‘Circuit Breakers:’ Air Bag or Band-Aid? : Stocks: Wall Street is divided on anti-crash rules that apply the brakes in a steep market decline.

One of the controversial “circuit breaker” mechanisms adopted by the New York Stock Exchange since the 1987 market crash kicked in Thursday for the seventh time this year--and once again appeared to achieve its purpose of stabilizing share prices and staving off panic.

Many on Wall Street are pleased with the rule, which bars computer-driven trading linked to stock index futures once the Dow Jones industrial average has fallen 50 points. Additional circuit breakers--culminating in the suspension of all stock trading--take effect in the event of more radical market declines.

“The circuit breakers are working,” said Glenn Fogle, a mutual fund manager with 20th Century Funds in Kansas City, Mo. “They hold back the computer-driven business and force someone to make a conscious decision to sell. Computers don’t have emotions, and it’s better that the market reflect the emotions of the people who own the money.”

Yet many others contend that circuit breakers are a bad idea. Critics say they simply delay stock price changes that are bound to take place anyway, and thus render the markets less efficient. And, it remains unclear what the effects of the more Draconian circuit breakers would be, in the event of a severe sell-off.

“At best, they slow things down,” said Gus Sauter, vice president for quantitative equity investing at the Vanguard Group, a mutual fund company in Valley Forge, Pa. When the Dow industrials were down 72 points Thursday morning, the 50-point rule actually delayed a recovery, Sauter said, by preventing stock prices from adjusting immediately to a rally in the futures market.

Clearly, the 50-point rule slows the decline of share prices, noted Jeremy Siegel, a finance professor at the University of Pennsylvania’s Wharton School of Business.

“I don’t think it makes any difference to where the market is eventually going to go, but it may cut back on intra-day volatility,” he said.

Siegel pointed out several pitfalls, however.

For one, the market inefficiency caused by delaying price changes may make the U.S. stock market relatively less attractive to investors, he said. If so, the rules may be depressing share prices across the board.

In addition, Siegel said, records show that price slides tend to accelerate as they approach the 50-point level, as investors try to beat the cut-off. This “suction” may be even more dramatic and damaging in the case of other circuit breakers, the most extreme of which suspends all trading in the event of a 250-point decline in the Dow industrials.

Still, market watchers say the circuit breakers have helped to stave off panic on the part of individual investors. That may be especially important in the current market, which has been driven to new heights by hordes of first-time investors putting their savings into mutual funds.

Some critics question whether even that effect is a good thing.

Amar Bhide, a management professor at the Harvard Business School in Cambridge, Mass., said the whole idea of regulatory intervention toward building public confidence in Wall Street is wrongheaded.

“To the extent they contribute to the perception that Wall Street is a well-run, well-governed casino,” Bhide says, rules such as the circuit breakers encourage a short-term investment mentality and attract small investors who should not be in the stock market at all.

Putting on the Breaks

In the wake of the 1987 stock market crash, Federal regulators and stock exchange officials agreed on a series of “circuit breaker” mechanisms designed to prevent extreme swings in share prices.

* The 50-point rule: When the Dow Jones average falls (or rises) 50 points from the previous day’s close, computer-driven sell (or buy) orders linked to stock index futures trading are blocked. This prevents automated hedging, or risk-reduction, strategies from accelerating a market decline.

* The “sidecar” procedures: When the price of the main S&P; 500 stock index futures contract traded on the Chicago Mercantile Exchange falls by 12 points--equivalent to about 90 points in the Dow Jones average--trading in those contracts is suspended for 30 minutes. Programmed buy and sell orders for the corresponding stocks on the New York Stock Exchange are diverted into a special computer file, where they are held for five minutes. In the event of a severe order imbalance on a particular stock, trading in the stock is halted, and information on the imbalance is disseminated to the market.

* Trading halts: If the Dow Jones average falls 250 points during one day, trading on all U.S. equity and futures markets is suspended for one hour. If the Dow Jones average then falls an additional 150 points, trading is suspended for an additional two hours.