Streetwise Professor

November 17, 2010

Russia Quick Hits

Filed under: Economics,Politics,Russia — The Professor @ 8:39 pm

A few interesting things on Russia that deserve some comment.

Item 1.  This article from the FT Beyond Brics blog notes that although other emerging markets are worried that Uncle Ben’s Quick Bucks AKA QE2 are putting upward pressure on their currencies, and are experiencing substantial capital inflows, Russia is the laggard, with a declining currency and net capital outflows:

At a time when most emerging markets are struggling to stem the tide of liquidity from the developed world, Russia stands virtually alone in anticipating more capital flowing out of the country than coming in this year.

On Monday, Russia’s central bank raised its forecast for net outflows in 2010 to $22bn. Although this is much lower than the outflows of $134bn in 2008 and $57bn in 2009, the contrast with the emerging world as a whole – which the International Institute of Finance expects to experience net private capital inflows of $825bn this year – is striking.

The weak ruble is particularly amazing, given that other commodity currencies are very strong.  That is a very telling commentary on Russia and its economic prospects.

The net capital outflows reflects two things: (a) relatively little money flowing into Russia, and (b) a lot flowing out.  The former is readily understood, given the very weak investor protections, and the horrible experiences of many foreign investors (Shell, BP, Telenor, Ikea, and on and on).  The latter is very revealing too, though.  The distribution of wealth is highly concentrated in Russia, so net wealth outflows mean that even the extremely wealthy–those that have investible wealth and the ability to move it overseas–perceive that the risks of investing in Russia are extreme.  Even given the vaunted discounts in Russian equity prices, they put a lot of their money overseas.  They realize that they have their wealth at the whim of Putin and the siloviki.  Better to get it (and in many cases, their families) in a place where it’s harder for the state and the power structures to get at it.  They have more influence in the system than foreigners, but “more” doesn’t mean “a lot.”

The BB post links to this article from the FT in October (which I had missed).  It gave me a chuckle:

Russia: Laws do exist but enforcement is patchy [!]

. . . .
The government, meanwhile, is making a concerted effort to do something about the bad reputation Russia has in the business world. Legislation is planned and there has already been some progress.

But the laws are not the main problem, say most experienced investors.
“The biggest problem is not the law itself, it is the implementation of the law,” says the president of a big investment bank in Moscow. Most serious legal wrangling is done in London courts, as few trust Russia’s legal system to deliver an impartial verdict.

Yes, Russia, in theory, has laws to protect investors.  And the USSR had a democratic constitution.  But as the article notes, the formal protections don’t mean bupkus in a country with a court system that gives new meaning to the words suborned and corrupt.

The FT article also states that corporate governance is a problem because “companies tend to have highly concentrated ownership – a legacy of high cash flows and low share prices when most were born.”  Uhm, not really.  Indeed, this has cause and effect reversed.  The concentrated ownership is the effect of legal weakness.  Who wants to be a minority investor in Russia?  (If you answered “yes” to this question: please just send me the money.  You’ll have as much as if you invest in Russia, and I’ll be better off.)  The lack of effective (as opposed to formal) legal protections is why (a) publicly traded Russian stock prices are so low, and (b) ownership is concentrated.  Owners of big stakes would like, most probably, to sell off some of their shares, but they can’t precommit to protect small shareholders, and the courts won’t make them do it, so the small fry only buy at a discounted price that makes the sales less attractive.

Item 2.  Foreign policy.  Stephen Blank writes a typically excellent analysis of Russian foreign policy, and the Obama administration’s delusional Russian policy.  The whole thing is worth a read, but the conclusion hits the nail:

This absence of discernible quid pro quo in return for U.S. concessions casts serious doubt on Obama’s new approach to Russia. The current administration has not shown why improved ties with the other side are important, what the positive gains may be, what the limits of this reset policy may be, and why it should command serious domestic support. Here, Washington’s silence on these important questions has opened the door to a likely Republican and conservative Democratic assault on the forthcoming treaty, which would jeopardize the continuation of the overall policy. Indeed, the same is true in Russia—and Medvedev’s lack of control over his own government should also cast serious doubt on the reset: Putin’s faction, after all, has already tried to organize military alliances with Latin American states like Venezuela and Ecuador, alliances hostile to the United States and designed to secure Russian air and naval bases in those counties (as well as in Bolivia) to support Hugo Chávez’s Bolivarian Revolution.

Clearly, pushing the reset button, from Russia’s point of view, means one thing: getting a free hand to pursue policies that are in many respects fundamentally driven by anti-Americanism and its own sense of Great Power entitlement. The fact is that Russia has long since decided that we are its prime adversary, and its model for relations with the U.S. is not far removed from the peaceful coexistence model of the Brezhnev era, another period in which détente only succeeded to a limited degree and foundered on missile placements in Europe and Soviet adventurism in the Middle East and the third world. The recent episode of the twelve Russian “sleeper” agents caught and deported by the United States illustrates the problem of the current Russian mind-set. The scope and scale of this operation (and who knows how many other such operatives are “out there”) underscore Moscow’s guiding assumption that the U.S. is its prime adversary, which in turn illustrates Russia’s addiction to Cold War tactics and thinking. Medvedev may call for “modernization alliances” with the U.S. and Europe, but his government’s actions indicate that it sees us as anything but a friend.

We should indeed take Moscow and its plans seriously. For the most part, unfortunately, those aims and interests are antithetical to the cause of stopping Iranian proliferation and preserving peace and security in Europe. A realistic understanding of Russian intentions, rather than the vacuously optimistic view shared by many commentators who should know better, ought to be the true basis for engaging Moscow diplomatically. Any reset in relations should come from a cold-blooded calculation of our interests, not sentimentality or illusion—and certainly not with a trusting (and unreciprocated) acceptance of Moscow’s self-serving definition of its bottom line or its “sphere of influence.” Getting real about Russia does not mean taking Moscow lightly or rejecting cooperation when it is desirable, but it does mean advancing our own goals as seriously as Russia is advancing its own.

