Streetwise Professor

Although this has been rumored for weeks (due to the dogged reporting of Powerline), yesterday the White House admitted that hackers, likely Russian (I’m shocked! Shocked!), had compromised the (allegedly non-classified) computers of the Executive Office of the President.

Did Putin have the hackers insert malware that triggered a popup saying: “Who’s Your Daddy?”

But here’s the best part (and per usual, “best” means “worst”). We didn’t discover this ourselves. An “ally” informed us.

It would be so hilarious if the “ally” is Israel. (Germany would be a close second in hilarity.) It would also be so karmic.

But I guess this isn’t possible, because a confidential administration source said the information came from an ally, and we know what Obama, Kerry, etc. think of Israel, and “ally” isn’t the first word that trips off the tongue.

The hits just keep on coming, don’t they folks? But yes, by all means let’s hear some more lectures about how since “you didn’t build that” we need bigger government, delivered by the least competent administration ever.

In his latest disquisition on Ebola, Obama plumbed new depths of incoherence. Which for him is saying something. He  responded specifically to questions about how to rationalize the military’s policy of quarantining returning servicemen and women from West Africa (though they don’t say the q-word), while adamantly opposing quarantining of civilians. He offered two justifications (I won’t call them “reasons”). The first was that civilians and military personnel have different levels of exposure due to the nature of their work in West Africa:

Well, the military is in a different situation, obviously, because they are, first of all, not treating patients.

So let me get this straight. People with more exposure to infected patients require fewer precautions upon their return. Rrrriiiiiggghhhttt.

The second reason is that the military works for him, so they just have to suck it:

Second of all, they are not there voluntarily.

It’s part of their mission that’s been assigned to them by their commanders and ultimately by me, the commander in chief. So, we don’t expect to have similar rules for our military as we do for civilians. They are already, by definition, if they’re in the military, under more circumscribed conditions.

When we have volunteers who are taking time out from their families, from their loved ones and so forth to go over there because they have very particular expertise to tackle a very difficult job, we to want make sure that, when they come back, that we are prudent, that we are making sure that they are not at risk themselves or at risk of spreading the disease.

Last time I checked, military people were volunteers (and have been since 19-freaking-73), taking time out from their families and loved ones and so forth on extended deployments because they have very particular expertise to tackle difficult jobs. Oh, and in doing so, especially for the last 13 years, have done so in most of the earth’s hell holes at great personal risk.

But I guess they’re not doing God’s work, so they just need to embrace the suck.

If you ever wanted to understand Obama’s true feelings about the military in two paragraphs, now you have it. They start at scorn and go downhill from there.

Don’t think this won’t be noticed, all the way from E-1 to O-10. And there might be some O-11s spinning in their graves.

And of course, there was the obligatory condescending invocation of Science!, this from a guy who despite his resemblance to Urkel never struck me as a guy handy around the Bunsen Burner:

But we don’t want to do things that aren’t based on science and best practices, because, if we do, then we’re just putting another barrier on somebody who’s already doing really important work on our behalf. And that’s not something I think any of us should want to see happen.

And for a bonus Science! lecture, Jocylyn Elders emerged from obscurity to deliver it. (If you guessed “dead” in “dead or alive”, sorry: you lose).

These constant sneering references to Science!, clearly intended to intimidate the peasants into silence, are beyond insufferable. Because whenever Obama speaks about Science!, all I can think of is this:

An Antares spacecraft operated by Orbital Sciences and contracted to NASA to carry supplies to the International Space Station exploded on liftoff in Virginia. A failure for the American space program? Yes. But the major failure may be due to the fact that this craft, like most others operated by US companies, relies on Russian engines. Soviet engines, actually. I mean literally built in Soviet times. They have been refurbed, but Orbital Sciences was supposedly concerned about quality:

The NK-33 engine that powered Antares’ first flight was built decades ago by Russia’s Kuznetsov Design Bureau and is no longer in production. Further, Orbital is uncertain about the quality of Aerojet‘s remaining stockpile of 23 NK-33s, beyond those set aside for NASA’s CRS-1. Aerojet Rocketdyne is Orbital’s primary subcontractor and overhauls the old NK-33 engines into a configuration for Antares, dubbed AJ-26.

