September 21, 2010

Exchanges Propose More Price Controls

The Boii are back in town!

I refer not to the 1976 rock hit by the Irishmen of Thin Lizzy, but to the central European tribe that gave Bohemia its name. We just finished getting tribal in the Czech Republic and Austria, eating and drinking by bike from Prague to Vienna. And with the leaden nature of food and drink there, you’d not be advised to do one without the other.

Examining data, markets expected upside before the Fed gave more reason today. Where August trading showed striking amounts of speculative trading, indicating abundant day-to-day opportunism, September shows higher program trading, lower speculation and more selective rational investment. These are hallmarks of better certainty, even if the reasons are structural rather than fundamental. We take upside in whatever form it may come. We suggest you leverage it in your IR programs.

Speaking of markets, Jacob Bunge wrote in yesterday’s Wall Street Journal that exchanges are proposing new rules for market makers. NYSE Euronext, NASDAQ OMX and BATS want to require broker-dealers posting bids and offers to stay within 8% of the national best price to avoid triggering 10% circuit breakers on individual stocks.

What should public companies – without whom the plethora of tradable securities, from equities, to ETFs, to ETNs, to indices, swaps, futures, contracts for difference, options, derivative baskets, and oculus, dihedral and other sophisticated relative volatility tactics, would not exist – think?

Did anyone ask you: “So how about we force broker-dealers to set the price of your stock, instead of letting your business fundamentals and your real buyers and sellers do it?”

As Ben Stein’s character said in Ferris Buehler’s Day Off: “Anyone? Anyone?”

Think about it. If differentiating your shares now is difficult, try it when broker-dealers are required to keep prices in certain ranges. The narrow spaces will be filled up with more machine orders, more multi-asset-class trading to capitalize on tiny divergences rather than the lasting, productive output of successful businesses reflected in buy and hold investment.

Somebody concerned about systemic risk will always argue the merits of measures to mitigate it. And this is precisely how one is hoisted by one’s own petard. Systemic risk is a direct by-product of a system of rules, not human behavior. You cannot have price controls and free markets simultaneously. It’s oxymoronic. And you can even drop the oxy.

Now wouldn’t controls on bids and offers rid markets of stub-quote (outlier bids) risk and smooth out volatility? This is the same thinking that buttressed Fannie and Freddie in the housing market. Now, nobody knows the value of a house anymore. The US Federal Reserve has been trying it since 1913 with the dollar, which now has the purchasing power of a microscopic flake of gold.

Price controls are no solution to valuation problems. And the last darned thing public companies and investors should embrace is the argument that, for safety’s sake, somebody is gonna set your stock price for you.

For that matter, why must public companies, whose pumping blood of liquidity feeds the capital corpus, be made involuntary host? Only two parties benefit from price-controlled bids and asks: The exchanges, which will see more transactional data to monetize; and quantitative traders, who can count on rigid parameters between which to run faster and more synthetic trading models at less price risk.

What can you do? When the comment period comes from the SEC, how about 5,000 letters from executives of public companies asking why controls on stock prices benefit investors hoping to be rewarded for buying and holding stakes in enterprising businesses?

Gone only a week in the Czech Republic for Becherovka, Budvar and Pilsner Urquell, and we come back to find somebody trying to control something yet again.

Really, exchanges?  Why not ask issuers what they think before proposing to the SEC what you’ll do? Public companies are your seminal constituency. At this rate, public companies may soon be better and freer on the Prague Exchange. They might get free Pilsner Urquell, too.

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