Kevin Drum

Will Derivatives Ruin Cap-and-Trade?

| Mon Jun. 8, 2009 1:07 PM EDT

Rachel Morris has on online piece today suggesting that the same Wall Street rocket scientists who destroyed the global economy via derivatives trading may be getting ready to do the same thing with carbon permits from a cap-and-trade system.  After all, if they can slice and dice subprime mortgages, why can't they do the same for packages of carbon permits?

I've got a few problems with this, though.  First, there's this:

Cap and trade would create what Commodity Futures Trading commissioner Bart Chilton anticipates as a $2 trillion market, "the biggest of any [commodities] derivatives product in the next five years."

I'm not entirely sure what this means, but my best guess is that Chilton is forecasting a market with a notional value of $400 billion per year.  This is not as large as it sounds.  The notional value of the CDS market in 2007, for example, was over $50 trillion.  Chilton's estimate for the carbon market is less than 1% that size.  Likewise, the underlying value of the actual carbon permits is likely to be on the order of $50-100 billion a year, which is less than 1% of the underlying value of, say, the U.S. stock market.  Even if Wall Street went nuts with this stuff, it couldn't do too much damage.

Then there's this:

In addition to trading the allowances and offsets themselves, participants in carbon markets can also deal in their derivatives — such as futures contracts to deliver a certain number of allowances at an agreed price and time.

This is true, but carbon permits are essentially commodities, and the kinds of derivatives traded on commodity exchanges are generally forwards, futures, and options.  But while these may be derivatives, they're mostly not the rocket science kind.  They've been around forever, they're well understood, and they weren't responsible for any of the problems that caused our current meltdown.

Beyond that, these kinds of derivatives can actually be pretty helpful.  They're generally used for two purposes: (a) managing volatility and (b) speculation.  The first is an unalloyed good thing, since one of the main complaints about a cap-and-trade system is that it doesn't provide investors with a fixed carbon price they can plan around.  Futures contracts help with that.  And speculation, though it often gets a bad rap (sometimes deservedly), can be helpful too if it provides a price signal today for possible permit scarcity tomorrow.  Driving up the price sooner rather than later can actually motivate higher levels of investment in green technology.  (The downside: if Congress bollixes the law and speculators decide that there are going to be loads of permits in the future, they'll drive the price down.  But if Congress screws up that badly, the whole system isn't going to work worth a damn anyway.)

Finally, there's this:

Perhaps the biggest uncertainty hinges on how offset derivatives—such as a contract to buy offset credits at a future date for a determined price — will be monitored. This too would be left to the White House task force to figure out. It will be a tough task because the quality of offset projects is notoriously difficult to verify. Sen. Jeff Bingaman (D-N.M.) has described them as "fraught with opportunity for game playing, which will be fully exploited, I'm sure."

Offsets are a big problem, but their problems have nothing to do with derivatives.  They're a problem because it's really, really hard to insure that an offset (say, planting a million acres of trees in Brazil in order to make up for emitting a million tons of carbon) is real, that it's something that wouldn't have been done anyway, and that it's effectively monitored to make sure it's permanent.  Those are genuinely big issues, but they're issues that are inherent in the whole concept of offsets.  Making derivatives out of them doesn't change things much.

With all that said, the piece is worth a read.  I have my doubts that derivatives are really that big a problem in the carbon market, and in any case I'd just as soon see them regulated by the same mechanisms we come up with to regulate all the other derivative markets, rather than being treated as a one-off special.  Still, it's worth knowing about this stuff, and worth taking some time to address in the Waxman-Markey markup process.  For example, Bart Stupak's provisions for making sure carbon derivatives are exchange traded, which Rachel mentions in her article, are well worth trying to protect through the end of the legislative process.  After all, if Wall Street objects, it almost has to be a good thing, doesn't it?

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Chart of the Day

| Mon Jun. 8, 2009 12:04 PM EDT

Nate Silver informs us today that although there aren't very many women in Congress, the women we do have are more likely to come from male-dominated congressional districts.  The effect is most pronounced in strongly Democratic districts (blue line), but it's there in Republican and neutral districts too.

Why?  Who knows.  It seems unlikely that a fairly small difference in male:female population ratio would actually be noticeable by the residents of a district, but Nate says the effect is pretty robust.  In other words, it's probably not a fluke.  So what's the answer?  Some underlying variable that drives both things?  Are women less likely to vote for a woman than men are?  (Maybe some kind of analysis of exit poll results would help here.)  Leave your guesses suggestions for further research in comments.

