Streetwise Professor

December 30, 2009

Sent to Afghanistan Without a Map

Filed under: Military,Politics — The Professor @ 6:12 pm

The foundation of any military plan or strategy is The Objective.  All details of implementation are directed towards achieving it.  Any strategy that lacks a clear objective as its foundation runs extreme risks, and is likely to result in confusion, and work at cross purposes by those in charge of developing and implementing it.  If you don’t have an objective, you’re never going to achieve it.  And if you do have an objective, but don’t spell it out, you can’t count on anybody devising or implementing a strategy to achieve it.

Perhaps not surprisingly, the Obama Afghanistan strategy suffers from this fundamental defect.  But don’t believe me.  Believe that right wing rag, the Washington Post.  In an article conveniently (for the administration) buried on the Saturday after Christmas, and overshadowed by the junkbomber fiasco, the Post paints a devastating picture of strategic confusion traceable directly to Obama’s complete failure to state unambiguously his objective:

Nearly a month after Obama unveiled his revised Afghanistan strategy, military and civilian leaders have come away with differing views of several fundamental aspects of the president’s new approach, according to more than a dozen senior administration and military officials involved in Afghanistan policy, all of whom spoke on the condition of anonymity to discuss internal deliberations.

Members of Obama’s war cabinet disagree over the meaning of his pledge to begin drawing down forces in July 2011 and whether the mission has been narrowed from a proposal advanced by McChrystal in his August assessment of the war. The disagreements have opened a fault line between a desire for an early exit among several senior officials at the White House and a conviction among military commanders that victory is still achievable on their terms.

. . . .

The president avoided details in his Dec. 1 address, leaving it up to members of his Cabinet and to his advisers to explain the specifics. The result has been a wide divergence of expectations. Gates, appearing on NBC’s “Meet the Press” the Sunday after the speech, said that perhaps only “some handful or some small number” would be withdrawn. Biden, during his MSNBC appearance last week, said a chart showing an increase in U.S. deployments this year would be “coming down as rapidly over the next two years.”

The ambiguity over the meaning of the July 2011 deadline has generated uncertainty over the president’s intent. “Is the surge a way of helping us leave more quickly, or is the timeline a way to help win support for the surge?” asked a senior Democratic staff member in Congress. “Which is the strategy and which is the head-fake? Nobody knows.”

One senior military officer in Afghanistan said he and his fellow soldiers “don’t know if this is all over in 18 months, or whether this is just a progress report that leads to minor changes.”

“Until they tell us otherwise,” the officer said, “we’re operating as if the latter is the policy.”

A ‘dramatic change’?
Although senior-level civilians in the administration emerged from the review process thinking the mission had been circumscribed, senior military officials continue to have a different view. The result, as they see it, is that the White House has embraced McChrystal’s original plan.

“We had already been pretty focused that we wouldn’t try to clear and hold things more than we needed to,” said a senior commander involved in the war. “It wasn’t a dramatic change by any means.”

White House officials have cited a meeting among NSC staff members and McChrystal in which the general displayed a slide stating that his mission was to “Defeat the Taliban,” which some civilians deemed overly ambitious because it suggested that every last member of the Taliban would have to be killed or captured. The officials said the mission was redefined to avoid the term.

But to military officers, defeat “doesn’t mean wipe everyone out,” the commander said. “It means after Waterloo, Napoleon still had an army but he wasn’t going to threaten Europe. We used that view when we worked defeat.”

Even before the White House review had finished, the commander in charge of day-to-day operations, Lt. Gen. David M. Rodriguez, had developed a plan to concentrate U.S. and NATO efforts in 80 of the country’s nearly 400 districts.

“They’re taking credit for some of the things that McChrystal was already doing and calling it a narrowed focus,” a senior military official said.

White House advisers maintain that the review process did refine the mission beyond what McChrystal had proposed over the summer.

“There was a real narrowing here,” the senior administration official said. “Stan has a big leadership task to adapt his original concept to the new strategic guidance.” [It really bugs me when anonymous officials refer to Gen. McChrystal as “Stan.”  That is really patronizing–it speaks volumes.]

This part is particularly amazing:

Terms such as “winning” and “victory” have been eschewed by the White House. Obama did not use either in his Dec. 1 address, and he said in an interview earlier this year that he was uncomfortable using the term “victory” when fighting “a non-state actor, a shadowy operation like al-Qaeda.”

