In the past, they put their savings into the stock or bond market, often in a 401(k) or IRA account, investing toward retirement, a home, their children's education. Most sought a safe and steady return. The same holds true for pension funds, insurance and trust companies, and other investors that often are required by law or charter to adhere to a "prudent man" standard.
But they've all been forced to share the road with daredevils - short-term traders often driven by mathematical models that may dictate several trades per day just to exploit temporary trends or market discrepancies. Hedge fund managers, program traders and other speed demons trumpet their intent by asking for a 20 or even 30 percent slice of the profits - advertising that they will drive at least 20 percent or 30 percent faster than the average Joe to earn their fee.
Interacting in unforeseen and unexpected ways, these traders frequently magnify market swings and swerves. Like racers weaving into and out of traffic lanes to gain a quick advantage over other travelers, they are frequently generating chaos and increasing the probability of accidents and even massive car pileups.
As a consequence, market gyrations of up to 8 percent - the kind of return long-term investors would be happy to earn in an entire year - now are happening within a single day.
The risk is running long-term investors off the road. Many now actually prefer zero returns in secure Treasury bills to the volatility of the market.
Clearly the market has got to win them back - the economy can't rebound without their capital.
The solution? It's time to change the rules of the road. Or rather, it's time to create an alternate road with different driving rules.
I happen to be a person who likes to drive reasonably fast - and I also like to achieve good financial returns. But I would not advocate letting NASCAR drivers practice their trade on regular city streets and highways. In public places, there are speed limits and other rules of the road to obey.
If drivers want to go faster, they can practice their craft at Laguna Seca, Sears Point, Daytona or Indianapolis - and earn a very good income for showing off their skills.
Similarly, we need to consider banishing the financial racers from our regular streets and highways. I'm not saying we should outlaw their sport. I love going to the racetrack and watching cars zoom by at 150 miles per hour. I am just opposed to them doing it next to me while I am trying to drive safely to my retirement home.
So let's start a new stock market - and bond market, if you wish. On that market, it will be illegal to engage in short sales and to buy securities on margin. No derivatives can be linked to these securities. No futures, no puts, no calls, no collars. Just plain vanilla stock and bond trades are allowed.
I would call it the Prudent Investors Exchange - PIE for short. As in plain as apple pie.
Investors on the PIE would be required to hold their securities for a minimum of, say, three days - just like we require minimum holding periods for insider trades or to obtain favorable long-term capital gains treatment from the IRS. Regular investors need some liquidity, but the goal is to separate them from the speculators.
Then public corporations would freely choose whether they wanted to list on the Prudent Investors Exchange or stay on the exchanges as they exist today: the Nasdaq, New York Stock Exchange and so forth.
I would expect the PIE list to include those corporations wanting access to the funds of prudent individual investors, conservative mutual funds, pension funds and similar institutional investors bound by the prudent man rule.
Companies preferring access to fast money would continue to list on exchanges unfettered by the prudent man restrictions.
This kind of dramatic reform won't be an easy sell, but it isn't unprecedented. The market has always evolved in response to changing realities: switching to electronic trading, for example.
Indeed, there are signs that many companies would be receptive to an alternative trading format. Consider that after stocks plummeted last fall, it prompted a three-week ban on all short selling of financial stocks - a move so beneficial to stabilizing the market that Citibank clamored to keep it in place.
Speculators who have profited from the current winner-take-all environment are unlikely to embrace my idea. To the contrary, I anticipate they will scream about as much as my 2-year-old grandson does when anyone tries to take his toys away. Hedge fund operators and short-term traders won't welcome the fact that I'm proposing to take away their ability to make short-term profits on the backs of long-term investors.
In fact, when I recently tested my idea out at a forum of about 200 financial experts and investors in San Francisco, all liked it, save one participant. No surprise that he was a hedge fund manger.
But short-term traders will have difficulty arguing that their activity either increases returns earned by the corporations in which they invest or helps the average investor invested in the same markets to achieve higher returns. Not only do these short-termers fuel uncertainty and sometimes exacerbate swings, but they also leave a lower residual rate of return available for everyone else.
History tends to go in circles, and there is one common theme that characterizes all financial crises in recent memory: the central role played by complex financial trading strategies.
Developed by so-called rocket scientists, these strategies use high leverage, short selling, puts, calls, derivatives and mathematical program trading models. Ironically, many of these models were developed to reduce risk and enhance returns for the individual executing the trade - but they often do the precise opposite for other market participants.
Two decades ago, this was true in the October 1989 market collapse, which was driven by program trading.
Ten years ago, it was true in the collapse of Long Term Capital Management, which was caused by a failure of the mathematical models developed by no less than two Nobel Prize winners.
And it is true again in the current situation, where speculators helped to propel the market free fall. Yes, subprime mortgages proved to be vulnerable to default, but short sales, derivatives and complex structured mortgage bonds caused the market to implode.
Prudent investors remain understandably skittish. They won't drive the economy toward necessary recovery unless we can convince them that the roads are reasonably safe. So let the NASCAR investors compete with other NASCAR investors - and let the rest of us steer clear of them.
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