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Debt Driven Bubble Threatens Market Stability

Aug 7, 2010 3:12:14 PM - thesundayleader.lk

By Abdul H. Azeez

The Securities and Exchange Commission cracked down on the booming Colombo Stock market by imposing a daily 10% upward and downward price band with effect from Thursday. This move followed the suspension of a few firms from trading after prices of their stocks fluctuated at high levels.
The four stocks, namely Environmental Resources Investments (ERI), Dankotuwa Porcelain, Blue Diamonds and Touchwood Investments, have since been removed from suspension but have predictably been unable to find buyers. This has seen their prices drop almost at the below rate of 10% on Thursday and Friday.
The stocks were suspended due to their prices fluctuating at unusual rates without rational fundamental reasons. A source at the SEC said that this indicated that there was some extent of market manipulation going on. He also added that this was mainly driven by brokers.
‘The market loses stability with phenomenon like these and several foreign fund managers have expressed concern’.
Insiders say that the SEC’s actions have come somewhat late as shares like Blue Diamonds and Dankotuwa Porcelain were trading erratically with no relation to the companies’ financials for a long time. Foreign investment has been pulling out at a steady trickle for some months now and the market is mainly driven by retail investments.
The SEC source said that the prices were driven up by bubbles that spring up due to large scale buying. ‘When a broker buys a large amount of shares of a given company the prices of those shares will rise. This drives further purchases and ultimately results in a price bubble that bursts with disastrous consequences for the ultimate owners.’ He went on to add that most of these purchases were funded by debt (facilitated by low interest rates) and has resulted in a credit crisis for some.
The SEC called in six brokers, namely Acuity Stockbrokers, Asia Securities, Asha Phillip Securities, Capital Trust, Capital Alliance and Bartleet Mallory to account for trades carried out on the three days preceding the regulatory intervention. But the SEC states that such trades have been carried out by a lot of stockbrokers over the recent past.
However the brokers aren’t completely to blame since there are counter regulations preventing them from refusing to carry out transactions requested by customers. The SEC has further banned the placing of orders for time periods greater than one day.

The new regulations will mean that trade will be less volatile yet will also restrict market forces. But the SEC retorts saying that 10% of market growth a day is more than enough for investors to be happy with.
Despite the news of the regulations market capitalization topped 1.7 trillion marking an increase of 57% year to date. Performance dropped on Friday however and the majority of stocks saw a decline in their value. Analysts are divided in their opinion on what the future consequences of the SECs actions will be. Some say that such a bubble was inevitable since the market couldn’t have kept climbing forever while others see this as a temporary glitch and say that any plunge in prices will stabilize soon.
In another incident, the SEC issued a strong reprimand against the activities of a firm which was alleged to have carried out financial transactions similar to that of a stockbroker and immediately ensured that it suspended it business activities. First Class Business Solutions, the firm in question, was advised to apply for a license if they were interested in carrying on market related activities in the future.