Streetwise Professor

The shrieking and rending of garments du jour emanates from Trump’s decision to withdraw US troops from the path of a Turkish-backed invasion of northeastern Syria.

What, pray tell, is the US supposed to do? Resist a vastly superior force armed with heavy weapons, artillery, and air support with 1,000 light infantry and support troops? Did these people attend the George Armstrong Custer School of Warfare?

Oh, I forgot. Custer didn’t have air support at Little Bighorn. The US has the most powerful air force in the world. Maybe if we ask really nice the Turks will allow us to use the Incirlik airbase to launch bombing strikes against them.

Or is the US supposed to go large, and bulk up its forces sufficiently to fight Turkey in northern Syria? Riddle me this, military geniuses: just how would they get there?

Putting aside their tactical and logistical inanity for now, the critics of Trump’s move focus on two issues: the betrayal of the Kurds who fought ISIS in Syria, and the supposed surrender of American strategic interests in Syria.

As for the first issue, with respect to ISIS, the interests of the US and the Kurds of the YPG were aligned: both were enemies of ISIS. Yes, the YPG assisted in the US in its fight against ISIS, but it is equally fair to say that the US assisted the Kurds in their fight against ISIS. It was an alliance of convenience, and completely transactional.

That alignment of interests does not extend to supporting the Kurds in their conflict with Turkey. Yes, Erdogan’s Turkey is a colossal pain in the ass, and is at best a frenemy to the US, but it is not in US interests to engage in an outright war with Turkey, either directly, or by proxy, to advance the interests of the Kurds in their generations-long conflict with Turkey.

Along these lines, the key thing to keep in mind in the Middle East generally, and Syria in particular is: everyone sucks. Everyone. Everyone is awful. Sometimes the interests of awful group X align with the US, and we work with them (often to our regret). But that doesn’t change the fact that they are awful. This dew-eyed romanticism about the Kurds ignores this cardinal rule.

With respect to the second issue, I read drivel like: “Now that Trump made the US a bystander in Syria, Turkey and Russia are in the driver’s seat.” Or “US allied Kurds strike deal to bring Assad’s troops into Kurdish areas, dimming prospect for further US presence in Syria.”

They say this like these are bad things! Bystander sounds good to me, given the alternative of wading in. Syria is a dystopian hellhole that makes Westeros (after Daenerys’ flyover!) look like Mr. Rogers’ Neighborhood. I want to stand as far away from that as possible. Who in their right mind thinks otherwise?

Seriously: I want someone to make a coherent case that lays out the American national interest in Syria, and what is the price of achieving it. The first principle of war is “the objective.” So, just what is the American objective in Syria?

Destroying ISIS was arguably a legitimate interest. The current chaos may work to ISIS’s advantage, but is addressing that issue even possible given the potential for force-on-force conflict between Turkey and Syria, and thus potentially between Turkey and Syria’s patron, Russia? Who are we going to fight? Turkey? Russia? Syria? All of the above?

Are you people using a single brain cell?

This crowd is also freaking out that Putin and Erdogan may benefit from the US withdrawal. I seriously find it hard to imagine how both would benefit, precisely because they are on the opposite side of what is going on at this moment, with Syrian army forces moving to confront Turkish-backed forces. If they succeed, what will Erdogan do? Most likely, by reinforcing his proxy forces with Turkish formations. If they fail, what will Putin do? Probably reinforce Syrian forces with Russian ones, and provide heavy air support. Which will certainly kill Turks. Thus, the most likely outcome will be conflict between Russia and Turkey.

So how are Erdogan and Putin both going to come out on top? How are both going to be in the driver’s seat?

Apropos Henry Kissinger and the Iran-Iraq War: it’s a shame they both can’t lose. But maybe Kissinger is wrong, and they both will!

And we really shouldn’t care who “wins.” For here, to the victors will go the spoiled. Syria is a wrecked country with few prospects of seeing peace, let alone prosperity, in the foreseeable future. Or forever.

I laughed out loud when I read some idiot write that Putin desires eastern Syria’s oil riches. Some riches. Before the recent unpleasantness, in 2010, Syria produced a grand total of 385,000 barrels per day. Compared to Russia’s ~10 million. Syria has always been an oil pygmy. And the meager resources it had before the civil war have been wrecked, and will take billions of dollars to restore.

Yet it is this kind of “analysis” that we hear repeatedly.

If Putin and Erdogan and Assad want to fight over this rotted corpse, why should we care?

Let’s say the US magically vanquishes Assad, Russia, and Turkey. Then what?

Anybody taken a look at Iraq lately? Yeah, that’s gone and is going so great we can surely magically heal Syria. There is no upside for the US in Syria. It is a distraction, and a potentially costly one, from the potential for peer conflicts with China, and yes, Russia. We’ve already pissed away trillions in Iraq and Afghanistan, and wasted tens of thousands of American lives in those places. The last thing we should do is add to the butcher’s bill and the financial cost.

The problem with Trump’s critics on this–and other things, especially in foreign policy–is that they don’t evaluate the real choices, the real trade offs. They engage in nothing but magical thinking that bears no relationship to the ugly reality on the ground. They apparently have some ideal outcome in mind (the US vanquishes Putin and Assad and makes Syria a beacon of hope in the Middle East) but have no clue on how to achieve that outcome.

The fact is that Syria is a place where angels fear to tread. But we surely have a surfeit of fools who are willing to rush in regardless.

