Streetwise Professor

I’ve written often before of the Russian military’s software problem, or meatware problem if you will: its inability to attract or dragoon  sufficient numbers of physically and mentally fit individuals to the ranks.  Between a demographic deficit and the assiduous efforts of anyone with half a wit to escape the draft, the Russian military is undermanned, and those men are disproportionately physical or mental weaklings.

If you want an indication of how desperate they’ve become, the military has announced it will now allow recruits to bring their pet dogs into service with them, if the dogs can be trained to perform tasks useful to the Army.

This is manipulative and cruel and sick.  This is the army of dedovshchina: the institutionalized abuse of new recruits by those who have been in the service a mere few months more.  Those recruits foolish enough to bring their pets along will have to watch those pets be abused and tortured by sadistic “grandfathers” who will engage in such depravity as a part of their efforts to terrorize their subordinates.

It will happen.  You know it will.  As LaRussophobe says: there’s sick, and there’s Russian sick.

But the military with the software problem continues to indulge its hardware fantasies.  Like building multiple aircraft carrier groups centered around nuclear powered flattops.  This from a country that couldn’t even recondition its existing carrier (the Gorshkov, which the Indians were foolish enough to buy) without running years beyond schedule and billions over budget.

In some earlier posts discussing the role of banks in commodity markets, I suggested that the decision should not be a binary one: banks in, or banks out.  Instead, the preferable approach would be to levy capital charges on bank commodity operations that reflected the risks of these operations, thereby attempting to ensure that banks internalize the TBTF costs associated with them and scale their commodity businesses accordingly.

The WSJ reports that the Fed is leaning towards this approach:

Federal Reserve officials are considering imposing a new capital surcharge on Wall Street banks that own oil pipelines, metals warehouses and other lucrative physical-commodities assets, according to people familiar with the matter.

Such an approach could encourage banks to pare back their involvement in physical commodities, which has increasingly raised concerns among regulators and lawmakers.

While no decision has been made, imposing a surcharge would allow the Fed to sidestep a legal jam caused by existing laws that set Goldman Sachs Group Inc. and Morgan Stanley apart from peers and give the former investment banks broad leeway to own commodities.

The devil, of course, is in the details.  The question is whether the surcharge will be set in a way that accurately reflects the relevant risks, or whether instead it will be set at punitive levels to achieve via misdirection what the Fed is apparently reluctant to do in a straightforward fashion (due to fears of legal challenge): i.e., precluding banks from participating in physical commodity markets.

In other words, this proposal is fine in principal, but could be a disaster in practice.  If the Fed really wants to drive banks out of commodity markets, I would much prefer it do so forthrightly, rather than by hiding behind capital surcharges that it chooses to achieve that outcome.

The NYT’s James Risen allegedly interviewed Edward Snowden.

I say allegedly because (as @catfitz notes) Risen did not communicate with Snowden face-to-face, but communicated with someone via encrypted communications.  That someone could be anyone, as far as Risen knows.  Or it could be Snowden, playing the role of Charlie McCarthy with some FSB or GRU mouth breathers playing the part of Edgar Bergen.  Think of Sabu, communicating with all of his Anon pals, with FBI agents hovering.

These circumstances make the headline angle of the article-that Snowden made sure that neither Russian nor Chinese intelligence could access any of the files he stole-completely unverifiable, and actually dubious.  Would the FSB (or GRU) let Snowden say that yeah, the Russians have everything? Not bloody likely.  Would they require him to say the exact opposite?  Damn right.

So why couldn’t Risen travel to Russia and meet Snowden face-to-face?  Does Snowden-or the FSB-think that Risen is a US agent who will meet Ed with a concealed ice pick that he will plunge into his skull?  Then how about a face-to-face meeting, but with Risen and Snowden separated by bullet proof glass?  Come on.  There are so many ways to grant someone like Risen an interview with Snowden such that there is zero risk to Snowden’s safety.  The fact this hasn’t happened raises extreme doubts about whether Snowden is actually free to speak.

The fact that neither Risen, nor anyone else in the media, have pointed this out is beyond shameful.

But you know the way it is.  They are so invested in the Snowden narrative, that they will do nothing to call it into question.

If you read the article-and if you do, I suggest you keep a barf bag handy-you’ll see Snowden’s grandiosity on full display.  He claims he had identified security problems while on his Geneva assignment, and raised these with his superiors, who dismissed them.  According to Eddie, this is what planted doubts about the NSA in his hyper-developed mind, and started him on the path to Saving the World.

Yes.  Superiors sometimes engage in CYA, and slam those who point out their flaws.

If that’s the case, then quit.  Don’t use this as a pretext to steal highly classified documents and share them with the world.  Snowden arrogates to himself the duty of promoting national security, and does so in a way that could reasonably be interpreted as the actions taken out of pique by an individual who did not get his way.

Snowden’s superiors were accountable.  To whom is Snowden accountable?  Oh.  That’s right.  I forgot.  He fled the country to avoid being held accountable.

