Newspaper article THE JOURNAL RECORD

Fierce Debate Erupts over Capital Shortage during Crash

Newspaper article THE JOURNAL RECORD

Fierce Debate Erupts over Capital Shortage during Crash

Article excerpt

A fierce debate has erupted over whether the market collapse was made worse, and the entire system threatened, by a shortage of capital on the part of certain securities firms that play a key role in the functioning of the exchanges.

These firms are known as ``specialists,'' and they are at the heart of the New York and American Stock exchanges. The specialists oversee trading.

Each specialist is granted exclusive domain over particular stocks. Any exchange member who buys or sells IBM shares does it at the IBM post, under the oversight of the IBM specialist (though special automated procedures exist to handle small orders).

Normally, the specialists function by matching orders to buy with orders to sell, but it is also their duty to maintain a ``fair and orderly'' market. When trading is cascading in one direction, it is their job to try to insure that all investors can make their trades and smooth the market by buying when all others are selling or selling when all others are buying.

Ordinarily the specialists' monopoly is quite profitable. But in resisting the tide, they put their own money at risk in huge sums.

In contrast to the exchanges, in the electronic over-the-counter market operated by the National Association of Securities Dealers, any number of securities dealers can become a ``market maker'' in a stock by standing ready to buy or sell those shares to satisfy investor demand.

Both specialists and market makers were hit on Oct. 19 with tidal waves of selling. As prices plunged, every share they bought handed them a loss. The market rests on the assumption that as the price falls, buying interest will reappear. But that Monday, stocks had reached a free fall.

Making matters worse, the banks that lend money to these market makers reduced or cut off their lines of credit in some instances. Had that financing been halted long enough, the real ``meltdown'' that was narrowly averted might have occurred.

The New York Stock Exchange has said that on the morning of Oct. 20, the specialists had accumulated about $1.5 billion to $2 billion worth of stock as they sought to satisfy investors who had panicked and sold their shares during a 508-point loss by the Dow Jones industrial average on Monday. Before that, the most stock they had ever owned was about $400 million, the exchange said.

By all accounts, the specialists were in no condition to handle another 500-point loss. That is why Oct. 20 presented an even graver risk to the market system: The capital resources behind the market - whatever money the specialists had or could borrow - were depleted.

``We got awfully close to shutting down,'' said Kenneth Leibler, president of the American Stock Exchange. ``I don't know how much longer we could have taken things heading straight down the way they were for a while. …

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