CFTC +SEC

One of the proposals in updating the regulation of the financial system is merging the CFTC (commodity futures trading commission) and the SEC (securities exchange commission). I might be more than a little biased, but I believe this is a bad idea.

Historically, New York (home of a majority of stock trading) and Chicago (home of the worlds largest futures exchanges) have been bitter rivals. New Yorker's won't say it, but, basically, they believe us mid-westerner's have mud stuck between our toe's when it comes to financial pedigree.

Chicago, on the other hand, has been the home of innovation for the diversification of asset classes. e.g. futures on treasuries, currencies & stock index futures.

As an example, on black Monday in 1987, it is a little known fact that futures on stock indexes, saved the American financial system from collapse. How did this happen? Simple really.

Back in "the day", the NYSE (New York Stock Exchange) operated under a rule called the "uptick rule". In order to be a market maker on the exchange trading floor, you had to agree to this rule. Basically, what it meant is that a market maker could not get "short", or sell a stock (in the expectation that the market maker could buy it back at a lower price later) unless there was an uptick in the stock price.

Well, on black Monday, there were no upticks, so the only thing market maker's could do was to buy what everyone else was selling. Eventually (around 11:30 a.m. cst), the market maker's ran out of money and the system was on the threshold of collapse. Phone calls were made the SEC and the Federal Reserve to inform them that "we're out of money". What is a capitalist market system to do?

The Chicago Mercantile Exchange, by the way, had suspended trading. The Chicago Board of Trade, never closed down on black Monday. The CME has a contract on the S& P500, the CBOT, had a little known contract called the "Blue Chip Index".

In, steps the CFTC, and in the first time in the history of commodities trading increased the margin (money needed to trade) requirements for equity index futures by a factor of 10X. Effectively what this did was to raise margin requirements on "winning" positions. Investor's had to meet this new margin requirement immediately, or face forced liquidation of their positions. On black Monday, everyone was "short" or expecting prices to drop. The margin requirement forced market participants to go "long", or buy equity index futures. Basically, this action by the CFTC stopped the market decline dead in it's tracks, and the bottom of the stock bear market was made. This action occured in the CBOT Blue Chip Index and then the CME re-opened it's doors.

Many market pundits point to last years elimination of the up-tick rule as a major contributor to the economic situation we find ourselves in currently. Do you really want the SEC and CFTC under the same roof? When that roof is going to be located in New York?