Soros Weighs In

Drudge links to a Financial Times contribution by George Soros:

In the past, whenever the financial system came close to a breakdown, the authorities rode to the rescue and prevented it from going over the brink. That is what I expected in 2008 but that is not what happened. On Monday September 15, Lehman Brothers, the US investment bank, was allowed to go into bankruptcy without proper preparation. It was a game-changing event with catastrophic consequences.

For a start, the price of credit default swaps, a form of insurance against companies defaulting on debt, went through the roof as investors took cover. AIG, the insurance giant, was carrying a large short position in CDS and faced imminent default. By the next day Hank Paulson, then US Treasury secretary, had to reverse himself and come to the rescue of AIG.

But worse was to come... The panic then spread to the stock market. The financial system suffered cardiac arrest and had to be put on artificial life support.

How could Lehman have been left to go under? The responsibility lies squarely with the financial authorities, notably the Treasury and the Federal Reserve... they could and should have done whatever was necessary to prevent the system from collapsing. That is what they have done on other occasions. The fact is, they allowed it to happen.

On some level, Soros is likely correct in arguing that we would have been better off had US authorities bailed out Lehman. Concretely: if, the subsequent TARP would, then, have been avoidable, it would have been quite the good deal for tax-payers.

The dynamic, however, bears scrutiny. There are many reasons why Lehman's failure froze the financial system, but Soros describes a key one: The general expectation by market participants that financial authorities would save Lehman. In as much as past Government actions justified that expectation, Soros is correct in blaming authorities for the panic that ensued when they did not live up to to the expectation they had a strong hand in setting. I would think he is somewhat wrong in arguing that the crux is the not-meeting, as opposed to the setting-of, that expectation.

From a public-interest perspective, I think it is easy to argue that we are much better off when participants in our financial markets are speculating financially and economically (e.g.: over the strength of this or that business) as opposed to politically (e.g.: over whether the government will do this or that). It is, then, against the public interest for Government to engage in behavior which encourages the latter over the former.

On a deeper level, too, credit default swaps played a critical role in Lehman’s demise. My explanation is controversial...

First, there is an asymmetry in the risk/reward ratio between being long or short in the stock market... Being long has unlimited potential on the upside but limited exposure on the downside. Being short is the reverse... The asymmetry serves to discourage the short-selling of stocks.

The second step is to understand credit default swaps and to recognise that the CDS market offers a convenient way of shorting bonds. In that market the asymmetry in risk/reward works in the opposite way to stocks. Going short on bonds by buying a CDS contract carries limited risk but unlimited profit potential; by contrast, selling credit default swaps offers limited profits but practically unlimited risks.

The asymmetry encourages speculating on the short side, which in turn exerts a downward pressure on the underlying bonds.

By "controversial", he must mean, simply (and, given the source, astoundingly) "untrue".

It is true that in as much as a stock price can theoretically rise infinitely, shorting a stock entails theoretically infinite risk. On the other hand. it is not at all true that selling CDS entails unlimited risks. Selling CDS is, fundamentally, the same as selling insurance. A seller of CDS has no more "practically unlimited risk" then a seller of life insurance. More to his point, the price of CDS no more exaggerates a company's likelihood of default then the price of life insurance exaggerates the likelihood of one's premature demise.

When an adverse development is expected, the negative effect can become overwhelming because CDS tend to be priced as warrants, not as options: people buy them not because they expect an eventual default but because they expect the CDS to appreciate during the lifetime of the contract.

It is unclear to me how he is arguing buyers motivations affects the sellers (or any) risk. If a buyer purchases CDS without expectation of default, and the underlier defaults, that is a bonus. Conversely, a seller has no business writing CDS without expectation of default.

No arbitrage can correct the mispricing. That can be clearly seen in US and UK government bonds, whose actual price is much higher than that implied by CDS. These asymmetries are difficult to reconcile with the efficient market hypothesis, the notion that securities prices accurately reflect all known information.

It is certainly true -- and not particularly difficult, to my mind, to grasp -- that efficient market hypothesis is limited by the laws of supply and demand.

The third step is to recognise reflexivity – that is to say, the mispricing of financial instruments can affect the fundamentals that market prices are supposed to reflect. Nowhere is this phenomenon more pronounced than in the case of financial institutions, whose ability to do business is dependent on confidence and trust.

That means that “bear raids” to drive down the share prices of these institutions can be self-validating. That is in direct contradiction to the efficient market hypothesis.

Putting these three considerations together leads to the conclusion that Lehman, AIG and other financial institutions were destroyed by bear raids in which the shorting of stocks and buying of CDS amplified and reinforced each other.

