Wall Street Critics Call for Further Market Reform

NEW YORK —  As the final echoes of last Friday’s stock market avalanche fade, some in the investment world are arguing that the big slide shows that the job of reforming the market system is only half complete.

Some Wall Street critics assert that the use of trading halts in the futures market but not in the stock market increased panic and hastened stocks’ fall. Other critics, including many individual investors and the brokerages that serve them, are complaining that the fall was worsened by computer-guided program trading.

The critics haven’t found a receptive audience among government regulators and market administrators, who seem to have spent more time this week hailing the markets’ performance than searching for new cracks in the edifice. Few observers believe that the gripes will bring about change in Washington, or in the New York or Chicago markets.

But the critics are adamant. “We saw in October, 1987, what program trading does on a bad day,” said John W. Bachmann, managing principal at the Edwards D. Jones brokerage in St. Louis. “We saw it Friday. And it looks like a lesson we will have to keep on learning.”

The programs instruct traders to buy or sell huge groups, or “baskets,” of securities simultaneously at key moments. Some program trading is a type called index arbitrage, in which traders buy and sell big blocks of shares in New York and stock index futures in Chicago.

These stock index futures are investments that are worth the value of a collection of shares at a set point in the future. Index arbitrage players profit by exploiting tiny differences in the value of stock index futures and the underlying shares themselves.

The foes of program trading assert that when the programs kicked in late Friday, they produced selling momentum that pounded the Dow Jones industrial index to its 190-point loss. Program trading of all kinds amounted to about 13% of New York Stock Exchange volume last Friday and about 16% on Monday, exchange officials say.

They assert that the program trading activity wasn’t enough to have precipitated the slide. The big program traders, which include such firms as Kidder, Peabody & Co., Salomon Bros., Merrill Lynch & Co. and Morgan Stanley & Co., point out that the presidentially appointed Brady Commission of 1987 found program trading not guilty of provoking the October, 1987, crash.

Defenders of the practice observe too that program trading will soon be available to investors through overseas markets, making it futile, they say, to ban it here. They note that the New York Stock Exchange is due this month to begin trading an investment whose price fluctuates with the value of all stocks in the popular Standard & Poor’s 500-stock index. The availability of that investment is expected to remove much of the incentive for index arbitrage.

Rep. Edward Markey (D-Mass.), chairman of a House subcommittee that oversees securities regulation, says he’s considering amending a pending bill to allow the Securities and Exchange Commission to halt program trading in emergencies. But Markey may not have much support for the idea. Even Rep. John Dingell (D-Mich.), chairman of the House Energy and Commerce Committee and a critic of stock index futures, isn’t sure it would help to order the computers unplugged.

Still, the critics are unappeased. Bachmann says the program trading has caused “lots of anger” among the firm’s clientele, and not because they lack sophistication. “You can sit in Grand Island, Neb., and understand a lot about life that you couldn’t see standing in New York talking to people who always agree with you,” he said.

William J. O’Neil, an investor and chairman of the Investor’s Daily financial newspaper, urged in a front-page editorial in his paper Tuesday that program trading be outlawed or sharply restricted because it is “a major disincentive for public ownership of any American company.”

As these critics push for further reform, another group argues that some changes made since the 1987 crash have been half-steps that worsened the system.

Specifically, they maintain that trading halts imposed in futures and options last Friday effectively closed half the escape hatches for investors, heightening panic and increasing the flight from stocks. Eliminating the chance to escape through half the markets was “the worst of all possible worlds,” William C. Freund, former chief economist at the New York Stock Exchange, wrote in an opinion page article that appeared Tuesday in the Wall Street Journal.

The temporary closings came about because of “circuit breakers” that the Chicago Mercantile Exchange has put in place since the crash. Under this arrangement, trading in the S&P; 500 index was halted at 3 p.m. for 30 minutes after the index had slid 12 points, or the equivalent of a 100-point drop on the Dow.

Options on many stocks were also halted while trading in New York continued. Trading in the S&P; 500 index was resumed at 3:30 p.m. but closed again at 3:45 p.m., when the index had fallen another 30 points to its daily limit.

Some advocates of the circuit breakers maintain that the halts gave traders time to digest what was happening in the market and kept the big investment banks from making the index arbitrage trades that some critics felt accelerated the 1987 crash.

The critics see it differently. Robert Gordon, president of Twenty First Securities in New York, noted that the Brady Commission’s central conclusion about the 1987 crash was that the futures and stock market now operate as one market and should be regulated as such.

“They’ve ignored that lesson,” he said. “It’s better to have no rule than a rule like this that affects one market and not the other.”