Letter-128: What the Clintonians should be doing

“Darkness cannot drive out darkness; only light can do that. Hate cannot drive out hate; only love can do that.”

-- Martin Luther King, Jr, 1957

“Behold, I send you forth as sheep in the midst of wolves: be ye therefore wise as serpents, and harmless as doves.”

-- The Gospel of Saint Matthew; 10:16

Update on November 14th: Mr Trump calls for less violence, less fear and more calm.  “I am so saddened to hear that. And I say, ‘Stop it.’ If it-- if it helps. I will say this, and I will say right to the cameras: Stop it.” http://abcnews.go.com/Politics/donald-trump-tells-protestors-dont-afraid-calls-hate/story?id=43513069 

Update on November 17th: President Obama supports the right to protest and does not condemn the violence, though it is now seen to be dissipating.  “I have been the subject of protests during the course of my eight years and I suspect that there has not been a President in our history that, at some point, has not subject to these protests. So, I would not advise people who feel strongly or are concerned about some of the issues that have been raised during the course of the campaign...to be silent. What I would advise...is that elections matter, voting matters, organizing matters...Do not take for granted our systems and way of life....” https://www.c-span.org/video/?c4631544/protesting-right  

Introduction. Other letters home have focussed on the following topics ad nauseam.

1. The Republican Party de-railed in 2015 and 2016.
2. Why I was an early (from April or May 2015) and resolute Never-Trump Republican.
3. Why I had difficulty with the candidacy of Senator / Secretary Clinton.
4. Why I voted as a Must-Stop-Trump Republican in favor for Senator / Secretary Clinton.
5. Why I mourn the Secretary’s / Senator’s defeat; why I accept the victory of Mr Trump out of deference to the Electoral College; as well as, what the frightened and shocked supporters of the Secretary / Senator can properly do now.

These essays are long and tedious due to precise thinking and research, not to mention their typically wordy pedantry; there is no need to re-state their contents. 

End the Violent Protests NOW. While protesting the dis-connect between the popular vote and the likely Electoral College vote is well within people’s political rights, the violence in places like Portland is harmful to the interests of the people who fear a Trump-Pence Administration. Such violence, I believe, likely reflects the presence of street-punks using the cover of these protests to do what they want to do: break things, attack others and indulge in apolitically anti-social behaviors. 

President Obama and the Secretary / Senator have been remiss in not condemning the violence and calling for the latter’s supporters to be calm.  Mr Trump should be calling for a halt to the intimidation reportedly occurring around the country. Beyond the necessity of public decorum in the exercise of democracy, such violence – perhaps tacitly sanctioned by people in power of the demoralized Democratic Party – is self-defeating.

The viral video of the racist assault on an older white man, presumed and not proven to be a voter of Mr Trump, may be one anecdote. Yet, if a picture is worth a thousand words, then this ugly video is worth a million (1,000²). These visual anecdotes and news coverage of violence could make the fears about Mr Trump’s victory a self-fulfilling prophecy. Consider the following scenario.

1. Violence alienates the moderate majority of Americans as well as, obviously, Mr Trump’s supporters and law-&-order conservatives; thus sympathy is lost for the supporters of the Secretary / Senator.
2. Only 20-30% of Americans own guns, notwithstanding there being more guns than people across the country. 
3. Assume that half of those who own guns keep only one fire-arm to protect the homestead.
4. The remaining people who own guns possess, on average, six-to-eight guns; these people are part of the N.R.A. voting base of Mr Trump’s candidacy.
5. At least a few of these multiple gun owners already belong to militias or, many more, to gun clubs easily transformed into militias.
6. Mr Trump decides to ‘punch back’ as he has been shown to do and indirectly signals that people need to “make America safe” with “muscular” neighborhood policing in which such 'neighborhood watches' supplement the established law enforcement apparatus.
7. Extremists within the voting base of Mr Trump heed that call.
8. Street violence erupts and violent protestors are wiped out since they do not have the guns.
9. Mr Trump now consolidates his power either through direct usurpation of it or by using intimidation to lock in an illegitimate re-election, with the possible repeal of the twenty-second amendment; failing that, locking in an authoritarian oligarchy.

The likelihood of this scenario – one among a host of speculative thought experiments – remains admittedly low. Nevertheless, it is possible, if the utterances of Mr Trump during the campaign indicate his course forward as Mein Kampf apparently did for Hitler. Simply said, one can not yet infer that Mr Trump’s harsh rhetoric was anything but the impulsive diatribes of a self-serving pragmatist. Keep in mind, however, that this is how fascism starts.

My concerns of six months ago were presented as an analogy; no longer a luxury afforded by the here-&-now. People ought to face this uncertainty with caution and with contingent responses at the ready. In any case, these violent protests and the widespread alienation they are likely to engender will weaken the protestors’ position by enervating any inclination of the incoming team of the President-elect to listen to their concerns.

A course forward. Peaceful, assertive protests can and should continue. The leadership of this opposition should be careful not to let these protests dissipate into a visceral but ephemeral phenomenon. After all, Mr Trump did not win a mandate, at least by the numbers. He will need to reach across political divides to accomplish anything.

With the popular vote – though skewed toward too narrow a voting base – in their pockets, people concerned with the loss of Senator / Secretary Clinton need to be smart about informal and publicly aired negotiations with the President-elect. There is a movement building on-line to lobby Electors to change their Electoral College votes on December 19th from Mr Trump to Senator / Secretary Clinton. 

