Streetwise Professor

In my most recent post on the Bashneft saga, I surmised that there might be a quid pro quo: Rosneft would be allowed to buy the smaller producer in exchange for a promise to proceed with its long delayed privatization. It appears that something along those lines is what is going on, although whereas I conjectured that Putin made this offer to Sechin, Bloomberg reports that Sechin is pitching the idea to Putin:

Rosneft PJSC chief Igor Sechin, not taking no for an answer, has come up with a proposal to expand his energy empire while helping critics in the Russian government meet their goal of reducing the widest budget deficit in six years.

Sechin, a longtime ally of President Vladimir Putin, has asked the government to let state-run Rosneft buy its controlling stake in smaller oil producer Bashneft PJSC for $5 billion in cash, a premium to the market, according to two senior officials. Russia could then earn another $11 billion by proceeding with its delayed sale of 19.5 percent of Rosneft itself, generating a $16 billion windfall that would cut this year’s projected deficit in half, they said.

Sechin is also proposing to sell off small pieces of Rosneft to multiple investment funds and trading firms, rather than a big chunk to the Chinese or Indians.

This illustrates the transactional nature of Putinism. Presumably other interested parties have submitted their proposals to Putin, who will decide based on a mixture of efficiency, fiscal, and political considerations. The political considerations will focus on the distribution of rents among his retainers in exchange for political support and other services that those favored can provide Putin. Putin is in essence holding an auction, and the technocratic opposition to a Rosneft acquisition (at least before it privatizes) essentially forces Sechin to bid more aggressively.

One interesting aspect of this is the sequencing. If Putin bestows Bashneft on Rosneft in exchange for a promise of a future privatization, would Sechin dare to stall or delay once Bashneft is in hand, resorting to his usual arguments that due to this, that, or the other, the price isn’t right? If Rosneft sells off a stake in exchange for Putin’s promise that it can then acquire Bashneft, might Putin say at a later date: “Things have changed, so I’ve changed my mind”?  Making commitments credible in a personalized, natural state is not an easy thing. And these things get harder, the older Putin gets, as the end game problem looms larger by the day. The ability to evade future performance depends on  the political balance and economic conditions at the time performance is required, and those can shift dramatically.

So this is Sechin’s bid. It will be interesting to see whether Putin accepts it, and the conditions that he imposes in an attempt to make sure that Sechin lives up to his half of the bargain. Those conditions will reveal a good deal about not just Sechin’s current position within the hierarchy, but the degree of trust between the major players in the regime.

Yesterday Elon Musk announced the introduction of a 100kW battery pack that would create the quickest production car, capable of doing 0-60MPH in 2.5 seconds. But even Musk admits that production volume will be low, due to the cost and complexity of the new pack. Further given that it will add $10k to the price of an already very expensive vehicle, it will do nothing to advance Tesla’s ambitions of becoming a mass production company.

But it gives Elon the opportunity to strut and amaze the technofanboyz. Wow! Even more ludicrous!

But whenever Elon makes a big splash announcement, there is a very high probability that the true intent is to mask some other far less favorable news. And that was the case yesterday. While everybody covered the battery story, and gave it prominence, only a few covered a far more important, but unflattering story, and did so in a perfunctory way. Specifically, in an SEC filing Musk announced that he was buying $65 million of Solar City’s $124 million bond offering. But it gets better! His cousins, the CEO and CTO of Solar City, are each plunking down $17.5 million. Meaning that related insiders are buying more than 80 percent of the bond issue.

In other words, the market won’t touch these bonds with a ten foot pole, but Elon and his cousins must step into the breach. Mind you, this is happening after Tesla has offered to bail out–excuse me, buy out–Solar City. One would think that would be a credit risk positive, right? Apparently one cash bleeder buying another cash bleeder isn’t appetizing to potential bond investors, even in this era of yield famine–the Solar City bonds weren’t drawing any buyers at a yield of 6.5 percent.

Yet again, this illustrates that the Solar City deal is all about propping up a floundering enterprise, all in the name of staving off a reputation damaging failure.

I also wonder where are Elon et al getting the $100 million to pay for the bonds. Is Elon pledging more of his Tesla stock to Goldman, etc., to secure loans to buy the bonds?

There are other indications that Tesla’s financing issues are beginning to bite. Musk noted that

While the P100D Ludicrous is obviously an expensive vehicle, we want to emphasize that every sale helps pay for the smaller and much more affordable Tesla Model 3 that is in development. Without customers willing to buy the expensive Model S and X, we would be unable to fund the smaller, more affordable Model 3 development.

Which means that the company is having difficulty funding Model 3 development and production (and the Gigafactory) through the capital markets. The bond markets are pretty much off-limits now. The company just did a big equity sale, and will issue more shares to buy Solar City. Tesla’s financial infrastructure looks shaky indeed. Further, it’s not as if the Models S and X are flying off the lot: Tesla inventories consist predominately of the more expensive 90kW battery versions.

So don’t get dazzled. Don’t get distracted by the superspeedy squirrel. Elon makes such announcements in order to divert attention from bad news. Indeed, when Musk makes a splash, you should start looking out for what he’s trying to hide.

Biofuel Renewable Identification Numbers–“RINs”–are back in the news because of a price spike in June and July (which has abated somewhat). This has led refiners to intensify their complaints about the system. The focus of their efforts at present is to shift the compliance obligation from refiners to blenders. Carl Icahn has been quite outspoken on this. Icahn blames everyone, pretty much, including speculators:

“The RIN market is the quintessential example of a ‘rigged’ market where large gas station chains, big oil companies and large speculators are assured to make windfall profits at the expense of small and midsized independent refineries which have been designated the ‘obligated parties’ to deliver RINs,” Icahn wrote.

“As a result, the RIN market has become ‘the mother of all short squeezes,”‘ he added. “It is not too late to fix this problem if the EPA acts quickly.”

Refiners are indeed hurt by renewable fuel mandates, because it reduces the derived demand for the gasoline they produce. The fact that the compliance burden falls on them is largely irrelevant, however. This is analogous to tax-incidence analysis: the total burden of a tax, and the distribution of a tax, doesn’t depend on who formally pays it. In the case of RINs, the total burden of the biofuels mandate and the distribution of that burden through the marketing chain doesn’t depend crucially on whether the compliance obligation falls on refiners, blenders, or your Aunt Sally.

Warning: There will be math!

A few basic equations describing the equilibrium in the gasoline, ethanol, biodiesel and RINs markets will hopefully help structure the analysis*. First consider the case in which the refiners must acquire RINs:

Equation (1) is the equilibrium in the retail gasoline market. The retail price of gasoline, at the quantity of gasoline consumed, must equal the cost of blendstock (“BOB”) plus the price of the ethanol blended with it. The R superscript on the BOB price reflects that this is the price when refiners must buy a RIN. This equation assumes that one gallon of fuel at the pump is 90 percent BOB, and 10 percent ethanol. (I’m essentially assuming away blending costs and transportation costs, and a competitive blending industry.) The price of a RIN does not appear here because either the blender buys ethanol ex-RIN, or buys it with a RIN and then sells that to a refiner.

