Streetwise Professor

December 31, 2013

Let’s Play Connect the Dots! What Did the NYT Conveniently Leave Out of Its Hit Piece?

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 9:26 pm

It’s New Years Eve, and perhaps a little game is in order to get ready for the turn of the calendar in about 3 hours.  Let’s play connect the dots.

  • In July, David Kocieniewski writes a big-totally incoherent, but big-article in the New York Times on the aluminum warehouse controversy involving Goldman Sachs, JP Morgan and others. The article focuses on Goldman’s Metro Warehouse in Detroit.
  • On 1 August, 2013, the law firm Lovell, Stewart, Halebian and Jacobson LLC files suit against Goldman Sachs for violating Sections 1 and 2 of the Sherman Antitrust Act in its operation of the Metro Warehouse in Detroit.
  • The Lovell, Stewart complaint cites the Kocieniewski article.  Numerous news articles state that Lovell, Stewart is the firm that filed the complaint.
  • Lovell, Stewart is one of the leading plaintiffs’ law firms in the country.  It is indisputably the leader in manipulation class action lawsuits filed under the Commodity Exchange Act.  LSHJLLP has been the lead counsel or co-lead counsel in virtually every major manipulation lawsuit in the US, and has won hundreds of millions of dollars in settlements in such cases.  Its web page lists numerous past and current commodity manipulation cases, as well as other cases filed against financial institutions.
  • I have worked as an expert in numerous cases for Lovell, Stewart (and its predecessor law firms) going back to 1994.  Many of these are manipulation cases.
  • David Kocieniewski knew, before writing his hatchet job, that I had worked for Lovell, Stewart.
  • Kocieniewski did not ask me about my work for Lovell, Stewart.  He did ask me about my work for trading firms and banks.  I did mention, on my own initiative, that I had been adverse to such firms in some of my work.
  • Kocieniewski mentioned my work for trading firms and banks, but did not mention my work for Lovell, Stewart.

So there are the dots.  Help me connect them.

Seriously.  I would like you to tell me in the comments what you see when you connect those 8 dots: what inferences do you draw?  I know what I see, but I’d like to crowd-source this.  Maybe you all see something different.  Thanks in advance for your help, and have fun playing!

And to all my readers: have a Happy and Healthy New Year.  Your interest and continued support is what makes this a rewarding endeavor.  Cheers!

Thank You, Dr. Sowell

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 1:06 pm

I have always admired Thomas Sowell greatly.  I read his Knowledge and Decisions during my first year of graduate school, and it had a profound effect on my thinking and way of looking at the world.  I also read most of his work on discrimination, and found his book on Marxism to be a classic in intellectual history: a truly fair and penetrating appraisal of Marx, and Marxists (the two things aren’t the same, which is one of the points of the book).  Conflict of Visions is a classic: there is no better book for understanding the intellectual roots behind the political divisions in the West.  Yes, Sowell has strong views, but he is like John Stuart Mill in his ability to characterize his opponent’s views fairly and objectively.

Sowell has also been the subject of some the the ugliest personal attacks directed against any scholar over the last 40 years.  For the progressive left, to be black and on the right is to be an anathema who must be destroyed.  Yet he has handled the vicious attacks on him with equanimity and humor, and has never been cowed.

It is therefore beyond humbling to have Dr. Sowell come to my defense, and take on the New York Times “hit piece.”

All I can say is that I am honored beyond words.  Thank you, Dr. Sowell.

December 30, 2013

Here Comes the Cavalry

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 9:39 pm

The NYT hatchet job has elicited quite a bit of discussion on the web, and on Twitter.  Several major bloggers have saddled up and ridden to the defense of Scott Irwin and I.  Pride of place goes to Felix Salmon, who wrote a long and thoughtful post at Reuters. This is particularly gratifying, because Felix and I have had our differences in the past (e.g., over the empty creditor problem) but I have always found him to be extraordinarily fair and open minded.  Felix wrote his piece before I posted mine, meaning that his was based on publicly available information (including his past interactions with me) which confers a considerable degree of objectivity: most importantly, it shows that information that the NYT ignored or distorted was there in plain sight.  Felix is like a judge entering a summary judgment motion against the NYT, with prejudice, making it unnecessary for the defense even to present its case.  I think it’s correct to say Felix’s verdict is pretty brutal, but eminently fair.

