Streetwise Professor

October 27, 2023

18 Observations on Israel-Hamas

Filed under: History,Military,Politics — cpirrong @ 2:13 pm
  1. Israel has played the role of Sisyphus in Gaza for virtually the entire nearly 2 decades since it left Gaza. The horrific Hamas attacks of 7 October reveal the futility of that “strategy,” and persisting in it will only guarantee a repeat–or worse. Although success is not guaranteed, at least at a price acceptable to Israel, it should now endeavor to push the rock down the other side of the mountain and extirpate Hamas.
  2. Israel seemed determined to do that in the immediate aftermath of the horrific attacks, but has delayed, apparently due to pressure primarily from the US but also Europe. The claim is that the US needs a delay in order to rush anti-air and anti-missile defenses to protect its troops and facilities in the Middle East. Perhaps, but the mixed messages coming out of Washington suggest that there are elements within the administration who are opposed to Israel eliminating Hamas.
  3. The US’s and Europe’s interests are not aligned with Israel’s. The “leaders” of other nations do not face the threat from Hamas that Israel does, and would much prefer to kick the can down the road and make the reckoning the problem of future governments. Furthermore, Europe in particular is infested with Arab and Muslim populations who are violently anti-Israel. Feckless Europeans are deathly afraid of mass uprisings among these populations in the event of an overwhelming Israeli invasion of Gaza.
  4. The 7 October attack obviously represents a colossal intelligence failure by Israel and the United States. Virtually all such intelligence failures reflect not the failure to obtain the necessary information, but instead the failure to interpret the information properly. Such failures are almost always attributable to the dominance of preconceived beliefs that are inconsistent with the information. That is, to an overweighting of prior beliefs and a failure to update them upon receipt of contrary information. In the presence of such beliefs, the information produces, at most, cognitive dissonance that leads to its being dismissed.
  5. That appears to be the case for 7 October. Israel had been engaging with Hamas for months, and had become convinced that Hamas had become focused on economic development in Gaza, and hence that it would not jeopardize greater access of its population to Israeli labor markets and the like.
  6. There is no doubt in my mind that Hamas deliberately cultivated such beliefs precisely in order to lull Israel into a false sense of security. This is a staple of Muslim, Koranic war fighting doctrine. Israel and the United States–again–mirror imaged by thinking Hamas was motivated by the kinds of economic considerations that guide policy in their countries, and by ignoring Hamas’s adamant Muslim beliefs and tactics.
  7. Post-7 October and during the period of threatened a massive Israeli move into Gaza there has been a virtually unanimous outcry for a renewed pursuit of the “Two State Solution.” The Two State Solution is a zombie idea advanced by zombie politicians. It will never live but it won’t die.
  8. Those who matter in the Palestinian polity–the hardest men with the guns–have no interest whatsoever in the 2SS. None. Zero. Zip. Nada. They are interested only in a One State Solution, with the extermination of Israel and the creation of a Palestinian state “from the river [Jordan] to the sea.” And these maximalist goals are supported by a large majority of Palestinians. The refusal of Western politicians to listen to Palestinians’ openly stated goals is precisely why these poltiicans are utterly useless, and why this conflict persists. Denial ain’t a river in Egypt, and it is a disastrous basis for policy.
  9. To the extent that various Palestinian interests do play along with a 2SS they are just reenacting Mohammed’s hudna with the Quraish–and at times have said that openly (e.g., Arafat). A means to buy time and gather strength for an ultimate resumption of a war of extermination.
  10. All of the above implies that all of the conventional wisdom and shibboleths that have dominated Western discourse and policy for the past 50 plus years should be eliminated, with extreme prejudice. But the scales still obviously remain over Western eyes–and many Israeli eyes too. Politicians are loath to admit failure or to admit that they were wrong. They are loath to jettison the comforting belief that this is a conflict that can be resolved through some Westphalian negotiation between non-ideological sovereigns, rather than an intractable ideological struggle between implacable foes with utterly incompatible objectives. So the zombies carry on with their zombie policies, meaning that the horrors will carry on as well.
  11. One wonders what Hamas intended to accomplish on 7 October. Perhaps an orgy of murder and rape was a sufficient end in itself for Hamas, because beyond that it accomplished nothing for Hamas and indeed may have put it in an existential crisis by greatly increasing the likelihood that Israel would respond by attempting to eliminate Hamas.
  12. But there is no reason to believe that Hamas is primarily an independent actor. Looking at cui bono, the most likely beneficiary is Iran. These events occurred precisely when Israel and Gulf Arab states were on the verge of mutual recognition that would have created an anti-Iran axis. That rapprochement is now in shambles. Thus, one explanation for the Hamas attack, and its timing, is that it was intended to prevent this development.
  13. If so, it has succeeded admirably–at least on the surface. If the Saudis et al do indeed back away from the normalization of relations with Israel, they will be handing Iran a victory. One can only hope that their public statements are a blind, and that in private they are actually continuing to move forward with Israel.
  14. Iran is the center of gravity in this conflict. Financially and militarily it is the driving force behind the anti-Israel axis (which includes Hezbollah as well as Hamas and Islamic Jihad). Heretofore, Iran has been largely immune from direct attack because it can act powerfully through its proxies. A crucial question is whether Iran will remain merely the puppet master and paymaster if Israel succeeds in destroying Hamas. Its calculation will depend on its perception of the consequences of direct intervention (by, for example, launching missile strikes on Tel Aviv).
  15. Minimizing this threat requires putting at risk things vital to the Iranian regime. The two most precious things are their own hides, and their nuclear program.
  16. Russia has come out foursquare behind Hamas and against Israel. (A Hamas delegation is in Moscow as I write this). This despite the fact that Putin has had good relations with Israel historically. But the reason is readily understood–again, it is Iran. Iran is a major supplier of weapons (especially drones) to Russia in its war against Ukraine.
  17. One would think that since everything and everyone remotely pro-Russian is an anathema in present day DC, the Russian-Iranian alliance would make Iran an anathema. Yet the US has been notably circumspect in its condemnation of Iran despite its obvious central role in fomenting anti-Israel violence. The administration has bent over backwards to say it has no evidence of “direct” Iranian involvement in the Hamas atrocities–although what short of Iranian missiles impacting Tel Aviv would constitute “direct” involvement remains unstated. In his statements Biden has avoided even saying the word “Iran.”
  18. This is another baleful legacy of Obama’s obsession with treating with Iran and normalizing the Islamic republic. Taking his statements at face value (not that you should), Obama believed he was (and is, via his marionette successor) contributing to stability in the Middle East that would allow the US to pivot to Asia. How’s that working out, genius? Empowering Iran (via monetary payments, reintegrating them into the world oil market, restraining Israeli actions against it, etc.) has instead led to a situation in which substantial American military resources are being sucked back into the region. But the pro-Iran elements in the administration (and the State Department) still seem to be driving policy–yet another zombie policy implemented by zombie politicians and apparatchiks.

