Streetwise Professor

Today it was the WSJ’s turn to run a long piece on the BP-Rosneft-AAR fiasco.  There’s nothing really new here.  But it is interesting to see the Russian spin–spin that makes more plausible the interpretation that BP was played all along..  A few samples:

The Rosneft deal was negotiated personally by Igor Sechin, a key ally of Mr. Putin and chairman of Rosneft, and publicly blessed by Mr. Putin. But when the tycoons complained about the new venture, the Kremlin didn’t shut them down. People close to AAR say they checked every major move against BP with President Dmitry Medvedev and Mr. Putin.

. . . .

A Kremlin spokesman declined to comment, saying the matter was one for the prime minister’s office. Dmitry Peskov, Mr. Putin’s spokesman, confirmed the prime minister discussed AAR’s plans to challenge the deal with Mr. Fridman in late January. “The government has neither the right nor the intention to intervene,” he said.

. . . .

Mr. Sechin had also warned BP’s Russian partners that an agreement was in the works. When Mr. Dudley met Mr. Fridman that evening, the Russian tycoon already knew of the planned meeting with Mr. Putin.

. . . .

Mr. Putin received the BP and Rosneft executives the next day at his official residence outside Moscow. Amid congratulations, he made his warning about the limits of Kremlin control. Mr. Putin’s spokesman said the comment was meant as a general one, not specific to BP’s partners.

So, Sechin is keeping AAR informed of his big deal.  Putin then, and his spokesman now, signal that their hands are tied.

Yeah, right.  The fact is that Putin has myriad levers to pull–if he wants to.  That’s what BP was counting on.  He is deciding, deliberately, purposefully, not to pull them.  It’s not a question of “can’t”: it’s a question of “won’t.”  Why won’t he?  A newfound fondness for contractual rights?  No, seriously.

Don’t buy the story that Putin’s hands are tied.  People should really be trying to figure out why he’s trying so hard to convince the world that’s so.  That’s the real story.  The real mystery.

Meanwhile, the clock is ticking on BP to salvage the deal.  Here, “salvage” means: “pay their reservation price, leaving all the benefit in Russian hands, and crumbs–at best–in its shareholders’ hands.”

BP has until Wednesday to make a deal with AAR.  This reminds me of a story about a former colleague, now passed, sadly.  He’d totaled a car in an accident, and needed to buy a new one stat to take his family on a long planned vacation.  So he walks into the dealer and says: this is the car I want, and I need it by noon today.

Needless to say, he paid sticker.

BP’s Dudley could only wish he’s bargaining with a car salesman.  The whole world knows his bargaining position–or lack thereof.  The only plausible cover he has in dealing with AAR is to claim he can’t take too bad a deal or his shareholders will revolt.  But he and the board are so invested in the Rosneft deal that the credibility of that representation is pretty thin.  So Fridman et al have nearly carte blanche to name their own price. Somehow I don’t think they’ll need William Shatner to provide instructions.

The Journal article reports one BP insider’s take on the situation: “We’re kind of in a predicament.”

You don’t say.  Wow.  I wonder how much that guy gets paid to come up with such blinding insights.

CFTC Commissioner Bart Chilton has been touting research that he claims supports his view that speculation has distorted prices, thereby necessitating position limits.   I’ve read each one.  My conclusion: if this is the best he can come up with, the case for position limits is weaker than I thought.  And that’s saying something.

The citations fall into a couple of categories: superficial quasi-academic studies, and quotations from various figures, including some well-known economists, who have done absolutely no serious research on the subject.

Here are my quick takes on each one.

Since Chilton has had three years to trawl the earth to find work that would support his idee fixe, it is rather amazing that this is the best he can come up with. It’s rather sad, actually, that he believes that he is looking at the problem in a “more sophisticated way.” Although Chilton says that based on his literature review, “[i]t’s simply not the case that ‘there is no evidence that financial investors affect commodity prices,'” that’s not true. What I wrote in Regulation last summer, and what I’ve repeated numerous times on this blog remains true. As yet there is no serious theory, and certainly no serious evidence that speculators have distorted commodity prices.

