Is the Role of The Stock Market Being Perverted?

Stocks represent shares of corporations and are basically contracts that allow people (investors) to own portions of these companies. If a corporation thrives, the stock may appreciate in value or issue dividends to stockholders. But investors can lose money if a company does poorly and the price of the stock goes down. Risk is inherent in investing, but knowledge can aid in choosing companies that will perform well.

The stock market is simply a place where shares of corporations can be traded through brokers who find buyers and sellers for the stocks. Issuing stock can help corporations obtain funding for various objectives that will hopefully achieve future profitability. Stocks and the stock market benefit both corporations and investors by encouraging the free flow of capital and the expansion of the economy. Government agencies regulate the market to make certain transactions are being done equitably and that no parties have an unfair advantage in the trades that are occurring.

Stocks and stock trading goes back at least to the 17th century, with the New York Stock Exchange founded in 1792. While the NYSE once handled the overwhelming bulk of the trades, in recent decades other exchanges in multiple locations have been receiving a majority of the trades. There have been periods where stocks soared and times when the market crashed, but in general both investors and corporations (and the economy) have done well over the long term by utilizing the mechanism of the stock market. People may be placing bets on companies by investing in them, but they are providing necessary capital and stand to profit if their companies do well. It is easy to see that trading in stocks and the stock market are of great social value.

However, the advent of computerized high-frequency trading has changed the way the stock market operates, with millions of trades executed daily that are not based on economic fundamentals. With mathematical algorithms that can pick up momentary imbalances in the prices of certain stocks, and small disparities in the prices among the various exchanges, financial institutions use computerized programs to buy and sell large volumes of stocks instantaneously. Though perhaps only making pennies on each share traded, the profits can add up for these institutions when millions of shares are bought or sold. The majority of trades that now take place daily through the stock market are by these computerized programs. And there are no human specialists in place to stop trading when problems arise.

These trades are of no benefit to the corporations whose shares are in play and do not benefit long term individual investors or investment funds. In fact, though they do provide some additional liquidity, they are of no major value to society and are in some ways harmful. They also do not meet the original objectives for the creation of stocks or the stock market. Providing an advantage to those able to trade large volumes of stocks instantaneously, they can alter the prices of the stocks in which they trade, distorting the market. Because of the actions of these high-frequency traders, individual investors have become fearful of the stock market, believing buying and selling of stocks is weighted against them.

The fears of investors and the public at large have also been heightened by trading programs that have gone awry, the most recent being that of Knight Capital last week which sent out a torrent of erroneous trades that could not be halted for 30 minutes. Faulty trading because of these computerized programs have happened a number of times over the last few years, the most frightening occurring in May of 2010 when the Dow Jones intraday average dropped nearly 1000 points, 9.2%, before partially recovering. More than $1 trillion of market value was erased during this period.

Various commentators have asked for the SEC and regulatory agencies to demand more stringent controls from those institutions that engage in computerized trading and have asked for tougher penalties when these programs spew out erroneous trades. However, since these trades provide unfair advantages to the companies that employ them and are of no benefit to the corporations whose stocks are traded, nor to individual investors, and produce no discernible value for society, this type of trading should be banned completely or taxed highly to make the trades less profitable.

The stock market should be a place where corporations and investors are confident that stocks will be traded fairly. Computerized rapid-fire, high-volume trading is a method of gambling that is of no value except to the companies with the esoteric trading algorithms that may or may not work and can produce disastrous market gyrations that destroy market credibility.

Resurrecting Democracy

A VietNam vet and a Columbia history major who became a medical doctor, Bob Levine has watched the evolution of American politics over the past 40 years with increasing alarm. He knows he’s not alone. Partisan grid-lock, massive cash contributions and even more massive expenditures on lobbyists have undermined real democracy, and there is more than just a whiff of corruption emanating from Washington. If the nation is to overcome lockstep partisanship, restore growth to the economy and bring its debt under control, Levine argues that it will require a strong centrist third party to bring about the necessary reforms. Levine’s previous book, Shock Therapy For the American Health Care System took a realist approach to health care from a physician’s informed point of view; Resurrecting Democracy takes a similar pragmatic approach, putting aside ideology and taking a hard look at facts on the ground. In his latest book, Levine shines a light that cuts through the miasma of party propaganda and reactionary thinking, and reveals a new path for American politics. This post is cross posted from his blog.

  

Author: ROBERT A. LEVINE, TMV Guest Voice Columnist

Political junkie, Vietnam vet, neurologist- two books on aging and dementia. Last book on health care reform- Shock Therapy for the American Health Care System. New book on the need for a centrist third party- Resurrecting Democracy- A Citizen's Call for a Centrist Third Party- will be available early October 2011

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3 Comments

  1. Yes, it is being abused. As is the entire financial system. I get the terrible feeling that its all become a big game to the guys working the markets. They don’t take it seriously anymore as long as they can get their payouts, they’ll bet the house, which is backed by the Fed Govt, and what the hell if it all comes tumbling down. Without intense and enforced regulation these guys are going to ruin everything all over again just like they did in the 1920′s. And the GOP will be there to pave the road for them every step of the way.

  2. Nice post. I realized long ago the immense disconnect between the market and the actual performance of businesses, but could not have put it as well as you have.

  3. RAL, I get your point, but I am reluctant to agree at this point. Last time they tried to help the market, they killed Glass-Steagal.
    Although this looks different and it is for own good, etc., it could be a slippery slope to over constraint on trading.
    No, I am not a trader, instantaneous or not.

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