Equation (2) is the equilibrium in (an assumed competitive) ethanol market. The price an ethanol producer receives is the price of ethanol plus the price of a RIN (because the buyer of ethanol gets a RIN that it can sell, and hence is willing to pay more than the energy value of ethanol to obtain it). In equilibrium, this price equals the the marginal cost of producing ethanol. Crucially, with a binding biofuels mandate, the quantity of ethanol produced is determined by the blendwall, which is 10 percent of the total quantity sold at the pump.

Equation (3) is equilibrium in the biodiesel market. When the blendwall binds, the mandate is met by meeting the shortfall between mandate and the blendwall by purchasing RINs generated from the production of biodiesel. Thus, the RIN price is driven to the difference between the cost of producing the marginal gallon of biodiesel, and the price of biodiesel necessary to induce consumption of sufficient biodiesel to sop up the excess production stimulated by the need to obtain RINs. In essence, the price of biodiesel plus the cost of a RIN generated by production of biodiesel must equal the marginal cost of producing it. The amount of biodiesel needed is given by the difference between the mandate quantity and the quantity of ethanol consumed at the blendwall. The parameter a is the amount of biofuel per unit of fuel consumed required by the Renewable Fuel Standard.

Equation (4) is equilibrium in the market for blendstock–this is the price refiners get. The price of BOB equals the marginal cost of producing it, plus the cost of obtaining RINs necessary to meet the compliance obligation. The marginal cost of production depends on the quantity of gasoline produced for domestic consumption (which is 90 percent of the retail quantity of fuel purchased, given a 10 percent blendwall). The price of a RIN is multiplied by a because that is the number of RINs refiners must buy per gallon of BOB they sell.

Equation (5) just says that the value of ethanol qua ethanol is driven by the relative octane values between it and BOB.

The exogenous variables here are the demand curve for retail gasoline; the marginal cost of producing ethanol; the marginal cost of producing BOB (which depends on the price of crude, among other things); the marginal cost of biodiesel production; the demand for biodiesel; and the mandated quantity of RINs (and also the location of the blendwall). Given these variables, prices of BOB, ethanol, RINs, and biodiesel will adjust to determine retail consumption and exports.

Now consider the case when the blender pays for the RINs:

Equation (6) says that the retail price of fuel is the sum of the value of the BOB and ethanol blended to create it, plus the cost of RINs required to meet the standard. The blender must pay for the RINs, and must be compensated by the price of the fuel. Note that the BOB price has a “B” superscript, which indicates that the BOB price may differ when the blender pays for the RIN from the case where the refiner does.

Without exports, retail consumption, ethanol production, biodiesel production, and BOB production will be the same regardless of where the compliance burden falls. Note that all relevant prices are determined by the equilibrium retail quantity. It is straightforward to show that the same retail quantity will clear the market in both situations, as long as:

That is, when the refiner pays for the RIN, the BOB price will be higher than when the blender does by the cost of the RINs required to meet the mandate.

Intuitively, if the burden is placed on refiners, in equilibrium they will charge a higher price for BOB in order to cover the cost of complying with the mandate. If the burden is placed on blenders, refiners can sell the same quantity at a lower BOB price (because they don’t have to cover the cost of RINs), but blenders have to mark up the fuel by the cost of the RINs to cover their cost of acquiring them. here the analogy with tax incidence analysis is complete, because in essence the RFS is a tax on the consumption of fossil fuel, and the amount of the tax is the cost of a RIN.

This means that retail prices, consumption, production of ethanol, biodiesel and BOB, refiner margins and blender margins are the same regardless of who has the compliance obligation.

The blenders are complete ciphers here. If refiners have the compliance burden, blenders effectively buy RINs from ethanol producers and sell them to refiners. If the blenders have the burden, they buy RINs from ethanol producers and sell them to consumers. Either way, they break even. The marketing chain is just a little more complicated, and there are additional transactions in the RINs market, when refiners shoulder the compliance obligation.

Under either scenario, the producer surplus (profit, crudely speaking) of the refiners is driven by their marginal cost curves and the quantity of gasoline they produce. In the absence of exports, these things will remain the same regardless of where the burden is placed. Thus, Icahn’s rant is totally off-point.

So what explains the intense opposition of refiners to bearing the compliance obligation? One reason may be fixed administrative costs. If there is a fixed cost of compliance, that will not affect any of the prices or quantities, but will reduce the profit of the party with the obligation by the full amount of the fixed cost. This is likely a relevant concern, but the refiners don’t make it centerpiece of their argument, probably because shifting the fixed cost around has no efficiency effects, but purely distributive ones, and purely distributive arguments aren’t politically persuasive. (Redistributive motives are major drivers of attempts to change regulations, but naked cost shifting arguments look self-serving, so rent seekers attempt to dress up their efforts in efficiency arguments: this is one reason why political arguments over regulations are typically so dishonest.) So refiners may feel obliged to come up with some alternative story to justify shifting the administrative cost burden to others.

There may also be differences in variable administrative costs. Fixed administrative costs won’t affect prices or output (unless they are so burdensome as to cause exit), but variable administrative costs will. Further, placing the compliance obligation on those with higher variable administrative costs will lead to a deadweight loss: consumers will pay more, and refiners will get less.

Another reason may be the seen-unseen effect. When refiners bear the compliance burden, the cost of buying RINs is a line item in their income statement. They see directly the cost of the biofuels mandate, and from an accounting perspective they bear that cost, even though from an economic perspective the sharing of the burden between consumers, refiners, and blenders doesn’t depend on where the obligation falls. What they don’t see–in accounting statements anyways–is that the price for their product is higher when the obligation is theirs. If the obligation is shifted to blenders, they won’t see their bottom line rise by the amount they currently spend on RINS, because their top line will fall by the same amount.

My guess is that Icahn looks at the income statements, and mistakes accounting for economics.

Regardless of the true motive for refiners’ discontent, the current compliance setup is not a nefarious conspiracy of integrated producers, blenders, and speculators to screw poor independent refiners. With the exception of administrative cost burdens (which speculators could care less about, since it will not fall on them regardless), shifting the compliance burden will not affect the market prices of RINs or the net of RINs price that refiners get for their output.

With respect to speculation, as I wrote some time ago, the main stimulus to speculation is not where the compliance burden falls (because again, this doesn’t affect anything relevant to those speculating on RINs prices). Instead, one main stimulus is uncertainty about EPA policy–which as I’ve written, can lead to some weird and potentially destabilizing feedback effects. The simple model sheds light on other drivers of speculation–the exogenous variables mentioned above. To consider one example, a fall in crude oil prices reduces the marginal cost of BOB production. All else equal, this encourages retail consumption, which increases the need for RINs generated from biodiesel, which increases the RINs price.

