The financial media is duly falling in line and giving a thumbs up to the proposed merger between the New York Stock Exchange and Deutsche Börse. Mayor Bloomberg contends it is both good for New York City and provides customers better service in an era of increasingly global equity trading. Industry analysts approved. Not surprisingly, stocks of other exchanges are up based on takeover speculation.
Your truly is wary about concentrations of power in the financial arena, and consolidation of stock exchanges has the potential to go in that direction. One critic of the deal was former Goldman Sachs co-chairman John Whitehead. Admittedly, some of his objections sound quaint, echoing the hand wringing of the 1980s when the Japanese acquired trophy assets such as the Rockefeller Center. From Bloomberg:
“I speak out rarely, and this is one time when I can’t hold myself back,” he said, adding that the exchange is an “important symbol” of American capitalism and of New York City’s status as a global financial center. “I think of it as a holy institution.”
Now before you start chuckling, Whitehead is old enough to have been in the finance game when propriety meant something and firms were concerned about their reputations. And his antiquated-sounding views ironically serve to illustrate how the US has degraded its brand as a financial center.
The US used to be the place for international companies to float their stocks. And one of the reasons investors came here along with issuers wasn’t the depth of the markets alone, but that the US had the fairest markets with the best rules and the most extensive disclosure. A 1994 article by Amar Bhide in the Harvard Business Review, “Efficient Markets, Deficient Governance,” describes the virtues of the US regime, so it isn’t all that long ago that American preeminence in this realm was unquestioned. You could see it just by looking at financial reports. The ones from overseas markets had less frequently issued financial statements (semi annual rather than quarterly), typically fewer balance sheet and income statement line items, and shockingly little in the way of footnotes, and nothing resembling the sort of narrative you’d get in a 10-K. You had a much dimmer idea of the company’s operations and performance that you did from a similar US concern.
Whitehead raises a substantive issue:
Whitehead said the consolidation makes him uncomfortable.
“Competition among stock exchanges is a good thing, not a bad thing,” he said.
I have a different reason for being uncomfortable. The failure of exchanges, contrary to popular perceptions, is not impossible. We came within three minutes of having the Chicago Merc and likely the NYSE fail in the 1987 crash. The Merc customer was where S&P index futures traded, and a customer failure to pay $400 million meant that the Merc was similarly going to come up $400 million short on a loan it owed to Continental Illinois. The executive responsible for the account said she could not forgive the repayment. It was only by happenstance that the bank’s chairman was in early that morning and authorized the credit extension, allowing the Merc to open. Had the Merc collapsed, the odds of a knock-on NYSE failure were high. The New York Stock Exchange was also at risk of not opening, and its chairman John Phelan feared if it did close, it would never open again.
One has to wonder how a merged entity would evolve, and whether the two exchanges would come to operate as a single exchange. If so, that would create all the regulatory and resolution headaches we see now with the TBTF banks: issues of lack of clarity as to which national regulator is responsible for what, with a lot of activities falling between the cracks by design of the banks, and the near-impossibility of resolving them due to the fact that their activities extend across multiple nation-based bankruptcy regimes.
Admittedly, exchanges in recent history have been more tightly regulated than financial firms, but the flip side is that their increased size and cross border operations will give them much greater ability to pressure regulators than before.
The arguments in favor of the merger all stress greater efficiency. But as any systems engineer will tell you, improvements in efficiency too often come at the expense of safety.