Streetwise Professor

September 20, 2013

The Madness of King Vlad

Filed under: Politics,Russia — The Professor @ 7:51 pm

Vladimir Putin has a bug up his  . . . . Let me rephrase that.  Vladimir Putin appears to be obsessed with homosexuality, and particularly European attitudes towards it.  This is bad enough on its own terms, but is even worse when one recognizes that eagerness to expound his views on such a subject is symptomatic of a deeper disturbance.

The specifics.

At yesterday’s Valdai audience, he hypothesized that his Bunga Bunga Buddy Silvio Berlusconi’s legal and political problems arising from his, um, relationship with an underage girl were gender-driven.  According to Vova, Italians would have been totally cool with it if Silvio had bedded a boy instead of a girl.

That’s one theory.

Now maybe Italians are different than Lousianians, but Putin’s hypothesis about Berlusconi is the exact opposite of that of another corrupt, roguish politician with a horn dog rep, former Louisiana governor Edwin Edwards.  Edwards famously opined “the only way I can lose this election is if I’m caught in bed with either a dead girl or a live boy.”  Edwards’s political longevity and success in the face of numerous scandals parallels that of Berlusconi, suggesting that Italians and Louisianians aren’t that different after all.  I would suggest that there are a lot of similarities between Louisiana politics and Italian.  Meaning that I would tend to believe Edwards in these matters, over Putin.

Another Putin Pearl of Wisdom uttered at Valdai is that homosexual marriage is causing Europe to die out.


After being condemned internationally for promoting legislation that was aimed he said at protecting minors from homosexual propaganda, he suggested same-sex marriages were contributing to Europe’s low birth rate. “Europeans are dying out,” he said. “Same-sex marriages can’t produce children.”

For one thing, Europe’s demographic decline began long before anyone seriously considered same-sex marriage.  So as an empirical matter, this theory makes absolute zero sense.

For another thing: is he freaking kidding us?  If gay marriage is why Europe has a low birth rate, what’s Russia’s excuse?  Who’s dying out faster? Europe or Russia? What explains homophobic Russia’s “dying out”?

This is mind boggling, really.  Russia has had existential demographic problems for more than 20 years.  Putin recognizes these problems, and has pushed various initiatives to raise birth rates, with very limited success.

Talk about seeing the speck in Europe’s eye and ignoring the plank in Russia’s.

Reading the coverage of Valdai, the NYT oped, and other recent Putin utterances suggests he is becoming increasingly unhinged. More specifically, he is succumbing to a common malady of autocrats: surrounded by lackeys who constantly affirm his genius, and with no one willing to challenge him, he thinks himself infallible and that any thought that crosses his mind is an amazing insight that must be shared with the world.  He feels himself omni-competent, able to expound on any subject.  He’s not quite in Kim Jung Il or Kim Jung Un territory yet, but he’s on his way.

And he hinted at Valdai that he will run for president in 2018. (As if this is a shock.  Look.  Someone in his position cannot play Cincinnatus. George Washington he ain’t-and the Russian Federation isn’t Federalist America.)  Meaning that Russia will be ruled by an increasingly detached and delusional ruler until he assumes room temperature.

Great Britain-and the world-survived the madness of King George. But Britain had strong institutions, and as a parliamentary democracy with a constitutionally limited monarch, it could survive the periodic insanity of the head of state.  Russia has weak institutions and is a Potemkin democracy rather than a true parliamentary one.  Russian government is highly personalized, and highly dependent on the personality of the ruler.  As a result, it is much less likely to be immune to the flights of fantasy and whims of that ruler.

What’s more, given that that ruler has pretensions to playing a leading role in international affairs, his delusions will be afflicted on the rest of the world.  Obama’s capitulation to him on Syria and Snowden will only feed these pretensions, and Putin’s belief in his genius and omnipotence. So you can chuckle at Putin’s bizarre utterances, but realize that they are symptomatic of a deeper disturbance that will only grow worse with time, with malign consequences not only for Russia but the rest of the world.

Remember Chickamauga!

Filed under: Civil War,History,Military — The Professor @ 4:17 pm

Today is the sesquicentennial of the second day of the Battle of Chickamauga.  This was the most brutal, sanguinary Civil War battle west of the Appalachians, and the second bloodiest of the entire war.  It was also a swirling, confusing affair, a meeting engagement between two armies on the move that metastasized as units arrived on the battlefield.  The Union army was marching hard to get back to Chattanooga; the Confederates were trying to interpose themselves between the Federals and their base.   The conflict started towards the north, and then moved progressively south with charge and countercharge, as new units marched onto the field.  The confusion was compounded by the fact that most of the battle was fought in dense woods broken only by scattered clearings.  Regimental officers could not see their entire battle lines because of the timber and battle smoke that hung thick in the woods.  There were numerous successful flank attacks at the brigade and division levels because units became separated in the woods, leaving open flanks; attackers pounced on these exposed flanks undetected because of the thick foliage.

Bumbling generalship and command strife also contributed to the confused nature of the fighting.  The most egregious blunder was of course Union commander Rosecrans’ order to move Thomas J. Wood’s division out of line based on a misapprehension: Rosecrans’ aide could not see Brannan’s division in the heavy timber, and thought there was a gap in the line between Wood’s division and Reynolds’s.  Acting on this report, Rosecrans thought he was closing a gap when he ordered Wood to “close up” on Reynolds, but he was really opening one: Wood had to move out of line to get around Brannan in order to reach Reynolds.  Through this opening James Longstreet’s corps poured through, routing the entire Union right and center.  (It is quite possible that Longstreet’s attack would have been nearly as successful even if Wood stayed in line.  The Union divisions in front of his corps were small, and had taken heavy casualties the day before, and Longstreet attacked in mass and had great superiority of numbers at the point of attack.  For instance, Longstreet’s left smashed right through Davis’s division in minutes, and would have done so even if Wood had been in line: it is quite possible that Wood’s two small brigades would have been similarly overwhelmed had they not moved.)  That tactical error was just the culmination of a series of Rosecrans’s mistakes.  His scattered and hasty advance south of the Tennessee River based on a belief that the Confederates were in disorganized retreat from Chattanooga made him vulnerable to defeat in detail by the massing Confederates.  He was racing back to Chattanooga to escape the trap he had so injudiciously thrown his army into.

