Saturday, December 24, 2011

Holiday Break -- See you after the new year

I'll be taking a break from posting this week and next. I expect to post again on Sunday, January 8th. Have a safe and happy holiday!

Sunday, December 18, 2011

The incompetent and unscrupulous: Confidence in the age of MF Global

Those who are incompetent require our correction. The incompetent need to know how to succeed. Maybe this takes education. Maybe it takes better judgement. Maybe it takes a thoroughgoing review of their errors. While the incompetent may elicit our scorn, they do not merit our moral indignation.

That is reserved for the unscrupulous. The unscrupulous are sometimes incompetent. But often they are quite competent at taking our money under false pretenses.

What the recent MF Global bankruptcy--the eighth largest in U.S. history--tells us is that the world's financial system may be moving headlong into a collision of incompetence with unscrupulousness. (Full disclosure: I had a small account with MF Global and so have had a ringside seat, so to speak, in the bankruptcy proceedings.) I do not mean to say that before now there was no unscrupulous behavior in the financial system. What I mean to say is that it does not matter how competent someone believes a firm is at investing or handling money; if the firm is perceived as dishonest, that's it!

So far the revival of stock and commodity markets around the globe via enormously stimulative budget and monetary policy has assured most people with invested money that the authorities are, in fact, competent to manage downturns, even severe ones. Markets may not be back to their previous highs, but they are a far cry from the devastation of late 2008 and early 2009.

Now the competence of those authorities is being questioned as Europe appears mired in a long battle to save the euro as the currency of its 17-country Eurozone. The question is: Should the average investor--the buy-and-hold investor--stick it out once more and trust in the authorities to make things all better? That is a monumental question.

But soon that question will be competing with an even uglier one? Can I count on the institutions which hold my money and investments--primarily brokerages and banks--to deal honestly and fairly with me? Can I count of them not to steal my money?

As the questions of competence and trust converge, the financial system seems increasingly imperilled. If authorities do everything right, but investors believe they can no longer trust their brokers and banks not to steal their assets, the competence of the authorities in monetary and fiscal policy will simply not matter. And, if investors should simultaneously lose faith in the ability of authorities to handle the roiling financial crisis in Europe and lose trust in their brokers and banks to safeguard their money, we should be prepared for a wipeout that will make 2008 look like a day in the park.

This is the scenario lurking behind the MF Global collapse. Clearly, MF Global was incompetent at managing its risks including the risk that its lenders such as banks and hedge funds would withdraw funding for its positions. (Firms such as MF Global borrow money short-term to buy long-term assets and profit from the difference between the interest payments on short-term funding and the stream of revenues from long-term assets. The short-term funding must be periodically renewed. If this seems risky, it is.) The lenders stopped lending not necessarily because they believed MF Global to be unscrupulous, but because they believed the firm was no longer competent to manage the risks associated with its portfolio of highly leveraged investments. Fearing losses on their loans, they didn't roll over their financing.

Then came act two. MF Global misappropriated protected customer funds to support its precarious positions, especially those in European government bonds which seemed increasingly dicey this fall. Perhaps the firm felt it would be able to pay customers back once the fuss died down, and no one would be the wiser. But the fact that MF Global managers carefully covered their tracks in making the transfers tells us what we need to know. They believed what they were doing was illegal.

Here is the problem that regulators face. Prior to the MF Global collapse they had been able to say that no holder of a regulated futures account had ever suffered a loss of deposits (collateral or cash). Naturally, people lose money on futures positions every day. But that's a far cry from having money which has been deposited to support those positions simply stolen. That makes it impossible to collect money even if you win your bets, since the money that is supposed to be transferred to you from the people on the losing side of the trade just isn't there.

Futures accounts are not insured for such losses for the simple reason that the regulators wisely decreed that customer money and firm money have to be separated, and customer money simply cannot be used for the firm's own trading without customer consent. There was no consent, and there would have had to have been collateral posted or contractual obligations agreed to had there been any consent.

Worse still, the CME Group, owner of many U.S. futures exchanges, was the auditor for MF Global and thereby responsible for making sure customer money was properly segregated and actually in the right accounts every day. One would think that the owner of the exchanges would have a special interest in making sure one of the world's largest futures brokerages--with which the exchanges do business every day in huge volume--is handling customer money properly.

