Streetwise Professor

March 11, 2019

Another Data Point on the Renewables Fairy Tale

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 7:39 pm

A coda to yesterday’s post. The EIA announced that in 2018 60 percent of new US electricity generating capacity was fueled by natural gas. This outstripped wind by a factor of almost 3, and solar by a factor of almost 5.

But those ratios understate matters, given that capacity factors for natural gas are about double those for renewables. Thus, in terms of actual real generation, natural gas added about four times as much effective capacity in 2018 as renewables. Not to mention that combined cycle plants are available pretty much on demand, rain or shine, day or night. Unlike the wind and the sun.

This despite the continued subsidization of renewables.

So tell me again how renewables will permit the fossil fuel-free electrification of the economy. I like fairy tales.

Print Friendly, PDF & Email

March 9, 2019

Message to Merkel: Merging Two Piles of Manure Does Not Improve the Smell

Filed under: Economics,Politics,Regulation — cpirrong @ 5:29 pm

Reuters reports that Deutsche Bank and Commerzbank have begun merger talks. The German government has been pushing for such a merger. In part, Berlin is hot for a combination because it wants to create a “national banking champion”:

And as Mr Scholz and Mr Kukies’ clandestine London meetings show, the idea is now gaining traction in Berlin. Policymakers and corporate bosses see a stable national banking champion as the backbone of their export-led industrial policy, vital if the country is to weather the next downturn that many economists warn looms large.

This is hilarious and infuriating on so many levels.

First. Hmmm. “National champion” sounds kinda, uhm, I dunno, nationalist, doesn’t it? And Frau Merkel keeps telling us only bad people are nationalists, and nationalists are bad people.

Again–German hypocrisy knows no bounds.

Second, by what financial alchemy does merging two horribly underperforming banks create anything of championship caliber, unless you mean a national champion clusterf*ck? Both banks are priced at a huge discount to book–for good reason. Both have returns on equity that are at the bottom of league tables. Merging two manure piles will not improve the smell.

Further, Deutsche Bank in particular is already a bloated monstrosity. Successive CEOs have failed to rationalize it. Every merger faces huge integration challenges, which would only complicate the task of rationalizing and downsizing DB.

Moreover, Deutsche Bank is already a huge systemic risk, given its size and dodgy balance sheet. Mashing it together with Commerzbank will only increase its systemic importance, and its complexity, and hence its systemic risk.

And this is yet more hypocrisy: the Germans are always lecturing everyone (especially the Italians and Greeks) about financial imprudence, and the risks that they impose on Germany. Speak for yourself, Fritz. DB is the poster child for financial imprudence. So why not make it bigger? What could possibly go wrong?

Maybe sanity will prevail, and the merger will not go through. But the very fact that it is being thought of, and indeed pushed by the German government, tells you everything you need to know about how hypocritical, and how clueless, the German government is.

Print Friendly, PDF & Email

March 4, 2019

The New Green Trojan Horse

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 7:16 pm

My daughter alerted me to this interview of Rhiana Gunn-Wright, “one of the architects of the Green New Deal.” It’s annoying–I swear I would have gone completely mental had she said “right?” one more time–but educational. Not because you will learn anything about the way the world works, but you will learn the way the minds of the Green New Dealers work.

The interview is hosted by ex-Obamaite Jason Bordoff, now of Columbia University’s Center on Global Energy Policy. Given Bordoff’s current gig, he was obviously interested in the GND’s implications for energy. After all, the supposed raison d’etre of the GND is that our current energy system, dependent on fossil fuels as it is, is causing us to hurtle towards catastrophic warming.

But whenever Bordoff asked a question about energy, or climate policy, Gunn-Wright couldn’t even feign interest. Her responses were in the vein of “whatever”, and then she launched into impassioned monologues about what really interested her–a laundry list of progressive dreams from health care to child care to labor policy.

What’s clear from Gunn-Wright’s performance is that “climate change” is merely a Trojan Horse for a hard-core leftist agenda. The plan is to use climate alarmism to stampede voters into electing hard-left politicians who, once ensconced in power, will implement what good (I use that term ironically) socialists have been drooling to implement for decades–since before the original New Deal.

Meaning that if you think the GND as presented by the likes of AOC and Sen. Ed Malarky–excuse me, Markey–would be ruinously expensive–you ain’t seen nothing yet!

