Streetwise Professor

April 22, 2011

Don’t Blink!

Filed under: Derivatives,Economics,Energy,Politics,Regulation — The Professor @ 7:53 pm

I was interviewed for about 10 minutes for a Fox News story on energy prices and Obama’s anti-speculation rant: about 3 seconds made it on air.

April 21, 2011

The Department of Distraction Swings Into Action

Filed under: Commodities,Derivatives,Energy,Politics,Regulation — The Professor @ 3:20 pm

It is becoming clear that Obama’s criticism of speculators was not a one-off. Instead, it is part of a broader campaign to demonize them. Today’s installment of the Two Minutes’ Hate came courtesy of the Justice Department (so tempted to use quotes around that). Eric Holder announced the formation of an Oil and Gas Price Fraud Working Group consisting of Department of Justice, the National Association of Attorneys General, the Commodity Futures Trading Commission, the Federal Trade Commission, the Department of the Treasury, the Federal Reserve Board, the Securities and Exchange Commission, as well as the Departments of Agriculture and Energy.  The Group’s charge is:

In March 2011, President Obama asked the Attorney General to work with federal and state agencies to monitor oil and gas markets for potential wrongdoing.   In response to the President’s call for action, Department of Justice leadership consulted with federal agencies and state attorneys general and discussed pending inquiries in some states, the most effective legal tools and areas that require additional exploration.   As a result of this examination and to further the central mission of the Financial Fraud Enforcement Task Force, the Attorney General formed the Oil and Gas Price Fraud Working Group.

The Oil and Gas Price Fraud Working Group will explore whether there is any evidence of manipulation of oil and gas prices, collusion, fraud, or misrepresentations at the retail or wholesale levels that violates state or federal laws and harms consumers or the federal government as a purchaser of oil and gas.   The Working Group will also evaluate developments in commodities markets and examine investor practices, supply and demand factors and the role of speculators and index traders in oil futures markets.

Here’s the Reuters feed on Obama’s announcement:


Here’s some additional reporting on Obama’s remarks today:

“The attorney general’s putting together a team whose job it will be to root out any cases of fraud or manipulation in the oil markets that might affect gas prices – and that includes the role of traders and speculators,” President Obama said at a town hall meeting in Nevada on Thursday. “We are going to make sure that no one is taking advantage of American consumers for their own short-term gain.”

That same article quotes Northwestern polisci professor Laurel Harbridge, giving the enabling professoriate’s take on this gambit:

Laurel Harbridge says the formation of the investigative group is a way for the president to take control of the situation without taking more extreme steps.

“Doing something that suggests that there’s at least the possibility that gas prices are high because of manipulation or something like that kind of turns the high gas prices into something that he’s combating and he’s against rather than either a problem that can’t be dealt with or something that’s due to domestic policy decisions,” Harbridge said.

In other words, it’s an opportunistic effort to scapegoat others on the basis of zero evidence in order to distract attention from the real issues–but that’s cool!

Here’s a non-enabling professor’s take:

Craig Pirrong, a finance professor at the University of Houston who specializes in commodity prices, says the task force is hardly needed, since the agencies already have the tools to monitor for fraud and take action. [Yeah.  It’s like their day job.]

“This is a transparently political fishing expedition that insinuates that fraud or manipulation is distorting oil prices without providing even the flimsiest factual basis for such a suspicion,” Pirrong said. “This is part of a broad effort by the administration to deflect criticism with regard to gasoline prices.”

Actually, the “fishing expedition” characterization is probably optimistic.  Especially given Obama’s assertion of ownership of the issue, and his personal identification with the claim that speculators are distorting prices, there is a high likelihood that fishing expedition will give way to witch hunt.  Remember when Obama told bankers “[m]y administration is the only thing standing between you and the pitchforks”?   It is becoming increasingly clear that Obama won’t be standing between oil “speculators” and the pitchforks this time.  Indeed, he’s taking leadership of the mob.

