Streetwise Professor

Today’s oil market, that is.   January Brent on ICE down 11.4 percent to $47.53/bbl.   January WTI on NYMEX down a mere 9.5 percent to $48.28/bbl.   And our favorite, Urals Med, down to $43.79/bbl in European trading.

The oil market continues its death ride strapped to the equity market.   This is historically unusual.   From 1985-2008, on average a 1 percent move in the SP500 was associated with a 0–yes zero–percent move in WTI.   That is, there is historically zero correlation between WTI and the SP.     In the summer of 2008, the correlation was negative–when the oil market went up, the stock market went down.   During this period, a 1 percent increase in the price of WTI was associated with about a .8 percent decline in the S&P.   This is consistent with supply shocks being the main driver of oil prices during that period.   An adverse supply shock raises oil prices and constrains economic activity, leading to lower stock prices.

What a difference a few months makes.   During October and November, oil and stock prices have been moving in the same direction, in a virtually unprecedented way.   A one percent change in the price of oil during these months is associated with a .85 percent change in the S&P   in the same direction, i.e., a one percent drop in the price of oil is associated with a .85 percent decline in the S&P.

In the past 20 years, the largest value of this coefficient is .4.   So, in the past two decades oil and stocks have never been even close to as highly correlated as they are now.

This all means that demand is now in the driver’s seat.   A decline in the S&P reflects bearish prospects for the economy.   Bad economy–low demand for oil–low oil price.

Today’s oil price bloodbath sure speaks volumes about the market’s assessment of the credibility of OPEC General Secretary al-Badri, who said today:

OPEC is ready to cut production by a significant amount when it meets later this month in Algeria, prompted by high oil inventories, the group’s secretary-general said on Monday.

“We are all geared toward a cut in Algeria,” Abdullah al-Badri told a news conference in Tehran, two days after the Organization of the Petroleum Exporting Countries decided at a meeting in Cairo to delay a decision on a new supply reduction.

Tell us another one, Abdullah!

Today’s plunge also speaks to those in Russia, and those bullish on Russia, who are counting on OPEC to ride to Russia’s rescue.   Don’t count on it, in other words.   To believe such is to grasp at straws in the tempest.

The market’s scoffing at al-Badri’s whistling-past-the-graveyard bravado reflects a clear-eyed appraisal of the realities facing OPEC.   As I’ve noted on SWP before, cartels in general, and OPEC in particular, face serious problems from cheating.   It is collectively rational to cut output to raise prices, but individually rational for each individual member country to produce more than its quota. This prisoner’s dilemma undermines cartel discipline, and means that cross-my-heart-hope-to-die promises to cut output are worthless.

Due to the sharp contraction in oil demand (as manifest in the decline in prices and the rapid growth of inventories), most OPEC countries are operating well below capacity.   This cushion would only increase were they to cut output in response to OPEC agreement.   They therefore have the ability and incentive to increase output beyond their quotas.   And believe me, they will.

This bodes ill indeed for Russia’s recovery.   The only somewhat gloomy World Bank report on the Russian economy, which predicted a slowdown in growth to 3 percent was predicated on an oil price of $74.45/bbl for 2009.   That is looking increasingly unlikely, meaning that the 3 percent growth number is similarly unlikely.

The first reliable indicators of damage to Russia’s real economy are also becoming available.   Manufacturing activity has declined more than in–wait for it–1998:

Russian manufacturing shrank more in November than during the 1998 financial collapse as the global economic crisis drove output and new orders to record lows and companies cut jobs, VTB Bank Europe said.

VTB’s Purchasing Managers’ Index fell for a fourth month to 39.8, its lowest level, from 46.4 in October, the bank said in an e-mailed statement today. The previous low was 43.2 in September 1998, a month after the government’s ruble devaluation and default on $40 billion of debt. A figure above 50 means growth, below 50 a contraction. The bank surveyed 300 purchasing executives.

“The sense of doom and gloom was only deepening,” in November, Tatiana Orlova an economist in Moscow at ING Group NV said by telephone. “The mood isn’t getting any better.”

Industrial production has slumped and unemployment is rising as declining commodities prices and the seizure of credit markets prompt an outflow of capital. Investors withdrew $190 billion from the country since August, BNP Paribas SA estimates, as oil fell below the $70-a-barrel average needed to balance the 2009 budget.

“Driving the rapid contraction of the manufacturing sector in November was a record fall in incoming new work,” the bank said in the statement. New export contracts tumbled because of “fallout from the global financial crisis.”

(Not that things are rosy in the US.   Here manufacturing dropped by the largest amount in 26 years–that is, since the Reagan-Volker recession.)

But nonetheless, the Russia Central Bank continues its insane policy of supporting the ruble, thereby accelerating the erosion in its currency reserves:

Dec. 2 (Bloomberg) — Russia’s central bank probably doubled spending of foreign reserves to defend the ruble from its biggest weekly plunge against the euro in more than four years, according to the median of 10 analyst estimates.

Bank Rossii may have sold $5.75 billion of foreign currency last week, based on the average of predictions ranging between $2 billion and $6.5 billion. That’s likely to contribute to a decline of about $6.25 billion in Russia’s overall cash pool, compared with $3.6 billion in the previous week, the survey by Bloomberg shows.

Russia lifted interest rates twice last month and drained $148 billion from the world’s third-largest reserves since August to stem a 16 percent currency slide against the dollar. BNP Paribas SA estimates that investors withdrew $190 billion since August as oil prices below the $70-a-barrel average needed to balance the 2009 budget triggered Russia’s worst financial crisis since the government’s default a decade ago.

“The central bank is willing to use reserves daily to make sure the ruble falls at their pace,” said Elina Ribakova, chief economist in Moscow at Citigroup Inc., which forecasts a 15 percent fall in the ruble next year. “I expect continued declines in reserves until the end of the year and into the next.”

Bank Rossii buys and sells foreign currency to keep the ruble within a trading band against a basket comprised 55 percent of dollars and rest in euros. Policy makers widened the band three times last month as the ruble lost 3 percent versus the basket.

The Russian currency weakened 2.3 percent against the euro last week, its biggest plunge since August 2004. It traded near the weakest in 2 1/2 years against the dollar yesterday.

Currency Gains

The government may have deepened the reduction of its reserves from $449.9 billion last week by transferring cash to state lender Vnesheconombank, said Tatiana Orlova, an economist in Moscow at ING Groep NV.

