Streetwise Professor

November 22, 2011

Clearing Up Some MF Misconceptions–And Raising a Question

There are many misconceptions about the CME’s responsibilities in the MF Global situation, and the implications of this situation for the CME’s longstanding claims that no customer has lost money as a result of a clearing member default.  These misconceptions are epitomized by this Sun Times article:

CME owns the Chicago Mercantile Exchange, Chicago Board of Trade and the New York Mercantile Exchange, where much MF Global business took place. It legally clears, or guarantees, the trading on its markets and often boasts that no customer has ever lost money because a trading firm failed.

That more than 100-year record may be in jeopardy with MF Global, one of the largest brokerages on the Chicago and New York commodity markets. Former New Jersey governor and Goldman Sachs Group Inc. chairman Jon Corzine led the firm but made a disastrous investment in European debt.

The claim is true, and regardless of what happens with MF it will remain true.  The clearing guarantee is not in play here.

If clearing firm A defaults, customers of clearing firms B, C, etc., will get paid as long as the clearinghouse is solvent.  That has always been the case in the past, and it is true now.

It is possible that customers can lose money under the omnibus account system employed in the US, if there is a default on A’s customer account, and A cannot cover it, then A’s customers bear some of the losses.  As an example of this, the London customers of Griffin trading lost money when that firm went bust in 1999: no US customer customer lost.  (Customers of a COMEX member, Volume Investors, did lose when that firm went under).

There was no default in either MF Global’s house or customer accounts, so the clearinghouse guarantee never came into play.  So the Sun Times account–like many others–is fundamentally misleading.

Moreover, 60 percent of customer margin associated with open positions was transferred to other clearing members.  Most of the missing money in question, from what has been reported, was customer money on deposit at MF Global but not margin associated with open positions.  (That is the case with two MF customers I know personally.)  The CME clearinghouse guarantee has nothing to do with that money.

CME has raised the amount that it is willing to commit to cover any shortfalls from the bankruptcy trustee’s distribution of cash to customers.  This is not the CME’s legal obligation, but is, as I said in an FT article a couple of weeks ago, an indication of the importance of this situation to CME’s reputation.

CME will be subject to scrutiny primarily for its role as the MFer’s Designated Self-Regulatory Organization (and hence responsible for auditing it) prior to the firm’s rapid implosion.  Moreover, as Jeff Carter (a one-time CME floor trader and board member) writes, CME has not done itself any favors with its handling of the “public perception of the crisis.” (Though I have also heard that CFTC is attempting to control what the exchanges–CME and ICE–are saying.  As well it might, as it will also come under considerable scrutiny.)

A big question in my mind is why Corzine isn’t getting the Madoff treatment from the Feds and the media.  He has been called to testify in front of a House committee.  I wonder if he’ll invoke the amendment that comes right after the one about unreasonable searches and seizures.  But it is amazing to me how little critical coverage he has received.  Especially given the bad press that rich bankers are getting these days.

Oh, I forgot.  He’s a progressive Dem in good standing.  What was I thinking?  My bad.

So there are two major things wrong with coverage of the MFer’s tale.  The first is that the role of the CME’s guarantee to its customers is being misrepresented with some regularity–including by the home field rag.  The second is that the most likely culprit–and certainly the person ultimately responsible for the firm’s collapse, and anything that occurred as the firm crashed and burned–is all but invisible.

November 21, 2011

Cue Gomer Pyle: Russian Privatizations Delayed

Filed under: Economics,Politics,Russia — The Professor @ 9:39 pm

Surprise, Surprise, Surprise.

Earlier this year, to great fanfare, Russia announced plans to privatize large stakes in major corporations like Sberbank and Rosneft.  Originally the idea was that the privatizations would raise money that would improve Russia’s fiscal situation, and lead to improved governance and management of these woefully corrupt and mismanaged entities.

But that’s exactly the problem, isn’t it?  There are some people who recoil at the very idea of improved governance like vampires recoil from the sunlight.  People that rule in Russia.  People like Igor Sechin.

