In September 1873, the biggest U.S bank at the time, Jay Cooke & Company, collapsed in speculator fashion. Its failure led to the Panic of 1873 and the eventual Long Depression which spread to both Europe and North America. In response, the American government shut down the New York Stock Exchange (NYSE) to avoid an imminent market collapse.
This closure was the first of many occasions where governments saw fit to temporarily halt trading, ranging from honoraries like Charles Lindbergh’s iconic New York City to Paris flight and the Apollo 11 moon landings to sudden disasters like the John F. Kennedy assassination and the Twin Towers attack.
In today’s world, markets have become more advanced and more automated: exchanges have built-in crash protection in the form of circuit breakers that stop trading temporarily after markets drop a certain percentage. If you’ve been watching the news recently, you’ve probably heard the phrase “limit up” or “limit down.” This terminology derives from FINRA’s (Financial Industry Regulatory Authority, Inc.) LULD system, a system to prevent unstable markets from both collapsing and “melting-up” on an intraday basis — if prices move 7%, trading halts for 15 minutes, then, if prices move 13% trading halts for another 15 minutes, then, if prices move 20%, markets close for the day.
The problem with circuit breakers, however, is they fail to stop a crash over the long term. They delay the inevitable as it takes only an extra trading day to enter bear market territory. So with the global economy shutting down, society embracing self-isolation and social distancing, treasury bid-ask spreads widening to record levels, corporate credit spreads blowing out, and volatility reaching levels not seen since 2008, you would think these are enough legitimate reasons to take things a step further and close the stock market. Though, in the past, during the Spanish Flu outbreak — the deadliest pandemic in history — and Black Monday — the biggest market selloff in history — markets remained open and recovered from their lows.
This time, while the world comes to terms with both the latest pandemic outbreak and the resulting stock market meltdown, some investors are calling for a temporary shutdown. Popular stock market commentator, Jim Cramer, says markets should close until the authorities contain the virus, “If the stock markets aren’t needed to raise capital then all we would be doing is facilitating the selling of stocks for the people who need cash now or fear that the companies they are owners of can’t withstand the downturn,” while on Twitter, activist investor, Bill Ackman, has pleaded to the President to close America’s borders, “Tell all Americans that you are putting us on an extended Spring Break at home with family.”
However, there’s skepticism as to whether a shutdown will save the stock market. Carnegie’s finance professor, Chester Spatt, says manipulating the market mechanism exacerbates the problem in the real economy, “the uncertainty is real, and it doesn’t go away if you don’t allow people to trade,” while Georgetown University professor, James Angel, gives a more emotional response saying, “The fact that you don’t like the price is no reason to stop trading.”
But which side is right? To find out we have to consider the past and understand what drives stock markets higher today.
History is on the skeptic’s side as previous attempts to stop falling stock prices had no lasting effect: The longest market closure was in World War 1 from July 31, 1914, to December 12, 1914, where although trading ceased, stock prices fell instantly to what the market was willing to pay. Behind the scenes, the shutdown turned investors into lawbreakers overnight by forcing them to trade on the black market. Dealers bypassed the trading ban by creating a “substitute market” on New Street: a small roadway behind the NYSE.
Today, with the accessibility and interconnectivity modern technology provides, we could see the “Silk Road” of stocks reemerge, but this time online. While virus fears worsen, stock prices on the black market will continue to price in reality, and once the real markets open, arbitrage will come into play — though, because of circuit breakers, we’ll have to wait a few days to know the true damage.
Then, there’s how modern-day markets work: a debt-based global financial system that relies heavily on a constant supply of credit. With debt markets closing alongside the stock market, lockdown inhibits a guaranteed buyer of stocks as companies will no longer be able to execute share buybacks — the main driver behind the U.S equity rally over the past decade. Only recently, we got a glimpse of how important debt is to global stock markets: Even with the Philippino government halting trading for two days, stocks that rely heavily on buybacks have plunged an additional 18% on reopening. All preventative measures failed to subdue further pain.
It’s becoming clear that we have to face the cold, hard truth: nothing can stop a stock market collapse when the global economy screeches to a halt. Despite our best efforts to save the stock market, it’ll never come out of a recession in the green. Although the inevitable bear market will cause an abundance of both pain and loss, it’s a sacrifice we have to make to restore order; an inconvenient tradeoff: economic destruction in exchange for a quick resolution to a deadly global pandemic.