A $1.8 billion loan to Evraz Group SA, Russia’s second- largest steelmaker, may also appear in the reserves data for last week, said Katya Malofeeva, an analyst in Moscow at Renaissance Capital.

An acceleration of purchases of rubles from the reserve combined with the fact that the ruble continued to fall last week suggests that a speculative attack against the currency is gaining speed.   And Russia is getting what for this, exactly?   Letting the ruble go to find an equilibrium level consistent with the dramatically weakening fundamentals (i.e., a plummeting oil price) would ease the drain on the reserves, and would also help the country’s increasingly desperate manufacturing sector.   But it would represent a very public repudiation of the Putin’s main economic argument.   So, expect speculators to make money at Russian expense, and for most Russians to see exactly bupkus from the summer’s oil windfall.   Easy come, easy go.

So, to tie everything together.   The price of oil is a hostage of the financial crisis in the West, with the linkage between the oil price and stock prices tighter than ever.   Russia’s economy is hostage to the price of oil, with the linkage again arguably tighter than ever.   With no end in sight to the West’s economic travails, this means that economic growth in Russia in 2009–even 1 percent–is likely a pipe dream, and that an economic contraction is far more likely.

The only question is what will be the broader fallout of a sharp decline in the ruble (inevitable, sooner or later) and a recession in Russia, against the background of unrealistic expectations stoked by a government controlled media.   Will Russians behave in the stereotypical, fatalistic fashion, and accept yet another disappointment with resignation?   Or will this spark another of Russia’s paroxysms of political chaos?   The latter is not a certainty, but it cannot be ruled out.   And the more severe the contraction becomes, the more likely that outcome.

Those who have read SWP regularly will have deduced that I have a historical bent.   Although historians and economists (and other social scientists) tend to think and analyze problems in very different ways, I think that history is quite often a useful source of material on which to test theories and conjectures, and a source of inspiration and ideas useful in the generation of new theories and models.   It also frequently proves quite useful in debunking assertions about the necessity or sufficiency of a certain factor causing some outcome.

Today’s historical excursion examines a couple of episodes in the past relating to clearing.   Specifically, two occasions in which important exchanges, the London Metal Exchange and the Chicago Board of Trade, adopted central clearing under government pressure only after a long period of resistance.   In each case, the memberships and/or leaderships of these exchanges steadfastly refused to introduce clearing until forced to do so by regulators.   In each of these cases, the regulators’ rationales were tangential, at best, to the actual economic purpose and effects of a clearinghouse.   It seems that as various government entities are pushing a clearing solution for the CDS market that we are in the process of repeating history.

A central counterparty/clearinghouse was first adopted in the US in 1891 in Minneapolis.   From time to time in the following years, some members of the Chicago Board of Trade proposed that the exchange adopt the “Minneapolis Model.”   Each time, either the membership or the board of directors rejected these proposals.

All of the merits of central clearing were pretty well understood.   In particular, CBT members understood that clearing would reduce the amount of money that would be tied up in margins–although some considered this a bug, not a feature.

The standoff between the advocates and opponents of clearing continued literally for decades.   The impetus for the move that actually resulted in the creation of the Board of Trade Clearing Corporation originated in the passage of the Grain Futures Act of 1922.   This Act gave the Secretary of Agriculture considerable power over grain exchanges.   The Secretary could put an exchange out of business by revoking its designation as a contract market.

In 1925, William Jardine was Calvin Coolidge’s Agriculture Secretary.   He was convinced that large speculators were manipulating the grain markets, to the detriment of farmers, and wanted to do something to stop it.   In another foreshadowing of current events, Jardine was convinced that identifying who held large positions would facilitate deterrence.     He further thought that a clearinghouse would achieve this objective because it would require the registration of all positions in order to perform its work.

Of course, it would have been possible to register positions without creating a central counterparty.   Indeed, such a change to clearing procedures had been proposed, but not adopted, in 1911.

The directors of the CBT continued to balk at creating a clearinghouse, until two influential members of the exchange, L.F. Gates and J.C. Murray, who served on the exchange’s Grain Exchange Legislative Committee, wrote a letter warning of dire consequences if the exchange failed to act.   Gates and Murray said that failure to implement the clearinghouse plan could lead to a revocation of contract market status.   Stung into action by their warning, the directors approved the creation of a clearinghouse (and a Business Conduct Committee to police the exchange’s members.)

Jim Moser argues that Jardine’s pressure was not what caused the CBT to adopt the central counterparty.   He notes that the exchange could have satisfied Jardine’s demands for transparency by registering every trade, but not providing a central guarantee.   He concludes that the directors’ reluctance to adopt the CCP was based on privacy concerns that Jardine alleviated.   From this he infers that the directors’ objection to the clearinghouse was not the risk sharing aspect of its operation, but the possibility that its operation could result in disclosure of position information.

Perhaps.   But it seems that if there was a strong demand for risk sharing via a CCP, the exchange could have found away to address the privacy concerns.     Thus, another, and in my view more straightforward, interpretation of events is that there was not a uniform desire for a CCP, and there was strong opposition to the concept; and that Jardine’s threat to shut down the exchange compelled the directors to pacify him by adopting a method that he had endorsed–the Minneapolis Method.

That’s one of the problems with history–it seldom permits definitive answers as to cause and effect.   But regardless of the interpretation, the extreme reluctance of the Board to adopt a CCP suggests that the concept is not nearly as beneficial as its advocates suggest.   To be sure, there were legal and privacy objections, but (a) where there’s a will, there’s a way, and (b) it is often the case that explicit objections camouflage the true reasons for opposition.     And to me, the most straightforward interpretation of the facts is that the CBT adopted a central counterparty not because of its inherent economic benefits, but only as result of government pressure motivated by considerations completely unrelated to the costs and benefits of sharing default risks. The failure of the CBT to adopt a central counterparty voluntarily is consistent with the view that this method of allocating default risk has costs that exceed the benefits.

The LME was another exchange that adopted central clearing only when its very existence was threatened by government action.   The LME had suffered a major crisis in 1985-1986 with the collapse of the International Tin Council’s price support program.   Tin prices collapsed, contracts were breached, and many LME members suffered huge losses, with some closing their doors.   Prior to the Tin Crisis, the LME had been strictly a principals’ market, with all dealings done on a bilateral basis just as is the case in OTC markets today.   The LME clearinghouse was merely a mechanism for netting payments and deliveries, similar to a bank clearinghouse.   It was not a CCP.   Indeed, the LME had consciously resisted creation of a CCP for years after this practice had become standard in both American and British commodity markets.