October 16, 2023

Alfred E. Goldman

Filed under: Clearing,Derivatives,Economics,Exchanges,Financial crisis,Regulation — cpirrong @ 12:52 pm

In March, 2020 the Federal Reserve injected massive amounts of liquidity into the markets in response to a blow-up in Treasury basis trades. I wrote about it here.

In recent weeks, the Fed, the BIS, and the BoE have raised red flags about the renaissance of this trade and the resulting potential for systemic risk a la 2020. Not all are convinced. Goldman Sachs in particular is in Alfred E. Neuman mode: What? Me worry?

FT Alphaville quotes Goldman’s rates strategy team as follows:

We do not think the trade poses a major risk to Treasury markets in the near term . . . Leverage in the system is materially lower than it was in 2019/20 as a result of a series of [initial margin] increases (and price declines). The large increases in IM, which were in theory calibrated to the extremely elevated levels of Treasury market volatility of the past few years, should mean additional large increases may not be necessary — at least in the near term, we expect to migrate to a less volatile rate regime.

This assessment is based on a fundamental error that I went on about ad nauseam in the post-Great Financial Crisis clearing debate, specifically, concluding that if leverage goes down in one part of the system it goes down systemically. Wrong. Wrong. Wrong.

Yes, the ostensible purpose of higher margins is to reduce leverage in the margined trades. But especially for the hedge funds and other sophisticated entities who engage in the Treasury basis trade at scale, they can substitute one form of leverage for another.

As a first approximation, a fund has a leverage target or a level of debt capacity, it can fund the higher margin in the less leveraged futures trade by increasing leverage elsewhere. The funds will typically evaluate leverage holistically, not on a trade-by-trade basis.

It is therefore fundamentally logically flawed to conclude that “leverage in the system” (which is in fact source of systemic risk) has declined because it has gone down in one piece of it.

If there are constraints on funds’ ability to offset mandated leverage reductions in one type of trade by increasing leverage elsewhere, that would increase the cost of engaging in that type of trade and would impact the scale of that trade. But what has alarmed the central bankers is exactly that the scale of the trade has increased and now exceeds its 2020 level:

Note that leveraged funds’ Treasury futures shorts are currently substantially larger now than in 2020. Thus, despite higher margins, the scale of the trade is subsantially larger–and it is the scale–and the concentration–of the trade that poses systemic risks.