Relatedly, earlier this evening I saw Hillary Clinton reading a statement advocating the passage of the new START.  It was painful for many reasons.  First, her shrieking, shrill voice.  Second, her statement that “some people say we should hit the pause button.”  I mean, give the effing button metaphors a rest, OK?  It’s not like the original button thing (in Latin type, not Cyrillic; mistranslated; dorky) worked out so well for you, Hillary.  (Steven Hayes said on FNC Special Report that listening to her makes him want to reach for the mute button.  I hear you, man.)  Third, on the substance her remarks were weak.  Fourth, she was just reading, and obviously so–kind of mailing it in.  (And for those who lament the fact that she lost to Obama–she would have been a disaster in her own special way.)

Item 3.  There are many stories about plans in the works to re-engineer Russia in order to solve the “monogord” problem.  (Monogorods are single industry or single company towns, many of which are in dire straits because the town industry/firm is itself in dire straits.) In a nutshell, the plan is to induce people to  leave the monogorods, and concentrate in 20 large urban areas.

This is the antithesis of recent Putin initiatives, which involve injecting financial support into the monogorods, mainly on an ad hoc, squeaky-wheel-gets-the-grease basis.

The articles are rather unclear on exactly how this is to be accomplished.  But it is clear that it is to be a state-directed effort:

The authors warn that new urban centers must not evolve spontaneously, so as not to pose “serious risks” for the state and create imbalances in regional development. Among the factors that could trump the novel ideas is that Russian laws do not currently allow the formation of agglomerations, as this contradicts the system of intergovernmental relations. The suggestive boundaries for such agglomerations also do not correspond to the country’s current administrative divisions, which could be a potential problem when distributing budget funds.

Spontaneous order?  Nope.  Can’t have that now, can we?  That would be so un-Russian.

There’s an irony here.  The monogorods were largely a creation of Soviet social engineering.  The de-monogorodization of Russia is to be latter day offsetting social engineering.  That’s not likely to work out any better.  The government doesn’t have the information to determine what the “right” configuration is, and what’s more (apropos Item 1), any government effort will be distorted by corruption and rent seeking.  It would be better that the government create a rational framework of laws and regulations, and (again apropos Item 1) a relatively uncorruptible enforcement system that will support the flow of resources–including, crucially, human resources, to their higher value use.

But that’s the problem.  That isn’t going to happen any time soon.  It is very hard, and the powers that be have little incentive to make it happen given how well the current system works for them.  So, again, they’ll try to reverse the perverse effects of the previous policies of treating people like animals and shunting them about to meet state purposes by creating new policies that treat people like animals and shunt them about to meet the new, improved state purposes.

If it even happens.  It looks like this is a Medvedev initiative (the policy document comes from the Presidential administration) and as noted above, clashes with the Putin approach to the problem.  And if that’s the case, bet on Putin and his approach.

November 16, 2010


Filed under: Clearing,Derivatives,Economics,Financial crisis,Politics — The Professor @ 7:58 pm

In my recent piece on clearing in the Journal of Applied Corporate Finance, I wrote:

It is equally unknown what clearing market structure will evolve, and how close this structure will come to approximating the ideal structure.  In this regard, it is essential to keep in mind two facts.

First, the extensive scale and scope economies associated with clearing make it likely that the clearing industry will be highly oligopolistic, and that strategic considerations will influence decisively the way that the industry develops.   Moreover, scope economies across trade execution and clearing (Pirrong, 2010b) will also affect the strategic and efficiency forces that will shape industry structure.  Strategic considerations will almost certainly drive a wedge between what is optimal for the individual decision makers, and what is optimal for the economy.  This is particularly true inasmuch as there is no market mechanism evident that would induce CCPs to internalize the systemic externalities associated with their failure.

. . . .

Second, industry evolution will inevitably be a highly politicized process.  Dodd-Frank gives regulators enormous discretionary authority over the operation of CCPs.  Interested parties will influence the regulatory process for their private benefit.  Political tradeoffs, rather than efficiency considerations, also threaten to cause serious divergences between the structure that evolves in practice, and the one that would optimize the relevant economic tradeoffs.  The effects of politics are particularly pronounced in this context because finance is a truly international industry, and hence jurisdictional issues and competition between jurisdictions will play a decisive role in determining the industry’s ultimate configuration.  For instance, governments in major financial centers (e.g., the US, London, the EU, and individual countries in the EU, Japan, Singapore, and Hong Kong) have all expressed a strong interest in domiciling CCPs, for both economic and political reasons.  But accommodating these interests would fragment clearing, reducing netting benefits and raising serious concerns about coordination during a crisis.  Moreover, regulatory competition between jurisdictions to favor their local CCPs could compromise financial market stability.

There is another mandate in Frank-n-Dodd, this one for reporting all swaps transactions to trade respositories.  The scale and scope economy issues, and the jurisdictional and political issues are also present for repositories, and a recent article in eFinancial News demonstrates that the problems in the likely evolution of clearing market structure that I identified above, with the associated inefficiencies, are coming to pass with the repositories:

However, repositories are not a cure all. While the concept of a trade repository is not controversial, there are issues to address. Most notably, the sudden explosion of repository providers is leading to fragmentation, a problem familiar in other areas of the market, such as the clearing landscape.

Market participants are concerned that fragmentation would undermine the purpose of repositories to provide a single integrated view of derivative risk. The DTCC’s Douglas said: “The problem with trade repositories is that if everyone wants to build their own, how can regulators be sure that they are seeing the whole picture?”

l;”>The market has also raised concerns that multiple repositories may lead to double-reporting, while others highlight the implicit problem of dividing repositories along asset-class lines.

Richard Metcalfe, head of global policy at the International Swaps and Derivatives Association, which supports repositories in principle, warns that this approach does not show the trade data in its fullest context. He said: “You are looking at derivatives in isolation from positions that dealers might be hedging or adding to.”

