Streetwise Professor

So Edward Snowden has allegedly released a statement justifying his actions.  I say allegedly because there is nothing that actually connects this statement to him:

Former National Security Agency contractor Edward Snowden spoke publicly for the first time in many weeks, sort of. The famed leaker didn’t speak for himself; rather, someone read a written statement on his behalf before a committee hearing at the European Parliament in Brussels on Monday.

Read closely.  It’s not just that Snowden didn’t speak for himself, it’s not even certain that he wrote the words read “on his behalf”: “someone read a written statement on his behalf.”  That kinda insinuates he wrote the statement, but the author of the article is obviously not willing to assert that conclusively.  It doesn’t say that Snowden “wrote the statement read . . . on his behalf.”  There was a written statement.  Someone read that statement on Snowden’s behalf.  Like a classic con or deceptive ad, you’re expected to conclude Snowden wrote the statement read on his behalf, even though that’s not what the sentence actually says.  It invites your mind to fill in the gaping gap.

Please. I could read a written statement on behalf of Pancho Villa.  Doesn’t mean that Pancho Villa wrote it, or even endorsed it.

So we have these words that the reporter suggests were from Snowden’s mouth, but nobody saw Eddie’s lips move.

Was a burning bush involved?

And for crying out loud, why does Eddie need people reading stuff on his behalf?  If he is truly a free agent, he could put videos on YouTube: as @libertylynx notes, if Al Alwaki can post YouTube videos, why can’t our Ed?

Obvious conclusion: Snowden is not a free agent.  Likely conclusion: Snowden did not write these words.

So who did?  There are some Greenwald tics (“odious” is one of his favorite words).  And some Appelbaum tics (“creative output” is one of Appelbaum’s h/t @libertylynx.)  I’m guessing a collaborative effort, sort of like Murder on the Orient Express, involving Greenwald, Appelbaum, Poitras and maybe Assange.  Or to extend the Biblical analogy: it’s widely accepted by Biblical scholars that the Word of God is actually the creation of a committee.  This statement, and the acceptance speech for the human rights award won by Snowden (and read by Appelbaum), sure have the same feel.

But let’s suspend disbelief for a minute. Let’s take it as given that these words were written on tablets handed down by Ed.

Behold:

“The surveillance of whole populations, rather than individuals, threatens to be the greatest human rights challenge of our time,” Snowden, via Radack, continued. “The success of economies in developed nations relies increasingly on their creative output, and if that success is to continue, we must remember that creativity is the product of curiosity, which in turn is the product of privacy.

Does this make any sense?  Re surveillance of whole populations, as @catfitz notes, the surveillance of a very limited subset of information on everybody by a big machine is very different from surveillance of an individual by a pair of human eyes: the former is what Snowden has disclosed, and the latter is what we should really be focused on-and which Snowden provides no evidence occurred outside the law.  And how is curiosity the product of privacy?  And how can creative output help economies if it’s secret?  What pompous tripe.  (More evidence of Appelbaum authorship.)

And more:

“If we are to enjoy such debates in the future, we cannot rely upon individual sacrifice. We must create better channels for people of conscience to inform not only trusted agents of government but independent representatives of the public outside of government. When I began my work, it was with the sole intention of making possible the debate we see occurring here in this body and in many other bodies around the world.”

First, who appointed Snowden to this role? He claims to hold others to account: to whom is HE accountable?  In fact, he ran to Russia precisely because he wanted to escape accountability.

Second, there are unintended consequences: why should Snowden’s intentions matter?  The consequences of his acts are what are relevant.  The road to hell is paved with good intentions: and like I say, Snowden’s road led to Russia, which is sort of the same thing.

And third: note the pompous, grandiose tone.

Serendipitously, I was reading World War II Magazine this weekend, and came across an article about another young, grandiose American bureaucrat with access to highly sensitive information that he believed he had both the right and the obligation to reveal to achieve some higher purpose.

Tyler Kent was a clerk who decoded highly classified messages in the US embassy in London in 1940.  Many of these messages were between Churchill and Roosevelt.  Some of these messages involved attempts of FDR to supply Great Britain with war material, arguably in defiance of the Neutrality Acts.

Kent was a Lost Cause Southerner, anti-Semite, and isolationist.  He fervently believed that the US should not become involved in any way in the European war, and that FDR was illegally maneuvering to bring the US into the conflict.  There were many Americans who believed the same thing, and who would have seized upon the documents he stole to accuse the administration of crimes  in the same way that many in the US today have seized upon the documents Snowden stole to accuse the US government of crimes.