The fraught relationship with Russia, and Russian threats (uttered by Rogozin the Ridiculous, true) to cut off supplies of engines to the US has spurred efforts here to develop an American engine. Maybe NASA and the Pentagon should expedite those efforts.

The uniformed military has laid down a major marker in the tussle over Ebola quarantines. The Joint Chiefs of Staff recommended a 21 day quarantine from all service personnel returning from West Africa:

The Joint Chiefs of Staff have recommended to Defense Secretary Chuck Hagel that all troops returning from deployments in West Africa to combat the Ebola virus be quarantined for 21 days, the Pentagon said Tuesday.

Army Gen. Martin Dempsey, the chairman of the Joint Chiefs, delivered the service chiefs’ recommendation to follow the Army’s lead on the policy of 21 days of isolation, said Rear Adm. John Kirby, the Pentagon press secretary.

On Monday, Gen. Ray Odierno, the Army chief of staff, ordered 21 days of isolation and “enhanced monitoring” for Army Maj. Gen. Darryl Williams and 11 other troops who were returning to Italy from leading the initial efforts by the military to contain the Ebola virus in Liberia.

The Army has already ordered a quarantine of its personnel, and Hagel has stated that he will not overrule that decision. Now he has to decide whether to order a quarantine policy for all services:

Kirby said Hagel “supports the decision the Army leadership made” while stressing that Hagel had yet to reach a decision on whether the 21-days isolation rule should apply to all services.

The Pentagon press secretary said there was no timeline for Hagel to make a decision but added that one was expected soon.

Given the administration’s  obvious and almost frenzied opposition to any quarantines or travel bans, this is a major repudiation of Obama policy and judgment. I suspect it reflects a judgment on the civilian leadership that transcends the Ebola issue.

For his part, Obama strode to the WH lawn to tell us that quarantines and travel bans were bad because, Science! And because health workers were doing God’s work. Well, doing God’s work is not incompatible with taking prudent precautions to prevent said workers from infecting God’s children. Quite consistent with it in fact.

Meanwhile we learned some suspiciously suppressed facts about Quarantines are Bad poster nurse Kacia Hickox. Some very interesting facts. Such as that she worked/works for the CDC. And that she was miraculously able to retain a high-powered civil rights attorney almost immediately after being quarantined, and that this said attorney is connected to the White House. There are no coincidences, comrades.

Hickox raised alarms in my mind with her stridency and sense of entitlement, and failure to even acknowledge that as a public health worker, there might be a public health case, rather than a Kacia Hickox case, for quarantining her. How warranted those concerns were. So if you are wondering what Ebola Czar Ron “Flounder” Klain has been doing out of the public eye, wonder no longer.

Back to the JCS. Now Hagel is well and truly between a rock and a hard place. The uniformed military is almost certainly livid over the way the campaign against ISIS is being waged, and the events over the past several years that have led up to it. To have Hagel cave on Ebola to pressure from Obama would only stoke  that anger. Obama has done serious damage to many institutions in this country. Civil-military relations could be yet another.

Matt Levine graciously led his daily linkwrap with a response to my post on his copper column:

It’s not that hard to manipulate copper.

Craig Pirrong, who knows a lot more about commodities markets than I do [aw, shucks], objects to my take on copper. My view is sort of efficient-markets-y: If one person buys up all the copper in the LME warehouses and then tries to raise the price, the much much greater supply of copper that’s not in those warehouses will flow into the warehouses and limit his ability to do that. And I still think that’s broadly true, but broadly true may not be the point. Pirrong quite rightly points out that there’s lots of friction along the way, and the frictions may matter more than the limits in actual fact.

. . . .

