Streetwise Professor

Tsar Vlad the Lachrymose has won his electoral bid to return to return to Russia’s presidency.  This result is hardly surprising (though for a while there was some question as to whether he would win in the first round).

What is interesting, and rather difficult to forecast, is how things will play out from here.

Part of the reason that it is difficult to forecast is that what happens will depend largely on how the results are interpreted and perceived.  The likely outcome depends on expectations; expectations depend on perceptions; and perceptions are fluid and subject to influence.  That is, there are multiple equilibria here.

The key issue in the near to medium term is whether it is widely perceived in Russia-and among the elite especially-whether Putin really won decisively (as he claims, winning 60+ percent), or whether a far narrower margin of victory was grossly inflated by fraud.  The more widespread the perception that Putin felt it necessary to manufacture a huge margin, the more vulnerable he will be.  In contrast, if it is widely accepted that his margin was legitimate and largely untainted by fraud, his position will be strong, at least in the near term.

Again, although what happens on the streets will be a good measure of how widespread the perception actually is, that’s not where the real action will take place. The real action will take place within and among the clans, the elites.  But continued protest will foment infighting that could destabilize the structure that Putin has built.

Putin really had a hard choice. A narrow victory would have undermined his position as the balancer among the factions among the elites. A big victory tainted by fraud would also undermine his position.  But whereas a narrow victory could not be spun any other way, Putin at least has a chance of convincing enough people that a large margin was in fact fairly won.  Hence the incentive to commit fraud was intense.

The opposition’s best strategy is to continue to hammer on the fraud issue.  Tainting Putin’s victory, using a judo move of turning the margin of victory against Putin (which would be ironic, given Putin’s judophilia), is the best way of undermining him and destabilizing the equilibrium he has established.

Over the longer term a several questions loom large.

The first is whether Putin really believes his campaign rhetoric that the opposition is subversive and traitorous, or whether that was merely babushka and muzhik bait.  If the former, things could get ugly, especially if the opposition persists in its efforts to accuse him of fraud and corruption-and in its ridicule, especially, for ridicule is deeply angering to an extremely vain man like Putin.  (And indeed, the most recent ridicule focuses on the manifestations of his vanity.)

The second is Putin’s ability to deliver on his promises, or pay the cost of doing so.  His lavish promises-most of which I predicted in the immediate aftermath of the December Duma election-are estimated to cost $160 billion, to which must be added extravagant military spending plans. These promises make him even more slavishly dependent on oil prices, a dependence which has wreaked havoc on his grandiose plans in the past: the cocaine blues phenomenon.  Conditions are quite bullish now, but there are many factors-continuing European economic problems, and slowing Chinese growth-which could turn the market bearish in short order-and as 2008 demonstrates, oil prices can plummet with alarming speed.

This, of course, gives Putin an incentive to stir the pot in the Mideast.  Not only does it feed his anti-US, anti-West obsessions, it helps pay for his extravagance by propping up the price of oil.  But even his stirring would not be enough to prevent problems if demand conditions soften, causing oil prices to soften along with them.

The third is the fact that familiarity breeds contempt.  People eventually tire of even the most popular politician; this is especially true when that politician’s face is ubiquitous, as is Putin’s: cults of personality sour eventually. Moreover, ambitious people grow resentful of a dominant figure that impedes their ability to advance.  And leaders in power for extended periods become tired, bored, and soft, and hence more likely to make mistakes.  They tend to become caricatures of themselves, inviting distaste-and yes, ridicule. Even in the absence of a crisis, these factors cause the phenomenon noted by Enoch Powell: “All political lives, unless they are cut off in midstream at a happy juncture, end in failure, because that is the nature of politics and of human affairs.”

It is only a matter of time before that happens to Putin.  The only real question is when, and how exactly.

All of these factors suggest that Russia is in for a period of political instability.  The only way that it will escape this instability in the near to medium term is if it becomes widely accepted that Putin’s 60+ percent margin is in fact legitimate, and represents a broad popular mandate.  This will allow him to overawe those within the elite contemplating making trouble. (I should note that Putin’s order to Sechin to prepare legislation mandating “criminal proceedings against officials at state companies who fail to report incomes or ties to private businesses” is clearly a preemptive attack on those who might be thinking of mounting a challenge against Putin. He’s not taking chances.)

But that is anything but a sure thing.  Indeed, I think it is relatively unlikely.  The narrative of corruption and manipulation is too well established. And even if that comes to pass, the other factors mentioned above are likely to undermine Putin before too long, leading to instability as the factions and clans jostle for power and spoils.

