Streetwise Professor

A couple of articles echoing SWP themes.  This one is a case study of the dangers of being a foreign investor in Russia.  The moral  (or should that be “immoral”?) of the story: as a foreign minority investor in Russia, the law is more likely to be used as a sword to attack you than a shield that defends you:

In March 2008, Kores Invest, controlled by Federation Council Senator Leonid Lebedev, bought majority control of TGK-2 during the final privatization auctions. Kores was required under mandatory laws to offer to buy out minority shareholders at the same price. PCM tendered its shares, along with other minority shareholders. But by the time the proceeds were due, prices had fallen significantly because of the economic crisis. Ever since, Kores has created legal diversions to avoid meeting its obligations.

Kores owes PCM and other minority shareholders more than $300 million. But Kores effectively sued itself, obtaining an injunction blocking the previously agreed buyback. Appeals have since been repeatedly adjourned on flimsy technicalities.

Kores also prevented Sberbank from meeting a guarantee to pay buyback receipts to TGK-2 minority shareholders if the principal owner failed. Sberbank’s involvement would have amounted to official recognition of Kores’ default. So Kores obtained a second injunction.

Kores then opened up a third front of legal obfuscation, claiming that the buyout obligation was invalid under the country’s strategic investment law — a connection it made based on TGK-2’s small involvement with the treatment of radioactive material. This is clearly an arbitrary application of the law.

The article points out some implications of a judgment supporting Kores’s arguments:

Many leading Russian companies, including Gazprom, Rosneft and Novotek, have offshore affiliates. All these firms, of course, are treated as “domestic” for the purposes of the strategic investment law. If the Supreme Court fails to overturn successive rulings in favor of Kores, many of Russia’s most important commercial entities will be in breach of the law. Some of the most significant transactions in Russia’s recent history could be rendered null and void.

Ah, but remember what Fitzgerald wrote: “The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.” And by that definition, the Russian legal system is filled with Real Men of Genius.

The second story relates to Russia’s military manpower woes:

Russia’s attempts to build a modern military have run into a roadblock: there are not enough conscripts to fill the ranks. In the fall of 2008, the Russian military was a reservist/mobilization force. According to the Chief of the General Staff and First Deputy Defense Minister, Army-General Nikolai Makarov, “83 percent of the army” had only officers and weapons and required reservists to fill the ranks that “would have required a lot of time” (www.newsru.com, February 17).

The Kontraktniki approach has been written off as a failure.  Russia had “several frontline all-contract airborne and army units, but now they have been disbanded.”  Given that the airborne troops have been the most reliable units in the Army since late-Soviet times, that hardly provides confidence that the country has a dependable rapid reaction force:

Following the introduction of one year conscript service the airborne forces formed five “first use battalions” with 70 percent of contract soldiers “most of whom have combat experience” (RIA Novosti, May 26). These battalions (around two thousand men in total) seem to be all the combat ready forces Russia has today for possible offensive action.

I’ve mentioned the over-officered nature of the Russian armed forces before.  It has gotten better due to some recent reforms (which basically turned many officers and their families into borderline-homeless), but it is still pretty amazing:

In 2008, there were 1,130,000 active service personnel in the armed forces with about half a million of them officers and praporshiki [warrant officers].

That’s about 45 percent, for those scoring at home.  Like I’ve asked before: what were they all doing?  Keeping control of the barracks was obviously not it.  (Although Moscow Mayor Yuri Luzhkov claims that “the threat of hazing is practically nonexistent”!)

The Russian military recently completed its Vostok 2010 exercises, getting some good reviews from some people who are not always members of the pom-pom squad.  But I find it hard to believe that a military so dependent on scraps of Russian manhood, who barely serve long enough to learn the location of the latrine, and who, Luzhkov notwithstanding, spend a large part of their time either suffering beatings or in fear of suffering beatings, is capable of carrying out complex, combined arms operations.  So color me skeptical.

I’m sure you’re shocked.

This article from The Moscow Times, about Moscow’s problem with stray dogs, had me chuckling.  It provides an interesting perspective on how pervasive corruption is in the country.  I mean, in Russia, the connected can even find a way to make a buck–or a million bucks–from Fido:

By the numbers, the authorities care about stray dogs as much as people.