Moreover, Kent was in contact with right wing elements in Britain that were opposed to Churchill and supported a peace with Germany: he and they were hoping Kent’s documents could be used to discredit Churchill and isolate his government from American support, thereby achieving their objective, much as Snowden is directly and indirectly connected with various anti-US and anti-German elements in the US and Germany, and as Snowden documents were used (unsuccessfully) by Der Spiegel in an attempt to sway the German elections.  Last, but not least, Kent was deeply enmeshed with Russian intelligence forces: his mistress was NKVD operative, he circulated in groups that were deeply penetrated by Soviet intelligence, and the only question is whether Kent was a knowing or unwitting tool of the NKVD.

So more than 70 years apart we have young, grandiose individuals who believed that their theft and disclosure of highly classified information was a righteous act aimed to end the criminal acts of the government that they had sworn to serve.  Both Kent and Snowden claimed that their intentions were entirely idealistic.  Both were objectively, if not subjectively, serving the interests of truly malign powers: and the most plausible interpretation is that somewhere along the line, they became objective servants of malign powers that were enemies of the US.

Another revealing aspect of the story.  Kent’s treason was discovered by MI5, which had thoroughly penetrated the pro-Nazi groups that Kent was in communication with.  MI5 soon began to spy on Kent quite closely, and eventually raided his apartment, where they found the documents he had stolen.  Suitcases full of them: the 1940 equivalent of USB drives.  (They also found a Russian emigre woman who was almost certainly an NKVD agent: Kent was wearing his pajama bottoms, and the woman his pajama top.)

This, boys and girls, is exactly why allies spy on allies.  Because not everyone who works for an ally is an ally.  In fact, some are the most dangerous of enemies.

And the US was damn glad that the Brits were spying on an American.  I am convinced that say, the Germans, are quite happy that we are spying on them, for they know they have people working for them who are actually working against them.

One final note.  Churchill used the Kent episode to convince a hitherto reluctant Home Secretary John Anderson to support a parliamentary act authorizing the arrest and detention of suspected Nazi supporters.  Unintended consequences are a bitch.

Kent was tried by the British.  Note this further parallel:

Some Americans saw Kent as a martyr whose only sin had been to act boldly in an effort to keep their country out of a European War.

Ambassador Joseph Kennedy was hardly so sympathetic: “I wouldn’t have favored turning Kent over to Scotland Yard or have sanctioned his imprisonment in England.  I would have recommended he be brought back to the United States and shot.”

Edward Snowden need fear no such fate. Other than that, he has a lot in common with Tyler Kent.  A lot.

In one of those episodes of Kabuki theater so common in Russian politics, Igor Sechin and Prime Minister Dmitri Medvedev discussed buying out minority shareholders in TNK-BP.  Medvedev expressed concerns about Russian corporate governance, and the nation’s bad reputation among international investors, and suggested to Sechin that a gesture by a state corporation could help improve this image:

Warning that Russia faced an economic “abyss” if it did not push through serious market reforms, Mr Medvedev urged Rosneft to improve corporate governance. “A state company can give an example of the right way to treat minorities. This will improve the investment climate,” he said

Sechin responded by saying that the company would consider voluntarily buying out minority shareholders in the TNK-BP holding company, despite the fact that it was under to legal obligation to do so.

My first reaction was one of surprise, and positive.  Then I saw the details.  Medvedev and Sechin agreed that the minority holders would be paid a 20 to 30 percent premium over the average price over the last several months.   A premium? Great, right?

Not really.  Sechin’s previous refusal to buy out the minority shareholders had crushed the share price.  He said they’d get squat, and the stock price fell to squat.  Now he’s generously offering to pay squat plus 20 percent.  Yes, this is better than nothing, but doesn’t really represent reasonable compensation.

In other words, the stock price was predicated on an estimate of what pittance Sechin might be persuaded to part with, rather than an objective appraisal of the value of the shares.  Offering to pay a small premium over the pittance price is hardly a great boon to the minority holders.

In terms of precedent, it also creates uncertainty due to the circularity of the process.  Think about a future episode.  The price of minority shares will depend on what shareholders and potential buyers think the acquirer can be persuaded to give up in compensation.  This compensation is not based on an independent appraisal of the value of the assets but the previous price, which is based on an estimate of the compensation; this is an infinite loop with no linkage to the value of the assets which the shares give a claim to.   This makes the price indeterminate.

