Streetwise Professor

2014 is in the books, and fittingly the last day of the year  saw a fall in the price of oil. The nearly 50 percent decline in oil prices from the end of June to today was the biggest commodities story of the year. This decline has spawned numerous conspiracy theories, which like most conspiracy theories, are pure bunk.

Most of the stories focus on Saudi Arabia and shale oil. In some versions, the Saudis decided to crash the price of oil to drive out competition from US shale production. I analyzed, and dismissed, this story some weeks back. In other versions, the Saudis decided to crash the price of oil in order to strike a blow at its arch enemy Iran, or in some variants, at Iran and Russia (either in cahoots with the US, or to punish Russia for its support of Assad).

Well, to crash prices it is necessary to increase output. The Saudis, however, did not increase output over the past 6 months: it has remained relatively static. This couldn’t be more different from what happened during the 1985-1986 price collapse, to which the most recent decline is often compared. In the early-80s, the Saudis cut output from about 10 million barrels per day (mmbpd) to as low as 3.5 mmbpd in order to maintain prices in the face of rampant cheating on output quotas by other OPEC members. Realizing that it was being the chump, the Saudis increased output about 44 percent. Nothing like that has happened in the past six months.

The other purported cause of the price decline is the increase in US output. This increase is indeed remarkable, but its timing and magnitude doesn’t explain the price decline. US output has been rising inexorably for a couple of years, and the rate of increase has exceeded forecasts, but not by nearly enough to explain the post-June price decline. Since June, US output has risen by about 100kbpd per month. Cumulatively, that’s about 600kbpd, or a less than .7 of world output. Even using an elasticity on the high side of 10*, this could account for about a 7 percent decline in the price. What’s more, some of the US increase has been needed to offset the on again, off again production in Libya and declines in production in Mexico.

Meaning that the focus on the supply side has been totally misplaced. This in turn implies that all of the hyperventilating about S&S-Shale and the Saudis-is wrongheaded.

Instead, the most likely explanation for the price decline is a decline in demand. The fall in price parallels quite closely declines in world GDP forecasts. Chinese manufacturing in particular has slowed. This has been reflected in other commodity prices which are driven by Chinese industrial demand, most notably iron ore, which has fallen almost 50 percent over the last year, and copper, which has fallen by about 15 percent since June. And somehow I don’t think the Australians or Chileans are attempting to punish their economic rivals or geopolitical enemies. They are just along for the ride on the demand train.

The biggest price daily oil price decline occurred the day after Thanksgiving, when OPEC announced it would not cut output. Prices have also declined on days when the Saudis or other Gulf states reiterated their intention to maintain output. But maintaining and increasing output are two different things. The Saudis didn’t announce that they were opening the taps, like they did in 1986. They are just saying they won’t shut them. And as I argued in an earlier post, given their market share and the elasticity of demand for oil, that’s a rational thing to do without having to resort to predatory explanations.

Again, although most analysis focused on supply, the post-Thanksgiving price decline was really attributable to demand too. Market participants were predicting that OPEC would cut output to support prices in the face of falling demand, and this expectation helped to prop up prices. When the expectation was contradicted, prices fell.

I was only surprised that people were surprised that OPEC didn’t cut output. I didn’t see that happening, and I was right: The Saudis only cut output very modestly (by about 3 percent) during the price collapse in the aftermath of Lehman. Where I was wrong was not understanding that it appears that it was almost universally believed that OPEC was almost certain to make a large cut: I was right about the Saudis, but wrong about what everybody thought about the Saudis. This is why I am blogging, rather than sipping Mai Tais on a yacht that would make Abramovich green with envy.

So, it’s not exactly a case of move along, there’s nothing to see here: the price decline is certainly worth watching. It’s just that what you are seeing is not the result of some grand scheme engineered by the Saudis or anybody else. If there is any scheming going on, it is China’s attempt to move to a more sustainable growth model that is less dependent on stimulus-driven investment in industry and infrastructure.

It is certainly the case that the decline in commodity prices generally, and the oil price in particular, could have -and is indeed already having-seismic economic and geopolitical consequences. It is definitely the case that Russia and Iran are going to suffer mightily as a result of the price decline. This may in turn force them to dial back their geopolitical ambitions, although particularly in the case of Russia it could lead to the opposite response by a desperate leadership. But just because these outcomes might be desirable to the US or the Saudis doesn’t mean that the price decline was deliberately engineered to produce them. They are just consequences of broad economic developments that were intended by no one. For the Saudis, the unintended geopolitical consequences at best palliate some serious economic pain.

