Even Big Investors Are Losing Trust in the Stock Market

The Wall Street Journal reports today that big traders—mutual funds, pension funds, sovereign wealth funds, etc.—are increasingly avoiding public markets to execute their stock trades:

Investors say such measures are increasingly necessary because the proliferation of algorithmic trading and other structural issues, including the fragmentation of the market, are hurting their ability to get the best prices and execute large trades quickly.

A trade has the possibility of wending its way through 13 exchanges and more than 40 “dark pools,” off-exchange trading venues that don’t publicly display stock trades. A trade could also be executed inside a large broker-dealer that matches buyers and sellers from its own holdings.

….Institutional investors long have complained that market complexity can make trading more difficult and that high-frequency traders were driving up prices by jumping microseconds ahead of big orders. But big investors say the cat-and-mouse games are growing more elaborate—and counterproductive—by the day.

Roughly speaking, there are two concerns here. The first is that high-frequency trading is distorting the market. The second is that large trades done in dark pools get leaked before the trades are finished, allowing other traders to sneak in and game the price. This is happening during an era in which stock markets are shrinking—there are now fewer publicly traded companies on American exchanges than at any time since 1990—which probably exacerbates the problem.

Somehow I have a feeling that Felix Salmon is going to come along and tell me why this is a smaller issue than I think it is, but I’m getting less and less open to such arguments over time. Big, transparent equity markets are public goods that build trust in the financial system, and the more transparent they are the better. Opacity mostly just contributes to growing financial rents among the very rich, and there’s simply no reason to think that this is a positive development.

There’s no turning back technology, so maybe this is one of those things that we just have to deal with somehow. But if we don’t deal with it, it won’t stop here. There are too many smart people and too much improving technology for that. Better to do it now than later.


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