Streetwise Professor

After a quiescent period over the holidays, Ukraine-or more specifically, Kiev-erupted into protest today.  The provocation for the renewed protests was the hurried passage of a set of laws to to crack down on the opposition.  Blockading public buildings, wearing helmets, driving in a line of cars more than five vehicles wide, or engaging in “extremist” activity are now banned.  No setting up tents or sound stages without permission. NGOs that receive any funding from abroad must register as “foreign agents.”  (Sound familiar?)   All this was stitched together in a highly irregular procedure organized by Yanukovych’s Party of Regions.

Today’s protests–mainly not in Maidan, but near government buildings some blocks away–resulted in clashes between the Berkut (Ukraine’s interior ministry forces) and the protesters.  Klitschko tried to cool things down, and blamed the clashes on provocateurs. As day dragged into night, a stalemate developed.  The protestors created a barricade of buses and security force vehicles.  The protestors were on one side, the police sheltering on the other.  The protestors lobbed rocks at the police.  (If you look at the live stream now, 20:05 CST, you’ll see the ground littered with stones.)  The police fired back with gas and flash grenades.  Whenever the protestors would approach the buses in large numbers, the security forces would unleash a barrage of grenades and drive back the protestors.  Things see-sawed back and forth for hours.  Eventually the protestors set several vehicles alight with Molotov cocktails.  After some feeble attempts by the police to douse the flames with hoses, eventually a water cannon vehicle was deployed to put out the fire.  The battle ebbed with the flames.  The police withdrew, and the protestors thinned out, with just a few now milling around.

Yanukovych’s move was at the very least inspired by Putin, and plausibly ordered by him.  All of the laws passed are quite similar to those that Putin has put in place in Russia.

Although today’s conflict could have escalated, the security forces did not press the issue.  They did not mount an assault, but contented themselves with lobbing grenades and crouching under their shields close to the bus barricade.

Yanukovych’s middle choice is not sustainable.  It was sufficiently violent to outrage and galvanize the opposition, and will reinvigorate it.  But it was not violent enough to crush it.  Something will have to give.

Ukraine is a divided country.  The eastern part would be quite content if the government cracked now helmet-less heads.  The western part would likely respond by going into outright revolt. Forced to rely on his eastern, ethnic Russian base, and pushed by Putin, on balance it would seem that Yanukovych will escalate the crackdown.  There seemed to be hesitancy today, but perhaps that reflects surprise at the intensity of the protest.  The element of surprise is now gone.  The government is now on notice.   Putin will demand results. The die has been cast.

For better or for worse, this will be decided in the streets.

I wonder how the Olympics will play into this.  The events in Kiev put Putin in something of a dilemma.  He doesn’t want events in Kiev, with which he and Russian are unmistakably implicated, to spin out of control while during the Olympics on which he has staked so much.  But he doesn’t want the the opposition to grow, and become emboldened by government hesitancy, and live on into the spring when better weather can only increase its numbers.

In other words, Putin and his puppet are in something of a delicate situation.   Given this  delicacy, and the fact that things can develop spontaneously due to the actions of individuals in the streets-protestors, provocateurs, or militiamen-it is hard to predict what will happen.  My guess is that sooner or later it will come to a violent climax.

Aside: Watching the live streams, I wondered what similar coverage would have looked like in St. Petersburg in 1905 or Petrograd in 1917.

Obama’s approval rating has plummeted, to Bush 2006 levels.  So, of course, the reason must be . . . what, exactly?  The utter Obamacare fail? Nope. A foreign policy that only the Keystone Kops could love? Nope. A stagnant economy? Nope.

Come on, dummy.  There is only one possible answer. ONE!: RACISM!!!!

Note that Obama’s approval rating has fallen more than 20 percent since his re-election  So is he suggesting that in the past year 20 percent of Americans have all of a sudden decided that they just can’t abide the idea of a black guy as president? Because to be logically consistent, and consistent with the data, that would have to be the claim.  This is about the delta, not the level.

A claim that would require that attitudes towards race be highly fluid, whereas in fact they are, for better or worse, pretty much fixed in any individual, and if they change, they change slowly (alas).

The far more reasonable explanation is that piss poor performance (but I understate) is finally overcoming the goodwill–much of it based on a fervent desire for a black president to succeed–that Obama has benefited from for years.