The NYT business section ran a fairly long article on the BP-Rosneft fiasco.  As a.russian noted in a comment to my earlier post on the subject, the Times piece supports my argument that BP was counting on Russian lawlessness to overcome the black-and-white of its agreement with its AAR Russian partners:

This time, it had appeared that Mr. Dudley and BP might have protection from higher-ups. Rosneft’s chairman, Igor I. Sechin, is also a powerful deputy prime minister.

A senior BP official with knowledge of the company’s work in Russia said BP lawyers had understood that the agreement with Rosneft was “on the edge” of violating the TNK-BP shareholder agreement. But the deal also appeared to coincide so strongly with Russia’s national interest that the company assumed the Kremlin would discourage the Russian shareholders in TNK-BP from making trouble. [Translation: “discourage”=”Threaten with adjoining cells in Chita.”]  The BP official spoke on the condition of anonymity because he was not authorized to talk on the record.

The article contains this howler:

Mr. Putin, too, now seems to be distancing himself from the BP-Rosneft deal. In March, he told Russian journalists at a news conference that Mr. Dudley had not warned him of the possible legal challenge from the Russian oligarchs.

“I was completely in the dark,” he said, according to the newspaper Vedemosti. “When I met with BP’s director he didn’t say a word about this,” Mr. Putin said, referring to Mr. Dudley.

I am sure that Mr. Dudley also didn’t say a word about the sun rising in the east, the color of the sky, or Joe Biden’s hair plugs: one needn’t waste time by belaboring the universally known.  The shareholder’s agreement wasn’t a secret.  And even if it had been a secret from the wider world, do you think for a moment that Putin, ex-spook and head of a government lousy with current and ex-spooks wouldn’t have known about an important fact in the most important industry in Russia?  In the dark?  As if.

I still think there is a substantial likelihood that BP was played from the beginning, that Sechin/Putin and the AAR oligarchs have been tag-teaming.  But even if that’s not the case, it is impossible to know what the true story is, and what its implications are.

The BP-Rosneft deal also inspired (if that’s the word) the most ludicrous thing I’ve read in a long time (h/t R):

Russia Investors Should Study Kremlinology

Kremlinology was once the speciality of spies and diplomats: These days, foreign investors and companies need a degree in it too. Oil major BP had expected Russian political influence would secure its $16 billion share swap deal with state-owned Rosneft. Instead, its oligarch-backed opponent, Alfa Access Renova, has successfully blocked the plans: Arbitrators confirmed an injunction on the deal on Friday. But could bad news for BP encourage others investing in Russia?

Kremlinology was almost always a farcical failure at its heyday.  And BP’s current predicament is attributable precisely to its attempts to practice Kremlinology.  It was too clever by half in its belief that it could unwrap the riddle inside the mystery inside the enigma, and that it could play power politics in Russia.  It completely outsmarted itself.  If you believe you really know what’s going on there–then you’re the mark.  That’s all the Kremlinology you need to know.

The WSJ article argues gamely:

Both AAR’s legal victory, and the move against ministers’ corporate influence, fit a theme reformers want to promote: that Russia’s investment climate is improving.

It is still far too early to draw any conclusions about the outcome of the AAR-BP-Rosneft affair.  And the broader implications of that affair are even more uncertain.  Even if this does represent a case in which the Russian state respected investor rights even though it would have preferred to do otherwise, who is to say that this is a precedent, rather than a one-off?  Perhaps the internal politics cut one way this time: who is to say they will cut the same way next time?  If Putin is backing off now because he needs the money (which the WSJ suggests), how will he behave when his needs are less pressing?  The whole thing about Russia is that there are no–zero, zip, nada–ways of making and keeping credible commitments.  Everything is driven by the particulars of the parties and the moment.  That’s what you need to know about Russia: anyone who thinks that he can use Kremlinology to understand even approximately those particulars, and how they are likely to shift, is in for a rude surprise.  As an alternative, I’d suggest reading entrails.  It’s far more reliable.