But this isn’t the worst part of the “interview.”  I call total bullshit on one of the last paragraphs:

Mr. Snowden said that the impact of his decision to disclose information about the N.S.A. had been bigger than he had anticipated. He added that he did not control what the journalists who had the documents wrote about. He said that he handed over the documents to them because he wanted his own bias “divorced from the decision-making of publication,” and that “technical solutions were in place to ensure the work of the journalists couldn’t be interfered with.”

First, “bigger than he had anticipated.”  Meaning that his judgment is not reliable in these matters.

Second-and this is the big thing-“he did not control what the journalists who had the documents wrote about.”  This is completely, totally, absolutely, utterly at odds with what Snowden has said before.  He claimed earlier that he vetted every document to make sure that nothing that truly compromised national security would be released:

Snowden said that he admires both Ellsberg and Manning, but argues that there is one important distinction between himself and the army private, whose trial coincidentally began the week Snowden’s leaks began to make news.

“I carefully evaluated every single document I disclosed to ensure that each was legitimately in the public interest,” he said. “There are all sorts of documents that would have made a big impact that I didn’t turn over, because harming people isn’t my goal. Transparency is.”

Note the grandiosity.  He’s better than Manning and Ellsberg because he-and he alone-“carefully evaluated every single document I disclosed to ensure that each was legitimately in the public interest.”

Now, he says the exact-the exact-opposite.  Now he claims that his desire to ensure that what is published would not reflect his bias (like his f*cking bias matters a damn) led him to abdicate totally the decision on what to publish to Greenwald and Poitras.  Indeed, rather than vetting every document carefully before it is released, he now claims that he implemented “technical solutions . . . to ensure the work of the journalists couldn’t be interfered with.”  He tied himself to the mast.  He made it impossible for him to intervene.

So which is it Ed? Did you carefully control the release of every document to protect national security, or did you turn over the decisions completely-completely-to admitted, and ardent, anti-Americans?  Just so your bias-it’s always about you, isn’t it?-won’t interfere with momentous decisions about national security?  Apparently Greenwald and Poitras have no biases.  For crissakes, they are walking, talking, breathing biases.

It can’t be both.  In other words, Ed lied. Either to Risen now, or before, when he claimed that he was controlling the release of the documents.

And which is it, Risen? The quote about “every single document” is in the Guardian, from one of the few interviews with Snowden.  Obviously something you should have read while following the story-and re-read while preparing for your “interview.”  So why did you not call out Ed-or whoever the hell was on the other end of that encrypted communication-on that flagrant contradiction?  That’s beyond dereliction.

Will someone other than one of those lowly bloggers that Obama says should be ignored point out this fundamental, crucial, contradiction?  It strikes at the heart of Snowden’s credibility.

And, speaking cynically, this is precisely why I believe that the answer to my question will be a resounding “no”.

The Snowden farce just gets more farcical by the day.  In the most recent episode he was given the “Sam Adams Award.”  No, this has nothing to do with beer, let alone an American patriot.  Instead, it is granted to an American whistleblower.

There was no press coverage inside the event (tell me of another awards ceremony you can say that about).  The attendance was extremely limited, apparently consisting of Ed, his lawyer Kucherena, Sarah Harrison, and four previous recipients of the award.

Conspicuously absent from the event was Snowden’s father Lon, who was in Moscow and had met with Kucherena prior to the ceremony.  Al Jazeera also reports, based on anonymous reports, that Lon and Ed met on Thursday, before the ceremony.  The event must have required some advanced planning, to get all of the Americans there.  Lon’s visit also presumably required considerable planning, just to deal with the visa issues.  The pointed non-invitation of Lon Snowden to an event he could have been invited to and was available to attend is very puzzling.  Even more puzzling if he’d already seen Ed.

The only documentation of the event is a couple of minutes of video fragments provided exclusively to Wikileaks. One of the clips is silent, for crying out loud.

A few thoughts on this charade:

