Streetwise Professor

The FT reports a huge boom in rail in the Midcontinent, with oil shipments from the Bakken driving this growth.  And who is capturing the bulk of this traffic?

The exports have helped North Dakota become the second-biggest oil producing US state, behind only Texas. Customers of BNSF, the railway that handles 44 per cent of the region’s oil exports, have built terminals on its routes through the region capable of handling 1m barrels of oil a day.

. . . .

Mr Smith says BNSF should retain between 25 and 37 per cent of the Bakken Shale’s export market once pipelines arrive, and when the field is fully developed, that should provide more traffic than its current 44 per cent market share.

“As long as we can provide transportation services to markets that pay better than [the market served by] the pipeline, we’re going to maintain and retain our market share,” Mr Smith says.

And who owns BNSF?  Berkshire Hathaway, of course.

I’m sure that’s totally immaterial to the government’s failure to approve the building of the northern piece of the Keystone XL pipeline.

Speaking of Buffett, his most famous utterance is about derivatives being financial weapons of mass destruction.  That quote is recycled over and over and over again when anyone wants to warn about the dangers of derivatives.

But Buffett doesn’t take his own advice.  In 2007-well after his FWMD quote-Berkshire sold credit protection on municipal bonds.  $8.25 billion in notional, to be exact.  He exited that trade last month, but remember it whenever Buffett’s quote is used.  Also remember his big sale of S&P 500 put options right before the crisis.

It’s not as if I’m shocked that multi-billionaires are out to make money, and will use a variety of means (e.g., influencing government policy to benefit an investment from competition, taking risks that they damn in public-perhaps thereby scaring off competition, cornering markets) to make it.  Just saying don’t fall for the folksy shtick, and think that Buffett is a better brand of billionaire.

A spate of news out of China all points in one direction: a slowdown, and perhaps a severe one.  Whether it is stock prices, PMIs, or data from the banking sector, or capital flows, the signs are all quite bearish.  The perpetual China bulls are doing their best Alfred E. Newman “What? Me worry?” imitation, claiming that the omniscient and omnipotent Chinese government will order another stimulus splurge that will propel Chinese growth back to stratospheric levels.

Interestingly, the Chinese government seems to be reluctant to oblige.  And with good reason, IMO.  The economy is already wildly unbalanced, with investment representing an entirely disproportionate share of GDP.  What’s more, much of this investment has been malinvestment.  As Baldingsworld points out, the signs are everywhere, such as 50 percent vacancy rates in apartments and massive investments in wind electricity generation capacity that doesn’t actually generate, you know, any electricity.  (Another competition we should lose, Barry!)  I’ve already blogged about the appalling returns on Chinese investments in solar: that post has sparked a lot of comments on Seeking Alpha. Then there are the bridges that fall down.  Then too there is the accumulation of large quantities of inventory of stuff like copper, coal, and iron ore (that shows up as investment) that just sits there.

And the phenomenon is economy wide.  The IMF notes that China’s manufacturing capacity utilization is 60 percent-as compared to US utilization at about 80 percent (which is low by historical standards).  Capacity utilization began to decline with the onset of the crisis, but has continued to drop post-stimulus, suggesting that much of the capacity resulting from stimulus measures has been unutilized, or underutilized.

Now all of this investment, when made, contributed to GDP and represented a healthy fraction of Chinese GDP growth.  To those of you who actually consume (or get utility) from “aggregates”, this is wonderful news!  But the joke is on you. Paying people to dig holes (or eat the inedible) may contributes to GDP-but you end up with holes (or indigestion).

Investment involves a sacrifice of current consumption (including consumption of leisure), and makes sense only if it generates a sufficiently large increase in future consumption.  Empty apartments, collapsed bridges, idle factories, piles of inventory, and oversized pinwheels do not produce any consumption gain.  The resources used to create them were wasted.

