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2012-10-21 — ritholtz.com
``The SEC hoped these new regulations would increase competition. Indeed, spreads have narrowed in the most active stocks and commission rates have dropped, but there's no free lunch. Due to a lack of economic incentives, traditional market makers, who used to act as shock absorbers in times of volatility, have exited the business, only to be replaced by "automated market makers". Their operating model is based on paying brokers to direct trades to them -- called "payment for order flow" -- and then using powerful computer systems to make a small profit per share on turnover of these trades.
Rather than helping customers achieve best execution, automated market makers use these orders to trade for their own account. They have little or no obligation to facilitate trades when times get tough. Moreover, the lack of spreads has caused many broker dealers to exit the business of underwriting IPOs, leaving a void in our economy.''
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