Markets

Michael P. Regan is a Bloomberg Gadfly columnist covering equities and financial services. He has covered stocks for Bloomberg News as a columnist and editor since 2007. He previously worked for the Associated Press.

If you think the circuit breaker fiasco that shut down China's stock market this week is one of those "this could never happen here in the U.S." type of things, think again.

In fact, a good case could be made that a circuit breaker should have paused trading in the world's largest equity market as recently as this past summer. Under rules currently in place, markets would be frozen for 15 minutes if the S&P 500 tumbled 7 percent. They'd shut for another 15 minutes if the plunge reached 13 percent, and a drop of 20 percent would close the whole show down for the rest of the day.

In the epic U.S. market rout of Aug. 24, it appears that the only reason a 15-minute circuit breaker wasn't triggered soon after the open was because of some widespread delays in the trading of many stocks on the New York Stock Exchange. As a result, according to an SEC autopsy of the day, the index's early calculations continued to use the previous day's prices for companies that hadn't started trading. 

However, exchange-traded funds and futures contracts tracking the S&P 500 were plunging at rates that would've triggered the pause:  

Same Index, Different Story
Losses in ETFs and futures were big enough to trigger a circuit breaker on Aug. 24.
Source: SEC Research Note: "Equity Market Volatility on August 24, 2015"

As a result, the market was never paused -- and those of us who follow the never-ending debate about how to fix perceived problems with our marvelously complex stock market were thankfully spared were deprived of an important debate on whether circuit breakers like this are a good idea.

That's important because the circuit breaker in China was met with a lot of backlash that could potentially color the debate about the usefulness of the same type of tactic in the U.S. As Gerry Alfonso, a trader at Shenwan Hongyuan Group Co. in Shanghai, told Bloomberg:  "It is clearly adding some unintended consequences, such as people trying to sell before the break, which is actually accelerating the decline."  Or as Remco Lenterman, an adviser to the European Principal Traders Association, tweeted: "As expected, closing a market for an entire day does not inspire confidence." 

China's market officials reacted to the backlash by simply suspending the circuit-breaker system. This, of course, is opening them up to more ridicule for basically improvising when it comes to important policies.

But maybe they're actually on to something in China with that swift response. The wild swings in the U.S. stock market in August also highlighted some serious flaws in other measures undertaken to reduce volatility. Pauses in trading of individual securities known as LULD halts -- limit up, limit down -- took place 1,278 times on Aug. 24, according to the SEC's report. They involved 471 securities, meaning many experienced multiple halts, and 60 percent of them took place when the stocks or ETFs were on their way back up. Short-sale restrictions were triggered in more than 2,000 securities, encompassing about a third of the S&P 500's market cap. 


As a result, big swaths of the market were acting -- to use the technical jargon -- pretty screwy, even as conditions were not met to halt all trading. So it's possible that well-intentioned measures meant to calm markets were creating unintended consequences that fueled the volatility, just as many contend happened this week in China.

Policies such as these in the U.S. take months or years of study and testing, dozens of comment letters and countless obnoxious tweets before they are enacted. It might not be a bad idea if a little improvisation is built into the process. For example, LULD halts may serve a useful purpose in relatively calm markets if they're triggered by an errant trade, but maybe they should be turned off if they're being triggered because traders simply want to buy or sell in a hurry. Conversely, there's an argument to be made that it might be prudent to hang a "back in 15 minutes" sign on the entire market because of circumstances other than just a 7 percent decline in the S&P 500. The Knight Capital blowup in 2012 comes to mind, as does the Nasdaq data-feed failure a year later, as well as several other misadventures of modern markets.  

This type of improv would require swift collaboration between government officials, exchange executives and other market participants. So, come to think of it, maybe it's one of those "this could never happen here in the U.S." type of things after all.  

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Michael P. Regan in New York at mregan12@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net