But when Gates visited Kabul a week after Obama’s speech, he made a point of telling military personnel there that “we are in this thing to win.”

“From a moral perspective, when you ask soldiers and families to sacrifice, we do that to win,” the Pentagon official said. “We need to be able to articulate winning.”

Damn right.  Defining “winning” is another way of establishing the objective: after all, “winning” means “achieving the objective.”  If you don’t define winning, how the hell can you devise a strategy to win?  And how can you pretend you have a strategy to achieve something, when you haven’t said what that something is?

The primary job of the commander in chief is to identify the nation’s interests and specify strategic objectives intended to advance those interests.  The Post piece makes it clear that Obama is failing in that task.  Failing completely.  His seeming allergy to the very idea of victory will be self-fulfilling, because by refusing to identify an objective (i.e., what would victory look like?) he will ensure that victory by any measure is virtually impossible.

Obama’s mistake here is so fundamental, and so obvious on even common sense terms, that I struggle for an explanation.  Does he believe that if he sets no verifiable definition of victory, he can avoid accountability if that objective is not achieved?  That is, is this just political trimming, the ordinary ambiguity that politicians exploit to avoid responsibility for failure?  Or is it that he, Hamlet like, could not come to a decision on the objective in Afghanistan, but the political pressure to do something became irresistable, so he announced a half-baked strategy?  Either alternative is frightening, and a grave failure of responsibility to those who are being sent to risk their lives in Afghanistan (figuratively) without a map.

Other alternatives come to mind, but those are even more damning, so I shrink from listing them.

What else could it be?  I am open to suggestions.

December 29, 2009

Burn the Village to Save It

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 3:24 pm

The mouse-cat-dog-elephant-mouse dialectic is starting to dawn on a select few, especially in Europe.  Jeremy Grant of the FT reports that the new head of the London Stock Exchange, Xavier Rolet, has issued a pretty clear warning:

Clearing houses in Europe should be regulated by central banks to guard against the risk of a catastrophic failure by one of them, the  London Stock Exchange’schief executive said.

Xavier Rolet, a former  Lehman Brothers and  Goldman Sachs banker, said that it was “very dangerous” for clearing houses’ capital bases and risk models to differ from country to country.

His comments come amid growing concerns that the insistence by policymakers that more financial instruments – such as over-the-counter derivatives – should be processed through clearing houses could overwhelm a clearer and spark a new crisis. [Emphasis added.]

In honor of the new Holmes movie just released on Christmas: no sh*t, Sherlock.

Some other “duh!” moments:

The Financial Services Authority, which regulates clearing houses in the UK, said last week: “The drive to have a significantly greater proportion of OTC derivatives markets centrally cleared will further increase the systemic importance of [clearing houses].”

Mr Rolet said it was possible that a clearing house could be overwhelmed if in the case of a default the clearing house members were unable to cover the margin calls that the clearer would make to cover the losses.

You mean that clearing doesn’t make the risk of default disappear, but just shifts it around in a different–and potentially worse–way?  Next, they’ll tell us there’s no Santa Claus.  I am so disillusioned.

Sarcasm aside (but never far away 🙂 ), Rolet has clearly recognized the dialectic that the mandated expansion of clearinghouses will launch:

He said that clearing houses should have access to the funding provided by central banks through their discount window in the case of an emergency.

“This is not about fear-mongering, but where a clearing house has a substantial amount of ‘binary risk’ products that require a potentially huge collateral [margin] call which the [members of the clearing house] are not able to supply then the question is: who funds it?” said Mr Rolet.

“It seems sensible to us that the central banks should have at least a funding relationship to clearing houses.”

He said Europe needed a “harmonised, integrated clearing industry with standardised regulation” and “lending arrangements” with central banks.

In other words, world governments are responding to fears that interconnected financial institutions are too big to fail and will inevitably receive central bank or treasury or central bank + treasury bailouts by creating new interconnected financial institutions that are too big to fail and providing them with a guarantee of central bank support.

The inherent logical disconnect here is as stark as the old line from Vietnam: “We had to burn the village to save it.”  The only difference is that the Vietnam line was almost certainly apocryphal (the figment of Peter Arnett’s imagination), whereas what is happening in financial markets is all too real.

