Streetwise Professor

In a speech Tuesday, SEC Chairwoman Mary Schapiro suggested imposing affirmative obligations on high frequency traders:

The SEC should consider whether traders with the “best access” to markets should be obligated to buy and sell stocks to preserve liquidity, Schapiro said today in a speech at the Economic Club of New York. The agency is also examining whether stock quotations should have to stand for a minimum amount of time. Such a change would stop high-frequency traders from repeatedly placing and canceling orders in milliseconds.

“Some could argue that May 6 was an aberration — another perfect storm — and now that it has passed markets have naturally adapted leaving no need for a comprehensive review of our market structure,” Schapiro said. “I disagree.”

Schapiro hearkened back to an earlier era, when some (and I emphasize some) market makers had affirmative obligations:

“In the old manual market structure, the market participants with the best access to the markets — the specialists and the dominant exchanges — were subject to significant trading obligations,” Schapiro said. “These traditional obligations have fallen by the wayside.”

First, a little history.  The affirmative obligation to make markets–to “lean against the wind”–was not universal.  Yes, NYSE specialists had such an obligation.  But NASDAQ market makers did not.  Nor did futures or options market makers.  Moreover, it should be noted that in exchange for their affirmative obligation, specialists were the beneficiaries of many privileges; I’ll return to this point below.

Also in a historical vein, (a) affirmative obligations are not a panacea, (b) market makers frequently attempt to avoid their obligations in times of stress, and (c) evaporating liquidity in times of stress is driven by fundamental economics, not technology, meaning that HFT-oriented markets are not uniquely vulnerable to this problem: there is, in brief, no Golden Age to which we can return through the waving of the regulatory wand.

These points are best illustrated by the events of the 1987 Crash.  The Brady Report documents that specialists were not uniformly acting as price stabilizers.  On the 19th, 26 percent of specialists were trading in a way that exacerbated price trends; on the 20th, as many specialists were trading in this way as were leaning against the wind.  The Report concluded that the behavior on the 20th reflected the fact that many specialists exhausted their capital on the 19th, which limited their ability to supply liquidity on the 20th:

The limited nature of some specialists’ contributions to price stability may be have been due to the exhaustion of their purchasing power following attempts to stabilize the markets at the open on October 19.

Moreover, even though HFT was not even a gleam in the eyes of its creators in 1987, liquidity suppliers in other markets responded to the intense uncertainty by drastically reducing the amount of liquidity they supplied.  Of NASDAQ, the Brady Report said:

During the week of October 19, some market makers formally withdrew from making markets.  In addition, some market makers ceased performing their function, merely by not answering their telephones during this period.  .  .  .  There were also widespread reports that many market makers, who normally stand ready to buy and sell hundreds and sometimes thousands of shares at their quoted prices, were only willing to fulfill their minimum obligation by buying and selling 100 shares at the quoted price.  Another indication of deterioration in market making performance is the withdrawal by some market makers from the SOES [Small Order Execution System] system, thus reducing from 1,000 to 100 the number of shares they were obligated to buy or sell.

In addition, bid-offer spreads also widened during the period.

Interestingly, the Brady report noted that although futures locals had no obligation to supply liquidity, they were “as a group somewhat more aggressive than normal in taking net positions on October 19.”  But, this herculean effort also exhausted their capital, and limited their ability to make markets late in the 19th and on the 20th.  I can attest, from personal observation, that by the afternoon of the 19th, most locals were out of the pits: they had been yanked out by their clearing firms.  Many of the remaining locals were standing with their arms crossed over their badges, to reduce the possibility that somebody would write down their ID on a trade ticket, hoping to win the outtrade lottery.

So: Don’t blame the loss of liquidity during periods of stress on technological innovation.  It happened in the horse and buggy days too.  Also: don’t expect that affirmative obligations are sufficient to ensure that markets are immune to crashes.

As I wrote in the immediate aftermath of the Flash Crash in May, the no free lunch principle works here.  The imposition of affirmative obligations to supply liquidity when it is unprofitable to do so will reduce the return on market makers’ capital.  Absent some other compensation, this will lead to the exit of market making capital.   As a result of this exit, investors will pay the cost of the affirmative obligation in the form of higher spreads/greater price impact during times when the affirmative obligation constraint is not binding.  Moreover, the exit of market making capital will offset to some degree the effects of the obligation: when the constraint binds, market makers will be risking a greater fraction of their capital to make markets during stressed times than they would in the absence of the constraint, but this greater fraction will be applied to a smaller pool of capital.  It should also be noted that one of the costs of fulfilling the obligation is that market making capital will be depleted during times of stress, thereby reducing liquidity subsequently (until new capital can flow into liquidity supply).

The previous paragraph contains the phrase “absent some other compensation.”  In the old days of the specialist system, specialists had various privileges that allowed them to trade profitably–at the expense of their customers.   These privileges were rationalized, in part, as a means of compensating specialists for their affirmative obligations.  Again: no free lunch.  Investors end up paying for the obligation.

The primary effect of affirmative obligations is to change the pattern of liquidity supply over time.  Less liquidity supply in “normal” times (due to the exit of market making capital, or profits that market makers earn from privileges extended to compensate for the costs of the obligations), less liquidity in post-stress periods, and perhaps more liquidity supply in stressed times.

It is possible that this altered pattern of liquidity supply is welfare enhancing.  But Schapiro’s remarks, and much of the post-Flash Crash commentary, does not acknowledge the costs of imposing affirmative obligations.  Thus, the proper cost-benefit trade-off question has not even been posed, let alone answered.