• The fact that the video was provided exclusively to Wikileaks demonstrates the close cooperation between Assange/Wikileaks and the Russians/FSB.  It bolsters the case that Wikileaks may have been conspiring with the FSB all along to bring Snowden to Russia.  The primary open question is when that conspiracy began.  Perhaps it began in Hong Kong.  Perhaps Assange or his representative Harrison suggested that Snowden go to the Russian consulate.  But it plausibly began earlier.
• This Wikileaks-FSB nexus is a big deal.  Not that you’d know about it from the media.  Why won’t a single journalist point this out and do some serious investigation here?  Is the Snowden narrative just too good to question?  I’m looking in particular at Luke Harding, who knows first hand the evils of the FSB which he has described in detail, and who works for a publication that Assange screwed royally.  Is it because the Guardian is so invested in the Snowden story that he/they won’t question this connection?
• Why wasn’t Laura Poitras there to film the event?  You’d think it would be great material for one of the three documentaries she tells sycophantic interviewers she’s working on.  And why wasn’t Greenwald there to hook up with his friend Ed, whom he claims to communicate with daily?
• Even American civil libertarians should take considerable comfort in what passes for a whistleblower in the US.  If the four present at Ed’s ceremony are those with the most damning secrets to reveal about US evils, we’re in pretty good shape.  The most prominent, Ray McGovern, is a 911 Truther loon.  Thomas Drake is a more equivocal figure, but (a) he hasn’t been able to point out one breathing victim of the surveillance apparatus he disclosed, and (b) has been prosecuted, but due to the protections of the American legal system he succeeded in fighting off the most serious charges, and received a light sentence.  The two women really push the envelope of the whistleblower definition.  Coleen Rowley blew the whistle on FBI incompetence in the Moussaoui investigation, not on any government violation of the law, or of the rights of any American citizen.  (She eventually went off the rails, falling in with Cindy Sheehan.) Jesselyn Raddack was a DOJ attorney who objected to the ethics-not the legality-of the FBI’s questioning of Johnny Walker Lindh (“the American Taliban”) without the presence of an attorney after his capture in Afghanistan.   Contrast this lot to, say, Sergei Magnitsky, who uncovered the theft of hundreds of millions of dollars by Russian tax authorities and ended up dead in his cell, or Alexander Litvinenko, who disclosed Russian turpitude in the Caucasus, and alleged that the FSB was behind the bombings of several Russian apartment buildings in 1999 and ended up dying horribly from polonium poisoning.  The comparison between the American and Russian whistleblowers, both with regards to the substance of their disclosures and their fates,  is that there is no comparison.
• Perhaps because they are starved of independent information on Snowden, due to the very strict control imposed over him, mainstream publications give uncritical attention to participants in the charade, quoting them liberally, without mentioning the very fact that their participation in a Russian-produced piece of agitprop calls into question their reliability.  Nor do they report critically on the backgrounds of these people.  For instance.  Seriously, WSJ: shouldn’t readers know that McGovern is a vehemently anti-American Truther?
• Finally, won’t anyone point out in a serious publication the utter absurdity of giving Snowden this award in the Land of SORM, which makes Prism and everything else Snowden (and McGovern and Binney and Drake) has disclosed look like a piker?  SORM collects both metadata and the contents of phone and email communication, and you know that there are no procedural or legal or constitutional safeguards in place that limit the use of that information by the FSB in the way that elaborate measures protect the illegal use of material collected by the NSA.  Irony is far too frivolous a word to apply here: even calling it flagrant hypocrisy seems entirely inadequate.

The Snowden story is bad enough.  The shockingly ignorant and uncritical coverage is even worse. It’s enough to drive one to drink, and I guess that in the event, Samuel Adams would be the beverage of choice.  As a reminder.

The EPA bowed to reality, and has admitted that the blend wall is real.  That is, (a) the vast bulk of autos in the US can only use gasoline with 10 percent of less ethanol, and (b) the mandated level of biofuel consumption exceeds 10 percent of US gasoline consumption.  The gap between the mandated use of biofuels and the actual use of biofuels had led refiners to scramble to by Renewable Identification Numbers (“RINs”) that they can substitute for actual biofuels to meet their mandate obligations.  But the supply of RINs is limited, and their price had skyrocketed started in the spring.  The available supply of RINs for 2014 would have been totally inadequate to cope with the increase in the mandated quantity for that year.  A quantity set by Congress in 2007 when it had no idea what market conditions would be it kicked in, and in defiance of technological realities.  Congress anticipated a steady increase in gasoline consumption, but stagnant economic growth and other factors have led to stagnant gasoline consumption, leading to the current yawning gap between the mandated quantity of biofuels and the quantity that can actually be utilized.

As a result, the EPA has decided to cut the mandated quantity for 2014 by nearly 1/6th, or 3 million gallons.

Economically this is the right result, but legally and procedurally it is a monstrosity.  Congress did give EPA the discretion to waive the mandate, but limited that discretion.  The agency can modify the mandate for two reasons.  Here’s how Reuters describes it:

This can be used to reduce the volumes in two cases: if enforcing the law were to cause economic hardship; or if it were simply not feasible due to “inadequate domestic supply”.

Making the “economic hardship” case is hard, so the EPA is using the second justification.  No.  Seriously.

The plain language of the law makes it clear that inadequate domestic supply of biofuels is the criterion for granting the waiver.  But we have a surfeit of biofuels, if anything: we can produce more of them than can be consumed.

Here’s the gobbledygook the agency uses to justify its decision:

“We interpret the term ‘inadequate domestic supply’ as it is used under the general waiver authority to include consideration of factors that affect consumption of renewable fuel,” the agency wrote in the proposed rules.

Uhm, “consumption” is related to demand, not supply.  But whatever.

The EPA seems inspired by this famous bit from Through the Looking Glass:

‘When I use a word,’ Humpty Dumpty said, in rather a scornful tone, ‘it means just what I choose it to mean — neither more nor less.’

‘The question is,’ said Alice, ‘whether you can make words mean so many different things.’

‘The question is,’ said Humpty Dumpty, ‘which is to be master — that’s all.’

EPA is clearly determined to be master of the words in the Renewable Fuel Standard, and make them mean just it what it chooses them to mean.

The Reuters article states that the EPA’s action is sure to draw a legal challenge from the biofuels industry, and that’s no doubt true.