What determines commodity prices is a complex issue.  Injecting superheated political rhetoric won’t improve our understanding, and in fact will inevitably have the exact opposite consequence.  This, combined with the implicit threat of legal investigations and perhaps legal action (“nice little market you have here–wouldn’t want anything to happen do it”) will have no positive consequences, and likely many negative ones.

It’s already ugly out there.  But it just got a whole lot uglier.

It would be nice if this witch hunt was as funny as this one:

I wouldn’t speculate on it, though.

April 20, 2011

Say Ho!: Some Real Texas History

Filed under: History,Military — The Professor @ 9:44 pm

Tomorrow, 21 April, is San Jacinto Day, the 175th anniversary of the Texians’ defeat of Santa Ana’s Mexican army at a battlefield near Houston. The Texans were commanded by Sam Houston. They surprised the–literally–napping Mexicans and routed them. The aftermath of the battle was not pretty. Let’s just say that payback (for the Alamo and Goliad) was a bitch.

Sam Houston was a remarkable figure, especially to people with Jacksonian sympathies. Interestingly, Houston attempted to restrain, with little success, the revenge-minded Texans. Listen to Scott Miller sing about him:

No Time For Sergeants

Filed under: Military,Russia — The Professor @ 9:03 pm

A lot of stories today about the Russian military’s chronic–and arguably fatal–software problem.

From the Wall Street Journal, a not surprising (if you’re a regular here) glimpse of the dysfunctional Russian army, and its Potemkin effort to create a “volunteer” army of kontraktniki. Watch the video at the link, especially the part at the end where the advocate for the volunteer force is interviewed.  He argues that Russia’s bane–corruption–has wreaked havoc with the reform effort.  He specifically claims that there are elements in Russia, including senior officers, who profit from the conscription system by taking bribes to facilitate draft avoidance.  The soldier who is the central character in the article itself claims that officers stole 1/3 of contract soldiers’ pay.

Who says that Russians don’t believe in the market system?  After all, everything is for sale.

This piece in Eurasia Daily Monitor argues that the highly touted campaign to create a real NCO corps in Russia is just another exercise in Potemkinism.

And this MT article claims that dedovshchina (barracks hazing) is driven by ethnic divisions.  I have no doubt that there are ethnic problems in the Russian military, but I am skeptical at claims that dedovshchina is predominately an ethnic phenomenon.  It is more likely that commanders are blaming North Caucasians because they are widely reviled in Russia, and hence they are ready scapegoats.  It’s easier to blame them than to address the fundamental rot that pervades the entire establishment.

I say again.  What is the point of spending hundreds of billions of dollars to buy hardware when the software that runs it is dysfunctional?  Other than the corruption possibilities, that is.

Why Medvedev Is President

Filed under: Russia — The Professor @ 8:30 pm

Because he’s short (like Putin).  And because of this:

h/t R.

Update: I think that it’s quite likely that this was released by Putin supporters to make Medvedev look silly and, uhm, unmanly. And the fact that he’s dancing to a song titled “American Boy” can’t go over well with the mouth-breathing set.

A Russian Oil Company With a Heart of Gold

Filed under: Economics,Energy,Politics,Russia — The Professor @ 2:44 pm

I thought I was going to need a new computer monitor after doing a comic spit take upon reading this:

Transneft Says Higher Dividends Would Deprive Orphans, Sick

OAO Transneft, Russia’s monopoly pipeline operator, says paying more dividends would curtail aid to orphans and other charity work.

Transneft made 3.2 billion rubles ($112 million) of charitable contributions in 2009, 7.8 times more than the dividends it paid to private investors, according to the company’s financial reports. That spurred preferred shareholders such as Prosperity Capital Management Ltd. and East Capital to demand more information as they seek a larger slice of profit.

Higher dividends would reduce money destined for “the sick, supporting sport, renovating churches and monasteries,” Moscow-based Transneft said in a document dated March 16 and filed as part of the company’s appeal against a ruling requiring it to release board minutes.

Given that Transneft is one of the most corrupt companies in the galaxy, I’m guessing that the widows, orphans, and monks who are getting the cash not going to shareholders have numbered Swiss accounts, and are driven to and from vulgarly luxurious dachas in gated communities in black Mercedes with flashing blue lights, chauffeured by neckless men in black turtlenecks.