The old Greenwald-Stein paper written in the aftermath of the ’87 Crash theorizes that there are market failures during times of market stress, and that there is insufficient liquidity supplied during these periods.  But it is not clear that affirmative obligations are the most efficient way to address that problem.  Perhaps some other strategy, such as shifting from continuous to call trading during such periods, would be more efficient, especially inasmuch as this does not distort liquidity supply in “normal” times, as the affirmative obligation would.

It must also be recognized that defining and enforcing an affirmative obligation in the current market is much more difficult than was in the case with the NYSE under the specialist system.  The “right” obligation is by no means obvious.  HFT firms will design their systems to mitigate, not to say evade, the obligation arising under any set of criteria.  The details here will be very important, and very difficult to get right.

Another thing that Schapiro mentioned in her speech was the high rate of order cancellations, which she suggested indicate that much HFT liquidity supply is chimerical.  To address these, she mooted the idea of a minimum time for which orders must be in force.

Oi.

Limit orders are  short options.  Options are costly.  Mandating a minimum time quotes must be maintained increases the cost of those options.  Market makers will respond accordingly, by increasing spreads and reducing depth.  Again, investors will pay.  No free lunch, again.

Moreover, this recommendation cuts against the concern that liquidity dries up in stressed times.  The option inherent in a quote is more costly when markets are volatile: that’s exactly why market makers reduce their commitments during volatile times.  A minimum quote time will make market makers even more reluctant to supply quotes in volatile/stressed times.  So this measure, by itself, could make liquidity strikes more likely, not less.  To offset this, by imposing affirmative obligations, would result in higher liquidity costs in normal times: the no free lunch principle, yet again. (It would also make enforcement more difficult and costly, as market makers would have a greater incentive to evade the obligations.)

Bottom line: there is no quick fix to the evaporation of liquidity during stressed times.  Evaporation is driven by fundamental economic considerations: it is more costly to make markets during volatile periods.  Rule changes will not alter that fundamental fact.  That fundamental fact holds across trading technologies.

The costs of rules intended to increase liquidity supply in volatile times will be paid for.  Period.  The only question is when and how.  A reasoned policy debate would focus on identifying and quantifying the relevant trade-offs.  And it is my obligation to affirm that hasn’t happened yet.

The FT ran a rather bizarre editorial on end user exemptions from clearing mandates.  As seems to be the wont of clearing advocates of late, it is strident, but hardly persuasive.

Here’s the core of the argument:

But the fact that reform might impose higher costs on non-financials is precisely the reason for sticking to it. Costly margin requirements indicate that the derivatives companies purchase not only insure them against adverse market movements but can require them to make substantial payments should market conditions move against them. If OTC derivatives are cheaper than taking out insurance, this suggests that the systemic risks of the OTC market and the banks that dominate it are being borne by taxpayers. Ending this subsidy would force corporations to bear the fair economic cost of their actions.

This is apparently the S&M theory of public policy: unless a policy inflicts pain, it is ineffective.  The more costly a policy is, the better it must be!

Here’s my most charitable characterization of the argument:  Due to Too Big to Fail, banks subsidize their customers.  In particular, they subsidize them by taking on default risk and not charging for it.  Therefore, it is necessary to impose costs on these customers in the form of collateral requirements in order to eliminate the subsidy.

Here is one testable implication of this theory: in the absence of TBTF subsidies, all deals will be fully collateralized.

This implication is refuted by experience.  For instance, prior to the formation of the Chicago Board of Trade Clearing Corporation (under government pressure), margining was discretionary.  Exchange rules permitted parties to demand margin: it did not require it.  Routinely brokerages extended credit to their customers and to other brokerages that they traded, and did not require the posting of initial margins, and only required posting of variation margins when a pre-established  credit limit was breached.  These brokers were not the beneficiaries of any TBTF subsidy.  So, credit exposure via incomplete collateralization existed even in the absence of a TBTF subsidy.

Moreover, this theory doesn’t explain why the credit terms extended by OTC dealers vary by customer and deal.  Such variation in credit terms means that dealers are evaluating credit and charging for it based on the nature of the customer and the trade.  Of course, it is possible that these terms are too generous overall (due to TBTF) but the behavior of dealers belies the simplistic story that the FT spins, to the effect that dealers don’t care about credit risk in doing derivatives deals, and hence it is necessary to deny them the discretion to choose their own credit terms.

Furthermore, the FT editorial, like much of the pro-clearing discussion, implicitly assumes that everything else will remain the same after the imposition of a clearing mandate; collateralization will reduce counterparty risk in derivatives trades, and other credit risks will remain unchanged, so overall banks will face fewer default risks.  This is certainly incorrect, and market participants will respond to a mandate by taking actions that undo much of its effect.

For instance, the mandate that all deals be collateralized effectively tells dealers: Thou shall not extend credit through derivatives transactions.  But there are multiple ways that dealers can extend their customers credit.  In particular, if precluded from extending unsecured credit through a derivatives trade, they can substitute other forms of unsecured credit for that they would have offered their customers via derivatives.  Now, revealed preference implies that this is not the preferred arrangement, as otherwise end users and dealers would have chosen it in the first place.  But the use of other forms of credit to finance, effectively, margin/collateral will almost certainly be a second best response to the mandate.  Thus, collateral requirements will do far less to reduce the amount of credit and leverage in the system than their advocates believe.

