because it tends to occur at times when the supply of liquidity is constrained, and it therefore can contribute to liquidity crises/liquidity hoarding and can cause a vicious spiral. In addition, as the article on the NZFOE demonstrates other measures that are intended to save the clearinghouse (partial tearups, in that instance) redistribute default losses in unpredictable ways, and it is by no means clear that those who bear these losses are less systemically important than, or more able to withstand them than, those who would bear them in an uncleared world.

The article on the NZFOE episode points out another salient fact: dealing with a CCP crisis has huge distributive effects. This makes any CCP action the subject of intense politicking and rent seeking by the affected parties, and this inevitably draws in the regulators and the central bankers. This, in turn, will inevitably draw in the politicians. Thus, political considerations, as much or more than economic ones, will drive the response. With supersized CCPs, the political fallout from any measures adopted to save CCPs (including extending credit to permit losers to make margin calls) will be acute and long lived.

Thus, contrary to the way they were hawked in the aftermath of the crisis, CCPs and collateralization mandates are not fire-and-forget measures that reduce burdens on regulators generally, and central banks in particular. They create new burdens, as regulators and central banks will inevitably be forced to resort to extraordinary measures, and in particular extraordinary measures to supply liquidity, to respond to systemic stresses created by the clearing system.

In his academic post-mortem of the clearing during the 1987 Crash, Ben Bernanke forthrightly declared that it was appropriate for the Fed to socialize clearinghouse risks on Black Monday and the following Tuesday. In Bernanke’s view, socializing the risk prevented a more serious crisis.

When you compare the sizes of the CCPs at issue then (CME Clearing, BOTCC, and OCC) to the behemoths of a post-mandate world, you should be sobered. The amount of risk that must be socialized to protect the handful of huge CCPs that currently exist dwarfs the amount that Greenspan (implicitly) took onto the Fed balance sheet in October, 1987.

Put differently, CCPs have become single points of socialization. Anyone who thinks differently, is fooling themselves.

Addendum: The last sentence of the Bernanke article is rather remarkable: “Since it now appears that the Fed is firmly committed to respond when the financial system is threatened, it may be that changes in the clearing and settlement system can be safely restricted to improvements to the technology of clearing and settlement.” The argument in a nutshell is that the Fed’s performance of its role as “insurer of last resort” (Bernanke’s phrase to describe socializing CCP risk) during the Crash of 1987 showed that central banks could readily handle the systemic financial risks associated with clearing. Therefore, managing the financial risks of clearing can easily be delegated to central banks, and CCPs and market users should focus on addressing operational risks.

There is an Alfred E. Newman-esque feel to these remarks, and they betray remarkable hubris about the powers of central banks. I wonder if he thinks the same today. More importantly, I wonder if his successors at the Fed, and their peers around the world, share these views. Given the experience of the past decade, and the massive expansion of derivatives clearing world, I sure as hell hope not.

 

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March 7, 2016

Clear the Way: LSE (and LCH!) on the Block

The biggest news from the exchange world in a long time is the proposed merger between LSE and Eurex. Both entities operate stock exchanges, but that’s a commoditized business these days, and it’s not the real driver of the merger. Instead, LSE’s LCH.Clearnet, and in particular LCH’s SwapClear, are the prizes. LSE and Eurex also both have valuable index businesses, but its hard to see how their value is enhanced through a combination: synergies, if they exist, are modest.

There are potentially large synergies on the clearing side. In particular, the ability to portfolio margin across interest rate products (notably various German government securities futures traded and cleared on Eurex, and Euro-denominated swaps cleared through LCH) would provide cost savings for customers that the merged entities could capture through higher fees. (Which is one reason why some market users are less than thrilled at the merger.)

A potential competitor to buy LSE, ICE, could also exploit these synergies. Indeed, its Euro- and Sterling-denominated short term interest rate futures contracts are arguably a better offset against Euro- and Sterling-denominated swaps than are Bunds or BOBLs.

The CME’s experience suggests that these synergies are not necessarily decisive competitively. The CME clears USD government security and STIRs, as well as USD interest rate swaps, and therefore has the greatest clearing synergies in the largest segment of the world interest rate complex. But LCH has a substantial lead in USD swap clearing.

It is likely that ICE will make a bid for LSE. If it wins, it will have a very strong clearing offering spanning exchange traded contracts, CDS, and IRS. Even if it loses, it can make Eurex pay up, thereby hobbling it as a competitor going forward: even at the current price, the LSE acquisition will strain Eurex’s balance sheet.

CME might also make a bid. Success would give it a veritable monopoly in USD interest rate clearing.

And that’s CME’s biggest obstacle. I doubt European anti-trust authorities would accept the creation of a clearing monopoly, especially since the monopolist would be American. (Just ask Google, Microsoft, etc., about that.) US antitrust authorities are likely to raise objections as well.

From a traditional antitrust perspective, an ICE acquisition would not present many challenges. But don’t put it past the Europeans to engage in protectionism via antitrust, and gin up objections to an ICE purchase.

Interestingly, the prospect of the merger between two huge clearinghouses is making people nervous about the systemic risk implications. CCPs are the new Too Big to Fail, and all that.