Given that (unlike in 2008-2009) the demand decline isn’t due to weakness in the US economy, on the whole the US will benefit from the lower oil price, though some regions (like here in Texas and in North Dakota) will obviously suffer. Drilling activity in the US will decline, but this shouldn’t warm Saudi hearts, because if demand rebounds and drives up prices, drilling will rebound too. The oil and the technology aren’t going anywhere: they are on tap for when the price is right.

Recent academic research shows that most of the price variations in oil over the past decades have been demand driven, rather than supply driven. This most recent decline is just another example of that.

Conniving oil ticks and outlandish Texas oilmen make colorful copy , but usually the world is much more prosaic. Oil supply is very inelastic in the short run, so when demand declines even modestly, prices can plunge. This is counterintuitive to most: how can small changes in demand have such huge effects on prices? This leads to speculations about conspiracy, especially when the price changes can shake nations like Russia to their cores. But such speculations are idle. The normal operations of commodity markets routinely produce such price movements. Which is precisely why subjecting grandiose ambitions for geopolitical power to the vicissitudes of commodity prices is the strategy of fools.

And yeah. I’m looking at you, VVP.

Putin may not be having a happy New Year, but I close this post by wishing all my readers all the best for 2015. Enjoy the schadenfreud!

*This elasticity of 10 is related to the sensitivity of oil consumption to prices. Speculative storage makes oil demand more elastic. Indeed, in response to the price decline, visible speculative storage (primarily at Cushing) has increased, and the market has moved into a contango, which is associated with greater storage.

One of the most vivid memories of my early trips to New York was the three card monte games on virtually every corner. The guys would slide their bent cards on the top of cardboard boxes. The most amusing memory is that when a cop would approach one of the card sharps. The hustler running that table would whistle, and you could see others on nearby corners fold up their boxes in a flash and scurry off onto a side street.

Well, they’re back. And like everything else, their games are more expensive. Now you get the privilege of losing $100 when you play: back in the day, it was merely $20.

Speaking of three card monte, it appears that currency traders have figured out the three card monte game that Elvira Nabiullina of the Central Bank of Russia has been playing. The ruble resumed its plunge, declining more than 9 percent today.

As I noted last week, it looks for all the world that the CBR is trying to fool the suckers and hide the black lady with a lot of sleight of hand. Rather than spend reserves officially to prop up the ruble, the CBR is lending dollars to the big banks (VTB and Sberbank) which is lending them to Russian exporters, and the government is ordering the corporates to sell dollars and buy rubles, thereby supporting the currency. See! Reserves stay the same! The country’s finances are healthy!

But if you watch closely, and follow the money and the risk, and you’ll see that the CBR has effectively spent the reserves, or at least put them at significant risk of loss, by replacing dollar liabilities of the US government with dollar liabilities of soon-to-be-junk corporates whose ability to earn dollars to repay the loans has plunged along with the prices of commodities, especially oil.  If that happens, the CBR will have to eat the losses on the collateral posted by the banks (i.e., the loans the banks make to the Russian corporates).

This con game worked for, oh, a good week or so. Today’s big ruble move suggests that market participants are seeing through the scam. So lookout below, and don’t stand under a falling ruble, lest you end up like Wile E. Coyote looking up at the anvil that’s about to drive him into the pavement.

Come to think if it, it amuses me to imagine Putin in the role of Wile E., watching all of his machinations and dreams of conquest come crashing down upon him.

Me-meep.

PS. In the early-80s, the three card monte wager was a little more than 1/2 of the price of a barrel of oil. Today, the price of a barrel of oil is a little more than 1/2 of a three card monte wager. Food for thought.

As part of its efforts to address its looming financial crisis, the Central Bank of Russia announced a new program to assist Russian companies needing dollar and euro financing, and in particular, needing dollars and euros to repay maturing loans. The CBR will lend USD and EUR to banks for 28 to 365 days. The banks, in turn, will lend to exporters and foreign currency borrowers: the banks secure the borrowings with the CBR by pledging as collateral the loans extended to exporters.

