Off With Their Heads. Dillinger Four. Dead to Me. Lawrence Arms. Give them a listen. Not exactly music that hath charms to soothe a savage breast-more the opposite, probably. But if you like melodic, chord-based punk it’s all good.
For something a little more laid back, Lucero is a good pick.
The logic that OTC markets are superior only works on the premise that banks are competing with exchanges on a level playing field. But prior to the financial crisis of 2007-2008 (and until the effort to reform finance is successfully completed), the playing field has been not level: banks have enjoyed some significant privileges. Key among them was the failure of some banks and regulators to properly price the credit risk embedded in derivatives.
This is a very strong statement, and one which John and Antonio do not provide persuasive evidence. Their evidence is a post at FTAlphaville by David Murphy, which details the history of credit value adjustments (CVA), and a BIS report. David notes that although in the early days of OTC markets, banks did not charge for the credit embedded in derivatives, they eventually did so. Parsons-Mello argue, based on the BIS report, that regulators lagged these developments, and did not impose adequate capital charges on OTC derivatives exposures, particularly on CVA exposures which were larger than actual default losses.
There is some empirical evidence that speaks to this issue. Papers dating back to the 1990s demonstrated that interest rate swap prices vary with counterparty credit risk, although the effect was small primarily because netting and the fact that principal is not at risk in an IRS made the credit exposures relatively small. Counterparty credit risk in CDS is much larger. Recent work by Gandhi, Longstaff, and Arora found small pricing effects in intedealer CDS trades, that became larger in the aftermath of the 2008 Crisis. They conclude that the small effect reflects the fact that most interdealer traders were collateralized, though by variation margin rather than independent amounts (the OTC equivalent to initial margin). The use of collateralization to reduce credit exposure is inconsistent with the hypothesis that credit risk embedded in derivatives is underpriced.
No doubt Parsons-Mello would interpret the evidence differently than Gandhi et al.
Collateralization is one way to control credit exposure. Credit limits are another. Reducing credit limits of firms that suffer adverse shocks to creditworthiness would tend to reduce the impact of such shocks on pricing. Since credit exposure can be managed on a variety of margins-pricing, collateralization, credit limits-just looking price effects is not sufficient to determine whether credit risks embedded in derivatives are overpriced or underpriced.
The Mello-Parsons argument depends crucially on inconsistent capital treatment across equivalent categories of risk. It is also somewhat in tension with an argument that they have made before that collateralization mandates do not raise the costs of trading OTC derivatives. As they have pointed out before (as have I), credit that is embedded in a derivatives trade can be unbundled into a default free (collateralized) derivative and an unsecured credit line. If capital charges are set consistently across equivalent risks, regulations that reduce credit exposure in a derivatives trade (e.g., a collateral or clearing mandate) can and will be offset by a substitution of an equivalent form of credit, leading to little or no change in overall exposure, just a change in its composition.
There is no reason to believe that regulators set capital charges consistently. I think that John and Antonio are arguing that they should. I would suggest that this is an impossibility. This has been a theme of mine in several posts relating to Basel rules (you can find more related posts by typing “Basel” into the search bar). The capital charges are inevitably make crude distinctions between different sources of risk. Banks who understand the true risks far better optimize their activities to take advantage of disparities between their more informed estimates of actual risk and the regulatory risk charges. Moreover, they tend to do so in a way that is highly correlated across banks because they all face the distorted capital cost structure. Maybe making derivatives-related capital charges more sensitive to counterparty credit risk will reduce the subsidy of risk arising in derivatives books and the risk exposure there will fall commensurately; but the resulting structure of capital charges are likely to subsidize another risk, leading banks to pile into that activity.
In other words, risk based capital charges are an extremely blunt tool. They are a form of regulated pricing, and like virtually all regulated price structures, lead to acute distortions. I am skeptical that they are a reliable means of reducing systemic risk. Indeed, by inducing correlated risk taking across financial institutions, they can actually exacerbate that risk. (Mello-Parsons do recognize the difficulties of setting the capital charges: I think the difficulties are so acute as to make it virtually impossible to get anywhere near right, and very easy to make big mistakes.)
