Streetwise Professor

I saw Ridey-Scott’s Napoleon on Thanksgiving. I am not thankful.

The film has been savaged by numerous reviewers, so perhaps it is gratuitous for me to put the boot in, but I figure I have to get my money’s worth somehow.

I went in ready to grant liberal artistic license and overlook some historical inaccuracies. For instance, yeah Napoleon didn’t shoot cannon at the Pyramids of Giza, but whatever.

But the movie definitely violated the terms of its license in ways that are grossly misleading. For example, Napoleon was a spectator of the Battle of Waterloo–when he wasn’t taking a nap, that is–and fled after watching “la Garde recule” and the Prussians crushing his right flank. He definitely did NOT lead a cavalry charge–especially given that he might well have been suffering from hemorrhoids at this climactic moment of his military career. Depicting him doing so gives an extremely distorted picture of Napoleon the man and the historical figure. (Napoleon’s departures from his armies in Egypt, Russia, Germany–after Leipzig–and Waterloo were the subject of criticism, but the film only mentions the criticism regarding Egypt.)

This is not a minor rewriting of history.

The battle scenes were painful to watch because of their comic book unrealism. My groaning began at the very outset. Napoleon’s attack on the British at Toulon was nothing like the actual thing. He didn’t assault a masonry fortress (which I think was depicted by the Vauban fort at Collioure, one of my favorite places): he assaulted earthen fortifications. His leadership there was valiant, widely admired, and oft remarked upon: in Ridley-Scott’s version he was just part of the crowd.

And speaking of earthworks, the French at Austerlitz and the British at Waterloo didn’t have them, let alone trenches festooned with fraise.

Yeah, I get that it is hard to depict on the screen the surprise that Napoleon pulled at Austerlitz by abandoning then assaulting the Pratzen Heights, but to convey surprise by having French cannoneers hide under white tarps pulled over their (non-existent in reality) trenches is just silly. Better to describe Napoleon’s tactical coup through dialog.

I could go on dissecting the battle scenes, but will leave it at that.

These failings are minor compared to fundamental problems in plot and character development.

Most notably, the real Napoleon was amazingly charismatic, and that never comes through in the film. Not only is Joaquin Phoenix too old by far to play anyone but the dying Napoleon, his Bonaparte comes off as something of a loser closer to the shlub living with mom in The Joker than a world striding colossus. Who would follow this guy to the concessions stand, let alone into the frozen wastes of Russia? Maybe a more accurate depiction of Toulon, or a scene of Napoleon at the Bridge of Lodi, would have helped convey why Napoleon could move armies and nations.

For understandable reasons–not least that it is easier to portray inter-personal dramas than sweeping historical events like epic battles–a good deal of the plot revolves around Napoleon and Josephine. We know that Napoleon was smitten by her, and often acted like an idiot about her especially in his absence, but Napoleon Dynamite seems like a manly chick magnet in comparison to Phoenix’s Napoleon Bonaparte the lover. And the depiction of Josephine also makes one wonder what Napoleon–and the many other men in her life–and I do mean many!–saw in her.

As another illustration of Ridley-Scott’s fundamental distortions of history that goes well beyond justifiable artistic license, in the film’s telling Napoleon leaves Elba because he reads in the newspaper that Josephine was canoodling with Tsar Alexander. FFS. (His departure from Egypt was also supposedly in response to being informed of Josephine’s infidelity.)

Napoleon thought much more above the neck than below the waist. This film would have you believe otherwise.

Casting was uniformly odd. The character playing Robespierre, for example, would have been better suited as Danton :P. (That said, the scene in which Robespierre was accosted and shot himself–unsuccessfully–was one of the better ones in the movie. Another was the assault of the Council of Five Hundred on Napoleon’s person during the Brumaire coup.)

Another minor but repeated and therefore annoying irritation was the atmospherics. The weather in most scenes was depicted as cold, cloudy, and/or rainy: scenes in sunny places (like Egypt or at Tilsit) take place largely in tents. You would think that France was Ridley-Scott’s native Yorkshire. He has said that the dreary, ever-raining atmospherics of Blade Runner were inspired by memories of his Yorkshire childhood. So I guess in Napoleon he gave us have Blade Runner meets Bonaparte.

But maybe that’s the point. Maybe Ridley-Scott is trying to say that Napoleon’s world was dystopian. There are certainly many–and have been since he exploded on the world stage–who believe that Napoleon led the world to perdition, and that is a valid stance for Ridley-Scott to take. But it begs the questions of what drove him to it, and why people followed him to the dystopia to which he led them. Ridley-Scott and Joaquin Phoenix provide no answers.

All of these liberties–to characterize them kindly–could be excused if they were taken in the cause of conveying fundamental truths. But they do the exact opposite. They give us an inverted Napoleon.

Successful biopics, like say Lincoln or Patton, succeed in this despite departures from the literal truth. Yes, Ridley-Scott made a daring choice of attempting to cover virtually the entire sweep of one of the most eventful lives in recorded history, and one that spanned more than two decades, unlike Lincoln which focused on a few months or Patton which covered barely three years. But that choice means that he had to be all the more precise and creative in his choice of how to convey accurately Napoleon’s personality and conduct. By choosing dramatic devices that uniformly deceive and distort, Ridley-Scott fails his audience, and fails the history he claims he wants to portray.