This effort is most unlikely to succeed. And it would be less justifiable than the current situation since the action would be tantamount to revising the traditional rules of the game simply and nakedly to attain an outcome currently not favoured under them. Such a perceived end-run would widen the emotionally-charged division in the streets and likely precipitate more violence as the truly deplorable among the “deplorables” would be all too happy to strike back. 

Mr Trump’s menacing comments about the prospective reaction of his followers to a rigged nomination or election should have given all Americans, at least those committed to the democratic rule-of-law, reason to pause. His comment of Second Amendment supporters taking matters into their own hands were the Senator / Secretary elected was, and remains, genuinely disgusting and frightening. Yet, these two articles do a creditable job of rebutting this proposition of inducing last-minute switches in Electoral College votes:

• http://www.vox.com/policy-and-politics/2016/11/11/13588048/electoral-college-petition-clinton-trump; and,
• http://www.snopes.com/2016/11/11/the-electoral-college-and-the-popular-vote/.

In fact, in several key states, an Elector who does not vote for Mr Trump, as the winner of that state, will simply be removed and replaced by someone who will. Nevertheless, this idea of seeking to intervene into the Electoral College voting process contains the seed of valuable activism. In laying out the following suggestion, the underlying assumption here is that Mr Trump is a bully and very defensive one at that. 

At least in school-yards and on the streets, bullies and punks tend not to target those who appear ready to resist. Mr Trump has displayed a tendency to punch back from the safe distance of the speaker's podium or insulated by the social media. We have yet to see him overtly call for violence. So the way to push back is artfully. That means peaceably, with maximum decorum, and with an evident respect for the rule-of-law.

That push-back will get the President-elect’s attention and, hopefully, will not give him cause to punch back. This position is one of negotiation, a process Mr Trump understands very well as a businessman. The message will also appeal to Americans’ higher instincts. So, by using the Electoral College voting sessions on December 19th as ideal pressure points for negotiation:

• set up rallies at the State Capitols of as many of the thirty states that Mr Trump carried as possible with a particular focus on the key states with close popular votes.
• make sure to place articulate and presentable people in the audience of the electoral college voting session in each state that permits public access to the proceedings;
• have well-respected organizations like the N.A.A.C.P., A.C.L.U., the Southern Poverty Law Center and, if available, more centrist organizations transparently sponsor and finance these events;
• cooperate with law enforcement to assure civility and turn over to the police any violent protestors or others displaying aggressively anti-social behaviors (as precursors to violence);
• distribute professionally written and non-combative pamphlets making the case that Mr Trump is not fit for the Presidency and that people’s rights are at stake; as well as,
• publicly thank the Electors for being open to considering the views the anti-Trump people and endorse the eventual vote cast by the Electors, whatever it is.

Below are the eight targeted states on which this coordinated rally ought to focus. As a housekeeping point, a ‘faithless Elector’ is one who switches his or her vote away from the candidate to whom (s)he is pledged to vote; in this case to Mr Trump.

Target State	Electors	Faithless  Consequences
Arizona	11	None
Florida	29	Unspecified
Georgia	16	None
Iowa	6	None
Michigan	16	Removal; replaced
North Carolina	15	$500 fine; replaced
Pennsylvania	20	None
Wisconsin	10	$1,000
Total	123
42 of 123 (⅓) Electors must switch their votes from Mr Trump to Secretary / Senator Clinton

Conclusion. As stated above, no Electoral College votes will change (nor should they). This public and orderly assembly, however, will articulate the interests of the aggrieved without provoking further conflict. The significance of this losing battle is that it establishes a platform to pressure the new President’s policies. 

Why? 

Because, by focussing on these eight states, these rallies will be big news. Additionally, this lobbying platform will galvanize a source of public accountability toward Mr Trump, his temperament, his election, his people, his followers and his past. Finally, its civility will less likely harden opponents' positions by setting examples of courage with decency. After all, the United States is exceptional for being a nation founded on an idea rooted in human dignity:

• http://nedmcdletters.blogspot.com/2014/03/letter-96-is-american-exceptionalism.html; and,
• http://nedmcdletters.blogspot.com/2014/05/letter-98-just-what-is-human-dignity.html.

Letter 127: the manic panic of Election 2016

"The only thing we have to fear is fear itself"

--President Roosevelt, 1933

"Holy sh*t!"

--Bluto, 1978

Introduction. This is not an analysis of what happened on Tuesday, the eighth of November. Truthfully, I have no idea why Mr Trump won the election any more than I have an idea of how he will act. Though not altogether surprised by the outcome, I am disappointed and, with breaking news reports, increasingly concerned less with Mr Trump than with his supporters.

After all, most demagogues are self-serving pragmatists and I believe Mr Trump will be the same. Nevertheless, one should prepare for the contingency of his usurping power at the expense of others or to lock in a permanency of power. That citizen preparedness gives Mr Trump the opportunity to try to “Make America Great Again” but reminds him that he exercises power on behalf of and granted by the people.