What, most directly, brought Lehman down was the market's reluctance to lend to it and the threat of rating agency downgrade. Prospective lenders and raters were certainly scared off by falling stock and rising CDS prices that indicated the markets increasing expectation of a Lehman collapse. Assuming Soros' "controversial" position that lenders and raters mis-read the information in those prices, its still a rather odd argument that Lehman was destroyed by "bear-raid". In the end, Lehman was an obscenely levered company and, as such, heavily dependent on near complete confidence and trust. It is hard to sensibly argue that it was Lehman's falling stock and rising CDS price, and not its manifestly atrocious performance that cost it the needed confidence and trust. The bear-raiders, then, were the opposite of "self-validating", they did what investors are supposed to do, expose an emperor with no clothes.

Unlimited shorting was made possible by the 2007 abolition of the uptick rule (which hindered bear raids by allowing short-selling only when prices were rising).

I don't have a strong opinion on the matter, but when the S.E.C. removed the uptick rule it did so on the basis of research indicating its purposelessness.

That is what AIG, one of the most successful insurance companies in the world, failed to understand. Its business was selling insurance and, when it saw a seriously mispriced risk, it went to town insuring it, in the belief that diversifying risk reduces it. It expected to make a fortune in the long run but it was destroyed in short order.

The primary difference between selling CDS and selling insurance are the collateral obligations. If I buy insurance, I know that the seller is subject to all sorts of regulatory requirements that give me confidence that it will be able to meet its obligation to me. If I buy CDS, I have no such assurance. Instead, I require collateral. The higher the price of the CDS, the more collateral I require. In other words, with ordinary (e.g.: car) insurance, the seller only pays out in the case of an event (e.g.: an accident), with a CDS the seller pays out in based on the markets expectations of an event. Given that and the reality that when one company defaults, the likelyhood of other companies defaulting tends to increase, the sort of diversification strategy which works well for ordinary insurance will not work well for CDS.

In the end, as it was the inability to post price-based collateral, as opposed to inability to make payments that did in AIG, Soros' argument that AIG "saw" mis-pricing to profit in the upward bias of CDS prices baffles.

...What would have happened if the uptick rule on shorting shares had been kept ... and speculating in CDS had both been outlawed? The bankruptcy of Lehman might have been avoided but what would have happened to the asset super-bubble? One can only conjecture. My guess is that the bubble would have been deflated more slowly, with less catastrophic results, but that the after-effects would have lingered longer. It would have resembled more the Japanese experience than what is happening now.

The analogy to Japan is telling. The Japanese banks, after all, were failed banks that, with the support of the government, limped along. To compare the American banks to the Japanese banks is to implicitly acknowledge that ours too are failed banks, destroyed by their own incompetence and mismanagement and some not "self-validating bear-raid".

...What about credit default swaps? Here I take a more radical view than most people. The prevailing view is that they ought to be traded on regulated exchanges. I believe they are toxic and should be used only by prescription. They could be used to insure actual bonds but – in light of their asymmetric character – not to speculate against countries or companies.

Again, even if Soros is correct, this is (yet) another odd argument. If the market saw in the price of CDS a greater loss of confidence then really took place, the most straightforward solution would be to demonstrate that such that in the future the market would be better able to understand the information embedded in the price of CDS. Perhaps it is because Soros know that his "controversial" argument will not be well accepted by the market, that he advocates it being imposed.

The bursting of bubbles causes credit contraction, the forced liquidation of assets, deflation and wealth destruction that may reach catastrophic proportions. In a deflationary environment, the weight of accumulated debt can sink the banking system and push the economy into depression. That is what needs to be prevented at all costs.

It can be done – by creating money to offset the contraction of credit, recapitalising the banking system and writing off or down the accumulated debt in an orderly manner. They require radical and unorthodox policy measures. For best results, the three processes should be combined.

This is all sensible up to a point. If it were simply "toxic" derivatives which caused the current meltdown, then the steps Soros describes including the re-capitalizing the banking system plus limiting the use of these derivatives are all that is called for. If however, the root cause of the melt-down is deeper and more systematic, without addressing it, we are headed for of wash. rinse. repeat.

...In addition, banking regulations need to be internationally co-ordinated. Market regulations should be global as well. National governments also need to co-ordinate their macroeconomic policies in order to avoid wide currency swings and other disruption.

This is rich.

Weegars

Was watching a Frontline piece about Uighurs interned in Guantánamo Bay.

The Guardian describes the situation:

Seventeen Chinese prisoners who have been held for nearly seven years in Guantánamo Bay will be informed on Monday that they could spend the rest of their lives behind bars, even though they face no charges and have been told by a judge they should be freed.

No country is willing to accept them and the US justice department has now blocked moves for them to be allowed to go to the US mainland, where they had been offered a home by refugee and Christian organisations.

The men's lawyer, Sabin Willett, is flying to Guantánamo Bay this weekend to break the news to the men, who are members of the Uighur ethnic group seeking autonomy from China...

Last month a federal judge ruled that the men should be freed. "They were on freedom's doorstep," said Willett. "The plane was at Gitmo. The stateside Lutheran refugee services and the Uighur families and Tallahassee clergy were ready to receive them." However, the justice department appealed against the ruling and Willett claims this will put the men into a potentially endless limbo.