The Renewable Fuels Association has also raised a stink about speculation and the volatility of RINs prices in a recent letter to the CFTC and the EPA. The RFA (acronyms are running wild!) claims that the price rise that began in May cannot be explained by fundamentals, and therefore must have been caused by speculation or manipulation. No theory of manipulation is advanced (corner/squeeze? trade-based? fraud?), making the RFA letter another example of the Clayton Definition of Manipulation: “any practice that doesn’t suit the person speaking at the moment.” Regarding speculation, the RFA notes that supplies of RINs have been increasing. However, as has been shown in academic research (some by me, some by people like Brian Wright)  that inventories of a storable commodity (which a RIN is) can rise along with prices in a variety of circumstances, including a rise in volatility, or an increase in anticipated future demand. (As an example of the latter case, consider what happened in the corn market when the RFS was passed. Corn prices shot up, and inventories increased too, as consumption of corn was deferred to the future to meet the increased future demand for ethanol. The only way of shifting consumption was to reduce current consumption, which required higher prices.)

In a market like RINs, where there is considerable policy uncertainty, and also (as I’ve noted in past posts) complicated two-way feedbacks between prices and policy, the first potential cause is plausible. Further, since a good deal of the uncertainty relates to future policy, the second cause likely operates too, and indeed, these two causes can reinforce one another.

Unlike in the 2013 episode, there have been no breathless (and clueless) NYT articles about Morgan or Goldman or other banks making bank on RIN speculation. Even if they have, that’s not proof of anything nefarious, just an indication that they are better at plumbing the mysteries of EPA policy.

In sum, the recent screeching from Carl Icahn and others about the recent ramp-up in RIN prices is economically inane, and/or unsupported by evidence. Icahn is particularly misguided: RINs are a tax, and the burden of the tax depends not at all on who formally pays the tax. The costs of the tax are passed upstream to consumers and downstream to producers, regardless of whether consumers pay the tax, producers pay the tax, or someone in the middle pays the tax. As for speculation in RINs it is the product of government policy. Obviously, there wouldn’t be speculation in RINs if there aren’t RINs in the first place. But on a deeper level, speculation is rooted in a mandate that does not correspond with the realities of the vast stock of existing internal combustion engines; the EPA’s erratic attempt to reconcile those irreconcilable things; the details of the RFS system (e.g., the ability to meet the ethanol mandate using biodiesel credits); and the normal vicissitudes of the energy supply and demand.  Speculation is largely a creation of government regulation, ironically, so to complain to the government about it (the EPA in particular) is somewhat perverse. But that’s the world we live in now.

* I highly recommend the various analyses of the RINs and ethanol markets in the University of Illinois’ Farm Doc Daily. Here’s one of their posts on the subject, but there are others that can be found by searching the website. Kudos to Scott Irwin and his colleagues.

After months of watching Rosneft, Lukoil, Gazpromneft, and others shout “Bashneft is mine!” “NO! It’s mine!”, Putin has apparently lost patience and said “None of you will get it!” Last week Medvedev announced that the sale of the company (seized from oligarch Vladimir Evtushenkov’s Sistema in 2014) would be delayed indefinitely.* Rustem Khamitov, president of Russian Republic of Bashkortostan (where Bashneft is located), suggested that the sale be delayed five years. Meaning never.

Yes, Medvedev made the announcement, but a decision like this is obviously Putin’s. Medvedev’s job is to announce controversial decisions or release bad news that Putin doesn’t want to be questioned about. Coming as it does in the midst of the surprise defenestration of Putin’s chief-of-staff Sergei Ivanov and other high-level reshuffling, this has set off considerable speculation about the real reason for the decision.

The main subject of speculation is what this means for Igor Sechin, head of Rosneft. Sechin wanted Bashneft badly, but the technocrats in the government, led by another Igor–Deputy PM Shuvalov–were fighting this tooth and nail. Perhaps Putin just got tired of the fighting, and pace my introduction, decided to end it by putting the company on the shelf.

Or maybe there is something more to it. The official reason given for the delay of the Bashneft is that the company is that the government wants to prioritize the sale of a piece of Rosneft:

Deputy Prime Minister Igor Shuvalov on Wednesday said Russia would consider selling Bashneft stake after it has completed the privatization of Rosneft,

“A sale of a stake in Rosneft is on the forefront now. We should focus on that. After selling the Rosneft stake, [the government] will return to selling Bashneft as we have a Presidential order to privatize this company,” Interfax news agency quoted Mr. Shuvalov as saying.

One interpretation of this is that is a big defeat for Sechin. Sechin has fought “privatization” for years. When the oil price has been high, Sechin has said that it would be stupid to sell because the company was undervalued; when the oil price has been low, Sechin has said that it would be stupid to sell when the stock price is commensurately low. In Sechin’s view, the market undervalues Rosneft 100 percent of the time, and the price is never right. The real reason is that nosey outside investors would cramp Igor’s style.

If this signals Putin’s resolve to push the sale of Rosneft, it would be a stinging defeat for Sechin. This would fit with the firing of Ivanov, as it would represent a further winnowing of the old guard.

A more charitable interpretation is that this is Putin’s way of cutting the baby. Shuvalov and others had objected to Rosneft’s participation in the Bashneft auction because purchase of the company by a state company would not be a proper privatization, and would violate Russian law. Perhaps Putin promised Bashneft to Sechin, but only after a sale of the stake in the company (which would still remain majority state owned).

What is clear is that the decision is not purely an economic one, but is driven by regime politics. Politics will drive the ultimate disposition of the company (and Rosneft), and will provide some information about who’s up and who’s down within the elite.

The episode provides a demonstration of the importance of rent seeking within a natural state like Russia. The delay is driven by a battle over rents, and the delay is quite costly. The Russian government needs quite badly the money (a material $5 billion or so) that a sale would generate. Oil in the $40-$50 range and sanctions have put a serious dent in Russia’s fiscal situation, and it has blown through a good fraction of its rainy day funds. Further, the stock price of Bashneft fell 8 percent on the day of Medvedev’s announcement. This is a measure of the value destroyed by state ownership.

This is real money, particularly for Russia right now. That Putin is willing to leave it on the table is a measure of the price of politics in Putin’s natural state.

* Evtushenkov’s fate is a perfect illustration of the parlous nature of an oligarch’s existence. Those attempting to draw inferences from past connections (such as they were) between Trump and Russians really need to keep that in mind, but never do. Hell, if figures like Yakunin, Victor and Sergei Ivanov, and perhaps now Igor Sechin can fall from favor, past connections with far lesser figures are less than meaningless.

