New Regulation and a Redefinition of Libor Collide

The financial markets have become somewhat obsessed with the SEC regulation of money market funds triggering a rise in Libor. The obsession is for good reason: estimates are that Libor benchmarks underlie about $350 trillion in financial contracts. A fundamental shift in Libor is like a disturbance in the force. There has been a lot of terrific research and articles published that focus on the ramifications of the money market fund regulation, but none that I personally have seen yet that include the impact of the recent (March 2016) substantial broadening of the definition of Libor and the Fed’s similarly defined overnight bank funding rate, which they have been tracking since 2014 and recently (March 2016) began publishing. That is what I focus on in this note.

Executive Summary

·         New regulation: The following two controversial and long-debated SEC regulations implementing reform measures on money market funds are set to go into effect in October 14, 2016.

1.       The net asset values (NAVs) or prime institutional money market funds will no longer be held constant at $1, but will float with the market value of the underlying assets.  

2.       Prime money market funds will have the ability to impose “gates” on redemptions for up to 10 days, and assess liquidity fees, if liquid assets fall below a 30% threshold. This will apply to both institutional and retail prime money market funds.

·         Prompts an exit: Not unpredictably – since it was predicted by absolutely everyone – this has resulted in a “rush for the exits” ahead of the October effective date. Since the beginning of 2016 – becoming pronounced in June 2016 - assets in these funds have dropped by roughly $400 billion, from $1.3 trillion to $900 billion, due to a combination of investor redemptions and fund conversions.

·         Raises the cost of commercial paper: Money market funds have been the dominant investor group lending US dollars to both financial and non-financial corporations - heavily foreign-based corporations – via the US commercial paper market. Ninety-day commercial paper rates have risen ~20 bps since late June when the exodus began in earnest, triggering equivalent increases in other short-term wholesale funding rates, e.g. certificates of deposit and eurodollar deposit rates (= Libor).

·         Propagates to other short-term funding markets: A priori one would expect short-term financing rates to be strongly correlated with one another, and typically they are. However, any trader or analyst of short-term interest rates will caution you that the various wholesale funding markets which supply the financing are not necessarily fungible. That’s what we’re witnessing now; e.g. a foreign-based company which raises US dollars by issuing commercial paper cannot easily replace that funding at similar cost by borrowing eurodollars from a US or foreign-based bank on a revolving basis.

·         Exacerbated by central bank and Libor administrators tying these financing sources together: The implementation of these money market reforms has (perhaps inadvertently) coincided with initiatives by the Federal Reserve and the Libor benchmark administrators to:

1.       Broaden the definition of wholesale bank funding rates, including a rewrite of the definition of Libor that became effective in March 2016; and the Federal Reserve’s overnight bank funding (OBF) rate, meant to eventually supplant the fed effective, which the Fed began publishing in March 2016.

2.       Anchor the calculation of the OBF and Libor rates to transactions.

3.       The redefinition of Libor greatly expands the list of counterparties and eligible transactions, directly linking USD Libor not only to eurodollar borrowings, but also to transactions in the commercial paper and certificate of deposit market.   

·         As 3m CP and 3m Libor rates rise in tandem: The massive drawdown of prime money market fund financing has – so far, “modestly” - driven up wholesale US dollar funding rates by approximately 20 bp for financial companies and about 10 bp for non-financials in 90-day commercial paper; a similar amount in 3m certificates of deposit, and  20 bp in 3m Libor.  This has, of course, put upward pressure on Eurodollar futures contract rates, which has in turn contributed to some widening of front-end swap spreads and Libor-OIS spreads.

·         Projection – it’s not finished, and it will be sticky: Expect the rise in wholesale funding costs to be persistent, since it’s due to a regulatory and policy shift, not to a change in credit fundamentals. It also has further to go. Better analysts than myself have predicted ~$600 bn total eventual drawdowns from prime MMFs, which would mean we have about ~$200 bn left to go. That could add at least 10 bps more to 3m Libor, which would top it out based on current levels at ~95-100 bps. Over time, that increase should revert somewhat as CP issuers adapt, restructure and attempt to seek out cheaper financing. But don’t expect the reversion to be substantial.

Background on the interbank lending rates: Eurodollars and Fed Funds

What’s a eurodollar?

A eurodollar, or eurodollar deposit, are US dollar-denominated deposits held at foreign banks or foreign branches of US banks. So $1 million US dollars on deposit at JP Morgan in London, or Deutsche Bank in Frankfurt, or Bank of Tokyo-Mitsubishi in Tokyo are eurodollar deposits. Although the “euro” moniker has remained, eurodollar deposits refer to any US dollar denominated bank deposits held offshore.

Is there a difference between borrowing dollars from foreign banks (eurodollars) versus borrowing them from a US bank (fed funds)?

Yes. There used to be somewhat less of a difference before the definition of Libor was broadened. Now it’s more substantial. This regulatory-induced rate increase has exposed a tiny 2 bp crack. Since the underlying structures of the two markets are beginning to diverge more, if the markets come under significant stress I think you could see larger variances in Libor and OIS rates and increased spread volatility.

The reason is that the federal funds market is still functionally an inter-bank and government-sponsored (GSE) lending market. Daily fed funds trading volume in the post-crisis, post quantitative easing world is comparatively small, at about $65 billion per day. The daily fed effective rate has held almost perfectly steady at 40 bps since late June 2016 – a modest increase of 3 bps from 37 bps, where it had held steady since the last Fed hike in December 2015. By comparison overnight Libor – which is a tiny bit more volatile – has increased rather steadily from 36.6 bps in Jan 2016 to 41.8 bps currently. An increase of 5 bps versus 3 bps would perhaps be insignificant, except the difference propagates forward into longer term rates, and is reflected in widening Libor/OIS spreads.

