Should circuit breakers be revamped? No, they should be scrapped. Regulators meeting with executives of the exchanges last month discussed a proposal for tripling the size of the so-called circuit breakers, triggers that halt trading when the stock market drops precipitously.
But the circuit breakers are fatally flawed, and can't be fixed by tinkering.
During the Oct. 27 market plunge, the circuit breakers failed to halt the rout. In fact, the circuit breakers worked as many had predicted. They caused many investors to try to sell when they saw the breakers were about to trip and halt trading.
Thus, not only did the circuit breakers fail to reduce market volatility, they worsened it.
Revamping the circuit breakers, perhaps by widening the bands before they are triggered, won't solve the herding problem. If the market is bad enough to warrant circuit breakers, investors might become even more determined to sell as the trigger point approaches. Since markets plunge steeply only after they have risen sharply, one might suggest imposing circuit breakers on a market that rises too much too quickly, cautioning investors that buying activity is overheated. But that might trigger panic buying and more volatility.
Markets find ways around artificial constraints. Stocks that can't be traded in the United States might trade abroad, unless circuit breakers halt all of the world's markets simultaneously.
The Securities and Exchange Commission and the various exchanges seem to want revamped circuit breakers. But their quest is futile. Circuit breakers suggest markets free-fall for non-fundamental, irrational reasons. Some declines are deepened by arbitrageurs using derivatives. Circuit breakers make arbitrageurs and others more nervous, not less.
By meeting behind closed doors to discuss the issue, market overseers add to the uncertainty of the circuit breakers. Their reticence will heighten, not calm, fears. A better idea: Scrap the breakers.
