Sep

22

LackBlame innovation for driving profits to zero. Then come the crises, the deregulation or re-regulation and the destruction of an eco system. The net result is the tipping point, a cascade, a rapid rise in temperatures and pressure, then a meltdown of the core. Then the speculators have all "been there done that" and know what to do next time we park the car in a dimly lit parking lot. Get the joke, and the joke is: a private transaction in a dimly lit lot may be more free market and profitable than on any low fee exchange today. Risk? Aaah to me it is about the same. Let's take a look.

Crash of 87..Innovation: portfolio insurance and program trading.. Crash. Regulation.. Brokers must answer phones.. scandals.. re-regulation.. electronic orders must be filled automatically by SOES. Outcome, eco system breakdown.. Small brokers swoop in, drive the profits from spreads and the ripping off of customers at open and close to zero.

Tipping point: Innovation..Electronic ECN networks to manoeuver around the brokers' market making systems..Brokers must now deal without side source of liquidity. Brokers stop making markets in tech stocks..focus on Investment Banking to fill demand of a viral marketing boom. Demand for Tech IPO's and the internet. Prices rise to ponzi-esque levels, pushed up by a mutual beneficial exchange..day traders, the small private specs want high prices, sellers are banished, brokers benefit from high prices to bring investment banking biz… and crash..

Regulation.. to save day traders and small specs from themselves..big brokers with a regulator in their pocket demand rules to protect themselves from evil speculators.. which drives out most small brokers.. The innovators, the small brokers with ECN's are sold to the big brokers.. they see orders first, shut out small specs, profits dive to zero.

Small specs go to work for old friends at hedge funds that now control ECN's with big brokers.. High frequency trading is born.. Innovation: computers now have the power to be programed to run faster than an army of fast fingered day traders..Old day trading firm's managers now work for hedge funds programming and operating auto X ECN's and markets. Servers are moved geographically, like day traders once moved themselves, to get fastest access and flash quotes.

The other half of the day traders (self employed small specs) attack the next slow moving system in need of reform and drive profits to zero, real estate transactions. The 6 percent broker fee and 5k closing costs, 4-6 weeks to close is driven to 48 hour no fee, no doc fast movers. Profits off transaction for slow movers are driven to zero. Once again the only way to profit is to drive the prices of the underlying product to uneconomic levels. Hot products are not IPO's but the new condo developments and CDO's…Prices crash, brokers and private specs once more driven from the markets.

Scandal forces change.. the last of the hold outs, the former NYSE big man that held an ironclad grip on the specialist regime, made too much profit for some. This PR blunder destroyed the specialist system. The merger of ARCA and the NYSE seat members was one of those inside jobs where everyone in the trading community either laughed or said good. "Those damn specialists have been robbing me for 2 cents a share for 50 years." Oh but wait.. Lets go back to 1987! Was it the specialists that didn't answer the phones or do the best job they could..or was it the Nasdaq early electronic markets? Free, low cost, open access markets have a risk.

Of course, brokers' management find they can't "make it up on volume" off equities. NYSE is spun off with the Arca ECN. Investment banking dries up after crash, once again look to innovation..First is the logical boom, just like last time, its off RE and CDO's..But wait there is more. Why not invent a new tracking stock like they did to satisfy the tech boom's demand. Let's do commodity ETF's.

Its a win-win situation, the pension funds can diversify without being ripped off by those nasty speculators in the pits. Once again electronic volume soars, transaction profits are driven to zero.. and the only way to profit is to send the underlying up to uneconomic prices..oil and many commodity-prices go parabolic during the great recession and financial panic extremes, then, of course, as usual, crash.

Here we are! What a fair system! Yikes! Anyone can have direct access to any market for a low fee, get a transaction and fill price in under one second. How wonderful! Except for the fact now information travels so quickly, from Shanghai to London, NY, San Fran and back to Tokyo and everyone in between has fast access. The split second any new information is let out, all quotes and prices disappear. Uh oh, what if everyone was electronic with all the same information in hand?

Wouldn't the market now be efficient? Sureeeeeeee until the liquidity pump is shut down, then boom. Once again it's like the 100-year old books, where J.P. in a top hat must step onto the exchange floor and say no worries all the money you need is on hand at a reasonable rate. Problem is there is no exchange floor. The banker in chief must go on 60 minutes TV news show to say all is well. So many are on the same side of the bets now that the funds target rate is zero and they have an asset purchase backstop! "WOW..this is just like back in nineteen hundred and" is the quote.

If we have 150 of our closest buddies standing shoulder to shoulder would we make better, quicker decisions? Is pit trading beneficial to the markets' eco system?  Perhaps not, but I can tell you first hand, we would all be much braver.

The markets have changed forever. These seven month, 7 week, 7 day in a row random runs are nothing new. They are in the 100 year old books when a few big global banks controlled the markets. We are now in the new era of electronics, rapid fire trading and information. Okay that is not new, what is new is now everyone has all of the above.

Which makes it an illusion of control. The few control too much of the money flows. Few have reserves, there is no profit on transactions. There is no back up for the system when the few the proud the elite turn off the spigot and the illusion of liquidity and control vanishes.

Hey, its all good here, we went from 6 cents a share 30 years ago after fixed commissions,  to 2 cents a decade ago..to now 1/2 cent a share fees all in, on stocks. That is fantastic reduction in the cost of doing business. Only problem is we need others to trade with and against.  A small spec and trader could always come and go as we please. Problem is now everyone thinks they can.

Aaah don't worry we have the federalies as a back stop say the bankers.. Oh boy just wait, until a few big specs find the time to break the central bank…then the forest fire that can't be extinguished.. and finally in 100 years the full cycle, the eco system is restored..and those without license and government inside contacts will again profit off mutually beneficial exchanges for a reasonable fee above zero..the salesman and specialist will return.

I imagine some dude said about the same things in 1939, after the telegraph, telephone, RCA tech boom and bust and government intervention..or the 19th century RR boom… or..

However our never ending quest to reduce costs drives all profits to zero, we kill one another, watch the boom, the bust and the Man left standing is always the government regulator. Their blue ribbon panel on market reforms is the final 'get the joke'. The government never becomes efficient.. so it was much better to pay that broker or pit trader his 2 cents after all…unless you prefer to trade with the Feds.


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3 Comments so far

  1. Jeff Watson on September 22, 2009 7:19 pm

    I vote for this to be "The Best Article of the Year" on Daily Speculations. Jeff

  2. the crowd on September 23, 2009 2:10 am

    I second this… (only joking!)

  3. Glenn Tipton on September 23, 2009 3:18 am

    "Hey, its all good here, we went from 6 cents a share 30 years ago after fixed commissions, to 2 cents a decade ago..to now 1/2 cent a share fees all in, on stocks"

    And of course individual investors of gone from paying outrageous commissions to some broker to paying ~7 bucks online.

    A great post LACK!

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