Streetwise Professor

There has been a lot of controversy about the first (that we know of) major special operations raid carried out post-inauguration. The raid–in Yemen–did not go according to plan. A member of Seal Team 6 was killed. Two other Americans were seriously injured. A V-22 Osprey was damaged in a hard landing and had to be destroyed. Civilians were killed, including (allegedly) the 8 year old daughter of Anwar al-Awlaki, and several other women (who may, or may not, have been firing weapons).*

Immediately the raid was politicized. An ex-Obama administration official, one Colin Kahl, immediately took to Twitter to claim that, contrary to Trump administration statements, the raid had not been considered or planned under the Obama administration. Instead, Kahl claims, only a “broad package” of operations was discussed prior to the departure of the Obama administration, and this “information was shared” with the incoming administration.

I call bullshit. This kind of operation requires detailed planning and extensive intelligence collection, both of which take time. It takes more time for this to work its way up through the chain of command, including I might add a review by the lawyers to evaluate the risk of civilian casualties. There is no bleeping way in hell this went from a “broad package” to lead flying in a week. It would have been reasonable for the lame ducks to leave the decision to the new team, but it is risible to claim that this was an impromptu rush job undertaken by a rash Trump administration. (For one thing, there is no way Mattis would have signed off on any such thing.)

So what went wrong? Murphys Law. Shit happens. That is the nature of special operations raids. They are inherently risky, tightly coupled operations where pretty much everything has to go right in precise sequence. When they go wrong they tend to go horribly wrong, because they involve small elements who are usually outgunned, relatively immobile, and isolated if they lose the element of surprise or run into an obstacle that delays their quick ingress or egress.

These operations rely on surprise, speed, and sometimes brutal shock action.  All the planning and training and experience in the world cannot guarantee these things will work. The “for the want of a nail” phenomenon is baked into special operations.

Apparently the SEALs operating in Yemen in late-January lost the element of surprise, and rather than abort they relied on aggression to attempt to complete the mission. In so doing, they suffered casualties and inflicted a lot of them, including some on civilians.

This is nothing new. Almost exactly two years earlier, a raid to rescue western hostages in Yemen was compromised by a barking dog. A week before the election, a Special Forces team was shot up in Afghanistan because it ran into an unexpected gate: two very experienced SF men were killed and several others were wounded.

The Obama administration obviously owns that last one, and arguably is was more of a clusterfuck than what happened in Yemen last month. But you haven’t heard much about it, have you? Go figure.

As for the Osprey, they are prone to “brownouts” (i.e., the pilot losing his bearings when the huge rotors blow up a cloud of dust while landing), as occurred in Hawaii in 2015. They can also lose lift because they enter a vortex ring state. (This is the leading theory of the crash of the stealth helo during the bin Laden raid.) Again, this is another roll of the dice with this kind of operation with this kind of aircraft.

I could go on and on. The success rate of US (and also UK and Australian) special operators is amazing, but periodic disasters are part of the package.

As for the civilian casualties, that to is inherent in the nature of these operations, and the enemy against whom they are directed. These terrorists, be they in Afghanistan or Yemen or wherever, are typically embedded in the civilian population. In Afghanistan in particular, they are just part of the ordinary menfolk. Such is guerrilla warfare. Even if civilians are not targeted, they will be killed.

What happened in Yemen a couple of weeks back is not extraordinary, given the nature of the operation, and most importantly, the extent and intensity of these kinds of operations that the US is conducting in Southwest Asia, Africa, and the Middle East. Indeed, it is a testament to the skill of US special operators that these things don’t happen more often.

