Streetwise Professor

January 12, 2019

A Great Passes: Harold Demsetz

Filed under: Economics,Regulation — cpirrong @ 1:40 pm

Last week, the great economist Harold Demsetz passed away at age 88. Harold (whom I knew slightly) was truly a giant, who made seminal contributions to industrial organization, property rights economics, transactions cost economics (especially his early recognition of the bid-ask spread as a cost of transacting, well before it became a focus of research in finance), information economics, and the theory of the firm.

He also coined the memorable phrase “nirvana economics,” which skewered the then-prevalent (and alas, too often currently prevalent) tendency to compare imperfect market outcomes with perfect ones, soon followed by a prescription for regulation to correct the “market failure.” He noted–and this can not be emphasized enough–that the true “relevant choice is between alternative real institutional arrangements.” That is, there are government failures too, and it is necessary to evaluate those in order to make policy choices. Nirvana is not a choice.

Like many great economists of his era (e.g., Coase), Demsetz’s work was literary rather than formal, but that definitely does not mean it lacked rigor. Demsetz wrote well, and could present tightly reasoned and impeccably logical theoretical arguments without resorting to a single equation. His article on entry barriers is a great example of this. There was a great deal more economic logic and insight in a typical Demsetz paper than in the typical modern densely mathematical work.

Demsetz’s biggest contribution to my economic education was his work that confronted, and largely demolished, the prevailing structure-conduct-performance paradigm in industrial organization, and the related empirical work on the relationship between industrial concentration and profits, which concluded that a positive correlation was the result of market power. End of story.

Demsetz demonstrated (as Sam Peltzman formalized shortly afterwards) that cost-concentration correlations could give rise to profit-concentration correlations even in the absence of market power. A simple story that illustrates the point is that a firm that experiences a favorable cost shock when its competitors do not will expand at their expense, and earn a profit commensurate with its greater efficiency. This tends to increase industry profitability and concentration.

Demsetz also showed in a famous paper (“Why Regulate Utilities?” that structural monopoly (e.g., a “natural monopoly” due to extensive scale economies) does not necessarily convey market power. Further, in
“Industry Structure, Market Rivalry, and Public Policy” he argued that competition for the market could be quite intense, and even thought it might result in a firm obtaining a large market share, (a) the firm’s ability to exercise market power might be limited, and (b) competition for the market could be an engine for progress, including notably product and process innovation.

In this work, and that of his contemporaries primarily at Chicago and UCLA, Demsetz undermined the prevailing paradigm in industrial organization, with its simplistic equation of market structure and market power. This resulted in a revolution in economic science, but also public policy, and in particular antitrust policy.

Alas, there is a counter-revolution afoot, and quite depressingly Chicago is one of the leaders in this. In particular, Luigi Zingales and the Stigler Center (!), and the Center’s Promarket blog, are among the leaders in resuscitating the notion that concentration is per se objectionable, and creates market power. In my perusal of this literature, and the voluminous writings about public policy it has spawned, I find no real intellectual advance, and indeed, perceive severe retrogression. In particular I find little effort to confront the Demsetz critiques (and the critiques of others that followed).

It is very sad that Harold Demsetz passed, although after a long and very productive life. It is sadder still that many of his most perceptive insights predeceased him.

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January 7, 2019

Lost in Space? Some Musings on the Economics of an Independent Space Force

Filed under: Economics,History,Military,Politics — cpirrong @ 8:30 pm

One of the Trump administration’s (and really, Trump is the one pushing it) more interesting ideas is the creation of an independent military “space force” as a separate service branch, co-equal with the Army, Air Force, Marines, and Navy. Given that this proposal gores many, many political oxen inside the military and without, it’s hard to get an objective viewpoint. Everyone’s opinion is colored by their vested interest.

I have no answer as to whether it’s a good idea or not. But I do have some thoughts on the appropriate framework that could contribute to a more objective evaluation. Specifically, transactions cost economics and property rights economics (and organizational economics, which has some overlap with these) address issues of how formal organizational structure, and the ownership and control of assets, can affect the allocation of resources, for better or worse. And that is the issue here: can a reorganization involving the creation of a new entity that has control rights over assets heretofore controlled by other entities improve the allocation of defense resources?

I mused on this topic long ago, but have never really pursued it in a serious way. But I’ll muse some more given the newfound topicality.

It’s useful to divide the analysis into two parts. First, how does organizational structure, and in particular the assignment of rights of control over existing assets (e.g., artillery pieces, aircraft), affect military effectiveness and combat power? Second, how does organizational structure affect the choices regarding which assets to invest in?

With respect to the first issue, over the centuries militaries have devoted considerable effort and thought to organizational charts, and the allocation of control rights over military hardware and military units. Some simple examples: should each division have its own artillery, with all guns being under division control, or should some guns be assigned to battalions subject to control at a higher level (e.g., corps, army)?; should all tanks be concentrated in armored divisions, or should infantry divisions also have organic tank units?; should submarines be employed in support of fleets, or operate independently?

As with all resource allocation decisions, there are trade-offs, and militaries have struggled with these. There has been experimentation. There has been success and failure. Changes in technology have necessitated changes in organization, because the nature of specific weapons systems may affect the trade-offs. These are arguments that never end, as the incessant reorganizations of militaries (e.g., the U.S. Army’s recent shift to a brigade-based structure) demonstrate.

A couple of transactions cost economics insights. First, most decisions regarding the use of military assets are made subject to severe temporal specificity. If I am under attack, I need fire support NOW. Moreover, it may be the case that even in a large military only a few resources are available to provide that support. Temporal specificity creates transactions costs that can impede the allocation of resources to their highest value use.

Second, trade is unlikely to be a viable option, especially given temporal specificity. “Hey. I need some artillery support on my position right now. Can you give me an offer on what that will cost me?” Yeah–that works. The prospects for spot exchange are almost non-existent, and intertemporal exchange is unlikely because (a) timelines are short (for a variety of reasons), making end game problems acute, and (b) potential parties to an exchange are unlikely to be interacting repeatedly over time with reciprocal needs.

Since voluntary exchange is out (except in very unusual circumstances) resources need to be allocated by authority. Which makes issues of organization and the allocation of authority (control rights) paramount.