Is the Electoral College another Laureate Education or Trump University? One consequence of the results of which I remain certain is that the Electoral College will come under intense scrutiny. Though my preferred candidates won the popular vote in 2000 and 2016, each lost in the Electoral College. In 2000, the far better man, for whom I did not vote, went on to be a great President. While those incongruent outcomes were inconvenient to many at the time, the Electoral College deserves our support for two reasons.

• The Electoral College embodies the logic of our Federalist Republic.
• The Electoral College assures a wider base of governance.

The Federalist Logic. In this case, at least as I view it from past readings, the Electoral College represents the second key set of stake-holders (i.e., the individual states). The Constitution integrates two agreements: a unitary social contract across the citizenry to delegate enumerated powers to its elected government as well as a compact among the participating states.

The Federalist Protection. This discussion is a little longer. Although Mr Trump lost the popular vote, if one casually surveys the blue-versus-red map, Senator / Secretary Clinton carried only nineteen states, largely arrayed along the West Coast and the Boston-D.C. corridor. Arguably, this was the same base for President Obama in 2008 and 2012 with a few more states carried by the outgoing Chief Executive.

Aside from the racism I believe President Obama faced, one might conclude that much of the static that he received and the reason for the widespread repudiation of his policies lay in the fact that too narrow a demographic of the country agreed with them. In most years, a broader base would serve the wider interests in a more balanced manner. Obviously, 2016 was not one of those ‘other’ years.

My personal support for Electoral College reflects my upbringing, my neighbourhood growing up and the students with whom I went to high school. That is a ‘never forget’ attitude about the holocaust and, thanks to urbane high school teachers and very thoughtful parents, a concern that such a mass-murder might occur anywhere (as it has in Rwanda, Cambodia, Syria, Bosnia and elsewhere).

This other safeguard is one I wrote about in college when the anti-Mexican nativist rhetoric was frothing over for the first time. Back then (i.e., in the late 1970s) I argued that a demagogue theoretically could whip up an anti-immigrant frenzy, piling up super majorities in Texas, California, New York (due to a prejudice against Puerto Ricans), Arizona, New Mexico and Florida to carry the popular vote. 

That could happen with, according to the 1970 census, only one available to me at the time, if the demagogue carried 60% in those six states but, due to other proposals (infrastructure; re-industrializing) appealing to other voters less concerned about Mexicans, a respectable 47.5% in all the others. If only the popular voted sufficed, he would win with 51% of the popular vote and could then try to usurp the power to kill off the Mexicans. 

In the Electoral College, however, that demagogue would only get 139 Electoral College votes (about 25% of the number of Electors per state in 1976). So, to quote that great mid-century American philosopher, Dick Martin, 'You bet your sweet bippee' I want to keep the Electoral College! 

The galling irony of 2016 remains the fact that this protective mechanism has landed a demagogue into office who has made Mexico his private political piñata. A quick check of the above-detailed scenario with 2016 statistics would yield a popular vote majority – in line with that of the Secretary / Senator on Tuesday evening – with 55% of the seditious-six and 48% of the other forty-four states and D.C. voting for the demagogue.

One could argue that the slight up-tick in the ‘etc.’ states would reflect the diffusion of undocumented Latinos and, therefore, additional friction in states like Colorado, Nevada, New Jersey or Illinois. In the Electoral College, that demagogue would gain only 167 votes (as opposed to 368 for the opponent who lost the popular vote).

Graduating Class of 2016 of the Electoral College. Barring the unlikely scenario of at least forty-two electors ‘pledged’ to Mr Trump deciding to switch to the Secretary / Senator, the President-elect will be inaugurated in roughly two months on the twentieth of January 2017. This prospect is understandably engendering anxiety among minority segments who have received open protection from the Administration of President Obama.

While the future appears to be darkening, people are not powerless. The sense of doom descending upon so many people is warranted but disproportionate. I am reminded of two things a brilliant German diplomat said to a room full of Pashtun Elders in Afghanistan. That this urbane and soft-spoken man had the courage to walk into that room, without armed guards, instantly earned the respect of his armed audience.

1. “We do not need to like each other, trust each other or even respect each other. We merely have to work together.”
2. “Please give me your pencils.” The Elders, mystified, coughed up a dozen or more. “You say you can do nothing to stop the Taliban?” The audience nodded upon hearing the translation. “Well, I bet I can break all these pencils and the strongest among you can not.” The Pashtuns almost laughed, looking at the diplomat’s diminutive stature. “Come on, the strongest amongst you come up here and try to break these pencils.” A tall, burly fellow, who could lay waste to the short pudgy European proceeded to the front of the room and took the pencils; try as he might, he could not break the pencils. Finally the diplomat held out his hand and collected the pencils from the sweating Afghan. “Now, I will break these pencils that this gentleman could not.”

There was suppressed laughter and evident disbelief across the room. The diplomat took the pencils and proceeded to break one at a time. By the third pencil, the Elders were laughing and cheering. They were empowered. Since most Afghans are ‘less educated’ (i.e., illiterate), lasting eloquence comes through imagery.

The point was taken: one-off, scattered resistance would do little to stop Taliban infiltration. A concerted effort by standing together might not keep the militants out of the village, due to ancient customs, but it would keep the guests quiet. In the case of a Trump Administration, networks of potentially targeted groups can integrate peacefully to deter unfair treatment.