Other members of the cavalry include Jeff Carter’s Points and Figures blog (who was the first to arrive on the scene), Peter Klein at Organizations and Markets, Sonic Charm (or is it Crimsonic?) at Rhymes With Cars and Girls (who always cracks me up, whatever he’s calling himself these days), and John Hinderaker at Powerline. Peter and John point out the double standard under which academics who work with private business are often accused of being corrupt, whereas the motives of those who accept money from the government are almost never questioned.   Peter focuses on the Fed, John on climate research.  The common conclusion of all is that the NYT piece was a deeply biased smear written in bad faith with ulterior motives.  Crimsonic calls for a retraction.  Interesting idea.

Felix’s post and mine also unleashed a torrent of tweets.

Thanks to all.  I’m sure this isn’t over yet.  So keep your horses watered and your powder dry.

I Have Not Yet Begun to Write: Responding to the New York Times’ Farrago of Dishonesty, Insinuations, and Ad Hominem

Filed under: Commodities,Derivatives,Economics,Energy,Exchanges,Politics,Regulation — The Professor @ 12:49 pm

The New York Times, in an article written by David Kocieniewski, has singled out me and the University of Illinois’ Scott Irwin for an extended ad hominem treatment alleging that our statements and research on commodity speculation are tainted due to financial connections with “Wall Street.”  As one individual put it to me, the article is “nasty, biased and thinly researched.”   All true (if incomplete-the list of sins is even longer).  But at the risk of providing credence to the incredible, I believe some sort of response is warranted.  So here it goes.

Let me start by saying I have been very fortunate. I have been able to pursue my academic passions, publish papers and books on them, and consult and testify as an expert witness on many matters related to these passions. Through each and all parts of this, I have been true to my Chicago School roots and to what I thought the data and good economics showed.  My opinions on speculation are the product of my training and my research, period.

Moreover, completely contrary to the impression in the NYT piece, the vast bulk of my consulting and testifying work has been adverse to Wall Street and commodity trading firms.  Virtually none of this work relates to the alleged subject of the NYT story: the impact of speculation on commodity prices.  In fact, much of this work relates to market manipulation (which is distinct from speculation) by commodity traders.  I have been, and continue to be, on the side of plaintiffs in attempting to hold traders who abuse markets accountable for their conduct.

The failure of David Kocieniewski to point out this salient fact alone betrays his utter unprofessionalism and bias, and is particularly emblematic of the shockingly shoddy excuse for journalism that his piece represents.

Moreover, none of the research or writing I have done on the speculation issue received financial support from any firm or entity with even a remote stake in this issue.  I started writing about this on my blog in 2006, and have been arguing this issue on my own time with no financial support from anyone.  Unlike, say, Ken Singleton (whom I admire immensely and am not accusing of anything remiss) I have not written any commissioned research on the subject of commodity speculation.  My work that has been done with firms that are connected, in some way, to commodities trading has been on subjects unrelated to financial speculation, and/or with firms that are not financial speculators, and/or took place well after my opinions on the subject were a matter of public record, including in national publications like the Wall Street Journal.  Therefore, to suggest some connection between my paid outside work and my opinions on speculation is misleading, deceptive, and plainly libelous.

True to my Chicago School roots, I believe this is a data issue informed by a strong understanding of the theory and empirics of commodity pricing-a literature to which I have  made many peer reviewed contributions.  And I have been open and remain open to reviewing any data on any market.  I further note that the vast bulk of other research on this subject, undertaken by world-class scholars including James Hamilton and Lutz Killian supports  my conclusions (and those of Scott Irwin).  Ironically, considering the where this piece appears, even Paul Krugman is in agreement.

The simple explanation for my views is that I am avowedly a “super-freshwater economist” by training and conviction.  Because I know that drinking saltwater makes you go crazy. Kidding aside, my work on speculation is a piece with all of my academic work, my background, and my training.  Randall Kroszner, former Fed governor, told me once that I was one of the last true Chicago School economists. That’s a compliment, that’s pretty accurate, and that’s aspirational.  That is a much better predictor of where I come down on any issue than anything else: including money.

What’s more, I do not solicit, have never solicited and would not solicit money for any institution or purpose based upon my views of speculation or the policy issues relating to speculation. Or any other issue.

A couple of other points before getting into specifics.

First, there are no coincidences, comrades. The NY Times has been Tiger Beat effusive in its praise for Gary Gensler of the CFTC.  This piece attacking two of the most prominent academic critics of Gensler’s efforts to impose a speculative position limits rule comes out days after the Commission approved a new version of the rule, and is in the midst of the comment period leading up to the formulation of a final rule.  Gensler fought for this rule for 5 years, and he views it as an important part of his legacy.  That is, there is a clear political agenda at work here: to kneecap those who have the audacity to oppose the regulatory agenda of Gensler and his media acolytes.

