Streetwise Professor

December 18, 2012

Yes. There Will Be a Tugboat.

Filed under: Military,Politics,Russia — The Professor @ 9:25 pm

Russia has dispatched a “flotilla” to the coast of Syria, in the event that it is necessary to evacuate Russians.

This, along with Russian outreach to the Muslim Brotherhood in Egypt, is tangible evidence that Bogdanov’s main fault in lamenting the possibility of Assad’s defeat was the sin of speaking the truth.  (Assad and the Brotherhood are arch-enemies.)  Watch what they do, not what they say.

And never fear! The tugboat will be near!:

Then on Tuesday, the Russian Defense Ministry announced that a flotilla of five ships — a destroyer, a tugboat, a tanker and two large landing vessels — was being sent from Baltiysk, a port in the Baltic Sea, to relieve ships that have been near Syria for months.

December 17, 2012

Guns: The Seen and the Unseen

Filed under: Politics,Uncategorized — The Professor @ 9:34 pm

The unspeakable horror in Newtown has understandably led to a surge in calls for greater gun control.  Which in turn calls for a response, as I am skeptical of most gun control, and have supported concealed carry.

It goes without saying that I would like to live in a world where Newtowns don’t occur.  But trying to bring that world into being requires addressing numerous practical difficulties, and taking seriously the unintended consequences and the trade-offs of any measure intended to achieve that end.  Intentions are one thing: results are another.  I am more interested in the latter.

At the outset, it is worthwhile to point out that there are two distinct problems with guns: mass shootings like Newtown and Aurora, and the daily toll of gun-related violence, which tends to be disproportionately concentrated in particular urban neighborhoods.  (Case in point: Chicago.  There have been 516 murders this year in Chicago, most with guns, and most in a handful of neighborhoods of the city).  There are approximately 11,000 firearms homicides in the US each year, of which a small fraction are the results of mass shootings.  Most are sad and grubby deaths that receive cursory attention.  A newspaper article or two, a report on the evening news, before disappearing into oblivion.

It is also essential to remember that there is considerable evidence (some of which is admittedly controversial) that firearms ownership by law abiding individuals, and permitting individuals to carry firearms outside their homes reduces crime, including violent and property crimes.

Insofar as mass murders  involving guns (a subset of all mass murders) are concerned, it is evident that the problem is an intersection between madness and guns.  Which raises the questions: How can the dangerously insane be prevented from accessing weapons?  What are the costs of doing so?

The difficulties of preventing the dangerously insane from obtaining weapons are severe, and the costs of doing so are likely to be extreme.  And by “costs” I do not mean merely the dollar costs of enforcement, but the hardships imposed on individuals that result from the inability to identify reliably who is a real danger of committing a mass murder.

In brief, we know that mass murderers are crazy, but very few crazy people are even potential mass murderers.  What’s more, we know that there is little ability to identify, ex ante, which individuals out of the population of the emotionally disturbed are true risks.  We are dealing with tail risks of a population that is already in the tails of the general population.  People whose behavior is irrational by definition, making it extremely difficult to identify just who from among the population of mentally disturbed individuals has a rare form of disturbance that makes them a higher risk to commit mass violence.

Perhaps some necessary conditions, or things approaching necessary conditions can be identified.  Loners.  Obsession with violent video games.  These individuals share some characteristics, but only a few people with those characteristics are risks.

Meaning that any attempt to identify those who pose the greatest risk is likely to be subject to very high rates of both false positives and false negatives, even if there was a concerted effort to evaluate the mental health of every gun purchaser.  Some of the high risks will go unidentified, and some of the low risks will be falsely considered high risk.

Both types of error are costly, and it is necessary to recognize that there is a trade-off.  If you try to reduce the risk of a false negative (a real threat that goes undetected) you increase the likelihood of false positives (those who pose no threat are prevented from obtaining a firearm, or even worse, are institutionalized or medicated against their will).

Making the best trade off depends on the costs of the two types of errors. Those advocating far more restrictive gun laws believe that the cost of a false negative is so high that we should accept a very high rate of false positives.  That is, that there is little cost of denying anyone who poses even the slightest risk from obtaining a weapon: what does anyone need a gun for, anyways?  And especially: what does anyone need a semi-automatic weapon for?

If you really believe that there is no benefits to owning a gun, but only costs, you would conclude that gun bans are justified: the cost of a false positive is zero, and there is no need even to attempt trying to identify who is a risk or not.   Psychological screening would be a waste.  If you believe the cost of a false positive is zero, any effort to try to identify is a risk is unjustified.

But that means that the question of the efficient response to the risk of mass shooting is inevitably tied to the potential benefits of gun ownership, and also to the efficacy of bans and their potential unintended consequences.

The evidence here is admittedly controversial, but my reading of that evidence is that it is highly likely that private gun ownership, and permitting people to carry firearms outside the home, does provide substantial benefits in terms of reduced violent and property crime.