I know that these racial theories of opposition to Obama are in the blood of those that inhabit the fever swamps of the left, like some sort of ideological malaria: they are convinced that only a racist could disapprove of Obama.  But a president has to transcend the insanity of his most rabid supporters.  Indeed, it is quite a testament to Obama’s character, and his political desperation, that he feels compelled to dog whistle to the rabid, and has no problems in doing so.

Race is such a divisive and polarizing issue that a president should do everything possible to downplay, rather than emphasize, racial divisions.  He should certainly not attempt to exploit race for petty political purposes, or to excuse his political and policy failures.  Racial appeals are more befitting a Jim Crow-era Southern politician than a Lincoln, to whom Obama has compared himself.

Racial appeals are the last refuge of the demagogic scoundrel.  They are the last thing we need now.  A man of honor who put the country’s interests above his own would eschew such appeals.  Indeed, he would chastise his supporters for making such arguments.

But we are talking about Obama, aren’t we?

Emails from two readers raise some interesting points about the alleged front-running of Fannie and Freddie by swap dealers.

And that’s one of the points.  Swap dealers. These were principal-to-principal transactions: the dealers were the principals to the trades.  Front running  traditionally involves violation of an agency relationship.  A broker that has a fiduciary relationship with a customer who trades ahead of that customer’s order is front running.  The dealers have no fiduciary duty to their counterparties, as far as I know.

Also, F&F were repeat players, and could refuse to trade with dealers they thought were taking advantage of information about their order flows.  Back in the block trading days, firms that “bagged the street” by selling blocks when they were in possession of private information had a difficult time of finding counterparties.  As a face-to-face market, something similar should have worked in the swap market.

This correspondent also suggests that F&F might have benefitted from this, and may have let dealers know what was coming so the dealers could hedge, meaning if anybody was hurt here, it was the futures traders who were picked off by the dealers placing their hedges. (But then again, given that this would have happened over a long period of time, the futures quotes should have compensated the traders for the risk of being picked off in this way.)

So, there is some doubt that this is even front running, let alone manipulation.

The other correspondent wonders whether the new Dodd-Frank language banning “any act, practice, or course of business that is fraudulent, deceptive or manipulative.”  That could be.  The same language is in SEC Rule 10b-5, and this has been used to prosecute front running.  So it wouldn’t be surprising to see this used to in the Fannie and Freddie case.

Based on information that is coming out today–including some interesting comments by Anders and aaa here on SWP–should be eliminating any doubts you might have (e.g., commenter Brett) regarding the source of the hack attacks on US retailers.  All roads lead back to Russia.  The only real question is the role of the government.

First, aaa pointed out that the attacks were traced back to the hacker “Hell”, who is believed to be Russian, and who was involved in hacking Navalny.  Then Anders weighed in, including a very interesting link arguing that “Hell” is not an individual, but instead a collective (a “drain tank”) of FSB officers working for its Center of Informational Security–its cyberwarfare unit (also known as vch) 64829 which was implicated in a hack of Facebook this summer.

But there’s more: Target data was moved to a server in Russia.

And there’s more: the creator of the malware used in the hack has been identified as a Russian teen.  He is not suspected in the hack, but he did allegedly sell the malware to several “eastern European” crime syndicates.  Is it too much of a stretch to think that a well-known hacker in Russia is known to the FSB and has to share his goodies with them as well?

And oh.  The name of the software is the Russian word for “potato.” (It also means “code stream” in geek speak.)

Given the fact that Russia is notoriously the vortex of criminal hacking (2 Russian hackers are on the FBI 10 Most Wanted List, bringing the total number of Russians on the list to 4: quite an achievement), there is a strong circumstantial case that this is a Russian operation.  It is also plausible that there is state involvement, and it is almost incomprehensible that this could happen without state knowledge.

One other fact supports that conclusion.  The dog that hasn’t barked: Eugene Kaspersky.  Kaspersky brags at his virtuosity at uncovering malware.  He was a press whore on Stuxnet.  But he has been conspicuously silent on this hack.  Funny, that.  He is quite the braggart when it comes to uncovering allegedly US government malware, but the cats get his tongue when it comes to Russian-origin malware unleashed on American retailers just in time for Christmas.

Kaspersky would have every incentive to grandstand and reveal his forensics.  Indeed, to saying nothing, and to let an American firm get all the credit for uncovering this, raises questions about whether his vaunted  operation is really as good as he claims.  Silence would seem to be against his commercial interest.

