Stopping the Bleeding: Circuit Breakers (Chapter 28, Part 2)
The Panic Button
In the second half of Chapter 28, Larry Harris looks at what happens after the crash starts. When the market is in freefall, regulators have several “panic buttons” they can press to try and restore order.
The Toolkit of Restraint
Regulators use a few different tools to slow things down:
- Trading Halts: Literally stopping the clock. (e.g., NYSE Rule 80B).
- Price Limits: Common in futures markets. If the price drops 5%, trading stops for the day.
- Transaction Taxes: Making it more expensive to trade frequently.
- Margin Requirements: Forcing traders to put up more cash so they aren’t as “leveraged.”
Do Trading Halts Actually Work?
This is a massive debate.
- The Pro-Halt Argument: A timeout gives people time to cool off, look at the news, and realize that the world isn’t ending. It also allows value traders to find cash and step in to buy the dip.
- The Anti-Halt Argument (The Gravitational Effect): If you know the market is going to shut down when it hits a 10% drop, and it’s currently at 9%, you will rush to sell right now before you get locked in. The existence of the halt actually “pulls” the price toward the limit faster.
Rule 80A: The Arbitrage Collar
One of the most controversial rules was NYSE Rule 80A. It kicked in after a 2% move and restricted index arbitrage.
- The Real Reason: Harris points out that this rule didn’t really stop crashes. Instead, it was an example of “Regulatory Capture.” The specialists on the NYSE floor hated competing with high-speed arbitrageurs, so they lobbied for a rule that hobbled their competitors during volatile times.
The Politics of Regulation
Why do we have so many rules if they don’t always work? Regulatory Risk. If a crash happens and the regulators did nothing, they get fired. If a crash happens but they had “Circuit Breakers” in place, they can say, “We tried our best, the market was just too crazy.” Most circuit breakers are designed more to protect the regulators’ jobs than to protect the market.
How to Actually Prevent Bubbles
Harris argues that the best way to stop bubbles isn’t circuit breakers—it’s empowering Value Traders.
- Make it easier to Short Sell.
- Make information Transparent and Free.
- Lower the costs for the “smart money” to trade against the “dumb money.”
Summary: Fear and Greed
Bubbles and crashes are human nature. No computer algorithm or trading rule will ever completely stop people from being too greedy or too afraid. The goal of market microstructure is just to make sure the “plumbing” can handle the surge when it happens.
Next time, we’ll look at the final chapter of the book: Insider Trading.