Streetwise Professor

August 31, 2013

Another Fine Mess Gets Even Finer

Filed under: Military,Politics — The Professor @ 4:35 pm

So Obama, in an oddly delayed statement, has stated to the surprise of many that he will seek Congressional approval for military action in Syria.  This is the right thing to do, Constitutionally, but I don’t think that Obama was struck by pangs of Constitutional conscience.  His was a pragmatic decision.  And likely an overdetermined one.  There is no popular support for intervention.  There is, no doubt, considerable unease in Congress, especially in the Democratic caucus, and especially in the progressive portion of that caucus that is Obama’s political home.  He knows that by going in without Congressional approval, he owns 100 percent of the outcome-which is unlikely to be a good one, or which at least has a high probability of being an ineffectual or ugly one.

And there’s another potential factor.  There is no way Obama wants to go to the G20 in Russia with TLAMs flying, or in the immediate aftermath of an attack.  Hell, for him time with Putin is like a root canal without anesthesia even when he isn’t attacking one of Russia’s allies.  One can only imagine how gruesome it would be when he is.  Congress is in recess, and will not return until after Obama has returned to the US.

One last issue: Obama’s heart is obviously not in an attack.  Perhaps he believes, Micawber-like, that if he delays for a couple of weeks, something may turn up and relieve him of the burden of ordering an attack.

In other words, Obama has several reasons to stall for time.  Seeking Congressional approval permits him to do just that.

But in choosing this course, Obama has traded one risk for others.  In particular, he risks being humiliated in Congress, as Cameron was humiliated in parliament.  There are reports circulating, however, that Obama plans to proceed with a strike even if Congress does not approve.  This risks a Constitutional crisis.

There’s also the issue of how this will be perceived in Damascus, Tehran, Moscow, and elsewhere.  No doubt the charmers in the echelons of power in those places are chortling, if not guffawing.  They will conclude that Obama cannot even muster the fortitude to order a feckless strike-one that he again touted as feckless (but as a feature, not a bug).  They are unlikely to place much stock in Constitutional niceties anyways, but the fact that Obama made this announcement after days of stories reporting that he would “consult” with Congress but not seek its approval will no doubt be interpreted as a loss of nerve.

Which could unleash another perverse dynamic.  Part of Obama’s motivation for an attack is to redeem his credibility, in the aftermath of his “red line” ad lib (I will pass over the “Assad must go” statement in silence).  Obama may feel compelled to act more aggressively if this latest pause is widely perceived as an indication of his weakness and lack of will.

Lost in all this is a coherent discussion of how an attack would serve American interests, or save the lives of innocent Syrians.  Yet again, Obama’s statement made it plain that he views a strike as a means of expressing disapproval of the use of chemical weapons. He was-again-at such pains to convey that any attack-if it ever happens-will be sharply limited.  Therefore, there has been no discussion of how this would deter Assad (or any other dictator) from using chemical weapons, or advance American interests, or accelerate the end of the Syrian civil war.

In other words, the fine mess has gotten even finer.

August 30, 2013

A Disturbing Coda: We Saw it Coming and Did . . . What?

Filed under: Military,Politics — The Professor @ 8:00 pm

There was one very disturbing revelation in Kerry’s presentation.  Kerry stated that US intelligence had observed preparations for the chemical attack and monitored communications about it beginning three days before the attack occurred.

What did the US do to attempt to prevent this attack? If a private warning to the Syrians didn’t work, maybe a public release of some of the information would have had a deterrent effect.  And if it didn’t, it would have eliminated any doubt about Assad’s personal culpability: he could not claim it was underlings acting without his knowledge.  Moreover, did the US issue any warnings to the potential targets?

This is very disturbing.

Here’s the Beef: SWP v. BIS in IFRe

This article by Chris Whittal in International Financing Review does a good job at summarizing my beef with the BIS’s Macroeconomic Assessment Group on Derivatives.  I appreciate Chris taking the time to speak with me and broadcasting my analysis to a broader audience.