Remarkably, the LME’s resistence to the idea continued after the Tin Crisis.   Thus, even a major series of dealer defaults was not sufficient to convince the membership that a central counterparty was a superior method of sharing default risks.   The LME adopted a CCP only after the newly formed U.K. Securities and Investment Board (SIB) made it clear that it would deny the LME its license to operate unless it introduced an independent CCP.

Most of the benefits attributed to CCPs are private benefits that accrue to their members–lower collateral, more efficient sharing of default risk, prioritization of derivatives counterparties over other creditors.   If this was all there was to the story, derivatives markets participants should adopt a CCP without fail.   But, as these historical episodes demonstrate, they don’t.   Indeed, they demonstrate that the resistance to the idea can be so strong that only intense government pressure can overcome it.   Thus, there must be more to the story.   There must be some costs sufficiently large to overwhelm the private benefits commonly attributed to a CCP.   These costs, unfortunately, are seldom–if ever–the subject of serious analysis.   They should be.   A reasoned judgment about the efficiency of a CCP must be predicated on a judicious weighing of both costs and benefits. Presumably 1920s grain traders and 1980s metals traders whose livelihoods depended on the efficient operation of their markets made such a judicious appraisal, and decided that the costs outweighed the benefits.   That should give advocates of CCPs pause, and spark a more thoughtful consideration of their full effects.

Throughout the period of explosive growth in OTC derivatives, market participants have arrived at a similar judgment.   The concept of clearing is well known.   The subject has been mooted–and rejected (for the most part).   That judgment should not be overridden without excellent justification.

Heretofore, that justification has been totally lacking, but government pressure to adopt a CCP for credit derivatives, and perhaps eventually other derivatives, is unrelenting.   There are repeated invocations of   “systemic risk” and the bandying about of scary (and often mixed) metaphors–“weapons of mass destruction,” “time bombs,” etc.   But the concept of systemic risk is never precisely defined, nor do the advocates of clearing of OTC derivatives present any serious argument as to how a CCP would reduce that which is scary (but undefined.)

Typically, the argument stops at “a CCP would net which would reduce replacement costs in the event of a default, thereby lowering the costs that other dealers pay when one dealer defaults.”   That argument is incomplete, not generally true, and arguably false.   It fails to recognize that netting just redistributes default costs from derivatives counterparties to other creditors, some of whom may be systemically important; it does not consider that the formation of a CCP may increase the sizes of positions that traders hold, thereby increasing the potential for default losses; it ignores the effects of a change in risk allocation on asymmetric information and the incentives to monitor counterparty risk; it overlooks the fact that a CCP, by effectively guaranteeing customer positions, requires dealers that are members of a clearinghouse to bear the costs of a defaulter’s entire net position (including trades done with non-member customers), rather than merely their direct trades with the defaulting member.

If systemic risks are an increasing function of the default losses that dealers incur, it is a straightforward exercise to create examples in which such losses (and hence systemic risks) are higher, rather than lower, with a CCP.   This is true even if one ignores the effects of asymmetric information.   The monomoniacal focus on netting obscures the myriad effects of the mutualization of default risk, and leads to a wild overestimate of the efficacy of clearing in reducing systemic risks.

The government forcing grain traders or metals traders to adopt an inefficient method of allocating default risks is bad enough, but the social costs of these actions were likely bearable because these markets were small in the scheme of things.   Forcing the adoption of clearing in the massive OTC financial derivatives markets is another thing altogether.   Here the costs of a mistake could be huge.   The incomplete and faulty analysis that is being used to justify the creation of a CDS CCP greatly increases the odds that its adoption would in fact be such a mistake.

The seeming compulsion to “do something” in the face of a burgeoning credit crisis threatens to hasten the implementation of an ill-considered plan with major systemic consequences.   Let’s hope that that compulsion is replaced by contemplation and measured action before it is too late.

Whenever oil prices move a lot, I field a lot of calls from reporters. Oil prices plummeted yesterday, so I was interviewed by NPR (Morning Edition) and for local Houston TV news. So for today’s listening and/or viewing pleasure (and I use that term advisedly):

Here’s the link to the NPR piece. Here’s the Houston Channel 2 10PM News piece (there’s a video link to the right.)

The Houston reporter mis-spelled my name as “Perron.” Hey, lose an “r” and marry a scheming blonde, and maybe I can become dictator of Argentina!

Another funny thing about the Houston interview. We did it in front of my place at around 615 PM, so it was dark. I was staring into a bright light, making me feel like I was being given the third degree in an old film noire. A neighbor drove by, and seeing the TV truck and presumably thinking that local news was covering a murder or something, shouted to the reporter (Daniella Guzman)–“What happened? Anything the matter?” Daniella responded: “Just interviewing your neighbor, who is an expert on oil prices.” To which I added–“Well, I play one on TV.” Always wanted to use that line.

Senator Thomas Harkin (D-for-don’t even need to ask, IA) has introduced legislation that would require all derivatives trading activity to take place on a futures exchange regulated by the CFTC.

That’s a really dumb idea, even from a senator.

The rationale for this move is somewhat inscrutable.   Harkin said:

The economic downturn in this country is forcing us to examine all contributing factors on our markets.   With the value of swaps at a high of some $531 trillion for the middle of this year — 8 1/2 times the world GDP [gross domestic product] of $62 trillion — it is long past time for accountability in the markets.

Can you say non sequitur?   I knew you could.

The Solon of the Sow Belt continued:

By regulating all futures contracts, the Derivatives Trading Integrity Act restores confidence in the markets and provides the soundness and integrity the financial system needs

And just how does it do that?   Does your assertion make it true, Senator?

Market participants and the instruments they trade are heterogeneous.   This heterogeneity can–and almost certainly does–make it efficient for multiple, differentiated trading platforms to exist side-by-side.   Heck, even the most homogeneous of financial instruments–the stock in a particular company–trade on different types of trading mechanisms in order to meet the diverse needs and preferences of investors with different information and preferences regarding the rapidity with which they want to trade.   Closely related instruments can trade on a variety of platforms.   For instance, cash Treasuries and Treasury futures trade using very different mechanisms.   In a nutshell, it is desirable to allow the development of a variety of different trading mechanisms (microstructures) to permit a discriminating match between the characteristics of the mechanism and the characteristics of the instruments and their traders.

Forcing a one-size-fits-all trading approach completely ignores this heterogeneity.     It will impose costs on market users, and may even serve to undermine their soundness and integrity.

