Streetwise Professor
July 5, 2010
NASA’s Mission to the (Crescent) Moon
Earlier this year, Obama announced the cancellation of NASA’s manned space programs, including a new manned moon mission. He had more important things in mind for the space agency. In an interview with Al Jazeera, part of an outreach initiative growing out Obama’s Cairo speech, NASA chief Charles Bolden said that Obama gave him three objectives: First, inspiring more children to be interested in science and technology; second, building international relations, and, wait for it:
Third, and perhaps foremost, to find a way to reach out to the Muslim world and engage much more with dominantly Muslim nations to help them feel good about their historic contributions to science, math and engineering [emphasis added].
I am not kidding. It is July 5, not April 1. Don’t believe me, check out the interview (the quote is right at the beginning, around the 1:15 mark):
I am ambivalent about NASA, and government funded manned space travel. I am not ambivalent about this drivel. The first two “missions” that Obama charged Bolden with are juvenile (literally, in the first instance) and inane. The third is utterly insane. A pitch perfect paean to political correctness and therapeutic self-esteem politics.
If there is a case for NASA, it is that it invests in the creation of knowledge and technology that generates substantial spillovers: investments that would not be made otherwise either due to free rider problems, or the inability of private enterprises to finance investment at the efficient scale. The missions that Obama charged Bolden with are about as far from this defensible mission as earth is from Alpha Centauri.
The Mission to the Crescent Moon is particularly grating. Like most efforts ostensibly directed at improving the self-esteem of others, it is patronizing and condescending. Moreover, it will be counterproductive because it plays right into some of the most self-destructive habits of thought prevalent in the Muslim world: habits of thought that encourage some to engage in other-destructive terrorism.
Specifically, the contrast between a mythical, glorious past and a squalid present naturally demands an explanation. The prevalent explanation in the Muslim world is that it is the result of dark conspiracies hatched in the West: conspiracies of Christians, and especially Jews, to deny the followers of one true religion their rightful dominant place in the world. Emphasizing past achievements (and probably exaggerating those) that far outstrip present ones as Obama charged Bolden to do can only feed the sense of grievance.
If anything, “dominantly Muslim nations” and their citizens could use a little less self-esteem, not more. Nothing feeds paranoia, alienation, and anger like an unrealistic self-regard at stark variance with true accomplishments.
NASA is not a social work organization. It is not ACORN for science and math. Its overriding purpose is to explore space. If that doesn’t generate value that exceeds the cost, then shut it down.
July 4, 2010
Unvexed to the Sea
Not only is the 4th of July the anniversary of the Declaration of Independence: it is also the anniversary of the surrender of Vicksburg in 1863. That was the culmination of what to my mind is the most outstanding campaign of the Civil War, and arguably of American military history. Indeed, it is one of the most impressive campaigns in all of military history.
Grant’s Vicksburg campaign was a masterpiece of what is now referred to as “the operational art.” It involved an impressive and creative use of combined arms: Grant utilized David Dixon Porter’s riverine Navy force brilliantly to move his army to the south of the city and break a stalemate. It employed deception: Grierson’s raid and Grant’s simultaneous threatening of multiple strategic points paralyzed the Confederate response and reduced Pemberton and Johnston to piecemeal, spasmodic, lurching reactions. Grant utilized maneuver brilliantly, and as a result always had a substantial preponderance of force at every engagement. The logistics of the operation were challenging and complex, but were accomplished faultlessly.
Grant had at his disposal an incredible army of hardy, strapping Midwestern farmboys. They had ample combat experience, gained at battles like Donelson, Shiloh, and Corinth, but hadn’t suffered the shattering casualties that hampered the effectiveness of some armies, like the Army of the Potomac.
Grant has a reputation as a butcher, but Vicksburg belies that. It is hard to find anything to criticize about the entire operation.