Moscow City Hall has allocated $190 per month for every stray dog that is housed in its animal shelters this year — the same amount that Prime Minister Vladimir Putin has deemed as Russia’s minimum living wage in 2010.

In addition, millions of dollars have been earmarked to construct animal shelters and to neuter strays.

But despite the cash windfall, few shelters are opening, and there has been no decrease in the 30,000 stray dogs that City Hall and animal rights activists say are roaming the streets.

Mayor Yury Luzhkov says the problem has grown so acute that hundreds of strays might need to be put to sleep.

“In good facilities, a dog can live up to 15 years,” Luzhkov said on city-controlled TV Center television last month. “We cannot take care of dogs for such a long period of time. No city budget could survive such a heavy burden.”

But animal rights activists and a former City Duma deputy say the real burden on the city budget is that money earmarked for the animals has disappeared into a black hole.

Indeed, a review of official documents obtained by The Moscow Times found that stray dogs are part of a lucrative — and extremely murky — business that has helped enrich a relative of at least one senior city official. The review also suggests that poor planning and a lack of due diligence are costing the city dearly.

If there’s a will to chisel dough–and believe me, there’s a will–there’s a way.  Or a million ways.

The story also reminds me of my rather humorous encounter with Moscow’s strays, in August 2005.  I was walking through Red Square on my way back to the Hotel Rossia–hey, if I was going to do Moscow, I was going to do it old school–near midnight one evening.  I was with two Italians, now American academics, one male, and one female.*  While we were walking through the ???????, about 10 of the skinniest dogs I’ve ever seen came loping along, their tongues hanging out in the warm evening.  (It wasn’t as hot as it is now in Moscow, or even close, but it was uncomfortably warm.  And the Hotel Rossia didn’t have AC.  Man did they improve the country by blowing up that dump.)

No big deal, right?  The dogs looked pretty harmless.  And one boy dog was very interested in one girl dog so not so interested in three things on two legs.  But the female Italian screamed “I’m terrified of dogs!” and jumped into my arms, wailing hysterically.  The male Italian, I kid you not, was hiding behind me. I just yelled “scat” a few times and stomped my foot heavily (my arms being tied up by one panicked Italian), and the dogs just gave me a look and turned 90 degrees, loping off towards St. Basil’s.

Little did I know that there was gold in them there paws.

* I will think twice before going around Moscow with Italian academics again.  The three of us had broken off from a larger party after dinner.  The others–all Italian–were arguing with the maitre d’ of the restaurant where we’d eaten.  The place gave all the indications of being mob friendly (you’d think Italians would notice!), and I had no interest in doing a reprise of the Uneasy Rider: the last thing I wanted was to get in a fight, in Moscow Russia on a Saturday night.  So I threw money on the table and split.  I seriously checked the internet the next few mornings to see whether there any reports of missing Italians.  Apparently they made it back alive.

On Monday I gave a talk on Russian, Chinese, and Venezuelan energy policies to a group of State Department officers and some other government folks from places like ONI.  All of the people involved have energy as some part of their portfolio, and were on a trip to Houston to learn about a variety of energy issues.

At the Q&A after my talk, one person asked me: “At the Iran desk we are confused about Russia’s policy towards Iran.  It would seem that they have an interest in keeping Iranian energy, especially gas, out of the market, so would have an interest in robust sanctions.  How do you explain their lukewarm support and their dealings with Iran?”  After recovering from the “you’re asking me?” shock, I responded that it doesn’t confuse me at all.  The Russians want their cake and to eat it to.  They are playing a double game.  They benefit from turmoil in the Middle East, especially in the Gulf.  It is quite useful to them to have the US distracted by Iran, leaving Russia more space in the Near Abroad.  Russia has  strong economic interests–in nuclear power, and arms, in particular.  They don’t want to see Iranian gas to to Europe, but have no problems with it going south and east.  At the same time, they are trying to reach some kind of accommodation with the US, and aren’t thrilled about an Iran with nuclear weapons.

