

From Congress, a Law [JOBS Act] Befitting a Sausage Factory - JumpCrisscross
http://dealbook.nytimes.com/2012/04/03/from-congress-a-law-befitting-a-sausage-factory/?nl=business&emc=edit_dlbkam_20120404

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sp332
>Grant Thornton asserts that the decline is a result of changes in market
structure. One reason is decimalization — pricing stocks in cents rather than
fractions — that took profits out of trading that had previously given brokers
an incentive to list small companies.

Is there a simple explanation for why changing from fractions to cents would
remove profits?

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JumpCrisscross
Market makers make their money off the bid-ask spread, i.e. buying at the bid
and selling at the ask (you and I, on the other hand, must do the reverse).

Before decimilisation the minimum spread would be 1/16 (or even 1/8th) of a
dollar. Today it is not uncommon to witness penny (or even fraction of a
penny) spreads. Thus, the minimum theoretical spread realisable from making
markets in a security dropped by 84% ($0.0625 to $0.01).

If previously broker-dealer A had a cost of one cent per trade and broker-
dealer B had a cost of half a cent per trade, it just meant that B-D B made
more profit - he couldn't undercut A. Thus both would survive. Today
competition has driven the bid-ask spread to cost delta so low that market
makers need large volumes to break even on their operations - this kind of
volume can only be realised in frequently traded securities, i.e. larger
companies.

Essentially, the wider spread subsidised inefficient market making operations,
e.g. the making of markets in smaller companies. The positive externalities of
those activities may have outweighed the dead-weight loss of the implicit
subsidy.

Note that there is a valid counter-argument that says fractional pricing meant
a company that today has a penny spread and a company that today has a dime
spread would be seen as equally profitable to deal in, on a unitary basis,
from the market maker's perspective, while today the less liquid stock is far
more profitable (again, on a unitary basis). Thus, by this line of logic,
decimilisation _increased_ the incentive for market makers to make markets in
less liquid securities, e.g. smaller companies.

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SoftwarePatent
> Congress simply doesn’t understand financial markets and instead legislates
> to the political winds.

Sure, and while we wait for that to change (never happen), let's allow people
the freedom to make their own decisions about fundraising and investing. This
bill is realistically the most we can hope for, especially in an election
year.