In the ongoing evaluation of what has been happening in the repo market, market participants have identified post-crisis regulations as a potential source of the problem. In particular, these regulations (including the Liquidity Coverage Ratio) require behemoth banks like JP Morgan and Citi to hold large amounts of reserves, and makes them reluctant to lend them out even when repo rates spike.

Having long said that the various liquidity regulations intended to prevent a recurrence of the last crisis could be the cause of a new one, I am certainly quite sympathetic to this view. However, information that is coming out now suggests another potentially complementary and aggravating factor.

In particular, reserve holdings are very concentrated:

Fed data show large banks are keeping a disproportionate amount in reserves, relative to their assets. The 25 largest US banks held an average of 8 per cent of their total assets in reserves at the end of the second quarter, versus 6 per cent for all other banks. 

Meanwhile, the four largest US banks — JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — together held $377bn in cash reserves at the end of the second quarter this year, far more than the remaining 21 banks in the top 25

Moreover, the big banks have been reducing their reserves:

Analysts and bank rivals said big changes JPMorgan made in its balance sheet played a role in the spike in the repo market, which is an important adjunct to the Fed Funds market and used by the Fed to influence interest rates.
Without reliable sources of loans through the repo market, the financial system risks losing a valuable source of liquidity. Hedge funds, for example, use it to finance investments in U.S. Treasury securities and banks turn to it as option for raising suddenly-needed cash for clients.
Publicly-filed data shows JPMorgan reduced the cash it has on deposit at the Federal Reserve, from which it might have lent, by $158 billion in the year through June, a 57% decline.

Although JPMorgan’s moves appear to have been logical responses to interest rate trends and post-crisis banking regulations, which have limited it more than other banks, the data shows its switch accounted for about a third of the drop in all banking reserves at the Fed during the period.
“It was a very big move,” said one person who watches bank positions at the Fed but did not want to be named. An executive at a competing bank called the shift “massive”.
Other banks brought down their cash, too, but by only half the percentage, on average.
For example, Bank of America Corp (BAC.N), the second-biggest U.S. bank by assets, with a $2.4 trillion balance sheet, took down 30% of its deposits, a $29 billion reduction.

So . . . substantial concentrations of reserves, and declining levels of reserves. Yes, these are all potential consequences of Frankendodd. But they also are potentially symptomatic of market power and the exercise thereof.

This triggered a synapse, which led me to recall a 1993 article from the Journal of Monetary Economics by R. Glen Donaldson. Donaldson’s article was motivated by a study of the Panic of 1907, when a “cash syndicate” (led by . . . J.P. Morgan, in person and through his eponymous bank) lent to cash strapped trust companies facing depositor runs at very high rates.

Donaldson presents a model in which a spike in the need for cash by a set of market participants (trust companies facing depositor outflow, in his model) makes the funds held by a group of other institutions pivotal: these institutions face a downward sloping demand curve for their funds because of constraints on competitive suppliers of funds. The pivotal institutions supply funds (through a repo-like transaction in which they buy securities from the trusts) at a supercompetitive price (by buying the trusts’ securities at subcompetitive prices). In his model, collusion between the pivotal institutions exacerbates the rate spike.

The main implication of the model is that spikes in the demand for funds lead to spikes in interest rates that are bigger than would prevail in competitive conditions.

There is an element of non-linearity in the model, because the big suppliers’ funds are not pivotal in normal conditions, but become so when the demand becomes sufficiently large. This leads to a switch from competitive to monopoly pricing, which in turn causes a spike in rates.

I should note that the regulatory and market power stories are not mutually exclusive, and are indeed complementary. Regulatory constraints can increase the demand for funds (making it more likely that the big suppliers will be pivotal) and can reduce the supply of funds from the smaller suppliers (which lowers the threshold for the switch from competitive to monopoly pricing, and makes the demand curves for the big suppliers funds steeper, leading to a higher monopoly rate).

I therefore consider it a plausible hypothesis that market power contributed to the repo market spike, and that one channel by which regulations contributed to the spike was through its effect on market power.

How can this hypothesis be tested? Conceptually, if regulatory constraints alone caused the spike, then those in possession of large quantities of reserves (e.g., Morgan) were absolutely constrained in their ability to lend additional reserves: the difference between the repo rate and the Fed Funds rate would represent the shadow price on this regulatory constraint.

If a big bank or banks exercised market power, this constraint would not be binding.

Operationalizing this test is likely to be complex, however. Big holders of reserves will inevitably make all sorts of arguments to say that they couldn’t have lent more.

This brings to mind the California electricity crisis in 1999-2000, when generators operated below various capacity measures, but pleaded that constraints (by unplanned outages, or NOX regulations, etc.) reduced their effective capacity below these nominal capacity measures. Given the complexity of operating a power plant, it was very difficult to determine whether the generators were withholding capacity, or in fact offered as much as they were capable of doing.

Despite the difficulty of operationalizing the test, I think it is something for regulators to attempt. There is a colorable case that the repo rate rise was exacerbated by market power, and given the importance of this market, this possibility should be investigated rigorously.

As an aside, the Donaldson model appeared only a few months before my Journal of Business article on market power manipulation. The two articles have a lot in common, despite the fact that they were developed totally independently, and seemingly involve completely unrelated markets (money vs. physical commodities). However, the core arguments are similar: economic frictions can periodically create market power in markets that are usually competitive.