Assessing a CVA-based capital charge also creates the very serious risk of inducing vicious cyles/feedback loops, especially during times of crisis. CVA charges are based on CDS prices, and CDS prices vary not just with expected default rates and losses, but also embed risk premia and liquidity adjustments that depend on market frictions and market-wide conditions. Put differently, CDS prices reflect default rates and losses in the equivalent measure, and the market chooses the measure. During crisis periods in particular, as liquidity dries up and risk limits (e.g., VaR limits) bind, expected default losses in the equivalent measure rise relative to expected default losses in the physical measure, meaning that CDS spreads widen absolutely and relative to what the spreads implied by expected default losses.
With CVA-based capital charges, such widening in CDS spreads will lead to higher CVAs and more variability in CVAs, which depending on how the CVA charge is implemented, could lead to higher capital charges, or to actions intended to reduce capital charges. Increases in capital charges raise the costs associated with outstanding positions and new deals, thereby leading to reductions in positions, increases in collateral postings, or both. These will tend to exacerbate market stresses, as firms dump positions to reduce exposures (and CVA) and sell assets to raise cash to meet collateral calls, which will lead to additional price movements that can affect CVAs, and on and on.
Put another way, it binds regulatory capital very tightly to conditions in the CDS market. The more concerned you are about the functioning of that market, especially during times of stress, the more concerned you should be about hardwiring regulatory capital requirements to the CDS market.
That is, like any market-price based mechanism for setting collateral or capital charges (think of VaR), a CVA-based mechanism is highly likely to be procyclical, and perhaps severely so. This makes it a major potential source of systemic risk.
In sum, I do not discount the possibility that capital requirements led to an underpricing of credit risk in OTC derivatives, and hence caused these markets to be larger than they should have been, or would have been given requirements that discriminated accurately among different risks in banks’ books. The evidence one way or the other is rather thin. I am highly skeptical, however, of the ability of regulators to address this problem without creating others equally severe, given the information advantages that banks have and their ability to optimize their risk taking subject to the (distorted) structure of capital requirements.
Moreover, I am downright frightened of basing derivatives capital requirements on CVA, or any market-price based measure. It is individually rational for banks to price using CVA, but tying capital charges to this measure will almost certainly lead to procyclical capital charges that are highly correlated across major financial institutions. That is a very bad-and very scary-idea.
I therefore do not dismiss the Mello-Parsons diagnosis, though I am not completely sold. I am particularly concerned that any “cure” could be worse than the disease.
For years Russia and Gazprom have pooh-poohed the shale gas revolution. No longer. Putin has raised the alarm:
Russian President-elect Vladimir Putin urged energy producers from the world’s biggest natural- gas exporter to “rise to the challenge” of a changing market as the U.S. increases output of shale gas.
U.S. shale gas production may “seriously” restructure supply and demand in the global hydrocarbons market, Putin said today in an address to the Russian lower house of parliament.
The impact of shale is being felt immediately in pricing, with customers demanding concessions on Gazprom’s oil-linked pricing mechanism. The divergence between oil and gas prices has exploded, and now tops 52 (WTI to Henry Hub) and 60 (Brent to Henry Hub): historically, the ratio has been around 10. Although the disparity is not nearly so large in Europe, oil-linked gas prices have diverged substantially from spot prices there as well.
In defense of the oil peg, Gazprom’s Alexander Medvedev keeps blowing the same gas:
Mr Medvedev insists that the oil link is here to stay. “[Because] the liquidity of the gas market is so low, spot pricing can’t give the right price signals, to suppliers or customers,” he says. “We want predictable prices for the consumer.”
To repeat: liquidity is endogenous, and liquidity feeds to liquidity. A move to a market-based pricing mechanism would lead to a spiral of liquidity, just as occurred in the US following deregulation in the early-1990s.
