Kevin Drum - August 2010

Crop Circles on Wall Street

| Thu Aug. 5, 2010 1:36 PM PDT

You've all heard of the Mandelbrot set, right? It's the fractal image shown on the right. It looks pretty ordinary, but if you zoom in you start to see a lot more detail. Zoom some more, and there's even more detail. You can zoom forever, and you'll keep finding more detail no matter how fine a microscope you use, much of it surprising and unpredictable. (Try it!)

Well, it turns out you can do much the same with stock market trading charts. Take a look at the chart for a single day's trading and you'll see a pattern. Zoom in to a single hour and you'll see a different pattern. Zoom in again to a single minute, or a single second, and you'll see something different still.

So how far down can you go? Last year's "flash crash," which saw the Dow plummet nearly a thousand points in a few minutes, was widely blamed on high-frequency traders who use computer algorithms to execute trades at very high speeds, and that made some folks at Nanex curious about what was really going on. Alexis Madrigal tells the story:

Most stock charts show, at best, detail down to the one-minute scale, but Nanex's data shows much finer slices of time. The company's software engineer Jeffrey Donovan stared and stared at the data. He began to think that he could see odd patterns emerge from the numbers. He had a hunch that if he plotted the action around a stock sequentially at the millisecond range, he'd find something. When he tried it, he was blown away by the pattern. He called it "The Knife."

....High-frequency traders do employ algorithms to look for patterns in the market and exploit them, but their goal is making winning trades, not simply sending quotes into the financial ether....The algorithms we see at work here are different. They don't serve any function in the market. University of Pennsylvania finance professor, Michael Kearns, a specialist in algorithmic trading, called the patterns "curious," and noted that it wasn't immediately apparent what such order placement strategies might do.

Donovan thinks that the odd algorithms are just a way of introducing noise into the works. Other firms have to deal with that noise, but the originating entity can easily filter it out because they know what they did. Perhaps that gives them an advantage of some milliseconds. In the highly competitive and fast HFT world, where even one's physical proximity to a stock exchange matters, market players could be looking for any advantage.

Donovan calls these patterns "crop circles," and he gives them all names: Castle Wall, The Waste Pool, Depth Ping, Boston Shuffle, BOTvsBOT, etc. Most of them involve sending out thousands of quotes per second, and you can see them all here. If Donovan is right, this isn't even high-frequency trading, which is iffy enough. It's high-speed quote stuffing and market spoofing designed primarily to screw up other traders, something that John Bates, a former Cambridge professor and the CTO of Progress Software, calls "algorithmic terrorism." That's a wee bit melodramatic, but it's still a nasty look at what's happening in our financial markets these days. This kind of behavior is hardly new, but it's certainly gotten a lot faster and a lot harder to detect.

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Breitbart's Latest

| Thu Aug. 5, 2010 11:36 AM PDT

Meet Dr. Kevin Pezzi, the latest addition to Andrew Breitbart's stable of internet stars. Seriously. Click the link. You want to meet this guy. You can thank me later.

What They Know

| Thu Aug. 5, 2010 11:22 AM PDT

The Wall Street Journal is running a good series this week on privacy in the digital age called "What They Know." This is from their piece today on cell phone tracking:

Global-positioning systems, called GPS, and other technologies used by phone companies have unexpectedly made it easier for abusers to track their victims. A U.S. Justice Department report last year estimated that more than 25,000 adults in the U.S. are victims of GPS stalking annually, including by cellphone.

....There are various technologies for tracking a person's phone, and with the fast growth in smartphones, new ones come along frequently. Earlier this year, researchers with iSec Partners, a cyber-security firm, described in a report how anyone could track a phone within a tight radius. All that is required is the target person's cellphone number, a computer and some knowledge of how cellular networks work, said the report, which aimed to spotlight a security vulnerability.

The result, says iSec researcher Don Bailey, is that "guys like me, who shouldn't have access to your location, have it for very, very, very cheap."

If you don't want to be tracked and think you might be, remove the battery from your phone. That's what domestic-violence shelters do: "As soon as victims arrive at shelters run by A Safe Place, 'we literally take their phones apart and put them in a plastic bag' to disable the tracking systems, says Marsie Silvestro, director of the Portsmouth, N.H., organization, which houses domestic-violence victims in secret locations so their abusers can't find them."