But maybe not.  For Kaspersky’s firm exists at the sufferance of the FSB and the Kremlin.  Kaspersky’s silence is all the more revealing in light of that fact.

I am sure you will be stunned–utterly gobsmacked, in fact–to learn this, but the hack on Target and other major retailers during the Christmas shopping season has Russian fingerprints all over it:

Parts of the malicious computer code used against Target’s credit-card readers had been on the Internet’s black market since last spring and were partly written in Russian, people familiar with the report said. Both details suggest the attack may have ties to organized crime in the former Soviet Union, former U.S. officials said.

Don’t you just love that last formulation?  FSU.  So, you know, this could be an Uzbek hacking ring.

Because we just can’t possibly utter the word “Russia.” After all, we depend on Putin for so much.  Peace in Syria.  A rapprochement with Iran. Mustn’t cross him, now! (And note that former officials have to be quoted, meaning that current officials daren’t utter a word that even indirectly implicates Russia.)

The article notes that this was an extremely sophisticated attack that was undetectable by anti-virus software. (Hmm.  Why didn’t Kaspersky discover this and announce it to the world, like Stuxnet.  Is he slipping?  Or is he, shall we say, selective and discriminating in what he discovers and reveals to the world?)

What are the odds that the FSB-and hence Putin-were unaware of this? Their monitoring of electronic communications in Russia is ubiquitous.  Moreover, it is well-known that they let hackers operate–for a share of the take.

Meaning that the odds are vanishingly small.

In other words, the Russian security apparatus was almost certainly complicit in targeting Target.  In targeting you.  While you were out trying to buy something nice for your kids or your mom for Christmas.

The outrages pile up, one after the other. Snowden. FU, US deals between Iran and Russia.  All-in support to a murderous regime in Syria. And now, almost certainly, brazen mass theft during the Christmas season.

Yet the administration is utterly supine.  Who knew anyone could have so many cheeks? Again: no current administration people could be find to say anything even off-the-record.  Instead, our Secretary of State yucks it up by giving the Foreign Minister of Russia, Lavrov, two potatoes (?!?).  (Which were oddly elongated in shape, sort of like Kerry’s head.  Do they have Mr. Potatohead in Russia? If so, oh the fun they could have!  Secretary Potatohead!)

I am so glad-so glad-that Putin is the defender of traditional Christian values. After all, he never tires of telling us so.

Oh. I forgot.  I am supposed to be totally up in arms that the NSA is collecting my metadata.  Totally.  Like NSA gives a crap whom I call or text–as long as those calls don’t intersect with some jihadi in Yemen, or the like.

So yeah.  Snowden can lecture us about how we are living in the New 1984, and frighten us with new tales of metadata collection of foreigners, while people in his host nation (almost certainly with the complicity of the government) are stealing us f*cking blind by taking our actually important personal financial and identity information to the bank.

If we buy into this, we deserve everything we get.  Everything.

Wake up, people.  If you are more afraid of the NSA, which yes collects massive amounts of information but does so under a set of elaborate set of institutional and legal constraints for national security purposes, than you are of an utterly unconstrained and malign government in Russia that provides protection to utterly ruthless and avaricious hackers who are out to empty your bank account, and likely shares in their take, you are an idiot.

And more.  Remember the Snowden story before this one: that the NSA is actively attempting to penetrate computers in Russia.  That is a feature, not a bug, people. We should be damned glad they are doing that–even if we should be appalled that this information is being splashed across the front pages. If the Target hack, which traces back to Russia, doesn’t convince you of that, I can’t help you.

Marx said that history repeats itself, first as tragedy, then as farce.  The Obama administration is attempting to one-up Marx and compress the process, with its simultaneously farcical and tragic policies on Iran and Syria.

Obama is clearly so dead set on achieving some legacy building agreement with Iran that he is willing to swallow any insult.  Such as the announcement of a Russian-Iranian agreement whereby Iran will provide oil to Russia, in exchange for Russian goods–but more likely, Russian money as well.

