Why Wall Street is unnecessary

By Jim Jubak

Do we need Wall Street?

I don't think so.

At the moment, we don't have much choice but to bail out the world's Wall Streets to end the mess that is the global financial crisis. So much of the world's money now flows through the huge financial institutions in New York, London, Frankfurt, Paris, Tokyo and Hong Kong that if we didn't repair the money pipelines, the global economy would grind considerably more slowly.

But that doesn't mean we need Wall Street in the future. As it's currently structured, Wall Street is an anachronism. It ignores the way the Internet has changed global commerce. It relies on a few big institutions for guarantees when much of the global economy is discovering the power of aggregating smaller players. It bundles most services into one-price, take-it-or-leave-it packages at a time when even the airlines -- hardly a cutting-edge industry -- have discovered the profits in allowing customers to buy only what they need.

Change comes slowly

So let's not use this crisis merely to slap some new regulations on Wall Street. Instead, let's drag Wall Street kicking and screaming into the 21st century by putting in place rules that would open the financial markets to new players and provide the safeguards that would assure investors they could trust their money to the new players.

It's not that Wall Street can't change. It's just that it doesn't change very quickly.

When the National Association of Securities Dealers started the Nasdaq stock market in 1971, Wall Street scoffed. The Nasdaq market did away with the human market makers that the New York Stock Exchange still uses to guarantee liquidity -- theoretically, at least -- in the trading of listed stocks. Instead, the Nasdaq uses an electronic market platform to link potential buyers and sellers.

On April 9, volume on the New York Stock Exchange was a light 1.8 billion shares traded. The Nasdaq exchange saw volume -- if you correct to count volume the same way on both exchanges -- of about 4.5 billion shares. Last month, only about 45% of the trading volume in NYSE-listed stocks actually took place on the NYSE. (The rest was routed through electronic exchanges similar to Nasdaq in such centers of world capital as Cincinnati.)

The old way

The argument put forward by companies dominating world financial markets is that the way that things are done is the best way. Of course, the way things are done currently also happens to be the very way that ensures the profits at these giant companies -- but never mind.

So, for example, the global economy needs the giants of New York, London and Tokyo to form underwriting syndicates so that companies can raise the billions they need to continue and expand their business. When an Exxon Mobil (XOM, news, msgs) or an IBM (IBM, news, msgs) needs to raise $20 billion by selling bonds or shares, it goes to Goldman Sachs Group (GS, news, msgs), Deutsche Bank (DB, news, msgs) or other big investment banks. It's a lucrative business. The fee for an equity underwriting can run to about 3.5% of the total raised.

Is that intermediary role played by the investment banks still necessary, now that the Internet can link buyers and sellers and provide access to volumes of information on the deal?

A little ahead of its time

The highest-profile challenge to the system came with the 2004 initial public offering for Google (GOOG, news, msgs). The company ran an auction to sell shares via the Internet that raised $1.4 billion for the company and resulted in an initial market valuation of $30 billion. Wall Street predicted that the auction would fail -- specifically, that the auction would set the share price too low and leave too much money on the table.

Because many IPOs for hot companies underwritten by Wall Street leave huge amounts of money on the table, it's hard to judge the share offering on this basis. Google's shares did close up $15 a share, about 18% above the offering price on the day of the IPO, but that's not an extreme result in the history of hot IPOs.

But the auction was plagued by other problems that the Securities and Exchange Commission and other regulators would need to address before more companies could raise money this way -- and before more investors would feel confident in participating. In the week before Google's IPO, for example, the company's founders, Sergey Brin and Larry Page, broke the SEC's "quiet period" rules. And the company failed to report in its IPO offering documents the number of shares it had already issued to employees and consultants from September 2001 to July 2004. The number of such shares, and the number that could be sold immediately upon or shortly after the IPO, would be of vital interest to anyone buying shares at an IPO, because quick sales of those shares could send the stock price tumbling. An experienced investment bank would have headed off all these problems -- I'd hope -- in a traditional IPO. Brin and Page were amateurs in this realm, and it showed.

Continued: What is needed now

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