I yield to no one in my loathing for the Renewable Fuels Association, but they have the law on their side in this case, even if the law is indeed an ass. If the rule of law is to mean anything, laws must be enforced as written, not waived at will, especially when the justification for the waivers flies in the face of the black letter language of the statute.

If we really want a country of laws, the laws need to be enforced and followed, not waived.  We need to work to rule.  To bring home to Congress its folly, and to force it to change the law to bring it into conformity with economic reality, the RFS must be enforced, down to the last comma.

And the principle should be applied more broadly.  Obamacare is a prime example.  Ever G*d damned provision on every one of its 2000 plus pages should be enforced, no ifs, ands, buts or waivers, to make manifest its absurdity, thereby making possible a substantive change in the law-and perhaps scrapping it.

Maybe in the scheme of things RINsanity isn’t a big deal.  But it illustrates quite powerfully the degeneration of the rule of law in the US and the increasingly arbitrary nature of American government.

At the dedication of a new Rosneft refinery (for giggles imagine in your mind’s eye Obama doing something similar at an Exxon one), Putin made a strong statement regarding the compensation-or not-of the TNK-BP minorities.  In a nutshell: you’ll take the crumbs I give you and you’ll like it.

Rosneft should buy out the minority shareholders of TNK-BP Holding at the prevailing market price, not at the peak levels of the past, Russian President Vladimir Putin said on Friday, indicating there will be no increase for investors hoping for an improved payout.

“The valuation and payouts should be carried out for those who wish to sell not at peak levels but today’s market price,” said Putin, who was in Tuapse on the shore of the Black Sea for the opening of an oil refinery by Rosneft. “That should be the basis. No one should be deceived or robbed.”

Oh no one is being deceived here, but robbery is another matter: the minority holders know they are getting robbed.

Note that Putin doesn’t advocate the payment of a premium on the market price, or acknowledge that the market price was depressed as the result of legitimate fears-stoked by Sechin’s Rosneft-is-not-a-charity rhetoric-that the minorities would get a pittance.

This is everything that Sechin could ask for-and probably did.  But it is a huge dis of Medvedev.  Medvedev had publicly pressed Sechin (in a joint appearance) to up the compensation for the minority shareholders, by paying a premium over the average of the market price since the time of Rosneft’s acquisition.  Medvedev had said that this measure was an essential step in assuring foreign investors that they would be treated fairly, thereby making them more willing to invest.

Putin’s decisive rejection of Medvedev’s position tells you all you need to know about the prime minister’s influence in the country, and his ability to control Sechin and other silovki.  Perhaps more importantly, it tells you that Putin couldn’t care less about fixing the severe legal and institutional defects that make investment in Russia so fraught with risk, and which have brought on the stagnation that some have been predicting for some time (ahem) and which is now pretty much obvious to anyone who pays the slightest attention.  (The IMF’s recent appraisal of the Russian economy pretty much puts the seal on stagnation as the new conventional wisdom.  The few Russians of stature who can speak out-and by few, I mean like one, Kudrin-say the same.)

This may seem a small story, but it speaks volumes.  For those of you cock eyed optimists who had hope that Putin would feel compelled to reform in order to stave off stagnation and rejuvenate economic growth, now is time to face reality and abandon it.

I choose (d): All of the above.

Sechin held forth on the purchase of the TNK-BP minority shareholders.  The circumstances were rather extraordinary.  Late Friday night Rosneft’s PR people called a press conference to be held the next morning.  Obviously this was something that couldn’t wait

As for the “thief” part, Sechin gave no ground on piddling compensation to be offered the minority shareholders.  (I should note that BP is a beneficiary of this theft, and arguably an accessory after the fact to Rosneft’s theft of Yukos assets.)  He went with the “we’re paying the market price” line even though the market price of the minority shares had been hammered by realistic fears that Rosneft would not pay fair value.

But that wasn’t the main focus of his remarks.  That’s where the “thug” part comes in.  He was furious-furious-that an investor had the temerity to bring up the subject to Putin:

He seemed less concerned about the substance of the shareholder’s complaint–the fund manager voiced a concern widely held in the market that Rosneft’s offer to buy out minorities was unfairly low–than the fact that the investor had taken it directly to Mr. Putin during a public question-and-answer session at an investment conference.

“This was an attempt to apply pressure, maybe even to manipulate the market,” Mr. Sechin said of the fund manager’s question to the president.

“They should have said, ‘We thank Vladimir Vladimirovich (Putin) for the opportunity to work in Russia and please let us buy something else,’” he added, with only the faintest hint of a smile.

The concern was voiced by a representative of Franklin Templeton Investments, a veteran of emerging-markets investing. Templeton, the questioner said, had bought a stake in TNK-BP Holding, the traded unit of Anglo-Russian oil giant TNK-BP Ltd. in 2006. When Rosneft bought TNK-BP in March of this year, it bought out BP PLC and a group of Russian billionaires who were the British giant’s partners, paying a total of about $56 billion in cash and stock.

