ship brokering

I sometimes wonder why independent ship brokering companies exist at all. Ship owners and cargo providers could come together and establish a centralized forum where all the relevant information (e.g. ship positions, availability dates, cargo positions and destinations) is uploaded and continuously updated. But neither party is interested in the idea of introducing such absolute transparency into the market. In fact, each party thinks he is better off under the status quo regime.

This sounds logically impossible. How can both parties be better off at the same time? For example, using the centralized forum, they could (in principle) agree on the same freight rate and split the brokerage fees.

Nevertheless the status quo persists. Why?

1) Perhaps brokering companies are way too entrenched and powerful to be entirely removed from the system.

2) Ship owners and cargo providers are unable to discover what their losses/gains would be under a centralized forum scheme. Perhaps they are prevented from doing so by their own employees or brokers who subtly manipulate their information channels.

Example: Brokers may be supplying false information.

Example: Assume that the ship owner is a large public company whose shareholders can not keep track of the daily business affairs. The employees receive fixed salaries. Therefore their financial wellbeing is not correlated with the freight rates. In particular they will lose nothing by making favors to brokers who take them out to fancy dinners. Employees will do their best so that the shareholders will not be able figure out the suspiciously low freight rates at which their ships are being rent out. (Remember that the shareholders only look at the aggregate quarterly figures...)

2) Thinking of ship owners as a single class may be misleading. Say there are 10 ships owned by 10 different ship owners and 10 cargos owned by 10 different cargo providers. Assuming that there are no idle ships lying around, at any point in time there will be 10 outstanding brokered transactions. The number of parties (ship owners or cargo providers) who could have obtained a better deal through a centralized forum is at least 10. (It is probably strictly greater than 10 since brokerage fees usually steal profits from both sides.) Say 7 ship owners and 4 cargo providers would have been better off with a centralized forum. (Here we implicitly assume that, at the end of each brokered transaction, parties can figure out how the deal would have unfolded through such a forum.) In other words, if there was a democratic council composed of ship owners, then 70% of the members would have voted to circumvent the brokering companies and establish a centralized forum. On the other hand, a democratic council composed of cargo providers would have voted in favor of the status quo regime. Assuming that each council holds equal power in shaping the future of the freight markets, nothing will be done and the status quo will persist.

3) Incorporating a time dimension to the above analysis yields some more insights. Say there are 10 discrete time periods. At the end of each period ships deliver their cargos and 10 new voyage contracts get brokered. Let S=(8,10,10,9,9,2,3,2,2,5) be the vector that represents the number of ship owners who would have been better off with a centralized forum. (e.g. This number is 8 at time 1, and 9 at time 4.) Let C=(2,5,3,2,8,8,7,9,8,10) be the corresponding vector for cargo providers. During the first 5 periods, ship owners are pissed off at the brokers and are willing to overthrow the status quo regime. During the first 4 periods, they complain about the situation and seek cooperation from cargo providers for changing the market structure. Cargo providers are pretty happy with the status quo and therefore turn down ship owners’ offers until period 5 during which 8 of them become worse off due to a major change in market dynamics.

(For example, this change may be due to a sudden spike in the fuzziness of the market information that cargo providers receive through means other than their brokers. In that case the independent brokers can demand above-normal brokerage fees by claiming that the markets are very tough at the moment and there are not many available ships around. The cargo providers will not be able to verify these claims due to the fuzziness. They will probably go ahead and trust their brokers who helped them close the nice deals during the first 4 time periods.)

Now cargo providers will change their minds and decide to cooperate with the ship owners for the establishment of a centralized forum. Planning starts but the project never takes off. After period 5, tides change. Now ship owners feel better off with the current regime and defect from the project. Note that, across the 10 time periods, the average number of ship owners who would have been better off with a centralized forum is 6 (=(8+10+10+9+9+2+3+2+2+5)/10). The corresponding average for the cargo providers is also 6. Assuming that the underlying markets dynamics are not expected to change, does this imply that the ship owners will make the statistical inference that the current regime will not be in their favor in the future? No.

a) Ship owners will probably behave myopically with respect to time. Example: During the time period from 10 to 15, they may again start to feel that they are better off under the current regime. The feeling may be strong enough to make them shelve the plans of establishing a centralized forum.

b) Moreover, the identities of these 6 losers will change over time. Therefore it will be difficult to get a democratic “over-throw the status quo” vote out of the ship owners’ council. (Example: If ship owner X becomes a loser for three consecutive time periods, then other ship owners may believe that X will be among the 6 losers during the next period too. This belief may be ungrounded since the underlying dynamics may be totally random. In other words losing three times in a row may be just due to bad luck.)