So there are limits to cornering, but they may not be binding on an actual economic actor: You can’t push prices up very much, or forvery long, but you may be able to push them up high enough and for long enough to make yourself a lot of money.

I agree fully there are limits to cornering. The supply curve isn’t completely inelastic. People can divert supplies (at some cost) into deliverable position. The cornerer presents the shorts with the choice: pay me to get out of your positions, or incur the cost of making delivery. Since those delivery costs are finite, the amount the cornerer can extract is limited too.

I agree as well that corners typically elevate prices temporarily: after all, the manipulator needs to liquidate his positions in order to cash out, and as soon as that happens price relationships snap back. But that temporary period can last for some time. Weeks, sometimes more.

What’s more, when the temporary price distortions happen matters a lot. Some squeezes occur at the very end of a contract. This is what happened in Indiana Farm Bureau in 1973. A more recent example is the expiry of the October, 2008 crude oil contract, in which prices spiked hugely in the last few minutes of trading.

The economic harm of these last minute squeezes isn’t that large. There are few players in the market, most hedgers have rolled or offset, and the time frame of the price distortion is too short to cause inefficient movements of the commodity.

But other corners are more protracted, and occur at precisely the wrong time.

Specifically, some corners start to distort prices well before expiration, and precisely when hedgers are looking to roll or offset. Short, out-of-position hedgers looking to roll or offset try to buy either spreads or outrights. The large long planning to corner the market doesn’t liquidate. So the hedgers bid up the expiring contract. Long still doesn’t budge. So the shorts bid it up some more. Eventually, the large long relents and sells when prices and spreads get substantially out of line, and the hedgers exit their positions but at a painfully artificial price. I have documented price distortions in some episodes of 10 percent or more. That’s a big deal, especially when one considers the very thin margins on which commodity trading is done. Combine that price distortion with the fact that a large number of shorts pay that distorted price to get out of their positions, and the dollar damages can be large. Depending on the size of the contract, and the magnitude of the distortion, nine or ten figures large.  (I analyze the liquidation/roll process theoretically in a paper titled “Squeeze Play” that appeared in the Journal of Alternative Investments a few years ago.)

But this is all paper trading, right, so real reapers of wheat and miners of copper aren’t damaged, right? Well, for the bigger, more protracted squeezes that’s not right.

Most hedgers are “out-of-position” they are using a futures contract to hedge something that isn’t deliverable. For example, shippers of Brazilian beans or holders of soybean inventories in Iowa use CBT soybean futures as a hedge. They are therefore long the basis. Corners distort the basis: the futures price rises to reflect the frictions and bottlenecks and technical features of the delivery mechanism, but the prices of the vastly larger quantities of the physical traded and held elsewhere may rise little, if at all. So the out-of-position hedgers don’t gain on their inventories, but they pay an inflated price to exit their futures.

This is why corners are a bad thing. They undermine  the most vital function of futures markets: hedging/risk transfer. Hedgers pay the biggest price for corners precisely because the delivery market is only a small sliver of the world market for a commodity, and because the network effects of liquidity cause all hedging activity to tip to a single market (with a very few exceptions). Thus, the very inside baseball details of the delivery process in a specific, localized market have global consequences. That’s why temporary and not very big and localized are not much comfort when it comes to the price distortions associated with market power manipulations.

Gunvor announced plans to sell assets in Russia:

Oil trading house Gunvor is seeking to cut exposure to Russia by selling assets in the country which had long been one the main generators of its growth and profit before the United States imposed sanctions on its co-founder.

. . . .

Now the company, led by the veteran Swedish oil trader, is looking to rebalance its asset portfolio and divest a significant part of business in Russia to acquire new assets in Europe, the United States, Asia and South America.

“Since a significant portion of our investments are in Russia, over time Gunvor will be looking to sell selectively part of those assets. We do not expect this will have any impact on our existing trading activities in Russia,” the company said on Sunday.