Hannah Arendt once wrote that “one of the greatest advantages of the totalitarian elite in the twenties and thirties was to turn any statement of fact into a question of motive.” This quote came to mind when reading Matt Stoller’s hit piece on Aaron Director on the Stigler Center’s Pro-Market blog.

Director was one of the major moving forces behind the Chicago revolution in antitrust scholarship in the 1950s and 1960s. Although he published little himself, through his teaching, and his interactions with other faculty in economics, law, and business at Chicago, Director challenged the consensus on antitrust, especially in areas like vertical restraints. The challenge that he inspired pretty much overturned this consensus, and it is fair to say that the Chicago became the replacement paradigm. A good portion of the industrial organization and antitrust scholarship of the past 50 years has been aimed at challenging the Chicago view, but nonetheless, many of its key insights remain regnant.

Stoller does not mount a serious attempt to critique Director’s actual contributions, or to explain them, as Sam Peltzman does in his two posts on Director. Rather than challenging Director and his followers on the facts, or on the analysis, Stoller instead questions Director’s motives. It is attack by ad hominem.

In Stoller’s telling, for much of his life, Director was a good progressive, and a devotee of Henry Simons. As such, he was an antimonopolist who favored aggressive antitrust enforcement. But then Simons died, and Director “suddenly” converted to a right-wing pro-business fanatic in order to appease a major funder who according to Stoller was an “extreme right-wing[er]” and quasi-fascist:

Director suddenly decided that conservative ideas were compatible with corporatism after all. Monopolies, apparently, were always created by government. At this moment, Director broke with the conservative tradition and birthed neoliberalism, the anti-government, pro-monopoly philosophy that now dominates policymaking globally. Director convinced George Stigler and Milton Friedman of the new creed. Both had opposed corporate monopolies, but flipped to support Director’s new movement. The Chicago School was born.

Thus, Director was nothing but an intellectual Judas, who sold out his firm convictions for a few pieces of silver.

This begs so many questions it isn’t funny. Take Stoller’s premise as fact. How, pray tell, did Director convince such notoriously strong minded people like Stigler and Friedman? Did he pay them off? No really–how did he persuade them?

And how did he persuade others, such as Bork, who was a major force in reshaping antitrust law? And how did the Chicago school antitrust/industrial organization ideas midwifed by Director have such a profound effect on the economics and legal academy outside of Hyde Park, and then the courts? Especially since they were initially so contrary to the professional consensus, and indeed attracted substantial (and often hysterical) opposition?

There must have been something to the ideas, eh? But not in Stoller’s telling. Instead, according to him, Harold Luhnow got his money’s worth by getting Director to turn from anti-monopolist to pro-monopolist, and somehow (mesmerism?) Director convinced myriad intellectuals (and judges) to go along.

The closest that Stoller comes to addressing any of the scholarship that Director inspired is a drive by shooting on John McGee’s Journal of Law and Economics (1958) paper that contended that, contrary to the overwhelming conventional wisdom, Rockefeller’s Standard Oil did NOT engage in predatory pricing.

Stoller refers to a paper which disputes McGee’s findings. Fine. But he is presented with the problem that, as shown by Joshua Wright, McGee’s article had far less of an impact on academic and legal thinking on predatory pricing than the 1975 Areeda-Turner article. But no problem! Just turn this question of fact into one of motive: “It didn’t hurt [Areeda-Turner’s] motivations, of course, that they were both on the payroll of IBM, which was at that moment in a bitter series of antitrust lawsuits which included, you guessed it, predatory pricing claims.”

Disgusting.

Stoller writes: “With support on the right and the left, courts soon accepted Director’s ideas, laundered through McGee, Turner, and Areeda.” Again: through what powers of mind control did Director get “liberal Democrats” from Harvard to launder his dirty ideas? Inquiring minds want to know!

But Stoller’s distortion of history doesn’t end here. His explanation for the rationality of predatory pricing goes like this:

Contra Director’s logic, predatory pricing is quite rational. A competitor to a corporate goliath can’t borrow an infinite amount of money to lose until prices come back, nor can a competitor just shut down until prices go back up. No bank would lend to a competitor of Standard Oil, just as no one today will lend to a retailer competing to lose money against Amazon. 

Wow. That logic sounds familiar! Yes, I remember now: in 1966 one of my thesis advisors, Lester Telser (a contemporary of McGee’s in the PhD program at Chicago), published an article titled “Cutthroat Competition and the Long Purse” which explored that very same logic.

It gets better.

Lester’s article was published in what Stoller portrays as the main vehicle for Director’s malign influence: the Journal of Law and Economics. Better yet, Telser thanks Director for his input. Better yet: Telser’s article was published in an issue honoring Director, on the occasion of his retirement from Chicago and editorship of the JLE.

Of course, you would never know this, if you read Stoller. Stoller also fails to mention that Sam Peltzman told an anecdote regarding Director and predatory pricing in a JLE article on “Aaron Director’s Influence on Antitrust Policy,” published as a sort of obituary at the time of Director’s death in 2004. In Sam’s telling, Director, in his typical Socratic style, led his students through an analysis of predatory pricing . . . in which he concluded that the defendant in a predatory pricing case “most likely was guilty as charged.”

It is particularly astounding that Stoller should overlook this anecdote, given that it was republished on the very same Pro-Market website. So it’s not like Stoller had to, I dunno, get onto JStor and do some real research on whom he was supposedly analyzing.