Yesterday Willett said his clients were "saddened" by the latest events. The men, who are Muslims, were in Afghanistan in 2001 and were captured by Pakistani troops and handed over to the US. So far, more than 100 countries have been asked to take them as refugees but none have agreed. Willett blamed US authorities for incorrectly describing them as terrorists.

According to the US justice department, the men "are linked to an organisation that the state department has labelled to be a terrorist entity, and it is beside the point that the organisation is not 'a threat to us' because the law excluding members of such groups does not require such proof."

Willett is also angry the defence department will not agree to let him meet his clients unless they are chained to the floor. He called for this restriction to be lifted: "Just permit these men one shred of human dignity." He added: "Americans are not supposed to treat enemy prisoners of war this way under the service field manuals, or the Geneva conventions - if anyone paid attention to the field manuals or the Geneva conventions anymore."

On one hand, this story, in its own way, is a defense of the Bush Administration. Willet is, no doubt, cartoonishly -- and not innocently -- naive in suggesting that other nations refuse to take in the Uighur because of incorrect description by US Authorities rather than pressure from the Beijing. These prisoners are, certainly, infinitely better off in Gitmo then in any Chinese facility. Gitmo can not be closed without resolving their situation.

On the other hand, there is strong critique here. There is a weakness to a policy that, apparently, does not accept the Chinese position that these men are properly held terrorists, yet cannot find the courage to defy the Chinese by taking them in as refugees.

Above all, these are people who have -- in the eyes of the law -- committed no crime, and yet, are being treated, in ways bigger and smaller, in-humanely. Their treatment may be far less then (the loaded word) "torture", but to watch it is to feel, deeply, "not-in-my-name".

Embedded in a simple (person's) reading of our founding, governing, documents is the idea that our rights, by virtue of our human-ness, are established before any government; that the state needs to be restrained from violating them. This idea has lost some currency. Our rights today are more generally held to be established by the government. This distinction is not without difference. It is the difference between wrongfully-detained Uighurs being treated with human-decency and being purposelessly chained to the floor.

That said, treating people with human-decency has never been the strong suit of any state.

Nationalization via Regulation

The Times published an article about how Bank credit decisions are hurting some businesses. In between the lines is who is making the decision:

...until recently, banks had largely chosen to keep past-due borrowers afloat, in the hope that a housing recovery might pave the way for them to repay their debts in full.

Only now, with the economic outlook darkening, are lenders stepping up foreclosures of troubled loans. Zelman & Associates, a housing analysis firm, estimates that losses on land and construction loans could eventually reach $165 billion, one reason federal regulators are pushing banks to come to grips with the problem.

“When we talk to regulators now, they say they’ve lost patience,” said Ms. Zelman, who is chief executive of Zelman & Associates.

There may be times and places where the regulator-as-coach is more appropriate then the regulator-as-referee, and the current crisis may well be one of them. On the other hand, this approach to financial service regulation well pre-dates the current crisis. It is also worth recognizing that the regulator-as-coach, more or less, amounts to nationalization.

On a related note, [Richard] Parsons to become chairman at Citigroup.

Citigroup's board has been the target of much scrutiny among investors for allowing the bank to invest so heavily in the risky housing market.
As that criticism escalated over the past several weeks, so did speculation that Parsons - one of the only directors with experience in both banking and leading a large company - would become chairman.

Before helping negotiate Time Warner's merger with America Online in 2000 and serving as the new company's CEO and chairman, Parsons was chief executive and chairman of Dime Bancorp, a thrift bank, in the early 1990s.

Parsons was also an economic adviser on President Barack Obama's transition team.

As the AOL merge was disastrous for Time Warner, Parson's service to President Obama, as opposed to his private sector accomplishments, likely drove this choice.

Sickening

The facts are these:

On October 9, WTAE Pittsburgh Chanel 4 reported:

Pittsburgh Steelers wide receiver Hines Ward has been fined $5,000 by the NFL for a hit during a Monday night game against the Ravens on Sept. 29.
Known as much for his crushing hits on defenders as he is for scoring touchdowns, Ward was not penalized on the play during the Steelers' 23-20 overtime win.
The league deemed the play "unnecessary roughness."

Safety Ryan Clark was also fined $7,500 for a helmet-to-helmet hit on wide receiver Matt Jones during the Steelers' 26-21 win over the Jacksonville Jaguars on Sunday night.

Both fines come in the same week that linebacker James Harrison was fined $20,000 for criticizing a call made by officials during the Jacksonville game.

On October 30, the Pittsburgh Post-Gazette Reported:

Safety Ryan Clark revealed that he was fined $5,000 by the NFL for wearing eye black with the No. 21 etched into it Sunday. Clark said he did it to honor his late Redskins teammate Sean Taylor, who was murdered in his Florida home last year. Clark, who wears No. 25, wears a No. 21 practice jersey in honor of Taylor. Clark said he will continue to wear the eye black with "21" in it.

