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October 20, 2007, 2:30 PM

The Future of the Stock Market

Participants: Justin Fox (moderator), Bernard Madoff, Ailsa Roell, Robert A. Schwartz, Muriel Seibert, Josh Stampfli

The stock market conveys a classic image of Wall Street—traders in rolled-up sleeves, a sea of hands waving, frantically placing orders before the closing bell. Frenzied cries for margin and more margin are mythologized in accounts of the crash of '29. But while some of the old accoutrements on the trading floor of the New York Stock Exchange continue to function as curious anachronisms, the modern stock market is a multinational, digitized institution whose activities often occur in rooms where the only sounds are the tap-tap of a computer keyboard. In musical terms, it's as if the drama of Beethoven's Fifth Symphony were replaced by John Cage's famous homage to silence, "433." How have technological innovations hastened the growth of the markets? How have these innovations facilitated trading and created or failed to create more orderly market conditions? In addition, what is the role of human emotion within the increasingly mechanized world that characterizes the buying and selling of securities, and what new financial instruments have been created in response to the apparatuses of computerized exchange? Fear of loss and greed, in terms of the ever-increasing drive to maximize gains, are still primary human motives in stock market trading, but how do technological advances interact with fluctuations eventuated by purely human drives?

Justin Fox is the business and economics columnist for Time magazine, and writes the Curious Capitalist blog at Time.com. Before joining Time in January, Fox spent more than a decade at sister publication Fortune, where he covered a wide variety of topics related to economics, finance, and international business. Fox's book, The Myth of the Rational Market, will be published by Collins in April 2008.

Bernard L. Madoff is Chairman of Bernard L. Madoff Investment Securities LLC, which he founded in 1960, and of Madoff Securities International Limited in London. He is a member of the London Stock Exchange, the Security Traders Association, and the Advisory Committee on Market Information of the U.S. Securities and Exchange Commission. Mr. Madoff is past Chairman of the Nasdaq Board of Directors.

Ailsa Roell is Professor of International and Public Affairs at Columbia University's School of International and Public Affairs. Her academic specialty is financial economics and the regulation of financial markets. Her research and teaching spans securities markets, corporate finance, and corporate governance. She has published extensively in the area of stock market microstructure, with empirical and theoretical papers on market trading architecture and its impact on liquidity and price formation.

Robert A. Schwartz is Marvin M. Speiser Professor of Finance and University Distinguished Professor in the Zicklin School of Business at Baruch College, CUNY. His research is in the area of financial economics, with a primary focus on the structure of securities markets. He has published over 50 refereed journal articles and fifteen books, including The Equity Trader Course (co-authored with Reto Francioni and Bruce Weber), Equity Markets in Action: The Fundamentals of Liquidity, Market Structure and Trading (co-authored with Reto Francioni), and Reshaping the Equity Markets: A Guide for the 1990s.

Muriel Siebert has been called The First Woman of Finance. She is the first woman to own a seat on the New York Stock Exchange and the first to head one of its member firms—Muriel Siebert & Co., Inc. She served for five years as the first woman Superintendent of Banking for the State of New York. While President of the New York Women's Agenda, she developed a Personal Finance Program that was introduced into the economic curriculum of New York City's public high schools. She is widely interviewed on subjects pertaining to financial market information. Her autobiography, Changing the Rules—Adventures of a Wall Street Maverick was published by Simon and Schuster in 2002.

Josh Stampfli is the head of the automated market-making group at Bernard L. Madoff Investment Securities LLC. He designed the trading logic to manage position risk and handle the order flow inherent to the firm's business of providing liquidity to its customers and has also developed independent automated proprietary strategies. He has over 15 years of market experience, ranging from computerized equity trading to statistical fixed income arbitrage, and has experience trading stocks, bonds, swaps, and various derivative products.


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Discussion Board

This forum allows for an ongoing discussion of the above Philoctetes event. You may use this space to share your thoughts or to pose questions for panelists. An attempt will be made to address questions during the live event or as part of a continued online dialogue.
Fadi Chama says:
Who is really paying the money that the traders are winning?
What did we learn from the 1987 crash?
Ailsa Roell says:

During Saturday’s panel discussion some questions from the audience focused on issues relevant to personal investors who follow the market closely and trade on a fairly frequent basis in order to safeguard their retirement income. I wasn’t ad rem enough to respond adequately on the spot so I’d like to speak my mind here!

I. One of the questions raised was, how to assess a stock’s value if different analysts all come up with widely divergent views on what it is worth. My strongly held opinion is that one should ignore the lot of them! The current stock price is a better guide to the stock’s value, as it represents the combined views of all the people who have put their money where their mouth is by actively expressing a willingness to trade at that price.

