Mike Piwowar
Former SEC Commissioner, Distinguished Policy Fellow, Georgetown Center for Financial Markets and Policy, Executive Director, Center for Financial Markets, Milken Institute
The continued spread of COVID-19 throughout the world has posed serious uncertainty and volatility in global financial markets in recent weeks, prompting debate about whether markets should remain open during times of crises.
On March 26 the Center for Financial Markets and Policy (CFMP) hosted a discussion about the functioning of markets during these unprecedented times, and the policy implications of choosing to close or ban certain activities during periods of extreme stress.
Speakers
Panelists
Former SEC Chief Economists – Chester Spatt, Craig Lewis, Jeff Harris, Jim Overdahl, Larry Harris
Moderator
Should the market be closed during this time? What essential functions do markets provide?
Even though some investors, like Warren Buffett, might not need the market to be open every day, the five former chief economists unanimously agreed that keeping financial markets open is essential to providing liquidity and information for both businesses and policymakers.
Without the process of price discovery and information aggregation provided by the market, Lewis and Overdahl said that investor confidence would erode as risk management suffers and many might be trapped into their positions.
From a regulatory standpoint, Harris also pointed out that markets can provide early and important indicators to policy makers. For instance, seeing the Russell 2000 index drop significantly more than the S&P 500 can help policy makers gain a sense of what is happening to small businesses during this crisis.
Spatt reminded participants of the nuanced distinction between liquidity and solvency issues. While some firm’s business model won’t be suitable in the long run (i.e. won’t be able to remain solvent), he thought that most companies’ troubles might come from liquidity constraints. However, the Federal Reserve has done a decent job of resolving liquidity concerns, such as quickly stepping into the repo market last winter.
Is there any time markets should be closed? Should we shorten trading hours? What about circuit breakers?
In the past, namely right after 9/11, the market was closed for a short period of time. Overdahl noted that events like that are exceptional since they undermine the underlying market infrastructure, making it difficult for the clearing houses to settle and process trades. A systemic event that impedes large money flows and makes the solvency of counterparties uncertain can pose challenges as well
Another reason to close the market has to do with safety and feasibility — the government might choose to close the market to protect the workers and traders on floor-based exchanges. However, Spatt argued that recent transitions by exchanges to fully electronic trading systems have solved this problem and proven to be extremely helpful for keeping markets operating throughout the coronavirus crisis.
Lewis, Harris, and others all maintain that shortening trading hours will serve no purpose because markets now operate globally on all time zones, and there is a significant amount of post and pre market trading. However, the panelists agreed that circuit breakers can still help slow things down when there is high uncertainty to give liquidity providers more time to process information.
Why don’t we ban short selling like we did in 2008?
Overdahl said that back in 2008 there was a lot of political pressure to impose the ban, even though that was contrary to the SEC’s view. He believed the ban had harmful effects, citing several unintended consequences including a significant drop in liquidity for options instruments, the creation of a “list risk” around exemptions from the ban, and losses to firms that wanted to raise money through the convertible bond market
Finally, Spatt argued that short sellers are not to blame for lower prices. In fact, they can often support prices by offering investor’s another means of expressing their view on a company’s fundamentals. For instance, recently uninformed traders kept pushing the price of Zoom Technologies (ZOOM) through the roof – even though it has nothing to do with Zoom Video Communications (ZM) – because ZOOM stock was difficult to borrow, making it expensive for short sellers to bet against the misinformed traders that had been buying the wrong stock. Furthermore, according Harris, an incomplete ban would only incentivize CEOs to try to cover up their mistakes to prop up stocks’ prices.
CFMP Director Reena Aggarwal and Associate Director Alberto Rossi provided the opening and closing statements. The Center for Financial Markets and Policy is committed to leading thought provoking, open discussions on critical policy and regulatory issues related to global financial markets.
The panel received tremendous support from over 300 attendees and was moderated by Mike Piwowar, executive director, Center for Financial Markets, Milken Institute and CFMP distinguished policy fellow.. Panelists included former Commodity Futures Trading Commission (CFTC) chief economists James Overdahl and Jeff Harris, along with former U.S. Securities and Exchange Commission (SEC) chief economists Larry Harris, Chester Spatt, and Craig Lewis.
Takeaways
- Financial markets should not be closed and their hours should not be shortened because the information and risk management functions they provide are too valuable for investors and policy makers.
- Short selling should not be banned because past experience has shown us that a ban can have far too many negative unintended consequences.
- Policymakers need to focus on providing liquidity for the market and financial assistance for companies which will struggle to remain solvent through the duration of this crisis.