The war in Ukraine grinds on with no appreciable movement on either side–except in the body counts.

The conflict is often compared to World War I, but this is in some respects unfair to World War I. Territorial gains on both sides are measured in meters–when there is any progress at all. Even catastrophic assaults like the Second and Third Battles of Artois in 1915 saw the French advance a few miles.

The most extreme current example is the sustained Russian assault on Avdiivka. Day after day for more than a month the Russians have mounted attacks on the three fronts of the Ukrainian salient enclosing the town. And day after day their attacks are repelled with massive losses. Many times the assaulting troops do not even make it to the contact line, being smashed by Ukrainian artillery and drones as they move to contact.

At most the Russians take a field or two here, a tree line there.

The Ukrainian experience to the south, around Verbotene, is much the same. The Ukrainians made some decent (albeit slow) progress there during the summer, creating a modest bulge in the Russian positions, and here and there breaching Russian minefields and fortifications. But for months the two sides have fought to a standstill, exchanging fields and tree lines here and there.

Moreover, in each location the attackers at first attempted armored assaults, only to suffer massive tank losses from mines, artillery, and drones. Consequently, each now mounts small infantry assaults. In Avdiivka, the Russian AFVs drop off their mounted infantry a couple of kilometers from the front. The soldiers slog forward and then throw themselves into frontal assaults.

You can find lots of video of the results on Telegram. It is not pleasant viewing.

And if these infantry assaults succeed breaching enemy lines? Nothing will change. Just as in WWI, infantry cannot exploit a penetration by infantry. The “successful” attackers are worn out and often combat ineffective due to heavy losses. Even if they were capable of moving forward, or reserves could be rushed into the breach (something neither side has proved able to do) the defenders can withdraw and regroup faster than the attackers can advance. Meaning that a “breakthrough” just moves the stalemate a kilometer or two. Absent the ability to exploit with armor–and crucially, without the logistics to support armored exploitation–decisive advances are impossible.

The stasis of the battlefield is in large part due to the inability of either side to achieve air superiority. In Ukraine, air superiority does not refer to manned fixed wing aircraft or helicopters, but drones. Both sides are able to operate drones for both reconnaissance and attack with relative impunity. This is a major reason (mines being another) for the impotence of armored forces.

The only front holding out the prospect for maneuver is in the south, on the left bank of the Dnieper/Dnipro River near Kherson. Unlike on the remainder of the front, here Russia did not create deep lines of entrenchments, and its forces are spread relatively thin. But an advance here would require Ukraine to send large amounts of supplies over a wide river, and it is doubtful that it is capable of doing this. (Its logistic capabilities to support a deep drive are suspect generally, even without the necessity of bridging a wide river, and defending the bridges.)

The Ukrainian government and its Western supporters claim that if it only had more weapons, it could drive out the Russians. Given the trivial incremental effect of the offensive weapons already supplied, this is to be seriously doubted.

The real constraint on Ukraine now is manpower, not equipment. It started at a severe manpower disadvantage, exacerbated by the emigration of many military aged men, evasion of conscription, and lukewarm volunteering. In contrast, Russia has proved able to replace its ravaged ranks by hook and crook, even without resorting to a formal nationwide mobilization. Even at an inflated exchange ratio, this meat swap is a contest that Ukraine cannot win.

That said, there is no real prospect for peace because Zelensky and many others in Ukraine are still wedded to the idea of driving Russia out of Ukraine altogether, and Putin is perfectly willing to pay the exchange rate for as long as it takes to out wait Ukraine.

Israel stupidly hit pause in the other war, in Gaza, apparently bowing to U.S. pressure. The pressure was stupid, and bowing to it was too. Israel was making steady progress at extirpating Hamas and digging up–literally–its military infrastructure.

The deal it made with Hamas takes off the pressure on the terrorist organization. Moreover, the terms of the deal, in which Israel releases more prisoners than Hamas does hostages only encourages future hostage taking. This is utterly insane.

The fecklessness of Biden and his administration exceeds even what I had expected–which is saying something. The only American hostage released so far is . . . wait for it . . . a relative of one of the connoisseurs of Hunter’s art. I mean you cannot make this shit up. And it demonstrates that the administration calculates that it will pay no political price.

The proper response to the taking of American hostages should have been reboot of “Perdicaris alive or Raisuli dead.” The Hamas “leadership” livin’ large in Qatar (apparently on large stacks totaling billions) should have been told: all our hostages alive, or you dead.

But noooooo. Indeed, that’s not even the worst example of his cravenness. Yesterday, he abjectly apologized to five (unnamed) Muslim heavyweights for questioning whether Gazan “authorities'” (AKA Hamas stooges’) casualty figures are accurate.

Joe is disappointed in himself. Aren’t we all. Aren’t we all.

He “promises to do better.” Even though the bar is very low indeed, I’m taking the under on that one. It’s always the sure bet with Biden.

War is always grim. These wars are even grimmer than most. They will be long running attractions, with no constructive results.