The surrender on the 4th did not fully open the Mississippi River: that didn’t occur until 9 July, when Port Hudson capitulated. But that was inevitable once Vicksburg fell.
Vicksburg is worth a visit. Although the most crucial battlefields of the campaign are not systematically protected, the ground of the siege is contained within the Vicksburg National Battlefield Park. The siege works and many of the approach trenches are well-preserved. The most important battle of the campaign, Champion Hill, is now accessible due to the work of the Civil War Preservation Trust, although much of the hill itself was excavated for gravel for I-10 decades ago.
Port Hudson is also a worthwhile trip, though beware! On my visit there some years ago I just about stepped on the biggest damn water moccasin you’ve ever seen. I was stepping gingerly after that, I’ll tell you what.
A Chip Off the Old Blog, Continued
Renee’s blog post was featured at the top of the Pittsburgh Tribune-Review’s Best of the Blogs for this week. Following her in the list were Josh Marshall, Jim Treacher (Washington Trawler), The Corner, Powerline. That’s a pretty impressive 4th of July parade to be leading, Renee. Keep it up!
The Last, Best Hope on Earth?
Harry Jaffa argues that Lincoln was different from his political peers in that he believed the Declaration of Independence, rather than the Constitution, to be the seminal document of the American Founding. Lincoln believed, and fervently so, that the Declaration literally meant what it said: that all men are created equal. He further believed that it was his solemn duty as a statesman to ensure that the nation realized that ideal.
Obama has been compared to Lincoln, largely on the basis of some superficial similarities. (Very superficial. Like: “tall guys from Illinois.”) But it is clear on the substance, and on the belief in the truth and relevance of the Declaration, that the comparison is decidedly inapt. Indeed, laughable. Lincoln’s commitment to the Declaration, and the belief that the United States was indeed the “last, best hope of earth” was fervent, undeniable, and repeatedly expressed. Lincoln did believe that America was exceptional, and that it although it was flawed, it embodied an ideal that was an example for all of humanity.
In contrast, Obama’s views on those propositions are, at best, ambivalent. As Charles Kessler of the Claremont Review of Books writes:
The second new element in President Obama’s liberalism is even more striking than its postmodernism. It is how uncomfortable he is with American exceptionalism—and thus with America itself. President Obama considers this country deeply flawed from its very beginnings. He means not simply that slavery and other kinds of fundamental injustice existed, which everyone would admit. He means that the Declaration of Independence, when it said that all men are created equal, did not mean to include blacks or anyone else who is not a property-holding, white, European male—an argument put forward infamously by Chief Justice Roger Taney in the Dred Scott decision, and one that was powerfully refuted by Abraham Lincoln.
In short, President Obama agrees with his former minister, Reverend Jeremiah Wright, much more than he let on as a presidential candidate. Read closely, his famous speech on that subject in March 2008 doesn’t hide his conclusion that Wright was correct—that America is a racist and ungodly country (hence, not “God Bless America,” but “God Damn America!”). Obama agrees with Wright that in its origin, and for most of its history, America was racist, sexist, and in various ways vicious. Wright’s mistake, Obama said, was underestimating America’s capacity for change—a change strikingly illustrated by Obama’s own advances and his later election. For Obama, Wright’s mistake turned on not what America was, but what America could become—especially after the growth of liberalism in our politics in the course of the 20th century. It was only liberalism that finally made America into a decent country, whereas for most of its history it was detestable.
Unlike most Americans, President Obama still bristles at any suggestion that our nation is better or even luckier than other nations. To be blunt, he despises the notion that Americans consider themselves special among the peoples of the world. This strikes him as the worst sort of ignorance and ethnocentrism, which is why it was so difficult for him to decide to wear an American flag lapel pin when he started running for president, even though he knew it was political suicide to refuse wearing it.