But Rosecrans was not the only blunderer.  Confederate commander Bragg frittered away the golden opportunity of trapping Rosecrans, due in part to his inept planning, and in part to the fact that his subordinates so heartily disliked him that they did not execute his orders efficiently.  Neither commander exerted any real control on the 19th, the day of the meeting engagement, but when the lines stabilized on the 20th, Bragg’s attack on the Union left was woefully executed at huge loss, again largely due to Bragg’s inability to get recalcitrant corps commanders to implement his plan, and the incompetence of those corps commanders (notably Polk).

As a result, this was not a battle of generalship (except in the negative sense).  It was a soldier’s battle.  On the first day in particular, moreover, it was not really a single battle, but a series of disjointed actions fought at close range between regiments, brigades, and divisions.

The Chickamauga battlefield was one of the first preserved by the Federal government, and is almost entirely intact.  Moreover, due to its early preservation, veterans of the battle erected numerous monuments marking where they fought.  The War Department (which managed the Park at the time of its creation and for some years afterwards) also erected numerous plaques describing the movements of each brigade involved in the battle.  Most of the markers are accurate.  One exception is around Snodgrass Hill and Horseshoe Ridge.  Gracie’s The Truth About Chickamauga does a good job at explaining how that part of the battlefield was mismarked, and why.  (In a nutshell: the process of placing markers and writing the descriptions was dominated by a figure, Henry Boynton, who wanted to exaggerate the role played by the brigade to which he belonged.)

I’ve walked pretty much every foot of the battlefield, on multiple occasions.  You really have to do that if you want to understand the action, and appreciate the conditions.  Two pieces of advice if you want to do the same, especially in the summer. 1. Check for ticks (especially if you’re blonde!). 2. Watch for snakes. Both are abundant in those Georgia woods.  Then there was that time I almost stepped on a wild turkey, which flew up right into my face.  I don’t know who was more surprised or freaked out, me or the turkey.  (Don’t go there!)

My grandfather first took me to the battlefield when I was 9, as part of an epic Civil War trip that was the genesis of my interest in the War.  We started at Shiloh, then Vicksburg, then Corinth, then Chickamauga-Chattanooga, then Fredericksburg, Chancellorsville, Wilderness, Richmond, and Antietam, before completing the journey in Gettysburg.  Now that’s a helluva trip, and my grandfather was an excellent storyteller who helped bring the battles to life. I have the vivid memory of him illustrating the Wood-close-up-on-Reynolds story using Tiparillo boxes on the kitchen table.

My great-great grandfather George Immel fought in the battle, as a member of the 92nd Ohio Volunteer Infantry.  Ironically, given the blogging proclivities of his descendant, he was an orderly to his brigade commander, Brigadier General Ivan Basil Turchin, nee Turchaninov (Ива́н Васи́льевич Турчани́нов), a Russian emigre.  Turchin was quite a character, as was his formidable wife, who intervened personally with Lincoln to save Turchin’s career after he had been relieved from command for sacking the town of Athens, Alabama in retaliation for guerrilla attacks on his brigade.  He went all Russian, in other words.

There is one story of the battle that  was passed down through the family.  George said that the most remarkable thing about the battle was the continuous noise, from all directions.  The roar was unceasing on Saturday the 19th until night fell (though there was also a night attack by Cleburne’s division that evening).  Then it began again the next morning, and didn’t stop until late in the day.

Turchin’s brigade played a rather prominent role in the battle.  It helped stop the attack of Cheatham’s division near Brock Field on the 19th, then later in the day led a counterattack that flanked elements of Bates’s and Law’s brigade that had penetrated the Union center around the Brotherton House.  On the 20th, it was in Thomas’s main line on the Union left, and behind some log barricades repulsed the attacks of Cleburne’s division.  (It was a part of Reynolds’ division, which Wood was supposed to close up on.)  During the final Union retreat, the brigade executed a bayonet charge through the McDonald Field, driving off the Confederates who threatened to cut off the escape route to Chattanooga.

That is the story of just one brigade, but overall the battle was fought largely at the brigade level.  On the Union side, divisions from the three main corps (XIV, XX, and XXI) were jumbled together, and only the commander of the XIV corps (George Thomas) really exercised any control over his entire unit: the other corps commanders (McCook and Crittenden) were rendered almost supernumerary, and Thomas ended up commanding large portions of their units.  Moreover, the terrain made controlling larger units almost impossible, so much of the battle devolved into brutal firefights between brigades.

Although it is a fascinating battle to study, with many stories of great personal bravery, ultimately all it produced was a monstrous casualty list.  It was almost utterly devoid of strategic impact.  Rosecrans’ Army of the Cumberland escaped by a hair’s breadth back to Chattanooga, and Bragg’s Army of Tennessee did not pursue (to the fury of Nathan Bedford Forrest).  A desultory siege followed, but Lincoln rushed reinforcements from the Army of the Potomac and the Army of the Tennessee while Bragg’s Army declined in numbers when Longstreet, disgusted by Bragg’s leadership, took off to attack Knoxville.  Under the command of Grant, the reinforced Federal forces drove Bragg from the heights overlooking Chattanooga.  (The 92nd Ohio participated in the decisive charge on Missionary Ridge.)

During this attack, the Union soldiers who had been defeated 150 years ago today shouted “Remember Chickamauga!” as their battle cry.  I remember it, and you should too.

September 18, 2013

There is Nothing New Under the Sun, Warehouse Games Edition

Filed under: Civil War,Commodities,Economics,Exchanges,History,Politics,Regulation — The Professor @ 7:12 pm

I am working on a project about the economics of commodity trading firms.  One of the interesting questions is what physical assets commodity trading firms own.  In my research on this question, in an attempt to get some historical context, I turned to the excellent Federal Trade Commission Report on the Grain Trade, a five volume study released in the early-20s.  (There is reputedly a sixth volume on manipulation which I and others-Jerry Markham, for one-have feverishly searched for without luck.)   This is truly an excellent piece of work.  Many of the analyses are off, but as a detailed portrait of the grain trade in the 1900-1920 period, it cannot be beat.  Unfortunately, there is nothing comparable for other time periods.

