WEBVTT 00:01.940 --> 00:05.760 Professor Robert Shiller: What I want to talk 00:05.761 --> 00:10.031 about today is about places where stocks are exchanged--or 00:10.032 --> 00:12.282 bonds or other securities. 00:12.280 --> 00:14.560 It's another huge industry. 00:14.560 --> 00:18.770 I would say it's part of our information technology--our 00:18.767 --> 00:20.447 information network. 00:20.450 --> 00:24.740 What we have to do is find a national or international price 00:24.735 --> 00:27.965 for a security. The problem is that when 00:27.974 --> 00:31.824 securities are traded without a central market, 00:31.816 --> 00:36.486 different people will be getting different prices for the 00:36.493 --> 00:41.193 same thing. We have what's called--or maybe 00:41.185 --> 00:48.105 the term--what markets do for us is--the important term is "price 00:48.114 --> 00:49.634 discovery." 00:49.630 --> 00:54.480 00:54.480 --> 00:58.760 That means that there is a market price that an asset would 00:58.761 --> 01:03.261 have if everybody in the whole world were free to buy and sell 01:03.263 --> 01:07.253 the asset on the same market and at the same time. 01:07.250 --> 01:11.710 But if you don't have an organized exchange, 01:11.713 --> 01:18.463 which is open and available to everybody without a lot of cost, 01:18.459 --> 01:23.179 then you don't have effective price discovery and that means 01:23.175 --> 01:28.285 that nobody knows what the asset is worth in the whole market. 01:28.290 --> 01:31.880 We take price discovery for granted but we have to realize 01:31.882 --> 01:35.542 that there's a technology that brought us that and it's the 01:35.537 --> 01:38.627 technology that we want to emphasize that has been 01:38.626 --> 01:41.726 improving over the years; it's not static. 01:41.730 --> 01:49.100 I wanted to start by just defining some important terms 01:49.095 --> 01:53.865 regarding exchange of securities. 01:53.870 --> 01:59.230 One important term is "broker"--and I'll put it over 01:59.228 --> 02:02.588 here--another one is "dealer." 02:02.590 --> 02:11.520 Those are the two kinds of people who trade securities. 02:11.520 --> 02:17.930 It's important to keep the concept, so one thing that's 02:17.929 --> 02:23.149 used to describe is to start with the letters 02:23.151 --> 02:30.151 BOAC--that sounds likes it's British Overseas Airways 02:30.153 --> 02:33.723 Corporation, but that's not what I mean. 02:33.720 --> 02:36.770 This is a mnemonic to remember broker. 02:36.770 --> 02:46.150 It says brokers act on Behalf or for 02:46.146 --> 02:57.976 Others as an Agent for which they earn a 02:57.978 --> 03:02.888 Commission. 03:02.890 --> 03:07.280 03:07.280 --> 03:14.610 A broker goes between two people and the two people trade 03:14.612 --> 03:20.002 with each other. The broker makes it happen and 03:19.997 --> 03:26.357 the broker receives a fee called a commission for bringing these 03:26.355 --> 03:32.005 people together so that they could find each and make the 03:32.006 --> 03:34.626 deal--make the trade. 03:34.629 --> 03:42.199 For dealer, we have a different--it's DHPM. 03:42.200 --> 03:50.470 03:50.470 --> 04:02.600 A Dealer acts for Herself or Himself 04:02.596 --> 04:13.786 as a Principal for a Markup; 04:13.790 --> 04:18.590 04:18.592 --> 04:22.512 difference. In contrast to a broker, 04:22.505 --> 04:30.355 the dealer actually buys and sells himself or herself and 04:30.357 --> 04:38.067 that means the dealer has an inventory of whatever it is 04:38.068 --> 04:45.358 that--so that the dealer has something to sell. 04:45.360 --> 04:50.480 If you go to a dealer and buy a security, you're buying it from 04:50.479 --> 04:54.029 the dealer out of the dealer's inventory. 04:54.029 --> 04:58.909 If you sell through a dealer, you sell to the dealer. 04:58.910 --> 05:06.070 There's a fundamental diff--the markup is the difference between 05:06.065 --> 05:11.285 the price that the dealer buys and sells at; 05:11.290 --> 05:13.080 so, you see that there's a fundamental difference. 05:13.079 --> 05:18.559 Now, securities law says that you can never function as both a 05:18.558 --> 05:22.688 broker and a dealer in the same transaction. 05:22.689 --> 05:24.629 You've got to be one or the other. 05:24.630 --> 05:27.240 The same person can do both. 05:27.240 --> 05:31.470 You can be both a broker and a dealer, but not in the same 05:31.470 --> 05:38.540 transaction. We also have the term in 05:38.537 --> 05:50.087 finance "broker-dealer" and that's called BD. 05:50.089 --> 05:58.419 A BD is a firm that hires--that employs brokers and dealers. 05:58.420 --> 06:04.190 The fact that they hyphenate them doesn't mean that any one 06:04.187 --> 06:09.157 transaction involves both brokering and dealing. 06:09.160 --> 06:19.370 06:19.373 --> 06:20.583 ordinary life. 06:20.579 --> 06:23.749 When you buy and sell a house, your real estate agent is a 06:23.749 --> 06:26.079 broker. The real estate agent usually 06:26.079 --> 06:29.989 does not buy the house from you if you're selling your house. 06:29.990 --> 06:33.260 Or if you call up a real estate agent and say, 06:33.256 --> 06:36.736 "I want to sell my house," the agent doesn't say, 06:36.740 --> 06:41.700 "okay I'll buy it;" so, that person is operating as 06:41.699 --> 06:44.899 a broker. However, if you go to an 06:44.898 --> 06:50.158 antique shop and say you want to buy a chest of drawers or a 06:50.157 --> 06:53.897 dining room table, you'll be dealing with a 06:53.900 --> 06:56.880 dealer. I guess there are fundamental 06:56.876 --> 07:01.086 reasons in why it works out well in one and why it tends to break 07:01.085 --> 07:04.495 down differently for the different--why is it that we 07:04.504 --> 07:07.994 have dealers for antiques and brokers for homes? 07:07.990 --> 07:13.000 Well, I think it has something to do with--can you tell me, 07:12.998 --> 07:15.328 why do we do it that way? 07:15.329 --> 07:20.109 I was thinking it has something to do with the information cost 07:20.113 --> 07:25.053 of--since buying a house is such a big decision and you've got to 07:25.052 --> 07:27.832 go looking at the houses anyway. 07:27.829 --> 07:32.909 Somehow, antiques--you wouldn't have an antique broker would 07:32.913 --> 07:36.763 you? I guess you could. 07:36.759 --> 07:40.079 People could have antiques for sale in their homes and the 07:40.077 --> 07:42.927 antique broker would take you around on a tour. 07:42.930 --> 07:45.810 I wonder if that was my Blackberry. 07:45.810 --> 07:47.480 I am so wired here. 07:47.480 --> 07:56.270 07:56.271 --> 07:57.511 Blackberry. 07:57.510 --> 08:17.750 08:17.750 --> 08:23.880 The concept of a BD is that it is something regulated, 08:23.884 --> 08:30.254 once again by the Securities and Exchange Commission; 08:30.250 --> 08:36.200 that means any BD must register with the SEC. 08:36.200 --> 08:41.980 08:41.980 --> 08:45.020 In that sense, we have a sort of licensing for 08:45.024 --> 08:49.524 BDs. BDs in turn are responsible for 08:49.515 --> 08:55.445 their employees, who are acting as brokers and 08:55.446 --> 09:02.686 dealers, and the employees will have to be appropriately 09:02.694 --> 09:06.484 licensed. What BDs do is, 09:06.478 --> 09:13.588 according to our securities law, they would manage their 09:13.587 --> 09:20.177 employees exams through FINRA--now, I mentioned that 09:20.179 --> 09:23.259 before. That's the successor to 09:23.261 --> 09:26.191 National Association of Securities Dealers; 09:26.190 --> 09:30.720 that has exams for brokers and dealers. 09:30.720 --> 09:37.530 What it is--a BD is a company that hires people and they 09:37.526 --> 09:44.576 become licensed as brokers or dealers through their own BD 09:44.580 --> 09:48.350 using FINRA, so that's the organization 09:48.346 --> 09:49.786 method that we have. 09:49.789 --> 09:55.729 The reason why we have it this way is that there are so many 09:55.728 --> 10:02.068 instances of bad behavior among brokers and dealers that have to 10:02.070 --> 10:05.560 be handled. This goes back to a basic theme 10:05.559 --> 10:09.639 of this course that human nature is imperfect and while economics 10:09.644 --> 10:13.354 theory tries to describe people as honest and following the 10:13.347 --> 10:20.407 rules, there are so many opportunities 10:20.407 --> 10:29.427 for bad behavior that have to be corrected. 10:29.429 --> 10:34.929 I've taken the licensing exams for FINRA because I wanted, 10:34.934 --> 10:38.704 myself, to do creating of securities. 10:38.700 --> 10:42.870 I think it's actually a very good program they have and they 10:42.867 --> 10:46.887 have continuing education that brokers and dealers have to 10:46.894 --> 10:49.274 take. One thing that they do in the 10:49.271 --> 10:52.811 continuing education--I was impressed with what they've come 10:52.813 --> 10:56.423 up with--they have actors and actresses portraying situations 10:56.416 --> 10:59.836 that brokers and dealers will come up with--will encounter 10:59.838 --> 11:01.878 that are not quite ethical. 11:01.879 --> 11:06.549 I remember there was a scene where a woman comes up to the 11:06.545 --> 11:11.285 broker and there's a document that--she has a joint account 11:11.292 --> 11:15.962 with her husband and there's a document that requires both 11:15.957 --> 11:17.837 their signatures. 