"As of November, margin-debt as tracked by the NYSE was at its lowest level since June 2005"

From the WSJ:

"By MICHAEL S. IRENSKI

Investors who trade stocks with funds borrowed from their brokers cut back on their debt during the turbulent stock market last year, leading to a decrease in the level of so-called margin debt.

Margin debt at New York Stock Exchange member companies, as tracked by the exchange, fell 37.6% through November from the end of 2007.

The Big Board's data show that debit balances in margin accounts for customers of NYSE-member securities firms fell to $201.48 billion in November, the most recent data available, from $322.78 billion at the end of 2007. December 2008 numbers will be available later this month.

As of November, margin-debt as tracked by the NYSE was at its lowest level since June 2005, when margin debt was at $200.5 billion.

Market analysts track margin-debt activity as an indication of investors' appetite for speculative trading.( WHICH IS LOW AT PRESENT )

A potential pitfall for those trading "on margin" is a sharp decline in stock prices, which can expose investors to margin calls( PART OF A CALLING RUN ), requiring them to post additional collateral or their brokers may sell their securities to cover the debt. A wave of margin calls can worsen selling pressure on stocks."

Long term, this seems like good news. Investors could be sitting on a lot of cash, and far less debt.

"But it was the SEC’s decision in the 1990s not to take a stand on the controversial issue of “payment for order flow”

From the FT, another SEC failure. Perhaps James Grant is right:

"SEC inaction that helped fuel scheme

By Greg Farrell in New York

Published: December 23 2008 23:32 | Last updated: December 24 2008 01:44

Stung by claims that it missed discovering a massive fraud, the Securities and Exchange Commission is now poring over Bernard Madoff’s books, trying to unpick an alleged Ponzi-like operation that appears to have lost investors tens of billions of dollars.

But it was the SEC’s decision in the 1990s not to take a stand on the controversial issue of “payment for order flow” that helped fuel the rise of Bernard Madoff Investment Securities, the successful broker-dealer operation two floors above Mr Madoff’s private fund operation in Manhattan."

From the SEC:

"Payment for Order Flow

As a way to attract orders from brokers, some exchanges or market-makers will pay your broker's firm for routing your order to them – perhaps a penny or more per share. This is called "payment for order flow." Payment for order flow is one of the ways your broker's firm can make money from executing your trade. The firm can also make money by internalizing your order.

Upon opening a new account and on an annual basis, firms must inform their customers in writing whether they receive payment for order flow and, if they do, a detailed description of the type of the payments( NOTE WELL ). Firms must also disclose on trade confirmations whether they receive payment for order flow and that customers can make a written request to find out the source and type of the payment as to that particular transaction.

To learn more about the basics of trade execution – including order routing, payment for order flow, and internalization – you should read Trade Execution: What Every Investor Should Know.

http://www.sec.gov/answers/payordf.htm"

Back to the post:

"According to regulators and competitors, Bernard Madoff Investment Securities, enjoyed at least a decade of outsized growth in the 1990s because it paid brokers for business and exploited wide bid-offer spreads in the market.

By paying for order flow, Mr Madoff’s firm siphoned roughly 10 per cent of the volume of trading on the New York Stock Exchange away from the specialist firms that dominated the Big Board’s floor, creating what was known as a “third market”. Then, according to competitors and regulators, Mr Madoff’s firm thrived by trading within the bid-ask spreads, which could be sizeable.

“Mr Madoff was the cleverest and most successful competitor the specialist business ever had,” says Robert Fagenson, former chief executive of the Van der Moolen specialist firm. “When he created the third market his firm was fabulously profitable.”

The SEC had a long-standing rule regarding disclosure of any “remuneration” received in connection with stock transactions. But as the practice of brokers paying for order flow became popular in the 1980s, concerns were raised about whether the brokers doing the paying were buying stocks at the best prices for investors( HOW NICE ).

In 1990, the NASD empanelled a group of experts to study the subject. The committee was headed by former SEC chairman David Ruder, and included Mr Madoff. The so-called “Ruder committee” delivered a report in July 1991 dubbed, “Inducements for Order Flow”.

The report found no legal basis for restricting the practice of payment for order flow, but recommended that the NASD require its members to disclose in advance the “factors that influence their order-routing and execution decisions”( LIKE PROFIT ).

“There was some concern about payment for order flow,” says Mr Ruder, a professor at Northwestern University School of Law. But the report was broadened to include all “inducements for order flow” because, says Mr Ruder, “there’s practically no business done on Wall Street without some exchange of value, promise of future business, custody work or stock loans( YES )”.

In the 1990s, then SEC chairman Arthur Levitt criticised payment for order flow in speeches, but he never restricted the practice. Mr Levitt says he often asked his counsel for market regulation to figure out a way to ban the practice, but those requests went nowhere.

By paying for order flow, Mr Madoff’s firm generated so much traffic that it could act as a market maker, matching buyers and sellers outside of the NYSE. But that kind of traffic cost money, a penny or two per share. The key to the firm’s profitability was that Bernard Madoff Investment Securities did not accept limit orders( ORDERS AT OR BELOW A SPECIFIC PRICE ), according to Mr Fagenson. Without limit orders, the firm was able to buy securities on behalf of one broker for, say, $40.25, and match those same securities to a buy order at $40 per share( IN OTHER WORDS, NOT IN THE CLIENT'S BEST INTEREST BUT THEIRS ). An order for 100 shares of a stock, executed in such a way, generates $25 in profit.