With respect to space assets, the case for a space force relates to the fact that many space assets (a) offer value to air, naval, and ground forces, and (b) there are economies of scale and scope. Having each service invest in its own space assets likely sacrifices scale and scope economies, but eliminates the need for inter-service bargaining over access to these assets, and reallocation of these assets in response to shifting military needs.

Allocating space assets to one existing branch (e.g., the Air Force) would facilitate exploitation of scale and scope economies, but would require inter-service bargaining to permit the non-controlling service to get access. A specialized space force permits exploitation of scale and scope economies, but also necessitates inter-service bargaining. The key question here is whether a specialized force would have better incentives than an operational force. For example, the Air Force might favor itself over other services when deciding how to utilize space assets, whereas a separate space force would not be as parochial.

With respect to the second issue–which assets are procured–the impact of organization on the Congressional procurement process is paramount.

The services are highly politicized organizations, and certain specializations within a service may exercise disproportionate influence. For example, the “fighter mafia” in the Air Force is legendary. As another example, in the pre-WWII U.S. Navy, battleship admirals held sway. These factions within a service may warp and stifle the development of new technologies, new doctrines, or investment decisions: the stultifying effect of the dominant infantry branch within the pre-WWII U.S. Army on the development of armored forces (both hardware and doctrine) is an example.

Creation of a separate force that invests in assets provided by the other branches would tend to undermine the power that any faction in a particular branch could exercise. The branches would have to form coalitions to influence Congressional funding decisions. But the creation of a new entity with its own vested service interest and its own ability to influence Congress could prove problematic as well.

For example, in the immediate aftermath of the formation of the Air Force, beliefs that nuclear weapons made most conventional forces–including conventional air arms–obsolete, led the Air Force to try to persuade Congress to slash spending on conventional forces in order to focus on strategic forces, especially bombers. This led to the “Revolt of the Admirals.” It also led the Navy and even the Army to invest in nuclear capabilities in order to claim strategic relevance and maintain their share of the budget. These investments were almost certainly wasteful, and would not have been made but for the independent Air Force’s influence.

Perhaps the most important historical example that could shed some light on the desirability of an independent space force is the creation of a separate Air Force in 1947, and the Johnson-McConnell agreement of 1966, in which the Army ceded to the Air Force control over all fixed wing aircraft.

The effects of this reorganization were probably beneficial overall, but there certainly were problematic effects. In particular, it almost certainly attenuated the Air Force’s incentives to provide ground support, and resulted in the Army investing excessively in rotary wing aircraft (i.e., attack helicopters) to provide it.

Perhaps a better idea would have been to create a separate strategic air wing (first including strategic bombers, then strategic bombers and ICBMs, as well as air superiority fighters), and permit the Army to operate tactical aircraft for ground support. This was essentially what was done in in the immediate aftermath of WWII, with the creation within the Army Air Force of a Strategic Air Command, a Tactical Air Command, and an Air Defense Command.

The Marine Corps, and to some degree the Navy, provide a model. Each operate their own fixed wing air services, specialized to provide the kinds of air power each needs. Marine air is relentlessly focused on providing close air support. The Marine operational commander has control over these assets, and does not have to haggle with another service to get them. Moreover, the Marines’ acquisition decisions (notably the division between fixed and rotary wing aircraft) are oriented towards getting the optimal mix for the specific mission.

I have only touched upon some of the relevant considerations–there are no doubt others I have missed. Moreover, I have given only superficial attention even to the issues I raise. But this should be sufficient to show just how complicated this issue is. Organizational decisions, such as the creation of a separate space force, will have profound implications for how military resources are allocated, and what resources will be invested in in the first place. Crucially, the assets in question cannot be allocated by markets or the price system, so it is not a question of organization v. market, but the form of the organization(s). Further, military assets are complex, long-lived (and becoming more so–note that B-52s may be operational for more than a century), and can be extraordinarily specialized and hence specific (in the TCE meaning of that term). Technology is incredibly dynamic, and needs shift dramatically over time as new threats emerge. This all means that organization and the allocation of control rights matter. A lot.

And perhaps most importantly, organizational choices will be made in a politicized environment, and will affect political bargaining in the future. This will inevitably distort current choices (e.g., whether a space force will be created in the first place, what assets it will control) and future choices as well. It also makes it very difficult to sort through the debate on the topic, because everybody involved is a political player with its own political interests.

That makes it all the more important to establish a relatively objective and rigorous intellectual framework in which to analyze these questions. I think that transactions costs economics and property rights economics hold out great promise as the basis for such a framework.

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January 5, 2019

Vox Populi v. Vox Domini Super Eos Electos

Filed under: Economics,History,Politics — cpirrong @ 7:27 pm

For weeks France has been wracked by the “gilets jaunes” protests directed at President Emmanuel Macron. The protests had slackened recently, but today they flared up again, perhaps due to the arrest of a gilets janues leader. (Was this just stupidity, or does Macron want to stoke the protest? Dunno.)

The French protests represent yet another battle in the global war between the hoi polloi and the elite. The catalyst for the French protests was a quintessentially elitist policy initiative: a tax on motor fuel, with the stated purpose of combating climate change.

Even on its own terms the tax is stupid. Even assuming a very high temperature sensitivity to CO2, the reduction in emissions resulting from the tax would have a vanishingly small effect on global temperature. Furthermore, like most of Europe, French gas taxes are extremely high, and almost certainly far above the level that would efficiently address externalities arising from motor fuel consumption.

The protestors may understand that the tax does not make sense as a way of addressing climate change. But their interests are far more down-to-earth. This is another tax imposed on the most heavily taxed country in the OECD. Further, it falls most heavily on the rural population, and the working population, and has little impact on the metropolitan elites. It is, in a sense, the straw that broke the camel’s back.

With consummate tone-deafness, Macron galvanized the protestors with remarks that would make the fictional Marie Antoinette (“let them eat cake”) blush. Hey, if driving costs too much, just carpool! Or take the bus! Yeah. He actually said that (unlike Marie and the bit about the cake).

