Streetwise Professor

The European Commission released its “Communication to a Cast of Thousands” on “Ensuring efficient, safe and sound derivatives markets: Future Policy Actions.”  It is, at best, a series of policy proposals based on nothing more than assertions delivered from on high.  These assertions are both logically dubious and completely empirically unsupported.

The main policy recommendations are to force the bulk of derivatives trades into centrally cleared platforms and exchange trading.  This will be accomplished by margin and capital requirements, and mandates.

At one level, the EC report identifies the appropriate objective: to encourage market structures that “allow markets to price risks properly” (p. 2).  However, it provides neither theoretical nor empirical support for its assertions that its policy actions will in fact improve risk pricing.  At root, its argument is that centralized price setting dominates decentralized price setting.

As has been known since Hayek and his peers, the relative efficiency of centralized vs. decentralized price setting depends crucially on the information available to those setting the prices.  Recognition of the crucial issue of information is completely lacking in the EC document.

The Olympian tone of the document is well summarized by the statement that it is adopting a new regulatory approach “where legislation allows markets to price risks properly” (p. 2).  In other words, it is legislation that is the essential determinant of whether markets price risks properly or not.  As if.

The document states “the proposed measures will shift derivative markets from predominantly OTC bilateral to more centralised clearing and trading.”  Putting all this together means that the EC is asserting that the existing market structure is history’s greatest market failure.   One would think that such a sweeping claim would require some supporting evidence and theory.  The EC document provides none whatsoever.

The assertion that markets have systematically failed to price risks occurs throughout the document.  For instance, it says: “the function of prices to allocate resources must be restored: derivatives should be appropriately priced in relation to the systemic risk they entail.”  The necessity of a “restoration” implies that: (a) the market has done a bad job in pricing these risks in the past, and (b) regulators can do better going forward.  Although one may agree with (a), it is essential to avoid the Nirvana fallacy: the crucial element of a policy recommendation is the comparative performance of imperfect markets and imperfect regulators.  Thus (b) is the crucial issue.  Sadly, the EC consistently falls prey to the Nirvana fallacy, and asserts without providing the least support that of course regulators will do it better than markets.

The document reeks of the Olympian disdain of Eurocrats in love with their own superiority.  It is the Nirvana fallacy distilled into 9 pages of text.

For instance, we get pearls like: “Such contracts will continue to be cleared bilaterally with counterparties exchanging collateral to cover their exposure.   However, current collateral levels are too low.”  What is the basis for such an assertion?  Who knows?  And, even granting the possibility that some collateral levels may be too low, there is also the possibility of setting them too high.

You’ll search in vain trying to find any reasoned discussion of (a) the relative costs of excessive or deficient collateralization, or (b) the information available to regulators and market participants that they can use to set these levels.

The document suggests that initial margin levels “will be specific to counterparty characteristics.”  This has to mean measurable characteristics.  But what information does a regulator have to measure the counterparty characteristics necessary to set initial margin levels?  Is that information better or worse than the kind of information that large dealers have?  I have very strong priors on the answer to that question: the dealers.

If you think differently, fine.  But before you decide, I suggest that you consider the entire credit rating agency fiasco, in which credit risk evaluations based on measurable characteristics were made by a small number of (centralized) entities.  Not only were these evaluations systematically flawed (thereby raising similar concerns that regulatory decisions regarding initial margin levels will be so too), crucially they were extremely brittle because of the lack of diversity in evaluations and the information on which they were based.  Thus, the errors the agencies made had broad systematic effects.  In contrast, a more diffuse mechanism for establishing initial margins, in which multiple agents possessing different information evaluate counterparty risk and price it appropriately is less susceptible to such systematic errors.  Since systematic errors can translate into systemic risk–as the AAA CDO disaster demonstrated–this is a very serious concern.

Bad pricing of relative counterparty risks across transactors will lead to a misallocation of trading activity and counterparty risk exposure across them.  Those whose counterparty risks are underestimated will trade too much; those whose risks are overestimated will trade too little.  These errors are inevitable, so the crucial question is what sort of market arrangement will minimize the costs of these errors.

This depends on the information available to those making the decisions.  In my view, major dealers will almost inevitably have more information individually than would a central regulator or clearinghouse.  Moreover, since in a market structure like that has evolved heretofore numerous entities are collecting information and making these judgments, there is the possibility of the aggregation of diffuse private information.  This possibility is absent in a highly centralized structure.

Put differently: the EC (and its American counterparts) are acting as if they had never heard of the socialist calculation controversy.  (Which is probably true–all the worse for them if so.)  Namely, how does a central agent set prices in a world with diffuse private information about costs and value?  Information about counterparty risk is highly diffuse, and largely private.  How can a central agent set the “right” prices in such an environment?  Can markets do it better (even if not perfectly)?

We have all too much experience with the defects of central price setting as compared to decentralized price setting in markets (cf. the USSR) to be at all confident with the relative superiority of centralized counterparty risk pricing.  At the very least it is incumbent on the advocates of such a centralized approach to address seriously the possibility (demonstrated by vast experience in many contexts) that centralized price setting in derivatives markets will founder on the same information problem that has wreaked havoc with other efforts to set prices centrally.  Tragically, they don’t even acknowledge the problem, let alone provide a convincing analysis supporting the contention that centralized pricing will dominate private, decentralized pricing.

Similar problems are inherent in the EC’s recommendation of differential capital charges for cleared and non-cleared derivatives contracts.  Again, what is the basis to believe that the regulators have the information to set this differential (or the levels) properly?  This ability is blithely assumed in the EC report; again this crucial issue is not even acknowledged.

It does not inspire confidence that the EC paper invokes the authority of the Basel Committee on Banking Supervision as the model for the setting of capital charges.  That would be the source of the same Basel rules that made it very attractive for systemically important financial institutions to load up on AAA CDOs.  We all know how that worked out.  Another illustration of the socialist calculation problem in action.

Beyond the complete failure to engage the fundamental informational questions, the paper says things that cast serious doubt on the competence of the EC to make such sweeping changes to financial markets.  For instance, there is a statement in the paper that strongly, strongly suggests that the EC does not understand the first thing it is talking about.

Specifically, on p. 6, it asserts, in a completely conclusory way, with no supporting evidence or argument whatsoever, that counterparty risks of “contracts that are cleared on a CCP” are lower than “the counterparty credit risks of those [contracts] where clearing is done bilaterally.”

