Few Agree on Way to Prevent Crash : Regulators Are Stymied on Cure for Stock Market
John W. Bachmann’s customers are panicky. Bachmann is head of a big St. Louis brokerage firm, Edward D. Jones & Co., and he says that last October’s stock market crash has sent his customers--largely small investors--scurrying to the sidelines, slashing his company’s trades by 25%.
He has a solution: tougher regulation of the markets, so that the big institutional investors “can’t sell two years’ worth of stock positions in 10 seconds.” Otherwise, he says, small investors will always see themselves as at the mercy of the big guys.
Myra Drucker is one of those big guys--she manages a $1-billion retirement portfolio for 64,000 workers and pensioners of International Paper. Her portfolio survived the crash with only minor wounds: It lost $160 million on stocks but made up $155 million of that in the stock futures markets. And for the year as a whole, it showed a 21% profit.
Drucker says she could not have done that well if the government had followed Bachmann’s advice and limited her ability to engage in high-speed, computer trading in several markets at once. New rules designed to slow the market’s pace “make me nervous,” she says.
These sharply contrasting views of what the market needs--a free-wheeling atmosphere for the big bundles of managed money or a slowdown to calm the individual investor--are a formula for regulatory and legislative stalemate.
And that is just what has developed in the five months since the Oct. 19 crash. Although the government’s financial regulators and members of Congress all fear a repeat of Oct. 19, hardly any two policy-makers agree on how to prevent one.
“All the elements we had on Black Monday and Terrible Tuesday are there, and we could have it again,” warns Senate Banking Committee Chairman William Proxmire (D-Wis.). “Nothing has changed.”
In particular, regulation of the financial markets remains split between the Securities and Exchange Commission, which oversees trading of stocks, and the Commodity Futures Trading Commission, which supervises the buying and selling of stock-index futures.
Computer-driven “program trading” in stocks and stock-index futures is widely believed to have contributed to the sharpness of the market crash.
And, at present, the rules governing stock trading differ from those governing trading in stock-index futures--contracts for the purchase on a particular future date of a particular group of stocks at a price tied to the level of a major stock-market index, such as the Standard & Poor’s 500.
Fed Oversight Urged
A presidential commission, headed by former Sen. Nicholas F. Brady (R-N.J.), recommended in January that the Federal Reserve receive overall authority for regulating both stocks and stock-index futures. It also suggested “circuit breakers”--such as price fluctuation limits and automatic trading halts--to prevent wild price swings such as those of Oct. 19.
The White House, philosophically leery of regulation, backed away from its own commission’s report and last week ordered the existing regulatory agencies--the SEC, the CFTC, the Fed and the Treasury Department--to work on developing a common position.
“The idea of this group is to decide what can be done . . . to reach a consensus among the regulatory agencies,” said an Administration official who asked not to be named.
That is a tall order. Right now the regulatory agencies agree on very little.
The Fed, despite the Brady Commission’s recommendations, shuns permanent regulatory authority over the securities markets. Fed Chairman Alan Greenspan has said that such a role could make the nation’s central bank appear to play the role of guarantor for the securities industry and that in turn might lead to reckless borrowing by securities firms.
Share Few Ideas
The SEC and the CFTC agree that the Fed should not be able to supervise their regulation of the securities markets. Beyond that, they share few ideas.
SEC Chairman David S. Ruder believes it is only logical for regulation of stocks and stock-index futures to be consolidated in his agency.
Ruder told Congress last Thursday that he believed margin requirements on the purchase of stock-index futures, now in the regulatory domain of the CFTC, should be stiffened and made consistent with those for stocks. Stock-index futures can be bought with down payments of as little as 10%; stock margins, by contrast, are 50%.
Even within the SEC, however, only two of the other four commissioners agree with Ruder that the SEC’s authority should be expanded. SEC member Joseph Grundfest, who disagrees with Ruder, said that a campaign to augment the SEC’s authority would become “a classic political confrontation about whose ox gets gored. People will get bloodied and not win.”
The CFTC, not surprisingly, prefers Grundfest’s position to Ruder’s. CFTC Chairwoman Wendy Lee Gramm insists that prices collapsed naturally last Oct. 19, not as a result of sophisticated trading techniques that should be regulated out of existence.
Calls for Stability
“Enormous selling pressure came from many investors,” she said. “Regulators are not in a position to prevent prices from going down. That’s a very tall order . . . . What we need now is stability, not change. Given the enormous amount of stress, the markets worked remarkably well. We do not need more regulatory boxes.”
