What Business is Wall Street In?
09-21-2012, 10:59 AM
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What Business is Wall Street In?
Thought Cuban's blog was interesting this morning.
Wall Street doesn’t know what business it is in. Regulators don’t know what the business of Wall Street is. Investor/shareholders don’t know what business Wall Street is in.
The only people who know what business Wall Street is in are the high frequency and automated traders. They know what business Wall Street is in better than everyone else. To traders, whether day traders or high frequency or somewhere in between, Wall Street has nothing to do with creating capital for businesses, its original goal. Wall Street is a platform. It’s a platform to be exploited by every technological and intellectual means possible.
The best analogy for traders? They are hackers. Just as hackers search for and exploit operating system and application shortcomings, high frequency traders do the same thing. A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it. A high frequency trader wants to jump in front of your trade and then sell that stock to you. A hacker will tell you that they are serving a purpose by identifying the weak links in your system. A trader will tell you they deserve the pennies they are making on the trade or the rebate they are getting from the exchange because they provide liquidity to the market.
I recognize that one is illegal, the other is not. That isn’t the important issue.
The important issue is recognizing that Wall Street is no longer serving the purpose what it was designed to. Wall Street was designed to be a market to which companies provide securities (stocks/bonds), from which they received capital that would help them start/grow/sell businesses. Investors made their money by recognizing value where others did not, or by simply committing to a company and growing with it as a shareholder, receiving dividends or appreciation in their holdings. What percentage of the market is driven by investors these days?
I started actively trading stocks in 1992. I traded a lot. Over the years I’ve written quite a bit about the market. I have always thought I had a good handle on the market. Until recently.
Over just the past 5 years, the market has changed. It is getting increasingly difficult to just invest in companies you believe in. Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks. And those macro issues impact automated trading decisions, which impact any and every stock that is part of any and every index or ETF. Combine that with the leverage of derivatives tracking companies, indexes and other packages or the leveraged ETFs, and individual stocks become pawns in a much bigger game than I feel increasingly less comfortable playing. It is a game fraught with ever increasing risk.
So back to the original question. What business is Wall Street in?
Its primary business is no longer creating capital for business. Creating capital for business has to be less than 1pct of the volume on Wall Street in any given period. (I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason). It wouldn’t shock me that even in this environment that more money flows from companies to the market in the form of buybacks (which i think are always a mistake), than flows into companies in the form of equity.
My 2 cents is that it is important for this country to push Wall Street back to the business of creating capital for business. Whether its through a use of taxes on trades (hit every trade on a stock held less than 1 hour with a 10c tax and all these problems go away), or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 1 year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years. However we need to do it, we need to get the smart money on Wall Street back to thinking about ways to use their capital to help start and grow companies. That is what will create jobs. That is where we will find the next big thing that will accelerate the world economy. It won’t come from traders trying to hack the financial system for a few pennies per trade.
And solutions won’t come from bureaucrats trying to prevent the traders from hacking the system. The only certainty when bureaucrats step in is that the law of unintended consequences will smack us all in the head and the trader/hackers will find new ways to exploit the system that makes them big money and even more money for the big institutions that develop products for the other institutions that are desperate to play the game.
Regulators have got to start to recognize that traders are not investors and vice versa and treat them differently. Different regulations. Different tax structure. Different oversight. Individual investors and the funds that just invest in stocks and bonds are not going to crash the market. Big traders who are always leveraging up and maximizing the number of trades/hacks they make will always put the system at risk. We need to recognize that they do not serve much of a purpose other than to add substantial risk to the global economy. That their stated value add of liquidity does not compensate the US and World Economy nearly enough for the risk of collapse they introduce into the system.
Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders. The Government needs to create simple and obvious incentives for this business and extract compensation from the traders/hackers for the systemic failure risk they introduce.
There will be another flash crash, and probably a crash far worse than the May 2010 flash crash simply because there are too many players looking for the trillion dollar score. They can’t all win, yet how many do you think wouldn’t risk everything, even what is not theirs, for that remote chance to score big? Put another way, there is zero moral hazard attached to any trade. So why wouldn’t traders take the biggest risk possible?
There is value to trading automation. It is here to stay. There is absolutely NO VALUE to High Frequency Trading. None. We need to bring our markets back to their original goals of creating capital for business. It’s impossible to guess how many small to medium size companies have been held back from growing and creating jobs and wealth because of lack of access to capital from the stock market. It’s not impossible to know that our economy has suffered because Wall Street equity markets are no longer a source of equity for helping companies grow, it is not a platform for hackers and that needs to change. Quickly.
The only people who know what business Wall Street is in are the high frequency and automated traders. They know what business Wall Street is in better than everyone else. To traders, whether day traders or high frequency or somewhere in between, Wall Street has nothing to do with creating capital for businesses, its original goal. Wall Street is a platform. It’s a platform to be exploited by every technological and intellectual means possible.
