Streetwise Professor

Or you’ve been working to devise US energy policy over the last couple of decades.  But I repeat myself: the latter group is a proper subset of the former.

I am referring to articles running in the official house organs of the conventional liberal wisdom, the WaPo and the NYT, which confirm the obvious: government subsidies for energy, and particularly “alternative” energy and renewables, have proved to be a dreary litany of failure after expensive failure.

These failures were predictable–and in fact predicted.  But the predictions have been ignored.  For decades, as the WaPo article points out in excruciating detail.  Good money has been thrown after bad which had been thrown after worse.  These decisions have been driven by political economy rather than economic calculation.  If something needs a subsidy, that means it costs too much for the value it produces.  Yes, there can be circumstances in which there is some value that is not internalized by the producer, in which a subsidy may theoretically be justified.  But as the historical record makes abundantly clear, that’s not what drives how subsidies are allocated: they come out of the political sausage grinder, and it is politics and political connections that turn the crank.

Whatever you think about ExxonMobil, they deserve credit for not buying into the “beyond petroleum” moonshinery of BP and some other supermajors in the last decade.  During the Bush years, XOM CEOs Lee Raymond and Rex Tillerson steadfastly refused to commit capital into renewables and alternative energy, and resisted playing the subsidy game: they were unabashedly an oil company, and didn’t pretend otherwise.  They had seen the boondoggles of the 1970s–remember Synfuels?–and didn’t want to squander valuable capital on similar boondoggles in the new millennium.  Unfortunately, Congress and two administrations–particularly the current one–haven’t been quite so perceptive.   As a result tens of billions of dollars have been wasted, and wasted predictably.

Maybe Obama hasn’t heard that Medvedev is on his way out the door, and doesn’t speak for Russia–as if he ever really did:

President Barack Obama said the U.S. must be joined by Russia and China in a “common response” to keep up pressure on Iran over its nuclear program.

“We discussed Iran and reaffirmed our intention to work to shape a common response so that we can move Iran to follow its international obligations when its comes to its nuclear program,” Obama said after he and Russian President Dmitry Medvedev met in Honolulu where both are attending the Asia- Pacific Economic Cooperation forum.

Perhaps he has also failed to notice that rather than agreeing to a “common response” to Iran in the aftermath of a damning IAEA report, Russia has roundly criticized the report, and basically claimed that it is an American-led conspiracy against Iran:

A Russian government statement last Wednesday, by contrast, ridiculed it as “a compilation of well-known facts that have intentionally been given a politicized intonation.”

The Russian statement, which could be mistaken for something produced by the Iranian regime, alleged that the report’s authors “resort to assumptions and suspicions, and juggle information with the purpose of creating the impression that the Iranian nuclear program has a military component.”

A Russian government statement last Wednesday, by contrast, ridiculed it as “a compilation of well-known facts that have intentionally been given a politicized intonation.”

The Russian statement, which could be mistaken for something produced by the Iranian regime, alleged that the report’s authors “resort to assumptions and suspicions, and juggle information with the purpose of creating the impression that the Iranian nuclear program has a military component.”

. . . .

While Russia’s reaction to the IAEA report should serve as an embarrassment to those in Washington who touted the reset, more serious is the effect that continued Russian intransigence will have on preventing Iran from obtaining nuclear-weapons capability. In response to the report, Russia has said it would block any new sanctions by wielding its veto power at the United Nations Security Council. “The world community will see all additional sanctions against Iran as an instrument of regime change in Tehran,” Deputy Foreign Minister Gennady Gatilov told the Interfax News Agency. “This approach is unacceptable to us, and the Russian side does not intend to consider such a proposal.”

Yup.  That Reset thing is sure paying dividends.

Russia never had any intention of formulating a common response with the US on Iran–or any other issue of substance–unless that “common response” was fully in accord with the Russian position.  That’s fine.  I have no problems with that.  What is beyond problematic is an administration that insists on pretending that the interests of Russia and the US are aligned, when in fact they are clearly not.

And it is beyond ridiculous to include the emasculated lame duck Medvedev as a player in the charade, when anyone paying the slightest attention knows that he’s always been a laughingstock and that Putin has no interest in resolving the Iranian situation.

In fact, the reverse is almost certainly  the case.  Continued turmoil in the Gulf is a great way to keep the price of oil up and the US tied down–both of which Putin perceives to be major policy objectives.