As President Obama hinted in his Berlin speech during the campaign, he really thinks of himself as a multiculturalist, as a citizen of the world, first, and only incidentally as an American. To put it differently, he regards patriotism as morally and intellectually inferior to cosmopolitanism. And, of course, he is never so much a citizen of the world as when defending the world’s environment against mankind’s depredations, and perhaps especially America’s depredations. In general, the emotionalist defense of the earth—think of Al Gore—is now a vital part of the liberalism of our day. It’s a kind of substitute for earlier liberals’ belief in progress. Although his own election—and secondarily liberalism’s achievements over the past century or so—help to redeem America in his view, Obama remains, in many ways, profoundly disconnected from his own land.
This is a very different state of mind and character from that of Franklin Roosevelt, who was the kind of progressive who thought that America was precisely the vanguard of moral progress in the world. This was the way Woodrow Wilson, Lyndon Johnson, and every great liberal captain before Obama thought about his country—as a profoundly moral force in the world, leading the nations of the world toward a better and more moral end point. Obama doesn’t think that way, and therefore his mantle as an American popular leader—despite his flights of oratorical prowess—doesn’t quite fit him in the way that FDR’s fit him. One can see this in the tinges of irony that creep into Obama’s rhetoric now and then—the sense that even he doesn’t quite believe what he’s saying; and he knows that but hopes that you don’t.
Obama’s ambivalence is, in many ways, the perfect symbol of the dilemma of the contemporary liberal.
As people have become increasingly aware of this ambivalence, Obama’s popularity has plunged. And there is a growing realization that “ambivalence” might actually understate the matter. Obama’s associations of a lifetime, of whom the aforementioned Reverend Wright is just one, are anything but ambivalent in their views of America. If they believe that America is exceptional, it is only because they believe that America is exceptionally malign, evil even. There is a suspicion that political caginess leads Obama to conceal his true sympathies for these views. The habitual apologies, the routine criticism of his country while abroad, the notable imbalance between criticism and praise of the country’s past and legacy, all contribute to a palpable fear that Obama is actually the anti-Lincoln.
This unease–to put it mildly–that many people have with Obama is much more visceral, and much more important, than disagreements about this health care policy or that, or the handling of the Gulf oil spill. Indeed, for many people the significance of these things is not the policy specifics themselves, but what these policies reveal about Obama’s heartfelt beliefs about the nation and its meaning. A fear that he does not share their beliefs about the country, its ethos, and its values.
I think this helps explain the tremendous anxiety in the country. Yes, dreary economic news and the steady bubbling of oil from the Gulf contribute to that anxiety. But it is more than that. More basic. An anxiety rooted in a fear that they are being governed by a foreigner. Not a foreigner in the birther “he was born in [state country of choice here]” (non-)sense. But a foreigner in the sense of someone alien to, or at the very least alienated from, their beliefs about America and what it means.
Divides over belief are much more intractable than divides over policies. The latter are amenable to compromise, and can be influenced by facts and data. The former, cannot. Which means that the next two plus years will be as tumultuous politically as any period in recent American history. Obama and his ilk are notable for their Europhilia, and we are on the brink of descending into a European-style political conflict that America has largely avoided in large part because of a shared belief in some fundamental tenets about the country’s political meaning and heritage that is typically lacking in Europe. The fear that the president, and a large fraction of his political allies, do not share those beliefs will make the coming political conflicts and campaigns of a like not seen in this country in living memory.
Buying an Espionage Option
The debate over the Russian spy scandal is still rolling along at my first post on the subject. I don’t have a lot more to say, because there hasn’t been a great deal of new information. In the absence of new facts, this story has followed the trajectory of many spy stories. It has largely degenerated into a babble of Holmes-and-Moriarty-on-the-train-style arguments, most flogging a particular pet cause, i.e., to exculpate Russia or to damn it. My favorite of these is that the Russians deliberately set up a ring of bumblers to distract the FBI from its real, and capable, deep cover illegals. Not disprovable, so not worth any time arguing about.