So Russia wants a Goldilocks approach–not too tough, but not too lax.  It wants to keep Iran on a low boil, not too hot and not too cold.

Hence the to-ing and fro-ing, the double dealings, and so on.  Alleviating pressure from their western flank by agreeing to weak sanctions–that give Russia the flexibility to engage in business dealings with Iran, including the sale of advanced S-300 antiaircraft missile systems.  When Ahmadinejad throws a hissy over Russian support for sanctions–no matter how tepid–they try to assuage him.  They criticized the EU’s more robust sanctions.  Russia and Iran signed an energy cooperation “roadmap.” And of particular interest, given that the Iranian regimes greatest vulnerability to sanctions is in motor fuels (given its inadequate refining capacity), Thursday it was announced that Russian companies including Rosneft, Gazprom Neft, and Tatneft  would start “serious deliveries” of gasoline to Iran.

In short, Russia is playing both sides against the middle, extracting concessions from the US and the EU, including special treatment, to agree to sanctions, and then turning around and dealing with the Iranians.  The resulting state of not war-not peace suits them just fine.  It seems pretty obvious, and it would be rather unsettling if the State Department really finds this befuddling.  Russia is pursuing its own interests, and those interests are not congruent with ours.  That the Russians are doing so by talking out of both sides of their mouths should be expected.   Indeed, I would be more worried if they didn’t.

Folks are all atwitter about Russia’s tentative plans to sell off stakes in state companies, including Rosneft, in order to raise money to plug its budget deficit.

A few brief comments.

First, I’ll believe it when it happens.  This is something being pushed by Kudrin on fiscal grounds, but it no doubt rubs many powerful people the wrong way.  Outside investors, minority or no, can be troublesome because they have an interest in knowing where their money is spent.

Second, since protections for minority investors are so weak in Russia, it is very hard for these pesky folks to see where their money is going, and to do anything about it when they find out it’s going somewhere it shouldn’t.  So caveat emptor.  Or, as I wrote in one of the very first SWP posts, a fool and his money . . .

Third, the case of Hermitage Capital and William Browder and Sergei Magnitsky should be a cautionary tale about the risks of being a portfolio investor who dares to point out self-dealing and corrupt practices in Russian corporations.  So if you invest, keep your mouth shut: you’re just along for the ride.  Sound like fun?

Fourth, strategic investment in Russian companies isn’t all that appetizing either.  The most recent example of this ConocoPhillips’ decision to sell its stake in Lukoil, an ostensibly private Russian oil company. CP invested in the expectation of doing joint projects with Lukoil in Russia, but that didn’t pan out, apparently due to government intransigence:

ConocoPhillips’ investment into Lukoil avoided a similar breakdown, but it didn’t lead to any new projects or any significant influence in the Russian company’s board room.

“I think all sides were disappointed,” said Ron Smith, head of Europe, Middle East and Africa research at brokerage Chevreux. “It worked well in theory, but just didn’t turn out quite as rosy as they had figured.”

“It’s a major hurdle for foreign companies putting new money to work in Russia,” Smith said. “The real problem is that the Russian government doesn’t see the need for foreign companies to work in [exploration and production] anymore.”

Hardly a story to encourage the return of foreign direct investment, which Russia desperately needs.

Fifth, selling off minority stakes is not privatization in any meaningful sense.  Control does not pass into private hands: private money passes into state hands.  Big difference.

Sixth, it’s not a one way street. The  cage match between Deripaska and Potanin over Norilsk Nickel (which Deripaska says he will “fight to the death“–here’s hoping this is one time Oleg tells the truth!) could lead to the government to take a stake in the company to put an end to the fighting, which is destroying value.  Deripaska gadfly John Helmer (who claims that he was the target of a Rusal assassination plot) unwraps the mystery inside the riddle inside the enigma by reading Bloomberg backwards, and claims that Deripaska will be the one without the chair when the music stops.  Which goes to show that “privatization” in Russia is not a permanent condition.  What the government giveth, the government taketh away.