It is therefore incredibly disgusting to see this politicized. Yes, ex-Obama admin people and their water carriers in the media are primarily culpable in this incident, but they have help, notably from John McCain who really needs to STFU: his hatred of Trump leads him to make opportunistic statements (e.g., calling this mission a failure) that convey a very misleading picture of realities. This politicization does not help the US military, or enhance the effectiveness of its operations. Most of the politicized criticisms also tend to be blissfully ignorant of military realities.  There is a justification for having a debate about whether the current anti-terror strategy that relies heavily on high tempo special operations is worth the risk. But that discussion has to be predicated on the understanding that things like those that transpired in Yemen in January (and in December, 2014) are inherent to that strategy, and do not necessarily imply failure or incompetence.

*The only basis for the claim that Awlaki’s daughter was killed is a statement by her grandfather.

Deutsche Bank quite considerately provided a real time example of an unintended consequence of Frankendodd, specifically, capital requirements causing firms to exit from clearing. The bank announced it is continuing to provide futures clearing, but is exiting US swaps clearing, due to capital cost concerns.

Deutsch was not specific in citing the treatment of margins under the leverage ratio as the reason for its exit, this is the most likely culprit. Recall that even segregated margins (which a bank has no access to) are treated as bank assets under the leverage rule, so a swaps clearer must hold capital against assets over which it has no control (because all swap margins are segregated), cannot utilize to fund its own activities, and which are not funded by a liability issued by the clearer.

It’s perverse, and is emblematic of the mixed signals in Frankendodd: CLEAR SWAPS! CLEARING SWAPS  IS EXTREMELY CAPITAL INTENSIVE SO YOU WON’T MAKE ANY MONEY DOING IT! Yeah. That will work out swell.

Of course Deutsch Bank has its own issues, and because of those issues it faces more acute capital concerns than other institutions (especially American ones). But here is a case where the capital cost does not at all match up with risk (and remember that capital is intended to be a risk absorber). So looking for ways to economize on capital, Deutsch exited a business where the capital charge did not generate any commensurate return, and furthermore was unrelated to the actual risk of the business. If the pricing of risk had been more sensible, Deutsch might have scaled back other businesses where capital charges reflected risk more accurately. Here, the effect of the leverage ratio is all pain, no gain.

When interviewed by Risk Magazine about the Fundamental Review of the Trading Book, I said: “The FRTB’s standardised approach is basically central planning of risk pricing, and it will produce Gosplan-like results.” The leverage ratio, especially as applied to swaps margins, is another example of central planning of risk pricing, and here indeed it has produced Gosplan-like results.

And in the case of clearing, these results are exactly contrary to a crucial ostensible purpose of DFA: reducing size and concentration in banking generally, and in derivatives markets in particular. For as the FT notes:

The bank’s exit will reignite concerns that the swaps clearing business is too concentrated among a handful of large players. The top three swaps clearers account for more than half the market by client collateral required, while the top five account for over 75 per cent.

So swaps clearing is now hyper-concentrated, and dominated by a handful of systemically important banks (e.g., Citi, Goldman). It is more concentrated that the bilateral swaps dealer market was. Trouble at one of these dominant swaps clearers would create serious risks for CCPs that they clear for (which, by the way, are all interconnected because the same clearing members dominate all the major CCPs). Moreover, concentration dramatically reduces the benefits of mutualizing risk: because of the small number of clearers, the risk of a big CM failure will be borne by a small number of firms. This isn’t insurance in any meaningful way, and does not achieve the benefits of risk pooling even if only in the first instance only a single big clearing member runs into trouble due to a shock idiosyncratic to it.

At present, there is much gnashing of teeth and rending of garments at the prospect of even tweaks in Dodd-Frank. Evidently, the clearing mandate is not even on the table. But this one vignette demonstrates that Frankendodd and banking regulation generally is shot through with provisions intended to reduce systemic risk which do not have that effect, and indeed, likely have the perverse effect of creating some systemic risks. Viewing Dodd-Frank as a sacred cow and any proposed change to it as a threat to the financial system is utterly wrongheaded, and will lead to bad outcomes.