11:17.840 --> 11:22.540 The broker hands it to her and she signs and then he says, 11:22.536 --> 11:26.076 okay can you get your husband to sign it? 11:26.080 --> 11:30.640 She says, oh he already did, look--right in front of the 11:30.641 --> 11:35.621 broker and then they show the BD backing down--this is in the 11:35.617 --> 11:39.297 skit that I saw--and accepting, okay. 11:39.299 --> 11:41.639 She said, I'm sure it's all right with him; 11:41.640 --> 11:43.290 so he says, all right. 11:43.289 --> 11:47.129 The skit goes on and shows how much trouble he got into for 11:47.134 --> 11:49.794 accepting. Then, the husband shows up the 11:49.793 --> 11:53.583 next day and they're getting a divorce and he's furious and he 11:53.581 --> 11:55.751 [the broker] tries to cover it up by 11:55.754 --> 11:57.684 pretending he didn't know. 11:57.679 --> 12:00.439 She then comes back and admits that he [the broker] 12:00.439 --> 12:03.639 just told me it was all right that my husband--I could sign 12:03.641 --> 12:06.661 for my husband. There are all kinds of moral 12:06.660 --> 12:10.950 issues that arise and I think that the system works as well as 12:10.954 --> 12:13.774 it does because we have institutions. 12:13.769 --> 12:17.199 We recognize that there's a tendency for all kinds of bad 12:17.196 --> 12:20.856 behavior. My own experience with FINRA 12:20.863 --> 12:24.823 was increased confidence in our BDs. 12:24.820 --> 12:29.830 I think that we have a good system--that there's going to be 12:29.828 --> 12:33.138 a lot of temptation for bad behavior. 12:33.139 --> 12:37.809 We have a pretty good system in this country for educating 12:37.812 --> 12:39.782 people not to do that. 12:39.779 --> 12:46.849 We also actually go after BDs who do things that are seemingly 12:46.854 --> 12:49.384 innocent. For example, 12:49.381 --> 12:53.031 churning--I mentioned this before. 12:53.029 --> 12:58.529 Churning is overtrading a customer's account. 12:58.529 --> 13:05.019 It's not obvious to uninformed investors that it isn't a good 13:05.022 --> 13:11.842 idea to trade stocks every other day, but it's obvious to anyone 13:11.840 --> 13:15.490 in the field. If you're trading stocks that 13:15.485 --> 13:19.155 frequently, there's just no way that you could make money. 13:19.159 --> 13:24.439 There's nobody who can get a 50% return on stocks with 13:24.436 --> 13:27.716 reliability. We know that David Swensen--we 13:27.722 --> 13:31.192 mentioned him before--has got 18%, but he's the star and 13:31.192 --> 13:34.412 you're not going to do that well, realistically. 13:34.409 --> 13:38.029 If you're churning--if you're paying more then 18% in 13:38.025 --> 13:41.845 commissions every year, you just don't have a chance. 13:41.850 --> 13:44.910 A broker could try to hide behind some kind of 13:48.238 --> 13:50.118 that. But fortunately, 13:50.118 --> 13:54.238 we have good enough regulatory agencies to stop that, 13:54.241 --> 13:57.221 so right now, brokers who churn their 13:57.222 --> 14:01.392 portfolios will be caught by market surveillance and they 14:01.391 --> 14:04.371 will be thrown out of the profession. 14:04.370 --> 14:08.560 It's actually--you can be disbarred--prevented from 14:08.558 --> 14:10.148 trading for life. 14:10.149 --> 14:14.479 That's the kind of regulations we have. 14:14.480 --> 14:19.910 I think it's a very--the world is more ambiguous and faces more 14:19.908 --> 14:23.408 moral dilemmas than you would imagine. 14:23.409 --> 14:26.589 You have to get out into the business world and start seeing 14:26.591 --> 14:27.941 how often they come up. 14:27.940 --> 14:31.930 It's kind of remarkable that we have a system that handles these 14:31.927 --> 14:33.697 dilemmas as well as we do. 14:33.700 --> 14:37.670 You see a lot of anger now, for example with the subprime 14:37.665 --> 14:41.345 crisis, and people who supposedly or allegedly behave 14:41.347 --> 14:44.397 very badly. Certainly some of them did 14:44.398 --> 14:47.378 behave badly, but we have a system that, 14:47.379 --> 14:51.589 I think, has developed over many years that works pretty 14:51.585 --> 14:54.465 well. Now these are--so, 14:54.466 --> 15:01.516 brokers and dealers are people who work with the exchanges, 15:01.519 --> 15:08.149 but I want to go on to talk about the exchanges themselves 15:08.150 --> 15:11.640 on which these people trade. 15:11.639 --> 15:16.249 This is, unfortunately, a difficult topic to keep up 15:16.249 --> 15:21.039 with because the exchanges are changing every year. 15:21.039 --> 15:25.269 I think a big impetus for change is the advance of 15:25.271 --> 15:27.431 information technology. 15:27.429 --> 15:30.359 I might say also, financial technology. 15:30.360 --> 15:36.560 This is a world in rapid change; it's not fixed at all. 15:36.559 --> 15:42.989 I wanted to just talk about different kinds of exchanges 15:42.987 --> 15:45.587 that we have. Traditionally, 15:45.586 --> 15:48.906 we say there are--in the U.S., there are four markets. 15:48.910 --> 15:53.400 15:53.399 --> 16:01.949 One of them is called the first market and this is traditional 16:01.951 --> 16:07.841 and that is the New York Stock Exchange. 16:07.840 --> 16:11.090 I'm going to come back--it's now called NYSE-Euronext, 16:11.094 --> 16:13.984 but let's just be traditional for the moment. 16:13.980 --> 16:18.640 New York Stock Exchange is the old original stock market and 16:18.642 --> 16:21.962 the dominant one, so we call that the first 16:21.960 --> 16:28.040 market. Then there's the second market 16:28.041 --> 16:38.121 and that is NASDAQ and that stands for National Association 16:38.116 --> 16:47.146 of Securities Dealers Automatic Quotation System; 16:47.149 --> 16:52.459 that was the first electronic exchange. 16:52.460 --> 17:00.760 It was founded--the New York Stock Exchange was founded in 17:00.759 --> 17:09.059 1792, NASDAQ was founded in 1971--very different tradition 17:09.058 --> 17:13.728 between the two. I should say, 17:13.734 --> 17:21.884 the second market--I have to add that--is the NASDAQ National 17:21.877 --> 17:28.797 Market because NASDAQ is divided into two parts; 17:28.800 --> 17:30.440 there's the national market. 17:30.440 --> 17:35.470 The third market, so called third market, 17:35.472 --> 17:42.082 is NASDAQ small-cap; small-cap means companies whose 17:42.080 --> 17:44.930 capitalization is low. 17:44.930 --> 17:47.380 Capitalization, remember, is the price per 17:47.382 --> 17:50.792 share times the number of shares, so it's the value of the 17:50.793 --> 17:51.873 whole company. 17:51.870 --> 17:59.110 17:59.109 --> 18:02.239 The small caps are treated separately on NASDAQ. 18:02.240 --> 18:10.000 Then, there's the fourth market and that's beyond the exchanges 18:10.003 --> 18:12.363 itself. This is--it's large 18:12.358 --> 18:15.008 institutions trading amongst themselves; 18:15.010 --> 18:24.410 18:24.410 --> 18:27.730 it does happen. There's no law saying you have 18:27.725 --> 18:29.435 to go through an exchange. 18:29.440 --> 18:34.120 You can just buy and sell whatever. 18:34.119 --> 18:38.609 Especially if it's a very large transaction it can happen that, 18:38.613 --> 18:42.423 as part of some deal, institutions will trade shares 18:42.419 --> 18:45.699 and they don't have to go through the market. 18:45.700 --> 18:51.940 We really think that these are the most important markets. 18:51.940 --> 18:56.640 Let me--incidentally, these are not the first stock 18:56.641 --> 18:59.431 exchanges. The United States did not 18:59.433 --> 19:01.233 invent the stock exchange. 19:01.230 --> 19:05.800 I think maybe I mentioned this before, but Ulrike Malmondier, 19:05.804 --> 19:10.064 who is a professor at Stanford, has researched the Ancient 19:10.063 --> 19:14.093 Roman stock exchange and claims to have identified--I think I 19:14.087 --> 19:17.907 said this before--but has claimed to identify where in the 19:17.910 --> 19:21.330 Roman forum the Roman stockbrokers worked and it was 19:21.330 --> 19:23.410 out of a certain temple. 19:23.410 --> 19:26.240 You can find the location when you visit Rome now. 19:26.240 --> 19:28.200 I think it's in ruins, but you can find where they 19:28.200 --> 19:31.180 traded stocks; it was never very big. 19:31.180 --> 19:34.860 Then, some people in Anthrop had the first modern stock 19:34.861 --> 19:38.271 exchange--I don't know, like many centuries ago. 19:38.269 --> 19:43.929 Amsterdam was an early--London was an early stock exchange. 19:43.930 --> 19:48.140 So, we came kind of late in the United States to stock 19:48.140 --> 19:52.510 exchanges--1792 is kind of late in the world history. 19:52.510 --> 19:55.960 However, I think that the U.S. 19:55.960 --> 20:02.230 actually features somewhat prominently in the history of 20:02.229 --> 20:08.379 stock exchanges because there was a New York Securities 20:08.384 --> 20:15.114 Law--1811--which became a model for securities law and which 20:15.109 --> 20:22.289 made the stock exchange in New York especially important. 