In our capitalist system, the supposed purposes of financial markets are twofold: To coordinate resources, getting them to their most productive economic uses, and to provide corporate governance via the votes that come with stock ownership. By trading assets and pursuing personal profit, investors on financial markets are supposed to power both goals.
This is because trading is presumably happening with some kind of strategy and intent: human beings investigate companies and industries and make their trades accordingly — or they rely on other people who specialize in giving that advice. That's why brokerage giants like Charles Schwab and the somewhat-less-gigantic TD Ameritrade traditionally provided their customers with financial advisers as a core part of their business. They act as financial middle men, linking investors to trading opportunities, facilitating the transactions, and providing financial advice along the way.
On Monday, Charles Schwab inked a $26 billion deal to buy TD Ameritrade. The resulting "goliath" wealth management firm will control a whopping $5 trillion in assets. But just as interesting as the merger itself are the tectonic changes in American financial trading that set the stage for it — in recent decades, financial management by adviser has essentially died off.
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Schwab itself more or less delivered the death blow last October, when it shocked financial markets by announcing it would no longer charge customers fees for online trading on stocks, exchange-traded funds, and more. Those fees had already been falling for years, after a 1975 regulatory decision that did away with fixed trading commissions. After that, brokerages started competing on who could offer the lowest price. Another major factor was the mid-1970s invention of the index fund, a form of "passive" investment that simply allocated a trader's money based on each company's market share of a particular index, like the S&P 500. Index funds obviously don't rely on human advice or strategy, and thus can be offered to customers for cheap. As of 2014, index funds accounted for one third of all investment firm activity.
These developments, combined with the increased ability to offer cookie-cutter financial advice online via computer algorithms, meant that actual advice from actual human beings — which is comparatively expensive to offer — was slowly competed out of the market. By the time Schwab made its announcement last October, commissions had already been reduced to 4 percent of its revenue. In fact, it was already getting 57 percent of its revenue from interest on the uninvested cash people left in their accounts.
Today, Schwab is basically a brokerage firm that sits atop a more traditional bank: Its offer to facilitate financial trades encourages people to park their money with the firm, and it pays them interest on it. But that money also allows Schwab to engage in other financial and banking activities like lending, and it gets more interest back on that activity than it loses to its clients. It's making money on the spread, same as a traditional bank. Schwab's stock trading business was already a kind of bonus it offered purely to lure in customers, so eventually Schwab just figured it should offer that bonus for free.
Schwab's rivals like TD Ameritrade and E-Trade were dependent on commissions for a larger part of their revenue — 15 or 16 percent, in Ameritrade's case. And unlike Schwab, they don't own a banking operation themselves; they partner with traditional banks in an arrangement that has much the same ultimate effect. Giving up on trade fees was a bigger blow to their business models. But, facing down price competition from Schwab, they had no real choice. The whole industry rapidly followed Schwab's lead and offered zero-commission trading.
This brings us back to Monday's merger. Given the way Schwab's business model now operates, scale is everything: the more customers park their money with the firm, the more profit it can make. Meanwhile, Schwab's competitors face the choice of having to battle on the same scale-based playing field as an already-bigger rival, or just make as much money as they can now by getting bought out. The merger was in both sides' interest, and more mergers in the industry are probably coming down the pike.
Is this bad for customers? Not necessarily. If advice from real life human beings actually made any kind of noticeable difference in people's financial trades, brokerages would have presumably noticed that value by now, offered the service, and taken advantage of the profit opportunity. Instead, they've moved in the opposite direction. Index funds, for example, have been such a massive success precisely because there's no evidence that relying on a particular adviser with particular theories and strategies actually nets investors any more money over the long haul than just putting their portfolio on autopilot. That suggests customers aren't losing out on anything from Schwab-style changes, and are just benefiting from the lower prices.
That doesn't necessarily mean, however, the Schwab-Ameritrade merger is out of the woods with antitrust regulators. The merged company's next biggest rival will only control $500 billion in assets. And while these brokerages no longer charge fees for the trades they facilitate, they do still serve as a kind of landing pad for independent financial advisers, providing them logistical and administrative support. Schwab controls roughly half of that market, and Ameritrade another third.
Moreover, the argument against concentrated market power is not always just that it hurts customers with higher prices. The case against Walmart, for example, is not that it may eventually gouge shoppers. It's that, by pushing out mom and pop stores and driving down wages, Walmart's market power harms society in other ways. In the case of giant investment firms, they can get so big that they really can't avoid holding significant ownership stakes in multiple companies in the same industry — such as airlines, for example. Studies suggest that situation can lead to dampened competition in those other industries, and thus lower-quality outcomes for their customers.
Finally, there's a deeper existential question here. Like I said, the ostensible purpose of financial markets is to provide the strategic thinking for the whole capitalist system. But if the firms like Schwab and Ameritrade find that not strategizing at all actually gives their investors better value — and if they find it's profitable to merge into de facto central planners, doing their investment on algorithmic autopilot — what does that say about that system?
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