Eugene Linden
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The Supreme Court's Own Goal on Climate Change

[This article appeared in Lawfare. It's long for a musing, but I think it's important that the public see just how shoddy was the majority reasoning in West Virginia v EPA]

In 1970, Sen. Roman Hruska of Nebraska achieved a dubious immortality when he argued that mediocrity deser...

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Fire & Flood
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Deep Past
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endangered animals
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The Ragged Edge of the World



Winds of Change
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Afterword to the softbound edition.


The Octopus and the Orangutan
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The Future In Plain Sight
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The Parrot's Lament
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Silent Partners
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Affluence and Discontent
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The Alms Race
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Apes, Men, & Language
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SustainableFollies

BY EUGENE LINDEN


Monday, May. 24, 1993
HOW ARE AFRICAN ELEPHANTS SIMILAR TO MINKE whales? Neither animal is in immediate danger of extinction, but both are protected by international hunting bans because past efforts to exploit the beasts commercially have driven their populations into precipitous decline. Countries that have well- managed elephant herds, including Zimbabwe, South Africa and Botswana, are eager to sell ivory, just as Norway and Japan want to kill whales. But conservationists are loath to exempt specific nations from the ivory-trade ban for fear that any traffic in tusks will bring a reprise of the rampant cheating that occurred before sales became illegal in 1989.

When it comes to exploiting nature, humans seem to be like alcoholics: either on the wagon or on a binge. The fashionable and optimistic belief that humans can reap nature's bounty in a controlled fashion -- an ideal known as "sustainable use" that has long been the prevailing philosophy of conservationists as well as many businessmen -- is turning out to be a chimera.

Though many of the world's fisheries are ostensibly managed on a sustainable basis, important species are in danger. Among them: bluefin tuna, cod and haddock in the Atlantic; certain varieties of grouper and snapper in the Gulf of Mexico; and sardines and anchovies in the Pacific. The United Nations and World Bank sponsored the Tropical Forestry Action Plan to sustain forests, but instead the plan spurred further deforestation. When asked by an environmentalist what he meant by sustainable, a World Bank agronomist replied, "Fifty years of timber production." Even the rubber tappers of Brazil's Amazon rain forest, who along with their martyred leader, Chico Mendes, became symbols of the sustainable use of tropical forests, overexploit their ecosystem. Writing in the journal BioScience, John Browder notes that in search of food and sources of cash, these seringueiros can kill off wildlife and cut forests as much as settlers do.

Sustainable use is not some fringe idea, but rather the central organizing principle for global environmental policy, a concept refined over two decades at international conferences. It is often paired with "sustainable development" -- the notion that economic development, if carried out in a careful manner, can proceed without exhausting the natural resources needed by future generations. As recently as last June during the Earth Summit in Rio de Janeiro, governments tried to forge an action agenda based on sustainable development.

Now, however, scientists are beginning to acknowledge that theories of sustainable use and development almost never work in practice. "What we are seeing is that conservation and development are not the same process," says the Wildlife Conservation Society's John Robinson, a leading revisionist on sustainable use. "If you are interested in development, you cannot get there by doing conservation, simply because the most diverse ecosystems are usually not the most productive in human terms." This means that development almost always brings losses of biological diversity. Instead of preserving the variety of a rain forest, for example, humans have the urge to chop down the trees and plant uniform crops.

What's good for society in the long run is of no immediate concern to people who use up natural resources. Given the high cost of modern fishing equipment, an individual fisherman is driven to catch every last fish rather than limit catches and ensure long-term supply. And no matter how good the plan to manage an ecosystem, some people will cheat.

Environmentalists cling to the idea of sustainable development because it enables them to present themselves as advocates of economic progress and, as Robinson puts it, "the concept allows them to play with the big boys and have an impact on huge development projects." If sustainable development proves illusory, environmentalists will be left with a huge problem: there is no big idea ready to fill the void. With human numbers expected to double in the next 60 years, policymakers must now find some new trail map that will enable humanity to walk the ledge between rising material expectations and the wholesale collapse of the biosphere.

Robinson believes environmentalists will have to embrace anew the politically incorrect concept of pure preservation for some vital areas. For their part, policymakers must try to guide development away from sensitive ecosystems and toward regions where inevitable losses of diversity are more "acceptable." An economics that accurately accounted for the costs of destroying species would also help. Most likely, though, a sustainable future will not come from policy wonks, but rather from a broad change in values as ordinary people react to ecological disasters around them.

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Short Take

HOW THE OPTIONS TAIL HAS COME TO WAG THE MARKET DOG: A Simple English Language Explanation of How Structural Changes in the Stock Markets Contribute to Whipsaw Movements in Prices.

Lately a string of violent price movements and reversals in the equity markets make it look like the markets are having a nervous breakdown. The last day of trading in April 2022 saw a 939 point drop in the Dow. The day before that, the Dow rose about 625 points, and two days before that it fell over 800 points. The very next week, after two quiet days, the Dow rose over 900 points after the Fed announced its biggest rate hike in 22 years (ordinarily a big negative for the markets), and then, the next day, fell over 1000 points (more on this later).  There have been plenty of headlines – about the Ukraine Invasion, inflation, the threat of a Fed caused recession, supply chain disruptions – to justify increased uncertainty, but the amplitude of the moves (and the sudden reversals) suggest something more may be at work. Here follows an effort to explain in simple language the significant changes in the market that have contributed to this volatility.