The result of the CME's poor supervision was a huge seize-up in futures trading as a significant portion of the world's largest players in the futures markets found their money frozen, waiting for someone to sort out the mess. Nearly six weeks after the collapse customers are only now getting a portion of their cash back, around two-thirds of it. The rest will have to wait for a claims process, and there is currently no guarantee that the remaining third will be paid back.

Now, if you are a futures trader and especially if you trade on behalf of clients, would you want to continue to trust the current U.S. regulatory system to safeguard your money? Why not go to say, Canada, where regulators appear to take their jobs more seriously and trade there? After all, Canadian customers of MF Global didn't lose a penny.

That's what the domestic futures exchanges and brokerage firms are facing. A gradual and perhaps persistent loss of business to someplace where traders feel assured about the safety of their funds. And, many small traders are simply giving up trading futures at all, believing the regulatory authorities are incompetent and the brokerages too crooked to deal with.

Now, I'm imagining such an outlook migrating to people holding stocks, bonds, and mutual funds at brokerages and mutual fund companies. I'm even imagining that outlook infecting regular checking and savings account holders at banks. It may already be happening in Europe in countries such as Italy and Greece where wealthy people seem to be shifting their money to safer banks in Germany or even outside of the Eurozone altogether.

These types of fears have a way of taking on a life of their own and spreading all of a sudden across the globe. I've mentioned before that Nicole Foss, writer for the financial commentary site The Automatic Earth, has said that liquidity and confidence are the same thing. If I lose confidence that my investments and cash in brokerage accounts and bank accounts are safe for whatever reason, then I will sell my holdings and withdraw my funds moving them to where I think they will be safe. If enough people do this, liquidity dries up as everyone heads for the exits at the same time. There are not nearly enough buyers to handle the sell orders in various markets. And, if people withdraw money from banks, the banks must quickly find some other source of liquidity than customer deposits. Such liquidity problems are already appearing at banks in Europe. And through it all, it will not matter whether investor fears are actually justified.

As the prosecutions of financial malfeasance rise, as the revelations of double dealing and outright theft abound, as the ability of European, American and Asian authorities to calm markets is eroded, the intersection of incompetence and unscrupulousness is poised to fling the global financial system into the dark unknown. These kinds of complete meltdowns have occurred in individual countries with disastrous results; Argentina comes to mind. But a grand failure of this sort on a global scale was only really hinted at in 2008. That's how bad it could be next time.

Sunday, December 11, 2011

Deconstructing "ethical oil"

When I stumbled across the site EthicalOil.org recently, I thought there was a small chance that it was a parody. And, it turns out that the site reads like a parody in some places even though I am certain that the owners are dead serious.

You see, the site is a defense of the Canadian oil sands industry. The argument it makes is that because human rights standards are much better in Canada than in many other oil exporting nations, Canada should be considered a more "moral" source of oil. In fact, the oil from the oil sands is touted as a "fair trade choice."

Once I'd read through the site, it was hard to imagine why the oil sands industry would even want it online. If these people were working for me with the express mission of defending the oil sands, I would fire them. Let me explain why.

First, the site claims to be based on a book called Ethical Oil: The Case for Canada's Oil Sands. At the bottom of the EthicalOil.org home page the book is described as follows:

In Ethical Oil, Levant [the author] turns his attention to another hot-button topic: the ethical cost of our addiction to oil. While many North Americans may be aware of the financial and environmental price we pay for a gallon of gas or a barrel of oil, Levant argues that it is time we consider ethical factors as well.

I am certain you are now scratching your head thinking you could do a better job of arguing the case than that. Since when, I hear you saying, did things financial and environmental stop being moral issues? That's strike one.

But the embarrassment has only begun. A set of rotating stories under "Featured News" includes a photo of two burka-clad females in front of the White House holding a hand-lettered sign which says "Stop tar sands, Stop Canada, Americans4OPEC.com." This strange scene seems contrived, and it is. The accompanying text reads as follows:

Americans4OPEC: Blame Canada!
Earlier today, I snapped a few photos of Americans4OPEC, which today joined the anti-Keystone XL protests outside the White House. Here’s one of the photos and the group’s press statement. You can visit their website at Americans4OPEC.com

Americans4OPEC statement (sic), which is available on their website:

"For more than 40 years, we Americans have powered our businesses, fueled our cars, and made our lives more comfortable with the help of OPEC oil. We think that special relationship is worth protecting..."