Thinking from a real options perspective makes things look even worse.  Real options theory says that under conditions of uncertainty, it is better to wait to invest because information about the value of the investment is revealed over time: just as one should only exercise a call on a stock early if pays a dividend, one should exercise the option to invest only when the immediate flow of services/consumption from the investment-the dividend-is sufficiently large to offset the information-driven benefits of waiting.  Empty apartments and underutilized factories and disconnected windmills are not generating any flow of services/consumption/dividends.  Indeed, inasmuch as they depreciate and require maintenance, they are producing negative flows.  Thus, the investments in them are at best premature, and at worst a total waste: in the future, information may reveal that the resources should have been used to produce something else.

Investment for investment’s sake, or to produce some economic aggregate number that gets people to ooh and aah (based on the fiction that the increase in the aggregate corresponds to an actual increase in the production of, or the potential to produce, things people actually value) is a waste.  Moreover, it is typically a drag on future economic performance, in part because worthless assets funded by borrowing weakens the banking system making it more difficult to finance truly valuable investments, in part because worthless assets aren’t yielding income or enhancing the productivity of labor.

You get something like Japan, now in year 21 or so of its Lost Decade.  Or worse.  And in China, worse is a very real possibility.  Moribund economic performance is a conformist society like Japan’s doesn’t lead to social convulsions.  China’s history is one of  convulsions.  Which is no doubt why China’s government stimulated like crazy in 2009.  That bought time.  But reality eventually intrudes.  Malinvestment can only go on for so long.  The wealth it creates is chimerical, and people are not happy when the fantasy is revealed as such. And 1.3 billion unhappy Chinese is not a comforting thought.

I have lived through the time when first the USSR and then Japan were touted as economic titans that would leave the US in the dust.  Amazingly, the optimism about China has been even more extreme.  And, methinks, the comedown that China will experience will be just as extreme.

Norwegian state oil firm Statoil, which has considerable production in the Bakken, has announced plans to lease 1K railcars to ship oil from ND to refineries throughout eastern North America (h/t Greg L):

Statoil ASA said it is leasing more than 1,000 railroad cars to carry crude oil from fields in North Dakota to refiners across North America, in a bid to overcome pipeline bottlenecks that plague the booming oil-producing region.

The Norwegian oil giant’s railroad effort is a new sign of how the U.S. pipeline network is having a hard time keeping pace with the oil boom triggered by hydraulic fracturing, forcing companies to come up with creative workarounds.

Nowhere is the challenge more apparent than in North Dakota, which this year unseated Alaska as the country’s second-largest oil-producing state. In May the state produced 639,000 barrels per day, or about 10% of the oil produced in the U.S., up from 364,000 barrels per day in May 2011, according to the U.S. Energy Information Administration.

Beginning in early September, the trains that Statoil will have secured with long-term leases will have the capacity to move some 45,000 barrels of crude per day to refiners across North America, more than enough to cover the entirety of the company’s current net production there, company spokesman Ola Morten Aanestad said. Potential destinations include refineries in the East, West and Gulf Coasts and Canada, Mr. Aanestad said.

It would take 14 or 15 days for the trains to make a round trip to Canada, the U.S. East Coast or the Gulf of Mexico, including the loading and unloading of crude, Statoil said. The company didn’t disclose the party it was leasing rail cars from or the price it would pay.

Note what is missing from this story: a mention of the rail carrier that benefits most from all this traffic.  That would be BNSF.  You know, Rail Buffett.

If you don’t believe that fact has anything to do with the Obama administration’s decision to put Keystone XL pipeline running from Canada and the Bakken region to Cushing (and thence to the Gulf) on the regulatory siding, have I got a deal for you!:  Prime oceanfront real estate in the Badlands.

ICE has created something of a kerfuffle by its announcement that it will convert its cleared energy swaps contracts to futures.  Despite a lot of breathless reporting, there is less here than meets the eye.