After the initial shock, Macron caved, and shelved the tax. But the protests continued, with varying degrees of violence around the country (e.g., torching toll booths). This is because the tax’s significance was more symbolic, relating to the excessive taxation in France, and the sneering indifference of the elite to the fate of non-elite France, which Macron has personified all too well. So, as is often the case in coordination games, once people became aware of each others’ dissatisfaction, the protests took on a life of their own even after the initial catalyst was removed.

Today the protestors gathered in front of the Paris Bourse, demanding Macron’s resignation. Surely, he won’t, but his evident unpopularity will hamstring his ability to govern for the remainder of his term.

The government response has been somewhat amusing. One tack was that police resources were inadequate to deal with both the protests and terrorism. “France Doesn’t Have Enough Cops.” That is, the government of the most heavily taxed advanced economy in the world cannot perform the primary duty of the state: to secure the safety and property of its citizens. So don’t protest, because that make it impossible to combat terrorists.

But of course they should be given more money and power.

In the United States, there is also an outcry against the president, but it is the inversion of the one in France. Whereas in France it is the ordinary people taking to the streets in opposition to the governing elite, in the US the governing elite is taking to the media and the bowels of the state to oppose Trump.

There are no widespread protests on the streets of the US (Antifa freaking out in Portland doesn’t count), and especially lacking are protests by ordinary citizens against Trump. And why should there be? For most Americans, the last two years have been pretty good insofar as bread-and-butter issues are concerned (as epitomized by yesterday’s job report, both on the number of jobs and wage growth). No, the frenzy in the US has focused on issues that ordinary Americans don’t give a rat’s ass about, but which drive the governing class into paroxysms of fury–e.g., alleged (but completely unproven) allegations of “collusion” between Trump and Putin/the Russians.

These allegations are merely useful cudgels with which to beat Trump. The fury of the governing class really stems from his running roughshod over their presumptions and privileges. He’s just not one of them. He insults them. He tramples their amour-propre. He does not worship their idols. Indeed, he trashes them. Icky people like him.

So whereas the ordinary French have taken to the streets, the governing class has taken to pulling the levers of its power–the FBI (even before the election), the American star chamber (aka the Mueller Investigation), incessant and hopelessly biased media coverage, and now, threats of impeaching “the motherfucker.” (To which I say–be my guest. Look at how well that worked out in 1998-99.) There are even those who have advocated a coup.

I daresay that the governing class in the US sees what is going on in Paris and other places in France, and shudders. It shows how deeply loathed the governing class is, and how a seemingly small spark can ignite a political firestorm against them. They have certainly questioned the protests’ legitimacy, at times in their desperation succumbing to the last refuge of the idiot–blaming it on the Russians. Case in point, the pathetically hilarious Max Boot (hey, Max, can you do a pushup?) who at one time pined for an American Macron, only to be subjected to ruthless–but completely warranted–ridicule when the French protests erupted. In a nauseating attempt to rationalize the complete popular repudiation of his man crush on Macron, Max insinuated that although the Russkies may not have caused the protests, they fanned the flames through their diabolically clever exploitation of social media.

The condescension here is palpable, and reflects a pattern that I’ve pointed out going back to 2015. Rather than acknowledging that widespread popular dissatisfaction with the elites–as epitomized by Brexit, the Trump election, various European elections, and now the protests in France–were due to repeated elite failure unsullied by any success, they add insult to injury by accusing their opponents of being stupid, unwitting pawns of their current bête noire.

It is indeed amazing to see that an incessant barrage of attacks from the governing classes have not moved the needle on Trump in the slightest. If anything, they have bound him and his supporters more tightly, because the latter recognize that an attack on Trump is just as much an attack on them.

The most common divide in polities around the developed world right now is between the governing and the governed. The self-conceived and self-congratulatory elite vs. the ordinary. France is just the most recent battleground. It wasn’t the first, and it won’t be the last. The battle is becoming more intense because the objects of popular disdain refuse to acknowledge any responsibility for creating the conditions that have spurred popular discontent.

The same thing happened in France, 230 years ago. The nobility in the ancien regime stubbornly and righteously clung to their privileges, and their conviction in their own superiority. Worked out swell for them, right? But some people never learn.

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December 27, 2018

The Market Is Down! Round Up the Usual Suspects!

Filed under: Economics,Exchanges,HFT — cpirrong @ 7:38 pm

Every time there is a major market selloff–like now–there is a Casablanca-like rush to round up the usual suspects. Treasury Secretary Steven Mnuchin blamed the Volcker Rule and HFT. This WSJ article blames algos (including HFT), but throws the kitchen sink in for good measure.

Truth be told, virtually every major market drop is unexplained at the time, and even well after, which only spurs the search for villains and scapegoats. There was no obvious spark for the Crash of ’87, and in the years since, many suspects have been named but none have been convicted. The same is true of the Crash of ’29. Perhaps the best effort–interesting, but not definitive–is George Bittlingmayer’s attribution of Black Tuesday to an unexpected shift in antitrust policy under the Hoover administration. But that came 65 years after the event!

The most recent selloff is no exception. The WSJ article lists a variety of bearish developments, but any such exercise smacks of post hoc, ergo propter hoc “reasoning.” Further, the article quotes various people who claim that the price decline is difficult to square with fundamental economic data–welcome to the club! The same is true for 1987, 1929, and other major declines. Recall Paul Samuelson’s aphorism: the stock market predicted 10 out of the last 5 recessions.

Part of the difficulty is that stock prices depend on expected cash flows, and expected returns, both of which can vary due to factors that are difficult to observe in public data. Asset pricing economists have a lot of theories of time varying expected returns–hinging on theories of time varying risk premia–none of which have strong empirical support. Modest changes in risk premia/expected returns can cause big valuation changes. Recent conditions (political/geopolitical risk, monetary policy changes) plausibly have affected risk premia, but our ability to map these relationships is virtually nonexistent, so at best we can formulate largely untestable hypotheses.

And untestable hypotheses are effectively speculations and opinions, and like certain body parts, everybody has one.

Given these realities, most major asset price movements are difficult to explain.