More generally, though, what do they know? The answer is: a lot. Probably more than you think, and the Journal's series is a good reminder that if you care about privacy, you should care at least as much about the private sector as you do about the government. Beyond cell phones, the Journal uncovers plenty of other good stuff too. For example, here's a story about the skyrocketing use of browser cookies to track your movements across the internet, and here's a graphic that shows which sites are the biggest abusers. The winner? Dictionary.com, with msn.com and comcast.net not far behind. Wikipedia is the only site they surveyed that uses no tracking cookies at all.

There's plenty of other good stuff at the main site, including advice on how to avoid being tracked (or, at least, how to avoid being tracked as much). It appears to be 100% accessible to nonsubscribers and it's well worth checking out.

How is Obama's Record on Trade?

| Thu Aug. 5, 2010 9:41 AM PDT

Dan Drezner tallies up Barack Obama's record on foreign policy, and as usual he's pretty underwhelmed on the subject of trade:

3) Trade: Blech. Let me repeat that — blech. I understand that the administration is on barren political terrain when dealing with this issue. Still, the phrase "Obama administration's trade agenda" is pretty much a contradiction in terms at this point. The Doha round is dead, and the only trade issue that has the support of policy principals is the National Export Initiative — and you know what I think about that. Unlike the other three issues, the administration hasn't even bothered to put much effort onto this one — though the recent pledge to get the Korea-U.S. Free Trade Agreement (KORUS) ratified is promising. GRADE: F

I don't expect to make much headway with Dan on this subject, but I think he's all wet here for two reasons. The first is that "barren political terrain" he acknowledges. No president can reasonably be expected to put a ton of political muscle behind a lost cause, and major progress on, say, the Doha round, was pretty clearly a lost cause from the day Obama entered office. In the face of a catastrophic global recession, there was never even the slightest chance of gaining support either at home or abroad for any major trade initiatives, and it's simply not reasonable to expect Obama to put any energy behind it. Not only would it have gone nowhere, it might even have been counterproductive. Better to wait until the global climate provides at least a bit of a tailwind.

Second, this isn't a classroom, where you get an F for not showing up. In politics, you get an F for actively damaging things. Obama hasn't done that. He's simply ignored trade as an issue. But he hasn't done any harm, and under the circumstances that's quite possibly about as much as a trade enthusiast could have hoped for.

I think Dan will be on firmer ground in a few years. When the economy picks up and trade issues get pushed back into the foreground, what will Obama do? We won't know until it happens, and in the meantime his (lack of) performance should earn him an Incomplete, not an F.

Help Coming for Homeowners?

| Thu Aug. 5, 2010 9:19 AM PDT

The Obama administration's program to address home foreclosures, HAMP, has been a pretty dismal failure. Only a small fraction of the money allocated to help homeowners has been spent and only a few hundred thousand loans have been modified. So what's next? James Pethokoukis passes along the latest dirt:

Main Street may be about to get its own gigantic bailout. Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages — one in five — are underwater with negative equity of some $800 billion. Recall that on Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. The actual vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obama’s loan modification effort. HARP was just extended through June 30, 2011.

....Keep in mind the political and economic context. The nascent recovery is already running out of steam....The president’s approval ratings are continuing to erode, as are Democratic election polls. Democrats are in real danger of losing the House and almost losing the Senate. The mortgage Hail Mary would be a last-gasp effort to prevent this from happening and to save the Obama agenda. The political calculation is that the number of grateful Americans would be greater than those offended that they — and their children and their grandchildren — would be paying for someone else’s mortgage woes.

Maybe this happens, maybe it doesn't. But it would sure be an improvement over spending the money on "foreclosure mills," as Fannie and Freddie do now:

The business model is simple: to tear through cases as quickly as possible. (Stern's company handled 70,382 foreclosures in 2009 alone.) This breakneck pace stems from how the mills get paid. Rather than billing hourly, they receive a predetermined flat fee for the foreclosure — typically around $1,000 — plus add-ons for each of the related services. The more they foreclose, the more they make. As a result, consumer attorneys and legal experts say, even families who have been foreclosed upon illegally—and who can afford to make good on their mortgages—end up getting steamrolled. "It's 'How fast can I turn this file?'" says Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington, DC. "For these guys, the law is irrelevant, the process is irrelevant, the substance is irrelevant."