Welcome to the party, people. But it’s a little late to start worrying. As I pointed out going back to the 1990s, there are strong economies of scale and scope in clearing, meaning that consolidation is nearly inevitable. With swaps clearing mandates, the scale of clearing has been increased so much, and new scope economies have been created, that the consolidated entities will inevitably be huge, and systemically important.

If I had to handicap, I would put decent odds on the eventual success of a Eurex-LSE combination, but I think ICE has a decent opportunity of prevailing as well.

The most interesting thing about this is what it says about the new dynamics of exchange combinations. In the 2000s, yes, clearing was part of the story, but synergies in execution were important too. Now it’s all about clearing, and OTC clearing in particular. Which means that systemic risk concerns, which were largely overlooked in the pre-crisis exchange mergers, will move front and center.

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February 27, 2016

The Last Shriek in the Retreat: Neocons Threaten to Leave the Republican Party

Filed under: History,Politics — The Professor @ 8:20 pm

Arch neoconservative Robert Kagan looks upon the Trump phenomenon with horror, and has declared his intention to leave the party and vote for Hillary Clinton. He has much company among fellow-neocons, and  #NeverTrump has become a thing on Twitter.

I guess Thomas Wolfe was wrong: you really can go home again. The neoconservative movement was begun by an assortment of leftists whose political home was the Democratic Party. They ranged from dyed-in-the-wool Trostskyists (or is it Trotskyites?) to New Deal Democrats. The rise of the New Left in the 1960s and 1970s left the soon-to-be-neocons marginalized within the Democratic Party, and they decamped to the Republican Party. Now that they are being marginalized in the Republican Party (such as it is) by a populist uprising, so they are looking to return to their old political home. Not that they will fit in comfortably there, either.

Kagan calls Trump a Frankenstein’s monster. This is rich with irony, because if that’s true, he, and his fellow neocons are Dr. Frankenstein, or at least Igor. The George W. Bush administration represented the neocon ascendency, especially in foreign policy. From that catastrophe was born Obama, and now Trump. The brutal repudiation of Jeb Bush, and the lack of widespread outrage among the hoi polloi at Trump’s borderline-Truther attack on George W., demonstrates how totally the Bushes, and their neocon advisors, have been rejected.

If Kagan et al want to go back to the Democrats, and embrace the Hildabeast, I reply as my grandfather would have: “Here’s your hat. What’s your hurry?” Or, more crudely: “Don’t let the door hit you in the ass on your way out. I wouldn’t want you to damage the door.”

Why? Well, precisely because neoconservatives are antithetical to the classical liberal, small government, and libertarian types who are also called “conservative” in the American political lexicon.

There are two big points of contrast between neoconservatives and small government conservatives, Jacksonian populists, and other non-neoconservative elements on the right.

Neoconservatives are anti-individualist, and statist. Neoconservatives owe a considerable part of their philosophical foundation to Leo Strauss. Following Strauss, neoconservatives are hostile to individualism, and the natural rights of individuals. Individuals pursuing happiness are merely egotists, and lack virtue. Achieving virtue requires collective projects, carried out through the state, and guided by an elite.

These projects should be pharaonic in scope. In the 2000s, neoconservatives were pushing the “national greatness conservatism” agenda. The goal of policy should not be to promote the betterment of individuals’ lives, but to pursue great projects worthy of a great nation and a great people. New space programs. Massive infrastructure investments. Such projects can only be executed by the Federal government.

Neocon political heroes were men like Teddy Roosevelt–a progressive, remember.

For the neoconservatives, foreign affairs present the greatest opportunity for the pursuit of endeavors worthy of a great nation. Spreading democracy, through regime change and war if necessary, is such an endeavor.

To some, the phrase “war is the health of the state” is a damning criticism. To many neocons, it is anything but. Wars fought in a virtuous cause are a good thing, and require a strong and healthy state.

This, of course, is what impelled Bush foreign policy, and led to its ignominious repudiation among a large majority of Americans. Obama, remember, won primarily by running as the anti-Bush. It would be fair to say that he won by running as the anti-neocon.

In the current campaign, Rubio is the standard bearer for the neocon cause. Trump, and to some degree Cruz, are prospering in large part because of their opposition to that cause.

Neocons are elitist and anti-populist. Again reflecting their Straussian roots, neocons believe that a robust state pursuing grandiose national projects can only be led by an elite. The people are too fickle, too ignorant, and too self-regarding to be trusted to carry out great schemes. But to implement their agenda in a democratic system, neocons have to manipulate public opinion, in part by telling different “truths” to different groups.

One remarkable tell of this elitism is immigration policy. Kagan and other major neoconservatives (e.g., Jon Podhoretz) adamantly support open borders. (Keep that in mind when you parse what Rubio has to say on immigration.) Opposition to unlimited immigration has been the singlemost important issue in galvanizing Trump’s support.

Robert Kagan and his cabal find themselves in their current straits because of the disastrous effects of big government elitism. Again, the catastrophe of the Bush years, which began with a disastrous intervention in Iraq and ended with a financial crisis, utterly discredited the self-anointed elite. Interventions during the Obama years–notably in Libya–that neoconservatives strongly supported only cemented the popular revulsion.

And said people are rising up, pitchfork and torches in hand, with Trump at their head, to storm the neocon castle. Further evidence of the cluelessness of Kagan and his ilk, they don’t understand that in the popular mind they are Dr. Frankenstein. If the neoconservatives don’t like the current political environment, they have primarily themselves to blame. It is in large part a reaction to them, and what they wrought.

