But the same big question could be asked: So what? Why is it regulators’ business to make sure we all have cheap trading costs?
Again, I realize that the gang around the bar might think this one is obvious, too, since trading costs have come down dramatically, and the structure that brought about the reduction created HFT and all the electronic exchanges that we see today. Those who survived the change are in business because of the reforms. So why wouldn’t they applaud them?
Yet problems arise when antitrust regulators are put in charge of holding down costs. First, consider the distortions that come about when trustbusters are able to succeed in some cases and not in others. Let’s say, for example, that we get cheap trading costs but not cheap beer, or vice versa. This would cause us to over-consume or under-consume beer or trading services relative to the other, sending poor signals to the producers of these goods as to what we really want or need. Where’s the efficiency in that?
Second, forcing producers to receive less so consumers can pay less may have consequences in terms of the quality of the product or its methods of delivery, either of which could rile consumers. Cutting corners in beer -- like reducing alcohol content, as Maker’s Mark did recently to the chagrin of its fans, or reducing the number of brands or their distribution to your favorite bars -- could seriously annoy some drinkers. More consequentially, messing with the structure of equity trading to lower costs could harm the market’s ability to deliver capital to companies, or a reliably stable trading environment, or an understandable trading process that makes investors feel comfortable investing.
Third, lowering prices across all the industries that are vulnerable to antitrust attack could have unexpected disinflationary or deflationary effects, which are beyond the remit of the antitrust agencies individually, or the antitrust process in general. While this problem may seem small, since it would be expected to proceed gradually as industries are attacked sequentially (although the Wall Street Journal says the DOJ now is simultaneously attacking seven industries in “Antitrust, Coming to a Court Near You”), the much-lamented lack of pricing power across many industries today is certainly a complicating factor in the mission of the Federal Reserve to enable growth without inflation.
The commoditization of every aspect of the financial industry is a case in point. From exchanges to brokers to investment banking, research and the decline in the number of public companies, there has been a significant decline in Wall Street as an industry as its pricing power disappears. That decline has been accompanied by a decline in jobs for Main Street as the doldrums in new-company creation continue. More troubling, the Wall Street product today has fewer fans than it did before its pricing power was removed.
Diehard market structure types may imagine that market structure has nothing to do with capital formation, as they each tout their favorite fixes for current problems. But the fixes the experts have touted since the National Market System was launched in 1975 were for the same problems they are still trying to fix today, namely, the lack of fairness, access, transparency, best price, etc. The only difference is that the problems have speeded up and the fat tails have become obese, a result that appears to have been caused by, and certainly happened alongside of, the previous fixes.
[Related: “Narrower Spreads: A Trivial Pursuit”]
It may be instructive to contemplate that this same market structure process is now going after beer. If the trustbusters are as successful at destroying the pricing power and organization of the beer market as they have been at destroying the pricing power and organization of capital markets, then we’d all better drink up now.
Steve Wunsch is a writer and consultant on stock market structure living in New York City. He was the founder of the Arizona Stock Exchange launched in 1992 and an inventor of the ISE Stock Exchange launched in 2006. His latest book, Nature’s God, discusses the inappropriateness of antitrust as a market design tool.
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9 Comments to "Beer, Competition and Transaction Costs":
lberke
21 February 2013
Here here, well done Steve! Love the beer analogy and clarity of thought. To take your story one step further, ask some of the market structure afficianados of the regulatory variety standing with you at the bar whether they think that prices are not the only issue that "reform" should address. It may be that certain varieties of beer shouldn't be served at all. Like HFT and its impact on market behavior, certain beers may actually have immeasurable and unquantifiable impact on the willingness of patrons to consume it. If Washington could only determine not just the price at which beer should be sold but which individual beers should be made available and to whom, well then surely we will have eliminated the risks associated with joining your friends for a glass.
Comments (129)
John Harris
21 February 2013
You never fail to bring incisive perspective to the subjects of market structure and network formation, Steve. Without differing with the substance of your analysis in any way, let me just add for your consideration a slightly different take on the issue of pricing power.