The Franklin Templeton representative said last week the stock had been trading at about 85 rubles ($2.10) a share before the Rosneft-TNK-BP deal was announced. The price Rosneft paid to BP and the Russian billionaires, he said, worked out to about 100 rubles a share. Then he added that Rosneft had just announced it planned to report a gain on the transaction because auditors had found the real value of TNK-BP was even higher than what Rosneft had paid–about 123 rubles a share.

His questions were simple: he asked the president if he thought Rosneft’s 67 rubles was a fair price and if such behavior would serve as a precedent for other state-controlled companies.

But here’s the good part.  And by “good” I mean “bad”:

“They’re a great fund, but no one should put pressure on us,” he added, referring to Franklin Templeton. Mr. Sechin said he’d had his staff identify the employee who asked the question, as well as to pull the records of the fund’s ownership, how much it had earned in dividends and how it had voted at annual meetings.

“Everything suited them,” he said, marveling that after such returns the fund would accuse Russia of “putting the squeeze on investors.”

Identify the employee who asked the question, etc.  No.  One would never construe that as a threat in Russia.  Never ever ever, right?

Reality: The message to Franklin Templeton is clear: we know who you are, and if you do that again, we will make you pay.  And for anyone else that has an idea of opening his pie hole, you might want to think about that again, fool. Ask Browder about that.

As for hallucinations, there were several.  For instance, Sechin lauded Russia’s investment climate.  No, really!  He did!

Mr. Sechin praised Russia’s investment climate, repeatedly crediting Mr. Putin for passing regulatory and other changes to stimulate oil production on the Arctic shelf and in other hard-to-produce fields.

“We have reinforced-concrete political stability led by Vladimir Vladimirovich,” Mr. Sechin added.

No further comment necessary.  Other than to say that Sechin’s nose will look tanned even in the middle of a sunless Arctic winter.

Another hallucination involved the shale revolution:

His brief tour of competing oil producers covered the Middle East and Venezuela, but didn’t include North America. [Talk about whistling past the graveyard!] When asked later about surging production of shale oil and gas that’s likely to help the U.S. overtake Russia as the largest producer of the fuels in the world this year, he acknowledged the boom but seemed dismissive. Echoing a view common among Russian officials but discounted in much of the rest of the oil world, he said the impact would be limited to the “local market.”

“We won’t be competing with them on global markets,” he said.

He brushed off a suggestion from a Russian journalist that Rosneft should focus on its own vast reserves of shale oil and gas and leave its current costly drive into the Arctic offshore for the future.

“There will be competition, but we have competitive advantages,” he said.

Um, the oil market is essentially a world market, and supply shocks in one “local market”-you know, like North fricking America-have world-wide implications.  A one percent change in world output emanating from North America has pretty much the same effect on price as a one percent change in world output emanating from Iraq or Nigeria or Russia or Libya: roughly speaking, about a 10 percent impact.  In the medium to long run, there is no “local” in the oil market.  This is Oil 101.  But apparently it’s lost on the CEO of the largest oil producer in the world.

Moreover, the technology of shale is mobile, and will be, after tweaks to accommodate disparate geologies in China and elsewhere, this technology will lead to increased world output, lower world prices-and lower profits for Rosneft.

But the hallucinations don’t end there:

Russian state oil giant Rosneft has plans to extract oil in the next 100 years and sees no significant threat from the increase in shale gas production in the United States, CEO Igor Sechin told journalists Sunday.

“We have a 100 year work prospect,” Sechin said. “As for the shelf, we have no other alternative. In general, oil needs to be extracted,” he said adding that the US shale production is high-cost, which makes it impossible for export.

So shale is expensive, but Arctic projects are cheap?  Seriously?  “Oil needs to be extracted”?  What, regardless of cost?

Yes, shale oil production is expensive compared to other, more traditional resources.  But Arctic projects are incredibly costly, especially for an inefficient, technologically lagging company like Rosneft, which needs western partners to develop these resources-but can’t find the way to play nice with its ostensible collaborators.  Hell, even Shell, which is a far more technologically sophisticated company than Rosneft, and which has a proven track record with technologically challenging projects, has been humbled by its recent failures in the Arctic:

Voser, who will be replaced next year, also said Shell’s failed Alaskan Arctic exploration, marred by technical and regulatory problems, is one of his biggest disappointments on the job, the FT said in a story published Sunday.

Shell RDSA still doesn’t know if it will return to the Arctic next year or in 2015, he said. The company spent $5 billion in the Arctic without being able to complete any wells.

If Shell finds the Arctic a perhaps insurmountable challenge, one can only laugh that Sechin thinks that Rosneft will be able to produce oil in the Arctic economically, even if that oil just needs-needs, I tells ya-to be produced.

One can only marvel at Sechin’s performance. It encapsulates myriad Russian dysfunctions.  A complete disregard for property rights.  Thuggish intimidation of those who question authority.  A complete denial of reality, with the only question being whether that denial is the product of delusion, or just plain dishonesty.

As a friend often reminds me.  Eta Rossiya.