If one defines counterparty credit risk as being the probability distribution of default losses, this statement is completely wrong.  Holding positions and the portfolios of the transacting parties constant, the probability distribution of default losses is the same between centrally cleared and bilateral contracts.  All central clearing does is change the allocation of those default losses across market participants.  That is, holding the market and credit risk exposures of market participants constant, the total dollar amounts of defaults is the same in every state in the world in cleared and bilateral markets.  Clearing changes the allocation of these given dollar losses across market participants, not their magnitude, or their probability distribution.

It is possible that this re-allocation of risk can be efficiency enhancing, but that is not a given.  Moreover, the fact that the EC apparently believes that CCPs somehow make counterparty risk magically disappear, it is almost certain that it has not thought seriously about the efficiency implications of this reallocation.  Why think about allocation of something that you believe won’t exist due to some form of financial alchemy?

This raises very serious concerns.  Read literally, the EC document implies that the Commission believes that clearing makes default risk disappear.  This is wrong, wrong, wrong.  It is understandable that someone operating under such a delusion would be very enthusiastic about clearing.  It should also be understood, however, that the enthusiasm of someone operating under a delusion is very, very dangerous.

The foregoing analysis assumed that positions would be the same in cleared and bilateral regimes.  However, the adoption of central clearing will almost certainly affect the sizes of positions that market participants take.  This, in turn, will affect overall default risks, and the allocation of these risks.  Indeed, given that clearing involves the mutualization (i.e., socialization) of risk, there is the distinct possibility that the effect of these changed positions will be to increase total default exposures; mutualization means moral hazard, and moral hazard tends to encourage risk taking.  Although CCPs can control this risk taking through margins, this is costly.  I have pointed out in my academic work that clearing can lead to increased overall risk exposures for other reasons as well.  Not that you would know this from reading what the EC–or any American official–has said on the subject.

Nor would you know that under certain types of structures, default losses borne by systemically important institutions can be higher under clearing because under these structures, CCP members guarantee customer trades, whereas in a bilateral market customer counterparties of a defaulting firm suffer default losses.  This is part of the allocational aspect of clearing, and means that systemically important institutions that backstop CCPs can actually suffer greater default losses in a cleared market than they would absent clearing.

I must say again: the case for forcing changes in market structure, most notably forcing adoption of clearing through either carrots (differential margin and capital charges) or sticks (mandates) has not been made.  Not in the least.  The key issues have not even been raised, let alone addressed.  The informational challenges that clearing poses have been assumed away.  Policies based on ignoring core issues do not inspire confidence, to say the least.

Sad to say, the Olympian, arrogant, government-knows-best attitude embodied in the EC paper is also manifest in the pronouncements of US regulators.  Most notably, Gary Gensler of the CFTC has come out in favor of trying to force virtually all trading onto exchanges and clearing.  And none of the arguments he makes in support of this view–none–grapple with the fundamental informational issues.

Unless and until those advocating a radical restructuring of the financial infrastructure, complete with implicit and explicit government pricing of counterparty risk, acknowledge and address the informational and incentive challenges associated with such a change, there can be no confidence that the change will be a beneficial one.  Indeed, given the sorry experience with centralized, hierarchical, regulatory price setting mechanisms in environments where information is private and diffuse, the odds favor the opposite result.

When make cartoon arguments for clearing (and for exchange trading), I have a sinking suspicion that the results will be anything but funny.

None.

By all appearances, both the US and Europe are on the fast track to a complete restructuring of the financial system based on a shockingly incomplete understanding of the true trade-offs.  In so doing, we are laying the groundwork for the next crisis, and a loss of efficiency until that crisis materializes.  Heaven help us.

Old hat to SWP readers (I wrote about this repeatedly from last December through March), but apparently “news” to the NYT:

While OPEC members limped through a period of painful production cuts this year, Russian oil companies enjoyed an extraordinary run.

The year that has gone by since Russian officials floated — and then retracted — a proposal to coordinate production limits with the Organization of the Petroleum Exporting Countries illustrates why the Kremlin is unlikely ever to actually do so.

Already the world’s largest oil producing nation, Russia, pumping prodigiously through the downturn, this summer passed another milestone. As Saudi Arabia tightened its belt to live by OPEC cuts, Russia surpassed it to become the world’s largest exporter.

. . . .

Improbably, the once-neglected oil sector has emerged as one of Russia’s few growth industries, helped by the tax cuts, a devaluation of the ruble that aided exporters and a change of policies that may invite foreign companies back into the sector.

“OPEC made a concerted effort to stem its exports,” said Alex Fak, an oil analyst at Troika investment bank in Moscow. “The result of that action was higher oil prices. So Russia was encouraged to produce more and sell more. Which is what it did.”

Yet, for a time, officials had seemed ready to revise the long-held axiom that Russian national interests were not served by cooperating with OPEC. Sharp price declines had turned Russian oil companies, just a few months earlier seen as money printing presses for the government, into money losers. Far from propping up the Russia government, which relies on oil exports for about 40 percent of its budget, they needed help themselves.

Anyone who really believes that Russian officials were ready to cooperate with OPEC is incredibly credulous.  The Russians are notorious for playing double games, and for double crossing.  I just wonder if OPEC was as credulous as the New York Times.

So, here I lie, flat on my back, having taken a full-speed run at the derivatives regulation football, only to have Barney Frank snatch it back at the last minute during markup.  In contrast to the proposed OTC derivatives bill I praised a couple of weeks ago, the bill as passed by Frank’s committee includes both a clearing mandate, and an exchange trading mandate:

The committee, headed by Representative  Barney Frank, a Massachusetts Democrat, is set to complete action today on the legislation, which would require many derivatives transactions to go through central clearinghouses. The administration wants to subject broker dealers such as  JPMorgan Chase & Co.and derivatives users such as  American International Group to new margin, collateral and disclosure requirements.

. . . .

Frank plans to offer today an amendment that would mandate trading on exchanges or swap execution facilities for standard contracts between dealers and their biggest customers. Barr called that provision “essential.”

As I’ve written repeatedly, here and elsewhere, I believe that both of these provisions are deeply misguided.  I won’t belabor the argument, which the interested reader (or those suffering from insomnia) can find by searching the site or clicking the derivatives category link.   I will just say again that Frank is reinventing the wheel, as an exchange trading mandate was the magic bullet of derivatives reform in 1922.  It eventually proved unworkable, and will do so again–only much, much faster.

Raising the cost of managing risk will lead to greater risks.  It’s not that complicated.