Moreover, and perhaps more importantly, if TBTF subsidies are the Original Sin, merely foreclosing one way to exploit these subsidies will have little effect on the riskiness of banks.  So if dealers are foreclosed from exploiting TBTF subsidies in their derivatives business, they have every incentive to find other ways to do so.  And they are sure to be creative.

That is, TBTF subsidies are like water.  They will find some outlet.  Dam up one outlet, and the water will find its level through some other channel.  So maybe OTC derivatives won’t be the source of the next crisis (just as they weren’t the source of the last crisis), but if TBTF continues to exist, risk taking will be continued to be subsidized, some excessive risks will be undertaken somewhere, and inevitably, this will cause problems down the road.

But whatever the next crisis, we may be able take comfort that derivatives will not have caused it.  Very cold comfort.

There will be other unintended consequences.  Even though dealers and other intermediaries are likely to try to design financing methods and provide services that reduce the operational and financial burden of end user collateral requirements, again by revealed preference, these alternatives are more burdensome to end users than the incumbent system.  As a result, some end users will decide not to hedge; others will hedge less.  Others will adopt different capital structures that are less efficient.  As a result, more end users will suffer financial distress, and others will incur costs in the form of less efficient investment policies, etc.  These are real costs.  And they can result in defaults–just not on derivatives trades.  Are we really better off when a firm that eschews hedging because of the higher burden inherent in collateralization defaults on its debt to a bank when the risk it would have hedged comes to pass?

If TBTF is the real problem, it is counterproductive to try to address it through micromanaging the ways that financial institutions  attempt to exploit the TBTF subsidy.  Deal with the real problem–the subsidy–rather than attempt to anticipate and foreclose every possible way that clever bankers can attempt to milk this subsidy.  Deal with TBTF upstream, not downstream.

Like a child’s security blanket, clearing and collateral mandates give some a sense of warmth and security.  And a false sense of security, as it turns out, because they do not eliminate or even reduce substantially the true source of danger in financial markets.

Obviously an adherent of the view that the best defense is a good offense, Vladimir Putin responded to a question from a British reporter (Richard Beeston) about the continued presence of Lenin’s corpose in Red Square by bringing up–Oliver Cromwell. Huh?

All was well until I asked him about Vladimir Lenin, whose body still lies in state in Red Square, Moscow. Was it not time to bury him?

The Russian leader’s piercing blue eyes narrowed and he lost his composure: “What about Cromwell, was he any better than Lenin? There are memorials to Cromwell all over Britain. The Russian people will in time decide what happens to Lenin.”

Here’s a more complete account:

Richard Beeston: Thank you Prime Minister. Richard Beeston, The Times, London. Last week we talked about the past, about Russian history and especially about the turbulent 20th century which was fatal for many Russians. I am amazed that with seven years to the centenary of the Bolshevik Revolution, Vladimir Lenin is still lying on display in the Mausoleum in Red Square, with guards standing around him. Don’t you think its a good idea to finally bury him before this event, to help Russia turn a new page? Thank you.

Vladimir Putin: Are you from Great Britain?

Richard Beeston: Yes.

Vladimir Putin: Then I have a question for you. Was Cromwell better or worse than Stalin?

Richard Beeston: Probably just as bad. But he is not displayed on Trafalgar Square, but somewhere in Westminster, at the back.

Vladimir Putin: But there are monuments to him all over Britain, everything in its season. When time comes, the Russian people will decide what to do. History is something that avoids hassle. Next question please.”

Although the Irish might disagree, Beeston was wrong to equate Cromwell with Stalin: the latter’s crimes dwarf the former’s.

More to the point, Putin completely ignores the actual question–the continued presence of Lenin on Red Square.  That’s a different thing altogether than the statues of Cromwell scattered across Britain.

Indeed, the historical comparison is quite illuminating.  After the Restoration of Charles II (whose father Cromwell had beheaded), Cromwell’s corpse was dug up from Westminster, hanged, drawn, and quartered; the punishment meted out to traitors.  His head was displayed on a pike for decades afterwards, and then was sold from hand to hand, and displayed as a curiosity for centuries thereafter.

Continued display in a referential way in the capital vs. symbolic repudiation, desecration, and ridicule.  See the difference?  I knew you could.

And let’s say, counterfactually, that the UK continued to let Cromwell rest in an honored place.  Would that be appropriate?  Would this justify the continued honoring of another mass murderer (who also put Cromwell to shame, BTW)?

By going on the offensive (in multiple meanings of the word), Putin avoids answering, in an honest way, the justification for honoring Lenin long after the USSR fell.  As for the “Russian people will decide”: As if.  When have the Russian people been allowed to decide anything?

Seldom does one see such 190 proof, distilled essence of whataboutism.  (Well, sometimes in the comments at SWP.)  It is a low rhetorical dodge intended to allow the whatabouter to escape confronting the issue head on.  It would be better if Putin gave a full-throated defense of Lenin, or of the propriety of keeping his embalmed corpse on display.  You might disagree with his reasoning, but at least if he answered so he would be respecting the question and the questioner, and acknowledging the weightiness of the issue.

But perhaps the whataboutism is telling: perhaps it betrays that even Putin knows that he cannot make a reasoned and reasonable defense, so he feels compelled to stoop to such discreditable rhetorical dodges.

More substantively, reporting from Putin’s Valdai performance almost universally agrees that it indicates he is planning to resume the presidency.

What, this is news?