We Are All 17 Year Olds Now

| Mon Jun. 8, 2009 11:19 AM EDT

This was all over the tubes yesterday, but it's so entertainingly crazy that I feel like I have to pass it along.  It's Sen. Chuck Grassley's Twitter feed, and Grassley really seems to have fully channeled the junior high school spirit of the whole thing.  First he's annoyed at an anodyne Obama call to "deliver" on healthcare because Obama is, like, obviously a slacker since he took some of the weekend off for sightseeing.  Then, a few minutes later, he's annoyed all over again.  Finally, this morning he feels compelled to toss a random barb at Al Gore.

Very strange.  Is Grassley off his meds or something?  Or did someone hijack his Twitter account?  That was actually my first thought, but his office hasn't denied the tweets so I guess they're really his.  Thus does Twitter make fools of us all.  Enjoy.

Gays in the Military

| Mon Jun. 8, 2009 1:09 AM EDT

Here's some good, if unsurprising, news: support for allowing gays to serve openly in the military is up considerably since 2004.  For the past few decades public opinion on all kinds of gay issues has trended more tolerant by about 1% per year, and Gallup's latest poll confirms this: in the past five years support for allowing gays and lesbians to serve has increased from 63% to 69%.

Perhaps surprisingly, the biggest shift comes from conservatives, who have become more supportive by 12 percentage points, moving from 46% in favor to 58% in favor.  Regular churchgoers and the young have also made bigger-than-average jumps.

There's a rule of thumb that says social policies are resistant to change until they garner two-thirds support from the public.  Allowing gays to serve openly in the military has now officially passed that point.  That means it's safe to keep your campaign promise and act, Mr. President.

Lessons on Being a Prick

| Sun Jun. 7, 2009 2:58 PM EDT

I see that the conservative movement is continuing its long descent into juvenile thuggery and intellectual gutlessness as a substitute for actual ideas.  It's like being back in seventh grade.  Nice work, NRO.

Nonboiling Frog Update

| Sat Jun. 6, 2009 6:12 PM EDT

Frog blogging?  Seriously?  I say: bring it on, guys.  Inkblot and Domino are snoozing in terror at the competition.

On the other hand, we all heartily approve of catblogging spontaneously becoming a topic of conversation over twelve packs of Red Stripe and stale Tostitos.  And I have to admit that MoJo's interns have found themselves a handsome looking little amphibian.  Click on the link if you want to help them name their new little critter.

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Friday Garden Blogging - 5 June 2009

| Fri Jun. 5, 2009 3:19 PM EDT

It's been a busy week and we all need a break.  So how about a nice, soothing garden to help everyone relax?  Here at Drum Central, the flowers are blooming, the upside-down tomato plant is thriving, our new redbud tree is growing, the sun is shining, and birds are chirping in the birdbath outside the kitchen window.

And, of course, Inkblot is admiring it all — as well he should since he's spent so many backbreaking hours supervising the gardeners.  It's exhausting!  And with that, I'm off to the car dealer to pick up my newly repaired and hopefully non-coolant-leaking wheels.  Have a nice weekend, everyone.

Standing Up to the Imperial Presidency

| Fri Jun. 5, 2009 2:49 PM EDT

House Democrats, led by Barney Frank, are finally standing up against the Obama administration's support for the Detainee Photographic Records Protection Act of 2009 — an Orwellian amendment that would retroactively bypass FOIA and allow the administration to unilaterally block the release of photos of detainee treatment with no justification except their own say so.  Good.  Nick Baumann has more.

More on Obama and Democracy

| Fri Jun. 5, 2009 2:43 PM EDT

Via email, reader Dan R. reacts to my post this morning on George Bush and his failed democracy agenda:

The problem with Bush's so-called "democracy promotion" wasn't just that it was half-hearted or hypocritical, but that it was such a simplistic approach to democracy: Elections are all that counts. It showed little appreciation for the elements of civil society that are a fundamental requirement of a successful democracy, and that make U.S.-style democracy possible in the U.S. but might not make it possible in a lot of other countries.

Now, I don't think Obama wants to go out and say that some countries aren't educated enough or have the civil traditions and institutions required for American-style democracy. So he's treading a fine line. But the reality is that the things he talked about — rule of law, government transparency, lack of corruption, equal administration of justice, freedom of the press, minority rights — are more realistic goals for many countries and appropriate way-stations on the way to what we would consider a full-fledged democracy.

I think Obama is exactly right in focusing on the values that underly democracy rather than the external forms....By striking a middle ground between "idealists" who would make democracy and human rights the sole focus of foreign policy and "realists" who would ignore American values in favor of American interests, this kind of thinking represents a very sophisticated step forward in our foreign policy.

Quote of the Day #2

| Fri Jun. 5, 2009 1:26 PM EDT

From Bob Enyart, spokesman for Colorado Right to Life, on the assassination of abortion doctor George Tiller:

"If a Mafia hit man gets killed, people recognize it's an occupational hazard."

According to the LA Times, this was his way of explaining that "his group doesn't condone Tiller's slaying."