The Rules Of The Game

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The world’s financial market is now a completely integrated whole. But where are the referees?

Wall Street was on its own and saw some of the wildest days that capitalism has ever known. Commodore Vanderbilt was prevented from buying control of the Erie Railroad when the management adopted the simple expedient of secretly printing more and more shares and throwing them on the market. But the brokers, who made their livings by taking small commissions, realized that such tactics were lethal to the Street in the long run. After all, who would want to buy a share of a company if there was no way to know the percentage of ownership each share represented?

So when the New York Stock Exchange and the Open Board of Brokers merged in 1869 and formed an institution large and powerful enough to dominate the Street, the brokers moved. They quickly imposed a set of rules requiring advanced disclosure of stock issues, an open registry of shares outstanding, and so forth. Furthermore, they required all members to trade in listed securities only on the trading floor, where the Exchange could keep an eye on things. Wall Street settled down almost at once.

By the 189Os the great investment banks, epitomized by J. P. Morgan & Company, were becoming the dominant institutions on Wall Street as they raised the capital needed for the industrialization of the country by floating stock issues and bonds. But they needed to know the exact financial situation of each company in order to protect their own interests and the interests of their customers as well. Thus it was the investment bankers who were the main force behind the new requirement that companies issue quarterly and annual reports and adhere to a common set of accounting standards now known as Generally Accepted Accounting Principles (GAAP).

In the 1920s it was the brokers— the force for reform in the 1860s— who needed reforming. The Exchange was owned by the brokers and was largely controlled by the specialists, who were supposed to see that trading in each stock was orderly, and by the floor traders, who owned seats on the Exchange but traded only for their own accounts. The specialists, by the nature of their jobs, were richly supplied with insider information, and the floor traders were perfectly positioned to take advantage of that information. Together they manipulated stocks to their own profit but to the detriment of the investing public.

There was little to be done in the 1920s. But the Great Depression brought the Securities and Exchange Commission into existence as a watchdog. Moreover, the disgrace of Richard Whitney, the highly respected president of the Exchange and leader of its anti-reform forces, who was caught embezzling from his clients, changed the atmosphere on Wall Street. Rules forbidding insider trading and safeguarding investors’ money were issued, and the Exchange got a new constitution that took its important public functions much more into account, despite its private ownership.

By the 1970s the growth of pension and mutual funds had caused a surge in volume, and the microprocessor had begun a new communications revolution. Markets such as NASDAQ were competing ever more effectively with the NYSE by offering lower commission costs. The large brokerage houses such as Merrill Lynch that had developed after World War II and brought Wall Street investing to Main Street America wanted to end the oldest rule of all on the New York Stock Exchange: fixed commissions, which obliged everyone to charge the same price. In 1975, with the help of a timely shove from the SEC, the brokers were able to eliminate the fixed commission. Volume soared and paved the way for the extraordinary bull market of the 1980s and 1990s.

Today Wall Street is changing once again, thanks to the Internet. Day traders are not unlike the floor traders of the 1920s, able to trade in and out of a stock hundreds of times in a day at very little cost. More important, the world’s financial market is now a completely integrated whole. But where are the referees? Unlike the market, they are still limited to acting within sovereign countries. In the not too distant future, a global Wall Street with only local regulators is likely to provide the market with days of excitement unseen since the Civil War.

But somebody besides me will have to write that story.