I just want to draw attention to one article written by America’s premier scholars on Soviet espionage during the Cold War, Harvey Klehr and John Earl Haynes. They make the good point that one should not read to much into the fact that this ring had yet to make any serious attempts at espionage, if public reports are to be believed. But as Klehr and Haynes argue, operations of this sort are not intended to generate intelligence immediately. Instead, they are long term investments intended to create the capability–the option–to secure intelligence in the future when its value is particularly high:
There has already been speculation that despite years of residence in the United States, none of the accused had been able to gather and transmit any classified information. Since none has been charged with espionage, it is plausible that their actual value to Russia until their arrests had been minimal. The charges they do face, money laundering and failure to register as foreign agents, carry substantial penalties, but apart from a message from Moscow suggesting that their major task was to get close to policy makers, there is little indication of what their masters wanted them to do. That has led a number of commentators to dismiss this gaggle of agents as a bad example of a bureaucracy so addled that it spent large amounts of money to construct a spy ring whose tasks could have been met by anyone with access to the Internet.
This dismissive response misses the point. Russian intelligence, the SVR, made a very expensive, long-term investment by inserting these “illegals,” as agents without diplomatic cover are known, into the United States with instructions to spend several years constructing new identities and burrowing deeply into American society. The pay back in terms of espionage tasks performed (either procurement of information or, more likely, recruitment of sources with access to sensitive information and servicing those sources) would come only after five, ten, or more years of slow development.
If one takes this seriously, the most surprising thing is the fact that there seems to have been extensive contact between the plants and their Russian contacts prior to the time that they were activated for serious spying. (The contacts are still here, by the way: at least they have not been publicly kicked out of the country, as is pro forma in such episodes. Why?) Often, illegals are left with only infrequent contact for extended periods until they are activated. Perhaps this reflects a deep-seated fear in the SVR that the good life in America would be too attractive, and that these individuals would be very reluctant to perform on call at some distant date. Hence, keeping them busy and engaged on seemingly menial tasks was deemed essential to ensure that they stayed in the SVR’s orbit and control.
Like everything else, just a guess. But I think the question is an interesting one.
July 3, 2010
Two O’Clock on That July Afternoon
About this time of day, 147 years ago, 15,000 Confederate soldiers topped the gentle rise of Seminary Ridge and began trudging towards the Emmitsburg Road, and beyond it, a low stone wall just below the crest of Cemetery Ridge. When it ended, the Confederate force reeled back, blasted and torn. A few stalwart men had penetrated a point in the Union line where the 71st Pennsylvania had broken, but the breach was soon sealed by a horde of running, shouting–and shooting–Federals from Pennsylvania, New York, Ohio, Minnesota, Massachusetts, Maine, and Vermont.
If you’ve stood on the ground, you wonder what Robert E. Lee could have possibly been thinking. Advancing a mile without cover against a line of veteran troops on an elevation, with cover, and with ample artillery. To me, it was the culmination of a little more than a year of remarkable achievements by the Army of Northern Virginia that had hurled its opponent from the very gates of Richmond onto the soil of Pennsylvania, winning engagement after engagement. Hubris born of a year of amazing victories had convinced him that his men could accomplish anything.
But not all of his men were convinced. His chief subordinate, James (“Old Pete”) Longstreet surely was not. He resisted launching the assault, his opposition verging on insubordination. And it is not as if Longstreet was a timid man who routinely opposed the offensive. In fact, he was the architect of three of the greatest, most successful assaults of the Civil War: at Second Manassas, Chickamauga, and the Wilderness. But he was a realist, and he foresaw what awaited his division, and the two of A. P. Hill’s Corps, that were to make the assault over that ground, against that enemy.
Lee realized it too, but too late: “It is all my fault” he said, as the broken ranks that had stepped off so confidently an hour or so before streamed back torn and bloodied, and so many fewer than before.