This problem may be partially addressed by developing interconnectivity between the different trade repository providers. Interconnectivity would help build a full regulatory picture but would still afford dealers a choice of reporting venue, according to Philip Brown, head of client relations for Europe and the Americas at Clearstream.

. . . .

“>But the legislation is not yet finalised and the industry will have to move fast before the proliferation of repositories in both US and Europe renders the task of standardisation slow, tedious, and painful.

Metcalfe said: “I think the key issue is can we ensure that supervisors work together internationally to ensure that the information can be aggregated.”

It’s easier to create repositories than CCPs.  That’s why the process of creating them is further along than for CCPs.  But you can expect that all of these problems will occur in spades as development of clearinghouses proceeds in the coming months and years.

It’s also important to remember that repositories just consolidate data, not risk, so the consequences of getting it wrong are not as severe, by far, with repositories as compared to CCPs.  Fragmentation seriously impairs the allocation of risk, by reducing netting possibilities, reducing diversification, and limiting cross margining.  It also will create the potential for serious coordination problems in the event of a crisis; poor coordination across CCPs could greatly exacerbate the effects of a crisis.

Which all means that when you see the difficulties already becoming manifest in trade repositories, you should be very concerned about the effects of a clearing mandate.  Frank-n-Dodd, and what the EC is doing, can mandate clearing, but they can’t mandate market structure.  That is going to evolve in a messy way, driven by the nature of indivisibilities and politics–as the repository experience is showing.  And a messy evolution in clearing is a very sobering prospect, given that our legislative and regulatory betters have decided it wise to put all our eggs in that basket.

This was unintended, but not unpredictable.  At least it shouldn’t have been.  But one hopes that even for the dreamers and the slow learners, that what is happening in trade repositories is a cautionary tale that will open their eyes to what is likely to transpire in clearing.

The War on the History of the War Continues

Filed under: History,Military,Politics,Russia — The Professor @ 7:20 pm

Russia plans to impose extraterritorially its uniquely self-serving interpretation of WWII history (h/t R):

Dmitry Medvedev, the Russian president, created a commission of 28 legislators and senior intelligence officers which will identify foreign “revisionists” who “disparage the international prestige of the Russian Federation”.

The move, condemned as “Orwellian” by its critics, comes shortly before the Russian parliament is expected to pass controversial legislation outlawing the “rehabilitation of Nazism”.

The bill has attracted criticism because of its definition of Nazi rehabilitation, with those who “belittle” the Soviet Union’s role in the war or criticise it in any way being regarded as equally culpable as those who glorify Hitler.

Those found to contravene the new law, which Russia insists is little different from Germany’s Holocaust-denial legislation, face up to five years in prison.

Foreign countries whose officials who the commission rules to be guilty of the new crimes will face sanction as well. The bill gives Russia the authority to expel ambassadors or sever diplomatic relations with offending nations and to impose full transport and communications blockades on them.

. . . .

A Russian MP yesterday said that the Baltic states deserved “to suffer punishment” for holding such views.

The new law could also be used to bar Western historians who accuse the Red Army of carrying out atrocities during its advance on Berlin or point out that Nazi Germany and the Soviet Union were once allies under the Molotov-Ribbentrop pact.

It is particularly disgusting that Russia asserts that this legislation is equivalent to German Holocaust denial laws.  Indeed, this is an inversion of those laws, because it makes denial of historical facts and suppression of historical debate official state policy.   Moreover, it is bad enough that a country adopts an official historical viewpoint, and enforces it with coercive means. It is beyond the pale to force other sovereign nations to adopt the same official viewpoint.  Can you say imperialism?  I knew you could.

Distortion of the Stalinist past, or amnesia about it, is not limited to WWII:

Our data verify that Russians have limited knowledge about the Stalin-era repressions. Only 28 percent correctly indicated that “millions or tens of millions” suffered, 31 percent cited lower figures, 24 percent simply did not know, and 17 percent had never even heard about them. This manifestation of “absent memory” is especially pronounced among 20-year-olds: 35 percent of them have not heard of the repressions.

It is peculiar that Russia, which after 1991 could have foresworn any responsibility for USSR and its gruesomely bloody history, has instead embraced an airbrushed, distorted vision of it.  It would not have taken much mental agility to separate, for instance, the bravery of Soviet soldiers and their essential role in defeating Hitler from the crimes of the mendacious leaders and the Party committed before, during, and after the War.  Such a separation would have built up some good will and trust.  But rather than attempting to separate Russia from the USSR, Russia conflates the two: historical revisionism about the actions of the USSR is deemed to “disparage the international prestige of the Russian Federation.”

RF=USSR.  USSR=RF.  I didn’t say it.  They did.

But I guess “peculiar” is not the right word.  “Revealing” is, and what this all reveals about the Russian ruling elite is quite disturbing.  And yet they continue to express surprise and anger at the fear, mistrust, and loathing that Russia inspires among its neighbors.  I mean, really: get a clue.

But the whitewashing of the past, and the angry and at times violent reaction to those who object to this whitewashing suggests that cluelessness is not really the problem.  Rather, these are symptoms of a malignant narcissism that impedes natural development and healthy relationships with other nations and peoples.  That is something that one cannot reset, and even the attempt creates the grave risk of being exploited by the narcissist.  So though it’s all to easy to dismiss this as a tempest in a historical teapot, that would be unwise.  This battle over the past is all about the present, and those in the US and Europe and elsewhere should pay heed to what this says about Russia and those who rule it.

As Good as Dead?

Filed under: Military,Politics,Russia — The Professor @ 6:22 pm

Senator John Kyl says that the Senate will not consider the new draft START treaty with Russia this year during the lame duck session.