Conclusion. This election may be the opportunity American governance has been awaiting to split the voting electorate up into three general parties: liberal (i.e., traditional Democrats); conservative (i.e., traditional Republicans); and, Centrists (i.e., moderates of both parties). In many cases, the presidential election would end up with the members of the Electoral College negotiating who becomes President.

Since they would hold the balance of power, the Centrists would side with the Democrats, with a moderating influence of course, during periods of progressive growth or change. They would side with the Republicans, with that moderating influence, when the mood called for consolidating changes to make them sustainable or, in rarer cases, to scrap ill-advised innovations and start over.

This dream scenario is workable but is a long way’s off, if ever, from fruition. In the here-and-now, certain groups have reason to be worried. Personally, I believe that nothing terrible is going to happen thanks to our institutional constraints laid out under the Constitution, chiefly the weak Executive and the implicit right to revolution against tyranny. 

What is important here is not to react but to bring civil pressure pro-actively, visibly and contingently. Doing so peacefully is, I remain convinced, the most effective way to persuade Mr Trump against keeping some of his pestilent promises.

Example of the mechanics in action. Many people I know have felt that the extensions of political rights and protections to the LGBTQ community were too much, too soon. For my part, to protect our gay and transgender brethren, moderate Republicans, together with humanists and moderate people of faith, will need to seek out their more liberal counterparts. 

Together, this informal coalition can push back – through orderly protests, petitions, letter-writing campaigns to Congress and the White House – on the future President Trump not to eviscerate gains in civil rights. This group can also contest the policy assertions of the religious right, actively questioning through a national audience what would Jesus do were He standing in front of a gay married couple. 

Similar coalitions need to stand up to protect the rights of Muslims, Mexicans, women and blacks. These coalitions sound difficult to build but just look at the success of I.S.I.S. in building a bloody coalition of radical jihadists from all over the world through on-line recruitment. Such grass-roots civil resistance may seem impossible to build. One need look no further than the baby-boomers of two generations ago.  

Those ‘effete intellectual snobs’, as criticized then as millennials are today, brought down a régime waging a terrible war in Indo-China. These ‘progressive’ coalitions, though I view them more as American than as political, must take extra care not to admit violent elements (e.g., those calling for the murder of police officers) into their fold lest they lose credibility with moderates across the country and provoke Mr Trump to 'punch back'. 

Letter 126: Thoughts on the 2016 Election (¡as if anybody REALLY cares what I think!)

“This election is incredibly important to the future of our nation, and we, the future of this country, need to have a say in who is representing us and making decisions on our behalf.”

-- The Vermont Cynic; November 2nd, 2016

“As a citizen, you need to know how to be a part of it, how to express yourself - and not just by voting.”

-- Justice Sandra Day O’Connor

Choosing Senator / Secretary Clinton was not easy; voting for her was. The choice was never one of picking the candidate of one of the two major parties; Mr Trump was unfit for the office and responsible for very ugly personalities and behaviors during the campaign (http://nedmcdletters.blogspot.com/2016/04/letter-116-time-to-toast-these-crumpets.html). Additionally, the Libertarian ticket of Governors Johnson and Weld complicated things as they represented a choice consonant with my personal politics as a Republican. My hesitation always boiled down to certain basic questions involving the Senator’s / Secretary’s character:

• a conflict-of-interest between then Secretary of State Clinton and the Clinton Foundation;
• the prospect of President Bill Clinton being back in the White House; as well as,
• anecdotal evidence that Senator Clinton had been too close to the banks principally responsible for the crash of 2008.

Other questions, outside of those of character, included those of lasting health-care reform, the economic prisoners’ dilemma in trade policy as well as an overall lack of private sector experience or expertise in business. Notwithstanding my evident pretension to intellection, I would like to address these BIG-3 issues briefly.

Conflict of Interest. The F.B.I. Director acted rightly in alerting Congress to the possibility of new evidence emerging with newly uncovered e-mails and then alerting those same leaders that his first letter had been a false-alarm. The revelation of foreign government contributions not disclosed to the State Department were disturbing but explicable; there simply was no evidence – at least yet – that these governments benefitted from these contributions. Nevertheless, any conflict of interest asserted againt Secretary Clinton and the Clinton Foundation paled in comparison to the interwoven interests of Vice President Cheney with Halliburton-Kellogg, Brown and Root a decade ago.

Much like the Senator / Secretary, Vice President Cheney apparently had unseemly ties to a private interest but no direct evidence of overt wrong-doing ever emerged. Since I had accepted the integrity of Vice President Cheney enough to vote for President Bush, I really had to cut the Secretary / Senator the same slack. Though I have yet to read it (and likely never will), the book, Clinton Cash, likely exposed some unsavory business dealings. The Senator / Secretary, however, did not participate in these transactions; her husband did.

President Bill Clinton back in the White House. This single prospect proved to be the largest potential deterrent for my voting for the Secretary / Senator for reasons I have mentioned in the past (http://nedmcdletters.blogspot.com/2016/04/letter-116-while-hill-pill-gives-me.html). Often, I have felt that voting for the Senator / Secretary would have been much easier had she divorced her husband. To me, at least, the ‘Bubba factor’ remained the single largest risk-factor with her candidacy. Nevertheless, Secretary / Senator Clinton remains an independently spirited woman with a mind – a great mind – of her own. Hopefully, her character will prove to be as great and independent.