The “move against ministers’ corporate influence” is even more difficult to interpret.  Yes, on its face, it is encouraging.  But relying on superficial readings is very dangerous when it comes to Russian politics.  Is it a desperate gambit on Medvedev’s part?   What are its odds of succeeding?  Is this just part of a mechanism to redistribute the goodies?  To cut down to size some people who have gotten too big for their britches and pose a threat to Putin–at least from his paranoid perspective (paranoia being a highly valuable trait among autocrats)?  (Firing everybody to get rid of one somebody is not unknown, even in the US: cf. the Clinton DOJ’s firing of all US attorneys to get rid of a particularly meddlesome on in Arkansas.)  The opening salvo in a power struggle?  (In which case, run, don’t walk, to the nearest exit.)  Even if it is legit, how likely is it to succeed?  Will it really transform in a fundamental way the political and business system in Russia?

Fools rush in where angels fear to tread.  Rushing into Russia on the basis of a few ambiguous developments which could possibly, maybe, be interpreted as the harbingers of a new investment environment would be quite foolish indeed.

Russia is oh-so-reasonable.  In negotiating over missile defense with the US, it insists on only one thing.  Just one!  One little thing!  They are sooooo reasonable.  After all, who could possibly object to this?:

“We insist on only one thing,” [Sergey Ivanov, Russia’s deputy prime minister] said of the nascent US-backed missile defence shield. “That we are an equal part of it.”

“In practical terms, that means that our office will sit for example in Brussels and agree on a red-button push to launch an interceptor missile, regardless of whether the missile is launched from Poland, Russia or the UK.”

Here are some suggested answers:

1. Uhm, sorry–no.
2. Hell no.
3. What the bleep are you thinking?  What the bleep are you snorting?  Bleep no.
4. Sure.  When the sun becomes a red giant and swallows the earth.

I’d vote for #3 or #4 but will be grateful if we get #1 with the current lot in charge.  After all, why do you think the Russians made the demand, unless they thought there was a reasonable shot at having it accepted?

When Deputy Economy Minister Andrei Klepach gave a speech in which he lamented Russia’s ability to compete against imported Chinese electrical equipment due to its hands being tied by commitments made to facilitate admission to the World Trade Organization, Putin blew a gasket:

Mr. Putin then burst out, using sharp language, that Russian officials should ignore the rules. “This is a direct order,” Mr. Putin said, according to a report on the meeting in St. Petersburg by the Interfax news agency.

“As soon as we start fulfilling W.T.O. obligations without being a member, they, our partners, will lose any wish to admit us,” Mr. Putin said. “Why the hell should they admit us if we already observe everything?”

The fact is that Putin is a protectionist at heart.  His constituency is the large industrial interests–with whom his personal financial interests are almost certainly aligned.  A passive, disengaged, diffuse population of consumers who bear the burden of these policies, and who are almost certainly unaware of the impact of protectionism on their living standards is a far less pressing concern for Putin.  What’s more, as I’ve written frequently, protectionism is one of Putin’s important tools in maintaining the equilibrium in the Russian natural state.  Which suggests that Russian accession to the WTO will likely resemble the horizon to a sailor far from shore: no matter how much speed he makes, it never gets closer.

Today is the 146th anniversary of Lee’s surrender at Appomattox Court House.  Which reminds me that the Civil War Sesquicentennial is about to commence in earnest.  This coming week, April 12-13, marks the 150th anniversary of the bombardment of Fort Sumter, which was the start of the shooting war.

I don’t remember the Centennial, but have read some about it.  That was truly a national event, with many official commemorations.  The Sesquicentennial appears certain to be much more low key.  Moreover, the Centennial was more politically fraught, because it occurred at the height of the Civil Rights movement, during a period in which the real political consequences of the Civil War were still unresolved.  As a result, there was a rather unreal atmosphere surrounding the Centennial.   There’s a very funny Fawlty Towers bit where Basil constantly reminds his hotel employees not to talk about WWII in front of some German guests.  In contrast, during the Centennial, there was a concerted effort to do nothing but talk about the war qua war, and to remain silent about its politics and social dimension because those were still live, painful, and controversial issues.