Obama Does the Impossible: He Turns SWP Into a Pacifist

Filed under: Military,Politics — The Professor @ 5:05 pm

I thought my capacity for astonishment and dismay had been exhausted, but I was wrong.  For today’s developments have show Obama to be even more strategically challenged than even I thought possible.  (That phrasing is incredibly generous, by the way.)

First, Kerry comes out and lays out a bill of indictment against the Assad regime.  He provides extensive evidence that the Syrian military used chemical weapons on civilians with malice aforethought. He makes an aggressive case that inaction is not an option.

Cut to the White House.  Well, not literally.  For although Kerry’s remarks were broadcast live, Obama refused to permit the networks to carry his statement live.  I can understand why.

Because after Kerry averred that inaction isn’t an option, and Obama said:

“This kind of attack is a challenge to the world,” Mr. Obama said, adding America cannot accept a world in which “women and children are gassed.”

but then he said that he hasn’t decided to act.  I see.  It’s unacceptable.  Except not so unacceptable that he’s decided to do something about it.

Then, he said that if he does act, the military actions would be “limited, targeted”:

President Obama tried Friday to assure a war-fatigued American public that his response to the alleged chemical attack in Syria would be a “limited, narrow act” and not the beginning of another extended conflict in the Middle East.

“We’re not considering any open-ended commitment. We’re not considering any boots-on-the-ground approach,” Obama said in brief comments on Friday.

Obama said he had not decided how he would respond, although his administration has acknowledged it is considering missile strikes to send a message to Syrian President Bashar Assad.

Note that he focused on making clear what he wouldn’t do, not what he would.

And if he wants to  “send a message”, tweet something, FFS.  The military ain’t Twitter.

Furthermore, sublimely ignorant of history and the thought processes of dictators and totalitarians, Obama utterly misunderstands that the message that he thinks he is sending is the exact opposite of the  message that will be received:

The goal of the cruise missile strikes the United States is planning to carry out in Syria is to restore the smudged “red line” that President Obama drew a year ago against the use of poison gas.

If carried out effectively, the strikes may also send a signal to Iran that the White House is prepared to back up its words, no small consideration for an administration that has proclaimed that the use of military force remains an option if the leadership in Iran insists on fielding a nuclear weapon.

But the military strategy that the Obama administration is considering is not linked to its larger diplomatic strategy of persuading President Bashar al-Assad of Syria to yield power and support negotiations that would end the bloody civil war.

The message Iran (and Assad) will receive is that Obama is not serious; that he will do nothing to threaten their survival; that he will only  deliver ineffectual strikes that they can easily absorb.  Which means that they will not be deterred or prevented from acting more aggressively: to the contrary, they will be encouraged to act more boldly.  Obama thinks he is flashing a red light-or maybe a yellow one-but Assad and the Iranians will see nothing but green, and will put the pedal to the metal rather than slam on the brakes.

In other words: if you want to send a message, you have to use a language the intended recipient understands.  For those facing existential threats (Assad) and those on a Mission From God (Iran), the only message that will concentrate their minds is one that threatens annihilation.

Note too that the primary objective is to redeem Obama’s past mistake of drawing a red line he had no desire to enforce, rather than to achieve any objective that advances American interests, or which truly protects innocent lives.  Politicians are a narcissistic lot, but this is off the charts narcissistic-disgustingly so.

And look at the last sentence: the use of force is “not linked to its larger diplomatic strategy.”  Are you effing kidding me?  War is politics carried out by other means.  Force and diplomacy are complementary.  The primary reason to use force is to shape the conditions for a favorable negotiated outcome.  If you say that military action is unlinked to diplomatic strategy, you should just walk around with a sandwich board that says “I AM A MORON.”

Is it possible to be more divorced from an understanding of the uses and limits of military force?

