Streetwise Professor

ExxonMobil’s CEO Rex Tillerson (whose first name gives you an idea of his self-image) has decided to suspend offshore gas exploration projects in Ukraine, while continuing extensive cooperation with Russia (including a project very close to Crimea).

Talk about shivving someone when they are down.  Although any project like that the one that Exxon shelved would only produce years from now, if ever, a necessary condition for Ukraine to escape the Russian yoke is that it reduce its dependence on Russian energy, particularly Russian natural gas.  The Exxon decision makes that prospect ever more unlikely.  Ukraine’s bargaining power vis a vis Putin has just taken a big hit.  The Exxon betrayal also has huge symbolic importance: it indicates that energy companies are likely to deal with the devil-Putin-and willingly throw Ukraine on his tender mercies.  This will further convince Ukraine, and the Euros, that the country’s only option is to kneel before Don Vladimir.

Tillerson claims that he has no qualms about continuing to work with Russia, because he perceives no political risk:

“As for the current situation, obviously it’s early days,” he said. “There’s been no impact on any activities or plans at this point, nor would we expect there to be any, barring governments taking steps beyond our control.

“In terms of our view of country risk, geopolitical risk, other than things like sanctions, we don’t see any new challenges out of the current situation,” he said.

If you don’t see any new challenges relating to political risks in Russia arising from this situation, Rex, you need to get an eye test.  The substantial sell-off in Russian stocks was all about political risk.  And a victory in Ukraine would embolden Putin and make him more likely to expropriate western energy companies, including Exxon.

But maybe Tillerson’s vision is just fine. As I wrote about a couple of years ago, Exxon has tried to manage that expropriation risk by tying its ventures in Russia to cooperating with Rosneft in the Gulf of Mexico in what is effectively an exchange of hostages: if Russia takes from Exxon in Russia, Exxon can retaliate against Rosneft here. Maybe that’s what convinced Tillerson he can deal with the devil.  He gets the devil’s goodwill by abandoning Ukraine, and feels confident that the hostage he holds in the GOM will protect XOM against future Russian predations.

Arguably this is a smart bargain from the perspective of Exxon shareholders. But there are huge externalities here. Ukraine is obviously a big loser.  But so are other investors in Russia who are not so fortunate as to have valuable hostages as does Exxon.  But US national interests, and the interests of myriad US allies, notably Poland and the Baltic states, are also severely damaged by Tillerson’s cynical calculation.

This is precisely the circumstance in which it is justifiable, and indeed necessary and desirable, for the government to address a serious collective action problem through the imposition of sanctions on Russia and companies that provide it material and moral support (as Exxon is doing), and through the use of carrots and sticks to cajole companies like Exxon to provide aid and comfort to Ukraine.

But, cynic that I am, I doubt that this will happen.   The reason that Germany and the UK are so adamant against sanctions or any other economic measures against Russia in response to Ukraine is that it hits their businesses’ bottom line, and those businesses are are pressuring their governments very hard to take a soft line on Putin.  No doubt Exxon is doing the same.

Lenin was right about at least one thing, perhaps.  That capitalists would sell you the rope you use to hang them.  Or in this instance, Exxon will gladly sell Russia the rope Putin uses to hang Ukraine.

The consensus opinion after Putin’s press conference earlier today is that he has lost his mind.  It was rambling, angry, discursive, and at times just bizarre.

Of course all of the usual Putinisms were there.  Most notably, blaming the West for everything in a stream of whataboutism.  This was accented by claims that the Ukrainian opposition consists mainly of thugs and fascists; that Yanukovych was wrongly ousted and didn’t order any violence against protestors; and that the opposition was very well trained and professional, having passed through training camps in the Baltics and Poland.  (Take this as a very ominous warning, people.)

My dear colleague, look how well trained the people who operated in Kiev were. As we all know they were trained at special bases in neighbouring states: in Lithuania, Poland and in Ukraine itself too. They were trained by instructors for extended periods. They were divided into dozens and hundreds, their actions were coordinated, they had good communication systems. It was all like clockwork.  Did you see them in action? They looked very professional, like special forces. Why do you think those in Crimea should be any worse?