A month later, Clark was featured in the Post Gazette again:

Ryan Clark, absolved by the league office for what should have been a legal hit Sunday in New England, is ready to do it again, and if he gets a chance to tee-up Terrell Owens of the Cowboys, he said he'll take it.

"I try to hit everybody," Clark said yesterday, hours after learning the league judged his hit on Patriots receiver Wes Welker clean. "I don't care which one. I'll take them all, I don't turn any of them down. We're just going to go out there and play.

"If that opportunity presents itself [against Owens], of course you take that shot...

Clark's big hits from his free safety position have been resounding this season, drawing one fine and some putdowns from the opposition. Even New England cheap-shot artist Vince Wilfork called him a cheap-shot artist.

He was flagged by at least two officials on the field Sunday when as a pass was tipped and sailed beyond Welker's reach, Clark slammed into him, shoulder first. The officials told Clark he should not leave his feet, but the NFL's vice president of officiating said there's no rule against that.

"A lot of people think it's a foul to leave your feet," Mike Pereira told the Boston Herald. "Launching is not a foul. ... It is a foul to hit with your helmet against a defenseless receiver. It is a foul to throw a forearm into the neck or head area of your opponent. I don't think either of those things happened. I'm not a fan of those high hits, but if you do it with your shoulder, you're OK."

In other words, there should have been no flag thrown.

"Like I said Sunday, I thought the hit was clean," Clark said. "I was just playing football. It's good they said something like that but if you look at that situation, if we'd have lost that game, if that drive would have cost us the game, it would not have mattered much what they say after the fact."

Still, Clark's big hits in the secondary add another component to the creation of the NFL's best defense...

Clark received the ultimate compliment from the offense's big hitter, Hines Ward.

"I watched it," Ward said, "and I heard it from the sideline and I said, 'Oooh, I'm glad that wasn't me.' "
...
The controversy that swirled around Clark's hit on Welker is merely the latest involving the Steelers this season. Ward twice was fined for hits in which he was not penalized, and he too was absolved by the league for a block that broke the jaw of Cincinnati linebacker Keith Rivers and riled the Bengals. Clark and linebacker LaMarr Woodley also were fined for hits.
...
"I think our team is being made out to be somewhat dirty at times and I think we're just physical and play a hard-nosed brand of football. But you can't stop playing that way."

Readers can judge for themselves whether the unapologetic Clark was wrongfully made out to be somewhat dirty (or rather, whether Clark is only "somewhat" dirty):



This is, of course, not the end of the story. The Times describes the action in the AFC championship game:

...It was, fittingly, a brilliant 40-yard interception return for a touchdown by Steelers safety Troy Polamalu — shades of his Ravens counterpart Ed Reed — that secured the win with 4 minutes 39 seconds remaining in the game.

Then a brutal hit on Willis McGahee dislodged the ball from his hands, gave him a neck injury that caused him to be taken off on a cart, and handed the ball to the Steelers, ending the Ravens’ last chance for a comeback.

The hit in question was a flagrant helmet-to-helmet hit. Not only was Clark not -- as by rules he should have been -- ejected, the result of the play -- a McGahee fumble -- stood.



Football is, of course, rightfully, a physical, hard hitting, game. But it ought not be a barbaric game. Nobody should like to see the stretcher come out. There should be no place in football for players aiming to seriously injure -- or kill -- other players. At the very least, Clark plays the game with callous disregard for the possibility of serious injury to other players or himself.

To be fair, this is not simply about Clark. The Steelers as a team take pride in their, not simply toughness, but almost brutality. The organization is, above all, concerned about how Clark contributes to their NFL-best defense. Clark has been made to understands viciously cheap-shotting opposing players as part of his job. The NFL itself is as, if not more, concerned about individual etchings in eye-black and players criticizing calls then reckless, life threatening, game-play.

On a simple human level, these morally empty prioritizations are sickening.

Long Road Back

From Ben Smith, Moderate Republicans:

If there were a strong moderate strain in the GOP leadership, it would be saying things along the lines of a new essay by former Virginia Rep. Tom Davis in the Ripon Society's publication. The essay argues that the GOP needs a few clear principles on big issues, that social issues are a distraction, and that there's no hope to be found in looking back.

Davis writes:

What we can’t do is go back. I’ve heard much talk of going back to our conservative roots, to the issues that helped us win in 1980 and 1994. That issue matrix has changed so much as to be nearly unrecognizable now. The voters who dealt us our electoral disasters in 2006 and 2008 did so because they thought we were all too true to our roots. That we were exclusive, favored rich over poor, and didn’t care sufficiently for the plight of the little person.

Also, I suspect this call to return to our “roots” really is a call to do nothing. And doing nothing, I hope Republicans will agree, is not an option.

This may be a valid argument, but it's not one that you'll find anywhere near the center of Republican politics now, after the Democratic takeover has purged it of its swing-district moderates. It's not something anyone in the race for RNC chairman would dare whisper.

Tom Davis is clearly correct on a few counts.