On 23 December 2014, the Bank of Russia Board of Directors took a decision to introduce a new instrument — FX loans secured by a pledge of claims on FX loans. This decision aims at expanding credit institutions’ possibilities to manage their own FX liquidity, as well as to refinance external FX loans of Russian exporters, which are soon to be redeemed, given a restricted access to international capital markets. The introduction of the said operations will also be conducive for the exchange rate to return to its fundamental values and to the achievement of demand-and-supply balance in the forex market amid lower exchange rate volatility.

The said operations will be effective until 1 January 2018. The earlier set total maximum amount of credit institutions’ debt to the Bank of Russia equivalent to US$ 50 billion applies to FX repos and FX loans secured by a pledge of claims on FX loans and remains intact.

Note that this program will be in place for more than three years. This is compelling evidence that the CBR expects the crisis to last for some time. Whether the CBR’s resources will last that long is another matter.

Through this mechanism, the CBR is using “credit institutions” as cutouts to lend to Russian corporates. Rather than borrowing FX from foreign banks, the “exporters” will borrow from the CBR via the banks. And who would these exporters be? Well, the biggest are energy producers (Rosneft and Gazprom in particular) and other natural resource firms. Given that Rosneft is sanctioned, and hence is most restricted in its access to foreign debt markets; is an extensive foreign borrower; and due to lower oil prices is facing greater difficulties servicing this debt; it is likely the biggest beneficiary of this program.

Through this action, the CBR is weakening its balance sheet. It will replace $50 billion in low credit risk assets (e.g., US Treasuries) with high credit risk assets from companies like Rosneft (BBB-, and almost certain to be junk soon). Moreover, the CBR is taking on wrong way risk: the loans will be most likely to default or require restructuring precisely when the Russian economy is weakest.

I also suspect that this dovetails with the stealth capital controls, in which the government has commanded state enterprises to reduce their dollar holdings. Some of the dollars that they will spend will be obtained from the CBR via this loan program. This combination of programs therefore allows the CBR to use reserve dollar and euro holdings to support the currency without recognizing declines in official reserve holdings.

Desperate times call for desperate measures, and these measures are desperate indeed.

Putin, the alleged personification of the Russian nation, is conspicuously un-Russian in at least one important way: he is a teetotaler. But I suggest that he become a true embodiment of the narod and take up heavy drinking. It might improve his understanding of economics.

There is no better illustration of Putin’s economic ignorance than his recent call to cap the price of vodka. His reasoning? If the current economic crisis causes its price to rise, Russians will substitute towards samogon:

“The overshoot of vodka prices leads only to increasing consumption of bootleg [spirits],” said Putin, who is known for promoting a healthy lifestyle. “I think the relevant structures [government bodies] should think of that,” he added.

Actually, price controls on vodka will have the opposite effect. Price controls reduce production, leading to shortages. The true price of vodka will rise above the officially sanctioned price.* The higher prices and shortages of licit liquor encourage the production and consumption of homemade moonshine made out of . . . well, you probably don’t want to know. (But if you do.) Alcohol poisonings will likely actually rise rather than fall.

This is Vova’s way of promoting a healthy lifestyle. His misunderstanding and mismanagement of the vodka market is a very symbolic of his misunderstanding and mismanagement of Russia’s economy generally.

No wonder Russians are such prodigious consumers of alcohol, in whatever form that is at hand.

*The “true” price could be the black market price. Alternatively, it could be the controlled price plus whatever costs are incurred (value of time spent in line, bribes, etc.) to get access to vodka at the controlled price. It can also be paid in the form of lower quality. Lower quality, of course, reduces the difference in value between store bought vodka and samogon, inducing a substitution towards the latter.

Bowing to the inevitable, Rosneft and Morgan Stanley scuppered their agreement to sell MOST’s energy trading operations to the Russian company. The official explanation was that the deal failed to get approvals from US regulators.

Go figure.

Glad that the Committee on Foreign Investment in the United States,which consists of Treasury, Justice, Homeland Security, Defence, State, Commerce, the US Trade Representative and the Office of Science and Technology Policy, saw off Igor and Co. Putting the FU in CFIUS.

That said, even if the regulatory approvals had been forthcoming, I don’t see how the deal would have worked. As I wrote in September, I didn’t see how a company without access to long term dollar credit (due to sanctions) could operate economically such a credit-intensive business as oil trading. Hell, today Rosneft’s other big announcement was that it paid off some loans it took on when it acquired TNK-BP. When a company announces a loan repayment like it’s some sort of triumph, you know that they aren’t in any position to buy and run a trading business.

