Should the NYSE Be Allowed to Merge?

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Psst. How do you say Sell in German? (Brendan McDermid/REUTERS)

Call it the World Stock Exchange. And be afraid.

On Wednesday, news emerged that parent of the New York Stock Exchange, NYSE Euronext, is considering merging with the Deutsche Borse, which is the largest stock exchange in Germany. Of course, the New York in the NYSE has long been outdated. Despite it’s headquarters, the NYSE has long been much more than a place for US companies to trade. Many foreign companies are listed on the NYSE. What’s more, the NYSE, through its merger with Euronext, already owns exchanges in Amsterdam, Brussels, Lisbon and Paris. But in the past few years, fewer and fewer companies, at least as a percentage of worldwide IPOs, have gone public in the US. Just one sign of the NYSE’s dwindling stature: NYSE is actually worth less than the Deutsche Borse, $9 billion vs. $11 billion. The merger is a way for the NYSE to capture more of those IPOs that are listing elsewhere. Also, Deutsche Borse has a large derivatives trading business, which has become a focus for the NYSE and the Borse as smaller operators have stolen away both exchanges’ increasingly electronic stock business.

But is a bigger exchange better for investors? Colin Barr at Fortune.com says no. I would tend to agree. Here’s why:

Barr’s main point is that as exchanges have gotten bigger they have wandered from what should be their main role in an economy: Connecting small investors with small companies  so they can get capital to grow and create jobs.

But bigger stock exchanges don’t bring good tidings for the rest of us. Indeed, another round of exchange mergers will only intensify problems that skeptics have been railing about for years – particularly since last spring’s Flash Crash.

The stock markets, critics contend, no longer serve the purpose they were created to serve, helping small and midsize companies grow by raising capital cheaply from the public.

Instead, the big exchanges increasingly battle one another to serve the biggest companies — and to bring in low-margin trading volume that comes as often as not from computers seeking out freebies like trading rebates.

Like their cousins the too-big-to-fail banks, the exchanges now profit as much at the expense of the U.S. economy as to its benefit.

The question is whether this is a function of the economy or not. There have been relatively few IPOs in the past decade. So it stands to reason that the exchanges would focus on large established companies. That’s the only game in town. I think that as the economy improves and more companies are ready to go public, and investors are ready to buy in, we should see a shift of the exchanges back toward catering to smaller companies.

But, even so, it is likely that the past decade of evolution into electronic trading and more importantly high frequency trading have made the NYSE and other large exchanges inhospitable places for small-cap companies. If you think computerized trading adds volatility to Citigroup, then is sure to make the chart of a recent IPO look like a punk rock hairdo. As a result, you might see more companies, like Facebook, decide to sit out the public markets as long as possible, and that’s not a good thing.

Still, there may be even a larger concern. In the 1990s and early 2000s we heard a lot about capital becoming increasingly global and that markets had to react to that and allow money and investment to flow easily around the world. The problem is we saw what happens when the barriers to investing around the world came down. It was in part what caused the financial crisis. As US mortgages became the hot, safe investment, money poured in from around the world creating a huge bubble and eventually the painful bust. The NYSE-Deutsche Borse is another step toward making it easier for the global pool of capital to flow around the world and inflate new bubbles. I’m not sure how you stop that from happening. But this seems like another step in the wrong direction.

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