Don't Blame Traders for Making Money

Bees pollinate.  Bees make honey.  Bees can sting, too.  That hurts.

Spiders are scary.  But they also eat harmful insects.  Sometimes they bite, and some of the bites are painful, and poisonous.

Vultures are gross.  They eat dead things.  Nature's cleaning crew.

Sharks eat things.  Mostly other sea creatures, but sometimes they eat people who venture into the shark's dinner buffet line.

Traders trade.  They're supposed to make money doing it, but sometimes they lose money making risky investments.

Do we blame bees for being bees?  Do we blame spiders for being spiders?  Do we even want to think about vultures eating carrion, much less damn them for doing it?  Do we blame sharks for eating the occasional person?  (Well, unless you're Captain Quint and are convinced sharks eat people with menace and forethought, but that was Hollywood fiction.)

Then why do we want to villainize traders for trading?  The object of trading is to make money.  Traders don't go to work every day hoping just to break even, or take a loss that produces money for some other entity.

A recent article in the New York Times scandalizes profitable electric market trading and blames traders for "making consumers pay more."

When the regulators and legislators decided to create a competitive electricity market, they spread a bunch of financial chum in the water to attract investors to come buy the products the market created and shoulder some of the risk of wild price swings in order to shield utilities and consumers.  The NYT article puts it this way:

The contracts were intended to protect the electricity producers, utilities and industries that need to buy power. The thinking was that the contracts would help them hedge against sharp price swings caused by competition as well as the weather, plant failures or equipment problems. Those lower costs could reduce consumers’ bills.

So, the traders came.  They ate the carrion.  But, the nature of risk means there's a balance between reward and loss.  Sometimes you win, sometimes you lose.  The NYT article concentrated on a winner, without mentioning any losses.  The NYT article lambastes DC Energy for being successful.  What do the NYT reporters think would happen if DC Energy, and all other traders, stopped buying these electric market products?  Could we do away with competitive markets?  Would consumers pay more or less if we did?

When a trader buys one of these products they are assuming risk that they may lose their investment.  If they lose, should consumers make them whole?  Of course not, the trader assumed the risk when he bought the product.  But, when they win, people like Mayor Margot Garant think the trader should give the money they made back to the consumers.

“Why aren’t we getting that money?” said Margot Garant, mayor of Port Jefferson.

Because you didn't take the risk, Margot!

Traders serve a purpose to keep competitive electricity markets functioning.

Trading firms like DC Energy say they ultimately benefit consumers by bearing financial risks and fostering competition. They argue that power companies can hedge only if someone else is willing to speculate. Market forces, they say, can also help power companies determine where to invest in the grid.

“We believe this type of activity should cause prices to better reflect true costs and thus create a more efficient electricity infrastructure that should better serve the retail customer,” Andrew J. Stevens, a co-founder of DC Energy, said in an email.

A trader made this very apt analogy to me:

"Traders should perform a valuable role -- they absorb risk that other market participants don't want to take.  Kind of like insurance companies, which can be wildly profitable too. It's like asking: what would happen to home prices if we disallowed insurance companies from selling homeowner's insurance? If people couldn't insure their home and had to assume the risk and liability of it burning down, people would be less likely to buy homes, would be more worried when living in their homes, etc.  In general, insurance companies provide a stabilizing effect on the housing market.  As a society, we accept this even though we know that insurance companies generally collect more in premiums than they pay out in claims. In other words, they are profitable, yet that doesn't seem to irritate people so much because we like going to bed at night knowing that our homes are insured."

So, why do we revile all traders, even ones making money legally?  Is it because taking down successful traders makes big headlines for regulators swaggering through the OK Corral with their market manipulation magnum drawn?  It's nice to think that some really smart guys are keeping us safe from bad traders doing things that are illegal, right?

But, the regulators aren't that smart.  If they were, we wouldn't have electricity markets with money-making loopholes big enough to drive a truck through.  When a trader makes a bunch of money making legal trades, we ought to punish the regulators, or the market monitors, or the RTO personnel who created these badly designed market products.  Why do we want to punish the trader for doing what traders do?

Maybe it's because those not-so-smart regulators want to drive all the traders who are smarter than they are from the market.  That may be the only way to stop traders from making money in our competitive electricity market.  Only then will the regulators be the smartest guys in the room, but our competitive electricity market won't survive it.

WANTED:  Really stupid traders to assume electric market risk and take losses.  Must be dumber than regulators and market monitors/designers and have an endless supply of cash to give away to consumers.  Apply at FERC or your regional transmission organization.