Streetwise Professor

June 24, 2010

That’s His Story, and He’s Sticking To It

Filed under: Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 3:46 pm

He being Gary Gensler, and his story being that mandated clearing will improve the stability of the financial system by eliminating interconnectedness:

“Over-the-counter derivatives are meant to lower risk on our economy, and to some extent they do,” Mr. Gensler says. “But they have concentrated risk in a few big banks…through their interconnectedness.” He says forcing them onto clearinghouses would shift the risk from any single institution to the clearinghouse. It can more easily offset, for instance, bets that interest rates will rise with bets that they will fall. That would make it possible to allow a big financial firm that is floundering to fail, restoring market discipline.

Repeating the same BS over and over doesn’t turn it into gold.  Clearinghouses are interconnected.   And they will almost certainly be too big to fail–and they can fail, a point that Gensler has never acknowledge.  Even the New York Times sort of gets it (although I disagree with a lot of what they say in this editorial).  “Interconnection” is just about the worst argument to make in support of clearing mandates.

Gensler has company in Europe. Gertrude Tempell-Gugerel of the European Central Bank supports central clearing mandates, for equally inane reasons.  She starts out with a non sequitur (since Lehman and AIG failed, clearing must be better–wrong), and goes downhill from there:

Therefore central clearing has become part of the G20’s agenda and mandatory clearing is seen as a tool to address the risks in OTC derivatives trading. Should a counterparty involved in OTC trading go bankrupt under central clearing, it would not create the chain reaction that the default of Lehman Brothers triggered. A central counterparty (CCP) would allow an institution with offsetting positions to net their exposures and substantially reduce counterparty risk.

In addition, a CCP would need to comply with high risk management standards and require counterparties to post appropriate collateral. Moreover, mandatory reporting of contracts to trade repositories would significantly enhance information on OTC derivatives exposures, to the benefit of authorities and market participants alike.

No chain reaction is possible when there is a clearinghouse?  Really?  What is the color of the sky on the planet where that is true?  Netting already takes place to a considerable extent.  Indeed, clearing done badly can actually REDUCE the amount of netting, if clearing is fragmented by product and even within products (e.g., multiple competing interest rate swap or CDS CCPs). And for the billionth time (perhaps I exaggerate), netting like this is a private benefit: if the benefit is as great as Gert (and many other regulators) say, why haven’t private parties fallen all over themselves to exploit it?  Mightn’t there be some costs that more than offset this putative benefit?   “High risk management standards”–why not impose them on banks?  And what about the information disadvantage that CCPs are likely to suffer vis a vis dealer banks?  That goes unmentioned.  Collateral can be the trigger for a systemic crisis.  Moreover, Tempel-Gugerel overlooks the likely equilibrium responses to a clearing mandate.  Rather than extending credit implicitly in derivatives transactions (as is often the case now) big banks are likely to extend credit to their customers to permit them to post margins, leaving the overall amount of leverage in the system pretty much unchanged.  Since it’s leverage that is ultimately the source of systemic risk, this obsession with collateral is likely to provide a false sense of security.  The information benefits can be achieved by mandatory trade reporting to a repository (which I’ve advocated for well over 7 years) without requiring mutualized counterparty risk sharing, or centralized risk pricing (in the face of severe information disadvantages).

The advocates of clearing mandates have had almost two years to come up with credible arguments, and to attempt to rebut counter arguments.  They’ve done neither.  They keep recycling the same old BS, and don’t even acknowledge, let alone address, the myriad arguments that have been raised against clearing mandates.

Policies built on willful ignorance do not end well.

In Another Sign of the Impending Apocalypse

Filed under: Commodities,Economics,Energy,Financial crisis,Politics,Russia — The Professor @ 3:25 pm

Igor Sechin is on a charm campaign.

Let me repeat that.   Igor Sechin is on a charm campaign.

