Better Safe Than Sorry: Why U.S. Securities Exchanges Closed for Second — and Maybe Third — Straight Day

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It has been estimated that as many as 60 million people could be directly affected by Hurricane Sandy, but there are a few ways in which the entire country will feel the impact of this powerful storm. One way is through the closing of U.S. securities exchanges for the second straight day — the first time since 1888 that the country’s primary stock exchanges have been shut down for consecutive days due to weather.

The nation’s stock exchanges — like the New York Stock Exchange, NASDAQ, and the lesser known electronic forums like BATS and Direct Edge — decided in conjunction with Federal regulators to remain closed throughout Monday and Tuesday. The bond markets were active until noon yesterday, but are closed today. Securities markets are expected to open Wednesday, although a final decision will be made later in the day.

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Until late Sunday night, however, it was thought that the recent evolution of stock exchanges towards decentralized, electronic markets would enable trading to go on regardless of the weather situation in New York. Indeed, even with the decision to shut down trading both yesterday and today, some analysts still believe that market activity could have continued without any problems. As Adam Sussman of market technology consulting firm TABB Group told Fortune, “Stock trading could absolutely be operating right now . . . I’m kind of surprised they decided not to trade electronically.”

Once upon a time a crippling storm like Sandy hitting New York City would have undoubtedly shut down financial markets. The last time the New York Stock Exchange was shut down for weather was in 1985, when New York City was besieged by Hurricane Gloria. The broader stock market was so dominated by activity on the NYSE at that time that according to a report in Reuters,”it could essentially make decisions about the market unilaterally.” But because so much trading activity has since moved from the floor of the New York Stock Exchange to a combination of electronic exchanges across the country, the decision to halt trading Monday and Tuesday was made by committee.

There were several reasons why Wall Street decided to close for business, but the basic rationale was that the risks of opening markets far outweighed the benefits. Keeping the market closed for a couple of days will cost the exchanges and large Wall Street firms tens of millions of dollars, according to Reuters, but concerns about the safety of Wall Street workers and the stability of the markets in general convinced banks and exchanges to play it safe.

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Firstly, even if securities trading is much more decentralized and spread across the country, a large amount of activity still takes place in lower Manhattan, much of which was expected to and did end up experiencing flooding and loss of power. As Bob Pisani of CNBC wrote yesterday:

“It was not just an issue of whether the NYSE floor should be open or closed. There are thousands of traders and support personnel that work for brokerage firms in downtown and midtown Manhattan, as well as Jersey City. The employees come from Staten Island, Long Island, Connecticut, upstate New York, and New Jersey. What do you do with the employees once you get them into their offices, and then can’t them out?”

In addition, regardless of whether or not electronic trading was going to happen early this week, the weather would have kept many traders from doing their work, resulting in lower-than-normal volumes. This would have made the markets vulnerable to manipulation. As Jim Cramer, host of Mad Money told The Today Show this morning:

“There would be so few players that you could move stocks in any one direction if you had just a couple million dollars. What people don’t recognize is that even though we can trade machine to machine, if individuals aren’t involved there is a capability for true mayhem.”

In addition to this risk of market manipulation, many have speculated that the electronic exchanges were wary of going it alone given the problems that have plagued these venues in recent years. Issues from the NASDAQ bungling of the Facebook IPO, to the Knight Capital high-frequency trading mix-up have caused many to question the stability of the electronic exchanges and question their ability to smoothly facilitate trading under stressful conditions.

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But the exchanges insist that the primary reason for proceeding cautiously was concern for the security of the financial system. As one anonymous exchange official told Reuters, “This is not the time to be thinking about your own pocketbook, first you think about what is best for the markets.”

And aside from lost revenue on the part of large banks and exchanges, two or even three days of lost trading activity — if the markets can’t open tomorrow, either — won’t pose that great a risk to capital markets. As Sam Stovall, chief equity strategist at Standard and Poors told CNBC, markets may experience greater volatility as trading begins, but the lasting effects of the hurricane and the closed markets should be minimal.  “History says that hurricanes typically don’t trigger market declines,” Stovall said. “Individually, the market’s performance following major hurricanes has been uneven, as equities are more likely driven by wider-reaching global events than localized natural disasters.”