The GSEs (primarily the Federal Home Loan Banks) are the biggest lenders of funds. The GSEs cannot earn interest on excess reserves (IOER), so they are willing to lend their cash at slightly lower rates than IOER (currently 50 bps). The ultimate fed funds borrowers are typically smaller banks and thrifts – often using a larger bank as intermediary – who are structurally short of funds.

By contrast, the eurodollar market is much more liquid with a larger group of borrowers and lenders.

The following is excerpted from an excellent post, The Eurodollar Market in the United States, on the Liberty Street Economics blog of the Federal Reserve Bank of New York (emphasis added):

Although Eurodollar deposits, by definition, are held by institutions outside the United States, there is an active market for Eurodollar deposits inside the United States, particularly in New York City. U.S. depository institutions and U.S. branches of foreign banks (FBOs), which we will collectively refer to as U.S.-based banks, indirectly borrow in Eurodollars by accepting Eurodollar deposits through offshore branches and then transferring the funds onshore. U.S.-based banks take Eurodollar deposits predominantly through their Caribbean branches (usually located in the Bahamas and the Cayman Islands). While these trades are booked offshore, the transactions are typically negotiated by traders located in the United States and the proceeds are often used to fund U.S. operations.

In the United States, Eurodollars and fed funds are regulated similarly. Fed funds, according to Regulation D, are exempt from reserve requirements. Although the Fed can impose reserve requirements on net Eurodollar deposits of U.S.-based banks, it has imposed a zero reserve requirement since 1990, making the treatment of Eurodollars effectively the same as fed funds. As a result, U.S.-based banks consider funding through fed funds and Eurodollars to be close substitutes. An important difference, however, is that fed funds can only be lent by depository institutions, government-sponsored enterprises, and a few other eligible entities, whereas a broader set of institutions can invest in Eurodollar deposits.

The eurodollar and fed funds markets as currently functioning do not have many active lenders and investors that overlap. The decline in relevance of the Fed funds market is one of the reasons the Fed is seeking to supplant the fed effective rate with the overnight bank funding rate (OBFR).

The what?

It’s ok. Only short-term interest rate geeks have paid attention to it so far. Here are the details, excerpted from Overnight Bank Funding Rate Data by the Federal Reserve Bank of New York :

The overnight bank funding rate is calculated using federal funds transactions and certain Eurodollar transactions. The federal funds market consists of domestic unsecured borrowings in U.S. dollars by depository institutions from other depository institutions and certain other entities, primarily government-sponsored enterprises, while the Eurodollar market consists of unsecured U.S. dollar deposits held at banks or bank branches outside of the United States. U.S.-based banks can also take Eurodollar deposits domestically through international banking facilities (IBFs).

The overnight bank funding rate (OBFR) is calculated as a volume-weighted median of overnight federal funds transactions and Eurodollar transactions reported in the FR 2420 Report of Selected Money Market Rates.

The daily volume in fed funds transactions is roughly $65 billion. The daily volume in OBFR – which is fed funds + US-based eurodollar transactions – is roughly $250 billion. So the US-based eurodollar market with about $185 billion in average daily trading volume is much deeper and more liquid than the fed funds market.

Pressure in Commercial Paper Market Impacts USD Financing for Foreign Banks

To the extent that US-based banks experience any financing stress propagating to these two funding markets, the OBFR should detect it. Any deviation between OBFR and overnight Libor should be due to difference in the cost of eurodollar deposits for US-based and non-US based banks. Currently that difference is 1.8 bps (see graph below). As stated previously, that may sound trivial, but considering there has been no fundamental shift in credit quality, a pure regulatory change has produced a small financing gap between US-based banks and foreign banks requiring USD funds.

Why has the gap appeared? Because the biggest issuers in the financial CP market are foreign banks and other foreign financials. Wholly domestic issuers that are US-owned (the red line in graph below) are the minority of issuers in the financial CP market. 

Therefore any rise in rates in the financial CP disproportionately affects foreign-based firms, with or without domestic operations. That also accounts for the rise in Libor rates – particularly 3m Libor, which is closely tracking the rise in 90-day financial CP. That’s what we examine next: how the redefinition of Libor has created a much closer link between other wholesale funding markets, and no longer reflects a purely inter-bank lending rate.

The Redefinition of Libor

The Libor acronym comes from London Interbank Offered Rate. The old definition of Libor, under the previous administrator the British Bankers’ Association (BBA), asked panel banks to submit rates at which they believed they could borrow funds (e.g. be offered eurodollar deposits) from another bank for various terms, from overnight to one year. The panel banks were chosen to be AA-rated global banks with branches in London. Libor rates were therefore understood to reflect inter-bank lending rates for offshore funds in various currencies.

Prior to 2012, the rate submission process was: outside the regulatory perimeter, largely unsupervised, and conflicts of interest were not addressed. The explosion of the Libor scandal revealed persistent and at times widespread manipulation of the Libor rate submission process by traders, lax oversight by the BBA who repeatedly ignored warnings that the rates being submitted were tampered with and did not reflect actual borrowing rates, and pressure at times during the crisis from both bank management (and reportedly at least one government central banker) to report lower borrowing rates so that banks and the global financial system would appear more stable than perhaps they were. Legal ramifications from the Libor scandal have already landed several people in jail and resulted in a massive reform effort aimed at restoring confidence in the widely used interest rate benchmarks (e.g. Libor is referenced by an estimated US $350 trillion of outstanding contracts in maturities ranging from overnight to more than 30 years).  