Regarding analysts: in-house analysts are essentially salesmen for their firm’s investment banking services. An investment bank with reliably bullish analysts is going to draw in business and that remains true even if the analysts’ compensation is not explicitly linked to that. Their hiring and firing decisions will reflect that. I found the spate of analyst scandals a few years back incomprehensible: how could anyone ever have thought that analysts were disinterested in the first place? Would you expect an ad agency specializing in cigarettes to go out of its way to draw attention to lung cancer? Now that all the dust has settled, the fact remains that analysts still have a fundamental conflict of interest and their pronouncements, however sincerely felt, should still be taken with a heavy dose of skepticism.

II. On how to safeguard one’s retirement income by staying alert and trading actively, the best strategy is not to trade actively but to buy and hold a well diversified portfolio that trades off risk and return in a manner appropriate to your needs. That is, avoid churning your investment portfolio on the basis of the latest news: it has already been incorporated in the stock price thanks to the countless thousands of other traders who also read the newspaper and interpret current developments. All you do by trading is incur the costs of trading (explicitly, commissions; implicitly, bid-ask spreads) - these are small these days (normally well below 1% even for a small trade) but they do add up if you trade often. This is a consensus view from decades of academic research, elegantly expressed in Burton Malkiel’s perennial classic A Random Walk Down Wall Street.

If you actively enjoy thinking about stocks and trading them, fine, go ahead! Some people enjoy going to Las Vegas and playing the slot machines. On average, they lose money, but I guess the thrills and excitement along the way make it worthwhile! Since trading costs are quite small for liquid stocks these days, there is scope for a lot of entertainment value at a fairly low cost.

There is one exception to my wet-blanket view of active trading: if you have genuinely unique insights into security values based on your own life experience or analytical skills – I am sure there are quite a few retirees in New York City in this position. Personally, after over 20 years of teaching and researching finance, I can count on the fingers of one hand the instances where I have had genuine inside insights, ripe for conversion into trading gains (for example, some software innovations were rolled out in academe before becoming available to a wider audience; daily familiarity made me one of a small group of people best able to evaluate their likely success in the wider marketplace). But who is to say? After a lifetime of success in business and/or the professions, there are surely many NYC retirees who have the unique capabilities needed to outwit the thundering herd.

Over the last decades retirement plans have steadily migrated from defined-benefit to defined-contribution plans, where instead of being promised a guaranteed annuity in some form, the retiree simply reaps the fruits of his/her investment decisions. This shifts investment risks from employers (and their shareholders) to the beneficiaries, who may not have the time, skills or inclination to avoid exposing themselves excessively to fluctuations in securities market returns. And with pension contributions basically invested in a limited range of alternatives on behalf of dispersed beneficiaries who bear all the risks without having much of a say in how their money is managed, we’ve built up a second layer of separation between ownership and control: under a defined-benefit plan, at least the company responsible for providing the benefits is the residual claimant and would have a strong incentive to enforce appropriate money management. Finally, an additional uncomfortable effect of the trend is that one of the biggest risks we face, namely longevity risk, is no longer automatically insured (those who go to the trouble of buying annuities face prices which can be staggeringly unfair in actuarial terms).

III. Regarding the comment about recent innovations like municipal bond ETFs: these broaden the range of affordable options open to small investors, because the trading costs are not as punitive as those for the underlying individual municipal bonds. The municipal bond market is notorious for its murky pricing. The underlying reason: individual munis are so thinly traded that it makes no sense for any market maker to spend the time and effort needed to quote continuous prices at which he stands ready to trade. And this does require a lot of time and effort because the market maker needs to stay abreast of all the news: if the municipal sewage plant in Nowhere, USA malfunctions he’d better know about it fast, or he can be sure there will be sellers unloading the munis onto him before he finds out. For more thickly traded securities, market makers are willing to quote prices anyway, because they see enough ordinary trading volume to recoup such occasional losses – but not in the muni market. As a result, there is no firmly quoted, easily identifiable going market price for a muni. The price paid by ordinary investors for munis can be substantially less advantageous than it should be (deviations of 5% between prices paid at roughly the same time are commonplace), with only the professional competence, energy and sense of duty of the broker limiting the extent of price gouging. Now, bundling munis into mutual funds or ETFs spreads the risks considerably; and so the bundled instruments can be continuously priced and traded at quite low bid ask spreads (though about double those on highly traded stock ETFs).

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