20:22.289 --> 20:28.839 The 1811 Securities Law in New York established two important 20:28.840 --> 20:32.450 principles. The first one was that anybody 20:32.452 --> 20:36.472 can set up a corporation and have it traded on the stock 20:36.472 --> 20:39.802 exchange. Anybody who satisfies some 20:39.799 --> 20:44.129 criteria specified by the securities regulator, 20:44.133 --> 20:49.133 but the criteria did not involve the state legislature 20:49.127 --> 20:52.987 convening and giving you permission; 20:52.990 --> 20:54.190 it was automatic. 20:54.190 --> 20:59.030 Didn't matter who you were; they would do anybody, 20:59.025 --> 21:02.435 but of course there were restrictions. 21:02.440 --> 21:05.660 The company may have had certain capital requirements and 21:05.656 --> 21:07.606 the like, but it was democratic. 21:07.609 --> 21:11.169 Until then, it used to be that in many countries companies 21:11.165 --> 21:14.405 would require an act of parliament to be found or the 21:14.409 --> 21:16.779 king would have to sign something. 21:16.779 --> 21:19.509 Now, it was very clear that it was democratic. 21:19.509 --> 21:27.489 The other thing that the New York Securities Law of 1811 did 21:27.489 --> 21:34.519 was make it law that limited liability was always the 21:34.521 --> 21:38.431 standard. That is that--limited liability 21:38.426 --> 21:41.326 means that you, as a stock market investor, 21:41.333 --> 21:45.003 can never be sued for the misdoings of the company you 21:45.003 --> 21:48.633 invested in. This was a very fundamental 21:48.626 --> 21:53.876 step in securities law because before 1811, while there was 21:53.881 --> 21:59.501 some limited liability--the idea was already out there and some 21:59.498 --> 22:04.938 companies put limited liability clauses in their charters--it 22:04.935 --> 22:08.645 was never so clear as in New York. 22:08.650 --> 22:12.960 So, you didn't want to trade and buy a few shares on some 22:12.956 --> 22:17.416 exchange because you had the possibility of getting hit for 22:17.417 --> 22:19.747 that; they could come after you. 22:19.750 --> 22:24.570 With the New York Securities Law of 1811, the New York Stock 22:24.570 --> 22:29.800 Exchange began to really prosper because then it became something 22:29.799 --> 22:34.699 that anybody in the world could come in and buy a share there 22:34.702 --> 22:38.792 and have no worries--except, you could only lose your money 22:38.788 --> 22:40.138 that you put in, nothing more. 22:40.140 --> 22:44.010 That turned out to be a very important innovation, 22:44.010 --> 22:46.860 which came in the U.S., and accounts, 22:46.855 --> 22:51.195 I think, for the importance of New York in finance. 22:51.200 --> 22:56.190 It was copied later in the nineteenth century all over 22:56.189 --> 23:02.119 Europe--this kind of securities law--but it took a long time. 23:02.119 --> 23:08.359 The New York Stock Exchange was founded in 1792, 23:08.361 --> 23:13.011 outdoors under a buttonwood tree. 23:13.009 --> 23:15.879 I've always wondered, what was a buttonwood tree. 23:15.880 --> 23:21.810 I guess some stock exchanges occurred in coffee houses. 23:21.809 --> 23:24.079 People used to like coffee, just as they do now, 23:24.075 --> 23:26.095 and that's a good place to trade stocks. 23:26.099 --> 23:29.389 You would be at Starbuck's or something in London 23:29.393 --> 23:33.243 probably--the equivalent of Starbuck's--and it would be a 23:33.236 --> 23:35.566 natural place to trade stocks. 23:35.569 --> 23:39.399 Actually, the New York Stock Exchange was founded under a 23:39.399 --> 23:41.539 buttonwood tree. I looked it up, 23:41.536 --> 23:45.036 a buttonwood tree is just a sycamore or American plain tree 23:45.042 --> 23:48.252 and we have them--I was wondering--we have them around 23:48.245 --> 23:50.555 here; they're just outside somewhere. 23:50.559 --> 23:54.509 I don't know why they call them buttonwoods; 23:54.509 --> 23:56.449 maybe they made buttons out of them--of the wood. 23:56.450 --> 24:03.220 24:03.220 --> 24:08.840 The system has gone on now for well over two hundred years but 24:08.840 --> 24:12.710 it's changing because of our technology. 24:12.710 --> 24:20.360 24:20.359 --> 24:25.789 It's one of the themes of my book, New Financial 24:25.785 --> 24:31.425 Order, as to how much technology has advanced our 24:31.428 --> 24:35.658 financial markets and institutions. 24:35.660 --> 24:39.720 There was some--if you look at the number of stocks traded on 24:39.715 --> 24:42.615 the London Stock Exchange, say, around 1800, 24:42.622 --> 24:46.432 it was just a handful; it was just not very big or not 24:46.431 --> 24:50.011 very important. But, it was certain kinds of 24:50.009 --> 24:55.319 information technology that really made stock exchanges take 24:55.319 --> 24:57.269 off. I'd like to just mention a few 24:57.265 --> 25:01.135 of them. One was--we were living in a 25:01.140 --> 25:04.870 very primitive world in 1800. 25:04.869 --> 25:10.909 People were actually using feather pens--that's what you 25:10.906 --> 25:17.546 would use at that time; also, paper was very expensive 25:17.549 --> 25:20.409 in 1800. If you bought a newspaper, 25:20.410 --> 25:24.240 if you look at newspapers from 1800, there would be a single 25:24.244 --> 25:27.564 sheet, typically, that folded in half--of paper. 25:27.560 --> 25:30.570 Why was that? Well, it's because paper was so 25:30.569 --> 25:34.999 expensive, because in 1800 paper had to be made out of scraps of 25:34.997 --> 25:36.807 cloth; they didn't have wood pulp 25:36.808 --> 25:39.298 paper and they didn't have--it had to be made by hand. 25:39.299 --> 25:45.219 You'd have people washing the fabric and then laying it on a 25:45.223 --> 25:49.543 screen--all by hand--and then rolling it; 25:49.540 --> 25:52.090 so, it was too expensive. 25:52.089 --> 26:00.369 We got--in the nineteenth century, we got cheap paper and 26:00.368 --> 26:09.388 then we got--I mention that I think it's important for--we got 26:09.386 --> 26:13.356 carbon paper; this came in the nineteenth 26:13.364 --> 26:16.624 century, although there were some maybe primitive versions. 26:16.620 --> 26:17.980 It allowed you to make copies. 26:17.980 --> 26:23.030 The typewriter--that came in in the late nineteenth century, 26:23.026 --> 26:28.156 so you could make records much more accurately with--and make 26:28.157 --> 26:32.857 copies and it's important to make copies so that they're 26:32.861 --> 26:36.541 backed up. We had printed forms, 26:36.539 --> 26:42.039 although those actually go back to the--in Holland, 26:42.039 --> 26:47.649 I think, we traced them back to maybe the 1700s. 26:47.650 --> 26:50.780 The idea is having a document with spaces to fill in numbers 26:50.784 --> 26:52.914 and then you put it in the typewriter; 26:52.910 --> 26:56.610 you've got printed up multiple copies of this with carbon paper 26:56.605 --> 26:59.735 between them. You type--it's very accurate; 26:59.740 --> 27:02.050 it makes it possible to do business. 27:02.049 --> 27:06.349 We invented filing cabinets in the 1890s; 27:06.350 --> 27:11.700 27:11.700 --> 27:13.960 that's comparatively recently--it's kind of amazing. 27:13.960 --> 27:16.580 Filing cabinets--we have the drawers that come out and you 27:16.579 --> 27:20.619 put file folders in; it wasn't until the 1890s that 27:20.617 --> 27:23.427 that came in. Before that you would take 27:23.432 --> 27:26.292 documents and tie them up with ribbons and put them on 27:26.290 --> 27:28.670 bookshelves. Well, there may have been other 27:28.673 --> 27:30.963 systems as well, but we didn't have the modern 27:30.956 --> 27:33.336 filing cabinet. The really important thing was 27:33.336 --> 27:34.456 electronic technology. 27:34.460 --> 27:43.620 We had the telegraph, which came in by Samuel Morse 27:43.617 --> 27:47.277 in--when was that? 27:47.280 --> 27:50.160 1840s? I think I might have it. 27:50.160 --> 27:59.130 Samuel Morse graduated from Yale University in 1810 and he 27:59.127 --> 28:06.057 patented the telegraph in 1837; so it was 1837. 28:06.059 --> 28:09.849 I'll mention--there's also a college here. 28:09.849 --> 28:12.769 Are you, anyone from Morse College? 28:12.770 --> 28:15.790 Yes? Only one, nobody else from 28:15.785 --> 28:18.645 Morse? There's a good number. 28:18.650 --> 28:22.340 He did something very important. 28:22.339 --> 28:26.849 Incidentally, he lived--his house is 58 28:26.846 --> 28:33.956 Trumbull, which is three blocks from here and if you want to, 28:33.960 --> 28:39.890 you can walk over there and see Morse's house. 28:39.890 --> 28:43.530 He used to have inventions parked out on his front lawn, 28:43.525 --> 28:47.535 but they're not there anymore; they've taken them in. 28:47.539 --> 28:51.629 This was a very important invention because electronic 28:51.634 --> 28:55.344 communication instantly--or at the speed of light 28:55.342 --> 28:59.362 essentially--is what now underpins our exchange. 28:59.359 --> 29:06.119 The next thing that happened, and that's a little bit later 29:06.115 --> 29:11.235 in the technology, was the ticker machine. 29:11.240 --> 29:17.950 It's not entirely clear who invented it but--because there 29:17.947 --> 29:24.297 are various versions--but apparently it was invented by 29:24.301 --> 29:32.311 Thomas Edison. This was--he was--this was his 29:32.305 --> 29:36.805 first invention. You've heard of many inventions 29:36.813 --> 29:37.573 from Thomas Edison. 