A recent Office of Financial Research paper by Samim Ghamami and Paul Glasserman asks “Does OTC Derivatives Reform Incentivize Central Clearing?” Their answer is, probably not.

My overarching comment is that the paper is a very precise and detailed answer to maybe not the wrong question, exactly, but very much a subsidiary one. The more pressing questions include: (i) Do we want to favor clearing vs. bilateral? Why? What metric tells us that is the right choice? (The paper takes the answer to this question as given, and given as “yes.”) (ii) How do the different mechanisms affect the allocation of risk, including the allocation of risk outside the K banks that are the sole concern in the paper? (iii) How will the rules affect the scale of derivatives trading (the paper takes positions as given) and the allocation across cleared and bilateral instruments? (iv) Following on (ii) and (iii) will the rules affect risk management by end-users and what is the implication of that for the allocation of risk in the economy?

Item (iv) has received too little attention in the debates over clearing and collateral mandates. To the extent that clearing and collateral mandates make it more expensive for end-users to manage risk, how will the end users respond? Will they adjust capital structures? Investment? The scale of their operations? How will this affect the allocation of risk in the broader economy? How will this affect output and growth?

The paper also largely ignores one of the biggest impediments to central clearing–the leverage ratio.  (This regulation receives on mention in passing.) The requirement that even segregated client margins be treated as assets for the purpose of calculating this ratio (even though the bank does not have a claim on these margins) greatly increases the capital costs associated with clearing, and is leading some banks to exit the clearing business or to charge fees that make it too expensive for some firms to trade cleared derivatives. This brings all the issues in (iv) to the fore, and demonstrates that certain aspects of the massive post-crisis regulatory scheme are not well thought out, and inconsistent.

Of course, the paper also focuses on credit risk, and does not address liquidity risk issues at all. Perhaps this is a push between bilateral vs. cleared in a world where variation margin is required for all derivatives transactions, but still. The main concern about clearing and collateral mandates (including variation margin) is that they can cause huge increases in the demand for liquidity precisely at times when liquidity dries up. Another concern is that collateral supply mechanisms that develop in response to the mandates create new interconnections and new sources of instability in the financial system.

The most disappointing part of the paper is that it focuses on netting economies as the driver of cost differences between bilateral and cleared trading, without recognizing that the effects of netting are distributive. To oversimplify only a little, the implication of the paper is that the choice between cleared and bilateral trading is driven by which alternative redistributes the most risk to those not included in the model.

Viewed from that perspective, things look quite different, don’t they? It doesn’t matter whether the answer to that question is “cleared” or “bilateral”–the result will be that if netting drives the answer, the answer will result in the biggest risk transfer to those not considered in the model (who can include, e.g., unsecured creditors and the taxpayers). This brings home hard the point that these types of analyses (including the predecessor of Ghamami-Glasserman, Zhu-Duffie) are profoundly non-systemic because they don’t identify where in the financial system the risk goes. If anything, they distract attention away from the questions about the systemic risks of clearing and collateral mandates. Recognizing that the choice between cleared and bilateral trading is driven by netting, and that netting redistributes risk, the question should be whether that redistribution is desirable or not. But that question is almost never asked, let alone answered.

One narrower, more technical aspect of the paper bothered me. G-G introduce the concept of a concentration ratio, which they define as the ratio of a firm’s contribution to the default fund to the firm’s value at risk used to determine the sizing of the default fund. They argue that the default fund under a cover two standard (in which the default fund can absorb the loss arising from the simultaneous defaults of the two members with the largest exposures) is undersized if the concentration ratio is less than one.

I can see their point, but its main effect is to show that the cover two standard is not joined up closely with the true determinants of the risk exposure of the default fund. Consider a CCP with N identical members, where N is large: in this case, the concentration ratio is small. Further, assume that member defaults are independent, and occur with probability p. The loss to the default fund conditional on the default of a given member is X. Then, the expected loss of the default fund is pNX, and under cover two, the size of the fund is 2X.  There will be some value of N such that for a larger number of members, the default fund will be inadequate. Since the concentration ratio varies inversely with N, this is consistent with the G-G argument.

But this is a straw man argument, as these assumptions are obviously extreme and unrealistic. The default fund’s exposure is driven by the extreme tail of the joint distribution of member losses. What really matters here is tail dependence, which is devilish hard to measure. Cover two essentially assumes a particular form of tail dependence: if the 1st (2nd) largest exposure defaults, so will the 2nd (1st) largest, but it ignores what happens to the remaining members. The assumption of perfect tail dependence between risks 1 and 2 is conservative: ignoring risks 3 through N is not. Where things come out on balance is impossible to determine. Pace G-G, when N is large ignoring 3-to-N is likely very problematic, but whether this results in an undersized default fund depends on whether this effect is more than offset by the extreme assumption of perfect tail dependence between risks 1 and 2.

Without knowing more about the tail dependence structure, it is impossible to play Goldilocks and say that this default fund is too large,  this default fund is too small, and this one is just right by looking at N (or the concentration ratio) alone. But if we could confidently model the tail dependence, we wouldn’t have to use cover two–and we could also determine individual members’ appropriate contributions more exactly than relying on a pro-rata rule (because we could calculate each member’s marginal contribution to the default fund’s risk).

So cover two is really a confession of our ignorance. A case of sizing the default fund based on what we can measure, rather than what we would like to measure, a la the drunk looking for his keys under the lamppost, because the light is better there. Similarly, the concentration ratio is something that can be measured, and does tell us something about whether the default fund is sized correctly, but it doesn’t tell us very much. It is not a sufficient statistic, and may not even be a very revealing one. And how revealing it is may differ substantially between CCPs, because the tail dependence structures of members may vary across them.

In sum, the G-G paper is very careful, and precisely identifies crucial factors that determine the relative private costs of cleared vs. bilateral trading, and how regulations (e.g., capital requirements) affect these costs. But this is only remotely related to the question that we would like to answer, which is what are the social costs of alternative arrangements? The implicit assumption is that the social costs of clearing are lower, and therefore a regulatory structure which favors bilateral trading is problematic. But this assumes facts not in evidence, and ones that are highly questionable. Further, the paper (inadvertently) points out a troubling reality that should have been more widely recognized long ago (as Mark Roe and I have been arguing for years now): the private benefits of cleared vs. bilateral trading are driven by which offers the greatest netting benefit, which also just so happens to generate the biggest risk transfer to those outside the model. This is a truly systemic effect, but is almost always ignored.

In these models that focus on a subset of the financial system, netting is always a feature. In the financial system at large, it can be a bug. Would that the OFR started to investigate that issue.

Michael Weiss essayed a lame (but I repeat myself) attempt of a rebuttal of the DIA document I wrote about over the weekend: Weiss’s response was apparently sparked by the fact that Sputnik (and not me!) gave the document attention. (It came out in June 2015, not last May as I had thought.)