There is a long piece about him in a recent FT:

As Russia seeks to shake off an economic crisis that wiped out layer after layer of the oil-fuelled gains of the Putin era, Mr Sechin – viewed with fear and awe for overseeing the state takeover of the strategic heights of the economy – is striking a new, surprisingly accommodating tone. The Kremlin, taken aback by how vulnerable Russia’s oil and gas-driven economy proved to be to the global financial crisis and recession, has started to change its tune.

I said Sechin is trying to be charming.  I didn’t say that he had gone so far as to actually tell the truth, or anything.  In fact, he makes a couple of complete howlers.  One relates to how Rosneft, and other Russian state  energy companies, came by some of their prize assets:

In his first public comments on how the reinvigorated Putin state managed to recover important energy assets from oligarchs who picked them up cheaply during chaotic post-Soviet privatisations, Mr Sechin says these properties were not “repossessed”. It was, he insists, a legal process where state companies paid market prices for assets that are now managed no differently from private ones.

Riiiiigggghhhhtttt.  Legal process.  Market prices.  Uh huh.  Tell me another one, Igor.

So he obliges:

Russia’s state-controlled companies cannot use their resources as political weapons, or “instruments to put pressure on consumers” as he puts it. The likes of Rosneft and Gazprom are, he adds, “normal public companies, working under international laws, and this makes it impossible for them to break their obligations to consumers”.

Stop it, you’re killing me!

But he can’t stop:

Russian companies are not subject to state fiat in the same way as national oil companies set up by the world’s other big producers.

“When we speak with our colleagues from Opec, they say that Russia should operate quotas just like they do. I tell them that unfortunately we have no such instruments, because Russian oil companies are private companies. Even those that are partly state-owned are private companies. They are working in the conditions of the market and have obligations to their partners which do not allow them to take unilateral decisions.”

Sechin has been peddling this line going back to late-2008, when he was playing Lucy and the football with OPEC.  As I wrote then, and in early-2009, it is complete tripe.  Not that I WANT Russia to cooperate with OPEC, but even given that it has some “private” companies rather than completely nationalized oil sectors, Russia can control exports at a whim, and has the policy tool to do so: its export duty.  By raising the export duty, Russia would reduce export volumes, just as by reducing output national oil companies can reduce export volumes; both actions raise the world oil price.  Russia tweaks its oil export duty all the time.  It adjusts other export duties as well, in order to achieve policy objectives.

In brief: if Russian (and Sechin) wanted to coordinate output with OPEC, it would have no difficulty in doing so via the export duty.  The truth is, it doesn’t want to coordinate output with OPEC; it doesn’t want to cut Russian output.  Quite rationally, Russia wants OPEC to bear all the costs of supporting world oil prices by cutting OPEC output, and to reap the benefit by producing as much as it can.  That’s what Russia has done.  Like I say, as a net short, I (and the US) benefits from Russia’s action; the world is a better place for it.  But it doesn’t do Sechin’s credibility any good for him to tell such laughable falsehoods.

Perhaps Sechin’s choir boy act indicates that finally, Russia has learned that you catch more flies with sugar than gall.  Perhaps.

But I wouldn’t consider this to be a sincere conversion.  It is, at best, a pragmatic trimming in response to changed economic and political conditions.  And if and when those conditions change again, don’t be surprised if the Old Igor, the Bad Igor, returns, fangs bared.

Whether it is with Sechin or Lavrov or Putin or Medvedev: anyone who puts their faith in their more moderate statements does so at their peril.  For as Sechin demonstrates, even when he tries to act nice, he does so with a stream of falsehoods.

You Tell ‘Em, Timmy! (And Barry!)

Filed under: Economics,Financial crisis,Politics — The Professor @ 3:02 pm

I have been in Germany (in Strasbourg today, returning to Germany tomorrow).  It has been amusing to watch the German reaction to the hectoring/lecturing from the US about the need for Germany to increase government spending.  The German reaction ranges from bemusement to disdain.  Here’s the Bloomberg take:

Merkel, addressing a business audience in Berlin today, said she told Obama in a phone call that cutting government debt is “absolutely important for us,” exposing a second point of contention ahead of the June 26-27 G-20 summit in Canada.