I am somewhat amused by the statement that the company “expect this will have any impact on our existing trading activities in Russia,” because it is well known that it has been cutting back on these activities for some time.

Some obvious explanations include a genuine desire to rebalance its asset portfolio, a need for cash due to persistent suspicions about the company leading to constraints on its ability to access the credit markets, and a desire to put paid to those suspicions by cutting back exposure to Russia.

Knowing the way Russia works, I would advance another hypothesis for Gunvor’s actions. It has been told to sell out, because someone covets those assets, and because after Timchenko’s departure (and Putin’s being cashed out?) the company has lost its krysha. Russia is the country of “nice little port you have here. It’d be a shame if something happened to it. Or to you.” When you have something that somebody important wants, you’d better say da! and accept the price offered without complaint. Just ask Vladimir Yevtushenkov.

One of the assets that Gunvor is selling is its stake in the port in Novorossiisk. Wouldn’t you know who expressed an interest in acquiring a stake in the the port there? Yeah. Igor. And Rosneft has oil trading ambitions, and the Ust-Luga port on the Baltic could fit quite nicely into that.

So keep an eye on who buys. Given that this is hardly a peachy time to sell assets in Russia, given the country’s growing economic isolation and the fear of further sanctions, Gunvor’s announcement is quite telling. The buyer is likely to be Russian, and the set of possible buyers is quite limited, which means that Gunvor is not likely to get top dollar for these assets. If Rosneft or another national champion with close connections to Putin ends up being the buyer, my suspicions that Gunvor was pushed out of Russia will be largely confirmed.

Someone at Gunvor told the FT that Russia was “Gunvor’s heritage, not its future.” That’s definitely true. The only question is why. I strongly suspect this is not totally voluntary, and to the extent that it is, it reflects Gunvor’s judgment that the legal and economic and political risks of operating in Russia are no longer worth the candle.

From day 1 of the Ebola episode in Dallas, the administration has been adamantly opposed to travel bans and quarantines, especially of health care workers who have been to West Africa. When New York and New Jersey implemented quarantines, the administration leaned on governors Cuomo and Christie very hard: Cuomo relented considerably. The administration argues that imposing restrictions on returnees from the Ebola-stricken region will impede efforts to control the outbreak there.

I’ve expressed skepticism about those arguments, but if you don’t give me any credence, what about the US Army?:

The U.S. general appointed to oversee America’s fight against Ebola in West Africa has been quarantined in Italy with at least 10 other Americans upon returning from the disease-stricken continent.

Major General Darryl A. Williams, who was appointed head of the U.S. command center in Liberia that coordinates the response to Ebola, was isolated along with several other Americans over the weekend, CNN reports.

The General’s “plane was met on the ground by Italian authorities ‘in full CDC gear,’” a U.S. official was quoted as telling CNN.

Williams and the others will now be monitored for 21 days at a U.S. military compound in Italy, according to the report.

To steal a phrase, the US military is pretty much the ultimate reality-based community–except when political pressure gets too hard to bear. But in most matters of life and death involving its areas of competence, the military doesn’t bend to political fashions, especially progressive ones. It balances risk and reward, based on its best understanding of the facts (which is often imperfect, admittedly) and decides accordingly.

So for the Army to decide, in the face of the obvious potential for fierce disagreement with the administration, that quarantine is the right thing to do, you can be pretty sure that decision is the result of a sober appraisal of the situation. Indeed, the willingness to buck administration preferences gives you an indication of the strength of the Army’s convictions.

The US military has always been more serious and squared away and apolitical with regards to biological and chemical threats. It should be assigned primary responsibility in dealing with the situation in the US too, but turf wars have ruled that out. (Hot Zone describes the turf fights between CDC and the Army during the Clinton administration during an episode involving infected monkeys in Virginia.)

The Army action is basically calling bull on the administration’s frantic anti-quarantine position. Between Dr. Barry and the US Army, I know whom I trust more.