4) Brokers may be performing important services other than simply bringing the two parties together. In other words clients may be enjoying non-monetary gains that could not be possibly provided by a centralized forum. For example, ship owners could be assigning a positive value to the market tips they receive from their brokers. Reliable gossips about the financial situations of various cargo providers (e.g. commodity traders) may help the ship owners by facilitating counter-party risk evaluations.

5) Absolute transparency in the shipping market may have indirect, harmful commercial consequences for ship owners or cargo providers. For example, a commodity trader may not want to post cargos to an open forum since that would amount to disclosing all its trades to public. Strategically and selectively disclosing such information may be beneficial for the trader. However a wholesale disclosure will probably not be in his favor.

Post Script 1:

You can generalize the above analysis to any type of brokerage institution. (e.g. Stock brokers, real estate brokers, marriage brokers, recruitment brokers…)

Post Script 2:

Through a centralized forum, information flows as follows:

(green=ship owner, red=cargo supplier, dark blue=forum)

Note the following two properties of the graph:

1)Every node is only two steps away from each other. In other words information flows lightning fast.

2)There is no single node (or a group of nodes) that is separated from the rest of the graph. This implies that every single information reaches to every single node.

Due to brokers' efforts, the actual freight markets are pretty connected as well. However the information flows slower:

(Light blue=broker)

free floating tankers

Supply/demand dynamics play an important role in the determination of stock prices. That is why you can not simply go ahead and buy a large stake in a public company at its prevailing market capitalization. The price reflects the beliefs of the current market participants and your entrance will change the dynamics of the game.

For instance, the way you enter the market will make a significant difference. There are two important points to consider here:

1) It is usually not a good idea to reveal your identity early on. If the market thinks you are more informed about the value of the stock than they are, then they will be more hesitant to sell at the prevailing prices.

2) Large orders suck liquidity out of the market and cause big ripples in prices. (Price may shoot up even before the execution of the large order due to information spillover and front-running.)

Therefore it is usually a good idea to hide your intention of acquiring the company by executing small orders through various different intermediaries. (Note that there are existing laws that will force you to reveal your position after gathering X percentage of the available shares.)

Is there an exact definition of what constitutes a "large" order? No. There are two importanat parameters here.

1) First is the percentage of shares that is free floating. For example, some shares are held by institutions on a long term basis and are not available for spot trading. Unless those institutions are willing to engage in a block trade with you, the only shares you can demand are those that are free floating (i.e. changing hands in the spot market). Let's assume that you want to buy 1% of the total number of outstanding shares. In other words, if the total number is 1000, your order will be for 10 shares. Now assume that the percentage of free floating shares is only 20. Although your order looks small compared to the total number shares, it demands 5% of the number of shares that are available.

2) Will that 5% move the market price? That depends on how much liquidity you will be sucking out of the market. If trading volumes are low and bid/ask spreads are high, then you are more likely to cause a ripple.

The concept of free floating is relevant to commodity markets as well. Let's consider an example. What will happen to tanker freight charges if the world seaborne crude oil trade slows down 1% in terms of tonnage? For the sake of simplicity we can disregard the size segregation in the tanker market. Moreover, since it is pretty easy to move ships across continents, we can assume that the geographical effect of the slowdown will be arbitraged away and the freight rates will go down globally.

Here the important parameter is the percentage of ships on the spot market which is the arena where freight rates get determined. Each big oil company has its own tanker fleet which is usually supplemented by some ships on long-term time charter. If these ships are all occupied (or if none of them are available around the port where the cargo needs to be picked up from), then the company will hire a tanker in the spot market. And when the company needs less ships, it will pay less visits to the spot market.

This is where an analogy with stock markets can help us. One can think of the freight charge as the stock price and the percentage of ships on spot market as the percentage of shares floating. As pointed out in the analysis above, 1% contraction in the global demand can have the effect of 5% contraction on freight charges if percentage of ships on spot market is 20.

steepening yield curve

Why is the yield curve of US government bonds steepening? Does the movement signal an end to the current recession? Perhaps. Unfortunately there is no way to be sure.

The spread between the long-term and the short-term yields may widen due to several reasons:

(Here bonds should be understood as "US government bonds".)

-Investor start to shun the long-term bonds for their greater sensitivity to interest rate fluctuations.

-Investors switch to the short-term bonds for the greater liquidity their markets enjoy.

-Investors predict that US will run into fiscal problems and funding difficulties in the future, and this will lead to higher future short-term interest rates in the bonds market.

-Investors believe that inflation rate will increase in the future. Therefore they demand higher future short-term interest rates in order to attain the same inflation-adjusted rate of return.

-Investors think that FED believes that inflation rate will increase above the targeted level. (If so, FED will take action and employ monetary policies to increase the future short-term interest rates.)

-FED decides to to pursue a less aggressive monetary policy and tones down its current quantitative easing program. It starts focusing solely on the short-end of the yield curve and removes the artificial ceiling from the long-term yields. (In other words it continues buying short-term bonds and stops purchasing long-term ones.)

