Producing too little, charging too much.


Jamie Dimon, the CEO of JP Morgan, worries that derivatives reform will eat into his profits:

Revenue lost by dealers could be significant. Research and advisory firm TABB Group estimates the top 20 dealers generate around $40 billion annually from privately-traded derivatives, excluding credit default swaps.

Jamie Dimon, chief executive of JPMorgan Chase & Co , told bank analysts earlier this month that forcing dealers to trade derivatives on exchanges could cost his firm up to a couple of billion dollars in revenue annually.

Did you see what’s missing from this argument?

Let’s say I run a store that sell tacos. I make a profit running this store because I sell a lot of tacos and I do it well. The government wants to tax tacos, and I go out and yell about how I will make less profits. The reason I say this is because the government is going to shrink the market for tacos – I and everyone else will sell less of them because demand will go down.

Is that the case here? From Financial Times:

Trading in some of the over-the-counter derivatives widely blamed for aggravating the financial crisis is likely to surge if legislators press ahead as expected with proposed reforms, according to Icap, the world’s largest interdealer broker.

Michael Spencer, chief executive, said on Tuesday that along with a rise in electronic trading, the introduction of clearing would expand the market for instruments such as credit default swaps – mirroring the effect that the arrival of electronic trading had on futures, foreign exchange and other asset classes…

His comments come after similar predictions by Jeff Sprecher, chief executive of IntercontinentalExchange, the US futures exchange and operator of the biggest CDS clearing house. Mr Sprecher said he believed that the CDS market would overtake the interest rate swaps market, partly as a result of clearing…

Mr Spencer said: “If we are correct that the markets become more cleared – which I think is very highly likely – and that they go electronic, the ramifications for this in OTC volumes are likely to be extremely positive.”

So if this reform takes place, the amount of derivatives traded is likely to increase. JP Morgan would lose profit, though everyone would be buying more of the product they sell. This is not like the example above. Of course, these are interested parties in reform being quoted here, but the general argument that a presumption for clearinghouses and exchanges would increase the volume of traded derivatives is an opinion I hear more often than not.

Remember in economic theory the problem of a monopolist isn’t that he or she a terrible person, it’s that he or she charges too much for a good and produces too little of it. Notice that it seems that taking this market and modernizing it, given people access to price information and equal footing to participating in trading, would increase volume and decrease profits. Isn’t that what markets are supposed to do?

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2 Responses to Producing too little, charging too much.

  1. noompa says:

    Thanks- I think this is an important distinction that enough people aren’t making. Sure, at the simplest level, profits will go down: but its because of increased competition, not because of “excessive” regulation. As a matter of fact, a market of the sort proposed (and opposed by Dimon) would be decreasing the amount of deadweight loss (evident in the graph) and increasing the efficiency of the market.

    Now, insert the (in)appropriate response from Mitch McConnell here.

  2. Ed says:

    Setting aside the factual inaccuracy of his comments for just a moment, can we marvel at how quickly “excessive regulation” became a valid argument again?

    Then again, I guess excessive regulation must have caused the crisis in the first place.

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