In some respects, it is remarkable that neoconservatives (whom Reagan did not like) and small/smallish-government types were able to coexist in the same party for so long. But the stresses that have accumulated in fifteen years of foreign policy failure and economic malaise are too much for whatever bonds held these disparate groups together to hold. So Kagan and his fellow neocons will go their own way, and will not be missed. If they are perceived as being instrumental in putting Hillary in the White House, they will be the target of even more enmity by those they left behind.

The fundamental fact is this. In the Republican Party or out of it, neoconservatives are not friends of individual liberty and a modest, constrained state. To the contrary, they are its enemies. Whatever else the Trump movement accomplishes, it has already succeeded in forcing the neoconservatives to drop their Straussian deceptions and reveal their true beliefs: a big state and an interventionist foreign policy that is more than comfortable with using war to achieve their messianic purpose.

 

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February 26, 2016

The Notorious S.W.P., or, Dr. Pirrong Goes to Washington

Filed under: Commodities,Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 8:20 pm

If Elizabeth Warren were to have her way, you’d see my mug on the wall of your local Post Office. What have I done to become to earn her nomination as Public Enemy? Having the temerity to oppose position limits, and co-authoring a report summarizing the deliberations of the CFTC’s Energy & Environmental Markets Advisory Committee, which strongly criticized the need for, and details of, the Commission’s proposed position limits rule.

The backstory is this. In 2015 I was an associate member of EEMAC. (As of 10 days ago, I am a full member.) The Committee’s sponsor, Commissioner Christopher Giancarlo, asked me to write the (Dodd-Frank mandated) report summarizing the Committee’s deliberations at two meetings in 2015. I agreed, and along with Jim Allison (who just retired from ConocoPhillips), I wrote a relatively short draft that just summarized the transcripts of the two meetings. The report went through some additional edits, and was then submitted to the nine full members of EEMAC for their approval. It was approved by an 8-1 vote.

The conclusions and recommendations of these meetings were rather straightforward to recapitulate, because there was considerable agreement on the major issues of (a) whether position limits were necessary, (b) the proposed rule’s bona fide hedging exemptions, and (c) whether to implement limits for spot months only initially, or to implement for all months.

If you read the transcript, and read the final report, you will see that the report is a faithful record of what happened during the meetings. As I said in yesterday’s meeting, I viewed my role to be that of “faithful scribe,” and that’s what I was.

But since the message in the report was NOT what Elizabeth Warren (and one of the EEMAC members, Public Citizen’s Tyson Slocum) wanted to hear, Warren, Slocum, and Warren’s journalistic creatures (most notably the New York Times) decided to kill the messenger. Warren wrote a letter to the CFTC, demanding that the report be withdrawn. Slocum wrote a dissent to the majority report. Assorted journos scurried along behind. Each called foul on my authorship. Here’s what Warren said about yours truly:

The second panelist I am concerned about is Dr. Pirrong. According to the New York Times, “Mr. Pirrong has positioned himself as the hard-nosed defender of financial speculators – the combative, occasionally acerbic academic authority to call upon when difficult questions arise in Congress and elsewhere about the multitrillion-dollar global commodities trade…. [who] has reaped financial benefits from speculators and some ofthe largest players in the commodities business,” and played a key part in “a sweeping campaign [by the financial industry] to beat back regulation.”10

With specific regard to the position limits rule, Dr. Pirrong served as a consultant for the International Swaps and Derivatives Association – a lead plaintiff suing to block the very rule he was asked to provide his views on for the EEMAC.11 There is no record indicating that these conflicts were even disclosed by Dr. Pirrong when he served as a witness, let alone addressed by the EEMAC.

Thanks, Liz! You’re too kind! Honored to be the kind of person your kind of person considers a threat.

One of the journalists slouching after her, the New Republic’s David Dayen weighed in:

The recent inclusion of Craig Pirrong on the committee is perhaps the most flagrant example. Pirrong, who co-wrote the first draft of the report with James Allison, is a professor of finance at the University of Houston, who has been paid by several industry participants and trade groups for his research into commodity speculation. He was also a paid research consultant for the International Swaps and Derivatives Association, the very group that got the initial rule overturned by the courts.

The CFTC report relies mostly on Pirrong’s research and a presentation he made to the committee last year, which did not include the opinion of anyone who believes in the dangers of excessive commodity speculation. In fact, 10 of the 13 witnesses at EEMAC meetings came from industry, two were representatives of CFTC, and the other was Pirrong. The meetings never mentioned that there would even be a final report.

This is amusing on several levels. The first is the fact that the New Republic became the dumpster fire of left-wing opinion rags under the ownership of Christopher Hughes (which ended today, with the magazine’s sale).

The second is that last sentence about no mention of a final report. Er, it’s mandated by law, genius. A law you no doubt love, no less–Frankendodd.

The third-and best-is the title of the piece: “Why Elizabeth Warren is on the Warpath This Week.” This is particularly hilarious. I could see a right-wing mag saying that, as a snarky allusion to the very blonde Warren’s exploitation an alleged Cherokee heritage to game affirmative action to work her way up the greasy pole of legal academia (thereby earning herself the nickname Fauxahontas). But for a lefty to title a piece that way is too precious.