I have mixed thoughts about the treaty, but found the administration’s haste in trying to get it passed during a lame duck session disturbing.  Questions have been raised.  The administration says that they have answers.  Fine.  They can give those in due course and permit a thorough vetting.  If the answers are persuasive, the treaty can and will pass.  The attempt to jam it through before the new Senate convenes in January betrays not just political fears, but a lack of confidence in the persuasiveness of the administration’s answers to the objections that have been raised.

That’s the Way Rackets Work

Filed under: Commodities,Energy,Politics,Russia — The Professor @ 6:15 pm

This is one of those stories (h/t JRL) that can be read on many levels:

Meeting of the Security Council chaired by President Dmitry Medvedev will discuss energy security in late November. The necessity of a federal law “On energy security of the Russian Federation” and legislative and organizational measures will be considered at the meeting.

The state aspires to complete information on oil and to control over it. The Interior Ministry is supposed to combine  efforts with the Energy Ministry in prevention of oil thefts. By and large, the matter concerns establishment of Oil Control, a system that is supposed to shut down the black market of oil products. Work on this mechanism has been under way since earlier this year, when oil companies complained to the president against countless illegitimate mini-refineries that were making fuel of dubious quality and selling it domestically and abroad.

A source within the government announced that approximately 10% (about 50 million tons) of all oil made annually disappears without a trace. “As matter stand, oil companies do not want the state to know exactly what they have. The intended involvement of law enforcement agencies is not going to make them happy at all.”

Political Information Center Director General Aleksei Mukhin allowed for the possibility of a connection between the idea to establish a control mechanism and the notorious YUKOS affair. Mikhail Khodorkovsky and Platon Lebedev are facing charges of theft of 350 million tons of oil. The verdict will be passed in mid-December. “The state wants control over commercial activity of the fuel and energy complex,” said Mukhin. “The Interior Ministry
and Federal Security Service have some serious lobbyists working for them. With information on the movement of fuels in Russia and abroad available to them, these structures will be able to influence oil companies’ marketing policies… Reorganization of the Interior Ministry is about to put an end to police generals’ business ventures. They need something else… I suspect that losses of oil will only increase now.”

On the one hand, I would not put it past some Russian oil businesses to attempt to escape the country’s onerous tax burden on oil.  On the other hand, this gives the Interior Ministry access to extremely valuable commercial information that they can utilize for various nefarious purposes that just happens to line the pockets of Ministry personnel.

It seems that some firms in the oil industry were too clever by half, asking the state to intervene to crack down on some dodgy competitors, only to find that the Interior Ministry would take this as an invitation to get up close and personal with all of their businesses.  Proving yet again that it’s very dangerous to give the slightest opening to the operators of protection rackets, as they will take what you offer plus anything else that they feel like taking.  You give an inch, they’ll take miles.

November 15, 2010

Transportation Sodomy Administration

Filed under: Politics — The Professor @ 3:35 pm

I fly a lot.  A lot.  My heavy air travel began in August, 2001, so I’ve seen the post-911 evolution of airport security from beginning to end.  I’ve seen airport security Kabuki theater more times than Cats has been performed on Broadway.  In the process, I’ve learned things: like, for instance, that chunky peanut butter is a verbotten gel.  I’ve seen the fiendishly clever ploys used to keep terrorists off-guard, such as the shoes go in the tray this week, but on the belt and not in the tray the next.  Yeah.  That’ll work.  Through long exposure I’ve become inured to that combination of incompetence and attitude that puts a majority of TSA screeners in the same league as toll booth attendants and DMV personnel.

But it’s going from bad to worse.  That’s because TSA is now giving air travelers the unpalatable choice between (a) taking a dose of radiation and be ogled in the nude, or (b) being subjected to a physical search that would be a felony sexual assault in any jurisdiction in the US. “Air travelers” who, by the way, include small children.

Or sometimes both.  My wife was going through security in St. Louis* about a month ago.  She was told to go through the new screening device.  She said she’d prefer not to.  So they said if she didn’t, she would have to be subjected to the intrusive physical search.  She decided to go through the screening device.  And when she stepped out, they subjected her to the degrading, abusive, humiliating physical search anyways.  Surely, just to teach her not to Question Authority.  The SOB carrying out this public service (take out the “l” from “public” and you’d have an accurate description of the process) did it, my wife said, with a half-assed grin on his face.

There’s a word for people like that.  It starts with “P” and rhymes with “tricks.” But they’re from the government, and they’re there to serve and protect you, so you’d better shut the hell up.

This cannot be justified on any rational basis.  The cost of the equipment, the personnel required to perform these loathsome tasks, the time lost by travelers, the health risks from additional radiation, not to mention the very real psychic cost of being groped by some TSA dope cannot possibly exceed the benefit arising from any miniscule decline in the likelihood of a terrorist incident.

What’s more, this initiative is intended to prevent a recurrence of things like last Christmas’s Junk Bomber.  That, you’ll recall, was the result of a massive intelligence and procedural fail on the part of the very same yo-yos responsible for mandating the new policy.  Since they are incapable, apparently, of denying boarding to an individual who (a) traveled through Yemen, (b) was been identified as a  terrorist threat by his own father, and (c) didn’t have the proper identification, they have decided to subject tens of millions of innocent people to abusive invasions of personal space and privacy.

I would much prefer that TSA adopt policies that rely on utilizing information that would permit a more discriminating–yes, discrimination in this, as in taste, is a good thing–targeting of security efforts on individuals that are more likely to pose a terrorist threat, instead of relying on this perverse (in many senses of the word) and indiscriminate game of X-rated Blind Man’s Bluff.  The operative principle of which appears to be that it is preferable to violate the persons, privacy, rights and dignity of everybody, rather than a rationally selected few.  That it is better to subject tens of millions to degrading assaults, than to identify a few whose behavior or associations make them greater risks, and subject them to some additional questioning (of the type that El Al has used with great effectiveness).

This isn’t insanity.  This is the exponential of insanity.

God give me the strength to keep my temper and hold my tongue.  I think I’m going to need it.