According to a letter sent by deputy prime minister Igor Sechin to prime minister Vladimir Putin and seen by Vedomosti, the FT’s sister paper, the state is thinking about delaying the secondary public offerings until after the group’s stock start trading at their initial share prices again.

. . . .

The comments appear to signal the start of a new tug-of-war over the privatisation programme between Putin and Medvedev’s allies – a fight that is likely to only get more convoluted after the two leaders switch roles in May.

Medvedev’s allies?  Just who would they be, at this juncture?  And if they are allies, how does being allied to a political eunuch matter?  How very droll.

But Courtney Weaver is just warming up:

Regardless of who wins, the privatisation plan will eventually go ahead: the government needs the proceeds from the estimated $32bn in asset sales. But the delays and changes will do nothing to win over investors, who have long been sceptical about the programme.

Another howler.  The main force behind fiscal probity in Russia was Alexi Kudrin.  He’s gone–precisely because he opposed “Medvedev’s” (actually Putin’s, as recent events show clearly) grandiose rearmament plans as fiscally irresponsible.  Who else has the ability to stand up to Sechin and the other vampires?  (Don’t say Putin, because he is one of the other vampires.)

This is actually quite a favor to those who would have been lured, Charlie Brown-like, into taking a kick  at Lucy Sechin’s football, only to wind up flat on their backs, like so many before.

So everybody should be happy.  The vampires can continue to sink their fangs into state-owned behemoths, protected by the darkness that envelops them.  And fools-with-money foreign investors will likely be spared having their capital sucked out by self-same vampires.

SWP Early Edition: Sovereign CDS

Back in the summer I argued that sovereign CDS are acutely vulnerable to wrong way risk.  Indeed, the problem is so severe as to call into doubt the viability of these instruments.  From today’s Dow Jones News Wires:

But some market participants said that, if risk aversion from Europe spirals out of control and credit markets freeze, a large firm could fail to meet its obligations in a credit-default swap, setting off a chain reaction that threatens to destabilize the global banking system.

They are urging closer scrutiny of banks’ gross sovereign CDS positions and of the interconnectedness of the banking system.

“When there is a high degree of correlation between the underlying risk and that of the hedge counterparty [in this case, the sovereign and a bank selling CDS], can you rely on a payment from your protection seller?” asked Joyce Frost, partner at Riverside Risk Advisors LLC, a derivatives consultancy.

The correlation may be so strong, she said, that if Italy, for example, continues to deteriorate, the protection purchased from a highly correlated European bank may not be worth as much as originally thought. The value of that hedged position would be worth less than if the CDS were written by an uncorrelated counterparty–a U.S. or Canadian dealer, for example.

This is a phenomenon market experts call “wrong-way risk.”

Katy Burne goes on to argue that “[t]he lack of sovereign CDS clearing makes individual institutions more vulnerable to a messy default.”  This is fundamentally incorrect.  Clearing does not make wrong way risk go away because banks are CCP members, and would be on the hook in the event that a big loss on sovereign CDS caused a bank/clearing member to default.  In particular, the senior tranche of a CDO-like nature of CCP default funds makes them acutely vulnerable to wrong way risk.

Wrong way risk is intrinsic to sovereign CDS.  If big sovereigns are at risk of defaults that would cause payouts on CDS–heck, if even sovereigns that seem small in the scheme of things, like Greece, are in trouble–banks are likely to be in trouble.  The correlation is a fundamental feature of the instrument.  Whether banks are the ultimate counterparties in bilateral trades or via CCPs is immaterial: the problem is there.

MFers Really Be Dippin’

Filed under: Derivatives,Economics,Exchanges,Financial Crisis II,Regulation — The Professor @ 1:11 pm

The latest estimates of the shortfall in MF Global customer accounts have doubled, to $1.2 billion:

The trustee overseeing the wind-down of MF Global Holdings Ltd.’s brokerage said more than $1.2 billion in customer funds could be missing from the failed firm, more than double the original estimate of missing cash.That estimate of missing funds represents funds that should have been segregated in stand-alone customer accounts by MF Global in accordance with regulations, the trustee said.