The best analogy for traders? They are hackers. Just as hackers search for and exploit operating system and application shortcomings, high frequency traders do the same thing. A hacker wants to jump in front of your shopping cart and grab your credit card and then sell it. A high frequency trader wants to jump in front of your trade and then sell that stock to you. A hacker will tell you that they are serving a purpose by identifying the weak links in your system. A trader will tell you they deserve the pennies they are making on the trade or the rebate they are getting from the exchange because they provide liquidity to the market.
I recognize that one is illegal, the other is not. That isn’t the important issue.
The important issue is recognizing that Wall Street is no longer serving the purpose what it was designed to. Wall Street was designed to be a market to which companies provide securities (stocks/bonds), from which they received capital that would help them start/grow/sell businesses. Investors made their money by recognizing value where others did not, or by simply committing to a company and growing with it as a shareholder, receiving dividends or appreciation in their holdings. What percentage of the market is driven by investors these days?
I started actively trading stocks in 1992. I traded a lot. Over the years I’ve written quite a bit about the market. I have always thought I had a good handle on the market. Until recently.
Over just the past 5 years, the market has changed. It is getting increasingly difficult to just invest in companies you believe in. Discussion in the market place is not about the performance of specific companies and their returns. Discussion is about macro issues that impact all stocks. And those macro issues impact automated trading decisions, which impact any and every stock that is part of any and every index or ETF. Combine that with the leverage of derivatives tracking companies, indexes and other packages or the leveraged ETFs, and individual stocks become pawns in a much bigger game than I feel increasingly less comfortable playing. It is a game fraught with ever increasing risk.
So back to the original question. What business is Wall Street in?
Its primary business is no longer creating capital for business. Creating capital for business has to be less than 1pct of the volume on Wall Street in any given period. (I would be curious if anyone out there knows what percentage of transactions actually return money to a company for any reason). It wouldn’t shock me that even in this environment that more money flows from companies to the market in the form of buybacks (which i think are always a mistake), than flows into companies in the form of equity.
My 2 cents is that it is important for this country to push Wall Street back to the business of creating capital for business. Whether its through a use of taxes on trades (hit every trade on a stock held less than 1 hour with a 10c tax and all these problems go away), or changing the capital gains tax structure so that there is no capital gains tax on any shares of stock (private or public company) held for 1 year or more, and no tax on dividends paid to shareholders who have held stock in the company for more than 5 years. However we need to do it, we need to get the smart money on Wall Street back to thinking about ways to use their capital to help start and grow companies. That is what will create jobs. That is where we will find the next big thing that will accelerate the world economy. It won’t come from traders trying to hack the financial system for a few pennies per trade.
And solutions won’t come from bureaucrats trying to prevent the traders from hacking the system. The only certainty when bureaucrats step in is that the law of unintended consequences will smack us all in the head and the trader/hackers will find new ways to exploit the system that makes them big money and even more money for the big institutions that develop products for the other institutions that are desperate to play the game.
Regulators have got to start to recognize that traders are not investors and vice versa and treat them differently. Different regulations. Different tax structure. Different oversight. Individual investors and the funds that just invest in stocks and bonds are not going to crash the market. Big traders who are always leveraging up and maximizing the number of trades/hacks they make will always put the system at risk. We need to recognize that they do not serve much of a purpose other than to add substantial risk to the global economy. That their stated value add of liquidity does not compensate the US and World Economy nearly enough for the risk of collapse they introduce into the system.
Wall Street as a whole needs to be in the business of creating capital for companies and selling shares to investors who believe they are shareholders. The Government needs to create simple and obvious incentives for this business and extract compensation from the traders/hackers for the systemic failure risk they introduce.
There will be another flash crash, and probably a crash far worse than the May 2010 flash crash simply because there are too many players looking for the trillion dollar score. They can’t all win, yet how many do you think wouldn’t risk everything, even what is not theirs, for that remote chance to score big? Put another way, there is zero moral hazard attached to any trade. So why wouldn’t traders take the biggest risk possible?
There is value to trading automation. It is here to stay. There is absolutely NO VALUE to High Frequency Trading. None. We need to bring our markets back to their original goals of creating capital for business. It’s impossible to guess how many small to medium size companies have been held back from growing and creating jobs and wealth because of lack of access to capital from the stock market. It’s not impossible to know that our economy has suffered because Wall Street equity markets are no longer a source of equity for helping companies grow, it is not a platform for hackers and that needs to change. Quickly.
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09-21-2012, 01:12 PM
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As a guy that works in the industry, I think he nailed several important elements. HFT does add liquidity to the market... until it doesn't. When HFT and algorithmic traders withdraw that liquidity, it happens in the blink of an eye and magnifies everything.