In perusing Volume I, on country grain marketing, I came across this choice quote from the president of the CBOT in 1887:

The alliance between railroads and elevators has resulted in reaching out after millions of bushels not naturally tributary [to Chicago] and when gathered here preventing it by such tricks of the trade as you are familiar with from ever getting away again as long as storage can be collected on it.

. . . .

The grain bought elsewhere by warehouse proprietors is promptly sold to you here on future delivery, which, however, you can only get on payment of such premiums as the urgency of demand may enable them to exact.

. . . .

While the elevator proprietors are willing to pay 1 cent per bushel more for grain to “go into store” in their own warehouses than the market price of the same grain in store . . . is conclusive that the first storage charge is not legitimate, and also that the subsequent terms of storage are unduly profitable.

Replace “grain” with “aluminum”, and you could run this as a news story in 2013.  Goldman’s operations at Metro are almost identical to the operations of the warehousemen in Chicago that President Wright fulminated about 126 years ago.

The FTC study also notes that shuttling grain between warehouses was a part of the game more than a century ago.  It quotes Taylor’s magesterial history of the CBOT, describing an event from 1896:

The Armour Elevator Co. was charged with having transferred 1,200,000 bushels of wheat from one part of the north side system to another, without inspection, on such dates that the receipts resulting therefrom were just regular on the delivery day, May 1.

And not a bankster in sight.  (It is an interesting coincidence that 1896 was the year Goldman-Sachs was invited to join the NYSE.)

The morals of the story.  First, the ability to play warehouse games is inherent to the business of public warehousing of commodities. Second, banks are not uniquely susceptible to playing those games: when conditions are right, whoever owns the warehouses can play the games.  Third, systems of self-regulation are often incapable of addressing these problems.

On the last point, it is important to remember that the seminal case in the history of regulation in the United States, Munn v. Illinois, grew out of the warehousing battles in Chicago during the Civil War and its immediate aftermath.  The Supreme Court decided that the State of Illinois had the power to regulate grain warehouses, and this decision provided the basis for subsequent exercise of regulatory powers by states and the Federal government.

In other words, what is old is new again.  Journalists and regulators and legislators act as if the kinds of games played today are somehow new and unique.  They aren’t.  The commodities business hasn’t changed that much in a century and a half.  The things that were good, bad, and ugly in 1869 are around today, and will be around in 2069 and 2169.

September 17, 2013

Enjoin This!

Filed under: Derivatives,Economics,Regulation — The Professor @ 7:28 pm

Legendary Chicago prop shop* DRW has sued the CFTC, asking a Federal judge to enjoin the agency from filing an enforcement action against the firm.  Based on the facts alleged in the DRW complaint, CFTC should pray that the judge grants the injunction, thereby saving the agency of total humiliation at trial.

The details are kind of geeky, but I’ll try to summarize in as close to plain English as I can.  At issue is DRW’s trading-and quoting-of swap futures contracts traded on the Nasdaq Futures Exchange and cleared on the International Derivatives Clearinghouse.  As a cleared contract, the swap futures was subject to daily mark-to-market.  OTC swaps (at the time) were not collateralized or subject to mark-to-market.  As basically anybody who has been around futures markets since the early-90s knows, this differential margining treatment should cause swap prices to differ from futures prices.

Hell, this has been known in the academic literature since 1981, with the publication of a paper by Cox, Ingersoll, and Ross.  The basic idea is that marked-to-market futures have payoffs that are linear in the interest rate, but swaps have payoffs that are a convex function of the interest rate due to discounting: futures cash flows respond immediately to interest rate changes due to daily variation margining, but the effects of interest rate changes on the swap are not realized until the expiration date of the swap.  This leads to a “convexity bias”: the futures are biased relative to the swap, due to the fact that with discounting, the present value of the swap cash flows are a convex function of interest rates.

Basically, there’s an advantage to being short the futures compared to being short the swap.  If interest rates go up, the short futures position profits, and the short can invest the resulting variation margin inflow at the higher interest rate.  If interest rates go down, the short futures position loses, but the short can borrow to cover the margin call at a low interest rate.  The  swap short can’t play this game because the OTC swap is not marked-to-market.  This advantage of being short the future should lead to a difference between the futures yield and the swap yield.

DRW recognized this difference between the swap and the futures.  Hence, it did not enter quotes into the futures market that were equal to swap yields.  It entered quotes at a differential to the swap rate, to reflect the convexity adjustment.  IDC used these bids to determine the settlement price, and hence daily variation margin payments.  Thus, the settlement prices reflected the convexity adjustment.  Not 100 percent, because DRW was trying to make money arbing the market.  But the settlement prices were closer to fair value as a result of DRW’s quotes than they would have been otherwise.

CFTC apparently believes that the swap futures and the swaps are equivalent, and hence DRW should have been entering quotes equal to swap yields.  By entering quotes that differed from swap rates, DRW was distorting the settlement price, in the CFTC’s mind anyways.

Put prosaically, in a way that Gary Gensler (the lover of apple analogies) can understand, CFTC is alleging that apples and oranges are the same, and that if you bid or offer apples at a price different than the market price for oranges, you are manipulating.


The reality, of course, is that apples and oranges are different, and that it would be stupid, and perhaps manipulative, to quote apples at the market price for oranges.

The CFTC is completely confused.  Shocking, I know.  Perhaps-perhaps-trading to affect the settlement price is a necessary condition for a manipulation allegation.  It is notsufficient condition. The crucial issue is whether the trading/quoting moves the price towards the appropriate competitive price, or away from it.  Prevailing law requires a finding of an artificial price (for a completed manipulation) or the intent to cause an artificial price (for an attempted manipulation).  DRW’s trading-quoting, actually-moved the settlement price closer to the proper value, relative to OTC swaps.  That is, its activities made the settlement price less artificial.  Bidding/offering at the OTC swap yield would have been artificial because such quotes would not have reflected the substantive economic differences between futures and swaps.  Due to convexity and the lack of any adjustment for it in the Nasdaq Futures contract, there should have been differential between the two prices.  Bidding/offering at zero differential would have caused settlement prices to diverge from fair value relative to swaps.