I’ve argued repeatedly that with respect to clearing (i.e., default risk sharing) in particular, there is a strong case to be made that some instruments should be centrally cleared–but some should not.   Central clearing provides benefits, but it comes with costs due to asymmetric information.   Indeed, since market participants internalize most of the benefits from clearing, they have a strong incentive to adopt it unless there are even larger costs.

With respect to the soundness of the financial system, forcing central clearing can increase systemic risk.   Clearinghouses don’t price dealer balance sheet risk–dealer counterparties in bilateral OTC markets do.   Dealers typically have better information about the creditworthiness of their counterparties than a clearinghouse will.   Thus, they can price default risk more accurately.   Clearinghouses treat all members as if they are the same–even though they are not, having different balance sheet risks, for instance.   This equal treatment of the unequal tends to divert trading activity towards riskier firms more likely to default.   Reductions in collateralization reduce trading costs and encourage an expansion of trading activity.   At best, clearing redistributes the default losses, and this redistribution (away from derivatives counterparties to dealers’ other creditors) can exacerbate, rather than reduce systemic risks.

Market participants recognize all of these effects.   They imply that there are costs to central clearing, and the fact that OTC market participants have not adopted clearing for many derivative products is strong evidence that these costs exceed the benefits that clearing would provide them.   They certainly know more than a certain senator from Iowa.

There is a case to be made for creating a centralized database of derivatives trades.   This can be done, however, without forcing everything onto exchanges, or requiring clearing.

There is also zero evidence that the current financial problems were in any way caused by OTC derivatives trading.   Of all the implosions of financial firms, only AIG’s was directly attributable to derivatives trading.   Moreover, the much feared knock-on effects from the failure of a big derivatives dealer have yet to materialize, and won’t in my view.   The biggest problems in the financial system are attributable to securitization, and the collapse of real estate prices.   These, in turn, are traceable to a variety of sources (e.g., the Fed, lax banks)–none of which are the OTC derivatives market.   So, when bloviating about “contributing factors,” it would be worthwhile for the senator to take a serious look at what those contributing factors actually are, rather than reflexively blaming derivatives.   His criticism echoes the common descripton of derivatives as “financial weapons of mass destruction.”   (And, by the way, (a) if I hear or read that expression one more time as a QED-end-of-argument-substitute-for-analysis, I just may go postal, and (b) if Warren Buffet is so smart and has avoided taking undue risks, why has the CDS spread on Berkshire Hathaway blown out?)   The substitution of conventional wisdom for serious thought is intellectually lazy, and a recipe for policy failure.

The funny thing (in the laugh-to-keep-from-crying sense) about Harkin’s proposal is that it harkens (I’m so punny) back to Congress’s first regulations of derivatives markets in 1921-1922.   At that time, Congress required all grain futures to be traded on a “contract market”–i.e., an exchange–registered with and approved by the government (USDA at that time, later the CEA and still   later the CFTC.)   So, rather than come up with something new, Harkin resurrects an approach first trotted out when Ford was actually a vibrant concern–and Henry Ford I was running it.   I thought we were in the era of change–silly me.

That approach caused no end of problems as the pace of financial innovation picked up in the 1970s and 1980s, as it became increasingly clear that not everything SHOULD be traded on an exchange.   This led to a sequence of Rube Goldberg-esque attempts to reconcile the irreconcilable–the exchange trading requirement and the fact that not everything was most efficiently traded on exchanges. The passage of the much (and wrongly) maligned Commodity Futures Modernization Act eliminated the confusion and legal risk that the old approach had created.

In brief, forcing a one-size-fits-all approach is doomed to failure because it fails to take into account the heterogeneity of financial instruments and financial market participants.   We have the proof of experience that it is doomed to failure.   But nonetheless, Harkin is playing King Canute, trying to force markets to conform to his will.   Good luck with that.   All it will do is create opportunities for lawyers–and undermine the efficiency and arguably the soundness of our financial markets.

I am sure that it is just coincidence that Harkin is Chairman of the Senate Ag Committee, which has jurisdiction over the CFTC–which, under Harkin’s bill, would have regulatory authority over every derivative traded from sea to shining sea.   Think of the campaign contributions!   The thought never crossed his mind, I’m sure.

Like Lily Tomlin said, we try to be cynical, but it’s hard to keep up.

I find it somewhat curious that the Russian government would bail out the oligarchs by giving them state funds to pay off their debts to Western banks. If the ultimate objective of Putin, Sechin, and other siloviki is to reverse loans-for-shares, and effectively re-nationalize large corporations, there is a much more cost effective way to do so.

The shares of Deripaska, Fridman, and the others are held as collateral against their FX borrowings from Western banks. The fact that these oligarchs are facing collateral calls in the aftermath of plummeting stock prices means that the amounts due on the loans exceeds the value of the shares, and almost certainly by a lot. Giving state funds to meet the collateral calls means that the state is effectively keeping the shares out of the bankers’ hands by paying the higher prices that prevailed at the time the loans were taken. If the oligarchs default on the loans from the state, sure, the shares will fall into the mitts of Sechin, etc., but a lot of cash will have gone out the door to achieve that end.

So, why not let the oligarchs twist in the wind, default on their loans, and deliver up the share collateral to the banks? I doubt the banks have the slightest interest in holding large positions in these companies on their books. They’ll want to sell. Then use the state funds to swoop in and buy the stock at the current, depressed prices.

That’s a lot more cost effective than effectively paying the high prices at which the oligarchs margined the shares.

To summarize: Loan to the oligarchs, oligarchs default–the state gets the shares and pays the high price at which the shares were margined. Let the oligarchs default to the banks, buy back the shares at the current low prices. Result: Russian government gets the shares under either scenario, but pays a lot less to get them in the second one.

Doesn’t seem like a hard call.

Which suggests something else is going on.

One surmise: if Western banks get a large position in these companies for even a short period of time, they’ll want to do due diligence before selling their positions. That would involve pesky accountants turning over rocks, investigating contracts, examining subsidiaries, and in general, finding out where the cash comes in and most importantly where the cash goes out. Sure, Russian courts would attempt to stymie the process, but there’s no doubt that said accountants would discover some very, very interesting things. And we can’t have that, can we?

So, this suspicious mind hypothesizes that the ulterior motive for keeping the oligarchs’ shares out of Western hands at any price is that by failing to do so, Putin, Sechin, et al would run a serious risk of having some major tunneling schemes laid bare. And any guesses as to where those tunnels lead?