That said, there are smart ways of doing a quarantine, and dumb ways. The measures initially adopted by New York and New Jersey seem to be  ham-fisted. The quarantined nurse in NJ has something of a legitimate beef (mixing meat metaphors!), although her claims that quarantines are totally unnecessary for returning health care workers comes off as entitled and clueless, especially given the infections of health care workers here in the US and Europe, and the large numbers of deaths among such workers in Africa. One would think that someone who is  selfless enough to risk contracting the disease in Africa would be willing to take prudent precautions to prevent it from spreading at home.

The Army way seems to be the right way. A special facility, outside the US, where those working in the afflicted region are quarantined  in a comfortable, secure facility before returning to the US.

@libertylynx pointed out to me that quarantine can be a financial burden and family hardship on aid workers, many of whom are missionaries without substantial financial resources. That problem is easily solved, as it involves only money, and not a lot at that. There is a way of balancing the need to attract people to West Africa to fight the disease, and limiting the possibility that they can spread the virus back to the states on their return.

Put differently, the cost of compensating the workers for the burdens of a quarantine pales in comparison with the cost of dealing with an outbreak in the US. Even if the probability that  returnee would spread the virus is small, given the huge cost of a US outbreak and the huge benefit of attracting workers to fight the disease the affected region, it is cheap at twice the price (or much more) to compensate them for the time and hardship a quarantine imposes. Pace Adam Smith: compensating differentials in action.

That said, the Army’s action speaks many volumes. It is saying that from a medical perspective, quarantine is a prudent measure. If the administration is concerned about deterring the travel of needed workers to Africa, the costs of that prudence can be easily paid. Rather than stubbornly fighting quarantines and travel bans, the administration should focus its efforts on designing and getting passed financial compensation measures that balance risk and reward.

Bloomberg’s Matt Levine is usually very insightful about markets, and about financial skullduggery. Alas, in his article on developments in the copper market, Matt is passing off a bad penny.

The basic facts are these. A single firm, reportedly well-known (and arguably infamous) metals trading fund Red Kite, has accumulated upwards of 50 percent (and at times as much as 90 percent) of copper in LME warehouses that is deliverable against LME futures contracts. Such an accumulation can facilitate a corner of the market, or could be a symptom of a corner: a large long takes delivery of virtually the entire deliverable stock (and perhaps all of it) to execute a corner. So the developments in LME copper bear the hallmarks of a squeeze, or an impending one.

What’s more, the price relationships in the market are consistent with a squeeze: the market is in backwardation. I have not had time to determine whether the backwardation is large, controlling for stocks (as would occur during a corner), but the sharp spike in backwardation in recent days is symptomatic of a corner, or fears of a corner.

Put simply, there is smoke here. But Matt Levine seems intent on denying that. Weirdly, he focuses on the allegations involving Goldman’s actions in aluminum:

Loosely speaking, the problem of aluminum was that it was in deep contango: Prices for immediate delivery were low, prices for future delivery were high, and so buying aluminum and chucking it in a warehouse to deliver later was profitable. So people did, and the warehouses got pretty jammed up, and other people who wanted aluminum for immediate use found it all a bit unsporting.

. . . .

The LME warehouse system is an interesting abstract representation of a commodity market, but you can get into trouble if you confuse it with the actual commodity market. One example of the trouble: Goldman and its cronies were accused of manipulating aluminum prices up by putting too much aluminum in LME warehouses.

Well, yes. But the point is that there are many different kinds of manipulation. Many, many different kinds. An Appeals Court in the US opined in the Cargill case that they number of ways of manipulating was limited only by the imagination of man. Too true. The facts in aluminum and the facts in copper are totally different, and the alleged forms of manipulation are totally different, so the events in aluminum are a red herring (although it is copper that is the red metal)

Levine also makes a big, big deal out of the fact that the amount of copper in LME warehouses is trivial compared to the amount of copper produced in the world, let alone the amount of copper that remains in the earth’s crust. This matters hardly at all.