This bigger scale could be because raising margins doesn’t really constrain the ability of funds to lever up to engage in basis trades. Or it could be that even though the higher margins raise the cost of the trade, the spread has widened sufficiently to offset, or more than offset the higher cost. For example, constraints on dealer balance sheets that impair liquidity in the cash market could depress cash prices relative to futures prices.

Goldman’s errors don’t end there. One thing that could spark a margin spiral is an increase in initial margins that induces mass liquidations that lead to changes in the basis that lead to large variation margin obligations–something that Goldman doesn’t mention.

Alfred E. chimes in again here: “The large increases in IM, which were in theory calibrated to the extremely elevated levels of Treasury market volatility of the past few years, should mean additional large increases may not be necessary — at least in the near term, we expect to migrate to a less volatile rate regime.” That is, Goldman’s conclusion is essentially based on a very benign view on Treasury volatility.

There are myriad reasons to take a different view. The US’s acute fiscal situation and the accompanying periodic debt limit dramas. The constrained balance sheets of dealers that limit their ability to supply liquidity to the Treasury market. The prospect for an extremely chaotic election year. And geopolitics, with now two major disturbances ongoing (Ukraine and Israel/Gaza) with one continually on the boil in the background (China/Taiwan). And highly unsettled geopolitics with a feckless and befuddled administration at the tiller.

That is, it isn’t the level of margins that really matters. It is the possibility that margins may increase due to higher volatility. Goldman/Neuman isn’t worried. I think that’s unduly optimistic. Furthermore, an assessment of systemic risk must be based on the likelihood that Goldman’s don’t-worry-be-happy opinion is wrong.

And remind me: did Goldman predict the increase in Treasury volatility in 2019 or 2020? Stuff happens. Unknowns and unknowns and all that.

Furthermore, higher volatility->higher IM->liquidation of basis positions->margin spiral isn’t the only potential source of systemic risk. Other economic shocks can cause leveraged funds to slash positions and leverage, leading to liquidations of basis positions and the triggering of a margin cascade. That is, there is the possibility of fire sales.

These shocks can be systematic–a broad decline in stock or bond markets–or concentrated at a few funds, or even one, due to bad trades in other markets.

The 30 25 year anniversary last month of the LTCM collapse brings the latter to mind. Bad bets on convergence trades forced LTCM to liquidate and delever. Understandably, it attempted to unload its most liquid positions–including short Treasury futures. Treasuries had a massive rally on LTCM day that was not matched by a similar rally in the underlying, less risky Treasuries.

A squeeze–not unheard of in government debt futures markets–can also impose losses on basis trades, leading to liquidations that can exacerbate the price impact. Or a Treasury flash crash (in yields, and hence a flash spike in prices) like on 15 October 2014.

In sum, size does matter. Basis trades have become big again, and the factors that lead Goldman to parrot Alfred E. Neuman are hardly persuasive. From a systemic risk perspective, basis trades represent dry tinder that can explode into flame. Can does not mean will. But the possibility is there, and the effect if the right spark hits the tinder depends on the size of trade. The big scale and concentration of this trade thereby justify far more concern than Goldman expresses.

October 8, 2023

Michael Lewis Jumps the Shark, Which Is Too Bad, Because In a Just World He’d Fall and Get Eaten

Filed under: Blockchain,Cryptocurrency,Economics,Exchanges — cpirrong @ 6:31 pm

Michael Lewis is out with a book on Sam Bankman-Fried and FTX–just in time for SBF’s trial! What great timing!

I am sure that when Lewis started the project, he did not anticipate that he would have to use the trial of the person whom he had intended to be the hero of his story to turn the FTX lemon into marketing lemonade. But so he has.

Lewis was interviewed by 60 Minutes Last week, where he offered this gem:

This isn’t a Ponzi scheme. In this case, they actually had a great, real business. If no one had ever cast aspersions on the business, if there hadn’t been a run on customer deposits, they’d still be sitting there making tons of money.

Other than that, how was the play, Mrs. Lincoln? Or, if it wasn’t for that damned Russian winter Napoleon’s descendants would still be ruling France!

Where to begin? First, Ponzi schemes are not the only form of financial fraud so by rejecting that FTX was a Ponzi he does not prove it was not a fraud. Second, and more importantly, this begs the question of why there was a run. Did the customers just decide to run on a whim? Or maybe it was sunspots (a la last year’s Nobel winners Diamond and Dybvig)!