Economics of Contempt (a lawyer and former Dem legislative aide) says that Frank sandbagged the dealers:

Frank really sandbagged the dealers with his exchange-trading amendment. The dealers support a central clearing requirement for standardized swaps, but not an exchange-trading requirement (with at least some justification). Frank’s discussion draft had only required central clearing, and then he surprised everyone on Wednesday with his amendment requiring exchange-trading. It was a politically savvy move if Frank was planning to require exchange-trading all along—don’t give the dealers time build up opposition to the amendment and it’s much more likely to pass. My sense is that Frank simply changed his mind at the last minute, for whatever reason.

“Changed his mind at the last minute, for whatever reason.”  A 180 degree turn at the last minute!  With no substantive reason given!  That’s the way to determine the fate of the world’s largest financial markets!  I feel so much better now.

Barney–I take back every nice thing I said about you.  Indeed, I’ve upped my grandfather’s exchange rate of attaboys taken away per attaboys given from 10 to 100.  Or 1000.

Many clearing/exchange trading developments in the news.  Unlike Barney and Geithner and Gensler and the clearinghouse mandate herd in the US, the Europeans are getting nervous about forcing things:

anks should be “incentivised” but not forced to shift privately-negotiated derivatives contracts onto exchanges to cut risk, the European Union’s executive will say next week, according to people familiar with the situation.

The European Commission is expected to publish a policy discussion paper on regulating the $450 trillion over-the-counter (OTC) derivatives markets on Oct. 20.

“I think they want to keep it a reasonably high level so they have room for manoeuvre. Expectations for October 20 were for more detail but the industry will be disappointed,” a source with knowledge of the paper said on Tuesday.

The largely unregulated market includes credit default swaps (CDS), which are used to bet on whether a company will default on its bonds and have been blamed for amplifying last year’s severe financial crisis that hammered economies worldwide.

The Commission published a preliminary paper in July which focused on the need for standardisation and central clearing of CDS contracts, saying the case has yet to be made on mandatory exchange trading.

“It hints at exchange trading by using the word incentivising transition to try to get more use of standardised products,” the source said of next week’s paper.

The July paper was more open on the issue of exchange trading, only saying it needed further study.

Incentives would likely comprise heavier capital charges on banks which trade OTC contracts that are not standardised or centrally cleared, the source added. Cleared contracts already have a zero weighting for capital requirements.

The latest paper is also expected to push for greater transparency and for a central data repository. It reflects global efforts to regulate derivatives and other lightly supervised parts of the system.

I critiqued the EU’s July report when it came out.  If this report is to be credited, the Europeans seem to have adopted the basic approach I have been advocating–more reporting, no clearing mandate.  But then, I said that about Barney Frank too, so I’m not holding my breath.  In any event, I will read the EU report that comes out tomorrow with interest.

The “incentivizing” approach has some problems too, though.  “Holding more collateral”  is a very general concept.  The key thing is choosing just how much, and how much that varies across products, and crucially–since collateral is all about counterparty risk–how much that varies across counterparties.  Choosing the wrong levels, and choosing the wrong relative collateral levels across deals and counterparties can make things worse rather than better.

The collateral rules will induce gaming and strategic product design to mitigate collateral impacts.  Moreover, as demonstrated in the case of “AAA” CDOs, incorrect choices of capital haircuts can lead financial institutions to take highly correlated positions (i.e., hold essentially the same instruments because their capital charges are too low) that actually exacerbate systemic risk.  Moreover, it is important that relative collateral charges be appropriate across cleared and non-cleared products.  If non-cleared products are charged too much, it could increase the risks that clearinghouses face, and if they don’t price their risks properly, this can also contribute to systemic risk.

I am deeply, deeply skeptical that regulators have the information and knowledge necessary to set these charges.  This is a price fixing exercise.  When have governments EVER demonstrated that they have the information, knowledge, and incentive to set the levels of prices properly, or to set relative prices properly?  “Hold more collateral” sounds great in theory, but is a real source of potential systemic risk when one remembers that you have to specify exactly the amounts of capital every market participant must hold against every instrument, and when one remembers further that setting them wrong can be worse than not setting them at all.

Looking backwards to fix the causes of earlier crises frequently results in a failure to comprehend how the supposed “fixes” lays the groundwork for the next crisis.  Regulation of collateral levels could well do just that, in the same way as Basel capital requirements were a major contributor to the last crisis.

In one last piece of clearing news, the Frank bill also attempts to micromanage the organization, ownership, and governance of clearinghouses:

Derivatives legislation approved by a U.S. House panel yesterday would prohibit swaps dealers such as  Goldman Sachs Group andJPMorgan Chase & Co. from collectively owning more than 20 percent of a clearinghouse.

“An inherent conflict exists between broker dealers and clearinghouses and exchanges,” Representative  Stephen Lynch said when he introduced his provision on Oct. 14. “Brokers and dealers should not be able to capture trading and clearing intermediaries.”

. . . .

The amendment on clearinghouses would restrict swap dealers, “major swap participants,” and any “person associated with a swap dealer or major swap participant” from collectively controlling more than 20 percent of the voting rights in a facility used to clear derivatives contracts. It also would limit membership on boards of the clearinghouses and establish other rules aimed at limiting conflicts of interest.

This restriction on ownership and governance could have serious unintended consequences.  Remember what clearinghouses are.  They are mechanisms to share risk–default risk, in fact. It is well understood that there is typically a close relationship between control rights and cash flow rights/risk exposure (e.g., the ubiquity of 1 share-1 vote).  This makes good economic sense (as Grossman and Hart demonstrated years ago).  A mismatch between risk exposure and control rights means that those with the control don’t bear the full costs of their decisions: the risk is borne by others.  That is a recipe for excessive risk taking and other distorted decisions.

The traditional clearinghouse involves big intermediaries sharing counterparty risk, and since they bear the risk, they control the entity.  This suggests that there will likely be an equilibrium response to the proposed restriction on control rights; firms whose control rights are limited will likely similarly limit the risk exposure they are willing to take.  So, if the big dealers and major trading firms (e.g., hedge funds) that are deemed major swap participants are limited in the control they can exert, they will almost certainly similarly reduce the risk that they will absorb.