ICE has merely relabeled its cleared energy swaps as futures in order to avoid burdening its customers with the costs that Frankendodd imposes on swaps.  Futures and swaps are subject to different regulatory regimes.  Firms with sufficiently large swap positions are considered swap dealers under Frankendodd, and must meet a variety of requirements that those not blessed with this designation can avoid: holders of equivalent futures positions need not meet the same requirements.  Swaps trades also involve additional reporting obligations not imposed on futures trades.

So what ICE will do effective in January is change the name of its contracts, thereby reducing the regulatory burden on its customers, without changing their economic substance one iota.  Note that these are cleared swaps, so the change doesn’t create a new clearing obligation on those trading them.  The central counterparty for the futures will be the same as for the swaps: ICE Clear Europe. The contracts will have identical settlement terms.  They will have identical cash flows.  They will trade on the exact same ICE platform.  The economic substance of every aspect of the old “swap” transaction and the new “futures” transaction remains the same, from execution to clearing to settlement.  Nothing changes but the name.

And the regulatory burden.

Which points out the potential for absurd outcomes under Frankendodd.  The CFTC has labored mightily to craft definitions of a swap and swap dealers and major swap market participants.  Where one falls under these definitions matters a lot.  Firms will endeavor to take measures that minimize the regulatory burden they face. ICE is basically picking the low hanging fruit, and taking note of Congress’s morbid obsession with “OTC swaps” and idealization of futures by magically transforming the former into the latter, and thereby making life easier-and cheaper-for its clients.

The incentive to label or structure transactions to achieve the same economic outcome at lower regulatory cost will be quite strong in the Frankendodd era.  This will initiate a regulatory dialectic in which regulators will attempt to adjust regulations in order to limit such attempts to escape regulatory burdens by relabeling or restructuring; the regulated will adjust to the adjustments; the regulators will adjust some more; and on and on.*

The lawyers will rejoice.

Much of the reporting on the ICE move has been pretty far off base, such as this from the WSJ:

Derivatives exchange IntercontinentalExchange said it plans to overhaul trading in trillions of dollars of energy contracts starting in January, becoming the first exchange to take such a step ahead of new financial regulations.

ICE is pushing trading of certain energy contracts onto its exchange, a move that would likely diminish the more-opaque world of over-the-counter derivatives trading. The plan will likely appease lawmakers who have decried the lack of transparency in such portions of the financial markets.

Derivatives exchange IntercontinentalExchange said it plans to overhaul trading in trillions of dollars of energy contracts starting in January, becoming the first exchange to take such a step ahead of new financial regulations.

ICE is pushing trading of certain energy contracts onto its exchange, a move that would likely diminish the more-opaque world of over-the-counter derivatives trading. The plan will likely appease lawmakers who have decried the lack of transparency in such portions of the financial markets.

. . . .

Many energy producers and users generally have preferred swaps contracts because each contract can be written up individually and to a company’s own specifications. That has enabled them to be more targeted in their hedging. Futures contracts, by contrast, are generally standard contracts covering the price of a specific energy grade to be delivered at a certain time.

Pretty much none of that is true.  All of it suggests a change in the way these instruments are designed, traded, and cleared, none of which is in fact changing. The contracts are already standardized, traded on an electronic platform, and cleared.  This is not a movement of bespoke, uncleared, bilateral contracts onto an exchange.

Look.  It’s long been known that the economic substance of swaps and futures are effectively identical, especially when the former are cleared.  Changing the label-hell, call them bananas-doesn’t change the economics.  If the CFTC had even less burdensome regulations for bananas, ICE would launch ICE Bananas.

Which illustrates that Frankendodd is quite often and in many ways truly bananas.

* Relabeling of derivatives contracts was employed in the 19th century to avoid legal restrictions.  When Illinois banned options trading, traders bought and sold the same things, but started calling them privileges.