I think his description of HFTraders as hackers is spot-on. Likewise, his description of Wall Street's role having moved away from the role of pairing companies with capital and investors with stakes in those companies.
One thing he didn't mention was the evolution of the exchanges themselves, and their primary sources of revenue generation.
I think his description of HFTraders as hackers is spot-on. Likewise, his description of Wall Street's role having moved away from the role of pairing companies with capital and investors with stakes in those companies.
One thing he didn't mention was the evolution of the exchanges themselves, and their primary sources of revenue generation.
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09-24-2012, 01:33 PM
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So, this blog establishes pretty clearly that the various securities markets are today engaged in principally for the purposes of speculation rather than investment.
One question I'd ask: the blog takes the tone that this is an inherently bad thing: why?
Consider, for instance, the commodities markets. The very essence of futures trading is speculative, and yet these exchanges have existed since the early 1700s, prior to the founding of the US. Exchanges such as the Chicago Mercantile Exchange and the Chicago Board of Trade exist solely for the trading of futures / options contracts, and these date back to the mid to late 1800s, long before the existence of computers and high-speed data networks (the CBOT even predated the electromechanical stock ticker by 20 years.)
If I were to pose one question to the author of that blog, it would be this: You've established the obvious, that securities exchanges are speculative in nature. Now explain to me why this is inherently bad and is worthy of the reform that you propose.
Am I mistaken in understanding that their revenue comes principally from:
A: Listing fees, which are an annual fee paid by corporations (such as AAPL) to the exchange in return for the service of being listed on that exchange, and
B: Exchange fees, which are a small fee levied on each purchase and sale of a security or contract which is transacted through the exchange. (eg: If I buy 100 shares of stock, and I pay a $5 fee to my broker, a small portion of that fee winds up being paid all the way back to the listing exchange itself.)
... and that this has not meaningfully changed over the history of their existence?
One question I'd ask: the blog takes the tone that this is an inherently bad thing: why?
Consider, for instance, the commodities markets. The very essence of futures trading is speculative, and yet these exchanges have existed since the early 1700s, prior to the founding of the US. Exchanges such as the Chicago Mercantile Exchange and the Chicago Board of Trade exist solely for the trading of futures / options contracts, and these date back to the mid to late 1800s, long before the existence of computers and high-speed data networks (the CBOT even predated the electromechanical stock ticker by 20 years.)
If I were to pose one question to the author of that blog, it would be this: You've established the obvious, that securities exchanges are speculative in nature. Now explain to me why this is inherently bad and is worthy of the reform that you propose.
A: Listing fees, which are an annual fee paid by corporations (such as AAPL) to the exchange in return for the service of being listed on that exchange, and
B: Exchange fees, which are a small fee levied on each purchase and sale of a security or contract which is transacted through the exchange. (eg: If I buy 100 shares of stock, and I pay a $5 fee to my broker, a small portion of that fee winds up being paid all the way back to the listing exchange itself.)
... and that this has not meaningfully changed over the history of their existence?
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09-24-2012, 01:44 PM
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If I were to pose one question to the author of that blog, it would be this: You've established the obvious, that securities exchanges are speculative in nature. Now explain to me why this is inherently bad and is worthy of the reform that you propose.
[...]
Am I mistaken in understanding that their revenue comes principally from:
[...]
...and that this has not meaningfully changed over the history of their existence?
[...]
Am I mistaken in understanding that their revenue comes principally from:
[...]
...and that this has not meaningfully changed over the history of their existence?
I'll try to expound later, but it's a nuanced argument and evolution.
Cuban's main point is not that "Wall Street" being engaged in speculative behavior is bad. It's the specific nature of the highly compressed "trading" versus "investing" behavior.
As for the exchanges, it's again about nuance. You have the basics, but the specifics of who and how the fees are charged (again, circling back to HFTraders) and the potential conflicts of interest that arise. See: NYSE fined for putting some HFTraders in front of other retail customers.
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09-24-2012, 02:22 PM
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I am reminded of a line from the movie "Trading Places" in which Dan Acyroyd, upon entering the floor of the commodities exchange, remarks "Here it is. The last bastion of pure capitalism left on earth."
See: NYSE fined for putting some HFTraders in front of other retail customers.
Because we all know, of course, that allowing a business to give preferential treatment to its most loyal / profitable customers runs contrary to the basic tenets of a capitalist economy.
(see: frequent flyers, frequent gamblers, travel club members, season ticket holders, fleet purchasers of cars/trucks, etc.)
I wonder what would happen if two restaurant owners approached the same wholesale distributor wanting to buy a certain product which, due to a poor harvest, was in short supply. Might the distributor's actions be biased by the fact that one of the prospective customers owned a chain of thirty restaurants and did 100% of his business with that supplier, while the other owned only a single restaurant and was not an exclusive customer of the distributor?
Last edited by Joe Perez; 09-24-2012 at 02:38 PM.
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