Faulkner wrote a famous elegy to the (mis-named*) Pickett’s Charge:
For every Southern boy fourteen years old, not once but whenever he wants it, there is the instant when it’s still not yet two o’clock on that July afternoon in 1863, the brigades are in position behind the rail fence, the guns are laid and ready in the woods and the furled flags are already loosened to break out and Pickett himself with his long oiled ringlets and his hat in one hand probably and his sword in the other looking up the hill waiting for Longstreet to give the word and it’s all in the balance, it hasn’t happened yet, it hasn’t even begun yet, it not only hasn’t begun yet but there is still time for it not to begin against that position and those circumstances which made more men than Garnett and Kemper and Armistead and Wilcox look grave yet it’s going to begin, we all know that, we have come too far with too much at stake and that moment doesn’t need even a fourteen-year-old boy to think This time. Maybe this time with all this much to lose and all this much to gain: Pennsylvania, Maryland, the world, the golden dome of Washington itself to crown with desperate and unbelievable victory the desperate gamble, the cast made two years ago….
Faulkner’s description was not accurate when he wrote it. Not every Southern boy imagined himself in the shade of the trees on Seminary Ridge in the early afternoon of 3 July, 1863: maybe every white Southern boy–a revealing lacuna. But even with that modification, Faulkner’s characterization of the youthful Southern imagination is now an anachronism. Well into the 20th century, the Civil War–pardon me, the War of Northern Aggression–was deeply imbued in the consciousness of most white Southerners. Now, even in the deepest recesses of the erstwhile Confederate states, thoughts of the war hardly enter the minds of 14 year old boys. Yes, interest in the War is more intense in the South than in the remainder of the country, but that isn’t saying much. Today, Southern 14 year olds are far less distinct from their Northern peers than was the case when Faulkner wrote.
And yes, there are a large number of people with an abiding intellectual interest in the War, some going so far as to want to relive the lives of Confederate soldiers to the extent possible in the modern world (as described in Confederates in the Attic). But the very intensity and novelty of these aficionados demonstrates how things have changed: whereas during Faulkner’s day a deep, mystic, and romanticized connection with the Civil War was ubiquitous in the South, today any connection is limited to a very few, often quite eccentric, individuals.
Which is for the good. I am an ardent historical preservationist who believes that the past can be instructive and should be preserved. But preserving an idealized, romanticized view of a culture that enslaved millions was destructive. As much as I am in awe of the bravery and martial skill of the soldiers of the Confederacy, I have no fondness for the Lost Cause, which is really a fondness for a profoundly unjust social system, the remnants of which persisted for far too long after the War. So I am grateful that, in 2010, the Southern boy for whom it is “still not yet two o’clock on that July afternoon in 1863″ is the exception, rather than the rule.
* Pickett’s Division represented only one of three that made the assault. Two divisions from A. P. Hill’s Corps, Pettigrew’s and Trimble’s, also participated. (I saw a plaque honoring Pettigrew at the University of North Carolina, Chapel Hill, during a visit in April; he entered the school as a 15 year old.) Trimble was horribly wounded and captured. Pettigrew was mortally wounded on the retreat from Gettysburg. A. P. Hill was physically incapacitated during most of the battle, most likely from the effects of syphilis, and was shot in the last days of the War, during Grant’s final assault on Petersburg. Pickett’s survival (in a charge that felled every one of his brigade commanders–Garnett and Kemper and Armistead–and all but one regimental commander) and the Virginia-centric bent of post-war historiography ensured the connection between his name and the charge.
July 2, 2010
Gettysburg
Today is the 147th anniversary of the second day of the largest battle of the American Civil War–and the largest battle ever fought in the Western Hemisphere. During a few short hours (the major Confederate assault did not begin until mid-afternoon, and the battle ended around dark), the two sides suffered collectively tens of thousands of casualties in swirling, intense, and confusing combat concentrated in a few acres of rolling Pennsylvania countryside.