As for the argument that these companies are Russia’s “crown jewels”–please. I would be embarrassed to admit such a thing. RusAl is an aluminum company, for crissakes. Is Alcoa an Ameican crown jewel? If that’s the kind of company that is Russia’s hope for the future, things are worse than even I thought. Norilsk Nickel? Well, that’s a little better than aluminum, but not much. Steel companies? Come on, this is 2008, not 1938 or even 1958.

It is always suspicious when somebody seems anxious to pay more for something than they have to. That’s what the Russian government is doing by bailing out the oligarchs. The only thing the bailout seems to accomplish is keep prying eyes away from the books and operations of the oligarchs’ companies. I have a very difficult time of thinking of any benign reason why anybody would pay such a high price to do that.

Vladimir Putin has sharply criticized businesses and individuals that have taken capital out of Russia. Central Bank head Sergei Ignatyev seconds that emotion.

Central Bank Chairman Sergei Ignatyev backed Prime Minister Vladimir Putin’s call for stricter banking oversight by government, law-enforcement and financial authorities amid capital outflow.

“When there is a significant capital outflow, a more effective, tighter oversight of the situation is needed,” Ignatyev said Monday in comments broadcast on Vesti-24. Net private capital outflow reached $50 billion in October, he said, citing preliminary estimates.

Lenders that have received government funds meant to boost liquidity in Russian markets are increasingly transferring money abroad, Putin said during a government meeting Monday, according to Vesti’s web site.

He also on Monday warned against “corporate egoism,” saying that emergency funding must work “within Russia, as intended,” he said, Interfax reported.

Putin and Medvedev clearly desire to step capital flight, and various ideas have been mooted to achieve that objective in the aftermath of the $50 billion outflow in October. All of these ideas involve the employment of state power in one way or another.

Rather than attempting to stop the flow through capital controls, or by exerting pressure on Russian businesses and banks, Putin, Medvedev, and Ignatyev would be better served by stepping back and asking: “Why is capital fleeing the country at such a rapid clip?” But then again, they probably wouldn’t like the answer. It is a vote of no confidence in the security of capital from the predations of the state, in the the government’s policies, and the country’s investment prospects.

After a week of relative quiescence in both Russia and the West, economic tremors are being felt again. We are not through the woods yet. In this environment, the relative vulnerability of Russia to investor yips and the resulting capital flight are pronounced. Putin can attempt to command the capital to stop, but it won’t. Indeed, the more he attempts to impose additional controls, the more he will frighten investors about the security of capital, and the more desperate and creative they will become in their efforts to get their money out. Putin will have no more success in stemming capital flight than King Canute did in commanding the tides to cease. (And I am aware that there are alternative interpretations of the Canute myth, one being that he issued his famous command to rebuke flattering courtiers. That’s definitely not Putin’s motivation.)

In other, related news, Ignatyev also conceded that the Ruble is likely to fall:

“I do not rule out more flexibility in the ruble exchange rate with some tendency toward a weakening of the ruble against some foreign currencies in the current conditions,” Ignatyev said.

That’s central banker-speak for “Going Down!” And the market reacted, right on cue, with the Ruble selling off almost 4 percent (for December delivery) on the CME, and the Ruble spot down about 1.8 percent.

Here’s my interpretation, FWIW. The currency is the most visible indicator of economic conditions and confidence in the Russian economy and the government’s management thereof. Regardless of what Russians see on TV, they will know things are not going well if the Ruble continues to depreciate. From an internal political management perspective, I doubt the government wants to see a substantial decline in the Ruble. Such a decline would alert people to the severity of the economic situation, give the lie to the soothing “it’s not our problem” rhetoric coming from the Kremlin, and represent a repudiation of the government’s management of the economy.

But macroeconomic considerations, capital flight, and especially the decline in the price of oil will make it extremely difficult to defend the Ruble. The fundamentals are not auspicious. Moreover, Russian corporations and oligarchs, including those near and dear to the Kremlin and the White House (on the Moskva, not the Potomac) owe substantial amounts–in hard currency–to Western banks. Margin calls and debt repayments will force Russia to choose between dipping into hard currency reserves to pay off the debt, or letting the companies fall into foreign hands.

Russia has large currency reserves compared to 1998, but the demands on those reserves are much greater too; state debts are much more modest, but private and corporate debt is massively greater, and is secured by assets that the Kremlin is loath to lose control of. I see the willingness to let the Ruble decline despite the political dangers this entails as an admission the $500+ billion in reserves is insufficient to defend the currency and pay off foreign creditors, especially in the face of a likely extended slump in oil prices. Given this Hobson’s choice, Putin and Medvedev have chosen to keep Russian companies in Russian hands, and to let the currency take care of itself; the political fallout will be managed by, uhhmmm, other means, most likely.

As I said some time back, the financial crisis is showing that “$570 billion can evaporate in a trice.” It may not evaporate in Russia, but it will decline steadily and perhaps precipitously in the coming weeks and months. And it is coming pretty clear that it will go primarily to Western banks to keep them from obtaining big stakes in Russian corporations, rather than to defending the currency. Ordinary Russians will pay a price, in terms of higher prices for imported consumption goods, and domestic substitutes.

I know there are very few new things under the sun . . . but although I’ve read a great deal about clearing, I don’t think that I’ve seen anyone point this out: The main benefit commonly attributed to a central counterparty (CCP)–netting–effectively gives derivatives counterparties a priority in bankruptcy that they would not otherwise possess. As a result of the effective change in priority, the initiation of clearing transfers wealth from CCP members’ other creditors to their derivatives counterparties (who include CCP members.) That is, in dollar terms, formation of a CCP is not a positive sum game (although it can be from the perspective of the CCP members), but a zero sum game. CCP members win at the expense of the other creditors of their members.

This has important implications. Advocates of centralized clearing argue that netting reduces systemic risk by reducing the cost of replacing defaulted derivatives positions. In a bilateral market, counterparties must replace all of the defaulter’s out-of-the money positions; with a CCP, they replace only the net positions. Since replacement is costly (as the counterparties lose in-the-money positions and replace them with new ones of zero value), netting reduces the losses counterparties incur, thereby reducing the likelihood that the counterparties will in turn default; that is, netting reduces the susceptibility of the market to a “daisy chain” of defaults.

Or does it? What about the other creditors? Netting eliminates an asset: the dealer’s in-the-money derivatives positions that are net against some or all of its losing positions. Without netting, both derivatives counterparties and other creditors would have a claim on this asset. With netting, the asset disappears, meaning that the other creditors cannot use it to satisfy their claims against the bankrupt dealer. Thus, netting favors derivatives counterparties at the expense of other creditors.

