Prof. Jayanth R. Varma’s Financial Markets Blog

A blog on financial markets and their regulation

Monthly Archives: January 2018

Regulation as Pigouvian stealth taxation

“Regulation is stealth taxation,” said US President Donald Trump at Davos yesterday. Can this taxation be Pigouvian, and can this stealth taxation be a good idea? That is the claim in Turk’s thought provoking paper “Securitization Reform after the Crisis: Regulation by Rulemaking or Regulation by Settlement?”

Turk argues that:

  • The enforcement actions (and multi-billion dollar settlements) against large financial institutions relating to their securitization activities

can been seen as imposing a Pigouvian tax on the specific market externality associated with securitization, and therefore come surprisingly close to a first-best policy intervention.

  • The statutory rulemaking process established under the Dodd-Frank Act

missed the mark because it was premised on a flawed theory of the role that securitization played the crisis, which emphasized traditional notions of fraud rather than poor risk-management.

  • However, the more informal Regulation by Settlement was much more effective.

It appears to me that there is no convincing evidence that securitization imposes large negative externalities requiring a Pigouvian tax. On the other hand, there is somewhat more evidence that banking creates large negative externalities, and Basel 3 is a kind of Pigouvian tax on banking. This Pigouvian taxation has also happened by stealth in the name of risk reduction.

We should worry about the knowledge deficit and the governance deficit in these exercises in stealth taxation. Regulators probably think that they have calibrated the Pigouvian tax correctly; but this is more likely to reflect conceit than genuine expertise in this field. Even if the expertise is granted for the sake of argument, the governance issue remains: can taxation be delegated to unelected regulators?


Financial Crisis and Response History

About a month ago, the US Federal Deposit Insurance Corporation (FDIC) published a 278 page document entitled “Crisis and Response: An FDIC History, 2008–2013.” It is a quite sanitized history compared to the excellent accounts of the crisis that came out many years ago (especially the books by Hank Paulson and Andrew Sorkin). Yet, I found that there was much of value in the FDIC book. There is of course a wealth of official and authoritative data, but there are also many interesting insights from the perspective of the regulators dealing with it in real time.

I wish Indian regulators could publish something similar about the various crises in Indian financial markets covering say 1990 to 2010 – the Harshad Mehta scam of 1992, the vanishing companies of 1995, the Ketan Parikh episode (especially the fate of the Calcutta Stock Exchange), the UTI Unit 64 bailout, Global Trust Bank, and Satyam. If the report of the Financial Crisis Inquiry Commission (FCIC) in the US did not affect the ability of the FDIC to publish their history, there is no reason why the reports of the Joint Parliamentary Committees (JPCs) should be an obstacle for the Indian authorities (RBI/SEBI/MOF/MCA) to publish their accounts of these episodes.

Why Intel investors should subscribe to the Linux Kernel Mailing List or at least LWN

On January 3 and 4, 2018 (Wednesday and Thursday), the Intel stock price dropped by about 5% amidst massive trading volumes after The Register revealed a major security vulnerability in Intel chips on Tuesday evening (the Meltdown and Spectre bugs were officially disclosed shortly thereafter). But a bombshell had landed on the Linux Kernel on Saturday, and a careful reader would have been able to short the stock when the market opened on Tuesday (after the extended weekend). So, -1 for semi-strong form market efficiency.

Saturday’s post on LWN was very cryptic:

Linus has merged the kernel page-table isolation patch set into the mainline just ahead of the 4.15-rc6 release. This is a fundamental change that was added quite late in the development cycle; it seems a fair guess that 4.15 will have to go to -rc8, at least, before it’s ready for release.

The reason this was a bombshell is that rc6 (release candidate 6) is very late in the release cycle where only minor bug fixes are usually made before release as version 4.15. As little as 10 days earlier, an article on LWN stated that Kernel Page-Table Isolation (KPTI) patch would be merged only into version 4.16 and even that was regarded as rushed. The article stated that many of the core kernel developers have clearly put a lot of time into this work and concluded that:

KPTI, in other words, has all the markings of a security patch being readied under pressure from a deadline.

If merging into 4.16 looked like racing against a deadline, pushing it into 4.15 clearly indicated an emergency. The public still did not know what the bug was that KPTI was guarding against, because security researchers follow a policy of responsible disclosure where public disclosure is delayed during an embargo period which gives time to the key developers (who are informed in advance) to patch their software. But, clearly the bug must be really scary for the core developers to merge the patch into the kernel in such a tearing hurry.

One more critical piece of information had landed on LWN two days before the bombshell. On December 27, a post described a small change that had been made in the KPTI patch:

AMD processors are not subject to the types of attacks that the kernel page table isolation feature protects against. The AMD microarchitecture does not allow memory references, including speculative references, that access higher privileged data when running in a lesser privileged mode when that access would result in a page fault.

Disable page table isolation by default on AMD processors by not setting the X86_BUG_CPU_INSECURE feature, which controls whether X86_FEATURE_PTI is set.

As Linus Torvalds put it a few days later: “not all CPU’s are crap.” Since it was already known that KPTI would degrade the performance of the processor by about 5%, the implication was clear: Intel chips would slow down by 5% relative to AMD after KPTI. In fact, one post on LWN on Monday evening (Note that Jan 2, 2018 0:00 UTC (Tue) would actually be late Monday evening in New York) did mention that trade idea:

Posted Jan 2, 2018 0:00 UTC (Tue) by Felix_the_Mac (guest, #32242)
In reply to: Kernel page-table isolation merged by GhePeU
Parent article: Kernel page-table isolation merged
I guess now would be a good time to buy AMD stock

The stock price chart shows that AMD did start rising on Tuesday, though the big volumes came only on Wednesday and Thursday. The interesting question is why was the smart money not reading the Linux Kernel Mailing List or at least LWN and getting ready for the short Intel, long AMD trade? Were they still recovering from the hangover of the New Year party?

Madness on both sides

Forbes India has an article on Bitcoin in the January 5, 2018 issue. It has the following quote from me:

Which is more crazy: That bitcoin has a market capitalisation of a couple of hundred billion dollars, or that 11 trillion dollars of bonds are trading at a negative yield, which means that people are lending money with the full knowledge that they will not even receive the full principal back let alone earn any interest? After the global financial crisis of 2008, many feel that the actions of central bankers have been reckless, and it is no wonder that these people are attracted to a currency that is not subject to the whims and fancies of central bankers. There is madness on both sides (fiat currencies of advanced countries and cryptocurrencies) and it is best to view both with equal detachment.

This is not the first time that I have stated the view that virtual currencies are a response to bad things happening in the real world (see for example, this blog post from October 2017).