According to Mr Fagenson and other specialists on the NYSE, Mr Madoff paid a penny per share to brokers who routed their transactions through his firm. By exploiting gaps in the bid-ask spreads of, say, eighths of a dollar, Mr Madoff’s firm would make more than 12 cents per share on trades, and give up only 1 cent per share for the order flow. For a firm that represented about 10 per cent of volume on the NYSE during the 1990s, the business model generated big profits.

All that changed in 2000, when the markets shifted from spreads of eighths and sixteenths to decimals. “One thing we can surmise is that when the minimum spread went from a sixteenth to a penny, there was a margin erosion of over 90 per cent( GOOD WORK. I WONDER IF THAT FIGURED INTO TO HIS CASH FLOW PROBLEMS ? ),” said Mr Fagenson."

Just another part of the Fiduciary Mismanagement committed daily and for years legally

"not be How are you going to fix the SEC? but How are you going to shut it down and replace it with something better?"

Justin Fox with a version of James Grant's argument about closing down the SEC:

"Mary Schapiro, reported to be the President-elect's choice to run the Securities and Exchange Commission, is—by several miles—the most qualified person for the job. She's served a previous six-year stint on the SEC (she was first appointed by Ronald Reagan), including a period as acting chairman. She's been chairman of the Commodity Futures Trading Commission. She's currently CEO of the Financial Industry Regulatory Authority, the self-regulatory body for Nasdaq and the New York Stock Exchange. The woman has forgotten more about running a securities-regulation outfit than anyone else in the country can ever hope to know.

But the events of this year—the Bernard Madoff debacle being just the latest and perhaps the most shocking of them—would seem to raise the question of whether securities regulation as practiced over the past few decades is really worth anything at all ( YES IT IS ). This can't just be blamed on George Bush and the weak series of SEC chairmen he appointed. Yeah, Arthur Levitt was better than Chris Cox, and he tried to use his SEC chairmanship as a bully pulpit to rail against some of the excesses of the late 1990s. But the bread-and-butter work of the SEC hasn't changed all that much. It was and is mostly busy work. Look through the enforcement actions of the past year and they're generally either penny ante lawsuits against minor manipulators or cases of closing the barn door long after the horses (and their billions of dollars) have escaped ( VERY TRUE ). Look through the 1999 list and it isn't all that different—although it is longer.

The first explanation for this lack of regulatory success is that regulators are never going to catch every financial shenanigan before it blows up. They don't get paid enough, there aren't enough of them, and—as Gillian Tett put it in at FT column last spring—they're as wary as anyone on Wall Street or in the City of "challenging the dominant financial creed."( I AGREE ) Bad stuff is going to happen from time to time, especially after a long period of benign financial conditions that rewarded the Pollyannas and punished the skeptics in the private sector ( TRUE ). No amount of regulatory reform can prevent that ( TRUE ).

But there's a second problem with financial regulation that has to do with the structure of the SEC and the rest of this country's financial regulatory agencies. Each tries to manage an impossible balancing act between looking out for consumers/investors and promoting the health of the particular financial sector it regulates( ABSOLUTELY. THAT'S OUR SYSTEM ). This seems to have been a crucial factor in the SEC's failure to uncover Madoff's fraud, despite repeated tips. Madoff was a pillar of the brokerage community, a man the SEC looked to for advice on how to regulate markets. Who were the people at the SEC to believe when whistleblowers questioned the numbers generated by Madoff's money-management side business—their friend or some cranky outsider? ( EXCELLENT POINT )

There's really no solution to the first problem, other than doing away with all financial regulation in the hope that this would make investors and creditors more vigilant( JAMES GRANT'S PROPOSAL ) . That probably wouldn't work, and definitely ain't gonna happen( THE IDEA HAS MERIT, BUT WE HAVE THE SEC IN ORDER TO GIVE THE AVERAGE CITIZEN SOME, POSSIBLY MISPLACED, FAITH IN THE SYSTEM. ACTUALLY, GRANT COULD ARGUE THAT THE SEC GIVES THE AVERAGE CITIZEN FALSE CONFIDENCE THAT THE MARKETS AREN'T RIGGED AGAINST THE AVERAGE CITIZEN ) . But the second, structural problem with the SEC and its brethren in Washington is fixable. If there were one agency charged with looking out for the interests of investors and consumers of financial products, and a different agency (or agencies) responsible for the health of financial institutions, the bureaucratic incentives would seem to dictate a much more aggressive pro-consumer approach than we've seen so far ( I AGREE, AND CALL IT RATIONALIZATION ). And the funny thing is, this division of labor was a centerpiece of the Blueprint for a Modernized Financial Regulatory Structure that Hank Paulson unveiled in March ( THAT WAS ACTUALLY A PRETTY GOOD DOCUMENT. PEOPLE SHOULD READ IT ).