Weiss’ piece is classic in the annals of farcical reasoning and logical fallacies. His complete failure to address the document and its implications betrays just how damning it is to his cause. If this is the best e’s got . . .

Weiss started out his attempted rebuttal with one of his specialities, an ad hominem attack:

At the time, this document was taken up with similar if paradoxical enthusiasm by far-left anti-imperialists (such as the Guardian’s Seumas Milne, now Labour leader Jeremy Corbyn’s spin-doctor) and anti-Muslim reactionaries (such as Pamela Gellar) as proof of a nefarious conspiracy led by Washington to encourage a takfiri takeover of the Levant.

None of which has anything to do with the substance of the document.

Weiss then quotes the report:

“If the situation unravels there is the possibility of establishing a declared or undeclared Salafist principality in Eastern Syria (Hasaka and Der Zor), and this is exactly what the supporting powers to the opposition want, in order to isolate the Syrian regime, which is considered the strategic depth of the Shia expansion (Iraq and Iran).”

He fails to mention that this prediction was made in 2012, and it came to pass, almost exactly. That does speak to its credibility, no?

Weiss scorns the idea that the document was “secret”–putting that word in scare quotes. Well, it was classified as . . . SECRET/NOFORN. I guess that kinda makes it officially secret, eh? He also notes the heavy redactions. So what? Does he have any reason to believe the redactions contradict the opinions that are not redacted–which are not qualified in any way? It is far more likely that the redactions include classified information that supports the conclusions that are expressed in the underrated portions.

Weiss then tries to dismiss the report as just one of many reports turned out by the Washington paper machine:

As The Daily Beast’s Jacob Siegel reported when the document was published, appraisals such as these are too numerous count at the Pentagon, much less be read by senior military or policy planners. And few ever rise to the level of adopted policy prescription.

Nor did this one, as anyone who has watched events unfold in Syria over the last four years can easily determine for himself.

This is an inversion of the importance of the document. The reason that the document is damning is precisely that it was ignored by the administration. The DIA writes a hair on fire warning to the security establishment, and the warning is utterly ignored, with the result being that the dire predictions it made came to pass. Whereas Weiss attempts to claim that the fact that the document was ignored means that it is irrelevant, this is precisely what makes it relevant, and damning to the administration. It either ignored its predictions that were borne out in blood, or it was actually complicit in the Salafist-supporting policy that the document describes.

Weiss then plays a shell game with the chronology:

If the United States had sought to rob Iranian clients and proxies of strategic depth in Syria, then it would plainly not be “de-conflicting” at present with the Syrian and Russian air forces, both of which are providing close air support to those same clients and proxies on the ground.

The document was written in 2012. The “de-conflicting” with Syrian and Russian air forces began in 2015. Much water has passed under the bridge in that time, including Obama’s classic walkback from the “redline” on Assad in 2013, the Iran nuclear deal in 2015 (and the negotiations leading up to it in 2014), the farcical collapse of expensive US efforts to train Syrian rebels, and most importantly the spectacular rise of ISIS in 2014-2015 that the DIA document so presciently predicted. The situation is so different now that current administration policy in no way implies that it was not allying with Salafists in 2011-2012 in an attempt to bring down Assad. At that time, the administration was also crowing about its “success” in Libya, and looked to repeat it in Syria. Now it wants to be completely shed of the situation. Four years of failure will do that.

Weiss finishes with another bait-and-switch:

Moreover, given the president’s well-known reluctance—criticized by his ISIS “co-founder” Hillary Clinton—to substantively aid and arm nationalist Free Syrian Army rebels in 2012 (when the document was drafted), one could argue his policy has been the very opposite of what’s in this document.

The bait-and-switch is that the DIA document doesn’t talk about US support for Weiss’ beloved and allegedly moderate, non-sectarian FSA: it talks about the “supporting powers” favoring Salafists, including AQI, the predecessor of ISIS: the FSA is not mentioned. It is well known that the Gulf states pumped large resources into these groups. Turkey is also clearly implicated (as another leaked report, this one from German intelligence, asserts). The US was clearly aligned with these nations in the objective of “Assad must go”, and indeed, the lukewarm support for the FSA actually supports the DIA’s claim that the “supporting powers” (including the US) had put their money on the Salafists, instead of the FSA.

Further, who knows what covert support the CIA was providing, and to whom? Rumors continue to swirl about a weapons pipeline from Libya to Syrian rebels. I have always have found it more credible that the US mission in Benghazi was attempting to intercept weapons on the loose in Libya to prevent them from flowing to Syria, but I am becoming more open to the possibility that the CIA was indeed running weapons from Libya to Syria. The complete silence about what was going on at the CIA Annex there–a silence in which Republicans on the Intelligence Committee like McCain and Graham and Rubio join in–even in the aftermath of September 11, 2012 makes me suspect that the CIA was doing something much more than a gun buyback program intended to help improve the ‘hood.

I also note that Weiss makes no effort to disprove the assertions in the DIA document that Salafists dominated the Syrian opposition from the beginning. This is important because Weiss made a name for himself by playing war tourist in Aleppo, claiming that he was visiting moderate rebels, and because ever since he has been spinning the tale of a moderate opposition that was abandoned by a feckless US. If the revolution was Salafist from the get go, Weiss comes off as a fool and useful idiot at best, and a collaborator with Islamists at worst. His silence on this point in the DIA document speaks volumes.

In short, Michael Weiss makes a great case for the importance of the DIA document by failing so miserably in his lame attempt to make a case against it.

Although it is hyperbole to say that Obama and Hillary Clinton “founded” ISIS, there is little doubt that they certainly enabled its dramatic expansion. Obama’s mishandling of the American withdrawal from Iraq (scathingly documented in “Losing Iraq“, a production of the notoriously right-wing PBS Frontline) and his passivity as ISIS mounted its major drives in late-2013 and early-to-mid-2014 were necessary to ISIS’s dramatic expansion.

A declassified Defense Intelligence Agency document, made public by Judicial Watch in May, makes clear that DIA was aware of what was going on, and predicted what transpired with uncanny accuracy. More disturbingly, the document can be read to suggest that the administration willingly supported jihadist elements in Syria–including ISIS–as part of its “strategy” to oust Assad.

Insofar as predictions are concerned, these excerpts from the document (which is heavily redacted) speak for themselves:

That’s pretty much exactly what happened.

The timing is rather awkward for the administration.

This is exactly the time, mind you, that Joe Biden was strutting around claiming that Iraq was the administration’s greatest foreign policy achievement.

Please spare us any more such successes. A few more like them and we’ll be ruined.

Note too in particular the arrow of causality here. Supporting the insurgency in Syria blew back into Iraq, and advanced the Sunni uprising that has convulsed the country in the past four years. Meaning that the administration supported actions in Syria that destabilized Iraq precisely when it was cutting US forces there that had been essential to maintaining the country’s tenuous stability.