This means that holding the dealer’s position constant, netting engineers a transfer of default loss, not a reduction of total default loss. It only does so when one considers only derivatives counterparties, and ignores the defaulter’s other creditors.

This has implications for systemic risks. Perhaps netting reduces the possibility that a dealer’s default will cause derivatives counterparties to default, but it increases the likelihood that its other creditors will face financial distress, and perhaps bankruptcy. The defaulter’s other lenders may include banks, hedge funds, money market funds, commercial paper investors, and so on. These lenders may also be systemically important, in the sense that their financial distress can have ripple effects, or trigger a cascade of subsequent defaults.

It is therefore by no means obvious that the ultimate effect of the formation of a CCP is a reduction in systemic risk exposure. Netting redistributes the wealth effect of a default. Unless derivatives counterparties are uniquely systemically important, netting can actually worsen systemic risks.

These points can best be illustrated by an example. Large dealers typically buy and sell the same contract in large quantities. For instance, a dealer may buy 1000 contracts and sell 500 of the same contract to different counterparties. This dealer has a net exposure of 500 long contracts.

In a bilateral market, the offsetting 500 contracts are not eliminated by netting. This has several implications. First, a firm with offsetting positions often has to post collateral on the both the purchased and sold contracts, even though some of those contracts offset (thereby resulting in no market risk exposure.) Since collateral is costly (because it requires the dealer to hold liquid instruments with lower yields than alternative investments), the firm incurs a cost on the offsetting positions that could be avoided if these positions were netted out. Therefore, given the positions held by market participants, the formation of a CCP that nets positions economizes on collateral.

Second, as shown by Jackson and Manning (2006), the lack of netting increases the costs of replacing defaulted positions. Consider a dealer in a bilateral market who is long 1000 and short 500 contracts. Assume that the dealer defaults when the long positions are a liability to him, and the corresponding 1000 short contracts are an asset to his counterparties, and his 500 short positions are an asset to the dealer. The counterparties must replace the contracts at the prevailing market price (at which the short positions they enter have zero values, and hence are neither asset nor liability.) This is an economic loss to the victims of the default, which is reduced by whatever they realize from their claim on the assets of the defaulter, which will be less than what they are owed. It is important to recognize that these replacement costs are incurred on the entire gross position of 1000 contracts.

In contrast, in a cleared market, replacement costs are incurred only on the 500 net positions. Thus, clearing and netting reduces the losses that the defaulter’s counterparties incur to replace the defaulted positions because fewer positions (and sometimes no positions) must be replaced.

It should be noted that this “benefit” from netting is in fact a transfer, rather than a true cost savings. In the absence of netting, the non-offset in the money positions (in the example, the dealer’s 500 short contracts) are an asset to the defaulting firm. This asset can be used to pay the defaulter’s creditors, including derivatives counterparties and others. Netting reduces assets and liabilities by an equal amount; netting reduces the claims against the defaulter’s assets, but reduces the assets by an identical amount. Thus, the total loss suffered by creditors does not change, although the allocation of the loss is likely to change.

In the context of the example, without netting shorts holding 1000 contracts must share with all the other creditors the defaulter’s remaining assets, including the defaulter’s 500 short positions. With netting, in contrast, shorts holding only 500 contracts must share with all the other creditors the defaulter’s remaining assets, which do not include the 500 netted short positions. Thus, in effect, netting gives derivatives counterparties a priority claim to one of the defaulter’s assets–his winning derivatives positions–assets that they would have to share with other creditors absent netting.

An extension of the example illustrates these points. Assume that in a default, the 1000 contracts cost the counterparties $1 billion to replace, and hence the defaulter’s 500 short contracts are worth $500 million to the defaulter in the absence of netting. The defaulter has other assets of $700 million, and other liabilities of $1 billion. In a bilateral setting, the defaulter has assets of $1.2 billion, and liabilities of $2 billion. If the defaulter’s assets are split pro rata among the derivatives counterparties and the other creditors, the victims of the default receive $600 million, and hence lose $400 million. Other creditors also receive $600 million and lose $400 million.

With netting, the derivatives counterparties have a claim of $500 million ($1million on each of the 500 contracts that do not net out), and the defaulter’s assets are $700 million because netting reduces both assets and liabilities by $500 million. Pro rata division of the defaulter’s assets results in a payment of $233.3 million to the derivatives counterparties, meaning they lose $266.7 million. The other creditors receive only $466.7 million and lose $533.3 million. Thus, although netting makes the derivatives counterparties better off, it makes the other creditors worse off by the exact same amount.

Thus, netting effectively transfers wealth in a default from a defaulter’s other creditors to its derivatives counterparties. In the example, netting redistributes $133.3 million from other creditors to the derivatives counterparties. Reductions in replacement costs therefore do not reduce social costs, unless some frictions, related perhaps to systemic risks, imply that giving one set of claimants priority enhances wealth. I discuss this issue further below.

In sum, netting by a CCP benefits its members by (a) reducing collateral, and (b) reducing replacement costs. The important part of that last sentence is “its members.” It is important for two reasons. First, this is a private benefit that these firms will presumably take into consideration when evaluating the net benefits to them of cooperating to create a CCP. Second, since one of the benefits to a CCP’s members is actually a transfer from other creditors, dealers may have an excessive incentive to form a clearinghouse. This makes the absence of a CCP all the more peculiar–and supports the possibility that other costs, such as those arising from asymmetric information, exceed the private benefits of netting received by CCP members.

Netting can also affect systemic risk by affecting the scale of dealer trading activities. To the extent that that the introduction of a CCP reduces the costs dealers incur at the margin to engage in derivatives trades, dealers will trade more. By accumulating bigger positions, they can pose a greater systemic risk.

Netting can affect marginal cost in at least two ways.

First, netting reduces costly collateral. Lower collateral costs induce greater trading activity. (In the 1920s, opponents of central clearing at the CBT argued that bilateral trading encouraged “conservatism”–i.e., less trading–because it imposed higher collateral costs which restrained trading activity.)