On Sunday 19 November 2023 the flamboyant–outré, actually–Javier Milei won the presidential election in woeful, tragic Argentina. “Won” does not really fully capture the result–he trounced his opponent, winning almost 56 percent of the vote.

Milei is repeatedly compared to Donald Trump, but there is really no comparison. He is truly unique among prominent world political figures. So unique that mainstream sources don’t know how to pigeonhole him–though God knows they strive mightily to do so.

Since he is not a leftist, he is of course repeatedly called “far right.” But any epithet that is used to describe both the open borders, anti-collectivist Milei and the nationalist, anti-immigration Alliance for Germany (AfD) is obviously meaningless–except as a signal from the left that someone is beyond the leftist pale.

He is also referred to as a populist, but that also widely misses the mark. Milei is a self-described anarcho-capitalist, whereas most populists now and historically (such as the Populist Party in the United States in the 1890s) are openly hostile to capitalism and markets: modern populists hurl the “neoliberal” insult at those with pro-market views far milder than Milei’s.

Even Milei’s dogs’ names advertise his beliefs and intellectual heroes. They are Murray (for Rothbard), Milton (for Friedman of course), and Robert and Lucas (a twofer for the late Robert Lucas–one of my professors at Chicago). What, no Friedrich? Milei should have cloned another one! (These pets are all clones.)

When I wrote Milei is not a leftist, let’s say that rather understates the matter. Milei loathes leftists and leftism, and repeatedly refers to them on television and in public appearances in scatalogical terms, and calls them “leftards.” He despises collectivism, and asserts bluntly that leftists are out to destroy you. His mission is to destroy them first.

As someone so vehemently hostile to the left and well outside conventional political categories, Milei’s victory has triggered a mass moral panic, especially in the media. The New York Times’ coverage was (unintentionally) hilarious: “Some voters were turned off by his past outbursts and extreme comments over years of work as a television pundit and personality.” Well, obviously a lot more weren’t, but I guess one has to take solace where one can, eh, NYT?

Milei’s agenda is indeed a radical one, especially for a statist basket case like Argentina. To combat the country’s massive (140 percent annualized) inflation, Milei says he will dollarize the economy and eliminate (“burn down”) the central bank. He also wants to reduce radically the role of the state in Argentina’s economy. He says he wants to “chainsaw” the government–and emphasizes the point by campaigning with an actual chainsaw.

His election on this program sparked a rally in Argentine financial markets, with government debt rising modestly and stock prices rallying smartly.

But will Milei be able to deliver? Some early commentary has doubted his ability to govern based on the fact that his party’s representation in the legislature is well below a majority.

Yes, that may be an issue, but not the major obstacle to Milei’s ability to transform Argentina into what it was at the dawn of the 20th century–an advanced, rapidly growing economy and a relatively free society.

The real obstacle is one that is faced by anti-statists everywhere–the bureaucracy. (I do not say “civil service” because that phrase is at best aspirational and more realistically a patent falsehood. Akin to the Holy Roman Empire that was neither holy nor Roman, the “civil service” is neither civil nor a service.)

Argentina’s bloated state is its own clientele with its own interests–mainly self-preservation and an expansion of its powers. Moreover, it has created a whole host of patronage clients in business and labor. Milei’s agenda is an anathema to this nexus of public and private interests. They will go to the mattresses and make war to the knife to subvert Milei and his agenda.

Even a president with an electoral mandate–like Milei–faces formidable obstacles to implementing his agenda. The most important obstacle is what economists call an “agency problem” (which in the U.S. could be referred to as an “Agency problem”). The bureaucrats are agents of the chief executive, but it can be nigh on to impossible to get these agents to implement the executive’s directives if they don’t want to. Their incentives are not aligned with the executive, and are often antithetical. As a result, they resist and often act at cross purposes with the executive.

The modern chief executive’s power to force his bureaucratic agents to toe the line is severely circumscribed. At best, the executive can make appointments at the upper levels of the bureaucracy (such as the heads of ministries or departments), but the career bureaucrats who can make or break the executive’s policy are beyond his reach, and not subject to any punishment if they subvert the executive’s agenda.

This problem is not unique to Argentina. Indeed, it is the main defect in the governance of virtually every country in the world. Cf. Suella Braverman in the UK, who was recently defenestrated as Home Minister for daring to offend the sensitivities of the British civil servants. (I again emphasize this phrase’s oxymoronic nature.)

But the travails of the likes of Braverman (or Trump) are likely to pale in comparison to Milei’s in confronting the gargantuan Argentinian state and bureaucracy. Even if he avoids Trump’s fault of repeatedly appointing those hostile to his agenda to the positions in the bureaucracy he can hire and fire, Milei will still face the immense task of bringing those myriad bureaucrats outside his direct reach to heel.

There are indications that Milei understands this problem, and has devised a solution. Rather than attempting to control particular bureaucracies, he states that he wants to eliminate government departments (like the Ministry of Education) altogether. This is likely the only way to succeed, but whether he can cut the bureaucratic Gordian Knot a la Alexander brings us back to the question of his doubtful legislative backing.