I vividly remember in the aftermath of the 1987 Crash, when I was a PhD student at Chicago. Gene Fama distributed a Mandelbrot article to all PhD students. The article presented a simple model in which long periods of price increases are followed by crashes. As I recall, the essence of the model was that if good news was received today, it was likely that there would be good news tomorrow, but if good news was not received today, the likelihood of receiving good news tomorrow was lower. In essence, it is a regime switching model, and a switch in from a good news regime to a bad news regime leads to a big valuation change, due to the transition probabilities.

Fama’s point in distributing the article was to emphasize that discontinuous changes in prices are not inconsistent with a “rational” market. Seemingly small fundamental shifts can lead to big price changes.

Again, a hypothesis–and a virtually untestable one.

What about blaming algos, a la Mnuchin and the WSJ? Well, blaming HFT–directly, anyways–makes no sense. Yes, HFT is programmed to respond to market signals, but it is negative feedback by nature. It tends to be stabilizing, not de-stabilizing.

There may be an indirect connection: HFT liquidity supply can dry up when order flow becomes toxic, and the decline in liquidity makes prices more sensitive to order flow, leading to larger price movements. The Flash Crash is a classic example of this. But that’s not unique to HFT. It is inherent to market making, and HFT basically puts what is in a market maker’s (e.g., old-time floor trader’s) synapses into code. Market makers pulling back–or shutting down altogether–occurred long before markets went electronic, and before anybody even dreamed of HFT.

If liquidity has declined–and the WSJ points to some limited evidence on this point–it is likely a response to market conditions, rather than a cause thereof. It’s something that occurs in almost every period of elevated volatility. It’s more of an effect of some common cause than an independent exogenous cause.

Further, by virtually every measure, the increasing automation in markets has led to greater liquidity. Much of the bitching–including in some quotes in the WSJ article–emanates from traditional liquidity suppliers who have lost out to more efficient competitors. Believe me, if order flow had become more toxic, these guys would have pulled back too, and probably more severely than HFT has done.

What can exacerbate market movements is positive feedback trading strategies. Portfolio insurance during the 1987 Crash is a classic example. The WSJ article points at algorithmic momentum trading strategies, and indeed these are positive feedback in nature. But they are not unique to algos: meatware implemented momentum/trend following strategies long before they were embedded in software. Momentum trading is something else that long predates the rise of the machines.

Several quotes in the WSJ article made me laugh. One was: “’Human beings tend not to react this fast and violently.’” Really? Heard of Black Monday? Black Tuesday? Silver Thursday? Black Friday? I’m sure there’s a Color Wednesday to fill in the week, but none comes to mind. Regardless, the point remains: human beings reacted rapidly and violently long before trading machines were even dreamt of.

Here’s another: “Today, when the computers start buying, everyone buys; when they sell, everyone sells.”

This is called “not an equilibrium.”

The bottom line is that the stock market sometimes decline substantially, without any obvious cause. Indeed, the cause(s) of some of the biggest, fastest drops remain elusive decades after they occurred. This is true across virtually every institutional and technological trading environment, making it less likely that any particular selloff is uniquely attributable to a change in technology. Furthermore, large market moves in the absence of any decisive event or piece of news is not inconsistent with market “rationality”, or due to some behavioral anomaly (which is inherently human, by the way).

But humans crave explanations for phenomena like big movements in the stock market, and this demand calls forth supply. That the explanations are for the most part untestable and hence not scientific only means that there is little check on this supply. Anybody can offer an explanation, which likely cannot be proven wrong. So why not? But if you understand that mechanism, you should also understand that you shouldn’t pay much attention.

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December 5, 2018

Judge Sullivan Channels SWP, and Vindicates Don Wilson and DRW

Filed under: Derivatives,Economics,Exchanges,Regulation — cpirrong @ 10:52 am
After two years of waiting after a trial, and five years since the filing of a complaint accusing them of manipulation, Don Wilson and his firm DRW have been smashingly vindicated by the decision of Judge Richard J. Sullivan (now on the 2nd Circuit Court of Appeals).

Since it’s been so long, and you have probably forgotten, the CFTC accused DRW and Wilson of manipulating IDEX swap futures by entering large numbers (well over 1000) of orders to buy the contract during the 15 minute window used to determine the daily settlement price.  These bids were an input into the settlement price determination, and the CFTC claimed that they were manipulative, and intended to “bang the close.”  The bids were above the contemporaneous prices in the OTC swap market.

The Defendants claimed that the bids were completely legitimate, and that they hoped that they would be executed because the contract was mispriced because of a fundamental difference between a cleared, marked-to-market, daily-margined futures contract and an uncleared swap.  The former has a “convexity bias” and the latter doesn’t.  DRW did some IDEX deals with MF Global and Jefferies at rates close to the OTC swap rate, which it thought were an arbitrage opportunity, and they wanted to do more.  And, of course, they  received margin inflows to the extent that the contract settlement price reflected the convexity effect: thus, to the extent that the bids moved the settlement price in that direction, they expedited the realization of the arbitrage profit.

Here was my take in September, 2013:

Basically, there’s an advantage to being short the futures compared to being short the swap.  If interest rates go up, the short futures position profits, and the short can invest the resulting variation margin inflow at the higher interest rate.  If interest rates go down, the short futures position loses, but the short can borrow to cover the margin call at a low interest rate.  The  swap short can’t play this game because the OTC swap is not marked-to-market.  This advantage of being short the future should lead to a difference between the futures yield and the swap yield.

DRW recognized this difference between the swap and the futures.  Hence, it did not enter quotes into the futures market that were equal to swap yields.  It entered quotes at a differential to the swap rate, to reflect the convexity adjustment.  IDC used these bids to determine the settlement price, and hence daily variation margin payments.  Thus, the settlement prices reflected the convexity adjustment.  Not 100 percent, because DRW was trying to make money arbing the market.  But the settlement prices were closer to fair value as a result of DRW’s quotes than they would have been otherwise.

CFTC apparently believes that the swap futures and the swaps are equivalent, and hence DRW should have been entering quotes equal to swap yields.  By entering quotes that differed from swap rates, DRW was distorting the settlement price, in the CFTC’s mind anyways.