The only thing that likely connects the price to value is the knowledge that someone in Sechin’s position would refuse to go along with the deal if the compensation paid represented a large fraction of value.  That is, in the present instance, Sechin may be willing to act all cooperative because the stock price has been so far below value that he’s not really giving up that much.   Here the fraction of value believed acceptable to the acquirer can anchor the stock price to value-or, more accurately, some fraction of value.

For instance, say the fair value of the shares is 100 Rubles, and that it is widely believed that an acquirer like Sechin will be willing to pay 15 percent of this value to make the minority shareholders go away, or to get political pressure off his back, or to make it look like he’s being all magnanimous.  So the shares sell for 15 Rubles.  If the conjecture is correct the future Sechin will be able to get the shares for 15 Rubles, which he’s willing to pay, but which is far below value.   So again, it’s what the acquirer is willing to pay-or believes he can get away with paying to avoid political flack-rather than value that determines price.  That doesn’t provide any real protection to minority shareholders.

This means that this apparent concession really doesn’t fix the fundamental problem that vexes Medvedev.  Only some independent appraisal mechanism and a legal obligation to treat minority shareholders fairly will do that.  Tying the buyout price to the previous market price doesn’t.

Speaking of Medvedev, this Kabuki play seems to be a part of a political campaign on his part.  In addition to the colloquy with Igor, he published a long article in Vedemosti raising an alarm that Russia faced a serious risk of prolonged economic stagnation.  The central part of his diagnosis is Russia’s institutional rot, the natural state that I’ve written about since the very early days of this blog:

I believe that the protection of private property and competition remains our unconditional political priority. The Russian economy still posts low investment levels, and this is not only caused by specific arithmetic calculations of potential capital-efficiency volumes. Investors still harbour irrational fears of working in an incomprehensible and sometimes unpredictable Russia. Add to this the absolutely explainable distrust of public institutions, including the judicial system and law-enforcement agencies. This is something which is very sad. As Fyodor Dostoyevsky wrote, capital likes external and domestic stability, otherwise it hides.

Among other things, this situation is caused by the fact that many officials, judges and police officers (although, of course, not all of them) still believe that state property, and therefore state companies, have the right to better protection, and that these rights are infinitely greater than those of individuals. They also believe that the latter pursue exclusively personal interests and are therefore suspicious and must be rigidly controlled.

The most frequently quoted phrase in this (“the irrational fears”) actually doesn’t make sense: in context, it is clear that Medvedev believes the fears are very rational.  Read that way, the diagnosis makes perfect sense: it’s not all that different from what I’ve written here for years.

But when it comes to recommending reforms, Medvedev shrinks from his diagnosis and advances technocratic proposals that will do nothing to correct the very real evils he identifies in the paragraphs quoted above.  The proposal that companies like Rosneft and Gazprom create and operate their own universities is particularly risible.  Russia’s problem is not a shortage of institutions of higher education, and the idea that corrupt and hidebound entities like Gazprom or Rosneft would be able to become world class educators is so bizarre that one wonders what Medvedev was thinking.

In other words, Medvedev is playing his by now familiar role of being one of the few in the elite that speaks frankly about Russia’s serious institutional weaknesses (Kudrin being another), but being completely unable to do anything about it.  The buyout of the minority shareholders in TNK-BP is just another one of those token efforts that betray an understanding of the Russia’s fundamental problems, and the complete lack of will to do anything serious about it.

Now meth heads will have someone to look down on.  Krokodil has reached the US.  This is bad, bad stuff.  I cannot even imagine how anyone can think of putting this stuff in their bodies.

Was this stuff imported from Russia?   Or did somebody just import the “recipe”?

My frequent sparring partner, John Kemp of Reuters, reads the IHS study justifying the benefits of bank involvement in commodity markets, and is not convinced. I agree that the report is rather lame, but am not convinced by Kemp’s critique, and the policy implications he draws.

One of Kemp’s points is that banks are not essential to the purchase, sale, transportation, storage, or processing of commodities.  Other entities, most notably commodity trading firms like Vitol or Glencore or Trafigura, can provide the same services as the banks.

