Some doubt circuit breakers will prevent another ‘flash crash’

By Stevenson Jacobs
Associated Press / May 20, 2010

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NEW YORK — Two weeks after the stock market’s record dive, regulators have a plan to keep it from happening again by essentially calling “time out’’ when trading gets too chaotic. The question is whether that will work.

The big exchanges say new “circuit breakers’’ would help prevent free falls. Not everyone is convinced. Some say the plan is too limited; others say it goes too far.

Who’s right may not be known until there is another wild trading day like the one that stunned Wall Street on May 6. Intense selling sent the Dow Jones industrials down almost 1,000 points in less than 30 minutes.

Under the Securities and Exchange Commission’s 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 a.m. and 3:35 p.m. Eastern time.

The idea is that by giving investors a break they would be less likely to set off chain-reaction selling.

That’s one of several possible causes of the May 6 plunge. The “flash crash’’ briefly wiped out $1 trillion in market value.

What if the new circuit breakers were in place that day?

“I believe that day would’ve played out significantly different,’’ said Joe Ratterman, chief executive of the third-largest US stock exchange, the BATS Exchange, which helped devise the proposed 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 on economic or corporate news.

On May 6, about 30 stocks in the S&P 500 index fell at least 10 percent within five minutes.

Still, given that regulators have yet to determine the cause of the market’s dive, some question how they can be so sure they can prevent another drop.

“I’m absolutely skeptical,’’ said J.W. Verret, who teaches securities law at George Mason University. “One risk I see is that we’re coming up with solutions before we understand the problem.’’

He called circuit breakers a “blunt instrument’’ that could interfere with the markets’ role in determining what a stock’s price should be.

Others say the proposed rules don’t go far enough.

The new circuit breakers would apply to all 50 or so US exchanges but would kick in only for 500 of the 8,000 publicly traded US stocks.

After a six-month trial, the SEC and the exchanges could expand the rules to include more stocks.

“If you’re going to put in circuit breakers, then put them across the board,’’ said Ted Weisberg of Seaport Securities.

But circuit breakers are “a Band-Aid, not a solution,’’ he said.