I am not advocating confrontation with anything–except reality.  And few things are as unrealistic as a belief that Russia has any interest in forming a common front to restrain Iranian nuclear ambitions.  And nothing is less realistic than a belief that Dmitry Medvedev matters one whit when it comes to Russian foreign policy as he rides into obscurity, accompanied by the sound of scorning taunts.

German energy giant RWE has been hurt badly by the yawning gap between spot gas prices and the prices it pays some of its suppliers, which are based on a formula tied to oil prices.  The firm has made some progress modifying those contracts with its suppliers, notably Norway’s Statoil:

RWE has managed with three of its suppliers to either end some long-term contracts – which in total account for half of the RWE’s gas purchases and run as long as 2036 – or to index them to the price of freely traded gas on European exchanges, it said on Thursday.

But one big supplier holds out.  No points for figuring out which one:

Negotiations with Russian state-owned gas monopoly Gazprom, the world’s largest natural gas producer, are continuing, RWE Finance Chief Rolf Pohlig indicated.

“It’s about a lot of money in an area where we have different opinions. That’s certainly more confrontational,” he said.

Russia is playing “hardball” said Frank Umbach, writing for the Geopolitical Information Service.

“Norway has shown a lot of flexibility so as not to lose important market share in Europe. But Russia considered itself to be in a stronger position and insisted on its long-term contracts,” he said.

The Norwegians are being more reasonable and flexible than the Russians.  Go figure.

But the 25 percent ($100/mcm) price gap between the oil-linked price and current spot prices is putting pressure on Gazprom.  It has made noises about adjusting contract prices:

A $100 gap between the forward price of gas in Europe and the current price of some Russian contract gas points to a possible deal with German consumers, who are seeking relief from high contract prices, Russia’s gas export chief said on Tuesday, Interfax reported.

Gazprom Export Chief Executive Alexander Medvedev, speaking in Lubmin, Germany, following the launch of the first phase of the new Nord Stream pipeline, which will ultimately carry 55 billion cubic metres per year to Germany from Russia along the floor of the Baltic Sea, said gas cost $500 per thousand cubic metres under some contracts this quarter.

Forward prices are now at around $400, he said. “This is a good basis for finding a good resolution with our German friends,” Medvedev was quoted as saying.

It is becoming increasingly clear that the oil-linked mechanism is becoming obsolete.  Gazprom’s arguments about the necessity of the mechanism are risible, especially in light of increasing liquidity in spot markets at European hubs.  Indeed, there is a positive feedback mechanism here.  Wider use of spot pricing mechanisms by Statoil and other suppliers increases the liquidity of trading at European hubs, which makes spot prices from these markets even more reliable as the basis for supply contract prices.  This process occurred after deregulation of gas markets in the US, and soon resulted in the evolution of liquid, deep, and transparent spot and forward markets at a variety of points.  Utilities now routinely buy gas at prices indexed to spot gas prices at these points.

And it is not just gas.  This process is also proceeding rapidly in iron ore, another commodity that historically has been bought and sold under annual negotiated contract prices.  But the development of some modest spot trading soon revealed substantial disconnects between contract and spot prices during the financial crisis of 2008-2009, which drove more activity to the spot market, which undermined the forward pricing system.  As a consequence, the industry moved to quarterly pricing, but that system is now under stress as well:

But this system is now under pressure as spot iron ore prices, at 15-month lows of $128 a tonne, are well below the quarterly price of $175, providing an incentive to steel mills to default on their contracts and buy instead on the spot market.

“This quarterly system, which has been in since late 2009, now looks to be failing,” says Rob Clifford, mining analyst at Deutsche Bank in London.

Another industry figure quoted in the article says that the movement to spot pricing is “accelerating.”  This is an illustration of the positive feedback effect at work.  The more spot trading there is, the less viable negotiated pricing becomes: the process feeds on itself with tremendous speed.

The Chinese were a big force pushing the iron ore industry towards shorter-term pricing mechanisms, and they are evidently taking this lesson to the gas market:

Russian energy giant Gazprom expects to rely heavily on liquefied natural gas (LNG) exports to Asia as talks with China on pipeline gas supply have stalled, the company’s head said on Sunday.

Gazprom has been mired in painstaking discussions with China about Russian pipeline gas supply since 2006 but the talks appeared to hit a dead-end over pricing terms.