Zarif also met with President Vladimir Putin to reportedly discuss an unprecedented deal to barter Iranian oil for Russian goods. Informed sources in the Russian government have confirmed that Moscow is in the process of finalizing an agreement to buy half a million barrels of Iranian crude a day, while Iran will buy Russian goods in exchange. At present, Iran exports only a million barrels a day as a result of United States and European Union sanctions aimed to curtail its nuclear program. Western-imposed banking restrictions have also severely hampered Iran’s ability to freely use its oil revenue. China is currently Iran’s biggest oil buyer, taking in some 420,000 barrels of crude a day in exchange for other goods. If the oil deal with Russia goes ahead, Iran may extend its shrunken oil exports by 50 percent and collect some $1.5 billion in extra revenue a month. This may undermine Western sanctions, which may have forced Iran to consider permanently constraining its nuclear program in the first place; while Russia may become Iran’s main oil buyer

Russia says that there are no internationally agreed upon sanctions, so it is perfectly free to deal with Iran.

That’s probably true in legal terms, but note that was true yesterday, and last month, and last year.  But Putin didn’t do this.  Until now.  Because he sees that Obama is so desperate for a deal that he knows that he can get away with pretty much anything, and that Obama won’t do or say a damned thing. (And no, State Department expressions of “concern” don’t count.)  So Putin and the Iranians are basically doing donuts on the White House lawn, with their windows down and their middle fingers up.  And Obama just draws the drapes in the Oval Office.

Indeed, note that in some respects, this deal is against Russia’s interests: the more Iranian oil on the market, the lower the price Russia gets for its exports.  But either the geopolitical benefits make this worth it to Putin, or he and his cronies take a sufficient cut of the Iranian sales that he can accept the costs to Russia and the government’s budget, or both.

Meanwhile, Iran says that even if it does enter a deal to suspend enrichment of uranium, it can reverse that decision “in a day.”  Asymmetries in commitment are always an impediment to a deal.  Or they should be.  Iran has made it clear that it can walk out on its commitments in a day.  But what if the US and the Europeans suspend their sanctions?  There is no way those can be re-instituted in months, or ever, let alone a day.  So a deal doesn’t lock in Iran to any commitments, but does lock in the US and Europe.

Only suckers enter into deals like that.  Or those who are so intent on creating a legacy achievement that getting a deal is all that matters, even if it is a sham that will collapse in due course.  (And looking back, at the way Obama gave the back of his hand to Iranian protesters in 2009, it is evident that he had his mind on this from day one: or perhaps more accurately, Valerie had her mind set on this.)

The fact that Russia is so willing to provide Iran with an escape from any sanctions also indicates that they have calculated that Obama has already capitulated.  He will swallow anything–any insult, any concession–in order to get an ayatollah’s signature on a piece of paper that the Iranian regime will disregard the instant it is in its interest to do so.  Most smugglers try to hide their activities.  Putin realizes he needn’t bother.  There are no consequences for flagrantly carrying on right in front of Obama’s eyes.

And then there is Syria.  Today Kerry gave a droning statement (but I repeat myself) begging the opposition to attend Geneva II.  He reiterated that Geneva II is intended to implement Geneva I.  Which, if you even remember it, was adopted in June, 2012.  18+ months ago.  During which time 100+ Syrians have died every day.  Say 60,000 in round numbers. And they will continue to die, for an indeterminate time, because as Kerry is at pains to emphasize, Geneva II is just the beginning of a process.  And the process requires agreement between Assad and the opposition.  Which means never.

Recall that in September, Kerry compared Assad to Hitler.  Now, he does not condemn him at all, except for “playing games” with relief convoys.  Barrel bombs, torture, mass killings (as long as they aren’t with chemical weapons!) are totally fine.  Just no game playing!

Like I said: a tragical farce.  Or is it a farcical tragedy?

But of course the Iran-Russia story and the Syria story are connected.  By making the deal on chemical weapons with Assad, we essentially became his partner.  What’s more, since Iran, Russia, and Syria are tightly allied, Obama knows that doing anything that increases the odds of Assad’s downfall will scupper his overriding objective: a deal with Iran (no matter how fleeting and ineffectual that deal will be).

Translated: Sorry, Syrians. You have to die in your thousands, while the “process” of reconciling the irreconcilable drags on, and Obama sacrifices you–and the interests of the United States and its allies–to his narcissistic ambitions.

Syrians are paying a dreadful price for Obama’s narcissism every day.  The entire region is paying a price, because the festering sore in Syria is the host to myriad jihadists who range from the bad (the Islamic Front) to the terrible (the Al Qaeda affiliate Al-Nusra Front) to the utterly bestial (ISIS/ISIL).  The US and its allies (notably Israel) haven’t paid the price yet, but Obama has sowed the wind, and we will reap the whirlwind in due course.  An empowered, messianic Iran, with Russia providing money and cover, and convinced that the US is a paper tiger, is likely to take actions that will unleash a devastating sequence of events.  It’s a matter of when, not if.