Moreover, there is some evidence that private ownership and concealed carry deters some mass shooting episodes.  A paper by Lott and Landes presents evidence that “that the only policy factor to have a consistently significant influence on multiple victim public shootings is the passage of concealed handgun laws.”  Further, their evidence suggests that concealed carry reduces the death and injury rate in an attack; Lott and Landes explain this as the result of the ability of armed individuals to disrupt or end an attack before law enforcement can arrive to do so: one example is the principal in Pearl, MS, who stopped a mass shooter with the gun he retrieved from his car before police arrived.  They also present evidence that gun free zones actually increase the risk of mass shootings: would be mass killers deliberately choose to carry out their plans where the odds of facing armed opposition are the lowest.  Yes, they are insane in the sense that they relish taking human life, but that does not mean they are not calculating and rational in the sense of being able to devise means best suited to carry out their twisted aims.  Indeed, they can be hyper-rational in this respect, making elaborate plans to obtain weapons and to use them in ways that will maximize their kill counts.

Furthermore, bans are not likely to be very effective at keeping weapons out of the hands of those who are more likely to commit (non-mass) murder or other violent crimes.  Cities in the United States provide one example.  Cities with very draconian gun laws also tend to have very high murder rates.  Chicago is a prime example.  Of course there is a cause-and-effect issue here (i.e., draconian laws are more likely to be adopted in jurisdictions with high crime rates), but increasing restrictions on gun ownership in these does not clearly result in declines in murder, and as noted before, there is evidence that reducing restrictions leads to declines in murder rates.  Similar results are found in some international comparisons: high murder rates often go hand-in-hand with draconian restrictions on gun ownership (cf., Russia), meaning that bans are not sufficient to reduce murder rates to low levels.  (Russian murder rates are substantially higher than in the US, for instance, despite the fact that gun laws in Russia are far more restrictive.  Unfortunately, it appears that Russia does not break out firearms homicides, so a comparison of gun-related homicides in the US and Russia is not possible.)  Other states-notably Switzerland-have high rates of gun ownership, and very low murder rates.

Bans also do not necessarily eliminate mass shootings.  Norway and Germany, to mention but two examples, impose onerous restrictions on gun ownership, but have experienced mass shooting episodes.*  Those obsessed with killing wholesale find can find ways to satisfy their obsessions.

The co-existence of highly restrictive gun laws and high murder rates, and the occurrence of mass shootings in jurisdictions with such restrictive laws show that “ban” is an intended effect of such laws, rather than their actual effect.  This should not be surprising.  These laws are likely to have the smallest impact on those who are involved in criminal activity precisely because guns are particularly useful in such endeavors.   Restrictive laws tend to reduce substantially gun ownership by those who present a low risk of committing crimes, but whose ownership helps deter crime: they have much less of an impact on the possession of weapons by those who present a high risk of committing crimes.  Thus, bans have a lot of false positives (the law abiding choose not to own weapons) and a lot of false negatives (criminals get guns), and both the false positives and false negatives are costly.  They tend to disarm those who pose no danger, but not appreciably reduce the ability of the dangerous to obtain weapons.

Indeed, those deranged few who desire to commit mass murder are likely to be the least sensitive to increases in the cost of obtaining weapons that result from the adoption of more restrictive gun laws.  Those bent on mass slaughter are willing to go to great lengths to achieve their twisted destinies.  Their obsessions make them inelastic demanders, and drive them to find any way to circumvent restrictions on obtaining guns.

The numbers of weapons these individuals acquire is often taken as evidence of the laxity of gun laws.  But the very fact that these individuals acquire far more weaponry than they need to carry out their crimes or could even possibly use suggests that raising the cost of acquiring a weapon is unlikely to have much of an impact on their ability to commit mass murder.  Their purchases of weapons could be reduced substantially without reducing their ability to commit mayhem precisely because they tend to buy more weapons than they actually need for that purpose, or use in their crimes.   The accumulation of excessively large arsenals is a symptom of their disorder, but their disorder is such that even if restrictive laws curtailed their arsenals, they would still accumulate enough weapons to engage in mass slaughter.

The (empirically supported) likelihood that gun ownership has a deterrent effect on mass killings, and the likelihood that restrictions on gun ownership will not reduce the willingness and ability of mass murderers to obtain weapons, mean that more restrictive gun laws may not even reduce the frequency or severity of mass shootings.  Moreover, the (again empirically supported) likelihood that private ownership of guns and concealed carry laws have a deterrent effect on crimes (including murder) other than mass shooting, means that greater restrictions on gun ownership and use do come at a cost.

If this analysis is correct, more draconian gun laws motivated by a desire to ensure no Newtown ever happens again are unlikely to achieve their intended effect, and will have pernicious unintended effects.  The laws will not constrain or deter those bent on mass murder, and will result in increases in other crimes (including murder).

A couple of other points.

The first is that many Americans derive utility from guns, for reasons other than their value in self-defense.  For some it is hunting.  For others, it is just throwing lead at paper.  For others, gun ownership-and especially possession of assault rifles-is a statement of personal autonomy and individual liberty, and a connection with their heritage.

The Smart Set finds these attitudes-especially the last-totally alien and illegitimate, and unworthy of any consideration whatsoever.  That is an assertion of the superiority over one belief system over another.  It is interesting to see where those who go on endlessly about the importance of diversity draw the line, and just whom they put beyond the pale.