Stoller also fails to acknowledge that Director’s alleged ability to mesmerize did not even extend to nearby offices at the University of Chicago Law School: Richard Posner, for example, acknowledged that predation could occur.

Stoller also evidently has no clue as to how academia works. Provocative articles like McGee’s inevitably spur others to challenge it. And indeed, there have been numerous articles over the years that identify conditions in which predation can work. As it turns out, however, the conditions are much more fragile than Stoller lets on.

In sum, Stoller’s post on Director is an appalling piece of work. It fails to join Director’s actual work, and relies on vicious ad hominem to discredit the work which he does not like by attempting to discredit the motives of the person.

I don’t really give a damn about Matt Stoller. What I do find especially disgusting is that the Stigler Center at the Booth School of Business would lend its imprimatur to a piece that violates the fundamental norms and ethics of scholarship. If Pro-Market wanted to provide a critical view of Director, the Chicago School of antitrust has a lot of serious critics who could analyze his work and the work that he inspired. Instead, Pro-Market provides a platform for an intellectually disreputable attack on alleged motives, and one that provides no substantial evidence for its central claim, and which begs so many questions as to be self-refuting.

Appalling, and an affront to the long tradition of economics and law at Chicago.

On my flight back from Geneva, I watched Argo, the Ben Affleck film about the rescue of 6 Americans who escaped the embassy in Tehran when it was taken over by Iranian “students” in 1979, and who hid out in the Canadian embassy.

The hero of the movie is Tony Mendez, a CIA exfiltration expert. Yay! CIA! CIA!

The only problem is that the only reason that Mendez was needed to pull off the miracle escape was that the CIA failed utterly in its primary mission: intelligence. The agency was completely blindsided by the Iranian revolution, and had indeed specifically told President Carter that Iran was NOT in a pre-revolutionary situation. Right before the actual revolution toppled the Shah.

If the CIA had done its job, Tony Mendez wouldn’t have been needed to do his. The abject failure of his organization to perform its primary function competently was the predicate for his heroism.

This is only one of the CIA’s colossal failures. Off the top of my head, I can think of: the massive overestimate of the size of the Soviet economy, the (not unrelated) failure to foresee either Gorbachev or the collapse of the USSR, the Soviet invasion of Afghanistan, being gobsmacked by India’s atomic test, 911, the various Iraq War fiascos, and the failure to predict Saddam’s incursion into Kuwait.

Mendez was awarded the Intelligence Star, the highest honor that a US intelligence agency person can receive. And justly so.

But what about all of those whose failures paved the way for his medal? Did they pay any professional price at all for their failures?

I seriously doubt it. They all probably just worked their way down the belly of the bureaucratic snake, getting advancement on schedule before retiring with full benefits.

The primary source of bureaucratic dysfunction–and as the record shows, the CIA has been dysfunctional since its founding–is a lack of accountability. There is little price for failure, no matter how egregious that failure might be.

There is an even more sinister aspect to that lack of accountability, an aspect that is particularly important for intelligence agencies, and which has also been demonstrated time and again.

An intelligence service like the CIA must operate in secrecy, but that secrecy makes accountability almost impossible. That, in turn, allows agency personnel–especially at the highest levels, where secrecy is greatest, and who have powerful political connections–to engage in crimes, and political machinations, with little risk of being detected, and even less of being held to account.

But it gets worse. Access to vast amounts of very sensitive information gives intelligence agency personnel incredible power through blackmail, or the threat of blackmail. I am reminded of this story about German Chancellor Conrad Adenauer, from Paul Johnson’s Modern Times:

He had little affection beyond his own family circle and his closest associate was Hans Globke, co-author of the Nuremberg Laws, who ran the Chancellery and Adenauer’s private intelligence service. ‘And who knows’, Adenauer would smirk, ‘what Herr Globke may have in his safe?’

Before our eyes we are witnessing the consequences of the unaccountability of the CIA (and the FBI), and its vicious response to anyone who dares attempt to hold it accountable. Trump, and latterly his Attorney General, William Barr, are currently under relentless assault from leakers in the “intelligence community,” aided and abetted by their house organs, notably the Washington Post and New York Times, for their temerity in investigating the events that culminated in the Mueller probe. (I’m old enough to remember when the WaPo and NYT were in high dudgeon about the misdeeds of the CIA and FBI. Good times!)

Funny, isn’t it? I’m also old enough to remember being told that attempts to subvert American elections were a crime of the first order, and that no stone should go unturned and no lead unfollowed in the attempt to investigate and punish such actions.

But that apparently only applies to things that might implicate Trump.

I’m also old enough to remember that attacking an investigation was an admission of guilt, cuz “if you have done nothing wrong and have nothing to hide, you have nothing to fear from an investigation.”

That is so 2018! Now the “intelligence community” and its schooling pilot fish are utterly freaking out over Barr’s diligent efforts to delve into the machinations that surrounded the 2016 elections. Hey, if you have nothing to hide, dudes . . .

When someone screams: “DON’T DIG BEHIND THE GARAGE! WHY ARE YOU DIGGING BEHIND THE GARAGE?” it’s a good bet that there’s something buried behind the garage.

Barr currently has not just a shovel, but a power shovel behind the garage in Langley, and other places around the world, where the US intelligence agencies skulked in the shadows in 2016. And it has them completely freaking out, and fighting back with every weapon at their disposal.

So keep digging Bill. And the louder they scream, bring in more heavy equipment.

Maybe Barr’s attempt to bring the intelligence agencies to account is a Quixotic task. I hope not. It is impossible to exaggerate how much is at stake here.