-Foreign investors worry about a future devaluation of dollar. (If so, they will ask for deeper discounts while buying US bonds. This is due to the fact that they will presumably convert the money back to their respective home currencies after selling the bonds.)

-Investors believe that the global supply in the government bond markets will increase and US will face stiff competition against other nations. Therefore, in order to attract the desired number of investors, US will have to offer higher short-term interest rates in the future.

-A syncronized sell-off depresses long-term bond prices. (For example, investors may be adjusting their portfolio in order to get more commodities and stock market exposure. Also there may be a movement towards non-dollar denominated markets.)

-Dynamic hedging of mortgage convexity risk may be amplifying the fluctuations in the long-term bond prices. (As mortgage backed securities move into the hands of sophisticated investors and active hedgers, this activity increases.) In other words, higher interest rates on long-term bonds may be a consequence of higher interest rates on callable fixed rate mortgages.

-Investors think that the economy will revert back to positive growth in the near future. (If so, FED will respond by tightening the money supply and increasing the short-term interest rates. Remember that FED aims at sustainable growth with low inflation. It will interfere and calm down the "animal spirits" if growth gets out of control.)

liquidity and deflation

During times of crisis and loss of confidence, people hoard liquid items such as gold, silver, cash and government bonds. These items are of two uses:

- They are non-perishable and hence can be used to transfer wealth into the future.

- They are extremely easy to exchange into other goods.

Hence low bond yields and deflation are consequences of the same phenomenon. As liquidity becomes more desirable, bonds become more expensive in terms of dollars and dollars become more expensive in terms of less liquid items such as cars/houses/food etc.

behavior and recovery

I become very skeptical when I see industry leaders asking consumers to switch back to their previous boom-period consumption habits. The arguments are devilously one sided.

Consumers' thrifty behavior feeds on itself by worsening the crisis. That is true, but companies are not innocent neither. They are also over-panicking and acting in stingy ways. Costs are being cut and investments are being shelved. Even if money starts flowing from consumers to companies, there is no guarantee that the companies will not use it to increase their cash position or to pay down their debt.

Let's build a toy model. Assume that the economy does not recover without both companies and consumers going back to their previous spending habits. Hence consumers will hold on to their money until they are sure that companies will cooperate in case they start spending again. (If consumers spend and companies do not, then the economy will not recover and consumers will be left with insufficient savings.) The pay-off structure looks as follows (Red=Downturn persists. Blue=Economy recovers.) :

There are two Nash-Equilibriums here: (Win,Win) and (Lose,Lose). Today we are trapped in the latter. If consumers (companies) think that companies (consumers) will spend as before, then they will spend as before too. If consumers (companies) think that companies (consumers) will stay thrifty, then they will also stay thrifty.

The skeptic inside me says that the companies will not cooperate. (The industrial leaders on TV act brave but in reality they are probably very conservative.)

Today's consumer savings will play an essential role in tomorrow's recovery. They will make the industrialists that survive the current crisis very rich. Will those on TV be among this privileged class? I doubt that. The reason why they are on TV is because they doubt it also.

lessons from a plane flight

- There is no free lunch. Sitting next to an exit door will give you more leg space. But on the other hand you will be the last person receiving meal since the distribution starts (simultaneously) from the two ends of the plane. And since you get to choose the last, you will be left with the crappier meal option.

- Sometimes your leader will lie to you for your own good. Just about ten minutes before the arrival time, the pilot announced that our landing time was being delayed due to heavy traffic at the airport. Then we circulated around the airport for about half an hour. My friend was agitated. He cursed at the pilot and complained about the infrastructural inefficiencies and deficiencies of Istanbul. The truth was that there was no traffic. We could not land because the city was being combed with the heaviest surface winds in its near history. (I knew this in advance due to a phone call just before the departure.) The pilot chose to tell another story in order to avoid an unnecessary panic.

- Leading people in a territory with many unpredictable elements requires guts. I knew what was expecting us when the pilot finally announced that we had obtained the permission to land. It was an absolute roller-coster experience. (I remember myself uttering several "Bismillah"s in a reflexive fashion. I am agnostic!) If I was in charge of the plane, I would have probably directed it to another airport. Perhaps I am extremely risk averse when it comes to making decisions about other peoples' lives. Anyways the decision required real guts. That is indisputable.

- Spread the risks. Never put all eggs in one basket. The whole executive team of our company was flying together. We should have splitted the group and flied separately. If the plane had crashed, the company would have gone along with it.

fluctuations without guarantees

Constancy of economic conditions numbs the imagination and eventually leads to a complete ignorance of history. Asset managers start acting as if the correlations across different assets will always stay the same. Firms start behaving as if the economic stability will linger on forever. Low interest rates available in the foreign credit markets become too tempting to ignore and the exchange rate risks seems too low to factor into calculations. Then a crisis hits out of nowhere. Dollar appreciates and the companies without a dollar denominated income start defaulting on their interest payments...