Reducing the budget deficit by 10 billion euros ($12 billion) per year “won’t put a brake on the world’s economic growth,” Merkel said, relating what she told Obama yesterday. Germans are more likely to spend money if they feel the government “is taking precautions” to ensure solid finances, she said.

Four days before world leaders meet in Toronto, Germany is heading for conflict with the rest of the G-20 over tighter financial regulation, a banking levy and U.S. calls to boost growth rather than cut debt.

The G-20 must “safeguard and strengthen” the economic recovery and promote “global demand growth that avoids the imbalances of the past,” Obama said in a June 16 letter to fellow G-20 leaders. He expressed concern about “heavy reliance on exports by some countries,” which he didn’t name. Treasury Secretary Timothy F. Geithner called on June 5 for “stronger domestic demand growth” in European countries like Germany that have trade surpluses.

I have been ambivalent on Merkel.  She has been good on some issues, but has been terrible on Russia, and hasn’t shown a lot of leadership in the Greek/PIIGs crisis.  But at least it is clear that she hasn’t drunk the Keynesian KoolAid that Timmy! (and Obama, and Summers, etc.) are pushing.  Indeed, it is encouraging to see the leader of a major government acknowledge, at least implicitly, the Ricardian point that current consumer spending depends in no small way on expectations about future government expenditures: “Germans are more likely to spend money if they feel the government ‘is taking precautions’ to ensure solid finances, she said.”  It would be refreshing if our policy makers would consider the possibility that American consumers and investors are reluctant to spend freely because of the looming fiscal imbalances in the US.  Unlikely, but refreshing.

June 22, 2010

What Is It About Guys Named Mac?

Filed under: Military,Politics — The Professor @ 2:40 pm

Three of the greatest crises of American civil-military relations involved generals of Gaelic descent: George B. McClellan, Douglas MacArthur, and now Stanley McChrystal.

Of the three, McChrystal’s sins are the least serious, but also the dumbest.  I mean, talk about a charlie foxtrot moment: just whose great idea was it to let it all hang out for Rolling Stone, for crissakes?  I mean, this is so gobsmackingly stupid on the surface that it leads me to believe that there is a deep, crafty, guerilla war strategy under the surface: perhaps (and I am just pulling this out of you-know-where) McChrystal and his staff had made every effort to make their serious concerns about the war in Afghanistan made known through channels, but had failed, and turned to this desperation ploy to focus attention on the issue.

Nah.  I don’t believe it either.

Mass career suicide is not the American Army (or Navy or Air Force) way (and the same is true for just about every military in memory, except for the Japanese in WWII, who took it literally).  And even if McChrystal et al believe that the situation has reached a crisis stage, and that they deem it their duty to sacrifice their careers to express their deep objections to the way the war is being run from Washington, there is a right way to do that.  Shooting off your mouth to a journalist from some leftist rag isn’t it.

But regardless of the reasons for the disclosures to a freaking rock magazine (the most damaging of which came from the mouths of the General’s staffers, rather than his own), they give a glimpse of a very disturbing, dysfunctional relationship between the military commanders in the field in Afghanistan, and the entire civilian chain of command, from the Ambassador in Kabul, to the National Security Advisor, to the VP, and to the President himself.  The men in the field apparently have nothing but contempt for Obama and those who work for him.  (Only Hillary comes off well–another reason, as if she needs one, to watch her back.)   Moreover, such backbiting is hardly a harbinger of victory: instead, it is a symptom of a failing military effort.

It is hard to say whether it would be worse if the disdain is warranted, or not.  My sense is, though, that the distrust of the field commanders for the civilian leadership is largely merited.  Obama only talked about Afghanistan during the campaign to demonstrate his tough guy bona fides.  When in office, his reluctance to take charge of the war was palpable.  Instead of leadership, he gave a series of dog ate my homework excuses, played Hamlet, and finally “decided” on a strategy that was fundamentally flawed and doomed to failure.  He has subsequently all but washed his hands of the matter, relegating it to the very bottom of his priority pile; McChrystal’s discouraged and discouraging assessment reported in the article is probably an accurate one.  Joe Biden is Joe Biden.  The only quibble that I would have with the characterization of Jim Jones as a “clown” is that I probably would have inserted “ass” before “clown.”  Eikenberry was a backstabber from day one.

