Wikipedia describes “arbitrage” as follows:

In economics and finance, arbitrage is the practice of taking advantage of a price difference between two or more markets: striking a combination of matching deals that capitalize upon the imbalance, the profit being the difference between the market prices.

Arbitrage is a simple, common and accepted investment strategy. Today, large banks make billions on the arbitrage opportunity set up for them by the U.S. government. Banks serve as intermediaries for the Treasury Department, who sells government bonds to take on debt, and the Federal Reserve, who buys the bonds with printed money (quaintly called “Quantitative Easing”). The price difference is not a commission or fee, it is the difference between the price set by the Treasury and the price on the “open market”. We can debate how open a market is when it is dominated by one entity with bottomless pockets, nonetheless, for the banks involved, this spread in prices becomes an arbitrage opportunity. There is a guaranteed market and thus, for the banks, an instant and risk free profit.

I once read a book that described an early arbitrage of gold in European markets. This was hundreds of years ago. Some bankers had figured out that there was a distortion between the price of gold in one market – say Germany – and another, like England. Using a fancy telegraph machine to communicate prices, the bankers would buy gold at a lower price in one market and then sell it at a higher price in another. After shipping risks, the price difference was an instant and risk free profit.

High frequency traders are, in a way, creating an artificial arbitrage when they use their co-location in the exchanges and their super-fast networks to get out in front of traders. They distort prices slightly ahead of known demand and, in doing so, create instant and risk free profits for themselves. This is a little different in that the HFT’s actually artificially create the arbitrage opportunity; HFT is not about price discovery but about creating that arbitrage.

We are comfortable with most of these arbitrage opportunities and even praise them as a smart and innovative aspect of capitalism and free markets. Indeed, the job of a market is price discovery and so arbitrage is a necessary and important balancing mechanism. Yet one simple form of arbitrage – one available to the ordinary guy with a car and a smart phone – has infuriated public officials, as well as some drivers and fairness advocates, in San Francisco.

Monkey Parking (twitter) is an app that allows someone to alert drivers when a parking spot is coming available. A driver looking to park then bids on that spot and the individual vacating waits for them to show up. Monkey Parking handles the transaction, the seller leaves the spot and the driver pulls in.

Obviously an app like Monkey Parking would not work in my hometown of Brainerd, Minnesota. Here there is so much parking that nobody would ever pay for it. The supply, even at a price of zero, vastly exceeds the demand. This is true for most American cities, even where they charge for parking. In San Francisco, however, there is a huge arbitrage opportunity because, at current prices, there isn’t enough parking to meet the demand. Those who use the Monkey Parking app are engaging in the long accepted practice of arbitrage. They are exploiting the difference between market prices – the cost of parking set by the authorities and the actual cost the market will pay – and pocketing the difference as instant, risk free profit.

San Francisco officials are not sold on the merits of arbitrage as a way to correct market imbalances, as least not when it comes to parking. The city has issued a cease and desist to Monkey Parking and has threatened any who use it with enormous fines. Here is what City Attorney Dennis Herrera said in a press release:

"Technology has given rise to many laudable innovations in how we live and work -- and Monkey Parking is not one of them," Herrera said. "It's illegal, it puts drivers on the hook for $300 fines, and it creates a predatory private market for public parking spaces that San Franciscans will not tolerate….People are free to rent out their own private driveways and garage spaces should they choose to do so. But we will not abide businesses that hold hostage on-street public parking spots for their own private profit.

Note that the only reason it is illegal is because the city has said so. There is nothing inherently illegal about what Monkey Parking does. Neither the company nor the app occupies any parking spot or creates an agreement for occupying a parking spot. The city of San Francisco has simply decided that they don’t like it. Ironically, the city has indicated Monkey Parking violates California’s Unfair Competition Law, but who is Monkey Parking competing against? They simply facilitate an arbitrage no differently than the telegraph allowed those bankers to arbitrage gold prices. Would San Francisco have shut down the telegraph?

There are three market responses to solve this problem. The first is to allow the people of San Francisco to use Monkey Parking and other similar apps to continue to arbitrage the difference in prices. This is politically unpalatable because it is seen as unfair by those who would like to be able to pay the below-market price for parking. It is also dumb because, from a market perspective, the taxpayer has paid for those parking spaces and is allowing the value they created to leak to private individuals.

The second is to build more parking. The arbitrage opportunity is available because, at the current price, more people want to park than there are available parking spots. The problem here is a difference between supply and demand. Build more parking and San Francisco can keep the price to park at the current level. Of course, one must question whether or not the city can break even building more parking at the current low rates. I suspect, as do some others with more insight, that they cannot, that they are in fact currently losing money subsidizing parking. At the end of the day, losing money on parking is also dumb policy.

This brings us to the obvious response, the choice that the market is screaming for: raise the price of parking. If parking were more expensive, there would be a balance between supply and demand and the Monkey Parking people would have nothing to arbitrage. The city/taxpayer would capture that difference and there would be ample amount of parking available at the current market price. The people who like their parking at below-market prices wouldn’t like it, but then again, wouldn’t we all prefer to pay less than cost for the products and services we use. The world doesn’t work that way (at least not for long).

I’m rooting for Monkey Parking in this one. If you believe our cities have too many parking lots and not enough productive space, you should be too.