Put prosaically, in a way that Gary Gensler (the lover of apple analogies) can understand, CFTC is alleging that apples and oranges are the same, and that if you bid or offer apples at a price different than the market price for oranges, you are manipulating.


The reality, of course, is that apples and oranges are different, and that it would be stupid, and perhaps manipulative, to quote apples at the market price for oranges.

Here’s Judge Sullivan’s analysis:

[t]here can be no dispute that a cleared interest rate swap contract is economically distinguishable from, and therefore not equivalent to, an uncleared interest rate swap, even when the two contracts otherwise have the same price point, duration, and notional amount.  Put another way, because there is some additional value to the long party . . . in a cleared swap that does not exist in an uncleared swap, the economic value of the two contracts are distinct.

Pretty much the same, but without the snark.

But Judge Sullivan’s ruling was not snark-free!  To the contrary:

It is not illegal to be smarter than your counterparties in a swap transaction, nor is it improper to understand a financial product better than the people who invented that product.

I also wrote:

In other words, DRW contributed to convergence of the settlement price to fair value relative to swaps.  Manipulative acts cause a divergence between the settlement price and fair value.

. . . .

In a sane world-or at least, in a world with a sane CFTC (an alternative universe, I know)-what DRW did would be called “arbitrage” and “contributing to price discovery and price efficiency.”

Judge Sullivan agreed: “Put simply, Defendants’ explanation of their bidding practices as contributing to price discovery in an illiquid market makes sense.”

Judge Sullivan also excoriated the CFTC and lambasted its case.  He blasted it for trying to read the artificial price element out of manipulation law (“artificial price” being one of four elements established in several cases, including inter alia Cargill v. Hardin, and more recently in the 2nd Circuit, in Amaranth–a case that was an expert in).  Relatedly, he slammed it for conflating intent and artificiality.  All of these criticisms were justified.

It is something of a mystery as to why the CFTC chose this case to make its stand on manipulation.  As I noted even before it was formally filed (my post was in response to DRW’s motion to enjoin the CFTC from filing a complaint) the case was fundamentally flawed–and that’s putting it kindly.  It was doomed to fail, but the CFTC pursued it with Ahab-like zeal, and pretty much suffered the same ignominious fate.

What will be the follow-on effects of this?  Well, for one thing, I wonder whether this will get the CFTC to re-think its taking manipulation cases to Federal court, rather than adjudicating them internally in front of agency ALJs.  For another, I wonder if this will make the CFTC more gun-shy at bringing major manipulation actions–even solid ones.  Losing a bad case should not be a deterrent in bringing good ones, but the spanking that Judge Sullivan delivered is likely to lead CFTC Enforcement–and the Commission–quite chary of running the risk of another one any time soon.  And since enforcement officials are strongly incentivized to, well, enforce, they will direct their energies elsewhere.  I would therefore not be surprised to see yet a further uptick in spoofing actions, an area where the Commission has been more successful.

In sum, the wheels of justice indeed ground slowly in this case, but in the end justice was done.  Don Wilson and DRW did nothing wrong, and the person who matters–Judge Sullivan–saw that and his decision demonstrates it clearly.

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November 29, 2018

News for Barry: You Didn’t Build That

Filed under: Economics,Energy,Politics — cpirrong @ 9:59 am
Hard as it is to believe, it appears that Obama has become even more supercilious since his departure from the Oval Office.  All of his sneering grandiosity was on display during a visit to Houston.  (I hope you are sitting down for this: I didn’t attend!)

Being in Texas, Obama felt that he should be thanked for the dramatic growth in US oil production: “You wouldn’t always know it, but it went up every year I as president. That whole, suddenly America’s like the biggest oil producer and the biggest gas—that was me, people.”

I’m wracking my brain here, trying to recall something he said some years ago.  Oh yeah, I remember now: “If you’ve got a business, you didn’t build that.”

Barry: you definitely didn’t build that.  Yet you claim credit anyways.  You remind me of the rooster that believes the sun rises because he crows.

Long-time commenter Howard Roark noted to me on Twitter that the “you didn’t build it” remark was arguably the worst of his many execrable utterances.  That’s probably true, and he makes it all the worse by claiming credit for building something which he had less than bupkis to do with.

Obama also claimed credit for the economy’s recent performance.   He noted, in essence, that the first derivative in GDP was positive during his term, so that he is responsible for the first derivative being positive now.  Apparently the man who is so smart that he can apply the theory of relativity to constitutional law doesn’t understand second derivatives.  Economic growth has accelerated markedly under the Trump administration, and has achieved 3.5 percent growth, something that Obama dismissed as an impossibility when he was criticized for the anemic 1-2 percent growth rate in the aftermath of the Financial Crisis (when one would have expected growth at a rate above long term trend, not below). (I love the title of the linked paper, by the way.  Hilarious!)

But Obama was done.  After claiming credit for building everything, he shared his deep thoughts on identity politics:

“Which is why, by the way, when I hear people say they don’t like identity politics, I think it’s important to remember that identity politics doesn’t just apply when it’s black people or gay people or women,” Obama said. “The folks who really originated identity politics were the folks who said Three-Fifths Clause and all that stuff. That was identity politics … Jim Crow was identity politics. That’s where it started.”

He’s largely correct that Jim Crow and “all that stuff” was identity politics.  But rather than using this to show that identity politics is fundamentally wrong, he uses it to somehow validate its current incarnation.  It happened before, so you can’t criticize it now.  Two wrongs make a right.   You did it to us, so we get to do it to you.

Please go away.  So we can miss you.  Except that I won’t.  But go away anyways.



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November 27, 2018

The Overlords of the Overton Window

Filed under: Economics,Politics — cpirrong @ 8:28 pm
Facebook, YouTube, and in particular Twitter have been bingeing on banning of late.  The targets of these proscriptions have been anything but random: those who do not perform proskynesis before the current gods of the left.  This means that conservatives and libertarians are disproportionately affected, but even some who do not fall into those political categories are at risk.

The environment has become so hostile that at least one prominent figure, Instapundit (Glenn Reynolds, a law professor, of all things), has said “you can’t fire me, I quit!” and left Twitter.  Others less prominent have made similar decisions, and others have self-censored.

