Streetwise Professor

In the immediate aftermath of the abortive deposit levy in Cyprus, I confessed being unsure as to why Russian stocks took a bigger hit than about stocks in any other country, including those in the EU where the precedent of expropriating insured depositors would seem to be most salient.

Upon reflection, the most likely explanation is that Cyprus’s financial straits would impede the utility of the country as a tax haven for Russian companies.

Although European and US stocks have rebounded, Russian stocks haven’t.  This got me thinking about the implications of the recent deal for Russian companies.

Capital controls appear to be the key.  If Russian corporates can get their money into Cyprus, receive the favorable tax treatment, and then get it out again, boomerang-like, they are OK.  Conversely, if Cyprus becomes a roach motel, where money goes in but can’t get out, that would really put a tax crimp on Russian corporates.

There have been wildly conflicting claims about the prospects for capital controls in Cyprus.  This seemingly official announcement only adds to my puzzlement:

Capital controls imposed to avert a run on banks in Cyprus after a painful EU rescue plan will be “loose” but will apply to all banks on the island, the Central Bank governor said on Tuesday.

“We aim for some restrictions which, in the words of the president, will be loose,” Cyprus Central Bank governor Panicos Demetriades said. He said the measure would apply to all banks based on the island.

Demetriades said the restrictions would be “temporary” but would not say how long they would last.

“Temporary” I sort of get.  Though I think of the withholding tax, which was a “temporary” wartime measure adopted in 1942.  Better yet, the “temporary” tax on telephone services, adopted to fund . . . the SpanAm War in 1898.  Still on your bill today, folks.

The “loose” part is a mystery.  WTF does that mean, exactly?

My interpretation: Cyprus wants to ensure that Russian companies can continue to boomerang money through the country.  If capital controls are “tight”, Cyprus becomes a roach motel, and Russian money will not check in knowing it wouldn’t be able to check out.

My question: what say the Germans about this?  I sense that the back-and-forth over capital controls is just part of the battle between the Germans and the Russians, in which the Cypriots want to support the Russian side.  I suspect the Germans will consider “loose” to be unacceptable. Meaning that there will be more conflict to come.

The anti-Russian implications of the German hard line on Cyprus are striking, and hard to understand completely, given the fact that Germany has taken a relatively pro-Russian line in Nato.  But perhaps there’s something deeper going on here.  Maybe something personal.  I wonder if Putin regrets setting his dog loose on Merkel-a notorious caninophobe.  Could caninophobia have led to Russophobia?

Although Medvedev fulminated at the injustice of the Badinov Bank solution, subsequent Russian reaction has been more accepting: the man who matters-Putin, not Medvedev-“has decided to support it.”

Perhaps Putin is just bowing to reality.  I’m more interested in whether the deal makes economic sense, especially as compared to the levy scheme that went down in flames.

The fundamental fact is that the two big Cypriot banks are insolvent.  Assets are less than liabilities.  The resulting loss must be borne by someone or someones, specifically:

1. Equity holders. (Ha!)
2. Bondholders.
3. Unsecured depositors.
4. Secured (guaranteed) depositors.
5. Taxpayers.
6. Extraterrestrials.

With all due deference to Krugman, let’s rule out (6).  With respect to (5): (a) Cypriot taxpayers-uhm, Cyprus is bankrupt (which is why it needs 10 billion euros in bailout funds), so Cypriot taxpayers aren’t a realistic alternative, and (b) bowing to political pressure and an impending election, Merkel has ruled out German taxpayers.

So that means that the loss must be borne by those with claims on the insolvent banks.  The proper way to do it is to work through those claimants in order of seniority from junior (equity) to senior (insured deposits).  That’s what has been done now.  That’s the right way to do it.  It’s what should have been done at the outset, given the economic and political realities.

The problem with the solution that went down in flames is that it violated the priority of claims.  Apparently in an attempt to appease the Russians, Cyprus’s president Nicos Anastasiades decided to reduce the losses imposed on uninsured depositors-who include many Russians-by imposing losses on insured depositors, most of whom are the countrymen he was actually elected to represent. Moreover, the levy was imposed equally across claims on Cypriot banks, regardless of the severity of their insolvency.  This was also highly objectionable, because it meant that depositors at banks that were truly egregious in their risk taking were treated identically to those who were less egregious.  Under that rule, no depositor has any incentive to avoid especially risky and reckless banks, or to monitor bank riskiness.

