Wednesday, November 9, 2011

Wall Street: Home of the Vanishing IPO

In this recent CNBC interview, David Weild of Grant Thornton describes the current state of the IPO. market:

Weild points out the following:
  • Small Cap initial public offerings are at their worst level since 1985
  • 500+ initial public offerings per year was the norm in the 1990s
  • We have a bigger economy now so we should be doing around 700 yet we're only doing 150
  • Private companies in need of capital these days are starved of it
  • There's nothing better than confidence in the IPO market to jump start investment in private startups
  • Fundamentally-oriented investors are increasingly replaced by a market that lends itself to electronic speculative trading/information mining technologies
This Barron's article, From Bankers to Speculators, points to, as a primary cause, things like Regulation NMS (Regulation National Market System) and related reforms that were put into place between 1997 and 2007. The impact on the capital raising community was not insignificant. According to the article, the community was pretty well eliminated by the changes beginning with Order Handling rules (1997).

The article makes a direct connection between some of the reforms (an example being decimalization) and the steep decline in initial public offerings...

"By eliminating human traders, NMS killed off the culture of honest service that underpinned capital formation, freeing the former investment banks to focus instead on speculation. Investment banks and bankers were transformed from socially useful capital raisers to socially harmful, too-big-to-fail problems for the U.S. taxpayer. It was not a good trade."

Not at all.

David Weild and Edward Kim further explain the connection in this June 2010 Grant Thornton study, Market Structure is Causing the IPO Crisis - and More.

Here's a few relevant excerpts from a New York Times article published late last year. The economy suffers if businesses can't or won't raise funds in capital markets.

"We should be very concerned about this trend," said Andrew W. Lo, the director of the MIT Laboratory for Financial Engineering. "Capital markets are central to business formation and economic growth..."

More on the steep drop in initial public offerings. According to the article, IPOs peaked at 756 in 1996 and fell to 36 during the financial crisis. In 2010 it was up to around 100.

Now, we're still barely doing 1/5 that peak amount. So IPOs are...

"...still running below the level required to hold constant the number of public companies. And that, analysts say, has unsettling implications for American job growth."

More recently, John Bogle said this in a Morningstar interview:

"...our financial system has directed around $200 billion a year into initial public offerings and additional new public offerings and then additional offerings of company stock--$200 billion. We trade $40 trillion worth of stocks a year. So, that's 200 times as much speculation as there is investment. One only has to understand that all this trading back and forth, by definition, doesn't enrich the investor, because if I buy, you sell and vice versa, but what it does is enrich the croupier in the middle, which we call Wall Street..." - John Bogle

I think it is fair to say that the proportion of pure speculation to capital formation that facilitates new business creation is just a little out of balance.

The above New York Times article said it best:

"It is a remarkable turnabout for the nation's markets and, to some, deeply unsettling. This is Wall Street, after all — home to the largest and deepest capital markets on the planet."

What used to be a vibrant capital raising community now uses the bulk of its energy to speculate. As the Barron's article says, from "socially useful capital raisers to socially harmful".

The cost? Something that was for good reason an admired, effective, and vital system is allowed to fall by the wayside. It can be fixed but, for now, it's less admirable, less effective, while remaining just as vital to our capital development.

Adam

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