This is the site's attempt at satire (and it's also intentionally misleading). After reading the story or clicking through to the Americans4OPEC site, if you haven't figured out that the burka-clad protesters aren't real and that this is a satire, a note in small type at the bottom (if you make it that far) will tell you that "Americans4OPEC is not a real organization, but a satire created by EthicalOil.org to highlight the choice Americans now have."

Okay, in order for a satire to work, you don't really want to tell the reader up front that what he or she is reading is a satire. You want the reader to figure this out; it's part of the fun. On the other hand, a satire, to be effective, really ought to be funny. This one isn't. Strike two!

Far more insidious is the confusion this site sows about the label "ethical." We might consider the mere purchase of certain products or services as unethical. Or we might consider the conditions under which a product is grown, mined, manufactured, or traded, or a service rendered as unethical.

For example, we might consider the purchase of African ivory as unethical. (It also happens to be illegal.) We might also consider it unethical to eat bluefin tuna--which is highly prized in raw fish dishes such as sushi--because the species has declined so much due to overfishing.

However, we don't say that the purchase of coffee is in and of itself unethical. We now sometimes say that the terms of trade for the coffee growers is often unfair and therefore unethical. And, this accounts for the growth of fair trade certified coffee. The feeling is that the grower ought to get more of the proceeds from his or her coffee than international trade arrangements and powerful food companies have provided in the past.

Obviously, the argument being made by EthicalOil.org is that Canadian oil from the oil sands is more ethical because of the conditions under which it is produced which exhibit higher concern for human rights than in many other exporting countries. And, now we see why the authors of the site do not wish to talk about environmental aspects of the oil sands. Because to do so would force us to include the first ethical category in our discussion: namely, whether it is moral for us to consume increasing amounts of oil or even any at all given the implications for pollution and climate change.

But let's accept for a moment that we should limit our discussion to the relative human rights records of various regimes which export oil. If we buy oil from Canada, or at least refined products made from oil produced in Canada, should we feel better about ourselves? Not particularly, would be my answer. The key fact about tradable oil is that it is fungible. It can be moved virtually anywhere in the world. If we don't buy oil from Saudi Arabia or any of the other regimes thought to be inimical to human rights, those regimes will simply sell their oil to someone else. None of it will go to waste.

The only way those regimes might be penalized is if total consumption worldwide slumped, driving prices down. But this would force us back onto the first ethical category: namely, that the most moral thing we could do is simply to consume a lot less oil. Naturally, the supporters of the site do not want to discuss this logical conclusion of their argument. (The site, however, unwittingly mentions conservation in one paragraph as a means to wean America off OPEC oil. So, the authors are unconsciously aware that reducing overall consumption is really the only way to reduce the perceived evils associated with oil use including that of rewarding oil-exporting regimes having poor human rights records.)

The argument for using less oil overall is simply rejected in the book upon which the site is based. Here's the conclusion to that book (available on Amazon for those who want to check it out without buying the book):

The world isn't throwing out the internal combustion engine anytime soon. In fact, in countries like India, China, and Brazil, the world is buying more cars than ever. So we're stuck with oil for a long time, whether we like it or not. The only question that remains is: if we have to produce oil, and we have to buy oil--and we absolutely must do both--whose oil should we do our best to support? Who can we trust to do it the most morally?

There can be no doubt: Canada does it best. We're an energy superpower. And we're an ethical superpower too, setting international standards for how we treat the environment and how we treat each other. And if our goal as moral citizens is to make the world a better place, then there is only one choice: to pump as much oil as we possibly can out of Fort McMurray. Pump and steam and dig and drill and get that oil out of the sand in any and every way we can. Every drop of oil from Alberta is one less drop from some fascist theocracy, or some brutal warlord; one less cent into the treasuries of Russia's secret police and al-Qaeda's murderers.

Canadian oil sands oil is the most ethical oil in the world, and the people who invest there, work there, and support the oil sands with their patronage and their encouragement should be proud. Whether they realize it or not, they are all, gradually, helping to make the world a more moral, humane, and better place.

Think about it. The action that will be the most moral is "to pump as much oil as we possibly can out of Fort McMurray." This is only moral if you limit your moral evaluation to the relative human rights records of oil exporters. Otherwise, it isn't. And, you must ignore the necessity of bringing down consumption worldwide to really force any pain on the aforementioned egregious exporters. This is hardly a compelling case. Strike three!