The Badinov Bank alternative is therefore defensible on rule-of-law grounds, whereas the levy alternative was not: moreover, the Badinov bank alternative is economically more sensible, especially in terms of giving depositors better incentives.

The irony, of course, is that Russia would have been better under the Anastasiades alternative.  Russian depositors at the Popular Bank of Cyprus will be especially hammered under the Badinov bank alternative, because that was the baddest bank of them all.  Whereas they were looking at a 10 percent loss under the levy scheme, they are now looking at losses upwards of 30 percent.

Oh well.  That’s the way the seniority cookie crumbles.  And that’s how it should be.  Let the crumbs fall where they may.

The contours of the latest deal between the EU and Cyprus are becoming clear.  No “levy” on deposits.  Deposits under 100ks will not be touched.

In place of the levy, Cyprus will move to a good bank-bad bank structure.  All deposits less than 100k will go to the good bank.  All deposits over 100k will go to the bad bank.  Since the bad bank’s assets will be, well, really bad, its depositors will get cents on the euro.  Estimates are that the bad bank depositors will suffer losses of between 30 and 90 percent.

A large fraction (most?) of the bad bank deposits will be Russian.  Meaning that Russians will take a big hit.

This is pretty much what the IMF and the Germans wanted initially, but backed off from in the face of intense opposition from Cyprus-which didn’t want to shaft the Russians, in the hope of perpetuating its status as an offshore haven.

Imposing big losses on depositors, insured or not, makes runs in Spain and Italy more likely in the event that it appears that they will have to throw themselves on the tender mercies of the Europeans (read Germans).

The Russians will no doubt be furious, setting up potential confrontations going forward.  The Cyprus drama seems to be a proxy war between Russia and Germany, which is hard to explain given Germany’s previously benign approach to Russia: for instance, Germany scuppered US attempts to advance the progress of Georgia and Ukraine towards Nato membership.  So why is Germany so insistent on doing something that inflicts large losses on Russia-and elite Russians?  Can the impending German election explain it?  Or does Germany think that the fate of the Euro is on the line, and if saving the Euro p*sses off the Russians, so be it.  Or is it something else?  I wonder.

Regardless of the exact reason, Russians are now effectively the not so proud owners of a bad bank.  Bank Badinov, as it were:

I’ve been asked for my take on the Senate report/hearings on the London Whale.  I’m responding more out of a sense of duty, rather than any actual enthusiasm for the subject.

There are two issues that need to be distinguished, IMO: the operational aspects of JPM’s CIO, and the economic substance of the transactions that cost the bank billions.

The operational aspect is indeed appalling.  The reliance on a spreadsheet with manual inputs to quantify the risks of the CIO is truly appalling.  Division, multiplication-whatever!   The failure to take into account market liquidity, and the ability to get out of a huge position in the event that circumstances changed.

The battle over marks-hardly surprising.  It has always been so, and will continue to be so long after we have all shuffled off this mortal coil.

With respect to the economic substance, I don’t have much to add beyond what I said last summer, or beyond what the wickedly sardonic Rhymes With Cars and Girls has written over the past days.  I encourage you to read Crimson Reach’s posts.

In a nutshell, Crimson ridicules the presumption that banks can invest in ways that are immune to the risk of loss, and mocks the Shocked! Shocked! response when losses are actually realized.  Relatedly, he eviscerates the attempts to distinguish between “hedges” and “speculative” trades.

These distinctions are indeed Talmudic.  Any investor-including banks-makes risk-return trade-offs.  With respect to banks particularly, they are in the business of taking credit risk.   There are myriad ways of taking on credit risk.  Making loans.  Buying or shorting corporate debt.  Buying or selling CDS .  What really matters is the risk of the overall portfolio.  There are many ways to achieve the same risk profile.  And since banks inevitably take on risk, there are many ways to lose money.  And believe me, banks have found them all.  Sovereign debt (remember the LatAm debt crisis, anyone?), mortgages, corporate debt, consumer lending.

What JPM described as a “hedge” was really a trading strategy was not a mechanical offset of an existing position.  It was designed to perform (relatively) well in a particular state of the world, i.e., another financial crisis.  In that sense, it was taking a view on the potential damage associated with that state of the world, and the likelihood of that state.  That state didn’t occur, and the position performed badly.

Like I said, there are myriad ways to invest or trade based on that view, and there’s virtually no way to prevent banks from investing or trading based on their views on risk.  That’s what banks do.  Deal with it.