Speaking of AOC, thinking of her reminded me of Mark Twain: “First, suppose you are an idiot; now suppose you are a member of Congress. But I repeat myself.” I think even Twain would be gobsmacked by the stupidity of Ocasio-Cortez. It’s beyond disturbing that such a moron promoting such a malign program is taken seriously, and has indeed bamboozled virtually every Democratic presidential candidate into endorsing her program.

But maybe that’s the good news. I think that it is highly likely that as enthusiastically as the coastal elites have embraced GND, it will prove toxic at the ballot box. Trump’s full-throated attacks on socialism certainly indicate that he believes so. And he has an innate sense for these things, as the very fact that he is president demonstrates.

One last thing. If you think I was scathing about the GND, I had nothing on Richard Epstein. He about jumps out of your computer in this podcast from a few weeks back. Worth a listen–especially as an antidote to the leftist bromides of Rhiana Gunn-Wright. Right?

Print Friendly, PDF & Email

February 20, 2019

Is Ivan Glasenberg Playing B’rer Rabbit?

Filed under: Climate Change,Economics,Energy,Regulation — cpirrong @ 7:31 pm

In the folk tale about B’rer Rabbit and the Tar Baby, the trapped trickster bunny is at the mercy of B’rer Fox. The Fox debates ways to dispose of the Rabbit–hanging, drowning, burning–and the Rabbit pleads to do any of those things–just don’t throw him into the briar patch. Falling for the reverse psychology, B’rer Fox hurls B’rer Rabbit into the supposedly dreaded briars, after which B’rer Rabbit says: “Born and bred in the briar patch. Born and bred!”

Yesterday mining behemoth Glencore announced that it would cap coal output at 150 million tons per year, claiming that the cap was an acknowledgement of the threat of global warming. Various activists claimed vindication and victory.

Might I offer a more cynical explanation? Getting thrown into the output limitation briar patch is exactly what B’rer Glasenberg wants. A firm exercises market power by limiting output to raise price: global warming gives Glencore an elite-blessed excuse to limit output, i.e., exercise market power. It will be especially beneficial for Glencore if other coal producers are stampeded into cutting output too.

Indeed, you know how this will play out. The activists will now descend on the other producers, holding up Glencore as a shining progressive example. Some, perhaps most, and maybe even all, will capitulate, further increasing prices.

And Glencore/B’rer Glasenberg will laugh all the way to the bank.

As an aside, this is an interesting illustration of the theory of the second best. In a world without any distortions, an exercise of market power is a bad thing–it reduces welfare. But in a world with other distortions, an exercise of market power can enhance efficiency.

If due to an externality, coal output in a competitive industry is too large, the exercise of market power mitigates the effect of the externality.

Print Friendly, PDF & Email

February 13, 2019

Brave Green World

Filed under: Climate Change,Economics,Politics,Regulation — cpirrong @ 11:21 am

I was considering not commenting on the Green New Deal, given the largely negative–and often incredulous and scathing–response that its release evoked. Including from mainstream Democratic politicians, notably Nancy Pelosi. But most of the cast of thousands currently seeking the Democratic presidential nomination have embraced it to some degree or another, and the criticism has spurred a counterattack from many media precincts. The plan will therefore not be consigned immediately to oblivion, so I will weigh in.

In a nutshell (emphasis on the “nut”), the proposal aims at making the US “carbon neutral” in a mere decade by eliminating the internal combustion engine, retrofitting every existing building in the US, largely eliminating air travel and replacing it with high speed rail, and reducing, er, flatulence from cows by sharply reducing our consumption of meat. No biggie, right?

I find it somewhat ironic that hard on the heels of the announcement of the basics of the GND, the hard left governor of California, Gavin Newsome, said it was necessary to “get real” and recognize that the state’s high speed rail project was a disaster, and to eliminate most of the route.

But “getting real” is not on the GND agenda.

If implemented, the GND would effectively destroy a vast amount of the existing US capital stock, or require its replacement with less productive capital. This will make Americans poorer, in terms of consumption of goods and services.

The proponents of the GND commit the fundamental economic fallacy of arguing that this destruction of productive resources will bolster the economy because of all the jobs that will be created to build a fossil-fuel free power system, electric autos, massive rail systems, etc. The reality (sorry, but I can’t help dealing in reality) is that jobs are a cost, as is the decline in consumption required to make massive investments in new capital to replace existing capital.