If these big dealer firms don’t absorb the risk, who will?  What alternative risk sharing model does the committee have in mind?  I am highly skeptical that the traditional clearinghouse mutualized risk sharing model will work with this governance model.  So what risk sharing model will be used instead?  Will public shareholders bear the risk (through their equity investments)?  That is, will clearinghouses become more like stock insurance companies, rather than mutuals?  Is this wise, given the survival value that the mutual model has demonstrated in clearing over the years?  (If sharing of default risk through the equity markets was the wise thing to do, why hasn’t this been utilized more in the past?)

And the big question: Is there the slightest reason to believe that those who proposed and voted for this restriction have thought even superficially about its consequences?  (I amuse myself sometimes.)

Here we have the spectacle of people who probably hadn’t even heard of clearing a year ago presuming to impose by legislative fiat the most detailed rules specifying what must be cleared, how it must be traded, and how the clearinghouses are organized to do their business.  These decisions will have huge consequences, almost certainly all of them unanticipated and unintended.  And many of these unintended consequences will almost certainly be adverse, perhaps extremely so.

Again, the metaphor of the Sorcerer’s Apprentice comes to mind.  These people think that they are in control, but they are not: they are in fact unleashing forces beyond their control, and the effects are not likely to be good.

That Sergei (“The Tarantula”*) Lavrov shot down in flames Hillary Clinton’s attempt to get Russia to agree to tough sanctions on Iran. Actually, I’m not.  I would have only been surprised if Lavrov and Putin had expressed a willingness to do something serious.  I would like to ask, though, that anyone who did fall for Medvedev’s showing a little ankle on this to email me at [email protected].  Have I got some deals for you!

And if anyone is confused on this, consider that Putin has also expressed his deep, deep concern for those oh-so-fragile Iranian psyches, and is recommending that nobody do anything that might scare the poor dears:

Russian Prime Minister Vladimir Putin Wednesday warned major powers against intimidating  Iran and said talk of sanctions against the Islamic Republic over its nuclear program was “premature.”

Putin, who many diplomats, analysts, and Russian citizens believe is still Russia’s paramount leader despite stepping down as president last year, was speaking after U.S. Secretary of State Hillary Clinton visited Moscow for two days of talks.

“There is no need to frighten the Iranians,” Putin told reporters in Beijing after a meeting of the Shanghai Cooperation Organization.

“We need to look for a compromise. If a compromise is not found, and the discussions end in a fiasco, then we will see.”

“And if now, before making any steps (toward holding talks) we start announcing some sanctions, then we won’t be creating favorable conditions for them (talks) to end positively. This is why it is premature to talk about this now.”

Premature, premature, premature.  Manana, manana, manana.  Get the picture, Hillary?  Russia ain’t going to do jack to pressure the Iranians.  Move on to plan B, or C, or whatever one we’re on now.

So just what did we get for the unilateral shafting of the Poles and Czechs?  Just asking.

For an interesting contrast, watch Putin and Russia deal with China. Putin traveled to China to announce big energy deals with great fanfare.  Everything is agreed!  Uhm, except the price.  Details, details.

China has shown no interest whatsoever in agreeing to the same oil-based pricing formula as Gazprom employs in its European sales contracts.  Given the bilateral monopoly condition that would characterize any Gazprom/Russia-China deal, the same sorts of issues that I addressed in my take-or-pay post will make any Russia-China agreement very hard to negotiate and enforce.  So, I wouldn’t hold my breath in expectation of such a deal any time soon.

It is very interesting to note, though, how much more difficult it is for Putin and Russia to deal with China than the Europeans.  The old standby divide-and-conquer gambits that routinely work with the Euros are not an option in dealing with China.  Putin doesn’t look quite so smart or powerful in dealing with a single, hardheaded negotiating partner as he does in rolling divided, squabbling, and politically vulnerable Europeans.  If the Euros were smart they would watch, learn, and imitate.  Note that this is a conditional statement, not a prediction.  I doubt that they will.

Roman Kupchinsky at Jamestown notes that the Chinese are also quite concerned about the Russian ability to deliver on all the blank gas checks they’ve written–a point I’ve made repeatedly on SWP:

[T]he main concern analysts have is Russia’s ability to supply 68 bcm of gas per year to China while meeting long-term commitments to European customers as well as rapidly increasing Russian domestic demand for gas.

Earlier this year, Gazprom announced that gas from the Sakhalin-1 project will not be sold to China, but diverted instead to the gas hungry Russian Far East region of Vladivostok.  Gazprom is holding talks with Exxon about buying all of its gas output from Sakhalin and industry sources say the company is offering prices equal to Russia’s domestic gas prices – which are far below world prices. Exxon said it is studying all options to sell gas from Sakhalin-1.

In addition to making promises to supply China, Gazprom has also stated that it wants to capture  10 percent of the U.S. gas market within the next 5 years by selling some 66 bcm of gas in the form of LNG. The plan envisions that Sakhalin-2 will supply the bulk of this LNG.

The bottom line is whether Russia is capable of building such costly pipelines as Nord Stream, South Stream and a second string of Blue Stream; while at the same developing the Yamal peninsula into a major gas producing center and finishing the Shtokman project? These projects, and others too numerous to mention, are projected to cost hundreds of billions of dollars which Russia does not have and which Western companies might not want to spend given the shaky business reputation of Gazprom and its management.

Exactly.  The Chinese presumably extracted something from Putin in exchange for letting him put on this Potemkin/Putinkin-goes-gas display.  But China will almost certainly not rely in a serious way on Russian promises of future energy supplies, because it understands that Russia’s ability to perform on its commitments is so doubtful.  If it does enter into agreements with Russia, it will likely impose contractual terms that will shift the major risk of non-performance due to the inability to obtain the necessary supplies to the Europeans.  Yet more reason for the Euros to get their act together.

* I am counting the seconds until the eruption of howls of protest from Cutie Pie at this arachnomorphism.

Exactly 36 minutes after I wrote this:

At least Barney Frank has made a step towards understanding the intricacies of something as complex as clearing.  Would it be too much to hope that he keeps pulling on the string until the entire case for clearing mandates unravels?  Probably.

Matt Leising at Bloomberg sent me this:

Legislation proposed by U.S. Representative  Barney Frank would weaken an Obama administration  guideline requiring the most common private derivatives to be traded on exchanges or regulated systems.

The Massachusetts Democrat, who heads the House Financial Services Committee, released a  draft bill Oct. 2 that allows for no change in how standardized over-the-counter derivatives are currently traded as long as they are reported to regulators. The Obama plan, released in August, specifies “mandatory trading” on exchanges or swap-execution platforms that would have to be registered with the Commodity Futures Trading Commission or the Securities and Exchange Commission.