Western companies with the misfortune of partnering in some way with Mikhail Fridman live in fear of the Tyumen Arbitration Court. Funny thing.  Holders of small positions in companies owned by Fridman that are in a battle with a western partner go to the Tyumen court to sue the western company for some breach, and ask for-and win-huge judgments.  The court has tortured Telenor for years.  And now BP is on the Tyumen rack:

A Russian arbitration court on Friday ordered BP BP.LN +1.39% PLC to pay just over 100 billion rubles ($3.1 billion) in damages to its joint venture TNK-BP in a suit bought by an investor, a ruling that the British company called a “corporate attack.”

“We will challenge today’s ruling in accordance with the procedure established by the law, and expect that the court of appeal will adopt a reasonable and fair decision,” BP said. “We consider this claim as an attempted corporate attack and believe that today’s ruling should be canceled.”

The ruling, from the arbitration court in Tyumen, is to take effect in 30 days unless appealed, in which case it would become effective at the end of the appeal process, BP’s lawyer said.

The order to pay damages comes amid rising tensions between BP and its partners in the 50-50 TNK-BP venture—a group of Soviet-born billionaires known as AAR. Earlier this week, BP said it was in talks to sell its stake in TNK-BP to state-run OAO Rosneft,ROSN.RS -10.01% a move that analysts said could put pressure on AAR, which is also bidding for the stake.

This is taking place against the background of maneuvering over the fate of TNK-BP, which appears to be developing into a The Good, The Bad, and The Ugly-like three way standoff between BP, AAR (in which Fridman is a partner and the strongest figure), and Rosneft.  (The only problem with that analogy is that none of these seems well-cast in the role of Eastwood’s The Good.  However, the the roles of “Bad” and “Ugly” are easily filled, and indeed the guy playing one could readily play the other.)

That contest is puzzling on many levels, and I have no idea what is going on.  Nor does pretty much anybody on the outside-and perhaps not so much on the inside either.  But the Tyumen court judgment gives Fridman leverage in this game.  Talk about home court advantage: nothing in sports comes close.

That the European Bank for Reconstruction and Development believes that Russia is anything but “an island of stability”, being instead a high beta economy that will suffer substantially if the crisis in Europe worsens:

Russia’s economy is more vulnerable to the effects of the euro zone’s fiscal and banking crises as commodity prices fall, the European Bank for Reconstruction and Development said Wednesday.

Starting in October, the EBRD slashed growth forecasts for eight economies in Central Europe, or CEB, and the Baltics and seven economies in Southeastern Europe, or SEE, citing their close trade and financial links to the euro zone.

With strong growth elsewhere in the global economy supporting prices for oil and other raw materials, the EBRD’s forecasts for Russia were largely unchanged. But in its latest report on the outlook for the economies in which it invests, the bank said the impact of the currency area’s prolonged crisis will spread further east and drag Russia down.

“The negative spillovers are reaching east, and to Russia in particular through two main channels: lower commodity prices and a general reduction in risk appetite,” said Piroska Nagy, the EBRD’s director for country strategy and policy.

You can see the channels work in real time.  Right now oil is being buffeted by two conflicting forces: developments in the Eurozone involving primarily Spain and Italy, and developments in the Middle East involving Iran and Syria.  Bad (good) news about the situation in Spain drives down (up) the price of oil; increased (reduced) fears that Iran will do something aggressive in the Straits of Hormuz drives up (down) the price of oil.  And the Russian stock market and the ruble move nearly in lockstep with these movements.

The EBRD is not alone.  Maplecroft, a political risk think tank, also believes Russia’s economic fate depends on what transpires in the Eurozone:

Countries in central Europe and Scandinavia as well as commodity-exporting African countries Ivory Coast and Mozambique are also among the 17 economies classed as being at “extreme risk”, while the BRICs quartet of big emerging market nations Brazil, Russia, India and China is also highly exposed, the survey showed.

. . . .

Arab Spring countries Tunisia, Egypt and Libya follow closely behind, while Russia, Brazil and India were also tagged with a high exposure to the euro zone crisis.