Put differently, if CFIUS hadn’t have gotten Rosneft, the sanctions would have.

This might actually be a blessing to Morgan Stanley. The current high volatility, contango, low price environment is actually quite favorable for trading. Low prices reduce working capital needs. Contango makes for profitable storage opportunity. Volatility creates trading opportunities. MOST might actually get more now than Rosneft had agreed to pay.

*Title inspired by Springsteen’s Blinded by the Light.

Hard on the heels of Putin’s press conference, Obama held one of his own. Blessedly, it was shorter. That’s the only good thing I can say about it.

At least Putin’s pressers offer some entertainment, some of it intentional, some of it accidental. Obama’s appearances are as entertaining as a root canal performed to the accompaniment of fingernails on a blackboard.

I will limit myself to comments on two issues.

First, yet again Obama slagged on Keystone XL. And yet again, he delivered a disingenuous, economically ignorant attack on the pipeline:

“There is very little impact – nominal impact – on U.S. gas prices, what the average American consumer cares about,” Obama told reporters during an end-of-year press conference.

. . . .

“It’s good for the Canadian oil industry, but its not going to be a huge benefit to us consumers,” he said.

Obama stressed that the issue at hand for Keystone is “not American oil, it is Canadian oil.”

“That oil currently is being shipped out through rail or trucks and it would save Canadian oil companies, and the Canadian oil industry enormous amounts of money if they could simply pipe it all the way down to the Gulf,” Obama said during his final press conference of 2014.

“It’s very good for Canadian oil companies, and it’s good for the Canadian oil industry but it’s not going to be a huge benefit to U.S. consumers, it’s not even going to be a nominal benefit to U.S. consumers,” Obama said.

Where to begin?

1. What the hell did the Canadians ever do to him? Does he hate them because they are members of the British Commonwealth? (And we know he loathes Britain.) It is truly astounding to see a president who is so solicitous of many thuggish regimes be so dismissive of a longtime friend and ally. Speaking about Keystone, Obama turns into an American Firster nativist, rather than his usual pose as Citoyen du Monde.
2. Last time I checked, the oil would be refined-and value added to it-in American refineries.  That would benefit American oil companies, American workers, and the owners and employees of companies that supply the refineries. The money savings would be split between American and Canadian companies. But maybe because the refineries are located in Texas and Louisiana, which have repudiated Obama massively, that’s a bug not a feature. Or maybe Obama doesn’t understand that oil doesn’t magically transform itself into gasoline, diesel, etc.
3. Or maybe Obama persists in the delusion that the oil will be exported, disregarding basic economics, common sense, and the analysis of his own State Department.
4. There would be no impact on gas prices only if the supply of Canadian crude is completely inelastic: in this case, the quantity of oil produced and refined would be the same, regardless of how costly it is to transport it to market. If supply is somewhat elastic, lowering transportation costs increases output, which lowers product prices; moreover, holding output fixed, reducing transportation costs reduces the final product price. And perhaps most importantly, the alleged justification for stopping Keystone is the environmental damage Canadian heavy crude inflicts. But if supply is perfectly inelastic, there is no environmental benefit of raising transportation cost, because this will not affect the amount of oil produced, and hence will not affect the amount of CO2 it produces. (Not to mention that pipelines are a safer, more environmentally sound way of transporting this oil.) So if Obama is right about gas prices he is wrong about environmental benefits, and vice versa.

Unbelievable.

Come to think of it, I think that Obama’s real reason for opposing Keystone XL is that the Venezuelans would be the biggest losers. I am pretty sure he has much more of an affinity with Chavistas than Canucks.

Which brings me to the other issue: Cuba.

I am ambivalent about the embargo, or the lack of diplomatic recognition. I can argue either side. But there are many things about this initiative that make me uneasy.

For one thing, Cuba is in dire straits. This is where Venezuela comes in. The Bolivarian paradise has been carrying the Castros’ shambolic regime for years, but is now itself on the verge of economic collapse. Default is imminent, and at the current level of oil prices economic collapse is a real possibility. Venezuela is already cutting back support to the Cuban regime, and will cut it back further. Given that, the Castros are desperate, and Obama could have extracted a much better deal. A deal that would have given some benefit to the Cuban people, rather than bailing out the regime and allowing to continue its repression and depredations.

