Friendly weekend conversation

By: Ray Pellecchia

File Under: NYSE

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Specialists remain a lightning rod for conversation, as I found out when I posted Quant funds are 'less reliable as market makers' -- WSJ.

Here's what I wrote:

Quant Funds (WSJ.com yesterday, Breaking Views column) -- "Last week's rout illustrates that, unlike the specialist at his post, these funds are less reliable as market makers. The huge lashings of leverage they employ make them susceptible to margin calls by lenders. To meet these demands for more collateral, many were forced to liquidate positions in a disorderly fashion last week. Rather than providing liquidity, these funds removed it at the moment it was needed most."

Neither hedge funds nor anybody else should be expected to act like specialists. No one else has the same obligation that specialists have -- to apply their capital to counter rapid market swings and dampen volatility. That's why it's critical for us to have a rule set that encourages specialists to participate in this way, when appropriate. I'm keeping an eye out for developments on that front and will continue to keep you posted.

And here's the ensuing discussion, all from this past weekend:

Ray, i agree that its extremely important to have specialists provide liquidity when the markets need it the most. To expect hedge funds or other quants to play this role is foolish. It always takes market turmoil for regulators to realize the value they play in creating a orderly market. Thanks.

by tony dey on August 17, 2007 8:54 PM

Ray,
I think you've made your point on how important you think specialists are for the stock market. I happened to look at the market share of specialists on the stock they trade, and they often are less than 2% of the volume in the past couple days. This is less than any significant black box trading firm.

So you can keep on pretending you still believe they're an important part of the NYSE - you'll get most high volume traders smiling as we know all this will be history within the next year.

Also, who did you ever hear say they expected "hedge funds to act like specialists"? For one thing, hedge funds try to make a living trading on level field high other market participants, when specialist already know their only chance for survival is to get some preferential treatment. It's been a couple months since they realized their "skills" won't be enough in a fair market.

by nicolas on August 17, 2007 9:25 PM

Tony -- I agree. It takes a period of volatility to remind us of the auction's ability to minimize price swings. Thanks for writing.

Nicolas -- Who did I ever hear say that? The quote I used is directly from the Journal's Breaking Views column. In case you missed it, the words "Quant Funds" are the hotlink.

No one is asking for special treatment for specialists. The current rule set is stacked against them, however. In instances when specialists could be providing needed liquidity, they have to stand at the back of the line, missing the market. All I'm looking for are fairness and a shot at competitiveness.

I think your 2-percent number is low, but I'm not going to quibble over that now.

Lastly, don't be doubting my sincerity, saying I'm pretending. If you believe that specialists will be gone within a year, I respect your opinion even though I disagree with it. Show me the same respect. Let's talk again next year and see who was right.

Thanks for writing.

by Ray Pellecchia on August 17, 2007 11:23 PM

Ok, let's talk about this again next year.

If specialists want to provide liquidity to the market and take advantage of their algos without the hurdles you're mentioning, why don't they start a subsidiary and do so? everyone's allowed to post liquidity. TradeBot, Getco, Knight, they're all doing it and you don't hear them complaining, do you?

The truth is, LaBranche's market value (for example) is worth less than the stake they own in the NYSE. I guess that's a good hint as to how the market values the specialist business for the near future.

I think you need to market NYSE's hybrid model, whether you believe in it or not. I don't doubt your integrity, and I understand you need to "sell your product". This blog is a good source of information and thoughts, but I find there are too many references to specialists, who have became a marginal component of trading. Clearly they and mentionned in more than 5% of your posts, even when the connection with the theme of the post (last week's quant funds collapse) is very mild.

by nicolas on August 18, 2007 11:11 PM

I must agree with Nicolas, I believe someone complained about there orders going to Vinny, Vinny and Vinny. I think he works there now! Also NYSE merged with a firm that came out with a song called "Joey the Specialist". Ray the days of people on the floor are numbered 8*(.

by Alexander Coe on August 19, 2007 8:07 PM

Nicolas -- Constructive criticism of the blog noted, thanks.

Specialist firms can indeed establish off-floor trading operations (and at least some have done so, I know), but these must be separate and distinct from their roles as NYSE specialists.

Their trading as specialists is subject to requirements and restrictions that are making the job difficult. Their role as provider of stabilizing liquidity has diminished, but I believe it can be renewed with the right regulatory changes. I think that's an important role, and that's why I mention specialists so much.

Alexander -- It's hard to believe the changes this place has been through in the last few years, and they keep on coming. You couldn't have written the script this way. But I'll say this: I like the team we have on board. I wouldn't bet against them. Thanks for writing.

by Ray Pellecchia on August 20, 2007 9:17 AM

Welcome to workin' week, folks. Your comments are always welcome, even those that (gasp!) don't agree with mine.

I don't have any NYSE trivia today, so here's who was born On This Day (NYTimes.com): Isaac Hayes, 65; Jimmy Pankow, 60 (Chicago); Robert Plant, 59; Doug Fieger, 55 (The Knack, remember them?); John Hiatt, 55; Fred Durst, 37 (Limp Bizkit); and Brad Avery (Third Day).

Tags: New York Stock Exchange, Hybrid Market, NYSE, trading, stock market, specialists, quant funds