A Broader, Transaction-Based Definition of LIBOR, Incorporating Commercial Paper

On March 18^th, 2016 the London-based Intercontinental Exchange (ICE), the benchmark administrator for Libor that replaced the BBA, published a revised Roadmap for ICE LIBOR which formally changed the definition and rules for the calculation of Libor rates across the five major currencies it oversees (USD, EUR, CHF, GBP and JPY).

The following are excerpts from the Roadmap explain some of the reasoning behind the change in the definition of Libor addressing: 

• The dramatic expansion of the counterparty list for tracking wholesale bank funding transactions; 
• The broadening of the funding locations included from a purely London-based market to a global market; 
• And, of course, anchoring the rates submitted in actual transactions as opposed to freeform estimates of funding costs, where these transactions include: unsecured deposits, commercial paper and certificates of deposit. 

Bingo. USD Libor is now directly linked not only to eurodollar deposits but also to the USD commercial paper and CD markets.

Note: that the Intercontinental Benchmark Administrator (IBA) is the group within ICE responsible for overseeing (edited for brevity and spelling, emphasis added):

Counterparty Types

LIBOR was initially created to be a gauge of unsecured funding for banks which was, to a very great extent, driven by interbank activity prior to the financial crisis.

The activity in that market has decreased markedly and wholesale deposits negotiated with other counterparties are playing an increasingly important role in bank funding. This change of behavior led IBA to conclude that unsecured loans by corporates (i.e. non-financial corporations, termed in the Feedback Statement and in this Roadmap as “corporations”) in addition to financial institutions should be eligible as counterparties to transactions that inform LIBOR submissions - where the bank is the borrower and the corporation is the lender.

The feedback to the consultation confirmed that, consistent with the original purpose of LIBOR and to reflect the changes in bank funding in recent years, a broader set of wholesale funding entities should be regarded as eligible counterparty types.

In calculating their LIBOR submissions, panel banks will use transactions where they receive funding from the following wholesale market counterparties:

 Banks

 Central Banks

 Corporations as counterparties to a bank’s funding transactions but only for maturities greater than 35 calendar days

 Government entities (including local /quasi-governmental organizations)

 Multilateral Development Banks

 Non-Bank Financial Institutions, including Money Market Managers and Insurers

 Sovereign Wealth Funds, and

 Supranational Corporations.

Including trades with corporations will increase the quantity of transaction data available to set the rate thus also helping LIBOR to meet the strategic direction set by the FSB and other official sector bodies for anchoring LIBOR in transactions. IBA estimates that the inclusion of such trades could increase the transaction volume by up to 15%, depending on the relevant currency and tenor.

Funding Locations

LIBOR is a global rate and transactions from an expanded list of funding centers will be used. IBA will maintain an Approved List of Funding Locations.

The Approved List of Funding Locations will be owned by the LIBOR Oversight Committee and will be based on the major centers in Canada, USA, EU, EFTA, Hong Kong, Singapore, Japan and Australia. This list can be adjusted as necessary according to a set of predefined criteria:

 a material level of transactions that will inform transaction-based calculations

 a satisfactory regulatory oversight regime for wholesale funding transactions

 an absence of capital controls, sanctions or other regulatory steps that would influence rates, and

 The location is used by one or more bank(s) or a bank has requested to use the location.

Since each of the LIBOR panel banks has its own organizational and geographical profile, IBA will agree the appropriate locations with each bank bilaterally from the Approved List of Funding Locations, being mindful of the need to safeguard the representativeness of the transactions and their pricing.

Product Types

IBA is standardizing the acceptable Level 1 (Transactions) as the VWAP of transactions in the following:

 Unsecured Deposits

 Commercial Paper – fixed-rate primary issuances only, and

 Certificates of Deposit - fixed-rate primary issuances only.

Closing Remarks

There is certainly a great benefit to expanding the definition of Libor to encompass the range of global wholesale bank funding markets and the variety of counterparties that lend in these markets. Clearly such a redefinition is supported by regulators and central banks, and will provide a clearer picture of bank funding costs over time.

The potential downside is that these various wholesale funding markets are not nearly as fungible as those regulators appear to assume. So a regulatory induced twitch in one source of funding is now be immediately propagated to Libor, driving up rates for consumers, non-financial corporations and effectively the entire financial market complex outside of what was once strictly AA-bank lending. That’s not necessarily unreasonable, but it does perhaps beget more caution on the part of the SEC, the Fed, the ECB and the myriad of other regulators before they go blithely handing down rule changes. 

The Dog Oscars

Catching up on some things I wrote and distributed to my super exclusive email list, but never got around to posting here. 

This is a recap from the first night of the Westminster dog show, which was held on February 16, 2016. Dogs rule. 

The Hound Group

More diverse than its name implies, the group includes sight hounds and scent hounds and lie around on the couch and destroy your shoe collection hounds. There are two sizes of actual Beagles plus three dogs that look like Beagles, if Beagles were the size of Labrador Retrievers. The most ancient of dog breeds are part of this group – the Afghan Hound and the Pharaoh Hound – plus more recently developed breeds for sport hunting in the US – the American Foxhound and the American English Coonhound.

Note to potential owners: Although most are highly sociable and make great companion animals, these dogs were bred to track, hunt (and some to kill) other animals. Not necessarily the dogs to own if you also enjoy the company of cats, hamsters, rabbits or other prey-type animals.