Gazprom has insisted on the oil-linked mechanism for sales to China, but the Chinese have said no dice.  Hence the “stalled” contract talks.  Keep this in mind every time Putin or Sechin or anybody from Gazprom say that a deal with China is all but final: that is so much bull.  I know: shocking, isn’t it?  I bet you are so disillusioned.

The threat to move to LNG sales to Asia is just another Gazprom/Russian vaporcontract threat intended to put pressure on the Chinese–just as they use threats to sell to China to put pressure on the Europeans.  LNG is costlier, and definitely not Gazprom’s comparative advantage.  The gas that Gazprom would sell to China is much more efficiently sent to them via pipeline than to other Asian locations via LNG: and don’t think that the Chinese don’t know this.   Moreover, Gazprom would face much more intense competition in the LNG market from not just Qatar (mentioned in the article), but the US and soon Canada which has some geographic advantages in serving Pacific markets and which is facing declining demand for its gas in the US due to the shale boom.  This is a transparent bluff.  It will be called.

So who is Gazprom going to use as its next bogeyman buyer if it can’t use the Chinese to frighten the Europeans and other Asian markets to scare the Chinese?  Martians?

Probably not, given what just happened with Russia’s Mars mission.

In sum, cracks in Gazprom’s pricing structure are becoming more apparent by the day.  It continues its frenzied attempts to paper over these cracks, but these attempts are quite clearly futile and rather pathetic if you think about the economics.  The increase in world gas supplies and the integration of the world gas market with LNG are fundamentally undermining Gazprom’s competitive position, and rendering its pricing mechanism obsolete.  The positive feedback mechanism, in which the improvement of spot market liquidity drives more activity to the spot market and spot-based pricing mechanisms, improving spot liquidity even further, means that all of Gazprom’s frenzy will be for nought.

Which all means that last week’s much ballyhooed opening of the Nordstream pipeline does not represent the harbinger of increasing Gazprom–and Russian–power in the European energy market.  Instead, it is a day-late-and-several-billion-dollar-short (about $9 billion, to be exact) monument to the past.  Yes, Gazprom will likely sell gas through that pipeline for years to come, but it will have to do so at prices determined in increasingly liquid and competitive spot markets

Sucks to be Gazprom.  But it will be fun to watch!

Today marks the 93rd anniversary of the end of WWI, the most epochal event of post-ancient history.  It destroyed a world that had been evolving since the collapse of Rome.  The human, physical, political, and civilizational destruction wrought in four years, three months, and two weeks was unprecedented.  Out of the rubble came the malign forces that shaped the subsequent decades, most notably Bolshevism, Fascism, and Naziism.  World War II and the Cold War and all that followed were the direct consequences of The Great War. Its direct and indirect death toll is arguably in the hundreds of millions.

Its effects plague the world to this day.  The Israeli-Palestinian conflict has its roots in WWI.  Much of the turmoil in the Middle East can be traced to the precipitous collapse of the Ottoman Empire brought on by the war.

As I’ve written before, during a trip to some battlefields in France last spring, the history of the war itself–the campaigns and battles–is dreary and depressing, beyond my poor powers to convey.  A visit to a cold, clammy, dripping, dark and oppressively claustrophobic fort at Verdun for even a few minutes is a soul-sucking experience; what it was like for the poor poilous who inhabited these tombs day after day is beyond imagining.  The Ossuary there is indescribably depressing.

So yes, on 11/11/11  remember the Americans who fought and suffered at St. Mihel and in the Argonne, and in all the conflicts since.  But it’s also worth a moment to recall how in a complex system things that seem small in the scheme of things–like Serbian nationalism–can change everything profoundly in a historical instant.

One of the most underreported stories of the last week is the non-demotion demotion of Bill Daley as Obama’s Chief of Staff.  The prevailing narrative is that Daley was ineffective in working with Congress.  This view from lefty Jonathan Chait seems closer to the mark:

Daley, pursuing his theory, heavily courted business leaders. He made long-term deficit reduction a top priority, and spent hours with Republican leaders, meeting them three-quarters of the way in hopes of securing a deal that would demonstrate his centrism and bipartisanship. The effort failed completely.

. . . .

The effort failed because Daley’s analysis — which is also the analysis of David Brooks and Michael Bloomberg — was fatally incorrect. Americans were not itching for Obama to make peace with corporate America. Americans are in an angry, populist mood — distrustful of government, but even more distrustful of business.

. . . .

