The computer-directed trading programs accused of exaggerating swings in the stock market were temporarily shut down yesterday, as congressional regulators called for tighter controls over Wall Street's most exotic investment techniques.
The New York Stock Exchange urged its members to stop using so-called "program trading" for the time being, but denied it was trying to kill off the method that has enabled big investors to systematically play the market and make millions of dollars with virtually no risk.
Program trading involves using computers to assess market conditions and calculate guaranteed profit opportunities, and then using that information to buy or sell as many as 500 stocks at once.
Because the technique requires sophisticated computer systems and hundreds of millions of dollars of cash, it can be used only by the biggest investment houses and money managers. That has led to complaints that the practice is unfair to small investors.
Congressional overseers of the financial markets yesterday said that Monday's market crash was accelerated by program trading -- which also is known as portfolio insurance or index arbitrage, named after the stock market index futures contracts that are played against stock prices by program traders.
"Program trading was caught red-handed as the chief villain behind the meteoric velocity of the decline," said Rep. Edward Markey (D-Mass.), chairman of one House subcommittee that oversees the stock markets.
"Whatever happens, program trading makes it worse," said Rep. Dan Glickman (D-Kan.), chairman of another panel responsible for regulating markets.
Glickman said federal regulators have failed to get a handle on computerized trading because three congressional committees and two rival federal agencies share regulatory responsibility. "The Federal Reserve, the Securities and Exchange Commission, the Commodity Futures Trading Commission and the banks should sit down and talk about how they can best prevent" a repeat of Monday's plunge, he said.
Markey called a subcommittee hearing for Thursday morning to consider a possible ban on program trading, saying, "I think we have to ask the fundamental question {of} whether these mechanisms serve any purpose."
Program trading was virtually halted yesterday by a series of moves by the three markets on which most of the trading takes place: the New York Stock Exchange, the Chicago Mercantile Exchange and the Chicago Board Options Exchange.
The NYSE urged its members early in the day "to refrain from using the NYSE Order Delivery System for purposes of executing index arbitrage." Because the Order Delivery System was set up specifically to handle the huge baskets of stocks bought and sold through program trading, the request effectively shut the programmed market down. "This request is effective until further notice," the exchange said.
The CME and CBOT temporarily closed down trading in the stock index futures and options that are needed to make program trading work, further hobbling the practice. The Chicago markets blamed technical factors for the temporary shutdowns, but when trading reopened about an hour later, there was virtually no program trading, Dow Jones New Service reported.
Program trading is a recent stock market phenomenon made possible by two inventions: powerful computers that can analyze stock prices instantaneously and new investment vehicles created to mirror broad trends in the overall stock market.
The new investment device crucial to program trading is stock index futures contracts, which are meant to allow baskets of stocks to be traded like commodities such as wheat or corn -- -- for delivery some time in the future, at a price determined now.
The Chicago Mercantile Exchange created a futures contract a few years ago based on the Standard & Poors 500-stock index, one of the most popular indicators of broad stock market trends. The S&P 500 contract covers 100 shares of each of the 500 stocks in the index, to be delivered from a month to a year or more from now.
Speculators who believe the stock market is going up can buy S&P 500 futures contracts at the current market price, making a small down payment known as a margin deposit. If the stock market does go up, the contract can be sold at a profit; if not, the buyer losses money.
Soon after stock index futures were invented, traders discovered that the prices of the futures contracts did not always reflect the total price of the 500 stocks. Now and then during the day's trading activities in New York and Chicago, small differences would show up between the two prices.
The differences made it possible -- at least in theory -- to buy S&P stocks in New York and sell them for future delivery in Chicago and make a profit, or vice versa. The technique of buying in one market and selling in others is common in oil and other commodities and is known is arbitrage.
Only when powerful computers made it possible to instantly track the price of all 500 stocks in New York and simultaneously watch the S&P 500 futures markets 1,000 miles away did traders begin to make big money playing the two markets against each other.
Program trading amounts to "looking at the mistakes that the index market is making," said Glenn Willett Clark, a Washington lawyer and writer on commodity issues. "Program traders are making easy money from the fact that indexes haven't caught up with the present values on the NYSE."
Clark noted that stock index futures were created not by the Securities and Exchange Commission, which oversees the stock market, but by the Commodity Futures Trading Commission, the agency set up to regulate the grain markets. The CFTC answers on Capitol Hill not to committees that oversee the stock markets, but to the House and Senate agriculture committees.
Index futures, he said, "are too important to be left to a bunch of farmers."
The CFTC repeatedly has cited stock index futures as an example of the kind of investment innovation made possible by financial-market deregulation. When it approved trading in the instruments, the agency said the index futures would allow stock buyers to hedge the risk of stock market price changes, just as wheat futures contracts allow a baker to be insulated from changes in the price of grain.
CME chairman Bill Brodsky yesterday disputed the contention that program trading played a big part in Monday's stock market decline, saying that the exchange's records show relatively little program trading during the day. "It was very plain that the stock market was going to come down on Monday," he said, citing its decline the previous Friday, rising interest rates, the weakness of the dollar, disputes between the United States and Germany over economic policy and jitters caused by incidents in the Persian Gulf.
Brodsky said two previous studies of sharp market declines have shown "that program trading was not a big factor," and predicted that same will prove to be the case this time.
Even congressional leaders who are skeptical about program trading expressed doubt yesterday about banning the technique. Said Sen. William Proxmire (D-Wis.), chairman of the Senate Banking Committee: "We ought to be very cautious about this. It's hard to hold back on technology."
Staff writers Sharon Warren Walsh and Cindy Skrzycki also contributed to this report.