Dog in the group that is smarter than you: the Basenji. Intelligent, obstinate, sneaky – they understand what you want them to do, they’re just not sure they care. A great dog for people who are still emotionally attached to a high maintenance ex-girlfriend.

Perennial crowd favorite: the Basset Hound, because how can you not love a dog where part of the breed description is “long, velvety ears”.

Group winner: the Borzoi, Lucy. A stunningly elegant super athlete. Only the Saluki combines as much beauty and grace with speed and agility.

Criminally overlooked: the Redbone Coonhound. Didn’t even get a glance as the judge passed her when selecting the group finalists. Coonhounds generally don’t have a lot of prestige at Westminster. A fact which hurts their confidence not at all.  

The Toy Group

Group winner: a black and white Shih Tzu named Panda, sporting a $500 cut and blow out, wearing a topknot cinched by a turquoise hair barrette that matched his handler’s dress.

And that’s pretty much all you need to know about the toy group.

Oh, alright. There are 23 breeds in the toy group. Though like the Beagles and Coonhounds in the hound group, multiple versions of the same dog are considered distinct breeds, due to color combinations or type of coat (curly or flat, short or long). So the group includes two Chihuahuas, two English Toy Spaniels, the nearly identical looking Cavalier King Charles Spaniel, three Terriers, and two toy versions of regular sized dogs (the Poodle and the Manchester Terrier).

Easily mistaken for an Ewok: The Brussels Griffon.

Most awkward styling: the handler for the Chinese Crested. Do not have the same haircut as your dog. Especially when it looks better on the dog.

The Non-Sporting Group

Every contest needs a “catch all” category, and this is it at Westminster. These are all purpose dogs. The group includes some breeds which are ancient, like the Shar-Pei and Chow Chow; and others that are of more recent or of indeterminate origin, such as the Dalmation and French Bulldog. Despite some very popular breeds, the non-sporting group does not tend to produce many best in show winners. The last time dogs from the non-sporting group prevailed were in back-to-back wins in 2001 and 2002 by a Bichon Frise and a Miniature Poodle.

Group winner: Annabelle, the lumbering English Bulldog, who narrowly beat out a Disney-worthy Dalmation.

Sighs of embarrassment: for the handler who was wearing a snappy plaid suit, roughly matching the coloring of her dog, and perhaps absentmindedly tucked a white dishtowel into the waistband at the back of her skirt. Trotted energetically around the ring, looking like she had just come from the toilet.

The Herding Group

Note to potential owners: These are intelligent, focused, high energy dogs. They will herd everything from sheep to cattle to toddlers. Some were bred to do so over variable terrain and long distances. Like many of the hunting dogs in the hound group, few are adaptable to apartment living unless they get a lot of exercise.

I have to admit I fell asleep before the judging for the herding group started. The odds-on favorite to win Best in Show is in this group, and she did in fact win last night, to roars from the crowd.

Group winner: Rumor, the German Shepherd. You do not have to love dogs to love this dog. Wow. Hoping she takes Best in Show tomorrow (unless the Brittany wins the sporting group!).

Big shout out: To the handlers throughout the evening who would give their dogs a discreet smooch while taking them off the podium or after trotting around the ring. So genuine and sweet.

Beer For My Horses

It has been a rough few weeks around the globe for those who are committed or aspire to defend and uphold justice. Amidst escalating international terrorist attacks and domestic mass shootings, the US is heading into a presidential election cycle with two candidates who – if polls can be believed – are both “historically unpopular” among voters. This seems to be contributing to deepening political polarization in the country, and a bubbling up of partisanship in unfortunate places. Including, most recently, from Supreme Court justices.

Sidebar 1: Recent polling which portends to analyze voter sentiment and predict outcomes on both referendums (e.g. Brexit) and candidates (e.g. the nomination of Donald Trump) has been widely criticized  by many; and defended as accurate, though subject to misinterpretation, by some. Political theory being perhaps as subject to revision as economic theory, there is now an entire meme among political scientists and professional pollsters dedicated to understanding (or explaining away) how they misjudged the rise of Donald Trump.

Sidebar 2: “Historically unpopular” might be a little overstated by the media, since history in this context begins in 1936. The first modern presidential polling was conducted by George Gallup (natch) who used a statistical random sampling of voters. Prior to Gallup, polling was often done by magazines who simply surveyed their own subscribers. Not surprisingly, their “projections” were similar to those you might expect the National Review or Slate would produce if they conducted such polls of their readers.

Ginsburg Weighs in on Presidential Campaign

In a disturbing ethical lapse, Supreme Court Justice Ruth Bader Ginsburg damaged her own reputation, and that of the independence of the Supreme Court, when she unwisely remarked on the presidential candidates in a series of three media interviews.

Excerpts from a July 8^th, 2016 article by Mark Sherman of the Associated Press, Ginsburg doesn't want to envision a Trump win, following an interview with Justice Ginsburg (emphasis added):

In an interview Thursday in her court office, the 83-year-old justice and leader of the court's liberal wing said she presumes Democrat Hillary Clinton will be the next president. Asked what if Republican Donald Trump won instead, she said, "I don't want to think about that possibility, but if it should be, then everything is up for grabs."

"It's likely that the next president, whoever she will be, will have a few appointments to make," Ginsburg said, smiling.