July 2d was the day of Devil’s Den, Little Round Top, the Wheatfield, the Peach Orchard, Culp’s Hill and Cemetery Hill. It was also the source of intense controversy that rages to this day. Lee-Longstreet. Meade-Sickles. My bookshelf groans under the weight of books on the battle, and the controversies.
An Enemy to the Party!
I have often expressed my admiration for Russia’s Finance Minister, Alexi Kudrin. My respect has only increased after reading this broadside:
Russian Finance Minister Alexei Kudrin’s proposal to raise the retirement age is an attack on the United Russia party that Prime Minister Vladimir Putin chairs, a senior party official said.
“Kudrin, with fatal insistence, is advocating increasing the pension age,” said Andrei Isayev, the party’s first deputy secretary of the presidium, according to comments posted on the United Russia website today. “He is making an active play against the party, causing the electorate’s outrage.”
Against the party! Heaven forfend! That sounds right out of the 1930s–or 1984.
Kommersant adds additional detail, emphasizing that Isayev leveled the most devastating charge against Kudrin: he’s a liberal:
Isayev called the finance minister “liberals’ informal leader” trying to engineer “a decrease of the ruling party’s support in elections” through knowingly unpopular initiatives that would make voters indignant. “Since United Russia said more than once that it would vote against any increase of the retirement age… it is clear that Kudrin’s proposal is but an attempt to put a spoke in the party’s wheels.” Warming up to the subject, Isayev said that the latest political season revealed an alarming trend, namely that the opposition was now criticizing both the ruling party and its leader Vladimir Putin. “Considering how closely Putin and United Russia are associated in the eyes of voters, our opponents hope to boost their own political clout at the cost of United Russia leader’s,” said Isayev.
Interesting how Isayev is accusing a senior minister in the government, who serves at Putin’s pleasure, of being an “opponent” and de facto member of the opposition. Further interesting that Isayev considers it “an alarming trend” that the opposition would have the temerity to criticize United Russia–and Putin. Uhm, what are oppositions supposed to do? Oh, I forgot: there’s not supposed to be an opposition.
The hysterical nature of Isayev’s screed suggests either a Sovietesque intolerance for dissent, or nervousness about the party’s political prospects, or both.
In fact, Kudrin is an ultimate realist who deals primarily in facts rather than dogma, especially party dogma. His proposals are based on a sober appraisal of objective forces.
Russian macroeconomic policy has been quite reasonable under Kudrin’s stewardship. He has always been a voice of sanity during both boom and bust. Which is probably why Putin keeps him around despite the fact that he crimps the style of the siloviki and nouveau apparatchiks like Isayev.
And Kudrin is not a member of the “what, me worry?” school of Russian demographics (the charter member of which is a frequent commentor:) :
The number of working adults will equal that of pensioners by 2030, Kudrin said. There are 128 working adults for every 100 pensioners in the country today, he told the St. Petersburg International Economic Forum last month. Russia’s demographic problem is “worse than in other countries,” he said.
Indeed, demographic concerns underlay his proposal. In contrast, political short-termism of the rankest sort motivates the histrionics of Isayev.
Kudrin’s grounding in reality, and his focus on the long term is why I admire him. His ability to do that under what have to be difficult political circumstances is all the more admirable.
Which is why that I wish that the SVR would hatch diabolical plot to plant Kudrin as an “illegal” in the US, with the ultimate aim of infiltrating him into the deepest recesses of American economic policy structures.
July 1, 2010
What is a Swap Execution Facility?
Frank-N-Dodd mandates that all cleared swaps trade on either a contract market (i.e., an exchange) or a “swap execution facility.” There’s been a lot of uncertainty about just what a swap execution facility (“SEF”) is, but the bill provides enough clues to get a pretty good idea.
The short answer: a lot like an exchange. A whole lot.