This is true, but beside the point.  There are few types of firms that are utterly essential, with no substitutes.  Even banks are not irreplaceable in the functions that Kemp, and others, agree is appropriate for them.  Their core function of providing credit can be performed by the capital markets.  Or loan sharks.

The fact that banks can profit as a result of their activities in physical commodities should create a rebuttable presumption that they are providing economic value.  In a reasonably competitive market, where costs and benefits are internalized, firms that survive do so because they can provide a good or service of equal or better quality at equal or lower cost to other potential suppliers.  Indeed, in these circumstances, all active sellers have marginal costs that are approximately equal: cost functions determine the relative outputs of the active suppliers.   Driving out suppliers who can profitably service part of the market will drive up prices, reduce output, and reduce welfare: some of the output supplied by the eliminated firms will go unproduced, and the rest produced at higher cost.

Competition is not the issue. The market for commodity intermediation is highly competitive: even the big banks account for a relatively small share of activity, and the biggest players account for no more than 5-6 percent of trading activity in any major commodity market.  And even if banks accounted for a big share, that could be due to a cost advantage.

Which brings me to Kemp’s second objection, which potentially has more merit.  The above says “where costs and benefits are internalized.”  Kemp brings up, quite properly, the possibility that banks get a subsidy as a result of too big to fail, and hence the true costs of their activities are not internalized.

The immediate implication of this is that banks are too big, and that there market share in physical commodity activities is too big.  But “too big” does not mean that the right share is zero.  Banning bank participation in physical commodity markets, or excluding them from certain activities, is likely to be an overreaction, not a Goldilocks (“just right”) strategy.  They might be too big now, but zero is almost certainly too small.

Note too that eliminating banks from physical commodity markets, or restricting their participation, does not eliminate the TBTF subsidy.  Yes, they might not be able to exploit the subsidy by getting too big in commodities, but they are not going to let the subsidy money burn a hole in their collective pockets.  Won’t let them exploit the subsidy in commodities?  They’ll find someplace else to do it.  Restricting activity in one market segment will not appreciably reduce the TBTF subsidy that banks reap.

The right way to address this problem is to find ways to get banks to internalize the true costs.  This is best done by capital requirements that reflect the risks of the activities banks engage in, and the costs associated with bail outs.  Restrictions on permissible activities are a meat cleaver approach that will not mitigate the TBTF subsidy.

Kemp also goes on about the metals warehouse games.  As I’ve said repeatedly, both here and in media interviews, banks are not uniquely positioned to engage in such sorts of shenanigans.  If the conditions are right, whoever owns the warehouses will play the games. The best way to deal with this problem is ex post deterrence, either through private action (e.g., the numerous class action lawsuits against Goldman for its alleged warehouse manipulations) or government enforcement actions.

The role of banks in physical commodity markets will remain under scrutiny-and attack-for the foreseeable future. Many of these attacks are predicated on ignorance, not to say stupidity.  Kemp isn’t guilty of those things, but his analysis is nonetheless misguided.  Even when he identifies a real potential problem-the TBTF subsidy-eliminating banks from the physical commodity market is not the appropriate way to address it.

This illustrates a general point I’ve mentioned in many forums.  Attempting to address TBTF problems, and systemic risk problems, through structural interventions such as clearing mandates, SEF mandates, Glass-Steagall, or preventing banks from participating in commodity markets, is inefficient and likely ineffectual.  It is better to operate at the level of fundamental incentives, by getting banks and other financial intermediaries to internalize the costs and benefits of their activities. This is an easy principle to state in the abstract, though hard to implement in practice: just what is the right capital charge overall, and how should different bank activities contribute to this charge?  Not an easy question to answer.  Although imperfect, that’s still a better way of addressing these problems than mandating market structures.

If you want an illustration of the primitiveness of the Russian economic and political system, and that of the systems in the Former Soviet Union generally, look no further than this story.

In terms of economic primitiveness, the fact that a dispute over potash (potash! FFS)  is elevated to a matter of state requiring the direct involvement of heads of state illustrates perfectly the dependence of FSU countries on the production and export of basic materials.  For all the yammering about economic transition, all the FSU economies, including notably Russia’s, remain dominated by the production of basic materials.  As witnessed by evidence accumulating day-by-day that the FSU countries are becoming economic satrapies of China, as demonstrated by the Chinese acquisition of a large stake in Uralkali, the mooted Chinese acquisition of huge tracts of land in Ukraine, and the plethora of Chinese energy deals in Kazakhstan and Turkmenistan.