The first casualty will almost certainly be McChrystal.  A president cannot afford to be dissed so publicly, especially a president in an extremely weak political position.  (In this Obama is similar to both Lincoln and Truman at the times of their confrontations with their generals, but Obama is no Lincoln or Truman).

But it should not end there.  Obama has handled Afghanistan poorly, and needs to change directions forcefully and rapidly.

The stakes here are not as high as when McClellan was sitting at Harrison’s Landing in 1862, or when MacArthur was in Japan/Korea in 1951.  The country does not face a full blown insurrection that has achieved a series of major military victories.  We are not engaged in a full-scale conventional conflict  in the shadow of nuclear confrontation, facing stalemate or an escalation to a major land war in Asia–perhaps involving the use of nuclear weapons.

But they are high enough.  This situation has to be fixed, and fast.  The disclosures in the article is merely a symptom of a deeper, underlying problem.  The mission in Afghanistan is in crisis, as was inevitable almost from the moment that Obama chose the politically palatable but militarily impractical middle option of a mini-surge into a logistical backwater with a short time line.  Fecklessness in matters military eventually extracts its price, and we are paying that price now.  This matter deserves far more presidential attention than anything–oil spill or no. Commander in chief is the president’s first and foremost responsibility.  He has fallen down badly on this responsibility to date, and needs to change that.  Now.

This is not to say that McChrystal’s way is the right way.  There has been a lot of cogent criticism of his approach (e.g., from Michael Yon).  But Obama’s way is definitely the wrong way.  He has to acknowledge that, and devise a new strategy that reflects military reality rather than political expediency.

But sad to say, I would estimate the likelihood of that happening to be small indeed.  It is a triumph of hope over experience (to borrow from Samuel Johnson) to think that the crew that got us into this fine mess will get us out, particularly given its appalling performance on just about every test of executive leadership.

Re-establishing Radio Contact

Filed under: Commodities,Economics,Uncategorized — The Professor @ 1:37 pm

I’ve been incommunicado for several days, up in the Austrian Tyrol, where the internet is but a rumor, for the most part.  (Yes, TRex, there are parts of Europe where internet access is difficult, at best.)

The weather was appalling, but the valleys I visited were stunning.  Even though the highest peaks were shrouded in heavy cloud, and I had only glimpses of the rocky and glaciated summits, the views were spectacular.  Makes me wish I was a skier, although some of the slopes look downright suicidal.

Like I say, the weather was bad.  Under 10C in the valleys, with a constant drizzle: exactly freezing at 2000m, an elevation I reached via a ski lift.  There was snow both evenings at elevation: today starting about 1800m there was about 10 cm of wet, heavy snow.

Not exactly what I was expecting on the first days of summer, but that’s life in the mountains.  Enough to whet my appetite for a return visit.

The trip to the area south of the Inn followed a very enjoyable three days of teaching in Geneva, at HEC (Hautes Etudes Commerciales) of the University of Geneve, in Geneva, Switzerland.  I taught a specialized course on commodity price modeling for a masters program in commodity markets and trading, with 17 students from all parts of the commodity business and all types of commodity firms.  It is a pleasure having self-selected students who have an intense interest–and career prospects–in the rather arcane subject I teach.  The students were enthusiastic and active.  I look forward to repeating the experience next year.

I’m now in Nurnberg, Germany, on my way north to participate in a ceremony in a street will be named for one of Mrs. SWP’s great-grandfathers in a little town called Rotenberg am der Fulda.  Ironically, one of my GGGFs came from the same area–Kassel.  Then off to see the areas from whence the Pirrongs (or Pirrungs or earlier than that, Pierrons) lived before seeing the light and decamping to the US: namely, the countryside east of Saarbrucken.  Then perhaps a side trip to Strasbourg.

