Felix Salmon
188 μ¢¤³£ ¬μμ¬
Credit Suisse, Goldman Sachs, and
Merrill Lynch—that had spent limitless
hours and dollars on lobbying the ¤
to push Reg £« through. Rather than
being a utility owned by its members,
the £Ý¤ was now a proÄt-maximizing
entity like all the other exchanges.
On top o there being competition
among the many new exchanges, every
major broker-dealer also engages in
“internalization”—eectively acting as
its own mini-exchange and fulÄlling
orders with its own inventory o shares
rather than sending them on to any
exchange at all. Not so long ago, i you
phoned up a broker and placed an order
to buy 100 shares o «, that order
would likely be Älled on the £Ý¤.
Today, ̈μ¡s compete with one another
to pay your broker for the privilege o
taking the other side o your trade. This
fragmentation beneÄts ̈μ¡s, who are
constantly searching for order Áows
that they can keep for themselves rather
than having to compete for them on an
open market. It also helps the major
global securities Ärms that orchestrated
the end o the £Ý¤ monopoly in the
Ärst place, since they are paid for—or
take direct advantage of—the retail
order Áow that they generate. Between
them, these huge companies now have
a market share north o 70 percent.
The big test o any stock market is
whether it has depth: whether it’s
possible to buy or sell a large number o
shares in a small amount o time without
moving the market. Traders will natu-
rally Áock to such a market, creating even
more depth—a virtuous cycle that results
in monopolies, such as the one the £Ý¤
enjoyed until 2005. The £Ý¤’s monopoly,
in turn, allowed it to be technically
innovative, introducing everything from¤ or any other federal agency ever did.
The £Ý¤ enforcement arm had deep
institutional knowledge. It knew, for
instance, that i a broker placed a trade
in « stock at 12:04:45 «, he would
need at least 22 seconds to walk over to
a dierent specialist to place a dierent
trade. The £Ý¤ used this kind o
information to conduct forensic exami-
nations o suspicious transactions,
examinations that the ¤ would Änd
completely impossible to perform.
Today, however, the regulators are on
their own; the individual exchanges
have all but abdicated even the pretense
o having a governance structure with
any teeth. And as Mattli points out,
“The creation o exploitative schemes by
particularly powerful actors to beneÄt
themselves is rational in a system o bad
governance because the chances o getting
caught are tiny and the reputational or
material consequences o such behavior
are largely insigniÄcant while the proÄts
from such schemes are high.”
THE END OF AN EMPIRE
What caused this enormous change?
The short answer is the Regulation
National Market System, or Reg £«, a
rule promulgated in 2005 by the ¤ in
the name o market eciency. It osten-
sibly modernized markets by moving
stock trading away from the £Ý¤ and
toward numerous other exchanges, but
it also marked the death o the old
£Ý¤. Up until that point, the exchange
was a mutual society: Ärms could buy
seats, and the exchange was owned by
its members. After 2005, it demutual-
ized, stopped selling seats, and became
just one among many exchanges, most
o which were owned and operated by
enormous global broker-dealers—think