STAFF NEWS & ANALYSIS
More Trading Curbs for NYSE
By Staff News & Analysis - May 19, 2010

Trading Curbs to Be Tested for Six Months … Exchanges are expected to introduce new trading curbs known as circuit breakers for large U.S. stocks over a six-month pilot program, as regulators move to avoid a repeat of the severe market plunge on May 6, two people familiar with the talks said on Tuesday. The circuit breakers need to be in place and operational by June 14, one of the sources said. Both sources requested anonymity because the talks are private. Multiple sources previously told Reuters the breakers would halt all trading when individual stocks drop or rise by 10 percent in five minutes. … The restrictions would not go into effect immediately because the rules are in the proposal stage and need to be ironed out. Circuit breakers will act as "speed bumps to help the market adjust quickly to the high levels of volatility," Schapiro said by video link from Washington at a conference in Boston. The SEC and exchanges are considering circuit breakers that would halt trading in a company's stock if the stock fell more than 10 percent in five minutes, multiple sources have said. Regulators are also mulling circuit breakers that would halt trading across all markets, giving investors time to digest any news and adjust trading strategies. – Reuters

Dominant Social Theme: Just helping investors, big and small, to trade responsibly.

Free-Market Analysis: We wonder that anyone can report these issues with a straight face anymore. Well, obviously Reuters can. But at what point do observers finally say "enough" when it comes to regulatory democracy and its ever-evolving attempts to "fix" elements of industry that have been broken by previous regulations. The cognitive dissonance continues to build.

Modern economics (neo-classical and post marginal utility) tells us that every regulation is a price fix inevitably resulting in a queue, a misappropriation of resources, a scarcity, etc. Imagine, now, the amount of regulations that have been passed into law by such entities as the US Congress and the regulatory mavens at the EU. The mainstream press tends to criticize "do nothing" legislatures, but unfortunately anything a legislature does distorts economic freedom and interferes with the marketplace.

Of course it will be argued that only legislatures and regulators can rectify by market failures – but what exactly are those? Inevitably, when market failures are examined, one finds that the failure is the result of previous rules enacted to supposedly fix a different market failure. And on it goes. Here's some more from the Reuters article:

Breakers that would temporarily stop trading when the broader market falls five percent are being considered, people familiar with the talks told Reuters. That is tighter than the minimum 10 percent threshold already in place. Regulators have not yet pinpointed what caused the afternoon market plunge and quick recovery on May 6, which rattled investors around the world. Later on Tuesday, the SEC and the Commodity Futures Trading Commission are due to disclose their preliminary findings on the meltdown.

We remember when market stops were put in after the crash of 1987 on the NYSE. We were surprised by the aggressiveness with which the trading halts were developed by the SEC, in concert with the securities industry. But in reviewing the changes that have been made generally to stock trading, especially in the past 25 years, it becomes obvious that markets are likely more manipulated than ever, the volatility stronger and the advantages accrued by the large professional trader evermore clear cut. The idea that regulations can somehow make markets such as the NYSE in any sense "fairer" or more predictable is a position seen increasingly as neither popular nor credible.

We've expressed a point of view previously that American stock markets – the only ones historically that have received considerable consumer interest and participation – began their ascent after the Civil War along with other sorts of industrial-mercantilist practices. It was in part government incentives to railroad companies that created 19th century trading manias. But the real action in stock markets started after the advent of the Federal Reserve in 1913. It was the Fed's ability to pump up the money supply that wetted the appetite of stock investors as it swelled the prices of various equities themselves.

The interest in stocks came to a grinding halt during the Great Depression but in the 1940s and 1950s, the Big Board itself launched a series of road shows to tempt Americans into buying stocks once again. The result of these promotions, when combined with the activities of the Fed itself (in swelling the money supply and thus stock prices), resulted gradually in additional participation by US investors. This participation was buttressed in the 20th century by a veritable blizzard of books and articles purporting to show that stock investing (especially of the buy-and-hold variety) was both prudent and profitable.

Central banking money pumping and media stock-market approbation were two legs of a three-legged stool however, when it came to supporting stock investing. The third leg was regulation itself, which, under the guise of protecting the consumer, began to voraciously centralize order flow by mandating the kinds of strategies that the controller of large money pools could use. Mutual funds in particular have been the victims of these regulations with every regulation only adding to the predictable nature of these investments while depriving their operators of various strategies that might in some way hedge risk or provide a richer strategy set.

Ultimately, modern portfolio theory wins the day. This academic perspective shows us that most profits are realized from moves in the larger market rather than an individual stock. And from our perspective, this provides a powerful argument for investing according to Austrian free-market economics using the business-cycle itself as an investment tool. During a bull market, stocks may move up because of the push of money printing. During a protracted bear market when fiat money printing is less effective within the larger market, alternative investments in commodities and especially money metals may tend to be the best investments.

After Thoughts

Continued efforts to regulate the world's largest stock markets are actually making such markets ever more fragile and prone to breakdown. The more order flow that is concentrated and herded in one direction or another by regulatory fiat, the easier it is for those with powerful computers and access to powerful amounts of capital to create profit-making strategies that benefit from misguided regulatory efforts. The best strategy, if one wanted to introduce increased trading robustness would be aggressive deregulation of the market and market players. Seen from this point of view, regulatory mandates when it comes to trading are increasingly counterproductive.

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