This is an improvement?  It’s always advisable to start thinking about living with the mice before bringing on the elephants.  If we are serious about attacking too big to fail, rather than creating institutions that concentrate risk and establishing new implicit and explicit commitments to support them in a crisis we should be doing the exact opposite.  Xavier Rolet is doing a great service by pointing out the logical implications of force-feeding central countperparties.  The question is, whether anybody–especially in the US, and particularly in the US Congress (yeah, that means you, Barney & Chris, living, breathing weapons of financial mass destruction)–is paying attention.  Or even cares.

The Other Shoe Drops

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

Remember back in October and November, when the Russians and the Americans confidently declared that they would conclude negotiations on a new strategic weapons treaty in time for the expiration of Start I on 5 December, 2005?  That date came and went, but again both sides said that things were on track to reach an agreement soon.

Not so fast.  Today Putin dropped this bomb (pun very much intended):

Russian Prime Minister Vladimir Putin on Tuesday said U.S. plans for a missile defence system were hindering talks on a new nuclear arms reduction treaty.

Speaking to reporters in the Russian Far Eastern city of Vladivostok, Putin said U.S. plans for the missile shield in Europe would destroy the strategic balance between the United States and Russia.

“In order to preserve balance… we need to develop offensive weapons systems,” Putin said. He added that Russia wanted access to more information on U.S. missile defence plans and would link such a demand with the new nuclear treaty.

Classic, classic Soviet negotiating gambit.  As negotiations reach their climax, and expectations for a new deal are very high, throw in a completely new issue.  Can’t have a “balance” if one side has an operative defensive system and the other doesn’t.  Cutting weapons would actually enhance the power of a defensive system and thereby undermine the balance further.

So . . . it is a clear implication of Putin’s statement that no new strategic weapon deal is possible while the American defensive system to replace the one that Obama terminated is under development.  Putin is clearly saying that no nuclear weapons reduction deal is possible unless the US kills its defensive systems.

This puts Obama in an extremely awkward position–which was no doubt Putin’s objective. Make Obama choose between something he desperately, and dreamily, wants–a nuke treaty with the Russians–and something that he is viscerally opposed to–BMD.  All at a time when Obama’s political position on security issues is extremely shaky.  Off the top of my head, a list that could be greatly expanded: the earlier unilateral concession on the Eastern European missile defense system, the diffident and frankly disgusting approach to Iran, Fort Hood, Afghanistan, and now terrorism in the aftermath of the Detroit attack.  No doubt Putin has viewed this litany of demonstrations of weakness and cluelessness with glee, and is betting that he has taken Obama’s measure: and his bet is that Obama will cave.

But, it could work the other way.  With his entire national security policy under assault, Obama may conclude that another concession in the face of a neo-Soviet negotiating stunt will utterly destroy his credibility on any security issue, particularly given how arrogantly he touted the superiority of the Aegis-based system in the aftermath of his precipitate abandonment of the Czech and Polish ABM sites.  As a result, he may conclude that he has to stand up to Putin on this matter, treaty be damned.

Given Obama’s unmistakable personal preferences (e.g., his overall distaste for security issues, and his Pavlovian tendency to concede rather than fight), Putin may be quite correct in his wager.  From his perspective, it is certainly worth playing this gambit, because if he is right he wins on a major issue for him and the Russian security establishment, but even if Obama plays against type Putin is no worse off than he was before playing it.

My main question is whether anybody on our negotiating team, in the State Department, the DoD, or the White House is surprised by this.  If they are, they are utterly unqualified for their positions.  It will be quite telling to see how–and if–the administration responds to Putin’s gambit.

December 27, 2009

Uhm, I Wouldn’t Book That as Revenue Just Yet

Filed under: Financial crisis,Politics,Russia — The Professor @ 10:04 pm

Sberbank’s German Gref is still bent out of shape about GM’s walking away from an Opel-Magna-Sberbank/GAZ deal:

Russian lender OAO Sberbank demanded compensation from General Motors Co. for the failed deal to buy the U.S. auto maker’s German subsidiary, Adam Opel GmbH.

Sberbank’s chief executive, German Gref, said in televised remarks Friday that GM should pay “voluntary” compensation for its decision in early November to scrap the selling of a 55% stake in the struggling Opel to Sberbank and Canadian auto-parts maker  Magna International Inc.