In other words, DRW contributed to convergence of the settlement price to fair value relative to swaps.  Manipulative acts cause a divergence between the settlement price and fair value.

Many futures contracts have been mispriced for a considerable period of time post-introduction,.  Eurodollars were mispriced relative to swaps until people figured out the convexity issue in the early-to-mid-90s: the academic literature diffused into practice much more slowly back in those days.  But even simple cash-and-carry relationships have sometimes been violated in new futures.  Most notably, S&P 500 futures were mispriced for a considerable period too in 82-83, and maybe a little bit afterwards (I’ll have to go dig up the papers that provide the evidence of this).  Were people that bid/offered/traded to take advantage of/arbitrage this mispricing manipulating?  That would be an odd theory, since this trading made prices less “artificial”, i.e., closer to fair value relative to the underlying.

In a sane world-or at least, in a world with a sane CFTC (an alternative universe, I know)-what DRW did would be called “arbitrage” and “contributing to price discovery and price efficiency.”  Voluminous CFTC materials (and testimony by CFTC officials before Congress) identifies these as legitimate, and indeed salutary, futures market activities.

Another shocking aspect of this story is that the two biggest firms on the other side of the contract from DRW-Jefferies and, yes, MF Global-didn’t understand the effect of convexity.  Jefferies claims it relied on IDC’s representations that swap futures and OTC swaps were equivalent, and hence thought it was making an arbitrage profit as a result of trading the futures and swaps at a differential.  In fact, it was the source of arbitrage profits because it was trading at a differential that was too small, relative to what it should have been to reflect fully the convexity effect.

Moreover, IDC should thank its lucky stars that DRW did nudge the settlement price through its quotes.  If it had marked the futures to market at the OTC swap yield instead of the price reflecting the DRW quotes, MF Global’s position would have been substantially under margined, subjecting the clearinghouse to substantial loss (or, at least, substantial delay to recovery) in the aftermath of MF’s default.

I shake my head in amazement at all this.  Especially at the CFTC.  It stands there dumb and mute when major manipulations occur, and then leaps on trading that is manipulative only in its deluded imagination (and complete ignorance of things practitioners have known for 20 plus years).  Its manipulation enforcement is a race between Type I and Type II errors.  It reminds me of the old joke about the lawyer who said “I lost the cases I should have won, but won the cases I should have lost, so on average, justice was done.”

Well, it would be a joke, but this isn’t funny. Especially since the CFTC’s authority now extends far beyond the futures markets, which are important enough as it is, to the far larger OTC markets.  Huge sums are at risk to the ignorant judgments of the CFTC.

The CFTC has apparently adopted the William Clayton Rule: “The word ‘manipulation’ . . . in its use is so broad as to include any operation of the . . .  market that does not suit the gentleman who is speaking at the moment.” This is not a good thing, when the “gentleman speaking at the moment” exercises the power of the Federal government. Hopefully the judge will do DRW, the markets-and the CFTC-a favor by slamming on the brakes on this inane enforcement action.

*Not to be confused with a chop shop! True story. My first year at Chicago a gang ran a chop shop out of the garage next to the student housing building where I lived.  Quite an adventure when the cops raided the place at 6AM one morning.  Shots fired. Reminded me of the old Second City bit where the cop fires several rounds and then shouts “Halt!”

September 16, 2013

Attack of the Commodity Market Critic Zombies

Filed under: Commodities,Derivatives,Energy,Exchanges,Politics,Regulation — The Professor @ 8:01 pm

Going through my news clips this morning made me feel like I was in a video game fighting off hordes of zombies. Commodity market critic zombies.

Zombie #1: Gretchen Morgenson, with an article on RINs. It is a farrago of innuendo and idiocy.  Really, it is 9 pages long, and I could write 20 listing all the fundamental flaws.  I don’t have the energy for that (no pun intended), so I’ll limit myself to the greatest hits.  In a nutshell (emphasis on the nut), it is a typical Morgenson piece: if banks are involved it’s bad;  if people are speculating it’s bad; if there are unintended consequences of government policies, it’s not the fault of the stupid government, it’s the fault of those who have to deal with the stupidity, and who figure out ways to make money out of artificial bottlenecks created by the stupidity.

The article is an assemblage of assertions and allegations totally lacking in evidence.  Morgenson alleges JP Morgan has speculated in RINs.  Which it denies.  She insinuates that the market might be manipulated, but provides no evidence.  She mentions a “corner”, but obviously doesn’t understand how a corner works: that would require the accumulation of a long futures/forward position, but she provides no evidence that anyone has accumulated such a position. (CME shows a grand total of a whopping 558 RIN contracts outstanding.)

Morgenson is obviously very suspicious of speculation-kind of funny, since her entire article is completely speculative-and suggests that speculation distorts-i.e., manipulates-prices.

Assume arguendo that Morgan or some other evil bank did figure out that the blend wall would hit and that RINs would become more valuable as a result, and hence accumulated them.  If it is right, it will profit when prices rise.  That doesn’t mean it caused the prices to go up. Prescience isn’t the same as manipulation.

Morgenson should be forced to write on the blackboard, Bart Simpson-like:






. . . .

The real problem here is something that makes only a cameo appearance in Morgenson’s story: the artificial RIN bottleneck created by an idiotic government policy that was adopted based on a forecast of future gasoline consumption (‘cuz yeah, we’re so good about making energy forecasts) and an ignorance of the technological realities of ethanol.  It is inevitable that someone would figure that out, and make money off it.  Inevitable.

Quite honestly, you’ll learn more about the reality of RINs from one of those ubiquitous Hitler videos than the New York Times (h/t @izakaminska):

Speaking of tow-headed troublemakers named Bart . . . that brings us to Zombie #2. Taking a break from edifying us all about the evils of HFT, polymath Bart Chilton went off on the evils of banks in commodities:

Mr. Chilton, in prepared remarks viewed by The Wall Street Journal, said it’s “nearly impossible to figure out exactly what banks own.” He said the CFTC can see what banks are trading in derivatives markets tied to commodities, but doesn’t know what physical assets like oil tankers and aluminum they hold.

“Unless we can see that, we can’t reasonably and responsibly protect against market manipulations,” Mr. Chilton, a Democrat, plans to say in speech to a business association in Michigan Saturday.