What matters is the steepness of the supply curve into warehouses. If that supply curve is upward sloping, a firm with a big enough futures position can corner the market, and distort prices, even if the amount of copper actually in the warehouses, or attracted to the warehouses by a cornerer’s artificial demand, is small relative to the size of the world copper market.

Case in point. In December 1995 Hamanaka/Sumitomo cornered the LME copper contract holding a position in LME warrants that was substantially smaller than what one firm now owns. Hamanaka’s/Sumitomo’s physical and futures positions were small relative to the size of the world copper market, measured by production and consumption. But they still had market power in the relevant market because it was uneconomic to attract additional copper into LME warehouses.

Another example. Ferruzzi cornered the CBT soybean contract in July, 1989, owning a mere 8 million bushels of beans in Chicago and Toledo. But since it was uneconomic to move additional supplies into those delivery points, it was profitable for, and possible for, Ferruzzi to corner the expiring contract.

World supply may have an effect on the slope of the supply curve into warehouses, but that slope can be positive (thereby creating the conditions necessary to corner) even if the share of metal in warehouses is small. The slope of the supply curve depends on the bottlenecks associated with getting metal into warehouses, and the costs of diverting metal that should go to consumers into warehouses. These bottlenecks and costs can be acute, even if the amount of warehoused metal is small. Diverting copper that should go to a fabricator or wire mill to an LME warehouse is inefficient, i.e., costly. It only happens, therefore, if the price is distorted sufficiently to offset this higher cost.

Levine ends his post thus:

One example of the trouble: Goldman and its cronies were accused of manipulating aluminum prices up by putting too much aluminum in LME warehouses.The worries about copper — that it could be cornered, pushing prices up — stem from there being too little copper in those warehouses. Both of those things can’t be true.

Yes they can, actually. Different commodities at different times with different fundamental conditions are vulnerable to different kinds of manipulation. It is perfectly possible for it to be true that aluminum was vulnerable to a manipulative scheme that exploited the bottlenecks of taking the white metal out of warehouses starting some years ago, and that copper is vulnerable to a manipulative scheme that exploits the bottlenecks of getting the red metal into warehouses now. No logical or factual contradiction whatsoever.

I know you are better than this, Matt. Don’t let your justifiable skepticism of allegations of manipulation make you a poster child for the Gresham’s Law of Internet Commentary.

Today Putin appeared at the Valdai Discussion Forum, and gave a performance that raises serious doubts about his sanity.

He ranted against the west, and the US in particular:

“Statements that Russia is trying to reinstate some sort of empire, that it is encroaching on the sovereignty of its neighbours, are groundless,” the former KGB spy declared in a speech delivered standing at a podium, without a smile, in a ski resort in mountains above the Black Sea city of Sochi.

Listing a series of conflicts in which he faulted U.S. actions, including Libya, Syria and Iraq, Putin asked whether Washington’s policies had strengthened peace and democracy.

“No,” he declared. “The unilateral diktat and the imposing of schemes (on others) have exactly the opposite effect.”

He denied the US is a democracy, and expressed his befuddlement at the electoral college. (Note to Vlad: It’s worked for 225 years.) All that was missing was a rant about hanging chads. He accused the US of organizing a coup in Ukraine and supporting Islamic terrorists. He made not-so-veiled nuclear threats. And on and on and on.

My favorite was his statement that Occupy Wall Street was “choked in its cradle.” He’s just pissed that his influence op fizzled. (I remind you that The News Agency Formerly Known as Russia Today, AKA Putin’s Agitprop Network, was constantly hyping Occupy. As was his pilot fish-or is it more than that?-Zero Hedge.)

It was truly a bizarre performance, chock full with paranoia and resentment.

It follows soon after an interview by former FSB head Nikolai Petrushev that blamed the CIA for everything under the sun, most notably events in Ukraine, which he said was a coup by “self-described Nazis”(!). Fellow ex-KGB mouth breather (but hey, he did sport some bitchin’ flairs back in the 70s) Sergei Ivanov has made similar statements lately.