Indeed, Milei needs to be more than a mere Alexander. He must be a Hercules to clean the Augean Stable of the Argentinian state. I don’t hold out much hope–Hercules is a mythical figure, remember. But it is at least refreshing that someone has been elected to play Hercules, and one who is eager to take on this labor. Would that this starts a trend worldwide.

Nota bene: This post also appears at the Brownstone Institute, under the title “Milei’s Task Ahead: Defeating the Administrators.” Give it a click. Brownstone is a good organization that deserves your support. The website has a lot of interesting articles and is worth regular visits.

About 3 weeks have passed since my previous post making 18 observations on Israel v. Hamas. Events in those 3 weeks prompt some additional observations.

1. Israel appears to be filtering out the near universal screeching, preaching, and second guessing regarding its methodical campaign in Gaza, where assault by fire has been succeeded by a ground assault. It recognizes that a cease fire or “pause” would rescue Hamas from destruction, and likely in the long run result in more Gazan (and Israeli) deaths than will result from a campaign that extirpates the terrorist organization that rules Gaza. That is, it has determined not to play Sisyphus again.
2. It is likely that Israel recognizes that the screeching, preaching, and second guessing is almost totally ineffectual posturing by pusillanimous western politicians and Hamas fellow travelers, and that the costs of bending to this criticism far exceed any benefits that would result from doing so. Doing so would spare Israel’s enemies, and not make it any friends. So the dogs are barking loudly, but the Israeli caravan is moving along inexorably.
3. Indeed, those who could pose the greatest threat to Israel–namely Arab states, especially the Gulf states–are making only perfunctory criticisms at most–when they are not outright criticizing Hamas strongly as the UAE did today. It is telling that Saudi Arabia does not permit pro-Palestinian (i.e., pro-Hamas) protests while the streets of Paris, London, and Washington are awash with them. One can only imagine what the Saudis, etc., are telling Israel in private.
4. Meaning that the pro-Palestinian ferment is a far bigger threat to western governments than to Israel. Which helps explain the bleating of those like Macron.
5. The Biden administration is like a deer in the headlights. Its initial unambiguous pro-Israel stance unleashed a firestorm on the Democratic Party’s left that jeopardizes Biden’s already extremely shaky political situation. This firestorm has led to–well,what better way to put it?–insurrectionary actions (at least as those have been defined for the last 35 months). These include a boisterous protest inside the Our Lady of Our Democracy, AKA the Capitol, an attempt to storm the White House, and an attack on a reception at Democratic Party headquarters in DC. This is a no-win situation for Biden and the Democrats. Breaks me all up.
6. There is opposition to the administration’s largely pro-Israel stance from within the State Department. I’m shocked! Shocked! Well, not really. The State Department has been anti-Israel since 1948. Truman recognized Israel only over the determined resistance of the “striped pants boys” in the State Department. La plus ca change.
7. Reactions in the West generally, and the U.S. in particular are quite clarifying. In particular, the Left’s embrace of Hamas–largely dishonestly camouflaged as concern for oppressed Palestinians–is quintessential the-enemy-of-my-enemy “logic” that demonstrates the profound anti-western animus of the left. The Palestinian cause has been a major element in the anti-Western alliance since the 1960s. The USSR was a major supporter of Palestinian “resistance,” and now Islamist Iran–a rabid revisionist anti-Western nation–is the major supporter of violent Palestinian forces. Political Islam is also profoundly anti-Western. The Western left is also rabidly anti-West–and terms like “colonialism” are barely concealed anti-western code. A common enemy unites Western leftists and Islamist terrorists, and explains the enthusiasm of the former for the latter. They don’t love the Palestinians. They both hate you.
8. The most bizarre manifestation of this nutty nexus is “Queers for Palestine” and the like. If the self-described queers actually went to Gaza, the only question among the Palestinians would be whether to hang them from cranes, throw them off rooftops, or crush them under large rocks. But since the self-described queers have no intention of setting a single painted toenail in Gaza, they can embrace Hamas from the safety of leftist enclaves like Cambridge and Amherst as a means of undermining traditional Western societies, ethics, and morality.
9. The events since 7 October 2023 have demonstrated beyond any doubt the utter depravity of western–especially American–universities. Certainly the humanities and most of the social sciences, and clearly the administrations (administrators being a dominant force in the modern university), but also a non-trivial portion of the STEM faculties. And the more “elite” the university, the more profound the depravity. There really was not much doubt about the state of universities prior to 7 October, but whatever doubt that remained has been pulverized. I know how we got here, but I don’t see any way back. The institutional dominance of anti-western forces in the quintessential product of Western Enlightenment is too entrenched to be overthrown.
10. These events have also made plain the depravity of public education in the United States. The vacuity of Zoomers, and their embrace of pathological pro-Palestinian propaganda like Osama bin Laden’s post-911 letter, show that the left’s march through the institution of public education has triumphed. And again, I don’t see any way back, especially given the vice grip of the teachers’ unions. Until that is broken, public education will become even more broken.
11. Hezbollah doesn’t appear to be in any hurry to commit suicide by throwing in with Hamas. Its histrionics and support of groups that pull Uncle Sam’s beard in Syria and Iraq aside, the same is true of Iran. Which makes it all the more inexplicable that the Biden administration continues to shower billions on it. All that will do is convince the mullahs that they can go further without triggering a response that hits them where it hurts.
12. Insofar as the Israeli campaign itself is considered, it is proceeding relentlessly and methodically. It has surrounded northern Gaza, then proceed to cut that half almost in half (from east to west). The Israeli inkblot will continue to expand until Hamas is eliminated in all of northern Gaza. There are very few reports of pitched battles, suggesting that Hamas realizes it is overmatched and that Israel’s overwhelming force and obviously long-standing operational plan make all but scattered resistance futile. The urban warfare nightmare widely predicted for Israel has not materialized. Casualties have been light, as compared to expectations and previous experiences in urban battle (e.g., Fallujah). Total Israeli casualties so far amount to the toll of a few hours of Russian assaults on Avdiivka, Ukraine. But that is a subject for another day.