Yes. Those evil Poles and Lithuanians, training crack troops to throw rocks and fashion catapults.  Definitely far more lethal than camouflaged masked men toting AKs.

More broadly, Russia and Putin are always right: the West is always hypocritical and wrong.

Putin also denied the obvious, claiming that there are no Russian troops in Crimea, just local “self-defense forces” which he denies were trained by Russia.

In other words, there is no agreement on the basic facts of the situation, meaning that any attempt at negotiation with him, either by the Ukrainian government or the West, is doomed to failure.  He rejects the legitimacy of the protests,  views the outcome as a fascist coup arranged by the West, and denies that Russia is directly involved in the occupation of Crimea.

These were the substantive elements of insanity (paranoia, specifically) of the conference.  But Putin added various asides that illustrated a man that feels no need to self-censor, but is so convinced of his own brilliance that anything that crosses his mind should be shared with the world.  These “thoughts” were truly bizarre and mendacious, and even more suggestive of madness.

For instance, when discussing the alleged self-defense forces in Crimea, Putin claimed they were just kitted out in store-bought gear:

QUESTION: Mr President, a clarification if I may. The people who were blocking the Ukrainian Army units in Crimea were wearing uniforms that strongly resembled the Russian Army uniform. Were those Russian soldiers, Russian military?

VLADIMIR PUTIN: Why don’t you take a look at the post-Soviet states. There are many uniforms there that are similar. You can go to a store and buy any kind of uniform.

They must have some awesome Army-Navy stores in the FSU: not only can you get up to date cammo, you can also pick up the latest AKs and military trucks.

Then he went on to criticize the massive corruption and social stratification in Ukraine, but denied there was anything comparable in Russia:

Corruption has reached dimensions that are unheard of here in Russia. Accumulation of wealth and social stratification – problems that are also acute in this country – are much worse in Ukraine, radically worse. Out there, they are beyond anything we can imagine imagination. Generally, people wanted change, but one should not support illegal change.

Words fail.

In the same breath, he gave a Ukrainian history lesson:

In my opinion, this revolutionary situation has been brewing for a long time, since the first days of Ukraine’s independence.  The ordinary Ukrainian citizen, the ordinary guy suffered during the rule of Nicholas II, during the reign of Kuchma, and Yushchenko, and Yanukovych.

Ordinary Ukrainians guys suffered under Nicholas II, Kuchma, Yushchenko, Yanukovich.  Anybody notice a name missing from that list?   Stalin, maybe?  (Lenin should get honorable mention too.)  The guy who killed one-third of the Ukrainian population via starvation and executions, a total of around 3-8 million people? Think there was a little suffering in 1932-1933? As bad as Yanukovych was, his total body count during the uprising is on the order of the body count every 6 minutes at the height of the Holodomor.

This omission is particularly disgusting given the immense psychological toll that the Holodomor took and continues to take on Ukrainians.  Don’t think that the omission will not resonate deeply in Ukraine.  It is a taunting reminder of how Russians deny, deny, deny the Holodomor, and get incensed-hysterical, actually-at any moral claim made against them by Ukrainians.

The impression of insanity is only reinforced by other actions during the past several days, including a live fire exercise in the Baltic (witnessed by Putin) and today’s launch of an ICBM test.  Put it altogether, and Putin gives the impression of approaching Kim Jung Un or Kim Jung Il levels of aggressive craziness.  (And for those who say these exercises and tests were planned in advance, they could have easily been canceled if Putin wanted to lower the tension level.  The fact he let them proceed tells you all you need to know about his intent and mindset.)

So what are the broader implications of his disturbing display of mental imbalance?  No doubt the Europeans are even more intimidated now, and will be all the more reluctant to challenge a leader with a nuclear arsenal that they view as mad.

And that raises another possibility: that Putin was playing the psycho for effect.  The Slavic version of Nixon’s Madman Theory, and which Machiavelli wrote about centuries earlier: he wrote that leaders can find it “a very wise thing to simulate madness.”

I will say, watching the video, that Putin did a very, very credible impression of a madman, but that’s necessary to make the gambit work, isn’t it?