Linking to a speech by Benoit Coeuré of the ECB (who gave the keynote at the Paris conference I spoke at a month ago), ISDA’s Derivativiews blog points out how the reporting of derivatives transactions has been totally botched due to jurisdictional fragmentation:

Mr. Coeuré asks an important question about transparency in his speech: “Does…the supervisor responsible for the supervision of a large cross-border financial institution at a consolidated level have direct and immediate access to information on OTC derivatives transaction that encompass all transactions entered into by all entities of this group? Is the information accessible, in other words can it be easily aggregated across trade repositories and jurisdictions?”

He then goes on to say: “My answer would be a clear no!”

And we agree.

Mr. Coeuré went on to discuss privacy laws, blocking statutes and indemnification clauses in several jurisdictions which restrict access to the detail of OTC derivatives transactions; the inability to aggregate data across trade repositories and jurisdictions; and differences in the type and level of information required for reports across jurisdictions. He ultimately broke the problem into three main issues: information gaps, data fragmentation across trade repositories and jurisdictions and obstacles impeding authorities’ access to data.

ISDA notes that this mess was predictable, and predicted.  I agree: I was one of those who predicted this years back, based in part on my experience with attempting to create an energy data hub in 2003-2004.  Both commercial and political pressures have led to the proliferation of repositories.  Market participants and regulators have beavered away erecting a derivatives Tower of Babel, a collection of databases that serve as a barrier to the sharing of information, rather than a means of sharing information.

I would further note that there are other, deeper problems that call the entire exercise into question.  It may do more harm than good.

First, OTC derivatives represent only a subset of exposures, and therefore even if one had a single, unified database of all derivatives trades one would still have an incomplete picture of interconnections in the system as a whole.

Second, and more fundamentally,  even if regulators were to know the totality of interconnections with only a slight degree of imprecision, what could they do with that information?   The financial system is complex, and it is impossible to know how the system will react to the failure of one node (or several nodes) in that system, or even the threatened failure of some nodes.  Indeed, the actions of market participants depend on their beliefs; the stability of the system depends on how market participants behave; and the beliefs of these market participants is unknowable.  Meaning that even an accurate map of all interconnections is not sufficient to understand the susceptibility of the system to crisis: one has to know about the expectations and beliefs of market participants.

Moreover, if one views a crisis as a period when the financial system goes chaotic (in the technical sense of the term), even the slightest imprecision in measuring the state of the system (where the state includes actual interconnections/exposures and beliefs about these interconnections and the beliefs of others and beliefs about how people will act on those beliefs and on and on) means that one cannot predict how the system will behave: the defining characteristic of a chaotic system is extreme sensitivity to initial conditions, so if you measure those conditions with even the slightest error, you will not be able to predict its evolution, or its response to a shock.  Moreover, it means that one cannot predict the effect of interventions in the system when (a) the system is chaotic or on the cusp of chaos, and (b) one cannot measure the state of the system with near perfect precision.

In other words, even if the Tower of Babel problem is corrected, and one measures derivatives exposures with considerable accuracy, one can have little confidence that regulators will have the information necessary to identify an incipient systemic event, or how their interventions will affect the system.  Indeed, in crisis situations, a little knowledge can be a dangerous thing: interventions in a chaotic system based on an imprecise measurement of the state of the system, let alone an incomplete understanding of the dynamics of the system, can make things worse, not better.

This suggests that the entire enterprise of attempting to map the system is futile, and perhaps even dangerous.   This enterprise is predicated on a mechanical view, a view that characterizes the financial system as stable and predictable if you have enough information.  If instead the system is complex and on the edge of chaos, this view is completely misguided because no amount of information is enough.  Moreover, this view encourages hubris and can result in interventions that destabilize instead of stabilize.

This is the knowledge problem on krokodil.  Centralized intervention in a complex system based on imperfect knowledge is a very dangerous thing indeed.

SEC Chair Mary Jo White has made something of a stir with her recent speech on equity market structure.  One interesting thing was her attempt to downplay regulation as a cause:

Although some have argued otherwise, these developments are not attributable solely to regulatory choices. Competition plays a powerful role. Well before Regulation NMS, market participants were trading in dark pools and trading with highly automated strategies. Many jurisdictions around the world with different regulatory structures than ours are dealing with analogous issues related to off-exchange venues and automated trading.

This is a slippery and somewhat disingenuous argument. It starts out with an Obama-esque straw man: I don’t know of any credible analyst of these issues who claims the problems in market structure are “attributable solely” to regulatory choices.  Having knocked down that straw man, she focuses on somewhat off-topic technological issues and thus totally sidesteps saying what role regulation, and notably RegNMS have played.

I generally agree with her emphasis on empirical evidence as the basis for policy choices.  But the empirical research has to consider all potential issues-including potential regulatory culpability.

The part of White’s speech that attracted the most comment relates to exchange competition and the self-regulatory model:

Exchange Competition and Self-Regulatory Model

Another set of assumptions about our current market structure is related to the nature of exchange competition and the nature of the self-regulatory model itself.