Second, this kind of ad hominem attack will have the effect (which is likely intended) of serving as a warning to other academics who cross powerful political interests with their academic research, and who have the temerity to speak out on controversial matters.  How can this be seen as anything other than having a chilling effect on other academic researchers in the the financial and commodity markets?  But maybe that’s exactly the point.

Now some specifics.

  1. There are many egregious distortions in the article, but the most egregious is Kocieniewski’s lying by omission.  Lying. By. Omission. Specifically, he omits the salient fact that the bulk of my consulting engagements (in the form of expert testimony) have been adverse to commodity traders and banks.  I have testified numerous times about manipulations by these types of firms, and have testified against them on other matters unrelated to manipulation.
  2. Let’s examine some of the firms I have been adverse to in my work over the past 20 years, shall we?  Off the top of my head: BP (twice); AEP; Ferruzzi (a commodity trading firm); Duke Energy; Nasdaq market makers; JP Morgan; MetLife; Morgan Stanley; Goldman Sachs; Cargill; Amaranth (a hedge fund that was one of the largest speculative-industry players in the country); Moore Capital (one of the world’s largest hedge funds, and another huge speculative industry player); Optiver (a major trading firm); Pimco (the world’s largest fixed income fund); Merrill Lynch (twice); Sumitomo (major copper trader); Microsoft; Cantor Fitzgerald (twice); and on and on.  A veritable murderers’ row of banksters and traders and energy firms.
  3. I say again: by omitting any mention of this work the Times is lying by omission, and presenting a biased and extremely distorted picture of me and my work.  This biased selectivity makes a joke of the Times’ motto “all the news that is fit to print”.   Leaving out this salient fact makes it plain that Kocieniewski and the Times have an agenda, and no interest in presenting a complete picture of me and my work.  The Times article (inaccurately-see below) lists some of my work on the side of commodity traders and exchanges to create the impression that I am their creature, but leaves out the work in which I have been their fierce antagonist-and in the performance of which I have contributed to their payment of damages running into the many hundreds of millions of dollars.  This failure to mention evidence that contradicts his pre-conceived conclusion is shoddy, dishonest journalism.
  4. Nowhere in the article does the article point out any mistakes or inaccuracies in my research or Scott’s, only making it plain that the problem is that our research does not fit his and the NYT’s preconceived notions about speculators.  I spoke to the reporter for quite a while.  Mostly about the substance of my arguments.  None of that made it into the article, and the reporter wasn’t even able to find another academic to criticize my arguments (or Scott’s): there’s no evidence he even tried, suggesting that the substance was irrelevant to him.  The failure to address the substance of my arguments is very telling.  If I am merely advancing some illegitimate commercial interest, my arguments would be easy to refute, no?  Moreover, Kocieniewski fails to mention my numerous peer-reviewed publications on commodities.  This provides independent validation (though imperfect, because I have serious criticisms of peer review) of my work on the behavior of commodity prices.
  5. There are several factual errors.  Most notably, Kocieniewski claims I wrote a “flurry” of comment letters on speculation/position limits.  I guess in the NYT Thesaurus, “flurry” is a synonym for “one.”   For I wrote a single comment on the issue: as I noted in an earlier post, the comment must have had something of an effect because the CFTC’s new speculative limit proposal eliminates language I had criticized in my letter.  (I also wrote a comment on the CFTC rule proposal relating to clearinghouse governance.  Thus my “flurry” of comments to the CFTC on Frankendodd totals two snowflakes.)  Also, the article ominously suggests that I simultaneously had undisclosed “financial ties” to banks and trading firms when I wrote the study on the systemic risk of commodity trading firms for the Global Financial Markets Association (GFMA).  This is not correct.  I agreed to write a white paper on commodity trading firms for Trafigura more than a year after writing the GFMA report.  Indeed, the GFMA report led to the Trafigura engagement.  Which again indicates that public revelations of my views typically precede any paid retention.
  6. Obviously, the story of the GFMA study, which I have discussed earlier on the blog, demonstrates clearly that my opinions are not for sale, and that I have stood up to and do stand up to “Wall Street.”  I would specifically note that one thing that I adamantly refused to remove from that study, despite the insistence of the attorney for JP Morgan’s commodity trading division, was my statements that commodity trading firms have been known to manipulate markets.
  7. Kocieniewski’s’ claim that I somehow conceal my consulting work by referring to myself “solely as an academic” is refuted by the biography linked to in his story.  That bio includes the following language, which I include in the bio for every speaking engagement I undertake: “Professor Pirrong has consulted widely. His clients have included electric utilities, major commodity processors and consumers, and commodity exchanges around the world.”  Therefore, Kocieniewski’s characterization of how I represent myself is deceptive and fundamentally dishonest.  I gladly reveal that I consult because it suggests I might actually know something about the real world that real people might learn from.
  8. Kocieniewski’s representations about disclosures are invalidated by his dishonest handling of chronology.  He insinuates that I did not disclose my work for the CME or commodity trading firms when I testified before Congress in 2008. But the work for CME Group, GFMA, Trafigura, etc., that Kocieniewski mentions occurred in 2011 and later.  My disclosures in my testimony were accurate at the time I made them.   But I guess I should have invented a time machine, or become Karnac the Magnificent and disclosed things that I would do in the future.
  9. The Times insinuates that my work for CME, Trafigura, TruMarx and others is related to the speculation issue, and hence taints my opinions about this matter.  My work for CME has consisted of evaluating the performance of the WTI contract as a hedging mechanism and an expert witness engagement regarding a patent on electronic trading systems: neither has anything to do with commodity speculation.  Trafigura is a physical commodity trader that uses derivatives almost exclusively to hedge, not speculate.  TruMarx launched a platform to trade physical energy, primarily between end users: again, nothing to do with financial speculation.  These matters and these companies are not related to the financial speculation issue, and Trafigura and TruMarx in particular have no real stake in the speculation debate.  Moreover, my work for them has nothing to do with the speculation issue.  Either Kocieniewski is ignorant of the fact that many commodity traders are not speculators, in which case he is not competent to be writing this story, or he is counting on the inability of his readers to understand the great diversity of firms involved in commodity markets, most notably the fact that many (most?) are not speculators, in which case he is attempting to mislead.  I know where I am laying my bets.
  10. The Times also mis-states facts about Scott Irwin, but that is mainly for Scott to correct.  One particularly egregious thing stands out which I cannot let pass though.  Kocieniewski talks about the $1.5 million that CME Group donated to the University of Illinois.  But not one cent-one cent-of that went to Irwin’s Department of Agricultural and Consumer Economics, let alone to Irwin personally.   To say that Kocieniewski’s connection of the CME’s financial support for the University of Illinois (a $4.4 billion dollar operation) and Scott Irwin is scurrilous is an extreme understatement.

