ICT impact on a profession: Elimination of the intermediaries

This video describe the evolution of trading stock from the issue of the self regulation and national market amendment on May 1st 1975 to the introduction of Internet online trading  in the nineties. The story is told through one of the bigger players “Ameritrade”, who was one who introduced the concept of discount trading and Internet trade to the market . 

Additional Link: The Self Regulation and National Market Amendment (SEC 1975)

For years, only professional stockbrokers, Hedge Fund professionals, or asset managers with expensive computer hardware could trade online. They had privileged access to valuable information. In order to buy or sell stocks, bonds, ETF, or commodities, an individual investor was required to place orders through their professional wealth managers or stockbrokers, who charge commissions estimated to 2% to 2.5% of the value of the order. The professionals offer their clients detailed research reports, stock recommendations, and financial planning services.

In 1994, a small discount broker, K. Aufhauser & Co, saw the opportunity use the advancement of ICT to offer their clients the possibility to trade online over the Internet. Aufhauser was now able to operate with fewer personnel because the client was investing his money directly in the stock exchange. The company also took advantage of a significant cost saving which additionally benefited customers in the form of lower trading costs. This situation allows for the idea that the cost savings are justified because the intermediary appears to function solely as a facilitator of trading.

However, the flaw in this reasoning is the failure to consider the valuable advisory role of these professionals in the trading process.

Following Aufhaser, the low barrier to entry level brought this new market many small companies that took advantage of the internet to offer their clients online trading platforms. The commissions were dramatically bellow the one previously offered by the brokers. For example, by early 1999, a company such as E-trade was charging between $14 and $20 per order, while a company like Merrill Lynch was charging $500 for a full service broker four years prior.

By the mid 2000s, the estimated number of new companies such as TD Ameritrade, Scottrade, and  A*Trade, was 150 and started to compete with large renamed brokerage companies. These companies lowered the commissions again as low as $6.99 or even totally free by the end of the 2000s. By the same period, the volume of online trades represented 40% of all stock traded.

For many wealth managers and brokers, this situation marked the beginning of the end for the profession in the short term, and for the global economy in the long term. In fact, they argued that their high commissions were well justified because of the valuable information and advice that they provided to their clients. The pressure put on broker companies created the necessity for them to adapt. The landmark event occurred in June 1999 when Merrill Lynch, the world largest full service broker, started offering online trading. 

This situation is one of the causes that lead to the financial crisis in 2008 because of the creation of a speculative bubble. Assording to the research of of Smith, Suchanek, Willians (1988), Caginalp, Porter & Smith (2000) and Schiller (2000) “ the number of non-experienced investors is larger than the number of experienced investors, the uncertainty towards the future value of an asset as opposed to the risk, the more money to invest” that creates a speculative bubble.