Is the Proposed NYSE-Deutsche Börse Merger All It’s Cracked Up to Be?

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.

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  1. rjs

    Former House Speaker Newt Gingrich on Thursday called talks that could lead to Deutsche Boerse acquiring the New York Stock Exchange “a fundamental blow to our capacity to lead the world.” “Why are we falling behind?” Mr. Gingrich asked an audience at the Conservative Political Action Conference on Thursday. “Why is the New York Stock Exchange being taken over by Frankfurt? Why are we in a mess?

    The short answer (according to Mr. Gingrich): “The Obama administration is anti-jobs, anti-small business, anti-manufacturing, pro-trial lawyers, pro-bureaucrat, pro-deficit spending and pro-high taxes.”

    1. Daniel Plainview

      This is why I hate some Republicans. And hate is not too strong a word, I honestly feel hatred for them. This merger has absolutely nothing to do with President Obama (unless you think the bailouts of large banks is connected, and that is a HUGE stretch of the imagination).

      You know if Obama tried to stop this, Gingrich would call it “government interference with the private market” so typical of Republicans, Gingrich wants it BOTH ways. It also indirectly relates to the fact that large private banks (Too systemically threatening to fail) are the last people on earth now who want to see Fannie and Freddie cleaned up.

      This is an extremely dangerous road we are going down here, extremely dangerous. If the Justice Department doesn’t get involved with this using anti-Trust laws (or national sovereignty laws, if we have any that cover this type issue) to stop it, I predict a MAJOR disaster resulting from this which will equate to something near to the passage of the Gramm-Leach-Bliley act, which is one of the worst pieces of legislation passed through Congress. In fact I can’t think of a worse one at the moment.

      1. Daniel Plainview

        One thing I would like to add here. I think Yves often likes to present herself as being for the little guy. And maybe she is. But it’s fascinating to me how many swipes she likes to take at the SEC, and we rarely here a peep or so much as a halfhearted squawk from Yves on the lack of action by FINRA on much of these stock market manipulations and FINRA’s “look the other way” attitude on stock market corruption.

  2. Deus-DJ

    The question is why they want to merge to begin with. If we can answer that question correctly(not their bullshit reasons of efficiency or increased competition) we can rightly oppose or support this merger.

  3. Tim

    Personally I really don’t see that many synergies between the NYSE and Deutsche Borse or for that matter Toronto and the LSE. When it comes down to it the underlying plumbing of clearing, settlement, and trading rules are just fundamentally different between Europe and North America and I don’t see market participants on either side wanting to give up their existing long held practices. Where there definately are synergies are between Deutsche Borse and the Euronext part of the NYSE which again has never really integrated with the NYSE. If you assume the Euro is going to remain the common currency for much of Europe there really is not much of a need for multiple exchanges in Europe just as you have seen over the years the old regional exchanges in the US become obsolete.

    Now futures is a different story but that is more because the main non US futures exchanges that were started in the 1980s such as LIFFE, SIMEX, IPE etc all copied the trading practices at the time of CME/CBOT. Again there are some exceptions like the London Metals Exchange that has its own very OLD history.

  4. nonclassical wasn’t Fannie and Freddie who caused financial meltdown. There is doubt whether there actually WAS meltdown, other than of 3 or 4 major “investment banks”, which was caused by over-leveraging themselves at 100-1..such as Lehman.

    Read this:

    Bartlett and Steele wrote the definitive “The Demise Of The Middle-Class In America” regarding the S & L bailouts..prescient.

    Many of Republi$$K$$ans here, and on other forums are in complete denial=Bushitters actually disallowed states from doing proper investigations of what was happening with “securitized mortgages” (using them as collateral to borrow against to SPECULATE) by raising the “interstate commerce act”. We should all know Senator Phil Gramm of Texas wrote a flyer into bill in last session of Clinton era
    DISALLOWING AUDITS of banks who operated as such..which is the reason for “stress tests” rather than AUDITS.

    There are some very smart people on this forum, but as Yves
    Smith noted on FCIC, the Fannie and Freddie nonsense is Republi$$K$$an (“K-Street”) disinformation. It would have cost less than $300 billion to bail out ALL “subprime loans”
    held by..we need to follow the money. When we do, as the article above notes, we find it was PIRATED by Bushit. We also find this from Robert Johnson, ex-Senate Banking Committe Chairman on derivatives: “Circa 2001, derivatives market valued $880 billion, by 2007, $600 TRILLION-95% of derivatives are owned by 6 U.S. investment banks:

    It’s pretty simple to “follow the $$$$”…I wonder if Yves thinks the continuation of “Too Big To Fail” under this merger is further muddying of those waters?

  5. ds

    This looks like the typical merger – big payout to the executives but no real value created. I don’t see the benefit here at all. The cme-cbot merger wasn’t all that great for the cme shareholders and those two exchanges were located blocks from each other!

  6. jck

    The TBTF issue is big one here, particularly for clearing and derivatives trading, not so much for stocks where both DB/NYSE are losing market share to the electronic exchanges. Didn’t check the numbers but suspect the valuation for the stock trading part was very low.

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