But if you respect the values of others, you cannot discount these attitudes when determining the trade-offs involved in restricting the rights of people to possess and use guns.

The second is that weapons do not pose unique issues.  With virtually everything there is a tradeoff involving lives on one arm of the balance. Automobiles and swimming pools and bathtubs and step-ladders and even buckets (in which approximately 20 children drown annually) kill people every year.  We accept this reality because the cost of further constraining our use of these things is greater than the value of the risk of death that necessarily accompanies their very existence.

The most vehement gun controllers view weapons differently from autos, to take one example, even though the number of people killed by autos per car in the US is about 3.6 times the number killed by guns for each firearm in the country.  They do so because they believe that autos provide benefits that exceed the costs resulting from auto-related deaths, but deny that guns offer any benefit  whatsoever.

I would grant that the benefits of guns are smaller, and more difficult to quantify, than the benefits of cars.  But a strong case can be made that the costs of restricting gun ownership exceed the benefits of such restrictions, and by a large margin.   Restrictions on gun ownership and use are unlikely to reduce the incidence of wholesale killing carried out primarily by the insane, and may indeed increase said incidence.  Restrictions on gun ownership have little demonstrable effect at reducing retail killing in places like the South Side or West Side of Chicago, and likely subject the law abiding to greater risk.  The denigration of the psychic utility of gun ownership is an act of cultural hegemony by an elite that would shriek in outrage at an attempt to impose Western values on Africans or Asians.

The desire to say “No More Newtowns!” is understandable.  But there are no easy ways to achieve that laudable goal. The most commonly advocated measures to restrict access to guns would likely not reduce the risk of mass killings, but would have unintended, and largely unseen, effects.   Most notably, they shift the balance of power between the criminal and the law abiding in favor of the former.  People will die as a result, but the connection between these deaths and the restrictive laws is largely unseen.

As a general rule, I am highly skeptical about public policies adopted as the result of highly visible tragedies.  The focus on the exceptional tends to distort judgment, and distract attention from the more diffuse-and hence less noticeable-effects of measures intended to prevent their recurrence.  The unseen is easy to ignore, but it is there.  It is imperative to look for it, and not overlook it in the glare of lurid tragedies.

This is especially true of events like those that transpired in Newtown.  The urge to do something-anything-is understandably strong, given the unspeakable pain of seeing innocent lives cut down.  But it is a sad fact that there is likely little that can be done that will reduce the risk of new Newtowns, and indeed, some measures may actually increase those risks.  And these measures also increase the odds that innocent people will die at the hands of criminals, but that increase in innocent deaths, occurring one at a time throughout the country, does not have the same impact as a single act of mass violence even if the number of lives lost is actually greater.

We live in a fallen world.  As much as we wish it were otherwise, there is no easy way to deter or prevent the depraved from committing their acts of depravity.  And we must always be cognizant that our attempts to do so may actually do more harm than good.

Unfortunately, I think that reality is likely to be ignored.

*In a comment on an earlier gun-related post, Green as Grass acknowledges that mass killings have taken place in the UK despite gun bans, but suggests that the lower frequency of such episodes in the UK may show that bans at least reduce their likelihood.  This may be true, but there are other differences between the US and the UK that could explain the difference.  The US has always exhibited higher rates of violence than European countries; the reasons for this are the subject of intense dispute, but it is an empirical fact.  In econometric terms, there is a country fixed effect, and once this is accounted for it is by no means obvious that the difference between the rates of mass killing in the US and the UK is explained by differences in gun laws.

December 12, 2012

Putin’s State of the Nation: Back to the Future

Filed under: History,Russia — The Professor @ 9:44 pm

Vladimir Putin delivered his annual State of the Nation address yesterday.

It can be summarized simply: “Western ideas out of Russia: Russian money out of the West.”

He harkened back to Russian traditions, in line with his recent spasm of nostalgia-marked by calls to revive the Hero of Socialist Labor decoration and Tsarist regimental names.  He lamented Russia’s degraded spirituality, and called for a restoration of Russian spiritual traditions and a rejection of foreign influence.  He lauded democracy, but with peculiarly Russian characteristics: to Putin, democracy is “the power of the Russian people with their traditions” and “absolutely not the realization of standards imposed on us from outside.” Further, he recommended a ban on foreign investments by government officials. He excoriated companies for using offshore tax havens and lamented that nine out of ten large transactions involving Russian companies were executed under foreign, not Russian law.  He pleaded: “We need a whole system of measures to ‘de-offshore’ our economy.”

All a piece with a longstanding historical pattern in Russia, where for centuries tentative reformist movements and wary engagements with the West have inevitably been followed by conservative reaction, authoritarian relapse, and rejection of foreign influence.  These conservative episodes have been sparked by unsettling domestic political ferment and the aging of the leadership.  Like now.

Putin’s speech gives the lie to the numerous commentators who predicted that Putin would have to liberalize politically and wean the economy from energy and state enterprises in order to prevent decline or revolution.  As if this is consistent with an understanding of the nature of Putinism, Russian history, or the way that aging men think and behave.   What were they thinking?