I’ve been in France and Switzerland for a week lecturing and teaching. And what a stupid week it was. Arguably the most stupid week of my life.

Not with my trip–that was great. What was cosmically stupid went on in the US during it.

It started with the Greta Thunberg circus at the UN. Sorry, but “for the children” was well past its sell-by date when Hillary wretched it up decades ago. It is putrid beyond belief now. Teenagers have no moral or intellectual authority to harangue and hector about things they cannot remotely comprehend. Greta and the other muppets are just that . . . puppets being manipulated by cynical, power-seeking adults.

But that was just the hors d’ouevres. The cosmic stupidity was the impeachment farce sparked by a “whistleblower.”

The entire affair screams setup. The Dossier, Part Deux: Whistleblower.

To begin with, the stampede to impeachment began, and was affirmed by Nancy Pelosi, based on news reports about a whistleblower complaint, rather than the complaint itself or primary sources documenting the events at issue. And this despite the fact that the administration promised that it would release both within days–and did.

But the rush to judgment wasn’t a bug: it was a feature. No waiting for the actual facts to come out. Verdict first! Trial after!

And the administration’s release of the transcript of the call that allegedly so shocked the whistleblower and his multiple as yet anonymous sources demonstrates exactly why: the transcript refutes many aspects of the pre-release news reports, and contains crucial details that the whistleblowing complaint left out.

They make you swear to tell the whole truth when you testify, because leaving out facts is as dishonest as telling outright lies: the news reports were clearly not the whole truth, and as such represented a vile lie. Given this, the impeachment train definitely had to leave the station before the facts came out.

The hypocrisy is also beyond belief, even by current DC standards. The first favor Trump asked Ukrainian president Zelensky for was help in investigating . . . wait for it . . . foreign interference (or more accurately, foreign assistance in American i.e., Democratic interference) in the 2016 election. (This is the part left out of the original news reports.)

You see, foreign interference with American democracy is the worst thing ever, and no stone must go unturned investigating it . . . except when American Democrats are involved in it. But you are a traitor for trying to bring that to light, especially with the assistance of foreigners.

Trump also asked Zelensky about a Ukrainian prosecutor whom Joe Biden bragged about using–what’s that term?–oh yeah, “a quid pro quo” (the withholding of American aid) to get fired. A prosecutor who was investigating Biden’s son.

But Trump supposedly went beyond the pale at even hinting at a quid pro quo with Zelensky.

And how dare you–or Trump–connect dots!, you traitors you! Never mind that many of the people denying a possible connection between Biden’s demand to have the prosecutor fired and the firing of the prosecutor want you to believe that because Carter Page was in Moscow Trump was on the take and had models peeing on him in a Moscow hotel room.

Like I say. The hypocrisy is beyond belief.

The whole Biden affair is appalling on its face. Biden’s son Hunter–an admitted crackhead who was canned from the Navy for being a crackhead–couldn’t get any job that required him to piss in a cup (which is nowadays most jobs other than those that require you to say “do you want fries with that?”), and has zero experience in energy or Ukraine, yet miraculously wound up with a $50K/month no work job advising a Ukrainian energy company. (There’s also the issue of the lifelong loser’s ability to play rainmaker in China.)

Silly me. I though we were supposed to be deeply, deeply concerned about the Emoluments Clause. Another one-way DC street, apparently.

Then we get to the issue of the fact that the whistleblower complaint was–by his/her admission–hearsay. Funny, given credible whistleblowing complaints are supposed to be based on first-hand knowledge.

Sorry. “Were supposed to be.” Sometime between the date of the call and the filing of the complaint, the rules were changed by “the intelligence community” (AKA The Blob) to permit second- and third-hand information to serve as the basis for these complaints.

When this lot is involved, there are no coincidences, comrade. The fix was in, from the inside.

Since the substance of the call did not support the initial hysteria, the ground has now shifted to “coverup” because the White House ordered the call (along with some earlier ones) to be stored on a highly classified code word access system.

The chutzpah meter pegs on that one. Presidential calls with foreign leaders are supposed to be confidential, and open discourse is possible only if all involved believe that confidence will be respected. But from virtually day one in the Trump administration, details of confidential calls were leaked–presumably by someone in The Blob.

So it makes sense for Trump to attempt to lock down his calls. The leaking of (false and misleadingly incomplete) details of a call under the guise of “whistleblowing” is proof positive of his suspicions, and justification of his precautions, for all the good it did. Where there’s a will to leak, there’s a way. But there’s no reason to make it easy.

And boil the argument down to its essence. Trump has abused power by attempting to prevent leaks that interfere with his ability to perform his duties as chief executive.

Obama is no doubt laughing his ass off now.

And The Blob is the real abuser of power. It has no authority to leak, and the audacity of claiming that attempts of the legitimate, elected authorities to curb its leaking are an abuse of power is something to behold.

Operation Dossier and Operation Mueller failed. But the Deep State is nothing if persistent. Operation Ukraine is yet another attempt to interfere in the US political process, and indeed in the US elections.

And to be honest, I get far more furious at Americans doing it than foreigners.

The panicky haste with which the Democrats are proceeding with impeachment speaks volumes. It betrays their belief that the array of lunatic buffoons and buffoonish lunatics that comprise the party’s presidential candidates would lose, and lose badly, in 2020. So they need to resort to extra-electoral mechanisms to destroy whom they do not believe they can defeat. And in this effort, they have the full support of arrogant and unaccountable apparatchiks up and down the bureaucracy of the federal government.