The CFTC has been investigating firms that store and deliver aluminum, including Goldman Sachs and J.P. Morgan, after complaints from companies that use the metal. Beer and soda companies, can makers and other end users said firms that warehouse aluminum inflate prices by holding onto it for longer than necessary.

Banks that trade commodities have come under fire from government officials, companies and consumer groups who say they exert too much influence over markets for some raw materials.

Mr. Chilton plans to raise that concern in the speech, saying banks that own commodities and trade in derivatives based on the prices of those commodities have a potential conflict of interest.

“The prices of commodities are supposed to be based upon supply and demand,” Mr. Chilton plans to say. “However, what if you control, or have significant influence upon, the supply or the demand?”

Mr. Chilton also is expected to say the public should be able to “easily locate and click on a link to find out” what physical commodities banks own. He will also call on lawmakers to rein in banks’ role in the buying and selling of physical commodities and not leave the decision to the Federal Reserve.

Click on a link to find out physical positions.  Right, Bart.  Uhm, you can’t even do that for futures positions.  And care to share any evidence demonstrating that any banks exert a “significant influence” on supply and demand in any energy commodity?  Their market shares in physical tend to be very small.  Check out the stat on Morgan Stanley in the Morgenson article-Montaigne markets 2.5 percent of gasoline in the US. Big freaking whoop. JP Morgan serves one piddling refinery on the East Coast.  Sheesh.

Conflict of interest: the classic problem raised by people who don’t have a real argument. Speaking of real arguments, how’s this for a doozy:

“Maybe it’s just me, but I don’t think the American public wants banks owning grain elevators, electric companies, large warehouses or shipping and distribution interests,” Chilton said in the speech.

Wow.  Let no one ever question Bart’s ability to make a substantive economic argument, backed with empirical evidence.

Zombie #3: Lina Khan, in The New Republic. Again, far too much idiocy to deconstruct in detail.  One illustrative example: the insinuations about “inside trading.”  Trading on private information is quite different than inside trading.  The later involves the violation of fiduciary duty or the theft of corporate information that belongs to shareholders.  Trading on private information is the lifeblood of virtually all markets.  It’s called “price discovery.”

The huffing and puffing about Cargill and Trafigura operating hedge funds is another faux controversy.  These funds are regulated just like funds operated by other entities.  Moreover, there are Chinese walls restricting the flow of information between the company-managed funds, and other trading operations.

Furthermore, Khan makes broad allegations of manipulation.  I assure you that yes, manipulation does occur in commodities markets, and that trading firms sometimes execute these manipulations.  But manipulation is subject to regulation (contrary to the statements that these markets are unregulated).  Moreover, the allegations of manipulation in the article are amazingly vague, and unsupported by any evidence.  The article is a classic illustration of the Clayton Definition of Manipulation: Any Practice That Doesn’t Suit the Person Speaking at the Moment.

For instance:

Experts warn that this degree of involvement across the entire production cycle gives a handful of sizable firms even greater unchecked power over our most basic goods. “Clearly if you control the physical stock and stand to gain from managing the release of that stock, it would be foolish to expect companies not to take advantage of that,” said Sophia Murphy, senior adviser at the Institute for Agriculture and Trade Policy and author of “Cereal Secrets,” a report on the major grain traders.

Part of the trouble is that no public body oversees global physical stocks. Andres Missbach, co-author of Commodities: Switzerland’s Most Dangerous Business, said the vast storage capacity these companies have amassed equips them to create artificial shortages in the short-term if they wish. “We have no idea if they are manipulating,” he said. “We can only say they have the capacity to, and that there is no regulator ensuring that they are not.”’

Unchecked power? Seriously?  What fraction of global physical stocks does any firm own?  The article says that Glencore “controls” 50 percent of the trade in some commodities.  If you read Glencore’s statements, they refer to “freely traded” supplies, which are a fraction-and often a small fraction-of total supplies.  For commodities like oil, the biggest trading firms account for 5 percent or less of total supply.

“We have no idea if they are manipulating.”  LOL.  Remember what Judge Easterbrook wrote: “The undetected manipulation is the unsuccessful manipulation.”

I am quoted in the article, but my quotes are rather innocuous. Khan tried to get me to support her trading-firms-are-evil line, which I obviously declined to do: in fact, I disagreed strongly. Those quotes didn’t make the story, naturally. Yeah. No agenda there.

One last thing. All three are rather strange zombies, because they are apparently afraid of the dark.  Each mutters ominously about dark markets, trading in the dark, blah blah blah.

News flash: the “lit” transparent futures markets are the exception that proves the rule.  Virtually all commodity markets are bilateral search markets with little pre- or post-trade transparency.  This makes good economic sense given the heterogeneity of commodities, the idiosyncrasies of and variability in supply and demand for specific varieties, the desire to customize terms, and the low rate of transaction flow in any particular variety or at any particular location.  Commodity trading firms essentially customize commodities by transporting, refining, blending, storing them, etc.  The one size fits all standardization that is necessary to support continuous, centralized markets (like futures markets) is completely maladapted to the trade of actual physical commodities.  Physical markets and futures markets serve vastly different functions, and accordingly operate on vastly different lines.

Zombies that are afraid of the dark.  Too funny. Get a frickin’ night light, Gretchen, Bart, and Lina.

It never ceases to amaze me how commodities bring out the loons, and cause people to lose all ability to reason.  Like zombies.  Like Gretchen, Bart, and Lina.

September 15, 2013

If You Have Lemons, Make Lemonade: Or, We’ll Always Have Paris (if Not Pittsburgh)

Back in Houston after time in Geneva, and a quick day trip to Paris for a conference.  The conference was sponsored by the ECB, Banque de France, and the Bank of England.  It was an examination of the progress in OTC derivatives regulation since the G20 declaration in Pittsburgh in September, 2009.

For the most part, the audience was central bankers, and the theme was “Yay! Look what we’ve accomplished!”  And of course, I had to rain on that parade.  My paper was titled “Bill of Goods: CCPs and Systemic Risk”, and the themes were (a) most of the arguments about how clearing would reduce systemic risk (e.g., the effects of netting) are wrong, and (b) clearing and collateral mandates created new sources of systemic risk.  Meaning that the G20 sold us a bill of goods in Pittsburgh.