I could go on, and may expand on this in a subsequent post.  But this should suffice to show that the New York Times published a hit piece to achieve a political purpose.  That piece is is a farrago of dishonesty, insinuations, innuendo, and ad hominem.  It is dishonest to its very core because of its egregiously biased omission of some essential material facts and deceptive presentation of others.

And pace John Paul Jones,  I have not yet begun to write-and fight-on policy issues that matter to me.  I will continue to bring my style of economics, data, and facts to issues upon which I can make a constructive contribution. The fact that the New York Times feels compelled to answer with fundamentally dishonest ad hominem means that it knows it cannot win on the substance, and that it views me (and Scott) as a threat to its agenda.  That’s all the encouragement I need to keep it going.

December 25, 2013

A Christmas Message From Our New Messiah

Filed under: History,Military,Politics,Russia — The Professor @ 5:19 pm

Befitting a boy who obviously views himself as the Second Coming, Ed Snowden blessed us mere mortals with an “Alternative Christmas Message” on BBC4.  It’s not as bad as you’d imagine.  It’s worse.

The main theme was “end mass surveillance.”  Apparently irony is lost on Ed, because he delivered this message (filmed by Laura Poitras, ‘natch) from Moscow, capitol of the Land of Sorm.  I might take him seriously if he delivered the same message on NTV, or in Red Square-or to Putin’s face, a la Khodorkovsky circa 2003.

This epistle comes hard on the heels of an extended Snowden interview with Bart Gelmann.  Actually, “interview” doesn’t really convey the full truth.  “Slobber job” comes somewhat closer.

The very first day the Snowden story broke, a friend asked me what I thought of him.  My very first impression was of a grandiose narcissist.

I didn’t know the Nth of it. The entire interview consists of Snowden instructing us on his great moral superiority (especially over those in government whom he refers to as “the overseers”) and penetrating judgment.  Some lowlights:

“For me, in terms of personal satisfaction, the mission’s already accomplished,” he said. “I already won. As soon as the journalists were able to work, everything that I had been trying to do was validated. Because, remember, I didn’t want to change society. I wanted to give society a chance to determine if it should change itself.” [Oh how will we ever thank you?!?]

“All I wanted was for the public to be able to have a say in how they are governed,” he said [from Russia]. “That is a milestone we left a long time ago. Right now, all we are looking at are stretch goals.”

. . . .

“I am not trying to bring down the NSA, I am working to improve the NSA,” he said. “I am still working for the NSA right now. They are the only ones who don’t realize it.”

And the best one:

“Let them say what they want,” he said. “It’s not about me.”