In sum, if you’re thinking of investing in this simulacrum of privatization, on the outside chance it comes to pass: to learn more about Russian state-business relations, you’re probably best advised to re-watch The Godfather movies.

Not long ago I wrote a post about commodity forward curves, focusing on the confusion between “backwardation” as the term is used in the market, and as misused by Keynes, to the confusion of many.  The basic point was that  Keynesian “normal backwardation” stories cannot explain directly observable forward curves.  Normal backwardation is about risk premia–differences between futures prices and expected spot prices–and these risk premia are not observable directly.

For an asset that is always in positive supply, there can be backwardation in the Keynesian sense but the forward curve will always be at full carry.  Arbitrage considerations drive the forward curve, and risk preferences of the marginal speculator affect both spot and futures prices, without affecting the spot-futures spread.  In essence, if the futures price is downward biased, the spot price will be less than the present value of the expected spot price; this price depression causes an appreciation in the spot price that rewards someone holding the asset for the risk, and this upwards drift over and above the risk free rate is exactly the same as the upward drift in the futures price.  Changes in risk preferences affect both spot and futures prices in the same way by the same amount, leaving spreads unchanged.

But commodities are not always in positive net supply.  There are sometimes stockouts.  Indeed, stockouts must occur in an efficient equilibrium, as if not, some units of the commodity would be produced but never consumed, which would be wasteful.

If risk preferences are to affect the forward curve, then, it must be through their effect on stockholding.  I have investigated this using a dynamic structural storage model of the kind that I examine in detail in my forthcoming book.

The technical details in a nutshell:  I utilize a simple model in which there is one random, mean reverting demand shock; that is, the demand shock follows an O-U process.  Production costs are subject to decreasing returns.   I solve the dynamic programming problem giving the optimal storage rule using the standard machinery.

To take risk preferences into account, I take a trick from contingent claim pricing theory.  If the marginal speculator is risk neutral, the forward price is the expected spot price, where expectations are taken with respect to the true (physical) probability measure.  If the demand shock risk is priced, however, due to risk aversion, the forward price is the expected spot price, where the expectations are taken with respect to an equivalent measure.  The demand shock process in the equivalent measure has a “drift” that differs from that of the process under the physical measure.  A negative drift adjustment means that the forward price is downward biased (Keynesian backwardation).  A positive drift adjustment means that the forward price is upward biased.

I solve the dynamic program for the storage problem under three values of the drift: zero, as under the assumed physical measure, plus 5 percent and minus 5 percent.

The results are interesting, and intuitive (I think, anyways).  The drift–and hence risk preferences–have a first order effect on inventories.  With downward bias, inventories are lower than under the physical measure.  Intuitively, downward bias makes it costly to hedge inventories, so inventories are smaller.

I’ve studied the performance of these model economies using long simulations.  Interestingly, even though inventories are smaller in the downward biased economy, the effects on prices are relatively small.  Plots of the spot prices (based on the same sequence of simulated shocks) from the two economies are almost on top of one another, and the average difference in prices across the simulations is about 1 percent.  There is a slight difference in price volatility (about a 5 percent difference).  Volatility is higher in the downward biased economy as demand shock-buffering inventories are smaller in that economy.  Importantly, prices are highly correlated across the two economies.  Demand shocks are the main drivers of price movements in both economies, and for an identical set of demand shocks, price movements are highly correlated.

Spot-forward spreads are affected somewhat.  (I simulate a spot-3 month spread).  Backwardations are more pronounced, and more frequent, in the downward bias economy.  This is because stockouts are more likely in this economy due to the smaller stockholdings.  But overall, the differences in calendar spreads between the two economies are not large (although they are larger than the price differences); the time series plot of the simulated spread for the downward biased economy is a slight displacement of the simulated spread for the risk neutral economy.  Backwardations peak at about the same times in each simulation, and contangoes/full carry periods exhibit large overlaps (though not complete overlaps, because there are times that the downward biased economy exhibits departures from full carry when the risk neutral economy does not).

One key result is that almost never in the simulations does a substantial backwardation exist in the downward biased economy while the risk neutral economy is at full carry.

