Streetwise Professor

April 20, 2015

Cargill: Still Private After All These Years to Solve Agency Problems, or Because of Them?

Filed under: Commodities,Derivatives,Economics,History — The Professor @ 8:29 pm

The commodity trading sector is remarkable for the prevalence of private ownership, even among the largest firms. My recent white paper discusses this issue in some detail. In a nutshell, publicly-held equity is a risk sharing mechanism. The ability of commodity traders to share some of their largest risks-notably, commodity flat price risks-through the derivatives markets reduces the need to rely on public equity. Moreover, private ownership can mitigate agency problems between equity owners and managers: the equity owners are often the managers. As a consequence, private ownership is more viable in the commodity trading sector.

The biggest cost of this ownership structure is that it constrains the ability to fund large investments in fixed assets. Thus, private ownership can impede a firm’s ability to pursue asset heavy strategies. As I note in this white paper, and my earlier one, commodity firms have used various means to loosen this constraint, including perpetual debt, and spinoffs of equity from asset-heavy subsidiaries.

Another cost is that owners tend to be poorly diversified. But to the extent that the benefits of high powered incentives exceed this cost, private ownership remains viable.

Cargill is the oldest, and one of the largest, of the major privately held commodity traders. (Whether it is biggest depends on whether you want to consider Koch a commodity trader.) It is now commemorating its 150th anniversary: its history began as the American Civil War ended. Greg Meyer and Neil Hume have a nice piece in the FT that discusses some of Cargill’s challenges. Foremost among these is funding its ambitious plans in Indonesia and Brazil.

The article also details the tensions between Cargill management, and the members of the Cargill and McMillan families who still own 90 percent of the firm.

The last family member to serve as chief executive retired in 1995, and now only one family member works full time there. This raises questions about how long the company will remain private, despite management’s stated determination to keep it that way. The families are already chafing due to their inability to diversify. Further, at Cargill private ownership no longer serves to align the incentives of owners and managers, in contrast to firms like Trafigura, Vitol, and Gunvor: even though Cargill is private, the owners aren’t the managers. Thus, the negatives of private ownership are becoming more prominent, and the benefits are diminishing. There is separation of ownership and control, with its associated incentive problems, but there is no compensating benefit of diversification.

Indeed, it is arguable that the company remains private because of agency problems. Current management, which does not own a large fraction of the firm, is not incentivized to privatize: there would be no big payday for them from going public, because they own little equity. Moreover, as long as the families can be kept happy, management doesn’t have to worry about capital market discipline or nosy analysts. Thus, management may be well entrenched in the current private structure, and the number of family owners (about 100) could make it difficult to form a coalition that would force the company to go public, or to craft a package that would make it worth management’s while to pursue that option.

In sum, Cargill is a marvelous company, and has been amazingly successful over the years. Its longevity as a private company is remarkable. But there are grounds to wonder whether that structure is still efficient, or whether it persists because it benefits management.

Print Friendly

A Russian Troll Trolls From the Land of Trolls

Filed under: Climate Change,Military,Politics,Russia — The Professor @ 2:22 pm

Trolls are characters from Scandinavian folklore who inhabit desolate islands, so it only seems fitting that Rogozin the Ridiculous trolled Nato from a desolate Norwegian island. Rogozin, who is banned from traveling to Norway due to sanctions, showed up on Svalbard (formerly Spitsbergen), which is sovereign Norwegian territory (though Russians have residence and commercial rights there under the Svalbard Treaty). Rogozin obnoxiously (but I repeat myself) tweeted that “the Arctic is Russian Mecca.” The Norwegians are not amused. Nor should the US. But we seem unfazed.

Wouldn’t you know, the United States is assuming the chairmanship of the Arctic Council from Canada. In the face of Russia’s quite in-our-face assertion of control over the Arctic (of which the Ridiculous One’s “Russian Mecca” Tweet is just an example), and its dramatic increase in its military activities and presence in the Arctic, what is John Kerry’s priority for the Council? You guessed it: climate change. You know, for the polar bears.

