May 3, 2011
WHENEVER large share offerings like last month's Hutchison Port Holdings Trust (HPHT) and Mapletree Commercial Trust (MCT) are floated, it is routine to see 'stabilisation managers' appointed to support prices just after listing. Similarly, when stock prices plunge, an inevitable clamour is raised for regulators to intervene via 'circuit breakers' to maintain and support the market.
In both cases, despite the obvious connotations of manipulation and the impression of a false market given, most observers have been led to believe that circuit breakers and stabilisation activities are acceptable because, when properly regulated, they can be beneficial to the financial market.
According to conventional wisdom, this artificial containment of volatility is desirable because it facilitates placements, promotes investor confidence, and encourages investment and capital raising. There's an odd logic at work here which essentially is that, although manipulation is frowned upon, controlled manipulation is OK if it serves a greater good. But does it really?
Silent risks
In their excellent article titled The Black Swan of Cairo, in the May/June issue of Foreign Affairs, writers Nassim Taleb and Mark Blyth argue that suppressing volatility makes the world less predictable and more dangerous.
'Complex systems that have artificially suppressed volatility tend to become extremely fragile, while at the same time exhibiting no visible risks. In fact, they tend to be too calm and exhibit minimal variability as silent risks accumulate below the surface,' wrote Messrs Taleb and Blyth.
'Although the stated intention of political leaders and economic policymakers is to stabilise the system by inhibiting fluctuations, the result tends to be the opposite. These artificially constrained systems become prone to 'Black Swans' - that is, they become extremely vulnerable to large-scale events that lie far from the statistical norm and were largely unpredictable to a given set of observers.'
The writers conclude that it is both misguided and dangerous to push unobserved risks further into the tails of the probability distribution of outcomes and to allow these high-impact, low-probability 'tail risks' to disappear from policymakers' field of observation.
Although the study was mainly about the current turmoil in the Arab world, the same arguments apply to financial markets, which are just as complex as the political arena. The message isn't difficult to understand: try and keep a lid on things or stifle the market's natural tendencies, and you might succeed for a while; but eventually there's a price to be paid, which may be very painful (as many Arab regimes have discovered these past few months).
In the case of Wall Street, complacency and groupthink among regulators that theirs was the best policed market in the world led to a largely unnoticed buildup of risks in the housing sector, which in turn enabled the investment banks to pull off the sub-prime scams they did.
On a smaller but no less relevant scale is the adoption of price stabilisation for new listings. If the market is happy with the price and is comfortable with the company's prospects, the price will rise no matter what the efforts of the stabilisation manager; conversely, if the stock isn't popular or its prospects deemed to be less than stellar, the price will fall regardless of artificial, officially-sanctioned support.
Such has been the case with last month's mega-IPO HPHT, which was offered at US$1.01 and whose post-listing saw its stabilisation manager buy a total of 540 million shares between April 5 and 12 at prices ranging from US$0.975 to US$1.01. After April 12, after the manager stopped buying, the counter has not performed. The stock closed at US$0.92 last Friday.
Circuit breakers
Similarly, MCT's managers were active last week buying at the offer price of 88 cents. So far, that level is still holding (barely) but it remains to be seen if MCT goes the same way as HPHT - and if the efforts to stabilise price movements turn out to be yet another exercise in futility.
As for circuit breakers, our thoughts were already detailed in this column last week ('Does the SGX really need circuit breakers?', Hock Lock Siew, BT, April 25); suffice to say that, given the lack of evidence so far, it's hard to be convinced there really are benefits in halting trading during times of high turbulence.
The fundamental problem is that when it comes to complex systems like the stock market, trying to curb its natural behaviour by treating it in a linear domain leads to complacency, the buildup of larger-than-foreseen risks and, eventually, larger-than-necessary mistakes.
Markets would be far better off doing away with artificial controls that seek to suppress volatility or bias prices towards the upside, while protecting the downside, since these controls simply delay the inevitable.