Of the BRIC group of major emerging countries only China was ranked with no more than a medium exposure to the euro zone.

In other words, Russia will suffer substantially if things go pear shaped in Spain (as they are likely to do, IMO, given the daily blob like growth of the problem with regional bailouts, bank problems, and a looming deepening of the recession), without the consolation of pleasant weather and nice beaches.

During all the whinging about WTI, and the claims that it was inferior to Brent as a benchmark, I pointed out that although the former was subject to short term issues that could be fixed by investment in infrastructure, the latter was plagued by far more intractable problems that would compromise its viability over the medium-to-long term.  Indeed, WTI’s problems reflected an unexpected supply surge that actually bodes well for its long term viability, whereas Brent’s inexorable production decline would be virtually impossible to fix.

That reality is now becoming more widely recognized, pace Javier Blas’s piece in the FT:

The drop in production is putting the Brent benchmark in danger. Platts, the pricing agency that acts as the de facto regulator of the Brent physical market, is looking for solutions. It will need to work closely with ICE Europe, the exchange home of Brent futures and options, and the UK’s Financial Services Authority, which has an interest in the Brent derivatives market running smoothly.

The usefulness of West Texas Intermediate, the US crude oil, as a global benchmark has suffered over the past two years due to the so-called ‘Cushing syndrome’ – a glut at the Oklahoma town that serves as the delivery point of the contract. This glut is due to surging production and limited pipeline offtake capacity, and pushed WTI prices below what global fundamentals suggested.

Brent is now suffering from the opposite problem. The ‘North Sea syndrome’ – falling regional output combined with unlimited seaborne offtake capacity. The problem could push Brent prices above what global fundamentals suggest.

It is a lot easier to build pipelines than develop vast offshore oilfields. (Well, it is if administrations I won’t bother to mention let pipeline development proceed.)  This means that WTI’s “problems” can be fixed-and indeed, that its problem (a surge in supply in regions tributary to the delivery point) is a feature not a bug.  Brent’s.  Not so much.  Meaning that before very long CME/NYMEX is likely to be laughing, and Platts and ICE will be sobbing.

Like Freddie Krueger, I’m baaaaaack again, folks.  This time, more regularly, I trust.

Catching up on a few things that have caught my eye since last time-and like Freddie, I brought my knives.