I do have to give them credit for chutzpah, though.  The thought of Transneft’s management’s tender spot for widows and churches brings to mind Nathan Detroit and his gang visiting the Save-a-Soul Mission in Guys and Dolls.

In other Russian oil transportation news, Transneft has announced that it plans to sue the Chinese oil company CNPC for underpayment on oil shipments made over the new Russia-China pipeline.  Back in 2009, at the depths of the financial crisis when Russia and China negotiated the financing for the pipeline and prices on terms that were very favorable to China, I predicted that there would be contractual disputes when prices turned around.  Could this be the first inkling of the accuracy of that forecast?  The reporting is currently too thin to tell.

That’s not surprising since Transneft, hardly a paragon of transparency (indeed, it’s the poster child for opacity), is the only source of information.  This bears some watching going forward.

Yellow Dog Republicans? Always? Who knew!

Filed under: History,Politics — The Professor @ 12:09 pm

Professor Obama’s exegesis of the political history of Texas:

“Texas has always been a pretty Republican state, for historic reasons.”

Always?  I know some people think the universe began about 4000 years ago, but to say that Texas has “always” been “pretty Republican,” you’d have to believe the universe began in the 1970s, at the latest, and more accurately the 1980s: Phil Gramm’s change of party after Reagan’s election is probably the true watershed of the shift in Texas’s party allegiance.  Bill Clement was the first Republican governor elected in the state since Reconstruction–and that was in 1979.

Indeed, from its statehood in 1845 until very, very recently Texas was overwhelmingly Democrat.  Nowadays the phrase “blue dog Democrat” is current, but in Texas until very recently the saying was “yellow dog Democrat”–that is, Texans would vote for a yellow dog, as long as it was a Democrat.

The phrase “for historical reasons” also lingers in the air.  I wonder just what he believes those historical reasons are.  My guess: that phrase is code for “Texans are irredeemable racists.”

It’s worth watching the video of the interview.  Obama’s petulance is on full display at the end–actually after the interview is over, when he is clearly and extremely p*ssed at the temerity of the reporter to call bullsh*t on his answers.

Remind me.  During 2008, weren’t we told repeatedly that Obama had a wonderful, presidential temperament?  Oh that, and really, really smart and informed.  Just when will he deign to show them off?

Don’t Blame Me! Blame Those Damned Speculators!

Filed under: Commodities,Economics,Energy,Politics — The Professor @ 11:51 am

Obama has inserted himself into the oil speculation debate, adding his voice to the baying mob demanding that the usual suspects be rounded up for causing excessively high oil prices:

President Barack Obama on Tuesday blamed speculators for driving gasoline prices higher and straining American consumers, saying there was enough oil in world markets to meet demand.

. . . .

Obama said that global oil supply is adequate and that speculators are driving up prices significantly.

“It is true that a lot of what’s driving oil prices up right now is not the lack of supply. There’s enough supply. There’s enough oil out there for world demand,” Obama said.

“The problem is … speculators and people make various bets, and they say, you know what, we think that maybe there’s a 20 percent chance that something might happen in the Middle East that might disrupt oil supply, so we’re going to bet that oil is going to go up real high. And that spikes up prices significantly.”

Glad that The All Knowing All Seeing Obama is able to assure us that “There’s enough oil out there for world demand.”  Was that before Libya, after, or both?

But let’s consider that last paragraph, about “speculators and people mak[ing] various bets.”  (Are speculators not people?  Or are some people who bet not speculators?  I’m confused.  Not least by the fact that we’ve been told repeatedly that Obama is so0000 articulate.  Or at least his teleprompter is.)

I say: don’t damn these people, but thank the Lord for them.  They are looking  to the future, and evaluating factors that could impact supply and demand in the future.  They are collecting and evaluating information to attempt to determine the likelihood that oil (and other commodities) will become more or less scarce.  This is essential because expectations about the future are crucial for our decision making today: how much oil to store, how many wells to drill, what kind of cars and machinery to build and buy.  You can’t do things right today unless you evaluate future risks carefully.

