The floor was quaint, it was fun, the relationships were rich and rewarding, the sense of being part of “the greatest market in the world” was intoxicating, and if you were any goodyou could make a handsome profit year after year. But to the customers it was opaque,slow, uncontrollable and prone to mischief. In a casino, the house always wins, and thenagging thought of institutional traders was that they were the suckers in this game.It is easy to understand the members’ desire to see the floor live on, in the same way it iseasy to understand nostalgia for steam trains. Walking onto the floor is a magicalexperience that thrills all who experience it. The pulse of action, the camaraderie, thesense that something immensely important is being conducted in a very clever manner cannot fail to impress. The problem of the exchange floor may be that of the steam train:while peculiarly both quaint and impressive, they were too noisy, too dirty, too slow, and,most importantly, technologically outdated.John Thain’s clever solution to this problem was to buy off the seatholders by buying themout. In a situation where seat prices had declined from $2.6 million to under one million,seatholders were attracted to a premium that recognized the value of corporate control.Substituting a corporate culture for the mutual benefit society gave the exchange theflexibility to innovate. The quid pro quo to the former members was an attempt to retain arelevant functionality for the floor in the hybrid market.Many observers conclude that the floor-based exchanges are outmoded: aren’t all marketplaces going to be electronic in the near future? Or not?Assuredly, the floor was a vital institution for centuries, evolving with the changing needs of its customers. The pace of change is quickening, calling into question the floor’s verysurvival. This raises some important questions: Does the floor still add value? Will itsurvive? Is the vaulted eye-to-eye interaction truly necessary? Or will the floor populationfind it more to convenient to operate the same functions in a computer-filled floor booth, inan upstairs office or at home in their pajamas?To answer these questions, we need to consider the value-added functions of anyexchange, and discuss how they have been allocated to the floor. We will explore thesteps that got us to where we are, then discuss what an ideal market might look like, andconclude with how close to ideal we are likely to come. In the process we will discusswhether a fully automated exchange is likely or desirable. By “fully automated exchange”we mean one in which the computer performs, among other automated functions, thedrawing of liquidity and price discovery.
Competition on Commissions, then on Spreads
Some might date the beginning of the demise of the floor (if that’s what it turns out to be) tothe regulatory changes that instituted fully directed commissions on May 1
. 1975.Everyone knew deep down that commission schedules based on retail-sized orders couldnot survive the rapidly growing domination of institutional trading, yet no one knew whatthe post May Day world would bring.3