But the episode is more interesting for its demonstration of the institutional primitiveness of Russia, and the other FSU countries.  In advanced countries, commercial disputes are adjudicated or arbitrated through institutional processes:  indeed, they would have never have progressed to the point at which Belarus and Russia now find themselves.  But the institutional underdevelopment in Russia and Belarus and other FSU states means that rule is personalized, and commercial disputes between large businesses must be resolved-or not-through the personal intervention of heads of state.

Could anything illustrate more tellingly the personalized, de-institutionalized nature of rule in Russia than Putin’s personal involvement in such a matter?  Could you hallucinate, even after a bender that would put the Hangover I, II, or III to shame, Obama or Bush or Clinton doing any such thing?  And this is not a one-off.  Putin is repeatedly involved in grubby commercial negotiations (usually over natural resources) within Russia, and between Russia and other FSU countries.

This is a perfect illustration of why I have long believed that Russia is doomed for perpetuity to exist in an economic limbo as a natural resource state falling further and further behind not just more advanced, institutionally developed nations like the US, but even other institutionally challenged countries like China.

In other words, the Former Soviet Union is Totally F’d Up.  And will remain so.

A few days back the WSJ ran an interview with security software expert and entrepreneur Eugene Kaspersky.  It includes several nuggets of comedy gold.  Like this:

WSJ: How would you describe your relationship with Russia’s security agencies?

Mr. Kaspersky: It’s exactly the same as with other agencies [around the world]. Maybe it was developed before we did it with other countries, because I am based here in Moscow. But technically it’s almost no different: Supporting them with investigations. They are responsible for the investigation of high-profile attacks. So we do this work for them if they don’t have their own resources.

WSJ: Do they pay you?

Mr. Kaspersky: No, it’s free. We advise them about national cybersecurity strategy. That’s the same as we do in Washington, and the same in Brussels. From time to time, we have requests about investigations, and if we find a high-profile victim in Russia, of course we also report it. That’s the same as we do in countries around the world. [High-profile victims include] ministries, governments, science, space, critical infrastructure.

There’s a difference between “free” and “voluntary.”  You know that helping out the “security agencies” in Russia is a condition for doing business, staying in business, and staying out of jail-and maybe staying alive.  And its risible  that the relationship is limited to providing advice on “national cybersecurity strategy.”  You Kaspersky users: ask yourself what other services the firm is providing the FSB for free, and then go out and get yourself a different antivirus software.

Then there’s this:

WSJ: If you were to find a Stuxnet equivalent made by Russian authorities, would you report it?

Mr. Kaspersky: Of course we would report it.

If you believe that, Mr. Kaspersky has a deal for you! A famous bridge connecting two boroughs in NYC.  Only one owner!  Cheap!

This is truly important, so pay close attention!

Yesterday I was shocked to hear, and then catch a quick glimpse of, a P-3 Orion flying at low altitude (I guessed less than 2000 feet) over the University of Houston campus.  Then I heard it again.  And again.  And again today.   It is a four engine, prop-driven aircraft, so it makes a lot of noise at that altitude.

The primary use of the venerable P-3 is as an anti-submarine aircraft, a role it has played since the 60s (it is based on a Lockheed Electra airframe, a 1950s design).  Figured there were no submarines in downtown Houston, so I was very puzzled.

Today, taking my afternoon constitutional, I heard the plane and got a good view of it.  It didn’t have USN markings or color scheme.  Instead, it had a long blue stripe along the side.  Searching Google Images, I found a picture of a NASA P-3 with that color scheme.  A little more digging uncovered this article from the Baltimore Sun describing how NASA flew a P-3 at low altitude over Baltimore as part of an air quality testing program.  Yet even more digging and I was able to determine that yes, NASA is conducting tests under the AQ [Air Quality] Discovery program in Houston this month.

That mystery solved, I can get back to work.  Work will include a couple more posts this evening.

One of the enduring mysteries of the Snowden affair is whither Sarah Harrison.

Well, it’s not really a mystery.  She is caught in the same trap as Snowden.  She knows too much, and the Russian FSB (or is it GRU?) spider cannot let her  escape the web.

Assange is doing his best to suggest that Harrison is potentially in control of her fate.  But his rather pathetic efforts to do that show clearly that he is desperate to find out what her circumstances are, exactly.

A month ago, he tweeted that Harrison was in “self-exile.”