Whatever "issue matrix" means, it is nearly unrecognizable and so the old terms, like "moderate" are empty of meaning.

This issue matrix is obviously multi-dimensional and there is no one path to success or defeat, but the following appears mostly true: The GOP has done best when it has portrayed itself as aligned with the values and interests of ordinary Americans in contrast to elitist and effete Democrats. The GOP has done most poorly when it is portrayed as a tool of the Rich and Powerful, unable to care less about the issues and concerns of ordinary Americans. Whatever the way back, it likely involves strengthening the former narrative and weakening the latter.

But he is wrong on some big things:

In as much as conservative social values are the GOP's best hope to make in-roads amongst generally socially conservative minorities, it is not in the GOP's interest to drop altogether its support of conservative social values.

It is rather perverse for a conservative to conflate "our roots" with being exclusive, favoring rich over poor, and not caring sufficiently for the plight of the "little person". That is a liberal's caricature of conservative roots.

I would like to believe that long road back for Republicans lies in remembering and exploiting the Democratic party's fatal flaw. In the end, the Democratic party is the party of We-Know-Better-Then-You. Democrats tend, reflexively, to prefer policies that make choices for people to policies that empower people to make their own, educated and informed, choices. The Republicans, then, ought, once again, become the party of You-Decide.

Change We Can Believe In

The President weighed in in the Times about the need for a college football playoff system.

Rick Reilly makes a compelling argument that Utah is the national champion.

Argue with this, please. I beg you. Find me anybody else that went undefeated. Thirteen-and-zero. Beat four ranked teams. Went to the Deep South and seal-clubbed Alabama in the Sugar Bowl. The same Alabama that was ranked No. 1 for five weeks. The same Alabama that went undefeated in the regular season. The same Alabama that Florida beat in order to get INTO the BCS Championship game in the first place.

FIND ME ANYBODY ELSE THAT WENT UNDEFEATED. THIRTEEN-AND-ZERO. BEAT FOUR RANKED TEAMS. WENT TO THE DEEP SOUTH AND SEAL-CLUBBED ALABAMA IN THE SUGAR BOWL.
Yeah, that's how it is now in the shameful, money-grubbing world of college football. If you're Florida and you beat Alabama, you get a seat in the title game. If you're Utah, you get a seat on your sofa.

Kindler, Gentler 24

Drudge links to Barack Obama 'kidnaps' 24 hero Jack Bauer

As the hero of the television action series, Bauer became a modern icon of rugged American values and a fictional flag waver for the Bush administration's determination to defeat terrorists...

And in an apparent bid to get in tune with the new president, the new season opens with Bauer facing a congressional investigation probing his use of torture and summary executions in previous series. "It's better that everything comes out in the open," Bauer says, echoing Democrat demands for greater transparency over US counter-terrorist tactics.

It is hard -- given that Jack insults the motives and integrity of the, presumably Democratic, congressional investigators -- to see how one can read the season opener as being sympathetic to Democrats.

The argument Jack makes is one a conservative would be hard pressed to disagree with: The American people ought to know about and be able to choose the steps people are taking on their behalf/in their name. Jack expresses a confidence that the American people -- if not cultural/political elites -- will decide wisely.

The Passed-Over Cardinals

The coach was passed over for a head coaching role by his former team.

The quarterback was passed-over by the NFL Draft, the team he took to the super-bowl twice winning once, and then a succession of teams.

The running back was passed over by his old team despite being their all time leading rusher.

How can you not cheer the success of these real life bad-news-bears?

Obama Heart David Brooks

DrudgeReport links to a 1996 interview in which Obama sounds very much like David Brooks:

"What concerns me the most are children and the way they are treated," he says about why he will pursue a career in public office. "As an African-American, I am very concerned about children from poor neighborhoods, the problems they deal with, the total lack of a stable environment to enable them to grow and develop. It depends a lot on the economy, the opportunities they are given, their own selves and their parents. It also depends on values, for instance on the kind of family values that get talked about a lot, especially by politicians."

He continues, saying, "values don’t just belong to individuals, they are also collective. Children are exposed to the values around them, and if they come to believe that the lives of their parents and their community cannot be rewarded, if their schools and homes are crumbling, how can they come to believe in their own values when they don’t have any to begin with? My priority is to return social values to public debate, because we are all one big family, transcending racial or class differences. We have obligations and responsibilities towards one another."

He says, "perhaps that’s where the private and public spheres meet, when it comes to couples, relationships, families or tribes. What’s important is empathy, an understanding of shared responsibilities, the ability to put yourself in other people’s shoes.

It is a standard part of the (neo-)conservative narrative that well-intentioned great society government programs (e.g.: welfare and integration) aimed at helping individuals wound up destroying communities -- homes and neighborhood schools -- and hurting the people they sought to help.

Obama appears, in this interview, to implicitly endorse, at least something close to this view.