I don’t know whether he’s truly mad, or merely feigning it, but the effect will likely be the same.  The disturbing display of mental imbalance will work to his favor, and lead the Europeans in particular to back away slowly, letting him keep his current conquests, and prepare for his next move.  He may back off now, but he will be back for more.  And quite possibly not just in Ukraine.  But in the Baltic states and Poland.

And now for something completely different . . . finance.  (More Russia/Ukraine later.)

The Bank of England wants to put a stay on derivatives contracts entered into by an insolvent bank, thereby negating some of the priorities in bankruptcy accorded to derivatives counterparties:

he U.K. central bank wants lenders and the International Swaps and Derivatives Association Inc., an industry group, to agree to temporarily halt claims on banks that become insolvent and need intervention, Andrew Gracie, executive director of the BOE’s special resolution unit, said in an interview.

“The entry of a bank into resolution should not in itself be an event of default which allows counterparties to start accelerating contracts and triggering cross-defaults,” Gracie said. “You would get what you saw in Lehmans — huge amounts of uncertainty and an uncontrolled cascade of closeouts and cross defaults in the market.”

The priority status of derivatives trades is problematic at best: although it increases the fraction of the claims that derivatives counterparties receive from a bankrupt bank, this effect is primarily redistributive.  Other creditors receive less.  On the plus side, in the absence of priorities, counterparties could be locked into contracts entered into as hedges that are of uncertain value and which may not pay off for some time.  This complicates the task of replacing the hedge entered into with the bankrupt bank.   On balance, given the redistributive nature of priorities, and the fact that some of those who lose due to the fact that derivatives are privileged may be systemically important or may run, there is something to be said for this change.

But the redistributive nature of priorities makes me skeptical that this will really have that much effect on whether a bank gets into trouble in the first place.  In particular, since runs and liquidity crises are what really threatens the stability of banks, the change of priorities likely will mainly just affect who has the incentive to run on a troubled institution, without affecting all that much the overall probability of a run.

Under the current set of priorities, derivatives counterparties have an incentive to stick longer with a troubled bank, because in the event it becomes insolvent they have a priority claim.  But this makes other claimants on a failing bank more anxious to run, because they know that if the bank does fail derivatives counterparties will get a lion’s share of the remaining assets.  By reducing the advantages that the derivatives couunterparties have, they are more likely to run and pull value from the failing firm, whereas other claimants are less likely to run than under the current regime.  (Duffie’s book on the failure of an OTC derivatives dealer shows how derivatives counterparties can effectively run.)

In other words, in terms of affecting the vulnerability of a bank to a destabilizing run, the choice of priorities is something of a Hobson’s choice.  It affects mainly who has an incentive to run, rather than the likelihood of a run over all.

The BoE’s initiative seems to be symptomatic of something I’ve criticized quite a bit over the past several years: the tendency to view derivatives in isolation.  Triggering of cross-defaults and accelerating contracts is a problem because they can hasten the collapse of a shaky bank.  So fix that, and banks become more stable, right? But maybe not because it changes the behavior and decisions of others who can also bring down a financial institution. This is why I am skeptical that these sorts of changes will affect the stability of banks much one way or the other.  They might affect where a fire breaks out, but not the likelihood of a fire overall.

The pusillanimity of the US in the face of Putin’s aggression is bad enough (spare me any more expressions of “deep concern”), but it pales in comparison with the utter cowardice of the Europeans, especially the Germans and shockingly, the British.

There is only one explanation: they have been cowed by their energy dependency on Russia, and corrupted by dirty Russian money-much of which is merely money Europeans spent on Russian energy, recycled/laundered through European financial institutions.

There are myriad reports that Britain will not support any trade or financial sanctions against Russia. The fig leaf is that such measures will damage the world economy:

However, a document photographed in Downing Street suggested that Britain is concerned about the economic impact of any sanctions against Russia. The paper states that the “UK should not support, for now, trade sanctions … or close London’s financial centre to Russians”.

Seriously?  This gives new meaning to the old phrase “perfidious Albion.”

But what should we expect, really? Britain showed its true colors in its abject refusal to investigate seriously the Litvinenko murder and release any evidence that would make plain the connection between the murderers and the Russian state.  Heaven forfend that real estate in Belgravia take a hit.