What eventually tipped the balance in favor of the Secretary / Senator was the basic decency and integrity displayed by Chelsea Clinton. Ms Clinton, I have to believe, got that character formation from her mother, a life-long practicing Methodist.

Coddling the banks and other corrupted business interests. While the repeal of Glass Steagall Act and the subsequent collapse of the banks were not only disappointing but also disastrous, the Senator / Secretary was not present in the Senate for TARP II (though she probably supported it). My hope remains that Senator Warren persuades her to pursue a restoration of Glass-Steagall. On the trade front, the Secretary / Senator hopefully will be accountable to the supporters of Senator Sanders.

Sticking to the Positive. My vote was rather easy, in the end, due to certain plusses of, and supporters for, the candidacy of Secretary / Senator Clinton.

1. The Democrats gave the country a vision – “Stronger Together” – to vote for rather than a person, or Mexicans, to vote against.
2. Secretary / Senator Clinton emerged stronger from exhaustive and exhausting investigations dragged out for partisan reasons.
3. Senator / Secretary Clinton made it clear that her pro-choice stance did not imply that she deemed abortion to be an acceptable form of birth control.
4. Senator / Secretary Clinton did accept responsibility for the e-mail server and for the loss of Americans in Benghazi.
5. The Secretary / Senator had positives in her background, including work for the Children’s Defense Fund.
6. People whom I admire but are as diverse politically as President and Mrs George H.W. Bush (R) as well as Senators Sanders (l), Warner (R) and Warren (D) supported the Secretary / Senator.
7. The Clinton Foundation really has performed heartening work for the most part.
8. The Senator / Secretary brought a deep experience to the job.

Conclusion. The next right thing to do for the next right reason was for me to vote. Whether I had voted Democratic or Libertarian, I had faith that, no matter how flawed the Senator / Secretary might be, she was loyal to the Republic and the country could manage four-to-eight years under her leadership, no matter how tainted. Mr Trump, on the other hand, openly attacked our weakened democracy by demonizing people and claiming the electoral system had been rigged (http://nedmcdletters.blogspot.com/2016/05/letter-116-b-getting-historical.html).

Senator Sanders had a better claim to the rigging charge. That he did not press it said a lot about him and enough about Secretary / Senator Clinton. Hopefully, Senator Sanders will keep the Senator / Secretary intellectually honest should the American people elect her as President. The list of people arrayed against Mr Trump from within the G.O.P. was impressive and indicative of the principles compromised by this candidacy.

Letter-125: Old banking proposal from 2008

"Those who cannot remember the past are condemned to repeat it."

--George Santayana, 1906.

"Man's capacity for justice makes democracy possible; but man's inclination to injustice makes democracy necessary."

 --Reinhold  Niebuhr, 1944.

This is a re-print of a letter sent to President Bush in 2008. Though incredibly stilted, the discussion focusses on fixing the corruption of the derivatives market. On the banking side, the proposed course was simple. Bring back the Glass-Steagall to separate of the banks and investment banks with some additional parameters focussed on proprietary trading. 

To implement this proposal would require the express-bankruptcy resolution of the key 'culprit' banks with systemic risk. In the the interim, the Federal Reserve could run the ABA cash transfer system to administer the overnight lending system during the industry re-structuring.

==================

SUMMARY PROPOSAL for REFORM of CREDIT DERIVATIVES

Summary & Conclusion.  The credit derivatives markets – principally but not exclusively for credit default swaps – represent the accumulation, over a decade of active trading, of millions of over-the-counter (OTC) transactions.  These contracts act like credit insurance policies since pay-out patterns resemble those of bond insurance or options.  This brief thought-experiment identifies a simple solution to an emerging crisis. This solution will test political courage since it strikes at the heart of the current, albeit dysfunctional, credit derivatives market.  The success of this plan will not solve the credit crunch but will remove an ongoing cause for alarm, thus encouraging regulators to focus support on regional and community banks.  These reforms will not enmesh the Federal government in private markets in favor of a bold one-time intervention to set them right.  There are two key precedents underlying this problem-&-solution set: the London reinsurance spiral of the 1980s and the intervention led by the Federal Reserve after Long-term Capital Management Llc failed in the 1990s.

Background of the Credit Derivatives Market.  The credit default swap market tried to replicate the success of the earlier markets for interest rate swaps (e.g., fixed vs floating coupon rates) and options (i.e., caps and floors) over two decades starting in the mid-1970s. Like caps and floors, credit derivatives were contingent payments upon the occurrence of explicit events.  Like interest rate swaps, these derivatives referenced a notional and, for speculators, unowned security to fix the amount of contingent payments.  Credit derivatives sold by banks served as substitute guaranties of third-party bond or credit issuers (i.e., “reference parties”) for the benefit of derivative counterparties, usually other banks or mono-line bond or financial guaranty insurers.  Global money-center and investment banks warmed up to these instruments since they conferred steady intermediation fees without the capital burdens of traditional letters of credit (LOCs). 

To make a market in these OTC transactions, 20-30 financial institutions emerged and largely adapted transaction-specific documents to template agreements sponsored by International Swap & Derivatives Association (ISDA).  Since ISDA contracts basically covered a different class of trade for interest rate swaps and since various institutions had internal policies dictating idiosyncratic practices, credit derivatives trades were usually unique to the two counterparties.  Use of ‘long-form confirmations’, scheduled for replacement by reconfigured ISDA templates, entrenched the reliance upon OTC trading.  In ten years, credit derivatives mushroomed to $60+ trillion – as large as, or larger than, the global GDP – but were poorly documented among market-makers via long-form confirms.