Really?  This raises an interesting question.  Just what kind of visa does Harrison have?  Russia is notoriously difficult on visa matters, and it has been an enduring mystery regarding what visa she entered the country on, and more importantly, on what visa is she staying in the country.  Tourist visas are for 30 days.  Sarah is well past that sell-by date.  But she remains nonetheless.

So maybe Russia has a super-secret “self-exile” visa.  Which she can’t tell us about herself.

Or maybe she’s a prisoner, in which case the visa is irrelevant.

If Sarah is at liberty, why isn’t she speaking for herself?  Apropos that: A few days ago Assange emailed a Brazilian newspaper appealing to the Brazilian government to offer Harrison asylum.  Via Google translate:

“The decision of President Dilma Rousseff to cancel the visit to Washington was an ” important symbolic act ,” Julian Assange said in an email sent to the Brazilian newspaper Folha de Sao Paulo. According to the publication, Assange wrote that “the measure should be followed by other initiatives such as grant asylum to British journalist Sarah Harrison ” Wikileaks member who accompanied Edward Snowden on his trip to Moscow.

. . . .

The Australian says that Harrison can not return to the UK for their involvement in the asylum application of former NSA contractor

. . . .

Julian Assange , during his participation from the Embassy of Ecuador in London , at the seminar “Freedom , privacy and the future of the Internet ” , in Sao Paulo . . . .  Assange also spoke about the relevance of that Brazil granted asylum to the British : “It’s an opportunity for the country to take the banner of human rights that the United States dropped. “

Joshua Foust tweeted that Harrison was asking for asylum.  Um, no, actually.  Harrison hasn’t been heard from by anybody since the Snowden press conference: Assange is begging for Brazil to offer asylum, and Harrison has nothing to do with this appeal.  And that’s precisely why Assange put this out.  This is his fishing expedition, an attempt to get the Russians to let her go, or at least provide some information on her status.

Good luck with that, Jules.  Assange is trying to play on Brazil’s anger over the Greenwald revelations that the NSA intercepts Brazilian communications, including Rousseff’s.  One problem.  Brazil rejected Snowden’s appeal for asylum after the Greenwald story came out.  Brazil’s official umbrage is for public consumption.  Canceling a visit is cheap: aiding and abetting Snowden and Harrison is something altogether different.

And if Russia is Assange’s real intended audience . . . LOLOLOLOL.  Like they give a crap about Jules, except for how they can use him.  Again, Sarah is the Woman Who Knows Too Much. She ain’t going nowhere, even if Brazil were to offer to let her lead the next Mardi Gras parade.

Speaking of Greenwald, there’s a typically mendacious interview with him in Ha’aretz, conducted by a typically mendacious journalist, Noah Shiezaf, the epitome of the Israel-hating Israeli (and hence a fitting interviewer for the America-hating American Greenwald).  There’s a lot in this interview, and I’ll say more about it later, but one thing jumped out:

Greenwald is currently at home in Brazil, where he continues to work on stories deriving from the Snowden material. My interview with him was conducted via Skype. Greenwald confirmed to me that he is in constant contact with Snowden, via encrypted chat services.

Constant contact? Really?

Hmm. La Cuckaracha-aka Snowden’s Kremlin supplied and Kremlin friendly lawyer Kucherena-sings a different tune:

“I am his only link with the outside world at the moment. Even his contacts with his parents are carried out through me,” Kucherena said in an interview published in Itogi weekly magazine.

So who’s the liar?

Well, both are, obviously.  This most recent claim of Kucherena that he controls all of Snowden’s contacts is at odds with his earlier statement that Snowden was free to travel, and does so:

“He walks around. He can travel. He does travel, because he is interested in our history,” said the lawyer, adding that nobody had yet recognised Snowden on his travels.

But even if you aren’t willing to go so far as to claim that both are liars, one has to be: Greenwald’s and Kucherena’s claims are utterly incompatible, so one of them has to be full of it.

And, pray tell Glenn, how can you be sure that the person on the other side of that encrypted chat is Snowden?  Seriously?  Or if it is Eddie, how can you be sure that he is not being instructed on exactly what to say by a mouth-breathing FSB/GRU minder?

You can’t.  Obviously.

Is it too much to ask some real journalist to call bullshit on this entire charade?  Why are Greenwald, Assange, and Kucherena able to spout such utter crap, without anyone pointing out that what they say is, well, utter crap?