The divisions among the regulatory agencies are reflected in the congressional committees that oversee them.
Rep. Edward J. Markey (D-Mass.) is chairman of the House Energy and Commerce subcommittee on telecommunications and finance, which has jurisdiction over the SEC, and he argues that the SEC’s responsibilities should be broadened.
“These markets are not separate from each other; they pound at each other,” Markey said. Potential crises “require an expert agency, the SEC, to have daily, hourly monitoring powers.”
The perspective is different at the House Agriculture Committee, which oversees the CFTC. If the CFTC lost some of its regulatory authority or were absorbed by the SEC, the Agriculture Committee would lose a source of its power--an outcome that committee Chairman E. (Kika) de la Garza (D-Tex.) is determined to prevent.
“It’s not a matter of jurisdiction,” De la Garza insisted. “If it ain’t broke, don’t fix it. The CFTC, with the tools we’ve given them, was able to properly manage the situation. They supplied information to the SEC, in fact.”
The market crash, De la Garza maintains, was simply a natural event that could not have been forestalled. “These are human beings gambling with their money or somebody else’s money,” he said. “That’s all it is, just people gambling. What makes a fellow dump this stock and buy that one?”
Rep. Leon E. Panetta (D-Monterey), an Agriculture Committee member, agrees with De la Garza that the CFTC should not lose regulatory authority. But he concedes that the reason has to do with more than considerations of efficiency and good government.
“I don’t imagine there’s a chance the Agriculture Committee would be willing to give up jurisdiction,” Panetta said. “Most of the committees already are concerned with their basic powers being eroded. Every chairman, not just in agriculture, is going to be very selfish about giving up any turf.”
In the Senate, where the Banking, Housing and Urban Affairs Committee has jurisdiction over the SEC, committee Chairman Proxmire would like to beef up the SEC’s authority at the expense of the CFTC.
But Proxmire finds opposition even within his own committee. CFTC Chairwoman Wendy Gramm is the wife of Sen. Phil Gramm (R-Tex.), whom Proxmire describes as “probably the most articulate and, in some ways, the most persuasive and forceful member of the Banking Committee.”
The argument over regulation is, at its heart, a debate over the best way to cope with an investment world that has changed radically since today’s regulatory structure was built.
“Our securities markets were not structured with the thought that there would be a large number of institutions, all of whom would want to sell the whole market at the same time,” SEC Chairman Ruder says.
Gone are the days when massive investments lay untouched for years at a time, Ruder says. Institutions--pension funds, mutual funds and other massive aggregations of money--now move in and out of the markets with great speed and aggressiveness.
Can Hedge Their Bets
Money managers at the big institutions, armed with powerful computers that can complete massive trades in seconds, can hedge their bets by buying stocks and selling stock-index futures, or vice versa. The argument continues over whether such “program trading” contributed to last October’s breathtaking market collapse, but many individual investors have already made up their minds.
An angry woman in Missouri wrote Markey’s House subcommittee: “When one company can hit a button on a computer and send the market down 100 points in 10 minutes, it is more like gambling. And I am not a gambler. I am an investor.”
A Maryland financial manager complained: “It is now a massive game where those with the largest, fastest computers buy and sell stock without the least thought of sharing in the development of a stronger, more competitive economy.”
With so many investors scared away, the stock market is failing to carry out its basic role--generating money for new companies to go into business and for established firms to expand. Before the crash, $2 billion a month in new shares was being marketed. That fell to $250 million in January and $110 million last month.
Myra Drucker, who manages International Paper’s huge portfolio, worries that the regulators will bend toward the individual investor with changes that are “detrimental to my ability to use markets in a continuous fashion.”
By dealing in stock-index futures, she said, “I helped to secure the benefit promises to my employees, and I helped to do that in a fashion that was cost effective to the shareholders.”
To congressional critics, however, her techniques are dangerously akin to gambling. “We need less speculation,” Proxmire said, “less gambling, less opportunity for people to make a quick buck or lose a quick buck.”
If rivalries among regulators and legislators forestall action, Markey said, “it would be a real tragedy and a historic mistake. I feel very strongly (that) changes have to be made.”
Markey warned that the market’s rebound since Oct. 19--the Dow Jones industrial average has made up about 350 points of the 508 that it lost that day--is nothing more than “a false economic spring . . . . Wishful thinking has taken over the minds of many.”