“We think that GM’s commitment went so far that they should have sealed the deal,” Mr. Gref said.

Note to Gospodin Gref: a deal ain’t a deal until the right people sign on the dotted line.

Voluntary.  That’s pretty funny.  It also speaks volumes about Sberbank’s legal position.  Meaning, they don’t have one.  (Sorry, Sergei–but that’s the way it is.)

I do agree with Gref on one thing: GM never should have gone as far as it did.  But it was better that it pulled out before it was too late.

The little DJ wires piece is entertaining for another reason: it provides a reminder of 2009’s greatest pot-meet-kettle moment:

The move to scrap the deal angered Russian politicians, and Prime Minister Vladimir Putin asserted that GM had exhibited an “arrogant attitude” in abandoning months of negotiations.

That still makes me laugh.

Baby, It’s Cold Outside

Filed under: Energy,Politics,Russia — The Professor @ 9:46 pm

Which means that it must be time for another Russia-Ukraine gas row.

After months of happy talk in which both sides repeatedly claimed that there was no prospect of a repeat of the 2005-06 and 2008-09 imbroglios, a few days ago Gazprom CEO Alexei Miller raised the alarm:

However, despite the expected rise in cold weather demand, Russian gas export monopoly Gazprom (GAZP.MM) said on Friday Ukraine had cut gas purchases in recent days.

“We assess the situation with payments for Russian natural gas deliveries in December as very alarming,” Gazprom’s chief executive Alexei Miller told state television.

“In the middle of December, there was a trend of a reduction of gas off-take which confirms that Ukraine is facing serious difficulties with (future) gas payments,” Miller said.

A new wrinkle this year is Russia cutting off oil shipments through Ukraine for export:

Traders said on Friday Russia’s pipeline monopoly Transneft told oil firms to scrap oil export plans via Ukraine’s Black Sea port of Yuzhny and gave no reason for the move.

“All volumes have been taken away. There will be no supplies in January (from Yuzhny),” said one trader, who asked not to be named because he is not allowed to comment on the issue.

This cutoff is probably a combination of signal (we can do it with oil, need we remind you we can do it with gas?) and economic pressure (reducing Ukrainian transshipment revenues).  Maybe the signal will get through, and Ukraine will come up with the scratch.  But with the elections impending, and the usual chaos of Ukrainian politics, it very well may not.

So, in the midst of another brutal winter (AGW=anthropomorphic global what?), Europe could be facing yet another gas crisis.  How often does that have to happen for the Europeans to get their act together?

How the System Really Works

Filed under: Politics — The Professor @ 4:44 pm

Our nation’s ass-clown Secretary of Homeland Security assures us that the fact that NWA flight 253 DIDN’T go down in flames proves “the system works.”

Let’s see, an individual with more red flags than a May Day parade gets a multiple entry visa to the US even though: (a) he’s on a terrorist watch list, (b) has been denied a visa to the UK where he studied for several years, and (c) his own old man has told the US ambassador to Nigeria that the guy is an extremist.  He makes it through security in two airports with high explosive crammed around his package.  He gets approval to board a flight to the US after the government reviewed the passenger manifest.

If that’s the system working, God help us when it doesn’t.  Just like with Robert Richard Reid (h/t KMcC), the only thing standing between in air immolation of hundreds was the abject incompetence of the would be bomber.

Relying on the stupidity of one’s enemies is not a system.

You want to know how the system works?  I’ll tell you how the system works.

In June, on a family trip to Italy, Mrs. SWP really got to like fresh Italian tomatoes, and got the idea to bring home some seeds to grow in her garden.  I wondered whether it was OK to bring in seeds, so I checked on the Customs Department website, which said that seeds were on the “General List of Approved Products.”  Thinking it was OK, we bought a couple of packages.  We were good boys and girls, and declared them on our Customs form.  We were pulled aside when we went through Customs, and were told that no seeds were not allowed. l mentioned the web page, but to no avail.

But because we’d declared something, the Customs people went through all our baggage.  On the plane, we’d been given a snack, including a ham sandwich sealed in a plastic wrapper.  I wasn’t hungry, so I had put it in one of the carry-ons.