Greenwald in particular.  Presumably because too many journalists are invested in his narrative, and believe it’s too good to check.  And to me, this enabling behavior is even more disturbing than Greenwald’s mendacious, agenda-driven “reporting.”

The BIS has been one of the major advocates for mandated clearing.  They have produced an analysis claiming that mandated clearing will increase GDP growth by .1 percent or more per annum.  I criticized this calculation claiming that it was predicated on a fallacy: namely, that multilateral netting and collateralization, result in a reduction in the costs of OTC derivatives borne by banks, and thereby reduce the risk that they will become dangerously leveraged.  In fact, these measures redistribute losses, and will not affect the overall leverage of a financial institution in the event of an adverse shock to its balance sheet.

Stephen Cecchetti, the head of the BIS’s Monetary and Economics Department has responded to this sort of criticism.  Here’s his argument regarding multilateral netting:

Before turning to the costs, I think it is worth responding to criticism of this approach. First, some critics have argued that, by focusing on derivatives exposures, the Group has ignored the impact of multilateral netting on other unsecured creditors. The main claim is that multilateral netting dilutes other unsecured creditors.

This is correct. Multilateral netting does dilute non-derivatives-related claims to some extent. However, this is neither new, nor is it unique to derivatives. In fact, repos, covered bonds and any other secured loans result in dilution and subordination. For repos, that counterparties can close out a position and seize collateral in default has led to comment and worry for some time. Given that this is all well known, I would think that it is already reflected in the pricing of the instruments involved. Presumably no one will be terribly surprised by this when it is applied to derivatives, and so the impact will be muted. It is a stretch to see how this redistribution of a part of the risk associated with OTC derivatives transactions increases systemic risk.

This argument totally fails to meet the criticism.

First, there has been some repricing, but it is incomplete.  Repricing only takes place to the extent that adoption of mandated clearing occurs, or is at least anticipated, and does not occur for derivatives contracts and other liabilities until they mature.  Since many derivatives and other liabilities have maturities extending well beyond the clearing implementation dates, these have yet to be repriced.

Yes, the most run-prone liabilities, such as short term debt, have been repriced, but that’s not all that important.  Even if banks adjust their capital structures to reflect the repricing, they will still have large quantities of such liabilities which are now more junior and which will pay off less in states of the world when a bank is insolvent.  The higher yield received in normal times compensates the creditors for the lower returns that they get in bad states of the world, and most notably in crisis times.  And it is exactly during these crisis times that these liabilities are a problem.  Due to repricing, there may be a lower quantity of such short term debt, but this debt will be more vulnerable to runs as a result of the subordination inherent in multilateral netting.  Excuse me if I don’t consider that a clear win for reduced systemic risk, and fear that it in fact represents an increased systemic risk.  That is no stretch at all.  None.  Cecchetti’s belief that it is a stretch reflects a cramped and incomplete analysis of the implications of subordination.

In terms of the BIS’s claim that will boost economic growth, Cecchetti’s argument does not rebut in any way what I have been saying.  The BIS argument is based on a belief that netting makes the pie bigger.  My argument is that it does not make the pie bigger, but just resizes the pieces, making some smaller and others bigger.  Nothing in what Cecchetti writes demonstrates the opposite, and in fact, his acknowledgement that netting dilutes other creditors is an admission that the effects of netting are redististributive.

Once that is recognized, the entire premise behind the BIS macroeconomic analysis of the OTC derivative reforms collapses, and the conclusions collapse right along with it.

Cicchetti mischaracterizes the critique when he insinuates that it means that netting increases systemic risk.  I’ve said that’s one possible outcome, but mainly have used the redistribution point to refute the claim (made by the BIS and others) that netting reduces systemic risk. The channel by which the BIS claims it will is predicated on the belief that netting reduces default losses rather than reallocates them.  If they only reallocate them-which Cicchetti effectively acknowledges-this channel is closed, and the asserted benefit does not exist.  It’s very simple.

Therefore, Cicchetti may “remain convinced that the Group’s analysis accurately captures the benefits of the  proposed reforms,” but his conviction is based on faith rather than economic reasoning: his attempted defense notwithstanding, the Group’s analysis is contrary to the economics.