My reply? Yawn.

This ad hominem ankle biting is old and tiresome. This is what passes for serious criticism on the left. It is particularly appalling that a former dean of Harvard Law School can’t do any better than this. No substantive criticism whatsoever. You’d think that if I was just a paid hack that the substance of what I’ve written would be readily dismantled. But Warren and her acolytes don’t even try.

Which is probably wise. That is revealing in itself: you don’t fight battles you know you would lose, so you choose other methods, such as ad hominem slurs, questioning motives rather than challenging facts and logic.

The gravamen of the criticism, such as it is, is also just plain wrong. Warren, Slocum, Dayen, the New York Times, and various Twitter trolls all cite to the 2014 New York Times article which claims that I did paid research for multiple speculators. As Slocum put it in his dissent: “The Times continued that Dr. Pirrong has a long list of paid contracts with energy speculators.”

Long list? The article lists three.

  1. CME. Not a speculator. My work for CME consisted of writing an analysis of the hedging performance of the WTI contract, and serving as an expert in patent litigation involving Globex. Nothing to do with speculation.
  2. Royal Bank of Scotland. Never did work for them. Not an energy speculator.
  3. Trafigura. Not a speculator. A hedger.

As I pointed out at the time of the NYT article, using Trafigura as the Gotcha! just demonstrated how clueless the author of the Times piece was. Now Warren and Slocum are exhibiting similar cluelessness. Trafigura is not a speculator. Its main use of derivatives is as a hedger, and on the short side. Further, contrary to the insinuation that Trafigura likes high prices, it is generally neutral as to price level because it makes money on margins not flat prices, and in fact can profit in low price environments–and has profited handsomely in the recent historic price decline.

People with such a limited understanding of the way things actually work are not worthy of serious attention. Those who are stubbornly and deliberately ignorant (like Warren and Slocum) just deserve scorn.

As for the ISDA connection, I did write a comment letter that ISDA submitted in conjunction with its comment letter on position limits. However, I was NOT paid for that. I directed that ISDA make a donation in my name to the Wounded Warriors Project.

This confusion about who is and who isn’t a speculator illustrates the cosmic stupidity of Warren’s (and Slocum’s and the journalistic clique’s) criticism of EEMAC and its make-up. There are no true speculators represented on the Committee–either its full or associate members. None. No banks–Warren’s usual bêtes noires. No hedge funds. No managed futures funds. No ETFs. Speculators qua speculators were conspicuous by their absence. It is impossible to argue that the EEMAC was doing Wall Street’s bidding.

Instead, the membership is dominated by end users-including public utilities, municipal utilities, producers, merchants-and exchanges. These entities are not speculators whose participation would be constrained directly by the limits, but are mainly hedgers who would face substantial compliance burdens and undue constraints on their risk management activities. Further, they rely on the liquidity and risk bearing capacity supplied by speculators to hedge cheaply and effectively. Constraints on speculation threaten to raise hedging costs. Moreover, if speculation indeed destabilized prices, these firms would suffer.

Thus, these are the firms that limits are intended to help. And they are saying loud and clear: don’t do us any favors.

But Warren et al are apparently incapable of–or more likely, unwilling to–distinguish among the diverse participants in energy markets. To them, everyone is a speculator, and opposition to speculative limits is some dark conspiracy among those who engage in destabilizing betting on commodity prices. Thus, Warren’s criticism of the make-up of EEMAC is extremely indiscriminate and profoundly ignorant. She is so invested in her black-and-white cartoon view of the world that she can only explain opposition to restrictions on speculation as some evil plot by malign corporate interests and their lackeys–including yours truly.

And considering all that, I wear Warren’s hatred like a badge. I must be doing something right. And I plan on keeping on doing it.

As Maria Callas said, “When my enemies stop hissing, I’ll know that I’m slipping.” With Warren hissing at me like a cobra, I guess I ain’t slipping yet.

As for the substance of the meeting, the EEMAC’s efforts may be for naught. Chairman Massad clearly signaled that he is hell-bent on proceeding with implementing the position limits rule. In doing so, he used a simile that rivals Gensler’s apple metaphor for inanity:

“It strikes me a bit like saying you’re against speed limits because they may make you late for work,” Massad said.

Huh? No, it’s not like that at all. The comparison is so off-base it’s not even worth trying to modify it to make it coherent.

As the participants in EEMAC clearly and almost unanimously stated, they are against position limits because they are all pain, and no gain. The “speed limits” aren’t necessary because the activity that they constrain does not create dangerous risks. Further, not only do they not produce any appreciable benefit, they constrain perfectly legitimate and salutary actions by large numbers of market participants.

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February 21, 2016

The first rule of the Republican Establishment is: You do not talk about the Republican Establishment

Filed under: Politics,Uncategorized — The Professor @ 2:55 pm

The straw man argument is one of the oldest–and lamest–rhetorical tricks. Obama is a master. But he’s by no means alone. Alleged intellectuals (and yet another 5 time Jeopardy champion!) like John Podhoretz play this cheap trick, as in this Podhoretz article denying the existence of a Republican Establishment.

