Markets & Finance

Stocks: Time to Slow Things Down?


Market experts consider such steps as banning short-sellers, requiring trading breaks, and setting up exchanges for credit default swaps

As panic-selling tears through (BusinessWeek.com, 10/9/08)> the world's stock markets, destroying billions of dollars in wealth in mere hours every day, experts both inside and outside the nation's stock exchanges are calling for dramatic steps to stop the routs. A full-scale ban or restriction on short-selling, regulation of traders who use powerful computer programs to trade millions of shares of stock in seconds, and even temporary breaks in the trading day to give investors a chance to catch their breath are among the ideas being bandied about.

The bear market that has knocked the Dow Jones Industrial Average down more than 20% since the beginning of the month probably couldn't be reversed by such emergency measures, experts say. But steps that would slow traders down, especially those who drive prices quickly with rapid-fire computerized trading, could forestall the panic and help restore confidence in the underlying health of companies beaten down by the markets.

The major U.S. exchanges for years have had "circuit-breakers" in place that halt trading for a time when the Dow moves dramatically, typically a 10% move. So far, that threshold hasn't been breached. Now, however, exchanges are considering such moves as readopting a rule that bars short-selling unless a stock moves upward first—the so-called uptick rule. More dramatically, Nasdaq is talking with the U.S. government about banning short-selling for short periods—three to five days, say—once a stock drops 20% or more in a day, a person close to the talks tells BusinessWeek.

Introducing Inefficiency

It's all designed to put oil on the very roiled waters. The Dow lost another 128 points (BusinessWeek.com, 10/10/08)> on Oct. 10, bringing its total slide to 1,874.19 points for the week. By that measure, the market is off 22% since the beginning of October and has shed some 32.8% of its value in the past six months.

"People are panicking. They are reacting, and amplifying [their reaction] are a lot of intraday [and] high-speed traders," says Matt Samelson, a senior analyst with Aite Group, a capital-markets consultancy. "What you really want to do is make the markets less efficient. We're in unprecedented times, and given how technology is driving everything, you've got to find a way to disengage a bit of that technology."

Samelson favors temporary measures that market players would likely find extreme: Instead of just banning short-selling for a few days on a few hundred stocks, as regulators recently did, he would ban it altogether until the markets settle down, he says. That way, anyone who profits on plunging shares—particularly program traders and hedge funds that move huge quantities of stocks—would be taken out of the markets.

Strong Opposition

The idea is sheer heresy to people who run the options markets. Not only would such a step interfere with the market's role as an exacting barometer of investor sentiment, they say, but it would hamper the option world—where traders protect their option deals with short-sales. Indeed, the Chicago Board Options Exchange chief William J. Brodsky says the "draconian" measure would "severely compromise the ability of market makers to make markets." It would also suck out liquidity—the presence of ready buyers and sellers—just when it's needed most, he contends.

And yet, backers of restrictions on short-selling believe such limits would give investors some confidence that at least one group of speculators can't so easily gang up on specific stocks. Top officials at NYSE Euronext, operators of the New York Stock Exchange, are calling for restoration of the "uptick" rule, which requires that stocks tick up in price before short-sellers can move in. The rule, which disappeared amid the growth of superfast trading in recent years, would at least hamper short-selling.

"It might address the fear environment with respect to short-selling," says Richard Ketchum, chief executive of NYSE Regulation, a unit of NYSE Euronext. He says the uptick rule could slow the "cascade selling" that is driving current prices down, seemingly unabated and irrespective of fundamental values in the stocks.

Taking a Break

Stuart I. Greenbaum, an economist who teaches about markets at Washington University and Northwestern University, says such steps to regulate the markets can force panicky investors "to sit on the side for a short while." That can help calm the jitters. "It buys you some time, nothing more."

But time can be helpful in a period when fear is trumping reason, exacerbated by automated trading. "My great anti-hero, Alan Greenspan, talked about irrational exuberance," says Greenbaum. "This is irrational depression."

Greenbaum would also like to see tougher oversight on major market players. Hedge funds, so-called algorithmic traders that use computers to move massive quantities of stock, and others that can affect prices dramatically ought to be regulated more closely, he says.

Indeed, some market watchers say regular breaks in the trading day could similarly force investors to pause and assess their decisions more carefully. Shutting down trading for, say, 15 minutes at a time, several times a day, could help investors take breaks to evaluate their trading decisions more carefully. "It might put the manual element back in to slow things down," says Aite analyst Samelson.

Bringing Trades to Light

The exchanges are looking, too, at longer-term fixes. Nasdaq has applied for the right to operate an open exchange for interest-rate swaps. Several other exchanges—such as a joint venture of the Chicago Mercantile Exchange and the Citadel hedge fund, as well as NYSE Euronext, Atlanta's IntercontinentalExchange and Eurex, the derivatives unit of Deutsche Börse—want to create markets for credit default swaps.

Such contracts have been blamed for much of the credit-market tightening in recent days. They are now typically traded between single large institutional investors and don't have the help of a clearinghouse backing them or transparent pricing. Investors are extremely nervous about the value of these invisible swaps held by financial institutions. Shareholders in, say, Goldman Sachs (GS) don


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