That's from Andy Kroll. Read the whole thing.

Prop 8 and the Courts

| Thu Aug. 5, 2010 8:32 AM PDT

Matt Yglesias on yesterday's court ruling that tossed out California's ban on gay marriage:

Whenever a favorable-to-progressives judicial ruling come down, the concern trolls come out of the woodwork to fret about the backlash. So in the wake of a win for the left on Proposition 8 in California, I wanted to go on record alongside Ryan as thinking such concerns are, when genuine, wildly overblown.

The American political system has a lot of features that differentiate it from most modern liberal democracies. These features include an unusually large number of veto points and also a greatly empowered federal judiciary. I’m not a huge fan of either feature, but the system is what it is and the interplay between the two means that responsible political advocates will always want to use all the levers at their disposal — including litigation — in order to get their way. Once laws are on the books, overturning them is generally an extremely cumbersome process. Merely persuading most people that you’re right doesn’t do the trick. And the system doesn’t really function in a “majoritarian” way at any level so the non-majoritarian aspects of seeking policy objectives through the courts don’t differentiate them from anything else.

I agree. There's no doubt that judicial decisions create backlashes, but the evidence is pretty thin that they create backlashes that are any worse than legislative or executive decisions. For better or worse, everyone involved in the American politics is now well aware that courts are an important part of the political process and they're fair game to be exploited as effectively as possible. That's just the way things are, and both sides play the game equally hard.

In this case, however, there's a different concern: using the judicial system might be perfectly kosher, but was it wise? The answer is: only if you win. And there are pretty substantial doubts that yesterday's victory will hold up all the way to the Supreme Court. Judge Walker's mountainous finding of facts aside, do we really think the Supreme Court is ready to rule that every state in the union is required to allow same-sex marriage? Maybe! But the odds seem long, and if we lose the case it's likely to be a decade or two before the court is willing to reconsider.

In the end, that might not be so bad. There's still a chance of winning, and a loss only means that we go back to state-by-state battles, which is exactly where we are now. But it's still a key question.

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Gay Marriage and Justice Kennedy

| Wed Aug. 4, 2010 10:53 PM PDT

Dahlia Lithwick says Judge Vaughn Walker's ruling today in the Proposition 8 case was a triumph of "science, methodology, and hard work." Personally, I would have preferred an opinion that was based a little less on a mountain of science and methodology and a little more on a mountain of compelling legal doctrine, since that's what's going to matter when this case gets to the Supreme Court. Still, Lithwick does point out something else interesting about Walker's decision: he relies a lot on arguments that seem designed to appeal to Justice Anthony Kennedy:

I count — in his opinion today — seven citations to Justice Kennedy's 1996 opinion in Romer v. Evans (striking down an anti-gay Colorado ballot initiative) and eight citations to his 2003 decision in Lawrence v. Texas (striking down Texas' gay-sodomy law). In a stunning decision this afternoon, finding California's Proposition 8 ballot initiative banning gay marriage unconstitutional, Walker trod heavily on the path Kennedy has blazed on gay rights: "[I]t would demean a married couple were it to be said marriage is simply about the right to have sexual intercourse," quotes Walker. "'[M]oral disapproval, without any other asserted state interest,' has never been a rational basis for legislation," cites Walker. "Animus towards gays and lesbians or simply a belief that a relationship between a man and a woman is inherently better than a relationship between two men or two women, this belief is not a proper basis on which to legislate," Walker notes, with a jerk of the thumb at Kennedy.

Kennedy, of course, might possibly be the swing justice when this case gets to the Supreme Court, so this could be a pretty effective tactic. Maybe that mountain of facts has an audience after all.

A Chinese Bump in the Road

| Wed Aug. 4, 2010 6:09 PM PDT

This doesn't sound good:

China’s banking regulator told lenders last month to conduct a new round of stress tests to gauge the impact of residential property prices falling as much as 60 percent in the hardest-hit markets, a person with knowledge of the matter said....Previous stress tests carried out in the past year assumed home-price declines of as much as 30 percent.

