Commentary

Who Needs the NYSE?

By Stephen Moore
This article was published in The Washington Times, May 21, 2004.

You’ve got to hand it to Richard Baker, the Louisiana Republican who chairs the House Financial Services Committee. Mr. Baker is earning a reputation as the foremost muckraker in Congress as he battles powerful and politically influential special interests in Washington. He takes on corporate titans that even Ralph Nader would likely shy away from.

Last year, Mr. Baker caused quite a hullabaloo in Washington by questioning the wisdom of the multibillion-dollar subsidies Uncle Sam lavishes on housing finance giants Fannie Mae and Freddie Mac. These lucrative Government Sponsored Enterprises have spent millions upon millions of taxpayer dollars to protect their fortresses from just this kind of political assault. It’s a good bet not many young rising stars in Congress would have the spinal fortitude to take on these imbedded special interests. He does it because the benefits Uncle Sam confers on Fannie and Freddie are a national outrage.

This week Mr. Baker took on sacred cow: the New York Stock Exchange. On Tuesday, Mr. Baker held a hearing on whether the New York Stock Exchange is really necessary anymore. That’s a good question to ask in this new information age economy, which is slaying dinosaur industries the way cicadas shed their exoskeletons.

Mr. Baker pointed out the New York Stock Exchange derives its power, not from the marketplace, but from government charter. This government sponsored enterprise is a minute tax on stock transactions for services that may no longer be necessary. After all, the Nasdaq functions quite well without the services and fees of the New York Stock Exchange.

Most Americans — and especially members of the shareholder class — probably have a warm and fuzzy feeling about the NYSE. After all, isn’t this institution the very symbol of America’s hyper-efficient financial markets that trades almost one-quarter of the world’s wealth? When we think of the NYSE, we are reminded of photos of world leaders, titans of industry and Hollywood celebrities standing perched above the exchange floor ringing the bell to begin a day of trading. This is unbridled capitalism at its rawest and most virtuous form. Isn’t it?

There is mounting evidence the NYSE has become a stodgy and outmoded inhibitor of market efficiency that survives mostly because of government protectionism. What other institution could have paid its Chief Executive Officer Richard Grasso tens of millions of dollars in compensation for a job that is essentially ceremonial?

In this age of electronic markets, companies such as eBay, Instinet and Yahoo can execute trades in nanoseconds. Unfortunately, the U.S. Securities and Exchange Commission still requires stock brokers to send their investors’ orders through the NYSE, where service is slow and unreliable and where unnecessary middlemen take a slice of the action.

The NYSE is supposed to help the mom and pop investor and maintain the integrity of our stock markets. Nowadays, it acts as an unnecessary toll on transactions.

The root of the problem appears to be the so-called “trade-through” rule, which sends orders through the NYSE to ensure that investors get the best price. But Nasdaq stocks are traded without the big board and investors aren’t getting cheated.

Moreover, it appears because the big board is so slow and cumbersome compared to computer-based transactions, investors may not get the best price at all, especially when the market is volatile and prices are changing instantaneously.

Perhaps the most harmful monopoly power bestowed on the NYSE is its status as an information cartel for the stock market. Brokerage firms are forced by regulation to send information that telegraphs their customers’ willingness to buy or sell stock at a given price (information of great value) to the exchange for aggregation. Those same firms are then required to buy the aggregated data stream back when providing a stock quote to their customers. This grants the NYSE with an information cartel and impairs the liquidity of the stock market.

This informational monopoly, not surprisingly generates huge revenues for the exchange. The NYSE maintains this arrangement benefits investors. That may be so, but more likely it imposes “rents” on stock trading firms and ultimately their investors. This may explain how it is Richard Grasso and his lieutenants became the best paid “regulators” on Earth.

I freely admit I am stumped in trying to come up with an estimate as to how much this sweetheart deal between Congress and the New York Stock Exchange costs investors. It’s hard to know how much efficiency is lost by current trading rules, established decades and decades ago, before the information revolution. As we move ever swiftly into an electronic age, where billion-dollar decisions can now be made at the stroke of a key pad, it does seem the NYSE is as relevant as the rotary telephone.

Kudos to Mr. Baker for trying to get to the bottom of this mess. He is doing a big favor for the 110 million American shareholders who, unlike the NYSE, don’t have well-heeled lobbyists looking out for their best interests.

Stephen Moore is a senior fellow at the Cato Institute.