No.  The Russian hamster wheel is making another turn, like it has for centuries.  Few countries are prisoners of their history in the way Russia is.  Putin has announced to the world that he is taking Russia back to the future.

HFT: Whose Gnu is Gored, or Not?

Filed under: Commodities,Derivatives,Economics,Exchanges,HFT,Regulation — The Professor @ 4:41 pm

I laughed out loud, and very hard, watching this video (from RT, no less, though via Tabb Group) about HFT.  It is an interview with David Greenberg, who spent 25 years trading CL on the floor of the NYMEX.

What made me laugh?  The part (starting around the 1:30 mark) where Greenberg notes that when public news comes out, HFT traders pull their quotes “in nanoseconds.”  But back on the floor, there would be brokers who would be quoting customer limit orders, and “before his clerk could grab him on his neck, I could go ‘SOLD!'”

Let me translate.  Floor traders had a speed advantage over customers off the floor who were trading by limit order.  When market-moving news came out, floor traders like Greenberg could exploit their speed advantage, and trade against stale customer limit orders that were entered before the information was released. In so doing, the locals, due to their time-and-space advantage, took money from customers.

Yeah, it didn’t happen in a nanosecond, but that doesn’t mean jack.  What matters is that even on the floor, the faster took money from the slower: seconds, nanoseconds, whatever.  This was true in 1990, 1890, and hell, in 1790 or 1690 in the Osaka rice market.  Locals on the floor had a speed advantage over those off the floor, which they exploited ruthlessly .  And this inevitably resulted in wider markets, as off-floor traders quoted wider spreads precisely because of their vulnerability to being picked off.

Not to go all Einstein on you (as if), but speed is relative.  The stale quote problem is not a function of the absolute speed with which some traders can react, but the relative speed.  Humanoid locals in the pit were pitifully slow, compared to robot traders-especially customers who had to play telephone (literally) to yank their orders.  But that doesn’t mean that predatory trading-taking advantage of the slowest gnu in the herd-was less severe on the floor than in an electronic market.  What drives the losses from stale quotes is relative speed.  And I would argue that relative speed differences were even greater in the floor days than now.

And what ticks off old-timers like Greenberg is that the easy pickings aren’t there for the taking anymore.  HFT traders, through their tremendous speed, and their ability to scrape numerous sources of electronic information, can pull their quotes in an instant when market-moving news comes out.  They thereby protect themselves from being picked off.

Which is precisely why they can quote very tight markets.  And which is precisely why guys like Greenberg hate them.  They have ruined a total racket.  How dare they?!?!

Greenberg also talks about how in the floor days prices would move in stages to a new level after information was released.  Now the movement is much faster.  That’s bad how, exactly?

One could argue that if HFT completely withdraw their quotes, that the market will overshoot.  Prices move a lot because HFT traders totally pull their quotes.   Once the information has been digested, they quote again, and presumably the new quote level is between the pre-information release price and the quote/price immediately following the pulling of HFT quotes.

This has a testable prediction: price reversals should be larger in electronic markets than floor markets.  Or to refine the test: price reversals in the aftermath of big price moves (in response to the release of particularly salient information) should be bigger in electronic than floor markets.  To refine the test: the magnitude of price reversals should vary directly with the prevalence of HFT.

This all brings to mind two conversations, held more than 10 years apart, with a legendary trader.  A guy who made 100s of millions of dollars.  In about 2000, this trader told me he was ecstatic about the advent of electronic trading because he was “tired of getting raped by the floor.”  (Exact quote.)  In 2012, he was lamenting the advent of electronic trading because he couldn’t keep up with HFT.

Keep this in mind when you hear laments about HFT, especially from market veterans.  It’s all about whose gnu is gored, or about how the gnus have become so fast that it’s hard to gore them anymore.

December 11, 2012

Don’t Leave Home Without It

Filed under: History,Military — The Professor @ 9:46 pm

In a 2-1 decision, a panel of the 7th Circuit Court of Appeals struck down Illinois’ draconian gun control laws.  I am quite pleased with the result, but rather than discuss the law (which is an abomination-good riddance!) or the decision as a whole, I’m going to focus on one part of Judge Posner’s decision that made me smile due because it resonated with family history.

Specifically, this part:

And one doesn’t have to be a historian to realize that a right to keep and bear arms for personal self-defense in the eighteenth century could not rationally have been limited to the home. Suppose one lived in what was then the wild west—the Ohio Valley for example (for until the Louisiana Purchase the Mississippi River was the western boundary of the United States), where there were hostile Indians. One would need from time to time to leave one’s home to obtain supplies from the nearest trading post, and en route one would be as much (probably more) at risk if unarmed as one would be in one’s home unarmed.

Here’s the family connection-directly from the Ohio Valley.  My great-great-whatever grandfather, Abel Sherman, was a Revolutionary War veteran and an early settler in the Ohio Territory, outside of Marietta (“Campus Martius” when he arrived).  He and his family had a farm in Olive Green, near Marietta, and hard on the Ohio River.  During the Indian War of 1794, he and other local families retreated to a small fort.  Abel became concerned about the fate of his cattle, so he set out alone to find them.   He went out armed with his Revolutionary War musket.