This is war to the knife.

It’s time to go to the mattresses, and to take on and take out the mob–The Blob–that is arrogating to itself powers far beyond those conferred on it by the law.

The most contentious battle in American securities markets right now is being waged over exchange pricing of data, in particular over proprietary order book feeds. The battle pits the exchanges against market users (e.g., HFT firms, institutional traders) with the latter claiming that the prices charged by the former border on the extortionate.

The critics actually have a very good point. The economics of the situation imply that the prices the competing exchanges charge are ABOVE the price a monopoly would charge.

No. Really.

So how could competing firms charge a supra-monopoly, let alone supra-competitive, price? The answer to this question is something pointed out by the first true mathematical economist, Augustin Cournot, in his Principes Mathematique, published in 1838. In that book, Cournot laid out “the problem of complements.” Cournot showed that imperfectly competitive firms overprice complementary goods. (Cournot’s example involved zinc and copper in the production of brass. They are complements used in fixed proportion.)

The basic issue is that when goods are complements, if firm A raises its price firm B that produces a complement to A’s good cannot steal sales from A by cutting its price (as would be the case of A’s and B’s goods were substitutes). This reduces the incentive to cut price, and actually provides an incentive to increase prices in order to get a bigger piece of the surplus that is generated when the consumer buys both goods.

This situation fits the stock market case perfectly. Execution services on US exchanges (e.g., NYSE, BATS) are substitutes, but data services are complements.

Consider an HFT firm. One source of profits for this firm is to exploit price discrepancies across exchanges. This requires having near immediate and simultaneous access to prices across all exchanges. Or consider a buyside firm that is trying to minimize execution costs by a clever order routing strategy. Optimizing the allocation of orders across exchanges requires knowing the order book on all the exchanges.

In other words, there are many market participants who have to collect the entire set (of exchange data). This makes the data provided by competing exchanges complements, which by the Cournot logic, forces prices above the competitive level, and indeed, above the monopoly level.

Furthermore, the problem becomes worse, the larger number of exchanges. This is a situation in which lower concentration leads to less competitive outcomes. (Robin Hansen made a similar point recently.)

This is yet another example of the only law that is never repealed: the law of unintended consequences. The intent of RegNMS was to increase competition in the execution of stock trades, and it has done a marvelous job of that. However, the unintended effect of this “fragmentation” (i.e., the increase in the number of execution venues and decline in concentration across exchanges) has been to create and exacerbate a complements problem in data.

A couple of final points. Perhaps one could make a second-best argument here: low execution fees and high data fees may be a good way of covering the fixed costs of operating exchanges (a la Ramsey pricing). Perhaps, but unproven.

What is the right regulatory response? Not clear. I addressed similar conundrums in my 2002 Market Macrostructure article. Natural monopoly-style/pricing regulation could mitigate the overpricing problem, but entails its own costs (e.g., undermining incentives to innovate). The issue is particularly challenging here because efficiency-enhancing competition on one dimension (execution) leads to inefficient problems-of-complements competition on another (data).

As I argued in Market Macrostructure, it really comes down to an issue of property rights. Should exchanges have exclusive ownership of their data? Should this ownership be attenuated in some way, such as limitation on prices, or a required pooling of data that would be sold by a monopolist, with revenues shared by the exchanges? Here is a case where a monopoly would actually improve outcomes.

Maybe that is the way to split the baby, politically. Exchanges would get rents, but efficiency would be improved. Not a first-best solution, but maybe a second best one, and one that could represent a Coasean bargain between exchanges and their customers. And perhaps the regulator–the SEC–could help facilitate and coordinate that deal.

In the Gilded Age, American financial crises (“panics,” in the lexicon of the day) tended to occur in the fall. Agriculture played a predominant role in the economy, and marketing of the new crop in the fall led to a spike in the demand for cash and credit. In that era, however, the supply of cash and credit was not particularly elastic, and these demand spikes sometimes turned into panics when supply did not (or could not) respond accordingly.

The entire point of the Fed, which was created in the aftermath of one of these fall panics (the Panic of 1907, which occurred in October), was to make currency supply more elastic and thereby reduce the potential for panics. In essence, the Fed had one job: lender of last resort to ensure a match of supply and demand for currency/credit, when the latter was quite volatile.

This week’s repospasm is redolent of those bygone days. Now, the spikes in demand for liquidity are not driven by the crop cycle, but by the tax and corporate reporting cycles. But they recur, and several have occurred in the autumn, or on the cusp thereof (this being the last week of summer).

One of my mantras in teaching about commodities is that spreads price bottlenecks. Bottlenecks can occur in the financial markets too. The periodic spikes in repo rates–not just this week, but in December, and March–relative to other short term rates scream “bottleneck.” Many candidates have been offered, but regardless of the ultimate source of the clog in the plumbing, the evidence from the repo market is that there are indeed clogs, and they recur periodically.

The Fed’s rather belated and stumbling response suggests that it is not fully prepared to respond to these bottlenecks, despite the fact that their regularity suggests that the clogs are chronic. As the saying goes, “you had one job . . . ” and the Fed fell down on this one.

And maybe the problem is that the Fed no longer just has one job, and it has shunted the job that was the reason for its creation to the back of the priority list. Nowadays, the Fed has statutory obligations to control employment and inflation, and views its main job as managing aggregate demand, rather than tending to the financial system’s plumbing.