“Nothing will really change” the way trades are executed under Frank’s draft proposal, said  Kevin McPartland, a senior analyst in New York at TABB Group, a financial-market research and advisory firm. “There’s no reason, at least that I can see, why anybody would go to an exchange.”

Moreover, Frank’s proposed bill does NOT mandate clearing, although it does empower the CFTC to require clearing of some contracts:

The Commission shall monitor swap activity and transaction data  and by rule or regulation identify specific swap contracts that it determines are required to be cleared  consistent with the public interest, after taking into  account the following factors:

[List omitted.]

I keep having this mental image of Barney Frank falling off a horse on the way to Damascus.

In brief: no clearing mandate, but mandated reporting of derivatives trades to a central data repository.  Just what I’ve been advocating on this blog, and in my writings (such as here).  CFTC has the power to mandate clearing, but that’s a far different thing than a Congressional mandate.

Color me shocked.  Pleased, but shocked.

But not everyone is pleased.  CFTC Chairman Gary Gensler for one is put out by the lack of a clearing mandate:

Gary Gensler, the CFTC chairman, said he was concerned about a provision in the legislation to require securities and futures regulators to determine on a contract-by-contract basis whether a particular swap needed to go through a transparent clearinghouse.

“I believe it is best for a clearinghouse that is managing its risk to determine if a particular product should be cleared,” he commented.

Gensler pointed out that an Obama administration proposal for derivatives regulation has a presumption that if any standardized product was accepted for clearing, it and all future iterations of the product must go through a clearinghouse, which is an intermediary between the buyer and seller of the swap.

Gensler and legislators support permitting tailored swaps to continue to trade on the over-the-counter market as long as they meet new reporting, record-keeping and capital requirements.

The CTFC official also took issue with a measure in the Frank proposal that he believes could exempt a broad range of entities from the definition of “major swap participant” and help them avoid regulation.

“The discussion draft, perhaps inadvertently, widened this exception such that the major swap-participant category would exclude any entity entering into a swap for risk-management purposes,” Gensler said. “This could have the unintended consequence of exempting a broad range of entities from the definition of a ‘major swap participant’ and thus exempt such entities from regulatory requirements outlined in the proposal.”

I’d say I feel your pain, Chairman, but I’d be lying.

I am still astounded at this development.  Now if only Geithner, Gensler, Collin Peterson, the Senate Finance and Ag Committees, etc., see the light and experience their own conversions we’d be really getting somewhere.  Hey, a boy can dream, can’t he?  I mean, if Barney Frank comes around to my way of thinking, anything is possible.

Needless to say, I doubt there are many things that Barney Frank and I agree on.  There is still great potential for mischief in a lot pending before his committee.  But, for now I will avoid what my inimitable grandfather called “handing out attaboys one at a time and taking ’em back five at a time.”

For now, I’ll just say: ‘attaboy, Barney.

The gas trade in Eurasia is conducted primarily under “take-or-pay” contracts, which obligate the buyer to pay for the contracted amount, regardless of whether they take the gas or not.  The Russians buy from Turkmenistan under take-or-pays, and sell to Ukraine and Eastern and Western Europe under such contracts.

Problem is, nobody is taking or paying.  Ukraine renegotiated its take-or-pays under the threat of neither taking nor paying.  Russia infamously balked on its take-or-pay obligations to Turkmenistan, and in so doing, caused an explosion in Turkmenistan’s pipeline system.  Both countries are still at loggerheads.  Now Europe is balking at paying the Russians:

Europe’s three largest purchasers of Russian gas – German E.ON, Italian ENI and Turkish Botas – have all challenged Gazprom over paying for deliveries of gas that they contracted for but did not take due to reduced demand in 2009.

These three, along with other European companies, all have long term “take or pay” contracts with Gazprom. According to  Kommersant Daily the total amount due to the Russian concern is approximately $2.8 billion.

The European’s point out that Russia made a deal with Ukraine that released the later from paying the full sum of contracted gas earlier this year and they insist on the same treatment. The companies also point out that Russia did not pay Turkmenistan any compensation whatsoever after it ceased taking delivery of Turkmen gas in April.

Once upon a time take-or-pays were common in the US too.  An excellent paper by Scott Masten and Keith Crocker in the AER in 1985 argued on classical transactions cost economics grounds that these contracts were to protect site specific investments in gas wells.  In those days, gas was purchased by pipelines that both transported the gas, and served as merchants: they bought the gas at the wellhead and sold it to industrial users and municipal utilities.  Given the natural monopoly aspects of gas transportation, this “bundling” of merchant and transport functions created a potential for holdup.  Once a well was in the ground, the (usually one) pipeline capable of shipping the gas could opportunistically demand a lower price, particularly when demand was low.  Masten and Crocker showed that take-or-pay was like a pre-packaged expectations damages clause that gave the parties an incentive to perform when the buyer would otherwise have an incentive to breach.

Seismic shifts in the gas business resulting from the perverse effect of price controls; the energy price shock of the 1970s; and the subsequent deregulation of gas prices by Reagan in the 1980s; combined to wreak havoc with these contracts in the 1980s.  Many pipelines had entered into huge take-or-pays in the 1970s when there were widespread fears of gas shortages and energy prices skyrocketed.  When prices plummeted, these contracts were extremely burdensome to the buyers, who sought any way to escape their obligations.  Moreover, the disparity between contract prices and market prices provided incentives for end users to try to buy gas directly from producers, and somehow secure the ability to transport the gas.

In the end, the entire structure of natural gas regulation collapsed.  Starting in 1986, the Federal Energy Regulatory Commission passed a series of orders that “unbundled” the merchant and transportation functions of pipelines.  Essentially, pipelines became regulated common carriers obligated to provide open access transportation to anyone who was willing to pay the tariff rate.

Soon thereafter, a vibrant gas market developed.  In place of negotiated contracts between big buyers and big sellers, there developed a whole array of markets, including daily markets, monthly markets, longer-term markets, futures markets, and swap markets.  Long term, take-or-pay contracts went the way of the dodo because every seller could contract directly with many buyers (who could get access to transportation), reducing the potential for holdup and opportunistic breach.

In brief, take-or-pay was largely an artifact of the integration of the pipeline transportation and marketing of gas.  Once pipelines became open access common carriers, these contracts became unnecessary, and buyers and sellers relied on more market-like arrangements.