While on his search, he came across some wild tomatoes.  He was picking them and putting them in the front of his long hunting shirt when he was attacked from behind by a lone Indian prowling the woods.  The Indian-Silverheels-felled Abel with a tomahawk blow to the head.  He then scalped Abel, and hid his old musket in a hollow log.  Silverheels proceeded to Detroit, where he sold Abel’s scalp for a double price, Abel being double-crowned, so Silverheels cut the scalp in half and sold it as two separate scalps.

How are all these details known?  Well . . . Abel’s family went looking for him, and found him dead, the tomatoes still in the front of his shirt, and his gun in the hollow log.  And some years later, an Indian came into a logging camp, and asked the loggers for a drink.  While in his cups, sitting by the fire, he regaled the loggers with the tale of his killing a white man picking tomatoes in the woods during the late war.  The story was complete with details about the man’s unique scalp, and th emplacement of the odd musket in the log.

Unbeknownst to Mr. Silverheels, one of the  members of the rapt audience was Abel Sherman’s son (the brother of my Great-Great-whatever-minus one Eli).

The next day, Silverheels was found dead by the side of the trail, shot through the heart.

I’ll leave it up to you to connect the dots.

So Judge Posner was spot on.  You were probably more in danger outside your home in the late-18th century Ohio Valley than inside it.  So taking a gun with you while trekking to the trading post-or looking for your cows-was advisable.

But as Abel’s fate shows, a weapon might have been a necessary condition for self-defense: it wasn’t a sufficient one.

Abel’s story is told in detail in the History of Washington County, Ohio.  His first gravestone contained a rough carving of a scalped head.  His more permanent marker was inscribed thus:

Here lyes the body of Abel Sherman who fell by the hand of the Savage
on the 15th of August 1794, and in the 50th year of his age.

His musket is in the little town museum in Waterford, Ohio, and the original tombstone is now in the Campus Martius Museum in Marietta:

Obama Relied on the Kicking Game, and It Will Cost Us

Filed under: Military,Politics,Russia — The Professor @ 3:49 pm

Apropos my post yesterday on Russia’s psychological complexes driving its Russia policy, this long article quotes several Russian commentators drawing similar conclusions.  Namely, Russian policy is driven as much by psychology and need to maintain face as it is by objective calculations of interest-more, in fact; its policy of backing Syria to the hilt is doomed to failure; and this failure will be extremely costly to Russia.

Not that American policy is anything to boast about.  Quite to the contrary.  It is a mess.  Allowing the conflict to metastasize has empowered radical elements, particularly jihadist ones.  So the US formally named one of the Syrian opposition groups, Jabhat al-Nusra a terrorist organization in an attempt to split the most radical elements and the more moderate (by Middle Eastern standards, anyways) parts of the opposition.  Fail: it brought the factions closer together.  Some elements in Syria went all Spartacus, declaring (on a Facebook page) “We are all Jabhat al-Nusra.”

This is just going so swell.  I’m sure it will only get better and better.

The situation in Syria was a colossal mess to begin with, and there was no easy answer at any time.  There were choices between bad and really bad.  A Libyan outcome represented sort of an upper bound.  But it looks like we’re on the way to post-1988 Afghanistan smack dab in the middle of the ME, rather than in the back of buggery in the Hindu Kush.

Obama never had an appetite for such messy interventions  And I sympathize with him that any action would have been messy.

What I don’t sympathize with, at all, is the fact that his instinctual dislike for intervention wasn’t the only driver behind his complete passivity, or even the main one.  It is abundantly clear that he didn’t want any foreign complications interfering with his reelection campaign, so all hard decisions on Syria were punted to beyond November 6.  Well, we’re there now.  And the jihadis didn’t call a fair catch, but are tearing up field like Billy “White Shoes” Johnson.  I think they will take it to the house.  Won’t we have fun then.

Add this mess to the huge pile, foreign and domestic, that Obama pushed beyond the election.  He relied on the kicking game, but it is evident that his coverage is terrible.

It will make his second term hell.  More for us than him, unfortunately.

December 10, 2012

The Wages of a Zero Sum Mindset, Russo-Syrian Edition

Filed under: Military,Politics,Russia — The Professor @ 3:50 pm

Russia’s defense of Syria’s Assad is overdetermined.  (And don’t believe for a minute its claims that it is not protecting Assad: walks like a duck, quacks like a duck, flies like a duck-it’s a duck.)

There are military-diplomatic reasons.  Syria is a long-term ally in the region-Russia’s last one.  Syria provides Russia with its only port in the Med.  Russia has legitimate fears of another jihadi outpost, this one at the heart of the Middle East.

There are domestic political reasons: in a reprise of its role in the Holy Alliance, Russia’s extreme fear of an popular overthrow of the government leads it support any regime facing popular opposition, no matter how odious that regime might be.

But a big reason can only be described as psychological, and rooted in Russia’s obsession with the Cold War, and in particular its loss in the Cold War to the US,.   Recent Russian squealing about the US’s alleged lapsing into a Cold War mentality (e.g., the Magnitsky Act) is so much projection that reveals just who really thinks about the Cold War non-stop. More generally, Russia is obsessed with respect, and regaining its great power status.

