Friday, May 7, 2010

The SEC, the CFTC, and Yesterday’s Stock Market Volatility

It is not clear as of this writing what the full story behind yesterday’s wild volatility, especially over a period of 20-25 minutes starting at 2:42 p.m.  One of the explanations is that some market facilities, including the New York Stock Exchange, briefly stopped the trading of some stocks as the volatility started, which channeled orders to the automated systems that kept trading the stocks.  There may have been some data entry by trader or traders that were errors.  The fall of Accenture to about a penny from the $40 range and back up to around $40 does look like the result of an error or errors, as do the price movements of Procter & Gamble.

In response to the unusual market activity, the SEC and the CFTC issued a joint statement yesterday that they are working together and with other financial regulators and the exchanges on reviewing what happened and to make recommendations based on what they learn.

Whatever happened here, two points come to mind.  First, market structure, including rules, are very important, and that very different rules among market places which trade the same thing or trade close substitutes may cause serious problems during times of unusual trading activity.  The SEC may not have fully analyzed this with respect to the markets it regulates, and the SEC and the CFTC may not be coordinating as well as they should, which is admittedly difficult because the statutes the two agencies administer are very different.

The second point is that there is a great deal of overlap between what the SEC and the CFTC regulate.  The case for merger of the two agencies continues to grow stronger.  While the two agencies will no doubt cooperate in their review of yesterday’s market activity, rules might be better coordinated if there were only one agency.

Moreover, if the consensus is that the market for all derivatives, not just exchange-traded futures contracts, options on securities, and some other types of options under CFTC jurisdiction, should be subject to a market regulator as well as institutional regulators, then the case for merger becomes even more persuasive.  Our balkanized regulatory structure has contributed to inconsistencies, regulatory capture, and, as the financial crisis has shown, regulatory failure.

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