And please, oil prices that diverge radically from gas prices are giving better price signals? Really?
Finally, since when are oil prices predictable? Yes, historically they are less volatile than gas prices, but that’s irrelevant. Volatility per se is neither good nor bad. Prices that don’t adjust to reflect supply and demand conditions for the particular commodity are sending bad signals. If supply and demand are volatile, or there are rigidities and bottlenecks that make it difficult to adjust output in respond to shocks, then prices have to be volatile to send the right signals. A price that is perfectly predictable is likely sending the wrong signal at all times but on a set of measure zero.
No, if prices are volatile, than customers who don’t like the risk should have the opportunity to hedge that risk via derivatives markets. That’s exactly what happened in the US markets. But that would involve speculators who take on that risk, and we can’t have THAT now, can we?
The pricing mechanism is really just a means to an end, from Gazprom’s perspective, the end being high prices. You can bet the company would jettison the link in a second if the divergence was working the other way. But the availability of low cost supplies will undermine that end, as Putin publicly recognizes. The biggest potential obstacle to those supplies hitting the market is environmental restrictions on tracking. Hence the widespread suspicions that Gazprom bankrolls anti-fracking campaigns and organizations, particularly in Europe. (Good luck with that in China!)
Gazprom is one of the world’s least efficient companies. It can survive due to a relative lack of competition. Vigorous competition from new supplies will dramatically erode its profitability-and with that comes damage to the budget of the Russian state, not to mention the personal budgets of all those myriad officials who feed at the Gazprom trough.
The day can’t come soon enough.
Sergei “The Tarantula” Lavrov has no problems with Islamist parties taking power in Arab countries (h/t R):
“Political Islam is a normal phenomenon. It does not raise any concern with us, and we do not have to try hard to learn to work with these parties because we have worked with them, the Islamists, for a very long time,” he said in an interview with the Rossiya-24 television channel.
“If we talk about trusting the people’s choice, I see nothing terrifying here,” Lavrov added.
To hear a high level Russian government official wax eloquent about “trusting the people’s choice” is just too much. This is a government that puts obstacle after obstacle in the way of the formation of parties that could challenge the ruling elite. A government that is paranoid about popular movements. Where “managed democracy” is all about eliminating real choice.
With respect to Islamic parties in particular, what do you want to bet that Sergei and the gang would not be so equanimous to the formation of Islamic parties in the Caucasus? A region where “working with them” means “drowning them in the outhouse.”
No, Russia is quite OK with Islamic parties in the Middle East because they are likely to be reliably anti-American, and apt to stir up trouble that will keep up oil prices. At home, not so much.
Hypocrisy comes natural to diplomats. By that standard, The Tarantula is one of the world’s greatest.
Fiona Hill’s and Clifford Gaddy’s The Siberian Curse documents how the Soviet/Russian obsession with developing Siberia led to a colossal waste of resources. From the blurb:
This is a provocative look at a problem that has been overlooked since the collapse of the Soviet Union. Using economic statistics, economic geography, and history, the book argues that what traditionally has been perceived as one of Russia’s major strengths – its enormous size – is in fact its greatest weakness. The authors describe how years of forcing people and economic activity out into the vast, resource-rich, but inhospitably cold, territory of Siberia has burdened Russia with huge problems and costs. Defying nature as well as the market, the Bolsheviks forcibly industrialized the gigantic landmass they inherited from the Tsars in 1917. They deployed slave labour to build factories and cities and operate industries in some of the most forbidding places on the planet. They then used costly incentives to attract new workers when the prison camps closed. Today, people and factories languish in places communist planners put them – not where market forces would have attracted them. The book explains why this problem was not rectified in the 1990s and why it is likely to persist. Russian leaders still see Russia’s future prosperity as intimately linked to Siberia and its resources. They focus on Siberian redevelopment rather than resettlement to the warmer, western regions of the country. The authors conclude by considering ways in which Russian leaders should rethink the relationship between Russia, its economy, and its territory, especially Siberia.