June 18, 2010

The Potemkin Legacy Endures

Filed under: Military,Politics,Russia — The Professor @ 3:03 am

Vladimir Putin is touting Russia’s 5th Generation fighter (h/t R):

Prime Minister Vladimir Putin climbed into the cockpit of Russia‘s newest fighter jet on Thursday and said it would trump a U.S.-built rival, the F-22 Raptor.

Putin watched a test flight of a “fifth-generation” stealth fighter, dubbed the T-50 and billed as Russia‘s first all-new warplane since the collapse of the Soviet Union in 1991.

“This machine will be superior to our main competitor, the F-22, in terms of maneuverability, weaponry and range,” Putin told the pilot after the flight, according to an account on the government website.

Putin said the plane would cost up to three times less than similar aircraft in the West and could remain in service for 30 to 35 years with upgrades, according to the report.

. . . .

ccording to the government website, the test pilot told Putin the controls of the T-50 allowed the pilot to operate most of the plane’s systems without taking his hands off the joystick, which he said would be very useful under high forces of gravity.

I know, I’ve flown,” Putin replied. Sukhoi has said the plane should be ready for use in 2015. [Emphasis added.]

What a riot.

First of all, it just provides further proof, as if any was necessary that (a) Putin is an egomaniacal tool with a Mitty-esque fantasy life (you look so butch in those uniforms, Vladimir!), and (b) the US is so inside his head it’s hilarious.

Second, and more substantively, anybody who believes one word quoted in that article probably also responds to emails from Nigerian scammers.

The utter decrepitude of the Sovie-sorry-Russian military industrial base makes the successful serial production of a 5G aircraft a pipe dream.  Russia hasn’t been able to deliver on its repeated promises to dramatically increase new weaponry in the hands of the military–even for relatively prosaic things like tanks.  It has to buy much less complicated equipment on the international market–witness the Mistral episode and the recent reports of a $12 billion foreign arms shopping spree.  Russia cannot even build its own UAVs, and is depending on Israel for the technology and manufacturing know-how.   A good chunk of Russian defense expenditure gets lost in the maw of corruption.  Even the highest profile military building program–the Bulava missle–is an ongoing farce.

Russia has little or no experience with stealth technologies analogous to the US prior to its development of the F22.  Moreover, Russian engine development and manufacturing has always been spotty, at best, and the engines of something like an F22 are extremely complicated indeed.  (I recall reading earlier that there is a possibility of joint development and manufacturing of the 5G plane with India.  That would be the India whose Mig-21s kept crashing, usually because of failures in Indian made replacement engine parts.  That inspires confidence!)  I could go on.  Sukhoi says it will have the aircraft in service in 2015.  NFW.

Does anyone actually believe this stuff?  Does Putin?  Who is fooling whom?  Is Sukhoi putting on a Potemkinesque display for a gullible Putin who so wants it to be true?   Or is this just Putin’s cynical boob bait for that (unfortunately all too large) portion of the Russian populace–including an all too large portion of the political class–stuck in the Glory Days of superpower competition?  All that I am sure of is that somebody is being played, because  pigs will fly before the T-50 is operational.

June 16, 2010

This Too Was Predictable

Filed under: Military,Politics — The Professor @ 1:49 pm

While I’m in I Told You So mode, there is a dawning recognition that Obama’s setting of a withdrawal deadline for Afghanistan was a blunder of the first magnitude.   Hmm.  Didn’t somebody call Afghanistan “The Graveyard of Timelines“?, writing “any thoughts of ‘time lines’ or ‘exit strategies’ in Afghanistan are delusional.” Or what about this?

Good American soldiers and Marines are getting killed and maimed for no good reason.  This is a crime.  It is a crime because men are dying for nothing, and the outcome was eminently predictable.  Obama’s whole “plan,” such as it was, depended on getting the Afghans to “stand up”: but with a time line inevitably raising questions about the credibility of the American commitment, any Afghan with half his wits about him would hedge his bets, and be very, very leery about standing up.  Winning a counterinsurgency depends crucially on getting the locals on your side–to provide intelligence, and to not support the enemy with intelligence, shelter, or supplies.  But again, no villager is going to risk his neck for the Americans if the Americans are going to be gone in months.  The Obama approach was doomed to failure, and that failure is looming.  No wonder Patraeus passed out before testifying in Congress.  And no wonder allies, most recently the Poles, are bailing.  (The fact that Obama bailed on them recently probably had something to do with that as well.)

