Sunday, November 20, 2011

Guest post: Wall Street, part 2

From Jerry Gettinger of Scottsdale...

What's Broken on The Street
My previous essay proffered the idea that Wall Street was broken and needed a major overhaul in order to "fix" it. First, it is important to identify what is broken and then we can suggest how to fix it.

30 years ago, The Street was the center of the world when it came to Capitalism. Socialists saw it as the root of all evil relating to our society. Graduates saw the Street as a most desirable career choice.

Companies such as MCI received capital to innovate and challenge competitors with new ideas and inventions. Money flowed from investor to company.  Employment thrived with every new business. Brokers made money, investors made money and business made money. An example of capitalism working the way it was meant to.

What happened?

No one change can be attributed to the malfunction. Several changes in the mobile seem to be responsible.  Competition for listings among exchanges, making memberships (to exchanges) more available, globalization and, probably the most important factor that caused changes... computers.  As competition between exchanges grew, rules concerning what type of trading was acceptable changed in order to attract speculators. This type of business served no purpose but to generate profits. It did not take long for "program trading" to dominate transactions on various exchanges.

Computer generated trades and anomalies between and within exchanges generated substantial profits with little or no risk. It is worthwhile noting that not one of these transactions sent monies to corporations for expansion or modernization. In every instance, the only reason for the transaction is to make money! A financial dead end!

Let me explain how this type of trading works: suppose there is a stock that trades on both the NYSE and the German Stock Exchange. At a particular time, there is 5-cent difference in the price with the stock on the NYSE selling at $23.10, and on the German Exchange at $23.05. Computers that are programed to monitor for this situation will simultaneously buy on the German Exchange and Sell on the NYSE for a 5 cent profit. Not much, you think? Multiply a nickel times 200 million shares! Then, take that figure and multiply by six, (that number is an example of how many trades of this sort is done daily by one broker.  It may be more or less.). The transaction delivers riskless profits that serve no function in the economy. No job creation, no business expansion. Just more money.

In addition, the "Bush tax cuts" have encouraged this type of business by taxing the income from this type of transaction and all related transactions at a more favorable rate.

That is the problem.

The game, which use to have rules to protect the individual now have none. Wall Street has gone from a level playing field to a 90-degree hill for the single investor. The market place is completely distorted. The individual is at the mercy of the big traders (spelled computers). An estimated 85% of the trades on the NYSE are computer generated.

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