Results for the upward biased economy are symmetric.  Inventories are larger, price volatility smaller, and prices about the same in the upward biased economy as in the risk neutral one.  Spreads tend to be closer to full carry, and backwardations are not as extreme, although the timing of backwardations is highly coincident in the two economies.

This has implications for the speculation debate.  Changes in market structure that lead to increased integration between a commodity market and the broader financial markets can, in theory, have an impact on the behavior of the commodity market.  In general, if you believe that a commodity market that is, as in the Keynesian treatment, isolated from the broader financial market exhibits “normal backwardation”, then the entry of diversified speculators that results in a dissipation of downward bias will have some effect on prices and spreads, and potentially a big effect on inventories.

The effect on prices and spreads is likely to be very hard to detect.  Even with a relatively big bias like that I assumed in the simulations, the effects on prices and spreads are not large.  Scholars have had a very hard time detecting any risk premium/bias in forward prices going back to the seminal contribution of Telser in 1960.  Certainly, there are no reliable estimates of bias as large as I assumed in my simulations.  This suggests that any effects of increased speculation on price bias/risk premia would be too small to have any effect on prices and spreads that could be identified reliably.

So, I am skeptical that any “financialization” of commodities that has occurred in recent years has had an effect on price levels or forward curves that can be distinguished against the normal noise in prices and spreads.

It should be noted, moreover, that integration of the commodity markets into the broader financial markets leads to consistent pricing of risks across markets.  Indeed, arguably differences in risk prices is a major driver of flows of capital.  If, for instance, a commodity market (say, oil) is not perfectly integrated in the financial system, so the price of oil price risk is higher than the price justified by risk premia on other investment opportunities in the economy, investors have an incentive to take on more oil price risk in order to capture its too high price. This will reduce the bias.

Integrating fragmented markets and equalizing price differences is typically efficiency enhancing.  It leads to a more efficient allocation of risk.  That’s a big part of what capital markets should be about.

In the commodity case, if the isolated commodity market exhibits downward biased forward prices, the entry of speculative capital that reduces this bias makes hedging cheaper, and encourages the holding of larger buffer stocks.  This reduces price volatility.

Phil Verleger has argued that this process has occurred in the energy markets.  That due to greater financialization, inventories are larger.  He points to the specific case of heating oil, and argues that recent stock buildups encouraged by more speculative activity in the market have helped prevent big price spikes during cold snaps.

These conclusions are also diametrically opposed to the scare stories that are repeatedly told about the effects of the entry of financial players into the commodity markets.  People telling those stories–and you know who they are–assume that the good old days when commodities and finance didn’t mix (which was never completely the case) were some sort of golden age, and that the entry of financial players has upset the operation of the market.

The simple model I’ve set out here implies that such entry may indeed change the market, but in a salutary way by leading to a more efficient allocation of risk.  The effects on price levels and spreads are likely small, and certainly not  immense, as the commodity Cassandras have asserted.  The effects on inventories are likely larger, but this effect is salutary, and tends to reduce price disruptions in the market.

The basic moral of the story: be very skeptical about claims that changes in the degree of financial participation in commodity markets have first order effects on prices and spreads.  Don’t try to explain changes in the shape of forward curves based on changes in speculative activity in the markets.  Intertemporal optimization–adjustment of inventories–in response to fundamental shocks is the most important driver of forward curves, and changes in financial participation likely have second or third order effects on prices and spreads.

The Russian military replaced its two year conscription term with a single year term in order to combat the brutalization of new recruits by more experienced soldiers, a practice called dedovshchina.  This “fix,” apparently, has made things worse, not better:

The number of conscripts who suffer physical abuse at the hands of their colleagues in the Russian armed forces has grown significantly in 2010, the Vedomosti daily said on Tuesday.

Hazing – the physical and psychological torture of younger conscripts by their elders – has long been a problem in Russia and has its roots in the Soviet era.

During January-May 2010, 1,167 draftees were subjected to hazing, an increase of 150% during the same period in 2009, the paper said.

This is consistent with what I wrote a couple weeks back, namely, that hazing within a structured hierarchy is likely to be less intense than hazing within a near anarchic situation in which soldiers are struggling for the right to haze.