In essence, the operators of social media platforms present a Hobson’s Choice: You can censor yourself, or they will censor you.  The end result is the same: systemic biases against expression of certain political, religious, and socio-cultural opinions on the most widely used social media platforms. Twitter, Facebook, and Google are the Overlords of the Overton Window, and largely dictate the range of acceptable public discourse.

The Overton Window has always existed, but what is acceptable to express has heretofore been the result of a more decentralized, emergent process.  There was give-and-take.  There were actually multiple windows, and entry and exit were easier.  There was no centralized authority who could dictate what was acceptable: what was acceptable emerged.

What is disturbing, and positively Orwellian, about the Window today is the aggressive role of an extremely ideological, self-appointed set of censors who face little competition and who largely can control access to the means by which opinion is now expressed.  The centripetal force of virtual social networks give exceptional power to those who control access to those networks. By conditioning access on adherence to their views, the psychopaths who control these networks (and tell me honestly that you don’t believe that Zuckerberg and Dorsey are psychopaths) can coerce acceptance of their beliefs.  The technology of networks tends towards monopoly, and those who control these monopolies exercise disproportionate control over the expression of opinion, belief, and thought.

That is, traditionally the Overton Window was more consensual.  It is now increasingly the dictat of a narrow and insular set of individuals who by the whims of competition in network markets have achieved considerable power.

One of the most explicit examples of how this operates relates to the issue of transgenders–an issue you that probably was so obscure to you that it never penetrated your consciousness until recently.  Twitter has recently banned people–including someone who would best be described as a hard-core feminist–for challenging this newly decreed orthodoxy.  Twitter has just announced a policy of banning people who “misgender” (e.g., call individuals with testicles “he” though they identify as women) or “deadname” (e.g., use the name Robert to refer to someone born with testicles and named Robert by his parents, but who now identifies as Roberta).

This is revealing on several dimensions.  First, it reveals that social media has an Animal Farm-like hierarchy.  Female feminists are pretty high up on the hierarchy, but somewhere below transgenders.  So if a female feminist transgresses the transgender norm, she becomes a non-person.  Better stick to attacking those lower in the hierarchy, like straight white males!

Second, a marginal (and arguably minuscule, in terms of numbers) group is sanctified, and obeisance to that group becomes a litmus test for acceptance, and freedom from attack/banning.  Question the sanctified, and you are a non-person, and anathematized.

The marginal and extremely unconventional nature of the group is extremely important to the process.  Who cares if you affirm that ice cream is great?  But affirming that the extremely marginal and unusual are great does not come naturally, and indeed, it is costly to those of a more traditional bent.  It is also costly because it takes some effort to figure out what you are supposed to affirm, especially since it is outside your realm of experience.

But the cost is the point!  You have to pay the cost in order to avoid ostracism.  To demonstrate your fealty.  Bending the knee is deeply symbolic precisely because people naturally rebel against it.  Because it is psychically costly.  Those with strength of will are ostracized, and those made of softer stuff validate the beliefs of the overlords by worshipping their gods.

This is the way that cults operate.  Acquiescing to bizarre beliefs and engaging in bizarre rituals demonstrates fealty to the cult.

And don’t think that this will end when all users of Twitter and Facebook get their minds right and adopt Mark’s and Jack’s dictated opinions regarding transgenders (which are likely purely instrumental).  At such point, transgenders become totally useless.  Totally. New tests of loyalty and conformity will become necessary.  A new group will be sanctified.  I shudder to think what it will be, but I guarantee it will happen.  And at that time transgenders will become as irrelevant as past causes célèbres, e.g., gays.  (Don’t hear much about them anymore, do you? Old news.  Hence not useful.)

One often-heard viewpoint expressed by usually conservative and libertarian people is that this is, if not OK, something we have to accept because it is not the government that is imposing restrictions on freedom of expression.  These are private individuals in control of private entities.

This is seductive logic, but it is extremely defective because it ignores objective realities.

The concern about government restriction on freedom of speech is that it has a monopoly of force that it can use to overawe and oppress.  Further, government restrictions on speech reduce accountability of government, and therefore undermine checks on its power.

We should have similar grave concerns about private individuals and private enterprises that utilize their right to control access to near-monopoly platforms to overawe and oppress.  Further, these are intensely political entities whose controlling personalities desire to exercise political power, preferably with limited or no accountability.

The line between public and private that is often drawn here is completely imaginary.  No, these are not government entities.  But they are entities that desire to exercise great influence over the government, through various means. and to exercise control over individuals in ways governments have only fantasized about.  (The symbiosis between Google and the government of the PRC is not an accident, comrades.)

Checking their power is therefore completely consistent with a belief in the primacy of individual liberty.  Indeed, given the steady erosion in limits on government, shackling those who exert disproportionate influence on government and the political process is all the more vital to those who champion individual freedom.  (This is exactly why Facebook and Twitter and Google should be the LAST entities you want determining what is, and what is not, acceptable political speech, and what is fake news, and why the insistence by politicians that they do so is the bootleggers-and-baptists problem from hell.)

Those who care about individual liberty must strive to reduce the power to coerce, regardless of whether that coercive power is wielded by a government, or an individual, or a non-government entity.  Coercion is the thing.  Not the identity of the coercer.

Further, as I’ve noted several times before, the classical liberal/limited government tradition has recognized the dangers of private monopoly, and has constrained it through the imposition of open access and non-discrimination requirements.  If such requirements are justified for innkeepers and stagecoaches and railroads, they are more than justified for social media platforms, especially given the public goods nature (in the strict economics sense of the term) of their output–something that cannot be said of innkeepers and stagecoaches and railroads.

So, echoing Lenin, what is to be done?  One thing is clear: direct approaches are fruitless.  If Glenn Reynolds censors himself, that just saves Jack Dorsey the trouble.  The end result is the same: Jack wins.

A la Liddell-Hart, Fuller, or Sun-Tzu, an indirect approach is necessary. I’m not sure what that approach should be, but these military thinkers (no, that’s not always an oxymoron) have identified key aspects of it.  Identify the enemy’s center of gravity (and we should indeed view these people and companies as our entities).  Then don’t attack their strong points, but find their blind spots, their vulnerabilities, and strike at those.  Find the back door to the center of gravity.