In another Russian chapter of the Satayana Chronicles, it appears that Putin has similarly grandiose plans to develop Siberia. Indeed, it is Satayanesque in both choice of goals (exploitation of Siberian mineral wealth) and means (a state corporation endowed with special privileges):
Putin is pushing development of the Far East and eastern Siberia, and with it a revival of some mines dating back to Tsar Nikolai II, after winning another six-year term as president. During campaigning for the March 4 election, he said a state corporation was needed to speed up projects.
Putin’s first deputy, Igor Shuvalov, may be a candidate to head the body, Vedomosti said yesterday. Russia may use earnings from the 2.6 trillion-ruble ($90 billion) National Well-Being Fund, it reported, citing a law drafted by the Economy Ministry.
“The driver of Russia’s development isn’t in Europe any more, it’s in Siberia,” said Artem Volynets, chief executive officer of En+ Group, billionaire Oleg Deripaska’s mining and energy holding company. “China has emerged as a major economy in the last decade and is ready to consume commodities from across the border. If we don’t do it, somebody else will: Africa or Australia.”
This drive is predicated on the belief that proximity to the Chinese market will make these developments profitable. But economic geography is not measured only as the crow flies. Climate, and its effect on human habitability, and the nature of the terrain are as or more important. And it is not as if the distances are small: to the contrary, they are still vast. Moreover since these distances must be overcome through the construction of infrastructure that must cope with climatic and terrain challenges: the developments proposed are scattered, and hence cannot exploit the economies of density that characterize transportation costs. Most telllingly, they must also overcome the arguably heavier burden of corruption, and its consequent inflation of costs.
Yes, Brazil or Australia are further from China than Siberia, but ocean transport is cheap compared to the cost of constructing low density transport infrastructure across alternately boggy and frozen wastes.
The development plan recognizes that these initiatives are not commercially sustainable. Subsidies are needed, including subsidies to pay the compensating wage differential necessary to induce people to live and work in Siberia-a region where people have been fleeing from since the collapse of the USSR made this possible:
The state won’t be able to exile prisoners into Siberian labor camps like Stalin, who also sought to stifle Zionist calls for a home in Palestine by setting up the Jewish Autonomous District. Instead it will need to lure workers to the region by ensuring employment and building roads, houses and schools.
The Far East lost more than 20 percent of its population from 1990 to 2011, according to data compiled by Andrei Kokoshin, a former deputy defense minister now at the Russian Academy of Science. To reverse the trend, Russia must provide startup funds and cheap mortgages, he said.
At least $425 billion of investment is needed by 2030, with the state providing a quarter of that, or $6 billion a year, six times its rate of spending in the past decade, Kokoshin said.
Some of these monies will likely come from the National Well Being Fund. Such a huge subsidy from the state makes the unviability of these efforts plain. The Fund monies could be much better spent on human-scale projects in the populated part of Russia. But that’s not the Russian way. The projects will also benefit from highly favorable tax treatment (zero percent profits tax) and effectively unlimited rights of eminent domain. It is exempt from numerous laws and regulations.
The organization of the state corporation is rather remarkable. It reports directly to the President-Putin, for the foreseeable future-and appears outside any real legislative checks, such as they are in Russia. It is therefore a marvelous source of power, and corruption.
The scale of the project is so vast, and the powers carved out by Putin so expansive, that it has drawn comparison to Ivan IV’s oprichina, a state-within-a-state. I doubt that Putin’s men will be roaming the countryside toting dogs’ heads, as did Ivan’s oprichniki, but there is more than a little justice in the comparison. As described, this seems very much like a private Putin enclave, separate from the formal structures of the state. It is more state than corporation.
The grandiose project has earned one influential foe: Kudrin:
The Russian government’s plans to create a mega state corporation to develop Russia’s depressed eastern Siberia and the Far East will make the investment climate in the country worse, former Finance Minister Alexei Kudrin said on Tuesday.