And it’s not just me, people.  Walter Russell Mead has been critical of Obama on Syria, but he is broadly sympathetic with him: he voted for Obama.  But he is incredulous, not to say disgusted:

But it’s troubling in that, of all the justifications for the use of force, “restoring credibility” is about the lamest. Unless the attacks are going to be in far greater force than we have been led to expect, they will not do all that much to restore credibility. More importantly, the cause of that loss of credibility in this case goes far, far beyond the question of whether the US will use force when its “red lines” are crossed. The Obama administration’s credibility in Syria hasn’t sunk because of the red line comment; it has sunk because the statements that “Assad must go”, coming more than once from top members of the administration, turned out to be hollow: there was no plan to make sure that he would go, and no action came when he didn’t go.

A spasm of bombing in Syria that is unrelated to a broader plan for ending the conflict and changing the regime there won’t restore this Administration’s credibility on the Syria issue. As always, let’s hope that there are things going on behind the scenes that we haven’t read about in the newspapers—but based on the the facts available to the public at this time it appears that the United States is about to bomb Syria without really knowing what it hopes to accomplish. Clausewitz would not be pleased.

No shit.

Although I could, on a very narrow margin, rationalize using force aggressively against Assad to achieve strategic and humanitarian objectives, I cannot abide any military operation in Syria undertaken by this administration.  Its painfully obvious lack of any strategic sense and utter incomprehension of the way that people like Assad and the mullahs think means that any military action that this administration devises will be entirely counterproductive.

I am by nature a pugnacious person. (Who knew?) It takes quite something to turn me into a pacifist.  But Obama has turned the trick.  Quite an achievement.

August 29, 2013

By Popular Demand: Clearing Mandates and Systemic Risk

A couple of people have expressed interest in my paper on clearing mandates and systemic risk.  So here it is.

In a nutshell: the arguments that clearing (and non-cleared derivatives) collateral mandates will reduce systemic risk are fundamentally flawed.  Ironically, this is because the analyses do not take a truly systemic approach.

My counterarguments will be familiar to those reading my posts on clearing over the past five years (!) but this piece lays them out in one place.  One stop shopping, as it were.  Or maybe one stop slashing.  (One of my lawyer clients remarked to his partner yesterday that I wrote “slashing” blog posts.  I said “Don’t leave out the burning!”)

August 28, 2013

“A Shot Across the Bow”, AKA Distilled Strategic Idiocy

Filed under: Uncategorized — The Professor @ 8:30 pm

I surely hope this is the biggest head fake in history.  Because if it isn’t, we are so screwed:

President Obama on Wednesday advocated a “shot across the bow” for Syria in the interest of U.S. national security, despite growing concerns from congressional lawmakers over the possibility of an American military strike.

In an interview with PBS, Obama for the first time said publicly the U.S. has concluded the Syrian government carried out a chemical weapons attack against civilians last week, saying the administration does not believe the country’s opposition has such weapons at their disposal.

Obama said he has not yet made a decision on how to respond, but said “international norms” state the use of chemical weapons should not be tolerated.

“We cannot see a breach of the nonproliferation norm that allows, potentially, chemical weapons to fall into the hands of all kinds of folks,” Obama said, saying U.S. national security could be at risk if that occurred.

“If we are saying in a clear and decisive but very limited way, we send a shot across the bow saying, ‘stop doing this,’ that can have a positive impact on our national security over the long term,” Obama said.

Shot across the bow?  Seriously?

And what if the Syrian ship doesn’t heave to?  What then, Sun Tzu? And why would you expect them to heave to?  Assad is in a struggle for survival, after all.

International “nonproliferation” norms?  Do you think dictators in existential struggles give a flying f*ck about “international norms”?  And, um, this isn’t a proliferation issue.  This isn’t a fall-into-the-hands-of-the-wrong-kind-of-folks issue.  (“Folks”?  Seriously.) This is a use issue. They already are in the wrong hands, for crissakes.