* Word to the wise.  St. Louis Lambert Terminal 2 has, by far, the worst TSA performance of all the airports I’ve been to.  And I’ve been to most of them.  Slow with a lot of attitude.  The TSA people at the Asheville, NC airport were by far the friendliest and most helpful of those at any airport I’ve visited.

November 13, 2010

Tell Me Another One

Filed under: Military,Politics,Russia — The Professor @ 8:00 pm

Kommersant ran a breathless story about the alleged defection of a Russian SVR (the foreign intelligence service) officer who was responsible for Russian operations in the US, including the spy ring busted in July.  Maybe the essence of the story is true, but some details seem to be pure BS, which calls the rest into question.

Most wildly implausible bit:

The unnamed source also claimed that American investigators had tortured Vasenkov, breaking three ribs and a leg in the process. A retired SVR officer interviewed by Russia Profile found the claims credible, and compared this to the methods used in Iraqi prisons, saying they were just another sign of lowering the bar in modern-day spy games. “These are Iraqi methods,” the officer said. “What comes to mind are the videos we saw from Iraqi prisons. They could not outplay him honestly and resorted to impermissible foul play. Yes, they probably always do that in American football, but this is not American football.”

Uhm, Vasenkov/Lazaro was arraigned in the US on July 8, and on the a plane to Vienna for the swap the next day.  He was seen in open court.  No press account mentioned a limp or a cast, and during his statement he did not mention anything about getting beaten up.   Kind of hard not to notice when somebody has a recently broken leg.

And spare me the Iraqi prison stuff.  We know all about what happens in Russian prisons to regular people.  Captured agents, one can only imagine.  The Russians probably taught the Iraqis a good deal, back in the day, and perhaps the Russians learned something from the Iraqis too.

The other suspicious part of the story seems like boob bait for the babushkas:

Kommersant also quotes an unidentified Kremlin official as suggesting that a Russian hit squad was already planning to kill the colonel. “We know who he is and where he is. Whether he betrayed for money or was simply caught up in a situation, make no mistake – Mercader has already been sent to get him,” a senior Kremlin aide told the paper, in obvious reference to Ramon Mercader, the Soviet secret agent believed to have killed Leon Trotsky with an ice pick. The Kremlin source said Shcherbakov would spend the rest of his life fearing retribution.

Yeah.  Sure you know where he is.  And if you did, sure, you could get to him with an ice pick, no problem, thereby avenging the insult to the Motherland and proving yet again that the fate of Traitors is Death! Death! Death!

And it’s kind of incongruous, don’t you think, that in one paragraph we have former SVR officials tut-tutting about alleged (and almost certainly fantastical) “Iraqi methods” and tackle football resulting in a few broken bones, and in another current Kremlin officials boasting about the inevitability and desirability of cold blooded murder?  So, on the one hand, Russians are shocked! shocked! that their spies get smacked around a little, but think it’s just copacetic to whack ours.

As usual, there’s all sorts of Kremlinology ricocheting around to explain the leak.  One theory is that it’s part of a FSB plot to get rid of SVR head Fradkov and roll the SVR back into the FSB, thereby undoing one of Yeltsin’s early post-collapse policies.  That may be true, but I wouldn’t be surprised if that doesn’t happen, even if the FSB would like it to happen.  It is SOP for authoritarian leaders to have multiple intelligence/security services.  This is wise for a variety of reasons.  One can be played against the other.  Information from one can be checked against that from the other.  Information is power; concentrating all the information in one entity gives that entity all the power.  In a dyarchy, too, it is almost inconceivable that the two leaders would permit concentration of major intelligence assets in a single agency.  (Yes, there is still the GRU, but a reconsolidation of the old KGB would upset the current precarious balance between the FSB and GRU.)

Some of the revelations, if true, would be pretty shocking, and put the SVR in a pretty bad light.  The alleged defector purportedly has a daughter living in the US.  He had turned down a promotion–a promotion that would have required him to take a polygraph exam. But all this could just be more BS in a publicity campaign against Fradkov and the SVR.  Or it could be true.  Either way, it doesn’t speak well of Russia’s security services.  Which warms the cockles of my heart.

November 11, 2010

One Member, One Vote?

Filed under: Clearing,Derivatives,Economics,Exchanges,Financial crisis,Politics — The Professor @ 9:50 pm

Frank-n-Dodd mandated clearing.  The CFTC is now promulgating a raft of rules regulating the clearing process.  One of these rules limits the ability of clearinghouses to determine to whom they offer clearing services, and how:

The Commodity Futures Trading Commission approved a proposed rule to force the world’s largest banks to offer swaps clearing services to smaller firms, a change that would promote competition in the $615 trillion market.

. . . .

“Swaps dealers or major swaps participants are prohibited from interfering with or attempting to influence decisions related to the provision of clearing or the acceptance of clearing customers,” according to the proposed rule. The potential regulation now enters a 60-day public comment period before any final CFTC vote.

I’ll defer comment now on this particular rule because it hasn’t been posted on the CFTC website yet, and want to read the full rule rather than going on just the news report.  But this does relate to a general issue that I’ve been thinking about lately: CCP governance.  So I’ll provide some general analytical observations on this subject that are likely to be relevant as the CFTC and SEC proceed on clearing issues.

I’ll focus on CCP membership and its implications for the way CCPs are run.  In particular, in addition to controversy about who should be allowed to open clearing accounts and who should have a say in who can do so, there is also controversy about who should be able to become a CCP member, and CCPs’ ability to set membership standards and to exclude some firms from membership.  This issue came up at the roundtable I participated in on 22 October.  There is a group of smaller banks and brokerage firms that are pressing to become CCP members, and to limit the ability of CCPs to set standards that could result in their exclusion.  This is likely to be a big issue going forward.