Here’s Podhoretz’s straw man definition:

The Republican Establishment was a subset of the American Establishment. These were not formal entities; they were not entities at all. Indeed, the term for them only came into common currency in England in the 1950s, when the British journalist Henry Fairlie used it to describe a group of people who went to the same schools, ate lunch in the same clubs, and so from childhood came to share the same set of attitudes that permeated the way they exercised power and transmitted cultural messages through the system. It is meaningful that Fairlie described it so pointedly just as it was crumbling away in England; perhaps it was only as it was melting away that its skeletal structure could be seen and its genus and species identified.

and:

an Establishment is a set of people in the elite who share the kinds of cultural and social commonalities that truly define a kind of social and political caste, and for which important matters are transmitted invisibly through family and educational and social ties so that they end up operating almost unconsciously from the same base of experience.

How’s that for crypto-academic argle-bargle?

It’s also completely at odds with the way that the term is hurled as an insult in the ongoing 2016 presidential contest in the Republican Party. In the current political discourse, the term is not used as it would be in a sociology seminar. In fact, those using the term today are referring precisely to people who sound like they are giving a sociology lecture.

Instead, it is used by normal people to refer to a particular group of individuals concentrated in Washington, DC. This group consists of senior elected officials (especially in the Senate), Republican Party functionaries, and assorted courtiers in journalism (notably the Weekly Standard, National Review, and Commentary), think tanks, and lobbying firms. The extended establishment includes businesses who are dependent on regulation and government expenditure (e.g., defense contractors).

This is a self-perpetuating group whose primary purpose is not ideological or principled, but is instead dedicated to maintaining power, access to power, and the sinecures attendant to power. These are people who speak of the nation, but whose real obsession is much more parochial: their horizons do not truly stretch beyond the confines of the 202 area code. These are people who are mainly interested in being players. Winning the game is actually secondary.

Indeed, the thought of a game that can actually be won or lost is rather terrifying to them, because losing would mean that they could be unceremoniously ejected from their comfortable perches. An unending, static contest is much more to their interest, and their liking.

This group has many mechanisms of social control to keep its members in line. Withholding funding, social ostracization, or providing plum jobs or committee assignments are all used to coerce or seduce loyalty.

This is why Trump and Cruz are so terrifying to the establishment. Trump is not dependent on it in any way. Indeed, he has gained traction precisely because he insults it at every turn, and they can do nothing about it: their levers of social control do not work on him. The establishment recoiled in horror at his remarks about Iraq and 911, but this did not dent his popularity, and likely increased it: the fact that he was willing to say such outrageous things about the establishment signaled that he is the kind of guy that many Americans are thirsting for, because it shows he does not play by the establishment’s rules.

For his part, Cruz has shown that he will not play by establishment rules either, even though as a Senator he is ostensibly an insider. He has fought against the Republican Senate hierarchy (the heart of the Republican establishment) in a very public way from day one, and has expressed his disdain for it while doing so. This has earned him the hatred of the 202 in-crowd: witness the intense anti-Cruz fury of establishmentarian emeritus Bob Dole. But again, this is a feature, not a bug for many Americans.

Establishment political culture is not new. Americans have long been inured to the existence of a governing class consisting of different partisan elements that is more engaged in advancing its interests as a class than national or popular interests. What is different about 2016 is that many Americans believe, with good reason, that the governing establishment is utterly indifferent to their concerns: once upon a time, the establishmentarians were able to fake sincerity, but now they don’t seem to try to do even that. Further, the fact that the establishment has done pretty well for itself in the past decade, while many Americans can’t say the same, feeds anger. Washington seems like pre-Revolutionary Versailles to many Americans.

On the Republican side, immigration has proved to be the issue that has alienated the establishment from those outside of DC. Trump realized this early, and seized on it. It is the issue that will make it difficult indeed for the Republican establishment’s preferred candidate-Rubio-to win. Too many people who vote in Republican primaries identify with Trump on this salient issue, rather than Rubio.

It must be noted that the disdain for the governing establishment is not limited to the Republicans. Hillary’s inability to shake a dotty socialist demonstrates that many Democratic voters are also deeply alienated. Hillary is rightly perceived as the insiders’ insider, and her risible attempt to sound militant comes off as dishonest and phony.

Podhoretz’s attempt to deny the existence of a Republican establishment has a comic element to it. It reminds me of the rules of Fight Club: The first rule of the Republican Establishment is: You do not talk about the Republican Establishment. The second rule of the Republican Establishment is: You do not talk about the Republican Establishment. Podhoretz’s attempt to deny its existence betrays a deep fear. He is very much a part of that establishment, and his access, influence, and income are threatened by the barbarians at the gates. He is not alone, and as a result the desperation is palpable: witness the frenzied attempts to pump up Rubio.

What Podhoretz and his ilk aren’t getting, however, is their efforts are completely counterproductive. Since they are the problem in the minds of many Americans, their attempts to promote one candidate and tear down others hurts the former and helps the latter: their endorsements are an insult, and their insults are endorsements.

They don’t have a positive agenda to offer, and preservation of their class is hardly a selling point in the current political environment. And an establishmentarian’s denial of the existence of an establishment will do nothing to convince anti-establishmentarians that their anger is misdirected. To the contrary, it will come off as another act of condescension-“the establishment doesn’t exist: who are you gonna believe, me, or your lying eyes?”-that will just feed the anger.