Thus the question (which I have posed before): is Putin genuinely mad, or is he, pace Machiavelli, “simulating madness at the right time.” Is he pissing purple, or chewing the scenery in an attempt to intimidate a feckless west, who could use his insanity as a justification for leaving hime a wide berth?

Although I don’t discount embellishment, I think he is unhinged at his core.

First, he is under tremendous pressure. Crimea was a bloodless triumph, but the follow on in the rest of Ukraine has turned into a bloody, expensive, and largely unsuccessful mess. Instead of sweeping to an easy victory that would net him all of Novorossiya and subject Ukraine to his control, he has had to fight a nasty campaign that has netted him only the blasted remnants of an already shambolic rump piece of Sovokistan, also known as the Donbas. He has earned the intense enmity of the vast bulk of the Ukrainian population. At best, by freezing the conflict he can prevent Ukraine from developing into a “normal” (i.e., westernized) country (something that horrifies Putin), but he cannot incorporate it into a New Russian Empire, except at ruinous cost.

What’s more, Russia’s already creaking economy is under tremendous stress. Part of that stress is due to the inexorable working of sanctions, which have deprived his cherished national champions of access to western capital, and his energy companies access to needed technology. A bigger part of that stress is attributable to a global growth slowdown that has caused oil prices to fall by about 20 percent. These economic stresses deprive him of the resources needed to underwrite his ambitions. Moreover, they create tremendous divisions and anger within the elite, thereby complicating his task as the chief balancer. If they go on long enough, they will create another front: popular anger, or at least resentment and a piercing of the perception of universal popularity.

Second, Putin comes by his paranoia and anti-US resentment honestly. It has been on display for years, too long and too often to be an act. It comes naturally to a KGB man, and was reinforced by relentless indoctrination in the service: read the Patrushev interview to see a rather comprehensive statement of this world view.

Third, dictators and autocrats almost inevitably succumb to madness and paranoia. They are surrounded by sycophants whose obsequiousness feeds a sense of omnipotence and omniscience. Cults of personality feed this sense even more. They rule by intimidation and fear, and hence hear no dissenting voices. There is no institutional check on their power. All of this means that there is no pushback on crazy, so craziness metastasizes.

Such a man is unlikely to be appeased, and difficult to deter. Reducing the dangers he poses requires chipping away at his capabilities, and confronting him with power that he cannot overcome.

Recently an (incredibly campy) art exhibition in Moscow compared Putin to Hercules. (Given Hercules’ goatish omnisexuality and Putin’s homophobia, this is rather amusing.) But I think another ancient parallel is likely to be more apt: Sampson. Putin is unlikely to go quietly into that dark night, and if he is doomed he is likely to try to bring down everything around his ears. The problem is that backing off will just create a vacuum that he will fill, and just defer the inevitable reckoning. It is unlikely that conflict with him can be avoided, because he will seek it out. How do you appease the paranoid?

As bad as the Middle East is, the real existential threat in the world right now is Putin. (Heaven forfend, but I actually agree with George Soros.) He has 4,500 nukes, and he knows how to use them.

That he’s mad, or at the very least wants to be viewed as being mad, makes that the most daunting challenge the United States and the West face. Given the Lilliputian leaderships in the US and Europe, that is not a comforting thought.

Due to the five year gap in 30 year bond issuance, in mid-September the CME revised the deliverable basket for the June 2015 T-bond contract. It deleted the 6.25 of May, 2015 because its delivery value would have been so far below the values of the other bonds in the deliverable set. This would have made the contract more susceptible to a squeeze because only that bond would effectively be available for delivery due to the way the contract works.

The CME issued a memo on the subject.

Somebody obviously didn’t get it:

It looks like a Treasury futures trader failed to do his or her homework.

The price of 30-year Treasury futures expiring in June traded for less than 145 for about two hours yesterday before shooting up to more than 150. The 7.3 percent surge in their price yesterday, on the first day these particular contracts were traded, was unprecedented for 30-year Treasury futures, according to data compiled by Bloomberg. Volume amounted to 1,639 contracts with a notional value of $164 million.