Nothing like that is in prospect in contracting for pipeline-transported gas in Eurasia.   This is primarily true because the mother of all bundled gas companies–Gazprom–sits at the center of everything.  Indeed, Gazprom wants to extend its integrated activities into downstream marketing.

With an integrated Gazprom in the middle, European buyers cannot contract with Turkmenistan directly, meaning that the Turkmen need some contractual protection against expropriation.  Similarly, with all its specific investments in pipelines and producing fields, Gazprom is potentially vulnerable to holdup and opportunistic, inefficient breach, by buyers.  There is unlikely to be any prospect for the development of a vibrant gas market resembling that of the US anytime soon given the integrated, monopolistic market structure, particularly in Russia.

This also means that pricing mechanisms in contracts will have to rely on relatively inefficient proxies, like lagged oil prices.

But, as current events demonstrate, and as events in the US in the early-80s showed, take or pay contracts are also subject to breach when contract prices diverge from market values.

Things are not likely to change for the foreseeable future because Putin has announced his intention to retain the integrated, export monopoly structure of Gazprom:

Russia will maintain gas giant Gazprom’s (GAZP.MM) export monopoly in the medium term but will seek to liberalise the domestic gas market, Prime Minister Vladimir Putin said on Tuesday.

“In the near future we will try to liberalise the domestic market…, will try to liberalise access to pipelines. But the monopoly for sales on external market will be maintained…in the medium term for sure,” Putin said.

If in the long run we’re all dead, I guess in the medium run we’re all old.

It is an interesting question as to why Russia relies on an export monopoly to extract rents, rather than other mechanisms.  For instance, as in the oil market, Russia could permit open access to its pipelines and permit direct contracting between buyers and sellers, but charge a hefty export tax.  It does something analogous to this in oil.  Alternatively, it could permit direct contracting and open access common carriage, but instead of setting tariffs at levels sufficient to provide a competitive rate of return, it could set them at monopolistic levels and extract rents that way.

Both mechanisms would like be more efficient than the current system, with an integrated export monopolist.  These mechanisms would involve deadweight losses from monopoly/monopsony pricing, but would mitigate the transactions costs associated with the current structure.  Under these schemes, markets for gas could develop that would price efficiently, and which would be more flexible and less susceptible to the kinds of misalignments so evident today.  That is, transactional hazards would be mitigated under such alternatives.

So why not do it?  I have some cynical explanations.  Most importantly, the current opaque and convoluted system maximizes the potential to siphon off rents to private/siloviki pockets–or should I say the private accounts of public officials?  The tax alternative would result in monies going to the government; not that government monies are immune from theft, but it is likely easier to divert the money directly from Gazprom.  Moreover, it would give more folks a license to look into the company’s operations.  It would also expose those in Gazprom who do shady things to try to circumvent the taxes to the risk of ending up in a jail cell next to Khordovsky.

Similarly, the creation of efficient markets and fixed tariffs would make Gazprom’s finances much more transparent.  People would have a better idea of Gazprom’s real revenues, and the efficiency of its operations.  The company’s finances would be a lot simpler, and given this simplicity it would be easier to detect the diversion or tunneling of funds.   Put differently, an unbundled pipeline company with a regulated tariff provides fewer–though not zero–opportunities for theft than an immense corporate octopus engaged in all sorts of opaque deals.  The merchant function in particular permits all sorts of deals with shady intermediaries that can be–and almost certainly are–used to divert monies into silovik pockets.

Given these realities, it is likely that the Eurasian pipeline gas market will continue to be burdened by high transactions costs and inefficient contracting practices.  Contractual breaches and supply cutoffs will be chronic, especially when gas values move a lot one way or another.  In contrast, the open access US market has shown its ability to deal efficiently and rapidly with extreme shocks to supply and demand conditions.  But Gazprom ain’t going open access in the medium term, and in my view, in the long term either barring some miraculous change in the political economy of Russia.

Congressional proposals regarding derivatives on carbon dioxide subject these products to the most onerous regulatory regime: they require trading on exchange, just like derivatives on agricultural products.  This probably reflects the fact that those legislators who are most concerned about carbon vapor are the same ones who get the vapors from derivatives.

The International Emissions Trading Association has warned against such a cramped regulatory regime:

The rules for buying and selling pollution credits under a proposed U.S. “cap-and- trade” program shouldn’t be tougher than those being debated in Congress for other markets, the  International Emissions Trading Association said today.

Geneva-based IETA, whose members include  Chevron Corp.,American Electric Power Co. and  Goldman Sachs Group Inc., said in a  report that “future financial services reform legislation should supersede the carbon market oversight provisions” of any cap-and-trade legislation that passes Congress

. . . .

Some lawmakers have expressed concern that a new U.S. carbon market may be more vulnerable than others to manipulation and fraud. They are considering special rules for the cap-and- trade program that would restrict OTC dealing in futures and other derivatives contracts, block the involvement of banks and impose price controls.

‘Out of Step’

These proposals are “out of step” with the new regulations being considered for other markets, IETA said. The group said concerns over manipulation and fraud can be dealt with through “stringent disclosure requirements of all OTC transactions” to the Commodity Futures Trading Commission.

The group said while lax oversight can enable fraud, “overly cumbersome oversight rules can discourage market participation, stifle investment, raise compliance costs, and threaten the program’s environmental performance.

The IETA concerns are quite sensible: the very onerous regulations in the Waxman-Markey (ACES) bill are not.

I’ve written in detail about the problems with the ACES regulatory scheme in a piece for the Brookings Institution that will be coming out in a volume later this fall.  It is available online now (follow the link).

Here are some of the arguments I make there, in brief:

Manipulation of carbon derivatives would not be impossible: even though the costs of delivery are theoretically zero (involving only book entries), just as in Treasury markets there will be frictions that can be exploited by a manipulator.  However, it is better to deter such manipulations ex post than attempt to prevent them by imposing tight trading regulations.

Moreover, an exchange trading requirement will prevent many market participants from realizing the risk management benefits of derivatives.  Most firms that face carbon price risk (in the event of the adoption of a cap and trade scheme) will face long-lived exposures that interact in a complex way with other risk exposures.  For instance, in a cap and trade world a power plant faces risks from power prices, fuel prices, and the quantity of power generated, as well as carbon prices.  Moreover, these exposures are likely to be non-linear in nature (due to the options inherent in plant operations, like the ability to turn it on and off, and perhaps fuel switching options).  In addition, they are likely to be very long-lived, because the plant is long-lived.

