View from City Road: Technology transforms Wall Street and may kill it

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DELMONICO'S, the Wall Street institution that counts among its past patrons Charles Dickens, Mark Twain and Oscar Wilde - not to mention their stockbrokers - hardly has the air of a restaurant suffering irreversible financial decline. Each lunchtime still finds the lions of the American securities business holding court amid its Victorian stone columns and velvet curtains.

Yet last month, without so much as a passing mention in the Wall Street Journal, the restaurant that claims to have invented Baked Alaska, Lobster Newburg and Chicken a la King quietly filed for bankruptcy under America's Chapter 11, succumbing to years of ambitious spending and mismanagement.

Like its favourite watering hole, Wall Street hardly has the feel of an institution in chronic decline. Last week, the member firms of the New York Stock Exchange reported a record dollars 1.5bn profit for the first quarter of the year, 10 per cent better than the year before and roughly double their earnings for the last three months of 1992.

And the profits are not simply coming from broking all the savings flooding out of low-yielding bank accounts looking for a decent return. Mergers activity 1980s-style is reviving for the first time in five years, thanks to a spate of multi-billion- dollar telecoms deals. 'It's rush hour on the information superhighway,' one Journal headline put it this week.

But Wall Street as we know it - a narrow canyon of skyscrapers teeming with overpaid bankers - is doomed, many of its denizens fear, and it is this very industry, computerised telecommunications, that is partly to blame.

It's not so much that Wall Street is physically threatened by the fact that investors can now trade NYSE shares from a PC in a basement office on Long Island, or for that matter, from a laptop in a Colorado condo. For some time now Wall Street has become less of a place and more of a concept. It is that technology and market deregulation are combining to make the NYSE, brokers, underwriters and market intermediaries in general, obsolete.


Unlike many industries that have still to realise a return on their huge investment in computer technology, the US securities business has been transformed by automation. Floor trading on stock and commodities exchanges may still rely on paper trading tickets (although an agreement this week means even their days are numbered), but just about every other aspect of the market place has gone digital.

The dollars 19bn Wall Street has spent on computerised communication has afforded the industry huge productivity gains, allowed firms to relocate back offices to New Jersey, Florida and Texas, created global financial markets, and provided them with ever more exotic investment products. Without computers there would not be indexing, derivatives or programmed arbitrage.

What information technology may have brought Wall Street is profitability. Thanks to the paradox of financial markets, computers have also opened Wall Street's franchise to global competition, enabled rivals to copy new investment products quickly, narrowed spreads and made available to clients the very information they have traditionally paid their brokers and bankers for.

For years Wall Street has made its money buying at one price and selling at another; 'the less the customers knew, the wider the spread and the more money for the house', notes Paul Gibson, a veteran business journalist and the author of Bear Trap, a new book on the industry's decline.

But the diffusion of real-time market information - to fund managers, through computerised discount brokers, and now directly to individual investors over inexpensive cable- television services - has meant that spreads between bids and asking prices are evaporating. On 30-year US Treasury bonds, they're a quarter of what they were 10 years ago; for collateralised mortgage obligations, they're one tenth. And each new generation of products rarely, if ever, matches the profitability of those it replaces.

The ravages of technology are compounded by the effects of deregulation the industry itself has often championed. Twenty years ago, the US ended fixed brokerage commissions and liberalised pension investments, creating the competitive crisis Wall Street faces today. Now the street is bracing itself for the release later this summer of 'Market 2000', the Securities and Exchange Commission's proposals for the first important market reform since then.

'Market 2000' is only likely to make it even harder for Wall Street to earn profits the old-fashioned way, Mr Gibson argues. Armed with information that is at least as good as their former advisers', and empowered by more liberal securities and investment laws in the US, its erstwhile clients are increasingly bypassing Wall Street.


Big companies like Philip Morris, Du Pont and IBM are increasingly taking their brokerage and investment banking needs in-house. Individual investors, scared out of the market by the volatility of the past six years, have turned to mutual funds, which, like Fidelity Investments, are creating their own internal stock markets. Pension funds increasingly conduct their investment privately; less than 10 per cent of index trading last year, for example, was conducted through traditional exchanges.

As the amount of money coming into the markets has grown, it has thus been concentrated among fewer buyers, creating a shift of power away from Wall Street's traditional sellers - who now, by one estimate, outnumber buyers six to one.

This ratio, Mr Gibson argues in his book, goes a long way to explaining the increasing desperation in the securities business to come up with ever riskier strategies to make money. Wall Street's profits, he points out, are extracted from ever more dangerous pursuits - outrageous leveraging and mergers activity in the 1980s, and now rampant speculation in interest rates and currencies in the 1990s.

Yet the industry's return on equity has slid from more than 30 per cent a decade ago to less than 9 per cent - a ridiculous level for such a risky business. Transparent markets, ultimately, are making Wall Street's middlemen superfluous, Mr Gibson argues.

But Wall Street, like Delmonico's, continues to function and even prosper despite its longer-term difficulties. Delmonico's patrons like to point out that this is not the first time the restaurant has faced apparently insurmountable difficulties, having survived Prohibition, the Depression and closure for five years between 1977 and 1981.

'We've been here 155 years,' Delmonico's treasurer, Edward Huber, says. 'And we expect to be here 155 more.'