Very interesting:

About three weeks ago, a fisherman found the decomposing remains of Russian Major General Yuri Ivanov, 52, washed up on the beach along the Turkish Mediterranean coast.

Ivanov was the deputy director of the GRU, the Russian spy agency which is largely comparable to the American CIA. Consequently, Ivanov had his finger on the pulse of Russia’s worldwide espionage operations.

The circumstances seem to indicate that Ivanoz’s death was quite possibly a homicide but official sources claim Ivanov merely drowned while swimming. Unexplained is the fact that his security detail was nowhere to be found when he went “swimming” and no one seemed to miss him before he was found.

. . . .

Also, Ivanov was part of the high-level investigation team that studied the 2004 Beslan massacre and virtually alone in claiming that the Russian government was whitewashing the whole violent and deadly episode as something other than obvious terrorism. Ivanov and Yuri Savelyev contended that the Kremlin’s official version of the events at Beslan was a fabrication.

Ivanov implicated Putin by name as the person who ordered that RPGs be fired at the school, contrary to the official blame being put on the Chechen terrorists. The exploding grenades started the bloody end to the massacre.

Passing strange, isn’t it, how those who cross Putin and/or the FSB tend to suffer deaths premature even by the appalling standards of Russian men?  (But hey, maybe Ivanov was just swimming drunk to escape the heat.)  Savelyev should be sweating right now–if he hasn’t been for the last 5 plus years.

Note that Ivanov was GRU, and the GRU and the FSB (and before it, the KGB) have been a long history of vicious rivalry.  Moreover, the FSB was in charge of the Beslan operation.  Finally, Putin is ex-FSB/KGB.  A very combustible mix.

Perhaps the only surprise is that Ivanov lived as long as he did.

Commentor Oleg Vishii posted the article, and added a story about Stalin’s policy of eliminating threats.  This, plus the Ivanov episode, brings to mind a famous Stalin remark: “Death solves all problems.  No man, no problem.”

Note: This is a reconstruction of a post written on Monday, 6 September.  It, and another post, were lost as result of a server crash.  I doubt I’ll redo the other post (about Obama’s Labor Day speech).  About 20 comments were also lost, for which I apologize to the commentors.

On Friday I attended a conference on OTC clearing sponsored by the Chicago Fed.  The conference was excellent, and organizers Ed Nosal and Robert Steigerwald of the Fed, and Darrell Duffie of Stanford, did an excellent job of assembling a stellar group of speakers.  I had the privilege of moderating (Me?  A moderator?) one of the panels.

The speakers represented all of the major constituencies; sell side/dealers, buy side, end users, exchanges, CCPs, regulators.  Perhaps not surprisingly, there was little consensus on important issues relating to governance, organization, capital requirements, collateral, the number or size of CCPs, or any of the important matters that still remain to be decided.  It is evident that the coming months and years will be fraught with uncertainty as the industry gropes towards equilibrium in the Brave New World of Dodd-Frank.

The lunchtime speaker was Citadel founder Kenneth Griffin.  Griffin gave a paean to central clearing, and to Dodd-Frank more generally.  Clearing is cheaper operationally and administratively.  It reduces risk.  It economizes on capital.  It is the cure for all that ails the financial markets.

So if it is so wonderful, what stands in the way of its adoption?  Per Griffin: a small, self-interested cabal of dealers who reap billions and billions of profits at the expense of end users, and who will lose their ill-gotten gains in a cleared world.

This narrative is a familiar one, the stock theme of the advocates of central clearing.  And as I’ve said on numerous occasions, this story begs far more questions than it answers.  Most importantly, if the efficiencies of clearing are so manifest, and the market power losses so large, why don’t basic competitive forces undermine dealer dominance?  An inefficient business, with high monopoly markups on top of that, is a juicy target for entry by more efficient suppliers.  You would expect such a business to suffer erosion in market share; quite rapid erosion, in fact.  But the reverse has happened to dealers in recent years, as OTC markets have grown absolutely and relatively.

Maybe competition doesn’t work, or works differently, in OTC derivatives markets.  If so, it would be nice to have a convincing model, backed by empirical evidence, to explain such an anomalous outcome, so different from the received understanding in economics, and from the experience in many other industries.  Needless to say, Griffin didn’t provide either model or evidence.

He didn’t help himself by quoting OCC data about concentration in US OTC markets.  This is akin to the drunk looking for his wallet under the lamppost.  The OCC data are readily available and easy to use, but they are incomplete because they only cover US banks.  More comprehensive surveys indicate that there are currently 10 or 11 major international dealer firms; there were 14 prior to the crisis.  I’d be interested to hear Mr. Griffin identify other industries with 10-14 major competitors, and argue that they are similarly uncompetitive.

Moreover, it is well known that concentration figures can be very misleading measures of competitiveness.  They do not measure the effects of potential competition.  Moreover, concentration ratios are endogenous.  As Demsetz showed long ago, industries can become concentrated and profitable as efficient producers gain market share at the expense of less efficient rivals.

It’s not just me, folks.  After Griffin’s talk, I chatted with an economist, a former colleague with a very responsible non-academic policy and research-oriented job who was unpersuaded by Griffin’s jeremiad.   This individual said: “He ignores the IO [industrial organization] questions.”  Exactly.  Why is the industry organized this way?  Why doesn’t competition erode market power and market power rents?  Why don’t putatively more efficient organizations and institutions (clearing, in Griffin’s view) displace less efficient ones?  Why do the inefficient survive?