But Obama will have secured peace in our time: or his time, more precisely. His legacy will be secured, and any malign consequences that occur in 2017 and beyond, well, those will obviously not be his fault.  He gave us peace, after all, and if war comes, it will be because some lesser being screwed up.

Farcical tragedy.  Tragical farce.

I have studied manipulation for going on 25 years now, and one of my pet peeves is the promiscuous and imprecise use of the term.  I often quote a cotton broker, William Clayton, who in Congressional testimony said “The word ‘manipulation’ . . . in its use is so broad as to include any operation of the cotton market that does not suit the gentleman who is speaking at the moment.”

Case in point: a story from a couple days ago about the FBI investigating the trading of interest rate swaps:

Wall Street traders may be manipulating a key derivatives market and front running Fannie Mae and Freddie Mac, hurting the US-owned mortgage giants in the process, according to an FBI intelligence bulletin reviewed by Reuters.

. . . .

Disclosure of the suspected manipulation and front running came in an FBI intelligence bulletin that was distributed last week by the bureau’s field office in Charlotte, North Carolina, to security officers at financial services firms.

Front running  is not manipulation.  Manipulation distorts prices, and causes them to move away from where they should be (at least temporarily, although the effects can be highly persistent).  If anything, front running causes prices to move where they were going to go anyways, but faster.   Front-running is a source of information leakage.

Front running raises the trading costs of the entity that is front run–allegedly Fannie and Freddie in this case.  It results in a redistribution of wealth away from those who are front run to the front runner.  But these effects are notably different from real manipulations, like corners and squeezes, or banging the close/settle, or the release of false information.

In the stock and futures markets, front running by a broker or specialist is a violation of the agency relationship with the client.  In securities markets in the US it is a violation of Section 10(b) of the 1934 Securities Exchange Act.  I don’t know, and don’t have time to research at the moment, whether front running of interest rate swaps falls afoul of any law or regulation.

But it ain’t manipulation, as the term should be construed as conduct that distorts prices.  Although everything that is manipulative is bad, not everything that is bad is manipulative.  But as William Clayton noted 80 odd years ago, that distinction is almost universally overlooked.  Especially now, in media coverage of financial markets.

The most recent Snowden revelation, courtesy of the NYT-go figure-is that the NSA has used trade craft and high technology to penetrate offline computers.

Note  the headline and the first couple of paragraphs, which are oh-so-vague about just what computers are penetrated.  It could be yours!!!!!!

Not really.

And look at this, from the first paragraph: the NSA’s actions “also create a digital highway for launching cyberattacks”.   The targets of said attacks are not named, leaving it for suggestible minds to conclude that the NSA is targeting the innocent.  The insinuation–a NYT speciality–is that the intent of the NSA action is aggressive, and therefore somehow illegitimate.

You have to read four paragraphs into the story to find this:

The radio frequency technology has helped solve one of the biggest problems facing American intelligence agencies for years: getting into computers that adversaries, and some American partners, have tried to make impervious to spying or cyberattack. In most cases, the radio frequency hardware must be physically inserted by a spy, a manufacturer or an unwitting user.

The N.S.A. calls its efforts more an act of “active defense” against foreign cyberattacks than a tool to go on the offensive.

So we are attempting to penetrate the computers of “adversaries.”  Like China and Russia.  Good of the NYT to acknowledge we actually have adversaries.

But of course, what the left hand giveth, the lefter hand must take away.  The very next sentence:

But when Chinese attackers place similar software on the computer systems of American companies or government agencies, American officials have protested, often at the presidential level.

And you thought moral equivalence was dead!

If you read the article carefully, you will conclude-despite the efforts of reporters David Sanger and Thom Shanker to obfuscate-that the NSA is engaged in defending the United States against malign countries that have long waged asymmetric combat against us, and which could be military adversaries in open conflict in the future.  Not likely, but possibly.

Shocking, I know, that an entity called the National Security Agency would be engaged in such outrageous efforts to defend US national security.  The nerve.

Look, the NSA and other intelligence agencies spend boatloads of money.  This is actually something that is worth paying for.