1. The LIEBOR mess continues to metastasize.  It is now sucking in regulators.  Including Timmy! It appears that the dissembling about LIBOR, TIBOR, EURIBOR, etc., was the worst kept secret in the world’s financial centers.  And let’s pray that’s true.  If the Fed, the Bank of England, etc. DIDN’T know that there was a complete disconnect between the rates that banks reported to the BBA and the rates at which they were actually borrowing (or not)-now THAT would be a reason for panic.  In fact, they were all-bankers and regulators alike-operating pursuant to the Juncker Maxim: “When it becomes serious, you have to lie.”
2. I detest manipulation of markets, and have made a life’s work of studying it, calling out manipulators, and now and again testifying against them.  But I find it disgusting to hear high government officials in high dudgeon on the subject, when they are in fact often the most outrageous and shameless manipulators.  The most flagrant example: the Lilliputians who are the collective “leadership” of the EU and the Eurozone.  For what else can you call their repeated fudges, misstatements, lies, etc. related to the latest “solution” to Greece’s problems, or Spain’s, or Italy’s, than “manipulation”?  How many billions have changed hands on the EUphoric rallies that occur after the announcement of such solutions, and on the, umm, “retracements” that occur when the truth comes out.  The agreement on a Spanish bailout, and banking regulation changes, that came out of the most recent Summit of the Lilliputians is only the latest example.  Look.  Europe is screwed.  Metaphysically.  The math does not work.  Cannot work. Even mores, the politics cannot work.  The core is empty.  No real deal is possible.  Accept it.  And once you accept it, mock any pronouncement of the next “solution”.  And for God’s sake don’t buy except on the theory that other suckers buy and you will sell out before they do.
3. FCM Peregrine Financial Group apparently absconded with $220 million of “segregated” customer money.  This is both shocking and depressing 10 months after MF Global.  The scheme has apparently been going on for at least two years.  But the CFTC allegedly gave all FCMs the full anal probe post-MF, and saw-like Sergeant Schultz-NOTHINK! So since they can’t find a rather banal fraud at a middling futures brokerage, it’s truly obvious that they have game to regulate the entire world, and every complex financial institution and complex derivative trade in it.  What could go wrong? No doubt that the Peregrine debacle will lead to calls for more regulation.  Regulation, the only human activity where failure is the primary justification for more of it.
4. The CEO of inter dealer broker GFI, Mike Gooch, has said that hedge funds need to become liquidity suppliers/market makers in order to fill the gap left by banks, post-Volcker Rule.  I predicted this would be the outcome in a couple of posts written soon after the rule was mooted.  There is a serious question here: will this really lead to greater stability during times of financial turbulence?  Given that credit to hedge funds-which comes largely from banks, by the way (funny thing, that!)-typically contracts severely during periods of such turbulence, their market making activities are likely to contract as well during such times.  Meaning that market liquidity supplied by hedge funds will be highly pro-cyclical.  Bank supplied market liquidity is too, but the ones subject to the Volcker Rule-you know, the ones who have sticky insured deposits-are likely to be able to resist these cyclical pressures better than hedge funds because their funding is not as fragile.  So yes, Mike, hedge funds will be needed to fill the gap left by the exit of prop trading banks, but they won’t be there precisely when needed.  Things will work just swell.
5. Gazprom was named the most opaque corporation in the world.  I am shocked and stunned.  It is allegedly the most profitable.  Again, no surprise: government enforced monopoly is a nice gig.  But the company has been forced to make price concessions on contracts to big customers.  It is fighting a rearguard action against the flood of gas being discovered around the world.  It won’t happen overnight, but government mandated monopoly or no, the company’s future is not bright.
6. The to-ing and fro-ing over privatization in Russia continues.  Putin allegedly threw a spanner into Sechin’s ambitions to acquire “privatized” assets, including electricity generators.  But his words are pretty weak: “That does not mean we should limit ourselves to participation by Rosneftegaz.”  So you could envision some competitors in the bidding process, and them prevailing enough times to give the impression that a real privatization is going on.  But this is likely to be a Potemkin privatization, and Sechin et al are likely to prevail.  Sechin certainly thinks so: “Russia’s most influential energy official, Igor Sechin, said on Tuesday the state-owned energy holding Rosneftegaz was given permission to invest cash on its balance sheet in comments which seem to contradict assertions by a top government official [Akardy Dvorkovich].” I would bet on Sechin.  Hands down.
7. There is a spate of bad news about the weakness in China’s economy.  I have been a China bear for going on three years, or more actually.  The first reason for my pessimism has always been China’s ramshackle and rigged financial and banking systems: this predates the crisis.  This post provides an excellent overview of the reasons to find that system “scary.” Yes, the Chinese government has papered over past problems, but there are limits to this, as there are to all things.  Indeed, as the economy has gotten larger, and in the aftermath of the crisis and the massive monetary and fiscal response thereto, the state’s capacity to continue to do this is very questionable.  The second reason is that, contra Tom Friedman or Ray LaHood, I adamantly do not believe that the allocation of capital by the state, directly, and indirectly through financial repression and a hugely distorted banking system, will end well.  In fact, I believe the exact opposite is true.  Suppressing price signals and allocating capital to cronies and state owned enterprises is a recipe for grotesque misallocations of capital.  In the short to medium term, it can lead to impressive GDP numbers.  But spending insane amounts on investment eventually leads to catastrophe if that investment doesn’t produce returns.  That, in a nutshell, is what China looks like to me.  And these two sources of pessimism feed off one another: when the investments don’t generate returns, and in fact generate losses, the banks and trust companies and insurance companies and whatever that provided the finance are toast.  When you force feed a goose, you can at least get good liver pate (but not in California!).  When you force feed investment, eventually you get a bust.