29:37.569 --> 29:44.109 Quite remarkable that his first invention was in the area of 29:44.112 --> 29:47.552 finance and that was in 1867. 29:47.549 --> 29:51.349 How old do you think he was when he invented the ticker 29:51.346 --> 29:53.876 machine? He was twenty-three; 29:53.880 --> 29:57.380 so that's just a--those of you who are thinking of your 29:57.380 --> 30:01.010 careers, some people get started at a good, young age. 30:01.009 --> 30:06.459 You probably don't even know what a ticker machine is. 30:06.460 --> 30:09.810 Do you know what I'm talking about, a ticker machine? 30:09.810 --> 30:11.800 Some of you do anyway. 30:11.799 --> 30:16.869 What it was was like a computer printer. 30:16.870 --> 30:19.340 I mean. he was just like way ahead of 30:19.336 --> 30:21.446 his time. We have these printers--you 30:21.447 --> 30:24.837 have one in your room or somewhere--that when electronic 30:24.842 --> 30:27.932 signals come to it, it prints out on the paper; 30:27.930 --> 30:32.920 well, he invented one in 1867. 30:32.920 --> 30:38.480 What it did--remember the telegraph machine that Morse 30:38.482 --> 30:43.522 invented was--it required humans on both ends. 30:43.519 --> 30:46.659 One person would be tapping on the Morse Code on one end and 30:46.662 --> 30:49.812 there would be another person listening on the other end who 30:49.805 --> 30:51.505 would transcribe it by hand. 30:51.509 --> 30:54.609 So, Edison thought, well there's no reason why it 30:54.606 --> 30:58.086 shouldn't be done mechanically at the receiving end, 30:58.089 --> 31:02.789 so he invented a sort of automatic typewriter that 31:02.787 --> 31:06.377 printed out. The initial application of it 31:06.378 --> 31:10.178 was to stocks because that was--that's the kind of 31:10.177 --> 31:14.517 information people needed continually on a big basis. 31:14.519 --> 31:19.789 He invented this printer and it's a little different from 31:19.789 --> 31:23.929 modern--we have a standard paper size now, 31:23.930 --> 31:27.220 which is 8.5" x 11", but he didn't want to use all 31:27.220 --> 31:29.050 that. Remember, paper was more 31:29.053 --> 31:31.673 expensive then and he didn't need to get a lot, 31:31.665 --> 31:33.535 so he changed the shape of it. 31:33.539 --> 31:36.389 So, the paper, instead of being that wide, 31:36.387 --> 31:40.477 was like that wide because all he had to put was symbols for 31:40.484 --> 31:44.584 stocks--abbreviations for their names--and then the price at 31:44.582 --> 31:48.222 which it traded. He wanted to get a lot of these 31:48.223 --> 31:52.113 in rapid succession out, so he didn't need a wide width. 31:52.110 --> 31:53.680 It's all very logical. 31:53.680 --> 31:56.990 It was basically a computer printer with a narrow width. 31:56.990 --> 31:59.630 I forgot to bring it today; I should have. 31:59.630 --> 32:02.730 I was telling someone at the New York Stock Exchange that I 32:02.726 --> 32:05.926 was telling my students about the ticker machine and students 32:05.929 --> 32:09.239 didn't--my students didn't seem to know anything about it. 32:09.240 --> 32:12.540 Then he sent me as a gift a ticker tape; 32:12.539 --> 32:14.889 it was just a roll of paper tape. 32:14.890 --> 32:19.090 They were using ticker tapes at the New York Stock Exchange 32:19.089 --> 32:22.129 until 1964, I think it was, and he said, 32:22.125 --> 32:26.795 well we still have some in the attic and he gave me a roll. 32:26.800 --> 32:28.700 Maybe I'll try to bring it. 32:28.700 --> 32:32.870 This is just, maybe, a curious history about 32:32.871 --> 32:36.631 communications. Do you know what a ticker tape 32:36.627 --> 32:41.477 parade is? Some of you--these ticker 32:41.478 --> 32:50.938 machines used to be printing out stock prices constantly, 32:50.940 --> 32:55.310 so this tape was just constantly running and it would 32:55.313 --> 32:58.933 pile up in these huge wads of paper tape. 32:58.930 --> 33:02.770 They had to always dispose of it at the brokerages because all 33:02.771 --> 33:06.421 this paper tape had to be thrown away and it was a disposal 33:06.424 --> 33:08.604 problem. Whenever there was a parade 33:08.598 --> 33:10.958 down Wall Street, people would--they would use 33:10.962 --> 33:14.112 this ticker tape like confetti and they would tear it up into 33:14.114 --> 33:17.274 shorter lengths and they would toss it out the windows and so 33:17.265 --> 33:19.835 you'd see all this paper tape coming down. 33:19.839 --> 33:25.279 We still--this is all obsolete now, but in a sense it is 33:25.281 --> 33:30.621 electronic communication technology that--I guess we're 33:30.624 --> 33:35.614 still wasting a lot of paper; we just changed the width, 33:35.605 --> 33:37.845 so we don't call it tape anymore. 33:37.849 --> 33:41.029 We call it printer paper or something like that, 33:41.031 --> 33:43.131 so it's not exactly the same. 33:43.130 --> 33:55.570 33:55.569 --> 34:02.099 The idea that we should have one market--when we have ticker 34:02.099 --> 34:09.069 tape machines--we still use the word ticker symbol for the short 34:09.071 --> 34:15.071 abbreviation of a stock, so every stock has an 34:15.066 --> 34:17.546 abbreviated name. 34:17.550 --> 34:20.870 We don't need abbreviations anymore because our printers are 34:20.865 --> 34:23.445 much more effective, but we still have them. 34:23.449 --> 34:28.769 That's the official--the ticker symbol is the official name for 34:28.769 --> 34:33.659 a stock or other security that's traded on an exchange. 34:33.659 --> 34:38.329 When you have electronic communication, 34:38.326 --> 34:45.326 it should create a national market that is--where everyone 34:45.326 --> 34:49.006 is getting the same price. 34:49.010 --> 34:53.600 However, it doesn't necessarily work automatically. 34:53.599 --> 35:01.499 In 1975, people made a number of complaints to our lawmakers 35:01.498 --> 35:06.248 in Washington that, in fact, while we have ticker 35:06.251 --> 35:09.331 machines and we have a lot of--well actually, 35:09.329 --> 35:12.129 they were already gone by ‘75, but there were a lot 35:12.130 --> 35:13.680 of electronic communications. 35:13.679 --> 35:17.029 But, some people were not always getting the same price. 35:17.030 --> 35:19.430 Someone would say, I placed my order in the 35:19.429 --> 35:22.399 Philadelphia Stock Exchange and I got a bad price. 35:22.400 --> 35:25.690 I realized later I could have traded at some other 35:25.689 --> 35:28.709 exchange--nobody told me--at the same time. 35:28.710 --> 35:34.850 So, Congress created--it was The Securities Act of 35:34.847 --> 35:41.107 1975--wanted to create a national market system. 35:41.110 --> 35:48.210 35:48.210 --> 35:52.100 So, Congress mandated that securities brokers set up some 35:52.098 --> 35:56.258 kind of electronic system that would allow people to trade on 35:56.263 --> 35:59.183 whichever exchange has the best price. 35:59.179 --> 36:02.799 It was sort of a challenge to the monopoly of the New York 36:02.798 --> 36:06.348 Stock Exchange because your broker--if you place an order 36:06.353 --> 36:10.483 with your broker this--we would have a new electronic system. 36:10.480 --> 36:14.230 The broker would look over all the different exchanges and see 36:14.226 --> 36:17.836 which one had the best price; that's what you want as a 36:17.844 --> 36:21.234 customer. It was implemented with 36:21.234 --> 36:26.414 something called the ITS--Intermarket Trading 36:26.409 --> 36:33.699 System--which allows a broker to look over all the exchanges to 36:33.700 --> 36:36.640 find the best price. 36:36.639 --> 36:40.209 That was set up with computers in 19--or in the early 36:40.214 --> 36:42.624 '70s--1975 or shortly after 1975. 36:42.620 --> 36:52.070 It's been in place ever since; however, because it was 36:52.068 --> 36:56.478 mandated by Congress, the computer system was up to 36:56.479 --> 37:00.889 date and modern in the early '70s or late '70s, 37:00.889 --> 37:06.319 but it hasn't kept up and it's considered slow, 37:06.318 --> 37:11.748 as a sort of dinosaur, and people want to avoid 37:11.746 --> 37:17.376 trading in it. In 2006, all the major 37:17.376 --> 37:26.296 exchanges proposed that we replace the ITS with something 37:26.303 --> 37:33.143 called NMS linkage, which is just a more modern 37:33.142 --> 37:39.812 version of the computer technology, but I haven't heard 37:39.806 --> 37:44.616 anything about it being implemented. 37:44.619 --> 37:48.039 Again, since I don't trade--maybe some of you know 37:48.044 --> 37:50.984 what's happened with NMS linkage system. 37:50.980 --> 37:55.610 Let me put this--NMS linkage was proposed, 37:55.609 --> 37:59.109 but you see what's happening. 