The effort failed because Daley’s analysis — which is also the analysis of David Brooks and Michael Bloomberg — was fatally incorrect. Americans were not itching for Obama to make peace with corporate America. Americans are in an angry, populist mood — distrustful of government, but even more distrustful of business.

. . . .

Since that debacle, Obama issued a course correction and started pursuing a strategy that’s in line with the realities of public opinion and the Congress, as opposed to Daley’s fantasy version thereof.

There is a core of truth here.  Daley was seen by many in corporate America as someone who would serve as a counterweight to Obama’s leftist instincts.  That’s obviously not going to happen.  And that’s why this story deserves more attention than it has gotten.  It is an indication of where Obama is going. (And just to make clear: I am no fan of Daleyesque corporatism.)

I also surmise that there’s another thing going on here, a Chicago game.  Although Chicago is a One Party State, that party is rent into factions that barely coexist at the best of times, and battle viciously at others.  Obama’s alter ego (or is it Svengali?), Valerie Jarrett, and Daley are from opposing, hostile, factions.  Jarrett was not pleased by Daley’s presence.  Jarrett is a hardcore progressive.  Daley’s goal–as described by Chait–was to soften the progressivism.

Daley’s departure likely marks Jarrett’s victory.  It also signals, as Chait suggests, a turn to a more hardcore progressive policy and strategy: if Jarrett has the wheel, there ain’t going to be any right turns.  It is a move towards the Occupy types and a move away from the corporatist, Democratic party establishment personified by Daley.

Helluva choice, eh?

But it means that the next 12 months will be even more confrontational and contentious, and the next election will be among the most divisive in recent history.  I’m thinking ’68, or something in the 19th century divisive.

Today saw another indication of Obama’s choice.  He has delayed consideration of the Keystone Pipeline from Canada to the US.  This represents another genuflection to Obama’s environmentalist, leftist base.

Substantively, the decision is weak.  Obama said the environmental issues needed further study.  But never have the opponents of the pipeline recognized that there are environmental trade-offs.  Less oil from Canada means no probability of a pipeline spill: it is unlikely to affect the amount of oil produced as Canada can look to other markets.  But less oil from Canada means more oil imports via ship and more offshore drilling, both of which pose their own environmental hazards–hazards that are almost certainly far more acute than those posed by Keystone.  Not to mention the benefits of reducing reliance on oil from places like Venezuela.

The administration also cannot get its story straight.  Today, the State Department said this was purely a department decision, with no White House interference or politics involved:

Election-year politics played no role in the decision, a State Department official said today.

“The White House did not have anything to do with this decision,” Kerri-Ann Jones, assistant secretary of state for oceans and international environmental and scientific affairs, told reporters on a conference call. “They did not direct us to make this decision.”

Funny.  Obama and his Press Secretary Jay Carney apparently weren’t aware of this:

Obama has indicated he will make the final call. In a television interview on Tuesday, he outlined the economic and health criteria he would consider when the State Department’s recommendations come his way.

Activists viewed that as a departure from White House assertions that State was running the process.

White House spokesman Jay Carney played down the president’s comments, saying State was taking the lead but the final decision would clearly represent Obama’s opinions.

“The State Department is part of the Obama administration, and you can expect that the ultimate outcome of this process will reflect the president’s views,” Carney said.

So which is it?

For those of you a little slow on the uptake, discount what the State Department person says.  This was all politics, and all Obama.

This, and the Daley demotion, are clear indications of where Obama is going.  And where he is going is left, and likely hard left.

Well, not real hoppy marsupials, actually.  But kangaroo courts are definitely native to Russia.  Case in point, a story that is bizarre even by Russian standards:

A Russian judge decided to adjourn hearings on a $2.8 billion lawsuit against BP Plc executives on Thursday for one day, saying there were not enough chairs in the courtroom to accommodate the public.

. . . .

Both cases are now due to be heard on Friday, when the judge said the hearings should resume in a bigger room, according to law firm Liniya Prava, which represents the plaintiff.

A spokesman for a law firm which represents BP’s legal interests confirmed the development, calling the decision “a strange twist of the Russian judiciary”.

So somebody wanted a delay in the hearing, and the judge had to come up with some lame excuse.

In another legal story of a company that like BP is ensnared in Russia’s Kafkaesque legal system, Telenor is trying to get an arbitration panel to prevent Alfa Group from engaging in a legal subterfuge in their battle over governance of mobile operator Vimpelcom:

Telenor has asked an arbitration panel to uphold a key shareholder agreement in mobile phone operator Vimpelcom and thereby effectively block the appointment of a new board, the Norwegian firm said on Tuesday.