Barney and Chris did not come down Mount Sinai with tablets containing commandments written by the finger of God. They sat on Capitol Hill and churned out hundreds of pages of laws based on a cartoonish understanding of the financial system, information provided by highly interested parties, and a frequently false narrative of the financial crisis. These laws, in turn, have spawned thousands of pages of regulation, good, bad, and very ugly. What is happening in swaps clearing is very ugly indeed, and provides a great example of how major portions of Dodd-Frank and the regulations emanating from it need a thorough review and in some cases a major overhaul.

And if Elizabeth Warren loses her water over this: (a) so what else is new? and (b) good! Her Manichean view of financial regulation is a major impediment to getting the regulation right. What is happening in swaps clearing is a perfect illustration of why a major midcourse correction in the trajectory of financial regulation is imperative.

Advocates of the anthropogenic climate change hypothesis excoriate anyone who expresses skepticism as being anti-science. One of the hallmarks of true science is uncompromising commitment to the integrity of data. Ironically, this is a norm that warmists repeatedly transgress.

Case in point: the influential paper by Thomas Karl and coauthors which purports to show that the 15+ year pause in warming was chimerical. But a former NOAA scientist who was the primary steward for temperature data, and the designer of climate data protocols, has blown the whistle on this article. Dr. John Bates asserts that the data was fundamentally flawed, that the basic protocols were not followed, that Karl et al repeatedly made choices that biased their results in favor of finding warming, and that they failed to submit the data for review. To give just one example of their dubious choices, these “scientists” forced the more reliable buoy sea surface temperature data to conform with less reliable data collected the old fashioned way by ships.

But it gets better. And by better, I mean worse: “the computer used to process the software had suffered a complete failure,”  which means the study cannot be replicated. (What?!? No backup?!? How is that possible?)

Replication is another bedrock principle of science. Since Karl et al cannot be replicated, for all intents and purposes the article does not exist. The journal that published it–Science–should withdraw the paper, especially since Karl et al violated the journal’s policies involving data archiving and documentation. Indeed, Science should repudiate it. It should be removed from all citation indices, and any journal that published a paper that cites it should carry an errata listing all of these articles. Further, the conduct of the researchers should be evaluated in order to determine whether any federal funding supporting the research should be returned.

Would that this were a one-off. Alas, basic temperature data has been manipulated in a perfect illustration of Orwell’s dictum: “He who controls the past controls the future. He who controls the present controls the past.”  Those who control the data in the present have “adjusted” historical temperature records repeatedly, and almost uniformly in a way that shows more rapid warming. This has involved, for instance, reducing recorded temperatures from decades ago–most notably from the 1930s, which was a very warm period in the original, unadjusted data. By making the past cooler, these manipulations have increased the estimated rate of temperature increase, thereby advancing the warming narrative, and exerting control over current and future policy. The adjustments have not been done transparently, and they cannot be reviewed or replicated. God only knows if the original data has been retained with its integrity intact.

But even that Orwellian fiddling with the past was not enough to eliminate all anomalous evidence: the pause was flatly inconsistent with the predictions of the climate models, and in an effort redolent of “hiding the decline” of Climategate infamy, Bates makes a compelling argument that Karl tortured the data in order to “bust” the pause. And before anyone could check, checking became impossible.

It is not too much of an exaggeration to say that the data have been raped, by Karl in the present instance, and by many others who are actually allegedly the stewards of the basic records. This is profoundly unscientific, which makes the arrogant posturing of individuals like Karl, who presume to judge those who disagree with them as being anti-science, all the more insufferable. It also makes one wonder what they are afraid of, if the evidence regarding warming is so overwhelming and incontrovertible.

One of the most encouraging aspects of the new administration is its apparent commitment to rollback a good deal of regulation. Pretty much the entire gamut of regulation is under examination, and even Trump’s nominee for the Supreme Court, Neil Gorsuch, represents a threat to the administrative state due to his criticism of Chevron Deference (under which federal courts are loath to question the substance of regulations issued by US agencies).