Then there’s Germany.  Despite the fact that Merkel herself has all but admitted that Putin is insane, Germany is adamant against taking any measures that will actually inflict pain on Russia.  Indeed, Foreign Minister Steinmeier met with Lavrov in Geneva, and bleated out a statement about the necessity of relying on diplomacy:

Ahead of an extraordinary meeting of EU foreign ministers in Brussels, Germany’s Foreign Minister Frank-Walter Steinmeier said international diplomacy must prevail to solve the crisis.

“Crisis diplomacy is not a weakness but it will be more important than ever to not fall into the abyss of military escalation,” Steinmeier told reporters.

Steinmeier also suggested a fact-finding mission by the Organization for Security and Cooperation in Europe (OSCE), Europe’s main human rights and democracy watchdog, as an initial response.

“We are considering whether it wouldn’t make good sense to create transparency about what is happening on the ground in eastern Ukraine and Crimea instead of being dependent on rumors,” he said.

Yes.  There is so much ambiguity about what is happening on the ground.  We are so starved of facts about what Russia is doing.  Fact finding! That’s what we need!

There are none so blind as those who will not see.

Remember that Steinmeier is a SPD leader, and Schroeder’s political protege.  And further remember that Schroeder is Putin’s apologist and waterboy, and has been awarded for his lifetime of service with a sinecure as chairman of the board of Gazprom’s Nordstream pipeline.

If there was ever a more vivid illustration of why I’m damned glad NSA was giving extra special attention to German politicians, I’d be hard pressed to think of what it might be.

Indeed, this seems like a perfect time for a dump of some juicy kompromat on Herr Steinmeier and his ilk in the SPD.

In light of this, thinking of all the condescension and moral superiority directed at the US by German politicians and the German populace in the past 12-13 years is beyond nauseating.

Germany dresses up its cowardice in the garb of moral superiority.  In fact, its cravenness is driven by its dependence on Russian energy and the deep ties of German businesses to Russia.  Germany gets about 1/3 of its gas and about 28 percent of its coal from Russia (h/t @libertylynx).  The European oil market is also highly dependent on Russian supplies.

And of course, Germany has increased its dependency as a result of an insane energy policy, retiring its nuclear generators in a hysterical reaction to Fukushima (lest there be any tsunamis in Bavaria) and forcing a massive reliance on inefficient renewables.

Churchill said that the Germans are either at your throat or at your feet.  It’s quite obvious that the current generation of Germans has an intimate acquaintance with Putin’s taste in footwear.

The Balts and Poles are rightly freaking out.  Just today the Russians conducted live fire exercises in the Baltic.  Yes.  Totally pacific.  Just routine, surely.  But the Germans consider these long suffering victims of Russian (and truth be told-German) oppression as annoyances who are interfering with their desire for Ostpolitik and Ostwirtschaftlich.   Germany stymied the effort by Latvia and Lithuania to invoke Article 4 of the Nato Washington Treaty.  But Poland is having another go.

Ironic, isn’t it, that countries that border the Baltic are the true Atlanticists now?  The original Euro-Atlanticists, the UK and Germany, have been suborned by energy dependency and dirty Russian money. Germany accepted American protection when it faced an existential threat from Russia, but now repays the favor by running interference for Putin when it perceives that only Untermenschen  in eastern Europe are going to be ground under the Russian boot.

The poet Auden called the 1930s a “low, dishonest decade.”  The 2010s are proving to be one of history’s rhymes. The same fecklessness and cravenness in the face of aggression, and this cowardice is yet again dressed up in the language of high principle.

Appalling.

In 2007, in my 60th post on SWP, I wrote a post about Putin and the Euros, titled “A Man in a Hurry.”  If you look at Putin’s aggression in Ukraine, and the utterly pusillanimous European response to this aggression, that post from more than 7 years ago is quite clearly prophetic, to the last jot and tittle.

