Regulatory Panel Scored for Inaction as Market Plunged
As financial markets flew into turmoil last week, analysts blamed program trading for much of the volatility. And the Commodity Futures Trading Commission, an obscure federal agency responsible for regulating a key component of that trading, did what it has done throughout its 12-year history: It let the markets regulate themselves.
Rather than exercise broad emergency powers under which it could have slowed or even stopped trading, the commission stood by as the Chicago Mercantile Exchange and other exchanges took steps that, by the end of the week, had all but halted program trading.
Meanwhile, the commission devoted its resources to marshaling statistics to determine what role the controversial practice had played in the market decline.
To the CFTC, the week’s experience demonstrated that “the systems in place are working as they were intended to work despite unprecedented markets,” Commissioner Robert R. Davis said.
But the episode renewed charges by critics that the commission, which was founded in 1975 to regulate the trading of contracts to purchase pork bellies and other commodities, has failed to adequately oversee trading in new stock-index futures.
Under the 1975 law that established it, the commission has made its first priority the encouragement of trading and left the protection of traders as secondary.
“Until now, both the CFTC and its industry constituency have worked toward more volume, more trading instruments and higher turnover,” said James Stone, chairman of the commission under President Jimmy Carter. “Perhaps now the ultimate constituency, the American public, will fight for its interest, economic stability, as a countervailing force.”
Stone, who as a commissioner opposed the creation of stock-index futures in 1982, called for “tightened regulation” of futures trading through increases in margin requirements and tighter limits on the positions speculators can take. “If these aren’t sufficient,” he said, “then the instruments themselves aren’t worth the gamble.”
While few critics have argued that the commission should have shut markets down last week, some members of Congress have begun to take a new look at program trading, which the CFTC made possible in 1982 by authorizing the sale of stock-index futures.
Many analysts believe that program trading--simultaneous, computer-directed trading in stocks and stock-index futures--accelerated the downward spiral of the stock markets.
Tail-Wagging Watchdog
“The burden of proof is on the financial community to demonstrate that the benefits of program trading outweigh the enormous potential for disaster which was evident last Monday,” said Rep. Edward Markey, (D-Mass.), whose finance subcommittee opens closed-door hearings today into the cause of the market collapse.
Markey said the subcommittee will seek to determine “what regulatory measures are needed to reduce the risks of these trading practices or whether financial markets would simply be better off without stock-index futures.”
The commission, whose job it would be to enforce those regulations, has been widely viewed since its inception in 1975 as a tail-wagging watchdog, lacking both the teeth and the ferocity to overcome industry’s deep-seated resistance to regulation.
Since former CFTC Chairman Susan M. Phillips returned to the University of Iowa three months ago, the commission has limped along with an acting chairman, Kalo A. Hineman, a wheat farmer and cattleman with little experience with such esoteric financial instruments as stock-index futures before becoming a commissioner in 1982.
Congressional sources said squabbles within the Republican Party about the next CFTC chairman have left the commission to drift in recent months. “They’re caught without a leader, with an acting chairman who clearly doesn’t have the backing of the White House,” said one Senate aide.
The White House, the congressional sources said, sought to give the job to Mark Sullivan, a securities lawyer who is associate director of the White House personnel office. But it was strongly opposed by Senate Minority Leader Bob Dole (R-Kan.), who supported Hineman, a fellow Kansan.
To break the deadlock, the White House may offer the job to Wendy Lee Gramm, the chief deregulator at the Office of Management and Budget, the sources said.
Hineman, meanwhile, said last week that it would be “a dangerous thing to shut down markets without complete information.” And on Tuesday he reported that the commission’s preliminary investigation suggested that program trading had little role in last week’s market plunge.
Speaking at a commission meeting, Hineman said that index arbitrage--simultaneous dealing in stocks and stock-index futures--accounted for a relatively small percentage of the more than 600 million shares traded on Black Monday, the day the Dow Jones industrial average plunged 508 points. It probably accounted for an even smaller percentage afterwards, when stock and commodities exchanges took steps to curb program trading, he said.
Hineman’s approach is in keeping with the commission’s history. In the early 1980s, some CFTC officials complained that trying to police the commodities industry with a small budget and small staff was like being armed with a popgun.
More recently, as the commission has sought to keep pace with a four-fold increase in futures trading in the past 10 years with a staff whose size has remained almost constant, it has devoted most of its resources to computerized surveillance of trading activity. It has delegated some of its other tasks--including the registration and evaluation of brokers--to an industry group, the National Futures Assn.
At the same time the commission has had to adjust to rapidly changing futures market preferences that have shifted from commodities such as pork bellies and wheat to financial instruments such as Eurobonds and stock indexes, which together now account for two-thirds of the volume of the trading overseen by the CFTC.
Commission officials insist that they are doing what Congress intended.
“There’s a very strong tradition of self-regulation in the industry,” said Kate Hathaway, the commission’s communications director. “We are an oversight agency. We are not on the front lines.”
In contrast to the Securities and Exchange Commission, which regulates the stock markets, the primary task of the CFTC by statute is to ensure that the marketplace remains competitive, efficient and free of fraud, Hathaway said. Customer protection is a secondary task, she said, and for that reason the CFTC has devoted the bulk of its resources to market surveillance.
A measure of the close relationship between the CFTC and the industry is the fact that the commission has never exercised its power to turn down an industry proposal to create a futures contract based on a new stock index.
Rarely Exercises Authority
“We do get contracts that we have questions with or problems with,” a commission official said. “But there’s a lot of behind-the-scenes between the exchanges and the commission,” he said, and the problems are always straightened out.
The commission last declared an emergency in 1980, when it temporarily closed the grain markets after Carter imposed an embargo on grain sales to the Soviet Union. “We have plenty of authority,” said Fowler West, the longest serving of the current commissioners.
But it rarely exercises that authority. And last week, as chaos gripped the markets and concerns about program trading increased, the commission remained in “constant contact” with the commodity exchanges in Chicago, Kansas City and New York but made no recommendation as to what course should be taken.
Had it declared an emergency, the commission could have unilaterally increased the good-faith deposits required of traders, lowered the ceilings on speculative trading or even closed the markets altogether.
Instead, the commission remained quiet and exchanges acted on their own to raise the good-faith deposits--from $5,000 to $20,000 at the Chicago Mercantile Exchange--and to impose limits on the degree to which stock-index futures prices would be allowed to fluctuate.
As legislators ponder the future of the CFTC, they will consider proposals to bolster the CFTC’s authority or even to merge the commission with the SEC, which is widely regarded as a tougher regulator.
“The best argument for putting the tangible commodities under the SEC is that it has a better history of regulation and enforcement,” said one key House aide. “I would merge the whole shooting match into one agency.”