The Current Predicament.  Largely unregulated, credit derivatives volume, as measured by notional principal, dwarfed the actual principal amount at risk by third-party reference entities.  Additionally, bond insurers entered the market by issuing one-off policies bound through special-purpose vehicles.  The multiples of notional-to-actual principal suggested the existence of conditions conducive to a spiral.  The London reinsurance market (LMX) had already experienced just such a spiral (http://www.elbornes.com/index.php?section=articles&param=19) in the late 1980s, leading to significant insolvencies on the Lloyds exchange.  Though traumatic at the time, this spiral was minor compared to the threat presently posed by the credit derivatives market.  In the LMX spiral, reinsurers laid off exposures to each other, often over ‘hand-shakes’.  Individual reinsurance loss limits were high enough to divide into discrete layers for sale to retrocessionaires (i.e., reinsurers of other reinsurers).  Premiums remained rich enough for several parties to extract fees over successive transactions. 

Thus reinsurers passed around the same risk several times over, eventually assuming risk they had previously underwritten and then retroceded without realizing the implications of doing so.  This spiral, when large catastrophe losses precipitated it, short-circuited the market and concentrated insurance losses among certain reinsurers beyond their abilities to indemnify, precipitating their insolvencies.  The credit derivatives market has created excess layers of coverage, subject to an LMX-like spiral.  Since a credit derivative contract typically indemnifies the default of a reference security, the terms of these not-quite-matching trades vary among the rapidly trading counterparties; only a minority of trades – i.e., the core market – involves end-users for actual credit exposures assumed.  Speculators have also penetrated the credit derivatives market in a search for profits from unexpected defaults or turn-arounds. 

In practice, market-makers execute large volumes of off-setting trade at razor-thin spreads.  Only recently have market-makers realized how vulnerable they are to a collapse of what is appearing to be a house-of-cards constructed on opaque financial transparency.  Market-makers have unknowingly – and negligently – re-assumed the very risks they off-loaded just a few trades ago.  Like the childhood game of musical-chairs, the music has stopped and frozen the market awaiting a credit indemnity spiral triggered by defaults of reference entities.  Downgrades of the credit ratings of market-makers are forcing them to post collateral, imposing large cash demands.  Most of these embattled market-makers are not insolvent (i.e., without the financial nutrition of capital) so much as they are illiquid.  Market-makers simply cannot convert their embedded wealth to cash in a timely manner. 

As with humans, financial institutions succumb more quickly to the lack of water than to the absence of food.  The inability of some market-makers to monetize illiquid assets has crippled them or hastened their demise.  Now the counterparties of the increasing number of defunct or paralyzed market-makers no longer have off-setting positions for some of their trades, requiring additional capital to cover a contingent and unhedged indemnity payment; these unexpected burdens are undermining the OTC market.  Limited interventions by the CBOT and others have slowed but not reversed this gradual melt-down.  With the hazards finally identified and appreciated, the solution becomes straight-forward: stop the spiral immediately; settle accounts; and, re-open the global market on a manageable scale.  The zero-sum game of private competition precludes any one, or several, of the market-makers from taking the initiative to extricate everyone from this predicament.  A decisive, if short-lived, intervention by financial services regulators remains the last option available to policymakers in the countries domiciling these troubled institutions.

A Simple Solution but a Bitter Pill.  There are 20-30 market-makers in credit derivatives that dominate the market, perhaps 80-90% or more of the of approximately $60 trillion of aggregate notional principal valued on a gross replacement basis; or  $30 trillion of two-way (i.e., symmetrically offsetting) trades.  The regulatory stakeholders overseeing these market-makers need to convene a summit with them, as did the Federal Reserve a decade ago when Long-term Capital Llc collapsed ten years ago.  These stakeholders must mandate, through moral suasion or (if necessary) regulatory coercion, the following actions:

• suspension of market-making activities pending a study by the stakeholders (essentially occurring right now);
• re-arrangement by market-makers of transactional data by reference entities, not counterparties, within 90 days;
• replacement of contract-specific terms by a universal definitions of credit events and standardized terms;
• netting out of exposures among market-makers by reference entities (not counterparties) with no differentiation recognized for unique contractual provisions (i.e., condense the spiral to the core  market exposure);
• formation of a ‘best-efforts’ (i.e., not guaranteed execution) cross-border credit derivatives exchange supported by cash and capital commitments from market-makers with contingent indemnities by the regulators;
• transfer to the global credit derivatives exchange of contracts carrying more than $10 million of actual credit exposure insured with 100 trades;
• future trades to be executed from the exchange or subject to 30% LOC credit enhancement;
• mandate of market-makers to issue LOCs covering 30% of core exposure ineligible for transfer to the exchange;
• requirement of end-users to support net notional principal amounts of their credit derivatives portfolios with credit enhancement LOCs issued at cost by their market-making counterparties equal to 30% of principal insured; and,
• issuance by central banks of short-term credit support lines, extendible for up to five years, to support newly issued LOCs and facilitate the transition of the OTC derivative trades to the traditional banking products.