What we have seen over time is a consolidation of Wall Street. Tens of thousands of entrepreneurial ventures operating in a highly-competitive market have been displaced by a market arrangement in which thousands still compete, but the vast majority of them in the orbit of a few, politically-powerful super-firms that operate with implicit, government guarantees. Hand in hand with this evolution has been comparable change in other industries. We are now in a syndicalist or fascist economy, where we have market domination by a small number of government-favored institutions, especially in the financial, pharmaceutical, medical, communications, defense, and agricultural sectors. Thus far, only the information technology industry remains competitive and relatively free and open, outside of businesses that require easements to operate.
So, under this evolved market structure, pricing power may not be what it seems. Wall Street - big Wall Street - enjoys the most valuable pricing power on earth: power over the price of the world's reserve currency. Everything else is peanuts by comparison. Who cares about commissions on stock trades when you control a legal counterfeiting operation? Throw the rabble a bone and all that.
Similarly, capital formation is not much of an issue in a syndicalist or fascist economy. The favored enterprises have unlimited access to capital. By way of example, why does Boeing need access to Main Street capital when it can get all the money it needs from the Ex-Im Bank?
Thank you, as always, for a terrific essay.
stevewunsch
21 February 2013
Thanks, Laurie, well put. I can only hope DOJ doesn't read Tabb, as it might take up your suggestion to "determine not just the price at which beer should be sold but which individual beers should be made available and to whom." Of course, I don't much care, as long as I can get my Budweiser, which seems safe for now. But once they get going, you never know what these do-gooders will do!
John, your comment as alway is full of food for further thought, for which I thank you. I think you're right about the fascism characterization. And I do remember reading that Hitler's Germany had no trouble growing quickly once the Nazis ramped up infrastructure spending, which was quite popular with the "Volk" at the time, who were sort of like our "99%" or "middle class." The question, of course, is not how Boeing gets funded, but how the next industry we've never heard of gets funded. Since there is no chance that either the Ex-Im Bank or today's infrastructure spenders will be able to recognize the value of a new idea with the untested promise of those that regularly emerged from Nasdaq in the 'eighties and 'nineties, the trick is figuring out how to get out from under Washington's wet blanket. The pricing power that matters is that which suddenly appears out of nowhere, as a new product or service we didn't know we wanted comes into being, commands our attention and dollars, and takes its place as part of our ever-evolving infrastructure. It is antitrust's mission to kill those industries and the markets that give rise to them, largely through the insertion of artificial competition. This puts them in the position of being old, dying or dead industries in need of infrastructure spending . . . or market structure reform.
Comments (46)
lberke
21 February 2013
Steve and John,, right again. This type of mandate is a threat to capital formation and entrepreneurship as well as government interference with capital market activity. Not just pricing but formation. I'm not for monpolies or fraud but I worry that the Next New Thing is so buried with the costs of compliance that it never has a chance to survive let alone prosper.
Comments (129)
John Harris
21 February 2013
Good points, Laurie and Steve. How many innovative financial services or technologies cannot make it out of the starting gate because venture investors don't want to fund highly-regulated businesses or compete in a market where the chosen few have implicit government guarantees? And who can blame them? Or, to take a recent and particularly repugnant case of regulatory stupidity, look at what the CFTC has done to Intrade and its many U.S. customers. Here we are in the supposed Land of the Free and Brave, and we can't risk ten bucks in a prediction market the rest of the world can patronize.
At the moment, the constituency for change is too small. The U.S. regulatory regime will get worse before it gets better. Eventually, competition from other countries will make the present situation untenable, but that may take a long time to pass.