Why should a dictator fighting for his life capitulate to a “very limited” strike?  Won’t the limited nature of the strike tell him that we are not serious?

Those questions are purely rhetorical.

I’m also rather mystified at the fetishization of chemical weapons.  Yes, death by chemical weapons is horrific.  But so is death by artillery, bombing, automatic weapons, and bayonets. 100,00 have perished by “conventional” means in Syria: the death of one percent as many people by “unconventional” means somehow justifies actions that the far more numerous deaths by HE and flying lead don’t?

And I have yet to see Obama or anyone in the administration articulate how any intervention-let alone “very limited” intervention that is guaranteed to be totally ineffectual-will advance US interests.  Not one mention of the implications for the Middle East, specifically the standoff with Iran, stability in Lebanon, Hezbollah, Israel, anything. But I guess that’s because for the “progressive” left, advancing American interests is a bug, not a feature.

This interview is truly a distillation of strategic idiocy.

Another Free B(I)S Sandwich

Filed under: Clearing,Derivatives,Economics,Financial crisis,Politics,Regulation — The Professor @ 8:04 pm

A quick reprise on the BIS study purporting to show that Frankendodd and EMIR will increase economic growth by better than .1 percent per year.

A footnote in my earlier post questioned whether multilateral netting via single-category CCPs really reduced exposures substantially, if at all, compared to cross-product bilateral netting.  The BIS study assumes-without any support that I can identify-that multilateral netting via CCPs is four times (!) as effective in reducing exposures as bilateral netting.

Again, I’m aware of no theoretical or empirical support for this number.  The standard Duffie-Zhou theoretical analysis doesn’t reasonably support such a conclusion, and that is a purely theoretical exercise.  Such a remarkable assertion should require some empirical support.

More importantly, this assumption begs a huge question: since derivatives counterparties internalize the benefits of netting (even when it imposes external costs on other claimants), if multilateral netting compresses exposures by so much, why weren’t banks falling over themselves years ago to move trades to CCPs, thereby reducing (shifting, actually) risk and freeing up capital? Why is it necessary to unleash Frankendodd to force dealer banks to pick up this money off the sidewalk?  I thought they were greedy SOBs.

I see only two answers.  First, that the netting economies really aren’t that large.  Second, the dealer banks recognized that that increased netting merely transferred exposures to other creditors, who would adjust the prices of credit accordingly, making the (alleged) reduction in derivatives exposures not worth the cost of setting up and operating a CCP, posting collateral, etc.

Either way, there is no way to reconcile the BIS report’s claims that (a) netting of derivatives exposures is true net benefit, and (b) this net benefit can be achieved only as a result of regulation that forces dealer banks to clear to achieve multilateral netting economies.  Indeed, to the extent that netting redistributes wealth from non-derivatives creditors to derivatives counterparties, dealer banks would have an excessive incentive to adopt clearing/multilateral netting.

In other words, the BIS report implicitly assumes that greedy bankers stupidly overlook oodles of money ready to be stuffed into their pockets.

Why do I get the impression that this was a put-up job intended to give the G20 something to crow about at the upcoming meeting in St. Petersburg?

John Kiff of the IMF tells me via Twitter (where he tweets as @kiffmeister) that the report recognizes some of the problems I identified in my post, namely that there are other sources of systemic risk than the counterparty risk channel that is the basis for the analysis.  Yeah, that’s true, but I have looked through the report carefully, and can find no recognition whatsoever of the fact-and it is a fact-that collateral and netting have redistributive effects.

August 27, 2013

Russian Hospitality

Filed under: Military,Politics,Russia — The Professor @ 8:30 pm

The latest in the Snowden fiasco is a report in Kommersant, which claims that Snowden stayed at the Russian consulate in Hong Kong for several days, including his birthday. Ah yes, that famous Russian hospitality.