37:59.110 --> 38:00.570 [The NMS Linkage plan was activated and replaced the ITS 38:00.571 --> 38:01.661 in June 2007] When the government tries to 38:01.660 --> 38:04.490 mandate a linking of exchanges, that's not the same thing as 38:04.492 --> 38:07.892 having a market impetus for linking of exchanges, 38:07.889 --> 38:14.419 so what's actually happened is really ignoring the national 38:14.418 --> 38:18.128 market system. Computer technology has 38:18.132 --> 38:23.372 advanced so rapidly it starts to create opportunities for people 38:23.371 --> 38:28.361 to set up their own competing systems and who cares about the 38:28.361 --> 38:30.871 ITS, which is a dinosaur, 38:30.869 --> 38:32.629 which nobody likes. 38:32.630 --> 38:36.040 That's something we have to recognize--that there are 38:36.037 --> 38:39.897 different approaches and there are going to be clever people 38:39.904 --> 38:43.644 who come up with new ideas about how to trade stocks. 38:43.639 --> 38:50.579 This brings us to the so called ECNs. 38:50.579 --> 39:00.489 They were called electronic communications networks and what 39:00.491 --> 39:11.411 happened was with the advent of the Internet--in the mid-1990s, 39:11.409 --> 39:15.999 people started setting up websites that looked like stock 39:15.999 --> 39:18.949 exchanges, but maybe they weren't. 39:18.950 --> 39:24.620 39:24.619 --> 39:30.799 I guess the first one was Instinet--I'm not sure it's the 39:30.801 --> 39:35.621 absolute first one, but Instinet was--now, 39:35.619 --> 39:42.209 understand that an exchange has to register with the SEC. 39:42.210 --> 39:44.180 The SEC has all kinds of requirements, 39:44.175 --> 39:47.145 and if you're setting up some website, you probably can't 39:47.150 --> 39:49.010 satisfy all those requirements. 39:49.010 --> 39:52.490 So, Instinet set up an electronic bulletin board, 39:52.485 --> 39:55.445 I called it, which was not an exchange but 39:55.454 --> 39:59.734 it was a place where people interested in buying and selling 39:59.726 --> 40:02.546 shares could post their interest. 40:02.550 --> 40:06.410 It was like an electronic bulletin board, 40:06.412 --> 40:11.532 so it would be especially important for people who are 40:11.530 --> 40:16.840 placing really big orders because they might want to not 40:16.841 --> 40:21.381 just put it on the floor of the exchange. 40:21.380 --> 40:27.490 But to--they might want to say something on the thing about 40:27.493 --> 40:34.243 under what conditions I would buy this or something like that. 40:34.239 --> 40:37.649 It became more flexible and became very popular among 40:37.654 --> 40:39.234 institutional traders. 40:39.230 --> 40:45.360 Then there was a number of other--now the SEC allowed them 40:45.359 --> 40:50.629 to function as ECNs, which is a separate category, 40:50.628 --> 40:55.358 and they started to look like exchanges. 40:55.360 --> 40:58.610 I guess the legal history of these is very complicated. 40:58.610 --> 41:01.370 They ended up merging with exchanges; 41:01.369 --> 41:07.379 this is in the 1990s and early 2000s. 41:07.380 --> 41:12.730 I remember one that impressed me because I had heard in the 41:12.730 --> 41:19.130 '90s a talk from the founder; Island was an exchange that was 41:19.134 --> 41:26.684 created--can you see this?--that was created for small investors. 41:26.679 --> 41:31.339 It actually started to look a lot like an exchange. 41:31.340 --> 41:36.430 What I found interesting about Island--the person I heard speak 41:36.429 --> 41:40.529 about it in the '90s spoke of this as democratizing 41:40.534 --> 41:43.784 institutions. It was the Web culture taking 41:43.783 --> 41:46.343 over what the stock exchanges had done. 41:46.340 --> 41:53.610 What Island did was it posted its limited, so called, 41:53.613 --> 42:01.873 "order book" on the Web to the whole world to see and it was 42:01.865 --> 42:07.455 kind of challenging stock exchanges, 42:07.460 --> 42:12.280 which had kept the order books more or less in secrecy. 42:12.280 --> 42:16.890 Let me just step back and let's go back to what happens on an 42:16.888 --> 42:20.958 exchange and how Instinet and Island are different. 42:20.960 --> 42:23.430 There was another one--another big one was called 42:23.426 --> 42:25.426 Archipelago--that sounds like Island. 42:25.429 --> 42:30.129 It was another website that you used to be able to get on and 42:30.134 --> 42:34.764 you could read these order books for any stock and you'd see 42:34.759 --> 42:38.679 some--let's step back and talk about what's goes on 42:38.679 --> 42:43.459 traditionally at the New York Stock Exchange and still goes on 42:43.462 --> 42:47.142 today. The New York Stock Exchange is 42:47.138 --> 42:52.298 the biggest stock exchange in the U.S., but also in some ways 42:52.295 --> 42:54.525 the most-old fashioned. 42:54.530 --> 42:58.630 They still have a floor, a trading floor. 42:58.630 --> 43:06.750 Most stock exchanges have abolished their trading floor. 43:06.750 --> 43:10.270 I just gave a talk in Moscow at their stock exchange and I was 43:10.274 --> 43:13.284 mentioning something about trading floors and someone 43:13.278 --> 43:15.818 raised his had in the audience and says, 43:15.820 --> 43:19.010 you're talking at the Russian Stock Exchange trading floor; 43:19.010 --> 43:20.650 that's where my talk was. 43:20.650 --> 43:22.380 I didn't even know I was in it. 43:22.380 --> 43:27.770 I was in the German Frankfurt Stock Exchange and I was--they 43:27.773 --> 43:31.433 said, I'll show you our trading floor. 43:31.429 --> 43:34.969 So, I walk in and I just see a bunch of school children and 43:34.974 --> 43:38.524 they had--there was nobody there except school children. 43:38.520 --> 43:40.020 It had turned into a museum. 43:40.019 --> 43:41.959 That's what's happening all over the world because 43:41.956 --> 43:43.256 everything is going electronic. 43:43.260 --> 43:47.110 The New York Stock Exchange, and the Toronto Stock Exchange, 43:47.113 --> 43:50.773 and the American Stock Exchange are the few--or is it the 43:50.770 --> 43:52.620 Montreal, I forget now--anyway, 43:52.622 --> 43:54.822 there are very few that still do it this way. 43:54.820 --> 43:55.800 [The Toronto Stock Exchange replaced its trading floor with 43:55.802 --> 43:56.722 an electronic system in 1997--the Montreal Exchange has 43:56.717 --> 43:57.767 also augmented its trading with its SOLA platform introduced in 43:57.767 --> 43:58.357 2005.] We still have a floor [at the 43:58.360 --> 43:58.920 New York Stock Exchange]. 43:58.920 --> 44:02.830 So, you have, for each stock, 44:02.826 --> 44:10.776 you have a specialist who stands at a post on the floor of 44:10.778 --> 44:15.838 the exchange; so each stock has a specialist. 44:15.840 --> 44:22.610 Then you have traders who roam around the floor and go 44:22.612 --> 44:30.542 to--these are brokers or dealers who are trying to buy and sell 44:30.535 --> 44:37.305 stocks and they go to the various posts and make their 44:37.308 --> 44:40.878 rounds. They have so many stocks they 44:40.881 --> 44:44.771 want to buy and so many they want to sell and they go around 44:44.770 --> 44:46.880 on the floor of the exchange. 44:46.880 --> 44:49.060 If they want to buy a particular company, 44:49.059 --> 44:52.169 they go to--they know where that specialist is and they go 44:52.165 --> 44:55.695 there. On the floor of the exchange, 44:55.701 --> 45:00.861 they can either buy and sell from the specialist, 45:00.860 --> 45:03.750 who is a dealer, who maintains an inventory, 45:03.752 --> 45:07.652 or they can buy and sell from anybody else they meet at the 45:07.654 --> 45:09.954 post. Of course, everyone there is 45:09.947 --> 45:12.287 licensed; it's not open to the public. 45:12.289 --> 45:17.769 What happens is, there is a crowd that develops 45:17.768 --> 45:25.028 at each specialist's post and the crowd consists of people who 45:25.034 --> 45:30.874 decided to go to that specialist's post to look at 45:30.870 --> 45:36.230 what they want to possibly buy or sell. 45:36.230 --> 45:38.270 They can buy or sell from anyone. 45:38.269 --> 45:41.569 The specialist is sometimes just standing there watching and 45:41.574 --> 45:42.754 it's all happening. 45:42.750 --> 45:45.730 The specialist--and the New York Stock Exchange 45:45.727 --> 45:49.677 maintains--that the specialist fulfills an important function, 45:49.676 --> 45:52.326 which is to create an orderly market; 45:52.329 --> 45:56.689 so, the specialist has a responsibility as well as an 45:56.686 --> 45:59.706 opportunity. The other people at the crowd 45:59.709 --> 46:03.219 are just doing their own business, but the specialist is 46:03.216 --> 46:06.656 supposed to be obligated to preserve a good market. 46:06.659 --> 46:11.129 If for some reason the price is dropping rapidly and the 46:11.125 --> 46:14.205 specialist thinks something's wrong, 46:14.210 --> 46:18.500 the specialist is supposed to come in and buy on his or her 46:18.495 --> 46:21.735 own account; that's an obligation. 46:21.740 --> 46:27.550 46:27.550 --> 46:29.740 There have been problems. 46:29.739 --> 46:32.219 For example, in 1987, when the stock market 46:32.216 --> 46:35.156 dropped precipitously, there were criticisms of the 46:35.164 --> 46:38.294 specialists for not buying to support the market. 46:38.289 --> 46:40.749 But then, specialists said in their own defense, 46:40.746 --> 46:41.736 what could we do? 46:41.740 --> 46:43.000 The market is crashing. 