Word to the wise.  Just as when someone says “It’s not about the money” it’s about the money, when someone says “it’s not about me” it’s about them.

Then there are whoppers like this:

“I don’t care whether you’re the pope or Osama bin Laden,” he said. “As long as there’s an individualized, articulable, probable cause for targeting these people as legitimate foreign intelligence, that’s fine. I don’t think it’s imposing a ridiculous burden by asking for probable cause. Because, you have to understand, when you have access to the tools the NSA does, probable cause falls out of trees.”

If probable cause “falls out of trees”, why is the number of times that metadata connections have led to the issuance of less than 60 warrants to surveil communications of American subjects (which do require probable cause)?  Note the fundamental dishonesty of this statement.  Yes, collection of metadata is fairly characterized as indiscriminate (but also fairly characterized as Constitutional based on Supreme Court decisions), but to go beyond that does require NSA to obtain warrants based on “individualized, ariticulable (and articulated) probable cause.”  To insinuate otherwise, as Snowden does, is low and dishonest.

For a supposed genius who should be trusted with substituting his judgment on matters of secrecy and security for those who are the legitimately constituted authorities to make such judgments, Ed is totally clueless on the paradox of markets for information:

“But when you weigh that against the alternative, which is not to act,” he said, “you realize that some analysis is better than no analysis. Because even if your analysis proves to be wrong, the marketplace of ideas will bear that out. If you look at it from an engineering perspective, an iterative perspective, it’s clear that you have to try something rather than do nothing.”

Um, that doesn’t work when the issue is what is, and what is not, legitimately a state secret.  Revealing what is secret, and then asking “should this be kept secret” is an absurdity.  Once the secret has been revealed, the question becomes totally moot.  (“Hey.  We’ve broken the German Enigma code.  Should we keep this a secret, or not, people?”)

This is exactly why issues relating to security and secrecy are so difficult.  They are fundamentally incompatible with public debate, except in broad generalities.  And this is precisely one of the benefits of republican, as opposed to democratic, government.  But it is a difficult challenge even for republican (i.e., delegated) government, and is definitely not amenable to the simplistic nostrums that Snowden (and others, like Assange and Greenwald) push, dripping Olympian disdain all the while.

Moreover, Snowden does not address, and the sycophantic Gelmann does not press him to address, other crucial questions.  For instance, if Snowden’s overriding concern is for individual privacy, why have the bulk of the recent revelations involved matters of intelligence involving foreign governments?  Moreover, if Snowden had a very specific concern relating to individual privacy, why did he indiscriminately scrape documents reputed to number in the millions, rather than limiting his whistle blowing to a smaller set of representative documents that would illustrate his point?  Relatedly, was there a way to make his point that posed less of a threat to US national security than stealing hundreds of thousands of documents, then absconding to countries hostile to the United States?  And if his case is so overwhelming, why has virtually every story-every damned one-been presented in an exaggerated and misleading way, with the errors and distortions being pointed out with devastating accuracy usually within 24 hours?  Doesn’t that suggest that he is not the honest agent for the public interest he claims to be?

Not to say that the Gellman piece was without its comic moments:

It would be odd if Russian authorities did not keep an eye on him, but no retinue accompanied Snowden and his visitor saw no one else nearby. Snowden neither tried to communicate furtively nor asked that his visitor do so. He has had continuous Internet access and has talked to his attorneys and to journalists daily, from his first day in the transit lounge at Sheremetyevo airport.

Stop it Bart! You’re killing me! Um, have you ever heard of, I dunno, electronic surveillance?  Do you really f*cking believe that the Russians didn’t hear every word you uttered?  Ever think that “continuous Internet access” might be continuously monitored?  That those daily conversations with lawyers and journos are monitored-and perhaps scripted?  Can you really be such a big dipshit?

The only thing more depressing than the Snowden Sermon is that so many people eat it up.  At best he is a pretentious poser who arrogates to himself decisions on grave matters of national security that he is judgmentally and temperamentally incompetent to make.  At worst he is the witting agent of a foreign power, and has been all along.  Either way: the (grandiose) gift who keeps on giving, and giving, and giving.  Such Christmas gifts we could do without.

December 24, 2013

Neanderthals Have Rights Too!

Filed under: Commodities,Economics,Financial crisis,Politics,Russia — The Professor @ 2:55 pm

Whenever I see a picture of Rusal CEO Oleg Deripaska, I know that Neanderthals still walk the earth.  This particular Neanderthal is in serious financial difficulties these days.  When Rusal IPOd about four years ago, it was priced at HK$10.20/share, and it’s been all downhill since.  The stock is now trading for about 75 percent less, at HK$2.32.  Rusal is levered up to the wazoo, and Deripaska has other pressing obligations, including construction projects at Sochi  made at Putin’s insistence which will almost certainly be huge white elephants.