He brought up energy, in which clearing has made strong inroads in the past 8 years, to bolster his point.  The problem is that the case of energy suggests quite the opposite.  Clearing grew in energy naturally, organically, without a push from Dodd, or Frank, or the Fed or anybody else.  If this can happen in energy, and this is efficient, why can’t it happen in other sectors of the OTC market?

Inquiring minds, open to persuasion, want to know.  Griffin didn’t deliver.  What he did deliver was a sermon, complete with saints and devils.

Moreover, the Citadel commander’s argument presumes that end users–who, as he properly notes, must be the ultimate source of any dealer market power profits–are the victims of some sort of battered spouse syndrome.  For end users are among the most vociferous opponents of clearing mandates.  FMC Treasurer Thomas Deas was quote outspoken on this score at the session immediately prior to Griffin’s speech.  Why are end users the most ardent defenders of a system that is supposedly rigged against them, and robs them blind?

Griffin also failed to analyze seriously the trade-offs of alternative ways of allocating and pricing counterparty risk.  No suggestion of any comprehension of issues relating to the information and incentives to price and manage counterparty risk.  No mention of moral hazard or adverse selection.  No discussion of how the industry will evolve and how this will affect the ability of clearing to realize its full potential.  Most importantly, no mention of the potential systemic risks in clearing–a point mentioned prominently in the opening remarks at the conference delivered by Chicago Fed President Charles Evans.

He did acknowledge objections to clearing mandates–but in an incomplete way, and in caricature.

If the substance was, to me, unpersuasive, the delivery and tone were off-putting in the extreme.  “Supercilious” hardly does it justice.

The serious people who spoke on all sides of the clearing issue during the conference proper raised many interesting arguments and issues.  They made it plain that the way forward will be complex, and that it is by no means evident that the way mapped out by Frank-n-Dodd will improve the efficiency, stability, and safety of the financial markets.  Griffin’s talk was, in contrast,unserious, one-sided, and ultimately unconstructive.  Manichean sermons, delivered in sneering and belligerent tones, are like that.

1-3 September marked the 7th anniversary of the Beslan School Massacre.  It was, sadly, an all too familiar admixture of the basic ingredients of Putin’s Russia: incompetence, callousness, lack of accountability, and, especially, mendacity.

All of these marked the preliminaries to the attack, the attack and counterattack, and the post-attack actions of the government.

How could a large (but still not definitively determined) number of terrorists train for an extended period without detection?  How could they travel, laden with automatic weapons and explosives, and reach a school without detection?  (Relatedly: there are reports that they had planted weapons in the school prior to their assault.  How could that happen?)  Why didn’t the authorities react to an advanced warning of the impending assault?

One possibility that has been raised is that corruption played a role in all of this.  In Russia, such allegations are too credible to be dismissed out of hand, though they are not proven.

As to the government’s response to the attack itself.  The authorities (the FSB, and especially its Vympel and Alpha units) mounted a conventional military assault that would have been appropriate if assaulting a defended compound without over a thousand hostages at risk.  But there were more than a thousand hostages at risk.  The hostages died wholesale, most killed by weapons wielded by the FSB.  Many died in a fire in the school gymnasium, which most likely resulted from the use of a thermobaric weapon (sometimes rather misleadingly referred to as a “flamethrower”).  In the assault that followed, T-72 tanks fired into the burning building. Apparently as many as 9 of the thermobaric Shmel rockets were fired into the building.  A BTR APC fired a 14.5 mm (.50 cal) weapon into the school.

The assault was ill-planned and unprofessional.  Large numbers of armed locals participated in the attack.  The lack of planning was not surprising, given that there was no unity of command: there were apparently two command centers, the visible one, headed by the local FSB authorities, but the real commanders–the “heavies”– from FSB headquarters in Moscow secretly in charge and planning and executing the assault; this division, it became clear in the end, was tailor made to make patsies of the locals.  There was virtually no provision for emergency assistance to fight the fires or deal with casualties.

As bad as the execution of the attack was, the aftermath was arguably worse.  The school was leveled by bulldozers the day after the end of the siege.  The debris–including human remains–was deposited in a garbage dump.  Many bodies were buried unceremoniously in a nearby field.  The exact number of dead was never accurately determined.  Nor were the number of terrorists.  Nor was it established that all of the terrorists were killed or captured: it is possible that many escaped in the frenzy of the assault.

The mendacity began almost as soon as the assault.  In an attempt to downplay the situation, Kremlin announced that there were only 354 people in the school, when in fact there were more than 3 times as many people there.  That was their story, and they stuck to it through the three days.  This blatant lie enraged the terrorists, and intensified an already dire situation.  While the siege was in progress, and in the aftermath of the attack, the Kremlin lied repeatedly.  These lies were echoed in the state controlled media–when it reported on the events at all.  The government insisted that the tank and APC fired only after all the live hostages had escaped–which (a) was vehemently denied by survivors, and (b) which those making the decision to fire could not possibly have known to be true or false at the time the firing took place.

Foreign and domestic journalists (e.g., Anna Politkovskaya) were prevented from traveling to Beslan.  When Politkovskaya succeeded in getting on a plane, she was poisoned.  (It has been hypothesized that the reporter’s murder was related to her discovery of damning evidence about the government’s role in Beslan.)  Journalists who  made it to Beslan were detained, harassed, or arrested; the authorities confiscated equipment from some reporters.