What is more disturbing about the document is its statements about the relation between the rise of ISIS and US policy regarding the Syrian revolution. First, the memorandum forthrightly documents that from the very beginning, the Syrian revolution was predominately jihadist in nature:

It is not possible, therefore, to argue that once-upon-a-time there was a non-jihadist, secular, and moderate opposition in Syria that was supplanted by extremist elements only because the West did not push out Assad.

What is even more disturbing is the DIA’s statement that it was US policy, in conjunction with its “allies” in the region like Saudi Arabia, Qatar, and Turkey, to support these jihadist elements. For the very next point states:

Read “C.” above carefully. “[T]here is the possibility of establishing a declared or undeclared Salafist principality in eastern Syria. . . . this is exactly what the supporting powers to the opposition want, in order to isolate the Syrian regime, which is consider the strategic depth of the Shia expansion (Iraq and Iran).”

Recall that the memo specifically identifies “the West” as a supporting power. Further recall that this is the time when “Assad must go” was Obama’s mantra.

This puts an entirely different gloss on Obama’s insouciance towards ISIS during this period. It is clear that the Gulf States and Turkey were all in with Salafist elements. DIA makes the US firmly complicit in this, at the very least via an act of omission (failing to oppose the actions of the regional Sunni powers), and more plausibly as an act of commission.

Understanding the necessity of reading between the lines in an official intergovernmental communication like this, it is clear that DIA is essentially telling the administration (this Secret document was distributed to Hillary and Obama, among others) that it is engaged in a dangerous policy. This is the DIA’s demarche protesting administration Syria policy. One can only imagine what is in the redacted bits.

At the very least, even if you do not believe that the public portions of the document adequately support the charge that Obama and Clinton deliberately supported the rise of ISIS as a matter of policy, it does show that they were forewarned of what was happening and did nothing to stop it. This implies either complicity in the machinations of the policy of the Gulf states and Turkey, or analytical incompetence.

Remember, this is a document prepared by a part of the US intelligence establishment, not the Russians. But it strongly echoes many things that Lavrov and Putin said at the time, and have said since.

There are other interesting aspects of the document that are illuminating. In particular, it gives the lie to claims by Michael Weiss and other anti-Assad, Salafist-supporting Neocons that Assad created ISIS to divide the opposition.

Paragraph “B.” is of particular relevance. Please take this into account when reading future deep thoughts by Weiss et al about the nature and origins of the anti-Assad opposition, and the necessity of taking down Assad.

This internal US intelligence document clearly lays great responsibility for the rise of ISIS at Obama’s feet. This document is not hindsight brilliance and ass-covering: it is foresight and forewarning.

The document also reveals the utter incoherence of US policy in the region. The ostensible rationale for trying to topple Assad (and this was certainly the motivation of the Gulf states) was that his regime was a supporter of Shia infidels, notably Iran and Hezbollah. And there is a realpolitik logic in attacking Syria as part of a campaign against Iran. But during this time the administration was also working on a rapprochement with Iran. Square that circle for me.

One other thing. This document came out in May. Have you heard of it? Almost certainly not. I hadn’t, until an ex-intel guy on Twitter made me aware of it.

If something analogous had been about the Bush administration circa 2005, and had been released while he was still in office, it would have been the subject of non-stop frenzied–nay, hysterical–coverage. But even while the war on ISIS goes on, and ISIS and ISIS sympathizers launch terror attacks in the US and Europe, and the sectarian war in Syria drags on, this document that places considerable responsibility for ISIS’s rise on the shoulders of the current president, and the Democratic nominee to replace him, gets no coverage whatsoever. This utterly damning document speaks directly to Hillary’s mindset and competence, yet it has been consigned to the memory hole by a media that is intent on ensuring her election.

The drumbeat about Trump’s connections to Russia pounds on, and is mainly sound and fury, signifying nothing. The campaign consists mainly of unsubstantiated theories, insinuations, and innuendo. Further, these appear to be tenuous at best and are often wildly implausible.

The gist of the theory is that Trump has said nice things about Putin. Putin has said nice things about Trump. Trump has criticized Nato. Putin obsesses over Nato. The DNC email was hacked, possibly by the Russians, embarrassing Hillary. So why? Trump business connections, naturally!

This theory has been floated by Democratic operatives, by George Will (heretofore not suspected to be a Democratic operative), and the #neverTrump crowd, and echoed repeatedly in the media. In ironically Russian fashion, the campaign has moved to social media, where reliable little pilot fish plumping for media attention and maybe even an apparatchik role in the Clinton administration (yeah, I’m looking at you @CatchaRUSSpy) are spreadin’ the word.

My basic problem with this is the whole idea of secret Trump business dealings that could only be revealed by looking at his tax returns. “Secret Trump business dealings” is an oxymoron. His whole MO is self-promotion and hype. If anything, he overstates his business successes. He is not the man to hide his light under the bushel basket.

Now if you were talking about Soros, no doubt he has massive number of business dealings that have escaped the public eye. But Trump? He’s all about the publicity. What’s more, litigation and leaks from partners or bankers would have almost certainly revealed any major dealings long ago. If Trump has succeeded in keeping some big deal in Russia completely secret for years, he’s the man we need in charge of our national security! He would clearly be far more capable of keeping secrets than Hillary.

As for his not releasing his tax returns, I can think of 1,000 better reasons than concealing past dealings with Russians. This fact is overdetermined, to put it mildly.

Trump has been quite open in the past about his attempts to get into Russia, and how those attempts came to nothing. And let’s be real here. Every major business in the world looked to Russia as a huge opportunity in the 90s, and into the 2000s. For many–most, arguably–it ended in tears. Yes, look askance at businesses that did well there: many almost certainly succeeded because of corrupt deals. I’m thinking Siemens, or HP. (And to be fair, it seems that Siemens bribed everybody everywhere.) But those who tried and failed (a) can’t have continuing relationships that would be advanced or jeopardized, (b) likely didn’t pay bribes, or bribed the wrong parties, and (c) are likely to have a rather jaundiced view of Russia and Russian politics.

Further, when you are talking about Russia, past business dealings have very little connection with current conditions. One of the most pronounced regularities of Russia is that those who are riding high one minute quite often come to very hard falls somewhat later. Yesterday’s insiders are outsiders and sometimes pariahs today. If you have a connection with someone who is now on the outs with Putin, that connection is a liability to be shed, not an asset to be maintained.

Further, as Russia recovered from the 1998 crisis, and was riding high during the oil price boom, previously successful Westerners were considered less and less necessary, and were sidelined and forced out. Westerners became resented as parasites who attempted to exploit Russia’s weakness. Successful foreign investors had a huge target painted on their backs: look at TNK-BP, or Telenor/Vimpelcom. Once they didn’t need your money, they looked for any way to take the money you’d already made.