Obama’s rhetoric was also offensive, and at times historically ignorant. He characterized the embargo as a “failed policy.” Pretty rich for a serial failure to insult 9 previous presidents and 26 Congresses. He could have made an affirmative case for a new policy, and recognized the reasons for the previous policy, without such condescension.

Moreover, he made mention of the need to move beyond “the legacy of colonialism and communism.” Communism isn’t a legacy in Cuba: it is a daily reality. Insofar as colonialism is concerned, is Obama referring to Spain? Because he sure as hell can’t be referring to the US: Cuba was never an American colony. The Teller Amendment to the declaration of war against Spain in 1898 forbade the US from annexing Cuba. It was under US administration for four years, but achieved full independence in 1902. (Obama made the colonialism/communism remark in a discussion of Latin America generally, but this doesn’t really save him. Cuba is the only longstanding Communist country in Latin America; colonialism ended in Latin America in the 1820s; the US-via the Monroe Doctrine-kept out colonial powers in the 19th century; and colonialism is the least of Latin America’s problems, which tend to be very much home grown. In mentioning colonialism, Obama was just regurgitating a standard prog trope.)

Obama also engaged in his self-indulgent habit of making history all about him. He noted that Fidel Castro assumed power two years before Obama’s birth, and the Bay of Pigs invasion occurred soon before he was born. (Interesting that he uses the “I” word to refer to Bay of Pigs, but not Ukraine.) Who cares? What does this have to do with anything?  Does he have to bring himself into everything?

I’ve therefore decided that I will hereafter designate all dates by BO and AO: Before Obama and After Obama. Castro assumed power in 2BO. Bay of Pigs occurred in Year Zero. Obama elected in 47 AO.

The means by which Obama pursued this policy was also typically high handed, and failed to include or consult with anyone in Congress. And no, I don’t include corrupt tax scofflaw Charlie Rangel, who was photographed lounging like a beached whale in the Cuban sun after helping in the negotiations.

The means and the outcome of the Cuban opening also make me uneasy about deals with Iran.

I could go on, but I’ll close with one point. People have compared this to Nixon’s opening of China. Superficially, this is plausible. But there is a major difference.

Nixon could go to China because his stalwart anti-Communist credentials (which had won him the intense enmity of the left) made it credible that Nixon was acting in the interests of the US, rather than indulging his ideological preferences: if a McGovern or a Henry Wallace had attempted the same there would have been justifiable suspicions of their motives and the benefits to the US. In contrast, Che is worshipped has a hero rather than condemned as a psychopathic murderer in Obama’s political circles. His administration has taken a very benign approach to leftist Latin American regimes, including Venezuela and Nicaragua. This raises doubts about what his Cuba initiative will entail, and whether it will advance American interests or benefit the long-suffering and repressed Cuban people.

So to summarize Obama’s last press conference: he slammed a long-time ally and sucked up to a long-time enemy. Which pretty much summarizes his foreign policy, generally.

Michael Coscia, the defendant in the maiden criminal manipulation “spoofing” prosecution, is calling for dismissal of the case on the grounds that the relevant Frankendodd language is “hopelessly vague.”  This is the obvious argument for him to make. The defendants in the BP propane criminal case walked because Judge Miller decided that the anti-manipulation language of the Commodity Exchange Act was “unconstitutionally vague” as applied to the facts of the case. In some respects, the blame for this goes back to the horrible CFTC decision in the case in re Indiana Farm Bureau. In any event, spoofing does indeed sound like a pretty damn vague allegation. Given that, it will be quite interesting to see whether the DOJ fares better in a Chicago courtroom than it did here in Houston in 2009.

What a wild day. The Ruble weakened dramatically from the open this morning (15 December), falling about 2.5 percent. Then the Russian Central Bank intervened, spending a rumored $1 billion to prop up the currency. This caused about an 86 pip rally, but this lasted for mere moments, and then the Ruble rocketed lower, reaching 64.24 by the end of the day. That’s down a mere 10.22 percent boys and girls. (The weird thing about currencies quoted like the Ruble is that up is down.)

Here’s the ugly picture. You can see the little bitty (and very temporary) impact of the intervention at a little after 8am.