And in thinking through the problem, don’t get hung up on false distinctions between public and private.  This is only to play into the hands of those who want to dominate you.

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November 25, 2018

There Is a Great Deal of Ruin In a Nation, Venezuelan Edition (With Broader Lessons)

Filed under: Economics,Politics — cpirrong @ 8:03 pm
Igor is not pleased with Maduro’s Venezuela, which is stiffing him:

The head of Russian oil company Rosneft (ROSN.MM), Igor Sechin, flew to Caracas this week to meet Venezuelan President Nicolas Maduro and complain over delayed oil shipments designed to repay loans, two sources briefed on the conversation said on Saturday.

The visit, which was not publicly disclosed, is one of the clearest signs of strain between crisis-stricken Venezuela and its key financier Russia.

Over the last few years, Moscow has become Venezuela’s lender of last resort, with the Russian government and Rosneft handing Venezuela at least $17 billion in loans and credit lines since 2006, according to Reuters calculations.

State oil company PDVSA is repaying almost all of those debts with oil, but a meltdown in its oil industry has left it struggling to fulfill obligations.

Sechin and a large delegation of executives met with officials at PDVSA in a Caracas hotel this week. Sechin also met with Venezuela’s leftist leader Maduro, and chided him over oil-for-loans shipments that are behind schedule.

“He brought information showing that they were meeting obligations with China but not with them,” said one source with knowledge of the talks.

Two things strike me about this story.

First: Hahahahaha.  Suckers.

I remember vividly snickering at those who thought the Chinese and Russians were sooooo smart to extend credit to the Venezuelans..  How this was a geopolitical masterstroke.

Really?  How’s that working out?  Obviously not well.  Ask Igor!

Tell me again how it is GENIUS! to lend money to a country that is imploding because it is in the thrall of an insane crypto-socialist ideology.  Venezuela’s trajectory was obvious at the time the Chinese and Russians thought they would lend it money.  Seriously: lending to socialists is hardly ever a paying proposition, and lending to Bolivarian socialists was certainly so.

But by all means, keep pouring money down ratholes! Be my guest!

Second.  The Venezuelan experience demonstrates the truth in Adam Smith’s aphorism about there being “a great deal of ruin in a nation.”  The torment of Venezuela is extreme.  The populace lives in utter penury, which only grows worse by the day.  The inflation rate is currently in the 6 figures, and is on track to reach 7 figures late by the end of this year, or early in the next.   This is Weimar-Hungary-Zimbabwe territory.  Crime is rampant.  Human degradation is everywhere.

Yet the Maduro regime is largely secure.  It maintains the loyalty of the security forces, and this has deterred a serious popular uprising.   Indeed, the economic catastrophe is not causing Maduro to relent: to the contrary, it spurs him to crack down even more intensely.

This situation has been developing for years.  Indeed, you can pinpoint the decisive moment, and it relates to Sechin’s current target–national oil company PDVSA. In the aftermath of an abortive US-supportive coup in 2002, Maduro’s predecessor Hugo Chavez responded to opposition within the company by purging the technically and managerially competent, and replacing them with loyalists.  What was once one of the most competent national oil companies in the world began its descent into failure, and the entire country followed in its wake.

There is a broader lesson here: Smith’s dictum, empirically validated in Venezuela, implies that expectations that economic pressure on rogue regimes will lead them to moderate their behavior, or result in their overthrow, are chimerical.  Rogue regimes respond to pressure and economic failure by intensifying oppressive measures.  By doing so, they can survive for a very, very long time.

The problem of coordinating opposition against a steely regime is difficult to overcome.  Usually, such regimes fall only when they attempt to respond to popular discontent through “reforms” and a softening of repression (cf. Gorbachev in the USSR).  Hard men like those in Venezuela or Iran understand this lesson, and have no intention of relaxing their grips.

That is, economic failure, whether internally created (as in Venezuela) or the result of internal dysfunction exacerbated by external pressure (as in Iran or North Korea) almost never results in the collapse of repressive regimes.

This is not to say that economic sanctions or other forms of economic pressure are not justified.  It is just that the expectations for such acts must be realistic, and the goals chosen accordingly.  Realistically, economic pressure can reduce the capabilities of rogue regimes to wreak havoc outside their borders.  It cannot truly threaten the existence of these regimes.

Since there is so much ruin in countries–especially highly repressive ones–expecting to change them by ruining them is futile.

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November 24, 2018

The Most Annoying and Pathetic Geopolitical Entity Ever? I Think So!

Filed under: Cryptocurrency,Economics,Politics — cpirrong @ 7:59 pm
There may be a more annoying geopolitical entity in history than the EU, but I’ll be damned if I can think of one.

In recent weeks, a group of northern EU states centered on the Netherlands have formed the “Hanseatic group” to represent their positions, regarding the Italy situation in particular.  This has outraged the French and the Germans.  In response to the blonde upstarts, French economy minister Bruno le Maire lashed out:

Speaking at a dinner with his Dutch counterpart Wopke Hoekstra in Paris on Thursday, Bruno Le Maire said he was “not comfortable” dealing with the Hanseatic group — eight to 10 countries that have agreed common positions calling for more national responsibility and stronger rules in the eurozone.

“Let’s imagine that France tries to create a club of the southern countries with Portugal, Italy, Spain — what would be the reaction of the other member states? Do you think that it would be a positive one? Do you think it would improve the situation of Europe?” Mr Le Maire told the Financial Times.

“I am not comfortable with the idea of creating new circles, new clubs, new leagues within Europe. If you want to create new divisions between the north and the south, or the west and east, you will never have France on your side,” said Mr Le Maire, who has spearheaded French ambitions to reform the eurozone in a partnership with Germany.

Some Franco-German initiatives, such as a blueprint for a eurozone budget, have met resistance from countries led by the Netherlands. The group has also advocated tougher enforcement of budgetary rules and moves towards debt restructuring in the eurozone to be agreed by EU governments next month.  (Emphasis added.)

Did you catch that?  Franco-German ambitions to reform the eurozone–OK!  Lilliputian resistance–BAD!!!!