Putin for one marinates in these obsessions.

One effect of this obsession is the pronounced tendency to oppose reflexively anything that the United States supports, or that Russia even suspects it might support.  Hence, the fact that the US is attempting to orchestrate Assad’s ouster is sufficient for Putin and Lavrov and the rest of the gang to oppose it.

Ironically, in so doing they are jeopardizing Russia’s more objectively-based reasons for wanting to maintain a foothold in Syria.  By creating obstacles to every attempt for the UN or NATO to get rid of Assad and transition to some other government, Russia (assisted by China) has ensured that the conflict has become a protracted war to the knife in which the most radical forces-jihadi forces, in particular-have decisive advantages.  Given its longstanding relationship with all aspects of the Syrian military and security forces, and its connection with Assad, if anyone could have brokered an outcome that would have avoided the bloodshed and chaos that have occurred in the last two years, and which will almost get worse when the inevitable comes to pass, it was Russia.  But it dug in its heels, permitting Assad to hang on, and to escalate, and to make a cataclysmic end almost certain.

When this end occurs, Russia’s influence in Syria will be nil, and its image in Syria and the Middle East generally will be deeply blackened.  It can kiss Tartus good bye.  There will be a major jihadi enclave that much closer to Chechnya.

If it had not responded so reflexively to western initiatives to find some way of getting Assad out, and indeed, if it had utilized its connections and influence, it could have preserved something.  Instead it will lose everything.  Even overlooking the humanitarian catastrophe that is unfolding, and the dangers that a post-civil war Syria will pose to its people and the region, and just looking from a purely self-interested Russian perspective, Putin and Lavrov played this badly.  The opposite game will prove very expensive for Russia.  Yes, the US would have gained from Assad’s departure, especially at the outset (not so clear now, given how things have gone, but his eventual departure is inevitable).  In the Russian zero sum world view, given the salience of the US in the Russian mind, that was sufficient reason to fight for Assad to the bitter end.   But it will prove to be a grievous wound, and an entirely self-inflicted one

December 8, 2012

HFT Wolves and HFT Sheep

Filed under: Derivatives,Economics,Exchanges,HFT,Politics,Regulation — The Professor @ 2:21 pm

A paper on HFT by Baron, Brogaard and Kirilenko is attracting a lot of attention.  They provide shocking evidence: HFT traders make money.  Who knew?

What is garnering the most attention is their analysis of profit by counterparty.  For instance, Bart Chilton was shocked to find that passive HFT traders earned a $5 per contract profit on average when trading with small traders.

The numbers are interesting and all very nice, but the interpretation is far more equivocal than the authors-and HFT critics like Chilton-would have you believe.

One issue is “how big is big?” or “big compared to what?”  Is the per contract profit supposed to be zero?

The paper reports eye-popping Sharp ratios, which suggests that HFT earns abnormal profits.  But great caution is required.  This Sharp ratio only takes into account the authors’ estimate of the capital required to support the HFT positions: given the rapid mean reversion of positions (especially for “passive” HFTs), this capital can be quite modest.  But HFT also requires a substantial investment in systems, software and human capital.  And data! A huge cost.  Arguably the trading capital is the smallest portion of the capital required to setup an HFT and keep it running.  Leaving those investments out of a Sharp ratio calculation renders the number utterly meaningless.  The fact that these are numbers from a single market and HFT traders usually trade in many markets also makes it impossible to know what the profitability of HFT firms is.

Indeed, given that there is free entry into HFT, why wouldn’t we expect the marginal entrant to just earn the market rate of return on all capital employed?  If a study that takes all the relevant costs and investments into account finds that the marginal HFT trader earns abnormal returns, the appropriate response would be to identify  the source of the entry barrier that gives rise to this rent, and attack that.

Another issue of interpretation relates to defining the but-for.  That is, what is the alternative to which HFT is being compared?  An electronic market without HFT?  Floor markets?  Consider the latter.  There is no doubt that floor traders-locals-reaped profits in the same way as the HFT traders in the Baron et al analysis.  Some were “passive”-quoting bids and asks, and supplying liquidity and trading against order flow.  Others were “active”-speculating on price movements, and always alive to picking off stale limit customer limit orders.   Some did both.  Given that the per contract profits reported in the Baron et al paper are fractions of a tick, it’s almost certain that floor traders earned profits as large or larger than they report for HFT, particularly if you leave out important cost/capital components (e.g., the opportunity cost of a seat).

When it comes to floor trading, we know that the marginal trader was earning a rent.  Know as in metaphysically certain.  How do we know that: seat prices were positive, and frequently very large. (A paper I published in 1999 shows that Q-ratios for exchanges calculated using seat prices were astronomical.  This provides clear evidence of rents.)  The seat price is the capitalized value of the abnormal profits earned by the marginal floor trader.  And we know the entry barrier that gave rise to these abnormal profits: exchange limitations on the number of memberships.

So that would be an interesting comparison.  The (appropriately calculated) profit of the marginal HFT firm vs. the marginal profit of floor traders (as measured using seat prices).

