Securities and Exchange Commission Chairman David S. Ruder called yesterday for the creation of an emergency system to provide additional capital to brokerage firms during financial market panics.
Ruder said that the commission's review of trading on Oct. 19 -- so-called Black Monday -- and the days that followed has indicated so far that brokerage firms lacked adequate capital to facilitate orderly trading.
In a luncheon speech at the National Press Club, Ruder stopped short of recommending a specific regulatory solution, but emphasized that capital adequacy was the most important issue to have emerged in his review of the stock market drop.
"I do consider that to be the crucial question for examination," Ruder said. "We need to develop a system whereby brokers have more access to capital on an emergency basis. ... We didn't have enough buying power in the market."
Ruder said it was possible that if major Wall Street brokerage firms had access to additional capital, the trading halts and steep drops that affected many well-known stocks last month could have been less severe.
However, he said it was unclear whether major firms that did not offer to buy stocks during the panic were short of capital or simply staying on the sidelines because they were eager to avoid further losses.
Ruder said that in devising a solution to the capital situation, it would be important to understand whether the stock market swings last month represented a "temporary imbalance" or part of a new trading trend characterized by "event-driven volatility."
Wall Street sources have said that in the days following Black Monday, the lack of capital among specialists on the floor of the New York Stock Exchange contributed to the trading problems. Specialists assigned to specific stocks are responsible for helping to maintain orderly trading by buying when the public is selling and selling when the public is buying.
However, the selling pressure was so great that the specialists' capital was exhausted, Ruder said yesterday. He said specialists had $1.5 billion in stock positions and "they didn't have any more capital."
Ruder said any emergency system to provide greater capital during financial market crises also could include ways to provide fresh capital to the NYSE specialists.
Ruder also revealed yesterday that on Oct. 22, the SEC considered asking the Chicago Mercantile Exchange to delay the opening of trading in the Standard & Poor's 500 futures index contracts the next morning. The S&P 500 futures contract is a financial contract based on the combined prices of 500 stocks.
Ruder said the SEC was worried that the extraordinarily large disparity in opening prices between the declining index futures and the underlying stocks was so great that it could push stock prices into an undesirable opening drop.
Ruder explained that the SEC was worried that specialists on the floor of the NYSE, who make decisions about the appropriate opening price for stocks, would be negatively influenced by the drastically lower futures prices. "Our thought was that opening stocks without the overhang of the futures ... might produce a more orderly opening," Ruder said. However, after the Mercantile Exchange announced price limits designed to minimize the daily swings in futures prices, the SEC decided to postpone any formal request that the opening of futures trading be delayed.
In addition to studying the stock market collapse and recommending possible regulatory responses, Ruder said other areas the SEC will focus on are internationalization of the securities markets; potential repeal of the Glass-Steagall Act separating commercial and investment banking; policing illegal, insider stock trading, and improving protections for investors.