Yeah, sunspots, that’s it. Other than that, SBF would be sitting fat and happy. (Though mainly fat–he’s lost weight in the pokey.)

Uhm, no, actually, aberrations in the sunspot cycle didn’t spark a collective frenzy by depositors. The simple fact is that SBF was using customer monies for all sorts of purposes, ranging from funding a lavish lifestyle for himself (and his loathsome parents) to covering losses at the FTX-affiliated hedge fund (the very existence of which should have been the first red flag). The “aspersions” cast upon “the business” were basically factual revelations that “the business” was a financial disaster that used customer monies in violation of laws, duties, customs, and promises.

In other words, there was a run for the reason that there are usually runs: the customers of an entity operating on first-come, first-serve basis learned that said entity was financially suspect. Get your money, and let the devil take the hindmost.

And as for “great real business”–apparently not only did Michael Lewis drink deep from the crypto Kool Aid, he’s still binging on it. There were numerous reasons to be skeptical about crypto since it began (and I expressed skepticism from virtually the time of its emergence about a decade ago), and the dubiousness of the entire endeavor has only deepened. To claim that crypto exchanges were viable businesses that would make “tons of money” on an ongoing basis is utterly delusional.

The simple fact is that Michael Lewis is a deeply, deeply, deeply compromised narrator here. He was “embedded” in FTX for months. He had unparalleled access to the chubby wunderkind. And then the whole thing imploded in scandal.

Meaning that Michael Lewis has to–has to–make his would-be hero SBF a tragic one, wrongly and unjustly brought down by powers beyond his control. For consider the alternatives.

The first is that Michael Lewis had a front row seat to a massive fraud, and that he–the alleged eagle eyed chronicler of the corruption, shenanigans, misdeeds, and absurdities of mainstream finance (investment banks, the stock market, etc.)–missed what was going on in front of his very eyes.

The second is that Lewis knew something was wrong, or at least suspected it, and remained silent.

The first alternative would be a major blow to Lewis’ credibility and reputation. The second would basically make him an accessory to a major crime.

To escape this dilemma, Lewis must insist–and demand that you believe him, and not your lyin’ eyes–that there was nothing wrong at FTX. Indeed, everything was right at FTX, except shit happened. Or something. Given his massive conflict of interest, Lewis’ arguments are utterly untrustworthy, and smacking of special pleading.

I have heard it said that SBF fooled a lot of people, so you need to cut Lewis some slack. Uhm, no. If your whole shtick is your financial gnosticism, your unique ability to perceive and interpret the greedy, grubby, self-interested behavior of financial market denizens, “I wuz fooled just like everybody else” doesn’t cut it when a greedy, grubby, self-interested shlub ran his scheme in front of your very nose.

It is quite clear what has happened here. Lewis’ well-worn–but quite lucrative–MO is to pick out some misfit hero or heroes fighting against the financial Man, and make him/her/them the protagonist of a just so story. Misfit David vs. Goliath.

SBF was to all appearances a gift to Lewis from the literary Gods. Crypto was the vanguard in a supposed revolution against the traditional financial system and institutions that Lewis had inveighed against for years. SBF fit the quirky misfit role to a “T.” He also talked in lofty phrases about his effective altruism, his lack of personal financial motivation, and his desire to use the wealth generated by his genius to make the world a better place.

It had the makings of the Michael Lewis book to top all Michael Lewis books, and SBF to be the hero of all Michael Lewis heroes.

And then it all went horribly, horribly wrong.

So what’s Michael Lewis to do? Since the elites (which includes Michael Lewis) don’t do mea culpas, let alone retire to a monastery, the only thing he could do–spin like a dreidel.

It is immensely amusing to me that Lewis clearly doesn’t understand the fundamental absurdity of his arguments. If you are really a crypto true believer, which Lewis clearly is, it is because you believe that a trust-based financial system is fundamentally flawed, and that trustless crypto is the answer. But Lewis also argues that FTX’s “great real [crypto] business” failed due to an irrational loss of trust. Both of those things cannot be true.

So Lewis has jumped the shark here. But due to his spinning, and his existing reputation, it is quite likely that’s a bad thing–but only because it means that the shark won’t eat him, as would be a just outcome.

I criticized Lewis’ Flash Boys when it came out 9+ years ago, so I have been a skeptic for a long time. But I have nothing on Scott Locklin, who wrote this in the immediate aftermath of the FTX implosion (and who also ridiculed Lewis’ Flash Boys). Locklin makes me look like a milquetoast. Definitely worth a read

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