The paper also reports substantial skewness in the profitability in HFT.  But there was substantial skewness in profit on the floor too.  The Tom Baldwins and Harris Brumfelds made huge money, a lot of other traders did quite well, and a very large fraction-arguably a majority-were on breaking even and at risk of getting blown out.    And this isn’t a recent phenomenon.  In the 19th and early 20th centuries, titans like Old Hutch made substantially more money than the run of the mill pit trader.

Which brings me back to my constant refrain: what’s really all that different about HFT?  The functions and behaviors of market participants are pretty much static.  We have uninformed traders and informed traders.  We have liquidity suppliers and liquidity demanders.  We have opportunistic traders looking to take advantage of a time-and-space advantage, and the ability to respond sooner than others (thereby profiting at the expense of the slow).  The functions haven’t changed: just the technology for carrying out those functions has changed.

I’d wager that an analysis based on exchange street books from the floor days (which report price, volume, and trader type by CTI indicator) would produce very similar results to the HFT study’s, although the inability to observe the bid-ask on the floor makes it difficult or impossible to break down members trading on their own account (CTI1s) into “active” and “passive” categories in the same way Baron et al do.  I am highly confident that such a study would find that: CTI1s made per contract profits as large or larger than HFT traders; CTI1s profited primarily in trades with CTI4s (customers), and that there was variation in the per contract profit depending on whether the CTI4 was big or small; that floor trader Sharp ratios based only on the capital required to support their positions would be very large; and that there was substantial skewness in the profitability of CTI1s.

Perhaps the most interesting aspect of the study is the distinction between aggressive and passive HFT traders.  It is very hard to criticize passive HFT, because they are clearly providing liquidity (although no doubt Bart will find bad things to say).  The activities of aggressive HFT-HFT firms that are almost always hitting bids and lifting offers-could well be less salutary and perhaps inefficient.

Aggressive firms could be creating adverse selection.  One aggressive strategy could be to invest substantial real resources into scooping up huge amounts of public data, analyzing it faster than anybody else, and trading faster on it than anybody else when they recognize that quotes don’t reflect the information.  Some of this information could be obtained by scraping news and social media sites.  Some of it could be generated by statistical arbitrage: analyzing vast quantities of data to identify pricing relationships across multiple instruments; identifying times when prevailing quotes across these markets deviate from these relationships; and buying cheap and selling rich when such deviations are found.  To the extent quote submitters-including passive HFT firms-do not have this information, the aggressive firms will be better informed, profit at the expense of quote setters, and thereby cause liquidity suppliers to widen their quotes.

If that’s all there is to it, aggressive HFT would be inefficient.  Real resources are devoted to earning a rent, and this rent seeking distorts prices (notably the price of liquidity), thereby inducing others trading for risk-related reasons to trade too little.

But price discovery is the flip side of adverse selection.  Informed trading drives the price discovery process.  The question becomes what is the value of the price discovery provided by aggressive HFT.  Impossible to answer quantitatively.  I would surmise that the conventional wisdom is that the value is small.  Why do we need to have prices adjust by a fraction of a cent to reflect information a fraction of a second sooner?  What real decision (e.g., investment decision, planting decision) is going to change if a price embeds slightly more information a blink of an eye sooner?  I am similarly skeptical about the value of speeding up price discovery, and therefore am quite willing to accept that some aggressive HFT is opportunistic rent seeking, and hence inefficient.

But even granting that, what are you going to do about it?  Is there a way of restricting rent seeking HFT that does not also burden beneficial HFT, for instance by imposing costs on passive HFTs that supply liquidity?

It’s not obvious that there are discriminating ways of pricing trading services in ways that reduce opportunistic trading without also reducing liquidity supply and trading for risk shifting reasons.  Tinkering with maker-taker fee structures, or tinkering with price schedules more generally seems to be the most sensible way to do it.  The question becomes: who should do the tinkering?  Exchanges presumably have the strongest incentives to drive out the opportunistic wolves that feed on the sheep, and the best information to do it.  I therefore don’t see a strong case for external regulation intended to reduce rent seeking HFT.  Let the exchanges handle it.

It is obvious that some of the regulations that have been proposed would make things far worse, rather than better.  Time-in-force rules are probably the best-or worst-example of that.  Requiring quote submitters-including passive HFT firms-to keep quotes in force for some minimum time period makes them incredibly vulnerable to the opportunistic HFT firms.  The aggressive HFT firms feed off of quotes that aren’t adjusted to reflect the information they produce by stat arb or whatever.  Time-in-force rules make it harder to adjust quotes, giving more targets of opportunity to aggressive HFT traders.  Prediction: TIF rules will increase aggressive HFT trading; reduce passive HFT trading; lead to aggressive HFT representing a higher proportion of HFT overall; and lead to wider spreads.

And ironically, these effects will increase the profits HFT firms earn at the expense of non-HFT traders. So, Bart: if you think the profits that HFT earns off the little guys are unconscionable now, be careful what you ask for.  Some of the restrictions on the “cheetah traders” that you advocate will make those profits even more unconscionable.