Excerpts from a July 10^th, 2016 article in the New York Times by Adam Liptak, Ruth Bader Ginsburg, No Fan of Donald Trump, Critiques Latest Term, following an interview with Justice Ginsburg (emphasis added):

“I can’t imagine what this place would be – I can’t imagine what the country would be – with Donald Trump as our president,” she said. “For the country, it could be four years. For the court, it could be – I don’t even want to contemplate that.”

It reminded her of something her husband, Martin D. Ginsburg, a prominent tax lawyer who died in 2010, would have said. “ ‘Now it’s time for us to move to New Zealand,’ “ Justice Ginsburg said, smiling ruefully.

Excerpts from a July 13^th, 2016 CNN interview with Joan Biskupic, recapped in article Justice Ruth Bader Ginsburg calls Trump a 'faker', he says she should resign (emphasis added):

Supreme Court Justice Ruth Bader Ginsburg's well-known candor was on display in her chambers late Monday, when she declined to retreat from her earlier criticism of Donald Trump and even elaborated on it.

"He is a faker," she said of the presumptive Republican presidential nominee, going point by point, as if presenting a legal brief. "He has no consistency about him. He says whatever comes into his head at the moment. He really has an ego. ... How has he gotten away with not turning over his tax returns? The press seems to be very gentle with him on that."

"At first I thought it was funny," she said of Trump's early candidacy. "To think that there's a possibility that he could be president ... " Her voice trailed off gloomily.

"I think he has gotten so much free publicity," she added, drawing a contrast between what she believes is tougher media treatment of Democratic candidate Hillary Clinton and returning to an overriding complaint: "Every other presidential candidate has turned over tax returns.”

While some in the media praised Ginsburg for her “characteristic candor,” legal analysts and court watchers across the ideological spectrum were less glib. The accepted reality that Supreme Court justices have ideological leanings and strongly held beliefs crashed headlong into:

1.       The separation of powers between the executive and judicial branch;

2.       The presumption that judges should not only be independent and impartial; but also,

3.       Judges should maintain the appearance of being politically impartial to defend the credibility of the Court.

By July 14^th, 2016, Ginsburg issued an apology for her remarks via a Supreme Court press release (which I cannot currently find on their website, but will link to it if I do). It is recapped in CNN article by Ariane de Vogue, Ruth Bader Ginsburg: "I regret making" Donald Trump remarks, excerpted below:

"On reflection, my recent remarks in response to press inquiries were ill-advised and I regret making them," Ginsburg said in a statement. "Judges should avoid commenting on a candidate for public office. In the future I will be more circumspect."

Hours after releasing the statement Ginsburg talked exclusively to NPR's Nina Totenberg, and expanded upon her statement. She called her comments "incautious."

"I did something I should not have done," she added. "It's over and done with and I don't want to discuss it anymore."

Ginsburg's criticism had caused controversy not only in political circles but also among legal ethicists who suggested Wednesday that if the current election were ever to come down to a Bush v. Gore-like challenge, Ginsburg would have to recuse herself.

"A federal law requires all federal judges, including the justices, to recuse themselves if their 'impartiality might reasonably be questioned'," said Stephen Gillers, a legal ethicist at New York University School of Law. "Under this test, Justice Ginsburg's remarks would prevent her from sitting in the unlikely event of a 'Clinton v. Trump' case that determines the next president."

“You’re Splitting Ideological Hairs”

No. Ruth Marcus in the Washington Post makes the case more persuasively than I can.  In an excellent, and at points ironic and hilariously partisan column,  Justice Ginsburg's damage to the Supreme Court, Marcus distinguishes between ideology and partisan politics (excerpted, edited for brevity):

It is naive to imagine that justices don’t have political views, or strong political preferences. Of course they do. It is the rare justice who ends up on the court without having ties to politics and politicians.

But there is a difference — a big one — between having a preexisting political relationship or predilection that the public might reasonably presume (no one would mistake Ginsburg for a potential Trump voter) and one that is so strongly held that the justice feels impelled to make it public.

That approach is not mere window-dressing. Judicial silence is the tribute that the imperative to appear impartial pays to reality.

Some people will read this and snort: The justices are political animals like all the others; they decide based on their political views, not on the law.

This dismissiveness ignores and obscures the distinction between ideology and partisanship. Broadly speaking, Republicans and Democrats have differing conceptions of the role of the judiciary, the meaning of the Constitution and the proper approach to its interpretation. It is no surprise, and no tragedy, that judges appointed by Republican presidents tend toward one set of reasonably predictable conclusions and those named by Democratic presidents another.

Ginsburg’s remarks — like Scalia’s duck-hunting — present a problem, and not just for her. They drag the court down to the level of other political actors, into the partisan muck. They reinforce the public’s perception that this game, too, is rigged — more than it actually is. 

Definitions, provided by Google, for my own reference - because I wanted to make sure I understood and agreed with the distinction Marcus and other legal analysts have made.

ideology – a system of ideas and ideals, especially one that forms the basis of economic or political theory and policy.

partisan – an adherent or supporter of a person, group, party or cause, especially a person who shows a biased, emotional allegiance. In politics, a partisan is a person who strongly supports their party’s policies and are reluctant to compromise with their political opponents.

partisanship – prejudice in favor of a particular cause; bias. “An act of blatant political partisanship.”

