You Cannot Force People To Make Markets

At the risk of beating a dead horse, I want to come back to an essential point that is necessary to remember in any discussion of market structure reform.  This morning I praised Floyd Norris for an interesting article about how MBIA’s loss expectations have evolved.  Tonight I give him a thumbs down for his analysis of “liquidity providers” versus “market makers.”  Norris writes:
“I have heard people from Wall Street say that it is unreasonable to require market makers to make markets rather than simply post “stub bids” of one cent when they do not want to take part.  One even suggested that the solution was to bar retail investors from placing orders to sell at the market price, lest such orders hit a market unwilling or unable to handle them at reasonable prices.  Such an order should have a 3 percent range of allowed prices, so that the order would not be executed at an unreasonably low price, it was said.
Give me a break.
This could never have happened a decade or two ago. Then markets had market makers, who were required to maintain bid and ask prices.  There were primary markets that set prices.  Prices could plunge — see 1987 — but not like they can now without anything really happening other than a breakdown of Wall Street systems.”
Since I’ve addressed these topics at length previously on this blog, I’ll just copy&paste the comment I left on Norris’s post, and refer you to my prior writing on the subject:
“Floyd – the point of preventing market orders is to protect unsophisticated retail investors who don’t understand what “market” means. I’m all in favor of it, because I would guess that 99% of the time a retail investor sends a “market” order they don’t really mean “market” – they assume that they will be filled near the current price, which is a faulty assumption.

As for other possible solutions: you can’t force market makers to step in front of a falling market. It’s impossible. It doesn’t matter what you call them – market makers, specialists, liquidity providers – markets can still crash.

I’m not sure why you claimed “This could never have happened a decade or two ago” and then provided evidence that it did – 1987. Markets have always crashed, and they will always crash – it cannot be legislated away.

Note that the markets recovered almost instantly from the May 6th “flash crash’s” temporary lack of bid-side liquidity – the same cannot be said for the 1987 crash which was presided over by real live market makers.”


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