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07/01/91

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Gridlock on Wall Street

STANFORD -- No sooner had the stock market crashed to a close on Monday, Oct. 19, 1987, than everybody and his uncle -- including Uncle Sam -- began looking for an explanation for the disastrous events that had occurred that month.

No wonder. According to the government's Report of the Presidential Task Force on Market Mechanisms (better known as the Brady Report, named after treasury secretary Nicholas P. Brady): "From the close of trading Tuesday, Oct. 13, 1987, to the close of trading Monday, Oct. 19, the Dow Jones Industrial Average declined by almost one-third, representing a loss of value of all outstanding United States stocks of approximately $1 trillion."

One of the key findings of the Brady Report was the failure of the interrelated system of markets -- stocks, futures, and stock options -- to act as one. The task force considered the breakdown a primary cause of crash-related problems. The report recommended that henceforth the three markets be combined under one regulatory agency.

Allan W. Kleidon, associate professor of finance at the Stanford Graduate School of Business, believes that the Brady Report, issued less than three months after the crash, was a rush to judgment.

In a recent paper, "One Market? Stocks, Futures and Options During October 1987," written with Robert E. Whaley of Duke University, Kleidon notes that the futures and options markets operated largely in unison during the crash, even though they are regulated by separate agencies. But the linkage between the cash and options markets, both regulated by the Commodities Futures Trading Commission, suffered a breakdown.

Kleidon and Whaley trace the problem to an antiquated mechanism for processing stock orders on the New York Stock Exchange, which has since been corrected. Delays of up to 75 minutes in processing, due to queues at the computer card printers caused by the extraordinary volume of orders, resulted in the breakdown -- "not the fact that these markets have different regulatory authorities," Kleidon said.

"The answer to the market integration issue, at least as evidenced by the crash, appears to lie in developing more efficient means of trade order execution, rather than in imposing a common regulatory structure," Kleidon concludes. "The changes in regulatory authority recommended by the Brady Report are misplaced."

-jz-

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