Back to Rogozin, last seen here performing so marvelously in his role as commissar of the Vostochny Cosmodrome. His intervention into the management of the troubled project (including threats to “rip off the heads” of those holding up construction) have worked wonders. Well, mainly, they’ve resulted in a spread of strikes protesting lack of pay. And to save costs, the construction of infrastructure to support manned launches is being deferred, resulting in at least a two year delay in the use of the facility for such purposes. Well played, Bozo! The mind boggles at the thought of what you’ll accomplish in your icy Mecca.

Believe it or not, Rogozin has intense competition for the title of most insane Russian official today. His competition is Nikolai Rogozhkin, Putin’s representative in the Siberian Federal District. (Hey. Rogozin, Rogozhkin: pretty similar! Lame attempt at a pseudonym?) Siberia is beset by wildfires already, and there are fears that this summer will make 2010 look like child’s play. So whom does Rogozin-sorry, I mean Rogozhkin-blame? Saboteurs, of course! Wreckers! Fifth Columnists! Oppositionists! As for his reasoning, check out the most outrageous flouting of Occam’s Razor I have ever seen:

Rogozhkin said he had flown in a helicopter and seen fire sites in “places where a normal person cannot go, even one who is well-prepared.”

“A specially trained person would be needed for this, and it would take at least 24 hours,” he said.

So rather than reason: “It is nearly impossible for a normal person to set these fires, so they must have a natural cause”, Rogozhkin the Almost as Ridiculous concludes that it isn’t a normal person after all. It is a specially trained person.

You literally cannot make up this stuff.

Print Friendly

April 19, 2015

Victor Davis Hanson and the Streetwise Professor: Peas in an Anti-Progressive Pod

Filed under: History,Politics — The Professor @ 4:57 pm

It’s kind of spooky that Victor Davis Hanson and I will frequently draw the same conclusions from a particular Obama remark or action, phrase our analysis in similar terms, and do so almost simultaneously. This VDH piece from April 14 and mine from April 11 are a case in point. We both conclude that Obama’s foreign policy is driven not by incompetence (though there is that) but instead it is the result of conscious choice based on his beliefs and mindset. VDH and I both attribute Obama’s actions to his “romantic” view of Third World nations and revolutionaries, and his belief in America’s sins. Our conclusions are based on the same words uttered by Obama, and by same actions that Obama has undertaken.

I am not asserting a causal relationship here. Instead, this is an example of “multiple discoveries”, a phenomenon studied by the sociologist Robert Merton, and the Stiglers, père George (an economist) et fils Stephen (a statistician).

That is, similarly prepared or disposed minds, presented with the same facts, are likely to reach the same conclusion. Hanson and I are both conservatives who have spent our professional lives in the progressive swamps of academia, and who are hence quite familiar with the leftist infatuation with anti-Western movements abroad and disdain (and often hatred) for the United States. Through long exposure, we are well versed in leftist cant. We are both steeped in history, although Hanson is a real historian, and I am just an amateur. We both share a tragic view of man, and a belief that there are historical regularities that connect all ages: this gives us a neuralgia to progressivism (literally understood based on a knowledge of its Hegelian roots) and makes us shake our heads at people like Obama, who quite openly believes that things that happened before he was born, or came of age, are irrelevant (except, of course, if they can be used to shame western culture-the Crusades!-or the US-slavery!-or idealize “the other”-remember the beautiful Caliphate!).

In other words, we are almost destined to see Obama in the same way, and interpret his remarks and actions  nearly identically.

Print Friendly

More Obama & Wilson Parallels

Filed under: History,Military,Politics — The Professor @ 3:57 pm

Watched a show on CSPAN3 (yes, it’s an exciting life I lead) involving a discussion of Woodrow Wilson and the Versailles Treaty and the League between Prof. Melvyn Leffler of the University of Virginia, and Oxford’s Prof. Margaret MacMillan, author of “The War that Ended Peace: The Road to 1914.” Leffler made two points that resonate today, when thinking about Obama. (This discussion is around the 1:05 mark of the video.)