As I noted before, playing with the length of service will not eliminate hazing as long as survival of the fittest rules the barracks, rather than the officers or competent and experienced NCOs.  But changing conscription terms only requires the passage of a law.  Reforming an entire culture, including a generation of officers comfortable with the status quo, is a much harder task.  A task, methinks, that is beyond the capability of Russia to perform–and one that the officer corps apparently has little interest in performing regardless.

Barney Frank threw a fit when he was refused a senior discount.  For $1.  Yes.  A meltdown over O-N-E dollar:

Massachusetts Congressman Barney Frank caused a scene when he demanded a $1 senior discount on his ferry fare to Fire Island . . . . Frank was turned down by ticket clerks at the dock in Sayville because he didn’t have the required Suffolk County Senior Citizens ID. A witness reports, “Frank made such a drama over the senior rate that I contemplated offering him the dollar to cool down the situation.”

So here we have a guy who is notoriously liberal with other people’s money having a hissy over a buck.  An alleged man of the people giving a poor clerk a hard time because he can’t follow the rules.

Would it be too much to ask Frank to show the same miserly attitude about other people’s money as he apparently does with his own?

We all know the answer to that, don’t we?

The visitors’ center at the Waterloo Battlefield plays clips from the 1970 Sergey Bondarchuk film, Waterloo.  The museum gift shop has DVDs of the movie in French, Dutch, German, and some other languages, but not English.  But I saw an English copy on Amazon (with Chinese subtitles!), so I bought it and watched it over the weekend (subtitles off).  I’d seen the movie as a 10 year old when it first came out: I haven’t seen it since.  It was cheesy in spots, and Rod Steiger was over the top as Napoleon, but the battle scenes were pretty amazing even 40 years after they were filmed.

The movie was an expensive collaboration between the Soviet Bondarchuk and the Italian producer Dino De Laurentiis.  The battle scenes are immense and elaborate.  And the interesting thing is that 15,000-odd Soviet infantrymen were the combatants on film, and that Cossacks were among the 2,000 cavalrymen.  The Soviets reengineered the landscape at the shooting site in Ukraine, building replicas of buildings like Hougoumont and Le Haye Sainte, constructing hills, planting fields as they were at Waterloo. and installing an elaborate underground irrigation system to create the mud that was an important feature of the Waterloo battlefield and battle.  At the time, it was a hugely expensive movie, and would have been more so if it had been filmed anywhere but the USSR.

So if Russians playing Frenchmen lose a big battle, who gets credit for the win?

Watching Waterloo motivated me to revisit Amazon, where I bought another Bondarchuk epic with a reputation for its elaborate battle scenes, War & Peace.  With English subtitles, which will be on.

Every once in awhile there are stories that capture a major difference in mindset between Russia and the US (or the West, generally).  This is one of those stories:

Russian Prime Minister Vladimir Putin says he has met the Russian agents recently deported from the US – and claimed they were living “tough lives” and had been “betrayed”.

. . . .

ked whether he had sung karaoke with them, Mr Putin said: “We did, but not with a karaoke box. We sang to live music and we sang ‘Where the Motherland Begins’ and other such songs.”

The song became hugely popular after it featured in a 1960s film about a Russian spy working in Nazi Germany.

I can’t imagine a western president or prime minister doing such a thing.  Cordell Hull’s statement that “gentlemen don’t read other gentlemen’s mail” was an extreme, but for the most part American, and most western European statesmen view espionage as something of a necessary evil, and certainly consider those who practice it as rather unsavory.  A karaoke party with spies is almost beyond imagining.

But, it goes to prove the accuracy of LR’s characterization of Putin as a “proud KGB spy.”

The song they sang is also very, very revealing.  It is of the Soviet era.  Moreover, the implicit equation of spying in the US with spying in Nazi German speaks volumes about the attitudes of the Russian security services–and those in government that are just spies seconded to other posts.

Finally, this is choice:

Mr Putin went on to say that the spy swap with the US had come about as a result of “betrayal”.