The main reason for My Favorite Neanderthal’s financial distress is the depressed price of aluminum, which is down by about a third in the past three years.  For a smelter like Rusal, the only saving grace is the high premium of cash aluminum over the prices of metal in LME warehouses.  That premium is inflated by a bottleneck at LME warehouses like Goldman Sachs’s Metro in Detroit.  If that bottleneck is widened, the huge stocks accumulated during the financial crisis will make their way onto the market, crushing premiums and bringing down the price that Rusal (and Alcoa and Chinalco) get for their production.  This would probably be enough to put Rusal and Deripaska over the brink.

Stung by intense criticism, the LME has announced rule changes intended to loosen the bottleneck.  The mooted rule changes are a mortal threat to Deripaska, so he’s suing in London.  This is not surprising, because Deripaska has nothing to lose.

What is somewhat surprising is the specific claim that Rusal/Deripaska are making:

“Rusal has alleged that the consultation conducted by LME was unfair and procedurally flawed, that the LME’s changes to its warehousing policy are irrational and disproportionate, and that Rusal’s human rights have thereby been breached,” Hong Kong Exchange and Clearing, also known as HKEx, said in a news release. [Emphasis added.]

Human rights.  What a riot.  I know that many Russians have sued in European courts claiming that their human rights have been violated by the Russian government.  In 2012, there were over 22000(!) such claims filed in the European Court of Human Rights, which I believe is the largest total for any country.  The Court rejects virtually all these claims, but still enough proceed to make Russia consider invalidating the Court’s decisions.  (Ironically, this story appears today.  Merry Christmas!)

So I guess Rusal is playing turnabout is fair play.  Good luck with that, Oleg. Methinks the LME will prevail, cash aluminum premiums will fall $75/$80 per tonne or so, and Rusal will soon be staring bankruptcy in the face.  And maybe Neanderthals will become extinct after all.  Financially, anyways.

How Many Rooms In the Kalashnikov Mansion?

Filed under: Guns,History,Music,Politics,Russia — The Professor @ 2:22 pm

The widow of the heir to the Winchester Repeating Arms Co. fortune, Sarah Winchester, believed that her home in New Haven, CT was haunted by the ghosts of men shot with Winchester rifles.  A medium told her to move west and build a house big enough to house all of the spirits.  So she moved to the Santa Clara Valley in California, and in 1884 began construction of a house.  Construction continued, day after day, for 38 years, as Winchester directed the addition of room after room after room to appease those haunting her. Today the Winchester House is a museum.

Yesterday, the inventor of the Kalashnikov assault rifle, Mikhail Kalashnikov, left this mortal coil at age 94.  It is almost certain that the ubiquitous AK-47 (and its successors like the AK-74) has killed more people than any firearm in history.

Pace Mrs. Winchester, how many rooms would be required in a Kalashnikov mansion to house all of the pour souls slain by Kalashnikovs?  A city of Winchester Mansions, probably.

Kalashnikov himself was disturbed but realistic about what his mechanical genius had wrought:

Mr. Kalashnikov said he regretted that it became the weapon of choice for guerrilla armies. “It was like a genie out of the bottle, and it began to walk all on its own and in directions I did not want,” he told Britain’s Guardian newspaper in 2003. But he added, “I sleep soundly. The fact that people die because of an AK-47 is not because of the designer, but because of politics.”

This is true.  In particular, the politics of the USSR (and the People’s Republic of China), which liberally supplied AK-47s to its clients around the world, and which armed, directly and indirectly, numerous guerrilla forces engaged in conflicts euphemistically known as “wars of national liberation.”  Once millions of AKs were in circulation, as Kalashnikov said, “they began to walk all on [their] own” to every corner of the globe.  The genius of the design is that a child can use it.  And tens of thousands of child warriors have.

Look at the photos from any of today’s most brutal conflicts.  Syria. Central Africa. You see AKs, not FNs or M-16s.

A toxic combination.  A weapon of brilliant simplicity and durability produced by one of the most malign states in history, which had no compunction against indiscriminately flooding the world with them as part of a geopolitical strategy intended to realize the imperatives of a twisted ideology.  Meaning that Comrade Kalashnikov’s mansion would have to have rooms almost without number.

December 22, 2013

SIPs as Public Goods: Underinvestment in Linkages in Securities Markets

Filed under: Derivatives,Economics,Exchanges,Regulation — The Professor @ 7:30 pm

A few days ago the WSJ reported that US securities exchanges are close to upgrading one of the Securities Information Processors, the part of the RegNMS market structure that links the various exchanges.  The SIP consolidates and disseminates quote data from the various exchanges.  It provides the linkages that are necessary for the links-and-information structure created by RegNMS.

