Thursday's Plunge Still Has Regulators and Exchanges Guessing

Securities and Exchange Commission Chair Mary Schapiro met today with officials from New York Stock Exchange Euronext (NYX) and Nasdaq OMX Group (NDAQ) to discuss the May 6 market plunge that sent the Dow Jones Industrial Average diving nearly 1,000 points before shooting back up several hundred points.

The Associated Press, which disclosed the meeting earlier, says "The leaders for major securities exchanges have agreed in principle to a uniform system of 'circuit breakers' that would slow trading during periods of intense market volatility."

That would be a big step forward, but the actual reason for Thursday's precipitous sell-off remains unresolved. It has been blamed on human error or software glitches or inconsistent trading procedures among exchanges, and it heightened unease among some elected officials over the growing use of electronic trading systems that use high-frequency-trading algorithms. Last week, Sen. Ted Kaufman (D-Del.) and Mark Warner (D-Va.) pressed the SEC and Commodity Futures Trading Commission to report their findings to Congress on the issue as part of the Wall Street Reform bill. Senate Banking Committee Chairman Chris Dodd (D-Conn.) called on Sunday for the enactment of a consistent marketwide circuit breaker to prevent a recurrence of what happened Thursday.

A Cure Worse Than the Problem?

But as stock markets stage a huge rally today, some market experts worry that the federal government will overreact to the recent turmoil and the extreme volatility.

"I'd like see them to come up with a plausible explanation for that and a private sector response to it. . . .I don't know that new regulations are needed at this point," says David John, senior research fellow at the conservative Heritage Foundation, adding that efforts to ban high-frequency trading will only drive it to overseas markets with little or no regulation. "I don't see how the cure might not be worse than the problem," he says. "The biggest mistake that was made was effectively deciding which trades to honor and which ones not to honor. . . .Realistically speaking, it's a pretty fine line between a computer malfunction and someone who mistakenly hits a buy order on their E*Trade account."

Speaking on CBS's Face the Nation yesterday, Dodd argued that programs that automatically trade securities in microseconds feed a "casino environment" and put ordinary investors at a disadvantage. He said his committee would hold hearings on the topic soon.

Mending Fences

Given the recent negative publicity from the SEC's lawsuit against Goldman Sachs (GS) for allegedly selling mortgage-backed securities that the Wall Street firm secretly designed to fail and its role in helping the Greek government hide its debt problems, the financial services industry has fewer friends then ever in Congress. The Securities Industry and Financial Markets Association backs what it calls "responsible financial reform" that should exclude the Volcker Rule, which aims to prevent banks from making certain types of investments for its own account, and other efforts to regulate derivatives.

Wall Street already is trying to mend fences with Congress. Goldman Sachs reportedly is in talks with the SEC about settling the charges against it, which may possibly include dumping CEO Lloyd Blankfein, as my colleague Gene Marcial notes. Some analysts estimate that Goldman may have to pay much as $1 billion to bring the incendiary SEC civil lawsuit to an end.

Even if Goldman and the SEC were to settle, it seems clear that the battles between Wall Street and Washington have only just begun. And if a cogent explanation for what happened last week doesn't appear soon, lawmakers might take matters into their own hands -- for better or worse.