Thou (Federal Judges) Shalt Not Campaign for Politicians

The  Code of Conduct for United States Judges spells out the ethical standards for federal judges. The Code was initially adopted by the Judicial Conference in 1973. Canon 5 of the Code reads as follows (emphasis added):

Canon 5: A Judge Should Refrain from Political Activity

(A) General Prohibitions. A judge should not:

(1) act as a leader or hold any office in a political organization;

(2) make speeches for a political organization or candidate, or publicly endorse or oppose a candidate for public office; or

(3) solicit funds for, pay an assessment to, or make a contribution to a political organization or candidate, or attend or purchase a ticket for a dinner or other event sponsored by a political organization or candidate.

(B) Resignation upon Candidacy. A judge should resign the judicial office if the judge becomes a candidate in a primary or general election for any office.

(C) Other Political Activity. A judge should not engage in any other political activity. This provision does not prevent a judge from engaging in activities described in Canon 4.

The Code of Conduct applies to all lower court federal judges. The Supreme Court justices voluntarily follow the principles outlined in the Code of Conduct, but are not obligated to obey them. There are occasionally calls for the justices to adopt a formal code of ethics. Such controversies typically arise when a group or members of Congress want a Supreme Court justice to recuse him or herself from a particular case, though Ginsburg’s remarks have raised the issue in this different context.

“What did you think of Sotomayor’s ‘black lives matter’ dissent in Utah v Strieff?”

If you haven’t yet read about this case and the court’s opinion, please do. There are many excellent articles covering the case – read at least one on each side. I also highly recommend reading on The Federalist Society website the article Utah v Strieff: Fourth Amendment Rights Without Remedies and the Problem of Arbitrary Police Power, by Evan Bernick.

I’m not enough of a legal scholar to truly parse the constitutional merits of the case. I’m still in the phase of reading the law community’s response to the majority’s decision and the dissents (as opposed to the media’s response) so I can adequately understand the historical context of Fourth Amendment rulings, the current legal context, and the potential ramifications.

All that being said, I did read the majority opinion (5-3) written by Clarence Thomas and Sotomayor’s dissent. (I have not yet read Elena Kagan’s dissent.) I am deeply uncomfortable with the decision - which continues to erode the rights of citizens subjected to search and seizure without reasonable suspicion of unlawful conduct – and the majority’s rationale. I found myself in agreement with the initial sections of Sotomayor’s dissent, and at points cheering her on – while at the same time feeling like she later badly and needlessly overstepped the legal arguments (which were clearly strong) in favor of cultural and political partisanship. Which brings me back to concerns about justice, and the difference between having a well-structured and informed ideology versus a blatant partisan bias. It undermines the legal argument and impairs both actual and perceived impartiality.

But those are only my opinions, and they are admittedly not yet well-developed.

The Irony and the Rednecks

Please look past the association of country music with southern rednecks (North Carolina, represent!) or at least appreciate the irony of what I am about to quote:

You know justice is the one thing you should always find

You got to saddle up your boys, you got to draw a hard line

When the gun smoke settles we'll sing a victory tune

And we'll all meet back at the local saloon

And we'll raise up our glasses against evil forces singing

Whiskey for my men, beer for my horses.

Excerpted lyrics from Beer for My Horses, by Toby Keith

An Abbreviated and Biased Timeline of the European Union

This is the first post in a series of how Britain leaving the EU might impact the financial services industry generally, and the fixed income and foreign currency markets in particular. To put the UK vote in context – we consider the rather laborious and at times contentious development of the EU, which evolved from a loosely defined trading area to a single market with a (mostly) common currency. Over the decades, the majority in several countries chose not to join the EU or EEA for reasons similar to why Britain has now chosen to leave it. In that respect, although the outcome of the vote may have been unexpected by the pollsters, it was hardly unprecedented.

Editorial aside: As an observer and citizen of a former British colony (hat tip to both King George and George Washington), it has at times been difficult to understand what all the elbow-throwing is about between the countries in the Europe. However, we fought a war to gain our sovereignty and lower our taxes (oh, the irony) so it’s understandable that significant net benefits should accrue from willingly ceding such power to a supra-sovereign organization. Let’s hope the new government – once elected - quickly puts a plan in place for ongoing relations with the EU and moves forward. There are two obvious options (e.g. the Norway model or Switzerland model) which we briefly touch on in this post, and have been discussed ad nauseum in the press. (Pardon for adding to the nausea.)

An Abbreviated and Biased Timeline of the European Union

1957: The European Economic Community (EEC) was created by the Treaty of Rome in order to facilitate an economic integration of its member states. This economic integration included a customs union and a common market. The six founding members of the EEC, often referred to as the “inner six”, were: Belgium, France, Italy, the Netherlands, Luxembourg and West Germany.

·         A customs union is a type of trading bloc with free trade between the members and a common external tariff. Customs unions alone generally only cover free trade of goods, and do not include free movement or trade of services, capital or labor (people) between members.

·         A common market is one where members have relatively free movement of capital and services, though significant non-tariff trade barriers may remain, e.g.  there may be differences in members safety, packaging and marketing standards. A common market can be considered a first step towards a single market.

As part of the common market, the Treaty of Rome also outlined objectives for a Common Agricultural Policy (CAP) and a Common Fisheries Policy (CFP). These policies would be drafted, adopted, come into force, be criticized, debated and reformed (many times) over the following years as the EEC, and later the EU, developed.

1960: Britain responded to the formation of the EEC in part by instigating the formation of a competitive organization, the European Free Trade Association (EFTA). The EFTA was established as a free trade area for European states who were either unable or unwilling to join the EEC. The seven founding members of the EFTA, often referred to as the “outer seven”, were: Austria, Denmark, Norway, Portugal, Sweden, Switzerland and the United Kingdom.