IMO things have swung too far the other way in museums, especially National Park Service museums, related to the Civil War, where a tedious and pedantic political correctness aimed at influencing current attitudes hangs over virtually every exhibit.   I hope–probably in vain–that the Sesquicentennial will be marked by a more objective, and less politicized, discussion of this seminal period in American history.

For those who thought my judgment regarding Arab military culture and performance was unduly harsh, or those who are interested in a more detailed take, I recommend this article from 1999 in the Middle East Quarterly.  There’s a bonus Russian/Soviet connection in the conclusions section:

When they had an influence on certain Arab military establishments, the Soviets reinforced their clients’ cultural traits far more than, in more recent years, Americans were able to. Like the Arabs’, the Soviets’ military culture was driven by political fears bordering on paranoia. The steps taken to control the sources (real or imagined) of these fears, such as a rigidly centralized command structure, were readily understood by Arab political and military elites. The Arabs, too, felt an affinity for the Soviet officer class’s contempt for ordinary soldiers and the Soviet military hierarchy’s distrust of a well-developed, well-appreciated, well-rewarded NCO corps.

Arab political culture is based on a high degree of social stratification, very much like that of the defunct Soviet Union and very much unlike the upwardly mobile, meritocratic, democratic United States. Arab officers do not see any value in sharing information among themselves, let alone with their men. In this they follow the example of their political leaders, who not only withhold information from their own allies, but routinely deceive them. Training in Arab armies reflects this: rather than prepare as much as possible for the multitude of improvised responsibilities that are thrown up in the chaos of battle, Arab soldiers, and their officers, are bound in the narrow functions assigned them by their hierarchy. That this renders them less effective on the battlefield, let alone places their lives at greater risk, is scarcely of concern, whereas, of course, these two issues are dominant in the American military culture, and are reflected in American military training.

Change is unlikely to come until it occurs in the larger Arab political culture, although the experience of other societies (including our own) suggests that the military can have a democratizing influence on the larger political culture, as officers bring the lessons of their training first into their professional environment, then into the larger society. It obviously makes a big difference, however, when the surrounding political culture is not only avowedly democratic (as are many Middle Eastern states), but functionally so. Until Arab politics begin to change at fundamental levels, Arab armies, whatever the courage or proficiency of individual officers and men, are unlikely to acquire the range of qualities which modern fighting forces require for success on the battlefield. For these qualities depend on inculcating respect, trust, and openness among the members of the armed forces at all levels, and this is the marching music of modern warfare that Arab armies, no matter how much they emulate the corresponding steps, do not want to hear.

Although a dozen years old, this appraisal of Soviet military-political habits resonates given the ongoing travails over reforming the Russian military.  These efforts are bordering on crisis, with the Chief of the Russian General Staff, Nikolai Makarov making a stinging attack on Russian military education and research, and on the President of the Academy of Military Sciences, Makhmut Gareev.  Compare, for instance, the foregoing statement about the gulf between officers and soldiers in the Soviet military with this anecdote:

In Russia’s traditional peasant army soldiers and sergeants were considered the scum of the earth and only the promotion to officer level brought privileges and the rank of a human being. In the early 1990’s together with a high-ranking Russian military delegation in Germany, I listened to a top German general’s banquet address that began with: “We as soldiers….” As the translation continued, an angry Russian lieutenant-general whispered in my ear: “Why is he insulting us? We are not soldiers – we are generals.”

The linked article provides more details about the ongoing implosion in Russian military manpower and the tragi-comic flailing attempts to address it.  I say again: what sense is there spending on the order of $700 billion in new weapons if there aren’t enough trained men to use them?  Other than being a way to line the pockets of those who command such a Potemkin force, and those who receive the contracts to do so, it makes no sense at all.