The SIPs have been a source of chronic complaints in the industry.  The current fix was compelled by a breakdown in the SIP over the summer that caused a shutdown in trading of some stocks.  But even when the SIPs work, they disseminate information more slowly than the private connections between exchanges and HFT firms.  This gives an advantage to HFT traders.

The WSJ story indicates that the operating system of the SIP is obsolete.

This issue illustrates an inherent problem with a utility-type model in securities markets. I discussed this problem in my research in the late-90s and early-00s, including in a JLEO article that was published in 2002.  That research was focused on a CLOB model, but the same issue is relevant for a the current SLOB (Simulacrum of a Limit Order Book) model. Specifically, a utility CLOB (or SLOB) has strong public good aspects.  All market participants benefit from better technology and improved performance, but would prefer that others pay for it.  Collective action and public goods problems tend to lead to under provision of quality and technological improvement.

SIPs are industry public goods, and face the same problems.  No wonder they are obsolescent.

There are other problems with the linkages approach that undermine incentives to  invest in SIP quality and technology.  The whole idea behind the linkages approach is to facilitate competition between exchanges.  But exchanges have no incentive to facilitate competition between themselves.  Competition is likely to be weaker with a kludgy linkage system, so why should exchanges push to improve it?  Not to mention that some interests, notably HFT, which would face a diminished competitive position with  more advanced SIP, also have an incentive to impede updates.

This is an inherent challenge to the linkages approach.  Its effectiveness depends on, well, the technology that links markets.  But the incentives to invest in those linkages are suboptimal due to the public good problems, exacerbated by the fact that competing exchanges don’t have an incentive to intensify competition between them.

But as I’ve often written, the alternatives have their own problems.  Most notably, if you don’t mandate linkages between markets, order flow network effects tend to cause the dominance of a single exchange.   So you need linkages and socialization of order flow if you want competition, but there will be underinvestment in the linkages.

US securities markets are committed to the linkages approach.  Public goods problems that provide inefficiently weak incentives to invest in the links necessary to make the approach work mean that it will be beset by chronic difficulties.

December 20, 2013

Khodorkovsky Meets Churchill

Filed under: Energy,Politics,Russia — The Professor @ 12:01 pm

In a whirlwind sequence of events, Putin announced that Mikhail Khodorkovsky would be pardoned; he was pardoned; he left his Russian prison camp; and finally, he boarded a plane for Germany, where he landed a few hours ago.

This is obviously a welcome development, but one that raises many questions.

It is yet another embodiment of the Churchillian cliche. For the “whys” of the release itself, and its timing, are mysterious, etc.

There is a clear official narrative.  Khodorkovsky requested pardon based on humanitarian considerations (in November) and it was granted on humanitarian grounds a little more than a month later.

But what lay behind Khodorkovsky’s decision to request a pardon?: he had said in the past he would never do so. His lawyers were unaware that he had made any such request, and were completely nonplussed by Putin’s almost off-hand announcement of the pardon.

Had he finally been broken?  Did the prospect of yet another sham trial and inevitable conviction convince him that he had to concede to Putin, and allow his torturer to appear magnanimous and achieve a political benefit? Or did Putin approach Khodorkovsky and offer the pardon, backed by a threat of horrible future consequences if he did not?  If so, why?  What benefit does Putin expect to gain?

Most of the conjecture behind Putin’s motives in granting the pardon focus on the upcoming Sochi games.  Yes, I know Sochi is a big deal to Putin, and perhaps (as rumor has it) part of the deal is that Merkel will attend the games: but her presence will make all the more conspicuous the absence of Obama, Hollande, and numerous other first-tier national leaders. In some respects, if it appears that Putin had to make such a big concession in order to get one world figure to attend the Olympics, it will make him look weak, almost pitiful.

As I have written before, Putin has always had a visceral, Pavlovian reaction to the mere mention of Khodorkovsky’s name.  He hated the man.  Moreover, Putin and Russia had been the subject of years of criticism for imprisoning him.  But Putin was evidently willing to live with that criticism and the associated political and economic costs for 10 years.  Is the benefit of a somewhat reduced negativity of coverage of Sochi (and there will be many other things that can and will be criticized) enough to overcome the personal hatred and the other benefits that Putin (by revealed preference) clearly obtained by keeping him behind bars?  The Sochi effect seems so transitory, I find it hard to believe that is the main driver.  Again: this pardon will have only a modest impact on the tenor of the coverage of Sochi, and the coverage of Russia during Sochi.  And much of that coverage will be: “Yes, he freed Khodorkovsky, but why was he imprisoned in the first place? Yes he freed Khodorkovsky, but look at how little has really changed in Russia.”

