Each Sunday I compose a list containing the most thought-provoking and interesting content I’ve consumed during the past week. Primarily as a way to keep inventory of material that influenced me and my way of thinking.
Papers/Notes
Risk Update: February 2024 – Where’s the Risk? by Convex Strategies.
Ok, enough already, you don’t have to beat us over the head. We believe that balance sheets will not return to past levels of normal size. Not all the troops are going to be withdrawn. That gives us at least one clear answer to ‘who’s going to own the 40?” The central banks, again. Financial repression. But what else are they telling us? A couple of pretty significant things. First up, ISDA, presumably on behalf of the big banks, issued the below letter to the full slate of bank regulators in the US; the Federal Reserve, FDIC, Office of the Comptroller of the Currency.
“To facilitate participation by banks in U.S. Treasury markets – including clearing U.S. Treasury security transactions for clients – the Agencies should revise the SLR to permanently exclude on-balance sheet U.S. Treasuries from total leverage exposure, consistent with the scope of the temporary exclusion for U.S. Treasuries that the Agencies implemented in 2020.”
SLR stands for Supplementary Leverage Ratio. It is the broadest capital requirement and is a measure of capital to total assets. It might better be referred to as a Gross Leverage Ratio. It counts, on the slimmest of capital requirements, even those sneaky 0% RWAs (Risk Weighted Assets). It was the one thing post GFC (Global Financial Crisis) that Basel rules implemented that actually made banks somewhat safer. As soon as it got tested, in March 2020, the Fed gave banks an exemption from it. The banks (assuming we consider the banks and their regulators as separate actors) now want the exemption made permanent. The letter makes it clear what is the relevant issue here.
“It is important that banks have capacity to absorb a continued high volume of U.S. Treasury issuance, with the market projected to grow to exceed $35 trillion in the next five years, as well as to facilitate access to cleared U.S. Treasury markets (including cash as well as repurchase and reverse repurchase transactions (together, “repos”) and related derivatives markets.”
Answer #2 to “who’s going to own the 40?” The banks, again. More financial repression.
For those that want to get into the weeds on the inner workings of a Sharpe World risk methodology this is truly a rare gift that puts it right out there. The gist of the ‘proposed rule change’ is to hardcode into the SEC’s rules, that OCC operates under, an existing OCC margin practice (thus outside the current rules). That margin practice is how they circumvent their own margin requirements, ‘regular control’, during times of stress and high volatility, ‘high volatility control’, in order to prevent ‘procyclicality’. At least that is their opinion.
“OCC has established a proprietary system, the System for Theoretical Analysis and Numerical Simulation (STANS), that runs various models used to calculate each Clearing member’s margin requirements. One of the OCC’s margin models generates variance forecasts for the returns on individual equity securities, the result of which OCC then includes as one of the inputs to the margin calculation. As discussed in more detail below, OCC has observed that this particular model may produce results that are “procyclical,” which means that changes in margin requirements produced may be positively correlated with the overall state of the market and, if not appropriately addressed, could threaten the stability of its members during periods of heightened volatility. For example, procyclicality may be evidenced by increasing margin in times of stressed market conditions and low margin when markets are calm. A sudden, extreme increase in margin requirements could stress a Clearing Member’s ability to obtain liquidity to meet its obligations to OCC, particularly in periods of high volatility. If that Clearing Member subsequently defaulted, the resulting suspension and liquidation of the defaulting Clearing Member’s positions could result in losses chargeable to the mutualized Clearing Fund. Charging a loss to the Clearing Fund may result in unexpected costs for non-defaulting Clearing Members, stressing their ability to obtain liquidity to meet their own financial obligation in stressed market conditions.”
Read that carefully (and probably read it again) and think about the supposed role that central clearing is meant to play in the global regulatory regime of mitigating systemic risk. In other words, putting any one Clearing Member at risk during stressed environments, could put the whole system at risk, thus the regular margin methodologies need to be circumvented during times of stress. All Clearing Members are deemed too interconnected to fail, so we reduce their margin requirements, from what is the current rules, when stress and volatility are high.
This has been going on in some sort of ad hoc manner for some time already, with an unspecified subjective approval process getting run by what they dub the Market Risk Working Group (MWRG). Now, the OCC would like its regulators to hardcode the practice into their official rules. OCC has been implementing these “high volatility control settings” (reduction of margin requirements relative to “regular control settings”) practices for some time, implementing across both of what they term “global control settings”, across all or a class of risk factors, as well as “idiosyncratic control settings”, for individual risk factors.
They give some examples of the implementation of ‘global control settings’, one specifically to do with March 9, 2020, a day when the SPX fell 7.5%, where the MRWG approved a 50% weighting of the margin between regular control settings and high volatility settings which resulted in $20bio less margin being placed than the otherwise $100bio that would have been required (thus, would have been $40bio less if they had gone to the full high volatility control levels). Again, you heard that correct. Their solution to high stress/high volatility is to reduce the otherwise margining requirements.
