It's cold outside. This means that it must be time for another Russia-Ukraine gas row.

After months of happy talk in which both sides repeatedly claimed that there was no prospect of a repeat of the 2005-06 and 2008-09 imbroglios, a few days ago Gazprom CEO Alexei Miller raised the alarm:

Saturday’s WSJ carries a story lamenting the “death” of derivatives overhaul. Like Twain’s, rumors of this death are exaggerated. The derivatives “reforms” that passed the House before the holiday were not immaterial, even if they were not everything supporters were hoping for (and thank God for that).

The main complaint is that the OTC markets were not killed by forcing all trading onto exchanges, a la the Grain Futures Act of 1922 (how’s that for a model of modernity!?), and that customers were given some exemptions from a clearing requirement.

That noise you heard emanating from your chimney on Christmas Eve wasn’t Santa Claus’s sack full of gifts: it was an unlimited contingent liability, gifted to you, the taxpayer, hitting your hearth when you were sitting down to a holiday feast. Because a $400 billion limit just wasn’t enough.

And no, I’m not talking about the healthcare monstrosity passed by the Senate on Christmas Eve. I’m talking about the Treasury’s stealth, Christmas Eve-post market “announcement” that (a) Fannie Mae (FNM) and Freddie Mac (FRE) would no longer have credit lines of a mere $200 billion each, but would instead have unlimited lines from the Treasury, and (b) they are no longer under any immediate obligation to reduce their massive mortgage security portfolios.

Why is it that everything involving Russian business, and especially Oleg Deripaska, is murky beyond belief. In a battle of leaks with Reuters, Bloomberg reports that the Hong Kong Stock Exchange has approved a $2 billion Rusal IPO. Supposedly, however, the exchange imposed an unprecedented condition: That retail investors not be permitted to buy shares. But the Hong Kong securities regulator says that such a constraint is not permissible under the law. It also makes no sense. Even if they can’t buy at the IPO, what’s to prevent them from buying in the secondary market. Thus, the constraint would not protect retail investors.

John Helmer reports that there has been no formal announcement of the listing approval under the official protocols (i.e., a posting on the HKEx website). Moreover, exchange officials have been dodging questions. Thus, it is by no means clear that the IPO has truly been approved.

Igor Sechin is playing Lucy with the football yet again:

Russia will seek opinion from foreign investors on proposed changes to laws needed to unlock the country’s lucrative oil, gas and metals reserves and woo back companies scared off by a decade of resource nationalism.

Several of my academic articles are about competition between exchanges. The basic conclusion of these articles is that the network effects of liquidity make price discovery a natural monopoly. This means that a competition between two exchanges that do not attempt to “cream skim” uninformed order flow is likely to result in a winner-takes-all outcome, where all trading “tips” to a single exchange. If a new entrant challenges an existing market, given the stickiness of order flow, the winning exchange is likely to be the incumbent.

Jeremy Grant in Sunday’s FT provides a text-book example of the phenomenon. About a year ago a group of banks (UBS, Morgan Stanley (MS), Goldman Sachs (GS), Credit Suisse (CS), BNP Paribas (BNPQY.PK), Société Générale, Deutsche Bank (DB), Merrill Lynch and Citi (C)) that control a large fraction of order flow set up the Turquoise exchange to compete with the London Stock Exchange (LDNXF.PK). The banks hoped that the competition would force LSE to cut fees.

This article from the Moscow Times makes the point, by now familiar to readers of this site, that Russia’s inability to precommit not to expropriate and exploit foreign investors will hamstring its efforts to modernize:

But whatever hopes that Russia’s leaders might hold, the lines between commerce, state bureaucracy and law enforcement continues to be blurred. This makes it impossible to give investors any reliable guarantees. Even when Western corporations believe that they can still make a profit despite the lack of legal guarantees, injustices such as the death of corporate lawyer Sergei Magnitsky will cause many Western investors to think twice before they increase their Russian exposure.

Timmy! Geithner is joining the pitchfork-and-torches crowd. First, he blasts financial executive pay, and demands immediate changes:

"It is very important that we change the way these executives are paid, the form of compensation, this year,” Geithner said in an interview yesterday for Bloomberg Television’s “Political Capital with Al Hunt,” which is being aired throughout the weekend. “We have to end that era of irresponsibly high bonuses."

I’ve had several calls from reporters asking my opinion on the Lynch Amendment to Barney Frank’s derivatives regulation bill. For some reason, Forrest Gump pops into my head every time that question is asked. You know, the part where he says “stupid is as stupid does.”