The closing paragraph:

I think that most Europeans, and those few Americans who seem to pay much attention to these issues, are nonplussed by Putin’s audacity in large part because they are projecting their attitudes onto him. They cannot envision why someone would engage in such seemingly short sighted actions. As a recent Newsweek story puts it, they wonder why Putin is risking severe “blowback.” However, their attitudes have evolved and developed in a completely different institutional, economic, and political environment than Russia’s. The Euro-American environment is much more conducive to taking the longer view that the unsettled (and unsettling) environment that characterizes Russia today. So, the Europeans–and Americans–should be ready for more “surprises” from Putin–which shouldn’t be surprises at all.

My main question is why a blogger, and amateur student of Russian politics, could figure this out, but the State Department, the intelligence agencies, the national security community, the vast bulk of think tanks, and the editorial pages of every major US paper couldn’t.  And why they haven’t been able to do so despite all that has happened since.  Georgia.  The castling move whereby Putin resumed the presidency.  The unrelenting crackdown on civil society.  It’s one thing to ignore reality when it’s lying around.  It’s another to ignore it when it is hitting you in the goddam face.

I’m not claiming genius.  Quite the contrary. This shouldn’t have been that hard.  I’m claiming common sense and a willingness to look objectively at reality.

But maybe that’s the problem.  All the king’s horses and all the king’s men were unable to do that for the reason I mentioned in that old post: a dominant mindset in which the bien pensants projected their own self-image onto Putin.  A failure of a navel gazing elite.  (We would be better served by a naval gazing elite, but since history ended that’s apparently so passé.)

This, frankly, is why we are where we are today.  Which is totally f*cked, by the way.

While I’m in this mood, I will also take credit for being among the first to advocate what is now becoming recognized as the only real way to hit Putin and the Russian elite where it hurts: an aggressive investigation of all the dirty money these bastards have squirreled away around the world.

Sadly, although this is widely recommended, the Germans and the British are going to fight this tooth and nail.  More on that later.

Postscript. Speaking of Putin as a Man in a Hurry, imagine my surprise to read Matthew Kaminski’s WSJ piece last night in which he said that Crimea was Putin’s appetizer, and characterized Putin as “a man in a hurry.”  Perhaps it is just coincidence, but more than 24 hours before I had written a post in which I had said that Crimea was Putin’s appetizer, and  that I had long said that Putin was a man in a hurry.  Surely a coincidence, except for the fact that the only references I can find to Putin being a man in a hurry are things I wrote.  Also probably a coincidence that 24 hours after I wrote a post saying that the EU had “midwifed” a deal with Yanukovych and that the ultimate outcome would probably be him ruling over a “rump state” in eastern Ukraine, Andrew Peek in the Fiscal Times uses the exact same words to express the exact same ideas.   It’s not like “midwifed” and “rump state” are everyday expressions.

Sorry.  Perhaps this is self-indulgent.  But this happens with some frequency.  Too often to be purely coincidence.  Citation/acknowledgement is the coin of the realm in academia, and as a result, using without attribution is tantamount to grand theft, which is why it gets under my skin.  But I guess journalism and academia are quite different.  In fact, I don’t guess: I know.  Journalists (and many bloggers) are the biggest lifters of the work of others that I know of.

In one of his famous papers, Durability and Monopoly, Coase conjectured that a durable goods monopolist could not exercise market power because he could not credibly commit to reduce output.  Let’s say that the monopolist had a stock of the good equal to X.  He sells the monopolist quantity of .5X.  Once he does that, he has an incentive to sell half of the remaining half.  Then he has an incentive to sell half of the half of the remaining half.  And on and on.  Understanding this, consumers believe that the monopolist will eventually sell all X units, and hence will pay no more than P(X)-which just happens to be the competitive price.  Due to the inability to precommit, the monopolist cannot charge a monopoly price and extract a monopoly rent.  (Stokey and others have proved Coase’s conjecture formally.)

The other day I was speaking to someone in the aluminum business.  He related a conversation with a Russian guy who traded for Rusal-Oleg (“The Living Neanderthal”) Deripaska’s aluminum company.  Since the Crisis, huge stockpiles of aluminum have built up.  These stocks weigh on prices.  Rusal and others are keeping these supplies off the market, but that still doesn’t support prices because consumers realize that they will eventually be released.  Rusal (and others) cannot credibly commit not to sell these ingots in the future.

What a dilemma.

