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Making Markets: Opportunism and Restraint on Wall Street.

If you have any interest, professionally or personally, in the financial markets, you will love this book. The securities markets often are viewed as examples of free markets where prices are formed by supply and demand, under rules set by self-regulation and government oversight. Based on thirteen years of research and extensive fieldwork, Professor Abolafia has analyzed three principal securities markets (the bond, stock and futures markets) and concluded that attention should be reoriented from an economic explanation to a social explanation of their operations. He sees not the invisible hand of market efficiency but rather the visible hands of those who construct market arrangements. He sees a complex world of social organization, not a world of unbridled competitive abandon, a world in which powerful competitive actors create systems to restrain themselves and others. It's a totally different way of viewing markets.

Within this analytical framework, the author also examines major deviations from accepted norms, such as the Salomon Brothers rigging of the government bond market in 1991, the Hunt brothers attempt to corner the silver market in 1980 and Michael Milken's domination of the junk bond market in the 1980s. However, the major part of the book is devoted to reporting on personal interviews with traders, market makers and exchange specialists. The focal point of the study is the trading floor and its market arrangements. The "fundamental premise developed here is that financial markets are socially developed institutions."

Nevertheless, while the three markets involve the exchange of highly standardized financial instruments in an auction market, each has different institutional arrangements that "reflect social structural differences in the markets, including differences in the social cohesion of market makers' networks, distinctive jurisdictional conflicts among interest groups on the trading floor, and differences in the involvement of the government in the market."

The underlying behavior of traders is structured around the conflict between short-term self-interest and long-term self-restraint. Consequently, major scandals are viewed not as unique individual departures from accepted conduct but rather as part of a pattern of extreme acts of opportunism that exceed the tolerance of powerful stakeholders inside and outside the markets; pressures rise to restrain extremes.

The contrasts drawn among the three markets are fascinating. Bond market trading is not done on an organized exchange but over-the-counter where traders act as both brokers filling orders for customers and dealers buying or selling for their firm's accounts. Huge profits, both firm and personal, are made by strategies described at various levels of opportunism; traders react instantly and instinctively to how they expect other traders to react to information. Trading is impersonal, aggressive, detached from the customer and subject to little regulation.

By contrast, the futures markets operates under systems of formal and informal control. Trading is done face to face, an environment where reputation is a valued form of social capital, because traders are mutually dependent, and social mechanisms have developed that include informal norms, formal rules of trade and organizational arrangements to coordinate collective action. The exchanges are legal monopolies that retain their dominance through economies of scale and active maintenance of the market. Behavior in these markets consequently is highly structured.

As an example of the experience of "outsiders" in this market, the Hunt brothers tried to control the silver market in 1980. They ultimately were driven into bankruptcy by changes in the rules and regulations. The Chicago Board of Trade first limited the number of contracts individual speculators could hold, then the Commodities Exchange in New York ruled that speculators with long positions could no longer buy but only sell their holdings to bullion dealers and other commercial investors, many of whom had large "short" positions in silver. Finally, the Federal Reserve restricted bank loans for speculation in commodities and precious metals (the Hunt's borrowings to cover speculative losses accounted for 12.9 percent of all business loans in the United States in February and March 1980). This forced a margin call the Hunts could not meet, and further Federal Reserve action was necessary to ensure the survival of the interlocked system of banks, brokerage house and exchanges.

The New York Stock Exchange (NYSE) is an older market and with much more structured formal controls than either of the other two. Until 1960, the NYSE was controlled by the specialists on the floor, who, acting as both agents for customers and dealers for their own accounts, were the dominant force on the exchange floor. The increasing role of large investment organizations on both the buy and the sell side shifted control to the specialists' customers, the member securities firms. Large institutional trades that the specialist could not easily handle, the ending of fixed commissions in 1975, and the development of program trading significantly reduced the specialists' role; the governance structure of the Exchange became "less like a private club and more like a public corporation." New technology increased the number of transactions that could be processed but also increased the opportunity for surveillance, and the specialist is threatened with extinction.

The "third" market (trading blocks of NYSE-listed stocks away from the floor) and the "fourth" market (automated transaction systems that match trades by computer) have reduced the dominance of the NYSE in trading stocks of major corporations. Increased volume and the diminished role of the specialist, who has an affirmative responsibility to maintain orderly markets, have resulted in much greater market volatility. In the future, the author believes that regulating the trading floor will become moot as trading will flow increasingly to low cost worldwide electronic networks where computers match bids and offers anywhere in the world.

This book is a excellent description of the rapidly shifting securities markets and how trading functions and is controlled. Although briefly discussed, comment is limited on the effects on the securities markets of the expanding role of the large institutional investor, the increase in trading by market participants for their own accounts rather than for customers, the impact of the surging public interest in mutual funds, the expanding globalization of trading and investing, and the effects of worldwide mergers and acquisitions among investment organizations. But then no one book could cover all of these topics. The author has limited his discussion to an important and shifting area in the investment field and has told his story well.

Edmund A. Mennis Palos Verdes Estates, California
COPYRIGHT 1997 The National Association for Business Economists
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Copyright 1997 Gale, Cengage Learning. All rights reserved.

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Author:Mennis, Edmund A.
Publication:Business Economics
Article Type:Book Review
Date:Oct 1, 1997
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