In contrast, most liquid exchange traded derivatives are simple, vanilla, linear products (forwards) with short maturities, or simple vanilla options with shorter maturities.  These are not well-suited to managing the complex risks that many carbon-intensive companies are likely to face.

Furthermore, the costs of rigid mark-to-market collateralization are high, and many market users could avoid these costs by trading customized OTC products.

This all means that requiring only exchange trading of carbon derivatives is likely to greatly increase the costs, and reduce the effectiveness, of carbon price risk management.  This will force firms exposed to carbon risk to bear risks that cost more for them to incur than it would cost the potential counterparties of customized derivatives.  By impeding efficient risk transfer, onerous regulations will increase the costs of a cap and trade system.

This is bad public policy.  Congress should be looking for ways to mitigate the costs of a CO2 trading system, not increasing them.  Impeding carbon risk management would do just that.

The joys of dealing with Putin’s Russia.

First, from Stratfor:

The Israelis also understand the Russia factor. Russia is engaged in an ongoing struggle to win Washington’s recognition of its influence in the former Soviet region. So far, the United States hasn’t given Russia what it wants. Consequently, Russia continues to flaunt the leverage it has with the United States over its ties to Iran. Not only can Russia completely destroy the effectiveness of a U.S.- led sanctions regime, but it can provide Iran with critical weapons systems that could seriously complicate an attack against Iran down the road. The Israelis simply are not seeing the value in delaying much longer.

Israel therefore is leaning heavily on the United States to reach some sort of compromise with Moscow and bring the Russians in line on the Iran issue.

Russian President Dmitri Medvedev made a statement on Wednesday that might indicate that such a compromise has a chance — however slight — of happening. “I told the president of the United States that we think it necessary to help Iran make the right decision,” Medvedev said, with just the right touch of ambiguity. “As for various types of sanctions, Russia’s position is very simple, and I spoke about it recently. Sanctions rarely lead to productive results, but in some cases, the use of sanctions is inevitable. Ultimately, this is a matter of choice, and we are prepared to continue cooperating with the U.S. administration on issues relating to Iran’s peaceful nuclear program, as well as other matters.”

This is a notable shift in tone coming out of Moscow, but does not yet signify that a deal has been made between the Americans and the Russians that would alleviate the crisis over Iran. Our Russian sources are hinting that something bigger may be under way, but they also have made it clear that this is just the beginning of negotiations. One source in particular has indicated that thus far, Washington is at least considering a Russian demand to postpone the U.S. deployment of a Patriot air defense battery in Poland. In return, Moscow would stick to its pledge to delay delivery of the S-300 strategic air defense system to Iran. In essence, this would be a mutual commitment to postpone commitment to their strategic allies.

A few comments.

First, many US commentors and Obama cheerleaders have seized on Medvedev’s words–which Stratfor rightly characterizes as ambiguous–like drowning men grasping at straws.  Note: (a) Medvedev doesn’t matter, Putin does, (b) there is so much wiggle room in this statement it means nothing, and (c) there are more examples of Russian now-you-see-it-now-you-don’t, Lucy-and-the-football dekes than it is possible to count.  There’s a sucker born every minute, and anyone who relies on Medvedev’s words is a sucker indeed.

Second, note Medvedev’s use of the phrase “Iran’s peaceful nuclear program.”  That is, he does not even concede acknowledge that Iran’s program is explicitly intended to develop a nuclear weapon.  Given Russia’s enabling of Iran’s nuclear ambitions, this isn’t surprising.  But note that this formulation gives Russia a perfect escape valve from supporting any sanctions: why would you impose sanctions on a “peaceful” program.  Until Russia officially and unambiguously acknowledges that Iran’s nuclear program is military in nature, there is no reason whatsoever to place any reliance on Russian support against Iran.

Third, note the disgusting, revolting immoral equivalence here.  Iran=Poland.  On the one hand: A totalitarian dictatorship that supports terrorism; a virulently anti-American and anti-Western regime; a Holocaust celebrator (not denier); an aggressive, irredentist nation; a crazed, millenarian theocracy.  On the other: a democracy that has supported the battle against terror and tyranny; pro-Western and pro-American; a nation that has grappled with its anti-Semitic past; a nation that is merely looking to defend itself from the predations of outsiders rather than dominate others; a religious, but politically secular country.

Contra Obama, and pace Mark Steyn: Nations should be–must be–defined by their differences.  The differences between Iran and Poland are so stark that the foregoing list barely even scratches the surface.  To treat Poland as a bargaining chip with the Russians in dealing with Iran is beyond disgusting.

And note: the Russians will just take any concession and ask for more.   Note very well: when it comes to Eastern Europe, the former Soviet space, and Poland in particular, Russia wants the United States to make very public concessions so as to undermine American credibility among these nations, all the better to induce them to reach an accommodation with Russia: an accommodation that will effectively concede Russian suzerainty.

Iran is important.  But to make concessions to Russia in the vain hope of making progress on containing the Iranians would be a strategic mistake of historic dimensions, not to mention a deep stain on American honor.  (How’s that for Jacksonian, Steve?)

Russian grabbiness is not limited to the diplomatic sphere.  It also extends to energy.  (You’re shocked to read this, I’m sure.)  Yes, Putin the Spider (too bad his first name isn’t Boris) is more than willing to lure Western energy firms into his Arctic web, but on his terms:

This looks like a proposal to form a cartel-type arrangement of gas (mainly LNG) exporters through price-formation and market share allocation. Russia would provide the gas resources while international companies would provide the technology and, presumably, share in a commercial bonanza through this arrangement. Moscow probably hopes that some international companies would vie with each other to be picked for the project on this basis.

The conditions for participation would, however, force the international companies to turn over to Gazprom their own competitive assets and lose some of their revenue sources. As spelled out by Shmatko and Economic Development Minister Elvira Nabiullina, international strategic partners in this project would be asked to: transfer Western technologies for the manufacturing of advanced drilling equipment, onshore and offshore, to Russia; allow Gazprom direct access to gas markets in consumer countries, using the distribution networks of partner companies; recognize a right for Russian companies to acquire energy infrastructure on territories of consumer countries; and assist Gazprom with marketing methods and personnel training (Interfax, RBK, September 24).

So, Russia gives access to Yamal in exchange for: money, technology, expertise, access to Western domestic markets (which Putin knows will be protected by Western legal norms), marketing, and training.  And, rest assured, that access to Yamal and the goodies of the cartel arrangement can be taken away at a whim–and likely will be taken away once the gas actually flows.