Now, obviously Eddie didn’t look up the address in the phone book,  knock on the door and say: “Hey bro, I’m kinda hot right now and I need a place to stay.  Can I crash on your couch?  And hey, it’s my birthday: let’s party!”  Either he had pre-existing contacts with the Russians, or more likely, Wikileaks and/or Poitras/Greenwald had such contacts, and used them to secure Snowden a place to hide.

Which raises some questions.  Were these contacts that had been developed for reasons independent of Snowden, which Harrison or Poitras drew upon when things started to close in on Snowden in Hong Kong.  (The US had filed an extradition request the day before Snowden bunked with Boris and Natasha.)  Or, had Poitras and perhaps Wikileaks and perhaps Snowden/Appelbaum/Greenwaldj been working with the Russians in connection with Snowden’s espionage?  I lean towards the first interpretation, but don’t rule out the second.

Regardless, the story makes Putin’s “I’m Shocked! Shocked! that Snowden turned up here” routine look totally disingenuous.

One other aspect of the Kommersant story: it says that Snowden couldn’t accompany all those journalists to Havana because the Cubans caved to American pressure, and denied him permission to enter the country.  This is looking like a mistake.  It would be better for the US for Snowden to be anywhere but Russia.

But Russia could have arranged for Snowden to leave the country without having to worry about US leaning on any transit country.  A Russian flotilla just docked in Venezuela.  Why didn’t Eddie hitch a ride?

Obama Chooses Door Number Two. The Worst Choice.

Filed under: Military,Politics,Russia — The Professor @ 11:58 am

As I wrote over the weekend, I am ambivalent about going into Syria, perhaps leaning slightly towards a robust air campaign undertaken with the explicit objective of facilitating the fall of Assad’s regime. What I am not ambivalent about is the middle option.  A symbolic strike, or a punitive one.

But, of course, that’s apparently what Obama is going to do:

Any strike by the United States and its allies on Syria will probably aim to teach President Bashar al-Assad – and Iran – a lesson on the risks of defying the West, but not try to turn the tide of the civil war.

U.S. and European officials say a short, sharp attack – perhaps entirely with cruise missiles – is the preferred response to what they believe is Assad’s responsibility for a chemical weapons attack on rebel-held areas last week.

If such a strike goes ahead, President Barack Obama’s administration will have to select its targets with extreme care as it tries to deter not only Assad but also Syria’s ally Iran over its nuclear program.

“The administration has to decide what its objective is – punishment to show that there is a price and to re-establish a deterrent, or to change the balance of power in Syria,” said Dennis Ross, a top White House adviser on the Middle East until late 2011. “I suspect it will be geared towards the former.

We should be thinking Linebacker II.  But Obama is evidently going with Rolling Thunder Lite.

I say again: Assad is facing a battle for survival.  He wouldn’t have used CW if he didn’t believe his survival is at stake.  Punitive, “extremely careful” strikes will not do that, and will in fact tell Assad-and the Iranians-that we are not serious.  That we are not a serious threat to his survival.

This is the worst option.  The worst. It will have the same diplomatic blowback that a robust strike would have, but will achieve nothing on the ground.

It also appears that Obama is going to proceed without even a fig leaf of Congressional approval.  This is wrong as a Constitutional matter, but it is also a huge mistake for Obama.  The inevitable failure will be his and his alone.

It ain’t just me.  Walter Russell Mead is aghast.  The Institute for the Study of War provides a detailed analysis showing the futility of the limited strikes that Obama will apparently launch.

This is nuts.

Speaking of nuts, there is a story making the rounds about that the Saudis tried to entice the Russians to bailing on Assad by promising cooperation to control the oil market, the gas market, and to keep Chechen terrorists in check.  I call bullshit.  First, the Saudis have been trying to get Russia to cooperate with OPEC for years.  It’s always the Russians who have said no.  Second, and more importantly, I doubt that the Saudis control the Chechens, and even if they did, there is no way in hell they would say this to the Russians.  This sounds like some Russian info op.