Gary Gensler has been a menace to the market system for as long as he has been in government. Those of you who have followed this blog for a long time know that I relentlessly criticized him during his tenure as CFTC chairman. He apparently took notice, because he banned me from the CFTC building. I also consider it extremely likely that he was the moving force behind the 2013 NYT supposed hit piece on me–for which I should probably thank him, because on net that has turned out to be a major positive.

Gary Gensler. (Though this is how I like to think of him.)

At CFTC, Gensler was merely an Igor implementing the Frankendodd creation of his congressional masters. As head of the SEC, however, Gensler has become a full-fledged Dr. Frankenstein, stitching together regulatory monsters that threaten to stalk the landscape leaving economic devastation in their path.

I have already written several times about the SEC’s misguided Treasury clearing mandate. But that is only one of Gensler’s Monsters. There are many others.

Perhaps the most monstrous is the SEC’s proposed rule on climate-related disclosures. This would mandate that public companies disclose their carbon emissions–and those of their suppliers. This is at best vast speculative endeavor, and and worst an impossibility. It’s main concrete effect will be to provide a pretext for lawsuits against companies targeted by activists who will allege that the companies’ calculations were wrong, or were lies because alternative internal calculations came up with numbers that differed from those reported in their 10Ks.

The regulation would also require companies to make fulsome disclosures of their climate risks. Another speculative endeavor that cannot produce any meaningful or useful information. It requires each company to characterize the interaction between one complex system–climate–and another complex system–the economy–to predict the adverse consequences of this interaction for it, a small part of the economic system allegedly impacted by climate. Prognostications about climate are themselves wildly uncertain–indeed, arguably the biggest risk is model risk. Predicting how climate will impact economic outcomes at the company level under myriad possible climate scenarios is a mug’s game.

And indeed, it is even worse than that. For there is another element to the problem–government policy. This introduces an element of reflexivity that is particularly devilish. Government policy will respond to climate and economic outcomes as well as interest group pressure, and will affect economic outcomes (though whether these policies will actually affect climate outcomes is dubious). This is arguably by far the biggest risk that companies face.

Meaning that if the regulation comes into force, I recommend the following boilerplate disclosure for all companies: “We face the risk that some government agency will adopt a boneheaded policy that will dramatically raise our cost of doing business or eliminate the markets we service.”

This will also be a boon to lawyers. “Company X failed to disclose the risk associated with [insert climate scenario here] described in [poorly executed paper published in obscure journal].”

I could go on. But in Congressional testimony John Cochrane did a lot of the heavy lifting for me, so I direct you there.

And I ask: how will this information improve the allocation of capital? It is more likely that this will just add noise that impedes efficient capital allocation, rather than actionable information that improves it. The hive mind of investors is likely far more adept at evaluating the effects of the climate-economics-policy nexus than the managers of corporations.

I further note that this obligation’s burdens are greater for small companies than big ones. Meaning that it will likely lead to exit and consolidation, and greater concentration. Which other parts of this administration–notably Lina Khan’s FTC–think is a great evil. Ironic, that. Ironic, but not humorously so.

Moving right along, the trendy Gary has targeted the New Thing, Artificial Intelligence. In public statements Gensler has made the at least somewhat plausible argument that interactions between very similar AIs can produce destabilizing positive feedback mechanisms. But the SEC’s proposed AI regulation instead focuses on potential agency problems:

Today’s predictive data analytics models provide an increasing ability to make predictions about each of us as individuals. This raises possibilities that conflicts may arise to the extent that advisers or brokers are optimizing to place their interests ahead of their investors’ interests. When offering advice or recommendations, firms are obligated to eliminate or otherwise address any conflicts of interest and not put their own interests ahead of their investors’ interests. I believe that, if adopted, these rules would help protect investors from conflicts of interest — and require that, regardless of the technology used, firms meet their obligations not to place their own interests ahead of investors’ interests.”

The SEC remedy for this litany of horrors?

But under the guise of minimizing conflicts of interest, the SEC now proposes requiring advisers and broker-dealers to write new internal procedures and to log all uses of technologies relating to predictive data analytics for agency review. If left unchallenged, the new rules would hamper the American financial industry’s world-beating innovation.