Telenor’s power struggle with Russia’s Alfa Group intensified in June when Alfa’s Altimo unit said it had cut its stake in Vimpelcom to less than 25 percent, thereby voiding the shareholder deal and allowing a board reshuffle from Dec. 10.

Telenor said in a statement that it believes Altimo sold the stake to a company ultimately controlled by the owners of Alfa Group and that the shareholder pact should therefore be upheld.

“We’re asking the arbitration panel for a temporary injunction to uphold today’s shareholder agreement,” Telenor spokeswoman Marianne Moe said.

And what a coincidence!  Mikhail Fridman’s Alfa Group is at the center of both the TNK-BP and Vimpelcom disputes.  Beware to investors who get involved in anything with Fridman/Alfa.  For you are likely to see kangaroo justice in its native habitat.

France and Germany are finally coming to realize that if they don’t amputate, they will die of gangrene:

The discussions among senior policymakers in Paris, Berlin and Brussels raised the possibility of one or more countries leaving the euro zone while the remaining core pushes on toward deeper economic integration, including on tax and fiscal policy.

The change has been discussed on an “intellectual” level but had not moved to operational or technical discussions, the EU official said. A French finance ministry spokesman denied there was any project in the works to reduce the currency bloc’s membership.

Yeah.  What’s the hurry?  Italy is just imploding.  Greece is a lost cause.

The time for putting on berets and sitting around smoking Gauloises at the cafe while discussing oh-so-intellectually the economics of optimal currency zones has passed.  Operational and technical discussions should have taken place long ago, on a contingency basis.  For the contingency has arrived.

The Europeans have consistently been a step behind.  Many steps actually.  This article, presumably intended to demonstrate how far their thinking has evolved, does the exact opposite.  It shows just how far behind events they are.

Ironically, in financial markets positive feedback loops are typically a very negative thing.  Self-reinforcing spirals in tightly coupled systems like the financial markets are usually downward spirals.

Margining and collateral mechanisms are the most important positive feedback mechanism in financial markets.  AIG and MF Global are two examples of how these mechanisms turn high flying financial firms into smoking holes in the ground.  They suffer losses, counterparties demand more collateral, that puts further stress on the firm, they lose customers, counterparties demand even more capital, and before you know it–impact with the ground at high speed.

Procyclicality of margin can work at the level of the market too.  We are seeing the first signs of that with respect to Italy today.  LCH.Clearnet SA (the French arm, and not RepoClear) raised margins on Italian government debt today.  This will tend to induce some sales of leveraged Italian bond positions, which will reduce prices further.  Similarly, increasing haircuts will tend to reduce liquidity, which will also tend to put downward pressure on prices.  Lower prices and lower liquidity put further pressure to raise haircuts.

So–lookout below!  The spiral has begun.  Keep eyes on RepoClear.  I imagine it will be under tremendous pressure to avoid jacking up repo margins.  And who knows, since the 450 basis point  margin raising trigger* is based on the spread over an average of German, French, and some other countries’ debt, maybe RepoClear won’t have to raise margins on Italian bonds because French yields are rising too, due in large part to French banks’ holding of $400 billion in Italian bonds.  The looking glass world of Europe . . . .

Another comment, following on the previous post.  There will be tremendous pressure on CCPs to accept riskier collateral in the clearing mandate world.  Sovereign debt has been a primary asset for margining purposes, and the assumption has been that this collateral is low risk.  But we now know that is a fiction.

Pressure to expand collateral pools, combined with the risk that said collateral can decline in value, and precipitously, creates another positive feedback mechanism.  Markdowns in collateral held at CCPs (or indirectly, via collateral transformation services) will induce fire sale liquidations of margined positions, or of other assets in order to raise cash to offset the decline in the value of collateral.

Geithner, Gensler and others have touted collateral as the elixir for all derivatives market ills.  No.  In some circumstances the elixir is really a deadly poison.  Positive feedback mechanisms destabilize financial markets, and collateral mechanisms are among the most important sources of positive feedback in these markets.  We are moving to a regime in which more collateral is being required, collateral mechanisms are being made more rigid and less flexible (e.g., reducing hypothecation) but the supply of safe collateral is contracting–or at least not growing commensurately with the demand.  This will be a major source of fragility in the system, and one that has been built into the system all in the name of making it more robust.  Another gift from the sorcerer’s apprentices.