Yes, sometimes speculators arrive at pessimistic conclusions that cause prices to go up today.  But here’s the thing: without this “speculative” price impact, there will be no adjustments today to the risk of potential future shocks, meaning that the impact of these shocks will be even more severe in the future.

For instance, a rational response to a real risk of a future supply disruption in the Middle East–and does any sentient being believe that the risk of such a disruption has not increased?–is to store (and produce) more oil today.  That increased storage does tend to drive up current prices.

But let’s say that there is no informed speculation, and as a result no additional oil is stored or produced.  If a supply disruption indeed occurs, that oil that isn’t stored isn’t available to cushion the price impact the disruption causes, meaning that prices will spike more without the speculation than with it.  This speculation has made the present a little less pleasant, but only in order to reduce the likelihood of much greater unpleasantness in the future.

Indeed, if there is a criticism to be made of speculation, it is that too much information is collected and prices are too accurate.  Individuals collect information to earn a profit at the expense of the uninformed.  The expenditure of real resources to obtain a transfer is welfare reducing, all else equal.

Even if you buy that critique, though, you can’t criticize speculation on the grounds that Obama chooses.  By collecting information related to future supply and demand conditions, speculators acting as Obama describes ensure the more efficient allocation of resources over time.  Sometimes that indeed causes prices to be higher today–but that’s not a bad thing because it reduces the likelihood of even greater price spikes in the future.

Obama’s resort to populist anti-speculative boob bait is a piece with what we’ve seen in the last days.  I thought Obama and his people had figured out that he was overexposed and had limited his appearances.  But then he gave two speeches–one on Libya, the other on the budget–that went over like lead balloons.  Obviously acting presidential didn’t work, so Obama went back to the one thing he thinks he can do: campaign.

So in April of 2011, we’re seeing appearances and rhetoric that you’d expect to see in October, 2012.  Indeed, apparently the Ryan plan has stung him deeply, and he is responding in full Alinskyite “Pick the Target, Freeze It, Personalize It, and Polarize It” mode.  The level of mendacity is astounding, and in a perverse way, Ryan should be flattered.

How long did that era of new civility last?  Just asking.

This is distressing and revealing.  It is distressing because the nation faces a truly existential fiscal crisis.  It is revealing because it is now painfully obvious that the only thing Obama knows how to do is to fall back on political demagoguery and dishonest personal attacks, delivered in campaign settings long, long before the campaign should begin.

The fact that Obama has joined the anti-speculation know nothings reveals that he’s not the least bit interested in doing anything serious about energy either.  It’s so much easier to blame speculators who are actually providing the signal service of (a) ensuring that market prices reflect information about future supply and demand, and (b) thereby encouraging immediate responses in consumption, production, and storage that will mitigate the adverse impact of those future supply and demand risks.  That’s because it’s so much easier to shoot the messenger than to do something constructive about the message.

April 19, 2011

Armageddon Time

Filed under: Clearing,Derivatives,Economics,Financial crisis,Politics,Regulation — The Professor @ 6:50 pm

I haven’t written much about clearing lately, and I just know some people are going through withdrawal as a result, so a quick post to feed your jones.

The ISDA Annual General Meeting was in Prague last week.  Clearing was on everybody’s mind.  There were numerous discussions that echoed things I’ve said on SWP and in my academic writing over the past 2.5 years or so.

One example: the head of UniCredit Group’s commercial and investment banking expressed concerns that CCPs will be  undercapitalized.  He compared them to, yes, monoline insurers:

Mustier said the “thin capitalisation” of CCPs – which will end up clearing hundreds of trillions of dollars notional in standardised derivatives – could be compared with monoline insurance companies that underwrite securitisations. Before the crisis, individuals who questioned the ability of monoline insurance companies to underwrite large amounts of securitisations using little capital were told small levels of capital were appropriate because the underlying deals had high credit ratings and the risks had been modelled, said Mustier – although he emphasised CCPs have other lines of defence, which makes the monoline comparison an unfair one.