The definition of what must be disclosed is comprehensive:

“an analytical, technological, or computational function, algorithm, model, correlation matrix, or similar method or process that optimizes for, predicts, guides, forecasts, or directs investment-related behaviors or outcomes in an investor interaction.” 

This would basically encompass EVERY analytical function performed by covered entities, including e.g., quant traders’ algorithms, portfolio optimizers, and on and on and on. Basically any use of statistical methods is implicated (note the reference to “correlation matrix”).

Perhaps the “investor interaction” language will limit this to principle-agent applications (as bad as that would be), but it is so broad that it is highly likely that the SEC will interpret it to cover, say, an HFT firms algorithms to predict and analyze order flows. That involves “an investor interaction.”

This all brings to mind previous regulatory initiatives to require disclosure of all trading algorithms–something that was mercifully killed.

And what will the SEC do with this information? This would represent a massive amount of highly technical information that the SEC would not have the capacity or expertise to analyze proactively, and information that would metastasize inexorably. Hell, even storing the information would be a challenge.

Again, like the climate reg, this seems all pain no gain. This disclosure would entail massive cost. And for what? To find an agency violation needle in a massive informational haystack? Agency violations (such as trading ahead) that could not be detected using existing methods?

But that’s not all!

Gensler also looks askance at exchange volume discounts. Why? Because NO FAIR:

“Currently, the playing field upon which broker-dealers compete is unlevel,” said SEC Chair Gary Gensler. “Through volume-based transaction pricing, mid-sized and smaller broker-dealers effectively pay higher fees than larger brokers to trade on most exchanges. We have heard from a number of market participants that volume-based transaction pricing along with related market practices raise concerns about competition in the markets. I am pleased to support this proposal because it will elicit important public feedback on how the Commission can best promote competition amongst equity market participants.”

Volume discounts are obviously pervasive throughout the economy in the US and indeed the world. So why should these be somehow so nefarious in stock trading as to require their elimination?

Let’s apply some economics–which alas is an alien concept to Gensler. There are two basic reasons for volume discounts.

One is that it is cheaper to service bigger customers. In which case volume discounts are efficient, and banning them would be unambiguously bad.

Another is that it is a form of price discrimination. For example, big intermediaries may find it easier/cheaper to shift business between exchanges than smaller intermediaries, in which case their demand for the services of a particular exchange would be more elastic than the demand of the smaller firms. Exchanges would then rationally charge lower prices to the more elastic demanders.

The welfare effects of this type of price discrimination are ambiguous, making the case for banning it–even if it can be established that the volume discounts are demand-elasticity-driven discrimination vs. cost-based discrimination–ambiguous as well.

With respect to “concerns about competition,” well, elasticity-based discrimination requires that inter-exchange competition not be perfect in the textbook sense. But if that is what is driving the volume discounts, outlawing them treats a symptom of market power rather than market power itself, and how “imperfectly competing” exchanges will price when they can’t price discriminate is very much an open question–and exactly why the welfare effects of price discrimination are ambiguous.

Gensler seems to be channeling discredited Robinson-Patman like logic that protected the high cost against competition from the low cost. That is anti-competitive, not pro-competitive.

These are only some of the monsters the Frankensteinian Gensler is assembling in his DC laboratory. I could go on, but you get the idea.

There is hope, however. Whereas Gensler’s CFTC actions were largely rooted directly in very specific statutory directives, his work as Dr. Frankenstein is based on extremely expansive interpretations of the SEC’s statutory authority dating back to the 1930s. Such expansive interpretations–not just by the SEC, but many other agencies–are currently being challenged in the courts, including cases pending before the Supreme Court.

It is possible therefore, and indeed to be fervently hoped, that the Supreme Court will hand down decisions that demote Gensler back to Igor implementing very specific Congressional mandates, and end his career as regulatory Frankenstein.

And the benefits of such decisions would extend beyond reining in the SEC, for as bad as it is that agency is probably not the worst offender–the EPA probably is, but the competition for this dubious honor is intense. The administrative state–the American Mandarinate, as I like to think about it–needs to be culled. And with extreme prejudice, and as soon as possible.

The Treasury basis trade continues to be in the news, with one of the biggest basis traders–Citadel’s Ken Griffin–complaining that the SEC should regulate hedge fund basis trading, but should instead make sure that banks aren’t supplying too much leverage to . . . well, hedge funds mostly. This seems like a raising rival’s costs gambit. No doubt restrictions on leverage would hit Griffin’s competitors harder, whereas SEC regulation might have a more even impact.

Regardless, one question that hasn’t been asked in all the to-ing and fro-ing about Treasury basis trades is why they exist at all, let alone why they get so big. This graph (courtesy of FTAlphaville, based on CFTC data) provides a major clue:

Note the mirror image between leveraged funds (mainly hedged funds) and asset managers (ostensibly non-leveraged funds–the reason for the “ostensibly” will become clear shortly).

To the extent that hedge funds’ short positioning reflects basis trades, the graph suggests the following. Hedge funds take a leveraged market neutral position, buying bonds, funding them via repo, and selling futures. Futures are in zero net supply: the graph shows that the longs on the other side of the hedge funds’ futures short are asset managers.