First, Leffler pointed out that Wilson made many compromises in Paris, but adamantly refused to make any compromises with his domestic opposition. Leffler further noted that contemporaries noted the contrast.

Second, and relatedly, Leffler emphasized that Wilson hated and despised his domestic opponents, in particular Henry Cabot Lodge. MacMillan related some anecdotes about what she called Wilson’s “stupidity” in dealing with the opposition, in particular his very public scorn for the domestic opposition that just intensified their desire to defeat him. She said that Wilson didn’t just disagree with Lodge: he believed Lodge was evil, and wouldn’t do a deal with the Devil. MacMillan said that [I paraphrase] “Wilson believed if you disagreed with him, there was something morally wrong with you.” (This is around the 1:08 mark.) That is, Wilson’s refusal to compromise on the League (even though MacMillan claims that many of Lodge’s objections were reasonable) stemmed from a visceral hatred and disdain for his political opponents. This refusal to bend (indeed, Wilson instructed Democratic senators to vote against an amended treaty) doomed his beloved League to defeat.

The parallels with Obama are quite apparent. One wonders if the outcome will be as well, that is, whether Obama’s disdain for Republicans will doom his beloved Iran deal to defeat.

Print Friendly

April 18, 2015

Alfred E. Obama

Filed under: History,Military,Politics,Russia — The Professor @ 2:37 pm

Obama reacted in his best Alfred E. Newman “what? me worry?” fashion to Putin punking him by selling S-300 missiles to Iran. Short version: “What took you so long, Vova?”:

President Obama said that he was “not surprised” Russia sold an advanced missile system to Iran in the midst of his negotiations with the Ayatollah to prevent Iran’s nuclear facilities from making a bomb. He went even further to say that he expected the deal to happen a lot sooner than it did.

“I’m frankly surprised that it held this long given that they were not prohibited by sanctions from selling these defensive weapons,” President Obama said on Friday.

Another example of the flexibility that Barry promised Vladimir via the whisper to messenger boy Dmitri.

Correct me if I’m wrong, but supposedly the big payoff to the Reset was Russian cooperation on Iran. But apparently Obama believes that the sell-by date of that cooperation has long passed. Or , he doesn’t really give a damn about keeping Iran in a box.

And look at what he did there. He totally buys the Russian and Iranian line that these are “defensive weapons”, and hence pose no problem: again, “what? me worry?” Is he that stupid? Does he not realize that a strong shield protects those who wield the sword? These AAMs dramatically undercut the credibility of any military response to Iran’s developing nuclear weapons: they thereby undercut the credibility of Obama’s vaunted deal. (Although that presumes that Obama actually intends to deprive Iran of the bomb. His actions repeatedly cast doubt on that presumption.)

If defensive weapons as so benign, why doesn’t Barry supply them to Ukraine? Indeed, the defensive weapons (e.g., ATGMs) that Ukraine is pleading for cannot serve the same strategic function as the S-300s supplied to Iran. They are truly useful only in local defense, particularly by an army like Ukraine’s that is hard pressed to hold its own ground, let alone attempt to project power. They can help make a Russian invasion too costly for Putin to undertake, but cannot provide a shield behind which an aggressive power can develop the means to carry out its expansionist schemes. So Obama should shove Putin’s words about the benignity of defensive weapons back in his botoxed face. “What’s good for Iran is good for Ukraine, Vlad.”

But instead, Obama (and the feckless Europeans) cringe before Russia’s freak outs about providing one bandolier, bullet, bayonet or trainer to Ukraine, or stationing one tank in the Baltics. Indeed, the Russians also went ballistic (figuratively) by threatening to go literally ballistic over Nato ABM systems.

Ponder the hypocrisy here. It is a thing to behold. Russia told Israel to lie back and enjoy it because S-300’s are purely defensive. But any Nato defensive missiles in Europe have become “objects of priority [Russian] response [i.e., they are now nuclear targets].” (General Dempsey has Obamaitis, apparently, saying that he’s “not surprised” by Russia’s rhetoric. This guy is becoming a daily embarrassment.)