As I’ve written for years, there are difficult trade-offs here.  On the one hand, there is the issue of market power.  I’ve shown–in work going back into the 1990s–that when there are substantial scale economies, as is the case in clearing, it is possible for a CCP–even if it is member-owned, and a not-for-profit–to exercise market power by limiting membership.  That is, a suboptimally small “club” of intermediaries can get together and form a CCP, without fear of competition from another CCP due to the scale economies.

On the other hand, allowing open access can jeopardize the financial security of the CCP.  I want to focus on this issue.

A key point here is heterogeneity.  CCPs with heterogeneous members, in particular firms that vary in their financial strength, risk management capabilities, etc., face difficulties that CCPs with more homogeneous members do not.  These difficulties, in fact, can undermine the ostensible public purpose behind mandating CCPs: reducing systemic risk.

CCPs are firms that have to be governed and managed.  It is well known that heterogeneity increases the costs of governing cooperative organizations.  Henry Hansmann’s The Ownership of Enterprise provides numerous examples of this.  Conflicts between members are more likely, the more heterogeneous they are.  In particular, some members can attempt to use the organization to transfer rents from other members.  In my 2000 JLE paper “A Theory of Financial Exchange Organization” I explain a lot of the supposedly inefficient and cumbersome governance mechanisms in futures and stock exchanges as a rational way of mitigating rent seeking among the heterogeneous members of these exchanges.

Let’s take the case of a CCP in particular.  A CCP mutualizes risk, and therefore creates potential moral hazard problems.  The CCP can mitigate these problems by imposing capital requirements, and crucially, by choosing margin/collateral policies.

When CCP members are heterogeneous, in particular, when some are better capitalized than others, or when some incur higher costs to post collateral than others, the members will disagree on what the appropriate margins should be.  The better capitalized firms and those who incur lower costs to post collateral will prefer higher margins.  The more poorly capitalized firms and those who incur higher collateral cots will prefer low margins.

The well capitalized firms are concerned that since clearing makes the cleared products fungible, customers don’t care who they trade with.  Since risks are shared, every member is effectively a perfect substitute from the perspective of customers.  Thus, clearing tends to make it easier for less-well capitalized firms to get business.  But since default risk is mutualized, this reallocation of trading activity towards the less-well capitalized firms tends to force the better-capitalized firms to suffer more default losses.  One way (albeit, imperfect) to control this problem is to raise the costs that the less-well capitalized firms incur (relative to the costs of the better-capitalized ones).  Since collateral is typically costlier for the lower-cap firms, this can be done by charging relatively high margins.

Thus, I would expect that more highly capitalized firms would prefer higher margins than the less highly capitalized firms.  (Similar arguments can be made relating to other risk control policies that CCPs might adopt.)  The more heterogeneous the membership, the more acute the conflict between the members.

The CCP governance mechanism has to have some way of dealing with these conflicts, and making decisions.  Some decisions are going to be made by voting.  With one-member, one-vote kinds of systems, the median member will drive the outcome.  A CCP with a few big members and a larger number of small members may therefore tend to choose policies that favor the smaller members.  This is not likely to be optimal from a systemic risk perspective, and is also likely to result in larger members doing things to limit their exposure.  This in turn limits the risk sharing benefits that a CCP can offer.

Other kinds of voting rules can mitigate these problems, e.g., rules that are based on size or capitalization in some way, with bigger/better-capitalized members having more votes.  But smaller members are unlikely to be satisfied with merely belonging to a CCP but having to defer to the bigger members on key policy issues.  Hence if they pressure regulators and Congress to craft regulations that require CCPs to admit them, they are also likely to pressure regulators and Congress to craft regulations of CCP voting rules that give them some influence over CCP decisions.

Other decisions will be implemented by CCP management.  But CCP managers will be accountable to the members, and subject to influence by them.  Here again, voting rules will matter.  Moreover, Peltzman-Becker pressure group considerations suggest that managers, like politicians, will adopt policies that balance support among the various constituencies.  Median-voter type considerations again exist.  This means that CCPs with more heterogeneous members are likely to adopt policies that appeal to the median member.

In brief, when trying to determine the riskiness of CCPs, you have to consider how they are governed and managed.  Moreover, you have to recognize that governance and management depend on the composition of the membership.  And in particular, that CCPs with more heterogeneous members will behave differently than CCPs with more homogeneous ones.

One concern that is oft-expressed is that there will be a “race to the bottom,” with CCPs competing on margin and thereby compromising safety and creating systemic risks.  Given the economies of scale and scope in clearing, I doubt that the competition between CCPs will end up being all that intense, although there may be an initially period of intense competition that results in the market tipping to one or two dominant CCPs.

This analysis of CCP governance suggests another concern, and one that I think is more of a real worry.  Namely, that member heterogeneity can lead CCPs to adopt policies that benefit the median member, but which are not optimal from a systemic risk perspective.   Clearing inherently faces a moral hazard problem.  This moral hazard problem can create systemic risk.  Member heterogeneity makes it more difficult to control this moral hazard problem.  Internal pressures from riskier members–who can essentially pass their risks and the associated costs on to less risky ones–can lead CCPs to choose margin and other risk control policies that are not systemically optimal.  Internal pressures to reduce margins, rather than a race to the bottom between competing CCPs, is something to be concerned about.

One other historical note that illuminates another important cost of heterogeneity.  In Banking Panics of the Gilded Age, Elmus Wicker shows that with one notable exception (the Panic of 1873), the New York Clearinghouse was unsuccessful in dealing with financial panics and contagion.   (NYCH was a bank clearinghouse, not a derivatives clearinghouse, but there are important similarities.  Most importantly, NYCH had the ability to mutualize some risks.)  Wicker argues that conflicts between heterogeneous members were the main impediment in dealing with panics.  Although mutualization of risks would have mitigated panic (because the banks collectively were more likely to be solvent than any individual bank), mutualization transferred wealth from the stronger banks to the weaker ones.  The inability to overcome this distributive conflict stymied the ability of the NYCH to respond to crises in an effective way.   Thus, not only can heterogeneity increase the likelihood of a problem at a CCP (due to its effect on the severity of moral hazard problems), it can reduce the effectiveness of a CCP in dealing with a crisis situation.