 

“This time it’s different” is perhaps the most dangerous phrase in finance as usually it’s uttered by market cheerleaders just before a bubble bursts. That said, markets do change, and those changes have their impacts. One change in the markets has been the shift from intermediaries (such as brokers) to direct electronic trading, a shift that has made the markets somewhat frictionless, and allowed computer driven funds to do high speed trading. This shift began a couple of decades ago. Today’s markets can move faster than a human can react.

 

Another shift has been the degree to which passive investing through index funds and algorithmic trading through various quant funds have come to eclipse retail investing and dominate trading. A consequence of this is that to some degree it has mooted individual stock picking because when investors move in or out of index funds, the managers have to buy or sell the stocks held on a pro rata basis and not on individual merit. This change too has been developing over recent decades.

 

A more recent and consequential shift, however, has been the explosion in the sale of derivatives, particularly options (the right to buy or sell a stock or index at a specified price on or before a specific date). Between 2019 and the end of 2021, the volume of call options (the right to buy a stock at a specified price on or before a particular date) has roughly doubled. During times of volatility, more and more retail and institutional investors now buy calls or puts rather than the stocks. 

 

Today, trading in options has reached a scale that it affects market moves. A critical factor is the role of the dealers who write options and account for a significant percentage of the options issued. Dealers have been happy to accommodate the growth in option trading by selling calls or puts. This however, makes them essentially short what they have just sold. Normally, this doesn't matter as most options expire out of the money and worthless, leaving the happy dealer to book the premium. Being short options, however, does begin to matter more and more as an option both moves closer to being in the money and closer to expiration. 

 

This situation is more likely to occur when markets make large and fast moves, situations such as we have today given the pile of major uncertainties. Such moves force dealers to hedge their exposure. 

 

Here’s how it works. If, for instance, a dealer has sold puts on an index or a stock, as a put comes closer to being in the money (and closer to expiration), the dealer will hedge his short (writing the put) by selling the underlying stock. This has the combined effect of protecting the dealer -- he's hedged his potential losses – while accelerating the downward pressure on the price. In other words, this hedging is pro-cyclical, meaning that the hedging will accelerate a price move in a particular direction.

 

Traders look at crucial second derivatives of stock prices, referred to by the Greek letters delta and gamma to determine exposure to such squeezes. As an option moves closer to in the money it's delta -- it's price movement relative to the price movement of the underlying, and its gamma -- the rate of change of the delta relative to a one point move in the underlying, both rise. The closer to both the strike price and expiration date, the more the dealer is forced to hedge. The result is what’s called a gamma squeeze. Once the overhang of gamma exposure has been cleared, however, the selling or buying pressure abates, and gamma may flip, with new positioning and hedging done in the opposite direction. The result can be a whipsaw in the larger markets. This same phenomenon can happen with indexes and futures.

 

How do we know that the hedging of option positioning are contributing to violent price changes and reversals in the market? While not conclusive, perhaps the strongest evidence is that large lopsided agglomerations of options at or near the money have been coincident with surprising market moves as expiration dates approach. In fact, some market players use this data to reposition investments, in effect shifting investment strategy from individual companies to the technical structure of the markets. This is what Warren Buffett was referring to when, at his recent annual meeting, he decried the explosion of options and other Wall Street fads as reducing companies to “poker chips” in a casino.

 

The week of the May Fed meeting gave us a real-time example of how a market move that looks insane on the surface reflects the underlying positioning in various derivatives. To set the stage: ordinarily, given debt burdens and the threat of recession, the markets would be expected to react badly to a Fed tightening cycle that is accelerated by the biggest rate hike in 22 years. On Wednesday, however, market indices began to soar on Wednesday when Fed Chairman Powell, one half hour after the Fed announced it 50 basis point raise, suggested that the Fed was not considering larger 75 basis point hikes during this tightening cycle. Traders interpreted this as taking the most hawkish scenario off the table. Up to that point, institutions were extremely bearish in their positioning, heavily weighted to puts on indexes and stocks, and also positioned for future rises in volatility in the markets. Right after Powell made his comments, investors started hedging and unwinding this positioning, and all the pro-cyclical elements entailed in this repositioning kicked in. By the end of the day, the technical pressures producing the squeeze had largely abated, setting the stage for a renewed, procyclical push downward the next day, as the negative aspects of the tightening cycle (and other economic headwinds) came to the fore. 

 

What these violent moves in the market are telling us is that while in the broader sense, this time is not different --the overall sine wave of the market is still that bubbles build and burst -- how the present bubble is bursting may be following a different dynamic than previous episodes. The changes since the great financial crisis-- the rise to dominance of passive trading through indexes and algorithmic trading through various quant strategies – reduced the friction in the markets as well as the value of picking individual companies. Now, the more recent explosion of option issuance, further accelerates market moves, and leads to unpredictable reversals that have to do with option positioning rather than fundamentals such as earnings, politics, or the state of the economy. 

 

The tail (the options and other derivatives markets) now wags the dog (the equities markets).

 

 



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