I think it is fairly clear that the Republican side of the establishment is doomed, which is precisely why people like Podhoretz are so intent on denying its existence. I sometimes wonder whether the party is in the throes of a collapse comparable to the Whigs in the 19th century. Its passing will not be lamented. What remains to be seen is whether what replaces it will be an improvement.

 

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February 20, 2016

Brent: The George Washington’s Axe of Oil Pricing Markers

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Regulation — The Professor @ 12:53 pm

Platts is preparing for a Brentless future by introducing a new Dated Brent CIF Rotterdam assessment.  The idea is that as North Sea production continues its decline, other streams of light crude that are imported into Rotterdam can be added to the assessment. Adding (or substituting) say Nigerian crude to the FOB Brent assessment would be much more difficult because of locational differences: FOB Nigeria and FOB North Sea can be quite different, even adjusting for quality, due to freight differentials. A CIF contract eliminates that.

The decline in North Sea production has been occurring for some time, so the need to adjust the pricing mechanism has been apparent. Plants has been thrashing around for a while, mooting the possibility of adding other crude (e.g., Urals Med) to the assessment.  It had already widened the delivery window to make more cargoes eligible (remember 15 Day Brent? 21? It’s now 25 Day.) This problem has become more pressing though, as the decline in prices is hastening the decline in North Sea production.

It is ironic that at the same time that Platts (and therefore, ICE) are grappling with the problem of  declining supply, the main rival to Brent has the exact opposite problem. The WTI contract is currently drowning in oil. Storage at Cushing is bumping up against capacity, and there are reports that some storage operators there are refusing requests to store additional crude.

Although the current situation at Cushing (and in the North American market generally) is as much a demand story as a supply story, the facts are that (a) the NYMEX WTI contract is linked to a much more robust and flexible production base than Brent, and (b) the WTI contract’s periodic difficulties are due to infrastructure issues that are more readily, cheaply, and rapidly addressed than production issues. Thus it has been for the past five years or so, as I discussed when I wrote that those foretelling the demise of WTI were fundamentally mistaken:

But these problems are all surmountable.  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.

Brent’s problems are more fundamental, because they arise from declining supply.  Even as paper volumes continue to rise, physical volumes available for delivery are falling inexorably.  The Brent complex had faced this problem before, and confronted it by adding Forties, Oseberg, and Ekofisk to the eligible stream.  But BFOE production has declined from 1.6 mm bbl/d in 2006 to barely more than half that today.  And the decline continues apace.  This makes the contract vulnerable to squeezes of a kind that were chronic in the 1990s and early 2000s, and which spurred Platts to add the three other grades to the benchmark.

. . . .

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.  But the Brent contract will be an inverted paper pyramid, resting on a thinner and thinner point of crude production.  There will be gains from trade–large ones–from redesigning the contract, but the difficulties of negotiating an agreement among numerous big players will prove nigh on to impossible to surmount.  Moreover, there will be no single regulator in a single jurisdiction that can bang heads together (for yes, that is needed sometimes) and cajole the parties toward agreement.

The CIF alternative makes sense, and is probably superior to the “economic par” contract I suggested in the 2011 post. But once you move to a Rotterdam pricing basis, why remain tied to an assessment mechanism based on transactions in immense full cargoes? The large size of the lots inherently limits the number of transactions, which makes the assessment mechanism more erratic and subject to manipulation. The lumpiness of the market has also led Platts to design a baroque process involving bids and offers, contracts for differences, futures prices, spreads, etc., to increase the number of trades that go into the assessment.

The WTI contract, in contrast, is based on delivery in store of modest-sized (1000 barrel) units of crude. This is much more flexible, and permits a large number of firms to participate in the delivery process. This makes delivery and the threat of delivery a reliable and efficient way of ensuring convergence of futures to cash market values. The mechanism is not immune to all types of manipulation: delivery squeezes are still possible (though relatively unlikely in current market conditions). But small numbers of transactions can’t have a pronounced impact on pricing, and the in store delivery mechanism does not rely on an arcane and mysterious assessment mechanism (which also helps to enrich the party making the assessment).

So rather than shifting to a Rotterdam CIF mechanism, why not shift the futures market to a Rotterdam in store delivery contract? This mechanism is more flexible and resilient in the short run, and is readily adjusted in the long run to respond to changes in the underlying physical production base as NYMEX did by adding foreign crude streams (including Brent) to address the (then) declining domestic production base.

I can see why Platts wouldn’t like this, but it has some decided advantages for ICE, not the least of which is reducing its dependence on Platts. Given the difficulties of changing contract specifications, or generating liquidity for even a better contract introduced in competition with an established liquid one, I doubt this will happen. Which means that ICE, and the market generally, will have to continue to endure periodic changes the “Brent” assessment mechanism as North Sea production continues to decline.

I put “Brent” in quotes because the handwriting is on the wall: any future European-based contract may be called “Brent” even after Brent (and Forties, and Oseberg, and Ekofisk) no longer represent the bulk of the benchmark stream. The contract will come to resemble the old Harry Anderson comedy bit, where he juggled a chainsaw and an axe. He would stop juggling, hold up the axe and say: “This is George Washington’s axe. The handle was replaced years ago, and I just put on a new head, but it’s George Washington’s axe!” So it will be with Brent, and sooner than anyone would have thought even a few short years ago.