August 26, 2013

The BIS: Out to (a Free) Lunch

The BIS has released a report titled “Macroeconomic impact assessment of OTC derivatives regulatory reforms.” It concludes that the benefits of these reforms-including Frankendodd-will greatly exceed the costs, because (a) financial costs of a financial crisis are immense, and (b) the reforms will greatly reduce the probability of a financial crisis.  Specifically:

In its report, the MAGD focuses on the effects of (i) mandatory central clearing of standardised OTC derivatives, (ii) margin requirements for non-centrally-cleared OTC derivatives and (iii) bank capital requirements for derivatives-related exposures. In its preferred scenario, the group found economic benefits worth 0.16% of GDP per year from avoiding financial crises. It also found economic costs of 0.04% of GDP per year from institutions passing on the expense of holding more capital and collateral to the broader economy. This results in net benefits of 0.12% of GDP per year. These are estimates of the long-run consequences of the reforms, which are expected to apply once they have been fully implemented and had their full economic effects.

Don’t believe it for a minute.  The methodology of the analysis is irretrievably flawed.  The net benefits are the free-est of lunches, because the report does not take into account the redistributive aspects of the collateralization and netting that results from clearing, capital, and uncleared derivatives collateral mandates.  That is, it fails to recognize that the reduction in counterparty credit losses on derivatives that result from the “reforms” are accompanied by an increase in losses suffered by somebody else.  It accounts for a transfer as a social gain.

In broad strokes, the BIS analysis goes as follows.  Financial institutions are connected to one another by OTC derivatives trades.  One way of measuring this interconnection is the CVA-the credit value adjustment on derivatives trades.  The CVA is (roughly speaking) loss given default per dollar of exposure times credit exposure times the probability of default.  If a given bank, B say, takes a hit of X to its balance sheet, due to a bad investment, or a rogue trader loss, or whatever, its probability of default goes up.  This raises the CVA.  This is immediately recognized as a mark-to-market loss, dollar for dollar, by its counterparties.  These counterparties tend to be systemically important banks, and the loss makes them more leveraged.  The greater leverage makes them riskier, and more subject to default.  This raises their probability of default, which imposes CVA losses on their counterparties, and on and on.  In this way, a shock to one bank propagates throughout the system, and feedback effects intensify the original effect.  The end result is that major financial institutions become more leveraged, and the more leveraged the system, the more prone it is to a very costly crisis.

But Frankendodd lurches to the rescue!  By collateralizing and increasing netting*, Frankendodd reforms reduce credit exposure in derivatives.  Therefore, the CVA hit from a given rise in the probability of default is smaller.  The leverage in the system doesn’t rise nearly as much when bank B takes the hit of X to its balance sheet.  So a given shock has a substantially smaller impact on systemic leverage, and hence systemic risk.  Yay!

Not so fast, people.  Notice the flaw in the logic?  Remember what started the cascading effect in the pre-Frankendodd world: an increase in the probability of default at B due to some adverse shock to its balance sheet.  Collateral and clearing mandates reduce the exposure of derivatives counterparties to this shock.  But a default doesn’t just affect derivatives counterparties: it hurts all of B’s creditors.  Roughly speaking, the total cost incurred by B’s creditors as a result of an increase in the probability of default due to the loss of X is loss given default times total liabilities times the change in the probability of default.  Given total liabilities, this does not change when derivatives are collateralized or netted more extensively.  This, in turn, means that the decline in derivatives CVA that results from more derivatives collateral and netting is matched by an increase in losses suffered by other creditors.  The “reforms” shift around the losses: they do not reduce them in aggregate.

