The nation's oldest and most successful price-fixing monopoly came to an end a decade ago. And as in Saigon, which fell at the same time, life for the inhabitants of the New York Stock Exchange has not been the same since.
From its very beginnings under the famous buttonwood tree in lower Manhattan during the late 18th century, the exchange based its operations on two principles: a monopoly of trading in listed securities and a fixed-price commission schedule yielding roughly 1 percent to the broker. Those two principles proved remarkably durable through booms, busts, wars and the growth of a nation into superpower status.
The NYSE's price-fixing monopoly ended involuntarily on May 1, 1975. Prodded by the Justice Department, the Securities Exchange Commission ordered the end of fixed commissions and the beginning of competitively negotiated ones.
Brokers reacted to the advent of competitive commissions on that May Day 1975 as though Wall Street was being demolished to make way for low-income housing. They predicted that terrible things would happen to the nation if their fellow brokers were free to set the commission rates they charge the public. Brokers argued passionately against competition on a variety of principles, but their passion clearly came from the recognition that their own principal was at risk.
When principal and profit are at risk, consistency is a dispensable principle. Brokers, being largely conservative by nature, preached the hard virtues of competitive capitalism to the rest of the nation even while they practiced the soft vices of monopoly and price fixing in their own business. Few brokers saw this inconsistency between word and deed, and even those few naturally feared the emergence of a new order in a suddenly uncertain future.
The future came hard and fast. A few firms tried to limit discounts to 8 to 10 percent for large institutional customers but, in a stunning display of competition in action, their phones simply stopped ringing. Business went to brokers offering larger discounts off the old commission rates. Within days after the May Day end to monopoly, 40- to 50-percent discounts became standard for institutions comprising about half of the market.
Any business that slashes prices so quickly and deeply is in for a shakeout. Stories abounded of brokers who went from making six-figure incomes to driving taxis. Many brokerage firms were as badly managed as old law firms, with an abundance of prima donnas and an absence of efficient business procedures. Those inefficient firms that survived under the umbrella of fixed commission rates dissolved under the downpour of rate competition when the umbrella folded. By the end of 1975, 35 brokerage firms had disappeared.
Out of short-run disaster came long-run opportunity. Few would have believed it possible a decade ago, but recently John J. Phelan Jr., chairman of the New York Stock Exchange, was quoted as saying that freeing commission rates "was the best thing that ever happened for the industry."
Volume is the key. When commission rates came down, volume soared five-fold to its current average of 100 million shares a day. The major contribution to increased volume and profit for brokers comes from institutions whose turnover rate now exceeds 60 percent, indicating a level of short-term speculation once confined to Las Vegas.
Brokerage profits and NYSE membership are both up sharply over the last decade, but the best single measure of prosperity in a profit-oriented business is the amount of capital committed to it. Firms dealing with the public now commit $17 billion in capital to their operations, a five-fold increase since May Day.
Growing prosperity does not mean evenly shared prosperity. Predictably, vigorous competition has created a new class of winners and losers.
The losers go well beyond the obvious lame ducks whose days were numbered anyway. Old line firms that depended on ancient relationships instead of present performance were left hanging by their old school ties. Dillon Read and Kuhn Loeb, once "special bracket" investment banking firms, fell into obscurity because they could not meet the challenge of better-capitalized and more vigorous competitors. Even Morgan Stanley, the premier firm of the old order, lost its long-held lead in underwriting and now is just one of many large and capable competitors.
The losers include aspiring financial conglomerates that purchased brokerage firms in the elusive hope of participating in Wall Street profits. Prudential Insurance paid a premium price for Bache; last year Bache lost more than $100 million. Sears' purchase of Dean Witter has yielded disappointing returns to date, and only time will tell if Equitable Life Assurance does any better with its recent purchase of Donaldson, Lufkin & Jenrette. Brokerage firms are uniquely people-intensive operations that do not fit well as divisions of larger corporate bureaucracies.
As the losers fade from view, the new winners push themselves into prominence. Salomon Brothers, once known as a pedestrian bond trader, is emerging as the new powerhouse, based on deep capital resources, broad distribution capability among institutions and, most importantly, aggressive personnel. Drexel, Burnham, also an obscure firm a decade ago, now is the leader in financing the huge junk bond market for lower-rated companies.
Competition, a force the exchange suppressed for two centuries, now extends beyond commission rates on old products to the creation of entirely products and services. Drexel created today's junk-bond market and Salomon created the zero-coupon treasury receipt (also known as CATS, Certificates of Accrual on Treasury Securities). Both firms enjoy large profits as a reward for their poineering, but both are very much aware that those profits will disappear if they relax their competitive efforts. In a business filled with energetic and capable competitors, the advice of the late Boston Pops conductor Arthur Feidler applies to firms as well as to individuals, "He who rests, rots."
Competition frequently means survival of the cheapest. Discount brokers now command 20 percent of the retail market by offering discounts of up to 70 percent off the rates charged by full-service brokerage firms. Today, the investor who can do without a full-service broker's advice also can do without his high commission rates. Before May Day 1975, that option simply did not exist.
The biggest winner from increased competition among brokers is the investing public they serve. There are old brokers who remember May Day 1975 with the same feelings old sailors reserve for Dec. 7, 1941. For the investing public, which benefits from lower commission rates and a broader choice of investment products, however, these are the good old days. By James Gipson; Gipson is president of Pacific Financial Research, Beverly Hills, Calif.