Darkness By Design: The Hidden Power in Global Capital Markets
by Walter Mattli
Princeton University Press, 2019

Walter Matlli, professor of international political economy has written the ominous sounding Darkness by Design: The Hidden Power in Global Capital Markets. The book is a critique of the governance and structure of capital markets based on the view that “markets are more than simple coordination systems.” Specifically, “they are organizations governed by their own rules and regulation” and “are deeply political organizations or governance systems where contending groups of members or stakeholders are frequently embroiled in intense battles to shape market rules and structure according to their own narrow preferences.” So power can affect market outcomes as well as market structure.  

Mattli first shows us what good governance looks like by way of the old New York Stock exchange and the centralized market that existed. The benefit of centralization is that “dominance means public visibility, which brings with it particular reputational vulnerabilities.” This not only disincentivized bad behavior, but incentivized sober deliberation and spending the money necessary to build and maintain “robust market infrastructure.” Mattli makes this even more concrete by taking us to the trading floor to show how market makers acted as brokers while maintaining order and fairness. These market makers (or specialists) had a positive obligation to “maintain a fair and orderly market in the stocks they managed” (which would entail buying in falling markets and selling in rising markets) and a negative obligation to “refrain from trading for their own account except in cases where such dealer intervention would help minimize the effects of temporary disparities between supply and demand.” He also surveys the very strict rules of the old NYSE (meant to ensure integrity and fairness) in the context of market surveillance, and then adumbrates the extensive nondisciplinary and disciplinary actions the NYSE would take to enforce its rules.

This is contrasted with bad governance found in fragmented markets. For example, the breakdown of the market making obligations discussed above. In 2008 the NYSE announced the decision to abolish the negative obligation. This had what Mattli considers “predictable consequences.” First market makers have become “middlemen bent on maximizing short-term profits” and this has had the effect of turning market making into an adversarial and opportunistic enterprise. Additionally, market makers now only keep minimal inventories which harms their “ability to maintain orderly markets when large shocks hit the stocks.” And lastly, new market makers drawn to large cap stocks, rather than small cap where they are more scarce, reducing liquidity for small stocks. Mattli notes that this was only “the first nail in the coffin of good market governance” and then goes on to show how fragmentation has affected information asymmetry in trading data and market microstructure (specifically special order types), as well as in dark pools and failing surveillance.

After a summary of different regulatory schemes Mattli comes to the happy conclusion that “regulatory intervention in capital markets is rarely the only or necessarily the most effective answer.” Rather it may be better to have “market solutions to market failures, sometimes nudged or facilitated by regulators.” Specifically, he would like to see a movement back toward consolidation and centralization. Recognizing that “this conclusion will undoubtedly surprise – perhaps even appall – readers who have long bought into the conventional view that equates centralization or consolidation with monopoly or oligopoly” he invites “such readers to open their eyes to the reality of power politics in markets and reconsider the logic of reputational effects of bad governance for different market structures.”

Darkness by Design goes a long way to that end. The book’s structure is logical in its contrast of good governance as compared to bad governance embodied in the old and new NYSE; All concepts are clearly and succinctly explained along the way which makes it inviting to new readers if they wish to grapple with the material (there is a glossary in the back of the book for reference, and students of economics may find it helpful to read the appendix ‘A Theoretical background Note’ before jumping into the body of the work); Finally, there is a wealth of interesting empirical analysis and footnotes that are sure to interest the experienced reader. There are few books on the structure and governance of equity markets, and even fewer that can be enjoyed by new and experienced readers, Walter Mattli’s sets a high standard.

—David Murphy holds a Masters of Finance from the University of Minnesota.