The New York Stock Exchange has received a lot of unwelcome attention in the last few weeks, particularly the revelation concerning the compensation it authorized for its chairman, Richard Grasso. Mr. Grasso's resignation did not stop the calls for a thorough review of corporate governance at the Exchange, and it appears that the new interim chairman, John Reed, will suggest some far-reaching reforms.
But the questions about the NYSE go a lot further than its governance alone, and the Grasso compensation issue is in many ways related to deeper structural issues. The exchange is a member-owned facility that is overseen by the Securities and Exchange Commission and operates under SEC regulations that make it difficult for securities listed on the NYSE to be traded elsewhere. As in other areas of the economy-Fannie Mae and Freddie Mac come to mind-the combination of government support and insulation from competition can give rise to unusual opportunities for profit--I think economists call these rents--often at the expense of consumers who have no choice about where they must do business.
The Brian Becker paper we will consider today raises questions that were implicit in the Grasso case, but now arise in a different aspect of the NYSE's operations. The paper examines the profitability of NYSE specialists-the designated market makers for NYSE-listed securities who have exclusive access to information about buying and selling interests in the securities for which they are responsible.
As a preliminary matter, Becker's research indicates that the operations of these specialists are unusually profitable. Of course, there is nothing wrong with extraordinary profitability. It can arise from more efficiency, better technology, smarter trading, harder work, greater risk-taking and a host of other things we want to encourage. However, when we see high levels of profitability in organizations that are able to avoid competition and market discipline because of some degree of government protection and support, we wonder whether the two are related. If so, it means that the public-in this case investors-are paying more than they have to for the service involved. It can also mean that abuses of other kinds--as in the Grasso case--could be present, because the organization is not subject to the usual controls, such as market discipline, that can hold such abuses in check.
The key question associated with the current structure of the securities market in the United States is whether the NYSE should remain as it is--essentially a public utility, shielded from competition--or should be opened to competition with other market venues that may offer similar or better services to investors in NYSE-listed securities, possibly at lower cost.
This conference is the second in a series on the structure of the securities markets that AEI will sponsor this year. The third conference will be on October 21, when we will consider a survey of what institutional investors believe they need in order to function efficiently in the securities market.
Peter J. Wallison is a resident fellow at AEI.