Obama identifies empathy -- identifying, being fundamentally concerned, with the suffering of an-other -- as the solution to the breakdown of communities. A lack of empathy is the certainly, once he points it out, perhaps the most visible evidence of the dis-function of broken communities.

Obama leaves open what sort of policies he envisions to rebuild communal empathy. But it is clear that he understands the flawed nature of the knee-jerk great society liberal approach.

Obama and Hamas

Drudge links to Obama camp 'prepared to talk to Hamas'

The incoming Obama administration is prepared to abandon George Bush's doctrine of isolating Hamas by establishing a channel to the Islamist organisation, sources close to the transition team say.

The move to open contacts with Hamas, which could be initiated through the US intelligence services, would represent a definitive break with the Bush presidency's ostracising of the group. The state department has designated Hamas a terrorist organisation, and in 2006 Congress passed a law banning US financial aid to the group.

The Guardian has spoken to three people with knowledge of the discussions in the Obama camp. There is no talk of Obama approving direct diplomatic negotiations with Hamas early on, but he is being urged by advisers to initiate low-level or clandestine approaches, and there is growing recognition in Washington that the policy of ostracising Hamas is counter-productive. A tested course would be to start contacts through Hamas and the US intelligence services, similar to the secret process through which the US engaged with the PLO in the 1970s. Israel did not become aware of the contacts until much later.

There is less to this story then meets the eye. Obama is not likely to discontinue any of the policies by which Bush isolated Hamas. The idea that the current administration does not already have clandestine lines of communication with Hamas (for example: through Egypt) is silly.

The explicit 'break' from current doctrine is this: The Bush administration conducted clandestine negotiations with Hamas, as it did with Iran, clandestinely and indirectly, while Obama has advisors who would have him conduct clandestine negotiations directly and more publically. Bush's approach is based on the belief that direct and public negotiation with the United States is a diplomatic carrot -- by virtue of the legitimization it implies -- which American diplomats should not simply give away. I have a harder time understanding the rationale of the anonymous Obama advisors. Perhaps they do not see direct or public negotiation as extending implied legitimization to actors like Iran and Hamas.

The bigger question is not "how", but the "what". Bush extended clear terms -- fundamentally the same as what the US required of the PLO back in the day -- for including Hamas more directly in the conversation. Obama has given no real indication that he intends to relax these conditions. On the other hand, one doesn't have to read too deeply between the lines to sense that his anonymous advisors would have him do so.

Richard Haass, a diplomat under both Bush presidents who was named by a number of news organisations this week as Obama's choice for Middle East envoy, supports low-level contacts with Hamas provided there is a ceasefire in place and a Hamas-Fatah reconciliation emerges.

Another potential contender for a foreign policy role in the Obama administration suggested that the president-elect would not be bound by the Bush doctrine of isolating Hamas.

"This is going to be an administration that is committed to negotiating with critical parties on critical issues," the source said.

These are not consistent positions. As Hamas is a more critical party and the issues are more critical if there is no cease fire and no Hamas-Fatah reconciliation, the anonymous contender would not support the conditions Haass would have. Implicit in Haass' position is the supposed Bush doctrine of viewing negotiation as a reward for good behavior.

..."Secret envoys, multilateral six-party talk-like approaches. The total isolation of Hamas that we promulgated under Bush is going to end," said Steve Clemons, the director of the American Strategy Programme at the New America Foundation. "You could do something through the Europeans. You could invent a structure that is multilateral. It is going to be hard for the neocons to swallow," he said. "I think it is going to happen.

This reminds me of Met fans who chant "Yankees Suck" at Shea when the Mets do well. Policy makers should have greater concerns then how well neocons are swallowing what.

...the president-elect would be wary of being seen to give legitimacy to Hamas as a consequence of the war in Gaza.

Bruce Hoffman, a counterterrorism expert at George town University's school of foreign service, said it was unlikely that Obama would move to initiate contacts with Hamas unless the radical faction in Damascus was crippled by the conflict in Gaza. "This would really be dependent on Hamas's military wing having suffered a real, almost decisive, drubbing."

Even with such caveats, there is growing agreement, among Republicans as well as Democrats, on the need to engage Hamas to achieve a sustainable peace in the Middle East – even among Obama's close advisers.

The argument for engaging Hamas depends on the low likelyhood of Hamas participating in a "sustainable" peace still being greater then the likelyhood of Hamas being made irrelevant.

Hoffman's opinion is mind-bogglingly perverse. Hamas's military wing suffering a real, almost decisive, drubbing dramatically increases the likelyhood of Hamas being made irrelevant as their primary selling point is "We, better the Fatah, can stand up to Israel". To the degree that Hamas is not going away, there is some argument that it has to be dealt with. But why would anyone want America to rescue Hamas from the jaws of irrelevancy?

Which gets to a more fundamental point. In the end, negotiations with Hamas may well be a necessary evil. They ought not be something anybody is anxious to do.

Risk and Regulation

The Times has a good article about RISK Mismanagement. Between the lines, it well illustrates the dynamics by which ill-concieved financial service regulation worked against the health and stability of the financial system.