Apparently the issue is that MF held about $600 million of its own capital in customer seg accounts to cover potential customer defaults (which as a clearing broker it is on the hook for).  Add that $600 million to the $600 million original shortfall estimate (which apparently was made without taking into account the MF Global capital held in the accounts), and you get to the $1.2 billion figure.

Already ugly.  Getting uglier.

When financial/trading firms implode, they do so with incredible speed. A lot of money sloshes in and out of them every day, and in the desperation and chaos of the implosion controls break down–and are sometimes deliberately broken down.  In the scramble for cash to meet incompatible demands from importuning creditors and clients, a lot of money can go out the door.  This isn’t like the collapse of a manufacturing firm with assets like machines and buildings that are hard to turn into cash quickly, and which keeps little cash on hand.  Firms like MF have mainly liquid assets, and handle large quantities of cash and liquid assets for others.  Thus, there is a much greater risk of illicit transfers in collapse of this type of firm than in others.

Interestingly, this is one reason why financial firms have fragile capital structures.  If they didn’t, it would be quite easy for managers to misappropriate assets.  Capital structure fragility and the associated potential for runs are a disciplinary device: customers and funders who suspect misappropriation can run, and destroy the firm in a trice.

But this disciplinary device is imperfect, as are all such devices.  Sometimes managers misbehave, and these firms implode quickly as customers and funders flee. We are witnessing exactly that with MF Global.

Smoke on the Water

Filed under: Russia — The Professor @ 12:39 pm

And no, this isn’t a paean to Dmitri Medvedev’s fave band, Deep Purple.  It’s about another Russian transportation debacle–indeed, another riverboat debacle.  The only thing that differentiates this story from earlier ones is that fortunately nobody died this time:

Three people were hospitalized after a massive fire engulfed a riverboat on the Moscow River early Monday morning, Interfax reported.

The 96-meter vessel, the Sergei Abramov, was docked at the Northern River Port when it erupted in flames around 4 a.m., sending guests and crew fleeing for dry land. Five were injured in the blaze, including two crew members and a firefighter.

“Erupted in flames.”  “Massive fire.”  More great slogans for Russian tourism promoters.

November 19, 2011

Without Panzers–and the Will to Use Them–This Won’t Work

Filed under: Economics,Financial Crisis II,Politics — The Professor @ 2:05 pm

The Telegraph reports that elements in the German government are contemplating a radical strengthening and centralization of EU government:

The six-page memo, by the German foreign office, argues that Europe’s economic powerhouses should be able to intervene in how beleaguered eurozone countries are run.

The confidential blueprint sets out Germany’s plan to tackle the eurozone debt crisis by creating a “stability union” that will be “immediately followed by moves “on the way towards a political union”.

It will prompt fears that Germany’s euro crisis plans could result in a European super-state with spending and tax plans set in Brussels.

The proposals urge that the European Stability Mechanism (ESM), a eurozone bailout fund that will be established by the end of next year, should be transformed into a version of the International Monetary Fund for the EU.

. . . .

The German plan begins with a proposal to create “automatic sanctions” that could be imposed on euro members spending beyond targets set by the European Commission. Germany is demanding that if euro rules are “consistently violated”, it should be able to demand action from the European Court of Justice.

Germany, Finland, Austria and the Netherlands would be able to ask EU courts to impose sanctions, from fines to the loss of budgetary sovereignty, to protect the euro.

The memo states the EMF would be given “real intervention rights” in the budgets of euro members who have received EU-IMF bailouts.

This. Is. Not. Gonna.  Happen.


For two reasons.

First, most Germans don’t have the stomach for it.  It cuts against everything in the German post-war identity, most notably the intense desire among most Germans to turn their backs on the nationalism and will to power that brought on two world wars that ended with the utter destruction of the old Germany.  And knowing this, those who would be subject to Teutonic dictates will play the guilt card for all it is worth.  The only risk of this is that they overplay their hand.