Update: Lest there be any confusion, I definitely do not believe that Arabs and Russians are all that similar in terms of their martial attributes.  The paranoia and the obsession with hierarchy are among the few commonalities.  For instance, Russian soldiers through history have been anything but runners.  Indeed, they’re notable for their mulish willingness to hold a futile position and die in their thousands, as at Borodino, or innumerable combats in WWII.

It is now widely–and officially–acknowledged that there is a stalemate on the battlefield in Libya.  Who could have possibly predicted such a thing?  That was a completely rhetorical question.

So we are now apparently contemplating committing ground troops to Libya as part of a NATO force to help the rebels in their battle to oust Khaddafy.  According to General Ham of Africom, this isn’t ideal.  Not because the rebels are completely inept.  Not because the US has no real vital interests there.  But because the optics wouldn’t be good.  Seriously.

How inept are the rebels?  Former Marine C. J. Chivers describes them thus:

But by almost all measures by which a military might be assessed, they are a hapless bunch. They have almost no communication equipment. There is no visible officer or noncommissioned officer corps. Their weapons are a mishmash of hastily acquired arms, which few of them know how to use.

With only weeks of fighting experience, they lack an understanding of the fundamentals of offensive and defensive combat, or how to organize fire support. They fire recklessly and sometimes accidentally. Most of them have yet to learn how to hold seized ground, or to protect themselves from their battlefield’s persistent rocket and mortar fire, which might be done by simply digging in.

Prone to panic, they often answer to little more than their mood, which changes in a flash. When their morale spikes upward, their attacks tend to be painfully and bloodily frontal — little more than racing columns down the highway, through a gantlet of the Qaddafi forces’ rocket and mortar fire, face forward into the loyalists’ machine guns.

Actually, anyone with a passing familiarity of military history would have known this already.  John Keegan’s book A History of Warfare discusses different military cultures.  He notes that the Arabs have been raiders since time immemorial; running has always been an integral part of their way of war, standing and fighting not.  “Flash changes in mood” are characteristic.  In WWI, Lawrence quickly realized that it was hopeless to try to make regular soldiers of the Arab tribesmen: their genius was for guerrilla warfare, for hit and run.  Someone who has read Seven Pillars would recognize Chivers’ description immediately; I wonder if he patterned it on Lawrence.  Even Faisal understood the limitations of his tribal warriors in a conventional fight.  Every Arab army in the world, with the possible exception of parts of the Jordanian which was well-trained by Britain in the 1940s and 1950s, is notorious for lax discipline, poor maintenance, a vast gulf between officers and men, and corruption.

To put it as provocatively as possible, recall Moshe Dyan’s response when he was asked what was the secret for his military success: “Fighting Arabs.”  When it comes to conventional war, that’s a tendentious appraisal–but an accurate one.

More recently, we have been working assiduously to train Iraqi troops for eight years.  The progress is slow and uneven.   Very slow.  Very uneven.  Old cultural habits die hard.

So we are supposed to go in and try to train an Arab tribal rabble while it is under assault?  And expect it to achieve anything?  Granted, they will be–are–fighting an army that is atrocious even by the standards of Arab nations, but their prospects for doing anything but perpetuating a stalemate are virtually nil.  Even if the focus is on making them effective irregulars in line with cultural tradition a la Lawrence, the result would not be decisive: such a force at best prevails by wearing down its opponent over a long period.  Not an option for us here.

Using US and NATO forces to support the rebels would be doomed to failure.  Then what?  What is the next escalation, the next we’ll-try-this-and-hope-it-works?  What will win out, Obama’s pacifism or his ego?

Remember how Obama said that “empathy” was one of his primary criteria for selecting a Supreme Court justice?

Here’s Mr. Empathy in action:

Maybe empathy is only required of wise Latinas.

Will he get off the eight miles a gallon thing already? Sheesh. That’s poised to become the New Slurpee Line that he beats to death.  If he keeps it up, he’s going to have to pay Scott Miller royalties.

