It’s getting expensive to be old-fashioned.
Some people like to walk into their bank and have the teller show them cash representing the interest that was just posted to their savings account so they can be sure it’s there.
They certainly are entitled to do so, but starting in June the First National Bank of Chicago will impose a fee on customers who step up to its teller cages for routine business. Other banks likely will follow suit.
Likewise, many individual investors like to receive a written confirmation from their broker before they send in payment for stock purchases. Others like to receive the stock certificates when they buy stocks. Such services may soon cost investors special fees, if they don’t already.
In June, the securities brokerage business will reduce the time to settle a “buy” or “sell” transaction to three business days after the transaction is executed from five days.
In some respects, the so-called T-plus-3 rule is long overdue and may not be quick enough. But many brokerage firms will use the shortened settlement period to impose new or higher fees on customers who prefer to pay for stock purchases through the mail only after they receive a confirmation of the trade or who demand custody of stock certificates.
In a simple transaction, done the old-fashioned way, an investor calls his or her broker and buys 100 shares of a stock at the market price.
The broker can execute the transaction within seconds. But before the transaction is “settled,” the broker prepares and mails a confirmation slip to the investor with a return envelope for the payment. The investor is supposed to remit the payment quickly enough for the transaction to be closed five business days after the order was placed.
Likewise, if the customer phones in an order to sell stock, the brokerage firm is supposed to deliver the payment within five days.
The new rule will be three days. Given the state of mail delivery in many areas of the country, the old-fashioned customer who waits for a written confirmation will have a hard time getting payment in the hands of the brokerage firm within three days after the order. This customer may be charged interest, like a bank customer with an overdraft protection service.
The settlement period was extended to five days from four in the late 1960s because brokers lacked the back-office capability to handle an increasing volume of business. Many brokerage firms were closed to new business each Wednesday, just so they could clear up the paperwork once a week.
Today, when financial transactions flash around the world in seconds, the five-day settlement period seems quaint and out of date. When the stock market crashed in 1987, investors and brokers alike were reminded that a lot can happen in five days.
If you sold stock through a broker in the midst of a crash, the person who bought it might simply walk away from the deal during the settlement period because the value of the purchase had eroded sharply. Such reneging put brokerage firms on the hook, because they were obliged to pay the seller but did not have a buyer.
“We concluded that removing days out of the settlement process would remove risk from the marketplace,” said Dick Stream, director of operations and information services at the Minneapolis brokerage Piper Jaffray and chairman of a Securities Industry Association subcommittee on T-plus-3.
T-plus-3 may be advantageous to an investor selling securities, because it means faster crediting of the funds collected. But investors who keep stock certificates at home or in a bank vault will be under a tighter deadline to deliver them to their broker by three days after their “sell” order is executed.
In truth, the pros and cons of T-plus-3 should be of interest to only a small minority of brokerage customers. Increasingly, individual investors maintain cash accounts with their broker to facilitate “buy” and “sell” transactions. They also keep their stocks in “street name,” which means they are registered to the broker, instead of having certificates registered to themselves.
This trend is no accident. For years, brokerage firms have been trying to transform themselves from a transaction-oriented business, which ebbs and flows with the popularity of investing, into less volatile businesses of managing financial assets for investors and collecting fees regardless of the customers’ “buy” and “sell” orders.
As the accompanying graphic shows, the percentage of revenues brokerage firms make from traditional commission business has declined sharply since 1976. Revenues from mutual fund sales and asset management fees, on the other hand, are growing.
Charles Carlson, editor of Dow Theory Forecasts, says T-plus-3 gives brokers a wedge to get more of customer assets into their firm, “which is the name of the game on Wall Street.”
That’s fine, as long as investors realize the conveniences they are being encouraged to use at their broker are conveniences for the broker as well.
Dumb question: I’ve always heard that derivatives trading is a zero sum game-for every winner there is a loser. So, who were the winners in all the derivative losses we’ve been hearing about in Orange County, Calif., and elsewhere?
This is a composite question from several readers who called and wrote on this point in recent weeks. Media coverage of the derivatives story, especially a recent CBS “60 Minutes” segment on the subject, prompted such questions.
Derivatives are financial instruments that derive their value from an underlying security, commodity or financial transaction. In effect the various components of simple investments and transactions, such as interest rates and principal on loans, are stripped away (deconstructed, if you prefer) and reconstructed into new investments.
In a traditional derivative, soybean futures strip away the time required to grow the beans. If the farmer doesn’t want the risk of a change in the market price between planting and harvesting, he can sell it to someone who does through the futures market.
Last week, Robert Citron pleaded guilty to six felony fraud charges in connection with his derivatives trading that bankrupted Orange County. But weren’t there some winners for all the losses the Orange County investment fund suffered?
“That’s absolutely correct,” said Scott Lummer, managing director at Chicago-based Ibbotson Associates. The winners were companies or institutions that sold floating-rate investments, known as inverse floaters, that were structured to pay lower interest rates as interest rates went up.
Who would buy such an odd investment? Well, Mr. Citron, for one. Lummer said the “tendency for some financial managers to be creative just for the sake of being creative” has transformed the derivatives business from a fairly straightforward matter of risk transfer into a financial bazaar in which the demand for exotica produces a supply of exotica.
Conceiving dubious and complex financial risks and marketing strange investments to transfer those risks is a profitable business for Wall Street. But in a larger sense it’s hard to see how even the winners in this zero-sum game are better off.
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The weekly dumb question is answered each week in the belief that there is no such thing as a dumb question when it comes to understanding the financial markets. My address is Room 400, 435 N. Michigan Ave., Chicago, Ill. 60611. My phone number is 312-222-3599. My Internet address is webarnhart@aol.com.