Exceptions to be addressed include bond insurance policies for collateralized debt obligations (CDOs); small transactions of market-makers ineligible for inclusion on the proposed best-efforts exchange; and, exposures of non-market-making financial institutions (principally end-users).  These exceptional exposures can be backed by LOCs issued by TARP-supported or non-market-making banks supplemented by a second layer of credit support from the central banks.  This structure will absorb all loss scenarios except for the worst-case.  For example, with this structure, CDOs will be able to withstand a 30% or higher default rate followed by losses principal in line with historical experience.

=======================================

The Honorable George W. Bush

President; The United States of America

1600 Pennsylvania Avenue, N.W.

Washington, D.C. 20500

December 15, 2008

Attention          Mr Henry Paulson; Secretary of the Treasury

Re                    Proposed Solution to Credit Derivatives Spiral

Gentlemen:

First of all, permit me to wish you and your families’ holy days that are happy, joyous and free of conflict.  Secondly, I write you today out of a sense of thankfulness for allowing me the privilege of serving my country in Iraq after my banking career.  I would appreciate your support in working with a provincial reconstruction team in Afghanistan.

The primary purpose of this letter, however, is to make available to you a thought experiment That is a pedantic way of saying an outline reflecting experience in banking; strength in extracting actionable thinking points from volumes of information; and hope that a shake-out / melt-down in the credit derivatives market is one crisis we can avoid with relative ease.  Please refer to the two-page attachment that follows.

The current financial crisis – I prefer to think of it as a set of challenges – emerged over years of policies and practices, most of them sound.  If there is a crisis, it involves shoddy lending practices in a confined area of the market, obscured for a time and profited by securitization, and a liquidity trap created by fear.  The mortgage crisis, however, lies beyond my frame-of-reference. 

Credit derivatives do not; I became familiar with default-swaps, wraps and other grown-up tinker-toys.  This challenge has been waiting to happen but need not graduate to a crisis level.  The challenge is for you to take the initiative, bring in the other powers participating in the recent financial summit and exert American leadership in coordinating a uniform, highly coercive but short-term regulatory response to re-structure this over-the-counter market to allow it to digest and dispose of the overhang or exposure.

Successive trades among market-making counterparties referencing the same risks have layered the credit derivatives market with illusory exposure.  What has happened in this market is that fear stomped hard to deflate the financial soufflé created by this layered exposure; the challenge remains not allowing the casserole dish (the underlying economic foundation of the market) to shatter in the process. 

As market makers net out exposures based on the principal insured, credit derivatives will rationalize into an organized options market for hedging purposes.  The intervention basically imposes uniform terms on over-the-counter instruments to permit this netting.  Subsequent to that initiative, a self-regulating cross-border market can function with a light touch from government or international agencies.

President Bush, I opened this letter by saying that I am writing you out of gratitude.  It is also out of loyalty.  Your work will come to be appreciated in time.  Your legacy will be strong.  But there is a reason why Moses marched the Israelites through the desert for two generations.  Likewise, In Iraq and the Middle East, such a gradual assimilation of new values will take place.  It had to start some time in some way.  You had the courage to do it.

If you interested in my credentials for making the above-cited proposal, please contact me nedmcd@yahoo.com and I will be happy to forward my résumé and a make a case why I can lead this effort.  Secretary Paulson, I hope you find some of this thinking helpful.

Very truly yours,

Edward J. McDonnell  III, CFA

Letter 124: Climate Change as a Critical Issue

"The conquest of nature, in which the bourgeois [engineering] mind trusted so much, enriches life but also imperils it."

--Reinhold Niebuhr, 1944.

Introduction. This essay will come across as very pedantic to most people, including me. As I articulate my thoughts on climate change, I have to apologize for the stilted style of this letter. As a student of the humanities – primarily languages and political theory – I am not well equipped to discuss a scientific topic, particularly one as nuanced as climate change. My thoughts follow my reading of a long and thoughtful essay published by the American Institute of Physics, “The Discovery of Global Warming”, published in February 2016.

Précis of the Article. The article itself requires at least an hour of one’s time, carefully focussed. The summary supplied by the A.I.P. is long, too (https://www.aip.org/history/climate/summary.htm).  The article is worth the investment, especially for the uninitiated like me. In a capsule, then, this essay reviews the history of the hypothesis and research of the Greenhouse Gas Theory, dating back almost two centuries. The pace of research had been slow-going for a century or more due to the imprecision of measurement tools and the greenhouse theory being incidental to a ceaseless scientific quest to explain the ice-age.

The open-air tests of the atomic bomb during the 1950s and the power of computers in the 1960s re-focussed concern on the emissions of Carbon Dioxide (CO2) into the atmosphere and their possible effects on the wider ecosystem. As scientists better understand the complexity and interaction of different components of the atmosphere, together with absorption rates of CO2 by the oceans, the implications of a thermally imbalanced future now supersede the fascination with an icy past. Arguments against global warming persisted but the data confirming a scenario worse than anticipated overwhelmed them.

My view. To avoid dumping a lot of verbiage on people better informed than I, I will state my unscientific reasoning – though quite deferential to those minds far deeper than mine – as to why this issue needed to be addressed and debated seriously in 2016. From my perspective, one informed by reading philosophy and trying to pay attention to ethics, I submit the following propositions.

