You are hilarious ("And, girl, I don't drive slow.")!

I used to spend some time in Houston and Dallas when I was an oil E&P analyst. Oh, the humidity! But I do love Texas. There's just a whole layer of BS that never seems to settle on a West Texas wildcatter. Know what I mean?

Good summation, but can I say Ouch on the cost of travel?

Houston may not be as populated as NYC but it is one big ass city in area and it takes me an hour to just get across the city on the freeways, no lights and no traffic tie-ups. And, girl, I don't drive slow.

I pass all my expenses on to my customers, who I assume pass it on to the lawyers (I hope), but this is so new I don't know when I may be required to eat a bigger share of the fuel costs.

Instead of waiting to prove a point, I suggest we refresh that Tree of Liberty with the blood of a few tyrants. Of course I, I , I would never pull a trigger. Bigger

Nope. I can tell you exactly what I did say about the housing market three years ago – "What the hell are these Bozos thinking Who is giving them the bad crack?" and continued to rent.

I can tell you exactly what I said during the tech bubble: "I don't know if these prices reflect the real value of the stocks, since this is new technology and so much of the valuation of these tech firms is in FGV, it's difficult to disagree with either the lowest or highest valuations. It is worrying, though, that anything at all with a "dot com" at the end of its name is enthusiastically embraced by the market." I gave this answer as part of the an interview question for an equity research position (yes, I go the job).

There are some key differences in dot com stocks and the housing market. And these differences make all the difference in whether there will or won't be a bubble.

The housing market is extremely fragmented, illiquid and impossible to short. This makes it impossible to correct prices and it is prone to bubbles. The oil futures market, in contrast, is not fragmented, extremely liquid, easy to price and has no short restrictions.

The dot com boom resulted from new technology and there was a lot of disagreement about fair value. Imagine trying to guess the impact of television or computers when they first came out. The valuations that those two technologies would have traded at had people known the impact would have been much higher had the impact been correctly guessed at the time that technology first hit the market. Opinions about the impact of the internet and associated technologies varied widely and it was difficult to identify market saturation ahead of time. These kinds of markets are prone to bubbles as well.

Oil futures, by contrast, are not a new, difficult to price asset. In fact, it is a very old, exceptionally easy to price asset.

You seem to discount the possibility of the market acting irrationally in the short term.

No, I don't. I'm just saying that "short term" in a liquid, easy to price market lasts about a second.

Benjamin Graham's basic formula of PE and Equity/Asset ratios for example

I hate to tell you this…but, Graham & Dodd's fancy and loooooooong formulas are a lot less intuitive and precise than the formula for futures pricing. One of Graham Dodd's pricing formulas is rocket science compared to futures.

Further, who is to say that the current 5% margin requirement provides the correct amount of liquidity to the market? Is it not posssible that 5% is too low just as 50% might be too high?

The "correct" amount of liquidity is always as much as possible. The more opinions, the more sure you are of the price, the tighter the market and the lower the transactions cost. The margin should be low enough that it maximizes the number of market participants to increase liquidity and high enough that participants can't get so levered that large numbers of them can blow themselves up when trades go against them. The right amount of leverage is rightfully determined by the leverage providers because a lot of things are taken into consideration when extending leverage.

"It is also not even within the realm of possibility that today's 5% margin purchases of oil futures are tomorrow's sub prime mortgage portfolios?"

Simply put: highly unlikely. Unlike housing loans, the assets backing these loans are very liquid and can be disgorged quickly to meet margin calls. Leverage is a whole side discussion on its own. But, that's not the context in which you brought up margin. That's a whole different conversation. You wanted to increase margin to reduce trading – i.e. liquidity. That's a stupid reason to jack up margin. While the buyer is using that margin to buy futures, the seller is using that margin to sell futures. Incidentally, a reduction in liquidity in the oil futures market will translate into higher margin requirements (depending on how much the liquidity is reduced) to compensate for the lowered ability to disgorge large positions without moving the market around. In these markets, unlike the housing markets, margin is sort of self-regulated.

In the long run, the market will correct; it always does. The question is how long can we wait for the market to once again act rationally.

In the deep, broad, easy to price, extraordinarily liquid oil market? 10 seconds would be "the long run". Your question assumes an irrational market. I should mention that you have presented no evidence that the oil futures market actually is behaving irrationally.

Not that I'm a big fan of Keynes, but he was right when he said "the market can stay irrational longer than you can stay solvent".

I love that quote. It's particularly true of illiquid markets. Also true in the short run when volatility picks up in markets due to some catastrophic event like the Russian debt default.

I also love "in the long run, we're all dead", which is also a quote attributed to Keynes. I should remember that one more often when I get frustrated.

but this time I think you may be mistaken in rigidly defending the status quo.

Well, okay. Fine. Let's restrict trading in oil futures and see what happens. I don't have a long commute and I live well within my means, so I can afford it

I wonder if you would have posted similarly 3 years ago during the peak of the housing bubble or 10 years ago during the peak of the tech bubble? You will likely counter that the assets in question and the markets on which they trade are dissimilar, which is true. But the short term irrational behavior of those markets is not dissimilar.

You seem to discount the possibility of the market acting irrationally in the short term. If I follow your logic, market irrationality should be eliminated by "fourth grade arithmetic" and, on the blackboard at least, it is. The theory is correct, it just fails in practice. After all, one would assume basic arithmetic (Benjamin Graham's basic formula of PE and Equity/Asset ratios for example) would have applied eight years ago to stock valuations and yet somehow the Nasdaq composite topped 5000 with a P/E of 388. Where were all the short sellers and value investors bringing equilibrium to the market during that run? Were they out chasing purple fairies? (Sorry to be snarky but you introduced the purple fairies to the thread)

Further, who is to say that the current 5% margin requirement provides the correct amount of liquidity to the market? Is it not posssible that 5% is too low just as 50% might be too high? The debt and equities markets manage to function on 50% margin requirements and don't seem to lack for participants. Is it also not even within the realm of possibility that today's 5% margin purchases of oil futures are tomorrow's sub prime mortgage portfolios? Naahhh! No chance that an institutional investor would ever make THAT kind of mistake and be caught short when the market corrects. Can anyone be certain that today's oil investors are more savvy and rational than Bear Stearns CDO portfolio managers were?

Having said all that, I don't believe in the myth of the evil speculator. I do believe in the reality of the irrational short term market and I think (and I admit there is a distinct possibility I may be wrong) that the 5% margin requirement contributes to that irrational behavior and should be raised.

In the long run, the market will correct; it always does. The question is how long can we wait for the market to once again act rationally. Not that I'm a big fan of Keynes, but he was right when he said "the market can stay irrational longer than you can stay solvent".

It is not often that I disagree with your opinions or those of our hosts, but this time I think you may be mistaken in rigidly defending the status quo.

Let me play devil's advocate for a moment and ask a more relevant question. What if fairies wore purple dresses, flew in posses of 10 and granted wishes to pretty people?

Fantasy?

No more fantastic than your question.

Futures contracts are the easiest derivative to price. They are spot price of oil + cost of storage + interest. All three components are known. If a speculative premium cannot be quantified it is only because the person doing the quantifying isn't capable of fourth grade arithmetic. If demand for futures contracts is driven up (reflect a "speculative premium"), speculators will seek to profit from that premium by shorting contracts right to the point where that premium is eliminated. The only way for that premium to exist is to reduce liquidity in the oil futures market by jacking up margin requirements (driving marginal players out of that market and reducing participants) and by other restrictions on the number of market participants.

Go ahead and try that. Reducing liquidity is the fastest way known to man to ensure that a speculative premium will exist for more than 10 seconds.