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Wednesday, May 18, 2011

The Derivatives Market’s Helpful Enemies

It's hard to understand why the professed free-market types have so little concern for distortions due to market power, and often argue against intervention to make markets more competitive:

The Derivatives Market’s Helpful Enemies, by Luigi Zingales, Commentary, Project Syndicate: ...[T]oday the market for derivatives is oligopolistic, with a few banks running huge profit margins. And, regardless of whatever political motivations might lie behind the latest investigations, this market concentration is a real problem. According to a 2009 study by the European Central Bank, the five largest CDS dealers were party to almost half of the total outstanding notional amounts, while the 10 largest CDS dealers accounted for 72% of the trades. The markets for other derivatives are not much better.
A high degree of concentration distorts the market... Over-the-counter trading also contributes to the opacity of derivatives markets, further reducing competition and increasing the margin enjoyed by the traders...
The major investment banks are fully aware that every day that they delay appropriate market regulation, they earn millions of dollars for their managers’ bonus funds. It is no surprise that the reform process is taking so long.
According to European Commission spokeswoman Amelia Torres, the latest efforts at antitrust enforcement can be seen as complementing pending derivatives regulation. To overcome the enormous lobbying power of investment banks – and thus help to ensure global financial stability – any tool is helpful, even if it comes wrapped in a package of European ideological bias.

Zingales argues that the solution is to force derivatives onto organized exchanges (and, as noted in the article Dodd-Frank does this to an extent, but does not go far enough). More transparency is needed, but I don't think this goes far enough. We need regulators to actively break-up industries where size leads to market distortions or systemic risk.

    Posted by on Wednesday, May 18, 2011 at 10:17 AM in Economics, Market Failure, Regulation | Permalink  Comments (8)


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