There are many such models, but by far the most widely used is called VaR — Value at Risk... one reason VaR became so popular is that it is the only commonly used risk measure that can be applied to just about any asset class... Another reason VaR is so appealing is that it can measure both individual risks — the amount of risk contained in a single trader’s portfolio, for instance — and firmwide risk... Top executives usually know their firm’s daily VaR within minutes of the market’s close.

Risk managers use VaR to quantify their firm’s risk positions to their board. In the late 1990s, as the use of derivatives was exploding, the Securities and Exchange Commission ruled that firms had to include a quantitative disclosure of market risks in their financial statements for the convenience of investors, and VaR became the main tool for doing so. Around the same time, an important international rule-making body, the Basel Committee on Banking Supervision, went even further to validate VaR by saying that firms and banks could rely on their own internal VaR calculations to set their capital requirements. So long as their VaR was reasonably low, the amount of money they had to set aside to cover risks that might go bad could also be low.

The intent of the regulators was sensible enough. Firms ought to report risk exposures to investors. Banks with riskier investments ought maintain larger capital cushions. In the end, however, attempts to enforce these good ideas with regulation are almost intrinsically problematic because risk is a rather difficult thing to quantify simply and objectively. There is almost willful oblivious-ness in coming up with a single number and blessing it as a functionally complete and objective measure of risk. But the bureaucracies -- large-firm management and the regulatory agencies -- required such a number.

Tangentially, its worth making explicit what is inherently put at stake by the notion that risk can be quantified simply and objectively: Were that true, free markets would be of limited practical value, and command economies would be the order of the day.

...Taleb, a trim, impeccably dressed, middle-aged man — inexplicably, he won’t give his age... He also went from being primarily an options trader to what he always really wanted to be: a public intellectual. When I made the mistake of asking him one day whether he was an adjunct professor, he quickly corrected me. “I’m the Distinguished Professor of Risk Engineering at N.Y.U.,” he responded. “It’s the highest title they give in that department.” Humility is not among his virtues. On his Web site he has a link that reads, “Quotes from ‘The Black Swan’ that the imbeciles did not want to hear.”
...
“Why do people measure risks against events that took place in 1987?” he asked, referring to Black Monday, the October day when the U.S. market lost more than 20 percent of its value and has been used ever since as the worst-case scenario in many risk models. “Why is that a benchmark? I call it future-blindness.

“If you have a pilot flying a plane who doesn’t understand there can be storms, what is going to happen?” he asked. “He is not going to have a magnificent flight. Any small error is going to crash a plane. This is why the crisis that happened was predictable.”
...
Eventually, though, you do start to get the point. Taleb says that Wall Street risk models, no matter how mathematically sophisticated, are bogus; indeed, he is the leader of the camp that believes that risk models have done far more harm than good. And the essential reason for this is that the greatest risks are never the ones you can see and measure, but the ones you can’t see and therefore can never measure.


There is something almost explicitly svengali about this Taleb; His ultimate claim -- Risk models are imperfect, ergo, they are useless -- is more theatrical then intelligent. (Tangentially, his argument mirrors that of a former manager of mine against using unit tests).

On the other hand, the pilot analogy touches on a key point. What he describes -- any small error crashing the plane -- is a system that is not robust. Systems are not made robust by meditating over the un-imagineable. They are made more robust, in the first instance, by being made more adaptable, in the second instance, by incorporating lessons learnt-the-hard-way and, above all, by redundancy. Its not difficult to demonstrate how ill-concieved well-meaning attempts at financial service regulation often -- by adding rigidity and introducing centralized points of failure -- make the system more brittle. And the lessons-learnt by politician-regulators are often different then those of market participants.

...The Securities and Exchange Commission, for instance, worried about the amount of risk that derivatives posed to the system, mandated that financial firms would have to disclose that risk to investors, and VaR became the de facto measure. If the VaR number increased from year to year in a company’s annual report, it meant the firm was taking more risk. Rather than doing anything to limit the growth of derivatives, the agency concluded that disclosure, via VaR, was sufficient.

That, in turn, meant that even firms that had resisted VaR now succumbed. It meant that chief executives of big banks and investment firms had to have at least a passing familiarity with VaR. It meant that traders all had to understand the VaR consequences of making a big bet or of changing their portfolios...

...All over Wall Street, VaR numbers increased, but it still all seemed manageable — and besides, nothing bad was happening!

The primary job of the SEC, of course, is not to protect the stability of the financial system (for example, by limiting the growth of derivatives), but to protect investors. In mandating the publication of VaR, it actually suceeded to the degree that investors were informed about the increasing riskiness of their investments.

The question, then, is why investors were not concerned. I believe it can be easily argued that regulations intended to make investment easier and safer, to protect investors not just from fraud, but from research and dilligence, have the effect of dumbing down investors, and so reducing their ability to over-see the companies they own.

