Karl Denninger, “Price Discovery: Uh, No - Just More Theft”

 “Price Discovery: Uh, No - Just More Theft”

 by Karl Denninger

“There are two "social goods" that merit the existence of a "strong" capital market. Those are capital formation and price discovery.

Capital formation happens only when an original issue is created.  That is, when a company comes to market with an IPO, when it takes "Angel Investor" money, or when it is seeded by the founder's savings.  It is capital formation that creates new jobs, new industries, and innovation.  It is capital formation that justifies, in the main, the existence and maintenance of a capital market structure such stock exchanges, bond markets and similar.

Price discovery is what everything else in the capital markets devolves down into.  Price discovery is the short term for haggling - negotiation, auctions, disagreement over value.  One party is later proved right, and the other proved wrong.  There is no job creation, innovation or industry that is put forward by price discovery.  However, without price discovery Capital Formation becomes extremely difficult in any sort of public market, since there is no means available to know if you're forming capital at a reasonable rate of return other than by the experiences of others.  It is therefore a necessary function and a social good.

But price discovery requires public markets.  That is, it requires exposition of bid, offer and size where we can all see it.  In addition a public market must demand that the participants be able to clear the trades they put on - that is, that if they claim they intend to buy or sell something, they have the economic power (or ability to acquire the product or service to be sold or bought) prior to entering into the transaction and for the entire period that the position remains open. As soon as you get rid of the public exposition of these elements, said market is no longer a market - it is now a mechanism to steal. And that's exactly what the banks have been doing - and continue to do - when it comes to derivatives.

On the third Wednesday of every month, the nine members of an elite Wall Street society gather in Midtown Manhattan. The men share a common goal: to protect the interests of big banks in the vast market for derivatives, one of the most profitable — and controversial — fields in finance. They also share a common secret: The details of their meetings, even their identities, have been strictly confidential. Strictly confidential eh?  Even their names are secret?

This is no small - or laughing - matter.  If you heat with oil in the home, this winter you may have "locked in" a price before it got cold for the winter on a per-gallon basis.  You did this because the company you contacted with entered into a derivative trade - that is, he bought forward your expected consumption, paying a (hopefully small) premium now as effective "insurance" against a price spike.  But this sort of "insurance" only works in a transparent manner if the people selling it and buying it are doing so in the public eye.  If they're not - and if one or more of them are suppressing that price discovery through secrecy then the "spread" - or the amount that you pay for the contract, is not matter of auction - that is, bidding by multiple people.

Rather, it is set by a cartel. Cartel behavior in the United States - ala OPEC - is supposed to be broadly illegal. They wouldn't be doing that, would they? The banks in this group, which is affiliated with a new derivatives clearinghouse, have fought to block other banks from entering the market, and they are also trying to thwart efforts to make full information on prices and fees freely available.

Oh I guess they might be. See, secrecy is the only way to protect outsized margins - what economists call "economic rents."  If you have an open auction-style market, "rents" fall until there is nobody willing to provide the service requested at a cheaper price.  Indeed, that's the point of price-discovery, in part - to discover the price at which someone will clear a transaction - not just the price of a given good or service.

But heh, what's an extra few tens of billions of dollars that is effectively stolen from consumers and producers across the economic spectrum through cartel-like behavior - behavior that, under existing anti-trust law, should be considered illegal. It's not like this is new, right, nor is buying off regulators - like The Fed, like the CFTC, like Congress...”

http://market-ticker.org/

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