Obama also channeled good old Alfred E. when he downplayed Khamenei’s insistence that sanctions would be eliminated immediately upon reaching an agreement, and that military sites were completely out of bounds to inspectors:

“It’s not surprising to me that the supreme leader or a whole bunch of other people are going to try to characterize the deal in a way that protects their political position,” Obama said in a news conference Saturday at the Summit of the Americas in Panama.

Talk about projection! What the hell has Obama been doing in the past three weeks other than “try[ing] to characterize the deal in a way that protects [his] political position”?

Obama is also demonstrating that his vaunted flexibility is not limited to Russia, saying that he is open to “creative” approaches to lifting sanctions early. He claims that he insists on “snapback” capability, but anyone who believes sanctions can be snapped back is out of his bleeping mind. Or is a liar that is “characteriz[ing] the deal in a way that protects his political position.” That is, saying anything to protect a deal that he wants, hell or high water.

If Obama is Alfred E. Newman, I am definitely not. Me worry. In particular, me worry that we are bumping against the limits of the amount of ruin in a nation that Adam Smith wrote about.

Print Friendly

A Greek Gas Farce

Filed under: Commodities,Energy,Financial Crisis II,History,Politics,Russia — The Professor @ 11:44 am

Der Spiegel reported that Greek officials claim that the country is on the verge of signing a deal with Russia that would give the Greeks €5 billion upfront, to be repaid from transit fees on a yet-to-be-built Turkish Stream pipeline: the Russians deny any deal. The quoted (but anonymous) Greek official said that this would “turn the tide” for Greece.

Really?

Some thoughts off the top.

First, Greece owes €320 billion, including payments of €30 billion in 2015 alone. It is “scraping the bottom of the barrel” by borrowing from various state entities (e.g., the public transport system) to meet April payroll. It has a budget deficit of €23 billion. Deposits at Greek banks fell by about €20 billion last week. This creates a liability for the Bank of Greece to Target2 (i.e., to the members of the ECB). A measly €5 billion will buy it a few weeks time, at best.

Second, it’s not as if creditors (e.g., the EU and the IMF and Target2 members) are going to give Greece discretion over how to spend this money. And they have many levers to pull. So it would set the stage for more arguments between the creditors and the debtor.

Third, the Russians are likely to write terms that secure the debt and give it priority over other creditors (at least with respect to any future transit fees). (Just remember how tightly the Russians crafted the Yanuk Bonds.) The Euros will flip out over any such terms. This would set up an epic The Good, The Bad, and the Ugly three-way standoff.

Fourth, this initiative would be directly contrary to European energy policy, which is finally attempting to reduce dependence on Russia and limit vulnerability to Russian gasmail and the use of energy as a wedge to create divisions within the EU.

Fifth, what are the odds that the pipeline will get built? The Europeans are against it. It requires the Greeks and the Turks to play well together, and we know how that usually works out. It requires additional investment in infrastructure in Turkey, which is problematic. Further, the Russian track record on these sorts of projects leaves much to be desired.

So what happens if the pipeline isn’t built, or is delayed significantly. No doubt the Russians will anticipate this contingency in the debt agreement, and write things in such a way that they have security or priority, which will just spark another battle with Greece’s European creditors.

In sum, such a deal would hardly be a solution to Greece’s problems. Indeed, it only escalates conflicts between Greece and the EU.

Which may be Putin’s purpose, exactly. Exacerbating Greek-EU conflict over a matter involving Russia directly at a time when Greece could scupper the extension of sanctions against Russia suits Putin perfectly. The fact that the pipeline is as much pipe dream as realistic project doesn’t matter a whit. This is all about stirring trouble. And that’s Putin’s speciality.

Print Friendly

April 14, 2015

Obama the Negotiator at Home and Abroad: Compare and Contrast

Filed under: History,Military,Politics,Russia — The Professor @ 6:56 pm

We know that Obama knows how to play tough in negotiations. We know that he can engage in brinksmanship. We know he can draw red lines, and stick to them. Just look at past confrontations with Congressional Republicans, especially over budgetary issues, the debt ceiling, and Obamacare.