The way, in the end, VaR analyis owes its universal adoption to regulations illustrates a crowding out effect. I interviewed in the credit risk department of a large -- relatively unscathed -- bank in march 2007. In one of my conversations we talked rather explicitly about the limitations of the sorts or risk numbers people threw around, but also, how regulatory requirement (Basel II above all), sort of forced banks to spend resources on risk analysis they understood to be less then useful, that could have been better allocated to more useful analysis.

Which gets to some core problems with the current conception of regulation. If a regulator is better then a private firm at managing risk, then that firm ought not be in business. And if the firm is better, then the regulator ought not be telling it how to manage risk.

Further, this is an example of how regulation can introduce single points of failure (in this case: a flawed risk management practice) into a system.

In a crisis, Brown, the risk manager at AQR, said, “you want to know who can kill you and whether or not they will and who you can kill if necessary. You need to have an emergency backup plan that assumes everyone is out to get you. In peacetime, you think about other people’s intentions. In wartime, only their capabilities matter. VaR is a peacetime statistic.”

This hits the nail on the head. Which is to say, VaR is a wonderful tool, with great utility in certain contexts (peacetime), but it is not a one-size-fits-all measure of risk. That some people viewed it as such says more about those people then it does about the tool.

And I think the frame-of-mind of those people is a key point here. If you are a "Risk Manager" in a giant bank, responsible for controlling risk across a mind-boggling array of products and activities, you need simple numbers. All the more so, if you are a regulator with responsibility across a whole economy. This is the black hole at the heart of the system. The choice between coming up with "God-Blessed" (to use a term loved by a Risk Manager I once worked with), if not-entirely-meaningful, numbers or throwing one's hands in the air.

Which is not to say that risk cannot be managed, only that risk management doesn't scale well. Or, rather, that it needs to be re-concieved as it scales. Which is to say, government regulators should be more concerned about, for example, structural risks like mis-aligned incentives, or the existence of firms too big to fail, then with how individual firms manage risk.

...the big problem was that it turned out that VaR could be gamed. That is what happened when banks began reporting their VaRs. To motivate managers, the banks began to compensate them not just for making big profits but also for making profits with low risks. That sounds good in principle, but managers began to manipulate the VaR by loading up on what Guldimann calls “asymmetric risk positions.” These are products or contracts that, in general, generate small gains and very rarely have losses. But when they do have losses, they are huge.

This is a really interesing angle that I had not recognized. The danger, in setting rules, is that they always have unintended consequences. The more universal a rule, the more dangerous those consequences.

Overheard On CNN

Around 10:15, CNN's Chief Business Correspondent Ali Velshi on AC360 explaining the details of Obama's planned stimulus plan:

...Here's the surprise, up to 40% of it ($300 Billion) is going to go toward tax cuts... They divide up between individual and business tax cuts... [the business tax cuts are] maybe not a bad idea. But tax cuts for individuals tho, Anderson, it didnt work last time around, if it did, last spring, we wouldn't be in a recession...

That analysis is almost too silly to comment on. Its fascinating to me that CNN has learned to love tax cuts for businesses while warning their viewers of the futility of individual tax cuts.

Which, puts me in the odd position of sort of agreeing with CNN. As a political matter, I don't love business taxes since they decrease transparency. Corporate taxes are borne, in differing measures, by customers, employees and shareholders. Who precisely bears how much of a corporate tax is near impossible to measure. Its a way, therefore, of taxing people on the sly. To believe that government ought to be open and transparent is to be biased against corporate taxation.

Gas Guzzling

Articles of the auto industry troubles cannot help but condemn our addiction to gas guzzling.

Its not clear to me that this condemnation is all that sensible or innocent. Buying a large "gas guzzling" car is a rational, even environmentally friendly, descision for for families with more then two children. The Prius is not a family car.

The demand, then, that American automakers make fewer Caravans and more Priuses is, simply, a demand that they cater less to a certain sort of Americans (families with more then two children) and more to the sort now in power.

Mike Shanahan

The Broncos have begun searching for Shanahan's replacement:

Owner Pat Bowlen, chief operating officer Joe Ellis and personnel chief Jim Goodman jetted off to New York on Saturday for a dinner meeting with New York Giants defensive coordinator Steve Spagnuolo, followed by a Sunday conversation with New England Patriots offensive coordinator Josh McDaniels.

The trio will return to Denver for interviews at team headquarters next week with Tampa Bay Buccaneers defensive coordinator Raheem Morris and Dallas Cowboys offensive coordinator Jason Garrett.

I have to imagine that top tier coaching prospects like Spagnuolo, McDaniels and Garrett will have little serious interest in coaching for Bowlen. All else being equal, why choose to work for a guy who has fired Dan Reeves, Wade Phillips and, now, Mike Shanahan.

They may well wind up with Morris. His defensive focus matches their primary need and his relative inexperience may limit his alternatives. If this happens, they will have replaced a super-bowl winning hall of fame head coach with a 32 year old who has yet to even hold co-ordinator responsibilities.