Equity exchanges today operate fully electronic, high-speed trading systems using a business model that mostly was developed by electronic communications networks, or ECNs, prior to Regulation NMS. Indeed, in many ways, today’s exchanges are yesterday’s ECNs.

Exchanges differ from ECNs, however, in significant respects. Exchanges, for example, continue to exercise self-regulatory functions, even as they operate as for-profit entities.

This model for exchanges has encountered challenges. As I noted earlier, for example, the “lit” exchanges no longer attract even one-half of long-term investor orders.

From time to time, equity exchanges have adopted trading models that use different fee structures or attempt to focus on different priorities, such as order size or retail investor participation. These models have been met with mixed success, which raises the question as to whether exchanges have a real opportunity to develop different trading models that preserve pricing transparency and are more attractive to investors.

As is true for all important aspects of our current market structure, the current nature of exchange competition and the self-regulatory model should be fully evaluated in light of the evolving market structure and trading practices. This evaluation should include whether the current exchange regulatory structure continues to meet the needs of investors and public companies. Does it provide sufficient flexibility for exchanges to implement transparent trading models that can effectively compete for investor orders? Does the current approach to self-regulation limit or support exchange trading models?

This evaluation should also assess how trading venues can better balance their commercial incentives and regulatory responsibilities. For example, is there an appropriate balance for exchanges in key areas, such as the maintenance of critical market infrastructure? And are off-exchange venues subject to appropriate regulatory requirements for the types of business they today conduct?

One thing that jumps out at me is the suggestion that there is a tension between the for-profit model and self-regulatory responsibilities, with the corollary suggestion (rather obliquely made) that for-profit exchanges should be stripped of some regulatory responsibilities.

Let me break it to everyone: there is a tension between the not-for-profit model and self-regulatory responsibilities as well.  Not-for-profit exchanges were not charitable organizations.  They were established and run by very profit driven intermediaries (brokers, liquidity suppliers) who adopted the non-profit form to prevent redistribution of wealth among heterogeneous members.  This form was economically rational in floor trading days, when intermediaries and exchanges had highly specific capital that needed protection against expropriation. A big technological shock-the move to electronic trading-meant that the non-profit form was not longer needed to protect these specific investments, or to prevent exchanges from using pricing of their services to redistribute wealth among members.

As I wrote about extensively during the mid-90s, traditional exchanges did a good job at some self-regulatory functions, and a bad job at others.  Manipulation was one that exchanges policed quite badly, for instance: contract enforcement was one they did quite well.

In these papers, I identified a couple of factors that affected the effectiveness of exchange self-regulatory efforts.  One was whether the exchanges internalized the benefits.  In the case of manipulation, for instance, the effects of corners and squeezes on the derived demand for the services of exchange members did not reflect the effects of corners and squeezes on market participants generally.  The price and quantity of exchange services depends on the impact of manipulation on marginal customers, but inframarginal customers bore the brunt of manipulations.  Moreover, some effects were public bads, such as the effect of manipulation on the informativeness of prices.

Another factor is the distributive effects across exchange members.  Self-regulations that led to overall efficiency gains but hurt some members were often not adopted due to such conflicts: the battles over grain warehouses in Chicago in the 1860s and 1870s is an example.

Similar problems afflict for profit exchanges, though internalization problems are probably the most acute now: the movement to the for-profit form has reduced the conflicts within exchanges.

Back around 2000, when the move to for-profit exchanges was gaining momentum, I wrote a paper on the implications of this for self-regulation.  I put it aside.  I should probably dust it off and revise, but the basic conclusion holds true, I think: for-profit exchanges have good incentives to regulate some things, bad incentives to regulate others.  The task is to identify these various strengths and weaknesses, and allocate regulatory responsibilities accordingly, always keeping in mind that the alternative-public regulation-has its weaknesses and strengths too.

The one major issue that has brought this to the fore is the breakdowns in the SIPs that connect exchanges and are necessary for the information-and-linkages approach adopted by the SEC in RegNMS (and Congress under the original NMS mandate) to work.  This is predictable, based on the analysis presented above.  SIPs have some attributes of public goods, and no exchange internalizes the benefits and costs of SIP performance.  Not surprising, then, that this has proved to be a weak link in the current market structure.  But since SIPs have natural monopoly characteristics, it’s not an easy task to determine how they should be owned, priced, and governed.  But the question hasn’t been framed this way, which means that it’s unlikely to be answered properly.  (Recall that the old Intermarket Trading System was also a chronic problem in the pre-RegNMS world: it was sort of a joke, actually.)  SIPs are analogous to transmission in electricity, and transmission has always proved the most difficult part of the system to regulate and price.  (Yes, there are important technological differences, but the similarities are relevant.)

Some things in White’s speech appear contradictory.  For instance, she questions whether a one-size-fits-all market structure is appropriate, then denigrates exchange efforts to experiment with different models: “These models have been met with mixed success, which raises the question as to whether exchanges have a real opportunity to develop different trading models that preserve pricing transparency and are more attractive to investors.”  It seems to me that exchanges have had plenty of opportunities, and that the mixed success suggests that the potential for differentiation (including moving away from one-size-fits-all) is rather limited.

