Regulators Testify on Market Dive, New Rules
Two weeks after the stock market's epic dive, federal regulators and U.S. securities exchanges have a new plan to keep it from happening again, proposing that essentially markets call a "time out" when trading gets too chaotic.
The question is whether it will work. The big stock exchanges say that new curbs on trading known as "circuit breakers" will help prevent runaway market drops. But not everyone is convinced. To some market watchers, the rules are too limited. To others, the rules go too far.
The government's two top market regulators are appearing before a Senate panel Thursday in the aftermath of the wild trading day that stunned Wall Street, and Washington, on May 6. Mary Schapiro, chairman of the Securities and Exchange Commission, and Gary Gensler, head of the Commodity Futures Trading Commission, will testify at the hearing.
Also coming before the Senate Banking subcommittee on securities are senior officials of the Financial Industry Regulatory Authority, which is the brokerage industry's self-policing body, and the parent companies of the New York Stock Exchange, the Nasdaq stock market and the Chicago Mercantile Exchange.
The SEC on Tuesday unveiled the new plan for circuit breakers, which was agreed upon with the exchanges. Under the plan, trading of any Standard & Poor's 500 stock that rises or falls 10 percent or more within a five-minute period would be halted for five minutes. The rules would be applied if the price swing occurs between 9:45 am and 3:35 pm New York time — nearly the entire trading day.
The reality, however, is that it may not be know whether the new curbs are effective, too limited or too extreme until there is another day like May 6, when intense selling sent the Dow Jones industrials down to a loss of almost 1,000 points in less than a half-hour.
The idea behind the circuit breakers is that by giving investors a break during extreme market dips, they'll be less likely to set off a chain reaction of human and computerized selling.
That's one of several possible causes of the May 6 plunge. The drop, dubbed by some a "flash crash," briefly wiped out $1 trillion in market value as some stocks traded as low as a penny.
Meanwhile, the investigation by the SEC and the CFTC has brought out only a preliminary picture of what caused the cascade of market distress that day. Investigators are focusing on, among other things, a possible link between the steep decline in prices of stock indexes, and "simultaneous and subsequent" waves of selling in individual stocks.
Also being looked at is a "severe mismatch" of liquidity in the market that may have been worsened by the withdrawal of electronic traders and the use of so-called "stop-loss" market orders, a new report by staff of the two agencies said. Stop-loss orders set the price at which a stock is automatically sold when it declines to a specified level.
What if the new circuit breakers were in place on May 6?
"I believe that day would've played out significantly different," said Joe Ratterman, CEO of the third-largest U.S. stock exchange, BATS Exchange, which helped devise the new rules.
"There would've been chaos," Ratterman said, "but that pausing would've created enough breathing room for people to realize that the falling prices weren't based on fundamentals," or economic or corporate news.
"You wouldn't have seen all those stocks trading for a penny."
About 30 stocks in the S&P 500 index fell at least 10 percent within five minutes. Halting trading of those stocks would have put a lid on the panic and kept more investors in the market, said Manoj Narang, founder and CEO of Tradeworx, a firm that uses super-fast computers to trade.
Narang's firm and others stopped trading on May 6 to avoid trades that would later be canceled. That can happen in times of extreme volatility, when the prices on some trades turn out to be wrong. Thousands of trades were indeed canceled that day. However, some analysts believe that by not trading, those firms accelerated the market's fall because they increased the vacuum of both buyers and sellers.
"I would've loved to have kept trading because we would've done great," Narang said.