1. No matter who is right or wrong in general – and the timing of specific scenarios in particular – we know that the emissions of CO2 and other greenhouse gasses have accelerated exponentially over the last century.
2. Since the ecosystem for all living things, sentient or not, is delicate, dumping more and more CO2 indefinitely cannot confer long-term benefits for man and the lower species under his stewardship.
3. Using hydrocarbons profligately and dumping CO2 into the air heedlessly then becomes unethical at some point; current evidence points to crossing that threshold very much sooner rather than later.

That is my opinion, unscientific as it is. We face a matter of ethics, now. Assuming a significant risk of disrupting the delicate equilibrium of the ecosystem for the sake of our convenience and comfort becomes increasingly difficult either to justify or countenance. 

Additionally, insisting on irrefutable proof of the greenhouse effect will delay a response to a time when such counter-measures will likely be too late. Beyond the rarefied world of ethics and stewardship comes likely geopolitical consequences of confronting the possible, and increasingly probable, hazard of a greenhouse effect:

• locked-in poverty for poorer nations;
• permanent suppression of economic advancement of the global working class;
• competitive pressures forcing all competing economies to fall back on hydrocarbons; and,
• a marginalized impact of renewables.

To stanch the CO2 belch across the world means that developing countries like China, Russia, México, India et al. can no longer rely on cheap hydrocarbons to lock in pricing advantages. One can see why, quite easily, these nations are reluctant to forfeit an advantage that, after all, once aided the Western Powers (including Australia, Japan, New Zealand, Canada and the U.S.) to enjoy unheralded prosperity, often at the colonial expense of these same emerging economies.

Further, free-trade compounds this prisoner’s dilemma as developed countries become competitive once again when wages rise in developing countries. This on-shoring phenomenon will last only as long as it takes for the developing nations’ wages to depress once again to sweat-shop levels. Then workers in the developed countries will suffer a renewed suppression of earnings power as the on-shored companies gradually off-shore once again; this alternating of on-and-off-shoring will become a ‘double-dribble’ at the bottom by the bottom three billion.

The pressure to relax CO2 emission standards for economic reasons may overwhelm environmental ethics. Consequently, alternative trade arrangements, besides the free-fall of free-trade, may be necessary for nations to pursue policies aimed at stemming the dumping of greenhouse gases into the atmosphere (http://nedmcdletters.blogspot.com/2016/06/letter-121-uk-breaks-it-or-brexits.html). Such policies may well be viewed as acts of economic hostility by developing nations dependent upon cheap hydrocarbons.

The necessity of a concerted effort to render renewable energies viable will be, to re-use an old political term, the “moral equivalent of war”. Such renewables ought properly to include nuclear power, itself beset with challenges around safe disposal. Some use of hydrocarbons may be inevitable for the Navy, etc. Policymakers need to determine whether syn-fuels, including bio-fuels, sufficiently reduce CO2 emissions.

Rebutting the Rebutters. Most of the arguments I have come across seem to zero in on inconsistencies in the findings of proponents of the greenhouse gas theory. The logic seems to say that these exceptions belie the consensual theory, rather than prove the rule. There have been disturbing reports of greenhouse skeptics being hectored by members of a ‘politically driven’ consensus. Nevertheless, the convergence of several disciplines toward a uniform consensus places the burden of proof upon these skeptics.

Thus far, in my mind at least, the anti-greenhouse partisans have failed to meet that burden. While many argue that these skeptics are supported by hydrocarbon interests, that affiliation, however, does not suffice to discount their counter-arguments but does expose an irony. Pro-business perspectives base their practices and arguments on the ‘equilibrium’ established by the market-place. Yet these same people appear to be willfully oblivious to the delicate environmental balance upon which humanity itself depends.

Given the sensitivity to changes in initial conditions brought out in computer simulations and Chaos Theory, ignoring the possible fragility of such a systemic equilibrium over millions of years makes the skeptics look like wishful thinkers only too willing to play Russian roulette with the ecology that sustains all life. Of the many counter-greenhouse arguments I have heard informally, the two most compelling, for me a least, have been:

• the idea that a slight shift in the Earth’s orbital course around the Sun is likely to create a countervailing cooling of temperatures; as well as,
• the thesis that the drawing of conclusions from the study of that last sixty years of greenhouse data is akin to someone watching six seconds of a gridiron game and making inferences about what the rules are; who the teams are; what the final score will be; which team will win; as well as, how the rushing and passing statistics will break-down.

Almost two generations ago at college, one Economics Professor had us reading about the greenhouse effect while a History Professor cautioned us that a new ice-age was in the offing (in ten thousand years). The comparative timing of any fall-out from the former trumped that of the latter (i.e., centuries, at the most optimistic at that time, for the greenhouse effect versus millennia for any ice age). Subsequent research from other disciplines began to argue for a far more imminent impact. That is to say: any countervailing cooling from a change in the Earth’s orbit would be far too little, far too late.

The second argument about calling the football game in six seconds has an intuitive appeal to anyone acquainted with statistical testing and sampling. Yet this argument has broken down over the past generation as testing of air-bubbles in ancient glaciers has lengthened the sample from six seconds of one game to a whole season of sixteen games played by all thirty-two teams in the National Football League. That paradoxically newer, yet much older, evidence successfully breaks down this intuitive skepticism.