·         The EFTA does not have a customs union – so there is not a common external customs tariff - but it does coordinate trade policy among its members.

·         Members were also allowed to negotiate individual trade agreements with non-member countries.

1961: Denmark, Ireland, Norway and the United Kingdom apply for membership in the EEC. Their membership was rebuffed (vetoed, actually) by then-President of France Charles de Gualle, who feared that inclusion of the UK would function as a back door to US influence.

1962: Common Agricultural Policy The CAP, formally adopted in 1962, is a system of agricultural subsidies, price supports and farming programs.

·         CAP has been a primary source of conflict, both within and outside the EEC (now EU), since its inception. The cost of the CAP program represented 71% of the EU budget in 1984, The cost has declined, but still totals 39% of the EU budget as of 2013.

·         Currently only 5.4% of the EU’s population works on farms, and the farming sector contributes only 1.6% of EU GDP (as of 2005).

·         Among the many criticisms of CAP is that it allows outdated farming and production methods; contributed to artificially high food prices in the EU; encourages overproduction of some crops and products; results in quotas and waste; provides overly generous welfare to inefficient and unprofitable rural farms; is environmentally unfriendly, and increases poverty in developing economies.

·         Waves of CAP reforms have been proposed – and some adopted – over the years. The EU farming lobby is still powerful.

·         The CAP subsidies particularly irk more urban countries, such as the UK and Norway, who are net payers into the EU, and those like Sweden who believe all farm subsidies should be abolished.

1967: The four countries resubmit their applications for membership; in 1969 Georges Pompidou succeeds Charles de Gaulle as President of France and the veto is lifted.

1970: Common Fisheries Policy The CFP was created to manage fish stock for the EU as a whole, and maintains a system of quotas, regulates production and grading, sets minimum prices and buys up unsold fish, and sets trading rules for non-EU countries. The CFP almost immediately became a sticking point for the countries of northern Europe. Excerpted from Wikipedia, Common Fisheries Policy:

The first rules were created in 1970. The original six Common Market members realized that four countries applying to join the Common Market at that time (Britain, Ireland, Denmark including Greenland, and Norway) would control the richest fishing grounds in the world. The original six therefore drew up Council Regulation 2141/70 giving all Members equal access to all fishing waters, even though the Treaty of Rome gave no authority to do this. This was adopted on the morning of 30 June 1970, a few hours before the applications to join were officially received. This ensured that the regulations became part of the acquis communautaire before the new members joined, obliging them to accept the regulation. At first the UK refused to accept the rules but by the end of 1971 the UK gave way and signed the Accession Treaty on 22 January 1972, thereby handing over an estimated four fifths of all the fish off Western Europe. Norway decided not to join. Greenland left the EC in 1985, after having gained partial independence in 1979.

When the fisheries policy was originally set up the intention was to create a free trade area in fish and fish products with common rules. It was agreed that fishermen from any state should have access to all waters. An exception was made for the coastal strip, which was reserved for local fishermen who had traditionally fished those areas. A policy was created to assist modernisation of fishing vessels and on-shore installations.

·         Unlike the heavy subsidies and relative cost of the CAP, the CFP currently represents 0.75% of the EU budget. The fishing industry is a small component of EU GDP, contributing less than 1.0%.

·         Criticism of CFP by conservationists and those in the commercial fishing industry has been intense over the years, with blame for the decline in fishing stocks pointing in many directions.

·         Reforms and amendments to the CFP have occurred routinely over the years, but ultimately little satisfactory progress has been made, and many in Britain still cited the intrusion of CFP as another reason to leave the EU.

1972: The people of Norway vote in a referendum, rejecting membership in the EEC by a majority of 53.5%. This is partially due to Norway wanting to maintain control over its fishing grounds and fishing industry, which is the second largest contributor to GDP in Norway after oil. Norway remains in the EFTA.

1973: Denmark, Ireland and the UK complete negotiations, sign the accession treaties and join the EEC, leaving the EFTA.

1981: Greece joins the EEC.

1986: Spain and Portugal join the EEC.

1987: The ongoing enlargement of the EEC leads to a desire to further integrate the foreign policy and economies of the members. The Single European Act (SEA) was the first major revision of the Treaty of Rome. It was developed and signed in 1986, and came into force in 1987. The Act extended powers, made some reforms and set an objective for the European Community of establishing a single market by December 31, 1992. The import of the Act was to pave the road for the establishment of the European Union (EU).

·         A single market is an area where there are no restrictions to the free movement of goods, services, capital and people.

1988: Throughout the build-up of the EEC and eventually the EU, many members and nations expressed varying degrees of concern about the supranational nature of the European Community (EC) and the loss of sovereign powers – or delegation of sovereign authority – to the EC. In her famous Bruges speech in September 1988, then Prime Minister of Britain Margaret Thatcher, summed up the “eurosceptic” view:

“To try to suppress nationhood and concentrate power at the centre of a European conglomerate would be highly damaging (...) We certainly do not need new regulations which raise the cost of employment and make Europe's labour market less flexible and less competitive with overseas suppliers  (...) And certainly we in Britain would fight attempts to introduce collectivism and corporatism at the European level - although what people wish to do in their own countries is a matter for them".

-excerpted from The Single European Act and the road toward the Treaty of the European Union.

Editor’s note: Ok, here is where my already abysmal grasp of European politics and culture clashes fails completely. But an absurdly condensed timeline of events: ramifications from the cold war between the USSR and the US, civil protests and revolutions in eastern Europe against Communist rule, eventually led to the collapse of the Soviet Union and later re-unification of Germany from 1989-1992. This dramatically changed the perceived balance of power and economic landscape in Europe and globally. There is ongoing pressure from many countries to expand the EC, and resistance from some EC leaders and members to do so.