These views will often be wrong.  Which is why banks frequently lose a lot of money.  When they share the same views, and hence trade/invest the same way, they will lose money at the same time: that’s when we have a systemic risk problem.  Again: LatAm sovereign debt in the ’80s; mortgages in the ’00s.  The blessing of the JPM case was that it was pretty much alone in its strategy.

Insofar as the atmospherics are concerned, I am sure that any forensic examination of any of these loss-making episodes would reveal the same kinds of behavior documented in the Senate report.  The same duplicity.  The same attempts to avoid blame.  The same attempts to defer recognition of losses.  The same arguments and backbiting.

The biggest problem with JPM was that, well, it was big.  If you look at many major financial debacles, a common feature is that big institutions make bets that are so big that they become price makers rather than price takers.  When the bets go wrong, and they want to get out, or to reduce exposure, size becomes a liability, rather than an advantage.  Size creates positive feedbacks, and in financial markets, positive feedbacks have very negative effects.  The holder of a big position suffers losses, and tries to reduce exposure: they are so big that these attempts move prices against them, thereby exacerbating the losses.

That’s what happened to LTCM.  That’s what happened to JPM’s CIO.  The difference was that JPM had the capital to survive: LTCM didn’t.  Another good thing.

Carl Levin is using the Whale Trade to dragoon the regulators into implementing the Volcker Rule, which is intended to prevent banks from “trading”, and to limit their activities to “lending” instead.  Again color me unimpressed.  Banks have proved since time immemorial that they can lose vast sums lending, thank you very much.  One of the virtues of trading is that the discipline of mark-to-market forces realization of losses sooner: it’s harder to conceal losses on the trading book than the banking book.  (I understand the complexities here.  Especially when banks are subject to capital requirements, realizing losses can force banks to shrink balance sheets in ways that generate fire sales and positive feedbacks.)  Yeah, the traders at CIO tried to finesse/manipulate the marks to defer recognition of the losses.  But they wouldn’t have even had to resort to chicanery had these losses been on the banking book: in a (perhaps perverse) way, the frantic attempts to jigger the marks demonstrate the ruthless disciplinary effects of marking to market.

In brief, drawing distinctions between “hedging” and “speculating” or between “trading” and “lending” or “investing” or “market making” is typically futile.  Banks can f*ck up-or make lots of money-doing any of these things. And have.  Rather than attempting to micromanage the activities of banks, it’s better to focus on making sure they have the incentives to take risks prudently, and have the capital to absorb the inevitable losses.

Which is why, as far as I am concerned, the would-be Ahab Carl Levin set out to kill a great whale, and brought home a minnow.

SWP, 18 March 2013: “Cyprus: The Essence of FUBAR.”

Krugman, 21 March 2013: “Cyprus: The Sum of All FUBAR.”

It wouldn’t be the first time someone has lifted something from SWP, but Krugman?  The mere possibility forces me to re-evaluate my thinking on Cyprus.  But then again, you know what they say about blind hogs and acorns.

One Cyprus scenario that has received considerable hype is that Gazprom will bail out the country in exchange for rights to develop its offshore gas resources.  IMO, this reflects a fundamental misunderstanding of Gazprom’s interests.  If anything, Gazprom has an incentive to pay to ensure that Cyprus’s gas reserves are not developed.

That is, Gazprom has every reason to want the gas to remain under the sea.  Eastern Med gas would compete with Gazprom’s Russian production: if Gazprom controlled Cyprus’s gas, sales from these fields would cannibalize sales of Russian gas.  Meaning that Gazprom has no real interest in developing Cypriot gas-to the contrary.

Obtaining exclusive development rights would give Gazprom the right to not develop, and to prevent anyone else from doing so.  This would suit it quite well, and it might be willing to pay something for that right.  But as desperate as Cyprus is, it has to realize that giving Gazprom control over its gas destiny would deprive it of the future revenue its resources could generate.  It is highly doubtful that Cyprus could negotiate a deal that would effectively compel Gazprom to develop the country’s gas.  Therefore, by dealing with Gazprom it would essentially be writing off any prospect of enjoying the benefits of future gas production.