The official investigations on the episode were farcical.  Despite the fact that local authorities were frightened to death to do anything, out of fear of angering Putin and the Kremlin, the investigations placed all the blame on the local officials.  The Kremlin received no criticism at all.  Putinism in a nutshell: claiming authority over everything, but accountable for nothing.

But the most mendacious act was Putin’s–no surprise here.  Responding to foreign criticism of the government’s handling of the disaster, Putin referred to the Cold War and said that the West was making the criticism to “pull strings so Russia won’t raise its head.”  Russia and Putin, always the victim of some dark foreign conspiracy.

To make clear: the ultimate responsibility for the outrage rests on the heads of the terrorists.  But the government bears a heavy burden for handling a terrible situation in the worst possible way.  (Oh, on reflection, perhaps there were worse ways.  Like obliterating the building in an artillery barrage or airstrike.)

Proving that nothing succeeds in Russia like failure, opportunist that he is, Putin used Beslan to deepen the power vertical and expand his control over local governments.  Yet another casualty of Beslan was the election of regional governors.  Post-Beslan, they would be appointed by the president, and rubber stamped by local legislatures.  However you look at it, the Kremlin failed at Beslan, but came out strengthened by the carnage.   Given this, on the cui bono principle, there should be no surprise at the widespread suspicion that the Kremlin was complicit in Beslan.  I personally discount such theories, but they don’t make it easy.  Not easy at all.

Although by some measures (such as debt-to-GDP and deficit-to-GDP ratios) Russia’s fiscal situation appears favorable relative to that of the United States, for a variety of reasons, and for now, the US can finance its massive and burgeoning spending in a way that Russia cannot match.  The fiscal strain in Russia, with a deficit of 5.4 percent of GDP, is forcing Finance Minister Alexi Kudrin to search for ways to plug the gap.

For one, he is encouraging bad habits–like cigarette and alcohol consumption  (H/T S/O):

Smoke and drink more, Russia’s finance minister Alexei Kudrin urged citizens on Wednesday, explaining that higher consumption would help lift tax revenues for spending on social services.

“If you smoke a pack of cigarettes, that means you are giving more to help solve social problems such as boosting demographics, developing other social services and upholding birth rates,” Kudrin said, quoted by the Interfax news agency.

“People should understand: Those who drink, those who smoke are doing more to help the state,” he said, offering unconventional advice as the Russian government announced plans to raise excise duty on alcohol and cigarettes.

In present value terms, this is definitely a loser, even when evaluated from the narrow perspective of government funding, and ignoring the total costs to the Russian population.  The present value of the future costs to government revenue resulting from greater consumption of these goods, in terms of early mortality (and the consequent loss in earnings–and hence taxes) and greater health care expenditures almost certainly exceed the value of the short term revenue jolt this higher consumption would provide.

It is also sad to see Kudrin sink to Orwellian arguments like: “If you smoke a pack of cigarettes, that means you are giving more to help solve social problems such as boosting demographics, developing other social services and upholding birth rates.”  Translation: kill yourself so we can pay others to have babies!

Huh?  And come on: these measures are necessary to pay for existing programs, not to pay for new initiatives.

But the financing constraints of the Russian government (which reflect, in large part, the nation’s perceived unreliability as a political risk) and the relentless presentism of the government (which I’ve written about before, and which arises from a variety of causes) mean that Kudrin has to let the future care of itself.

How nice.  It’s also interesting to note how Kudrin has learned his lesson from Gorbachev and Perestroika.  Gorbachev cratered the USSR’s already shaky financial condition (with oil revenues down due to plunging prices and plunging production, and imports up due to agricultural failures) by cracking down on vodka sales.  Less vodka sales, less taxes.  Another nail in the Soviet coffin.  Kudrin isn’t going to repeat that mistake!

Moreover, the fiscal crunch is also driving the prospects for the sales of stakes in Russian state companies, like bank VTB, and Rosneft.  This initiative is on the slow track, however, with an announcement that there will be no sales in 2010, and no decisions have been made about what firms, and how much of them will be sold in in 2011 and beyond.

Here Russia’s reputation again is hurting it.  The Russian government will retain control of the corporations, and given protections for minority shareholders, and the prospect for re-nationalization (on dictated terms) at some future date, mean that the price the country would get is likely to be discounted heavily.  Put differently, this is not a conviction privatization, driven by a recognition that reducing government ownership and control would improve efficiency; it is a desperation sell-the-family-jewels-gambit where the buyer realizes that he doesn’t get them free and clear and may have to sell them back at an unfavorable price later.  Thus Russia is unlikely to get the price that it wants, but may be forced to sell anyways even at a big discount to meet its pressing fiscal demands.

Some folks have pretty much figured this out:

Troika Dialog economist Anton Strutchenevsky said the lack of certainty in the government’s position is evidence of the fact that the government sees privatization as an ad-hoc measure, necessitated by the need to fill the black hole caused by the shortfall in budget inflows of oil money. “If, hypothetically, the price of oil jumps to $100 per barrel today, the government will trash all these privatization plans,” Strutchenevsky said. He pointed to another “weak point in the program,” which he said makes the whole scheme looks like half-measures. “The state will continue to control and manage most of the enterprises and corporations slated for privatization, since it will retain some 50 percent plus share in most of them,” he said. “You cannot privatize without transfer of some ownership and control. Few investors want to sleep in bed with a government that makes all the investment decisions.”

So, Russia is in the situation where its fiscal choices include inducing the population to kill and incapacitate itself more quickly in order to raise more taxes today, and selling shares in state companies at big discounts that reflect its inability to credibly protect the buyers.  With the price of oil drifting lower the pressure to make these unpalatable choices have only increased.

