SEC Rethinks Stock Market ‘Circuit Breakers’
The Securities and Exchange Commission, its hackles raised by a wild stock sell-off that nearly provoked a total trading halt March 8 on the New York Stock Exchange, is reconsidering the “circuit breakers” designed to cushion investors from panic selling.
The rethinking comes as a growing number of traders, large investors and academic observers contend that the arsenal of trading limitations and market halts enacted after the October 1987 crash have become outmoded by the market’s powerful surge since 1990. Most critics argue for raising the trigger points at which the trading curbs are initiated.
This week, for example, the “collar” limiting computerized program trading after a 50-point rise or fall in the Dow Jones industrial average kicked in twice--for the 30th and 31st times this year.
“It’s a little ridiculous,” Jeffrey Tabak, a New York program trader, complained earlier this week. “The 50-point rule is now kicking in almost every day.”
An SEC spokesman said Friday that “there’s been no decision one way or another” on possible changes. But he acknowledged that officials of the agency, which has recertified the rules every year without alteration, have been meeting with executives of securities firms to determine how much interest exists in making changes.
From the NYSE’s standpoint, however, the answer is: virtually none. The Big Board insists the circuit breakers have worked perfectly and says it has no immediate plans to change them.
“We’ve heard from newspaper people and some academics [questioning the circuit breakers],” Edward Kwalwasser, the NYSE’s group executive vice president for regulation, said in an interview this week. “But we haven’t heard from the membership.”
He added that the SEC staff agreed in talks as recently as late last year that the curbs were working properly.
The circuit breakers were enacted in 1989 and 1990 principally to keep massive computer-driven trades from building momentum and turning trends into stampedes--to put “sand in the wheels” of a developing panic, in the words of former NYSE economist Roger Kubarych.
The most common curb is imposed after the Dow Jones industrial average moves 50 points in either direction from the day’s opening. The “collar” prevents computerized program trades from being executed except on a market tick opposite from the overall trend. In other words, in a 50-point down market, programs can only be executed on a 1/8-point rise in the index, and vice versa. Upon larger drops, the rules are sterner. A 250-point drop in the Dow mandates a one-hour trading halt, and 400 points stop all trading for two hours.
Market observers argue that the fixed trigger points have been rendered obsolete by the post-1990 bull market, which brought the Dow index to 5,584.97 at Friday’s close. Because the Dow is the benchmark for the circuit breakers, that means their triggers have shrunk in percentage terms to less than half their original levels.
A drop of 250 points, for example, is today a much less significant move in percentage terms than it used to be. In late 1988, the Dow stood at about 2,148, and 250 points in a day would have represented a free fall of more than 11%.
Then-NYSE Chairman John Phelan “rightly judged that would be a shock of historic dimension,” recalled Kubarych, who is now general manager of the consulting firm of Henry Kaufman & Co. Under such circumstances, he said, it was felt that an otherwise unthinkable shutdown would enable investors and traders to catch their breath.
Today, 250 points amount to only about a 4.5% change in the Dow--well short of a cataclysm by any measure. In fact, many traders say the market could absorb a 250-point one-day drop much more easily than it could the shock of a trading halt. Accordingly, many proposals for change involve simply doubling the trigger points. Some professionals favor changing from fixed-point tripwires to percentage changes, although such moving targets might prove difficult to track.
Some traders say the hazards of the 250-point trading shutdown were particularly underscored by the close call on Friday, March 8.
At 3:15 p.m. that day, the Dow had plunged 217.5 points, or only 32.5 points short of a shutdown. It was the market’s closest call since the rule’s 1989 implementation.
Because less than an hour remained in the trading day, the circuit breaker would have shut down all trading until the following Monday. Thus, traders and investors trapped in losing positions would have spent the weekend contemplating a market that had hit its lows and seemed determined to plummet further.
“That in itself might even have forced a greater dislocation on Monday,” argued Holly A. Stark, head trader for the New York money management firm of Dalton, Greiner, Hartman & Maher. “The timing would have been very inauspicious.”
For one thing, it would have deprived the market of a tempering rally; in the last 45 minutes of trading Friday, the Dow rebounded more than 46 points, setting up Monday’s 110-point recovery.
For all that, the emerging debate appears focused more on relocating the circuit breakers than on eliminating them entirely. To some people, that suggests that the curbs have proven their value, for they were at first highly controversial.
Today, the curbs are given considerable credit for restoring public confidence to a stock market that had been shaken by a series of horrific crashes, the worst of which was a 508-point collapse in the Dow on Oct. 19, 1987.
“Things happened so fast in 1987 that the average guy couldn’t react, and the system couldn’t handle him if he could,” recalled Brian Kent, a trader at the Pacific Stock Exchange for Ronald E. Melville Inc. By contrast, he said, the 171-point fall March 8 was “slow and steady,” without panic.
Nevertheless, some observers believe that debating the circuit breakers is much like debating earthquake preparedness--it generally becomes serious only after the Big One hits.
“We hear from the exchange that they’re not unhappy” with the limits as they are now, said Robert Farrell, chief market strategist at Merrill Lynch & Co. “But if we did get to the 250-point trading collar, that might be one of the things that causes a reappraisal.”