Second, and relatedly, this brings to mind what Andrew Jackson said about a Supreme Court decision he didn’t like:  “…the decision of the Supreme Court has fell still born, and they find that they cannot coerce Georgia to yield to its mandate,” often punched up to “John Marshall made his decision, now let him enforce it.”

Germany will find that it cannot coerce Greece, or Portugal, or Spain, or Italy–or France–to yield to its mandate.   Demanding action from the European Court of Justice?  I don’t think I’ve read anything so hilarious in months.

The courts can decide–but what executive power enforces the decision?  And how would said executive power–which does not now exist, and which would have to be created with the agreement of those against whom it would be wielded–deal with the riots, the strikes, the economic chaos that any attempt to enforce such decisions would inevitably create? What would the Greeks or Italians have to lose?  And think of the havoc they could wreak on Germany.  Like Sampson, facing penury anyways if they meekly submitted to German demands, it would be far more viscerally satisfying for them to pull down everything on everyone–including the Germans.  Which the Germans would soon figure out, and refuse even to attempt such coercion.

Germany doesn’t have much in the way of a Panzerarmee any more, and even less the will to use one.   So just how could it possibly enforce its will on unwilling and recalcitrant foreigners?  Even if–as unlikely as that is–said foreigners were to agree formally to submit ex ante, does anyone seriously imagine that these promises would be credible ex post?

This German foreign office memo is a bureaucratic fantasy completely disconnected from gritty realities.  Decisions, dictates, and ukases are useless unless they can be enforced.  German politicians and diplomats can thunder all they want, but absent credible coercive powers their threats are empty.  Germany does not have these coercive powers–largely a result of decisions Germans consciously made as an effort to distance themselves from their past.  If it did, it would not use them.

No.  The real choices remain amputation or gangrene: between breaking up the Eurozone, or socializing and monetizing (which is a form of socialization) debts.  Coercing the deadbeats to pay–the essence of the German foreign ministry document–is not a viable option. Germany has neither the means nor the will.

Energy in the Executive Stymies Energy In America

Filed under: Economics,Energy,Politics,Regulation — The Professor @ 9:00 am

The last 10 days have seen events that illustrate the idiotic alpha and omega of the Obama administration’s energy policy.  These tell you everything you need to know about its complete inversion of priorities, and its utter incomprehension of how energy, markets, and government work–or don’t.

On the one hand, there is the Congressional testimony of Energy Secretary Steven Chu defending the $500 million plus Solyndra debacle, news about a Kennedy company with equally illusory prospects receiving a federal loan guarantee almost three times as large, and reports that 80 percent of Department of Energy “green energy” loans went to Obama donors.

On the other, there is the administration’s delay in approving the Keystone XL pipeline, and yesterday’s announcement that the USDA was imposing a six month delay on auctioning shale gas properties in the Wayne National Forest in Ohio to further “study” the surface impacts of hydraulic fracking.

Note the contrast.

On the one hand: An unshakable commitment to throw vast sums of money extracted by coercion from American citizens at delusional, patently uneconomic projects that will produce little energy, and which just oh-so-coincidentally (It is a coincidence!  Really! Chu says so!) happen to be owned by Obama donors.

On the other hand: Using every regulatory power available to stymie the investment of private capital freely provided in economically viable projects that will produce large amounts of energy now and into the future, pursuant to highly speculative–and dubious–theories about the environmental impact of these projects.

The mental vacuum in which these environmental impacts are conceived is beyond belief.  Are trade-offs considered?  Surely you jest.  In the case of Keystone, for instance, the administration did not give the slightest inkling that it had considered the George Bailey question: What would happen if Keystone was not born?  Would there be a greater reliance on the use of seaborne oil transportation, which is far more environmentally risky than pipeline transport?  Would it result in greater off-shore oil production in the Gulf?  (You’d think that the Mocondo experience would make that a particularly salient issue to an allegedly environmentalist administration.  You’d be wrong.)  Would it result in the building of a pipeline in other environmentally sensitive areas (e.g., the Canadian Rockies), over which the oil would be transported and then put on environmentally riskier tankers?