The tougher assumption may underscore concern that last year’s record $1.4 trillion of new loans fueled a property bubble that could lead to a surge in delinquent debts. Regulators have tightened real-estate lending and cracked down on speculation since mid-April, after residential real estate prices soared 68 percent in the first quarter from a year earlier.

This comes via Ryan Avent, who says:

Whatever it means for China, it's unlikely to be good for the rest of the world. China is likely to try and innoculate itself against a housing-driven slowdown by turning up the support for exporters while the financial fall-out settles. If it does, it will siphon demand away from other economies. But if it doesn't, the housing hit to China's economy will be more severe, which will have much the same effect — a reduction in the demand boost from China to the rest of the world.

It may just be a bump in the road to global recovery, but every bump is a big one these days.

Bumps make me very, very nervous these days.

Prop 8 Unconstitutional — For Now

| Wed Aug. 4, 2010 3:18 PM PDT

Judge Vaughn Walker has released his long-awaited opinion on the constitutionality of California's Proposition 8, which bans gay marriage: in a nutshell, it's not. There's no rational basis for prohibiting same-sex marriage, he ruled, and therefore it violates both the due process and equal protection clauses of the 14th amendment of the U.S. constitution. The full opinion is here.

But as we all know, his ruling per se doesn't matter. It will be appealed to the Ninth Circuit Court shortly, and after that it's sure to be appealed to the Supreme Court. What's more, a stay is likely in the meantime. So the question is, how compelling is his opinion? Is it likely to sway members of either the circuit or supreme courts?

I am nothing close to a legal expert, so feel free to ignore what follows even more than usual. But I have a feeling the answer is no. The problem is that Walker's ruling relies very, very heavily on the factual evidence provided by each side's expert witnesses. But he obviously didn't think much of the witnesses called by the defense:

[P]roponents in their trial brief promised to “demonstrate that redefining marriage to encompass same-sex relationships” would effect some twenty-three specific harmful consequences. At trial, however, proponents presented only one witness, David Blankenhorn, to address the government interest in marriage. Blankenhorn’s testimony is addressed at length hereafter; suffice it to say that he provided no credible evidence to support any of the claimed adverse effects proponents promised to demonstrate.

....Blankenhorn offered opinions on the definition of marriage, the ideal family structure and potential consequences of state recognition of marriage for same-sex couples. None of Blankenhorn’s opinions is reliable....[T]he court finds that Miller’s opinions on gay and lesbian political power are entitled to little weight and only to the extent they are amply supported by reliable evidence.

So the proponents' expert witnesses were, to put it bluntly, just a couple of hacks. Conversely, Walker says, he was very impressed with the plaintiff's expert witnesses. Then, following a list of 80 findings of fact, he ruled that prohibition of same-sex marriage was plainly unconstitutional:

To determine whether a right is fundamental under the Due Process Clause, the court inquires into whether the right is rooted “in our Nation’s history, legal traditions, and practices.”....Never has the state inquired into procreative capacity or intent before issuing a marriage license....Race restrictions on marital partners were once common in most states but are now seen as archaic, shameful or even bizarre....The marital bargain in California (along with other states) traditionally required that a woman’s legal and economic identity be subsumed by her husband’s upon marriage under the doctrine of coverture; this once-unquestioned aspect of marriage now is regarded as antithetical to the notion of marriage as a union of equals....The evidence did not show any historical purpose for excluding same-sex couples from marriage, as states have never required spouses to have an ability or willingness to procreate in order to marry. Rather, the exclusion exists as an artifact of a time when the genders were seen as having distinct roles in society and in marriage. That time has passed.

Italics mine. This strikes me as an Achilles heel in his opinion, since it suggests that if you think genders still have any distinct role in society at all, then there's a rational basis for prohibiting same-sex marriage. I'm guessing there are at least five Supreme Court judges who think that. But Walker doesn't: "The court defers to legislative (or in this case, popular) judgment if there is at least a debatable question whether the underlying basis for the classification is rational." He then goes on to rule not only that the plaintiffs made a better case, but that it's hardly even a debatable case:

Proposition 8 cannot withstand any level of scrutiny under the Equal Protection Clause, as excluding same-sex couples from marriage is simply not rationally related to a legitimate state interest. [Italics mine.] One example of a legitimate state interest in not issuing marriage licenses to a particular group might be a scarcity of marriage licenses or county officials to issue them. But marriage licenses in California are not a limited commodity, and the existence of 18,000 same-sex married couples in California shows that the state has the resources to allow both same-sex and opposite-sex couples to wed.