Put differently: Time-in-force rules don’t constrain aggressive traders who are taking quotes instead of making them.  They only constrain those making quotes and thereby make them vulnerable to the takers.  This makes sense how, exactly?

In almost any human endeavor, there is opportunism and rent seeking and inefficient behavior that goes on side-by-side with beneficial, wealth increasing conduct.  We don’t have the information or sufficiently discriminating and cheap deterrents to eliminate bad conduct altogether.

When it comes to any financial trading-old school floor trading or HFT-dominated electronic trading-rent seeking trading will occur.  When evaluating HFT generally, and restrictions on HFT that do not discriminate between the virtuous and vicious forms of the activity, you have to take the good with the bad and see which predominates.  The vast bulk of the existing empirical evidence shows that HFT is associated with better market quality in terms of spreads and depth.  So even though some HFT is almost certainly predatory, the effects of the predatory trading are more than offset by the efficient, wealth-increasing kinds.   Indiscriminate regulations that constrain both types of HFT are therefore highly objectionable.  Not a good idea to shoot a prize bull in the head because it has a parasite that available drugs won’t kill.  But that’s what those who get all hot and bothered about aggressive-and arguably parasitical-HFT threaten to do with indiscriminate regulations that would impede all HFT.

If Madoff and Stanford Had Only Posted on Facebook or Tweeted

Filed under: Exchanges,Politics,Regulation — The Professor @ 12:50 pm

The SEC would have totally nailed them.  Totally.

The absurdity is so obvious no further comment is required.  Bureaucracy in action, or inaction as the case may be.

December 5, 2012

Samson Gives His Chains a Tug, To Prove a Point

Filed under: Military,Politics,Russia — The Professor @ 7:56 pm

A quick comment on the situation in Syria.

First, I think a tipping point is nearing.  The rebels are chipping away at the regime’s forces.  The Syrian government is abandoning bases, and its perimeter is gradually but inexorably shrinking.

The way these things work is that the beleaguered force eventually cracks, and the withdrawal turns into a rout.  I think that point is coming soon.

Don’t believe what I say?  Look at what the Russians are doing: trying to create a pro-Russian opposition force.  Which strongly suggests that the Russians believe that Assad’s jig is up.

Second, there is considerable shrieking about reports that Assad is preparing chemical weapons for use.  The most recent report is that the Syrian army is mixing Sarin for use in shells/bombs.

Look.  Assad has no way out.  It’s a case of when you got nothin’, you got nothin’ to lose.  If he tries to leave, abandoning the Alawites, they will hunt him down and kill him.  He has to see it to the bitter end.

And that’s exactly what Assad is signaling.  He wants the world to see these preparations.  He is broadcasting his willingness to play the Samson Strategy.  Given his lack of options, this threat is quite credible, and he is counting on this leading to an intervention that will allow him to save his hide-and the hides of friends, family, and co-religionists.

The relevant question is: what will the US do about it?  There are no easy answers here.  But by distancing itself as far as possible from the conflict, the Obama administration has allowed it to metastasize to a point where any culmination is likely to be near apocalyptic.  No outcome here would have been pretty-Libya would probably be considered a good outcome by comparison-but there is bad and there is worse.  By inaction (e.g., backing off whenever the Russians throw a fit) we have made the worse outcomes more likely.

And as if to prove my point, soon after completing the above, this WSJ article came to my attention:

The Obama administration and its allies are intensifying efforts to weaken Syrian rebels they believe are linked to al Qaeda and other extremist groups, as the battle to overthrow President Bashar al-Assad seems to gain ground, said U.S. and European officials.

The U.S. Treasury Department is preparing to sanction one of the militias fighting against Mr. Assad, called Jabhat al-Nusra, as a foreign terrorist organization. The sanctions bar U.S. entities from doing business with it and freezes its assets inside the U.S.

U.S. officials said the designation was designed to signal to the opposition coalition and Middle East governments that Washington won’t accept radical Islamist forces playing a central role in any government after Mr. Assad’s expected fall.

Yeah.  That will work.  We won’t accept it.  I’m sure they’ll pick up their AKs and RPGs and go home.

The strength of the jihadi element is a monotonically increasing function of the duration of the conflict.  Jihadis have advantages.  Zeal, organization, a network.

Revolutions always select on the most extreme, the most violent, the most fanatical, the least scrupulous.  Don’t want those people in charge? Don’t let revolutionary forces fester.  That’s what has happened in Syria, and there is no way-none-to put that toothpaste back in the tube.

It’s hard to exaggerate how pathetic this feeble-“symbolic”-attempt is, at this late date.  No doubt election considerations convinced Obama that this was something that could be dealt with later, post-11/6/12.  Later is now.  And it’s a helluva a lot harder to deal with now.

I think Obama is going to be the poster child for the expression “be careful what you ask for: you might get it.”  He wanted to be elected in the worst way-and was.  Now he will have to deal with a slew of crises foreign and domestic.  And no, I won’t rejoice in his agonies, because (a) he’ll rationalize that the problems aren’t of his making, so  he won’t really agonize, and (b) we’re the ones that will have to endure the agony of his inability to deal with these problems.

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