Session 7: Thin Markets and Market Manipulation:
Rosa Abrantes-Metz (Global Economics Group and NYU Stern School of Business) examines market manipulation in the financial services industries, with focuses on financial benchmark and credit ratings. Evidence has been found on individual quotes for undisclosed financial benchmark, which indicates flawed benchmark structure LIBOR and some other structure concerns. With examples of gold and silver, Rosa suggests that the problem of manipulation is worsen with a lack of independent monitoring. According to her, the signs of structure failure are obvious, and possible solutions include appropriate structure targeting specific flaws and market screening.
Regarding credit rating, she argues with identification of the underlying causes that the problem is “rating shopping,” where issuers seek out credit rating agencies (CRAs) which rate their products well. Effective policies should be addressed to solve this problem, and calls for “market share caps” would not be part of them. There are worries on the quality of ratings especially in structured finance. Structure finance ratings have been “inflated” as a result of monopsony power that clearly affects the ratings by CRAs. A unanimity of opinion at a more liberal level would encourage CRAs to reveal truthful ratings.
A main message that Rosa tries to deliver is that in both markets discussed, there seems to be a misdiagnosis to the weakness of the structure. If this misdiagnosis problem is not fixed, proper policies could not be addressed and problems would be worsen.
Mike Waterson (University of Warwick) gives a very critical view of regulation in the UK electricity market. While viewing the original 1990 vision of privatisation as “pioneering,” the response to problems has been delayed, piecemeal and performed without regard to the wider effects of changes. Waterson argues that through this process the design of the market has been distorted beyond recognition.
The main four conflicting priorities are controlling the environmental impact of generation, supplying electricity to all consumers, keeping the price of electricity low, and ensuring sufficient investment in capacity. These problems exist at the supply level but are most acute in generation.
The 1990 blueprint for the industry was to vertically disintegrate the market, allow trading in a main “pool,” and allowing competition in both generation and supply. The first two of these no longer apply, since all major firms are vertically integrated and there is no longer central trading pool. The consolidation of firms to six major suppliers has threatened competition at all levels.
Vertical integration was permitted in an attempt to encourage competition in generation. Large subsidies at the expense of customers were used to increase capacity when needed, such as the large payment to EdF for the construction of a new nuclear power plant, and for renewable power sources. The wholesale market suffers from a lack of liquidity as a result of the elimination of the general trading pool which came with vertical integration, seen as necessary in order to spur investment in generation. Each of these changes in policy were made to tackle a single problem, without much regard for the effects on the other policy priorities.
There is a recognition among policymakers of these problems but apparent confusion in how to solve them. Subsidies for power storage and for holding flexible generating capacity have been suggested but the current Feed In Tariff system, which gives constant payments to generators, means the economics of this system are presently unworkable.
A solution must involve a new recognition of the need to optimise across the whole market rather than focusing on individual fuels. Supernormal profits are necessary to induce private investment and the subsidisation of environmentally damaging fuels is an ever-present problem.