As Adam Smith said, there is much failure in a nation.  And America is more resilient and stronger than any.  But it is not without its limits.  Those limits are being tested.  A disastrous health care bill.  Fiscal diarrhea (the latest: a request for $50 billion of emergency funding for states–a big wet kiss to public sector unions and employees).  A string of foreign policy fiascos, all born of utter fecklessness mixed with complete cluelessness.  A fumbling response to a massive oil spill, culminating in an otherworldly speech that said precious little about responding to the spill in the here and now, but instead dissolved into vaporous fantasies about green energy.

All of that is discouraging.  But nothing as compared to the criminal waste of American lives due to a plan founded not on military reality or strategic wisdom, but on political expediency and short-sighted political calculation.  Given that the result was completely foreseeable, that is utterly inexcusable.

Y’all Should Have Thought About This Ahead of Time: I Did

Filed under: Commodities,Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 11:43 am

Matt Leising and Shannon Harrington report that smaller firms are accusing the big dealers of blocking access to clearinghouses:

Rules intended to lessen the risk of a systemwide failure are “working to restrict access to only the incumbent dealers,” the Swaps and Derivatives Market Association said in a statement sent today to Theo Lubke, senior vice president at the Federal Reserve Bank of New York. The group of more than 20 brokers including Jefferies & Co., Imperial Capital LLC and Newedge USA LLC formed in February to lobby Congress and regulators for access to derivatives clearing.

Intercontinental Exchange Inc.CME Group Inc. and other companies that operate clearinghouses for the $615 trillion privately negotiated derivatives markets enforce capital requirements and trading rules intended to bolster the ability of the clearinghouses to withstand losses. Those requirements, though, prevent all but the world’s largest banks, including Goldman Sachs Group Inc., JPMorgan Chase & Co. and Barclays Plc, from sending trades to the clearinghouses, according to the statement by the brokers group.

“The effort to protect clearing, however, is actually a proxy war to limit competition to the incumbent dealers’ $100 billion in profits for derivatives execution,” the brokers group said. Mike Hisler, a spokesman for the association, and Ray Zorovich, the group’s policy assistant, are listed as contacts on the statement. Hisler also is a partner at New York- based Hexagon Securities LLC, a member of the association.

This was only a matter of time.  I’ve written academic articles dating back well into the 1990s that in the presence of large scale economies in a particular service (e.g., trading), including scale economies arising from network effects, a suboptimally small coalition of suppliers can form a cooperative firm that offers this service (see, for instance, my 1999 J. of Financial Markets and 2002 J. of Law, Econ., and Org. articles).  The cooperative is smaller than optimal, but just big enough that no competing coalition can form because it cannot achieve the same scale economies.  Because it is suboptimally small, and faces no competition, the members of the dominant coalition/cooperative firm earn rents.

I applied this argument to clearing in the early-2000s, and again in a couple of papers done in 2007 and 2008.  So, what Matt and Shannon report is no surprise to me.  None whatsoever.  It was a direct implication of the work I’ve done for going on 15 years.

Indeed, when many asked me whether dealer opposition to clearing was motivated by their desire to limit competition, I would often reply that forming a clearinghouse that limited entry was perhaps the best way to cartelize the industry, and make even more profits.

But that’s not the end of the story.  I’ve also written that there are good economic reasons to limit entry into a clearinghouse.  In particular, rigorous financial requirements are necessary to ensure the safety and soundness of the CCP.  Moreover, I’ve also written that the transaction costs/organizational costs of operating a clearinghouse will be greater, the more heterogeneous the membership: this provides further justification for limiting membership to a relatively homogeneous group of firms.  Setting margin, capital levels, etc. is more difficult, and the process more rancorous, the more heterogeneous the membership.  (The effects of heterogeneity on governance was the focus of my 2000 JLE piece on exchange organization.)