The coverage of the impending regulatory rollback is less that informative, however. Virtually every story about a regulation under threat frames the issue around the regulation’s intent. The Fiduciary Rule “requires financial advisers to act in the best interests of their clients.” The Stream Protection Rule prevents companies from “dumping mining waste into streams and waterways.” The SEC rule on reporting of payments to foreign governments by energy and minerals firms “aim[s] to address the ‘resource curse,’ in which oil and mineral wealth in resource-rich countries flows to government officials and the upper classes, rather than to low-income people.” Dodd-Frank is intended prevent another financial crisis. And on and on.

Who could be against any of these things, right? This sort of framing therefore makes those questioning the regulations out to be ogres, or worse, favoring financial skullduggery, rampant pollution, bribery and corruption, and reckless behavior that threatens the entire economy.

But as the old saying goes, the road to hell is paved with good intentions, and that is definitely true of regulation. Regulations often have unintended consequences–many of which are directly contrary to the stated intent. Furthermore, regulations entail costs as well as benefits, and just focusing on the benefits gives a completely warped understanding of the desirability of a regulation.

Take Frankendodd. It is bursting with unintended consequences. Most notably, quite predictably (and predicted here, early and often) the huge increase in regulatory overhead actually favors consolidation in the financial sector, and reinforces the TBTF problem. It also has been devastating to smaller community banks.

DFA also works at cross purposes. Consider the interaction between the leverage ratio, which is intended to insure that banks are sufficiently capitalized, and the clearing mandate, which is intended to reduce systemic risk arising from the derivatives markets. The interpretation of the leverage ratio (notably, treating customer margins held by FCMs as an FCM asset which increases the amount of capital it must hold due to the leverage ratio) makes offering clearing services more expensive. This is exacerbating the marked consolidation among FCMs, which is contrary to the stated purpose of Dodd-Frank. Moreover, it means that some customers will not be able to find clearing firms, or will find using derivatives to manage risk prohibitively expensive. This undermines the ability of the derivatives markets to allocate risk efficiently.

Therefore, to describe regulations by their intentions, rather than their effects, is highly misleading. Many of the effects are unintended, and directly contrary to the explicit intent.

One of the effects of regulation is that they impose costs, both direct and indirect.  A realistic appraisal of regulation requires a thorough evaluation of both benefits and costs. Such evaluations are almost completely lacking in the media coverage, except to cite some industry source complaining about the cost burden. But in the context of most articles, this comes off as special pleading, and therefore suspect.

Unfortunately, much cost benefit analysis–especially that carried out by the regulatory agencies themselves–is a bad joke. Indeed, since the agencies in question often have an institutional or ideological interest in their regulations, their “analyses” should be treated as a form of special pleading of little more reliability than the complaints of the regulated. The proposed position limits regulation provides one good example of this. Costs are defined extremely narrowly, benefits very broadly. Indirect impacts are almost completely ignored.

As another example, Tyler Cowen takes a look into the risible cost benefit analysis behind the Stream Protection Rule, and finds it seriously wanting. Even though he is sympathetic to the goals of the regulation, and even to the largely tacit but very real meta-intent (reducing the use of coal in order to advance  the climate change agenda), he is repelled by the shoddiness of the analysis.

Most agency cost benefit analysis is analogous to asking pupils to grade their own work, and gosh darn it, wouldn’t you know, everybody’s an A student!

This is particularly problematic under Chevron Deference, because courts seldom evaluate the substance of the regulations or the regulators’ analyses. There is no real judicial check and balance on regulators.

The metastasizing regulatory and administrative state is a very real threat to economic prosperity and growth, and to individual freedom. The lazy habit of describing regulations and regulators by their intent, rather than their effects, shields them from the skeptical scrutiny that they deserve, and facilitates this dangerous growth. If the Trump administration and Congress proceed with their stated plans to pare back the Obama administration’s myriad and massive regulatory expansion, this intent-focused coverage will be one of the biggest obstacles that they will face.  The media is the regulators’ most reliable paving contractor  for the highway to hell.