This means that Gazprom’s interests and Cyprus’s are not aligned: the latter wants to maximize the commercial development of its gas fields, the former has no such interest.  Cyprus’s horizon might be very short, given its pressing financial needs, but it would have to discount the future extremely heavily to make a deal with Gazprom remotely rational.  I consequently deem it very unlikely that Cyprus and Gazprom could reach a mutually beneficial deal.

Development rights to Cyprus’s gas might be valuable collateral for loans that ease the country’s current financial straits.  But Cyprus should look energy firms whose interest is to maximize the commercial prospects of its gas resources, rather than Gazprom, which would like nothing better than to sabotage their development.

I’m talking about the Brussels Bozos, so the post title is a completely rhetorical question.

What I’m referring to specifically is that the Eurocrats were supposedly “blind-sided” by the opposition to the depositor bail-in in Cyprus, and the impending defeat of the proposal in the legislature.

What, did they think that Cyprus would roll over and sheepishly-and I do mean sheepishly-comply with the EU’s dictates?  Did they really think that local politics wouldn’t rear its ugly head, and disrupt their orderly little world?

The sad thing is that I think the answers to those questions is “yes.”  Or, more accurately, “YES!”  The EU is an elite project and the elites presume that the hoi polloi will slavishly adhere to their master’s dictates.  That’s probably true on small matters.  Even medium-sized matters.  Perhaps many big matters.  But to Cyprus, this is an existential matter.  What does Cyprus have to lose?  Yes, the EU-and the Cypriot government-are telling horror stories about the nasties that await if they reject the monster mash bailout/bail-in, but the consequences of the monster mash are bad enough that it is perfectly understandable-to normal, sentient people, anyways-if the hoi polloi are willing to take a roll of the dice.  What’s more, such a reaction to a dictate from afar is more than perfectly understandable.  Human beings being human beings, damn them, will often refuse to take their medicine just because they are being forced to.  But I guess I am expecting way too much when I suggest that the Eurotards should actually condition their policies on an understanding of human nature in its fallen, tragic state.

The Euros choices were two: bailout Cyprus completely, or do the monster mash of bailout and bail-in.  Helluva choice.  Either alternative would have pernicious consequences in Spain, Italy, etc.   Encourage runs, or encourage moral hazard and brinksmanship.  And the fact that those are the choices is exactly why the Eurozone and the EU are beyond absurd.

If you’ve been waiting your entire life to witness the pure, un-adulturated, distilled essence of FUBAR, your dreams have been answered: for behold Cyprus!

For in one fell swoop, the with their monster mash of a bailout-bail-in of Cyprus, the Eurotards have succeeded in: gutting the rule of law and due process; riding roughshod over democratic institutions; increasing the risk of a catastrophic bank run in the event any Eurozone country (e.g., Spain) is believed to need to seek assistance; and sparking a huge diplomatic row with Russia.  Well played! Well played, indeed!

For those dwelling under a rock: as part of a 10 billion euro bailout for Cyprus, the Euros (meaning primarily Germany) required the imposition of a tax on deposits in Cypriot banks: a 6.75 percent tax on deposits below 100,000 euros, and 9.99 percent on deposits above 100K euros.

The bail-in essentially guts deposit insurance, which allegedly protects deposits below 100K.  A run on Cypriot banks is almost inevitable, because who is to say that this haircut is the last?  What’s worse, depositors in other peripheral banks have to take seriously the prospect that they will be similarly expropriated, in the event that their banks and/or sovereigns (to the extent this distinction has any meaning) require a Eurozone bailout.  This makes them much more likely to run at the first hint of trouble.  And of course, these things can be self-fulfilling.  If, say, Spanish depositors become more worried about the financial condition of the country’s banks, fearing having some of their deposits confiscated they might start to pull their funds from the banks; in the event, unable to fund themselves, the banks-and the Spanish government-may be forced to throw themselves to the tender mercies of the Germans, et al, leading to the imposition of the dreaded deposit tax.

The dynamics in these situations are always complicated, and highly dependent on beliefs, but it cannot be gainsaid that the actions in Cyprus increase appreciably the odds of a destabilizing run somewhere in the Eurozone, especially on the periphery.  Therefore, it is worthwhile to keep an eye on deposits at peripheral banks for any evidence of the beginnings of a run.  Relatedly, keep an eye on Target2 balances; an uptick in German Target2 assets could indicate attempts by peripheral depositors to move their funds to core banks.