Here’s what Cicchetti says about collateral:

A second concern that has been raised is that the regulatory insistence on increased collateralisation will simply redistribute counterparty credit risk, not reduce it. To see the point, take the simple example of an interest rate swap. The primary purpose of the swap is to transfer interest rate risk. But the mechanics of the swap mean that there is always a risk that the parties involved will not pay. This is a credit risk. In the case where the swap is completely uncollateralised, it is clear that the instrument combines these two risks: interest rate (or market) risk, and credit risk.

Now think of what happens if there is collateralisation. At first it appears that the credit risk disappears, especially if there is both initial margin to cover unexpected market movements and variation margin to cover realised ones. But the collateral has to come from somewhere. Getting hold of it by borrowing, for example, will once again create credit risk.

The point is that, by collateralising the transaction, the market and credit risk are unbundled. I would argue fairly strenuously that unbundling is the right thing to do. Unbundling forces both the buyer and the seller to manage both the interest rate and the counterparty credit risks embedded in a swap contract. In the past, some parties seem to have simply ignored the credit component. Unbundling sheds light on the pricing of the two components of the contract. A more transparent market structure with more competitive pricing will almost surely result in better decisions and hence better risk management, risk allocation and ultimately lower systemic risk. The AIG example is a cautionary tale that leads us in this direction.

I agree completely that clearing unbundles price and credit risks.  This is particularly true under a defaulter pays model, in which the CCP members bear very little default risk.   In fact, this is the focus of a chapter I’m writing for my next book.

But Cicchetti’s assertion that unbundling is a good thing begs a huge question: why were risks bundled in the first place?  By way of explanation, sort of, Cicchetti asserts, without a shred of evidence, that market participants often ignored credit risk bundled in derivatives trades.  Even if that’s true, why would they necessarily take it into consideration merely because it’s unbundled?  I think the most that can be said is that ex post it appears that market participants underestimated credit risk prior to the crisis.   And if they did this with derivatives, they did it with unbundled credits too: look at the massive repricing of corporate paper and the virtual disappearance of unsecured interbank lending starting in August 2007.

But more substantively, there can be good reasons for bundling market risk and credit risk.  I explore these reasons in detail in my Rocket Science paper, which has been around for years.  In particular, there can be informational synergies.  These are quite ubiquitous in banking, and explain a variety of phenomena, such as compensating balances which require firms that borrow from a bank to hold some portion of the loan in deposits at the same bank: this is a form of bundling.  Moreover, bundling can be a way of controlling a form of moral hazard, namely asset substitution/diversion.

At the very least, bundling is so ubiquitous in banking (and finance generally, e.g., trade credit) that it is extremely plausible that there are good economic reasons for it.  The reasons for this practice should be understood before implementing massive policy changes that forcibly eliminate it for massive quantities of contracts.  It is rather frightening, actually, that Cicchetti/the BIS are so cavalier about this issue, and are so confident that they know better than market participants.

And again, even if credit risk is priced more accurately in an unbundled world (which Cicchetti asserts rather than demonstrates), bank capital structures in an unbundled world can be fragile and a source of systemic risk.  For instance, collateral transformation trades used to acquire collateral to post as CCP margin are arguably very fragile and systemically risky even if they are priced correctly.

What’s needed is a comparative analysis of the fragility/systemic riskiness of the bundled and unbundled structures, and this BIS/Cicchetti do not provide.

Cicchetti’s speech suggests that BIS has heard the criticisms of clearing mandates, but doesn’t really understand them, or is so invested in clearing mandates that it refuses to take them seriously.  Regardless of the reasons, one thing is clear.  The BIS has taken a big swing at a rebuttal, and missed badly.

The Military Channel is showing Operation Pacific, starring John Wayne.  The UVerse description of the movie is: “A Naval commander anxious to get his nonexploding underwater missiles working . . . ”  Underwater missiles?  You mean like, torpedoes?  And “nonexploding”?  You mean like, defective?

This film is about the scandalous experience with the Mark XIV torpedo during WWII.  This weapon malfunctioned with alarming regularity in 1942 and 1943, before the defects in the detonators were discovered.  The Bureau of Ordnance stubbornly refused to believe there was anything wrong with the weapon, and blamed the submariners for the failures.

The movie is a fictionalized account of the process of diagnosing the detonator defects and fighting the Navy bureaucracy.  Not that you’d know that from the description, which reads like one of those instruction manuals translated from Korean by a native Japanese speaker.  Or is it that those who wrote the description don’t know what torpedoes are, or believe that the potential audience doesn’t?