The point of producing–including through the use of labor which entails the cost of foregone leisure–is to consume. The GND will unambiguously reduce consumption of goods and services, and make us poorer. GND is crypto-Keynesianism at its worst.

Then there is the detail of paying for this. Here advocates of GND invoke MMT–Magical Monetary Theory. Sorry, MMT actually stands for “Modern Monetary Theory” but my description is far more accurate. MMT is free lunch economics writ large, mistakes accounting identities for economic substance, and commits errors that would be embarrassing for someone in their first session of Econ 101 at one of your more backward community colleges.

The Magical Monetary Theorists argue that an endeavor as massive as the GND can be paid for by printing money.

Really. Don’t believe me? Consider this (rather conclusory) tweet by a major MMT advocate, Stephanie Kelton:

Q: Can we afford a #
? A: Yes. The federal government can afford to buy whatever is for sale in its own currency.

What follows (as is usually the case with MMT arguments) is a verbal discussion of a game of financial Three Card Monte.

Read that again: ” The federal government can afford to buy whatever is for sale in its own currency.” But at what price, dear? At what price? Venezuela has been operating on this principle, and is on pace to achieve record inflation of more than a million percent per year.

All of which obscures the economic essence. Investment today requires people to reduce consumption of goods and services. They only do so in anticipation of consuming more in the future–the “more” is the interest/return on capital from the investment. In private capital markets, the interest rate/return on capital adjusts so that the additional consumption people demand to fund investment is just paid for by the additional production flowing from the assets invested in.

In GND, as noted above, the massive investment will not result in a greater flow of goods and services in the future that will make people willingly reduce their consumption today. Indeed, future consumption in goods and services will decline. The private rate of return will be negative.

And indeed, GND implicitly acknowledges this. Its entire rationale is to reduce carbon emissions, under the theory that these are a “bad.” That is, the payoff from the massive investment (the sacrifice of private consumption) is a lower level of bad carbon emissions.

But to the extent that the reduction of this particular bad is a good, it is a public good. Everyone benefits from a decline in this putative pollutant, regardless of their contribution in paying for the reduction. Meaning that it cannot be financed voluntarily via private capital market transactions, but must be compelled, and paid for through massive taxation.

Printing money only changes the form and/or the timing of the taxation. Inflation is a tax. Moreover, if you borrow/print to pay for investment today, the investment cost not covered by the inflation tax must be paid for by higher taxes in the future. Like the old oil filter commercial: you can pay me now, or you can pay me later. But you must pay.

This is not hard. But reality is not magical.

Furthermore, given that it will be the most massive government program in history, it will entail all of the rent seeking and waste inherent in such programs.

I should also note that it will entail massive redistribution, most notably from rural, exurban, and suburban areas to urban ones as it will dramatically raise the costs of transportation and mobility which are borne disproportionately by those living outside cities. If a few Euro cents/liter fuel tax in France sparked massive protest in non-metropolitan France, just think of what would be in store in the far more sprawling US in response to taxes orders of magnitude larger than those imposed by Manny Macron.

These costs could be justified if the cost of carbon is sufficiently high, in which case the social rate of return could be substantially higher than the private rate of return, and the cost of capital. But even if one believes the most alarmist estimates of the cost of carbon, the adoption of GND by the US would have a modest–and arguably trivial–impact on emissions and temperatures, given the level and growth of emissions elsewhere, especially in China and India. Thus, the social rate of return is almost certainly far below the cost of capital.

The advocates of GND argue that the US needs a grandiose mission. The analogies that they draw are to NASA’s moon landings, or–get this–World War II and the defeat of the Nazis.

But neither Apollo nor even WWII envisioned the radical transformation of society–which is an explicit goal of GND. Apollo was a focused, and by comparison with GND, a relatively moderate expenditure financed in the ordinary course of government business and intended primarily as a campaign in the Cold War, undertaken at a time when the Johnson administration waged another Cold War campaign–Vietnam–with the specific objective of minimizing disruption to US society and the economy. World War II definitely altered every aspect of American life, but these disruptions were also viewed as temporary sacrifices necessary to win the war, to be reversed at its conclusion. Which happened in the event: the US demobilized rapidly, and most wartime expedients (e.g., rationing, the massive employment of women in manufacturing) were scrapped precipitously at its conclusion. As happened in WWI as well: Harding’s 1920 campaign slogan was “return to normalcy” after the extraordinary measures adopted during the war. But GND proposes to be the new normalcy, deliberately destroying the old normalcy.

