Dispelling the ostrich theory of market regulation
Closing your eyes is a natural response to being scared. My kids do it during movies. And when I was a kid, I was taught that Ostriches do it when they sense danger. But the head-sand bury is a myth. [1] It is no more true than the misguided belief that closing exchanges will make everything better during times of market uncertainty and negative news.
Yet this is what some commentators are calling for. CNBC featured an op-ed yesterday by one of its anchors titled: “Coronavirus is restricting market efficiency — We need a two-week trading holiday.” [2] The writer asks, “How many times will the circuit breakers need to be triggered for governments and policymakers to seriously consider shutting markets? Two weeks might give everyone a chance to focus on the underlying problem.”
Yesterday also featured Treasury Secretary Mnuchin announcing that shorter trading days was one option being considered. He said: “we may get to the point where we shorten the hours, if that is what they [exchanges] need to do.” [3]
These are both bad ideas.
It is important to recognize that asset valuations change whether or not trading occurs. Owners of stocks and bonds reassess their perceptions every time new information arrives, which is 24/7 in a global economy. Their valuations adjust when markets are closed. And the longer we wait to let them express their views through trading, the larger the potential disconnect between the last known price and the true market price.
This could have profound consequences. Market closures prevent investors, regulators, political leaders, and ordinary citizens from learning about the well being of the economy. Trading reflects people putting their money whether their mouth is. There is no better way to survey economic developments than through market prices. Their absence will allow the coronavirus response to become untethered from economic reality. That would be a terrible outcome.
While shortening the trading day is a less a less bad idea than closing markets altogether, which the Secretary said was not being considered, it is unlikely to mitigate declining economic conditions. And it could very well make the situation worse, by making markets even more volatile than they already are.