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February 16, 2016

Deep Social Thought: Trump=Bitter Clingers+Facebook

Filed under: Economics,Politics — The Professor @ 8:20 pm

I am not a Trump supporter, for many reasons. But the depth and intensity of support that he has attracted is an important social and political phenomenon, that needs to be understood before the deep concerns and anger that he has tapped can be addressed with good policies.

I made a preliminary attempt here. Others have done a much more thorough job. Most notable of these is Walter Russell Mead, on whose idea of Jacksonian Americans I drew upon in my post. His Andrew Jackson, Revenant, is a must read on the subject. So are Charles Murray’s Trump’s America and Angelo Codevilla’s Does Trump Trump?

Then there is Tom Nichols. The Naval War College professor’s theory is–I am being serious here–“Facebook envy.” Specifically, social media has made middle and working class Americans newly and keenly aware that there are people with more stuff than them. This has made them green with envy, and their envy-fueled anger has driven them to support Trump.

I think that is a very fair summary. Read for yourself:

In other words, Trump (and Sanders) have convinced people that the same socioeconomic arrangements that once benefitted them are actually screwing them, mostly on the premise that it’s not benefitting them enough.

No one factor explains Trump, but this underlying resentment is at least in part a result of the Information Age, which is spurring one of the biggest experiments in relative deprivation in human history. People who once had little idea how others outside of their social circle lived now constantly compare themselves not just to their neighbors, but to the wealthy, and even to the super-wealthy. They are not just keeping up with the Joneses next door, but via the Internet and cable they’re keeping up with the Reeds down the street, the Browns in the next town, the Smiths in the next state, and the Kardashians all the way across the country.

As one wag on Twitter put it, call it the “HGTV Effect.”

This is only possible because of new technology.

There are two parts to this theory. That the Trump phenomenon is driven by envy, and that this envy is a new phenomenon that was impossible in the era before Facebook.

This would be news to Rousseau, Kierkegaard, Nietzsche, Veblen, and Weber, just to name a few. Each of these wrote when literacy was rather limited, and newspapers and pamphlets represented the cutting edge of information technology. Yet each of them also devised theories of social relations based on the tendency of humans to compare themselves and their circumstances to those of others; to seek social status; and to measure status by material attainment. Not just absolute material attainment, but in comparison to others. Kierkegaard and Nietzsche explicitly used the French word “resentissment” that Nichols drops in his piece.

And all without Facebook. So the idea that some technological shock was necessary to cause Americans to cast a covetous eye at the wealth and consumption of others is beyond farcical. Concern about relative standing is as old as society.

Then there’s the issue of whether the visceral anger that Trump (and to some degree, Bernie Sanders) have tapped a manifestation of a mortal sin, or whether it is reflects legitimate grievances (which is a different issue as to whether Trump can address these grievances).

In fact, there is a strong basis for those grievances. In attributing Trump’s popularity to the base motives of his supporters Nichols is deeply condescending and insulting.

The grievances stem from two sources, which are somewhat interrelated.

The first is clearly economic. The middle and working classes in the United States have seen their incomes stagnate. The gap in incomes between those with and those without college educations has increased substantially. The expectation of upward mobility that was commonplace in post-WWII America no longer exists for many Americans.

It is remarkable that Nichols quotes and links to Murray, but fails to acknowledge that Murray has documented in detail (in his book Coming Apart) how the white middle class has become increasingly marginalized, and has experienced decline in several important socioeconomic dimensions.

Just what has driven these developments is the subject of intense controversy among economists. There is no consensus, which should not be surprising because it is unlikely that any major social development can be attributed to even a small number of causes, and because explaining complex phenomena is inherently difficult. But the data do clearly demonstrate that the phenomenon exists. What Trump is tapping into is therefore a legitimate-if somewhat inchoate–movement that reflects deep social forces, not the temper tantrum of people who don’t know how good they have it, and whose worst instincts have been awakened by Facebook.

The second major source is deep disillusionment with the “elites,” combined with the mixture of dismissiveness and condescension with with the elites have responded to the dissatisfaction of the hoi polloi. Codevilla in particular has eviscerated “the Ruling Class.” Thomas Sowell’s scathing criticism of “the Anointed”, which long predates the Trump phenomenon is good on this subject as well.

The gravamen of this criticism is quite simple. American governing elites have amassed a remarkable record of failure in foreign policy and economics. Iraq and the Great Financial Crisis are just the two most conspicuous examples. Yet, the elite has made out better than OK, and there has been virtually no accountability for these failures. That rankles deeply.

Furthermore, the elites–in both parties–often appear to have more globalist loyalties, than local ones. Jacksonians are nationalists, which is why Trump’s slogan of “make America great again” resonates deeply. This also explains why many Americans are perfectly content to extirpate ISIS, with few reservations about the inevitable collateral damage, but have no interest whatsoever in getting engaged in allegedly idealistic ventures in Syria–especially since the elite has shown no competence whatsoever in bringing these ventures to a successful conclusion (cf. Iraq, Libya, Afghanistan).

What’s more, the elite doesn’t get it. The GOP establishment’s response to Trump (and Cruz, who draws from the same well) proves this. Rather than trying to understand, and to come to grips with, the widespread discontent, the establishment has circled the wagons and doubled down on the condescension. The Nichols article is one example. So is National Review’s shrieking anti-Trump jeremiad.