Some key points:
- An SEF must permit multiple participants to trade by accepting bids and offers made by multiple participants. This means that an SEF must be a “many-to-many” execution platform. A “many-to-one” platform, such as an electronic system in which a bank or broker-dealer posts bids and offers that customers can execute against wouldn’t qualify.
- They must permit “impartial access,” although that term is not defined. But it suggests a mechanism in which no one can be excluded. (Here the link to clearing is important. If anybody is allowed to enter bids and offers that others can execute against, they must be effectively equivalent as potential counterparties. Clearing standardizes–homogenizes–credit risk across counterparties.)
- The bill specifies that the goal of the section on SEFs is to promote pre-trade transparency.
- SEFs must establish and enforce rules to deter trade abuses. They must have the capacity to investigate to detect rule violations.
- Relatedly, they must collect information that can be used to establish whether rule violations have occurred.
- They must permit trading only in non-manipulable swaps.
- They must monitor trading to ensure that rules are adhered to. In particular, they must engage in real time monitoring of trading, and have systems to permit accurate and comprehensive trade reconstructions.
- SEFs must monitor trading in swaps markets to prevent manipulation.
- The bill states that SEFs “shall” impose position or accountability limits.
- SEFs are required to adopt rules to provide for the exercise of emergency authority.
- They are to make public “timely” information on price and trading volume and other trading data, as prescribed by the CFTC or the SEC (for security-based swaps). That is, they must offer “timely” post-trade transparency, but just what constitutes “timely” is an open question. (Yet another thing on regulators’ plates.)
If you compare this list to the obligations imposed on contract markets (i.e., futures exchanges), you’ll see that SEFs are subject to almost all of the same obligations as contract markets.
In essence, SEFs must be a many-to-many execution platform that is also self-regulating entity that polices for trade practice violations and manipulation. The combination of many-to-many with “impartial access” and extensive pre-trade and post-trade transparency effectively requires the creation of a public exchange; the mandated link between clearing and SEF execution is also very (futures) exchange-like.
It seems unlikely that “dark pool” like structures would meet these requirements; these are often not many-to-many, frequently don’t permit the making or executing against bids/offers (e.g., crossing networks), and offer limited pre- and post-trade transparency (hence the “dark” in “dark market”). Traditional dealer-client execution wouldn’t cut it either: that’s not many-to-many. Moreover, the real time trade monitoring and the ability to engage in accurate and comprehensive trade reconstructions seems to be an insuperable obstacle for voice brokers, meaning that effectively the bill requires the creation of electronic exchanges.
This suggests that (a) market participants will have a very limited choice of methods for executing transactions in swaps, and (b) these choices are far different than market participants have opted for currently. Congress, in its infinite wisdom, is forcing pretty close to a one-size-fits-all trade execution system on the market.
The lack of diversity in execution methods compatible with the SEF mandate contrasts sharply with the incredible diversity of market participants. It is well known that these diverse participants would like to have access to a variety of execution methods compatible with their particular needs. For instance, those wanting to trade in very large quantities often prefer–and often strongly prefer–not to trade on many-to-many exchange-type markets because of information leakage, price impact, front running, etc. The incredible array of execution platforms in equity markets testifies to this, as does the variety of derivatives execution methods, which range from order driven exchange markets to voice brokered markets to electronic dealing systems to telephone markets.
What is the rationale for restricting choice in execution? The only hint of a justification is the desire for greater transparency. But it is well known that transparency has costs as well as benefits. Mandating a high level of pre- and post-trade transparency just begs the question of why market participants would systematically choose the wrong level of transparency (i.e., a level that does not maximize the difference between costs and benefits), and why even if some market participants might profit from a sub-optimal level of transparency, competitive forces don’t prevail in overcoming the self-interest of a subset of participants. Moreover, transparency isn’t the only thing that matters to market participants. Other aspects of execution affect their costs and benefits as well. A myopic focus on transparency alone ignores these other relevant dimensions.