Big mistake.  A Customs agent said I was trying to bring meat into the country against the law.  I was nonplussed, as the damn thing had been given to me on the plane, and there had been no mention that was verboten.  But the agent relented, saying that since we’d been honest about declaring the seeds, she’d let me slide this time and not have to pay a $250 fine.  How big of her.

But that wasn’t the end of it.  Each of the three times I have come back into the country since, I’ve had the Immigration agent draw a big black mark on my Customs form.  When I get to Customs, they pull me aside and go through my stuff.  The first time this happened, I quite politely asked two different agents what was going on, and received abuse–yes, smart-assed abuse–in return.

So that’s how the “system works.”  American citizens who accidentally bring a ham sandwich off an airliner have a harder time getting into the country than does a foreigner with known terrorist connections and  Pentaerythritol tetranitrate jammed up against his junk.

December 26, 2009

If Only It Were True!

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 5:10 pm

Today’s WSJ carries a story lamenting the “death” of derivatives overhaul.  Like Twain’s, rumors of this death are exaggerated.  The derivatives “reforms” that passed the House before the holiday were not immaterial, even if they were not everything supporters were hoping for (and thank God for that).

The main complaint is that the OTC markets were not killed by forcing all trading onto exchanges, a la the Grain Futures Act of 1922 (how’s that for a model of modernity!?), and that customers were given some exemptions from a clearing requirement.

The article quotes Stanford’s Darrell Duffie’s explanation for resistance to the bill:

For Wall Street, switching to exchanges would have cut their profits in a lucrative business. “Exchanges are anathema to the dealers,” because the resulting added price disclosure “would lower the profits on each trade they handle, and they would handle many fewer trades,” said Darrell Duffie, a finance professor at Stanford business school.

Darrell is a very smart man–a helluva lot smarter than me–but in this instance he is lost in (Hilbert?) space.  Sure the dealers want things their way.  GM wants people to buy their cars, too.  But wanting it doesn’t make it happen.  That’s called magical thinking, which has a rather bad habit of running smack dab into reality.

And here, the reality is that it was customers–those allegedly the victims of the dealers–that argued strenuously for the exemptions.  Again, how does anyone (including Darrell) explain this?: Stockholm Syndrome?  Battered Spouse Syndrome?

Another reality is even plainer: dealers evidently offered end-users a superior bundle of pricing, product design, transparency, and credit and collateral arrangements, as compared to exchange-traded alternatives. Exchanges have striven hard to make inroads into the OTC business.  There was no major entry barrier preventing somebody or several somebodies from starting exchanges.  But OTC grew absolutely and relative to exchanges nonetheless. Like it or not, the OTC market won in a competitive battle against the exchanges.

It would be nice if somebody asked “why?”  They might find the answer somewhat illuminating.

There is also an element of intellectual incoherence here.  (More than an element, actually, but I’m in a giving holiday spirit.)  One of the supposed justifications for clearing is that dealers are too inter-connected.  But as written, the legislation forces clearing on dealers–thereby just creating another form of inter-connection.

The primary economic justification for clearing is to protect customers against dealer (or FCM) default.  After all, for years the Board of Trade Clearing Corporation touted the fact that “no customer has  lost money as a result of a default by a clearing member to  BOTCC.” Note the (emphasized) fact that the CUSTOMERS didn’t lose money as a result of a clearing member to BOTCC.  Other members of BOTCC had to cover the costs of clearing member defaults.  Note too the careful wording–some customers can, and have, lost money as a result of member defaults, but the chain of losses didn’t run through BOTCC.

Put differently, the primary justification for clearing is that it improves the quality of service that customers of intermediaries receive.  A clearinghouse made this argument for decades.  But the legislation leaves out the customers, by and large.  Because the customers want it that way, and have made that preference clear through both their economic choices and their lobbying voices.  So what’s the point?

There are other stories that speak to the incoherence of the whole mandated clearing effort. It is finally dawning on some that the creation of one clearing house will create a massive point of vulnerability, but that multiple clearinghouses will require these to be inter-connected.  Thus, the idea of using clearing to eliminate, or even reduce, systemic risk by eliminating inter-connections is a complete mirage.

These remarks by Pierre Gay, Asia-Pacific head of Newedge, the world’s largest futures broker, are priceless:

But forcing all such business to pass through a central clearer would be “a bit too much”, he argued in an interview with the Financial Times.