Most asset managers do not, and in some cases even cannot, take leverage directly. So for example they are constrained in their ability to just buy Treasuries with borrowed money (e.g., via repo). But the basis trade allows them to lever up via futures. So in some sense, the basis trade is just an additional link in a chain of intermediation. Laundering leverage, if you will.

(A more complete picture might add swap dealers to the picture. Some managed money, such as leveraged ETFs, enter into swaps with dealer banks. The dealer banks in turn can hedge by taking offsetting futures positions.)

The hedge funds expect to earn a small margin on the trade–on average, though there is risk. The market is pretty competitive, so to a first approximation that margin (the difference between the actual futures price and the theoretical futures price derived from bond prices, bond vols and correlations, and repo rates) equals hedge funds’ marginal cost of supplying this intermediation. The asset managers on the long side of the futures trade are willing to pay “too high” a futures price (relative to bond prices) because this is a cheaper way of achieving a leverage target than via the available alternatives.

The March 2020 experience shows that the basis trade can be a fragile one that creates some systemic risk: this is why regulators are concerned about basis trades now, to Ken Griffin’s chagrin. Providing this leverage intermediation/laundering creates tail risks for the hedge funds that do so. This raises the question of whether there are regulatory constraints that inefficiently constrain the ability of asset managers to take leverage more directly, rather than via a longer dealer (or money market) to hedge fund to asset manager chain. If so, such constraints could give rise to unnecessary (systemic) risks.

If regulators are concerned about the systemic risks in basis trades, they should take a systemic approach–and understand more fully why basis trades exist in the first place, and why they have periodically become so large. Looking at individual links in the chain (hedge funds, or by Griffin’s lights, banks) can be misleading because it begs the question of why the chain exists in the first place. The link that is driving the process is likely the one that has escaped discussion so far–the asset managers at the end of the chain. Why do they want leverage and why is the basis trade the most cost effective way of supplying a lot of it? Could it be the most cost effective because other, more directly intermediated sources of leverage are unduly expensive because of regulatory or institutional constraints? Definitely worth regulators’ attention.

The market for United States Treasury securities (notes and bonds) has been a source of concern for some years, dating back to the Treasury “flash” event of 15 October 2014, but especially in the aftermath of the “dash for cash” during the March 2020 Covid scare. The relentless selloff of Treasuries in the past year plus has contributed to the angst.

This has led the SEC to propose various changes to the structure of the Treasury market. The most important of these is mandated central clearing of most Treasury cash trades and repos. Well, since Gigi is back in the clearing saddle, I guess I have to mount up too.

The main justifications of the mandate come from Darrell Duffie and various collaborators at the New York Fed (notably Michael Fleming). The IMF has also produced an analysis outlining justifications of the mandating of clearing.

Just as with the Frankendodd clearing mandates, the case for Treasury clearing is very weak.

The basic argument is that Treasury market liquidity has eroded, and that clearing will enhance market liquidity. The supposed main cause of the decline in liquidity is that primary dealers face balance sheet constraints that limit their ability to intermediate the Treasury market.

In the Duffie paper and the Duffie, Fleming et al paper he cites, the main evidence of the deleterious effects of balance sheet constraints comes from the “dash for cash” in March 2020. Summarizing a variety of measures of market liquidity using principal components analysis, they show that liquidity usually varies inversely with market volatility, but liquidity declined far more than predicted by volatility alone in 2020. This was due, it is claimed, to the fact that dealers were not able to increase their holdings of Treasuries due to balance sheet constraints. Their ability to make markets was therefore constrained.

There is a big problem with this analysis. Dealers ended up holding far more Treasuries because Covidmania caused a sharp drop in the demand to hold Treasuries by hedge funds and others–they wanted to substitute cash for Treasuries. Part of the demand drop was accommodated by a price decline, but evidently dealers’ demands did not drop as much as the demands of non-dealers: thus, there was a major portfolio adjustment, with hedge funds etc. reducing their holdings and dealers absorbing as much of these sales as their balance sheets allowed.

Thus, this was a structural change in demand that led to major portfolio adjustments. Yes, the portfolio adjustments were accompanied by a decline in conventional measures of liquidity (bid-ask spreads, depth, etc.) but this decline in liquidity was a consequence of the underlying shock, and clearing of cash Treasuries or repos would have had little, if any, impact on this decline. Even if clearing increased dealers’ balance sheet capacity (something I discuss further below), given the underlying Covid-driven (and Covid policy-driven) demand shock it is highly likely that this incremental capacity would have been fully utilized as well and liquidity would have been about as bad.

This extraordinary shock that led to strained dealer intermediation capacity is different than the types of shocks that dealers typically intermediate. The role of Treasury liquidity suppliers–be they dealers or prop trading firms–is the same as the role of liquidity suppliers in any other market, be it stocks or currencies or commodities: to utilize inventory adjustments (balance sheet) to absorb temporary, temporally uncorrelated, and largely cross-sectionally uncorrelated investor (buy side) demand shocks. The dash for cash was a long-lasting shock highly correlated across major investors in Treasuries. It was a systematic shock that led to a long lasting adjustment in dealer portfolios, whereas market makers absorb idiosyncratic shocks that do not require long lasting adjustments to dealer portfolios.