This contrasts starkly with his abysmal negotiating strategies with foreign adversaries. The unilateral concessions, by the bagful. The failure to extract any meaningful concessions from his interlocutors. The declaration of red lines, followed by at most mewling protests when the lines are crossed.

The Iran negotiations are of course the most prominent example. But consider the opening to Cuba. Indeed, it is really impossible to consider this a negotiation at all. Instead. Obama has just unilaterally undone a set of restrictions that have been in place for years, including today’s removal of Cuba from the State Department’s terror supporting nations list.

And Cuba has done what in return? Bupkis.

Whatever you think about the embargo and the terrorism list designation, we have issues with Cuba, notably its expanded cooperation with Russia (which last year Newsweek called “Partying like it’s 1962“), including the reopening of the Lourdes surveillance facility: note, that the Cold War is not over for everyone. To ease up on Cuba at the very same time it is increasing its cooperation with an aggressive and truculent Russia is astounding. Human rights is another issue.

So we have things that we should want from Cuba, and the means to extract them. Cuba is in dire economic straits, especially since its most recent patron, Venezuela, is circling the bowl at mach speed. So the US has leverage, just as it does with Iran. And the costs to the US of continuing the embargo are trivial. Threats to walk away-or to increase the pressure-are quite credible. There is a huge asymmetry in bargaining power here.

You know how Obama would play this hand with Republicans. We see how he plays it with the Castros and Khamenei. It’s not that he doesn’t know how to play hard ball: It’s that he doesn’t want to.

The question is why? I keep returning to the theory that he  believes that the exercise of American power abroad is illegitimate, and that in the cases of countries like Iran and Cuba, he actually believes that the US owes redress for past transgressions.

If you all have a better theory, I’d like to hear it. But your theory has to explain why a man who can be so obdurate in negotiations at home is so pliable-to put it mildly-in negotiations abroad.

Print Friendly

Putin Punks the President. Again.

Filed under: Military,Politics,Russia — The Professor @ 9:34 am

Putin just punked Obama. Again. This time by announcing the resumption of the delivery of S-300 antiaircraft missiles to Iran, and the beginning of the oil-for-goods swap that had been mooted some months ago, and doing so before the non-ink on the nuclear non-deal with Iran has dried. Lavrov put the boot in, by stating that the moves advanced the negotiations on Iran’s nuclear program:

“It was done in the spirit of good will in order to encourage progress in talks,” Lavrov said. “We are convinced that at this stage there is no longer need for such an embargo, specifically for a separate, voluntary Russian embargo.”

The Daily Beacon goes into the wayback machine and reminds us that in 2010, the administration asserted that the sale of S-300s was a red line. But we know about Obama’s red lines, don’t we? And you know Putin does.

Shockingly, Kerry expressed “concern” at the Russian move. (That was sarcasm, people.) Kerry is doubly punked, because just the other day he cited the Russians as agreeing with him on the understandings reached in Lausanne.

Kerry is the biggest buffoon and chump to serve as Secretary of State in the 229 year history of the republic (but perhaps the most arrogant). (And that includes James Buchanan! At least we will probably be spared a Kerry presidency.) He has been spinning and harrumphing non-stop in defense of the non-deal. For instance, he claims that we will be able to detect any Iranian violations because Science! (the usual lefty magical incantation). Further, he says Congress (and everyone else) should but out because Obama has a “global mandate”:

Secretary of State John Kerry described the nuclear agreement with Iran as a “global mandate” that Congress only “assisted” in creating. “This is a global mandate issued by the United Nations,” Kerry said Sunday on CBS’ “Face the Nation.” “Congress assisted by passing sanctions.”

Um, you would have thought that Kerry would have given up such “global” formulations after the “Global Test” fiasco of 2004. But of course not.

And I think my copy of the Constitution is complete, and I can’t find “global mandate” anywhere. Interesting, isn’t it, that two ex-Senators who were once insistent on Congressional prerogatives are now utterly dismissive of the legislative branch. Further proof that where you stand depends on where you sit.

