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June 22, 2016

The False Choice Between Regulation and Growth.

The SEC Approval of IEX’s Exchange Application Is a Big Victory for Investors, Market Stability, Competition and our Economy, but it is also a Huge Victory for Private Sector Innovators, Newcomers, Disruptors, and Dreamers:  As we argued, the Securities Exchange Commission’s (SEC) approval of The Investor’s Exchange (IEX) exchange application last Friday was a huge victory for many very important reasons. 

First, it was a victory for long-term investors, market stability, a level playing field, competition and our economy broadly.  Our public securities markets are essential for companies large and small to access capital and for our economy to grow. That requires investors to have faith and confidence in our markets and trust that they are relatively fraud-free and fair. Without that, people don’t invest in stocks, companies don’t get funded, jobs don’t get created and everyone’s standard of living declines. 

Those are the risks in today’s fragmented equity capital markets that are too often rigged by predatory high frequency trading (HFT) practices that rip off investors and destabilize the markets.  By taking away the HFT predators’ unfair advantages, IEX levels the playing field and aligns the markets once again with the interests of long-term investors rather than millisecond traders

Second, it was a huge victory for private sector innovators, newcomers, disrupters and dreamers.  IEX’s Founder and CEO Brad Katsuyama and his team came up with a profit-making private sector solution to a very serious public problem.  They then fearlessly and relentlessly took on the very powerful, connected, embedded incumbent predatory HFT industry and its many (mostly purchased) allies.  This has been a years-long pitched battle. Opponents of IEX, seeking to protect tens of billions of dollars in profits, have done everything they could in the Washington influence game to kill IEX, but IEX nonetheless won. 

Given everything IEX had going for it (i.e., the merits, a high profile boost by author Michael Lewis’ book “Flash Boys,” powerful and influential buy side and other allies, etc.), a loss for IEX would have had a devastating and chilling effect on anyone else thinking about challenging an embedded incumbent industry or practice that was aggressively seeking regulatory protection against disruption and innovation.  (Unfortunately, we have seen this happen in the derivatives SEF space where the derivatives dealers’ club of just four dealer banks continue to control more than 90% of the US derivatives markets and have maintained an anti-competitive two-tier derivatives market.) 

Thus, this isn’t just a victory for IEX, but also for the movement back to capital markets that serve the public and the real economy.  (Assuming IEX meets its “next challenge: delivering on its promise.”) This victory should inspire others who have ideas, innovations and solutions to challenge the few who are indeed rigging and exploiting the current system.

But, as is too often the case in the Alice-in-Wonderland world that is Washington, DC, the SEC’s approval doesn’t mean the fight is over.  There’s a real possibility that the incumbent firms that fought IEX at the SEC will now sue in court in an effort to overturn the decision.  Also, IEX isn’t some magic solution to all or even most of the problems that plague our markets and, therefore, the SEC – while they should be congratulated for doing the right thing here – we must do more to take back our markets for long-term investors and the public, as we detailed here.


Rebutting — Again — the False Choice Between Regulation and Growth: One of the most persistent falsehoods in the aftermath of the 2008 financial crisis has been that the financial rules put in place to reduce Wall Street’s high risk activities that threaten Main Street jobs, homes and growth have somehow stunted economic growth.  Despite the fact that it is demonstrably false (the worst financial crash and economic disaster since the Great Depression of the 1930s killed jobs and growth, not the rules to prevent that from happening again), the myth persists, mostly due to a disinformation campaign by the self-interested industry and their witting and unwitting allies. 

The latest rebuttal comes from no less an authority than Martin Gruenberg, Chairman of the Federal Deposit Insurance Corporation in a speech last week in Washington.  Reforms put in place since the crisis, “have been largely consistent with, and supportive of, the ability of banks to serve the U.S. economy.” On the topic of profitability, he noted, “…bank earnings have been on a generally favorable trajectory as we move farther from the crisis.” 

Moreover, the evidence shows, for example, that better regulated and capitalized banks not only lend more generally and lend through the business cycle in particular (i.e., lend more than less well capitalized banks in a downturn), but also lower their cost of capital because the market correctly perceives them as less risky and less likely to fail.

Equally important, not only is the economy growing and the banking sector doing well, but the rules are keeping protections in place to prevent the next Wall Street-caused financial crash and resulting taxpayer funded bailouts of the too big to fail firms.  Therefore, “stronger and more resilient banking organizations should make the economy and financial system as a whole better able to navigate such conditions and less prone to a collapse in market liquidity,” Gruenberg stated. 


Photo by Charlie Archambault

#EndingTBTF, Part III: Neel Kashkari, President of the Federal Reserve Bank of Minneapolis, took his Ending Too Big to Fail project on the road this week, co-hosting the latest forum with Adam Posen and the Peterson Institute for International Economics (PIIE) in Washington, DC. 

Launched with an important speech at the Brookings Institute earlier this year, President Kashkari has embarked on a year-long exploration of potential transformative changes that could truly end the danger and threat posed to the American people from too-big-to-fail banks.

This forum was the third in a series (all available at a dedicated section of the Minneapolis Fed website: #EndingTBTF ) and focused on the cost-benefit analysis of increasing bank capital and continued the broader conversation on ending TBTF.  As with the past gatherings, it had an all-star cast in addition to President Kashkari and PIIE President Posen, including Bertrand Badre and Bill Cline, among others.  While we don’t agree with everything said, the presentations, panels and discussions were all thought provoking, including some interesting comments from the audience including Better Markets’ President and CEO Dennis Kelleher.

Regardless of the outcome (which we’re cautiously optimistic about), President Kashkari’s initiative is providing a significant public service by continuing to explore these issues and by keeping them on the public agenda.  As Better Markets detailed in a report, the 2008 financial crash and the economic catastrophe it caused is going to cost the United States more than $20 trillion, which is more than $170,000 for every woman, man and child alive in the country today.  We simply cannot afford another financial crash and the Minneapolis Fed is doing its part in making sure that doesn’t happen. 


If you Care About your Money and the Security and Dignity of your Life in Retirement, Then you Need to Watch This: Last week’s episode of HBO’s satirical news program Last Week Tonight with John Oliver brilliantly and understandably talked about the recently finalized best interest fiduciary duty rule and why it is so very important to every American.  Oliver used his unique brand of satire to show, in hilarious terms and using financial industry advertising, exactly why it is critical for financial advisors to put their clients’ interests first and the absurdity of doing anything else.  Do yourself a favor: take the time to watch the entire segment here.

Better Markets in the News:

Washington Critics of IEX Quiet After SEC’s Green Light: Morning Consult by Ryan Rainey 6/20/201

Articles of Interest:

Puerto Rico, Bondholders Remain at Odds Wall Street Journal by Heather Gillers and Matt Wirz 6/21/16
FSOC Finds Fintech May Pose Risks to Financial Stability American Banker by Lalita Ciozel 6/21/16
Brexit: what happens if the UK remains Financial Times by Dan McCrum 6/21/16


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