SEC Targets DOW at 500

February 24, 2010--The SEC voted today in favor of a weakened version of the uptick rule. The uptick rule was implemented in 1938 to prevent market crashes and was repealed in 2007, one month before the financial crisis began. The rule prevented selling of borrowed shares from driving prices down in "bear raids." Many individuals have blamed bear raids for the severity of the economic crisis and have called for the reinstatement of the rule. However, today the SEC listened to several hedge funds and hedge fund industry organizations in making the rule only effective when a stock drops by more than 10% in a single day. This new rule does not prevent bear raids over multiple days, and it does not prevent the panics they can cause.

The SEC repealed the uptick rule in 2007 after a pilot study tested the rule's effect on the market. The study was done in a rising market where bear raids are unlikely. Still, while the SEC reported that the pilot study indicated no effect of the rule, analysis by the New England Complex Systems Institute showed that the data was misinterpreted. The pilot study results actually indicates that stocks with the uptick rule had much better returns --- by almost 5% per year. The average returns of stocks since WWII is 6.5%. According to this result, if the rule had not been implemented in 1938, the DOW would stand at under 500 today.

The study also showed that without the uptick rule there are many fewer stabilizing buy and sell orders, and many more large changes in price down and up. This makes the market much more vulnerable to external shocks and panics.

Will the DOW drop from its current value at 10,000 to 500? This seems an extreme prediction, but an incredibly large drop is not unprecedented. The crash of 1929 did not hit bottom until 1932, when the market was almost 90% below its 1929 peak. Should the market today go down by 90% of its peak in 2007, the index would stand at 1,400, more than 500 but surely a drop that would have devastating impacts.

MEDIA CONTACT:
Cam Terwilliger
617-547-4100
cam@necsi.edu

The New England Complex Systems Institute (NECSI) is an independent non-profit research and education institute developing new scientific methods, and applying them to the challenges of society. Based in Cambridge, MA, NECSI engages in original research, education, and community development. To find out more, visit www.necsi.edu.