In other words, lavishing billions on unicorn fantasies flogged by political and ideological allies, and throwing regulatory roadblock after regulatory roadblock at real, viable projects.  And both the lavishing and the blocking based on literally incredible environmental theories.

In Federalist #70, Alexander Hamilton extolled “energy in the executive.”  In the past days we have seen an executive devoting all its energies, positive and negative, to pushing some projects that will produce no energy, and to thwarting others that will.   An energetic twofer: they will make us poorer, by making energy more expensive, and they will not help the environment–and will quite plausibly make the environment worse.

That kind of energy we can very much do without.

November 16, 2011

Big Wheel Keep On Turnin’

Filed under: Economics,History,Politics,Russia — The Professor @ 2:58 pm

No, not Proud Mary: the hamster wheel from hell that is Putin’s purgatory.

His imminent return as president has sparked a series of stories that highlight the dreary prospects for the Glorious Motherland.

Like this one, from the Telegraph, detailing how as many as 30,000 business people (which, in Russia, really means businessmen) have fled, often without their money, which has been seized by the “law enforcement” authorities:

Russians who have been forced to live overseas also estimate that tens of billions of pounds worth of assets have been illegally seized by the Russian government as Mr Putin has strengthened his powerbase.

According to Andrey Borodin, the former head of the Bank of Moscow, the talent drain will only increase when Mr Putin, currently prime minister, runs for re-election as president in March – a poll he is almost certain to win.

“We call ourselves Putin’s exiles,” he said in an interview with the Daily Telegraph, his first since fleeing Russia last year.

He said Mr Putin and President Dmitry Medvedev, who is set to swap jobs with his mentor, were “using the law to act as gangsters”.

“But unlike gangsters in the West they have one big advantage: they have the police, the prosecutors and the judges on their side,” he said.

Now, you might reply, that these businessmen are just criminals and their fortunes ill-gotten.  First, that’s no doubt true of some of them.  Second, it would hardly be a ringing endorsement of the Russian system, or Russian commercial ethics, would it, if tens of thousands of businessmen in a country notorious for its low rate of business formation were crooks?   Just why couldn’t honest people survive in such a system?  Two possible answers: (a) there aren’t many, and (b) the absence of a rule of law and property rights, and the predation of the  state, mean that honesty isn’t a survival strategy.  Not a great choice, is it?

Indeed, Russia provides the best illustration of Balzac’s statement that “the secret of great fortunes without apparent cause is a crime forgotten, for it was properly done.”  (Sometimes bowdlerized to “behind every fortune there is a great crime.”)  For those of you who doubt that, explain the Abramovich-Berezovsky trial, dissected brilliantly here by my colleague Paul Gregory (an excellent economist and a historian of Stalinist Russia–and the son of an emigre from Chita).

“AHA”, defenders of Putin are likely to say: “That’s all about the ’90s.  That’s exactly what our hero has eliminated.”

But as Paul trenchantly notes, Abramovich did exactly the same as what Khodorkovsky–a current resident of Chita–is alleged to have done: selling oil at below market prices to offshore shadow companies that then sold it at the market price, and then siphoning the profits into foreign bank accounts without paying tax.  Note: Abramovich admits under oath to having done this.  But he is a free man, and Putin has not raised a finger against him.  Indeed, he is in good standing with Putin.

No.  The main difference between the ’90s and now is that corruption and economic crime on a vast scale has been nationalized, and benefits those in the state apparatus and those who pay obeisance to it.

What’s more, it is not just the wealthy or businessmen who are leaving to protect their ill-gotten gains and their precious hides.  It is also the educated, and members of the supposedly burgeoning middle class that differentiates the new Russia from the old (h/t R) who are leaving, or giving the idea serious thought.  There’s even a name for it now: “The Putin Decade Exodus.”  Decade!  What optimists!