* The term “trigger” is hardly comforting in this context.

Last week the Basel Committee released its revised proposal on capital requirements for exposures to CCPs.  It made a few tweaks to its earlier proposal, which had attracted considerable criticism.  The critics are not mollified, and some new criticisms have been directed at the new version.

I won’t deconstruct the new proposal in detail.  I’ll just focus on a few of the high level issues, all in the way of reiterating a broader point that I’ve raised previously.

One criticism of the new proposal is that it imposes punitive burdens on client clearing, and is therefore inconsistent with the stated goal of encouraging the movement of more derivatives transactions to CCPs.  Against this, it is claimed that the new rules facilitate portability of client accounts between clearing firms.  So, you won’t be able to find someone willing to clear for you in the first place, but you’ll be able to move your account easily.  Or something.

The allegedly punitive treatment of client clearing, combined with the capital and margin burdens placed on non-cleared trades, will tend to reduce end user hedging with derivatives.  This is clearly an undesirable outcome, and will induce end users to devise alternative means (and in particular, to adjust their capital structures) in order to achieve the same objectives as they currently do through derivatives.  These alternatives  are likely to be more costly than derivatives.  Moreover, they will still result in the creation of counterparty risk (or credit risk).  From a systemic perspective, it is not clear that the ultimate effect will be to reduce the amount of credit risk, or improve its allocation.

The new draft reduces slightly the capital charges for default fund contributions, but the treatment is still sufficiently tough to make it likely that CCPs will jack up margins to avoid incurring the high capital charges associated with exposures in excess of the CCPs “hypothetical capital.”  Maybe this is precisely the intent, because the idea that derivatives trades should be massively collateralized is a matter of faith among many regulators.  But demanding high collateral can lead to many adverse effects, including less hedging, the utilization of riskier assets to pay initial margins, the substitution of other forms of leverage, including fragile repo-based collateral transformation services, and the engineering of securities that can be used as collateral (either directly with a CCP or indirectly via a collateral transformation) but which are loaded with systematic tail risk.

The proposals retain the very crude distinctions between risk exposures.  Capital charges across exposures do not vary sufficiently to account for their different risk characteristics.

All of these issues point out the basic problem with Basel capital requirements.  These rules are essentially price controls.  They cannot–metaphysically–get the prices right.  The way the risks are priced via capital charges will affect resource and risk allocation decisions.  Those subject to the rules will have the information and incentive to figure out how to minimize their impact, and will tend to load up on risks that are underpriced and take too few of the overpriced risks.  Many of the endogenous responses to the capital charges will occur in unexpected ways and places, and the connection between these responses and the rules will often be highly indirect and difficult to identify.

But the big problem is that since everybody is facing the same distorted price signals, they will tend to make correlated mistakes.  This increases the vulnerability of the system.  That’s why Basel is faulty generally.  The CCP capital charges are just a particular example of that.  They are intended to reduce systemic risk, but they largely ignore how the system will respond to the rules, thereby creating new vulnerabilities.

Just step back and look at what is going on now in Europe.  One of the basic principles of Basel II was that sovereign debt was safe.  Another was that mortgages were safe.  Financial Crisis I exploded the latter belief.  Financial Crisis II is demolishing the former.  But the favorable capital charges accorded these investments encouraged the supply and demand for both.

If you haven’t noticed, this is not working out well.  The CCP capital charges will have far reaching effects on how much risk there is in the system, and where it resides. The necessary crudeness of the capital rules, their inability to price different risks in a discriminating way, and the endogenous behavioral responses that they induce not just in clearing but throughout the interconnected financial markets, will create new systematic errors and vulnerabilities that won’t work out to well either.

The conceit of these rules is that they are pricing systemic risk.  How is that even possible when those formulating rules do not–and realistically, cannot–consider fully the systemic responses to them?  Charging a price can make things worse if the price is wrong.  A financial Gosplan hardly inspires confidence, and methinks that’s exactly what Basel is.

As usual, Deus Ex Macchiato is worth reading:

One difficult criticism for those of us who believe that strong financial regulation is necessary – even if we don’t believe that the current structure is heading in the right direction – is that of rent seeking. The issue is that the stronger regulatory power is, the more it can be exploited. For me, the clearing provisions in Dodd Frank are a great example of this. The clearinghouses have been handed juicy profits by regulatory fiat.

Read the rest.  That’s an order.