As I am sure you all know, the amendment introduced by New Jersey representative Stephen Lynch, imposes restrictions on the ownership and control of the clearinghouses that the Frank bill will require the vast bulk of derivatives to be traded through. The amendment imposes similar restrictions on ownership of exchanges and swap execution facilities.

An argument is a connected series of statements intended to establish a proposition.

So sayeth Michael Palin, in the priceless Monty Python Argument Clinic Sketch. In his recent testimony before the Senate Ag Committee, CFTC Chairman Gary Gensler makes an unconnected series of assertions (many categorically untrue) intended to establish a proposition. Here’s the SWP annotated version:

Since last September, the government’s case for bailing out AIG has rested on the notion that the company was too big to fail. If AIG hadn’t been rescued, the argument goes, its credit default swap (CDS) obligations would have caused huge losses to its counterparties—and thus provoked a financial collapse.

The sites mentioned have quoted the part of the post which notes that unlike the other banks that received payments via the Maiden Lane III SPV, Goldman Sachs (GS) had sold protection on CDOs to its customers, and thus was potentially exposed to collateral calls from them. This means that with no cash flows from AIG (AIG) (or Uncle Sugar), Goldman would have needed to find a few spare billion lying around to meet its obligations–at a time of a market meltdown. (Think of how the market would have responded had Goldman not met the calls, or been observed scrambling around to do so.)

There is another reason to reject their analysis. It should be incumbent on one who justifies the existence of an externality to justify a particular policy to (a) identify the transactions costs that preclude internalization of this externality, and (b) demonstrate that their policy would create a net benefit, by, for instance, reducing transactions costs. AEFLS don’t even try to do this (another symptom of the Nirvana fallacy). And when one examines the particulars, it is highly doubtful that the costs of the purported externality are as large as AEFLS insinuate that they are.

“One of the huge lessons of our work over the last few years has been how shockingly stupid incredibly smart people can be,” said Davidson, who with Blumberg has been reporting on the crisis for nearly two years as part of National Public Radio’s “Planet Money” team. “That includes bankers, regulators and investors.”

Krugman is bashing Timmy! Geithner for his role in the AIG bailout. This poses something of a dilemma for yours truly. My sentiments parallel those of Henry Kissinger during the Iran-Iraq War: too bad they both can’t lose.

All snark aside, the SIGTARP report that has put Timmy! (oh, that was snarky–sorry) on the hotseat raises some questions that have been totally ignored over the debate over whether the Fed should have sent Goldman et al to the barber shop to get a haircut on the valuations of their swaps with AIG.

In his megalomaniacal effort to use the financial crisis as a Trojan horse to advance his campaign “on every front to increase the role of government,” Barney Frank is hellbent on fixing things that demonstrably didn’t break. Even under the extreme stresses of the crisis. Case in point: he wants to require clearing of foreign exchange derivatives transactions:

If it didn’t break, why fix it?

Yes, Russia can breathe easy. Even when it comes to corruption, it’s not the worst! Bad, tied for 146th out of 180, according to an average of surveys assembled by Transparency International, but not the worst. Indeed, not even the worst in the FSU–several ‘Stans are all well below Russia.

And I am sure that the “whatabout Ukraine” crowd is asking, well, “whatabout Ukraine.” Well, amusingly, it is tied for 146th place, although since ties (based on rounding to 1/10th of a point) are arranged alphabetically, and the lowest and highest scores for Ukraine are both higher than Russia’s, my guess is that without rounding Ukraine edged out its former Gulag cellmate.

Under either the House (Frank) or Senate (Dodd) bills, most derivatives would have to be traded on exchanges, and be cleared. (Clearing is a way of mutualizing default risks. At present, default risks in a particular contract are directly limited to the buyer and seller.) (BTW, when you hear “Frank and Dodd” do you think Fannie Mae and Freddie Mac? I do. Does this inspire confidence? Self-answering question.) These efforts are strongly supported by Treasury Secretary Timothy Geithner, CFTC head Gary Gensler, and SEC head Mary Shapiro.

That border is very, very busy today. Indeed, so much is happening there that it is difficult to keep up. In the aftermath of the financial crisis, Congress and regulators are beavering away on laws and regulations that will completely reshape the organization and regulation of financial markets, and especially of the area of particular interest to me–derivatives.

I welcome Gillian Tett’s recognition that clearing is not the silver bullet–or the “magic wand”–that will make financial crises a thing of the past. This bit is particularly spot on:

What is notable about the reform debate this year, is that there has been remarkably little public discussion among politicians - or among regulators - about how to guarantee that any future clearing house will be strong enough to withstand future shocks.