Writings/Essays
Resist the Machine Apocalypse by Iain McGilchrist.
For reasons of survival, one hemisphere of the brain, the left, has evolved over millions of years to favor manipulation—grabbing, getting, and controlling—while the other, the right, has been tasked with understanding the whole picture. So conflicting are these goals that in humans the hemispheres are largely sequestered, one from the other. Our seeming ability these days to hear only what comes from the left hemisphere does not arise from the brain’s having changed radically in the last couple of centuries, though it is indeed always evolving. It’s more like this: You buy a radio set, and you soon find a couple of channels worth listening to. After a while, you find yourself listening to only one. It’s not the radio set that has changed; it’s you. In the case of the brain, it would not matter so much if we had settled on the intelligent channel—but we didn’t. We settled on the one whose value has nothing to do with truth, or with courage, magnanimity, or generosity, but only with greed, grabbing, and getting. Manipulation.
When we are functioning well, the right hemisphere tests against experience the left hemisphere’s theory about reality. But the left hemisphere’s vision of a lifeless, mechanical, two-dimensional, geometric construct has been externalized around us to such a degree that when the right hemisphere checks back with experience, it finds that the left hemisphere has already colonized reality—at least for those of us who lead a modern Western urban life. It finds a perfect simulacrum of the world according to the left hemisphere.
AI—artificial information-processing, by the way, not artificial intelligence—could in many ways be seen as replicating the functions of the left hemisphere at frightening speed across the entire globe. The left hemisphere manipulates tokens or symbols for aspects of experience. The right hemisphere is in touch with experience itself, with the body and deeper emotions, with context and the vast realm of the implicit. AI, like the left hemisphere, has no sense of the bigger picture, of other values, or of the way in which context—or even scale and extent—changes everything.
Apart from that nightmare, there is much to fear if we leave important decisions in the hands of AI. All decisions affecting humans are moral decisions. And morality is not purely utilitarian; it cannot be reduced to calculation. Every human situation is unique, its uniqueness arising from personal history, consciousness, memory, intention, all that is not explicit, all that we mean by the deceptively simple word “emotion,” all the experience and understanding gained through and stored in the body, all that makes us humans and not machines. Goodness requires virtuous minds, not merely following rules.
The prospect of cyborgs is grim as well. The best way to destroy humanity would be to hybridize it with machines. I do not call those who pursue this aim evil—they may simply have a failure of imagination or of understanding. But the aim itself is evil, if we can call anything evil. It can only further degrade our idea of what a human life is for, and it opens us up to totalitarian control.
If we are not to become ever more diminished as humans, we need to remain in control of machines, not come under their control. I am not talking about an apocalyptic future; I am talking about apocalypse now. We are already calmly and quietly surrendering our liberty, our privacy, our dignity, our time, our values, and our talents to the machine. Machines serve us well when they relieve us of drudgery, but we must leave human affairs to humans. If not, we sign our own death warrant.
The Distinctiveness of Human Aggression by Rob Henderson.
Wrangham states that self-domestication and morality are intertwined. Morality can only evolve among a species that is intensely sensitive to social disapproval. Negative moral judgement is extremely unpleasant for most people. For our ancestors, cultivating a good reputation was crucial. Troublemakers were ridiculed, ostracized and sometimes murdered. Today, we often feel self-conscious even in one-shot interactions with people we will never meet again. This doesn’t make rational sense, until you understand that early humans almost never interacted with anonymous strangers. For them, every social interaction held potentially life-threatening importance. We still carry this psychology with us today. We will endure minor and sometimes even extreme discomfort to avoid the negative judgement of strangers. Of course, morality has differed throughout time and across cultures. As the book states: “Society influences what we care about, but evolution has produced the fact that we care.”
Rethinking My Economics by Angus Deaton.
I am much more skeptical of the benefits of free trade to American workers and am even skeptical of the claim, which I and others have made in the past, that globalization was responsible for the vast reduction in global poverty over the past 30 years. I also no longer defend the idea that the harm done to working Americans by globalization was a reasonable price to pay for global poverty reduction because workers in America are so much better off than the global poor. I believe that the reduction in poverty in India had little to do with world trade. And poverty reduction in China could have happened with less damage to workers in rich countries if Chinese policies caused it to save less of its national income, allowing more of its manufacturing growth to be absorbed at home. I had also seriously underthought my ethical judgments about trade-offs between domestic and foreign workers. We certainly have a duty to aid those in distress, but we have additional obligations to our fellow citizens that we do not have to others.
Podcasts/Conversations
25 Sayings on Vol and Risk – Part 5 of 5, Alpha Exchange
Alice’s Adventures In Wonderland, In Our Time.
New Atheists and Cosmic Purpose without God (Zizek, Goff, Nagel), Philosophize This!
Long vol, short prediction models 