Sunday, August 30, 2009

The market is not a level playing field, nor should it be

There has been growing debate about institutional trading practices, with politicians and the public again demonizing moneyed players on Wall Street. These practices are facilitated by technology that has made speed of execution an advantageous and profitable backroom for dealing securities microseconds before they become available to the broader trading public. A recent article by MSN’s Michael Brush explains this high speed trading, flash trading, and black pools. Coming to the defence of these practices are investment professionals like Donald Luskin and Chris Hynes, co-authors of a Wall Street Journal op-ed piece that fuelled expected wrath from investors who smell rats on Wall Street again.

However, the anger of the public on these technologies and alternate markets is simply another form of populism. The notion of equality and a level playing field in the markets is misguided. Markets operate at many levels, from small investors with sleepy mutual funds held for years at their bank to highly capitalized banks with multi-million dollar trades executed many times a day. Markets now operate 24-hours a day in a broad range of securities and assets. The key growth for these tremendously important  capital markets is liquidity – the ability of the industry to bring in capital to individual markets and spur trading. Without liquidity the world’s markets would collapse into the dark ages.

How could there be a level playing field in the high stakes game of investing? Without expanding institutional liquidity the markets would become extremely volatile. Without technology driving the growth of institutional liquidity the capital stock does not grow.

Too often critics of the market – markets where the best rise to the top based on human and capital resources – cry foul because their utopian desire for equality is transgressed. But the beauty of a free market is that it expands the pie, and gives every player a chance at growing assets. However, not every player is entitled to the same resources. Risk and reward are the underlying determinants of the playing field. The more you put at risk, the more resources – human and capital – demanded. Wall Street represents the the best, the brightest players in the market. It is capitalized accordingly. This has always been the case.

It is important that ordinary investors recognize the benefits of free markets and the way resources are allocated by pricing mechanisms. Yes, it would be great if everyone had access to the same computers, the same capital, the same acumen. But that vision is a corruption of the human condition, it is the disabling framework of socialism.

Every day trader knows that the propensity of making profits does not improve with the frequency of trading. High speed trading and back room dealing does not improve the prospect of success any more for the players, either. Every buyer must find a seller. Every winner meets a loser. That is the market.

The market should not be viewed as some egalitarian model. It is not. Instead, it is a mechanism for growth where every player has a role and an opportunity to build their assets commensurate with their human and capital resources. Fairness is not a single level playing field.  If we try to make it so, we will handicap growth and violate our liberty.

Post a Comment