The other day I mentioned gerrymandering in a blogpost. Political parties have gerrymandered their states to ensure dominance of their parties. The same thing goes on in government agencies in a different way. Big corporate players use money and influence to dominate agencies. The SEC and alphabet soup of agencies that regulate the US financial system is a case and point. This is also the major reason I was against net neutrality regulation. The FCC is not any different and over time the advocates for net neutrality will find the big corporates gaining more, not less, power. Professor George Stigler was correct in his analysis that big government creates big lobbying. It’s not the other way around.
Today in the Wall Street Journal is an editorial by Antonio Weiss. He makes the case for not repealing legislation like Dodd-Frank. It’s not just my opinion that Dodd-Frank was one of the worst pieces of legislation ever passed in the history of the United States. Professor Craig Pirrong, an expert on markets has written extensively about it, calling it FrankenDodd. Professor John Cochrane also has a distaste for it. In early 2009, Cochrane also came out strongly against bank bailouts.
Weiss is so off base when it comes to engineering competitive markets, you wonder if he ever participated in one. He sounds as if he is writing out of an Ayn Rand politburo.
To this end, we are releasing an interagency report on the events of last October that highlights the evolution in the structure of the market for Treasury securities and will allow us to have a more substantive, and less speculative, discussion of a complex set of events and issues.
Here is a bedrock economic fact that you can build some market structure off of. When competition is increased the amount of quantity or service produced goes up. The price that one pays for it goes down.
Since Dodd-Frank was passed, competition has gone down. By the way, since Obamacare was passed, competition has gone down too.
Pricing in the stock market is many fold. Most retail customers focus on the commission they pay. Big brokers and big banks will try and scare you, “If we change the market structure, we will have to increase brokerage costs.”. That’s total bullshit. If the change market structure to make it flatter and more competitive and at the same time decrease the regulatory hurdles it takes to become a broker prices will go down.
You probably didn’t know this, but the initial startup cost to set up a new commodity exchange is minimum $2M dollars. $350,000 in legal fees for CFTC paperwork alone. By increasing competition, we’d drive trading costs down. We’d also increase innovation.
The other part of the cost of trading is the bid/ask spread. The wider the spread, the higher the costs. An example of this is examining US Treasury trade prior to the introduction of futures. Before futures, the b/a spread was very wide, sometimes as wide as half a point. Post introduction of futures, it became a tick wide, or $31.25. That saved the US Treasury trillions on the cost of the national debt.
Joe Saluzzi and Sal Arnuk have been on top of the market structure thing for a long time. I don’t see HFT as a boogeyman like a lot of people do. My thought is change the market structure to make it hyper-competitive and flat. Then, let’s see how HFT fits into the picture.
After the outage at the NYSE, people are wondering why the exchange didn’t spend more on technology. It’s because the regulators have created economic incentives that gutted the exchange. They don’t have the money to spend on new technology. By creating new regulation that drives more competition and makes trading more transparent, the NYSE would increase their profits and plow them back into technology. If they didn’t, they’d die because another exchange would be more innovative and pick up their business.
Here is what I would have been saying for years that the SEC should do to make markets better. This applies to Forex, corporate and muni bonds, and cash treasury markets too. Corporate and Muni bond markets are so opaque it would make your head spin. Trading costs are huge and cost local taxpayers billions. But that’s for a different blog post.
- End internalization. Let every order come to the market. No more bucketing of trades. It’s illegal in the futures industry.
- Ban pay for order flow. End the shenanigans that create a tiered distribution network which favors some companies over others. Increase competition!
- End dark pools. Make everyone compete on the same bid/ask spread. Bring trading out of the shadows and into sunshine.
- Deregulate all the hoops it takes to set up a brokerage agency, and an exchange.
Do that, and let’s see what happens to liquidity, trading costs and the market.