Tangled Webs

    The Computer, The Bull & The Plan
Issue 4.7
May 5, 1999

The Plan

I have a plan.

I plan to develop software that will buy and sell stocks for me, thus allowing me to purchase and then retire to a small Pacific island full of scantly clad, nubile young women. I admit this may not be the most realistic of plans, but it's a fun one to think about. Preliminary software testing has been inconclusive.

Personal stock-picking software aside, the effect the Internet has had on the US stock market over the last four years has been nothing short of astounding. And the changes we have just seen will pale in comparison to those we are about to witness.

Research done as CS First Boston determined that the volume of American online stock trading is increasing at the astronomical rate of 30 to 40 percent per quarter. Internet brokerage accounts now account for 25% of all retail stock trades and 15% of total stock trades, with both percentages rapidly increasing. We are now seeing a steady movement away from mutual funds and traditional brokers and towards deeply-discounted brokers operating over the Internet.

Despite the popularity of stock trading on the Net and the profusion of investment-related websites, the Internet and Wall Street are at philosophical odds on one crucial point. Traditional stock exchanges, such as the New York Stock Exchange, operate as cartels. Stock transactions may only take place between members of the exchange and according to the rules set by the exchange, and the exchange decides who can be a member. No matter what technology is used to place the order, the actual transaction usually takes place between two guys screaming at each other on a trading floor. These sort of practices made sense when they was developed over a century ago, but today they are laughably inefficient and somewhat quaint.

Computers are far more effective at matching buyer and seller and the can do at a very small cost. Fully computerized stock transactions could cost consumers only a fraction of a cent rather than the $10 to $50 they must now pay to brokers. The Internet is becoming increasingly important to stock trading, but if there is one thing that has no chance of survival on the Internet, it is a high-priced middleman.

The Computer

Of course, as a computer expert, I am expected to make outrageous predictions about the Internet and computer technology putting an end to Wall Street as it has existed for over a century. In this case, however, the US Securities Exchange Commission seems to see things pretty much the same way.

Last December, the SEC announced significant regulatory changes designed to promote the creation of virtual stock markets, called Alternative Trading Systems. Datek, one of the leading one-line brokerages, has already announced plans to register its Island Trading System as an independent stock exchange, and many other companies are expected to follow.

Furthermore, the new regulations have a notably populist bent. Traditionally, the difference between what the buyer pays and what the seller receives, known as the spread, is pocked by middlemen, and this generates a tremendous amount of revenue for them. Due to the cartel-like nature of stock trading, there has been little buyer or seller could do about it.

Alternative Trading Systems, however, are required to make all prices public, and this will greatly reduce or even eliminate the spread. Today, institutions can get a better price than the general public, but these new transparent pricing policies promise to change that. It's not that the SEC is forcing the NYSE to change the way it does business, but it seems pretty clear that few people will be willing to pay high fees to middlemen when they can get a better price by not doing so.

There is also serious talk of extending trading hours or even allowing stock trading to go on 24-hours-a-day. Other than widespread nervous breakdowns among day-traders, this will have only positive effects. It will also bring the concept of the stock market more in line with cyberspace. As these online trading systems are inevitably linked together we will see the emergence of a stock-market Internet and the end of the Wall Street cartels we have today.

The Bull

Like the Internet itself, the changes afoot will give consumers greater choice and access to more accurate information. And like the Internet, they will result in increased consumer participation in the markets. This silver lining, however, is not without its clouds. After all, greater consumer participation in the US stock market via the Internet has been largely responsible for many of the laughably overpriced American technology stocks, and has certainly contributed to the run up of the US market overall.

Not a few commentators refer to the US stock market "bubble" and compare it to the Japanese and other Asian economic bubbles that, once burst, proved so disastrous. The comparison, however, is inappropriate. Granted, US stock prices will eventually fall back to Earth, and those who invested in stratospherically-priced, poor-quality stocks will loose a great deal of money. When that happens, we will see the same gnashing of teeth we are now seeing from Asian stock-market speculators.

When that happens, however, a lot of once small companies will have used the capital they raised by issuing shares to the public to become a real force in the American economy. Regardless of their stock price, they will continue their day-to-day operations creating jobs, paying taxes and growing the US economy. By that time, of course, I will be watching events from a small island in the South Pacific.

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© Copyright 1999, Tim Romero, t3@vanguardjp.com
This article fist appeared in the Mar 28, 1999 edition of The Japan Times.
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