The best-only?-hope of avoiding such an outcome is that Spaniards, Greeks, Italians, etc., believe that Cyprus is truly an exceptional, one-off case as the Eurocrats claim.  Which leads to the question: what differentiates Cyprus to such an extent that events in Cyprus do not cause depositors in Spain, etc., to update their beliefs regarding the probability they will be similarly expropriated in the event of a bailout of their countries’ banks?

There is one obvious answer: Russia.  Or, more properly, Russian money.

Cyprus has been the most popular destination for Russian funds leaving the country, and most notably dirty money: much of the money stolen in the Hermitage/Magnitsky fraud, for instance, went to Cyprus initially.  Germany’s intelligence service, the BND, said in a leaked report that a Euro bailout of Cypriot banks would largely benefit Russian depositors whose money has dubious origins.

This became a huge political issue in Germany.  The Social Democrats made a bailout of Cypriot banks political poison for Merkel: No bailout of Russian thieves!  She is ramping up for an election campaign, and in no way could be seen as bailing out dirty Russian money.

Supposedly she (and the IMF) wanted to force uninsured depositors (including many of the Russian depositors) to bear the entire burden of the bail-in, but Cyprus’s government refused.  Hence sharing the pain with smaller depositors.  But that has unleashed a furious reaction in Cyprus, and it is likely that the deal will be redone so as to put more of the burden on the uninsured (read-Russian) deposits and less on the insured deposits.

Which will only infuriate the Russians more.  And they are already plenty furious.  Putin just about lost his sh*t today, calling the original deal “unjust, unprofessional, and dangerous.”  And that’s before any adjustment of the deal to the further detriment of Russian depositors.

Any initial schadenfreud should be stifled: yes, the Russians are the masters of unjust expropriation, but two wrongs don’t make a right.  If some Russian money in Cyprus is dirty, being laundered, etc., the right way to handle it is to investigate and provide protections of due process to ensure that the guilty are identified and punished, and the innocent are spared: the Eurotard approach is Red Queen justice: “Sentence first! Trial later!”  The innocent are swept up with the guilty.  This is why the Euro approach guts the rule of law, with all of the pernicious effects that inevitably accompany such actions.

In some respects, Putin’s reaction is a surprise.  Given his declamations against tax evasion and the off-shoring of Russian money, there are some benefits to closing down an offshore bolt-hole for Russian money that Putin would prefer to remain in Russia.  But the unilateral Euro action no doubt rankles deeply, and no doubt strikes very close to home for Putin and some of his cronies.

It is very interesting to note that Russian stocks and the ruble took a far bigger hit from the Cyprus news than did Eurozone stocks.  The loss (about 2 percent on the major Russian indices, MICEX and RTS, and a .7 percent decline in the ruble, as compared to less than 1 pct declines in European stocks) cannot be explained by the direct effect of the expropriation.  Estimates are that there are about 30 billion euros in Russian deposits in Cyprus: 10 percent of that is only 3 billion euros, far less than the decline in Russian market capitalization.  Meaning that there is some indirect channel by which the expropriation is hitting Russian corporations: I am still trying to think through what that channel might be, but haven’t arrived at any opinions yet.

Whatever the reason, the market reaction demonstrates just how important the Cyprus issue is to Russian interests.  It will further stoke Russian paranoia-an amazing accomplishment.  It could cause a major diplomatic fallout between Germany and Russia, which would have substantial geopolitical implications.

All in all, it is hard to imagine how the Eurocrats could have played this any worse.  They didn’t really solve Cyprus’s debt problem.  They made it all the harder to deal with debt and banking problems outside of Cyprus.  They committed a major foreign policy blunder.  A truly amazing trifecta.

One final thought.  This points out the absurdity of the Euro project.  If tiny Cyprus is too big to fail, if the effects of its default would be so horrible that the Euro mandarins feel it necessary to take such a desperate and dangerous measure to prevent it, how can the Euro be anything but an absurdity?

Last year there were concerns about a “hard landing” in China.  Those fears have dissipated with 7.8 percent growth in the fourth quarter.  Now there is widespread optimism that China’s growth will continue inexorably: the recent spike in iron ore prices (which had plunged when concerns about the Chinese economy were most acute) is a very visible sign of that.

But . . .

