What are over-the-counter stocks?
We've told you how credit default swaps caused trouble for the economy, which are tricky instruments traded in the over-the-counter, or OTC, market. In this Marketplace Decoder, Rico Gagliano explains.
An old-fashioned general store (iStockPhoto.com)
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KAI RYSSDAL: If you think conventional stock markets like, say, the Nasdaq have been scary places this year -- and they have -- then brace yourself. Because there's another way to buy and sell almost anything Wall Street can dream up. It's called the over-the-counter markets.
Beyond subprimes and mortgage backed securities OTC might be yet another reason we're in this mess. Rico Gagliano explains in this installment of the Marketplace Decoder.
Rico Gagliano: OK, to truly understand this thing, we gotta take you back to the 1700's. And by "we" I mean Mike Hatley, president of Westgate Horizons Advisors.
Mike Hatley: The New York Stock Exchange started in the 1700's. Before that, stocks actually traded in the general store.
A general store was like a retail outlet for stocks. And there were a bunch of general stores, all over the Big Apple.
HATLEY: You would go to the merchant at the store if you wanted to trade a stock, and you would trade the stock literally over the counter.
Now you know from going, say, shoe shopping that it's tough to check out every shoe joint in town to find the best deal on that limited-edition pair of Pumas. Same went for stocks -- different general stores might sell the same stock at different prices.
Number of people decided, including Alexander Hamilton, that it would be really a good idea if there was a central place to do all the stock trading, and they formed the predecessor of the New York Stock Exchange.
But even today, not every stock sells on the NYSE. Some don't sell on any exchange. Those stocks, and many other financial products that aren't sold on exchanges, still trade OTC -- Over the Counter.
Jeff Carter: Over-the-counter trading is trading that's done in an unregulated market.
Jeff Carter is an independent speculator and a former director of the Chicago Mercantile Exchange. He says "unregulated" is the operative word here. On a regulated exchange, traders can only work with shares listed on the exchange. OTC traders can sell anything they want -- from penny stocks to complex credit default swaps. There's no middle man, and few rules. Kinda like the old general store writ large. And it's not for everyone.
Carter: The average Joe on the street is not equipped to do over-the-counter trading, and they're also not probably big enough. These are big, big transactions -- it's a professional market.
But recently, professionals have lost big in the OTC market, thanks to the unexpected collapse of big players like Lehman Brothers. So Carter says there are moves afoot to build in some safeguards. For instance by creating so-called "clearing houses," which ensure traders can actually afford to make deals. And he says the government may consider some oversight, too.
In Los Angeles, I'm Rico Gagliano for Marketplace.
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