According to EPA numbers, the only automobile that operates at 8 MPG even in the city is a Bugatti Veyron, which sells for $1.7 million.  So I don’t think that’s what Obama is talking about.  The next worst mileage is for Aston Martins, Bentleys, and Rolls-Royces–at 11 MPG city.  Again, I don’t think that’s what Obama’s talking about.

He mentioned SUVs.  The lowest mileage–city–are for Chevy Suburbans, at 10 MPG.  They get 15 highway, almost twice 8 MPG.

So maybe he means old clunkers.  But even very few old clunkers get 8 MPG.  In high school I had a ’66 Buick Wildcat with a 425 cubic inch V8.  When you floored it, two things happened:  you were thrown back into your seat by the acceleration, and you could see the needle on the gas gauge decline noticeably.  And it got more than 8 MPG.

And if he did mean old clunkers, what could you get if you traded it in?  If you’re driving something like that, it’s not out of choice–it’s out of necessity.  So telling somebody like that to buy a new car is pretty heartless.

Bill Clinton knew that faking empathy (“I feel your pain”) was politically smart and, well, civil.  Insulting people (especially one who was quite likely chosen as a likely Obama supporter to ask him a question), and completely stepping in it (“even if you have a big family, it can’t be that big.  Ten kids?” . . . awkward pause) is just off-putting and declasse.

As for the substance of Obama’s energy remarks in response to the question, it was a typical melange of the sensible (oil is a world market; supply can’t be increased today) and the idiotic (we only have two percent proven reserves, etc.).  Unfortunately, when it comes to policy, idiocy is in driver’s seat.

To reprise Scott Miller from “Eight Miles a Gallon”: “Gonna invent a big engine, make it run on bullshit, put it in a chassis, buddy it will ever quit.”   Hey, if somebody could do that, Obama could provide the BS and make the US energy self-sufficient for years to come.

There’s actually an Obama two-fer here: “Invent a big engine, make it run on bullshit, put it on a train track . . .” But is it high speed rail?

On Monday, Fed Chairman Ben Bernanke gave a speech on clearinghouses to the Atlanta Fed’s annual conference.  Ironically, Bernanke echoed the theme of my talk at that conference in May, 2009: central counterparties (CCPs, i.e., clearinghouses) could fail, and are a potential source of systemic risk:

Overall, the historical record shows that clearinghouse arrangements have generally withstood even severe crises. This solid performance reflects good planning and sound institutional structures but also some degree of good luck, as crises have also revealed important vulnerabilities, vulnerabilities which prompted subsequent reforms by both the private and public sectors. Clearly, if we do not want to put all our trust in continued good fortune, we will have to continue to be proactive in identifying and remedying weaknesses in these critical infrastructures.

. . . .

Clearinghouses around the world generally performed well in the highly stressed financial environment of the recent crisis. However, we should not take for granted that we will be as lucky in the future. Past crises, including the financial panic of 1907 and the 1987 stock market crash, led to significant reforms and improvements in clearing and settlement that paid off in subsequent periods of financial stress. Given the growing interdependencies among clearinghouses, along with the new mandates for central clearing, now is a good time to reflect on the lessons of the recent crisis and consider whether further improvements are possible. For more than a century, financial stability has depended on the resilience under stress of clearinghouses and other parts of the financial infrastructure.

As we rely even more heavily on these institutions in the United States and around the world, we must do all that we can to ensure their resilience, even as our financial system continues to evolve rapidly and in ways that we cannot fully predict. In short, I think Pudd’nhead Wilson would agree that that is one important basket.

Bernanke discusses some historical episodes in which CCPs teetered on the brink, notably the Panic of 1907 and the Crash of 1987.  He notes, quite rightly, that the expanded role of clearing under Dodd-Frank (and likely in Europe under EMIR) means that CCPs are even more systemically important, and that it is therefore essential to ensure their safety and soundness.