And of course genuflecting to some “global mandate” gives power to malign actors, like Putin, who can jerk us around at will. This is particularly disturbing when we have an administration that is quite willing to be jerked around by not just Putin, but Khamenei, Assad, and assorted other thugs and punks.

So what’s Putin’s game here? Beyond the sadistic pleasure of torturing Obama, I mean. Economically, an Iran deal does not favor Russia. So is this part of a particularly Byzantine plot to undermine the deal? It certainly gives lots of ammunition to opponents of a deal in the US, Israel, and even France. (Germany and the UK are hopeless.) But perhaps as this Bloomberg piece suggests, Putin is willing to take an economic hit for a geopolitical gain. I don’t know exactly.

But what I do know is that Putin is re-fighting a Cold War that Obama believes is over because he wants it to be over. Because Obama doesn’t believe that in war, the other guy gets a vote: Obama believes his is the only vote that matters. This delusion is refuted daily, but Obama persists in it.

 

Print Friendly

April 12, 2015

The War on Excavators

Filed under: History,Military,Politics — The Professor @ 11:34 am

Once upon a time, American pilots adorned their aircraft with enemy insignia to commemorate their aerial victories.

Here’s WWII Europe air ace Gabby Gabreski in his P-47 Thunderbolt:

gabreski_p47

Here’s Pappy Boyington in his F-4U Corsair:

boyington_f47

The tradition continued in Korea, here with Ralph Parr in his F-86 Super Saber:

parr_f86

Vietnam too: here’s Robin Olds (an all around badass, by the way) in his F-4 Phantom II:

olds_f4

The fighter jocks were not the only ones. Bombers commemorated their missions with nose art:

b17-nose-art

I wonder if, and how, pilots participating in the ongoing campaign in Iraq and Syria are commemorating their accomplishments. This would be the most obvious choice to adorn an F/A-18E or an F-15E or a B-1B:

excavator-3518579

I am quite serious. If you follow the CentCom (or DoD) news releases, you will note that “excavators” are one of the top targets of the air campaign. Nary a day goes by without a press release announcing the bombing of another excavator. On Thursday, the US destroyed 9 (9!) excavators, 7 at one location (Bayji).

Obviously, excavation contractor is the most dangerous job in Iraq. (It would be an interesting test of Adam Smith’s theory of compensating wage differentials!)

I get why they are targets. ISIS uses them to build defensive fortifications. They are stationary targets that are easy to identify and hit. They are mainly in isolated areas and engaged in purely military work, and therefore can be destroyed with little risk of killing civilians.

But still. Excavators are hardly high value strategic targets. They support ISIS military operations, but are hardly essential to them: anyways, fortifications are irrelevant if there is no serious possibility of a ground attack, and the key positions in the fortifications could be knocked out when they are manned in preparation of any such attack. Destroying excavators does not crimp ISIS financially in any serious way.

In brief, the War on Excavators is a confession of the strategic inanity of the current air campaign. It smacks of “Well, we’re over here, and we gotta bomb something!” rather than demonstrating a Resolve to destroy ISIS, Inherent or otherwise.

A famous Bush quote criticizing a previous non-serious air campaign comes to mind: “When I take action I’m not going to fire a $2 million missile at a $10 empty tent and hit a camel in the butt.”

Regarding tents: we bomb those too. No news on whether any camels were harmed.

Print Friendly

April 11, 2015

The Risks of Clearing Finally Dawn on Tarullo: Better Late Than Never, I Guess

Filed under: Clearing,Derivatives,Economics,Politics,Regulation — The Professor @ 10:11 pm

In October, 2011 I was in a group of academics invited to meet the Board of Governors of the Fed to discuss our research. The theme was network industries, and I was to make a presentation on the network aspects of clearing and its implications for systemic risk.

My most vivid memory of the meeting has little to do with my presentation. Instead, it relates to Ben Bernanke, who sat facing me, directly across the massive boardroom table. Bernanke obviously had a headache. He was rubbing his temples, and he asked a staffer to bring him a cold can of Diet Mountain Dew, which he held against his forehead while closing his eyes. Figuring that a Bernanke headache would portend bad financial news, I was sorely tempted to excuse myself to call my broker to sell the hell out of the S&P.