So the really important question for Mary Schapiro may not be How are you going to fix the SEC? but How are you going to shut it down and replace it with something better?

Update The wording change in the first paragraph (in bold) is in response to commenter barracho, who writes, "i can name at least three people who have forgotten more about securities--and commodities futures and options--regulation than mary schapiro will ever learn." I can't vouch for that, but neither can I vouch for my original statement ( SHE'S WELL QUALIFIED ) . What is undeniable is that she's spent the last 14 years running major regulatory agencies and self-regulation operations, and I don't know of anybody who can come close to topping that.

As to his final question, all I want is the system to be Rationalized. How to do that is an open question, and Justin Fox's idea might be the best. Let's look into it.

"If anyone can force a merger of the S.E.C. and the C.F.T.C., she can."

Floyd Norris on the NY Times asks a question on many people's mind:

"Can She Save the S.E.C.?

Mary Schapiro, a veteran and diligent regulator if ever there was one, is reported to be Barack Obama’s choice to head the Securities and Exchange Commission. It is a choice that should please those who hope the S.E.C. can recover from what must be the worst year in its history ( IT MIGHT BE ONE OF THE WORST IN THE HISTORY OF REGULATORS ).

Ms. Schapiro has been around Wall Street regulation for decades. She worked at the Commodities Futures Trading Commission as a staff member in the early 1980s, then became a member of the S.E.C. and chairwoman of the C.F.T.C. She helped clean up Nasdaq and now runs Finra, the industry self-regulator. She has been appointed to jobs by Republicans and Democrats.

She will have to take a leading role in shaping the new regulatory system to replace the one that failed so badly. The bank regulators also have much to answer for, and it was the Federal Reserve that championed doing nothing about the shadow financial system that has now brought down the economy. But somehow the Fed has emerged as likely to take control of the regulatory apparatus when it is redone, while the S.E.C. has lost clout and reputation.

She showed herself a skilled infighter when the regulatory operations of the N.A.S.D. and the New York Stock Exchange were merged into Finra, a deal designed in part to reduce overlapping rules that raised costs for Wall Street. She emerged on top of the combined organization.

Chris Cox, the outgoing chairman, leaves behind a demoralized agency. Its regulation — or lack thereof — of Bear Stearns and Lehman Brothers became a subject of scorn. Now its failure to catch on to what Bernard Madoff was up to is condemned by Mr. Cox even before the investigation gets going, further damaging morale.

“I can recall nothing that rivals this in the history of the S.E.C. in terms of condemnation for how the staff had handled an investigation,” Jim Cox, a securities law professor and longtime S.E.C. watcher at Duke University, told Bloomberg News yesterday. (The two Coxes are not related.)

You may recall that relatively early in his tenure, Chris Cox did something similar after news organizations reacted with outrage to S.E.C. subpoenas of journalists. I assume he wants to send an image of an S.E.C. that is not afraid to admit its mistakes, but internally it came across as unprecedented for a chairman to rebuke the staff so publicly.

During his tenure, he moved to make it harder for the staff to file charges against companies, and the commission delayed settlements while commissioners negotiated to impose smaller penalties than the companies had agreed to pay( HE'S A DISASTER. PLEASE STOP CALLING HIM A LIBERTARIAN. THE BRAND WON'T RECOVER ).

She will have to decide whether to try to slow down the adoption of international accounting standards in this country, something Mr. Cox seems to want to make a fait accompli before he leaves.

With politicians and bankers pushing the S.E.C. to let banks fudge the numbers on their asset values by claiming they are worth more than any bank is willing to pay for them ( I KNOW SMART PEOPLE LIKE THIS, BUT IT CAN'T BE THE ONLY ACCOUNTING METHOD USED. I WOULDN"T MIND A DUAL SYSTEM ), she may have to decide whether to fight or cave.

If anyone can force a merger of the S.E.C. and the C.F.T.C., she can( RATIONALIZATION. I'VE SAID THAT IT IS ESSENTIAL FOR THESE REGULATIONS TO WORK IN PRACTICE. NO MORE SHOPPING FOR REGULATORS ). Only the futures industry lobbyists, who like the C.F.T.C.’s gentle non-regulation, and the House and Senate Agriculture Committees, who love getting Wall Street money, think it makes any sense to have one regulator for trading in stocks, and another one for trading in stock index futures ( I AGREE ). Everyone assumes the futures industry is too strong to allow such a merger to happen, especially with a president from Chicago. If she could persuade Mr. Obama to push strongly for such a merger, it would be a real sign that he is a serious reformer ( I AGREE ).

In picking Ms. Schapiro, Mr. Obama has chosen someone who knows all the issues and all the players and who is committed to effective and rational regulation."

The main function of the SEC, and it will accomplish this only if it does its job well, is to assure average citizens that the system isn't rigged in favor of the wealthy and powerful. That is, any more than it already is in its natural functioning. Otherwise, Jim Grant's call for the SEC's abolition, since it gives a false sense of security to investors, makes sense. Sometimes, poor regulation is worse than no regulation. The signs go from "Buyer Beware" to "Buyer Guaranteed".

I wish her luck, for all of our sakes.