In other words, the RCB blew $1 billion for a blip. A billion here, a billion there, and you’re talking real money. In so doing, the RCB gifted those evil speculators whom Vlad inveighed against about $65 million in a few short hours. Merry Christmas!

Ominously, this decline was not a response to a similar decline in the price of oil. Although oil ended down on the day, it was rallying on news from Libya at the time that the Ruble was plunging. What precipitated it? One leading candidate is Friday’s announcement that Ru626b in Rosneft bonds could be used as collateral at the RCB: this approval came much more rapidly than normal. Thus, in effect, the RCB was lending rubles to Rosneft, using bond investors as cutouts. Rosneft felt obliged to issue a press release saying that “not a single ruble, raised within the bond issue, will be used to buy foreign currencies.” Note the weasel phrase: obviously rubles are fungible, so the loan frees up other rubles for Rosneft to sell. Meaning that this smacks of an RCB bailout of Rosneft. This is bad enough, but it could also foreshadow similar actions for other beleaguered Russian companies.

Then, in the very early hours of the 16th, Moscow time, the RCB announced a whopping 650 basis point increase in the interest rate, from 10.5 percent to 17 percent.

The initial effect has been to bring the Ruble back under 60. There is reason to doubt that this will last. First, previous rate increases-though not as big as this-had only a temporary effect on the relentless decline in the currency. Moreover, the rate rise will be highly contractionary, and a weakening economy will put downward pressure on the Ruble. Further, people draw inferences from central bank actions: perhaps the RCB is signaling a very serious fundamental weakness or an impending bank run or its belief that many Russian corporates will be dumping rubles to raise dollars and Euros; any of these signals would mean that its intervention could have the perverse effect of fueling a further decline. In addition, the rate rise does nothing to eliminate the need of Russian firms to obtain dollars to repay maturing debts.

Even if the rate intervention works in the sense of stabilizing, or even reversing, the collapse in the currency, this will come at a cost. As I noted, the effect of the rate rise will be highly contractionary. The government had already been predicting a recession. That is now a certainty, and it is likely to be a severe one. Especially if oil continues doing the limbo.

The RCB action reminds me of a fox chewing off its snared leg. The best of some very bad options.

The situation is obviously volatile, with many things going on (including pronounced weakening in other emerging market currencies and stock markets as well as the oil situation). Moreover, it will no doubt engender a political response, which will feed back onto the markets. How it will affect the increasingly paranoid Putin is hard to know. A climbdown (if credible) in Ukraine would do wonders for the Ruble, but methinks Putin is more likely to double down than climb down.

One prediction is safe: the next days will be memorable. Deserving of some memorable music: Rocket to Russia, by the Ramones.

There’s a whole lotta stupid in Frankendodd. A whole lot. The SEF Mandate is at the top of the list, but the “Swaps Pushout” isn’t far behind.

The Pushout was the brainchild of ex-Arkansas Senator Blanche Lincoln. (NB: I understand the risks of using “brain” in the same sentence as “Blanche Lincoln”.) Blanche, she of the historic 21 point annihilation in the 2010 midterms.

In brief, the Pushout required federally insured banks to move-“push out”-some swaps dealing activities to separate subsidiaries that do not have access to federal deposit insurance. This does not apply to all swaps, mind you. Not even to the bulk of them (interest rate swaps, many CDS). But just to commodity derivatives (other than gold), equity derivatives, and un-cleared CDS.

I took particular interest in this because-again-it slammed commodity derivatives. It was one of several provisions (position limits being another prominent example) that explicitly targeted commodities. Apparently the belief is that commodity derivatives are uniquely risky and subject to abuse, which is just untrue.

Consider a dealer making a market in a commodity index swap. That swap is easily hedged in the futures markets. Ditto with a NYMEX lookalike gas or oil swap. Yes, maybe an unhedged commodity swap is riskier than your typical unhedged IRS, but so what? That’s not the way dealers typically trade (they typically run matched books, or nearly matched books), and capital requirements and other regulations mean that riskier positions incur additional costs that mitigate the incentive to take on excessive risks.

So commodity derivatives (or equity derivatives) don’t create exceptional risks that justify exceptional treatment. What’s more, creating stand-alone affiliates to handle this business entails additional costs. More people. Duplication of infrastructure. Additional capital. There are also scope economies (deriving in particular from capital efficiencies that arise from greater netting opportunities that arise from holding multiple, relatively uncorrelated, positions in a single book). Sacrificing those scope economies will lead to fewer commodity swaps dealers, which in turn makes hedging costlier and the market for these swaps less competitive.