In the meantime, I will remain on my personal picket line. I have plenty to keep me busy that doesn't require me to submit to the madness of Dodd-Frank.
stevewunsch
21 February 2013
You're both right that we are smothering new business formation with foolish regulation. But to be clear, the Nanny State is doing this not only under its authority to prevent fraud, but under its authority to prevent monopoly. John, I think you dispensed nicely with the silliness of fraud protection in your Intrade example. But Laurie I think we have to realize that solving the "cost of compliance" problem fully will require a new acceptance of what free market network formation often leads to, namely monopolies. Nasdaq once did a great job of matching investor money with new companies in need of capital, somehow handling the cost of compliance in the process. That it did this job so well that it became a monopoly and therefore a target for DOJ should not trouble us. it is DOJ and antitrust that should trouble us. They are what is killing new business formation now. As I put it in my book, "Do we really want dozens of stock exchanges? Hundreds? Thousands? if so, why? If not, how do we determine what the right number is? Why can't the right number be 1, if that is what free market competition leads to?" Network scientists could do us all a favor by formally exploring such questions, which as near as I can tell, neither SEC nor DOJ have grappled with in a stock exchange competition context. Hence, the smothering.
Comments (46)
John Harris
22 February 2013
Absolutely right, Steve - if the market determines that one exchange is the correct number, so be it. And I suspect that something close to one - but not exactly one - is the right number within certain, reasonably homogenous market segments (I doubt, in other words, that the market would determine that a single exchange for all securities and commodities on earth would be optimally efficient).
That said, with respect to Nasdaq and the antitrust case, my memory is that this was a self-inflicted wound. What caught DOJ's attention was not Nasdaq's near-monopoly but evidence of price coordination among dealers, i.e., a lack of real competition. Mind you, as an anarchist, I do not object to price fixing and am happy to let competitive forces deal with such phenomena; I want market discipline for such behavior, not government discipline. But in this case, after the Vanderbilt study, DOJ faced public embarrassment if it failed to act. Normally in securities matters DOJ subordinates itself to SEC, but occasionally - Nasdaq and BrokerTec come quickly to mind - DOJ feels compelled to act. I'm not defending DOJ's actions, just offering an explanation.
stevewunsch
22 February 2013
Those are useful clarifications, John, and I agree with all of them. The price fixing that the Christie/Schultz study revealed, which it called "tacit collusion," and which the parallel investigations by SEC and Justice both confirmed in spades, would have made for an open and shut case if the dealers and Nasdaq had not settled. I perhaps shorten the story too much when I simply refer to Nasdaq then as a monopoly, but I doubt any judge would have had any difficulty reaching the same conclusion at trial. Price fixing is, after all, one of those "per se" violations for which there is theoretically no defense. But now that I have awakened your inner anarchist's faith in letting the market decide, let me suggest the possibility that, while the violations were indeed clear cut enough to have been a "self-inflicted wound," there is another perspective worth considering. They also may have created the extra incentives for raising capital that led to all those great new companies that now constitute America's high tech advantage. Quarter ticks (the flip side of the strange missing "odd eighths" that Christie/Schultz highlighted) were perhaps integral to enabling the companies we celebrate today to go public. This is in fact the subtext, hidden and unacknowledged, behind the JOBS Act's planned pilot. Whatever becomes of that pilot, it is not likely to result in an affirmation of the freedom of markets to determine their own structures and rules, much less to grow into monopolies if that is what their members and the public demonstrate a demand for. The ability to engage in antitrust violations was key to forming the great old markets of the West, all of which are in the process of being busted and "deregulated" via antitrust. If antitrust had existed before these markets formed, they would never have formed in the first place. It is inconceivable to me that they will be able to re-form in the presence of antitrust, the SEC or DOJ. So, as I say in the book, the future high tech advantages are likely to go elsewhere, like to Brazil, Turkey or China, none of which appear to be enamored of the SEC's NMS model.
Comments (46)
John Harris
22 February 2013
That makes sense to me, Steve. If I may paraphrase and don't misunderstand you, the quarter ticks and tacit collusion on the market-making side of the ledger may have provided some measure of compensation for the price risk that firms accepted as underwriters and dealers, whether for syndicate operations or the provision of after-market support. I am sure I both miss and gloss over much of the elegance of the proposition, but even at that superficial level, I can appreciate that without that added compensation, the price risks may have been unacceptable.
As for the JOBS Act, I was encouraged by what firms such as Second Market were doing prior to the passage of the act. I do not know whether the JOBS Act has hurt their business, but I would guess it has. Certainly, as I read the act, it foreclosed what I considered to be the most promising way forward - or rather, way back - to a free market.