Sitting next to me was Governor Daniel Tarullo. Truth be told, I was not impressed by his questions, which seemed superficial, or his mien, which was rather brusque, not to say grouchy.

He was definitely not sympathetic to my warning about the potential systemic risks of clearing: he made some skeptical, and in fact dismissive, comments. It was quite evident that he was a believer in clearing mandates.

It appears that Tarullo is still struggling with the idea that CCPs are a risk, but at least he’s open to the possibility:

JPMorgan Chase & Co. and BlackRock Inc. have argued for years that a key response to the last financial crisis could help fuel the next one. [What? No mention of SWP? I was way ahead of them!] Global regulators are starting to heed their warnings.

At issue is the role of clearinghouses — platforms that regulators turned to following the 2008 meltdown to shed more light on the $700 trillion swaps market. A pivotal goal was ensuring that losses at one bank don’t imperil a wide swath of companies, and the broader economy.

Now, Federal Reserve Governor Daniel Tarullo is quizzing Wall Street after big lenders and asset managers said clearinghouses pose their own threats, said three people with knowledge of the discussions who weren’t authorized to speak publicly. Among the concerns raised by financial firms: Relying on clearinghouses shifts risk to just a handful of entities, and the collapse of one could lead to uncapped losses for banks.

. . . .

Tarullo, the Fed’s point man on financial regulation and oversight, has publicly conceded that it’s hard for banks to determine their own market risks if they can’t evaluate how badly they would be hit by the failure of a clearinghouse. It’s “worth considering” whether clearinghouses have enough funds to handle major defaults, he said in a Jan. 30 speech.

Tarullo’s speech is here. Although he is still obviously a clearing fan, at least he is starting to recognize some of the problems. In particular, he acknowledges that it necessary to consider the interaction between CCPs and the broader financial system. Though I must say that since he mentions multilateral netting as the primary reason why CCPs contribute to financial stability, and margins as the second, it’s painfully evident that he doesn’t grasp the fundamental nature of clearing. In the first instance, netting and collateral just redistribute losses, and it is not clear that this redistribution enhances stability. In the second instance, although he acknowledges the problems with margin pro cyclicality, he doesn’t explicitly recognize the strains that large margin flows put on liquidity supply, and the destabilizing effect of these strains.

So it’s a start, but there’s a long way to go.

Tarullo pays most attention to the implications of CCP failure, and to measures to reduce the likelihood of this failure. Yes, failure of a large CCP would be catastrophic, but as I’ve oft written, the measures designed to save them can be catastrophic too.

Tarullo would be well-advised to read this short piece by Michael Beaton, which summarizes many of the issues quite well. The last few paragraphs are worth quoting in full:

In general, I think what we need to take away from all of this is that systemic risk can be transferred – it’s arguable whether or not it can be reduced – but it certainly can’t be eliminated, and the clearing model that we are working towards is a hub and spoke which concentrates risk on a very, very small number of names.

A decentralised network is arguably stronger than a hub and spoke model, mainly because open systems are generally regarded as more robust than closed ones. The latter is what the clearing model operates on and you have that single, glaring point of failure, and there’s really no escape from that.

So, going back to the original questions – do I think the proposals are enough?  I think it goes a long way, but fundamentally I don’t think it will ever resolve the problem of ‘too big to fail’.  I’m just not convinced it’s a problem that is capable of resolution. [Emphasis added.]

Exactly. (The comparison of open vs. closed systems is particularly important.)

Since clearing mandates create their own systemic risks, the Fed, and other central banks, and other macroprudential regulators, must grasp the nettle and determine what central bank support will be extended to CCPs in a crisis. Greenspan extemporized a response in the Crash of ’87, and it worked. But the task will be orders of magnitude greater in the next crisis, given the massively increased scope of clearing. It’s good that Tarullo and the Fed are starting to address these issues, but the mandates are almost 5 years old and too little progress has been made. Faster, please.

 

Print Friendly

Next Page »

Powered by WordPress