This is concerning, as dislocations in short-term funding markets can destabilize the system. These markets are systemically important, and failure to ensure their smooth operation can result in crises–panics–that undermine the ability of the Fed to perform its prioritized macroeconomic management task.

One of the salutary developments post-crisis has been the reduced reliance of banks and investment banks on flighty short-term funding. The repo markets are far smaller than they were pre-2008, and the unsecured interbank market has all but disappeared (representing only about .3 percent of bank assets, as compared to around 6 percent in 2006). But this is not to say that these markets are unimportant, or that bottlenecks in these markets cannot have systemic consequences. For the want of a nail . . . .

Moreover, the post-crisis restructuring of the financial system and financial regulation has created new potential sources of liquidity shocks, namely a supersizing of potential demands for liquidity to pay variation margin. When you have a market shock (e.g., the oil price shock) occurring simultaneously with the other sources of increased demand for liquidity, the bottlenecks can have very perverse consequences. We should be thankful that the shock wasn’t a Big One, like October, 1987.

Hopefully this week’s tumult will rejuvenate the Fed’s focus on mitigating bottlenecks in funding markets. Maybe the Fed doesn’t have just one job now, but this is an important job and is one that it should be able to do in a fairly routine fashion. After all, that job is what it was created to perform. So perform it.

The Sino-American “trade war” narrative is one of the most idiotic ones in recent memory, and given that it has to compete with things like “Russian collusion” that’s saying a lot. This narrative is appealing to superficial, lazy journalists, is tailor made for governments and companies looking to excuse poor results, and fits right in with the relentless anti-Trump media drumbeat.

Trade is just one weapon in a deeper geopolitical/geostrategic contest between the United States and China. This contest pits an established status quo power with an emergent, revanchist, revisionist one. These powers have fundamentally different visions for the operation of the global system.

The struggle is being waged in myriad dimensions, and often in a quite asymmetric way. One of China’s most deadly–literally–asymmetric weapons is fentanyl. And anyone who thinks that China’s shipping of massive quantities of this extremely dangerous drug to the US is not an intentional asymmetric warfare tactic is delusional.

Consider this story about the “rise and fall of an Eagle Scout’s Fentanyl Empire.” Consider this line in particular:

The case against Shamo detailed how white powder up to 100 times stronger than morphine was bought online from a laboratory in China and arrived in Utah via international mail (emphasis added).

China is the most intrusive security state in the history of the planet. In particular, its surveillance and censorship of the Internet is beyond intense. Nothing happens on the Internet in China without the security establishment/Party knowing about it, and allowing it.

Further, China is the most ruthlessly repressive state in the world, and has absolutely no compunction about summarily executing those who cross it. They will even go one better, and sell the organs of those they execute. If it wanted to crack down on the fentanyl trade, it could do it. With extreme prejudice.

So if it is possible for an American to buy massive quantities of fentanyl online in China, it is because the Chinese government wants to sell massive quantities of fentanyl to Americans.

That is the real trade war that is going on. The trade in fentanyl is a deliberate tactic by China to kill Americans and weaken American society.

China is playing for keeps. Yet a large portion of the American establishment has been corrupted and co-opted by China, and/or is so blinded by Trump hatred that they turn a blind eye to this conduct, when they are not bewailing any attempt to confront China.

Yes, the opioid crisis–which should really be called the fentanyl crisis, because prescription opioids are not the big killer–reflects serious problems in American society. But it is necessary to recognize that China is exploiting those problems in a most cynical way. By all means attempt to address the demand issue, but do not ignore the supply issue. And in particular do not ignore the fact that the supply issue is only one aspect of a struggle between the United States and the worlds most repressive and most totalitarian power.

The primary reason for my deep skepticism about the wisdom of clearing mandates was liquidity risk. As I said repeatedly, in order to reduce counterparty risk, clearing necessarily increased liquidity risk through the variation margining mechanism. Further, it was–and is–my opinion that liquidity risk is a far graver systemic concern that counterparty risk.

A major liquidity event has occurred in the last couple of days: rates in the repurchase market–the major source of short term funding for vast amounts of trading activity–shot up to levels (around 5 percent) nearly double the Fed’s target ceiling for that rate. Some trades took place at far higher rates than that (e.g., 9.25 percent).

Market participants have advanced several explanations, including big cash demands due to corporate tax payments coming due. Izabella Kaminska at FTAlphavile offered this provocative alternative, which resonates with my clearing story: the large price movements in oil and fixed income markets in the aftermath of the attack on the Saudi resulted in large margin calls in futures and cleared OTC markets that increased stresses on the funding markets.

To which one might say: I sure as hell hope that’s not it, because although there was a lot of price action yesterday, it wasn’t The Big One. (The fact that Fred Sanford’s palpitations occurred because he couldn’t get his hands on cash makes that bit particularly apropos!)

I did some quick back-of-the-envelope calculations. WTI and Brent variation margin flows (futures and options) were on the order of $35 billion. Treasuries on CME maybe $10 billion. S&P futures, about $1 billion. About $2 billion on Eurodollar futures.

The Eurodollar numbers can help give a rough idea of margin flows on cleared interest rate swaps. Eurodollar futures open interest is about $12 trillion. Cleared OTC notional volume (not just USD, but all IRS) is around $80 trillion. But $1mm in notional of a 5 year swap is equivalent to 20 Eurodollar futures with notional amount of $20 trillion. So, as a rough estimate, variation margin flows in the cleared IRS market are on the order of 100x for Eurodollars. That represents a non-trivial $200 billion.