There is one form of differentiation that White seems to be quite suspicious of: trading on dark venues:

A steadily increasing percentage of trading occurs in “dark” venues, which now appear to execute more than half of the orders of long-term investors.

Combine this with her desideratum for trading: models “that preserve pricing transparency and are more attractive to investors.”  Well, here we have a great example of a non-one-size-fits-all model that is obviously more attractive to some investors, but it bothers White (and regulators generally).  One of the things that makes dark venues popular to long-term investors is precisely the lack of price transparency.   Ironically, the SEC has always claimed the markets should favor long-term investors, and indeed White starts her speech by arguing that the markets cannot serve their capital formation function without long-term investors.  Thus, the “and” in that phrase is problematic.

One interpretation is that White doesn’t want one-size-fits-all, but that the varieties that have evolved-dark venues that accommodate long-term investors and lit venues that accommodate some long-term investors and most others-aren’t to her liking.  This is not a convincing position.  It begs the question of why the long-term investors White favors prefer a venue she disfavors.  It also doesn’t come to grips with the literature which shows that off-exchange trading venues reduce trading costs for uninformed, liquidity traders-which can include long term investors who initiate and liquidate positions for non-information driven reasons.  It also is in tension with her statement that for-profit exchanges with a strong profit motive are trying to innovate: if they are losing business to dark venues as a result of, say, predatory conduct carried in lit markets, they have an incentive to devise rules and pricing structures that curb the predatory conduct and thereby attract the return of those who have fled to dark venues.

It also bears emphasis, for this point is often forgotten, that dark venues have always been with us, and that large, long-term investors have been the users of these venues.  Back in the day, this was the function of block markets.  Dark venues have largely replaced the block markets, serve the same function, and service the same investor base.  That’s true even though much of the trading on dark venues is not in blocks (although some dark markets are essentially for block trading).  As Duane Seppi demonstrated years ago, block trading and the protocols surrounding it were ways of screening out informed traders.  Dark venues have other means of performing the same function, without imposing the constraint that trades occur in blocks.

Summing up, it’s good to see these market structure issues get such serious attention.  It’s less encouraging to see that regulators are focusing on secondary or tertiary issues (e.g., whether self-regulation is incompatible with for-profit exchanges) and have certain preconceptions that makes them unduly suspicious of departures from one-size-fits-all trading that accommodate the needs of an important category of market users-indeed, the category that the SEC has long said it desires to protect. (As an aside, which I may expand upon later, the SEC’s preferences, and its suspicion of dark markets, is likely driven by political economy considerations.  Namely, exchanges exert more political influence, and have influenced the SEC to advance their interests.)

In my opinion, the SEC’s immediate priority should be fixing the SIP (if it deems that links-and-information is sacrosanct).  This fix should look at ownership, organization, and governance, based on an understanding of the public good attributes of the SIP.  (Longer term, the RegNMS links-and-information approach needs a new look.)  In addition, the empirical approach that White rightly advocates should look at dark venues through objective eyes, free from prejudices which are all too apparent (as the very term “dark” demonstrates).  It’s especially important that the reasons for the commercial success of dark markets be understood and explained before it is lamented.  A case can be made that the non-one-size-fits-all model that works best could consist of dark and light venues operating side-by-side, serving different investor clienteles.   It’s certainly a model that has existed over time, and in a wide variety of different countries.  Maybe there’s something to it.  Perhaps we should understand what that might be, before monkeying with market structure any more.

Obama asserts 2 propositions vigorously:

1. I will not negotiate with the Republican Party leadership in Congress.  (With Republicans in Congress mind you. Mullahs, Putin-whole different story.) (Given Democratic comparisons of the Republicans to suicide bombers, the Taliban, etc., perhaps this is a corollary of the “We don’t negotiate with terrorists” principle.)

2. I have bent over backwards to work with the Republican Party.

The scary thing is that I am pretty sure that Obama believes this. It’s not an act. He sees no contradiction whatsoever between these irreconcilable beliefs. He believes he’s been totally flexible and accommodating. Totally.

Look.  I think that Obamacare is a disaster, but that the Republicans played this like idiots: they aren’t known as the Stupid Party for nothing.  Ted Cruz was a debating star at Princeton who thought that studying with alums of “lower Ivies” (like Penn) at Harvard Law was beneath him, but he strategized this like the holder of a diploma from a penitentiary correspondence school. If anything, this strategy has cemented Obamacare, rather than undermined it.

But the most important cause of the current impasse is that a hardcore partisan president is partisan out of near religious conviction in his righteousness, and the near religious conviction that his opponents are evil.  He is willing to compromise on things he doesn’t really care about-and Syria and Iran fall into that category-but it’s a zero sum game to him on domestic matters. He doesn’t want to win: he wants to extirpate his enemies. Beginning to understand this, the Republicans have every incentive to double down.  Meaning that the conflict and crisis will only metastasize.

Every day I pray more fervently that Adam Smith (“much ruin in a country”) and Bismarck (“a special providence for  . . . the United States of America”) are right. We’re testing both.