In the aftermath of the 2008-2009 crisis, Western financial connections became even more suspect as threats to Russian sovereignty.

And for those who have been paying attention Putin has been dramatically narrowing his circle of insiders, and that circle consists increasingly of those from the security services. Indeed, even some of the various security services are being left out in the cold. And worse: for instance, the head of the customs service was recently raided. Right now, the FSB, the GRU, and Putin’s new national guard are inside the circle. Everyone else dreads the knock at the door.

Insofar as biznessmen are concerned, (a) Putin has always had a deep suspicion of them, and (b) those who were seemingly favored in the 90s and 2000s are clearly on the outs now. The favored business people at present are Timchenko and the Rotenbergs. Show me any Trump dealings with them, and we’ll talk.

But this last point raises one of my pet peeves. Those who now pontificate on Russia and Trump’s connections clearly have NOT been paying attention. They betray a superficiality that would be embarrassing in a comic book. Many of the people and things that they mention became irrelevant years ago.

Further, one should be chary about claiming that they know what goes on in Russia, and in Putin’s pea-picking mind. Riddle, mystery, enigma, and all that. But fools rush in where angels fear to tread. And many a fool is making bold claims about a country and a politician they know little about, can know little about, and which until recently they ignored altogether. But now they’re experts.

The very byzantine nature of Russian politics and business over the last 25 years means that very few outsiders have navigated it successfully, even for a time, let alone many years. All I can say is that if Trump was (a) able to survive and thrive in that world, and (b) do it without anybody knowing, he’s a Machiavellian mastermind who would scare Putin to death.

The strained attempts to tie Trump to Putin are also transparently intended to distract attention from the embarrassing content of the DNC leaks–and, methinks, preempt leaks that are likely to come, from the Clinton Foundation, or even from Hillary’s server.  It’s a twofer for Hillary: discredit the message by emphasizing the malign (alleged) messenger, and tie the malign messenger to her opponent.

Beyond the implausibility of the insinuations, I doubt this will affect anyone who is not already a Hillary acolyte. Russian generally and Putin specifically are not bogeymen to most Americans. It’s not 1983. It’s not as if there are many people out there who would say “I liked this Trump fellow, but this Russia business  is just too much.” Those who don’t like Trump have many other reasons to do so; those who do are likely care little about Russia one way or the other; and those on the fence likely rank Russia low on the list of factors that will cause them to jump one way or the other.

So in the end, I find this obsessing about a Putin-Trump bromance to be amusing and embarrassing. I would be shocked that there’s any there there. It runs counter to Trump’s type, and it runs counter to history. The controversy transparently (pants?) suits Hillary’s political needs. Those who are hyping it are clearly partisan, and clearly ignorant. There are plenty of real issues to talk about, involving both Hillary and Trump. Let’s get on with that.

Both parties officially favor a restoration of Glass-Steagall, the Depression-era banking regulation that persisted until repealed under the Clinton administration in 1999. When both Parties agree on an issue, they are likely wrong, and that is the case here.

The homage paid to Glass-Steagall is totem worship, not sound economic policy. The reasoning appears to be that the banking system was relatively quiescent when Glass-Steagall was in place, and a financial crisis occurred within a decade after its repeal. Ergo, we can avoid financial crises by restoring G-S. This makes as much sense as blaming the tumult of the 60s on auto companies’ elimination of tail fins.

Glass-Steagall had several parts, some of which are still in existence. The centerpiece of the legislation was deposit insurance, which rural and small town banking interests had been pushing for years. Deposit insurance is still with us, and its effects are mixed, at best.

One of the parts of Glass-Steagall that was abolished was its limitation on bank groups: the 1933 Act made it more difficult to form holding companies of multiple banks as a way of circumventing branch banking restrictions that were predominant at the time. This was perverse because (1) the Act was ostensibly intended to prevent banking crises, and (2) the proliferation of unit banks due to restrictions on branch banking was one of the most important causes of the banking crisis that ushered in the Great Depression.

The contrast between the experiences of Canada and the United States is illuminating in this regard. Both countries were subjected to a huge adverse economic shock, but Canada’s banking system, which was dominated by a handful of banks that operated branches throughout the country, survived, whereas the fragmented US banking system collapsed. In the 1930s, too big to fail was less of a problem than to small to survive. The collapse of literally thousands of banks devastated the US economy, and this banking crisis ushered in the Depression proper. Further, the inability of branched national banks to diversify liquidity risk (as Canada’s banks were able to do) made the system more dependent on the Fed to manage liquidity shocks. That turned out to be a true systemic risk, when the Fed botched the job (as documented by Friedman and Schwartz). When the system is very dependent on one regulatory body, and that body fails, the effect of the failure is systemic.

The vulnerability of small unit banks was again demonstrated in the S&L fiasco of the 1980s (a crisis in which deposit insurance played a part).

So that part of Glass-Steagall should remain dead and buried.

The part of Glass-Steagall that was repealed, and which its worshippers are most intent on restoring, was the separation of securities underwriting from commercial banking and the limiting of banks securities holdings to investment grade instruments.

Senator Glass believed that the combination of commercial and investment banking contributed to the 1930s banking crisis. As is the case with many legislators, his fervent beliefs were untainted by actual evidence. The story told at the time (and featured in the Pecora Hearings) was that commercial banks unloaded their bad loans into securities, which they dumped on an unsuspecting investing public unaware that they were buying toxic waste.

There are only two problems with this story. First, even if true, it would mean that banks were able to get bad assets off their balance sheets, which should have made them more stable! Real money investors, rather than leveraged institutions were wearing the risk, which should have reduced the likelihood of banking crises.

Second, it wasn’t true. Economists (including Kroszner and Rajan) have shown that securities issued by investment banking arms of commercial banks performed as well as those issued by stand-alone investment banks. This is inconsistent with the asymmetric information story.

Now let’s move forward almost 60 years and try to figure whether the 2008 crisis would have played out much differently had investment banking and commercial banking been kept completely separate. Almost certainly not. First, the institutions in the US that nearly brought down the system were stand alone investment banks, namely Lehman, Bear-Sterns, and Merrill Lynch. The first failed. The second two were absorbed into commercial banks, the first by having the Fed take on most of the bad assets, the second in a shotgun wedding that ironically proved to make the acquiring bank–Bank of America–much weaker. Goldman Sachs and Morgan-Stanley were in dire straits, and converted into banks so that they could avail themselves of Fed support denied them as investment banks.

The investment banking arms of major commercial banks like JP Morgan did not imperil their existence. Citi may be something of an exception, but earlier crises (e.g., the Latin American debt crisis) proved that Citi was perfectly capable of courting insolvency even as a pure commercial bank in the pre-Glass-Steagall repeal days.