The bill to create the state corporation, already nicknamed “Far Eastern Republic,” was finalized by the Economic Development Ministry and filed with other ministries for approval. The mega-corporation will be partially exempt from federal legislation and be subordinate only to the president.
“These plans immediately cross out the target for Russia to jump to the 20th place in international doing business ratings from the current 120th position,” Kudrin said.
. . . .
“The creation of such a market player capable of implementing any private project, considering the state’s administrative resource and using special preferences, means that any other investor in this area must be aware that at any moment another player with special preferences, special administrative resources and special access to finances may come to the market,” he said.
Kudrin is now more outsider than insider, so it is doubtful that his trenchant criticism will make the slightest difference.
No, this seems to be an extractive institution par excellence, both literally (in that it is focused on mining) and figuratively (in the Acemoglu-Robinson sense). A vast tunneling scheme that takes resources from the Russian state, and directs them to exorbitantly expensive projects directly under presidential control, permitting the skimming of vast sums. Credit Mobilier on PCP. Just think of the possibilities. Putin and his minions can issue huge contracts to favored firms (in which they hold stakes, or from which the collect bribes), and pay for them with state money. They can allot development rights to favored parties, and collect some boodle by various means.
Under the USSR, it is at least possible that there was an ideological basis for the obsession with Siberian development, as demented as the idea was in practice. Putin should have the advantage of learning from the failure of the Soviet efforts. Either he is insane in the Einstein trying-the-same-thing-repeatedly-expecting-a-different-result sense, or he just views this as a marvelous opportunity to accumulate power and money. I’m not ruling out the former, but I’m leaning heavily towards the latter.
In per capita terms, certainly, and perhaps overall. Stories yesterday, based on a Russian source, report that Russian cybercrime revenues totaled $2.3 billion (for attacks emanating from Russia) and $4.5 billion (for attacks launched by Russian speakers) in 2011. This is out of a total of $12.5 billion worldwide. So even if China was responsible for the other $8 billion, Russians on a per capita basis Russians earn 4.5 times from hacking than Chinese. And obviously the multiple is greater when you base off of world wide population.
This NYT article claims that hackers in Russia are untouchable. I’m shocked! Shocked!
Law enforcement groups in Russia have been reluctant to pursue these talented authors of Internet fraud, for reasons, security experts say, of incompetence, corruption or national pride.
Yeah, maybe, but that’s not really it. As the article points out later:
Computer security researchers have raised a more sinister prospect: that criminal spamming gangs have been co-opted by the intelligence agencies in Russia, which provide cover for their activities in exchange for providing expertise or allowing their networks of virus-infected computers to be used for political purposes, like crashing dissident Web sites.
Sometimes, the collateral damage for online business is immediate. A year ago, for example, hackers used a network of infected computers to direct huge amounts of junk traffic at the social networking accounts of a 34-year-old political blogger in Georgia, a country that fought a war with Russia in 2008. The attack, though, spun out of control and briefly crashed the global service of Twitter and slowed Facebook and LiveJournal, affecting tens of millions of computer users worldwide.
The Russian authorities have repeatedly denied that the state has any connection to cyberattacks.
Of course they deny. That’s exactly the point. Cutouts. Plausible deniability. Well, not so plausible.
And it was not just Georgia: Estonia was subject to a cyberassault during the conflict over the Bronze Soldier a/k/a Monument to the Unknown Rapist.
The efforts are now being directed at internal enemies:
Cyber attacks on websites of independent-minded news outlets such as Ekho Moskvy radio and cable and Internet TV channel Dozhd around the time of a December parliamentary and election have raised concerns about a crackdown on dissent.
Those attacks “confirmed the worst fears that the Kremlin can use the hacker community to organise attacks on independent media sites and the opposition,” said the report from Britain-based human rights advocacy website OpenDemocracy.
