STOCKS TANK ON CHINA FEARS
A 7 percent plunge triggers the circuit breaker and sends global markets reeling.
Bloomberg News T he man responsible for stock circuit breakers says Chinese officials must revise their safety net to avoid creating panic, joining critics who argue the nation’s trading halts are triggered too easily for such a volatile market.
“They’re just on the wrong track,” said Nicholas Brady, 85, the former U.S. Treasury secretary who ran a committee that recommended the curbs on equity trading after the 1987 crash. “They need a set of circuit breakers that appropriately reflects their market.”
Brady spoke Thursday after Chinese regulators suspended their newly introduced program that ends stock trading for the entire day after a 7 percent plunge. The halt was set off twice in its first week of operation, bolstering speculation China set its threshold too low.
“The right thing to do is to widen their band,” Brady said in an interview.
The U.S. confronted a similar problem in the 1990s. The curb that the Brady Commission helped implement shut the market for the first time on Oct. 27, 1997, when the Dow Jones Industry Average lost 554 points. That was only a 7.2 percent decline, almost identical to the Thursday plunge in China’s CSI 300 Index.
The trouble was that a decadelong surge in U.S. stock prices had diminished the value of each point in the Dow. The 1987 crash’s 508-point slump had amounted to a 23 percent tumble, three times greater than the decline that froze trading 10 years later. Regulators and exchanges pushed through a revision: If the Dow fell
10 percent, there would be an hour pause. At 20 percent, trading would cease for two hours, and at 30 percent, the day would end early.
In recent years, the benchmark that triggers the halts switched to the Standard & Poor’s 500 Index, and the levels changed. Now it takes 7 percent and 13 percent drops to prompt a brief pause, and a 20 percent decline to close markets early for the day.
Whereas 7 percent losses are rare in the U.S. — they were only common during the 2008 financial crisis, October 1987 and the Great Depression — Chinese shares dropped about that much seven times in the past year.
“I don’t think this is an exact science,” said Sang Lee, an analyst at financial-markets researcher Aite Group. With circuit breakers, “If you set these too low, instead of easing volatility it may increase volatility.”
That echoes the view of Brady, who was chairman of Wall Street powerhouse Dillon Read & Co. when President Ronald Reagan asked him to figure out what happened during the 1987 crash and propose solutions.
Brady deserves credit for introducing circuit breakers, according to Robert Glauber, a Harvard University lecturer who advised the Brady Commission and once ran the National Association of Securities Dealers.
“Brady was worried then and worried now that the pace of markets was going faster than people could calculate,” Glauber said Thursday. “What you really needed was a time out. That’s what we proposed.”
The basic idea was to give humans time to reflect on what just happened following a plunge, to decide whether losses had gone too far and whether it was time to buy.
“If anything, it’s more necessary now because computers are faster and people’s brains are about the same speed,” Glauber said.
The China Securities Regulatory Commission said late Thursday that it was suspending the circuitbreakers program, adding to concern policymakers are struggling with how to contain turmoil in the nation’s financial markets. Officials went to extreme lengths to support shares in the midst of a $5 trillion rout last summer, including ordering stock purchases by state funds, suspending initial public offerings and allowing trading halts that froze hundreds of shares.
Some investors in China said the circuit breaker actually intensified losses, prompting traders to dump shares out of fear they’d be stuck holding stock if the pause was triggered.
That conflicts with Brady’s vision for what circuit breakers are meant to do. He said his innovation stemmed from a construction job he once had. In the world of electronics, circuit breakers prevent damage by switching off a circuit when there’s an overwhelming surge of power.
“The circuit breaker that I invented restores calm,” he said.
-7% beijing: A woman reacts to the plunge in the Shanghai Composite Index at a brokerage in Beijing on Thursday. The nose dive triggered a halt in trading and sent markets across the globe tumbling. Ng Han Guan, The Associated Press
-3.1% hong kong: A man walks past a board displaying the benchmark Hang Seng Index.
-2.3% japan: A man looks at an electronic stock board of a securities firm in Tokyo.
-2.3% u.s.: A screen shows the market movements at the New York Stock Exchange.
Nicholas Brady created circuit breakers for the U.S. market.