So call me Mr. Popular.

A good part of the rest of the program on Wednesday was the Craig show.  The next panel was chaired by someone from the ECB, who gave a rather injured defense of the Pittsburgh agenda: I wasn’t mentioned by name, but it was pretty clear that she was attempting-ineffectually, IMO-to rebut me.  Several of the panelists said “as someone said in the previous panel”-and then referred to something that I had said.

Then a representative from the BIS presented, to much fanfare, the results of the Macroeconomic Assessment that I criticized heavily before I left for Europe.  After presenting the results, he discussed criticisms and caveats, and spent most of the time attempting-even more ineffectually, IMO-to rebut the arguments I raised in my post.

Very flattering.  Thanks.

The next panel was another group of academics.  The authors of two of the three papers, Bruno Biais and Hector Perez-Saiz (from the Bank of Canada), stated that their papers were motivated/inspired by my earlier research (which Biais called “seminal”).

Even more flattering.

My panel generated some interesting discussion and questions.  Many related to Dale Rosenthal’s paper about the potential inefficiencies that can occur when defaulted positions are replaced (or hedged).

As I’ve written for 3-plus years, the one main benefit of CCPs is that a centralized mechanism (e.g., an auction) for replacing/hedging defaulted positions is likely to be more efficient than an uncoordinated scramble in a bilateral OTC market.  The question is whether this function can be unbundled from the other functions performed by CCPs, which may not reduce systemic risk, and may in fact increase it.

Indeed, since there will be massive quantities of non-cleared derivatives, many of them of the more complex variety, the clearing mandates will not eliminate the replacement/hedging problem.  Even if the cleared derivatives are handled in an orderly auction process, these massive quantities of non-cleared derivatives will not.  These positions will have to be dealt with, and there is a serious risk that the process of replacing them will be very chaotic and destabilizing.

I confess to amazement that in all of the post-Pittsburgh regulatory efforts, this issue has escaped attention.  The focus on clearing, margins, SEFs, etc., has apparently taken up all the oxygen.  This is truly unfortunate, because a centralized auction mechanism to replace or hedge defaulted positions is likely to be far more effective and efficient than a non-centralized mechanism.  Put the other way, the decentralized mechanism is likely to be chaotic and destabilizing and excessively volatile.

Again, the clearing mandate does not solve this problem because many derivatives, especially the most exotic and illiquid (and hence problematic) ones will be outside CCPs, and CCP auction processes.

Which got me thinking (during a conversation with Dale Rosenthal during a break) of how this issue could be addressed.  What popped into my head? The swap dealer designation.

For the most part this designation is all pain, no gain.  How could we make lemonade out of this lemon?  Well, the thought that comes to mind is that designated swap dealers could be required to participate in the auction/hedging of a positions defaulted on by another swap dealer (or dealers).

I am somewhat reluctant to advance this proposal, because I am usually skeptical about mandating anything.  But there is arguably a public good (in the technical sense of the term) element to the process of  replacing/hedging defaulted positions: as the Rosenthal paper suggests, there are potentially many coordination and strategic behavior problems when this process is decentralized.  Consequently, it is worth some further thought.  (The clearing and collateral and capital obligations of swap dealer designation do not have as compelling a public good justification.)

The details will be challenging. In particular, since not all swap dealers will trade all of the types of instruments in a defaulted portfolio, it is not immediately obvious how to determine, in advance, each designated dealer’s auction obligations: that is, it’s not obvious how to specify which auctions each dealer must participate in.  For instance, it makes little sense to require BP or Cargill to participate in auctions for interest rate swaptions.  So who has to participate in what auctions?  Given the plethora of categories (interest rates, credit, equity, FX, commodities) and currencies, there is likely to be a plethora of auctions, and thus it will be difficult to say who is obligated to participate in what auctions.

However it is specified, this obligation will arguably make the swap dealer designation more onerous, and firms will attempt to structure their businesses to avoid falling afoul of it.  But the biggest dealers will not be able to avoid it.  What’s more, if I am correct that a centralized mechanism for handling defaulted positions is a public good, the creation of such a mechanism will actually redound to the benefit of all market participants, including the swap dealers.  After all, they are likely to have the biggest positions to hedge and replace in the event of a major default, and would benefit from a reduction in the risk of this process, and an improvement in the efficiency of the pricing mechanism in the aftermath of a major default.

This is something that at least deserves some consideration.  And, of course, regulators appear to have ignored it altogether in their focus on clearing and margins.  Which is another reason why I am not a G20 cheerleader, 4 years after Pittsburgh.

September 14, 2013

No Peace, No Honor

Filed under: History,Military,Politics,Russia — The Professor @ 12:12 pm

With great fanfare, Kerry and Lavrov announced a deal on Syria.  Well, not really a deal: a “broad framework” under which Assad will declare his stockpiles, allow “unfettered” access by UN inspectors, and then turn them over for ultimate destruction in a facility to be built near Tartus.

I can see it now.  Hans Blix is on the phone to all his old buddies, telling them “we’re putting the band back together.”

I remember the Iraq version of this movie from 10-20 years ago.  Didn’t end well.  Hell, it didn’t begin well.   In fact, it pretty much sucked all the way through.  It sort of worked as a farce, but purely an unintentional one.

Why would anyone expect the sequel to be any different?  The three card monte games played with chemical weapons and inspectors? The Russian interference?  The passive aggressiveness by the targeted government?  The only way it will be different is that it will be even more farcical this time because Assad and the Russians will know with virtual metaphysical certainty that there will be no consequences for obstructing the process, whereas Saddam had no such knowledge.  Indeed, as part of the deal worked out in Geneva, the UN resolution that will implement the agreement will not specify that Assad can be attacked by force for non-compliance.

In reality, I don’t think anybody does expect it to be different.  From the Russian perspective, that’s a feature, not a bug: a big stall that keeps Assad in power indefinitely is exactly what they want.  From the American perspective, Obama is so desperate to extricate himself from the hole he dug with his big mouth (“Red line”, “Assad must go”) he is willing to go along with the charade and declare Peace in Our Time.  His flunkies and fanboys are already pushing this line.