(There's actually a lot more to amuse you or befuddle you with its ineptitude on the EthicalOil.org site if you have the necessary inclination.)

While unlocking the oil in the oil sands is most certainly the carbon bomb for our atmosphere that its opponents say it is, to be fair, so is every other source of carbon fuel, including sources for supposedly "clean" natural gas. It is not so much that the Canadian oil sands are better or worse than other sources of fossil fuels, but rather that their exploitation is made inevitable by the way we live. If we don't like the oil sands, then we must build a society that does not require their exploitation. This is doable with the technology we have (but perhaps not with the politics we have). The originator of the "ethical oil" argument, however, tells us that it will be impossible to build such a society until very far into the future. He is wrong--dead wrong, I would say.

If this is the argument upon which "ethical oil" rests, then it is one of the most unethical arguments ever made. Believing such an argument or using it cynically to deceive others may condemn us to catastrophic and irreversible climate change. And, it will also prevent us from preparing for an orderly transition away from fossil fuels--a transition that may be forced upon us in the not-too-distant future.

Now how's that for ethics?

Sunday, December 04, 2011

Oryx and Crake comes to mosquito town

In Margaret Atwood's novel Oryx and Crake the brave new world of genetic engineering has devastated the human population. How this devastation comes about is explained in flashbacks that precede the opening scene. Naturally, the architect of this catastrophe thought what he was doing was a benefit.

What may seem like a benefit to society isn't always a benefit except to those who profit from it. So much has been written about the evils of genetically engineered food crops that it would be redundant to rehearse them all here. But what if the offending genetic technology were to be trained on a human problem that everyone believes ought to be tackled, namely mosquito-borne diseases?

The idea is to create wingless mosquitoes that can't get off the ground and so die practically in the place of their birth. That idea is now a reality. And, where it has been tested, both in and out of the laboratory, it has been a smashing success, bringing mosquito populations down by 80 percent in very short order.

That means that diseases such as dengue fever, yellow fever and malaria which infect tens of millions of people each year would be considerably reduced.

But as with any alteration in an ecosystem, you can never do just one thing. What will the unintended consequences of such mass eradications be? The writer of the article cited above does acknowledge that mosquitoes are part of the food chain and their decline could affect birds and fish. He says that could have consequences for pollination since birds are part of this process for some plants. He also suggests such eradications might open a niche for an even nastier creature.

But then he goes on to say that "this could be one of the most human-friendly modifications we could make to our world. And it would certainly be no worse for the environment than our habit of clear-felling forest areas."

So, there you have it. Humans are creatures who routinely affect the surface of the Earth and the biosphere on a massive scale, so why not this modification which seems so small and so humane? I take my response from Dr. Phil of television fame: "So, how's that workin' out for you?"

This is the same logic that has been used to justify genetically engineered (GE) food crops, and then fiber crops such as cotton and trees, and finally crops that produce pharmaceuticals. Each introduction was always a step forward for human comfort and well-being. Now, we have weeds which resist the herbicide that only a decade ago was supposed to be the great savior of the cash crop farmer by reducing the chemical, labor and financial inputs of those who planted crops that resisted the same herbicide. That herbicide known as glyphosate may now be altering the microflora in the soil in a way that leads to so-called "sudden death" of GE crops.

We have butterflies that die from the pollen of corn. We have rising farmer suicide rates in India where GE cotton that was supposed to increase yields instead fell victim to disease leaving farmers destitute. And, we now have the specter of genetic contamination of food crops with genes from plants grown in the open to produce pharmaceuticals. Would you like a little insulin with your corn flakes?

I have no doubt that this new technique for controlling mosquito populations will spread. It seems as if it will be safer--for humans at least--than chemical sprays and more effective than bed nets. If this method of eradicating pests works well, where will we draw the line? Shall we rid ourselves of rats in cities? Seems like a good idea. How about loathsome raccoons who love our garbage and can carry rabies? Maybe you're feeling a little queasy about that one. Why not get rid of coyotes which destroy so much of our livestock each year? But wouldn't that upset the normal predator/prey balance for other species as well?

The effects of this type of mosquito eradication on local ecosystems may indeed be minor. But, there's really only one way to find out. Try it on a large scale in a lot of places. And, that's what scares me!