“The risk we see is that…it would transfer the risk from bank to bank, to a clearing house, which, being private, would also have to make a profit and we could create a globally risky situation.”

Mr Gay said clearing was one possible solution for OTC derivatives, “but we don’t think it is the only one and we should look at other solutions”.

“If we were able to have a platform where prices became more transparent, where we know what is trading during the day, it would help the bank [and] the buy side to have a better view of what the real price is,” he said.

Mr Gay said it was for regulators to decide how this should be done. However, he stressed it would be possible for banks, brokers and other parties to mark contracts to market themselves.

Other critics of the proposed regulation have pointed out that if central clearers took on a widening spread of risk, they would end up looking very much like investment banks – and might need to be regulated similarly. [Emphasis added.]

You don’t say.

In other words, clearinghouses will perform the same economic function as large dealer banks–of absorbing and allocating default risk.  They don’t make it disappear.  They will be inter-connected.  They will also pose systemic risks.

FT’s Lex has also noticed:

True, regulation that mandates clearing could weaken banks’ hand. But it is not only banks that might resist extending clearing requirements. Clearing houses themselves have fought to retain control of which products can be cleared. They need to mark positions to market in order to collect margin which, in the case of CDS, must reflect the possible payout in the event of an underlying default. Illiquid products, then, are unsuitable.

Whether clearing CDS, or other OTC products, becomes big business is yet to be seen – clearing is, after all, akin to a utility. But it therefore merits careful supervision. If multiple profit-driven clearing houses compete, this could muddy risk management. A seller of protection might appear moderately exposed within one platform but egregiously so across the system. [This is just another way of discussing the interconnection point.]

Regulators, too, should take a dim view of competition that focuses on margin requirements or the type of collateral accepted. Clearing helps to reduce risk in the system – not eliminate it.

Today’s FT has an article by the COO of the exchange BATS which similarly points to the fact that the introduction of multiple CCPs will effectively create the same sort of interconnection concerns and problems as the current dealer structure:

So what are the solutions? The US, for example, has single post-trade providers. While this facilitates competition between trading venues and lowers post-trade costs via processing economies of scale, the monopolistic position of the post-trade service provider results in a lack of efficiency and innovation.

A more pragmatic model is one in which a small number of competing CCPs interoperate. For example, CCPs A, B and C provide interoperating C&S services for multiple MTFs (multilateral trading facilities) and exchanges.

Trading/clearing participants could select their preferred CCP rather than one designated by the MTF or exchange. Participants could also elect to clear all of their business through a single CCP, providing netting possibilities which in turn allow for more efficient margining and settlement. Direct competition would also oblige CCPs to focus on improving cost, efficiency and service.

To date, with the exception of a handful of arrangements, there has been little progress in implementing interoperable clearing models, especially interoperable clearing models involving three or more CCPs.

Within this context, it is important to note that interoperable clearing poses additional risks that need to be appropriately mitigated. In particular, under an interoperable clearing model, CCPs are no longer exposed only to risk from their clearing members but also to financial and operational risk from the CCPs with which they interoperate. Where CCPs were previously “risk aggregating”, they thus also become “risk taking” entities. Again, this must be mitigated.

BATS Europe supports a model under which the CCPs margin each other on a fully collateralised basis, as if the other CCP were just like any other clearing member. This approach minimises the interdependence of CCPs under interoperation and thus seeks to ensure the continued systemic stability of the current system.

The CCPs will continue discussions of whether there can be a more efficient interoperation framework in the future but this is likely to be more complex from a risk, legal, operational and regulatory view point and thus will take significant time to research and implement.

[Emphasis added.]

This dawning understanding that clearing is not a magic bullet, and which might create problems similar to or worse than the ones that it is intended to solve, reminds me of the old story about the Indian village infested by mice, that brought in cats to eliminate the mice, that brought in dogs to deal with the proliferation of cats, that brought in elephants to drive out the hordes of dogs . . . and then brought back the mice to rid themselves of the rampaging elephants.

The belief that clearing somehow eliminates risks is another example of magical thinking.  It is another way of performing a particular economic function.  The fact that it was not the mechanism by which vast numbers of market participants chose to perform this function raises, again, the question “why not?”  Now, it is possible that some particular transaction cost precluded this choice, and that a mandate or some form of regulation will reduce this transaction cost.  But inasmuch as the entire argument for clearing has been predicated on magical thinking, and indulging the Nirvana fallacy, rather than a hard-headed analysis of the REAL trade-offs, there is room for considerable skepticism that this is actually the case.