The best BRIC.  Ha!

Obama’s recent interview with Brian Williams contained a couple of doozies.

The first was his response to a question about Glenn Beck:

I — I do think that it’s important for us to recognize that right now, the country’s going through a very difficult time, as a consequence of years of neglect in a whole range of areas. Our schools not working the way they need to, so we’ve slipped in terms of the number of college graduates, you know?

A financial system that was not, you know, operating in a way that maintained integrity and assured that the people who were investing or who were buying a home or were using a credit card weren’t getting in some way cheated. We had a health care system that was broken and that was bankrupting families and businesses. All those issues are big, tough, difficult issues. And those are just our domestic issues. That’s before we get to policy issues in two wars. And a continuing battle against terrorists who want to do us harm.

So, given all those anxieties — and given the fact that, you know, in none of these situations are you going to be fix things overnight. It’s not surprising that somebody like a Mr. Beck is able to stir up a certain portion of the country. [Emphasis added.]

This is just a variation on the “anxious bitter clingers” theme.  Moreover, it ain’t him, Obama is saying: it’s the anxious times in the country.

But even on a superficial level it makes no sense.  Glenn Beck was around on election night, 2008.  He was trying to “stir up” stuff back then.  Didn’t work, obviously.

Moreover, Obama has also claimed that since his election (a) he has put the country back on the track to a healthy economy, indeed bringing it back from the brink of utter collapse, (b) fixed the health care system, and (c) fixed the financial system, including provisions that he claims will make people less vulnerable to mortgage and credit card scams.  He also took credit–just last night–for ending one of the two wars he speaks of, and putting the other on a trajectory to an American exit.   So, according to Obama, he is putting the country firmly on the path to prosperity and peace.

So, if you believe Obama’s pitch, all of the factors he lists as the sources of discontent in the country should have gotten better since he was elected, and it should be harder for Glenn Beck to stir people up today than in months past.  But it is clear that discontent has risen dramatically since Obama was elected; Glenn Beck and Sarah Palin couldn’t have attracted a fraction of the crowd they did on Saturday in November, 2008 or even in August of 2009.

Obama’s explanation of the Beck phenomenon is therefore clearly false; or at least, it is impossible to square with his statements about his accomplishments.  And the most plausible explanation–that this and myriad other political developments are a reaction to, no a reaction against, Obama–is something that he just cannot face.  (And I should say that Beck is riding the wave–he didn’t create it by any means.)

The other doozy relates to a peripheral–or, perhaps more accurately, fringe–issue, but one that is telling in its own way:

Well, look, Brian, I — I would say that I can’t spend all my time with my birth certificate plastered on my forehead.

Well, look, Barack.  Nobody is asking you to spend “all your time”  with your birth certificate plastered on your big old forehead.  That argument is another soldier in your army of straw men.   Some people are asking you to just, you know, show it.  Like once.  One look would be enough.  Then everybody would be satisfied.  It should take about 10 seconds of your time to authorize the release of the certificate.  Then nobody would hound you about your citizenship ever, ever again.  You would presumably be happier not being slandered by ignorant boobs.  Indeed, you would prove that those questioning your birthplace indeed have hyperactive–and arguably paranoid–imaginations.  Seems like a winner for you.

Adamant disclosure.  I am not a birther.  I believe that Obama’s coyness about his birth certificate is an Alinskyite gambit, intended to get a certain excitable portion of the population, uhm, stirred up, and embarked on a snipe hunt.  By so doing, he discredits them and allows him to paint his opposition as a whole as unbalanced.  It also allows him to play the victim–which he does in this interview–presumably to attract sympathy.

Very clever.  But hardly presidential.  It is cynical and manipulative and divisive, and contributes to the poisonous political atmosphere.  It distracts attention from the real issues he claims to be so serious about addressing.  There is no honorable reason not to release it.

This interview gives an idea as to why Obama has transformed from political messiah to political leper.  He insults vast swathes of the electorate, insinuating that they are conspiracy theorists, and so stupid and emotionally damaged that they are prey to being stirred up by exploitive demagogues (as he paints Beck).  He fails to confront the real reasons for his unpopularity in an honest way.  He advances wildly inconsistent theories–he’s clearly making things better but everybody thinks that they’re worse.  He plays low political games.

He needs to remember the first rule of holes: when you’re in one, stop digging.  But instead, he’s just redoubling his shoveling.  And in so doing, he is digging his political grave.

On 1 September, 2005, the attack by Islamic terrorists of diverse nationalities on School Number One in Beslan began.  It ended two days later, with hundreds dead, many of them schoolchildren.

May the innocent rest in peace.

Beslan is wrapped in more uncertainty and controversy than other horrific events during the Putin years–Ryazan, the Kursk, Nord Ost, the Moscow Underground bombing.  That’s saying a lot, because the competition is pretty intense.

Time allowing, sometime over the weekend I’ll try to put together a few thoughts on Beslan and its legacy.

