By Nicholas Brady and Robert Glauber*
Circuit breaker trading halts, now a part of daily stock market trading, were put in place in 1988 in response to a recommendation from the Brady Commission, which was appointed by President Reagan after the “Black Monday” stock market crash on October 19, 1987. On that day the Dow Jones Index dropped 22.6% amid chaotic trading, a fall which dwarfs the 13% drop last Monday.
The original circuit breakers were measured in absolute points on the Dow Jones Index. They have been modified several times by the SEC over the years. Today, they are set in percentage drops on the S&P 500 Index. A 7% drop halts trading for 15 minutes. A further drop to 13% produces another 15-minute halt. A further drop to 20% produces a close in trading for the rest of the day. Circuit breakers have been activated, soon after the market’s opening, four times in the last two weeks: March 9, 12, 16 and 18. Nobody was surprised. They are a well understood part of the market’s architecture.
The Brady Commission proposed that circuit breakers be in place “prior to a market crisis” to put investors and traders on notice of “the natural limit to … [market] liquidity.” The Commission cited several benefits. They “facilitate price discovery by providing a ‘time-out’ to pause, evaluate, inhibit panic and publicize order imbalances.” They also “counter the illusion of liquidity by formalizing the economic fact of life … that markets have limited capacity to absorb massive one-sided volume.” Circuit breakers can’t stop a market that wants to go down. What they can do is give participants a time-out to take a deep breath, evaluate the situation and perhaps interrupt the sense of panic. With a brief time to think again, perhaps some sellers will withdraw to the sidelines and value buyers will enter the market.
By these measures, we think that the circuit breakers in their four recent outings did a creditable job. On three of the four days, the market stabilized near the 7% down trigger for most of the rest of the day. On March 16, the market traded until noon in the neighborhood of the 7%-down trigger, but then later in the day traded down almost twice as much. Circuit breakers can’t produce miracles. They can just provide a “breather,” a chance to interrupt panic.
Circuit breakers make sense. But closing markets abruptly and with little warning is a bad idea and can cause real panic. If markets are shut, investors and traders are locked into positions and can’t liquidate. They can just get more worried and more frightened. Back on October 19, 1987, exiting after a speech at 1pm, SEC Chairman David Ruder was asked if he had discussed closing the NYSE with President Reagan. He said, although he hadn’t talked with the President, “anything is possible.” In the next 45 minutes, markets plunged even more dramatically than they already had.
What makes circuit breakers work is that they are pre-planned, part of the market landscape. Ad hoc, unplanned closings are an entirely different matter. That kind of decision is a big mistake. In 1987, the Hong Kong Stock Exchange chairman closed the market without warning. It took a week to reopen. In the last couple of days, SEC Chairman Jay Clayton was asked to respond to rumors that the government might shut down stock markets. He said, “Markets should function through times like this.” He’s absolutely right. Reacting to health concerns, the NYSE has announced that it is closing its trading floor. But that’s not the same as closing the stock market. Exchange trading can, and will, go on through computers.
Circuit breakers made sense in light of the 1987 stock market crash. They have been improved in design. It’s fortunate they have been triggered only rarely. But it’s good to have them in place now. And they are doing the job for which they were intended.
* Nicholas Brady was chairman of the Brady Commission and Secretary of the Treasury in the George H.W. Bush Administration. Robert Glauber was executive director of the Brady Commission and Under Secretary of the Treasury.