That is, the kind of portfolio adjustments that occurred in response to Covid were fundamentally different in nature from the kind of portfolio adjustments that firms undertake to make markets. A long term transfer of risk rather than a short term transfer.

Therefore, using the dash for cash as the basis for policies intended to improve Treasury market liquidity is fundamentally misguided.

Be that as it may, it provides the underlying logic advanced for clearing mandates: improving liquidity requires increasing dealer balance sheet capacity, and clearing can supposedly do that.

How can clearing improve balance sheet capacity? The mandate defenders offer that hardy perennial as a justification: netting. For both cash Treasuries and repos, the argument goes, netting out offsetting exposures reduces the amount of capital and cash that dealers require to intermediate. For cash transactions, Duffie, Fleming et al estimate that netting would reduce daily settlement volumes substantially (70 percent in March 2020 according to their figures). This, and other factors, allegedly result in freeing up of dealer balance sheet capacity.

This analysis begs an important question: since dealers would internalize the benefits of more economical use of balance sheets that would result from clearing, why is it necessary to mandate it? Why don’t dealers and other market participants voluntarily utilize clearing more extensively in order to economize on the use of a scarce resource–balance sheet? After all, historically voluntary adoption of clearing in the stock market (e.g., NYSE clearing and CBOT clearing in the 19th century) was specifically intended to reduce settlement volumes by netting. In the case of the CBOT, the clearinghouse netted payment obligations but did not mutualize credit risk on derivatives transactions or impose margins (which were negotiated bilaterally).

The alleged failure of profit-motivated entities to reduce cost (from inefficient use of balance sheets) suggest that this does not come for free: at the margin there must be some cost for clearing that is greater than the putative benefit. That is, profit maximizers will balance marginal private benefits and marginal private costs. The benefits of netting from clearing are private, and thus the current degree of penetration in clearing likely reflects an efficient balancing of these marginal benefits and costs. The advocates of a mandate surely have not shown otherwise.

I further note that, as I wrote repeatedly during the Frankendodd era, netting redistributes default risk rather than reduces it. It is by no means clear that the distribution of default risk under central clearing/netting is more efficient than that under bilateral clearing.

Put differently, the advocates of clearing (both cash and repo) have not identified a “market failure”, e.g., a benefit from clearing that market participants do not internalize. Such a failure is a necessary (but not sufficient) condition for regulatory intervention such as a clearing mandate.

With respect to repo clearing, another supposed benefit is the disparity of margins (“haircuts”) in the repo market. Haircuts for some counterparties are low, but for others they are higher. Central clearing would impose uniform, value-at-risk (“VaR”)-based margins.

The operative theory behind central clearing is that the “loser pays”, namely the resources (margin, default fund contribution) posted by a counterparty is sufficient to cover any losses in the event of that counterparty’s default. Ideally, counterparty credit risk in central clearing is zero, though in reality some always remains.

Well, this begs another question: is the optimal amount of counterparty credit risk/default risk zero (or close to zero) in all transactions? Relatedly, is it optimal not to permit the pricing of counterparty credit risk, where the price varies by the creditworthiness of counterparties, with high credit quality entities paying smaller haircuts than lower quality credits? Central clearing makes pricing independent of creditworthiness, whereas bilateral arrangements that advocates of clearing dislike allow pricing of credit risk that reflects assessments of creditworthiness of counterparties.

Since credit risk mitigants (including margins/haircuts) are costly, and since market participants trade-off the costs and benefits of credit risk and its mitigants, allowing choice and competition on this dimension has strong justifications. Certainly the advocates of mandatory Treasury clearing have not identified a “failure” in this market that justifies regulatory intervention in the form of clearing mandates.

Put differently, clearing mandates force market participants to a corner solution–clear everything, and impose margins that make counterparty credit risk de minimis. The existing state of the market, where market participants can choose to clear with a CCP or not, reveals that they strongly do not prefer the corner solution. Furthermore, the advocates of clearing have failed to identify any market failure that implies that the interior solution/equilibrium is inefficient and can be improved by mandating the corner solution.

And the advocates have yet again failed to recognize the trade-off inherent in clearing: that is, the trade-off between counterparty credit risk and liquidity risk. This despite the fact that the reality of this trade-off has been made abundantly clear (no pun intended) repeatedly in the past–and including in particular the Treasury market basis trade turmoil during the dash for cash.

The real issue in Treasury markets right now, and the real threat to their stability, is the massive deficits in the United States, and the resultant increase in Treasury security issuance and Treasury securities outstanding. It is deficits and issuance that are driving the massive increase in the size of Treasury markets, and the consequent strains on the ability of dealers and others to intermediate the swollen market.

This is a challenge that no rearranging the market structure furniture on the deck of SS Treasury Titanic will fix. Furthermore, the economic case for mandating clearing of Treasury cash and repo transactions is laughably weak even if one overlooks that fact that clearing does not get at the real problem. But it appears that Gigi (cheered on by the Fed) will mandate a corner solution that makes the market less efficient, not more.