That’s all for now folks.  Catch you again soon. Promise.

Barclays’ has copped to an attempted manipulation of LIBOR.  It has agreed to pay about $450 million to the UK’s FSA, the CFTC, and the USDOJ.  The CFTC filing states that Barclays had two motives for its actions.  First, when Barclays’ reports to LIBOR were high relative to other banks’ (which Barclays people referred to as having their head above the parapet) and thereby raising questions about the bank’s financial condition, it allegedly reduced reported rates in order to allay such fears.  Second, the bank’s traders allegedly influenced rate submissions, and conspired with traders at other banks to change their submissions, in order to advantage derivatives positions.

As I noted in 2008, when the story first broke, the second possibility created substantial legal liability for banks like Barclays that submitted the false reports.  Under the anti-manipulation law in effect in the US at the time, it was necessary to have specific intent to create an artificial price of something like the LIBOR-based Eurodollar futures contract.  The emails divulged today suggest such a specific intent.

Perhaps crucially, the Order only finds that Barclay’s attempted to manipulate, not that it had in fact succeeded.  This will be an important issue going forward.  To prove manipulation, and crucially, to collect damages, it will be necessary to show that Barclay and other submitters of LIBOR quotes indeed distorted the index, that is, they caused an artificial price in a futures contract based on LIBOR or some other interest rate like Euribor.

Proving this will be a very data intensive exercise.  Moreover, there are two distinct issues-the impact of manipulation on the final settlement price of the futures contract (which is based on LIBOR), and the impact of manipulation on futures prices prior to expiration.  The second issue will prove more challenging than the first because the connection is more direct in the final settlement price.  Even that will pose some issues, however, because of the necessity of identifying the “but for”, i.e., what interest rate should banks like Barclays have reported.   This will necessarily require looking at actual interbank transactions, raising the question of how many such transactions there will be during periods of time of money market stress starting in 2007.

These issues are not impossible.  Similar, and arguably even more challenging issues, were confronted in a class action lawsuit against those who misreported  natural gas prices to publishers like Platts.  (Full disclosure: I consulted with plaintiffs in that matter, and wrote a declaration in support of certain aspects of the plan of allocation of settlement monies.)

The whole fiasco does point out, yet again, the overriding importance of basing cash-settled indices on actual transactions, wherever possible.

This is becoming an important issue in oil markets as well, as “Price Reporting Agencies” like Platts and Argus are under great scrutiny.  But oftentimes the problem is not amenable to easy solution.  You can’t have a reliable transaction-based index that is not susceptible to manipulation if (a) there are few transactions, and/or (b) market participants have the option to report transactions.  Pharonic pronouncements from regulators that PRAs make bricks without straw are futile.

None of these issues are new.  I (and my colleagues at UH) dealt with them in 2003 in our efforts to create an “energy data hub” in the aftermath of the price reporting scandal post-Enron.  Voluntary reporting is extremely problematic.  Compulsory reporting (along the lines of one of the few salutary features of Frankendodd) is necessary (but not sufficient for some markets) to produce reliable price indices.  Arranging this on an international market like oil seems virtually impossible to implement, let alone enforce.

This is the longer explanation behind my rather cryptic quote from this WSJ article from last week.

Going back to LIEBOR, the Barclays $450mm coughed up is the first fine, but it won’t be the last one.   In the energy markets, the CFTC collected about $250 million: fines will be many multiples of that in LIBOR and Euribor and TIBOR and whatever.  And believe it or not, the really big money will likely be in civil litigation, and the battles will be much more intense there as well, IMO.

