Are we repeating history? NASD in the early 1990’s versus CDS market today?
We haven’t had a history lesson in a while, have we? Today let us look at the NASDAQ. The National Association of Securities Dealers And Quotations had its roots back in 1939, although its modern roots as an electronic collection of quotes go back only to 1971. The system was created by the Bunker Ramos Corporation, and it was a great hit among brokers. The NASDAQ in 1980 began displaying inside quotations, allowing brokers to see the best bid and best sell prices. Also in the 1980’s, NASDAQ began reporting trade size and price information just a mere 90 seconds after the trades took place. The SOES system was created as well, although initially it was voluntary, as it only became mandatory to honor SOES quotes a few years after the 1987 crash. Of course the SOES system gave rise to the SOES bandits, and their morphing into Island, and then Instinet, and then NASDAQ the exchange. Well, actually we did that history lesson a few months back.
Today’s history lesson recalls the oligopoly that NASDAQ was in the early 1990’s. Spreads were kept artificially wide, and NASDAQ was rife with abuses from market makers. In fact the SEC brought charges in four general areas: 1) broadcasting fake quotes to deceive investors about the movement of the market, 2) using inside information about unannounced buy orders to purchase shares in order to quickly resell them, 3) refusal to honor posted quotes, and 4) delaying reported trades to drive up the price of a stock. Finally in 1996 the US Justice Department charged two dozen firms with collusion, leading to a whopping $910 million in settled fines.
The lack of the ability to self regulate fairly, and their continually putting their own interests ahead of their customers, led the SEC to take this big-boy dealer-insider-market and make it wide open, and well designed for mom and pops. Reg ATS mandated orders to the quote. Then came decimalization, and ultimately REG NMS, which has fragmented our current markets into a bad jigsaw puzzle held together with HFT glue. Hell, you know all this. We all watched it happen. And once it happens we all know how hard it is to turn back the clock. We can’t put the toothpaste back in the tube. We can’t put the genie back in the bottle. We can’t…. well enough with the metaphors.
Only here is the thing. Are we not learning from history? Will we repeat history in the derivatives market? There is a real battle going on in the CDS market. Please read this outstanding NYT article: A Secretive Banking Elite Rules Trading in Derivatives by clicking here. Essentially, there is great resistance by all the big banks to bring transparency to the swaps market, and to allow them to trade on an exchange, which would make them much more transparent. They do not want their margins shrunken or disclosed. They are therefore lobbying and fighting tooth and nail to resist the market being made electronic, much to firms like Citadel’s chagrin.
So what is the right model for derivatives: the leveraged and risky products that repeatedly savage investors every few years or so? Which is the greater evil? An oligopoly of big banks (the article references these members: Thomas J. Benison of JPMorgan Chase & Company; James J. Hill of Morgan Stanley; Athanassios Diplas of Deutsche Bank; Paul Hamill of UBS; Paul Mitrokostas of Barclays; Andy Hubbard of Credit Suisse; Oliver Frankel of Goldman Sachs; Ali Balali of Bank of America; and Biswarup Chatterjee of Citigroup) running an opaque system of swap trading, with wide margins, that make hedging costs for real main street companies artificially high? Or a Swaps market controlled by HFT firms, trading for virtually little margin, but making it up in speed and volume?
Which poison do you prefer?
Interesting times folks.