“The number of denial of service attacks on political targets has continued to grow,” the report said, referring to the most common form of assault used by pro-Kremlin activists, in which a flood of requests forces a site to shut down.
The quid pro quo here is obvious. Like pomeshchiki of old who received land in exchange service to the state, the the hackers get the right to harvest credit cards, bank accounts, etc., in return for providing cyberservice for use against the state’s enemies. And, of course the hackers no doubt have to share some of their $4.5 billion with the security services that suffer their existence. крыши are expensive.
Make no mistake. Russian hacking a very feudal business, a combination of an economic enterprise and a way of providing military force to the state.
Various legislative bodies in Russia have either passed, or are considering, legislation outlawing “gay propaganda”. This legislation reflects widespread hostility towards gays in Russia:
St. Petersburg’s parliament was the latest to enact such a law, which imposes fines of up to $17,000 for spreading “propaganda of sodomy, lesbianism, bisexuality or transgenderism among minors,” and the national parliament in recent weeks has taken up similar legislation. In a country where a 2010 poll by the respected Levada Center found that 74 percent of Russians deemed gays and lesbians “morally dissolute or deficient,” advocates for gay rights worry that the laws could rapidly become more common.
These efforts have received the official endorsement of the Russian Orthodox Church.
I would be most interested to learn how people who preen about their hatred of bigotry, but simultaneously laud the Putinist state and the tolerance of Russians, and defend the Holy Church against the blasphemies of Pussy Riot, explain this wave of anti-gay legislation.
I would also be interested in hearing non-tendentious explanations of this phenomenon.
China and Russia are holding joint naval exercises in the Yellow Sea. This comes at an interesting time. China has been involved in a serious of confrontations with virtually every nation bordering the South China Sea, including one currently ongoing with the Philippines. Chinese obstreperousness has had an effect quite the opposite of what its leadership likely intended. It has driven all of these littoral nations into deeper relationships with the United States.
China is a striving naval power, and Russia is a declining one, so Russia is definitely playing Sancho Panza in these exercises. Moreover, China and Russia are rivals in many spheres. Russia is deeply concerned about China’s rise, and the threat that poses to its vast Siberian territories. Moreover, China’s rise, and Russia’s absolute and relative decline, is deeply humiliating to Russia. For its part, China believes that it should exercise far more influence than Russia, given its greater economic heft. There are also longstanding grievances between the countries, and China in particular has a very long memory.
Consequently, these joint exercises (like other ones the countries have put on) don’t presage the development of an enduring alliance based on deep common interests. There are more points of contention than common goals. But in the short run, both share an antipathy for the nation they perceive to be the hegemon that is thwarting their ambitions. So they can come together to form a common front against the US.
But if anything, this is only likely to reinforce the concerns that east Asian nations have about China. Moreover, the decrepitude of the Russian fleet makes this gesture purely symbolic. Even if this is more than just a one-off display of solidarity against the US, Japan, South Korea, and other American allies in the region, it will have virtually no effects on the balance of sea power in Asia.
Everyone knows that about the only thing that China and Russia have in common is a desire to overcome American hegemony, especially in areas they perceive to be their special spheres of influence. These exercises are merely a reflection of that well-known fact, and little more.
I was serious when I said I was particularly interested in your opinion regarding the RCN spy allegations. I know you can offer a unique perspective on this, and since you are definitely quite open to making your views known on other matters, not only here but on other forums, I am somewhat surprised that you are silent on this one.
Sgt. Mom at Chicagoboyz has a very good post detailing the history of the Texas War of Independence and the climactic Battle of San Jacinto. It is edifying reading, though I’m sure its meaning will be lost on certain of you who cannot distinguish between a truly inspiring story of a struggle for independence and revanchist and paranoid nationalist rantings.
As a postscript, given the link to the Scott Miller song about Sam Houston, I was going to title yesterday’s post “Say Ho” but I thought that would be misleading by causing people to think I was writing about the Secret Service.
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