(August 25) – “A quarter century ago, the old order passed on Wall Street. A new system forced price competition where there had been none, and that soon changed the financial landscape in ways no one had expected. Something very similar will begin next week,” writes Floyd Norris in today’s New York Times.
“The change on May Day 1975 was the end of fixed commissions. Suddenly, brokerage firms could seek business by offering to charge less on stock trades.”
“Commissions on institutional orders collapsed far faster than Wall Street expected. Some brokerage firms were forced out of business. Discount brokers appeared, and big blocks of stock traded as never before.”
“On Monday, the New York Stock Exchange and the American Stock Exchange will begin trading a total of 13 stocks in dollars and cents, rather than using fractions. Sometime next year, all stocks will be traded that way.”
“That change, in itself, is unimportant. Whether a price is quoted as a quarter or as 25 cents is irrelevant. What is important is that arbitrary limits on price competition are vanishing. In 1997, the smallest change in price on the Big Board was cut in half, to one-sixteenth of a dollar, or 6.25 cents. Now it will go to a penny.”
“Wall Street hopes that will bring a gradual reduction in spreads, the difference between the best price offered to buy a stock and the best price offered to sell it.”
“Bernard L. Madoff, the chairman of a firm that bears his name, says that for the largest 600 stocks, the spread now averages 10 cents a share. He thinks that will come down to a range of 5 to 7 cents and forecasts that additional volume will preserve brokerage firms’ profits.”
“Unfortunately for Wall Street, these changes have a way of arriving at inopportune times. In 1975, the market had just ended a severe bear market, and the public had lost interest in stocks. So, Wall Street was confronted with shrinking profit margins when it could least afford them.”
“Now, profits are high. But the Internet has opened up new ways to trade stocks and set off intense competition among different markets. That competition makes it likely that spreads — at least for the most active stocks — will sink more than many brokerage firms would like. The options markets, where competition is less cutthroat, have adopted rules to limit price changes to a nickel on many options and a dime on others. But efforts to arrange such civilized competition among stock markets fizzled.”
“Such efforts will continue, and the Securities and Exchange Commission will have to watch closely to make sure that rules do not inhibit price competition. But if the S.E.C. is vigilant, the world will change. Michael LaBranche, the chief executive of LaBranche & Company, a leading Big Board specialist firm, forecasts that exchanges and market makers that pay brokerage firms for sending orders to them will have to pay less. That will put pressures on profits of Internet brokers that charge low commissions and make their money from such payments.”
“Wall Street fears that a surge in message traffic will strain computer systems. But once the computer power is in place, trading methods will change. The role of limit orders — in which an investor sets the price at which he or she will trade — could expand since it will almost always be possible to seek a price between the posted prices.”