Sorry about the prolonged interruption.  Work demands-notably testimony in a couple of cases-intervened.  One of the cases, believe it or not, stems from the California electricity crisis of the summer of 2000.  The wheels of justice do grind slowly.  We’ll see how fine.  On Tuesday, I testified at a FERC hearing/trial relating to refunds demanded by electricity buyers in California.

The interruptions may recur going forward.  I appreciate your patience, and the inquiries of those who wondered about my absence.

A few quick comments on things that caught my eye in the past couple of weeks.

• My last post was on the administration’s sole commitment to transparency, i.e., it’s chattiness on sensitive intelligence matters, in an information operation designed to make Obama look like a synthesis of Rambo and Thomas Aquinas.  In the weeks following, this issue has caught fire to some degree, at least in DC (though popular opinion has been somewhat muted).  There have been numerous calls for official investigations. These are not purely partisan. Diane Feinstein and Carl Levin have also expressed dismay at the leaks.  And in the latest episode of the inversion of transparency, Obama has asserted executive privilege in the Fast & Furious matter.  His assertion is either facially baseless and contrary to established precedent-or implicates him in a coverup.
• Hillary botched the Russian helo to Syria story. By suggesting that Russia was sending new equipment to Syria, Hillary gave the Russians the opportunity to make outraged denials. On the subject generally, here’s a question that I think is important, but which hasn’t been asked.  Where is Syria getting the spare parts and support services for its Russian/Soviet weapons?  Especially at the increased operational tempo, Syria would need a steady supply of spares to keep its forces in the field.  And likely also some repair and support services.  Arab armies are notoriously-notoriously-bad at this.  (It’s something that has driven American trainers assigned to Arab armies, such as Egypt’s, absolutely crazy over the years.)  I wish someone would ask, investigate, etc.
• Obama met with Putin in Cabo.  Obama came out of the meeting looking like he would have preferred 32 root canals sans anesthesia.  He got nothing from Putin.  Well nothing substantive, that is.  But I am sure that Putin gave him plenty of disdain.  Obama later said that China and Russia were not on board regarding Syria.  No sh*t.  What was his first clue?
• Putin looks bad in the photos from Cabo BTW.  His face looks puffy and waxy.  I’m guessing steroids.
• It has been reported that Putin will attend the Olympics in London after all.  Not the opening ceremonies, as is traditional, but the judo competition.  You know, to see the next generation of Russian billionaires.
• Putin jetted from Cabo to St. Petersburg, for the Annual Economic Forum.  He was in fine form, and in some ways, a flashback to 2008.  That is not a compliment.  In 2008, Putin famously asserted that Russia was an island of stability in the world economic storm.  That was right before the country suffered the biggest decline of any major economy.  Putin also lashed out at the west generally and the US in particular for causing the world crisis.  He repeated both themes yesterday, in a somewhat schizophrenic performance.  First, he stated that Russia is a strong country capable of withstanding another global economic crisis. This despite the fact that Russia is even more dependent on energy/oil now than in 2008, and that the link between economic crisis and oil prices is as strong today as it was four years ago. In other words, Russia is more dependent on oil than ever but Putin believes it is perfectly positioned to withstand another crisis.  Or something.  And speaking of oil, Brent is trading with an $89 handle, down 4 percent on the day and over 20 percent over the last several weeks, and Urals with an $88 handle (a $1.60 discount to Brent). Recall that Russia’s budget balances at Urals=$117.  This may explain the vituperativeness of Putin’s attack on the US and the west.  The more nervous he gets about economic conditions, the more he directs his salvos westward.  This reflects, IMO, his rage at the fact that Russia is hostage to the west, via the commodities price channel.  It is an inevitable consequence of the marriage of comparative advantage and the natural statism of Putinism.  And it drives him nuts.
• Putin also channeled his inner Barney Frank and said that the west needed more effective regulation of derivatives markets. (Bad mental image, I know.)  The man is an expert on everything.

That’s all for now, folks.  Will post as circumstances permit.