So what is the lesson here? Should Chief Financial Officers make sure that there is no significant mismatch between the currencies of their liabilities and income? Yes and No. In times of crises even a dollar denominated income may not to save you from defaulting on your dollar denominated liability.

Consider the case of a typical commodity exporter that sells a locally mined good into a dollar denominated international market. The dollar income leads to an ungrounded feeling of security which encourages the company to take on substantial amounts of dollar denominated debt. A worldwide financial crisis unexpectedly unfolds and causes a big stir. Companies who used to depend on the availability of cheap trade finance withdraw from the market. The financially weak ones default on their payments and the increase in counterparty risk results in a scare. Everyone in the sector starts working on a strictly cash basis and the trade volumes collapse. End-users of the commodity start complaining about the price as dollar appreciates against the currencies of their clients. The revenues of our commodity exporter diminish along with the fall in sales volume and prices. Soon or later the result is a default.

Lesson: Currency mismatch is only part of the story. No matter what you do, there is no guarantee that the value of your assets will fluctuate in tandem with the value of your liabilities.

cash-hoarding believers

Today central banks employ monetary policies aimed at encouraging consumption. When interest rates go down, people are supposed to be more tempted to spend money on tangible goods and investments. Unfortunately this is not happenning so far. The interest rates hit almost zero and people still continue to hoard money and cut on consumption.

Interest rates cannot go below zero. If they ever did, you would simply pull your savings out of the deposit account and put them in a safe. So the essential question is how central banks can punish people for hoarding cash in a zero-interest rate environment.

Marvin Goodfriend suggested imposing a carry tax on money. Such a tax would effectively act as a negative interest rate. However the employment of such a policy is problematic for several reasons:

1) It is impossible to tell how much cash a person is really hiding under his pillow without constant (very costly) monitoring.
2) There may be a massive switch into another currency. (This problem could be dealt with if "prominent" nations are willing to coordinate and impose the same percentage of carry tax on their currencies.)
3) People may lose confidence in the fiat currency regime and resort to gold as a medium of exchange. (In order to avoid such a situation the government can resort to banning individuals from holding precious metals. Such a move may sound like a violation of basic, constitutionally granted liberties. But that should not be surprising. All fiat currency regimes contain a hidden element of coercion. Otherwise why would anyone be willing to hold pieces of paper that are backed by government bonds which are essentially just promissory notes that pay the same pieces of paper in future? Almost everyone suspects that the regime is constructed upon a web of faith. However, for some reason, some are unwilling to make the connection between faith and coercion. It is certainly not a coincidence that the history is littered with examples of religious faith and coercion feeding off from each other.)

strategy, chaos and morality

Do not attempt to strategize in an environment where there are just way too many unknowns. A strategy can succeed only when you can "anticipate" and "adjust". If you can not anticipate, all you will end up doing is constant revision. When there is chaos and panic, just follow the trend and panic.

Do not whine about how irrational the markets have been behaving lately. The set of rational strategies changes along with the market conditions. However if you are too arrogant and slow to "adjust", these shifts will go unnoticed.

Do not stick to moral principles. Principles lead to predictability and predictability is a weakness. If other actors can anticipate your behavior within reasonable bounds, they will push you to a corner from which you can exit only by violating your principles. Soon you will find yourself outside the game.

macroeconomic misconceptions

- Forget about textbook relationships between macroeconomic variables. Even the most innocent looking relationship breaks down in practice. For example lower interest rates may lead to deflation as opposed to inflation. Say a substantial number of consumers decides to lock up their income in cheap car loans to buy imported cars. Then these consumers will have less money to spend elsewhere. Assuming that most of the money spent on cars gets sucked out of the country and does not indirectly return to it, this change in consumer behaviour will create a deflationary pressure on the prices of goods for which demand has now diminished. If such goods carry more weight in the official inflation formula than cars do, then the reported inflation rate may become negative.

-There is nothing inherently wrong about excessive consumption. What is dangerous from a macroeconomic point of view is unsustainable consumption. If the rich desires to buy fancy stuff, that is fine. As long as this behaviour can be prolonged, the system will experience no shocks. On the other hand, if the government suddenly withdraws a subsidy which was supposed to be in place for at least several decades, then the system will experience a demand shock. The people who used to receive the withdrawn subsidy will change their consumption behavior, and the businesses which expanded their production capacities to deal with the increased consumption that used to be financed by the subsidy will suffer from an unanticipated decline in revenues. Even if the government decides to spend the freed-up money on other things (i.e. there is no absolute change in the aggregate demand), the system will still suffer a shock due to the change in the composition of the aggregate demand.