Dreams of perfect market are fine, as long as they don't come true
In these times of financial wrongdoing and subsequent systemic changes, it's only natural to wonder what a perfect investment world would look like.
Imagine an international network of clean, frictionless markets in which nobody ever gets the better of anybody else. Buying, holding, and selling costs are minimal, if not nonexistent.
Everybody, large investor or small, has a fair and equal chance at success. Customers, not just brokers, can be seen cruising about in yachts.
Before we get enraptured, there's a missing element in this vision that might make it nothing more than a mirage. It's not at all clear who would have the incentive necessary to build and maintain this wonderfully level playing field, or to keep the game going at its usual lively pace.
''If all the so-called abuses were suppressed and the public protected against crooks and against its own greed and ignorance, so that nobody could lose money, who in blazes could make money?" asks a character in Edwin Lefevre's ''Reminiscences of a Stock Operator," written in 1922. ''If everybody bought at the bottom, from whom would he buy?"
Lefevre's fictionalized account of the exploits of legendary speculator Jesse Livermore has just been republished in an appealing coffee-table book that got me started thinking these thoughts.
As events unfolded in the '20s, we had a chance to study in excruciating detail the Lefevre character's argument that ''legislation can't help much, because it can't keep a man from wanting to get something for nothing."
The stock market hit a ruinous boom-bust cycle in the late 1920s and the 1930s that led to a new regime of regulation, including creation of the Securities and Exchange Commission. Passage of the Investment Company Act of 1940 laid the groundwork for the modern mutual fund industry, a giant step up from much of what the '20s had to offer the public.
No doubt about it: US markets work vastly better with regulation, based on well-written legislation, than they ever did before. Today, the possibilities for improvement are by no means exhausted.
That isn't the same thing as saying that all regulation is good, or that someday we will have a really wonderful thing going if we can just get the money-grubbing capitalists out of the picture. Capitalist money-grubbing is what makes the system work.
Perhaps investors are like basketball players, who need ever-vigilant referees to keep them from too much elbowing -- but without whom there wouldn't be a game. Of course, investing is a serious activity pursued with real money, and with great consequences for individuals and economic society.
In that context, consider these dreamy possibilities: Stock exchange specialists and dealers who make markets in unlisted stocks are replaced by a fully automated black-box system that matches buy and sell orders without asking any reward for itself.
The pace of trading is much slower, because every participant in the market now has the same information. There is little point in trying to trade against the ups and downs of the market, since much of the emotion has been removed. In this efficient atmosphere, virtually all pension funds, mutual funds, and other pools of money are set up to track the market indexes at the lowest possible cost.
The circle is complete. But alas, there is nothing in the middle -- no give and take to set securities prices where, or approximately where, they ought to be. The indexes are useless since there is no longer anything of tested value to base them on.
Try to visualize what happens when some shocking development occurs. It would have to be an ''exogenous" shock, such as the terrorist attacks of Sept. 11, 2001; ''endogenous" shocks, such as the stock market crash of October 1987, would be things of the past.
When some external trauma hits, how is the perfected, emotionless mechanism of the markets supposed to handle the resulting onslaught of imperfect, human behavior? Who's in charge, who's accountable? When it has to function under pressure, the perfect market might turn out to be no market at all.
Not to worry too much about this dilemma. Experience teaches that few things in life are ever perfected, and the day of perfect markets will most likely never come. The good news is that might be for the best.
Chet Currier is a columnist for Bloomberg News.