There are some murmurs of discontent from those who intend to remain, and some suggest that this could pose political problems for Putin and Putinism.  But the Russian polity is so de-institutionalized, and the populace so atomized, that this is unlikely.  As a Russian participant at the most recent Valdai charade said:

“Because of the Soviet legacy and the 1990s, ordinary Russians don’t trust one another,” adds James Sherr of the Royal Institute of International Affairs. “They don’t combine in collective political activity. They solve their problems independently, with their families and friends. They opt out.”

Add to that the pervasive state control of most Russians’ primary sources of “information” (of which the refusal to permit foreign news broadcasting outlets in Russia that I mentioned earlier today is just one example), and the prospects for change via conventional political means look dim indeed.

In Russia, the lyric “meet the new boss, same as the old boss” is literally true.  The purgatory will persist.  The hamster wheel will keep on spinning.

And the devotees of the personality cult will swoon all the same.  Some of them I can understand. Those who passeth all understanding are the Paulians who channel RT and furiously defend what is really a libertarian dystopia and its overlord.

That is something I really would like to understand.  I would really like to see a non-spittle flecked explanation of the affinity of some Paulians for Putin.  Any takers?

No, This Article Was Not Written in 2004

Filed under: Politics,Russia — The Professor @ 8:54 am

Some people are a little slow on the uptake:

Perceptions Grow Of Putin Personality Cult

As Prime Minister Vladimir Putin prepares to return as president for six years or even 12 years, Russians are increasingly aware of a cult of personality surrounding the leader, according to a recent poll.

Fully a quarter of Russians now say that all the signs of a Putin personality cult are already apparent, compared with only 10 percent in March 2006, according to a survey published Thursday by the Levada Center. Meanwhile, the proportion of Russians  who say there aren’t any signs of a Putin personality cult shrank to 33 percent in the October survey, from 57 percent in March 2006.

Wow.  “Fully a quarter.”  WTF are the other 75 percent thinking?  Well, we know 33 percent are delusional as they don’t see “any signs.”

Putin is the modern poster boy for personality cults.  Anybody that doesn’t see that is really drinking the Coolaid.*

In other shocking news, apparently there won’t be an America Today–or “AT”–in Russia any time soon:

Russia will not change legislation forbidding foreigners to set up media outlets in the country when it joins the World Trade Organization (WTO).

“Our main restriction on the media is that foreign nationals and stateless persons cannot act as founders,” Maxim Medvedkov, Russia’s chief WTO negotiator, told reporters on Wednesday.

Take heed, all you “libertarian” cheerleaders for RT–and full fledged members of the VVP personality cult.  Which is all too weird.

* Inside joke.  The other day some Twitter troll pretending to be Mr. All American Libertarian was defending Russia, Putin, RT.   He made several errors that no American would–including saying that someone was really drinking the “Coolaid.”

Dr. Coase Has Answered the Phone

Filed under: Economics,Energy — The Professor @ 8:45 am

Free money will not stay on the table for long.  Earlier this year I wrote about the value that was available for the taking by reversing the flow of the Seaway Pipeline connecting Cushing, OK and the Gulf.  ConocoPhillips (COP) owned half of the pipeline, and its refinery operations benefited from the low price of crude in the Midcon due to the backup of Canadian and Bakken crude in Cushing. Hence it balked at reversal. But the differential between the Cushing price and the price in the Gulf meant that it was possible to make COP a deal that more than compensated for any loss in refining profits resulting from a reversal of Seaway and the resulting increase in Midcon crude prices.

Well, that deal has just been done.  Enbridge has bought COP’s 50 percent share of Seaway, and immediately after that announcement Enbridge and Enterprise, the owner of the other 50 percent, announced that they will reverse the pipeline.  150K bbl will flow by the 2Q 2012, and 400K by 2013.

The result?: an immediate compression of the Brent-WTI spread.  WTI nearby is up $2.40/bbl, Brent down about $1.60..

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