In other words: asynchronous performance.  The Western companies do everything today: the Russians “promise” to do something later.  Another sucker’s game.

Will there be any suckers to play?  Sad to say, the answer is likely “yes.”  I would hope that anti-trust authorities in nations intending to import Yamal gas, and in nations whose companies would participate in the project, will subject any such agreement to intense scrutiny.

The energy majors–and the Europeans–would be much better advised to do things like ramp up exploration of shale gas in Europe than invest huge sums in Yamal.

One has to have some grudging admiration for Russia’s aggressive negotiating, given its fundamental economic, demographic, political, and social weaknesses.  By the same token, one has to have nothing but disdain for those who seem more than willing to be duped and pushed around by a has-been giant with feet of clay.

Russians have a reputation for being a dour, humorless people.  I know this is wrong.  There are some great Russian comedians; and no, I’m not talking about Yakov Smirnov.  Take Vladimir Putin–please.

Consider this comic classic: “Putin seeks stable and long term partners for Arctic investments“:

Russia wants foreign energy majors for “stable and long-term” partnerships to develop gas deposits on the Arctic peninsula of Yamal, a region with enough gas in the ground to satisfy world demand for five years.

Prime Minister Vladimir Putin, hosting executives from several international energy companies on Thursday, said Russia would consider tax breaks to encourage development of gas fields in the region. State giant Gazprom (GAZP.MM) backed the move.

“We would like you to consider yourselves participants in our undertaking,” Putin told a meeting in Salekhard, the capital of the Yamalo-Nenets region. “The main condition from our side is that partnerships should be stable and long-term.”

“The main condition from our side is that partnerships should be stable and long-term.”  From “our” (i.e, the Russian) side.  Stop it!  You’re killing me!  You’re one of the great dead-pan comics of all time!

Uhm, Vladimir.  Any “short-termism,” any “instability” that has plagued past western energy investments (and other investments, cf. Telenor), has one source, and one source only: your side.  Russian opportunism and expropriation.  And not just directed against foreigners, but against the unfavored in Russia too (most notably Khodorkovsky).

The Telegraph opines that this reflects Putin’s desperation, given Gazprom’s financial difficulties and limited technological expertise:

No doubt his guests salivated at the idea of getting a piece of the action. By 2020, Yamal is estimated to be capable of yielding up to 300bn cubic meters of gas annually. This compares with a total annual Russian production that currently stands at around 550bcm. State-owned Gazprom spends around 25pc of its capex on the Yamal fields.

But Gazprom is running late, and it’s running short – of both technology and money. It needs foreigners. The aim is to use the Yamal resources to become a major player of liquefied natural gas – which can be exported anywhere without the need for pipelines. Hence Putin’s friendly hand.

. . . .

But Western companies should pause and think. They’ve been burnt before – as when Shell was bullied out of the Sakhalin-2 gas project three years ago. Since then, the legal framework under which Western companies operate hasn’t improved a bit.

What has changed is Putin’s need for foreign capital and expertise. This would be a good thing if it were accompanied by more than words to reassure investors that their money is safe and that they can plan on staying in Russia for the long term, without the hassle of corrupt bureaucrats and judges. Westerners must seize the chance to extract serious concessions from Russia before they rush head-first into the great gas hope, in what otherwise risks being a triumph of greed over experience.

In one of my earliest SWP posts, I noted that fools and their money are soon parted, and that companies would be foolish to invest in specific assets in Russia–particularly in the energy sector, or any other sector deemed strategic.  With the experiences of Yukos, Telenor, Shell, TNK-BP, and arguably now Exxon behind them, western investors have to know that the likelihood that they will be parted from their money is very high if they fall for Putin’s come hither look, and get entangled with Gazprom in Yamal or anywhere else.

Put differently, Putin is the spider, and any investor would be the fly.  Putin may be desperate now, but once there is pipe in the ground and the gas is flowing, his (or his successors) desperation will disappear, and the temptation to expropriate will be irresistable.   Once caught in the Russian web, any foreign energy investor is likely to be the spider’s meal, sooner or later.

Like the Telegraph says, absent credible, enforceable legal safeguards, western investors should avoid Putin’s blandishments like the plague.  The existence of a resource is a necessary, but by no means a sufficient, condition for a profitable investment.  To profit, you must be able to protect the asset against the predations of the state.  These protections are completely absent in Russia.  STAY AWAY.

It is sometimes argued that, echoing Willie Sutton, energy majors have to invest in Russia because that’s where the oil and gas are.  But, Russia is the Willie Sutton of nations: it will rob energy investors because, as Willie said, that’s where the money is.  But only if they are foolish enough to put it in Putin’s reach.  If they do, it will be no laughing matter.

The CEO of the Australian Stock Exchange (ASX) hit the nail on the head.  Hell, he drove it right through the board:

The chief executive of the Australian Securities Exchange has criticised the Obama administration’s planned regulatory reforms of the US financial system, arguing they are “draconian” and out of touch with market developments.

Robert Elstone, head of the  ASX, said the reforms were too broad, targeting parts of the securities markets – such as the over-the-counter swaps market – that had not been big contributors to the global financial crisis. [Emphasis mine.]

Emphasized, because true.

More truthiness:

The best hope for regulators and governments, he said, was to develop market-oriented people and market-oriented skills to stay abreast of developments in the securities industries.

The OTC swaps market was already transparent, he said, adding that to compel that market to come “on exchange and be centrally cleared” was “overkill”.

“Compel” is the key word.  If somebody builds it, and the market comes, more power to them.  It’s the compulsion in the near complete absence of a plausible, let alone convincing, identification of a market failure that is deeply troubling–and the recipe for future trouble.

Legislators should be forced to watch this line played before their eyes, A Clockwork Orange-stye, until it penetrates their skulls:

“I think that the notion that any corporate or government regulatory agencies are always going to be one or two steps ahead of the market is a flawed notion.”

That’s worth repeating:

“I think that the notion that any corporate or government regulatory agencies are always going to be one or two steps ahead of the market is a flawed notion.”

Right now our generals in Washington are assiduously deconstructing the last war.  Not a good way to prevent the next one.  Especially inasmuch, as Mr. Elstone notes, they aren’t even properly deconstructing the last one.

Where’s our Robert Elstone?  Nowhere to be found.  Not in DC anyways.  And today, that’s where it matters.