What sets these futures apart from others is they’re the first ones where the U.S. government’s decision to stop issuing 30-year bonds from 2001 to 2006 must be accounted for when valuing the derivatives. The size and speed of yesterday’s jump indicates the initial traders of the contracts hadn’t factored in the unusual rules governing these particular products, said Craig Pirrong, a finance professor at the University of Houston.

“That is humongous,” said Pirrong, referring to the 7.3 percent jump. “We’re talking about a move you might see over weeks or a month occur in a day.” Pirrong said he suspected it was an algorithmic trader using an outdated model. “I would not want to be that guy,” the professor said.

Here’s a quick and dirty explanation. Multiple bonds are eligible for delivery. Since they have different coupons and maturities, their prices can differ substantially. For instance, the 3.5 percent of Feb 39 sells for about $110, and the 6.25 of 2030 sells for about $146. If both bonds were deliverable at par, no one would ever deliver the 6.25 of 2030, and it would not contribute in any real way to deliverable supply. Therefore, the CME effectively handicaps the delivery race by assigning conversion factors to each bond. The conversion factor is essentially the bond’s price on the delivery date assuming it yields 6 percent to maturity. If all bonds yield 6 percent, their delivery values would be equal, and the deliverable supply would be the total amount of deliverable bonds outstanding. This would make it almost impossible to squeeze the market.

Since bonds differ in duration, and actual yields differ from 6 percent, the conversion factors narrow but do not eliminate disparities in the delivery values of bonds. One bond will be cheapest-to-deliver. Roughly speaking, the CTD bond will be the one with the lowest ratio of price to conversion factor.

That’s where the problem comes in. For the June contract, if the 6.25 of 2030 was eligible to deliver, its converted price would be around $142. Due to the issuance/maturity gap, the converted prices of all the other bonds is substantially higher, ranging between $154 and $159.

This is due a duration effect. When yields are below 6 percent, and they are now way below, at less than 3 percent, low duration bonds become CTD: the prices of low duration bonds rise less (in percentage terms) for a given decline in yields than the prices of high duration bonds, so they become relatively cheaper. The 6.25 of 2030 has a substantially lower duration than the other bonds in the deliverable basket because of its lower maturity (more than 5 years) and higher coupon. So it would have been cheapest to deliver by a huge margin had CME allowed it to remain in the basket. This would have shrunk the deliverable supply to the amount outstanding of that bond, making a squeeze more likely, and more profitable. (And squeezes in Treasuries do occur. They were rife in the mid-to-late-80s, and there was a squeeze of the Ten Year in June of 2005. The 2005 squeeze, which was pretty gross, occurred when there was less than a $1 difference in delivery values between the CTD and the next-cheapest. The squeezer distorted prices by about 15/32s.)

The futures contract prices the CTD bond. So if someone-or someone’s algo-believed that the 6.25 of 2030 was in the deliverable basket, they would have calculated the no-arb price as being around $142. But that bond isn’t in the basket, so the no-arb value of the contract is above $150. Apparently the guy* who didn’t get the memo merrily offered the June future at $142 in the mistaken belief that was near fair value.

Ruh-roh.

After selling quite a few contracts, the memo non-reader wised up, and the price jumped up to over $150, which reflected the real deliverable basket, not the imaginary one.

This price move was “humongous” given that implied vol is around 6 percent. That’s an annualized number, meaning that the move on a single day was more than a one-sigma annual move. I was being very cautious by saying this magnitude move would be expected to occur over weeks or months. But that’s what happens when the reporter catches me in the gym rather than at my computer.

This wasn’t a fat-finger error. This was a fat-head error. It cost somebody a good deal of money, and made some others very happy.

So word up, traders (and programmers): always read the memos from your friendly local exchange.

*Or gal, as Mary Childs pointed out on Twitter.