The original New Deal as implemented was also not intended to be as transformative as its latter day green version (though the more Bolshi elements of the Roosevelt administration did harbor such ambitions).

What are the politics here? This is being pushed by the urban progressive left, epitomized by Alexandria Ocasio-Cortez, D-Brooklyn. (Sorry, Tatyana!) The ubiquitous AOC is the face and voice of the movement, though frankly I doubt it would get the same attention if her face looked like, say, Debbie Wasserman-Schultz, and I wonder whether her Munchkin voice will eventually grate on even her fellow travelers, not to mention the rest of us.

But the main political effect here is to cause deep fissures in the Democratic party. Mainstream elements are in a state of near panic, which they are attempting to conceal, with little success.

And this will redound to the benefit of Donald Trump. Opposition insanity is the greatest gift an incumbent can receive. And methinks this is a gift that will keep on giving, through November 2020.

Print Friendly, PDF & Email

January 22, 2019

Regulating Carbon Emissions: Efficiency vs. Redistribution

Filed under: Climate Change,Economics,Energy,Politics,Regulation — cpirrong @ 8:01 pm

Bloomberg reports that New York state’s plan to eliminate its few remaining coal power plants has caused power prices for delivery in 2020, 2021, and 2022 to increase. Eyeballing the chart, the impact of the proposed regulation is on the order of $7/MWh, or about 25 percent of the 2019 price.

Coal represents a dwindling fraction of New York’s generation. The EIA reports 0 electricity from coal in October, 2018. As of 2014, the last full year for which I could find data on the EIA website, coal accounted for 4.6 million MWh, out of a total of 137 MWh of generation.

The efficiency impact of this depends on (a) the estimated social cost of carbon, (b) the kind of generation that will replace the shuttered coal plants, and (c) the non-energy costs that this replacement generation creates.

If you believe that the cost of carbon is $40/ton, if coal is replaced by zero emissions generation, the move is efficiency enhancing. A coal plant with a heat rate of a little more than 10 implies a carbon cost per MWh of $40. This is well above the price increase of around $7.

If coal is replaced by natural gas, with a carbon cost of about $20/MWh, the call is closer, but still comfortably in favor of eliminating coal.

Lower social costs of carbon of course affect the math. The other thing to keep in mind, though, is that the price is for energy only. Changing the generation mix also affects the need for ancillary services to maintain grid stability. In particular, substituting diffuse and intermittent renewables for coal increases the non-energy costs of supplying electricity. These costs can be appreciable, though again it’s difficult to see them being so large as to overcome the approximate $160 million in carbon cost savings from eliminating coal, based on a $40/MWh CO2 cost, ~4 MWh of coal fired generation, and replacement of coal by zero carbon emissions generation sources.

What’s truly startling about the numbers, though, is the redistributive impact. Price is driven by marginal cost, and the price impact suggests that the cost of the marginal megawatt hour from coal replacement generation is about $7/MWh above that of the eliminated coal units. Note: that $7/MWh price increase benefits every single MWh generated by inframarginal units (e.g., combined cycle NG). Coal represents (as noted before) ~3 pct of NY generation, but the remaining 97 percent will see a big increase in margins.

This is a crude calculation, but roughly speaking the regulation will result in a transfer of about $1 billion/year from consumers to owners of generation (~140 million MWh x $7/MWh). The vast bulk of this $1 billion will be a quasi rent for inframarginal generating assets. (About $28 million–4 mm MWh/year x $7/MWh–will cover the cost of the more expensive generation that replaces coal plants.)

As is often the case with regulation, the wealth transfers swamp the efficiency effects (which total at most $130 million=~4 MM MWh x $33/MWh in social cost savings). (Since coal generation has probably dropped from the 4 million in 2014, and the price impact reflects the elimination of the remaining coal generation, the total efficiency effects now are probably substantially smaller than $130 million.)

Thus, although this regulation is sold as one benefitting the environment, I strongly suspect that the political coalition that has given it birth is strongly supported by incumbent generation operators selling into the New York market. That is, it smacks of the typical special interest regulation that benefits a small concentrated group at the expense of a large diffuse one (i.e., the consumers in New York), all dressed up in pretty green (environmental green camouflaging Benjamins green, as it were).