And just how, exactly, does this revelation advance the interests of the privacy of US citizens, which I though was Eddie Snowden’s big concern?  Hell, how does it advance the interests of privacy of private citizens of China and Russia, for that matter?  This is directed at the governments of those countries.

Can we just get over the pretense that Snowden is a whisteblower concerned about privacy issues?  That’s just the candy coating on a huge poison pill–an information operation directed against the United States.  This whisteblower persona gives Snowden immunity from scrutiny, and from behind this cover he lobs info bomb after info bomb against US national interests, compromising extremely sensitive operations intended to protect the US against nations that bear it very, very ill will.

Imagine if during WWII, prior to June 4, 1942,  someone had revealed the the US had broken the Japanese JN-25 Code.  Or if someone had disclosed the Ultra secret–that Britain and the US had broken the Enigma cipher.  I really can’t find any meaningful distinction between those hypotheticals, and the reality of what Edward Snowden–and the New York Times–has done, and will be continuing to do.

Update: The article mentions submarines, but it doesn’t draw the best submarine analogy.  During the Cold War, the US Navy’s submarine force engaged in highly clandestine, dangerous, imaginative and largely successful efforts to penetrate Soviet communications.  For instance, US subs tapped underwater telephone cables in Soviet harbors. (Read the book Blind Man’s Bluff for the details.) This was of vital importance during the Cold War.  What the NSA is doing now with Chinese and Russian computers is not different, in any material way.

Scott Irwin has provided his responses to David Kocieniewski.  Read the whole thing.

It’s My Turn

The responses to the recent NYT article by David Kocieniewksi certainly make interesting reading.   I don’t want to belabor points already made so well by others in response to the numerous problems with the article (especially Craig).  Instead, I want to offer some additional points that I think merit further consideration or elaboration:

1. To start, it is important to clarify that the heart of the controversy is the trading activities of a new type of participant in commodity futures markets—financial index investors—during the 2007-2008 commodity price spikes.  The concern was that unprecedented buying pressure from index investors created massive bubbles in commodity futures prices, and these bubbles were transmitted to spot prices through arbitrage linkages between futures and spot prices.  The end result was that commodity prices far exceeded fundamental values during the spikes.  Dwight Sanders and I labeled this the “Masters Hypothesis” in honor (dishonor?) of the central role that hedge fund manager Michael W. Masters played in pushing this line of thinking.   It is crucial to understand the key features of the Masters Hypothesis.  First, it implies that index buying in commodity futures markets created massive price bubbles—20, 30, 50% overvaluations (take your pick).  Second, it implies the price bubbles were long-lived, measured in months if not years.  These features have driven the acrimonious debate about “speculation” in commodity markets that first erupted in 2008.  Without the charge of massive and long-lasting bubbles the intense public policy debate about speculation limits would not have taken place.
2. My position on the validity of the Masters Hypothesis has been consistent from the earliest days of the controversy.   In fact, in an ironic twist, one of my earliest publications on the controversy was an op-ed that Dwight Sanders and I jointly authored—drum roll please—yes, in the NYT in July 2008.   A few quotes:  “Over all, there is limited evidence that anything other than economic fundamentals is driving the recent run-up in commodity prices…The complex interplay of these factors and how they affect commodity prices is often difficult to grasp immediately, and speculators are a convenient scapegoat for the public’s frustration with rising prices. That’s unfortunate because curbing speculation — and hobbling the ability of businesses that rely on futures markets to reduce their risk — is counterproductive.{
3. If my work was somehow tainted by associations with “Wall Street,” then why the editorial endorsement by the Paper of Record in 2008?   It also seems convenient that this little fact was omitted in Mr. Kocieniewksi’s recent article.   I made sure he was aware of my previous NYT op-ed article when he interviewed me. I suspect he was already aware of it given his exhaustive background research on the two of us.
4. The academic research pertaining to the Masters Hypothesis since 2008 has been overwhelmingly negative.  I submit that there is very little credible academic research that is consistent with the basic tenets of the Masters Hypothesis.  That is, index buying is not associated with massive and long-lasting price bubbles in commodity futures markets.  There are no “accidental Hunt Brothers.”   Some unnamed persons (one has the initials GG) like to characterize academic research on the subject as being roughly equally divided between studies that find a positive impact of index positions on prices and studies that fail to find an impact.  This characterization is misleading.  Yes, some studies find evidence of a positive impact but the impacts are invariably small and fleeting or do not line up with the spikes of 2007-2008.  This type of evidence does not support the Masters Hypothesis.  So, when properly interpreted the evidence to date is not divided equally, but instead overwhelmingly rejects the Masters Hypothesis.  And this is what is important from a public policy perspective—small impacts do not provide much justification for costly new regulation of commodity futures markets.
5. My approach to research on the market impact of index investment has always been to go where the data lead.  My co-authors and I have sliced and diced the available data many different ways and we cannot find a smoking gun (a full list can be found here).  As I like to put it, if the Masters Hypothesis is true then the relationship between index positions and commodity futures prices should literally jump off the page.  It does not.  Importantly, there is also limited evidence of bubbles in commodity futures markets independent of whether or not they are associated with index investment.   My co-authors and I could not find evidence that bubbles have become larger or longer-lasting since index investment came on the scene.  If anything they have become smaller and less frequent.
6. If my research on speculation is slanted/biased/tainted then it sure has fooled a whole bunch of academics who serve as journal editors and reviewers.  I have published 13 papers since 2009 dealing directly with the speculation controversy in 9 different academic journals.  And several more are currently under review.  Yes, under review.  This means the articles don’t get published unless they first pass muster with reviewers and then a journal editor.  I don’t know exactly how many editors and reviewers I have dealt with on these papers (several were invited submissions but still subject to peer-review), but it is safe to say that it must be at least 20-30 people.  So, we are to believe that my biased research ran this gauntlet of editors and reviewers and the bias managed to go undetected the entire time?  Give me a break.
7. Just for the record, I want to state in public that I did not even know about the Chicago Mercantile Exchange (CME) donations to the business school here at the University of Illinois when the donations were made.  I only became aware of them in the last year or so through conversations with our development staff.   (OK, I should actually be a little embarrassed by that last statement given my work on commodity futures markets.)   In any event, to draw an inference between the gifts to the business school from the CME and my research really is ridiculous.  I made this clear in my interviews with Mr. Kocieniewksi.
8. I do have a long working relationship with the CME, and before that, with the Chicago Board of Trade (CBOT).  This after all is my research area.   The CME has not funded any of my research since 2007.  However, I did work on a commissioned white paper for the CME in 2005 when the grain contract convergence problems first erupted.  My co-authors (Phil Garcia and Darrel Good) and I were paid a total of $15,000 for the work, which we split equally.   I did accept a position on a new Agricultural Advisory Council that the CME started in late 2013.  The council will meet three times a year at various locations around the country and serve as a sounding board for various issues that come up with regard to agricultural futures markets.  I will receive the same $10,000 annual stipend for this position as the other members of the council.   That is the sum total of my financial ties to the CME.
9. I have had numerous interactions with CME staff in recent years on a host of issues related to commodity futures markets, including, of course speculation.  Sometimes I have reached out to them and sometimes they reach out to me.  Most of the time it is the former and involves pretty obscure questions about things like how the grain delivery process works or help in getting some data.  My research would be far less interesting and useful without this help.  I have the utmost respect for the professionalism of the CME staff and I have never been asked for any type of quid pro quo.  Never.  When I have agreed to participate in presentations, write blogs, etc. I have done so because I believed my research and analysis contributed to better understanding of the issues.
10. My other research on commodity market speculation has been funded from three main sources.  First, the Laurence J. Norton Chair that I hold here at the University of Illinois provides earnings each year that go to support my research program (thank you U of I!).  Second, I have had two grants from the Economic Research Service of the USDA on commodity speculation related topics since 2008.  The first one included work directly on speculation while the second focused on convergence in grain futures contracts. Both have been completed.  Third, Dwight Sanders and I did a commissioned study for the OECD in 2010.  I lost track of the emails with the exact amount we were paid but I know it was only a few thousand dollars.
11. Yieldcast is a product of T-Storm Weather that I helped develop with a former graduate student, Mike Tannura, and Darrel Good.  Yieldcast provides “real-time” U.S. corn and soybean yield forecasts for subscribers.  My main role is to build the statistical models that form the basis of the forecasts and to prepare the weekly forecasts during the growing season.  As indicated in the NYT article I do not have direct contact with Yieldcast subscribers.  I am fortunate that side of the business is ably handled by Mike Tannura through T-Storm.  It is really laughable to think that I have somehow been rewarded through this channel by Wall Street as a payoff for my speculation research.  I know how hard Mike has worked to build the base of subscribers for this product, and if it only were that easy!  I have never seen one email, one voice mail, or absolutely anything that connects my research on speculation to taking out a subscription for Yieldcast.
12. As the NYT article indicated, Dwight Sanders and I did conduct a study in 2012 for Gresham Investment LLC on the market impact of index investment.   Given the political sensitivities surrounding the speculation issue, I gave considerable thought as to whether I ought to pursue the consulting project.  I knew some would see taking any funding from a commodity firm as being a conflict of interest.  But, the project provided access to detailed firm level position data that has previously been unavailable to researchers and this made it worthwhile in my mind.  Sure, I didn’t mind getting paid as well.  The NYT article got it wrong when it said I was paid the full $50,000.  Dwight and I split that equally so I was actually only paid $25,000.  We are working on several interesting papers based on this new dataset.
13. If the charges (really, innuendoes) in the NYT article are baseless, then readers might reasonably ask what does motivate my “defense of Wall Street”?  Good question.   I am indeed a “freshwater” economist that became convinced early in my career that commodity futures markets were an invaluable market institution that improved the discovery of prices and the ability of market participants to shift risks.  While these markets are by no means perfect (as Craig’s work on manipulation highlights), on balance, the good vastly outweighs the bad.  So, when the current speculation controversy erupted in 2008 I was struck by the similarity of the present controversy and those that have buffeted the industry in the past.  Change only the names and dates and not all that much is different.  This has been a reoccurring theme in my own writings since 2008 (including the July 2008 NYT article…could not resist).  And I admit that I made an intentional decision early on to play a more public role in the present controversy.  Three of my professional heroes are Holbrook Working, Tom Hieronymus, and Roger Gray, who spent much of their illustrious academic careers defending futures markets.  All the motivation I needed.