When the hypocrisy was pointed out, Bruno a dit non! non! non! C’est totalement différent!

When asked whether the Franco-German alliance was not a “club”, Mr Le Maire said: “That is totally different. This is not a club. This is what is at the core of the European ambition: peace between France and Germany. This is at the core of the European Union.”

So, is M. Le Maire suggesting that absent the EU, jackbooted Germans would soon be marching in the shade along the tree-lined French roads?  If he is, that’s quite the insult to Germany, non?  But if he is, he is utterly delusional: to quote Patton, the post-post-modern Germans couldn’t fight their way out of a piss-soaked paper bag, and what’s more, have no desire even to try.  They’ve found alternative means to achieve dominance over the continent, and the French are now their (junior) allies in that endeavor.  A key part of that strategy is divide-and-conquer, and “clubs” like the Hanseatic one threaten that gambit.

Germano-French ambitions extend beyond Europe.  They want to leverage their dominance in the EU to a position of world influence.  Fortunately, here their efforts have proven again and again to be laughable.

A particularly juicy example is the hilarious efforts of the EU to set up a special purpose vehicle to facilitate trade with Iran in defiance of US sanctions, pour epater le bête orange.  They have made grandiose announcements.  Only one problem: European companies don’t want to touch this with a ten foot pole.  Make that two problems: no European government wants to touch it either:

So up to now the commission has been unable to find a home for the SPV. Not even a post restante address. No EU country has offered to host it. The sad SPV has been wandering between railway stations and airports, without a nationality, a bank account or even a real name. If I passed it on the street, I would put a euro in its hat.


And as I’ve pointed out since the day of the announcement, it is an utterly pointless exercise because it addresses every issue except the one that matters: secondary sanctions.  Once the US seized upon this mechanism, any attempt to circumvent sanctions by avoiding the dollar became utterly pointless: do a barter deal, or a Euro deal, or a Venezuelan crypto bolivar deal with a sanctioned Iranian company, and the Treasury will still hammer you.  So, if you want to do all your biz in cryptobolivars–knock yourself out! But if you want to do any business with the USD at all, think twice about dealing with a sanctioned entity by an SPV or any other way.  And pretty much every European company has decided that one thought is sufficient.

M. Le Maire seems to be getting a glimmer of a clue that the EU is a geopolitical lightweight:

“I’m not sure the Hanseatic League would be in a position to face the competition with China and the US”, he said. “If we are creating closed clubs, alliances within the EU then we run the risk of losing time and weakening our common project.”

Bruno. Dude: the EU is not in a position to face competition with China and the US.  This is proven daily.

So under German-French “leadership” the EU is likely to lurch along like it has been for years.  Compensating for their inability to achieve their vaulting global ambitions by beating up on the EU’s smaller members.  Annoying.  But in the end, risible and pathetic.

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November 18, 2018

File Under “Duh”

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 7:25 pm
The IEA points out the obvious:

Driving electric cars and scrapping your natural gas-fired boiler won’t make a dent in global carbon emissions, and may even increase pollution levels.

Higher electrification may lead to oil demand peaking by 2030, but any reduction in emissions from the likes of electric vehicles will be offset by the increased use of power plants to charge them, according to the International Energy Agency’s annual World Energy Outlook, which plots different scenarios of future energy use.

Substitution electrical motors for internal combustion engines involves a substitution of one fossil fuel for another?  Who knew?  WHY WASN’T I TOLD????

Further, especially when it comes to countries outside the EU, Canada, and the US, this will result in a substitution towards coal, electrification will involve a substitution of higher-CO2 intensive fuel (coal) for lower CO2-intensive fuel.

But, but, but . . . renewables! Right?

Of course, Bloomberg feels obliged to quote a green fantasist:

“Electrification is a necessary part of deep decarbonization because it is relatively easy to decarbonize the power sector,” said Lauri Myllyvirta, a senior analyst at Greenpeace’s air pollution unit. “But electrification only helps if the power sector moves rapidly towards zero emissions.”

Zero emissions power sector.  “Relatively easy to decarbonize.”  Apparently, Greenpeace does not require drug tests.  Or perhaps, they do, but if you test negative you’re fired.

What is the cost of zero emissions power sector? (Anything is “easy” if cost is no object.)  Even far smaller renewable penetration (Denmark, Germany, California) results in substantially higher electricity costs.  Costs which fall extremely regressively, especially if implemented no a global basis, but upper middle class types who populate Greenpeace and Green Parties etc. couldn’t be bothered thinking about that.

Furthermore, there is no proof that renewables scale, and indeed,  basic considerations and basic economics strongly suggest they will not and cannot.  Renewables are diffuse and intermittent, and as a result maintaining reliability is costly, and this cost increases at an increasing rate the larger the share of renewables in the generation mix.

But, but, but . . . . batteries!

Batteries have been the subject of intense research for decades, and costs are falling, but again there are serious doubts that they can scale sufficiently to make zero emissions power even remotely attainable.  Indeed, batteries perhaps can handle diurnal variations in renewable power production, but handling the massive seasonal fluctuations in power demand is another matter altogether.

Further, from a lifecycle perspective, it is by no means clear that electric vehicles reduce CO2 emissions.  What’s more, the monomaniacal focus on CO2 ignores the other environmental and economic consequences of renewables generation, including profligate use of land, blended birds, the pollution created by extraction of minerals used in batteries and motors, and the pollution caused by the disposal thereof.

These issues always bring to mind James Scott’s Seeing Like a State, which shows that “high modernist” projects envisioned by alleged elites invariably result in catastrophe because they inevitably impose simplistic, low-dimension measures on complex, high-dimension systems.  Unintended consequences usually strike with a vengeance, and even the intended consequences fail to materialize.

The massive re-engineering of society required to de-carbonize is in many ways the zenith of high modernism, and is destined to produce a nadir of consequences, even compared to some of the other disasters that Scott examines.

The IEA’s caution should be heeded.  But it will not be.  Those Who Know Better will plunge ahead, until it becomes clear that they in fact know very little about what they imagine to design.  Alas, they will not bear the costs of their conceit.  The Lesser Thans will, and the lesser you are, the greater the costs will be.


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