Stock Market Needs Anti-Dumping Rules
The recent announcement by New York Life Insurance Co. that it is liquidating its entire $1 billion stock portfolio because of its dissatisfaction with the market's volatility furnishes dramatic evidence that the flight of the investor from the securities market continues unabated. Now, not only the small investor but also some larger institutions are exiting a stock market in which sharp fluctuations in the Dow Jones Industrial Average, often unaccompanied by any significant external news or event, recur with predictable frequency.</br></br>The pattern of these fluctuations is particularly revealing. Often, trading will remain flat throughout the day, only for prices to dive suddenly at the close in the face of heavy institutional trading. Admittedly, one cannot legislate a secure investment environment, but investors are unlikely to return to the market until they see it as a relatively stable repository for their funds. A market that can move 20-30 points in a few minutes, because of sudden selling pressure, will not be so perceived.</br></br>Yet, wasn't it exactly this problem that the proposals of the Brady Commission and other recent reports were supposed to address? The short answer is no. The recommendations advanced by both Brady and the SEC understandably focused on a worse-case scenario: how to avoid a financial meltdown. As a result, short of a catastrophic event, their proposed reforms will have little impact and could even be counterproductive.</br></br>Consider, for example, the two most discussed Brady proposals: (1) the circuit-breaker reforms, and (2) the recommendation that margin rules be effectively equalized between the securities and futures exchanges. Will it create confidence among small investors to know that in the future a brief inter-market trading halt will occur once the stock market declines 250 points or more? Such a proposal is as reassuring as a contingency plan for urban survival after a nuclear holocaust.</br></br>More important, circuit breakers create an incentive to sell as their triggering point is neared; thus, they can exacerbate matters by encouraging a "run on the bank" as investors sell because they suspect others will also do so as the trigger point is neared. If trading halts are to reduce volatility, they will have to be introduced at a much earlier point and seek to bridge temporary order imbalances. Although probably feasible, such a proposal risks the danger that any halt will be interpreted as an adverse signal that triggers still more selling.