1992: The European Economic Area (EEA) is proposed in 1989 by then-EC president Jacques Delors, as an alternative to expanding the EEC. The EEA agreement is signed in 1992 by the then seven states of the EFTA and the then 12 member states of the EC, and becomes effective in 1994.

·         The EEA allows members of the EFTA access to the internal market within the EU.

·         EEA members are required to adopt most EU legislation concerning the single market, with notable exceptions for the laws governing agriculture and fisheries.

·         The EEA provides for the free movement of persons, goods, services and capital within the internal market of the EU.

1992: Switzerland rejects ratification of the EEA Agreement. Switzerland remains a member of the EFTA and over time negotiates a series of bilateral trade agreements with the EU.

Sidebar: There has been an enormous amount of ink, political speculation and media commentary devoted to Britain modeling either the “Norway model” or the “Swiss model” for its future relationship with the EU. Functionally the two options boil down to EFTA membership with the EEA agreement (Norway) or EFTA membership with bilateral trade agreements (Switzerland). We will delve into this in detail in a later post. Below are excerpts from a recent article  by Espen Eide, a former foreign minister of Norway and current resident of Switzerland (edited for brevity).

Could Britain mimic the ”Norway model” or the “Swiss model” when it exits the EU?

As an EEA member, Norway does not participate in decision-making in Brussels, but we loyally abide by Brussels’ decisions. We have incorporated approximately three-quarters of all EU legislative acts into Norwegian legislation – and counting. We have legally secured access to the single market, and we practise the free movement of people, goods, services and capital. Norway is more closely integrated into many aspects of the EU than even some of the EU’s members. Our subscription to freedom of movement and our membership of the Schengen area means that Norway has even higher per capita immigration than Britain.

Those campaigning for Britain to leave the EU and chose the Norwegian way can hence correctly claim that a country can retain access to the single market from outside the EU. What is normally not said, however, is that this also means retaining all the EU’s product standards, financial regulations, employment regulations, and substantial contributions to the EU budget. A Britain choosing this track would, in other words, keep paying, it would be “run by Brussels”, and it would remain committed to the four freedoms, including free movement.

British voters might also hear about the virtues of the “Swiss model”. It so happens that I currently live in Switzerland. My new alpine homeland is in most respects in a similar position to Norway, but instead of the EEA, it has chosen an array of bilateral agreements with the EU on most aspects of integration.

Compared to the EEA arrangement it can be seen as an even more cumbersome way of integrating into a EU-led market. Where the EEA is dynamic – which means it trails the developments of EU policy in all relevant areas – the Swiss arrangements are static. Crucially, too, they don’t cover services, which are so central to Britain’s economy.

To make the point louder: services = financial services. If Britain wants its banking and financial services industry to retain single market access to the EU, it will likely need to pursue EEA and EFTA membership (the “Norway model”). Unfortunately this would not allow Britain to regain control of its borders and immigration – which was a crucial motivation for many who voted to exit the EU.

1993: Passage of the SEA immediately led to drafting of the Maastricht Treaty (also known as the Treaty on European Union or TEU), whose goals were to strengthen supranational powers creating the European Union (EU), increase economic integration, establish some fiscal and monetary policy objectives and eventually lead to a monetary union (e.g. the introduction of the euro as a common currency). The Maastricht Treaty was drafted in 1991 and came into force in 1993. The EC was officially absorbed by the EU.

1994: Norway has a second referendum on EU membership, which is rejected by a 52.2% of voters. Norway remains in the EFTA.

Why did the majority of Norwegians not want Norway to become a member of the EU?

A recent response to this exact question, from the Minister Counsellor for Culture and Communication of at the Royal Norwegian Embassy in Paris, Rune Bjastad (edited for brevity):

“The arguments for saying ‘no’ were that membership was a threat to the sovereignty of Norway, the fishing industries and agriculture would suffer, that membership would result in increased centralisation, and there would be less favourable conditions for equality and the welfare state. Fishing is extremely important to the Norwegian economy, especially for coastal areas. It is the second largest industry in our country, after oil.

“But we must immediately say that economically, Norway is already part of the EU Internal Market. The question may be a bit misleading: in fact, we are strongly integrated in the European Union, even if we are not members.

“Economically, we are equal with other member states, through the Agreement on the European Economic Area, the so-called EEA. Since 1994, Norway has participated fully in the Internal Market.

“The Norwegian economy is strong, unemployment is low. Norwegians therefore see no economic argument in favour of EU membership.”

1994: The second stage of the Economic and Monetary Union of the EU is launched with the establishment of the European Monetary Institute. Austria, Sweden and Finland also join the EU.

Sidebar: The UK chose not to join the European Monetary Union (EMU). Its currency remains the pound sterling, which has taken a heck of a beating – hitting a 30+ year low against the US dollar – since the Brexit vote on June 23^rd.

1999: The euro becomes the official currency of the European Monetary Union (EMU), and the European Central Bank (ECB) begins operations.

2002: Euro notes and coins are put into circulation and the euro replaces old EMU member currencies entirely. There is heady talk that the euro could soon equal or supplant the dollar as the preeminent global reserve currency.

For the record, to date the euro has never even come close to matching the ubiquity, trading volume, perceived safety and global currency status of the US dollar. In our next post we will touch on this when we discuss the more recent developments in the EU.