In brief: just as is the case in virtually all trading services, market structure issues in clearing are extremely, extremely knotty because of the pervasive scale and scope economies.  The pronounced scope and scale economies create opportunities for the exercise of market power, most notably by the formation of cooperative firms that restrict entry and face no competition.  This is the way that exchanges earned rents for their members for years, and years, and years.  At the same, time, open entry is particularly problematic for CCPs given the effects of heterogeneity on governance costs, and the extreme importance of financial stability.

Battles over market structure in securities have been raging for decades, due in large part to similar considerations.  Ditto recently in futures markets.  (Note the battles that raged over the CME-CBT and CME-NYMEX mergers.)

Note that this battle over entry is going to create serious legislative and regulatory conflicts because, as I have pointed out ad nauseum (including in a forthcoming Policy Paper for Cato) there is a fundamental tension between enhancing competition and reducing systemic risk in CCPs.  Conventional political economy considerations are going to play out here.  The pressure of the SDMA and other firms will inevitably lead to regulatory interventions that will open up entry and access, and thereby threaten to compromise the financial soundness of CCPs.

The irony is almost too much to take.

There are no free lunches.  None.  Only very difficult trade-offs.

Is their any evidence that any legislator or regulator has given serious consideration to this problem?  Not that I’ve seen.  But now, with clearing mandates on the horizon, there will be years of knock down-drag out fights over CCP rules, membership requirements, etc.  At every turn, there will be a tension between the systemic risk issues and the competition issues.  The results will not be pretty: they will be driven by the political economy considerations that dominate all such issues.  Economic efficiency and the soundness of the financial system will take a back seat, a distant back seat, to rent seeking.  We know how that usually works out.

No regulator or legislator can say that s/he wasn’t warned.  They just weren’t paying attention, or thinking seriously about the subject.  Oh yes, they said: just mandate clearing and we can go live on the big rock candy mountain.  As if.

For some reason Mark 6:4 just popped into my head.

I think I’ve made the analogy before on SWP, but it bears repeating.  There’s an old story about the Indian village that is beset by mice, and brings in cats to get rid of them.  The village is soon overrun by the cats, so they bring in dogs to scare off the cats, but then the dogs become a plague, so they bring in the elephants . . . and then realize that mice weren’t such a bad problem after all, so they bring back the mice to scare off the elephants.  The moral: short sighted “solutions” to a problem adopted without consideration of all of the consequences can lead to worse problems than you started with.

The criticism of CCP membership problems is just a harbinger of things to come: after too long, the mice might look pretty good by comparison.

June 15, 2010

1815, 1915

Filed under: Military — The Professor @ 2:24 pm

Yesterday I toured the Waterloo battlefield.   Quite a contrast to the sprawling WWI and WWII battlefields I’ve been visiting over the past 10 days.  I could see virtually the entire battlefield standing on a single spot in the center of the Allied lines.  (I could definitely see the entire field from the Lion Monument, a man-made monstrosity erected years after the battle.)

In the WWI battle sites I have visited—and virtually all the ones I haven’t—the armies attacked straight ahead because there were no flanks: frontal assaults were the rule because there was no real alternative.

Napoleon, in contrast, had no such excuse.  He attacked straight ahead across rising, open ground against enemy troops posted in strong buildings (e.g., Hougoumont) or in defilade even though there were two open flanks.  He wasn’t forced to attack straight ahead.  He chose to.

I’ve read some about Waterloo, though nearly not as much as about American Civil War battles, including Gettysburg, Sharpsburg, Chickamauga, etc., and I know that Napoleon’s decisions are controversial.  There are many explanations for his decisions, but after going over the battlefield, it seems difficult to come up with a convincing reason to do what he did.  For a man whose very name is a byword for military genius, his final battle was the epitome of tactical mediocrity and unimaginativeness—at best.