But the Russian Rusal trader had a solution.  He said: “If only there was a way to make all this aluminum radioactive! Then all our problems would be solved!”

And he’s right: once contaminated, the metal would be unsaleable. Credibility problem solved.

Call it the Aluminum Meets Polonium Solution to the Coase Conjecture.

As I said yesterday, the appetite comes with the eating, and Putin would snap up the rest of Ukraine.  Having finished up the appetizer of Crimea, he is now digging into the main course.  Today the upper chamber of the Russian trained seal show, aka its parliament, approved Putin’s request for authorization to send Russian military forces into Ukraine.  Not Crimea. All of Ukraine.  It was sure a cliffhanger following the debate and vote on Twitter.  The issue was in doubt to the very last vote.

Sorry.  In times like these one needs to find humor where one can, and black humor and sarcasm are about all that work.

Putin’s “request” for authorization included all of the elements laid out by Medvedev and Lavrov and others in the Russian hierarchy in the immediate aftermath of Yanukovych’s fall.  Like I said, they were building the justification for intervention in Ukraine.  This was in the works from the very beginning of the crisis.

Why is Putin moving so quickly?  I think this is overdetermined.  A mixture of personal/subjective and objective/pragmatic considerations.

First, as I said from the very early days of this blog, Putin is a man in a hurry: it is part of his nature.  His impatience was no doubt increased by the burning desire to revenge what he views as a personal humiliation inflicted on him by the Ukrainian revolutionaries at the climax of his Olympic extravaganza.

Second, Ukraine is in a chaotic state, as is every government in the immediate aftermath of a revolution. The military is no doubt reeling and riven by dissent and rivalry.  The government has little idea of which units and commanders it can rely on.  There is no experienced competent authority in place, especially in the defense and interior ministries.  There cannot be a unity of command in such circumstances.  Moreover, parts of the country are ripe for putsches by fifth columns supported and guided by Moscow.  (During the Cold War, Soviet operational plans for an invasion of Europe included extensive provisions for sowing chaos in rear areas, including by fomenting civil unrest.)  A disorganized, chaotic polity is much easier picking than would be the case in a few months, or even a few weeks, when it has had time to get its feet under it.

Third, Putin has taken the measure of his opponents in the West, and found them lacking.  Note the timing.  Within mere hours of Obama’s craven and empty warning, Putin moves to war.  He knows he has nothing to fear from Obama.  Obama’s warning turned out to be less of a deterrent, and more of an invitation.  Obama’s pre-gala dinner act had pretty much the same effect on Putin as Dean Acheson’s neglect to mention that South Korea was in the US security perimeter had on Stalin. And you know that Putin has nothing but scorn for the Euros.

Fourth, knowing the dithering nature of the Western leadership, he wants to get inside their slow decision loop (I don’t call it an OODA loop because there is considerable doubt whether any “Act” would be involved).  By moving fast, he can present them with facts on the ground that will be virtually impossible to reverse.  Possession is nine-tenths of the law.

So here we are.

A couple of other points must be made.

First, this has to be the most complete public humiliation inflicted on any American president ever.  Obama gave what he thought was a stern warning, and within hours Putin defied it with relish.  Such defiance is a sign of complete disrespect.

Second, this represents another utter and abject failure of US intelligence, which evidently had concluded that Putin would not invade.  In this, they were at one with the bien pensant set, epitomized by Dmitri Trenin, but which sadly in this instance included Mark Galeotti, who is usually more wise to Putin’s thuggery.

If I had to guess at a diagnosis, I would say that this is a case of projection and mirror imaging.  Rather than seeing Putin as he is, the intelligence community assumed that Putin is a rational actor not really different from any Western leader.  Putin is a rational actor, perhaps, but his premises, goals, and interests are far different.  By failing to understand him, the IC completely miscalculated and misunderstood.

Then there is one other aspect to this.  Was it an analytical failure only?  Or was there an information failure?  Indulging in some speculation, I wonder if it is possible that information obtained from Snowden allowed the Russians to identify and plug some vulnerabilities in their communications that deprived us of vital information precisely when it was needed.

Regardless.  This whole episode is an utterly ignominious failure by the US and European “leadership.”

Somewhere Chamberlain is smiling.  He has company.