It appears that this rebound is the result of another dose of stimulants, notably an injection of credit.  Which (a la Michael Jackson) gives less of a lift each time it is applied.  Now it takes about 3 RMB of credit to generate a RMB of GDP growth.  Moreover, this application of stimulus has deepened the investment-dependence of the Chinese economy, and delayed its transition to a more balanced, natural system.  Furthermore, to the extent that the projects funded by this debt don’t generate sufficient returns, the borrowers will not be able to repay; this risks a solvency crisis, and of course, a liquidity crisis that can break out when lenders are solvent, but at elevated risk of becoming insolvent.

A few articles in the last few days suggest that the optimistic turn may be quite overdone, and that there are dangers lurking beneath the sea of debt.  Chinese banks are rolling over local government debt that was used to fund stimulus spending.   Chinese heavy manufacturing enterprises are becoming increasingly indebted, and are staying afloat with borrowing.  The shadow banking system is growing and mutating.

The Chinese economy is still largely centrally planned.  Not directly, but through subsidies and especially through subsidized credit.  Admittedly, my priors are that centrally planned economies are doomed to difficulty, even though they can produce spurts of measured growth.  With sufficient coercive powers, such governments can keep things going for quite a while.  But there’s a point when they can’t.  I wouldn’t be surprised if China is approaching that point.  In other words, the further injection of credit may have just deferred the hard landing . . . and made it all the harder.

Hint: collateral crunches are not an ab exercise.  Instead, regulators and legislators around the world are waking up to the reality of what they have wrought: that the regulations that they blithely decided to impose on the derivatives markets are likely to have severe adverse consequences.  Specifically, Europeans have awakened to the fact that clearing and collateral mandates will be extremely burdensome on firms that use derivatives to manage risk, but who pose no real systemic threat.  Thus, a committee of the European Parliament has voted to send clearing regulations back to the European Commission for reconsideration.  There is a realization that a “collateral crunch” is impending as a result of these various regulations:

This has led to talk of a “collateral crunch”, with most central counterparties accepting only government bonds or cash as collateral, assets that may not be readily available. This is more restrictive than at present, with corporate bonds and even equities often accepted as collateral in uncleared bilateral deals, if lodged in sufficient quantity.

The problem may be particularly acute for mutual funds, as an equity or corporate bond fund will simply not possess anything it can use as collateral. Instead it may have to use the securities lending or repo markets to secure suitable assets.

But many pension funds will also be hit. As Mr Haines points out, even the index-linked government bonds that pension funds do tend to hold in abundance are not generally accepted as collateral by central counterparties, even if conventional bonds issued by the same governments are.

Estimates of the cost of using the repo market to access the necessary collateral range from 50 basis points of a pension fund’s assets to several hundred basis points, Mr Haines adds. Alternatively, pension funds may feel pressured to alter their asset allocation so they do have sufficient in-house collateral.

Totally unpredictable, right?  Uhm, not really.

I find it particularly amusing that virtually every article on the effects of Frankendodd and Emir bewail the “unintended consequences.”  A million pardons, but that was a theme here on SWP, and in various presentations I made, before Frankendodd and Emir were actually adopted.  Unintended, but eminently foreseeable-and totally ignored.

The recent angst focuses on initial margin: the amount of capital that has to be tied up to support derivatives positions from the moment they are initiated.  Given that collateral is costly, the large increases in initial margin will require derivatives users to choose between continuing to use them to manage risk, but obtain lower returns, or to eschew derivatives and live with greater risk.

The benefit received in exchange for this very real cost?  Given that many entities so affected pose no systemic risk, it’s quite difficult to identify any gain.

Not that initial margin is unimportant, but the focus on it distracts attention from what I believe to be the true systemic risk inherent in clearing and collateral mandates: the contingent needs for liquidity to make variation margin payments.  Big price moves lead to big variation margin flows.  These will tend to occur when markets are stressed and liquidity becomes scarce.  Thus, the need to make variation margin payments will exacerbate stresses on the market, especially will stress liquidity supply mechanisms.  Given that financial crises are, typically, liquidity crises, this is a major systemic problem.

So by all means pay attention to the drag that the dramatic increase in initial margin requirements will impose.  This is a drag that will be experienced day after weary day.  But do not overlook the truly dangerous unintended consequence of the clearing and collateral mandates in Frankendodd and Emir.  The stress that these mandates will put on liquidity supply mechanisms at the precise instant that these mechanisms are at risk of failure.

What could go wrong?

I say again: regulate/legislate in haste, repent at leisure. The seeds for the next crisis are being sown in the alleged attempts to prevent a recurrence of the last one.  Legislative and regulatory generals fighting the last war.