“I don’t want to make a comparison between clearing houses and other very leveraged financial institutions of the past such as monoline insurance, for instance, where we had roughly the same ratios, because in clearing houses we have something that is fundamentally different, which is the initial deposits that financial participants provide when they open up a trade, and the margin calls, which should mitigate the risks of clearing the position,” said Mustier. “But, nevertheless, clearing houses are very thinly capitalised even if their structure should protect them.”

On the one hand I agree with Mr. Mustier–there is a danger CCPs will be undercapitalized. On the other hand, I think the comparison with monolines is a very fair one. Indeed, this is the gravamen of my post on wrong way risk in CCPs. As Jon Gregory has pointed out, monoline insurers were subject to wrong way risk because they were insuring very senior claims. They insured AAA tranches, and the junior tranches provided a cushion that made it very unlikely that the monolines would have to pay off. Armageddon had to happen for the monolines to pay off on what they insured. But Armageddon did happen, they had to pay off, and they had far too little capital to deal with it.

The initial margins that Mustier refers too, along with the default fund contribution of a defaulting CCP member, are exactly like the junior tranches of the securities that monolines insured.  Those funds will get blown through only in Armageddon, and it is quite possible that in such a situation, CCP capital will prove inadequate.  And even if it is sufficient, under those circumstances the member firms–primarily banks–are going to absorb huge hits.  Which kind of defeats the whole purpose of CCPs–to insulate big financial institutions from risk during crises.  Actually, there’s no “kind of” about it.

The dangers of fragmentation of CCPs resulting from the desire of each major jurisdiction to have its own clearinghouses was another theme of the AGM:

“We must not fragment the clearing house and exchange environment. A fragmented approach will lead to weaker institutions, and greater risk.”

But while Rohner urged closer co-ordination of regulatory reform, he warned it is not a sure thing: “Governments may be unable or unwilling to achieve the necessary level of co-operation, which could lead policymakers to resort to ring-fencing or other limitations on structures or geographic reach to protect the home market or taxpayer. This could fragment the OTC derivatives market.”

And yet another SWP theme is that low entry requirements for CCP membership are extremely problematic.  Cue Athanassios Diplas of Deutsche Bank and Tom Benison of JPM:

Regulators are pushing for CCPs to lower their barriers to entry, letting weaker firms into clearing’s inner circle – but these firms could be overwhelmed in a crisis, the larger banks argued.

“Let’s say you’re a clearing member with $75 million in capital, and your cost of entry to a CCP is $25 million for the guarantee fund – and you join two CCPs. But those CCPs also have the right to call on you for an additional $25 million if they run out of money,” said Athanassios Diplas, global head of counterparty portfolio management at Deutsche Bank, at a press briefing. “They can’t both get it, they don’t know about each other – and the assessment will come at the worst point in time – the day after the Lehman Brothers collapse, for example.”

Tom Benison, managing director for credit trading at JP Morgan, echoed the point. “If one CCP has to make a call for more funds, it’s likely to mean we’re really far out in the tail when it happens – which means every CCP is really far out in the tail. So how many CCPs are calling for funds?”

Benison’s point is a variation on the wrong-way risk point I’ve made before: CCPs are going to call on member capital during extreme circumstances–the Armageddon scenarios.  That’s precisely when those entities may themselves be facing dire circumstances, meaning that the capital might well not be there  when you need it.

Now, you may just write me off as a running dog of the big banks.  All I can say is that I’ve been making these arguments in my spare time for a long time–in some cases, before the crisis and before clearing mandates were even thought of and before anybody was really thinking about clearing period. And regardless, if the argument is faulty–have at it.

In my view, the concerns expressed at the ISDA AGM are real ones.  Ones that didn’t even enter the heads of  the Sorcerer’s Apprentices who conjured clearing mandates to life.  But they are ones that market participants and regulators are going to have to deal with going forward.  And the very scary thing is that we’ll only find out in the next financial Armageddon time whether they’ve got it right.  Which, given the very unsettled situation around the world, could happen sooner than we’d like.

