The stock market's gyrations are frightening people, making them think that things are coming apart. And they have reason to be concerned.
The problem is that the market where the stocks of America's biggest companies are traded has grown beyond efficient regulation as it has become dominated by large institutions trading big blocks of securities.
Right now, the market is a mess, as the report of the Presidential Task Force on Market Mechanisms--known as the Brady Commission--makes clear. The report says that stock trading almost collapsed in the two-day debacle of last Oct. 19 and 20.
But it wasn't millions of small investors, nor even thousands of large ones, who caused the financial panic.
Instead, says the report, "selling by a number of institutions employing portfolio insurance, and a small number of mutual funds . . . encouraged a small number of aggressive, trading-oriented pension and endowment funds, money management firms and investment banking houses" to sell in anticipation of further market declines.
The result was a vicious circle of declining prices in common stocks on the New York Stock Exchange and stock index futures contracts on the Chicago Mercantile and other exchanges, and a near collapse of the financial system.
Heavy stuff. Who were those institutions? The Brady Commission--named for its chairman, Nicholas F. Brady, the head of Wall Street's Dillon, Read & Co.--maintains a decorous silence on the names.
But nothing stops Wall Street scuttlebutt. Market participants and observers may not know for sure which funds and brokerage houses the Brady Commission is referring to.
But they look at institutions known for using aggressive investing techniques, draw their own conclusions and come up with such blue-ribbon names as the Harvard University endowment, the Rockefeller Foundation, the General Motors pension fund and the Goldman, Sachs and Morgan Stanley investment banking houses.
The names of the Fidelity group of mutual funds and companies prominent in employing portfolio insurance--a method of hedging stocks with futures--Wells Fargo Investment Advisers, the investment unit of Aetna Life & Casualty, and Bankers Trust Co. also come up.
In one sense, what the institutions did was rational. They sold stocks when they saw prices going down. But their selling turned into the classic start of a bear market, everybody rushing for the exit at once.
And in another sense, their selling involved abuses. There were conflicts of interest as brokerage firms put their own interests ahead of their customers'.
And the decline was greatly aggravated by the speed at which big institutions could unload billions of dollars worth of stocks, using the stock exchange's electronic trading mechanism--a system that in many cases unfairly puts institutional orders in ahead of those from individual investors.
The other difficulty arose from the efforts of institutions to hedge their portfolios against loss--or to lock in a sure profit--by simultaneous buying and selling of futures contracts on the Standard & Poor 500-stock index--traded in Chicago--and the underlying stocks, traded in New York.
The trouble, again, was that too much hit the markets at once and information on prices could not keep up with the pace of trading, leading to chaos and headlong waves of panicked selling.
There is nothing inherently wrong with futures trading, of course. Farmers and grain dealers have used futures markets for more than 100 years as a form of hedge or insurance against price fluctuations. In the last decade, the markets have facilitated global trading in currencies and government securities--$25 billion a day in Treasury bill futures trades in Chicago, for example.
But futures trading does not yet work well in stocks, for several reasons. For one thing, says the Brady report, there is a lack of common regulation of the stock and future markets. Brokerage houses use information gained from customers in one market to make an unethical killing in the other.
Clearing firms in Chicago and specialist firms on the New York Stock Exchange were undercapitalized before the crash and are hurting more than ever now. So they're not able to keep price movements as regular and narrow as they used to be, and thus the markets have become more volatile since the crash.
So what's to be done? The Brady Commission phrased its recommendations most diplomatically, so as not to distress the Reagan Administration and the New York Stock Exchange--both of which want to hear no evil.
But the chaos and chicanery the report describes says loudly that stronger regulation and reform are needed because the markets aren't working. More than that, they remain in danger of the kind of collapse that once brought the country to its knees.
"The illness is still in the system," says Howard Stein, the chairman of Dreyfus Corp. and a rady Commission member. Until something is done to cure it, people will have cause to be frightened.