The great irony, of course, is that Putin campaigned on the theme of stability, and by stoking Russian fears of chaos.  But his personalized, brittle system is inherently unstable.  It does not have the institutional foundation necessary for true stability, and cannot manage transition smoothly.  It has, in Marxist terms, serious internal contradictions that will in the not too distant future create the kind of instability that its designer promised it would prevent.

Some very eye opening reading regarding Daniel Ivandjiiski (aka Tyler Durden) of Zero Hedge (big h/t @ReginaldQuill).  In a nutshell, the allegation is that (a) a certain Keith Dalrymple, and others, sold short the shares of Gerova, and (b) Ivandjiiski/Zero Hedge and a Forbes.com blogger*, Neil Weinberg, working with Dalrymple, spread negative information on the company.  The plaintiff, investor Noble Investment, claims a loss of millions.

There’s a lot of interesting subplots here, including a byzantine Bulgarian connection.

Another interesting thing to note.  The complaint claims that zerohedge.com is registered to Krassimir Ivanjiiski’s ABC Media.  You’ll remember Krassimir.  The guy with the Warsaw Pact CV from central casting.  Footnote 2 is particularly intriguing.

This is a complaint, and no verdict has been rendered. But this is the kind of thing I was talking about in my post on ZH last week.

Interestingly, ZH, which normally is quite, er, verbose, hasn’t said a word about this.  I’m shocked! Shocked!

Some folks, notably Felix Salmon, raised questions about ZH in 2009, then lost interest.  Perhaps it’s worth a second look.

* Forbes really needs to take a closer look at its bloggers. Some-like my colleague Paul Gregory-are great. Others, umm . . .

The first post I wrote on SWP related to the pricing of message traffic on electronic trading systems. This has become a major issue in the debate over HFT, with (as I noted last week), the SEC musing about impose by regulatory fiat pricing schemes that would penalize cancellations.

But as Jeremy Grant notes in a couple of articles in the FT, exchanges are already implementing pricing schemes to deal with “stupid algos”-and I would argue, “evil algos” too. There is a process of market experimentation going on, with some disagreement among exchanges. Deutsche Borse is considering a pricing scheme similar to that the SEC is considering-imposing a tax on all cancellations above some level. ICE has criticized this idea, arguing that such a scheme does not discriminate between “good” cancellations and “bad” ones: that was my objection to the SEC idea. Instead, ICE assess charges for cancellations based on how far the orders are away from the inside market. Orders close to the inside bid-ask are more likely to be liquidity enhancing, and less likely to be opportunistic efforts to clog the exchange systems. This is far more discriminating approach.

But there is a bigger point here: who should be making these decisions, exchanges or regulators? A strong case can be made for the former.  Exchanges internalize many, and arguably most, of the costs and benefits.  Opportunistic algos reduce the derived demand for exchange services, costing the exchange money.  Good algos that contribute to liquidity increase the derived demand for exchange services, making the exchange money.  Exchanges have an incentive to get the pricing right to encourage the good and discourage the bad, and moreover are likely to have better information, and to be less susceptible to rent seeking influence activities, than government regulators.

Different exchanges engage in different experiments on pricing.  This contributes to a discovery process that is likely to reach an efficient outcome than the process that legislatures and regulators use to set prices and procedures.  Exchanges that develop effective pricing policies gain imitators: those that don’t, lose business.

Yes, it is possible that there are externalities that exchanges don’t take into consideration.  But only fools believe that regulators can understand, quantify, and correct these externalities.  Indeed, the process by which regulators internalize such effects is often highly distorted and inefficient, due to constraints on information and public choice problems.

Exchanges are clearly aware of the relevant issues, are highly motivated to address them in a discriminating and effective way, and are in fact trying to do just that.

Deus ex Machina has a typically succinct and excellent post on CCPs.  He argues that CCPs perform two functions, derivatives receivable insurer and central margin custodian, and there is no reason why these functions must be combined in a single entity.

Absolutely true. I have made this point several times, notably in this Cato policy review piece.

My only quibble with DEM is that CCPs perform more than the two functions.  In addition to those, it serves as a trade data repository, monitor of the creditworthiness of its members (which, admittedly, could be considered part of their derivatives receivable insurer function), and importantly, default manager.

But DEM’s (and my) fundamental point remains the same: what is the economic rationale for combining in all these functions in a single entity for all derivatives?  Maybe this bundle is optimal for some derivatives (e.g., highly liquid, mainly short maturity futures and options), but not for others.  But why is that the right bundle for all derivatives?  Is there a reason to believe that the market will necessarily settle on the wrong bundle, thereby requiring the mandating of the futures bundle for all derivatives trades?

Vital questions, IMO, but ones that have seldom been asked by people who merrily dictate market structure and contracting practices.  Or by academics for that matter.

DEM’s numbering of the functions of CCPs brings to mind a Monty Python sketch (but then again most things do):