Second, reductions in replacement costs could have a similar effect. Here the analysis is more complicated, however. Holding the terms of the dealers’ other liabilities constant, a reduction in replacement costs due to netting encourages dealers to trade more. However, the dealer’s creditors will certainly respond to the implicit reduction in their seniority resulting from clearing by adjusting the terms on which they supply capital to the dealers. Increasing the scale of trading activity increases the default costs other creditors incur. If creditors price capital appropriately, and charge the firm an additional dollar for each additional dollar of default cost they absorb as a result of an expansion in dealers’ trading activity, the dealers will internalize the cost of the transfer, and reductions in replacement costs will not distort their incentives to trade. Given the complexity of dealer balance sheets and the difficulty in evaluating total derivatives exposure, however, it is possible that other creditors will not fully recognize the implications of an expansion of a dealer’s trading activity, and underprice capital as a result. This would encourage the dealer to expand trading activity excessively, as the costs of this expansion are borne by other creditors.

To the extent that lower collateral requirements and replacement costs encourage dealers to trade more, reductions in dealer default exposures that result from clearing will be smaller than one would estimate holding positions constant. Larger positions increase default losses, offsetting in part or in whole the effect of clearing on default losses per trade.

In sum, it is clear that the distributive effects of clearing have not been widely appreciated–if they have been recognized at all. Netting via clearing effectively gives derivatives counterparties a priority claim on some of a dealer’s assets–the portion of a dealer’s positions that are offset by other positions. In a bilateral market, all creditors, not just derivatives counterparties, would have a claim on that asset. This redistributes the burden of a default from derivatives counterparties to a defaulter’s other creditors. Netting is therefore effectively a zero sum game, not a positive sum game. Moreover, the losers may not be members of the clearinghouse, which could distort the incentives to create a CCP. Furthermore, the systemic effects of this redistribution are ambiguous. Imposing additional losses on other creditors could put them into financial distress, even while it eases financial distress from derivatives counterparties. Financial distress by these creditors could also pose a systemic risk.

Thus, the debate over the formation of a CCP should be framed very differently than it has been heretofore. The appropriate question is: Should derivatives counterparties receive a priority claim on a defaulter’s assets? That is, should derivatives counterparties receive priority over a defaulter’s other creditors? The answers to these questions are not immediately obvious.

A couple of thoughts regarding clearing, both important and overlooked, methinks.   They’ve been on my mind for awhile, and I have a moment to get them off.

First, the issue of systematic risk.   The chairman of The Clearing Corp, Goldman’s Michael Dawley has stated that a central counterparty for CDS contracts would reduce systemic risk.   The article in which Dawley is quoted does not go into detail as to how a CCP would reduce systemic risk.   Presumably, by regularizing procedures and centralizing information, it would mitigate operational risks that could metastasize into systemic ones.

But let me interject a note of skepticism.   Systemic risk presumably arises because of an externality.   Private contracting decisions can lead to outcomes that jeopardize the financial and payments systems.   Damage to the payments system, for instance, can impose immense costs on individuals not parties to the original contracts that were the source of the contagion.   It is the existence of this externality that means that private contracting decisions, notably, decisions regarding the amount of risk to incur, may be suboptimal.

Such costs are external to the parties to CDS contracts in a bilateral OTC market, and are almost certainly external to a CCP, especially one owned and governed by large dealers.   That is, creating a clearinghouse does not internalize the externality that is the source of systemic risk.   Indeed, if a CCP prices risks badly (due to asymmetric information, for instance), it might actually exacerbate systemic risks.

I therefore conclude that the formation of a CCP is not sufficient to reduce substantially systemic risk, and that expectations or representations that it will (beyond the effect of reducing operational risks) are overly optimistic.

Second, consideration of the balance sheet risks in OTC markets led me to think about balance sheet risks for exchange clearinghouses.   The brokerage/FCM industry has evolved dramatically over the past decades, and now clearinghouse membership is dominated by the big banks, whereas at one time the clearing business was less concentrated, and less dominated by huge integrated financial institutions.

As I’ve written in posts about OTC clearing, these huge, integrated financial institutions have opaque balance sheets that carry a great deal of risk that is difficult for third parties to evaluate.   As clearing members, they expose exchange clearinghouses to their balance sheet risks.   Moreover, exchange clearinghouses don’t attempt to evaluate this risk (almost certainly because they lack the information to do so), and certainly don’t price it.

Thus, the evolution of the clearing business has arguably increased exchange clearinghouses’ vulnerability to balance sheet risks.   Given the potentially disastrous implications of a clearinghouse failure (and it’s not outside of the realm of possibility–both CME and CBT clearinghouses came within an ace of failure on 10/20/87), this is something that deserves some attention, but which has not heretofore.

he FT has an interesting article about how changes in the bankruptcy code in 2005 made it easier for firms in derivatives transactions to settle trades and demand additional collateral from their counterparties. According to the article, this made it easier for counterparties to demand additional collateral from Bear and Lehman when these companies began to experience trouble, and this accelerated their demise.

The article is wrong, though, on one thing. It says:

Lawyers said under the old rules, creditors of companies facing financial difficulties were wary of settling trades or seeking extra collateral because they knew such demands could precipitate a bankruptcy filing and potentially freeze their claims.

The more important issue was that settlements and collateral obtained 90 days or less prior to a company’s declaration of bankruptcy could be deemed a “preference.” The bankruptcy trustee could sue the counterparty of the bankrupt firm to “to recover from creditors payments made shortly before the bankruptcy filing where the payment gave the creditor more than other, similarly situated, creditors would get through the bankruptcy process. ” Thus, if a firm settled an outstanding derivative contract with a firm that eventually went bankrupt within 90 days of the settlement, and received a $1 million payment from the eventual bankrupt pursuant to the settlement (e.g., the parties agreed to close a trade that was underwater from the perspective of the eventual bankrupt), the trustee could sue and claw back the entire $1 million. The firm that had obtained the money in the settlement is then put in the same boat with the rest of the bankrupt’s creditors. Treating settlements and collateral demands as a preference increases the default risk exposure of parties to derivative contracts.

There has long been a safe harbor provision in the bankruptcy code that protected settlements on forward contracts from preference claims. (I’ve worked as an expert in several cases involving forward contract settlements in bankruptcy.) The 2005 bankruptcy code broadened the safe harbor protections to cover explicitly instruments (e.g., swaps) and market participants; prior to this time, it was a matter of uncertainty whether certain kinds of swaps and other derivative contracts would fall under the safe harbor protections. Thus, the change to the bankruptcy code clarified ambiguities in the code, and reduced the legal risks of engaging in derivatives trades.