The clash between the diversity of market participants and the my-way-or-the-highway SEF rules will result in chronic conflict in coming years. There will be a demand, and likely a very strong demand, for the creation of alternative execution mechanisms to accommodate diverse trader needs. There will be conflicts with regulators, and litigation, over whether these alternative mechanisms fall afoul of the SEF requirements. There will be lobbying for exemptions, exceptions, and new laws permitting the creation of new kinds of facilities.
In 2005, I wrote that there was a 30 years war over securities market structure that was effectively started by the Securities Act Amendments’ mandate of a National Market System in 1975: that is now on its way to becoming a hundred years war (with the fallout from the Flash Crash just being the catalyst for another intense battle in that war). The SEF mandate will spark a long running battle in derivatives market structure as well. This is not the end of battles over derivatives market structure: this is the beginning.
The SEF rule is a Procrustean bed: an “arbitrary standard to which exact conformity is forced,” “a scheme or pattern into which someone or something is arbitrarily forced.” Just why such conformity is optimal in a market with a wide range of buyers and sellers of different sizes, different trading objectives, different demands for immediacy and liquidity, etc., is hard to comprehend. I understand that the nature of trading markets makes it that they are unlikely to be highly competitive (and I’ve written about that extensively in my academic work), and that as a result some inefficiencies (notably market power) can persist. But competitive forces do exist, and especially given modern electronic trading technologies, it is possible for these competitive forces to respond to, and accommodate, diverse transacting preferences.
But rather than let market forces work, albeit imperfectly, Congress would rather play Procrustes, forcing traders large and small onto the same type of trading platform.
Where’s Theseus when you need him?
Off the Reservation
Patrick Pearson is head of market infrastructure for the EC’s financial market regulator. He apparently hasn’t read the memo declaring that clearing mandates will usher in the era of the Big Rock Candy Mountain:
Central clearing . . . is a concept so dear to regulators [sic] hearts that it has become something of a mantra — particularly since the demise of Lehman Brothers and the counterparty risks that were brutally revealed by that event. So when Patrick Pearson . . . stood up to address an ABS conference in London on June 15 his words took some in the audience by surprise. ”Clearing houses don’t reduce counterparty risk,” he stated. ”They simply redistribute it. Central counterparties (CCPs) can act as a channel for risk. Their failure s far more dangerous than the failure of one single counterparty.”
. . . .
“If we shift massive amounts of OTC derivatives onto an exchange–are they safe enough to manage the risk? . . . . We don’t know. There are 13 clearing houses in Europe. If one defaulted there would likely be multiple defaults of clearing houses across the region. Just imagine how the markets would react.”
Hallelujah. How long have I been waiting for a regulator or legislator recognize those basic facts.
The author of this piece, Louise Bowman, recognizes that Pearson has gone off the happy talk reservation and committed the dire sin of telling the truth:
Hang on! The market has long worked on the assumption that central counterparty clearing will be mandated in Europe — it is just a matter of when . . . . The question is therefore what the highly eloquent Pearson was trying to say. In addition to questioning whether central clearing reduces counterparty risk he suggested that exchange trading of OTC derivatives might not be adopted in Europe–something that has also been seen as almost inevitable given the regulators’ drive for transparency in this market.
It is encouraging that not everyone in a position of regulatory responsibility has drunk deep the Klearing KoolAid. It will be interesting to see how things develop in Europe. It will be especially interesting to see whether an extended debate over clearing and exchange trading mandates lead to rather testy interactions between US and European officials, as alas, KoolAid seems to be the only thing served on Capitol Hill, Pennsylvania Avenue, and 21st St.
Pearson is, so far, pretty much a voice in the wilderness. One hopes, however, that he catalyzes a more constructive debate on these issues. There is a growing group of clearing skeptics among academics and practitioners. Pearson’s outspokeness raises the possibility that the skeptics’ arguments might actually receive a serious hearing at least somewhere it matters.
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