For some reason, the Clash come to mind:

PS. Hopefully quite soon a more authoritative and complete discussion of these issues that I’ve just completed (the draft, anyways) will be released. As they say: Watch this space!

April 17, 2011

Gates and the Ghost of Christmas Future

Filed under: History,Military,Politics — The Professor @ 7:41 pm

Robert Gates’s public criticism of Obama’s budget speech was the most under-reported story about the battle over the nation’s fiscal future.  Gates had already gone off the reservation about Libya and other matters, but this takes it to a whole new level:

The United States would have to abandon some military missions and trim troop levels if President Barack Obama presses ahead with new proposed defense cuts, the Pentagon said on Wednesday.

. . . .

Minutes after Obama announced his austerity plan, the Pentagon renewed those concerns even as Gates endorsed Obama’s commitment to a thorough review before making any cuts.

Obama has pledged that his budget reductions will not compromise national security.

Pentagon Press Secretary Geoff Morrell said Gates “has been clear that further significant defense cuts cannot be accomplished without reducing force structure and military capability.”

The Pentagon said Gates was not informed of Obama’s decision on budget cuts until Tuesday. Morrell said the issue would not affect the timing of Gates’ expected retirement. [Emphasis added.]

. . . .

“The secretary believes that this process must be about managing risk associated with future threats and national security challenges and identifying missions that the country is willing to have the military forgo,” Morrell said.

Here’s one interpretation of Gates’s startling remarks:

Jamie Fly of the Foreign Policy Initiative suggests a different approach. He told me last night, “Secretary Gates fended off previous White House attempts to raid the Pentagon’s coffers but he seems to have lost the latest battle in a big way. If he really believes, as his previous statements indicate, that the type of cuts outlined by the President today will put our national security at risk, he should resign rather than continue to serve in an administration that is increasingly unserious about national security.”

Jennifer Rubin repeats her argument that Gates needs to resign.  But I don’t think that she–and any of the too few others that have written about this issue–have thought through the meaning of Gates’s public dissent, and hence have not fully grasped its gravity.  When someone who is more apparatchik than prima donna acts in this way, it is extraordinary.  It suggests something very serious behind the scenes.

I believe that had any member of other administrations, notably Bush’s but even Clinton’s, had been so outspoken in his or her criticism of the president and his policies on so many dimensions (Afghanistan, Libya, defense budget cuts) the press would be all over it.  Interesting, isn’t it, that the press is largely averting its eyes in this instance?

One brief comment on Libya, which is transitioning from farce to whatever is beyond farce.  France and Britain are running out of precision guided munitions.  No doubt this is in large part Sarkozy and Cameron doing their best Tom Sawyer imitations, trying to get Obama to finish the job they started.  But given the way the UK in particular has gutted its defense (or “defence”) establishment in recent years, it’s likely the case that non-US NATO nations do not have the capacity to do anything serious for any period of time, even against a 5th rate military power like Libya.  Which gives the lie to the “handing off the mission to NATO” line.  (Anyone who bought that one in the first place: please contact me.  I have some excellent deals for you!) In the meantime, Khaddafy is apparently sufficiently emboldened to make public rounds, making plain the incoherent and pathetic nature of the campaign against him.

Keep all that in mind when you evaluate Gates’s rebellion.  I’ve said before that Britain is like our Ghost of Christmas Future; it has gone far further down the path that the progressive left in the US would like to go, and we can see the results and profit from them–if we are as sensible as Scrooge.

In particular, Britain’s impotence in Libya is a great illustration of what happens when you cannibalize the military.  That’s what Gates is worried about, and warning about.  If he believed that he had a chance of getting a fair hearing within the administration on the issue, I’m sure he’d play Mr. Inside.  His determination to go rogue, to play Mr. Outside, is an indication that he believes he has no such chance.  Which means, most likely, that competing visions of American priorities, strategies, and the means needed to achieve them will be yet another issue in what is shaping up to be the most divisive–and consequential–presidential election in recent history.

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