In reality, there will be no peace.  Maybe-maybe-no one will be killed by the Syrian regime with chemical weapons in the coming months, but people will continue to die in their thousands.  They will die in myriad horrid ways, by bullet, shell, bomb, or a by knife in the guts or across the throat.  But there won’t be videos of gasping victims on YouTube, so we don’t have to trouble ourselves about it, apparently.

It is beyond nauseating to read Kerry’s remarks from Geneva about the Syrian civil war generally.  In my mind’s eye, I have this vision of a wooden Kerry (but I repeat myself) propped up on Lavrov’s knee, with Lavrov’s arm up the back of Kerry’s jacket.  That’s because when I read this, it’s hard to distinguish from ventriloquism:

“If we can make this framework a success, we save lives in the region and lay the groundwork for more cooperation” between Moscow and Washington, Secretary of State John Kerry said Saturday after three days of negotiations with his Russian counterpart, Sergei Lavrov.

“There is no military solution” to the Syrian civil war, Mr. Kerry added. “It has to happen at the negotiating table.”

The Russian line, to the last jot and tittle.

Look. Two sides-N sides, really, given the nature of the opposition-in an existential conflict ain’t going to sit down and talk it over and reach some amicable agreement.  Negotiations necessarily take place under the threat of force, and depend on the fortunes of the battlefield.  The sentiments that Charlie McKerry mouthed (I can see Lavrov’s lips moving!) are all high-sounding and stuff, but they are just bilge.  A noble lie intended to distract attention from a very ugly truth.

In sum, there will be no peace in Syria as a result of this deal, and Obama purchased this (temporarily) face-saving deal at the price of humiliation and dishonor to the United States.

Yes, given the Bush legacy and the nature of the conflict in Syria, there was never an easy way forward there, and it would have been a difficult chore to obtain popular support for American involvement.  The time for involvement was early-to-mid-2011, but once Obama let that opportunity pass, the prospects only worsened.  What’s more, Obama views himself as an ender of wars, and clearly has no heart for a new conflict.  (Drone strikes don’t count: that’s just the Jupiter complex at work, and the preference for drones is actually symptomatic of his unwillingness to use more traditional military methods.)

Given all that, a principled position would have been to state, forthrightly, that the US will not get involved.  But Obama’s contradictory statements, and in particular, his threats to use force post-August 21 have led to an even worse outcome.  Not only will the civil war continue indefinitely with all its ferocity, but by abandoning even a “shot across the bow” against a regime he accused of crimes against humanity and grabbing for a transparently fraudulent deal offered by someone who actively wishes the US ill, Obama has come off as feckless, opportunistic, weak, unserious, lacking in strategic sense, and totally overmatched by Putin.  Hard men in Russia, Iran, China and Syria will become emboldened, and those in the region who look to the US for support will make different calculations.

In other words, even if you believe that the appropriate outcome is for the US to stay the hell out-and that is a defensible position-there are better and worse ways to reach that outcome.  I find it hard to believe any worse way of getting there than the way Obama has managed to do it.  But he still has 3 plus years to go in his administration, so he has time to prove me wrong and make it even worse.

September 12, 2013

Obama Puts Bismarck to the Test

Filed under: Military,Politics,Russia — The Professor @ 1:38 pm

Second terms seldom end well.  Some implode in scandal (Lewinsky; Iran-Contra; Watergate).  Some dissolve into incoherence, as second raters take over key positions.  Some are overwhelmed by events, frequently of their own making, combined with exhaustion (Bush comes to mind especially).  All are bedeviled by the end-game problem.  Many-especially Republican administrations-are particularly hampered by a hostile press.   Modestly successful first term administrations should take a lesson from James K. Polk and rest on their laurels, but he is the exception that proves the rule.

But I am hard pressed to find a historical precedent for the public humiliation of a president so early in his second term, due to his own strategic foreign policy blunders, as we are witnessing with Obama at present.  Even a decidedly friendly press recognizes that the Syria situation has degenerated into an epic debacle.   Some objective observers, who want desperately to succeed, have been brutal in their criticism: Walter Russell Mead comes to mind.   He calls the Syrian episode a “clusterfarce.”  Very clever. You know exactly what he means to say but is too polite to say.

The twists and turns of the last weeks are mind boggling, and too tiresome to recount.  But I think, at root, they are readily explained.  Obama had no stomach for intervention in Syria, but felt compelled to do something due to his previous ad libs (“redline”, “Assad must go”) and political pressure in the face of atrocity, even though his most fundamental instincts and beliefs (other than an instinct for political survival and a belief in his destiny) counseled him to stay out.  Faced with a varied political opposition, and not convinced in the prudence of intervention, Obama seized upon the Putin/Assad offer to put Syrian CW under “international control” despite the obvious fact that this was a practical impossibility, in order to avoid taking a military action he fundamentally detested.  His desperation is palpable, and no amount of posturing will show otherwise.

Some of the political opposition was well-intentioned.  Some of it was opportunistic and loathsome-particuarly that part of which regurgitated the propaganda put forth by Putin and the Iranians.  Regardless, Obama made no serious effort to present the case for intervention either to Congress or to the American people.  He didn’t use the opportunistic right as a foil, like he usually does in domestic brawls (where he runs against Limbaugh, for instance). Again, his heart wasn’t in it.

It is distressing beyond words to watch Obama seize on the Putin Fig Leaf mere weeks after Putin humiliated him over Snowden.  After Snowden, he had to know that Putin is no friend, but he played along anyways.  (It would actually be worse if post-Snowden Obama does not grasp that Putin is an adversary bent on besting the US, and indeed, humiliating it.)

It is even more depressing to witness Putin strut around, and rub Obama’s nose in it-and the nation’s collective nose in it-with an obnoxious oped in the NYT.  I take that back.  It was not obnoxious.  It was mendacious.  The Russian exceptionalist ridiculing American exceptionalism, and posing as a prince of peace, even though everything Russia has done since the Syrian revolution began has served to prolong and intensify the brutal war.   Obama has performed the miracle of making Putin look like the reasonable peacemaker.