Although Bernanke has taken up a theme that I’ve been flogging for going on 2.5 years now, please don’t get the impression that he got the idea from me.  Bernanke wrote an important paper on clearing and the Crash (RFS, 1990) that was instrumental in helping me understand the “plumbing” of the market and where it can go wrong.  I lived through the Crash, and witnessed first-hand of the near implosion of the clearing system in Chicago, but Bernanke’s article helped me understand some of the issues on a deeper level.   Indeed, I think that one salutary effect of my speaking and writing on the subject has been to make more people in industry and government aware of what Bernanke wrote 20+ years ago.  Credit where credit is due.

I agree with what Bernanke says in this speech, but I think it’s essential to go further.  Bernanke focuses on the potential for CCP failure, and how that can be prevented.  That’s no doubt important, but that’s not the only systemic risk arising from clearing mandates.

Most importantly, the imposition of these mandates will alter the entire financial system.  They will alter the way firms contract, how they borrow, their capital structures, etc.  These changes will have systemic effects and affect the way the system operates in a crisis.

Moreover, I am concerned that a focus on protecting CCPs can lead to the adoption of policies that are destabilizing.  For instance, conventional means of strengthening CCPs can increase their vulnerability to wrong way risk.

As another example, CCP margining can have destabilizing effects.  Although the regulatory tendency to protect CCPs may lead them to agitate for more collateral, and tighter collateralization mechanisms, this can have destabilizing effects during a crisis.  Similarly, having immense amounts of liquid assets tied up in collateral at CCPs can make the system more vulnerable to liquidity shocks.  Put differently, it increases the burden on central banks to respond to liquidity shocks.

Consider the following scenario.  There is a spike in the demand for liquidity.  Vast amounts of liquid assets are tied up in derivatives collateral at CCPs.  One likely response to the liquidity shock is to liquidate derivatives positions to free up the liquid assets–“dead liquidity”–held at CCPs.  This can lead to big price movements that can be destabilizing.  Central banks may need to be especially aggressive in supplying liquidity to avoid these problems.  Perhaps this would require extending credit to CCPs, or to their members, in a way that would effectively permit rehypothecation of margin monies to the Fed.

Again, clearing mandates are a major change to the financial system.  There will be far reaching effects on all aspects of financial contracting.  Most of these are unpredictable and will be dynamic.  But regulators have to be aware of those ripple effects, and understand that those effects will depend on how CCPs operate and how they are regulated.  A microprudential focus on CCPs (which is the default tendency of financial regulators) could have perverse macroprudential effects.

I’m sure Bernanke is aware of that, but a conventional reading of this “watch that basket” speech could lead regulators to focus on the microprudential, and overlook the potentially perverse unintended macro implications of that focus.

I liked Bernanke’s historical discussion.  The Panic of 1907 case is particularly interesting, and I will discuss it in some detail in my forthcoming book.  One thing that is of particular interest, that Bernanke does not discuss, has implications for one current regulatory debate.

Specifically, as shown by Elmer Wicker in his book Banking Panics in the Gilded Age, the New York Clearing Association often failed to deal effectively with panics by mutualizing risk because of heterogeneities among its membership.  Although mutualizing risk would have mitigated adverse selection problems (because there was less uncertainty about the condition of the banking system as a whole than individual banks), it also would have transferred wealth from the healthy banks to the unhealthy ones.  The disagreements among heterogeneous banks undermined coordinated action during several crises–including especially the Panic of 1907.

That is worth keeping in mind today when evaluating proposed rules regarding CCP membership policies.  Encouraging open access through low capital requirements, or aggregate ownership restrictions, as proposed by the CFTC, will lead to more heterogeneous memberships at CCPs.  This will have many perverse consequences, including the real potential for the same kind of problems that undermined the effectiveness of the NYCH in the Gilded Age.

I’m pleased that Bernanke brought this episode into the public eye.  I’m also pleased that he has brought the potential vulnerabilities of the clearing system into the public debate.  His speech is a welcome antidote to the superficial happy talk of Geithner and Gensler and the cheerleaders for Frank-n-Dodd.  Without a sober recognition of the vulnerabilities that a greater reliance on clearing can create, the cure may actually kill us in the next crisis.