Obama’s speech on Iraq seemed listless and perfunctory.  Much of it was boilerplate–no surprise there.  Some of it was disturbing, most notably his continued ambivalence on Afghanistan:

Within Afghanistan, I have ordered the deployment of additional troops who-under the command of General David Petraeus -are fighting to break the Taliban’s momentum. As with the surge in Iraq, these forces will be in place for a limited time to provide space for the Afghans to build their capacity and secure their own future. But, as was the case in Iraq, we cannot do for Afghans what they must ultimately do for themselves. That’s why we are training Afghan Security Forces and supporting a political resolution to Afghanistan’s problems. And, next July, we will begin a transition to Afghan responsibility. The pace of our troop reductions will be determined by conditions on the ground, and our support for Afghanistan will endure. But make no mistake: this transition will begin – because open-ended war serves neither our interests nor the Afghan people’s. [Emphasis added.]

He throws a small bone to the critics of his Afghanistan policy with his remark about “conditions on the ground.”  But everything else in the statement–including the phrases I’ve italicized–clearly indicate that the American commitment is tightly circumscribed.  Moreover, the commencement of the drawdown is written in stone (“But make no mistake: this transition will begin”).  The only flexibility is on the pace of the drawdown–not its inevitability.

This is all delusional because the goal of his policy–Afghanization, the building of Afghan capacity to secure the country’s future–is completely incompatible with this cramped timeline.  It is widely recognized that Afghan state and military capability are years behind Iraq’s, and there are grounds for concern about the viability of Iraq’s as an independent entity even after many years of robust American support and training.  So there is no way Afghanistan will be capable of what Obama wants in July of 2011, or years beyond that.  If we are lucky, the drawdown in Afghanistan will commence when we are at the end of the beginning of the beginning.  This is a disaster in the making.  A warm up the helos and clear the roof of the embassy-type disaster.

But that’s not the main thing that struck me about the speech, because it was completely in line with his previous statements.  What hit me was the clunky attempt to “pivot” to the economy.  This was hardly a thing of grace, and in its own way is quite revealing:

Unfortunately, over the last decade, we have not done what is necessary to shore up the foundation of our own prosperity. We have spent over a trillion dollars at war, often financed by borrowing from overseas. This, in turn, has short-changed investments in our own people, and contributed to record deficits. For too long, we have put off tough decisions on everything from our manufacturing base to our energy policy to education reform. As a result, too many middle class families find themselves working harder for less, while our nation’s long-term competitiveness is put at risk.

And so at this moment, as we wind down the war in Iraq, we must tackle those challenges at home with as much energy, and grit, and sense of common purpose as our men and women in uniform who have served abroad. They have met every test that they faced. Now, it is our turn. Now, it is our responsibility to honor them by coming together, all of us, and working to secure the dream that so many generations have fought for -the dream that a better life awaits anyone who is willing to work for it and reach for it.

Our most urgent task is to restore our economy, and put the millions of Americans who have lost their jobs back to work. To strengthen our middle class, we must give all our children the education they deserve, and all our workers the skills that they need to compete in a global economy. We must jumpstart industries that create jobs, and end our dependence on foreign oil. We must unleash the innovation that allows new products to roll off our assembly lines, and nurture the ideas that spring from our entrepreneurs. This will be difficult. But in the days to come, it must be our central mission as a people, and my central responsibility as President.

Note the direct assertion that the same kinds of things that work in a military campaign are what are needed to rejuvenate the economy.  This is not new.  Statists are fond of using military metaphors to describe the economy, and military style, command and control, methods to address economic issues.  Lenin’s writing is littered with military metaphors.  (And no, I’m not saying Obama is a Leninist.)  Ditto fascist economic tracts.  (And not saying he’s a fascist either.)  In the US, during the New Deal, military metaphors and command and control type measures to address the crisis were all the rage.   In the 1970s, Carter said that fighting the energy crisis was the “moral equivalent of war,” and attempted to implement a raft of centralized, government-driven initiatives to deal with energy.   Statists rattle the economic saber at every opportunity.

Obama’s speech reflects a similar mindset that the economy is something that is amenable to central direction and control, like a military campaign, as does his recent statement on the economy:

“Every single day, I’m pushing this economy forward, repairing the damage that’s been done to the middle class over the past decade and promoting the growth we need to get out people back to work,” Obama said in his statement.

General Obama, leading the economic charge.  “Fighting for economic recovery on all fronts.”  He called for a “full-scale attack” on economic issues, and called on the Republicans to end their “blockade” against a “jobs bill.”  It is amazing that a man that is so painfully, obviously diffident–at best–about his real military responsibilities as Commander-in-Chief is so aggressive in his deployment of military imagery–and centralized, quasi-military methods–on economic matters.

This is fundamentally wrongheaded, and actually destructive.  The economy is not an army, to be commanded and directed.  Centralized methods founder on information and incentive problems, and the daunting complexity and interconnectedness of the economic system.  Attempts to centralize invariably impair efficiency, and stymie growth, rather than the reverse.  This is particularly true when helter skelter attempts to restructure massive parts of the economy create pervasive uncertainty that paralyzes private decision makers.  Military-style, centralized, command and control methods are the last thing the economy needs to prosper.

I’ve said before that the greatest lesson of the Great Depression is that we learned the wrong lessons from the Great Depression.  There was at the time (notably at Chicago), and increasingly so today, a recognition that the dirigiste thrust of Roosevelt’s policies and the great uncertainty created by the improvisational nature of the centralized policies exacerbated the depth and duration of the Depression.

This is a plausible reading of the current situation as well.  If Obama truly views economic matters in the way suggested by his rhetoric, as something amenable to centralized, hierarchical, military-style methods, we can anticipate a continuing, stumbling recovery, if we’re lucky.  In other words, General Obama’s ringing call to economic arms will not lead us to victory, but to quagmire–to appropriate a word so beloved of his ilk.