I also visited the sites of the battles leading up to Waterloo, Quatre Bras and Ligny (including visits to towns defended by the Prussians, such as St. Amand).  Or tried to, anyways.   There’s nothing at either battlefield to speak of.

The differing psychological impact of c1815 and c1915 battlefields on me, as a visitor, was striking.  The carnage and slaughter at Waterloo was immense (with estimates of 63,000 casualties in total, or about a third of the combatants), and far more concentrated geographically and in time than in the typical WWI battle.   Yet, at Waterloo, as at Gettysburg, or Blenheim, or other pre-20th century battlefields I have visited, I do not experience the same sense of melancholy as I did in visiting the Meuse-Argonne, or Verdun.  I don’t understand why exactly, but I think it has something to do with the fact that the WWI attacks were futile, and had virtually no chance of achieving decision.  Men were sacrificed wholesale for no purpose, and no real possibility of achieving any purpose.  In contrast, although decision on the battlefield was rare prior to the 20th century (as shown by Russell Weigley in his The Age of Battles: The Quest for Decisive Warfare from Breitenfeld to Waterloo), there was always the possibility of a decisive result.  Waterloo, for instance, was clearly decisive.  The sacrifices of WWI seem pointless, and without even the possibility of a point.   That’s not true of earlier combats.  Nor is it true of WWII battles, many of which were tactically and strategically decisive.

Perhaps that’s the difference, but I’m not sure.   What I am sure of is that I left Waterloo in a far different psychological state than I left Verdun.

June 14, 2010

But I Thought Spot Markets Were the Bomb, or Continued Adventures in Russian Transaction Cost Economics

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 2:37 pm

Apparently Gazprom’s Alexei Miller didn’t get Putin’s memo on spot markets as the cure to all your commodity contracting ills:

Addressing the annual European Business Congress in France for the first time since 2008 – when he predicted oil prices would soar to $250 per barrel – Mr Miller said sales had recovered in the first few months of 2010, “but the month of May has seen the positive trend reversed. As we see, financial turmoil in the eurozone has started to affect energy markets”.

Swiping at those pressing for linkage to spot prices, Mr Miller said this price could soon rise as demand recovered, while Gazprom’s long term contracts offered greater stability.

“In several cases we have agreed to take into account the spot market component,” he said. “But please note: when in a couple of years the market bounces back, do not ask us to revert to previous price practices.”

Tying gas prices to oil made some sense when (a) these things were closer substitutes, and (b) there was absolutely no spot market in gas, but a well-developed oil spot market.  The case, on transaction cost grounds, for utilizing oil as a pricing benchmark for European gas is far, far weaker when there is a growing (organically) spot market for gas in Europe.

Miller is, surprise, surprise, talking his rather large, and underperforming, book.  With weak demand and surging supply for gas, the relation between gas values and oil prices is far weaker than it was only a couple of years ago.  Miller wants to live in the past, and keep on pricing like it’s 2007.  But it’s not, and it’s not likely to be for a long, long time.  Demand looks to be weak for an extended period, especially given Europe’s current economic ferment, and the supply situation has been turned upside down by shale gas and its concomitant effects on LNG flows.  Oil and gas have diverged, and not in a way that is favorable to Gazprom.  Miller way want to hold back the tide, but the pressures on the existing pricing mechanism are likely to grow over time, and rapidly.

Perhaps recognizing this, Miller tries to rain on the shale parade:

In his speech, Mr Miller also sought to dispel what he said were “myths” that a recent surge of LNG and the rapid development of shale gas in the US could threaten Gazprom’s position on global markets.

Citing high investment requirements for developing shale gas deposits and “low output at wellheads”, Mr Miller said shale gas could only serve as a replacement for the depletion of local traditional gas production. “There are no reasons to crown it and elevate it to the throne,” he said.

Hmm.  Then why is Gazprom moving into shale?  And more importantly: the markets apparently think quite differently.

And speaking of “depletion of local traditional gas production”: where is Gazprom going to replace its depleting local traditional gas production?

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