This means that regulators should be extremely careful when crafting rules for CCP membership and voting policies.  Yes, there are legitimate grounds for concern that CCPs will use membership policies to exercise market power.  But there are also grounds for concern that forcing CCPs to admit more firms will lead to more heterogeneity, and that this can raise governance costs and jeopardize the financial safety of CCPs.  Similarly, regulation of governance and voting procedures to give more power to smaller members can also raise governance costs and jeopardize safety.  Inasmuch as the ostensible purpose of CCPs is to improve the stability of the financial system, it would be perversely ironic if political pressures induced regulators to adopt rules on CCP membership and governance that created systemic risks.  Tread carefully, people.

November 9, 2010

Mama Told Me Not to Come: Diary of the Tattoo Challenged, 8 November, 2010

Filed under: Music,Punk — The Professor @ 3:01 pm

I attended the Social Distortion concert at the Orange Peel in Asheville, NC yesterday–combined a trip to see my folks with a trip to see the mirror image of my folks, Mike Ness (though he is a dad–as I’ll discuss more below).  The thing that struck me while waiting between the openers (Frank Turner) and Social D was that I was the only person in sight without a tattoo (though I did see one girl later without one–what was her problem, anyways?)

The winner of the evening was this nightmare Goth bitch whom I stood next to for most of the show.  Don’t look at me!  I’m just reading the labels!  Really!

Specifically: She had “Nightmare” tattooed across the back of the neck.  (I didn’t know there was a Nightmare Diocese.)  She had “Goth!” tattooed on the fingers and thumb of her right hand, and “Bitch” on the fingers and thumb of the left (conveniently positioned facing outwards for easy reading!)

But there’s more!  She was wearing just a chemise, and her shoulders (and visible) front were fully tattooed.  Pictures.  No words.  Except for the “Nightmare” thing.

I’m not done!  She also had non-tattoo body decorations.  She looked like she had taken a bite out of my grandmother’s pin cushion, but hadn’t spit out 8 or so of the pins.  And I wouldn’t say that her ears were pierced.  I would say they’d been excavated.  She had huge holes in her lobes, which had been stretched to reach nearly to her shoulders.  I hadn’t seen the like since reading National Geographic when I was 10.

I can’t imagine that there was anybody there more elaborately and deliberately defaced than she.  I’m not saying that there wasn’t, just that I couldn’t possibly imagine it.

The show, you ask?  But I was talking about the show.  Oh, the music, you mean.

Two words:

Damned good.  They’d cancelled the two previous shows because, as Ness said at the show, he was “sick as a f*cking dog.”  But he was sick in the good way on Monday.  High energy.  Tight and loud.  He was fantastic on the guitar.  They played about 1:50, with only  5 minute break.  My favorites: “Don’t Bring Me Down” and “Bakersfield.”  Only disappointment: didn’t play “Far Behind.”  One tune from their upcoming CD, which sounded really good.

It was a younger crowd than at the last Social D show I saw in beautiful Sauget, IL, at Pops nestled conveniently between the Hustler and Penthouse Clubs.  And with youth, came energy.  I was closer to the stage (about 4 bodies back), so it was more crazed than even the Murphys back in March.  Constant body slamming, though I was on the receiving end I wasn’t deliberately initiating.  Often hit, never knocked down, though I did knock down one knucklehead that was getting a little carried away.  After he hit me full speed about the fifth time I gave him a two hander which sent him and about 3 other people in the pit sprawling.  Whoops.  A member of the security “Krewe” (that’s what the shirts said) wasn’t too pleased.  He came up and shook his finger in my face, and shouted something.  Yeah, like I could hear you, man.  No problems after that.

Except for the beer shower.  Some girl accidentally doused me with beer, right on the top of my head.  I looked back and she was so apologetic.  She started wiping off the dripping beer with the sleeves of her shirt, and then said: “Let me give you a hug to apologize.”  So she did.

The funniest part of the show (for me, anyways) was right at the very end.  Right before the finale number, “Ring of Fire,” Ness delivered a little patter, saying “this next one’s a love song, so guys lean over and say something loving to your girlfriend, I can’t tell you what to say, but if you say the right thing maybe she’ll drive you home and run all the red lights and you’ll get lucky, but if you don’t she’ll just throw you a bottle of Jergins” (though he pronounced it “jerkins”).  While he was giving this little monologue, some kid, a guy, leans over to me and says: “This dude is like 50 years old.”  I could only look at him, smile and chuckle.   (Ness isn’t 50, BTW.  Only 48.  Although I think he’s turned over the odometer several times more than I have.)

This was Social D’s first time in Asheville.  I was wondering why they’d play there, and about half way through the show I found out.  Ness’s son came out to play guitar on one number.  Ness said his son, 18, lives in Asheville.  I would surmise he goes to Warren Wilson College.  Let’s just say they’d never ask me to teach there.  Ha.  He played very well.

All in all, a blast.  I should also say I really liked the leadoff band, Frank Turner.  It was like Deliverance meets Hell’s Angels meets the Muscle Shoals Horns.  You know a band is good when you’ve never heard them and you can immediately get into the rhythm and beat of every song.  Definitely buying their CD.

I’m psyched and ready to do it again.  Houston, November 19.  House of Blues.  A little too upscale for a band like Social D, but it’ll do.