This is....a bit glib, no? Obviously no one is suggesting that California lacks the printing capacity to produce more marriage licenses. And then the final paragraph:

Proposition 8 fails to advance any rational basis in singling out gay men and lesbians for denial of a marriage license. Indeed, the evidence shows Proposition 8 does nothing more than enshrine in the California Constitution the notion that opposite sex couples are superior to same-sex couples. Because California has no interest in discriminating against gay men and lesbians, and because Proposition 8 prevents California from fulfilling its constitutional obligation to provide marriages on an equal basis, the court concludes that Proposition 8 is unconstitutional.

Needless to say, I agree with every word of this. It's an exhilarating and heartening ruling and I hope the Ninth Circuit Court and the Supreme Court uphold it unanimously. But at the appellate level, the expert opinions offered in the case aren't going to be especially relevant, and that's almost entirely what Vaughn based his ruling on. What's more, Vaughn went even further, clearly displaying his contempt both for the defense's witnesses and for its decision not to bother contesting the facts, and that contempt might come back to bite him. In the end, he essentially ruled that bans on same-sex marriage are nothing more than an "artifact" of history, and I have severe doubts that this is going to withstand scrutiny. At the Supreme Court level, the briefing attorneys won't be limited in their presentation of the law, and all they have to do is show some rational reason for existing bans. It doesn't have to be a great reason, and it doesn't have to be a reason that anyone mentioned at the district level, just one that's not plainly looney. I'm not sure that Vaughn was persuasive in ruling that no such reason exists.

I hope I'm all wet about this. Obviously district courts rule on facts and appellate courts rule on the law, so maybe I'm making too much of this. But my guess is that none of the expert testimony in this case is going to make a whit of difference at the Supreme Court, and without that it's not clear the ruling can be sustained. We'll see.

Defunding Healthcare

| Wed Aug. 4, 2010 2:01 PM PDT

Apparently the latest Republican brainstorm on healthcare reform — assuming they win control of the House in November — is to pick out bits and pieces of the legislation and refuse to fund them. Austin Frakt is worried:

Make no mistake, repeal by purse strings could create a mess. The law has many moving parts that act together to create a sensible, complete whole. And implementing a piece of legislation as complex as the ACA requires fully funding the agencies that oversee it. So, this strikes me as the most politically viable, serious attack on health reform.

....The combination of “savings” created by failing to fund implementation and tax cuts is likely to appeal to the Republican base. Keep in mind that the ACA does very little for the broad middle-class of voters who are covered in the large-group market. In these hard economic times, such voters may prefer some money in their pockets than additional spending on a program for which they expect little benefit. (Of course losing one’s job jeopardizes one’s insurance so the ACA really does add a meaningful layer of protection for all Americans.)

So, I worry about this. The legislation may be Democratic sausage, but I prefer it to the Swiss cheese the Republicans intend to dish up.

I wonder how this plays out politically? Even a landslide would only give the GOP a small majority, maybe five or ten seats, which means they'd have to keep party discipline almost 100% waterproof in order to do this. Could they pull that off?

Maybe. But minority parties have a much bigger incentive to stick together than majority parties do: the cost is zero and the PR is good. But what happens when they're running things? If Democrats can find even a dozen Republicans who aren't quite willing to make a hash out of healthcare for real — as opposed to just talking about it — then funding is safe. And they might. Talking smack is one thing, but there are still a few non-bomb-throwers on the GOP side who might flinch at voting for the real-world chaos this would produce.

Alternatively, this will all be moot because America will step back from the brink on November 2nd and have second thoughts about turning the country over to the lunacies of the tea party. For now, this is still my guess. Dems will lose 30-35 seats and maintain very narrow control of the House. I can't say I'm willing to put any money on this prediction, though.