46:43.000 --> 46:46.470 So, it's not clear that specialists make a huge 46:46.469 --> 46:50.089 difference, but that's the presumed advantage. 46:50.090 --> 46:56.340 Now it used to be--this is an interesting historical 46:56.343 --> 47:03.213 thing--that before the 1930s there were two crowds on the 47:03.210 --> 47:08.170 stock exchange. There was the buy/sell crowd 47:08.169 --> 47:13.809 and there was another part of the floor--I can't find this in 47:13.805 --> 47:17.745 my notes--where stocks would be rented. 47:17.750 --> 47:22.170 I had the dates here and I don't remember. 47:22.170 --> 47:22.800 I can't find it in my notes. 47:22.800 --> 47:27.380 47:27.380 --> 47:28.390 [Charles Jones and Owen Lamont report in their study of the 47:28.385 --> 47:29.355 loan crowd that data on their trades was published in the 47:29.357 --> 47:30.137 Wall Street Journal from 1919 to 1933.] 47:30.137 --> 47:32.527 Well anyway, shares are--it's called the 47:32.526 --> 47:33.446 loan crowd. 47:33.450 --> 47:39.330 47:39.329 --> 47:43.119 There used to be a special part of the floor of the New York 47:43.115 --> 47:47.025 Stock Exchange where stocks would be lent rather than sold. 47:47.030 --> 47:49.840 There are two things you can do; there are two kinds of trade. 47:49.840 --> 47:51.960 You go to a real estate broker--you can say, 47:51.961 --> 47:55.071 I want to buy a house or you can say, I want to rent a house. 47:55.070 --> 47:57.550 The broker can do both of those for you. 47:57.550 --> 48:01.710 Same thing with stocks--you can say, I want to buy a stock or 48:01.707 --> 48:04.337 you can say, I want to rent a stock. 48:04.340 --> 48:06.910 Or you can go the other way--I want to sell a stock and I'd 48:06.909 --> 48:08.149 like to rent out my stock. 48:08.150 --> 48:10.160 Why would anyone want to rent a stock? 48:10.160 --> 48:14.910 Well, that's called short sales. 48:14.909 --> 48:17.009 They would rent a stock and sell it. 48:17.010 --> 48:23.090 It used to be that--of course, if you're lending out a stock, 48:23.089 --> 48:27.749 you might demand some compensation for that. 48:27.750 --> 48:32.440 They used to argue--there would be a specialist crowd called 48:32.438 --> 48:37.048 the--there would be a loan crowd that would argue about the 48:37.048 --> 48:40.318 rental cost, which is an interest cost for 48:40.315 --> 48:41.825 borrowing a security. 48:41.829 --> 48:45.749 The Wall Street Journal used to publish--there were two 48:45.748 --> 48:49.218 stock sections; there was the price section and 48:49.220 --> 48:51.370 there was the loan section. 48:51.369 --> 48:56.719 That, however, disappeared after the stock 48:56.719 --> 48:59.719 market crash of 1929. 48:59.719 --> 49:05.429 Apparently, it disappeared because of concern that shorting 49:05.426 --> 49:09.456 stocks was the cause of the 1929 crash. 49:09.460 --> 49:10.930 The story was that J. 49:10.934 --> 49:13.744 Edgar Hoover, who was head of the F.B.I., 49:13.743 --> 49:17.613 thought that shorting stocks had caused the Crash and he 49:17.605 --> 49:19.355 didn't like it. If J. 49:19.362 --> 49:23.172 Edgar Hoover didn't like what you were doing back then, 49:23.166 --> 49:25.346 you were afraid and worried. 49:25.349 --> 49:27.699 So, the New York Stock Exchange, without ever 49:27.702 --> 49:30.062 publishing it, just shut the whole thing down 49:30.055 --> 49:32.295 and to this day, we don't have a loan crowd 49:32.301 --> 49:35.431 anymore. We do still lend out shares, 49:35.433 --> 49:39.523 but it's not done on the floor of the exchange. 49:39.519 --> 49:45.239 Anyway, the specialist at the floor of the exchange has a book 49:45.244 --> 49:49.284 and it used to be a big thick paper book. 49:49.280 --> 49:57.910 What the specialist would do--the specialist would record 49:57.913 --> 50:05.933 in the book offers and bids--bid and asked prices. 50:05.929 --> 50:11.839 There would be people who would tell the specialist that I want 50:11.841 --> 50:17.751 to sell so many shares at such a price or buy so many shares at 50:17.752 --> 50:23.382 such a price and the book would show the list of orders that 50:23.377 --> 50:25.567 were outstanding. 50:25.570 --> 50:32.530 Now, this comes back to--I should clarify kinds of orders. 50:32.530 --> 50:37.760 50:37.760 --> 50:41.980 When you call up a broker and say, I would like to buy or sell 50:41.981 --> 50:46.001 shares, there's different--you can give--you're giving your 50:45.995 --> 50:49.505 broker an order. You can give the broker a 50:49.508 --> 50:50.698 market order. 50:50.700 --> 50:54.890 50:54.889 --> 50:58.109 If you give a market order to your broker, you're saying you 50:58.112 --> 51:01.392 only have to give the broker one number, which is a number of 51:01.389 --> 51:04.579 shares. So, I can have a buy order or a 51:04.584 --> 51:06.764 sell order--market order. 51:06.760 --> 51:09.200 If it's a buy order, all I do is say, 51:09.199 --> 51:12.999 I want you to buy for me, let's say, 1,000 shares of this 51:12.995 --> 51:15.905 company at whatever price is out there; 51:15.909 --> 51:20.809 just get the best price you can, but execute it right now. 51:20.809 --> 51:25.639 It only gives a number of shares. 51:25.640 --> 51:31.380 51:31.380 --> 51:35.300 Another kind of order, however, is a limit order. 51:35.300 --> 51:41.700 With this order you have to tell the broker both the number 51:41.700 --> 51:44.570 of shares and the price. 51:44.570 --> 51:51.330 There's either a buy or a sell, so if it's a buy limit order, 51:51.326 --> 51:56.506 you want to say, I want you to buy the stock at 51:56.505 --> 52:01.005 any price up to the one I mentioned. 52:01.010 --> 52:07.000 So, I would give--I would say, 1,000 shares at $30 a share and 52:06.995 --> 52:12.975 that means that if it's a buy order, you wait until--you don't 52:12.980 --> 52:15.630 execute it immediately. 52:15.630 --> 52:20.660 You execute it when the price falls below $30. 52:20.659 --> 52:24.369 A person would do this who thinks, I think the stock is a 52:24.371 --> 52:27.421 good buy at $30, but not where it's trading now 52:27.420 --> 52:30.090 at $35. So, I just put--and just tell 52:30.094 --> 52:33.924 my broker, I want you to take this limit order and I don't 52:33.917 --> 52:36.127 expect you to fill this order. 52:36.130 --> 52:39.630 Maybe you'll never fill it, but I just want it to be there 52:39.630 --> 52:40.920 until I correct it. 52:40.920 --> 52:43.880 You're just supposed to be standing ready and you're 52:43.878 --> 52:47.178 supposed to notice when the price falls below $30 and then 52:47.184 --> 52:49.914 you buy. If it was a sell limit order 52:49.905 --> 52:52.935 you would say, I want you to sell it if the 52:52.943 --> 52:54.683 price gets up to $40. 52:54.679 --> 52:58.389 Again, if it's above the current market price, 52:58.386 --> 53:02.036 it won't be executed now; it might never be executed. 53:02.039 --> 53:09.119 Then there's another kind of order called a stop-loss order. 53:09.120 --> 53:14.070 53:14.070 --> 53:16.510 With a stop-loss order, like a limit order, 53:16.508 --> 53:19.468 you have to both give a quantity and a price to your 53:19.469 --> 53:21.559 broker when you place the order. 53:21.559 --> 53:26.339 It's similar to a--it's in a different--a stop--a sell--you 53:26.337 --> 53:29.217 could have the same numbers here; 53:29.219 --> 53:34.509 you could say 1,000 and $30 again, but it would have a 53:34.512 --> 53:36.512 different meaning. 53:36.510 --> 53:42.760 A stop-loss order says to sell when the price hits $30. 53:42.760 --> 53:47.120 In this case, if it were a stop loss order 53:47.116 --> 53:53.696 for 1,000 shares at $30 it would be to sell--if the price today 53:53.704 --> 53:56.684 is $35--not buy. It's a different 53:56.679 --> 53:59.279 motivation--that you would do a stop-loss order. 53:59.280 --> 54:00.780 You see the difference? 54:00.780 --> 54:04.550 If it's a limit order, I'm saying I think the stock is 54:04.550 --> 54:07.240 only worth $30; I want to buy it when it gets 54:07.244 --> 54:09.504 down to $30. With a stop-loss order, 54:09.496 --> 54:13.216 if the actual price today is $35 a share, I'm saying, 54:13.219 --> 54:16.019 I'm worried about the stock crashing on me, 54:16.023 --> 54:19.163 so I want you to get me out if it's crashing. 54:19.159 --> 54:22.579 The broker has to know, well when do I get you out? 54:22.579 --> 54:26.119 Well, you have to say when, so this is when. 54:26.119 --> 54:29.089 So, you'd be telling, if it's a sell order, 54:29.087 --> 54:32.897 you would be telling your broker, sell the stock if the 54:32.902 --> 54:34.742 price falls below $30. 54:34.739 --> 54:37.339 There's a fundamental difference between a limit order 54:37.341 --> 54:38.521 and a stop-loss order. 54:38.520 --> 54:40.370 There's also a buy-stop order. 54:40.369 --> 54:45.129 You could tell your broker, I want you to buy the stock if 54:45.131 --> 54:47.471 the price rises above $40. 54:47.470 --> 54:50.260 Now, why would someone do that? 54:50.260 --> 54:53.320 Why would you tell--have an order to buy the stock only if 54:53.317 --> 54:54.387 it gets expensive? 