Only damper on the evening occurred during the drive back to my folk’s house around midnight.  I came upon a motorcyclist who had wiped out, and was lying sprawled in the middle of the road.  I was the first person there, and thought he was dead at first because he wasn’t moving.  I jumped out of the car, and when I reached him I saw that he was breathing, though unconscious.  Somebody else came up and called 911, but it was 5 minutes until the cops and EMT arrived.  During that time the guy regained consciousness and started thrashing around, so I tried to keep him calm and hold him down.  I was worried about him hitting his head again, so I put my hand on the back of his head, only to feel a goose egg literally the size of a real goose egg.  He hadn’t been wearing an helmet, and a good portion of his scalp was also ripped open but still attached, so I got pretty bloody.  He was talking by the time the EMTs arrived, and his eyes looked fairly clear, so I think he’ll be OK.

November 8, 2010

QE2 or Titanic?

Filed under: Uncategorized — The Professor @ 11:15 am

The Federal Reserve has launched a second round of “quantitative easing”–QE2.   How is it that this “easing” leaves me uneasy?

Macro is not my thing.  But economics is economics, and I know enough to have serious questions about quantitative easing.  I may not be able to tailor a magnificent macro suit, but I can pretty much tell when the king is naked, and I think that’s the case here.

Bernanke is arguing that easing is needed because of deflationary concerns.  But has there ever been a deflationary episode during which commodity prices spurted ahead?  Definitely not during the 1930s.  Not in the 1920-1921 crash (which at its outset was more severe than the Great Depression).  Not in 1893.  In all of these episodes, commodity prices crashed.  So if this is deflation, it is a weird deflation.

Bernanke was asked about this specifically at a presentation at Jacksonville University.  His answer was not comforting:

Asked by a student if “skyrocketing” commodities prices may threaten his inflation outlook, Bernanke said rising commodities prices are “the one exception” to a broad reduction in inflationary pressures. Overall, excess slack in the economy will make it difficult for producers to push through higher prices to consumers, he said.

Well, exceptions can be pretty damned informative.  Anomalies are the things that should make you question your analysis.  If there is “excess slack” why is the demand for commodities high?

Relatedly, in what deflationary or near deflationary episode has the country facing the more severe deflation problem seen its currency depreciate, rather than appreciate?  Japan’s skyrocketing yen is consistent with deflationary pressures there.  Commodity prices have risen little, if at all, in yen terms.  But the dollar has cratered.  How is that consistent with a US deflationary episode?  Another anomaly in the deflation story.

Bernanke is known primarily as an expert on the Great Depression.  It is pretty clear that that is the mental model he is relying on when deciding that QE is necessary.  But there is always the possibility that he is the general fighting the last war.  Or that he is the master with the hammer, but the current problem isn’t a nail.  Before plunging ahead with a radical scheme, I’d want to have a better understanding why these anomalies exist, and what they mean.  To me, they suggest that the Depression template is a very bad fit.  But it is driving his thinking.  I am worried when people fix monomaniacly on things that confirm their priors and dismiss those that don’t.  That’s not the recipe for wise decisions.

Bernanke acknowledged in a WaPo oped that the 2008 crash was a global phenomenon, but that the slow recovery is primarily an American (and Japanese) one.  In the Jacksonville talk, he acknowledged that emerging markets are booming.  Parts of Europe, especially Germany, are growing smartly.  Even the UK has bounced back better than the US.  So what makes the US different?  Is this difference something that can be addressed by QE?  

I have my doubts, particularly in an open economy: a lot of the stimulus will spill over to–is spilling over–to emerging markets.  I think that there is a good possibility that America’s economic sluggishness is a reflection of the grim fiscal situation and the spate of regulatory and other government burdens that have been piled on in the last 2 years.  If that’s the case, then QE2 will not correct stagnation, and risks stagflation.

I also have my doubts as to how this is going to work, exactly.  In his WaPo oped, Bernanke touts the interest rate channel.  That’s hardly persuasive.  He also mentions boosting the stock market, and I think that is more accurately reflective of his true strategy.  QE2 is a hair of the dog gambit: asset bubbles got us into this mess, an asset bubble will get us out.  He’s not Helicopter Ben–he’s Bubble Ben.

I could see–barely–this working if QE were to boost housing prices.  This would ease pressure on household balance sheets, drying out underwater mortgages, which could spark an increase in consumption.

But although Ben can open the monetary floodgates, he’s powerless to direct where the flood of money goes.  Right now it’s heading to emerging markets, commodities, and to some degree stocks.  Housing does not seem to be benefitting.  And this could be contbuting to the QE decision loop.  The Fed and Bernanke point to the CPI as evidence that there is little inflation, and that we are on the cusp of deflation.  But CPI has a large housing component (about 25 percent, if memory serves).  This could be giving a misleading picture of true inflationary pressures.

I wonder what the monetary channels are now.  One possibility is that easing leads to asset price inflation first and foremost, and that goods price inflation occurs with a lag.  By the time that monetary pressures show up in the goods price measures that the Fed/Bernanke are monitoring, it may be too late to intervene to prevent a big inflationary spurt, or any such intervention may crater the economy.  The dilemma that I disussed in late-08 to early-09–where the Fed is faced with the grim choice between rampant inflation and a major recession–is still present.

This means that QE is unlikely to do anything to boost the American economy.  At the same time it is already sharply increasing international tensions in a way that poses a real risk of trade, currency, and investment protectionism.

All of this also injects a tremendous amount of uncertainty into the economy.  This uncertainty makes decision making harder–and investment/resource allocation mistakes more likely.  I once quoted Sherwin Rosen’s bracing remark in his Econ 300 class in Chicago in ’82 or ’83: “The problem with inflation is that it f*cks up relative prices.”  Well, even if QE doesn’t spark measured inflation, it almost certainly will–and arguably already is–f*cking up relative prices.  That’s not good.  And just the uncertainty itself is a drag on the economy, as decision makers decide that procrastination is the better part of valor.

You don’t have to go all Austrian to have serious concerns that continued monetary stimuli can distort price signals, leading to perverse resource allocations, and economic problems down the road when these misallocations become manifest. 

In brief: I see a lot of icebergs out there, but Captain Ben has just ordered all ahead full.  I hope there are enough lifeboats.

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