That is, the “reforms” don’t reduce the losses that result from the balance sheet shock that raises B’s probability of default: they redistribute them.  Note, moreover, that many of the same big financial institutions that benefit from the decline in derivatives CVA are hurt by the loss on B’s other liabilities, because these institutions are exposed to one another through a variety of claims, not just derivatives.  Moreover, some of the others (non-bank creditors) that suffer from the redistribution may be systemically important too: money market funds that invest in the short term debt of financial institutions (including B) are one example.  Repo is another example.  Thus, the overall effect of Frankendodd and EMIR on systemic risk is quite equivocal.  It shifts around losses, and there is no guarantee that the shift in losses improves the stability of the financial system.

But the BIS study does not treat the redistributive effects of the derivatives reforms.   It treats them has a net gain.  This is fundamentally, basically, and irredeemably wrong.  Wrong, wrong, wrong.  When evaluating systemic risk, it ignores the systemic redistribution of losses.  As a result, it overestimates the gains of the regulatory changes.

To a first approximation, given the redistributive nature of their effects, the benefits of the reforms is zero.  The BIS recognizes that they involve costs.  Meaning that to a first approximation, Frankendodd and EMIR reduce wealth, rather than increase it.

But that’s just a first approximation.  To understand fully the effects, you’d have to know how losses are redistributed, and the systemic importance of those who suffer bigger losses and of those who realize smaller ones.  You’d also have to understand how financial contracts will change in response to the new set of creditor priorities inherent in the Frankendodd and EMIR rules.   Financial contracts-capital structures, if you will-will change in response to the new rules.  Claims will be repriced.  There is going to be a new, different equilibrium structure of financial contracts.  Maybe this new structure is less fragile.  Maybe it is more so.  I don’t know: the system is so complex that it will respond to this big shock in surprising ways.  All I do know is that this where you need to look to figure out the effects of the so-called reforms on systemic risk, and this ain’t where the BIS looks.  It counts benefits conferred on some subset of claimants, while ignoring the costs imposed on others (that are approximately equal in magnitude).

In other words, the BIS is hawking a free lunch, and as Friedman said, there ain’t no such thing.

The BIS study also has a particular model of systemic risk: the counterparty credit contagion model.  B takes a hit, that spreads to C, D, and E, which then spreads to F, G, and H, and on and on, until most everyone drops dead like Aztecs fell to the smallpox.  This is a common way of formalizing systemic risk, but reminds me of the story of the drunk looking for his keys under the lamppost because the light is better there, not because he lost them there.  If you look at the history of financial crises, they almost never look like the systemic crises in these contagion models.  An idiosyncratic shock at one institution doesn’t bring a house of cards crashing down.  The collapses of individual institutions (Bear, Lehman) are symptoms of a deeper-and systemic-rot.

In sum, the BIS analysis is fundamentally flawed, and hence gives a wildly misleading estimate of the social benefits of the clearing and collateral mandates embedded in Frankendodd and EMIR and regulations adopted by other G20 nations.  It is a sad, sad example of a reputable institution falling prey to free lunch fallacies.

It is particularly sad because it’s not as if this hasn’t been pointed out before.  I raised the problem five years ago.  So you may say-well, who are you anyways?  Well, Harvard’s Mark Roe, one of the most accomplished bankruptcy scholars in the legal academy, has made the same point (and graciously cited my work).  And, truth be told, it is a staple of the bankruptcy literature.  And it’s also sad because I hear such “logic” over and over from regulators (e.g., scholars and policymakers at the Fed).  They presume to identify systemic benefits based on analyses that look at only a portion of the system.

And speaking of sad.  Could the BIS please spring for a typesetting program like LaTeX that prints readable equations?  Please?

* It is by no means clear that moving more trades to clearing will reduce credit exposures in derivatives via netting, especially given the fragmentation of CCPs by product and jurisdiction.  CCPs permit multilateral netting, but (a) bilateral trades can be compressed multilaterally, and (b) cross-product netting of exposures within dealer books can be larger than multilateral netting in single-category CCPs.  But that’s really a secondary issue.  The most important thing to remember is that the primary effect of netting is to redistribute default losses from derivatives counterparties to non-derivatives creditors.

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