Yes, there are potentials for offsets, so these numbers are not additive. For example, a firm might have offsetting positions in EDF and cleared IRS. Or be short oil and long Treasuries. But variation margin flows on the order of $300 billion are not unrealistic. And since market moves were relatively large yesterday, that represents an increment over the typical day.

So we are talking real money, which could certainly contribute to an increased demand for liquidity. But again, yesterday was not remotely a truly epic day that one could readily imagine happening.

A couple of points deserve emphasis. The first is that perhaps it was coincidence or bad luck, but the big variation margin flows coincided with other sources of increased demand for liquidity. But hey, stuff happens, and sometimes stuff happens all at once. The system has to be able to withstand such simultaneous stuff.

The second is related, and very concerning. The spikes in rates observed periodically in the repo market (not just here, but notoriously in China) suggest that this market can go non-linear. Thus, even if the increased funding needs caused by the post Abqaiq fallout wasn’t The Big One, in a non-linear market, even modest increases in funding needs can have huge impacts on funding costs.

This highlights another concern: inter-market feedback. A shock in one market (e.g., crude) puts stress on the funding market that leads to spikes in repo rates. But these spikes can feedback into prices in other markets. For example, if the inability to fund positions causes fire sales that cause big price moves that cause big variation margin flows which put further stress on the funding markets.

Yeah. This is what I was talking about.

Today’s events nicely illustrate another concern I raised years ago. Clearing/margining make markets more tightly coupled: the need to meet margin calls within hours increases the potential stress on the funding markets. As I tell my classes, unlike in the pre-Frankendodd days, there is no “fuck you” option when your counterparty calls for margin. You don’t pay, you are in default.

This tight coupling makes the market more vulnerable to operational failings. On Black Monday, 1987, for example, the FedWire went down a couple of times and this contributed to the chaos and the potential for catastrophic failure.

And guess what? There was a (Fed-related!) operational problem today. The NY Fed announced that it would hold a repo operation to supply $75 billion of liquidity . . . then had to cancel it due to “technical difficulties.”

I hate it when that happens! But that’s exactly the point: It happens. And the corollary is: when it happens, it happens at the worst time.

The WSJ article also contains other sobering information. Specifically, post-crisis regulatory “reforms” have made the funding markets more rigid/less-flexible and supple. This would tend to exacerbate non-linearities in the market.

We’re from the government and we’re here to help you! The law of unintended (but predictable) consequences strikes again.

Hopefully things will normalize quickly. But the events of the last two days should be a serious wake-up call. The funding markets going non-linear is the biggest systemic risk. By far. And to the extent that regulatory changes–such as mandated clearing–have increased the potential for demand surges in those markets, and have reduced the ability of those markets to respond to those surges, in their attempt to reduce systemic risks, they have increased them.

I have often been asked what would cause the next financial crisis. My answer has always been: the regulations intended to prevent a recurrence of the last one. Today may be a case in point.

Democratic presidential candidate Robert Francis “Beto” (AKA “Beta”) O’Rourke, currently running neck-and-neck with Rounding Error, is attempting to jumpstart his floundering campaign with strident threats to confiscate “assault weapons”:

“Hell, yes, we’re going to take your AR-15,” the former Texas congressman shouted, to cheers from the audience. “We’re not going to allow it to be used against our fellow Americans anymore.”

This prompted Texas state representative Briscoe Cain to tweet: “My AR is ready for you Robert Francis.”

Beta then proceeded to go all drama queen, replying on Twitter: “This is a death threat, Representative. Clearly, you shouldn’t own an AR-15—and neither should anyone else.”

Going even drama queenier, Beta reported Cain to the FBI.

FFS. So what’s next? Will Beta demand the digging up and ritual burning of Charlton Heston’s corpse? (Actually kind of amazed YouTube/Google hasn’t consigned that to its memory hole.)

Beta, who is from Texas, apparently needs a Texas history lesson. Cain’s sentiment has a long tradition in Texas, dating from the dawn of the Republic in 1835, in fact.

The story is this. In 1831, the Mexican government gave the Anglo “Texian” citizens of Gonzales a small cannon for use in defense against marauding Comanches. When the Texians became restive a few years later, and began to resist the Mexican government, the Mexicans thought better of their gift and sent a detachment of 100 men under a Lieutenant Francisco de Castañeda to retrieve it. Men from Gonzales and other towns rallied, and told Castañeda to bugger off. They emphasized their message with a homemade flag depicting the image of a cannon, with the words “Come and Take It” emblazoned on it.

After some fitful skirmishing, Castañeda decided he’d rather not, actually, and so he scooted off, leaving the cannon in the Texians’ hands.

Castañeda was not only present at the very beginning of the Texas Revolution in Gonzales: he was present at the end, surrendering the Alamo to Juan Seguin on 4 June, 1836. Two time loser. Id, puta!

State Rep. Cain was therefore echoing a proud Texas tradition, and O’Rourke, who affects some Mexican connection with his faux nickname (why isn’t that considered cultural appropriation?) (maybe his ancestors served in the San Patricio Battalion!) is the one playing the role of the threat to the liberties and right of self-defense of Texans–and Americans generally.

So as someone who got to Texas as soon as I could, I say to Beta: Come And Take It. And that is your history lesson for today.