And then they express shock and surprise that Trump only seems to get stronger. They don’t realize that even though they aim their insults at Trump, they hit the Jacksonians instead. And as Mead rightly pointed out, honor is deeply important to Jacksonians, and insults to their honor trigger their formidable combative instincts.

I still doubt (as I did last year) that Jacksonians can be part of a winning political coalition. I still believe that although their passions and beliefs are attractive to many, they repel many others. I also continue to doubt that the remedies that Trump proposes (especially on economic issues like protectionism) will  ameliorate the ills that have galvanized his followers.

But I do not doubt at all that superficial, condescending, and insulting analyses of what drives Trump supporters  will only strengthen Trump–even if they are written by a five time Jeopardy Champion. Saying that a large swathe of Americans with legitimate grievances, and legitimate critiques of their “betters,” are nothing but bitter clingers whose baser instincts were catalyzed by too much time on Facebook is not just deeply insulting. It is a sure fire way to strengthen Trump, not cut him down to size.

Those who disagree with Trump’s policies need to understand and engage the forces he has tapped. They need to persuade and attract, not insult and repel. If Trump becomes the Republican nominee, let alone president, it will be because his opponents fail in this task.

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February 15, 2016

“More Europe.” Yeah, Who Wouldn’t Want More of This?

Filed under: History,Politics,Regulation — The Professor @ 7:34 pm

Two stories that illustrate what a clueless monstrosity the EU is. (H/T to @libertylynx on both.) (I was about to write “has become”, but that would be wrong–it’s been this way from the beginning.)

First, “France fails to win immediate EU action on farming crisis“:

France failed to secure further relief measures for its struggling livestock farmers at a meeting of European Union agriculture ministers on Monday, as it tries to contain protests sparked by persistent low prices.

French dairy and meat farmers have been staging protests for weeks, blocking roads, dumping manure, straw and earth in front of public buildings and supermarkets.

The growing crisis had prompted President Francois Hollande last week to promise tax cuts for farmers and to call for decisions at the EU farm minister meeting.

France, the EU’s largest agricultural producer, had gone to Monday’s EU meeting with a set of proposals to regulate oversupply in the milk and pigmeat sectors, but the European Commission asked it to come back with new proposals.

From the time that the Common Agricultural Policy began in the early-1960s, European farm policy has been a special interest nightmare. Agricultural markets have never been permitted to work, and 300+ million Europeans have been held hostage by a few million (relatively inefficient) farmers, particularly (but not exclusively) in France.

Second–again from France!–“Most vulnerable industries need 100 percent free carbon–France“:

Energy intensive industries most likely to leave the European Union because of costs should get all of their EU Emissions Trading System permits free until other major blocs have a carbon price in place, France‘s economy minister said on Monday.

The European Commission is revising its rules for handing out free permits to cushion energy intensive industries, such as the steel sector and oil refiners, from the expense of offsetting emissions on the ETS.

As if this wasn’t completely predictable. Apparently the Europeans believed that the world would immediately see the error if its ways, and defer to the shining example of Europe on climate change policy.

Actually, the rest of the world–the developing world/emerging markets in particular–pretty much decided that they didn’t like being poor, and if the Europeans were going to burden their energy intensive industries with myriad restrictions in the name of battling global warming, the rest of the world was perfectly willing to seize on the opportunity.

I could go on. The immigration mess. The fact that European post-crisis financial regulation (MiFID II and EMIR) makes Frankendodd look like light touch regulation. Energy policy. The list is endless.

There’s an old joke that Arkansas exists so that Mississippians have someone to look down upon. (Or is it Mississippi exists so that Arkansans have someone to look down upon?) I often think that the EU exists so the US has someone to look down upon. As dysfunctional as we are, we ain’t got nothing on them.

What makes it worse is that Europe presumes to lecture the world on policy and governance. That, and all the navel-gazing “more Europe” crap. “More hitting myself in the head with a ball peen hammer” sounds preferable.

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Rubio of Arabia

Filed under: History,Military,Politics — The Professor @ 1:08 pm

When asked what would make a good president, Marco Rubio answered: “Do they the know difference between Sunni & Shia..between ISIS & Al Qaeda?”

Apparently those able to answer the $200 question in Teen Jeopardy would make good presidents.

Rubio has been Johnny One Note on the Shia-Sunni issue. He is beyond insipid. It also brings to mind the time of the Iranian Hostage Crisis. The prevailing narrative at the time was that Shias were radicals, and that Sunnis represented the “moderate branch of Islam.” In retrospect, this was the Saudi propaganda line, and they are pushing the same thing today.

Perhaps it was excusable for Americans in 1979 and 1980 to be ignorant of the deep radicalism that permeated Sunni Islam. But in the aftermath of at least 20 years of Sunni terrorism, the relentless proselytizing of the Wahhabis, and the insidious operations of the Muslim Brotherhood, it is inexcusable to swallow the Saudi narrative, hook, line, and sinker, as Rubio clearly has. To add insult to injury, he presumes to lecture us on his superior knowledge of the nuances of Islam.

The best Western analogy to what is going on in Islam right now is the 30 Years War. A sectarian conflict between two branches of the same religion, being fought across a good portion of a continent. Taking sides in that is idiotic. But that is exactly what Rubio and his supporters and advisers are pushing, and claiming that it is wisdom.

 

 

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