Wall Street remembers May 1, 1975, with the same feelings the U.S. Navy reserves for Dec. 7, 1941. After generations of preaching the rigorous virtures of competitive capitalism while practicing the pleasurable vices of monopoly and price fixing, Wall Street met its Pearl Harbor in the form of price competition within its own ranks. The capable brokers and the efficient firms have survived the shakeout that began that May Day, but Wall Street, unlike the Navy, has little chance to achieve redemption or to inflict revenge for the calamity that has overtaken it.
To understand the present upheaval, one must understand the old order that preceded it. The club that was to become the New York Stock Exchange was formed nearly two centuries ago under a buttonwood tree in lower Manhattan. The club was based on three principles that remained intact through booms, busts, wars and the growth of the country from a few former colonies huddled on the Atlantic Coast to the most powerful nation in the world. The three principles were: a club monopoly of trading, limited club membership and a fixed 1 percent commission.
Shortly after the club was formed, Colonel Bronk rode in from the area that now bears his name (belonging to the Bronks family, corrupted to the Bronx) and tried to go around the club in selling some securities. He failed, and no one seriously challenged the club again until the late 1960s. The club proved to be one of the most durable institutions in the country, and many people thought it would last forever.
Of course, nothing lasts forever. The third market undercut the club's monopoly of trading by conducting transactions in listed stocks away from the New York Stock Exchange. The most serious challenge to the club came on the critical issue of commissions, however.
The fixed-commission schedule of roughly 1 percent yielded a bonanza to brokers in the 1960s as both stock prices and stock volume rose to set records. Many brokers made six-figure incomes while still in their 20s. The spectacle of this largesse led to pressures to cut commission rates, particularly by large institutional investors such as bank trust departments and pension funds whose own employes did not share in the bonanza.
Under prodding from the Securities and Exchange Commission, broker commission rates were made negotiable on large trades of more than $500,000. Much to the dismay of brokers, competition quickly forced large discounts. As a result, there was considerable apprehension at the approach of May Day 1975 when the SEC ordered that all rates be made negotiable. A few major institutional brokers announced they would limit discounts to 8 percent off the old fixed rates and then sat back to see what would happen.
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Nothing happened, and that was the problem. Brokers who offered small commission discounts to institutions found their phones stopped ringing. Other brokers offered more generous discounts in an admirable display of competition in action. In a matter of days, even the major brokerage firms cut their prices drastically, too. Instead of an 8 percent discount off the old rates, discounts of 50 percent became common, and ones of 80 percent to 90 percent were not unusual.
Any industry which slashes its prices that sharply is in for a shakeout of the less efficient firms. May brokerages were managed as badly as old law firms, with an abundance of prima donnas and an absence of cost controls and efficient procedures. The weak and inefficient firms that survived under the umbrella of fixed prices simply dissolved under the downpour of price competition.
At first, the benefits of negotiated commissions went to large institutional investors, but slowly they became available to individual investors as well.
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Today even a small investor who needs only trading services and who can dispense with a broker's advice can save 50 percent or more by going to a discount broker. As with the deregulation of airlines, the resulting price competition generated lower prices for the public.
Unlike the case with airlines, however, competition came as a result of more government regulation, not less.
The results of price competition lived up to the hopes of its advocates and to the fears of its opponents. The advocates thought Wall Street was overcharging the public and hoped rates would fall, but few dared hope that rates would fall as far as they did.
The opponents of price competition feared that the inefficient firms would go out of business and, in fact, some did. Wall Street has not collapsed, however, but has become leaner and much more efficient than before. It does a better job of executing trades and does it with fewer employes. Many brokers still feel a fond nostalgia for the bygone era of fixed prices and large profits but, for the investing public that benefits from lower rates through price competition, these are the good old days.