My sense is that for some reason, Putin no longer considers Khodorkovsky the threat he once was.  Perhaps Khodorkovsky’s physical or mental condition.  Or perhaps some deal between the two men.  This would make the cost of releasing him low, and the benefit of the release is likely bigger now than it would have been earlier, or after the Olympics are over.  So Sochi may explain the timing of the pardon, but not the pardon itself.  There are other hidden facts and conditions and understandings that have overcome Putin’s previous implacable determination to keep Khodorkovsky in jail.  Those facts, conditions, and understandings neutralized Khodorkovsky as a threat.

The Russian stock market jumped on the news, but not remarkably so.  A one percent move, an order of magnitude smaller than the price decline that occurred when Khodorkovsky was arrested.  And in my opinion, that one percent move is overdone.  For this announcement reinforces, rather than negates, the singular fact that makes Russia toxic for investors, and for foreign investors in particular: that Russia is a country of the rule of a man not laws.  The sudden and almost cavalier and improvised approach to the pardon makes it clear that Putin can make major decisions on a whim.  Yes, the Tsar can giveth.  But this just reminds that the Tsar can taketh away too.  It is the highly personalized, arbitrary, and a-institutional nature of the Russian system of law and governance that makes it a dangerous place to invest and do business.  The pardon decision only emphasizes that nature.

So Godspeed to Mikhail Khodorkovsky on his release from a decade of torment.  But be cautious about drawing larger conclusions from his pardon.  We don’t know the real story as to why it occurred.  Moreover, it is an illustration of the defects of Putinism rather than a sign that Putinism is actually changing for the better. Life for Khodorkovsky has changed dramatically in the last few hours: life in Russia, hardly at all.

December 17, 2013

Winner’s Curse

Filed under: Economics,History,Politics,Russia — The Professor @ 10:04 pm

I mentioned this in the earlier post, but it deserves a post of its own. The more I think about it, the more astounded I am at the folly of using Russia’s national welfare fund to buy Ukrainian government debt.  The purpose of this fund is to provide a cushion in the Russian state budget in the event of a decline in economic activity and government revenues, most likely due to a decline in the price of oil.  For all of its dysfunctions in property rights, the rule of law, etc., Russia earned high marks for its relatively prudent fiscal policy, largely due to the guidance of Alexei Kudrin.  The reserve funds were a big part of that, building up when times were good and available to be tapped when things went sour.  In recent years, Putin’s need to buy support has undermined this prudent policy.  Now all prudence is out the window.

For as I noted earlier today, this “investment” is rife with wrong-way risk.  Due to the same tight connection between the Ukrainian economy and the Russian one that compelled Yanukovych to submit to Putin, there will be a strong positive correlation between the price of these bonds and the performance of the Russian economy.  If the Russian economy tanks (due to an oil price decline, for instance), Ukraine’s economy will tank right along with it.  More severely in fact.  And when its economy tanks, the price of its bonds will tank too.

This is exactly what you don’t want in a “rainy day” investment.  Preferably you’d like something negatively correlated, but at the very least, you’d like something only weakly correlated  But instead Putin has invested one-sixth of the national welfare fund in a highly correlated investment that will perform badly just when Russia would need the money.  This is financial insanity.  Kudrin must be stroking out.

But that means that this fits in perfectly with Putin’s obsession with Ukraine.  So he’s “won” the Ukraine (assuming, of course, that Clockwork Orange doesn’t strike again).  But what has he won?  An economic basket case, a cesspool of corruption, and a dysfunctional Sovok state.  He’s spent $15 billion (plus another $5 billion in gas price cuts), but he’ll spend a lot more.  Because this will not address Ukraine’s fundamental economic problems.  Yanukovych will be back for more, and more, and more.

And why is Putin committing such a blunder?  Because of his delusions of grandeur. His desire to reverse the collapse of the USSR, which he considers history’s greatest geopolitical tragedy.  His obsession with gathering again the Russian lands.  And the Russian obsession with Ukraine.  They truly believe it to be naturally subordinate to Russia.  Not a real country, as Putin said to Bush.  To Putin, and to most Russians, an independent Ukraine is a monstrosity.

Insane.  Utterly insane.

You’ll read about this being the latest in Putin’s run of political and diplomatic triumphs.  With a few more such triumphs, Russia will be undone. He has won the bidding war with the EU (not that it was much of a contest).  But he-and Russia-will suffer the winner’s curse.

Be careful what you ask for, Vlad.  Be very careful.

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