Yes, in this instance perhaps–depending on one’s assumptions about the cost of carbon and the incremental uplift costs created by the regulation–this bargain has produced an efficient outcome. But the redistributive nature of this regulation, and those like it, creates a great risk that such regulations will be introduced even when they are inefficient.

Those harmed include ordinary New Yorkers lighting their homes, and commercial and especially manufacturing firms (and their employees) who pay higher power costs. (Employees will pay in lost employment and lower wages, due to a decline in derived demand for labor driven by higher costs of other inputs.) In France, a seemingly small imposition on a similar group sparked widespread social unrest. It hasn’t happened in the US yet (or in places like Germany, where consumers and employers are paying steeply higher electricity costs due to anti-carbon regulations), but US states should be aware that such policies could trigger resistance here as well–especially if and when the hoi polloi realize that the biggest winner from these policies is not the environment, but companies that are pretty unpopular to begin with.

Print Friendly, PDF & Email

January 12, 2019

A Great Passes: Harold Demsetz

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

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

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

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

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

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

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

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

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

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

Print Friendly, PDF & Email

December 5, 2018

Judge Sullivan Channels SWP, and Vindicates Don Wilson and DRW

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

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

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

Here was my take in September, 2013:

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

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

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

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


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

Here’s Judge Sullivan’s analysis:

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

Pretty much the same, but without the snark.

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

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

I also wrote:

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

. . . .

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

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

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

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

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

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

Print Friendly, PDF & Email

November 18, 2018

File Under “Duh”

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

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

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

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

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

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

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

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

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

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

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

But, but, but . . . . batteries!

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

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

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

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

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


Print Friendly, PDF & Email

October 18, 2018

Ticked Off About Spoofing? Consider This

Filed under: Commodities,Derivatives,Economics,Exchanges,Politics,Regulation — cpirrong @ 6:51 pm
An email from a legal academic in response to yesterday’s post spurred a few additional thoughts re spoofing.

One of my theories of spoofing is that is a way to improve one’s position in the queue at the best bid or offer.  Why does one stand in a queue?  Why does one want to be closer to the front?

Simple: because there is a rent there to capture.  Where does the rent come from?  When what you are queuing for is underpriced, likely due to some price control.  Think of gas lines, or queues for sausage in the USSR.

In market making, the rent exists because the benefit from executing at the bid or offer exceeds the cost.  The cost arises from (a) adverse selection costs, and (b) inventory cost/risk and other costs of participation.  What is the source of the price control?: the tick size.

Exchanges set a minimum price increment–the “tick.”  When the tick size exceeds the costs of making a market, there is a rent.  This makes it beneficial to increase the probability of execution of an at-the-market limit order, i.e., if the tick size exceeds the cost of executing a passive order, it pays to game to move up in the queue.  Spoofing is one way of gaming.

This has a variety of implications.

One implication is in the cross section: spoofing should be more prevalent, when the non-adverse selection component of the spread (which is measured by temporary price movements in response to trades) is large.  Relatedly, this implies that spoofing should be more likely, the more negatively autocorrelated are transaction prices, i.e., the bigger the bid-ask bounce.

Another implication is in the time series.  Adverse selection costs can vary over time.  Spoofing should be more prevalent during periods when adverse selection costs are low.  These should also be periods of unusually large negative autocorrelations in transaction prices.

Another implication is that if you want to reduce spoofing  . . .  reduce the tick size.  Given what I just discussed, tick size reductions should be focused on instruments with a bigger bid/ask bounce/larger non-adverse selection driven spread component.

That is, why police the markets and throw people in jail?  Mitigate the problem by reducing the incentive to commit the offense.

This story also has implications for the political economy of spoofing prosecution (which was the main thrust of the email I received).  HFT/algo traders who desire to capture the rent created by a tick>adverse selection cost should complain the loudest about spoofing–and are most likely to drop the dime on spoofers.  Casual empiricism supports at least the first of these predictions.

That is, as my correspondent suggested to me, not only are spoofing prosecutions driven by ambitious prosecutors looking for easy and unsympathetic targets, they generate political support from potentially politically influential firms.

One way to test this theory would be to cut tick sizes–and see who squeals the loudest.  Three guesses as to whom this might be, and the first two don’t count.

Print Friendly, PDF & Email

Next Page »

Powered by WordPress