Second, and relatedly, because they could not take deposits, and therefore had to rely on short term hot money for funding, the stand-alone investment banks were extremely vulnerable to funding runs, whereas deposits are a “stickier,” more stable source of funding. We need to find ways to reduce reliance on hot funding, rather than encourage it.

Third, Glass-Steagall restrictions weren’t even relevant for several of the institutions that wreaked the most havoc–Fannie, Freddie, and AIG.

Fourth, insofar as the issue of limitations on the permissible investments of commercial banks is concerned, it was precisely investment grade–AAA and AAA plus, in fact–that got banks and investment banks into trouble. Capital rules treated such instruments favorably, and voila!, massive quantities of these instruments were engineered to meet the resulting demand. They way they were engineered, however, made them reservoirs of wrong way risk that contributed significantly to the 2008 doom loop.

In sum: the banking structures that Glass-Steagall outlawed didn’t contribute to the banking crisis that was the law’s genesis, and weren’t materially important in causing the 2008 crisis. Therefore, advocating a return to Glass-Steagall as a crisis prevention mechanism is wholly misguided. Glass-Steagall restrictions are largely irrelevant to preventing financial crises, and some of their effects–notably, the creation of an investment banking industry largely reliant on hot, short term money for funding–actually make crises more likely.

This is why I say that Glass-Steagall has a totemic quality. The reverence shown it is based on a fondness for the old gods who were worshipped during a time of relative economic quiet (even though that is the product of folk belief, because it ignores the LatAm, S&L, and Asian crises, among others, that occurred from 1933-1999). We had a crisis in 2008 because we abandoned the old gods, Glass and Steagall! If we only bring them back to the public square, good times will return! It is not based on a sober evaluation of history, economics,  or the facts.

An alternative tack is taken by Luigi Zingales. He advocates a return to Glass-Steagall in part based on political economy considerations, namely, that it will increase competition and reduce the political power of large financial institutions. As I argued in response to him over four years ago, these arguments are unpersuasive. I would add another point, motivated by reading Calamaris and Haber’s Fragile by Design: the political economy of a fragmented financial system can lead to disastrous results too. Indeed, the 1930s banking crisis was caused largely by the ubiquity of small unit banks and the failure of the Fed to provide liquidity in such a system that was uniquely dependent on this support. Those small banks, as Calomaris and Haber show, used their political power to stymie the development of national branched banks that would have improved systemic stability. The S&L crisis was also stoked by the political power of many small thrifts.*

But regardless, both the Republican and Democratic Parties have now embraced the idea. I don’t sense a zeal in Congress to do so, so perhaps the agreement of the Parties’ platforms on this issue will not result in a restoration of Glass-Steagall. Nonetheless, the widespread fondness for the 83 year old Act should give pause to those who look to national politicians to adopt wise economic policies. That fondness is grounded in a variety of religious belief, not reality.

*My reading of Calomaris and Haber leads me to the depressing conclusion that the political economy of banking is almost uniformly dysfunctional, at all times and at all places. In part this is because the state looks upon the banking system to facilitate fiscal objectives. In part it is because politicians have viewed the banking system as an indirect way of supporting favored domestic constituencies when direct transfers to these constituencies are either politically impossible or constitutionally barred. In part it is because bankers exploit this symbiotic relationship to get political favors: subsidies, restrictions on competition, etc. Even the apparent successes of banking legislation and regulation are more the result of unique political conditions rather than economically enlightened legislators. Canada’s banking system, for instance, was not the product of uniquely Canadian economic insight and political rectitude. Instead, it was the result of a political bargain that was driven by uniquely Canadian political factors, most notably the deep divide between English and French Canada. It was a venal and cynical political deal that just happened to have some favorable economic consequences which were not intended and indeed were not necessarily even understood or foreseen by those who drafted the laws.

Viewed in this light, it is not surprising that the housing finance system in the US, which was the primary culprit for the 2008 crisis, has not been altered substantially. It was the product of a particular set of political coalitions that still largely exist.

The history of federal and state banking regulation in the US also should give pause to those who think a minimalist state in a federal system can’t do much harm. Banking regulation in the small government era was hardly ideal.

Yesterday the WSJ broke a story about a strange coincidence: nearly simultaneously with the release of four Americans held prisoner by Iran, the US shipped $400 million to Iran. The administration denies any connection between these two events, claiming that the money is related to resolution of a longstanding dispute dating back to the days of the Shah.

But who you gonna believe, them or your lying’ eyes? And truth be told, the administration–as desperate for a deal with Iran as it was–had to know how bad the optics were. If it had any choice in the matter, it would have insisted on a decent interval between the prisoner release and the flow of the money. If there wasn’t a connection, the Iranians would have likely accommodated. But the fact that they didn’t tells you that it was a deal: money for the bodies. What’s more, bad optics from the American side were good optics to Iran.

But let’s put aside the issue of whether this was a swap. Let’s suspend disbelief and assume that the bodies and money flowed pursuant to totally separate deals negotiated in hermetically sealed rooms separated by 50 Chinese walls preventing a flow of information between those negotiating about the money and those negotiating about the Americans held captive.

Even granting that wildly implausible hypothesis, the deal stinks to high heaven because of the way the money flowed. In cash. Once in Iranian hands, it was basically untraceable and there is no way the US can use its dominance of the banking system to stop the money flowing to illicit uses, or even detect when it does.

The Iranians now have $400 million of USD, EUR, and CHF to direct to terrorist groups. Even worse, you know who wants cash more than Iran because it is unable to use the banking system? North Korea. You know who has been cooperating with Iran on nuclear and missile technology? North Korea. Now the administration has gifted Iran hundreds of millions that it can send without a trace to North Korea in exchange for nuclear and missile technology. What’s even more astounding is that this coincided with a deal that was intended to delay Iran’s development of nuclear weapons. But this Air $n€ flight to Iran is directly contrary to that purpose, because it facilitates Iranian evasion of restrictions on its nuclear program.

Not to mention that it will also likely bolster another extremely bad actor, North Korea. Funding work on NoKo nuke and missile technology will make two unpredictable and dangerous regional troublemakers stronger.

This makes Operation Fast and Furious look benign and intelligent.  How soon before a US special operations raid on terrorists seizes currency sent to Iran on the night flight from Geneva? How soon before that money pays for an intensification of NoKo and Iranian weapons development?

It gets better. The Iranians, apparently knowing a sucker when they see one, have seized two more Americans. And now that he has reaped most of the financial gains from the nuclear deal, Khamenei is expressing reservations about it and suggesting that Iran will pul out.

For those who have been to the bazaar, you will realize that these are means of extracting even more from Uncle Sucker. And as long as Obama and  his hapless Sancho Panza, John Kerry, are in office, they will almost certainly get their wish.