NY Times
WASHINGTON — The kind of bungee jump that stocks took Thursday, plunging abruptly before snapping partway back in a brief frenzy of electronic trading, has worried market operators and experts on trading for some time. Despite a surprising consensus about what needs to be done, federal regulators have not shown much urgency in rewriting the rules governing an increasingly fragmented, and computerized, trading system.
That appears likely to change after the wild, record-setting ride that briefly sent the market spinning out of control. President Obama and lawmakers called for action, and regulators at agencies including the Securities and Exchange Commission promised to deliver, even as they struggled to understand the origins and particulars of Thursday’s chaos.
The gist of the solution, according to regulators, traders and academics is that markets need uniform rules for intervening when a stock goes into free fall.
“We need to work out a common consensus as to how markets react when stock prices start to plunge in very short time periods,” said Richard G. Ketchum, the chief executive of the Financial Industry Regulatory Authority, the industry group that polices brokers and exchanges.
Asked why exchanges had not already agreed on such rules, Mr. Ketchum responded: “I can’t say that I have a good answer for that. We should have. And now we must.”
The much-discussed “stock market” — with its connotation of a single entity — is a misnomer. Investors can buy and sell stocks through about 50 markets in the United States. Most of the trades are placed through computer networks, at the direction of computer programs, and orders are routed automatically to the market offering the best price.
It is a system that sometimes spins out of control if the computerized sellers cannot find enough buyers. Last year, on April 28, 2009, the stock price of Dendreon, a Seattle biotechnology company, plunged 69 percent in 70 seconds before trading was halted. When trading resumed the next day, most of the loss was instantly erased.
The same pattern unfolded Thursday, as shares in companies including Procter & Gamble fell precipitously.
Because such declines can reflect a temporary shortage of buyers rather than a permanent loss of value, some of the markets impose “circuit breakers” that pause trading to protect sellers from taking unnecessary losses. The New York Stock Exchange, for example, briefly suspended trading in some shares on Thursday, then slowed the pace of trading to give sellers a better chance to find buyers.
But experts say such safeguards make sense only if they are applied uniformly. When the New York exchange suspended trading Thursday, sellers simply moved to other exchanges with fewer restrictions. In some cases, the supply of buyers on those exchanges already had been exhausted, causing the computerized trading programs to offer shares at lower and lower prices. Some of the resulting downward spirals ended at one penny.
“When the New York Stock Exchange went into slow motion, a system designed to stabilize trading actually backfired in practice,” said James J. Angel, a professor at Georgetown University who studies financial markets. “No exchange should have an independent circuit breaker.”
The S.E.C., which oversees the nation’s equity markets, requires a suspension in trading only in the event of a broad market collapse, defined as a drop of at least 10 percent in the Dow Jones industrial average, which is based on the share prices of 30 large American companies.
Other countries, like Germany, impose similar circuit breakers on trading in shares of any individual company that has a similar drop, but the S.E.C. has never done so. A former S.E.C. official said the possibility had been discussed in recent years, but “I don’t think there was quite the urgency to deal with it.”
The S.E.C. and the Commodity Futures Trading Commission said in a joint statement on Friday that the issue now had their attention.
“We are scrutinizing the extent to which disparate trading conventions and rules across various markets may have contributed to the spike in volatility,” the statement said. “This is inconsistent with the effective functioning of our capital markets and we will make whatever structural or other changes are needed.”
Early this year, the S.E.C. also began a broad review of equity markets, including whether computerized trading is properly regulated.
The heads of several of the largest electronic exchanges said Friday that they would support industrywide rules for breaking free falls.
But there are other ideas to keeping computerized markets in check. Lawrence E. Harris, a finance professor at the University of Southern California, said regulators should simply require all sellers to specify a minimum price below which they do not want to complete the sale of their shares. Market orders, placed at the best available price, can be too risky in the fast-moving age of electronic trading.
On Thursday, some sellers placed orders that were not fulfilled until prices had plunged as low as a penny a share. If sellers had placed “limit orders” instead, those transactions would not have happened, Professor Harris said.
“Electronic exchanges in most other countries only accept limit orders,” said Professor Harris, a former S.E.C. chief economist. “Without any mechanisms to stop the market, we just had stocks falling through the ice.”
But Rafi Reguer, a spokesman for the electronic exchange Direct Edge, said retail investors liked market orders because limit orders could be rejected, forcing the seller to try again, in some cases at a lower price.
“Sometimes what people value is the certainty of execution,” Mr. Reguer said.
Experts also note that the value of limit orders can be subverted if investors routinely set unrealistically low limits, to avoid the inconvenience of having their orders rejected.
The BATS Exchange, a large electronic exchange based near Kansas City, rejects orders if the price would be more than 5 percent or 50 cents away from the last completed transaction.
During the market panic on Thursday, between 2:40 and 3 p.m., BATS prevented more than 47.6 million orders from executing — more than 95 percent of all orders during that period, according to Randy Williams, a spokesman for the company.