It is certainly the case that absent the risk of preference claims, derivatives counterparties are more likely to demand that financially shaky trading partners settle contracts that are assets to the financially sound company, and liabilities to the troubled one, or to demand additional collateral from the troubled company. This creates the potential for “runs” on shaky derivatives dealers. Counterparties want to be first in line to get more cash (either from settlements or collateral) from firms that might go under.

Although it seems that runs are a bad thing, the Diamond-Rajan articles on financial fragility show that runs can serve as a disciplining device for financial intermediaries who supply liquidity. Intermediaries supply liquidity. They take funds from lenders, and invest them in higher returning projects. The financial institution has an information advantage in engaging in this information intensive intermediation, however, that allows it to act opportunistically. Absent some form of market discipline, the information advantage allows the intermediary to hold-up the suppliers of funds. Diamond-Rajan show that runs are a disciplining force, and absent such discipline, the opportunism problem results in suboptimal creation of liquidity.

Many aspects of derivatives contracting in OTC markets, including credit triggers that require the immediate liquidation of contracts or the ability to call for additional collateral in the event of a credit downgrade by a party to a derivatives contract encourage run-like behavior. Although there is not an exact analogy between derivatives contracting, and the lending/financing intermediation that Diamond-Rajan model formally, derivatives dealers do supply liquidity to the derivatives market, and especially in more specialized contracts do have an information advantage in dealing with their counterparties. The Diamond-Rajan logic therefore suggests that it may be necessary to subject the dealer to the risk of runs to discipline opportunism. Thus, the fragility of derivatives dealers, so graphically illustrated by recent events, may be efficient, as unsettling (no pun intended) as that conclusion sounds.

Diamond and Rajan argue that measures intended to reduce the likelihood of runs on financial institutions can actually reduce the efficiency of financial markets by raising the cost of disciplining liquidity suppliers. This higher cost of enforcing contracts leads to a smaller supply of liquidity. Thus, in their models, eliminating runs is a bad thing, not a good one, as intuition might suggest.

If this logic extends to derivatives contracting, it has implications for the appropriate regulation of derivatives dealers. I conjecture that the logic can be so extended, but this deserves some formal modeling. Add that to the pile.

I’ve argued that the current financial strife in Russia is an opportunity for sharks to take big bites from state funds, for the connected to get at the various reserve funds that have tempted them for a long time, but have been out of reach until now. Pavel Baev’s recent piece in the Eurasian Daily Monitor agrees:

All these voices are lines in a long rhyme that invariably ends with the reference “… in the house that Jack built,” and everybody in Russia knows who the architect in question is. That Vladimir Putin has never been able to admit a mistake is only part of his motivation for stonewalling the analysis of the unfolding disaster. A greater part of this determination comes from the need to keep the system of unaccountable redistribution of financial resources going for as long as possible, while the key players seek to compensate their colossal and totally unexpected losses.

Two features of this desperate looting of fast-shrinking reserves came into sharper focus last week. First was the mind-boggling scale of the external indebtedness of Russian companies, not only of all state-owned energy giants like Gazprom and Rosneft but also private “oligarchic” empires close to the Kremlin. The sharp fall of their market capitalization has triggered many “margin calls” for repaying the borrowed money since the collateral has lost value. As a result, Russian “champions” have to pay back up to $210 billion by the end of 2009 (The New Times, October 20). The political decision to rescue the loyal entrepreneurs by providing $50 billion for refinancing their foreign debts can solve some immediate problems, but the applications have already exceeded the designated sum, and many investment programs that are supposed to support Russia’s continuing growth, for instance in the newly-privatized electricity sector, have been gutted.

The second feature is the spectacular increase in corruption schemes and channels in the emergency situation of siphoning off hard-currency reserves that still amount to half a trillion dollars, which is approximately equal to the corporate debt. The decisions about rescuing banks that are known to be “close” to certain officials and opening credit lines to companies with unknown ownership structures are so opaque that the international financial services company Standard & Poor’s revised its outlook on Russia’s sovereign credit rating from “stable” to “negative” last week (www.newsru.com, 23 October). Corroborating this was Transparency International, which gave Russia its worst mark in eight years, so that in the Corruption Perception Index it now shares 147th place (out of 180) with Bangladesh, Kenya, and Syria (Nezavisimaya gazeta, October 24).

Medvedev quite possibly feels the need to add more substance to his anticorruption initiatives and provide some explanations for the apparent lack of results from the much-advertised interventions. Putin, however, cannot tolerate dissent from his junior partner, since any crack in the monolithic system of power could trigger an avalanche of desertions and revelations that would demonstrate that corruption is not a mere defect in his course of expanding state control over the economy but its core substance. His approval ratings may still remain high; but the social contract of “Putinism,” according to which the population enjoys the fruits of petro-prosperity while ignoring the shameless thievery of the ruling elite, is about to expire (www.gazeta.ru, October 22). The peculiar two-headed form of leadership was designed by the over-confident “tsar” for presiding over a permanent party of distributing tons of easy money; but it cannot function in the situation of escalating squabbles between elite clans and gathering social discontent. Cutting Medvedev down to size with his address was easy, but now Putin has to decide how much longer he can postpone the hard tasks of managing rather than explaining away the crisis that has transformed his pet projects into toxic assets.

Three of Baev’s points in particular echo my previous analyses: (a) “the spectacular increase in corruption schemes and channels in the emergency situation of siphoning off hard-currency reserves that still amount to half a trillion dollars”, (b) “any crack in the monolithic system of power could trigger an avalanche of desertions”, and (c) “the social contract of ‘Putinism,’ according to which the population enjoys the fruits of petro-prosperity while ignoring the shameless thievery of the ruling elite, is about to expire (www.gazeta.ru, October 22). The peculiar two-headed form of leadership was designed by the over-confident ‘tsar’ for presiding over a permanent party of distributing tons of easy money; but it cannot function in the situation of escalating squabbles between elite clans and gathering social discontent.”

In a nutshell: Baev portrays a brittle natural state with stability dependent on simultaneously redistributing wealth to favored and powerful interests while generating enough growth to pacify the larger populace that is vulnerable to collapse due to defections of the powerful when the rents run low.

The impetus for Baev’s piece is that Medvedev’s speech to the Duma scheduled for last week has been delayed indefinitely, with no explanation that passes the laugh test. It is passing strange that in the midst of an existential crisis, the President’s speech has been delayed. It certainly gives the lie to the air of confidence that the government is attempting to project.

Maybe Kevin Bacon can do a public service announcement to help them out.

Let’s start a campaign: Free Dmitri Medvedev!