Sunday, August 26, 2007

TimesSelect Why the Roller Coaster Seems Wilder

Published: August 26, 2007


STOCKS regained some composure last week, and not a moment too soon for investors worn out by the market’s turbulence. Credit markets remain easily spooked, however, and justifiably so. There is still so much that investors do not know about what lurks in portfolios around the world and exactly when it might jump out and say “boo!”

Periods of volatility come and go, of course. The question is, are the recent wild swings temporary, or are they a result of fundamental changes in the makeup of the markets?

Certainly, the huge pools of capital overseen by hedge fund managers play a big role in the volatility. And their propensity to congregate in the same trades means this: When the bets go awry, everybody runs for the exits.

The trouble is, their choice of refuge is often the United States Treasury market, which, at $4.4 trillion or so, is easily swamped by them. The mortgage securities market, for example, is $9 trillion, and when investors want to shift out of those securities and into the haven of Treasuries, volatility happens.

But other factors may be making the stock market’s downstrokes more pronounced. That is the view of Muriel Siebert, the Wall Street veteran and financial sage, former state banking superintendent of New York and founder of the Siebert Financial Corporation, a discount brokerage firm. Ms. Siebert, who has seen her share of markets, both bull and bear, said she believes that several recent changes to stock trading practices may be exacerbating the downdrafts when they come along.

“We’ve never seen volatility like this. We’re watching history being made,” she said. “When I look at it, I see changes in the marketplace that are influencing this.”

Naturally, as with everything market-oriented, the factors that concern her are related. Item 1: the Securities and Exchange Commission’s elimination last month of the uptick rule on short sales. This regulation was put in place in 1938 to defang so-called bear raids on stocks, when sellers ganged up on companies’ shares and profited by driving them down.

THE uptick rule required that anyone shorting a stock — selling shares he or she does not own in hope of making a profit — can do so only on an uptick in its price. But the S.E.C. got rid of the rule on July 6, after it concluded that such restrictions “modestly reduce liquidity and do not appear necessary to prevent manipulation.”

The commission drew its conclusions after years of study, analysis and discussion, of course. But Ms. Siebert said that with the rule no longer in place, it is easier for sellers to overwhelm stocks on down days. Their short sales may not be placed in the same bear-raid manner — they may be trying to hedge other positions, for example — but the downward push on a stock is the same.

“I don’t think we know the effect of it,” Ms. Siebert said. “The S.E.C. took away the short-sale rule and when the markets were falling, institutional investors just pounded stocks because they didn’t need an uptick. We have to look at that and say, ‘Did that influence and add to the volatility?’ ”

Her second concern relates to the influence of electronic trading in big-name stocks. The specialist system — in which a human being with capital at stake is obligated to use it to maintain orderly markets — has been in decline for years. But Ms. Siebert said that the recent down days in the stock market might have a lot to do with the fact that the New York Stock Exchange is now dominated by computerized trading. Unlike specialists, machines that match orders don’t have to put up capital to stabilize disorderly markets.

“Yes, the specialist system was like a candy store,” Ms. Siebert said. “But they also had an obligation to deploy capital and to the extent that institutions and hedge funds are placing orders electronically, it’s a plain and simple bid-and-ask procedure.”

Fans of electronic trading and the I-hate-specialists crowd will laugh this view off as antiquated. But recall that in the 1987 market crash, Nasdaq market makers — the equivalent of today’s electronic trading — abandoned their markets altogether. It was ugly.

Ms. Siebert is all in favor of trading online — two-thirds of her firm’s business is done on the Internet. But she said that the New York Stock Exchange should examine the spreads in its electronic trades — the difference between the bid and ask prices when transactions occur.

Wider spreads are often found in stocks where market makers put little or no capital at risk. “The spreads in New York Stock Exchange stocks were significant” during the recent wild swings in the market, she said.

Professional traders like volatility because it gives them profit opportunities. But individual investors, in Ms. Siebert’s view, are scared away by it. “Should we be looking at this, or are we just going to accept that markets will be this volatile?” she asked. “If so, will individuals continue investing in them?”

INDIVIDUAL investors are a concern to Ms. Siebert because her brokerage firm caters to them. But her point is well taken. Individuals should have confidence that they will not be whipsawed when they try to buy stocks.

Of course, the fact that hedge funds use such enormous leverage is another element at work here. Ms. Siebert said it would be instructive for regulators to get a handle on the degree to which leverage contributes to violent moves in stocks.

“These things represent a change in the way markets are moving,” she said. “Did they add to the pressures in the markets? Is anybody asking these questions? Or am I expecting too much?”


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