“Traitors always end badly. They finish up as drunks, addicts, on the street,” he said.

And when asked by reporters if Moscow was planning to take revenge, he said it was incorrect to ask about it.

“It cannot be solved at a press conference. They live by their own laws, and all special services are well aware of these laws,” he said.

Drunks?  Nah, that would be too easy.  The last two paragraphs are rather ominous.  Don’t ask, don’t tell.  Don’t believe in bonhomie between leaders at press conferences (at least I presume he’s referring to Obama-Medvedev conviviality).  I get the definite “payback is a bitch but we don’t talk about it” and “resets only go so far” feel.

The definitive attribution of the capture to betrayal is also very interesting.  I don’t know whether to believe it–it could be easier to blame something like this on betrayal than to an error in the SVR or the effectiveness of US counterintelligence–but knowing Putin it suggests that drunkeness and addiction may be the last thing some people have to worry about.

In a harbinger of an avalanche of unintended consequences from Frank-n-Dodd (not to mention the health care fiasco), Ford Motor Company yanked the sale of securitized auto loans because the members of the credit ratings cartel refused to allow the company to utilize their ratings out of fear of liability provisions in the new law (h/t ASI/Tim Worstall):

Market participants said the auto maker pulled a recent deal, backed by packages of auto loans, because it was unable to use credit ratings in its offering documents, a legal requirement for such sales. The company declined to comment.

The nation’s dominant ratings firms have in recent days refused to allow their ratings to be used in bond registration statements. The firms, including Moody’s Investors Service, Standard & Poor’s and Fitch Ratings, fear they will be exposed to new liability created by the Dodd-Frank law.

The law says that the ratings firms can be held legally liable for the quality of their ratings. In response, the firms yanked their consent to use the ratings, hoping for a reprieve from the Securities and Exchange Commission or Congress. The trouble is that asset-backed bonds are required by law to include ratings in official documents.

The result has been a shutdown of the market for asset-backed securities, a $1.4 trillion market that only recently clawed its way back to health after being nearly shuttered by the financial crisis.

“Issuers have stopped issuing bonds,” said Paul Jablansky, senior ABS strategist at the Royal Bank of Scotland in Stamford, Conn.  [Emphasis added.]

So we have the regulatory analog to a bad drug interaction.   One government policy, imposing liability on ratings issuers, is toxic when mixed with another, a requirement that public debt offerings be rated.

Brain teaser: now that the federal government is writing a blizzard of new policy prescriptions, do you think the likelihood of such toxic interactions will rise or fall?  Now that’s a real toughie, huh?

The legal privileging–no, fetishization–of credit ratings and the ratings cartel was a material contributor to the financial crisis.  But in layering on a new regulation in an effort to “fix” the ratings system while retaining that privileging, Congress just created new problems.

It is this kind of policy boomerangs that will continue to weigh on investment and innovation in the coming years.  Putting a boot in the ABS markets as they struggle to their feet is hardly the way to encourage  a recovery in credit an investment.

The faint recovery is clearly a major concern to the administration.  But rather than grapple with the possibility that their Dr. Feelgood (or Dr. Morell) prescription practices constitute a serious drag on the economy, administration officials are spinning an alternative narrative that casts blame elsewhere.  Taking the lead in this effort is Timmy!, who after being under a rock for the last several months, is now making the rounds telling the tale of how the economy is suffering from some form of PTSD; that business reluctance to invest and hire, and consumer reluctance to spend, has NOTHING, NOTHING to do with government hypertrophy and hyperactivity, but is instead attributable to flashbacks about the crisis.

Today Timmy! was weaving the narrative on Meet the Press.*  Get used to hearing it again and again if the economy continues to stumble.  And get used to the economy continuing to stumble as the number of bad policy interactions, and the fear of bad policy interactions, grows.

* What is it about Timmy! always looking at every interviewer sideways out of the corner of his eye, with his head half-turned?  It is very weird.  Any body language experts have an interpretation?  For his part, MTP host David Gregory played Charlie McCarthy to Krugman’s Edgar Bergen, asking several times whether it wouldn’t be better to spend more, more, more! to stimulate the economy.