Mark Cuban has touched on what is at the center of why financial regulation is so difficult: the roles, values, and differences of the primary and secondary markets.

All of Wall Street exists to do one thing: connect those with capital to those who want it.

The primary market exists to do what Wall Street is meant to do: a company or other entity wants money, an investment bank connects that company with investors, and investors hand over the money. Wall Street acts as a classic broker, executing the function it was meant to perform (match those with capital to those who want capital). For its services, it takes a cut.[1]

This part of Wall Street - the primary market - works reasonably well and there aren't many complaints about it.[2] In fact, people sometimes complain about the IPO market getting too hot, which really just means that more companies in the real economy are getting money. The biggest ongoing complaints about the primary market are that the big banks charge too much for the capital raises and that they hype up the securities. Neither is a particularly cutting complaint though, nor is either issue crippling in any way to the capital markets.[3]

This brings us to the secondary market - the stock market as most people know it. Most people never participate in the primary market (i.e. in the first sale of securities), but rather in the secondary market. Here's the core question: WHY DOES THE SECONDARY MARKET EXIST?

The secondary market serves a support function to the primary markets. It provides "liquidity" to the primary investors - that is, it gives them a reasonably easy and cheap way to offload their shares should they choose to do so. The idea is that if there's a ready secondary market for the shares, primary market investors will be more willing to participate in deals because they know they can get out quickly and cheaply if they want to, and they'll be willing to pay a higher price for the shares for the same reason. In more technical terms, the secondary market serves to increase the flow of capital to companies and lower the cost of capital for companies.

And this is where all the problems Mark Cuban is citing come in, plus all the problems that financial regulators were trying to deal with in the last regulatory push (Volcker rule, Glass-Steagall, etc.).

The main issue here is that you can't really draw much of a line between "market-making" and short-term trading. Market-making is something most people agree is a good thing - you want a healthy number of market makers competing transaction costs down and providing sufficient liquidity (again, all to serve the health of the primary markets). And short-term trading is something that most people feel is a bad thing - it creates short-term thinking in the markets, which usually flows over into the companies, so you have everybody thinking about the next quarter, which leads people to ignore longer-term and deeper issues. But both market-makers and short-term traders are just buying and selling securities - it looks exactly the same. This is why the Volcker rule is so ineffective. The rule stated that a financial firm could only have a few percent of its capital in "proprietary trading," but every trader at any financial firm knows that most of the trading (and most of the lucrative trading) happens on the market-making desks. Buy a portfolio of illiquid emerging market bonds at 70 cents on the dollar from an investor looking to offload quickly, warehouse it for a few days, and offload at 85 cents. That's market making. And it's also short-term trading. There is no difference. The trader had to make a judgment about whether he would profit on the trade - whether the price of the bonds would hold up until he could offload it, or whether he got it at enough of a discount that even a move against him wouldn't hurt him. He probably thought about whether he could hedge it while he held it or if he could somehow line up a buyer before he even bought it. A high frequency trader is technically doing the exact same thing - just buying and selling; they just get very fancy about figuring out whether they'll profit on the trade: fractional penny arbitrage opportunities, information about where the price is headed in the next half-second, etc.

The best idea I've heard in terms of tackling this specific issue is to alter the tax structure. Mark Cuban advocates this in the form of a 10 cent tax on trades held under 1 hour. Another version I've heard is to levy a similar penalty tax on any capital gains reaped on a trade held less than 3 months (i.e. taxed as income plus a penalty; right now it's just taxed as income), and to move the lowered long-term capital gains tax rate to gains on investments held for more than 2 years (right now, long-term is 1 year). This would certainly discourage short-term trading, but that would mean that it would also make trading slightly more expensive for everybody, which some people think would be a good thing in that it would make people think twice before they traded something, while others argue that it would be a terrible thing because it would hurt the smallest players (individual investors) the hardest - after all, they're the ones who feel trading costs the most in percentage terms (trading costs as a percentage of the amount they're investing).

As a final thought, while all this trading and short-term thinking seems like it hurts us in the long-term, I don't think this is where our energies should be focused in terms of regulation. Trying to get people to stop short-term trading in the market would be like trying to get people to stop going to see movies for all the violence. Sure, it'd be nice if everybody thought like Warren Buffett in the market, and it'd be great if everybody just wanted to watch Stanley Kubrick films. But the important thing is not to get people to be "better," but to ensure they can't cause much damage as they're acting on their impulses. People like violence, but we keep guns away from them. People like short-term trading, so we need to keep LEVERAGE away from them. If you limit leverage, you limit bubbles and busts. It's that simple and that difficult. Bubbles and busts will still happen because people will chase up prices of some securities and then run for the hills once prices falter, but you need to make sure they're just running and not rocketing. Leverage is that rocket - limit it, and you've got the most elegant solution to the major problems of the financial markets. Don't try to enforce good behavior; just limit the power of bad behavior.

[1] Some people complain about the size of the cut that Wall Street takes for these services. The cut is stable and large for 3 reasons: 1. There's an oligopoly at the top. 2. The risks to a failed capital raise are huge, financially and reputationally for the company raising capital, so they usually opt to go for one of the few top players (protecting the oligopoly). 3. Like most large negotiated transactions, there are higher costs of doing business (think cars and houses).

[2] In the primary markets, the area that probably poses the biggest danger to the economy and society as a whole is when it gets into non-plain-vanilla securities, i.e. stocks & bonds work just fine, but derivatives and other instruments (like some asset-backed securities in the last crisis) get a bit more tricky. But I'm going to leave those aside for now since Mark Cuban is mostly addressing trading in the stock market and plain vanilla capital raising.

[3] The costs have been pretty stable for long stretches of time without seemingly barring companies from raising capital or making the capital raise so prohibitively expensive that people don't participate. And on hyping the securities, investors know that there's a financial relationship between the company and the bank, and they're for the most part pretty aware of this and therefore do much of their own research. All the major mutual funds and hedge funds do their own research and know not to rely on bankers (to the point that many portfolio managers ask that the bankers remain silent during meetings with companies that are raising capital until the discussion gets to specific deal terms, and if the company is not raising capital but just meeting with portfolio managers or analysts, the PMs or analysts often don't even allow bankers in the meeting room but ask them to wait out in the lobby or waiting area).