Scott Irwin

University of Illinois

Risk Magazine’s annual review issue includes a set of short contributions on the progress that has been made on the G-20 OTC derivative reforms.  (If you run into paywall problems: there are ways.  There are ways.)  The contribution by yours truly is under the category Academics (plural) even though I am the only academic in the piece.  I guess I count for double, or something.
But that’s not the best part.  The best part is the headline:

Progress and peril: Davie, Dodd, Maijoor, Pirrong and more on the G-20 reforms.

Sharing top billing with Chris Dodd!  What is the world coming to?  I guess it could be better (or worse): it could have been Barney.  Or Gary.  Or Bart.

To spare you having to scroll through all of the contributions by politicians, lawyers and people who actually work in these markets, here’s my two cents:

When the Dodd-Frank Act was passed, I thought the Sef mandate was its worst part. It has nothing to do with the act’s ostensible purpose – reducing systemic risk – and imposes a one-size-fits-all model for trading swaps that will likely decrease the efficiency of the market. The made-available-for-trade provision of the Sef rule merits the title ‘worst of the worst’. This says if a Sef applies to the CFTC to trade a particular type of swap, and it approves the application, all trading of that type of swap must occur on a Sef. This turns the ordinary competitive process on its head. In most markets, a firm introduces new products, and if it is desirable to consumers, it sells. If the product is flawed, it doesn’t. Under this rule, a firm that introduces a flawed execution method imposes this bad choice on all consumers.

The CFTC could prevent such a perverse outcome by not approving an application. However, the agency’s animus to the traditional dealer-centric trading model and its fetish for transparency means the CFTC sets very low standards for approval. It also demonstrates the CFTC’s bizarre interpretation of cost-benefit analysis: it considers only the trivial cost of filing an application, and totally ignores the massive costs that would result if traders are forced to execute in an inefficient way.

Swap market participants and transactions are diverse. There is no execution model to fit all – counterparties themselves are best placed to determine how to execute their trades. Sef mandates already constrain choice, and made-available-for-trade puts the execution decision in the hands of third parties whose interests are not aligned with those actually trading. Given the size of these markets, if the untried Sefs don’t work as hoped – even for a modest subset of traders – the dislocations and inefficiencies will be immense.

The Risk editors chopped my last line, which was: “I fear that the epitaph of the OTC swap market will be: ‘Died of a Theory.'”  (A line lifted from Jefferson Davis’s epitaph on the Confederacy.)  The Theory, of course, is that traditional means of executing OTC derivatives trades are flawed, if not evil, and that Gary Knows Best in imposing a simulacrum of a centralized, order driven market that has worked well for futures on swaps, which are different in many ways.