In other words, like many parts of Frankendodd, the Pushout was all pain, no gain. And the pain, mind you, will be suffered not so much by the dealer banks, but by the firms in the real economy that use commodity derivatives to hedge their price risks.

That said, it never seemed to be that big a deal, given the relatively small scale of commodity derivatives and equity derivatives in comparison to IRS and other trades that banks were allowed to keep on the books of insured entities. Small beer compared to the rest of the havoc wreaked by the rampaging Frankendodd Monster.

But this obscure provision could be the one that brings on yet another government shutdown. The most hardcore lefties in the Senate (e.g., Elizabeth Warren) and the House (e.g., Maxine Waters) have drawn a line in the sand over the part of the “Cromnibus Bill” that would repeal the Pushout. If passed, “Cromnibus” would fund the government (except DHS) for the next year, thereby avoiding another shutdown.

But claiming that eliminating the Pushout would be an unconscionable capitulation to Wall Street, the lefties are going to the barricades, and threatening to bring DC to a grinding halt rather than let the Pushout bite the dust. This is not about substance, but symbolism. It is also about a defeated party carrying out a rearguard action on ground where its most rabid partisans can rally.

You cannot make up this stuff. Blanche Lincoln’s populist hobby horse, a desperate effort by a doomed politician, could be the pretext for yet another unproductive partisan confrontation that has virtually nothing to do with the more serious issues associated with funding the government for the next year. (If the Pushout hadn’t passed, would Lincoln have lost by 25 points or 15, rather than 21?) (I note that Gary Gensler worked very closely with Lincoln on Frankendodd: “During drafting sessions, Gensler sometimes sat at the table reserved for staff, advising its Democratic chairwoman, Blanche Lincoln of Arkansas.”)

Cromnibus raises very serious issues. The Swaps Pushout isn’t one of them. But rather than joining the debate on the real issues, or conceding their thumping at the polls, demagogic progs are screaming Swaps Pushout or Fight.

What a travesty.

Global regulators are concerned, and apparently mystified, by the evaporation of liquidity in bond and stock markets:

Global financial regulators worry that banks are scaling back costly market making functions and that this could leave investors stranded, as well as squeezing funds to drive economic recovery, a senior official said on Tuesday.

. . . .

David Wright, secretary general of the International Organization of Securities Commissions (IOSCO), which groups market regulators like the U.S. Securities and Exchange Commission and Germany’s Bafin, said it was an issue that was being looked at.

“We have seen a ‘Houdini’ disappearance of market makers in general,” Wright added. “First of all we have got to establish the facts, look at the markets … and see if this is a big problem … It’s a new frontier-type issue. I think it’s partly caused by some regulation, but we need to know.”

Partly caused by regulation? What was your first clue, Mr. Wright?

Between the impending Volcker Rule and more stringent capital rules and limitations on off-exchange dealing in stocks, regulators have piled restriction on restriction on market making activities. And they are shocked that liquidity is drying up?

Reminds me of a guy standing with a gasoline can and a blowtorch, and wondering just how his house caught on fire.

The article focuses on Europe, but it’s an issue in the US too. And Canada:

The Bank of Canada warned that investors in the nation’s corporate bond market may be underestimating the difficulty of selling the securities in a market downturn, putting them at risk of greater losses.

Rising holdings of corporate bonds in mutual and exchange-traded funds could exacerbate price swings if the funds are forced to sell in a rout, the central bank said in its semi-annual Financial System Review. Some market participants also “believe” dealers are reducing market-making activity, or acting as the middleman between trades, which may make it harder to unwind large positions, the bank said.

“A potential deterioration of liquidity in Canadian corporate bond markets may not be fully priced in,” according to the report. “Market trends suggest that more sizable price swings might be observed in the future than previously, should investors seek to simultaneously unwind large positions.”

In the aftermath of the post-crisis regulatory bacchanalia, the regulators are finally coming to recognize the unintended consequences of their actions. They are starting to see-sometimes rather dimly, pace Mr. Wright-that regulations intended to make the system less risky are creating new risks.

I’ve used the analogy of the Sorcerer’s Apprentice before. It’s as relevant now, as it ever was.