54:54.389 --> 54:58.339 Well, the people who would do that are people who have shorted 54:58.342 --> 55:00.672 the stock. If you've shorted the stock and 55:00.666 --> 55:03.506 the stock price starts going up, you're potentially in big 55:03.511 --> 55:05.831 trouble. So, if you worry about that, 55:05.828 --> 55:09.428 then you can say a buy-stop order and place that with your 55:09.428 --> 55:13.728 broker. What Island did--I'm going back 55:13.732 --> 55:20.012 to--the brokers used to have all these orders--well, 55:20.010 --> 55:22.540 the market orders wouldn't end up on their book because it 55:22.537 --> 55:24.707 would just be executed immediately and it would be 55:24.710 --> 55:26.760 gone. These limit orders and 55:26.755 --> 55:31.085 stop-loss orders would be on the book of the broker and the 55:31.092 --> 55:35.502 broker would then know--the specialist at the exchange would 55:35.504 --> 55:39.454 have this book, which recorded customers' 55:39.446 --> 55:41.986 orders. So, the specialist would 55:41.989 --> 55:46.309 understand the market because it would have a whole bunch of 55:46.314 --> 55:48.444 these orders on the books. 55:48.440 --> 55:55.750 The nice thing about Island, when it became part of our Web 55:55.750 --> 56:02.870 culture in the 1970s, is they created their own book 56:02.867 --> 56:10.597 on the Web, so you could get--you could actually--it was 56:10.598 --> 56:13.408 open to everyone. 56:13.409 --> 56:22.229 You'd have the--you would have buy orders and sell orders and 56:22.226 --> 56:29.716 this would be something you could see on the Web. 56:29.719 --> 56:32.839 Actually, you can see things like this on the Web now too, 56:32.835 --> 56:34.635 but not through Island anymore. 56:34.639 --> 56:40.569 Let's say this is some company, let's say it's IBM, 56:40.567 --> 56:45.307 and you would see something like this. 56:45.309 --> 56:50.689 It would be--the buy orders would--it would be--the first 56:50.691 --> 56:54.921 one would say for $90 a share, 100 shares. 56:54.920 --> 57:02.390 Someone's willing to buy 100 shares at $90 and over here you 57:02.391 --> 57:09.231 would see something like, someone is willing to sell at 57:09.230 --> 57:13.030 $92, let's say 200 shares. 57:13.030 --> 57:18.040 There's no trade here, right? 57:18.039 --> 57:21.889 If somebody is willing to buy at 90 and someone else is 57:21.888 --> 57:24.808 willing to buy at $92 there's no trade. 57:24.810 --> 57:30.180 Then you'll see other orders; somebody else is willing to buy 57:30.182 --> 57:36.092 at 89 1/2, say 200 shares, and you see these descending. 57:36.090 --> 57:40.960 I'm just making up numbers--$88 for 1,000 shares and so on. 57:40.960 --> 57:47.170 On sell, we then see other people, someone who's going at 57:47.168 --> 57:49.828 92 1/4 for 300 shares. 57:49.829 --> 57:53.509 I'm showing all the purchases in round lots; 57:53.510 --> 57:55.010 a round lot is 100 shares. 57:55.010 --> 58:00.490 You could also have odd lots, but most of the time people put 58:00.485 --> 58:02.945 round lots on as a trade. 58:02.950 --> 58:08.440 This book would then sit there; there's no trade here. 58:08.440 --> 58:11.980 This is the inside spread. 58:11.980 --> 58:18.380 That is the--on the limit order book, those are the trades that 58:18.375 --> 58:23.635 are closest to execution, but it's not an executable 58:23.635 --> 58:27.545 trade yet. What would happen then--and it 58:27.546 --> 58:31.656 was as you would watch the book--and since it's now 58:31.657 --> 58:35.107 electronic, it corrects itself quickly. 58:35.110 --> 58:37.400 I don't know what the specialist had to do with a 58:37.401 --> 58:39.891 feather pen. Originally, they would have to 58:39.894 --> 58:43.604 cross these things out with ink and the book was probably hard 58:43.604 --> 58:46.224 to maintain, but now it's all automatic. 58:46.219 --> 58:51.439 Suppose someone comes in with a buy order for 100 at 90 and a 58:51.440 --> 58:56.310 sell order for 100 at 90, so someone's willing to sell at 58:56.313 --> 59:01.223 a lower price. What happens immediately on 59:01.217 --> 59:07.147 this--this thing becomes executed and disappears, 59:07.151 --> 59:12.221 so you see that happening on the book. 59:12.219 --> 59:15.739 It's fun to watch an electronic book. 59:15.739 --> 59:21.309 This is what brokers see who are members of NASDAQ and they 59:21.305 --> 59:24.755 see the electronic trading system. 59:24.760 --> 59:31.450 Of course, there are many such books now that are available. 59:31.450 --> 59:38.210 59:38.210 --> 59:42.010 The dealer--the specialist on the exchange also has his 59:42.008 --> 59:46.228 own--his or her own--bid-asked spread, which is also an offer 59:46.228 --> 59:48.688 to buy or sell on the exchange. 59:48.690 --> 59:51.470 Incidentally, Island would only allow one 59:51.474 --> 59:54.054 kind of order, at least originally. 59:54.050 --> 59:57.380 It was only limit orders because they didn't--they had a 59:57.380 --> 1:00:01.010 system where you had to put it onto their book and everything 1:00:01.013 --> 1:00:04.933 had to appear on the book, so it was just a limit order 1:00:04.933 --> 1:00:09.343 book originally. The history of this--I guess 1:00:09.335 --> 1:00:15.805 one thing I wanted to--what I was leading up to is that the 1:00:15.810 --> 1:00:18.490 ECNs are history now. 1:00:18.489 --> 1:00:21.069 They've been generally merged and acquired. 1:00:21.070 --> 1:00:24.340 Notably, the New York Stock Exchange, which has been the 1:00:24.337 --> 1:00:28.387 holdout doing floor trading, bought Archipelago because 1:00:28.390 --> 1:00:33.630 Archipelago was growing so fast doing this kind of electronic 1:00:33.629 --> 1:00:36.549 trading; it was really catching on. 1:00:36.550 --> 1:00:41.580 New York Stock Exchange began to worry that it was starting to 1:00:41.575 --> 1:00:43.465 get behind the times. 1:00:43.469 --> 1:00:47.039 The New York Stock--these things, which were started by 1:00:47.043 --> 1:00:51.083 kids--young college students in the late ‘90s--just grew 1:00:51.080 --> 1:00:55.320 so fast and they got so big that Archipelago was starting to look 1:00:55.316 --> 1:00:59.746 like it was going to get bigger than New York Stock Exchange. 1:00:59.750 --> 1:01:03.360 So, finally New York Stock Exchange merged with them and 1:01:03.363 --> 1:01:06.783 they changed the name after 200 years in business. 1:01:06.780 --> 1:01:11.890 They changed the name to NYSE Archa--Archa is short for 1:01:11.892 --> 1:01:14.072 Archipelago Exchange. 1:01:14.070 --> 1:01:17.540 That didn't last long; they changed their name again. 1:01:17.539 --> 1:01:21.799 They just merged--New York Stock Exchange merged with the 1:01:21.804 --> 1:01:25.544 European Stock Exchange, Euronext, and so now it's 1:01:25.536 --> 1:01:27.436 called NYSE Euronext. 1:01:27.440 --> 1:01:31.690 Everything happened so fast and it seems fast to me. 1:01:31.690 --> 1:01:36.280 The New York Stock Exchange is in the process, 1:01:36.282 --> 1:01:42.002 we think, of merging with the American Stock Exchange and 1:01:41.996 --> 1:01:45.156 that's happening right now. 1:01:45.159 --> 1:01:47.489 [NYSE Euronext announced on January 17,2008 a "definitive 1:01:47.486 --> 1:01:49.976 agreement" to acquire the AMEX.] I wanted to just finish with 1:01:49.978 --> 1:01:52.348 just a little bit of a thought about what it means to be a 1:01:52.346 --> 1:01:53.506 dealer in this market. 1:01:53.510 --> 1:02:00.150 What is it that if you are a dealer operating on one of these 1:02:00.153 --> 1:02:04.143 exchanges, you are placing orders, 1:02:04.139 --> 1:02:09.929 effectively, in somebody's book and standing 1:02:09.931 --> 1:02:13.031 ready to buy or sell. 1:02:13.030 --> 1:02:18.300 A dealer is someone who is trading everyday, 1:02:18.302 --> 1:02:23.822 who has an inventory of stocks for trading. 1:02:23.820 --> 1:02:28.930 I want to just maybe close with a little thought about what it's 1:02:28.934 --> 1:02:30.724 like to be a dealer. 1:02:30.719 --> 1:02:36.409 I've never been a dealer and I don't know the emotional thing, 1:02:36.411 --> 1:02:41.641 but the problem with being a dealer of any kind--maybe it 1:02:41.637 --> 1:02:45.657 takes a certain moral stamina, mental stamina, 1:02:45.657 --> 1:02:48.987 to do this kind of thing--is that you're trading everyday. 1:02:48.989 --> 1:02:53.069 You're not someone who's managing the Yale portfolio. 1:02:53.070 --> 1:02:57.230 What you're trying to do is make money everyday by buying 1:02:57.227 --> 1:03:01.677 low and selling high and you have to be ready to stand--ready 1:03:01.681 --> 1:03:05.171 to take orders--because people come to you. 1:03:05.170 --> 1:03:08.650 Someone will come to you or there will be someone in a 1:03:08.650 --> 1:03:12.590 specialist's crowd who wants to place an order or buy or sell 1:03:12.590 --> 1:03:14.560 and you have an inventory. 1:03:14.559 --> 1:03:21.529 You're like an antiques dealer and one problem is that your 1:03:21.533 --> 1:03:27.173 life's work, unfortunately, as a dealer is summarized by 1:03:27.171 --> 1:03:29.861 your portfolio and your inventory. 1:03:29.860 --> 1:03:32.580 That's why I didn't become a dealer, actually. 