The older I get, the more confused I am. In the beginning, market makers and specialists were manipulative and kept spreads wide. Slow markets were expensive and unresponsive. And research was corrupt, as it was paid for by underwriters catering to issuers.
Then regulation and technology clipped colluding market makers' and specialists' wings, fragmentation accelerated exchanges, and the relationship between underwriters and research was severed. Just to ensure "safety," regulators layered on fraud protection (Sarbanes-Oxley), cracked down on money launderers (Patriot Act), eliminated uneven corporate information distribution (Reg FD), and cracked down on pernicious naked short sellers (Reg Sho). So now the market is better, right? Well ...
Today, even sophisticated traders have a hard time managing their order flow. Capital is non-existent. The markets are so fast that an eye blink is an eternity. Fewer public companies have analyst coverage. And issuers, traders and investors are abandoning the market: The number of U.S. publicly listed companies on major markets is down 44 percent from its 1997 high; investors have pulled out more than $525 billion from U.S. mutual funds since 2007; and U.S. equity trading volume is down 43 percent from a May 2010 peak.
Simple Is As Simple Does
Given the past few years, one could argue that these intended "improvements" have actually hurt the markets. Many market participants are saying we need to go back to simpler times, when spreads were wider, trading was slower, markets were simpler, research was more prevalent, and capital was more pervasive.
But do we really want to go backward? While more companies were going public 10 years ago, were the companies or the markets back then really better? Corporate corruption was rampant, specialists were taken away in handcuffs, market makers joined them on the perp walk, and research was biased.
On one side we have simple markets aligned toward growing public companies, which stimulates the economy and creates job -- but seems to come with higher transaction costs and a market in which the few can manipulate the many. On the other side is competition-driven pandemonium. Market structure is messy and displayed spreads are narrower, but it is virtually impossible to measure transaction costs and technology again allows the few to manipulate the many.
[Exchanges Fight Back Against the Dark Pools]
So maybe market structure doesn't matter? Maybe we shouldn't worry about jobs? Maybe this has nothing to do with market structure and everything to do with interest rates, regulation and oversight?
We've had 30 years of declining interest rates -- what CEO would believe the value of his or her company would appreciate less than the cost of debt? So why sell ownership when the one-year Libor is 1 percent and 20-year borrowing rates are below 4 percent? Why dilute ownership when it's much cheaper to borrow?
In addition, private equity has become so large and sophisticated that raising capital is relatively easy. Maybe public markets should just be a facility for private investors to cash out? When the smart are selling, however, buyers should be cautious.
Legislators and regulators have not helped, either. In the desire to show strength, legislators and regulators have upped fraud penalties. Instead of just levying fines, business leaders are now threatened with jail. Not that fraud is good, but one needs to wonder if the penalties are worth the risk? A paycheck in the bank may be safer than risking it all on a business.
Finally, while we are cracking down on crime, governments are making it harder to foresee the future. With the U.S. government threatening default and the European Commonwealth in turmoil, clarity is low and uncertainty is high, pushing investors toward the safety of government debt instead of corporate growth.
So what is the answer: Faster or slower? Tighter or wider? Public or private? Machines or people? Who knows? Maybe it's all moot anyway, as the only thing that will re-inflate the equities market is a combination of higher rates, more-controlled government and regulation, and a stable economy. That way companies are incented, and investors can have faith that the capital they are investing has a good shot of producing a return. Until then, it may all just be gambling.