Instead, as a result of the intellectual laziness and groupthink that has brought us to this point, we are far more likely to find ourselves in the position of those Indian villagers, who didn’t think more than one step ahead; who didn’t consider the consequences of a major intervention into their ecology (and as Vernon Smith points out, markets reflect a form of ecological rationality); and who didn’t pause to wonder whether their intervention could actually make things worse.

Thus, in my view it is to be regretted that the WSJ’s story about the death of derivatives overhaul is an exaggeration.  Would that it were so!

Merry Christmas?

Filed under: Financial crisis,Politics — The Professor @ 2:20 pm

That noise you heard emanating from your chimney on Christmas Eve wasn’t Santa Claus’s sack full of gifts: it was an unlimited contingent liability, gifted to you, the taxpayer, hitting your hearth when you were sitting down to a holiday feast.  Because a $400 billion limit just wasn’t enough.

And no, I’m not talking about the health care monstrosity passed by the Senate on Christmas Eve.  I’m talking about the Treasury’s stealth, Christmas Eve-post market “announcement” that (a) Fannie Mae and Freddie Mac would no longer have credit lines of a mere $200 billion each, but would instead have unlimited lines from the Treasury, and (b) they are no longer under any immediate obligation to reduce their massive mortgage security portfolios.

Oh, and the GSE CEOs will receive $6 million each in pay, and other executives will get a bundle too.

It is incredibly ironic that with all of the vitriol directed at Citi, BofA, Goldman, etc. (much of it deserved), the (Barney) Frankenstein’s Monsters (sorry, couldn’t resist), the GSEs, get a blank check and their executives a big payday.  This gives new meaning to the term “piggybank.”

A couple of comments.  First, although many in the beltway have labored mightily to deflect any allegations that Fannie and Freddie played a central role in the real estate bubble and the subsequent credit crisis, the outsized losses these institutions have suffered, and will suffer yet, make it quite clear that their role was not immaterial.

Second, coverage of the story (and I pity the poor reporters who had to cover this on Christmas) makes it quite plain that this is part of the administration’s continued efforts to prop up the housing sector.  That is, rather than trying to accommodate an adjustment of the economy that would correct past distortions in the allocation of resources, the administration (hand in hand with the Fed) is attempting instead to restore what was quite evidently an unsustainable status quo.  This will only defer the pain of adjustment, and likely make it worse in the future.  (Kicking the can down the road, in the words of one of the people quoted in the article.)

Don’t dare speak to me of “financial regulation reform” while these financial mutants live.

Whatever rhetorical excess Andrew Jackson directed at the Bank of the United States would pale in comparison to what Fannie and Freddie and their political masters richly deserve.

F&F should be wound down, and sooner rather than later.  But nooooo.  They are too politically valuable.  They were political creatures that warped the economy (and the allocation of capital) in years past, and as this story makes plain, will continue to do so in years to come.

Fannie and Freddie.  The gifts that keep on giving.

December 24, 2009

Merry Christmas!

Filed under: Uncategorized — The Professor @ 11:48 pm

A Merry Christmas to all who have taken some of their valuable time to visit SWP.  Yes, even S/O 🙂

In all seriousness, I do appreciate everyone who has visited, read, and especially commented.  It is an interesting little platoon that has assembled here, virtually.

Have a happy holiday, and a joyful and productive 2010!



Have I Got This Right?

Filed under: Military,Politics — The Professor @ 6:07 pm


  1. In the summer of 2009 (or later–the chronologies aren’t that clear) the US government deemed  Anwar al-Awlaki to be perfectly acceptable as a pen pal and research assistant to Major Nidal Hasan, even though they were corresponding about jihad and the acceptability of killing American soldiers, and
  2. In December, 2009, the US government deemed al-Awlaki a sufficiently grave threat to our security security that he could be terminated with extreme prejudice (along with several members of his tribe) and no due process (not that I object) in an airstrike in Yemen.

Just checking.

In one of their “research” exchanges, Hasan expressed his desire to join al-Awlaki in paradise.  Well, not quite sure about the destination, but one necessary condition for that meeting has apparently been met.

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