1:03:32.579 --> 1:03:38.779 I don't--I guess you have to have the right stomach of steel 1:03:38.775 --> 1:03:41.955 or something. The thing that I wanted to 1:03:41.961 --> 1:03:45.061 impress on you is that no matter how well you do, 1:03:45.059 --> 1:03:49.239 your cumulative score is there in your portfolio and it's a 1:03:49.241 --> 1:03:50.901 competitive business. 1:03:50.900 --> 1:03:56.150 So, you run the risk of being ruined at any time in your life. 1:03:56.150 --> 1:04:01.050 This just--I want to remind you of what's called the gambler's 1:04:01.047 --> 1:04:05.457 ruin problem because being a dealer is a little bit like 1:04:05.463 --> 1:04:10.203 being someone who goes to the gambling casino everyday. 1:04:10.199 --> 1:04:13.139 If you enjoy your visit to the gambling casino, 1:04:13.142 --> 1:04:15.192 maybe you want to be a dealer. 1:04:15.190 --> 1:04:18.210 Actually, I don't really enjoy it, so I'm just not the right 1:04:18.207 --> 1:04:19.227 person to do this. 1:04:19.230 --> 1:04:22.710 What I really wouldn't like about it is that you always 1:04:22.705 --> 1:04:25.335 stand the chance of being ruined--that is, 1:04:25.344 --> 1:04:26.764 losing everything. 1:04:26.760 --> 1:04:28.130 So, I just want to review. 1:04:28.130 --> 1:04:32.010 This is a little bit of mathematics that is in market 1:04:32.009 --> 1:04:33.799 microstructure theory. 1:04:33.800 --> 1:04:44.390 1:04:44.389 --> 1:04:49.019 Suppose you're a dealer and you have a way of either winning or 1:04:49.017 --> 1:04:51.627 losing money on each transaction. 1:04:51.630 --> 1:04:59.610 Suppose the probability of winning on a transaction is 1:04:59.612 --> 1:05:08.802 equal to p--that's the probability of winning on one of 1:05:08.800 --> 1:05:12.790 your trades. To simplify this thing, 1:05:12.794 --> 1:05:15.484 let's say that you either win or lose. 1:05:15.480 --> 1:05:24.860 If you win, you get $1; if you lose, you lose $1. 1:05:24.860 --> 1:05:30.720 So, you win $1 with probability p and you lose $1 with 1:05:30.722 --> 1:05:33.362 probability 1 - p. 1:05:33.360 --> 1:05:38.850 1:05:38.849 --> 1:05:42.209 I want to know, what is your life career going 1:05:42.211 --> 1:05:46.621 to look like if you're just doing this everyday for the next 1:05:46.619 --> 1:05:50.969 thirty years? Well, the first question is, 1:05:50.973 --> 1:05:56.043 what is the probability of your being ruined? 1:06:00.004 --> 1:06:05.594 and let's not say--thirty years is close enough to infinity, 1:06:05.590 --> 1:06:08.760 but let's just say you're going to do this forever because I 1:06:08.759 --> 1:06:12.089 don't want to have to figure out the effect of the last day. 1:06:12.090 --> 1:06:15.270 What do you think is the probability of being--remember, 1:06:15.271 --> 1:06:18.511 being ruined means having your inventory fall to zero. 1:06:18.510 --> 1:06:25.930 You start with S dollars--that's capital S 1:06:25.928 --> 1:06:30.108 dollars--which is an integer. 1:06:30.110 --> 1:06:34.190 When S falls to zero, you are "ruined;" 1:06:34.190 --> 1:06:36.670 you don't have any money left; you're out of the game; 1:06:36.670 --> 1:06:39.420 and you will be dismissed from the exchange. 1:06:39.420 --> 1:06:42.230 If you can't trade anymore, you don't have anything. 1:06:42.230 --> 1:06:45.560 You have to start with something, otherwise you can't 1:06:45.559 --> 1:06:48.549 trade at all. So, S is something like 1:06:48.545 --> 1:06:50.535 $100. If p as a point--do any 1:06:50.538 --> 1:06:51.808 of you know the answer? 1:06:51.809 --> 1:06:55.679 What's the probability that I will eventually be ruined? 1:06:55.680 --> 1:07:01.280 1:07:01.280 --> 1:07:04.310 This isn't something that you got in your probability theory? 1:07:04.309 --> 1:07:10.269 You got it right--that's right, it's 100%. 1:07:10.269 --> 1:07:15.109 You will with certainty be ruined. 1:07:15.110 --> 1:07:22.840 In fact, the probability of ruin is ((1 - 1:07:22.835 --> 1:07:34.225 p)/p)^S, if p is greater than .5 1:07:34.229 --> 1:07:40.409 or greater than-equal to .5. 1:07:40.409 --> 1:07:43.999 That's because, if you substitute in .5, 1:07:44.002 --> 1:07:48.242 this is 1, so, the probability of ruin is 1. 1:07:48.239 --> 1:07:51.859 If it's--if the probability is greater than .5, 1:07:51.855 --> 1:07:56.645 then the probability of ruin will be something less than 1. 1:07:56.650 --> 1:08:02.380 This is actually easy to derive because--think of it this 1:08:02.380 --> 1:08:06.880 way--we'll call this the probability of ruin, 1:08:06.883 --> 1:08:10.263 if you have S dollars. 1:08:10.260 --> 1:08:17.990 The reason it has this is because if I start with s 1:08:17.985 --> 1:08:22.855 dollars, there are two possibilities: 1:08:22.864 --> 1:08:26.934 either gain $1 or lose $1. 1:08:26.930 --> 1:08:34.580 So, this probability of S has to equal p x 1:08:34.584 --> 1:08:42.394 Pr(S + 1) + (1 - p ) x Pr(S – 1:08:42.389 --> 1:08:45.829 1). That is the probability--this 1:08:45.828 --> 1:08:50.768 is the probability of ruin if you have S + $1 and this 1:08:50.768 --> 1:08:55.378 is the probability of ruin if you have S - $1. 1:08:55.380 --> 1:08:59.010 So, the function determining probability of S has to 1:08:59.008 --> 1:09:00.508 satisfy this equation. 1:09:00.510 --> 1:09:04.280 Also, we have the restraint--the probability of 1:09:04.284 --> 1:09:09.044 ruin if you have zero dollars is 1, so this is a difference 1:09:09.043 --> 1:09:11.963 equation. If you solve it, you get this. 1:09:11.960 --> 1:09:17.770 What it means is that you had better have a probability of 1:09:17.773 --> 1:09:23.693 winning substantially above $1 or else have an awful lot of 1:09:23.688 --> 1:09:26.338 dollars to start with. 1:09:26.340 --> 1:09:28.750 Unfortunately, it's hard to get the 1:09:33.078 --> 1:09:36.978 because you're living in a competitive marketplace. 1:09:47.125 --> 1:09:50.235 your whole life, always with a probability that 1:09:50.242 --> 1:09:53.632 the rest of my life is going to end up in ruin. 1:09:53.630 --> 1:09:57.550 So, you may have been very successful and you now have 1:09:57.547 --> 1:10:01.017 S = 1000, but the probability keeps going 1:10:01.020 --> 1:10:03.460 down, but it never hits zero. 1:10:03.460 --> 1:10:07.680 Student: A gambler can take money off the table. 1:10:07.680 --> 1:10:09.040 Professor Robert Shiller: Well, 1:10:09.035 --> 1:10:10.715 that's what you have--that's what people do. 1:10:10.720 --> 1:10:14.370 Student: I think you're saying that the specialist--the 1:10:14.372 --> 1:10:15.812 first few [inaudible]. 1:10:15.810 --> 1:10:16.900 Professor Robert Shiller: Well, 1:10:16.898 --> 1:10:18.428 they are taking money off the--maybe because they are 1:10:18.428 --> 1:10:22.578 doing that. You live your life and you take 1:10:22.582 --> 1:10:26.682 money off. Yeah, you're right; 1:10:26.680 --> 1:10:31.190 I don't have to play it out to the bitter end like this. 1:10:31.189 --> 1:10:35.809 I wanted to show--this is actually--this mathematical 1:10:35.807 --> 1:10:41.397 model is something that you will find in the Page 1 or Chapter 1 1:10:41.402 --> 1:10:46.822 of a market microstructure textbook because you're right; 1:10:46.819 --> 1:10:50.019 there are strategies that can prevent ruin like that. 1:10:50.020 --> 1:10:55.170 This is the basic--this is just--I'm presenting this as a 1:10:55.170 --> 1:11:00.230 very simple model of what underlies the restriction on a 1:11:00.228 --> 1:11:02.828 broker. A broker has to 1:11:02.832 --> 1:11:08.462 maintain--create a strategy such that this p is 1:11:08.457 --> 1:11:14.717 sufficiently probable--that this ruin problem doesn't become 1:11:14.719 --> 1:11:18.269 catastrophic. The way they do that, 1:11:18.271 --> 1:11:22.261 they set the bid-asked spread that a dealer has with 1:11:22.259 --> 1:11:25.229 consideration of this ruin problem, 1:11:25.229 --> 1:11:28.229 which has to be the focal point of their attention. 1:11:28.229 --> 1:11:32.759 They have to set the bid-asked spread wide enough so that they 1:11:32.755 --> 1:11:36.905 feel comfortable enough with this probability of ruin. 1:11:36.909 --> 1:11:41.369 If you don't--of course, it's a competitive market and 1:11:41.365 --> 1:11:45.395 so you can't get this probability up too high. 1:11:45.399 --> 1:11:50.359 So, if you don't like this, don't become a dealer; 1:11:50.360 --> 1:11:51.690 that's the way it is. 1:11:51.689 --> 1:11:55.309 The people who are in this business are people who can 1:11:55.307 --> 1:11:57.557 tolerate this prospect of ruin. 1:11:57.560 --> 1:12:01.930 On the other hand, ruin isn't death; 1:12:01.930 --> 1:12:03.190 that's another thing you were saying. 1:12:03.189 --> 1:12:07.229 I can make a living doing this for a while and I am taking 1:12:07.230 --> 1:12:10.350 money out and that's part of the strategy. 1:12:10.350 --> 1:12:13.290 Maybe I'm just being too much of an academic here. 1:12:13.289 --> 1:12:17.169 I live in great comfort in academia and these beautiful 1:12:17.171 --> 1:12:20.481 surroundings. This university has been around 1:12:20.480 --> 1:12:23.740 for 300 years; I have no worries. 1:12:23.739 --> 1:12:28.439 So, you might want to consider an academic career instead of a 1:12:28.439 --> 1:12:29.979 career in finance. 1:12:29.979 --> 1:12:35.019 I hope to see you again then on Friday. 1:12:35.020 --> 1:12:38.000 I think we'll have a good time with Schwarzman.