The Putin Plan will only result in delay, rather than resolution of the humanitarian and political crisis in Syria.  Already Assad is laying down conditions: he will accede only if the US stops supporting the opposition and pledges to forego any use of force in the future.   In other words: we surrender first, he’ll give up his CW.  But you know in reality he’ll pocket the surrender, and then go on exactly as he pleases.

I am in Geneva right now, and a few hours ago and a few miles away Kerry and Lavrov went through the motions of negotiating a path forward based on the Russian proposal.  Perhaps they should go to a railway car in Compiègne instead.

It’s obvious that I am no fan of Obama, but it must be noted that even many of his reliable supporters recognize this has been an epic debacle.  Only the sycophants attempt to portray his conduct as cagey and statesmanlike.

There are those who take glee in Obama’s distress.  I am not one of them.  Through his blunders he has humiliated his office, and humiliated the country.  His personal distress is irrelevant: the damage to the nation far too relevant indeed.  He has emboldened our enemies-and yes, Russia is an enemy and views the US as its enemy-and dismayed our friends.  Radical and dangerous forces-notably the Iranians-will be tempted to take advantage, and allies disconcerted by Obama’s fecklessness and confusion (Israel, Saudi Arabia) may feel impelled to act on their own in self-defense, despairing of the ability and willingness of the US to act decisively.  Such a situation is fraught with danger, especially with a wounded president.  That the wounds are self-inflicted makes it all the more discouraging.

I noted the other day that Obama sounded an uncertain trumpet on Syria.  Demons have responded to that call.  I have no idea how he retrieves the situation, especially when he must rely on pompous buffoons  like Kerry and Hagel and Biden for advice and execution.

I have often said I hope Bismarck was right about the special providence that America shares with fools and drunkards. Putin certainly doesn’t believe in it, but never have we needed more for this to be true.  Obama has definitely proven himself to be no Bismarck, but he had better hope Bismarck was right.

September 10, 2013

The New Lord Haw-Haw

Filed under: Military,Politics,Russia — The Professor @ 2:25 pm

In WWII, Lord Haw-Haw was the appellation given to English speakers living in Germany who delivered propaganda broadcasts on Nazi German radio.  The most notorious of these was William Joyce, who was executed for his collaboration.

We now have a Lord Haw-Haw for the 21st century: Jacob Appelbaum, who has decamped to Berlin (where he is a neighbor and collaborator of Laura Poitras).   Jake is going around giving talks accusing the United States of being the most malign force in the world.  He only brings up, say, China, claim that “people say that China is bad but they have nothing on the US.”

Case in point is this talk in front of the European Parliament in Brussels.  (I am only linking, not embedding, because I do not want that creature’s mug appearing here.)

Note extreme claim after extreme claim, none of which are verified or even verifiable.  For instance, his “partner” being hovered over by night-vision goggle wearing agents of the security state.  The proof for which is . . . Jake’s word.  Sorry.  Not nearly good enough.

Appelbaum paints a picture of an Orwellian state in which everyone-including you, gentle readers-is the subject of constant surveillance.  Note the typical conflation of “can-does” that is characteristic of this lot.

Note to something else I’ve pointed out before: Appelbaum’s repeated use of his own personal experiences to illustrate broader points.  In fact, they do the exact opposite.  They demonstrate exactly that Appelbaum is the exception that proves the rule.  He is trying to garner sympathy for himself by saying that he is you, or could be you.  But he ain’t, and you aren’t.  Don’t be fooled.  Don’t be played.  Don’t be flattered by his line “the state thinks you are so important they are after you”.  The state is after him for things unique to Jacob Appelbam: He is involved up to his neck in a variety of murky schemes that reek of criminality. I suggest taking a read of Catherine Fitzpatrick’s writings about him.  He is a manipulative snake, and people trust him at their great peril.

There are a lot of people who criticize the US government and US society quite vociferously, and quite viciously, from the United States, without experiencing anything that remotely resembles harassment.  Again: What Appelbaum and Poitras are experiencing (and no doubt they are exaggerating their experiences) is the result of some very specific conduct, not their brave speaking of truth to power.

Again, Appelbaum is saying believe him, not your lying eyes.  It is the very exceptional nature of his experience that totally undermines the veracity of his entire narrative.

One other thing that always bothers me about the Jake the Snake: the incestuous relationship between Tor (for which Appelbaum is a spokesman amongst other things) and the US government.  Why won’t Appelbaum come clean on that?

I think the Haw-Haw/Appelbaum metaphor is quite apt.  Like Lord Haw-Haw, Appelbaum scurried to Berlin to deliver egregiously dishonest and manipulative propaganda broadcasts against his country.  Indeed, what Appelbaum is doing is arguably far worse.  For whereas Joyce limited his efforts to radio broadcasts, Appelbaum is involved in many far more active measures, not the least of which is his collaboration in the Snowden espionage-certainly after the fact, and quite plausibly before the fact.   And, of course, collaboration in Snowden espionage now means collaborating with Putin and the Russians.

And where are real journalists on this? They have been conspicuously  silent on this lot; given the Berlin-Greenwald-Snowden connection, that’s quite a feat.  Moreover, their agenda is hardly hidden, and their association to Snowden says quite a bit about Snowden. But I guess the media like the story too much to question it, and those who might question it are intimidated into silence by the rest of the tribe.

September 9, 2013

We’re So Screwed

Filed under: Military,Politics — The Professor @ 3:24 pm

Do we have the dumbest foreign policy team in history?

First, SecState Kerry advertises that any strikes on Syria will be “unbelievably small.”

This is going to deter who from doing what, exactly?  This is what I’ve been on about ever since the to-ing and fro-ing about how little we could get away with doing in Syria started.  It will have no deterrent effect, and if it sends a signal, it will be one of utter fecklessness.  They are rolling in the aisles in Damascus, Moscow, and Tehran.

Then Kerry suggests that Syria could avoid a US strike by putting its chemical weapons under international control.

That’s bad enough-how could we ever know he put them all under international control?  But it’s worse.  When Lavrov and Assad jumped at this, Kerry said that his proposal was merely “rhetorical.”

Again.  Not from The Onion.

I am tired after a long day, and tired of watching this display of incompetence.  I will just point out these things, and presume that the self-evident idiocy means that further comment is unnecessary.

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